September was a busy month, and I've been out of town this week.
I'd like to comment on the wild ride in financial markets since the summer.
The broad market has been trained to focus increasingly on financial gameplaying (and heroic government-led rescues) since the advent of the Greenspan era in 1987.
In essence, Mr. Greenspan played the hero in every crisis, rewarding the financial community for turning its focus to Federal Reserve monetary action and government fiscal policy rather than to the traditional concerns of the state of the business cycle and the health of the economy.
This growing dependency of the financial markets on central bank policy easing (and corresponding money creation) has led us to our present precarious position.
It is now rare to hear public discussion of such issues as long-term sustainable business plans, cost-benefit analysis, risk management and reduction, and above all, of the benefits of a competitive and unencumbered marketplace, as we now inhabit an environment where increasingly large-scale government-driven market interventions are viewed not only as desirable, but as necessary to avert the collapse of our financial system.
(If this sounds like an addictive cycle - don't be surprised - it is! Why else would we now be outlawing short-selling while legally-sanctioned accounting methods do not stop short of permitting full scale financial
misrepresentation? The
fraudsters are protected by the SEC while those who engage in critiquing and selling such practices short are punished. The regulatory system itself is
operating in reverse - taking us further down the garden path through protecting the most egregious corporate risk-takers.)
All eyes are now on the Fed - and recently - on the government itself, as a source of answers to the perennial problem of the ebb and flow of financial markets. Business leaders expect no truly hard times and no sustained recessions. Executives can be rewarded with multi-million dollar pay packages for steering great companies into the ground. Consumers expect endless flows of borrowed cash, followed by government action to rescue them if they take on greater financial commitments than they can honour.
In short, something has gone fundamentally wrong with financial markets, as well as with our perception of prudence and risk. We believe that risky and unaccountable behaviours are without consequence, and that someone will always be there to fix any problem that becomes too large, whether for risk-taking financial dealmakers or for consumers and homeowners who have borrowed more than they can repay.
In the meantime, popular demand for gold is running at its highest levels in 30 years. Gold is returning to the hands of the public at such a torrid pace that the forms of physical gold most favoured by small investors (coins and small bullion products) are now in extremely short supply.
Kitco, Canada's largest bullion dealer, is
presently posting the following announcement:
"The following products have been temporarily removed from our Precious Metal Store until further notice due to production and delivery delays that retailers are currently facing; 1 oz Gold bars, 1 oz Kitco Gold bars, 10 oz Gold bars, 1 oz Silver Eagles, 1 oz Silver Maples, 1 oz Silver Philharmonic coins, 1 oz Olympic Silver Maples, 100 oz Silver bars and 1 oz Palladium Maples." 
The phrase "too big too fail" has become a commonplace, creating a financial market predicament that is "too big to bail."
Two interesting tidbits this week.
(1) After several months of reining in monetary expansion in recognition of surging inflation, the adjusted monetary base of the US has soared to the sky in September. Monetary inflation is back
bigtime. The US money supply has already doubled since the beginning of the millennium, which is the massive driver behind gold's price rise to date. To quote
Ed Bugos, the ultimate guru on the matter,
"The Federal Reserve has just expanded its balance sheet more in one month than it has in almost all of its first 86 years of existence. I am not kidding. Its assets, which represent the cumulative reserves the Fed has "created," totaled less than $700 billion at the turn of the millennium and continued to expand by about $50 billion per year after that, up until this month. In September alone, reserve bank credit inflated by almost $600 billion. It is a record, and has already affected the monetary base.
"Up until September, the Fed had been careful to sterilize its liquidity provisions by selling Treasuries, reverse repos or simply by lending its securities off balance sheet. So while it has extended credit since August 2007, it has not monetized much of the liquidity.
"Besides, usually, other factors offset the Fed's injection of 'liquidity,' such as cash withdrawals from the banking system (represented by an increase in 'currency in circulation') and other activities that may increase money flows back into the Fed... like the money raised by the Treasury for the Fed under its recently created 'Supplementary Financing Program.'
"Since announcing this new program two weeks ago, the Fed has received about $350 billion from the Treasury. Additional factors of decrease include about $80 billion in deposits that came into the Fed during September via reverse repos and 'other' deposits, a $26 billion decline in outstanding repos and about $4 billion in currency (cash) leaving the banking system. The NET factor of increase to reserve bank credit for the month of September was about $170 billion. That is money created out of thin air... unsterilized."
To translate... Mr. Bugos is saying that the Federal Reserve has been trying to keep money flowing without increasing the supply of money. The reason is that increasing evidence of inflation has been making it more difficult for the Fed to rationalize money supply growth, which of course is the primary driver of inflation. However, faced with "the end of the world as we know it," the Fed has become ever so willing to drive the money supply through the roof, once again creating massive inflation. Why? To prevent a probable financial meltdown. What caused the meltdown in the first place? Glad you asked! It was the Fed's money supply increase in the first place... which financed excessive government spending and the excessive accumulation (and disregard) of risk on both Wall Street and Main Street....
Folks, we have one big national and international dysfunctional family here!
Read Mr. Bugos' article in full
here. For a
commentary on his analysis, click
here.
(2) Equally interesting.... We are now in the fifth year of the second 5-year Central Bank Gold Agreement. This is the agreement by which central banks determined, at the outset of the millennium (in 1999), to rid their coffers of gold, the archaic relic, to the tune of 500 tons per year. As is well-known, Gordon Brown, as treasurer, had already drained Britain's coffers of "unwanted" gold before the present millennium began. Most other countries have been quick to follow in his footsteps. Now, with broad classes of financial assets revealed to be much more risky than central bankers had previously pretended, gold has suddenly (as has been the case from time immemorial) become a necessary holding to preserve financial stability.
"Sales of gold by European central banks are likely to be lower than expected over the next year as the global banking crisis boosts bullion's appeal as a 'safe' reserve asset.
"And banks elsewhere in the world, most notably in Asia and the Middle East, may even become buyers of gold in an attempt to diversify their reserves away from the dollar, analysts say.
"Under the terms of the Central Bank Gold Agreement, signed in 1999 by key European institutions including Germany's Bundesbank and the European Central Bank and renewed in 2004, members can sell up to 500 tonnes of gold a year.
"But in the fourth year of the latest agreement, which ended on Friday, sales fell well short of this ceiling, to just over 357 tonnes. (Ed: The lowest since 1999.)
"With banks worried by the outlook for the financial sector, sales could be even lower in the final year of the pact.
"'Given the damage done to a lot of other paper assets that were formerly considered secure, there will be greater risk aversion among central banks,' said Philip Klapwijk, executive chairman of metals consultancy GFMS. 'This will only boost gold's status within central bank reserves.'
"A key reason why central banks want to hold onto gold is the instability of their most common reserve asset, the dollar. "
Given fundamental conditions, in my humble opinion, gold should in fact presently be trading at twice that price. Of course, "should" is usually a dangerous word. Gold has no obligation to have any price other than that assigned to it by the market. Therefore, I am alleging neither that gold nor the market is at fault. What I am saying is that the market will change when perceptions change. Fundamental factors suggest that gold's present inherent value is roughly twice what people pay to buy and sell it today. Therefore, those who are buying gold today are, in my opinion, making a better decision than those who are selling it. Why? The sellers are giving it away under distress at "half price." The buyers are obtaining it at half price. I know which side of that trade I want to be on.
Our thinking has not yet caught up to reality in my view - but don't worry - it will.
Why? Because reality will inevitably catch up to us!!!
We are in the earliest stages only of the unwinding of excessive risk. We are "
whistling in the dark" if we believe that throwing taxpayers' (not yet earned) money at the problem will make it go away.
In fact, am not entirely opposed to the bailout scheme in the present context - it may help a great deal to maintain interbank liquidity by creating a temporary government-sponsored market for the purchase of unsaleable bank assets (
many but not all of which are of bad quality).
But the bailout will not resolve the fundamental economic weakness that is now upon us. Our present broad economic problems are a consequence of nothing less than financial
exhaustion. Every conceivable means of creating, slicing, dicing, and repackaging debt has now been tried - and the most ludicrous of them have utterly failed, undermining in turn even the considered plans of the most financially cautious and responsible of our citizenry.
We are
all impacted by the present financial epidemic. Despite the failures of multiple banks, the end of the government sponsored enterprises, and the end of investment banking on Wall Street, we still don't seem to have recognized this most fundamental fact....
There is much more to come in the way of economic weakness and difficulties. This is what happens when the extremes of the business cycle are amplified on both the upside and the downside by rampant speculation and recklessness at all levels of the economy.
That is, bigger upside - bigger downside. It is fairly symmetrical.
Consequences exist, and there is no simple way around them, other than simply paying the price of our prior irresponsible economic decisions.
At such historic junctures, citizens have always turned to gold to preserve wealth. This time will be no different.
At some point, therefore, the gold price will begin to reflect how deep and far-reaching the present risks actually are. My estimate is that an appropriate gold price right now would be approximately twice gold's present monetary exchange rate of roughly $800 per ounce. And that proposed doubling, in turn, is in all likelihood merely a stepping stone along the way in a greater historic process involving the fundamental revaluation of gold for decades to come.
We remain in the very earliest stages of placing an appropriate financial value upon the ability of gold to preserve value in a world that has fundamentally lost sight of what value actually is. Gold's price is as low as it is today (roughly equivalent to 1980s peak price level, disregarding 28 years of roaring inflation) because those who hold it have not yet fully considered its worth in their hands. When continued financial crisis makes that understanding more clear, the monetary amount we pay for gold is very likely to double from today's price in the $800 range.
The time frame for the present revaluation is likely to be quite brief in historical terms, though I lack the ability to predict when this price adjustment will occur. Obviously I believe that gold should be priced at $1600 today, and that is not yet the case. But do not doubt gold's power to accrete value to itself in times of crisis. It will come soon enough.
October 11, 2008: Note that the price of gold has moved $100 in a day twice in the past month (September 17 and October 10).
I take the recent volatility as evidence of the capability of gold to sustain price readjustments in increasingly larger steps. Gold has its enemies, and these powerful moves will not always be in favour of short-term oriented gold traders (as was certainly the case on October 10 - and will be again). But gold's increased recent volatility fundamentally equips the metal of kings to undertake the sort of powerful price revision that I am now suggesting. Note, however, that in my experience, gold rarely takes on value in other than unsettling ways to those who trust in its enduring power to preserve hard-won savings.
Gold is to some degree a wild beast that cannot be tamed by any single human interest group. Gold marches to its own drummer, and perseverance is required to reap the benefits of its undeniable strength relative to all other classes of investment. In fact, gold is in a category of its own. It cannot be likened to any other holding. Those who are unfamiliar with its unrestrained behaviour are as likely to be unsettled as as to be rewarded by owning it. So take this as a cautionary note! Riding the gold bull has never been easy, but it has inevitably been rewarding for those who have perceived correctly when its time to outshine all other investment options has come.
Inevitably, at some point over the next one to three years, gold will startlingly readjust our concept of what it is and of what it is able to do for those who choose to hold it. It is possible that no more than one more year will be required for this fundamental readjustment to occur.
This readjustment will constitute the first wave of the
golden tsunami that I am quite certain is
on its way even now.
Oh, and here's an interesting note. The 40-point percentage drop in the Dow over the past year is now the greatest on that index since 1900, including 1929-1930, the one-year period that kicked off the great depression. Note also how the present decline is at almost four times the magnitude of the 11% year 2000-2001 decline.
Of course, when you analyze the performance of the Dow in gold terms, the drop is greater still, reinforcing the failure of the Dow against gold that in fact began in the year 1999. Based on historic indicators, the Dow could
still lose 80-90% of its value in gold terms from here. At
Dow bottoms, the index is usually at or near
parity with the gold price. The primary question from here is whether gold rises that much or the Dow falls that much. This in turn will depend primarily on the extent to which inflation erodes the real value of the Dow - and enhances the monetary value of gold. That is, the greater the amount of inflation, the higher the nominal value of the Dow, and the greater the monetary cost of gold.
Many commentators have warned that US and world markets were in unprecedented bubble territory since the early to mid-1990s. The one-year decline of 2007-2008 seems finally to have
justified their warnings.
By the way, the only surprise for gold investors so far in the present market panic has been the extent to which the market has allowed the trading price of precious metal (and commodity) mining shares to fall. As the gold price has remained firm through the stock market correction, there can be little doubt that the earnings of the gold miners will be rising from year to year.
That is, the large miners will ultimately do fine, and their market value will certainly recover to better levels than before, but the same cannot be said for junior miners and explorers. There is now a crisis in the liquidity-dependent small capitalization gold mining and exploration sector.
Bottom line - mineral deposits are very expensive to find, and mines are expensive to permit, build and operate. Small mining and exploration companies depend upon the availability of capital through both the stock market and the banking and credit systems. Interestingly, if the various international inflationary
rescue plans that are now being contemplated bear fruit, the smaller miners will benefit doubly: (1) Any fix to the banking system that works (click
here for a
Canadian perspective) will again at some point make funds available for mineral exploration and mine development; and (2) the global financial repair, however it ultimately works out, will inevitably be extraordinarily inflationary in nature, giving greater value to the products of the miners.
If the rescue plans fail, which is of course a very real possibility, then the current pall over the small cap mineral and mining sector will surely be extended. Inevitably, the bigger miners who can fund exploration and development costs through their increasingly profitable production operations will then be snapping up the best of the juniors, as buyouts by producers will become the only method of funding new mineral exploration and mining ventures.
When this time comes, there will be one critical distinction between the depressed small cap mining sector and the mainstream business sector.... The assets of the explorers and mine developers will be appreciating in real value, even as the assets of consumer-dependent businesses and financial entities continue to fall in real value until such time as Western consumers recover from the credit and debt binge of the past three decades.
Here is another way to think about it. In an environment of coordinated international currency devaluation, currencies will inevitably lose ground against tangible assets. This is a time-honoured economic principle and historical truth that has never once failed to demonstrate itself. When currencies decline in value, things that are real take on value relative to currencies.
I have even begun to think of it this way. Commodities have already become the currency of a planet with a population of
6 billion, 850 million souls (
four billion of them Asians) who can easily live without the promises of banks and governments, but who cannot survive without things that are real. Tell me that as Asia rises its citizens will not require - or will fail to obtain as needed - iron, copper, nickel, zinc, lumber, agricultural produce or water. In our current inflationary environment, where governments are now frankly discussing trillions of dollars in rescue packages, the value of money is a fiction - whereas the value of things that are real cannot be questioned.
We also know that, unlike ourselves in the present age, Asians are savers. And while we in the West happily trade away our gold and silver, the savers of the East are snapping it up - in fact, more rapidly than we can hand it over to them, thus creating the recently reported shortages in the physical precious metal markets. Asians require iron and petroleum to live, but they will demand precious metals when they save. These are the fundamental facts in the background which are ever so visible, and yet simply not under discussion.
While we here in the West play with trillions of dollars in electronically created money, the savers of the East are taking a stake in the future through investment in precious metals and other tangible assets. This is the fundamental economic fact of our time.
Present global phenomena can thus be understood in the historical context of the rise of the East, which is a larger historical trend in the background of global economic developments. That is, Western economies are ultimately built on the backs of financially exhausted Western consumers. The distress has many years to continue. Alternatively, Asian economies have so far been built on the savings of thrifty citizens, who are only now entering the consumer marketplace at still quite a gradual pace. Many years of growth in Asia lie ahead, and Asia will become increasingly independent as this region of the globe moves towards domestic sources of revenue, and away from its present export-driven business models.
Now... if a sufficient body of investors can appreciate the subtle distinction between real and imaginary value, it is possible that the small cap mineral and mining sector might recover handily prior to its assimilation by large-scale miners. I for one would like to preserve the independence of the small miners and explorers, but I cannot realize this project alone. There will have to be a sufficient body of other investors who see it as I do.
Time will tell regarding the fate of the junior precious metal mining and exploration sector. My guess is that the timing of the golden tsunami will make it or break it one way or the other. That is, if the golden tsunami arrives sooner, say within the next year, small cap shares may recover quite quickly. Based on my thesis, their assets are literally enduring wealth stored in the ground. If the landfall of the tsunami is delayed by several more years, then the small cap sector will be bought up by the larger mining companies (who certainly understand the value of their assets), and we will see a massive consolidation of the mining sector.
It is ironic that in today's world, governments are spending trillions of dollars in anticipated taxpayer contributions to purchase financial assets that are worthless while at the same time, global investors are spurning the ownership of assets of enduring and appreciating value. But this is the world we live in... bizarre though it may be. There is no other.
18 July 2011: Better late than never. Gold topped $1600 for the first time today, with the recent high $1607.30. All I can say is, "There's more where that came from!"Here's the chart:
The rate of change is picking up...._
The "smartest man" visited Canada last week, and commented favourably on the Canadian investment scene. (I will add that this is in spite of the incompetent Conservative Party of Canada's running the show!).
The smartest man is Krishnamurthy Narayanan, and he is the manager of the contrarian US Dollar CI Global Opportunities Fund. His sister, Indra Nooyi, is the current CEO of Pepsico.) For the full article, visit the Globe & Mail site here:
"In a different era, The Smartest Man might have been a rocket scientist, or an engineer, or a medical researcher, or maybe a university professor. The academic résumé says: MBA, PhD in finance and economics from the Massachusetts Institute of Technology, studied under Paul Krugman, who just won the Nobel prize for economics. But this is – or at least was – the age of finance, and The Smartest Man became a hedge-fund manager, placing money on his views rather than just writing them.
"You buy Canada, says Mr. Narayanan, who can't believe the way the Loonie has been savaged. 'The currency is ridiculously undervalued. I can't think of any country in the world that has no fiscal deficit, no trade deficit and no inflation – except Canada. I think the Canadian dollar should go through parity.
He adds...
By the way, here is what Mr. Naryanan stated in his Globe & Mail interview over a year ago (September 11, 2007):
"It is speculative excess on mathematical steroids," he said. "Asset-backed commercial paper created mismatches on length of loan and length of borrowing. It was a classic case for a collapse."
I can't seem to find much to disagree with in what Mr. Narayanan is saying.
