Tag Archives: INFLATION

THE LABOR CRISIS IS ALL OVER THE NEWS: HOW WILL IT PLAY OUT? AND SOME UNINTENDED CONSEQUENCES

THE LABOR CRISIS IS ALL OVER THE NEWS: HOW WILL IT PLAY OUT? AND SOME UNINTENDED CONSEQUENCES

We wrote a month ago about the labor crisis within the restaurant industry.  Today, the business press, in writing and on TV, has more than discovered the situation, with a continuous din. Our discussion below is intended to provide more insight as to how it plays out. Since something like 20 million Americans are employed within the hospitality industry, encompassing restaurants, retail and hospitality, the implications for our overall economy are significant.

The restaurant industry is now forced to pay anywhere from $12 to $16/hr. for starting crew members and, even at that wage, it remains difficult to find candidates to interview. Some companies are offering referral bonuses to existing employees, $50 to just show up at an interview and many other enticements. On a recent trip to South Carolina, I saw signs to this effect in the windows of almost every restaurant on the commercial strip. The most striking offer was at McDonald’s, a willingness to pay $28,000 as a starting wage to a trainee who would be a manager within 90 days. We don’t know what the “qualifications” would be to get that job, and the prospect might be slated to be a “shift” manager, rather than general manager. However, no matter how well “qualified” that person would be, is seems a sign of clear desperation that a store owner is now required to hand over the keys to a $3M restaurant, for even a shift, after only 90 days of training. Parenthetically, almost all the management teams of publicly held companies have recently reflected the labor “challenge”, though the longer term margin ramifications haven’t been explored.

The debate about the cause of the crisis unfortunately, as most policy discussions do these days, comes down to a political divide. The left suggests that it is the fear of interacting with the public while Covid-19 is not yet eliminated, even $15/hr is barely a living wage, some potential recruits still have to stay home with children that are not yet back in school, and recruits are just looking for the right opportunity. Conservatives suggest that extended and enhanced unemployment benefits amount to more than a full time employee would earn while working and “if you pay people to stay home, they will stay home”.

The enhanced unemployment benefits are slated to remain until September 6th, and it seems unlikely that the Biden administration will modify that. However, South Carolina and Montana announced last week their plan to withdraw from the Federal Program at the end of July, at least a few other states will likely follow,  and the US Chamber of Commerce announced its support of stopping the extra $300/week.

THE RESULT –some obvious, some not so obvious – including some unintended consequences.

  • Crew wages are taking a major step higher, and what goes up will not, in this case, come down.
  • Store level managers and other field supervisors will also receive wage increases over time.
  • Staffing will remain a challenge, at least until September, because only half the country is Red, and Blue states will mostly keep the unemployment programs in place.
  • Store level service will likely suffer and/or training costs will increase materially for raw recruits.
  • Menu Prices will move higher, and customers, with inflation news rampant, will understand.
  • Store level and corporate margins will be hard pressed to move higher (than in ’19), since manu prices can only be raised with great caution. The other “prime cost”, namely Cost of Goods Sold, is likely to trend higher, affected by higher beef, chicken, etc.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT- CAN THE FED “CONTROL” THE SITUATION?

SEMI-MONTHLY FISCAL/MONETARY REPORT- CAN THE FED “CONTROL” THE SITUATION?

The capital markets traded to the upside in April, as the Biden administration lays out their agenda and the Federal Reserve assures everyone that they continue to have everything under control. We suggest that you come to your own conclusions. Ben Bernanke had no clue that the financial crisis of ’08-’09 was coming, though there were quite a few warning bells ringing. You never know which snowflake will start the avalanche.

THE DEFICITS AND THE DEBT

For those of you that like to know the latest deficit and debt numbers look like, the US deficit for the month of March was $660 billion, up from $119 billion in ’20, just before the pandemic related spending took off. The deficit for the first six months of the current fiscal year has therefore been $1.7 trillion, up from $741 billion in ’20. Since the comparisons from here will be up against the huge spending from April through September of the fiscal year ending 9/30, the comparisons will be “tougher”, depending on what stimulus programs are implemented.

Safe to say that the deficit for the current year ending 9/30/21 will be substantially more than the $3.1 trillion of last year. No doubt the total debt, not including unfunded entitlements, will be in the area of $30 trillion somewhere in the fourth calendar quarter of 2021. This continues to be of prime importance because heavy debt burdens the recovering economy and enormous spending, mostly financed by our Federal Reserve’s currency creation, will be necessary to keep the economy from collapsing. With the 2022 very important congressional election season beginning in just a matter of months, you can bet that the Biden administration will spare no expense to make the economy look good.

INFLATION OR DEFLATION?

There is an increasingly active debate developing as to whether inflation, or possibly some form of deflation, is in our future, and when. Keep in mind that both can happen, just as we have already seen higher prices in assets such as stocks, bonds, real estate and others. On the other hand, general income levels have not moved by much and “core inflation”, excluding food and energy, is still subdued.

Both inflation and deflation can be good for gold. The miners did very well during the deflationary 1930s, in spite of a fixed gold price, because their costs were coming down as the worldwide economy collapsed. Gold did even better in the inflationary 1970s, moving from $35 when Nixon eliminated convertibility in 1971 to $850 early in 1980. On balance, we prefer inflationary trends and that is what central banks around the world are desperately trying to provide.

There are some very obvious short term trends that point to inflation. There is major upward pressure on the minimum wage, with an apparent shortage of workers. There have been shortfalls in supply, and higher prices for semiconductors, lumber, copper, agriculture, gasoline, used cars, and housing. Interest rates, while still low, have moved upward, which could signal the bond market’s expectation of higher inflation. The M-2 money supply has moved up by 24% in just the last year, the most rapid rate in 150 years, and economics 101 dictates that more money chasing the same amount of goods should be inflationary at some point. Most importantly, consumers increasingly expect inflation to accelerate, and that expectation alone can be a critical ingredient. Lastly, the weakness in the US Dollar points to higher domestic inflation.

On the other hand, some of the most intelligent observers, including Lacy Hunt, Gary Shilling, and David Rosenberg, believe that the likely inflation coming out of the pandemic, over the next six months, will be modest. Fed Chairman, Jerome Powell, calls it “anchored” and “transitory”. Hunt and Schilling have had three decades of accurately calling for low interest rates, a sluggish economy, and subdued inflation, largely as a result of the debt burden. David Rosenberg, perhaps the economic commentator with the most well documented view, is looking for a short term economic bounce, accompanied by a modest uptick in inflation, but a return to economic malaise within six months.

Powell believes the Fed can control inflation by reversing the accommodation, allowing interest rates to rise, just as Paul Volker did in from 1979 to 1982. Hunt and Shilling and Rosenberg believe that the economy will go nowhere because of the debt and the aging demographics. The debt, in their mind, is a huge problem over the long term, but the Fed activities preclude a full scale  economic collapase. It seems to us that one of the most important ingredients in the reasoning of Powell, Hunt, Shilling and Rosenberg is that inflation is been “anchored” for the last ten years, even though the deficits and debt have gone through the roof. Therefore: the same beat can go on for the foreseeable future.

Though these are very smart people that we are trying to interpret and “second guess” to a degree, we are inclined to think that inflation will be higher, and longer, than is suggested above. Historical precedents may not apply because this monetary experiment is of a different magnitude than has ever been seen before.

Firstly, the Fed can’t “pull a Volker”, if inflation takes off, because the $28 trillion of debt now compares to $1 trillion in 1980, and today’s many trillions of unfunded entitlements were of little concern forty years ago. The annual operating deficit was only about $100 billion in 1980 compared to perhaps $4 trillion today. Even with an economy that is 6-7 times larger today, the problems are of a different order of magnitude. Raising interest rates, as Volker did, would trigger a massive decline in asset prices and a terrible depression.

The assumption by Powell and the others is that, based on the lack of inflation the last ten years, as deficits and debt built up, there is reason to believe that further monetary accommodation will, similarly, not create an inflation problem. We have seen that, though the Fed took its balance sheet from $1 trillion to $8 trillion in the last ten years, financing most of the annual deficit with newly printed dollars, the “velocity” of the monetary aggregates collapsed at the same time so the new currency did not pressure the CPI upward.

The Fed wants 2%+ inflation, and $7 trillion of new currency did not get the job done. In an extreme example, do you believe that $100 trillion of new currency, chasing the same amount of goods and services, would drive prices higher? We would say: highly likely. Seven trillion dollars didn’t get the job done. One hundred trillion dollars probably would.

The only remaining question becomes: What amount of new currency, between $7 trillion and $100 trillion, would kick off inflation? We think we are going to find out. Nobody knows how the above discussed elements will interact, but we expect a stagflationary period during the foreseeable future, likely with an even weaker economy and higher inflation than in the 1970s.  We also expect gold and the gold miners to be among the very best asset classes to own in the turbulent period ahead.

Roger Lipton.

ROGER’S “FOLLOW THE MONEY” APRIL ARTICLE – in the prestigious RESTAURANT FINANCE MONITOR

ROGER’S “FOLLOW THE MONEY” – APRIL ISSUE, RESTAURANT FINANCE MONITOR

Inflation is Coming and My Thoughts on Franchising

By Roger Lipton

INFLATION IS COMING

The U.S. Federal Reserve Bank was formed in 1913 to control inflation and manage the economy so as to avoid severe economic cycles. It has clearly failed in terms of controlling inflation, since a 1913 U.S. Dollar is worth about $.02 today.  More recently, since the U.S. went off the gold exchange standard in 1971, the Dollar has declined by about 85%. In terms of controlling business cycles, the U.S. has ad: the Roaring Twenties, the Great Depression in the 1930s, World War II, which had to be financed with debt in the ‘40s, inflation running to 12% and the Fed Funds Rate at 18% in the ‘70s, the dotcom bubble and burst of 1999 to 2001, the financial crisis of 2008-09, and the monstrous debt buildup and suppressed interest rates over the last 10 years.

More “money” has been created by the Fed in the last 18 months (adjusted for inflation) than was needed to pay for five years of World War II, and the debt as a percentage of GDP is above where it was in 1945. The M2 money supply in the US has increased by 24% over the last 12 months, the highest within recorded data over 150 years, and 27% most recently.

Fed Chairman, Jerome Powell, says there is a need to raise interest rates and reduce the Fed balance sheet, but adds “There will be a time, but not now.” However, the US debt has increased every year since 1957. There was a budget “surplus” in the last three years under President Clinton and the first year under President George W. Bush, amounting to just under $800 billion over four years, but the debt still increased each year due to “off-budget” items. (Only in D.C. can this happen.) Powell has reiterated the Fed’s objective to generate inflation of 2%+, indicating potential rampant inflation can be controlled, but the current financial experiment is unprecedented in time and magnitude. Our bet is that inflation is coming, higher than the Fed expects and it will be difficult to get the genie back in the bottle. Manage your business accordingly.

THE TIMES THEY ARE ‘A CHANGIN’ IN THE FRANCHISE  WORLD

We wrote here last month that almost all of the mature publicly held franchising restaurant chains are hardly growing their U.S. units. We pointed out that, for a number of reasons, the unit level economics are just not attractive enough for franchisees to encourage unit expansion. Needless to say, higher sales would be transformational. The less obvious, and potentially contentious “adjustment” that could help a great deal is a revision of the franchise structure.

When Ray Kroc started franchising McDonald’s more than 60 years ago, the royalty rate was 1.9% By the 1960s, franchisors had started charging 2%-3%, by the 1970s 3%-4%, and 5% seems to be the standard today, plus at least 2% for advertising and other fees.

Some franchisees, at chains such as Dunkin’, Burger King and Jack in the Box are still making decent returns at  the store level because the store leases were signed 10 or 15 years ago and occupancy expenses are lower  than today’s economics would allow. While single unit franchisees who personally manage their stores can still make a living, a multi-unit owner, who  is the best prospect for unit expansion, paying a non-family store manager, is typically fortunate to be making 17-18% store level EBITDA, of which depreciation is not free cash  flow in the long run. Subsequently, rebating 7 points or more out of 17 or 18 points starts to feel like a pretty big load, and there is still local G&A to be carried. Even if store level EBITDA, before royalties, is in the low 20s, rebating over 7 points is a heavy price to pay. Considering the changing economics over the last two to three decades, there are no material operating expenses that are lower as a percentage of sales, certainly not occupancy or labor, and food costs are unpredictable commodities. The biggest single negative trend that nobody would debate is the intensive competition that has become commonplace.

The time has come for lower fees, especially ongoing royalties. We understand that this suggestion will be resisted by existing large chains, most especially those publicly held, because it would be an obvious reduction of the current royalty stream. However, well established franchisors could, and should, absorb more of the additional systemwide needs, such as technology upgrades. “Mid-cap” franchising companies could put some part of the following suggestions in place.

If I were running an early stage franchise company, I would put in place a sliding scale royalty system, charging 2.5-3.0% at a modest sales level, higher if the franchisee does better. Give them a little room to make money if the store doesn’t do quite as well as everybody hopes. If the store clicks, everybody is happy and the 4-5% on the higher sales won’t seem like such a burden. For my multi-unit franchisees, I would charge lower up front fees for additional stores and this is sometimes already being done (whether  admitting it to Wall Street or not). This is logical and appropriate because less franchise support is required as a franchisee builds local infrastructure.

It seems to us that a young franchise company adopting this strategy would have a huge competitive edge and the total royalty stream is likely to build more rapidly using this progressive approach. Profitable franchisees, and a more appropriate sharing of store level profits, considering today’s economic realty, make for a successful system in the long run.

Roger Lipton has followed the restaurant industry for four decades. Founder of money management and investment banking firm, Lipton Financial Services, Inc., he publishes regularly at www.rogerlipton.com.   He can be reached at lfsi@aol.com and 212 600 2266.

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

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

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

 FROM GAMESTOP TO GOLD – WHAT’S THE STORY ?

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

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

Here is the application to the gold and silver markets.

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

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

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

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

THE BACKDROP

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

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

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

Back to the current situation:

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

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

THE ECONOMY IS WEAK

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

EMPLOYMENT GAINS HAVE STAGNATED

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

US GDP STILL VERY WEAK

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

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

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

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

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

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

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

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

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

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

THE RESULTANT FEDERAL RESERVE/TREASURY DILEMNA

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

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

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

The objectives are inconsistent.

THE RESULT

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

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

Roger Lipton

YEAR END FISCAL/MONETARY SUMMARY – GOLD, AND THE GOLD MINERS, RE-ESTABLISH UPWARD TREND, WITH GOOD REASON!!

YEAR-END FISCAL/MONETARY SUMMARY – GOLD, AND THE GOLD MINERS, RE-ESTABLISH UPWARD TREND, WITH GOOD REASON!!

December, and the fourth quarter, continued in the same vein as the first three calendar quarters.  The operating leverage for the miners is starting to be recognized, since the move in mining stocks in December was more than double the 3.7% that gold bullion moved. It was a similar case for the year, with gold bullion up 17.9% and the miners up about double that. The most impressive relative move of the month was the last two days when the miners were up  2-3% with bullion up only 0.4%, so it is possible that this is the beginning of the still very depressed mining stocks catching up to the bullion price. The performance of our investment partnership, almost entirely invested in gold mining companies, mirrored that described above.

While bullion (at $1525/oz.) is down about 20% from its high of $1900/oz. (in 2011), the miners are down 50-70%, so the mining stocks could go up 100% or more with bullion rising 20-25% to the previous high. Since we believe that bullion will sell for something like $5,000/oz. within the next few years, you can see how our portfolio could multiply by many times the current price.

There is no reason to change our longstanding view that gold mining stocks have the most upside potential of any liquid asset class we know of. All the reasons we have been discussing for the last six years are only intensifying, and the potential reward for our patience has increased with time. You can review at your leisure our article written in August  of this year: THE CASE FOR GOLD – we are gratified that a true giant of the gold mining industry, Rob McEwen, who built Goldcorp, one of the largest and successful mining companies (recently merged with Newmont Mining),  has re-published (with our permission) our article on the website of his young company, publicly traded McEwen Mining (MUX). . Maybe we know something, after all 😊

Our many articles on this subject, largely summarized in THE CASE FOR GOLD, are hereby augmented with the following thoughts regarding Inflation, Central Bank Gold Purchasing, US Deficits and Cumulative Debt, Interest Rate Expectations and Worldwide Economic Trends.

INFLATION, which is supportive of the gold price, is not dead, as widely assumed. The apparent absence of inflation, as measured by the Bureau of Economic Statistics, has provided comfort to the PHDs at central banks. However (1) the price indexes that are quoted, inexplicably excluding food and energy which are consumed daily, have been manipulated periodically to put a false face on reality. Among other benefits to our government, understated inflation provides an insufficient increase to entitlements such as social security payments (2) Though certain imported apparel prices and some consumer electronics have not increased in price, asset prices (explicitly targeted by central banks), including stocks and bonds and prime real estate and collectibles have made the rich richer while the middle class strains to make ends meet. Inflation is with us when a Van Gogh painting sells for $240M or a NYC coop sells for over $100M. The super rich are purchasing iconic items which they know will command a premium price long into the future, as opposed to holding the colored paper that they know will have a tiny fraction of its current purchasing power. Even an understated 2% annual inflation rate destroys 50% of your purchasing power in 35 years. A 1971 dollar is worth about $0.15, a 1913 dollar is worth less than $.03. That Van Gogh or Central Park South penthouse will do better than that. The chart below shows how big ticket items, where the money is spent, have inflated over the last twenty years at rates well above those reported by our Bureau of Economic Analysis.

CENTRAL BANKS INCREASE GOLD BUYING, and the inevitable ramifications are becoming more obvious. Central Banks, most notably China and Russia, are buying physical gold at a record rate in 2019, at the same time reducing US Treasury Securities as a percentage of their reserves. Central banks collectively, even with China’s understated purchases, are now absorbing more than 20% of annual worldwide gold production. Furthermore, an increasing amount of trade is taking place between China, Russia, and the Mideast, conducted in terms of Yuan and Rubles and Gold, and the ounces of Gold it takes to purchase a gallon of Oil may indeed be a very important guidepost that determines the future relationship between various currencies. With geo-political-trade tensions so high, nothing would please the Chinese, the Russians, or the Saudis more than an ability to conduct more of their business in something other than US Dollars. Well connected sources are increasingly suggesting that China, combining the gold ownership of its many government agencies, likely owns upwards of 20,000 tons of physical gold, rather than the 1,900 tons owned by the Peoples Bank of China, which they report. This dwarfs the 8,100 tons the US has owned since 1971. Russia, with their rapidly increasing 2,200 tons, is the largest owner relative to the size of their economy and currency and most able to implement some sort of a gold related monetary system if they were so inclined.

There are reports of international discussions relating to a new “reserve currency”, joining or even replacing the US Dollar. The Bretton Woods Agreement of 1944 assumed the US would maintain the “value” of the US Dollar by backing it with gold. The USA has blatantly abused its trading privilege during the last 75 years by “closing the gold window” in 1971, generating annual operating deficits in 35 out the last 39 years, running up $23 trillion of debt (excluding tens of trillions of unfunded entitlement)  and printing $4 trillion of fresh (fiat, i.e.unbacked) money by our Federal Reserve Bank. International monetary circles are starting to consider a new monetary “approach”, and worldwide central banks may be anticipating that likelihood by way of their physical gold purchases.  We believe that China could announce, almost any time, a new form of currency, perhaps a so called crypto-currency, backed by upwards of 20,000 tons of gold. At the same time, a new base price for gold bullion at $5,000/oz. or more would be supported by the Chinese.

The current worldwide fiscal/monetary “promiscuity”, unbacked paper currencies being diluted into oblivion by the politicians of the day, cannot go on indefinitely without predictable ramifications. When a trend cannot go on, by definition, it will not. We view gold as re-emerging as the true currency, the store of value and unit of exchange it has been for 5,000 years. Central banks, including our most direct political and economic adversaries, get it. The public in China and India get it. Investors in North America hardly at all, some might say “whistling past the graveyard”. It’s going to be interesting.

THE FEDERAL DEBT is north of $23 trillion in the US, also growing rapidly in the other largest trading nations in the world. We’ve pointed out many times that the debt is increasing even more than the annually budgeted operating deficits would imply. This can only happen with governmental accounting. The difference is due largely to the federal government borrowing from the social security trust fund. In the fiscal year ending 9/30/19, for example, the operating deficit was $984B but “off budget” spending, financed by the social security system which is itself approaching insolvency, took the cumulative debt up an extra $206B, from $21.97T to $23.16T. This is not “one off”, it happens almost every year and is to be expected. Therefore, we can expect the total deficit in the fiscal year ending 9/30/20 to be something like $24.5T, on its way to $26T by the time the newly elected president takes office in January,’21. This assumes that there are no economic disruptions, and a recession, with lower tax revenues and larger deficits are out there somewhere. All of this is very important because, the larger the debt the more difficult economic growth becomes. Whether we’re talking about an individual, a family, a company or a country, the more effort it takes to service debt, the less investment can be made in productive pursuit. Our economy and other major worldwide economies will therefore continue to be kept afloat by central bank financial creativity. It will work until it doesn’t, and will inevitably be accompanied by many unintended painful consequences.

INTEREST RATES are not going to change much in the foreseeable future. Interest payments on the debt are barely tolerable only because rates are so low. Every increased point (100 basis points) of extra interest equates to $230B of extra interest as current bonds mature, and over 50% of our outstanding debt is under 5 years. This extra interest would be a material increment and would squeeze out potentially productive government spending. Higher interest rates, which the US Fed tried briefly a year ago, stopped our economy and the stock market in its tracks, and the policy was quickly reversed. The US economy has stabilized currently but GDP growth is projected to be no more than a tepid 2% this year, even less than it was a year ago when slightly higher interest rates took their toll. The only way interest rates could rise by much is if the Federal Reserve, and other central banks, lose control over the situation and this would be a sign of impending financial chaos. Lower interest rates are possible, but the 10 year treasury note is under 2%, and the marginal benefit of lower rates from here is debatable. Negative interest rates on something like $13T of sovereign debt is a fact of life, but that approach has its own set of unintended consequences, and adoption by the US Fed would clearly be a sign of desperation. Give or take 50 basis points, we believe interest rates are “range bound” for the next year or two.

WORLDWIDE ECONOMIC TRENDS support our contention that worldwide central banks, in support of local economies, will maintain low interest rates interest rates, which provides a major tailwind for our portfolio. Headlines in the Wall Street Journal today, January 2, include (1) Asian Economies Must Brace for Chill Wind From China (2) Japan’s Lost 30 Years (with debt going to 250% of GDP) Give Pause to Those Looking at U.S. (3) Japan Has Gone from Growth Market to Bargain Rack (4) ‘Japanification’ Haunts Slow Growth Europe (5) Latin America’s ‘Oasis” Descends Into Chaos. As Wendy’s put it, thirty years ago: “Where’s The Beef”.

PUTTING IT ALL TOGETHER, we’re certainly pleased that our gold mining oriented investment partnership provided positive results in December, the 4th quarter, and the year.  The mining stocks have just begun to gain investment traction. It seems that, until now investors and analysts have not believed that gold at $1400-1500 per oz. is here to stay. They have been therefore unwilling to adjust upward their estimates of gold reserves, mine lives, earnings and cash flow expectations for the gold mining companies. Gold bullion prices have now clearly broken out on the upside from their six year “consolidation” and the possibility (we call it a likelihood) of a big upside move now comes into view. We can therefore expect upgraded expectations and higher valuations.

There have been virtually no major new gold reserves discovered in the last ten years, and new mines take many years to get permitted. Higher prices will allow expanded mining of some lower grade reserves by established companies but will not allow new mines to come onstream for many years. Existing miners have made major progress in cost control over the last few years and are in a position to improve cash flow and profits dramatically, even at current prices. Operating results for the quarter ending 9/30/19, the first quarter in eight years that the gold price was something like $200/oz. higher than a year earlier, have begun to demonstrate the operating leverage that is in place. We believe that the bull market in gold and gold mining stocks has resumed and the upside potential is very substantial.

Roger Lipton

 

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

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

A LESSON IN “MAKING MARKETS”

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

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

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

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

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

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

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

Roger Lipton

HELLO 2016 – THE ECONOMY, INFLATION VS. DEFLATION, INTEREST RATES & GOLD

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INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

ABOUT GOLD, THE FED, THE CHINESE YUAN (ALL GROWN UP)

To access this content, you must purchase Website Subscription.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.