Tag Archives: deficits

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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SEMI-MONTHLY FISCAL/MONETARY REPORT – CAPITAL MARKETS GYRATE – THE RUBBER MEETS THE ROAD!!

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SEMI-MONTHLY FISCAL/MONETARY REPORT – CAPITAL MARKETS GYRATE – THE RUBBER MEETS THE ROAD!!

Most of the trends we describe in this semi-monthly (or bi-weekly) column are very long term in nature. Day to day capital market trends are driven by short term trading techniques, often driven these days by computers that are making decisions based on price patterns, with no regard for the underlying fundamentals. I believe that the fundamentals drive the price patterns over the long term, not the reverse, and make my financial bets accordingly, in restaurant industry investments as well as broader decisions with my total capital. Lots of market commentators, including the infamous Jim Cramer who is a brilliant short term trader, fit their daily commentary to the daily price action, because there must be a reason that the market was strong or weak today. Trying to “game” the markets day to day is not the way to make money and keep it over the long term, and keeping it can be even tougher than making it, because there are lots of ways to lose.

We believe that a lot of the long term problems that have been overhanging the capital markets for decades are becoming very intense, and are likely to explode in the fairly short term, like a simmering ember prepare to ignite. The deficits, the debit, the spending, the money creation by Central Banks, the suppression of interest rates, the challenging worldwide economy, the wealth gap, the political dysfunction, the social unrest, and I could go on.

The current day to day news flow demonstrates the increasing intensity of the problems.

(1) The US Treasury must raise over $100B every week, to finance the annual deficit and refinance the maturing debt, and the Federal Reserve is no longer a buyer but a seller of securities. Last month’s “bid to cover” ratio for two year US Treasuries has been coming down in recent months, last month was the lowest since December 2008. You might remember that this was the peak of the financial crisis of ’08-’09.

(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, in turn reducing the demand for our securities, contributing to higher interest rates here which slows our economy.

(3) Readers of this column know that we have been skeptical of the apparent strength in our economy, though only six to nine months ago, reporters were talking about “worldwide synchronized growth” with no sign of inflation, truly a “goldilocks” situation. Headlines in today’s Wall Street Journal say “GLOBAL ECONOMIC SLOWDOWN DEEPENS”, “INFLATION TICKS HIGHER…”, “INTERNATIONAL FIRMS IN US SEE AUTO TARIFFS AS A THREAT”. Japan and Germany reported GDP contraction in Q3, Chinese growth continues to slow. So much for Goldilocks.

(4) Jay Powell, our Fed Chairman, has a serious problem. He is committed to raise rates further, and continue to sell off assets (which are only down about 7% from the peak 14 months ago), but higher rates will further stall our economy. His other choice is to back off, even do QE4 in some form, ignite inflation (and a run on gold), but that has its own risk of economic disruption. We may already be in an  unrecognized “stagflation”.

(4) The US current deficit 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 last week, 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 nondefense 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. Today’s Wall Street Journal has the headline DEMAND FOR RISKIER DEBT LETS COMPANIES SHIFT ASSETS.  The text starts….”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”?

(5) 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..if rates rise, it’s a ticking time bomb”.

Ludwig von Mises, the legendary Austrian economist long ago provided a succinct summary: “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.”

Unfortunately, though Jay Powell, and other Central Bankers,  might wish to persist in (just the beginning) of 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 accomodate. The best we can do is to stay physically fit and financially flexible.

Roger Lipton

 

 

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GENERAL EQUITY MARKET VOLATILE – RE: GOLD, THE SPRING IS COILED, THE GUN IS LOADED

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GENERAL EQUITY MARKET VOLATILE – RE: GOLD, THE SPRING IS COILED, THE GUN IS LOADED

November 1, 2018

The general equity market was volatile and weaker during October. Gold bullion, and the mining stocks were relatively quiet, all changes rather immaterial.  Gold bullion was up 2.2%; the mining stocks as represented by an average of the three mutual funds we track (Tocqueville, Oppenheimer and Van Eck) down an average of 1.8%, possibly weaker from the tail end of the Vanguard liquidation we have discussed. The two ETFs, GDX and GDXJ were up an average of 1%, so obviously their holdings did better than the broader mutual fund portfolios.  Though it’s our job to focus, and report, on small changes such as these, the longer term is obviously our major concern. The downside damage in the gold sector over the last several years obviously dwarfs a few points one way or another, and the upside when it comes will make our monthly reports seem immaterial.

The following bullet points summarize our current thoughts:

  • Gold, as a “safe haven” is not yet in great demand in “the West”, though major accumulation continues in China & India and all major Central Banks. North American investors will see the light sometime soon, especially if the equity market’s recent downside volatility persists.
  • The mining stocks continued to act a bit weaker than bullion in October, possibly representing the tail end of the Vanguard liquidation.
  • It is just a question of time until Jay Powell, Fed Chairman, backs off of his intention to keep raising rates, and reinstitutes an accommodative monetary policy (QE4, or whatever). This will happen when the stock market takes a more sustained tumble and the slowing worldwide economy becomes more apparent. Calendar ’19 will not have the tailwind of much lower tax rates, and the resumption of monetary stimulus should generate much more interest in gold related securities. The gun is loaded, the spring is coiled.
  • Central Banks, including Russia, Poland, Turkey, India, China, and others, are steadily increasing the gold bullion reserves within their foreign exchange holdings. Through September, the amount bought was the largest in six years, over 200 tons, and that doesn’t include China, who alone may be purchasing that much, or more.
  • Central Banks, on the other hand, are reducing their holdings of US Treasury securities, expressing dissatisfaction with our accelerating deficits.
  • China, allowing their currency to cheapen, has virtually offset the effect of the new tariffs. This demonstrates how major trading competitors can use their currency as an economic, and even political, weapon of sorts.
  • China, Russia, and Europe have set up alternate payment systems that do not require the use of US Dollars, undermining the credibility of the US Dollar as a reserve currency. The last time there was a major movement away from the US Dollar was 1971, when Richard Nixon ended the dollars convertibility into gold, inflation took off and gold went from $35 to $850/oz.
  • The recently announced merger of Barrick Gold and Randgold, both within our portfolio, is no doubt a reflection of what they perceive as a bargain price level, and their desire to be the very strongest participant in a dynamically evolving gold market. These kinds of transactions often occur at the bottom of a cycle.
  • Goldcorp, one of the premier gold mining companies, also in our portfolio, just announced a buyback of approximately $350M of their public shares, an obvious statement that their stock is considered substantially undervalued, and another possible indicator of an inflection point.
  • There have been hardly any major gold discoveries in recent years, as opposed to a decade ago. Since major new mines can take a decade or more before production commences, increased demand will not bring out more supply for many years, even at higher prices, and the upside price volatility will be that much greater.
  • Considering that the price of gold bullion, though down this year, has been fairly steady the last several months, even in the face of higher interest rates and a strong US Dollar, we believe the stage is set for a major rally in gold bullion and the mining stocks once the dollar weakens a bit (or more) and/or the stock market has its long overdue correction (or worse).

For the above reasons, and many others, we believe the stage is set for a major upward move in the most unloved asset class on earth.  Legendary investors like John Templeton are famous for saying that the time to buy is when there is “blood in the street”. It seemed that way to us a few years ago, but nobody can tell when the bottom will be put in. None of the concerns that we have been enumerating regularly have gone away. It’s not a question of “if”, just a question of “when?”.

Roger Lipton

P.S. As I finish this letter, at 10:18am on November 1, the dollar is weak, gold bullion is up 1.2% and the mining stocks are up about 3%. Every long trip has to start with a single step?

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – YOU DON’T WANT TO KNOW HOW THE SAUSAGE IS MADE !!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – You Don’t Want to Know How the Sausage is Made !!

The general capital markets were fairly unchanged in June, gold bullion was down 3.4%. Interestingly, the gold mining stocks were down hardly at all. The gold mining ETFs, GDX and GDXJ, were almost exactly flat. The three major gold mining mutual funds were down an average of 0.8%.  Every indication is that substantial quantities of physical gold continues to move from West to East but the “paper” market, including options and futures, dominates the day to day price. The mining stocks acted noticeably better, when normally they could be down (or up) at least twice the price of gold. There was documented accumulation of GDX and GDXJ which is often a precursor of an upward move in bullion and an even larger move in the miners.

THERE IS NO SHORTAGE OF MACRO DEVELOPMENTS WITH LONG TERM IMPLICATIONS !!

In just the last few days, the following articles support our long held conclusions that a great deal of turmoil in the worldwide financial/capital markets is ahead, which we believe will cause our Fed and other Central Banks to “cave” and move back to monetary accommodation, which will spark a new run in gold related securities:

(1)    First Quarter GDP latest revision shows 2.0% real growth, down from the last estimate of 2.3% and the previous estimates in the high 2s. As for Q2’18, the latest NY Fed estimate is 2.7%, a lot lower than the highly touted 4% or more the Atlanta Fed and others have been talking about.  Even if Q2 comes in north of 4%, real GDP growth over the last year or so has been no higher that the “high 2s”, not much higher than the average of 2.3% average of the last 8-9 years and that modest increase from the “low 2s” is largely due to more government spending financed by more government debt and this is not healthy or sustainable over the longer term.

(2)  The global yield curve, the spread between 1-3 year and 7-10 year government securities, has just gone “negative”, per the JP Morgan GBI index. This yield curve “inversion” most of the time presages a recession within 6-12 months.

(3)    With the Chinese stock market down 20% from its early ’18 high, a Chinese government think tank (backed by the Chinese Academy of Social Science) has warned of a “financial panic” in the world’s second largest economy, caused by leveraged purchase of shares (as in 2015), rising US interest rates, trade tensions with the US, bond defaults and liquidity shortages in China. The Chinese government should “be willing to step in with full financial support, rather than taking piecemeal steps” the study said. Just yesterday, the Financial Times reported that the China Development Bank was tightening loan approvals for its “slum development” policy, a program which has provided (a cool) $1 trillion to homebuyers since (only) 2016. The implications of the monetary manipulations by the world’s second biggest economy are huuuge!. Our take: a much higher gold price will accompany future economic “adjustments” that will have been exacerbated by governmental interventions.

(4)    Russia has cut its US Treasury holdings over 50%, from $102.2B to $48.7B in just four months from 12/17 to 4/18. While these numbers are small relative to the trillions that China and Japan hold, US Treasury securities held by all foreigners, as a percent of their reserves, has declined from 64.59% in 2014 to 62.7% in 2017, so they are steadily diversifying away from dollar related securities. Gold, as a share of foreign exchange reserves has held steady. Central Banks have continued buying hundreds of tons annually, as they have since 2009. They bought 116.5 tons in Q1’18, the most in any Q1 since 2014 and up 42% YTY.

(5)    The Wall Street Journal, several days ago, headlined “UK Central Bank Warns on Debt Risk”. The article said “it sees pockets of risk to the stability of the financial system including US corporate borrowing, risky loans in Britain, foreign-currency lending and emerging markets….as central banks step back from the easy-money policies of the past decade and trade tensions escalate.” You can google the full article, but we don’t make this stuff up.

(6)    Just under the previous article, on June 28th, the headline read: “Fed’s Ability to Fine-Tune Interest Rates is Tested”. The Fed lost “control” of the markets in ’08, salvaged the situation with trillions of financial accommodation. In some ways, the problems are larger today and the Fed, with their hundreds of PHD economists, has had a poor forecasting record.

(7)    While many observers underplay “systemic” risks in today’s financial markets, leverage in derivative securities is larger, non-financial corporate debt is at a new high (exceeding the last high in ’08), ETFs made up of cap-weighted securities will have little liquidity in a downdraft, which especially could apply to high yield fixed income ETFs. Rising default rates on student loans and subprime auto loans, sharply rising US deficits, underfunded social security and federal health care obligations are all problematic whether the market overlooks these trends for the moment or not. The momentum in capital markets can turn, literally, on a dime. If someone doesn’t think the Chinese monetary manipulation has provided at least the possibility of “systemic risk” to the worldwide economy, they are living on the wrong planet.

(8)    The equity markets are highly valued by historical standards. Interest rates are still very low which means bond prices also have substantial downside risk, especially the high yield sector where investors around the world have been “reaching for yield” for a decade.

Conclusion:

Many of the above factors have been in play over the last four or five years, building over decades, and the timing of the unwinding of the worldwide credit bubble continues to be uncertain. It’s been said that in every crisis, you can look like a fool either before the event or after. Another advisor, when asked how a crisis develops, said “very slowly and then very quickly”. Just recently, we asked a highly regarded economist and market strategist, who agrees with us, when the turn will come. His response was as good as any: “On any given Sunday”. When it happens, a great number of people will say “how could I have not seen that?”

Roger Lipton

 

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD LOWER LAST FRIDAY – “MANIPULATION”???

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD LOWER LAST FRIDAY, “MANIPULATION” ???

Not much has changed fundamentally in the last couple of weeks. The economy is doing somewhat better, aided materially by increased government spending. Capex investment by corporations is still lagging, housing and auto activity are slowing as interest rates rise, the deficit moves predictably higher as health care costs, higher interest rates on the US debt, and much higher defense spending are long term facts of life. Though consumer sentiment and business optimism is much improved over the last year or so, consumers are still stretched financially and the possibility of a tariff “war” continues to unsettle capital markets and the business community.

Gold and gold miners have been quietly consolidating over the last few months, but had an uncharacteristically volatile day, on the downside last Friday.  That just happened to be an option expiration day, which often can generate unusually large price changes.  This type of volatility, heavy trading volume, especially at illiquid times of the day (“middle of the night”), and at inflection points for the technical chartists, used to be fairly frequent occurrences, in the gold markets in particular. It seemed like every time there was especially bullish news for gold, the price would get hit, with heavy volume in futures and options at times of the day when nobody “in their right mind” would be trying to liquidate a “real” physical position unless they were consciously trying to manipulate the short term price of “paper” gold. In any market where there are futures and options trading, aggressive traders of the “paper” who don’t have to immediately deliver the physical “underlying”, can trigger “stop loss” orders at certain predictable prices. Over time, these distortions get corrected, but the short term volatility can be unsettling. Longer term physical buyers use these distortions as buying opportunities, and it is no coincidence that China, India, Russia, and others have continued to be major buyers of physical gold, demonstrating their diversification of assets away from US Treasury issued securities. China and Russia, in particular, have clear reasons to undermine confidence in the US Dollar, improving trade and investment in the Yuan and Ruble, and a higher gold price would do just that. They understand the nature of the worldwide currency debasement and are doing what they can to cope, though our politicians lack the political will to do the same.

Friday, the fifteenth of June, was an option expiration day which, in and of itself, can increase price volatility. It cannot be coincidental that, after India and China had closed their physical trading markets, large quantities of gold futures contracts were dumped into the CME’s Globex computer trading system just before the Comex gold pit opened for the day (at 8:20 a.m. EST).  The chart below shows the price action, and note especially how the trading volume exploded higher from the typically much lower levels. IN ONE HOUR, from 8-9am EST, futures contracts representing 9.03 million oz. of gold traded, which is slightly more than the 9.01 million oz. of TOTAL GOLD STOCK in the Comex vaults, and 17.7x the number of gold oz. “available to deliver”. For the entire day, 49.5 million oz. worth of “paper” traded, the equivalent of about six months of entire worldwide production.

It does not seem farfetched to conclude that nobody in their right mind would choose this particular time of day and month to “dump” such a large quantity of “real” gold, unless the seller wanted the price lower. This has happened before, and an artificially low short term price gave way to much higher prices in the near future. No individual seller is larger than the worldwide market, over a reasonable period of time. A buyer at an artificially high price had better be prepared to buy “it all”, because they will own it. A seller, at a price lower than the true market would allow, had better have an enormous inventory because the buyers will keep coming. It will be interesting to see how this latest incident of seemingly irrational volatility gets resolved.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – ECONOMIC STRENGTH “OVERSTATED”, CAPITAL MARKETS QUIET, PRECIOUS METALS “CONSOLIDATE”

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SEMI-MONTHLY FISCAL/MONETARYUPDATE – ECONOMY “OVERSTATED”, CAPITAL MARKETS FIRM FURTHER, PRECIOUS METALS “CONSOLIDATE”

June  4, 2018

The equity market firmed in May and the fixed income market strengthened late in the month, after sinking mid-month, ending modestly higher (yields lower) than at May 1. Precious metals related holdings were quiet overall. The gold miners did slightly better than gold bullion which was down 1.2%.  We can’t help but repeat last month’s statement, that we continue to feel that the gold mining stocks, which represent almost all of our portfolio, represent the best value (and most unloved) asset class of all. The “money” is being safely stored, in the ground.  It is just a question of when it will be brought north and exchanged for the “colored paper” of its time, and the quantity of green paper (in the US) will be a multiple of the current $1300 per oz. The dramatic increase in profits for the gold miners will put their stocks an order of magnitude higher than they are currently.

The thoughts that currently come to mind are as follows:

  • The economy, while firming, is not at the 3-4% GDP growth that the administration advertises. After several quarters last year that averaged about 3.0% of real GDP growth, Q1’18 finally came in at a modest 2.2%. It will obviously take GDP growth of well over 3% (far from certain) for the rest of the year to reach the 3% annual objective. The higher interest rates will hinder consumer spending as well as limit the government’s ability to stimulate. Also, an inhibition, the tariff/ trade negotiations continue to keep the business community and capital markets on edge.
  • The Fed is barely keeping up with the plan to shrink their $4.2 trillion balance sheet. While they are stretching to reduce by the current rate of 2.8% (big deal!) annually, interest rates are steadily moving higher which drags on the economy and insures that the current selling program won’t make much of a dent before the program gets abandoned, and it won’t be long.
  • Inflation (which is a good reason for owning gold) is not as dormant as commentators indicate. “Core Inflation”, the most commonly quoted indicator, excludes food and energy. You know what grocery and restaurant prices (heavily influenced by higher labor costs) are doing, and the recent gasoline price rise is absorbing a lot of the recent tax cut.
  • The US deficit in the year ending 9/30/18 is officially estimated at $825B, but I’ll take “the over”. Certainly at least $1 Trillion is in the cards for 9/30/19 with higher defense spending, higher interest costs, and lower taxes on an economy that remains sluggish.

We believe that, due to any number of possible catalysts, the Fed will back off. The inevitable new round of stimulus should finally spark gold related securities much higher. It’s just a question of time.

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY REPORT – THE ECONOMY, FED’S BALANCE SHEET, INTEREST RATES, GOLD

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SEMI-MONTHLY FISCAL/MONETARY REPORT – THE ECONOMY, FED BALANCE SHEET, INTEREST RATES, GOLD

A PROGRESS REPORT: IN SUMMARY

THE ECONOMY

Meet the new economy, very similar to the old economy. While the Trump administration touts the 3% (and moving higher) economy and history making low unemployment rate, real GDP growth came in at 2.3% in Q1, down from the 3.2% peak of Q3’17 and 2.9% in Q4’17. Both of the H2’17 reports were inflated by storm remediation expenses. Keep in mind that government spending, now at a record level, contributes to GDP, so the “organic” economic growth is very similar (within a couple of tenths) to the 2.3% average under the Obama administration, even in spite of deficit spending that is ramping higher. The 3.9% low unemployment rate is a function of a participation rate moving lower, not materially more employment. There is no question that things are a lot better than nine years ago when 600,000 workers were let go each month and there are more companies looking for workers as the necessary skills are often not present. Balancing the picture: while the tax cut has now kicked in, so have higher gasoline prices, and the consumer savings rate is moving higher once again after coming down late last year. Our readers know that we look at restaurant sales as a predictable leading indicator of the general economy. Today’s Miller Pulse headline tells us that April sales were “the highest since 2016”.  Unfortunately, the 1.6% sales gain in April was overcome by negative traffic of 0.7%, the 26th straight month of traffic decline. Two year same store sales rose 1.2% in April, vs. 1.1% in March and a 1.8% decline (the storms no doubt) in February.  If we consider that prices are rising by a couple of percent per year, traffic is running down 3 or 4% over two years. “Down so far, down looks like up to me” is the country western song writer’s way to put it.

THE FED’S BALANCE SHEET AND INTEREST RATES

We all know that the Fed is normalizing it’s balance sheet, by $10B/month in Q4’17, then $20B/month in Q1’18, now at $30B/month in Q2, going to be $40B/month in Q3 and $50B/month in Q4. These reductions are supposed to be “automatic” as treasury securities and other holdings mature and the balance of the planned decrease is liquidated. We have discussed before how interest rates have steadily moved upward, beginning exactly last October when the normalization started. The planned reduction got behind almost immediately in Q4’17, kept pace through in Q1’18 and April’18, though not making up the shortfall of Q4 and has gotten further behind in early May. Our analysis shows that the cumulative shortfall is about $30B at this point, and of course that can change week to week. It may be no coincidence that interest rates are back to their high this morning, with the ten year at $3.05%, as the Fed tries to reduce by $15B or more this week to catch up. The bottom line is that the Fed’s balance sheet normalization is more than likely to drive interest rates still higher, at least that’s the way it looks so far. This interest rate rise in turn affects housing (see Home Depot stock this morning), auto sales, consumer interest expense, and contributes to a stronger dollar which undermines the general economy further.

GOLD and GOLD MINING STOCKS

The stock market has been up eight days in a row (until today), interest rates (and the dollar) have been firming slowly (more than “firm” this morning) so there continues to be no urgency to look to gold as a “safe haven”. We have pointed out in the past that neither higher interest rates nor a strong dollar are a death knell over time for gold related securities but in the short run a weak dollar and lower interest rates are better. Considering the recent strength in the dollar and the steady march of interest rates higher this year, the fact that gold bullion is virtually unchanged for the year and the mining stocks are down only modestly is not terrible performance. The gold mining companies, which is our primary way to participate in this out of favor asset class, are holding the “real money” in the ground for safekeeping. It’s just a question of time until they bring it north and exchange it for the “colored paper of the day”, at much higher dollars per ounce than today.

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – MODEST APPARENT CHANGES IN APRIL, HUUUGE DEVELOPMENTS UNDER THE SURFACE

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – Modest apparent changes in April, huge developments under the surface!

 

The results for all the capital markets changed only modestly in the month April, in spite of intra-month volatility. Gold bullion was down almost exactly 1%, Gold mining stocks were up about 1.2%. We continue to feel that the gold mining stocks, represent the best value (and most unloved) asset class of all. The “money” is being safely stored, in the ground.  It is just a question of when it will be brought north and exchanged for the “colored paper” of its time, and the quantity of green paper (in the US) will be a multiple of the current $1300 per oz. The increase in profits for the gold miners will be huuuge and the stocks should sell for multiples of the current price.

We believe that the lackluster price action in gold and the miners has been due to the expectation of much higher interest rates, an apparently stronger economy, the perceived lack of a need for gold as a “safe haven”, and the renewed strength in the US Dollar. We don’t believe any of these factors will last much longer, and none of which will preclude higher prices in the long run.

The US economy is not as strong as advertised. After several quarters last year that averaged about 3.0% of real GDP growth, Q1’18 came in at a modest 2.3%. It is important to note that government spending of $4.5 trillion is part of our $20 trillion GDP economy. When government spending of $150 – $200 billion (over perhaps H2’17) to repair storm damage, that adds 1.5 to 2.5 points to GDP growth. That means that something like half (or more) of the “growth” in the last six months (as a % of $10T of six months’ GDP) was due to storm remediation. (That’s correct, I checked the math three times.) As another example, an increase of $100 billion in defense spending, over a year, will add 0.5% to our annual GDP. So, the bigger the deficit (in turn increasing interest expense), the better the GDP appears. The apparently stronger GDP growth in H2’17 was also positively affected by the weaker dollar and this, too, has changed lately, probably contributing to the tepid 2.3% Q1’18 GDP real growth.

Interest rates have moved up steadily, as the Fed has simultaneously raised the short term Fed Funds rate and sold increasing amounts of its bloated $4.3 trillion balance sheet. The much higher interest expense, combined with government spending will explode the deficit, which in turn will burden the economy even further. The Fed will back off. We will have new round of stimulus, much bigger than the “financial heroin” hit of ’08-’09. That should finally spark gold related securities much higher. It’s just a question of time.

Roger Lipton

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