If you have $100 and put it in the bank with a negative 1% interest rate—at the end of the year you can withdraw $99. But, gold could be at the same level that you purchased it.
Gold is a "non-liability backed currency," explained Bill O'Grady, chief market strategist at Confluence Investment Management. "Every other currency in the world is created by debt. Gold is not —that is its allure."
The Swiss National Bank (SNB) dropped a bombshell on the markets this week as it abandoned its currency peg at 1.20 francs per euro. The Swiss initiated this peg back in 2011 in order to support the competitiveness of Swiss industry, amid a rising tide of flight-to-quality and safe-haven flows into the Swiss franc.
So, why did the SNB pull the plug now and what does it mean for gold?
"I honestly think the reason they did this is they were tipped off that the ECB was going to something big next week and they just didn't want to expand their balance sheet anymore," said O'Grady.
The SNB has spent billions defending the currency peg in recent years. The European Central Bank is widely expected to announce an asset purchase program on January 22, in its efforts to fight a deflationary and slow growth environment in the euro zone. Part of the SNB's policy shift this week included a decrease in its negative interest rate policy. The SNB lowered its target range for the three-month Libor rate to minus 1.25% to minus 0.25%.
This in turn is positive for gold.
"When you end up with negative nominal rates in a deflationary environment, it reduces the carrying costs for gold," explained O'Grady. "The lower interest rates go, the more attractive other stores of value become. Quantitative easing and zero-interest rate policy have effectively destroyed cash as an asset class," he added.
Gold has been rallying since early November, alongside a strengthening U.S. dollar. That is unusual. Generally, gains in the U.S. dollar are a negative factor for gold. But, not this time. O'Grady points to falling rates as a reason.
The U.S. and global economy are undergoing another round of transformation, driven by technology and now the robotic and automotive revolution, which includes deflationary tendencies as part of the trend. "Technology destroys whole industries. Uber is trying to destroy the taxi industry. It's driving down price through nothing more than a smart phone app. This is happening across all industries," said O'Grady.
The technology is increasing productive capacity, but not increasing demand, which in turn puts downward pressure on prices, in effect a deflationary impact.
As the ECB and the Bank of Japan continue their fight against deflationary tendencies, the negative interest rate environment is unlikely to change anytime soon.
"The longer the central banks are unable to inflate their economies, the stronger gold would probably get," concluded O'Grady.
By Kira Brecht, Kitco.com
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