SEMI-MONTHLY FISCAL/MONETARY REPORT – THE VIRUS IS CONTROLLABLE, THE FED IS NOT !
FOREWORD: This report is early because major developments are practically daily, all very supportive of higher gold prices. Gold bullion, and the gold miners are up sharply this month. Relative to our Investment Partnership, RHL Associates, LP (almost entirely invested in gold mining stocks): Considering the pace of news and the volatility of prices, new investors (minimum $250,000), or additional investment by existing investors (no minimum), will be allowed to add funds as of closing prices on Wednesday, April 15th. If interested, call at 646 270 3127 or email at email@example.com. (This is not a solicitation, which can only be made by way of an offering circular, to be provided.)
We have long held the view that the worldwide economy has been built, for forty years but especially over the last ten years, on an increasingly dangerous foundation of credit and debt. The necessary financial measures to deal with the current health crisis are being imposed on a system that is already loaded down with far too much debt, short term and long term. With interest rates artificially suppressed, many trillions of dollars have been mis-allocated as investors in both equity and debt have reached for yield in increasingly risky ventures. Governmental deficits, after ten years of steady, if tepid, worldwide growth, were already approaching record levels. The US Federal Reserve asset base, which expanded from $1T to $4.5T to cope with the last financial crisis in ’08, had been lately reduced to only $3.7T. So much for Keynesian economics, where the central bank stimulates the economy in bad times, and removes the stimulus in better times. The result, predictably, is that there is now no margin for error.
Less than six weeks ago, on March 3rd, when the coronavirus crisis was just emerging, we said:
“It is important to note that the monetary stimulus that supported the worldwide economy ten years ago……will of necessity be dwarfed by today’s needs.
“Today’s starting point for the Fed balance sheet is just over $4T and the ending point could be $10T. It always takes more (financial) heroin to maintain the (monetary) high.
” Our conviction is that the Fed, and the other Central Banks around the world have become impotent. Each round of stimulus the last twenty years has been increasingly less effective in stimulating growth. It is called a “diminishing marginal return on investment”. Monetary stimulus has run its course. It then falls back to the need for more fiscal stimulus, in the form of tax cuts, etc. That will have a limited effect, also, but will explode the deficit.”
WE WERE WRONG: WE SUBSTANTIALLY UNDERESTIMATED THE NEED
The US government (followed by others worldwide) are throwing trillions of dollars around like confetti. We are together watching the daily news as everybody, large and small, is being supported for an indefinite period. (Turns out that Bernie Sanders didn’t have to get elected.) The Fed assets are already over $6T, up almost $1T in the last two weeks alone. Ten trillion dollars is the consensus, but our bet is at least $15T within a year, and more later. They have to purchase most of the US Treasuries that will be sold to finance a US operating deficit that will be something like $4-5T this year. They are also buying securities of all types, including High Yield Debt, Mortgages and Municipal Bonds. Since capital gains tax receipts are important to cities, states, and the Federal government, their absence will compound the problem for all. We have seen no discussion yet on the news about the $6T of underfunded pension liabilities, which the Fed will be called upon in a declining stock market.
ONE YEAR AGO, ON 4/15/19, WE WROTE AN ARTICLE ABOUT INTERVENTION IN NORMAL SUPPLY/DEMAND RELATIONSHIPS, E.G. GOVERNMENTS NOT ALLOWING FOR TRUE “PRICE DISCOVERY” . PART OF THE ARTICLE IS AS FOLLOWS:
“Where are we in this process ?? In addition to the negatively yielding fixed income government securities, the Bank of Japan (that has been doing this for almost thirty years) now owns about $250 billion of Japanese ETFs, or 75% of that entire market of ETFs. On the fixed income side, the Bank of Japan owns about 45%, or $4.5 trillion worth of all the Japanese government bonds outstanding. With it all, the Japanese economy is still running well below 2% real growth, with inflation at well under the 2% objective. It is of course an important sub-text that central banks worldwide are trying to stimulate inflation, rather than subdue it, which was the original objective. Closer to home, we have been informed that our Fed is abandoning QT, preparing for a new form of QE, which, some have suggested, could include the purchase of US equities as well as bonds.
“Here’s a quick economic lesson for the hundreds of PHDs that are working within central banks. Don’t intervene in a market unless you are prepared to BUY IT ALL, because you will, eventually. Witness the holdings of the Bank of Japan, who have been at this game the longest, still without the result they have been reaching for. Aside from a long list of unintended consequences that have yet to play out, the attempt to lighten the inventory, (Sell to whom?) has just been demonstrated in the US. One down month in the stock market (December ’18) with the two year treasury rate approaching 3% and the US Fed caved. Whom do you think the Japanese Central Bank can sell to?”
BACK TO TODAY, APRIL 13, 2O20
Governments and Central Banks, around the world, are doing precisely what is described above, buying all kinds of securities at prices higher than the free market would call for. The end result is that they will own it all. The previous owners are getting a gift, with an unnaturally high price.
CONCLUSION AND STRATEGY
It’s been said that “In every crisis, you can look like a fool either before, or after”. The fiscal/monetary trends we have been “foolishly” describing “before”, along with the predictable consequences, are now being all too vividly demonstrated. However, there is another, unexpected by all of us, consequence.
The long term trend of increasing deficits and increasingly sluggish growth (burdened by the higher debt) is now being compressed in time and very substantially magnified. What might have played out over ten years is now taking place in a matter of months. The Fed balance sheet, for example, which we always believed would get to $10T, perhaps in 5-7 years, will now get there late in 2020. Operating deficits, scheduled to grow steadily in the 2020s from comfortably over $1T this year to $2T or more by 2030, will now have a much higher baseline. Just as we have said, however, the economy will be far too burdened by debt to grow strongly, if at all. There may well be a short term rebound when the cabin fever breaks, but it will be short lived. Consumers will have been traumatized. Businesses will be trying to rebuild balance sheets, and there will be new rules for all to play by.
Stock investors, at Thursday’s closing prices , have generally given back about five years of gains, and could give up the previous five as well if there is another downleg.
On the other hand, gold, the “real money” has protected purchasing power over the very long term. Gold bullion after bottoming several years ago at $1050, has been steadily higher and is now selling only about 15% below its all time high of $1900 in 2011. Our preference, the gold mining stocks, have not done as well since 2012, still down more than 50% from their highs in 2012. Our choice has been admittedly costly, but we wanted the operating leverage that the mining companies provide with a rising gold price. This continues to be the case, and we think the upside opportunity in the gold mining stocks is greater than ever. Coming off the lows of early ’09, gold bullion doubled in price and the miners more than quadrupled. The opportunity is even larger today since (1) balance sheets are better (2) management teams are improved (3) energy prices represent 15-20% of operating costs. Crude oil was between $80-120 per barrel back in ’09-’11, now a fraction of that, so profits at these higher gold prices will be that much more impressive.
We have been heavily invested in this area for 6-7 years, writing on this subject for the last four years. The articles are available, for FREE, on this website.
We believe that gold bullion will go up 3-4x or more and the gold mining stocks by a multiple of that. We can not think of any other asset class that offers nearly as much opportunity. We had previously thought that this would play out over perhaps five years, we now believe that it could be a much shorter time frame.