by Dave Kranzler, Investment Research Dynamics:
Given the large increase in the amount of gold that is flowing to the east, I think it’s easy to make the case that this massive demand for physical gold is a major factor in pushing the price of gold higher. A similar argument can be made for silver, particularly with India and China, which require a lot of silver for their implementation of national solar energy grids. The breadth of countries with Central Banks now accumulating gold was not much of a factor until the last couple of years and I believe the proliferation of eastern Central Banks has offset the seasonal weakness that historically has affected the March through June period.
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Secondarily, despite the rhetoric about the Fed’s hawkish monetary policy, take a look at the Fed’s actions vs its words. Despite the maintenance of the Fed funds range at 5.25-5.50% and the monthly QT operations, financial system liquidity has been rising. The M2 money supply measure has been rising since October 2023. More significant, the Fed’s reverse repo facility has been drained over the last twelve months. This is money that returns to the financial system, primarily in the form of banking and financial system liquidity. The Fed could keep that money in the facility with just a small increase in the rate it pays. But for some reason it wants that liquidity to flow into the financial system. In addition, the Chicago Fed’s National Financial Conditions Index shows that the Fed has set the easiest systemic financial conditions since the end of January 2022, one month before the Fed began hiking rates.
The Fed is thus masquerading as a monetary hawk when, in fact, key liquidity indicators reflect the reality of an easy monetary policy. I would argue that the Fed has created this systemic liquidity to offset the deteriorating quality of large and small bank balance sheets – primarily CRE and consumer loans but also leveraged corporate loans. Regardless, the rise in financial system liquidity, in addition to the massive demand in the physical market, is the reason gold and silver prices have been rising steadily since November 2022.
M2 has been rising since October 2023. Most market participants are unaware of this fact because the M2 posts on social media show the YoY percentage change in M2, which is deceptive. This chart is through the end of June, the latest date for which the Fed posts M2 data (intentionally):
Similarly, and again through the end of June, the Monetary Base (formerly MZM) has been rising since March 2023:
The increase in the Monetary Base is more impactful in terms of causing inflation (dollar devaluation) because the Monetary Base is coins/currency in circulation plus banks reserves. Both represent instant spending or lending power.
The final, and foremost aspect of the Fed’s “stealth QE” is the $2 trillion drain of the Fed’s reverse repo facility. The facility was at $2.375 trillion at the end of March 2023. Since then more than $2 trillion has disintermediated into funding Treasury debt and the banking system, ultimately finding its way into the wider financial system. The Fed could have kept that liquidity “captive” with just a small hike in the rate it pays for overnight RRPs. But note that the Fed let the facility start draining around the same time as the regional bank CRE crisis. That crisis, by the way, is now detonating bombs on the Too Big To Fail bank balance sheets (among several other areas of balance sheet distress).
This “stealth QE,” which is undeniable, is the reason that gold has been hitting successive all-time highs. It will be interesting to see if the Fed cuts rates at its September FOMC meeting because it’s obvious the economy is flopping around like a near-dead fish on a dock in Montauk. The problem is that a rate cut could trigger another wave of yen carry-trade unwind, which would cause another sharp sell-off in the stock market.
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