A Look at One Chart Should Be Enough...

16 September 2012

I know that ratio charts are confusing to many.

Let me explain. The above chart depicts the ratio of the market value of the Toronto Gold Mining Stock Index (SPTGD) to the US dollar price of gold. That is, the value of the index is divided by the price of gold, on a daily basis, to create what is known as a "ratio chart."

What this chart is telling us is that the SPTGD index used to be valued at 0.723 times the price of gold (roughly 3/4 of the gold price) at its highest point, which was over 10 years ago, in May 2002. As you can see, physical gold has been a better investment than Canadian gold mining stocks for over ten years. And, despite their recent strong recovery, no real impression has yet been made on the long-term chart (as gold is rising rapidly too).

The funny thing is, gold mining is a much more profitable business now than it was back then, though arguably the 2002 ratio showed excessive early optimism. That is, as the price of gold rises, the margins of the gold miners increase, so their profits climb at a faster pace than the rise in the price of gold (though their costs are also escalating, to a lesser degree in most cases, for exactly the same reasons that the price of gold is rising).

However, if this ratio were simply to return to its longest-term stable value, which persisted from early-2003 to mid-2007, then we would be looking at a range of .40 - .55 in the ratio. Let's call its stable value ".50."

In other words, should the SPTGD:GOLD ratio recover its median value, it would appreciate 150% from where it is now (.195 as of September 14, 2012). That would be no small potatoes.

I think it will - because the deflation trade is now "over" (see previous posts).

Mark my words.

Though the trend has fallen from its stable value level for 5 years, I think we'll be back there within only about two years. What makes me say that? Look at the uptrend from 2000 to 2002 in the above chart (not the lower one). When this ratio climbs, that is the angle it tends to follow (you can see fractal slices of this same behaviour in the above ratio chart in later 2003, and in later 2008 to early 2009). For complex reasons, charts tend to repeat such patterns (the study of these patterns is known as fractal analysis).

So yes, in 2014, I expect to see a ratio in this chart of .50. Given that I am correct (only time will tell), where might the SPTGD index then be valued? (The chart of the SPTGD index itself is immediately below.)

I think it is conservative to suggest that gold, which is now on a "tear" due to announcements of global quantitative easing, is likely to be at the $2500 level in 2014. I believe a lower gold price than that in 2 years is unlikely, and that an even higher price is quite possible. But at $2500 gold and a 0.50 ratio in this chart. the SPTGD would be valued at more or less $1250. Where is it today? $346.60. That would represent an appreciation in the SPTGD of 261%.

Anything even close to this would also be no small potatoes.

What do bull markets do? They disappoint the impatient and amaze the persistent.

Think that's unlikely? Well, look at the SPTGD chart movement (second chart) between May 2005 and May 2006. In exactly one year, only 7 years ago, this index gained a full 122%. And earlier, between late 2000 and May 2002, the SPTGD index gained 180%, this time in 1-1/2 years. So what I'm saying is that a similar uptrend, persisting for 2 years, could very possibly lead to appreciation of more than 200%.

Again, why is this possible? Because the deflation trade is over. It changes everything for gold and gold mining investors.

Don't get shaken off by volatility, which isn't going to go away....

My advice: Persist, and prepare to be amazed.

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Economics 00000002

15 September 2012

I've been arguing lately that economics is easy. Here is the advanced level....

Just caught this nugget from Warren Buffett:

"Value investors are not concerned with getting rich tomorrow. People who want to get rich quickly, will not get rich at all. There is nothing wrong with getting rich slowly."

Also see: Economics 00000001.

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Economics 00000001

15 September 2012

I commented on September 13, 2012 that I didn't have much more to say about gold investing. However, people do sometimes approach me and tell me that they don't understand economics.

Actually, there is nothing easier than economics.

Here is is.

1. If you save money, you will do well.

2. If you borrow money, you will do poorly.

3. High interest rates encourage people to save money.

4. Low interest rates encourage people to borrow money.

The Federal Reserve has just "promised" that (short-term) interest rates will remain very low (near zero) until at least mid-2015. They are also printing $40 billion new dollars every month to make it easier for people to borrow money.

How do you think we will do?

Here ends the lesson.

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Mr. Draghi Is Sterilizing His Purchases, What Could Possibly Go Wrong?

6 September 2012

This post is being entered quickly, so it is for "those in the know." If You don't understand what Mr. Draghi just did (explanation here), then this post will not be much help to you.

My thoughts on Mr. Draghi's plans to buy the debt of troubled Euro nations and "sterilize" it by selling the central bank's best-quality assets follow (originally posted here):

Obviously Mr. Draghi will do unsterilized sovereign bond buying at some point. Even with supervision, the PIIGS will be badly behaved. But I don't think he can just print right away.

On the upside (for him), he doesn't have to raise German cash or sell German debt IF he prints new Euros and buys the sovereign debt of the PIIGS without obtaining "real" money from the better-off EMU members. It seems to be a process. The original rules under which the Euro was constructed are going out the window, one by one. It seems only the Germans have a long memory. However, the EMU had, until recently, been a win-win game for all the players. Greece got to pretend there is no tomorrow. Germany boosted exports. France got to play both sides.

Now, the only course of action that will keep the win-win equation going a little while longer will be unsterilized purchases of "junk" government debt. If the junk is bought with printed money, then it is nobody's (and everybody's) obligation. What could be the downside? Apart from the certainty of ultimate currency collapse, it's looking pretty cheery out there.... Currency destruction is obviously a problem for another day.

With new Euros, China benefits, etc., etc. It's all a big, globally connected, spinning wheel (until the wheel comes off the cart). But let's deal with that chapter when we get there. Certainly the precious metal market is having no trouble figuring it out. The gold buyers are voting with their feet. So why don't the Germans just buy gold? Everybody's happy, and Germany still wins.

8 September 2012: OK. More information is in. The plan is to encourage deposits at ultra-low interest rates, and thus take money out of circulation in exchange for the purchases of "junk" sovereign bonds of no more than 3 years' duration (the shorter term chosen presumably to reduce risk).

Hmmm. Exactly why would this work? The take-away is that the junk is going to get bought to keep the Euro currency wheel spinning a while longer, perhaps much longer. But, exactly how is this ever going to play out over the medium to long-term? Why would I, or any entity, wish to give the ECB my hard-earned cash on deposit, knowing that the central bank is decimating its asset base with the worthless government bonds of profligate Eurozone nations? This does not add up on so many levels!

Here is the current situation and its implications, according to the WSJ. Interestingly, business confidence is so low at this time, it's easy right now to get partners to park cash with the ECB for vanishingly low interest:

In principle, “sterilization” is a process that ensures that individual actions by the central bank don’t result in an overall increase in the money supply. Monetarist theory dictates, after all, that it is excessive monetary growth that leads to inflation, which is what the ECB is exclusively mandated to guard against.

Every week since it started buying bonds under its old Securities Markets Program, the ECB has withdrawn from circulation an amount of money equivalent to what it had spent so far in buying them. For the last six months, this figure has hovered around €210 billion. The amount falls as the bonds it holds mature.

It has done this by offering one-week deposits to the banking system. Banks bid competitively for the deposits, and the rate bid has tracked the ECB’s own overnight deposit rate very closely. It has been only fractionally above zero since the ECB last cut its deposit rate in July.

Fears that it would prove difficult for the ECB to sterilize such a large amount of money regularly have so far been unfounded. On the few occasions when it has failed to auction the full amount of deposits, it has been due to exceptional, technical factors in the money market which have never lasted beyond a day or two.

This situation might change if the ECB and the euro zone succeed in restoring so much confidence to the region’s financial markets and economy that banks start again to lend to each other, and to businesses and households. Before the crisis, the private sector routinely created a multiple of the money created by the central bank.

But the link between central bank money and privately created money has changed beyond recognition since 2007. Growth in broad money aggregates has collapsed despite the ECB more than doubling the size of the monetary base, which typically consists of cash in circulation plus banks’ reserves at the central bank.

As of today, the precautionary hoarding of reserves by euro-zone banks is so great that banks are holding over €770 billion in excess reserves in accounts at the ECB, voluntarily “sterilizing” money the ECB created without forcing it to lift a finger.

The ECB is sterilizing another €209 billion by paying only 0.01% on the deposits it auctions. In the current environment, it does not seem like the ECB would struggle to withdraw from the market any amount of liquidity it wanted to. Even so, the numbers implicit in the ECB’s new bond-buying scheme are daunting. Excluding treasury bills, there are some €390 billion in Italian bonds that fall due in the next three years.

For Spain, the number is €203 billion, for Portugal and Ireland combined, another €50 billion, according to national debt agency data. In all, a total of over €640 billion. Of this, it seems likely that the ECB already holds — and sterilizes — a large part of its €209 billion SMP portfolio. There are no precise data yet on the ECB’s holdings, but only around 40 billion euros is accounted for by Greece.

Thus the amount that the ECB needs to sterilize could easily double or treble from its current level. This may incline it to sterilize more over a longer time-frame of a month or three months or even more, so as to reduce the potential for volatility in the money market. The ECB has already examined such options internally two years ago, but chose not to proceed.

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Art Cashin Correctly Identifies August 1971 As the Date of Our Downfall

1 September 2012

Art Cashin recently identified August 1971 as "the most disastrous moment in US history." I concur.

His article is here:

The Most Disastrous Moment In US Economic History Occured In August 1971

My comments to other readers (whom I thought missed the point of the discussion) are here:

Uh. I think we are forgetting the real question here. Do we want our currency to be stable in value, or to be a plaything of the central banks and politicians? I for one opt for the former. Fixing the currency to something real of course achieves that purpose more effectively than any other known strategy.

Humans are still emotional, so the gold standard doesn't "fix" problems, rather, it prevents their development, and that is what is at issue here. When the currency is unstable, the citizenry are literally forced into speculative assets as a means of preserving wealth. You don't have to agree on all points with Mises to see that easy money promotes capital misallocation, as we've had boatloads of that since at least the Vietnam war, and in spades since the advent of the Greenspan/Bernanke era.

Would preserving the gold standard have created a "perfect" financial world? Of course not. But we would have averted the worst of the excesses of the past 4 decades, and savers/investors, rather than speculators and manipulators, would have been rewarded.

The current US economy is hugely allocated to the practice of financial management (and law). Doug Casey identifies financial management alone as accounting for roughly 22% of the US economy (it should be more on the order of 1%). This is because value is being destroyed everywhere, and savers are desperate.

The world economy is imbalanced towards the holders of real assets - oil in the Middle East and Asia and cheap labour in southeast Asia. Islamic extremism has been funded by inflationary monetary policy, which has run up the price of Middle Eastern oil. The present regime is a disaster, and none of our political leaders has a plan to deal with it (apart from Mr. Paul, with whom I certainly do not agree on all points).

Was the abandonment of the gold standard the worst event of the second half of the twentieth century? Yes, certainly. Mr. Cashin is absolutely correct here.

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