-- Posted Tuesday, 9 April 2013 | | Disqus
By James S. Anthony
As we write this, the gold price is weak and sentiment has never been more negative. Measures such as the Daily Sentiment Indicator have recently hit lows last seen in 1994 and 1997 while MarketVane's bullish consensus and Hulbert's HGNSI index of gold portfolio managers have broken to lows below those recorded in 2008. The major banks have cut their price forecasts and some have declared an end to the bull market for gold which has tallied 11 straight years of higher closing prices. Could all these people be wrong?
Meanwhile, equity markets have lately gone from one new high to another, especially in the U.S. As we have noted previously, gold's performance tends to be the inverse of paper assets, which appear to be back in the ascendency. The bullish consensus on stocks has never been higher. Could all these people be right?
The world's central banks are printing their currencies in absolutely unprecedented quantities. This policy has historically helped gold, but not this time. The excess liquidity is currently regarded as favorable for equities and also bonds which the central banks and/or their commercial banking familiars are buying with all the newly created currency. A strong bond market has made the equities look even more attractive. Price inflation doesn't seem to be a threat and we are continually told that as soon as it is, the central banks will start tightening, reducing their balance sheets and raising interest rates. Europe is no longer an issue the way it was in 2011 when gold was setting new highs; the European Central Bank ("ECB") has promised to do whatever it takes, print as much as needed, as long as the recipients sign on to austerity programs designed in Germany. So, in light of these developments, who needs gold?
Goldilocks is back. Money printing is good. Risks have never been lower. What could possibly go wrong? Most investors appear to be willing to believe this tale of bliss. Others are cynically willing to dance until the music stops, always assuming they will know enough to leave early. We did not forsee the further gold market deterioration that has taken place in the first quarter of 2013. But nor do we believe it is likely to last long. We think it's 2007 all over again...a wide-spread refusal to see the facts and a very dangerous set up for severe financial disorder, dead ahead. Perhaps you think that a crisis is not imminent...that the authorities will be able to hold the system together for a few more years. Perhaps, but we think not.
In our opinion, the market has a distorted view of reality which is misinterpreting data to fit its biases. Like all distorted views, it has supporting logic. The cornerstones of the conventional view are: (1) the U.S. economy is recovering; (2) the European banking system has been saved; and (3) the U.S. Federal Reserve ("Fed") will drain the excess liquidity from the system before the inflationary consequences arrive. If you accept this view, selling gold and gold stocks makes sense. Many already have. If you have doubts about this thesis, holding on to your gold exposure makes sense because gold and gold equities are currently priced as if these three statements are facts.
The U.S. Recovery
The argument that the U.S. economy is recovering rests in large measure on an improving labor market. This is the right indicator since the Fed itself has explicitly tied its policies to levels of unemployment. But this indicator is not flashing recovery, in our opinion.
The mainstream media continually repeat that the U.S. unemployment rate hit a four-year low of 7.7 percent in February of this year. But is unemployment actually going down? Given federal deficits of more than $6 trillion over the last four years and a $2.4 trillion expansion of the Federal Reserve's balance sheet, you would hope so. The numbers say otherwise. The headlines reported that 236,000 jobs were added to the economy in February, 2013 but 296,000 Americans left the labor force the same month. And that is how the U.S. unemployment rate is going down - by classifying huge numbers of unemployed Americans as not wanting jobs. More than 146 million Americans were employed in 2007. In February of this year, only 142.2 million Americans had a job and the population has grown steadily since 2007.
We believe the employment-to-population ratio is a much better measure of labor market conditions than the headline unemployment rate. This ratio measures the proportion of the country's working-age population that is employed.
As you can see, the percentage of civilian, working-age Americans with a job has fallen from about 63 percent to below 59 percent since 2008 and it has not turned higher. This is the first time in the post-World War II era that the employment-to-population ratio has not bounced back following a recession. At this point, the employment-to-population ratio has been at or below 59 percent for 42 months in a row. Looking at employment levels, there has been no labor market recovery.
Quality of employment is as much an issue as quantity. According to the federal government's February Household Survey, the number of full-time jobs declined that month by 77,000, offset by a jump in part-time workers. Part-time jobs are jobs only in the broadest sense of the word. But the most surprising development from a quality standpoint was that the number of multiple job-holders in February rose by a record 340,000, probably because median household income in the United States has fallen for four consecutive years. How many unemployed people got jobs? Not as many as you thought.
Subsequent to our writing of this report, the U.S. Bureau of Labor Statistics released its March employment report estimating that only 88,000 jobs were added to the U.S. economy in that month. Despite this disappointing number, the headline unemployment rate fell again to 7.6% as a shocking 496,000 people left the labor force in March alone, bringing the workforce participation rate to its lowest level since 1979.
The real facts about the labor market were spelled out in a March 22, 2013 speech by Fed Governor Sarah Bloom Raskin:
"About two-thirds of all job losses resulting from the recession were in moderate-wage occupations, such as manufacturing, skilled construction, and office administration jobs. However, these occupations have accounted for less than one-quarter of subsequent job gains. The declines in lower-wage occupations such as retail sales and food service accounted for about one-fifth of job loss, but a bit more than one-half of subsequent job gains. Indeed, recent job gains have been largely concentrated in lower-wage occupations such as retail sales, food preparation, manual labor, home health care, and customer service...the average wage for new hires has actually declined since 2010."
Why is this data relevant to gold? A relatively encouraging February employment report was greeted as evidence that the economic recovery was likely strong enough to warrant an early reduction in the Fed's Quantitative Easing ("QE") program and therefore gold was sold. The labor market is not simply an indicator of economic recovery, it is the very engine of it, driving retail sales, savings and investment
There is a pattern here. Every year since 2009 has begun with the anticipation that the U.S. economy would achieve 'escape velocity' and the Federal Reserve would begin to exit its asset purchase programs. And each year, 2010, 2011 and 2012, the economy has slowed by year end and further Fed stimulus has been implemented. In our view, this year will be no different because the labor market shows no signs of strengthening. Talk of a Fed exit will recede to be replaced by yet more easing.
The Euro Zone (EZ): Hanging From a Thread?
The EZ countries recently reported their PMIs for March, 2013. The PMI is a gauge of a country's manufacturing sector. Anything above 50 indicates expansion from the month before. Anything below 50 indicates contraction. Every major country was below 50, including Germany. For the EZ as a whole, the PMI hit a three month low of 46.8; output and new orders fell at an accelerating rate, driving further job losses with the unemployment rate already at a record high 12%. The decline was especially steep in France, Italy and Spain.
The most worrisome aspect of this slow grind down in the EZ economy is its effect on Europe's weakest link, its commercial banking sector. The EZ banking system is nearly four times larger by assets than that of the U.S. ($46 trillion vs. $12 trillion), with at least twice the amount of leverage (estimated at 26 to 1 for the EZ vs. 13 to 1 for the U.S.). European banks are also capitalized very differently; they rely upon deposits and short term funding from the wholesale market much more than U.S. banks so they do not have as much long term debt protecting them and their depositors from insolvency. In other words, European bank capital structures are acutely vulnerable to a loss of confidence and their leverage also makes them highly sensitive to loan losses in an economic downturn.
Furthermore, the EZ banks are stuffed with European sovereign debt as they have been encouraged to play the game of pledging their assets as collateral to the ECB for cheap cash to buy sovereign bonds. The ECB has subsidized this very profitable carry trade by dropping their collateral quality requirements to slightly above the grade of used chewing gum while also slashing reserve requirements to just 1%. To top it all off, the ECB does not have a clear mandate to act independently to save the system (requiring ongoing approvals from Germany for policy initiatives) and there is neither a joint-and-several deposit guarantee nor a formal resolution procedure for insolvent banks among the 17 EZ members.
What could go wrong? Anything and everything. For example, bank deposits in Spain are bleeding away at annual rates of 10%, requiring them to sell assets. At the same time, these banks need to continue to purchase sizeable amounts of Spanish government bonds; the Spanish government's debt-to-GDP ratio continues to rise because required fiscal adjustments are too large and recessionary trends are taking their toll on government finances. Governments do not have any cash reserves; insolvency is only a failed debt auction away and can happen at any time.
The EZ last went into crisis in the spring of 2012 when the Spanish banking system nearly collapsed. The ECB had pumped €1 trillion into the EZ banks via its LTRO 1 and LTRO 2 programs in December 2011 and February 2012 to defend the banking system against the looming Greek default. The ECB then found itself facing a problem far greater than Greece. Spain's banking system has over €3.7 trillion in assets compared to Greece's €338 billion. Spanish banks were leveraged at about 20 to 1 with much of their borrowed money invested in Spanish sovereign bonds. And in the spring of 2012, Spanish bonds were plummeting. (Source: Phoenix Capital Research).
At this point, ECB President Mario Draghi had to make Spanish bonds rally to prevent a Spanish banking collapse. He couldn't simply buy them because the power to do so is not in the ECB's mandate and Germany had openly opposed the unconditional monetization of bonds. The ECB needs Germany's support if it wants to keep the EZ together. So Draghi hinted at providing unlimited bond buying for EZ sovereign bonds in June 2012 and then officially stated that this was now the ECB's policy in September 2012 (the so-called OMT program which is Quantitative Easing, "QE", by another name). The ECB didn't actually buy any bonds. Draghi simply stated that he would do so if required and if the countries needing help formally requested a bailout. A bailout would trigger an austerity program imposed by the European Union (Germany) and the ECB similar to Greece, amounting to a nearly complete loss of economic sovereignty.
Draghi's promise worked, effectively putting a floor beneath EU sovereign bonds. Debt markets were reassured that the ECB would buy if it had to, so commercial banks began to purchase Spanish debt again, increasing their positions to record highs. The Spanish national social security fund was also a massive buyer. Spanish bonds rose and Europe's banking solvency crisis was considered over. But nothing was actually resolved. The banks remain acutely fragile. Meanwhile, the pressures are now beginning to mount once again as the EZ economy declines. In addition, the collapse of the Cyprus banking system (which has been 'resolved' by seizing large deposits and imposing capital controls) now brings into question the stability of the all-important bank deposit base in the peripheral countries of the Euro Zone. Depositor confidence must be protected at any cost.
In our view, the EZ banking crisis is about to reawaken and this time ECB promises will likely not suffice. Outright monetization (the OMT program) will begin, assuming Germany confirms its support.
Meanwhile, the Fed, a central bank which requires no approvals, has been aggressively funding EZ banks. In the week ended February 27, 2013, following the shocking defeat of Euro-supporting Presidential Candidate Bersani in the Italian elections, and the even more shocking victory by Euro-skeptics Berlusconi and Grillo, the Fed injected a record $99 billion of excess reserves into foreign banks. As the Fed's own H.8 Statement (http://www.federalreserve.gov/releases/h8/current/) made clear, its reserves in foreign (read European) banks soared from $836 billion to a near-record $936 billion. Of the $1.884 trillion in very fungible Fed cash parked in various domestic and international U.S. banks, just half of it, or $949 billion, is actually allocated to U.S. banks. The other half sits within the accounts of foreign banks operating in the U.S. Does this look like a central bank in search of an exit?
There Is No Central Bank Exit
Columbia University Professor Michael Woodford, a closely followed monetary theorist, told a London Business School seminar on March 28, 2013 that it is time to 'come clean' and state openly that bond purchases are forever and "the sooner people understand this, the better." Quantitative easing will never be reversed, he said. "All this talk of exit strategies is deeply negative." He noted that the Bank of Japan made the mistake of reversing all its money creation from 2001 to 2006 once it thought the economy was safely out of the woods. But Japan crashed back into deeper deflation as soon the Lehman crisis hit.
David Stockman, former budget director for President Reagan, recently provided another reason why QE can never be taken back. Writing in the March 30, 2013 edition of the New York Times, he notes that the Fed has "dropped interest rates to zero and then digitally printed new money at the astounding rate of $600 million per hour. Fast-money speculators have been 'purchasing' giant piles of Treasury debt and mortgage-backed securities, almost entirely by using short-term overnight money borrowed at essentially zero cost, thanks to the Fed. Uncle Ben has lined their pockets."
These front-running speculators who are renting the Treasuries, not owning them, will beat the Fed to the exit, says Stockman. "If and when the Fed - which now promises to get unemployment below 6.5 percent as long as inflation doesn't exceed 2.5 percent - even hints at shrinking its balance sheet, it will elicit a tidal wave of sell orders, because even a modest drop in bond prices would destroy the arbitrageurs' profits. Notwithstanding Mr. Bernanke's assurances about eventually, gradually making a smooth exit, the Fed is domiciled in a monetary prison of its own making."
Furthermore, Stockman projects that the U.S. federal deficit over the next 10 years will be much greater than estimated by the Congressional Budget Office which has used ridiculously rosy assumptions in its projections. "While the Fed fiddles, Congress burns. Self-titled fiscal hawks like Paul D. Ryan, the chairman of the House Budget Committee, are terrified of telling the truth: that the 10-year deficit is actually $15 trillion to $20 trillion, far larger than the Congressional Budget Office's estimate of $7 trillion. Its latest forecast, which imagines 16.4 million new jobs in the next decade, compared with only 2.5 million in the last 10 years, is only one of the more extreme examples of Washington's delusions."
A larger deficit means more QE, not an end to it. If the Fed isn't a buyer of Treasuries and mortgage-backed securities, who is? In our view, it will not take long for gold to respond positively.
Watch For These Three Things
The fundamentals for gold have never been better, in our view, and we believe that the market is going to begin responding to them once again, in the very near future. First, we believe you will see evidence starting in the second quarter of this year that the U.S. economic recovery has been an illusion and that more monetary stimulus will come later in the year. Second, we anticipate that the first and second quarter financial statements of the Euro Zone banks are likely to show a disconcerting weakening of balance sheets including the early signs of deposit flight from weaker banks in the periphery countries. Third, we expect that the real dilemma of the Fed and other central banks will become better understood this year...that they cannot exit and that they will need to continue to expand their balance sheets to accommodate slowing growth and growing fiscal deficits as far as the eye can see.
Seabridge Gold Inc.
Tel. (416) 367-9292 ext 228
Fax. (416) 367-2711
www.seabridgegold.net
James S. Anthony, Director, is one of the original founders of Seabridge Gold Inc. (TSX: SEA) and served as Chairman of the Board from 2002-2012. He was an advisor to a number of major corporations and venture capitalists focusing primarily on corporate strategy, and was a policy consultant to several government ministries, before starting up Seabridge in 1999 in partnership with Rudi Fronk. A keen student of economics, his analysis of financial markets contributed to the forming of Seabridge's unique corporate strategy which highlights maximum leverage to a rising gold price. Mr. Anthony's commentaries in the Company's quarterly reports correctly anticipated the nature of the current economic crisis years in advance and predicted a powerful, long term bull market in gold marked by its transition from a commodity to the world's preferred currency. His views on the gold market are valued by many institutional investors worldwide.
-- Posted Tuesday, 9 April 2013 | Digg This Article
| Source: GoldSeek.com
