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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The US Dollar Is Well on its Way to Equivalency with Monopoly Money

3 August 2012

This wonderful graphic comes from Jim Sinclair.

Take your pick.

There is now little difference remaining between the two.

And... think before you act!

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Roubini Predicts a "Global Perfect Storm" for 2013

9 July 2012

As you know, in the world of investments, very little can happen for lengthy periods, and then profound changes can impact the markets in periods of only days and weeks. Think 2008, for example.

Nouriel Roubini is suggesting that 2013 could make the year 2008 pale by contrast.

On July 7, 2012, he made the following points:

· "By 2013, the ability of policy makers to kick the can down the road is going to run out of steam.

· "In the Euro-zone the slow-motion train-wreck could become a faster-motion train wreck.

· "The U.S. looks close to stall-speed and a recession, given the latest economic data. The landing of China is becoming harder rather than softer.

· "The other emerging markets are all sharply slowing down in terms of growth--the BRICs, China, Russia, India, Brazil, and also Mexico, Turkey. Partly it's because there's a recession in the Eurozone and U.K., partly it's because they're not doing their reforms.

· "And finally there is the time bomb of a potential war between Israel and the U.S. and Iran. Negotiations have failed. The sanctions will fail. Obama doesn't want a war before the election, but after the election, regardless of whether it is Obama elected or Romney, chances are the U.S. is going to decide to go and attack Iran and then you'll have a doubling in global oil prices overnight.

· "So, it's the perfect storm! You could have a collapse of the Eurozone, a U.S. double-dip, hard-landing of China, hard-landing of emerging markets, and a war in the Middle East. Next year could be a global perfect storm."Well, it's much worse, because like 2008 you have an economic and financial crisis, but unlike 2008, you're running out of policy bullets. In 2008, you could cut rates from 5%-6% down to zero, do QE1, QE2, QE3, you could do fiscal stimulus up to 10% of GDP, you could backstop a guarantee bailout of banks and everybody else. Today, more QEs are becoming less and less effective because the problems are of insolvency not illiquidity. Fiscal deficits are already so large that everybody has to cut them, not increase them. And you cannot bail out the banks because (1) there is political opposition to it, and (2) governments are near insolvent and they cannot bail out themselves, let alone bail out the banking system.

· "So the problem is that we are running out of policy bullets. We're running out of policy rabbits to pull out of the policy hats compared to 2008. So if a freefall of markets and economy does occur, you don't have any more of a safety net of enough policy bullets to try to absorb the shocks, because we've been spending the last 4 years using 95% of those bullets. So we are running out of bullets."

Thanks to Business Insider for this forewarning!

I am taking him seriously on this one.

Be alert!

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Differential Rates of Currency Decay Explain Europe's Unsolvable Dilemma

10 June 2012

Quick comment.

Since the nations of the world, led by the example of the United States, aboandoned the gold standard, all of them have allowed their currencies to decay at a steady clip. We call it "inflation," perhaps a euphemism. My suggestion, we should call currency destruction what is is, "currency decay."

If you understand this concept, you will understand the present problem with Europe.

In brief, the Deutsch Mark, if it stil existed, would rise relative to other currencies, as German monetary policy is less inflationary than that of most other major nations. Note - it is still inflationary, just less so relative to the policies of its peers.

In brief, this is why the European Monetary Union is failing. Greece has always permitted a rapidly decaying currency, as Greek citizens have a habit of taking long holidays, retiring at 60, not paying income and property taxes, and not even paying for government-provided services, including electricity. Similarly, Spain, Portugal and even Italy are "relaxed" when compared to the more industrious French and German economies.

So what we are seeing now is currency decay to the point of outright "rot" in Greece, and quickening currency decline in Spain (with Portugal, Italy, Ireland and certainly others "following along").

How does one maintain monetary union in such a case?

In brief, it can't be done.

The nations with slowly decaying currencies must continuously bail out those that tolerate more rapid decay and outright decomposition, with Greece being the current poster child.

It's not fixable.

(Thanks to Hookedblog for today's images.)
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What Is Wrong.... A One-Paragraph Summary

7 June 2012

This is a paragraph that I wrote to a liberal friend today (slightly expanded from the original):

I am not a conservative, but I also differ with many liberals, so I'm not sure what category I fall in. I believe in free markets, but our present market is manipulated. Our corporate "titans" seem to manage businesses for themselves, not for their shareholders. General Electric Corporation, as an example, has shed 58% of its value since the year 2000, and the broad markets have punished shareholders for 12 years. The ultra-rich are taking everything private, and closing out public participation in ownership of assets. Governments are adding gatekeepers and regulators, and shedding service providers, builders and maintenance workers. The income tax code is a Byzantine labyrinth that favours the rich and punishes the middle class. We are conducting costly wars on drugs, privacy and terror. Paul Krugman is calling for more debt, which cannot possibly work long-term (look at Japan for a trip down that road). Unions are losing the battle to protect their members, but winning the battle to prevent young people from entering the workplace. I hope you grasp my dilemma. It seems that everyone on both the left and the right is doing exactly the wrong thing. My personal investment strategy (precious metals) is predicated on the assumption that decision-makers everywhere, given a choice, will take action without consideration of long-term consequences. Our governments are accumulating debts that the young cannot pay, and the prospect is that we shall all be taxed at ever greater levels in order to fund the ballooning cost of a world that none of us wants. There are of course bright spots out there, but the broad trend is as negative as I have ever seen.
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The Market is an Instinctual Beast

31 May 2012

I've been thinking about the behaviour of markets lately. While there is a theory of "rational markets," I don't think it can be defended.

Better Mr. Keynes' trenchant observation, "Markets can remain irrational a lot longer than you and I can remain solvent!"

Indeed.

Rather, I argue that markets are instinctual beasts.

Having had years of experience horseback riding in the Canadian Rockies, I can attest that the horse is a very instinctual animal. It is also unstoppable when under the immediate influence of instincts such as "fight or flight," "startle," or "running with the herd." As the average horse weighs a half ton, basically, you don't stand in the way of an instinctual beast that is many times your own weight.

So too, we should not stand in the way of the market when its instincts are triggered. You have to "go with" the market, though obviously we can "steer" by choosing where we place our investments!

Another image of the market as an instinctual animal references the seasonal instincts of the birds. Right now, the robins are building their nests. As I have about 300 trees surrounding my home, I'm seeing lots of robin activity, right now. A naive investor might therefore conclude that the best place to invest is in nest-building materials.

However, as the seasons change, the instinctual behaviour of the robins will alter as well. Based on my own experience, after nest-building comes the territorial defense of the anticipated, and then the newly-hatched young.

And of course, the seasons change again, as they do in their cycles, and soon enough, all of the seasonal brids will leave, flying south. Those invested in nest-building materials will experience a "bear market."

Then it shall be widely assumed by the market that, as robins no longer live here, robins simply aren't a good investment. Until, of course, they return the following spring. The instinctual beast does not think that far ahead!

And so it goes with the markets.

Bill Fleckenstein observed this week, "the market is playing checkers, not chess." It thinks ahead, but only in somewhat obvious ways.

My present take is that the markets have been in a so-called "risk off" mode since 1999-2000, which involves moving out of equities and into government and other bond instruments. (In fact, the original move to bonds occurred with the ascent of Paul Volcker at the Federal Reserve, as, due to his influence, the prime rate peaked at 21.5% in December 1980, though that is another story.)

Now it is no secret that inflationary monetary policy relies on low interest rates to enable the jugglers to keep all their bowling pins in the air.

Of course, when inflation is in vogue, debts accumulate, and ultimately, this undermines the foundation of the bond market, as investors grow concerned about inflation eating away at their investment (as governments rely on monetary inflation to make debt repayment "affordable").

Bond buyers then demand higher interest rates as a "risk premium." This is what's happening in Greece, Spain and Italy right now. But countries with printing presses are accorded continuing low rates, as we are all willing to pretend - for a season - that inflation is not real.

Now it is my prediction that the seasons of the market will change yet again - it would hardly be surprising to anyone with a historical view. I suggest further that with the next seasonal transition, the markets' instunctual responses will also shift - and dramatically so!

When the robins have flown south, bonds will be viewed as vulnerable to devaluation by inflation (it's already happening, as I've written many times, but we simply pretend it's not).

The "risk off" instinct towards bonds has prevailed for 12 years, with a seemingly solid 20-year foundation undelying the recent era of the dominance of bonds. But this season, too, shall change, as all seasons do.

Now, when the instintual behaviour of the market next shifts, what should we expect?. In my view, bonds will become the next "risky" asset, and investors will begin to flee them in droves, with bonds emerging as "the next bear market." Today's ultra-low, even record-low bond interest rates will prove unsustainable, just as did investing in the nest-building business.

So if "risk off" is the current instinct of the market, driven by the buying of the bonds of governments that print their own money, what then shall be the next instinctive market trend?

Well, bonds will remain in a bear market, probably for a very lenghty period. The stock market, already dead in the water for 12 years, is not set to recover any time soon.

My prediction is that the next season will be that of the treasure hunter - dominated by those seeking "security" through a search for value. The new treasure seekers will dig much more deeply than today's "risk off" traders, who have little more than herd instinct to guide them.

Where have treasure hunters always looked? You know and I know that the object of the treasure hunter is gold, and this is where the instinctive behaviour of the market will turn next.

So, my advice is to find your treasure now, by holding your savings in precious metals and in the stocks of companies that mine or derive royalties from precious metal production.

I wish successful treaure hunting to you all!
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