Current news and commentary on themes discused in this blog are now being introduced on related pages. Two new pages with updates were added to today. Grim Realities and Inflation. A third new page links to real time gold prices. Pages with updates are marked with an #.
Jeremy Grantham’s April letter to investors:
Investment legend Jeremy Grantham publishes a quarterly letter to investors and a letter to Investment Committees. This week’s letter to investors is headed ‘Its everywhere, In everything : The First Truly Global Bubble (Obervations following a 6-week Round-the-World Trip).’ It’s a must read. You have to register but access to the site is free. He starts with this observation :
’From Indian antiquities to modern Chinese art; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; its bubble time’
Then he cites two pre-conditions for a bubble to inflate. First fundamental economic conditions must look at least excellent and near perfect is better. Second, liquidity must be generous in quantity and price: it must be easy and cheap to leverage.
What catalyst will burst the bubble this time round?
‘ Every bubble has always burst‘ is point 7 in an 8 point summary of conclusions Grantham lists. His headline market risks include less liquidity, rising inflation, reduced profit margins and unexpected events. The liquidity risk is well illustrated with an analogy to fair ground ping pong balls bouncing on a jet of water. If the force of the water lessens at some point all the balls will suddenly plummet to the ground. The difference between previous regional or sectoral bubbles and the current global bubble will be that this time round ”the bursting of the bubble will be across all countries and all assets, with the probable exception of high grade bonds.’
At the end of last year in a Financial Times article Professor Lawrence Summers expressed a similar view on markets pricing in ‘financial tranquility.’ ‘The new year’ he wrote ‘will begin with the greatest divergence for a generation between the general view of global risks as reflected by conventional wisdom and the risks as priced in financial markets. While the commentariat has been more alarmed about the state of the world than global markets for some years, the gap increased in 2006 as markets became more serene and everyone else grew more anxious.’ He concluded: ‘at least as far as the markets are concerned, perhaps the main thing we have to fear is lack of fear itself.’ Grantham warns investors of the prospect of a world where they are ‘paying for the privilege of taking risk.’
Where gold fits in:
As a member of the less tranquil commentariat I am with Summers that we have to fear lack of fear itself and question whether markets will still be pricing in financial tranquility at the end of this year. From my reading of developments on liquidity fonts, inflation and other fronts I doubt it. Hence my interest in gold as an asset and quasi currency with a unique risk reward profile that belongs on agendas whenever asset allocation and strategic investing decisions are being made.
But there is a distinction to draw between owning gold and gaining exposure to managed gold. Owning physical gold as crisis insurance always makes sense. Owning some gold or gold shares in a portfolio to spread risk often makes sense. But gold bought as another overpriced asset in a global liquidity boom won’t be exempt from falling asset prices. Protection from that scenario could be more robust through exposure to a managed fund also focused on risks and rewards in market volatility. The US Global Investors Webcast and Presentation ‘Gold Opportunities and Challenges’ mentioned in my blog of 11th April outlines such a strategy.
In his April 2007 Letter to the Investment committee ‘Part II : Yale Meets Goldilocks’ Jeremy Grantham explores the drive towards towards riskier assets, unprecedentedly low risk premiums across all asset classes and strategic options open to Investment Committees. Anyone with responsibility for savings and investments needs to recognise the risks. Managing them is for professionals.
The policy dilemma:
Dr Ivan Petrovich Pavlov, winner of the Nobel Prize for Medicine in 1904, opened his award lecture with a statement economists will appreciate: ‘It is not accidental that all phenomena of human life are dominated by the search for daily bread.” Pavlov is remembered for his studies on conditioned reflexes…. if you ring a bell before feeding your dog it will start to salivate whenever the bell rings, regardless whether or not there is food.
With inflation bells ringing on both sides of the pond will central bankers and policy makers respond again with reflex reactions and crank up interest rates? And how might their decisions affect our search for daily bread? We can find some clues in correspondence from Mervyn King, the Governor of the Bank of England to Gordon Brown the Chancellor of the Exchequer and the Chancellor’s reply . The gist is that CPI for March reached 3.1% - more than 50% above the 2% target. Energy prices and food, particularly milk, are the main culprits. National Statistics published in the UK further reveal that both consumer price inflation and retail price inflation have been rising steadily from the beginning of last year. Some insight on monetary events over the last few decades puts the dilemma policy makers are facing in perspective.
The credibility of all world currencies have been anchored only by commitments to maintain price stability since 1971, the year American President Richard Nixon severed all links between gold, the dollar and the international monetary system. Early commitments were fragile. Robert Mundell in his Reconsideration of the 20thcentury Lecture highlighted ’It had taken from 1952 to 1971 for U.S. wholesale prices to rise by by less than 30%. But after 1971 it took only 11 years for US prices to rise by 157%……inflation in the 1970s was worldwide….only in Germany did consumer prices in the decade of the seventies fall short of doubling….in Italy and the United Kingdom prices more than tripled…’
Paul Volcker, US Federal Reserve Board Chairman from 1979 to 1987, squared up to to the price stability commitment, tightened money supply, raised overnight interest rates as high as 18% and forced a recession to break the back of the 1970s inflation. Margaret Thatcher’s government followed a similar line.
But cranking up interest rates can also cause wanton damage. Thatcher’s successor John Major raised interest rates and disspiated billions of pounds supporting an artificial exchange rate for the £ in the European Exchange Rate Mechanism (ERM). Businesses were forced to the wall, unemployment rose and property owners with negative equity lost their homes. Major’s offensive ended when his Chancellor was forced to withdraw the £ from the ERM on the 16thSeptember 1992 - the day that became known as Black Wednesday. The billionaire George Soros had been selling the £ short, called Major’s bluff and at the expense of the UK taxpayer, courtesy their government’s hubris, pocketed a billion pound profit.
Good news and bad news:
The good news now is that Gordon Brown is encouraging the Bank of England’s Monetary Policy Committee to ‘continue to look through the short term volatility in inflation over the next year and set the Bank Rate to keep inflation on course to meeting the 2% target ‘in the medium term.’ In other words: no knee jerk response. The Chancellor’s thinking is in line with a dynamic macroeconomic policy focused on long term goals developed by, among others, the 2004 Nobel Prize Winning economists Prescott & Kydland.
But there is also bad news. Energy, commodity and food price rises aren’t short term blips bound to right themselves over the medium term and central bankers have restricted policy options open to them. For example if interest rates are raised in the UK and the £ gets even stronger exporters and home owners with mortgages will feel the pain. If the dollar is allowed to slide further US oil imports will cost more A Financial Times Lex comment Dollar Disorders illustrates how steeply the dollar has fallen, how much it could still fall and how overvalued the two dollar pound is in relation to purchasing power.
Inflation is back in the system:
It may sound over the top to say the inflation bell is tolling with inflation still as low as 3% and central bankers and policy makers on the case . But whenever inflation is rising gold has utility for investors and should be on the agenda for asset allocation and strategic investing decisions - even when the inflation bell is still only tinkling.
# Commentary updated on April 30th.
‘Brown lost £2 billion selling UK’s gold’ according to to-day’s Sunday Times. Their front page spread ends with a remark from George Osborne, the Tory shadow chancellor, that Gordon Brown ‘is in danger of getting a reputation as someone who has very poor economic judgement.’
Politicians, central bankers and other people who live in glass houses shouldn’t throw stones. Margaret Thatcher was Prime Minister in 1980 when the gold price spiked to a frenzied $850. Nobel Laureate Robert Mundell, the only celebrated world economist still interested in gold as a central bank asset, has sharply criticised all officials concerned for hanging on to gold at that price ‘as if their lives and careers depended on it.’
Not selling in 1980 for $850 was an immensely more costly blunder than the one Gordon Brown made selling for between $265 and $290 in 1999 . A quick back of the envelope calculation based on the £2 billion loss Gordon Brown is accused of making points to Thatcher’s blunder costing at least $5 billion. If we add compound interest for almost three decades it is probably in the range of $10 billion. Even more if we factor in that $850 in 1980 money equates to almost $2000 in 2007 after allowing for inflation. I thought Gordon Brown made a mistake in 1999. I still do. But in 1999 most highly respected economists thought otherwise. As recently as 2001 the late Rudiger Dornbusch, who with Robert Mundell was one the world’s most authoritative macro-economists, wrote that ‘there are very few certainties in macro economics but here is one. Gold as a financial asset ‘is dead’ and America’s gold in Fort Knox will ‘collect dust and no capital gains.’
There is also nothing new about the story in the Sunday Times that some officers in the Bank of England were not in favour of the sale. They reported in 1999 :’….the bank defended the sale decision and insisted it had agreed with the Treasury on the policy..’this is exactly the way gold sales were done in the seventies by the IMF ……..’
Gordon Brown will face a Parliamentary grilling next week when the Tories try to ‘undermine his reputation for economic competence.’ There have also been swathes of unsubstantiated rumours of irregularities and conspiracies surrounding the sale and, if they can be substantiated, Mr. Brown will certainly be embarrassed. But he should not be singled out for selling 125 tons of gold. Since 1980 the world’s central banks have sold or committed forward transactions for more than 20,000 tons of gold at prices usually less than half today’s price of $680.
Under a sub-headline ‘a secure asset’ today’s Sunday Times article also appears to extol the virtues of the gold standard. Sweeping statements made in a short column on the gold standard without detailing how it really worked and why it failed are glib. Reviewing the gold standard involves examining the extent to which it contributed to the severity of the great depression in the 1930s and to World War II. Even the World Gold Council, the gold mining industry’s mouthpiece, acknowledges now that the gold standard is unsuitable for today’s world.
Global security changed dramatically for the worse after the 11th September 2001.Chaotic conditions are developing in Iraq and the Middle East.Global financial imbalances menace global economic security. As a consequence today’s decisions on owning gold are as challenging as those Gordon Brown faced in 1999. There is nothing magical about the current $680 gold price. Some astute investors and commentators think it is still good value .Some even think it is cheap. If the economics question now is whether Britain should own more gold reserves it will be more interesting to know what Mr. Osborne, or others in public office, advise on future policy. More interesting than to hear them cry over milk spilled almost a decade ago.
The Ahmadenijad put: fuelling angst, insecurity, oil and gold price rises:
A Financial Times article titled ‘Iran’s Predicament’ explains why their economy depends on high oil prices. The bottom line is that if the oil price falls below $55 Iran can’t balance its budget or cater for the needs of its fast growing population. Now Ahmadinejad appears to stir up regional or international tensions whenever oil prices sink. Can we read into this an ‘Ahmadenijad put’ that will support oil prices in the same way the famous ‘Greenspan put’ has supported share prices?‘
The ‘Greenspan put’ came into being in 1998 in the wake of the collapse of the mammoth highly geared hedge fund Long-Term Capital Management. Financial markets faced meltdown. Greenspan, at the time Chairman of the US Federal Reserve, responded by cutting interest rates. Cheap money revived investor interest. A crash was averted and markets soon powered ahead. Investors have since believed that the US Federal Reserve will always inject liquidity to arrest any major fall in asset prices. Support for this belief comes again from former US Treasury Secretary Professor Lawrence Summers. In a March 25th article in the Financial Times he warns of the danger of ’a vicious cycle of (mortgage) foreclosures, declining property values, reduced consumption demand, more delinquencies and more foreclosures’. Summers concludes ‘if the dominant economic concern becomes a shortage of demand, it is incumbent on the Fed to provide stimulus so as to maintain conditions for growth and economic stability.’ In other words the Greenspan Put, now the Bernanke Put, is alive and well. (see The Goldwatcher posting Grim Reality Part I of March 30th 2007)
The ‘Ahmedinajed Put’ is unlikely to be as sticky as the ‘Greenspan Put’ has been but it certainly supports oil prices. At the beginning of February 2007 oil fell to $50, 10% below Iran’s $55 bottom line. By capturing 15 British personnel on March 23rd Ahmadinejad encouraged speculative money back into oil and drove futures back above $66. Then, when he made his grand farce in farsi release of the hostages in April he knew that four days later he would announce Iran had commenced uranium enrichment on an industrial scale and speculative money would again boost oil prices . The following chart illustrates oil futures prices from January 2006:
Oil Oil & gold price relationships:
In a webcast Gold Opportunities & Challenges Frank E Holmes, Chief Investment Officer of U.S. Global Investors, introduces extensive analyses on gold supply and demand fundamentals, long term price relationships between oil and gold and technical indicators including the well established phenomena of financial assets reverting to long term mean prices. Holmes’s conclusion illustrated in Chart 19 supporting the presentation is either gold must rise or oil must fall. Oil supply and demand fundamentals, without any support from Mr. Ahmadinejad’s tricks, leave little scope for a sustained price fall.
A royal own goal against Britain:
On their return home on April 7th the contingent of fifteen captured service personnel were given the opportunity to publicly set the record right. In a press statement their senior officer declared their capture had been illegal and confessions extorted in Iran under duress were false. The officer’s statement ended with a message to the media that they were ’finding their focus very uncomfortable and difficult’ coupled with a request to give them the ’space and privacy we need when we return to our homes’
However another farce was either orchestrated before the conference or scheduled to be spun out shortly afterwards. Through their chain of command, and with the blessing of the Defence Secretary, some of the company obtained a special and most exceptional concession allowing them to sell their stories for enormous cash payments reported as being in the range of £100,000 ($200,000). This farce turned into a tragedy. It made our military establishment and our nation look like trash and compromised the security of our forces on the ground in Iraq, Afghanistan and elsewhere.
The spin game The Royal Navy and the Ministry of Defence was playing ended with a wanton own goal scored against Britain. It could hardly have come at a worse time. Our internal and financial security were compromised when our Home Office was declared unfit for purpose a short while back. But when our Ministry of Defence behaves in a way that makes it look unfit for purpose the personal and financial security of the free world is also compromised.
Are there any more shoes to fall?
Wall Street shenanigans and gold as the anti-establishment investment par excellence:
As an anti establishment investment gold affords some protection against a government’s monetary printing establishment going into overdrive, its political establishment spending as if there is no tomorrow and its regulatory establishments failing to adequately protect the public.
A wave of fraudulent investment bank research fuelled the Nasdaq bubble that popped in 2000. Top investing banking names were implicated. Trillions of dollars were lost when markets crashed. Billion dollar fines imposed by regulators were paid by the culpable banks but their top brass escaped prosecution. The Sarbanes-Oxley laws followed imposing stringent compliance and reporting burdens on managers and advisers of companies listed on US Stock Exchanges. Burdens so onerous that promoters of companies now listing on international stock exchanges shun the US, fearful of high compliance costs and draconian punishments for transgressions.
Generally we have forgotten about the fraudulent research outrage. The grandees escaped prosecution. Instead we remember the trial of domestic goddess Martha Stewart. The case against her started with an insider trading investigation and ended with her serving a prison sentence in 2005 for another offence. In fact there was never an insider trading case for her to meet. But she was devious during interrogation, offended, and was severely punished. But making her the poster child for Wall Street shenanigans shows only how vicious and capricious both the legal system and the establishment can be.
A ’naked shorts - phantom shares’ scandal is now clouding Wall Street’s image. With it there is irony in relation to Martha Stewart. Shares in her company Martha Steward Omnimedia are among those that have been abused by short sellers and brokers unable to meet share delivery obligations. Today’s ‘Bullion Buzz, ‘ compiled by prominent gold bull Nick Barisheff, links to this revealing video on the subject.
Barisheff’s Bullion Buzz is published on the Bullion Marketing Services site. Here is the gist of today’s comment on the phantom shares/naked shorts video:
The video documents ‘naked short selling’, a manipulative, illegal trading technique that allows a trader to sell a stock short without first borrowing them. Hundreds of companies are at risk of manipulation by naked short sellers, where trades can’t be settled because stock has not been delivered by the buyer are on a list mandated by the S.EC. Among the names are Martha Stewart Living Omnimedia. Since January 2005, more than 4,559 securities have made the list, or roughly 1 out of 3 public companies! The SEC’s own data proves regulations are failing - some companies have remained on the list for more than 400 days. In some instances, more shares than actually issued, or available to be borrowed, have been sold short.
Reading between the naked shorts lines on gold:
Barisheff ends his note on naked shares with this comment taken from the Bloomberg video:
‘John O’Quinn, celebrated US attorney, says the deal is so rigged that an investor has more chance of being treated fairly in a casino in Las Vegas than in the stock exchange.’
Isn’t that going a bit too far ? It’s one thing to say some deals are rigged. But to say that investors are always cheated on stock exchanges is dead wrong. The Bullion Buzz newsletter also starts with these damning remarks on paper money by one Daniel Webster:
‘We are in danger of being overwhelmed with irredeemable paper, mere paper, representing not gold nor silver; no sir, representing nothing but broken promises, bad faith, bankrupt corporations, cheated creditors, and a ruined people.’
My first reaction reading the quote was that it was was way over the top. And, as the speech was made to the US Senate in 1833, it wasn’t really relevant. But, on reflection, if we go back to 1933 it was more than relevant. It was prophetic. And without some new disciplines in the realms of monetary and debt expansion Mr Webster’s words may well be prophetic again for 2033 - or before then. Thank you Nick Barisheff for the information. Mr. Webster’s quote will be used in my book with other comment on why gold, the anti establishment investment par excellence , made sense in 1833, 1933 and why it still does now.
Is Nancy Pelosi Jed Bartlet in drag or tough as Margaret Thatcher?
Within a few months the Bush administration will run out of money. US public debt outstanding is over $8.8 trillion. To be exact $8,849,665,208,495.43 last Friday. Lawmakers will be asked to agree to raise the current $8.965 trillion US debt ceiling by several hundred billion dollars.They will but with conditions. Nancy Patricia D’Alesandro Pelosi, now speaker of the United States House of Representatives, constitutionally only two heartbeats away from being President, is already making her own ex-officio visits to heads of state in the Middle East. She is not timid. A little over two months ago on January 23rd George Bush introduced his State of the Union address with a tribute to her starting:: ‘Tonight, I have a high privilege and distinct honor of my own — as the first President to begin the State of the Union message with these words: Madam Speaker.’
In London we watched the event live and shared the emotion of the moment. Why, we asked afterwards, were we so engaged? None of us were Americans and, after living through the Thatcher years, we weren’t exactly sentimental about a woman in such high office. Was it maybe seeing a humbled George Bush being gracious? The answer was simpler and really obvious. This was the West Wing. Live. The real thing. From 1999 till last year 150 episodes of the West Wing introduced us to life in the White House as if we belonged. There was even a series when fictional Democrat President Jed Bartlet and his deputy President were both disabled and the Republican speaker of the house was sworn in as President.
Debt, however, is now the grim reality issue in the U.S. It is growing exponentially, costs money to service and will eventually have to be repaid. The Comptroller General of the US, David M Walker, has calculated that if spending continues like there’s no tomorrow balancing the budget in 2040 could require cutting total federal spending by a as much as 60%, or raising federal taxes by 200%. When Bush took office in 2001 the US national debt ceiling was $5.6 trillion and falling. Budget surpluses since then have turned into deficits. Debt has gone up by nearly 50%. Faced with a potential government shut down last March the Senate agreed by 52-48 to raise the the nation’s debt limit to a touch under $9 trillion. At the end of last week there was little breathing space below the limit.
Pelosi intends, with bi-partisan support, to force Bush to change course on Iraq. On the way she will be asked to support entitlement and medicare reforms. The instinctive response is to say that’s not going to happen. Whatever the outcome of debt ceiling discussions they will be more nails in the coffin of the dollar. Buy gold.
However there are other possibilities. One is that US lawmakers may square up to the grim reality of exponential debt growth now and Pelosi may force a turning point. To be more than Jed Bartlet in drag, and I sense that she is, she will have to be as tough as Margaret Thatcher on economic fundamentals. The Goldwatcher will be watching her!