Tag Archives: deficits

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE (FINANCIAL) MUSIC PLAYS, THE DANCE CONTINUES!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – (FINANCIAL) MUSIC PLAYS, THE DANCE CONTINUES!

The general market was firm all month, and finished up for the month in spite of substantial weakness the last two days of the month. Gold bullion and the miners were down modestly most of the month (the miners down about 3% until last Thursday) but then got hit as well. Gold bullion finished the month down a little over 6% and the miners more like 10%. There are always a lot of moving parts but it seems like the major force driving gold and the miners lower was the dramatic increase in interest rates, to be discussed just below.

As most of our readers know, while we continue to be actively engaged within the restaurant industry, the majority of our personal liquid assets are invested in gold mining shares. That takes place within our twenty seven year old Limited Partnership, in which we are both the General Partner and the largest investing Limited Partner. Our writing within this website therefore reflects our two most active financial interests, the restaurant industry and the fiscal/monetary scene.

A SEVEN MONTH CONSOLIDATION IN GOLD & THE GOLD MINERS

It seems to us that by far the most significant recent influence on the price of gold and the gold mining stocks has been the steady rise in intermediate to longer term interest rates. The charts just below show how the price of gold started trending down, almost to the day back in early August, when rates started moving up. As shown in the charts below, while the 2 yr Treasury has moved hardly at all, interest rates from 5 yrs  to 30 yrs have moved steadily higher.

It is important to note that the ownership of gold (which itself pays no dividend or interest) competes in terms of current yield with short term rates (especially up to 5 yrs, 10 at the most), which have moved hardly at all. The two year still yields next to nothing. While the five year Treasury has moved from 20 bp to 60 bp is, this is only a nominal 0.4%, still almost nothing in terms of an annual return though it is a dramatic tripling of that rate. Even the ten year Treasury only yields about 1.5%, a lot less than the inflation rate, so the ownership of gold still has a “real return” over ten years.

There are two major potential drivers of higher interest rates. The first possibility is that the economy is getting a lot stronger and we don’t believe that is the case. The 4% increase in Q4 GDP was heavily influenced by the new stimulus checks, as well as pent up demand as the pandemic begins to wind down. The second possibility is the bond market’s anticipation of higher inflation, and we believe that is more likely the case. The most recent readings indicate a rate closer to 3% than 2% and the Fed is encouraging it. The Fed balance sheet continues to expand with their bond buying, $1.9 trillion of government spending is about to begin (with more to come), a new currency called Bitcoin has created a trillion dollars out of thin air and there are others such as Etherium. Commodity prices have moved sharply higher and a new $15 national minimum wage will contribute to higher retail prices. Lastly, as shown by the last chart below, the US Dollar has been weak, another harbinger of US inflation.

We should remind you at this point that higher interest rates would be very expensive for the US Treasury, since one extra point of interest on $28 trillion is $280 billion, blowing up the annual deficit even further. Though interest “earned” by Fed T’bill holdings is rebated back to the Treasury (after expenses), there are still many trillions of debt owned by individuals and foreign countries. Volker took interest rates higher from 1979 to 1982 to control inflation but the total US Debt was about $1 trillion then versus $28 trillion today, and the annual defict was about $100 billion versus $3- 4 trillion today. Unfunded entitlements was also a non-factor forty years ago while it is a hanging “sword of Damocles” today. Today’s economy is 7.5x the size of that in 1980, but the debt and the deficits are almost thirty times the size, excluding unfunded entitlements.

We’ve had higher interest rates (both short and longer term) reflecting higher expected inflation along with a sluggish economy before. In the 1970s gold went from $35/oz to $850/oz while stagflation took the Fed funds rate to 18%. Therefore, for all but the shortest term stock traders, negative real returns on short term US Treasuries (up to at least 10 yrs) remain a fact of life and gold related securities retain their allure. Our thesis remains very much intact.

FURTHER SHORT-TERM REFLECTION

Following the money in and out of Washington, DC: At this point, with foreign purchasers of US debt issuance backing off, our Fed Reserve is purchasing over 60% of newly issued US Treasury securities with new money printed out of thin air. The US Treasury sells the bonds to the Fed, pays interest (at low rates) and the Fed rebates their annual “profit”, derived from interest “earned”, after expenses, to the Treasury. The net effect is virtually a zero-interest cost on unlimited new capital and the Treasury doesn’t even have to issue colored paper. We listened last Wednesday to a congressman congratulating Fed chairman, Jerome Powell, on the Fed’s rebate of $88.8 billion for the year ending 9/30/20, which reflected the Fed’s “profit” after deducting $4.5 billion of operating expenses. This is noteworthy because (1) the $88.8 billion was generated from interest earned on the now $7.5 trillion balance sheet (created out of thin air), consisting largely of US treasury securities and (2) The annual US operating deficit is reduced by this $88 billion. (3) It costs US taxpayers four and a half billion dollars to manage this scheme. And there is no graceful way out of this mess.

THE REALLOCATION OF RESOURCES

As we wrote on this website two weeks ago, suppressed interest rates are a form of price fixing, and price fixing inevitably leads to the misallocation of resources. After the “revolution”, which will likely be financial, political and social, the sun will still rise in the east and set in the west. Life will go on, but the assets will have been reallocated among owners.

We have been fundamental value investors for over four decades and it has served us well over time. There have been successful investors that invest based on chart patterns rather than the corporate fundamentals, and that can work well for short term nimble traders. We believe, however, that, while charts can sometimes alert investors early to changing fundamentals, the charts reflect the fundamentals, not the reverse. We try to follow the advice of legendary investors like John Templeton, who suggested that you should buy “when there is blood in the street” and sell into broad euphoria.

FINALLY, OUR CONCLUSION

We cannot predict when the general stock market enthusiasm for SPACs and Bitcoin and technology companies selling for 50x SALES will run its course. With that backdrop, the gold miners trade at an Enterprise Value versus EBITDA (operating cash flow) of under 8x versus the S&P 500 index of double that and the spread is the widest in at least 10 years. Gold is the “real money” and the gold miners are storing it for us within their underground vaults (called gold mines). They will bring that currency north to exchange it for the colored paper of the day over time, and that will be reflected in the dividends paid and the price the shares trade for. There are lots of ways to protect oneself from the financial turmoil we foresee. In that context, mining stocks are the most undervalued asset class we know of and should therefore be a meaningful portion of an investor’s liquid assets.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – DRAMATIC DEVELOPMENTS, WITH PREDICTABLE RAMIFICATIONS!

SEMI-MONTHLY FISCAL/MONETARY REPORT – DRAMATIC DEVELOPMENTS, WITH PREDICTABLE RAMIFICATIONS!

The capital markets in January were dominated by the action in Gamestop and other heavily shorted stocks, so the Russel 2000 and Nasdaq indexes were up. The larger indexes, the Dow and S&P were down. Gold bullion was down about 3.2%.  Gold mining stocks, to be expected, were down about double that. However, the year has just begun, the dollar printing presses are preparing to print trillions of stimulus dollars, and the broad background, as discussed below, is moving in favor of the “real money” (i.e. gold, and it’s “little brother”, silver) on almost a daily basis. Additionally, the populist revolution of Robinhood traders, the last few days spilling over to silver, demonstrates how quickly and dramatically mass psychology can turn. It will take more than a group of young traders to move the gold and silver markets sharply higher but the institutions and computer driven trading programs are odd lotters at heart, chasing momentum rather than fundamentals. Gold related securities have had positive fundamentals for a long time now, so it’s just a question of time until the psychology turns. We discuss just below the analogies between Gamestock and the precious metals  before providing an update on the broader fiscal and monetary developments.

 FROM GAMESTOP TO GOLD – WHAT’S THE STORY ?

Recent short term trading developments seem far removed from precious metals but there are similarities that could come into play.

First, the buyers of Gamestop, from the trading platforms such as Robinhood, were out to punish the fat cat hedge funds that, as they see it, have gotten rich by shorting low priced stocks into oblivion. The new buying from the “little guys” forced the hedge funds that were short to limit losses by covering at increasingly high prices. A critical technical aspect of this situation is that the total short positions had been allowed (by hedge fund custodians such as Goldman Sachs) to be well over 100% of the shares outstanding, called “naked” shorting, and there was no way, until Robinhood suspended trading, that all the shares that had been shorted could be bought back. It should be noted that, while many commentators expressed concern about the price volatility, almost everyone is sympathetic with the little guy, nobody feeling sorry for the hedge funds that took huge losses. At least a couple of multi-billion dollar hedge funds closed their doors in the wake of the unprecedented upsurge.

Here is the application to the gold and silver markets.

First, the prices of gold related securities are thought by many (including ourselves) to be suppressed similarily as Gamestop. In the case of gold, the suppression is by worldwide politicians and their affiliated bankers, who don’t want a rising gold price to bring attention to the huge dilution of the unbacked paper currencies. Gold related securities, especially the gold mining stocks, for no apparent fundamental reason, have therefore participated very little in the asset inflation of the last seven or eight years. The fact is that several large market makers in gold and silver related securities, including futures and options, have paid fines amounting to hundreds of millions of dollars for manipulation of precious metal markets. There has, therefore, been a distortion in the “price discovery” of precious metals, just as we have described for years.

The other important similarity between Gamestop and Gold is the use by the Gamestop short sellers of “naked shorts” as described above. This “paper” that was over 100% of the total “underlying” created a potential demand, once the stock started going up, that was impossible to satisfy except at much higher prices. The term you will hear is “short squeeze”. The number discussed, relative to Gamestop, is that the total short positions amounted to 140% of the shares outstanding, a ratio of 1.4 to 1. NOW GET THIS !  In the gold market, the “paper”, that is composed of derivatives such as options, futures, ETFs, etc., that reside on top of the physical trading of the “underlying” gold is thought to be something like 100 to 1, that’s ONE HUNDRED TO ONE. We don’t mean to suggest that all of that “exposure” is on the short side, but a great number of positions are built on borrowed money, and no doubt a substantial amount is “short”. In addition, buyers (like the “little guys” at Robinhood) in the gold or silver futures market could require “delivery”, rather than a cash settlement, and the short seller would obviously have a bigger problem than just buying back the paper short and taking the loss. They would have to find a seller of physical metal.  It has been reported by dealers of physical gold and silver that there has been a huge increase in demand by retail buyers who expect delivery, not settlement in cash.  This spills over into the derivatives market as physical dealers buy options and futures contract to protect their profit between the time they give a customer their “report” and when the dealer receives, then delivers against payment the physical product.  A final simplistic point is that it takes ten years to bring on stream a newly discovered gold mine. In the stock market, Gamestop could issue more shares at some point and satisfy some of the demand. As it applies to gold, nobody can “issue” new gold bullion overnight. In fact, there are no new large gold mines scheduled to come on stream for years. If potential physical demand is to be satisfied, it has to come from an existing physical holder, and they will likely require a very much higher price.

As always, the timing of a large move in gold related securities continues to be uncertain, but some of the critical catalysts are similar in nature to those that drove Gamestop so dramatically higher. Everyone agrees that there are no possible fundamentals that could justify the recent price of Gamestop, even at $90, up from $20, let alone at a high of $500.  In the case of Gold, we are not suggesting that it should be trading  20-30 times higher, but somewhere between $6,000 and $10,000 an ounce  can be rationally jusified. That could take gold mining stocks up by least 10x and would be adequately satisfying.

With that review of the most current events in the capital markets, below is a continuation of our longer term broad fundamental perspective.

THE BACKDROP

It’s becoming a common refrain: “don’t fight the Fed”, originally coined by the late and great market strategist, Martin Zweig back in the 1980s.

Jerome Powell, Fed Chairman, has made it clear that he will do “whatever it takes” to get back to relatively full employment and balanced economic growth, “balanced” referring to a narrowing of the wealth gap. He has reiterated that he is “not even thinking about thinking about raising interest rates”, signaling that the Fed will continue to expand its balance sheet, keeping interest rates very low, bond markets and the stock markets still supported by the “Fed put”. The Fed’s largesse has no doubt been an important contributing cause of the weakness in the US Dollar, which supports exporting US industries.

A historical footnote: This disillusionment with the US Dollar is similar to 1969 and 1970 when the Europeans, led by France’s Charles DeGaulle, exchanged their predictably diluted Dollars for the US Gold. In the course of just a couple of years, the US Gold holdings were reduced from over 20,000 tons to the 8,400 tons that we still own today.  Richard Nixon famously “closed the gold window” in August, 1971, inflation took off, taking Fed Fund Rates to 18%, and the price of gold went from $35. to $850/oz. by January, 1980. An important corollary is that the amount of gold that  the US, as well as collective worldwide central banks, own, relative to the paper currency outstanding, is today at roughly the same (7-8%) level it was in 1971.

Back to the current situation:

Enter Powell’s predecessor, Janet Yellen, likely to be confirmed by the Senate as new Treasury Secretary. While the Fed and the administration’s Treasury Secretary are theoretically independent of one another, it has long been the case that the Fed is responsive to political concerns. Interest rates have firmed up a bit in the last two weeks, and the dollar has also bounced off its lows since early January.  Some headlines have said that “Yellen does not seek a weaker dollar for competitive purposes”, implying that she will favor a stronger dollar, likely accompanied by higher interest rates. Not exactly. She also said she is in a favor of a “market driven dollar”. All of her remarks indicate that she is agnostic as to where the Dollar trades.

Now let’s see what is going on in the economy and how Fed/Treasury policy will play out.

THE ECONOMY IS WEAK

Retail Sales Are Weak – December sales came in weaker than expected, down 0.7% YTY and November was revised to down 1.4% vs. originally estimated negative 1.1%. Further breakdowns of the overall numbers look even worse. Restaurant sales were down 4.5%, electronics -4.9%, appliances and furniture -0.6%, online sales -5.8% after -1.7% in November.  In essence, aside from restaurant sales, “stuff” in demand due to the Covid seems to have run its course. While we don’t doubt that a certain amount of demand will be released when the Covid-related cabin fever breaks, a case can be made that a traumatized consumer, who have saved or paid down credit balances with stimulus checks may well spend less and save more than was the case before the pandemic. From March through November, 2020, American households saved $1.6 trillion more than a year earlier, while credit balances collapsed at a record 14% annual rate.

EMPLOYMENT GAINS HAVE STAGNATED

Jobless claims in December were 965k, versus an estimate of $790k, in spite of Christmas retail hiring, much higher than November which was revised lower by 3k to $784k.

US GDP STILL VERY WEAK

US real GDP is improving relative to the disastrous 2nd and 3rd quarters, but still down very sharply from a year ago. While it is well accepted that 2020 will be a lost year, economists and commentators are quoting “growth of something like 6% in 2021. Goldman Sachs just raised their forecast from 6.4% to 6.6%, fueled by $1.9 trillion (or something close) stimulus’ effect on disposable incomes and government spending. The reality is, however, that the US economy has been growing at a tepid low to mid 2%+ range for twelve years now. It grew at an average of about 2.3% for eight years under President Obama. In the four years of the Trump administration, with the tailwind of lower taxes, major government deficit spending, less governmental regulation, a trillion dollars of repatriated overseas capital and interest rates very close to zero, GDP grew at an average of about 2.5%. This can fairly be called “the law of diminishing returns”, a lower “marginal return on invested capital” or, less charitably a “misallocation of capital”.

At the same time that economic signals are weakening, inflationary signals are more apparent.

The deficit so far this fiscal year, the three months through December, show a deficit 58% higher than a year ago. Unfortunately the new fiscal stimulus package, proposed at $1.9 trillion, will inflate the government spending again this year. Though the amount is negotiable, President Biden has stated that it is only a “downpayment” on future plans. It seems reasonable to expect this fiscal year’s deficit to at least approach the $3.1 trillion of last year, perhaps even exceed it.

We point out again that the debt increases almost every year at much more than the annual deficit would suggest. This is due to “off budget” spending, and those dollars are in large part borrowed from the social security fund.  The deficit shown above in ’19 was $984 billion but the debt went up by $219 billion more, $1.2  trillion higher in total. The deficit in the Y/E 9/30/20 was $3.1 trillion but the increase in debt was $4.2 trillion. People….these are not  trivial differences, and this huge accelerating debt load will further drag on our economy.

INFLATIONARY SIGNALS ARE APPEARING, though it still may be a way off

First, the parabolic increase in the M2 money supply has to be some cause for concern.

Secondly, reported import and export prices for December are cause for inflationary concern, and this could be one contributing factor to the rise in interest rates and the US Dollar. December import prices were up 0.9% instead of the expected 0.6%. November was revised slightly upward, from 0.1% to 0.2%. Export prices were also up much more than the expected 0.6% in December to 0.9%. November was also revised upward by 0.1% to 0.2%.

Lastly, the seemingly inevitable move to a nationwide $15 minimum wage could also contribute. While it is true that perhaps only 3 or 4 percent of the workforce earn the $7.25 minimum wage, with the lowest paid sector (leisure/hospitality) earning $17/hr, a higher minimum could well provide upward pressure. That $17/hr worker might not be happy earning just over the acknowledged subsistence level, and expect a bit more.  Its also true that employers will attempt to hold the pricing line by absorbing labor increases by way curbing expenses elsewhere, but a great deal of that may already be in place. In any event, we haven’t seen any arguments that a higher national minimum wage will be deflationary.

In spite of the factors provided above, the month to month CPI report doesn’t show much yet, up 0.4% in December but up just 1.4% for the twelve months ending December. The so called core-CPI, less food and energy, was up just 0.1% in December, up 1.6% for twelve months. The Fed, of course, has clearly stated a policy to allow inflation to run higher than 2% annually for a while because it has been under 2% for so long. Keep in mind that, while prices of goods and services (except for major expenses like education and health care) have been stable, asset price inflation has been huge. There is a reason why very rich people are paying over $100M for a residence or a rare painting. They want to own anything but cash. They don’t know what that Van Gogh or oceanfront property will sell for, but they know their cash will lose a lot of purchasing power. As always, inflation is the cruelest tax, affecting the rich the least. They have their land, homes, art, stock and stock options, gold, etc. It’s the lower and middle class that gets hurt, left to wonder why they are making more in nominal terms but have to work harder to make ends meet.

Inflation is in our future, guaranteed, with governments around the world printing currency at an unprecedented rate, with a stated goal of creating of something over 2% for a long time. Short term, however, there is a lot of under-utilized manufacturing capacity, consumer spending is still restrained, and rents (“rent equivalent” is over 25% of the CPI index) are stagnant as city dwellers move out. Education and Healthcare, two of the largest family expenditures, are not in the CPI that is most often quoted by officials. The CPI, also, does not reflect the inflation in asset prices, including speculations such as Bitcoin and Gamestop. For these reasons, the reported CPI may not take off for a while but inflation in the real world is inescapable.

THE RESULTANT FEDERAL RESERVE/TREASURY DILEMNA

The Federal Reserve and the supposedly independent US Treasury, as a result of at least forty years of fiscal/monetary promiscuity have incompatible masters to serve.

On one hand they are supposed to keep inflation at a tolerable level, these days no higher than a “symmetrical” 2%, At some point that will call for higher interest rates, and normalization to 150-200 bp above the rate of inflation, a range of 3.5-4.0%, providing a “real” return to savers. Unfortunately that would add an unacceptable $800-900 billion of annual interest to government expenses, blowing the deficit even higher, exacerbated further yet because tax receipts would contract as businesses cope with higher interest rates. So….interest rates might edge up, but not by much.

On the other hand the Fed’s second mandate is to foster full employment. This requires relatively low interest rates and continued government fiscal stimulus, which along with a weaker dollar will support US business activities. These policies problematically foster the inflation that they don’t want to get out of control.

The objectives are inconsistent.

THE RESULT

When in doubt, the policymakers will pursue the inflation every time. The public, especially the lower and middle class, doesn’t quite understand why they have to work harder and longer to make ends meet.  It is very apparent, on the other hand, when interest rates and/or taxes are going up and unemployment is rising. Far better for the incumbent politicians to stimulate the economy by way of government spending, low interest rates, and a lower dollar. Somebody else can deal with the inflation later on. Paul Volker came along in 1979 and Ronald Reagan stuck with him, enduring the higher interest rates of the early 1980s to squeeze out inflation, but there is no Paul Volker or Ronald Reagan these days and the problems (the deficits, the debt, the tepid economy, the already very low interest rates) are an order of magnitude larger.

The recent runup in speculative securities such as Gamestop could be a forerunner of a similar explosion in gold and gold mining stocks. As discussed above, the disdain for “the fat cats” is driving a populist revolt (with sympathy from both sides of the political aisle) that has driven heavily shorted stocks up by ten times and more in a matter of weeks. The stage could well be set, for a lot of the same reasons as discussed above for precious metal related assets. The Gamestop crowd, at the end of their recent run, broadened their focus to silver and silver miners, and gold rose in sympathy a couple of days ago. As attention is drawn to fiat currency alternatives, the price action of gold, silver, and the miners could start to reflect the compelling fundamentals.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – WE SUGGEST: THE FOUR MONTH CONSOLIDATION IN GOLD IS OVER

SEMI-MONTHLY FISCAL/MONETARY UPDATE – WE SUGGEST: THE FOUR MONTH CONSOLIDATION IN GOLD IS OVER

The US debt at 9/30/00, excluding unfunded entitlements,  just before President Bush took office was $5.7 trillion. Eight years later, at 9/30/08, just before President Obama, the debt was $10.0 trillion. Eight years later, at 9/30/16, just before President Trump, the debt was $19.6 trillion. Four years later, at 9/30/20, just before President Biden, the debt was $26.9 trillion.

                          

Quoting the most recent Congressional Budget Office (CBO) update :

“At 14.9 percent of gross domestic product (GDP), the deficit in 2020 was the largest it has been since the end of World War II. Much of that deficit stemmed from the 2020 coronavirus pandemic and the government’s actions in response—but the projected deficit was large by historical standards ($1.1 trillion, or 4.9 percent of GDP) even before the disruption caused by the pandemic. In the CBO projections, deficits as a percent of GDP fall between 2021 and 2027 (from 8.6 percent of GDP to 4.0 percent), and then increase to 5.3 percent of GDP by 2030—more than one-and-a-half times the average over the past 50 years.”

It is worth noting that the CBO has consistently overestimated the projected growth (and tax receipts), underestimated the spending and therefore substantially underestimated the deficit. With that in mind, the CBO projected 8.6% deficit in the current year,  as a percent of GDP would amount to about $2 trillion so the US will pass the $30 trillion round number in calendar 2022. No matter what Modern Monetary Theory tells you, the debt matters because it is a proven drag on growth. Even if interest rates continue to be suppressed, only 1% on $30 trillion is $300 billion so that’s a guarantee that the deficit will continue to be a problem. It’s also a guarantee that interest rates will not go up much if the Fed can control it. If and (as we believe) when that is no longer the case, it will indicate that the Fed has lost control, inflation is about to take off, and all bets are off in terms of the economy and capital markets.

NEGATIVE INTEREST RATES HIT A RECORD

New records are being set as $18.4 trillion of global debt is now priced to yield less than zero, up from less than $8 trillion in March and a five year average of $10.3 trillion. As noted monetary historian, Jim Grant, points out: “nominal negatIve yielding debt had never been seen in material size  in 4,000 years of interest rate history prior to the current cycle, and recent happenings suggest that upside-down debt may grow larger still”.

Negative “real” yields, which subtract the inflation rate from the stated “nominal” interest rate creates a strong incentive for investors to reach for yield in the capital markets, no matter what form that risk might take. This TINA (There Is No Alternative) approach to investing is why Tesla, Doordash and $60 or $70 billion worth of SPACs are trading where they are as stock market averages his new record highs. It also means that savers not willing to play the TINA game are being screwed (no better way to put it ), to the benefit of central bankers and politicians who are kicking the fiscal/monetary can down the road. Negative interest rates also improve gold as an investment because the absence of interest or dividends is better than the negative yield on government debt.

We have pointed out before that negative “real yields”, along with lots of other current indicators, have strongly supported higher gold prices. We are admittedly surprised that the gold price and gold mining stocks have given back over half of the mid-2020 gains, and we attribute this “consolidation” to (1) The group had become a little too popular in the middle of the year and technically needed a correction to  shake out the weak holders and set the stage for the next leg up (2) The stock market strength precluded a perceived need for a safe haven (3) The next trillion dollars of government fiscal stimulus was put on hold until after the election (4) The Federal Reserve balance sheet, above $7 trillion, is “only” growing by $150B/month, no longer a shock to the capital markets.

We do not believe that the current strength in cryptocurrencies such as Bitcoin is as much of a culprit as the factors above, since gold and gold mining stocks are far more of a long term “store of value” rather than the crypto currencies that are primarily trading vehicles.

We believe fiscal stimulus is coming shortly, to be followed by more fiscal/monetary support in just a few months and more after that, ad infinitum.

This point in time happens to coincide with gold bullion and the gold mining stocks trading just at the technical support price at the 200 day moving average. We are determined not to play it too cute with our holdings of gold mining stocks, trading out at a short term peak, and trying to time a re-entry. The long term potential is too compelling. The gold mining industry is the least expensive asset class we know of, not only protecting purchasing power over the long term, but a potentially very lucrative investment in nominal terms. We reiterate our belief that the gold price will increase by several times in value over the next three to five years and the gold mining stocks by a multiple of that. (Our investment partnership remains open to qualified investors.)

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – ECONOMIC, SOCIAL, POLITICAL, MONETARY WORLDS ARE IN HOLDING PATTERN, BUT GOLD PERKS UP!!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – ECONOMIC, SOCIAL, POLITICAL, MONETARY WORLDS ARE IN HOLDING PATTERN, BUT GOLD PERKS UP!!

THE CONTEXT

The general market has been very strong since the election, so there has been less perceived need for a “safe haven” such as gold. Gold bullion was therefore down about 5.7% in November and the mining stocks were down 8-9%. However, it has become increasingly clear over the last week or so that Janet Yellen, the apparently incoming Treasury chief,  will be a predictably doveish monetary policy participant. That is one reason that gold and the gold miners have “caught a bid” in the last few days. Perhaps it is dawning on investors that the deficits and spending and debasement of fiat (unbacked) paper currencies around the world will definitely continue. The new administration has been dubbed by some as “Obama 2.0”. Recall that in the first two years of President Obama’s administration gold bullion went up 100% and the gold miners went up over 200%.

We discuss below the recent short term performance, perhaps why gold has been in a consolidation mode over the last four months, and then a longer term discussion. While I understand that many of you don’t want to deal with these details, we like our readers to be as well informed as possible.

FOUR MONTHS OF CONSOLIDATION IN THE GOLD PRICE

The chart just below is over the last several years, and shows how the price of gold has correlated with “real yields”, that is the actual short term interest rate (inverted on the chart) adjusted for inflation. With short term rates less than 0.5% and inflation of 1.5-2.0% the “real yield” is now close to a negative 1.5%. That means that savers, in high quality fixed income securities, are losing purchasing power of 1.5% annually. It also means that, from the standpoint of current real return, investors are 1.5% better off in gold, yielding zero. The chart shows how gold has moved up in price as the real yield became increasingly negative. Over the last four months, however, you can see that the negative real yield (in red) stabilized and actually became a little less negative, so bears on gold speculated that interest rates were moving up, real yields might be rising and gold would be less attractive, so the gold price corrected over 10% from its high in early August.. Lately, however, you can see real interest rates (in red) breaking out on the upside, so the real yield (inverted on the chart) is becoming more negative. Contributing to this situation is over $17 trillion (a new high) of sovereign debt worldwide yielding less than zero. This type of action presaged earlier upward moves in gold bullion, and the miners, so that might well be the case again

LONGER TERM

The USA is the most powerful nation on earth. The holding pattern we are in before the new administration takes control, as well as the Covid-19 vaccines become widely distributed, has affected the world we live in, on many levels.

At the moment In the capital markets: The stock market chooses to look across the valley, flirting with an all time high as this is written. Traders have lightened up on their gold bullion positions, since a “safe haven” is not considered as necessary. Gold mining stocks have retraced virtually their entire gains since the first of the year. The reasoning in a nutshelll: (1) A new, more comforting, US administration is about to take office (2) Vaccines are on the way (3) There is no alternative to investing in the equity markets (TINA) since interest rates are so low.

Meanwhile: The facts of life include the following discussion points. Take them under consideration, with the cautionary overview that it is very difficult not to be seduced by the madness of crowds. 

With that preface:

The central banks around the world continue to stand by, prepared to accommodate further when necessary, which will no doubt be the case, though the form it takes is a bit more uncertain. Overall,  the basic situation has not changed, in terms of (1) Negative interest rate debt, which is at an all time high (2) The current deficits and cumulative debt are at record levels (3) Most asset classes have been bid to record levels (4) Governments around the world are searching for sources of funds, and the public will pay (5) Gold is underpriced, the gold mining stocks even more so.

NEGATIVE INTEREST RATES

The total worldwide sovereign debt now selling at negative interest rates has just hit a record of $17 trillion. China, for the first time, recently sold negative yielding debt. Major trading nations compete with each other to raise capital so the fact that German five year bonds sell with a negative .74% yield allowed the Chinese to provide an attractively higher yield at a negative 0.15% on their five year paper. The Chinese issuance was part of a package that yielded a barely positive 0.318% for ten years and 0.665% for fifteen years.

People…this kind of situation has not happened in recorded history, and is not good.

THE DEBT AND THE DEFICITS

As we have written before, the addict needs an increasingly large “hit” to maintain the “high”, though hardly anyone would say that the worldwide economic situation is rocking and rolling (i.e.”high”) While common wisdom these days is that the economy was strong before Covid-19 hit, US GDP  (up about 2.5% in calendar ’19) was forecast, before the Covid-19,  to grow only about 1.5% in Q1, clearly rolling over. The chart below shows vividly how large the stimulus, worldwide, has been, to get us through the pandemic, compared to the last crisis.

People….there has to be a hangover after this fiscal/monetary party.

MOST ASSET CLASSES ARE AT RECORD HIGHS

Ben Bernanke, Fed Chairman ten years ago, made it clear that his Fed’s objective was to support asset prices, which in turn would hopefully create a trickle down wealth effect for the broad economy. Janet Yellen, and now Jerome Powell have continued in the same vein. Moreover the mandate has evolved, as described by Powell, to achieve a “symmetrical” two percent inflation rate (tolerating above 2% for a while) and, most recently, economic growth that will benefit all segments of the economy, clearly targeting the wealth gap. This policy, echoed by central banks worldwide, has produced negligible interest rates of fixed income securities (all the way out to thirty years),  supporting the stock market because TINA (there is no alternative). The chart just below shows vividly how US equities (the S&P 500, ex financials) are selling at 49x free cash flow, almost 50% higher than at the top of the dotcom bubble.

People…..safe to say we are closer to a top than a bottom.

GOVERNMENTS NEED HELP, AND IT’S ON THE WAY, FROM US !!

First, we should understand that the minimal, or even negative, interest rates, are a form of wealth transfer. Fixed income security holders earn nothing, losing ground to even minimal inflation, and the government benefits from negligible interest cost on Treasury securities.

Additionally, though President-elect Biden publicly dances around the subject, it is clear that tax rates in the US will go up under his administration. It won’t be close to filling the cash flow gap but will be designed as acceptable to the public while the can (cash flow gap) gets kicked down the road. There has been a lot of discussion in the United Kingdom on this subject and our policies tend to mirror theirs.  Rather than a Value Added Tax (VAT) which would raise the most money but tax everyone, taxes targeting the rich alone are more politically preferable. This could include a tax on homes with a value above a certain level, much higher capital gains taxes, higher estate taxes, and higher rates on large incomes. The charts below show the long term trends in tax rates both in the UK and the US. Tax rates in the future may not match the 90%+ as shown in the charts, but higher than today they will be.

People…..it won’t be enough to materially reduce deficits, but everyone will be paying a more “fair share”.

GOLD IS UNDERPRICED, THE GOLD MINERS EVEN MORE SO

The price of gold has historically correlated strongly with the U.S. debt buildup, the growth in money supply, the buildup in negative yield debt, and Central Bank asset buildup. It has also protected purchasing power both during inflation (as in the 1970s) and deflation (as in the 1930s). By every measure, the price of gold should be a multiple of its current price. Central Banks around the world, who are most attuned to long term monetary trends, have been collectively buying over 400 tons of gold every year in the last ten. Though central bankers never admit to liking gold as an asset class, since a gold standard limits the ability of central banks to create more currency, this is a classic case of “do as I do, not as I say”. Gold mining stocks, whose earnings are leveraged to the price of gold, are even more underpriced than gold bullion itself. With the gold price almost the same as the $1900 high of 2011, the gold mining stocks are 50-60% below those levels. This undervaluation is underlined because, as the chart below shows, they have flipped from a negative cash flow position to free cash flow generators. One can only imagine how much cash they will generate as the price of gold (their end product) catches up with other asset classes.  Dividends are already being steadily raised by many of the major miners, just as they were in the 1930s, when Homestake Mining, between 1929 and 1936, paid out dividends worth three times the 1929 stock price.

People….it’s not a question of IF, more a question of WHEN.

CONCLUSION

We see no constructive movement, in terms of dealing with economic imbalances and fiscal/monetary distortions. The problems are an order of magnitude impossible to comprehend, let alone deal with, and have been created over decades, The current crop of politicians, worldwide, give no indication of a willingness to directly confront the situation.

We continually search for the flaws in our long term investment argument. If the facts, and important trends have changed, we would gladly adjust our approach. This is not the case, however. The fiscal/monetary influences on the worldwide economy have been on a parabolic ascent in recent decades. Stagflation, as in the seventies but worse, is the best outcome we can hope for in the foreseeable future. Events will at some point force the necessary financial, political and social changes necessary to encourage long term productive economic growth. The operative phrase is AT SOME POINT…..

Roger Lipton

SEMI/MONTHLY FISCAL/MONETARY UPDATE – ELECTION DAY !! – WHAT DOES IT MEAN FOR THE ECONOMY?

SEMI/MONTHLY FISCAL/MONETARY UPDATE – ELECTION DAY, WHAT DOES IT MEAN FOR THE ECONOMY?

It is difficult to step back from the 24 hour news cycle and focus on the forest, rather than the trees.  As of 9/30/2000, a mere twenty years ago when GW Bush was elected,  the total US Debt amounted to $5.7 trillion. In 2008  Barack Obama bemoaned the “irresponsibly built” debt of  $10.0 trillion, then took it to $19.6 trillion by 9/30/2016. Donald Trump campaigned suggesting he could balance the budget and begin to reduce the debt and the current total is now over $27 trillion. Even without the “extra” couple of trillion to cope with Covid-19, he was on pace to substantially exceed the pace of his predecessors. The deficit the next twelve months is likely to be in the $2-3 trillion range in the current fiscal year ending 9/30/2021, so the beat goes on.

Anyone who thinks our economy will resume long term real GDP growth in excess of 3% is ignoring the crushing burden of the ongoing debt buildup. The best we can hope for is “stagflation” as our dollar loses its purchasing power over the long term and the worldwide economy moves toward the “European Model”. This conclusion applies no matter which candidates, for the presidency and congress, prevail. The public (on both the political right and the left) wants health care insurance with no regard for pre-existing conditions, continuation of social security and other entitlements, increasing support for education at all levels, continued high defense spending, as well as other forms of government support. The Federal Reserve Bank has taken up the task of narrowing the wealth gap. All of this means continued major government spending, far in excess of government receipts. Larger government may be more predictable under Democratic leadership but will also be a necessary reality under the Republicans. Neither Trump, Pence, Biden or Harris created this situation. It has been created over decades, and the current players can only kick the can down the road, at best.

The worst outcome that we can envision is a deflationary depression, possibly one that could match or even exceed that of the 1930’s.

Our opinion is that the can gets kicked down the road, at least once more. These cycles take years to play out, so the timing of the ultimate “reset” is impossible to accurately  predict.

For the moment:  THE DISTORTIONS, AND PRESSURES ONLY INTENSIFY – YOU NEVER KNOW WHICH SNOWFLAKE WILL CAUSE THE AVALANCHE

There is lots of additional news, all of which only serves to intensify the financial distortions that we have been describing for years. With the US election upon us,  there seems to be nobody that expects government (fiscal) or federal reserve bank (monetary) support to be reduced after the election. It is virtually certain to be quite the contrary. Below we will hit a few “high” or perhaps “low” points, while quoting several more well known authorities than ourselves.

We have described many times how debt issuance brings forward demand, at the expense of future consumption. We have also pointed out, as Reinhart and Rogoff described over ten years ago in “This Time is Different” (chronicling 800 years of business history) that once government debt reaches approximately 100% of GDP it is a noticeable drag on productive growth.

Lacy Hunt and Van Hoisington of Hoisington Research said recently: “Countries in a debt trap (our italics) like the US, Japan, the UK and the Euro Area have experienced a fall in short term interest rates to the zero bound, in some cases into negative rates, thus eliminating monetary policy to play a role in supporting the economy.” In other words, once at zero, below zero can’t help much.

Hunt and Hoisington described the increasing burden of the debt buildup this way: “As proof of the connection (between debt and GDP slowdown), each additional dollar of debt in 1980 generated a rise in GDP of 60 cents, up from 54 cents in 1940. The 1980s was the last decade for the productivity of debt to rise. Since then this ratio has dropped sharply, from 42 cents in 1989 to 27 cents in 2019.”

Hunt and Hoisington also said “Debt financed fiscal policy can provide a short term lift to the economy that lasts one to two quarters. This was the case with….2009, 2018 and 2019. However, the benefit of these actions…even when the amount of funds borrowed and spent were substantial, proved to be very fleeting and the deleterious effects remain. The multi-trillion dollars borrowed for pandemic relief in Q2 encouraged the beginnings of a “V” shaped recovery, but this additional debt will serve as a persistent restraint on growth going forward. When government debt as a percent of GDP rises above 65% economic growth is severely impacted and becomes very acute (our italics) at 90%.”

Keeping the above in mind, we present the following chart, provided to us within our subscription to Grant Williams’ “Things that make you go hmmm”. Shown are examples of what was going on, describing profound societal adjustments that have accompanied the debt levels of today. Fifty one out of fifty two times in the past, when debt gets to 130% of GDP, the country eventually defaulted  on its financial obligations, one way or another, which is exactly where the USA is right now.

 

As the final footnote to this discussion, to demonstrate how dramatic the government intervention has recently been: the legendary investor, Howard Marks, pointed out recently that: “in the four months from mid-March to mid-July of this year, the Fed bought bonds and notes and other securities to the tune of more than $2.3 trillion. That was roughly 20 times what it bought in 18 months during the Global Financial Crisis (of ’08-’09).”  We have it it this way: the “drug addict needs an increasingly powerful ‘hit’ to maintain the ‘high’”.

Take all of this under consideration as you position yourself financially.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – THE DISTORTIONS, AND PRESSURES ONLY INTENSIFY – YOU NEVER KNOW WHICH SNOWFLAKE WILL CAUSE THE AVALANCHE

SEMI-MONTHLY FISCAL/MONETARY REPORT – THE DISTORTIONS, AND PRESSURES ONLY INTENSIFY – YOU NEVER KNOW WHICH SNOWFLAKE WILL CAUSE THE AVALANCHE

There is lots of additional news, all of which only serves to intensify the financial distortions that we have been describing for years. With the US election just days away, there seems to be nobody that expects government (fiscal) or federal reserve bank (monetary) support to be reduced after the election. It is virtually certain to be quite the contrary. Below we will hit a few “high” or perhaps “low” points, while quoting several more well known authorities than ourselves.

We have described many times how debt issuance brings forward demand, at the expense of future consumption. We have also pointed out, as Reinhart and Rogoff described over ten years ago in “This Time is Different” (chronicling 800 years of business history) that once government debt reaches approximately 100% of GDP it is a noticeable drag on productive growth.

Lacy Hunt and Van Hoisington of Hoisington Research said recently: “Countries in a debt trap (our italics) like the US, Japan, the UK and the Euro Area have experienced a fall in short term interest rates to the zero bound, in some cases into negative rates, thus eliminating monetary policy to play a role in supporting the economy.” In other words, once at zero, below zero can’t help much.

Hunt and Hoisington described the increasing burden of the debt buildup this way: “As proof of the connection (between debt and GDP slowdown), each additional dollar of debt in 1980 generated a rise in GDP of 60 cents, up from 54 cents in 1940. The 1980s was the last decade for the productivity of debt to rise. Since then this ratio has dropped sharply, from 42 cents in 1989 to 27 cents in 2019.”

Hunt and Hoisington also said “Debt financed fiscal policy can provide a short term lift to the economy that lasts one to two quarters. This was the case with….2009, 2018 and 2019. However, the benefit of these actions…even when the amount of funds borrowed and spent were substantial, proved to be very fleeting and the deleterious effects remain. The multi-trillion dollars borrowed for pandemic relief in Q2 encouraged the beginnings of a “V” shaped recovery, but this additional debt will serve as a persistent restraint on growth going forward. When government debt as a percent of GDP rises above 65% economic growth is severely impacted and becomes very acute (our italics) at 90%.”

Keeping the above in mind, we present the following chart, provided to us within our subscription to Grant Williams’ “Things that make you go hmmm”. Shown are examples of what was going on, describing profound societal adjustments that have accompanied the debt levels of today. Fifty one out of fifty two times in the past, when debt gets to 130% of GDP, the country eventually defaulted  on its financial obligations, one way or another, which is exactly where the USA is right now.

As the final footnote to this discussion, to demonstrate how dramatic the government intervention has recently been: the legendary investor, Howard Marks, pointed out recently that: “in the four months from mid-March to mid-July of this year, the Fed bought bonds and notes and other securities to the tune of more than $2.3 trillion. That was roughly 20 times what it bought in 18 months during the Global Financial Crisis (of ’08-’09).”  We have it it this way: the “drug addict needs an increasingly powerful ‘hit’ to maintain the ‘high’”.

Take all of this under consideration as you position yourself financially.

Roger Lipton

 

 

 

 

 

SEMI-MONTHLY FISCAL/MONETARY UPDATE – POLITICIANS BICKER, CONSUMERS AND INVESTORS, HOLD COLLECTIVE BREATH

SEMI-MONTHLY FISCAL/MONETARY UPDATE – POLITICIANS BICKER,  CONSUMERS AND INVESTORS HOLD COLLECTIVE BREATH

The general equity market was on the downside in September, up a little so far this month, probably based on the uncertainty relative to the election and the size (and nature) of the new stimulus program, still under negotiation between Steve Mnuchin and Nancy Pelosi. Gold bullion was down 4.3% in September, as the Fed Balance sheet “stabilized” around $7 trillion for a couple of months before taking off again. The gold miners were weaker in September, down a bit more than bullion. Both are still up substantially for the year.

Over the long term, the price of gold has closely tracked the increase in government debt. We’ve written almost continuously about the debt and the deficits and how increasing debt is a burden on the future economy. In simplistic terms, deficit spending (for an individual, a family, a business or a country) brings consumption forward at the expense of the future. It is just that simple and future consumption is currently being sacrificed at the altar of the can kicking (down the road) exercise.

A corollary to the current situation is that Federal Reserve money creation has been used to finance a very large portion of the US Federal deficit spending. As the table just below shows, the deficit in the current year has been $3 trillion for the eleven months ending 8/31/20. It seems like no accident that the Federal Reserve Balance Sheet has increased from approximately $4 trillion to $7 trillion currently, coincidentally exactly matching the eleven months of “stated” deficit.

But the story doesn’t quite end there. It’s true that the Fed, with the keystroke of a computer has created trillions of dollars to purchase US Treasuries, which has financed our massive spending deficits. The Fed has been a major buyer, for sure, but not the only buyer. In fact, the Total Public Debt of the US has gone up by almost exactly FOUR TRILLION DOLLARs in the last eleven months, a cool trillion dollars more than the stated deficit spending. Only with government accounting can the incremental debt not equal the deficit during the same period. Our website article on this subject, written in October, 2018, and provided to our investing partners  as well,  is provided just below.

https://www.liptonfinancialservices.com/2018/10/semi-monthly-fiscal-monetary-report-rising-deficits-even-faster-rising-debt-weve-only-just-begun/

In essence the reported monthly and annual deficits are just the numbers within the budget, and almost always the debt buildup is greater, most of it borrowed from the Social Security “lockbox”, now almost depleted. As our article two years ago pointed out, in the eleven years ending 9/30/18, the “extra” debt amounted to an enormous $3.24 trillion.

So the beat goes on, except:

All the numbers are an order of magnitude larger than just a couple of years ago. We all are well versed in the stated deficit, now over $3 trillion for fiscal 2020, but hardly anyone talks about the extra trillion of debt that has been incurred. A trillion dollars is still a great deal of money and the number of trillions is building rapidly. Just a matter of months ago, fiscal hawks were warning that the cumulative debt could approach $30 trillion by 2030, now more like the end of 2021, nine years earlier.

Many observers lose track, or lack perspective, over the actual results of various asset classes, including gold bullion. We all know that gold went from $35 to $850 in the 1970s after Richard Nixon eliminated the conversion of dollars into gold. From 1980 to 2000, with good reason, the price of gold suffered as Reagonomics (with Fed Chairman, Paul Volcker)  and then Clintonomics  kicked in and a strong economy with relatively modest inflation reduced the need for gold as a monetary safe haven. When US deficits increased dramatically in the early 2000s, with the cost of two wars, Y2k inefficiencies, and the aftermath of 9/11, gold started to perform well, and that has generally continued in the last twenty years. The chart below shows how gold bullion has performed in various currencies.

The chart is as of May, 2020, when gold bullion was up 14.3% in US Dollars and it has done even better since then. As you can see, 2013 was the one very poor year (out of 20). It is worth noting that our Partnership was down over 50% that year, since the gold miners typically go up and down more than the price of bullion. We have often pointed out that the upside performance of the gold miners has substantially lagged the price of gold bullion, and it was specifically the terrible 2013 from which we are expecting to recover.  Aside from that observation, you can see that gold bullion in US Dollars has averaged a 10.7% increase annually, almost exactly the 10.3% average of all currencies. There is nothing shabby about the price performance of gold bullion as an asset class, and when the gold mining stocks catch up, the same observation will apply.

Keep all of this in mind as the politicians, economists and pundits predict a new growth phase for the US economy. The Presidential “debate” on Tuesday evening only reinforced our view that the partisan (adolescent) bickering, the legislative dysfunction, the spending and deficits will all continue indefinitely, and there is no “graceful” way out of this political, social and economic mess. Gold and gold related securities have historically protected purchasing power over similar stressful periods, and we firmly believe that this time will not be different.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – CHAIRMAN POWELL SPEAKS, THE BIG NEWS IS NOT WHAT YOU’VE HEARD!!

SEMI-MONTHLY FISCAL/MONETARY REPORT – FED CHAIRMAN POWELL SPEAKS, THE BIG NEWS IS NOT WHAT YOU’VE HEARD!

The general capital markets were strong in August, both equity and fixed income, as the Fed continues to keep interest rates close to zero and grow the money supply at a double digit rate, M2 running at +24% annualized.  Gold related assets gave back hardly any portion of the year’s gain, even though, with a very strong stock market,  there was no obvious short term need for gold as a presumed “safe haven”.  Gold bullion was down 0.3% in August, gold mining stocks down a touch more. For the year, gold bullion is up almost 30%. The gold mining stocks are up more than that as investors are beginning to allocate a  portion of their assets to the precious metal sector. Our update from two weeks ago describes the value based appeal of gold mining stocks, and how their value has substantially lagged the increase in the price of gold bullion.  As we have said before, this is the very early stage of the resumed bull market in gold related assets.

There has been a number of fiscal/monetary developments within just the last week, none larger than the enlarged role of the Fed Reserve, embedded in the commentary of Chairman Powell last Wednesday.

JEROME POWELL DESCRIBES THE FED’S THIRD MANDATE !

Chairman, Jerome Powell’s, speech last week summarized the country’s tenuous financial condition, the Federal Reserve’s approach to dealing with the situation, and, most importantly, a revised view of their long term role. Recall that the Federal Reserve was established in 1913, with the primary role of maintaining stable prices while managing the US money supply to alleviate or avoid the financial panics that precluded the Fed’s creation. In the late 1970s, during a period of high unemployment and high inflation (“stagflation”), Congress broadened the Fed’s responsibility, creating the “dual mandate” of (1) encouraging stable prices and  (2) maximum employment, at the same time promoting moderate interest rates. It is on this basis that the presumably apolitical Fed has become increasing important to the US capital markets and the economy as a whole over the last four decades.

Powell’s much anticipated speech expressly described how the previously described 2% annual inflation target (which destroys about 50% of your purchasing power over 30 years) is now to be considered an “average long term” target. This means that if the inflation rate has been running below 2% for a period of time, the Fed will be tolerant of a range above 2% for a similar time. This was presumably the BIG NEWS.  This should not be news to our followers. In August, 2019, we started writing about all Fed governors invariably using the word SYMMETRICAL when describing the 2% target, and we explained what that means. How much above 2% is tolerable, and for how long, is uncertain, and can the Fed even control these parameters once the inflation genie is out of the bottle ? Only time will tell !

THE REAL NEWS: A third mandate is coming. As Powell described it, for the first time publicly, a broad review of economic conditions was put in place, including events called FED LISTENS. Community groups, apparently something like “town halls” talked to Fed representatives around the country, involving “a wide range of participants—workforce development groups, union members, small business owners, residents of low and moderate income communities, retirees, and others—to hear about how our policies affect peoples’ lives and livelihoods”. YOU CAN SEE WHERE THIS IS GOING. “A clear takeaway from these events was the importance of achieving and sustaining a strong job market, particularly for people from low and moderate income communities.” Further along in Powell’s talk last week, as part of the New Statement on Longer Run Goals and Monetary Policy Strategy” – Powell specifically states: “With regard to the employment side of our mandate, our revised statement emphasizes that maximum employment is a broad-based and inclusive goal….particularly for many in low and moderate income communities”.

What this means is: MONEY, trillions of dollars of it, to be printed up by the Fed to purchase the government securities that will finance the huge debts that will increasingly be a drag on future productivity. The Wealth Gap must be addressed, without question, so the Fed is correct to that point. However, inflation, in and of itself. creates  a predictable Wealth Gap. This Wealth Gap has increasingly asserted itself after Richard Nixon eliminated the exchange of US Dollars into gold in August, 1971, and the Fed started managing the money supply more aggressively.  This “third mandate”, now clearly described by Chairman Powell, allows the “fox to continue to be in charge of the henhouse”.

CONCLUSION: 

Inflation is coming, and it will not be “controlled” at 2.25% or 2.5%. So far it has been limited to “Assets”, rather than groceries and apparel, but that will change, as it always has. The Fed is now embracing an effort to narrow the Wealth Gap, as described above, but their effort will not succeed.  The well to do have their stocks, bonds, art, real estate, and perhaps even gold, so can largely maintain their purchasing power. Lower and middle class consumers, on the other hand, never quite figure out why the higher nominal amount in their paycheck doesn’t ever catch up with their needs.  Inflation is the cruelest tax, predictably embraced by the politicians (because they don’t get blamed), and the Federal Reserve, which was established to control inflation becomes an accomplice.

It takes a sound currency to support a productive economy that can grow for the benefit of all, and there is no prospect of that any time soon.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE MOVE IN GOLD, AND THE GOLD MINERS, HAS JUST BEGUN!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE MOVE IN GOLD, AND THE GOLD MINERS, HAS JUST BEGUN!

The capital markets continued to be supported by the Federal Reserve Bank’s continued accommodation, in its effort to counter the pandemic related slowdown. The Fed’s policy, to do “whatever it takes”, not even “thinking about thinking about” higher interest rates or tighter money, supported most asset classes, including gold bullion (up 10.8% in July, and up 29.8% YTD) and the gold mining stocks (which did even better). Our Investment Partnership’s portfolio, virtually 100% invested in gold mining stocks, has performed in a similar fashion. While we are pleased with the progress, we expect gold miners to continue to outperform bullion on the upside and feel it is only the top of the second inning for the major move to come. While gold bullion is now at an all-time high, the gold miners are still down more than 50% from their highs. We expect bullion to at least triple from here over the next 3-5 years and the gold miners to increase by a multiple of that. All the financial factors that the pandemic has brought into focus and magnified are still in play.

Prominent investment strategists at Goldman Sachs and other investment firms, as well as legendary investors such as Ray Dalio are now recommending gold and gold mining stocks as productive portions of a diversified portfolio. Virtually every point they make we have been discussing every month for seven or eight years. Goldman says gold is the “currency of last resort and there is more downside to come with interest rates”. Dalio points out that “China is an adversary, the dollar’s reserve status is at risk, there is no true ‘price discovery’ as the Fed is buying everything in sight, the deficits and cumulative debt are a huge burden on future economic growth, central bank balance sheets are exploding as they purchase stocks and bonds and gold bullion as well, all of which support an important allocation to gold”. Does any of this sound familiar?

In addition to the debt burden, another factor that slows the growth path is the aging population. The increasing portion of the US population represented by older people, similar to trends in Japan, China, and Europe, is shown in the following charts.

Lastly, an important feature of government spending in the US is the increasing burden of entitlements, social security in particular. Entitlements and defense make up about 75% of government spending, and that’s a major reason why the total budget is mostly (‘baked in the cake”. With everything else going on in the world, it is often forgotten that the social security system was put in place in the 1930s when the average life span of an American male was about 65, which today is about 80. There were also A LOT MORE workers contributing than recipients. The chart just below shows the steady contraction of that ratio, from 3.7 down to the low 2s.

The above chart is impressive….but the following chart shows numbers closer to the 1930s when FDR put the program in place, with 159 workers/recipient in 1940, decreasing to “only” 42 workers by 1945.

Combine the above charts dealing with Social Security with the reality of an aging population. Add to that what might be considered “anecdotal” in terms of our impression of the work ethic of the younger working age population. If “America’s Greatest Generation” of workers is being replaced by today’s youth, perhaps less convinced of the morality of capitalism, it is difficult to picture government spending coming down or GDP and productivity accelerating.

All of this is to say that central banks, around the world, will have no alternative to aggressive monetary accommodation. Governments, similarly, will do likewise with fiscal  measures. We can watch this play out currently on almost a daily basis, and this is at a scale unprecedented in modern business history. Gold bullion, based on many parameters which we have described previously, is as cheap now as it was in 1971, before it went from $35 to $850. At $850 it was likely “ahead of itself” but $300-400 would have been a rational range at that point. Accordingly, 8-10 times the current level, which discounted by 50% would be $8-10,000 per oz., can be justified today. The gold mining companies, leveraged to the price of gold, could (and should) go up by somewhere between two and four times that gain. This is the basis by which we suggest  that the gold mining stocks could increase by 10-20x their current levels.

With gold hitting all-time highs, and the gold miners at seven or eight year highs, you will no doubt hear a number of financial commentators suggest that “the easy money has been made”. Some will suggest taking profits, with an objective of getting back in at a lower level. We suggest that if you owned a stock that had gone from $11 to $20, but you think it will be $80 or $90 or $100 in a few years, would you sell it at $20 to try to buy it back at $19 or $18? Probably not :).

Over the very long term, gold should be considered a “store of value” rather than an “investment”. There is, after all, no dividend or organic growth.  At the present time, however, the investment characteristics of this asset class, substantially lagging the increased nominal prices of almost all others, are too compelling to ignore. That is why our investment partnership is 100% invested by way of the above approach.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CORONAVIRUS, EVEN SOCIAL UNREST, WILL PASS, ECONOMIC RAMIFICATIONS WILL BE FAR LONGER LASTING

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CORONAVIRUS, AND EVEN THE SOCIAL REST, WILL PASS, BUT THE ECONOMIC RAMIFICATIONS WILL BE FAR LONGER LASTING

PROLOGUE

We wrote most of this update a couple of weeks ago, before the horrific situation in Minneapolis triggered protests, often with accompanying riots, in major cities all over America. There is no doubt that the growing wealth and opportunity gap in America, in and of itself,  is adequate justification for protest and rebellion. The stage was set, on top of that, by the social and economic tension from several months of restricted activity due to the coronavirus pandemic. While we cannot claim to be an authority regarding social trends, the recent developments, unfortunately, magnify  and accelerate even further the trends we discuss below.

THE MONTH OF MAY

While the general equity markets were strong all month, as investors seem to assume that the Coronavirus pandemic is in the rear view window, gold bullion strengthened a bit as well, up 2.6% for the month. The gold mining stocks continued their strong relative performance of April, up by low double digits in May and now comfortably positive for the year. As we have suggested, the gold miners should move at a multiple of the gold price because of their operating leverage and that is happening. Most impressively, since March31st, the low point, gold bullion is up about 9.9% and our gold mining stocks are up over 5 times that, measured by an average of GDX and GDXJ, the two major gold mining ETFs.

We continue to point out that the miners are down a lot more from their highs of 2011-2012 than gold bullion. Bullion, at $1730/oz. is down about 10% from the high and the gold mining stocks are still down well over 50%. Theoretically, then, if gold bullion moves up by 10%, the miners could double. That might be a “reach”, but the seven times move over the last two months could be indicative of what is ahead. Let’s hope so.

The following update is longer than we like to provide. However, since there is so much misinformation about the role of gold and the prospects for the gold miners, we want our readers to  be as well informed as possible.

THE STIMULUS IS MIND BOGGLING –THERE IS NO END IN SIGHT, AND IT IS A WORLDWIDE PHENOMENON

The coronavirus will pass, but the economic ramifications will be far longer lasting.  You don’t get out of a fiscal/monetary hole by continuing to dig. The current health crisis has brought forward, accelerated, and magnified the economic trends that were already in place. The monstrous buildup in debt is important because economic history has clearly shown that the higher the debt burden the bigger the drag on productive growth. This is why the longest (and falsely promoted as “the strongest”) economic expansion in US history only provided 2.3-2.4% annual real GDP growth from ’10 through ’19. You heard it here first: there is no chance in hell that future growth (after the “dead cat bounce” from current levels) will be higher than 2% or so, likely to be materially lower, with the new debt burden that the world will be carrying. 

We all know that the Fed balance sheet is exploding, as it finances the monstrous government spending. It is instructive to look at the pattern of growth over the last dozen years, as the supposedly apolitical Fed ignores the conservative side of the Keynes economic equation. John Maynard Keynes suggested, in the late 1920s and early 1930s,  that the Fed should provide stimulus in hard times and pull it back in better times, presumably muting potential booms and busts. Unfortunately, economic conditions never seem to get good enough to remove the previous accommodation.

Recapping the last dozen years: The Fed Balance sheet was under $1T in early ’08. It grew to about $2.2T by late’08, stayed around that level until mid ’09 when it started moving to about $3T by late ’11. From late ’12 to late ’14 it moved to $4.5T where it stayed until early ’18. The economy apparently never got quite good enough to pull back between ’10 and late ’17. In early ’18 the Fed announced a program of “automatic” reduction, with the implied objective to get back to perhaps $2.5-3.0T. It got back (only) to $3.7T by the end of ’19, but with the economy softening and distortions in the short term “repo” bond market, the Fed backed off and built its asset base to $4.2T, clearly on the way to a new high by mid’20.

Which brings us to the current “new world”. Since March 4, 2020, the Fed has taken its balance sheet from $4.2T to $7.0T, and Chairman, Jay Powell, has indicated that he will do “whatever it takes”. We expect it to be $10T or more in a matter of months. Folks,, this does not provide organic, productive, sustainable economic growth. This only provides an addictive high (not so high, in this case), supportive by always increasing doses of fiscal/monetary drugs.

The money printing, as the Central Banks finance their respective deficits, is not limited to the United States. Just this week, the European Common Bank announced a $2T stimulus package and The Japanese Central Bank weighed in with $1T. While the European economy, in total, is larger than the US, the Japanese economy is only 1/6 our size, so these are huge numbers in any context.

The debt and deficits that require the Fed’s intervention are likewise exploding. The US debt, excluding unfunded entitlements like Social Security, is now approaching $26T, up from $22.7 at 9/30/19. The operating deficit which was supposed to be about $1.2T for the full year ending 9/30/20 is now expected to be at least $4.0T. The deficit in April alone was $738B. At this junction, after trillions of dollars have already been provided, it is clear that there is much more fiscal/monetary stimulus to come and nobody knows the ultimate magnitude or duration. Most importantly: virtually everyone, fiscal hawks and doves alike, bipartisan in nature, agree that the support must be provided, and we can all worry about the ramifications later.

 THE PRICE OBJECTIVE FOR GOLD BULLION

The price of gold has shown a strong long term correlation with the federal US debt. The buildup of the Federal Reserve balance sheet over the last fifteen years has also strongly correlated with the gold price. The above discussion therefore supports a materially  higher price of gold related securities.

We believe that gold has proven itself for thousands of years as a store of value, is the ultimate currency, and this is the single most important reason that it is worth owning. It competes with paper currencies as the supply and demand of one currency (gold) must relate to the supply and demand of unbacked colored paper. The following chart shows the value of the gold held by the United States, since 1918 (shortly after the Fed was established in 1913), relative to the adjusted monetary base. A chart looks similar on a worldwide basis. You can see that from 1913 until just before the end of WWII, the value of the gold was about 35% of the monetary base. After the Bretton Woods agreement in 1944 whereby the US Dollar was established as the reserve currency, the percentage drifted down. The monetary base was growing steadily, and the US gold backing was declining, but the world was relatively unconcerned during a postwar recovery period. In the late 1960s, however, as US spending for the Vietnam War and President Lyndon Johnson’s Great Society accelerated, US trade and operating deficits became widely anticipated. Over 50% of the US gold was exchanged for dollars within eighteen months prior to August, 1971, when Richard Nixon “closed the gold window”. At that point, our gold amounted to only 6-7 % of the US monetary base. This level is important because we are back to that same level today.

We are not suggesting that the US, or anyone else, will make their paper currency convertible into gold any time soon. It wouldn’t work for long, in any event, because deficits in all major trading countries are larger than ever, and paper currencies would once again be tendered for gold. No country could back their currency with gold, unless they were “balancing their books” or, at the least, that prospect was in sight. We do, however, feel that the value of the gold “in circulation” should have a relationship to the value of alternative currencies. You might be surprised to learn that the country most able to make their currency convertible into gold would be Russia, perhaps our most prominent political adversary and a consistently large buyer of gold.

The chart above indicates that 7% could be 35%, or five times the current price. This  ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1730/oz, or $8600 to $10,300/oz. This ballpark price range objective is at the current time. The monetary base is now rising at about 20% per year with all the money printing to support the economy in the current crisis. Though gold is now moving steadily higher, the monetary base is also rising so the price objective within just the next few years could be well over $10,000/oz.

THE TIMING – FOR GOLD BULLION PRICES

The following two charts provide insight into the possibility of an imminent major upward move. The first chart shows the high correlation of the gold price to the amount of worldwide sovereign negative yielding debt, which peaked at $16-17T in mid ’19 and is now in the low teens. Even in Germany, the strongest European country, the entire yield curve has been negative or close to it. We believe that the amount of negative yielding debt will continue its upward march and could even include some of the US debt, especially based on President Trumps implied blessing just two weeks ago. The continued upward trend of this indicator could be influential in breaking the gold price out above the previous all-time high of $1911. That, in turn, could ignite the price toward the price objectives noted above.

The second chart shows a nineteen-year price chart of gold. It shows the end of an 11-12-year bull market, ending in 2012, then a 6-7 year “consolidation”. The price has now clearly broken above $1400, the previous high. Chart technicians would say that the longer the base, the bigger the move. It is conceivable that a new bull market has begun that could last for quite a few years. This would tie in to our logic that the price of gold could be 5-6 times higher over a number of years.

There are other charts we could provide that show a long term correlation of the price of gold to the level of US debt. Over the last fifteen years the same sort of correlation has taken place between gold and the buildup of the Federal Reserve balance sheet.

THE GOLD MINING STOCKS

The chart just below shows the gold mining index, XAU, relative to the price of gold bullion. Since 2008, the relative valuation of gold equities to gold bullion has fallen 75% from the prior 25-year average. The ratio of the XAU Index to spot gold averaged 0.25x for a quarter century through 2008. As of 3/31/2020, the ratio was 0.05x.

We believe that the substantial divergence in performance is due to mostly outdated opinions.  Managements have been improved, balance sheets have been strengthened, operations have been streamlined. Additionally, energy costs, which are 15% or operating expenses, are much lower today than the range of $80-120/bbl of ten years ago.  Higher gold prices and lower expenses have produced impressive recent results from established miners and should become even more so.

SUMMARY

The healthcare crisis, now exacerbated even further by the social unrest,  has accelerated, magnified, and brought forward in time many of the long term fiscal/monetary trends that we have been expecting for some time. We continue to feel that gold mining companies are the single best asset class in terms of reward versus risk.

We’ve been joined lately in our conviction relative to gold by legendary investors and portfolio strategists such as David Rosenberg, Jeff Gundlach, Ray Dalio, Jim Roberts, Stanley Drukenmiller, David Einhorn, Stephanie Pomboy, Luke Gromen and others. Long term proponents of gold and gold miners such as John Hathaway Fred Hickey, Bill Fleckenstein and Peter Schiff are more convinced than ever. Though it’s nice to have some “smart money” in our camp, the investment world in general is just beginning to take small positions in this sector.

Gold bullion is up about 14% this year at this moment (a safe haven, after all). The miners, which were down for the year a month ago, are now in positive territory and catching up with bullion. In the last two months, gold mining stocks, as measured by an average of  GDX and GDXJ, the two largest gold mining ETFs,  have moved over 5x the price change of bullion (Our Investment Partnership, RHL Associates, LP, has done even better).  We believe we are still in the first inning of the resumption of the long term bull market for gold related securities.

Roger Lipton