Monthly Archives: April 2016

Gold is the spectre haunting our monetary system

Via TELEGRAPH By James Rickards

For a century, elites have worked to eliminate monetary gold, both physically and ideologically.

This began in 1914, with the UK’s entry into the First World War. The Bank of England wanted to suspend convertibility of bank notes into gold. Keynes counselled wisely that the bank should not do so. Gold was finite, but credit elastic.

By staying on gold, the UK could maintain its credit, and finance the war effort. This transpired. The House of Morgan organised massive credits for the UK, and none for Germany. This finance was crucial, and sustained the UK until the US abandoned neutrality and tipped the military balance against Germany. 

Despite formal convertibility of sterling to gold, the Bank of England successfully discouraged actual conversion.

Gold sovereigns were withdrawn from circulation and turned into 400-ounce bars. This form of bullion limited gold ownership to the wealthy, and confined gold’s presence to vaults. A similar disappearance of gold as a circulating currency occurred in the US.

 

Gold graph

The price of gold has jumped in recent years CREDIT: LONDON METAL EXCHANGE

In 1933, US President Franklin Roosevelt issued an executive order making ownership of gold a crime. FDR relied on the Trading with the Enemy Act of 1917 as statutory authority for this edict. Since the US was not at war in 1933, the enemy was presumably the American people. 

In 1971, US President Richard Nixon ended convertibility of US dollars into gold by trading partners of the US. Closing the gold window was said by Nixon to be temporary. Forty-five years later the window is still closed. 

In 1973, the G7 nations, and the IMF demonetised gold. IMF members were no longer required to hold gold reserves. Gold was now just another commodity. The view of the monetary elites was that gold was dead. 

Yet, like Banquo’s ghost, gold insists on its seat at the monetary table. The US holds 8,133 tonnes of gold. The members of the eurozone and ECB hold 10,788 tonnes.  China reports holdings of 1,788 tonnes, but actual holdings are closer to 4,000 tonnes, based on reliable data from Hong Kong exports and Chinese mining.

Russia has 1,447 tonnes, and has been acquiring over 200 tonnes per year. Mexico, Kazakhstan, and Vietnam, among other nations, have added to their gold reserves recently. (Pity the UK, which sold more than half its gold at rock- bottom prices between 1999 and 2002). 

After decades as net sellers of gold, central banks became net buyers in 2010. A scramble for gold has begun. 

What drives gold’s new allure? In some cases, central banks are constructing a hedge against US dollar inflation.

China has $3.2 trillion in reserves, over half of which is denominated in US dollars, mostly US Treasury notes. The dollar has no greater friend than China because its wealth is held in dollars. Still, inflation looms. China cannot dump its Treasury notes; the Treasury market is deep, but not that deep.

If Chinese selling of Treasuries became a threat to US interests, a US president could freeze Chinese accounts with a phone call. 

The Chinese know this. They are stuck with their dollars. They fear, rightly, that the US will inflate its way out of its $19 trillion mountain of debt.

China’s solution is to buy gold. If dollar inflation emerges, China’s Treasury holdings will devalue, but the dollar price of its gold will soar. A large gold reserve is a prudent diversification.  Russia’s motives are geopolitical. Gold is the model 21st century weapon for financial wars.

The US controls dollar payments systems and, with help from European allies, can eject adversaries from the international payments system called Swift. Gold is immune to such assaults. Physical gold in your custody cannot be hacked, erased, or frozen. Moving gold is a simple way for Russia to settle accounts without US interference.

Countries are also acquiring gold in advance of a collapse of the international monetary system. The system has collapsed three times in the past century. Each time, major financial powers came together to write new rules.

This happened at Genoa in 1922, Bretton Woods in 1944, and the Smithsonian Institution in 1971.  The international monetary system has a shelf life of about 30 years.

It has been 30 years since the Louvre Accord (an upgrade to the Smithsonian Agreement). This does not mean the system will collapse tomorrow, but no one should be surprised if it does. When the financial powers next convene to reform the system, there will be no appetite for the dollar’s exorbitant privilege.

The Chinese yuan and Russia ruble are not true reserve currencies. The only feasible benchmarks for a new system are the IMF’s world money, called special drawing rights, and gold. 

Critics claim there is not enough gold to support the financial system. That’s nonsense. There is always enough gold, it’s just a matter of price.

Based on the M1 money supplies of China, the eurozone, and the US, and with 40pc gold backing, the implied non-deflationary price of gold is $10,000 per ounce.

At that price, a stable gold-backed monetary system could be sustained.  When it comes to monetary elites, watch what they do, not what they say.

While elites disparage gold at every opportunity, they are buying it, hoarding it, and preparing for the day when one’s gold determines one’s seat at the table of systemic reform.

It’s past time to claim your seat with an asset allocation to physical gold.

 

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Un banquero catalán que se paseó por el mundo y cambio España

Agradezco a mi amigo y preescriptor RF la ayuda e inspiración en la elaboración de este artículo, y al profesor Jesús Huerta de Soto su generosidad de publicarla en la revista Procesos de Mercado.

En la época medieval, se conocía como Borne el espacio que tradicionalmente estaba reservado a las justas. Se trataba de un lugar ágorico, céntrico. La frase “roda el món i torna el borne” captura la idea de que todo acaba en el mismo lugar en donde empezó, con el matiz -si se quiere-, que borne en inglés significa a nacer; “torna al borne” significa volver a nacer: como si fuera posible tener dos vidas. Así exactamente sucede la vida del banquero, empresario, filántropo y benefactor Josep Xifré i Casas. He aquí una breve síntesis de su vida que bien merecería una novela. Mi intención es esa.

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Saudis Follow Michael Burry in Water Investment ValueWalk, By Mark Melin  

The latest hot investment is a water investment, one that is particularly liquid but deals in a scarce commodity.

Water has always been a valuable commodity, but it is one that many experts have said is under appreciated, under priced and laced with government subsidies. Hedge fund legend Michael Burry of The Big Short fame first popularized the idea of investing in water, and now the government of Saudi Arabia investing in U.S. water rights is raising eyebrows.

 

 

Water is a cheap commodity

The days of “cheap water” are behind us, Ben Grumbles, President of the U.S. Water Alliance, previously told ValueWalk. He says water and its infrastructure has been “taken for granted” and is “a leaking time bomb.”

The commodity that is perhaps most under appreciated in the U.S. was the focus of Michael Burry’s next “big short” for a reason.

“We often spout off the fact that 70% of the Earth’s surface is covered in water,” Burry was quoted as saying. “While this is true, freshwater – the kind we care about – actually only represents 2.5% of that amount. On top of that, only 1% of our freshwater is easily accessible, with most of the other 99% trapped in glaciers and snowfields. In the end, only 0.007% of the planet’s water is actually available to fuel and feed the world’s 7 billion people.”

The United Nations has noted water use has grown at over twice the rate of the world’s population, with today people using nearly 30% of the world’s total accessible renewal supply of water. Projections are that in less than 10 years, that percentage could reach 70% and by 2025, an estimated 1.8 billion people will live in areas plagued by water scarcity, with 2/3rds of the world’s population living in water-stressed regions.

Drinkable water is a scarcity issue, something that they are well aware of in Saudi Arabia.

Saudis pile in on water investment

Almarai Co., Saudi Arabia’s largest dairy company, recently purchased land and water rights in California’s Palo Verde Valley, an area that has preferential access to water from the Colorado River. The Saudi company was reported to have acquired a large tract near Vicksburg, Arizona, a region known for fewer well-pumping restrictions than other parts of the state. The purchase of nearly 14,000 acres enable the Saudis to take advantage of weakened water rules and the move is not sitting well.

“It flies in the face of economic reason,” said John Szczepanski, director of the U.S. Forage Export Council. “You’ve taken on all of the risk a farmer has. The only way you can justify that is that they’re really not trying to make a profit. They’re trying to secure the food supply.”

Indeed, not only does Saudi have a water problem, but it could be getting worse due to recent Government cuts (although at least for now the Government has no plans to stop water investments). A recent report from Jadwa Investment notes:

Another project to commence operations is the $2 billion oil-fired power and desalination plant in Yanbu, with a capacity of 2,500 mw of power and 550 thousand cubic meter a day (cm/d) of desalinated water.

And:

The rapid growth in demand for power and water will continue to be met with continuous project expansion.

Watch water investment, it could be the next big thing.

Zeno’s Paradox Janus, by Bill Gross

 

 

I once wrote that a good “bond manager” should metaphorically be composed of 1/3 mathematician, 1/3 economist and 1/3 horse trader. I still stand by that, although I would extend it now to the entire investment arena, especially after experiencing several years of “unconstrained” asset management. Surprisingly though, upon reflection, I find that personally I was never really an “A+ student” at any of the 3 but good enough at each to provide consistent long term alpha and above average profits for clients. In math, for instance, I was a 720 SAT guy but certainly nowhere near 800 status. In economics, I never got beyond Samuelson and an introductory MBA class at UCLA Anderson, but was self-educated enough to have forecast and ridden the secular bond bull market beginning in 1981, and fortunate enough – though “addled” – to have predicted the housing crisis, as well as named and described the “New Normal” that would follow. Horse trader? Well that’s an even more subjective assessment but I can remember being a rather mediocre fraternity poker player. You could usually bluff me out of a big pot, and these days in the market I find myself turning right sometimes when I should be going left. Whatever. B+, A-, B is how I would grade myself but the returns and the relative alpha compared to contemporaries proved to be the real scorecard, and I’m happy with the result, acknowledging of course that some in the “classroom” I worked and work with at PIMCO and Janus earned Summa Cum Laude status and more themselves.

But back to the 1/3 math thing. It’s there that I find the average lay and even many professional investors still thinking and managing assets at the grade school level. The childlike “teeter totter” principle, for instance which couldn’t be simpler in its visualization of bond prices going up when interest rates go down, produces foggy-eyed reactions from a majority of non-professionals, and from a few supposed experts as well. And too, the concept of longer maturities inducing more risk for bond holders seems to stump many. Heaven forbid the introduction of the more refined concepts of duration and forward yield curves as well as the extension into stocks with the addition of an equity “risk premium” and how it might be calculated. “Forget about the math,” many investors really seem to say – “let’s stick to the old Will Rogers adage, ‘If a stock is going to go up – buy it. If it ain’t going up – don’t buy it’!”

Well today’s markets are markets that increasingly will be dominated by math, not Will Rogers. And negative interest rates are front and center. To explain, let me introduce a twister I first came across during one of my high school math classes known as Zeno’s paradox. Zeno was an ancient Greek who posed the following conundrum: Imagine a walker heading towards a finish line 10 yards away but every step he took was half of the length of the step he took before. If so, even if he walked an infinite amount of steps he could never reach his destination. Mathematically correct but the real world resolution was that Zeno’s walker and everything else that we experience moves forward in full step integers as opposed to fractions. It was a mathematical twist only.

But there is no “math only” twist to today’s bond and investment markets. Negative interest rates are real but investors seem to think that they have a Zeno like quality that will allow them to make money. In Germany for instance, 5 year Bunds or OBL’s as they are called, yield a negative 30 basis points. That produces a current price of 101.50 at a 0% coupon that guarantees, guarantees that an investor will get back 100 Euros 5 years from now for every 101.50 Euros she invests today. Why would a private investor (the ECB has a different logic) buy a 5 year OBL at a minus 30 basis points and lock in a guaranteed loss? Well credit and electronic money has its modern day disadvantages in that you can’t withdraw billions of physical Euro Notes from the local bank, nor can banks withdraw some from the central bank. You have to buy something and that’s the yield that’s artificially being imposed. Besides, the purpose of it is to force the investor to buy something with a positive yield further out the maturity spectrum or better yet with a little or a lot of credit risk to get inflation and the economy’s growth engine started again. Seemingly logical, but as I’ve pointed out in recent years – not working very well because zero and negative interest rates break down capitalistic business models related to banking, insurance, pension funds, and ultimately small savers. They can’t earn anything!

Anyway, for those private investors that continue to hold 5 year OBL’s and lock in a guaranteed loss 5 years from now, many of them are using a bit of Zeno’s paradox to convince themselves that they will never reach the loss-certain finish line at maturity. They think that because 4 year OBL’s yield even less (-40 basis points), the 5 year OBL’s will actually go up in price (remember the teeter totter?) if 4 year rates stay the same over the next 12 months, and the ECB has sort of – sort of – promised that. Whatever it takes, you know. If so, the private investor will actually make a little money over the next year (10 basis points) and she can give herself a slap on the back for having eluded the ECB’s negative interest rate trap!

Ah but Zeno’s, Draghi’s, Kuroda’s, and even Yellen’s paradox is actually just that – a paradox. Some investor has to cross the finish/maturity line even if yields are suppressed perpetually, which means that the “market” will actually lose money. Yet who cares about Zeno and a bunch of 5 year OBL investors? Well 30-40% of developed bond markets now have negative yields and 75% of Japanese JGB’s do. Still who cares about them, just buy high yield bonds or even stocks to avoid Zeno’s paradoxical trap. No! All financial assets are ultimately priced based upon the short term interest rate, which means that if an OBL investor loses money, then a stock investor will earn much, much less than historically assumed or perhaps might even lose money herself. Yields have been at 0% or negative for years now across most developed markets and to assume that high yield bond and equity risk premiums as well as P/E ratios have not adjusted to this Star Trek interest rate world is to believe in – well to believe in Zeno’s paradox.

The reality is this. Central bank polices consisting of QE’s and negative/artificially low interest rates must successfully reflate global economies or else. They are running out of time. To me, in the U.S. for instance, that means nominal GDP growth rates of 4-5% by 2017 – or else. They are now at 3.0%. In Euroland 2-3% – or else. In Japan 1-2% – or else. In China 5-6% – or else. Or else what? Or else markets and the capitalistic business models based upon them and priced for them will begin to go south. Capital gains and the expectations for future gains will become Giant Pandas – very rare and sort of inefficient at reproduction. I’m not saying this will happen. I’m saying that developed and emerging economies are flying at stall speed and they’ve got to bump up nominal GDP growth rates or else. Cross your fingers. Zeno’s paradox was a mathematical twist only and the artificial/ negative interest rate world created by central bankers has similar logic. The real market and the real economy await a different conclusion as losses from negative rates result in capital losses, not capital gains. Investors cannot make money when money yields nothing. Unless real growth/inflation commonly known as Nominal GDP can be raised to levels that allow central banks to normalize short term interest rates, then south instead of north is the logical direction for markets.