“Tapering” is the latest buzzword to appear out of nowhere to dominate the economic news.
While the word gives the impression of something slow and gradual, news of tapering last week had gold prices and the Canadian dollar going down like they had been whacked with a mallet.
The term hit the news after a statement last week by U.S. Federal Reserve’s high mucky-muck, Ben Bernanke. Traders have for years carefully parsed the utterings of Federal Reserve chairmen. Economists have even researched whether their body language during Congressional hearings can affect the markets.
Bernanke announced that he thought the U.S. economy was recovering and he therefore planned to taper down the Fed’s program of quantitative easing, itself a buzzword from earlier in the financial crisis, from $85 billion a month to a still-whopping $65 billion a month.
While a normal person might think that a recovering U.S. economy might be good news, and that going from $85 billion to $65 billion was a relatively modest reduction, life is never that simple in the financial markets.
In simplistic terms, quantitative easing is a practice where the Fed tries to support the economy by printing vast sums of money to buy various kinds of bonds and other assets. The theory is that this injects cash into the economy, keeping asset prices high and interest rates low. Low rates encourage investment and job creation. And high asset prices help strengthen the balance sheets of various financial institutions, and also feed through to the stock market so that lots of investors saw their portfolios rise in value. They, in turn, feel wealthier and become more likely to stimulate the economy with their own spending.
While quantitative easing was always supposed to be temporary, markets got used to the Fed regularly injecting billions a month into the economy. Even news that the injections would be cut to “merely” $65 billion a month was enough to prompt a wave of sell orders.
While the daily ructions of the global bond markets may seem far from you and me, the effects quickly rippled through to currencies and metals.
The U.S. dollar strengthened sharply versus the loonie, rising by several cents in just a few days. That’s a big move in a short time. The market logic appears to be that less money-printing by the Fed will mean a lower supply of greenbacks in the long run, and that the value of the U.S. dollar will be less eroded by inflation. This makes the Canadian dollar a less attractive investment.
The result is that our dollar is worth less, which is bad for Yukoners who want to buy imported goods or vacation in Hawaii. It is good news, however, for Canadian manufacturers. It’s also modestly helpful for Canadian miners since commodity prices are usually denominated in U.S. dollars.
However, this benefit for miners was more than wiped out by a sharp drop in many commodity prices. Especially gold, which was trading under US$1,300 per ounce on Monday, when this column was written. That puts gold down around 25 per cent so far this year.
Goldman Sachs, a big New York bank, cut its forecast for gold sharply, pencilling in a price of US$1,050 by the end of 2014.
Silver also took a beating. It was trading under US$20 per ounce on Monday. UBS, another prominent markets player, cut its one-month silver forecast by a third to US$17.50 (although it forecasts a rebound later in the year).
The apparent market logic here is that the Fed will be printing less paper money, which means that inflation is less likely. And with inflation less likely, investors have less need to buy precious metals as a hedge.
This is the way the markets can turn good news into bad.
In the medium term, markets may come to view the tapering sell-off as an over-reaction. It really is fundamentally good news that the U.S. economy is growing at more than two per cent per year, that inflation is quiet and that the Fed expects unemployment to fall to the bellwether rate of 6.5 per cent sometime in 2014.
It’s hard to say what the exact outcome for the Yukon will be. Next week, the markets might seize on some other news and rebound. Or something like a natural disaster or further creaking noises from the Chinese banking sector might cause further alarm. Who knows?
The price of gold will be important to watch. Consider Victoria Gold, which Yukon businesses and workers are watching carefully since it is in the running to be the next mine to open in the territory. They need to raise investment cash to develop the mine. Their March 2013 investor presentation showed the estimated Net Present Value of their project with gold at US$1,325 and US$2,000.
After last week’s plunge, investors may now be asking themselves how they like the business case if gold goes even lower. Victoria Gold’s investor presentation also modelled the company’s ability to support debt if gold went as low as US$950. But nervous lenders will be asking themselves what happens if it goes even lower?
Silver prices are also worth watching. Alexco Resources Corp. announced earlier this month that it was laying off dozens of staff as silver fell to around US$22 per ounce from highs of over US$30 within the last year. Silver trading under US$20 won’t help the situation, although UBS predicts a rebound to the mid-twenties by 2014.
Who can predict what buzzwords the markets will drop on us next? The only thing we can predict for sure is that more Yukoners will be following Ben Bernanke’s twitter feed from now on.
Keith Halliday is a Yukon economist and author of the MacBride Museum’s Aurore of the Yukon series of historical children’s adventure novels. You can follow him on Twitter @hallidaykeith