Tag Archives: GDXJ

SEMI-MONTHLY FISCAL/MONETARY UPDATE – CAPITAL MARKETS ARE WORRIED BUT “TAPER TALK” IS JUST TALK

SEMI-MONTHLY FISCAL/MONETARY UPDATE – “TAPER TALK” IS JUST TALK

September was a weak month in all the capital markets: stocks, bonds and gold related securities as well. Gold bullion was down about 3.2%, with the gold mining stocks down more because of their leverage relative to the gold price. In the wake of congressional testimony from Fed Chair, Jerome Powell, and Treasury Secretary, Janet Yellen,  gold bullion went up almost 2% yesterday, the 30th, and the gold mining stocks followed. Perhaps it is beginning to dawn on investors how disingenuous the presentations were and how hopeless the fiscal/monetary situation is.

First, we have to comment on the absurdity of Powell and Yellen appearing together before Congress, presenting a united front. This is directly contrary to the guiding principle for the last 108 years, that the Federal Reserve and the US Treasury are designed to be independent of one another.

In any event, the talk all month was of the plans for the Federal Reserve to “taper”, that is to reduce the amount of securities they are purchasing (which has been running about $120B per month), allow interest rates to rise, in turn strengthening the US Dollar, which tends to weigh on the price of gold in the short run. For months now Powell has been describing the now obvious escalation in consumer prices (lately at 5%, well above the 2% Fed target) as “transitory” and “isolated”, and reiterating the Fed’s intention to reduce their monetary “accommodation” soon. The Fed would then purchase fewer Treasury securities, leading (some day) to a reduction of the Fed’s $8.5 trillion balance sheet, and allow worldwide interest rates to normalize from levels unseen in the 4,000 year recorded history of interest rates. Recall that after building the Fed balance sheet from $1T to $4.2T in ’08-’09, the taper at the time took it back 10%, to $3.7T before ramping it up to the current $8.5T. Can anyone say $20 trillion?

The problems with the plan, at the moment, are (1) The economy is not strong enough to withstand a material rise in interest rates, and a one point rise in interest rates would cost the US Government an extra $280B a year on its $28 trillion of debt. The burden would not be immediate because existing bonds would continue to exist but more than half of the $28 trillion matures within 5-6 years and it would not take long for the interest expense to build. In addition, the current annual $3T deficit would need to be financed as we go. (2) The Fed has been the “buyer of last resort” with their newly printed currency, its purchases approaching half of all Treasuries issued. China and Japan have been increasingly reluctant to maintain previous buying patterns, which is no wonder as they watch the Fed’s massive dilution of the US Dollar. (3) Jerome Powell was counting on inflation being “transitory” and “isolated”, allowing for the economy to recover without stagnating and allowing for a noticeable but not too burdensome rise in interest rates. You would think that the hundreds of PHDs at the Fed would have noticed that oil and gas prices have risen, menu prices are up, the minimum wage is a lot higher, supply chain challenges are commonplace and Dollar Tree Stores says more items will be priced over one dollar. Powell, just in the last few days, has suggested that inflation is running hotter and may not be as short lasting as he previously thought. He, at the same time, admitted that the economy “is not even close to satisfying requirements for a rate hike”. We can add that 25 or 50 basis points of higher rates is going to have virtually no effect, other than window dressing, on risk and reward within the economy. In 1979-80, Paul Volcker took the Fed Funds Rate to 18% to squeeze out inflation, which precipitated a recession that lasted until late 1982. We need not describe what effect a similar discipline would have on the worldwide economy today. The total US debt was $1 trillion in 1981 and the annual deficit was $100 billion. Though today’s economy is six times as big, today’s deficits and debt are 3-4x as big in constant dollars.

On the disingenuous front: Janet Yellen told us yesterday that the debt is not a problem because interest rates are so low. She did not elaborate that interest rates are so low because our Federal Reserve is buying half our debt with currency minted out of thin air. Yellen also informed our legislators that not increasing the debt limit (again) would be “catastrophic”, because we must, at all cost, pay off our existing creditors. A cynic might call this a “Ponzi scheme”, whereby new investors buy out the old investors.  Jerome Powell, after admitting that the current inflation is surprising, says the Fed is “prepared to use its tools” to control the situation, but he omitted details and the congressional legislators did not press the subject.

Our conclusions are not drawn out of thin air. Taper “talk” is just that. The Fed’s balance sheet has grown from $7.06 trillion on 9/30/20 to $8.49 trillion last week, growing at about $120B a month on virtually a straight line, and we don’t believe it flattens much any time soon. It is interesting that the $1.43 trillion increase is almost exactly half of the $2.7 trillion US deficit in the last eleven months. In short, the beat goes on, and the reasons referenced above indicate that there is no graceful way out of this situation.

Our best guess remains that a “stagflationary” period is ahead of us, perhaps begun already,  similar to the 1970s. On January 6, 1974 the NY Times said “There is One Surfeit: Shortages.” In August, 2021, they said “The World is Still Short of Everything. Get Used to It.” In 1973 the CPI was rising at 5.3% and the Fed Funds Rate was 6.75%. The Federal Reserve predicted that the jobless rate, then at 5%, would average 4.5-5.0% over the next few years, with consumer prices up 4.0-4.5%. Their objective at the time had been 2.5%, similar to today, ex “transitory” influences. By May, 1975, unemployment hit 9% and inflation averaged more than 10% in 1974-5. By 1979, the CPI hit 12% and the Fed Funds Rate reached 18%. In more recent times, Ben Bernanke, Fed Chairman in 2007, predicted that housing prices would remain elevated for the foreseeable future. So much for the Federal Reserve’s predictions and control over the situation. From 1971 to 1979 gold bullion went from $35/oz. to $850/oz.

We believe that the “taper talk”, valid or not, affected all capital markets in the last couple of months, increasing interest rates and improving the US Dollar’s relative value (which weighs on the price of gold), at the same time backing off both the stock and bond markets. On the last trading day of September, while the stock and bond markets meandered, gold and the gold miners were strong, so perhaps this was a case of “selling the rumor and buying the news” (after the Powell/Yellen testimony).

We continue to feel that gold bullion, and the gold miners leveraged to the price of bullion, should be an important asset class within any diversified portfolio.

Roger Lipton

 

SEMI-MONTHLY FISCAL/MONETARY UPDATE – MAY WAS GOOD FOR GOLD – NOT SO GOOD FOR BITCOIN, BUT YOU CAN EARN INTEREST ON YOUR CRYPTOCURRENCY

SEMI-MONTHLY FISCAL/MONETARY UPDATE – MAY WAS GOOD FOR GOLD – NOT SO GOOD FOR BITCOIN, BUT YOU CAN EARN INTEREST ON YOUR CRYPTOCURRENCY!

MAY WAS GOOD FOR GOLD

The general market was basically flat in May but gold bullion and the gold miners had a good month. Gold bullion was up about 7.7%, gold mining stocks did approximately double that, and our Partnership’s portfolio mirrored that. The result is that gold bullion has now retraced its earlier loss, is now virtually flat for the year, while the gold mining stocks are now ahead for the year. There is every reason to believe that the last three months for gold related securities are a harbinger of even better performance to come.

GOLD AND BITCOIN

It might not be a major factor, but bitcoin, which has likely attracted some potential gold buyers to the “digital gold, as bitcoin enthusiasts like to say, retreated from a high of $64,000 to a low around $30,000. We don’t view bitcoin as anything other than a symptom of the fiscal/monetary folly that has engulfed the civilized world the last ten years, but some speculators who might have “played” with gold or the gold miners have no doubt been seduced by bitcoin. We think, as we have repeatedly suggested, that gold is the real money, a durable and unique store of value and unit of exchange, as demonstrated over thousands of years. For what it’s worth, bitcoin is only one of 10,000 cryptocurrencies, and its dominance among them is being steadily diluted.

GOLD PROVIDES NO RETURN IN TERMS OF INTEREST OR DIVIDENDS, HOWEVER…….

The absence of a steady return, in the form of interest or dividends, puts gold bullion ownership at a distinct disadvantage to bonds or stocks. These days, however, there is virtually no return in safe short term fixed income securities. One year US Treasures pay 0.14% and 5 years only gets you 0.79%. The dividend return on the S&P 500 index is only 1.38% and there is a natural risk within stock ownership. With inflation running about 4% in the last twelve months, stocks and bonds have a negative “real return” of about 3%, so gold bullion is not at such a disadvantage. It is worth noting that many of the high quality gold mining companies are now paying dividends of 2% or more, allowing the gold mining stocks to be even more competitive. This is why the performance of gold bullion and the gold mining stocks have correlated strongly with the level of “real interest rates”. The more negative the “real” return on stocks and bonds, the better gold related securities do.

YOU CAN NOW EARN AN INTEREST RATE RETURN ON YOUR OWNERSHIP OF BITCOIN, HOWEVER…..

You will be hearing more about the opportunity to earn interest on your holdings of bitcoin or other cryptocurrencies.

At first blush, how can this be? Who is paying this interest, especially since bitcoin cannot be possessed physically?

This is a brave new world. Bitcoin and many of the other (10,000) cryptocurrencies are traded on a variety of exchanges. Some of those exchanges are allowing traders to “short” cryptocurrencies, just as investors have been allowed to short stocks and bonds for ages. To allow this, the exchange has to offer a cryptocurrency “savings account” to owners, in turn allowing the short seller to “borrow” the asset from the exchange, which appropriates it (temporarily) from the true owner. That means the exchange has to “remove” it, somehow segregating it from the owner’s account, providing it to the short seller, allowing for “delivery” to whomever is buying it from the short seller.

Just as when scarce stocks are lent by third parties (such as Fidelity, Schwab, etc) the short seller pays a fee for the “borrow” (can range from a couple of percent to upwards of 50% annually) and 40-50% of that is rebated to the true owner, who allows their stock to be “taken” temporarily by Fidelity or Schwab, and lent out. This can generate a very attractive “return” to the true owner. However, the risk to the lending owner is that the speculative security, which is “hard to borrow” and that’s why the short seller pays the interest charge, may be as risky as the short sellers believe, and decline sharply in price, more than offsetting the interest rebate to the owner. Parenthetically, the true owner can call for a return at any time if they want to sell the stock for any  reason. That in turn, can create a “short squeeze”, when the short seller is forced to buy back the stock, to return it to Fidelity or Schwab, who returns it to the selling true owner.

All of this negates one of the original advantages of bitcoin and the other cryptos, which was to prevent access by  third party agencies.

It also puts the cryptocurrency owner at the mercy of the “exchange”, on which cryptocurrencies are traded and within which ownership is maintained. Coinbase Global, Inc. (COIN) is the largest “exchange”, which came public recently and trades with its own Market Capitalization of about $50 billion. It is a “regulated” (sufficiently?, who knows?) cryptocurrency company that provides customers with a platform for buying, selling, transferring, and storing digital assets. Many exchanges offer a variety of interest rates on many cryptocurrencies. The interest rates vary widely, depending on the exchange and the cryptocurrency, and can sometimes provide even double digit yields.

However…..to earn that return you subject yourself to “third party” exposure, adding the exchange risk to the price risk of the crypto. How much do you really know about the exchange (depository) you have chosen, and what recourse do you have in the event of default?

THE BOTTOM LINE

I asked a good friend of mine, who has a substantial ownership of bitcoin, if he is earning any interest on his holding. He responded that he buys and sells bitcoin through Coinbase. He does not want to allow even Coinbase to appropriate his holding, let alone one of the other exchanges that are willing to pay a high interest rate. As of today, June 2, 2021, Coinbase does not show any interest rate offered on bitcoin, but the BlockFi exchange is paying 5%, Nexo is paying 6%, and Celsius is paying 3.5%, to name just a few.

There is no free lunch. Be careful out there!

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – DEFICITS EXPLODING, INFLATION UPTICKING, CRYPTOCURRENCIES LOSE THEIR LUSTER, WHILE GOLD RESUMES ITS UPWARD RUN

SEMI-MONTHLY FISCAL/MONETARY REPORT – DEFICITS EXPLODING, INFLATION UPTICKING, CRYPTOCURRENCIES  LOSE THEIR LUSTER, WHILE GOLD RESUMES ITS UPWARD RUN

I cannot resist commenting on, and correcting the latest version of revisionist economic history.

Just yesterday Maria Bartiromo was interviewing Peter Navarro, President Donald Trump’s Director of Trade and Manufacturing and a frequent economic spokesperson. After predictably predicting a weak stock market, burdened by the poor policies of President Biden, his description of the last ten years went like this: “Under President Obama, coming out of the 08-09 crash, the GDP grew by a meager 2%, and the debt doubled. Under Donald Trump, we grew at 3% and the economy was roaring before the pandemic hit.”

Not quite:

Under President Obama, the GDP grew by an average of 1.6%, held down by a negative 2.5% in ’09, coming out of the crash. Excluding ’09, GDP grew at an average of 2.2% over seven years.

Trump’s four years went +2.3% in ’17, +3% in ’18, +2.2% in ’19 and -3.7% in pandemically driven 2020. Excluding the last year, out of Trump’s control, just as Obama’s first year, Trump’s economy grew at an average of 2.5%.

So: A reasonably fair comparison would be that Trump’s economy, buttressed by lower taxes, a trillion dollars of overseas corporate capital repatriated, less legislative burden, and a friendlier business climate, grew three tenths of one percent faster than Obama’s. If one wants to include the first year under Obama and the last under Trump, under control of neither, the average would be 0.95% under Trump and 1.6% under Obama.

As far as the debt is concerned, under Obama the debt went from $10.6 trillion at 1/20/09 to $19.9 trillion at 1/20/2017, an increase of $9.3 trillion over EIGHT YEARS. The debt under Trump increased to $27.8 trillion at 1/31/21, an increase of $7.9 trillion over FOUR YEARS.

Don’t believe anything you hear and very little of what you read!

With that off my chest, the fiscal/monetary chickens are coming home to roost. The factors that we have been discussing for years are becoming too obvious for the financial markets and policy makers to ignore.

The table just below shows the monthly deficit numbers. For the month ending April, the deficit was “only” $226B, down from the explosion of $738B in the first full month of the pandemic last year. Still, we are running 30% ahead of a year ago, which finished in a $3.1 trillion hole, and there is huge spending ahead of us this year. With the trillions that are being thrown around, it seems likely that the deficit for the current year will be over $4 trillion. Keep in mind that our Federal Reserve is buying the majority of the debt that we are issuing to fund this deficit, so we are literally “monetizing” the debt by paying for the deficit with freshly printed Dollars. It is in this context that we have suggested that there is no need to raise taxes on anyone, rich or poor. None of it will supply more than a few hundred billion dollars per year, and there is much less aggravation for everyone if one of Jerome Powell’s hundreds of PHDs pushes a computer button and produces the US version of a digital currency. Of course, inflation will be the cruelest tax, especially on the middle and lower class citizen, but they will likely never understand the cause.

Inflation in consumer goods, rather than the asset inflation we have seen in the last ten years, is finally rearing its beautiful (as far as the Federal Reserve is concerned) head. Post pandemic demand, along with looser purse strings as pandemic relief checks are distributed, is replacing the pandemic induced reduction of demand that has suppressed the economy over the last year. As we wrote last month, some very bright economists are agreeing with Jerome Powell that inflationary indications are “anchored” and “transitory”, but we believe transitory may last longer and not so well anchored as expected. The last twelve months of the CPI are now above 4%, and the CPI is widely considered to be understating the inflationary facts of life.

We consider that there has been an undeniable bubble in all kinds of assets, from Tesla to Bitcoin, to collectible homes worth a hundred million dollars to crypto-art and lots of individual stocks that trade for 50x sales instead of a more modest multiple of earnings or cash flow. Investors of all stripes are reaching desperately for a “return”, as evidenced by the historically low yield spread between high yield debt and US Treasury securities, as well as the asset classes referred to above. As we write this, a number of these upside distortions are in the process of being corrected. Tesla is down from over $900 to under $600. Bitcoin is $43k, down from $64k three weeks ago, the bloom is coming off the SPAC rose, and GameStop is down well over 50% from its ridiculous high. However, the process has just begun and will no doubt play out over a number of years.

Gold and gold mining stocks seem to have consolidated adequately since last August, when interest rates went modestly higher, and have just now established new bullish chart patterns. Negative “real interest rates”, subtracting the inflation rate from the yield on short term treasuries, has a strong correlation with the price of gold. The more negative the “real” interest rate, the more attractive is gold bullion, with no dividend or interest. Almost to the day, last August, when interest rates moved higher, reducing the degree of negativity, the gold price started drifting lower. Real treasury rates never turned positive, but the smaller degree of negativity reduced the urgency for ownership of gold. While interest rates have not gone back down to levels of nine months ago, inflation has picked up substantially, so short term treasuries yield several points less than the 4.2% trailing twelve month inflation rate and gold therefore protects purchasing power very well without paying interest or a dividend. The result is that gold bullion, as well as gold mining stocks have now broken out above their 200 day moving average price lines, so technicians will reprogram their algorithmically driven computers. While gold bullion is still down a percent or two for the year, gold mining stocks are positive for the year and have never been fundamentally cheaper.

It continues to be our conviction that gold mining stocks, in particular, are the single best place to protect one’s purchasing power over the long term, and our investment partnership is invested accordingly. Since there seems to be an increasing interest in this subject, in very quick summation:  I am personally the largest Limited Partner, by far, as well as the Managing General Partner of RHL Associates LP, as I have been for the 28 year life of the Partnership. The minimum investment is $500k and the fee structure is “1 and 10”. Funds can be added on the first of any month and withdrawn at the end of any quarter with 30 days written notice. We remain open to new investors, keep our investors apprised on a monthly basis as to our performance, and can be contacted through this site or by email at lfsi@aol.com.

Roger Lipton

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

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

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

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

A SEVEN MONTH CONSOLIDATION IN GOLD & THE GOLD MINERS

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

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

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

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

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

FURTHER SHORT-TERM REFLECTION

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

THE REALLOCATION OF RESOURCES

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

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

FINALLY, OUR CONCLUSION

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

Roger Lipton

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

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

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

 FROM GAMESTOP TO GOLD – WHAT’S THE STORY ?

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

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

Here is the application to the gold and silver markets.

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

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

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

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

THE BACKDROP

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

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

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

Back to the current situation:

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

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

THE ECONOMY IS WEAK

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

EMPLOYMENT GAINS HAVE STAGNATED

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

US GDP STILL VERY WEAK

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

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

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

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

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

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

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

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

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

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

THE RESULTANT FEDERAL RESERVE/TREASURY DILEMNA

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

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

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

The objectives are inconsistent.

THE RESULT

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

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

Roger Lipton

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

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

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

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

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

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

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

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

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

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

Roger Lipton

 

 

 

 

 

SEMI-MONTHLY FISCAL/MONETARY UPDATE – WARREN BUFFET’S BERKSHIRE HATHAWAY ADDS BARRICK GOLD (GOLD) TO PORTFOLIO

SEMI-MONTHLY FISCAL/MONETARY UPDATE – WARREN BUFFET’S BERKSHIRE HATHAWAY ADDS BARRICK GOLD (GOLD) TO PORTFOLIO

The big news, after the market close last Friday evening was that Berkshire Hathaway Inc., in the quarter ended 6/30, added $565M of Barrick Gold Corp. (GOLD) to Berkshire’s portfolio. This is a very positive development, not only as a reversal of Buffet’s long held disdain for the “barbaric metal”, but as an endorsement for the ownership of gold mining equities. Buffet has been quoted many times as saying that gold “just sits there”, no dividend, no interest, no growth. With interest rates virtually at zero, gold’s lack of dividend or interest is no longer a drawback. The lack of growth can now be overcome by ownership of a well run mining company that is increasing production and will benefit, in a leveraged way, from an increasing price of their end product. This rationale leads to ownership of Barrick Gold (GOLD) and lots of other possibilities, all of which we continue to own.

EXPECT A DEBATE (got to fill the 24 hour news cycle)

On one hand: $565 Million is a rounding error for Berkshire’s $150B portfolio, far from a major purchase. Barrick is just a gold miner (not gold itself) and the purchase decision was possibly made by one of today’s day to day active portfolio managers at Berkshire, not Buffet himself.

On the other hand: $565M was likely not the end of the buying. It is six or seven weeks since the end of June, the portfolio managers know that Berkshire’s purchase will trigger a great deal of interest not only in GOLD but in the entire gold mining asset class. It is therefore highly likely that more Barrick, and perhaps other mining companies have been bought by now. It is possible also, that Berkshire’s further (perhaps even more substantial) buying contributed to the strong performance since June 30th of the gold mining stocks.  Furthermore, while Buffet himself might not have initiated the move toward gold mining, he was no doubt well aware of the decision and is prepared to defend it.

Parenthetically, it is worth noting that: While Berkshire has purchased a gold mining stock for the first time, sold were billions of dollars worth of JP Morgan Chase, Wells Fargo and Goldman Sachs. Seems like a parallel path to the “money management” activities of worldwide Central Banks, who have continued to buy gold bullion while they reduce (as a percentage of reserves) their holdings of US Treasuries.

THE PSYCHOLOGY OF OWNING GOLD RELATED STOCKS

We believe Berkshire’s purchase could provide a psychological inflection point. Though gold and the gold miners have performed well for the last eighteen months, and over the long term,  a money manager puts his professional life at risk (and possibly his marriage as well) by owning a controversial gold related security. An institutional money manager can buy any amount of Microsoft or Apple or even Tesla, and his stakeholders won’t be critical if it doesn’t work, especially since so many competing money managers will be suffering the same fate. On the other hand, everybody has an opinion about gold, well informed or not, so a mistake in this area could be fatal.

In essence, Buffet now provides “cover”.

OUR ARGUMENT: SPEND THREE MINUTES WITH ME, ON YOUTUBE, YOUNGER,  AND A LITTLE EARLY, IN 2012

https://www.youtube.com/watch?v=ah7Y2rHuhCs

THE UPSIDE

The “cover” that Berkshire’s purchase provides has the potential of unleashing the upside in the gold related asset class, so let’s look at the upside.

The chart just below shows gold bullion as a percent of US Financial Assets. The chart goes only to 2014, and while it is true that gold has come back to over $1900/oz., up about 60%, the other asset classes are up about the same amount, so the relationship shown still exists. With gold bullion about 4% of assets versus a previous high around 16% there is obviously a great deal of catching up to do.

Compound the above chart with that just below which shows how the gold mining stocks have very substantially lagged the price of gold.  As you can see, the miners strongly correlated with bullion until late 2012. It would now take a triple to catch up.

SUMMARY

All the reasons that gold bullion has maintained its purchasing power for 3,000 years, for 200 years, for 50 years, for 20 years, all but between 2012 and now, are very much in place. John Maynard Keynes is quoted as saying: “When the facts change, I change my views. What do you do, sir?” The facts are not only the same as eight years ago, but substantially magnified. Warren Buffet, and his portfolio managers, do not make a lot of long term mistakes, and we join them in the view that we are much closer to the beginning of a new bull market in gold related assets than the end.

Roger Lipton

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

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

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

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

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

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

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

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

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

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

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

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THERE IS NO GRACEFUL WAY OUT OF THIS MESS!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THERE IS NO GRACEFUL WAY OUT OF THIS MESS!

The capital markets were quiet in June compared  to April and May, but still productive for owners of gold related securities.  The general market was up slightly in June, but all indexes except Nasdaq are still down for the year. Gold bullion was up 2.7% (now up 17% for the year. The gold mining stocks, with their cash flow and earnings leveraged to the price of gold, are still cheap statistically and are moving at a dramatic rate. Most impressively, in the last three month, from the low point, gold bullion is up 13% and the gold mining stock indexes are up well over 50%.   As our discussion below shows, the trends are more than adequately clear, all supportive of much higher prices for gold bullion and especially for the gold mining stocks .Moreover, there is no graceful way out of this fiscal/monetary mess.

Pictures can efficiently provide a summary of what has been going on from a fiscal/monetary standpoint over many years, leading us to a considered opinion of what the financial world will look like in the future.

The chart just below shows the current 30 year yields in various countries around the world. It is an axiom that the bond market supposedly prices in some sort of a “real” yield on top of allowing for inflation.  With the US 30 year yielding close to an all time record low of 1.44%, hardly anybody expects inflation to be zero over the next 30 years, which would provide a 1.44% “real yield”. It is a better assumption that the pricing represents expectations of a weak economy as well as the US Fed’s intention to increasingly support the long end of the yield curve.  The 30 year is “bid” to represent a safe haven as well as a short term trade, rather than a 30 year investment.

We can also assume that interest rates will stay very low, if the US Fed has anything to say about it (and so far they have), because it is only the ultra low rates that allow the US to carry the sharply increasing debt load.  The charts below show the ongoing annual budget deficits as well as the increase in the Federal Reserve’s balance sheet, whereby the Fed has been financing an increasing amount of the US operating deficit. Lest you think that this will all change once the economy gets going, and the operating surplus will reduce the cumulative debtt: Since 1981 there have been a grand total of four surplus years, the last three under Bill Clinton and the first under GW Bush, before the two wars started. The total surplus in those four years was about $760B, so you can judge for yourself how much of a dent  a stronger economy will make in the current $26 trillion growing debt federal debt burden.

We can also assume that interest rates will stay very low, if the US Fed has anything to say about it (and so far they have), because it is only the ultra low rates that allow the US to carry the sharply increasing debt load.  The charts below show the ongoing annual budget deficits as well as the increase in the Federal Reserve’s balance sheet, whereby the Fed has been financing an increasing amount of the US operating deficit. Lest you think that this will all change once the economy gets going, and the operating surplus will reduce the cumulative debtt: Since 1981 there have been a grand total of four surplus years, the last three under Bill Clinton and the first under GW Bush, before the two wars started. The total surplus in those four years was about $760B, so you can judge for yourself how much of a dent  a stronger economy will make in the current $26 trillion growing debt federal debt burden.

You have now seen how the bond market is predicting slower growth, at least in part due to the growing debt burden (around the world), which has been financed largely by worldwide Central Banks.

The last chart shows the steady decline in GDP growth in almost every post-recession expansion since 1981. The most recent ten years is fresh in our mind. A business friendly outsider passed one of the largest tax reductions in history, allowed for repatriation of almost one trillion dollars that had been frozen overseas, reduced the legislative burden on businessmen and encouraged the Federal Reserve Bank to print trillions of new dollars and keep interest rates near zero. The result was a grand total of 2.3% real annual GDP Growth over the last ten years, perhaps 0.1% to 0.2% more in the last three years under President Trump than under President Obama. This can be best described as a minimal “marginal return on investment”.

The coronavirus pandemic will be in the rear view mirror at some point in the next six to twelve months. The trends as described above will not. Rates will still be low, as signaled by Jerome Powell just recently, through 2022. This is because (1) the economy needs the support and (2) the US budget cannot afford higher rates on $26 trillion of growing debt. The annual deficits and cumulative debt will continue to step up by record amounts because that is essentially baked in the cake at this point. Just yesterday Fed Chairman, Jay Powell, reiterated the intention to invest a trillion dollars in all kinds of corporate bonds and ETFs. Also under active discussion is a trillion dollar infrastructure program.

As a result of the domestic debt burden, amplified by similar trends in every major worldwide trading nation, our expectation is that, after the sequential improvement from depression level economic activity, average real GDP growth will be no better, most likely materially worse, than the meager 2.3% average real GDP growth of the last ten years.

We fully expect that gold bullion will outperform equities in the next ten years, just as it has in the last decade. The bond market has outperformed both, as the entire yield curve was repriced downward, but that is less likely, from current levels, in the future.  Gold mining stocks have substantially underperformed the price of gold bullion over the last ten years and we continue to believe that they will be the best performers of all.

Roger Lipton*

*Roger Lipton is the managing General Partner of RHL Associates, LP, a Limited Partnership  that is 100% invested in gold mining stocks.

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

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

PROLOGUE

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

THE MONTH OF MAY

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

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

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

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

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

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

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

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

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

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

 THE PRICE OBJECTIVE FOR GOLD BULLION

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

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

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

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

THE TIMING – FOR GOLD BULLION PRICES

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

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

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

THE GOLD MINING STOCKS

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

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

SUMMARY

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

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

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

Roger Lipton