The commodity landscape is always a fascinating one, and one that I think is worth your attention if you trade for periods longer than a week. Many traders are familiar with commodity currencies like the Australian Dollar, which has been the strongest currency in G8 for most of 2017, the New Zealand Dollar, and the Canadian Dollar.
Some savvy traders may even be familiar with the role that commodities play in emerging market currencies like the Mexican Peso and South African Rand among others whose economies are rich in resources as well dependent on trade. Trade and commodity demand tend to go together like spring and rain.
Lastly, the large confusion post-financial crisis has been the disappearance of inflation. Many Central Bankers promised it would come back, but it’s been hiding away in the one place that money or money-printing cannot seem to buy. The lack of inflation has been seen clearly from sovereign bond yields, which are related inversely to the price that has been on a long move lower (price higher) as demand was ever present for consistent coupons in the disinflationary environment.
Many Central Bank QE plans were activated to restore the price stability of inflation. This background in important because commodities are a key part of any market cycle that goes from rising to peak to correction to trough and repeats. The three markets that play along with the market cycle is the bond market first, which tends to rise (bond yields fall), followed by stocks (which admittedly do not look to have topped yet), and is last followed by commodities.
Commodities tend to market the final stage of a market cycle. In 2008, stocks topped out in November of 2007, and commodities, as witnessed most clearly by Oil, topped the following summer. As trend followers, this is important because despite what is happening with stocks and whether or not it is about to top or will continue to rise, we could still have a large trend ahead of us in commodities.
Naturally, as traders, there are important ramifications if this is to be the case. First, commodities themselves via CFDs could continue the trend that we’ve seen in much of 2017. As mentioned earlier, a derivative of commodities are the commodity bloc currencies that have trended strongly against the USD for most of 2017. Lastly, there is the inverse trade to commodities themselves, which is the US Dollar.
Historically, we tend to see strong moves in commodities with converse movements in the US Dollar. Therefore, if you have a good scent on where Commodities are headed, and that is confirmed with US Dollar moving in opposite directions, you likely have found a good theme that could trade and ride for a while.
Let’s take a look at some key commodity components to see what’s going on right now and how it might be helpful for understanding what may be coming down the road along with the possible trades this may make available.
While industrial metals may not be as fun to discuss at a dinner party as Gold or Oil, the implications of Industrial metal demand and therefore price is, of course, crucial. Gold tends to play the commodity role similar to the US 30yr bond, which is more of an inflation gauge than growth measure. However, the rise in the price of industrial metals like we’ve recently seen with Iron Ore Futures and Copper, that recently surpassed its November peak help to show rising demand, at a time when China appears to be reducing its supply.
A key story that popped up last week was that Anglo American, the mining giant has decided to halt some of their asset sales that are designed to clear up the balance sheet and help pay off debt or make money available for dividends. The important part of the story is why they decided to halt the sale of the assets that were their mines. They said that the mines had recently turned into a cash cow.
While the supply of metals got crushed alongside a lot of other commodity producers in the downturn of H2 2014 and 2015, the few that remained to appear to be sitting pretty one-quarter into 2017. Demand appears to be picking up, and there are fewer mines that we’ve seen in a long time that is there to meet that demand, which could make for profitable mining companies and a Bullish trend in the industrial metals if the trend continues.
Multi-Month Breakout In Copper
Chart Created by Tyler Yell, CMT
What Is Happening In The Energy Sector
The energy sector seems to have a lot of traders confused, and for a good reason. The market has been flat since the start of the year despite all the news of Trump Policies, OPEC cuts, and record positioning from hedgers and speculators.
Crude Oil Price Stability Above LT Polarity Zone
Chart Created by Tyler Yell, CMT
I would point out a few takeaways in the energy market. The news has not been encouraging given the rise in US Supply, but the price has been stable. This could be a component of rising inflation expectations, which was validated with last week’s CPI print in the US or a factor or rising demand.
Demand does appear to be rising, and given the recent reports of ~92% OPEC compliance, it appears the US Supply is not enough to prevent Oil from eventually moving higher. Obviously, as technicians, we need to have a point where the price looks to negate the theme and story we’re viewing. A breakdown below the $50 range alongside a strengthening dollar with DXY over 102 would put a large dent in the Oil Bullish story.
Price stability, for now, appears to be Bullish given that it is developing above prior long-term resistance. Should Oil eventually align with the Industrial Metals picture, we could be working on a move toward $60/bbl.
What is happening with the Denominator in the Equation? The US Dollar
Chart Created by Tyler Yell, CMT
The US dollar is akin to the axis on which global markets turn. It does not matter if you’re looking at Government Bonds, Equities, Global Alternative Assets or you-name-it, the US Dollar is in the mix. There are many reasons, but a large part in addition to being the global reserve currency is that the US Treasury Market is the defacto risk-free rate that nearly every asset pricing and portfolio risk measure utilize.
Therefore, the direction and the broader trend of the US Dollar matters, a lot. We can see that the USD got a large boost post the November election and this aligned nicely with a move higher in UST 2Yr Yields, which do a fine job of pricing in and acting as a Proxy of the Federal Reserve monetary policy in the coming 24 months. The current 2-yr Yield as of Mid-November sits around 2.2%.
This appears surprising given the recent Humphry-Hawkins testimony from Janet Yellen who noted that we could see 2-3 hikes per year coming up. This could indicate that the bond market (the supposed “smartest people in the room”) believes Yellen & Co. are getting ahead of themselves. Either way, the relationship we’ve seen is that it is difficult for the USD to breakout without 2 Yr US Yields moving higher, and that would appear to need an exogenous shock. For now, we’ll keep an eye on the uptrend, and a break of support to possibly validate the larger potential Bull Trend in commodities that I am proposing you should be on the watch out for in 2017.
What To Watch For Commodity Bloc FX
Chart Created by Tyler Yell, CMT
Lastly, it’s helpful to tie this all back to the FX market. The Australian Dollar has traded places with the New Zealand Dollar, and Canadian Dollar for the top spot on a relative strength basis for most of 2017 among G8 currencies. A key component of Momentum is that it is a force that is difficult to predict (will it turn/reverse), but rather easy to follow.
The commodity currencies that have headlined as strongest currencies in 2017 should continue to be on your radar and a break above AUD/USD resistance, the strong/ weak pairing of Thursday, February 16, 2017, at 0.7800 could be a further indication that a strong move higher is upon us as we may be making a move on USD weakness or commodity strength toward 0.8000.
Strong/ Weak Analysis For Thursday, February 16, 2017
Created by Tyler Yell, CMT
Such a move would likely be aligned with broader commodity strength that we encourage you to be looking for validation signs as well. – Tyler Yell
– John Grandits: In December, we argued gold’s post-election decline didn’t reflect its fundamentals and that now could be a good time to add some to your portfolio. It just so happened that shortly after, the price began rising. The yellow metal is up almost 8% since the beginning of the year—and the outlook for 2017 is bright. Net bets on higher future prices have almost doubled since January. Assets held by gold ETFs are up 34% from their December lows.
Given its recent surge, is gold still a “buy?”
With gold having its best January since 2012, many are expecting a pullback. While a retrenchment is possible, given the shifting political landscape, we think it has further to go.
Historically, the yellow metal has done well in times of uncertainty. While uncertainty rose following the election, gold fell. This was due to optimism surrounding Trump’s pro-growth policy announcements. However, since the inauguration, some optimism has evaporated, and investors are recalibrating their expectations and timelines for actual policy implementation.
As uncertainty surrounding immigration policies, the future of Obamacare and Dodd-Frank, and tax cuts continues, gold will be a likely beneficiary.
Are Investors Too Complacent?
The change in the drivers of economic growth is also good for gold. Since the election, it has been politics—not central banks—steering markets higher. This represents a major sea change. While the Fed’s actions post-financial crisis have been predictable, Trump is anything but. Therefore, we can expect twitchier markets ahead. Mohamed El-Erian has coined this period “Phase III” of the Trump Rally.
Given this is the second longest period in stock market history without a 10% correction, investors should proceed with caution. Higher volatility may very well be the story of 2017.
Increasing ambiguity has led to another positive development for gold—the drop in the dollar. The dollar index hit a 14-year high back in December. It then went on to have its worst January since 1987.
The dollar’s decline helps gold in two ways. First and foremost, gold and the dollar have a strong inverse relationship. When gold rises, the dollar falls—and vice-versa. Secondly, as gold is priced in US dollars, when the greenback falls, gold becomes cheaper for foreign buyers.
The situation in Europe also looks promising for precious metals. Following the “Brexit” vote last June, gold rose 7% in less than two weeks. If you thought Brexit cast doubt over the future of the EU, wait until you see 2017’s political calendar.
National elections are taking place in France, Germany, and The Netherlands. In all three countries, outsiders are gaining ground on traditional “centrist” parties. Greece is also back in the news with its perennial fiscal problems. That’s not to mention Italy, where a banking crisis is emerging.
Besides political happenings, the developing economic picture looks positive for gold.
On the back of improving economic data, the Fed raised interest rates last December for only the second time since 2006. They also laid out a plan to hike rates three times this year. As a result, equities moved higher while bonds sold off.
As expected, gold fell on this announcement. Higher rates are negative for gold as it increases the opportunity cost of holding the metal. While the rate hike knocked gold, the chances of more coming in the near-term fell after the disappointing January jobs report.
Adding to the optimism is the return of inflation. In December, the consumer price index (CPI) recorded 2.1% year-over-year growth. Expected inflation, measured by the 10-year breakeven rate, has consolidated above 2%. Both numbers are at their highest levels since 2014.
As the biggest driver of the gold price is real rates, this is a huge plus for the metal. At the moment, the negative correlation between gold and real rates is the strongest since records began in 1997.
Given the current setup, the January CPI number could have enormous implications. If it comes in over 2%, it may force the Fed to reluctantly raise rates in March. Higher rates will further tighten financial conditions. Given the elevated public and private debt levels, it would likely weigh on economic activity.
Following these developments, gold moved above its 100-day moving average (MA) last week. This is very bullish as the 100-day MA acted as both a floor and a ceiling during 2016’s rally and correction.
It’s worth noting the last two times it did this, gold advanced 18% and 13%, respectively.
With the Fed in a tricky situation regarding interest rates—and ambiguity likely to continue to surround the political arena—we may be in for a wild ride in 2017. Given the uncertain outlook and improving fundamentals for gold, now is a great time to add the yellow metal to your portfolio.
Notwithstanding the strong demand for gold and silver globally, buying activity in the U.S. retail market for physical bullion has fallen noticeably in the wake of Donald Trump’s election victory. And retail selling in the U.S. has increased. The bullion markets have entered a new phase.
The two terms of President Obama included the aftermath of the 2008 financial crisis, zero interest rate policy from the Federal Reserve, and multiple rounds of Quantitative Easing. Reasons to buy gold and silver were plentiful. Today, the reasons to diversify into gold and silver are as strong as ever, but they’re perhaps less obvious to the average retail buyer in the U.S.
Many of the people who felt deeply concerned about the direction of the nation under Barack Obama are more optimistic now. U.S. stock markets are moving relentlessly upward. Artificially low interest rates are sending home prices higher. Even the US dollar looks decent when compared to other world currencies.
The rationale for owning physical gold and silver isn’t making page one headlines. That does not mean the gold story is over. Rather the markets seem to be at a crossroads with investors waiting to see which direction events will take them.
One path is not bullish for precious metals prices. That route includes a stronger US dollar coupled with real economic growth and risk assets continuing to outperform.
The other two paths move through very different landscapes, but both lead to sharply higher gold and silver prices. The first path involves price inflation amid rapidly growing government debt. The need to hedge against the dollar’s declining purchasing power re-emerges in investor psychology. The second path leads toward geopolitical uncertainty and the return of safe-haven buying.
There are good reasons to expect metals markets will take one of the more bullish paths. Here are the potential catalysts as we see them today…
The Bureau of Labor Statistics just reported the biggest jump in the Consumer Price Index in four years. Bureaucrats have a sordid history of under-reporting the true price inflation rate.
But a massive devaluation of the dollar remains the only politically viable means of addressing our national debt and avoiding an overt default on entitlement obligations.
No election can change that imperative. It remains a matter of when, not if, Americans can expect big league price inflation.
President Trump and his advisors would very much like to see a weaker dollar, and they are saying that explicitly. The jawboning has even yielded some results. For the moment, however, they aren’t getting much help from Janet Yellen. The Fed is still signaling tighter monetary policy, which could make the dollar look stronger relative to other major currencies.
The administration has put some proposals on the table which would promote a decidedly weaker dollar. Trump’s bid to launch a massive infrastructure spending program is one of these. The anticipation of a trillion dollars worth of construction projects is already fueling inflation expectations.
The proposal for significant tax reductions is getting plenty of attention, but, as yet, not many see it as a significant driver of price inflation. It would be. Tax cuts work as a direct stimulus because people have more spendable cash left in their pockets. Any cuts could also undermine the dollar by driving up federal deficits and borrowing, assuming a booming economy doesn’t increase overall tax revenues.
Finally, should Trump convince congress to levy import or border taxes with a major trading partner such as Mexico or China, it will mean higher prices inside the U.S. That is the inevitable cost for such a policy.
Even the most optimistic Trump supporters should be planning for a bumpy ride on the way to reform. For starters, it is increasingly clear the president is at war with the Deep State – the unelected, often anonymous bureaucrats and elites who have been running our government from behind the scenes for decades.
This battle breeds uncertainty and the potential for real turmoil. It is impossible to confidently predict what the political landscape will look like just a few months from now, let alone a few years down the road.
The potential for widespread social unrest should not be discounted. Anti-Trump forces are already mobilized and cultivating enough hysteria to foment violence in places like Berkeley.
His supporters, by and large, seek to avoid physical confrontation. But that could change quickly if Trump’s war with the Deep State takes a turn for the worse.
The president has many enemies in Congress, including some powerful Republicans. What happens if the president is impeached? What if there is an assassination attempt?
Turn away from America’s extraordinarily volatile political scene, and you’ll find other reasons to retain some caution. This year promises to be pivotal in Europe. Anti-EU candidates just may win in upcoming European elections. Should that happen in either France or Germany, it is likely to shake markets to the core.
Europe isn’t the only continent with trouble brewing. Jim Rickards is among a number of experts who think the next economic crisis might kick off in Asia. Appearing on the Money Metals podcast last week, Rickards makes the case for China “going broke” as officials attempt to maintain a currency peg and grapple with the massive numbers of bad loans piled up in Chinese banks.
Current valuations in the U.S. equity markets should also be giving investors reasons for concern. Having risen dramatically as shown in the chart below, price-to-earnings ratios are signaling a significant correction may be just ahead.
The bull run in the S&P 500 has lasted almost 8 years. Do Trump’s plans for economic revitalization mean the run can persist for years longer?
It’s possible. There are two ways for valuations to fall back into line, and one of them is for corporate earnings to rise significantly.
The other is for share prices to fall… hard. For anyone who isn’t supremely confident in Trump’s ability to shepherd the tax cuts and a big infrastructure program through congress, this is the better bet.
Submitted by: Money Metals
In the next issue of The Austrian, David Gordon reviews Sebatian Mallaby’s new book, The Man Who Knew, about the career of Alan Greenspan. Mallaby points out that prior to his career at the Fed, Greenspan exhibited a keen understanding of the gold standard and how free markets work. In spite of this contradiction, Mallaby takes a rather benign view toward Greenspan.
However, in his review, Gordon asks the obvious question: If Greenspan knew all this so well, isn’t it all the more worthy of condemnation that Greenspan then abandoned these ideas so readily to advance his career?
Perhaps not surprisingly, now that his career at the Fed has ended, Old Greenspan — the one who defends free markets — has now returned.
This reversion to his former self has been going on for several years, and Greenspan reiterates this fact yet again in a recent interview with Gold Investor magazine. Greenspan is now a fount of sound historical information about the historical gold standard:
I view gold as the primary global currency. It is the only currency, along with silver, that does not require a counterparty signature. Gold, however, has always been far more valuable per ounce than silver. No one refuses gold as payment to discharge an obligation. Credit instruments and fiat currency depend on the credit worthiness of a counterparty. Gold, along with silver, is one of the only currencies that has an intrinsic value. It has always been that way. No one questions its value, and it has always been a valuable commodity, first coined in Asia Minor in 600 BC.
The gold standard was operating at its peak in the late 19th and early 20th centuries, a period of extraordinary global prosperity, characterised by firming productivity growth and very little inflation.
But today, there is a widespread view that the 19th century gold standard didn’t work. I think that’s like wearing the wrong size shoes and saying the shoes are uncomfortable! It wasn’t the gold standard that failed; it was politics. World War I disabled the fixed exchange rate parities and no country wanted to be exposed to the humiliation of having a lesser exchange rate against the US dollar than itenjoyed in 1913.
Britain, for example, chose to return to the gold standard in 1925 at the same exchange rate it had in 1913 relative to the US dollar (US$4.86 per pound sterling). That was a monumental error by Winston Churchill, then Chancellor of the Exchequer. It induced a severe deflation for Britain in the late 1920s, and the Bank of England had to default in 1931. It wasn’t the gold standard that wasn’t functioning; it was these pre-war parities that didn’t work. All wanted to return to pre-war exchange rate parities, which, given the different degree of war and economic destruction from country to country, rendered this desire, in general, wholly unrealistic.
Today, going back on to the gold standard would be perceived as an act of desperation. But if the gold standard were in place today we would not have reached the situation in which we now find ourselves.
Greenspan then says nice things about Paul Volcker’s high-interest-rate policy:
Paul Volcker was brought in as chairman of the Federal Reserve, and he raised the Federal Fund rate to 20% to stem the erosion [of the dollar’s value during the inflationary 1970s]. It was a very destabilising period and by far the most effective monetary policy in the history of the Federal Reserve. I hope that we don’t have to repeat that exercise to stabilise the system. But it remains an open question.
Ultimately, though, Greenspan claims that central-bank policy can be employed to largely imitate a gold standard:
When I was Chair of the Federal Reserve I used to testify before US Congressman Ron Paul, who was a very strong advocate of gold. We had some interesting discussions. I told him that US monetary policy tried to follow signals that a gold standard would have created. That is sound monetary policy even with a fiat currency. In that regard, I told him that even if we had gone back to the gold standard, policy would not have changed all that much.
This is a rather strange claim, however. It is impossible to know what signals a gold standard “would have” created in the absence of the current system of fiat currencies. It is, of course, impossible to recreate the global economy under a gold standard in an economy and guess how the system might be imitated in real life. This final explanation appears to be more the sort of thing that Greenspan tells himself so he can reconcile his behavior at the fed with what he knows about gold and markets.
Nor does this really address Ron Paul’s Concerns expressed for years toward Greenspan and his successors. Even if monetary policymakers were attempting to somehow replicate a gold standard environment, Paul’s criticism was always that the outcome of the current monetary regime can be shown to be dangerous for a variety of reasons. Among these problems are enormous debt loads and stagnating real incomes due to inflation. Moreover, thanks to Cantillon effects, monetarily-induced inflation has the worst impact on lower-income households.
Even Greenspan admits this is the case with debt: “We would never have reached this position of extreme indebtedness were we on the gold standard, because the gold standard is a way of ensuring that fiscal policy never gets out of line.”
Certainly, debt loads have taken off since Nixon closed the gold window in 1971, breaking the last link with gold:
|R1||17.24 Dec highs|
|R2||17.35 H&S neckline (broken at)|
|R3||17.63 20 DMA|
|R4||17.73 38.2% Fibo (Jul-Dec sell-off)|
|R5||19.00 Nov highs|
|R6||20.13 Sep 6 peak|
|R7||21.13 High so far|
|R8||21.60 Jul 2014 peak|
|S1||17.63 20 DMA|
|S4||15.82 May low|
|S5||15.63 Low so far|
|S6||15.44 Long-term UTL|
|S7||13.64 Dec low|
|Legend:DMA – daily moving averageFibo – Fibonacci retracement line
H&S – head-and-shoulder pattern
RL – resistance line
UTL – uptrend line
The fact silver prices have managed to accelerate higher while the dollar has been strengthening is noteworthy. With base metals generally rallying too, it looks as though silver is attracting industrial buying.
Last week’s CFTC data, up to the close on February 14, showed the net long fund position (NLFP) climbed 6,535 contracts to 84,812 contracts. This was the seventh consecutive week where the funds have been net buyers. Shorts have been cutting exposure for six weeks and the longs have been adding positions for eight weeks. At 104,765 contracts, the gross long position is still some way below last year’s peak of 123,737 contracts and the short position at 19,953 contracts is in low ground, the lowest since 2014 has been 12,375, while the highest has been 63,993 contracts.
The fact gold prices are holding up well, almost regardless of the dollar, and that dips have been short-lived and shallow also portrays a robust market. Overall, we still feel that bullion will remain sought-after as a safe haven in the days and weeks ahead. This is especially the case while geopolitical uncertainties are growing with the UK getting closer to Brexit, Greece facing debt repayment issues, Europe facing elections and US President Trump settling into his new role.
That said, prices rarely travel in straight lines so we should expect pullbacks along the way.
The sell-off in the second half of last year was significant but the downtrend looks to be over. The rebound now looks more than merely another counter-trend move and is more likely to be the start of a bull market, although to-date silver prices have rallied 16% rather than the 20% required to call it a bull market officially. That said, in the short term the latest up-leg is looking tired, the stochastics have swung lower and another show of dollar strength may act as a headwind, so we would not be surprised to see prices consolidate at lower numbers; but we expect dips will be well supported. – William Adams
– John Ross Crooks III: Investors are putting their faith in gold because they fear what’s coming for stocks.
Now, we can verify that their faith in gold has helped prices rise more than 7% this year.
Even while the S&P 500 has risen roughly 5%.
But despite the ongoing strength in stocks — the resilience of investors’ appetite for risk — gold investors fear that the happy times are about to change.
Think about everything that everyone is thinking about the state of economics and markets in the U.S. …
Consumer Price Inflation (CPI) is on the rise
The 5-year/5-year Breakeven (the Fed’s favored inflation gauge) is north of 2%
Fiscal infrastructure spending
Personal and corporate tax cuts are “coming”
GDP growth seems lacking and forecasts are being revised lower
Industrial production is iffy
Retailers are contending with border-tax proposals
Margin debt at the NYSE continues rising
Some indicators and analysts see weakness in corporate profits and margins, which have been a huge driver of returns in the last five years
The Federal Reserve is still jawboning about the need for more interest-rate hikes
Surely, these are only some of the things investors are thinking about.
But clearly the more-favorable items are taking precedence over the growing risks.
The S&P 500 is on the up-and-up.
And if Wave V (at the top of the chart) looks anything like Wave I …
The S&P 500 has another 7% or so to rise, from current levels, until this bull market tops out.
But if gold investors have a beat on what’s going on behind the scenes of this stock market rally … then a stock market correction is in order soon.
For triggers, watch how the dialogue plays out on tax reform. Some say that any real reform that cuts the corporate tax rate must coincide with a border-adjustment tax (BAT). And this potential BAT threatens to hit U.S. retailers hard.
Also, watch the developments in Federal Reserve rate-hike expectations. The major factors will probably be the resilience of GDP growth forecasts and the outlook for inflation, which could change if the price of oil cannot resurrect the bulls.
Finally, fiscal spending tends not to be the buoy to economic activity and corporate earnings … despite what many think. See the chart below from a blog called Variant Perception. In it, expenditures are inverted. So, the correlation suggests that the CAPE falls when fiscal spending goes up.
Remember, CAPE is the cyclically adjusted price-to-earnings ratio. Consider it a P/E that spans 10 years and offers a glimpse into longer-term equity valuations.
And let’s not forget what the debt burden might mean for the efficacy of such an infrastructure-spending plan. (It means the impact on economic activity will be muted even if the expenditures get approved.)
With that, I leave you with comments from a very concerning Bloomberg article by Danielle DiMartino Booth:
“… Combine the dynamic of tightening financial conditions with the Congressional Budget Office’s year-old calculations that the deficit … would more than double to 4.9 percent by 2026. The CBO projects debt held by the public will swell to 86 percent, twice the historic average and the highest since 1947.
“In terms of borrowing costs, the CBO assumes that the rate on three-month Treasury bills rises … while that of 10-year Treasuries increases … Just think of what that would do to Uncle Sam’s interest expense … with the national debt at the cusp of crossing the $20 trillion line. That’s on top of the $18.2 trillion in household debt.
“So, add rising deficits and higher rates together with a shrinking balance sheet that will slash Fed remittances back to the Treasury. Then factor in Trump’s proposed tax cuts, and just for proper measure, the looming reality that an aging population presents to entitlement spending. What do you get? Even worse debt-to-GDP levels than what the CBO assumes.”
I am not indicting President Trump when I ask: Should markets really be putting their faith in Trumponomics?
I fear the markets are nearing an end to the glory days.
Here’s the fact: if silver prices continue to move higher, as they have since the beginning of the year, silver stocks could surge in 2017. This is going to sound very bold, but it wouldn’t be shocking to see them double, triple, or more.
Why could silver prices surge?
You see, there are several reasons why silver prices could rise in 2017. You can read about the silver prices forecast here: “Silver Price Forecast for 2017.” But this is just one reason why the gray precious metal could soar, and buying silver stock could be the best way to make money.
Understand that in the silver market, there’s a disparity between demand and supply—the most basic economic factors. We currently see the demand for silver soaring, while the supply side is struggling.
To examine the demand side, look at the sales of silver at mints around the world. They are nothing short of impressive.
In the first month of 2017, the U.S. Mint sold over five million ounces of silver in American Eagle coins alone. (Source: “Bullion Sales,” U.S. Mint, last accessed February 16, 2017.) If we assume five million is the average for the next 11 months as well, the mint could be selling 60 million ounces of silver in the entire year of 2017.
But, don’t just stop here. Look at the Perth Mint, the biggest mint in Australia, as well. In January, it sold 1.23 million ounces of silver. This was over 180% higher than what the mint sold in December of 2016! It sold just 430,009 ounces of silver in December. (Source: “Perth Mint Gold and Silver Bullion Sales Jump in January,” CoinNews, February 10, 2017.)
This isn’t all for the demand side. Keep in mind, silver has huge industrial use as well.
It’s used in gadgets like cell phones and other electronics.
Currently, the demand for cell phones is huge and it wouldn’t be shocking if it gets bigger. I wrote about this not too long ago, on how many sell phones are expected to be sold between 2017 and 2019, and how much silver could be needed to make these phones.
Silver is also used in solar cells, and the demand for them is solid. This is despite the new U.S. administration being friendly towards coal and other fossil fuels. Investors have to look beyond the U.S. Elsewhere in the global economy, solar energy is becoming mainstream, and it’s going to require silver. Obviously with time, we will know more.
Adding to all this, it shouldn’t be forgotten that silver is used as a store of value, just like gold. Investors rush towards the precious metal in times of uncertainty and currency devaluation.
With this said, we are seeing news stories pop out of Europe that suggest the European financial crisis could be reviving again. If this continues, and we hear news of a bank default, this will cause investors to panic and boost the demand for silver.
As per the supply side, it looks like there are troubles brewing—there isn’t enough silver being produced.
Over the past few years, the decline in silver prices has been pretty much a blessing in disguise for those who are bullish on silver.
Lower silver value has caused companies to cut production. If you look at the statistics from major silver-producing regions, it becomes very apparent that the struggle is real.
Consider Canada as one example. In the first 11 months of 2016, primary silver production in Canada amounted to 331,645 kilograms. In the same period a year ago, this figure was 338,466 kilograms. If you do simple math, this represents a decline of over two percent year-over-year. (Source: “PRODUCTION OF CANADA’S LEADING MINERALS,” Natural Resources Canada, November, 2016.) Canada is one of the top 15 silver-producing countries in the world.
Look at Mexico as well, the biggest silver-producing country in the world. In the first 11-month of 2016, the monthly average silver production was 391,718 kilograms. In the same period of 2015, this was 414,425 kilograms. (Source: “Value and volume production of Silver,” Servicio Geológico Mexicano, November 30, 2016.) Again, simple math here; this represents a decline of about 5.4%.
Adding more to the misery, as silver prices were down, mining companies cut back on exploration. Keep in mind, when a company cuts back on exploration, it’s essentially investing less in its future production. Think of it this way; if a mining company doesn’t look for the metal (exploration), it will eventually run out of resources in the ground.
Keeping the demand and supply situation in mind, it’s not irrational to think there could be a shortage of some sort in the silver market. We have soaring demand and anemic supply. Economics 101 suggests this is a perfect recipe for higher silver prices.
One of the ways to value silver prices is to look at the gold-to-silver ratio. At the very core, this ratio says how many ounces of silver it takes to buy one ounce of gold.
With this in mind, please look at the long-term chart of gold-to-silver ratio below.
Chart courtesy of StockCharts.com
Notice how since 1992, the gold-to-silver ratio has been in a range from 80 to 40? If we assume the ratio hits the 40 level again, and assume gold prices remain at $1,250, silver prices would have to rise to at least $31.25—that’s over 73% from where they currently stand!
As silver prices surge, investing in silver stocks could provide the biggest bang for the buck.
Consider this: If an investor buys silver bullion for $18.00 an ounce and we assume the precious metal price goes to $31.25, their return would be just that, 73%.
Now look at silver stocks.
Assuming a silver stock produces an ounce of silver for $5.00 an ounce, with the current price of silver, it rakes in about $13.00 per ounce in profit margin—about 260%. If silver prices go to $31.25, its profit margin will increase to 525%. As this happens, its stock price will reflect this and soar much higher.
In other words; by investing in silver stocks, investor could get leveraged returns.
Still not convinced? Then look at this. In the past 12 months, silver prices have increased just over 12%. If you look at a well-run silver-mining stock like Hecla Mining Company (NYSE:HL), it has increased over 184.93%. In other words, for every one percent increase in silver prices, this mining stock provides a 15% return. Impressive.
Mind you; Hecla Mining Company is not a recommendation to buy, but rather an example of how silver stocks could perform when silver prices soar.
You see, when it comes to picking silver stocks in 2017, investors have to keep three things in mind.
First, if a silver company is producing the precious metal, it’s important to look at the price of production. If the company’s production price is lower than the spot price, then it’s worth a look. If a company is producing at a much higher price than the spot price, it’s losing money on every ounce it extracts from the ground.
Second, the quality of the grades in the ground is very critical as well. Silver mining companies usually report this information in their shareholders’ presentation or in their technical reports. The higher the grades, the better the company. Why? To extract the metal from the ground, with higher grades, it might take less effort, and it could help the company produce more silver and essentially increase shareholders’ value.
Third, the location of the property. A silver property in a mining-friendly and safe geopolitical area is far better than a property located in a country that has issues with mining and is prone to wars and corruption. If a silver company has a mine in a stable country, its actions are predictable and investors don’t get too many surprises.
With all this said, silver stocks are a place investors aren’t paying much attention to. With fundamentals in the silver market getting better, silver prices could soar. This is going to give a boost to silver stocks.
I will be bold here and say this; silver stocks are selling for literally pennies on the dollar. In the next bull run on silver stocks—that could very well be on its way—a lot of money is to be made. Investors could make massive returns. Their money could be doubling faster than any other asset class. – Moe Zulfiqar
Gold prices have been performing well since the beginning of 2017. The yellow precious metal is up roughly 7.30% year-to-date. Will gold prices go higher from here, or they are bound to go lower? If you look at gold prices from a technical analysis perspective, it’s projecting a bullish outlook.
Look at the chart below. Since 2011, the yellow precious metal prices have been in a downward channel (the blue lines in the chart). The mid-point of this channel is the most interest to note.
In late 2016, something interesting happened. Instead of dropping to the bottom of the channel, a level below $1,050.00, gold prices bounced higher midway.
Why is this significant? There are two things to keep in mind here.
First, and the most obvious, it says that gold prices are gaining strength and there are buyers.
Second, it’s looking as if there’s an emergence of a new trend in gold prices that’s pointing upward. Since the lows of late 2015, we have seen one higher high and one higher low. To get confirmation of an uptrend, at least one further higher high and one higher low is needed.
Chart courtesy of StockCharts.com
It would be interesting to see what happens once the gold price hits the top of the channel. If it breaks, then we could see resistance at around $1,367.00. If gold prices are able to move beyond this level, then we could see $1,550.00 without much resistance.
If the price of gold doesn’t break above the channel, and just touches the top of the channel, we could be seeing a move downward. Support could fall on the mid-point of the channel. If that level breaks, we could be looking at a much lower gold price. A price as low as $1,000.00 wouldn’t be out of the question.
From a fundamental perspective; there are bullish developments that shouldn’t go unnoticed. There three things that investors need to keep in mind:
Dear reader, as it stands, odds are in favor of higher gold prices ahead. Just like in 2016, it wouldn’t be shocking to see 2017 be another year when the price of precious metals rise.
As it has been repeatedly mentioned in Lombardi Letter, pay attention to gold mining companies. They are selling their stocks for pennies on the dollar, given the current value of gold. As the precious metal soars in price, gold stocks could skyrocket and provide leveraged returns. – Moe Zulfiqar
A tremendous interview with none other than Jim Rickards, author of several bestselling books including Currency Wars and The Death of Money. Jim talks about how China may be on the verge of collapse and the likelihood of chaos that would ensure in the global financial markets that could be, similar but much worse to what happened back in August of 2015. Jim also breaks down several avenues that in his studied view all point to higher gold prices. – Mike Gleason
Mike Gleason: It is my great privilege to be joined now by James Rickards. Mr. Rickards is editor of Strategic Intelligence, a monthly newsletter, and Director of the James Rickards Project, an inquiry into the complex dynamics of geopolitics and global capital. He’s also the author of several bestselling books including The Death of Money, Currency Wars, The New Case for Gold, and now his latest book The Road To Ruin.
Jim is a portfolio manager, lawyer, and renowned economist having been interviewed by CNBC, the BBC, Bloomberg, Fox News, and CNN, just to name a few. Jim, we really appreciate your time and welcome back. It’s great to have you on again.
Jim Rickards: Great to be with you.
Mike Gleason: Well, first off, Jim, you just published an article at the Daily Reckoning regarding China that I want to have you comment on. Now, since the election of Donald Trump who is advocating for import taxes on goods from China and elsewhere, most of the focus has been on trade and China’s efforts to devalue their currency. A trade dispute with China could certainly have significant repercussions in the U.S., but you raise a host of considerations beyond tariffs and currency markets. Talk for a minute about the internal politics of China, and then if you would, share some of the macroeconomic shifts you see developing between the U.S., China, and Russia, because things seem to be heating up here.
Jim Rickards: Sure. The thesis on China is really independent of the election of Donald Trump and Trump’s policy. Now, I think that’s a big deal obviously. Trump has very firm views on China and he’s got a staff of advisors who are going to pursue those, so I think there are a lot of very important things in play in the area of currency manipulation, tariffs, trade, subsidies to Chinese state owned enterprises, et cetera. We’ll talk a little bit about that but there are bigger things going on in China that are true, regardless of Trump’s policies, even regardless of his president. Just to cut to the chase, China is going broke and when you say that, people roll their eyes. They go, “What do you mean China’s going broke? It’s the second largest economy in the world and it’s got the largest reserve position in the history of the world and it’s got a big trade surplus. I mean, what are you talking about?”
Well, all those things are true. When I say they’re going broke I don’t mean that China’s going to disappear or the civilization’s going to collapse. What I mean is that they are running out of hard currency. They’re going to get to the point where they don’t have any money, or at least money that the world wants. Let me explain, Mike, exactly what I mean by that. Going back to the end of 2014, China had a reserve position of about four trillion dollars. That was the largest reserve position in the history of the world. Now, just for the listeners’ benefit, what is a reserve position? It’s actually very easy to understand.
Imagine you make $50,000 a year and your taxes and your expenses and your rent and all of the things you’ve got to pay come to $40,000 a year, and you have $10,000 left over, you put that in your savings account or you can put it in the stock market, whatever you want with it, but that simple example where you make $50,000, you spend and pay taxes up to $40,000, you’ve got $10,000 left over, that’s your surplus. That goes in your savings account, that’s your reserve. It’s no different for a country. A country exports things and gets paid in hard currency and then they import things and they have to pay hard currency to get it, and they invest overseas and people invest in them, so you’ve got all these capital flows and trade flows going back and forth.
But if at the end of the day you have more hard currency coming in than going out, that’s your savings, and your national savings account if you want to think of it that way, is your reserves. That’s what we mean by reserves and China had basically a four trillion dollar reserve at the end of 2014. Today, that number is about 2.9 trillion. In other words, they have lost 1.1 trillion dollars in their reserve position in a little over two years, not quite two years. The reserves are going out the door. Now, people say, “Well, you’ve got 2.9 trillion left, isn’t that a lot of money?”
Well, it is a lot of money except of the 2.9 trillion, about one trillion of that is not liquid, meaning it’s wealth of some kind, it represents investment, but China wanted to improve their returns actually on their investments, so they invested in hedge funds, they invested in private equity funds, they made direct investments in gold mines in Zambia and so forth, so about a trillion of that is, it’s wealth, but it’s not liquid. It’s not money that you can use to pay your bills. So now, we’re down to 1.9 trillion liquid. Well, about another trillion is going to have to be held in what’s called a “precautionary reserve” to bail out the Chinese banking system.
When you look at the Chinese banking system, private estimates are that the bad debts are 25% of total assets. Banks usually run with 5, maybe 7-8% capital. Even if you said 10% capital, well, if 25% of your assets are bad, that completely wipes out your capital, so the Chinese banking system is technically insolvent, even though they don’t admit that. I mean, they cook the books, they take these bad loans. Let’s say I’m a bank and I have a loan to a state owned enterprise, a steel mill or something and the guy can’t pay me, can’t even come close to paying me and the loan’s due, I say, “Well, look, you owe me 300 million dollars. I’ll tell you what. I’ll give you a new loan for 400 million dollars, but I’ll take the money and pay myself back the old loan plus the interest, and then I’ll give the new loan to your maturity and I’ll see you in two years.”
So, if you did that in the U.S. banking system you’d go to jail. You’re not allowed to do that. You’re throwing good money after bad and you’re supposed to right off a loan that is clearly not performing or where the borrower is unable to pay. But in this case, it’s just extend to pretend, and so it’s still on the books, in my example, 400 million dollar good loan with a two year maturity, but in fact it’s a rotten loan that the guy couldn’t pay in the first place, and now he just can’t pay a bigger amount. He’s probably going to go bankrupt and I’ll have to write it off at the end of the day. So, with that as background for the Chinese banking system, people kind of shrug and say, “Well, can’t China just bail it out? They’ve got all this money.”
Well, the answer is they could, and they’ve done so before, and they can bail it out, but it’s going to trust a trillion dollars, so you’ve got to put a trillion dollars to one side, for when the time comes, to bail out the banking system. Well, now you’re down to 900 billion, right? Remember, we started with four trillion, 1.1 trillion’s out door, 1 trillion’s their liquid, 1 trillion you’ve got to hold to one side to bail out the banking system, well now you only have 900 billion of liquid assets to defend your currency, to prop up the Chinese yuan. But the problem is the reserves are going out the door at a rate of, it varies month to month, 30, 40, 50 billion dollars a month. Some months more, some months over 100 billion dollars.
So, if you just say, “Well, I’ve got 900 billion in the kitty, it’s going out the door at 50 to 100 billion a month,” I’m going to be broke by the end of 2017. That’s what I mean by going broke. You say, “Well, wait a second. Where did the 1.1 trillion, the first part we talked about that the reserve position went down, where did the money go? It didn’t disappear.” Well, no, it didn’t disappear. What’s happening is that everybody in China is getting their money out. They’re scared to death that the yuan’s going to devalue, so what are the Chinese doing? By hook or by crook, some of it’s legitimate, some of it’s corrupt, some of it involves bribery, some of it involves false invoicing.
As I said, by hook or by crook. I travel around the world quite a bit and you go to Sydney, Australia, Melbourne, Vancouver, Canada, London, Istanbul, Paris, New York, the story’s the same everywhere. The Chinese are buying up all the high end real estate, the Chinese are buying up condos. Well, they sure are, and that’s part of this capital flight, that’s part of this money getting out of China. We’ve seen it before in Argentina in 2000, Mexico in 1994. It’s happened over and over again, and it always ends in complete disaster. This is what’s confronting China.
Mike Gleason: Wow, that sounds like a very bleak picture indeed. So, what can China do about this Jim?
Jim Rickards: If your investors, your citizens perceive that the exchange rate is going to break and you’re trying to maintain the exchange rate, the way you do it, you use your reserves to buy your own currency. So, if money’s going out the door and my currency’s trying to get weaker, and I’m trying to hold it up to a certain level, I’m trying to peg it to a certain level, how do I actually do that?
Well, the way I do it if I’m China, and I’m trying to prop up the yuan, I take dollars and I buy the yuan. Some businessman says, “I want to get my yuan out of the country,” and I’m the central bank, I say, “Okay, give me your yuan. Here are the dollars,” and you send the dollars out of the country. But I buy it at a fixed rate and that’s how I maintain the pace. In other words, you have to use up your reserves to maintain the peg if you have an open capital account and the peg’s always going to be under stress because of these interest rate and currency differentials. That’s what China’s doing. It cannot work, they will go broke, you always fail.
Now, having said that, China is not actually going to go broke. They understand what I just described to the listeners, they see this coming, so they’re saying to themselves, “What can I do? What can China do to keep it from happening?” Well, they can close the capital account and they’re starting to do that in a small way. The problem is it’s kind of all or none. You can completely close the capital account and use firing squads for anyone who tries to get the money out of the country, but now you’ve taken yourself out of the international monetary system. They can’t do that. They just got into the international monetary system, the Chinese yuan was just included in the IMF’s special drawing rights, that’s this world money that the IMF prints.
Having gone to great lengths to join the club, they can’t now quit the club and close the capital account. So, they’re working around the edges, but it will not be successful and always fails. They could raise interest rates, give up the independent monetary policy and say, “We’re going to raise interest rates to 10%.” Well, that could work because hey, you put the interest rates that high people will say, “Well, I’ll leave my money here. I’m not worried about the devaluation anymore because I’m getting so much interest that I’ll keep my money here.” The problem with that is going back to what I said earlier about the bad loans, there are companies who are already going bankrupt. What’s going to happen if you raise interest rates?
They’ll go bankrupt faster and then that’s going to cause unemployment, that’s going to destabilize the people in the Communist Parry of China, so they can’t do that, so what’s the third thing? If you can’t close the capital account, at least not completely, and if you can’t raise interest rates without sinking the economy, what can you do? You can devalue the yuan. That’s what they’re going to do. That makes that a very easy forecast. Now, I’m not going to say it’s going to happen tomorrow morning, but you look at how George Soros broke the Bank of England in 1992, this is how he did it. He just said, “I can sell Sterling longer than you can buy dollars,” and he did, and eventually the Bank of England devalued the currency.
That’s what China’s going to have to do, but now, come over to our friend, Donald Trump, President of the United States. What is his biggest complaint? He says that China’s a currency manipulator, they keep their currency too weak. Well, from 2000 to 2014, approximately, that was a valid complaint. They were keeping their currency too weak, but it’s not true anymore, as I described. China’s using their hard currency reserves to prop the yuan up, actually make it stronger, so it’s not true that they’re weakening the yuan today. They’re actually propping it up, as I said, they’re going broke in the process, but what’s going to happen if they devalue to save the capital account, to save the reserves? What’s that going to do? That’s going to inflame Trump and he’s going to come down with them with hammer and tongs and tariffs, and we’re going to have a trade war with China.
By the way, this has happened time and time again where something starts out as a currency war and it turns into a trade war. It’s what happened in the 1930’s, and I can kind of see that happening again. So, we’re looking at a train wreck, but in terms of what to expect, on August 10th, 2015, China devalued 3% in two days. Not 10%, not 20%, 3%. The U.S. stock market crashed immediately from August 10th to August 31st, 2015. The U.S. stock market went down over 10%. Think about where you were at the end of the summer in 2015, on vacation or taking the kids back to school or whatever, but people thought they were staring into the abyss.
Now, the Fed came out, they didn’t hike rates in September ’15, as expected. That was the famous liftoff which got postponed and there was a lot of happy talk, and yeah, the market turned around and I know it’s at an all-time high, but for those three weeks you saw the market completely crash. Well, what do you think’s going to happen if China devalues 5% or 10%? It’s going to be even worse. So, there’s just some big, big stressors in the system and I’m watching them all very closely. Interesting times.
Mike Gleason: Yeah, it certainly is, and China’s absolutely stuck between a rock and a hard place as you just described there. Now, let’s specifically talk about gold for a minute. Now, we can see two roads higher for gold prices from here, the first would be a return of significant price inflation and weakness in the US dollar. The second route to higher prices would be the return of safe haven buying, driven by serious geopolitical turmoil, China obviously would be at the forefront of that, and perhaps a shock to the global financial system. What do you see as the way forward for metals currently and what do you think could possibly derail this move higher in metals that we’ve been seeing here in recent weeks?
Jim Rickards: Well, I think both of those things are in play. They’re kind of opposites but that’s okay. Keep the opposites in mind, but whether it’s monetary ease and inflationary take off, that’ll clearly send gold higher. But even if the opposite happens, the economy slows down, the stock market crashes because of something like the Chinese devaluation that we just talked about, gold will catch the safe haven bid and that will send it higher. But there’s a third factor I would put into the mix which is just good old fashioned supply and demand. You know, I travel around the world quite a bit and when I go to Switzerland, I don’t spend a lot of time with the banks, I spend most of my time with refiners and vault operators and secure logistics providers, the people that actually handle the physical gold.
I recently returned from China, I was in Shanghai and Nanjing, and I met privately one on one with two of the five biggest gold dealers in China, the heads of precious metal trading for two of the big banks, and they said to me, “Don’t believe what you read. Demand for gold in China is as strong as ever. People can’t get enough.” Going back to what I said earlier about people getting the money out of China, well that’s fine, if you can, if you’re connected enough, or if you’re an oligarch, or a princeling, or a business person or whatever and you can find a way to do it. What if you can’t? What if you’re maybe an upper middle class Chinese (person), you’ve got some money, a couple hundred thousand dollars, maybe a million, but you’re not an oligarch, you’re not the son of a survivor of the Long March with Mao Tse-tung.
What do you do? You’re not buying a million dollar condo in Vancouver, you’re just trying to preserve your $100,000 that you’ve saved up for working hard all these years. Well, those people are buying gold. They don’t trust the stock market, they’ve seen the volatility, they don’t the trust real estate market, they know it’s a bubble. Some of them might have a condo in China, but there’s a limit on that, but they are buying gold. We see it in the figures from the Shanghai Gold Exchange. By the way, that was one very interesting thing I learned when I was in China, because we had some estimates, I formed some and others did as well, about how much gold is going into China or is available for investment by the Chinese.
Using mining output, there’s pretty good numbers from geological surveys. Hong Kong exports to China, those numbers are reliable, Swiss exports, those numbers are reliable. So, we don’t have a complete picture but we had a pretty good idea, and then we also had the Shanghai Gold Exchange physical sales, because that’s somewhat transparent. So, putting all that together we were saying somewhere between 1,000 and 1,500 tons a year going into China, but what I did not know until recently was how much of that was private demand and how much of that was government demand, meaning how much was going directly to the government reserve position, how much is being bought up by consumers in China.
What they told me, and these are the dealers, these are the people that actually deal on the Shanghai Gold Exchange and handle the metals, they said it’s 100% private. They said the government buys a lot of gold but they operate completely off the books, completely through stealth channels. I found out, amazing what they told me was that there was even more gold in China than I thought. I know the Chinese government’s buying gold, I know the people are buying gold, but if 100% of Shanghai is just going to consumers, that’s a huge number and the government’s getting whatever they’re getting through other channels.
Now, that makes it harder to estimate, but I know enough from being in Russia and Iran and Turkey, and other sources that China is in fact getting quite a bit of output. They’re probably getting it directly from the mines. In other words, the Chinese import figures go through the Shanghai Gold Exchange and feed a consumer demand, and the Chinese government controls the mining industry and probably takes all of that, that’s 450 tons a year and then some. So, there’s a lot more gold in China. Now, what it means, however, is I’m not a geologist, I’m not an expert on what they call “peak” gold, but I talk to enough mining interests and I know that mining output is flat lining at best, perhaps declining, and grade wars are getting worse.
There’s less gold for every ton of ore that you mine, new discoveries are not piling up, they’re not opening mines because of costs, et cetera, and the fact that the price of gold has been down somewhat. So, putting all that together, you see veracious demand, flat or declining supply, physical gold shortages popping up here and there. All it’s going to take is one publicized failure to deliver by a major bank or an exchange somewhere along the lines to start a buying panic.
Mike Gleason: Talk about what you’re expecting in terms of Fed policy here in the early part of Trump’s presidency Jim. Markets seem to be taking a bit of a wait and see posture here when it comes to monetary policy, how do you see gold responding based on that?
Jim Rickards: Gold’s got a little bit of a headwind right here in the short run, because I expect the Fed to raise interest rates in March.
If they don’t, they’ll almost certainly raise them in June, I think March, but whether it’s March or June, you’re looking at a rate hike, you’re looking at the market discounting further rate hikes. This is what Janet Yellen said in her recent testimony before the Congress, and so that’s going to make the dollar stronger which is a little bit of a headwind for gold. But just looking passed that a little bit, we have an extraordinary situation where there are three vacancies on the Federal Reserve Board right now. Two completely empty seats, and one, Dan Tarullo, who just announced his resignation.
He announced it, but I think it’ll be effective sometime in April, so count that as a third seat and then we have two others, one Janet Yellen, her term expires next January, so the President’s going to have announce that replacement by December, and then beyond that, Stan Fisher in the middle of next year. You’re looking at three seats immediately for appointees by the end of the year, including a new chairman, and then one just six months behind that. There are only seven seats on the Board of Governors at the Fed, so Trump is going to fill five of them at a minimum, so five of them in the next 16 months, and there’s one Republican already on the board, Jay Powell, you don’t hear much about Jay Powell, that’s because he’s outnumbered by the Democrats. Well, that’s about to change.
He’s going to find a lot of his buddies sitting next to him, so Yellen, to say her days are numbered as Chairman is an understatement. She’s going to be outvoted, outgunned, out manned almost immediately once the President makes these announcements. So, Trump basically owns the Federal Reserve Board because of this appointment position situation, so Trump’s going to get whatever he wants. The question is what does he want? Well, he kind of told us. He and Steve Mnuchin, the new Secretary of the Treasury said they want a weaker dollar. Well, okay, if you want a weaker dollar, then don’t be raising rates, don’t be pursuing a tight money policy.
If Trump follows through on the logic of the cheaper dollar, he’s going to appoint doves to the board, the market’s going to get the signal immediately, and the price of gold is going to soar because easy money, weak dollar means higher dollar price for gold. So, we’ve got some very short run headwinds, maybe between now and April, but for the certainly the second half, even the last three quarters of the year, I’m extremely bullish on gold.
Mike Gleason: We should probably also touch on developments in Europe, the Brexit vote last year may have signaled the beginning of the end of the European Union. There are some key elections coming up and nationalists and populists are polling well across Europe. If the anti-globalist candidates win elections in places like France or Germany, the EU will be in serious trouble. Would you care to speculate on the outcome of some of these important elections, and then what’s behind this movement, Jim?
Jim Rickards: Well, I don’t really speculate. I use a lot of science. I was one of the ones that beginning last March, that is March 2016, and continuing right up until a couple days before Brexit, to say that the UK would vote to leave the European Union and that you should short sterling and buy gold, and that’s exactly how it played out, so we got that one right now. Now what’s interesting is that I was on record, I have all the tapes and TV interviews and so forth, saying that the UK would vote to leave the EU, that they would vote for Brexit, and also that Donald Trump would win the election, which I got laughed at when I said it, but that turned out right.
So 99% of the pundits and market indicators and so forth, were on the wrong side of both of those. They said that the UK would remain, and that Hillary Clinton would win the election. Now, having said that, a lot of people are feeling burned. They’re like, “Oh, man, I got two big calls wrong, I don’t want to do that again,” so they’re now calling for these nationalist parties to win these elections in Europe and lead to the break-up of the European Union, the European Monetary Zone, the decline of the euro, et cetera. I’m now on the other side. Having correctly predicted Brexit and Trump, I’m going to say that these mainstream parties, Angela Merkel, the center parties in France and the Netherlands are going to remain in power, that the EU will stick together, that the euro will get stronger, so I’m extremely bullish on the European outlook.
Now, there’s going to be some volatility. Some of these minority parties are going to do better. Marine Le Pen will get more votes than she did the last time, the Freedom Party in the Netherlands, Geert Wilders will get more votes than he did the last time. He might even get more than everybody else, but not enough to form a government because no one else will play in his sandbox. So, I think you will see nationalists rising but not enough to takeover and at the end of the day, the center governments will remain in power and the European Union will remain intact, and go back to what I said before about Trump wanting a weaker dollar. Well, currencies are easy. They’re cross rates. So, if one goes down, the other goes up, so if you’re going to have a weaker dollar, that means you’re going to have a stronger Euro, so I’m very bullish on Europe and the Euro.
Mike Gleason: Yeah, interesting outlook there and we’ll see how it plays out. Your very studied view is worth a lot, so we certainly appreciate your time, Jim. It’s always a pleasure to speak with you.
We greatly appreciate you guiding and educating folks on the actions they can take with their investment lives, and hope you have a great weekend and we look forward to having you back on before long. Thank you, Jim.
Jim Rickards: Great, thank you.
Inflation just got another jolt, rising as much as 2.5 percent year-over-year in January, the highest such rate since March 2012. Led by higher gasoline, rent and health care costs, consumer prices have now advanced for the sixth straight month. In addition, January is the second straight month for rates to be above the Federal Reserve’s target of 2 percent.
Air fares are also climbing, and speaking of air fares, billionaire investor Warren Buffett added to his domestic airline holdings, we learned this week. Buffett’s holding company, Berkshire Hathaway, is now the second-largest holder of American Airlines, with an 8.79 percent share of the company. It also increased its holdings in Delta Air Lines by over 800 percent, to 60 million shares. The company now owns 43.2 million shares of Southwest Airlines, and it increased its stake in United Continental to about 28 million shares.
A March rate hike now looks all but imminent. Many economists—including the Goldman Sachs economists I had the pleasure to hear speak this week—expect to see at least three such hikes this year alone.
Gold responded accordingly, closing above $1,240 for the first time since soon after the November election. Below you can see the gold price charted against the inflation-adjusted 10-year Treasury yield, which is now in subzero territory.
The question I have is: Why would an investor deliberately choose to lose money? But that’s precisely what’s happening now with inflation where it is.
|Consumer Price Index||2.50%||2.50%||2.50%|
As of February 16
Source: Federal Reserve, U.S. Global Investors
These were among some of the topics addressed by former Fed Chair Alan Greenspan, who spoke with the World Gold Council (WGC) for the winter edition of its “Gold Investor.”
“Significant increases in inflation will ultimately increase the price of gold,” Greenspan said. “Investment in gold now is insurance. It’s not for short-term gain, but for long-term protection.”
He also reiterated his view, which I share, that gold is much more than just a metal but a currency:
I view gold as the primary global currency. It is the only currency, along with silver, that does not require a counterparty signature. Gold, however, has always been far more valuable per ounce than silver. No one refuses gold as payment to discharge an obligation. Credit instruments and fiat currency depend on the credit worthiness of a counterparty. Gold, along with silver, is one of the only currencies that has an intrinsic value. It has always been that way. No one questions its value, and it has always been a valuable commodity, first coined in Asia Minor in 600 BC.
Although major stock indices continued to hit fresh all-time highs this week on hopes of tax reform and fiscal stimulus, it’s important to temper the exuberance with a little prudence. The bull market, currently in its eighth year, is facing some significant geopolitical and macroeconomic uncertainty, and we could be getting late in the economic cycle. This makes gold’s investment case even more attractive. For the 10-year period, the yellow metal has shown an inverse correlation to risk assets such as stocks and high-yield bonds. It might be time to ensure that your portfolio has the recommended 10 percent in gold—that includes 5 percent in gold coins and jewelry, the other 5 percent in quality gold equities and mutual funds.
The long-term investment case for gold looks just as compelling following bullish reports this week from PricewaterhouseCoopers (PwC) and Morgan Stanley. China and India are the world’s top two consumers of gold, and both countries are expected to make huge economic gains in the next few decades. This is likely to boost gold demand even more, which has a high correlation with discretionary income growth.
China alone consumed approximately 2,000 metric tons in 2016, or roughly 60 percent of all the new gold that was mined during the year, according to veteran mining commentator Lawrie Williams, who based his estimates on calculations made by BullionStar’s Koos Jansen. The 2,000 metric tons is a much higher figure than what analysts and the media have been telling us, but I’ve always suspected China’s annual consumption to run higher than “official” numbers.
According to PwC’s models, China and India should become the world’s number one and number two largest economies by 2050 based on purchasing power parity (PPP). China, of course, is already the largest economy by that measure, but PwC sees the Asian giant surpassing the U.S. economy on an absolute basis by as early as 2030.
As for India, it “currently comprises 7 percent of world GDP at PPP, which we project to rise steadily to over 15 percent by 2050,” PwC writes. “This is a remarkable increase of 8 percentage points, gaining the most ground of any of the countries we modeled.”
I think it’s also worth highlighting Indonesia, which is expected to replace Japan as the fourth-largest economy by midcentury. E7 economies, in fact, could end up dominating the top 10, with Mexico moving up to number seven and France dropping off. You can see the full list on PwC’s site.
Then there’s Morgan Stanley’s 118-page report, “Why we are bullish on China.” The investment bank sees a number of dramatic changes over the coming years, the most significant being China’s transition from a middle-income nation to a prosperous, high-income nation sometime between 2024 and 2027. (The high-income threshold is a gross national income (GNI) of around $12,500 per capita.) This would make China one of only three countries with populations over 20 million that have managed to accomplish this feat in the past 30 years, the other two being South Korea and Poland.
This trajectory is supported by a number of expectations, including, most importantly, Morgan Stanley’s confidence that China will manage to avoid a debt-related financial crisis, as some investors might now believe is forthcoming. The bank’s view is that the Chinese government will successfully provide “adequate policy buffers and deft management of the policy cycle” to ensure the growth of per capita incomes.
Other key transitions will additionally need to take place for the country to reach high-income status by 2027, including transitioning from a high investment economic model to high consumption and implementing meaningful state-owned enterprise reform. Although China is currently transitioning from a manufacturing economy to one that’s focused on consumption and services, the country will also need to emphasize high value-added manufacturing.
In addition, since President Donald Trump has officially withdrawn the U.S. from the Trans-Pacific Partnership (TPP), China could very well use this as an opportunity to take the lead in global trade, Morgan Stanley writes. This view aligns with comments I’ve previously made. China is already reportedly weighing its options with two alternative free-trade agreements (FTAs), one that includes the U.S. (the Free Trade Area of the Asia Pacific) and one that does not (the Regional Comprehensive Economic Partnership). It’s probably safe to say, however, that given Trump’s opposition to FTAs, trade negotiations involving the U.S. are unlikely to happen anytime soon.
Taken together, this is all good news for gold. Again, when incomes rise in China and India, gold demand has historically benefited.
But it also makes China a compelling place to invest in. And yet investors have tended to be shy, underweighting the country for at least a decade in relation to the broader emerging markets universe.
This, despite the fact that China has largely outperformed emerging markets for the last 15 years. According to Morgan Stanley, the MSCI China Index has delivered a compound annual growth rate (CAGR) of 13 percent for the 15-year period, versus the MSCI Emerging Markets Index’s CAGR of 10 percent over the same period.
Is silver a good investment? Why should someone buy it?
It’s natural and even prudent for an investor to wonder if a particular asset is a good investment or not. That’s especially true for silver, since it’s such a small market and doesn’t carry the same gravitas as gold.
But at this point in history, there are compelling reasons to add physical silver bullion to your portfolio (and only one is because the price will rise). Here the top 10 reasons why every investor should buy some silver bullion …
#1 Silver is Real Money
Silver bullion may not be part of our currency, but it is still money. In fact, silver, along with gold, is the ultimate form of money, because it can’t be created out of thin air (and thus depreciated) like paper or digital forms.
And by real money, we do mean physical silver bullion—not ETFs or certificates or futures contracts. Those are paper investments, which don’t carry the same benefits you’ll find in this report.
Physical silver bullion is a store of value, just like gold. Here’s why.
Silver bullion has…
• No counterparty risk. If you hold physical silver, you don’t need another party to make good on a contract or promise. This is not the case with stocks or bonds or virtually any other investment.
• Never been defaulted on. If you own physical silver, you have no default risk. Not so for almost any other investment you make.
• Long-term use as money. A scan of monetary history shows that silver bullion has been used in coinage more often than gold!
As Mike Maloney says, “Gold and silver bullion have revalued themselves throughout the centuries and called on fiat paper to account for itself.”
Owning some physical silver bullion provides you with a real asset that has served as money for literally thousands of years.
#2 Physical Silver is a Tangible “Hard” Asset
Of all the investments you own, how many can you hold in your hand?
In a world of paper profits, digital trading, and currency creation, physical silver stands in contrast as one of few assets that you can carry in your pocket anywhere you go, even another country. And it can be as private and confidential as you want.
Physical silver bullion is also a tangible hedge against all forms of hacking and cybercrime. There’s no “erasing” a silver Eagle coin, for example, but that can certainly happen to a digital asset:
#3 Silver is Cheap
What if I said you could buy a hard asset at 1/70th the price of gold—and it would protect you just as well against crisis?
That’s what you get with silver bullion! It is much more affordable for the average investor, and yet as a precious metal will help maintain your standard of living as good as gold.
If you can’t afford to buy a full ounce of gold, silver can be your ticket to holding some precious metals.
This is also true for gift-giving. Don’t want to spend over a $1,000 on a present but would like to give a hard asset? Silver bullion just made it more affordable.
#4 Silver Bullion is More Practical For Everyday Small Purchases
Silver isn’t just cheaper to buy, but can be more practical when you need to sell.
Maybe someday you don’t want to sell a full ounce of gold to meet a small financial need. Enter silver bullion. Since it frequently comes in smaller denominations than gold, you can sell only what you want or need at the time.
Every investor should have some silver bullion around for this very reason.
Keep in mind that silver bullion can be sold virtually anywhere in the world.
#5 Silver Outperforms Gold In Bull Markets
Silver is a very small market—so small, in fact, that a little money moving into or out of the industry can impact the price to a much greater degree than other assets (including gold).
This greater volatility means that in bear markets, silver falls more than gold. But in bull markets, silver will soar much further and faster than gold.
Here are couple good examples… check out how much more silver gained than gold in the two biggest precious metals bull markets in the modern era:
Gain from 1970 low to 1980 high
Gain from 2008 low to 2011 high
You might say silver is gold on steroids!
We can expect this outperformance to repeat in the next bull market, too, because the silver industry remains tiny.
#6 Silver Bullion Inventories Are Falling
Governments and other institutions have traditionally held inventories of silver bullion. But today, most governments no longer hold stockpiles of the metal. In fact, the only countries that warehouse silver bullion are the US, India, and Mexico.
Look what’s happened to those inventories since 1996.
A big reason governments don’t hold a lot of silver bullion is because coinage is no longer made from the precious metal. But as you’ll see, silver is used in industry to a much greater degree now… so if future industrial needs are difficult to meet, governments will be ill-equipped to support those needs.
#7 Industrial Use is Growing
Believe it or not, you don’t go one day without using a product that contains silver.
It’s used in nearly every major industry, from electronics and medical applications to batteries and solar panels. Silver is everywhere, whether you see it or not.
As Mike says in his book, “Of all the elements, silver is the indispensable metal. It is the most electronically conducive, thermally conductive, and reflective. Modern life, as we know it, would not exist without silver.”
Due to these rare characteristics, the number of industrial applications for silver has skyrocketed. In fact, industry now gobbles up more than half of all silver demand.
Silver is used in a wide number of industries and products, and many of those uses are growing. Here’s a few examples…
• A cell phone contains about one-third of a gram of silver, and cell phone use continues to climb relentlessly worldwide. Gartner, a leading information technology research and advisory company, estimates a total of 5.75 billion cell phones will be purchased between 2017 and 2019. That means 1.916 billion grams of silver, or 57.49 million ounces, will be needed for this use alone!
• The self-heating windshield in your new Volkswagen will have an ultra-thin invisible layer of silver instead of those tiny wires. They’ll even have filaments at the bottom of the windshield to heat the wipers so they don’t freeze to the glass.
• The Silver Institute estimates that silver use in photovoltaic cells (the main constituents of solar panels) will be a whopping 75% greater in 2018 than it was just 3 years earlier.
• Another common industrial use for silver is as a catalyst for the production of ethylene oxide (an important precursor in the production of plastics and chemicals). The Silver Institute projects that due to growth in this industry, 32% more silver will be needed by 2018 than what was used in 2015.
There are a lot more examples like this, but the bottom line is that due to its unique characteristics, industrial uses for silver continue to expand, which means we can reasonably expect this source of demand to remain robust.
But that’s not the whole story… unlike gold, most industrial silver is consumed or destroyed during the fabrication process. It’s just not economic to recover every tiny flake of silver from millions of discarded products. As a result, that silver is gone for good, and limits the amount of supply that can return to the market through recycling.
So not only will the ongoing growth in industrial uses keep silver demand strong, millions of ounces cannot be reused. That might be a problem, because…
#8 Supply is About to Fall
As you might be aware, the silver price crashed after peaking in 2011. Over the next five years it fell a whopping 72.1%. As a result, miners had to scramble to cut costs to turn a profit. One of the areas cut dramatically was exploration and development of new silver mines.
It doesn’t take a rocket scientist to understand that if you spend less time and money looking for silver that you will find less silver. That drought in exploration and development is starting to take effect.
Low prices have affected how much scrap metal is available, too.
All of this is starting to have an impact on total supply.
Silver supply has fallen three consecutive years, the first time since 1991-1993.
As much as two-thirds of silver mine supply comes as a byproduct from base metal operations (copper and zinc, for example). But these other sources of supply will clearly have an impact on the availability of new metal coming to the marketplace.
These realities have set the stage for a peak in silver supply. If demand stays at current levels, it will be difficult for everyone who wants silver to get as much as they need. And don’t look now, but…
#9 World Demand is Growing
Global demand for silver bullion is growing. Virtually all major government mints have seen record levels of sales, with most already operating at peak production.
Surging demand is nowhere more evident than China and India. These two behemoth markets have long histories of cultural affinity toward precious metals. And with their populations growing (the opposite of what is happening in the West), their tremendous appetite will continue.
Here’s a couple good examples… check out the growth in silver demand in China (for all uses):
And look at the growth of silver jewelry in India:
This kind of demand doesn’t happen in a vacuum. Sooner or later there will be consequences when surging demand meets crimped supply—and those consequences are all positive if you own the metal.
#10 The Gold/Silver Ratio Favors Silver
Last, the gold/silver ratio (the price of gold divided by the price of silver) can give clues about which metal might be the better buy at any given time. Especially when the ratio reaches an extreme…
The gold-to-silver ratio averaged 47:1 during the 20th century. It’s averaged about 61:1 in the 21st century. So a ratio at or above 70 is in outlier territory and thus makes silver a good buy relative to the price of gold.
You can see that the ratio sank to almost 30 at the peak of the bull market in 2011. It reached as low as 17 in early 1980. This compression in the ratio shows just how much silver can outperform its cousin gold. It also confirms it is undervalued compared to gold.
• Add all up the reasons and silver just might be the buying opportunity of the decade.
It’s hard to find an asset with a greater distortion between price and fundamentals. Not only is it a good hedge against crisis, the price will be forced up by a perfect storm of fundamental factors.
– Jordan Roy-Byrne: The January headline consumer price index (CPI) came in at 2.5%, which is near a 5-year high. What happened to deflation? As a result, real interest rates declined deeper into negative territory or in the case of the 10-year yield, went from positive to negative. No this isn’t a commodity-driven story. The core CPI (ex food and energy) has been above 2% since the end of 2015 when commodities were in the dumps. Inflation is perking up and couple that with a Fed that pursues rate hikes at a glacial speed and that is very bullish for gold and silver.
The chart below is what I refer to as our master fundamental chart for Gold. It plots Gold along with the real fed funds rate and the real 5-year yield. In short, negative and/or declining real interest rates drive bull markets in Gold while rising real rates or strongly positive real rates (like in the 1980s and 1990s) drive bear markets in Gold. Since the middle of 2015 both the real fed funds rate and the real 5-year yield have declined by +2%. The real fed funds rate has declined from a fraction above 0% to now almost -2% (-1.88%). Meanwhile, the real 5-year yield has declined by roughly 2.5% in the past two years from nearly 2% to now -0.60%.
Fundamental analysis can be backward looking and that is why it is so important to verify fundamentals through the lens of technical analysis. While there are numerous charts we could show we want to present a fresh look at some sector relationships which help confirm the strong fundamentals currently supporting the sector.
In the chart below we plot the gold stocks (both the seniors and juniors) against Gold and we plot the juniors against the seniors. During a healthy bull market in precious metals, the miners should show strength relative to the metals and secondarily, the riskier and more volatile stocks should also show relative strength. First, we note the GDX to Gold ratio appears poised to break its 10-year downtrend this year. Second, we see that the GDXJ to GDX ratio (juniors versus the seniors) is one month short of a 4-year high.
Turning to the short-term, we note that Gold successfully tested its support at $1220/oz while the miners decline on Friday suggests they may need more time to digest recent gains.
With negative real interest rates in place and the gold stocks trading well above their rising 400-day moving averages while showing relative strength against Gold, it is quite clear the gold stocks are in the early stages of a new bull market. It’s also difficult for us to argue that Gold and Silver are not in a bull market. The technical setup is potentially in place for the sector to make an explosive move higher over the next 9 to 18 months. Pullbacks in 2017 need to be bought due to the upside risk over the intermediate term.
There’s a lot to like about emerging market stocks.
As we explained yesterday, they’re cheap. They’re in an uptrend. And their economies are growing quickly.
Plus, commodities are rising for the first time in years. That’s given them a big boost.
But like any investment, there are risks you have to consider.
Today, we’re going to look at the biggest threat to emerging markets. But don’t worry. There’s a way to get around this risk. We’ll explain how at the end of this essay.
But first, you need to understand what’s going on in the global currency market…
• The US dollar has broken out of its 30-year downtrend…
The chart below shows the performance of the US Dollar Index going back to early 1970s.
You can see this index peaked in the mid-1980s. It went on to fall for about three decades.
Then, in early 2015, it broke out of its downtrend. It’s since surged about 10%. That’s a huge move for the world’s most important currency.
To be clear, the chart above tracks the dollar’s performance against other major currencies like the Japanese yen and euro. It doesn’t show how the dollar’s done against emerging market currencies.
But the dollar’s done even better against these fragile currencies.
Over the past two years, the dollar’s up 37% on the Mexican peso… 48% against the Turkish lira… and 80% against the Argentine peso. The list goes on.
This is creating huge problems for many emerging markets. To understand why, let’s go back to 2009.
• Back then, the U.S. was battling its worst economic crisis since the Great Depression…
To stimulate the economy, the Federal Reserve dropped its key interest rate close to zero. It left it there for eight years.
Regular readers know this did almost nothing for the “real” economy. About all it did was encourage a lot of reckless borrowing.
U.S. corporations have borrowed almost $9.5 trillion in the bond market since 2009. That’s 61% more than they borrowed in the eight years prior to the 2008–2009 financial crisis.
• Foreign companies loaded up on cheap U.S. debt, too…
According to the Bank for International Settlements (BIS), emerging market companies now have more than $3 trillion in U.S. dollar-denominated debt. That’s more than the annual economic output of the United Kingdom, the world’s fifth-biggest economy.
For years, all this debt wasn’t a problem. The dollar was weak. But, as we just showed you, that’s no longer the case.
• Plus, U.S. interest rates are rising for the first time in over a decade…
As you’ve probably heard, the Fed raised its key interest rate by 0.25% in December.
The Fed also said that it wants to raise rates three more times this year.
If the Fed sticks to its plan, U.S. bonds could soon yield a lot more. This will make U.S. assets more attractive to foreign investors.
That would be bullish for the US dollar, which would make “cheap” debt held overseas a lot more expensive.
• This would create major problems for emerging market companies…
To see why, look at the chart below.
The green line is the US Dollar Index. The blue line is the WisdomTree Emerging Markets Corporate Bond Fund (EMCB). This fund tracks the performance of U.S. dollar-denominated bonds issued by companies in emerging markets.
The highlighted areas show that the EMCB and the US Dollar Index are inversely correlated. When one zigs, the other zags.
This isn’t surprising.
A strong dollar makes it hard for many emerging market companies to pay off their debts. This is why EMCB often falls when the US Dollar Index jumps higher.
• You can see why a rising dollar is a major threat to emerging markets…
But this doesn’t mean you should avoid all emerging market stocks today…
You just have to own the right ones. Here’s how you can stack the odds in your favor…
Invest in countries with low levels of “external debt.” This is debt issued in foreign currencies. These days, a lot of external debt is denominated in dollars.
According to global investment bank Société Générale, Russia, Brazil, and India have relatively low levels of external debt.
Turkey, Chile, and the Philippines, on the other hand, have much higher levels of external debt. This makes them riskier.
Once you find a country you would want to invest in, the next step is to pick a great company…
Invest in the right sectors. According to Société Générale, “extractive industries” have by far the highest external debt levels of any sector in emerging markets. This group includes miners and oil and gas companies.
Telecommunication, utility, and food and beverage companies have much lower external debt levels. These are safer industries to be in if the dollar keeps rising.
“We’re buying a situation that can only get better”…
That’s what E.B. Tucker told readers in the December issue of The Casey Report. He was talking about Russia’s currency, the ruble.
You can see what E.B. means in the chart below. This chart shows the performance of the Russian ruble since 2000. You can see it’s now worth about half as much as it was seventeen years ago.
But E.B. doesn’t think the ruble will stay this low for much longer.
To profit from a stronger ruble, E.B. recommended buying one of Russia’s largest companies. The company has a monopoly on one of Russia’s most important exports. It’s one of the most dominant companies on the planet.
We’ll have more to say about this opportunity in the coming weeks.
Courtesy: Justin Spittler
Emerging market stocks have been “dead money” for almost a decade.
Emerging markets are countries that are on their way to becoming “developed” like the United States or Germany. Brazil, Russia, India, and China—the so-called “BRIC” countries—are the biggest emerging markets.
More than 80% of the world’s population lives in these countries. Since 2008, these economies have accounted for 80% of the growth in global economic trade and output.
You would think this would have made them great investments. But emerging markets have actually been a horrible investment lately…
Take a look at the chart below.
It shows how the iShares MSCI Emerging Markets ETF (EEM), which tracks more than 800 emerging market stocks, performed from 2007 through 2015. You can see that it went nowhere.
You would have actually lost about 0.15% of your money if you held EEM over this period, and that includes dividends.
• Because of this, many investors have given up on emerging market stocks…
But that could soon change.
Last year, EEM gained 8.6%. It was its first annual gain since 2012.
This year, it’s already up 10%. That’s more than double the S&P 500’s 4% gain.
More importantly, it looks like EEM just “broke out.” Below, you can see it recently bucked a downtrend it’d been stuck in since early September.
• This is good news for emerging market stocks…
As we often point out, stocks usually keep rising after a breakout like this.
And that’s exactly what EEM’s done. It’s rallied about 6% since piercing its downtrend.
It’s now at the highest level since July 2015.
Of course, you probably want to know if emerging market stocks will keep rising.
Over the next couple days, we’re going to try to answer that question.
We’ll dive deep into the fundamentals of emerging market stocks. We’ll look at the good and the bad. By the end, you’ll know if emerging market stocks are right for you.
Let’s start with what we like about them…
• Emerging market stocks are much cheaper than U.S. stocks…
You can see this in the table below.
This table compares EEM with the SPDR S&P 500 ETF (SPY), which tracks companies in the S&P 500.
EEM’s price-to-book (P/B) ratio is 49% lower than SPY’s P/B ratio. Its forward price-to-earnings (forward P/E) ratio is 36% lower. It’s also 34% cheaper according to the price-to-sales (P/S) ratio.
Looking at this table, emerging market stocks might seem like a no-brainer. But let’s be honest…
• You should have to pay more for U.S. stocks…
After all, the United States is still the most powerful and stable economy on the planet. And investors pay premiums for safety.
Emerging markets, on the other hand, are far less stable.
China, the world’s biggest emerging market, is a communist country. Brazil, another huge emerging market, has had five currency crises in the last eight decades.
In short, emerging market stocks come with heavy baggage. Because of these risks, many investors want to “be paid extra” for owning emerging markets. ?They want better returns or higher yields.
With this in mind, you have to ask yourself: Are emerging market stocks worth the risk?
• Emerging market economies are growing rapidly…
According to the International Monetary Fund (IMF), emerging markets grew 4.1% last year. For perspective, the U.S. economy grew 1.6%.
This year, the IMF expects emerging markets to grow 4.5%. It expects the U.S. economy to grow 2.3%.
For 2018, the IMF projects that emerging markets will grow 4.8%, compared to 2% for the U.S. economy.
In other words, emerging market stocks are cheap and offer more growth potential. This is what every investor looks for.
But this has been true about emerging markets for years. And yet, they’ve basically done nothing while U.S. stocks have soared to record highs.
What would make this time any different?
• Commodity prices have taken off…
Palladium is up 14% this year. Silver’s up 12%. Copper has gained 9%.
Keep in mind, commodities have been falling for the better part of the last six years. The Bloomberg Commodity Index (BCOM), which tracks 22 commodities, declined 58% between April 2011 and last January. Since then, it’s up 21%.
This has given emerging market stocks a huge boost.
You see, countries like Brazil, Russia, Venezuela, and Saudi Arabia export far more commodities than they import.
When commodities rise, these exporters make more money. Their economies grow faster. Their stock markets climb higher.
Higher commodity prices could be the catalyst that emerging market stocks have been waiting for. But that doesn’t mean you should blindly invest in them.
Tomorrow, we’ll tell you what we don’t like about emerging market stocks.
At the end of that issue, you’ll know whether emerging market stocks deserve a spot in your portfolio.
China is driving the rally in emerging market stocks.
Earlier we told you that China is the biggest emerging market economy. It’s also by far the largest holding in EEM. It makes up 26% of the index. It has more impact on the fund than India, Brazil, Russia, and Mexico combined.
The chart below shows the performance of the iShares China Large-Cap ETF (FXI), which tracks large Chinese stocks, since last April. If it looks familiar, it’s because FXI has moved almost in lockstep with EEM over the same period.
This is important to understand.
You see, a lot of investors buy emerging market ETFs thinking they’re getting broad emerging market exposure. But many of these funds are heavily concentrated in big countries like China.
In short, if you own EEM, you’d better be bullish on China.
Courtesy: Justin Spittler
UK investors showed a “renewed confidence” in British-based assets in February but the continued popularity of gold points to lingering fears over political tensions, according to Lloyds Private Bank.
The British bank’s investor sentiment index climbed to 6.1% in February, its highest level since April 2016, as UK investors “continued to ride the positive wave of sentiment” from the beginning of the year.
The good vibrations from British investors comes despite the fact that asset performance was “more muted” this month, with an average uplift of just 2.4%, the bank noted.
This was especially noticeable in the case of UK property, which experienced a rebound in investor sentiment, despite the fact that it saw the biggest decrease in asset performance (-4.4%). Still, UK property rose to 31.3% on Lloyd’s investor sentiment index, in another sign that markets have begun to move past the volatility from the Brexit vote.
Investors’ enthusiasm toward UK shares also ran high during the month (15.5%), though was not as strong as the demand for the asset class in January (21.5%).
However, of all the assets highlighted in the study, gold proved the most popular among UK investors, rising 5.59% between January and February to a 46.37% approval rating.
The continued gold boon is further evidence that “investor optimism is tempered somewhat by the need to shield against persistent geopolitical uncertainty,” explained Lloyds Private Bank CIO Markus Stadlmann.
“It is worth remembering however that a sentiment in excess of 40% has historically been shown to be overly optimistic, which can create investor disappointment,” he added.
Eurozone shares registered the lowest sentiment on Lloyd’s index at -34.1%, reinforcing UK investors’ guardedness over uncertain political scenarios.
While investors remained cautious, Stadlmann said Lloyds has more confidence in the prospects of European companies over their American counterparts.
“Despite eurozone shares returning the lowest sentiment score once again, we remain more optimistic than some of our peers about the health of European corporates and the Eurozone economy as a whole. Conversely, we share investor caution towards US shares, having observed early indications that US corporate profits may have peaked, and in some cases are now in decline.”
Stadlmann also found investors’ increased confidence in commodities somewhat misguided, stating “we have yet to see enough of a fundamental recovery in supply and demand to consider reintroducing it to our client portfolio benchmarks.” Over a 12-month period, the asset class has seen an uplift in sentiment of 23.8%.
“Whoever has the gold makes the rules” runs the old saying.
So, where’s the gold?
Who’s producing? Who’s buying? Who’s selling?
In today’s Money Morning we look at international gold flows – with a particular focus on China.
The US government remains the world’s largest gold owner. It has 8,133 tonnes – amounting to more than 70% of US foreign exchange reserves – most of which is stored in Fort Knox. That’s almost an ounce per citizen, and close to 5% of all the gold that has ever been mined (roughly 175,000 tonnes).
Data-superman Nick Laird projects that if you add private and institutional holdings to that number, there are 26,000–27,000 tonnes in the US. That would be about 15% of all the gold that has ever been mined.
The US is top dog. It has the gold. And, internationally, it makes the rules.
But for how much longer? There are changes afoot.
China is now the world’s largest gold producer. It has held this title since 2007 when it overtook South Africa and it shows no sign of handing back the mantle.
Chinese gold production amounted to around 453 tonnes in 2016, according to the China Gold Association. The next largest producer, Australia, is some way off – about 180 tonnes lower. We don’t have the exact numbers yet for 2016, but it is likely to be close to the 273 tonnes it produced in 2015.
In third place we have Russia (250 tonnes), followed by the US (216 tonnes) and Peru (176 tonnes). South Africa has slid to a lowly seventh place.
In other words, about 15% of total global production is Chinese. And here’s the thing – of all that gold it produces, China barely exports an ounce. It keeps all of it. Not only that, but China is the world’s biggest importer. This title used to belong to India, but China became the leader in 2014.
Importing gold was something China began in earnest in 2011 – around about the time that gold peaked at $1,920 an ounce. The longer the bear market has gone on, the more China has bought. I’m not sure if that makes them canny buyers or the opposite, but something is going on and, when you consider the cumulative effects, it is something big.
China does not give us the precise import figures – arriving at them involves some sleuthing and there’s no one better at this than precious metals analyst, Koos Jansen.
In 2011 China imported most of its gold via Hong Kong, which does provide the figures. Imports came in at just below 400 tonnes – considerably more than the entire reserves of the UK (310 tonnes).
In 2012, China started importing from Switzerland too. In 2013, imports reached 1,400 tonnes. In 2014, China added the UK to the list of countries it imports from and in 2015, Australia. 2015 was a record year for imports – not far off 1,600 tonnes, roughly equivalent to Russia’s entire reserves.
And so to 2016. Jansen collates the export numbers from Hong Kong, Switzerland, the UK and Australia to arrive at the figure of 1,300 tonnes, down slightly on the previous year, but still 30% higher than total Swiss reserves.
In total, since 2011, China has imported more than 5,000 tonnes. That’s more than is in the vaults of the International Monetary Fund (IMF), and more even than Germany’s holdings (around 3,400 tonnes). Another three years at a similar rate, and China will have imported more gold than there is at Fort Knox.
The cumulative impact is astonishing. Add China’s domestic production into the equation, as well as the recycling of scrap, and it seems that since 2009, more than 12,000 ounces of gold have either been produced in, or imported to, China.
It’s pretty easy to start drawing the conclusion that China is planning to return the world to some kind of international gold standard and thereby undermine US imperial and economic might by destabilising the dollar.
It’s at this stage that I have to say: “Slow down! Slow down!” Not all of the gold is going into the vaults of the People’s Bank of China (PBOC). No need to make a run for the hills just yet.
China has encouraged private accumulation of gold, so much of the gold is falling into domestic hands. Again, just how much is difficult to quantify. Bron Suchecki of the Perth Mint, studying gold flows, argues that China aims for private citizens to accumulate 55% of flow – with the remaining 45% going to commercial banks and the Chinese central bank (the PBOC).
The latest statement from the PBOC is that it holds 1,842 tonnes. Given the amount of gold that has made its way to China, that 1,842 tonne number does seem suspiciously low – or at least towards the lower end of what is credible.
And it is likely that the Chinese would understate this number, first so as not to push the price up when they are still in accumulation mode; secondly, so as not to throw down any “we’re as powerful as you” gauntlets at the US.
But that is pure speculation on my part. Jansen tells me that his sources think the number is probably double the official number.
He has put together this chart, which estimates not all the tea, but all the gold in China.
But that growth in reserves since 2009 is quite something. At this rate China will soon be making all the rules.
It’s worth noting by the way that while US holdings amount to more than 70% of its foreign exchange reserves, China’s official gold holdings amount to just 2%. China could double or triple the amount of gold it owns, and it would still only amount to 4% or 6%. Even the UK’s paltry hoard amounts to 8.5%.
China needs more gold, and it seems to be trying to acquire it as discreetly as possible.
There are several takeaways from all this.
First, all of the gold that has made its way to China over the last few years stays there. It doesn’t come back. If ever there was a symbol of the transfer of wealth and power from east to west this is it.
Chinese gold imports may be down ever so slightly on 2014, but it is still an accumulator of physical metal – by far and away the world’s biggest.
If ever there is a Western buying spree, and China continues to hoard what it has, the lack of supply is going to push the price higher more quickly than in previous bull markets. We got a taste of this in the first six months of last year.
If China becomes a net seller, look out below. But I don’t think there’s too much danger of that. – Dominic Frisby
Gold prices of late have been testing support just under the market, if you will, preparing for a healthy rally into higher territory.
As I see it, a relatively small group of hedge funds and institutional speculators have been calling the tune for gold, trading the recent range, buying on dips, selling on rallies, and gradually adding to their physical holdings – a behavioral pattern we expect will continue within a rising trading range – at least until a price above the $1300 an ounce level is well established.
Contributing to support under the market, price-sensitive Asian traders continue to bottom feed, accumulating bullion for the billions of gold-friendly households in their region with cash to spend.
Meanwhile, short-term hour-to-hour and day-to-day price action has been governed by the latest news with respect to interest rates, inflation, the dollar, and Trump’s troubles in the White House.
With respect to prospective interest rates, a growing number of financial-market participants believe an increasingly hawkish Fed will vote for a quarter-point hike interest-rate hike as early as March when the FOMC, the Fed policy-setting committee, next convenes.
Conventional wisdom suggests that rising interest rates should be bullish for the dollar and bearish for gold.
But while nominal interest rates may be rising in the next few weeks and months, real “inflation-adjusted” interest rates are already falling, as evidenced by rising inflation rates – note this week’s consumer price (CPI) and producer price (PPI) reports both rising 0.6 percent for the past month.
In my view, an accelerating U.S. consumer-price inflation rate will outpace any increase in nominal rates brought about by the Fed – a trend that will contribute to record high gold prices in the next few years.
For the immediate future, the next few weeks, confusion at the White House and a weakening President may also benefit gold as Trump’s radical policy initiatives lose support, among Republicans in the House and Senate, and the ship of state seems increasingly rudderless.
Looking further forward, possibly even by the end of this year, there is a real chance the price of gold will recover much, if not all, of the ground lost since hitting its all-time high near $1,924 an ounce in September 2011.
For many years now, gold – real physical metal, not just paper proxies – has been moving from weak hands in the West to strong hands in Asian markets. When gold heats up, I expect a shortage of available supply, reflecting this geographic shift in ownership, will trigger a bidding war for gold, driving prices to unimaginable heights within the next few years.
Another significant source of physical gold demand – with significant price consequences – results from the recent relaxation of Islamic Sharia law making possible investment in physical gold by millions of religious Muslims around the world who, until now, eschewed gold. Many have great wealth – but strict interpretation of Sharia law has heretofore limited or prevented their investment in the metal. Within the next few years, we think Muslim demand could reach 500 tons a year, placing these investors on a par with China and India as a long-term sponge for gold.
Submitted by: Jeffrey Nichols, Senior Economic Advisor to Rosland Capital (www.roslandcapital.com)
On Monday I had the opportunity to attend a conference at Goldman Sachs’ Dallas office. Among the dozens of money managers and investors who attended, a combined $1 trillion in assets was represented.
The speakers were numerous, from famed economist Jan Hatzius, Goldman’s head of global economics, to Jeff Currie, global head of commodities research. Everyone was exceedingly smart and articulate, and I left the conference feeling recharged with much to think about.
One of the most fascinating takeaways was Goldman’s increased use of sentiment analysis tools. Basically what this means is sophisticated software trawls the internet in real time for public attitudes and opinions on companies, products, sectors, industries, countries—you name it. Sources can include press releases, news stories, earnings calls, blogs, social media and more. All of this data is gathered and analyzed, giving quants and other highly sophisticated investors a better idea of where tomorrow’s opportunities lie.
We have experience gauging sentiment using platforms designed by Meltwater and ScribbleLive, and I was pleased to see our efforts validated.
Goldman’s preferred system is Stanford’s CoreNLP, which is able to break down and analyze sentences in a number of different ways (and different languages to boot). Below is just a sampling of what the process looks like.
This strategy has been working well, Goldman said, and investors and managers plan to continue practicing it.
As I said, we take sentiment very seriously. In last week’s Investor Alert, we made note of the fact that the media’s use of the word “uncertainty” has soared to a record high since the November election. This is in line with recent movements in the Global Economic Policy Uncertainty Index, which is also now at all-time highs following Donald Trump’s election and Brexit in the U.K.
At the same time, small business optimism in the U.S., as measured by the National Federation of Independent Business (NFIB), soared to a 12-year high on the back of Trump’s election. At 105.8, its December reading was up a phenomenal five standard deviations. Much of this optimism was driven by Trump’s pledge to roll back regulations and lower corporate taxes, a point I’ve made several times already. Goldman echoed this thought, arguing the U.S. is behind the curve on cutting corporate taxes, compared to the average rate of the 35-member Organization for Economic Cooperation and Development (OECD).
Using its sentiment analysis tools, however, Goldman managed to come to these conclusions as early as November—which is the same month the investment bank turned bullish on commodities for the first time in four years.
Goldman’s line of reasoning? When business optimism goes up, capital expenditure (capex) also goes up, and when capex goes up, commodities tend to follow. I should add that the bank has historically been neutral on commodities, recommending an overweight position only four times in the last 20 years. So when it does become bullish, investors should pay attention.
But there’s more to the commodity investment case than sentiment. The timing looks ideal as well.
Below, take a look at the output gap, which measures the difference between an economy’s actual manufacturing output and its potential output. When the gap is positive, that means demand is high and output is at more than full capacity. When it’s negative, that means demand has shrunk and output is less than what an economy should be capable of producing.
You can see that the output gap in the U.S. is finally turning positive, therefore entering the third stage of the business cycle, the best for real assets. The third stage is expansionary, characterized as having high output and fast growth—not to mention traditionally higher returns. We all know that past performance is no guarantee of future results. But similar periods in the past—shaded in gray—were associated with commodity super-cycles, the most recent one being the 2000s commodities boom driven by emerging markets, particularly China.
So far this year, the Bloomberg Commodities Index has risen 1.7 percent, compared to a negative 3.4 percent for the same number of trading days last year. If you remember, commodities ended positively in 2016 for the first time in six years, so there should be further room to run.
The Global Economic Policy Uncertainty (EPU) Index is calculated as the GDP-weighted average of monthly EPU index values for the U.S., Canada, Brazil, Chile, the U.K., Germany, Italy, Spain, France, the Netherlands, Russia, India, China, South Korea, Japan, Ireland and Australia, using GDP data from the International Monetary Fund’s (IMF) World Economic Outlook Database.
Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.
The Bloomberg Commodity Index is made up of 22 exchange-traded futures on physical commodities. The index represents 20 commodities, which are weighted to account for economic significance and market liquidity.
The warring forces of inflation and deflation are at each other’s throats. Some see victory for inflation. Others for deflation.
So… What happens to gold?
Conventional wisdom says gold thrives under inflation and wilts under deflation. The case for gold under inflation is easy enough. Gold rises as the dollar falls. It’s the opposite under deflation.
But is conventional wisdom right about gold and deflation? Is it time to consider a different metric — not the nominal gold price — but gold’s purchasing power relative to consumer prices?
The late lamented Roy Jastram was a recognized authority on the gold standard. He authored a 1977 tour de force on gold under both deflation and inflation called The Golden Constant: The English and American Experience, 1560–1976.
Jastram went over the rainbow in 1991 but his book’s withstood time and tide.
Jastram examined three deflationary periods in history. The first was from 1814–30. The record shows prices fell 50% over those 16 years.
The second was from 1864–97. Prices fell 65% between 1864 and 1897.
The final deflationary period was 1929–33, the locust years of the Great Depression. Prices slumped 31% those four years.
So… How did gold do in these three deflationary periods stretching back 200 years?
First, the period between 1814 and 1830…
Prices fell 50%. But according to Jastram, gold’s purchasing power — not its nominal price but its purchasing power — increased a thumping 100%. Gold bought twice as much!
The chart below shows the nominal gold price rose over that period. But not nearly as much as its overall purchasing power.
What about the era between 1864 and 1897? Overall prices fell 65%. But Jastram claimed gold’s purchasing power surged 40%.
The chart shows the nominal gold price held fairly constant between 1864 and 1897. But again, gold’s purchasing power rose 40%.
Note well: This period encompassed the classical gold standard, 1870–1914. It also witnessed one of the greatest spurts of economic growth in history. Who says gold kills growth?
Prices fell 31%. The gold price also slipped, as the chart shows. But Jastram’s work showed gold’s purchasing power rose a hale and hearty 44%.
Here’s the chart of gold prices 1800–2010:
Gold’s purchasing power rose during all three deflationary periods in question. Its nominal price may not have risen — it fell between 1929 and 1933 — but gold commanded more goods each time.
In nuce: It doesn’t matter if gold falls if overall prices fall further — so gold is precious, even under deflation. Jim Rickards, in The New Case for Gold:
Assume gold is $1,200 at the start of a year and there is 5% deflation that year. Further assume that the dollar price of gold at the end of the year is $1,180. In that scenario, the nominal price of gold fell 1.7% but the real price of gold rose about 3.3%, because the $1,180 year-end dollar price is actually worth $1,240 in purchasing power relative to prices at the beginning of the year.
Now, it’s true… history can kick up plenty of dust, potentially making comparisons between erasa fool’s chase.
For example, the price of gold was fixed at $20.67 under the classical gold standard between 1870 and 1914. It remained $20.67 in the U.S. through 1934 when FDR devalued gold to $35 an ounce. That makes it harder to penetrate the cloud.
But as analyst Doug Eberhardt notes, maybe the gold price — and hence its purchasing power — may have surged even higher if gold traded at freely floating prices. From 1929–33 for example:
If people were rushing to the bank to demand gold coin for their Federal Reserve notes, the price of gold would have naturally moved higher. I don’t think anyone doubts that this would have occurred. Banks were failing at an alarming rate and people were running to the real wealth represented by gold.
Maybe gold would have vaulted much higher if it weren’t pegged at $20.67.
Jastram croaked before the 2008 crisis so on that score his book stands silent. But looking at the consumer price index (CPI) since 2009 we find a pattern of chronically low inflation. It’s averaged about 1.8%.
The CPI is a government tool, so your personal experience will vary with usage. But take it on its face for now.
Gold ended 2009 at $1,096 an ounce. It trades at $1,227 today… $131 higher. Yes, that includes a roughly $500 drop between 2012 and 2016. But the course of true love never runs true. Neither do long-term economic trends.
But if you measure gold not by its nominal price but by its purchasing power… history suggests deflation might not be so bad for gold after all.
Courtesy: Brian Maher
Yesterday, we talked about how to avoid getting sucked into the collective stupidity of the “all-time high” rubberneckers.
The markets continue to plow higher this week. The major averages are extending their gains. Different sectors and industries are popping up on our radar. Breakouts abound.
To begin the trading week, I promised to share three powerful trends we’re looking to play in the days and weeks ahead. I’m revealing the first big idea right now. Even with all eyes on the roaring markets, this major breakout continues to build under the radar. Now’s your chance to climb aboard before the herd catches on.
Let’s get down to business…
The real moves under the surface of the major averages haven’t earned much attention these days. That’s too bad. Because if you want to actually profit from the next thrust higher, you have to know what names are fueling the fire.
Right now, the market’s giving us some clues. Just barely scratching below the market’s surface reveals a couple of forgotten market niches that are set to line your pockets with profits.
Just check out copper.
While gold pulled back late last week, good ol’ Dr. Copper launched to prices we haven’t seen since 2015.
Keep in mind, copper has endured a painful downtrend for six years. The metal has now exploded out of its long-term downtrend after building a solid base last year. It’s time to get ready for some huge gains…
Your eyes aren’t playing tricks on you. This chart goes all the way back to mid-2010 when copper prices were double what they are today. The copper bull had even trickled down to the criminal class seven years ago. Opportunistic thieves were snatching up copper wire from construction sites and selling it for scrap. Heck, they were even stealing copper downspouts off historic homes in broad daylight to make a buck.
But there’s no problem an extended bear market can’t solve. As the commodity supercycle started to lose steam in 2011, so did the copper bandits. Spools of copper wire could safely sit overnight at jobsites once again. Back in the trading pits, folks lost interest in the metal as it sank back down near its financial crisis lows.
After copper was left for dead, it took several months of bottoming action for this commodity to build a proper base. Finally, we saw the rumblings of a potential breakout back in October. Fast forward to this year and copper is ditching its downtrend for gains.
Hop on the next leg of the base metals rally while you can…
I’ll be back tomorrow with another red-hot trading opportunity. You won’t want to miss it.
Courtesy: Greg Guenthner