Oct 31

Tea Leaves & $2000 Gold

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Yes, some people are still forecasting $2000 gold by year’s end…
 

BOB and BARB Moriarty launched 321gold.com over 10 years ago, adding 321energy.com the better to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy as well as precious metals.
 
Previously a US Marine fighter pilot, and holding 14 international aviation records, Bob Moriarty here tells The Gold Report why he’s 100% certain that a market crash is looming… 
 
The Gold Report: Bob, in our last interview in February, we had currency devaluation in Argentina and Venezuela, interest rate hikes in Turkey and South America, and a cotton and federal bond-buying program. Just eight months later in October, we’ve got Ebola, ISIS and Russia annexing Crimea plus a rising US Dollar Index. We’ve also got pullbacks in gold, silver and pretty much all commodity prices. With all this news, what, in your view, should people really be focusing in on?
 
Bob Moriarty: There is a flock of black swans overhead, any one of which could be catastrophic. The fundamental problems with the world’s debt crisis and banking crisis have never been solved. The fundamental issues with the Euro have never been solved. The world is a lot closer to the edge of the cliff today than it was back in February.
 
About ISIS, I think I was six years old when my parents pointed out a hornet’s nest. They said, “Whatever you do, don’t swat the hornets’ nest.” Of course, being six years old, I took stick and went up there and swatted the hornets’ nest, which really pissed off the hornets. I learned my lesson.
 
We swatted the hornets’ nest when we invaded Iraq and Afghanistan. What we did is we empowered every religious fruitcake in the world. We said, “Okay, here’s your gun, go shoot somebody. We’ll plant flowers.” We are reaping what we sowed. What we need to do is leave them to their own devices and let them figure out what they want to do. It’s our presence in the Middle East that is creating a problem.
 
TGR: Will stepping back allow the Middle East to heal itself, or will there be continued civil wars that threaten the world?
 
Bob Moriarty: We are the catalyst in the Middle East. We have been the catalyst under the theory that we are the world’s policemen and that we’re better and smarter than everybody else and rich enough to afford to fight war after war. None of those beliefs are true. The idea that America is exceptional is hogwash. We’re not smarter. We’re not better. We’re certainly not effective policemen.
 
The Congress of the United States has been bought and paid for by special interest groups: part of it is Wall Street, part of it is the banks and part of it is Israel. We’re just trying to do things that we can’t do. What the US needs to do is mind its own business.
 
TGR: You’ve commented recently that you’re expecting a stock market crash soon. Can you elaborate on that?
 
Bob Moriarty: We have two giant elephants in the room fighting it out. One is the inflation elephant and one is the deflation elephant. The deflation elephant is the $710 trillion worth of derivatives, which is $100,000 per man, woman and child on earth. Those derivatives have to blow up and crash. That’s going to be deflationary.
 
At the same time, we’ve got the world awash in debt, more debt than we’ve ever had in history, and it’s been inflationary in terms of energy and the stock market. When the stock and bond markets implode, as we know they’re going to, we’re going to see some really scary things. We’ll go to quantitative easing infinity, and we’re going to see the price of gold go through the roof. It’s going to go to the moon when everything else crashes.
 
TGR: How are you looking at the crash – short term, before the end of this year? How imminent are we?
 
Bob Moriarty: Soon. But I’m in the market. Not in the general market, but I’m in resources. There’s a triangle of value created by a guy named John Exter: Exter’s Pyramid. It’s an inverted pyramid. At the top there are derivatives, and then there are miscellaneous assets going down: securitized debt and stocks, broad currency and physical notes. At the very bottom – the single most valuable asset at the end of time – is gold. When the derivatives, bonds, currencies and stock markets crash, the last man standing is going to be gold.
 
TGR: So the last man standing is the actual commodity, not the stocks?
 
Bob Moriarty: Not necessarily. The stocks represent fractional ownership of a real commodity. There are some really wonderful companies out there with wonderful assets that are selling for peanuts.
 
TGR: In one of your recent articles, “Black Swans and Brown Snakes“, you were tracking the US Dollar Index as it climbed 12 weeks in a row, and you discussed the influence of the Yen, the Euro, the British Pound. Can you explain the US Dollar Index and the impact it has on silver and gold?
 
Bob Moriarty: First of all, when people talk about the US Dollar Index, they think it has something to do with the Dollar and it does not. It is made up of the Euro, the Yen, the Mexican Peso, the British Pound and some other currencies. When the Euro goes down, the Dollar Index goes up. When the Yen goes down, the Dollar Index goes up. The Dollar, as measured by the Dollar Index, got way too expensive. It was up 12 weeks in a row. On Oct. 3, it was up 1.33% in one day, and that’s a blow-off top. It’s very obvious in hindsight. I took a look at the charts for silver and gold – if you took a mirror to the Dollar Index, you saw the charts for silver and gold inversely. When people talk about gold going down and silver going down, that’s not true. The Euro went down. The Yen went down. The Pound went down and the value of gold and silver didn’t change. It only changed in reference to the US Dollar. In every currency except the Dollar, gold and silver haven’t changed in value at all since July.
 
The US Dollar Index got irrationally exuberant, and it’s due for a crash. When it crashes, it’s going to take the stock market with it and perhaps the bond market. If you see QE increase, head for your bunker.
 
TGR: Should I conclude that gold and silver will escalate?
 
Bob Moriarty: Yes. There was an enormous flow of money from China, Japan, England, Europe in general into the stock and bond markets. What happened from July was the equivalent of the water flowing out before a tsunami hits. It’s not the water coming in that signals a tsunami, it’s the water going out. Nobody paid attention because everybody was looking at it in terms of silver or gold or platinum or oil, and they were not looking at the big picture. You’ve got to look at the big picture. A financial crash is coming. I’m not going to beat around the bush. I’m not saying there’s a 99% chance. There’s a 100% chance.
 
TGR: Why does it have to crash? Why can’t it just correct?
 
Bob Moriarty: Because the world’s financial system is in such disequilibrium that it can’t gradually go down. It has to crash. The term for it in physics is called entropy. When you spin a top, at first it is very smooth and regular. As it slows down, it becomes more and more unstable and eventually it simply crashes. The financial system is doing the same thing. It’s becoming more and more unstable every day.
 
TGR: You spoke at the Cambridge House International 2014 Silver Summit Oct. 23-24. Bo Polny also spoke. He predicts that gold will be the greatest trade in history. He’s calling for $2000 per ounce gold before the end of this year. We’re moving into the third seven-year cycle of a 21-year bull cycle. Do you agree with him?
 
Bob Moriarty: I’ve seen several interviews with Bo. The only problem with his cycles theory is you can’t logically or factually see his argument. Now if you look at my comments about silver, gold and the stock market, factually we know the US Dollar Index went up 12 weeks in a row. That’s not an opinion; that’s a fact. I’m using both facts and logic to make a point.
 
When a person walks in and says, okay, my tea leaves say that gold is going to be $2000 by the end of the year, you are forced to either believe or disbelieve him based on voodoo. I don’t predict price; I don’t know anybody who can. If Bo actually can, he’s going to be very popular and very rich.
 
TGR: Many people have predicted a significant crash for a number of years. How do you even begin to time this thing? A lot of people who have been speculating on this have lost money.
 
Bob Moriarty: That’s a really good point. People have been betting against the Yen for years. That’s been one of the most expensive things you can bet against. Likewise, people have been betting on gold and silver and they’ve lost a lot of money. I haven’t made the money that I wish I’d made over the last three years, but I’ve taken a fairly conservative approach and I don’t think I’m in bad shape.
 
TGR: Describe your conservative approach.
 
Bob Moriarty: The way to make money in any market is to buy when things are cheap and sell when they’re dear. It’s as simple as that. Markets go up and markets go down. There is no magic to anything.
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Oct 29

QE, War & Other Autopilot US Action

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Ready for a clean break with Fed money creation…?
 

AMONG the many things still to be discovered is the effect of QE and ZIRP on the markets and the economy, writes Bill Bonner in his Diary of a Rogue Economist.
 
We can’t wait to find out.
 
The Fed has bought nearly $4 trillion of bonds over the last five years. You’re bound to get some kind of reaction to that kind of money.
 
But what?
 
Higher stocks? More GDP growth? Higher incomes? More inflation?
 
Washington was hoping for a little more of everything. But all we see are higher stock and bond prices. And if QE helped prices to go up, they should go back down when QE ends this week.
 
Unless the Fed changes its mind…
 
If the Fed makes a clean break with QE, it risks getting blamed for a big crack-up in the stock market. On the other hand, if it announces more QE, it risks creating an even bigger bubble…and getting blamed for that.
 
Our guess is we’ll get a mealymouthed announcement that leaves investors reassured…but uncertain. The Fed won’t allow a bear market in stocks, but investors won’t know how and when it will intervene next.
 
Last week, we were thinking about the reaction to the murder in Ottawa of a Canadian soldier who was guarding a war memorial.
 
There were 598 murders in Canada in 2011 (the most recent year we could find). As far as we know, not one registered the slightest interest in the US. But come a killer with Islam on his mind, and hardly a newspaper or talk show host in the 50 states can avoid comment.
 
“War in the streets of the West,” was how the Wall Street Journal put it; the newspaper wants a more muscular approach to the Middle East.
 
Why?
 
After a quarter of a century…and trillions of Dollars spent…and hundreds of thousands of Dollars lost…America appears to have more enemies in the Muslim world than ever before. Why would anyone want to continue on this barren path? To find out, we follow the money.
 
Professor Michael Glennon of Tufts University asks the same question: Why such eagerness for war?
 
People think that our government policies are determined by elected officials who carry out the nation’s will, as expressed at the ballot box. That is not the way it works.
 
Instead, it doesn’t really matter much what voters want. They get some traction on the emotional and symbolic issues – gay marriage, minimum wage and so forth.
 
But these issues don’t really matter much to the elites. What policies do matter are those that they can use to shift wealth from the people who earned it to themselves.
 
Glennon, a former legal counsel to the Senate Foreign Relations Committee, has come to the same conclusion. He says he was curious as to why President Obama would end up with almost precisely the same foreign policies as President George W. Bush.
“It hasn’t been a conscious decision. […] Members of Congress are generalists and need to defer to experts within the national security realm, as elsewhere.
 
“They are particularly concerned about being caught out on a limb having made a wrong judgment about national security and tend, therefore, to defer to experts, who tend to exaggerate threats. The courts similarly tend to defer to the expertise of the network that defines national security policy.
 
“The presidency is not a top-down institution, as many people in the public believe, headed by a president who gives orders and causes the bureaucracy to click its heels and salute. National security policy actually bubbles up from within the bureaucracy.
 
“Many of the more controversial policies, from the mining of Nicaragua’s harbors to the NSA surveillance program, originated within the bureaucracy. John Kerry was not exaggerating when he said that some of those programs are ‘on autopilot’.
 
“These particular bureaucracies don’t set truck widths or determine railroad freight rates. They make nerve-center security decisions that in a democracy can be irreversible, that can close down the marketplace of ideas, and can result in some very dire consequences.
 
“I think the American people are deluded…They believe that when they vote for a president or member of Congress or succeed in bringing a case before the courts, that policy is going to change. Now, there are many counter-examples in which these branches do affect policy, as Bagehot predicted there would be. But the larger picture is still true – policy by and large in the national security realm is made by the concealed institutions.”
Calling the Ottawa killing “war” not only belittles the real thing; it misses the point. There is no war on the streets of North America. But there is plenty of fraud and cupidity.
 
Here is how it works: The US security industry – the Pentagon, its hangers-on, its financiers and its suppliers – stomps around the Middle East, causing death and havoc in the Muslim world.
 
“Terrorists” naturally want to strike back at what they believe is the source of their sufferings: the US. Sooner or later, one of them is bound to make a go of it.
 
The typical voter hasn’t got time to analyze and understand the complex motives and confusing storyline behind the event. He sees only the evil deed.
 
His blood runs hot for protection and retaliation. When the call goes up for more intervention and more security spending, he is behind it all the way.
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Oct 23

An End to QE? A Good Man in Congress?

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God knows what Ron Paul was ever doing in US politics…
 

OVER the weekend, we were down in Nashville at the Stansberry Conference Series event, along with Ron Paul, Porter Stansberry, Jim Rickards and others, writes Bill Bonner in his Diary of a Rogue Economist.
 
The question on the table: What’s ahead for the US?
 
Ron Paul took up the question from a geopolitical angle. He told the crowd that the military-security industry had Congress in its pocket.
 
As a result, we can expect more borrowing, more spending and more pointless and futile wars. They may be bad for the country and its citizens, says Paul, but they are good for the people who make fighter jets and combat fatigues.
 
“We’ve been at war in the Middle East for decades,” he said…
“We supported Osama bin Laden against the Soviets in Afghanistan…and the result of that was the creation of al-Qaeda.
 
“Then we supported Saddam Hussein against Iran. Saddam and bin Laden hated each other. But after 9/11 we attacked Saddam, using a bunch of lies to justify it. We sent over military equipment worth hundreds of billions of Dollars. This equipment is now in the hands of ISIS – another enemy we created…and a far more dangerous one.”
Ron Paul is such a pure-hearted soul. What was a man like him doing in Congress?
 
It must have been some sort of electoral accident. Good men rarely run for public office. And when they do, it is even rarer for them to win.
 
Poor Ron is retired from Congress now. And he spends his time trying to “get the word out.” He thinks that if people only realized what was happening they would vote for more responsible leaders and more sensible policies.
 
Alas, that’s not the way it works. The further the country goes in the wrong direction, the more people there are who have a financial interest in staying on the same road.
 
We visited Ron in his office on Capitol Hill. He held a breakfast meeting with a small group of congressmen, trying to convince them to vote his way; we don’t remember what was at issue.
 
It was an uphill battle. Only a few members of Congress attended. And those few worried that their districts would lose money…or that the labor unions wouldn’t like it if they voted no…or that they might not get a plum committee assignment if they bucked their own party leadership. Ron was alone.
 
Politics favors blowhards, hustlers and shallow opportunists, we concluded. Which makes us wonder how Ron Paul ever got elected to Congress in the first place.
 
But not only did he get elected…once in Washington, he never sold out. Neither to the right nor the left. He opposed zombies, malingerers and bullies wherever he found them.
 
Which brings us to the subject of our own presentation to the Nashville crowd. We were following the (QE) money. “St. Louis Fed president James Bullard let the cat out of the bag last week,” we explained.
 
As Bullard told Bloomberg TV last week:
“I also think that inflation expectations are dropping in the US. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target.
 
“And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December.
 
“So…continue with QE at a very low level as we have it right now. And then assess our options going forward.”
We didn’t think it would happen so fast. We thought the central bank would wait. We expected a little more hypocrisy…a bit more posturing…a little more phony resistance…a few denials…
 
…the Fed should have played it cool…coy…elusive…hard to pin down, making investors really sweat before coming to the rescue.
 
We knew where the Fed would end up…but we didn’t know it would go there so quickly and easily!
 
Bullard is admitting to a staggering act of vanity and hypocrisy. In the land of free minds and free markets, apparently only the Fed knows what prices equities should fetch.
 
Henceforth, it will approve all price movements on Wall Street.
 
To bring you fully into the picture, dear reader, the US central bank has the economy, and the markets, hooked on cheap credit and printing-press money. It has been supplying both on a grand scale for the last five years.
 
But it had promised to stay away from the playground, beginning this month. Now that the economy is recovering, goes the storyline, the Fed will back away from its emergency measures and allow things to return to normal.
 
QE ends this month. Higher interest rates are expected next year.
 
No bubble has ever been created that didn’t have a pin looking for it. And nobody likes it when the two meet up. Last week, it looked as though the Fed’s bubble and Mr. Market’s pin were coming closer. Then quick action by Bullard helped push them apart on Friday.
 
QE began in November 2008. And zero interest rates began a month later. This has perverted prices for stocks, bonds, houses…and just about every other asset price on the planet. Stocks are worth more than twice what they were at the bottom of the crisis. The average house is worth $60,000 more.
 
Now QE is ending. And that means a lot less money gushing into financial markets.
Instead of increasing at a 40% rate as it did in 2012, what Richard Duncan calls “excess liquidity” – the difference between what the Fed pumps out via QE and what the government absorbs via borrowing – will go up only 6% this year.
 
Next year, there will be even less.
 
With less new money coming from the Fed…and still no real recovery…something’s gotta give. No matter what Fed officials say. And since stocks periodically go down anyway, this seems like as good a time as any.
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Oct 15

Up-to-Date with the Big Sell-Off

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The trouble began in 1968 with Lyndon Johnson…
 

THIS is what we’re hoping for, writes Bill Bonner in his Diary of a Rogue Economist
 
A big selloff.
 
Not that we want to see people lose money. What do you take us for?
 
But we’ve been watching this show for many years now. We want to see how it turns out.
 
To bring you up to date, in 1968, the US switched from gold to the kind of money that grows on trees. That’s when President Johnson asked Congress to end the requirement that Dollars be backed by gold.
 
It allowed a huge increase in credit…and debt. Thirty-seven trillion Dollars in excess credit allowed Americans to live beyond their means for decades. They were spending money that nobody earned or saved.
 
Year after year – through Democrat and Republican administrations…through good times and bad – debt continued to build up.
 
And as time went by debt became more important. The US economy…US financial assets…US lifestyles…and the US federal government all came to depend on it. None could survive in its present form if it were forced to live on what was actually earned.
 
When the US stock market crashed in 1987 Alan Greenspan came to the rescue with more EZ money.
 
It was a daring and provocative move; never before had the nation’s chief central banker expressed such an interest in stock prices. Previously, Mr.Market was responsible for the stock market; Mr. Central Banker stayed out of his way.
 
And ever since, central bankers have taken upon themselves the grave and absurd task of guarding speculators’ backs. That’s why the Fed intervened so eagerly in the markets in 2001 and again in 2008.
 
The Fed may not be able to spot a bubble, but it has no such trouble when it comes to busts. And although it has no interest in pricking a bubble, it treats a bear market as though it were an Ebola epidemic. Whenever there is the slightest hint of an outbreak, it rushes in with hoses and disinfectant.
 
That’s why we are so interested to see what happens next.
 
Will the Fed come to its senses and let Mr.Market do his work? Will it allow investment mistakes to be corrected quickly and naturally? Or will it meddle once again…and make them worse?
 
Perhaps we will find out soon.
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Sep 30

Making Money with Merchants of Death

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Want a truly “ethical” investment? Just stick to profit seeking instead…
 

“WHEN did you people turn into shills for the military-industrial complex,” asked one of our subscribers in an email, writes Addison Wiggin in The Daily Reckoning.
 
“My security would be greatly enhanced if every damn one of ’em would go home forever and the entire machine would grind to a halt, so don’t try to pump this bilge my way.”
 
We hear you. And we agree.
 
We’re not much on socially responsible investing…even when we judge a certain investment vehicle to be thoroughly irresponsible, if not downright reprehensible.
“The insidious increase in power,” says retired army Col. Lawrence Wilkerson, “and the influence over foreign policy that the military has is very dangerous. And maybe in the long run, it’s even more dangerous than a coup.”
Wilkerson was Colin Powell’s right-hand man in the military under the first President Bush…and again in the State Department under the second. It was Wilkerson who vetted the intelligence that went into Powell’s now-infamous speech at the United Nations 10 years ago during the run-up to the Iraq War.
 
He admits he fell down on the job.
 
The “mobile bioweapons labs” were the fantasy of an Iraqi defector, egged on by the Pentagon. In retirement, Wilkerson has turned into a trenchant critic of the military-industrial complex Eisenhower warned about 52 years ago. As such, he is also the harbinger of the military’s slow-motion coup.
 
“What happens,” Wilkerson explained to radio host Rob Kall in November of 2012, “is the power shifts gradually, and gradually, and incrementally over to the war-making side, to where you wake up one morning and all you’re doing is making war. And you have so many people – from Lockheed Martin, to the Congress of the United States, to the armed forces, to you name it – who are making so much money off that war-making that you can’t stop it. That’s not a coup, but it is something worse, in my view. It is, ultimately, the destruction of our Republic.”
 
So why, you might ask, would we suggest investing in defense or cybersecurity stocks or – to use a phrase made popular when Americans were having second thoughts about World War I – the “merchants of death”?
 
Simply put, because there are pitfalls of “socially responsible investing.”
 
We’re not much on socially responsible investing…even when we judge a certain investment vehicle to be thoroughly irresponsible, if not downright reprehensible.
“Maximizing profits and conforming to social policies are separate endeavors,” wrote the late Harry Browne in 1995. “You can cater to one endeavor only at the expense of the other.”
Name almost any investment, and we can come up with a valid objection to it…and not on hippy-dippy “save the Earth” or “fair trade” grounds, either:
 
If you own a gold stock, there’s a good chance the company is stomping all over the property rights of someone whose land happens to sit on top of a gold deposit. Third-world governments routinely cut sweetheart deals with mining firms to seize land held in the same family for generations, with zip for compensation.
 
Or if you own any kind of government bond, your stream of income depends on the ability of that government to extract tax payments from the citizens in its jurisdiction.
 
Meanwhile, if you shun the stocks of the major banks because they accept government bailouts, you’ve passed up monster rallies going back to late 2011 – 59% on J.P. Morgan Chase, 79% on Citigroup and 130% on Bank of America. Just sayin’.
 
Run down all 10 sectors of the S&P 500 and we’ll find something objectionable. Health care? The government has totally co-opted the insurance industry and Big Pharma…or maybe vice versa. Telecom? All the big companies collude with the National Security Agency’s warrantless wiretapping. Consumer staples? Hope you don’t mind General Mills and Kellogg sucking up the corn subsidies for breakfast cereal (and adding to kids’ waistlines, which you’ll pay for years from now when they develop diabetes and go on Medicaid).
 
Okay, you get the idea.
 
Back to Col. Wilkerson’s interview. It reinforces our own thoughts about the empire having a logic of its own. The military’s silent coup “is something that just happens, and it directs American policy toward war in an increased and ever-dangerous manner, and we wind up one day with no money left, no economy, and the only thing we’re good at (and that’s going away fast, because you need money in an economy to support a military) is the military.”
 
We’re no happier about it than you or Col. Wilkerson. But if government is going to direct more and more of the economy going forward, it only makes sense to “follow the money” and channel your own investment flows into those areas that will benefit most.
 
“The stock exchange isn’t a pulpit,” wrote Harry Browne. “If you want to promote a particular environmental policy, political philosophy or other personal enthusiasm, do it with the profits you make from hardheaded investing.”
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Sep 30

Bond Bubble vs. the Ice Age

Gold Price Comments Off on Bond Bubble vs. the Ice Age
Deflation and zero yields forever? Or a bond bubble bigger than we can comprehend…?
 

It SHOULD be striking that government bonds, in nominal terms, have never been this expensive in history, writes Tim Price on his blog, ThePriceOfEverything.
 
Even as there have never been so many of them.
 
The laws of supply and demand would seem to have been repealed. How could this state of affairs have come about? We think the answer is three-fold:
  1. The bond market is clearly not perfectly efficient;
  2. Bond yields are being manipulated by central banks through a deliberate policy of financial repression (and QE, of course);
  3. Many bond fund managers may be unaware, or unconcerned, that the benchmarks against which they choose to be assessed are illogical and irrational.
What might substantiate our third claim?
 
It would be the festering intellectual plague that bedevils the fund management world known as indexation. Bond indices allocate their largest weights to the most indebted issuers. This is the precise opposite of what any rational bond investor would do – namely, to overweight their portfolio according to those issuers with the highest credit quality (or perhaps, all things being equal, with the highest yields).
 
But bond indices do exactly the opposite. They force any manager witless enough to have fallen victim to them to load up on the most heavily indebted issuers, which currently also happen to offer amongst the puniest nominal yields.
 
As evidence for the prosecution we cite the US Treasury bond market, the world’s largest. The US national debt currently stands at $17.7 trillion…with a ‘T’. Benchmark 10-year Treasuries currently offer a yield to maturity of 2.5%. US consumer price inflation currently stands at 1.7%. (We offer no opinion as to whether US CPI is a fair reflection of US inflation.) On the basis that US “inflation” doesn’t change meaningfully over the next 10 years, US bond investors are going to earn an annualised return just a smidgen above zero per cent.
 
How do US Treasury yields stack up against the longer term trend in interest rates? The following data are from @Macro_Tourist:
 
10-year US Treasury yields since 1791
 
The chart shows the direction of travel for US market rates since independence, given that the Continental Congress defaulted on its debts.
 
Now, it may well be that US Treasury yields have further to fall. As SocGen’s Albert Edwards puts it:
“Our ‘Ice Age’ thesis has long called for sub-1% bond yields and I see this extending to the US and UK in due course.”
As things stand, the trend is with the polar bears. The German bond market has already broken down through the 1% level (10 year Bunds at the time of writing currently trade at 0.98%). 
Deutsche Bank Research – specifically Jim Reid, Nick Burns and Seb Barker – recently published an extensive examination of global debt markets (“Bonds: the final bubble frontier?”, hat tip to Arnaud Gandon of Heptagon Capital). Deutsche’s strategists ask whether bonds constitute the culminating financial bubble after almost two decades of them:
“After the Asian / Russian / LTCM crises of the late 1990s we entered a supercycle of very aggressive policy responses to major global problems. In turn this helped encourage the 2000 equity bubble, the 2007 housing / financial / debt bubble, the 2010-2012 Euro Sovereign crisis and arguably some recent signs of a China credit bubble (a theme we discussed in our 2014 Default Study). At no point have the imbalances been allowed a full free market conclusion.
 
“Aggressive intervention has merely pushed the bubble elsewhere. With no obvious areas left to inflate in the private sector, these bubbles have now arguably moved into government and central bank balance sheets with unparalleled intervention and low growth allowing it to coincide with ultra-low bond yields.”
The French statesman George Clemenceau once commented that war is too important to be left to generals. At this stage in the game one might be tempted to add that monetary policy is far too important to be left to politicians and central bankers.
 
We get by with free markets in all other walks of economic and financial life – why let the price of money itself be dictated by a handful of State-appointed bureaucrats?
 
We were once told by a fund manager (a Japanese equity manager, to be precise – rare breed that that is now), around the turn of the millennium, that Japan would be the dress rehearsal, and that the rest of the world would be the main event. Again, the volume of the mood music is rising in SocGen’s favour.
 
We nurse no particular view in relation to how the government bond bubble (for it surely is) plays out – whether yields grind relentlessly lower for some time yet, or whether they burst spectacularly on the back of the overdue return of bond market vigilantes or some other mystical manifestation of long-delayed economic common sense.
 
But Warren Buffett himself once said that:
“If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”
The central bank bond market poker game has been in train for a good deal longer than half an hour, and the stakes have never been higher. Sometimes, if you simply can’t fathom the new rules of the game, it’s surely better not to play. So we’re not in the business of chasing US Treasury yields, or Gilt yields, or Bund yields, ever lower – we’ll keep our bond exposure limited to only the highest quality credits yielding the highest possible return.
 
Even then, if Fed tapering does finally dissipate in favour of Fed hiking – stranger things have happened, though we can’t think of any off the top of our head – it will make sense at the appropriate time to eliminate conventional debt instruments from client portfolios almost entirely.
 
But indexation madness is not limited to the world of bonds. Its malign, unthinking mental slavery has fixed itself upon the equity markets, too. Equity indices, as is widely acknowledged, allocate their largest weights to the largest and most expensive stocks. What’s extraordinary is that even as stock markets have powered ahead, index trackers have enjoyed their highest ever inflows.
 
The latest IMA data show that more UK retail money was put into tracker funds in July than in any other month since records began. We accept the ‘low cost’ aspect of tracker funds and ETFs; we take serious issue with the idea of buying stock markets close to or at their all-time high and being in for any downside ride on a 1:1 basis. 
 
But there is a middle way between the Scylla of bonds at all-time low yields and the Charybdis of stocks at all-time high prices: Value.
 
Seth Klarman of the Baupost Group once wrote as follows:
“Stock market efficiency is an elegant hypothesis that bears quite limited resemblance to the real world. For over half a century, disciples of Benjamin Graham, the intellectual father of value investing, have prospered buying bargains that efficient market theory says should not exist.
 
“They take advantage of the short-term, relative performance orientation of other investors. They employ an absolute (not relative) valuation compass, patiently exploiting mispricings while avoiding overpaying for what is popular and trendy. Many are willing to concentrate their exposures, knowing that their few best ideas are better than their hundredth best, and confident in their ability to tell which is which. 
 
“Value investors thrive not by incurring high risk (as financial theory would suggest), but by deliberately avoiding or hedging the risks they identify. While efficient market theorists tell you to calculate the beta of a stock to determine its riskiness, most value investors have never calculated a beta. Efficient market theory advocates moving a portfolio of holdings closer to the efficient frontier. Most value investors have no idea what this is or how they might accomplish such a move. This is because financial market theory may be elegant, but it is not particularly useful in formulating a successful investment strategy. 
 
“If academics espousing the efficient market theory had no influence, their flawed views would make little difference. But, in fact, their thinking is mainstream and millions of investors make their decisions based on the supposition that owning stocks, regardless of valuation and analysis, is safe and reasonable. Academics train hundreds of thousands of students each year, many of whom go to Wall Street and corporate suites espousing these beliefs. Because so many have been taught that outperforming the market is impossible and that stocks are always fairly and efficiently priced, investors have increasingly adopted strategies that eventually will prove both riskier and far less rewarding than they are currently able to comprehend.”
That sounds about right to us. Conventional investing, both in stocks and bonds on an indexed or benchmarked basis, “will prove both riskier and far less rewarding” than many investors are currently able to comprehend.
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Sep 17

Mean Reversion to the Rescue

Gold Price Comments Off on Mean Reversion to the Rescue
Small-cap US stocks are lagging bigger companies. The lesson…?
 

SO FAR this year, writes Frank Holmes at US Global Investors, small-cap growth stocks have surprisingly been lackluster.
 
After 2013, when it gained a scorching 38.8%, the Russell 2000 has delivered a tepid 0.62% year-to-date (YTD).
 
 
Performance has been so poor, in fact, that the spread, or bifurcation, between the 12-month return residuals of small and large caps is at its widest since the dotcom bubble of the late 1990s and early 2000s. This bifurcation is one of the largest since 1975.
 
According to Morgan Stanley, we’re in the worst beta-adjusted period for small-cap stocks since the late 1990s. The 12-month return in August for small-caps was -9.7%, placing it in the bottom 6% of any 12-month period since the mid-1970s. 
 
 
The bifurcation is more than apparent when you compare the year-to-date (YTD) total returns of the big boys (those in the S&P 500 Index and Dow Jones Industrial Average) to their little brothers (those in the Russell 2000 and S&P SmallCap 600 Index).
 
The Russell, though it led the other indices in March, has failed to reach a new record high, which the S&P 500 and Dow managed to achieve in the last couple of months. 
 
 
Are we on the verge of another bubble? We don’t think so. History shows bubbles are associated with excessive leverage and lofty valuations. That is not the case this time.
 
In July, Federal Reserve Chairwoman Janet Yellen stated in her semiannual report to Congress that small caps appear to be “substantially stretched,” even after a drop in equity prices at the beginning of the year.
 
There may be some truth to Yellen’s remark, an ideological echo of former Fed Chairman Alan Greenspan’s now-famous “irrational exuberance,” his description of investors’ rosy attitude toward dotcom startups of the late 1990s and early 2000s.
 
Much of the valuation gap has evaporated. Looking at the price/earnings to growth ratio – 20x for the Russell 2000 and 18x for the S&P 500 – small caps have slightly higher yet reasonable multiples and may offer better long-term growth prospects.
 
The recent underperformance among small caps has been a headwind for a few of our funds, most notably our Holmes Macro Trends Fund (MEGAX),whose benchmark, the S&P 1500 Composite, tracks the performance of not just large- and mid-cap US companies, but small-cap as well. With a bias toward small-cap companies, the fund has underperformed compared to last year, when such stocks were doing well.
 
Because small caps tend to have higher beta than blue chips, you would expect them to outperform in a generally rising market – which we’re currently in. So it appears that a major rotation out of these riskier, more volatile stocks has inexplicably occurred, leading to the wide bifurcation between small and large companies. 
 
The good news is that, based on 20 years of historical data, stocks in the Russell 2000 tend to rally in the fourth quarter and continue steadily until around the end of the first quarter. Over this 20-year period ending in December 2013, the Russell has generated an impressive annualized return of approximately 10%.
 
 
Whether or not this fourth-through-first-quarter rally will recur in 2014 and early 2015 is impossible to forecast. What can be said, however, is that prices and returns do tend to revert back to their mean over time.
 
I discussed this concept in full last month in the second part of my Managing Expectations series,”The Importance of Oscillators, Standard Deviation and Mean Reversion“. Although small caps are underperforming right now, the concept of mean reversion suggests that they’ll return to their historical relationship with large caps eventually – just as they did following the dotcom bubble.
 
In his 2006 book The New Rules for Investing Now: Smart Portfolios for the Next Fifteen Years, investor James P. O’Shaughnessy makes the case that small stocks have a performance advantage over large stocks simply because, well, they’resmall. This might sound like circular logic, but as he writes:
“A company with $200 million in revenues is far more likely to be able to double those revenues than a company with $200 billion in revenues. With large companies, each increase in revenues becomes a smaller and smaller percentage of overall revenues. Small stocks, on the other hand, have a much easier time delivering great percentage growth in revenues and earnings.”
O’Shaughnessy examined every 20-year rolling time period beginning each month between June 1947 and December 2004. That’s 691 20-year rolling time periods. What he found is that “small stocks outperformed the S&P 500 84% of the time.”
 
 
If O’Shaughnessy’s research is accurate, it seems very reasonable to be optimistic in the long term. It would be myopic to look only at the Russell 2000’s recent underperformance and impulsively rotate out of small caps without also considering the decades’ worth of data showing the growth that can be achieved.
 
Comparing index funds to actively managed funds, Kiplinger columnist Steven Goldberg wrote last month: “[I]ndex funds are designed to give you all the upside of bull markets and every bit of the downside of bear markets. Only good actively managed funds can protect you from some of the pain of a bear market.”
 
We at US Global Investors agree with Goldberg’s attitude toward good active management. Although MEGAX might be temporarily underperforming right now as a result of the sentiment-driven and disappointing performance of small-cap stocks, we’re confident that they will eventually revert back to their historical pattern as fear over Fed tightening settles down and fundamentals prevail.
 
In the meantime, we will continue to apply our dynamic management strategy of picking stocks in the fund using the 10-20-20 model: we focus on companies that are growing revenues at 10% and generating a 20% growth rate and 20% return-on-equity. This approach has served us very well in the past and enabled us to select the most attractive growth-oriented companies for our clients. 
 
On another note, and as I explained in a recent Frank Talk, a strong US Dollar could spell trouble for commodities such as gold, which tend to have a historic inverse relationship to the Dollar.
 
 
When the Dollar does well, investors often choose to store their money in paper rather than bars. Though September is statistically the best month for gold, with the Dollar rising almost two standard deviations above its mean, this month might not be kind to the yellow metal and other commodities.
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Sep 15

Why Commodity Prices are Sinking

Gold Price Comments Off on Why Commodity Prices are Sinking
Natural resources from oil to food are falling fast in price. Why…?
 

Is the POST-COLD WAR global boom over? asks Donald Coxe, chairman of Coxe Advisors LLC, and a consultant to The Casey Report from Doug Casey’s research group.
 
Since the fall of Bolshevism, the world has seen remarkably sustained growth in international cooperation, brought about by freer trade and new technologies. Financial assets have generally performed well, increasing prosperity across most of the world. There were just two major interruptions – the tech crash in 2000, and the financial crash in 2008.
 
The world warmed up fast after the Cold War. Prices of most commodities rose, despite major corrections:
  • Oil climbed from $15 per barrel to as high as $140. It collapsed with the crash, but climbed back swiftly to near $100;
  • Corn climbed from $2 to as high as $8 before sliding to $3.60;
  • Copper climbed from 80 cents to $4.30 before sliding to $3
  • Gold shot up from $350 to $1900 before pulling back toward $1200.
So what’s happening with commodity prices now? Is this just another correction, or has the game really changed?
 
Commodity prices have risen against a backdrop of falling interest rates:
The US 10-year Treasury yielded 8% as recently as 1994, and as low as 2.1% during the crash. Recently the consensus target was 4% – before fears of outright deflation drove it to 2.4%. Bond yields have fallen below 1%. Even the bonds of the southern members of the Eurozone yield Treasury-esque returns.
 
Remarkably, those low yields persist even as major geopolitical outbursts have ended the mostly benign post-Cold War era. The foundations of global economic progress are being shaken by geopolitical earthquakes from Russia and Ukraine to Syria and Iraq, where a new caliphate has been proclaimed.
 
It seems bizarre, but the world is heading toward a revival of both the Cold War and the Ottoman Empire.
 
Unfortunately, these concurrent crises are occurring at a time when the great democracies’ leaders bear scant resemblance to those leaders responsible for the end of the Cold War and the launch of global cooperation and free trade: Reagan, Thatcher, and George H.W.Bush.
 
Mr.Obama won his nomination by voting against the invasion of Iraq. He ran on the promise of ending wars, not starting them. Now, faced with sinking popularity in an election year that could give Republicans complete control of Congress, he naturally fears dragging America into the ISIS chaos – or Ukraine.
 
Obama is also haunted by the collapse of his most daring and creative foreign policy achievement – the reset with Russia. Mr.Putin has doubled down on his Ukrainian attacks by warning that Russia should be taken seriously, because it is a major nuclear power and is strengthening its nuclear arsenal. Those with long memories recall Khrushchev banging his shoe at the United Nations and shouting, “We will bury you!”
 
Meanwhile, Western Europe’s leaders show few signs of being prepared for either crisis. Angela Merkel, raised in East Germany, is cautious to a fault. British Premier David Cameron is struggling to prevent Scottish secession and to deal with the likely return of hundreds of ISIS-trained British citizens. (Military analysts generally agree that well-funded returnees with ISIS training are much greater threats than Al Qaeda ever was…yet Cameron has failed to convince his coalition partner to support restraining their re-entry into British Muslim communities.)
 
The backdrop for long-term investing has, in less than a year, swung from promising to promises broken by wars and threats of more-terrifying wars.
 
Another unlikely threat is deflation. When central bankers have been running the printing presses 24/7…?
 
Most economists, strategists, and investors would have deemed deflation a near-impossibility with government debts at all-time highs, funded by money printed at banana-republic rates. Who thought that the Fed would quadruple its balance sheet? And who dreamt that such drastic policies would be sustained for six years and would be accompanied by outright deflation in much of Europe and minimal inflation in the USA?
 
So why have Brent oil prices fallen from $125 in two years despite production outages in Syria and Libya and repeated cutbacks in Nigeria? Are Teslas taking over the world?
 
The answer is that the US is once again #1 in oil production, thanks to fracking (in states that allow it). Mr.Obama likes to boast about the new US oil boom, but he has been a bystander to this petro-revolution. According to an oil company executive interviewed in theNew York Times last week, without fracking, global oil prices might be at $200 a barrel, and the world would be in a deep recession. He’s a Texan and thus inclined toward hyperbole, but his point is directionally valid.
 
US frackers – deploying advances in science and technology with guts and skill – have averted fuel inflation. And farmers, using the tools of modern agriculture – GMO and hybridized seed, farm machinery equipped with GPS and logistics, and carefully monitored fertilizers – have combined with Mother Nature to unleash record crops of corn and soybeans. So much for food inflation.
 
Capitalism is doing its job: to expand output of goods and services, thereby preventing shortages from derailing recoveries through inflation. That success story means central bankers can keep printing away.
 
So what should investors do? The S&P’s rally has been sustained through near-zero-cost money used to:
  • buy back stock to enrich insiders and please activist hedge funds which have borrowed big to buy big; and
  • prop up the overall market because investors have learned that buying on margin when the costs are minimal – and below dividend yields – just keeps paying off.
Stein’s law says, “If something cannot go on forever, it will stop.” Too bad it doesn’t say when.
 
Gold loses its luster when inflation seems to be as remote as a pot of gold at the end of the rainbow. It also loses appeal if even a concatenation of crises fails to send investors rushing into the time-tested crisis consoler.
 
We had predicted in February that 2014 would be the year of increasing geopolitical risks that would challenge conventional asset allocations. We see geopolitical risks expanding from here – not contracting – and stick to our investment advice that the broad stock market is precariously valued. A range of options is available for those who wish to hedge themselves against even worse news.
 
Gold is part of any such risk mitigation. So are long government bonds.
 
Most importantly, we have entered an era when wise investors will devote as much time to reading the foreign news as they allocate to reading the investment section.
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Aug 28

War Comes Home

Gold Price Comments Off on War Comes Home
New targets for all that surplus military hardware…
 

AMERICA’s attention recently turned away from the violence in Iraq and Gaza toward the violence in Ferguson, Missouri, following the shooting of Michael Brown, writes former US Congressman Ron Paul.
 
While all the facts surrounding the shooing have yet to come to light, the shock of seeing police using tear gas (a substance banned in warfare), and other military-style weapons against American citizens including journalists exercising their First Amendment rights, has started a much-needed debate on police militarization.
 
The increasing use of military equipment by local police is a symptom of growing authoritarianism, not the cause. The cause is policies that encourage police to see Americans as enemies to subjugate, rather than as citizens to “protect and serve.” This attitude is on display not only in Ferguson, but in the police lockdown following the Boston Marathon bombing and in the Americans killed and injured in “no-knock” raids conducted by militarized SWAT teams. 
 
One particularly tragic victim of police militarization and the war on drugs is “baby Bounkham”. This infant was severely burned and put in a coma by a flash-burn grenade thrown into his crib by a SWAT team member who burst into the infant’s room looking for methamphetamine.
 
As shocking as the case of baby Bounkham is, no one should be surprised that empowering police to stop consensual (though perhaps harmful and immoral) activities has led to a growth of authoritarian attitudes and behaviors among government officials and politicians. Those wondering why the local police increasingly look and act like an occupying military force should consider that the drug war was the justification for the Defense Department’s “1033 program”, which last year gave local police departments almost $450 million worth of “surplus” military equipment. This included armored vehicles and grenades like those that were used to maim baby Bounkham. 
 
Today, the war on drugs has been eclipsed by the war on terror as an all-purpose excuse for expanding the police state. We are all familiar with how the federal government increased police power after September 11 via the PATRIOT Act, TSA, and other Homeland Security programs. Not as widely known is how the war on terror has been used to justify the increased militarization of local police departments to the detriment of our liberty. Since 2002, the Department of Homeland Security has provided over $35 billion in grants to local governments for the purchase of tactical gear, military-style armor, and mine-resistant vehicles.
 
The threat of terrorism is used to justify these grants. However, the small towns that receive tanks and other military weapons do not just put them into storage until a real terrorist threat emerges. Instead, the military equipment is used for routine law enforcement. 
 
Politicians love this program because it allows them to brag to their local media about how they are keeping their constituents safe. Of course, the military-industrial complex’s new kid brother, the law enforcement-industrial complex, wields tremendous influence on Capitol Hill. Even many so-called progressives support police militarization to curry favor with police unions.
 
Reversing the dangerous trend of the militarization of local police can start with ending all federal involvement in local law enforcement. Fortunately, all that requires is for Congress to begin following the Constitution, which forbids the federal government from controlling or funding local law enforcement. There is also no justification for federal drug laws or for using the threat of terrorism as an excuse to treat all people as potential criminals. However, Congress will not restore constitutional government on its own; the American people must demand that Congress stop facilitating the growth of an authoritarian police state that threatens their liberty.
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Aug 14

Ban Gold Advertising & 22-Carat, Says Indian Professor

Gold Price Comments Off on Ban Gold Advertising & 22-Carat, Says Indian Professor
India’s gold demand set to surge by 2030 as 28% of 1.2bn population marry…
 

INDIA’S GOLD advertisements and 22-carat jewelry should be banned, says a professor of public policy in the sub-continent, urging the government to curb demand directly in the world’s No.1 consumer nation.
 
Writing in the Hindu Business Line, Professor Parkash Chander of Jindal School of Government & Public Policy at the private O.P.Jindal University in Haryana says that “Advertisements promoting gold jewellery ought to be banned if the government is really serious – as it should be – about taming the Indian demand for gold.”
 
With a gold and jewelry sector employing perhaps 3.5 million workers, India grew its private gold demand by more than a tenth in calendar 2013, but lagged China as the world No.1 after anti-gold import rules were imposed in July by the previous administration.
 
Unofficial inflows have surged however, with government seizures of barely 2.3 tonnes over the last 12 months dwarfed by estimates of 200-300 tonnes.
 
Noting the Indian public’s preference for 22-carat gold items, “Banning the sale and purchase of gold jewellery of more than 18 carats will…reduce India’s demand for gold,” reckons Professor Chander, also recommending a bank-deposit scheme to attract some of India’s estimated 20,000-tonnes private holdings, which can then be used to boost the Reserve Bank of India’s official gold bullion reserves.
 
What the Economic Times calls “the government’s constant encouragement to the banks to monetize the public’s gold holdings” have so far failed, thanks it believes to “the lack of world-class infrastructure to refine…this gold.”
 
The MMTC-Pamp facilities in Mewat, Haryana – the government’s new joint-venture processing plant with Swiss-based refiners Pamp – gained approval in May for producing London Good Delivery bars for the international wholesale market.
 
“[This] will enable local jewelers to exchange their scrap jewelry against world class gold bullion,” says James Jose of the Association of Gold Refineries & Mints, “thereby reducing direct gold bullion imports.”
 
Legal gold imports to India fell hard in the second-half 2013 after the Congress administration raised duty to 10% and banned new imports unless traders had re-exported 20% of their previous shipment.
 
Those rules have been widely seen driving the two-thirds plunge in India’s current account deficit, down from a multi-decade high of 4.7% of India’s GDP in fiscal-year 2012-13 to 1.7% in the fiscal year ending April 2014.
 
Accounting for the upper estimate of illegal gold smuggling, however, India’s CAD over the last fiscal year would have neared 2.2% on BullionVault‘s maths.
 
In the 12 months since the strict import rules were imposed, staff of national carrier Air India have been caught smuggling gold in 13 separate incidents, a junior civil aviation minister said last week.
 
The Indian government is expected to tighten security at the country’s 185 tax-free special economic zones after police arrested a driver trying to smuggle 25 one-kilo gold bars – worth around $1 million – out of the zone in Surat.
 
A relaxation of India’s gold import rules is meantime facing a court challenge by the jewelry industry, after a surge in legal inflows in June saw the new government state it has no intentions of easing the curbs further.
 
Approved banks and other importers must calculate their next quota using their total volume of exports they’ve made over the last 3 years. But so-called “star trading houses” were allowed from 21 May to calculate their new quota based on total gold inflows over the previous two years.
 
That change was made before the new BJP government of Narendra Modi was sworn in, but after its electoral victory over the previous Congress administration.
 
“There is no ground made out to recommend private players to import gold under 20:80 scheme,” says a petition to the Delhi High Couty from the Delhi Bullion & Jewellers Welfare Association, “particularly at a time when the new government is being formed…The circular [was] issued in haste without consultation.”
 
Further ahead, writes Professor Chander in the Hindu Business Line, “approximately 28% of India’s total population of more than 1.2 billion is in the 15-30 year age-group…a very large number of young people who are likely to marry over the next 15 years.
 
“Since marriages in India seldom take place without some gold jewellery for the bride, the demand for gold, unless controlled, will increase manifold” he believes between now and 2030.
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