Gold, T-Bills, and a Slow, Jobless Recovery: Choudhry

Moorad Choudhry, Head of Business Treasury, Global Banking HKSCKPVIamp; Markets, Royal Bank of Scotland
Friday, 29 Apr 2011 | 2:07 AM ET

Recent levels of two market indicators, one key and the other emotional, suggest that the US and EU economic recoveries have some way to run. More of that later.

But this is a sign, if any further were needed, that economic growth is not taking hold and that current policy is insufficient.

Having tackled the easy part (monetary policy, central bank rates and printing money) in full, and the hard part (fiscal policy, and spending cuts) only partially, it is apparent that this is not enough.

The low point for markets since the banking crash of the fourth quarter of 2008 is generally regarded to have been in March 2009.

After that, equity indices started rising again (and in every region are now above that month’s lows) as the world realized that the banking system wasn’t going to implode.

Of course, if we were to strip down the impact of those events to their simplest, all that happened was that the large losses and unsustainable leverage of banks and other corporates was merely transferred to sovereign balance sheets.

Why hasn’t that solved the problem? Because the recovery in the USA and Europe has been lackluster at best.

“Slow and patchy” would be a good description of the recovery so far, with the notable exception of Germany where gross domestic product (GDP) growth and jobs creation has been impressive.

Elsewhere, unemployment has remained high and consumer spending has remained sluggish, as both individuals and corporates deal with de-leveraging, higher prices and lower net incomes.

The bounce from the lows of the crash, observed after previous recessions, has not materialized, in part because central governments are struggling with their own fiscal problems and because the necessary “supply side” reforms needed to create more flexible labour markets are not being implemented.

The manifestation of this problem is evident in the price of gold. At the end of March 2009 it stood at $919.90, and at the start of 2010 had climbed to $117.68. At that point some commentators started targeting a $2000.00 gold price.

Yours truly was among those who weren’t impressed with this prediction. The price today stands at $1504.71.

Is it time to re-assess my view? In principle, no.

Gold is a commodity with no actual “value” as such (except to Derek Trotter types, who like to wear a lot of it! RIP John Sullivan, who sadly passed away this week at the tender age of 64) and it doesn’t pay a coupon.

Gold price rises reflect a risk-averse “flight-to-quality”, and have come about mainly because of US dollar weakness and worries on sovereign credit risk and inflation.

However, as soon as US dollar interest rates start rising, thedollarwill start appreciating, and at that point the price of gold will start falling back.

That was our argument in January 2010. However as US central bank rates have stayed at virtually zero, so the price of gold has risen steadily.

Unlike the European Central Bank, which raised rates this month, and the Bank of England Monetary Policy Committee, some of whose members would like to raise rates now, the US Federal Reserve shows no sign of wanting to raise rates.

The market expects no US rate rises in 2011, and possibly none in 2012 – the December 2012 USD overnight-index swap is trading currently at 0.24 percent, indicating virtually no change by then.

Given this scenario, the target price of $2000.00 for gold doesn’t look quite so far-fetched.

The economic recovery needs to have taken hold to a sufficient extent to enable monetary policy tightening to take place, and if that isn’t expected until well into 2012, that gives the shiny stuff over a year to appreciate further.

But this is meant to be a cold, unemotional blog - we’re not here to analyze jewelry! Fortunately we have an unemotional indicator to hand as well: the US 90-day Treasury Bill.

Having traded negative at the height of the bank crash and never having risen much above 25 basis points since then, it is now down to a yield of six basis points.

This is basically a zero yield, and the investor’s equivalent to storing money under the mattress.

Again, this is pure risk aversion: a significant volume of institutional investors’ cash is being placed in US T-Bills because the slow pace of recovery is making it difficult to identify safe havens.

So whether one is a fan of Only Fools and Horses or not, keep an eye on these two market indicators.

Right now, they’re telling us that the recovery is some way off, and that 2011 will remain crisis-filled.

Dr Moorad Choudhry is Head of Business Treasury, Global Banking & Markets, Royal Bank of Scotland, and Visiting Professor at London Metropolitan University.