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PRE GFC HIGH 10 YEARS AGO

This week has seen two milestones for the world’s largest share index, the S&P500 in the US. This week it hit a new all-time high whilst also marking the 10 year anniversary of its final high before the GFC saw it lose more than half its value. Since the GFC the US Fed pumped $4.5 trillion into the system to save and then refloat it, and boy did it ‘work’. Deutsche Bank just released the results of how 38 of the main global assets performed since that pre GFC peak. So to be clear these are how things have performed since the peak, not the bottom.



Not surprisingly the S&P500 topped the list. You will note too that a whole lot of bonds, topped by US High Yield have excelled courtesy of the 2nd of the Fed’s reflation vehicles… zero interest rates. When you look at the big winners they have all been the direct benefactors of the unprecedented quantitative easing and zero interest rate policies dominating markets since. You will note Gold came in 5th overall which might lead you to think people were happy to play the free money game but wanted their hedge in place to the inevitable outcome…

Interestingly too you will note many of the poor performers were from emerging markets and the still struggling Euro basket cases. The latter goes some way to explaining the following chart which shows how the ECB has overtaken both the Fed and Bank of Japan in the amount of money printing they have undertaken, buying up both sovereign and corporate bonds at a rapacious rate.



So the elephant in the room remains… what happens when the Fed embarks on pushing that pink line down with QT (Quantitative Tightening), in tandem with rate rises, and at a time that the market is overvalued, at all-time highs, and hooked on the ‘juice’? What happens if the ECB start to plateau out their white line when they still have basket case nations not even above pre GFC highs despite the ECB pumping over $5 trillion into the Euro market?

 

CRASH CATALYST – FREEZE TO FLIGHT

Yesterday we spoke of the “elephant in the room” with regard to the effect of central banks moving to tighten on global financial markets and there was plenty of news around this overnight. Last night the Fed released the minutes of their last meeting and they have been described as ‘schizophrenic’ in that on one hand they spoke of “many Fed officials concerned low inflation is not transitory," but then "many Fed officials saw another rate hike warranted this year". So our repeated warnings of a rate hike into weakness seem to be reiterated by the very instigator… Gold understandably jumped on the news… but shares kept going as well.. why?

Former fund manager and Bloomberg commentator Richard Breslow bravely made the call last night:

"as the long running debate about lack of volatility in the markets continues, I’ve got some good news for you. As long as you promise to be happy with what you wish for. It’s about to change…..I’m talking about good old fashioned two-way flow and nascent trends galore. And I’m officially declaring today the very start of the entire change over process.”

Volatility, or more specifically the lack of it, is most certainly one of the main themes in markets today. Simplistically that ever present central bank hand of support would explain it, so what happens when that is removed. Deutsche Bank just released a report that asks the question, is it complacency or are investors in ‘freeze’ mode amidst all the global uncertainty at the moment. They reference a similar thesis by the winner of this year's Nobel prize in economics, Richard Thaler of the University of Chicago. So what could move this from freeze mode to flight mode?

"the most likely causes of a shift to ‘flight mode’ and a rise in volatility? Here’s one possibility: by the end of next year, the combined expansion of all the major Central Bank balance sheets will have collapsed from a 12 month growth rate of $2 trillion per annum to zero."

Enter Exhibit “Elephant” we referred to yesterday…





The IMF have joined the chorus, warning that the market is now particularly sensitive to spikes in volatility:





Deutsche concludes somewhat ominously:

"As we look at what could shake the panoply of low vol forces, it is the thaw in Central Bank policy as they retreat from emergency measures that is potentially most intriguing/worrying. We are likely to be nearing a low point for major market bond and equity vol, and if the catalyst is policy it will likely come from positive volatility QE ‘flow effect’ being more powerful than the vol depressant ‘stock effect’. To twist a phrase from another well know Chicago economist: Vol may not always and everywhere be a monetary phenomena – but this is the first place to look for economic catalysts over the coming year."

Whilst they talk of this ‘catalyst’ coming next year, markets have taught us time and again that the only accurate predictor of a bubble bursting is hindsight. There is a famous saying in gold circles… better a year too early than a day too late.

 

WHY CHINA’S ICO BAN COULD WORK FOR YOU

Casey Research put out a very logical position on why we should be seeing the Chinese ban on ICO’s (Initial Coin Offerings) last month as an opportunity not a threat to crypto currencies. They demonstrate that China has a track record of banning technology companies to allow their domestic equivalents to flourish.

They banned Google as their domestic equivalent Baidu struggled, they banned Facebook so their own Tencent flourished, and Amazon and eBay allowing Alibaba to dominate… it’s a repeated pattern. Indeed the usual FANGS are nowhere to be seen whereas the five largest tech companies in China are Alibaba, Tencent, Baidu, JD.com, and NetEase.

But whilst they have banned ICO’s, Casey’s crypto expert Teeka Tiwari had this to say:

“China won’t let something as big as the blockchain go to a foreign competitor. Right now, platforms outside of China are dominating ICOs. If they don’t get back in the market soon, China will lose out on this lucrative market.”

He claims to have insider officials confirming the ban is only temporary whilst they figure out how to regulate the industry. Just as Baidu etc took off once they removed the competition, Chinese based crypto’s too will take off once they are allowed back in the market. Whilst you might dismiss this as having nothing to do with you as a ‘mainstream’ bitcoin or ether holder (as the alt currency world is one you don’t play in) you need to remember that bitcoin and ether form the basis buy in for many of these trades and ethereum tokens often the vehicle for them.

On that last point, analyst Lynn Sebastian Purcell explains nicely:

“…..Bitcoin is a digital currency that works by a blockchain technology. That technology just keeps track of who owns what, i.e., of the global leger of Bitcoin transactions. So the technology powers the coin.

The Ethereum network inverts that idea: the coin powers the technology. The blockchain technology is the Ethereum network, which runs a system of global "smart" contracts (i.e., they are like legal contracts, but are enforced automatically by a computer program). Ether is the coin that powers the Ethereum network; it's the "gas," so to speak. Each time the program runs, it requires "gas" to complete a transaction. The more people on the network, the more gas they need to buy, and so the more valuable Ether should be…..It is this unprecedented generality that forms the heart of the Ethereum network. Effectively, it's a single blockchain computing system, which is why the creator, Vitalik Butterin, calls it the Ethereum Virtual Machine. Other programs run on it, the way that programs run on the Windows operating system, or apps run on cell-phones. The difference is that apps are run on just one machine (your phone), while Ethereum "apps" are run on a distributed machine (the blockchain). Hence, why they're called DApps (distributed apps).”

Recently we wrote about China’s potential plans around the gold market too. Communism is a dirty word in democratic, capitalist countries but the control it allows could well be a massive theme of any global currencies repositioning soon, be that digital currency or the world’s oldest, gold….

 

WHY GOLD SUPPLY WILL FALL

Late last year we reported evidence indicating, as with Peak Gold, we have likely seen ‘Peak Silver’ last year. i.e. Gold and silver production are set to decline or at least plateau in the years ahead regardless of demand.

Precious metals mining stalwart Pierre Lassonde, founder and chairman of Franco-Nevada and past Chair and director of the World Gold Council, sheds some more light on this and weighs in on gold as an investment. The following are excerpts from an interview with Germany’s Finanz und Wirtschaft last week in an article tellingly titled “We Don’t Know How to Replace the Great Big Gold Deposits From the Past”. It’s a bit longer than normal but we think it’s worth the read:

“Mr. Lassonde, after a few difficult years gold seems to get its shine back. What’s next for the gold price?

Right now, there is more demand for paper gold than for physical gold. For instance, when you look at the refineries in Switzerland they will tell you that they’ve got the bouillon but they’re not busy. It’s not like a year and half ago when they had no stock and the gold bars basically were flying off their shelf the minute they were produced. So the pressure is in the paper gold market, the futures market.

What’s the reason for that?


Part of the recent strength of gold is what I call a risk premium on the world. There is a lot of speculation that has to do with the tensions around North Korea and President Trump. I don’t have a personal relationship with Mr. Trump but I know the man a little bit. When he was elected, my prediction was that he was going to tie up the US administration in a knot because he’s totally unpredictable. Nobody knows where he’s going and you cannot run a country that way.

And what does this have to do with gold?


Anyone else in the Oval Office would not make such outlandish statements as Mr. Trump makes. Gold (Gold 1285.64 -0.72%) is benefiting from that. After the US election, my prediction was that the dollar was going to suffer from Mr. Trump being in office. The price of gold is intimately related to the dollar. Gold is essentially the »anti-dollar»: If the dollar is strong, gold is weak and if the dollar is weak, gold is strong. So what we are seeing now is exactly what I have expected: a lower dollar and therefore a stronger gold price.

So where do you think the gold will go from here?


My view has been between $1250 to $1350 per ounce for this year and then slightly ramping up next year to around $1300 to $1400. But for gold to get into the next real bull market we need signs of inflation. So far we haven’t seen them. The Federal Reserve and other central banks have piled up huge reserves. But there is no inflation because the money is sitting within the banks and they are not lending it. Therefore, you don’t get a multiplier effect. But what happened recently in the US – the one-two punch with respect to the hurricanes »Irma» and »Harvey» – is going to require an enormous amount of reconstruction. This could finally move the needle on inflation. Also (ALSN 139.2 0.65%), Europe is doing much better. So at some point I suspect we are going to see inflation start to pick up a little bit.

What does this mean for the mining industry?


First of all, at a gold price of $1300 the industry by and large is doing well. I tell my peers: »If you are not making money at $1300 you should not be in this business.» So it’s a good price and you should be making good money. But the industry has had to shrink a lot. When the gold price dropped to $1000 at the end of 2015 everybody in the business was too fat. So the industry laid people off, consolidated, shrunk and many junior companies have been wiped out.

What are the consequences of that?


Production is declining and this is going to put an enormous amount of pressure on prices down the road. If you look back to the 70s, 80s and 90s, in every of those decades the industry found at least one 50+ million ounce gold deposit, at least ten 30+ million ounce deposits and countless 5 to 10 million ounce deposits. But if you look at the last 15 years, we found no 50 million ounce deposit, no 30 million ounce deposit and only very few 15 million ounce deposits. So where are those great big deposits we found in the past? How are they going to be replaced? We don’t know. We do not have those ore bodies in sight.

Why aren’t there any large discoveries anymore?


What the industry has not done anywhere near enough is to put money back into exploration. They have not put anywhere near enough money into research and development, particularly for new technologies with respect to exploration and processing. The way our industry works is it takes around seven years for a new mine to ramp up and then come to production. So it doesn’t really matter what the gold price will do in the next few years: Production is coming off and that means the upward pressure on the gold price could be very intense.

Why didn’t the industry put more money into exploration?

The industry has had to shrink a lot. Also, the boom in Exchange Traded Funds has changed the capital markets in a huge way: Companies that are part of an ETF get treated like chosen sons. But when you’re not in an ETF you’re getting marginalized. You become an orphan and the junior companies in particular have been completely orphaned.

How does that impact the funding of mining?


The thing with this industry is that you have to have an incredible amount of patience and you have to have money. And right now, it’s hard to get money. The risk appetite of investors has been gone for many, many years. If you are not one of the chosen few you can’t get money. You sit on the sideline and wait. In the past, more than half of the new discoveries have been made by junior companies. But they haven’t had any money now for like 10 years. So how are you going to find anything if you don’t fund the junior companies?”

He then went on to answer a whole lot of questions about his company’s response to these changes. Finally he was asked of his view on gold as an investment:

“What’s your advice for investors who are interested in gold?


It’s very interesting. When you look over a hundred years back there are periods of 10 to 30 years where you would rather be in the stock market. But then, there are other periods from 10 to 15 years where you would rather be in gold.

In which period are we today?


Let’s take the Dow Jones (Dow Jones 22997.44 0.18%) Industrial. To my mind, the Dow is essentially an expression of financial assets. Gold on the other hand is what represents hard assets: real estate, paintings and other hard assets. So when you look at the gold cycle from 1966 to 1980 [see the chart below], you can see that the ratio between the Dow and the gold price at the beginning topped out at almost 28:1: It took 28 units of gold to buy one unit of the Dow. Then the long term trend reversed and the ratio went all the way down to 1:1. A similar cycle took place in the 30s. The Dow crashed from around 360 in 1929 to 36 in the next years. So it lost like 90% of its value. On the other hand, the gold price went from 20 to 34 and the ratio essentially bottomed out at almost 1:1, like at the end of 1966 to 1980 cycle.

And what does that mean for investors today?

Today, the Dow is over 22,000 and the price of gold is around $1300. This equals a ratio of almost 18:1 and you can clearly see that the trend is starting to roll over. So what does it mean if we go down to a ratio of 1:1 once again? The gold price would hit a big number and nobody is prepared for that. I don’t know any more than anybody else because it’s about the future. But it happened already twice in the past 100 years. So I think the odds that it’s going to happen a third time are pretty good. History does repeat itself, never exactly in the same fashion, but in the same form. Therefore, I would rather own a little bit more gold than not. So I think for an average investor, it should be the absolute rule to hold around 5 to 10% gold in your portfolio, like rule number one.”

 

‘GREENSPAN PUT’ SAFETY NET IS GONE

Peter Schiff is renowned for some famous and very public calls on financial events. Most recently he was very vocal about the impending GFC in 2006 and 2007 before that crisis unfolded. Whilst there were a few, like now, that were sounding warnings just because markets were high, Peter was quite specific about the cause and effect… and he was bang on.

As we have written many times, this current market is notable for not just the high valuations on any number of measures, but it’s coincidence with incredibly low volatility (via the VIX). Indeed that relationship, as outlined by Schiff, is at an ALL TIME high.

“This means that the gap between how expensive stocks have become and how little this increase concerns investors has never been wider. But history has shown that bad things can happen after periods in which fear takes a back seat.”

Take a look at the following chart:



The reason? Schiff puts it squarely down to the undying belief by the market that the Fed will step in should there be any large market correction, just as they have done the last few times. Sharemarkets used to be widely understood as being risky and hence the VIX would (logically) rise alongside valuations. However after the 1987 crash we saw the now famous Greenspan Put where he said the Fed was at “its readiness to serve as a source of liquidity to support the economic and financial system” and lowered rates and flooded the market with cheaper money. That safety net was reinforced after the dot com crash when they slashed rates from 6% to 1% and then again after the GFC when they cut rates from 5% to nearly 0% PLUS launched the unprecedented Quantitative Easing program that saw them print $4.5t. Despite that stimulus the haul out of the crash for shares was slow. The charts below show what happened from each of the peaks of the chart above for shares and gold:





Those who sold their gold at its peak and bought underpriced shares have had a wonderful run since. In Australia, those who hung on to their shares have still not seen the pre GFC peak again.

But in essence all of the above is known by most people, it’s a history lesson. Where Schiff adds his views on going forward, and in the context of the biggest bubble in val v vix EVER, and the fact the Fed still has rates at just 1.25% and a $4.5 trillion balance sheet already from the last round of QE, is this:

“It should be clear to anyone that since the 1990s the Fed has inflated three stock market bubbles. As each of the prior two popped, the Fed inflated larger ones to mitigate the damage. The tendency to cushion the downside and to then provide enough extra liquidity to send stock prices back to new highs seems to have emboldened investors to downplay the risks and focus on the potential gains. This has been particularly true given that the Fed’s low interest rate policies have caused traditionally conservative bond investors to seek higher returns in stocks. Without the Fed’s safety net, many of these investors perhaps would not be willing to walk this high wire.

But investors may be over-estimating the Fed's ability to blow up another bubble if the current one pops. Since this one is so large, the amount of stimulus required to inflate a larger one may produce the monetary equivalent of an overdose. It may be impossible to revive the markets without killing the dollar in the process. The currency crisis the Fed might unleash might prove more destructive to the economy than the repeat financial crisis it's hoping to avoid.

We believe the writing is clearly on the wall and all investors need do is read it. It’s not written in Sanskrit or Hieroglyphics, but about as plainly as the gods of finance can make it. Should the current mother-of-all bubbles pop, for investors and the Fed it won’t be third time’s the charm, but three strikes and you’re out.”

We’ve written a bit of late on the global loss of faith in the USD. What we think Schiff is saying is that the sheer amount of debasement (through printing so much more) of that currency that would be required to reflate the next crash would ultimately see any semblance of faith in it evaporate. A fiat currency is based on nothing but faith and the promise of a government and market bulls can only be so blind as to the real value of their financial assets.

 

RIPPLE (XRP) JOINS THE CRYPTO OFFER

Today we add Ripple (XRP) to the crypto offerings alongside Bitcoin (BTC), Ethereum (ETH), and Litecoin (LTC). These four (along with Bitcoin Cash which we don’t trade) make up the top 5 of market capitalisation in the cypto currencies. Ripple is one of the oldest and is the 3rd largest with a market cap of $7.52 billion at the time of writing, still only a fraction of Bitcoin’s $98.6b and Ethereum’s $27.1b.

Ripple is quite different to the other crypto’s for a number of reasons. It is most ‘famous’ for being the crypto vehicle adopted by the big banks. Ripple claim “It’s the fastest and most scalable digital asset, enabling real-time global payments anywhere in the world.”

Ripple can polarise a little because it is the ‘banks’crypto’ and everyone hates the banks… so emotion not common sense can sometimes prevail. Banks have been around (and doing rather nicely thankyou) for a long long time so betting against them seems a little ‘brave’…

Some other misconceptions are that the banks won’t actually use it, that it is ‘centralised’ because Ripple Labs ‘control’ it, and there is unlimited supply. Well HuffPost interviewed their Chief Technology Office, Stefan Thomas, and all those claims appear false:

• “Ripple isn’t creating any other cryptocurrencies or proprietary coins for banks. XRP is it. That means that Ripple success directly equals XRP success.
• XRP will soon be more decentralized than even Bitcoin. Thomas recently wrote a blog post explaining how.
• Not only is there a finite amount of XRP — just as with Bitcoin — XRP is actually a deflationary cryptocurrency, which means that a tiny amount of XRP is permanently shredded after each transaction. It’s the opposite of unlimited supply. As time goes on, the supply of Bitcoin remains the same while the supply of XRP will actually shrink, making it even more valuable with each passing day. [and most definitely the opposite of fiat currency!!]
• What about the fact Ripple owns about 60 billion of the 100 billion available XRP tokens? Ripple just announced they are putting 88% of those tokens they own into escrow smart contracts for a period of at least four-and-a-half years. The structure of it means no one has to worry about Ripple flooding the market by selling their own XRP holdings. The fact that they are putting them into smart contracts means they can’t renege on that later even if they wanted to.”

Want to learn more? We’ve scoured the net and think the following from BoxMining is a pretty good balance of keeping it simple but (necessarily) ‘talking tech’:

“Protocol vs. Currency

So lets start off with one confusing factors. So I must make a distinction between Ripple the transaction protocol (which is used between banks and other businesses) and the ripple issued currency, XRP. When you see Ripple making gains its actually the XRP, the currency that is issued by Ripple, that is gaining. And this is actually quite different from the network protocol or Ripple protocol. Both share the same name and I’m sure this has definitely confused a lot of investors.

Ripple Protocol

So lets start off with the transaction network known as Ripple. So the Ripple protocol is based on technology that’s similar to blockchain but not completely the same. It doesn’t require any mining and its based on a consensus network instead of being consumer-facing which is what Bitcoin is. Basically, it’s for the everyday person.

Ripple is exclusively used by big institutions such as banks. The whole idea of Ripple is to allow banks to transfer any sort of asset, be it currency, USD, Euro, gold, or any other asset such as airmiles. You can transfer that between other institutions near instantaneously. This rivals systems such as swift. So if you ever bought Bitcoin with bank transfer you will know how painful that is. You have to contact your bank and send the transaction to a swift bank code account and this might take up to two to three days and theres a lot of transaction fees involved for both the sender and the receiver. Ripple is set to revolutionise this by providing near instantaneous, sub-second transactions for institutions such as banks. It’s already been adopted by quite a few big banks and

XRP – Currency of the Ripple Network

So now that I explained what is the Ripple transaction protocol, let’s move on to Ripple XRP. XRP is actually issued by Ripple Labs and is a form of cryptocurrency that can be traded and it’s not “mined”. So there is a finite number of ripples and that amount is actually issued by the company behind Ripple called Ripple Labs. Currently, it is freely tradable on numerous exchanges such as Poloniex.

XRP by itself has no underlying related assets or values eg. Its not tied to USD or gold. Rather, it can be used to act as an intermediate currency in institutions. It has one huge advantage in that transaction costs are very, very low (unlike Bitcoin, which is now reaching 1.5 usd in transaction fees).

Concerns about Ripple [note these are largely addressed above]

So moving on, XRP is currently only issued out at less than 40% of its total. The remaining amount (minus the 20% retained by the creators of Ripple) is held by Ripple Labs to distribute whenever and however they so wish. This is actually kind of interesting because unlike a lot of decentralized currencies, Ripple Labs plays a huge part in distributing XRP. Ripple Labs is actually a company and this is very different from Bitcoin, where Bitcoin is fully decentralized and doesn’t have a central controlling authority. Ripple Labs is registered in many countries and it could be sued and held under police custody. This is again very different from other technologies.”

 

WHY THIS CRASH WILL BE FAST & FURIOUS

We’ve written a bit about the lack of volatility in the US sharemarket of late. The VIX hit single figures last week, just as it did before the GFC and now another new record…. It has now been 243 days since the US sharemarkets dipped more than 3% in a day. That is the longest streak in history. Everything is awesome.



SovereignMan’s Simon Black is warning that this phenomenon is contributing to what he thinks will be a very big, but importantly, very fast crash when the next sizeable ‘dip’ happens.

But first the core reason why… This bull market we are witnessing on most valuations measures is ‘only’ the 3rd most overvalued in history (after 1929 and 2000). However this one is different in that everything is overvalued not just one or two sectors. History’s most overvalued market was the dot com bubble but blue chips were sold to get on the tech stock bullet train and that meant you had what’s called ‘dispersion’ in the market. That is not the case now, with everything being overvalued. Morgan Stanley recently noted:

“We say this not as hyperbole, but based on a quantitative perspective… Dispersions in valuations and growth rates are among the lowest in the last 40 years; stocks are at their most idiosyncratic since 2001.”

Black thinks a lot of this has to do with the proliferation of passive investment ETF’s and their outsized effect on markets. No less than $391 billion dollars poured into ETF’s to July 2017, up on the already record high $390b in 2016.

These passive ETF’s care little for valuations but just spread their buy across the whole index they are designed to track. The record inflows into these funds of course have the effect of pushing the valuations even higher.

Bank of America believes 37% of the S&P500 is now managed passively. The world’s largest are BlackRock and Vanguard who collectively have over $10 trillion in assets, $7.3 trillion of which are passive, and growing by $3.5b per day.

So what happens when (not if) the turn comes? Over to Mr Black:

Humans are emotional creatures. And when we do finally see that 3% (or even larger) down day, investors will rush for the exits.

And the computers will pile on the selling (every model based on historically low volatility will completely break when volatility spikes).

But when the wave of selling comes, who will be there to buy?

“As these passive funds dump the largest stocks in the world, we’ll see an air pocket… nobody will be there to hit the bid.

And when the drop comes, it will come faster than anyone expects.

So, while most investors are ignoring risk, I’d advise you to use this record-high stock market to your advantage…

Sell some expensive stocks to raise cash. Own some gold. And allocate capital to sectors of the market that haven’t been blown out of proportion thanks to the popularity of passive investing. That means looking at smaller stocks and stocks outside the US.

Even if stocks go up for another year, which they may, it’s simply not worth the risk to chase them higher… Because the downturn will be devastating.”

 

SILVER DEFICIT AS PRODUCTION PEAKS

Recently we wrote about further evidence that gold production peaked last year and now the same for silver. First Majestic Silver is one of the world’s biggest primary silver producers and their Vice President of Corporate Development, Todd Anthony last week had this to say regarding the chart below:

"According to the World Bureau of Metal Statistics, silver ore production is down 12% from its high at the beginning of 2016. This would equal to a 100 million ounce drop in global mine supply (from 850M oz to 750M oz). I wouldn't be surprised to see this statistic drop another 5% by year-end given the current supply issues in Mexico, Chile and Guatemala."

(if you can’t make out the numbers, the graph starts in 1995 and you can see the peak around 2015)



We remind you again that around half of silver is used in industry producing products that are largely discarded after use (electronics, solar panels, medical equipment, etc). In 2016 around 885m oz was mined compared to gold mine production of 104m oz, that’s a ratio of around 8:1 silver to gold and consider half of that 850m oz of silver is ‘used’. Now compare that 8:1 to the 75:1 gold silver ratio and asked yourself if silver seems a little undervalued…..

Per the table below (courtesy of the Silver Institute and in million oz) demand in 2016 was 1,028m oz meaning this fall in production is coinciding with an existing deficit in supply over demand.

Supply

Mine Production

885.8

Net Government Sales

–

Scrap

139.7

Net Hedging Supply

-18.4

Total Supply

1,007.1





Demand





Jewelry

207.0

Coins & Bars

206.8

Silverware

52.1

Industrial Fabrication

561.9

…of which Electrical & Electronics

233.6

…of which Brazing Alloys & Solders

55.4

… of which Photography

45.2

… of which Photovoltaic

76.6

… of which Ethylene Oxide

10.2

… of which Other Industrial

141.0

Physical Demand

1,027.8



Physical Surplus/Deficit

-20.7

ETP Inventory Build

47.0

Exchange Inventory Build

79.8

Net Balance

-147.5



Sometimes numbers just speak for themselves…..

 

“EVERYTHING BUBBLE” INCLUDES US PROPERTY

Further evidence has emerged that the ‘everything’ in the now entrenched “Everything Bubble” descriptor for our current market goes well beyond traditional financial markets. Whilst Canada and Australia have recently taken the global headlines for our property bubbles, the US, whose property bubble in 2006 triggered the GFC, is now above even those per GFC levels too. The US has seen the double whammy of strong price growth and poor income growth meaning their median new home sale prices to median household income has hit an all-time high of 5.45.



For perspective Australia’s median dwelling price for combined capitals sits at around $585,000 and against the 2016 census median household income of $74,776 gives us an even more concerning 7.8 ratio.

This, combined with the endless metrics of sky high US financials valuations, should reconfirm why gold and silver, whilst still firmly up on the November 2015 lows are, by any real measure ‘bouncing along the bottom’. Gold and silver are your ‘uncorrelated monetary asset’ and whilst financial and property assets are reaching all-time highs they are behaving as you should expect. That said there are plenty quietly loading up as can be seen from the following two graphs:





Whilst that is happening steadily the price growth is subdued. When the masses head for that door however…..

 

$100B BITCOIN ON ITS 9TH BIRTHDAY

Bitcoin celebrates two milestones today. On this day 9 years ago its creator, the anonymous Satoshi Nakamoto, launched what he called Bitcoin, a “Peer-to-Peer Electronic Cash System”. Now 9 years later Bitcoin has just surpassed the $100b market capitalisation milestone and done so hitting all-time price highs, smashing through the US$6000 mark Sunday night, and up over 500% just this year to date.

However for us the $100b market cap figure is more alluring for how little it is, not how big. Sure, its rise has been meteoric of late, but as we point out is the case for both gold and silver as well, compared to the $300 trillion total global financial assets or $500 trillion total global assets, $100b is barely a blip. The number of active users, too, needs to be looked at in context. Of the 7.6b world population, it is estimated only 3.9m people have a bitcoin wallet with 0.01 bitcoins or more, that is 0.05% participation. Even reports of 15m total crypto wallets (across all currencies) in existence is 0.19% but many are lost, inactive or of very little value. When you consider we’ve seen +500% gains this year with such relatively low participation and noting you can’t simply increase supply, it begs the obvious question of what happens when demand doubles to just 0.1% of the world wanting it? Or even tenfold to just 0.5%??

For a little more context on this year’s rises lets also look at the challenges faced by the world’s largest crypto currency. In January this year China alone accounted for nearly all bitcoin trade as the Chinese piled in.



Then Japan legalised it as a currency the next surge came along, along with a return of the US and famously took bitcoin past the price of an ounce of gold. More recently we saw China’s government crack down on ICO’s (initial coins offerings of new alternative coins) and then domestic exchanges, seeing a 30% drop in the price. However since then the Chinese have moved to other means to continue trading and we’ve seen more recently moves by the big Chinese exchanges to more friendly jurisdictions in Asia, notably Japan and Hong Kong, but with Singapore and South Korea coming too. Japan’s regulators approved 11 new exchanges in September alone.

This week the RBA joined a chorus of concern about how government can control this peer to peer network. They are clearly worried about a growing awareness of an alternative to their fiat currencies and their slow, centralised and expensive banking network.

What bitcoin has proven this year, reaching its 9th birthday in spectacular fashion, is that it is resilient, exhibits intrinsic value by virtue of constrained supply, has a fast growing acceptance as a medium exchange (including buying bullion from us!), and on any helicopter view of it in the context of the financial market it plays in, appears to be still very much in its formative stages.

 

FINANCIAL MATHS 101

Regular readers will have seen our oft repeated reminder that if you see a 50% decline in your wealth you need to make a 100% on what’s left just to get back to where you started. It’s just math but it’s math so often overlooked by investors entering a market when valuations are high and fervour abounds. FOMO (fear of missing out) reigns supreme….

Talking percentages rather than dollars or ‘points’ on an index can be a trap. You could buy into a market at 1000 (dollars or points, it doesn’t matter) and make 70% on your money, but it corrects by 50% before you sell. Simplistically you might think you are still 20% ahead, but let’s do the math. 1000 plus 70% = $1700 less 50% = $850. That’s right, you end up 15% behind, NOT 20% ahead.

Sorry to suck eggs for those more mathematically adept, but it is a very common mistake and one that even if not applied quantitatively, is too often overlooked qualitatively. In other words, even people who can do the math seem not to apply it to their investment thinking.

Lance Roberts of Real Investment Advice covered this quite nicely back in March of this year. He produced some charts that everyone should study closely. First the following is a map of inflation adjusted returns on the S&P500 (the world’s largest and most important share index) using Dr Robert Shiller’s monthly data all the way back to 1900. You’ve likely seen this before but have most unlikely seen the table he has added to the right. The dates (in US mm/dd/yyyy format) correspond to each of the ‘peak’ and ‘low’ orange dots and show the actual point gain or loss for each preceding period (together with the percentage equivalent). As you can see there are periods when the entire previous real (point or dollar) gains are completely wiped out.



He then illustrates the effect of this table in the following 3 charts:

Firstly by the usual ‘disarming’ percentage measure:



But when reconstructed using actual point gains and losses:



Or in summary:



So as you consider staying ‘fully’ in or entering financial markets now chasing that remaining possible 10 or 20% return, remember the math of what happens if we see another 50% fall before you sell. And if you think you will see it coming, we remind you of our recent article “Why this crash will be fast and furious”

 

WHEN BIG MONEY ENTERS

Two of Wall Street’s bigger players announced strategic moves into the monetary assets of gold and bitcoin over the weekend.

First, as we reported last month, Michael Novogratz has launched a crypto currency fund, Galaxy Investment Partners, investing largely in bitcoin, a “very big” holding of ethereum, and 30-35 other tokens and companies. The largely anticipated correction on bitcoin happened late last week and Novogratz was there at the bottom jumping in and purchasing $15-20m worth over the weekend as the price jumped back up $1000 from its bottom. He sees bitcoin hitting US$10,000 ($13,000) by March.

In an interview with Reuters he said he believes other large institutional investors are around 6-8 months away from adopting bitcoin. One (though unnamed) ‘big financial firm’ could launch what he called a ‘turning point product’ within 6 months.

However in terms of legendary status on Wall St, they don’t come any bigger than Ray Dalio, head of the world’s biggest hedge fund, Bridgewater. For context, back in August he had this to say:

“When it comes to assessing political matters (especially global geopolitics like the North Korea matter), we are very humble. We know that we don't have a unique insight that we'd choose to bet on. We can also say that if the above things go badly, 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% of your assets in gold as a hedge, we'd suggest you relook at this. Don't let traditional biases, rather than an excellent analysis, stand in the way of you doing this.”

We’ve just learned that he walked the talk and the latest disclosures show his fund increased its gold exposure via the GLD ETF by 575% to $473m and likewise iShares Gold Trust (IAU) up 266% to $138m. Their GLD holdings now make Bridgewater the 8th largest holder of GLD. For context however, the world’s biggest asset manager ($5.7 trillion), Blackrock, dwarfs all comers with a holding (18.6m shares) nearly 5 times that of Bridgewater and over double the second biggest of Bank of America’s 7.1m shares. We are firmly on record on our views of ETF’s, but keep in mind when you are big players like this, you can supposedly demand the metal not the money. That is not a luxury afforded to every day investors…

Yesterday the World Gold Council released their latest Gold-backed ETFs update for October. ETF holdings increased just 3.3 tonne, up to 2,347.6t globally. That came about from Europe adding 11.2t, North America losing 8t, and Asia (who generally prefer the real thing) up 0.8t. This is in line with the trend we outlined last week here of the US going ‘all in’ to the ‘everything’s awesome’ financial markets. That said, year to date, inflows to gold backed ETF’s is up a solid 8%, 182.2t or $7.8b so far.

Let us leave you with one of our favourite quotes from Ray Dalio…

“If you don’t own gold there is no sensible reason other than you don’t know history or you don’t know the economics of it”

 

YIELD CURVE SENDS A WARNING

It was a rough night on Wall Street last night on the back of a raft of ‘everything is awesome’ shattering economic data. Another stronger than expected inflation print (CPI up 1.8%) saw gold and silver stronger and raised concerns of a December rate hike, but then we saw a post hurricane crash back to reality in retail sales (just 0.2%), the biggest drop in the Empire Fed survey in 7 months, and the 3rd straight month of declining real wages (a first in 5 years).

The S&P500 lost 0.55% which broke its 52 year record of the longest streak of sub 0.5% falls. We also saw the US Treasuries yield curve (explained here, and last discussed here) flatten to its lowest since the onset of the GFC in November 2007…



….and continuing the post ‘this time is different’ post Trump election anomaly:



Deutsche Bank has released their view on this and it highlights the absolutely precarious nature of the position the Fed (in particular, but central banks more generally) have put the market in and how very difficult it will be to manage us out without triggering a crash of epic proportions.

“The largest, and possibly, the only risk capable of resetting the vol higher is the tail risk associated with bear steepening of the curve and disorderly unwind of the bond trade. This is the risk that would be probably impossible to control, its trigger being either excessive deficit spending or inflation.

It is precisely the severity of this problem that prevents return of volatility. Current monetary policy is focused on the management of the underlying tail risk and the Fed transparency and gradual hikes are all about the reduced manoeuvring space that has remained after almost a decade of stimulus. Fed has an uncomfortable (and complicated) task in this context: Fed needs to raise rates in order to prevent rates rise. What must not be, cannot be: Inflation cannot be allowed to develop because it would be no way of avoiding dramatic rise in rates. If the Fed embarks on aggressive hikes in order to fight inflation, rates would rise. If the Fed stays behind the curve, the market would bear steepen the curve. Either way, the long rates go up.”

So watch these signs like we saw last night carefully around inflation, market ‘health’, and that all important yield curve’s response.

Below is an interesting (in that history is not always an accurate predictor of the future…) comparison of the current set up for the Russell 2000 (the small cap index, topical after our article this week) which shows how quickly that curve can steepen (noting it is an INVERSE of the curve illustrated) and the effects on financial markets…

 

GOLD, SILVER & BITCOIN JUMP ON FAILING ‘MONEY’

The old and the new forms of real money both surged over the weekend on the back of a host of catalysts.

Gold jumped $20.48 (1.21%) and silver 30c (1.32%) Friday night, taking both comfortably over their 200 day moving average. That was the biggest jump in 3 months and putting gold very close to the magic US$1300 again.





But on the back of firstly Venezuela’s PDVSA defaulting (previously discussed here), and then Mugabe’s resignation backflip this morning in Zimbabwe we saw bitcoin sore above US$8000 for the first time.



But if you think US$8000 is impressive, consider that in Zimbabwe it traded at nearly US$13,500 as locals piled in trying to preserve their money in the troubled nation. Bitcoin gives them the double benefit of being impossible to confiscate and easy to move offshore.

Throughout history gold and silver have played the role of real money as fiat currencies collapse, just as we are witnessing right now in Venezuela and Zimbabwe. Bitcoin is now joining those ranks, adding fuel to an already hot market.

Visitors to our office will have seen one of our $50million or $100trillion Zimbabwe notes. Both are essentially worthless, such was the hyperinflation in Zimbabwe. Venezuela too is experiencing something like 2400% inflation right now.

Is it any wonder people flock to real money? Is it any wonder we discount the concern that gold and silver don’t offer a ‘yield’? Monetary assets are all about preserving your wealth as fiat depreciates every day and inflated financial markets crash. The world has just experienced (and still is) historically unprecedented money printing through quantitative easing. To date that hasn’t played out in the normal general inflation expected of such stimulus. What it has done is inflated financial assets to record highs. The big questions are when will that bubble pop and when will that general inflation be unleashed? Gold loves either scenario….

But we are in ‘the lucky country’ right? Such currency craziness could never happen here…. We’ll discuss that more tomorrow….

 

GOLD & SILVER IN “THE LUCKY COUNTRY”

What a 24 hours! Yesterday we reported gold had its best session in 3 months but last night it had its worst in 4 months?! (down AU$23 and silver down AU$0.56). If that isn’t confusing enough, it happened after we learned Angela Merkel failed to form a government throwing German politics into chaos. Normally that would see a flight to safety but instead shares rallied and gold fell, albeit probably in a knee jerk to the USD rallying on the falling EUR.

And so continues gold’s ‘bounce along the bottom’ albeit with a steady rise off that November 2015 bottom. Gold is up 6% year-to-date and silver up 1%. By comparison, and it’s a comparison people can’t ignore, bitcoin is up 710% this year and hit a new all-time high last night.

It’s a pattern testing people’s patience with the ‘hard’ assets of the 3 noted above. However if you remove the emotion and look pragmatically at the situation, you really shouldn’t be surprised nor disheartened.

US shares are hitting all-time highs and Aussie shares getting closer to revisiting their pre GFC high too. Gold and silver are your uncorrelated investment so really you should be expecting them to languish in such an environment. We will concede this financials bull market has lasted longer than most, but again unemotionally, despite the absurdity of what’s fuelling it, the amount of central bank stimulus put to this market should see it last longer than you’d expect.

FOMO or ‘fear of missing out’ is the emotion that needs to be held in check at such times. Read again our Financial Maths 101 article.

Every day that this financials market breaks record highs is a day closer to that math playing out.

We mentioned yesterday we’d talk about Australia being ‘different’ – we are of course ‘the lucky country’ are we not? For a start few realise that term was originally coined facetiously in the context of us squandering our gifted resources. Over the weekend you may have seen an article picked up by many majors titled “Australia’s economy is built on shaky foundations” authored by Matt Barrie and Craig Tindale. It is a must read for anyone in the ‘Australia’s different’ camp and we’d respectfully suggest it reinforces our point above about maintaining an uncorrelated balance in your wealth portfolio, ala physical gold and silver bullion.

You can (and should) read the full article here but if you are short on time let us highlight some key text.

“Our “economic miracle” of 104 quarters of GDP growth without a recession today doesn’t come from digging rocks out of the ground, shipping the by-products of dead fossils and selling stuff we grow any more. Mining, which used to be 19 per cent of GDP, is now 6.8 per cent and falling. Mining has fallen to the sixth largest industry in the country. Even combined with agriculture the total is now only 10 per cent of GDP.”

“With an economy that is 68 per cent services, as I believe John Hewson put it, the entire country is basically sitting around serving each other cups of coffee or, as the Chief Scientist of Australia would prefer, smashed avocado.

Successive Australian governments have achieved economic growth by blowing a property bubble on a scale like no other.

A bubble that has lasted for 55 years and seen prices increase 6556 per cent since 1961, making this the longest running property bubble in the world (on average, “upswings” last 13 years).”

“Urban planners say that a median house price to household income ratio of 3.0 or under is “affordable”, 3.1 to 4.0 is “moderately unaffordable”, 4.1 to 5.0 is “seriously unaffordable” and 5.1 or over “severely unaffordable”.

At the end of July 2017, according to Domain Group, the median house price in Sydney was $1,178,417 and the Australian Bureau of Statistics has the latest average pre-tax wage at $80,277.60 and average household income of $91,000 for this city. This makes the median house price to household income ratio for Sydney 13x, or over 2.6 times the threshold of “severely unaffordable”. Melbourne is 9.6x.”

“Unsurprisingly, the CEOs of the Big Four banks in Australia think that these prices are “justified by the fundamentals”. More likely because the Big Four, who issue over 80 per cent of residential mortgages in the country, are more exposed as a percentage of loans than any other banks in the world, over double that of the US and triple that of the UK, and remarkably quadruple that of Hong Kong, which is the least affordable place in the world for real estate. Today, over 60 per cent of the Australian bank loan books are residential mortgages. Houston, we have a problem.”

We remind you too that Australia’s sharemarket is dominated by our financial institutions than any other in the world.

And finally, and in a final reminder of our ‘maths’ fixation….

“We can’t rely on property to provide for our future. In 1880, Melbourne was the richest city in the world, until it had a property crash in 1891 when house prices halved causing Australia’s real GDP to crash by 10 per cent in 1892 and seven per cent the year after.

The depression caused by this crash was substantially deeper and more prolonged than the Great Depression of the 1930s. Macro Business points out that if you bought a house at the top of the market in 1890s, it took 70 years for you to break even again.”

“The luck country” was coined 30 years ago and here is a reminder how:

“We took the view in the 1970s — it’s the old cargo cult mentality of Australia that she’ll be right.

This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through.

In the 1970s … we became a third world economy selling raw materials and food and we let the sophisticated industrial side fall apart … If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn’t deal with these fundamental problems … Then you are gone. You are a banana republic.”

 

FED MINUTES BOOST GOLD

In yesterday’s article Jim Rickards said “Central banks are determined to get more inflation and will flip to easing policies if that’s what it takes.”

Since the last US Fed meeting at the beginning of this month, gold has outperformed all major asset classes, including the bull market S&P500, as the USD dropped. The market isn’t buying the December rate hike and ‘(QE) asset normalisation’ program.



Why? Because inflation, by the Fed’s preferred measure, isn’t happening. Rickards (courtesy of Daily Reckoning) had a bit to say about that too:

“But I remain sceptical about a December hike. As I explained above, the market is looking in the wrong places for clues to Fed policy. Jobs reports are irrelevant; that was ‘mission accomplished’ for the Fed years ago.

The key data are disinflation numbers. That’s what has the Fed concerned, and that’s why the Fed might pause again in December as it did last September.

We’ll have a better idea when PCE core inflation comes out Nov. 30.

Of course, the Fed’s main inflation metric has been moving in the wrong direction since January. The readings on the core PCE deflator year over year (the Fed’s preferred metric) were:

January 1.9%

February 1.9%

March 1.6%

April 1.6%

May 1.5%

June 1.5%

July 2017: 1.4%

August 2017: 1.3%

September 2017: 1.3%

Again, the October data will not be available until Nov. 30.

The Fed’s target rate for this metric is 2%. It will take a sustained increase over several months for the Fed to conclude that inflation is back on track to meet the Fed’s goal.

There’s obviously no chance of this happening before the Fed’s December meeting.

A weak dollar is the Fed’s only chance for more inflation. The way to get a weak dollar is to delay rate hikes indefinitely, and that’s what I believe the Fed will do.

And a weak dollar means a higher dollar price for gold.”

Overnight the minutes of that 1 November meeting were released and confirmed exactly those fears. Gold jumped nearly $12 on the news, putting it very close to the US$1300 resistance line. From Bloomberg:

“Several participants indicated that their decision about whether to increase the target range in the near term would depend importantly on whether the upcoming economic data boosted their confidence that inflation was headed toward the Committee’s objective. A few participants cautioned that further increases in the target range for the federal funds rate while inflation remained persistently below 2 percent could unduly depress inflation expectations or lead the public to question the Committee’s commitment to its longer-run inflation objective.”

And as for that financial markets bubble they are creating whilst they don’t raise rates?

“In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances. They worried that a sharp reversal in asset prices could have damaging effects on the economy.”

Indeed.,..

So again we have a Fed stuck between the ‘real world’ deflationary rock and the ‘financial assets’ inflated hard place. It’s hard to think of a result that isn’t favourable to gold.

And finally for the joke of the day, and in regard to their stated reduction of their QE amassed balance sheet of bonds…

“A few participants mentioned the limited reaction in financial markets to the announcement and initial implementation of the Committee’s plan for gradually reducing the Federal Reserve’s securities holdings.”

Now why would that be?



If your eyes can’t pick it, of the $4.5 trillion in bonds they bought with freshly printed money, they have reduced it by 0.17%.... Hmmm, and no reaction? Could it be, like rate rises, the market has come to expect more verbal implementation than actual implementation?

 

what happened to these guys? Did they go out of business for putting all their eggs in the Bitcoin basket?