QE3 arrives

QE3 arrives.

QE3 arrives…

Ben Bernanke announced the latest round of Quantitative Easing in the United States yesterday.  This will involve buying 40 billion dollars of mortgage debt every month in an effort to force some life back into the housing and construction sectors. This an open ended program tied to improvements in the unemployment rate. The implication here is that this program could continue indefinitely with all the attendant dangers an open ended money printing program carries. The policy of near zero interest rates has been extended until mid 2015 – this will mean interest rates will have been hovering near zero for 7 years by that stage.

 

Gold and silver have been range bound in both euro and dollar terms this year but with the announcement of ‘unlimited bond buying’ by Draghi at the ECB followed on by yesterdays QE3 from Bernanke will likely lead to both metals (and oil and a variety of other commodities) moving up strongly out towards and beyond previous all time highs. At this point we would be very surprised if gold did not break above 1400 euro an oz at some point before the end of this year and silver should be able to regain 30 euro’s an oz in the same time frame.

The early part of this year was dominated by headlines about an improving US economic outlook and pronouncements about the ‘end of the gold bull’ market. We suggested at that point that clients take a sceptical view of the supposed US recovery and we believe the sluggish summer numbers in the US vindicate that stance.   Now there is slowly growing scepticism in the US over the ecomonic recovery and that scepticism is likely to grow louder as the American economy is likely to continue underperforming in relation to employment growth etc although we would not rule out a short lived ‘sugar rush’ effect from QE3.

In Ireland there is some optimism that things are getting better. And on one level that optimism is justified in that Ireland at least has a healthy balance of trade with a strong export sector which is critical to building real wealth. Also property prices in Ireland have already adjusted downward significantly and are still dropping in a way that puts us ahead of the European curve – most of this downward price movement lies ahead for countries such as Spain.

Optimism is further bolstered by news of Irelands return to the debt markets with headlines last week in the Independent about Ireland successfully raising 500 million in the bond market. This is where things start to fall apart. While looking at a picture of Michael Noonan grinning from ear to ear (after the bond auction) we were simultaneously looking at  levels of international debt in various western and Asian countries (http://usdebtclock.org/world-debt-clock.html) in order to keep this 500 million euro bond issue in perspective. Ireland’s public debt to GDP ratio is 171% which gives us the third highest public debt level relative to GDP in the developed world – only Greece at 185% and Japan at 196% are worse! But most shocking of all is our external debt to GDP ratio which stands at 1266% -the next worst figure is 498% owed by the UK. These sorts of numbers really highlight the nonsense of these Irish bond issues – we are able to borrow on international markets because investors believe the ECB and the Germans will pick up our tab and prevent a default. Only a fool would buy Irish bonds based purely on the strength of the Irish economy relative to its indebtedness. Add to this Draghi’s ‘unlimited bond buying’ and you have to conclude this will not end well.

Investors seek out safe havens

Investors seek out safe havens in year 2011

Investors seek out safe havens…

 

The last several months have seen the gold price shoot from 1020 euro up to an all time high of 1375 euro this weekend. Given that last year’s all time high in euros was 1070 and the first six months of 2011 were spent in a trading range of 1000 to 1070 euro this is an extremely strong performance over the summer months. The pattern for metals is periods of strength followed by weakness and vice versa and gold seems to searching for an opportunity to correct at the present time but  the constant stream of bad news is preventing any correction from gathering strength.  Every time the price has moved down in the last 3 weeks the dips have been met by strong buying of  physical product which has driven the bears into hiding…

 

Silver had a strong start to the year and at the end of April it spiked up to almost 50 dollars an oz. But an increase in Comex margin requirements forced short term momentum traders to liquidate their positions and the price fell very sharply from just under 50 dollars to the low 30’s by early May. This popped the speculative element to the silver market very sharply and left long term investors to support the price and drive it forward.

 

Interestingly, while gold has moved forward strongly since then over the summer period, investors seem to have ignored silver as a monetary metal and focused on its industrial applications, and with economies across the world showing signs of slowdown or ‘double dipping’ into recession, this has meant a very stagnant silver price driving out the gold silver ratio once again to nearly 45 (spot gold 1344 vs spot silver 30.05) having dipped below 40 earlier this year. The 17 to 1 historical average still seems some way off at this point but this would certainly encourage us as to the likely out-performance of silver over the next several months.

 

While metals and US treasuries continue to perform strongly, currencies such as the euro and dollar and housing in Ireland are still slumping. Housing remains in the midst of a powerful deflationary trend and, with Irish banks in such poor shape this downward trajectory is set to continue for the next several years. Some great bargains are certain to emerge in this sector over the next 3 to 5 years but until the banks balance sheets are repaired there will be no possibility of arresting the slide in prices. Metals investors should be in strong positions here as they continue to make gains against the euro while the housing weakens even in euro terms. Those who have taken big positions in the metals markets will be able to go into property as cash buyers when they judge the time to be right.

 

The Swiss franc has been seen as a third ‘safe haven’ alongside gold and treasuries in a turbulent market. But in the last week the Swiss have announced moves to weaken their currency so as to protect their own export markets. While the S&P downgrade for US debt has tarnished treasuries somewhat, most investors and savers have simply ignored this downgrade and piled into treasuries as equity markets have come under pressure. This is a bad move. While many commentators are pointing to metals as a ‘bubble’ very few are highlighting the ‘bubble’ type behaviour evident in US treasuries at the present time. The US national debt continues to rise and the increase in the debt ceiling over the summer was a negative for treasuries, not the positive that most analysts seem to think. The reason for this should be obvious – why does the UScontinually need to raise its debt ceiling if it is in control of its debt and in a good position to repay the money it owes its bondholders? Think of it like this – if a family has maxed out its credit card bills and then to avoid defaulting on its payments it simply increases its credit limits on those cards does this represent any type of solution? And where will this lead? Default becomes inevitable whether for the individual or a nation, although the latter does have a printing press so the default can be outright or by stealth.

 

In summary this is a market where bad economic news, high debt levels and poor leadership are sending investors in search of safe havens. Three of the main havens have been the Swiss franc, gold and treasuries. But two of the three have significant issues at this time with treasuries likely to be the worst option. The Swiss franc actually has many attractive aspects as a haven but these are likely to outweighed by a government determined to weaken its currency as paper money gets caught in a race to the bottom. This is a scenario reminiscent of the currency wars in the 1930’s. In this developing situation, if treasuries were to weaken suddenly or more downgrades of US debt were to occur, the upside for gold is likely to be significant, or perhaps explosive. The same argument applies with even more force for silver as it remains highly affordable for all budgets at the present time.

Where to now for the Gold Bull

Where to now for the Gold Bull

Where to now for the Gold Bull

By Shane Carroll – Goldbank.ie

We are 10 years into a precious metals bull market which has seen gold go from under $300 an oz at the end of the stock market bubble in 1999 and 2000 to over $1500 dollars today. In the same time frame the Dow Jones has gone from 11722 on January 14th 2000 to 12084 on June 20th 2011. Impressive. Gold’s rise has been steady but not meteoric.

 

Against the euro the gains over the last decade have averaged 14% per annum and against the dollar those gains have been slightly higher at over 18%.But after a decade of good returns on gold and silver is it time for investors to exit the market ? Lets have a closer look at the factors in the years ahead that are likely to drive the gold price…

 

    1. Euro Sovereign Debt – debt loads in the P.I.G.S are unsustainable. In Greece’s case corrupt, incompetent politicians lied about their economic data for years. In Ireland’s case the state has been saddled with debts of private banks. Now, and as a direct result the state itself is heading towards bankruptcy and default. Greece is certain to default and Ireland is likely to follow. What is interesting to speculate is how long will it take investors to realise that it’s not small peripheral European  countries debt they should be worried about but the elephant in the corner – the heart of the current fiat system, the US itself and it’s impending default, outright or by stealth.

 

  1. Federal Reserve QE – The Fed is due to call a halt to Quantitative Easing this month. So we have the paradox that the Federal has pumped unparalleled liquidity and Keynesian stimulus into the US economy and yet its still tettering on the edge of a cliff with a raft of dismal economic data emerging this month indicating no signs of a robust recovery. Now the Federal Reserve, which has been buying up in excess of 70% of US government debt in the last 6 months is supposedly going to step back and allow private market participants to take up the slack. If the Fed had the guts to move into a tightening stance and step back from Quantitative Easing the US would go into a depression. But in order to correct the government induced imbalances in the economy that is what the Americans need right now. No chance the Fed will let this happen.
    1. South East Asian Support of US debt markets – China, Japan and South Korea are key to the health of the US bond market. Since the late 1990’s and the Asian currency crisis these countries have been building up their foreign reserves to protect themselves and their currencies should such a crisis recur. These three countries are amongst the biggest holders of US debt with Chinese holdings of US bonds being the biggest in the world. Interestingly, as the Federal Reserve has been buying more US bonds over the duration of QE2 China has fallen behind Brazil as the biggest buyer of US debt.

 

    1. US deficit – The US government is projected to run a record deficit of 1.4 trillion dollars this year and we have a farcical situation emerging where Congress is constantly being forced to raise the US debt ceiling amid warnings of financial Armageddon if ceilings are not constantly lifted. This is the equivalent to a spendaholic  consumer who can’t balance his income and expenditure and constantly has to raise the limit on his credit card to keep the ship afloat. No consumer is allowed to do this. So why should a country? The outcome, obviously, cannot be good. The US currently has a 14.3 trillion dollar debt ceiling. Does it really need more? Or should it just start trimming its expenditure instead of chasing US citizens all over the world, from Switzerland to Hong Kong trying to squeeze every last penny out of them. There is a very good reason US citizens are looking at other countries to park their wealth securely.

 

    1. Obama’s policies – Obama is a charismatic, movie star style president, in the JFK mold, no doubt about it. But that does nothing for a country that needs a hard nosed business focused president who puts moral and social issues on the back burner and focuses on balancing the countries books. That means low taxes, low regulation, sound money. But Obama doesn’t understand the impact of high tax and high regulations on business investment and he has never even heard of sound money. But he is odds on to win the next US election. This metals bull has a long way to run. As long as he is in power a weak dollar can be taken as a fact of life.

 

    1. US balance of trade – The US trade deficit is 43.7 billion as of April 2011. The trade deficit with important trade partners like China is a perennial US political football but nothing has been done to solve the problems leading to US over consumption and under production. The decline in US manufacturing is a tragedy for that country and rebuilding manufacturing capacity will be a slow difficult grind for that country. An economy that does not export more than it consumes will always have a pronounced tendency towards a weak currency and will suffer from spiralling debts. In Congress the argument is always thrown out that the Chinese are competing unfairly with America through low wages etc. But if this argument had any merit then how is it that a high income country like Germany does so well with its exports to China? In fact, Germany with a population only a fraction of the America’s exports more to China than the Americans do.

 

    1. American umemployment – unemployment in the US is stubbornly high at over 9%. The Federal Reserve’s stimulus has done little to reduce this. Governments and central banks cannot create employment in a stagnating economy – only private enterprise can do this. If government creates one job in the public sector they have to raise taxes to pay for that position – that money comes out of the productive economy and cannot then be used for investment in manufacturing capacity etc.

 

    1. European and US interest rates – under Jean Claude Trichet the ECB has kept interest rates at historical lows of half a percent while the US has rates of 0.25%. Both of these rates are far below rates to offer savers a return over inflation and provide a disincentive to keep wealth in paper form. This continues to fuel precious metals investment interest. In order to change this scenario significantly it would be necessary  to raise rates dramatically, back to historically high levels. Raises of .25% and .50% will not be sufficient to derail metals market participants. Prospects of the rates being raised back above the 5% to 7% level seem remote in the extreme at this point. But without them, why hold your wealth in paper?

 

    1. Break up of the Euro – if the Euro starts to crack and Greece defaults, and Ireland then does likewise, what will happen to the single currency? Who will want to hold the single currency if there is a possibility it will not exist in a few years time? But as we’ve discussed, the dollar, has many issues which make it potentially a worse guardian of your wealth than the Euro. With such enormous problems, neither of these two currencies look like a safe bet in the years ahead. This will continue to foster strong precious metals sentiment.

 

  1. Chinese investment market – wealthier consumers in China are buying metals and being encouraged by government to invest in commodities rather than an overheated property market. The Chinese Government has tried to dampen property speculation by raising property taxes and mortgage down payment requirements  and this has driven more investment in the metals markets by private citizens in China. The Chinese have huge savings rates compared to anywhere else in the world and as more of those savings are moved into metals this will have a profound impact on patterns of demand worldwide and on prices. As inflation in China becomes more of a concern (a result of the Chinese government trying to maintain a consistent price relationship between the Yuan and the US dollar) this trend towards metals purchases will likely accelerate. China is now the world’s largest Gold Producer and yet it produced only 340 metric tonnes of Gold compared to consumption in China of 700 metric tonnes leaving a deficit of 360 metric tonnes of Gold last year. These sorts of numbers give an idea of how influential China’s growing appetite for Gold will be in the investment landscape in the years ahead.

 

Over the last 10 years gold has risen approx. 600%. But compared to other asset classes gold still appears undervalued  – it still takes 8 ounces of gold to buy 1 share of the Dow Jones for instance. It still takes over 150 oz of gold to buy an average house in most western countries today (Ireland and the US being the obvious examples). After 40 years on a fiat money system it looks as if the dollar is headed the same way as all other historical fiat currencies – right back to its intrinsic value, zero. A new hard currency structure is the likely successor to all this chaos we are enduring now as central banks and governments use their best Keynesian box of tricks to no discernible effect except more chaos. You can’t change all of this. But you can protect yourself and preserve your wealth while others are losing theirs. Stick with gold in the difficult years ahead.

A New Gold Standard

A New Gold Standard - Robert Zoellick

A New Gold Standard?

Robert Zoellick Head of the World Bank since 2007 has called for a discussion on a new Gold Standard in an article in the Financial Times this week. Since 1971 when the US effectively declared bankruptcy by ending the Bretton Woods peg between the dollar and gold ($35 dollars equaled 1 oz gold) the global financial system has been a floating currencies system based on a paper dollar as the global reserve currency.

Zoellick suggests using gold as ‘an international reference point of market expectations about inflation, deflation and future currency values’. Even more significantly, and in our opinion, accurately,  Zoellick suggests that ‘although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today’.

The suggestion that we have been operating under a system Zoellick calls ‘Bretton Woods 2’ since 1971 is perhaps slightly misleading. To call the structure that international currencies have operated under as a system of any sort is very generous. ‘Organised chaos’ might be a better way of defining currency management since 1971. With no restraint on how much of the global reserve currency they printed the US has been on a printing spree with unintended consequences across the entire globe as deflation was exported abroad to developing countries in the 1990’s and then inflation on a vast scale was seen in both housing and stocks in the US and around the world.

As it becomes clear that this use of the dollar as a global reserve currency at the same time as the Federal Reserve uses and abuses the currency to try and ‘pump prime’ the American economy is becoming more untenable and less and less beneficial to other countries around the world the era of dollar hegemony appears to be drawing to an end. Despite this, the reaction to the idea of a new Gold Standard has been mainly negative. Almost none of the commentary reacting to Zoellick’s FT article has displayed any knowledge of how a Gold Standard actually works. Many of the critics of the idea have said it’s simply not practicable because the quantity of Gold available is not sufficient to support the modern world’s rate of growth etc.

A real functioning Gold Standard can operate on a single Krugerrand. All that matters is that governments set a credible price peg for their currencies against that single ounce of Gold. If the currency’s value falls below the peg then remove currency from circulation until the currency’s value rises to its pegged value again. If the currency’s value rises above it’s peg then do the opposite, and print more paper currency to reduce the value of the currency back to its peg (think QE2 with a purpose and end point). Economists, governments and central banks around the world, under the influence of Keynesian thinking seem to have forgotten that any government with a printing press has total control over its currency’s value  – reduce supply/increase value & increase supply/ reduce value. Simple, but far too straightforward for the brain boxes in the US Federal Reserve and the IMF. Defending currency value with interest rates is an invitation to speculators to put a currency to the sword.

What about a Gold Standard’s capacity to allow for rapid growth in an economy such as China’s or any other around the world today? Demand needs to be considered in relation to how much currency is produced. But consider this, if currency demand starts at 100 dollars and then rises to 200 dollars in a given economy then government can print an additional 100 dollars and double the paper money supply without any disruption to the Gold Standard price peg. Demand for Gold itself will not vary sharply in a well managed paper currency where the government’s promise to maintain the peg makes that currency as ‘good as gold’! This means that a proper Gold Standard can easily accommodate and facilitate any level of growth in an economy contrary to the misinformed commentary from so many economists today on CNBC, Bloomberg et al.

It is encouraging to see the beginnings of a debate around a new global economic system which will involve ‘hard’ currencies and will reduce the chaos a soft money system underpinned by a falling dollar causes. But Zoellick’s comments are only a beginning. And the outright rejection of his comments certainly highlights the fact that this debate will take years to resolve as governments and citizens around the world begin to recognise the need for a new Bretton Woods type agreement. And all the while this debate rages the precious metals bull market will continue to run and run.

Great Reasons To Buy Gold

Great Reasons To Buy Gold

Great Reasons To Buy Gold

1. Ireland’s economy.

Soaring unemployment, unsustainable debt and a government unwilling to take the action needed to help Ireland recover.

2. Anglo Irish Bank.

Need we say more – whether its €32 billion or €64 billion needed to bail out this toxic bank we’re being dragged into a black hole by this mess.

3. Diversification.

Everybody should have some Gold in their possession as a way to diversify their investment porfolio away from poor performance sectors like stocks and housing.

4. Quantitative Easing.

In other words – printing money! All the world’s central banks are tyring to outdo each other on this, trying to get their economies going again. Any cash you hold, whether in Euro’s or dollars is virtually certain to go down in value over the next decade, just as they have in the last decade.

5. Gold’s track record as an asset class.

In 1970, one gold ounce was worth $35 dollars. By 2000 one gold ounce was worth $270 dollars. In 2010 gold is worth over $1200 an ounce. Thats long term outperformance by any measure.

6. China.

The Chinese are the driving force of the world economy right now. They are swiftly gaining on the US to become the world’s largest economy. This is inevitable, when Britain was the centre of the world, it was also the world’s workshop, and the same was true of the US. China is the world’s workshop today. And the Chinese love gold as an asset class. They will be big buyers of gold in the coming years.

7. The Dollar.

The dollar and gold are vying for the same role in the global financial system. That is, the dollar currently claims the role as the basic measure of value in the global financial system. But since 1971, when the dollar gave up its fixed gold value and left the Bretton Woods system behind, the dollar has lost 97% of its value versus gold. What sort of value measure does that make paper currency? The free market is passing judgement year by year.

8. World Gold Supply.

South Africa used to be the biggest gold producer in the world. It has now been surpassed by China as production falls. But China consumes all the gold it produces and is a net importer of gold. This at the same time that global gold demand is rising relentlessly.

9. Gold is still cheap.

At the start of the 1980’s gold reached over $800 an ounce.When you adjust prices for inflation gold would have to reach over $2000 an ounce today just to equal that high in real terms.

10. Barack Obama.

Obama looks good and sounds good. But when it comes to economics he is not so good. The dollar needs a president who understands that if you print too much you destroy underlying value and currency confidence. America needs a president who understands that low taxes always lead to higher growth and higher tax revenues. Obama wants to raise taxes for the wealthy. Sounds good, but a terrible idea if ecomomic history teaches us anything. And to allow business to thrive Ireland and America need to allow bankrupt and insolvent businesses to go out of business.

Instead economic zombies are being created which will suck the economic life out of western economies for years to come and draw resources away from new start ups and entrepreneurs who can build real wealth. In the face of these economic policies it’s inevitable that gold will be the benficiary for years to come.