Posts Tagged ‘Fiat Currency’
Friday, April 20th, 2012
While Eric Sprott obviously has a modest axe to grind, his open and honest discussion with Charles Biderman on the difference between gold ETFs methods of owning gold, so-called physical vs paper gold, is noteworthy given the depth he goes into. After explaining the concerns of GLD, Pisani’s putterings, and tax-related differences, Eric goes on to discuss his and other physical trusts and how he started down this route. The latter end of the discussion shifts from the practicalities of owning ‘sound money’ or ‘hard assets’ to the thesis for doing so – the debasement of fiat currency and the printing press fanaticism being exhibited globally. Concluding with his thoughts on what could change this thesis, he sees the greatest risk that “we come to our financial senses” – a highly unlikely scenario given the dominoes likely to fall should that occur.
Tags: Assets, Axe, Debasement, Dominoes, Eric Sprott, Fanaticism, fiat, Fiat Currency, Paper Gold, physical gold, Pisani, Printing Press, risk, Senses, Sound Money, Thesis, Trusts
Posted in Markets | Comments Off
Tuesday, September 6th, 2011
Any time a major bank releases a report saying a given course of action is too costly, too prohibitive, too blonde, or simply too impossible, it is nearly guaranteed that that is precisely the course of action about to be undertaken. Which is why all non-euro skeptics are advised to shield their eyes and look away from the just released report by UBS (of surging 3 Month USD Libor rate fame) titled “Euro Break Up – The Consequences.” UBS conveniently sets up the straw man as follows: “Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change.” So far so good. Yet where it gets scary is when UBS quantifies the actual opportunity cost to one or more countries leaving the Euro. Notably Germany. “Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. ” It also would mean the end of UBS, but we digress. Where it gets even more scary is when UBS, like many other banks to come, succumbs to the Mutual Assured Destruction trope made so popular by ole’ Hank Paulson : “The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.” So you see: save the euro for the children, so we can avoid all out war (and UBS can continue to exist). The scariest thing, however, by far, is that for this report to have been issued, it means that Germany is now actively considering dumping the euro.
Fiscal confederation, not break-up
Our base case with an overwhelming probability is that the Euro moves slowly (and painfully) towards some kind of fiscal integration. The risk case, of break-up, is considerably more costly and close to zero probability. Countries can not be expelled, but sovereign states could choose to secede. However, popular discussion of the break-up option considerably underestimates the consequences of such a move.
The economic cost (part 1)
The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year.
The economic cost (part 2)
Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over EUR1,000 per person, in a single hit.
The political cost
The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.
A little more on that particularly troubling last point:
Do monetary unions break up without civil wars?
The break-up of a monetary union is a very rare event. Moreover the break-up of a monetary union with a fiat currency system (ie, paper currency) is extremely unusual. Fixed exchange rate schemes break up all the time. Monetary unions that relied on specie payments did fragment – the Latin Monetary Union of the 19th century fragmented several times – but should be thought of as more of a fixed exchange rate adjustment. Countries went on and off the gold or silver or bimetal standards, and in doing so made or broke ties with other countries’ currencies.
If we consider fiat currency monetary union fragmentation, it is fair to say that the economic circumstances that create a climate for a break-up and the economic consequences that follow from a break-up are very severe indeed. It takes enormous stress for a government to get to the point where it considers abandoning the lex monetae of a country. The disruption that would follow such a move is also going to be extreme. The costs are high – whether it is a strong or a weak country leaving – in purely monetary terms. When the unemployment consequences are factored in, it is virtually impossible to consider a break-up scenario without some serious social consequences.
With this degree of social dislocation, the historical parallels are unappealing. Past instances of monetary union break-ups have tended to produce one of two results. Either there was a more authoritarian government response to contain or repress the social disorder (a scenario that tended to require a change from democratic to authoritarian or military government), or alternatively, the social disorder worked with existing fault lines in society to divide the country, spilling over into civil war. These are not inevitable conclusions, but indicate that monetary union break-up is not something that can be treated as a casual issue of exchange rate policy.
Even with a paucity of case studies, what evidence we have does lend credence to the political cost argument. Clearly, not all parts of a fracturing monetary union necessarily collapse into chaos. The point is not that everyone suffers, but that some part of the former monetary union is highly likely to suffer.
The fracturing of the Czech and Slovak monetary union in 1993 led to an immediate sealing of the border, capital controls and limits on bank withdrawals. This was not so much secession as destruction and substitution (the Czechoslovak currency ceased to exist entirely). Although the Czech Republic that emerged from the crisis was considered to be a free country (using the Freedom House definition), with political rights improving relative to Czechoslovakia (also considered to be a free country), Slovakia saw a deterioration in the assessment of its political rights and civil liberties, and was designated “partially free” (again, using Freedom House criteria).
Similarly the break-up of the Soviet Union saw authoritarian regimes in the resulting states. Of course, this was not a change from the previous status quo, but that is not the point. The question is not how a liberal democracy develops, but whether a liberal democracy could withstand the social turmoil that surrounds a monetary union fracturing. We lack evidence to support the idea that it could.
Even the US monetary union break-up in 1932-33 was accompanied by something close to authoritarianism. Roosevelt’s inauguration was described by a contemporary journalist as being conducted in “a beleaguered capital in wartime”, with machine guns covering the Mall. State militia were called out to deal with the reactions of local populations, unhappy at what had happened to the monetary union (and specifically their access to their banks).
Older examples are less helpful, as they tend to be more akin to fixed exchange rate regimes under a gold standard or some other international monetary arrangement. Nevertheless, the Irish separation from the UK, or the convulsions of the Latin Monetary Union in Europe (particularly around the Franco-Prussian war in 1870 and its aftermath) saw monetary unions fragment with varying degrees of violence in some parts of the union.
Writing in 1997, the Harvard economist Martin Feldstein offered a view that seems to be somewhat chillingly precognitive. He said “Uniform monetary policy and inflexible exchange rates will create conflicts whenever cyclical conditions differ among the member countries… Although a sovereign country… could in principle withdraw from the EMU, the potential trade sanctions and other pressures on such a country are likely to make membership in the EMU irreversible unless there is widespread economic dislocation in Europe or, more generally, a collapse of the peaceful coexistence within Europe.” (emphasis added).
As for what happens if UBS, and the Euro Unionists lose the fight for the euro:
Our base case for the Euro is that the monetary union will hold together, with some kind of fiscal confederation (providing automatic stabilisers to economies, not transfers to governments). This is how the US monetary union was resurrected in the 1930s. It is how the UK monetary union, and indeed the German monetary union, have held together.
But what if the disaster scenario happens? How can investors invest if they believe in a break-up, however low the probability? The simple answer is that they cannot. Investing for a break-up scenario has not guaranteed winners within the Euro area. The growth consequences are awful in any break-up scenario. The risk of civil disorder questions the rule of law, and as such basic issues such as property rights. Even those countries that avoid internal strife and divisions will likely have to use administrative controls to avoid extreme positions in their markets.
The only way to hedge against a Euro break-up scenario is to own no Euro assets at all.
Alas, this will be the final outcome. Unfortunately trillions more in taxpayer capital will be lost before we get there.
In the meantime, enjoy as UBS just unwittingly announced the final countdown for the EUR.
Tags: Banking System, Civil War, Collapse, Consequences, Fame, fiat, Fiat Currency, Fragmentation, GDP, Gold, Hank Paulson, International Trade, Libor Rate, Monetary Unions, Mutual Assured Destruction, Opportunity Cost, Polity, Recapitalisation, Skeptics, Straw Man, Ubs
Posted in Gold, Markets | 1 Comment »
Monday, May 30th, 2011
The recent sluggishness in equity markets has certainly affected industrial commodities over the past few months, if not gold, which as pointed out earlier is just 2% below its nominal highs and rising despite the 4th margin hike on the Shanghai Gold Exchange overnight – once again gold is seen at the apex of the fiat currency replacement pyramid. So what could cause a rally in industrial commodities in the near term? Sean Corrigan lists the four key catalysts, whose occurrence listed in order of probability, could rekindle the recently faltering rally.
From the most recent edition of Sean Corrigan’s Material Evidence
So, the burning question now is whether commodity prices can shake off the disquiet caused by May’s sharp liquidation and validate the soundbite suppositions of the past few days.
With so much hot money still swilling around the world, readily available at low nominal and largely negative real rates of interest, we can never say never, but so many other beneficiaries of the Bernanke Bubble are either losing momentum and/or breaking trend, that it may be that the whole shell game has been busted pro tem.
Certainly, the fundamental backdrop is beginning to look less rosy, with Japan suffering a 13% decline in exports, Taiwan’s industrial expansion slowing, Thailand’s turning negative, US macro numbers registering a series of disappointments, UK businesses still cutting back on investment and broad swathes of China’s corporate landscape experiencing a severe margin squeeze.
Our feeling is that for a significant rally to take place from here (that is, without enduring any further, intervening weakness), one of four things has to happen soon, listed here in a loose order of their assumed probability:?
- The Japanese government will forego the chance to introduce the meaningful, permanent fiscal rebalancing to which it might accustom the electorate under the guise of a supposedly temporary, disaster?relief measure and inveigle the BOJ into monetizing (albeit at one remove) the vast reconstruction effort needed in the country instead.
- The Chinese will prematurely relinquish their fight against the inflation which was unleashed by their huge, unfocused stimulus’ efforts of the past two years, in the estimation that the threat to the regime’s predominance posed by slow growth and falling employment is now greater than that posed by rapidly rising prices.
- The Fed will find an excuse to revisit a programme of ’quantitative easing’ (i.e., money printing) without first being forced to sit by and watch a prolonged retrenchment in economic activity
- The US dollar will undergo a renewed, sharp decline, allowing existing carry?trades and ‘Risk On’ mixes to be reinstituted with the least demand for original thought. Here we should note that while, ceteris paribus, a flight from the dollar should not automatically boost commodity prices in other currencies, a combination of having a greater marginal impact in a much smaller market and the active contracting of paired trades does in practice tend to bring about such a broad appreciation.
If none of these US Cavalry troopers appear over the horizon in a timely enough fashion, or until there is unequivocal evidence that speculative appetite has otherwise fully returned, our worry is that the industrial commodities in particular remain at risk of another 10?15% correction and a more thoroughgoing purge of leveraged long positions before we can find some sort of meaningful base from which to re?enter a fuller exposure.
Copyright © Sean Corrigan, via ZeroHedge.com
Tags: Burning Question, Catalysts, Commodity Prices, Corporate Landscape, Corrigan, Disappointments, Disquiet, Fiat Currency, Gold Exchange, Hot Money, Industrial Commodities, Industrial Expansion, Japanese Government, Macro Numbers, Material Evidence, Rebalancing, Shell Game, Sluggishness, Suppositions, Uk Businesses
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Tuesday, October 26th, 2010
Bonfire of the Currencies
Investment Outlook (November 2010)
by Eric Sprott, Sprott Asset Management
World governments just can’t get enough conflict these days. They’ve now resorted to battling each other with money printing.1 The devaluation race is in full gear, and it’s tough to keep track of who’s winning. It’s been just wonderful for investors, of course. In addition to contending with 0% interest rates, they now have to navigate through increased currency volatility and uncertainties associated with potential inflation. Gold and silver are benefitting greatly from this ‘currency war’ as investors seek safe harbor in hard money. We can’t say we’re surprised to see gold and silver where they are, but it has been surprising to witness just how willing and open governments are to blasting their own currencies down in value. Although we have complete confidence that the economists at the world’s various central banks know exactly what they are doing, we’re content to own precious metals investments in the meantime until such a day arises when the currency war winner is finally announced.
Just to make sure you’re up to date in currency war news, the most recent devaluation shot was fired by the Federal Reserve on August 17, 2010, when it initiated its permanent open market operations (POMO) to stimulate economic activity. The central bank announced its intention to reinvest the proceeds of its maturing mortgage-backed security holdings back into Treasury bonds. Combined with recent comments by the Federal Open Market Committee (FOMC) on increasing the US inflation rate (through money printing), world governments have been coerced into action. They’ll be damned if they let the US devalue against their own respective currencies and slam their exports, so everyone’s devaluing in tandem. It’s literally a “race to the bottom”, with all major currencies on the potential fiat currency chopping block.
By our count, no less than 23 separate countries have now intervened in the foreign exchange market in some way since September 21, 2010. The goal for all is to increase the supply of their respective paper currencies in order to drive them down in value. In the cases where countries can’t print outright, they have intervened through capital controls or “open mouth” operations (ie. talking down your currency in policy meetings, etc.). Both approaches have significantly increased the currency market’s volatility. Japan’s October 5th announcement of a “new fund” to purchase assets ranging from government to corporate bonds has forced other countries to pursue the same policy, and the world now awaits similar announcements from the United States and UK in the form of new Quantitative Easing programs.2
Investors aren’t clueless, however, and many are shifting capital to protect themselves. A large number of commodities are now benefitting from the uncertainty created by the devaluation race. Gold, silver, oil, copper, wheat, sugar and platinum are all on the run, and yet we have no reported inflation! Kudos go to the Central Banks for orchestrating that economic miracle. Nonetheless, regardless of what the CPI says, it’s clear that investors are proactively preparing themselves for more printing, and gold and silver seem to be the most popular choices for investors seeking safe harbor.
If you haven’t participated in gold’s recent rise, don’t fret, because the fun has only just begun. While gold and silver bullion have increased by 20% and 32% since January 1, 2010, respectively, gold stocks as represented by the Market Vectors Gold Miners ETF (GDX), the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold Bugs Index (HUI) and the S&P/TSX Global Gold Index have all trailed gold’s performance for the entire year. You wouldn’t expect the senior gold producers to be trailing behind gold in this environment. After all, at $1,300 gold, these companies literally have a license to print money. What better business is there to be in right now? These are companies that can process an ounce of gold for $800 and sell it for $1,300, with virtually no sales risk. What other investment sector can boast that kind of margin in this environment?
We believe the gold producers present an excellent investment opportunity right now. To explain why, consider the NYSE Arca Gold Bugs Index (HUI). The HUI is a modified equal-dollar weighted index of companies involved in major gold mining. The HUI was designed to give investors exposure to near-term movements in the gold price by focusing on companies that do not hedge their gold production beyond 1.5 years. The HUI was launched with a base value of 200 in March 1996 and includes some of the largest gold mining companies in the world. Despite a 35% increase in the price of gold since March 2008, the HUI has barely moved at all. As Chart A illustrates, this gold equity index is currently trading at the same approximate level it was when gold was barely over $1,000. The current HUI valuation doesn’t reflect the operating leverage that the $350 increase in the spot gold price could potentially have on earnings – which brings us to an important point that investors often overlook in gold stocks.
Tags: Brazil, Central Banks, Chopping Block, CIBC, Commodities, Currency Devaluation, Currency Volatility, Currency War, Eric Sprott, ETF, Federal Open Market Committee, Fiat Currency, Foreign Exchange Market, Gold, Gold And Silver, Gold Bullion, Investment Outlook, Money Printing, Mortgage Backed Security, oil, Open Market Committee, Open Market Operations, precious metals, Printing World, Race To The Bottom, Security Holdings, Silver, Sprott Asset Management, Treasury Bonds, Us Inflation Rate, World Governments
Posted in Brazil, Energy & Natural Resources, ETFs, Gold, Markets, Oil and Gas, Outlook, Silver | Comments Off
Wednesday, October 13th, 2010
This article is a guest contribution by Econompic, October 12, 2010.
A reader of Crossing Wall Street blog responds to Eddy’s gold model post (which I looked into here) and puts everything in terms of gold, rather than dollars. Note that this is just a portion of that response and I recommend readers take the time to read the whole thing and think about it as it puts everything in a very different perspective. That response:
First, the dollar derives its value from its relationship to gold. So instead of the dollar price of an ounce of gold, it should be thought of as the gold price of a single dollar. (For instance, the current of gold price of single US dollar is presently about 1/1345th of an ounce of gold)
Second, on this basis, the relationship is somewhat clearer: when the purchasing power of an ounce of gold rises (i.e., when an ounce of gold commands more dollars) interest rates will be low; and, when the purchasing power of a an ounce of gold falls (i.e., when gold commands fewer dollars the interest rate will be high).
In other words… gold doesn’t rise in dollar terms when real interest rates are low (or negative), but rather interest rates are low because their is no demand for the dollar in gold terms.
A View from the “Gold Perspective”
Under the assumption that Gold IS the only real currency (it has the huge benefit that it cannot be depreciated – an ounce of gold in year 1 is an ounce of gold in year 2, year 3, … year 100), then the recent run up in gold is not appreciation relative to the dollar, but rather the US dollar has seen a severe depreciation relative to real currency (i.e. gold).
But, if the dollar is collapsing, then why aren’t prices of goods and services jumping?
Perhaps (bear with me, this perspective is new to me) we happen to be in a severe deflationary environment in real currency (i.e. gold) terms, offset (intentionally?) by a devaluation of our fiat currency to prevent a collapse in the price level of goods in $$ terms. This devaluation may be saving the economy from falling into a deflationary spiral if not pursued (our economy has a lot of hard assets that are used as collateral for dollar loans. A drop in the assets value would be extremely destructive as the value of these loans would fall if the price of the collateral was allowed to fall, which would cause asset prices to fall further… rinse – repeat).
The Great Depression was a deflationary environment as the dollar was backed by gold. Today, rather than deflation in dollar and gold terms, we have a disconnect between the dollar (slight inflation) and gold (massive deflation) in terms of goods / services.
Below is a chart of headline CPI (i.e. purchasing power of the dollar) vs. gold CPI (purchasing power in gold terms). Since the consumer price index began in 1947, goods / services cost ~900% more whereas goods / services cost 70%+ less in gold terms.
And a year by year comparison of CPI in dollar terms and gold terms shows the economy went “gold deflationary” during the telecom / Internet induced recession early last decade.
Still getting my head around this, but any comments are more than appreciated…
Copyright (c) Econompic
Tuesday, May 4th, 2010
The following is a guest contribution from Richard Russell, Dow Theory Letters, May 5, 2010.
I’ve spent roughly 64 years studying the stock market on a daily, weekly and monthly basis. I’d say that 80 percent of that time I was perplexed or unsure of my stand. I know in the advisory business you are always expected to know exactly what’s going on and where to place your money. In my experience, the more cock-sure the advisor, the bigger the quack.
One problem is that the stock market isn’t always talking, and when it isn’t, many advisors create scenarios so they can carry on the illusion for their readers that they, at all times, understand what is happening.
How about what’s happening now? Here’s what I think or suspect. I think we’re in a long-term bear market and currently operating in a rally in the bear market, a rally that most people take as a new bull market.
I firmly believe we’re witnessing a great primary bull market in gold. This bull market is opposing a long-term bear market in fiat or non-intrinsic currencies. Since there is no discipline putting a limit on fiat-currency production, I believe in our lifetimes we will see the end of fiat currencies as acceptable substitutes for real money. When that happens, there will be no ceiling for gold. In their guts and in their hearts, every seasoned investor knows this, which is why the bull market in gold will continue.
How high will gold go? Wrong question, how low will fiat currencies go? The answer, as Bob Dylan might say, is “blowin’ in the wind.”
June gold, above 1166, will signal an extremely bullish breakout. The chart above shows the large symmetrical triangle in gold. Recently, gold broke out above the triangle to a peak at 1166 (top arrow), then declined to test the upper trendline of the triangle. Now gold is pushing north again. If gold rises above 1166 to a new high for the structure, I think gold will make its way up to 1200. But first, June gold must close above 1166. Update – gold did close at 1171.80 for the day.
I think gold is now under heavy accumulation. I note that gold is often knocked down in the thin after market. I’m beginning to think that this is done on purpose. Large interests who want to accumulate gold have a reason to want to knock gold down, and thereby be able to accumulate it at “reasonable” prices. The last thing they want is for gold to run away on the upside before they have accumulated as much as they are able. I think this is particularly true of China and Russia and other Asian nations.
Suddenly it becomes known that Greece is in much worse shape than thought (Greek budget was a horrible 13.6% of GDP). This makes the euro a less wanted currency. If it turns out that Greece is in worse shape than thought, how about Spain and Portugal and Italy? The problems for the euro increase. Then there’s the even grimmer thought. When we come right down do it, are the US’s finances any better than Greece’s? And how about the UK? Greece has troubles, the euro has troubles, the dollar (now everybody wants the “safety” of dollars) is wanted, and the only completely safe currency (yes, gold is a currency!) is gold.
I want to clear one thing up. Most people and analysts think you buy gold as protection against potential future inflation. But big money does not think that way.
I watch the jewelry auctions, and I subscribe to the Sotheby’s and Christie’s catalogues. Prices for top-grade gems are going through the roof. I was talking to a jeweler friend yesterday who just returned from a Sotheby’s auction. He said he couldn’t believe the prices that some of the jewelry was going for. One diamond that he expected to be able to buy for $200,000 went for $950,000. He said he was staggered by the prices.
It’s’ apparent that BIG money is buying items of intrinsic value for the future. These buyers don’t really care whether their ruby rises in price over the next ten or twenty years. They know that twenty years from now that ruby will represent WEALTH.
And it’s the same thing with gold. BIG money gold-buyers know that gold represents eternal wealth. They don’t care whether, twenty years from now, gold is selling for 900 or 3000, what they do care about is that gold will always represent wealth, regardless of the markets and regardless of which political party is slapping on new taxes.
With the world choking on debt, the only guarantee of wealth now and in the future is something intrinsic, something representing wealth regardless of the world monetary system. If I told you I was going to give you a large steel box for your kids, and that box was not to be opened for fifty years, would you rather I put three million in cash in that box or three million in diamonds or gold? Me, I’d pick the diamonds or the gold. Which would you choose?
I put this question to an anti-gold friend of mine, and I asked him for his answer. He hacked and hawed, and told me that it was a trick question. But he never dared to give me a straight answer.
Silver has been called “the poor man’s gold.” Never mind, what I’m interested in is whether silver will remain in this ascending channel. A year ago silver was selling like something out of a compost heap. In early 2005 you could have bought all the silver you wanted in the six dollar range. Now silver will cost you around 18 dollars an ounce.
Today an ounce of gold will buy 64 ounces of silver. The historical ratio has been around 16 to 1, so silver compared with gold is cheap. Nobody knows whether silver will climb back to that old ratio, but we do know that silver is cheap. I like silver here, and the easiest way to buy silver is through the ETF (SLV). The negative — central banks don’t collect silver.
Tags: Acceptable Substitutes, Advisory Business, Arrow, Bear Market, Bob Dylan, China, Dow Theory Letters, ETF, fiat, Fiat Currencies, Fiat Currency, Gold, Guts, Illusion, Lifetimes, Quack, Rally, Real Money, Richard Russell Dow Theory, Russia, Scenarios, Silver, Stock Market, Symmetrical Triangle, Trendline
Posted in ETFs, Markets, Silver | 2 Comments »
Saturday, March 20th, 2010
This commentary is a guest contribution by Jamie Horvat and Charles Oliver, Sprott Asset Management.
Sprott Opportunities Hedge Fund Strategy
Market Review and Strategy Update
originally published February 26, 2010
The market appears to believe in the continuation of a Goldilocks economy – one that is neither too hot nor too cold, but where a sustained economic recovery and growth takes hold during a period of sustained low inflation and loose/accommodative monetary policy. It has been argued by many who believe in ‘cost push’ inflation that deflation remains the main concern as we have a sustained high unemployment rate and underutilized productive capacity.
However, we have argued in past market reviews that stagflation and potentially hyperinflation should be on investors’ minds. Money growth and inflation is a wellseated economic phenomenon first uttered by Thomas Joplin (1826) when he stated, ‘the general scale of prices existing in every country is determined by the amount of money which circulates in it’. More than a century later, Milton Friedman (1992) reiterated this view when he said that ‘inflation always and everywhere is a monetary phenomenon’. Quite simply, if you print enough money and force it into the system by expanding the monetary base, you cheapen this fiat currency versus all hard assets and real things. Governments can always create inflation – all they have to do is print enough money, or in today’s instance, hit a few computer keys.
Nothing shows the effect of the expansion of money supply on the value of a currency as simply as a chart of the US Trade Weighted Dollar against the backdrop of the expansion in the US Monetary Base.
Using Bloomberg data for both the trade weighted dollar (synthetically derived prior to the creation of the Euro through a legacy basket) and the US Monetary Base, we can witness a simple relationship. Although currencies are relative to each other and are cyclical through various periods of economic growth, the fact remains that as you expand the monetary base you cheapen fiat currency against all hard assets and real things. What is troubling is the recent explosion of the US monetary base over the past 18 months and the potential resultant effect it may have on the value of the US dollar as a medium of exchange and fiat currency.
Historically, there has been a 1 to 1 relationship between the monetary base and money supply – as all the money printed and created eventually finds its way into the system to be lent and spent. If the banks refuse to lend this money, the governments simply institute various programs to provide this money directly to the end consumer. We continue to believe that the US and various other governments have no other tool at their disposal other than the printing of money and the ongoing expansion of the monetary base in order to force spending and inflation back into the system.
In an environment where we continue to experience high levels of un- and under- employment, where foreclosures and underwater mortgages continue to mount, we continue to witness investors who are willing to pay staggering multiples for the potential of many years of sub-par earnings growth. As witnessed by the following chart, the S&P 500 had recently attained new highs in the forward P/E trading multiple.
Witness the 10-year rolling average multiple paid through long term trends of inflation and relatively low and/or stable inflation. We believe the peak of the Dot-com Bubble represents another turning point from financial, paper-based and levered assets to hard assets as a store of value. As you can see from the price chart of the S&P 500 below, the market has been both above 1,400 points and below 900 points twice since the peak in 1999.
By considering the prior two charts together, one can quickly realize that the market rally that has been unfolding since March of 2009 continues to be one based on multiple expansion rather than underlying strong company fundamentals. Similar to many prior periods of financial leverage, easy credit and excess, we do not believe that we are in a Goldilocks economy. The losses from excess leverage, easy credit, toxic securities, derivatives and potential sovereign defaults will continue to be socialized and dealt with through the creation of new money. This is essentially an attempt to ‘cheapen’ these obligations and push them onto the backs
of future generations, so that the ongoing debt super-cycle can continue. These are typically not 1 to 3-year events, but rather 15 to 20-year events of correction before the next new investment bubble emerges – similar to the sideways markets of 1900-15, 1930-50, 1965-80 and 1999-20??.
Given the volatile sideways nature of the marketplace, the S&P 500 has the potential to be above 1,400 points and below 900 points at least one more time over the next 3 to 6 years. To date we have witnessed two bear markets with gyrations of approximately 47% and 56%, and would expect at least one more bear market to arrive before it may be safe to fully venture out unprotected in the woods again. Our objective remains focused on moving on the margin to preserve capital and take advantage of this volatility as opportunities arise.
Currently, the market appears to be anticipating difficulties during the back half of 2010. There seems to be an increasing fear among investors over the sustainability of the ongoing market rally for several reasons… 1) the sustainability of China and its lending/spending programs; 2) increased consumer leverage (household debt to income levels at all time highs once again) and consumer spending without government support; 3) the end of government stimulus programs and; 4) potential for sovereign debt defaults. During the month of February, however, all of the concerns seemed to be forgotten as the market staged a broad rally with the S&P 500 up approximately 3.1%. Thus, while our strategy largely outperformed the index in January, the earlier tightening toward a 10% net long position caused us to give these gains back as the short portfolio was negatively impacted by market strength. In particular, performance seemed to come from the retailing segment in such names as our short position in Macy’s. We question the sustainability of the strength in the market and the retailer segment with consumer confidence falling to its lowest level since April 2009 and the outlook for jobs continuing to diminish – fewer people spending more?
Within the long side of the portfolio, defensives, such as consumer staples and technology names, continued to add value. Further, the energy sector continued to benefit from positive momentum. Arcan Resources released positive initial well results that were viewed positively by the market place, while Iteration Energy announced its intent to seek strategic alternatives for the company (putting itself up for sale being potentially one of them). In addition, energy services continued to perform well with talk of increasing day rates that may now be snuffed out by an early spring break-up.
The Federal Deposit Insurance Corp. (FDIC) recently stated that the US “problem” lenders list climbed to 702 banks, a 27% increase from 552 banks at the end of Q3’ 09 and the highest level in 17 years. Accordingly, with respect to the short portfolio, we believe our positions in various regional banks and mortgage insurers with increasing loan defaults should benefit the portfolio in the coming months. Furthermore, as new home sales hit a record low along with mortgage applications and sales of previously owned homes unexpectedly dropped within the US, we continue to question whether the federal tax credit for homebuyers has resulted in removing any pent-up demand. Given the ongoing rate of foreclosures (rising 15% in January and topping 300,000 filings for the 11th straight month) and negative mortgages, we are once again reviewing short positions related to the
housing industry. Lastly, with Greece under pressure, fears of a European Union collapse and the AAA ratings of both the United States and the UK being questioned by Moody’s and other ratings agencies, gold continued to shine, as demand for a dollar alternative continued to increase.
Jamie Horvat, Senior Portfolio Manager
Charles Oliver, Senior Portfolio Manager
Tags: Amount Of Money, Charles Oliver, Computer Keys, Economic Phenomenon, Economic Recovery, Fiat Currency, Gold, Goldilocks And The Three Bears, Goldilocks Economy, Hedge Fund Strategy, Horvat, Hyperinflation, inflation, Milton Friedman, Monetary Base, Monetary Policy, Money Growth, Money Supply, Productive Capacity, Sprott Asset Management, stagflation, Unemployment Rate
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Wednesday, March 17th, 2010
by Nick Barisheff, BMG Inc.
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Unlike the world’s currencies, gold retains its value
In a speech I recently gave at The Empire Club of Toronto , I referred to gold as the “anti-currency.” Gold is not and never has been a currency. Gold is something entirely different and far more valuable. It is money.
“If you’re holding paper currency, you have to have some kind of trust that the country that issued it is not just going to print its way out of its problems. That’s a real concern right now. Gold, on the other hand, has real intrinsic value, unlike a paper currency which can be debased by its government.”
- Sacha Tihanyi, currency strategist, Scotia Capital
Currency versus money
Most investors confuse money and currency, but they are not the same thing. Money is defined as a medium of exchange, a unit of account and a store of value. For centuries, money referred to coins made of rare metals (gold and silver) with intrinsic value, and to notes backed by precious metals.
Currency, while it is a medium of exchange, is not a store of value. It only derives its value by arbitrary fiat – government decree and hence the term “fiat currency”. Paper banknotes represent money but they are not money. They are simply promissory notes whose long-term “value” or purchasing power depends entirely on the fiscal and monetary discipline of the government that issued them.
And therein lies the problem. In an era of massive fiat currency expansion by profligate governments across the globe, today’s currencies are depreciating in value faster than yesterday’s news. Fortunately for precious metals investors, gold and precious metals have risen in value, and will continue to rise in value against all currencies because they have once again resumed their historical role as stores of value: money.
“When the price of gold moves, gold’s price isn’t moving; rather it is the value of the currencies in which it’s priced that is changing.”
- John Tamny, economist, H.C. Wainwright Economics
The decline of the world’s currencies
Currency debasement isn’t a recent phenomenon. For decades, governments around the world, through their central banks, have been creating money out of thin air to cover their excessive spending and mounting debt. Investors have for the most part accepted this subtle form of taxation, because it seemed to have little personal impact. But appearances are deceiving. Investors are discovering that the value of their dollar-denominated assets has actually declined a staggering 82 percent since 1971 (not coincidentally, the year the US cut its link to the gold standard). Figure 1 tells the story.
The media are using the wrong measuring stick
Every day, the media (via currency traders) informs Canadian investors about the latest price of the Canadian dollar in US dollar terms, while US investors compare the US dollar to a basket of the world’s major currencies. But this information gives investors surprisingly little insight into the true value of their portfolios. If we started measuring the world’s currencies against money (i.e., gold), investors would be horrified at the stark decline in the value of all currencies. Most investors’ portfolios are heavily weighted towards currency-denominated financial assets (stocks and bonds), but few realize that the true value or purchasing power of their portfolios is declining every single year because of currency depreciation.
The rate of currency decline is accelerating
Since 1913 (the year the US Federal Reserve was established), the US dollar has lost over 95 percent of its value. The US and Canadian dollars have lost 82 percent of their value since 1971, as noted earlier. But the rate of currency decline is now accelerating.
In the past ten years alone, the US dollar, the Canadian dollar, the UK pound and the euro have collectively fallen 70 percent in value if measured in real (currency-debased) terms. In other words, when they are priced in terms of gold (Figure 2).
It’s all about the (fiat currency) money supply
Not too long ago, all the world’s major currencies were backed by gold because it was a universally recognized store of value. The gold standard imposed fiscal and monetary discipline, since each country had to hold enough gold to equal the amount of money in circulation. But not any longer. Government spending around the world is exploding, and (fiat currency) money supply, along with government debt in the world’s major economies, is exploding along with it. But nowhere in the world has spending become more out of control than the US (Figure 3), where the monetary response to last year’s financial crisis is creating yet another bubble, and this time it will be the bubble to end all bubbles.
Countries are increasingly at risk of sovereign debt default
“In the process of saving a few ‘too big to fail’ corporations and their bond holders, policymakers are greatly increasing the risk of sovereign defaults.”
- Puru Saxena, editor/publisher, Money Matters
The risk of massive and widespread sovereign debt default has never been higher. “Official” US government debt has soared to 90 percent of GDP, while multi-trillion-dollar budget deficits for the next several years will send that number soaring. Japan, the world’s second-largest economy, was recently put on credit watch. Its debt is twice total GDP, yet its newly elected government has announced much higher spending for 2010. The UK’s 2009 budget deficit will be over 14 percent of GDP, adding to a net debt that will reach 56 percent of GDP this year, 65 percent in 2010 and 78 percent by 2015.
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Spain, Italy and Portugal are facing major fiscal deficits, as is Eastern Europe. Dubai is billions in debt and its prize jewel, Dubai World, is bankrupt. Greece’s credit rating has been slashed, and its debt is forecast to reach 130 percent of GDP. And then there is Iceland, whose debt had exploded to seven times GDP before the global meltdown. The country’s banking system has now collapsed, its currency is deeply devalued, its real estate market has imploded and the country is in a full-blown economic depression.
The incredible shrinking dollar
As the world’s reserve currency, the US dollar is a proxy for the rest of the world’s currencies. The dollar’s decline is a direct reflection of America’s deepening financial troubles, exacerbated by a ravaged banking system that, by 2010, may see over one thousand banks insolvent. In 2009, the US incurred a budget deficit of $1.4 trillion, and its debt rose by $1.9 trillion due to off-budget expenditures. These off-budget expenditures alone were more than the 2008 budget deficit. At the end of 2009, America’s total debt was over 100 percent of GDP.
In their attempt to reflate the bubble-driven economy, President Barack Obama, Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner have decided to add to this financial house of cards. Instead of raising taxes or cutting expenditures, they have decided to borrow their way out of the problem and have the Fed create money out of thin air, which will almost certainly create another bubble. This bubble will make the others pale by comparison and will help destroy the US dollar. The dollar may be the world’s reserve currency, but China and other countries are not only questioning its status, but also actively campaigning for greater use of alternative currencies.
Investors are demanding real money
Where are most investors putting their cash? It should no longer be in stocks. Key stock indices like the Dow Jones Industrial Average have been flat to negative in nominal terms since the end of the last century. But if the Dow is priced in gold (in other words, money) as opposed to depreciating dollars (in other words, fiat currency), its decline is far more dramatic. As Figure 4 shows, the Dow:Gold Ratio is not only in a downtrend, the downtrend is steepening which is a continuing indicator to move from equities to bullion.
Global creditors who currently hold trillions of dollars’ worth of dollar-denominated financial assets are dumping them to preserve their wealth. That is why gold bullion, along with its precious metals cousins, silver and platinum bullion, have been consistently keeping their value against financial assets (Figure 5).
Central banks are buying gold bullion
“We have a market-friendly Fed injecting a lot of liquidity in the system which will set us up for another bubble economy. Excessive monetary accommodation just takes us from bubble to bubble to bubble.”
- Stephen Roach, chief economist, Morgan Stanley
India recently bought 200 metric tonnes of gold bullion from the International Monetary Fund for $6.7 billion. Russia has recently added 120 tonnes of bullion to its reserves, while China has steadily (and surreptitiously) increased its gold bullion reserves from 600 tonnes in 2003 to 1,054 tonnes today. China is even urging its people to put five percent of their savings into gold and silver because it is so worried about the dollar. And because trillions of dollars of its reserves remain in US dollar-denominated assets, China’s central bank will be diversifying into gold for many years to come.
The world’s central banks know that gold is primarily a monetary asset, not a commodity. That’s why a growing number of them are quietly diversifying out of US dollars and adding to their 29,000 tonnes of gold reserves.
In its 2010 Precious Metals Outlook, Scotiabank noted that “seeing the value of the dollar steadily erode must be a nightmare for large US creditors such as China, Japan, South Korea, Russia, the oil producing countries and Sovereign Wealth Funds (SWF)…
Major investors are diversifying into gold
“Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that.”
- Lou Jiwei, Chairman, China Investment Corporation
It is not just governments that are dumping dollars for bullion. A rapidly growing number of sovereign wealth funds (including China Investment Corporation) are participating, as are major institutional investors. Hedge fund manager John Paulson, who made $3 billion in 2008 by shorting subprime mortgages, recently took a multi-billion-dollar position in gold as a hedge against inflation. Northwestern Mutual Life Co.’s CEO Edward Zore said his company purchased $400 million in gold (the first time in its 152-year history) because “the downside risk is limited, but the upside is large. We have stocks in our portfolio that lost 95 percent. Gold is not going down to $90.”
Hedge fund manager David Einhorn, through his Greenlight Capital fund, has sold gold ETFs in order to invest in longer-term and lower-risk gold bullion because of current US economic policy. Lone Pine Capital significantly increased its stake in gold this year. Perhaps of even greater interest to the unwary investor is a survey of US hedge fund managers by London-based Moonraker Fund Management: 90 percent (20 of the 22) of the hedge fund managers surveyed admitted they had bought physical gold for personal investment. These sophisticated investors know something that the average investor doesn’t: that the global policy response to the financial crisis will not only devalue the world’s major currencies, it will decimate the US dollar.
Many investors still view gold as a commodity
Individual investors are not so farsighted – yet. Because most of them have only experienced one kind of market – a 25-year bull market in stocks – many still think gold is just a commodity like copper, zinc or pork bellies. But gold is far more than that. It has a 3,000 year history as money; for much of that time, it was the universal medium of exchange because of its divisibility, portability, rarity, beauty, malleability and indestructibility. Despite today’s negative sentiment, gold is not a speculation or a barbaric relic. Gold is money. Gold retains its purchasing power year after year, as Figure 6 shows.
Forty years ago it took 66 ounces of gold to buy a compact car. Today it takes only 14 ounces. If you had put your money in gold instead of dollars, the same car would actually be 79 percent cheaper, because gold keeps its value. Houses, stocks and virtually every other asset on earth would also be cheaper if bought with physical gold.
The more investors learn about bullion, the better for their portfolios. If you are already a bullion investor, now is the time to add to your portfolio. If you are new to investing in bullion, now is the time to start dollar-cost-averaging into bullion. I encourage investors to learn as much as they can about bullion and about the markets in general. A good place to begin is the Learning Centre section of our website (www.bmgbullion.com). It offers a comprehensive look at the economy, money, markets and bullion investing, and provides a variety of thought-provoking articles written by experts in the field of gold and precious metals.
Gold is money
Gold is money because it cannot be created out of thin air by government decree. Unlike bonds, gold does not represent someone else’s liability and, unlike stocks, gold does not rely on someone else’s promise of performance. Gold is money because, unlike currencies, impatient monetary policymakers cannot change its value. The rising gold prices we have experienced for the last eight years do not signal a bull market in precious metals, but rather a vote of decreasing confidence in the future value of paper currencies.
Currency-denominated financial assets are a disaster waiting to happen. The current economic rebound is a mirage, being entirely dependent on something artificial and unsustainable: massive government spending. A new crisis is building out of unprecedented fiscal and monetary mismanagement. Fortunately, smart investors can protect their wealth from the coming storm. The true level of risk has not been priced into the markets. The time to shelter your wealth from the storm is now. And there is no safer investment on earth than bullion, because bullion is and always will be money.
1. Gold Outlook for 2010
Gold Resuming its Historical Monetary Role – as the Anti-Currency
Bullion Management Group
Nick Barisheff is the co-founder and President of Bullion Marketing Services Inc., which was established to create and manage The Millennium BullionFund. The fund is Canada’s first and only RRSP eligible open-end Mutual Fund Trust that holds physical Gold, Silver and Platinum bullion www.bmsinc.ca.
Tags: BMG Inc., Canadian Market, Currency Paper, Currency Strategist, Empire Club, ETF, ETFs, Fiat Currency, Fiat Money, Gold, Gold And Silver, Gold Bullion, Gold Metals, Government Decree, India, Intrinsic Value, Medium Of Exchange, Metals Precious, Money Currency, Paper Currency, precious metals, Price Of Gold, Promissory Notes, Purchasing Power, Rare Metals, Russia, Scotia Capital, Value Money, Wainwright
Posted in Canadian Market, Energy & Natural Resources, ETFs, India, Markets, Outlook, Silver | Comments Off
Wednesday, February 3rd, 2010
Embry concludes his address as follows:
“I now firmly believe the chances of gold ever trading below $1,000 per ounce are remote. The only caveat I would offer is that if the world suffered a catastrophic deflationary collapse, gold could briefly be swept under but would then re-emerge with even greater relative strength as the only true safe haven. However, in a world of pure fiat currency, I think a near-term deflationary outcome is highly unlikely. In fact, I strongly suspect gold is going to stage a parabolic rise from current levels in the not-too-distant future, a development that will come as a shock to the many detractors of the world’s only real money.
“Gold is the only real money because it isn’t someone else’s liability.
“This remains one of the best supply-demand imbalance stories I have encountered in my long career and it will only be enhanced by the existence of massive short positions that will be impossible to cover amid myriad paper claims on gold that dwarf the physical supply, which, by the way, is a subject for another day.”
Click here to read Embry’s interesting and educational speech.
Source: GATA, February 29, 2010.
Tags: Asset Management, Caveat, Chief Investment Strategist, Deflationary Collapse, Detractors, Distant Future, Existence, fiat, Fiat Currency, Gold, Gold Bullion, Gold Trading, John Embry, Money Gold, Ounce, Real Gold, Real Money, Relative Strength, Safe Haven, Shock, Speech Source
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Friday, November 27th, 2009
Stephen Jen (Blue Gold Capital), who was formerly Morgan Stanley’s expert on sovereign wealth funds believes that China, India and Russia’s continuing purchases of gold bullion could be the catalyst for gold to rise in price into the stratosphere. He says that as their foreign exchange reserves as a percentage of their GDP is nearing 100%, the pressure to diversify away from fiat currency could reach a critical tipping point, should they decide to simply double their exposure to gold. As of this week, it turns out that India may emerge as the buyer of the remaining half of the IMF’s 400-ton sale of gold.
Here is an excerpt from Ambrose Evans-Pritchard‘s Telegraph article:
China, India, and Russia have all been buying gold on a large scale over recent months.
Why should that stop when the AAA club of sovereign debtors is pushing towards the danger threshold of 100pc of GDP?
These new players account for almost all the accumulation of foreign currency reserves worldwide over the last five years, so what they do matters enormously.
After crunching the numbers, Mr Jen found that the share of gold in their reserves is just 2.2pc compared to 38pc for the Old World (perhaps we should just call them the deadbeats from now on). They would have to buy $115bn of gold at current prices to raise their bullion to just 5pc of total reserves, and $700bn to reach just half western levels.
The killer-term here is at current prices since any such move in the tiny global market for gold would send prices into the stratosphere.
The reality is that sovereign debtors to the US may not be able stop supporting their symbiotic monetary relationship with the dollar, by buying US treasuries, but they can increase their proportionate interest in gold denominated reserves.
Read the article here.
Tags: 2pc, Aaa Club, Accumulation, Ambrose, Blue Gold, China, Currency Reserves, Deadbeats, Debtors, Emerging Markets, Evans Pritchard, Fiat Currency, Foreign Currency, Foreign Exchange Reserves, Gold, Gold Bullion, Gold Capital, Imf, India, Morgan Stanley, Proportionate Interest, Russia, S 400, Stratosphere, Telegraph Article, Tipping Point, Treasuries
Posted in Canadian Market, China, Emerging Markets, Gold, India, Markets | Comments Off