Wealth won, wealth lost
What's your real rate of return?
"The returns of cash are terrible. So as a result of that, what we have is a lot of money in a place — and it needed to go there to make up for the contraction in credit — but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things. " -- Ray Dalio, Bridgewater
The dramatic breakdown in the real rate of return* on dollar-based savings instruments is perhaps the most important financial event of the past decade; save perhaps gold's rise as its most effective countermeasure. The absence of a real rate of return makes it impossible to preserve, let alone grow, wealth by traditional means. It destroys incentive and nurtures a culture of economic uncertainty. It promotes speculation and undermines the existing social contract. It makes it difficult for the federal government to obtain financing and for individuals to plan a comfortable retirement. In short, the problems associated with a negative real rate of return run deep and create an environment in which gold demand flourishes.
As illustrated in the first chart below, the real rate of return on dollar-based savings has been dismal over the past decade. By comparison gold's real rate of return, as shown in the second graph, has been nothing short of spectacular. In the process, gold owners have not just preserved savings during the uncertainties of the past decade, they have actually built wealth in real terms -- no small accomplishment. Thus the trend indicated in the first chart serves as an effective argument for a continuation of the trend demonstrated in the second chart.
In this context, Fed chairman Ben Bernanke's constant assurances that his easy money policies will continue at least until 2015 are cause for concern. Currently those who save in dollars at the bank are losing money in real terms at the rate of roughly two percent per year. Money in the process is losing one of its principle attributes. It is no longer considered a reliable store of value. Ray Dallio, the highly respected founder of Bridgewater Associates, the world's largest hedge fund, completes the thought posted in this month's masthead quote. He names gold as one of those other things:
"I think that their next move will be, as described, a move from liquidity to purchases and then we have a shift...I think the shift of the cash, that massive amount of cash will be a game changer -- into stocks, into everything. It will mean more purchases of goods and services and financial assets. It will be into equities, it will be into real estate, it will be into gold, it will be into a lot of….just basically everything."
Though money pumped into the economy acts like a high tide that raises all boats, it can also result in a tidal wave of uncontrolled inflation and out-of-the-box negative real rates of return. Wealth will be won and wealth will be lost in the years ahead as the cash to things scenario unfolds. How savers position themselves will make all the difference as to which side of the wealth scoreboard they find themselves. The defining question comes down to this: "What's your real rate of return?"
*Real rate of return equals the yield minus the inflation rate.
(1) I used the one-year certificate of deposit as a bellwether simply because the average investor is reluctant to commit capital to longer term instruments in a zero percent interest rate environment.
(2) Many believe the BLS' Consumer Price Index understates the inflation rate. If one were to use the Shadow Government Statistics' data model, for example, the negative real rate of return would be far worse than the one shown in the first chart. SGS utilizes the same methodology the BLS employed prior to 1980 before it introduced hedonic adjustments.
(3) Taxes were not taken into account in either chart.
(4) In the first chart, the extension of the red bars over the blue bars indicates the negative real rate of return on the one-year CD. In the second, the extension of the blue bars over the red bars indicates the positive real rate of return on gold.
(5) Monthly data, percent change from year ago. With thanks to the St. Louis Federal Reserve.
Short & Sweet
*** A consortium of conservative Swiss political groups, led by the Swiss People's Party has garnered sufficient petition signatures to place a referendum on the ballot that would ban the Swiss government from future gold sales and oblige its central bank to double its current gold reserves to 20% of current assets. Switzerland currently holds 1024 tonnes of gold. If the referendum is successful, it will add to the already considerable demand overhang from central banks looking to boost their reserves.
*** China is on course to become the world's largest economy by 2016 displacing the United States, according to a survey by the Organization for Economic Cooperation and Development.
*** Eugen Weinberg, market analyst at Germany's Commerzbank, says: "I think [the argument favoring gold] will be coming back in the second half of the year, and we are seeing the high prices in the second half of the year and probably record highs next year. But it will take time for this bottom to build up and to attract investors back to the market."
*** Those with who lean toward technical analysis in making investment decisions might be interested in this bit of analysis from The Money Pit's Frank Holmes: "It may be apt timing for investors to become reacquainted with gold, as our oscillator chart shows that the yellow metal appears to be oversold. On a year-over-year basis, gold has fallen more than 2 standard deviations, an event that has rarely occurred over the past 10 years. As I've indicated before, following these extreme lows, gold has historically rallied."
*** Never at a loss for words, or telling-it-like-it-is in as graphic manner as possible, here's what TV commentator Jim Cramer had to say about the fiasco in Cyprus: "And then the Europeans stepped in to stem the decline [of gold] with the absolute dumbest, most bone-headed plan I have ever seen to tax the depositors, the small-time depositors, of a poor country that is inundated with hot money, perhaps hot laundered money from the oligarchs of Russia. That's right, the Europeans with the help of the IMF reminded you just how stupid the concept of the euro is and how it is untenable both to own the euro and now to keep it in a European bank. Their moronic plan for Cyprus gave you a super reason to go right back into gold."
*** "The decline of Rome was the natural and inevitable effect of immoderate greatness. Prosperity ripened the principle of decay; the causes of destruction multiplied with the extent of conquest; and as soon as time or accident removed the artificial supports, the stupendous fabric yielded to the pressure of its own weight." -- Edward Gibbon, The Decline and Fall of the Roman Empire
*** In last month's issue we reminded our readers that "this is still Ben Bernanke's Fed and we shouldn't forget it." Now the Fed chairman himself has decided to step up and defend his turf. Beginning with the Federal Open Market Committee's March 20th meeting, the chairman will cut the time between the meeting and his press briefings. The reason? To thwart hawkish presidents of regional Fed branches who in the past have gotten ahead of the message Bernanke wants to send to the markets. That message, of course, has to do with continuing the Fed's aggressive money printing and interest rate policies.
*** "'The bigger the base, the higher in space', runs an old stock market saying. Another version is, 'the longer the wait, the bigger the break'." -- Dominic Frisby, MoneyWeek
*** "Scientists have long known that veins of gold are formed by mineral deposition from hot fluids flowing through cracks deep in Earth's crust. But a study published today in Nature Geoscience has found that the process can occur almost instantaneously — possibly within a few tenths of a second." -- Robert Lovett, Nature.com
*** He who has begun has half done. Dare to be wise; begin!" -- Roman philosopher, Horace
*** The U.S. national debt now tops $16 trillion and amounts to more than 100% of the gross domestic product. We offer the following two graphs by way of perspective. Please note the out-of-the-box growth in each since the 2008 crisis. With respect to the debt/gdp ratio, once the banana republics are delisted, the United States (105%) ranks fifth behind Japan (238%), Greece (165.3%), Ireland (125%), and Italy (120%) based on 2013 projections -- not the best of company in the global money game.
*** Texas governor Rick Perry wants to repatriate $1 billion in gold owned by the University of Texas now stored by the Federal Reserve in its New York vaults. UT purchased the gold a few years ago as part of a move to diversify its assets. Perry says Texas is at least as capable as the Federal Reserve in safeguarding its physical gold.
*** "If you're worried about the value of your savings account and whether someone's going to pare it unilaterally that makes gold more appealing. We do know some of those accounts are held by people who might well consider gold as an alternative investment." -- Peter Buchanan, CIBC World Markets, with reference to investors holding depositor accounts in Cyprus banks
*** "We have not reached this painful conclusion without careful research. We have had a series of meetings in Paris with money managers, central bankers, investors, and academics. All of our meetings here were private. In the candor of those private discussions, we come away with the most troubled view we have had of the Eurozone, the experiment in this single-currency block, and the market structures in Europe. This is a place in trouble. Courses of action that evidence more flailing than forethought are not making things any better." -- David Kotok, Cumberland Advisors
*** "I don`t think I own any US stocks, if I do its very few, so few I can`t even remember." -- Jim Rogers
*** Nigel Farage, Britain's Conservative Party ex-patriot and leader of the Independence Party, urges British expatriates in Spain to "pull their money out of the country's banks." Says Farage, "Even I didn't think that they would stoop to actually stealing money from people's bank accounts. There is going to be a big flight of money and that flight of money won't just be from Cyprus, it will be from the other eurozone countries, too."
Quote of the Month
"We live in a technological golden age but in a monetary and fiscal dark age. While physicists discover the so-called God particle, governments print and borrow by the trillions. Science and technology may hurtle forward, but money and banking race backward."
-- James Grant, Grant's Interest Rate Observer
How's your morning going?
The thieves in the night turned out to be the governments of Cyprus and the European Union. On the morning of Saturday, March 16, holders of bank accounts in Cyprus awoke to learn that the government had raided all bank accounts to the tune of 10% of balances over 100,000 euros -- a figure that later was raised to 40%. The government's run on the banks came as part of a sovereign debt repayment deal with the European Union in which it insisted that 10 billion euros be paid directly out of all individual accounts
in Cyprus banks. "The move," reports the New York Times, "raised questions about whether bank runs could be set off elsewhere in the euro zone." Jacob Kierkegaard, a economics specialist at the U.S. based Petersen Institute said, "What the deal reflects is that being an unsecured depositor or even a secured depositor in euro-area banks is not as safe as it used to be."
"The really puzzling thing is why did people not withdraw their money before? Did they not read the newspapers? Maybe they trusted the new president of Cyprus, who had promised them that he would never accept this? And why has there been so little deposit flight elsewhere in southern Europe? Did they, too, trust their governments? More importantly, will they continue to do so now?"
-- Wolfgang Munchau, Financial Times columnist
Editor's Note: The really puzzling thing to is why any investor/saver would fail to have 10% to 30% of his or her net worth in gold coins in this increasingly dysfunctional financial environment -- irrespective of where he or she might claim citizenship.
Food for thought / Michael Lewis
"I also found myself thinking: the English may finally have decided they have had enough of their experiment with the American financial way of life. If what happened in the Western world financial system had happened at another time in history, there would have been an obvious political response: a revolt against the Roger Younts of the world and, more generally, the grotesque inequities spawned by the putatively free financial marketplace. If the memory of British socialism wasn't so fresh—if people didn't still recall just how dreary London felt in 1980—they'd be pulling down the big banks, and redistributing the wealth of the bankers, and it would be hard to find a good argument to stop them from doing it. The absence of the satisfying political response to the financial crisis is due, at least in part, to the absence of an ideological vessel to put it in. No one wants to go forward in the same direction we've been heading, but no one wants to turn back either. We're all trapped, left with, at best, the hope that our elites might experience some kind of moral transformation."
-- Michael Lewis, author, The Big Short and Moneyball
Gold at $10 per ounce
It's no secret that gold's naysayers roll out the cannons whenever they see the price declining. Inevitably, the calls for the end of the bull market, unsupported as they might be, ring loud and clear. This rebuttal by famed Austrian economist Murray Rothbard published in 1973 reminds us that knocking gold is nothing new:
"All pro-paper economists from Keynsians to Friedmanites, were now confident that gold would disappear from the international monetary system; cut-off from its 'support' by the dollar, these economists all confidently predicted, the free-market gold price would soon fall below $35, and even down to the estimated 'industrial' non-monetary gold of $10 an ounce. Instead, the free price of gold, never below $35, has been steadily above $35, and has now climbed to around $125 per ounce, a figure that no pro-paper economist would have thought possible as recently as a year ago."
$10 an ounce? Sounds like Goldman Sachs recent call for $1200 per ounce. By the way the first leg of the 1970s bull market culminated in the vicinity of $200 per ounce, and the second leg after a brief correction in the mid-1970s to about $100 per ounce, topped out five years later at nearly $900 per ounce. Rothbard was right. The naysayers were wrong.
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Gold's naysayers and yeasayers at the big banks
Speaking of naysayers, when gold experienced its most recent break to the downside, the financial press made much ado about investment banks going negative on the yellow metal. I decided to do a bit of informal research to see how things stacked up. Searching around the web, I found gold forecasts for seventeen big banks.
Of those, seven had a bearish tilt:
And ten had a bullish tilt:
Bank of America
More banks are bullish than bearish. With respect to the attention grabbing naysayers, Sharps Pixley's Austin Kiddle said it best: "To be honest, it’s like dogs chasing cars on the highway. They are getting caught up in the flow and just running with the traffic."
Nine lessons on investing your money
We introduced our readers to these nine lessons all the way back in 1999. They were passed along to us by the legendary commodity market analyst R.E. McMaster, formerly editor of The Reaper newsletter (now remcmaster.com). The original source was a highly regarded money manager who handled accounts for wealthy Greek and Mexican merchant families.
1. It is easier to make a fortune than keep it.
2. Intelligence is an inadequate substitute for wisdom. Wisdom fears, respects the unknown and fosters humility. Intelligence can lead to self-destructive arrogance and ultimate failure.
3. Risk must have premium, and we must understand it well.
4. There is no order. There is no formula. There is no equation that works all of the time. It works just long enough to fool just a few more of us just a little longer.
5. What we fail to remember is that a paper gain is just that. Paper. Worth nothing. Not until we say sell, and not until we get cash. Anything less is just that.
6. When the Bass Brothers in Texas write a check for real money, their money, to buy 25% of the Freeport McMoran Gold Series II, we take notice. When the Fidelity Magellan Fund buys a fifty-million in Dell computer, we yawn. So, should you. It is other people's money.
7. Slick advertising budgets, powerful computers and few slabs of marble do not, by themselves, make a great financial institution.
8. Never invest in anything you do not feel comfortable with or understand well.
9. When a thousand people say a foolish thing, it is still a foolish thing.
Gold adds strength to national reserves as global order changes
"To an extent whether or not this manipulation is present, is of lesser importance than the shift in economic power from West to East – or at least from the developed world to the developing nations currently underway. It is the BRICS, and other developing nations, which are building up their official gold reserves to give them a stronger foothold as the global world order is seen to be changing. Indeed it is China among these which many assume is increasing its gold reserves fastest, but without officially announcing this lest such news causes the gold price to soar, thus making it more costly to continue its surreptitious gold purchase programme. But China is also probably unwilling to see the gold price fall back much either as part of its policy has also been to encourage precious metals investment by its people – and maintaining, and increasing, its peoples' wealth is an important factor in retaining control over its massive population."
Lawrence Williams, Mineweb
John Paulson's timely take on gold and Fed stimulus
At the end of March, we began to get some better numbers on the economy, a sign that the Fed's heavy stimulus might be finally having an effect. As luck would have it, I simultaneously ran into this recent missive from hedge fund proprietor John Paulson to his clientele. Paulson, as covered in last month's issue, has a $3.4 billion commitment to gold bullion and gold mining shares. Here is what he had to say about gold and the Fed stimulus program: "Despite recent negative performance, we believe that the outlook for gold and gold equities remains positive. The improved performance of the U.S. economy is consistent with our view that the Fed's massive stimulus program is beginning to take effect, and that the effects of quantitative easing will eventually result in higher levels of inflation. We believe this will ultimately be very positive for gold, even though we are currently in a low-inflation environment."
The double meaning of Ben Bernanke's exit strategy
In the past, the Fed could reverse the inflationary process by forcing banks to repurchase its bond holdings. How many banks will be willing to buy-back the mortgage-backed securities it so desperately wanted off their balance sheets? How willing is the Fed going to be to curtail direct government bond purchases at a time when the federal government finds it difficult to obtain financing? What would be the effect of higher interest rates on the federal governments budget deficit? (Interest costs already consume 7% of annual outlays. Should rates double, that figure would climb to 14% -- an amount equal to what the federal government now spends respectively on the military and education.)
Mr. Bernanke's term ends in January, 2014. He is quoted as saying that he is not the only one who can manage the Fed's exit from its stimulus program. He says that he has gone to some lengths to "depersonalize" monetary policy. These are not the kinds of statements one would expect from someone who wishes to keep his job. Standing at the monetary seashore and looking out at the rising inflationary tide is not the sort of thing any central banker would relish. The challenge for the next Fed chairman, whether it be Ben Bernanke or someone else, is whether or not what was wrought by policy in the first decade or so of the 21st century will be manageable in the second.
As to what might happen if Ben Bernanke actually does step down, we can only look to other central bank transitions around the globe. In each instance the successor has been farther to the left than his predecessor -- Carney following King (Bank of England) Kuroda following Shirakawa (Bank of Japan) Draghi following Trichet (European Central Bank). It would be stretch to think that the Obama administration, charged with appointing the next Fed chairman, would stray from the model.
Michael J. Kosares is the founder of USAGOLD and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold." He has over forty years experience in the physical gold business. He is also the editor of News & Views, the firm's newsletter which is offered free of charge and specializes in issues and opinion of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.
Disclaimer - Opinions expressed on the USAGOLD.com website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD does not warrant or guarantee the the accuracy, timeliness or completeness of the information found here.
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