U.S Dollar, Currency and Gold Outlook 2014

Rarely has the future been so clear. Really?? A lot of money has been lost jumping on the bandwagon. Let’s do a common sense check on the greenback to gauge where risks might be lurking and where there might be profit opportunities for investors.

In a “normal” economy capital is allocated according to the risk profile of the project under consideration. However, when the Fed actively distorts the price discovery mechanism with its QE programs, we believe it is impossible to move back to a normal economy.

Inflation promise?

The Fed has told the market in no uncertain terms that it is in no rush to raise rates. Outgoing Fed Chair Bernanke often argued one of the biggest policy mistakes during the Great Depression was to raise rates too early. Trouble is, removing stimulus might allow deflationary forces to take over once again, negating the “progress” that’s been made with cheap money. We interpret that to mean the Fed has all but promised to err on the side of inflation.

Hawkish Fed?

There is a bewildering opinion shaping that a Yellen Fed will be hawkish, especially since former Bank of Israel (BoI) Governor Stanley Fischer has been nominated to become Vice Chair. Already rumors are creeping up that uber-hawk Tom Hoenig will join the team.

The 2013 Federal Reserve Open Market Committee (FOMC) may have been the most dovish on record. The background here is the current FOMC lacks community banking experience. Unlike regional Fed Presidents, however, Fed Governors are nominated by the White House and confirmed by Congress. In our assessment, it’s unlikely an outspoken hawk will be nominated. Here’s what the 2014 FOMC looks like:

Let’s look across the border to get a better assessment of what all this taper talk is all about. Unlike the taper rhetoric, the practice has looked a little different.

The European Central Bank (ECB) is the only one that has not only been tapering, but mopping up liquidity. It’s not so much that the ECB wants to play the tough guy on the block, but that Eurozone central banking is more demand driven: as banks clean up their balance sheets, they return liquidity received from the central bank. We believe the euro will continue to benefit from risk friendly capital returning to the Eurozone

Bank of Japan (BoJ) has been the most prolific money printer over the past year. It may come as no surprise that the yen was the worst performer last year amongst major currencies. The yen has drifted sideways and have lost momentum. Meanwhile, the BoJ has recently ramped up its rhetoric on doing what is necessary to meet their 2% inflation goal. We don’t think it’s a surprise that Japan won the bid to host the 2020 Olympics, as the infrastructure investments needed are squarely in line with Abenomics. In that context, expect higher military expenditure as well. Our price target for the yen continues to be infinity, meaning we don’t see how the yen can survive this. That’s because the biggest threat facing Japan is that economic growth actually materializes: good economic data might cause bonds to sell off, making it ever more difficult to finance government deficits; if so, we expect the Bank of Japan at some point to step in to lower the yield on Japanese Government bonds (JGBs); the valve, we expect, will be the currency.

One reason why few analysts had predicted the euro to outperform others is because the common currency is historically often less volatile than other major currencies. But the euro had a lot of catching up to do. This year, we would not be surprised if the British pound were to outperform the euro given the tailwinds in the British economy. We also continue to see an adjustment in expectations at the Bank of England. At some point, structural weaknesses in the UK might take the upper hand again; that’s why we caution that this outperformance may only last for the first half of the year; we’ll keep a close eye on developments. Based on fundamentals, the New Zealand dollar should do great and continue to beat the Australian dollar. However, New Zealand isn’t exactly the biggest country and its currency can be notoriously volatile. So while things look good, that provides no assurance the currency will actually do well. At some point, good economic indicators coming out of China may well push up the Australian dollar and cause substantial profit-taking in the New Zealand dollar.

Emerging Markets

Emerging markets tend to be less liquid than developed markets. Last spring showed these matters: when volatility spikes because of uncertainty over the future course at the Fed, the previously perceived free lunch in capturing yield with low volatility in emerging market local debt markets causes stomach cramps. Not only will we likely have local disturbances with numerous elections coming up in emerging markets, but we think the heavy hand of policy makers in major economies may well persist. Most vulnerable in this context are the weaker EM countries – those with current account deficits. The notable exception here is India, where Reserve Bank Governor Raghuram Rajan has introduced major reforms since taking the helm last September. While Indian reforms always suffer from implementation risk, the Indian rupee has a lot of catching up to do. Conversely, however, even as Brazil may yet again raise rates, Brazil lacks a credible inflation fighting strategy.


China is moving ever closer towards opening up its capital account. This may well be the year where China reduces its U.S. Treasury purchases in a meaningful way and paves the way for market forces to play a greater role in setting exchange rates. In our assessment, little can stop the rise of the Chinese Yuan as a major currency in the coming years. The creation of a major currency takes more than a free float, but China is fostering all the other necessary elements.


The biggest risk for 2014 may be economic growth. That’s because economic growth throws a wrench into the bond market, making it ever more difficult for developed countries to finance their deficits. We believe it’s very unlikely the U.S. could afford significantly positive real interest rates for an extended period. As indicated earlier, the Fed may have all but promised to be “behind the curve” in raising rates. Even if the Fed wanted to raise rates, the stockpile of excess reserves accumulated from QE means that they will have to rely on new tools that require them to pay increasing amounts of interest directly to financial institutions. The potential political backlash of these new rate-setting tools may make it more difficult to mop up liquidity. Meanwhile, if economic growth and demand for loanable funds comes back, the banking system could pyramid those excess reserves into new loans that could dramatically increase the money supply and stoke inflation. The Fed may need to rely on capital adequacy ratios to contain bank balance sheet expansion, but it should be easy for banks to raise more capital in a good economic environment.

It’s in this context that the future may look bright for the shiny metal. Importantly, even with the price decline in 2013, gold played its role as a diversifier. The time to rebalance an equity portfolio is when times are good. We are not suggesting all this rebalancing should necessarily go into gold, but we are not convinced the bond market is the right place either. As our readers may well know, we think that the currency markets may provide opportunities that offer diversification.


Gold fell by 28% in 2013. That’s a huge reversal of a decade-plus trend. Between 2001 and 2012, gold managed positive gains every single year, a track record unmatched by any major asset.

The precious metal went from a low of $255 in April 2001 to a high of $1,900 in September 2011, for a peak return of 745%. Since then, gold has given back 35% from its $1,900 high, leading many to call the end of the gold bull market. But is it really finished? By looking at history and numerous indicators, we’ve found a different story. One that will jumpstart your 2014 profits…Simple Economics Guarantees a Gold Rally. Fundamental drivers for gold are so numerous we hardly know where to start. Unprecedented quantitative easing (money printing) and ultra-low interest rate policies imposed by central banks – especially in the United States, Japan, Europe and China – are in the news every day.

Shuttering Operations:

It’s no secret that falling gold prices have made numerous mines unprofitable. That’s pressured management at those mining companies to rationalize their operations. Producing gold at a loss doesn’t make for happy shareholders. So mines are being put on care and maintenance, seriously cutting into gold production worldwide. Lower gold prices have meant, of course, lower profits. So, miners are cutting back on expenses that aren’t immediately accretive, affecting the development of mine expansions, new projects, and exploration. That’s inevitably going to mean fewer ounces available to mine in the near and medium terms than would have been the case without this gold price rout. There were half as many drills looking for precious metals in the first 9 months of 2013 versus 2012


In response to lower prices, gold miners have resorted to mining higher-grade ores while leaving behind low-grade ores. That allows them to be more profitable on ounces produced this way, but it means much higher prices will be needed to go back to the lower-grade ores. In some cases, these may never even be mined out at all.

Physical Asian Buying:

Asia loves gold, and that trend continues. In the first nine months of 2013, India and China together had bought 1,500 tonnes of gold, easily dwarfing Western purchases. When Indian, Chinese, and central bank buying are combined, they account for nearly the entire annual world gold production. Overall, gold fundamentals have not only remained intact, they’ve continued to improve. So it’s easy to project them to push higher gold prices in the future. They’ve got the laws of economics behind them…

Gold Hits the Same Bottom – Twice

An important part of technical analysis involves analyzing price action. And gold’s had plenty of that over the past year. Most significant was the massive price drop in mid-April when a black swan crash-landed on the gold market. Over just two trading days, gold futures prices shed 13%, falling from $1,575 to $1,375. That $200 cliff dive was the largest two-day drop in 33 years. By late June the price had fallen further still, to $1,180 per ounce. So far, that’s been the low. Recent news of the Fed’s QE tapering again weighed on gold in late December, causing it to momentarily drop to $1,182, then immediately reverse upward by $32. While it’s still early to say for sure, that may have been a “double bottom” – dropping twice to the same level without moving further down – hit in June then in December. This increases the chances that the $1,180 level is the low for gold prices in this drawn-out consolidation process. We can see from this chart that gold has now twice “tested” $1,180 and moved higher from there. Does this mean gold’s price is out of the woods? Not necessarily, but the trees are thinning.

Too Many Contract Holders, Too Little Gold

It’s fair to say that after a long stretch of falling gold prices, the precious metal’s not just hated, it’s despised. And that’s often a tremendous contrarian indicator. Combine that with some recent action in the futures market, and we’ve got more very bullish indicators for gold

Recent Commitment of Traders (COT) reports at the end of 2013 showed that hedge funds (large speculators) had a record short position on the Comex in New York; extreme bearishness is a great contrarian indicator. On the flipside, the large bullion banks have reverted from holding net short positions to holding net longs in the stretch from 2004 until mid-2013.By late 2012, the four largest banks held a $12.5 billion short futures position. Since then, there’s been a massive reversal of some $20 billion, with these same banks now holding a $7 billion long position.

In the week of Dec. 23, 2013, Comex-registered gold inventories (gold available for delivery) dropped to their lowest in a year, with an incredible 92 claims for each registered ounce. What will happen when a few too many contract holders decide to take delivery at maturity?

Just the fact that there are so many claims for each ounce increases the odds that if too many deliveries are requested, the exchange could “default” and be forced to pay out in cash rather than gold. That would likely be a major shot in the arm for the price of gold. All of these factors point toward higher gold prices ahead. Does that mean they’ll go straight up? Unlikely, since nothing goes up in a straight line. So we can expect continued volatility in the gold price this year, with some risk for lower prices, but a strong bias to the upside. We’re likely to see gold close the year higher than where it started. Since its bottom in April 2001, gold has compounded at a rate of about 15% annually. Given that it has some catching up to do for the last couple of years. We could see the precious metal gain as much as 25% this year, bringing its price to the $1,600 range.

Your Best Move to Start the Year

What’s the best way to play gold right now? Gold’s cheap at these prices. If you don’t own any, buy some bars or coins. If you feel you don’t own enough, this looks like a good time to add to your holdings. Within gold equities, I really like the royalty companies. Many are cashed up and well-positioned to make strategic moves In this trying environment for miners struggling with rising production costs and scant financing options, royalty and streaming companies have the upper hand, able to do financing deals with extremely favorable terms (for them). They have cash when cash is scarce, and that will pay off big time.

Fundamentals, technical, and the end-around of contrarians are all lined up behind a bull run in 2014. And the timing is right to join the front of the line!!

Disclaimer: Midnight Breakfast or any of its owners does not hold any positions in any of the commodities, currencies and anyone taking any positions in these asset classes should do it based on their own research and at their own risk.


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