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I am very bullish on gold (even more on silver from here), as bullish
as I have ever been, maybe more.
I’ll summarize my reasons for you shortly.
I’ve been wrong about it for two years now, ever since $1350. Truth
is, I warned of that number as the lower end of a possible range of prices
through 2012 before the Fed rolled out “QE3”. Although I have never
rejected the possibility of even lower numbers for the bottom of this move, I
have argued against them…in particular I have ruled out the idea of gold
falling far below US$1000/oz., as per conventional bearish wisdom.
That’s because my downside warning had little to do with the end of a bull
market or increasing real interest rates. It was based on estimating
historical volatility –a kind of stress testing of the bull market hypothesis
using historical parameters. The $1250-1350 range was a fair
retracement in the context of most intermediate corrections. It more or
less matched a correction of a 2008 extent.
A 1975/76 type correction (-45%) suggests a non-bear market correction
down to the $1050 level is possible but I’ve ruled it out on the basis that
we had not seen the same upside volatility as back then.
My warning was simply reflected in the observation that most precious
metals investors had been stubbornly bearish on the general stock market
trend, as were many non precious metals investors, and all were
underestimating the potential upside in equities. Part of the reason
was that the Fed chairman was himself working the public up in a lather over
a “fiscal cliff” crisis –stemming from the fact that government spending was
frozen. The Fed was agitating for QE3, we would soon realize.
It was the perfect set up. The general psychology was widely bearish,
with investors having faced one crisis after another: the subprime crisis,
housing crisis, euro crisis, and now the fiscal cliff…
And gold had just spiked up to $1925 with gold bulls making noise about
all the doom and gloom.
If there were any better time for what the Fed did, I couldn’t imagine it,
especially in hindsight.
Gold sentiment was probably a little unsustainably bullish, especially
given that we were still waiting on the "flation” part of my stagflation
forecast. And many bulls were already anticipating more QE.
 It was clearly
priced in that market, and in the Treasury market. Meanwhile,
it seemed, gold bulls forgot that equity is traditionally a good hedge
against an inflationary policy as well, and they forgot this at the most
inconvenient moment –when equity investing was out of style, and the Dow/Gold
ratio had fallen too far too fast for where we are in this story.
Although the gold price fell through my 1350 floor quite decisively, even
if with some trepidation at first, it had stuck to my $1185 bottom from where
the bulls were able to stage a few good rallies for at least another year
before succumbing to the pressure of a continued rally in US paper assets –
and especially the US$.
My $1350 floor, it was apparent, had increasingly become an effective
resistance level.
Then, last fall, it appeared that even my second floor was going to waver.
The surprise came when the market popped back up above $1200 in January,
and then $1250, and it looked like a bear trap. I have to tell you,
even though that prospect may have weakened since, gold prices held up well
in light of how far the US dollar rallied against the euro, yen, and other
currencies in the intermediate sequence and given the massive corrections in
many commodities, including silver.
[Even if gold were to reach the bears’ ~$1000 target, I think
silver’s bottom is in at the $14 handle.]
Indeed, looking at the US$ chart for too long might give you plenty of
pause, if you’re a gold bull.
 
Should we take gold’s reluctance to decline on this as a sign that
this rally is going to fail?
I think so, to be blunt.
But picking a bottom is difficult. You will see it won’t matter, and
that anyone who buys gold/silver here is going to fare well in the future –
and certainly better than if they bought stocks or bonds, or real estate in
some places -where bubbles have reformed. Just make sure to manage your
risk so that you are not going to hurt if the ultimate bottom is another $100
or $200 lower. If that happens, and I don’t think it will, then you should
be able to view it as another buying opportunity. I certainly would.
The US$ Delusion
Keep in mind that the rally in the US$ index that occurred in the late
nineties only lasted six years, and that it was coming out of a ten year bear
market lasting from about 1985-94. It was a mild bear but it was a
bear. My point here is that since 1971, the origin of our current
monetary system, the US$ has never rallied longer than about three or six
years before continuing on in its permanent bear market.
Moreover, I believe the fundamental basis of the present US$ rally is
predicated on outright error.
The standard narrative behind the US dollar’s momentum is that it reflects
the relative strength of the US economy, and an imminent reversal in the
Fed’s policy. Ready for it?! This is where we are supposed to
believe the US dollar has rallied 25% in under a year because the central
bank has planted a seed about raising the official target rate by 25 basis
points sometime in the second half of the year, and maybe one or two more
before year end. Bond yields around the globe backed up nearly 50 basis
points just over the past six weeks, except in Germany which has been the
prime beneficiary of the roll out of the ECB’s QE last week (60 bln euros per
month for about 19 mo).
But that’s not quite the picture. It reflects the view that the US
economy is stronger than others and will be able to withstand the rate
increases, while at the same time the others are just now easing.
Misesians know that currency movements have nothing to do with economic
growth or health,
“The valuation of a monetary unit depends not on the wealth of a
country, but rather on the relationship between the quantity of, and demand
for, money. Thus, even the richest country can have a bad currency and the
poorest a good one.” - Manipulation of Money and Credit
Certainly from the supply side, the US$ story is overplayed, especially
relative to the Yen, and many of the central banks that had previously (i.e.,
during 2005-11) run more aggressive policies, but which today are pursuing
far less inflationary policies than the Federal Reserve and its cabal of
banksters.
The market is misinformed about this part, thinking that the Fed has been
reigning in money growth, and believing that the Fed is finally ready to
tighten, after saying it would every year now since 2009.
Another aspect of the standard narrative is that the dollar is benefitting
from a safe-haven run from collapses in emerging markets. While this
may be true, the capital flows in those cases are small in relation to the
flows that dominate trade between the more advanced economies, and the
following chart should leave no doubt about what has really been driving the
US dollar. Hint: it has nothing to do with the safe-haven trade or the
nonsense about rising real interest rates (this will be temporary).
Can there even be a doubt after studying that graph that the US$ is strong
because the expected rate of return on US assets (relative to non US assets)
has been growing in line with performance deltas?
[Red/bottom line in the graph above = (DJIA / DJ World average); black/top
line is the US$ index.]
You can do the same with chart after chart and hone in on specific
relationships and they are all the same. Now, whether they are growing
because of true economic growth or central bank money and interest rate
manipulation is the key to the puzzle, which I think will not be good for
the US dollar.
I suggest that the US$’s strength has nothing to do with economic
strength, a fed tightening, the onset of a period of increasing real bond
yields, or flight from emerging markets or other risky trades.
What I have argued is that the US dollar got caught up in a bizarre QE
related carry trade driven by the Fed’s global banking allies in Japan and
Switzerland who have been buying euro assets hand over fist over the past two
years in anticipation that the ECB would ultimately buy them back out higher.
The effect was that bond yields went to zero not just in Japan or in the
US but almost everywhere, and regardless of how bad your sovereign’s
paper. Not only were investors underestimating how much money growth
the private commercial banks have been creating in the US since the Fed
collapsed its last QE, but also, they have badly overestimated how much money
printing the BOJ has orchestrated, and how much the Swiss were going to
continue to contribute to this scheme. The burden thus falls
increasingly on the ECB now, but chances are euro may be a little oversold,
and yen about to reverse.
One of the effects of the Hamiltonian scheme was to suppress interest
rates on European sovereigns to levels that cannot justify genuine risk
assessments – either on a relative or absolute level – so that US-EU yield
spreads reversed from a situation where they were negative in 2010 at the
height of the euro crisis to positive (i.e. favoring US treasuries). To
the extent that this prevented yields from going higher on treasuries in 2014
as we expected this carry trade also supported the rally in US equities.
So there was sort of an overflow from the Japanese and Swiss carry trade
to the EU, and then to the US and elsewhere. But, you see, this is all
money; it has nothing to do with growth. And moreover, not only have
analysts around the globe miscalculated the amount of money growth the US is
itself responsible in the post 2008 period, they have over-estimated the
growth that they believe has come about largely due to those unsound
policies, as if there’d never be any growth without a printing press.
Even worse, they don’t understand the nature of the Japanese carry
trade. The BOJ purchases of its government’s bonds are
sterilized. They are not translating into money growth. What has
changed in Japan is that the pension funds and other institutions that have
traditionally been buyers of JGB’s have instead been selling them to the BOJ
and chasing yield in the EU – errr, I mean front running the ECB’s
quantitative easing program. I’m amazed no one else is screaming about
this blatant example of how the players really rake the system. For two
years the institutions with political influence have been buying up European
assets knowing and even pushing the ECB toward its current policy.
At any rate, that is beside the point.
The point is the delusion over yen policy, and its coming retribution.
So in our view, the US has not been tightening more than anyone else so
far, and given how much the commercial banks in the US have taken over the
Fed’s role in money creation it is obviously irrelevant.
What is relevant is that this money creation, both here and in Europe,
continues unprecedented in order to support nosebleed stock and bond
valuations and obscure government insolvencies.
I suspect that as the year wears on capital flows will favor European and
Japanese equities, which will undermine the US dollar. Not that I’m all
that bullish on non US equities –not beyond the short term.
But a big part of the question about the future, which I am unsettled
about, is whether the commercial banks in the US are going to continue to
drive money creation through lending, or whether the current back up in
global yields will undermine bullish momentum in stocks and call the Fed back
in for QE4.
I have no doubt, for what it’s worth, that the bull market in gold has
only been interrupted here.
Let me give you my fundamental rationale in bullet points.
The Bullish Case for Gold
Not in any particular order,
- The Fed’s deteriorating monetary ethic from one boom to
the next has resulted in the longest running cheap money policy in its
history, which has obscured the reality of the government’s insolvency,
and has trapped it in this policy by the very lie it is hiding…i.e.,
can’t afford to exit!
- Decades of consolidation in banking industry has
increasingly evolved into top down (central) management of entire
economic spectrum, which will likely compound their lending errors
- Central banks have joined together to suppress interest
rates to zero around the planet on even the worst quality of debts,
making records – but even more relevant to the timing of a reversal is
that there are signs of dissent in this scheme from Switzerland, Japan,
China, etc.
- Statistically we’re in the late innings of one of the
phoniest booms on record - by which i mean one driven largely by central
bank inflation as opposed to commercial bank credit expansion
- If we have learned anything from the Austrian school it
is that when the interest rate is suppressed through the printing press
we end up with a shortfall of saving and a lot of
unfinished/misallocated/wasted capital - i.e., which is the antithesis
of sustainable growth
- US dollar rally is completely erroneous (see above),
especially versus yen; US money supply has doubled to nearly $11
trillion since the 2008 crisis - more than most observers report owing
to their blind reporting of M2, which double counts credit aggregates
(like time deposits and MMF’s with check writing privileges) as deposit
liabilities. Thus for ex, M2 has grown just $4 trillion, or 50% in the
same period. At the same time the financially illiterate media has
completely over-estimated the amount of money Japan is creating, and
also how much the ECB has participated in this drama. So, for ex,
it would be a surprise for most people to learn that Japan has
consistently been the least inflationary of the central banks to date on
any time frame you pick; and secondly, that not only has the US expanded
money more than Europe in almost every year except last, but also, that
in the post 2008 environment it has been consistently inflating its
money supply at above average historical rates that have climbed the
rankings of the OECD’s top 25 - today it ranks along with countries like
India, South Africa, Mexico and other banana republics. Yet Wall
Street and the media are utterly blind to this disparity, believing that
the US$ is strong because of a tighter monetary policy. Delusion!
- Sentiment and psychology could not be more against the
Precious Metals, and bullish sentiment in the recovery story has reached
extremes too now. Gold bugs are laughed at and hated.
- Valuation of gold using my shadow indicator shows that
Precious Metals are the best value for a long term hedge against the
fallout from this policy - better than equities, bonds, real estate,
etc.
- We have reached the longest running and deepest bear
market in gold stocks on record now, next to the late nineties -just
adds to the weight of statistical anomalies
- The internet is exposing this fraud in real time through
education, and is an important element in the disruption of unsound
financial systems - revolution is in the air, currently being played out
geopolitically in ways that its participants don’t fully understand, but
tomorrow it will be played out in the economic drama of the dollar’s
fall from grace (also gravely misunderstood)
The Prudent Bear Market
The effect of the central bank’s interventionist (inflationist) policy –
in particular its interest rate suppressions and concomitant asset inflations
also known as quantitative easing or ‘pump priming’ – on the competitive
advantage of various investment strategies is one unappreciated example of
the moral hazards and unintended consequence of the policy. And it
exacerbates the irrational foundation that already leads entrepreneurs in
making erroneous decisions when it comes to coordinating resources along the inter-temporal stages of
capital. Even though entrepreneurs may know what the Fed is doing,
it is still rational to align their investment strategy to benefit from the
effects even though they may be contradicting a moral ethic by buying
government bonds, and/or even if they know that what they are investing in is
going to fail, ultimately. The incentives are still aligned for those
who know the score to participate thinking that they can beat the crowd
out. How many times have I heard smart fund managers and seasoned investors
tell me, ‘we should be able to tell when to get out.’
Everyone thinks they can outsmart everyone else in this business.
The Fed’s policy creates perverse incentives by socializing the risk and
amplifying the reward (soma), which makes value investing basically an
exercise in futility except perhaps in some relative context.
Anyone who has invested this way – and I don’t just mean in precious
metals – almost any prudent investment strategy has seen its limits
tested. The competition from less prudent crowd following or momentum
based strategies is intense, as they also have the best recent historical
returns to report.
The policy supports investment errors broadly, but also, plain gambling
and blind speculation, and it promotes the high rollers who push a company’s
future to the brink and continue to make money for everyone doing it on the
way up. As Shostak likes to put it, the policy sets “in motion an
increase in the diversion of wealth from wealth generating activities to
non-wealth generating activities”.
The policy promotes the worst kind of people to the top not just in
government, but in industry.
In this way it amplifies the cluster of errors across the economic
landscape.
And it leads step by step to the devolution of the financial industry.
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