In this exclusive interview, Marc Faber answers our followers’ questions on the future, the current global economy, central bankers’ manipulation and the impact on the economy and gold, the possibility for a debt jubilee and more…
Geoff: Hello, and welcome back to this month’s Ask the Expert. I’m your host, Geoff Rutherford, and online with me today we have a man who needs no introduction, Dr. Gloom and Doom, Dr. Marc Faber. Hello, Marc. How are you doing today, sir?
Marc: Fine. Thank you very much, and yourself?
Geoff: Wonderful. Wonderful. Thank you for joining us. We really appreciate that, today.
Marc: It’s my pleasure.
Geoff: So right now, Marc, we have a number of questions from our listeners. I’m not sure if you know, but all the questions here are questions submitted by our listeners here at Sprott Money, and let’s get it started to see what you have to say about these topics.
So firstly, it has been explained that the advantage of the US dollar being the world’s reserve currency is that the US government can print dollars it needs to pay its bills. Bonds are purchased by investors, both domestic and foreign, and the Fed creates money out of thin air. Why don’t other countries use their own central bank’s printing presses to buy their own bonds, and then use the currency they get from selling their bonds, to buy US dollars and then pay off the debts they owe?
Marc: Well basically, if the US buys its own bonds, then because of the status of being a reserve currency, they basically buy their own currency. If foreign governments would start to ease massively, then I suppose the currencies would weaken.
Now, you may say, “Well, why did the dollar strengthen amidst the fact that the US has printed money?” Well, there are some reasons. First of all, maybe the US dollar is not the ugliest among the several sisters, and two, because of the increase in oil production in the United States, the trade deficit has narrowed, and so the dollar can be strong for a while. I don’t think it will last, but the consensus is that the dollar is the strongest currency around. And these other countries, say if Thailand or Singapore or Indonesia would start to print money, then they would weaken their currencies, or that would be the perception.
Geoff: Now, you had mentioned oil as well, sir, and the next question is kind of along the same lines as that. With the slowing world economy that has led to a slowdown in oil demand, what do you think is the long-term future of oil? Likewise, if oil prices rise again, would you recommend buying Russian oil stocks?
Marc: Well, my view is that there are many explanations for the weakness in oil, including some theories that Saudi Arabia wanted to weaken Russia or the shale oil production in the US or Iran, and so forth. But my view is that the decline and sharp decline in oil prices signals a weakening global economy.
Now, in the last few days, I received many reports by brokerage firms and banks, and so forth. They all think that next year the economy in the world will be stronger than in 2014. This would not be my view. Reason A, the low yields on government bonds, that would seem to suggest to me that there are still some growth issues in the global economy, and the sharp fall in the industrial commodity prices would also suggest to me that the economy will be weaker than expected.
And I live in Asia. I can say that we’re not in a recession or in a deep recession, but there’s very little growth at the present time. In fact, I would argue that there’s hardly any growth at all. And as far as Russian oil stocks are concerned, and I think the oil price can rebound here short-term, but you might as well buy some oil drillers in the United States or oil servicing firms or oil companies. Why take a huge risk in Russian oil companies?
Geoff: Makes sense. Now likewise Sir, kind of moving over to gold as well, it has been said that you were not in favor of the Swiss Gold Initiative, in terms of the referendum. If that is the case, why?
Marc: That is completely untrue. I said that I was in favor, but I would prefer to have the National Bank in Switzerland owning at least 50% of their reserves in gold, not just 20%. That’s precisely what I said.
I also argued that it will not be accepted by the public, because the media was against it, all the political parties were against it, and so forth and so on. So I was in favor of it, but I didn’t expect it to be accepted by the public.
And the reason I’m in favor of it, I believe that central banks today have much too much power. Basically, central banks are run by bureaucrats, mostly academics. They studied at nice universities, and so forth. They crunch numbers. Ninety-nine percent of them never worked in the private sector, and to these people you give the authority, or the largest authority, to run the world with their monetary policies. That I will never understand. And I met many central bankers in my life. I would never give any dollars to them for management.
Geoff: Now, kind of sticking along the same line, sir, in terms of, I guess this is more a geopolitical question from one of our listeners. The question is, do you still consider the regimes of supposedly democratic Western nations to be legitimate? If not, what do you think is necessary to restore legitimate government in the Western world?
Marc: Well, this is a very interesting question because we have to ask ourselves, “What is a legitimate government?” Today we have a government, basically in the Western world, that has more voters who receive something from the state then people that actually pay for it. And so I think that democracy is an untested system. We had, maybe, 7000 years of history of civilization, and democracy is precisely, roughly maximum 100 years old, maximum, because in many countries, full democracy was only introduced less than 100 years ago.
Marc: Before, only a few people could vote, and the country that had basically invented democracy, Greece, only certain citizens could vote, not everybody.
Marc: And so I’m asking myself, historically seen, we have to see the outcome of democracy. I don’t believe it will be a good outcome. But anyway, different people may say, “Okay. All governments are bad, but democracy is the best.” I’m not sure about that. Because I’ in Asia, Japan in the ’70s, ’80s, and South Korea, ’70, ’80s, Taiwan ’70, ’80s, Singapore until today, Hong Kong, until today, these countries never really had democracy, but they prospered.
Now you may say, “Well, there were some unusual conditions because of this and that, and so forth.” That may be true, but nevertheless, I’ve seen prosperity already in countries like, or in cities like Venice, Florence, Amalfi,Siena, developed, and they didn’t have democracy. In the German towns where prosperity developed, the trading towns, the Hanseatic towns, they never had democracy. So I’m not sure if democracy is the best system. I’m not saying that it’s not necessarily the best system, but it’s not yet proven. It’s just that society says democracy is good, but maybe it’s a farce. Does your vote have any impact?
Geoff: Mm-hmm. I mean, I suppose it kind of goes back to human nature in that sense. In other words, people are going to be people, so even the system in communism, where there’s kind of this idealized equal opportunity, people are going to be people. Greed takes over, and we have what we have happening today, as you mentioned, with central bankers.
Marc: The problem with communism was that the whole economy was run by the government. In other words, essentially the whole economy was 100% government. That was a problem. In Singapore we had the leader, for the last, essentially, 50 years, and he’s done a great job. And in other countries also we had great leaders, but the issue really is, “How much government do you want? How much transfer payments do you want?” In my view, a small government is the best, the maximum, say 15 to 20% of GDP. But now, in the Western world, we have, through all the transfer payments, governments that are close to 50% of GDP, and in some countries, more than 50% of GDP.
Marc: So you have socialism. And I’m not suggesting that the capitalistic system in the best, but probably, of all bad systems, it is the best.
Geoff: Now let’s take a look now, kind of going back to precious metals, and our next question is, will the US put a windfall profits tax on gold and silver ones these metals begin to break out? What should be done of this occurrence?
Marc: Well, I think this is, again, a very good question, because I’m sure that this will happen, not just the profit tax. I think the US government, when gold really starts to move, will take it away. They will pay something. Say like in 1933, they paid $25 per ounce of gold that people held, and after they have collected most of the gold – of course not the gold that was held by government officials, or to precisely say “by corrupt government officials,” because they’re all corrupt – they revalued the gold to $35. So the investor lost out. And I think what will happen, the US will eventually, under some kind of an excuse, whether it’s terrorism or whatever it is, expropriate gold. They’ll pay, say, at today’s price, $1220 an ounce, and then they’ll go to the ECB.
The ECB and the Federal Reserve are one and the same. The Bank of England also. They talk to each other every day. They’re the chief manipulators of everything. And then they say to the ECB, “Well, because we do it, you also should do it,” and the Draghi-type of – I don’t want to say what I think of him, but I say, Draghi-type of personalities, they’re saying, “Yeah. Yeah. We’ll do it also,” and then the Bank of England, of course, will do it also. Then they knock on the doors of the thrifts and say, “You thrifts, you also have to do it,” and the thrifts, they have no backbones anymore. The thrifts will say, “Okay. We’ll also do it.”
And so the threat is really for an investor, is where do you store your gold? Because if you have it in a bank or in an ETF, it may be taken away. And whereas I think that the Sprott Physical Gold are the best ones. When the US knocks on the door of Canada and says, “You have to do the same,” the Canadians will also say, “Yeah. Okay.” And so the best, probably, to store gold in Dubai, in Hong Kong, Singapore, physically.
Geoff: Physical ownership makes more sense, clearly.
Marc: It’s better. . .
Marc: . . . gold shares are, of course, incredibly low, compared to the physical price of gold.
Geoff: Well here’s another question, Marc. It’s more along the terms of an investment for our listeners. So currently, is it better for amateur individual investors to have some exposure to equities and bonds, or should they stay away from those markets altogether?
Marc: My view is very simple. I have no clue, although I’m an investment advisor, how the world will look like in five years time. Now, maybe some forecaster knows, but I haven’t met them yet, and I’d like to meet them yet. The fact is simply, we don’t know much about the future. We even know little about the present and the past. And my advice to anyone investing is diversification. You have to own some equities. You own some gold. You own some cash and bonds, and you own some real estate. That is what you should do, because we don’t know.
But in general, I believe that investors will be deeply, and I repeat, deeply disappointed by future returns. Some assets will go up, and some assets will go down. Just consider, oil drilling stocks have declined by roughly 40, 50% from the peak.
Marc: The oil price is down 40% in six months. We have a lot of volatility. If you owned your assets in Japan, in equities you did okay, because the equity market has rallied. Whereas the yen has collapsed. But if you owned it, say, in real estate, the real estate hasn’t rallied as much as the yen went down. If you owned it in cash, you’ve been basically losing a lot of money. So we have, nowadays, a lot of volatility, and nobody knows. It depends all on the interventions.
But I would say this, the whole world believes that because of money printing, stocks will automatically go up. That is far from certain. At one point, this correlation between money printing and stocks going up, will break down the way the correlation between money printing and gold price broke down after 2011. So we don’t know. This is my view.
Now, you listen, and somebody says, “What kind of an idiot do you have in your interview? He doesn’t know,” but this is the fact. I’d rather say that nobody knows for sure. A lot of money will be lost by people who are overexposed in a sector that will collapse in price, and some people will make money because they gambled on the right move, in exchange rates or in bonds or and stocks. But I don’t know. So I’m diversified.
There’s one thing I know.
Marc: The end will not be pleasant. We have a systemic risk, and the system, such as it is today, is not going to survive for long, maybe another five years, maybe another 10 years, maybe only one year, but the end will not be pleasant for investors. That is what I know.
Geoff: Understood, sir.
Now, let’s take a look at this now. Given the recent quintupling of the US monetary base and revelations of massive serial rigging of global currency markets, what do you think will happen when the US dollar falls to its real value? What do you think that real value is, for that matter?
Marc: Again, you have very good questions. Nobody knows for sure. I mean, the US is still a superpower, from a military point of view. From a prestigious point of view, the US is in the dumps, because everybody in the world now realizes what kind of a hypocritic leadership the US has. They go around the world and tell people about democracy. They tell people about human rights, about torture, about evil regimes, about nation-building, and what do they do? Torture. It has been exposed. So the prestige of the US is gone, forever, and nobody will ever trust the US anymore.
Geoff: I agree, sir. I think after we saw what happened in the UN, with the Council, and we’re hearing Barack Obama called the three most relevant threats to humanity, and he names Ebola number-three and the Russian Federation number-two. I think we’ve reached the point of absurdity at this point.
Marc: It’s a complete joke. And you have Dick Cheney and his mafia colleagues telling the world that this was absolutely legal, and so forth. I mean, it’s a complete joke. The Americans, when they travel alone, they’re welcome everywhere, but nobody in the entire world likes the US government any longer. That should be clear.
Geoff: Right. I see what you mean, sir.
Marc: They’re the laughingstock of the world, the laughingstock. Actually, it’s more tragic. It would be nice to be the laughingstock, but people look at the US. They come and advise other countries how to run their business, and so forth, and themselves, they live by American exceptionalism. What kind of story is this? It’s actually depressing.
Geoff: Well, let’s take a look now at the idea of global debt. What is your opinion about the possibility of a global debt jubilee? How might one be manifested?
Marc: Yes. I mean, I think this is the real issue, in the sense that what could happen is that, in a concerted effort, central banks around the world would essentially buy up all the government bonds. It’s possible. We don’t know. The U.S. Treasury and the ECD. Actually, the Bank of Japan is a good example. They’re buying all the government bonds that the government is issuing. What the outcome will be, we don’t know for sure, but again, my view would be that the outcome will not be very favorable. At some point, yields on bonds will go up.
Now, you may say, “Okay. If the government buys all the government bonds, how can yields go up?” Well, they can go up because there is a lot of debt outstanding already, and whereas the government debt may not collapse in price, in other words, yields on government bonds may not go up substantially. What may happen is that corporate bond yields, and in particular, high yield bond yields could go up substantially.
But I’m just trying to say, in my view, the current regime, run by central bankers, is not going to end well. I mean, someone has to pay for the government’s expenditures, and if you have these kind of deficits that we have in most countries, eventually something will happen. And we do not only have rising government debt. We have rising corporate debt, rising household debt, and so forth and so on, and we have the unfunded liabilities. Nobody talks about that.
I mean, let’s put it this way, I think it’s important for the individual to think this through very carefully. I don’t think the real estate will be expropriated, because everybody owns real estate, so it’s politically not acceptable, but it can be taxed more heavily, because it’s very visible. So I’m not so sure that real estate is the best investment, but at least you’re not going to lose everything.
Then comes equities, if you compare equities, say. In Switzerland, blue-chip stocks yield, say, around, have a dividend yield of maybe 3%, two and a half, 3%, and the government bond yield now, in Switzerland, is less than 0.25% on 10-year government bonds. So if I buy a thrift government bond for 10 years, the maximum I will earn, if I hold it to maturity, is, as of today, precisely 0.24% per annum. Doesn’t even cover my fees to the bank.
Marc: Now, if I buy blue-chip stocks, I earn, say, a dividend yield of two and a half, 3%. In some cases more. In some cases a little bit less. But over a 10-year period, I think that the stocks are going to be a better investment than the bonds market.
Now, on the other hand, if I look at the US 10-year government bond yield, it’s 2.2% today. In France it is less than 1%. So I’m saying to myself, “Well, maybe government bond yields are reasonably effective,” and everybody is bearish about bonds. But as I said, I don’t know. I’m just saying, in absence of knowing, the best the investor can do is to say to himself, “Central banks have created a low-return environment, a low-return and high-risk environment, I may say, and in this low-return, high-risk environment, the best strategy’s probably to be diversified. I mean, I’m happy if, in the next five years, I don’t lose any money. (Laughs) Yeah right. I’m not greedy and want to earn any money. I prefer not to lose any.
Geoff: I think we don’t want to lose any, sir. I agree.
Marc: And US frauds, you know that. I mean, to take big exposures is a very risky proposition, and I want to explain to you why. When you print money, and this has been observed by Copernicus already in the 17th century and by David Hume and Irving Fisher, the money does not flow evenly into the system. So when you print money, some things go up, and others don’t. Some things go up, and then there is a bubble, and then collapse, like the NASDAQ in 2000 and the housing bubble in the US in 2007, and so forth and so on. So you just don’t know exactly when the bubble bursts, and not all assets’ prices are touched positively.
I was going to say, if you bought gold in 2011, at the peak, $1921, September, 2011, you lost a lot of money, but the logic would have said, “Oh. There’s money printing; the gold price will go up.
Marc: And so the way gold went down by essentially 40% since then and oil prices collapsed by 40% since then, the US stock market could also collapse, easily, by 40%. Actually, I’d be surprised if it only collapses by 40%. But I don’t know precisely from which level. That is the problem.
Geoff: Understood, sir.
Now, let’s take a look at a question about mining now. Recently, Rick Rule has said he’s expecting a capitulation in equities within the precious metals mining sector. Whether or not this capitulation is actually reached, with miners down 80%, why are institutional investors, or sovereigns like China, not moving into this space more rapidly and acquiring these shares at these hugely undervalued levels?
Marc: Well first of all, what is overvalued and undervalued is a subjective judgment, and I tend to agree with Rick that gold shares, okay, they’re down 80%, and they are cheap, compared to the physical price of gold and compared to Facebook and Google and all these Netflix type of stocks. That I agree entirely.
But you have to understand, institutional investors, either they are ETF, which are passive investors, so by indices, the S&P 500 or the Toronto Stock Exchange Index, or what not, or they are active managers, and the hedge funds are also active managers. Now, they don’t care about what will happen in five years time. They care what will happen within the next week. They want to be in stocks that move within a week, within a month, because they need to show performance. If they don’t show performance, then the clients leave them. So everything has become very short-term oriented, and I would suggest to an investor to forget about the short-term and to think from a longer-term perspective, where is their value?
I happen to think and agree with Rick Rule that there is value in gold mining shares, and I think they could easily rebound from this level by 30 to 40%. The GDXJ, the Junior Gold Mining Stock Index, has, in the first six months of the year, did rebound 40%, but then it came back again to essentially slow. So we have volatility in these stocks. And personally I hold, of course, much more in physical gold than in gold shares, but because I’m a director of NovaGold and Sprott Inc. and Sunshine Mining and Ivanhoe, I also own shares, and I think they’re very cheap at the present time, and they could easily double, all of them, easily.
Look. Investors buy high and sell low. Please remember that. I went to dinner, in 1999 in St. Moritz in Switzerland. There were lots of people with money and they said, “Oh. We make so much money buying and selling the NASDAQ and tech stocks as well. Then they ask me my opinion. I said, “Gold is very cheap.” It was, at that time, $255, or something like this. Then they said to me, “Gold only goes down,” because yes, it has gone down from $850 in 1980 to $255, but I told them, “Because it only goes down, it interests me to buy it, because it’s a neglected asset class.”
Now I don’t know, maybe gold goes still to $800 and maybe not. I don’t think so. But before the Swiss Initiative, the media was extremely negative about gold, because if the initiative in Switzerland would have been accepted, it would have given a message to the world, central banks may start, or they have to, under the pressure of the world, just to own some gold. And so the sentiment about gold, copper, the euro, oil, at the present time, is maximum, and I repeat, maximum bearish. So I think a rebound may take place. Is it the new leg in the bull market? Who knows? But I think gold could easily shoot up by $100 here, and gold shares could easily go up by 30, 40%.
Geoff: We really hope so. I think we’re waiting for a comeback at this point.
Marc: We shouldn’t hope. We should always think realistically. The fact is, simply, when I look at these people in central banks, and they’re monitoring things, and believe me they will never admit that they’ve been wrong. They’ve printed money like crazy, and the global economy basically is stagnating. And I’ve written about this. The more money you print, the more real wages go down. That is the problem.
Geoff: So Sir, the next question, actually – we just talked about Rick Rule – this question now is kind of centered around something that Jim Willie actually stated. Jim Willie states that the USA really didn’t stop their bond buying, and the reason Japan is printing is because the buying is going through their central bank now. Is there any truth to this? Have you ever heard anything about this before?
Marc: Well, there are many theories and so forth. I think they’re still buying bonds, because they earn the interest on assisting positions, and what they can do is, let’s say the ECD buy bonds, also the Bank of England or the bank of Japan, and so forth. That’s why said, the Fed and ECB and the Bank of England, the Bank of Japan, basically they talk to each other every day. They are the Mafia, the chief manipulators, and we don’t know exactly what is being said. That’s why it creates a lot of uncertainty in the markets, and in my view, undue volatility.
But one thing I’m sure of, before the whole system collapses, the governments and the agents, which are the treasury departments and the central banks, will do everything – everything – to protect the system from collapsing, and in my view, this will involve much more QEs around the world.
Geoff: Now, kind of going back to, we talked, well, I talked a little bit about Russia, and you talked about Russia as well. After the latest anti-Russia resolution, which I believe is Bill 758 of the U.S. Congress and a scathing condemnation and assessment of Ron Paul, do you think the US government is committed to starting World War III?
Marc: Well, I don’t think they’re committed to it. In principle, nobody wants war, but who knows? Under Obama, I don’t think it will happen. But in future governments, who knows? I hope it will not happen, because war is horrible, and the Western world, it does not have the spirit to fight wars anymore. You look at the millennials. (Laughs) How many of them do you think will be on the frontline. I have to laugh when I see all these Facebook clowns. If you think they’re going to fight the war . . .
Marc: . . . never. They’ll send some soldiers, mercenaries, and the mercenaries are basically out to make money, not to fight really wars for the purpose of an ideal or a purpose. They’re out there to make money, and so the outcome is going to be disaster. If the US couldn’t do any better in Afghanistan and Iraq, what do you think would they achieve against China or Russia?
Geoff: Very true. That’s very true.
Marc: It’s going to be a disaster, but for defense stocks, it may be good. For gold, it may be good. I don’t know. But I’m actually happy to be 68, so I’ll pass away in, say, 10 years time. Don’t have to watch the disastrous economic and geopolitical decisions of the Western world. Sometimes it depresses me. Believe me.
Geoff: Well sir, it’s been a pleasure speaking to you. Of course, we’ve been speaking to Dr. Marc Faber, Dr. Gloom and Doom himself, and we urge our listeners to go to GloomBoomDoom.com to get more insight from this man who’s been speaking today. Dr. Faber, thank you for joining us today, sir. It’s been a pleasure speaking to you.
Marc: It was my pleasure. Thank you very much. Yes. I also wish your listener Merry Christmas. Although, nowadays it’s not even politically correct to say that in many countries. You should say “Festive Season.” But Happy New Year is still valid.
Geoff: Wonderful, sir, and all the best to you, too.
Marc: Yes. Thank you very much.
Geoff:Wonderful, and to our listeners, thank you for listening. This is Geoff Rutherford for Ask the Expert here on Sprott Money News. This is the last Ask the Expert for the year, so have a Merry Christmas and a prosperous new year. Take care.
Crude oil and silver prices have crashed before, and they will again. But the one constant in our financial universe that seems inevitable, for the foreseeable future, is increasing debt. Crude oil and silver prices will follow increasing debt.
Examine the following chart of monthly crude oil prices. In the past 26 years crude oil prices have crashed 65%, 59%, 54%, and 76%. The current crash is about 51% so far.
Examine the following chart of monthly silver prices. You can see similar crashes of 64%, 46%, 51%, and 68% since 1986. Prices rallied after these crashes and went considerably higher. Sometimes it took years, but like the national debt, silver prices have substantially increased since 1913.
Examine the US national debt, which is currently over $18 Trillion = $18,000,000,000,000. Unfunded liabilities, which might be ten times larger, are not even considered in the following graphs. Adjust the national debt for population increases so we see only the per capita national debt. As expected, it is climbing exponentially higher, and accelerating since 9-11.
Following the increase in national debt is an increase in the currency in circulation and the prices for most commodities and consumer goods. Examine the graphs for population adjusted national debt, crude oil, silver, and the S&P 500 Index, all of which show annual averages of weekly prices. Note that all prices have been indexed to 1971 = 1.0 for comparison purposes.
Note that the recent crash in crude oil prices is not yet reflected in the annual average of weekly prices.
Crude oil and silver prices have crashed before, and they will again. But the one constant in our financial universe that seems inevitable, for the foreseeable future, is increasing debt. Crude oil and silver prices will follow increasing debt.
Expect the S&P to correct downwards (eventually), expect silver and crude to resume their upward trajectory (eventually, probably soon), and, like the inevitability of death and taxes, expect debt to inevitably accelerate higher.
WHEN the corrections will occur seems more and more under the control of the High Frequency Traders, the politicians, and the banking cartel. Sadly our global economic problems, which have been exacerbated by the crude oil crash, will not cured with more debt, which seems to be the preferred “solution.”
Gold and silver are real money, and they are insurance against the craziness and volatility of debt based fiat currency that is increasingly vulnerable to currency crashes like we have seen in Argentina, Venezuela, Ukraine, Russia and elsewhere.
A currency crash can also occur in Japan, Europe, and the United States. Those dollars, euros, and yen have counter-party risk while gold and silver do not.
Courtesy: Gary Christenson – The Deviant Investor
What will gold do in 2015 is a question that is top of mind of many gold investors, particularly during this period of the year. We reached out to gold analyst Ronald-Peter Stoeferle, Managing Partner and fund manager at Incrementum AG in Liechtenstein, author of the In Gold We Trust reports, to get his taken on the outlook for gold for 2015. His expectations for 2015 are summarized by the 10 charts in this article.
This year was cleary a mixed bag for the precious metals. On the one hand, gold stabilized and confirmed its trading range which was formed after last year’s price crash. Another positive fact is the relative strength of the price of gold in most major currencies non-U.S. Dollar, as evidenced by comparing the first two charts below (the first chart, Euro gold, looks relatively more solid than Dollar gold). On the other hand, silver and the miners went lower and broke below their trading range. That is clearly disinflationary, and disfinlation has been the main message that the precious metals complex has signaled in the past year. That is also the baseline for gold’s outlook for 2015.
The constant outperformance of the U.S. stock market was the main theme in financial media. Similarly, gold’s weakness has been emphasized over and over again in 2014. That has undoubtedly created the perception that stocks have been a much better investment class than gold. Although that conclusion sounds intuitive to some, it is not supported by the facts as evidenced by the following chart.
The next chart compares gold with the stock market performance in 7 major regions or countries in 2014. It shows that only the U.S. and Japanese stock market outperformed gold in 2014. As an investment asset, holding gold in 2014 was not a bad idea at all.
The Dollar and Euro gold price charts above show that gold was a rather stable asset class which is the baseline going into 2015. Ronald Stoeferle’s outlook for gold in 2015 is based on a continuation of that trend. It would not be realistic to expect a major move higher in the first half of 2015. Why? Because the current monetary and economic environment, characterized by a rise in negative real rates and a weakening of inflation momentum, is not very gold friendly.
The next chart shows negative real rates in blue and the gold price in gold. Since 2001, 56% of months had negative real rates. The level of interest rates has mostly determined the steepness of the gold price change. Real rates have been rising since 2011, not coincidentally the top of the gold price. Notice also on the chart how real rates are still in negative territory which suggests that the secular bull market is not over yet. It seems that the correction in the price of gold has reflected a lower level of real interest rate change.
This brings up the question whether we could potentially see positive real rates in 2015 driving gold into a secular bear market? Although nobody knows for sure, it seems an extremely unlikely scenario. First, try to imagine what would happen with the debt servicing cost if rates would rise. Second, with worsening results in the last earnings season(s), the effect of rising rates on corporate bonds would be very destructive. Third, the effect on the real estate market would be slightly devastating. Those are fundamental reasons to believe that the ongoing correction is not secular in nature.
The rate of inflation is slowing down which is, in simple terms, disinflationary. It is not so much the absolute rate of inflation that is relevant for the gold price, but rather the rate of change of inflation. Rising inflation rates generally mean that the environment for the gold price is positive, while falling rates of inflation (= disinflation) indicate the environment is negative. The next three charts set the expectation for the first months of 2015.
The gold to silver ratio keeps on rising, which points as well to disinflation. Expect this trend to continue in the coming months.
The third confirmation comes from the Incrementum Inflation Signal, a proprietary and an in-house developed indicator which signals the level of inflation / deflation. As the next chart shows, the predictive value of the indicator is very high; it has nailed every inflation rate change of substantial proportion since its inception. It currently has a low reading, comparable to early 2014, so the first period of 2015 should not be very gold friendly.
Meantime, we know for sure that monetary policy makers will continue to be the key trendsetters for the markets, including precious metals. Who believes that central planners have fixed all issues and that 2015 will go smooth economically? Probably central planners themselves hold that belief, as some of them are already starting a deleveraging process. Take the example of the U.S. Fed and Europe (see next chart).
Monetary policy will undoubtedly be the key driver for markets, money and metals in the years ahead. Stoeferle’s fundamental belief is that we will experience unintended consequences of these monetary interventions resulting in increasing volatility. Although nobody can predict the exact timing, it is realistic to expect this taking place somewhere in 2015.
As suggested by the above charts, the disinflationary trend is likely to continue in the short run. However, based on the steepness of the disinflationary / deflationary phases, one could expect extreme measures by central banks which could result in (highly) inflationary phases. In other words, because of monetary policy, one should realistically expect alternately periods of inflation and deflation.
The following chart makes the point on monetary inflation vs deflation. The U.S. and European central banks have embarked upon monetary disinflation in 2014. The real economy has not shown meaningful acceleration, however. It is fair to expect that monetary inflation will return. That is another fundamental driver for gold’s long term prospect.
Astute readers remember which draconian measures the U.S. Fed has underataken since 2007. We sum them up in chronological order: interest rate cuts in 2007/8, zero interest rates and communications policy since 2008, QE I between 2008 and 2010, QE II between 2010 and 2011, Operation Twist between 2011 and 2012, QE III since 2012.
All those measures have had only moderate results in the real economy, i.e. the results have not reflected the extreme character of the measures. That is why a disinflationary bust could be the trigger for central banks to launch one or more of the following measures in 2015:
Think for a moment about the last point in the list. Charging on reserves is really not that far away. The timing of the article could not have been better in that respect, as only a week ago the Swiss National Bank has announced a negative interest rates on some reserves of Swiss banks.
Another indication why gold is not set to rise sharply in 2015 is the historic behaviour of gold’s 200 day moving average. The next chart suggests that periods in which gold had moved longer than average above or below its 200 day moving average have taken some time till normalization or reversal took place.
Given all the above trends and data points, Stoeferle feels that gold is in a long term bottom range. Although the price of the yellow metal could go lower in the short run, it seems unlikely that another price crash similar to the one in the first half of 2013 is about to repeat. That is clearly a contrarian call compared to the expectations of “pundits” in the mainstream media (think of the calls of $800 gold).
As anecdotal evidence, the bonus chart below shows the liters of beer that can be bought during the Oktoberfest, with one ounce of gold. It is still above its long term average, suggesting the bull market is still intact.
In a larger sense, the Fed is already intervening in the oil sector via its zero interest rate policy (ZIRP) and its unlimited liquidity for financial speculation.
The problem with financializing a critical sector of the economy is the financialization process transforms it into a systemic risk. The trajectory of every financialized sector is the same: debt and leverage are piled ever higher on a base of collateral that eventually collapses as heightened risk becomes the Monster Id of a crowded trade.
Once the Monster Id burns through the firewalls that were supposed to limit risk, the crowded “safe” trade blows up and the conflagration quickly spreads throughout the financial system.
Every financialized sector thus has the potential to take down the entire financial system.
The mortgage sector is a prime example of this dynamic. The financialization of the mortgage industry created the subprime mortgage firetrap, which inevitably caught fire and threatened to burn down the entire global financial system.
The central bank that encouraged the financialization then has no choice but to intervene to save the system from the toppling dominoes of leverage and risk. Once the mortgage sector was fully financialized–securitized, tranched, packaged into collateralized debt obligations and other derivatives–the implosion of the weakest link (subprime mortgages backed by bogus collateral and liar loans) was baked into the financialization process.
As the systemic dominoes started falling, the Too Big to Fail (TBTF) banks had to be bailed out to the tune of trillions of dollars in guarantees, backstops and loans. As correspondent Mark G. has noted, the debtors are left to suffer the consequences of their risky debt, but the big creditors are saved from the consequences of their bad bets.
This is the essence of moral hazard–risk is disconnected from consequence by central bank intervention. Gains are privatized, losses are socialized, i.e. borne by the taxpayers and savers whose interest has been siphoned to private banks by the central bank.
Now the latest sector to be financialized, oil, has blown up, falling in a parabolic freefall from over $100/barrel to a recent low around $53. And once again, the sector’s losses are threatening to undermine sectors with no direct connection to oil.
When central banks feign disinterest in intervention, it can be taken as a sign that they’re either planning intervention or are already actively intervening via proxies. Central banks play two hands at all times: their propaganda campaign of talking up their intervention (“whatever it takes,” etc.) and their sustained opaque interventions via proxies.
When it behooves central banks to appear actively engaged in saving stock and bond markets from melting down, their interventions are publicly flogged on a weekly or even daily basis– for example, the QE campaigns 1,2 and 3.
When their interventions exceed their mandate for outright manipulation of markets–for example, buying future contracts in the S&P 500 within the last 15 minutes of trading to push the markets into the green–it’s all kept far from the public eye, hidden behind proxies.
Given the systemic risks arising from the meltdown of oil, why would the Federal Reserve let this latest implosion spread to the entire over-leveraged system? After six years of continual intervention in financial markets, why would the Fed suddenly cease its labors to keep imploding sectors from destabilizing the rest of the rickety structure?
It beggars belief that the Fed would stand by doing nothing, while the financial dominoes from oil’s 50% decline start toppling.
The question isn’t, why would the Fed intervene in the oil market? The question is, why wouldn’t the Fed intervene in the oil market?
The Fed, via proxies, might buy oil futures contracts to prop up the collateral, and (again through proxies) it might even start buying up impaired high-risk bonds based on oil.
In a larger sense, the Fed is already intervening in the oil sector via its zero interest rate policy (ZIRP) and its unlimited liquidity for financial speculation. Should the Fed turn the dial of intervention up by buying futures and oil-based bonds, it is not a new policy–it is simply a matter of degree. The intervention has been going on in every sector since 2008. The implosion of the oil sector is simply the latest outbreak of consequence following cause.
Courtesy: Charles Hugh Smith
If you only paid attention to the mainstream media, you’d be forgiven for thinking that the US is going to get away from the collapse in oil prices scot free. According to popular belief, America is even going to be a net winner from cheaper oil prices, because they will act like a tax cut for US consumers. Or so we are told.
In reality, though, many of the jobs the US energy boom has created in the last few years are now at risk, and their loss could drag the economy into a recession.
The view that cheaper oil automatically boosts US GDP is overly simplistic. It assumes that US consumers will spend the money they save at the pump on US-made goods rather than imports. And it assumes consumers won’t save some of this windfall rather than spending it.
Those are shaky enough. But the story that cheap fuel for our cars is good for us is also based on an even more dangerous assumption: that the price of oil won’t fall far enough to wipe out the US shale sector, or at least seriously impact the volume of US oil production.
The nightmare for the US oil industry is that the only way that the market mechanism can eliminate the global oil glut—without a formal agreement between OPEC, Russia, and other producers to cut production—is if the price of oil falls below the “cash cost” of production, i.e., it reaches the price at which oil companies lose money on every single barrel they produce.
If oil doesn’t sink below the cash cost of production, then we’ll have more of what we’re seeing now. US shale producers, like oil companies the world over, are only going to continue to add to the global oil glut—now running at 2-4 million barrels per day—by keeping their existing wells going full tilt.
True, oil would have to fall even further if it’s going to rebalance the oil market by bankrupting the world’s most marginal producers. But that’s what’s bound to happen if the oversupply continues. And because North American shale producers have relatively high cash costs (in the $30 range), the Saudis could very well succeed in making a big portion of US and Canadian oil production disappear, if they are determined to.
In this scenario, the US is clearly headed for a recession, because the US owes nearly all the jobs that have been created in the last few years to the shale boom. All those related jobs in equipment, manufacturing, and transportation are also at stake. It’s no accident that all new jobs created since June 2009 have been in the five shale states, with Texas home to 40% of them.
Even if oil were to recover to $70, $1 trillion of global oil-sector capital expenditure—in fields representing up to 7.5 million bbl/d of production—would be at risk, according to Goldman Sachs. And that doesn’t even include the US shale sector!
Unless the price of oil miraculously recovers, tens of billions of dollars worth of oil- and gas-related capital expenditure in the US is going to dry up next year. While US oil and gas capex only represents about 1% of GDP, it still amounts to 10% of total US capex.
We’re not lost quite yet. Producers can hang on for a while, since there has been a lot of forward hedging at higher prices. But eventually hedges run out—and if the price of oil stays down sufficiently long, then the US is facing a massive amount of capital destruction in the energy industry.
There will be spillover into the financial arena, as well. Energy junk bonds may only account for 15% of the US junk bond market, or $200 billion, but the banks are also exposed to $300 billion in leveraged loans to the energy sector. Some of these lenders are local and regional banks, like Oklahoma-based BOK Financial, which has to be nervously eyeing the 19% of its portfolio that’s made up of energy loans.
If oil prices stay at $55 a barrel, a third of companies rated B or CCC may be unable to meet their obligations, according to Deutsche Bank. But that looks like a conservative estimate, considering that many North American shale oil fields don’t make money below $55. And fully 50% are uneconomic at $50.
So if oil falls to $40 a barrel, a cascading 2008-style financial collapse, at least in the junk bond market, is in the cards. No wonder the too-big-to-fail banks slipped a measure into the recently passed budget bill that put the US taxpayer back on the hook to insure any ill-advised derivatives trades!
We know what happened the last time a bubble in financial assets popped in the US. There was a banking crisis, a serious recession, and a big spike in unemployment. It’s hard to see why it should be different this time.
It’s a crying shame. The US has come so close to becoming energy independent. But it’s going to have to get its head around the idea that it could become a big oil importer again. In the end, the US energy boom may add up to nothing more than an illusion dependent upon the artificially cheap debt environment created by the Federal Reserve’s easy money policy.
However, there are a handful of domestic producers with high operating margins that are positioned to profit right through this slump in oil prices.
The article Make No Mistake, the Oil Slump Is Going to Hurt the US Too was originally published at caseyresearch.com.
In a normal economic times falling energy costs would be considered unadulterated good news. The facts are simple. No one buys a barrel of oil to display above the mantle. No one derives happiness from a lump of coal. Energy is simply a means to do or get the things that we want. We use it to stay warm, to move from Point A to Point B, to transport our goods, to cook our food, and to power our homes, factories, theaters, offices, and stadiums. If we could do all these things without energy, we would happily never drill a well or build a windmill. The lower the cost of energy, the cheaper and more abundant all the things we want become.
This is not economics, it is basic common sense. But these are not normal economic times, and the mathematics, at least for the United States, have become more complicated.
Most economists agree that the bright spot for the U.S. over the past few years has been the surge in energy production, which some have even called the “American Energy Revolution”. The stunning improvements in drilling and recovery technologies has led to a dramatic 45% increase in U.S. energy production since 2007, according to the International Energy Agency (IEA). And while some suggest that the change was motivated by our lingering frustration over foreign energy dependence, it really comes down to dollars and cents. The dramatic increase in the price of oil over the last seven or eight years, completely changed the investment dynamics of the domestic industry and made profitable many types of formerly unappealing drilling sites, thereby increasing job creation in the industry. What’s more, the jobs created by the boom were generally high paying and full time, thereby bucking the broader employment trend of low paying part time work.
The big question that most investors and drillers should have been asking, but never really did, was why oil rocketed up from $20 a barrel in 2001 to more than $150 barrel in 2007, before stabilizing at around $100 a barrel for much of the past five years. Was oil five times more needed in 2012 than it was in 2002? See my commentary last week on this subject.
Despite the analysts’ recent discovery of a largely mythical supply/demand imbalance, the numbers do not explain the rapid and dramatic decrease in price. Yes, supply is up, but so is demand. And these trends have been ongoing for quite some time, so why the sudden sell off now? Instead, I believe that oil prices over the last decade has been driven by the same monetary dynamics that pushed up the prices of other commodities, like gold, or of financial assets, such as stocks, bonds, and real estate. I believe that oil headed higher because the Fed was printing money, and everyone thought that the Fed would keep printing. But now we have reached a point where the majority of analysts believe that the era of easy money is coming to an end. And while I do not believe that we are about to turn that monetary page, my view is decidedly in the minority. Could it be a coincidence that oil started falling when the mass of analysts came to believe the Fed would finally tighten?
If I am wrong and the Fed actually begins a sustained increase in rates starting in 2015, oil prices may very well stay low for a long time. But apart from the fact that our broad economy can’t tolerate higher interest rates, an extended drop in oil prices may create conditions that further force the Fed’s hand to reverse course.
If prices stay low for very long, many of the domestic drilling projects that have been undertaken over the past few years could become unprofitable, and plans for further investment into the sector would be shelved. Evidence suggests that this is already happening. Reuters recently reported a drop of almost 40 percent in new well permits issued across the United States in November (this was before the major oil price drops seen in December).
This huge negative impact on the primary growth driver of U.S. economy may be enough in the short-run to overwhelm the other long-term benefits that cheap energy offers. If prices stabilize at current levels, then the era of triple digit oil may, in retrospect, be looked back on as just another imploded bubble. And like the other burst bubbles in tech stocks and real estate, its demise will make a major impact on the broader economy. But there is a crucial difference this time around.
When the dot-com companies flamed out in 2000, most of the losses were seen in the equity markets. Dot-coms either raised money either through venture capitalists or the stock markets. They rarely issued debt. The trillions of dollars of notional shareholder value wiped out by the Nasdaq crash had been largely paper wealth that had been created by the sharp run up in the prior two years. As a result, the damage was primarily contained to the investor class and to the relatively few number of highly paid tech workers and entrepreneurs that rode the boom up and then rode it down. In any event, the Fed was able to cushion the blow of the ensuing recession by dropping rates from 6% all the way down to 1%.
The real estate and credit crash of 2008 was a much different animal. Despite the benefits that lower home prices may have brought to many would be home-buyers who had been priced out of an overheated market, the losses generated by defaulting mortgages quickly pushed lending institutions into insolvency and threatened a complete collapse of the U.S. financial system. Unlike the dot-com crash, the bursting of the housing bubble posed an existential threat to the country. The construction workers, mortgage brokers, landscapers, real estate agents, and loan officers who were displaced by the bust represented a significant portion of the economy. To prevent the bubble from fully deflating, the Fed bought hundreds of billions of toxic sub-prime debt (that no one else would touch) and dropped interest rates from 5% all the way down to zero.
I believe, a bust in the oil industry will likely play out somewhere between these two prior episodes. As was the case with falling house prices, while low prices offer benefits to consumers, the credit and job losses related to unwinding the malinvestments, made by those who believed prices would not drop, can impose severe short-term problems that the Fed will be unwilling to tolerate. Of course, long-term it’s always good when a bubble pops, it’s just that politicians and bankers are never prepare to endure the short-term pain necessary for long-term gain when they do.
A good portion of the money used to finance the fracking boom was raised by relatively small drillers in the debt market from banks, institutional investors, pension funds, hedge funds, and high net worth wildcatters. Public involvement has been involved primarily in the high yield debt market where energy companies have issued hundreds of billions of “junk” bonds in recent years. In 2010, energy and materials companies made up just 18% of the US high-yield index but today they account for 29%.
But many of the financing projections that these bond investors assumed will fall apart if oil stays below $60. Although the junk bond market is nowhere near as large as the home mortgage market, widespread defaults from energy-related debt could cause a crisis, which could make wider ripples throughout the financial edifice. Bernstein estimates that sustained $50 oil could result in investment in the sector to fall by as much as 75%. According to the Department of Labor, oil and gas workers as a percentage of the total labor force has doubled over the past decade, and have accounted for a very large portion of the high-paying jobs created during the current “recovery.” As a result a bust in the oil patch will result in a very big hit to American labor, causing ripple effects throughout the economy.
But we are far less able to deal with the fallout now of another burst bubble than we were in 1999 or 2007 (the years before the two prior crashes). I believe it will take much less of a shock to tip us into recession. But I don’t even believe that a burst energy bubble is even our biggest worry. Much greater and more fragile bubbles likely exist in the stock, bond and real estate markets, which have also been inflated by the easiest monetary policy in history. More importantly at present the Fed lacks the firepower to fight a new recession that a bursting of any of these bubbles could create. Since interest rates are already at zero, it has no ability to aggressively cut rates now in the face of a weakening economy. All it can do is go back to the well of quantitative easing, which is exactly what I think they will do.
Despite the widely held belief that 2015 will be the year in which a patient Fed finally begins to normalize rate policy, I believe the Fed has no possibility of withdrawing the stimulus to which it has addicted us. QE4 was always much more probable than anyone in government or on Wall Street cares to admit. A recession and a financial panic caused by sub $60 oil will significantly quicken the timetable by which the Fed cranks up the presses. When it does, oil could once again increase in price, along with all the other things we need on a daily basis. That should finally dispel any remaining illusions that the Fed could successfully land the metaphorical plane. More QE may minimize the damage in the short-term, but I believe it will keep us trapped in our current cocoon of endless stimulus, where we will slowly suffocate to death.
Courtesy: Peter Schiff
Note: In this article the times given are Eastern Standard Time. The software that generated the graph uses Mountain Standard Time. Therefore, read the x-axis two hours later than the axis indicates.
The Lawless Manipulation of Bullion Markets by Public Authorities
The Federal Reserve and its bullion bank agents are actively using uncovered futures contracts to illegally manipulate the prices of precious metals in order to keep interest rates below the market rate. The purpose of manipulation is to support the U.S. dollar’s reserve status at a time when the dollar should be in decline from the over-supply created by QE and from trade and budget deficits.
Historically, the role of gold and silver has been to function as a means of exchange and a store of wealth during periods of economic and political turmoil. Since the bullion bull market began in late 2000, It rose almost non-stop until March 2008, ahead of the Great Financial Crisis, which started with the collapse of Bear Stearns. When Bear Stearns collapsed, gold was taken down over the course of the next 7 months from $1035 to $680, or 34%; silver from $21 to $8, or 62%. The most violent takedown occurred as Lehman collapsed and Goldman Sachs was about to collapse. This takedown occurred during a period of time when gold should have been going parabolic in price. The price of gold finally took off in late October 2008 from $680 to $1900 while the Government and the Fed were busy printing money to bail out the banks. While the price of gold rose nearly 300% from late 2008 to September 2011, the U.S. dollar lost over 17% of its value, falling from 89 on the dollar index to 73.50.
The current takedown of gold from $1900 to $1200 has occurred during a period of time when financial and political fraud and corruption becomes worse and more blatant by the day. Along with this, the intensity and openness with which the metals are systematically beat down seems to grow by the day.
Comex futures trade 23 hours a day via a global computerized trading system known as Globex. The heaviest period of trading occurs when the actual Comex floor operations are open, which is8:20 a.m. to 1:30 p.m. EST. All other times Comex futures trade electronically via Globex. Gold and silver are smashed primarily during the Globex-only trading periods, when volume is often light to non-existent.
This graph of Comex futures trading on December 16th shows the sudden plunge in the price of silver.
The second stage of the sharp price drop begins at 1:30 pm eastern time (11:30 mountain time), after the Comex floor trading operation was closed for the day. This is typically one of the lowest volume trading periods, during which orders to buy or sell can cause significant price disruption to the market. There were no news or events that would have triggered the sudden selling of bullion futures, and none of the other markets experienced unusual movements while gold and silver were quickly plunging in price.
To put in perspective the 9,767 silver contracts sold in 15 minutes, the total trading volume in Comex silver for the 23-hour global trading period for Comex contracts ending at 5:00 p.m. on December 15th was 149,964 contracts, or an average of 6,520 contracts per hour. The only type of market participant that would dump almost 10,000 contracts in a 15-minute period is a seller who’s only motivation is to push the price of silver as low as possible. One entity that can afford to use capital like this is the Federal Reserve, because the Fed can create its own capital for free using the printing press.
In the background, the financial markets are becoming increasingly pressured by declines in emerging market currencies, insolvent sovereign governments–including here in the US–and perhaps a renewed derivatives crisis triggered by the collapse in the price of oil. The oil price decline could result in derivative problems larger than the subprime mortgage derivatives of the 2008 crisis.
The downward manipulation of the prices of precious metals prevents the “crisis warning transmission system” from properly functioning. More important, the decline in the price of gold/silver vs. the U.S. dollar conveys the illusion that the dollar is strong at a time when, in fact, the dollar should be under pressure from the over-issuance of dollars and dollar-denominated debt.
What we have been experiencing since the 2008 crisis is not only the subordination of US economic policy to the needs of banks “too big to fail,” but also the subordination of law and the financial regulatory agencies to the interests of a few private banks. The manipulation of the bullion markets is illegal whether done by private parties or on public authority, and so we have the spectacle of the US government supporting a handful of banks via illegal means. Not only has economic accountability been set aside, but also legal accountability.
Just as Washington places itself above laws prohibiting torture and naked aggression in order to conduct its self-declared “war on terror” and above the Constitution in order to construct a domestic police state, Washington places itself above the laws prohibiting market manipulation.
Obviously, the government’s claim to represent the rule of law is as false as all its other claims. The foul stench of corruption and hypocrisy that emanates from Washington is the smell of a dying country.
Never before has the “chasm of destruction” between economic reality and manipulated financial markets been this wide; and likely, never will it again. The “853 points of infamy” the PPT managed to goose the “Dow Jones Propaganda Average” this week, amidst not only the “most laughable FOMC statement ever,” but a slew of ugly economic, monetary and geopolitical developments was truly a sight to behold. Let alone, the accompanying, historically blatant precious metal capping; which frankly, can only be appropriately compared to last month’s efforts to prevent the “Save our Swiss Gold” referendum from being passed.
Moreover, in textbook bond rigging fashion, the 10-year Treasury yield was goosed higher heading into Wednesday’s FOMC meeting – to not only create the perception of a “recovering economy” whilst Whirlybird Janet spoke, but prevent universal realization of the “most damning proof yet of QE failure”; i.e., plunging rates amidst said supposed “recovery.” Unfortunately, amidst an onslaught of horribly bearish economic news – culminating on the largest weekly rig count decline in five years and most rapid fourth quarter Baltic Dry Index plunge on record – interest rates plunged anew Friday afternoon with the 10-year Treasury yield closing at 2.16%, enroute to its inevitable downside breach of 2.00%. As for gold, we kid you not, it was this week capped an incredible 35 times at the key round number of $1,200 that has served as the Cartel’s “line in the sand” the past two months.
The MSM did its best to hype oil rising to $56.50/bbl. Friday afternoon, after having fallen as low as $53.50 on Tuesday morning. Unfortunately, any number in the $50s – and for the high-cost U.S. shale industry, the $60s – is for all intents and purposes, catastrophic. I mean geez, it was last Friday when oil fell below $60 for the first time in five years, prompting the well-deserved fear that has caused high-yield bonds to plunge since; and countless global currencies – like the Ruble, for instance – to crash.
Three months ago, we deemed the unprecedented currency volatility caused by the collapsing global fiat Ponzi scheme the “single most Precious Metal bullish factor imaginable.” And this week, amidst the “bullishness” of the PPT-orchestrated equity surge, dozens of currencies closed at multi-year and in some cases all-time lows – including all five BRICS; as well as “commodity currencies” like the Australian Dollar, Canadian dollar, Indonesian Rupiah and Nigerian Naira; European toilet paper like the Euro, Pound and newly “NIRPed” Swiss Franc; and of course, the soon-to-be-hyper-inflating Yen. Which, consequently, is why gold’s three year, Cartel-orchestrated “bear market” is decidedly OVER.
Most ominously, the Yuan fell to its lowest level of the year; as despite China reporting a record trade surplus, the PBOC is clearly alarmed by the Bank of Japan’s aggressive Yen destruction; and thus, is stepping up the “final currency war” to a potentially catastrophic level. To that end, due to global fear that the “big one” has arrived, the dollar index has broken above its 2008 panic highs, yielding the potential for further currency calamity the world round. Which, of course, will yield earnings carnage for the U.S. multi-nationals that are Congress’ largest lobbyers; and subsequently, increasingly shrill calls for the Fed to debauch the dollar further!
Speaking of lobbying, even I was amazed that not a single media outlet reported Congress’ “delay” – likely permanently – of the “Volcker Rule,” which was to limit the ability of “banks” like Goldman Sachs and JP Morgan to speculate with depositor money. This, atop news earlier this week that Citibank-led lobbyists snuck into the “Cromnibus” spending bill full FDIC protection for more than $300 trillion of banking industry derivatives. I mean, if there’s anyone left that believes bankers haven’t taken over America, I’d be truly shocked. The damage these monsters have wrought upon billions of the world’s denizens is incalculable; and sadly, you “ain’t seen nothing yet.”
After this week’s shenanigans, it’s become crystal clear that globally, essentially anything published by governments or traded on financial markets is for all intents and purposes, fraudulent to at least some degree. As we wrote last week, it couldn’t be more obvious that “all economic data are lies.” And as for markets, we already knew America’s have been run by government and TBTF bank generated algorithms for some time. However, even I was taken aback when I learned that 76% of all European equity quotes are generated by manipulative HFT algorithms. But then again, I guess it’s “par for the course” in a world that is having the “veil” of fraud lifted so rapidly. Last week, for example, with ZERO attention from an MSM too foolish to realize a real story when they see it, we learned that up to 50% of all online advertising traffic is due to fraudulent “bots” that aren’t really clicking at all. In other words, the entire online advertising industry could be at risk; not to mention, the insane valuations of social media stocks that depend on them. Heck, the vilest of them all, Twitter, just deleted half of all accounts created in 2013, as they were just “bot” created fakes.
And thus, we warn readers to discount everything they are told by corporate, media and government sources; which cumulatively, have shed nearly all remaining conscience and credibility, they still had. And that goes triple for anything related to gold and silver – from media and Wall Street “forecasts”; to government reserves; exchange inventories, “open interest,” volume and “COT reports”; as well as “GOFO rates”; “derivatives outstanding”; and above all, anything related to GLD, SLV or other precious metal derivatives. Heck, after 12 years of following mining companies and their stocks – including five years within the mining industry itself – I’m not sure why anyone believes a word mining executives say about their reserves; feasibility studies; or anything related to the costs of exploration, development or production! And by the way, why anyone believes data from Chinese mining companies and exchanges would be any more genuine than American or European data is an even bigger mystery; as not only is the Chinese government’s precious metals strategy as “top secret” at it gets, but for centuries, Chinese society has been infamously opaque.
Which brings me to the biggest financial fraud of our lifetimes, that of the “Achilles Heel of the Financial World” – i.e., the tiny soon-to-be-extinct physical silver market. Yes, I know, I just warned to discount all information regarding precious metals supply and demand. However, that doesn’t mean it doesn’t exist – and of course, some data is more suspect than others. Below, I have compiled data of the “less suspect” type; and either way, whenever data paints PMs in a positive light – a rarity indeed – I am more inclined to believe it. For example, the U.S., Canadian and Indian governments published the below, wildly positive demand data – whilst the second graph, also care of the U.S. and Canadian governments depicts equally bullish supply data.
In the first, you can see that not only are the world’s top three silver demand sources – aside from the Chinese government, which purchases every ounce of Chinese-produced silver, and doesn’t publish import numbers – have not only generated an incredible 16% annual growth rate over the past seven years, but an estimated 7% this year alone. Better yet, the U.S. and Canadian demand occurred amidst the lowest Western sentiment since the bull market commenced 15 years ago, and the Indian demand amidst onerous 10% import tariffs and an openly anti-PM Indian Central bank. As for the second graph, it couldn’t be more obvious that U.S. and Canadian production – which combined accounts for roughly 6% of the global total – are in terminal decline. Not that the entire world is experiencing a decline this steep. However, generally speaking, whatever growth still remains is meager; and thus, the panel of experts on October’s “Miles Franklin Silver All-Star Panel Webinar” concluded that following the past three years’ Cartel-orchestrated price plunge; plus, a decade of exploration underinvestment care of the capital strangulation caused by mining share suppression; and of course, plunging base metal prices, given that the majority of silver production is by-product from base metal mines; it is entirely possible that global silver production declines 25%-50% over the next 3-5 years, unless prices significantly increase – NOW.
Moreover, not only is monetary demand at an all-time high, amidst the most wildly bullish fundamentals of our lifetimes – which will only become more so as “QE to Infinity” expands in earnest; but industrial silver usage is expanding significantly, given the unique characteristics that have made silver the world’s second most broadly used commodity, trailing only crude oil in number of applications. This joint report by the Silver Institute and CRU Consulting, published last week, forecasts silver industrial demand – that is excluding silverware, jewelry, and coins and bars – to increase by 27% over the next five years to 680 million ounces.
Simultaneously, the great Steve St. Angelo published this article Friday, describing how not only is GFMS (Gold Fields Mineral Services, a private PM consultancy) estimating global mine supply growth of less than 4% in 2014, but total supply growth of less than 2% due to plunging scrap supply at today’s historically suppressed prices. Moreover, Steve’s proprietary research reveals that 2014 mining supply growth is more likely to end 2014 at closer to 2% than GFMS’ 4% forecast; which, if this is the case, would put total supply growth not far above ZERO, with the aforementioned supply plunge looming and demand set to explode.
Based on this data, and the U.S., Canadian and Indian demand data above, I have put together the below chart. As you can see, the “industrial fabrication” demand described above has been relatively steady as a percentage of supply for some time; and if the aforementioned Silver Institute/CRU forecast is even remotelyclose to the truth, industrial fabrication demand will hover around 60% of available supply for the foreseeable future, particularly if said supply is in decline. As for demand, note the blue line below – of how the sum total of U.S. Silver Eagle, Canadian Silver Maple and Indian imports have risen from just 8% of total supply in 2009 to roughly 28% in 2014. None of these categories are likely to decline any time soon, and given such growth, this leaves the grey line, depicting demand from all other sources to be supplied by just 12% of the global supply output or roughly 120 million ounces.
Given that essentially ZERO inventories of material size, readily available for sale, exist, our expectations of an “inevitable, upcoming silver shortage” of epic proportions has never been more powerful. This data only bolsters our beliefs further; and thus, why anyone would not consider the purchase of even a modicum of history’s most time-proven financial insurance is beyond us. Given the horrifying global political, economic and monetary trends, it’s just a matter of time before TPTB lose control of the silver market (and many others, for that matter). And when they do, either you’ll have your gold and silver in hand or you won’t.
Courtesy: Andrew Hoffman via Milesfranklin
We know that money printing distorts the level of relative prices in an economy because, at certain times, some prices may increase faster than other prices. At other times, during another phase of monetary inflation, the prices of different goods, services and assets may increase while formerly rising prices might decline — if not in absolute terms, then in relative terms (commodity prices in the last few years).
Over the last 45 years I have observed that, in countries with high monetary inflation, real wages and incomes have tended to decline. Incidentally, this has also been the case since the turn of the millennium in the US, a period in which there has been a colossal expansion of money and credit.
During the great Weimar monetary inflation, real wages fell by about 50% from their pre-First World War level. Constantino Bresciani-Turroni (The Economics of Inflation, 1931) noted that the inflation influenced wages in different ways at different stages of the depreciation of the mark.
Until the summer of 1922 the principal effects were as follows:
(a) The increase in nominal wages was slower than the increase in prices caused by the monetary inflation. In other words real wages fell.
(b) As far as it concerned the workers’ incomes this effect was partly offset by the decline in unemployment which accompanied the depreciation of the mark
Bresciani-Turroni further wrote that commercial papers at the end of 1921 and 1922 showed intense activity in many industries, and in particular in those producing exports and production goods. “In that period real wages fell appreciably. The real wages of miners, which in the middle of 1921 were about 90% of the pre-war level, were scarcely 50% to 60% of the same at the end of 1922.”
Bresciani-Turroni then quoted some statistical studies, which suggested that “towards the end of 1922 real wages were, in the industries studied by the author, less than the subsistence minimum.”
Bresciani-Turroni further observed that, after 1922, nominal as well as real wages rose rapidly (unions gained more power, as unemployment had declined), but they never reached the pre-war level. Furthermore, as real wages rose, unemployment increased almost five-fold. Bresciani-Turroni also noted that:
A consequence of the fall in real wages was the continued fall in the ratio of wages to the total cost of production. For example, according to the results of an official inquiry in the textile industry, for most products the percentages of wages in the total cost of production was, towards the end of the inflation, much lower than the figures calculated for 1913.
As an example, in dyeing the percentage had declined from 36.9% to 27%. In the US, in recent years, wages and salaries have declined as a percentage of GDP while corporate profits are at an all-time high. As John Maynard Keynes opined, “It has long been recognized, by the business world and by economists alike, that a period of rising prices acts as a stimulus to enterprise and is beneficial to business men” (but not to the working class).
When, in the 1980s, I travelled frequently to Latin America I noticed that whereas most countries in the region were experiencing extremely high rates of monetary inflation and, therefore, rapidly depreciating currencies, real wages had collapsed. The result was that the high monetary inflation that Latin American central banks had created with the intention of stimulating economic activity was, instead, depressing incomes and, therefore, consumption and capital investments — in short, the entire economy.
I have mentioned the impact of monetary inflation on real wages because the conventional wisdom is that deflation is undesirable, while inflation is desirable. However, the evidence shows that real wages are more likely to increase during periods of deflation than during phases of high monetary inflation. During the Great Depression, real wages rose for a while and then remained rather constant.
I know that some people will immediately say: Yes, real wages during the Depression were sticky and didn’t decline, which problem led to very high unemployment. However, several economic papers have pointed out that there is no clear evidence that movement in real wages affects employment losses in any perceptible way.
This was also the case after 1989 in Japan, which had rising real per capita income gains while unemployment didn’t move up meaningfully. What is interesting to observe is the difference in the performance of real incomes in Japan post-1989 and since the introduction of Abenomics in early 2013.
Furthermore, I should point out that since 2011, the Yen has lost almost 50% of its value against the US dollar. In other words, in US dollar terms, Japanese households are now close to 50% poorer than three years ago. Over the same period of time, in dollar terms, the Japanese economy has contracted by a similar amount. What a great “success” Abenomics has been!
Naturally, the proponents of Abenomics and of Kuroda’s “courageous” (more likely “insane”) monetary policies will argue that the equity market has risen strongly since 2011. Yes, this is correct and we wrote favourably about Japanese stocks on several occasions in 2012 and 2013.
However, the problem for Japanese households is that they have only a very limited exposure to Japanese equities (only about 15% of financial assets); therefore, they benefit little from rising stock prices.
But the point I wish to make is that in the case of Japan the expansionary monetary policies of the Bank of Japan have not led to high domestic inflation but, rather, to a huge economic deflation in dollar terms. As an aside, during the period of high inflation in Latin America in the 1980s, I observed that while there was high inflation in domestic consumer prices, there was a complete collapse in the price level of consumer prices, and especially of domestic assets in dollar terms, because the decline in the value of Latin American currencies exceeded the rise in domestic prices.
Now, we need to ask ourselves why, in the current economic expansion, consumer price increases around the world have remained relatively muted (albeit far higher than official government statistics show) and why economies have failed to gain much traction despite highly expansionary monetary policies.
The simple answer is that the velocity of money has collapsed.
But why has the velocity of money collapsed?
The academic explanation is that, as Robert Auerbach (an economist with the US House of Representatives’ Financial Services Committee for 11 years) pointed out in 2013:
There is a massive misconception about where the Bernanke Fed’s stimulus landed. Although the Bernanke Fed has disbursed $2.284 trillion in new money (the monetary base) since August 1, 2008, one month before the 2008 financial crisis, 81.5 percent now sits idle as excess reserves in private banks.
The banks are not required to hold excess reserves. The excess reserves exploded from $831 billion in August 2008 to $1.863 trillion on June 14, 2013. The excess reserves of the nation’s private banks had previously stayed at nearly zero since 1959 as seen on the St. Louis Fed’s chart.
Auerbach points out that previously “banks did not leave money idle in excess reserves at zero interest because they were investing in income earning assets, including loans to consumers and businesses.”
Auerbach further explains that:
This 81.5 percent explosion in idle excess reserves means that
the Bernanke Fed’s new money issues of $85 billion each month have never been a big stimulus. Approximately 81.5 percent (or $69.27 billion) is either bought
by banks or deposited into banks where it sits idle as excess reserves.
The rest of the $85 billion, approximately 18.5 percent (or $15.72 billion), continues to circulate or is held as required reserves on banks’ deposit accounts (unlike unrequired excess reserves).
The official explanation as to why banks keep their funds in the form of excess reserves instead of lending them out is that the Fed has been paying big banks high-enough interest on the funds which they deposit at the Fed to discourage them from making loans.
You don’t need a Ph.D. economist to know that if you pay banks 1?4 percent risk free interest to hold reserves that they can obtain at near zero interest, that would be an incentive to hold the reserves.
Along the same lines, William T. Gavin, an economist at the St Louis Federal Reserve, wrote in its March/April 2009 publication: “First, for the individual bank, the risk-free rate of 1?4 percent must be the bank’s perception of its best investment opportunity.”
Frankly, I find it difficult to believe that banks didn’t hold any significant reserve balances with the Fed until recently and then, bingo, that all changed when the Fed started paying 1?4% interest. Surely, banks should find better opportunities by “investing in income-earning assets, including loans to consumers and businesses”, rather than leave “money idle in excess reserves” at 1?4% interest.
A more likely explanation is that the economy is still weak, with those people who want to borrow money having no access to additional credit, while those who can borrow money are already loaded with cash and don’t need any additional funds.
The 2014 Employee Benefit Research Institute Retirement Confidence Survey notes that 58% of workers and 44% of retirees report having a problem with their level of debt. Furthermore, 24% of workers and 17% of retirees indicate that their current level of debt is higher than it was five years ago.
More importantly, in the same way that banks are holding excess reserves at the Fed instead of lending to businesses, corporations and wealthy individuals prefer to play the capital markets or to invest in existing assets, rather than invest in new businesses.
I am aware that this is a very simplistic view, but my point is that all the liquidity that central banks have created isn’t flowing into the real economy but remains in asset markets (mostly financial markets) buying and selling currencies, bonds, stocks, real estate, art, entire companies, etc. For example, most corporations find it more advantageous to buy back their own shares (in order to boost their share prices) instead of investing in new plant and equipment. (In 2014, S&P 500 companies will spend almost 60% of their profit on share buybacks.)
Or take wealthy individuals as another example. Most of them invest in stocks, bonds, funds or real estate; very few of them go out and build businesses. Private equity funds do the same: instead of building new businesses, they tend to buy existing assets.
In fact, I would argue that central banks’ monetary policies have been too successful at boosting asset markets; because of this, they have been a complete failure at maximising the level of national income for the majority of people and at providing sustainable economic growth that would raise the standard of living of the majority of participants in the economy. Furthermore, the current global macroeconomic conditions remind me of the high-tech, media and telecommunication boom of the late 1990s, which ended in March 2000. As long as tech stocks moved up, investors showed very little or no interest in investing in old-economy companies, real estate and commodities.
The high-tech boom sucked in all the liquidity at the expense of other sectors of the economy. Now, we have the high-tech boom of the late 1990s magnified manifold, in the sense that global asset markets (with very few exceptions) have become hugely inflated and are attracting liquidity which, under stable monetary conditions, would have flown into real capital investments. In other words, central banks have been hugely successful at boosting asset markets while deflating real economic activity.
The mid-November Christie’s contemporary art sale in New York brought in the highest-ever total for an auction, grossing $852.9 million across 75 lots. The previous record for an auction was $745 million, which was set back in May, also at Christie’s contemporary art auction in New York. At the same time, real median incomes are probably deflating at a faster pace than official statistics show because the cost of living is rising far more rapidly than incomes.
Billionaire Tilman Fertitta, chairman of Landry’s Restaurants which counts among its properties such brand names as Morton’s, Rainforest Cafe, Bubba Gump Shrimp Co., McCormick & Schmick’s, Saltgrass Steak House, Claim Jumper, Chart House, etc., recently opined in a Bloomberg interview:
Well go buy something, whether at the grocery store, the drug store, the broom and mop store, and there is inflation everywhere. I have so many types of businesses so I buy everything from labor, to mops, to food, to shrimp, to steak and everything is more expensive. We are raising prices: that’s why right now you pay more for an airline ticket, you pay more for a hotel room, you pay more for a pot of coffee. There is huge inflation going on right now.
So, going back to my original question of whether, under certain conditions, the expansion of central banks’ balance sheets and policies of zero interest rates could actually have a deflationary impact, I believe that as long as savings and newly created fiat money flow into booming and speculative asset markets, real economic activity will remain depressed. A good example of this phenomenon is the housing market.
Home prices have recovered, though irregularly, and the rise has made the purchase of a home unaffordable for a large segment of the population. Otherwise, how can we explain the steep decline in the homeownership rate? In the meantime, the residential vacancy rate is extremely low by historical standards, which means that rental prices will likely continue to move up and squeeze the real incomes of the growing cohort of young tenants who can no longer afford to buy a house or a condo.
However, as Irving Fisher opined, “If all asset prices and incomes rose evenly no harm would be done to anyone. But the rise is not equal. Many lose and some gain.”
Courtesy: Dr. Marc Faber via The Daily Reckoning
As the price of silver fell to a new low in November, India imported a record amount of the shiny metal. Demand for the physical metal was so strong, India nearly imported the same amount of silver in November than it did for the entire year in 2009.
Koos Jansen at BullionStar.com, published a great article, India Silver Imported 6,789t YTD, showing just how much silver was imported into the country in October and November.
I took some of his recent data from that article and updated my graphs. India imported a staggering 1,254 metric tons (mt) of silver in November and 1,243 mt in October for a total of 2,467 mt. If we break down India’s silver imports on a quarterly basis, we can see just how big these numbers really are:
In just two months (Oct & Nov), India imported twice as much as in Jan-Apr, and a great deal more than the following two quarters. If India imports at least 700 mt in December, the fourth quarter will be nearly double the amount imported during the second highest quarter, Apr-Jun.
As Koos stated in his article, India has already imported a record 6,789 mt of silver Jan-Nov. If India does import 700 mt of silver in December, the total would reach 7,400+mt for the year. This would be an increase of 27% compared to the previous record of 5,819 mt set in 2013.
As I mentioned at the top of the article, India imported 1,254 mt of silver just in November, compared to a total of 1,274 mt for 2009. Furthermore, Indian silver imports in October and November (2,497 mt) were higher than the total in 2012 at 1,922 mt. These are big figures indeed.
Just to give the reader a sense of how much silver India imported, lets compare it to total global silver mine supply:
2014 Estimated Global Silver Mine Supply = 825 Million oz
2014 Estimated Indian Silver Imports = 234 Million oz
India’s estimated 2014 silver imports at 7,400 mt equals 234 million oz (Moz) or 28% of total world mine supply of 825 Moz in 2014 (GFMS estimate with my adjustment).
As I stated in my article, BREAKING: Significant Drawdown of U.K. Silver Inventories Due To Record Silver Demand:
According to GFMS Silver Interim Report released on Nov 18th:
Meanwhile demand for silver bars and coins has soared in recent weeks as bargain hunting retail investors returned to the silver market after a disappointing first half of the year. Nowhere is this more evident than in India where imports of silver are up by 14% year-on-year for the January to October period and set for an annual record. With imports in the first ten months totalling a massive 169 Moz many vaults in the UK, traditionally the largest supplier to India, have seen significant drawdowns, leading to more supply flowing from China and Russia.
If London was already suffering a drawdown of silver inventories in October from huge Indian demand, how bad is the situation after another 1,254 mt was imported by India in November? How tight is the wholesale silver market now?
The world has consumed its huge stockpile of above ground silver for the past 3-4 decades. and I believe will soon be faced with a serious problem. And that is, where will the market acquire silver stocks to offset annual deficits and increased demand in the future?
Currently, investors are swimming in worthless paper assets up to their eyeballs. This is very unfortunate as when the time comes to move into physical assets such as gold and silver to protect their wealth, there will be very little to go around… EXCEPT at much HIGHER PRICES.
Isn’t it fun to just watch the market numbers roll by from time to time as you go about your day, see Europe markets up 3%+, Dubai 13%, US over 2% (biggest two-day rally since 2011!), and you just know oil must get hit again? Well, it did. WTI down another 3%+. I tells ya, no Plunge Protection is going save this sucker.
And oil is not even the biggest story today. It’s plenty big enough by itself to bring down large swaths of the economy, but in the background there’s an even bigger tale a-waiting. Not entirely unconnected, but by no means the exact same story either. It’s like them tsunami waves as they come rolling in. It’s exactly like that.
That is, in the wake of the oil tsunami, which is a long way away from having finished washing down our shores, there’s the demise of emerging markets. And I’m not talking Putin, he’ll be fine, as he showed again today in his big press-op. It’s the other, smaller, emerging countries that will blow up in spectacular fashion, and then spread their mayhem around. And make no mistake: to be a contender for bigger story than oil going into 2015, you have to be major league large. This one is.
The US dollar will keep rising more or less in and of itself, simply because the Fed has ‘tapered QE’, and much of what happened in global credit markets, especially in emerging markets, was based on cheap and easily available dollars. There’s now $85 billion less of that each month than before the taper took it away in $10 billion monthly increments. The core is simple.
This is not primarily government debt, it’s corporate debt. But it’s still huge, and it has not just kept emerging economies alive since 2008, it’s given them the aura of growth. Which was temporary, and illusionary, all along. Just like in the rest of the world, Japan, EU, US. And, since countries can’t – or won’t – let their major companies fail, down the line it becomes public debt.
One major difference from the last emerging markets blow-up, in the late 20th century, is size:emerging markets today are half the world economy. And they’re about to be blown to smithereens. Sure, oil will play a part. But mostly it will be the greenback. And you know, we can all imagine what happens when you blow up half the global economy …
Erico Matias Tavares at Sinclair has a first set of details:
There are some signs of trouble in emerging markets. And the money at risk now is bigger than ever. The yield spread between high grade emerging markets and US AAA-rated corporate debt has jumped, almost doubling in less than three weeks to the highest level since mid-2012.
This means that the best credit names in emerging markets have to pay a bigger premium over their US counterparts to get funding. When this spread spikes up and continues above its 200-day moving average for a sustained period of time, it is typically a bad sign for equity valuations in emerging markets, as shown in the graph above. One swallow does not a summer make, but it is worthwhile keeping an eye on this indicator.
As yields go up the value of these emerging market bonds goes down, resulting in losses for the investors holding them. The surge of the US dollar in recent months could magnify these losses: if the bonds are denominated in local currency they will be worth a lot less to US investors; otherwise, the borrowers will now have to work a lot harder to repay those US dollar debts, increasing their credit risk. Any losses could end up being very significant this time around, as demand for emerging markets bonds has literally exploded in recent years.
As the graph above shows, the issuance of emerging market corporate debt has risen sharply since the depths of the 2008-09 financial crisis.These volumes are very large indeed, and now account for non-trivial portions of investors’ and pension funds’ portfolios worldwide.
As a result, emerging markets corporations are now leveraged to the hilt, easily exceeding the 2008 highs by almost a multiple to EBITDA. And why not? With foreign investors desperate for yield as a result of all the stimulus and money printing by their central banks, they were only too happy to oblige. And they were not alone. Governments in these countries were also busy doing some borrowing of their own, as their domestic capital markets deepened.
[..] foreign investors have also piled into locally denominated bonds of emerging markets governments. Countries like Peru and Latvia now have over 50% foreign ownership of their bonds. [..] But there are big speculative reasons behind the recent money flows going into these countries – which could reverse very quickly should the tide turn. [..]
If investors end up rushing for the emerging markets exit for whatever reason, with this unprecedented level of exposure they might be bringing home much more than a bruised ego and an empty wallet. For one, European banks are hugely exposed to emerging markets. Any impairment to their books would likely make any new lending even more difficult, at a time when there is already a dearth of non-government credit in Europe.
And if emerging economies falter, where will the growth needed to repair Western government and private balance sheets come from? It used to be said that when the US economy sneezes the rest of the world catches a cold. Now it seems all we need is a hiccup in emerging markets.
That’s what you get when emerging markets are both half the global economy AND they’ve accomplished that level off of ultra-low US Fed interest rates and ultra-high US Fed credit ‘accommodation’. All you have to do when you’re the Fed is to take both away at the same time, and you’re the feudal overlord.
Our favorite friend-to-not-like Ambrose Evans-Pritchard does what he does well: provide numbers:
The US Federal Reserve has pulled the trigger. Emerging markets must now brace for their ordeal by fire. They have collectively borrowed $5.7 trillion in US dollars, a currency they cannot print and do not control. This hard-currency debt has tripled in a decade, split between $3.1 trillion in bank loans and $2.6 trillion in bonds. It is comparable in scale and ratio-terms to any of the biggest cross-border lending sprees of the past two centuries.
Much of the debt was taken out at real interest rates of 1% on the implicit assumption that the Fed would continue to flood the world with liquidity for years to come. The borrowers are “short dollars”, in trading parlance. They now face the margin call from Hell as the global monetary hegemon pivots. The Fed dashed all lingering hopes for leniency on Wednesday. The pledge to keep uber-stimulus for a “considerable time” has gone, and so has the market’s security blanket, or the Fed Put as it is called. Such tweaks of language have multiplied potency in a world of zero rates.
Officials from the BIS say privately that developing countries may be just as vulnerable to a dollar shock as they were in the Fed tightening cycle of the late 1990s, which culminated in Russia’s default and the East Asia Crisis. The difference this time is that emerging markets have grown to be half the world economy. Their aggregate debt levels have reached a record 175% of GDP, up 30 percentage points since 2009.
Most have already picked the low-hanging fruit of catch-up growth, and hit structural buffers. The second assumption was that China would continue to drive a commodity supercycle even after Premier Li Keqiang vowed to overthrow his country’s obsolete, 30-year model of industrial hyper-growth, and wean the economy off $26 trillion of credit leverage before it is too late. [..]
Stress is spreading beyond Russia, Nigeria, Venezuela and other petro-states to the rest of the emerging market nexus, as might be expected since this is a story of evaporating dollar liquidity as well as a US shale supply-glut.
[..[ the Turkish lira has fallen 12% since the end of November. The Borsa Istanbul 100 index is down 20% in dollar terms. Indonesia had to intervene on Wednesday to defend the rupiah. Brazil’s real has fallen to a 10-year low against the dollar, as has the index of emerging market currencies. Sao Paolo’s Bovespa index is down 23% in dollars in 3 weeks.
The slide can be self-feeding. Funds are forced to sell holdings if investors take fright and ask for their money back, shedding the good with the bad. Pimco’s Emerging Market Corporate Bond Fund bled $237m in November, and the pain is unlikely to stop as clients discover that 24% of its portfolio is in Russia.
One might rail against the injustice of indiscriminate selling. Such are the intertwined destinies of countries that have nothing in common. The Fed has already slashed its bond purchases to zero, withdrawing $85bn of net stimulus each month. It is clearly itching to raise rates for the first time in seven years. This is the reason why the dollar index has jumped 12% since May, smashing through its 30-year downtrend line, a “seismic change” in the words of HSBC. [..]
World finance is rotating on its axis, says Stephen Jen, from SLJ Macro Partners. The stronger the US boom, the worse it will be for those countries on the wrong side of the dollar.
“Emerging market currencies could melt down. There have been way too many cumulative capital flows into these markets in the past decade. Nothing they can do will stop potential outflows, as long as the US economy recovers.
Hold it there for a moment. I don’t think it’s the US economy (its recovery is fake), it’s the US dollar.
Will this trend lead to a 1997-1998-like crisis? I am starting to think that this is extremely probable for 2015,” he said.
This time the threat does not come from insolvent states. They have learned the lesson of the late 1990s. Few have dollar debts. But their companies and banks most certainly do, some 70% of GDP in Russia, for example. This amounts to much the same thing in macro-economic terms. Private debt morphs into state debt since governments cannot allow key pillars of their economies to collapse.
These countries have, of course, built $9 trillion of foreign reserves, often the side-effect of holding down their currencies to gain export share. This certainly provides a buffer. Yet the reserves cannot fruitfully be used in a recessionary crisis because sales of foreign bonds automatically entail monetary tightening. [..] .. these reserves are a mirage. If you deploy them in such circumstances, you choke your own economy unless you can sterilize the effects. [..]
Investors are counting on the European Central Bank to keep the world supplied with largesse as the Fed pulls back. Yet the ECB could not pick up the baton even if it were to launch a blitz of quantitative easing, and there is no conceivable consensus for action on such a commensurate scale.
The world’s financial system is on a dollar standard, not a euro standard. Global loans are in dollars. The US Treasury bond is the benchmarks for global credit markets, not the German Bund. Contracts and derivatives are priced off dollar instruments. Bank of America says the combined monetary stimulus from Europe and Japan can offset only 30% of the lost stimulus from the US.
What more can I say? This is the lead story as we go into 2015 two weeks from today. Oil will help it along, and complicate as well as deepen the whole thing to a huge degree, but the essence is what it is: the punchbowl that has kept world economies in a zombie state of virtual health and growth has been taken away on the premise of US recovery as Janet Yellen has declared it.
It doesn’t even matter whether this is a preconceived plan or not, as some people allege, it still works the same way. The US gets to be in control, for a while, until it realizes, Wile E. shuffle style, that you shouldn’t do unto others what you don’t want to be done unto you. But by then it’ll be too late. Way too late.
As I wrote just a few days ago in We’re Not In Kansas Anymore, there’s a major reset underway. We’re watching, in real time, the end of the fake reality created by the central banks. And it’s not going to be nice or feel nice. It’s going to hurt, and the lower you are on the ladder, the more painful it will be. Be that globally, if you live in poorer countries, or domestically, if you belong to a poorer segment of the population where you are. In both senses, the poorest will be hit hardest.
It’s the new model along which the clowns we allow to run the show, do so. Unless ‘we the people’ take back control, it’s pretty easy to see how this will go down.
Courtesy: The Automatic Earth
A retrace that fills open gaps and kisses the 50-day moving average surprises everyone who was confident oil was heading straight down to $40/barrel.
When the conventional media ordains oil inevitably dropping to $40/barrel, I start looking for something else to happen–like oil going to $70/barrel. There are number of reasons this isn’t as farfetched as it might seem at the moment.
1. The huge gap begging to be filled on the chart of the Energy Select Sector exchange-traded fund XLE and a bunch of other energy-sector stocks and etfs. Gaps like this usually get filled sooner rather than later.
2. A bounce back to the 50-day moving average on the WTI oil index around $73 would be unsurprising. As the old saying has it, nothing goes down in a straight line, and since oil fell in a parabolic curve down, some sort of retrace to a key technical level of resistance is to be expected.
There are many ways to calculate Fibonacci levels, but a retrace to the 38.2% level equates to the mid-$70s. By my reckoning, the natural starting place is the recent high around $116 in 2011 to the recent low around $53. The 38.2% level is $24 + $53 = $77.
Maybe price doesn’t retrace all the way to the mid-$70s, but the possibility shouldn’t be discounted.
3. Too many punters have bet on oil dropping straight to $40/barrel, and all those put options offer the big financial players an incentive to spark a short-covering rally that outruns stops and scoops all the money by options expiration on January 16, 2015.
The more puts there are at $70/barrel (and equivalent levels in energy etfs, oil services stocks, etc., the greater the incentive to push the short-covering rally higher than expected.
4. The parabolic drop in oil resulted more from the panicky unwinding of a crowded and overleveraged trade than supply-demand. As I explained in my series on the financialization of oil, the financial pyramiding of oil is much less visible than supply and demand, so the mainstream media focuses on what’s easy, i.e. supply and demand issues.
The Oil-Drenched Black Swan, Part 4: The Head-Fake Disruption Ahead (December 4, 2014)
The Oil-Drenched Black Swan, Part 3: Multiple Risks, Multiple Unknowns (December 3, 2014)
The Oil-Drenched Black Swan, Part 2: The Financialization of Oil (December 2, 2014)
The Oil-Drenched Black Swan, Part 1 (December 1, 2014)
Crowded trades (trades where almost everyone is on one side of the boat) unwind in precisely this sort of freefall. Once the trade has been unwound, however, the selling cascade exhausts itself and insiders who know better start buying. Buying begets buying, shorts start covering, and voila, a retrace that fills open gaps and kisses the 50-day moving average surprises everyone who was confident oil was heading straight down to $40/barrel.
Courtesy: Charles Hugh Smith
With two reports a day, and often more, readers sometimes complain that keeping tabs on the thoughts of the various Gavekal analysts can be a challenge. So as the year draws to a close, it may be helpful if we recap the main questions confronting investors and the themes we strongly believe in, region by region.
When we have conversations with clients about China – which typically we do between two and four times a day – the talk invariably revolves around how much Chinese growth is slowing (a good bit, and quite quickly); how undercapitalized Chinese banks are (a good bit, but fat net interest margins and preferred share issues are solving the problem over time); how much overcapacity there is in real estate (a good bit, but – like youth – this is a problem that time will fix); how much overcapacity there is in steel, shipping, university graduates and corrupt officials; how disruptive China’s adoption of assembly line robots will be etc.
All of these questions are urgent, and the problems that prompted them undeniably real, which means that China’s policymakers certainly have their plates full. But this is where things get interesting: in all our conversations with Western investors, their conclusion seems to be that Beijing will have little choice but to print money aggressively, devalue the renminbi, fiscally stimulate the economy, and basically follow the path trail-blazed (with such success?) by Western policymakers since 2008. However, we would argue that this conclusion represents a failure both to think outside the Western box and to read Beijing’s signal flags.
In numerous reports (and in Chapters 11 to 14 of Too Different For Comfort) we have argued that the internationalization of the renminbi has been one of the most significant macro events of recent years. This internationalization is continuing apace: from next to nothing in 2008, almost a quarter of Chinese trade will settle in renminbi in 2014:
This is an important development which could have a very positive impact on a number of emerging markets. Indeed, a typical, non-oil exporting emerging market policymaker (whether in Turkey, the Philippines, Vietnam, South Korea, Argentina or India) usually has to worry about two things that are completely out of his control:
1) A spike in the US dollar. Whenever the US currency shoots up, it presents a hurdle for growth in most emerging markets. The first reason is that most trade takes place in US dollars, so a stronger US dollar means companies having to set aside more money for working capital needs. The second is that most emerging market investors tend to think in two currencies: their own and the US dollar. Catch a cab in Bangkok, Cairo, Cape Town or Jakarta and ask for that day’s US dollar exchange rate and chances are that the driver will know it to within a decimal point. This sensitivity to exchange rates is important because it means that when the US dollar rises, local wealth tends to flow out of local currencies as investors sell domestic assets and into US dollar assets, typically treasuries (when the US dollar falls, the reverse is true).
2) A rapid rise in oil or food prices. Violent spikes in oil and food prices can be highly destabilizing for developing countries, where the median family spends so much more of their income on basic necessities than the typical Western family. Sudden spikes in the price of food or energy can quickly create social and political tensions. And that’s not all; for oil-importing countries, a spike in oil prices can lead to a rapid deterioration in trade balances. These tend to scare foreign investors away, so pushing the local currency lower and domestic interest rates higher, which in turn leads to weaker growth etc…
Looking at these two concerns, it is hard to escape the conclusion that, as things stand, China is helping to mitigate both:
Beyond providing stability to emerging markets, the gradual acceptance of the renminbi as a secondary trading and reserve currency for emerging markets has further implications. The late French economist Jacques Rueff showed convincingly how, when global trade moved from a gold-based settlement system to a US dollar-based system, purchasing power was duplicated. As the authors of a recent Wall Street Journal article citing Reuff’s work explained: “If the Banque de France counts among its reserves dollar claims (and not just gold and French francs) – for example a Banque de France deposit in a New York bank – this increases the money supply in France but without reducing the money supply of the US. So both countries can use these dollar assets to grant credit.” Replace Banque de France with Bank Indonesia, and US dollar with renminbi and the same causes will lead to the same effects.
Consider British Columbia’s recently issued AAA-rated two year renminbi dim sum bond. Yielding 2.85%, this bond was actively subscribed to by foreign central banks, which ended up receiving more than 50% of the initial allocation (ten times as much as in the first British Columbia dim sum issue two years ago). After the issue British Columbia takes the proceeds and deposits them in a Chinese bank, thereby capturing a nice spread. In turn, the Chinese bank can multiply this money five times over (so goes money creation in China). Meanwhile, the Indonesian, Korean or Kazakh central banks that bought the bonds now have an asset on their balance sheet which they can use to back an expansion of trade with China…
Of course, for trade to flourish, countries need to be able to specialize in their respective comparative advantages, hence the importance of the kind of free trade deals discussed at the recent APEC meeting. But free trade deals are not enough; countries also need trade infrastructure (ports, airports, telecoms, trade finance banks etc…). This brings us to China’s ‘new silk road’ strategy and the recent announcement by Beijing of a US$40bn fund to help finance road and rail infrastructure in the various ‘stans’ on its western borders in a development that promises to cut the travel time from China to Europe from the current 30 days by sea to ten days or less overland.
Needless to say, such a dramatic reduction in transportation time could help prompt some heavy industry to relocate from Europe to Asia.
That’s not all. At July’s BRICS summit in Brazil, leaders of the five member nations signed a treaty launching the US$50bn New Development Bank, which Beijing hopes will be modeled on China Development Bank, and is likely to compete with the World Bank. This will be followed by the establishment of a China-dominated BRICS contingency fund (challenging the International Monetary Fund). Also on the cards is an Asian Infrastructure Investment Bank to rival the Asian Development Bank.
So what looks likely to take shape over the next few years is a network of railroads and motorways linking China’s main production centers to Bangkok, Singapore, Karachi, Almaty, Moscow, Yangon, Kolkata. We will see pipelines, dams, and power plants built in Siberia, Central Asia, Pakistan and Myanmar; as well as airports, hotels, business centers… and all of this financed with China’s excess savings, and leverage. Given that China today has excess production capacity in all of these sectors, one does not need a fistful of university diplomas to figure out whose companies will get the pick of the construction contracts.
But to finance all of this, and to transform herself into a capital exporter, China needs stable capital markets and a strong, convertible currency. This explains why, despite Hong Kong’s pro-democracy demonstrations, Beijing is pressing ahead with the internationalization of the renminbi using the former British colony as its proving ground (witness the Shanghai-HK stock connect scheme and the removal of renminbi restrictions on Hong Kong residents). And it is why renminbi bonds have delivered better risk-adjusted returns over the past five years than almost any other fixed income market.
Of course, China’s strategy of internationalizing the renminbi, and integrating its neighbors into its own economy might fall flat on its face. Some neighbors bitterly resent China’s increasing assertiveness. Nonetheless, the big story in China today is not ‘ghost cities’ (how long has that one been around?) or undercapitalized banks. The major story is China’s reluctance to continue funneling its excess savings into US treasuries yielding less than 2%, and its willingness to use that capital instead to integrate its neighbors’ economies with its own; using its own currency and its low funding costs as an ‘appeal product’ (and having its own companies pick up the contracts as a bonus). In essence, is this so different from what the US did in Europe in the 1940s and 1950s with the Marshall Plan?
With Japan in the middle of a triple dip recession, and Japanese households suffering a significant contraction in real disposable income, it might seem that Prime Minister Shinzo Abe has chosen an odd time to call a snap election. Three big factors explain his decision:
1) The Japanese opposition is in complete disarray. So Abe’s decision may primarily have been opportunistic.
2) We must remember that Abe is the most nationalist prime minister Japan has produced in a generation. The expansion of China’s economic presence across Central and South East Asia will have left him feeling at least as uncomfortable as anyone who witnessed his Apec handshake with Xi Jinping three weeks ago. It is not hard to imagine that Abe returned from Beijing convinced that he needs to step up Japan’s military development; a policy that requires him to command a greater parliamentary majority than he holds now.
3) The final factor explaining Abe’s decision to call an election may be that in Japan the government’s performance in opinion polls seems to mirror the performance of the local stock market (wouldn’t Barack Obama like to see such a correlation in the US?). With the Nikkei breaking out to new highs, Abe may feel that now is the best time to try and cement his party’s dominant position in the Diet.
As he gets ready to face the voters, how should Abe attempt to portray himself? In our view, he could do worse than present himself as Japan Inc’s biggest salesman. Since the start of his second mandate, Abe has visited 49 countries in 21 months, and taken hundreds of different Japanese CEOs along with him for the ride. The message these CEOs have been spreading is simple: Japan is a very different place from 20 years ago. Companies are doing different things, and investment patterns have changed. Many companies have morphed into completely different animals, and are delivering handsome returns as a result. The relative year to date outperformances of Toyo Tire (+117%), Minebea (+95%), Mabuchi (+57%), Renesas (+43%), Fuji Film (+33%), NGK Insulators (+33%) and Nachi-Fujikoshi (+19%) have been enormous. Or take Panasonic as an example: the old television maker has transformed itself into a car parts firm, piggy-backing on the growth of Tesla’s model S.
Yet even as these changes have occurred, most foreign investors have stopped visiting Japan, and most sell-side firms have stopped funding genuine and original research. For the alert investor this is good news. As the number of Japanese firms at the heart of the disruptions reshaping our global economy – robotics, electric and self-driving cars, alternative energy, healthcare, care for the elderly – continues to expand, and as the number of investors looking at these same firms continues to shrink, those investors willing to sift the gravel of corporate Japan should be able to find real gems.
Which brings us to the real question confronting investors today: the ‘Kuroda put’ has placed Japanese equities back on investor’s maps. But is this just a short term phenomenon? After all, no nation has ever prospered by devaluing its currency. If Japan is set to attract, and retain, foreign investor flows, it will have to come up with a more compelling story than ‘we print money faster than anyone else’.
In our recent research, we have argued that this is exactly what is happening. In fact, we believe so much in the opportunity that we have launched a dedicated Japan corporate research service (GK Plus Alpha) whose principals (Alicia Walker and Neil Newman) are burning shoe leather to identify the disruptive companies that will trigger Japan’s next wave of growth.
The US has now ‘enjoyed’ a free cost of money for some six years. The logic behind the zero-interest rate policy was simple enough: after the trauma of 2008, the animal spirits of entrepreneurs needed to be prodded back to life. Unfortunately, the last few years have reminded everyone that the average entrepreneur or investor typically borrows for one of two reasons:
Unfortunately, the second type of borrowing does not lead to an increase in the stock of capital. It simply leads to a change in the ownership of capital at higher and higher prices, with the ownership of an asset often moving away from entrepreneurs and towards financial middlemen or institutions. So instead of an increase in an economy’s capital stock (as we would get with increased borrowing for capital spending), with financial engineering all we see is a net increase in the total amount of debt and a greater concentration of asset ownership. And the higher the debt levels and ownership concentration, the greater the system’s fragility and its inability to weather shocks.
We are not arguing that financial engineering has reached its natural limits in the US. Who knows where those limits stand in a zero interest rate world? However, we would highlight that the recent new highs in US equities have not been accompanied by new lows in corporate spreads. Instead, the spread between 5-year BBB bonds and 5-year US treasuries has widened by more than 30 basis points since this summer.
Behind these wider spreads lies a simple reality: corporate bonds issued by energy sector companies have lately been taken to the woodshed. In fact, the spread between the bonds of energy companies, and those of other US corporates are back at highs not seen since the recession of 2001-2002, when the oil price was at US$30 a barrel.
The market’s behavior raises the question whether the energy industry has been the black hole of capital misallocation in the era of quantitative easing. As our friend Josh Ayers of Paradarch Advisors (Josh publishes a weekly entitled The Right Tale, which is a fount of interesting ideas. He can be reached email@example.com) put it in a recent note: “After surviving the resource nadir of the late 1980s and 1990s, oil and gas firms started pumping up capex as the new millennium began. However, it wasn’t until the purported end of the global financial crisis in 2009 that capital expenditure in the oil patch went into hyperdrive, at which point capex from the S&P 500’s oil and gas subcomponents jumped from roughly 7% of total US fixed investment to over 10% today.”
“It’s no secret that a decade’s worth of higher global oil prices justified much of the early ramp-up in capex, but a more thoughtful look at the underlying data suggests we’re now deep in the malinvestment phase of the oil and gas business cycle. The second chart (above) displays both the total annual capex and the return on that capex (net income/capex) for the ten largest holdings in the Energy Select Sector SPDR (XLE). The most troublesome aspect of this chart is that, since 2010, returns have been declining as capex outlays are increasing. Furthermore, this divergence is occurring despite WTI crude prices averaging nearly $96 per barrel during that period,” Josh noted.
The energy sector may not be the only place where capital has been misallocated on a grand scale. The other industry with a fairly large target on its back is the financial sector. For a start, policymakers around the world have basically decided that, for all intents and purposes, whenever a ‘decision maker’ in the financial industry makes a decision, someone else should be looking over the decision maker’s shoulder to ensure that the decision is appropriate. Take HSBC’s latest results: HSBC added 1400 compliance staff in one quarter, and plans to add another 1000 over the next quarter. From this, we can draw one of two conclusions:
1) The financial firms that will win are the large firms, as they can afford the compliance costs.
2) The winners will be the firms that say: “Fine, let’s get rid of the decision maker. Then we won’t need to hire the compliance guy either”.
This brings us to a theme first explored by our friend Paul Jeffery, who back in September wrote: “In 1994 Bill Gates observed: ‘Banking is necessary, banks are not’. The primary function of a bank is to bring savers and users of capital together in order to facilitate an exchange. In return for their role as [trusted] intermediaries banks charge a generous net spread. To date, this hefty added cost has been accepted by the public due to the lack of a credible alternative, as well as the general oligopolistic structure of the banking industry. What Lending Club and other P2P lenders do is provide an online market-place that connects borrowers and lenders directly; think the eBay of loans and you have the right conceptual grasp. Moreover, the business model of online market-place lending breaks with a banking tradition, dating back to 14th century Florence, of operating on a “fractional reserve” basis. In the case of P2P intermediation, lending can be thought of as being “fully reserved” and entails no balance sheet risk on the part of the service facilitator. Instead, the intermediary receives a fee- based revenue stream rather than a spread-based income.”
There is another way we can look at it: finance today is an abnormal industry in two important ways:
1) The more the sector spends on information and communications technology, the bigger a proportion of the economic pie the industry captures. This is a complete anomaly. In all other industries (retail, energy, telecoms…), spending on ICT has delivered savings for the consumers. In finance, investment in ICT (think shaving seconds of trading times in order to front run customer orders legally) has not delivered savings for consumers, nor even bigger dividends for shareholders, but fatter bonuses and profits for bankers.
2) The second way finance is an abnormal industry (perhaps unsurprisingly given the first factor) lies in the banks’ inability to pass on anything of value to their customers, at least as far as customer’s perceptions are concerned. Indeed, in ‘brand surveys’ and ‘consumer satisfaction reports’, banks regularly bring up the rear. Who today loves their bank in a way that some people ‘love’ Walmart, Costco, IKEA, Amazon, Apple, Google, Uber, etc?
Most importantly, and as Paul highlights above, if the whole point of the internet is to:
a) measure more efficiently what each individual needs, and
b) eliminate unnecessary intermediaries,
then we should expect a lot of the financial industry’s safe and steady margins to come under heavy pressure. This has already started in the broking and in the money management industries (where mediocre money managers and other closet indexers are being replaced by ETFs). But why shouldn’t we start to see banks’ high return consumer loan, SME loan and credit card loan businesses replaced, at a faster and faster pace, by peer-to-peer lending? Why should consumers continue to pay high fees for bank transfers, or credit cards when increasingly such services are offered at much lower costs by firms such as TransferWise, services like Alipay and Apple Pay, or simply by new currencies such as Bitcoin? On this point, we should note that in the 17 days that followed the launch of Apple Pay on the iPhone 6, almost 1% of Wholefoods’ transactions were processed using the new payment system. The likes of Apple, Google, Facebook and Amazon have grown into behemoths by upending the media, advertising retail and entertainment industries. Such a rapid take- up rate for Apple Pay is a powerful indicator which sector is likely to be next in line. How else can these tech giants keep growing and avoid the fate that befell Sony, Microsoft and Nokia? On their past record, the technology companies will find margins, and growth, in upending our countries’ financial infrastructure. As they do, a lot of capital (both human and monetary) deployed in the current infrastructure will find itself obsolete.
This possibility raises a number of questions – not least for Gavekal’s own investment process, which relies heavily on changes in the velocity of money and in the willingness and ability of commercial banks to multiply money, to judge whether it makes sense to increase portfolio risk. What happens to a world that moves ‘ex-bank’ and where most new loans are extended peer-to-peer? In such a world, the banking multiplier disappears along with fractional reserve banking (and consequently the need for regulators? Dare to dream…). As bankers stop lending their clients umbrellas when it is sunny, and taking them away when it rains, will our economic cycles become much tamer? As central banks everywhere print money aggressively, could the market be in the process of creating currencies no longer based on the borders of nation states, but instead on the cross-border networks of large corporations (Alipay, Apple Pay…), or even on voluntary communities (Bitcoin). Does this mean we are approaching the Austrian dream of a world with many, non government-supported, currencies?
In our September Quarterly Strategy Chartbook, we debated whether the eurozone was set for a revival (the point expounded by François) or a continued period stuck in the doldrums (Charles’s view), or whether we should even care (my point). At the crux of this divergence in views is the question whether euroland is broadly following the Japanese deflationary bust path. Pointing to this possibility are the facts that 11 out of 15 eurozone countries are now registering annual year-on-year declines in CPI, that policy responses have so far been late, unclear and haphazard (as they were in Japan), and that the solutions mooted (e.g. European Commission president Jean-Claude Juncker’s €315bn infrastructure spending plan) recall the solutions adopted in Japan (remember all those bridges to nowhere?). And that’s before going into the structural parallels: ageing populations; dysfunctional, undercapitalized and overcrowded banking systems; influential segments of the population eager to maintain the status quo etc…
With the same causes at work, should we expect the same consequences? Does the continued underperformance of eurozone stocks simply reflect that managing companies in a deflationary environment is a very challenging task? If euroland has really entered a Japanese-style deflationary bust likely to extend years into the future, the conclusion almost draws itself.
The main lesson investors have learned from the Japanese experience of 1990-2013 is that the only time to buy stocks in an economy undergoing a deflationary bust is:
a) when stocks are massively undervalued relative both to their peers and to their own history, and
b) when a significant policy change is on the way.
This was the situation in Japan in 1999 (the first round of QE under PM Keizo Obuchi), 2005 (PM Junichiro Koizumi’s bank recapitalization program) and of course in 2013-14 (Abenomics). Otherwise, in a deflationary environment with no or low growth, there is no real reason to pile into equities. One does much better in debt. So, if the Japan-Europe parallel runs true, it only makes sense to look at eurozone equities when they are both massively undervalued relative to their own histories and there are expectations of a big policy change. This was the case in the spring of 2012 when valuations were at extremes, and Mario Draghi replaced Jean-Claude Trichet as ECB president. In the absence of these two conditions, the marginal dollar looking for equity risk will head for sunnier climes.
With this in mind, there are two possible arguments for an exposure to eurozone equities:
1) The analogy of Japan is misleading as euroland will not experience a deflationary bust (or will soon emerge from deflation).
2) We are reaching the point when our two conditions – attractive valuations, combined with policy shock and awe – are about to be met. Thus we could be reaching the point when euroland equities start to deliver outsized returns.
Proponents of the first argument will want to overweight euroland equities now, as this scenario should lead to a rebound in both the euro and European equities (so anyone underweight in their portfolios would struggle). However, it has to be said that the odds against this first outcome appear to get longer with almost every data release!
Proponents of the second scenario, however, can afford to sit back and wait, because it is likely any outperformance in eurozone equities would be accompanied by euro currency weakness. Hence, as a percentage of a total benchmark, European equities would not surge, because the rise in equities would be offset by the falling euro.
Alternatively, investors who are skeptical about either of these two propositions can – like us – continue to use euroland as a source of, rather than as a destination for, capital. And they can afford safely to ignore events unfolding in euroland as they seek rewarding investment opportunities in the US or Asia. In short, over the coming years investors may adopt the same view towards the eurozone that they took towards Japan for the last decade: ‘Neither loved, nor hated… simply ignored’.
Most investors go about their job trying to identify ‘winners’. But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.
For example, if in 1981 an investor had decided to forego investing in commodities and simply to diversify his holdings across other asset classes, his decision would have been enough to earn himself a decade at the beach. If our investor had then returned to the office in 1990, and again made just one decision – to own nothing in Japan – he could once again have gone back to sipping margaritas for the next ten years. In 2000, the decision had to be not to own overvalued technology stocks. By 2006, our investor needed to start selling his holdings in financials around the world. And by 2008, the money-saving decision would have been to forego investing in euroland.
Of course hindsight is twenty-twenty, and any investor who managed to avoid all these potholes would have done extremely well. Nevertheless, the big question confronting investors today is how to avoid the potholes of tomorrow. To succeed, we believe that investors need to answer the following questions:
The answers to these questions will drive performance for years to come. In the meantime, we continue to believe that a portfolio which avoids a) euroland, b) banks, and c) commodities, will do well – perhaps well enough to continue funding Mediterranean beach holidays – especially as these are likely to go on getting cheaper for anyone not earning euros!
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Global silver mine supply this year may turn out to be less than the official estimates. GFMS released their 2014 Interim Report stating world silver mine supply is forecasted to increase 3.5% to 868 million oz (Moz) in 2014. They included a world map in their report showing the net change in production from various countries.
According to GFMS 2014 Silver Interim Report:
On the supply side, mine production is forecast to reach all-time highs in the silver industry in 2014 as supply from Guatemala, Mexico, Chile and Peru increases. This is forecast to see primary supply increase by 3.5% in 2014 to 868 Moz. Total supply to the market is expected to increase more modestly as scrap supply continues to contract, with an estimated 14% decline in scrap leading to total supply of 1,131 Moz, a 2.9% increase year-on-year.
If we look at the map provided by GFMS, they show an increase in annual production in GREEN, a decrease in RED and no change in shown in TAN:
I agree with GFMS on Guatemala, Chile & Peru… but not on Mexico. GFMS forecasts that Mexico will increase silver production 12+ million oz, shown in the light green color. However, Mexico’s INEGI just released their September figures year to date and it shows overall production nearly flat compared to the same period last year.
Guatemala will show the largest increase in silver production due to Tahoe Resources Escobal mine becoming commercial in January of this year. Guatemala’s Escobal mine will produce 20+ million oz a year.
Furthermore, the Chilean Copper Commission also released their most recent World Copper Market Review showing production of copper and various metals.
I put together a chart using data from the following sources:
Mexico’s 2014 silver production (Jan-Oct) was 151.7 Moz compared to 150.9 Moz the same period last year. Peru increased its silver production 4 Moz from 96 Moz (Jan-Oct) 2013 to 100 Moz this year. KGHM Polska Miedz, which accounts for Poland’s silver production (Jan-Sep) was up 1.1 Moz from 27.7 Moz in 2013 compared to 28.8 Moz this year.
Chilean silver production (Jan-Sep) was up 4.7 Moz from 28.4 Moz in 2013 to 33.1 Moz this year. The United States increased silver production (Jan-Jul) 1.5 Moz from 20 Moz in 2013 to 21.5 Moz this year. However, the biggest loser was Canada which saw a large 5.9 Moz decline in silver production (Jan-Oct) compared to the same period last year.
The net annual change in silver production from these six countries is 6.2 Moz, or an increase of 1.8%. I checked Australia’s data from their Dept of Natural Resources, but they only have figures for the first quarter of 2014. That being said, one of the largest primary silver mines, BHP’s Cannington located in Australia, has seen its year-over-year production decline 3.6 Moz in the first nine months of 2014.
In the GFMS global map above, they show silver production remaining flat in China and Russia, with large declines in Australia, North America and Kazakhstan. GFMS shows large increases in Guatemala, Mexico, Peru and Chile.
As I stated before, I know Guatemala will be up significantly due to the Escobal mine bringing online 20 Moz of new production, but I do not believe Mexico or Peru will be as strong as forecasted. If Australia is down 5-8 Moz, while Kazakhstan down considerably compared to last year, global silver production will come in less than GFMS forecasted.
It all depends on how China and Russia finish for the year. If they are flat or slightly lower, than total world silver production may be 10-15 Moz less than GFMS 2014 forecast of 868 Moz.
Yesterday, when we reported the latest rumor of Russian gold selling, this time out of SocGen, we said that “it should be noted that SocGen and its “sources” have a conflict: in an indirect way, none other than SocGen is suddenly very interested in Russia stabilizing its economy because as we wrote before, “Russia Contagion Spreads To European Banks : French SocGen, Austrian Raiffeisen Plummet” which also sent SocGen’s default risk higher in recent days. So if all it will take to stabilize the RUB sell off, reduce fears of Russian contagion, and halt the selloff of SocGen stocks is a “source” reporting what may or may not be the case, so be it.”
Moments ago, as if to deter further speculation that Russia is indeed converting hard money earned from real resources for fiat paper, the Russian monetary authority made it quite clear, that at least in November, Russia not only did not sell any gold, but in fact bought another 600K ounces in the month of November.
So we can now add another 600K to Russia’s most recent holdings:
Which of course means that the very “Russia is selling” rumors that were so effectively used to keep the price of gold low into the recent risk-flaring episode, were capitalized on by the very same Russia, which we do however know sold some $8 billion in US Treasurys in October bringing its total holdings of US paper to the second lowest since 2008…
… and which used these same low prices not to sell, but to buy. At the lowest prices possible.Courtesy: Zerohedge
The harsh reality is that U.S. shale fields have much more to fear from plummeting oil prices than the Russians, since their costs of production are much higher, says Marin Katusa, author of The Colder War: How the Global Energy Trade Slipped from America’s Grasp.
Russia’s ruble may have strengthened sharply Wednesday, but it’s plunge in recent days has encouraged plenty of talk about the country’s catastrophe, with some even proclaiming that the new Russia is about to go the way of the old USSR.
Don’t believe it. Russia is not the United States, and the effects of a rapidly declining currency over there are much less dramatic than they would be in the U.S.
One important thing to remember is that the fall of the ruble has accompanied a precipitous decline in the per barrel price of oil. But the two are not as intimately connected as might be supposed. Yes, Russia has a resource-based economy that is hurt by oil weakness. However, oil is traded nearly everywhere in U.S. dollars, which are presently enjoying considerable strength.
This means that Russian oil producers can sell their product in these strong dollars but pay their expenses in devalued rubles. Thus, they can make capital improvements, invest in new capacity, or do further explorations for less than it would have cost before the ruble’s value was halved against the dollar. The sector remains healthy, and able to continue contributing the lion’s share of governmental tax revenues.
Nor is ruble volatility going to affect the ability of most Russian companies to service their debt. Most of the dollar-denominated corporate debt that has to be rolled over in the coming months was borrowed by state companies, which have a steady stream of foreign currency revenues from oil and gas exports.
Russian consumers will be hurt, of course, due to the higher costs of imported goods, as well as the squeeze inflation puts on their incomes. But, by the same token, exports become much more attractive to foreign buyers. A cheaper ruble boosts the profit outlook for all Russian companies involved in international trade. Additionally, when the present currency weakness is added to the ban on food imports from the European Union, the two could eventually lead to an import-substitution boom in Russia.
In any event, don’t expect any deprivations to inspire riots in the streets of Moscow. Russian President Vladimir Putin’s popularity has soared since the beginning of the Ukraine crisis. The people trust him. They’ll tighten their belts and there will be no widespread revolt against his policies.
Further, the high price of oil during the commodity supercycle, coupled with a high real exchange rate, led to a serious decline in the Russia’s manufacturing and agricultural sectors over the past 15 years. This correlation—termed by economists “Dutch disease”—lowered the Russian manufacturing sector’s share of its economy to 8% from 21% in 2000.
The longer the ruble remains weak, however, the less Dutch disease will rule the day. A lower currency means investment in Russian manufacturing and agriculture will make good economic sense again. Both should be given a real fillip.
Low oil prices are also good for Russia’s big customers, especially China, with which Putin has been forging ever-stronger ties. If, as expected, Russia and China agree to transactions in rubles and/or yuan, that will push them even closer together and further undermine the dollar’s worldwide hegemony. Putin always thinks decades ahead, and any short-term loss of energy revenues will be far offset by the long-term gains of his economic alliances.
In the most recent development, the Russian central bank has reacted by raising interest rates to 17%. On the one hand, this is meant to curb inflation. On the other, it’s an direct response to the short selling speculators who’ve been attacking the ruble. They now have to pay additional premiums, so the risk/reward ratio has gone up. Speculators are going to be much warier going forward.
The rise in interest rates mirrors how former U.S. Fed Chair Paul Volcker fought inflation in the U.S. in the early ‘80s. It worked for Volcker, as the U.S. stock market embarked on a historic bull run. The Russians — whose market has been beaten down during the oil/currency crisis — are expecting a similar result.
Not that the Russian market is anywhere near as important to that country’s economy as the US’s is to its. Russians don’t play the market like Americans do. There is no Jim Kramerovsky’s Mad Money in Russia.
Russia is not some Zimbabwe-to-be. It’s sitting on a surplus of foreign assets and very healthy foreign exchange reserves of around $375 billion. Moreover, it has a strong debt-to-GDP ratio of just 13% and a large (and steadily growing) stockpile of gold. Why Russia will arrest the ruble’s slide and keep pumping oil
And there is Russia’s energy relationship with the EU, particularly Germany. Putin showed his clout when he axed the South Stream pipeline and announced that he would run a pipeline through Turkey instead. The cancellation barely lasted long enough to speak it before the EU caved and offered Putin what he needed to get South Stream back on line. Germany is never going to let Turkey be a gatekeeper of European energy security. With winter arriving, the EU’s dependence on Russian oil and gas will take center stage, and the union will become a stabilizing influence on Russia once again.
In short, while the current situation is not working in Russia’s favor, the country is far from down for the count. It will arrest the ruble’s slide and keep pumping oil. Its economy will contract but not crumble. The harsh reality is that American shale fields have much more to fear from plummeting oil prices than the Russians (or the Saudis), since their costs of production are much higher. Many US shale wells will become uneconomic if oil falls much further. And it they start shutting down, it’ll be disastrous for the American economy, since the growth of the shale industry has underpinned 100% of US economic growth for the past several years.
Those waving their arms about the ruble might do better to look at countries facing real currency crises, like oil-dependent Venezuela and Nigeria, as well as Ukraine. That’s where the serious trouble is going to come.
The collapse in oil prices is just the opening salvo in a decades-long conflict to control the world’s energy trade. To find out what the future holds, specifically how Vladimir Putin has positioned Russia to come roaring back by leveraging its immense natural resource wealth, click here to get your copy of Marin Katusa’s smash hit New York Times bestseller, The Colder War. Inside, you’ll discover how underestimating Putin will have dire consequences. And you’ll also discover how dangerous the deepening alliance between China, Russia and the emerging markets is to the future of American prosperity.
Courtesy: Marin Katusa via Casey Research
Jeffrey Nichols, Senior Economic Advisor to Rosland Capital, had the following comments today:
After some three years of disappointment, 2015 promises to be a good year for gold investors.
While the near-term price outlook remains uncertain, I feel fairly confident that gold will be considerably higher at this time next year – and on its way to new historic highs in the years ahead.
A number of factors, some interrelated, will drive gold higher.
Here’s my short list of the top gold-price drivers I expect will combine to reestablish the long-term uptrend in the yellow metal’s price.
Despite a few recent positive indicators – and the benefit of lower energy costs – I see the macro economy stumbling in the months ahead. This past year, the gold price has been negatively impacted by expectations the Fed will begin raising interest rates and shifting monetary policy away from accommodation.
Just as the market’s expectations of higher interest rates have been a negative for gold, a reversal in interest-rate expectations will be a plus for gold in the coming year.
During this time, institutional investors and traders have shunned gold, preferring to put their money into ordinary stocks and bonds where high returns have seemed assured. One indicator has been the fire-sale of hundreds of tons of metal by exchange-traded funds. These sales have now slowed to a trickle – and much of the metal previously in weak hands has now moved to long-term gold bulls in Asia.
We expect a dose of realism and a substantial correction (or worse) on Wall Street will reverse the flow of investment and speculative funds away from stocks and bonds back into gold.
Under this rosy scenario, renewed Federal Reserve monetary restraint along with higher-than-expected interest rates would scuttle the advance in equity and bond prices, sending a growing number of investors back to gold.
Courtesy: Jeffrey Nichols
I was in Memphis last week visiting some folks. I found myself in a conference room with some very seasoned commodity traders… veterans of the floor, some going back to the ‘70s. Let me tell you something: if you ever find yourself talking to a 40-year veteran of the commodities markets, you should listen to what he has to say. Anyone who can last that long trading futures is pretty smart.
Funny thing is, I’ve been around long enough that now I am one of the old traders!
But I’m not a commodities guy by training. I’m one of those slicked-back-hair moneychanger guys who is never going to get to heaven. But I always learn a lot when I go to Memphis—which, by the way, is the third-biggest futures trading city after Chicago and New York. There are quite a few large trading firms that specialize in grains, meats, and cotton. Memphis is a big deal, and probably the best-kept secret in the financial world.
So I asked about what it was like to trade live cattle during the BSE (mad cow) outbreak about 10 years ago. “How about limit down for an entire week?” they said. Small traders went under. Cattle ranchers went under, guys who lifted their hedges at exactly the wrong time. It was downright ugly.
That was bad.
But what’s happening to oil is a million times worse.
There are a lot of folks who get pretty angry when you suggest that a near-50% drop in the price of oil might be a negative in the short term. They look at you like you’re dumb. They talk about the massive benefit to consumers, the synthetic “tax cut” that everyone’s getting, what it’s going to do to consumption, etc.
All of this is true. But if you take a major commodity and slice it in half in the span of a month or two, there are going to be major consequences.
When I say that the commodities markets haven’t seen anything like this since 1980 when gold went haywire, I mean it. And you don’t put gold in your gas tank. Sure, there have been some minor calamities, like when cotton went parabolic a few years ago, but crude oil is perhaps the world’s most important commodity when you take into account both its economic and geopolitical significance. People go to war over the stuff. Routinely. And with oil falling from $105 to $57 in just six months, it might happen again.
We’ll get to that in a second. But for perspective, when people look at this move in oil 10 years from now, they’re going to call it the “Crash of ‘14.” That’s my prediction. A move of this magnitude in a short amount of time is a crash. When stocks went down 19% in a week in 2008, that was also a crash.
What’s the definition of a crash? I say any move over six standard deviations. For comparison, the Crash of ‘87 was 25 standard deviations—a move so uncommon, so statistically rare, that it wasn’t supposed to happen in a length of time greater than the age of the universe.
I haven’t done the math on oil yet, but if it’s not six standard deviations, it’s close.
* * * *
As you probably know by now, the move in oil has been more of a supply story than a demand story. We were drilling holes all over the planet in search of it. My wife works in the Turkana Basin, on the border of northwest Kenya and Ethiopia, which is one of the most remote spots in the world. They were drilling for it there, too.
That’s what happens when oil gets to $140 a barrel. People are incentivized to look for it. It takes time to explore and produce the stuff. It takes years for wells to finally come online and for supply to hit the market.
There are still projects that may never be completed, like Vaca Muerta in Argentina, that Yacimientos Petrolíferos Fiscales (YPF) is developing in conjunction with Chevron. The poor Argentinians—screwed again.
And like we’ve been seeing in the mining industry, once a company has brought production online, it’s difficult to take it offline. It’s hard to start it back up again, to get all the permits, to hire everyone back. So people will continue to produce at uneconomic levels for a long time, hoping that the price will come back, while simultaneously ensuring that it won’t for a long time.
So back to my earlier point—is it bullish or bearish for the US? It’s not a hard question to answer. People are making it hard. 20 years ago, it would have been unequivocally bullish. Now, maybe not. We produce slightly more oil than we consume. There will be winners and losers, which is being reflected in the stock market.
For some countries, it’s unequivocally bearish, especially for adversaries like Venezuela, Iran, and Russia. But also for allies, like Canada, which is probably in the most precarious economic position of any country in the world.
The takeaway is: an oil crash makes the world less stable.
* * * *
I am a decent economic historian, but kind of a crappy political historian. People keep telling me scary stories about Russia—how Russia today closely resembles Germany in the 1930s. How Putin is in the midst of a full-blown currency crisis. How the West is (perhaps foolishly) applying sanctions. How the threat of annexation of Russia’s smaller neighbors could be higher than we think. How the willingness of the West to challenge it would be very low.
All because the price of a commodity crashed.
Russia is very much a petrostate. There are others. Norway has been enjoying a phenomenally high standard of living for years, with some of the highest incomes and the strongest currency in the world on a purchasing-power parity basis. A lot of that had to do with a very successful and well-managed state-owned oil industry, and one of the largest sovereign wealth funds to boot. If you’ve seen a chart of Norwegian krone (NOK) vs. the Swedish krona (SEK) recently, you know that oil’s plummet has been a game-changer.
I fear oil. But I don’t fear oil because oil will make the stock market go down—which it will. I fear oil because there are going to be second- and third-order political effects that we cannot even conceive of right now. Take Venezuela—my prediction is that Venezuela will descend into anarchy and hyperinflation—a failed state. This has consequences for the entire region, but especially Colombia. Take Venezuela and multiply it by 100, and you get a sense of the magnitude of the problem that we’re facing.
* * * *
Old traders know: price moves like this do not happen in a vacuum. There’s a chain reaction that extends out for years. So in situations like this, I do what an old trader does: I reduce risk. I cut back my exposure to things that gain from stability, and I increase my exposure to things that gain from volatility.
Nobody has a playbook for this, because nobody saw it coming. But a leveraged long position with no cash is probably a bad idea right now.
Courtesy: Dan Steinhart via Casey Research
Since the beginning of this year, Wall Street economists and analysts have been consistently prognosticating that following the Federal Reserve’s latest bond buying campaign, economic growth would gather steam and interest rates would begin to rise. This has consistently been the wrong call as I discussed in April of this year in “Interest Rate Predictions Meet Bob Farrell’s Rule #9:”
“An interesting article hit my inbox this morning from WSJ MarketWatch which was titled ‘100% Of Economists Think Yields Will Rise Within 6 Months’ From the article:
‘Economists are unwavering in their assessment of where yields are headed in the next half year.
Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury yield to rise in the next six-months.‘
This is very striking from the standpoint that a separate poll of economists showed that there were none, zero, nada expecting an economic contraction either.
With literally 100% of all surveyed economists bullish on the economy, it suggests that there is nothing but clear sailing ahead for investors. Of course, it is also important to remember that it was this same group of“economists” that have been predicting the return of economic growth and higher interest rates for the last three years, as well. As we enter into the sixth year of the current economic expansion the unanimous ‘bullish bias’ is indeed fascinating.”
Almost 18-months ago, after interest rates initially spiked from historic lows, I began writing then that the bond “bull” market was not yet over despite the litany of articles and punditry claiming otherwise. Furthermore, I stated that interest rates would be lower in the future as the three primary ingredients needed for higher rates were missing: rising inflation, increased wage growth and economic acceleration.
So, as we pass the 6-month mark for those predictions, let’s take a look at where things stand now that the Federal Reserve’s latest QE campaign has come to an end.
As I discussed earlier this week on Fox Business News, the call for lower interest rates has continued to confound and frustrate the majority of mainstream analysts.
Will long-term interest rates eventually rise? Yes. However, as stated above, the ingredients necessary for a sustained rise in borrowing costs are not currently embedded within the economy. Furthermore, as I wrote previously, the current level of interest rates, given global economic conditions, is not unusual. To wit:
“Since then rates have continued to be in a steady decline as real economic strength has remained close to 2% annually, deflationary pressures have risen and monetary velocity has fallen. The chart below is a history of long-term interest rates going back to 1857. The dashed black line is the median interest rate during the entire period.”
“Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time. There have been two previous periods in history that have had the necessary ingredients to support rising interest rates.
Currently, the U.S. is no longer the manufacturing powerhouse it once was and globalization has sent jobs to the cheapest sources of labor.Technological advances continue to reduce the need for human labor and suppress wages as productivity increases. As discussed recently, this is a structural problem that continues to drag on economic growth as nearly 1/4th of the American population is now dependent on some form of governmental assistance.”
Importantly, since 2009, interest rates have only risen during the Federal Reserve’s QE campaigns as money was forced out of “safe haven” investments like bonds into “risk” assets in the equity markets. This, of course, was what was intended by the Federal Reserve under the assumption that inflating asset prices would lead to increased consumer confidence levels and higher rates of consumption.
(Note: As shown above, interest rates peaked during the latest QE program just as the Federal Reserve announced their first step in reducing bond purchases. Equities, at least for the moment, have appeared to peak as the last of the liquidity support was extracted from the financial markets.)
IF the Federal Reserve remains flat on monetary interventions, the current trend of interest rates suggests a retest of 2012 lows as economic growth slows domestically due to global deflationary pressures.
The Dollar & Oil
Like interest rates, the dollar has also been driven by the Fed’s monetary injections. Just as with interest rates, the dollar is a “safe haven” investment during times of global weakness and deflationary pressures. As shown below, the dollar has rallied strongly when the Federal Reserve has extracted support from the financial markets which has made “risk” based investments much less attractive.
Since oil is traded in US dollars globally, it is also not surprising to see the effect of the Fed’s interventions applied to oil prices.
As shown, oil prices rose sharply during QE programs as the push for “risk” drove money out of “safe haven” investments of the dollar and bonds and into oil contracts. As monetary interventions were extracted, or as during Operation Twist where the Federal Reserve was not actively monetizing debt, oil prices trended lower. The latest plunge in oil prices coincided with the end of the Fed’s latest QE program which, as expected, sent oil prices and interest rates lower and the dollar higher.
Another Year Of Bond Bear Disappointment
The recent decline in interest rates should really not be a surprise as there is little evidence that current rates of economic growth are set to increase markedly anytime soon. Consumers are still heavily levered; wage growth remains anemic, and business owners are still operating on an “as needed basis.” This “economic reality” continues to constrain the ability of the economy to grow organically at strong enough rates to sustain higher interest rates.
This is a point that seems to be lost on most economists who forget that the Federal Reserve has been pumping in trillions of dollars of liquidity into the economy to pull forward future consumption. With the Fed now extracting the QE support, it is very likely that economic weakness will resurface since the “engine of growth” was never repaired.
As I stated at the start of this post, while interest rates are indeed low currently, it is not the first time that we have witnessed such levels. Furthermore, interest rates can remain low for a very long time when there is a lack of sufficient economic catalysts to sustain the drag imposed by higher borrowing costs.
For now, as a contrarian investor, literally “everyone” remains piled onto the same side of the interest rate argument even after 18-months of being wrong. That alone is enough to keep me bullish on bonds and other interest-sensitive sectors of the economy for now.Courtesy: Lance Roberts
I have written article after article and given presentation after presentation about the dichotomy between paper and physical gold and have regularly highlighted the magnitude of the flow of gold out of the West and into strong Eastern hands. In the previous edition of this publication (“How Could It Happen?”), I imagined a future in which this stunning relocation of physical gold had finally mattered; and between publishing that piece and penning this one, a couple of interesting things have happened. Firstly, my friend Barry Ritholtz took a big, fat shot at me in a Bloomberg column entitled “The Gold Fairy Tale Fails Again.” Barry’s article (which was entirely consistent with his very public and oft-stated thinking and was, as is always the case with Barry, very well-written) took apart what he sees as the various failed narratives in the gold markets. He began with gold’s link to QE:
(Barry Ritholtz): [T]he most popular gold narrative was that the Federal Reserve’s program of quantitative easing would lead to the collapse of the dollar and hyperinflation. “The problem with all of this was that even as the narrative was failing, the storytellers never changed their tale. The dollar hit three-year highs, despite QE. Inflation was nowhere to be found,” I wrote at the time…
… moved on to the recent SGI:
Switzerland was going to save gold based on a ballot proposal stipulating that the Swiss National Bank hold at least 20 percent of its 520-billion-franc ($538 billion) balance sheet in gold, repatriate overseas gold holdings and never sell bullion in the future. This was going to be the driver of the next leg up in gold. Except for the small fact that the “Save Our Swiss Gold” proposal was voted down, 77 percent to 23 percent, by the electorate….
… then hit upon the recent Indian import restrictions and reports of gold shortages, which Barry clearly feels are spurious, before eventually finding his way to yours truly:
Perhaps the most egregious narrative failure came from Grant Williams of Mauldin Economics. He imagined a conversation 30 years from now about China’s secret three-decade-long gold-buying spree, dating to November 2014. Well, we only need to wait 30 years to see if this prediction is correct.
Now, in response to the lighting up of my Twitter feed after Barry’s article was posted (and my thanks to all those who kindly pointed it out to me), I would say this: Barry is right on all counts. For now.
I am delighted to be able to call Barry a friend and have absolutely no problem with his calling me out on what I said. Those of us who possess sufficient hubris to deem our thoughts worthy of distribution wider than the inside of our own heads are absolutely there to be taken to task should others disagree with us. We make ourselves fair game the second we hit the wires.
Sadly, none of us actually KNOW anything. How could we? We all take whatever inputs we find and then use them to reach our own conclusions based mostly on probability, and more often than not those conclusions are wrong.
HOWEVER… if your logic is sound and your thought processes rigorous, being wrong is often a temporary state — something that can also be said about being right, of course. In my humble opinion, the issue with gold today is not one of narrative, as Barry suggests, but rather that the extent of the current interference in markets by our friends at the various central banks around the world has meant that being wrong (no matter which part of the financial jigsaw puzzle you may be concerned with) has never been easier — even though being right has never, in my own mind at least, been more assured in the long term, certainly as far as gold is concerned.
As I slumped against the literary ropes, Barry threw one more punch when he suggested that the reader would “only need to wait 30 years to see if this prediction is correct,” but this is where I stop covering up and finally flick a jab or two of my own.
I think the chances of having to wait 30 years to see the gold conundrum resolve itself (in materially higher prices, I might add) lie close to those of Barry’s being invited to give the opening address at the next GATA conference. The evidence is crystal clear that significant quantities of physical gold have been pouring into Eastern vaults (due to both private and public-sector activity); and gold is, after all, a finite resource. Not only that, but the “weakness” in gold (which remains roughly 500% above its turn-of-the-century low, despite the recent 30% correction) is confined to the paper market.
Whilst this distinction between paper and real gold hasn’t mattered up until now, there will come a day when it absolutely does — to everybody — and at that point, anyone not positioned
correctly will be in a world of hurt.
(Charts below courtesy of Nick Laird at Sharelynx and Koos Jansen)
Tightness in the physical market has increased consistently as the likes of Russia continue to stockpile ever-increasing amounts of gold and as Chinese imports as well as withdrawals from the Shanghai Gold Exchange maintain a torrid pace. The only missing piece of the puzzle is the lack of any official acknowledgement that the Chinese have been doing the same thing to a far greater degree; and, as I wrote in “How Could It Happen?”, there is a curious demand for absolute proof from those who dispute official figures, whilst the principle of reasonable doubt continues to hold sway on the other side of the argument.
I suspect that imbalance will right itself — possibly very soon — and when it does there will be absolutely no putting the genie back into the bottle.
In the meantime, as Barry so confidently predicted, the Swiss Gold Initiative failed, but that was overshadowed (in my mind at least) by a couple of very interesting developments that were covered beautifully by two of my buddies, Willem Middelkoop (author of The Big Reset — a phenomenal read) and Koos Jansen.
Firstly, Koos reported on the increasing drive to allocate the gold held within the Eurosystem:
(Koos Jansen): [M]ost of the Eurosystem official gold reserves are allocated, and since January 2014 (which is as far as the more detailed data goes back) the unallocated gold reserves are declining, as we can see in the next chart. Unfortunately we do not know what happened prior to 2014.
Note, allocated does not mean the gold is located on own soil, but it does mean the gold is assigned to specific gold holdings, including bar numbers, whether stored on own soil or stored abroad. Unallocated gold relates to gold held without a claim on specified bar numbers; often these unallocated accounts are used for easy trading… The fact the Eurosystem discloses the ratio between its allocated and unallocated gold and, more important, the fact that the portion of allocated gold is far greater and increasing, tells me the Eurosystem is allocating as much gold as they can.
Secondly, another repatriation request was unearthed — this time made by perhaps the least likely source imaginable:
(Koos Jansen): In Europe, so far, Germany has been repatriating gold since 2012 from the US and France, The Netherlands has repatriated 122.5 tonnes a few weeks ago from the US, soon after Marine Le Pen, leader of the Front National party of France, penned an open letter to Christian Noyer, governor of the Bank of France, requesting that the country’s gold holdings be repatriated back to France; and now Belgium is making a move. Who’s next? And why are all these countries seemingly so nervous to get their gold ASAP on own soil?
Funnily enough, the answer to Koos’ rhetorical question about who’s next was answered just a few days later:
(Bloomberg): The Austrian state audit court says central bank should address concentration risk of storing 80% of its gold reserves with the Bank of England, Standard reports, citing draft audit report. Court advises central bank to diversify storage locations, contract partners. Austrian central bank reviewing gold storage concept, doesn’t rule out relocating some of its gold from London to Austria: Standard cites unidentified central bank officials. Austria has 280 tons gold reserves, according to 2013 annual report. Austrian Audit Court Will Review Nation’s Gold Reserves in U.K.
Say what you want about the gold price languishing below $1200 (or not, as the case may be, after this week), and say what you want about the technical picture or the “6,000-year bubble,” as Citi’s Willem Buiter recently termed it; but know this: gold is an insurance policy — not a trading vehicle — and the time to assess gold is when people have a sudden need for insurance. When that day comes — and believe me, it’s coming — the price will be the very last thing that matters. It will be purely and simply a matter of securing possession — bubble or not — and at any price.
That price will NOT be $1200.
A “run” on the gold “bank” (something I predicted would happen when I wrote about Hugo Chavez’s original repatriation request back in 2011) would undoubtedly lead to one of those Warren Buffett moments when a bunch of people are left standing naked on the shore.
It is also a phenomenon which will begin quietly before suddenly exploding into life.