Daily Updates

Gartman Sees Gold in Euros at Record as Currency Slides

Posted by Dennis Gartman - The Gartman Letter

on Friday, 4 November 2011 14:39

Gold prices in euros will rise to a record as Europes’s sovereign-debt crisis erodes the appeal of the 17-nation currency and boosts demand for the precious metal as an alternative asset, according  to economists Dennis Gartman

The CHART OF THE DAY shows gold has had an inverse relationship to the euro during the past week, as the metal jumped 3.8 percent and the currency slid 2.6 percent. The euro, which has declined in three of the last four months, may fall below $1.30 from about $1.38 yesterday, Gartman said.

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I think I know some lab mice that have received less examination than the 2012 Republican primary candidates. It seems with each passing cycle, the campaigning starts earlier, there are more debates, and the media frenzy gets more intense. Yet, with all the pyrotechnics and pageantry, it becomes difficult to figure out what these tricksters actually think when they’re behind the curtain. Since the gold price is inextricably linked to the long-term fate of the US dollar, it’s rather important for gold investors to be able to forecast how each candidate, if elected, would conduct his/her monetary policy.

Monetary policy is not nearly discussed enough in debates or television appearances – partly because too few viewers care about it, and partly because most candidates simply don’t understand the subject. The most common monetary policy platform amounts to little more than, “I’m opposed to China’s currency manipulation, and America needs a strong dollar!” (Little do they know that these two goals are right now in opposition.)

As we examine three frontrunners, it’s important to remember that their future policies can be difficult to distil, but that their past records are likely to be a more effective indicator than their present rhetoric.

HERMAN CAIN: THE FED CHAIRMAN
Cain’s lucky he’s known as “The Guy Who Makes Pizza” instead of “The Guy Who Prints Money.”

Herman Cain was Chairman of the Federal Reserve Bank of Kansas City from ’95 – ’96, and held the positions of Deputy Chairman and Board Member during the preceding six years. This was the heyday of Alan Greenspan’s bubble economy, and there is little record of Cain dissenting. While some have remarked that Cain knew little about economics when he joined the board, he has had ample time to learn. Yet, when challenged to name his favorite Fed Chairman at this year’s debates, Cain still chose Greenspan!

Cain’s flagship “9-9-9 Tax Plan” is drawing headlines, but it contains no in-depth discussion of monetary policy, other than brief allusions to a “strong dollar.” No mention of quantitative easing or the money supply. No condemnation of artificially-low interest rates.

Even if Cain were able to reduce taxes considerably, the spending would continue. Like many Republicans, Cain talks generally about spending cuts, but does not specifically target any budget items. We can assume any actual cuts he gets through Congress would be of the “slow the growth of future spending” variety.

With continued spending and record of inflation tolerance, Cain will most likely turn to the Fed to monetize the extra debt. This means a Cain presidency is likely to be very bullish for gold – with the mitigating factor that if given free reign, Cain might at least try to move the country back on a sustainable path.

Cain Presidency:

– Bullish for gold
– Bearish for USD

MITT ROMNEY: THE CLOSET DEMOCRAT
Consider the following quote: “My experience tells me that we were on the precipice, and we could have had a complete meltdown of our entire financial system, wiping out all the savings of the American people. So action had to be taken.”

It sounds like Tim Geithner, Ben Bernanke, or Paul Krugman. President Obama himself has said exactly the same thing countless times. Yet, this quote comes from Mitt Romney at a recent Republican debate.

Romney supported the TARP bailouts. Romney defends the Federal Reserve. Romney even implemented socialized medicine as Governor of Massachusetts. He says he would conduct monetary and fiscal policy “differently” than Obama, but when you’re car is headed over a cliff, it doesn’t much matter whether you drive on the right or left side of the road!

Just as with Cain, Romney still does not understand the terrible precedent set by the bailouts, and the devastating consequences loose monetary policy has on the US dollar and global economy. Worse yet, Romney hasn’t even offered a credible plan to reduce government involvement in the economy. Romney’s campaign slogan might as well be, “A New Face for the Status Quo.” And the status quo is a collapsing dollar and skyrocketing gold.

Romney Presidency:

– Very bullish for gold
– Very bearish for USD

RON PAUL: THE GOLD STANDARD
If Ron Paul were elected President, he would immediately move to cut spending drastically. This is clear based on his 35-year record of acting on his promises, and his recent campaign pledge to cut $1 trillion from his first proposed budget. He would face stiff resistance from both parties, for sure, but such a move would change the entire direction of public discourse.

Now, it’s important to remember that $1 trillion is only two-thirds of the 2011 deficit. So, even if President Paul got his entire budget approved, we still would be facing a growing debt of around $16 trillion at that point. While President Paul could order the Treasury to begin selling its toxic assets that are impeding economic recovery, he wouldn’t have direct control over the Fed – which, under Bernanke, would likely announce even more money-printing to counteract the President’s tough medicine.

But President Paul’s real silver bullet would come two years into his term when he would get the opportunity to nominate a new Fed Chairman. As someone who entered public life in response to the end of the gold standard under Nixon, Paul is certain to appoint the most hawkish Fed Chairman the country has ever seen. This would immediately reverse the misfortunes of the US dollar and could impact gold’s rise.

But remember, even in this pie-in-the-sky scenario, it will still take years for Bernanke’s devaluation damage to fully circulate around the global economy. That means gold could still appreciate well into a Paul presidency.

Ultimately, a Paul presidency could also lead toward a gold standard monetary system. In such a case, gold is likely to carry an even higher value as the premium for serving as the international reserve asset.

Paul Presidency:

– Bullish for gold
– Bullish for USD

RICK PERRY: THE BIG SPENDER
Rick Perry is a career politician now in his 11th year as Governor of Texas. He claims to be a tax-fighter, but he has signed several tax increases as Governor. To the extent that he has held the line on taxes, he’s overseen a more than doubling of Texas state debt. And not all of this money was going to pay for schools and roads. For instance, he created the $435 million Texas Enterprise Fund to subsidize politically connected businesses.

As a candidate, Perry has adopted Ron Paul’s rhetoric being critical of the Fed’s quantitative easing programs. He’s even gone as far as accusing Bernanke of “treason.” But he doesn’t show a deep understanding of what makes the Fed’s policies so destructive, and his campaign website makes no mention of monetary policy at all.

Still, Perry at least knows which way the wind is blowing, and he does have a record of vetoing expensive legislation. Overall, it’s hard to tell what kind of President he would be – a lot like it was for the last Texas Governor that become President. In the latter case, President George W. Bush claimed to be for small government and a humble foreign policy, but went the exact opposite way once elected.

Perry might make an attempt to change Washington’s direction, but he has neither the depth nor the steadfastness to really make it happen. Thus, the current gold/dollar dynamic would be likely to continue.

Perry Presidency:

– Bullish for gold
– Bearish for USD

NEWT GINGRICH: THE BENEDICT ARNOLD
In the mid-’90s, Newt Gingrich gained a reputation as a radical reformer after he led the Republicans to their first House majority in 40 years. He wrote a Contract with America, and made a good faith attempt to pass all of its provisions. This movement could be credited with stopping Hillarycare, enacting welfare reform, and reducing certain key taxes.

But in the years since, he has vocally supported programs like the costly Medicare Part D, teamed up with Hillary Clinton on healthcare, and supported mainstream Republican candidates over Tea Party challengers.

What happened? Clearly, Gingrich has been building bridges in order to be seen as a moderate candidate for his Presidential run.

If only he had kept to his original firebrand style, he might have had a shot at getting something done in the White House. Unfortunately, trying to become part of the establishment is a game with no end, and therefore Gingrich is likely to continue “reaching across the aisle” to author costly legislation. If he announces a Contract with Austerity, maybe I’ll change my tune.

Gingrich Presidency:

– Bullish for gold
– Very bearish for USD

HOW IMPORTANT IS THE PRESIDENT?
Despite what the media would have you believe, the President is not all-powerful. In fact, a President only has limited powers compared to Congress. Without the support of Congress and the American People, a President can be rendered a lame duck early on – like Jimmy Carter was.

The direction of gold under most candidates is fairly easy to predict – it will continue appreciating against the falling US dollar. This is simply because these candidates will not even attempt to address the disastrous fiscal and monetary policies that have brought us to this point.

The price direction under Ron Paul (and also Gary Johnson), however, would be less predictable. I believe both men would try their best to reverse the US decline that my strategy is insulating against.

In any case, even an authentic campaigner who understood the calamities of money-printing would be hard-pressed to actually save the dollar at this point. The history of fiat currencies has few – if any – examples of monetary debasement being reversed before the currency falls apart – and many cases of gold proving the superior asset.

BARACK OBAMA: THE WORST-CASE SCENARIO
There is one candidate in 2012 that we can be sure won’t even try to save the dollar, and that is President Obama. From his doubling down on the bailouts to his faithful support of Chairman Bernanke, Obama has done almost everything in a President’s power to hasten the dollar’s demise.

If he is re-elected, which still seems like a possibility, then you better put on your mining hats because the gold rush is on!

David Galland and gold fund manager John Hathaway discuss the disparity between gold stocks and bullion.

David Galland: A quick chat with John Hathaway, one of the top-performing gold fund managers in the world. Let’s just have a little, quick conversation about gold stocks. And, so I guess the first question – I’ve written some thoughts down here – is gold stocks really sort of underperformed bullion over the last little while or a few years.

John Hathaway: A couple of years.

DAVID: Why was that?

John: I think it’s the worries about a bear market and the fact that gold stocks are stocks and tend to perform with stocks and not bullion. They are riskier because they have business risk. The gold ETF has made gold very accessible, so the need to own – so the gold mining stocks don’t have a monopoly on people who are concerned about monetary debasement and I think that’s been a big factor.

David: The spread between cash cost and the price of gold these days – watching how far gold has run – has got to be advantageous to the balance sheets of these gold companies.

 

 

The Turning Point

Posted by Bill Gross - Pimco

on Friday, 4 November 2011 7:13

  • Once interest rates inch close to zero and discounted future cash flows are elevated in price, it’s difficult to generate much more return if economic growth doesn’t follow.
  • Equity markets should be dominated by dividend yields and the return of capital via share buybacks, as opposed to growth.
  • In fixed income assets, we suggest that portfolios should avoid longer dated issues where inflation premiums dominate performance.

Speaking of luck, the investment question du jour should be “can you solve a debt crisis with more debt?” Penny or no penny. Policymakers have been striving to answer it in the affirmative ever since Lehman 2008 with an assorted array of bazookas and popguns: 0% interest rates, sequential QEs with a twist, and of course now the EU grand plan with its various initiatives involving debt write-offs for Greece, bank recapitalizations for Euroland depositories and the leveraging of their rather unique “EFSF” which requires 17 separate votes each and every time an amendment is required. What a way to run a railroad. Still, investors hold to the premise that once a grand plan is in place in Euroland and for as long as the U.S., U.K. and Japan can play scrabble with the 10-point “Q” letter, then the markets are their oyster. Not being one to cast pearls before swine or little Euroland PIGS for that matter, I would tentatively agree with one huge qualifier: As long as these policies generate growth.

Growth is the elixir that seems to make every ache, pain or serious ailment go away. Sovereign debt too high? Just grow your way out of it. Unemployment rates hitting historical peaks? Growth produces jobs. Stock markets depressed? Nothing a lot of growth wouldn’t cure. But growth is the commodity that the world is short of at the moment, as shown in Chart 1. No country has enough of it – not even China – and many of the developed countries (specifically in Euroland) seem to be shrinking into recession.

nov_io_chart

The lack of growth, as explained in prior Outlooks over the past few years, is structural as opposed to cyclical, and therefore relatively immune to interest rate or consumption stimulative fiscal policies. 1) Globalization, 2) technological innovation, and 3) an aging global demographic have all combined to dampen policy adjustment post Lehman and will inexorably continue to work their black magic going forward. To defeat this misunderstood structural voodoo, countries would have to mint pennies by the billions, pretend to lose them, and then incredibly find them strewn all across their city streets like some global Easter egg hunt. Not gonna happen.

The situation, of course, is compounded now by high debt levels and government spending that always used to restart capitalism’s private engine. However, as economists Rogoff & Reinhart have shown in their historic text, This Time Is Different, sovereign debt at 80-90% of GDP acts as a barrier to growth. Because debt service and interest rate spreads start to rise at these debt levels, a greater and greater percentage of a nation’s output must necessarily be diverted to creditors who in turn become leery of reinvesting in a slowing economy. The virtuous circle becomes vicious in its reflexive counter reaction, spiraling into a debt/liquidity trap á la Japan’s lost decades if not stopped in time.

Halting the downward maelstrom is what current monetary policy is attempting to accomplish. With fiscal policy in most developed countries incredibly restrictive instead of stimulative, central banks have assumed the helm on their own – but it has been a long and relatively futile watch. Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill, for that matter. If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more seriously for retirement, why will lower interest rates cause them to spend more? As a matter of fact, savers will have to save more just to replicate their expected retirement income from bank CDs or Treasuries that used to yield 5% and now offer something close to nothing.

My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth. Instead, we are seeing: minimal job creation, historically low investment, consumption turning into savings and GDP growth at less than New Normal levels. The Rogoff/Reinhart biblical parallel of seven years of fat followed by seven years of lean is not likely to be disproven in this cycle. The only missing input to the equation would seem to be how many years of fat did we actually experience? More than seven, I would suggest.

The investment implications are numerous although far from certain. Equity markets should be dominated by dividend yields and the return of capital via share buybacks, as opposed to growth. A market P/E ratio of 15X is actually a 6.5% earnings yield – not a bad return compared to 2% 10-year Treasuries, but actually a little bit short when placed against Baa and High Yield corporate bonds, which represent a senior claim against earnings in a rather uncertain global economic environment.

Despite 2% 10-year Treasuries, low economic growth rates are usually supportive of high quality sovereign debt and they may likely continue to be as long as QEs continue. Investors should be mindful of the global bond market’s most recent historical example of sovereign debt returns in a slow/no growth environment – Japanese JGBs. Even after yields reached relative rock bottom by 2003, bond returns managed to outpace inflation as holders of 5–10 year maturities “rolled down”1 a relatively steep yield curve and added capital gains to a relatively paltry interest coupon. The same strategy can be conceptualized in the United States. A seemingly anorexic 1.00% 5-year Treasury yield would be turned into a 2% annual return by allowing it to “age” for 12 months and become a .75% 4-year with an assumed attendant 1% upward price movement. Sort of like finding a lucky penny – but dependent of course on a Fed policy that shows no sign of moving off the 25 basis point goal line.

One should not stray too far, however into Japanese la-la bond land. Developed economies – the U.S. included – have experienced 3%+ inflation in the midst of a New Normal economy where expectations 12 months ago would have been for far less. Sovereign monetary and fiscal policies, while generating undersized real growth, have managed to produce disproportionately large inflation. While “output gaps” represented by high unemployment might normally contain the rise, it has not done so to date. The answer might be found in the narrow output gap in developing economies and the transmittal of their inflation back into the U.S., U.K. and Euroland.

My point on the bond side is not to discourage the ownership of fixed income assets despite the relatively low expected returns, but to suggest that portfolios should avoid longer dated issues where inflation premiums dominate performance. Despite the Fed’s twist program, which promises to absorb almost all 20-30 year supply over the next 6 months, future QE programs hinted at by Yellen and Dudley – two of the three Fed Musketeers – are likely to push long-term yields higher because their policy objective is 2%+ inflation. Investors should consider migrating to the relatively safe haven of 1–10 year maturities offering “rolldown” total returns of 2–3% with far less duration risk. In addition, Agency mortgages are back on the Fed’s menu and may be a featured “special” in months to come.

In sum, with both earnings and bond yields near historic lows as a result of a lack of real growth in developed economies, investors will need to find lots of pennies to produce asset returns much above 5% in bonds or equities. Pension funds, Washington politicians, and indeed Main Street investors are likely expecting much more. One of the big problems of an asset-based economy is that once interest rates inch close to zero and discounted future cash flows are elevated in price, it’s difficult to generate much more if economic growth doesn’t follow. Such appears to be the case today. Unlucky…very, very unlucky.

About Bill Gross

Mr. Gross is a founder, managing director and co-CIO of PIMCO based in the Newport Beach office. He has been with PIMCO since he co-founded the firm in 1971 and oversees the management of more than $1 trillion of securities. He is the author of numerous articles on the bond market, as well as the book, “Everything You’ve Heard About Investing is Wrong,” published in 1997. Among the awards he has received, Morningstar named Mr. Gross and his investment team Fixed Income Manager of the Decade for 2000-2009 and Fixed Income Manager of the Year for 1998, 2000, and 2007 (the first three-time recipient). He received the Bond Market Association’s Distinguished Service Award in 2000 and became the first portfolio manager inducted into the Fixed Income Analysts Society’s hall of fame in 1996. Mr. Gross is a seven-time Barron’s Roundtable panelist (2005-2011), appearing in the annual issue featuring the industry’s top investment experts, and he received the Money Management Lifetime Achievement Award from Institutional Investor magazine in 2011. In a survey conducted by Pensions and Investments magazine in 1993, he was recognized by his peers as the most influential authority on the bond market in the U.S. He has 42 years of investment experience and holds an MBA from the Anderson School of Management at the University of California, Los Angeles. He received his undergraduate degree from Duke University.

“You’d expect that kind of exuberance from a man with everything to gain from seeing his vision made real, but it’s not just independent drillers such as Chesapeake that are talking big.ConocoPhillips (COP) is investing $2 billion in gas in 2011, up from $500 million two years ago.

Other multi-national oil giants, such as Exxon Mobil Corp. (XOM) and Royal Dutch Shell Plc (RDSA), are likewise diverting billions into domestic shale gas projects. “We believe so strongly in natural gas that it’s a major portion of our portfolio,” Conoco CEO James J. Mulva told an audience at the Detroit Economic Club in September.

Last month, the potential for U.S. shale gas spurred Kinder Morgan to acquire rival pipeline operator El Paso Corp. for $21.1 billion. It also drove the proposed $4.4 billion purchase ofBrigham Exploration Co. (BEXP) by Norway’s Statoil ASA. (STL)“

 

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