When Do You Skip Gold?

Time to Follow the Yellow Brick Road?

"You have to choose between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold."  -George Bernard Shaw

"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people."  -Fredrich August von Hayek

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” – Ernest Hemingway 

As we continue to deal with the fallout from the Great Recession (and with the help of primary campaign of Ron Paul), more and more people are rightfully questioning the status quo and asking themselves important questions. "What is money and how does our monetary system work?"  "What is fractional reserve lending?"  "What does the Federal Reserve do?"  "Should money be made available in unlimited quantities by the Fed, and who most benefits from its policies (hint: not you)?"  "Do deficits matter?"

More and more talk lately has been centered on the idea of a return to the gold standard, which many believe is clearly laid out in the Constitution.  Yes, the Founding Fathers knew the dangers of "fiat" -- money that has no intrinsic value but only has value via government regulation or law.  What we view as money is so because the government will accept only it for payment of debts.

All those and more are great questions, and Skipgold plans to address many of them in future posts.  But for now, we will stick with something a little simpler.  Mainly, why has gold been used as "money" so much in human history?  What makes gold so special compared to all the other elements on earth?

First, check out this great, short video that for some God-forsaken reason was not embeddable (at least not with my feeble computer skills).  Go ahead.  Click on that hyperlink.  I'll wait.

Okay, hopefully you found that interesting.  But even before the invention of the internet, many centuries ago Aristotle observed the basics of what good money should be.  Money should be:

• Durable: Money must stand the test of time and the elements. It must not fade, corrode, or change through time;
• Portable: Good money needs to hold a high amount of 'worth' relative to its weight and size;
• Divisible: Money should be relatively easy to separate and re-combine without affecting its fundamental characteristics. An extension of this idea is that the item should be "fungible", defined as "being freely exchangeable or replaceable, in whole or in part, for another of like nature or kind."
• Intrinsically Valuable: This value of money should be independent of any other object and contained in the money itself, starting with rarity.

There are so few materials that employ all those characteristics.  Agriculture products, diamonds, oil, artwork, etc. all come up short in one or more categories.  Unbacked paper money comes nowhere close to qualifying.  Gold does and that is why whenever it has been available it has become money.  In the same way steel, concrete and wood have been used for construction and oil has been used for energy, gold is most perfectly suited as money.  Get in a time machine with a pocket full of gold coins, and regardless of time or place in history you end up, you would be able to survive and transact.  A pocket full of Benjamin's would yield you some nice fire tinder or emergency toilet paper, and little else.

Skipgold has written much on gold since the start of the blog in 2005.  I suspect there will be much more written on this topic in the months and years ahead.  Since the fundamental problem of our economy is far too many debts and liabilities compared to the income that has to pay that back, I believe our monetary system will have to be remade at some point in our lifetimes.

QE or Not QE. Is That the Question?

Scene: Princeton University economics class taught by Ben Bernanke. After a late night of studying, a student falls asleep in class. This sent Bernanke into a tizzy and he came over and pounded on the desk, demanding an answer to a question he had just posed. The student, shaken but now awake says "I'm sorry Professor, I missed the question -- but the answer is increase the money supply..."

Despite all the models, the white papers, the academic credentials, and the sophisticated talk, all the Federal Reserve really does is print money.  That is the sum total of "quantitative easing", or QE.  Lots of people think that alone can create economic wealth, but I think that defies logic and common sense.  Didn't the Soviet Union prove that economic top-down control by a handful of elites doesn't work?  We do like our illusions.

As economic figures recently have been coming in generally weaker than expected, the calls from Wall Street for more manna from heaven have been heating up.  But does money printing work?  Can it be our economic salvation?  John Hussman writes one of the most worthwhile reads in his weekly missive, and a couple weeks ago he had this to say about QE:

Regardless of the fact that QE has had no durable economic benefits (more on that below), and does little but to repeatedly lay fresh wallpaper over the rotting edifice that is the global banking system, the main effect of QE has been to provide temporary support for the most speculative corners of the financial market after they have been pummeled…

Meanwhile, it is unwise to believe that additional rounds of QE will do much to help the economy in any event, as its primary effect is merely to drive investors into speculative investments by starving them of safer yields.

…The process stops when all speculative assets are finally priced so richly and precariously that the people holding the cash have no further incentive to chase the speculative assets, and are simply willing to hold idle, zero-interest cash balances [with the exception fo a few select investments, SkipGold is there now!].

Why does the Fed want this? Simple. Chairman Bernanke believes that by creating a bubble in speculative assets, people will "feel" wealthier and keep consuming - regardless of the fact that real incomes are stagnant and debt burdens are already intolerable, and despite the fact that there is extremely weak evidence for any such "wealth effect" in the historical record. Undoubtedly, it would be difficult for Bernanke to refrain from these reckless policies when everyone is crying "do something!" But the willingness to tolerate short-term criticism in the interest of long-term benefit is part of what separates leadership from cowardice…

Finally, the reason for doing QE through the Fed (rather than simply changing the maturity profile of the new Treasury debt) is that Wall Street - at least - believes that the Emperor is actually wearing clothes. Despite the fact that the main effect of QE is to boost speculation and release brief bursts of pent-up demand, both which immediately soften when the policies are suspended, this recurring pattern is still unclear to many investors and analysts. As long as that delusion persists, we can expect the Fed to periodically exploit it.

Ignore that the side-effect of this delusion is the misallocation of capital toward speculative assets in the belief that the Fed has set a "put option" under the markets. Forget that savings are discouraged, bad lending decisions are rescued, incentives and economic signals are distorted, and the accumulation of productive capital is disabled. We have the most creative, entrepreneurial nation on the planet, but our policy makers are intent on preventing debt restructuring and misallocating scarce capital. As a result, they continue to compromise long-term growth in favor of temporary bouts of short-term speculation.

That same speculation that has been driving the financial markets higher is also influencing the commodities market, including driving oil prices higher.  But don't expect any Presidential news conferences decrying stock speculators.

Respecting Our Elders to the Extreme

"The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed, lest Rome become bankrupt. People must again learn to work, instead of living on public assistance."

-Cicero

The wealthiest demographic in the country is the "over 65" segment.  That makes sense given they have had more years to accumulate assets and pay down debt ("net wealth" is total value of assets minus total liabilities). So I thought that this chart was particularly interesting given that the massive entitlement programs in this country acts as a transfer mechanism of wealth from the younger and working generation to those over 65 years of age.

In 1984, those over 65 years old had an average net worth roughly 10x those that were under 35 years old.  Fast forward 25 years and the elderly category has a net wealth nearly 50x those under 35.  What's worse, the youngest workers actually have lower nominal wealth, and their average real wealth dropped nearly 70% (no doubt student loans are a contributor to that).

As a side note, I found it interesting that the "under 35" segment of the population was the most likely to support the oldest presidential candidate in 2012, Ron Paul (also the only candidate who would actually make the necessary changes to get us on a sustainable fiscal path, but that's another issue).  Younger people are waking up to the fact that the buzzing sound they hear in the background is the shearing of the sheep for the wool that's being pulled over their eyes.

We need to reform the entitlement system in order to get our nations balance sheet on a sustainable path.  It also needs to be done from the perspective of fairness to the younger generation.

Apple of My Eye

“The average man doesn’t wish to be told that it
is a bull or a bear market. What he desires is to be told specifically which
particular stock to buy or sell. He wants to get something for nothing. He does
not wish to work. He doesn’t even wish to have to think.”  ~ Jesse Livermore

Johnny Appleseed, William Tell, Snow White -- these are all tales involving apples in some way.  And of course the most infamous apple of all might be the one that fell on the head of Sir Isaac Newton that led to his "discovering" of gravity (Ironically enough, though, he was a rather poor investor, losing millions in The South Sea Company mania.  "I can calculate the motions of the heavenly bodies, but not the madness of people.")

But today the only apple people care about is the company itself.  Apple Computer has almost single-handedly moved the stock market higher.  Consider that earnings for the S&P 500 in Q4 2011 grew 6.4% year-over-year.  However, if you exclude Apple, the other 499 companies combined grew just 2.2%.  Personally, I am indifferent to the stock, but I do own two Apple computers, two iPhones, and one iPad.  But great products and a great company do not necessarily make a great stock (I love my Nissan Pathfinder. Brand new fully loaded is a solid value at $37k, a steal below that, and I wouldn't touch it over $40k.  Same car, but it all depends on the value).  A short list for the...

Bull Case: given current earnings and growth estimates, the stock may be cheap.  Cash on hand is $98 billion, larger than the GDP of most countries on planet Earth.  It is one of the most innovative companies in the world, and there is probably not a company that has a more loyal customer base.

Bear Case: the chart is exhibiting the typical parabolic blow-off; the hype and mania are in overdrive and seemingly everyone loves the stock (once everyone is "in" there are no more buyers); I find it difficult to believe that Apple will be on the cutting edge of the fickle consumer electronics market for decades to come.  People will be drinking Pepsi and washing their clothes with Tide in 10 years.  Will Apple still be relevant?

Also consider this: Apple has become the largest company in the world by market capitalization, and last week Apple became larger than GE, Google, and Intel...combined.  Apple, with its handful of products, is also worth nearly 3x the value of product-deep Proctor & Gamble with sales of just 20% more.

Sorry, no prediction on the stock here.  Gun to head I'd lean a little more bearish.  With a stock price of $602.50 and a market cap of roughly $600 billion, I'm just putting up this post for posterity to see what happens with the most interesting stock in the world.

Name that Bubble

"Experience should teach us to be most on guard to protect liberty when the goverments' purposes are beneficent. Men born to freedom are naturally alert to repel invasion of their liberty by evil-minded rulers. The greatest dangers to liberty lurk in insidious encroachments by men of zeal, well meaning but without understanding."  --Justice Louis Brandeis

Despite their incompetence, our government and the Federal Reserve have been great at one thing -- promoting asset and credit bubbles.  These could not come to pass without massive deficit spending (false, unsustainable demand) and easy money policies (encouraging debt).  So we've had the Nasdaq bubble (still down over 40% from the peak 12 years ago) followed by the more painful housing bust.  And now we are on to yet another.  This one won't be as widely damaging as the housing bubble, but there will be about as many victims.

The answer?  Student loans.

The figure will almost certainly hit $1 trillion this year. After adjusting for inflation, students are borrowing twice what they did a decade ago.  Total outstanding debt has doubled in the past five years.  What explains this insatiable demand for this kind of debt?  Well, it's cheap, it's easily accessible, and it is fungible - a student can take out a loan, yet use part or all of the balance for tangential purchases like an iPad.  Unfortunately, student loans are the only debts that cannot be discharged in bankruptcy, so we are creating an entire generation of debt slaves.

To further the point, here is a great video by Peter Schiff (head of Euro Pacific Capital and former Senatorial candidate in Connecticut) discussing the good intentions of student loans gone awry:

Stocks? Still Overvalued.

"He's mad, that trusts in the tameness of a wolf, a horse's health, a boy's love, or a whor's oath."

-The Fool, King Lear 

Or the charlatans on CNBC.  As the chart shows, we've been living in a period of stock overvaluation for so long that no one recognizes real value anymore.  This is also the reason why equity returns for the past decade plus have been so dismal, and why they will likely continue to be dismal until valuations get back to reasonable levels.

Mike "Mish" Shedlock also has some excellent commentary on why stock returns will likely continue to disappoint.  The main reason?  Demographics.  The biggest holders of equities are baby boomers, and they are likely to generally be sellers of stocks to fund their retirements.  That factor is likely to be a major headwind (in addition to the current overvaluation) for stock returns in the coming decade.

The "Success" of Bernanke's Quantitative Easing

"When God desires to destroy a thing, he entrusts its destruction to the thing itself.  Every bad institution of this world ends by suicide."  -Victor Hugo

I don't know about you, but I am fired up about the Fed's next round of money-printing, also known as "Quantitative Easing", or QE-3 for short.  Investors are already anticipating it:

U.S. Index Futures Climb on Speculation Bernanke to Signal Third QE Round

Aug. 22 (Bloomberg) -- U.S. stock futures rose, signaling the Standard & Poor’s 500 Index will rebound from its biggest four-week drop since 2009, amid speculation the Federal Reserve will unveil further measures to support the economy…

“The market is expecting another round of asset purchases and it will come,” said Matthias Jasper, head of equities at WGZ Bank AG in Dusseldorf.

But I jest.  We are coming up on the one year anniversary of "QE-2".  Ben Bernanke is scheduled to speak Friday at the annual Jackson Hole event, and mention of another round of quantitative easing is being hoped for by the Fed's Wall Street allies.  For those promoting QE-3 -- you must assume that interest rates being too high are the key impediment to economic growth?  That's the story you are going with?  That interest rates are too high?  Okee-dokee.  The 10-year Treasury is very close to 2.0% and mortgage rates are dropping to fresh all-time lows.  And the Fed's answer is to implement a policy designed to further lower interest rates?  That's quite the theory.

John Hussman did a nice job last week of summarizing just how "successful" QE-2 has been, and maybe provide a glimpse of what's to come with the next round (and the next, and the next...):

Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That's a nice sentiment, but it does overlook one minor detail. QE2 didn't work.

Actually, that's not quite fair.

-The Federal Reserve was indeed successful at provoking a speculative frenzy in the financial markets, which has now been completely wiped out.

-The Fed was also successful in leveraging its balance sheet by more than 55-to-1 (more than Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or even Long-Term Capital Management ever achieved), and driving the monetary base to more than 18 cents for every dollar of GDP - a level that requires short-term interest rates to remain below about 3 basis points in order to maintain price stability ( see Charles Plosser and the 50% Contraction in the Fed's Balance Sheet ).

-The Fed was indeed successful in provoking a wave of commodity hoarding that affected global supplies and injured the poorest of the poor - particularly in developing countries.

-The Fed was successful in setting off a very predictable decline in the value of the U.S. dollar.

-The Fed was successful in punishing savers and the risk averse, and driving investors to reach for yield in risky investments that they would normally avoid were it not for the absence of yield.

-The Fed was successful in provoking those with strong balance sheets to pay down existing higher interest-rate debt, and in creating an incentive for those with weak balance sheets to issue more of it at low rates, resulting in a simultaneous deterioration of credit quality and compensation for risk in the financial system.

-The Fed was successful at boosting the trading profits of the banks that serve as primary dealers, by announcing precisely which securities it would be buying prior to Treasury auctions, and buying them on the open market a few days later from the dealers that acquired them. -

-The Fed was successful in creating a portfolio of low yielding securities that will be almost impossible to disgorge without capital losses unless the Fed holds them to maturity.

On proper reflection, the list of the Fed's successes from QE2 is nothing short of stunning.

It is beyond comprehension why anyone would wish for more of this recklessness.

Since the Fed enacted QE-2, GDP growth has been less than 1.5% annually, and the official unemployment rate has risen.  Quantitative easing is economically baseless, but in reading the bullet points above one can see why Wall Street and their media allies are such big fans.  It also exposes the rank hypocrisy of many of those who espouse "free markets" and "capitalism".  Many of them are nothing but welfare queens themselves.

 

It's a Little Late...

Wild swings in the market cause the average investor to make ill-timed decisions.  Better to stay conservative and diversified, and then sell-offs can be greeted opportunistically rather than fearfully.  When it comes to investing, think Pete Rose and Rod Carew, not Babe Ruth.  Striking out in investing means you may not get another at-bat.

When Noah started building the arc, it was sunny.  Preparing for a flood after 3 weeks of rain is an exercise in futility.

Commentary on the U.S. Downgrade

The markets worldwide got slaughtered today (actually, it's been a few weeks now).  Nearly everyone pointed to the downgrade by S&P of U.S. debt as the reason.  I think that's just a smokescreen for a much bigger fire.  And ask yourself, if the downgrade is so negative for Treasuries, why did they rally so hard today??

What ails us is far bigger than historic downgrades.

Worthwhile commentary from John Hussman today hit on more important topics, most notably this tidbit:

"Coupled with the slowdown in year-over-year GDP growth, the composite of economic and financial evidence we presently observe has always and only been associated with ongoing or immediately impending recessions. This is not an opinion or a viewpoint, but a fact of the data."

Very interesting considering everyone on Wall Street has been suggesting a second-half recovery.  We shall see.

And he also touched on the real #1 issue facing the U.S. (and global) economy: 

If there is one crucial point that should not be missed, it is this: the fundamental source of our economic challenges, from joblessness, to unresolved housing strains, to sovereign debt crises, is that our policy makers have repeatedly opted for fiscal band-aids and monetary distortions instead of addressing the core problem head-on. That core problem is simple: the careless encouragement of asset bubbles, and the refusal to restructure bad debt.

Encouraged by inappropriately easy monetary policy and lax regulatory oversight, the U.S. went on a debt-financed binge of consumption and unproductive investment that lasted nearly a decade. When that binge collapsed, policy makers ignored the fundamental need to restructure bad debt, and instead fought tooth and nail to defend bondholders and lenders who had extended credit carelessly. We are now left with a global financial system where the debtors are incapable of making good on those debts, and governments around the world are frantically trying to prop up bad debt with public funds and monetary policies aimed at distorting the financial markets even further.

…

The way that our policy makers address the recent weakness in the markets will tell a great deal about the prospects for a durable recovery. If the policy initiatives focus on subsidizing bad debt on the fiscal side, and distorting the financial markets on the monetary side, it would be best to use whatever short-term enthusiasm those proposals provoke as an opportunity to further reduce risk. The best policy responses are those that relieve some constraint on the economy that is binding. Another round of policies geared to creating an even larger sea of zero-interest liquidity, re-igniting asset bubbles, or further lowering already depressed Treasury yields, would be a signal of panic and incompetence from the Fed. If policy makers instead push to facilitate debt restructuring, coupled with pro-growth fiscal responses (e.g. R&D investment incentives, full funding of the National Institutes of Health, productive infrastructure investment, etc), yet another drawn-out cycle of distortion and crash might be avoided.

The Fed, the European Central Bank, the IMF -- these are the agents of the status quo and of large financial interests.  Their policies are ruinous.  I fear that instead of doing the right thing, policymakers will do the same thing they've been doing, only more of it.  The big picture is that we have wasted 4 years and untold trillions trying to hide the fact that nothing has really changed.  I could be convinced to go along with intelligent deficit spending (Hussman gives some ideas in his commentary) if it buys us time to restructure the underlying imbalances in the system.  But we've done nothing of the sort.  We've gone outside and put ice cubes on the thermometer and claimed we fixed global warming.

Despite that, it must be noted that I did put money to work today near the close.  That works for me, my risk tolerance, and current allocation.  Unlike most investors, I feel my eyes are wide open to the risks we face.  Careful out there.

The Other Side of the Equity Coin

"People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome."  -George Orwell

I try my very best not to get locked into an overly biased viewpoint.  Too many people stubbornly stick to a particular viewpoint and refuse to see the other side or even hear reasonable arguments that contradict their own beliefs (political affiliation, gold bugs, etc.).  So while I have been very cautious on the stock market for some time (most recently HERE) due to what I see is poor valuation, I took note when Martin Armstrong noted the following last week:

JUST when you thought it couldn’t get worse, surprise – THE BEST IS YET TO COME! Yes, the sentiment is going to change. But the change on the horizon for the next 4.3 years is going to be very different. We are entering a phase of the Private Wave where confidence in government sinks lower still. The irony of these types of moves is that the economic decline continues, but the financial markets recover with a twist. Capital becomes leery of government debt and thus the private sector rebounds in the face of rising unemployment and worsening economic statistics. 

It is absolutely critical to understand International Capital Flows. The Dow rose between 1932 and 1937 and unemployment exploded to 25% going into 1935, the Dust Bowl tore the economy apart, and the economy was far from booming. There was a lift due to the devaluation of the dollar. This is also the famous bank holiday. Much of the news between 1932 and 1937 was BEARISH. Yet the stock market rallied as a HEDGE AGAINST untrustworthy public debt. Even the city of Detroit suspended all payment on its debt. It made good in 1963 with the help of inflation. We face similar crisis in the state and local governments. Unemployment will rise as the local governments (WHO CANNOT PRINT MONEY LIKE THE FEDS NOR BORROW FROM THEM) are forced into reality.

Now, it's important to remember that future stock market returns are a direct function of how cheap stocks are today.  While I respect Armstrong and his unique point of view, in my opinion it's vital to realize that valuations in 1932 based on the Shiller P/E were in the 5-7 range vs. the over 20 now.  So even though the economy was terrible throughout the 1930's, stocks were very cheap in 1932, forecasting solid long-term returns even in a poor economy.  That is not all all the case today.  Still, it's an interesting concept and might be a tailwind for stocks (or at least to help with a floor).