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 21

Swiss Gold Vote: Should You Be Worried?

Gold Price Comments Off on Swiss Gold Vote: Should You Be Worried?
Switzerland’s gold referendum will force the SNB central bank to buy more than it sold in 2000-2008…
 

The SWISS GOLD VOTE in November – “Should I be worried?” asks a BullionVault user owning metal in Zurich, writes Adrian Ash at the world-leading physical gold and silver exchange online.
 
It’s no idle question. Governments do nasty things when they need to buy or keep hold of an asset.
 
Witness the United States’ compulsory gold purchase of April 1933 for instance…and its ban on hoarding, exporting or trading gold. 
 
Big difference here is that the Swiss public gets to vote on what drives such measures. Thanks to their petition system, the country’s junkies get junk on prescription…while minarets are banned. The changes proposed for 30 November would compel the Swiss National Bank to:
  • hold all its gold reserves in Switzerland; 
  • raise gold holdings to 20% of the SNB’s total assets; 
  • never sell gold ever again. 
This is a Swiss decision, and with the Franc effectively “backed” by gold again if this passes, it’s really not for us British turkeys…earning and holding British Pounds Sterling…to say whether or not a foreign nation should vote for Christmas.
 
But personally speaking, I’m no fan of central-bank gold hoarding. It tends to mark dark times, and still darker plans on the part of government.
 
The Swiss government is in fact pitted against this new gold plan. But still, it’s better by far to let gold circulate freely, I believe…outside state vaults and in private hands…just like the truly classical Gold Standard worked.
 
But let’s put my hopeless idealism, and the economic wisdom (or otherwise) of this 1930s-style Gold Standard proposal aside (for that is what it is). Just how desperate might the Swiss authorities become if the vote passes? Put another way, what impact might it have on the supply/demand balance worldwide, and hence prices?
 
First, the security of gold property held in Zurich or Bern, under the tarmac at Kloten or beneath the Gotthard mountains. Switzerland is a highly open economy, with financial services earning a huge portion of its tax revenues and employing nearly 6% of the working age population. Its banking reputation may have been dented in recent years (and its hard-won bank secrecy laws look set to be crushed by the European Union kowtowing to the US juggernaut). But physical gold storage, alongside refining imported gold bullion for export, continues to be a crucial industry.
 
By our reckoning, the world’s investors added 1,400 tonnes of gold to private and bank vaults in Switzerland between 2009 and 2013. For non-bank storage of physical property, it remains by far the most popular choice amongst BullionVault users, holding nearly 75% of the current record-high levels of client gold. To the best of our knowledge, no country enjoying such revenue – nor any state enjoying such confidence from foreign wealth – has ever turned it away. 
 
Even during the UK’s balance of payments’ crisis of the 1970s, foreign-owned bullion was allowed to enter and leave freely, sidestepping both VAT sales tax and the exchange controls blocking private British ownership of gold. London of course remains the centre of bullion dealing worldwide, just as Switzerland remains the No.1 choice for investment storage. It’s very hard indeed to see Switzerland attempting any kind of expropriation, compulsory purchase, exchange controls or punitive taxation – most especially of foreign-owned gold. 
 
So, with theft highly unlikely (especially against the popular pro-gold backdrop of a successful referendum), might the SNB rush to buy gold in December after the 30th November vote? Complicating factors start with the referendum process itself. Next month’s question gives no time limit for completing the extra gold buying, nor for repatriation of existing stock from foreign central-bank care. But if voters look harder (and they’ll be urged to think hard by the pro-gold billboard campaign set to start mid-November), then supporting documents set a deadline of 2 years for bringing the current gold home, and 5 years for reaching that 20% target. However, the clock will start running from the date of “acceptance”. But is that acceptance by voters (ie, November 30th) or by parliament and thus the regional cantons (ie, into Swiss law)?
 
This matters, because Swiss referenda, when approved by the public, can take up to 3 years to become law. So the whole process…if the SNB accepts its fate and doesn’t work with the government to refuse, reject or somehow revoke the Swiss public’s decision…could last up to 8 years.
 
Expect delays. SNB president Jordan has long spoken against the vote, and vice-chair Danthine did so this month (invoking the threat of deflation and Euro-led recession). Those policymakers are unelected, so Switzerland’s referendum pits popular, if not populist will against the technocrats. But elected politicians also oppose the move (and by a wide margin). Even if passed, in short, the spirit of the new rules will likely be hampered by those people charged with enshrining and then enacting them. 
 
The SNB is also a signatory to the fourth Central Bank Gold Agreement. Running for 5 years from 27 Sept. this year, it obliges the 22 central banks involved to “continue to coordinate their gold transactions so as to avoid market disturbances.” The expected transactions were of course sales (the first CBGA was signed after the UK’s sudden and clumsy gold sales announcement of mid-1999), but this treaty only offers further cover for delaying, going slow, or otherwise tempering the impact of buying.
 
An object lesson in central-bank recaltricance is the repatriation of Germany’s gold. Wanting some 300 tonnes from New York and 374 from Paris, the Bundesbank’s plan announced in January 2013 is scheduled for completion in 2020. Yet last year, only 5% of that total was shipped, barely one-third the average run rate required. Whatever the reasons, there really isn’t any hurry, not for the central bankers involved at either end of the transfer.
 
As for retrieving Switzerland’s current overseas gold holdings, we’re given to believe the Bank of England can “dig out” a 20-tonne shipment every two days. So if 20% of the SNB’s metal is still there in London, it could expect to get back the UK holdings inside 1 month. But only if the Bank of England devotes its entire vault staff to that task alone (it holds another 5,000 or so tonnes belonging to other customers besides the UK Treasury), and only if central-banking’s “old world” handshakes and winks are thrown over to appease public opinion.
 
Again, don’t bet on it. Central bankers have fat brass necks when it comes to defending themselves under cover of mutual independence from national governments and their voting publics. So might history offer some clues to the timing of Swiss buying?
 
Sucking in foreign money around WWII, and with exchange controls blocking many citizens abroad from buying investment bullion, Switzerland’s own gold reserves grew from 450 tonnes to 1,940 between 1940 and 1960. The sales starting 2000 took eight years to dispose of that much again, this time into a bullish free market (and again, after a public vote). Now something around 220 tonnes per year might be wanted – sizeable quantities to be sure, but in line with recent sources of demand like gold miners buying back the huge forward sales they’d made to insure against lower prices at the turn of the century (dehedging averaged 260 tonnes per year between 2000 and 2012) or the growth rate of new Chinese consumer demand (100 tonnes per year 2004 to 2013).
 
That extra demand, however, came during a strong bull market in prices. Miner dehedging in particular put a strong bid in the market, helping drive prices higher both mechanically (see the spike of early 2006 for instance) and psychologically (if gold-miner hedging had been bad for investor sentiment, then de-hedging could only be good). Many people now believe that forcing the SNB to hold 20% of its assets as gold will clearly drive market prices higher. Added to the repatriation of all Switzerland’s existing gold reserves…which could catch the cosy world of central banking asleep as Swiss law demands the gold is returned…it is expected to spark a huge squeeze on physical supplies worldwide.
 
We’re not so sure. Heavy central-bank gold sales during the 1990s are widely held to have pushed gold prices down. But those sales continued until the financial crisis began. By then, gold prices were 3 times higher from their lows of 2001, replaying what happened in the late 1970s, when the US Treasury was a big seller. Relatively heavy purchases – this time by emerging-market states – then coincided with the 2011 peak. But again, those purchases have continued as prices fell steeply.
 
Yes, back in 1998-2000, the Swiss gold sales discussed and then begun at the turn of this century helped drive the final nails into gold’s coffin-lid. But sandbagging the price, and dismaying dealers (as well as “bitter end” investors enduring the two-decade bear market starting with 1980’s peak at $850 per ounce), those huge sales in fact laid the floor for the 12-year bull market which followed.
 
Free from central-bank vaults like no time since before the First World War, gold rose and kept rising as private Western households, then Asian consumers, money managers and emerging-market central banks joined the gold miners themselves in buying bullion.
 
Gold is nearly as rich in irony as it is in politics. If the Swiss pro-gold campaign is trying to gerrymander a price-rise by forcing the SNB to turn buyer, history may yet – we fear – have the last laugh.
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Oct 20

The Fed Spots Inequality, Misses the Point

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Janet Yellen says US inequality is worse than any time since, umm, the Fed was created…
 

IT DIDN’T take long did it? asks Greg Canavan in The Daily Reckoning Australia.
 
Now the Bank of England, the Federal Reserve’s old partner in crime, is at it too. On Friday, the BoE’s chief economist, Andy Haldane, said he favoured delaying interest rate rises in the United Kingdom.
 
That, along with comments from the Fed’s James Bullard on Thursday, helped global markets to rally late last week. It’s having a nice effect on our market so far today too. It was just as well. The situation looked extremely dicey on Wednesday.
 
Given US markets haven’t even had a 10% correction, the coordinated comments have a whiff of panic about them. What…can’t markets even have a half-decent correction these days without central bankers wetting themselves in panic?
 
While the minions were trying to hold things together late last week, boss Janet Yellen was inadvertently making a pretty decent argument to end the Federal Reserve altogether. She just didn’t know it.
 
In a speech on ‘economic opportunity and inequality’ in Boston on Friday, Yellen came out with some clangers. Unfortunately, most observers missed the irony of some of her comments.
 
Yellen drew heavily on data collated from the Fed’s Survey of Consumer Finances, which began back in 1989. Take it away, Janet…
“By some estimates, income and wealth inequality are near their highest levels in the past hundred years, much higher than the average during that time span and probably higher than for much of American history before then.”
Hmmm…the past 100 years you say? The Federal Reserve came into being in 1913. A coincidence, do you think?
 
Not convinced? Give us some more stats then, Janet…
“After adjusting for inflation, the average income of the top 5% of households grew by 38% from 1989 to 2013. By comparison, the average real income of the other 95% of households grew less than 10%.
 
“The lower half of households by wealth held just 3% of wealth in 1989 and only 1% in 2013.”
That’s interesting. Go on…
“The average net worth of the lower half of the distribution, representing 62 million households, was $11,000 in 2013. About one-fourth of these families reported zero wealth or negative net worth, and a significant fraction of those said they were ‘underwater’ on their home mortgages, owing more than the value of the home. This $11,000 average is 50% lower than the average wealth of the lower half of families in 1989, adjusted for inflation.”
Wow! The average net worth of 62 million US households is just $11,000…half of what it was back in 1989, despite 25 years of (mostly) economic growth?
 
Is it another coincidence that just two years before 1989 the Federal Reserve embarked on a policy of full-blown central banking activism? In 1987, Alan Greenspan had just taken the helm from the last great central banker, Paul Volcker, when ‘Black Monday’ hit, on the 19th of October (nearly 27 years ago to the day).
 
Greenspan panicked. He promised the market liquidity and support and whatever else he could. The Fed hasn’t looked back since. From that day on, it’s been the market’s socialist tormentor and benefactor…creating crises and then trying to solve them by throwing money at the problem.
 
And where does the money end up? In the hands of the already relatively well-off, which is why Janet Yellen’s statistics look so horrible.
 
The irony of a new Fed Chief pointing all this out is particularly…rich. Actually, it’s nauseating. If you didn’t know any better you’d think she was actually having a laugh. It’s either ingenuous or the work of the devil.
 
In truth, I think it’s genuinely ingenuous on Yellen’s behalf. You don’t set out to become the world’s biggest do-gooder by being a hard-nosed realist.
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Oct 16

What the Panic’s All About

Gold Price Comments Off on What the Panic’s All About
Stock markets are sinking for nothing. And everything…
 

As RON BURGUNDY said in Anchorman, writes Greg Canavan in The Daily Reckoning Australia, “Boy…that escalated quickly. I mean that really got out of hand fast.”
 
Indeed it did. It was a wild night of trading on US markets Wednesday. The S&P500 was down 3% at one point, before finishing just 0.8% lower. US Treasury yields plunged on fears of lower economic growth while gold momentarily surged $25 an ounce and closed out the session up nearly $20 an ounce.
 
An afternoon rally saved Wall Street. Apparently – and this is really pathetic if there’s any truth to it – rumours surfaced that Janet Yellen thought the US recovery was on track, despite worries coming from Europe.
 
There were no such comments from Mario Draghi in Europe. As a result, European stocks took a beating. French and Spanish stocks fell more than 3.5%, while German and British bourses fell nearly 3%. But the rally in the US came after Europe closed for the day.
 
So what’s all the panic about? Nothing in particular, it seems. Or nothing and everything, all at once.
 
These panic liquidations represent a psychological shift in trader positioning. It’s representative of complacency giving way to risk aversion. And it has given way big time in the past few weeks.
 
You can see this change in the volatility index, the ‘VIX’, in the chart below. Also known as the fear index, you can clearly see the ‘fear spike’ since the start of October. This comes just a few months after volatility levels were the lowest since early 2007.
 
 
In other words, something has clearly changed in the mindset of the market. In the short term, it’s probably gone too far…and you can expect to see a rally soon and a diminishment of the current high levels of fear.
 
But you should take the surge seriously. This is the highest level of fear since the Euro crisis of 2011. Except now there’s no discernible crisis. That’s the worrying bit. The market is saying that something is wrong. It’s not immediately apparent, but something isn’t quite right.
 
Maybe it’s fear of the effects of a slowing global economy…an economy that has a truckload more debt weighing on it than it did before the last downturn. The Telegraph in the UK reports:
“Morgan Stanley calculates that gross global leverage has risen from $105 trillion to $150 trillion since 2007. Debt has risen to 275pc of GDP in the rich world, and to 175pc in emerging markets. Both are up 20 percentage points since 2007, and both are historic records.”
Yep, debt levels are a major problem. And they become a very big problem when economic growth slows. That’s because to service debt, you need to generate growth.
 
When growth stagnates or falls, the debt servicing burden becomes a problem. Debt-to-GDP ratios rise and there is less money left over in the economy for investment, wages and consumption.
 
Debt, especially unproductive government debt, has detrimental long term effects on an economy. Let it grow large enough and it will eventually choke an economy into recession/depression.
 
That the only apparent response to a slowdown in a debt-based monetary system is to increase debt levels tells you something is seriously wrong with the world’s system of ‘wealth creation’.
 
The only question now is how long it will take the Federal Reserve to start back-tracking on its ‘interest rate hike for 2015’ talk. After they do that, I wouldn’t be surprised to see them dip into the QE playbook…again. The big question though, it whether it will be too late to inject another round of confidence into the speculating community.
 
They’re wheeling Janet Yellen out to speak at the end of the week, so we may get an idea of just what the Fed is thinking. Yellen must be careful to retain the market’s confidence. That the US Federal Reserve has no idea what it’s doing is beside the point. What’s important is that the market thinks the Fed knows what it’s doing.
 
Yellen must keep this con game going at all costs. Good luck with that. When you’ve got a bunch of panicked, slobbering trader yahoos in your face desperate for some sign that you’ve got it all under control, any minor slip-up can be dangerous.
 
When traders panic, liquidity disappears in the blink of an eye. That’s because confidence creates liquidity, and fear destroys it. And right now it’s the fear of huge debt levels consuming economies that is weighing on traders’ minds.
 
Why it’s happening right now, when the issue has been around for a while, is irrelevant. The important point is that the punters are beginning to wake up to the risks. The only question is how much longer the Fed can continue to pull the wool over everyone’s eyes.
 
Can another bout of QE do the job for another six or 12 months?
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Oct 15

What the Bond Crash Will Look Like

Gold Price Comments Off on What the Bond Crash Will Look Like
A lot of very discontinuous action to the downside ahead…
 

“WHEN sorrows come,” wrote Shakespeare, “they come not single spies, but in battalions,” says Tim Price on his ThePriceOfEverything blog.
 
Jeremy Warner for The Daily Telegraph identifies ten of them. His “biggest threats to the global economy” comprise…
  1. Geopolitical risk;
  2. The threat of oil and gas price spikes;
  3. A hard landing in China;
  4. Normalisation of monetary policy in the Anglo-Saxon economies;
  5. Eurozone deflation;
  6. ‘Secular stagnation’;
  7. The size of the debt overhang;
  8. Complacent markets;
  9. House price bubbles;
  10. Ageing populations.
Other than making the fair observation that stock markets (for example) are not entirely correlated to economic performance – an observation for which Eurozone equity investors must surely be hugely grateful – we offer the following response.
 
Geopolitical risk, like the poor, will always be with us.
 
Yes, the prices for oil and natural gas could spike, but as things stand WTI crude futures have fallen by over 15% from their June highs, in spite of the clear geopolitical problems. And the US fracking revolution, in combination with fast-improving fundamentals for solar power, may turn out to be a secular (and disinflationary) game-changer for energy prices.
 
China, however, is tougher to dismiss. If we had any meaningful exposure to Chinese equity or debt we would be more concerned. But we don’t, so we aren’t.
 
Five of Jeremy Warner’s ‘threats’ are inextricably linked. The pending normalisation of monetary policy in the UK and US clearly threatens the integrity of the credit markets. It’s worth asking whether either central bank could possibly afford to let interest rates rise.
 
This begets a follow-on question: could the markets afford to let the central banks off the hook? Could we, in other words, finally see the return of the long absent and much desired bond market vigilantes?
 
That monetary policy rates are so low is a function of the growing prospect of Eurozone deflation (less of a threat to solvent consumers, but deadly for heavily indebted governments). Absent a capitulation by the Bundesbank to Draghi’s hopes or intentions for full-blown QE, it’s difficult to see how the policy log-jam gets resolved. But since all German government paper out to three years now offers a negative yield, it’s difficult to see why any Eurozone debt is worth buying today for risk-conscious investors. Cash is probably preferable and gives optionality into the bargain. ‘Secular stagnation’ is now a fair definition of the Eurozone’s economic prospects.
 
But all things lead back to Warner’s point 7: the size of the debt overhang. Since this was never addressed in the immediate aftermath of the Global Financial Crisis, it’s hardly a surprise to see its poison continue to drip onto all things financial. And since the policy response has been to slash rates and keep them at multi-century lows, it’s hardly a surprise to see property prices in the ascendant.
 
Complacent markets? Check. But stocks have lost a lot of their nerve over the last week. Not before time.
 
Ageing populations? Yes, but this problem has been widely discussed in the investment community over the past two decades – it simply isn’t new news.
 
We saw one particularly eye-catching chart last week, via Grant Williams, comparing the leverage ratios of major US financial institutions over recent years (shown below).
 
  
The Fed’s leverage ratio (total assets to capital) now stands at just under 80x. That compares with Lehman Brothers’ leverage ratio, just before it went bankrupt, of just under 30x. Sometimes a picture really does paint a thousand words. And this, again, brings us back to the defining problem of our time, as we see it: too much debt in the system, and simply not enough ideas about how to bring it down – other than through inflationism, and even that doesn’t seem to be working quite yet.
 
In a recent interview with Jim Grant of Grant’s Interest Rate Observer, Sprott Global questioned about the likely outlook for bonds:
“What would a bear market in bonds look like? Would it be accompanied by a bear market in the stocks?
 
“Well, we have a pretty good historical record of what a bear market in bonds would look like. We had one in modern history, from 1946 to 1981. We had 25 years’ worth of persistently – if not steadily – rising interest rates, and falling bond prices. It began with only around a quarter of a percent on long-dates US Treasuries, and ended with about 15% on long-dated US Treasuries.
 
“That’s one historical beacon. I think that the difference today might be that the movement up in yield, and down in price, might be more violent than it was during the first ten years of the bear market beginning in about 1946. Then, it took about ten years for yields to advance even 100 basis points, if I remember correctly.
 
“One difference today is the nature of the bond market. It is increasingly illiquid and it is a market in which investors – many investors – have the right to enter a sales ticket, and to expect their money within a day. So I’m not sure what a bear market would look like, but I think that it would be characterized at first by a lot of people rushing through a very narrow gate. I think problems with illiquidity would surface in the corporate debt markets.
 
“One of the unintended consequences of the financial reforms that followed the sorrows of 2007 to 2009 is that dealers who used to hold a lot of corporate debt in inventories no longer do so. If interest rates began to rise and people wanted out, I think that the corporate debt market would encounter a lot of ‘air pockets’ and a lot of very discontinuous action to the downside.”
We like that phrase “a lot of very discontinuous action to the downside”.
 
Grant was also asked if it was possible for the Fed to lose control of the bond market:
“Absolutely, it could. The Fed does not control events for the most part. Events certainly will end up controlling the Fed. To answer your question – yeah. I think the Fed can and will lose control of the bond market.”
As we have written on innumerable prior occasions, we wholeheartedly agree. Geopolitics, energy prices, demographics – all interesting ‘what if’ parlour games. But what will drive pretty much all asset markets over the near, medium and longer term is almost entirely down to how credit markets behave. The fundamentals, clearly, are utterly shocking. The implications for investors are, in our view, clear. And as a wise investor once observed, if you’re going to panic, panic early.
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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 26

End of the Central Bank Gold Agreement

Gold Price Comments Off on End of the Central Bank Gold Agreement
Well, end of one CBGA, start of another. Which says a lot about the Eurozone crisis…
 

THIS isn’t your father’s gold market, writes Adrian Ash at BullionVault. It isn’t even the same market as 10 years ago.
 
Because the buyers are different. So too are the sellers. 
 
During the 1970s, demand was led by investors…primarily in the rich West. Whereas today, the biggest buyers by far are Asian consumers, as the World Gold Council notes in its latest Gold Investor report.
 
Despite much lower incomes, India and China save a huge proportion of their earnings…and spend an ever greater share on gold the more income they earn. 
 
This makes it a “superior good” says Professor Avinash Persaud. Commissioned by the World Gold Council to study world gold buying demand, he says it increases faster than household income or GDP…something we’ve noted of Chinese gold demand before. 
 
On the supply side too, the gold world has changed. Besides a small rise to record mining output, the key source of the last 5 years was “scrap” sales from people needing to raise cash amid the financial crisis (a flow that’s now drying up. Fast). During the 1980s and 1990s, in contrast, central banks were the big source of existing above-ground metal, selling it down as prices fell…and worsening the drop by helping gold miners “hedge” their production by lending them metal to sell as well. 
 
Instead of the gold, Western central banks bought more “productive” assets. You know, like US Dollars, Euros, and government debt. 
 
Come the financial crisis however, central banks as a group worldwide turned into net buyers for the first time since the mid-1960s. First because emerging-market nations wanted to lose some of the Dollars piling up in their vaults (thanks to America’s perpetual trade deficit). Second because Western central banks…most notably in Europe…decided that selling gold during a crisis isn’t so clever. 
 
So, despite having an agreement in place to cap annual sales…aimed at avoiding the clumsy, price-damaging gold sales made by the UK in 1999…central banks in the West have stopped selling gold altogether. We think that’s likely to stay true all through the new 5-year agreement, signed in May and running from tomorrow until September 2019. 
 
The current CBGA (as we gold nerds know it) has seen European states sell barely 10% of their agreed limit. The new agreement doesn’t bother setting a cap at all. That might suggest they’re secretly planning big sales in future. But on the contrary, the lack of sales under the current CBGA made its 400 tonnes per year limit look stupid. 
 
Fewer than 18 tonnes were sold over the last 3 years in total…all of them from the German Bundesbank to mint commemorative coins. 
 
Just what would be the point of setting a sales limit from here? Fact is, central banks sell gold when times are good. They buy or hold when things are bad. They are not selling today.
 
We don’t think Eurozone central bank chiefs have any plans to sell until 2019 at the soonest. We do think there’s a message in there about the Eurozone crisis.
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Sep 20

Gold Price: Open Suppression in Action

Gold Price Comments Off on Gold Price: Open Suppression in Action
A short history of 1960s’ London Gold Pool, and its failure to suppress gold prices…
 

By the BEGINNING of the 1960s, the US Dollar peg of 35 to 1 ounce of gold was becoming more and more difficult to sustain, writes Julian Phillips at The GoldForecaster.
 
Gold demand was rising and US gold reserves were falling, both as a result of the ever increasing trade deficits which the US continued to run with the rest of the world. 
 
Shortly after President Kennedy was inaugurated in January 1961, and to combat this situation, newly-appointed Undersecretary of the Treasury Robert Roosa suggested that the US and Europe should pool their gold resources to prevent the private market price for gold from exceeding the mandated rate of US$35 per ounce.
 
Acting on this suggestion, the central banks of the US, Britain, West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg set up the “London Gold Pool” in early 1961. One wonders why they were so cooperative with the US.
 
Granted the gold that left these nations ahead of the war was still in the US and slowly but surely they felt it necessary to get it back. What happened in occupied Europe was that US Dollars became more abundant there and a market in ‘Eurodollars’ sprang up derived in part from US soldiers still in Europe. But the volumes grew more and more as the US established a perpetual Trade deficit feeding the rest of the world with them.
 
The ‘Pool’ came apart as Europe, under Charles de Gaulle, decided enough was enough and began to send the Dollars earned by Europe back to the US back and exchanged these for their gold. Then they were unwilling to continue accepting US Treasury Bills & Bonds in return. Under the terms of the ‘Bretton Woods Agreement’ signed in 1944, Europe was legally entitled to do this. It would appear that by the time the gold sent to the US before the war had returned to Europe, the US pulled the plug on exchanging gold for Dollars letting the London Gold Pool fold in April 1968. But the demand for gold from Europe did not abate. 
 
By the end of the 1960s, the US once again (as with the 1935 Dollar devaluation against gold) faced the stark choice of eliminating their trade deficits or revaluing the Dollar downwards against gold to reflect the actual situation. 
 
President Nixon decided to do neither. Instead, he repudiated the international obligation of the US to redeem its Dollar in gold just as President Roosevelt had repudiated the domestic obligation in 1933. On August 15, 1971, President Nixon closed the “gold window” at the New York Fed.
 
In other words the US defaulted on its agreement with Europe and once again Europe tolerated it. We have to ask why? How could a currency with, what was to become perpetually undermined by being printed and exported, continue to stand and become the world’s sole reserve currency and not collapse?
 
Military might, might add some pressure, but not among the allies. No, the key lay in the then established fact that you could only buy oil with US Dollars.
 
Nearly everything modern needed oil to work. Most nations import bills comprised 25% of so of oil. The US controlled Opec. and provided their political and military security. In turn the US had a firm grip on all their allies and secured their financial ’empire’. 
 
The last link between gold and the Dollar was gone. The result was inevitable. One of the prices paid by the US was to permit the oil producers to ‘nationalize’ their oilfield, production and the US and British companies that ran them, the ‘seven sisters’. The oil price began to run up from $8 a barrel to $35 a barrel vastly increasing the demand for Dollars and US Dollar liquidity. The US in turn permitted this, provided that the oil producers reinvested the capital they earned into the US Treasury market and US equities and US products (including military hardware). They were allowed to keep the interest income in their own hands under these conditions. This prevented the oil producers posing any financial challenge to the US 
 
The Persian Gulf was defined as part of the US’ ‘vital interests’, as a result. So if the allies in Europe wanted their economies to function properly they had to accept this fact. Quietly they accepted more and more US Dollars into their foreign exchange reserves. 
 
As the oil price rose the pressure on all currencies climbed too. In February 1973, the world’s currencies were “floated”. They were allowed to move to levels that reflected the state of their Balance of Payments. The US was excused all such value measurements because it was so needed by all.
 
By the end of 1974, gold had soared from $35 to $195 an ounce in an almost mathematically neat progression. This did not make the US happy at all, as it highlighted the real weakening of the US Dollar and the sagacious investor was fully aware of this.
 
So a war on gold was begun. This was not just manipulation but a transparent bullying attack on real money. At first the tactics used underestimated the power of gold and the trust placed in it.
 
Nevertheless the common theme to this manipulation was to suppress the gold price.
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Sep 17

Shanghai Gold Trading: The Real Challenge to London

Gold Price Comments Off on Shanghai Gold Trading: The Real Challenge to London
If China remains a one-way street for gold, it cannot become the world hub…
 

SHANGHAI this week launches a new international gold exchange inside the city’s free-trade zone, writes Adrian Ash at BullionVault.
 
Most everyone thinks this is important because “global gold traders [see] the zone as a gateway to China‘s huge gold demand.” But that’s the wrong way round. Because if it’s to have any real importance, the Shanghai FTZ gold bourse must mark a step towards China’s gold output and private holdings flowing out into the world, not the other way round.
 
Start with the situation today. China and the UK could hardly be more different when it comes to gold. China is the world’s No.1 gold-mining producer, the No.1 importer, and the No.1 consumer.
 
The UK in contrast…and despite spending its way to household debt worth 140% of income…has no gold jewellery demand to speak of. Private investment demand is also tiny compared to Asia’s big buyers
 
On the supply-side the UK hasn’t had any gold-mine output worth noting since 1938. Nor does it currently have any market-accredited refineries for producing large wholesale bars.
 
So you might think China plays a bigger role in the international gold market than does the UK. Yet nearly 300 years since it first seized the job, London remains the center of global gold flows, trading and thus pricing. For now at least.
Net UK gold imports, monthly data in tonnes, 2005-2014
 
Since 2004, and with no domestic mine output and next to no end demand, the UK has imported over 6,800 tonnes of gold, according to official trade statistics – more than China but behind India, the former No.1 buyer. It has also exported nearly 5,000 tonnes, more than any country except No.1 bar refiner, Switzerland.
 
That’s in a global market seeing some 4,500 tonnes of end-user demand per year. Because London is the heart of the world’s gold bullion market, and the central vaulting point for its wholesale trade. (Same applies to silver, by the way – the UK was the world’s No.1 importer and exporter in 2013.)
 
The relationship with prices is clear. When UK trade data (hat tip: Matthew Turner at Macquarie) show metal piling up in London’s vaults (which also offers the deepest, most liquid place for large investors to hold their gold in secure vaults, ready to sell or expand at the lowest costs) prices have tended to rise. But when the rate of accumulation in London is slowing, prices have tended to fall. Gold prices have sunk when London’s vaults have shed metal. 
 
On BullionVault‘s analysis, those months since end-2004 where Dollar gold prices rose saw net demand for London-vaulted gold average 38 tonnes. Falling prices, in contrast, saw London’s vaults lose 16 tonnes per month on average (imports minus exports). Exclude the gold-price crash of 2013 and we get the same pattern. Average net inflows when Dollar price fell were only 15 tonnes per month between 2005 and 2012. Rising prices, in contrast, saw London vaults add 48 tonnes net on average per month.
 
So what’s happening with London-vaulted gold really does matter to world prices. Far more, to date, than what’s happening to China’s flows.
 
Why? The Middle Kingdom’s modern gold boom has come in mining, importing and refining. But in exports it just doesn’t figure. Because bullion exports are banned, thanks to Beijing deeming gold to be a “strategic metal”.
 
Never mind that China now boasts 8 gold refineries accredited to produce London-grade wholesale bars. Out of a world total of 74, that’s more than any other country except Japan. But Chinese-made wholesale bars never reach London (or shouldn’t…) because they are dedicated by diktat to meeting its world-beating domestic demand alone.
 
China’s inability to export gold bullion puts a big block on it affecting world prices. Because while metal is drawn into China when domestic prices rise above London quotes (the so-called “Shanghai gold arbitrage” trade) it cannot flow the other way when Shanghai goes to a discount. Traders can only exploit the price-gap through in one direction.
 
Global investment flows are further locked out by Beijing’s block on foreign cash coming into China – another key difference between the UK and China in all financial trading, not just gold. Shanghai vaults have therefore been closed to international gold investment to date. So the impact of global flows on pricing has completely passed China by.
 
This may change this week however, when the Shanghai Gold Exchange launches its new international gold exchange inside the city’s huge free-trade zone on Thursday. Six major Chinese banks will provide clearing and settlement services. The first 40 approved members of the exchange include London market makers HSBC, UBS and Goldman Sachs. But whether global investors will choose to hold gold in Shanghai vaults remains to be seen. China remains a Communist dictatorship, after all. Whereas London, even in the dark days of 1970s exchange controls – which barred UK investors from buying gold, as well as moving cash overseas – still freely allowed foreign money to come and go as it pleased, not least through the City’s world-leading gold and silver markets.
 
Remember, China’s gold market has only answered Chinese supply and demand so far. Its mine-supply leads the world…but cannot reach it. China’s demand has meantime needed imports from abroad to supplement what Chinese mines produce. That demand leapt when world prices fell in 2013, doubling China’s net imports through Hong Kong from 2012 to well over 1,000 tonnes, and clearly showing that – for now – its gold market remains a price taker, not a price maker. The running is made instead by free-flowing investment cash choosing to buy or sell down gold holdings worldwide, and that decision shows up in London, center of the world’s bullion trade.
 
Yes, Shanghai’s new free-trade zone gold market marks one step towards changing that. Yes, the FTZ is very likely to replace Hong Kong as the stop-off point for gold imports entering the world’s No.1 consumer market. But only a truly liberalized gold trade, with foreign cash and gold flowing in…and out…right alongside China’s domesic flows will challenge London’s 300-year old dominance.
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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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