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Bilateral Trade & Cooperation In A “De-Dollarising” World

It’s no secret that Chinese President Xi Jinping and Russian President Vladimir Putin are two of the strongest beacons of political and economic cooperation visible in today’s geopolitical landscape. They admit it themselves. Only two weeks ago, Xi Jinping stated during his Russian visit that bilateral relations between the two nations “are now the best ever”.

The following picture of the two leaders at the BRICS summit of 2015 courtesy of kremlin.ru personifies the warm relationship between the two countries.



Some recent examples of this warm relationship include the joint statement of July 4th dealing with the Korean Peninsula issue; interestingly the first statement released under the name of both Foreign Ministries in a decade. There was additionally a subsequent joint statement on a broad range of international issues including terrorism, trade and weapons of mass destruction.

Even more interesting is the earlier Chinese Defence Ministry statement of June 29, confirming the signing of a military cooperation roadmap between the two nations extending out to 2020.

Importantly, Russia-China cooperation extends beyond the political and military spheres as we’ll discover. Significant efforts towards trade settled in Yuan have been made in what Live Trading News is calling a “first step towards an even more ambitious plan, using gold to make transactions”.

China is one of the world’s top importers of Crude Oil and Russia is neatly one of the world’s top exporters. The two market participants have been reported as taking steps to settle payments for this commodity in terms outside of the US dollar.

Journalist and economic researcher Frederick Engdahl writes that “in 2014 Russia and China signed two mammoth 30-year contracts for Russian gas to China. The contracts specified that the exchange would be done in Yuan and Russian Rubles, not in dollars. That was the beginning of an accelerating process of de-dollarization that is underway today”.

Furthermore, according to Paul Ebeling of Live Trading News, “when Russia and China agreed on their bi-lateral pipeline deal, China wished to, and did, pay for the pipeline with RMB Yuan treasury bonds, and then later for Russian Crude Oil in RMB Yuan.” Paul goes on to say that “the profits are then taken back to the Shanghai Gold Exchange to buy gold with RMB Yuan-denominated gold futures contracts.”

This idea is supported by comments made by deputy head of the Russian Central Bank Sergey Shvetsov on a visit to China in 2016, stating that the two nations have intentions to facilitate more transactions in gold and in March of this year, the Russian Central Bank opened its first overseas office in Beijing as an early step in phasing in a gold-backed standard of trade.

To the point of this article, the latest chapter in this evolving story comes from the Moscow based state owned banking and financial services company Sberbank (the largest bank in Russia & the third largest in Europe) which has now announced that it has begun trading in gold on the Shanghai Gold Exchange via its Swiss subsidiary.



According to a Reuters article published one week ago, “Sberbank was granted international membership of the Shanghai exchange in September last year and in July completed a pilot transaction with 200 kg of gold kilobars sold to local financial institutions, the bank said”. Notably, VTB (Russia’s second largest bank) is a member of the Shanghai Gold Exchange also.

Paul Ebeling provided a succinct summary of the development yesterday by saying that “Russia and China are creating a new paradigm for the world economy and paving the way for a global de-dollarization”. What is becoming increasingly clear through the formation of the SGE (something we’ve followed since inception) and beyond is that China and Russia as two of the world’s most active accumulators of gold have every intention of seeing its monetary use globally expanded.

 

Austrian Money Supply Growth & USD Falter: Another Recessionary Warning

Named after the famed Austrian School economist Ludwig Heinrich von Misus who passed away in 1973, the Mises Institute is an Alabama based organisation which exists to promote the teachings of von Misus and disseminate analysis based upon the Austrian Economics theory.

Economist and Political Scientist Ryan McMaken of the Misus Institute recently published an assessment of the US Dollar supply growth and his conclusions are supportive of other leading recessionary indicators such as those we’ve covered relating to credit growth using FRED data in the past weeks.



Ryan notes that according to the Austrian Money Supply Measure, the rate of growth in the US Dollar supply has fallen to its lowest in 8 years and 9 months. The AMS measure tends to produce a higher (and arguably more accurate) assessment of monetary expansion than the M2 metric and perhaps not so coincidentally, M2 supply growth now sits at a 1 year and 8 month low as pictured below courtesy of mises.org.



Notably, Ryan states that “Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.”

The key here is Ryan’s use of the word “preceded” which flags this metric as yet another leading indicator in the already growing pile of indicators available. It is noteworthy that this data doesn’t represent a contraction of supply (central banks have ensured a continuous supply growth in recent history) but rather a significant reduction in the rate of increase.

Ryan’s succinct conclusion is best reproduced verbatim. “The current subdued rates of growth in the money supply suggests an economy in which lenders are holding back somewhat on making new loans, which itself suggests a lack of reliable borrowers due to a lackluster overall economy. This assessment, of course, is reinforced by the Federal Reserve's clear reluctance to wind down its huge portfolio, and to end its ongoing policy of low-interest rates — concerned that any additional tightening might lead to a recession.”

The following plot generated this morning for our readers using the fred.stlouisfed.org series shows a variant of the US commercial and industrial loan data that we discussed earlier this month. This time discarding seasonal adjustment, we can clearly see an association between falling commercial lending rates and official periods of recession. Note the current decline through 1.98% highlighted also occurred during the GFC, the Dotcom recession and the 1990 recession which contributed to Bill Clinton’s 1992 campaign.



In concert with these economic warnings we also see gold strongly recovering from recent lows, now having broken the near-term technical resistance level of $1,250 that we referenced on the 19th to sit at a Friday close of $1,254.50 as pictured below. This marks a 3 week high, an increase of 2% for the week and importantly sees the gold price now above both 100 and 50 day moving-averages; a bullish sign.



These price gains are occurring in a languishing USD environment. The Dollar Index fell by another 0.4% on Friday and the EUR/USD pair saw an increase of 0.2923%. Commentators are attributing this shift to ongoing political unease within the White House, mixed US economic data and, in the case of Myra Saefong, “raising uncertainty surround the likelihood of another U.S. Federal Reserve interest-rate hike this year”.

One needs to wonder about the extent to which these catch-phrases can be used to explain the graphs that we continue to present. It could be possible that an arguably more fundamental appreciation of the deterioration of the global economy is being more broadly adopted; something supportive of safe-haven buying.

As always we recommend a balanced approach to investing which is a topic that will be addressed at the NUU Understanding Money Conference scheduled for Saturday 26th August. This conference will exhibit a range of presenters on a number of topics from the definition of money, its past and future, cryptocurrencies and of course gold as the oldest form of money. Ainslie Bullion will be presenting at the event and we look forward to seeing you there.

 

Marin Katusa Talks Gold Deposits After A Disappointing NAR Report

Marin Katusa of Katusa Research has been fairly actively talking about gold on Twitter of late. Today we explore some of his observations after first looking at the latest National Association of Realtors report.

Marin Katusa Talks Gold Deposits After A Disappointing NAR Report

Overnight price action in gold was fairly steady after hitting a four-week high earlier on Monday. This stabilisation of price was on the back of the latest National Association of Realtors (NAR) report which was a disappointment. The report indicated that consumers in the US bought 1.8% fewer pre-existing homes in June, equating to 5.52 million units. A decline was expected by economists but only in the order of 1% to 5.58 million units.

The next release of significance will come from the FOMC meeting which begins on Tuesday morning and ends early Wednesday afternoon US time. A statement will be released but the “Fed-watching” community expects no changes in US monetary policy. The tone of language used in the statement will be, as usual, finely dissected by economists and their brethren as we’ve identified previously, so as we wait for the outcomes of that release, let’s today turn our attention to Marin Katusa.

Receiving accolades from names such as Doug Casey and Rick Rule, Marin built an impressive fortune from investment research, especially in the gold and oil stock space.

Captured 4 minutes after it was tweeted this morning comes this comment from Marin. We often focus our attention on the increase in physical demand driven largely by China and India but if any chart speaks to the fall in gold supply, it’s this one.



Marin’s suggestion that the consumption of known deposits held by junior minors will be a means of compensating for organic discoveries is supported by the information we covered two weeks ago on senior silver producers such as the Coeur D’alene who are doing the same thing. As a 16 million ounce silver producer, Coeur is adding a lot of gold production because of the difficulty inherent in routinely keeping all revenues in silver when operating at that level. This gold production will to an extent come from deposits being targeted for acquisition by the major gold miners in order to maintain their own production.



Marin’s July 21st tweet pictured above illustrates that the reduction in gold discoveries has had a radical impact on gold reserves held by the major producers. It can be clearly seen that ounces in reserve peaked at just under 800 million in 2011 and by last year those reserves had more than halved. Maris suggests that this dynamic will see continued buyouts of junior gold companies but with such an aggressive trend, this is a stalling tactic at best. Without sustainable gold deposit discovery, supply will ultimately falter and in the current high physical demand environment, this is supportive of much higher physical prices going into the future.

 

UAE, Singapore & Sri Lanka See Boost In International Gold Buyers

Dubai is seldom covered in gold bullion news articles yet that shouldn’t imply that the city is not involved in the bullion space. “Gold And Diamond Park” on Sheik Zayed Road for example; an air conditioned mall consisting of over 60 jewellery stores and perhaps somewhat equivalent to London’s Hatton Garden district which we featured earlier this month, holds a 4.5 star rating on tripadvisor.com.au



It is currently being reported by a number of outlets that Dubai has seen increased gold sales of 10% from Indian buyers this month with outlets in Singapore and more broadly through Sri Lanka noticing a similar trend to a lesser extent.

India’s tax reform and more specifically the introduction of the GST on the 1st of this month has resulted in a 13% Indian gold premium relative to what can be currently purchased in Dubai. This has made it economical for larger Indian buyers to travel abroad in order to make their purchases.

On the 11th of this month when discussing the fact that Indians had pulled forward gold purchases to subvert the GST introduction, we wrote that “it remains to be seen whether the surge in Indian gold consumption currently is a replacement for the demand typically seen in Q4 or whether that cyclical demand will still be observable this year”. Obviously we will still need to wait for the complete 2017 picture but early indicators suggest that demand is being geographically dispersed rather than wavering.

Rajiv Popley, director of Popley & Sons recently said that "shopping for gold in Dubai, especially with a 13 per cent difference, is more lucrative and this will divert some business from India to Dubai".

Senior Operations Executive at BullionVault, Steffen Grosshauser, interestingly notes that Dubai’s boost “may prove short-lived as the Arab city-state moves to impose its own sales tax later this year”, referring to the 5% VAT scheduled for introduction within the UAE next January.

In a publication from earlier this month, The Tribune of India has reported that the post-GST era in India has seen an increase in what they call the “grey market”; referring to an observed increase in purchases made from “small-time goldsmiths who do not provide proper bills in return for waiving GST”. This is something that Steffen Grosshauser concludes is supportive of increased gold smuggling into India.

One thing is becoming certain. Demand for gold seems at least for now unabated in the face of government attempts to curtail its appeal. Whether it involves purchasing metal in more amenable political environments, utilising the grey market or some other means that we have yet to see play out, we are currently observing evidence of behaviour that speaks to a genuine desire to obtain a commodity of inherent value.

Gold.

 

Fed “No News” Statement Fuels Gold Bulls & Dollar Bears

The Federal Reserve’s overnight statement which, as was widely expected, left rates untouched was remarkable in terms of how unremarkable it was.

The concept of “balance sheet normalisation” which first featured in the Central Bank’s vernacular only 2 months ago or so, again made an appearance and was again accompanied with imprecise timing guidance such as “this year” and “relatively soon”.

We addressed the topic of balance sheet reduction on the 6th of this month when covering the release of the June Fed minutes and again exactly one week later on the 13th of this month when covering the conflicting messages being transmitted by Janet Yellen during her House of Representatives testimony. It is noteworthy that the gold price at that time was $1220.30 compared with the $1260.30 printed this morning; a rise of exactly $40 US in exactly 2 weeks.





The Fed’s overnight statement communicated that “the Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated; this program is described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans”.

Again, this is nothing new and the fact that the statement was conditional upon a “broad evolution” of the economy leaves wiggle room for changes in future policy direction.

The unremarkable nature of the Fed’s statement is supported by CIBC Capital Markets senior economist Avery Shenfeld who described the release as the “no news statement” and by Brown Brothers Harriman (BBH) who said that “the FOMC statement reads very much like the June statement.”

Avery Shenfeld elaborated by saying “of course interest rates were left unchanged, and they weren't quite ready to start the clock on letting bonds roll off their balance sheet, but saying it’s coming "relative soon" is in line with our view that it’s on tap for the September decision”.

BHH analysts also elaborated by saying that the lack of surprises in the Fed’s statement “freed up the market to keep doing what it was doing prior to the Fed decision”.

But what exactly was the market doing prior to the Fed decision? The answer may lay in the following two charts and the fact that the US dollar is now in a bear market.

Below is a plot of the US Dollar Index produced this morning for our readers with the post-Fed drop along with its notable impact on the current gold price (pictured above) being an obvious feature.



Frank Holmes, US Global Investors CEO discussed the longer term picture of the USD this week. On Monday, Frank wrote about the interesting scenario surrounding the 2017 five-year Treasury debt yield trend and the gold performance resulting from the Dollar’s continued slide. Adjusting for inflation, Frank notes that this year has seen an approximate 150% rise in the yield offered by the five-year instrument which would typically see significant downward pressure on gold given the opportunity-cost inherent in holding the latter in such a scenario. The USD bear market however (which saw a 13 month low in the USD:EUR pair just last week) has seen a greater than 8% YTD rise in gold which is atypical in such a bond yield environment. The scenario is pictured below courtesy of data from Bloomberg.



To succinctly articulate a conclusion, we delegate the remainder of this article to Frank Holmes himself.

“That gold is still holding at its current level—despite rising rates, despite a stock market that continues to rally—is ‘encouraging.’

All of what I’ve said so far pertains to the near-term. Gold’s medium- to long-term investment case, I believe, looks even brighter. Many unsettling risks loom on the horizon—not least of which is a record amount of global debt—that could potentially spell trouble for the investor who hasn’t adequately prepared with some allocation in a safe haven.”

 

Share Trading Versus Gold Panning: Where Effort Produces Value

Our Friday article on the balance of risks versus reward in today’s investment climate turned out to be a very timely one given the fact that the end of Friday’s equity trading session in Sydney saw a colossal fall of 82.2 points on the XJO index or a loss for the day of 1.4%. The move wiped out the prior three days of consecutive equity gains and took the index down by about 0.3% for the week.

In contrast, the USD gold price was last at $1,269.10, up another $9.10 from the time of our mail-out on Friday having briefly breached the $1,270 level.





CommSec’s Tom Piotrowski claimed that “there didn’t seem to be all that much that you could point the finger at” but did mention S&P500 futures, themselves influenced by “political developments in the US” when grasping at straws to assign blame. One can’t help but wonder about how much fundamentals are actually at play in a situation where the ongoing difficulties in repealing a health care act in a foreign country is attributed to daily market falls of this magnitude in our ASX200. After all, how does the continuance of ObamaCare cause A2 Milk to fall by 3% or Webjet to fall by 7%?

The answer may relate to the difficulty in determining value in today’s investment landscape and hence today we present news that helps to illustrate one of the foundations of value, effort.

As it turns out, the very day that our market dropped 1.4%, Thomas Curwen of the Los Angeles Times ran a story on modern day “gold fever” now gripping California following drought ending rain that has recently enabled long dry river beds to produce gold panning opportunities.

This year has seen the transformation of dry creek and river beds into areas of flowing water and with that, come the conditions required to deposit gold bearing overburden.



East of San Francisco near the Stanislaus National Forest is an example of such a gold producing region that was very profitable in the mid 19th century. In fact the broader Stanislaus River area as late as the 1970s saw a miner by the name of George Massie extract almost 800 ounces out of the ground; a win worth almost 1.3 Million Australian Dollars at the time of writing. As an aside, it seems unlikely that a similar acquisition of stock equity at the time would have resulted in an equivalent valuation now.

Californian gold deposits are a result of interactions between the Pacific & North American tectonic plates and, as pictured below, to this day are painstakingly retrieved by professionals, preppers and prospectors alike in what’s known as California’s “gold country”.



The LA Times article explains that in 2009 “a state judge issued an injunction that put a temporary moratorium on the use of motorized equipment near the state’s rivers and streams, putting an end to dredges that suction rocks, sand and pebbles from the bottom of a creek and pumps that circulate water into sluices located high on river banks.” The now running water has nullified the impact that the lack of machinery had on gold foraging and as such, a new resurgence in gold panning has begun.

Importantly, it’s not just the physical effort and the exposure to the elements that attributes value to gold that’s discovered in this manner, it’s the experience behind the effort. To be successful, gold panners require knowledge of geology and river dynamics. According to Tom this includes the ability to identify “rounded boulders tumbled together, orange soil tainted by rusted iron and veins of quartz hiding gold.”

The prospectors must “read streambeds, imagining how the current flowed during floods, hunting for any irregularity — a riffle, a ledge, a waterfall — that could create a backward eddy for the gold to escape the water’s momentum and drop to the floor.”

To attempt to quantify the gold that is potentially on offer, one participant described a moment when he discovered “a few gold specks, each no bigger than a fat flea” in his sludge bucket; the result of deploying many hours of effort.

Of course the effort and risk involved in commercial gold mining is simply a scaled up version of what we see happening in the Stanislaus region of California. When constantly discussing gold in terms of tonnes and at the level of governments however, perception of the effort behind those numbers can be lost

To exemplify, we will again conclude with a tweet from Jim Rickards made one week ago. It is staggering to imagine how many of the sludge buckets described above would be required to produce Russia’s 1,717 tons.

 

Everyone Is Now Talking About The Dollar

On this day in 1498, less than six years prior to his death, the Italian explorer Christopher Columbus first stood on the American mainland at a location in present-day Venezuela. At the time he called it “Isla Santa” thinking he was standing on an island.

Sadly 519 years later, despite controlling some of the world’s largest oil reserves, Venezuela is enduring incredible suffering at the hands of economic mismanagement. It is the most obvious modern example of the consequences of unrestrained money printing. We’ve covered Venezuela on numerous occasions and discussed the country’s gold draw down last year.

The prompt for this brief journey through the history of currency demise comes from the fact that this morning’s news theme seems undeniably focused on the US Dollar bear market currently playing out. Indeed the Dollar Index has fallen by approximately 9% for the year to date making 2017 the worst start to a year for the USD since 2002. This is something illustrated very well by Marin Katusa on twitter only an hour ago at the time of writing.



Only 2 hours ago, Reuters published an article discussing both the dollar and the fact that gold is now sitting at an approximate seven week high.

Citing “U.S. economic data that cast doubt on whether the Federal Reserve will raise rates again this year”, the article states that the dollar isn’t just falling against the heavily weighted Euro but against most major currencies.

Eugen Weinberg, an analyst at Commerzbank goes on to say that "U.S. politics is a mess and U.S. data has not been inspiring." Furthermore, considering that the USD is now at its lowest in over a year (a fact not missed again by Katusa Research as pictured below), Standard Chartered concludes similarly that "rising geopolitical tensions and political uncertainty, weak U.S. macro data and a weaker U.S. dollar have buoyed gold prices".



The consensus of analysts seems to be that subdued headline inflation along with anaemic wage growth have eroded the case for another Federal Reserve rate rise this year.



Edward Meir of INTL FCStone joined the chorus by saying "we think that there is more upside on gold. A combination of a weaker dollar and falling U.S. bond yields should propel the precious metal higher, with North Korea being a wild card."

Only 13 hours ago came further confirmation from investing.com which covered the fall of the DXY citing it at 93.25 after seeing a fall of 0.6% during Friday’s session. At the time of writing, the DXY has fallen further to 92.81.



“The dollar remained on the back foot after data on Friday showing that while U.S. economic growth accelerated in the second quarter wage growth and inflation remained sluggish” referring to the fact that Q2 GDP printed 2.6% versus an expected 2.7%, and core PCE dropped to 0.9% from a downward revised 1.8%.

Moving on to work from David Lawder who 3 days ago reported on claims by the IMF that despite recent falls, the “U.S. dollar was overvalued by 10 percent to 20 percent based on U.S. near-term economic fundamentals”.

David goes on to say that “the IMF's External Sector Report - an annual assessment of currencies and external surpluses and deficits of major economies - showed that external current account deficits were becoming more concentrated in certain advanced economies such as the United States and Britain, while surpluses remained persistent in China and Germany”.

Even CNBC reported last Thursday on the dollar’s impact on gold prices and other commodities, arguing that the inverse relationship between the dollar and dollar priced commodities may no longer hold.

Citing material from Citi Research, the article interestingly argues that the correlation is now gone.

"Commodity prices have traded in a strong inverse relationship with the U.S. dollar over the past decade or so, but this relationship broke down in late 2016 and the breakdown looks here to stay.

Case in point—commodities generated strong returns in the fourth quarter of 2016 with the Goldman Sachs Commodity Index moving 9 percent higher despite a stronger greenback which gained about 7 percent against major currencies.”

To succinctly summarise, we are seeing strong capitulation in the world reserve currency and the upward momentum in gold at the moment may not be halted by any recovery that the USD may manage. This is more broadly a part of something unprecedented in financial history and worthy of the investor’s attention. To that end, today we conclude with one of our own pieces of work:

“Philip Haslam’s post-GFC (2014) book “When money destroys nations” as a study of Zimbabwe’s hyper-inflation is one excellent example of the value of hard assets to the investor. One of the numerous anecdotes contained within includes the wide-spread purchasing of motor vehicles (despite the lack of fuel to drive them) in a desperate attempt to acquire anything physical instead of holding cash”.

 

RBA Holds On Rates As Aussie Household Mortgage Stress Hits 25.8%

The notable news feature since our last article was the RBA’s decision to keep rates at 1.5% yesterday following an 11% rise in the Australian currency this year.

Bloomberg’s Michael Heath penned an article with a title that sums up nicely the impact of the elevated AUD on the minds of the RBA board “Aussie Dollar Turns Into a Villain for Central Bank”.

The RBA started its easing cycle nearly six years ago now in an attempt to mitigate the impact of the decline in the mining driven component of the economy and has continued this trend citing concern over the now ongoing issues of stagnant wage growth and headline inflation that now seems almost unarguably resistant to classical stimulation techniques.

Of course more recently the issue of the higher Australian Dollar has comprised another figurative thorn in the RBA’s side as we have been covering lately.

RBA governor Philip Lowe in his statement yesterday remarked that “the higher exchange rate is expected to contribute to subdued price pressures in the economy” and further noted that “it is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.”

Interesting too was the collective yawn from the trading community evident in the almost unchanged AUD price, sitting above 80c before and after the announcement but since retreating to 0.79661 as pictured below. Note that times are in UTC and hence 10 hours behind local.



Indeed interest rate settings are arguably becoming an ineffective tool for the control of currency strength; a point well illustrated by the following Bloomberg comparison of cash rates versus the AUD over the past 3 years.



In the eternal search for inflation, Philip Lowe said that “the board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.” Traders are currently pricing in a 50 percent chance of a rate increase in July.

In bringing these articles to you, we attempt to go a little beyond the sound bites and to do so today we explore the problem plaguing not only the RBA but the Australian population in general; the impact of low rates on property.

While a stimulative rate setting tends to entice construction and consequentially the hiring of labour, it simultaneously tends to entice speculative purchasing due partly to the tax benefits currently available.

While this is a large topic and one well beyond the scope of this article, it is reasonable to say that the Sydney and Melbourne housing markets have displayed bubble characteristics in recent years. In fact according to Bloomberg, July property prices in Melbourne and Sydney rose 3.1% and 1.4% respectively despite moves by regulators to strengthen lending standards and depress demand for interest-only loans.

The result?

According to Digital Finance Analytics research to the end of July 2017, greater than 820,000 households are now considered to be in mortgage stress. This figure represents a staggering 25.8% of households and an increase of 0.4% from last month’s figure. Furthermore, Martin North in the Digital Finance Analytics Blog goes on to state that “we also estimate that nearly 53,000 households risk default in the next 12 months”.

This trend is pictured below courtesy of Digital Finance Analytics. Observe in particular the combination of increasing debt illustrated (ironically) by the silver line and stagnant wage growth illustrated by the green line.



Martin continues by saying that “the number under pressure have been rising each month. The RBA cash rate cuts have provided some relief, especially directly after the GFC, but now mortgage rates appear to be more disconnected from the cash rate as banks seek to rebuild their margins. The main drivers of stress are rising mortgage rates and living costs whilst real incomes continue to fall and underemployment is on the rise. This is a deadly combination and is touching households across the country.”

It is certainly counter intuitive to observe elevated levels of mortgage stress in an environment of record low interest rates; something we’ve discussed at the start of last month. As always we recommend a balanced approach to investing which is a topic that will be addressed at the NUU Understanding Money Conferencescheduled for Saturday 26th August.



Today we conclude by borrowing a comment posted yesterday by Macro Business contributor David Collyer in relation to the broader topic of mortgage stress.

“Please, for you own sake, diversify. Even modest steps can significantly alter your risk profile.

In the 1989 downturn, a bumper sticker said: ‘I am not participating in this recession.’ Choose now to be among those not participating in the coming severe downturn. Create these options for yourself.”

 

PLUMMETING SILVER PRODUCTION DEMONSTRATES ALLURING PROPERTY OF SILVER & BITCOIN MINING ALIKE


Exactly one week ago we posted an article entitled “Share Trading Versus Gold Panning: Where Effort Produces Value”. The piece related to the inherent value in the effort required to mine gold. Mining is a large scale, long term endeavour requiring allocation of capital and the adoption of financial and political risk to be at all viable.

Consequently, mining is a process that cannot be significantly altered in the short term. Coeur D’alene for example, a major silver miner, managed to reduce its costs by 26% from 2014 to the first quarter of 2017. Although an impressive reduction, the amount of time required to do that (especially when considering that the silver bear market started in 2011) is quite obvious.

We’ve noted previously that “mines are complicated and capital intensive. You can’t cut 26% costs in a mine overnight. There are a lot of moving parts and there are dozens of things that can go wrong”. A desirable result of this mining inertia is the fact that the commodities produced by mining operations are both limited in terms of supply and variable in terms of supply rate. These properties are interestingly also common to bitcoin mining, which is the analogous process by which bitcoins come into existence.

Topically, mining output restraint is very well exemplified by an SRS Rocco article posted on Friday. As pictured below, the article reveals that 2017 Q2 saw extraordinary falls in silver output from four of the top primary silver miners; Hecla, Endeavour Silver, Silver Standard and First Majestic.



Figures compiled from recently released company data show silver production reductions in the range of 20% to 34%; figures that fall “well beyond normal fluctuations in mining company production figures” and hence demonstrate fundamental supply side pressures.

This trend is perhaps even more obvious when the breakdown is viewed in terms of ounces as pictured below



The reasons for these falls are an effective way of demonstrating the difficulties native to mining operations. Hecla’s silver output for example was hindered by a labour strike at their Lucky Friday mine in Idaho. Endeavour Silver experienced output declines due to “narrowing veins, falling ore grades and less ore production due to reduced capital expenditures in the beginning of 2016” along with reduced access to mine areas “as pump failures due to power overloading caused flooding in some portions of the mines”.

Silver Standard’s mining output suffered from the closure of their Pirquitas open-pit operations coupled with the fact that their Chinchillas underground project which was intended to accommodate this closure won’t begin production until the second half of next year. Experiencing issues similar to Hecla was First Majestic which saw silver output impacted by an 8% drop in ore yield over the last 12 months and union related labour disruptions.

Far from an isolated set of coincides however, the article cites low silver prices as an overarching common factor in the declines experienced by these silver miners; something that fails to accurately price in costs of risk and costs of production.

This revelation plays out well in the wake of our article posted exactly 4 weeks ago entitled “Silver’s Flash Crash & The Real World Problems Low Prices Create”. In it we note that the between Coeur and Hecla, there could be a lot more than 30 million ounces of silver production a year in major trouble at current silver prices and this puts the supply side at further risk in an already high physical demand environment.

Owning an asset that can only be produced through an arduous process is an alluring proposition to investors and it is partly the difficulty inherent in mining that makes the decision to own that which is mined so easy.

 

WHAT THE BYZANTINE EMPIRE TEACHES US ABOUT USING BITCOIN & GOLD IN TANDEM

There is understandably much discussion at present surrounding the phenomenon that is Bitcoin. Certainly its divisibility, fungibility and lack of counter-party risk alone see it share properties with the long established kings of sound money, gold and silver. It seems curious however that many, including financial experts, speak in a manner that implies that precious metals and cryptocurrencies are adversarial in nature; competing for the affection of investors and traders alike. A good example of this mindset is the recent video exchange between Peter Schiff and Max Keiser at Freedom Fest, published on RT.

To address this mindset, today we summarise a piece by Nathan Lewis of Forbes who argues that Bitcoin and Gold should not be viewed as mutually exclusive assets and by using them in tandem, an individual can build a portfolio that provides for long term financial stability with transactional convenience and no counter-party risk.

Nathan writes that “gold and Bitcoin are actually somewhat complementary – that one’s strengths are the other’s weaknesses, and vice versa. This suggests that gold and Bitcoin together might have some role in our future. It's common to see Bitcoin even represented visually as a sort of gold coin.”



Gold’s strengths will not be news to this audience and include thousands of years of established stable value. Ancient gold coins from the Ptolemaic Dynasty of Egypt for example can easily purchase what they could during the Hellenistic period, even when disregarding the numismatic value obvious in this particular example. This stability is well suited to saving and storing wealth for long periods of time and is useful for the pricing of longer term instruments that would otherwise be distorted through the erosion of inflation.

One of Bitcoin’s strengths is its transactional utility. From the settling of international invoices to the ability to geographical diversify funds, Bitcoin has provided a means to avoid the costly and lethargic mechanisms characteristic of wire services such as Western Union. Notable however is Bitcoin’s lack of history and hence its present inability to reliably store value.

Nathan concludes that he can “see a situation where gold can be used somewhat like a ‘savings account,’ and Bitcoin as a ‘checking account.’ You would keep a Bitcoin balance for transactions, but maybe not a large amount. Bitcoin could be sold for gold, or gold for Bitcoin, as the need arose, to replenish your transaction account or transfer value to long-term assets. Prices and contracts might be denominated in gold, but payment made in Bitcoin at the daily market rate.”

Interestingly, this complimentary approach is not unique in history and can be observed in the use of the gold Solidus (pictured below) during the ancient Byzantine Empire prior to its fall to the Ottoman Turks in the mid fifteenth century. Nathan explains that “the Byzantine Empire had a system that was based on a highly-reliable gold coin, the Solidus, which did not change in value for over seven centuries. However, especially during the fourth century, most commerce was conducted with a variety of junky copper coins, whose market value against the solidus was quoted daily.”



Other examples of the historical separation of price benchmarking from transacting can be found. Ancient Mesopotamia is understood to have utilised silver for the quotation of prices yet relied on the exchange of other commodities at the market silver rate for physical payments. It could be argued then that Bitcoin is partly a modern implementation of a historically established mechanism that compliments gold’s strengths rather than competes with them.

Those interested in learning more may be interested in the upcoming NUU Understanding Money Conference. Scheduled for Saturday 26th August, this conference will exhibit a range of presenters on a number of topics from the definition of money, its past and future, cryptocurrencies and of course gold as the oldest form of money. Ainslie Bullion will be presenting at the event and we look forward to seeing you there.

 

wow. I just noticed the price of bitcoin. Looks like it is gold on steroids. unfortunately gold will never be able to rise like bitcoin has. gold can be regulated, manipulated; bitcoin cannot. gold and silver had their day in the sun in 2011. I think it will be another 20 years before anything substantial happens.

 

Do you think they can stave off world economic disaster for that long?

I think the wheels are on the verge of falling off now.

 

TWO OF THE WORLD’S LARGEST GOLD PROPONENTS NOW COMPETE OVER BITCOIN MINING

In order to address some of the discussion surrounding bitcoin’s role in a modern portfolio, we wrote yesterday about the concept of viewing gold and Bitcoin as complimentary assets from a historical perspective. What evidence of this synergy can be observed in modern times however? To answer this, it may be useful to explore what some of the largest gold advocating nations are doing.

We often write about the pro-gold policies pursued by Russia and China. In fact to support this, it has been reported this week that China’s gold reserves have now surpassed 4000 tons as at June.

Li Xuanmin of the The Global Times writes that although the PBOC “has not publically disclosed plans to increase gold reserves since October 2016, some market analysts, based on calculations on domestic gold output and imports in recent years, estimated that the country’s above-ground gold reserves totalled 20,193 tons as of June.”

Citing a report published over the weekend, Li notes that “while about 16,193 tons of gold are owned by Chinese citizens, the remaining 4,000 tons are held by the country’s central bank”. If these estimates are true then China may have displaced Germany in the ranking of central bank gold holdings.

Having established China and Russia as gold supporting nations, we can look to them for insight into how they view the appearance of Bitcoin in the global space. It is timely then that overnight news broke explaining that Russia is trying to rival China in Bitcoin mining. This suggests that pro-gold nations are also pro-Bitcoin.

Bloomberg is reporting that the equivalent of $100 million is set to be raised to facilitate Russian infrastructure capable of challenging the mining farms already established in China. The scheme is said to work through investments in RMC (Russian Miner Coin) which will allow for the rights to a share in the Bitcoin mined using the Russian company’s mining equipment.



China is already known to be a major player in the Bitcoin mining space. A significant number of their mines; simply structures containing specialised and dedicated computer equipment, are in the Sichuan province due to the cheap power provided by the hydroelectric dams there. Power consumption is one of the significant expenditures involved in Bitcoin mining and the China based Bitmain Technologies is a recognised leader in the production of specialised low power computing equipment for use in Bitcoin mining.



Interestingly however, RMC intends to utilise their own Russian designed semiconductor technology originally developed for low power satellite use in order to reduce the cost of running cryptocurrency mining computers and hence compete with the existing Sichuan infrastructure.

Vladimir Putin’s internet ombudsman, Dmitry Marinichev was quoted at a Moscow news conference as saying “Russia has the potential to reach up to 30% share in global cryptocurrency mining in the future”.

While on the topic of mining, we’ve recently been discussing how the risks and difficulties inherent in the physical mining of commodities are partly what gives that which is mined its value. Other news overnight demonstrates that real world issues impact the mining of Bitcoin in a similar fashion to how they impact on the tangible equivalent.

According to the South China morning Post, a destructive magnitude 7 earthquake has overnight struck the above mentioned Sichuan province. This is a place that is very involved in Bitcoin mining so this earthquake has been extremely devastating and possibly will impact the mining of Bitcoin. The issue was raised on Chinese forums but is difficult to quantify as the exact locations of the Chinese mining farms are apparently kept rather secret and for good reason.

The fact that Russia wants to rival China in this regard is quite interesting as it would mean an increase in mining decentralisation and an end to China’s monopoly on Bitcoin mining dominance. It is certainly interesting to observe two of the world’s most pro-gold nations pursue pro-bitcoin policies. Importantly, neither nation has abandoned or even curtailed their accumulation of gold; they appear to be simply augmenting it with smaller investments in the Bitcoin space. A salient observation for the personal investor’s consideration.

 

GOLD UP ON WAR RHETORIC

At the time of writing, gold is sitting at a $1,276.90 and the news community is unanimously attributing its now 8 week high to similarly heightened tensions between the United States and North Korea.

In daily terms, gold gained $16.70; a performance not bettered since May 17th when it gained $22.30. Silver, now at a two month high, saw its sharpest daily rise since September 21st of last year. Platinum also hit a 3 month high.



The mining community is also catching a bid with Bloomberg Intelligence’s gold miner index (which tracks 15 companies) rising over 1%. Randgold Resources and Barrick were particularly strong, both rising over 1.4%.

Yesterday saw an increasing exchange of words between the United States and North Korea with Donald Trump threatening “fire and fury like the world has never seen” and Kim Jong Un threatening missile strikes on the US territory of Guam. Although most news outlets are citing just this brief exchange, these comments stand on the back of a heated couple of days.

Over the weekend, new sanctions on North Korea were announced by the UN; a move antagonised further by Monday’s release of strategic exercise photographs around Guam by the United States. North Korea’s rhetoric included talk of using the “medium to long range strategic ballistic rocket Hwasong-12 in order to contain the U.S. major military bases on Guam including the Anderson Air Force Base”, the current location of a U.S. strategic bomber deployment.

These market responses are a good reminder of one of gold’s fundamental purposes. Lost in the daily technical analysis and discussions of mine supply is the immutable fact that gold is and has long been viewed as a safe haven asset. In the week of the Cuban Missile Crisis of October 1962 for example, gold demand was higher than during the 1960 gold rush and was supplied to the market by the then recently established London gold pool in order to retain the $35 price peg in place at the time.

Ross Norman, the CEO of London’s Sharps Pixley and a gentleman we’ve written of previously, commented on the recent safe haven buying saying that “it’s really gold behaving in its traditional manner as a safe-haven asset”.

Some commenters however see more positive drivers at play for gold prices currently. “Precious Metals Investing for Dummies” author Paul Mladjenovic overnight said “I think it’s going to be a stronger time for gold than in prior times” referring not just to the heightened geopolitical tensions but also to gold’s seasonality. “August, September, October tend to be good months for the metals and I think this time will be no different”.

Furthermore Paul notes that “we’re in the precursor production phase for things such as jewellery and other products such as electronics for the holiday season in the United States and Christmas world-wide so I think there’s a lot of great potential here definitely.”

Overnight, GoldCore authored a succinct summary of the escalation in tensions with North Korea which we will conclude with today.

“This should serve as a timely reminder that it is the bigger picture which is important when it comes to economics and finance. Whilst economic data such as employment figures are important, it is what the global picture and geopolitics look like over the long-term which will drive safe haven assets such as gold and silver.”

 

GLINT PROMISES GLOBAL GOLD CURRENCY


As gold continued its safe haven climb overnight in response to yet further tension between North Korea and the United States which we discussed yesterday, let’s turn our attention to modern efforts and a recent development in the field of gold as a modern global currency.



Indeed, one of the misinformed arguments against gold relates to it being perceived as an antiquated financial instrument in a modern digital world; yet such an assessment would be unfair. We see ongoing efforts undertaken by influential nation states to facilitate international trade with non-USD settlements including gold and our article on the cooperation between Russia and China three weeks ago speaks to this in more detail.

This is not just a trend among the big players however. As discussed earlier in the week, the transactional convenience of gold for the individual consumer is a field that innovation is targeting and the latest venture comes from a company in London called Glint.

We’ve written previously about London’s role as a global gold hub and the recent moves to impart transparency upon the gold space there. Now, Glint is claiming to provide “a new global currency, account and app” something that, according to The Coin Telegraph, “hopes to allow consumers to effectively perform point-of-sale transactions in gold”. Far from just a concept, Glint already enjoys financial support from Bray Capital along with numerous individual and institutional investors to the tune of £3.1 million. Furthermore, Glint has already secured approval from the Financial Services Authority to operate in the UK.

Glint is scheduled to launch in the last quarter of this year and is currently accepting registrations of interest. TechCrunch’s Steve O’Hear explains that “Glint will offer a frictionless way to both store and spend your money in gold, including at the point of sale, just like a regular local currency”. Although absent of any specifics, Glint’s app reference hints at the use of NFC (near field communication) mobile phone technology already provided by major banks and is visualised with the following image from the company’s website.



The Glint manifesto explains that “at a time of extraordinary monetary policy and when trust in currencies, banks and existing payment systems has been eroded, Glint helps us move to a more stable global economy”, further promising “money that is reliable and independent and gives you more control in the way you store, spend, exchange and transfer money”.

As is likely evident from the above declaration, Glint’s founders have significant commercial experience in precious metals. Glint’s CEO, Jason Cozens was one of the GoldMadeSimple.com founders, a business that facilitates the purchase, sale, delivery and storage of gold. Glint’s COO, Ben Davis is a financial and commodity market veteran of 17 years, was a former trading head at RBS and was involved in the founding of Hinde Capital at the start of the GFC, an investment company with a precious metals emphasis.



In a comment supportive of concepts we’ve already written about, Glint editor, Alex Matchett, said in an interview that he can “see a world where you have digital assets as a New School version of gold which is very credible, robust and secure and you have a Old School version which is actual gold — and what a great trading relationship there will be between the two!”

Furthermore, Alex describes a practical scenario where gold may play part in future point-of-sale transactions. “Say I’ve just looked at the gold price in euros and realised the euro has gone down against the pound by 1% and the gold price is looking perky and I say ‘do you know what, I think today I’ll buy my lunch in gold’. Having these choices as a consumer is quite fun don’t you think?”

Glint enters a market already introduced to similar offerings. The Goldmoney Mastercard for example is an established system that facilitates spending of physical gold holdings in a range of major currencies and it remains to be seen how exactly the Glint system will differ.



Noteworthy here are the parallels with bitcoin which is currently the beneficiary of similar efforts in the field of point-of-sale fluidity from companies such as (the also UK based) WirexApp. These developments speak to those who may hold reservations about gold’s liquidity or its relevance in an increasingly digitally connected world.

 

NEWCREST MARKET PERFORMANCE SPEAKS VOLUMES ABOUT GOLD

Last Thursday we wrote of safe haven buying of precious metals in response to the still ongoing North Korean tensions. Today we follow up with recent commentary and discuss what the performance of Australia’s biggest gold miner is telling us.



Today Newcrest Mining will be releasing its full year financial results. That in itself isn’t all that significant. What is significant however is Newcrest’s stock performance in the preceding trading day. Friday saw ASX : NCM manage a climb of 44c to close at $21.85 marking its highest point in almost four months and, more importantly, a gain in the context of an enormous 1.15% fall in the All Ordinaries index.

As Australia’s largest gold miner, the fact that Newcrest saw such contrarian success in the market leads to the conclusion that the broader investment community is not only positive on the company but by proxy, positive on the future demand for the product that they produce; an important indicator to observe.

In fact, gold has now twice broken the $1,290 mark on its continued upward momentum as pictured below.





As is often the case however, it is not just a single indicator that is screaming positively for gold at the moment. The last few days have seen an outpouring of support for gold and to a lesser extent Bitcoin within the financial community and this has been reflected in the price of both assets.

Let’s start with the Founder of Bridgewater Associates, Ray Dalio who recently had the following to say about gold’s prospects at the moment:

“We can also say that if the above things go badly (global geopolitical matters such as North Korea), it would seem that gold – more than other safe haven assets like the dollar, yen, and treasuries – would benefit, so if you don't have 5-10 per cent of your assets in gold as a hedge, we'd suggest that you re-look at this. Don't let traditional biases, rather than an excellent analysis, stand in the way of you doing this”.

The fact that these “other” safe haven assets are becoming less palatable to the investor is likely related to central bank induced distortions in these instruments. Just before the weekend, Michael Pento of Pento Portfolio Strategies described in a discussion with Jim Rickards that “we have an international sovereign debt bubble the likes of which we’ve never seen before. For instance, why is the Japanese 10 year bond yielding zero percent?”

Michael goes on to explain that with global inflation targets around 2%, holders of such debt are experiencing an erosion of capital and, importantly too, significant risk as “Japan’s debt to GDP ratio is now 250% and around the world, debt has increased by 70 trillion dollars since the start of the GFC”.

In that same exchange, Jim Rickards noted that “for the first time since 1937, the fed is tightening into weakness”. Jim further supports the popularity of gold and Bitcoin that we’ve recently been writing about by saying that “crypto-currencies are a form of money. When you buy Bitcoin for example, it’s a currency exchange. You’re getting rid of dollars and you’re taking on bitcoin”. To be clear however, Jim supplements this statement by asserting that he personally doesn’t own any digital currency, stating simply “I buy gold. Gold is a form of money”.

We have come a long way it seems in terms of mainstream sentiment since the famous “pet rock” comment, with articles positive for gold now finding somewhat regular homes on the pages of Australian news outlets. This is a point well exemplified by a piece published about 15 hours ago by the Sydney Morning Herald that quoted an ANZ representative saying that there is an expectation for “gold to break through the $US1,300 an ounce mark fairly soon, and then move higher. If you look over the medium to longer term we think gold will continue to appreciate. And certainly, our medium term target is for $US1400 an ounce”.

To wrap up our collection of quotes, let’s cite a report released on Friday where Simona Gambarini of Capital Economics said “gold prices are likely to remain well supported and could even rise above $1,350 per ounce, which hasn’t been breached since the Brexit referendum last year”.

Perhaps this pro-gold zeitgeist is at least partly due to the fact that last week marked the 10 year anniversary of the freezing of three mortgage exposed funds at BNP Paribas on the grounds of liquidity concerns; an unexpected announcement that preceded a 387 point fall in the Dow and the onset of the GFC. Regardless, a diversification into this area is something well worth considering and something that we will be discussing further at the NUU Understanding Money Conference in two weeks. We hope to see you there.

 

NEW GOLD TAX TURNS INDIAN IMPORTERS TO KOREA


The gold community has been keeping a watchful eye on how India’s gold consumption has reacted to the tax changes implemented this year. This is largely due to the fact that purchasing demand in the face of a more arduous tax environment can provide a good indicator of whether an asset is being purchased for its inherent value or for alternative reasons such as convenience or particulars surrounding the mechanics of moving and storing wealth in a tax efficient manner.

The astute eye is looking for either signs of abatement in gold demand from the world’s second largest consumer in the face of tax increases or rather a continuation of demand with an increase of tax minimisation techniques.



To date we have seen gold purchasing very strong in India with buyers employing a number of techniques to minimise the impact of the increased tax. These techniques include bringing purchases forward as we covered here and travelling to locations such as Dubai, Singapore and Sri Lanka which we wrote about here to make purchases in a more tax friendly environment.

It is becoming more evident that the GST imposed in India on the 1st of July this year which increased the previous 1.2% tax to 3% is seeing gold purchasers buy smarter rather than buy less. According to data from GFMS, to the end of last month, 2017 import figures in India are double what they were only one year ago at 550 tonnes.

Additionally, it is now being reported that 25 tonnes of gold is expected to be imported into India from South Korea over the months of July and August in legal exploitation of the fact that a 10% customs duty payable on gold is inapplicable due to the fact that a FTA (Free Trade Agreement) is in place between the two nations.

Notably, South Korea is being favoured over other FTA options due to the availability of gold in certain forms that avoid the 10% customs duty. These forms include coins.

The current South Korean import tally sits at 12 tonnes since the GST was introduced at the start of last month. The GST introduction was part of a tax simplification which abolished a previous 12.5% excise duty on such imports; a change that created the loophole now being exploited.

The discounted imports are impacting upon local vendors and refiners within India. MMTC-PAMP’s managing director in India, Rajesh Khosla told Reuters that those who currently import from South Korea “can give a $10 or $15 discount. Refiners are operating with a 0.65 percent margin. We cannot compete with someone who is giving a 1 percent discount”.

Only six weeks into India’s tax restructure and already new schemes are being adopted to minimise its financial impact on the profitability of gold. The windfalls in this case however may be short lived with a government spokesperson indicating that the Indian government has become aware of the loophole and is collecting data in order to determine how to resolve the issue.

 

LORD ROTHSCHILD REITERATES WARNING

Almost exactly a year ago, arguably the most famous name in global finance, Rothschild, and in this instance Lord Jacob Rothschild, said this:

“The six months under review have seen central bankers continuing what is surely the greatest experiment in monetary policy in the history of the world. We are therefore in uncharted waters and it is impossible to predict the unintended consequences of very low interest rates, with some 30% of global government debt at negative yields, combined with quantitative easing on a massive scale.”

That is only part of what he said and this was only part of a full article we wrote outlining why gold tends to go up when shares go down. It is certainly one worth revisiting here. One cannot understate the power this name has wielded in finance for over 250 years.

Late last week he was out again with his annual report and this is what he had to say:

“We do not believe this is an appropriate time to add to risk. Share prices have in many cases risen to unprecedented levels at a time when economic growth is by no means assured. The S&P is selling at 25 times trailing 12 months’ earnings, compared to a long-term average of 15, while the adjusted Shiller price earnings ratio, which averages profits over 10 years, is approximately 30 times.

The period of monetary accommodation may well be coming to an end. Geopolitical problems remain widespread and are proving increasingly difficult to resolve. We therefore retain a moderate exposure to equity markets and have diversified our asset allocation towards equity investments where value creation is driven by some identifiable catalyst or which are exposed to longer-term positive structural trends.”

This comes fresh after our recent article where Ray Dalio, the head of the world’s largest hedge fund, likewise warned people to get some of their money into gold before this plays out.

Whilst, as Rothschild and Dalio say, shares valuations are hitting new highs, gold is effectively bouncing along the bottom. Even so, this year gold has outperformed both the S&P500 and Dow Jones. In Australia, our stronger Aussie dollar has taken most of the shine off those 11% USD spot gains, up only 1.3% so far this year. That said, everything is relative and our own All Ords is up only 1.4% and depending where you live, property has even seen declines. As Lord Rothschild warns, the whole setup looks particularly fragile at the moment. When, not if, financial markets correct, history tells us gold and silver will languish no more.

 

THE “DISORDERLY” PROPERTY CRASH AND YOU

If you missed 4 Corners last night you should jump on iView and watch it. Ostensibly about mortgage stress, it also covered the likelihood of a property crash in Australia.

It covered ground we’ve covered here before. Australia has the second highest private debt level in the world, the debt to income ratio is 190%, our banks are highly leveraged into one market with 60% of their loan book being mortgages, and now record levels of mortgage stress being experienced by home owners. It was a trip around Australia from Brisbane to Perth and the view of those being interviewed was we were looking at a ‘disorderly’ crash soon, not an orderly one. It’s all just too strung out and precarious to end gently.

On this point one economist pointed out the current ‘perfect storm’ of record high property prices, record low interest rates, and low unemployment (not full, but not bad either). If just one of these 3 factors change – property prices come off (prompting valuation and equity issues), interest rates (and hence debt servicing costs) go up, or unemployment rises (meaning more people can no longer service that debt at all) – the whole thing could spiral out of control and hence the ‘disorderly’ crash scenario.

Whilst the program covered many bases it missed some critical ones, especially in terms of the broader market impacts. One could think it’s ‘other peoples’ problems’ if you don’t own property. We think that couldn’t be further from the truth and neither does finance writer for news.com.au, Jason Murphy who penned this great article recently.

Firstly we have to acknowledge the fact that Australia, having let our manufacturing industry die, is driven largely by mining and property, with the latter being the saving grace since the mining boom ended. So what happens to our sharemarket if property crashes and mining already has?

Australia’s sharemarket is more dominated by the finance sector than nearly any other in the world. Whilst the ASX200 comprises the top 200 publicly listed companies in Australia, 25% of its value is thanks to just the 4 big banks. As 4 Corners pointed out, and why Moody’s recently cut their rating, they are beholden to home mortgages for a very large portion of their profit in an unstable property market. But it doesn’t stop there of course. As Jason points out, we have the so called ‘wealth effect’ of people spending the value uplift in their property by drawing off their loan. This was a big contributor to the GFC where American’s were buying cars, plasmas, etc etc by increasing and redrawing from their mortgage as their property value kept going up. It was free money! But when that stops, so does all that spending that was going into a lot of those other 196 companies. One can quickly see how, in Australia in particular, a property crash likely means a sharemarket crash too. Oh, and property crashes tend to be U shaped, not V in that they last longer rather than bounce back. Since the GFC, US house prices only returned back to square in 2015 and Spain is still over 30% below the 2007 high. For context, Australia is 50% higher than it was in 2007 and barely saw a blip in the GFC (thanks mining boom….). One has to ask oneself, does that feel sustainable.

And if you think you neither own shares nor property privately (and have nothing to worry about) you likely do own shares through your managed super fund. Managed super funds tend to be very heavily weighted to shares and financial markets. Yet another clear warning to take control and establish your own Self Managed Super Fund ASAP.

The article also covers the dangers of cash in banks should we see a “major financial contagion” scenario where banks collapse. Again, we have covered this and point out the shortfalls of the so called deposit guarantee scheme.

Of course, as is sadly true of many main stream economists, the article missed the obvious safe retreat in such a market – gold, silver and bitcoin.

A stand out memory of the 4 Corners program were the young couple who proudly had multiple investment properties. They had a combined income of $135K. They had $1.2m of debt and estimated their houses were all worth $1.5m. So if the property market drops by 20% they are wiped out. All their eggs are in one basket rather than balancing across multiple, uncorrelated asset classes. Crashes have and always will happen. Don’t underestimate how big the next will be, manage your debt, spread your risk, be ready to capitalise on it.

Topically, the front page of today’s AFR sees property giant Goodman’s sitting on $2b of cash waiting for exactly that…

 

US DEBT CEILING – 7 DAYS TO GO


Debt ceiling standoffs are not a new thing to the US. Each time however they have ended up passing the bill in Congress to allow the US government to fund continual budget deficits, robbing future generations to pay for today’s excesses. We’ve quipped before, it’s not a debt ceiling but more like a debt target… they hit it every single time…

Let’s look at how we got here (again). Back in November 2015 Congress suspended the debt ceiling until 15 March 2017 meaning the statutory debt limit of the US government could not exceed the $19.8 trillion (yes, trillion!) at that day. Since then the US Treasury has bought time by what it calls ‘extraordinary measures’ which basically entails raiding federal pension funds. Steve Mnuchin, the US Treasury Secretary has just announced they run out of these measures by the end of this month, just 7 days away.

For further context they have raised the debt ceiling 78 times in the last 57 years so one could become complacent that it will just happen again. Once (essentially by accident) they didn’t, in 1979, and it cost the US around 0.6% in higher interest for an indefinite period. To see 0.6% increase now would cost them in the order of $1.2 trillion over the next 10 years. In 2011 we saw the ‘debt ceiling crisis’ standoff that resulted in Standard & Poors downgrading the credit rating of the US for the first time in history, the world’s reserve currency no less. In 2013 again there was a stalemate that saw the Government grind to a halt as public servants couldn’t be paid. More importantly, the world’s reserve currency looked on the brink of defaulting on its bonds, US Treasuries.

So why should we be worried this time? The New York Times put it well:

“First, the administration is confounded by inexperience, incompetence and infighting. Treasury Secretary Steven Mnuchin has little expertise in congressional stage management, but he understands the gravity of the situation and has lobbied for a clean debt ceiling bill — one without conditions or unnecessary amendments.

But that puts him in tension with his White House colleague Mick Mulvaney, the director of the Office of Management and Budget and a founding member of the Freedom Caucus, who has intimated that breaching the debt ceiling would not be that consequential, and who has argued that the must-pass legislation should be used to advance the hard right’s agenda. Without a firm signal from the White House that the debt ceiling should not be held hostage to political agendas, it will be hard to get Congress to do the right thing.

Every weekday, get thought-provoking commentary from Op-Ed columnists, the Times editorial board and contributing writers from around the world.

And that’s the second problem: Congress, and in particular the Freedom Caucus. As the health care fight showed, the caucus is fixated on cutting entitlement spending. It has made it clear that if the House leadership balks on their demands for major cuts in the 2018 budget, they’ll refuse to vote on raising the debt ceiling.

Finally, some conservative policy makers besides Mr. Mulvaney have convinced themselves that crashing into the debt ceiling won’t be a big deal because the government can “prioritize” its bill payments, so that interest on Treasury debt will be paid on a current basis, while other bills sit unpaid.”

Clearly the markets are more worried than the “it always resolves itself” camp as the relationship with the ‘other’ bond of choice, German bunds clearly illustrates below…