USAGOLD's NEWS & VIEWS newsletter
||Michael J. Kosares
"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose." - John Maynard Keynes
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WHY GOLD, WHY NOW
The China Syndrome
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"Perhaps we spend too much energy trying to foretell the future, and too little trying to be resilient whatever happens."
Keynes on the menace
of printing money
How the celebrated economist might have structured his investment portfolio today.
Michael J. Kosares, the author of these articles, has more than 40 years experience in the gold business. He is the founder and executive director of USAGOLD (both the website and gold brokerage service), the author of three books on the gold market, and the editor of "News & Views, Forecasts, Commentary & Analysis on the Economy and Precious Metals," the firm's client letter. He has written numerous magazine and internet essays and is well-known for his ongoing commentary on the gold market and its economic, political and financial underpinnings.
"I keep six honest serving men
(They taught me all I knew);
Their names are What and Why and When
And How and Where and Who."
– Rudyard Kipling –
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USAGOLD's News & Views newsletter has provided cutting-edge coverage of the gold and silver markets for over 25 years. Its content is widely quoted, re-circulated and sourced at websites all over the world.
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Gold in the zero-bound
by Michael J. Kosares
"When you have zero money for so long, the marginal benefits you get through consumption greatly diminish – but there’s one thing that doesn’t diminish, which is unintended consequences.” – Stanley Druckenmiller
Something happened on the way to negative interest rates. Something unexpected. Gold and silver demand went through the roof. The first two months of business at USAGOLD were reminiscent of the 2009 run to gold. In London, where people have the additional concern of a potential exit from the European Union, investors were lining up around the block to purchase precious metals, and reports were circulating that "Some London banks are placing unusually large orders for physical gold.” For the first two months of the year, the U.S. Mint reported gold coin sales running double what they were for the same period in 2015.
So what's behind the rush for gold at a time when the financial news is dominated with concerns about negative interest rates?
Worry over disinflationary/deflationary systemic risks is certainly one incentive, i.e., gold's safe haven appeal, but there is something else at work here though – a set of circumstances that forces us to think outside the box. Typically, we are programmed to believe that we will benefit from an investment because it goes up in value. In the case of the zero-bound, though, when interest rates are near zero, threatening to go negative in some countries (like the United States) and having already gone negative in others (like Japan, Sweden, Denmark and Switzerland), smart money begins to think about simply staying whole.
You can do that by going to cash, but, even better, you can do that by going to gold and silver where you can at least hope for a return on your money. During the Great Depression of the 1930s, gold paid off handsomely not necessarily because it went up in value, but because its value was fixed by government mandate while the cost of just about everything else went down. As a result its purchasing power increased and it served effectively as a deflation hedge. Some fear we may be slowly moving toward a similar situation today. Marc Faber, the maverick investment advisor, put it succinctly: “Leave a million dollars with a bank, and in a year, you get only something like $990,000 back. I would rather want to own some solid currency, in other words gold.”
The more skeptical among us might also begin to consider what else might be implied by central banks pushing rates below the low water mark. Could the economy and financial markets be in worse shape than they appear? Have central bankers run out of policy options – save helicopter money – to fight off the economic doldrums? Last, if one were to start making a list of potential unintended consequences of negative interest rates, it could become very long and very worrisome in a hurry.
In a fit of exasperation, JP Morgan's Bob Michele told CNBC, "There is a serious credit contraction underway, I think [Yellen] should acknowledge that. I think she has to look at the capital base being wiped off the banks in this downdraft and equities: that's not supposed to be happening right now. They're supposed to be bulletproof, and oh, by the way, gold at $1,200 an ounce, what does that tell you? It tells you that in a flight to quality, in a safe haven, people have more confidence in gold than in bank deposits or paper money. I think things have gotten out of control."
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State Street Global Advisors' George Milling Stanley similarly put his focus on the rapid change of sentiment taking place among investors. “People have become complacent about risks," he says, "whether it’s macroeconomic and geopolitical. What’s out of fashion may be coming back. That atmosphere of people feeling completely calm and untroubled, I think, is starting to go away. Gold is a very good risk-off trade, and I think people are starting to look very, very carefully at the risky positions that they have on a number of other markets.”
Volatility in the stock and bond markets early in the year has certainly pushed investment capital in the direction of gold and silver as indicated at the top of the page. Demand for the precious metals has been running strong for over a year now with little effect on the price. Now the demand has begun to translate to higher prices even in this disinflationary environment. Gold, as of this writing, is up 16% on the year and silver is up 6% – not bad in a zero-bound investment environment. Precious metals owners are not only holding their own, they are gaining wealth.
Note: Investopedia defines zero-bound as "A situation that occurs when the Federal Reserve has lowered short-term interest rates to zero or nearly zero. When interest rates are this low, new methods of economic stimulus must be examined and implemented."
The politics of gold
Please note in the chart immediately above the dramatic turnabout in central bank behavior toward gold after the 2007-2008 financial meltdown. Central banks not only switched from being net sellers to net buyers, they did so with a vengeance creating a nearly 1000 tonne annual swing in the fundamentals tables. Similarly, the national gold repatriation movements in Germany, Netherlands and Austria have put additional pressure on the supply side. Repatriated gold reduces the lease pool and forces bullion banks to repurchase the metal that has been out on lease.
In these ways, the politics of gold has shifted dramatically over the last several years. Some, not all nation states are in the accumulation mode while others are solidifying their position by making sure reserves are within national borders. Probably the most important change has been the absence of significant selling. This puts the full burden for supply on the mines and scrap recycling.
Central banks today do not store and accumulate gold to someday back their currencies. Instead, like private investors, they see it as a means to hedging their exposure to volatile currency reserves. I have remarked consistently that the role central banks play in the supply-demand dynamics constitues one of the more significant contributions to the long-term bullish fundamentals for gold. In my estimation, it has an even greater impact on private gold owners than if the world were to return to the gold standard.
Though the official sector is likely to continue stockpiling the metal, it is unlikely we will see a return to the gold standard anytime soon. If and when we do, it will be under the auspices of an international agreement every bit as painstaking and momentous as the post-World War II Bretton Woods Agreement. At that time there would likely be an upward, one-time revaluation of gold to accomodate the new system and balance the books between the various nation states. Until then, the gradual building of gold reserves in places like China is likely to continue with long-term positive results in the overall market. Under the current circumstances, when beggar thy neighbor currency policies carry the day, it is difficult to conceive of any country returning to the gold standard unilaterally. Such a move would amount to economic suicide.
Global banks, counter-party risk and gold
Much of the danger in the banks has to do with interlocking counter-party risks associated with deep derivative exposure and extreme leverage. Deutschebank’s net exposure alone is estimated at 55 billion euros. There is an element of critical mass in the derivatives exposure that could lead to a contagion effect like nothing we have ever seen in the financial system.
According to Banknet, Goldman Sachs, Citigroup, JP Morgan Chase, Bank of America and Morgan Stanley – the top tier of American banks – account for a whopping $200+ trillion in notional derivative exposure. When the markets are in turmoil, hefty margin calls could cause a chain reaction up and down the pecking order in the global financial system. There will be some big winners, but it is the big losers that will cause significant problems on Wall Street, as was the case in 2007 through 2009 when Bear Stearns, AIG and Lehman Brothers were pushed to the wall.
In addition, loan portfolios at all banks have greatly weakened. Credit downgrades, and all that they portend, could follow. In Europe, the door is still open to quantitative easing and bailouts. For American banks, however, it is a different story. If the extreme risks in European banks reported recently traverse the ocean (a likelihood), American banks will have a difficult time finding sympathy in an election year. Both the Trump and Sanders campaigns are propelled by an army of voters opposed to any further Wall Street bailouts. European bank stockholders, bondholders and depositors have already been put on notice that bank bail-ins are likely in the cards.
World faces wave of epic debt defaults, fears central bank veteran
“The global financial system has become dangerously unstable and faces an avalanche of bankruptcies that will test social and political stability, a leading monetary theorist has warned. ‘The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up,’ says William White, the Swiss-based chairman of the OECD’s review committee and former chief economist of the Bank for International Settlements (BIS).
I do not use the term “must-read” very often, but this article by Ambrose Evans-Pritchard (The Telegraph) fits the description. William White sits at the nerve center of the global central banking system. His understandings go beyond the academic to a first-hand, working knowledge of the problems central banks face. He also warns that “It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something.” He goes on to predict ‘bail-ins’ (in Europe) “any deposit holder above the guarantee of €100,000 will have to help pay for it. . .”
For the average investor, it is essential to understand gold’s role in the portfolio with respect to private and public bankruptcies. It does not protect because it might or might not go up in value during a debt implosion; it protects because it is an asset which is NOT simultaneously someone else’s liability. Gold carries no counter-party risks. Hence the common reference that it will be the last asset left standing.
Please see World faces wave of epic defaults/The Telegraph/Ambrose Evans-Pritchard
Michael Burry, real-life market genius from the Big Short, thinks another financial crisis Is looming
"Too, the crisis, incredibly, made the biggest banks bigger. And it made the Federal Reserve, an unelected body, even more powerful and therefore more relevant. The major reform legislation, Dodd-Frank, was named after two guys bought and sold by special interests, and one of them should be shouldering a good amount of blame for the crisis. Banks were forced, by the government, to save some of the worst lenders in the housing bubble, then the government turned around and pilloried the banks for the crimes of the companies they were forced to acquire. The zero interest-rate policy broke the social contract for generations of hardworking Americans who saved for retirement, only to find their savings are not nearly enough. And the interest the Federal Reserve pays on the excess reserves of lending institutions broke the money multiplier and handcuffed lending to small and midsized enterprises, where the majority of job creation and upward mobility in wages occurs.” – Michael Burry
Editor's note: The Fed’s excess reserve policy, which was the centerpiece of last month's feature article (Gold a safe harbor on an ocean of excess reserves), sterilized most of the money creation that was supposed to push the recovery. The end result is that we are right back where we started in 2007. The banks have been bailed out, but a whole new set of dangers looms on the horizon for the Main Street economy and Wall Street as well. Investors should keep in mind that gold has been a very good disinflation hedge, because more disinflation, and possibly even deflation, seems to be where we are headed. When Jessica Pressler (New York Magazine) asks Burry what makes him nervous these days, he responds, “Debt. The idea that growth will remedy our debts is so addictive for politicians, but the citizens end up paying the price. The public sector has really stepped up as a consumer of debt. The Federal Reserve’s balance sheet is leveraged 77:1. Like I said, the absurdity, it just befuddles me.” Burry’s current thinking serves as a useful warm-up to the rest of 2016 and and a warning to take precautionary measures.
Please see Hollywood occupies Wall Street/New York Magazine/Jessica Pressler (Interesting read.)
Heads up on stock market volatility
We do not pretend to be experts on the stock market. At the same time, there are so many prominent analysts predicting problems in the equities markets for 2016 that we thought it important to pass along some of their observations. With all the bad press, no one this time around is going to be able to use the excuse that they didn't see it coming.
“My view on ‘this time’ is clear. I remain convinced that the U.S. financial markets, particularly equities and low-grade debt, are in a late-stage top formation of the third speculative bubble in 15 years. On the basis of the valuation measures most strongly correlated with actual subsequent market returns (and that have fully retained that correlation even across recent market cycles), current extremes imply 40-55% market losses over the completion of the current market cycle, with zero nominal and negative real total returns for the S&P 500 on a 10-12 year horizon. These are not worst-case scenarios, but run-of-the-mill expectations.” – Jon Hussman, Hussman Funds
Editor's note: Hussman is one of the analysts other analysts study. He predicted both the 2000-2002 and 2007-2009 collapses. The third crest he references encompasses the present.
“RBS [Royal Bank of Scotland] has advised clients to brace for a “cataclysmic year” and a global deflationary crisis, warning that major stock markets could fall by a fifth and oil may plummet to $16 a barrel. The bank’s credit team said markets are flashing stress alerts akin to the turbulent months before the Lehman crisis in 2008. ‘Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small,’ it said in a client note.” – Ambrose Evans-Pritchard column
“While a few newspapers led their end-of-year reporting with the correct observation that US stock markets had “their worst year since 2008,” this assessment could prove overly partial in a number of ways. Most importantly, it obfuscates the fact that markets in this country, assisted by a bumper year for M&As and share buybacks, navigated quite impressively an unusual mix of potentially damaging headwinds: from the marked slowdown in global growth and reduced monetary stimulus from the Federal Reserve to geopolitical threats, risk and leverage over-extension, and the emergence of anti-establishment movements that added to the polarization of the two traditional parties and further paralyzed comprehensive policy making. . .
”“With less uniform support from central banks in advanced economies, the continued deployment into the equity markets of corporate cash — through additional share buybacks, higher dividends, and new M&A deals — is unlikely to be sufficient to isolate investors from economic, political and geopolitical turbulence. Greater financial market volatility is to be expected, with improved fundamentals needing to do a lot more of the heavy lifting if risk assets are to avoid a disappointing year in aggregate.” – Mohammad El-Erian
Editor's note: If one of those heavy-lifting fundamentals is price-earnings ratios, we could have problems. The Schiller PE ratio is in dangerous territory at levels seen only three times before – 1929, 1999 and 2007.
“Two European investment houses — Royal Bank of Scotland and Societe Generale — are calling for sub-$20 oil and a potential 75 percent rout in U.S equities. A J.P. Morgan investment officer recently told clients not to buy stocks on dips but rather sell them on rallies.” – Andrew Osterland, CNBC
Final note: MarketWatch reports too that George Soros is short the S&P – a position he revealed at the recent Davos conference. “The key issue,” he says, “is deflation…We just don’t know how to handle it. It’s a different environment, but now we have to face it.” On the reality of a hard landing in China and its net global effect, he says “I’m not expecting it, I’m observing it.” In other words, that train has already arrived.
We have seen in times past the net effect of everyone heading for the ‘exit doors’ all at the same time. We have even begun to see the effect in the past several weeks – particularly in the junk and emerging countries bond markets. There simply is not enough available liquidity when markets reverse to soak up the selling and that applies to all markets.
For gold, we are likely to see the opposite effect. There simply is not enough physical metal available to put a dent in the available liquidity once the selling of stocks, bonds (etc) begins. That is why buying the physical metal while things are quiet makes so much sense – in fact that’s why savvy investors today are buying the physical. They see what’s going on.
The real deficits
Here is an interesting chart for you – one you probably have not seen before. These are the annual additions to the national debt – the real deficits as opposed to the trumped up political deficits reported by the national media (which are usually substantially less). Note the incredible liftoff since the 2008 financial crisis. Not shown on the chart is Treasury borrowing for 2015. Congress lifted the moratorium on additions to the national debt on November 1, 2015. Since then, Treasury has added an astonishing $920 billion in red ink and we have gone over the $19 trillion mark for the accumulated national debt ($19.071 trillion to be exact).
We recently added this chart to our economic trends page, which we invite you to visit occasionally if you like to monitor important statistics affecting the gold market. You might also gain from a visit to our gold trends page, which shows correlations between economic data and the gold price plus some useful gold history in chart form, particularly if you are new to gold and looking to learn.
THE PRETENSE OF KNOWLEDGE
With that unsettling statistics on the national debt, we will bring our March issue to a close, but before we go, let me pass along some words of wisdom from one of my favorite economic philosophers, Frederich von Hayek. The following is an extract from his speech in acceptance of the Nobel Price for Economics in 1974 titled "A Pretense of Knowledge."
“If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.
There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, ‘dizzy with success’, to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.”
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.