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NEWS &VIEWS
Forecasts, Commentary & Analysis on the Economy and Precious Metals
Celebrating our 45th year in the gold business

February, 2018
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News & Views is the contemporary, web-based version of our client letter which traces its beginnings to the early 1990s as a hard-copy newsletter mailed to our clientele. The "Big Breakout of 1999" headlined in the November, 1999 issue of our newsletter moved the gold price from $250 to $325 per ounce. It was a major event.

The times have changed, but our mission has not. Simply put, it is to deliver value to our readers in the form of cutting-edge Forecasts, Commentary and Analysis on the Economy and Precious Metals. The very same mission that has been displayed in our banner for over twenty-five years.

MK Editor: Michael J. Kosares, founder of USAGOLD and author of The ABCs of Gold Investing - How to Protect and Build Your Wealth With Gold.

 

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Gold takes center-stage in dollar scare
Not strong, not weak but strategically benign

by Michael J. Kosares

Trump-Mnuchin qualifiers in dollar statements tell all

"While it's [a strong dollar] described as a desirable and intended thing, it might not be a choice. The size of dollar holdings of reserves (in dollar-denominated debt) and the dollar's role as the dominant world currency are anachronisms and large relative to what one would want to hold to be balanced, so rebalancings should be expected over time, especially when U.S. dollar bonds look unattractive and trade tensions with dollar creditors intensify." – Ray Dalio, Bridgewater Securities

whitehouse$$$Much is made of the direct inverse correlation between gold and the dollar, but acknowledging that relationship does not really get us anywhere. The bigger question is whether or not the dollar will continue to track lower as it has over the past 18 months or will it suddenly reverse course and head higher.

In the end, the international FOREX markets will determine the dollar's value against other currencies. That journey, though, will be influenced by other players on the stage, i.e., central banks and governments, including the U.S. government and the Federal Reserve, whose main interest will be the value of their currency, especially against the currencies of their largest trading partners.

It is there, on the ultimate battleground of the political economy, that the plots and subplots can become as twisted and complicated as the intricacies of a John LeCarre novel. Note, for example, the couching of terms in the following two statements delivered during the Davos conference late last month:

"I absolutely support a strong dollar over the long term." – Stephen Mnuchin, U.S. Secretary of the Treasury

"The dollar is going to get stronger and stronger and ultimately I want to see a strong dollar." – Donald Trump, President of the United States

Those qualifiers, over the long term and ultimately, tell all and go to the heart of what the administration intends. What happens to the value of the dollar between now and ultimately? What happens before the long-term policy kicks in? In its unambiguous ambiguity the Trump administration has signalled no intention of disrupting any market generated dollar weakness. It will stand aside. Beyond that, time will tell to what degree it will project the economic power of the United States if it becomes necessary to keep the exchange rate down.

For the markets, there was no ambiguity in the statements at all. The intent of the administration was crystal clear. Its dollar policy would be neither "strong" nor "weak." Instead it would be strategically benign. In the immediate aftermath of the Davos statements, the dollar cratered, gold jumped and the bond market went into a tail spin. For traders and speculators, the way was clear. As Marc Chandler of Brown Brothers Harriman told Financial Times: "While Mnuchin was only stating the obvious, Treasury secretaries since Robert Rubin have never really deviated from the strong dollar mantra. The mantra has never really meant much, but to deviate from it suggests that U.S. policy makers desire a weaker dollar."

So where do we go from here?

As the first two charts below amply illustrate, the dollar has been in long-term secular decline since the start of the fiat money era in 1971. Gold over the same period has been in a long-term up-trend. So the short answer to the headline question is that gold likely will be in a very strong position for the immediate future – a prognosis hinted by its performance over the past two years of dollar declines (first chart below).

Historically, though, the dollar declines have not been against other currencies only, but against goods and services as well (second chart below). In short, if the U.S government and central bank have favored a strong dollar policy, their efforts have pretty much amounted to a prolonged failure. From time to time, it needs to be noted, the dollar's secular down trend has been punctuated with periods of strength that then ultimately revert to the primary trend. We just recently completed one of those periods of strength in 2016 and seemingly have reverted to another period of weakness.

As you can see in all three charts, gold has served its owners well as a safe haven and asset of last resort. In fact, its history as a counter-measure to dollar depreciation has formed the basic rationale for gold ownership over nearly the past 50 years.

Now, with the dollar coming off its 2016 peak, market analysts are suddenly talking up the prospects for another episode of major dollar weakness against other currencies. However, unlike the last bout of dollar weakness in the early 2000s when disinflation bordering on deflation dominated the economy, analysts this time around are predicting the simultaneous return of price inflation.

The prospect of the two together – a crumbling dollar and inflation – spooked markets to the point that the Dow Jones Industrial Average gave up over 1000 points in a single week (1/29) and 665 points in a single day (2/2). This ramped-up scenario has all the earmarkings of a return to the stagflationary 1970s – something former Fed chairman Alan Greenspan has been predicting for some time now. In fact, two days before the February 2nd stock market reversal, he was on Bloomberg television warning of bubbles in both the stock and bond markets. Our third chart provides a clue as to how gold might perform in a 1970s redux.

(In the next section of this month's client letter, we delve into what appears to be the first signs of inflation's re-emergence: rising commodity prices.)

The specter of inflation – rising commodity prices

One easily forgotten, but still important, aspect of the low-inflation rate is cheap imports. Cheap imports, in fact, have masked much of the inflation that might otherwise have been stirred up by the easy monetary policies over the past decade. Thus when the Trump administration slaps sanctions on South Korean made washing machines, for example, that translates directly into higher prices for American consumers forced to purchase the domestically manufactured competition. Few believe that the Trump administration will stop with tariffs on South Korean goods.

Combine rising import prices with the on-going effects of a weaker dollar and we suddenly find ourselves worried about the specter of rapid price inflation. At some point along the way, inflation in turn spills over to the financial markets – stocks, bonds, real estate and precious metals. All will be affected and all in their own peculiar way. This paradigm shift will be a phenomenon for which we do not have an historical comparison at the this time. There is no way to predict the effects: Mild inflation? Double-digit inflation? Runaway inflation? The jury is out.

Already the GSCI Commodity Index is up 41% over the past two years – a phenomenon that many analysts see as an initial effect. Gold and silver, meanwhile, are up 25% over the same time period suggesting that the metals might have some catching up to do. History has shown that what is good for commodities in the end is good for gold and silver.



Source: tradingeconomics.com

The other inflation hedge – Silver

Germany's Commerzbank reports that Chinese silver imports rose 28% year-on-year to nearly 4,300 tonnes – a seven-year high and this occurs tellingly at a time when gold imports had decreased markedly. "Last year saw solar-cell production stepped up considerably for the second consecutive year in China," said the bank, "with over 50% more solar panels installed. This resulted in high demand for silver." Silver prices are very sensitive to industrial demand – something investors need to take into consideration if they have an interest in adding it to their portfolios. The price can jump quickly and radically as any long-term price chart will illustrate. This is particularly true during episodes of inflation.

At 80:1, where the silver/gold ratio stands as this newsletter is written, it is signalling silver's potential to outperform gold. Since the year 2000, every time the ratio has approached the 85:1 mark, we have had a correction, i.e., silver has gone up faster than gold, and at times, significantly. In an opinion piece for India's The National, Peter Cooper, its precious metals expert, writes: "[I]f you really want to play the commodities upturn cleverly, then buy what has been left behind in the price upturn so far, and that leaves you with silver, always loved by speculators for its volatility to the upside. Silver was the top performer in 2011, the last big year for precious metals, and if 2018 is another landmark year then it most probably will be again."

Trade and currency wars likely to inspire major global gold demand

"There's been a lot of thunder and now the storm is coming. Maybe the world economy can absorb all of this, but these actions on trade and currency have ripple effects around the world and I don't take them lightly." – Matthew Goodman, Center for Strategic & International Studies, as reported in Financial Times

January, 2018 will be remembered for the cracks it revealed in the global monetary and trade edifice. At the Davos conference, the rhetoric became unusually strident and purposeful with accusations and threats flying in all directions. In the end, the various confrontations highlighted just how sensitive foreign central banks and governments have become to the Trump administration's trade and currency policies.

"[T]he concern has been that dollar assets could lose their appeal if the dollar becomes too weak, if the Trump administration really does want to talk down the green back," writes CNBC's Patti Dom. "[TD Securities' Mark] McCormick said there was some speculation that the Trump administration weak dollar comments were a response to the reports earlier this month that China was considering cutting back on Treasury purchases because they are no longer as attractive and because of Trump trade policies. China is the largest holder of Treasurys, but it's not expected to back out of the Treasury markets in a significant way."

Nevertheless, the ever-present prospect of such sales hangs over Washington and Wall Street like a financial sword of Damocles. Speculators in global trading centers will be looking to capitalize on currency and market instability – a prospect likely to reinvigorate the various volatility indices the press is so fond of referencing. Along these lines, PwC Market Research Centre reports developing interest from sovereign wealth funds in alternative assets including gold. Sovereign funds now control about $7.4 trillion in assets, 23% of which is devoted to alternative assets. With hedge funds and a good many institutions already participating in the gold market, sovereign wealth funds join an increasingly crowded field. Should another crisis suddenly erupt, we could see a scramble develop for available physical metal.

Concerns surface about financing U.S. deficits

All of this comes on top of rising concerns about how the United States will go about financing federal government deficits sure to grow under the Trump fiscal program. China and Japan, at one time the two largest U.S. debt financiers, are largely out of the market.

Bloomberg suggests that "The world's biggest bond market is about to get a taste of the future, with the U.S. Treasury expected to unveil bigger note sales for the first time since 2009 to fund budget deficits that are likely to deteriorate for years to come. . .Dealers forecast an onslaught of debt supply that will lead issuance to at least double this year to more than $1 trillion, the most since 2010, starting with sales of short- to medium-term maturities."

Those concerns have surely played a role in the recent run-up in Treasury yields – the thing that spooked financial markets in early February and led to the Dow Jones Industrial Average shedding nearly 5% of its value in a single week. "The more important point," says Christopher Whalen, The Institutional Risk Analyst, "is that as the fiscal situation facing the Treasury continues to deteriorate, Fed officials will be under enormous pressure to accommodate swelling federal deficits – even if it means pretending that the central bank is a source of revenue to the Treasury. The operative model of political economy here is Argentina in the 1970s."

ChartNote: A number of news sources have run the 10-year Treasury yield chart to show the 30+ year bull market run for bonds. What they fail to show, in most instances, is what inspired it – the runaway inflation of the 1970s and parallel spike in interest rates and yields. For every action, as Sir Issac Newton instructed us, there is an equal and opposite reaction and implementation of that law applies to Fed policy in this respect as well.

After the 1970s inflationary spike, the Fed radically tightened the money supply and pushed interest rates higher (the Action). That combination inaugurated the long-term run to the bottom on yields you see on the chart. Now, in response to the conclusive disinflationary crisis of 2007-2013, it has responded with a flood of money and near-zero interest rates (the equal and opposite Reaction.) Gold reacted well to the systemic threats spawned by that disinflationary crisis and few would be surprised if it reacted other than positively to some future inflationary scenario as it did in the 1970s.

Gold and the Law of Attraction

This month we include something a bit out of the ordinary. Robert Kiyosaki, famous for his Rich Dad, Poor Dad book series, made some interesting comments about gold ownership during a video interview with Kitco's Danielle Cambone worth passing along to our readers. You can see the full interview at this link. It is a fascinating three minutes on one of the ancillary benefits to gold ownership that few people think about or acknowledge. Kiyosaki says that his ownership of gold has has been a source of more wealth coming his way, a manifestation of the Law of Attraction. "People believe what they want to believe,” Kiyosaki said, “some people believe that if you go to school you’ll be happy, or if you get married you’ll be happy….well, I don’t know about that, but gold has made me very happy."

His comments reminded me of an article published at USAGOLD's Gilded Opinion page that does not get much attention, but is one of the more important nuggets of wisdom we have posted at the site.

A Layman's Guide to Golden Guidelines
for Wise Money Management

by R.E. McMaster

But before you go to the that page, listen first to Kiyosaki talk with conviction about what he sees as one of his most important beliefs.  McMaster has a short section on the mentioned Law of Attraction in the piece linked above.  At one time, McMaster wrote one of the most widely followed commodity investment letters in the United States.  He is an old friend of the firm and his insights and wisdom in "A Layman's Guide.  . ." are priceless.

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LETTER TO THE EDITOR

Editor's note: We rate the prospects for a hyperinflation as low, but it remains a perennial concern among investors, particularly in light of what have seen in recent years in Zimbabwe and more recently in Venezuela. Below a reader in Holland asks some pointed questions on how exactly gold protects its holders against an inflation that has raged out of control. By the way, the strategies suggested below apply to double-digit and runaway inflation as well – the tamer versions of currency debasement. His question and my answer first appeared at MK's Short & Sweet, our online daily newsletter.

german fiatDear Mr. Kosares,

I have read your articles with great interest and pleasure. I believe we are in a corner which is far from the mainstream. In reference to buying gold as protection, I also read stories like "sell-cryptos-buy-gold," but it is never told what will happen when there is indeed hyperinflation.

It is said that the gold price can rise many fold. But if this happens, isn't it so that food prices and prices of other necessities to keep living will increase also many fold or even more than gold? I mean the seller of food will abuse the situation and ask 2 pieces of gold instead of a half piece of gold for a certain quantity of food. In short how can a citizen even with gold survive such an event.

But I indeed think if there is no financial system and with trust gone and no financial transactions between all the participants in the society, there will be severe troubles because the present society is so intertwined (just in time supply chain for every aspect of live). For example as the truckers say "with no trucks transporting a few days everything stops." And this is just one part of the economy. The collapse of the financial system will cause a shock wave through every part of society. Will gold protect against the retreat of the state?

But it is never told for example by gold analysts and others what happens then for gold owners in case of hyperinflation. Are gold owners also protected with the prices of necessities for living or survival also increase? Will these prices increase as fast as or faster as gold and other precious metals? This part is never explained. I also have never read what happened with the occasional gold owners during the Weimar hyperinflation.

Best regards,
RK
The Netherlands

You ask important, thoughtful questions, RK, that show you have given the hyperinflationary scenario a great deal of thought. Here are a few things to consider:

1. Gold will not only reflect the current rate of inflation, it will also anticipate future inflation. As millions of investors move capital out of the depreciating currency into appreciating gold and silver, its price velocity is likely to outstrip the rate of inflation by a wide margin.

2. Wage and salary increases simply cannot be approved and implemented in most businesses quickly enough to keep pace with the rapid rate of inflation. At the height of the nightmare German inflation, for example, employees were paid several times a day and people ran to the store with a pile of paper money in order to beat price increases. It was impossible for business owners to keep up with the rapid decreases in currency value at a time when the money could not even hold its value in transit between the office and the store. It is difficult to see how this logistical problem could be overcome even in the modern digitized environment due to the decision-making process and prudent care most businesses would have to employ even in an emergency environment.

3. As for the rate of return on savings or yield investments keeping pace with inflation, once again the problems revolve around timing. Let's run through a quick simulation to illustrate what I mean. Let's say that you wake up one fine morning to suddenly discover through a government announcement that the inflation rate had just jumped by 30%. The central bank board convenes an emergency rate-setting meeting and decides to raise interest rates to the 30% level. It, in turn, instructs banks to use that figure as the base rate to pay on depositor savings accounts. You visit your bank and buy a short-term time deposit that pays 30% interest. The problem, as you already may have recognized, is that you will not receive that 30% interest for a year. Interest accumulates over time and is not paid instantaneously. Meanwhile, the inflation rate is marching inexorably higher.

4. The prices of gold and silver, on the other hand, are determined instantaneously on computerized trading venues all over the world. If, for example, the government announced a sudden 30% increase in the inflation rate, you can be certain gold and silver would respond immediately – probably with a gain of 30% or more if inflation expectations were high. Gold owners would in turn receive the benefit of that price increase instantaneously – no wait involved. In the case of dollar savings, on day one you have $100,000 and ultimately, in one year's period of time, it will become $130,000. In the meantime, your $100,000 in gold has likely already appreciated in value to at least $130,000 on day one.
Both scenarios outlined in #2 and #3 – individual income and savings – would get much more complex than the simplistic scenario outlined if inflation rates were running 50%, 100% and 1000% – not annually, but daily.

As the old saying goes, time is money and in no situation will that become more readily apparent than in the event of hyper or runaway inflation. Gold, in short, is the most suitable, most liquid, and most responsive of the primary assets to an emergency situation like hyperinflation, even in the modern age, and that is why it is highly recommended.

Thanks for the good questions and good luck in the future, RK.

My best wishes,
Michael J. Kosares
USAGOLD

P.S. Interesting that you would ask specifically about gold's role in the German hyperinflation. The chart below is a quick reference how gold performed during that time period in Germany. Also, we have an excellent report posted here at USAGOLD in our Gilded Opinion Library titled The Nightmare German Inflation. It offers a general look at what happened in Germany from 1918 to 1924 and how various markets and investments performed under those strained circumstances – including gold. Hopefully, this study will answer some of the questions you asked that I did not address above.

weimar purch power

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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. (Please see our Risk Disclosure here.)


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