Will Sequestration Bolster Gold?

As the market and U.S. economy prepare for a flurry of activity this week -- including results from elections in Italy, testimony to Congress from Federal Reserve Chairman "Helicopter" Ben Bernanke, the release of the January minutes from the Federal Open Market Committee, and more housing data -- the defining event must be the onset of sequestration, set to go into effect on Friday. In the type of political theater that has become decidedly commonplace, President Obama is demanding an extension for cuts that he helped to set in motion, while Republicans are sticking to their stance that no agreement will be passed that doesn't include federal spending cuts and tax reform.

Each of the events I mentioned is likely to have an impact on the gold market, and they're all critical in positioning yourself for the week ahead. The Italian elections will speak directly to the austerity measures that have been passed and are considered critical in maintaining European debt stability; ongoing stability is bearish for gold. News from the Fed will signal to the market not only the current state of the economy, but also how the central bank is likely to approach quantitative easing throughout the year; an improving economy and less inflation-creating money printing are also bearish for gold. The health of the housing market will probably serve as a general barometer for the strength of the overall economy; a healthier economy is bearish for gold.

Still, with sequestration cuts looking increasingly probable, the gold market looks poised for a positive week. Coming off of a more than 2% decline last week, as represented by the SPDR Gold Trust (NYSEMKT: GLD  ) , gold prices have struggled over the past three months, down nearly 10%. Still, as quantitative easing continues and the economic turmoil that sequestration could cause looms large, gold has the potential to reverse and head higher. While Wall Street hasn't reacted with anything near the concern that was shown leading up to the fiscal cliff, it's hard not to believe that there is a bit of a "boy who cried wolf" phenomenon going on. Gold looks attractive at current levels for both the short term and the potential for a more meaningful reversal higher.

Sequestration
On March 1, a series of automatic spending cuts are set to go into effect. The cuts were initially conceived as a way to force the two parties in Washington to come up with agreed cuts, lest the automatic ones go into effect. Surprising nobody, the negotiations failed and the automatic cuts are now ticking ever closer to becoming a reality.

While there seems to be a disconnect between Republicans insisting upon cuts and those set to take effect, much of the commotion deals with the magnitude. Under sequestration, $1.2 trillion will be cut over the next 10 years. Just a big, scary number, right? Well, here are some of the details that should give us all a little pause. Federal law enforcement will lose 1,000 agents, 31,000 teachers could be laid off, the FEMA budget would lose approximately $1 billion, and the Department of Defense would lose $500 billion over the next 10 years. And before anyone starts thinking these are cuts we can all happily live with, the Congressional Budget Office has stated that sequestration cuts are likely to result in the loss of 1.4 million jobs.

Good for gold
The series of problems that would be created by sequestration cuts creates a cascading effect of positive catalysts for the gold market. Initially, the cuts will lead to increased economic uncertainty, which is bullish for gold. As jobs are lost, the Fed's targeted unemployment goals become a distant memory and quantitative easing continues or ramps up. As more money is pumped into the economy, inflation -- which I already see as inevitable despite the somewhat dubious Bureau of Labor Statistic claims that inflation is in check -- becomes even more certain. Inflation expectations are also bullish for gold. Overall, the general stance of the economy currently favors a run higher.

Why, then, has neither gold nor any of the major gold miners, such as Barrick Gold (NYSE: ABX  ) , Goldcorp (NYSE: GG  ) , or Newmont Mining (NYSE: NEM  ) traded higher? All three of the miners are down double-digits already this year. That's due in part to higher production costs -- as Barrick reported recently -- but the miners also tend to react in exaggerated ways when facing recessionary pressures.

GLD Chart

GLD data by YCharts.

Gold itself, and, in fact, Wall Street in general, have not moved much ahead of the deadline. While the bluster from Washington continues, just as before, another deal is expected. What this means is that if one doesn't come, the move will be even more severe. Getting positioned ahead of Friday is a tricky prospect, given how much data is to be released this week. Still, for the medium and longer term, I think gold still looks attractive, making the current weakness a nice buying opportunity.

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  • Report this Comment On February 24, 2013, at 4:02 PM, Matt1344 wrote:

    Wow! Government to cut spending by $1.4 trillion over the next 10 years ... However that is cut from a planned $10 trillion in deficit spending over that same time period. So we'll only add another $9 trillion +/- to the national debt... Of course interest rates cannot be allowed to increase significantly from where they are now lest all the governments income is spent paying the interest on the national debt. No doubt we will grow our way out of the problem...

    The FED will likely end up buying most or all of that debt as foreign nations say "Enough". I'm sure that will impoverish many through ballooning inflation if not hyperinflation... I do not believe reported inflation numbers, my food and energy costs seem to be significantly higher. It's assumed we can substitute a lower cost source for protein, for example, well you can't do that endlessly and many are probably already at the "bean" level. Where do they go next for protein??? Maybe we'll see some Soylent Green plants come on line...

    During this time we will continue to hear Social Security demonized even though Washington has "borrowed" and spent $2,4 trillion excess dollars collected from SS taxes. They will default on that debt either directly or through the continued devaluation of the dollar and lowered benefits.

    There may be some savings in Medicare as reimbursements are reduced and fewer doctors provide services to Medicare recipients thus reducing the number of procedures to be done each year. Even though the demand will be there the supply will not...

    I think we, as a country, may be past the point of no return. I'm sure few will agree with my bleak prognosis for the country and look forward to being proven wrong. That will not be done here, it will have to be done at the super market, gas station, in the halls of Congress...

    In the mean time few people own any significant amount of gold or silver in their portfolios. I doubt that will change and if they did decide to buy later there may be little available other than paper gold which I believe now represents 10 times the amount of physical gold available. The real gold market is pretty small compared to the value of the bond and equity markets. Maybe a few percent of assets could be moved into gold before all supply was locked up, and if you haven't notice central banks around the world have been net buyers for sometime now. Do you think they might know something??? Maybe not, they were sellers when prices were low...

    Just a few thoughts from an old guy, do your own due diligence before buying any asset I make no recommendations as I am not a professional.

    Take care, Ken

  • Report this Comment On February 25, 2013, at 9:44 PM, FarmBoy64 wrote:

    Hi Doug,

    Considering how much our federal govt spends, a reduction of $1.2 trillion over 10 years is not as much as it seems. A few of our recent fiscal years have each had deficits of $1 trillion or more, so this only averages out to about 10% of our current budget gap each year and is therefore an even smaller % of our total spending each year. For our economy to recover, we need to reign in spending much more than this.

    There is enough waste in our federal govt to absorb all of this without laying off people, so long as the cuts are made in the right place and federal workers work a few less days per year.

    Take care,

    Tom

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