Jim Rickards and Alex Stanczyk, The Gold Chronicles October 13th, 2016
*Analysis of recent correction in gold
*Market has priced in an anticipated Fed rate hike in December
*Fed will be forced to reverse course going into 2017 and ease
*This is a short term correction and is not signalling a new bear market
*Gold performance for the year
*Physical gold flows and the gold “float”
*Factors affecting short term USD/Gold price
*Factors affecting long term USD/Gold price
*Psychology of markets affecting availability of gold to the float
*Three demand spheres for physical gold flows, the West, India, and China/East Asia
*If Trump wins the election equities markets could have a substantial immediate drop, followed by a recovery
*SDR issuance is going to be highly inflationary
*Gold serves different roles in a Central bank portfolio versus an individual or institutional investor portfolio
*Gold’s role moving forward is one of insurance versus tail risks, systemic failures, and future liquidity crisis
*Gold held by central banks is the last line of defense for liquidity and confidence in central bank issued currency
*FX trading effect on gold pricing and alleged manipulation
*Gold Pool of the 1960’s, IMF coordination with the US selling gold into the market during the 1970’s
*International monetary system is missing an anchor and is considered “incoherent” by current and former officials
*Currency values continue to fluctuated wildy, this is a very unstable system
*Measuring the buying power of gold
Listen to the original audio of the podcast here
The Gold Chronicles: 10-13-2016:
Jon: Hello, I’m Jon Ward, on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest webinar with Jim Rickards in the series we’re calling The Gold Chronicles.
Jim Rickards is a New York Times bestselling author, the chief global strategist for West Shore Funds, and the former general counsel of Long-Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.
Hello, Jim, and welcome.
Jim: Hi, Jon. It’s good to be with you.
Jon: We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting, and he has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.
Alex: Hi, Jon. I’m looking forward to today’s discussion.
Jon: Later in this podcast, Alex will be looking for questions that come from you, our listeners. Your questions today are more than welcome, and as time allows, we’ll do our best to respond to them.
Jim and Alex, we’ve just seen a rapid and significant correction in the dollar price of gold with a small recovery over the past few days. This leads me to ask, has gold reached its peak? Are we about to see a new rise in the dollar and a concurrent collapse in gold?
First, Jim, maybe you could give us a macro view on this.
Jim: Sure. As our listeners know, going back to last June 23rd and 24th in particular, there was a big uptick in gold. That was the direct consequence of the U.K.’s decision to leave the E.U. – the so-called Brexit vote – and gold got a lift from around the $1260 per ounce level. At one point, it was as high as $1370 and backed off a little bit from there.
From about July 1st to September, it was trading in a range from approximately $1310 to $1365. The middle of the range or the place where it gravitated most of the time was around $1335/$1340, but it wasn’t showing any strong tendencies to break out. It would go down and then back up again. It stayed in that range centered around $1340.
Then a few weeks ago, it hit an air pocket and went down to the $1250 level where it has been bouncing around ever since. On September 6th, there was a break and it traded down to $1310, but the really decisive break was on September 26th. It went from $1310 all the way down to $1250 by October 11th, so that was definitely an air pocket.
I’m sure a lot of gold investors were discouraged, particularly those – including myself – who have been buying gold for a long time and had to live through that four-year bear market from August 2011 to late 2015. It was a long four years where we saw a lot of rallies and then they would get smashed down and then rally and then get smashed down.
I assume some gold investors saw this recent drawdown and said, “Here we go again. The whole thing was an illusion. We got smacked down again, and it’ll happen again.” Maybe there was a little bit of discouragement or pessimism that crept in.
I don’t think that’s warranted at all, because what we’re seeing is something quite different. It’s actually not that difficult to explain why I think gold will rally from here. And just to cut to the chase, this makes a good entry point for people who don’t already have their full gold allocation.
What happened was very simple. The market suddenly priced in an expectation of a Fed interest rate hike in December which I think is realistic. I’m quite sure the Fed is going to hike interest rates in December.
We had to get past that September meeting. No one really thought the Fed was going to raise rates in September; that was not a likely outcome. But the hawkishness of the statement and of a lot of Fed official comments since then has caused the market to say, “You know what? They did not raise in September. They’re obviously not going to raise in November.”
No one expects that. The November meeting is just a matter of days before the election, and whatever your view on the macro-economy or Fed policy, the Fed is going to keep their heads down. They’re certainly not going to make a big move just days in front of a US presidential election, so take November off the table.
That immediately causes everyone to look at December. There, the stars are aligned, if I can put it that way. The Fed is going to hike rates in December. I’ll digress a little bit and explain why we can be very certain about that, but to get back to the gold story for a minute, that’s what happened: gold got repriced.
In a world where interest rates are perceived to be going up and the dollar is stronger, the dollar price of gold goes down. There are other determinates of gold prices, and we’ll talk about those, but at a very simple level, a strong dollar means a lower dollar price for gold; a weak dollar means a higher dollar price for gold. Higher interest rates imply a strong dollar, so the market priced it in and – boom – there goes gold down to around $1250. It has rallied back a little bit from that and right now is closer to the $1260 level.
The question is, now that that’s behind us, where do we go from here? This is really what investors most need to know. Gold is nowhere near its peak. As our listeners are aware and very familiar with the math, gold will get to $10,000 per ounce. I’m not saying tomorrow or even next year, but sooner rather than later. We’ll come back to that during a question planned later in the podcast about SDRs and monetary confidence.
For right now, the Fed is going to raise interest rates in December. There are a number of conditions required for this to happen. A lot of people focused on the jobs report, and as far as jobs are concerned, it is mission accomplished. Unemployment is down around 4.8% or 4.9%. Job creation has been steady. I know the monthly job gains are not as big as they were in recent years, but they’re good enough. That’s really the point. They’re good enough for the Fed. We’re not losing jobs, we continue to create jobs, and unemployment continues to trend down. The labor force participation appears to be at a bottom. Maybe it’s even going to go up some. Real wages are not soaring, but they have a pulse. These are not blockbuster numbers, but they’re good enough given what’s already been accomplished for the Fed to say, “Okay. We’ve solved that part of our dual mandate.”
The other part of the dual mandate is inflation. They want to get inflation to 2%. They’re not there and haven’t been there for five years – really an outstanding failure on the Fed’s part. But that looks like it’s going away a little bit, mainly because the price of oil looks like it’s off the bottom. It’s rallied from lows of $24 a barrel in early 2016 and is back up to over $50 a barrel or so right now. I think there’s a ceiling around $60 a barrel, but you can still go from $50 to $60.
This is what Janet Yellen has been looking for. If you go back over all her speeches and comments, how many times does she use the word “transitory”? She said, “These deflationary or disinflationary pressures are transitory.” Three years is a long time to be transitory, but I guess patience pays, and now we see some of those trends reversing.
The Fed can look ahead and is always looking ahead. We don’t have rip-roaring inflation right now, but there’s some reason to believe that inflation is showing its face. At least the deflationary/disinflationary trends are over for the time being.
So you have mission accomplished on labor, inflation has a little bit of a pulse, and there’s consensus on the Board for a rate hike. Remember, there have been struggles between hawks and doves on not just the Board of Governors but also the Federal Open Market Committee. For several years, the regional reserve bank presidents have been a little more hawkish while the governors, particularly Yellen, from time to time have been a little more dovish.
At the last meeting, we saw three dissents. Three is not a palace revolution but it’s a lot of dissent. Those who dissented in September are certainly going to vote for a rate increase in December. They haven’t changed their view.
We’ve seen other views come out recently. In particular, Charles Evans, President of the Federal Reserve Bank of Chicago, widely respected, and one of the few recent reserve bank presidents who does have a lot of clout because he has some pretty good intellectual chops, which is how Yellen assesses it. He said that he thinks December is the time, and we haven’t heard anything to the contrary, so there seems to be a consensus on the Board of Governors.
The final missing ingredient was market expectations. The Fed does not want to raise rates at a time when the market is giving it a 20% or 30% probability because that means there’s shock. When you have a 20% probability of something and then it happens, you have to reprice the other 80% instantaneously. That’s the kind of market shock that can get out of control in a fragile system – and we do have a very fragile system. The Fed doesn’t want to see that, so what they’re trying to do – and it’s working – is get expectations up. Now market expectations are close to 70% that the Fed will hike rates.
The market is not always right about that. Longer-term expectations have been very wrong for seven years. The markets have consistently priced in rate hikes that never appeared. I’m not saying the market is flawless, but at a short-range, meaning two months, those expectations are important.
The Fed is saying, “Market, you have a 70% expectation priced in. We’d like to get that up to around 80% or 90% by December 15th.” There’s plenty of time to do that. They don’t want to rock the boat before the election, as I mentioned, but I would expect that as soon as the election is over, for that last four-week stretch before the December FOMC meeting, you’re going to hear one speech after another, even from the most dovish voices including Lael Brainard.
The other factor I forgot to mention was the international spillovers. Even if you think it’s all-signals-go in the US economy, are you doing something that’s going to create havoc overseas?
Just a few days ago, in connection with the IMF annual meeting in Washington, they issued a report saying that emerging markets were prepared for a Fed rate hike. These things don’t happen by accident. When the IMF comes out with something like that, that’s Christine Lagarde’s way of giving Janet Yellen a green light, saying, “We don’t think this is going to be Taper Tantrum Part 2.” Everyone’s reading from the same page of the hymnbook, so to speak.
Charles Evans is lined up, the Reserve Bank presidents are lined up, market expectations are lined up, and the IMF says emerging markets are ready for this. All the key variables are in line for a rate hike, so the down drift in gold was just a reflection of that. Gold was repricing a stronger dollar.
Where do we go from here? The problem is the Fed is raising rates for the wrong reasons. When I say “the wrong reasons,” the reason you’re supposed to raise rates is because the economy is robust, labor markets are tight, and inflation is picking up. The Fed is always behind the curve of this as they start to raise rates as a reflection of demand for money and to cool off an overheating economy.
We don’t have any of that. I described conditions that allow the Fed to raise rates. It’s not a complete disaster out there, but this is nowhere near the kind of robust growing economy that you usually have to see for the Fed to justify a rate hike.
What the Fed is doing instead is trying to raise rates so that they can cut them in the next recession. I describe this as hitting yourself on the head with a hammer because it feels good when you stop. The Fed is basically saying, “Normally you would not raise rates in such a weak economic environment, but there’s danger of creating asset bubbles. The next recession is probably going to be sooner than later. What are we going to do? How are we going to cut rates in a recession if we don’t raise them now?” That’s exactly what they’re doing, but it’s for the wrong reasons. They’re raising rates into a weak economy.
In my view, the Fed has overestimated the robustness of this economy. We are very close to a recession and may actually be in a recession, because you never know until after the fact.
What I see happening is an exact replay of what happened last year. Let’s go back to December 2015. We had almost exactly the same scenario of the Fed going all of 2015 without raising rates. Wall Street thought March 2015, then they said June, then they said September, but they were wrong every time. Of course, we on this podcast were saying the Fed would not raise rates until December, and by then it was clear they would. The market expectations were in line, and they raised rates.
What happened? The stock market crashed 11% from January 1st, 2016, to February 10th, 2016. Major stock indices were down over 11%. What happened to gold? It went to the moon. The first quarter of 2016 was the best quarter for gold in probably 30 years or certainly a very long time.
Again, the Fed looks like they’re going to absolutely repeat the blunder of 2015. They’re going to signal that they’re raising rates, and market expectations will line up. They will actually raise rates but will find out that they’re creating a stronger dollar. A stronger dollar kills exports, imports deflation, completely undoes their inflation target, and slows down the economy. The stock market will not be ready for it, because the market has to price in not only a 25-basis-point hike but also the expectation of further hikes down the road no matter what the Fed says about going slow.
This is like wash, rinse, and repeat. They are going to raise in December, and that’s what has caused gold to go down right now. They’re going to blunder; they’re going to slow down the US economy, if not put it in a recession, and they’re going to sink the stock market.
The reaction function will be that the Fed is going to have to flip to dovish to undo the damage, and that’s very bullish for gold. Gold will catch a bid, partly as a play to quality, when other things are falling apart.
My immediate forecast for the next couple of months is that gold is going to go sideways. It shouldn’t go down a lot from here because we’ve had the repricing. It could go up on a number of vectors such as the geopolitical vector, meaning the US, Russia, and Iran are very close to war in the Middle East.
The shooting has already begun. I’m sure listeners have heard about the Iranian-backed rebels shooting missiles at US ships, the US vessels responding with air strikes, Russia spreading high-tech surface-to-air missiles both in Iran and Syria, the US trying to come up with some kind of no-fly zone, the Russians saying no way, and US planes and Russian surface-to-air missiles operating at close proximity with no clear rules of engagement.
And let’s not forget, Donald Trump. Probably most people – certainly the markets and the betting odds – think that Clinton is a shoo-in, but I don’t. I don’t know who’s going to win the election, but I think it’s going to be a lot closer than the market expects. Trump, whatever else you may say or think about him, has had a kind word for gold.
We’re talking about gold in this podcast. I don’t get into politics, but I do get into markets, so a Trump victory would be extremely bullish for gold. Any flare-up in the Middle East is not good for the world but also good for gold in terms of a flight to safety.
Even if those things don’t happen, I think gold goes sideways until December. Then the Fed blunders, they have to flip to dovish probably early next year, and gold is poised for another leg up.
The short answer is that gold is nowhere near the top. I don’t think this is the beginning of a bear market or a correction. It was a one-time repricing to reflect increased expectations of Fed rate hikes. Those hikes are going to be self-defeating, the Fed is going to have to reverse course, and then gold will head up from there.
For those who are not fully allocated or haven’t invested in gold at all or are wondering if they missed the boat, this is a great entry point.
Jon: Thanks, Jim.
Alex, we’ve heard Jim’s analysis, and now I’m curious to know what signals you’re picking up directly from the gold markets themselves.
Alex: In regards to gold, I concur with Jim in that this is a short-term correction. I don’t think this in any way signals that gold is going into some kind of a new bear market. This correction is both normal and healthy. The run-up to the high this year was very fast paced, and I think sentiment needed the adjustment.
Let’s talk about some important basics here. First of all, many people focus on the US dollar price of gold, but we have to remember that gold is quoted in currency pairs in many currencies globally, not just the US dollar. For example, there is Indian rupee gold or Chinese yuan gold.
These pairs show that buying power measured in government-issued currency units – in other words, dollars, etc. – is fluctuating all the time. Some of these currencies are getting stronger, and some of them are getting weaker.
So far this year of 2016, even with this correction, gold is still up 18.2% in US dollar terms. In Chinese yuan terms, it’s up 22.3%. In Indian rupee, it’s up 19.2%. In the British pound, it’s up 42.3%. Even though we’ve had a correction, I’d say that so far this year, gold still performed quite well.
In terms of gold price, there are two different terms I hear in the industry. One is “the gold price” and the other is “the price of gold.” I’d point out that the difference between the two is that “the gold price” is the price reflected of what’s happening in the futures markets, and “the price of gold” is what you actually have to pay for physical gold versus a futures contract.
Speaking specifically to the US dollar gold price, it is largely influenced in the short term by interest rates as Jim mentioned. It’s also influenced by US dollar strength and on occasion geopolitical events. For example, gold had a big boost with Brexit.
At the end of the day, there are other factors and short-term swings that are driven mostly by speculation. Over the medium- and long-term, prices are driven by the general narrative, mostly from the West, of where they think the world is heading.
Aside from strong short-term drivers in price, the physical market – which is what I pay attention to quite a bit – is largely affected by the availability and flows of physical gold and what we call the float. We’ve mentioned this before on the podcast.
The float includes, in theory, all of the above-ground gold in the world. By widely accepted measures, we’re talking some 180,000 tons or so which is basically enough to fill an Olympic-sized swimming pool.
We call this “official gold,” a lot of which is accounted for and held by central banks, etc. Quite a bit is also in the form of jewelry. In India there’s something like 22,000 tons of gold in the form of jewelry in individuals’ hands. Likewise, in China, there’s something like 10,000 tons.
Any analysis of the physical gold market that does not consider above-ground stocks that could become available for sale is leaving out a really important factor. There are substantial amounts of gold that could become available to what we call the float depending on both price movement and psychology. These are two different things that are very important.
If the price is rising, some holders of gold who bought at lower prices might be willing to sell their gold back into the market and book some gains. We can observe this by the amount of scrap that becomes available in the float when the price rises. People may sell off what some of my colleagues refer to as grandma’s gold, or old jewelry, lying around that isn’t really being used and might fetch a good price if the price is rising.
This is normal behavior when markets are stable. It’s when markets are uncertain that psychology may shift to a mindset of protection. That’s exactly what we’re seeing today because of things like the ongoing sovereign debt crisis. We have demographic trends that are worsening a collapsing tax base already. We have perpetual zero interest rates or worse. Much of the world is in negative interest rates. Some analysts and money managers are saying that we have a gigantic bond bubble going on right now of historic proportions. Some governments are now resorting to 50- and 100-year bonds.
In short, I think the psychological tone of the market is shifting towards protection. This lowers the chance that already-owned investment gold – part of the 180,000 tons I mentioned – will be made available to the float for sale, and this increases the chances of strong pressure on the physical market during periods of demand.
One really interesting thing that has occurred with this correction and I don’t recall ever seeing before is that normally, when you have corrections and pullbacks in the price, futures and spot prices should equalize with physical market flows through arbitrage.
If you think about the large gold funds around the world, some of the largest – for example, GLD – bullion banks arbitrage the amount of physical gold held in that trust based upon the price of gold, and they’re making a spread in between with that arbitrage.
Even though we’ve had a roughly $100 price correction from this year’s high, these inventories are actually growing right now. I’ve never seen this before, and I’ve been in this industry for a very long time and observed these funds ever since they were launched. I believe what this means is that the bullion banks are positioning themselves for what they think could be more demand moving forward.
There are three of what I call “demand spheres” in the physical markets, and we measure where gold is flowing around the world according to the float. The first demand sphere is the West, which is the biggest influencer. It consists of America and all of the Western financial markets that often cue off of American financial analysis. There is also China and India.
The West has been the biggest influencer on the gold price this year. There have been net inflows into gold funds in the West of over 300 tons. This is equivalent to some $12 billion-plus in US dollars.
China has been a strong buyer this year as it has for a number of years. Now they’re nearing 1000 tons. They’re off by a strong percentage of what they normally do annually, but they’re still a large factor.
India, however, is off by quite a bit. India’s gold imports this year are off by almost 60%. By this time last year, India had already brought in 658 tons of gold, whereas this year, they’re only up to 270.
What this means to me is that prices have moved impressively this year even with India being off by more than half. Remember also that it was only recently that the Chinese people were allowed by their government to buy gold at all. There was a long period of time where it was illegal for the Chinese to buy gold.
Taking a forward-looking view, the last point I would like to make is imagine what it would be like if China, India, and the West were all buying at the same time.
Jon: That’s a deep and very informative analysis, Alex. Thank you.
Let’s stay on a subject that’s clearly relevant to the future state of gold. Jim, you’ve recently been previewing your new book, The Road to Ruin. In it, you develop a theme that you wrote about in The New Case for Gold: the coming ascendancy of the IMF’s own currency, the SDR.
We’ve talked about this on the podcast several times, but my question is, in a world where the SDR begins to displace the dollar’s dominance, what happens to gold?
Jim: Thank you for mentioning the book. For the benefit of listeners, I do have a new book that will hit bookstores on November 15th. It’s called The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis. It’s available for pre-order on Amazon now and is actually number one on the charts. Amazon has all these chart subcategories one of which is for money and monetary policy. The book is still about a month away from shipping, and it’s already number one, so it’s doing very well. Thank you.
Yes, I do talk quite a bit about the future of the international monetary system and the role of SDRs. I think many of our listeners are familiar with SDRs partly because of the work we’ve done on this podcast , but just for those who might not be quite as familiar, I’ll give a brief overview.
SDR stands for Special Drawing Rights – a slightly technical name, but it’s basically world money. I’m sure the people who created it didn’t want to call it world money because that’s a little spooky, but it is world money.
It’s not complicated. The Federal Reserve can print dollars out of thin air, the European Central bank can print euros out of thin air, and the International Monetary Fund can print SDRs out of thin air. They can act like the central bank of the world, create these SDRs, hand them out to the members, and they count as reserves.
All members of the IMF – 189 counties around the world – are bound by the articles of agreement to accept SDRs the same way you would accept dollars or euros or yuan or any other reserve currencies or gold, for that matter. It’s a way to create global reserves out of thin air.
Why am I talking about this, and why am I predicting a much bigger role for the SDR sooner rather than later? The answer is that it has been eight years since the last financial crisis – nine if you want to go back to the start of it in 2007 and a little over eight years if you want to go to the most acute phase in 2008. The history of financial crises and panics over the last 30 years is that they happen every seven or eight years.
We had a one-day collapse on October 19th, 1987, when the stock market dropped over 20% in one day – not a week or a month, but one day. That would be the equivalent of a 4000-point Dow Jones Industrial Average today. In 1994, the Tequila crisis; in 1998, the Russia / Long-Term Capital Management crisis; in 2000, the dot-com meltdown; in 2007, the mortgage crisis; in 2008, Lehman / AIG. I don’t have to go through all of them.
The point is that these things happen every seven or eight years, almost if not quite like clockwork. Well, it’s been eight years since the last one. How long do you think we’re going to go before the next one hits? The answer is it could happen tomorrow, it could happen any day.
In fact, I’ve done some research. Without taking sides in politics, I expect that if Trump wins on November 8th, we might expect an immediate 10% drop in the stock market. We might see the Dow Jones go down over 1000 points in one day, just like that, because they’re priced for a Clinton victory.
If Clinton wins, then nothing happens. It doesn’t mean the stock market is going to go up 1000 points, because they’re already priced for her victory. They’re not priced for a Trump victory, and there would be an immediate repricing that could be enough to start an avalanche of selling and contagion around the world.
An event of this kind could happen anytime, but certainly in the next couple years it is highly likely.
What happened the last couple of times we had a crisis? In 1998, Wall Street got together and bailed out the hedge funds. In 2008, the central banks got together and bailed out Wall Street. Who’s going to bail out the central banks the next time?
At the beginning of the crisis in 2008, the Federal Reserve balance sheet was about $800 billion. Today it’s closer to $4 trillion. They printed over $3.2 trillion to bail out the system the last time and a lot else besides. They guaranteed every money market fund, they guaranteed every bank deposit, and they did trillions of dollars of swaps with Europe. It was massive liquidity injection by the Federal Reserve and other central banks.
If somehow the Fed managed to get its balance sheet back to $800 billion – in other words, they created all this money to solve the problem and then they made the money go away and normalized their balance sheet – I’d be the first one to say, “Hey, great job. You saved the system and got back to normal. Nice going.”
But that didn’t happen. The $4 trillion is still on the balance sheet, so what are they going to do in the next crisis? Are they going to print another $4 trillion and take their balance sheet to $8 trillion? Legally they could and they might, but in my view, they’re going to be highly constrained. They’re going to push against an invisible confidence boundary.
This is true of central banks around the world, not just the Fed. They’re going to lose the confidence of their people who rely on the currency, their national governments’ policymakers, etc. They’re not going to be able to do what they did the last time.
So where’s the money going to come from? If you have a liquidity crisis – which I expect sooner than later – and you need a liquidity injection but it cannot come from central banks because they’re tapped out, their balance sheets are stretched, where will the money come from?
The answer is it will come from the IMF in the form of these SDRs. The IMF balance sheet is not stretched; they’re only leveraged about 3-to-1. Our friends at the Fed are leveraged over 100-to-1 so there’s not even a comparison there. The IMF will print SDRs and hand them out.
The question specifically was where does this leave gold? Gold wins one of two ways. Either way gold wins, but let me be specific about that claim.
The first way is that the SDR thing works. If people really understood it, they might have objections, but the truth is that nobody understands SDRs except a few PhDs and the people on this podcast. You can see that if you print two or three or four trillion SDRs and give them to all the countries around the world as part of the reserves, that’s going to be highly inflationary because that money is going to get spent.
A lot of the money the Fed printed did not get spent. It just got handed to the banks, and the banks gave it back to the Fed in the form of excess reserves. But SDR money that goes into reserves is going to be spent by the governments still being desperate to resort to fiscal policy, so-called helicopter money, and massive government spending.
The basic theory of Keynesianism is that if people won’t spend, the government will. So right now we’re in a liquidity trap. People don’t want to spend. They want to save, pay off debt, and put the money away for a rainy day. There’s deleveraging, so the money is not getting used. But governments are very good at spending money, as we know, and in the next crisis, they will.
They’ll recognize that you can’t have a pure monetary solution. You have to have a fiscal structural solution that will ramp up government spending. We’re already hearing about this from both candidates, Clinton and Trump.
So the IMF prints out five trillion SDRs worth about $7.5 trillion. One SDR is worth a little bit less than $1.50, so it’s somewhere between $7 trillion and $7.5 trillion. They’ll hand them out, and the governments will absolutely spend it, because that’ll be their job.
All that spending and money printing will be inflationary, so gold will go up for the reasons gold always goes up in inflation, which is you’re cheapening the dollar. That means a higher dollar price for gold. Gold is the ultimate inflation hedge and always has been.
Now let’s imagine another scenario. If the SDR rescue doesn’t work and there’s a massive loss of confidence in paper money, people will say, “You know what? We lost confidence in the dollar, the euro. You want us to accept these SDRs? We’re not accepting those, either. It’s just another fiat money bailout. It’s just more money printing by a different name. I’m out of here. I don’t trust any government money. I don’t trust any fiat currency. Give me hard assets. Give me land, gold, silver, fine art, jewels, water, energy, whatever it might be. I want to get out of the money system. I’ve lost confidence.”
Well, where do people go? They go straight to gold. They could also go to silver or art or some of the other things I mentioned, but a lot of that will go to gold.
If SDRs work, it’s inflationary and gold goes up. If SDRs fail, it’s destruction of confidence and gold goes up because it’s the only thing people will have confidence in. They are different paths but they end up in the same place, which is a much higher dollar price for gold.
Just to be clear, $10,000 gold doesn’t mean that you made five times your money in real terms. You might just be breaking even, but at least you are breaking even. In other words, you’re preserving wealth because $10,000 gold doesn’t mean that gold went up five times; it means the dollar went down 80%.
I’d much rather have gold than dollars. That’s the point of having gold: to preserve wealth. It’s not a bonanza, but at least you’re the person who is preserving wealth and are as rich as you used to be or have your savings intact when everyone else around you is getting wiped out.
If the SDR rescue works, it’s inflationary; gold goes up. If it fails, there’s a loss of confidence and gold goes up because it’s the only thing people will have confidence in.
Think of it as a horse race. Picture the Kentucky Derby with horses lined up in the paddock. The horses are named Dollar, Euro, Yuan, Sterling, Gold, and SDR. These are all the forms of money. The gate opens and they’re off. They’re coming around the track. One by one, the horses stumble or drop out. At the finish line, there are only two horses left, Gold and SDR. I think Gold wins the race.
Jon: Thanks, Jim.
Alex, I know you have many questions from our listeners. Before you turn to those, how do Jim’s predictions here appear to you as a key player in the physical gold market.
Alex: I have learned over the years that Jim’s forecasts are correct far more often than not, so I personally don’t tend to second-guess him too much. As you’ve mentioned before, Jim is an advisor to our gold fund, so we take what he has to say very seriously.
Almost everything he has projected in his books, from Currency Wars to The Death of Money and The New Case for Gold, has either already come to pass or there are events unfolding that would suggest they are on track to come true.
Considering gold, one thing that’s good to keep in mind is that gold serves different roles regarding central banks and monetary policy than it does for individuals and institutional investors.
For central banks of countries besides the United States, gold is a way to hedge the US dollar, but gold is also the last line of defense for liquidity and confidence backing central-bank-issued currency.
In other words, gold’s purpose in the central bank balance sheet is different than it is for an individual investor. As far as individuals go, our view of gold’s role moving forward is that of insurance versus tail risks and systemic events that could cause lock-up in liquidity or perhaps another global financial crisis.
People need to be thinking of gold in terms of what is least likely to be impacted if the engines of finance grind to a halt. It’s interesting that this discussion has been about the IMF and the SDR, because in one of its reports, the IMF said that gold is the only asset you can buy that essentially does not have counterparty risk. That’s even up and above SDRs.
Based upon our experience so far in 2016, this is exactly what has been happening. People who have never had an interest in gold or been an investor in gold are starting to take a really hard look.
For example, just over the last 48 hours or so, I’ve talked to potential investors who are representing millions and millions of dollars of investment. They’ve never invested in gold before, and they’re now starting to take a hard look.
I keep hearing a recurring theme in their language of “protect purchasing power.” I’ve heard that at least four times in the last 48 hours alone. This is a really important change in the gold markets, because in the decade that I’ve been in this industry, most of the people involved in precious metals are what many would refer to as gold bugs. These are people who were interested in gold and investing in it way ahead of the curve.
The truth is that a very small percentage of wealth is allocated into precious metals – something like 1.5%. I have always been a believer that as soon as the other 98.5% start taking a serious look at gold, then we’re looking at some major changes, so this is a very important change to me.
With that said, we have a number of different listener questions, and these are all directed at you, Jim.
The first one is, “What effect does $4 trillion dollars worth of gold traded per day in the FX markets have on gold price?” Another question about that asks, “Is it used to control the price or maybe manipulate the price?”
Jim: The volume of trading by itself isn’t the determinant of price. Obviously, it’s the bid offer or the direction of trading or where the market price clears. But the number is important because it shows – and I’ve always found this to be true myself –that the liquidity in the gold market is very good.
Gold is a funny market. When the volume isn’t very much, most market liquidity is not good and vice versa, but gold is a market where even when volumes are low, liquidity is good, meaning you can always buy and always sell. You can’t always guarantee a price, of course, but I’ve never seen a situation where gold went no bid.
There are situations where nobody wants to buy a particular stock or bond or real estate or condo or whatever until the price goes a lot lower and the markets clear, but gold does move more like the way economists imagine markets to move, which is that there’s a bid at every level even if it’s trending down or up.
The question was, “Is there manipulation of the gold market?” The answer is absolutely yes. It doesn’t mean there’s manipulation all the time, and it doesn’t mean that every price move is manipulated.
As I explained earlier in the call, the drop – the air pocket, as they call it – from about $1360 an ounce to $1250 an ounce was not manipulated in my view. That was a fairly rational repricing in reaction to a higher expectation of a Fed rate hike, although I also explained why I think the Fed rate hike will be self-defeating and lead to dovishness, because they’re tightening at the wrong time for the wrong reasons and gold will come back up again. I don’t view that as a manipulation.
There is statistical and empirical and other evidence that shows manipulation. I’ve been involved in various ways with some class-action lawsuits and spoken to the plaintiffs’ experts as well as PhD statisticians who have done very long, ten-year and longer, studies of this. The manipulation is very clear, but it doesn’t mean that it’s manipulated all the time or every move is manipulated. As I said, the most recent one is not that difficult to explain based on market forces.
The other observation I would make is that, yes, there’s manipulation but manipulation always fails in the end. It can succeed and often does in the short run, but it always fails in the end. You just have to look at two classic cases.
Look back at the collapse of the gold pool in the 1960s when a group of the G7 countries were trying to prop up the price of gold. They agreed to pool their gold resources and be sellers if the price got high and be buyers if the price got too low.
What they ended up doing is just selling all their gold in order to support the price. It was becoming untenable, and basically it collapsed. They were trying to keep the price at $35 an ounce, and the market was demanding more and more gold. They kept selling it to try to keep a lid on the price, but it didn’t work; it failed.
Then there was gold manipulation in the late 1970s when the United States and the IMF, operating hand-in-glove, dumped 1700 tons of gold on the market. That’s a lot of gold. That failed also. The price shot up to $800 an ounce in January of 1980 when that manipulation was over.
The manipulation going on today will fail. It’s painful if you’re on the wrong side of it, but in the long run, you will be vindicated.
Someone was asking, “If you think the Fed is going to raise rates in December but then go dovish after that, should I perhaps sell my gold position right now and buy back in at a lower price in December?”
The answer is no. I said I think gold will go sideways, not necessarily down between now and December. Anything can happen; I’m not completely ruling that out, but I don’t have a scenario where gold goes down until December and then goes up again. I have a scenario where it goes sideways and then goes up after that, probably late this year or early next year.
So I wouldn’t sell into this. As I said, if anything, it’s a good entry point to buy and add to your position.
Alex: I agree with that. As far as entry points are concerned, this is in my mind a gift.
The next question is coming from one of our international listeners in HBK Bangalore. We have quite a few listeners who dial in from around the world, and some of these folks are managing money professionally.
The question is, “Will the dollar weaken against other currencies? What are your thoughts on that if Trump were to win the election?”
Jim: That’s a tough one, mainly because Trump is such a wild card. You never quite know what he’s going to say next.
I believe the dollar would weaken because Trump is a bit of a mercantilist which is sort of an 18thcentury school of international economics. He says, “Be an exporter. Don’t be an importer. Put up tariffs against imports. Try to accumulate wealth.” He said some kinds of things about gold. These are all things indicating he would favor a weaker dollar to promote exports, because that’s what mercantilists want to do. They want to promote exports and build up reserves and surpluses.
He has also been fairly strident in attacking Janet Yellen. I’m one of the most persistent critics of Janet Yellen around, but I’m not running for president, either. You can read about it in my books or hear about it on podcasts like this, but there is some serious concern that he might actually try to push her out.
The Fed is independent and the Chairman has a four-year term. Janet Yellen’s term is not up until January 2018. Legally there’s nothing Trump can do to get rid of her, but he can make her life really uncomfortable. He can make her the object of critical speeches, if not ridicule, and push her into an early resignation. That would likely be very negative for the dollar.
I don’t want to put a stake in the ground although I don’t mind giving definitive forecasts if I have a good basis for them. That’s how I feel about the Fed hiking in December. That’s a very solid analysis, and I’m willing to be fairly definitive about that. I don’t want to say that the dollar will go down if Trump wins, but I suspect that’s a likely scenario. I feel much more comfortable saying that the stock market will go down.
I can see the stock market going down 10% almost overnight if Trump wins but then consolidating and coming back. Once that immediate repricing and shock effect is over, people might say, “Wait a second. This guy is talking about cutting taxes, infrastructure spending, making America great again, and renegotiating trade deals. He might actually be good for the economy in certain ways.” Then we might see stocks start to come back.
I don’t want to get too attenuated in the forecast, so I think the immediate reaction is that stocks go down, not 30% or 40%, but just because they have to reprice for an unexpected outcome. Yes, I think you might see the dollar go down, too, and definitely the dollar price of gold should go up. There’s very little doubt about that.
Alex: I found it very interesting what you just said about Trump having a mercantilist view. We’re not talking about this for purposes of the political discussion but more so for how politics affect the financial and market aspect of things.
Trump has repeatedly accused China of devaluing their currency, which I really find intriguing, because the US is constantly devaluing its currency, and so is virtually every other central bank in the world.
My question about that to you, Jim, is do you think he’s doing that as a posturing sort of thing in preparation for future negotiations with China, or do you think he really just doesn’t understand what’s happening?
Jim: He might have an intuitive understanding. Trump is a businessman, a builder, and an entrepreneur with some success and some failure as well. It’s all pretty well documented that he has made a few turns on what you might call the Wheel of Fortune.
Having said that, I don’t think he’s an economic or monetary expert by any stretch. He does seem open to getting advice and he might just have an intuitive feel that we need a more sound form of money.
By the way, I’ve heard the same thing from Ben Bernanke and John Lipsky. John Lipsky is not as well-known, but he’s a former head of the IMF. They both told me that they viewed the international monetary system as incoherent. That was their word, not my word. This is a fancy way of saying, “You know, this is getting wobbly. There’s no anchor.”
Just think of what has happened in currency markets in the last year and a half. We don’t have to go back 20 or 30 years; just go back to the summer of 2015. We had this shock devaluation of the Chinese yuan in 2015. Then we had this complete shock revaluation, upward valuation, of the Swiss franc where the euro fell against the Swiss franc last January by 20% in one hour. Then we had the Brexit where sterling fell 14% against the dollar in about two hours. We had the flash crash in sterling last Friday, not even a week ago, where it fell about 8% in seven minutes.
Think about it. The yuan, the dollar, sterling – these are all reserve currencies; the first, second, fourth, or fifth largest economies in the world. Money is supposed to be a stable store of value, and yet it’s bouncing around to 3%, 8%, 7%, 14%, 20% in a matter of hours. That’s not money. That’s not stability. That’s a very unstable system.
In effect, Bernanke and Lipsky were saying, “We got rid of fixed exchange rates. We got rid of the gold standard. We thought we had it all figured out with these floating exchange rates. Markets could adjust. We won’t have to go through these devaluation struggles anymore. Just let the market do the work.”
The problem is that without an anchor, there’s more involved than just the market. You can have manipulation, speculators, leverage, hedge funds, exogenous shocks. There are a lot of factors all of a sudden in a world of floating exchange rates that may be transitory but knock currencies for a loop.
We have this very unstable system, and it may just be the case that Trump has an intuition that we need an anchor.
Alex: It’s really incredible as far as the lack of stability in currency values. It all comes back to this whole thing we’ve talked about before – that there’s just no longer any anchor.
Jim: We haven’t had very many normal days lately, but on a normal day, the foreign exchange market trades at the fifth decimal place. You don’t see percentage-point moves in currencies. You see 3/10,000ths of 1%. That’s how currencies normally trade, and yet all of sudden, we’re seeing full percentage points – even multiple percentage points – in a single day or even a couple of hours. These are earthquake-style moves.
Alex: We thank everyone for submitting questions and are always appreciative as we do our best to get them all answered in the time allotted. We’re going to take one more that seems to be coming up quite a bit.
As I mentioned a little while ago, the people we’ve been talking to are constantly voicing concerns over protecting their buying power. John B. wants to know if you would provide some insight as to the buying power of gold.
Jim: The buying power of gold is measured in other currencies as long as things are priced in those other currencies.
I actually foresee a day when things will be priced in gold. You’ll go to get a new car and instead of saying the car is $25,000 or $30,000 or whatever, they’ll say, “I’ll take 25 ounces of gold.” You might be able to hand over 25 ounces of gold or some kind of gold warehouse receipt or something.
That would be priced in gold, but that’s not the world we live in today. We live in a world where things are priced in some currency – dollars, obviously. I’ll be going to Australia in about ten days, and I’ll be spending Australian dollars. I’ll go to Ireland and spend euros.
The principle is how much of that other currency can you convert the gold into if you need to buy something? That’s where gold performs a lot of functions, but as a form of money, it tends to be the one that doesn’t get devalued. It tends to be the one that will preserve purchasing power.
Here’s a simple example: If a car today costs $20,000, that would be about 15 ounces of gold, give or take. If we have a bout of inflation and the same car goes to $40,000, I would expect it would still only cost you 15 ounces of gold. In other words, the gold would be worth twice as much; the gold would be worth $2500 an ounce.
There’s no way that the price of everything else is going to double and the price of gold is going to stay the same measured in dollars. Obviously, the price of gold is going to double as an answer to the inflation, at least. If not, it’ll go up in anticipation of more inflation or loss of confidence in paper money or geopolitical shocks or some other factors.
That’s what gold does: it preserves your purchasing power.
Alex: I agree wholeheartedly. It’s something we’ve been talking to people about for many years.
And that wraps up our time. Jim, I want to thank you, as always, for incredible insight and discussion here today.
Again, Jim has a new book coming out, The Road to Ruin, available for pre-order on Amazon right now. Please go check it out. With that, I am going to turn it back to you, Jon.
Jon: Thank you, Alex, and thanks for your insightful contributions today.
I also want to thank you, Jim Rickards. It’s always a pleasure and an education having you with us.
Most of all, thank you to our listeners for spending time with us today. Let me encourage you to follow Jim on Twitter. His handle is @JamesGRickards.
Goodbye for now, and we look forward to joining you again soon. Bye-bye.
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