Nov 23

Ireland: What a Mess!

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But it might just create a chance to Buy Gold and other hard assets on the cheap…

WELL THIS should be interesting, writes Dan Denning in his Daily Reckoning Australia.

The EU/IMF bailout of Ireland is not going off without a hitch. The UK’s Telegraph reports that the Green party, which currently forms the junior half of Ireland’s coalition, might withdraw that support and call for new elections in January. This would call into doubt the ability of the current government not only to execute a deal with the EU and the IMF but also to pursue its four-year austerity program.

What a mess! We’ll get to how Ireland and Australia are similar in a moment. But first, please recall the words of the great philosopher of the New York Yankees, Yogi Berra. He once said, "When you come to a fork in the road, take it."

Today’s fork in the financial road leads down two different paths. One path is continued US Dollar devaluation and a strategic migration to emerging market assets (under the assumption that the BRIICS nations will eventually have to allow for currency appreciation…or face rampant food and fuel inflation). This trade favors Buying Gold, commodities, and tangible assets in general.

But remember what happened in 2008? The Global Financial Crisis actually led to a massive rally in the US Dollar. Emerging markets got hammered. The "risk" trades financed with cheap greenbacks were reversed and commodities took a shellacking as well.

Could that happen again? The boys at Knight Research think it’s going to happen again, but even bigger and badder this time around. In a recent research note, they wrote:

"We believe the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyse a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over."

This is the fork Murray has been preparing for in the Slipstream Trader for our subscribers  It would mean falling indexes in Australia, which would of course mean falling components of those indexes. Knight Research elaborates on this fork:

"The game is over. Presently, we believe that the broad-based resurgence of investor confidence in the emerging market and secular bull market in commodities will end badly; proving that the rally which commenced in Q2 2009, was in fact an ‘echo bubble’ facilitated by massive-and unsustainable-stimuli from the Chinese government.

"We believe that the end of the Great Consumer Credit Cycle and the vast structural differences in the terms of trade between the United States, the EU, and China, have finally caught up with the secular bull thesis on emerging market and commodities.

"Quite ironically, the Fed’s aggressive policies will likely prove to be the catalyst which breaks China’s unbridled expansion of credit and non-economic growth, ushering in a wholesale rebalancing of risk assets."

This is not a lukewarm prediction. It would quite obviously be mega bearish for the Aussie Dollar and for commodities. And thus far, there’s not much evidence to support that giant reversal is afoot that is more bearish for emerging markets than it is for the US Dollar. It’s a fork in the road, though. So we have to take it and see where it leads.

There ARE a few factors supporting the "Game Over" theme. One is that Ireland’s woes are not the last o the Eurozone’s problems. There is Greece. There is Spain. And really, Ireland is not even done and dusted yet. To some extent, Euro weakness is dollar bullish and contributes to the "Game Over" theme.

But the bigger factor is Chinese tightening, or just your basic traditional popping massive credit bubble. There are early signs of that. Last week China raised reserve requirements on banks again. And Citigroup agrees with our assessment that rising food prices in China could be bearish for metals.

China’s State Council is talking a big game on controlling inflation. Does it mean China is quickly shifting away from a bias toward export growth toward an inflation fighting bias? That’s the big question. If it does mean that, you can expect lower commodity prices.

For example, three-month copper on the London Metals Exchange fell overnight. The news preceding the drop was that refined copper imports to China fell by a third last month. Comex December copper traded lower too, near $3.75/lb.

We’re going to have Dr. Alex what he thinks about this. But we can guess. He probably loves it. He just got back from another site visit in Africa to a copper project. If you’re a Diggers and Drillers reader don’t worry. You’ve already read about this company. It’s not a new recommendation.

Alex has done his homework on the companies he’s recommended. Weakness in the copper price invariably follows through to the shares. If you’re a secular metals bull, you believe this lowers your average purchase price on the shares most likely to benefit from rising prices.

If you’re a bear on copper, well…you’re a bear. Go dance. Alex, of course, has taken the other fork in the road. This fork is for those who’ve realized the end of the Dollar Standard in the global money system is likely to be bullish for real assets, despite your reflexive US Dollar rallies. Europe’s chronic and structural problems add an element of Dollar support. But the long term story on this fork is to favor "real assets" over paper money.

Which brings us back to Ireland and Australia. Irelands bank’s went all in on the Irish property market. When the bubble burst, the banks were left holding the bag (a huge mortgage book). The bag was so heavy, in fact, it broke their back. So the government had to pick them up. And the bag was too big for the government to pick up too, especially given rising borrowing costs for countries at Europe’s periphery.

Could that ever happen in Australia? Could banks with massive over-exposure to domestic property be caught out by losses and unable to borrow from overseas except at much higher rates? And could the government be forced to step in and cover the bank at the cost of its own good credit?

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Nov 15

This Week on "States in Crisis"

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Ireland, Gold Futures, commodity speculation, and the rest of this week’s news – in advance…!

THIS WEEK’s episode of “The WelfareState in Crisis” features a guest appearance by the Emerald Isle,currently seeking about $110 billion in bailout money from theEuropean Union, writes Dan Denning in his Daily Reckoning Australia.

Actually, Ireland is not seeking that money, and that appears to be a part of the problem. The Irishgovernment is content that it’s managing its problems well,independent of European meddling.

But with 10-year Irish bond yieldsblowing out to a spread of 646 basis points over 10-year German debtlast week, European officials are worried that problems in Irelandare problems for the Euro. And if problems for the Euro get worse,that means problems for Portugal and Spain too.

No wonder the US Dollar quit fallinglast week. And no wonder commodities fell like a stone. Friday was anugly day for commodities speculators. The CRB Index in New York fell3.6%. Every single one of its 19 components was down. Sugar contractsfell 12% in London and corn and soybeans traded limit down.

Part of the shocking action incommodities futures markets is the raising of margin requirements byexchanges. It happened in silver last week. And it happened for sugartoo, when the ICE futures boosted margins on sugar contracts by 81%to shake out speculators. It will probably happen on Gold Futurestoo, and that might explain the $40 thud last Friday, among otherthings.

No one is forced to speculate, ofcourse. But this is what the Bernanke Fed has wrought. ItsQuantitative Easing action has put dollar owners in the position ofdoing nothing and losing money to inflation, or speculating intangible assets that go up in price relative to the dollar. And it’s not just commodities. It’s currencies too.

The G-20 summit in Seoul failed toproduce any result on competitive currency devaluations. No onereally expected it to. But what’s next? Since there is no quick andeasy solution to replacing a broken world currency system, the slow,difficult, and ugly scenario must take place. It will probably beslow, difficult, and ugly.

One thing you should expect more of isan escalating level of capital controls. Ironically, the firstmanifestation of this has been in export-oriented economies likeBrazil, where the government tripled a tax on foreign investment inlocal bonds from 2% to 6%. It was designed to prevent furtherappreciation in Brazil’s currency, which yields over 10% and is up35% in trade-weighted terms since last year.

China, South Korea and other countriesare taking similar measures. For big exporters, a stronger currencytranslates into a loss of competitiveness. And when capital marketsare wide open and you find yourself on the receiving end of hugeinflows, it can lead to rapid asset price appreciation and otherforms of less desirable inflation.

By the way, this shows you how everyoneis complicit in trying to return to the status quo ante GFC. Theexport-driven BRIICs want to pretend that the credit-financed Welfarestates don’t have real structural deficit and demographic issuesthat prevent a return to “normal” rates of consumption. They wantthe world be the way it was.

Here in Australia, other than houseprices being utterly unaffordable, it looks like things have neverbeen better. The rising Aussie dollar (up 17% since the end of Junealone) helps “contain” some of the inflation from booming coaland iron ore exports. That’s why the Reserve Bank of Australia isone of the only central banks in the world that does not appear to beactively trying to weaken its currency.

Maybe the RBA agrees with Bloombergthat on a purchasing power parity basis, the Aussie is trading at a30% premium to fair value. That makes it the most over-valuedcurrency in the world at the moment. If it’s a short-term trade(instead of long-term or secular trend in which the Aussie surpassesthe USD), the currency will weaken and not do any permanent damage toAustralia’s own export competitiveness by making Aussie exportsmore expensive than alternatives from Africa.

For now, the Aussie is the placeeveryone wants to be as well; a high-yield commodity currency from acountry with comparatively low public sector debt (although highhousehold debt), low unemployment, and economic growth correlated toAsia. What could possible go wrong when things can’t’ get anybetter?

Speaking of Asia, the other non-Irishnews that rocked commodity markets last week was that China againraised reserve requirements at key banks and may raise interest ratesto ward off inflation being poured into China from the U.S. Stocksand commodities fell hard.

What do you make of all this mess?

To us, it means that anxiety about theAussie being too strong for too long may be short-lived. China couldbe doing a dress-rehearsal for a much more dramatic fall in assetprices as the authorities try to prevent inflation from surging. Thishas obvious and bearish implications for commodity prices.

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Nov 04

Après le Fed, the Deluge

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$100 billion here…$900 billion there…and none of it real money…

AND NOW, the deluge. Or should we call it the Torrent Signal that our mate Kris Sayce has been banging on about for the last week? asks Dan Denning in his Daily Reckoning Australia.

That’s right – that gushing, gurgling, sputtering, splurging sound you hear is the sound of hundreds of billions of new US Dollars flooding into the economy and the stock market. Over the next eight months, the Federal Reserve will spend an additional $600 billion it doesn’t have buying US bonds in the name of "price stability".

If Kris is right, price stability is the last thing you’ll see at the small-cap end of town in resource-rich Australia. For a variety of reasons, Fed policy doesn’t seem to just trickle down into the small caps and junior Gold Mining and resource sectors. It rages on through like Old Man River.

All up, the Fed is going to chuck in about $100 billion a month into the market. It said more large-scale asset purchases were possible if inflation was too low or unemployment too high. Remember, the Fed has a dual mandate of price stability and full employment. These days, price stability apparently means creating enough money to support asset prices, lest they crash.

Even though we’ve said it before, it’s worth repeating: Everything the Fed does these days is designed to support US banks. Monetizing US government debt doesn’t do a lick of a good to improve the quality of the assets on US bank balance sheets. The Fed is merely trying to keep interest rates from spiking; an event which would send even more banks into terminal decline because of its affect on the housing market (which is already in serious trouble) and would put households in further defensive mode.

As far as the stock market is concerned, there are a lot of green numbers on the screen this morning. Because this $600 billion announcement was in the Goldilocks spot – not too large, not too small…just big enough to please the market without being so big it scared anyone about how inflationary it really is.

Please note that the Aussie Dollar moved above parity on the Fed move and stayed there. Is parity the new normal for the Aussie? Maybe. Speaking for ourselves, we’ve been waiting for a big correction in silver and gold to add to our precious metals holdings. But it just hasn’t come yet.

What could this mean? It could mean that the inter-market relationships that seemed to govern the movement of the Aussie Dollar, the US Dollar, and precious metals prices are breaking down. The greenback is getting weaker relative to everything else. The Fed contributes to this with its march to restore monetary insanity. Two years of grid-locked Washington dealing with a fiscal nightmare probably add fuel to the Dollar’s fire.

By the way, the real amount of QE, when you add in the Fed rolling over mortgage purchases, is closer to $900 billion. That’s almost enough to start a new war. But what’s a few hundred billion here and there when it’s not real money anyway?

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Nov 01

Financial Extremists

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Financialization has led to a world of useless analysts and "extremist" naysayers…

OH WOULD the International Monetary Fund please shut up and leave Australia alone? asks Dan Denning in his Daily Reckoning Australia.

According to a report in The Age, the IMF is about to release a report in which it reveals that Australian house prices are "moderately" overvalued by 15%. This is not nearly extreme enough, in our view…which makes us an "extremist" to use the words of our friend Rory Robertson, with whom we debated about house prices a few months ago.

Rory used the word like it was a bad thing, which, we suppose, it IS, when you’re using about people who blow things up for religious reasons (probably the image/impression he wanted to conjure). But we’ll let you in on a little secret…

When asset prices become unhinged from values – as they do in a worldwide credit boom – the world has become an extreme place. Extreme asset values are the rule and not the exception during a credit boom.

We are all extremists now, Rory. Because the Fed has forced us to be.

Incidentally, this is why returns on most asset classes are so tightly correlated during a crack up boom. There’s no point in differentiating between what’s cheap and what’s dear when everything goes up. Thus, bad credit (or too much credit) clouds good judgment.

To follow up on this thought, this explains how too much credit perverted Wall Street. Yes, the money was easy which probably lowered the threshold for committing fraud on a mass scale (subprime mortgage lending and securitisation). But if credit elevates asset values, then there is no need to an analyst anymore. You can’t distinguish yourself by virtue of the quality of your work. In fact, the quality of your work has less and less influence over the result, which is foreordained because of the flow of money into markets. This is why Wall Street (and America, and a lot of the Western world) have moved from a culture of merit-based achievement to a culture of "who can legally loot the most money."

This gradual corruption of the value of honest work and honest money is the result of the financialization of our economies. We’d argue that it all stems from the corruption of our money (fiat money). When the basic unit of value and of conducting transactions for goods and services becomes unreliable, unstable, and is designed to erode over time, is it any surprise that other values erode too?

Gold, which as a noble metal does not rust (or erode), is currently trading at US$1341. Everyone is wondering what the Fed will say next week. Everyone is expecting "the big one". But as our colleague Murray Dawes notes, the Fed is probably going to drip-feed support markets (through large-scale asset purchases) on an as-needed basis. This month could be a big fat nothing-burger if you’re expecting…a big fat policy announcement.

Or, in narcotic terms, the markets are looking for their next big hit. They are already nervous that if the Fed doesn’t bring more liquidity (smack) the big indexes will correct (come down) to reflect how they have mis-priced the Fed’s actual efforts. The Fed has left everyone guessing, but generally buying, which is probably what it wanted.

For our money, and probably because we just wrapped the October issue of Australian Wealth Gameplan (AWG) in which we wrote about the matter extensively, the real game changer in the world currency scene will come from the slowly but inexorably imploding US mortgage market. The recapitalization of US banks and improving their earnings is the real target of the Fed’s Dollar devaluation policy – which makes perfect sense when you recall that the Fed is a cartel of those very same banks. Of course it would act to save its member banks, even if it cost US taxpayers hundreds of billions and a real loss in American standards of living as a result of the end of the Dollar standard and lower US purchasing power.

Australia seems to be perfectly positioned for Dollar devaluation to the extent that it’s a commodity producer (commodities are priced in Dollars and thus growing in value as the supply of Dollars increases). It doesn’t hurt that Australia – like Singapore and Malaysia – is also a kind of China-proxy.

That is, those currently exiting the Dollar may be looking for a currency with a chance of growing in purchasing power. That would be China’s currency – if and when it ever lets that happen. This is also an issue we covered in the AWG report. But if you can’t buy Chinese assets or own Chinese currency directly because of capital controls, you have to do the next best thing.

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Oct 19

"More Inflation Needed"

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Fed policy is creating a surge across raw material prices, not just in gold and silver…

SO MOST INVESTORS know that the Federal Reserve’s "easy money" policy is creating an enormous amount of new credit and new money, write Porter Stansberry and Braden Copeland at Stansberry & Associates.

And most people know this policy has created an explosion in the prices of gold and silver.

But most people have no idea where the bulk of the Fed’s new money is actually finding its home: in Asia. This has enormous implications for you as an investor, which I’ll show you in a moment…

According to Bill Gross, who manages the world’s largest pile of fixed-income assets at Pimco, the Federal Reserve is going to resume large-scale quantitative easing at the rate of $100 billion per month. News of this plan has been leaking out for the last two months following an important speech Bernanke gave in Jackson Hole, Wyoming this summer. He said, essentially, we needed a lot more inflation.

If the Fed does resume quantitative easing at the $100 billion-per-month range, it would be buying the equivalent of all of the new debt the US Treasury is issuing – all of it. This represents an increase of roughly 30% to the money supply in the first year…an extraordinary amount of new cash.

Trade and capital flows are transferring most of the inflation the Fed is creating to the Chinese economy. US politicians continue to stimulate consumption in the US, while most of the production to meet this demand comes from China. We borrow and spend. They produce and profit. Hopefully, you understand printing more money and buying government bonds won’t change this dynamic. It simply results in still more money being sent to China.

What will China do with the flood of capital? Lots of things. But one thing it will certainly do is build more coal-fired power plants. Coal-fired plants produce 80% of the electricity in China, and demand for electricity is growing roughly 9% a year. It’s hard to comprehend how fast demand for coal is growing in China, but consider these facts…

China is now the world’s second-largest consumer of electricity, after the United States. A decade ago, China’s installed generation base was only 315 gigawatts. Today, it’s 900 gigawatts – and 78% of its production is still coal-based.

Today, China consumes three times more coal than the US – more than three billion tons. But China only has about half of the US’s coal reserves. And that means it must import a lot of coal.

At current growth rates, China would exhaust its current reserves in only 16 years. Obviously that’s not going to happen – more mines will be dug. But just as obviously, it will take a long time to build the mines and lay the railroad infrastructure required. In the meantime, China will need a lot of coal.

Current market surveys show China will import 150 million tons of coal this year. That’s only 5% of China’s total coal demand, but it represents 15% of the total US demand. Right now, almost all of this coal comes from Australia, where China takes up about 60% of the export supply of coal.

And here’s the crucial fact: China’s coal imports doubled in the last year.

We know total power production in China is scheduled to double over the next eight years. It’s building a new coal-fired plant nearly every week. The United States has built only 12 new coal-fired power plants since 1990. Assuming China’s coal imports double again (and they will), Chinese demand will exhaust Australia’s export capacity. And when China’s import demand doubles again after that (to 600 million tons per year), it will exhaust the world’s total export supply.

China’s not the only problem…Don’t forget about India.

India’s installed power base exceeds 600 gigawatts, and demand is growing at about the same pace as in China. India also relies on coal for most of its power (70%). It currently burns 500 metric tons of coal a year, mostly from domestic sources. But Vinay Kumar Singh, the CEO of India’s Northern Coalfields, says the country will need to import at least 250 million tons of coal a year by 2020. India’s imports of coal from South Africa rose 74% last year.

It’s no exaggeration to say China and India’s demand for electricity is the future of global power. Already China’s coal production represents more than twice the amount of energy produced from all of Saudi Arabia’s oilfields.

What’s fueling all of this demand for coal-fired power plants? Huge urban populations in China and India. Consider these figures. In America, the baby boomers – the 50 million Americans born in the years after World War II – produced the demand for vast amounts of new infrastructure in America.

There are 300 million newly urban Chinese people. And 300 million newly urban Indians. That’s 600 million people moving out of the Stone Age and into the modern world – a group 12 times bigger than the baby boomers. While it’s true these people will want to buy lots of things – from Cokes to Buicks – the thing they need most is electricity.

Americans don’t yet realize the Fed’s attempts to paper over our debts come with serious consequences. As our money loses its purchasing power, costs will rise – especially power costs. Undoubtedly, our politicians will blame "speculators" for the soaring price of coal. But the truth is, the paper that will push prices higher came from the Federal Reserve, not from any hedge fund.

Whether we realize it or not, we compete with other nations around the world for resources. Historically, our currency – as the world’s reserve currency – has given us an enormous advantage. Coal, for example, is priced in Dollars. But we stand on the verge of losing that advantage…and the consequences will be drastic. We will face higher prices for coal, among other sources of energy.

To hedge yourself from this coming Fed disaster, buy coal stocks is our advice. They’re going to go much higher in the coming years.

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Oct 18

Bunker Calling Outside World

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Today’s SMC…? It’s all SDW, whether in or out of the MSHJB…

SO MY WIFE is on the intercom again, asking about whether or not I am coming out of the cocoon-like safety of the Mogambo Screaming Heebie-Jeebies Bunker (MSHJB) to have lunch, or maybe get a shower, or say hello to her and the kids, or pick up my mail, and maybe just stop acting So Damn Weird (SDW) for a change, says the Mogambo Guru in The Daily Reckoning.

I explode into the intercom…

"So Damned Weird (SDW)? You think I’m acting So Damned Weird (SDW)? Everything everywhere is So Damn Weird (SDW), so how is it freaking possible to NOT be So Damn Weird (SDW), SDW, SDW, SDW?"

My voice rising, I continue…

"For instance, the bond market has become such an insane bubble that bond buyers have bid prices up so high (audience yells out ‘How high?’) that the yield is less than 2%!"

I could tell by the confused silence at the other end of the Bunker-to-Outside-World (BTOW) intercom that she needed some explanation. So I helpfully went on:

"Bond buyers are making a taxable Two Miserable Percent (TMP), while inflation, as measured by the GDP deflator, is 1.9%! Inflation as measured by John Williams at shadowstats.com is running somewhere in the 8%-plus range, and The Economist magazine is measuring a blistering 23.8% inflation in ‘all Dollar items,’ with a terrifying 20% inflation in the price of food! Yikes!"

I listened for a response, but it soon became apparent that she had hung up the intercom, probably going back into the house, yammering to the kids about how "Daddy is still acting weird and won’t come out of that stupid bunker of his" and all the rest of her lies.

This means to me that she, like buyers of bonds, must be standing around with a blank look on her face. Whereas they are also disgustingly drooling down their chins and onto their shirts and/or straight jacket, seemingly hypnotized at the piddly 2% gross yield on their investment, before being lessened by fees, expenses and taxes to finally result in earning, maybe, a lousy 1% nominal net on their money, while they are simultaneously losing 8% of the purchasing power of ALL their money because of 8% inflation!

It was not until I rudely shouted out, "Nice investing there, bond buying morons!" that Agora Financial’s 5-Minute Forecast came to rescue bond buyers from being diced and sliced by both my Sharp Mogambo Criticism (SMC) and my constant insinuations that there is a lot of incest, mental illness, stupidity, alcoholism and drug addiction in the ranks of bond buyers.

Agora reaches between us, pushes us apart, whereupon we retreat to neutral corners, and says to us both "And so it goes in a zero interest rate environment, when savers are punished and thus forced to reach for yield."

"Forced to reach for yield?" I stammer. "What a polite way of putting it! Reach for yield!"

This indicates a difference in writing style between polite professionals like The 5, versus weird guys like me who have a lot of obvious mental problems, all made worse from all the stress of watching the Federal Reserve continually create more and more money, especially so that the federal government can borrow this money and spend it, all with the horrific, terrifying result of roaring inflation in prices.

I would have phrased it somewhat differently. I would have said:

"When the Federal Reserve is actively destroying the USA by creating so incredibly much money, for so long, so that idiotic bond buyers are finally reduced to realizing a laughable after-tax 1% yield – if that! – from their investment in bonds, while suffering an 8% loss of buying power of all the money they have, and the value of everything they have, because of inflation, are these bond buying people half-witted lowlife morons or what?"

Fortunately, the woeful travails of bond buyers and the morons buying common equities soon leave me disinterested and bored, as I invest according to the Mogambo Investment Theory (MIT), which is to simply Buy Gold, silver and oil, which will tromp them all.

And with the Federal Reserve acting like it does, and the federal government acting like it does, profiting from inflation in prices by simply Buying Gold, silver and oil is so easy that I cannot stop myself from delightedly exclaiming, "Whee! This investing stuff is easy!"

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Oct 14

Money Supply & the Dollar

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How differing rates of "money growth" are weakening the US Dollar…

AT THE END of September the price of the Euro in US Dollar terms closed at 1.357 – an increase of 7% from the end of August, writes Dr.Frank Shostak, chief economist at MF Global in Australia and a regular contributor to the Austrian-school Mises.org, for the Cobden Centre.

The yearly rate of growth of the price of Euro stood at minus 7.3% in September against minus 11.5% in the month before.

The currency rate of exchange seems to be moving in response to so
many factors that it makes it almost impossible to ascertain where the
rate of exchange is likely to be headed.  We suggest that rather than
paying attention to the multitude of apparent variables, it is more
sensible to focus on the essential variable. As far as currency rate of
exchange determination is concerned we suggest that this variable is the
relative changes in the purchasing power of various monies. In short,
it is the relative purchasing power of various monies that set the
underlying rate of exchange.

A price of a basket of goods is the amount of money paid for the
basket. We can also say that the amount of money paid for a basket of
goods is the purchasing power of money with respect to the basket of
goods. If in the US the price of a basket of goods is $1 and in Europe an identical basket of goods is sold for 2 euros then the rate of exchange between the US$ and the euro must be two euros per one dollar.

An important factor in setting the purchasing power of money is the
supply of money. If over time the rate of growth in the US money supply
exceeds the rate of growth of European money supply, all other things
being equal, this will put pressure on the US$. Since a price of a good
is the amount of money asked for the good, this now means that the
prices of goods in dollar terms will increase faster than prices in euro
terms, all other things being equal.

As a result an identical basket of goods is priced now, let us say at $2, as against 2.5 euro. This would imply that the exchange rate between the US$ and the euro will be now 1.25
euros per one dollar. Note the fact that changes in a money supply
affect its general purchasing power with a time lag means that changes
in relative money supply affect the currency rate of exchange also with a
time lag. (When money is injected into the economy it starts with a
particular market before it goes to other markets – this is the reason
for the lag. When it enters a particular market it pushes the price of a
good in this market higher – more money is spent on given goods than
before). This in turn means that past and present information about
money supply can be employed in ascertaining likely future moves in the
currency rate of exchange.

Another important factor in driving the purchasing power of money and
the currency rate of exchange is the demand for money. For instance,
with an increase in the production of goods the demand for money will
follow suit. The demand for the services of the medium of exchange will
increase since more goods must now be exchanged. As a result, for a
given supply of money, the purchasing power of money will increase. 
Less money will be chasing more goods now. Various factors, such as the
interest rate differential, can cause a deviation of the currency rate
of exchange from the level dictated by relative purchasing power. Such
deviation, however, will set corrective forces in motion.

Let us say that the Fed raises its policy interest rate while the
European central bank keeps its policy rate unchanged. We have seen that
if the price of a basket of goods in the US is one dollar and in Europe
two euros, then according to the purchasing power framework the
currency rate of exchange should be one dollar for two euros. As a
result of a widening in the interest rate differential between the US
and the Euro-zone an increase in the demand for dollars pushes the
exchange rate in the market toward one dollar for three euros. This
means that the dollar is now overvalued as depicted by the relative
purchasing power of the dollar versus the euro.

In this situation it will pay to sell the basket of goods for dollars
then exchange dollars for euros and then buy the basket of goods with
euros – thus making a clear arbitrage gain. For example individuals will
sell a basket of goods for one dollar, exchange the one dollar for
three euros, and then exchange three euros for 1.5 basket, gaining 0.5
a basket of goods. The fact that the holder of dollars will increase
his/her demand for euros in order to profit from the arbitrage will make
euros more expensive in terms of dollars – pushing the exchange rate in
the direction of one dollar for two euros.  (We suggest that the
arbitrage will always be set in motion if the rate of exchange deviates,
for whatever reasons, from the underlying rate of exchange).

Since November 2009 the money growth differential between the US and
the Euro-zone has been in a visible increase. After closing at minus 24% in November 2009 the differential jumped to minus 4.2%
in August this year. We suggest that the strengthening in the
differential is the key reason for the underlying strengthening in the
Euro against the US$. Given the relatively more conservative Euro-zone
central bank versus the US central bank it is quite likely that the
money growth differential will continue to strengthen further – thus
providing further support to the Euro.

After closing at minus 3.7% in April the growth differential between
US and Euro-zone industrial production climbed to 0.11% in August. We
envisage that in the months ahead the differential is likely to
stabilize at the August figure. So from this perspective the slight
increase in the differential is likely to provide only marginal support
to the US$ versus the Euro. The differential between the federal funds
rate and the European central bank policy interest rate is likely to
stand at minus 0.75% in the months ahead. (The fed funds rate is
forecast at 0.25% while the ECB rate at 1%). So from this perspective it
is going to have neutral effect on the price of Euro in US dollar
terms.

Again we maintain that the strong support for the Euro versus the US$
is on account of a strengthening in the money growth differential since
November 2009. (Note again that the effect from changes in money supply
and the differential works on the currency rate of exchange
determination with a time lag). This means that the US$ is likely to
remain under pressure. An increase in the industrial production
differential is likely to mitigate the strengthening of the Euro against
the US$. On a short-term basis the price of the euro in US dollar terms
appears to be just about “right” as far as the valuation versus its
12-month moving average is concerned. The price to its 12-month moving
average ratio stood at 1.0 in September versus 0.9 in August. Note that in September last year the ratio stood at 1.08.

Prospects for the Yen against the US dollar

At the end of September the price of the US$ in Yen terms closed at 83.9 – a fall of 0.3% from the end of August. Year-on-year the price of the US$ in Yen terms fell by 6.5% in September after declining by 9.5%
in the month before. Observe that the Yen has been strengthening
against the US$ since July 2007. The price of the dollar to its 12-month
moving average stood at 0.94 in September the same figure as in August. Note that in September last year the ratio stood at 0.946.

Since November 2009 the money growth spread between the US and Japan has been trending up. The differential stood at 2.8% in August against 2.1% in July and minus 13% in November last year. Now after falling to minus 29.1% in February the industrial production growth spread between the US and Japan climbed to minus 9.2%
in August. In the months ahead we expect the growth spread to stabilize
at around the August figure. The interest rate spread doesn’t have much
importance at present given the policy rates in US and Japan are close
to nil. We suggest that in the months ahead the money growth
differential is likely to dominate the currency rate of exchange scene.
This implies that the price of the US$ in yen terms is likely to remain
under pressure.

Money growth differential continues to support Aussie dollar against the US dollar

At the end of September the price of the A$ in terms of US$ closed at 0.967 – an increase of 8.5%
from the end of August. The growth momentum of the price of the A$ has
also strengthened visibly. The yearly rate of growth jumped to 9.4% from 5.4% in August. The ratio of the A$/US$ to its 12-month moving average climbed to 1.076 in September from 0.999
in the month before – this could be interpreted that relatively to its
12- month moving average the price of the A$ in US$ terms is
over-stretched.

A major factor behind the strengthening in the A$ against the US$ is a
visible strengthening in the money growth differential between the US
and Australia. After falling to minus 15% in November last year the differential shot up to 9.1% in June before settling at 7.6%
in August. From the demand for Aussie dollars perspective a strong
increase in the price of gold provides important support for the
Australian currency versus the US dollar. From these two key factors we
suggest that for the time being the Aussie dollar is going to be well
supported in the months ahead, all other things being equal.

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Sep 30

Mine’s Bigger Than Yours

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Currency wars over who’s got the most money to burn are fuelling the Gold Price rally…

AS THE Gold Price moves through yet another major milestone – $1300 per ounce – some heavy hitters in the marketplace are beginning to wonder if the yellow metal’s rally is getting a bit too frothy, or even worse, writes Gary Dorsch, editor of the Global Money Trends newsletter.

Is a speculative bubble brewing – and one which might ultimately deflate under its own weight, leading to a sharp correction? On Sept 15th, famed hedge fund trader George Soros said that Gold Prices might continue to rise, but warned that that gold is the "ultimate bubble"…

"Gold is the only actual bull market currently. It just made a new high yesterday. In the present circumstances that may continue. I call gold the ultimate bubble, which means it might go higher. But it’s certainly not safe and it’s not going to last forever."

Soros has been bullish on gold in a big way, and as of June 30th, the Soros fund held 5.24 million shares of the SPDR Gold Trust GLD, a stake worth about $650 million today.

Soros’s fund also held equity holdings in Gold Mining corporations, plus other minerals, worth almost $250 million.

Over the past two months, there’s been a global stampede into precious metals, with investors of many different stripes, and from many countries, scurrying to Buy Gold and silver in both the physical market and through exchange traded funds.

The World Gold Council reported that the demand for gold worldwide surged 36% in the second quarter of 2010, swelling to 1,050 tonnes. The Greek debt crisis, instability in Irish and Portuguese bonds, and expectations the Fed would unleash "Quantitative Easing" (aka QEII) – flooding the world with a new tidal wave of freshly printed US Dollars – has supported the historic bull run. Europe accounted for more than 35% of the retail purchases of Gold Coins during the second quarter.

The latest surge in gold and Silver Prices was sparked in July, following comments from Fed officials signaling that QEII could be around the corner. On July 22nd, Fed chief Ben "Bubbles" Bernanke reassured congressional lawmakers the central bank is prepared to print more Dollars if the US jobless rate continues to hover around 10%.

"We are ready and will act if the economy does not continue to improve, if we don’t see the kind of improvements in the labor market that we are hoping for and expecting. Unemployment is the most important problem that we have right now. What we can do is make financial conditions as supportive of growth as we can and we certainly are doing that…"

On August 19th, St Louis Fed chief James Bullard was more explicit, signaling his backing for further monetization of the US government’s debt.

"Should economic developments suggest increased disinflation risk, purchases of Treasury securities in excess of those required to keep the size of the balance sheet constant may be warranted. Any additional Treasury buying should be undertaken in a measured, deliberate manner, commensurate with the magnitude of the deflation threat."


The Fed’s propaganda artists are operating behind a veil of "smoke-and mirrors", trying to instill the fear of consumer-price deflation amongst bondholders in order to justify another big round of stealth monetization of the US government’s debt.

The Fed’s first go-around with QE, totaling $1.75 trillion, combined with the Bank of England’s £200bn QE-scheme and the Bank of Japan’s ¥21 trillion QE-scheme, fueled a powerful rally in key commodity markets in 2009, lifting the Dow Jones Commodity Index (DJCI) from deep in negative territory, and onto the positive side, thus warding off the threat of deflation in the global economy.

However, since the Fed completed its 12-month buying spree in Treasury bonds and mortgage-backed bonds in March 2010, the year-over-year rate of increase in both the DJCI and the US Producer Price Index have petered out. Last November, the DJCI was hanging around the 135-level, just a shade below the 138.40-level that prevails today. If the DJCI stays stagnant or turns lower in the months ahead, it could knock the US-PPI into negative territory by year’s end, signaling the onset of another bout of deflationary pressures, and triggering a second round of the Fed’s QE.

Thus, on Sept 1st, Philadelphia Fed chief Charles Plosser said the Fed would embark upon further monetary easing if faced with a dangerous downward price spiral.

"If we do need to act, if fears of deflation were to become real, then we would need every ounce of credibility we can muster to convince markets we are not going to let deflation happen…

"I would certainly entertain the solution if I feared deflation, and if I feared that expectations were coming unglued in that direction – then we would have to take actions," he warned.


Interestingly enough, amid all this gloomy talk by Fed officials about the bogeyman of deflation, the demand for precious metals – traditional hedges against inflation and currency devaluations – is booming.

Why? Traders realize that the Fed’s magic elixir for fighting the scourge of deflation is more money printing – otherwise known as the nuclear QE-scheme. US bond dealers, who trade directly with the Fed, aren’t questioning whether QEII is on the table, but are rather taking bets on the size of the next tranche, with estimates ranging between $300 billion and $1 trillion.

Speculation that the Fed would unleash QEII soon has already spearheaded a new round of currency wars across the globe. Central bankers in Brazil, China, Chile, Japan, Russia, South Korea and Thailand have all stepped up their interventions, by injecting large sums of paper into the currency markets, while trying to prevent a precipitous decline in the value of the US Dollar versus their own currencies.

The amount of foreign currency reserves stashed away in the coffers of the Bank of Korea have climbed by $76 billion since April 2009, to a record high of $286 billion – and becoming the world’s sixth-largest after China, Japan, Russia, Taiwan and India. The BoK’s currency reserves are an indicator of the approximate size of its interventions in the foreign-exchange market, utilized to artificially hold down the value of the Korean Won vs. the US Dollar.

The value of the US Dollar is critical to Seoul, since Beijing pegs the Chinese Yuan to the US Dollar, and China is the biggest customer for Korean exporters. Thus, the BoK aims to protect its exporters in both the Chinese and US markets. However, the BoK hasn’t been able to turn the bearish tide against the US Dollar. It’s been overwhelmed by the ideas that the Fed would unleash nuclear QEII. Now the BoK can only try to stem the bleeding – engineering an orderly retreat for the greenback.

The Bank of Korea would of course be much wealthier if it had judged the Gold Price more correctly. The BoK holds only 14 tonnes of Gold Bullion, equivalent to just 0.03% of its total reserves. On Dec 9th, 2009, the BoK’s FX-chief, Lee Eung Baek argued:

"There’s an illusion in gold. Out of more than 200 nations, how many have bought Gold Bullion? Like other central banks, we have been increasing the types of currency reserves outside the Dollar. Gold offers little value, with no cash returns. Since India and Russia with large reserves bought gold, there’s speculation that Korea might buy it too. But we are not classified in the same category. There’s a slim chance that we will Buy Gold from the IMF…"

This was when the yellow metal was changing hands at $1226 an ounce, almost $100 below today’s price.

On Sept 16th, Tokyo’s financial warlords also intervened in world currency markets to drive down the exchange rate of the Yen.

The Bank of Japan sold an estimated ¥2 trillion ($23 billion) to buy up US Dollars. The first such intervention by Japan in more than six years, this was also the biggest ever one-day currency action, and breached a tacit agreement among the Group-of-Seven industrial powers (G7) to avoid unilateral currency interventions.

But Japan had threatened such action for more than six weeks, after the value of the US Dollar declined by 10% from May to a 15-year low of ¥83. The Japanese Yen also climbed sharply in relation to the Euro and the Chinese Yuan…meaning that Japan’s multinationals, listed on the Nikkei 225 index – and heavily dependent on exports – were suffering. The Dollar’s value had declined far below their average break-even point of ¥93, and threatens their ability to compete in selling goods abroad.

Japan’s foray into the currency markets triggered a short squeeze on over-zealous US Dollar bears, and lifted the Dollar as high as ¥86 in short order. However, the Dollar’s one-day rally quickly stalled, as speculators began to bet that the size of the Fed’s QEII would exceed the size of the Bank of Japan’s devaluation schemes. Earlier, the Bank of Japan boosted the size of excess Yen sitting in deposits held by Japanese banks to ¥30 trillion ($350 billion), in an effort to put a floor under the Dollar at ¥84.

Despite the massive size of the Bank of Japan’s injections of Yen into the local banking system, it hasn’t been able to turn the US Dollar’s bearish tide.

That’s because currency traders expect the Fed’s next round of QEII to trump the size of the Bank of Japan’s interventions. Also, US Treasury yields could resume falling further than comparable Japanese bond yields, thus narrowing the US Dollar’s interest-rate advantage over the Yen. In the current round of competitive currency devaluations, the Fed holds the trump card over the Bank of Japan.

Most interesting, Japanese 10-year bond yields are flirting with the psychological 1% level, despite the ballooning of the size of Japan’s public debt, now at ¥909 trillion ($10.5 trillion). Japan’s bond yields are falling, even though its debt-to-GDP ratio is about 180%, which on the surface is worse than 115% for Greece. Yet although public attention tends to focus on Japan’s gross debt, which has soared to ¥909 trillion, the government also owns about ¥700 trillion in assets.

That ¥700 trillion in assets includes roughly ¥180 trillion in real assets, such as public office buildings, and ¥520 trillion in financial assets, including stakes in special corporations. The government can sell these assets and use the proceeds to pay down debt. Thus, Japan’s net debt is about ¥200 trillion, or about 40% of its nominal GDP, which is over ¥500 trillion per year. Perhaps, this is why Beijing hasn’t been afraid to buy ¥1.7 trillion of Japanese government bonds in the first seven months of 2010.

Still, at yields of 1% or less for 10-year Japanese bonds, the only buyers would be short-term gamblers, or those who are convinced that Japan’s economy would be snared in the deflation trap for year’s to come.

Buying JGB’s at yields of 1% or less could lead to large losses over the longer-term. Thus, the more sensible investment for Japanese investors is to Buy Gold against the Japanese Yen. Priced in Tokyo’s money, gold has more than doubled over the past five years, and served as a good hedge against the Bank of Japan’s printing schemes.

Already, the Bank of Japan is monetizing half of Tokyo’s annual budget deficit of ¥44 trillion this fiscal year, and there’s pressure on the central bank to buy more government bonds to weaken the Yen. Although some traders might view the Bank of Japan’s bond-buying operations as a buy signal for JGBs, investors in Tokyo gold have profited more handsomely. Tokyo gold has been tracking the size of Japan’s outstanding debt, since Tokyo’s ruling elite prefer to pressure the central bank to monetize its debts, rather than sell-off state owned assets to finance budget shortfalls.

Gold’s not just tracking Tokyo’s monetary problems, either…

Bank Rossii, Russia’s central bank, manages the Ruble against a basket of Dollars and Euros to limit currency swings that may hurt it exporters. In August, Bank Rossii bought $1.1 billion and €136 million, trying to keep the Ruble within a floating range against the Euro-Dollar’s basket.

This summer’s agricultural drought, the worst in decades, has already shrunk Russia’s trade surplus to $8.3 billion in August, or 29% less than a year ago, and has slowed its economy’s growth rate to 2.4%, with 60% of the fall attributed to the agricultural sector. Thus, Bank Rossi is liable to start increasing the supply of Rubles in the money markets to limit further damage from adverse exchange rates moves to its economy.

The Kremlin earns most of its foreign currency from the sale of Urals blend crude oil, natural gas, and other natural resources, such as timber, platinum, and nickel. Along with rebounding energy and metals markets, Russia’s FX reserves have been replenished to around $478 billion today, from as low as $380 billion in March 2009. Moscow is keen to diversify some of its FX stash into gold, and last May, added 1.1 million ounces equaling 16% of monthly global mining output.

Overall, the Russian central bank bought gold at an average rate of 250,000 ounces per month for the past three years, and now holds an estimated 23.6 million ounces. As of the first quarter of 2010, Saudi Arabia said it had more than doubled its gold holdings from 143 tonnes in Q1 2008 to 323 tonnes this spring, for an average increase of 241,000 ounces a month, or about the same as Russia’s purchases.

Thus, gold traders will keep a close eye on the FX reserves of these two key oil producers.

Brazil has also ramped-up its intervention efforts in the foreign currency markets, buying US Dollars twice each day in order to prevent the greenback from falling below its latest defense line at 1.70 Reals.

Largely due to its super strong currency, Brazil’s trade surplus fell 44% to $7.9 billion in the first half of 2010, down from $13.9 billion a year ago, as imports grew nearly twice as fast as its exports. Four years ago, the Bank of Brazil (BoB) tried to prevent the US Dollar from falling below 2.10 Reals, but failed in its $100 billion intervention effort.

Currently, the BoB is trying to draw a red-line in the sand for the US Dollar at 1.70 Reals, but Brazil’s high short term interest rates, offered at 10.75%, are simply too irresistible to yield hungry investors from around the globe. Foreign inflows of cash into Brazil in the first ten-days of September alone was $2.14 billion. As a result of its relentless intervention efforts, trade surpluses, and foreign direct investment, Brazil’s FX stash has grown to $250 billion, and it’s the fifth largest lender to the US Treasury.

On Sept 15th, Brazil’s Finance chief Guido Mantega vowed to defend the country’s exporters, joining other governments worldwide that seek to weaken their currencies as a way of speeding up an economic recovery.

"We will not sit on the sidelines watching the game, while other countries weaken their currencies at the expense of Brazil. We’re going to take appropriate measures to stop the real from appreciating," he declared in Rio de Janeiro.


Under conditions of slowing growth in the US economy, there’s been an eruption of currency wars worldwide, with an increasing number of governments seeking to secure their share of export markets through outright intervention in the currency markets.

At the heart of the problem, US Senate Banking Committee chairman Christopher Dodd declared China a currency manipulator last week, and said its "economic and trade policies present roadblocks to our recovery." He accused Beijing of stealing intellectual property, violating international trade agreements and dumping goods. Since then, the US Dollar tumbled 1.2% to 6.7035 Yuan.

US Treasury chief Tim Geithner suggested that China should raise the Yuan’s exchange rate by at least 20% and issued a thinly veiled threat, noting that "China has a very substantial economic stake in access to the US market." Meaning, the biggest beneficiary of the growing currency trade wars is the precious metals – silver and Gold Investment – now basking in the growing supply of freshly printed paper currency worldwide.

The prospect of QEII by the Fed is prompting other central bankers to counter with currency devaluations of their own. Yes, some central banks such as Banco de Chile, the Bank of Australia, and the Bank of India are going the opposite way – lifting their interest rates, and their currencies have become magnets for foreign capital. But the Fed has concluded that the only expedient weapon in its arsenal to speed-up the US economy is to inject another tidal wave of US Dollars into the banking system, while aiming to artificially inflate the US stock market higher, and thus, create the illusion of greater wealth and better times ahead.

However, when seen through the lens of gold, or in "hard money" terms, the Dow-to-Gold ratio is still trapped near its lows of Q2 2009, highlighting the notion that the US-economic recovery has been mostly limited to Wall Street and US multinationals. Meanwhile, the divide between rich and poor in the US is getting wider. The Dow Industrials’ 3,800-point rally from the low of March 2009 was a monetary illusion, and Gold Bullion is still best way to preserve wealth.

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Aug 22

Any Growth in Gold?

Gold Price No Comments »

Physical gold looks like the best option according to this:

Gold Mining stocks face a slow, long-term decline in output…

PORTFOLIO Joe Foster calls himself a “stock picker”, says the Gold Report – and he’s pretty good at it.

Class A shareholders in Van Eck Global‘s International Investors Gold Fund have seen an average return of almost 25% for 10 straight years under his care. “I’m looking for the gold companies that are going to outperform the indexes, my peers and gold,” Joe says in this exclusive interview with The Gold Report…

The Gold Report: Joe, in your view, what are the catalysts that will push gold to the next level?

Joe Foster: Well, there could be a range of catalysts, any one of which could rear its ugly head.

TGR: Which ones are most likely?

Joe Foster: The financial system has not yet recovered from the shock of the credit crisis. We’re in the midst of a historic credit contraction that could turn into a deflationary credit contraction. As the Fed and the economy deal with this, there is a range of possibilities that could create a catalyst.

One would be further implementation of quantitative easing, where the Fed steps in and buys securities in order to prop up the financial system. A second is the housing market, which looks like it’s weakening again. If we see a double dip in the housing market, it could create the financial stress that provides a catalyst.

The sovereign debt issues are something that, to me, will be on the table for quite some time. They could flare up again in Europe and elsewhere. State and municipalities’ finances are in very difficult shape right now. We could see some form of stress in the municipal bond market that could cause some sort of a catalyst for gold, as well.

So there’s a range of catalysts that could come into the market over the next year or two that drive it higher.

TGR: The Fed may look at more quantitative easing, but it doesn’t really have a lot of room to operate as far as interest rates go. What sort of economic policy does America need at this point?

Joe Foster: I think our monetary system needs an overhaul. I guess some sort of stimulus, whether it be quantitative easing or some more fiscal stimulus, might be necessary to keep the economy from going into a deeper recession. But I think plans to create a more sound monetary system would go a long way toward boosting confidence in the government’s ability to handle these crises in the future or to prevent them from happening.

TGR: Do you think what is happening now will ultimately result in a new currency down the road? Perhaps even a global currency?

Joe Foster: A global currency would be very difficult. Just to have a sound Dollar again would create a lot of stability around the world. Many other countries still peg their currencies to the Dollar, so proper management of the Dollar would, in effect, create a sound global currency. The Dollar is still the world’s reserve currency. I’m calling for some sound money policies that we haven’t seen since the Dollar was floated back in the 1970s.

TGR: In a June commentary on gold you said, “states across the country are undertaking austerity measures to counter gapping budget deficits.” Could a state, or states, defaulting on loans or even declaring bankruptcy be the next leg down that turns the recession into something worse?

Joe Foster: Well, I doubt it would go as far as a state actually declaring bankruptcy. Congress looks like it’s going to approve another round of state aid to keep the states afloat. I think you would see the federal government step in before we saw a bankruptcy. But states like New York and California and others around the country are in serious financial trouble. We’ll have to see if the austerity measures that they’re implementing will keep them out of bankruptcy. I think this is more of a slow burn. I don’t see it as being the catalyst for the next leg in the gold market. I think we’ll reach the next leg in the gold market before any state reaches such a desperate situation.

TGR: How high do you see gold getting by the end of this year and through the end of 2011?

Joe Foster: I’m looking for it to make new highs as we trend into 2011, moving through the fall of 2010. The high was around $1,265 in June. We’ve been on a steady trend higher. There’s a lot of volatility in the gold market, but I would expect that trend to continue. It wouldn’t surprise me if it moved through the $1,400 level sometime during 2011.

TGR: You said that you believe that the government would step in and prevent a state from declaring bankruptcy or becoming insolvent. Do you believe the government is, to some extent, manipulating the gold market?

Joe Foster: I think that’s speculation. I haven’t seen solid evidence that the government is manipulating the gold market one way or the other. Even if they are, I think the market will determine where the Gold Price goes in the longer term.

TGR: You have managed assets for investors since 1998. In the post-2008 era, are you managing your gold fund the same way you did in the pre-2008 era?

Joe Foster: Well, we’re using the same strategies or similar strategies now that we have since this bull market began in 2001. Relative to our peers, we’re probably overweight in juniors and mid-cap companies and underweight in the large-cap companies. Some of the fundamental strategies that we use remain in place.

I would say that the big difference is that, prior to the credit crisis, we spent a lot of time explaining to investors why they should invest in gold as a hedge against financial stress. Since the credit crisis we don’t spend much time explaining why you should invest in gold because investors get it. Everybody gets it now that gold functions as a sound currency and as a financial hedge in times of turmoil.

I spend more time describing how we construct our portfolio and manage the fund because investors are now asking: “How do I invest in gold? Do I want Gold Bullion? Do I want a Gold ETF? Do I want a managed fund? Do I want an equity ETF?” Those are the questions that investors are asking now that we weren’t hearing prior to the crisis.

TGR: That’s noteworthy. But your asset allocation must’ve changed some since the crisis. You said it’s heavier than your competitors on juniors and mid caps.

Joe Foster: I’ve got an entire range. I’ve got companies from juniors all the way up to the largest producers in the fund. We play the whole spectrum of gold companies. It’s just that I’ve got a higher weighting in juniors and midtiers than I do in the large-cap companies. We’re stock pickers, we’re bottom-up, fundamentals-driven stock pickers. I’m looking for the gold companies that are going to outperform the indexes, my peers and gold.

TGR: You’ve certainly done a good job. Over the last 10 years, Class A shares in your International Investors Gold Fund are up almost 25%. Does gold’s steady climb upward provide a greater margin for error in gold fund management?

Joe Foster: Not really. When you look at Gold Mining, gold production peaked in 2001 and it’s been on a slow decline ever since. In an industry that’s in decline, you know you’re going to have winners and losers. The market likes companies that can provide growth. But in a declining industry those types of companies become fewer and farther between. And there are lots of gold companies that have underperformed gold in this cycle. So stock picking becomes very important. It’s not always easy to outperform gold in this type of an industry environment.

TGR: How do you go about picking stocks? What are you looking for?

Joe Foster: We look for growth. Companies that can develop properties at reasonable cost and that can increase their margins. The best kind of growth is organic growth, where companies discover deposits and develop them. That’s the first thing we look for, organic growth. The second thing would be growth through acquisitions. We look for management that can identify creative acquisitions and grow that way.

TGR: Is it still cheaper for companies to go out and raise money and drill for organic growth versus acquiring assets through M&A?

Joe Foster: It’s very difficult to do. For most of the industry, it’s almost impossible. The reason gold production isn’t increasing globally is that all the easy stuff has already been found. The prolific gold fields of South Africa, Nevada and Western Australia are all mature areas that are in decline. The industry hasn’t found another prolific gold area like Nevada. Instead, they have to look all over the world and into remote areas. There are new discoveries being made; it’s just not at the pace that we saw 20 years ago when Nevada and Western Australia were emerging.

TGR: You mentioned Nevada. When I was looking at your fact sheet on the International Investors Gold Fund, only about 10% of your holdings are based in the US Does America need more gold mines?

Joe Foster: The US is still one among the top-five gold producers in the world. It’s still a substantial gold producer. I don’t know if we need more gold mines. It’s a function of geology. Probably 90% of the gold production in the US comes out of Nevada. As I said earlier, Nevada is past its prime; it’s a region wherein production is in decline.

TGR: But California has banned new Gold Mining projects, and Montana has banned heap leaching as a form of gold extraction. We’re seeing some exploration success in places like Wyoming and Idaho. The US is still the fourth-largest country in the world by area, so you would think there are lots of areas that remain unexplored.

Joe Foster: Well, if the United States was more mining friendly, there’s no doubt it could be a much larger gold producer than it is; but, in all practicality, that’s not going to happen. Mining is such a miniscule part of the US economy that it’s not politically feasible to revise the mining laws in states like California and Oregon. It’s a bit much to ask in places like that.

TGR: Do you have some parting thoughts for us?

Joe Foster: Well, we talked about the gold market more in the near term, but this gold market’s been in bull mode for almost 10 years now. As far as we can tell, it could go on for another 10 years. Who knows? I think the actions we’re seeing among the monetary and fiscal authorities around the world are setting up a situation wherein we could see another inflationary cycle once we get through this credit contraction. I think in the longer term, the risk of an inflationary cycle is going to be with us for quite some time. That’s going to be the ultimate driver of this gold bull market.

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Aug 19

Goldman’s Gold

Gold Price 1 Comment »

Interesting article on Goldman and Gold.

Goldman Sachs is bullish on Gold Prices. Reason to worry…?

If GOLDMAN SACHS is publicly bullish on gold, is that a good thing or bad thing for gold bulls? asks Dan Denning in his Daily Reckoning Australia.

Wall Street’s notorious trading house published a report on gold last week setting a price target of US$1300 in the next six months. The report cited several factors. But before we get into them, we’ll confess it made us a bit nervous. Whenever a broker is saying one thing, you have to wonder if they’re actually doing the opposite.

That said, Goldman did make a point that is true of an asset in a bull market: it requires corrections to shake out the speculators and weak hands from time to time. Following the June high north of $1250 the net speculative long positions declined. Traders took profits. And so did momentum players in the exchange traded funds market.

But then something happened that naysayers such as Michael Pascoe and Rory Robertson did not expect. The gold bubble did not pop. Because it’s not a bubble. The momentum players departed and the price found plenty of support. It’s now around US$1220.

Goldman says the big catalyst for a further move higher (other than its announcement leading to a stampede of money into gold short-term) is a repricing of US growth expectations for the rest of this year and all of next. Maybe it’s a fear trade, or just bearishness on US corporate profits when unemployment keeps rising.

Either way, about the only dubious chart we saw in the whole report is the one showing lower US real interest rates and the Gold Price (exhibit five). As those cool cats in statistics say, correlation is not causation. Its possible low rates give speculators fuel to play in the gold market. But it’s more likely, we reckon, that US rates are low because the bond market is pricing in a deflationary scenario.

So why would gold rise in a deflationary scenario? Good question! It brings us full circle to the argument fund-manager David Einhorn made when we announced his gold position: you Buy Gold when you think monetary and fiscal policy are bad (we’re paraphrasing). Whether it’s inflation or deflation matters less than the fact that something unconventional and bad is going down. Gold does well in that environment, what with it being real money and all.

Take a look at the Aussie Gold Price chart below. It shows you that gold is much closer to making a new high in US Dollar terms than it is in Aussie Dollar terms. For Aussie gold to match the greenback gain, you’d need a much stronger greenback or a much weaker Aussie. It’s worth noting that following the Fed’s announcement that it would sort of begin quantitative easing part two, the Aussie made the second-largest declines against the greenback, trailing only the dreaded Esperanto currency, the Euro…

As we have banged on about gold for years now, we won’t test your patience much longer. But last week’s news that the Aussie unemployment went rate up in July wouldn’t be Aussie Dollar bullish, would it?

Maybe the Aussie will get a boost when this miserable Federal election nonsense is over. When thinking about the election we recall the phrase, “Don’t vote! It only encourages them.” Of course voting in Australia is compulsory. But it might be a fine worth copping if you can say you weren’t an accessory to “the advanced auction of stolen goods,” as Mark Twain once put it.

Seriously. If anything is clear so far about the difference between the two major parties, it’s that both treat Australians as chattel. We are but tax slaves who exist to fund the government’s spending pleasures. And the Greens? More like the Reds!

But that’s all politics. Financial independence is the only real defense against this kind of relentless State encroachment from all sides. Get it. Keep it. Defend it. And whether you like it or not, more and more governments across the world are spending out of an empty pocket. They’re spending to give people money that’ve lost jobs as a result of the structural shift in the labor markets. That shift came from globalization. The money might keep people above water for awhile, but it’s no replacement for a real job making real things.

More and more spending is going to simply pay the interest on previously borrowed money. This is probably the most dangerous aspect of a credit bubble. You borrow and spend all that money and, and the end of the day, you have nothing to show for it…no bridges…no roads…no factories…no real increase in the capital stock. Just a lot of over-priced residential housing that suddenly isn’t in such short supply as you thought. And now Australia finds itself at an interesting crossroads.

Just a little debt didn’t seem like such a bad idea at the height of the global financial crisis. Both Australia’s major political parties now promise to pay it off quickly, with all the bounty from mineral and energy royalties. Both will increase spending too, but in different places, cutting other spending priorities.

But should the housing bubble pop sooner rather than later, and should Aussie banks find themselves last in the queue for global capital in another phase of the Great Correction, the temptation for more government borrowing will be nigh irresistible.

Why? Well, our stance against government debt may seem dogmatic. But if it is, it’s because the modern State always abuses the power to borrow. Always. Whether it’s to fund politically popular but economically unproductive projects, or whether it’ just a way of putting off tough choices about actually reducing government spending and, thus, the reach of the State into private life, it’s always easier to borrow and kick the can down the road.

Debt is the health of the State in the same way that liquor is the health of the alcoholic. The relationship is inherently destructive. But we reckon that in the face of so much unproductive debt (household and sovereign) the only politically palatable policy response will be to monetise that debt: pay it off or buy it from bank with new money. The deflationists can enjoy their moment in the sun while it lasts. But it won’t last for long at this rate.

Buying Gold today? “If there’s an easier way, I’ve yet to find it,” says one BullionVault user…

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