Jim Rickards , The Gold Chronicles June 23rd, 2016
* Full commentary and analysis on Brexit (referendum for the UK remaining in the EU or leaving it)
* In British history this will stand out as a momentous day
* Betting pools are not a good proxy for UK citizens views on Brexit, bad science
* Gold prior to vote is priced for the UK to vote to remain in the EU
* A leave vote will cause gold to skyrocket and the GPB will lose 10% overnight
* Economists have a terrible forecasting record, and there is no reason to believe their projections will play out re Brexit
* The EU is a result of 60 years of work on a political project, not an economic project
* The currency wars arent going away.
*If you wait for a panic to get your gold, you wont be able to get your gold.
* Gold is beginning to reverse flows into London, averaging 60 tons per month since Feb 2016 creating tightness in the wholesale gold market at the refinery level
* If the UK leaves the EU, Scotland will likely leave the UK and join the EU
Listen to the original audio of the podcast here
The Gold Chronicles: 6-23-2016:
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 great to be with you. Thank you.
Jon: We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Hello, Alex.
Alex: Hello, Jon. Likewise, it is great to be here.
Jon: Alex will be watching for questions that come from you, our listeners. Let me say that your questions for Jim Rickards today are more than welcome, and you may post them at any point during the interview. You’ll see a box on your screen for typing in your question. As time allows, we’ll do our best to respond to you.
Well, Jim, here we are, June 23, 2016. Back home – for me, that is, not you – it’s Brexit Day. As we speak, my fellow countrymen in the UK are deciding whether or not to leave the European Union. It’s a cliffhanger. Opinion polls have been too close to call. Voting ends in just under four hours, and as for now, we don’t know how this will turn out.
Jim, you’ve recently returned from a trip to London to promote your book, The New Case for Gold. I am sure you heard a lot about Brexit from your contacts in the financial markets there. What can you tell us? What’s your firsthand feel of the situation?
Jim: That’s right, Jon, I just got back from London on Monday night. It was a fascinating visit and a very interesting time to be there. Of course, I love London, period, so there’s never a bad time to be in London, but this was an especially interesting time for the reason you mentioned.
Brexit is a big deal. It’s not quite the Battle of Hastings or Agincourt or D-Day, but I think in British history, this will stand out as a momentous day. I’m sure most of our listeners are pretty well informed, but as a bit of background, Brexit is short for “British Exit.” This is a referendum, i.e., an up-or-down vote by the British people on whether they should remain in the European Union or leave. Those are the two camps and what the campaigns are actually called, “Remain” or “Leave.”
I had the occasion to speak to someone who is an economist. He volunteered for one of the local polling stations to be a vote counter, because I guess they were short of volunteers, and he filled me in a little bit.
Here’s the lay of the land: This is the only issue on the ballot, so it’s not a cluttered ballot. There are no other elections going on. It’s very simple – you vote ‘leave’ or ‘remain.’ The question is worded in a straightforward way.
The polls close at 10:00 PM London time which is 5:00 PM New York time. They’re using paper ballots, so they’ll take a while to count, and there are no exit polls by the government, the BBC, or the networks. I’ll come back to that in a second, because there are some privately commissioned exit polls that could play a role, but we won’t have access to those unless they’re leaked. There are no media exit polls like the kind we are used to in the US.
Depending on how it goes, which votes are counted first and the distribution, we may get results by about 10:30 tonight, New York time. Let’s call that 3:30 AM London time, if I did the math right. If the count is really close, it could be as late as breakfast time in London on Friday morning, which would be closer to 1:00 AM here, somewhere after midnight. It could be a long night. It may be faster than that, so we’ll see how it goes.
As you know, in US elections they get the votes in, but they have these exit polls. Statistically, they can compare them and make a projection long before the votes are counted. That will not be the case here. They’re going to have to count the votes. Again, if it’s lopsided, we may know by 10:00 – 11:00 tonight, New York time. If it’s close, we won’t know until after midnight our time and breakfast time in the UK.
Why is this a big deal? It’s a big deal for a number of reasons. No one has ever left the EU. This has never happened before despite all the stress in Greece, Spain, Italy, and the Euro sovereign debt crisis throughout 2010, 2011, and 2012. We don’t have to revisit all the drama around Greece, but the fact remains, nobody left and things were worked out.
This would be the first time, so we have to revisit the issue. If there’s a way out as simple as a referendum, could others leave as well? It would call into question the integrity of the entire EU.
The Europeans are – without being vulgar – I’ll just say they are extremely angry at David Cameron, the British Prime Minister, for even doing this. It was a little bit of a stunt. They had an election in the UK two years ago, and it wasn’t clear if Cameron’s party, the Tories, the conservative party, would win. They weren’t in great shape.
He said to the voters, “If you elect me, I’ll give you a referendum.” The people said, “Okay, we like that,” so Cameron and the Tories were in fact elected in a bit of a landslide. But then he was on the hook to deliver the goods.
Now we’re up to the referendum day, but people in Europe are saying, “Wait a second. Why are you playing with the future of Europe for your own electoral prospects?” It’s a good example of short-term political thinking with long-term disastrous consequences. Why are we surprised when politicians do that? That’s what they do best, which is put their own interests ahead of the interests of larger groups.
There is quite a bit of annoyance in Frankfurt, Berlin, Paris, Madrid, and elsewhere around Europe that this is even an issue, because it does open the door to more people leaving. Beyond that, there are a lot of knock-on effects. Let’s see what happens.
Right now it is really is too close to call based on all the polls. You can pick your poll. There are certainly some polls that have shown Remain ahead and other polls have shown Leave ahead. A lot of polls, particularly recent ones, are within one or two percentage points both ways all within the statistical margin of error.
As an American, I think it’s a bit easier for me to detach my analysis from any personal preference I might have. That’s always difficult to do psychologically, but being objective about it, I think the fair thing to say is this is too close to call. I don’t know what’s going to happen. David Cameron said he doesn’t know what’s going to happen and Nigel Farage and others on the Leave side have said the same thing. It truly is too close to call.
A very interesting development has taken place, which I think has the potential to rock markets. While the polls are close along the lines I’ve described, there’s another source for information. I’m referring to bettors, betting parlors, with Ladbroke’s being the most prominent. There are others including Betfair, Ladbroke’s, some are online, and some with retail locations.
The odds-makers and these betting parlors have set the odds very heavily in favor of Remain. They’ve said there’s a 75% – 80% probability that Remain will win, so they’ve given Remain bettors very short odds and long odds to people who want to bet Leave.
There’s a phenomenon called the wisdom of the crowds. This is based on a book by James Surowiecki from five years back. Excellent book, by the way. He’s a good writer who did his homework. I read the book and use it myself in my own writings.
It says that if you have a very large group of people, even though they’re not expert and may not be that well informed, if you have enough of them and ask them to express a view on something, and you average that view, that is very likely to be the most accurate estimate you can get of the outcome of some uncertainty. It does better than the experts. I’m going to spend a minute on this because it’s really important to understand and it gets right to whether you should buy gold, believe it or not.
The classic case is guess the number of jellybeans in a jellybean jar. They’ll put a big jar of jellybeans on display and invite passersby to guess how many jellybeans are in the jar. Some physicist or engineer will sit there and calculate the volume of a single jellybean, the height of the jar, the circumference of the jar, make allowance for the space between the jellybeans because they’re irregularly shaped, write the equations, and all that. That’s the scientific way of doing it, but that guess will usually be worse than people who just say, “Ah, I think it’s 1,000,” “I think it’s 10,000,” “I think it’s 100,” etc.
The reason for that is if you have a large enough group, some people are going to make ridiculously high guesses and some are going to make ridiculously low guesses. Most people are going to try their best without the benefit of the science.
When you aggregate them all and average them, you’ll actually get a very accurate result whereas the engineer, with all his lines of code and calculation, will make some error that throws him off a little bit. This has been proven in many, many experiments.
That’s the basic theory of the wisdom of the crowds. Large groups of everyday citizens guessing produce better results than experts expressing a single point of view. That’s good science, and that’s true.
This is a good example of the old saying, “A little learning is a dangerous thing,” which means if you’re ignorant of something and you know you’re ignorant, you can take precautions. You can say, “I just don’t know what I’m doing here, so I’m going to be careful.” Conversely, if you’re genuinely an expert and confident in your expertise, you can use that accordingly. There’s nothing more dangerous than the person who thinks he’s an expert but isn’t really and goes ahead with great confidence and makes a blunder. That’s a pretty good description of the Federal Reserve. It’s a very, very problematic situation.
What has happened here, as best as I can tell, is that people take this wisdom of the crowds concept, this idea that somehow an average of a bunch of people acting together is better than any expert view, and they’ve applied it the wrong way. They’ve applied it to betting odds as opposed to the polls. The polls tell us it’s too close to call, but they’re looking at these 70% – 80% odds in Ladbroke’s or Betfair and saying, “See, it’s clearly Remain.” The markets have now priced in Remain.
Let me just spend a minute on what’s wrong with that, why you can’t take the wisdom of the crowds science, which is good science, and apply it to betting.
Number one, you’d have to assume that the betting pool is the same as the voting pool, because in a vote, all votes are weighted equally. In betting, I can come in and bet 10,000 pounds on Remain while somebody else could come in and bet 5 pounds on Leave. They’re going to give me short odds and they’re going to give the other guy long odds, because they don’t want to be wrong.
Bookmakers are pretty smart. They don’t want to take a beating. They just want to make a little bit on the difference, so they have to balance out the odds. That’s why they’re going to give me short odds in that situation. But that doesn’t mean it’s an expression of 70% of the people voting Remain. It just means that I put down a lot more money than the other guy.
Think about that for a second. Who has big money to bet? Bankers, elites, maybe journalists, people in London, and people who clearly favor Remain. Who’s going to bet a fiver or a tenner? It’s going to be the pub owner, the everyday citizen, etc.
When you look behind the numbers, it’s interesting that there are far more bets on Leave than there are on Remain. If all the bets were weighted equally (which they are not), Leave would have 80%. That’s because the big money is on Remain and you have to shorten the odds.
In other words, the betting odds are a reflection of how betting works and how bookmakers set odds so as not to lose money, but it doesn’t mean that there’s a 70% – 80% probability that Remain wins. What they’re really saying is there’s a 70% probability that Remain gets 50.1% of the vote, because it’s a binary outcome.
Those odds are not equal to an expected vote; they’re equal to a weighted vote of a non-representative pool of bettors. Remember, bettors are not betting what the voters are doing; bettors are betting what they think the voters are doing. You’ve got all kinds of cognitive biases in there.
There is also the filter of needing money to bet. You don’t need money to vote, but you do need money to bet. The betting pool is skewed in favor of people who have money to lose whereas the everyday citizen (or subject in the UK) might not have that.
When you do these wisdom of the crowds experiments, there are no barriers to entry. Anybody can go up and guess the number of jellybeans in the jellybean jar or guess the weight of the cow at a county fair, and so forth.
I spent ten years developing prediction markets for the CIA, so this is something I know a lot about. They are enormously powerful, but they have weaknesses. It’s like a kid playing with dynamite. You have to understand how the dynamite works or else you’re going to blow yourself up. I think there’s been a misinterpretation of what these betting odds really mean.
That doesn’t mean Remain won’t win. Like I said, it’s too close to call. I don’t know what’s going to happen. It could be Remain or it could be Leave. What I do know is that the markets have taken this betting data and misinterpreted it or over-interpreted it, and they’ve priced for Remain.
Right now, markets are priced for Remain. Gold has gone down, British sterling has rallied, and stocks have rallied. There’s a whole set of market consequences that have priced themselves in expectation of Remain winning, which in turn is based on the betting odds, which, in my view, is an over- or misinterpretation of what those odds really mean.
Everyone is leaning on one side of the ship. This is a fantastic trading opportunity for those who are interested. The thing is priced for Remain. What does that mean? If Remain wins, not much is going to happen, because the markets have already priced in that result. The markets have said, “We think Remain is going to win,” so if Remain wins, it’s like, “Okay, now what do we do?”
There’s always something going on in the markets, some volatility, but gold and silver are about where they would be if Remain wins. You’re not going to get a lot of juice out of those trays if Remain wins.
On the other hand, if Leave wins, that’s an earthquake. You’re going to see pound sterling drop 10% almost instantaneously, the biggest one-day drop of any major currency at least since the Washington Accord of 1971 when they devalued the dollar by 17%. You could see that coming.
I would expect gold to super spike up 10%, again almost instantaneously. Gold mining stocks might go up 20%. We’re not here as investment advisors, but as an analyst, I would say that you’re going to see earthquake-type moves if Leave wins.
I’m looking at this and saying that the polls and everything I hear tell me it’s 50/50, but the markets have decided, for whatever reason, to price big time in one of those two outcomes. If Remain wins, nothing else happens, but if Leave wins, look out below.
The markets never close, so sometime late tonight London and New York will be closed. Actually, London will just be getting ready to open and Asia will be open. Gold and currencies – these things trade 24 hours a day, so we’re not going to have to wait until Friday morning in New York time to see the impact of this. If Leave wins, that earthquake is going to start in Tokyo and rumble around the world.
This would give us the potential for contagion, which means, as the saying goes, what happens in Britain doesn’t stay in Britain. Why should a currency move 10% in one day? That is what’s going to happen if Leave wins. There’s no good reason for that, so it just shows you how unstable the monetary system is. There’s no anchor, there’s no gold standard, and there’s no fixed exchange rate. It’s just jump all, so sterling goes down 10%.
When things like that happen, somebody goes out of business. I’ve seen it too many times where somebody’s on the wrong side of the trade. Some hedge fund will fail, some dealer will close his doors, some house will close, as they say in the UK. Then the counterparties will say, “Where does that leave me?” Everyone is going to want their money back.
I’m not predicting this, but I’m saying you have the makings of a global liquidity crisis where the central banks are going to have to step in. It could start to look like 2008 although be uncertain whether it will go all the way, whether they will snuff it, or whether it will even happen.
I do agree if Remain wins, not much will happen, because it’s already priced in. Basically, you’re looking at a coin toss: 50/50, Leave/Remain. If it’s heads, not much happens, but if it’s tails, we could be looking at instantaneous 2008. That is a crazy situation. Thank you, Prime Minister Cameron.
I bought some gold the other day because, well, I like it anyway. I like it at this level. If Remain wins, not much happens to the price of gold, but I like my position. If Leave wins, I could make $100 an ounce in a heartbeat.
It’s a very volatile, very unstable, very interesting situation with a lot of stuff behind it, a lot of drama. Put the coffee on, stay up late, folks, because it’s going to be an interesting 24 hours.
Jon: Thanks, Jim. In a way, that clarifies an understanding about the gold situation. There’s just one thing about the gold part I don’t quite understand, which is with all the uncertainty and this toss-up situation, wouldn’t we expect the price of gold to have risen somewhat? Do the betting odds alone account for this slight depression in the price of gold? It seems a little strange to me.
Jim: As far as I can tell, yes. We all know that gold has been on a roll since late last year. It’s the best-performing asset of 2016. But we have evidence; it’s not just guesswork. The middle of last week, around June 15th, polls were showing a pretty healthy lead for Leave. It wasn’t a slam dunk, but the polls were leaning Leave. People seemed to be trending Leave.
That’s when gold went up to $1,305 or somewhere around there. It may be a little higher than that, but it was somewhere around $1,305 and $1,310 per ounce. Then the polls shifted a little bit to Remain, and gold went down a lot. It went down $50 an ounce to around $1,260.
That tells us, in the short run anyway (this is not a long-run analysis), that gold is trading based on the market view of Leave and Remain. The only point I’m making is that the market view is based on the betting odds, which are not a reflection of the polling data.
The real odds should be 50/50 in an equally weighted contest, but because of the composition of the betting pool, wishful thinking, cognitive biases, the wealthy favoring Remain, the everyday UK subject favoring Leave, somebody’s 10,000-pound bet versus somebody’s 10-pound bet, and how bookies function …. you’ve got to understand all this to know what these odds really mean.
That has skewed the market. Gold right now is priced for Remain. Anything can happen, we all understand that, but the more fundamental trend, and the reason I’ve got gold going up, is going back to the Shanghai Accord, which we talked about earlier, and that is this weak dollar play.
As I’ve said before, the dollar price of gold is just the inverse of the dollar. If you expect a strong dollar, look for a lower dollar price of gold. If you expect a weak dollar, look for a higher dollar price of gold. I expect a weak dollar, because the US economy is not too far from recession. They don’t want China to break the peg. China needs help. The whole thesis of the Shanghai Accord was that the dollar and the Chinese yuan would hold hands and stick it to the yen and the euro, which would then have to be the strong currency.
I did not have sterling in the Shanghai Accord because it wasn’t that important. As I mentioned, US, China, Europe, and Japan are almost 70% of global GDP. They’re the main event. That weaker dollar, higher dollar price for gold trend, let’s call that the meta-trend, is why I like gold at these levels.
Intervening in that was a short-term down draft clearly related to the odds of Brexit and people bidding up the price of gold because of the impact of Brexit and then letting it get knocked down again, as Remain seemed to prevail based on the betting odds from Betfair and Ladbroke’s. The higher-price trend is still intact, my long-term target of $10,000 an ounce and a collapse of confidence in the international monetary system is still intact, and my intermediate and long-term higher trends are intact. I see a short-term down trend because of Brexit.
To me, it’s a better entry point. Like I say, if Remain wins and tomorrow is a non-event, I haven’t been hurt; I still like gold. But if Leave wins, you could make a ton of money in one day.
Jon: Thanks for that clarification. Let’s shift for moment from the monetary aspect of this to the economics. Apart from a few advocates of the Leave campaign, the academic economists as a community seem to have taken a pretty unanimous stance on Brexit. They predict nothing but trouble from the UK leaving the European Union. Do you share that pessimism, economically?
Jim: You’re right, Jon. Just to summarize, mainstream economists (the MIT, Oxford, Cambridge, Polytech crowd) have described what will happen to the UK as a result of Leave as a cross between the Great London Fire of 1666 and the invasion by William the Conqueror. Yes, it’s the worst thing that’s happened in the history of the UK.
My retort to that is, can someone please tell me the last time economists were right about anything? If we could all raise our hands at once, I would love someone to raise his or her hand and tell me the last time an economist was right about anything.
I don’t put much weight on what economists say because, as we’ve said before in prior podcasts, they’re working with obsolete models. They don’t understand the dynamics of risk, of markets, and of economics, for that matter. That’s why they’ve been wrong about the impact of QE1, QE2, QE3, operation twist, currency wars, negative interest rates, and economic forecasts. They’ve been wrong about everything by orders of magnitude for about ten years.
They missed the crisis in 2008 and they missed the crisis in 1998. They’ve missed everything. They get every forecast wrong and every policy prescription wrong, so why should we believe them about Brexit? That’s one answer.
Another answer is there is a problem here. If they leave, sterling is really on its own. I said it would instantaneously go down 10% because the markets have, I think, mispriced the risk of leaving. Beyond that, or even if it remains and sterling stays where it is, I would expect it to go lower for other reasons.
This has to do with the UK’s lack of gold. They don’t have much gold. As our listeners know, the UK sold over half their gold at 45-year low prices, about $200 an ounce, in a series of auctions between 1999 and 2001. However, they are in the European Union.
They could probably join the euro on an emergency or expedited basis if they wanted to, if they needed to, if there was some collapse in confidence in sterling. Europe has 10,000 tons of gold and is a big, fat lifeboat. Think of sterling as the Titanic about to hit an iceberg. If the UK needed to hop in a lifeboat, Europe’s got a lifeboat with 10,000 tons of gold in it. But if they leave the European Union, they give up that option.
I wrote an op-ed published today in a publication called The Daily Reckoning. It said there are two things that might make sense: leaving and buying gold, or remaining and joining the euro. They make sense in different ways.
The one thing that doesn’t make sense is remaining and staying on sterling, or leaving and not buying gold. Of the two, leaving and not buying gold leaves them the most vulnerable because there is no anchor, nothing to back up their monetary position. There are dangers in leaving, not necessarily the dangers the economists are talking about, but other dangers they are not talking about. There will be some immediate impacts.
As mentioned earlier, I was just in London where I heard a lot of stories on the ground that you don’t get on websites, podcasts, and things like that, except for this podcast, because we tell it like it is. What I heard was that bank CEOs and managers issued memos to their staff basically telling them they have to vote Remain, their job depends on it. If Leave wins, there will be massive layoffs. They more or less threatened their own employees to vote Remain. Again, I’ll avoid vulgarity, but one guy said, “To heck with it, I’m voting Leave.” He had been threatened by memos from the boss but was going to vote Leave anyway.
As a quick aside, I did not meet anyone in London who was voting Remain. I talked to taxi drivers, shopkeepers, media people, and everyday citizens. That’s not scientific, not a poll, but it’s anecdotal. I understand that, but I was kind of struck by that. I was like, “Isn’t there one person here for Remain?”
The Remain crowd are the elites. A lot of these threats are coming from CEOs more worried about the interest of the bank than the interest of the employees. Let’s see if the layoffs actually materialize, but they might. People have announced contingency plans to relocate to Dublin, Edinburgh, Paris, but not so much Berlin. It’s funny, nobody wants to go to Germany, but they don’t mind going to Paris.
The point is, it’s not clear how much of those are just threats to get people to vote Remain and how much of that will actually play out. This remains to be seen, but it’s a big deal either way. I’m not going to make light of it. The thing I’m most focused on is the markets and how basically a 50/50 bet have all leaned to one side. That sets up a very interesting dynamic if they’re wrong.
Jon: Can I ask you one broader question? Does this drama around the Brexit bring to light a fundamental problem in the European structure – monetary union with the euro without having fiscal union? There are all these different governments with their own spending and taxation systems. That issue has never been resolved. Is this bringing that issue more to the fore in your mind?
Jim: It is in a different way. First of all – and I’ve said this repeatedly, but it doesn’t seem to sink in – the European Union as it exists today is the result of 60 years, 60 years, of progress in this direction starting with the European Coal and Steel community, the European pre-trade area, the EC (European Community), finally the EU, the Maastricht Treaty, and the European Central Bank.
This is all incremental and has huge economic implications. It has always been a political project, but it has never been an economic project. It is leading to a United States of Europe, something no expert really denies.
That’s one of the criticisms of the Leave camp. You hear it from Nigel Farage, Boris Johnson, and others that it is leading to a United States of Europe of which UK does not want to be a part. That’s really one of the main arguments for Leave.
The UK has this kind of convenient, halfway position, “Well, we’ll join the EU, but we won’t go to the euro. We’ll keep sterling and we’ll keep the Bank of England. We won’t do this but we will do that.” Europe is kind of sick of it, by the way. They’re like, “Hey, are you guys in or out?”
They’re asking the same question that the British voters are asking today, which is, “Are we in or out?” The answer is, they’ve always been halfway. One thing where David Cameron is being a little disingenuous is if Remain wins, the next logical step is to join the euro. They haven’t told the voters that, so it’s a little bit of dishonesty there.
Getting back to the Continent, you’re right; they have a combined monetary policy but they don’t have a combined fiscal policy. But guess what? They’re working on a combined fiscal policy. They just came up with a unified bank regulation and unified bank insurance scheme. The banking system is now more integrated than ever.
What does that mean? It means that if an Italian bank is failing, depositors, to the extent they’re insured, are going to get bailed in. You’re going to lose your money, or part of it, as is happening in Greece and Cyprus, but to the extent you’re insured, that insurance fund is backed up by the combined resources of all the countries in the European Monetary Zone. That’s not fiscal policy; it’s regulatory policy, but it’s not monetary policy. Good luck if you’re not insured or over the insured limit.
It’s an example of the kind of integration I expect within three or four years when they’ll have euro bonds. When I say “euro bonds,” I don’t mean the old dollar-denominated bonds issued in Europe. I mean bonds denominated in euros backed by the full faith and credit of the European Monetary Zone members led by Germany.
Germany knows this is coming, so they want to impose high standards. In other words, they’re saying to Greece and Spain, “We’re not going to backstop bonds unless you guys get your act together. Show us balanced budgets. Show us sustainable fiscal paths. Show us deficits below 3%, debt-to-GDP ratio below 60% or, if above that, trending in that direction. Show us all of that, lock it in, and then we’ll step up and have euro bonds backed by the full faith and credit of the European Monetary Zone.”
At that point, if everyone’s playing by the same rules, you basically might as well have a central European Ministry of Finance. If you’re all subject to the same budget constraints and debt-to-GDP ratio constraints, then why not have a unified finance ministry?
You can see it coming. That’s definitely where Europe is going. The UK is going to have to come along too, unless they hop off the bus today. It’s a big deal, but it does raise all those issues and is exactly why they’re not saying this publicly. They can’t. But the Europeans are livid with Cameron for putting all this in play. As the saying from that old movie goes, “Cameron has tampered with the primal forces.” This thing may spin out of control.
Jon: Speaking of primal forces, I have one last question that you’ve touched on already. Would you expand briefly on what the implications might be for the currency wars with either Remain or Leave?
Jim: I guess what I’m asking myself now, because I try to update my analysis, is whether currency wars are going nuclear. The currency wars are not going away. I say that because it’s the only thing that kind of works in the short run for a given country. It definitely does not work in the long run.
Currency wars don’t do anything for global growth. Cheapening your currency is not a sustainable policy option. However, in the short run, cheapening a currency can give you a little lift in exports. It can import a little bit of inflation and help nudge you towards your inflation targets in the very short run.
In the long run, you don’t get sustainable higher exports. You don’t get more jobs, because you import too much inflation. Inflation overwhelms the real benefits of the other things.
More to the point, other countries retaliate. They’re say, “Hey, we’re watching.” Japan is a classic example. The yen has been getting a lot stronger. It’s come up from 1.25 to the dollar to about 1.04 to the dollar. That’s more than 20% increase relative to the dollar in a little over a year with a lot of that just in the past month or so.
The yen is strengthening, and everyone is running around and saying, “Wait a second, you have to intervene. You have to cheapen the yen. Japan’s economy is a mess. They’ve got too much deflation, and we need a cheap yen.”
Yes, you might like it, but you can’t get it. They had it for three years, and they blew it. Japan had a cheap yen from 2013 to 2016. They had the opportunity but did nothing. They did no structural reforms, no real significant fiscal stimulus.
They could have opened up immigration from the Philippines, empowered women, or they could have reformed their retail distribution network. They didn’t do any of those things. They just relied on cheap currency.
Now the G7, the G20, and Jack Lew are saying, “Sorry, you had three years and you blew it. Now we’re going to stick it to you. Now you’re going to have a strong yen.” All these analysts running around waiting for intervention shouldn’t hold their breath. Japan has been told that they cannot cheapen the yen. That was the Shanghai Accord, February 26, 2016, Shanghai, China, G20 at the Central Bank Finance Ministry Summit on the sidelines. That’s what happened there.
The currency wars are alive and well. When I say, “go nuclear,” sterling drops 10% in on day, which I expect to happen if Leave wins. I’m saying it’s a coin toss, but if Leave wins, boom, what is that? That’s currency wars on steroids. At some point, the system spins out of control and investors throw up their hands and say, “You know what? I’m out of here. I don’t know what’s happening with sterling, dollars, yen, or yuan. I don’t want to know. Get me some physical gold. That’s money. Put it in a safe place. Go to the sidelines and just let this thing take its course.”
It’s happening already and is why gold has been on a strong run so far this year because of efforts to weaken the dollar. It’s diminishing confidence in Central Bank money. It’s happening anyway but that could accelerate.
My advice to investors is what are you waiting for? Get your physical gold now. Put it in safe, non-bank storage. Sit tight. It’ll do fine. Why are you waiting for the panic to make your move when you’ll find that you won’t be able to get gold.
We haven’t really talked much about my visit to Switzerland. I was in Zurich, Paris, and London over a ten-day period. I spent as much time in Switzerland as I did in London and heard some stories there straight from the horse’s mouth and people directly involved in the business that would make your hair stand on end. I will mention two briefly.
One is the big refiners are all located in Switzerland. There’s PAMP, Valcambi, Argor-Heraeus, and a number of others. One of them cannot source doré. For the audience’s benefit, doré are gold bars that come straight from the mines. It’s not pure gold but about 80% gold.
Refiners take the 80% gold bars and refine them into 99.99% gold bars of a different size as the market demands. They take one kind of gold and turn it into another kind of gold of greater purity.
This one refiner can’t get doré, which means the mines can’t give him gold. That’s how short the supply is. They have a waiting list of buyers and cannot fill all the demand from the buyers. There are shortages on the supply side.
How do you reconcile that? Well, economics 101 says a higher price is how you reconcile it. A higher price will draw more scrap. Scrap is bracelet, necklaces, jewelry from housewives and folks around the world. You’re going to have to raise the price to get people to part with their earrings, so to speak. That’s one way to do it.
The other source of gold in Switzerland has been gold coming from London vaults, so-called good delivery bars, 400-ounce bars. Swiss refiners have three sources: good delivery bars from London, scrap from everywhere, and doré from mines. Doré and 400-ounce bars are starting to dry up. Guess what? They’re flowing back to London, because GLD – the main gold ETF – keeps their gold in London. They’ve got to get the bars.
Gold has been flowing from west to east. We’ve heard that hundreds of times, that’s true. For years, gold has been flowing from west to east and is still flowing to the east. It’s slowed down a little bit, but it’s still flowing to the east. The east is not disgorging their gold. There’s no gold coming out of China. Talk to a refiner in Switzerland. He’s never seen a gold bar from China. They’re just not letting go of it.
Meanwhile, it’s starting to go the west again. Not coming out of the west, but going to the west. Where is that gold coming from? Some of it’s coming from scrap, but that’s going to be at much higher prices. Some of it’s coming from Dubai. Dubai has kind of stepped in as an emergency oxygen supply, but there’s not that much in Dubai.
I talked to a dealer in London who pulled a four nines (99.99% percent pure) gold 1-kilo bar out of his pocket and handed it to me. It’s about a $45,000 piece. I passed it around and said, “That’s really cool.” He leaned over and said, “Jim, you know, for a couple million dollars” – I didn’t have a couple million on me – “you could buy every 1-kilo bar in the UK.”
I said, “You’re kidding.” He said, “No, there aren’t that many. I’ve got some, and other people have some, but it’s all been shipped to China. You’ve got one in your hand right now. For a couple million bucks, you could buy every 1-kilo bar in the UK.”
I certainly thought the first person knew what he was talking about, but I asked someone else. The other person said, “Yeah, you’re right.” That’s how short the supply situation is.
That means only one thing. The price goes up. A shortage of supply is a vector pushing the price up. A weak dollar policy is a vector that will push the price up. If Leave wins, then forget it. It’s just going to go to the moon instantaneously. These are very interesting times in the gold world.
Jon: Thanks, Jim. That’s really some amazing and significant insight and information about gold. You mentioned your visit to Switzerland, and Alex was there. Let’s turn to Alex now for questions from our listeners. Maybe first you’d like to tell us a little bit about what you and Jim discovered there in Switzerland.
Alex: As you just mentioned, Jim and I were in Switzerland about a week or so ago. We conducted what we call a surprise inspection of Physical Gold Fund’s gold bars. I’m going to pop up a couple of pictures on the screen for you.
The one we’re looking at here is inside one of Switzerland’s most secure private vaulting facilities. You can see us holding roughly 400-ounce good delivery gold bars. This was part of what we did while we were there. There’s a close-up so you can see what those look like.
I’m not going to talk too much more about that. Essentially, we were just there to do a quick little surprise audit. As expected, everything was there and checked out properly. All the bar numbers were appropriate. We pulled a couple of bars for weighing, etc., and everything was just fine.
This whole Brexit conversation has been really fascinating. There has obviously been a ton of commentary on this particular subject from different sources, but our listeners today have been treated to a really in-depth view and analysis of what’s going on. I think our listeners definitely appreciate it.
Speaking to that, we currently have a record number of people on the webinar who have dialed in from all over the world. Many of our listeners traditionally are professional money managers, etc.
I was thinking that if the number of people on the webinar today is any kind of indication of how closely the world is paying attention to what’s going on with this Brexit situation, how does that feed into the idea that there could be a big contagion? Jim, do you have any thoughts on that?
Jim: Contagion is an interesting thing. You don’t know where it’s coming from. The mathematics are the same as the spread of a disease, so that’s why they call it contagion. It’s not just a metaphor; it actually proceeds in the same kind of exponential way. That’s the problem with contagion. You can say that someone is going to get infected, but you don’t know where.
The problem I see is that this will start in the UK if Leave wins. The two immediate impacts will be gold and sterling. But then you have to ask, “What are the knock-on effects?” The biggest supporters clearly in favor of Remain are the people of Scotland.
If the UK leaves the EU, then I would expect Scotland to leave the UK. They had their own referendum on that a year ago. They narrowly voted to remain in the UK, but that was based on the fact that the UK was in the EU.
Take the UK out of the EU, and Scotland will probably have another referendum, at which point they would leave the UK and probably join the euro. What are they going to do? Have a Scottish pound? They have no gold. I doubt England is going to give Scotland any gold.
You could have musical chairs where the UK leaves the EU, Scotland leaves the UK, and Scotland joins the euro. Who’s got the gold? Beyond that, even more short term, there’s just momentum. The whole system is set up like a row of dominoes.
I don’t know where sterling is at right this second, maybe $141, $142 or somewhere in there. If all of a sudden it gaps down to $130, that’s a 10% move, a monster move. People have stop losses at $135, but if it blows right through the stop, people have to sell. They’re out. That’s more selling that didn’t exist when it started to go down from $142 but is triggered conditionally on the market hitting $135. Then that starts asset selling, which feeds on itself.
If I’m wrong about the 10%, it just means it could be even more. Then we get margin calls, because there are leveraged players. With a margin call, I can’t sell the thing I’ve got the margin call on, because obviously that’s falling into the Grand Canyon.
The one thing I want to sell the most, I can’t sell. It goes no bid because it’s gone too far, so I’ve got to sell something else. I’ll sell the most liquid thing I have to get cash to meet the margin call on the thing that’s falling into the Grand Canyon. That could be anything. It could be Japanese stocks if I think that’s the liquid market or it could be US Treasuries if that’s a liquid market.
All of a sudden the selling pressure shows up in completely unrelated markets because people are trying to get cash to meet margin calls on things that are sinking like a stone. Then whenever it ends, they all want their money back. That’s a liquidity crisis. We don’t have the time to do the mathematics of it, but believe me, when you actually do look at the math, it’s scary stuff, recursive functions.
That’s how contagion spreads. That’s how panics start. That’s how they get out of control. That’s how they pop up in unexpected places.
It’s one of the reasons, in addition to gold, that I’ve always recommended 30% cash, because the person with 30% cash can do two things. One, you won’t lose on the cash, and two, you can go shopping in the ruins.
Alex: A quick comment before we jump into these listener questions here. We were talking a little bit about the gold flows east to west and now reversing into London. The average right now, since February, has been 60 tons a month flowing into London.
A segue data point is GLD inventory as a leading indicator. For those who are not familiar, GLD is a gold ETF trading on US exchanges. There are bullion banks that trade gold to the trust, and in exchange they get shares to sell on the market. There’s a lot of commentary around the idea that if people are putting money into GLD, then that means it’s topping.
Watching the inventory – I’m talking about the actual gold they have – if it is a leading indicator, this is a really interesting thing. They’ve added 13.37 tons since the 16th, which is 429,000 plus some change, troy ounces, and the equivalent value of $543.7 million. In other words, that means the bullion banks think Leave.
Now to our questions with the first one coming from Alex P. as a statement he wants you to comment on. “Only Parliament can officially vote to drop out of the European Union. Eighty to ninety percent of the members of Parliament are for staying in, even a huge majority of the conservatives. Does this mean the peoples’ vote is utterly meaningless?”
Jim: No. Our listener, Alex, is correct. Just voting Leave doesn’t mean they’re out of the EU the next day. That can only be an act of Parliament, and Parliament is heavily weighted for Remain.
A very good article on this has said that you would expect politicians, being politicians, to drag their feet. They’ll set up a commission to study how they’re going to leave. “How do we leave? Let’s have a two-year commission on that. We’re going to have to negotiate terms of withdrawal from the EU.” Then maybe a new government will come in and say, “It wasn’t our referendum. It was Cameron’s referendum, so forget them.”
There is this possibility of dragging it out for years and maybe not doing it at all, which would negate the vote, but at some point, people pick up pitchforks and torches and burn the place down. How often, how egregiously can you ignore popular opinion in favor of elite opinion before there is a reaction? The referendum itself is a reaction, so ignoring the results of the referendum would be even worse.
Maybe there would be a long, drawn out scenario where they’re still in the EU technically, but I would add that the markets don’t care. Markets are going to re-price as if you had left the EU tomorrow, even if you’re not or even if it’s a one- or two-year process.
Markets don’t wait around; they re-price immediately. If Leave wins the vote, markets will instantaneously re-price for Leave and then say, “Wait and see. Give us two years. Maybe we’ll re-price to Remain over the next two years if we can see that politicians are dragging their feet.” But they’re not going to wait for that.
There is a process to follow. The will of the people may not be honored in the fullness of time, but the markets don’t care. If Leave wins, the markets will instantaneously re-price for Leave.
Alex: Another question in regards to leaving has come from Anthony K. He starts out with a quick comment that says, “Thank you, Alex and Physical Gold Fund, for the greatest podcast series.” You’re welcome, and thank you for the kind words. His question is, “If the Leave camp ends up victorious, do you see a trend of euro-skeptic parties across Europe gaining popularity?”
Jim: I would not necessarily extrapolate from the UK leaving to Spain, Italy, and others leaving. The divide between the UK and the rest of Europe is unique and profound, much greater than the divide among European countries themselves even though they have different cultures, different languages, different histories, etc.
They have enough in common for some cohesiveness. They like the euro. Going back to 2011 – 2012, Nouriel Roubini, Paul Krugman, and Joe Stiglitz were running around, as they say, with their hair on fire. Greece was trying to leave, Spain was going to quit, and the euro was going to fall apart creating a northern tier and a southern tier.
I said, “Nonsense. Nobody is leaving, nobody is getting kicked out.” I was right about that. I based that in part on my travel to these countries. Everyone sits here in the United States reading The Financial Times and thinks they’re getting news from Europe. They’re not. They’re getting news from London, and people in the UK hate Europe.
You need to go to Greece or Germany or Italy. I’ve been to all those places and talked to people on the ground. One thing that struck me is that they polled the people in Greece and asked, “Do you want to reject the Germans?” to which they replied, “Yeah, we hate Germany. To heck with the Germans.”
But then they asked them, “Do you like the euro?” They said, “Yes, we like the euro.” The reason is obvious, which is for many years they were on the drachma. The government kept printing drachma and stealing their money. The euro, under German leadership, is very stable. They said, “We finally have the money that we like.”
Of course, Greece wanted it both ways. They did not want austerity, but they did want the euro. Well, you can’t have the euro unless you’re in the European Union. That’s the binding force, which the UK doesn’t have because they’re on sterling.
The second, more profound force, I believe is – and I’ve never heard this discussed, but I’m a lawyer so I’ll put my lawyer hat on – is the difference between civil law and common law. Mainland Europe has a civil law tradition going all the way back to the 6th century Code of Justinian, updated through the Napoleonic Code, through to modern legal codes.
The European approach to everything is if you need to figure something out, write a rule. If the rule doesn’t work, write another rule. If that doesn’t work, write another rule. Just keep writing rules until you figure it out. That’s codification law.
In the UK and the United States, Australia, Canada, and the Anglophone world, we have common law. We have rules and regulations, probably too many and we’re probably getting too much like Europe, but tradition allows for something called equity. Equity is a branch of law that says judges get to make things up.
Even if a strict law of contract says, “You should lose your case,” a judge looking at the case can say, “I know what the strict law of contract says, but there may have been mitigating circumstances. There’s unconscionability. There are other factors.” Judges have always had discretion to bend the rules to achieve justice or at least what a common law system sees as justice.
That’s a profound difference. The average pub keeper in Liverpool is not going to give you necessarily a dissertation on the difference between code law and common law, but intuitively they get it. They just don’t like being told what to do, but Europeans will say, “We have to tell you what to do, because that’s how we do things.”
That gap is profound and really unbridgeable unless the British simply want to give up their identity, which they don’t. I don’t see Brexit as a prelude to other countries leaving the European Union. What binds them is greater than what separates them, whereas in the case of the UK, with keeping their currency and keeping the common law, I think they’re too far apart.
Just to give a really quick example of this, when I was in Switzerland, I was out to dinner with Alex and my daughter. My drink was served, and there was a line on the glass and an official government seal on the line. I said, “What the heck is that?” It was the pour line. Some EU regulation from Brussels was telling some bartender exactly how much to pour, no more, no less.
I like going to bars where you have what I call a tall pour when the bartender gives you a little extra. I suppose some bartenders give you a little less. If you’re supposed to get a three-ounce glass of wine, you sometimes get two ounces, you sometimes get four. To me, that’s life, but I figure out the guys who give me a tall pour, and I go back.
Here was a line on the glass. I suppose you could say it wasn’t a rule; it was consumer information so I would at least know if I was going to be shortchanged. It’s an example of no end to the rules, no end to government intrusion, and that’s contrary to British culture.
I do think the Brits are different; they feel it in their bones. They kind of want to leave. It’s too close to call, but let’s get together in five hours and see what happens.
Alex: Some very good points you made there, Jim. This wraps up our time, so I want to thank you for your commentary and your time with us. Here’s to tall pours.
With that, I’m going to turn it back over to Jon.
Jon: Thank you, Alex. I’m going to underline what you said about that. When I grew up as a little boy in England in the 1950s, you’d hear people speak of going to Europe as you might speak of going to Japan. Europe was perceived as a huge, faraway place full of rather unreliable people who speak funny languages and eat strange food. I think that feeling has never really gone away even though London has become much more cosmopolitan, thank goodness, and our food has improved as a result.
Thank you, Jim, for tremendous insights. Alex and listeners, let me tell you that there’s another treat in store for you today. It’s a full day indeed. Coming up shortly on Bloomberg TV at 4:40 PM Eastern, Jim will be participating in The Great Gold Debate. That’s a special event scheduled at 4:40 PM Eastern on Bloomberg TV.
Jim will be debating Barry Ritholtz. Barry is a financial writer with a large international following, and he has a notoriously negative view of gold. You can expect some intellectual fireworks on that show. Just Google “The Great Gold Debate on Bloomberg,” and you’ll find your way there. It’s an encounter you surely won’t want to miss.
Meanwhile, our special thanks to you, Jim, on what I know has been and continues to be a very busy day for you. It’s always a pleasure and an education having you with us. Good luck in the upcoming debate on Bloomberg.
Jim: Thank you, Jon.
Jon: 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.
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