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Protect Your Wealth Against the Law of Unintended Consequences

Summary:
A number of weeks ago, I told you about my visit to the New York Stock Exchange (NYSE), where we celebrated the two-year anniversary of our quantamental gold ETF. The timing couldn’t have been better. Investor sentiment in gold was surging, as was the price of the yellow metal, on plunging yields around the world and uncertainty surrounding the U.S.-China trade war. Some of the institutional investors I met with at the NYSE relayed their clients’ concerns about the state of the world economy right now. They were receiving more calls and emails lately about gold, which has been used in the past as a hedge against government policy that was well-intentioned but that ultimately had unintended consequences. I can sympathize. The United States is the strongest, most prosperous country on the

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A number of weeks ago, I told you about my visit to the New York Stock Exchange (NYSE), where we celebrated the two-year anniversary of our quantamental gold ETF. The timing couldn’t have been better. Investor sentiment in gold was surging, as was the price of the yellow metal, on plunging yields around the world and uncertainty surrounding the U.S.-China trade war.

Some of the institutional investors I met with at the NYSE relayed their clients’ concerns about the state of the world economy right now. They were receiving more calls and emails lately about gold, which has been used in the past as a hedge against government policy that was well-intentioned but that ultimately had unintended consequences.

I can sympathize. The United States is the strongest, most prosperous country on the planet. This has been made possible only by free markets and the rule of law. But even the U.S. is not immune to the unintended consequences of well-intentioned policies. I believe gold is a rational investment to help protect your wealth against said policies.

The Law of Unintended Consequences

There are several recent examples. I called the Department of Labor’s (DOL) Fiduciary Rule one of the costliest financial regulations of the past 20 years. Meant to protect investors from nosebleed fees and advisors’ conflicts of interest, the rule may end up costing investors in the long run. I’ve heard from colleagues who said that a “cheaper is always better” attitude may exclude many smaller funds, ultimately giving retail investors fewer choices. Although the rule died in court last year, the DOL is expected to unveil a new version by the end of the year.

And then there’s the Recourse Rule. The little-known rule, enacted in 2001, is now widely believed by some experts to be partly responsible for the financial crisis that began in August 2007. I won’t get into the full details of what the rule did. In short, it changed banks’ capital requirements. Holding individual mortgages was given a greater risk-weight than highly-rated mortgage-backed securities (MBS), and so banks, trying to sidestep the additional capital requirements, securitized the loans—many of them “non-prime”—to which rating agencies gave the coveted AA- or AAA rating.

Those who’ve read Michael Lewis’ fabulous account of the housing bubble, The Big Short, or seen the Academy Award-winning film of the same name, know how this turned out for lenders—and, consequently, the world economy.

Over-regulation, then—as opposed to under-regulation—may have been the root cause of the worst economic crisis since the Great Depression.

“They’re Not Sending Their Best”

Adding insult to injury, it appears that some of these well-intentioned but ill-conceived rules and laws were imported directly from other parts of the world, particularly the European Union (EU). The Fiduciary Rule is a near-exact replica of the EU’s Markets in Financial Instruments Directive (MiFID II). The Recourse Rule was basically an addendum to Basel I, 1988’s series of banking regulations agreed upon by central bankers from around the world.

This is precisely the reason why some people vehemently oppose globalization. It’s precisely why the United Kingdom voted to leave the EU, why the American people elected Donald J. Trump.

“They’re not sending their best,” Trump famously said four years ago when he launched his presidential run. Of course he was referring to illegal immigrants, but he may as well have been speaking of the socialist policies the U.S. has adopted from the international community in past years.

Inflation Is Starting to Pick Up

My reason for bringing all of this up is to stress the importance of protecting your wealth, and your family’s wealth, against the law of unintended consequences. That’s why I have for years recommended that investors follow the 10 Percent Golden Rule. Gold has little to no correlation with stocks, making it an exceptional, time-tested diversifier when there’s market uncertainty. A 10 percent allocation, split between physical gold and gold mining stocks, is a rational way to the hedge against multiple headwinds right now, many of them sparked by poor government policies.

And yes, that includes trade tariffs. More than a year after the start of the U.S.-China trade war, we’re starting to see consumer prices increase. Tariffs are like taxes. Core inflation, which excludes food and energy, rose to a six-month high of 2.2 percent year-over-year in July. In the chart below, you can see that average inflation since the trade war started in March 2018 is higher than it was in the months prior.

Protect Your Wealth Against the Law of Unintended Consequences

This data becomes more tangible when you look at changes in price at specific stores. According to Gordon Haskett Research Advisers, a trip to Walmart or Target in June was nearly 5 percent more expensive than it was a year ago. That might not sound like much, but because of Walmart’s reputation of having low prices, even a slight bump up could be enough to prompt some shoppers to turn to deep-discount retailers like Dollar General, Gordon Haskett analysts say.

Protect Your Wealth Against the Law of Unintended Consequences

Pool of Negative-Yielding Debt Hits $16 Trillion

As I’ve pointed out before, inflation has been very constructive for the price of gold. With yields around the world falling deeper and deeper into negative territory, the yellow metal has hit new all-time highs in a number of currencies.

That includes the Canadian dollar, which is incredible news for the country’s massive metals and mining industry. Canada is the number five gold producer in the world behind the U.S., and nearly 60 percent of all global mining financings are done on either the Toronto Stock Exchange (TSX) or TSV Venture Exchange. In 2017, about 56 billion mining shares were traded in Canada, for a total value of C$206 billion. Last month, I highlighted several junior, mostly-Canadian miners that have made some monster moves lately thanks to higher metal prices in the local currency.

Protect Your Wealth Against the Law of Unintended Consequences

So will gold hit an all-time high in U.S. dollars? Already some analysts are making forecasts for $2,000 an ounce gold.

Speaking to CNBC this week, Daniel Ghali, a TD Securities commodities trader, said that as the pool of negative-yielding debt expands, “I could see a case for gold at $2,000.”

I could see this happening as well, especially if nominal Treasury yields turned negative. That’s no longer an absurd notion, says PIMCO’s global economic advisor, Joachim Fels. This week former Federal Reserve Chairman Alan Greenspan echoed that sentiment, telling Bloomberg that there’s “no barrier for U.S. Treasury yields going below zero. Zero has no meaning, besides being a certain level.”

Municipal Bond Investors Won Big in Last Downturn

Besides gold, municipal bonds are highly sought by investors right now due to their history of steady performance in good as well as bad times. Look at the chart below. State and local debt was up in most years going back to 1981, when during recessional years. Over the past 38 years, munis have delivered an impressive average annual return of 6.8 percent.

Protect Your Wealth Against the Law of Unintended Consequences

It’s no surprise, then, that inflows into muni bond mutual funds have done so well this year.
Investments were up 58 percent in the week ended August 7, for the 31st straight week of positive flows, according to the Investment Company Institute (ICI). Year-to-date, investors have added a whopping $58.3 billion to funds that invest in munis. Remember to follow the money!

Curious to know what’s next for gold? Check out my latest Frank Talk Live! episode by clicking here!

Gold through the ages - Click here to explore the timeline

Gold Market

This week spot gold closed at $1,513.38, up $21.07 per ounce, or 1.41 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, ended the week lower by 3.18 percent. The S&P/TSX Venture Index came in off 3.78 percent. The U.S. Trade-Weighted Dollar rose 0.73 percent.

Date Event Survey Actual Prior
Aug-13 Germany CPI YoY 1.7% 1.7% 1.7%
Aug-13 Germany ZEW Survey Current Situation -6.3 -13.5 -1.1
Aug-13 Germany ZEW Survey Expectations -28.0 -44.1 -24.5
Aug-13 CPI YoY 1.7% 1.8% 1.6%
Aug-13 China Retails Sales YoY 8.6% 7.6% 9.8%
Aug-15 Initial Jobless Claims 212k 220k 211k
Aug-16 Housing Starts 1256k 1191k 1241k
Aug-19 Eurozone CPI Core YoY 0.9% 0.9%
Aug-22 Initial Jobless Claims 216k 220k
Aug-23 New Home Sales 644k 646

Strengths

  • The best performing metal this week was palladium, up 1.88 percent, despite hedge funds cutting their net bullish positions to a 10-week low. Gold bulls outnumbered the bears in the weekly Bloomberg survey of traders and analysts for a second week as the metal notches a third weekly gain. Bullish respondents say the turmoil in global equity and bond markets is strengthening the investment case for gold. Silver is also rallying alongside gold on recession fears. The core consumer price index (CPI) rose 0.3 percent in July from the prior month, which is historically positive for the yellow metal.
  • A growing number of data points support another rate cut from the Federal Reserve next month as insurance against a global slowdown, writes Bloomberg’s Steve Matthews. Deutche Bank analyst Benjamin Fisher says that positioning is not stretched in gold equities, which means that there is alpha opportunity.
  • As the U.S.-China trade war moves into a currency war as well, demand for gold is skyrocketing as a perceived safe haven asset. Whitney George, president of Sprott Inc., says “gold is a currency, but it’s nobody’s obligation, so it will stand tallest when everyone else is trying to debase their currency to be competitive globally.”

Weaknesses

  • The worst performing metal this week was platinum, down 1.31 percent. Friday marked the seven-year mark since the Marikana Massacre when 34 miners were shot dead by police during a protest at Lonmin’s Markikana platinum mine. Retailers jumped, and gold plunged, after the Trump administration announced a delay until mid-December for the 10 percent tariff on some Chinese goods. Demand for gold as a safe haven was dampened on the news, but then recovered later in the week. According to data compiled by Bloomberg, the SPDR Gold Shares ETF saw almost $523 million of outflows on Tuesday after the news, the biggest one-day decrease since 2016.
  • Morgan Stanley says that gold stocks have run harder than warranted and are overbought as investors flock to safe haven assets. Barrick Gold is looking for buyers for Australia’s Kalgoorlie super-pit mine that was once the country’s largest and says that Northern Star has potential interest. Northern Star’s share price tumbled 8 percent on the news. This raises doubts about the potential purchaser of the mine that was once seen as a massive opportunity.
  • Anglo American Platinum Ltd, the world’s top platinum and palladium supplier, is looking to invent a new battery to counter the long-term threat of the electric car boom. Bloomberg writes that EV demand is a threat to demand for automobile catalysts, which use the two precious metals to clean toxic emissions. However, these two metals are heavier and more expensive than what is currently used in EV batteries.

Opportunities

  • Gold equities are cheap and have room to continue running relative to the gold price, as they are lagging their historical relationship. The chart below compares the price of the senior gold miners to the price of gold 10-years ago.  The miners have taken a much bigger drop than the gold price. TD Securities writes in a note that it expects a further rotation from producers down to the junior miners and eventually to the emerging producers to developers, which will be catalyzed by high profile M&A activity. Jeff Currie, global head of commodities research at Goldman Sachs, says that central banks are buying gold because they don’t want to own dollars with sanction, geopolitical and trade-war risks. UBS raised its gold price forecast in 2020 to $1,550 per ounce as their economists believe a U.S.-China deal is looking increasingly unlikely, reports Bloomberg.

Protect Your Wealth Against the Law of Unintended Consequences

  • Former Federal Reserve Chairman Alan Greenspan said this week that he wouldn’t be surprised if U.S. bond yields turn negative and that if they do, it won’t be that big of a deal. Greenspan said in a Bloomberg interview that “there is no barrier for U.S. Treasury yields going below zero. Zero has no meaning, besides being a certain level.” This comes as 10-year TIPS were negative for two days this week. Negative yields have historically been positive for the price of gold.
  • South Africa’s Public Investment Corp., the continent’s largest money manager, sees big investment opportunities in West Africa to drive the next gold mining boom. Mining research analyst Lebohang Sekhokoane says “when you look at the gold sector in West Africa, that’s where the sun is rising.” The firm highlights Ghana, where AngloGold Ashanti and Gold Fields are shifting more production to and away from South Africa. Cardinal Resources also has its 5.1 million ounce shovel-ready reserve in Ghana and could be a takeover target.

Threats

  • An 18 percent surge in bullion over three months is great news for mining companies, writes Bloomberg, but has spurred a burst of illegal prospecting that has helped fuel organized crime within some of the world’s top gold-producing regions. This is bad news for natives in these mining areas, leading to suffering caused by threats, danger and even mercury poising. In fact, a third of the gold imported from Latin America in 2013 was mined illegally – meaning proper permits were not obtained, areas were not environmentally protected or heavy machinery was used without oversight.
  • According to Morgan Stanley analysts, a supply gap for palladium, rhodium and platinum is seen persisting over the next four years, reports Bloomberg, as tighter vehicle emissions standards drive demand. Tighter emissions for heavy-duty vehicles could boost platinum use in China and India in particular, the article continues.
  • According to industry sources, China has severely restricted imports of gold since May, reports Reuters, in a move that could be aimed at curbing outflows of dollars and bolstering its yuan currency as economic growth slows. Shipments have been cut by around 300-500 tonnes compared with last year – worth $15-25 billion at current prices, the article continues. China is the world’s biggest gold importer, accumulating what is equivalent to one-third of the world’s total supply.

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Index Summary

  • The major market indices finished down this week. The Dow Jones Industrial Average lost 1.53 percent. The S&P 500 Stock Index fell 0.94 percent, while the Nasdaq Composite fell 0.79 percent. The Russell 2000 small capitalization index lost 1.26 percent this week.
  • The Hang Seng Composite lost 0.96 percent this week; while Taiwan was down 0.70 percent and the KOSPI fell 0.55 percent.
  • The 10-year Treasury bond yield fell 18 basis points to 1.56 percent.

Continue reading at …

August 16, 2019

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

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