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SEMI-MONTHLY FISCAL/MONETARY REPORT – RISING DEFICITS, EVEN FASTER RISING DEBT – “WE’VE ONLY JUST BEGUN”

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SEMI-MONTHLY FISCAL/MONETARY REPORT – RISING DEFICITS, EVEN FASTER RISING DEBT – “WE’VE ONLY JUST BEGUN

September was basically flat in the equity markets, the Dow and S&P up slightly, the Russell and NASDAQ Composite indexes down a bit. Gold bullion and the gold miners were very, very quiet. Gold bullion was down 0.6%. The large and small gold mining ETFs, GDX and GDXJ, were down 0.2% and 1.1% respectively. The three gold mining mutual funds that we track, TGLDX, OPGSX and INIVX were up an average of .015%. The adjustment of the Vanguard Precious Metals Fund, which we discussed last month, has apparently run its course by the end of September, with them selling something like $1.5 billion of mining stocks. The last time they did this, in 2000, it was just prior to a twelve-year bull market, during which gold bullion went up six times in value and the mining stocks by a multiple of that.

We discussed last month how the price of gold has generally followed the increase in US debt, which itself is a precursor of an increase in inflation, the only politically acceptable way of dealing with that debt. In August, 1971, Richard Nixon closed the “gold window” because the prospect of rising deficits were creating “a run” on the US gold reserve. The price of gold went from $35 to a high of $850 per oz. in the 1970s. The gold price went from $250 to just under $1000 per oz. between 2000 and 2009 with the rising deficits created by the aftermath of 9/11 and the cost of two wars. The move from the 900s to a high of 1850 between 2009 and 2011 took place as the deficits rose sharply in the early years of the Obama administration. The decline since 2011 has coincided with less concern, misguided as shown below, over rising deficits. We want to “close the loop” with specific facts about deficits and debt over the last eleven years. In summation, the annual “deficit” has come down materially less than advertised, is now going up materially more than presented, and the result of annual deficits, namely the cumulative debt burden is a larger problem than ever before.

The following table shows, over the last eleven years, the stated annual deficit, as well as the year end debt. The increase in debt has far exceeded the reported deficit. Over eleven years, the difference is a monstrous $3.24 Trillion. It is interesting that in fiscal 2014 and 2016, two of the four years (from ’13 to ’16) when the annual deficit was so widely advertised as being “reduced”, the debt somehow went up by an “extra” $1.39 trillion, from what we call “non-budgeted” spending.

As the following table shows, the stated deficit for the fiscal year ending 9/30/18 will be something like $830 billion. The increase in the debt, however has been $1.29 trillion, with an extra $460 billon “needed”. It is interesting that the 9/30/19 Congressional Budget Office estimates when presented in Feb’17 called for a deficit of $526 billion. By Feb’18, the 9/30/19 estimate had been increased to $984 billion. Just yesterday, the official CBO estimate is now $1.085 trillion for the next twelve months, ending 9/30/19. Based on (1) the historical pattern (2) the obvious spending needs for defense, higher interest rates, health care and other entitlements, storm remediation, etc. (3) the current administration’s conviction that you have to “spend money to make money” and lack of fear of debt: we will “bet on the over” in terms of the cumulative debt growing materially more than $1.085 trillion deficit forecast. The CBO estimates, by the way, call for increasingly large numbers beyond fiscal ’19.

There is, lately, a bit more concern by the politicians, economists, and pundits about the reported and projected deficits and cumulative debt. However, because the inflation, as presented by government statistics, has been modest, the general assumption is that it can be “controlled”, and as, Dick Cheney suggested, the “deficits don’t matter”. Others (such as Stanley Drukenmiller, Ray Dalio and Howard Marx)  have said something like  “ignore history at your own peril”, and we are in that camp. In terms of the deficits: as the song goes “We’ve only just begun”.  We believe there will soon be a major price to be paid for the financial promiscuity of politicians and central bankers in recent decades, especially during the last ten years.  Governments can’t print their way out the problem. One doesn’t get out of a hole by continuing to dig.

We continue to believe that, as the distortions within the worldwide financial system become more apparent,  the gold price will catch up with the inflation of most other asset classes, and the gold mining stocks will move by a multiple of the gold price.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – SLUGGISH GDP, FED NORMALIZATION BEHIND SCHEDULE, GOLD THREATENS AN UPSIDE BREAKOUT

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – GDP GROWTH SLUGGISH, FED BALANCE SHEET COMES DOWN-BUT BEHIND SCHEDULE, GOLD PRICE READY FOR UPSIDE BREAKOUT?

THE ECONOMY

It now seems clear that Q1’18 will not demonstrate a pickup in the economy. After 2.9% real GDP growth in Q4’17, lagging the much heralded 3% plus in Q2 and Q3’17 (Q3 aided by reconstruction activities after the storms), it now seems clear that Q1’18 will be closer to 2% than 3%. Recall that Q4 consumer spending, which included the best Christmas season in at least five years, included record high consumer credit card debt (with an increasing incidence of default) and a reduction of the consumer savings rate down to about 3% of household income, not the healthiest combination for longer term spending expectations. Sure enough, the first quarter of ’18 seems to be characterized by slightly higher consumer savings, as the public is still burdened with high health care, rent, and education costs. We saw a chart recently that indicates that about 33% of 25-29 year olds are living with parents or grandparents, up from about 26% in 2010. No doubt many of these Millennials are coping with the burden of student loans. Surveys indicate that many consumers are going to apply savings from the new tax bill against debts, rather than increase spending. Economic spokespersons (i.e.Kudlow, Mnuchin, etc.etc.) continue to predict that the tax bill will stimulate faster GDP growth and much higher tax revenues, in time reducing the federal debt burden. Time will tell, obviously, but the jury is still out, and the signs are not convincing so far.

FEDERAL RESERVE NORMALIZATION PROGRAM

The US Federal Reserve continues to “normalize” the bloated balance sheet, but is running behind schedule. Recall that the plan called for $10B/month reduction in Q4, $20B/month in Q1, $30B/month in Q2, $40B in Q3, $50B in Q4’18, and that’s as far as described. The plan fell behind schedule by $23B in Q4, fell another $4-10B behind plan in Q1 (depending on whether you use 3/28 or 4/4), so was $27-33B behind schedule as of 3/31, a significant percentage against the $90B that was scheduled. In the first week of Q2, ending 4/11, the Fed’s balance sheet was essentially unchanged. The rubber meets the road now with a reduction of  $30B monthly. Since the Fed’s activities affect short term interest rates rather than longer term, it could be instructive to look at what the bellwether ten year treasury note has done over the last six months. During Q4, as the Fed got $23B behind their $30B objective, the ten year traded between at 2.35% to 2.45%. The Fed stepped up their selling in Q1, meeting their quarterly objective (though not catching  up) and the ten year moved dramatically, from just above 2.40% to as high as 2.95% and closed Q1 at about 2.75%. So far in Q2, the ten year has traded back up to 2.85% as this is written.  The more volatile two year treasury, which bottomed around 1.3% in midSeptember, has moved in a straight line to 1.9% at 12/31, 2.27% at 3/31, and 2.38% today. These are very dramatic moves, and the pace of “normalization” continues to quicken. Time will tell what affect $30B/month of Fed “runoff” has on interest rates, but the possibility exists that rates could spike higher, especially if the Fed tries to catch up with the shortfall to date of about $30B. If interest rates spike upward in Q2, as they did in Q1, it could  be unsettling to capital markets that are already showing volatility that we have not seen in years

GOLD UPDATE

Gold has been “consolidating”, around $1350/oz., up 3-4% for the year, fairly firm day to day, seemingly threatening to break out on the upside. No doubt the increasing visibility of federal debt accelerating to over $1 trillion annually as far as the eye can see, is contributing to the interest, as well as the possibility of increased inflation. Since Central Banks, worldwide, are trying to stimulate inflation, it stands to reason that they would be continuing to purchase gold bullion, which they are. Market technicians, chartists, point to $1,375 and $1,400 per ounce as “breakout” levels on the upside. After a 4-5 year consolidation, some observers think gold bullion could make a move to new all time highs, above $2,000/oz. From our standpoint, the gold miners seem to be the most advantageous way to participate, since the gold mining stocks are even more depressed in price than the metal itself. The last time gold bullion was around $1,350/oz., in mid 2016, the gold mining stocks were about 35% higher. If the price of gold breaks out on the upside, the gold mining stocks should do even better.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – TAX “REFORM” LOOMS – CAN ECONOMY OVERCOME DEBT LOAD?

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – TAX REFORM LOOMS – CAN ECONOMY OVERCOME THE DEBT LOAD  ???

FOREWARD:

The general equity market continued strong in November, so there was no perceived need for a “safe haven” or “non-correlated” asset. Our precious metal portfolio was close to flat,  tracking the mining indexes almost exactly. GDX (the large miners) was flat, GDXJ (the smaller miners) was down 1.1%, TGLDX and OPGSX (Tocqueville and Oppenheimer) gold funds were down exactly 1.0%. So the beat goes on, and our conviction has not changed. We don’t know when the turn for precious metal holdings comes, obviously, but it is going to be dramatic. There is  no need to be “promotional” on this first fiscal/monetary post to be available  on the Restaurant Finance Monitor website. However, I am sufficiently convinced that a turn is near that we are accepting new investors into our investment partnership, with a reduced fee structure, for the first time since we began transitioning to a “gold fund” four years ago. We should interject here, to be legally compliant,  that this statement is not to be construed as an offering, which can only be made by way of an offering circular.

THE BACKGROUND

Nobody needs to tell me how painful it is to not be participating while the financial world “dances”.  Back in 1998 and 1999, our investing partnership was not benefiting while the dotcom mania roared. On January 1, 2000 I wrote that “we have seen this movie before, and know how it ends.” From March of 2000, when the dotcom bubble burst, our portfolio more than tripled over the next five years or so. The distortions within the financial markets today are must larger, and worldwide, in scope.

We could go back to the tulip mania of the 1600s, the Mississippi bubble in France and the South Sea bubble in Britain of the 1700s, but much more recently: the Japanese stock market peaked at 40,000 in 1990, descended to under 10,000 fifteen years later and still trades about 50% from that high; the dotcom mania of 1998-1999 was a “new paradigm”; and housing prices couldn’t come down, according to Ben Bernanke, Fed Chairman. The TV commentary was just as positive on 1/1/2000 and 6/30/2008 as it is today. Whatever modest strength there is in the worldwide economy has been supported by over TEN TRILLION DOLLARS of newly printed currency by the major Central Banks. It would be great if prosperity were that easy to create. The unintended consequences are still to come.

At the moment, with taxes and deficits all over the news cycle, it may be useful to reflect upon the fact that gold prices made their last major move, doubling in price from 2008 to 2011, just as it became clear that the annual deficits and cumulative debt were going nowhere but UP. The last several years, as there has been less concern about deficits, the gold price has in fact “consolidated”, but as described below: here we go again.

First, recall that, as we described a year ago, over the nine years ending 9/16, the reported annual deficits were a total of $7.755 trillion. However, the cumulative debt increased from $9.0T to $19.4T, an increase of $10.4T. So, as disturbing $7.755T of deficits are, an extra $2.64T (a lot of money) was spent, somehow “off budget”, capitalized “investment”, or whatever. The cumulative US debt was 20.24 at 9/30/17, up $700B from a year earlier, though Congress approved $503B in February 2016.

I am not making this up.

The site: www.usgovernmentspending.com, describes it this way: “People naturally assume that the annual Deficit is the total that the Federal government borrows each year. Actually, this is not so. The Deficit is simply the difference between the Federal Outlays and Federal Receipts. Usually the Feds borrow a lot more than the annual Deficit. The difference is “Other Borrowings”. Only in D.C. I have provided here the link to the “Spending Details”. Honestly, I can’t make sense of it, but the result is clear. https://www.usgovernmentspending.com/numbers The reason that increasing debt cannot be ignored is that the higher the debt load that any organization carries, the more difficult it is to invest for the future. This applies to an individual family unit as well as a government. A classic book, “This Time is Different. Eight Centuries of Financial Folly”, written by Reinhart and Rogoff in 2011, researched hundreds of situations over eight centuries, showing that when a government’s debt exceeds about 100% of their Gross Domestic Product, it becomes a serious burden on the ability to grow. The United States debt is now about 105% of our GDP, and that could be one of the key reasons that we have been stuck in a 2% economy for the last ten years. Some observers counter that Japan, after all, has a debt load that is 260% of their GDP, and their economy hasn’t collapsed, so our debt is modest in comparison. True enough, but their stock market is still down 50% from its high 28 years ago, and their government is frantically printing money to avoid a deflationary collapse. Right now, the Japanese government is buying $60B of securities, monthly, to keep interest rates low and try to stimulate their economy. Since their economy is one third our size, that would be the equivalent of us printing $180B monthly, over $2 trillion annually, which would not be viewed favorably by capital markets if it were necessary here.

The Current Situation – Talk about “Fake News”

This is what politicians “do”: The new tax proposals and budgeting discussion revolves around limiting the tax reductions (and therefore the potential “increase in the debt”) to $1.5 trillion over ten years. The Republicans, of course, are arguing that a better economy, scored “dynamically”, will “reimburse” the theoretical deficit with offsetting tax revenues. That debate aside, this whole discussion leads one to think that the $20.5 trillion today shouldn’t be allowed to be more than $22 trillion a decade from now. WRONG. What nobody tells you is that the $1.5 trillion increase is on top of the already budgeted TEN TRILLION DOLLAR increase based on present expectations by our Congressional Budget Office. (This is the so-called “baseline”, but you haven’t heard that word uttered by either political party). The current “baseline” debt is projected to increase roughly $1 trillion dollars every year over the next ten years. The debate therefore is not whether the debt is going to go from $20.5T to $22.0T, but whether it will go from $20.5T to $30.5 or $32.0 Trillion. Keep this in mind as you watch the celebratory dance of the Republicans after the tax reform, such as it is, becomes law. The Democrats will be screaming about the new Ponzi scheme, but it’s just like the old Ponzi scheme.

BACK TO THE FACTS

Of course there are lots of assumptions built into all these projections, and they could be materially inaccurate. Unfortunately, governmental agencies are notoriously overly optimistic, and spending is usually higher than projected, as described above. In the current fiscal year, ending 9/30/18, the CBO projection is an increase of $1.03 trillion. With spending on the storms, higher defense spending, higher health care expenses, I’ll take the “over” side of the bet on the size of this year’s deficit. As a corollary to this discussion, think about the fact that it is only the very low interest rates that have allowed us to carry the $20 trillion without blowing up the deficit even further. If interest rates should be higher, along with an additional $10 trillion (or whatever) of debt, the prospect of ever reducing the total debt burden is really remote. If Reinhoff and Rogart’s “This Time is Different” is even only directionally correct, we’re “screwed”.

As far as the proposed tax cuts stimulating the economy through lower taxes for the middle class, it is now clear that that many of the tax cuts will affect the wealthier citizens (which is what the Democrats have been screaming). The details currently in play are in a continuous state of flux and too numerous for us to analyze, and the House and Senate proposals are about to be modified further, no doubt further muting the potential benefits of this “huge” tax reform. Overall, however, we don’t expect the final “reform” to substantially stimulate the economy through better middle class consumer spending. Maybe on the business side. In terms of public discretionary spending, it will continue to be burdened by higher health care, education and housing expenses.

The public subsidies will continue, deficit spending will be at an increasing rate for the foreseeable future, and the much higher governmental debt load will be a drag on the desired economic growth. If there is any part of the current administration’s agenda that will work, it will be the reduced administrative burden, which is being implemented by executive order rather than legislation. We fear, unfortunately, that with an incomprehensible amount of debt. It could prove impossible to grow the economy faster than the debt load and achieve, in essence, “escape velocity”.

All of this is to say that there will be no political will to reduce deficits or debt, “normalize” interest rates, or implement the necessary adjustments to “the swamp”. The capital markets, including the ridiculous cryptocurrency mania, will adjust to more realistic economic expectations. Gold, the most “unloved”, the screaming “bargain” among asset classes, will “catch up” at some point soon. Bargains are always unloved at the bottom. Our ownership of the gold miners should benefit by a multiple of whatever the gold price does. The “money” is in the ground, so it is just a question of when it gets monetized by the mining process.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD “CONSOLIDATES” AS INVESTORS FEAR RATE HIKE – “PLAY IT AGAIN, SAM”

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SEMI-MONTHLY MONETARY UPDATE – GOLD “CONSOLIDATES” AS INVESTORS FEAR INTEREST RATE HIKE – “PLAY IT AGAIN, SAM!” (Woody Allen reference to Ingrid Bergman in 1942 film, “Casablanca”)

The capital markets, and gold related securities are fluctuating again, just as they did several months ago, with a pending interest rate hike (25 bp, big deal!). It is not the order of magnitude of the increase that investors fear, but the symbolic “direction”, possibly leading to more interest rate hikes in the future. This traditionally means lower prices for most asset classes, as investors require higher dividend and interest yields to compete with higher interest rates on the lowest risk government backed securities.

We continue to feel that interest rates will not rise materially. The debt, around the world, is too large and higher interest rates on newly issued paper would choke respective national budgets. Also, as far as the US rates, the export portion of our economy cannot afford the higher dollar which would result from higher rates. Our economy is barely running at a positive rate, in spite of near zero rates and trillions of monetary stimulus. This is supported just this morning with weak retail sales numbers from August, and the recently reported turndown in auto sales, in spite of heavy discounting. A higher Fed Funds Rate would accomplish only one thing. It would give the Fed room to come back down when the economy weakens further, which would be impossible from today’s rates already near zero. Rates will go up one day, but it will not be at the Fed’s choosing. They will have lost total control at that point, and the long term de-leveraging process will be entering its inevitable crisis stage.

As far as Gold is concerned, investors should understand that most investors consider higher interest rates negative for Gold, since gold ownership brings no dividend or interest. Minimal interest rates therefore allow Gold to be competitive in this regard, and right now the $13 trillion of negative yielding worldwide sovereign debt, and trillions more at negligible rates, allows Gold to be relatively attractive. Gold ownership allows investors to get all their money back in the future, rather than be guaranteed to get less than invested with a negative yield. This reality however, doesn’t get fully considered, as investors automatically sell almost all asset classes when an interest rate rise is expected.

Also relative to Gold’s presumed risk if rates go up, this is an inaccurate “myth” in any case. Gold’s performance depends on lots of other monetary and fiscal factors, such as prevailed from June, 2004 to June of 2006 when Gold increased in price from $390 to $630, up 62%. It so happens that Alan Greenspan raised interest rates by 25 basis points seventeen times. It also happens that the US deficit was “consolidating” after coping with Y2K, the dotcom crash and 9/11, before rising sharply to finance two wars later in the decade. More recently, the last time we had an actual rate rise, 25 basis points in December, 2015, precious metal securities bottomed almost precisely with the rate rise, and had a strong five months immediately thereafter. In the second half of May’16, gold investors feared a rate rise and in this case, when it did not materialize, Gold went straight up in June. Equity markets, in general, reacted similarly, both in January, and June, in the first case after an actual increase in rates, and in June after it was a false alarm.

So, “Play It Again, Sam”. Earlier this week, the US operating deficit for August was announced, a cool $107 billion, on the way to about $600 billion for the fiscal year ending September ‘16, and expected to continue rising.  We don’t know whether rates will be increased in September or not, but the market is reacting as it did in December and May. We suspect (can never be sure, of course) that the price of Gold will act just fine in very late September and/or October, whether a rate increase in announced or not.