Gold and Central Banks
October 27, 2009 by admin · 2 Comments
Weekly Wanderings 27 October 2009
This week…
- 2 great interviews from King World news summarised.
- Central banks shift their reserves away from dollars, and
- Mish Shedlock is outraged!
But first a quick word from B52 Ben…
This week among the wealth of interviews at King World News, Eric has two star guests – John Hathaway, extremely highly regarded manager of the Toqueville Gold Funds, and Louise Yamada, possibly the best technical analyst on Wall Street. If you are at all interested in precious metals investing, I strongly recommend that you check out Eric’s site – he has a number of very knowledgable and interesting regulars and guests that he interviews each week. In this week’s column, I am summarizing the contents of the two interviews mentioned above.
(a) Louise Yamada
(1) Continued gold uptrend.
Firstly, with respect to the gold market, the continued uptrend from 2002 to the present, characterized by a sequence of higher highs and higher lows, in all major currencies, indicates increasing demand for the metal. Also, as Eric mentioned, increasing institutional demand is occurring, suggesting that we could be in the second (of 3) major legs up in this gold bull market.
(2) Inflationary pressures on the bond market.
With respect to bonds, Louise spoke of the very long cycles in that market. The current uptrend is very long-lived. Currently, and for the foreseeable future, massive quantities of new debt are being issued. At the same time, foreign countries are becoming less inclined to purchase said debt, thus forcing the Fed to buy back some of this debt. This would be highly inflationary in the longer term. The only way to persuade foreigners to buy back more debt would be to raise long term rates – creating considerable pressure on the housing market, amongst others.
(3) Gold vs Fiat. The result of the pressures emerging from (2) above is to create yet more upward pressure on the gold price, as gold becomes not just a hedge against inflation, but also a hedge against all fiat currencies losing their value.
(4) Depression? If (2) above were to continue against a backdrop of serious economic weakness, rising long term rates could easily usher in a depression.
(5) Fate of the US dollar. The US dollar has been in a long-term downtrend against its major trading partner currencies since 2002. If the current actions of stimuli and quantitative easing are not reversed, serious problems lie ahead for the dollar. Growth coming from strong consumption (and not production) and big Govt spending leads to currency weakness. Louise also noted that the Chinese yuan is gradually becoming backed by gold, as China is now a leading producer, and not much leaves the country.
(6) Long-term target. The potential target for the USDX is now 60 (implying a further 20% fall in the dollar’s value – or a gold target of at least $1200/oz).
(7) Retirement Shortfall? With the movement away from retirement pension funds and towards 401k’s, we are heading to a future where retirees will have less and less purchasing power, thus leading
to a further headwind for the economy. Louise made the very good point that Social Security should not be viewed as an entitlement, but as an insurance against hard times in retirement.
(b) John Hathaway
(1) Gold buying. The gold price in US dollars has quadrupled since 2002. The fact that gold is trading now at over $1000/oz is waving a warning flag to those invested in paper assets. On balance there is now central bank buying of gold taking place…
(2) Central banks losing gold? Because the central banks leased out gold to financial institutions that may no longer have it, they are now possibly being forced to buy it back at much higher prices…
(3) Downside for gold? Probably limited to around $950/oz.
(4) Gold price manipulation? Although it has yet to be proven, it appears that the US and other governments have been actively holding down the price of gold… However, the focus now of governments is now more on protecting the economy than pretending the currency is strong, so there may be less downward pressure on the gold price going forward.
(5) Small gold float. The total worth of available above-ground gold is of the order of $1 trillion. However the total worth of financial assets that could move into gold is of the order of $90 trillion. What we see is that financial institutions are becoming increasingly disenchanted with paper financial assets and are increasingly searching for more reliable places to park their money, hence the burgeoning institutional interest in gold.
(6) Don’t forget silver! We could see $150 silver coming down the pike at some stage..
(7) Gold stocks provide leverage. As the gold bull market continues, assets which are currently marginal will become the blue chips of the future…. With this in mind, don’t forget the impending launch of the van Eck ETF for junior mining companies..
Central Banks Shift Reserves Away from U.S. Dollar
From Jeff Neilson on Seeking Alpha.
Jeff Nielson is from Canada and is a writer/editor for Bullion Bulls Canada. He has a personal background in law and economics. Bullion Bulls Canada provides general macro-economic and political commentary, since the precious metals markets are among the most complex (and misunderstood) in the world………..
The problem with trying to specify why the U.S. dollar is currently having its worst collapse in two decades is that one would wear out their fingers on their keyboard before they ran out of reasons.
Let’s start with economic fundamentals. The U.S. is hopelessly insolvent. It has over $57 trillion in current public/private debt (see “A Tale of Two Economies: U.S. versus China”). However, since none of the three levels of governments properly accounts for their future obligations, their largest liabilities are not even recorded on their balance sheets – with “unfunded liabilities” for the federal government (alone) somewhere around $70 trillion. With real GDP of roughly $11 trillion per year, this economy is simply much too small to even service those debts and liabilities. Given that there are no assets “backing” the U.S. dollar, then obviously the value of a currency of a totally insolvent economy is near-zero.With mountains of debt far in excess of the rest of the world combined, allowing (or rather encouraging) the collapse of the U.S. dollar is the only way for the U.S. government to delay formal bankruptcy.
Most of the remaining arguments which guarantee a weak dollar in the future fall under the category of either “supply” or “demand”. On the supply-side, a recent article in The Telegraph puts one measurement of U.S. money-creation at over 100% for the previous year, with the even more insolvent financial system of the U.K. showing growth in the money supply of more than 160%, using the same measurement.
This is more than ten times higher than during the loose monetary policy which caused all these bubbles in financial markets. Like an alcoholic, who reaches for a ‘bottle’ first thing in the morning to relieve his hang-over, the U.S. and U.K. are doing much more of what caused their problems in the first place – and calling it a “fix” (again, much like an addict).
Meanwhile, a world already over-saturated with U.S. debt has been bombarded with trillions of dollars in new U.S. Treasuries. The “TIC reports” for this year show that instead of the usual $100+ billion per month in accumulation of U.S. debt by foreign entities that these same investors have dumped (on a net basis) hundreds of billions of dollars of U.S. “assets” this year (see “Foreign Investors FLEE From U.S. Debt”). In order to pretend that there is still demand for U.S. Treasuries, the U.S. has begun to “monetize” this debt – printing money to “buy” its own debts.
The Federal Reserve has engaged in massive chicanery to hide most of these purchases, aided by the Treasury Department, with its own reports on Treasuries auctions now so convoluted that traders with decades of experience in this market are totally unable to even decipher the descriptions of what is taking place in those auctions.
Ultimately, the key demonstration of demand for the U.S. dollar (or lack thereof) are the currency reserve ratios of foreign governments. Over the last several decades, the holdings of U.S. dollars have constituted well over 2/3rds of the holdings of foreign governments. However, in the 2nd quarter, foreign governments were only putting 1/3rd of their surpluses into U.S. dollars – literally only half of historical demand.
Exacerbating this trend, thanks to the Wall Street-engineered global recession, those surpluses are all much smaller than they were just two years ago. Thus, at a time when the U.S. has doubled its supply of U.S. dollars, demand has simultaneously been cut by more than half. Even those without a firm grasp of basic economics can understand what these parameters mean. And the recent collapse in the U.S. dollar would have even been worse, but several Asian central banks intervened in currency markets last week by buying up some dollars – perhaps the only thing preventing the dollar from a complete nose-dive.
As if these economic and supply/demand fundamentals weren’t already bad enough, as many (including myself) have pointed out, the dollar has been selected by traders as the new “carry-trade” currency, inheriting the yen’s dubious honour as the world’s official “weakest currency”.
This new “role” for the dollar comes as the result of the combination of near-zero interest rates, along with an economy (and particularly, a financial sector) which is so weak that traders are convinced the U.S. government will be unable to raise interest rates at any time – again much like Japan, and its “lost generation” with the yen. The only way in which U.S. interest rates will rise is if higher rates are imposed on the U.S. by the global bond market. Since such a move would occur only based upon soaring U.S. inflation and/or a fear of imminent debt-default, even if rates were forced higher this would not cause increased demand (for the exact reasons why rates were forced up).
This carry-trade status ensures that the dollar will be even weaker in the future than it would have been on fundamentals alone, because the mechanics of the carry-trade dictate that vast quantities of the carry-trade currency are continually being dumped onto global currency markets.
If it seems that dollar-bears are taking excessive “pot-shots” at the dollar, it’s because there remains a huge contingent of inane dollar perma-bulls. These “experts” don’t let a little thing like the U.S.’s insolvency stop them from boldly predicting that the dollar’s current collapse is only a temporary, short-term trend. However, when it comes to “reasoning”, the dollar bulls are capable of nothing more than pointing to past periods of dollar weakness – and mindlessly concluding that those outdated patterns will repeat.
The problem is that in previous currency cycles, the U.S. wasn’t sitting with $57 trillion in existing debts, and an additional $70 trillion in unfunded liabilities. In past cycles the U.S. didn’t have interest rates frozen at their lowest level in history. In past cycles there was not a clear move away from the dollar by the entire global community. And (of course), in past cycles the U.S. dollar was not a carry-trade currency.
Yes, truly, it is “different this time.” However, don’t bother trying to convince dollar-bulls of this. They would much prefer living in the past.
Mike “Mish” Shedlock is one of the most respected financial bloggers out there and he’s not a happy camper…
Where’s The Outrage? from Mike “Mish” Shedlock at http://globaleconomicanalysis.blogspot.com
I don’t know about you, but I am outraged.
I am outraged and not just about Goldman Sachs, but about a process that allows, even encourages political pandering, by time and time again rewarding leveraged riverboat gamblers and failed institutions and at taxpayer expense.
I am outraged that real people are suffering massively while the influence peddlers have stolen the country for their own personal benefit.
I am outraged at a political system that is totally unresponsive to the American people.
I am outraged by campaign contribution and lobbying processes that allows corporations to buy votes with donations.
I am outraged how legislators ignored the wishes of the people who clearly did not want these bailouts in the first place.
I am outraged that very little of this is in mainstream media. Why is this stuff not on the frontpage of every newspaper in the country or at least in the editorial pages?
I am outraged that the average US citizen is not aware of any of this, instead depending on CNBC, or ”The View” for their interpretation of the world.
I am outraged how special interest groups have exercised their power to monopolize the economy for the benefit of themselves, US citizens be damned.
I am outraged that all these bailout programs are doing nothing to alleviate the massive consumer debt problems. Every program, virtually every program was designed to bailout lending institutions, not consumers.
I am outraged at fees charged by banks receiving bailouts.
I am outraged over government pension plans and government pay scales massively out of line with the private sector.
I am outraged that Congress and this administration thinks the solution to massive budget deficits are still higher budget deficits in excess of a trillion dollars.
I am outraged about indictments. Paulson Admitted Coercion to force a shotgun wedding between Bank of America and Merrill Lynch yet no indictments were handed out. Let the Criminal Indictments Begin: Paulson, Bernanke, Lewis.
I am outraged that US citizens are not concerned enough and not educated enough to demand change.
I am outraged that the two party system has failed. Neither party has delivered meaningful change on budgets, on taxes, on social security, on deficit spending, on the size of government, on military spending, or fighting needless wars.
I am outraged at a Fed that purports to be “inflation fighters” when the only source of inflation in the word are central bankers, and their fractional reserve lending policies.
I am outraged that Greenspan and Bernanke could not see a housing bubble that 1000 bloggers could see.
I am outraged at the selective memory of Bernanke when speaking to Congress about these problems.
I am outraged that Bernanke’s one sided response to asset bubbles, letting them grow without end, then bailing out the financial institutions that cause them.
I am outraged the Fed exists at all. It is a useless organization that cannot see bubbles, that panders to banks, that supports inflationary policies that are tantamount to theft by fraud.
I am outraged that the Obama Administration promised changed and did not deliver. “Yes We Can” was a lie. The reality is “It’s Business As Usual, Only Worse, With Higher Deficits”.
I am outraged there is not enough outrage over this.
Where the hell is the outrage?
Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Casey Research: When Will Inflation Really Hit Us?
October 24, 2009 by admin · Leave a Comment
With plenty of debate around about whether it is inflation or deflation we should worry about, the folks at Casey Research are definitely in the inflation camp. It’s worth paying heed to what they say as they were one of the few expecting the financial crisis to arrive. They may be USA based, but with the US dollar still being the worlds reserve currency, the rest of us won’t escape the inflation if or perhaps when it does arrive. Read on to learn what a potential timeframe for price inflation may be. And learn why they say you should still have plenty of cash right now (oh and gold too!).
By Terry Coxon, Editor, The Casey Report
Most of us are gathered at the station, watching for the Inflation Express to come rumbling in. But we’ve been waiting for a while now. Just when should we expect the big locomotive to arrive and start pushing the prices of most things uphill?
We’d all like to know the exact date, of course, but no one can know for sure. Not even a careful reading of the Mayan calendar will help. What we can do is estimate a time range for price inflation to show up, and that alone should have some important implications for investment decisions.
Why It’s Expected
The reason for expecting price inflation is the recent, rapid growth in the money supply and the deficit-driven likelihood that more such growth is coming.
As of July, the M1 money supply (currency held by the public plus checking deposits) had grown 17.5% in a year’s time. That’s not just unusually rapid, it’s extraordinarily rapid. Since 1959, M1 has grown more rapidly in only one other 12-month period – and that was the one ending last June, when the M1 money supply jumped 18.4%. Even in the inflation-plagued 1970s, growth in M1 never exceeded 10% in any 12 months.
Dropping large chunks of newly created money into the economy leads to price inflation, because the recipients are likely to find themselves overprovisioned with cash. As they try to unload the excess, they bid up the prices of the things they buy, whether it be stocks, shoes, gasoline, silver coins, or granola. The sellers of those things then find themselves cash rich and start doing some buying of their own, and so the wave of excess money and the bidding it inspires propagate through the economy.
The process isn’t instantaneous. It takes time. Just as each player in the economy has a sense of how much of his wealth he wants to hold in the form of money, everyone will move at his own speed to make adjustments when his actual cash holdings seem to be off target.
And the process can seem to stall, especially when fear is growing. When people are worried or otherwise feel a heightened sense of uncertainty, they will gladly hold on to abnormally large amounts of cash – for a while. But when fear abates, as it will when the economy begins to recover from the recession, that temporary demand for extra cash will also fade, and the hot-potato process of trying to pare down cash balances will emerge to do its inflationary work.
But when?
The speed at which the public tries to unload excess cash and the timing of the effects have actually been measured, in the work of the late Milton Friedman and his monetarist colleagues. The method was indirect and roundabout, and so the results, unsurprisingly, were nothing as precise as nailing down the value of a physical constant.
What the monetarists (or the first of them to be equipped with computers) found was that when the growth rate of the money supply rises:
• The initial effect is on the prices of bonds and stocks, an effect that comes within a few months.
• The peak effect on the growth rate of economic activity comes about 18 to 30 months after the pick-up in the growth rate of the money supply.
• The peak effect on the rate of consumer price inflation comes about 12 to 18 months after that, which is to say it comes 30 to 48 months after the peak growth rate in the money supply.
As Friedman famously put it, the lags in the effects of changes in monetary policy are “long and variable.” He might have said, “It’s a big, wide blur, but we’re sure we’ve seen it.”
And even that picture exaggerates the precision that’s available to us. The emergence of money substitutes, such as NOW accounts and money market funds, has added its own muddiness to the picture of how growth in the money supply translates into growth in the level of consumer prices. It is only because the recent episode of monetary expansion has been so extreme that we can look to the results just listed for an indication of what’s to come.
If you apply the findings of the monetarists to the present situation, here’s what you get. The peak growth rate in the money supply occurred last December, so based on the general monetarist schedule:
• Some of the effect on stocks and bonds should already have been felt.
• The peak effect on economic activity should come between the middle of 2010 and the middle of 2011.
• The peak effect on consumer price inflation should come between the middle of 2011 and the end of 2012.
A More Particular Schedule
This time around, should we expect things to move more rapidly or more slowly than average? My bet is on slow, which would push the peak inflation rate out toward the end of 2012. One reason for slow is that the government’s rescue packages are delaying the process. Rescuing banks that are choking on bad loans postpones the day of reckoning for both the banks and the loan customers. It retards the pace of foreclosure sales (whether of real estate or other collateral) and puts the deleveraging that has been going on since last fall into slow motion. A wilting of the recent stock market rally would confirm this.
Investment Implications
The big plus about the Mayan calendar is that, right or wrong, it is very definite about things. Human civilization will come to an end, I’m told, on Dec. 21, 2012 – not on the 20th and not on the 22nd. There was no room for monetarists in those step-sided pyramids, but there still are few what-to-do implications from the monetarist findings.
1. When you hear would-be opinion leaders cite the current absence of rising prices at the supermarket as proof that all the new money isn’t a source of inflation, don’t believe them. It is much too early for the inflation bomb to be going off, even though the powder has been packed and the fuse has been lit.
2. If the large and growing federal deficits and the Federal Reserve’s unprecedentedly easy policies tempt you to leverage up on inflation-sensitive assets, such as gold, give the idea a second thought. It likely will be a year or more until price inflation becomes obvious and undeniable (which is what it would take to bring the general public into the gold market). In the meantime, your inflation-sensitive assets could get paddled rudely as the deleveraging that began last year continues.
For at least the next year, the simple, fire-and-forget strategy is 50-50 gold and cash – gold for what looks to be inevitable but on its own schedule, cash to be ready for the bargains that may show up while we’re waiting for the inevitable to arrive.
The editors of The Casey Report keep their ears to the ground, listening for the first rumblings of the inflation stampede coming in. But you can bet on rising inflation – and interest rates – right now and be way ahead of the investing herd. To learn more about investing in this all but inevitable trend, you can visit the Casey Research Site and learn about their flagship publication The Casey Report.
Carry Trades, the New Zealand Dollar and Gold
October 21, 2009 by admin · Leave a Comment
Weekly Wanderings 21 October 2009
This week the US dollar carry trade, gold and scary charts!…
Each week over at MaxKeiser.com, Max and Stacy present a radio show entitled “The Truth about Markets”. There are at least two variants of the show, with one slanted towards Christchurch (New Zealand) listeners. In this WW, I summarize the points discussed this week in the show. (The full audio can also be downloaded here.)
(1) Carry Trades. The idea of a carry trade is to fund one asset by selling short or borrowing one currency or asset that is hopefully decreasing in value, and to use the proceeds to buy another asset that is hopefully increasing in value. New Zealand has been strongly affected by the Yen carry trade, in which large amounts of yen were borrowed at essentially zero percent interest and used to buy the kiwi (NZ dollar), which yielded a high rate of return because of our high interest rates here.
(2) There used to be a Gold Carry Trade, in which gold was borrowed from Central Banks, again at very low interest rates, then sold, and the proceeds used to buy other higher yielding assets, such as US Treasury bonds. When Barrick Gold announced recently that it was dehedging or closing its hedge book, this was seen by many observers as a signal that this version of the gold carry trade was essentially finished. (See this previous article for more on the Barrick dehedging: Professor Fekete: Why Barrick Gold has ended Gold hedging)
(3) One powerful effect of the gold carry trade was to artificially suppress the market gold price, thus creating downward pressure on it. Possibly the announcement by Barrick also contained a subtle signal from the powers that be that the price of gold would henceforth be allowed to move more freely.
(4) The US dollar is now, and has been for the last 12 months, available to borrow at essentially zero cost, indicating the beginning of a new US Dollar carry trade, and is now being used to buy other perceived higher yielding assets (like the resource currencies - the Australian, New Zealand and Canadian dollars). There is evidence that gold is a beneficiary of this new carry trade, and certainly there is now upward pressure on the gold price, and concomitant downward pressure on the value of the US dollar.
(5) Other upward pressures on the gold price include the existence of the exchange traded funds, GLD for gold and SLV for silver, which, although they are problematic to some extent, provide an easy way for the general public to invest in precious metals.
(6) Central banks around the world, most notably the Chinese, are buying gold in increasing quantities. Chinese officials have announced that every time the gold price sinks below a certain level, they will be a buyer, thus giving rise to the notion of the Beijing put, analogous to the so-called Greenspan put. The effect of this is to create a floor under the gold price.
(7) This new dollar carry trade could be derailed, if the US authorities were to raise interest rates substantially. However one powerful reason that this is unlikely to happen over the next couple of years at least, is because of the large number of ARMs (adjustable rate mortgages) in existence, whose rates would then have to be reset, dealing another crippling blow to the housing market.
(8) Speaking of interest rates, the RBA (Reserve Bank of Australia), has just chosen to raise interest rates. Well known Australian economist Steve Keen suggests that this is a serious error, because there is a housing price collapse yet to occur. We observe that one thing is certain: if Aussie housing prices were to collapse, NZ house prices would definitely echo that trend.
(9) Once the US dollar has assumed this role as a funding currency for carry trades, there is consequently tremendous pressure on its legitimacy as the world’s reserve currency, since its value is continually being forced down by the carry trade. This is one reason that monetary authorities around the world are calling for a new reserve currency. In fact, gold is now unofficially assuming that role.
(10) Monetizing the debt. Another thing that has worried foreign holders of US dollars is that the US would start to monetize its debt, meaning that yet more dollars would be created, thus further weakening the dollar. Bernanke promised he would not do this; however Zero Hedge has alleged that at the Treasury and Agency Bond auctions this week, within 30 minutes of the issue and purchasing of Fannie Mae bonds, they were sold on to the Fed…. If this is in fact the case, then foreign holders of large amounts of US dollars (e.g. China) have every reason to be agitated.
(11) Over the past few years, whenever the dollar has weakened to a significant extent, there has been co-ordinated action by central banks to force its value back up again. This does not appear to be happening this time around….
(12) We are very likely to be at the beginning of a period of sharply increasing volatility in the values of currencies, including gold.
Thank you, Max Keiser and Stacy Herbert
Now we would like to draw your attention to some alarming information, courtesy of Weiss Research. (You can sign up for a free eletter on their Money and Markets homepage.)
The charts speak for themselves….
US Debt: Worst Deficit of All Time
Total US Government Debts and Obligations
2 Ways a Government can Default
Hear the word I-N-F-L-A-T-I-O-N anyone?
Chart: Chinas Aquisition of Natural Resource Companies 2002-2008
This insatiable demand for commodities from a rapidly growing China is only going to continue to increase…….
GOT GOLD?
INVESTING IN NATURAL RESOURCES?
DIVESTING YOURSELF OF US DOLLARS?
Russia also ready to abandon the dollar
October 17, 2009 by admin · Leave a Comment
Russian Prime Minister Vladimir Putin annouced this week they are ready to consider using the Chinese and Russian national currencies when doing oil and gas deals with China, instead of the US dollar. They will join Brazil who recently agreed to trade with China in yuan (chinese currency) instead of dollars. Along with the annoucement last month from Iran that they are dumping the dollar to use the euro in their Oil Stabilisation Fund, to “protect itself from the fragilityof the US economy and the weak dollar” according to Iranian state radio.
While we think the US dollar is toast in the long run, there is so much negative news on the dollar coming out all at once that it makes us just a tiny bit suspicious. Regardless, the dollar continues to fall while just about everything else rises. In particular gold, silver and resource based currencies like the Canadian, Australian and New Zealand dollars.
When Money Becomes Worthless - (Hyperinflation Ensues)
October 15, 2009 by admin · Leave a Comment
In this article from Martin Hutchinson, he makes a very good argument for what the potential outcome of a continued flood of money into actual physical commodities, including gold, may well be… hyperinflation. The average man on the street will likely think this scaremongering but the points he makes should be read and implications considered closely. The risk appears very real…
When Money Becomes Worthless
- October 12, 2009
The Financial Times last Tuesday noted a disturbing new trend – hedge fund and other investors are increasingly seeking to invest in physical commodities themselves, rather than in futures. Given the excess of global liquidity, this is not entirely surprising. It does, however, raise an ominous possibility of a supply shortage in one or more commodities, caused by investor demand that exceeds available mine output and inventory. That could potentially produce a collapse in economic activity similar to that from the 1837-41 and 1929-33 liquidity busts, but with the opposite cause.
The problem arises because of the size of the world’s capital pools in relation to its volume of trade. The total assets of U.S. hedge funds in September 2009 were $1.95 trillion (down from almost $3 trillion a year earlier). That compares with total U.S. imports of goods and services in 2008 of $2.1 trillion. However, in addition to the hedge funds, there are other huge pools of money available for deployment in commodities markets. For example China and Japan each have around $2 trillion of foreign exchange reserves, while Saudi Arabia and the Gulf states have comparable sized pools of liquid assets available for investment. Since the available inventory of commodities is a fraction of their annual production, we could potentially end up with an extreme case of too much money chasing too few goods.
This would not matter much if investment were concentrated in futures markets. The open interest in such markets is controlled by the traders, who arbitrage to close positions as the settlement date nears. Thus when huge speculative money flows pour into futures markets, they drive up the price of the commodity concerned, but do not significantly interfere with the production of that commodity, nor with the flow of the commodity from producer to consumer.
Normally, commodity investment is confined to futures markets because it is much more convenient. The cost to a hedge fund or other financial investor of holding stocks of a commodity is quite high, normally sufficient to deter investors from attempting to buy commodities directly. They will only buy commodities directly if they are afraid that the normal arbitrage mechanisms between the futures markets and the commodity markets will be overwhelmed by the volume of demand, so that investment in futures will prove less profitable than it “should.”
When investment moves to physical commodities, as it may now be doing, it potentially disrupts trade flows. A ship laden with copper ore that would normally have sailed from Chile to a smelter on the U.S. West Coast is instead parked in a holding area in order that investors can profit from the rise in value of that copper. That reduces the amount of ore available to smelters. Since the balance between supply and demand of most commodities is quite delicate, and supply cannot be ramped up by more than a modest percentage at short notice, that could result in a physical shortage of the commodity at the smelter, shutting down the smelter for a period and depriving its customers of the copper products they need for their own operations.
Disruptions of commodity flows of this kind can potentially cause both hyperinflation and a major recession. The value of copper to the smelter and its customers is much higher in a shortage than if it is available normally, because the cost of closing their own operations is large – hence the price of any spare copper that might be available locally zooms upwards. Equally, the economic cost of shutting down the smelter and its customers far exceeds the value of the copper ore shipment. Products containing copper are suddenly in short supply, while workers lose their paychecks and so are forced to stop consuming at the same level.
The effect of a gross liquidity surplus is thus quite similar to that of a sudden shortage. In the shortage case, as in 1837-41 and 1929-33, prices decline sharply – in those two cases by as much as 20-25% – economic activity is hugely reduced as businesses are unable to obtain financing and workers are laid off. The resultant decrease in demand causes producers to lose money, eventually closing their doors, as well as bankrupting the financial system.
In a gross liquidity surplus, in which investment capital disrupts commodity trade flows, inflation rather than deflation results, probably very rapid inflation rather than the moderate 5% to 10% inflation we became used to in the 1970s. That inflation still further increases demand for commodities, worsening the problem. Businesses unable to obtain raw materials close their doors, workers’ real incomes decline sharply (even when they keep their jobs) and Gross Domestic Product declines similarly to the deflationary case.
We have never experienced a global hyperinflation, in which money is unable to purchase goods, so it becomes worthless. In particular countries, wars have produced this effect, notably in the Revolutionary wars in both the United States and France, when the “continentals” and “assignats” became of no value. Similar effects have been produced by excess money printing in Latin America; in hyperinflationary periods citizens of Argentina have starved, even though the country is one of the world’s greatest food producers. However, globally we have experienced nothing worse than the moderate worldwide inflation of the 1970s, in which trade flows were disrupted and incomes and assets affected, but commodities generally remained available in the market and output weakened but did not decline sharply.
The fascination of adding another chapter to economic historians’ textbooks is not sufficient to make global hyperinflation anything other than an event to be avoided at all costs. It might help the Ben Bernanke of 2080 to make better monetary policy decisions than the current incumbent, since he would have the chance to be the world’s greatest expert on the hyperinflationary crash of 2011. However, as far as this column is concerned, future generations can take their chances – we need to avoid hyperinflation happening to this generation.
The cost of avoiding this disaster appears to be steadily increasing. Once articles start appearing in the Financial Times about investors choosing to buy physical commodities rather than futures, many more such investors will be drawn into this activity. A moderate tightening of monetary policy that might well have deflected the forces of hyperinflation if it had been instituted several months ago may well prove ineffectual at this stage.
In determining the necessary monetary policy, the gold price provides a very useful signaling device (and its definitive breakout through previous highs last week provides a stern warning.) It does not matter one whit whether investors demand physical gold rather than futures, because gold has only insignificant industrial uses and the stocks of gold available in “inventories” such as Fort Knox are far more than sufficient to supply those uses for a decade if necessary. However, the commodity investment impulse is closely tied to the gold investment impulse; both reflect a well warranted distrust of fiat money and a desire to hold items of secure long-term value. Hence the gold price is available to show policymakers whether their monetary policy is appropriate.
If, following last week’s breakthrough, the gold price continues to increase, heading for $2,400 per ounce, the equivalent in today’s money of the 1980 high, that will be an excellent signal that monetary policy urgently needs tightening.
If, after a first monetary tightening, the gold price retreats for a few weeks and then breaks through its recent highs, that development will be a signal that monetary policy must be tightened further, as the flight to commodities has not halted.
Only when the gold price breaks definitively downwards, dropping 25% or more from its high, will policymakers know that they have succeeded in breaking the commodity investment mania. Such a development is however likely to occur only after a definitive crack in government bond markets, forcing policymakers to address their gigantic budget deficits as a matter of urgency.
Given the predilections of today’s policymakers, it is unfortunately unlikely that they will tighten monetary policy sufficiently to break the commodity flight, whatever the gold price does. Instead, led by the determined Keynesians of the International Monetary Fund, they are much more likely to attempt to control the gold price itself, either surreptitiously by selling off massive quantities of the world’s gold reserves, or openly by imposing limits on gold futures trading and possibly, like Franklin Roosevelt in 1933, making it illegal for ordinary individuals to own gold or to buy gold futures.
That will of course only make matters worse; it would be equivalent to trying to avoid a speeding ticket by smashing the car’s speedometer. Manipulating the gold price to pretend that liquidity is not excessive does not stop liquidity from being excessive. Nor does it lead any but the stupidest institutional investor to believe that his urge to invest in physical commodities is misguided. Rather, it will cause commodities investment to be carried out through shell companies in tax havens, away from regulators’ radar screens. The effect on global supply chains will be equally damaging, but policymakers will no longer have a straightforward way of determining how to avoid the resulting economic depression.
I wrote last week that tightening liquidity directly by entering into a central bank “exit strategy” is dangerous. However , the Financial Time’s story itself and the gold price breakthrough have significantly increased the size of the hike in interest rates necessary to halt the flight to commodities.
Time is short, and the probability of disaster is rising.
The Bears Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long ’90s boom, the proportion of “sell” recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.
Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005). Details can be found on the Web site www.greatconservatives.com
“Demise of the Dollar” story; inflation/deflation; the US$ and Treasury Bonds
October 12, 2009 by admin · Leave a Comment
Weekly Wanderings 12 October 2009
As usual in these weekly musings we present you with interesting items we’ve come across during the week…
Casey Research is one of the most respected research groups studying the precious metals investment arena and more generally, resource stock opportunities in all commodities. The group publishes a number of investment newsletters, and also some that are freely available, including Ed Steer’s Gold and Silver Daily. Ed is a member of GATA, the Gold Anti-Trust Action Committee, and he is an extremely astute observer of the precious metals market. In his latest missive, we find the following…
A couple of days ago I mentioned in my commentary that you should read what I call “the three most important paragraphs ever written.” They were contained in an essay by British economist Peter Warburton that he wrote way back in April of 2001. In case you never did take the time to read his essay, or the three paragraphs mentioned… I will quote them here. I urge you to print a copy of them and read them every day until you ‘get it.”
“Central banks are engaged in a desperate battle on two fronts”
“What we see at present is a battle between the central banks and the collapse of the financial system fought on two fronts. On one front, the central banks preside over the creation of additional liquidity for the financial system in order to hold back the tide of debt defaults that would otherwise occur. On the other, they incite investment banks and other willing parties to bet against a rise in the prices of gold, oil, base metals, soft commodities or anything else that might be deemed an indicator of inherent value. Their objective is to deprive the independent observer of any reliable benchmark against which to measure the eroding value, not only of the US dollar, but of all fiat currencies. Equally, their actions seek to deny the investor the opportunity to hedge against the fragility of the financial system by switching into a freely-traded market for non-financial assets.”
“It is important to recognize that the central banks have found the battle on the second front much easier to fight than the first. Last November, I estimated the size of the gross stock of global debt instruments at $90 trillion for mid-2000. How much capital would it take to control the combined gold, oil and commodity markets? Probably, no more than $200 billion, using derivatives. Moreover, it is not necessary for the central banks to fight the battle themselves, although central bank gold sales and gold leasing have certainly contributed to the cause. Most of the world’s large investment banks have over-traded their capital [bases] so flagrantly that if the central banks were to lose the fight on the first front, then their stock would be worthless. Because their fate is intertwined with that of the central banks, investment banks are willing participants in the battle against rising gold, oil and commodity prices.”
“Central banks, and particularly the US Federal Reserve, are deploying their heavy artillery in the battle against a systemic collapse. This has been their primary concern for at least seven years. Their immediate objectives are to prevent the private sector bond market from closing its doors to new or refinancing borrowers and to forestall a technical break in the Dow Jones Industrials. Keeping the bond markets open is absolutely vital at a time when corporate profitability is on the ropes. Keeping the equity index on an even keel is essential to protect the wealth of the household sector and to maintain the expectation of future gains. For as long as these objectives can be achieved, the value of the US dollar can also be stabilized in relation to other currencies, despite the extraordinary imbalances in external trade.”
The whole point of derivatives, and the lack of position limits in much commodity trading [particularly gold and silver] was precisely to suppress commodity prices and to divert massive monetary inflation into financial assets and away from things that might get measured by consumer price indexes.
Peter Warburton’s article is entitled “The Debasement of World Currency: It Is Inflation, But Not as We Know It”. The essay was originally posted over at David Tice’s website prudentbear.com… but this link is to the copy posted over at gold-eagle.com… and the link is here.
Max Keiser’s guest this week for his On the Edge show at www.maxkeiser.com is Jim Willie, of the Hat Trick Letter investment newsletter. Jim has a Ph.D in Statistics, and a long career working in applications of the discipline. He speaks with authority on the subject, and when he says that economic statistics relating to the unemployment and inflation that are published by the government are complete and utter fiction, it pays to take notice. John Williams of Shadowstats.com, another information resource we follow closely to ascertain what is really going on, concurs with Jim’s view.
If you want to save some time, we summarize the essential points of the interview below the videos:
- The big news this week is the possibility of the Demise of the Dollar. In the UK Independent newspaper, Robert Fisk published an article on the alleged drive by several important nations, including Japan, Russia and France among others, to replace the longstanding requirement to buy oil only in US dollars by an arrangement instead to purchase it in a basket of currencies. [Note: Check out our thoughts from lastweek on this news item along with some related video footage here in our "Latest Gold News" section.]
- Associated with this concept is the idea of a new global currency, which carries with it the requirement of the powers that be that it be backed up by a strong military force. Also just recently the G20 in Pittsburgh endorsed this idea of a global reserve currency constructed from a basket of currencies.
- The US is losing influence in the Gulf to Russia and China..
- A weakening dollar would lead to a powerful cost tsunami breaking over the US economy.
- The inflation/deflation debate hinges on the perception that, although the Fed is pumping huge amounts of money into the system, it is not flowing into the economy at large….. hence no apparent inflation.
- However, there is a vast money flow occurring - into the hidden unregulated OTC derivatives that accompanied the banking over-leveraging in the first place!
- Much of the speculative money flow over the past 20 years has been related to the yen carry trade – borrowing yen at effectively 0% interest, and investing the proceeds in (generally paper) assets that returned a yield.
- We are seeing the establishment now instead of a dollar carry trade – whereby weakening dollars are borrowed, again at effectively zero cost. This free money is being used to speculate in other assets – and it looks like gold and oil are among the instruments of choice here.
- It is a disaster for the world’s global reserve currency to be used as the funding currency for such a carry trade – it basically sends a message to the world that the US dollar is weak and likely to get weaker.
- The COMEX (the exchange where gold futures are traded) is in danger of default.
- The recent jobs report is a disaster. On the horizon could be a Treasury bond default. Rapidly rising interest rates coming down the pike??
As a final note, I would like to draw your attention to Jim Puplava’s discussion with Gerald Celente on the economy in the October 10th Financial Sense Newshour. The link is here, and the section begins at 16 minutes and 46 seconds into the broadcast. It’s always worth listening to Gerald Celente, who heads up the Trends Research Institute. The motto of the Institute is “Think for yourself”, and in today’s news world where every item and data point is “spun” for propaganda purposes, it has never been more necessary to do so.
Steve Keen: The Reserve Bank of Australia gets it wrong again
October 8, 2009 by admin · Leave a Comment
Is there an Australian in the house?
Today, yes there is. For any of our Australian brethren reading we feature some thoughts from one of your countrymen. Steve Keen was one of the very few academic economists worldwide that predicted the current debt fueled financial crisis as far back as 2005. He writes regularly on his blog here.
He gives his thoughts on why the Reserve Bank of Australia has likely made a mistake in calling the all clear and raising interest rates in Australia. Going so far as to say they may finally prick the ever expanding Aussie housing bubble (Aussie house prices are now virtually back to their all time highs).
But for our New Zealand readers we think it’s also an important read as where Australia goes we usually follow not too far behind. Especially when our main banks are all Australian owned - any trouble in their banking sector will be felt here too. The fact that house prices have also been rising again in New Zealand and like Australia did not fall greatly means we should pay attention to the happenings across the ditch in Australia. While Steve is firmly in the deflationist rather than inflationist camp and we are somewhat torn on the issue, it is always worth getting varied opinions. So over to Mr Keen…
Oh yes, and we have featured a video of Steve Keen previously too which you can watch here.
The RBA has put rates up now on the belief that the financial crisis is behind us, and it has to return to its established role of controlling inflation.
That this decision was likely was flagged by the speech by Anthony Richards last week, which implied that the RBA, having ignored the house price bubble created by private credit growth in the preceding two decades, was worried about the renewal of the bubble initiated by the Government’s First Home Vendors Boost (I refuse to call it by its official name, since the money clearly went to the vendors, while the buyers copped only higher prices).
Needless to say I am all for trying to contain the house price bubble, which I regard as a disguised Ponzi scheme that has sucked Australian households into unsustainable debt levels. It is quite possible that the increase in interest rates (which is sure to be fully passed on by lenders and will add $20 a week to the servicing costs of a now commonplace $400,000 home loan), combined with the phasing out of the Vendors Boost, will be enough to prick the bubble–especially if it is followed by another rise next month.
But the RBA is doing this in the belief that the economy will return to normal after the recent mild recession–normal meaning growing at about 3% per annum in real terms, and faster than that as it rebounds from the recession.
Unfortunately “normal” in our post-War experience has also involved a return to a rising private debt to GDP ratio. Every recession has involved a fall in debt-driven demand, and every recovery has involved a return to debt rising faster than income. As the global financial crisis has made many people realise, this is simply a formula for avoiding a crisis now by having a bigger one in the future.
I doubt that the RBA appreciates this even today. It is still mired in a neoclassical way of thinking about the economy, which myopically ignores the impact of debt-driven demand on the economy. This is why it can put up rates now in the belief that this will merely fine tune the economy’s performance–reducing the likelihood of inflation in the future.
I think it is likely that the RBA will achieve far more than it intends. The last time the RBA put rates up to attempt to control an asset price bubble that was already out of hand was back in 1989. That exacerbated the economic downturn that was already in train as the debt bubble of the 1980s started to collapse. I expect the outcome of this rate rise will be similar: a downturn that is already in train as a debt bubble bursts will be made worse by this increase in rates at a time of greatly heightened financial fragility.
The problem this time is I believe far worse than 1990. Then the household sector had a relatively low level of debt–the mortgage debt to GDP ratio was a comparatively trivial 18 percent, compared to its now record level of 87.5%. It was therefore possible for the financial sector to lend willy-nilly to households, something neoclassical economists facilitated by their enthusiastic deregulation of the financial sector.
Who is there to lend to today? All sectors of the economy except the government are carrying record levels of debt. Thus while the Vendors Boost and other enticements encouraged some additional borrowing by the already massively leveraged household sector–and gave us a household debt to GDP ratio that now exceeds America’s–I simply can’t imagine who (apart from the government) the financial sector can now sell debt to.
As a result, I doubt that we will see any sustained acceleration in the debt to GDP ratio, with the consequence that the debt-financed component of aggregate demand will be anaemic at best. Since that has been the major source of growth in aggregate demand for many years now, I expect that economic growth will be substantially less than the RBA anticipates.
If so, just as it killed a dragon that wasn’t there by its inflation-fighting rate rises up until March of 2008, it may be taming a lion that is sound asleep with its rate rises now. If economic growth does in fact stay well below levels that reduce unemployment in the coming two years, then there will be very good grounds for revoking the independence that the RBA has had in setting monetary policy. We may as well hand it back to the politicians, if the alternative is to leave it with neoclassical economists who don’t understand the dynamics of our credit-driven economy.
The demise of the US dollar by 2018?
October 7, 2009 by admin · Leave a Comment
With the US Dollar dropping significantly again yesterday, (and gold gaining significantly) the blame is being placed on an article from Middle East based U.K. journalist Robert Fisk in the British paper The Independent.
Mr Fisk says his contacts tell him that the Gulf Arab nations along with China, Russia, France and Japan, are planning on ceasing trading oil in US dollars and instead will use a basket of currencies including Gold, the Euro, the Japanese Yen, the Chinese Yuan, and a planned new Gulf currency.
This is meant to happen within 9 years. The article is a must read and can be found here.
We believe it’s merely a case of when not if the US Dollar loses it’s roll as the world reserve currency. But it’s very interesting that gold is now also being mentioned as one of the pieces in a possible new basket of currencies. However the US dollar is getting so much bad press at the moment that we wouldn’t be surprised to see it gain some strength in the short term. So US dollar priced gold could go either way at the moment it seems.
Anyway if there is any truth to the report, it is just further proof of the growing distrust of the money masters in the US. Not surprisingly though there have been loud denials from the Central Bankers of most of the countries mentioned. Here’s a video of Robert Fisk being interviewed on the subject. At the end he mentions the fact that there have been such vigorous denials may well be strong proof there is some truth to the report!
If you want to see a number of opinions on the story check this commentary out…
The world and the dollar react to Robert Fisk
Also this is an interesting video from Max Kaiser where he theorises that these countries are sick and tired of funding the USA’s wars across the globe, which is what they effectively do when buying US government treasuries. We discuss further the advantages the US has as the holder of the global reserve currency in our eCourse which you can access here.
Max also says his contacts reckon the new currency will be 50% backed by gold and that a 50% devaluation of the dollar is on the cards. All interesting stuff!
Chinese being encouraged to buy gold and silver
October 7, 2009 by admin · 2 Comments
16 August 2009: Up until this year it’s been illegal for the average chinese citizen to buy and hold gold and silver. Also this year the government made it illegal to export silver and investing in precious metals is now also being reported about in the Chinese government controlled media. See the video below.
We think this looks to be a very bullish signal long term for precious metals. You can also read a full expose from a local chinese source here. This is definitely worth a read and be sure to also read the third comment down by Kevin T.
Update: 7 October 2009: Here’s a video we’ve just come across with one mans very interesting and well reasoned theory as to why the Chinese government may be encouraging it’s citizens to buy precious metals…
The Role of Derivatives in the Financial Crisis
October 6, 2009 by admin · Leave a Comment
Weekly Wanderings 6 October 2009
As usual in these weekly musings we present you with interesting items we’ve come across during the week…
From Max Keiser this week at www.maxkeiser.com comes an interview with Janet Tavakoli, an expert among experts on structured finance – you know, all those things with funny acronyms like CDO, CDS, SIV, ABMS (A.K.A derivatives) - and author of a fascinating book on the recent and ongoing financial crisis entitled “Dear Mr Buffett”. The 2 part video interview is below but we also present a summary of the main points below the videos if you’re pressed for time today (or you’re unlucky enough to still be on very slow dial-up internet access!)
- What is a derivative and why have these financial instruments played such a big part in the recent (and still current) crisis? The main reasons are that they are extremely opaque, or lacking in transparency, they enabled the banks to greatly increase their leverage, and they vastly increased the potential for outright fraud.
- The Securities and Exchange Commission (SEC) COULD have stopped the resulting Ponzi scheme, but DID NOT.
- The major players in this market are banks such as Goldman Sachs, J.P Morgan, Citigroup and Bank of America (these having absorbed the other investment banks). The various mergers and buyouts that have occurred have greatly weakened the entire banking system – the DEBTS ARE STILL THERE.
- The Federal Reserve has also taken some of this “toxic waste” onto its own balance sheet.
- The problems in the banking sector are still there, just masked. A massive deflationary collapse is occurring – rising loan defaults, falling tax revenues, large increases in government debt and huge amounts of Fed money printing.
- Reported GDP growth figures are inaccurate because they have not taken account of this deflation.
- This debacle could have been prevented by putting the failing institutions into RECEIVERSHIP, instead of bailing them out.
- The problem now is that these massively leveraged debts are mounting, but INCOME to pay interest on the debt and, heaven forbid, even pay back some of the debt, is FALLING.
- Bottom line? OUR MELTDOWN RISK TODAY IS GREATER THAN IT WAS IN 2007!
And for those of you that just can’t get enough of the derivatives or want to hear more of what Janet Tavakoli has to say on the basis of the financial crisis, here is a (long but interesting ) 1 hour interview with her… We won’t hold it against you if you’re not up for it!
