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DAILY NEWS Mar 11, 2010 4:58 PM - 0 comments

Sober reflections from TD's chief economist

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By: Anthony Vaccaro

Maybe it wasn't what people came to hear - the event's sponsors after all were gold heavyweights Newmont Mining (NMC-T, NEM-N) and Franco-Nevada (FNV-T), and this was a luncheon at the Prospectors and Developers Association of Canada (PDAC) convention - but that didn't stop Don Drummond from telling the crowd that he expected the price of gold to fall in the near future.

Drummond, who is chief economist for TD Canada Trust, struck at the two central pillars that have long held up the faith of gold bugs -- namely that runaway inflation is imminent and, tied to that, that the US greenback will collapse.

Drummond, however, says neither is very likely.

On the inflation side Drummond points out that Central Banks across the globe are more harmonized than ever before when it comes to their approach to monetary policy, and that approach is to make containing inflation a top priority.

Should inflationary indicators such as the Consumer Price Index (CPI)
begin to get hot, Central Bankers would quickly douse the flames with tighter monetary policy via higher interest rates.

This duty to contain inflation is taken so seriously, Drummond says, that even in the United States -- where allowing inflation to "rip" could offer some benefits in the form of making its massive debt cheaper - it would hold sway over all other considerations.

Drummond also sought to correct what he sees in as a myth held in some circles. Mainly that the loosening of monetary policy has increased the money supply and by definition inflation has to follow thanks to an environment of "too many dollars chasing too few assets".

He reminded the audience that money supply is only part of the monetary exchange equation which links the money supply to inflation.

The equation states that money supply multiplied by the velocity of money (the number of times each dollar is spent in a year) is equal to the price of goods times the quantity of goods sold in that same year.

And while looser monetary policy does mean that money supply has increased, the velocity of money has actually decreased, warding off inflation.

The decrease in velocity is a consequence of the deep fears which arose during the financial crisis over counterparty credit risks. Banks and investors are now less easily parted with their dollars, making for a historically low velocity of money.

As for the collapse of the US dollars which Gold Bugs so devoutly believe to be coming, Drummond says don't hold your breath.

He points out that currencies are relative instruments -- there is no intrinsic value in the US dollar -- and consequently in order for the US dollar to collapse, another currency would have to sky rocket in value.

Scanning the world's main currencies he sees no basis for believing that the Canadian dollar, the Euro or the Yen would vault upwards as much as the US dollar would have to fall to make the doomsayers correct.

Despite such sober reflections, Drummond is by no means a cheerleader for the greenback.

Some factors that will continue to keep the dollar down, albeit more moderately than some would like, are the country's having one of the worst debt to GDP ratios of any developed nation, more constrained economic growth for the foreseeable future and some 4.6 million mortgages that are likely to default in the year ahead.

Still, such factors won't depress the dollar enough to bolster gold past its current levels. Indeed a chart posted by Drummond dealing with his price forecast for the yellow metal shows a decidedly downward slope going forward.

Drummond, however, is not so bearish on other commodities.

His confidence in all other mined commodities, except for potash, comes from his belief that the recent economic recovery is for real.

That belief is based on his contention that equity markets have been doing their job as "forward looking discounting machines" meaning that the market recovery ahead of economic growth signals that the recovery is for real.

So what commodities will partake in the new growth?

Drummond likes uranium, copper, and base metal prices to continue to rise....albeit at a more moderate inclining slope than the historic spike which many exhibited leading up to the 2008 crash.

Part of the reason why such record highs won't be reached again is that the former fuel behind the commodity boom, the American consumer, is severely weakened.

In the past economies coming out of a recession broke out hard and fast, with consumers eager to flex their purchasing power once again.

This time around, with credit tighter and consumers badly burned only recently, such consumption has been and will continue to be crimped.

Thankfully for miners, while still important, the American consumers aren't as important as they once were.

Emerging markets have been steadily taking up a larger portion of the global economy, and that trend, Drummond says, will continue, providing strong raw material demand.

He predicts that emerging markets will make up 60% of the global economy by 2020, while advanced economies will have fallen to 40%.

The two groups made a historical meeting in 2009 with both splitting their share of the global economy equally. The bad news for advanced economies is that they met emerging markets on the way down, while emerging markets arrived at the same point on the way up.

As for growth rates going forward Drummond expects the global GDP to grow at 4.3% in the coming years, with emerging markets growing at a clip of above 6% with advanced economies dragging along at a 1.8% pace.

Other aspects of the new economic order outlined by Drummond are aforementioned increased synchronization of monetary policies along with more inter-connected markets and fiscal policies.

He warned that such increased synchronization could offer more challenges for businesses as where in the past companies could move out of a depressed market into a hot one, such scenarios will become harder to find as the entire global economy moves in step.

Another interesting aspect to the new economic order, at least in the short term, is the loop that the traditional supply and demand model has been taken on according to Drummond.

This can be seen in the US housing market, where, while demand is behaving as it always has, supply is up to something new.

In traditional economic theory lower demand should lead to lower supply. But while Drummond says this did initially occur as an outflow of the 2008 financial meltdown, it has since been warped.

With so many home owners defaulting on their mortgages in the U.S. banks have claimed these assets and released them back onto the market.

This has increased supplies in a low demand environment, thus dropping price and causing more home owners to default on their mortgages.

Despite such a "tail chasing" situation, Drummond says that over all the housing market -- thanks in part to significant help from the Feds -- is moving in the right direction.



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