Monday, April 25, 2016

Gold at short term risk of correction but long term in a bull market

As 2015 came to a close, most investors believed that 2016 would be a year dominated by a series of Fed rate hikes. That conviction solidified in mid-October when comments from multiple Fed officials convinced many that prior hints that the Fed would stay at zero percent rates had been false alarms. The Fed delivered on its promise in mid-December by actually raising rates by 25 basis points. Based on this, gold declined by 10% from October 14 to the end of the year, nearly matching its six year low. Many on Wall Street thought the declines would continue into 2016. They were decidedly wrong.

In the first 14 weeks of the New Year, gold rose 16%. The first quarter qualified as its best beginning year performance in 30 years (CNBC, E. Rosenbaum, 4/14/16). The reversal was prompted by stumbling stock markets and a series of sharply dovish turns from central banks around the world.

Perhaps the main reason people buy gold is as a hedge against inflation. But uncertainty and fear contributed undoubtedly to gold's stellar first quarter rise. But will it continue? Opinions vary among some of the most revered gold analysts in large financial firms. They remain focused almost exclusively upon the major historical influence of the inflation outlook and possible rate hikes. And as a result, the mainstream financial firms have yet to alter their decidedly bearish outlook on gold. This could prove positive for those who take the contrarian position.

In March, Kitco reported that Robin Bhar, head of metals research for Societe General, forecast an average gold price of $1,150 an ounce for 2016. Combined with the likelihood that fear and uncertainty are receding, Bhar believes that there may be a growing realization that "the risk of an imminent U.S. recession, while not negligible, is far lower than the markets are currently factoring in." He expects the Fed could deliver multiple rate hikes in 2016 and perhaps several during the course of 2017. If this were to happen, the dollar should strengthen and gold should fall.

Mr. Bhar's view is supported by Goldman Sachs' global head of commodities, Jeff Currie, who in a CNBC TV interview on April 5th recommended not just a sell of gold, but a short sale. Given the drift of central bank policies around the world, it's hard to imagine why these banks can hold to these beliefs. This is particularly true in light of how widely and rapidly negative interest rates are spreading around the world. Bloomberg reports that as of Feb. 9, 2016, over $7 trillion of bonds, comprising some 29 percent of the Bloomberg Global Developed Sovereign Bond Index, offered negative yields. Another $9 trillion yielded zero to one percent. It is widely accepted that this number will grow rapidly as central banks push yields deeper into negative territory. These rates have already started to be passed through to consumers, who are being charged interest on their bank deposits.

Negative rates are now looming so large that on April 15, the Wall Street Journal dedicated almost its entire "Money & Investing" section to the global consequences of negative rates, a phenomenon that has no precedent in human financial history. The section included five separate articles that detailed the absurdities of negative rates, the strains they are placing on the financial system now, and the risks they create for the future.

When bank charges are leveled on cash deposits that earn no interest, which are held in debased fiat currency, it may become tempting for more and more individuals to withdraw their funds. Their alternatives could be to buy stock investments, or to hold physical cash in the form of bank notes (which may or may not be stuffed into mattresses). A fall in bank deposits could hurt banks just when they may be hit with fines and increased regulation. Furthermore, even if arguably remote, falling deposits could trigger a cycle of further withdrawals. Given that central banks may confront such a scenario with even more currency debasement, precious metals could become an alternative form of cost-free cash.

Sovereign debt (including negative rate bonds) form 'safe' holdings in the portfolios of major banks, insurance companies and pension funds. In fact, one of the stories in the Journal described how German insurance companies are required to hold large quantities of "safe" government debt as "assets." But these instruments not only offer negative returns, but they are vulnerable to declines in value if interest rates for newly issued bonds were to rise to anything approaching 'normal' rates. It may be unlikely that these bonds will allow the insurance companies to meet the promises they have made to policyholders. A similar dynamic could threaten the financial viability of the world's "too big to fail" banks. This is just one more reason that we feel the world cannot tolerate a return to free market interest rates at this time.

If the U.S. economy were to further approach recession, the Fed might have to choose between restarting its Quantitative Easing program or following Europe and Japan into negative territory. A return to QE would be problematic on two levels. Firstly, QE has recently been tried by the Fed, and there is little consensus that it was effective. Also, the goal of QE is to lower long term interest rates. But as long term rates are already at record lows in the United States, it is questionable that the Fed can push them down much further. This leaves negative rates, which work on the short end of the yield curve, as the more likely option. Notably, when asked in February at a Congressional hearing if the Fed would consider moving to negative rates, Chairwoman Janet Yellen refused to take such an experiment "off the table."

If negative rates fail to generate growth, and there is no sign that they will, central banks then may take the next logical step down the endless stimulus path. They may decide to bypass the financial system as a pathway to issue newly created fiat money (as in Quantitative Easing), in favor of delivering money directly to consumers. This is what is known as "helicopter money," which the banks could drop from the skies onto an economy in hopes of getting consumers to spend. (But with consumer demand as low as it is, it remains to be seen whether consumers will spend such a windfall or hoard it.) While these policies are still on the fringes of central bank discussions, they may not be so for long.

It should be apparent that bankers will not be deterred from trying any policy imaginable that punishes savers and destroys the value of fiat currencies. As these policies have shown to fail to achieve their goals, we should imagine that they will be administered for many years to come.

Having risen so fast this year, and with confusion apparent even at the Fed regarding the outlook for interest rates, the price of gold could correct in the short-term. However, over the medium to long-term we remain very bullish. This view will be validated or impeached based on the behavior of the Federal Reserve over the next few months.

Monday, April 18, 2016

Q1 was one of the worst for Active fund managers

The Winter of 2015-2016, which came to an end a few weeks ago, has been officially designated as the mildest in the U.S. in 121 years according to NOAA. While this fact will certainly add a major talking point in the global warming debate, it should also be front and center in the current economic discussion. The fact that it isn't is testament to the blatantly self-serving manner in which economic cheerleaders blame the weather when it's convenient, but ignore it when it's not. If economists were consistent (and that's a colossal "if"), the good weather would be taken as a reason to believe the economy is weaker than is being reported.

The two previous winters were much harsher. 2013-2014 brought the infamous "Polar Vortex," an unusual descent of frigid polar air that brought temperatures down significantly throughout most of the United States. The next winter was almost as bad, with colder than usual temperatures combined with record snowfalls in much of the country. These conditions were cited again and again by many economists to explain why Q1 GDP growth was so disappointing both years. Annualized growth came in at just -.9% and .6% respectively (Bureau of Economic Analysis). As both 2014 and 2015 got underway, economic optimism had been riding high. When both started off with such resounding stumbles, excuses were needed to explain why the forecasters were so wrong. The snow and cold provided those fig leaves.

As I quantified in a commentary on the subject two years ago, a bad winter can indeed put a chill into the economy, at least temporarily. In general, first quarter (which corresponds to the winter months of January, February, and March) shows annualized GDP growth that is roughly in line with the average of each of the other quarters. Since 1967, average annualized 1st quarter growth was 2.7%, not too far below the average 2.8% full year growth, based on BEA figures. But when winter gets nasty, the economy does slow noticeably in the first quarter.

The average annualized GDP growth for the 10 snowiest winters (not counting 2014) as reflected in Rutgers University Global Snow Lab (Seasonal Extent graph) was just .5%. While this phenomenon did not fully account for the poor results in 2014 and 2015, which missed the average by more than 2%, at least it provided a strong argument as to why we struggled unexpectedly. But that excuse is unavailable this year when the Q1 performance may be equally bad.

While official 1st quarter GDP estimates have yet to be published, researchers at the Atlanta Federal Reserve Bank put out an estimate called "GDP Now" that attempts to offer a real time estimate of economic growth. As late as mid-February, the GDP Now estimate was 2.7% for the first quarter, far below the 3.5% projection that the Fed had offered for the quarter back in December, but at least in the same ballpark. Since mid-March, the estimates have fallen steadily throughout and last week it was taken down to just .1% (although since increased to .3% today). (This comes after 4th quarter 2015 growth came in at a very disappointing 1.4%)

So if we assume that the official estimates (when they arrive in a few weeks) do not stray too far from these projections, economists will have to explain why we had a very, very bad quarter (in fact, two consecutive bad quarters) at a time when the weather should have been encouraging robust activity.

An analysis of the bad winters also reveals a clear tendency for the economy to bounce back strongly in the following quarter, confirming the theory that pent up demand in a bad winter, when it's too cold for people to go out and shop or for construction companies to break ground, results in increased activity in the spring. In the ten 2nd quarters that followed the ten snowiest winters, annualized GDP averaged a strong 4.4%, or almost four percent higher than the prior quarter. That trend was clearly seen in 2014 and 2015 when second quarter growth was an average 4 percentage points higher than Q1.

Most strategists are now confident that a similar rebound will occur this spring even if there has been no bad weather to create the "snap back" dynamic. But putting that aside, there is absolutely no evidence to support such an absurd conclusion, and any such beliefs are based on hope not reason. The weather was actually so warm this winter that rather than pushing economic activity forward into the second quarter, it likely could have pulled economic activity into the first. This could weigh down 2nd quarter performance.

We also should take note of the fast deceleration of the Atlanta Fed's GDP estimates and the fact that the biggest declines came at the end of the quarter. This may mean that we could be slowing down going into second quarter. Nevertheless, government and private economists still expect the traditional kind of 2nd quarter rebound.

But evidence arguing against this can be found in wholesale trade inventories for January and February that were released last week. Originally January inventories were reported as up .3% (U.S. Census Bureau), which was taken as a sign that business confidence was rising. At the time many thought that February would not sustain that pace and decline by .2%. Instead, January itself was revised to -.2% (from up .3%) and February was reported at down .5% (off of the already rolled back January number). This is a terrible outcome.

The bad dynamics have been apparent for a while in the inventory-to-sales ratio, which documents how difficult it has been for companies to move products. Last week some economists were relieved that this number had come down to 1.36 (U.S. Census Bureau). But that drop was only possible because the prior month had been revised up from 1.35 to 1.37 (a higher number indicates more stagnant inventories). Going into Q2 last year, most businesses still believed that the recovery was real, and they built their inventories throughout the quarter (which added to GDP). There is no sign that that is happening this year. I believe that based on the current high inventory-to-sales ratio companies will draw down their inventories this quarter, thus detracting further from GDP.

Another big difference between this year and the last two is the trajectory of our trade deficits. January and February trade deficits averaged $46.4 billion per month this year. They were just $41.1 billion in 2014, and $41.0 billion in 2015 (U.S. Census Bureau). Trade deficits detract from GDP.

Despite the weather, the inventories, and the trade deficits, very few of the most influential public and private economists have marked down their full year GDP forecasts very much, if at all. Goldman Sachs even believes so strongly in the strength of the recovery that it still expects the Federal Reserve to raise interest rates three more times this year (Wall Street Journal, Min Zeng, 3/31/16). The IMF just revised down its estimates for 2016 U.S. economic growth, but only by .2% from 2.6% to 2.4%. But if the 1st quarter matches the Atlanta Fed's current estimate, GDP growth for the rest of the year will have to average over 3.1% to achieve that.

This is likely the type of mindless optimism and herd mentality that caused only one in five U.S. large-cap fund managers to beat the S&P 500 in the first quarter. If you have no idea what's going on economically, you are unlikely to pick the right stocks. High priced hedge fund managers did little better. In fact, the first quarter was the worst quarter for active managers in eighteen years, according to data from Bank of America Merrill Lynch. This tells me that the degree of denial is still very high, and that those who resist the stampede may be in a position to realize gains when the likelihood of recession finally becomes apparent to all.

Unlike Goldman Sachs and other big banks, I do not see any more rate hikes in 2016. Instead, I believe that it is far more likely that the Fed will have to roll out more dovish forward guidance until the point where it officially calls off rate increases for the foreseeable future. After that, I believe it will have to take us back to zero percent interest rates, restart quantitative easing, and it may even take interest rates into negative territory. Take your stand accordingly.

Wednesday, April 13, 2016

The question to ask is when will QE4 be launched



Peter Schiff is a smart investor and author of several best selling books. He correctly predicted the economic meltdown of 2008 - 2009

Monday, April 11, 2016

Tax inversion rule changes could put American companies at risk of being acquired

By the government making it harder for American companies to buy foreign companies and invert, they are going to leave American companies vulnerable to being acquired by foreign companies instead.


Peter Schiff is a smart investor and author of several best selling books. He correctly predicted the economic meltdown of 2008 - 2009

Monday, April 4, 2016

US Fed rate hike talk is more bark than bite

The real problem is the U.S. economy. The U.S. economy is weakening. The economy already is in recession. The question is, when is the Fed going to acknowledge it ?

Central bankers at the Fed bark but they won’t bite. I knew all that talk was a bunch of nonsense.


Peter Schiff is an american investor and author of several best selling books. He correctly predicted the economic meltdown of 2008 - 2009

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