The Boy Who Cried Gold: Time To Listen
Investors have had a rough 2016 thus far with almost all indexes crashing. I always see more opportunity on the short side than the long side due to the simple notion: there is just not enough strength to push equities and assets such as real estate higher.
The media has furiously blamed China and Saudi Arabia for their economic troubles, since as history shows everyone denies their own involvement in what has gone wrong. But is this the accurate?
If China coughs; the whole world gets sick – this is of course true in our dynamic world and economies with globalization. But investors seem to forget one critical event that happened. Undoubtedly history has showed causes asset prices to plummet and the economy to recede: the Federal Reserves rate hike.
As i outlined in my previous article (Link Here), almost everytime after a rate hike, the economy is followed by a recession. Why? Because when the Fed artificially lowers rates then artificially raises them, its intervention alters the economy.
The Austrian Economic Business Cycle Theory (ABCT), which was brought into existence by Ludwig Von Mises and built upon by Fredrich Hayek and Murray Rothbard, is absolutely the most empirically accurate and logical measure of how the Fed causes the boom and bust.
Here is an example of the ABCT:
Suppose the economy is growing steadily at 4% GDP and long term interest rates (30/yr) are at 8%. The Fed decides the economy isn’t growing fast enough and rates are higher than liked. The Fed cuts rates to 3% and reduces reserve requirements of the banks, increasing the money supply. The lower rates encourage business borrowing and expansion, especially in manufacturing and higher order goods such as construction, commodities, etc. And also consumer debt expands greatly for the citizens such as student debt and auto loans, credit card debt and mortgages, etc. The added debt and consumption spurs growth higher making GDP increase from 4% to 5.5%, and now because the corporate profits increase and the stock prices of these companies trend higher and higher, making the owner of assets wealthier (the rich get richer effect). A mania and boom is here.
But this entire boom is artificial and created with printed money and low rates and cannot last indefinitely. Eventually prices rise from the inflation caused by money printing and the added velocity of money from increased borrowing and spending. And as inflation rises so will interest rates (who would lend at 4% when inflation is at 5%? The lender loses 1% annually while assuming all the risk, thus lenders will set rates above inflation to make a real return). The sudden rise in interest rates cuts the boom short and many businesses that we’re expanding and refinancing at lower rates or from over speculative investors wallets (examples Tesla, GoDaddy, Twitter, etc – companies that don’t make profits yet) can’t sustain. Also consumers collapse under increasing debt burdens they have to service due to higher rates and while suffering simultaneously from depreciating asset values (home prices, stock prices, bond prices, land, etc). People and companies need to deleverage, also the diminished demand from the over consumption and supply from the over production of the boom years needs to find equilibrium. The economy now enters a recession, or depression depending on how much the economy boomed (the “roaring” 20’s led to and set up the bust of the 1929-1940 Great Depression – the harder the boom the worse the bust).
Conclusion: There is no free lunch in the Austrian Business Cycle Theory. An expansion of money + cutting rates will spur growth temporarily and at the cost of a future bust since it wasn’t organically grown. Artificially lowering rates creates a boom and artificially rising them creates a bust. The bust period is years of when individuals deleverage (pay off debts – example of 2008 individuals paying off their underwater mortgages), cut back on reckless spending, and mal-investments are liquidated (fire sales, auctions) that were created during the boom years.
Thus, artificially spurring growth today will come at collapsing growth in the future.
Now, for the rest of 2016 what can investors expect? I guarantee predict a recession. It bolsters my confidence knowing that prominent investor and fund manager, John Hussman, agrees.
What then can investors do? Simple: Long gold.
The thesis for gold is pronged by 3 legs:
1. Peak Gold Production: from a supply/demand fundamental view, gold is now at peak production. As gold rose for 9 years, many mines came online and current mines had expanded. But since golds collapsing price from 2011 – current, mines have had to cut back expansion, production, and even many shut down.
Mr Nesis said: “The fourth quarter last year was in my opinion the peak quarter for fresh global mine supply. … I think supply will drop by 15 to 20 per cent over the next three to four years.”
2. Record Gold Shorts: from an investors perspective, when the entire crowd is short something, they will eventually have to cover all those positions with buy backs. Thus, record shorts means record buybacks. Imagine everyone on one side of a see-saw then suddenly weight going to the opposite side. Hedgefunds have been adding to their record gold shorts all the way into the final days of 2015, this could set up a massive short squeeze in gold, and at the very least, large amounts of buybacks.
Gold didn’t “hit a low,” it was driven down by the bullion banks who are agents of the Fed, acting on the Fed’s orders…the price of gold is not determined in the market in which gold actually gets bought and sold, it’s determined in a paper futures market in which the contracts are settled in cash. – Paul Craig Roberts
3. The Fed Cutting Rates/Another Round of QE: from a U.S. citizens and global investors perspective, this is the most important. What the Fed does impacts every market and economy. The Fed has raised rates which is proving to be an ill decision – the U.S. economy is in worse shape than it has been in since 2009 and the data shows we are already in a recession. Thus the Fed will be forced to cut rates (this author believes negative rates are coming to North America in 2016) and the lower rates coupled with shock from investors that everything is far from alright as the elites have preached, gold will benefit. in fact manufacturing and exports will also benefit from a weaker dollar – currently the dollar is hovering around decade highs since investors have been Fed the mantra that “everything is healthy”, but even former Fed Chairman, Ben Bernanke, sees this strong dollar peaking; and once something peaks it only goes down. And what directly benefits from a falling dollar? Gold.
The dollar has rallied against all 16 of its major peers during the past two years on speculation that the Fed would boost borrowing costs in contrast to other major central banks that were easing policy, including the European Central Bank and Bank of Japan.
As Part I. has showed, the economy has had its rates held down for so long that now with the Fed trying to raise them, a recession and bust are imminent. And as the data is already showing, it appears the Fed misjudged its rate rise. Thus, since the Fed is data dependent and the data is miserable, i am thinking two moves ahead and that a rate cut is around the corner, followed by QE/negative rates. This is almost completely a lone view of 2016. Pure contrarian thinking.
And as Part II showed, when if the rate cut does occur, the dollar will fall in value which will consequently cause gold to rise. And as gold rises, these record shorts will be squeezed and mass buybacks will add fuel to the fire of the already rising gold price.
My content is cherry picking high quality, low P/E & low P/B, minimal/free of debt/, cash loaded gold companies that no one seems to care about – yet. Companies such as Perseus Mining (PMNXF), Teranga Gold (TGCDF), Mandalay Resources (MNDJF), and Gold Resource Corp (GORO)
Investors have heard the boy cry gold before, why should they listen now?
Well, as the reader think about this: what has the Fed done in every recession?
As an investor, especially for large gains, one would rather be early than late.
Contrarian and Austrian - Value Investing Ideas - Anti-Government Philosophy - Author.