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The capital markets were volatile in February, stocks down, bonds down, gold bullion down 2.1%, the gold miners were down more (the gold mining ETFs, GDX: down 10.1%, GDXJ: down 6.8%, the three prominent gold mining mutual funds, Tocqueville, Oppenheimer, and Van Eck, down an average of 8.3%). Our gold related portfolio modestly outperformed the group, down a little less. However, the fundamentals described below continue to support our positioning.

The most prominent fundamentals that come to mind are:

(1) Central Banks, notably Russia and China, continue to accumulate gold bullion. The Central Bank of Russia bought another 20 metric tons in January, increasing its holdings every month since March 2015. Their official holdings, at 1857 tons now exceeds the announced reserved at the People’s Bank of China, but China hasn’t told us in almost two years (how much gold they hold. In  mid -2015, they announced an increase of about 600 tons (over the previous 6 years) to 1,658 tons, and then announced monthly increases for about six months thereafter, reaching about 1800 tons, at that point, officially. However,  China produces the largest amount of gold in the world, at over 350 tons annually (out of 300 tons mined worldwide), and none of it leaves the country, purchased by various Chinese government agencies. Informed observers (include ourselves) therefore believe that their agencies now own double or triple (or more) than indicated.1658 tons. In total, worldwide Central Banks (without China) continue to accumulate about 400 tons per year, as they have since 2009. It is interesting to note that Central Banks have bought 4-5 times as much gold in the last five years as they have US Treasury securities. That trend seems to be continuing. At the same time, new trading arrangements are taking place between China, Russia and the Mideast, with swap arrangements based on the relative prices of Chinese Yuan, gold bullion and oil. It will obviously benefit China and Russia, in lots of ways, if gold trades at a higher level.

(2) The US debt burden, annual and cumulative, is going up, big time, once again. We have written repeatedly that the annual stated deficits are understating the annual increase in total debt, because of “off budget” expenditures. Over the last nine years, while the reported deficits have totaled $7.5 trillion, the debt went up by $10.2 trillion, an understatement of a cool $2.7 trillion. It is now clear that the “reported” deficit in the US fiscal year ending 9/30/18 will, at the very least, approach $1 trillion, and be well above that number in fiscal ’19. It is anybody’s guess what the actual increase will look like, since DJT is not afraid of debt. When the deficit took off in 2009, the price of gold went up over 50% in the next two years and the gold mining stocks more than doubled. It is interesting that the GDX is at the same level today ($21-22/share) with gold bullion at $1310, as it was in early 2009 when gold was well under $1000, so the upside is that much greater.

(3) We wrote last month about how short term US interest rates have moved sharply higher, almost to the day when the US Fed started to unwind their bloated balance sheet. The pace was a modest $10B per month in Q4’17, going to $20B per month starting January ’18, then $30B per month in Q2, $40B per month in Q3, and $50B/mo. in Q4. Considering that the debt markets will not be supported by the Fed, as opposed to several years ago, we speculated that this will be an increasing burden over time, helping to push rates higher. So here is a day to day reading of the treasury market, courtesy of Gran’ts Interest Rate Observer. On Tuesday, two days ago: “a $60B auction of four week bills was priced to yield 1.495%, the highest since September 2008…..a $22B auction of 52-week bills fetched 2.02%, the highest since the 52-week auction was reintroduced in June 2008…the economist at Jefferies commented that: ‘the surge in bill supply has caused the market to cheapen up…there’s value in the yield. How much cash is there to absorb it?'”

By the fall of ’18 there will have been a trillion dollar swing, year to year, in terms of Central Banks supplying securities to the market rather than buying. On top of that, the US will be financing a trillion dollar annual deficit as well as rolling over a couple of trillion dollars of maturing short term securities. Personally, I don’t know whether the worldwide economy will be strong enough to provide the liqidity to absorb the anticipated supply of fixed income securities, but it sure seems like a question worth asking. Maybe this is one reason that central bankers continue to accumulate more gold than US fixed income securities.