Author: david@goldsilverdesk.com

December 3, 2020

December 3 – Alasdair Macleod:  

It is beginning to be obvious that global economic woes extend beyond covid lockdowns and that monetary inflation for the dollar, as the common foundation for other fiat currencies whose issuers face similar problems, will continue to accelerate.

Fiat currencies have only survived this long due to increased financialisation of the dollar and the US economy. Since the 1980s Wall Street has gradually dominated the US economy at the expense of Main Street. It has done so through monetary inflation, creating the conditions for the ultimate monetary collapse.

This article describes how the dollar’s collapse is likely to progress. There are two distinct aspects. The first is foreign selling, which is already becoming apparent in the weakening trade weighted index. The second is the realisation of domestic Americans that the purchasing power of their dollars will not remain stable, as the CPI suggests, but continue to decline, and that they should dispose of them sooner rather than later. There is evidence from prices of financial assets in a financialised economy that this is already beginning to happen.

Introduction

It is dawning on officials and commentators alike that the covid-19 crisis will not just go away and normality return when populations are vaccinated. The disease will be subdued, but the economic wreckage is immensely serious and long lasting. Talk of V-shaped or W-shaped recessions is increasingly being dismissed as little more than attempts to bolster consumer confidence or just wishful thinking. The damage to hospitality and retail industries is extremely serious, with bankruptcies extending to their suppliers and their supply chains as well. And it doesn’t stop with those sectors.

The global economy was already fragile, with nothing fixed by policies of extend and pretend since the Lehman crisis twelve years ago. In the advanced economies, monetary inflation has resulted in further accumulations of unproductive debt. And the greater the debt mountain, the greater the problem: modern economies have become prey to a fatal combination of profligate governments and zombie corporations managed by crony capitalists. It is a situation bound for failure, and the longer failure is put off the worse it will be…

Central to it all is an accelerating issuance of money by central banks. But the wise heads in commercial banks know they cannot be part of the solution, having already over-extended their balance sheets and are now suffering mounting bad debts. We blame the bad debts on the virus, but before the virus the global economy was already tipping into a credit-induced slump.

Have we forgotten the repo crisis, which, if nothing else, indicated that after eleven years of bank credit expansion, the banking system had run out of balance sheet capacity? Have we forgotten the trade war between the world’s two largest economies, and how that ground cross-border trade to a halt, driving exporting nations, such as Germany, into recession? And only then came the virus to deflect our attention from an already deteriorating situation.

To anyone relying on macroeconomic statistics, causes for alarm look overblown. But as Lord Canning remarked two hundred years ago, long before the modern reliance upon them, that you can prove anything with statistics — except the truth. The reality of Canning’s aphorism is set to surprise those who think GDP actually means something, and that changes in the CPI are an acceptable estimate of changes in the purchasing power of state-issued currencies.

This is the background to an acceleration of monetary inflation, which was with us long before the virus and its lockdowns. The virus merely made a deteriorating outlook even worse. As the second wave of covid-19 hits us, the full horror of the economic consequences is only now just dawning upon us. And our governments’ response can only be one: issue money without limit to stop zombie corporations from going bankrupt and to fund government deficits. Our economies are on the crumbling edge of a chasm, which without the support of increasing state intervention will fall into it. This imperative tells us that state-issued currencies are being sacrificed in a vain attempt to save us all.

Central to this sacrifice is the US dollar. As the world’s premier currency, it is the representative for all the others. If the dollar fails, the others fail. But the world’s insatiable desire for more dollars, vital for its credibility, is fading. That is the consequence of American trade protectionism and bank credit contraction replacing the previous vision of continual economic growth. All that is now history, and multinational corporations are beginning to realise it. Their need for yet more dollars is now diminishing with falling global trade prospects as America and China continue to pursue policies destructive to free trade.

International demand for dollars is reversing

In a number of recent articles, I have drawn a distinction between changes of a currency’s purchasing power emanating from the foreign exchanges and from purely domestic considerations. The motivations and reasonings of these two categories are different, and domestic users of the currency will be addressed later in this article. In the main, foreign users of the dollar are comprised of manufacturers exporting to another country including the US, businesses which will always require an element of treasury and currency management. This includes the maintenance of liquidity and the anticipation of foreign currency payments. The treasury department of a multinational corporation itself becomes a profit centre, dealing in the currencies of every country in which the corporation conducts business. And if the corporation manages its own employees’ pension fund, payment for foreign portfolio investment will usually be routed through the treasury department…

Billionaire Eric Sprott Buying

An organisation run on these lines does not take strategic positions, unlike foreign central banks and sovereign wealth funds, where politics can play a role. But it would be hard to refute the charge that as well as running a balanced position, corporate treasurers are tempted to speculate with their currency positions in order to generate extra profits. These speculations are normally in the more liquid currency and derivative markets. Nowhere is this speculation greater than in dollar exposure, where, according to the latest available figures from the US Treasury TIC system (for August) foreigners own an estimated $28.6 trillion, $22 trillion of which is invested in US long-term securities, an increase of $3.1 trillion since March. The balance is in cash and short-term Treasury and commercial bills.

Of that increase, $2.4 trillion was due to private sector foreign investors increasing their exposure to equities and equity funds, with a further $363 billion held by foreign official sources such as the Swiss National Bank and sovereign wealth funds. But adjusted for the performance of US equities, either private sector foreign-owned equities significantly underperformed the S&P500 index — up only 37% compared with 50% for the index and more for NASDAQ — or they have been net sellers.

Private sector foreigners have also reduced their holdings of Treasury stock and Agency debt by £254bn, which is hardly surprising, given ultra-low yields and the weakness of the dollar. But they have increased holdings of corporate debt, one assumes because of the attraction of higher yields, or just as likely, by investing in loans with an equity entitlement attached.

In addition to long-term financial investments, by August foreigners owned $6.6 trillion of dollar bank deposits and short-term bills, which together with the long-term investments described above totalled $28.6 trillion. This remarkable figure is about 140% of current US GDP and is easily the largest numerical displacement from national currencies into a foreign currency ever recorded.

The behavior of these foreign private sector investors is likely to determine the near-term course of financial asset prices as well as the future exchange rate for the dollar, so it is essential to look at the dollar’s prospects from their perspective.

Future trade prospects

It will shortly be dawning on foreign corporations that the counterpart to the massive increase in US budget deficits will be a broadly matching increase in the trade deficit — unless, of course, there is a substantial change in US consumer savings habits. But that is discouraged by the Keynesians in charge of economic policy, because it is only by maintaining current spending that a consumer recession can be avoided. This leaves enormous potential for foreign manufacturers to increase sales into US markets.

The other side to this benefit is a predicted increase in dollar balances in the hands of the treasury departments of non-US multinationals, already overexposed to dollars. And with interest rates close to zero, the penalty cost of selling those anticipated extra dollars for forward settlement is unusually low. It will become increasingly clear to those looking at international trade opportunities in a post-pandemic trading environment that international markets will be flooded with more dollars, and that the wise course would be to sell them for forward settlement ahead of the event.

The dollar is already hitting three-year lows, as Figure 1 shows. And if there is a glut of anything in the foreign exchanges, it is of dollars.

State actors view the situation differently, and most of them are pro-dollar, maintaining them as the core of their foreign currency reserves. The exceptions are found in Asia, with China pushing for her yuan to be more accepted for international trade settlement. But having had little alternative China itself has maintained large dollar reserves. Russia, which earns dollars through energy exports has been pursuing a policy of adding to its gold reserves at the expense of dollars. Iran has been frozen out of dollars. With the exception of India — which is fence-sitting with not enough gold at the state level and with a history of strongly pro-Keynesian economic policies — the Shanghai Cooperation Organisation, its associate and observer members, are firmly in China’s camp with a growing preference for gold and yuan for their foreign reserves.

While the dollar still dominates international trade settlement, the Asian tide is turning against it. The big dollar earners, and therefore funders of US Government debt, are based in the region. In particular, China has changed her approach from exporting to America to placing a greater emphasis on encouraging her consumers to consume. In doing so, she has changed her currency intervention policy, allowing the yuan to rise against the dollar. At the same time, she has sold dollars for stockpiles of raw and industrial metals, sending a clear signal where her preferences lie, and that she is a further seller of dollars and dollar bonds.

China is emerging as the new key player in an American hegemonic world, deserting the dollar and dollar denominated debt while the rest of the world is awash with dollars. Couple this with the prospect of an accelerating dollar supply as the trade deficit grows, being twin to the US budget deficit, and a dollar crisis is in the making.

In certain respects, the dollar is in the same position as the Icelandic kroner in 2008. Two years before, Iceland’s trade deficit had shot up to 20% of GDP, and led by Fitch, rating agencies began to change their ratings to negative. Previously available financing became more expensive. And when the Lehman crisis hit, global economic confidence in Iceland evaporated and banks, attempting to preserve their own balances sheets and liquidity, suddenly attempted to withdraw their exposure to Iceland.

Iceland’s three major banks were massively overextended, having balance sheet assets about ten times Iceland’s GDP. Even though their balance sheets were denominated in króna, their funding was predominantly in foreign currencies, and it was the withdrawal of this funding that collapsed the banks and the króna. Today, US funding is denominated in dollars, but since America began to rely on the maintenance of its balance of payments (i.e. trade deficits covered by inward foreign investment), like Iceland before the Lehman crisis funding it has become dependent on foreign investment.

As well as this underlying fragility for the dollar, there can be little doubt that current economic conditions are adding to the problems of foreign and domestic banks operating in dollar markets, and that a periodic crisis from a contraction of bank credit is overdue. If liquidity injections by the Fed into the repo market in September 2019 had not rescued banks from an impending liquidity crisis, a banking crisis would almost certainly be upon us by now. But since then, the situation has worsened considerably, requiring the Fed to dramatically expand its balance sheet to create extra bank reserves.

Just as Fitch rang the bell on Iceland’s crisis, one wonders at what point rating agencies will realise that the US trade deficit is now rapidly expanding and downgrade the US economic outlook. The figures are stark: the budget deficit for 2020 was estimated at $3.3 trillion — about 17% of GDP. Given there is a timing lag between the inflationary funding of a budget deficit and its re-emergence as a trade deficit, the trend emerging in the St Louis. FRED chart below is only a start.

It will shortly become clear that official estimates that the US Government’s funding deficit will stabilise later in the current fiscal year are wide of the mark. The Congressional Budget Office estimated the current 2021 fiscal deficit will be $1.81 trillion before the second coronavirus wave. That will almost certainly be a considerable underestimate. It must be admitted that other major currencies face similar problems from rapidly escalating budget deficits, but it is with dollars that the greatest imbalances lie.

To the current estimates of foreign ownership of dollars must be added the bulk of trade deficits yet to percolate through from last year’s fiscal deficit and all of the current fiscal year. The danger is that corporate treasurers in non-US multinationals will wake up to this overload of dollars at the same time and act accordingly — just as the international banks did following the Lehman Crisis with Iceland. (The krona crashed from the official peg, at 131 to the euro on 7 October 2008, to 340 in about a month.)

For now, it is inconceivable to forex traders that the dollar could suffer such a fall. Yet, the dynamics are there for them to wake up one morning and turn from complacency to panic. Whether a panic will happen out of the blue or triggered by systemic failures in payment or production chains, we shall only know in due course. For now, we can only know that a cliff edge exists.

The domestic outlook

As noted above, domestic consumers’ motivations are very different from those of actors in the foreign exchanges. After putting aside savings — today almost entirely comprised of mandated contributions into pensions schemes and insurance policies — they maintain a balance between liquidity available for spending and the purchase of goods. Changes in this balance by the population as a whole have a profound impact on prices.

Since 23 March, when the Fed’s monetary expansion was reset into hyperdrive, the sum of cash, checking and savings accounts at the banks held by domestic residents increased by just under 20% to $17.4 trillion at end-September. These balances are split between corporates and individuals, financial and non-financials, residents and foreigners. While the amounts that ended up in domestic consumers’ hands and their bank accounts cannot be known, the fact that the first stimulus included a direct cash injection into every adult’s bank account of $1200 adds to their cash balances relative to their purchases of goods. But this is only one aspect of the $2.2 trillion CARES Act, which aims to help individuals and businesses cope with the pandemic’s financial consequences.

While some people will use government sourced money to pay down debt or add to their liquidity balances, this is not typical behaviour. When economic conditions worsen, of which there can now be no doubt, not only will the bulk of the inducement to consumers to spend be spent as intended, but they will also tend to reduce their liquidity balances in favour of goods. This is because deteriorating economic conditions inevitably lead to lower cash balances being maintained. If these conditions persist, further reductions in the ratio of dollar liquidity to goods commonly purchased will simply undermine the purchasing power of the dollar to the point where it is no longer used as a medium of exchange.

These conditions are set to persist and develop with no prospect of an offsetting and sustained demand for dollars from foreign sources. Even before all the CARES Act funds have been spent, a further package is expected, to be paid for again by monetary inflation. It is quite possible that a further contribution to consumers’ bank balances will end up accelerating the disposal of money for goods, not only undermining the dollar’s purchasing power at a greater pace than the monetary expansion would suggest is reasonable, but it will intensify the feedback loops which make the inflationary degeneration almost impossible to stop.

In a modern financial economy, the first evidence of the adjustment to lower personal cash balances is seen in the increased prices of financial assets, with the exception of fixed interest bonds. Cryptocurrencies, equity markets, monetary metals, commodities and raw materials are all rising in price, a condition that can only occur as the result of monetary debasement. It is evidence that those that can are already dumping dollars for financial assets, which raises the question as to the effect on the dollar’s purchasing power of the next dose of monetary inflation…

Interest rates

When economic actors realise that monetary debasement is not a lone episode and will continue, a lender will take into account his estimation of the future depreciation of the money’s purchasing power up to when it is due to be repaid. This is the basis of time preference. Equally, a borrower will understand that when a loan matures its value expressed in goods will be somewhat lower, yielding a benefit to him. An understanding of this condition, whereby a fall in the currency’s purchasing power favours borrowers at the expense of savers needs no further explanation.

The conditions today add some complexity to this basic proposition. Thinking they are stimulating economic activity, central banks intervene to suppress interest rates, increasing the transfer of wealth from lenders to borrowers. The trick requires government statisticians to supress the evidence of increases in the general level of prices to allow capital to circulate between lenders and borrowers at suppressed interest rates.

Central banks have been pursuing policies of suppressing interest rates since the 1980s, when led by the Fed and the Bank of England, the US and UK economies began to be moved from a production to a financial basis. The financialisation of economic activity has had the effect of increasing the control of central banks over their economies, a power that has not been used wisely.

With that power has come a belief that monetary planning is the solution to everything. And as each policy step has failed in its objective, the suppression of interest rates has even taken them into negative nominal territory. Far from economic stimulation it has turned into a policy cul-de-sac; a brick wall beyond which no policy maker can travel. Because of financialisation, which has now made Wall Street considerably more important than Main Street, in economic terms the global interest rate structure has become so distorted that the rates at which savers will lend to borrowers no longer appear to matter. But with interest rate policies unable to suppress rates any further, they are finally beginning to rise. This is shown in Figure 2, of the benchmark US Treasury 10-year bond yield.

Rising yields for the benchmark 10-year UST is an early sign that the Fed is losing control over interest rates at the short end of the yield curve. Already, other than mandated pension and insurance funds, the only significant buyer of US Treasuries at these suppressed yields is the Fed.

The Fed is making the mistake of believing that having lowered its funds rate to zero and therefore the cost of borrowing they will stimulate economic activity. In fact, they stifle it, because no one in their right minds will lend money on terms where they are bound to lose. As this message becomes more widely understood and both domestic and foreign holders of dollars dispose of them instead of lending them, interest rates will rise irrespective of the Fed’s interest rate policies. They will need to rise to the level where economic actors feel they will be compensated for dollar debasement.

And here is the trap: raise the interest rate and government finances become completely undermined. The true cost of interest rate policies which support zombie corporations will also become apparent when they rise. Not only will inflationary funding become more expensive for all governments, not only will bad debts in the banking system suddenly emerge like a monster from the deep, but the increasing pace of transfers of wealth between the productive economy to the government and from saver to borrower will reveal how monetary inflation has hollowed out all aspects of the economy.

Faced with this prospect, the Fed will almost certainly refuse to raise rates sufficiently, and the dollar will continue to sink. But perhaps the decision will be taken from them: collapsing government bond prices will signal the game is up and the dollar, the reflection of full faith and credit in the US Government, will be on the way to extinction.

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December 05, 2020

December 5 (KWN) – Paul Wong at Sprott Asset Management:  Gold fell $102/oz (-5.42%) in November to close at $1,777, dipping below the $1,800 level and the 200-day moving average. Although there were not any significant deterioration in gold fundamentals last month, there was an unusual and dramatic shift in market expectations and positioning that impacted gold negatively.

…Though the split government result [in the US] was a welcomed outcome for the market, the stock market’s real fuel was unwinding the “crash hedges.”  The large number of crash protection hedges were unwound into a steep decay. The effect was essentially a short squeeze, forced buying into higher market prices.

Caught in the Wake of a Factor Quake

If the unwinding of the “crash hedges” was the fuel for a general market lift, then the Pfizer vaccine news was the booster rocket that ignited the reflation rotation trade. Pfizer’s vaccine news was well beyond the best-case scenario. With a 90% efficacy rate (optimistic range was 60% to 70%), vaccinations would only need to have about 60% coverage to achieve herd immunity, implying a much faster and more comprehensive recovery from COVID is now possible.

For the past five years, the market had been crowding more and more into the long duration trade (low growth, low yield, secular growth trade) until reaching extremes, such as having only five stocks comprise 24% of the weight of the S&P 500 Index, and growth versus value going parabolic. Pre-election, the market setup was extreme overcrowding in the long duration trade, severe factor crowding in quantitative funds, built-up massive crash hedges, all in a market with low liquidity and poor market depth. It was a completely one-sided trade gone wrong.

Post-election results and post-vaccine news, the market action may be best described as a “quant quake.”  Several multi-standard deviation price movements were observed, some bordering on near mathematically impossible among the factor returns. Such violent moves are a sign of a market caught well offside and in the grasp of an equally fierce short squeeze exasperated by a thin market. As funds scrambled to reposition desperately, every safe haven (bonds, cash and gold) was reduced with the proceeds redeployed toward the reflation trade. At that point, it was immaterial whether a “real reflation” event was occurring; the pain trade dominates everything and overshoots will happen as funds get squeezed. We see gold’s move from $1,950 to $1,777 as collateral damage in the flow-driven short squeeze and quant quake (Figure 1).

Gold Bullion Long-Term Secular Drivers

This sell-off in gold is its first real drop since the March lows, but gold’s macro fundamental drivers are not the cause. The short squeeze was not a sign of a macro breakdown. Money supply and the Federal Reserve (Fed) balance sheet have reached new all-time highs. From the May levels (post liquidity surge), the Fed balance sheet and M27 are still outpacing any prior COVID growth rate (Figure 2).

If we use the consensus view of $1 trillion in fiscal stimulus for 2021, this high money supply growth rate will continue in 2021. The U.S. dollar (USD), as measured by the DXY, is making new lows. A more robust global growth outlook is viewed as leading to further USD weakness. As the global recovery takes hold and resumes, the need for USD funding will decline. Real interest rates will keep falling, especially at the short end curve as the Fed has gone the AIT (average inflation targeting) route. For example, to drive home the point, if the Fed does not hike interest rates until inflation exceeds 2%, the real Fed Funds Rate will be -2%. With WAM (weighted average maturity) extension expected by the December FOMC (Federal Open Market Committee) meeting, we will likely see the long end contained and if breakevens rise, real yields as a result will fall. We already see signs of this move as shown in Figure 3.

A Revisit of the Long-Term Gold Theme and a Tale of Tails

Since the global financial crisis (GFC), the most significant risk has been solvency risk due to the extraordinary debt amounts at all levels. Pre-COVID, debt levels and leverage by any measure, far exceeded GFC levels. COVID starkly exposed the vulnerability of the financial system in quick order. In a matter of weeks this past spring, global central banks printed more than $12 trillion in liquidity, multiples of the GFC (Figure 4). The solvency risk situation is now the worst in history. As the GFC has demonstrated before, there is no real solution for solvency risk, only liquidity to delay the onset. If extraordinary amounts of liquidity could have created wealth, value or economic growth, the rewards would have been reaped during the past decade (Figure 4).

A Deflationary Feedback Cycle

The central bank response of greater liquidity and lower yields to force capital into risk assets and spur economic growth to outpace debt has not worked in the past decade. What has happened instead is almost the opposite, a deflationary feedback cycle. It goes something like this: lower yields lead to suppressed default rates and increased excessive capacity, which drive yields lower. For example, in 2020, to prevent bankruptcies (and avoid a depression), the Fed has promised the credit market a backstop for corporate issuers. The result is over $2.2 trillion of debt added to corporations thus far in 2020 alone.

Corporate debt to gross domestic product (GDP) is now the highest ever, another addition to the solvency risk bucket. Capital is now flowing into unproductive businesses and increasing excess capacity. Excess capacity is deflationary, leading to lower yields. Low yields raise investors’ need for higher-yielding junk bonds, and in turn, prop up more failing businesses resulting in additional excess capacity. The deflationary debt cycle continues.

The Bar is Being Lowered for More Extreme Risk Outcomes

There are two extreme outcomes at the end of the risk chain: a deflationary bust (the left tail) or an “inflationary blowout” (the right tail). In plain English: The tails on the far left and far right represent the least likely but most extreme outcomes. This inflationary blowout is not the common CPI (consumer price index) kind, but the debt jubilee (a clearance of debt, aka debt forgiveness or restructuring) and the extreme expansion of fiat-money-kind of blowout. The pandemic’s effects in the spring of 2020 would be an example of a massive deflationary shock and gold’s reaction to the shock was the expected response. The sudden decline in economic output spurs central banks to flood liquidity, collapse interest rates and unleash all manner of swap and credit facilities to ensure the continuation of functioning financial markets.

It is debatable whether central banks have run out of bullets, but there is little doubt that they have hit diminishing returns long ago. If the next shock occurs, it will likely exceed the COVID-level response just as the initial COVID response exceeded the GFC response. The stockpiling and compounding of legacy risks in the form of ever-greater debt levels ensure the reaction function will be greater than the last shock event. In other words, the bar is continuously being lowered for more extreme risk outcomes.

The inflationary blowout/debt jubilee/fiat money reset scenario is more challenging to envision because of its rarity (the last example was the end of Bretton Woods in the early 1970s). For the past four decades, secular deflationary forces have dominated. Due to QE’s (quantitative easing) limitations, money printed is mostly stuck in the financial system, as evidenced by the near complete collapse of the velocity of money and the ballooning of financial asset prices. Ironically, a likely scenario for the right tail risk event would be another deflationary shock that forces full-on money printing. Because of the compounding of past excesses, the zero bound and the diminishing returns on central bank liquidity injections, a debt jubilee or full-on MMT (modern monetary theory) type money printing has moved up the probability curve.  

Policymakers and the winds of social change will likely determine whether it will be a left or right tail outcome. Social change is complicated to assess, but QE’s effects (driving up asset prices to extreme levels but with a limited modest impact on the real economy) have created the most massive income and wealth disparity in history.

The vast majority of the population are in the have-not group saddled with debt but little financial assets, looking at inflated home prices while having no jobs or a subsistent employment level. From that perspective, an “inflate all away and reset it to zero” populist revolt has many historical precedents. For the minority with accumulated wealth, a “defend asset prices at all cost” would be the counter. There is not a lot of middle ground here. It is a complicated and risk-laden confluence of economics, politics, policies, social and cultural forces.

Gold Bullion: The Rare Right Tail Risk Hedge

For almost 40 years, bonds were one of the best tail hedges – deep, liquid, and the Fed liquidity function’s primary beneficiary. But with ZIRP (zero interest rate policy) and the long end under compression from Fed policy (AIT), the ability for bonds to act as a “put option” is gone. Bonds will still have a role and function as a portfolio diversifier, but its best days as an effective hedge has ceased. As a left tail hedge, it is limited due to the zero bound. Bonds cannot function as the right tail hedge; it would be the worst asset class in this scenario.

The ability to hedge the right tail scenario is very challenging, even for sophisticated funds. Under the right tail risk scenario, the economic and capital market outlook would offset hard assets’ valuation. A long volatility strategy may be useful but is limited to very sophisticated funds. A long volatility strategy would also be expensive as positive carry disappeared a decade ago. Gold is the only effective right tail hedge for the majority of funds and individuals. Gold is liquid, has no carrying cost, is easy to understand and has a long proven history against this type of tail risk that spans many centuries.

Pre-GFC, the probability of the right tail risk described above was remote at best, akin to science fiction. Post-GFC and pre-COVID, it was a possibility but rather unlikely. Post-COVID and with the entire world at the highest leverage-to-debt ever, it is now firmly possible though obscured by the sheer level of central bank liquidity. If there is another deflation shock, then the probability curve shifts higher again. The nature of this right tail risk is a significant wipeout of wealth, and history is replete with such examples. For large funds and wealthy individuals, this tail risk cannot be ignored entirely as the consequences are existential for capital preservation.  Most funds are short volatility type funds from a risk point of view and have very little if any long volatility tail protection for either of the described left or right scenarios. The surge in gold holdings is early recognition of this risk, but gold still remains well under-owned.

Gold: Right Tail Optionality, Convexity and Lower Volatility

Gold price behavior under the right tail risk scenario will be different; it will likely feature very high levels of convexity. The first will be price movement similar to what we have seen this year. The second feature will probably be heavy call option buying and the accompanying dealer gamma hedging driving prices higher (i.e., Nasdaq summer 2020 type action). The third will be volatility expansion similar to the late 1970s when realized volatility tripled.

Holding gold in a diversified portfolio has a long history of lowering overall volatility and improving efficiency. As a left tail hedge against a deflationary shock, gold has now likely surpassed bonds as well. But as a right tail hedge, there is no other asset other than gold that we believe provides right tail optionality with convexity.

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Fri, 08/07/2020 – 15:53
By Voima Gold

The spot gold price crossed $2,067 dollars per troy ounce today, another all-time high. Since the 1930s the U.S. dollar has lost 99% of its value against gold.

A world reserve currency is supposed to be superior in storing value, but through boundless money printing the U.S. dollar hasn’t been able to compete with gold by a long shot. In 1932 the gold price was $20.67 dollars per troy ounce, today it crossed $2,067 dollars.

That’s a 99% decline in value of the dollar against gold. Other reserve currencies such as the British pound and Japanese yen have done even worse. The yen has lost 99.98% of its value against gold in 100 years. Note, the chart below has a log scale.

Gold doesn’t yield, if you don’t lend it, but it’s the only globally accepted financial asset without counterparty risk. Because of its immutable properties gold sustained its role as the sun in our monetary cosmos after the gold standard was abandoned in 1971. Central banks around the world kept holding on to their gold, despite its price reaching all-time highs such as now. This is due to Gresham’s law, which states “bad money drives out good.” If the price of gold rises central banks are more inclined to hoard gold (good money) and spend currency that declines in value (bad money).

In the chart below you can see that gold’s purchasing power is remarkably stable. As the gold price rises through time it mainly compensates for fiat currencies being devalued versus goods and services. In other words, the price of gold goes up by the same amount that consumer prices rise. Gold even shows a tendency of increasing in purchasing power, which might reveal inflation numbers published by governments are too low. Another theory is that sound money, like gold, should rise in purchasing power as technological development makes goods increasingly cheaper to produce.

You might think that dollars with interest, for example U.S. government bonds (Treasuries), would have outperformed gold since the gold standard was abandoned in 1971. But this isn’t true. Gold has performed better than Treasuries.

In my view, the gold price will continue to rise and will be incorporated in a new international monetary system. The current all-time high in dollar or euro terms is just a nominal measure. When taking into account inflation gold is not at an all-time high, more importantly I’m expecting central banks to debase their currencies way more in the years ahead because the world has never been this much in debt. The debt levels around the world are completely unsustainable and can only be lowered through debt relief or inflation. The Federal Reserve and other central banks are communicating they choose inflation. A few months ago the President of the European Central Bank, Lagarde, said: “We should be happier to have a job than to have our savings protected.” That is a clear admission that (in this case) euro savings will be wiped out.

The Fed Tweets:
Jan Nieuwenhuijs@JanGold · Aug 6 The Fed is expected to make a major commitment to ramping up inflation soon

Forty People Tweeting about this…

Lowering the debt burden through inflation is “the most expedient, least well-understood, and most common big way of restructuring debts.” It has been done many times before in history (see chart below), and will be done again. Owning physical gold stored outside the banking system offers protection of your purchasing power from currency debasement.

After the Second World War the U.S. government capped interest rates at very low levels while boosting inflation. The results were deeply negative real interest rates (nominal rates minus inflation).

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October 01, 2020

Ted Butler

Butler Research

As widely telegraphed over the past week, the US Justice Department and Commodity Futures Trading Commission (along with the SEC) have settled the precious metals spoofing/manipulation case which first came into view in November 2018 with the announcement of a guilty plea by a former JPMorgan trader. The total fine of $920 million was the largest in CFTC history and the settlement included a Deferred Criminal Prosecution Agreement, the third (by my count) such agreement involving precious metals manipulation (BankAmerica and Scotiabank had previously entered into DPA’s involving precious metals manipulation).

https://www.justice.gov/opa/pr/jpmorgan-chase-co-agrees-pay-920-million-connection-schemes-defraud-precious-metals-and-us

As expected, the settlement narrowly focuses on spoofing, the illegal short term trading device and not the much more serious long term suppression of silver (and gold) prices that I claim JPMorgan has been guilty of since 2008.  As such, any claims by victims of JPMorgan’s illegal activities would have to show damage from very short term trading, a difficult and expensive undertaking. As I have explained previously, were the Justice Department and CFTC to have alleged a long term suppression of prices by JPMorgan that would have, effectively, put the bank out of business – period. Accordingly, no such finding was possible.

I’m not going to spend too much time on summarizing the case to this point, as it would be more instructive to look ahead and I believe there is plenty to anticipate as a result of the settlement. As long term subscribers might be aware, I began my focus on JPMorgan’s manipulation of silver and gold a year before I started this subscription service (in August 2009) when I discovered, via the August 2008 Bank Participation Report that JPM became the largest short seller in COMEX silver and gold as result of its takeover of Bear Stearns in March 2008. Subsequently, of the more than 1100 articles I have penned on these pages, almost all have featured and accused JPMorgan of manipulation. (I’ve sent all my articles to JPMorgan and the CFTC, as well as the CME Group).

As a result of a number of my articles around the time of the August 2008 Bank Participation Report and reader petitions, a formal 5 year investigation was initiated by the CFTC into silver manipulation, involving the DOJ and which was later reported to have focused on JPMorgan.  Although that investigation was concluded with no charges, I continued to allege that JPMorgan was manipulating the silver and gold markets.

On April 30, 2018, I called and wrote to the Public Integrity Section of the FBI, complaining that the CFTC was guilty of malfeasance in allowing JPMorgan to amass a perfect trading record in COMEX silver and gold futures, in which it never suffered a trading loss when shorting excessive amounts of metals contracts and then used its ability to suppress prices to accumulate massive amounts of physical silver and gold on the cheap. Based upon the timeline of the case and recent reporting on Bloomberg, I’m convinced my complaint prompted the Justice Department to take a closer look at JPMorgan, the first step of a process that concluded yesterday.

So while the Justice Department took a pass on going after JPMorgan on the much more serious grounds of price suppression and the accumulation of physical silver and gold at the manipulated prices it created by excessive short selling, at least it dinged JPM pretty good and, most importantly, brushed the bank back from hugging the plate (a baseball term for intimidation). While the $920 million monetary penalty is the largest in CFTC history, it’s widely acknowledged that to JPMorgan, it is no more than nickels and dimes.

The same cannot be said of the Deferred Criminal Prosecution Agreement; particularly because this is not JPMorgan’s first DPA. The only thing worse is a straight criminal prosecution, which would, effectively, put a financial institution out of business (think Arthur Anderson).  Although individual traders from JPMorgan still face criminal prosecution, that’s quite different than the bank itself being so charged. More than any amount of a monetary fine, a DPA carries serious ramifications and you can be sure that it has gotten JPM’s attention – just as it did BankAmerica/Merrill Lynch and Scotiabank, which also agreed to DPA’s for precious metals spoofing/manipulation. It’s getting to be easier to name those banks not (yet) agreeing to a DPA for spoofing.

Make no mistake, none of these banks would be so foolhardy as to knowingly violate the terms of their agreements with the Justice Department. And these agreements are not limited to spoofing; they include all manner of activities that can be considered illegal or manipulative. You can be sure that every attempt will be made at JPMorgan and the other banks, even those not charged, to remain on the up and up in precious metals for the foreseeable future. As such, this is not a big inducement to continue the decades-old COMEX manipulation. And that’s the first big takeaway.

I know the popular prevailing opinion is that JPMorgan got a wrist slap and it will soon be back to manipulating silver and gold. I would respectfully disagree. Criminal activity is not well-served when it is under close scrutiny by those capable of putting the criminals in prison or out of business. Suddenly, the landscape for continued price manipulation in silver (and gold) has gotten quite inhospitable. The old way of doing business would appear to have changed. Let me be clear in what I am saying. I think this settlement is far more significant than is widely believed.

I will acknowledge upfront that just because I have been on JPMorgan’s case like white on rice since the fall of 2008 and engaged in attempting to end the COMEX silver manipulation for more than 35 years, does it mean that my take is correct. If I turn out to be wrong, I will admit it, as and when the evidence dictates. But at this point, I believe the settlement is a seminal event in what has been a lifetime journey for me. Not just because of the settlement, but including other important factors as well, I believe the price path ahead for silver will be markedly different from the past.

In addition to confirming (at least to me) that my complaint of April 30, 2018 to the FBI was what tripped off the fresh look by the Justice Department into JPMorgan months later, I learned something important from the Bloomberg article written in advance of the just-announced settlement.

https://www.bloomberg.com/news/articles/2020-09-28/inside-the-jpm-precious-metals-desk-called-a-crime-ring-by-prosecutors

What I learned from the article was that spoofing – the entering of orders immediately canceled and intended to manipulate prices in the very short term – was a trading device developed by JPMorgan and other banks to offset the effects of High Frequency Trading (HFT) – computer to computer operations run by non-bank trading firms. I did know that the banks were the main practitioners of spoofing (due to repeated public charges), but never knew why that was so. Let’s face it, I and most of you aren’t engaged in high-speed computer to computer trading, as it has nothing to do with long term analysis and investment.

Yet, at the same time, as I described just a few days ago in the weekly review, this HFT and high-speed computer to computer trading has come to dominate not just silver and gold, but trading in all markets. I’m not excusing in any way the banks resorting to the illegal practice of spoofing to counterbalance the price-controlling influence of widespread and all-encompassing computer to computer trading, I’m just explaining that I learned something I feel is important from the Bloomberg article.

As a result, it seems to me, at a minimum, that the crackdown by the regulators on spoofing by the banks means that an important counterbalance to the all-pervasive influence of computer to computer trading has just been eliminated, or largely so, making HFT even more of a price influence than otherwise. I can’t imagine this was the Justice Department’s or CFTC’s intent, but the road to (price) perdition is paved with good intentions. It’s hard for me to see how the settlement doesn’t strengthen the influence of high-speed computer to computer trading.  What does this mean for silver and gold?

Well for starters, as I discussed on Saturday, this should increase price volatility and the magnitude of both up and down price moves. There’s little question in my mind that the sharp, near $10 price rise in silver in mid-July, followed by the more recent sharp, near $7 price selloff, reflects the growing influence of high speed computer to computer trading, aided by the forced withdrawal from spoofing by the banks. I am not necessarily putting a value judgement on this development, just trying to analyze the facts as they appear. That said, I think the price discovery process is nuts, but it is what it is.

Therefore, it seems most reasonable to expect sharper up and down moves than we’ve seen until now and position ourselves as appropriately as possible – meaning first to be mentally prepared for big down, but especially big up moves in silver. In fact, I don’t have much difficulty seeing a fairly quick up move in silver, whenever it starts, of $20 or more due to the effect of now-unencumbered high-speed computer to computer trading, coupled with silver’s spectacular fundamentals and the inevitability of an industrial user/investor rush to the physical metal.

Overarching the retreat from spoofing by the banks and the strengthening of HFT, of course, is the likely behavior of the 8 big shorts in COMEX silver and gold. While the Justice Department and CFTC will remain silent on this issue, from fear of attracting attention to the main reason for silver’s long term price suppression, the CFTC’s own data reveal a remarkable change of pattern over the past year or so in gold and more recently in silver. It’s no secret that these big shorts have suffered mightily (despite very recent relief on the latest selloff) for the first time where they have always enjoyed previous consistent success. And the big shorts have certainly appeared to have lost their previous appetite for shorting in near-unlimited quantities on rallies of late.

I am not suggesting the risk of selloffs is a thing of the past. What I am suggesting is that a confluence of forces have aligned that promise to propel silver (and gold) prices far higher than is currently imagined. While it is in the eye of the beholder as to whether the just-announced settlement between the DOJ/CFTC and JPMorgan was a wrist slap or a seminal event, I would suggest it could be both. Lost in the settlement is the fact that JPMorgan still has managed to pull off the double cross of the ages against its former big short partners in crime. In fact, its agreement with the regulators puts it in perfect position to do the one thing that would make the bank the most money possible, namely, nothing.

If JPMorgan abides by the terms of the Deferred Criminal Prosecution Agreement it has just entered into with the Justice Department and ceases to spoof or otherwise engage in manipulative trading practices, it’s hard for me to see how silver (and gold) prices don’t soon soar. In effect, the DOJ and CFTC have given JPMorgan the go-ahead to make a bloody fortune (on top of the bloody fortune it has already amassed). By not adding to shorts or engaging in spoofing to offset HFT high-speed computer to computer trading, there’s no reason prices won’t soar at some point.

I still reckon that JPMorgan or its insiders hold at least 700 million ounces of physical silver and 25 million ounces of physical gold on which more than $20 billion in open profits have accrued (despite the recent selloff). And my estimates may be too low. For instance, I claim that JPMorgan has been accumulating physical metals for some 9 years. In the case of gold, JPM’s holdings would amount to less than one percent of all the gold bullion in the world (less than a half of one percent of all the gold in the world). But seeing how long JPM has been accumulating physical metal and has, effectively, unlimited buying power, is it inconceivable that it could have accumulated, instead of less than one percent of the world’s gold bullion, less than two percent? That would give it 50 million ounces of gold. Just sayin’.

If the settlement does result in JPMorgan sitting on its hands and allowing silver and gold prices to soar, then we are about to enter a new era – quite different than the past several decades. If, however, JPMorgan and the other big shorts quickly resort to past practice, as most widely believe, and add aggressively to short positions on the next rally, then what I just opined will be wrong and I will admit as much. But it has been quite some time – more than six months since either JPM or the other big COMEX shorts have aggressively added to silver and gold shorts on the COMEX and I believe it is no coincidence that the lack of new shorting contributed mightily to what were the greatest price rallies in gold and silver in history. And I see no reason that, if the lack of shorting continues, even greater rallies lie ahead. 

Finally, the fact that the settlement has now been finalized and widely publicized means that more observers, not less, are now at least somewhat aware that JPMorgan and other banks have engaged in illegal trading activities in COMEX silver and gold. With that greater awareness comes a greater sensitivity to suspicions or allegations of additional illegal activities in the future. Certainly, if JPMorgan (or the big 8) adds aggressively to short positions on the next rally, in addition to admitting that my premise about the future was wrong, you can be sure that I will do everything in my power to convince the regulators to get after these sleazy crooks and SOBs. Count on it.

Ted Butler

October 1, 2020

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Anna Golubova
Friday October 02, 2020

There is a lot of confusion in the marketplace after U.S. President Donald Trump tested positive for coronavirus. Still, analysts remain bullish on gold next week, aside from a few caveats to watch out for.

“The Trump news trumps everything else – economic data, the stimulus package, etc.,” said Phoenix Futures and Options LLC president Kevin Grady. “Gold pulled back a bit. But with all the money out there, the yellow metal should be higher. There are a lot of speculators in the gold space right now. They are pushing the market lower.”

For now, gold seems to be stuck as it trades around the $1,900 an ounce mark, Grady told Kitco News on Friday.

The Trump’s coronavirus news should push people towards gold due to increased uncertainty, but since gold is currently trading in tandem with stocks, a lot depends on market reaction to next week’s developments, Grady explained.

“Gold and stocks are trading together. There is going to be a lot of uncertainty, and there is a risk that investors will choose to liquidate their positions just to protect themselves in case something bad happens over the weekend,” he said.

Next week will be all about watching how Trump’s illness develops and whether there is any chance the government can get the additional stimulus approved, said Kitco Metals global trading director Peter Hug.

“If the president gets really sick, you would expect that it would be positive for the metal just because of the uncertainty of the government being able to function without Trump. Offsetting that notion is the equity market, which is likely to continue weaker as people raise cash, which is negative for the metals,” said Hug. “Given what we know about Trump, will the government be able to get the stimulus package together prior to the election? The market needs it. If they don’t get, it is problematic for the equity markets and metals as well.”

It is in the interest of Republicans to get some stimulus out there to help stabilize the markets before the election, noted Hug. “If not, with a second wave coming and the economy slowing, there is going to be a downturn.”

Hug also mentioned worst-case and best-case scenarios for next week.

More serious implications for the president would be the worst-case scenario, he said. “This could potentially include liquidation in the equity market. People are already scared, so the first instinct could be to run to cash, which will hurt commodities and equities. Gold could trade down to $1,850, which is a fairly solid line. If we lose that, we could test into the low $1,800s,” Hug described.

The best-case scenario would be that Trump has symptoms but can still work. Also, if the stimulus package is passed and the equity market stabilizes. “Gold’s upside potential is a close above $1,925 and then $1,975,” Hug added.

Right now, Trump’s positive coronavirus test seems “just a bump in the road,” but the headlines from this week “raised more questions than answers,” said Walsh Trading co-director Sean Lusk.

Seasonality is also starting to play a role here, Lust added, noting that the first two weeks of October are traditionally good for gold. “Seasonally, gold will rally late this summer, sell-off post-Labor Day, re-buy in October and then correct again in November,” Lusk said. “Look for this market to be bought. Investors will come back on dips.”

There is still a lot of money just sitting on the sidelines ahead of the election, and there is a chance that gold attempts to climb back towards $1,980 in the next two weeks, Lusk added.

“We had a decent correction in gold of about $200 from its highs. Form a percentage standpoint, gold at the $1,980 an ounce level is a gain of about 30% since the start fo the year. Those are levels that will need to be recovered,” Lusk noted.

What to watch next week: U.S. VP debate, the stimulus package, and FOMC meeting minutes

With Trump in quarantine for the next two weeks, all eyes will be on the vice-presidential debate on October 7 between Vice President Mike Pence and Joe Biden’s running mate Kamala Harris, according to analysts.

“With Joe Biden riding high in the opinion polls, Kamala Harris’s job will be to prevent Pence from scoring too many points,” said ING FX strategists on Friday. “How will the dollar trade in light of these political developments? The early signs are that a big lead for the Democrats is seen as reducing the risk of a contested election, supporting risk assets and gently weighing on the dollar. Any Republican comeback could reverse this trend.”

The other big item on the agenda is the Federal Reserve’s September meeting minutes, which will also be released on Wednesday.

The message the markets will get is likely to be very similar to what Fed Chair Jerome Powell talked about during the press conference after the September’s rate announcement.

“There is little prospect of an interest rate hike in the next couple of years with officials and the FOMC’ dot plot; diagram suggesting it could be 2024 before we see an interest rate hike,” said ING chief international economist James Knightley.

Any progress on the stimulus package talks will also be carefully monitored by the markets with a potential for significant ripples in stocks and the precious metals market, ING added.

In terms of data, there is the U.S. ISM non-manufacturing PMI on Monday and jobless claims on Thursday.

By Anna Golubova

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