Markets can remain irrational for a very long time
by Egon von Greyerz
We ended 2015 as yet another year when most investors felt safe with their
stocks, bonds, property and other investments. But sentiment can change very
quickly and since the year end the Chinese market is down 14%, the S&P
down 6% and most global markets down 6-10%.
Most investors had been hoping that the investment Shangri-La would
continue for another year? Little do they realise that current values in no
way reflects real values or risk. As we know, markets can remain irrational
for a very long time. The risks that one day will bring the world economy
down have been with us for quite a few years. In 2007-9 world financial
markets were on the verge of collapse but a Central Bank programme of money
printing and guarantees amounting to $25 trillion kicked the can down the
road yet another time. It is too early to tell if the very strong falls in
world stock markets so far in 2016 are the beginning of the biggest bear
market since 1929. But is is not unlikely that this is the start of a bear
market which will see falls of up to 90% just like the Dow in 1929-32.
Fundamentals today are considerably worse than at the beginning of the Great
Depression.
The world has seen an acceleration in credit creation since the Fed was
founded in 1913 but the real acceleration started on 15 August 1971 when
Nixon abandoned the gold backing of the dollar. The 1987 stock market crash
and the property bubble in many Western countries in the early 1990s started
the final phase of easy money, led by Alan Greenspan’s irresponsible monetary
manipulations. But he was of course loved by politicians and investors since
he created another investment bubble leading to the 2000 crash. With more
easy money the world reached the next bubble and crisis in 2007-9. With the
help of Bernanke who was the most productive person ever in American history
we have now reached the super bubble era. Remember that Bernanke during his 8
years doubled US debt from $8 trillion to over $17 trillion. It took the US
government over 100 years to go from zero to $6 trillion, a feat that
Bernanke managed in a fraction (3/100th ) of the time.
To be fair, it is not just US debt which has ballooned. Global debt in the
mid-1990s was around $20 trillion and today it is $225 trillion. This is an
incredible 10 times increase in world debt in 20 years. And just since 2008,
global debt has increased by 50%. It should be clear to most observers that
this exponential growth in credit will not have a good ending.
Stock, Bond and Commodity Markets based on manipulation and financial
engineering
The effect of the debt creation is to hide what is actually happening in
the economy. Take for example workers’ wages in the US adjusted for real
inflation. Today they are half the level they were in 1973. So the perceived
improvement in living standards since then has been achieved by a massive
increase in both personal and government debt. It is the same with real US
GDP which is down 7% since 2006. John Williams of Shadow Government
Statistics has produced an interesting study showing that real sales per
share of S&P companies, adjusted for inflation and share buybacks, are
down 30% since 2008. Thus the current boom in stocks does not rest on a sound
foundation but rather on financial engineering.
We are being misled by manufactured and manipulated information in a world
of financial repression. It is of course possible to fool most of us most of
the time, but at some point in the not too distant future, financial markets
will tell us the truth. This will be when stocks and bonds crash together
with most currencies, led by the dollar. 
The falls will be
of equal magnitude to the credit creation we have seen in the last few
decades including the derivative time bomb of $1.5 quadrillion. So we will
see asset and credit markets losing 100s of trillions of dollars at a minimum
in coming years.
Super bubbles
We are most probably looking at the end of a major economic cycle. Whether
it is a 2000, 300 or a 100-year cycle, we will only know after the event. The
magnitude of so many bubbles on a global basis certainly points to a very
major cycle. There are many resemblances with the end of the Roman empire.
The excesses and moral decadence we are now seeing in the world certainly
point to the end of a major era.
There is of course no way of telling if the turn in the cycle is going to
happen in 2016 although this is not unlikely. The end of super cycles is very
difficult to time exactly. However, what is absolutely clear is that the
risks in the world are now greater than ever in history. I have discussed
above the asset and credit bubbles. These bubbles are ubiquitous and present
in Japan, China, most parts of Asia, Saudi Arabia and the Middle East,
Russia, Europe, Brazil and many countries in South America as well as North
America. The world has never before in history had a global bubble of this
magnitude.
Social unrest and risk of war
We also have many political and geopolitical problems around the world.
Most of the countries mentioned above will experience social unrest due to
the coming economic downturn. The migration in Europe will also give rise to
many problems. Another major risk is the potential of war and even nuclear
war in the Middle East and also between the US and Russia. A conflict between
the US and China in regard to the South China Sea is also a real possibility.
The risk of a major conflict is now greater than at any time since WWII.
The world is today a real minefield of economic and political risk and as
one mine goes off, the likelihood of a massive global domino effect it
substantial. As we don’t know when the first mine will detonate, we must take
all the necessary precautions we can to be prepared for what could happen one
day.
I won’t go into all the preparations that everyone should think about in
this article. Jim Sinclair recently published an excellent piece called “Be
Prepared” on his website jsmineset.
What is absolutely certain is that investors must now heed Mark Twain’s
words: “I am more concerned about the return OF my money than the return ON
my money”.
Unprecedented wealth destruction
As asset and credit bubbles implode, there will be the most enormous
wealth destruction that the world has ever experienced. It will be the
reverse of the massive growth in debt based assets that we have seen in the
last hundred years. But the obliteration of wealth will be even greater due
to the money printing that must central banks will undertake in the next few
years in order to attempt to avert a global collapse. However, the money
printing will have no beneficial effect but instead increase debt exponentially
leading to hyperinflation and the total destruction of most currencies and
the monetary system as we know it today. A deflationary implosion of the
financial system will then follow.
Most investors will not see this coming and won’t even consider the risk
of it happening. In my view, it is not a question of if only of when.
Wealth insurance
If you know that the risk of a fire is very high would you then not buy
fire insurance? One thing is certain, you cannot buy fire insurance after the
fire has started. Therefore, now is the time to insure against major risk.
Throughout history gold has been the best insurance available in times of
crisis.
For 5000 years, gold has been the only money that has survived and
maintained its purchasing power. Every single paper currency or quasi paper
currency like the Roman Denarius has eventually reached its intrinsic value
of ZERO. Gold has been the only stable money throughout history. 2000 years
ago an ounce of gold bought a good suit for a man just like it does today.
In order to insure wealth against the current unprecedented risks in the
world, investors should own an important amount of physical gold and store it
outside the banking system. Without doubt, this will prove to be the best
insurance against the coming wealth destruction.
Gold is today as unloved and undervalued as it was at the beginning of the
2000s at around $300 per ounce. The four year correction has probably ended.
At around $1,100 gold will be the best insurance cover that investors can
ever buy.
Egon von Greyerz
Matterhorn Asset Management AG
GoldSwitzerland.com
