YEAR-END FISCAL/MONETARY SUMMARY – GOLD, AND THE GOLD MINERS, RE-ESTABLISH UPWARD TREND, WITH GOOD REASON!!

December, and the fourth quarter, continued in the same vein as the first three calendar quarters.  The operating leverage for the miners is starting to be recognized, since the move in mining stocks in December was more than double the 3.7% that gold bullion moved. It was a similar case for the year, with gold bullion up 17.9% and the miners up about double that. The most impressive relative move of the month was the last two days when the miners were up  2-3% with bullion up only 0.4%, so it is possible that this is the beginning of the still very depressed mining stocks catching up to the bullion price. The performance of our investment partnership, almost entirely invested in gold mining companies, mirrored that described above.

While bullion (at $1525/oz.) is down about 20% from its high of $1900/oz. (in 2011), the miners are down 50-70%, so the mining stocks could go up 100% or more with bullion rising 20-25% to the previous high. Since we believe that bullion will sell for something like $5,000/oz. within the next few years, you can see how our portfolio could multiply by many times the current price.

There is no reason to change our longstanding view that gold mining stocks have the most upside potential of any liquid asset class we know of. All the reasons we have been discussing for the last six years are only intensifying, and the potential reward for our patience has increased with time. You can review at your leisure our article written in August  of this year: THE CASE FOR GOLD – we are gratified that a true giant of the gold mining industry, Rob McEwen, who built Goldcorp, one of the largest and successful mining companies (recently merged with Newmont Mining),  has re-published (with our permission) our article on the website of his young company, publicly traded McEwen Mining (MUX). . Maybe we know something, after all 😊

Our many articles on this subject, largely summarized in THE CASE FOR GOLD, are hereby augmented with the following thoughts regarding Inflation, Central Bank Gold Purchasing, US Deficits and Cumulative Debt, Interest Rate Expectations and Worldwide Economic Trends.

INFLATION, which is supportive of the gold price, is not dead, as widely assumed. The apparent absence of inflation, as measured by the Bureau of Economic Statistics, has provided comfort to the PHDs at central banks. However (1) the price indexes that are quoted, inexplicably excluding food and energy which are consumed daily, have been manipulated periodically to put a false face on reality. Among other benefits to our government, understated inflation provides an insufficient increase to entitlements such as social security payments (2) Though certain imported apparel prices and some consumer electronics have not increased in price, asset prices (explicitly targeted by central banks), including stocks and bonds and prime real estate and collectibles have made the rich richer while the middle class strains to make ends meet. Inflation is with us when a Van Gogh painting sells for $240M or a NYC coop sells for over $100M. The super rich are purchasing iconic items which they know will command a premium price long into the future, as opposed to holding the colored paper that they know will have a tiny fraction of its current purchasing power. Even an understated 2% annual inflation rate destroys 50% of your purchasing power in 35 years. A 1971 dollar is worth about $0.15, a 1913 dollar is worth less than $.03. That Van Gogh or Central Park South penthouse will do better than that. The chart below shows how big ticket items, where the money is spent, have inflated over the last twenty years at rates well above those reported by our Bureau of Economic Analysis.

CENTRAL BANKS INCREASE GOLD BUYING, and the inevitable ramifications are becoming more obvious. Central Banks, most notably China and Russia, are buying physical gold at a record rate in 2019, at the same time reducing US Treasury Securities as a percentage of their reserves. Central banks collectively, even with China’s understated purchases, are now absorbing more than 20% of annual worldwide gold production. Furthermore, an increasing amount of trade is taking place between China, Russia, and the Mideast, conducted in terms of Yuan and Rubles and Gold, and the ounces of Gold it takes to purchase a gallon of Oil may indeed be a very important guidepost that determines the future relationship between various currencies. With geo-political-trade tensions so high, nothing would please the Chinese, the Russians, or the Saudis more than an ability to conduct more of their business in something other than US Dollars. Well connected sources are increasingly suggesting that China, combining the gold ownership of its many government agencies, likely owns upwards of 20,000 tons of physical gold, rather than the 1,900 tons owned by the Peoples Bank of China, which they report. This dwarfs the 8,100 tons the US has owned since 1971. Russia, with their rapidly increasing 2,200 tons, is the largest owner relative to the size of their economy and currency and most able to implement some sort of a gold related monetary system if they were so inclined.

There are reports of international discussions relating to a new “reserve currency”, joining or even replacing the US Dollar. The Bretton Woods Agreement of 1944 assumed the US would maintain the “value” of the US Dollar by backing it with gold. The USA has blatantly abused its trading privilege during the last 75 years by “closing the gold window” in 1971, generating annual operating deficits in 35 out the last 39 years, running up $23 trillion of debt (excluding tens of trillions of unfunded entitlement)  and printing $4 trillion of fresh (fiat, i.e.unbacked) money by our Federal Reserve Bank. International monetary circles are starting to consider a new monetary “approach”, and worldwide central banks may be anticipating that likelihood by way of their physical gold purchases.  We believe that China could announce, almost any time, a new form of currency, perhaps a so called crypto-currency, backed by upwards of 20,000 tons of gold. At the same time, a new base price for gold bullion at $5,000/oz. or more would be supported by the Chinese.

The current worldwide fiscal/monetary “promiscuity”, unbacked paper currencies being diluted into oblivion by the politicians of the day, cannot go on indefinitely without predictable ramifications. When a trend cannot go on, by definition, it will not. We view gold as re-emerging as the true currency, the store of value and unit of exchange it has been for 5,000 years. Central banks, including our most direct political and economic adversaries, get it. The public in China and India get it. Investors in North America hardly at all, some might say “whistling past the graveyard”. It’s going to be interesting.

THE FEDERAL DEBT is north of $23 trillion in the US, also growing rapidly in the other largest trading nations in the world. We’ve pointed out many times that the debt is increasing even more than the annually budgeted operating deficits would imply. This can only happen with governmental accounting. The difference is due largely to the federal government borrowing from the social security trust fund. In the fiscal year ending 9/30/19, for example, the operating deficit was $984B but “off budget” spending, financed by the social security system which is itself approaching insolvency, took the cumulative debt up an extra $206B, from $21.97T to $23.16T. This is not “one off”, it happens almost every year and is to be expected. Therefore, we can expect the total deficit in the fiscal year ending 9/30/20 to be something like $24.5T, on its way to $26T by the time the newly elected president takes office in January,’21. This assumes that there are no economic disruptions, and a recession, with lower tax revenues and larger deficits are out there somewhere. All of this is very important because, the larger the debt the more difficult economic growth becomes. Whether we’re talking about an individual, a family, a company or a country, the more effort it takes to service debt, the less investment can be made in productive pursuit. Our economy and other major worldwide economies will therefore continue to be kept afloat by central bank financial creativity. It will work until it doesn’t, and will inevitably be accompanied by many unintended painful consequences.

INTEREST RATES are not going to change much in the foreseeable future. Interest payments on the debt are barely tolerable only because rates are so low. Every increased point (100 basis points) of extra interest equates to $230B of extra interest as current bonds mature, and over 50% of our outstanding debt is under 5 years. This extra interest would be a material increment and would squeeze out potentially productive government spending. Higher interest rates, which the US Fed tried briefly a year ago, stopped our economy and the stock market in its tracks, and the policy was quickly reversed. The US economy has stabilized currently but GDP growth is projected to be no more than a tepid 2% this year, even less than it was a year ago when slightly higher interest rates took their toll. The only way interest rates could rise by much is if the Federal Reserve, and other central banks, lose control over the situation and this would be a sign of impending financial chaos. Lower interest rates are possible, but the 10 year treasury note is under 2%, and the marginal benefit of lower rates from here is debatable. Negative interest rates on something like $13T of sovereign debt is a fact of life, but that approach has its own set of unintended consequences, and adoption by the US Fed would clearly be a sign of desperation. Give or take 50 basis points, we believe interest rates are “range bound” for the next year or two.

WORLDWIDE ECONOMIC TRENDS support our contention that worldwide central banks, in support of local economies, will maintain low interest rates interest rates, which provides a major tailwind for our portfolio. Headlines in the Wall Street Journal today, January 2, include (1) Asian Economies Must Brace for Chill Wind From China (2) Japan’s Lost 30 Years (with debt going to 250% of GDP) Give Pause to Those Looking at U.S. (3) Japan Has Gone from Growth Market to Bargain Rack (4) ‘Japanification’ Haunts Slow Growth Europe (5) Latin America’s ‘Oasis” Descends Into Chaos. As Wendy’s put it, thirty years ago: “Where’s The Beef”.

PUTTING IT ALL TOGETHER, we’re certainly pleased that our gold mining oriented investment partnership provided positive results in December, the 4th quarter, and the year.  The mining stocks have just begun to gain investment traction. It seems that, until now investors and analysts have not believed that gold at $1400-1500 per oz. is here to stay. They have been therefore unwilling to adjust upward their estimates of gold reserves, mine lives, earnings and cash flow expectations for the gold mining companies. Gold bullion prices have now clearly broken out on the upside from their six year “consolidation” and the possibility (we call it a likelihood) of a big upside move now comes into view. We can therefore expect upgraded expectations and higher valuations.

There have been virtually no major new gold reserves discovered in the last ten years, and new mines take many years to get permitted. Higher prices will allow expanded mining of some lower grade reserves by established companies but will not allow new mines to come onstream for many years. Existing miners have made major progress in cost control over the last few years and are in a position to improve cash flow and profits dramatically, even at current prices. Operating results for the quarter ending 9/30/19, the first quarter in eight years that the gold price was something like $200/oz. higher than a year earlier, have begun to demonstrate the operating leverage that is in place. We believe that the bull market in gold and gold mining stocks has resumed and the upside potential is very substantial.

Roger Lipton