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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CASE FOR GOLD – FROM THE “TOP DOWN” TO THE “BOTTOMS UP” – HOW HIGH, AND WHEN?

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CASE FOR GOLD – FROM THE “TOP DOWN” TO THE “BOTTOMS UP” – HOW HIGH, AND WHEN?

With gold in the news again, there are lots of reasons provided by observers, most of them of minimal importance. Ask yourself what has changed recently to justify the sudden resurgence of gold related securities, and the answer is “not much”. For years now we’ve had low interest rates, a sluggish economy, geo-political concerns, rising deficits and debt, etc.etc. For us, as our readers know, it’s not been a question of IF, more a question of WHEN. The following article provides our reasons why gold related securities should be an important portion of one’s liquid assets.

Our conviction regarding gold, and gold related investments revolves around our conviction that gold is the real money, has been for thousands of years, and the reasons have not changed. Gold is limited in supply, durable, and accepted worldwide as a unit of exchange and a store of value. It is true that gold is useless in terms of being consumed or generating a return such as a dividend. However, it is the indestructibility and scarcity that have made it most useful in terms of backing paper currencies that could otherwise be diluted into oblivion by the politicians of the day. This has in fact been the consistent case throughout history and it is hard to conclude that today’s politicians, worldwide, will prove to be any more disciplined than those of the past.

A second part of our premise is that without a sound currency, there cannot be a sound economy. Unless the public has confidence in the buying power of the earnings that are received as a result of their effort, they will exert less effort in that pursuit. This has been reflected through the ages, before and including ancient Rome to the 21st century.

A corollary of the paper currency dilution is the inevitable higher price of goods and services. You don’t need a PHD in economics to understand that an increasing amount of currency chasing a fixed amount of product will result in higher prices. It so happens that this result is far more acceptable from a political point of view than the fiscal and monetary discipline necessary to avoid deficit spending. This predictable outcome produces a cruel tax on the working middle class (wealth gap?) that doesn’t understand why they are taking home a bigger paycheck but it just doesn’t seem to go as far as expected.

Another way to look at gold ownership as a long-term hedge against inflation: If we view gold as a currency/commodity, which competes with other similar “asset classes”. This includes the latest asset class which consists of over 2,000 cryptocurrencies led by the headline grabbing bitcoin. The amount of gold that is produced every year amounts to about $160 billion each year, and increases by about 2% annually (which happens to be approximately the rate of long-term real growth in the worldwide economy). Compare this production of gold, requiring substantial capital investment and risk, with the creation of trillions of dollars annually of unbacked (fiat) paper currencies that are produced with the click of a computer mouse. Which asset class do you think will hold its “value” better over the long term?

THE WEALTH GAP

The “wealth gap” that is decried by politicians around the world began to rear its head in the 1970s. We believe it is no accident that August of 1971, when Richard Nixon closed the gold window, ushered in this unfortunate phenomenon. The chart below shows this clearly.

THE CURRENCY AND THE DEBT

The following charts show how public and private debt has expanded since 1971 and how the US currency in circulation has expanded exponentially. It is interesting to observe how the US public and private total debt exploded in 1930 as the GDP sank 30%, fell back through the depression, stabilized through WWII and the post war industrial expansion, before taking off in the 1970s. As above, we believe it is no accident that a 1971 dollar has retained only about 15% of its purchasing power by 2019.

Some might argue that inflation has been subdued in recent years, running under the Fed target of 2%, even though deficits are rising. In fact, many PHDs are scratching their collective heads, wondering why this is so. However, while apparel and some consumer electronic products have not risen in price, the cost of large ticket items such as education, healthcare and rent have risen sharply during this period of monetary accommodation. The paper currency creation, worldwide, with the stated intention of a “wealth effect”, has inflated stock and bond prices. That wealth has predictably largely bypassed the middle class consumer, but allowed a Van Gogh painting to sell for $250 million and co-ops in New York City and London to trade for $100M or more. The suppression of interest rates has also affected the purchasing power of the upper class and fixed income dependent savers in that you need  much more  savings to maintain a previously enjoyed living standard.

CENTRAL BANKERS

Central bankers have no use for gold because gold, as a governing mechanism for the issuance of the paper currency, puts the central banker out of business. However, they know where the bodies are buried so let’s follow what they do, not what they say. The following charts show the consistent accumulation over the last ten years by the central banks, notably by Russia and China, two or our greatest adversaries. It is worth noting that reported Chinese gold holdings are assumed by many to be very much understated.


GOLD HOLDINGS vs. MONETARY BASE

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. 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.

WHAT PRICE GOLD??

We refer to a couple of charts to approximate a reasonable level for the price of gold, relative to (1) a percentage of foreign exchange reserves and (2) as a percentage of paper currency in circulation.The chart just above this section shows that the value of the gold relative to the paper currency in circulation has a history, during steady non-inflationary growth, of being in the range of 25-35 %. The chart below shows the value of central bank gold holdings as a % of total foreign exchange reserves.

The chart above indicates that 7% could be 35%, or five times the current price. The chart below indicates that 7% could be 45% or 6.4x the current price. These ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1500/oz, or $7,500-9,000/oz. This ballpark price range objective is at the current time. Since the upward adjustment in the gold price will likely be over a number of years, the appropriate price would be even higher by then.

THE TIMING

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, now amounting to a cool $15 trillion. People, that’s a big number and even in Germany, the strongest European country, the entire yield curve is now negative. We believe that the amount of negative yielding debt will continue its upward march, and could even include some of the US debt. 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.


CONCLUSION:

You get the picture!!

Roger Lipton

P.S. We produced two YouTube videos back in 2012 relative to this subject matter, each of which remains completely relevant. They are each only three minutes long. We have provided those links below:

https://www.youtube.com/watch?v=1ebZO5iMNeg
https://www.youtube.com/watch?v=ah7Y2rHuhCs

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – PRECIOUS METALS ACT WELL, AS FUNDAMENTAL AND TECHNICAL FACTORS BOTH SUPPORT MUCH HIGHER PRICES

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – PRECIOUS METALS ACT WELL, AS FUNDAMENTAL AND TECHNICAL FACTORS BOTH SUPPORT MUCH HIGHER PRICES !!

FUNDAMENTALLY:

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

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

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

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

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

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

TECHNICALLY

In terms of supply of demand for physical gold:

(1) Russian and Chinese Central Banks continue their steady accumulation.

(2) India,  between their central bank and their population,  perennially the second largest accumulator of physical gold,  imported 78 tons in May alone, running 49% ahead of a year earlier.

(3) The price charts, for gold as well as gold mining shares, indicate much higher prices. Gold bullion has broken out to a five year high, though still 25% below the 2011 high. The gold mining shares are at three year highs, still 60% below the 2012 high.

SUMMARY

There are never any certainties, especially in the short run, but it seems like both fundamental and technical considerations are in gear, and indicating much higher prices.

Roger Lipton

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

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

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

THE SINGLE BIGGEST REASON TO OWN GOLD RELATED SECURITIES !!

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

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

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

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

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

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

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

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

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

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

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

Roger Lipton

 

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

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

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

IGNORE HISTORY AT YOUR OWN PERIL

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

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

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

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

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

Back to John Maynard Keynes and Harry Browne:

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

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

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

THE STATED DEFICIT IS THE TIP OF THE ICEBERG

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

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

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

WHERE DO WE GO FROM HERE?

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

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

Roger Lipton

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

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

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

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

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

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

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

One last point for this installment:

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

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

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

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

Sincerely,

Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD LOOKS GREAT TECHNICALLY, HERE ARE THE FUNDAMENTALS!!

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SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD LOOKS GREAT TECHNICALLY, HERE ARE THE FUNDAMENTALS!!

The capital markets these days are driven by computers, and their technical charting algorithms (“algos”). We believe, however, that over the long term it’s the fundamentals that matter. Chart patterns can carry the day, but at some point the fundamentals have to support the valuation. It’s been a painful six or seven years for investors in gold related securities, from 2011 when gold bullion topped out at $1850 and when the gold miners peaked a year later. Six years, though, within the context of modern economic and political history since 1913 when the Federal Reserve Bank was established, is obviously a small part. We believe that, even a few years from now,  2011-2018 will be viewed as a relatively brief price consolidation in the long term bull market for gold-related assets.

As we discuss the last 95 years of fiscal/monetary history, please refer to the chart we have provided below.

The Fed was established in 1913, to manage the money supply, in those days (since 1792) backed by gold, with the single stated objective of controlling inflation. It was hoped that management of the economy by the Fed would reduce the likelihood and severity of financial cycles (i.e.panics, booms, busts, etc.). In those days, it was a single mandate: inflation control, not including employment as is the case today.  105 years later, while we can’t say definitively whether more booms and busts would have taken place without the Fed, inflation control has been dismal. The 1913 US Dollar is worth about $.02 today. We suggest that the way we are going, in a lot less than 100 years from now, the US Dollar will be worth 2% of today’s paper currency. Our overriding thesis is that “gold is the real money”, as proven over 5,000 years of economic history. The fact is that there has never been an unbacked currency (“fiat” money) that has survived. It’s just a question of how long the politicians of the day take to destroy it. Every indication continues to be that the current crop of politicians, around the world, will be no different.

The table below shows, since 1929, the amount of debt the US owes (without unfunded entitlements). We have provided a commentary as to major economic and political events, especially relating to the status of gold in relation to the economy.

As a broad overview of the last ninety years in the table below, you can see that the debt as a percentage of GDP started rising materially through the depression of the 1930’s, peaked at over 100% of GDP when we were paying for WWII, came down materially until the late 1960s when LBJ instituted his “great society” and was paying for the Vietnam war. The Bretton Woods Agreement of 1944 created the US Dollar as the world’s reserve currency, to be the primary unit of exchange for worldwide trade. The US, in return for this huge privilege, was obligated to manage our economy, money supply, and spending in a responsible fashion. The US had the largest stash of gold among the world’s trading partners, with over 20,000 tons,  and our dollar was convertible into gold, at $34/oz. (after FDR raised the exchange rate from $20.67 during the depression).

The Bretton Woods Agreement worked fairly well, and the US, including the Fed, managed fairly well through the postwar rebuilding, until the late 1960s under LBJ. As spending increased and deficits loomed, major countries around the world, led by France’s Charles DeGaulle, started exchanging dollars for gold. The gold backing of our dollar, got down to about 6-7% of our currency in circulation, from the area of 25-30% in the postwar period. (It is worth noting that 6-7% is approximately the percentage where it is today, in the US and among major worldwide economies in total).  The US stash of gold was taken down to about 8,400 tons from over 20,000 tons in just a few years prior to 1971. Richard Nixon, his Treasury Secretary, John Connally, and Fed Chairman, Arthur Burns, made the decision in August’71 to “close the gold window”, ending convertibility into gold. Nixon, naturally, told the American public it was all for the best, would strengthen the economy, etc.. Predictably, however, over the next eight years, the price of gold went from $35 to $850, stagflation set in as the inflation rate went into the teens, interest rates went to the high teens by the time Jimmy Carter hired Paul Volcker in 1979.

Volcker started raising interest rates further, to squeeze out inflation, and Ronald Reagan,  taking office in early 1981, backed him in that process, tolerating the three year recession that ended in 1983. The stock market took off in August, 1982, anticipating the economic upturn.

At this point, you might suggest that a dedicated Fed chief today, backed by a financially astute President and legislative branch, could correct today’s problems, just as in the 1980s.

The problem is that debt as a percentage of GDP is over 100% today, versus 32% in 1980, the annual deficit is about 13-14x as big ( in an economy that is 6x as big), interest rates are very, very low now, so can’t be lowered by much to help the rebound, versus very, very high in the early 1980s, and the unfunded entitlements overhanging us now are a huge headwind that didn’t exist 39 years ago. You also didn’t have today’s worldwide co-dependency that complicates our ability to manage our own economy.

Moving on: from 1980 to 2000, with some fits and starts, the US economy grew fairly steadily, especially under Reagan and later under Clinton. While the debt was still rising, it was well below the 100% of GDP thought to be a troubling level. Relative to gold, the urgency of the 1970s had dissipated, with good reason as stagflation had been defeated, so gold retreated from $850 to a low around $250 by 2000.

From 2000 to 2009 gold went from $250 to $900 as GW Bush, financed by Alan Greenspan and then Ben Bernanke, spent money to offset the dotcom bust of 2001, the war on terrorism after 9/11 and the financial crisis of 2008-2009. The US Debt as a percentage of GDP went from the mid 50s to almost 100%, closely correlating with the rising gold price. When President Obama was elected, and it became clear that spending would continue, not only to close out the wars but on health care and other social initiatives, gold doubled again to over $1800/oz.

From 2011-2012 until today, gold and gold miners have suffered, because the annual deficits came down, from about $1.4T in 2010, to about $400B by fiscal 2015, and still “only” about $800B in fiscal 2018. This modest progress in controlling spending (we suggest “on the surface”) reduced the urgency for gold as a “safe haven”, an “uncorrelated asset”, or the “real money” (which is our primary motivation). At the same time, the stock market has risen steadily, as the Fed  (joined by other central banks) have provided minimal interest rates, to drive a stated “wealth effect”, also reducing the demand for gold. Even bitcoin, now largely abandoned, provided an alternative to traditional precious metals. It is noteworthy that the stated “on budget” deficits, have almost always been substantially exceeded by the increase in the total debt which includes borrowing from the social security trust fund and other emergency measures. You can see from the table below that, even with the lack of concern over deficits,  the total debt/GDP % never came down between 2011 and 2018, continuing to rise above the 100% danger threshold where it seriously drags on an economy.

Which brings us to where we are today:  We can anticipate, as far as the eye can see, sharply rising deficits and total debt, an economy that is already slowing from the 2.9-3.0% peak of calendar 2018, not much above the 2.3% of the Obama years. We note that a material portion of the modest 0.6-0.7% improvement has come from higher government spending, and the balance in a one time benefit from lower taxes. The public has spent their tax windfall on carefully selected items with Amazon, value meals at restaurants, and more pizza delivered from Domino’s. Businesses have spent their repatriated dollars and tax savings to a major extent on stock buybacks rather than capex. Government receipts are down, spending is up for defense, health care, interest payments and storm remediation (but not Nancy Pelosi’s travel). All projections call for a slowing economy over the next several years as well as higher deficits, which will be substantially exceeded by the increase in total debt. Of course, something like $100 Trillion of unfunded entitlements still loom.

In conclusion: The fundamental stage seems to be set for higher gold prices, which should carry gold mining stocks (even more depressed than bullion) much higher as well. In a long term sense, gold had a twelve year bull market from 2000-2011, has gone through a consolidation, in our view, unjustified by fundamentals. Justified or not, market place inefficiencies get corrected over time, the long term fiscal/monetary fundamentals support a much higher gold price, and most technical signals indicate that the long term bull market is about to resume.

Roger Lipton

FISCAL/MONETARY HISTORY – 1929 TO PRESENT
Fiscal Yr. 9/30 Debt ($Billions) Debt/GDP Percentage MAJOR EVENTS BY PRESIDENTIAL TERM
1929 $17 16% Market crash. Depression reduced tax receipts.
1930 $16 18% Hoover raises taxes, worsens depression
1931 $17 22% Smoot Hawley tariffs don’t help
1932 $19 33%
1933 $23 39%
1934 $27 40% FDR’s New Deal increased both GDP and debt.
1935 $29 39% GOLD AT $35/OZ.-FDR HAS OUTLAWED PRIVATE OWNERSHIP
1936 $34 40% HOMESTAKE MINING GOES UP IN PRICE BY 7X from 1930-35
1937 $36 39% US OWNS OVER 20,000 TONS
1938 $37 43% FDR cuts spending, Fed tightens. Serious recession.
1939 $40 43% Debt & GDP start rising, preparing for war.
1940 $51 50% Depression ends though employment doesn’t recover
1941 $58 45%        until after war, US enters war after Pearl Harbor in Dec.’41
1942 $79 48% Increased debt and GDP to support war effort
1943 $143 70%
1944 $204 91% BRETTON WOODS GOLD/MONETARY ACCORD –
1945 $260 114%  US DOLLAR TO BE WORLDWIDE RESERVE CURRENCY
1946 $271 119% Truman’s 1st term tight  budget. Peacetime recession
1947 $257 104%  US STILL OWNS OVER 20,000 TONS
1948 $252 92%
1949 $253 93%
1950 $257 89% Truman’s 2nd term. Korean War(1950-1953) higher debt & GDP
1951 $255 74% Recession after Korean War ends.
1952 $259 72%
1953 $266 68% Korean war ends
1954 $271 70% Eisenhower’s budget. Rate rise worsened recession.
1955 $274 65%
1956 $273 61% POST WAR DEBT FAIRLY CONSTANT
1957 $271 57%
1958 $276 58% Eisenhower’s 2nd term. Recession.
1959 $285 54%
1960 $286 53%
1961 $289 52%
1962 $298 49% JFK budgets. Cuban Missile Crisis. U.S. aided Vietnam coup.
1963 $306 48%
1964 $312 46%
1965 $317 43% LBJ’s budget. War on Poverty. Vietnam War. Fed raised rates.
1966 $320 40%
1967 $326 38%
1968 $348 37%
1969 $354 35% DEBT RISING, EXPECTATIONS WORSE, GOLD FLOWING OUT
1970 $371 35% Recession. Wage-price controls. Oil embargo. Int.rate double.
1971 $398 34% US GOLD DOWN TO 8400 TONS, NIXON ENDS CONVERTIBILITY
1972 $427 34% INFLATION TAKES OFF, GOLD GOES FROM $35 TO $850 BY 1979
1973 $458 32%
1974 $475 31% Stagflation. Watergate.
1975 $533 32% Ford budget.
1976 $620 33%
1977 $699 33%
1978 $772 32% Carter budget.
1979 $827 31% GOLD PEAKS AT $850/OZ.
1980 $908 32% Volcker raises rates to 20%. Iran oil embargo. Recession.
1981 $998 31% Reagan budgets 1st term.
1982 $1,142 34% Recessionn continues, stock market ramps in August.
1983 $1,377 37% Recession ends.
1984 $1,572 38%
1985 $1,823 42%
1986 $2,125 46% Reagan lowers taxes.
1987 $2,340 48% S&L crisis costs US gov. $50B
1988 $2,602 49% NO URGENCY TO OWN GOLD, FOR TWENTY YEARS (1980-2000)
1989 $2,857 50% DEFICITS RISING BUT ECONOMY IS STRONG
1990 $3,233 54% Bush 41 budget. Desert Storm. Recession.
1991 $3,665 59%
1992 $4,065 62%
1993 $4,411 64%
1994 $4,693 64% Clinton budget.
1995 $4,974 65%
1996 $5,225 64% Budget Act reduced deficit spending.
1997 $5,413 62%
1998 $5,526 61% No defict, but debt still up. Last Clinton budget.  Recession.
1999 $5,656 58% No deficit, but debt still up
2000 $5,674 55% NO DEFICIT, BUT DEBT STILL UP – GOLD AT $250/OZ.
2001 $5,807 55% Bust adds $22.9B to ’01 budget for War on Terror
2002 $6,228 57% First GW Bush budget.
2003 $6,783 59% War on Terror costs $409.2B. Bank bailout costs $350B.
2004 $7,379 60% Bush Tax cuts.
2005 $7,933 60%
2006 $8,507 61% Wars cost $752.2 billion.
2007 $9,008 62% Katrina Costs $24.7B
2008 $10,025 68% FINANCIAL CRISIS COSTS $242B, GOLD AT $900/OZ.
2009 $11,910 83% Great Recession and tax cuts reduce revenues.
2010 $13,562 90% Obama Stimulus Act cost $400 billion.  War cost $512.6 billion.
2011 $14,790 95% DEBT APPROACHING 100% OF GDP, GOLD  AT $1850/OZ.
2012 $16,066 99%  US CONTINUES TO ABUSE RESERVE CURRENCY PRIVILEGE…………
2013 $16,738 99% BY PRINTING TRILLIONS OF NEW DOLLARS
2014 $17,824 101% War cost $309 billion. QE ended. Strong dollar hurt exports.
2015 $18,151 99% FOR SIX YEARS, DEBT STILL RISING, BUT AT SLOWER PACE
2016 $19,573 104% NO URGENCY TO OWN GOLD, CORRECTS TO LOW OF $1050
2017 $20,245 103% Congress raises debt ceiling, again.
2018 $21,658 99% Trump tax cuts,spending up. Debt ceiling suspended ’til 2019.
HERE WE GO AGAIN! THE STIMULUS, AND DEFICITS, HAS NEVER, IN PEACETIME,
BEEN SO LARGE AND ACCELERATING,
ESPECIALLY IN THE MIDST OF SUPPOSED PROSPERITY
2019 $23,000 109% assumes no recession, $1.1T deficit, debt up by $1.342
2020 $24,500 111% assuming no recession, $1.2T deficit, debt up by $1.5T
2021 $26,000 113% assuming no recession, $1.2T deficit, debt up by $1.5T
YOU CAN MAKE YOUR OWN ASSUMPTIONS AS TO WHAT THE PRICE OF GOLD DOES FROM HERE!
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SEMI-MONTHLY FISCAL/MONETARY UPDATE – IT’S GETTING INTENSE!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Roger Lipton

 

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – MAJOR RISKS SURFACE

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

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

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

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

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

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

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

Roger Lipton

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Roger Lipton

 

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