Tag Archives: deficits

SEMI-MONTHLY FISCAL/MONETARY UPDATE – FED ACTS, CAPITAL MARKETS REACT, GOLD MINERS SHINE

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE FED ACTS, CAPITAL MARKETS REACT, GOLD MINERS SHINE

The general equity market was up just a little in July as the investing world waited to see how aggressive the Fed would be in terms of lowering rates. When the cut in rates yesterday afternoon was only 25 basis points, all capital markets sold off, with his remarks interpreted as if this cut would be “one and done”. This will not be the actuality, in our opinion, as extended monetary ease will be necessary to support the weakening worldwide economy. It is encouraging to us that, with gold bullion virtually flat for the month of July, based upon the prices of GDX and GDXJ, the two largest gold mining ETFs, and TGLDX, OPGSX, AND INIVX, the three precious metal mutual funds that we track,  the gold mining stocks were up about 5% for the month. This price performance is starting to reflect the inherent operating leverage within the miners vs. the price of gold bullion. For the year to date,  the gold mining stocks are up about 24.1%, nicely outperforming gold bullion which is up 9.9%.

The price action of gold bullion and the gold mining stocks is beginning to attract attention, but ownership is still almost non-existent among North American investors. Many of the reasons provided by observers have some validity, but are nothing new to all of us. The monetary stimulus, the deficit, the debts, the geo-political risks, the political dysfunction, the increasing social unrest and the wealth gap are all continuing worldwide trends that have long been in place but are suddenly become newsworthy. It’s been said, in response to how a crisis develops: “very slowly and then very suddenly”. The following are a few of the most important reasons that precious metal holdings are all of a sudden performing well.

FUNDAMENTALLY: David Rosenberg, one of the most highly regarded investment strategists, and not a perennial “gold bug” by any means, just a couple of weeks ago, wrote “WHY GOLD HAS ALLURE”.

(1) The Fed is set to cut rates (as discussed above), which will send the fed funds rate into negative territory in real terms.

(2) Geopolitical risks, including Iran’s behavior, are increasingly bothersome.

3) Trade talks with China do not seem to be making progress, and Beijing has “tools” to hit back, including the ability to weaken their currency and/or continue reducing their US Treasury holdings.

(4) The economic war between the US and France is heating up, as Emmanuel Macron imposes a tax on American large cap tech companies. At the same time, trade tensions increase between the US and Japan, as well as South Korea.

(5) The Chinese economy, as well as the entire Asian economy, is clearly in retreat, adding to the prospect of worldwide monetary ease.

TECHNICALLY: In terms of supply of demand for physical gold, and the price charts:

(1) Central Banks around the world have continued their massive accumulation, a total of 374 tons in the first half of calendar ’19. While the first half total was down around 5% from ’18, the annualized rate of 750 tons is far more than in prior years. Russian and Chinese Central Banks continue their steady accumulation.  India, between their central bank and their population, perennially the second largest accumulator of physical gold, imported 78 tons in May alone, running 49% ahead of a year earlier. Poland has now joined the other major buyers, buying a huge (for them) 100 tons in the second quarter alone. Sine the total annual worldwide production is about 3400 tons, these purchases are very meaningful.

(2) The price charts, for gold as well as gold mining shares, indicate much higher prices. Gold bullion has broken out to a five year high, though still 25% below the 2011 high. The gold mining shares are at three year highs but are still as much as 75% below their 2012 high.

The gold mining stocks are still substantially undervalued by many historical measures. Gold bullion, is down about 25% from its all time high of about 1900 in 2011, but GDX (the ETF with the larger miners) is down over 50% from its high and GDXJ (with the small to midsize miners) is down 75%. Our expectation is that gold bullion, will sell for a multiple of its current price and the mining stocks at a multiple of that. The timing, as always, is the big question, but the pieces seem to be falling into place, as outlined above.

In summary, there are never any certainties, especially in the short run, but it seems like both fundamental and technical considerations are in gear, and indicating much higher prices for precious metal securities.

Roger Lipton

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SEMI-MONTLY FISCAL/MONETARY UPDATE – GOLD STARTS TO SHINE, WITH GOOD REASON !!

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SEMI-MONTLY FISCAL/MONETARY UPDATE – GOLD STARTS TO SHINE, WITH GOOD REASON!

The general capital markets were strong in June: equities because investors came to the conclusion that the Fed “put” is back in place, and bonds because the Fed tightening (“QT”) is behind us. Gold and the gold mining stocks were strong as well, for lots of overdue reasons, a couple of which  are discussed below. Gold bullion was up 8.0% and gold mining benchmarks were up 18.4% (the average of ETFs,  GDX and GDXJ) and 16.2% (the average of precious metal mutual funds (TGLDX, OPGSX, and INIVX) respectively. Our  portfolio was up in line with the benchmarks. The  subject matter below describes only a couple of the many reasons that justify the recent overdue action in gold and the gold mining stocks.  Reminds me of the song “we’ve only just begun”.

THE SINGLE BIGGEST REASON TO OWN GOLD RELATED SECURITIES !!

The most important justification for our our ownership of precious metal related securities is the 5,000 year history of gold being the safest and surest protection of purchasing power. Gold is a unit of exchange and a store of value. There has never been an unbacked “fiat” currency that has survived. It is just a question of time until the politicians of the day dilute their currency into oblivion and today’s politicians (of both parties) are clearly on the same path. Our portfolio represents gold as the safest currency and we believe that the history of the quantity of gold owned by Central Banks relative to the amount of paper currency they have created (M2 or “FMQ” as shown on the below chart) is indicative of where we are at the moment. You  can see from the chart below that gold bullion relative to M2 was at a low in 1970 (before gold went from $35 to $850/oz. and 2000 (before gold went from $250 to $1900). Lo and behold, gold is at that level again today. In terms of a price objective, we believe $850, the top of the parabola in 1980, was too high. Probably $300-$400 was more appropriate. The move from $250 in 2000 to $1900 was more justifiable, based on our standard that the gold owned by Central Banks should be in the range of 25-40% of the paper currency out there. This is the range between 1790 and 1913, before the creation of Central Banks, when inflation was zero and real GDP growth averaged 4%. This is how we conclude that an appropriate price of gold today is perhaps $5-7000 per oz. Of course, this price objective is moving higher all the time as more paper currency is created. Two or three years from now, the objective could well be $9-10000/oz. We conclude that just because gold has gone from a low of $1050 a couple of years ago to $1400 now, we will not be tempted to lighten up any time soon. If we had a stock that had gone from $10.50 to $14.00 and we thought the upside was north of $50.00 per share, that would be a lot of money to potentially leave on the table. Don’t forget that the mining stocks, depressed as they still are, could move 2-3x as much as the gold price.

We like to keep our letters short, but since we recently reviewed the “state of the union” in terms of the current deficit, we present the information below. This part of the puzzle is important because it indicates how much new paper “fiat”, unbacked, currency must  be created to fill the deficit gap. We predicted a few weeks ago, when we published this information here that the deficit for the current year would be over $1 trillion. The Congressional Budget Office has now confirmed our work.

$206B US DEFICIT IN MAY – HEADING TO $897B FOR YEAR , MAYBE OVER $ONE TRILLION NEXT YEAR ? – YEAH, RIGHT !! – and the FED now agrees.

There are about 250 persons working at the Congressional Budget Office, according to their website. Their budget, according to Wikipedia was $46.8M annually, as of 2011, probably higher now. Their projections are widely quoted, and presumably relied upon by policy makers in our administration. The CBO updates their projections on an irregular basis, sometimes several times per year, sometimes only once per year. The update from 5/2/19, only two months ago has now been adjusted upward. Considering how far off their past projections have been, and the questionable assumptions within their analyses, it is a wonder that anyone takes these numbers seriously, and the latest installments provide a good example why not.

A brief two months ago, on 5/2, based on relatively firm numbers through March, and presumably pretty reliable indications through April, the CBO predicted that the US operating deficit through the current fiscal year, ending 9/30/19, would be $897 Billion. April and May results are now reported, and the table below shows the monthly numbers for the last two fiscal years.

You can see that last year’s total operating deficit was $779B, and the total debt went up by $1,271B (due to “off budget” items, the largest of which is the social security shortfall). The projection two months ago was for the current year’s deficit to be $897B, up 15.1% from fiscal ’18. The total debt is not projected, and you can see that number frozen the last few months since our administrators have already exceeded the formal debt “limit”.

The April result, with tax receipts generating the surplus (normal for April) of $160B, which was lower than the $214B surplus a year earlier, so the cumulative deficit through April (shown at the extreme right of the table) was up 37.6%. They May results showed a $206B deficit, up from $147B, so the cumulative deficit is up 38.6% year to  year. Last  year, the monthly deficits from June through September totaled  $246B. The CBO projection, on 5/2, of $897B for the ’19 year would allow for only $158B the rest of the year, down 36% from the last four months of fiscal ’18 – which was ridiculous.

We don’t have 250 professionals pushing numbers here but during the current year:  December’s YTY deficit reduction (which some might have considered hopeful) was on an  immaterially low base. March’s improvement was material, but March and April combined (tax season) showed a $13B surplus this year versus $5B in fiscal ’18, which is an immaterial change. May bounced back to a 40.1% increase YTY in the deficit. You can see, along with ourselves, that the last four months would have to be 36% lower than last year, improbable, to put it mildly.

Our projection, with 247 professionals fewer  than the CBO was for the following, and we published this conclusion several weeks ago: The last four months would provide a deficit about  40% higher than a year ago ($247B), which would provide for $346B  on top of the current $739B, for a total of $1.08 Trillion. This is 20% higher than the $897B projection made by the CBO with only five months left in the fiscal year. We shouldn’t have to point out that: if the CBO was 20% off the mark with five months remaining, their projections ten years out don’t have a great deal of credibility.

Furthermore: the total debt, whether or not the debt ceiling has been formally raised, will have expanded by $1.3-$1.5 Trillion, bringing it close to $23 trillion.

We have presented a great deal of information in this letter, and our conclusions are justified by much more. The biggest single reason that gold and gold mining stocks are going up in price is that they never should have gone down in the first place.  All the reasons we have discussed over the last six or seven years continue to intensify.

Roger Lipton

 

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – $206B US DEFICIT IN MAY – HEADING TO $897B FOR YEAR – YEAH, RIGHT !!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – $206B US DEFICIT IN MAY – HEADING TO $897B FOR YEAR , MAYBE OVER $ONE TRILLION NEXT YEAR ? – YEAH, RIGHT !!

There are about 250 persons working at the Congressional Budget Office, according to their website. Their budget, according to Wikipedia was $46.8M annually, as of 2011, probably higher now. Their projections are widely quoted, and presumably relied upon by policy makers in our administration. The CBO updates their projections on an irregular basis, sometimes several times per year, sometimes only once per year. The last update was 5/2/19, only about six weeks ago. Considering how far off their past projections have been, and the questionable assumptions within their analyses, it is a wonder that anyone takes these numbers seriously, and the latest installment provides a good example why not.

Six weeks ago, on 5/2, based on relatively firm numbers through March, and presumably pretty reliable indications through April, the CBO predicted that the US operating deficit through the current fiscal year, ending 9/30/19, would be $897 Billion. April and May results are now reported, and the table below shows the monthly numbers for the last two fiscal years.

You can see that last year’s total operating deficit was $779B, and the total debt went up by $1,271B (due to “off budget” items, the largest of which is the social security shortfall). The projection, six weeks ago, was for the current year’s deficit to be $897B, up 15.1% from fiscal ’18. The total debt is not projected, and you can see that number frozen the last few months since our administrators have already exceeded the formal debt “limit”.

The April result, with tax receipts was a surplus of $160B, which was dower than the $214B surplus a year earlier, so the cumulative deficit through April (shown at the extreme right of the table) was up 37.6%. They May results showed a $206B deficit, up from $147B, so the cumulative deficit is up 38.6% year to  year. Last  year, the monthly deficits from June through September totaled  $246B. The current CBO projection of $897B for the ’19 year would allow for only $158B the rest of the year, down 36% from the last four months of fiscal ’18 – which is  ridiculous.

We don’t have 250 professionals pushing numbers here but this year to date: December’s YTY deficit reduction was on an  immaterially low base. March’s improvement was material, but March and April combined (tax season) showed a $13B surplus this year versus $5B in fiscal ’18, which is an immaterial change. May bounced back to a 40.1% increase YTY in the deficit. You can judge for yourself the likelihood that the last four months will give us a deficit 36% lower than last year.

Our projection, with 247 professionals fewer  than the CBO is for the following: The last four months will provide a deficit about  40% higher than a year ago ($247B), which would provide for $346B  on top of the current $739B, for a total of $1.08 Trillion. This is 20% higher than the $897B projection made by the CBO with only five months left in the fiscal year. We shouldn’t have to point out that: if the CBO is 20% off the mark with five months remaining, their projections ten years out don’t have a great deal of credibility.

Furthermore: the total debt, whether or not the debt ceiling has been formally raised, will have expanded by $1.3-$1.5 Trillion, bringing it close to $23 trillion.

This reality is unlikely to be comforting to the capital markets.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – CENTRAL BANKS BUY STOCKS AND BONDS – A LONG TERM DISASTER !!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – CENTRAL BANKS BUY STOCKS AND BONDS – A RECIPE FOR LONG TERM DISASTER !!

A LESSON IN “MAKING MARKETS”

It’s been a number of years since we had an active market for initial public offerings. Decades, and a number of stock market cycles ago, this then young analyst watched quite a few small companies come public, in many cases underwritten by brokers much smaller than the surviving investment bankers of today. Some of those underwriting firms, well intentioned to be sure, supported the brand new issue with a supporting bid, figuring it was just a question of time before the market figured out that the stock was attractive, the supporting bid could be removed, the stock would be freely trading and move up, the public customers would be happy, and the broker might even make a profit when selling their acquired inventory. Other underwriters, not so committed to supporting the new issue price, allowed the stock to trade freely immediately, tolerating the higher volatility, and allowing the free market to establish (“discover”) the price, for better or worse.

The interesting aspect of these two approaches was as follows: The firms that intervened in the marketplace in many cases finally choked on the inventory, their capital was not sufficient to buy the stock forever, and they ultimately went out of business. The more prudent underwriters that allowed for “price discovery” (as the PHDs would put it) by the normal supply and demand of the marketplace lived to play another day.

This small scale example applies to the trading habits of worldwide central banks today. As the US government builds its debt over $22 trillion, which is more than 100% of our GDP, lots of observers say it is no big deal since Japan, for example, has government debt at 250% of their GDP. The Japanese economy is still functioning, with slow growth to be sure, but there is no evident crisis. This reminds me of the cartoon where the guy jumps off the cliff, and, while in the air, calls out: “I feel fine !!”

There are over $10 trillion of government securities trading with less than a zero percent yield. This is as a result of the US, ECB, Japanese and Chinese central banks buying stocks and bonds, supporting the price of stocks and bonds, and suppressing fixed income yields. In this absence of true price discovery by the marketplace, fixed income savers have been penalized, to the benefit of stock and bond holders, creating a wealth effect for the latter. This good fortune on paper could (and will) be temporary, but for the moment, just like the guy who jumped off the cliff, we feel fine !!

Where are we in this process ??  In addition to the negatively yielding fixed income government securities, the Bank of Japan (that has been doing this for almost thirty years) now owns about $250 billion of Japanese ETFs, or 75% of that entire market of ETFs. On the fixed income side, the Bank of Japan owns about 45%, or $4.5 trillion worth of all the Japanese government bonds outstanding. With it all, the Japanese economy is still running well below 2% real growth, with inflation at well under the 2% objective. It is of course an important sub-text that central banks worldwide are trying to stimulate inflation, rather than subdue it, which was the original objective.  Closer to home, we have been informed that our Fed is abandoning QT, preparing for a new form of QE, which, some have suggested, could include the purchase of US equities as well as bonds.

Here’s a quick economic lesson for the hundreds of PHDs that are working within central banks, which we guess isn’t part of the new Modern Monetary Theory. Don’t intervene in a market unless you are prepared to BUY IT ALL, because you will, eventually. Witness the holdings of the Bank of Japan, who have been at this game the longest, still without the result they have been reaching for. Aside from a long list of unintended consequences that have yet to play out, the attempt to lighten the inventory, (Sell to whom?) has just been demonstrated in the US. One down month in the stock market (December) with the two year treasury rate approaching 3% and the US Fed caved. Whom do you think the Japanese Central Bank can sell to?

The above described central bank intervention in capital markets will inevitably destroy most international currencies, including the US Dollar, because the money will have to be created to support the capital markets and the presumed wealth effect that will prevent economic collapse and that will be highly inflationary. This is the “bubble” that Donald Trump described when he was campaigning but that he has forgotten about since he is in office. The politicians and central bankers will continue to chase their long term (NEW) goal of creating inflation substantial enough to service long term debt obligations. The debt, worldwide, is far too large to be paid off in the currencies of today. Substantial inflation is the only politically acceptable remedy, since outright default is too obvious to the voting public.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – IGNORE HISTORY AT YOUR OWN PERIL !

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – IGNORE HISTORY AT YOUR OWN PERIL

The general market was up modestly in March while gold and the gold mining stocks were down modestly. For the year to date, in the first quarter, the gold mining stocks were up about 5-6%, fairly good considering the gold bullion was only up 0.6%, also considering that the general market and the US Dollar were strong, both of which normally track inversely to gold related assets. Monetary conditions are clearly becoming more accommodative, as central banks, worldwide, back off from raising interest rates and reducing  balance sheets. The discussion below provides only a portion of the argument why there should soon be a resumption of the long term bull market for precious metal related assets.

IGNORE HISTORY AT YOUR OWN PERIL

John Maynard Keynes had some good ideas back in the 1920s: the Federal Reserve Bank had been formed in 1913, and would manage the economy, control inflation, reduce the frequency and severity of booms and busts, stimulate the economy in hard times, and pull back the accommodation in good times.

Keynes articulated this very well, in 1923: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Harry Browne, the brilliant economist, and writer, who wrote “You Can Profit from the Coming Devaluation” in 1970 (which I republished in 2012), anticipating the devaluation of the US Dollar when Nixon closed in the gold window in 1971, put it another way. He said that “you can’t have a sound economy without a sound currency”.

Starting with the longer term view, under the management of our Federal Reserve, the 1913 Dollar (when the Fed was formed) has become worth about $.03. (In contrast, an ounce of gold still has roughly the same purchasing power.) More recently, over the last ten years, our Fed (with imitation by the ECB, Japan, and China) has given us several “QE’s”, during which short term interest rates have gone to zero, there is still something like TEN TRILLION of sovereign debt with rates at ZERO or less, and the Fed balance sheet went from $900B to $4.5 TRILLION

After several Quantitative Easings over the last ten years, a little over eighteen months ago the Fed announced that they would raise interest rates to “normalized” levels (presumably upwards of 3% for short rates and above 4% for  thirty year paper) and, on an automatic programmed basis, reduce the balance sheet to a more tolerable $2.5 trillion (still almost a triple from where it started in 2008). We predicted that this program wouldn’t go far, because the economy couldn’t tolerate it, and interest rates on (now) $22 Trillion of debt would wreck the US budget. Sure enough: it is now clear that the interest rates will not rise further, and the Fed balance sheet will only shrink perhaps another $200B this year, down to about $3.7 trillion. This latest objective apparently provides comfort that the economy will not be choked off from the “steady” growth: one year, in 2018, at 3.0% (with lower tax rates, repatriation of $800B of dollars overseas, and reduced governmental regulation), projected from this point to be back to the 2.3% range of the Obama administration.

Back to John Maynard Keynes and Harry Browne:

Keynes: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Browne “you can’t have a sound economy without a sound currency”.

Does any of this sound familiar? These days it’s called a “wealth gap”, and politicians are calling for rich people to “pay their fair share”. Savings haven’t been “lost”, but they are earning next to nothing unless large risk is undertaken.

THE STATED DEFICIT IS THE TIP OF THE ICEBERG

We’ve written extensively that the actual debt is increasing much faster than the “operating” cash flow statement implies. Some uninformed observers have said that this is just a question of short term working capital changes which even out over a number of years. The facts are (1) this phenomenon has happened almost every year. (2) Over the last decade, the increase in debt, above and beyond the total of annual deficits has amounted to a total over THREE TRILLION DOLLARS. That’s $3,000,000,000,000. A lot of zeros. (3)  It is a result of “Intragovernmental Borrrowing”, which doesn’t run through the annual operating budget. Specifically, as of 9/30/18, there was about $6 trillion of “Non-Public Borrowing”. 51% of that is from the Social Security Trust Funds. 17% from Military Retirements and Health Care Funds, 16% from Civil Service Retirements and Disability Funds, 6% from Medicare Trust Funds, and 11% from other Trust Funds. So our legislators are hollowing out the various funds that should be safely set aside to meet their intended purposes. Before we leave this subject, it is important to know that certain observers have opined that the US is not really in debt by $22 trillion, it’s only $16 trillion, a much lower percentage of our GDP, not nearly so dangerous. After all, we owe that $6 trillion to “ourselves”, the implication being that it doesn’t have to be honored. Tell that to the social security recipients, military veterans, civil servants and medicare recipients.

We provide below a table showing the most recent monthly deficits and increase in debt. You can see that in the fiscal year ending 9/30/18 the monthly deficits totaled $779B, but the debt increased by $1.27T. We say again: this is not a one year phenomenon. Three trillion, over ten years, has been “borrowed” from various trust funds. This year, through February, the operating deficit was $234B in February, up from $215B a year ago. Cumulatively the deficit for the year through February is $544B, up 39.1%. Relative to the increase in debt, it is up $599B cumulatively, actually decreasing by 2%, but still on track to run something like $1.3T for the year versus an advertised estimated deficit of about $1 trillion.

The last point, on the specific subject of deficits and the possibility of progress: It should be clear to all of us that both political parties are already in full “positioning” mode for the 2020 election. There will be no substantive improvement in the fiscal/monetary position of our country, especially since that would require reductions in entitlements, defense, or interest rate spending, none of which will occur. By the end of fiscal 2020, at 9/30/20, the total debt will be on the order of $24 trillion and growing. The financial, social, and political implications of that reality have yet to play out.

WHERE DO WE GO FROM HERE?

We go to Quantitative Easing again, BUT MUCH LARGER. When an addict is hooked, each hit has to be bigger than the last, to maintain the high. The Fed balance sheet went from $900B to $4.5T, a quintuple, and will only have come down by about 18% to about $3.7T. Never before in the history of the planet has ongoing monetary accommodation (including $1 trillion current deficits) been necessary in the middle of a (relatively) strong economy.  In addition to the modest reduction in the Fed balance sheet, short term interest rates, after going slightly negative, have only risen to 2.7% before the Fed said “basta” as the economy threatens to roll over. We can only imagine how much capital will need to be injected by the Fed, and how low or negative interest rates will be taken to counter the next recession.

In conclusion: Don’t believe the economic fiction that we need not fear inflation, from accommodation of the past or from further stimulation, that deficits don’t matter, that the new Modern Monetary Theory (described in today’s Wall Street Journal) will keep things under control. All kinds of assets have already been inflated in price, and that wealth effect has clearly been enunciated as a goal of the Fed. Unfortunately, the benefit has not been spread equally among citizens, and this is a worldwide problem. The saddest part is that the politicians of today, just as in the past, show no inclination to correct the fiscal/monetary policy in a constructive way. The longer this financial party continues, the worse will be the hangover. Nobody knows exactly what the “end game” looks like, but it is probable that gold related securities will be among the very best performing assets.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY REPORT – SAYONARA “QT” – WHAT’S NEXT ??

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SEMI-MONTHLY FISCAL/MONETARY REPORT – SAYONARA “QT” – WHAT’S NEXT ??

John Maynard Keynes had some good ideas back in the 1920s: the Federal Reserve Bank had been formed in 1913, and would manage the economy, control inflation, reduce the frequency and severity of booms and busts, stimulate the economy in hard times, and pull back the accommodation in good times.

Keynes articulated this very well, in 1923: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Harry Browne, the brilliant economist, and writer, who wrote “You Can Profit from the Coming Devaluation” in 1970 (which I republished in 2012), anticipating the devaluation of the US Dollar when Nixon closed in the gold window in 1971, put it another way. He said that “you can’t have a sound economy without a sound currency”.

Starting with the longer term view, under the management of our Federal Reserve, the 1913 Dollar (when the Fed was formed) has become worth about $.03. (In contrast, an ounce of gold still has roughly the same purchasing power.) More recently, over the last ten years, our Fed (with imitation by the ECB, Japan, and China) has given us several “QE’s”, during which short term interest rates have gone to zero, there is still something like TEN TRILLION of sovereign debt with rates at ZERO or less, and the Fed balance sheet went from $900B to $4.5 TRILLION .

After several Quantitative Easings over the last ten years, a little over eighteen months ago the Fed announced that they would raise interest rates to “normalized” levels (presumably upwards of 3% for short rates and above 4% for  thirty year paper) and, on an automatic programmed basis, reduce the balance sheet to a more tolerable $2.5 trillion (still almost a triple from where it started in 2008). We predicted that this program wouldn’t go far, because the economy couldn’t tolerate it, and interest rates on (now) $22 Trillion of debt would wreck the US budget. Sure enough: it is now clear that the interest rates will not rise further, and the Fed balance sheet will only shrink perhaps another $200B this year, down to about $3.7 trillion. This latest objective apparently provides comfort that the economy will not be choked off from the “steady” growth: one year, in 2018, at 3.0% (with lower tax rates, repatriation of $800B of dollars overseas, and reduced governmental regulation), projected from this point to be back to the 2.3% range of the Obama administration.

Back to John Maynard Keynes and Harry Browne:

Keynes: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Browne “you can’t have a sound economy without a sound currency”.

Does any of this sound familiar? These days it’s called a “wealth gap”, and politicians are calling for rich people to “pay their fair share”. Savings haven’t been “lost”, but they are earning next to nothing unless large risk is undertaken.

Where do we go from here? Quantitative Easing again, BUT MUCH LARGER. When an addict is hooked, each hit has to be bigger than the last, to maintain the high. The Fed balance sheet went from $900B to $4.5T, a quintuple, and will only have come down by about 18% to about $3.7T. Never before in the history of the planet has ongoing monetary accommodation (including $1 trillion current deficits) been necessary in the middle of a (relatively) strong economy.  In addition to the modest reduction in the Fed balance sheet, short term interest rates, after going slightly negative, have only risen to 2.7% before the Fed said “basta” as the economy threatens to roll over. We can only imagine how much capital will need to be injected by the Fed, and how low or negative interest rates will be taken to counter the next recession.

In conclusion: Don’t believe the economic fiction that we need not fear inflation, from accommodation of the past or from further stimulation, that deficits don’t matter, that the new Modern Monetary Theory will keep things under control. All kinds of assets have already been inflated in price, and that wealth effect has clearly been enunciated as a goal of the Fed. Unfortunately, the benefit has not been spread equally among citizens, and this is a worldwide problem. The saddest part is that the politicians of today, just as in the past, show no inclination to correct the fiscal/monetary policy in a constructive way. The longer  this financial party continues, the worse will be the hangover.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – PRECIOUS METAL PRICES CONSOLIDATE – WHY GOLD?

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – PRECIOUS METAL PRICES CONSOLIDATE – WHY GOLD?

The general equity market continued strong in February, while the precious metals complex consolidated the strong gains of December and January, with hardly any change. Gold bullion was down 0.6%, the gold miner ETFs (GDX and GDXJ) were down an average of 1.8%, the three mutual funds that we track (Tocqueville, Oppenheimer and Van Eck) were up an average of 0.6%. Our gold mining oriented investment partnership is performing in line with those ETF and mutual fund benchmarks, for the month and the year to date.

While we have a lull in marketplace volatility, it seems worthwhile to reflect on at least part of the essence of our conviction, why gold is the “real money”, proven to be so over literally thousands of years, currently representing probably the most undervalued asset class of all. It is true that there are other asset classes that have protected purchasing power as well or better than gold over chosen periods of time, such as: stocks of well run companies, well situated real estate, art created by legendary artists, to name just a few. Gold, however, the same gold that was produced in the days of King Tut (1341-1323 B.C.E.) has protected purchasing power without the uncertainty of stock picking, location analysis, or artist selection. An ounce of gold reflects roughly the same number of hours worked, and value of goods and services as it did 3,000 years ago, 200 years ago, 100 years ago, 50 years ago, and 20 years ago. (Not 6 years ago, to be sure, but give it time!)

Everyone talks about how inflation is “non-existent”, in spite of the monetary “accommodation”, which means money printing, unbacked paper currency creation with no limitation, debt levels worldwide still increasing. Even our Federal Reserve PHD’s are scratching their collective heads as to why inflation has not resulted from the trillions of paper dollars injected into the monetary system by the Central Banks. The new theory, dubbed Modern Monetary Theory, is postulating that the paper unbacked currency creation doesn’t matter. Remember the last “new paradigm”, the dotcom bubble of 1999-2000?

Let’s keep it simple. Put a few people in a small city, perhaps on an island, with a fixed amount of goods and services, and a fixed amount of money in circulation. If suddenly the money supply doubled, and there was no change in the goods and services available, what do you think would happen to prices? Of course everyone would have more “money” to spend, and they would compete for the “stuff” and prices (the quoted required paper exchange value) would of course rise. By the way: it’s the currency creation that’s the inflation, the cause, which we’ve already experienced.  The price rise is the effect of the inflation (insertion of more currency), and is coming.

So why hasn’t the price rise, following the “inflation” happened in the last ten years? The answer is, IT HAS! The Central Banks created trillions, which governments used to buy bonds and stocks around the world, keeping interest rates low in the bond markets, forcing fixed income buyers to reach for yield in the bond market and sometimes buy stocks in desperation while governments (Switzerland and Japan & others) bought stocks as well. This “misallocation of resources”, this “financial promiscuity”, this unprecedented monetary “experiment” has created not only artificially high stock and bond markets but private market valuations approaching $100 billion for unprofitable companies such as Uber and WeWork. Why do you think $100M (and higher) transactions in residential real estate are becoming commonplace and $200M was spent for a Van Gogh. People of substantial means are trying to get at least some of their resources out of “cash”, which they know is being diluted all the time. They don’t know what their Central Park West apartment or Van Gogh will sell for fifty years from now, but they are certain that the colored paper in their pocket will buy a very small fraction of today’s purchasing power. Grocery prices, certain Chinese or Mexican produced apparel, or increasingly powerful consumer electronics may not be quoted higher in price, but almost every important asset class other than gold has appreciated substantially, especially over the last ten years.

One last point for this installment:

While the hue and cry for a higher minimum wage has been a constant feature of our political and economic dialogue, let’s think for a moment about the way the economic world really works, and always has. Workers get a raise, $15 minimum hourly wage now in 20 states, and feel good for a little while, because they immediately have more discretionary income. However, the higher wage comes from their employer who produces goods and services and that production has to generate a return on investment. Since that employer’s profit margin has just been materially reduced, in probably a matter of months they will raise the price of whatever they are selling. So the employee who received higher pay fairly quickly finds that he or she is paying more for the stuff they are buying. This is why, it’s the middle class that really gets screwed by the inflationary process. The wealthy have their stocks, bonds, homes, art, stock options, etc. The impoverished have their various government benefits, food stamps, and emergency care at the hospital if they really need it. It’s the middle class, playing by all the rules, that can’t seem to get ahead. They are making more “money”, but don’t ever seem to get ahead.

Wrapping this up, the “Inequality of Wealth, the “Wealth Divide”, as the rich get richer and the poor left behind, that everyone talks about has been a feature of the last 47 or 48 years. Various charts clearly show that prior to the 1970s the purchasing power of the rich and poor was increasing at just about the same rate. The divergence in discretionary purchasing power clearly began in the late 1970s.

I don’t believe it is coincidental that Richard Nixon “closed the gold window” in August of 1971, eliminating convertibility of the dollar into gold. This predictably allowed for unfettered money creation, kicking off the double digit inflation of the 1970s, a fed funds rate that was 18% when Ronald Reagan took office, and the move in gold from $35 to $850/oz. The 1971 Dollar is worth about $0.15 today in purchasing power, and that seems to me like just yesterday. This is why it’s been said that “inflation is the cruelest tax”.

It just so happens that the gold owned by the US Treasury as well as the major trading countries collectively, relative to the unbacked (fiat) paper currency that is circulating, is almost the same very low percentage (6-7%) that it was in 1971, before gold went from $35 to $850/oz. in eight years. Most economists, even non “goldbugs” would agree that gold represents an alternative currency. This particular currency, gold, is mined, with great investment and risk, at the rate of about $140 billion per year. The colored paper that we all carry around in our pocket is being created worldwide, with the tap of a computer key, at the rate of trillions of dollars annually. Which currency would you suspect will maintain its purchasing power better over time?

Sincerely,

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – IT’S GETTING INTENSE!

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The general equity market had its worst December on record, with the averages down 10% and more. Gold related securities, however, began to prove their worth as an undervalued “safe haven” and an “uncorrelated” asset class. Gold bullion was up 4.9% and the gold mining stocks were up more than double that. One month of outperformance is not enough to establish a new trend, and the gold miners were still down for the entire year, but December does demonstrate how quickly trends can change. For lots of reasons which we outline below, we believe December may have been just the beginning of the resumption in the long-term bull market for gold related securities. The charts below provide a vivid picture of the most important long-term trends, and the prospects for substantial gains in our portfolio of gold mining stocks.                                                                               

While short term fluctuations and volatility can often dominate our thinking, we think the following charts provide valuable long-term context. There is no question that gold related securities are influenced by trends in the general capital markets, viewed as a “safe haven” from a decline in other assets, and heavily influenced by the direction of the US Dollar. The recent strength in the US Dollar, and the continuous rise in the general market have clearly undermined the performance of gold related assets. We believe the charts below show that the S&P average is likely closer to a long term high than a low, that the US Dollar is closer to a high than a low, gold bullion has been “consolidating” for 4-5 years, while gold related securities (represented here by the GDX ETF), are clearly near a long-term low, and may be emerging from its base.

First, the chart below shows the performance of the S&P 500 index, virtually straight up from the bottom in 2009, an unprecedented continuous rise. Most important, of course, is the decline which began in December, the sharpest correction in the last decade, and that has continued the first day of 2019. Should this decline continue, and there are lots of reasons why it should, gold related securities may be one of the very few safe havens.

The next chart is the performance of the DXY, the ETF representing the performance of the US Dollar, since 2005, versus other major trading currencies. You can see that the US Dollar has been trading very near its high and that has no doubt undermined the price of gold bullion in US Dollars. There is a lot of discussion as to whether our Fed, led by Jerome Powell, will be able to raise interest rates further at the same time the Fed balance sheet is reduced, both of which has contributed to the strong US Dollar. Should he decide to back off these programs, which we believe will be the case, that should contribute to a weaker US Dollar, and the chart shows the downside risk over time. A materially weaker US Dollar would be a strong tailwind to the price of gold related securities.

The next chart shows the price of gold bullion, represented by the GLD ETF, since its decline in 2012. You can see that the decline was 39% from the high to low. Since 2013, GLD has been in a trading range of about 20% from a little over 130 to a low of 105.  Right now GLD is trading about 8% below its “breakout” point of just over 130.

The following chart shows the performance of gold mining stocks, represented by the GDX ETF. You can see how substantially GDX has underperformed gold bullion, down 75% from the high of 2012 to the low in late 2015. The “trading range” since 2013 has been a very wide 56%, and you can see that GDX is still a lot closer to its low within the trading range than GLD. The “catchup” in GDX to get back to the high of the trading range in 2016, when GLD was a little over 130, would imply a 48% move, versus only 8% in GLD. We believe that December may have demonstrated the beginning of a positive move in GLD, and the beginning of the inherent upside leverage in GDX. We believe that the gold miners, which declined twice as much as GLD on the downside, could demonstrate even more leverage on the upside from this historically low base. Their December performance begins to demonstrate that potential.

Lastly, we provide a chart of Homestake Mining versus the Dow Jones Average during the depression of the 1930s, so even the prohibition of private gold ownership in 1934 was not sufficient to end that bull market in gold mining companies, even as the official gold price remained at $34./oz.

In terms of current news that supports our long term conviction, both bond and stock markets have had to digest lots of news in recent weeks, and it hasn’t always been pretty. Capital markets don’t like uncertainty, which exist relative to trade tariffs, the clearly slowing economies worldwide (US, Europe, Japan, China), the uncertainty regarding our Fed’s plan relative to interest rates, the exploding US deficits, Mario Draghi’s announcement of an end to QE in Europe, the ongoing political turmoil in and out of the White House, the collapse of Bitcoin and the crypto-currency market. The result has been more volatility, especially in the stock market, than we have seen in years. Intra-day moves of 3-4% have become common place, which in and of itself creates a level of discomfort among investors.

There are major macro developments, within the broad brush concerns above:

  • The new US fiscal year started in October, and the stated (now called “on-budget” by some) deficit was $100.5B in October, versus $63.2B last year. November came in at $205B vs. $139B last year. For two months, the deficit is $305B. vs. $202B, up 51%. The actual debt is up $334B, reflecting “off-budget” items, the largest of which is Social Security obligations. We continue to suggest that the “on-budget” deficit will be closer to $1.5 trillion in the current fiscal year, and the total debt will be well over $1.5 trillion, due to government spending (up 18% so far YTY),  higher interest costs, higher defense spending, higher VA support, health care support, THE WALL, etc. There seems to be rare bipartisan agreement right now regarding an unwillingness to talk about the explosion of the deficit and the debt. It is just too disturbing. All the deficit hawks have put their heads in the ground. THERE IS NO POLITICAL WILL in this area.
  • There is an ongoing move away from the US Dollar, the world’s dominant reserve currency since 1944. China, Russia, and mid-east countries are increasingly using the Yuan and gold for oil trades. There is also a consistent reduction within foreign exchange reserves, of US denominated securities. This has been accompanied by accumulation of physical gold, which can’t be diluted by a computer key-tap.
  • There are many indications that China is accumulating far more gold than they have announced. Recall that three years ago China announced that their Peoples Bank of China (PBOC) had increased ownership to 1600 tons from 1000 tons over the previous five years. Considering that China is the largest miner of gold on the planet, 400 tons per year, and nothing leaves the country, an increase of 600 tons over five years is obviously an understatement. It may be Chinese government agencies other than the PBOC that is holding it, but they are government “affiliates”. Various sources have reported that thousands of incremental tons have moved into the hands of various government agencies in recent years, and we would not be shocked if China announces at some point soon that they own 10,000 tons or more.  This would be substantially more than the 8,400 tons owned by the US, currently assumed to be the largest holder.  This would allow the Chinese to create a trading currency backed in some way by their gold ownership, joining, or even replacing the US Dollar as the primary trading currency worldwide. Surprisingly, based on reported gold holdings, Russia (which continues its aggressive gold purchase program) is in the best position to make their currency convertible into gold. Both China and Russia could have multiple political reasons to link the Ruble or Yuan to gold, provide more credibility to their currency than the US can provide.
  • Jay Powell’s newfound uncertainty over the pace of further rate increase provides the possibility that Quantitative Tightening is slowing down, if not stopping altogether should our economy weaken further. It is now clear that fourth quarter GDP will be more like 2% or so than the 4.5% in Q3. Especially in light of slowing economies elsewhere in the world, which will slow further if interest rates are moved higher, Powell may find that the next important course of action is “QE4” or whatever they choose to call the new monetary accommodation.
  • Since September, foreign purchases of US Treasury securities can no longer be made, financed by low interest (or negative interest) borrowing abroad, with currency hedging providing an overall positive carry. Borrowing costs abroad have gone up modestly, hedging costs as well, so the guaranteed positive return has gone away, removing some material portion of the $5-6 trillion of annual demand for US Treasury securities. Since $5-6T of US Treasury Securities have to be “rolled” over the next twelve months, the $1.5T of incremental government debt has to be financed, and the absence of perhaps $2-3T that was previously invested (and hedged) by foreigners, provide a total of something like an incremental TEN TRILLION of US securities that has to be bought in the next twelve months. People… ($10,000,000,000,000) this is a lot of money and could be a strain on the financial system, to put it really mildly.
  • The market for “leveraged loans” and high yield loans has shown serious signs of strain in just the last sixty days. Wells Fargo and Barclays Bank failed to sell $415 million of debt on Ulterra Drilling Technologies, a manufacturer of drilling bits. Blackstone received their funds to help in their buyout of Ulterra, but WF and BB are hoping to market the debt in a better environment in ’19. There were a number of other deals actually pulled from the market in Europe over the last several weeks. The Financial Times said today that the “’junk bond’ market, whether in loans or bonds – has frozen up, and the US credit markets have ground to a halt….not a single company has borrowed money through the $1.2T US high-yield corporate bond market through mid-December…..we haven’t seen the results at yearend, but if the freeze remained in place, it would be first month since November 2008 that not a single high-yield bond priced in the market..”

Our conclusion from all of the above is that our economy and, indeed, the worldwide economy will have very modest growth, at best. The debt load is too heavy, and the unintended consequences of ten years of monetary promiscuity have yet to play out. Equity investors right now assume that Jay Powell will more or less stick to his plan of generally higher interest rates, even if at a much slower pace. If he “cries wolf”, however, the equity markets would rally, but we don’t think for long. The last recession of ’08-’09 required “monetary heroin” to the tune of $4T in the US alone, but each hit has to be bigger to keep the addict functioning. Once capital markets realize that, a more major downdraft is likely. 

In the long run: we believe there will be a new monetary paradigm, and gold related securities will be an important part of a more disciplined fiscal/monetary approach. The ownership of gold has protected one’s purchasing power for the last five thousand years, the last two hundred years, the last 105 years (since the Fed allowed the US Dollar to be diluted by 98%), the last 47 years (since 1971, when the gold window was closed), the last 18 years (since 2000, when deficit spending accelerated once again).

It is of course true that since 2012 gold and gold related securities have been poor investments, but, in the sweep of history, that is a mere blip. With a new level of financial uncertainty compounded by geopolitical concerns and fiat currency dilution rampant around the world, it is only a matter of time before gold establishes itself again as “the real money”. Gold is not the only hedge against inflation, but, among the possibilities, it is currently the most undervalued.  As James Grant, the preeminent monetary historian has said: “A gold backed monetary system is not perfect, but it is the least imperfect system”. We don’t expect a new gold backed monetary system to be in place any time soon, but any small progress in that direction will allow for substantial appreciation in gold related assets.

Best wishes for a healthy, happy, and prosperous New Year!

Roger Lipton

 

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – MAJOR RISKS SURFACE

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – RISK & REWARD IN NEWLY VOLATILE MARKETS

Both bond and stock markets have had to digest lots of news in recent weeks, and it hasn’t always been pretty. Capital markets don’t like uncertainty, which exist relative to trade tariffs, the clearly slowing economies worldwide (US, Europe, Japan, China), the uncertainty regarding our Fed’s plan relative to interest rates, the exploding US deficits, Mario Draghi’s announcement of an end to QE in Europe, the ongoing political turmoil in and out of the White House, the collapse of Bitcoin and the crypto-currency market. The result has been more volatility, especially in the stock market, than we have seen in years. Intra day moves of 3-4% have become common place, which in and of itself creates a level of discomfort among investors.

There are major macro developments, within the broad brush concerns mentioned above:

  • The new US fiscal year started in October, and the stated (now called “on-budget” by some) deficit was $100.5B in October, versus $63.2B last year. November came in at $205B vs. $139B last year. For two months, the deficit is $305B. vs. $202B, up 51%. The actual debt is up $334B, reflecting “off-budget” items, the largest of which is Social Security obligations. We continue to suggest that the “on-budget” deficit will be closer to $1.5 trillion in the current fiscal year, and the total debt will be well over $1.5 trillion, due to government spending (up 18% so far YTY), higher interest costs, higher defense spending, higher VA support, health care support, THE WALL, etc. There seems to be rare bipartisan agreement right now regarding an unwillingness to talk about the explosion of the deficit and the debt. It is just too disturbing. All the deficit hawks have put their heads in the ground. THERE IS NO POLITICAL WILL in this area.
  • There is an ongoing move away from the US Dollar, the world’s reserve currency since 1944. China, Russia, and mideast countries are increasingly using the Yuan and gold for oil trades. There is also a consistent reduction within foreign exchange reserves, of US denominated securities. This has been accompanied by accumulation of physical gold, which can’t be diluted by a computer keytap.
  • There are many indications that China is accumulating far more gold than they have announced. Recall that three years ago China announced that their Peoples Bank of China (PBOC) had increased ownership to 1600 tons from 1000 tons over the previous five years. Considering that China is the largest miner of gold on the planet, 400 tons per year, and nothing leaves the country, an increase of 600 tons over five years is obviously an understatement. It may be Chinese government agencies other than the PBOC that is holding it, but they are government “affiliates”. Various sources have reported that thousands of incremental tons have moved into the hands of various government agencies in recent years, and we would not be shocked if China announces at some point soon that they own 10,000 tons or more. This would be substantially more than the 8,400 tons owned by the US, currently assumed to be the largest holder.  This would allow the Chinese to create a trading currency backed in some way by their gold ownership, joining, or even replacing the US Dollar as the primary trading currency worldwide. Surprisingly, based on reported gold holdings, Russia is in the best position to make their currency convertible into gold. Both China and Russia could have multiple political reasons to link the Ruble or Yuan to gold, provide more credibility to their currency than the US can provide.
  • Jay Powell’s newfound uncertainty over the pace of further rate increase provides the possibility that Quantitative Tightening is slowing down, if not stopping altogether should our economy weaken further. It is now clear that fourth quarter GDP will be more like 2% or so than the 4.5% in Q3. Especially in light of slowing economies elsewhere in the world, which will slow further if interest rates are moved higher, Powell may find that the next important course of action is “QE4” or whatever they choose to call the new monetary accommodation.
  • Since September, foreign purchases of US Treasury securities can no longer be made, financed by low interest (or negative interest) borrowing abroad, with currency hedging providing an overall positive carry. Borrowing costs abroad have gone up modestly, hedging costs as well, so the guaranteed positive return has gone away, removing some material portion of the $5-6 trillion of annual demand for US Treasury securities. Since $5-6T of US Treasury Securities have to be “rolled” over the next twelve months, the $1.5T of incremental government debt has to be financed, and the absence of perhaps $2-3T that was previously invested (and hedged) by foreigners, provide a total of something like an incremental TEN TRILLION of US securities that has to be bought in the next twelve months. People… ($10,000,000,000,000) this is a lot of money and could be a strain on the financial system.
  • The market for “leveraged loans” and high yield loans has shown serious signs of strain in just the last sixty days. Wells Fargo and Barclays Bank failed to sell $415 million of debt on Ulterra Drilling Technologies, a manufacturer of drilling bits. Blackstone received their funds to help in their buyout of Ulterra, but WF and BB are hoping to market the debt in a better environment in ’19. There were a number of other deals actually pulled from the market in Europe over the last several weeks. The Financial Times said today that the “’junk bond’ market, whether in loans or bonds – has frozen up, and the US credit markets have ground to a halt….not a single company has borrowed money through the $1.2T US high-yield corporate bond market this month….if the freeze continues until yearend, it would be first month since November 2008 that not a single high-yield bond priced in the market..”

Our conclusion from all of the above is that our economy and, indeed, the worldwide economy will have very modest growth, at best. The debt load is too heavy, and the unintended consequences of ten years of monetary promiscuity have yet to play out. Equity investors right now assume that Jay Powell will more or less stick to his plan of higher interest rates, even if at a slower pace. If he “cries wolf”, however, the equity markets would rally, but we don’t think for long. The last recession of ’08-’09 required “monetary heroin” to the tune of $4T in the US alone, but each hit has to be bigger to keep the addict functioning. Once capital markets realize that, a more major downdraft is likely.

In the long run: we believe there will be a new monetary paradigm, and gold related securities will be an important part of a more disciplined fiscal/monetary approach. The ownership of gold has protected one’s purchasing power for the last five thousand years, the last two hundred years, the last 105 years (since the Fed allowed the US Dollar to be diluted by 98%), the last 47 years (since 1971, when the gold window was closed), the last 18 years (since 2000, when deficit spending again took off).

It is of course true that since 2012 gold and gold related securities have been poor investments, but, in the sweep of history, that is a mere blip. With a new level of financial uncertainty compounded by geopolitical concerns and fiat currency dilution rampant around the world, it is only a matter of time before gold establishes itself again as “the real money”. Gold is not the only hedge against inflation, but, among the possibilities, it is the most undervalued right now. As James Grant, the preeminent monetary historian has said: “A gold backed monetary system is not perfect, but it is the least imperfect system”. We don’t expect a new gold backed monetary system to be in place any time soon, but any small progress in that direction will allow for substantial appreciation in gold related assets.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – TRADE, IMMIGRATION, MUELLER, YADA, YADA, DEFICITS EXPLODE

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – TRADE, IMMIGRATION, MUELLER, YADA, YADA, DEFICITS EXPLODE

There is lots of economic/political/social news day to day, but we believe the underlying fiscal/monetary problems will soon dwarf the currently discussed issues. In this country alone, billions of dollars per day (in deficit spending) are being created out of thin air.   It’s been said that “money is the source of all evil”. That may be true, but a currency of some sort is necessary to exchange goods and services to make social progress. Since we are in the midst of the largest monetary experiment in the history of the planet, and we don’t believe it will end well, unfortunately, we continue to monitor developments.

While there was quite a bit of intra-month volatility in the capital markets in November, the changes were minimal over the entire month. The precious metal markets were much quieter, but there was one notable down day, November 23rd, the reason not quite clear, with mining stocks down 3-4% which was not recovered by month end.  In any event, the gold mining industry, represented by GDXJ (the small to mid-cap miners) and the three prominent funds, Tocqueville, Oppenheimer and Van Eck were down about 2.7%.

Every indication is that the long-term financial issues overhanging the worldwide economy are becoming more intense every day, any one of which could ignite the monetary embers:

(1) The US Treasury must raise over $100B every week, to finance the growing deficit and refinance the maturing debt, and the Federal Reserve is no longer a buyer but a seller of securities. The “bid to cover” ratio for two-year US Treasuries has been coming down in recent months, and last month was the lowest since December 2008, the peak of the financial crisis.

(2) Major foreign purchasers of our debt, including China, Japan & Russia have backed off or eliminated entirely their purchases of US Treasury securities, to some extent replacing that portion of their foreign reserves with gold. As a corollary, the US trade balance that President Trump is so desperate to improve, would reduce the US dollars in foreign hands, which would in turn reduce the demand for our debt, contribute to higher interest rates, slow our economy, and trigger greater stimulus.

(3) Only six to nine months ago, reporters were talking about “worldwide synchronized growth” with no sign of inflation, truly a “goldilocks” situation. Just two weeks ago, headlines in the Wall Street Journal said “GLOBAL ECONOMIC SLOWDOWN DEEPENS”, “INFLATION TICKS HIGHER…”, “INTERNATIONAL FIRMS IN US SEE AUTO TARIFFS AS A THREAT”. As a corollary, Japan and Germany reported GDP contraction in Q3, Chinese growth continues to slow. So much for Goldilocks.

(4) The US current deficit, is exploding, will clearly be over $1 trillion in FY ending 9/30/19, with the total debt going up by more like $1.5T including borrowing from the Social Security Fund. There is no chance of less government spending, especially the next two years with the two houses of Congress split. According to the Wall Street Journal, the US will spend more on interest in 2020 than it spends on Medicaid, more in 2023 than it spends on national defense, and more in 2025 than it spends on all non defense discretionary programs combined. THIS IS SERIOUS, AND IT IS IMMINENT. The relevance of the deficits and debt is that the higher the debt load, the chance of the economy breaking out with productive expansion is reduced.

(5) The long-term suppression of interest rates has serious unintended consequences. Among them is the “misallocation of resources” as investors large and small “reach for yield”.  The current news flow is starting to reflect it. The Wall Street Journal two weeks ago had the headline DEMAND FOR RISKIER DEBT LETS COMPANIES SHIFT ASSETS.  The text ….” Investors are literally giving away the store to squeeze out meager returns from picked over market for corporate debt. Demand for riskier bonds and loans has been so intense that companies…are able to move valuable assets beyond the reach of creditors. Investors continue to make it easier for them to do so by agreeing to terms …that offer fewer and fewer protections.” The financial community has a very short memory. Ten years ago, the phrase was “covenant light”, and mortgage companies were making NINJA loans to homeowners with No Income No Job, and No Assets. Who said, “history doesn’t repeat, but it rhymes”? Just this morning, this was described in the Wall Street Journal in relation to sub-prime Auto Loans.

(6) Don’t take it from me. I’m just a veteran restaurant analyst. What could I know? However, within the last few months: Richard Fisher, former Dallas Fed Chair said: “…interest expense and healthcare expenditures will soon be more than 50% of revenues. At some point you have to pay the piper…We (the Fed) have been suppressing the yield curve. it’s a ticking time bomb”.

Ludwig von Mises, the legendary Austrian economist long ago taught us: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come soon as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

(7) Just last week Goldman Sachs came around (finally) to the view that markets offer an extremely attractive entry point for longs in goldWe see diversification value in adding gold to portfolios.” Goldman is (finally) forecasting a slowing US economy….at this stage of the business cycle, gold may be particularly appealing as a portfolio diversifier given that long-term bonds may be hurt if U.S inflation surprises to the upside … If U.S. growth slows down next year, as expected, gold would benefit from higher demand for defensive assets.”

Unfortunately, though Jay Powell, and other Central Bankers, might wish to persist in their collective attempt to contract credit, the politicians around the world can be expected to continue to kick the can down the road. Their unstated reality is “whatever happens will happen, but “not on my watch.” Politicians, economists, and capital market strategists, will soon be screaming “DO SOMETHING” and the Central Bankers will accommodate. Jay Powell gave us the first indication of that with his comments last week. Steven Mnuchin, Treasury Secretary, confirmed that just this morning, saying Powell is trying to position the Fed to stimulate when necessary.

Roger Lipton

 

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