Oct 27

Gold as Investment Insurance

Gold Price Comments Off on Gold as Investment Insurance
Just how much is enough? It depends on how you judge the risk of a serious stockmarket crash…
 

YOU WAKE UP in the morning, turn on the news, and get a sick feeling in your stomach, writes Brian Hunt, editor-in-chief at Porter Stansberry’s research group, Stansberry & Associates.
 
The stock market is crashing again. Another big Wall Street bank has failed. Your 401(k) has lost another 25%. It’s bleeding value every week.
 
Your dream of early retirement is history. You’ve lost so much money in stocks that even a “regular” retirement is in jeopardy. If you live a long life, there’s no way you’ll have enough money.
 
This is the financial disaster scenario that terrifies a lot of investors. It’s what kept people up at night during the 2008 credit crisis.
 
Could it happen again? Could another crisis cause the value of the US Dollar to collapse? Could the stock market suffer another epic decline?
 
Many people say the answer to these questions is “yes”.
 
Fortunately, I don’t need to know the answer to these questions…and neither do you.
 
The good news is that it’s very easy to buy insurance against financial disasters like these. I personally own this insurance. Many of the smartest, wealthiest people I know own it, too. It could mean the difference between a comfortable, early retirement…and just barely getting by.
 
First, it’s important to agree on what “insurance” is. In my book, buying insurance comes down to spending a little bit of money to hedge yourself against a disaster.
 
Throughout our lives, we spend a little bit of money on insurance and hope we never have to use it. For example, home insurance costs a small fraction of your home’s value. Buy it and hope you never have to use it. Same goes for car insurance. It costs a fraction of your car’s value, so you buy it and hope you never have to use it.
 
It’s the same with investment insurance. You can buy “investment insurance” and hope to never have to use it.
 
There are hundreds of wealth and investment insurance policies out there. They involve intricate details, lots of forms to sign, and payment of big fees to advisors and salesmen (which are often the same thing).
 
I’d rather keep things simple and keep money in my pocket instead of a salesman’s pocket. Here’s how you can do it…
 
Put a small portion of your wealth in gold bullion.
 
That’s it.
 
That’s all it takes to insure yourself against a financial disaster.
 
No complicated insurance products. No big fees to pay. Just pay a small commission to a gold seller, store the gold in a safe place, and you’re done.
 
Here’s why this “insurance” is important…
 
Some popular market gurus are predicting a global depression, a collapse in the Dollar, and a huge increase in the price of gold. The chances of them being right are relatively slim. People have been predicting the “next depression” for 30 years. The world just has a way of not ending.
 
However, the “doom and gloom” gurus bring up some good points. They aren’t crazy. There are some big risks to our financial system. The US government is spending way too much money on wars, Obamacare, welfare, and other programs. Europe and China’s economies could decline and trigger a global recession. These are all real risks to your retirement account.
 
I’m no doom-and-gloomer. I think the economy will deal with these risks and keep growing. Again, the world just has a way of not ending like so many people believe it will. That’s why I want to own stocks, bonds, and real estate. These assets will do well if the crap doesn’t hit the fan.
 
However, I also want insurance in case I’m wrong and the potential disaster that some are predicting takes place. People would likely flock to gold in a global financial disaster…and cause its price to soar.
 
That’s why it makes sense to buy gold as a form of insurance.
 
The good news is that you don’t have to buy a huge amount of gold to have a good insurance policy. You can place just 5% of your portfolio into gold.
 
Let’s say you have a $100,000 portfolio with 95% of it in blue-chip stocks and income-paying bonds. You place the remaining 5% of your portfolio into gold. This gives you $95,000 in stocks and bonds and $5,000 in gold.
 
If the predicted financial disaster doesn’t strike, your stocks and bonds will increase in value. Your gold will probably hold steady in price or decline a little. Since the bulk of your portfolio is in stocks and bonds, you’ll do just fine.
 
But what if the financial disaster strikes? I’ve heard some top financial analysts say gold could climb to $7,000 an ounce in the financial-disaster scenario.
 
Let’s say a financial disaster sends the value of your stocks and bonds down 50%. That would be a massive decline. Throughout history, only the worst, most severe bear markets sent stocks down this much.
 
This epic financial disaster would cut your $95,000 stock and bond position by 50%, leaving you with $47,500. But let’s say this disaster also causes gold to rise to $7,000 an ounce. Right now, gold is $1,230 per ounce. A rise to $7,000 would produce a more-than-fivefold increase in the value of your gold. It would cause the value of your $5,000 gold stake to rise to about $28,455.
 
Post-financial disaster, you’re left with $75,955 ($47,500 from stocks and bonds + $28,455 from gold). The disaster still hits you, but not nearly as hard. Your insurance played a big role in limiting the damage.
 
But what if you think the chances of financial disaster are higher than “unlikely”? What if you’re more worried than the average Joe?
 
If you are, simply increase the “insurance” portion of your portfolio. Instead of a 5% position in gold, you could increase it to 20%.
 
If the previously mentioned financial disaster were to strike your $100,000 portfolio weighted 80% in stocks/bonds and 20% in gold, the math works out like this:
 
The 50% decline in your $80,000 stocks/bond position leaves you with $40,000. Gold’s increase to $7,000 an ounce makes your $20,000 gold position increase to $113,821.
 
Your large gold insurance position actually produces a net gain in this scenario. You’re left with $153,821…an increase of more than 50%.
 
As you can see, the larger your gold-insurance policy, the better you do in the financial-disaster scenario. But if the financial disaster doesn’t strike, you won’t benefit as much because you hold less money in stocks and bonds, which do well if the economy carries on. And keep in mind…it would take a serious financial disaster to send stocks down by 50% and gold to $7,000.
 
Depending on what you think the chances of financial disaster are, you can adjust your gold-insurance policy. It all depends on your goals and beliefs.
 
Think the chances of disaster are slim? Consider a gold-insurance policy equivalent to 1%-5% of your portfolio. Think the chances of disaster are high? Consider a gold-insurance policy equivalent to 20% of your portfolio.
 
Are the “gloom and doom” gurus right? Is financial disaster around the corner? I don’t know the answer. Nobody does. But if you buy some “investment insurance” in the form of gold, you don’t need to know the answer. It’s simple. It’s easy. It’s low-cost.
 
You buy gold and hope to never have to use it. You’ll do fine if things carry on. You’ll do fine if the crap hits the fan.
 
And the peace of mind you get from owning gold “insurance” is worth even more than the money it could save you.
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Oct 20

Inflation, Like Hurricanes, Has Been Abolished

Gold Price Comments Off on Inflation, Like Hurricanes, Has Been Abolished
Not had one in nearly 10 years. So hurricanes will never return, right…?
 

IT’S BEEN over 3,280 days since a hurricane hit Florida, writes Dennis Miller of Miller’s Money at Doug Casey’s eponymous research group.
 
As hurricane season comes to a close next month, only Mother Nature knows how long the streak will last. Like many Floridians, my wife and I stayed home and rode out a hurricane – once! We’d built a home on Perdido Key, a barrier island west of Pensacola. It was engineered to withstand 150-plus mph winds, and it was a beautiful home with a master bedroom spanning the entire third floor, looking out across the Gulf of Mexico.
 
Hurricane Danny hit the Gulf shortly after we moved in. It was a fast-moving Category I with winds gusting in the 75-80 mph range. Full of confidence and a bit curious, we decided to hunker down and ride it out. At the speed it was traveling, it should have been over in a matter of hours. Then, Danny caught everyone by surprise and stalled in Mobile Bay, pounding us for three days.
 
The waves on the Gulf were terrifying. We watched the rising tide bang boats against the rocks and sink others. Our front door had a double deadbolt with a keyhole on each side. Water shot through three feet into the room for 24 hours straight. Newly planted palm trees strained against support wires and toppled onto their sides.
 
We tried to get some sleep in our bedroom, but we could feel the house move with each gust of wind. We watched bits and pieces of our neighbor’s tile roof fly off and smash a few feet from our house. We were trapped and terrified for three days.
 
The no-hurricane record has been all over the Florida news, highlighting concern that people are becoming complacent. They don’t understand what adequate preparation entails. The storm itself can be horrific, but the aftermath can be equally disastrous, leaving people without food, water, power, and access to basic services for several days. Homes that survive a storm often have to be gutted because of mold and mildew. Without power, sewage immediately becomes a problem.
 
Plus, if your flood, wind, and homeowners insurance is not up to date, say hello to serious financial hardship. Many Floridians discovered too late that their policy limits had not increased with inflation and wouldn’t cover the cost of rebuilding.
 
Just for fun, I told a friend that I was thinking about selling my generator and dumping our emergency supplies. He looked at me in disbelief and finally uttered, “Are you crazy? When the next one hits, don’t try to mooch off of us. It’s every man for himself.”
 
Exasperated, he explained that hurricane-causing conditions had not gone away. Until the sun no longer heats the water, we no longer have large and fast temperature changes, and there are no trade winds, a hurricane is a constant threat.
 
He was red in the face when he finished. I told him I was kidding and wanted to discuss something else: economic hurricanes.
 
Many financial pundits are shining the all-clear signal, saying that our economy is fine. People are bailing on gold and mining stocks because they’ve dropped so low. To paraphrase my colleague, Casey Research chief economist Bud Conrad, gold sentiment has dropped to zero.
 
Take a look at the price of gold over the last decade:
 
 
High inflation (Hurricane Danny) and hyperinflation (Hurricane Katrina) are two potential threats to all of our lives. While we hope neither hits, we should still prepare.
 
At Miller’s Money, we put metals into two categories. The first is core holdings. This is pure insurance against a catastrophe – much the same as our hurricane survival package. Not all storms are category V. Even if we don’t have hyperinflation, during the Jimmy Carter era we experienced double-digit inflation that devastated a lot of retirement nest eggs. Investors holding long-term 6% certificates of deposit would have lost 25% of their buying power during a five-year period, even after they collected the 6% interest.
 
What if the storm intensifies into hyperinflation and its inevitable aftermath? Many of the items we keep for hurricane emergencies may come in handy if the food supply is interrupted, electricity is cut off, or the currency collapses. Metals will protect us from the rising tide of inflation and protect our purchasing power.
 
The second category for metals and metal stocks is investment. These holdings are bought with the express intent of selling down the road for a nice profit. There is quite a debate going on in this arena. Some experts are touting the terrific buying opportunity. Others say gold is an ancient relic and there are a lot of better investment opportunities available. Should you take advantage of the buying opportunity or unload?
 
We set strict position limits in the Money Forever portfolio. When you’re investing money earmarked for retirement, which is our focus, the speculation portion is limited because preserving capital is the overriding consideration.
 
Gold stocks fall into two general categories. The first is established mining companies and the second is exploration and development companies. Stock in the first group is more directly related to the current price of gold. Every Dollar fluctuation in the price of gold adds or subtracts from their net profit as their costs are primarily fixed.
 
For exploration and development companies, it’s a combination of the price of gold, their ability to raise capital, and a heavy emphasis on the economic viability of their discovery. In a large number of cases a major mining company buys them out and takes them into the production phase.
 
In both cases, there are certain events that can produce spectacular results; however, the risk is also high. The real question is do you have room to invest any more capital in the speculative portion of your portfolio? That’s up to the individual investor to answer. If you do have room, there are some incredible bargains in the market today. Our metals team travels the globe and has identified many candidates selling at true bargain-basement prices.
 
What about your core holdings? Should you buy or lighten your portion of metals? The first question to answer is: do you have ample core holdings at the moment? We recommend holding 10%-20% of your net worth in core holdings, depending on your comfort level. (Mining stocks are generally not core holdings; they are speculative.) A lot of investors are slowly building to that target. If you think you should add more, then the current prices present a terrific opportunity.
 
Once you add to these core holdings, then the daily price fluctuations are no more relevant than the price of the case of beef stew we have stored in our closet. It’s insurance for a catastrophe we hope never happens. When the big one hits, we could probably sell our stew for an astronomical sum, but we won’t because it will help us survive. We would use some of our metal holdings, priced at current value, to buy things we need.
 
The same friend who was flabbergasted by my pretend plan to dump our hurricane supplies asked if I planned to sell any of our gold. I looked at him and asked, “Are you crazy?” Then I explained that the conditions that spawn inflation have not gone away either.
 
The reasons to own gold have compounded over the last decade. The US government has printed trillions of Dollars, our country’s debts are out of sight, and the Chinese and Russians are doing everything they can to oust the US Dollar as the world’s reserve currency. When the world no longer needs or wants to hold Dollars, they will fly out the door faster than any hurricane wind mankind has ever seen. The value of the Dollar will drop like a two-ton anchor and the price of gold will soar.
 
Precious metals are insurance against the ultimate financial hurricane. Fiat currencies eventually collapsed; the US Dollar will not get a free pass. Just as sure as the sun heats the water, we have large and fast temperature changes, and there are trade winds, an overly indebted government will experience a currency collapse.
 
We have all had ample warning and should be prepared. Don’t be fooled by the short-term thinking.
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Oct 10

Central Bank Gold Agreement No.4

Gold Price Comments Off on Central Bank Gold Agreement No.4
“We, the undersigned, aren’t selling gold anyway. But just so you know…”
 

In MAY 2014, the European Central Bank and 20 other European gold holders announced the signing of their fourth Central Bank Gold Agreement, writes Julian D.W.Phillips at GoldForecaster.
 
This agreement, which applies as of 27 September 2014, will last for five years and the signatories have stated that they currently do not have any plans to sell significant amounts of gold.
 
Collectively, at the end of 2013, central banks held around 30,500 tonnes of gold, which is approximately one-fifth of all the gold ever mined. Moreover, these holdings are highly concentrated in the advanced economies of Western Europe and North America, a statement that their gold reserves remained an important reserve asset, a statement made in each of the four agreements since then.
 
After 29 years of implied threats that gold was moving away from being an important reserve asset and the potential sales of central bank gold the gold price had fallen to $275 down from $850 in 1985. But the sales that were seen were so small that with hindsight they were seen as only token gestures. Today the developed world’s central banks continue to hold around 80% or more of the gold they held in 1970.
 
It only became clear subsequently that the real purpose behind these sales (from 1975) were to reinforce the establishment of the US Dollar as ‘real money’ and the removal of gold as such. The US government would brook no competition from gold, but continued to hold gold (as money ‘in extremis’) in ‘back-up’.
 
Then in 1999 the Euro was to be launched. It too needed to ensure that Europeans, who had a long tradition of trusting gold over currencies, would not reject the Euro in favor of gold and turn to gold and its potentially rising price. So it was decided that while gold was to be retained as an important reserve asset, its price had to be restrained for some time, while Europeans were made to accept the Euro as a reliable, functioning money in their daily lives.
 
To that end, major European central banks signed the Central Bank Gold Agreement (CBGA) in 1999, limiting the amount of gold that signatories can collectively sell in any one year. There have since been two further agreements, in 2004 and 2009. Now the fourth Central Bank Gold Agreement is in operation.
 
Together, the European Central Bank, the Nationale Bank van België/Banque Nationale de Belgique, the Deutsche Bundesbank, Eesti Pank, the Central Bank of Ireland, the Bank of Greece, the Banco de España, the Banque de France, the Banca d’Italia, the Central Bank of Cyprus, Latvijas Banka, the Banque centrale du Luxembourg, the Central Bank of Malta, De Nederlandsche Bank, the Oesterreichische Nationalbank, the Banco de Portugal, Banka Slovenije, Národná banka Slovenska, Suomen Pankki – Finlands Bank, Sveriges Riksbank and the Swiss National Bank say that…
“In the interest of clarifying their intentions with respect to their gold holdings, the signatories of the fourth CBGA issue the following statement:
  • Gold remains an important element of global monetary reserves;
  • The signatories will continue to coordinate their gold transactions so as to avoid market disturbances;
  • The signatories note that, currently, they do not have any plans to sell significant amounts of gold.
“This agreement, which applies as of 27 September 2014, following the expiry of the current agreement, will be reviewed after five years.”
The first clause confirms the ongoing role of gold as an important reserve asset. The most important part of the statement is the third part, where the signatories confirm “they do not have any plans to sell significant amounts of gold.”
 
In other words they have completed their sales. We do not expect them to resurrect their sales as they have fulfilled their purpose. Their sales stopped in 2010 in effect, bar some small sales by Germany of gold to be minted into coins. We did not consider these a part of these agreements.
 
The statement clarifies that none of the signatories will act independently of the rest and sell gold. They will coordinate any future transactions with the other signatories should a situation arise where a signatory wishes to sell again. We believe that this will not happen because of the financially strategic and confidence building nature of their gold reserves.
 
This agreement in lasting for five more years reassures the gold market that none of the signatories will sell gold for five years and even then they will likely make a further agreement for five more years.
To us this statement and agreement removes the specter of central bank gold sales in the future. As we have seen since these sales were halted in 2010, emerging market central banks have been buyers of gold steadily and carefully, without chasing prices.
 
We have the impression that the bullion banks go to prospective central bank buyers and ‘make the offer’ of gold available on the market, which the central bank then buys. They do not announce their intentions and act so as not to affect the price barring taking stock from the market.
 
This not only reassures gold-producing countries and companies, who can be reassured that there will be no policy of undermining the price of gold with uncoordinated sales of gold, but tells the rest of the world including emerging central bank buyers that there will be no supplies from them put on sale. Such buyers will have to find what gold they can on the open market or from their own production.
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Sep 18

US Dollar Index Still Rising

Gold Price Comments Off on US Dollar Index Still Rising
When the you-know-what hits the you-know-where, people buy what the…? 
 

“WE CONTINUE to believe that we are moving into a ‘strong US Dollar world’,” wrote Louis-Vincent Gave, the investment strategist, in a recent note to his investors, says Chris Mayer in The Daily Reckoning.
“This makes for a very different set of winners and losers, and very different portfolios, than what most investors have been used to over the past decade or so.”
I think there is a good case for a strong US Dollar for the rest of this year and into next. We’ll look into the argument here and what its chief effect is likely to be.
 
Gave’s comments inspired me to set down my own. In his note, Gave shared a chart showing the Dollar Index since circa 1985. The Dollar Index measures the value of the Dollar against a basket of foreign currencies. The Euro makes up more than half the index (and European currencies did before the creation of the Euro). The Yen, Pound and Canadian Dollar fill out the bulk of the rest of the basket.
 
I share the chart because I think the pattern shown might surprise you. After all, didn’t the US government run widening deficits after the crisis? Didn’t the central bank engage in “money printing”? And wouldn’t you expect these would drive the Dollar lower?
 
You might’ve. Plenty of people did. And they were (and are still) wrong. “As things stand,” Gave wrote, “we are basically trading roughly at the same levels that have prevailed for most of the post-2008 crisis period.”
 
 
I think there is a good case for a strong US Dollar for the rest of this year and into next.
 
In fact, the US Dollar Index recently put in an 11-month high. There are a few reasons I’d point to for that strength against foreign currencies to continue.
 
First, the US trade deficit continues to shrink. According to the latest readings in June, the deficit shrank by 7%. When the trade deficit shrinks, that means fewer net Dollars flow overseas. Hold that thought.
 
Second, the federal deficit is also shrinking. For the fiscal year ending September 2014, the deficit will be around $500 billion. That’s less than one-third of what it was in 2009 – the recent peak. Lower deficits means fewer Dollars injected into the system.
 
Now put the two together. You know basic economics. What happens when the supply of something gets tighter? Its value rises, assuming demand stays the same.
 
Aye, what about Dollar demand? There is steady demand for US Dollars from abroad, because it is the world’s reserve currency. Meaning just about everyone uses it to settle up international trade.
 
As Gave writes in his book, Too Different for Comfort, it’s not easy to unseat a reserve currency. After running through some history, Gave concludes:
“A reserve currency is thus a bit like a computer operating system – it pays to use the one that everyone else is using, and the more people use one system, the less incentive there is to switch. Once a reserve currency gets entrenched, therefore, it is exceedingly difficult to dislodge, because the benefits of the new currency have to outweigh those of the old one, not by a little, but by a lot.”
Of course, the Dollar’s standing won’t last forever. But I think we can safely say the US will remain the standard for years yet. There is simply no competitor on the near horizon. Not even one that’s close. True, a variety of emerging markets and other countries have learned to use other currencies to settle transactions. That’s just good sense. They’ve been caught short of Dollars before and had to endure a crisis of some sort as a result. But these transactions are small in the scheme of things.
 
Meanwhile, those foreign markets are growing and the demand for Dollars ought to remain at least stable. Thus, the Dollar Index is putting in that 11-month high.
 
Part of the US Dollar strength also comes from the fact that there are lots of attractive assets in the US that foreigners like to buy and own. They have to pay for them in Dollars. Gave makes this point in his book, too. When the US Dollar gets cheap, Brazilians rush in to buy condos in Miami. Canadians pick up second properties in Arizona. Russians buy New York condos. Foreign pension funds buy up US debt, stocks and real estate.
 
And whenever there is a crisis, what do people do? They go to cash, and that means US Dollars. They buy US T-bills. When the you-know-what hits the fan, it is still the Dollar they retreat to. They’re not buying Chinese Yuan. Gold is another asset seen as a safe haven, but the gold market is tiny and off the radar of the big pools of money out there. When a big fund wants safety, it turns to cash – US Dollars.
 
So let’s say the Dollar stays strong. What effect could it have?
 
It could drive US interest rates even lower. If you look at the 10-year securities of the big EU countries, Japan, Canada and other developed nations, you find that interest rates are all lower than in the US But as Gave asks, “Why own 10-year bonds yielding 1%, or Japanese government bonds yielding 0.5% in falling currencies, when you can own 10-year US Treasuries denominated in a rising Dollar yielding 2.5%?”
 
This is the question the market will be asking itself soon, especially as/if that Dollar Index continues to make highs. Then you can expect to see US Treasury yields falling to levels where these other developed markets already sit.
 
All is to say that if you are looking to get out of the US Dollar, cool your jets. As long as the trends above are in place, the Dollar Index might be on the verge of a bigger rally.
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Sep 05

What I Told Alan Titchmarsh About $1920 Gold Prices

Gold Price Comments Off on What I Told Alan Titchmarsh About $1920 Gold Prices
Three years to the day since gold prices peaked. Did you call it wrong…?
 

IT’S SAFE to say gold hasn’t been much fun since prices peaked three years ago this weekend, writes Adrian Ash at BullionVault.
 
Maybe I should have guessed at the time. Because the same day that spot prices hit $1920 per ounce…Tuesday 6 September, 2011…I got to talk gold as a guest on UK television’s biggest afternoon chatshow.
 
Gold on national daytime TV…? What more warning could gold bugs want? Hindsight screams sell.
 
Sadly for irony (and for all-knowing traders), my slot on The Alan Titchmarsh Show didn’t air until the Thursday, two days later.
 
But the die was cast. Or so hindsight says. The drop which began the very next day was obvious.
 
Emerging-market central banks should have stopped buying. Gold miners should have sold forward their future production to lock in record prices. And gold investors should have taken profits…quick! 
 
Gold sank 20% between September and the last day of 2011. It then rallied only to plunge 25% in spring 2013. Since then it has now traded dead-flat for 12 months, some 35% below its peak of three years ago.
 
Should we all have seen it coming? I think not. 
 
“Business is certainly strong,” as Paul Tustain, founder and CEO, noted to me here at BullionVault that same, hectic week in 2011. “But it’s still a tiny proportion of the investing public.
 
“The huge majority of people and portfolios still have no gold at all. What we’re seeing across the market is the prices being marked up by the dealers in search of supply, but no-one is being flushed out. 
 
“Gold owners simply don’t want to sell, not while the economic situation threatens the wholesale destruction of value in currency assets.” 
 
Re-read that last sentence again. Then cast your mind back to late-summer 2011…
  • US government debt was downgraded by the credit agencies; 
  • English cities and towns descended into rioting, looting and arson; 
  • Europe’s single currency experiment looked set to explode in general strikes and violence. 
Put another way, unemployment in rich Western countries was surging to Third World levels. The state was losing control. And nothing was “risk-free” anymore.
 
Clearly, some smart traders chose to quit getting long of gold. Because prices fall when bids refuse to meet offers, and fall they did. But to the best of my knowledge, no pundits or analysts called the top in gold prices. Not with any more confidence than the perma-bears who repeatedly called the top from 2009.
 
How could they? The economic, financial and social situation across the West hadn’t been this bad since perhaps 1939. 
 
Oh sure – Warren Buffett, the world’s most famous money manager (and one of its most successful) once advised investors to “Be fearful when others are greedy and greedy when others are fearful.” But you’d need some damned cold logic to overcome the fear sweeping the rich West in late-summer 2011. 
 
Indeed, you would have needed to get your head examined. 
 
Just what were the odds of a Eurozone break-up back then – better than evens? And the consequences of that? They could scarcely be imagined. Not when the only paper “safe haven”…US Treasury bonds…faced a genuine threat of default thanks to Washington politicians scoring points against the White House via the debt ceiling farce
 
In short, the gold market was NOT mis-pricing risk in September 2011. Nor were new buyers. That summer’s surge to record levels simply reflected the very strong chance that the crash of 2008 was only a warm-up. Investors, households and media all agreed. This time, the financial crisis really had landed. 
 
So forget hindsight. Buying gold at 2011’s record prices was not a “mistake”. Even if it has proven costly to date. 
 
There’s nothing today which makes those losses less painful. But if you view every decision you make as an all-in bet, then insurance will always look like “dead money”…unless disaster strikes. 
 
What if the crisis of September 2011 hadn’t eased off? Which outcome would you really prefer?
 
As I told Alan Titchmarsh three years ago:
“If you think the financial crisis is all over and everything’s going to be sorted out, then gold [at $1920…£1194…or €1375] probably looks pretty expensive as insurance for your other investments right now.” 
Gold is a lot cheaper today. Yet I’m far from sure the financial crisis has truly passed over just yet. 
 
I guess the European Central Bank agrees, now printing money to try and stoke the economy. Odds are that every other monetary power holding the cost of money at zero for the fifth year running thinks the same.
 
Maybe someone should tell the stockmarket. But then, no one rings a bell at the top. Not one you can hear at the time.
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Sep 05

Why Governments Meddle with Gold

Gold Price Comments Off on Why Governments Meddle with Gold
Of course gold is manipulated by government. That’s the point…!
 

THROUGHOUT history, there have been a constant flow of schemes to try to manipulate the gold price and gold itself in terms of paper money, writes Julian D.W.Phillips at the GoldForecaster.
 
These have come from governments, institutions as well as from individuals. The aim has always been to either establish the value of currencies or enhance that value in terms of gold. The first key to this is to ensure that the gold price is made in the paper currency and not the price of the paper currency in gold.
 
At school you probably read the book called The Alchemist, where villains tried to invent formulae where they could transform lead to gold. While what they managed to do was a good confidence trick, they could not replicate gold. Today the process continues, but now the boldness of government has gone as far as to say that paper money is better than gold in terms of its value. But gold is gold and for the prudent and those wanting to preserve their wealth over the long term, nothing can replace it.
 
Experiments using fiat currencies have been carried out since the days of distant Chinese dynasties in attempts to emulate or replace the real money of gold. The reason is simple and explained in a quote I borrow from Dan Popescu:
“Aristotle, the Greek philosopher, student of Plato and teacher of Alexander the Great, was mentioning fiat money 2,400 years ago when he said, ‘In effect, there is nothing inherently wrong with fiat money, provided we get perfect authority and godlike intelligence for kings.'”
But we can’t, which is why in history, there has never been a ‘money’ that can retain its value or replace gold as real money, in all seasons weathered by economies. 
 
It is because we don’t have perfect authority and governments do not have godlike intelligence that central banks need to attempt to manipulate the gold price in attempts to build and hold confidence in fiat currencies.
 
Why do governments keep coming back to these different types of money? They have a need to govern/control all types of money, their economy and their people. Without control over money the majority of a government’s power dissipates. That’s man’s history and his future, in this world. 
 
That’s why governments find themselves in opposition to real money, such as gold and silver, which essentially restrict and, in the end, governs governments when extreme times hit. This will happen in the near future once the monetary system fragments and when it does, governments will turn back to gold and later silver and try to hold as much as they can.
 
But this does not mean they will move away from fiat money, no, they will use precious metals to add credibility to the rising quantity of paper money. 
 
Please note we did not say backed by, or issued against it. Within the need for government issued money to retain credibility the concept of reformation of government issued money is unacceptable, because that in itself would be read as an admission of failure and give rise to falling confidence in it, an unacceptable option for governments.
 
The level of control over an economy must be maintained at all costs. Precious metals will be used to reinforce that control. As always, this will be done in the interests of the nation and its citizens.
 
Likewise, when governments manipulate the gold price, it is with the intention of enhancing the acceptance of fiat money and our dependence upon it as both a measure of value and a means of exchange. 
 
Often legislation and taxation are used to enhance its use and restrict the use of alternatives, either foreign money or precious metals. Manipulation has also been used by governments acting in concert such as after the ‘closing of the gold window’ by President Nixon in 1971. 
 
In 1933 the most complete form of manipulation was enacted by the US when it confiscated citizen’s gold allowing them only to retain $100 worth of gold, at the time this was five ounces of gold.
 
This brought the gold market to a halt with dealers (except where these coins were defined as rare coins) closing down, storage systems handing over client’s gold to the Fed and the gold market going into hibernation in the US for the next 41 years. Two years later the US government devalued the Dollar to $35 to one ounce of gold. While the reasons appeared plausible (to boost US money supply and protect the banking system, in the nation’s and its citizen’s interests, was what the public was told – listen to the actual speech). 
 
Many believe that today there are better ways of achieving the same objective without gold confiscation, so why could it happen again?
 
The world has become inter-dependent with the US Dollar which is the center of the global monetary system at the moment and from which nearly all other currencies stem. But the emerging nations, while feeding off the developed world’s economies are building a large degree of economic and monetary self-sufficiency. Recently they agreed to set up an institution replicating the IMF for the emerging world. Its headquarters will be in Shanghai. Their path to an international currency that will be an alternative to the Dollar is well under way.
 
China is at the forefront of this as its economy is expected to become the largest in the world by the end of this year or next. It will bring its own currency forward as a global reserve currency, breaking away from the Dollar in the process. Without the US Dollar’s hegemony, the Dollar cannot stand as the only measure of value and as the sole global reserve currency. With this in mind the demand for gold by central banks will rise to reinforce confidence in all currencies. 
 
And with the supply of gold at 3,050 tonnes of newly mined gold and ‘scrap’ sales, at best, at 1,200 tonnes, the gold market will not be able to supply the world’s needs for monetary purposes, in the event it is needed to reinforce confidence in local currencies. Hence gold confiscation, for completely different reasons than in 1933 is, in our opinion, a distinct probability. With potential Yuan convertibility coming at the earliest in late 2015 we are very close to that event.
 
After the confiscation of gold in 1933 followed by the devaluation of the Dollar by 75% in 1935, the bulk of the developed world’s gold moved across to the US The devaluation of the Dollar was not reflected in foreign exchange markets in 1935, so gold continued to be sold at $20 an ounce in countries outside the US while the US was paying $35. This is why the US amassed over 26,000 tonnes of gold before the Second World War.
 
We see this as part of the strategic alliance that matured in the Allies coming together in that war. The control of gold had to be out of the reach of the war in Europe. This price manipulation ensured that this happened.
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Aug 28

Authentic Fed Gibberish

Gold Price Comments Off on Authentic Fed Gibberish
Or AFG…as opposed to the inauthentic kind…
 

SO I was not at my personal best that morning, I admit it, writes the Mogambo Guru at The Daily Reckoning, but neither was the rest of the family, and making Freudian slips, while still early-morning groggy, is easy to do.
 
As I was to learn, everyone is all upset that I accidentally called the kids “stupid Earthling carbon units” instead of referring to them as “my wonderful, darling children”, which I admit I reflexively did NOT do because they are neither wonderful nor darling, but are instead some kind of mutant Dollar-gobbling machines.
 
The issue was about, again, getting braces for one of the kid’s teeth, I don’t remember which one.
“Don’t you see? The Dollar is losing its buying power…because the horrid Fed… continues to print So Freaking Much (SFM)…”
Naturally, as the caring, loving father, I patiently tried to explain that the mutant neo-Keynesian econometric lunatic Janet Yellen was at the helm of the evil Federal Reserve doing the same monstrous “money-and-thus-debt-creating” monetary expansionism crap that causes inflation in the prices of things you need and deflation in the prices of things you don’t, and gold goes up in price because it is the ultimate money which everyone will be turning to as all the other fiat-monies fail, slowly, terrifyingly, one after another, in the economic mayhem when insane levels of lunatic leverage are unwound.
 
I actually remember cleverly summing up by saying, “And therefore, we should put all our cash into gold, silver and oil! We should NOT, on the other hand, be foolishly wasting resources by getting braces for somebody’s teeth!”
 
Let the teeth grow in naturally, all crookedy and snaggly, and thus we will reap a veritable cornucopia of benefits! She will not be popular, based on her repellent looks, so we as parents won’t have to worry that she will get pregnant! Or have her stupid friends stealing food from our refrigerator, saving us money! And she will, out of bored necessity, busy herself educating herself in rigorous academics, excelling in sports, or doing something that can snag a nice college scholarship.”
 
Not content at that, I regret that I went on, “Or at least get off her fat butt, go out and get a job and pay for the damned braces herself, if it is so damned important to her, because, in case you people ain’t heard, I Ain’t Made Of Money (IAMOM)!”
 
The way their eyes were wide and staring, and their mouths were hanging open in stunned stupefaction, replete with glistening drool dribbling down their stupid chins, was my first clue that I was not succeeding in presenting my Mogambo Ironclad Economic Reasoning For Survival (MIERFS).
 
So, to remedy the situation, I helpfully continued, “Don’t you see? The Dollar is losing its buying power at accelerating rates, on its way to zero buying power, because the horrid Fed (and the other central banks of the world) continues to print So Freaking Much (SFM) money and credit, so that the bloated, bankrupt government can borrow it and cram it into the bloated, bankrupt economy. That causes gold, silver and oil to go up mightily in price! It’s guaranteed! It’s guaranteed because history shows they always do!”
 
I was instantly hurt and irritated that they did not leap to their feet, applauding in joy at my brilliant idea. That’s when I said, “Don’t you see what I am talking about, you stupid Earthling carbon units? When gold, silver and oil soar in price, that – that! – would be the time to sell a little bit of these wonderful appreciating assets, and use the pile of cash to have those nasty teeth pulled out and replaced with the latest and greatest innovations in implanted replacement teeth of the future, miracles of modern dentistry – maybe with built-in internet connectivity! – giving her a brilliant smile that her own stupid teeth could never even hope to achieve!”
 
Instantly, I was beset by the anticipated tide of people leaping to their feet, alright, only with no applauding, but instead having cereal bowls and spoons flying willy-nilly, a lot of screaming of really hateful words, how I was a horrible, horrible man who hates his children, and how they all wished I was dead, loudly daring each other to kill me (“I dare you!”), and blah blah blah.
 
Alas, my brilliant and wonderful Mogambo Ironclad Economic Reasoning For Survival (MIERFS) idea was for naught. Grasping at straws, I offered a little “happily ever after” treacle, saying, “Thus, she will be an inspiring story of an Ugly Duckling becoming the Beautiful Swan, a hero to ugly girls around the world, and her handsome prince will come along, and she will live happily ever after. In a castle!”
 
Desperate to seal the deal, I offered another hidden benefit. “And she’ll never have a cavity, or root canal, or crown, or bridge, or any of that expensive dental stuff to deal with, or pay for, ever again, either!”
 
But I see that my words that got me in trouble, which, thankfully, none of them recorded on their phones, and so it is just their lying words against mine.
 
But at least I am not poor Stanley Fisher, the vice-chairman of the Federal Reserve, who IS on record as saying, according to the Financial Times, “The challenge for policy makers was separating the cyclical from the structural, the temporary from the permanent.”
 
What? Hahaha!
 
Apparently, the structural part of the economy can exist independently of the cyclical, cyclical things don’t need the structural things, while cyclical things cannot become structural, and structural things cannot become cyclical! Hahahaha! The monetary policy of the United States is in the hands of these kinds of people? Yikes!
 
And don’t get me started on the insanity of hypothesizing something “permanent” in the economy, as nothing is permanent anywhere I look, but instead always in a state of decline. And so I would certainly rudely blurt out, “Drop dead, ya lowlife moron!”, the words dripping with all the scorn and contempt I could dredge up.
 
The part that almost made me pee in my pants was when he said, “The difficulty in disentangling demand and supply factors makes the job of the monetary policy maker especially hard since it complicates the assessment of the amount of slack, or under-utilised (sic) productive capacity, in the economy.” Hahahahahahahahahha!
 
I laugh uproariously! This Authentic Fed Gibberish (AFG)!
 
“Disentangling demand and supply factors”! Again, Hahahahahahaha! A new interpretation of Say’s Law? Hahahaha! As Bugs Bunny would say, “What a maroon!”
 
It all seems so, so easy to me. So easy, in fact, that I gleefully exclaim, “Whee! This investing stuff is easy!”
 
Perhaps this ridiculous nonsense was merely a ruse to distract us from asking how “tapering” of Quantitative Easing led the evil Federal Reserve to increase Total Credit by a hefty $11.5 billion in One Freaking Week (OFW) last week, and bought up a goodly $8.7 billion in US government securities, too, some or all of which may explain why the Monetary Base jumped up a massive $84 billion in that selfsame One Freaking Week (OFW) last week!
 
You can tell by the suddenly-serious look on my terrified face and my cold, steely gaze that when the vice-chairman of the foul Federal Reserve is saying things like that, and the Fed itself is creating cash and credit like that, and the population, and the politicians, and all our vaunted intellectuals of the United States are accepting things like that, then we are surely, surely doomed.
 
And if THAT if is not enough to make even the dullest Earthling carbon unit unhesitatingly want to go all-in, buying gold, silver and oil with a terrified, frenzied abandon, forsaking all else, then all the braces and the straightest teeth in the world will not be enough to pay for that dreadful mistake.
 
It all seems so, so easy to me. So easy, in fact, that I gleefully exclaim, “Whee! This investing stuff is easy!”
 
But to Earthling carbon units, it is apparently very difficult, if not impossible, to even vaguely understand. Maybe it’s their bizarre fixation on the straightness of their teeth!
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Aug 21

Central Banks Buying Gold "Firmly" in 2014

Gold Price Comments Off on Central Banks Buying Gold "Firmly" in 2014
Countries “not aligned” with US views likely to track Russia, buy gold…
 

GOLD BUYING by central banks has continued ahead of recent averages in 2014, according to several analysts’ notes.
 
“Central banks remained firmly on the buy-side of the gold market” in the first half of the year, writes Macquarie Bank analyst Matthew Turner in London.
 
Based on official gold bullion reserves as reported to the International Monetary Fund, Turner notes that his net figure of 113 tonnes for central bank gold-buying in H1 does not account for a 14-tonne drop in Ecuador’s holdings – withdrawn as part of a Dollars for gold swap with US investment bank Goldman Sachs, and set to be unwound with the gold bars returned in two years’ time.
 
“The Ecuador-Goldman Sachs deal,” agrees another London-based analyst, “simply reiterates that gold is a highly liquid asset that can readily be converted into cash.” A similar deal with the same bank was last year begun but dropped by the socialist government of Venezuela, which under the late Hugo Chavez withdrew its gold bullion reserves from London’s international trading center in what commentators called an attempt to “guard against” US seizure or interference with the Latin American state’s assets overseas.
 
According to IMF data, Moscow’s gold buying in 2014 rose from 5 tonnes in the first 3 months of 2014 to 55 tonnes between April and June, when the Ukraine crisis intensified after Russia’s annexation of Crimea in March. “Given Russia’s FX reserves have fallen,” says Turner, that “might reflect a preference for gold over government bonds in the current political environment.”
 
Also noting the increase in Russia’s gold reserves, “We would expect a range of countries who are not aligned with the USA to see ever greater attraction in holding gold as a reserve asset,” writes Mitsui analyst David Jollie, pointing to “indications” in reporting data which suggest Moscow may have reduced its holdings of US Treasury debt. 
 
Even though the US Dollar remains the No.1 central-bank reserve currency, “Any country that might come into political disagreement with the USA might have some fears that it might not be able to use its Dollar reserves,” says Jollie. “And such a country might also have little desire to fund the US Government’s budget deficit too by owning US Treasuries.”
 
The largest foreign holder of US Treasury bonds, China has not updated the world on its bullion reserves since 2009, when it revised its reported holdings 75% higher to 1,054 tonnes. Beijing is widely suspected of buying gold since then, with unreported central bank purchases explaining a gap between China’s private-sector demand and visible supply.
 
“China’s nearly $4 trillion in [foreign currency] reserves,” wrote British MP Kwasi Kwarteng – author of new book War and Gold: A Five-Hundred-Year History of Empires, Adventures and Debt – last month in the New York Times, “give it plenty of ammunition to claim leadership in the creation of a new monetary order.”
 
Kwarteng suggests Beijing may be buying gold to prepare for a bullion-backed Yuan – “not in the immediate future…[but] in, say, 20 years.”
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Aug 18

Gold Prices Lower on “Uneventful Monday,” Support from Hedge-fund Managers

Gold Price Comments Off on Gold Prices Lower on “Uneventful Monday,” Support from Hedge-fund Managers

GOLD PRICES have dipped below $1,300 this Monday afternoon. European stock markets rose following Asian gains. Analysts have referred to today as an “uneventful Monday”.

The single European currency trades Monday morning slightly lower, remaining in a tight range below $ 1.3400.

Reports of the destruction of an armed Russian convoy by Ukrainian troops on Friday pushed Brent oil up by one US dollar before coming back to trade below $103 per barrel as rumours seemed to be false, with Russia denying having crossed the border.  

Gold is expected to carry on “range trading… unless all the tensions in the world are sorted out,” says David Govett from Marex Spectron. “Gold is not the perfect safe haven … but it does knee jerk react to headlines and, as such, the downside should be limited for the time being,” he added.

In the Comex market of gold futures and options, gold’s bullish net position increased nearly 20% to 556 tonnes, the biggest jump for the last 8 weeks. The open interest gained for the first time in the last three weeks.

Silver cut the speculative net long position for the 4th week running.

Paulson & Co, the largest investor in the SPDR Gold Trust, maintained its stake in the exchange traded fund at 10.23 million shares in the three months ending June 30, as shown in US Government filings. This is the fourth consecutive quarter of unchanged holdings.

Another hedge fund giant, Soros Fund Management LLC, decreased its stake in Barrick Gold by more than 90% in the second quarter while it “nearly doubled” its ownership in the Gold Miners ETF and  initiated stakes in Allied Nevada Gold Corp, according to Reuters information.  

Axel Merk, chief investment officer of Merk Funds, considers that these actions underline that gold “has become increasingly attractive to hedge fund managers who are long-term investors as real interest rates remain negative.”

Gold closed its Monday’s trading session on the Shanghai Gold Exchange with a premium of $ 1.3 over the spot gold benchmark price in London. Reuters reports that physical demand in major buyers China and India has been weak with many consumers expecting prices to fall further. Bullion traders are expressing their worries that demand “might not pick up in the second half of the year, when it is normally stronger”.

This week’s macro data include US and UK CPIs plus the release of the FOMC minutes on Wednesday, which, according to analysts, should continue to reflect sustained improvement of the US economy, “and could give us a better idea of the Fed’s policy normalisation plan”. The Jackson Hole Symposium will start on Thursday, gathering central bankers from all around the world. This year’s title for the meeting is “Re-evaluating Labour Market Dynamics”. The US Fed Chairwoman, Janet Yellen, will speak on Friday.

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Aug 05

Tough Investing in Stagflation Ahead

Gold Price Comments Off on Tough Investing in Stagflation Ahead
Blame the Keynesians. It’s always and everywhere their phenomenon…
 

ALTHOUGH it might seem odd for a school of economics to largely ignore the role of money in the economy, writes John Butler – investing author, previously head of the Index Strategies Group at Deutsche Bank, and now commodities CIO at Amphora – at the Cobden Centre, this is indeed the case with traditional Keynesian economics.
 
Declaring in 1963 that, “Inflation is, always and everywhere, a monetary phenomenon,” Milton Friedman sought to place money at the centre of economics where he and his fellow Monetarists believed it belonged. Keynesian policies continued to dominate into the 1970s, however, and were blamed by the Monetarists and others for the ‘stagflation’ of that decade – weak growth with rising inflation.
 
Today, stagflation is re-appearing, the inevitable result of the aggressive, neo-Keynesian policy responses to the 2008 global financial crisis. In this report, I discuss the causes, symptoms and financial market consequences of the new stagflation, which could well be worse than the 1970s.
 
During the ‘Roaring 20s’, US economists mostly belonged to various ‘laissez faire’ or ‘liquidationist’ schools of thought, holding that economic downturns were best left to sort themselves out, with a minimal role for official intervention. President Hoover’s Treasury Secretary Andrew Mellon (in)famously represented this view following the 1929 stock market crash when he admonished the government to stay out of private affairs and allow businesses and investors to “Liquidate! Liquidate! Liquidate!”
 
The severity of the Depression caught much of the laissez faire crowd off guard and thus by 1936, the year John Maynard Keynes published his General Theory, there was a certain open-mindedness around what he had to say, in particular that there was a critical role for the government to play in supporting demand during economic downturns through deficit spending. (There were a handful of prominent economists who did warn that the 1920s boom was likely to turn into a big bust, including Ludwig von Mises.)
 
While campaigning for president in 1932, Franklin Delano Roosevelt famously painted Herbert Hoover as a lasseiz faire president, when in fact Hoover disagreed with Mellon. As Murray Rothbard and others have demonstrated, Hoover was a highly interventionist president, setting several major precedents on which FDR would subsequently expand. But all is fair in politics and FDR won that election and subsequent elections in landslides.
 
With the onset of war and the command war economy it engendered, in the early 1940s the economics debate went silent. With the conclusion of war, it promptly restarted. Friedrich von Hayek fired an early, eloquent shot at the Keynesians in 1946 with The Road to Serfdom, his warning of the longer-term consequences of central economic planning.
 
The Keynesians, however, fired back, and with much new ammunition. Beginning in the early 20th century, several US government agencies, including the Federal Reserve, began to compile vast amounts of economic statistics and to create indices to aggregate macroeconomic data. This was a treasure-trove to Keynesians, who sought quantitative confirmation that their theories were correct. Sure enough, in 1947, a new, definitive Keynesian work appeared, Foundations of Economic Analysis, by Paul Samuelson, that presented statistical ‘proof’ that Keynes was right.
 
One of Samuelson’s core contentions was that economic officials could and should maintain full employment (ie low unemployment) through the prompt application of targeted stimulus in recessions. As recessions ended, the stimulus should be withdrawn, lest price inflation rise to a harmful level. Thus well-trained economists keeping an eye on the data and remaining promptly reactive in response to changes in key macroeconomic variables could minimise the business cycle and prevent Depression.
 
For government officials, Samuelson’s work was the Holy Grail. Not only was this a theoretical justification for an active government role in managing the economy, as Keynes had provided; now there was hard data to prove it and a handbook for just how to provide it. A rapid, historic expansion of public sector macroeconomics soon followed, swelling the ranks of Treasury, Commerce, Labor Department and Federal Reserve employees.
 
Notwithstanding the establishment of this new economic mainstream and a public sector that wholeheartedly embraced it, there was some dissent, in particular at the so-called ‘freshwater’ universities of the American Midwest: Chicago, Wisconsin, Minnesota and St Louis, among others.
 
Disagreeing with key Keynesian assumptions and also with Samuelson’s interpretation of historical data, Monetarists mounted an aggressive counterattack in the 1960s, led by Milton Friedman of the Chicago School. Thomas Sargent, co-founder of Rational Expectations Theory, also took part.
 
The Chicago School disagreed that there was a stable relationship between inflation and employment that could be effectively managed through fiscal policy. Rather, Friedman and his colleagues argued that Keynesians had made a grave error in largely ignoring the role of money in the economy. Together with his colleague Anna Schwarz, Friedman set out to correct this in the monumental Monetary History of the United States, which re-interpreted the Great Depression, among other major events in US economic history, as primarily a monetary- rather than demand-driven phenomenon. Thus inflation, according to Friedman and Schwarz, was “always and everywhere a monetary phenomenon,” rather than a function of fiscal policy or other demand-side developments.
 
By the late 1960s the dissent played a central role in escalating policy disputes, due primarily to a prolonged expansion of US fiscal policy. Following Keynesian policy guidance, the government responded to the gentle recession of the early 1960s with fiscal stimulus. However, even after the recession was over, there was a reluctance to tighten policy, for reasons both foreign and domestic. At home, President Johnson promised a ‘Great Society’: a huge expansion of various programmes supposedly intended to help the poor and otherwise disadvantaged groups. Abroad, the Vietnam War had escalated into a major conflict and, combined with other Cold War military commitments, led to a huge expansion of the defence budget.
 
In the early 1960s a handful of prescient domestic observers had already begun to warn of the increasingly inflationary course of US fiscal and monetary policy (Henry Hazlitt wrote a book about it, What Inflation Is, in 1961.) In the mid-1960s this also became an important international topic. Under the Bretton-Woods system, the US was obliged to back Dollars in circulation with gold reserves and to maintain an international gold price of $35 per ounce. In early 1965, as scepticism mounted that the US was serious about sustaining this arrangement, French President Charles De Gaulle announced to the world that he desired a restructuring of Bretton-Woods to place gold itself, rather than the Dollar, at the centre of the international monetary system.
 
This prominent public dissent against Bretton-Woods unleashed a series of international monetary crises, roughly one each year, culminating in President Nixon’s decision to suspend ‘temporarily’ the Dollar’s convertibility into gold in August 1971. (Temporarily? That was 43 years ago this month!)
 
The breakdown of Bretton-Woods would not be complete until 1973, when the world moved formally to a floating-rate regime unbacked by gold. However, while currencies subsequently ‘floated’ relative to one another, they collectively sank in purchasing power. The price of gold soared, as did the price of crude oil and many other commodities.
 
Rather than maintain stable prices by slowing the growth rate of the money supply and raising interest rates, the US Federal Reserve fatefully facilitated the Dollar’s general devaluation with negative real interest rates. While it took several years to build, in part because Nixon placed outright price controls on various goods, eventually the associated inflationary pressure leaked into consumer prices more generally, with the CPI rising steadily from the mid-1970s. Growth remained weak, however, as the economy struggled to restructure and rebalance. Thus before the decade was over, a new word had entered the economic lexicon: Stagflation.
 
Keynesians were initially mystified by this dramatic breakdown in the supposedly stable and manageable relationship between growth (or employment) and inflation. Their models said it couldn’t happen, so they looked for an explanation to deflect mounting criticism and soon found one: The economy had been hit by a ‘shock’, namely sharply higher oil prices! Never mind that the sharp rise in oil prices followed the breakdown of Bretton-Woods and devaluation of the Dollar: This brazen reversal of cause and effect was too politically convenient to ignore. Politicians could blame OPEC for the stagflation, rather than their own policies. But an objective look at history tells a far different story, that the great stagflation was in fact the culmination of years of Keynesian economic policies. To generalise and to paraphrase Friedman, stagflation is, always and everywhere, a Keynesian phenomenon.
 
Why should this be so? Consider the relationship between real economic activity and the price level. If the supply of money is perfectly stable, then any negative ‘shock’ to the economy may reduce demand, but that will result in a decline rather than a rise in the general price level. The ‘shock’ might also increase certain prices in relative terms, but amidst stable money it simply cannot increase prices across the board, as is the case in stagflation.
 
They only way in which the toxic stagflationary mix of both reduced growth and rising prices can occur is if the money supply is flexible. Now this does not imply that a flexible money supply is in of itself a Keynesian policy, but deficit spending is far easier with a flexible money supply that can be increased as desired to finance the associated deficits. Yes, this then crowds out real private capital, with negative long-term consequences for economic health, but as we know, politicians are generally more concerned with the short-term and the next election.
 
Contemporary examples provide support for the reasoning above. It is instructive that two large economies, Japan and France, have been chronically underperforming in recent years, slipping in and out of recession. Both run chronic budget deficits in blatant Keynesian efforts to stimulate demand. In Japan, where the money supply is growing rapidly, inflation has been picking up despite weak growth: stagflation. In France, where the money supply has been quite stable, there is price stability: That is merely stagnation, not stagflation.
 
The UK, US and Germany have all been growing somewhat faster. Following the large devaluation of sterling in 2008, the UK experienced a multi-year surge in prices amidst weak growth, clearly a stagflationary mix. The US also now appears to be entering stagflation. Growth has been weak on average in recent quarters – outright negative in Q1 this year – yet inflation has now risen to 4% (3m annualised rate). Notwithstanding a surge in labour costs this year, the US Fed has, up to this point, dismissed this rise in CPI as ‘noise’. But then the Fed repeatedly made similar claims as CPI began to rise sharply in the mid-1970s.
 
In Japan, the UK and US, the stagflation is highly likely to continue as long as the current policy mix remains in place. (For all the fanfare surrounding the US Fed’s ‘tapering’, I don’t consider this terribly meaningful. Rates are still zero.) In France, absent aggressive structural reforms that may be politically impossible, the stagnation is likely to remain in place.
 
Germany is altogether a different story than the rest of these mature economies. While sharing the same, relatively stable Euro money supply as France, the price level in Germany is also stable. However, Germany has been growing at a faster rate than most other developed economies, notwithstanding a smaller deficit. This is compelling evidence that Germany is simply a more competitive, productive economy than either the US or UK. But this is nothing new. The German economy has outperformed both the US and UK in nearly every decade since WWII. (Postwar rebuilding provided huge support in the 1950s and 1960s but those days are long past.)
 
The persistence of German economic outperformance through the decades clearly demonstrates the fundamental economic superiority of what is arguably the least Keynesian set of policies in the developed world. Indeed, Germans are both famed and blamed for their embrace of sound money and fiscal sustainability. ‘Famed’ because of their astonishing success; ‘blamed’ because of, well, because of their astonishing success relative to economic basket cases elsewhere in Europe and around the world. As I sometimes say in jest to those who ‘blame’ the Germans for the economic malaise elsewhere: “If only the Germans weren’t so dammed productive, we would all be better off!”
 
Stagflation is a hostile environment for investors. As discussed above, Keynesian policies require that the public sector siphon off resources from the private sector, thereby reducing the ability of private agents to generate economic profits. So-called ‘financial repression’, a more overt seizure of private resources by the public sector, is by design and intent hostile for investors. Regardless of how you choose to think about it, stagflation reveals previously unseen resource misallocations. As these become apparent, investors adjust financial asset prices accordingly. (Perhaps this is now getting under way. The Dow fell almost 500 points last week.)
 
The most recent historical period of prolonged stagflation was the 1970s, although there have been briefer episodes since in various countries. Focusing here on the US, although there was a large stock market decline in 1973-4, the market subsequently recovered these losses and then roughly doubled in value. The bond market, by contrast, held up during the first half of the decade but, as stagnation gradually turned into stagflation, bonds sold off and were sharply outperformed by stocks.
 
That should be no surprise, as inflation erodes the nominally fixed value of bonds. Stock prices, however, can rise along with the general price level along as corporate revenues and profits also rise. It would seem safe to conclude, therefore, that in the event stagflationary conditions intensify from here, stocks will outperform bonds.
 
While that might be a safe conclusion, it is not a terribly helpful one. Sure, stocks might be able to outperform bonds in stagflation but, when adjusted for the inflation, in real terms they can still lose value. Indeed, in the 1970s, stock market valuations failed to keep pace with the accelerating inflation. Cash, in other words, was the better ‘investment’ option and, naturally, a far less volatile one.
 
Best of all, however, would have been to avoid financial assets and cash altogether and instead to accumulate real assets, such as gold and oil. (Legendary investors John Exter and John van Eck did precisely this.) The chart below shows the total returns of all of the above and the relative performance of stocks, bonds and cash appears irrelevant when compared to the soaring prices of gold and oil, both of which rose roughly tenfold.
Real vs nominal asset prices in stagflation (Jan 1971 = 100). Source: Bloomberg; Amphora
Some readers might be sceptical that, from their current starting point, gold, oil or other commodity prices could rise tenfold in price from here. Oil at $100 per barrel sounds expensive to those (such as I) who remember the many years when oil fluctuated around $20. 
 
Gold priced at $1300 also seems expensive compared to the sub-$300 price fetched by UK Chancellor Brown in the early 2000s. In both cases, prices have risen by a factor of 4-5x. Note that this is the rough order of magnitude that gold and oil rose into the mid-1970s. But it was not until the late 1970s that both really took off, leaving financial assets far behind.
 
If anything, a persuasive case can be made that the potential for gold, oil and other commodity prices to outperform stocks and bonds is higher today than it was in the mid-1970s. Monetary policies around the world are generally more expansionary. Government debt burdens and deficits are far larger. If Keynesian policies caused the 1970s stagflation, then the steroid injection of aggressive Keynesian policies post-2008 should eventually result in something even more spectacular.
 
While overweighting commodities can be an effective, defensive investment strategy for a stagflationary future, it is important to consider how best to implement this. Here at Amphora, we provide investors with an advisory service for constructing commodity portfolios. Most benchmark commodity indices and the ETFs tracking them are not well designed as investment vehicles for a variety of reasons. In particular, they do not provide for efficient diversification and their weightings are not well-specified to a stagflationary environment. With a few tweaks, however, these disadvantages can be remedied, enabling a commodity portfolio to produce the desired results.
 
For those inclined to trade commodities actively, and relative to each other, there are an unusual number of opportunities at present. First, grains are now unusually cheap, especially corn. This is understandable given current global weather patterns supportive of high yields, but beyond a certain point producers are fully hedged and/or are considering withholding some production to sell once prices recover. That point is likely now close.
 
Second, taking a look at tropical products, cotton has resumed the sharp slide that began earlier this year. As is the case with grains, we are likely nearing the point where producer hedging and/or holding out for higher prices will support the price. By contrast, cocoa prices continue their rise and I note that several major chocolate manufacturers have recently increased prices sharply to maintain margins. That is a classic indication that prices are near a peak.
 
Third, livestock remains expensive. Hog prices have finally begun to correct lower but cattle prices are at record highs. There are major herd supply issues that are not easily resolved in the near-term but consumers are highly price sensitive in the current environment and substitution into pork or poultry products is almost certainly now taking place around the margins. Left to run for awhile, this is likely to place a lid on cattle prices, although I do expect them to remain elevated for a sustained period until herds have had a chance to re-build.
 
Fourth, following a brief correction lower several weeks ago, palladium prices have risen back near to their previous highs of just under $900 per ounce. Palladium now appears expensive relative to near-substitute platinum; to precious and base metals generally; and relative to industrial commodities. The primary source of demand, autocatalysts, has remained strong due to auto production, but recent reports of rising unsold dealer inventory in a handful of major countries, including the US, may soon weaken demand. In the event that the fastest growing major auto markets – the BRICS – begin to slow, then a sharp decline in palladium to under $700 is likely.
 
Finally, a quick word on silver and gold. While both have tremendous potential to rise in a stagflationary environment, it is worth noting that, following a three-year correction, they appear to have found long-term support. Thus I believe there is both near-term and well as longer-term potential and I would once again recommend overweighting both vs industrial commodities.
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