James Turk: We Are In A Money Bubble Which Will Lead To A Fiat Money Collapse

Alasdair Macleod: What drives credit cycles and why the next credit crisis may be imminent

In this speech, given in Brussels to the Ludwig von Mises Institute Europe on 18 November, Alasdair Macleod, Goldmoney’s Head of Research, explains how the expansion of bank credit evolved following the 1844 Bank Charter Act in English law. 

Alasdair explains why bank credit expansion always leads to a crisis, and why the cycle of boom and bust has been repeated ever since. Special emphasis is given to the combination of bank credit expansion between 1922-29, when the Smoot Hawley Tariff Act was then passed by Congress on 30 October 1929. That month saw the Wall Street Crash, and by mid-1932 Wall Street had fallen by 89%. 

Today, there are striking similarities with that period. We have had a greater level of bank credit expansion since the Lehman Crisis, and a tariff war has erupted between the world’s two largest economies. 

Alasdair goes on to suggest the recent Repo failure in New York may turn out to be an important signal of impending systemic failure, echoing the events in October 1929, when capital markets suddenly realized the party was over and greed turned rapidly to fear.

- Source, James Turk's Goldmoney

Plans for a Global Dystopia

There appear to be policy areas being driven by statist responses to events, encouraging global institutions to take on a coordinating role. It means deeper levels of centralised planning by unaccountable bureaucrats. Assuming their plans continue to gain credence, we could end up with a dystopian world where supranational bodies direct individual governments to conform. We are already on this road to perdition. The OECD has coordinated attempts by governments to restrict the freedom of their citizens to avoid taxes by forcing over a hundred jurisdictions to automatically supply information on the financial affairs of every citizen, irrespective of nationality and where they reside.

By doing so, it has removed the necessity for governments to moderate their tax demands for fear that individuals will move their money out of reach. Information on private affairs are now exchanged automatically by banks, lawyers, financial advisors and accountants, without the individual’s knowledge. As a result of the introduction of the OECD’s common reporting standard, the organisation claims that over $85bn of additional tax revenue has been raised. The intention is to raise more, much more.

This has been the OECD’s mission for some time, leading the way for other supranational organisations to carve out roles for themselves. Ones that come to mind are the IMF, which with a green agenda intends to prioritise investment funding for alternatives to fossil fuels both directly and indirectly through the World Bank and the regional development banks. Subsidiary roles are likely to be played by other UN divisions, useful for binding emerging market nations to the plans.

Central banks acting in concert could have a new role of coordinating a monetary reset, which as we can deduce from Mark Carney’s speech at Jackson Hole in August is already being discussed. We shall start by looking at the state of current monetary policies, their failure, and the drive to replace them with something else, before addressing the energy question.

The monetary problem

There are two categories of folk who think everything to do with economics and money are not much to worry about; the disinterested public and the investment management community. Their livelihoods depend upon it. Another category, libertarians, Austrian economists, bitcoin fans, gold bugs and readers of and contributors to agglomerating sites such as ZeroHedge have views ranging from sceptical to downright catastrophic. Not known to many is another, the most important category, which is very worried indeed, and that is governments and their central banks.

These are the people quietly talking about a big-picture reset, those that know the post-Breton Woods fiat dollar system is no longer fit for purpose. They see escalating debt, interest rates failing to stimulate, and economic stagnation. They see a mismatch between international trade and the use of the dollar as a global settlement medium. They don’t talk about it much, to do so would frighten us, the lowly ruminants.

I was ruminating on this recently after Max Keiser, of the Keiser Report on RT, asked me what I thought of Mark Carney’s speech at Jackson Hole in August about a global monetary system to replace the dollar. I replied something about Carney about to retire, and presumably feeling slightly freer to express the concerns which he must share with his friends at the Bank for International Settlements, and various other monetary panjandrums who have observed the obvious: their cosy world of money-printing doesn’t work, is unlikely to ever work, and must be reformed to give them more control.

Since then my thoughts have turned to the reset problem in a broader sense. The assumption must be that time is available for such an event to be planned, or at least pre-planned as an insurance policy against monetary failure. In either event, it is putting the cart before the horse, because when a credit crisis hits it invariably takes the authorities by surprise, and it looks increasingly close in time. The priority will not then be monetary evolution but economic and financial rescue.

That point having been made, from the central bankers’ point of view, what is to be done? The obvious answer is to rig the game by changing the rules. As Keynes said, when the facts change, he changed. That way, they think they might dispose of the failing system and replace it with an updated one that suits their policy purposes better. With a bit of luck, declining confidence in the old will be replaced by a new paradigm, something that will allow them all, politicians and central bankers, to claim success for saving the Western world from a potential monetary crisis.

The problem is they don’t know how to do it, and they don’t yet know what the new paradigm will be. There is no unity on the matter, because for the Fed and the US Government it involves an unacceptable loss of monetary and political power. The Chinese, in partnership with the Russians, want to do away with the dollar, while the Europeans are leading themselves to a socialist dystopia at odds with Trump’s America, while being frightened of the Russian bear in the east.

This is why influencers like Carney can only hypothesize about a new monetary set-up involving a reduced role for the dollar. Central banks are exploring cryptocurrencies. It is reported that seven out of ten of them are researching the possibilities. That won’t save fiat currencies, but it might give central banks greater control over how their fiat currencies are used. Perhaps they think a state issued cryptocurrency can replace unadorned fiat. But then that raises two issues: if the existing fiat is failing it is likely a new state-sponsored cryptocurrency risks having a credibility problem from the outset and even if the public does accept it, its future issue will have to be strictly limited and the cycle of bank credit properly addressed.

But get it right and markets could be tamed, the logic goes. And somehow, a global cryptocurrency-based monetary system for international trade could replace the failing post-Bretton Woods monetary system reserved on the US dollar. For policy makers, it is becoming an urgent question, as a reading of Carney’s Jackson Hole speech makes clear.[i]

Specifically, in his speech Carney identified the existence of a global liquidity trap nullifying interest rate policy with three elements: a global savings glut tied up in dollars, a reduction in the scale of sustainable cross border flows and “fattening of the left-hand tail and increasing the downside skew of likely economic outcomes”.[ii] This last element of gobbledegook appears to translate into an acknowledgement of the failure of current interest rate policy to stimulate economic recovery, which cannot be admitted in plain English.

Carney’s problem, besides the veiled admission of policy failure, is he ignores the fact that America needs increasing quantities of foreign dollar ownership to fund its escalating budget deficit, without which the dollar fails, and term interest rates will soar. If he and his cohort push policies intended to redeploy funds that are otherwise destined for the dollar and US Treasuries, they will face strong opposition from the US Treasury and being based on the dollar, the likely collapse of the whole fiat edifice.

As for a reduction in cross border flows, that is a function of falling cross-border trade, not money. The reason cross-border trade has collapsed is because of the US-Chinese trade spat and its knock-on effects. Even if we pass on the gobbledegook of his third point, it is difficult for an independent observer not to take Carney’s speech as indicative of desperation, ivory-tower economic error or both.

Being based on Keynesian macroeconomic beliefs, we can take the evidence of economic error for granted, particularly since these beliefs have consistently failed to deliver any credible solution. It is the element of desperation we must explore further. If Carney feels a sense of desperation (and his speech reeks of it) then his fellow central bankers will as well. But instead of just abandoning failed policies, a bridge is required towards a new set of policies, a monetary reset. And it will almost certainly involve a greater suppression of the role of markets and an increase in state control over money and how it is used.

For central bankers, there is a fear that the emergence of a competing private sector crypto-payments system, even linked to a basket of fiat currencies, will challenge national currencies. They would have to be pretty dopey not to see that Bitcoin in particular is educating the masses about the moral fraud behind the expansion of fiat money. The challenge will be to come up with a credible alternative, completely under the control of a few major central banks. But first, the purpose of a state-backed cryptocurrency must be settled.

For every nation other than America, evolution from the failing post-Breton Woods monetary system is about reducing the role of the dollar in trade settlement and freeing up capital needlessly tied up in dollars. Before the invention of cryptocurrencies, this would presumably have been achieved through a combination of an evolutionary process and increasing use of currency swaps to enhance liquidity, particularly in euros and renminbi, to replace the dominance of dollars in reserve balances.

The facilitation of foreign trade appears to be the role most likely to be destined for a state-issued cryptocurrency. Initial swap lines of state-sponsored cryptocurrencies would be proportionate to the trade between existing currency blocks. It could then be deployed for trade settlement, which would require it to be made available to commercial banks. We then have two currency versions: an existing fiat currency which circulates domestically and a separate blockchain based currency reserved for international use. With an onshore and offshore version, there can be two interest rates suitably set for their applications, so long as arbitrage routes are severely restricted, with the offshore version trading at a premium.

Old hands in Britain will be familiar with the basic concept, before Margaret Thatcher removed exchange controls. To monetary planners, there are several perceived benefits from such a scheme, particularly for the Eurozone. By separating trade settlement from domestic currency circulation, de facto currency controls are introduced, permitting access to the state crypto currency to non-domestic trading entities and banks, while denying its use in the domestic economy. Importantly, the expansion of bank credit would be retained for the domestic currency only, managed through a two-tier interest rate policy.

Any investment in foreign currencies would require the payment of the premium that applies on the crypto version of the currency. The prospects of an international run against a currency such as the euro would recede, as the existing liquidity for international trade is replaced by a centralised, highly managed, trade-related cryptocurrency.

For policy makers at the ECB it must be a tempting solution if it can be made to work. It would give them greater monetary control overall, and they could attempt to stimulate the Eurozone economy by deploying deeper negative rates without the fear of a failing exchange rate.

From America’s point of view these moves or anything like them will almost certainly be strongly resisted. They need foreigners to buy dollars to fund the budget deficit. And they are now experiencing the flaws of US isolationism and Trumpian trade policies, which are already leading to a contraction and potential reversal of foreign flows into US Treasuries.

China would be an interested observer of these developments. She has been planning to issue a cryptocurrency of her own, which could allow her to internationalise a crypto version of the renminbi more rapidly than it has managed with its existing renminbi. Russia has already ditched the dollar for geopolitical reasons and is trying to gain control over the energy market from a moribund OPEC.

To summarise, discontent with the post Bretton Woods monetary system and the disproportionate role of the dollar are likely to be the reasons why so many central banks are looking at cryptocurrency solutions. But as stated at earlier in this article, it assumes pre-planning, those best-laid schemes of mice and men, are not overtaken by events...

- Source, James Turks Goldmoney, read more here

The Rise and History of Central Banking

Following the Barings crisis in 1890 the concept of a lender of last resort was widely seen to be a solution to the extremes of free markets. Initially, this meant that the bank nominated by the government to represent it in financial markets and to oversee the supply of bank notes took on a role of coordinating the rescue of a bank in difficulty, in order to stop it becoming a full-blown financial crisis. When the gold standard applied, this was the practical limitation of a central bank’s role.

This was the general situation before the First World War. In fact, even under the gold standard there was significant inflation of base money in the background. Between 1850 and 1914 above ground gold stocks increased from about 5,000 tonnes to nearly 24,000 tonnes. Not all of it went into monetary gold, but the amount that did was decided by the economic actors that used money, not the monetary planners as is the case today.

It was against this background that the US Federal Reserve Bank was founded in December 1913. Following WW1, it became a powerful institution under the leadership of Benjamin Strong. Those early post-war years were turbulent times: due to war time inflationary financing, wholesale prices had doubled in the US between 1914-1920, while the UK’s had trebled. This was followed by a post-war slump and by mid-1921 unemployment in the UK soared to 25%. In the US, the Fordney-McCumber tariffs of 1922 restricted European debtors from trading with America, necessary to pay down their dollar debts. A number of countries descended into hyperinflation, and the Dawes plan designed to bail out the Europeans followed in 1924.

While America remained on a gold standard, Britain had suspended it, only going back on to it in 1925. While the politicians decided overall policy, it was left to central bankers such as Strong at the Fed and Montague Norman at the Bank of England to manage the fallout. Their relationship was the most tangible evidence of central banks beginning to cooperate with each other in the interests of mutual financial stability.

With the backing of ample gold reserves, Strong was an advocate of price targeting through the management of money supply, particularly following the 1920-21 slump. His inflationary policies assisted the management of the dollar-sterling exchange rate, supporting sterling which at that time was not backed by gold. Strong also made attempts to develop a discount market in the US, which inflated credit markets further. One way and another, with the Fed following expansionary money policies and commercial bankers becoming more confident of lending prospects, monetary inflation fuelled what came to be known as the roaring twenties.

That came to a sharp halt in October 1929 when the credit cycle turned, and the stock market crashed. Top to bottom, that month saw the Dow fall 35%. The trigger was Congress agreeing to the Smoot-Hawley Tariff Act on 30 October, widely recognised at the time as a suicide note for the economy and markets, by raising trade tariffs to an average of 60% from the Fordney-McCumber average of 38%. President Hoover signed it into law the following June and by mid-1932 Wall Street had fallen 89%.

With such a clear signal to the bankers it is not surprising they drew in their horns, contracting credit, indiscriminatingly bankrupting their customers. All the expansion of bank credit since 1920 was reversed by 1934. Small banks went bankrupt in their thousands, overwhelmed by bad debts, particularly in the agricultural sector, as well as through loss of confidence among their depositors.

The depression of the 1930s overshadowed politics in the capitalist economies for the next forty years. Instead of learning the lessons of the destruction wrought through cycles of bank credit, economists doubled down arguing more monetary and credit inflation was the solution. To help economic sentiment recover, Keynes favoured deficit spending by governments to take up the slack. He recommended a move away from savers being the suppliers of capital for investment, with the state taking a more active role in managing the economy through deficit spending and monetary inflation.

The printing of money, particularly dollars, continued under the guise of gold convertibility during the post-war Bretton Woods system. America had enormous gold reserves; by 1957 they were over 20,000 tonnes – one third of estimated above-ground gold stocks at that time. It felt secure in financing first the Korean then the Vietnam wars by printing dollars for export. Unsurprisingly, this led to the failure of the London gold pool in the late 1960s and President Nixon suspending the fig-leaf of dollar convertibility into gold in August 1971.

Once the dollar was freed from the discipline of gold, the repeating cycle of bank credit was augmented by the unfettered inflation of base money, a process that has continued to this day...

- Source, James Turks Goldmoney

150 years of bank credit expansion is near its end

So that we can understand the financial and banking challenges ahead of us, this article provides an historical and technical background. But we must first get an important definition right, and that is the cause of the periodic cycle of boom and bust. The cycle of economic activity is not a trade or business cycle, but a credit cycle. It is caused by fractional reserve banking and by banks loaning money into existence. The effect on business is then observed but is not the underlying cause.

Modern banking has its roots in England’s Bank Charter Act of 1844, which led to the practice of loaning money into existence, commonly described as fractional reserve banking. Fractional reserve banking is defined as making loans and taking in customer deposits in quantities that are multiples of the bank’s own capital. Case law in the wake of the 1844 Act, having more regard to the status quo as established precedent than the fundamentals of property law, ruled that irregular deposits (deposits for safekeeping) were no different from a loan. Judge Lord Cottenham’s judgment in Foley v. Hill (1848) 2 HLC 28 is a judicial decision relating to the fundamental nature of a bank which held in effect that:

“The money placed in the custody of the banker is to all intents and purposes, the money of the banker, to do with it as he pleases. He is guilty of no breach of trust in employing it. He is not answerable to the principal if he puts it into jeopardy, if he engages in haphazardous speculation….”

This was undoubtedly the most important ruling of the last two centuries over money. Today, we know of nothing else other than legally confirmed fractional reserve banking. However, sound or honest banking with banks acting as custodians had existed in the centuries before the 1844 Act and any corruption of the custody status was regarded as fraudulent.

This decision has shaped global banking to this day. It created a fundamental flaw in the gold-backed sound money system, whereby the Bank of England, as a prototype central bank, could only issue extra sterling backed entirely by gold. Meanwhile, a commercial bank could loan money into existence, the drawdown of which created deposit balances. The creation of these deposits on a system-wide basis meant that any excesses and deficiencies between banks were easily reconciled through interbank lending.

Bankers’ groupthink and the credit cycle

While an individual bank could expand its balance sheet, the implications of all banks doing the same may have escaped the early banking pioneers operating under the 1844 act. Thus, when their balance sheets expanded to a multiple of the bank’s own capital, there was little cause for concern. After all, so long as a bank paid attention to its reputation it would always have access to the informal interbank market. And so long as it can call in its loans at short notice, the duration mismatch between funding by cash deposits and its loan book would be minimised.

Since the Bank Charter Act, experience has shown the expansion of bank credit leads to a cycle of credit expansion, over-expansion, and then sudden contraction. The scale of bank lending was determined by its management, with lenders tending to be as much influenced by their own crowd psychology as by a holistic view of risk. Of course, the expansion of bank credit inflates economic activity, spreading a warm feeling of improving economic prospects and feeding back into increasing the bankers’ confidence even further. It then appears safe and reasonable to take on yet more lending business without increasing the bank’s capital.

With profits rapidly increasing due to lending being a multiple of the bank’s own capital, confident bankers begin to think strategically. They reduce their lending margins to attract business they believe to be important to their bank’s long-term future, knowing they can expand credit further against a background of improving economic conditions to compensate for lower margins. They begin to protect margins by borrowing short from depositors and offering businesses term loans, reaping the benefits of a rising slope in the yield curve.

The availability of cheap finance encourages businesses in turn to enhance their profits by increasing the ratio of debt to equity in their businesses and by funding business expansion through debt. By now, a bank is likely to be raking in net interest on loan business amounting to eight or ten times its own capital. This means that an interest margin of a net two per cent is a 20% return to the bank’s shareholders.

There is nothing like profitable success to boost confidence, and the line between it and overconfidence is naturally fuzzed by hubris. The crowd psychology fuelled by a successful banking business leads to an availability of credit too great for decent borrowers to avail for themselves, so inevitably credit expansion becomes a financing opportunity for poorly thought out loan propositions.

Having oversupplied the market with credit, banks begin to expand their interests in other directions. They finance businesses abroad, oblivious to the fact that they have less control over collateral and legal redress generally. They expand by entering other lines of banking-related business, assuming their skills as bankers can be extended into those other business lines profitably. A near-contemporary example was Deutsche Bank’s failed expansion into global investment banking and principal trading in foreign securities and commodities. And who can forget Royal Bank of Scotland’s bid for ABN-Amro, just as the credit cycle peaked before the last credit crisis.

At the time when their balance sheets have expanded to many multiples of their own capital, the banking crowd then finds itself with lending margins too low to compensate for risk. Bad debts arising from their more aggressive lending decisions begin to materialise. One bank beginning to draw in its horns, as it perceives it is out on a limb, can probably be weathered by the system. But other bankers will stop and think about their own risks, bearing in mind operational gearing works two ways.

It may be marked by an unexpected event, or just an apparent loss of bullish momentum. With bad debts beginning to have an impact, groupthink quickly takes bankers from being greedy for more business to fearful of it. Initially, banks stop offering circulating credit, the overdraft facility that lubricates business activity. But former lending decisions begin to be exposed as bad when the credit tap is turned off and investments in foreign lands begin to reflect their true risks. Lending in the interbank market dries up for the banks with poor or marginal reputations, and banks begin to report losses. Greed turns rapidly to fear.

The cycle of bank credit expansion then descends into a lending crisis with increasing numbers of banks exposed as having taken on bad loans and becoming insolvent. A slump in business activity ensues. With frightening rapidity, all the hope and hype created by monetary expansion is destroyed by its contraction.

Before central banking evolved into acting as the representative and regulator for licensed banks, the credit cycle described above threw up some classic examples. Overend Gurney was the largest discount house in the world, trading in bills of exchange before it made long-term investments and became illiquid. When the railway boom faltered in 1866 it collapsed. Bank rate rose to 10% and there were widespread failures. Then there was the Baring crisis in 1890. Poor investments in Argentina led to the bank’s near bankruptcy. The Argentine economy slumped, as did the Brazilian which had its own credit bubble. This time, a consortium of other banks rescued Barings. Nathan Rothschild remarked that if Barings hadn’t been rescued the entire banking system in London would have collapsed.

Out of Barings came the action of a central bank acting as lender of last resort, famously foreseen and promoted by Walter Bagehot.

In the nineteenth century it became clear that crowd psychology in the banks, the balance of greed and fear over lending, drove a repeating cycle of credit boom and slump. With the passage of time bankers recovering their poise from the previous slump forgot its lessons and rhymed the same mistakes all over again. Analysts promoting theories of stock market cycles and cycles of economic activity need look no further for the underlying cause.

In the absence of credit expansion, businesses would come and go in random fashion. The coordinated expansion of credit changed that, with businesses being bunched into being created at the same time, and then all failing at the same time. The process of creative destruction went from unnoticed market evolution to becoming a periodic violent event. Monetary institutions still ignore the benefits of events being random. Instead they double down, coordinating their interventions on a global scale with the inevitable consequence of making the credit cycle even more pronounced.

It is a huge mistake to call this repeating cycle a business cycle. It implies it is down to the failure of free markets, of capitalism, when in fact it is entirely due to monetary and credit inflation licensed and promoted by governments and central banks...

- Source, James Turk's Goldmoney, read more here

Monetary Failure is Becoming Inevitable

Alasdair Macleod, with a background as a stockbroker, banker and economist, discuss the magnitude of a collapse of the dollar system and why it appears inevitable.

- Source, Jay Taylor Media

Building Empires Out of Gold

James Turk is widely respected as one of the true legends of the gold market, with over 40 years in the business. In conversation with Grant Williams, James looks back on his career, which is entwined with the modern history of gold, examining the potential for the next break to the upside and what comes next when empires of money end.

- Source

James Turk: Precious Metals Rigging Equals RICO Charges

As the rot within the global financial institutions continue to surface gold and silver will become more important every single day. Our economy, the world over, has been living on borrowed time since 2008. We are now 11 years into an experiment that has never been tried before. 

We are also seeing nations, globally, acquire gold like never before. I believe, as does a great many other people, these nations are gathering gold as a way of protecting their individual sovereignty. It is only a matter of time before the experiment fails and the wheels come off. 

If history is any indicator of future scenarios our current situation will probably end in a major, catastrophic war. Prepare now, pray a lot and stack physical gold and silver that you keep close at hand.

- Source, The Daily Coin

Attempt to Rescue the Lynchpin of the Eurozone

Why is the Fed rushing emergency injections of $75B per day into the banking system through bond repos, if we are supposedly "not in a crisis?" 

AlasdairMacleod, head of research at GoldMoney.com, returns to Reluctant Preppers to lay out his analysis that indicates Deutschebank as the most likely target of this extraordinary bailout. 

Macleod expounds further on what this massive attempt to rescue the most influential bank in the most influential country of the Eurozone means to us, the crisis-level of risk it reveals, and the grave implications to our financial lives as the crisis progresses towards sudden failure of the global banking and credit system.

- Source, Reluctant Preppers

Correcting GDP by Monetary Inflation

Let us assume there is an expansion of the quantity of money and credit. This can only become an addition to everyone’s earnings and profits, some of which will be reflected in rising prices and some in a deficit on the balance of trade. Nominal GDP cannot tell us anything about the loss of purchasing power of the currency, but we should correct GDP by the increase in money and credit to get a valid adjustment. But GDP includes exports, but not imports, so we need to capture the excess of imports over exports as well. 

This is because monetary expansion “escapes” to result in a deficit on the balance of trade, assuming there is no matching increase in the general level of consumer savings. America’s GDP adjusted for the increase of money and credit and the effect on the trade balance is shown in Chart 1, taken since the Lehman crisis when the current cycle of monetary expansion began.

While nominal GDP increased from $14,353bn in the first quarter of 2009 to $21,339 in the first quarter of 2019, adjusted for the expansion of broad money and the growing deficit on the balance of trade, it increased by only $642bn, a relatively small increase that can be easily explained by other variables, such as changes in flows between financial assets and non-financials, as well as between other categories included in the GDP compilation and those that are not. It was also close to the level of adjusted GDP in 2010, so has gone nowhere.

The lesson we learn from this is that all the money-printing and expansion of bank credit does virtually nothing to improve the economy. It is like flogging a dead horse that just won’t get up. Furthermore, if the Fed reintroduced massive QE for the next ten years, it would not engender any economic recovery whatsoever.

We have now established that issuing extra money and credit does nothing more than inflate the GDP statistic. The consensus today among both bulls and bears is that the pace of monetary expansion is about to accelerate again, confirmed by policy makers themselves. 

Therefore, nominal GDP will continue to increase, even in the teeth of an economic downturn. It will allow policy makers to claim they have rescued their economy from recession, or even from a prospective slump. The problem is then how to suppress the evidence of rising prices, the natural consequence of an increase in the quantity of money and credit that does not escape into net imports. It is necessary to give the appearance of economic growth.

Government statisticians have made significant progress in this direction. Independent analysis in the US by both Shadowstats.com and the Chapwood index suggests that prices are rising by approximately ten per cent per annum, not the 2% claimed by the government. It should be noted that in common with many other governments, the US Government faces some of its costs being indexed, so already has good reason to suppress evidence of rising prices, which they have been doing progressively since the 1980s.[i]

The fact of the matter is that changes in the general level of prices cannot be measured, and no one religiously buys the components of the consumer price index in the proportions allocated. Nor does anyone pay a hedonically adjusted price. This gives government statisticians with all their tools of statistical manipulation the ability to calculate whatever goal-sought result they want. The cumulative effect of this deception should not be underestimated, as Chart 2 illustrates.

Chart 2 shows end-year GDP between 2010 and 2018 deflated by the consumer price index for all items (US, city average, all urban consumers - the blue line). The end value of GDP adjusts from $20,898bn down to $18,231 in 2010 dollars, giving an average annual real growth rate of 1.71%. The red line is the end-year GDP adjusted by the Chapwood Index.[ii] The values taken are average annual inflation rates for all fifty cities included in the index, which are in turn comprised of the top 500 items on which Americans spend their after tax dollars. The average inflation rate of all these cities between 2010 and 2018 is exactly 10% and gives a final value for adjusted GDP in end-2010 dollars of $8,996bn. This is a drop in GDP values of 41%.

Besides showing that you can prove anything with statistics, the serious point is that by undermining the purchasing power of the dollar, monetary inflation has surreptitiously impoverished the American nation, something we also know from the wealth transfer effect of currency debasement. Clearly, the monetary authorities have pulled off an extraordinary trick: they have managed to transfer wealth from ordinary people and still be able to claim everyone is better off. Doubtless, they will not only continue with this monetary policy, but are about to accelerate it. Consequently, financial markets, being divorced from economic reality, will continue to believe everything is hunky-dory while the productive capacity of the economy continues to crumble – until they don’t.

It is a situation that one day will surely be corrected by a big adjustment; a sudden realisation of what’s actually happening. It can only lead to a crunch involving financial assets and fiat currencies, the apportionment between the two yet to be revealed. It is the stuff of the next credit crisis, which is bound to be crippling for the banks, a recurrence meant to be prevented following Lehman.

The authorities set up the G20 to coordinate plans to stop another banking crisis, but all they came up with was bail-ins to replace bailouts, and stress testing to identify banks in need of more capital. Both will not prevent another crisis, because they fail to address the cause. The forces behind a new financial calamity, driven by markets adjusting from extreme wishful thinking to reality, will only be appeased by a tsunami of new money.

The surprise is likely to be all the greater because adherents to the false science of macroeconomics, which includes the central bank establishment almost to a man, will find they have been misled by their maths, their statistics, and their charts. Instead of basing their approach on a proper understanding of the theory of money and credit, central banks and the economists in government treasury departments continue to worship their false gods. Because a banking crisis was averted in 2008/09 by nationalising or rescuing banks and other financial providers, it is believed the expansion of money and credit involved will work next time. The quantity required is whatever it takes to return order to the financial system.

All this extra money will ensure GDP will appear to grow, so long as evidence of price inflation remains suppressed. For believers in macroeconomics it will be proof the state theory of money works. It is pure deception.

Unfortunately, what is unseen is an acceleration in the rate of impoverishment faced by the wider population, that can only end in a collapse of the system. If you don’t believe it, talk to an Argentinian, a Venezuelan, or brush up your Shona and talk to a Zimbabwean.

- Source, Goldmoney

Goldmoney: Overthrowing The Establishment

Superficially, the electorates of America and Britain share one thing in common. They have both become sick of the establishment’s arrogant presumption that it knows better than the common people. Donald Trump spotted it and won the presidency in the face of enormous hostility from the establishment, both Democrat and Republican, as well as the deep state comprised of unaccountable intelligence operators and bureaucrats. The year before, the Westminster establishment found ordinary people rebelled against its assumed right to run the affairs of the electorate.

In Britain, if a mistake was made, it was to offer a referendum which produced the wrong answer. That is how the establishment appears to see it. In America, the UK as well as in Europe an elite has emerged for which democracy has become an irritant. But the establishment knows the rules and cannot deny their validity. The electorates in America and Britain have now given their establishments an unpalatable message, that they overrated their own importance. The bureaucrats no longer represent the interests of the people. Quite simply, the establishment and its bureaucrats have broken their contract with their electors, drifting away from the primary reason for their existence. The ordinary person has had enough of being ignored.

The result is the establishment is being forced to fight for its survival. President Trump has been fighting this battle on behalf of the American people for nearly two years. The British establishment has been fighting a rear-guard action for three over Brexit. Neither establishment has yet been vanquished. In America, there are signs of an accommodation, a compromise, which will allow the state to gradually resume control. In the UK, the survival of Boris Johnson and his new government depends on his refusal to compromise in its fight against the establishment’s Europhiles and placemen.

Brexit is a conflict that is only now being forced to a conclusion after three years of a Remainer government trying to appear to comply with the referendum result, while locking the United Kingdom into the EU, potentially in perpetuity. The electorate rumbled it and threatened the ruling Conservative party with extinction. Recognising the danger, their parliamentary party in conjunction with the party membership ejected the complicit Theresa May and elected Boris Johnson to take the country out of the EU on the delayed date of 31 October.

It is by no means certain Johnson will succeed. Remainers are now fighting his government in the courts, with the Supreme Court due to adjudicate next Tuesday (17 September) on whether the prorogation of Parliament was legal. And a way has to be found around the Benn-Burt Law, the last act of Remainer MPs.

The behaviour of the opposition parties in Parliament has been unedifying. The public sees a parliament out of control under a partisan Speaker. Not surprisingly, the opinion polls are swinging more in support of Johnson’s Conservatives and against the other parties, widening the gulf even further between Parliament and the people its members are elected to serve. If Parliament had any public respect before recent events, then it has certainly lost it now.

The similarities between President Trump’s position fighting the Federal establishment and that of Boris Johnson fighting Westminster gives the impression to many international observers that Boris is a British version of The Donald. Trump is urging the British to leave the EU, and thinks Johnson is the man to do it. Johnson is happy to encourage Trump’s support for a quick, post-Brexit trade deal. They get on together well.

But they are not peas in the same pod. Johnson has shown a free-marketeer grasp over trade issues and the damage that tariffs can do, while Trump is an interventionist. And when it comes to deficit financing, the evidence is emerging that Boris will fund promised spending in education, policing and health by cutting bureaucracy rather than relying on deficit stimulation now to provide tax income tomorrow. This is where Dominic Cummings comes into play.

This article skims over recent developments in Britain’s fight to free itself from the EU, particularly with respect to the role of Cummings. Making a huge assumption that Johnson and Cummings manage to implement Brexit on 31 October and the Conservatives are re-elected in a general election shortly, it also looks at how the government is likely to fund its promised expenditure plans...

- Source, James Turk's Goldmoney

Alasdair Macleod: Interest Rates Going To Zero

Goldmoney Tutorial: Vault Exchange

Watch one of our Relationship Managers walk you through exchanging metal from one vault to another.

- Source, James Turk's Goldmoney

John Rubion: Preparing for a World Run Amok

John Rubino, runs the popular financial website https://www.dollarcollapse.com, explains that we are in a debt bubble and this it is inevitable that bubble will burst.

- Source, Jay Taylor Media

Alasdair Macleod Impending Deeply Negative Interest Rates

Alasdair Macleod, a financial analyst at GoldMoney.com, talks about an article he wrote about deeply negative nominal interest rates.

- Source, Jay Taylor Media

The Startling Reason Why Gold Will Run Higher

Wait till you hear this breakthrough analysis of the REAL reason gold and silver's surge will run, and why we can look for this new bull market to be powerfully sustained. 

Alasdair Macleod, Head of Research at GoldMoney.com reveals his latest findings that a new and massive market phenomenon that defies technical analysis and dwarfs investor demand is the real and historic driver of what may become the most epic bull market that precious metals have ever seen!

- Source, Reluctant Preppers

Silver Prices with Explosive Upside

Silver prices have lagged gold prices since 2017 which has pushed the gold-to-silver ratio close to the all-time high. Silver prices are also significantly below what is predicted by our pricing model. We think that the reasons for this subdued performance are transitory and that silver will outperform gold again as the next precious metals cycle continues to rapidly unfold.

In spring 2017, we introduced a framework for understanding the formation of silver prices (Silver price framework: Both money and a commodity, March 9, 2017). In this report we are going to use this framework to analyze the recent performance of silver and give an outlook for where we think silver is heading over the coming months. In our framework piece, we concluded that silver is both money (store of value) and an input commodity and thus the impact of both industrial and monetary demand needs to be taken into consideration:

On the one hand, silver is a counterparty-risk-free form of money where replacement costs set the lower boundary for prices – the same energy proof of value that underlies gold prices. Thus, silver should be impacted by the same drivers as gold prices: Real-interest rate expectations, central bank policy, and longer-dated energy prices.

On the other hand, silver is a commodity with extensive industrial applications. Hence, changes in industrial activity should impact the price of silver as well.

In our framework note, we also discussed the two main reasons why we think that silver tends to outperform gold in bull markets and underperform in bear markets:

Because the value of global silver stocks is much smaller than that of global gold stocks – which is the result of silver being used in industrial applications – a rise in monetary demand for silver has a disproportionally large effect. In other words, when demand for metals increases as an alternative to fiat currency, there is simply less silver around to change hands.
A large part of global silver production is a by-product of other mining activities such as copper production. This base production is usually enough to meet industrial demand and “normal” monetary demand for silver. Because much silver is mined as a by-product, the silver cost curve has a discontinuous shape, meaning that base production is relatively cheap -- but to meaningfully ramp up supply, much more costly “pure” silver projects need to become economically viable. Hence, when a sharp increase in monetary demand leads to a shift on the cost curve, prices tend to increase sharply. This is illustrated in Exhibit 1. On a smooth continuous supply curve, an increase in expected future demand leads to a shift on the supply cost curve from A to B. However, for silver, the cost curve is different – it has a “kink” (an abrupt, discontinuous change in the first derivative) as a lot of silver is produced as a by-product, meaning it is produced almost regardless of the silver price. As such, small shifts in expected future demand lead only to very small changes in marginal costs. However, a sharp increase in monetary demand for silver leads to a sharp increase in the marginal cost of future supply (C to D), as an increase in future supply can only be achieved by sanctioning high-cost pure silver projects.

Silver prices have peaked in early 2011 at close to US$50.00/ozt and subsequently gradually declined to a low of US$13.70/ozt in late 2015, around the same time when gold prices hit their low. This silver price decline was in line with the findings of our model: Monetary demand for silver slowed down significantly as USD real interest rate expectations (10-year TIPS yields) rose from close to -1% to almost +1% (see Exhibit 2) which tends to be strongly negatively correlated with precious metals prices, silver more so than gold. As we have highlighted before, the decline in gold prices over that time-period was exacerbated due to a repricing in longer-dated energy prices, which has most likely negatively impacted silver prices as well. However, unlike gold – which since then has been on an upward trend and is up 40% from the lows – silver prices have been largely stagnating (see Exhibit 3).

Moreover, silver prices have not just detached from gold, they have detached from the predicted levels in our pricing model as well (see Exhibit 4). Our model predicts that prices should currently be roughly at US$25/ozt – US$8/ozt higher than they are. Importantly, when silver prices bottomed in late 2015, prices were exactly in line with the predicted levels from our model. Subsequently, our model would have predicted prices to rise on the back of slowly declining real-interest rate expectations and a modest growth in industrial output. The decline in real-interest rate expectations did lead to rising gold prices, but silver prices did not follow...

- Source, James Turk's Goldmoney, Read More Here

Why is China Now Buying Futures?

If I am correct in thinking the whale in the market is the Peoples Bank of China, then instead of suppressing the silver price, she is now hedging approximately one year’s silver imports against future price rises. Having pinpointed the switch from price suppression to futures accumulation to approximately March 2017, we can now say that courtesy of JPMorgan’s dealing skills, no one was aware of the Peoples Bank’s change in price strategy.

This was shortly after President Trump was elected and assumed office, which could have had a bearing. From China’s point of view, the geopolitical outlook had become very unstable, with its Washington sources reporting the Deep State’s conflict with Trump and its attempts to destabilise his administration. At the same time, the global economic outlook was improving, which would have led to greater global demand for silver, making it difficult for China to continue to suppress the price. These are good enough reasons to change price strategy and lock in silver prices by buying futures to cover future shipments.

More recently, China has begun to declare monthly additions of monetary gold reserves, a trend led by Russia and copied by other Eurasian central banks. Gold has suddenly caught a bid and having risen sharply become dangerously overbought. This is in sharp contrast to silver, which on the surface appears to have been side-lined.

The traders at the Peoples Bank now appear to have protected themselves against an increase in the silver price, which normally rises nearly twice as much as gold. Since the Peoples Bank also controls the nation’s gold, the silver desk could have known about the plans to announce monthly increases in China’s monetary gold reserves in advance. It would have been an added incentive for the desk to buy silver futures from the beginning of this year.

It will be interesting to see if this move, combined with China’s increasing gold reserves, results in a significant jump in the silver price. If the silver whale is China, then it’s a reasonable supposition that China is signalling by its actions that it expects dollar prices for gold, and therefore silver, to continue higher over time. An advantage of taking up a silver position is if things cut up rough in the gold market, China will not be implicated so far as Comex futures are concerned. Unlike large-scale dealings in Comex gold futures (which China appears to have studiously avoided), protecting prices on her silver imports is what the futures market is for and is unlikely to be politically contentious.

The message for silver investors is seven of the eight largest traders appear to have become complacent. If China is the whale in the market, then discovery could be a very painful process for them. Its unfolding could be dramatic, likely to coincide with the next move upwards in the gold price.

- Source, James Turk's Goldmoney

A Whale is Accumulating Silver Futures

Silver’s recent price performance has been disappointing. Normally, it is almost twice as volatile as gold, so when the gold price rises 11%, as it has since last December, you would expect silver to rise about 20%. Instead it has fallen marginally.

When we dig into the weekly Commitment of Traders’ Reports covering Comex futures, we see something very odd indeed. The largest four traders, normally bullion banks or major producers hedging future output, almost always run short positions against speculators’ longs. The more bullish speculators are, the more shorts are carried by the big four to accommodate them. Equally, they only go net long when the speculators are extremely bearish and are collectively marginally long or exceptionally net short. Not now, as the following chart of the Largest Four Traders net positions shows.

The number of contracts either net long or net short are derived from the concentration ratios in the weekly COT releases. The net long position is standing at a record high, a move that started in March 2017, marked by the arrow.

With respect to the concentration ratios, the CFTC’s explanatory notes state the following:

“The report shows the per cents of open interest held by the largest four and eight reportable traders, without regard to whether they are classified as commercial or non-commercial. The concentration ratios are shown with trader positions computed on a gross long and gross short basis and on a net long or net short basis. The "Net Position" ratios are computed after offsetting each trader’s equal long and short positions. A reportable trader with relatively large, balanced long and short positions in a single market, therefore, may be among the four and eight largest traders in both the gross long and gross short categories, but will probably not be included among the four and eight largest traders on a net basis.”[i]

So, anyone can be a large reportable trader. Gross positions include straddles and swaps between different silver futures, and do not concern us. It is the net position ratios that are relevant. Chart 1 above is of the four largest traders net positions in the markets calculated on this basis.

The next largest 4 traders can also be calculated by taking the concentration ratios of the eight largest and subtracting the four largest. It turns out, as one would expect when gold is very overbought, the silver positions of the next largest four at net short 20,131 contracts are close to a record short. The second four see prices have hardly moved, and the speculators in the Managed Money category are only moderately long. Despite their individual short positions, they don’t realise they are in acute danger of being victims of a major bear squeeze.

They appear to be blissfully unaware that they are as a group short to a very larger buyer in their own ranks. It is certainly possible no one has done the analysis covered in this article, because analysts and traders rarely look at the concentration figures. Furthermore, the correlation of the positions between the four largest and next four have not closely followed each other for some time as Chart 2 shows, which perhaps also encourages complacency.

We will return to that point later. However, it is only recently that the second largest four’s net shorts have exceeded those of the first largest four, and now we see the largest four traders are record long while the second largest four are record short.

This is the first time this has happened. It seems unlikely that in normal circumstances any of the largest eight would be running a diametrically opposed trading position to the other seven. Comex doesn’t work like that, con­­­­sisting of distinct groupings: producers and merchants hedging their future deliveries, bullion banks acting as market-makers, and speculators, who take on the price risk by going long. They all tend to stick within their group motivations.

Given these normally clear distinctions we can probably rule out a collaboration between more than one large trader. If two or more large traders were involved, it would be known by insiders and the other large traders would not risk being short.

Therefore, it is likely to be only one long position, far larger than the charts above indicate, given the largest four traders will include three other large shorts. We can only guesstimate its size. However, if we assume that the other three largest trades are short in tune with the others, our long trader, our whale, is very long indeed. The long position probably began in March 2017, when collectively the large four were net short 39,215 contracts. This is marked by the up arrow in Chart 1, where the trend reversed. If we take that as our starting point, we can see that as of 2 July (the most recent COT figures) the swing is nearly 50,000 contracts. That is an indication of the long position of our large trader, accounting for over 20% of silver’s open interest. Since each contract is for 5,000 ounces, it represents as much as 7,775 tonnes, which is 28% of 2018’s global mine production of 27,550 tonnes.

In the context of the silver futures market it is huge. But it seems unlikely to be an attempt to corner the silver market, because Comex-registered vaults have about 9,500 tonnes of silver bullion and LBMA vaults at the end of March had 36,195 tonnes. In other words, there is 1.66 times annual mine supply in these two vaulting systems alone. Given healthy vaulting supply, someone attempting a repeat of the Bunker-Hunts’ attempt to corner the market in 1979 has a massive hill to climb, particularly when such an attempt might be thwarted by the regulators changing the rules.

Putting cornering the market aside, we can also rule out a large speculator taking a punt on silver. A look at the Managed Money category net position tells us our whale is not there. Nor does a whale this size show up in the Non-Reportable category either.

By a process of elimination, it looks like a commercial entity, which uses silver for manufacturing purposes and is a continuing buyer of the metal. It would make sense that such a buyer would wish to hedge against future price rises by going long of futures. This being the case, it is a behemoth, larger than any individual processor. And that leads to one conclusion: it is probably the Peoples’ Bank of China, the state institution charged with managing all China’s silver distribution. But with a purely circumstantial case, we need more evidence.

- Source, Goldmoney

Myths About Gold as an Investment Medium

On Monday, Tom Stevenson, an investment director at Fidelity International, in his regular column in The Daily Telegraph wrote an article headed “Gold’s lustre may help hedge your bets if markets head south.” For a senior portfolio manager to recommend some portfolio exposure to gold supports this article’s contention that investment managers have noted the trend, but it appeared to present Stevenson with some difficulties arising from some common fallacies.

As a starting point, his article provides us with material to work with. His bias is clearly anti-gold. But his concern the gold price is telling him something important is evident from his headline, and he then enters into a mea culpa as to why gold should not be considered a normal investment. Stevenson trots out the usual anti-gold-bug stuff, claiming gold being only of interest to the kind of people who stockpile tinned goods and Kalashnikovs. But he also lists some of the alleged disadvantages of gold, commonly believed in the investment management industry.

Stevenson states it pays no income, is expensive to store and insure, it has no intrinsic value, no real use beyond looking pretty, it’s extremely volatile, it’s a greater-fool investment requiring another buyer to believe it’s going higher, and it’s value was higher forty years ago in real inflation-adjusted terms. We shall address all his points.

Before doing so, we must set one thing straight. What he didn’t mention is the common belief in investment management circles that gold is no longer money. We shall start with this issue, given its overriding importance, before addressing Stevenson’s other presumptions.

Myth 1. Gold is no longer money

The first step towards understanding the role of gold is to recognise it is money. It still competes with today’s fiat currencies as money and predates them by many millennia. Over the millennia there have been many other forms of money tried, and apart from silver, they have always failed. The gradual emergence of unbacked fiat currencies, particularly from the 1920s onwards, is the only monetary challenge to gold’s long history as money that has yet to fail.

With today’s state-issued currencies unbacked by anything other than public credibility in their issuers’ standing, the US dollar has loosely replaced gold as the principal currency against which all the other currencies are measured. This was by design: since 1971 the US Treasury has embarked on a campaign to deny gold’s role as money, promoting the dollar as the reserve currency instead.

In the past, when a state-issued currency was freely convertible into gold, its currency circulated as a gold substitute. Today, no currency is convertible into gold, so gold does not circulate as money even indirectly. By insisting its state-issued currency is used for tax payments, and therefore is the basis for everyone’s accounting, a government ensures it is the circulating medium. But another important function of money is as a store of value, preserving it for the lapse of time between it being earned and finally spent, and in this function state-issued currency fails.

The continual loss of purchasing power in fiat currencies since gold backing was removed has rendered them unsuitable as a savings medium. Only gold retains sound-money attributes and is still valued as such in a number of populous nations. In fact, the naysayers who claim gold is no longer money are only a very small proportion of the world’s population, given the general public as a whole in the advanced nations have no definite view on the matter. It is a common error to assume neo-Keynesian economists speak for entire populations.

For ordinary people, gold will become an increasingly important refuge, given the prospect of an acceleration in monetary inflation as the world tips into recession. With government spending already out of control, governments are relaxing budget discipline even further while promising greater spending. Consequently, the monetary quality which will become more valued is the ability to preserve value and it is upon this quality that gold markets are beginning to place a premium.

That is why gold is being valued as a more stable form of money, despite the fact it is not commonly found in general circulation. However, in the growing certainty that fiat currencies will die, gold can and will rapidly return to circulate as money.

We can now address Stevenson’s unfounded presumptions.

Myth 2. Gold doesn’t pay interest

Only hoarded gold, like physical currency cash, does not pay interest. Gold is loaned and borrowed for interest, just like fiat currencies. When markets are acting freely without state interventions and distortions, gold should have a lower originary interest rate than a fiat currency for the same loan term, because it is no one’s liability, unlike a fiat currency. The originary rate is shorn of all loan risks other than a pure time-preference value.

Today’s bullion market sets gold’s interest rate in the context of dollar interest rates. In London’s forward market, gold’s interest rate is termed its lease rate, which is derived from the gold forward rate (GOFO) and the London dollar interbank offered rate. GOFO is the rate at which a bullion bank is prepared to lend gold to another bullion bank on a swap basis against US dollars. The notional formula is the gold lease rate equals LIBOR minus GOFO.

In the days of the gold standard, when currencies were accepted as gold substitutes, the originary interest rate was that of gold. While it was impossible to quantify, because actual loan rates depended on borrower risk, the originary rate, as described above, was set by time preference. Expressed as an annualised interest rate, gold’s originary rate was normally in the order of two or three per cent.

Compared with today’s unbacked currencies, gold’s interest rate was very stable, but it was not immune to changes in its purchasing power. There were some fluctuations in supply, such as those caused by the Californian and South African mining booms. The rate of technological progress, to the extent productivity was advanced, lowering the general level of prices over time was also an important factor, which meant that a saver would experience the purchasing power of savings increase. For this reason, savers were prepared over time to accept a lower rate of interest on gold than would otherwise be the case.

The modern mantra that gold does not pay interest is simply untrue.

Myth 3. Gold is expensive to store and insure

This is untrue. At Goldmoney, fully insured annual storage fees for gold in LBMA approved vaults range between 0.01% and 0.018%.[iii] ETFs and mutual funds charge far higher rates for management, administration and custody. There is ample margin for Fidelity to pay Goldmoney’s vaulting and insurance fees, and for Fidelity to enjoy a substantial mark-up within its existing fee structure. We won’t hold our breath.

Myth 4. Gold has no intrinsic value

From Wikipedia, the definition of intrinsic value is as follows:

“In finance, intrinsic value refers to the value of a company, stock, currency or product determined through fundamental analysis without reference to its market value. It is also frequently called fundamental value.”

It is clear from this definition that the financial concept of intrinsic value depends on the income stream generated by an asset. In the case of a currency, this can only relate to the interest it earns for a lender. Like a currency, gold pays interest on being loaned out, so it must have an intrinsic value.

The concept of intrinsic value applied to money is little more than a red herring. But if we are to pursue it, we should observe that the suppression of interest rates reduces the intrinsic value of a currency, that zero interest rates remove it altogether, and negative rates give rise to negative intrinsic values.

On this basis, gold will always have an intrinsic value, while unbacked currencies in the current financial climate often do not. Gold clearly wins over today’s currencies on this basis.

Myth 5. Gold has no real use beyond looking pretty

We can all agree gold looks pretty. But it is also incredibly durable. Gold’s physical qualities and its rarity have made it the money of choice for diverse people and their cultures throughout the long history of mankind’s economic cooperation.

For Stevenson to imply that gold is only ornamental infers that the marginal price of gold is set by its supply and demand for that function. This is not the case. Gold is demanded in Asia for its property as a readily realisable store of value. It is a mistake to think diverse Asian communities, including the poorest in society, waste significant sums of their governments’ currencies on the frivolous function of making their women look pretty.

To have one’s accumulated wealth held beyond the control of government has proved to be a wise decision for the middle and lower classes in populous countries such as India, as well as all the other nations between Turkey and Indonesia inclusively. An Indian has seen the price of gold increase from under 200 rupees when Bretton Woods failed to nearly 100,000 rupees today. It is not so much a rise in the price of gold; rather it is a measure of the loss of purchasing power of the rupee. In Asia, where half the world’s savers reside, gold is the basis of a wise man’s family pension fund. Lack of gold ownership could be his western equivalent’s folly.

Clearly, gold is much more than a bauble upon which rupees and rupiah are continually wasted by ignorant natives. And if it is only pretty, why is it that central banks are adding to their gold reserves at a record pace?

Myth 6. Gold is volatile

This observation is in the same category as that which states the sun rises in the morning and sets in the evening. It appears to be true, but it is the result of the earth’s own rotation, not the sun rotating round the earth. Those that say gold is volatile subscribe to a flat-earth fallacy that ignores the volatility that arises from currencies.

Measured in dollars, in 1971 the price of a barrel of oil was $3.60. At that time, the official gold price, before gold backing for the dollar was suspended in August that year, was $42.22, which meant oil was priced at 0.085 ounces of gold. Today, the oil price is $57, an increase in the dollar price of nearly fifteen times. Measured in gold, the price is 0.04 ounces, roughly half the price in 1971.

Energy, typically measured by the price of oil, is the most important of all commodities to human life. The price in gold-ounces is demonstrably more stable than the price in dollars. Clearly, the volatility is in the currency and all the other currencies that defer to it, not gold.

Myth 7. It’s a greater-fool investment

That gold is a greater-fool investment, requiring another buyer to believe it is going higher, is surely the most preposterous statement for any investment manager to make. The whole basis of equity investment and dealing in derivative markets is just that. With this statement, Stevenson has defined his own company’s stock in trade. Every investment, putting aside bonds held to maturity, requires an exit strategy. If Stevenson and his colleagues apportion equities into their clients’ portfolios without one, they would have good cause to remove their funds and seek a manager who at least looks before he leaps.

With respect to gold, nothing is further from the truth, which is why it is so important to understand that at its most fundamental level gold is money and not an investment to be traded. You can trade it of course, but the ultimate purpose of owning gold is to spend it.

Myth 8. Gold’s value was higher 40 years ago in real terms

Besides being highly selective with his timing to make his point, Stevenson’s statement that gold has failed to keep pace with inflation over the last forty years is presumably made to emphasise gold is a disappointing investment. As an investment, it therefore must be under-priced, given gold is widely recognised to be a hedge against paper currencies losing purchasing power.

Stevenson’s approach is to only wrongly view gold as an investment, when in fact it is money. It is in the same category as uninvested cash, though with its own special sound-money characteristics. It is intended to be spent, not to be compared with financial assets. But as cash, it has retained purchasing power, which is more than can be said for the dollar. Since the Bretton Woods Agreement was terminated in August 1971 by President Nixon, the dollar has lost 97% of its purchasing power measured against gold.

If gold has produced a bad return for a dollar portfolio, one wonders what Stevenson thinks is a good one. To be fair, the performance of the S&P 500 Index gets close.

At the end of the same month the Bretton Woods Agreement was suspended, the S&P 500 Index stood at 97.24. Today it stands at 3,000. Therefore, the S&P500 has risen 30 times, while over the same period gold has risen nearly 33 times. Ignoring dividends, dealing costs to constantly rebalance the S&P index and the interest earned on gold, the performance is remarkably similar. But that is before considering the increased risk factors facing equities today, factors which are enormously positive for gold.

There is growing evidence of a developing global recession and a US slowdown. On the eve of these enhanced investment risks, the upside for the S&P500 seems limited at best, while there is a growing likelihood of an equity bear market developing. At the same time, the loosening of the Fed’s monetary policy clearly boosts prospects for the gold price.

- Source, James Turk's Goldmoney

The Reasoning Behind Gold’s Breakout

Gold’s dramatic move above $1400 has caught the investment establishment by surprise. Physical gold ETFs, as a proxy for direct portfolio investment, amount to only 0.05% of the estimated $250 trillion of global investment values. As well as being badly wrongfooted, investment managers have little understanding of the role of gold as money, believing it to have no role in the monetary system. They will have to undergo a rapid re-education. This article addresses their common misconceptions.

Introduction

One month ago, gold made a dramatic move above a three-year consolidation (delineated by the pecked lines in Chart 1), confirming for technical analysts that a bull market in gold dating from the December 2015 low at $1,050 is alive and well. Chart 1 shows that a basing process has actually been in train for over six years, highlighted by the lower rectangular box.

Technically, the post-Lehman crisis bull market, when gold more than doubled, was ripe for a set-back. After peaking at $1920 intraday in September 2011, the Cyprus banking crisis in 2012 failed to collapse the Eurosystem and the gold price fell heavily. The topping-out process is highlighted by the upper smaller box in the chart. But that is now irrelevant. What is relevant is gold appears to be breaking out of a multiyear base, solid enough to offer the prospect of a potentially strong bull market in the dollar price of gold.

For trend-chasing investors who form a large majority by sheer weight of managed money, this is the primary consideration. They will have ignored the debate about the weaknesses of fiat currencies, geopolitical tensions with the Asian superpowers and America’s acts of trade immolation. That was always going to be the case until such time as gold broke convincingly through the $1350 technical price ceiling. With the price now establishing itself at over $1400, an appraisal of the reasoning behind gold’s breakout is timely for these investors.

The dollar price is no more than a headline indicator for investors whose portfolio performance is not measured in dollars. Gold’s performance measured in other currencies has been far better. Since the price peak in September 2011, by mid-December 2015 the dollar price of gold had lost 45% of its value and has recovered to a net loss of only 24%. The gold price measured in the other major three currencies has performed significantly better, with the price in Japanese yen even higher now than it was at the time of the dollar’s 2011 all-time high. This is shown in Chart 2.

Furthermore, while the dollar price has only just caught the attention of mainstream dollar investors, residents of Euroland and Britain have seen gold in euros and sterling recover to within six and four per cent of the 2011 high respectively. Nearly three months ago, it was said that the gold price in 72 currencies stood at all-time highs. Given that emerging market and developing economy currencies tend to be weaker than the majors it is probably true.

Those who watch dollar headlines before jumping on a trend are late arrivals to a party already in full swing. Since the dollar price of gold bottomed in late-2015, the sterling price aided by the Brexit debacle has risen 63%, proving to be an excellent hedge against a falling pound. Gold priced in euros is up 45% from its lowest point, proving the wisdom of ordinary Germans who are the largest group of gold buyers in the Eurozone.

At a time of zero and negative interest rates and bond yields, these returns are doubly impressive. But there are remarkably few bulls on board with reasonable portfolio exposure. According to the World Gold Council, at end-June gold ETFs held 2,548 tonnes of bullion worth $115bn at current prices. While there are other gold-related regulated investments and derivatives, this feedstock of the raw stuff is tiny compared with the total value of global portfolio assets, which is probably in excess of $250 trillion.[i] Given that nowhere is physical bullion a regulated investment, direct holdings of vaulted investment bullion are unlikely to be significant in this context. Putting physical gold being held as an unrecorded asset to one side, to find physical gold in investment portfolios you have to dig very deep. On these figures, ETF bullion represents only 0.046% of estimated global portfolio values.

Estimates of physical exposure in portfolios should not be taken too literally, but from these estimates we can see that for all practical purposes gold’s breakout has left the trend-chasing establishment with almost nothing. For this reason, there is now likely to be a scramble to understand why gold has broken out. Portfolio managers will be keenly aware they are likely to come under pressure from clients to participate and will want to have answers.

This article is addressed to the portfolio managers and investors who are in the unfortunate position of not yet owning any gold or find themselves underweight in gold-related investments and are considering what to do about it. But first we must dispel some of the common myths about the role of gold, so we can approach the subject with clarity.

- Source, James Turk's Goldmoney

Current Gold Price Cycle Started at the End of 2015…

Since we have presented our gold price framework the first time in late 2015, we have argued that we have entered a new cycle in the gold market. At the time we believed that longer-dated oil prices (5-year forward Brent) had likely set a bottom in late 2015 (at US$47/bbl, now US$60/bbl) and that real-interest rate expectations (10-year TIPS yields) were close to their cycle peak at 0.8% (now 0.3%) (see Exhibit 2). Our view was that – while there was some room to the downside – risk for gold prices were clearly skewed to the upside. While we weren’t extremely bullish near term for longer dated energy prices[1], the reason for our bullish view on gold was that we saw much more downside risk than upside risk for real-interest rate expectations.

By the end of 2015, the FOMC members were predicting terminal Fed funds rates at 3.5% (see Exhibit 3). The Fed also has a PCE (Personal Consumption Expenditure) inflation target of 2%, which, in our view translates into CPI (Consumer Price Inflation) of around 2.5-3% that is embedded in TIPS yields. Thus, we expected TIPS yields not rise much above 1% even if the Fed was able to raise rates as many times as it signaled at the time.

Importantly, with terminal rates at just 3.5%, any economic slowdown or even a recession would require the Fed to sharply slash rates, maybe to even negative territory, which in turn would bring down real-interest rate expectations. Hence, we argued that the next larger move in gold prices would likely be up due to declining real-interest rate expectations.

However, we also acknowledged that there was significant uncertainty about the path of real-interest rate expectations for the next few years. The Fed’s famous dot plot simply shows what the FOMC members expect for future nominal rates, not their stated target. A sharp pick-up in economic activity could allow the Fed to raise rates further. In our view, a “normal” 10-year treasury yield of 5-6% would have had quite a strong negative impact on gold prices. Assuming that the Fed would stick to its inflation target of 2%, real-interest expectations would most likely be around 2-2.5%[2]. All else equal, our model would predict gold prices to drop below US$1,000/ozt in such an environment.

In the aftermath of 2016 US presidential elections, that was exactly what the market started to price in. The market hoped that deregulation would unleash economic growth that would offset the negative impact of the Fed unwinding its balance sheet. And for a while, it looked like the economic environment in the U.S. did indeed gain steam and surprised both the market and the Fed. In turn, the FOMC members started to raise their expectations for terminal rates from just 2.75% back to 3%.

While this pushed 10-year inflation expectations from 1.2% in early 2016 to 2.2% in 2018, nominal rates rose even more quickly as the Fed was finally able to raise rates multiple times a year, pushing the 10-year Treasury yield to 3.2% in late 2018. The result was that real-interest rate expectations rebounded one more time to 1.2% (see Exhibit 4)

Gold has predictably struggled a little bit in this environment, but the dreaded gold bear market scenario never materialized. The price of gold was close to US$1,300/ozt before election day and it was down less than US$100/ozt by the time we saw peak rates late last year, despite also being in a bearish energy environment.

Part of the reason for this resilience is that, while the Fed tightened monetary conditions by raising rates and unwinding its balance sheets, central banks globally continued to ease, and total central bank assets are right now at an all-time high. This also explains why gold prices in some other currencies are also at all-time highs. On net, the up cycle that started in 2015 remains intact, and it just got confirmed by the Fed.

- Source, James Turk's Goldmoney