Market Update: Anniversaries, Smart Money, Regulation and Banning Cash: It’s all about Trust!

It’s been a relatively uneventful month for precious metals so far, with the price of gold in USD up slightly, currently trading at USD $1,352 per troy ounce, whilst silver has eased somewhat.

In AUD, the price is just holding above $1,750 per troy ounce, with a stronger than expected Australian jobs report helping push the local currency back toward and indeed briefly above USD $0.77.

Though the precious metal market has no lack of support right now, a rally in risk assets, greater (though not great) chances of another rate hike from the Fed, a reduction in net gold longs from speculative traders in four of the last five weeks, and even some minor outflows from gold ETFs have acted to limit any further upside for precious metals of late.

Despite the constrained price action this month, there is still a lot of bullish commentary out there regarding the yellow metal, with Credit Suisse recently re-iterating their June 2016 call that gold prices would average USD $1,475 per troy ounce in Q4 this year. Were that to eventuate, a USD gold price in that region would likely coincide with a AUD price above the magical $2,000 per troy ounce mark.

Credit Suisse aren’t alone either, with UBS also optimistic, noting the constructive technical picture developing, with price targets of USD $1,475-USD$1,500 per troy ounce, provided support holds above or around the USD $1,300 level.

This optimistic outlook from UBS is aligned with their mid-long term view, with the bank noting that “Strategically, it was a key call of our 2016 strategy to see gold moving into an 8-year cycle bottom as the basis for a new multi-year bull market where we expect gold hitting new all-time highs into later this decade or at the latest into early next decade. In this context this year’s rally in gold and the precious metals camp is in our view just the beginning of a major bull market, which means it is a pure investment theme where every weakness is in our view a buying opportunity.”

It’s not just the banks either, with Peter Grandich (the “Wall Street Whiz Kid” of Grandich letter fame), recently stating that; “the mother of all bull markets in gold has only just begun”.

We obviously agree with the medium to long-term outlook espoused by UBS, and think that, potential short-term volatility notwithstanding, the metal will likely be the best performing liquid of the next few years, a view that is not new to readers of regular ABC Bullion market updates.

Having said that, after a 20% rally so far this year, Jackson Hole approaching next week (Yellen may be more “hawkish” that markets expect”) and the gold market itself at an important juncture (see chart below – which shows monthly US spot gold chart going back to 1996), caution, and a prudent approach to deploying capital into the sector is warranted.

Thanks to my colleague John Feeney - @JohnFeeney10 – for the chart.

Moving on from gold, and whilst things have been somewhat quiet on the precious metal front these past two weeks, there’s been no shortage of activity in other markets, and plenty of interesting analysis.

The most eye-catching of course is the continued decline in global bond yields, with the market value of negative yielding debt topping USD $13.4 Trillion last week.
As Robin Wigglesworth of the Financial Times recently noted, we are now well and truly in an investment bizzaro world, where investors are now buying bonds in the hope of capital appreciation, and equities for yield.

Wigglesworth was in effect echoing the views of James Abate, chief investment officer at Centre Asset Management, who noted last month that “the world has turned upside down”, when discussing the same phenomena currently at play in equity and fixed income markets.

The chart below shows fund flows into US fixed income products the past year or so. As you can see, it’s been more or less non-stop since the start of the year, with nearly USD $8bn flowing in one week in early July.

This change in investor behaviour is very interesting to note, and undoubtedly yet another unintended consequence of ZIRP, NIRP and global QE, alongside the impact it has at board level re payout ratios and capital investment, a subject I’ve discussed previously here.

It also makes one wonder, are equities now the smart money? I feel decidedly uncomfortable even putting that in writing, considering all the key ratios I’d look at to measure stocks (CAPE, Market cap to GDP, etc.) suggest risk markets are decidedly overvalued, and at risk of a major correction.

But the question needs to be asked – after all, confidence in bonds appears way too high, whilst the stock market, despite the overvaluation, is still decidedly unloved, as the following image (from a July 2016 Wall Street Journal article) attests.

Furthermore, when we look forward, we can’t help but feel equities offer a better chance of protecting wealth than bonds.

Sure a deflationary environment would crush equities, but it would also be fought tooth and nail by governments and central banks the world over, who know full well that the financial system itself won’t cope with a systemic deflation.

As such, if we assume that in the next 5-10 years we do see inflation rear its ugly head again (see here for an article on this very subject), then we’d much rather be in equities than in bonds, though we think the really smart money will be in precious metals, for we have no doubt that the non-market forces striving for inflation will win a decidedly pyrrhic victory.

As a final comment on this this, I listened in on a Betashares market update yesterday, where they asked their audience whether or not they thought the RBA would cut rates again, and whether or not the audience was bullish or bearish on the ASX going forward.

The reaction was very interesting. An overwhelming number (over 85%) of participants saw further easing from the RBA, yet most (some 65%) were NOT bullish stocks, even though in their view, cash rates will decline further.

That’s another indication of the caution out there regarding risk assets, and perhaps a sign that there is further upside in equities to come.

Happy Birthday
It seems strangely appropriate that whilst the world focuses on the Rio Olympics, and the gold medal winning antics of Usain Bolt, Michael Phelps, Simone Biles, and hopefully the Boomers, this week we mark the 45th anniversary of the day that then US President “temporarily” closed the gold window.

Ever since, the whole world has been operating in what is effectively unchartered monetary waters, with no currency anchored by a formal precious metal backing.

The non-gold backed US Dollar is now 45 years old, though as per the chart below it ain’t what it used to be, with citizens now needing closer to USD $600 today to buy the same amount of goods and services a single Benjamin would have procured back when Tricky Dicky was in the White House.

Whilst there are no shortage of commentators that will focus on what has happened to global money supply, inflation and debt to GDP ratios since that fateful day, we thought we’d share the following image, which shows income growth over a near 100 year period ending 2012, broken down between the top 1%, and bottom 90% of earners.

Note what has happened since the start of the 1970s.

Correlation does not equal causation as the saying goes, and globalisation and technology have obviously been factors, but surely even the most ardent defenders of our current monetary architecture (the PHD standard as James Grant calls it) must be somewhat curious why a system that was taken out of the hands of the people, and given to economic and monetary “experts”, seems to end up directing ever more wealth to an ever smaller group of people.

After all, if nothing else, “fairness” is the supposed reason justifying the monetary interventions we’ve seen since the early 1970s, as well as the almost constant fiscal stimulus that has led to record high government debt to GDP ratios across much of the developed world.

That kind of wealth disparity is the kind of thing one would expect to see in countries where the modus operandi is decidedly not “free market”, though as Vimal Gor of BT noted in his July 2016 update; “The slow transition from a capitalist society to a communist-lite one isn’t in our view just a thought experiment, it is there in fact.”

Where this all ends up is of course the $64,000 question, with the vast majority of people still seemingly willing to put their full trust in our unelected central banking overlords, though the team of skeptics grows by the day.

Regulation and Trust
The issue of trust, which I mentioned in relation to central banks in the section above, feeds directly into the last area I wanted to comment on in this update, which is the issue of regulation in general, and the ever- louder calls for banning cash.
 
To that end, I came across a fabulous blog this week titled “Regulation and Distrust”, which discussed the correlation between higher levels of regulation in a society, and higher levels of distrust.

It brought to mind a quote that has always stuck with me since I first came across it, which I’ve included below.
 
“The more corrupt the state, the more numerous the laws”

- Tacitus, born AD 56, died c AD 120

It looks even better in Latin, a subject I detested in school.
 
“Corruptissima re publica plurimae leges”
 
Back to the present, and the blog on regulation and distrust referenced a body of scholarly work that highlighted the fact that regulation is typically highest in societies and countries where levels of distrust are higher.

As per the blog; “Distrust makes people turn to government but in a society with a lot of distrust government is often corrupt and this makes people distrust even more.”

This line of thinking echoes an article from March of this year, where journalist Laurel Hamers noted that “people in countries with higher levels of rule-breaking were more likely to cheat”.

As to whether we are on the right track in our “communist monetary” but “free market” economic model, we thought we’d share the following chart, which highlights interpersonal trust attitudes in the United States from the 1970s to today. 

We haven’t had a chance to look for similar data in Western Europe or indeed Australia, but we have little doubt the overall trend would be very similar.

Banning Cash
The issue around declining trust levels, and ever-higher levels of regulation came to the fore for another reason this week, which was an article in the Economist to do with banning cash, as well as an online twitter poll on the subject.

The article can be found here, whilst I’ve also included the questions from that poll in the image below.

Discussing the above image first, it’s interesting the “reasons” one was allowed to choose as to why they still might use cash, or want the freedom to use cash.

Two of the four reasons were to do with being a criminal (tax evasion or drug use), whilst the other two would be highly unlikely, as I for one don’t know anyone who still uses cash for most day-to-day shopping (some people might), and definitely not for “everything”.

The article itself was of more interest, with the classic line that, whilst banning cash would cause some inconveniences, it would bring even bigger benefits, including making “monetary policy more effective……because savers would no longer be able to stuff cash under mattresses in case of negative rates”.

In other words – economists are in favour of cash bans, because it will give them more power!

Banning cash would also apparently help reduce crime, with Ken Rogoff arguing that “the bulk of the rich world’s currency supply is used to facilitate tax evasion and illegal activities such as human trafficking and financing terrorism”.

Do bad people use cash? Yes of course they do. Would eliminating cash therefore have some societal benefit? Arguably yes – though the idea it would eliminate crime in a world of cyber-hacking and electronic fraud is laughable.

The loss of liberty, freedom and choice is not given anywhere near enough attention either. After all – if we can ban cash, what else can we ban?

Taken to extremes, one could also argue we should outlaw junk food (this could “help” with the obesity epidemic), alcohol and cigarettes (think of the “potential” reductions in public health care spending), and maybe even the motor car (less “road deaths” and “good for the environment”).

What is also not mentioned at all in any of the discussions around the potential banning of cash is the fact (and I use the word fact deliberately) that banks around the globe have so far proved themselves fundamentally unworthy of the trust that we would need to put in them were a society to ban cash.

Don’t get me wrong, I’m not trying to join the ever-growing chorus of bank bashers – I am a believer that banks do play a critical role in a prosperous and efficiently functioning society.

But even in Australia, trust in our banks is questionable at best, with a recent poll suggesting 64% of people support a Royal Commission into our banks and their behaviour, with a vote in favour of such a move entirely non-partisan, carrying support from individuals, irrespective of whether they were Labour, Coalition or Greens voters.

And that is just Australia.

In the last few years, we’ve seen a large number of global banks pulled in front of regulators and authorities, and fined heavily for devious behaviour including currency manipulation, interest rate rigging, and securities fraud.

For a list of these fines, have a quick skim of this Reuters article, which highlights the fact that 20 of the worlds largest banking institutions have paid over USD $200bn in fines in the last few years.

More alarmingly, we’ve even seen major global banks admit to laundering drug money, and doing business with nation states that are suspected of supporting terrorism.
Does this mean that these banking institutions are entirely unworthy of trust, and are corrupt from top to bottom? No it does not, and I’d re-iterate my earlier comment that a healthy banking system is in many ways a pre-condition for a prosperous economy.

I’m also an active user of PayPass and other payment technologies myself, and am a fan of any technology that speeds up commerce, and reduces friction.

But that does not mean we should ‘ban cash’, and force people to keep 100% of their wealth tied up in the banking system, or in financial assets, at all times.

Competition after all is a very good thing, and to that end, we should make no mistake that any move to ban cash would represent a crossing of the Rubicon (hat tip to Tacitus, trying to stick with the Roman theme), from the financial repression of ZIRP, NIRP and QE, to outright financial tyranny.

It will do nothing to improve our economy, nor will it encourage investment or productive enterprise. Instead, it will engender fear, and even higher levels of distrust, a poor breeding ground indeed for an economy badly in need of positive catalysts.

For as long as this nonsense is discussed seriously in the monetary and political halls of power across the globe, a premium should be paid on defensive assets.

For myself at least, that means sticking with gold.

Until next time

Jordan Eliseo
 

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