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Many in this assembly would agree that policymaking has
been the biggest promotion in history and in recent desperation became
unusually reckless. Since the crisis began in 2007, Mother Nature has been
issuing margin calls on governments. What's more, even with the most
complacent of taxpayers governments will not be able to meet the margin calls
on their own folly. But to be fair, the establishment has had some moments of
glory.
The feature
of the 1970s was a horror show of soaring inflation for commodities, wages
and consumer prices. Eventually, many in Wall Street realized that inflation
had something to do with money supply and the critical numbers were released
late on each Friday. Repeat "late on each Friday".
Often the numbers would prompt big moves in the bond market so traders had to
stay at their desks - until late on Friday. No early weekends.
Then the Fed
changed the release day to Thursday. This has been one of the most brilliant
of policy moves, ranking right up there with the New York Stock Exchange
ending trading on Saturday mornings.
The rest of
the history of policymaking has been "same old, same old" to the
point where I recently had a startling revelation. Ninety percent of all
central bankers who have ever lived are alive today.
Daunting
isn't it?
It gets
worse. Ninety-five percent of all the reckless central bankers in history are
alive today.
If that isn't
bad enough, 90 percent of all of the gold bugs in history are alive today.
To be
serious, the gold bug original assessment of central bankers has been
appropriate as is current condemnation.
However, we
are at a fascinating point in history when Mother Nature and Mister Margin
take apart all the schemes of financial promoters. Actually, financial
history provides an impartial due diligence on all of the grand promotions -
including interventionist economics and central banking. Also financial
history indicates that the massive experiment in government intrusion is
coming to an end - thankfully.
Why do I
state this?
In the past
2,000 years there have only been three great experiments in authoritarian
government and each was accompanied by deliberate currency depreciation. Of
interest, is that each ran for around one hundred years and can be called a
Century of Tyranny.
Then a major
change in politics ended the game. The mechanism has been simple.
Essentially, the state spent, borrowed, inflated and taxed away all of the
wealth. Consequent hardship became widespread and forced folks to tighten
their belts, who in turn, forced local and federal governments to tighten
theirs.
The last such
century ended with the financial contraction that began with the 1618 crash.
Details are fascinating and even amusing, but time only permits one important
irony. The hardship prompted intellectual concerns such that Edward Misselden theorized that throwing credit at a credit
contraction would make it go away.
That was in
1622 and any number of intellectuals have since had
the same revelations. John Law was the next big name to make the personal
discovery as he was becoming the first reckless central banker during the
first huge bubble that blew out in May-June of 1720.
In London
this was labeled as the South Sea Bubble and in Paris it was the Mississippi
Bubble. This extravaganza set the pattern on all five subsequent great
bubbles - right out to the 2007 example.
The climax of
each bubble has had enough common features to conclude they are methodical.
- Government has a vested interest
and will do anything to keep the boom going. In 1720, England was on a
bi-metallic standard but quasigovernment agencies such as the South Sea
Company and the Bank of England provided plenty of ease to accommodate
speculators. Also, politicians were bribed. In France there was no
restraint upon currency issue and John Law had some eight printing presses
running and he could not keep that bubble from lasting past its
"best before date".
- This one is worth repeating -
real printing presses could not keep a mania going.
- Typically in the year the bubble
maxed out, gold's real price set a significant low. And then increased
for some twenty years.
- Since the calculation of the
Consumer Price Index became compromised we have used a proxy and that is
the price of gold deflated by our commodities index. This set a low of
143 in May 2007 and turned up as the credit markets turned down.
Eventually to disaster.
- Another example of methodical is
that most booms run for 12 to 16 months against an inverted yield curve.
In early 2007 we counted the reversal to steepening out to June of that
fateful year. Along with gold, the change began in May and that included
spreads reversing to widening.
In bringing
this up to date, the panic ended in 2009 and liberated the first business
cycle out of the crash. This has become mature and, globally, the economy is
rolling over right now. This will prove that all of the
stimulus was in vain. Particularly so, with the knowledge that the
fundamental post-bubble condition is severe recessions and weak recoveries.
Policymakers
did not prevent the bubble from climaxing, did not prevent a financial
collapse, could not restore a "normal" business cycle and haven't a
hope in hell in preventing this recession.
In which
case, central bankers have not materially altered financial history, and in
taking a larger perspective they have played an important role in assisting a
great bubble. Beyond this, it will become evident that their main function
has been to fund another experiment in unlimited government through
depreciation. What's more, it is unwinding in the same old way.
Relatively
high unemployment that hurts, especially with the governing classes still
living well. This is a classic - what's new is the extortionate monopoly of
unionized workers at local, state and federal levels. Similar dissatisfaction
with the governing classes in Eastern Europe in 1989 brought down one of the
most murderous police states in history. The state had tanks, AK 47s and the
Berlin Wall. The public will prevailed. The current
administration is pushing America's experiment in authoritarian government to
an alarming level. Or, according to David Alinsky,
to the ideals of his father's Rules for Radicals, which intends to
transfer all power to a community-organized mob.
In this case,
all the administration has is propaganda on how good Obama's ambition for
change is and that won't fly.
Why?
The economy
can't afford existing levels of government take, let alone a massive
increase.
The irony is
that while the administration has been building the regulatory equivalent of
the Berlin Wall, the opposing political will is beginning to take it apart -
brick by brick.
When will it
get exciting and what has this to do with gold?
Credit
markets have been likely to be benign into May and then reverse to another
disaster later in the year. With this, many asset classes will decline with some
suffering forced liquidation, and this will again curb the ability of the Fed
to print. The old pushing on a string problem.
Another
methodical feature of the post-bubble world is that the senior currency
eventually becomes chronically strong relative to most commodities and most
currencies for most of the time. One explanation has been that during the
mania most of the debt issuance is due and payable in the senior currency in
the financial capital. It used to be sterling and London, now it is dollars
and New York. Such debt service represents a huge short position.
Technically,
the Dollar Index has been in a pattern that is leading to a major advance.
This is confirming the historical imperative of a firming senior currency.
Now, as we
can all imagine an outbreak of sound money will be disquieting to central
bankers as well as to those "banking" upon the status quo of
depreciation. Don't toss out your gold positions because of the resumption of
another liquidity crisis. Gold stocks are unusually cheap relative to bullion
and have recorded a significant departure from the longer trend of the stocks
correlating well to the advance in the dollar-price of gold. That pattern
ended during the completion of our late bubble in 2007.
This has been
frustrating as base metal mining stocks were outstanding performers into 2008
and 1Q2011. Particularly as they outperformed metal prices when gold shares
were underperforming bullion prices. This is typical of the conclusion of a
bubble. The best time for the gold sector has been during the post-bubble
contractions when the mechanism is the equally long advance in real prices
for gold. Reliable copper data are available since the 1830s and the real
price has generally declined through the three subsequent Great Depressions.
For traders,
market historians and supply/demand researchers, this becomes very
interesting. On three Great Depressions when sterling was the senior currency
and the calculation of the CPI was reliable, gold's real price increased by a
factor of 1.7 times. No matter what was going on in domestic politics or
foreign affairs, gold's price went up by the same factor.
Despite the
consistency of each advance, the associated increase in gold production
varied all over the place. In the 1825 to 1846 Great Depression annual World
gold production increased by a factor of ten times. With the same price
increase during the 1873 to 1895 Great Depression gold production only
doubled, which was the case during the post-1929 Great Depression. This
suggests that trying to determine gold prices from even a thorough analysis
of supply and demand may not be practical. This, of course, includes all of
the informed comments about the Indian monsoons and the number of camels in
the Arab souks.
To be
serious, there is a methodical and obvious reason why Mother Nature increases
gold's real price during a Great Depression. She wants production to
increase.
Why?
During a
great financial mania normal instruments of credit expand inordinately. As if
this isn't bad enough, new and weird instruments are created. In our own new
financial era the madness created derivatives, such as "credit default
swaps", and even "contingent credit default swaps". In the
1720 madness a bewildered participant wrote "The poor English
nation run a madding after new inventions, whims, and projects [promotions]
... They can ruin men silently, undermine and impoverish, fiddle them out of
their money by strange, unheard of engines of interest, discount, transfers,
debentures, shares, projects, and the Devil and all of figures and hard
names."
Then, both
normal and innovative credit instruments contract within a brutal
disappearance of liquidity, otherwise known a crash. This in turn inspires
policymakers to throw credit at a credit contraction to make it go away,
which never worked in the past.
Fortunately,
Mother Nature has had a methodical way of restoring liquidity to the global
banking system. She raises gold's real price such that mine profitability
improves and production increases. Gold companies make money when most
industry and commerce are having trouble staying alive.
For example, Homestake was the premier producer and its earnings were
hit in 1929 largely due to the weak real price that goes with a bubble. Gold was
fixed at 20.67 per ounce then and until the end of 1932. The stock soared by
130 percent as earnings increased by a similar amount. All with no change in
the dollar price of gold. Then Roosevelt got in line with history and
assisted the natural increase in gold's real price.
Homestake stock could have been accumulated during 1930 at 9
dollars. It soared to 65 during the mid-1930s and was paying 4.50 per share
in dividends. Canada's big producer Dome Mines soared as well, as did many,
many juniors.
My own
experience in the exploration business began with a degree in Geophysics and
a couple years in the field. Then, like a fool, I made money on my first
stock purchase and thought I was a genius. No more living in the bush as I
got an indoor job with a large investment dealer in Toronto. In 1965 I
noticed that on any given day when New York and Toronto were strongly up,
gold stocks would be strongly down, and vice versa. I asked a veteran on the
equity desk "Why?". He said "That's
the way it works".
It wasn't
until the 1970s when the historical research was really advancing that I
realized that gold miners did well in a depression and that was still driving
the action. Then for a couple of decades such opposing action was barely
evident.
Last
September, gold set a high of 1900 and, for example, Royal Gold registered an
Upside Exhaustion. That's technical talk for a buying panic. September also
recorded selling pressures in orthodox stocks with the selling panic in
sovereign debt. The point to be made is the opposite action came in as gold
stocks went up as the big board went down.
Move ahead to
this spring when opposing action was again in play. Orthodox stocks up as
gold stocks declined. Now both are down, but with the distinction that the golds are really down.
How much?
In a hundred
years of data, starting with Homestake and changing
to the XAU in 1983 there was only one selloff to a monthly RSI worse than
now. That was a reading of 21 in 1924. Now its
plunged to 23.9 and the "terrible" lows were few in number. 24.8 was clocked in 1942, 27 in 1948 and 25.3 in 2008. That's
the list and all were followed by outstanding rallies - virtually immediate
to the reading.
Action in the
gold/silver ratio has provided an outstanding guide to important tops and
bottoms. This worked very well a year ago in April and silver's action now is
accomplishing the opposite extreme.
The S&P
is nowhere near such a severely oversold condition.
Market
history is poised for the start of the next stage of a lengthy bull market
for the gold sector and within a global recession - an even more compelling
condemnation of policymaking.
As welcome as
this would be to many in our assembly, it is worth
noting in closing, that there is no guaranty that financial history will
continue along the path that accomplishes another Great Depression. On the
other hand, there is no guaranty that it won't. It is prudent to consider the
odds.
Bob Hoye
Institutional Advisors
The opinions in this report
are solely those of the author. The information herein was obtained from
various sources; however we do not guarantee its accuracy or completeness.
This research report is prepared for general circulation and is circulated
for general information only. It does not have regard to the specific
investment objectives, financial situation and the particular needs of any
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advice regarding the appropriateness of investing in any securities or investment
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statements regarding future prospects may not be realized. Investors should
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Neither the
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from time to time, members of the Institutional Advisors team may be long or
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Copyright
© 2003-2008 Bob Hoye
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