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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON !!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON !!

The general equity markets were up modestly in April. Gold bullion was down a fraction of 1%. The miners, which had outperformed gold bullion in the first quarter gave back their gain. For the year to date both gold bullion and the gold mining stocks are essentially flat. Considering that the US Dollar is at a high and the general equity market has been strong, that is reasonably good performance for a non-correlated asset class.  Fundamentally: nothing has changed regarding the long term fiscal/monetary trends. In fact, the prospect for a major move in gold bullion and an even larger move in the gold mining stocks has only improved. The longer the fundamental factors that we present prevail,  the larger the price move in gold bullion and the mining stocks will be.

 Over the last month, the following bullet points come to mind:

  • Ten years after the sub-prime bubble of ’08-09, new financial excesses have arisen, including a private equity mania (Lyft, Uber,  Wework, etc.), a subprime auto bubble, a student loan bubble, a sovereign debt bubble among emerging economies, a “levered loan” bubble.
  • Central Banks continue to buy record amounts of gold bullion. They understand that the paper currencies are being diluted and are increasingly aggressive in diversifying their foreign exchange reserves away from US Dollar. China and Russia, increasingly considered our adversaries, are the most prominent gold bullion buyers. In India, where the public traditionally accumulates gold, the central bank has again become a substantial buyer, increasing their holdings by 50 tons (the total by over 10%) in just the last 15 months.
  • Debt creation as a GDP stimulant is increasingly impotent. As calculated by highly regarded economist, David Rosenberg, since 2007 “global debt has ballooned by $140 trillion while global GDP has risen by only $20 trillion. The “bang for the debt buck” is clearly diminished, and that will only get worse over time.
  • The highly touted 3.2% growth in US real GDP was largely dependent on non-recurring factors. Inventory build, government spending, and lower imports together contributed 2/3 of the total. The 3.2% number was also calculated based on only 0.8% annualized inflation, and that assumption is questionable. One thing we can count on, however,  is that economic performance in the US will continue to be presented in the most favorable possible  light between now and November, 2020.
  • Following on the previous point, just this morning Steven Mnuchin, Sec’y Treasury, pointed out that the US debt limit, which has already been exceeded, will have to be raised within six months, because our financial flexibility will have been utilized. $22 trillion is comfortably in the rear view window, and $23 trillion is months away.

The following discussion is a bit “technical” in nature, but we feel is crucial in terms of long term expectations for financial markets.

CENTRAL BANKS BUY STOCKS AND BONDS – A RECIPE FOR LONG TERM DISASTER !! – A LESSON IN “MARKET MAKING”

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

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

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

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

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

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

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

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE DEFICITS AND DEBT – HERE WE GO AGAIN!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE

The general capital markets were up modestly in July, gold bullion was down 2.3%. The gold mining stocks were down about 3.5%.  Most importantly, our conviction hasn’t changed regarding the long term outlook for our portfolio that is heavily invested in gold mining stocks.

While last month we outlined a group of tangible factors that support our thesis, it could be useful to go back to the biggest single reason that gold will be the surviving “currency”, protecting purchasing power best. The worldwide credit pyramid that has fueled the economic growth over the last forty years must be liquidated. Debts must be paid off, and the numbers are too large for the worldwide economy to grow out of the problem. “Default” will be the result, but refusal to pay is too obvious and makes the politicians look bad. Inflation is the only other solution since the voting public doesn’t understand who caused it. Gold has gone from $250/oz. to $1200/oz. since 2000, starting with the President GW Bush debts to finance the aftermath of 9/11 and then the two wars. Gold doubled from $900 in ’09 and the gold mining stocks quadrupled and more) as the deficit spending ramped up even further under President Obama.

Here we go again: The projected US deficit in the fiscal year ending 9/30/18 is projected to be about $800B, up from $600B last year. However, the cumulative debt in the 10 months ending today ($21.2 trillion) is already one trillion dollars higher than last September and is projected to be higher by $1.2 trillion by 9/30.

Only in governmental accounting can the annual deficits not total the cumulative increase in debt. This is not new. You have no doubt heard from politicians and economists who are concerned about the future deficit spending. Republicans are concerned when Democrats are in power, and now the situation is reversed. However, they don’t talk about the excess debt, on top of the budgeted spending, called other borrowing. Over the last ten years, the cumulative debt increase has exceeded the total of annual deficits by a cool three trillion dollars. People, this is a lot of money. While the annual deficits going forward are projected to be over a trillion dollars annually over the next decade, you can only imagine what the cumulative debt will look like after the other borrowing. We have described the situation in terms of US debts, but enormous potential credit problems also overhang the economies of China, Japan, and the Eurozone, the largest after the USA. What the endgame looks like is unknown, but it won’t be pretty.

Stay healthy. Stay financially flexible.

Roger Lipton

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

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

THE ECONOMY

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

FEDERAL RESERVE NORMALIZATION PROGRAM

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

GOLD UPDATE

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

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – GOLD SLOWLY RISES – BITCOIN “ADJUSTMENTS”

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – GOLD SLOWLY RISES –  BITCOIN “ADJUSTMENTS”

The price of gold bullion firmed a bit through the month of July, with gold bullion up about 2.3% for the month. The chartists could say that a base has been formed to support a major move upward. The gold mining stocks were up somewhat more, reflecting the operating leverage from the change in price of their end product. Our major position in the miners continues to be our  emphasis and, as we have pointed out before, has the potential to multiply our portfolio value by many times. The weakening of the US Dollar which began in June continued through July. A weak dollar is not a necessity for gold (and the mining stocks) to go up in price but, all other factors being equal, should prove to be a positive for us.

We talked last month about the steady increase in the monetary base that has been created by Central Banks worldwide, and that this financial experiment will undoubtedly end badly. An increasingly dangerous corollary of Central Bank currency creation is the purpose to which those funds are put to work. What is not well known is that Central Banks have been buying hundreds of billions of dollars of equities. Since major Central Banks cumulatively hold over $11 trillion of foreign currency reserves, it is natural that they should want to diversify those reserves away from the currencies which are being continuously diluted. Along with steady buying of Gold (which we suggest is the “real money”), the Central Banks are adding equities to the mix/

The Bank of Japan has been buying Japanese ETFs at the rate of $53 billion per year, and now holds over 71% of those ETFs. The bank is now one of the top 5 owner of 81 companies within Japan’s Nikkei 225 index. As reported by Grant’s Interest Rate Observer, the Japanese Financial Services Agency (Japan’s SEC) is now “paying close attention” to this phenomenon.

The European Central Bank has been buying 60 billion euros worth of bonds monthly, and Mario Draghi recently announced a continuation (A hesitancy to back off?) In the meantime, Deutsche Bank CEO, John Cryan, has said: “There has been absolutely no price discovery now in corporate bonds….which is a very dangerous situation”.

The Swiss National Bank has been steadily buying equity securities, including US based companies. Equity securities, as of Q3’16, comprised 20% ($128 billion) of their of their $643 billion in foreign exchange reserves, up from 7% in 2009, including investments of $1.7 billion in Apple, 1.08 billion in Exxon, and $1.2 billion in Microsoft.

Here in the US, our Fed has talked about beginning to unwind our $4.2 trillion balance sheet by no longer reinvesting the funds from securities that are maturing. The result of this form of money “tightening” can only be a guess, especially with an already soft economy.

These are serious amounts of capital being put to work in an increasingly dangerous way. To some extent, Central Banks are biased toward continued equity (and bond) buying, because their absence from the marketplace would cause a price decline and trillions of dollars of “paper losses” on their respective balance sheets. I learned a long time ago (the hard way) that when you become “responsible” for supporting a particular market, the best possible strategy is “get out of the way” and take the current loss before it inevitably becomes much larger. The key question, at this point for Central Banks, now becomes “Sell to Whom?”.

Lastly,  a Wall Street Journal  Headline this morning reads: Bitcoin RIval Arises From Sector Spat. I will write more about Bitcoin, and the other “Cryptocurrencies” in the near future. As a preview: I believe that years from now, books will be written about the current fiscal/monetary world we are living within, and the cryptocurrrencies will be appropriately viewed as symptomatic of the tail end of the financial folly. Stay tuned on this subject and, in the meantime, be careful out there.

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