“There are weeks when decades
happen”
-
Title of Goldman Sachs Commodities Update, 16th
April 2013.
Human beings are essentially
pattern-recognition engines. We are hard-wired to recognise patterns,
shapes and trends. Evolutionarily, this presumably yielded our ancestors
benefits in the form of helping them to anticipate shifts in weather and the
seasons, or to identify potential predators or sources of food. Human beings
also have a longstanding appreciation of stories. So when we encounter moments
of high drama, both of these evolutionary characteristics come to the fore: we
associate the drama with the potential for crisis or threat; and we immediately
start on a search for meaning. Who did it, and why ? Turning the drama into an
engaging narrative may even be more satisfying to the human brain than striving
for objective truth. Who cares if the story is nonsensical, illogical, or just
plain wrong, as long as it’s sufficiently enjoyable ? So when the gold price,
in US dollars, fell by over 13% in the space of just two trading sessions a
week ago, it was a natural reaction to start looking for significance (and to
try and identify the protagonists). It was also a cue for legions of the
misinformed, underinformed or chronically uninformed to start filling column
inches with mindless drivel about what, if anything, it portended.
It helps the narrative when the
instrument in question is so widely misunderstood. There are at least two
wholly distinct participants in the market for gold. There are
momentum-followers, who like to buy into rallies and sell into dips. These are
speculators in paper gold, for want of a better turn of phrase. And there are
those like us, tasked with the preservation of clients’ capital in real terms,
who favour gold as a form of sound money in the midst of a fraudulent global
monetary landscape, in which inflationism is not just the norm but now explicit
state policy. There are, indeed, other types of participant beyond these. There
are also entities (states, and their economic agents) who have a vested
interest in suppressing the gold price on the grounds that an elevated price
for gold denotes a growing suspicion at the inherent soundness of fiat
currency. Suffice to say that for us, the fact that the supply of gold cannot
be suddenly or arbitrarily expanded simply by political whim is its defining
characteristic, and one that trumps its perceived value as expressed in units
of baseless fiat money.
So, to accelerate to the point.
We had no target price (in US dollars, say) for gold before last week’s antics
in the futures market. We have no target price today. We will continue to hold
gold, and for that matter silver, for as long as there is risk of acute
monetary disorder in the global financial system. And we don’t hold gold in
isolation: we also invest into high quality credit instruments, high quality
equity investments, and uncorrelated funds. The beauty of this diversified
approach is that because each asset class is distinct and discrete, it is
comparatively rare for all four to move lock-step with each other. If all
tended to move in the same direction at the same time, there would be no
benefit from diversification. It is, indeed, plausible to presume that while we
were incurring some mark-to-market pain in our bullion and bullion mining
holdings, our trend-following managers were simultaneously making hay. It’s an
ill wind..
So some mysterious heavy selling
in gold futures is unlikely to shift our prevailing philosophy or process much,
if at all. If the politicians of the western world were suddenly to get
religion and start pursuing balanced budgets, or if the central bankers of the
western world were suddenly to abandon money printing, that might change
things.
Beyond that, we would simply like
to republish commentary we issued in November 2011, which we still think is
absolutely relevant to the environment today.
Spoiler warning
“I am certain that my fellow
Americans expect that on my induction into the Presidency I will address them
with a candour and a decision which the present situation of our people impel.
This is pre-eminently the time to speak the truth, the whole truth, frankly and
boldly. Nor need we shrink from honestly facing conditions in our country
today.. So, first of all, let me assert my firm belief that the only thing we
have to fear is fear itself – nameless, unreasoning, unjustified terror which
paralyzes needed efforts to convert retreat into advance.. In such a spirit on
my part and on yours we face our common difficulties. They concern, thank God,
only material things. Values have shrunken to fantastic levels; taxes have
risen; our ability to pay has fallen; government of all kinds is faced by
serious curtailment of income; the means of exchange are frozen in the currents
of trade; the withered leaves of industrial enterprise lie on every side;
farmers find no markets for their produce; the savings of many years in
thousands of families are gone..”
-
From President Franklin D. Roosevelt’s Inaugural
Address, March 4, 1933.
Just two years after ‘The China Syndrome’
lifted the lid on Spanish practices in the US nuclear industry, Jane Fonda and
her production company, IPC Films, did a similar hatchet job on US banks with
1981’s ‘Rollover’. The Alan Pakula-directed film is certainly of its time (that
is to say, paranoid and narrowly racist); environmental concerns have now
segued into economic and financial malaise, with Arabs and their petrodollars
as the enemy (if it could be remade today, and it probably couldn’t, the
Chinese and the Renminbi would doubtless be replacing them). Investors with
strong stomachs – and these days, that needs to be all of us – can watch the
devastating final minutes here,
as the US / global financial system is brought to its knees.
We
are often accused of being permabears, and it simply isn’t true. We will,
however, accept any charges of being brutal realists or pragmatists. What is
true is that the financial world has been in a state of crisis for at least the
past four years, and despite all the Sturm und Drang and the endless
pontificating from the markets commentariat, the nature of the crisis is
neither widely recognised nor widely understood. Greece, for example, is a
sideshow. But it is symptomatic of the cause, which we identify as
fundamentally a problem of debt.
As
Chris Martenson has observed (and
we note, in passing, how it takes non-financial professionals to see clearly
through the fog of the present), perpetual expansion is a requirement of modern
banking. The supply of credit at least doubled during the 70s, then again
during the 80s, then again during the 90s, then again during the noughties.
Martenson suggests, and we fully believe, that there is now simply more debt in
the world than can ever be paid back. You can see it in pictorial form here. Note that
that debt is concentrated in the western economies. So on the one hand, we have
a requirement for perpetual economic expansion, if only in the cause of debt
service. On the other hand, the western economies have run into the sand. A
recent McKinsey report on debt plainly identifies the problem. After a forty
year party of debt-fuelled growth, we have the hangover of deleveraging.
Historic episodes of deleveraging fit into one of four archetypes:
1)
austerity (or “belt-tightening”), in which credit growth lags behind GDP growth
for many years;
2)
massive defaults;
3)
high inflation; or
4)
growing out of debt through very rapid real GDP growth caused by a war effort,
a “peace dividend” following war, or an oil boom.
McKinsey’s
words, not ours. So choose your poison – assuming you have a choice.
And
therein lies the problem. The dead weight of debt was amassed in large part by
politicians promising more than they could ever deliver, with taxpayers now and
to be born involuntarily taking up the slack. And it was facilitated by banks,
the scale of whose malinvestment excesses has effectively caused their finances
to be fused with those of national governments. Whether the crisis is resolved
via options 1, 2, 3 or 4 (or combinations thereof) will be a function of
cultural stability and political will – it is certainly not precisely
predictable. The UK, so far, under a fractious coalition government has opted
for 1. The grisly farce that is Greece will probably plump for 2. Option 4
looks unrealistic but US militarism cannot be entirely discounted. Option 3
continues to look like the most politically expedient “solution” for most of
the indebted world. The business of investing involves a probabilistic quest
for certainty where none exists. Hence asset diversification. But we have
established to our own satisfaction a few ground rules. G7 government debt
looks like a ‘safe haven’ bubble that could end disastrously. But if G7
government bond yields really are sustainable at their current, pitifully low
levels, that implies a Japanified prolonged deflation that is logically
consistent with a disaster for most other traditional assets. So sensible and
uncorrelated investments scream out as one solution – we vote for systematic
trend-following funds, and are now examining insurance-linked and
infrastructure investments. And one thing “seems” certain: ongoing currency
debauchery in the west, which would make the case for the monetary metals even
without the simultaneous, grave and tangible threat to our banking and
financial infrastructure.
During
the conclusion of ‘Rollover’, a tearful young Asian banker summarizes the intra-day damage to her dealing room
head: stock market down 10%; the same for the dollar; rival firms essentially
bankrupt; gold just breaking above $2,000. His response: “By tonight, that’ll
be cheap.” The economic logic is sound. We have been conditioned for the last
forty years to price gold (for example) in an inconstant currency, the dollar.
(Using the euro, the mongrel currency of a mongrel political union, would make
the problem no more easily resolvable.) We make no apology for requoting
Andreas Acavalos on the topic:
“..the
problem of economic calculation under a fiat monetary regime is fundamentally
insoluble. It cannot be solved for exactly the same reason that you cannot
solve the problem of “measuring” a length of cloth with an elastic tape
measure. The only “solution” is to throw away the elastic and use a yardstick
that cannot be stretched at will.”
That
yardstick, of course, is gold. Mr Acavalos, again:
“Since
it is unfortunately not within our power, as ordinary citizens, to do away with
fiat money, we have to live with it and manage our affairs accordingly; we
must, in other words, take rational economic decisions in the context of an
irrational monetary regime that distorts relative prices and renders them
increasingly meaningless as guides of where to invest. Here, I think, is where
the role of gold comes in: acquiring gold is not an investment. It is a
conscious decision to REFRAIN from investing until an honest monetary regime makes
rational calculation of relative asset prices possible.”
According
to Wikipedia, the phrase “spoiler warning” started appearing during the early
days of the internet so that unwitting readers didn’t have vital plot points
inadvertently revealed to them ahead of time. We apologise for giving away the
plot to ‘Rollover’ – but as you’ll find if you make the attempt, it’s a
difficult film to track down. I cannot recall its ever having been broadcast on
terrestrial television here in the UK. Watch those final minutes and you can
appreciate why. Films about meteorites, volcanoes, even earthquakes, the
authorities can handle. Films about monetary and economic breakdown..
Confidence and trust are inherently part of the modern financial system. Once
broken and driven away, they will not easily return. With luck, the sort of
panic that we see in the last minutes of ‘Rollover,’ as an institutionalized
and local bank run becomes public and international, will not recur in our
lifetimes. But the current pace of “progress” in the euro zone and for that
matter global debt crisis might suggest otherwise. “By tonight that’ll be
cheap.” Six words that should inspire fear in every politician and monetary
policymaker, in Europe, the US and elsewhere.
Tim Price
Director of Investment
PFP Wealth Management
22nd April 2013. Follow
me on twitter: timfprice
Important Note:
PFP
has made this document available for your general information. You are
encouraged to seek advice before acting on the information, either from your
usual adviser or ourselves. We have taken all reasonable steps to ensure the
content is correct at the time of publication, but may have condensed the
source material. Any views expressed or interpretations given are those of the
author. Please note that PFP is not responsible for the contents or reliability
of any websites or blogs and linking to them should not be considered as an
endorsement of any kind. We have no control over the availability of linked
pages. © PFP Group - no part of this document may be reproduced without the
express permission of PFP. PFP Wealth Management is authorised and regulated by
the Financial Services Authority, registered number 473710. Ref 1019/13/JB
170413.
