-- Published: Wednesday, 10 October 2018 | Print | Disqus
Nobel laureate says current stock market echoes 1929
October is the month most closely associated with markets going bump in the night – 1907, 1929, 1987, 1997, 2007, 2008. Of all the October surprises, the 1929 crash had the most lasting consequences. Stocks declined 50% in the two months of September and October, 1929. (See chart below.) Before it was all over in 1932, stocks dropped a breathtaking 90% and did not return the old high of roughly 380 until the mid-1950s – one-quarter century later. Imagine having a million dollars in stocks at the end of the summer 1929 only to watch your portfolio drop steadily until it was worth $100,000 by 1932. “This bull market has echoes of the late 1920s," Nobel laureate Robert Shiller recently told CNBC. "The 1920s is quite a legend that people are often thinking about. I look at 1929 particularly as the end of the roaring ’20s and it ended in a bout of speculation. Between May and September of ’29 the stock market went up over 30 percent in just a few months."
The U.S. Mint reports soaring sales of American silver eagle bullion coins. According to its month-end report, it placed 2.897 million of the popular one-ounce coins through its wholesale network during the month of September – a gain of 89% over August’s 1.53 million ounces in sales and a more than 900% gain over the same month last year. The performance bodes well for demand as we move into the perennially strong fourth quarter of the year. Wholesalers report dealers stocking up for that demand and to get ahead of the Mint’s annual production shutdown later in the year. “The Mint ran out of silver Eagle bullion coins Sept. 6. Sales resumed Sept. 17,” reports Numismatic News. “Supplies as they are produced are being rationed. The Mint expects this situation to continue through the end of 2018. The Mint calls rationing 'allocation.' The biggest regular buyers get the biggest allocations among the official Authorized Purchasers.”
The New Monetary Policy and the specter of inflation
When the Federal Reserve bailed out the financial system by purchasing U.S. Treasuries and mortgage-backed securities, it included those items as assets on its balance sheet. Much of that capital was then redeposited with the Federal Reserve as excess reserves creating a liability on the central bank's balance sheet. Now, the Fed with much fanfare is reducing the asset side of its balance sheet. What is often neglected in the analysis is that it is also reducing liabilities. The chart below is a big-picture representation of the Fed's balance sheet reductions – both assets and liabilities. In 2016, Federal Reserve bailout-related assets were roughly $4.5 trillion. Bailout-related liabilities were about $2.5 trillion. At present, assets are $4.2 trillion and liabilities $1.8 trillion.
Since the process began in 2016, liabilities have run off the Fed's balance sheet at a much faster rate than assets, signaling the central bank's inflationary bias. Keeping in mind Milton Friedman’s widely accepted dictum that there is an 18 to 24 month lag between monetary stimulus and response, the first signs of inflation appear to be right on schedule. By September 2017 – two years from the initial draw downs – the official inflation rate had climbed back to the 2% mark. As of the September Consumer Price Index release, it had reached 2.8%.
“Banks in the United States have the potential to increase liquidity suddenly and significantly – from $12 trillion to $36 trillion in currency and easily accessed deposits—and could thereby cause sudden inflation," says Christopher Phelan, an economist at the Minneapolis Federal Reserve. "This is possible because the nation’s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy. . . What potentially matters about high excess reserves is that they provide a means by which decisions made by banks – not those made by the monetary authority, the Federal Reserve System – could increase inflation-inducing liquidity dramatically and quickly.”
Keeping an eye on Italy. . .
While the bulk of attention these days is centered on China and its economic woes, the markets are also keenly aware of the situation in Italy where its 10-year paper is taking a hit. The euro is collateral damage in the fray – down against the dollar today and adding to the drag on gold. At some point, one would think that the market sentiment associating this sort of thing with a stronger dollar will migrate to the bigger issue – an unraveling global economy and the very large systemic risks it represents. When that happens, gold will be understood again for what it is – a true depository of wealth that transcends the problems of nation-states and their currencies and, come hell or high water, a better alternative than the dollar.
Chart courtesy of TradingView.com Click to enlarge
China's Shangdong Gold acquires Argentina's largest gold mine
From a report in the South China Post:
“But [Shangdong Gold’s chairman, Li Guohong] said the company was confident that an upwards trend in gold prices will emerge within the next 12 months, with interest rates steadying in the US by the end of next year. Increasing geopolitical tensions will also fuel the demand for gold as a safe haven, he added. The company counts the Shanghai Gold Exchange, the world’s largest spot physical gold exchange, as its top client, making up 73 per cent of its sales in 2017.”
Shangdong Gold is state-owned. Its chairman’s optimistic view on gold’s future is particularly interesting when you take into account the current interaction between the yuan and gold. Does it tell us something about China’s intentions with respect to the yuan? China has publicly stated its interest in making the yuan a viable competitor to the dollar for international reserve status. One might read in all of this that Li Guohong and Shangdong Gold take that commitment seriously. By the way, those sales on the SGE are recycled to the nation’s population and banks which, in turn, are owned by the Peoples Bank of China. Acquiring mines, like the Valdero mine in Argentina, in our view, is a back-door scheme for China to build its gold reserves.
Eternal sunshine of a spotless mind
“I am aware of no plausible conditions under which current extremes are likely to work out well for investors," says John Hussman of Hussman Funds. "There are a few possibilities that could involve a smaller loss than the two-thirds of market capitalization that I expect to vanish, as the run-of-the-mill, baseline expectation for the S&P 500 over the completion of this cycle. Yet it’s worth recognizing that the completion of every market cycle in history has taken the most reliable valuation measures we identify (those best correlated with actual subsequent S&P 500 market returns) to less than half of current levels.”
Hussman recommends “humble cash” as the best option “because it offers opportunity to respond to deep market losses.” We would refine that a bit. Green cash is a good option under the circumstances Hussman describes. Gold cash is even better. Inflation could become an issue. If it does, gold can do things for you that green cash cannot – like appreciate, rather than depreciate, in value. The inflation does not have to rise to the level summarized in our accompanying photograph either. Historically, gold has proven to be a solid hedge against even comparatively minor doses of currency depreciation.
Fiscal year 2018summary
September 30th marked the end of the U.S. government’s fiscal year.
For the month, it added $58 billion to the national debt.
For the fiscal year, it added $1.271 trillion to the national debt.
For the calendar year thus far, it added $1.082 trillion to the national debt.
At fiscal year end, the national debt stood at $21.516 trillion.
“Trump is proving as indifferent to fiscal orthodoxy as to any other kind. The spending measure he signed...along with the one approved in March and December’s tax bill, amount to the biggest stimulus outside recessions since the 1960s. They sailed through a House led by the supposedly hawkish Paul Ryan, who’s due to step down in January without much progress on his goal of reining in so-called entitlements like social security – an illustration of how Republican deficit scolds are in retreat.” – Bloomberg, Ben Holland and Jeanna Smialek
Central banks add to reserves first six months of year
“Central banks,” reports the World Gold Council, “added a net total of 193.3 tonnes of gold to their reserves in the first six months of 2018, an 8% increase from the 178.6 bought in the same period last year. This marks the strongest first half for central bank gold since 2015.” Since the beginning of 2017, the biggest buyers were Russia – 383.3 tonnes; Turkey –125.8 tonnes and Kazakhstan – 68.4 tonnes. A surprise on the list, and reported here earlier this month, is India – 15.3 tonnes. The Peoples Bank of China, who many analysts believe to be the largest buyer, does not report publicly on its purchases. Some sources report though that its purchases could be as high as 500 tonnes per year.
Gold in five easy lessons
1. Don’t buy it because you need to make money; buy it because you need to protect the money you already have.
2. Don’t look at price as a barrier; look at it as an incentive.
3. Don’t buy its paper pretenders; buy the real thing in the form of coins and bullion.
4. Don’t fall prey to glitzy TV ads; do your due diligence instead.
5. Don’t allow naysayers to divert your interest; allow yourself the right to protect your interests as you see fit.
The investor sentiment cycle
We guesstimate that we are somewhere between “thrill” and “euphoria” on stocks and “despondency” and “depression” on gold and silver. In short, the time might be right for starting to leg-out of stocks and ladder-into gold.
“Two confrontational, nationalistic, and militaristic leaders playing chicken with each other, while the world is watching to see which one will be caught bluffing, or if there will be a hellacious war. We can also say that if … things go badly, it would seem that gold (more than other safe haven assets like the dollar, yen, and treasuries) would benefit.” – Ray Dalio, Bridgewater Associates
“[JP Morgan’s Marko] Kolanovic, who has dominated Institutional Investor’s annual rankings of top strategists for a decade or so, was out with a research note Thursday arguing that President Donald’s Trump’s isolationist foreign policy is a ‘catalyst for long-term de-dollarization.’ Put another way, the dollar is in jeopardy of no longer being the world’s primary reserve currency and all the benefits that go along with that, such as interest rates that are lower than they otherwise might be and the government’s ability to fund budget deficits in perpetuity. ” – Bloomberg/Robert Burgess
“Compared with stocks and other financial assets, gold looks inexpensive. More important, inflation is starting to pick up in the U.S. and in much of the world as central banks shrink their enormous balance sheets. And gold has represented a good defense against inflation eroding the value of a stock or bond portfolio.” – Barron’s/Andrew Bary
“Retailers are being forced to squeeze their margins or raise their prices, or both, on a variety of goods just as the holiday season arrives. ‘The new tariffs are bad news for the retail sector, especially as the latest round seems to extend the tax to a vast array of consumer goods,’ GlobalData Retail Managing Director Neil Saunders said in comments emailed to Retail Dive. ‘Many retailers will now be faced with a difficult choice of whether to pass the cost increases across to consumers or to take a hit on their margins. The exact response will vary from retailer to retailer but, both strategies are likely to be used.'” – RetailDive/Daphne Howland/9-24-2018
“Day-to-day, month-to-month, and year-to-year, the price of gold can fluctuate inexplicably. But over the long term, whether you’re comparing loaves of bread, home prices, or government tax revenue, it REALLY holds its value. This is one of the things that makes gold such an excellent hedge against political uncertainty, macroeconomic challenges, financial crises, inflation, etc. Said another way, gold is great insurance policy for all the ‘I don’t knows.’” – Sovereign Man/Simon Black
“Among the biggest threats to the U.S. economy, we believe, is the latent public pension crisis, which could be much worse than most people realize. The Wall Street Journal/Frank Holmes reported in July that pension plans nationwide are short some $4 trillion, ‘an amount that is roughly equal to the output of the world’s fourth-largest economy,’ Germany. Put another way, states and cities across the U.S. now face a funding gap of approximately $4 trillion, a sum that could continue to expand as more workers live longer and draw retirement benefits.”
Editor's note: Holmes goes on to suggest gold as a hedge against the latent pension crisis saying, “Historically, a defensive investment strategy has included a rotation into gold, bonds and other assets that are uncorrelated to the stock market.” Gold is an asset which is not simultaneously another’s liability. Pension funds by comparison are loaded with assets that are simultaneously someone else’s liability and carry precious little gold to offset the risks that represents.
“By way of confession and truth to podcast – let’s see, I confessed I was born in 1946 and that makes me, like, 37? Okay, I was born in 1946 and I was bullish on gold in 1945. I hope that puts my view on this into context. I’m chronically, sometimes profitably, but certainly very nearly continuously, well-disposed to the legacy monetary asset. I think that so many arrows point to it in the present day. I think it will become the beneficiary of – I’m talking about gold now – gold will become the beneficiary of so many trends. From the tinkering and the unprecedented experimentation of our central bankers’ fiscal profligacy – I’m starting to sound moralistic – I think that paper money is in a secular bear market and that the institution of managed currency will be seen to be a species of pretense, if not outright intellectual fraud. And I use that word advisedly. And I think that come the dropping of the scales from the eyes of the money holders of the world, gold will do better against almost every currency.” – James Grant/Interest Rate Observer
“Gold isn’t really an instrument that you should trade intra day…you can, but it's just not worth the risk…It is better to see an opportunity to position take and run with it…because this is how Gold reacts….it hangs about then makes its move…The pattern I have seen in August believes me to think Gold is ready for a break to the topside…Min 1214/17…but it really wouldn’t surprise me if Gold was at 1253 in a couple of weeks” – FXStreet/Carol Harmer
Editor's note: A view of the short term. . .Gold almost always surprises the bulk of short-term traders both to the upside and downside. It can move either loudly on a convergence of issues or quietly on what seems nothing at all. Even more surprising, it can confound traders by moving long after the experts predicted it would (or should) – as was the case following the early tremors in the 2008 financial earthquake.
“I was amused to read the NY Times op-ed, co-authored by the three leading US policy makers at the time of the crisis (Ben Bernanke, Tim Geithner and Henry Paulson). In a piece entitled ‘What We Need to Fight the Next Financial Crisis’ they lament the fact that ‘Congress has taken away some of the tools that were crucial to us during the 2008 panic. It’s time to bring them back (link).’ Tools! Apparently, they always need more tools. Rubbish, they had all the tools necessary. They just never recognised beforehand that the economy was a massive credit bubble – just like it is now. It was worse than that. In 2005 Bernanke had even derided an interviewer who asked him about the possibility that the housing bubble could burst. And I also remember Shelia Bair, who headed up the FDIC (the Federal bank liquidator) at the time, and had successfully seized and closed many banks during that period, including the massive Washington Mutual, lamenting that she had not even been consulted about Lehman’s.” – Albert Edwards, SocGen
“We have been in a state of stagnation since 2008. We’re moving towards stagflation. It feels good right now but it’s a false dawn.” – Alan Greenspan, former chairman of the Federal Reserve
“There are over 3,800 historical examples of paper currencies that no longer exist. Although some of these currencies, like the French franc or the Greek drachma disappeared as a result of being replaced by an alternative (euro), many disappeared as a result of government imprudence, debauching the currency and hyperinflation. In all of those cases, persistent budget deficits and printed money were common factors. This should sound worryingly familiar.” – Michael Lebowitz, Investing.com
“If we are lucky, the next Fed-caused downturn will cause only a resurgence of 1970s-style stagflation. The more likely scenario is the type of widespread economic chaos not seen in America since the Great Depression. The growth of cultural Marxism, the widespread entitlement mentality, and the willingness of partisans of various sides to use force against their political opponents suggests that this economic crisis will result in civil unrest that will be used to justify new crackdowns on individual liberty. Those who understand the causes of, and cures for, our current predicament have two responsibilities. First, prepare a plan to protect your family when the crisis occurs. Second, do all you can to spread the truth in hopes the liberty movement reaches critical mass so it can force Congress to make the changes necessary to avert disaster. Since the crisis will result in a rejection of the dollar’s world reserve currency status, individuals should consider alternatives such as gold and other precious metals.” – Ron Paul, former Texas Congressman and candidate for president
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