There has been an unprecedented attack on gold and mining shares over the
past three years emanating from financial institutions in order to support
the government's supposed success in bringing the economy back to health. And
even though gold mining shares are down 85% during this tenure, the case for
owning gold-related investments have never been more compelling.
The reason to own gold is the same today as it has been for thousands of years:
it is the perfect store of wealth. Gold is portable, divisible without losing
its value, beautiful, extremely scarce, and virtually indestructible. It is
simply the best form of money known to mankind.
The case for keeping your wealth in gold only becomes more bolstered when
real interest rates are negative, faith in fiat currencies is crumbling, and
nation states are insolvent. The massive and unprecedented Quantitative Easing
programs and Zero Interest Rate Policies among the Bank of Japan, Peoples Bank
of China, European Central Bank and Federal Reserve clearly show that Central
Banks have no escape from manipulation of their bond market, currencies, equities
and economies. Ms. Yellen's recent tacit admission that the Fed Funds Rate
must remain at zero percent for at least a full seven years was a clear validation
of this premise.
For example, if the BOJ were to stop buying every Japanese Government Bond
issued; interest rates would skyrocket, the stock market would crash and the
economy would melt down in a matter of days. This is because any nation that
has a debt to GDP ratio of 250%, over a quadrillion yen in debt, and is in
a perpetual recession should never be blessed with a 0.3% 10-Year Note yield.
Turning back to the Fed's recent decision to hold rates at zero, its inaction
should lift the veil on its omnipotence. As Clark Kent can attest, being "Superman" is
easy; returning to normal can be awkward.
With $44 trillion in total non-financial debt, which is up $12 trillion in
the last 10 years alone, we have also become a highly indebted nation that
has become completely addicted to lower rates. The U.S. high-yield bond market,
which was the catalyst of the 2008 financial crisis, has grown to $2 trillion
in size--a full $1 trillion of these new loans have been added since 2009.
But high yield isn't the only lesson unlearned since the 2008 crisis. According
to CNBC, nearly two-thirds of the high risk Ginnie Mae guaranteed securities
are issued by independent mortgage banks, affectionately referred to as part
of the "shadow banking system". And those independent mortgage bankers are
deploying some of the most sophisticated financial engineering that this industry
has ever seen...sound familiar? With credit scores of 520 and down payments
of just 3.5%, indeed it is clear that subprime mortgages are back with a vengeance.
Therefore, a rise in rates would further cool the already lukewarm housing
market. According to the National Association of Realtors, sales of existing
homes dropped 4.8% in August month over month to a seasonally adjusted annual
rate of 5.31 million. Home ownership rates at 63.4% are already at the lowest
level since 1967. Rising interest rates would not cause renters to become homeowners.
Instead, it would likely send the home price to income ratio, which is currently
at 4.4, crashing back to its long-term average of 2.6.
Turning to the interest paid on U.S. bonds, it is clear that mean reversion
of the 10-Year Note would bankrupt the Treasury. This is because that average
rate is north of 7%. If the Treasury was forced to service the existing $13.2
trillion of publicly traded sovereign debt at that rate it would take about
30% of all Federal tax revenue. Just imagine what will occur when rising rates
cause the economy and revenue to decline, as deficits explode. Remember that
annual deficits soared to $1.5 trillion during the Great Recession; and that
was with interest rates plummeting towards 2%.
And then we have emerging markets, where a rise in US interest rates will
reveal one of the great instabilities in the global economic system today.
A total of $9.6 trillion in U.S. dollar denominated debt is owned by non-U.S.
borrowers. When the U.S. dollar strengthens the cost to those foreign borrowers
rises...a lot. Emerging-market economies' debt is now 167% of their gross domestic
product, this is up 50 percentage points since the end of 2007, according to
figures from the Bank for International Settlements.
This led the economy of Brazil, which was already suffering the effects of
a slowdown in China, to announce austerity measures totaling $17 billion to
bridge the gap in its budget, after Standard & Poor's Ratings Services
downgraded the country's rating to below investment grade.
Turing back to the U.S. stock market, low interest rates have fueled a whopping
$2.5 trillion stock buyback binge since the end of March of 2009. Higher interest
rates would see the end of this corporate buyback scheme that provides an artificial
boost to EPS and share prices.
And not to forget the several hundred trillion dollars' worth of interest
rate sensitive derivatives, including credit default and interest rate swaps
underwritten by institutions, which will have to once again crawl back to the
government for another bailout once their bets become insolvent.
Finally, seven years of ZIRP has forced pension plans far out along the risk
curve in search of higher returns: vastly increasing the amount of equity exposure
in the portfolios in an attempt to generate the necessary 9% average annual
returns. However, the Dow Jones Industrial Average is already dropped to a
two-year low without one single basis point rate hike in the last nine years.
Ms. Yellen and company must be aware if a cycle of rate hikes were to take
place now it would not only bring increased competition for stocks but also
help push the anemic global economy into a recession. The result being that
there wouldn't be a solvent public or private pension plan in the entire nation.
The Fed is beginning to wake up to the fact that there is no easy escape from
its artificial zero interest rate policy. The Fed will not be able to move
very far off of the zero-bound range before the yield curve inverts and the
US, and indeed the entire global economy, melts down. This means real yields
will become more negative, the US dollar will lose more of its purchasing power
and economic instability will intensify over time--the perfect fundamental
backdrop for rising gold prices.
As the credibility and effectiveness of central banks comes more into question,
investors will seek comfort in gold because it is the sole monetary solution
that has stood the test of time. This is why there is a direct inverse correlation
between the faith in fiat currencies and the price of gold. Every few decades
a reminder is needed that all fiat currencies throughout history have lost
all of their value.
Therefore, if you are among those who own gold and gold mining shares...consider
yourself a part of a small and very fortunate club. A cadre of investors that
will be able to maintain its purchasing power and standard of living; while
those with complete faith in fiat currencies get summarily remanded to the
lower class.
