"As 2013 begins, the downside risks to the global economy are gathering force." - Noriel Roubini
"Madness is rare in individuals - but in groups, parties, nations, and ages it is the rule." - Friedrich Nietzsche
There is a kind of madness in the air, and not the harmless sort that inhabits the annual college basketball fest. Europe is closer to dissolution than tighter union. The United States has consigned itself to a self-imposed paralysis that originates in the nation's politics and terminates in its economics. In Asia, nation states have declared war -- over currency values -- an economic war that threatens to become a hot war and drag the United States into it. The Middle East, given last year's street riots, dreads the coming of a new Arab spring and what it might bring. The universal response from Berlin to Tokyo is to run deficits and print more paper money to cover them. Investors, inclined to believe none of this would resolve itself soon, responded by taking matters into their own hands. The U.S. Mint, a bell whether for international demand, reported record sales of American Silver Eagle sales in January, and the strongest month in two and a half years for the American Eagle gold bullion coins. The Mint reported continued strong demand for its bullion products in February -- up a robust 283% from February of last year.
Please note (below) the eye-catching spike in the monetary base since the end of 2012 -- a nearly 8% gain. We will be monitoring the data to see if this is a short-term move or something more permanent like the vertical trajectories of 2009 and 2011. Gold, as the chart illustrates, closely tracks but lags the monetary base. If nothing else, the extensive and on-going creation of money (whether or not it translates to double-digit price inflation) suggests that the Federal Reserve remains in crisis mode and that there might be volcanic risks in the banking and credit system rumbling just below the surface. Maybe the Fed knows something the rest of us do not -- something much more dangerous than the stubborn 8% unemployment rate. Economist Noriel Roubini (quoted above), who predicted the meltdown in 2008, warns of something worse in 2013.
Thus far all of the money created seems to have vanished into some unfathomable black hole. Disinflation/stagflation have persisted despite Ben Bernanke's yeoman effort to instigate the opposite. The cause and effect relationship between gold and the monetary base persists nevertheless, a direct result of gold being perceived as the ultimate store of value for all seasons. In other words, gold and the Federal Reserve are both reacting to the same stimuli, i.e., the presence of systemic risk. Gold's bull market has been fueled at its core by global physical demand from those who see coins and bullion as a refuge from those risks. It has proven to be just about the best disinflation/stagflation hedge available -- thus proving a utility that goes beyond its long-standing reputation as simply an inflation hedge. Should a virulent inflation suddenly appear, and that remains a possibility, gold likely will still follow the monetary base but for more established reasons.
Gold, in my view, has not reacted as yet to the roughly 35% expansion of the monetary base in late 2010-early 2011. Keeping the lag in mind, that reaction seems overdue. If gold were to react as it did to the 2009 surge in the monetary base, much higher prices could be in the offing over the next few years. Just as the credit crisis of 2008-2009 pre-dated gold's push to new all-time highs, a similar event, like the one Roubini forecasts for 2013, could serve as the launch pad for next leg in the bull market.
*** MarketWatch’ Mark Hulbert reports that “corporate insiders -- officers, directors and the largest shareholders” -- are aggressively selling shares at an “alarming pace." Such selling, he says, is usually a sign that market is about to sell-off. Notably, insider selling was a precursor to the 2000 point sell-off in 2011.
*** Of course the Wall Street mantra through all of this is that “we are not in a bubble.” Repeat after me: “We are not in a bubble.” The central banks have created layer upon layer of funny money now coursing through the economy. What doesn’t end up in the black hole of covered systemic risk ends up in one market or another. At the moment, the bubble is being blown full in the U.S. stock market, but with little of real value at these prices (no one seems to be making any money these days), one wonders how long it can last. A few warnings here and there have surfaced. Most of the action is in playing the indices rather than individual stocks or mutual funds. We have been told that this is a professionals’ market (read speculators’ market), i.e. the public isn’t participating. We all know what happens to markets like these and some of the old pros are calmly and quietly waiting for the hammer to fall.
*** It will be interesting to see how the upcoming introduction of gold ETFs affects demand in China. Traditionally, Chinese investors, like their American counterparts, prefer the physical metal to paper representations. However, institutions and investment funds tend to gravitate to the paper product. At present ETFs globally hold 2600 tonnes -- the fourth largest hoard in the world. The European Union owns the largest hoard at 10,800 tonnes. The United States is second at 8100 tonnes.
*** PIMCO’s Bill Gross recently told Barron’s magazine that gold is his top investment pick. "The Fed,” he says, “is buying 80% of the Treasury market today. It is remarkable to think that when the Treasury issues debt in the trillion-dollar-plus category, the Fed ends up buying most of it. The Treasury sells it to banks and primary dealers, who sell it back to the Fed at a higher bid."
*** The silicon had hardly gotten warm on last month’s newsletter (featuring currency debasement) when Venezuela announced a 32% formal devaluation of the bolivar against the dollar. The Venezuelan citizen who went peacefully to sleep with 1,000,000 bolivars in his or her bank account on Thursday, February 7th, awakened on Friday, February 8th, only to find that 680,000 bolivars in purchasing power had vanished by government fiat. The same individual who would have had the foresight to put away 1,000,000 in bolivars before the devaluation would have increased increased his or her nominal purchasing power by 47% to 1,470,000 bolivars. Of course, in real terms, the holder simply held on to his or her purchasing power. As the early 20th century economist Andrew Dickson White so succinctly put it with reference to the fiat money disaster in France just after the revolution: “There is a lesson in all this which it behooves every thinking man to ponder.”
*** Ernest Hemingway: "The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” Here is another quote from Hemingway: “I always try to write on the principle of the iceberg. There is seven-eighths of it underwater for every part that shows .Inflation, in the end, is a process rather than a singular event. In the inflation and war quote, he leaves seven-eighths of the matter underwater. In his imitable way, though, he drops the words “permanent ruin” like a rock on the reader’s consciousness.
*** Even as Ben Bernanke does everything in his power to debase the purchasing power of the dollar, Jack Lew, the incoming Secretary of the Treasury, goes on record as saying: "Treasury has had a long-standing provision through administrations of both parties that a strong dollar is in the best interests of promoting U.S. growth, productivity and competitiveness." Yada, yada, yada.
*** Income for Americans dropped 3.6% in December, the largest drop since 1993 according to the Commerce Department.
*** Bespoke Investment Group charts the change in gold under the last four Fed chairmen. Gold rose 47.5% under G. William Miller; 65% under Paul Volcker; 14.5% under Alan Greenspan and 182.9% under Ben Bernanke. "This," says Bespoke, "is more than double the return of gold under any of his three predecessors, and nearly as much as the total change in gold during the combined tenure of the last three Fed Chairs (201%)!"
*** The New York Times reported recently that Richard W. Fisher, the head of the Dallas Fed, owns $1 million in gold. When you consider that Fisher is worth $21 million, his gold holdings add up to a judicious hedge, and, as the article points out, "not an extreme bet on economic catastrophe."
• "China's foreign currency reserves," reports Bloomberg, "which have surged more than 700 percent since 2004, are enough to buy every central bank's official gold supply -- twice" If that's not a convincing argument for a radical adjustment in the price of gold, I don't know what is.
*** It is interesting to note that during the most recent fiscal year (September) for the Central Bank Gold Agreement (CBGA), the central banks sold a grand total of 4 tonnes of gold out of a 400 tonne allotment. In the real world of gold mobilizations, central banks bought 534.6 tonnes of gold – the highest level of purchases in half a century. Central banks buy gold for the same reasons individuals do – as a hedge against currency devaluation.
*** Some analysts pinned the blame for gold’s drop on the release of minutes for the January meeting of the Federal Open Market Committee. From the outside, it appears to have a rather chaotic meeting. One imagines people standing on chairs in order to be heard. It seems that some members believe that the Fed should at least be thinking about taking its foot off the accelerator, if not outright stomping on the brake. This came as a surprise to the markets and gold was included in the fallout. First of all, I don’t know if anyone was counting votes, but if they were, I would like to know how all this might fall out if a vote were taken. Getting on the record as being a cautious fellow is quite a different thing than being responsible for a policy that might send the economy into a tailspin. Second, this is still Ben Bernanke’s Fed and we shouldn’t forget it -- a point he made very clear in subsequent Congressional testimony.
*** All of this brings me to my final note on the recent downturn in the gold price – a recommendation to read this well-conceived opinion piece by one of my favorite journalists, the London Telegraph’s Ambrose Evans-Pritchard. It is titled “Gold’s Death Cross is a buy signal for China.” Says Pritchard, "Yes, the Chinese like the dollar again, but they already have a lot of dollars. They don't have much gold compared to their peers. So hold your nerve. The reality is that we have been moving for several years to an informal Gold Standard in which gold takes its place once again as a central store of value -- a currency of sorts -- in the mix of reserves."
*** Anytime gold corrects, there’s a bit of piling on and over-dramatization in the financial press. Much of the news centered around George’s Soros’ selling. The reports I read had him selling about 2 tonnes of gold – a figure representing roughly half of his $15 million in holdings. If so, Soros is minor player accorded way more status in the gold market than he deserves. John Paulson by way of comparison owns roughly $3.5 billion in ETF gold according to reports. There have been persistent rumors that Paulson is switching to physical ownership in the form of delivered bullion, although those rumors have not been confirmed.
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