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News & Views
Forecasts, Commentary & Analysis on the Economy and Precious Metals
Celebrating our 44th year in the gold business and 20th year on the world wide web

September, 2017
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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.

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


When the United States Owned Most of the Gold on Earth
Gold's legacy told indelibly in one straightforward chart

by Michael J. Kosares
Author, The ABCs of Gold Investing: How To Protect and Build Your Wealth With Gold
Founder, USAGOLD

Few Americans know that, just after World War II, the United States owned most of the gold bullion on earth – about 22,000 metric tonnes. In fact by 1945, it owned over 80% of the gold held by nation-states and central banks – an impressive display of economic power. Now it owns just over 8000 metric tonnes, which represents about 42% of the total global reserve.

The lost 14,000 tonnes were expended in defense of the $35 per ounce gold benchmark price established under the 1944 Bretton Woods Agreement. In addition to the fixed price of gold, the U.S dollar came to represent a fixed weight of gold, i.e., 1/35th of a troy ounce, and the rest of the world's currencies were then pegged to the dollar. The United States agreed under Bretton Woods to redeem gold from the other signatories at the rate of $35 per ounce should any of the participants determine that gold might be a better alternative for a portion of their reserves than U.S. dollars. "The dollar," American policy makers were wont to say, "was as good as gold."

Germany, France get the idea dollar not as good as gold

All proceeded in orderly fashion with little in the way of redemptions from the massive U.S. stockpile until the 1960s. Then a group of European nation-states, led by Germany and France, got the idea that U.S. inflationist economic policies had undermined the dollar, making gold a bargain at $35 per ounce. In other words, they came to the conclusion that the dollar was not as good as gold.  Steadily, over a decade long period, they exchanged dollars for gold at the U.S. Treasury's gold window. By the early 1970s, 14,000 tonnes of gold – or 64% of the stockpile – had departed the U.S. Treasury for European shores never to return.

In 1971 President Richard Nixon finally decided enough was enough. He closed the so-called gold window, devalued the dollar against gold, and freed the greenback to trade at market prices against other currencies. Fully abrogating the Bretton Woods Agreement, Nixon declared, in one of the more famous quotes of his presidency, "we are all Keynsians now." The era of global fiat money, with a fiat U.S. dollar as its centerpiece, had begun.

Had the United States refrained from its defense of the $35 benchmark, it would still own about 75% of the present 29,000 tonne global gold reserve. As it is, Nixon's revocation of the Bretton Woods architecture set the stage for the modern gold market. You can see the result in the chart immediately below. From it, I can draw three conclusions:

–– First, we are now in the 46th year of a super-cycle, secular bull market in gold that began in 1971 – a bull market directly tied to the fate of the now fiat U.S. dollar.

–– Second, the very same conditions which created that bull market are still in place today – nothing has changed fundamentally.

–– Third, as long as the same cause and effect remain in place, we can assume gold will continue to make sense as a long-term portfolio hedge.

Some will agree with those conclusions. Some will not. Some are on the learning curve, and it is to that group this piece is largely addressed.

In the end, it is the times that need to be hedged

Those who do not agree with those conclusions, it has been my experience, will continue to put their faith in the stock and bond markets and ignore the precious metals. There is no amount of persuasion that will convince them to do otherwise, and to try is pretty much a waste of time. Most importantly, whether they care to acknowledge it or not, they will put their faith ultimately in the federal government and the Federal Reserve.

Those who do agree will continue to hedge their portfolios with the precious metals, just in case the long history of economic breakdowns beginning with 1971 repeats itself yet again. To this group, the proper diversification is a small price to pay, a matter of practical financial planning that, in these times, provides some much-needed peace of mind. As for an end game to all this, they will keep in mind one of history's immutable lessons – sometimes the problems become too large for the government and central bank to control.

For those on the learning curve, a post I made at the USAGOLD blog recently titled "Historical inevitability and gold and silver ownership – In the end it's the times that need to be hedged" would be an informative follow-up to what you just read, another piece in the puzzle. It got significant play on the wider internet and speaks to the possibilities of an end game from the perspective of Strauss and Howe's fourth turning.




Charts courtesy of GoldChartsRUs/Nick Laird with thanks.

A dramatic shift in central bank attitude towards gold since the 2008 crisis

Please note in the chart immediately below the dramatic turnabout in the official sector's behavior with respect to gold after the 2007-2008 financial meltdown. Central banks in a word have become more defensive when it comes to their gold stockpiles, switching from their traditional position as net sellers to become net buyers. In the process, they created a nearly 1000 tonne annual swing in the fundamentals tables.

China and Russia were the most prominent players in the accumulation mode in 2016. Both purchased the output of their mining industry for national reserves. Though their production figures are counted in overall global output, most of that gold never reaches the open marketplace. The U.S. Geological Survey ranks China the number one gold producer (455 tonnes) and Russia number three (250 tonnes).

(Please see World Gold Production by Country.)

Probably the most important change, though, is the nearly complete absence of significant selling. Sellers have virtually disappeared, except under the most dire circumstances, as was the case with Venezuela's sales in 2016. (Its sale of roughly 40 tonnes was quickly absorbed without so much as a blip in the price.) Longer-term, the lack of central bank selling places nearly the full burden for supply on the mines and scrap recycling.

Central banks today do not store and accumulate gold to back their currencies. Instead, like private investors, they see it as a means to hedging their exposure to currency risk and general systemic risks in an increasingly volatile economic environment. As a result, the situation described above is not likely to change anytime soon.

What is behind the 'quiet' summer rally in gold and silver

Gold and silver turned in strong summer rallies this year. The interim bottom came on July 10th with gold at $1210 and silver just above the $15.30 mark. From there it has been pretty much straight up with a normal correction or two along the way. As this is written, gold is trading near the $1340 mark and silver just above $18.00. On the year, gold is up 16% and silver 10%.

Digging through the pile of rationale that always accompanies a rally in gold and silver prices, I can identify six, what I believe to be, elemental forces underlying gold and silver's 'quiet rally':

–– Increasingly difficult sailing for the Trump administration's pro-business, pro-growth agenda with multiple parties to blame

–– The Fed's inability to move forward on its desire to raise, or should I say normalize, interest rates and generate some inflation (See Gridlock at the Fed below)

–– The over-valuation of the stock market which, in turn, has inspired professional money to diversify with gold being one of the avenues

–– The possibility that there is more than enough rancor in Washington to cause a serious problem when extending the debt ceiling comes up for a vote 

–– Concerns about the longer-term value of the dollar under a presidential administration pushing for the trade advantages a weaker currency would bring

–– Geopolitical problems, particularly in East Asia and the Middle East, that defy easy resolution and are superimposed over the matrix of concerns just outlined

China to make Shanghai oil contract convertible to gold

An update on China's pivotal role in the gold market

"China is expected shortly to launch a crude oil futures contract priced in yuan and convertible into gold in what analysts say could be a game-changer for the industry. The contract could become the most important Asia-based crude oil benchmark, given that China is the world's biggest oil importer. Crude oil is usually priced in relation to Brent or West Texas Intermediate futures, both denominated in U.S. dollars. China's move will allow exporters such as Russia and Iran to circumvent U.S. sanctions by trading in yuan. To further entice trade, China says the yuan will be fully convertible into gold on exchanges in Shanghai and Hong Kong." –– Nikkei Asian Review

Anytime you want to extend the usage, stability and value of your currency, just introduce gold into the equation. Europe did it when it launched the Euro by making gold a reserve asset at the ECB and then marking that reserve regularly to market. it gave the currency credibility. Now China is introducing a similar gambit to get big oil producers to utilize the Shanghai oil futures contract in the massive oil trade.

Louis-Vincent Gave, chief executive of Gavekal Research, a Hong Kong-based financial research company, had an interesting take on the new Shanghai futures contract. "This would go down like a lead balloon in Washington, where the U.S. Treasury would see this as a threat to the dollar's hegemony...and it is unlikely the U.S. would continue to approve modern weapon sales to Saudi and the embedded protection of the House of Saud [the kingdom's ruling family] that comes with them."

Nevertheless, China will continue to push the yuan as a substitute for the dollar and, given the Gulf States' penchant for gold, the yuan-for-oil/oil-for-gold futures' contract could turn out to be an effective way to erode petrodollar supremacy in the oil business. In a certain sense, China's use of gold for this purpose serves as a reminder of its historic role as the ultimate measure of value and wealth.

Side note: Hearkening back to the lead article in this month's edition, it would be interesting to see how long China would honor the gold conversion, if it suddenly became a major drain on its national reserves.

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Here's why the deficits matter

Democrat Franklin Delano Roosevelt was the first to publicly declare that deficits did not matter since, he reasoned, we owe the money to ourselves. Dick Cheney, who should know better, made the same claim on behalf of Republican deficits. Deficit denial has never held water simply because holders of government paper, foreign or domestic, intend to be repaid and with interest. It’s that part about creditors demanding interest that blows a hole in the “deficits-do-not-matter” argument.

In 2016, the United States paid $433 billion in interest on the roughly $19 trillion accumulated national debt. If the average interest rate paid by the federal government were to rise from the 2.2% level to just 3%, the interest paid on the national debt would rise to nearly $600 billion, the amount spent annually on the national defense. In recent years, the level of interest payments has been contained by the low-interest rate environment. If the average rate paid were to return the 4.5% blended rate in 2008, the interest burden would rise to over $850 billion and consume 28% of the roughly $3 trillion the government takes in as reveue each fiscal year (2016).

In keeping with the historical review offered in the first section of this month's newsletter, I include the following two charts. The first shows the growth in the cumulative national debt since 1970 when the U.S. severed the link between the dollar and gold, as described above, and set the stage for the annual budget deficits which have become the chief feature of government finance with all its lack of anything resembling genuine discipline. The second shows the rise in the gold price in concert with the growth in the national debt. It appears gold has some catching-up to do.

Gridlock at the Fed

"The truth, yet unspoken from on high, is that radical monetary policy begets more radical monetary policy." –– James Grant

In this highly political environment, some think of the Fed as an oasis of collegiality, where the best interest of the economy is guarded with praetorian care – an institution that rises above the fray.  Not so.  The Fed is just as political as the rest of Washington D.C. and that is evident in the minutes from the latest FOMC meeting. There's a split at the Fed and it looks to be enough of one to paralyze monetary policy or, at the very least, freeze it as is for the time being.

That translates to a positive for the precious metals, since that policy is to keep interest rates low and to begin unwinding the $4 trillion in assets now on the Fed's balance sheet. The first undermines the international value of the dollar, a positive for gold. The second raises the specter of tighter money, more disinflation and global systemic risks, also a positive for gold. About the time the Fed's latest dilemma became apparent, gold bolted out of the starting gate.

All of this brings to mind the James Grant quote just above. It is the concluding sentence in a Financial Times editorial that questions global central banks' ability to extricate themselves from the low interest rate, bloated balance sheet matrix they created. With one well-conceived sentence, Grant gets to the heart of the matter.

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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 of 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.