Gold and the ‘Cobra Effect’

According to Wikipedia, “The cobra effect occurs when an attempted solution to a problem makes the problem worse, as a type of unintended consequence. The term is used to illustrate the causes of incorrect stimulation in economy and politics.”

The term comes from a story that references an attempt by the British government in India to reduce the number of deadly cobras. They offered a bounty for every dead cobra, which initially reduced the number of venomous snakes in Delhi. However, individuals began to breed cobras for income, and when the government became aware of this canceled the rewards program. This caused those breeding cobras to release the snakes in the wild which had the net result of increasing the population of the venomous snake.

Many analysts, including myself, have been under the belief that the monetary policy of the Federal Reserve and the majority of core central banks globally to attempt to stabilize their economies in light of the global pandemic could well have unintended and detrimental consequences down the road.

Larry McDonald, a New York Times best-selling author and CNBC contributor used this term in a blog for ‘The Bear Traps Report’ where he explained that current monetary policies by global central banks and government stimulus will lead to unintended negative consequences. In essence his point is that the solution could be worse than the problem.

In his blog he wrote that, “We believe we are at the early stage of the biggest cobra effect in the history of economics. As the massive monetary and massive fiscal stimuli (over $15T globally) conjoin to save the economy from a deflationary depression, they will cause instead a hyperinflationary economic collapse.”

Although Larry McDonald wrote this blog at the beginning of the year, it is nonetheless relevant today. With the upcoming virtual Economic Summit and Chairman Powell’s keynote speech, many traders will focus intently to see if Chairman Powell will suggest a more accommodative monetary stance than is currently in place. There is also the belief the Chairman Powell will rebalance the Fed’s target rate for rising inflation.

According to MarketWatch, “Powell is expected to advocate for a so-called asymmetric inflation target, one that allows policy makers to let inflation rise above their traditional annual target of 2%, which could be seen as bullish for gold and other precious metals.”

Concurrently tensions between the United States and China have risen to a new level. It was reported that China had launched missiles which included an ‘aircraft-carrier killer’ into the South China Sea during their recent wargames as a warning to the United States.

Collectively this revitalized the bullish market sentiment in gold and silver which had been absent as both precious metals have been trading under pressure for the last week. As of 4:30 PM EDT, gold futures basis the most active December 2020 contract is currently up $39.90 (+1.97%) and fixed at $1961. Silver futures gained approximately $1.26 in trading today (+4.80%) and are fixed at $27.535.

Wishing you as always, good trading,