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Discussion Topics -- August 21, 2014
Summer's Over, Buckle Your Seat Belt
Interest Rates and Gold
Demographic Challenges
Mis-priced Risk

(August 21, 2014 discussion) With only the last few days of summer remaining, its time to buckle our seat belts and get ready - the fall is traditionally a very active time of year for the gold market. This week featured the Jackson Hole Symposium, which is an annual meeting of the Federal Reserve governors to discuss the state of the American economy and plans for Fed policy. Perhaps the most analyzed topic is interest rates, with much discussion centered on when actual rate hikes are set to come. Just murmurs of hikes coming 'sooner than expected' caused a little sell off in gold on Thursday. But we're not buying it. Stocks and bonds don't seem to believe the hype as yields continue to push lower, while stocks still hover near all-time highs. Gold seems to be the only asset 'trading the rumor', but that in-and-of-itself is a bit misplaced. Traditionally, the Fed is more reactive than proactive, and interest rate increases tend to be responses to strengthening labor conditions as well as increased inflation. As such, gold has actually typically performed very well during environments where rates are rising, namely in the late 1970's as well as the early 2000's.

Meanwhile, the stock market is seeing more and more in the way of analysts calling for large-scale pullbacks. Most recently, analyst Harry Dent called for stocks to fall dramatically (5000 DOW in two years), due to major demographic challenges in our economy. His reasoning centers around the idea that the only reason stocks have not already responded to this is because of the injections of liquidity by the Fed following the financial crisis. And while Mr. Dent's analysis may be a little extreme, he highlights a very important problem for most developing economies, from our own, to Japan, to European countries as well. We have an aging population with fewer and fewer young people to support it. This strikes at the heart of our potential for long term economic growth, our ability to maintain entitlement programs, and the solvency of our governments. Moreover, Fed injections, combined with the investing behavior of this aging population, have mis-priced risk across multiple asset classes, creating irrationalities in many markets, as investors desperately seek guaranteed yield to the point of reckless abandon. Junk bonds for example are trading with yields only 2X as great as those of long-term treasuries, a clear disconnect between price and risk. It is possible, though, that this phenomenon is starting to turn over. There have been substantial flights of capital from the junk bond market over the past few months. Are the insiders starting to exit?

So where do precious metals stand in all of this? The ratio of the value of gold and silver to housing, bonds, and stocks all point to precious metals being one of the only undervalued investible asset classes. Moreover, silver is looking increasingly undervalued compared to gold. And to bring it all together, as Grant Williams references in his latest letter, physical gold supplies are under far more pressure than they were the last time a financial crisis hit, and a significant stock market pull back took place. What will happen the next time around as the gold market's biggest sellers (Central Banks) have now turned into buyer's and holders? Who will supply the vast amounts of gold that the public will demand when the believers refuse to sell? It will be an interesting environment, to say the least.. 24:04 Minutes, with Jonathan Kosares, Peter Grant and George Cooper.

Figure 1

Dollar index

Figure 2

Bond Yeild

Figure 3

Gold Price Graph

Figure 4

Silver Gold Price ration since 2000

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