SURVIVING THE BUBBLE: How I Learned to Stop Worrying and Lovethe Gold

June 27, 2017

2017 Thesis: Gold as the Anti-Bubble

• We are near the end of the biggest financial bubble in history.

• In the expansion phase of a bubble, gold struggles to maintain its value in real terms.

• In the contraction phase, gold’s value increases in real terms and outperforms all other assets (See bubbles of 1720, 1772, 1825, 1873, 1929, 2000 and 2007).

• Gold stocks substantially outperform gold as costs fall.

What’s a Bubble?

Bubbles are periods of extreme asset valuations and extreme bullishness, unsupported by economic facts, ending in a crash. Bubbles have three necessary components:

• A credit boom• A narrative• Time and the Hyman Minsky Hypothesis

The DotCom Bubble (1997-2000)• Fed eased to: prevent recession caused by collapse of peripheral

Asian economies; to combat collapse of LTCM, and; in case Y2K destroyed the world’s computer infrastructure.

• Markets believed we stood on the brink of the greatest technological revolution of all time. The internet would generate huge advances in productivity and profitability. Old economic measures would no longer apply in THE NEW ECONOMY.

• The last recession was in 1994…ample time to forget discipline and develop Minsky’s Ponzi credit market.

Conclusion: Market valuations reached all-time highs. AOL bought Time-Warner on eye-balls…the worst merger ever. The market exhausted itself. NASDAQ fell 83% top to bottom.

The Housing Bubble (2002-2007)• Fed did not want to accept a recession. Interest rates were

dropped quickly to 1% and held there until mid-2004, to stimulate the economy. The money had to go somewhere.

• Housing prices never go down. Real estate is “safe as houses”. Ninja and liar’s loans and MBSs got rid of all the adults. The Fed said you can’t have a bubble in housing. Housing construction went nuts and so did house prices.

Conclusion: The housing market stopped going up in late 2006 as it ran out of buyers. Bad loans started to surface. A rush for liquidity caused a massive recession. TARP and the end of mark-to-market accounting saved the banking system.

The Everything/Everywhere Bubble (2009-??)• The Fed wanted a demand-led recovery. Interest rates were

quickly dropped to zero and held there until late 2016. The Fed balance sheet expanded by $3.2 trillion (5 fold) via asset purchases ending in 2014. Re-investment continues. Other CBs follow in Japan, China and Europe.

• Interest rates hit 5000 year lows. Median stock hits all-time high P/E and price-to-sales ratios. Credit spreads hit new lows as investors reach for yield. World-wide debt explodes to almost $250 trillion, up 75% since 2008.

• The narrative: Central Banks can save the day.Conclusion: Guess.

The Mother of All Bubbles

Monetary Easing Does Not Generate Growth• Net Real Investment has only grown 1% per year

since 2000.• GDP growth is at depression levels.• Wages have stagnated despite a lower

unemployment rate.

The Great Depression vs Now

• Here is the GDP performance for the 1930s:1930 (-8.5%), 1931 (-6.4%), 1932 (-12.9%), 1933 (1.3%), 1934 (+10.8%), 1935 (+8.9%), 1936 (+12.9%), 1937 (+5.1%), 1938 (-3.3%) and 1939 (+8.0).

• The average GDP growth for the decade of the Dirty 30s: 1.33%.

• The average GDP growth for the Past 10 Years: 1.33%.

Can Central Banks Save the Day?

The narrative: Surely they can keep the game going. Just keep interest rates low and print lots of money.

The Market Is More Powerful ThanMonetary Policy• As the dotcom bubble began to unravel in 2000,

the Fed very aggressively cut interest rates from 6% to 1% but the NASDAQ fell 83% from top to bottom anyway.

• In 2007, as the economy began to weaken, the Fed aggressively cut rates from 4.75% to zero and pushed trillions of dollars in short-term liquidity into the financial system. Nonetheless, the economy collapsed and the average stock fell 60%.

Aggressive Easing Has Negative Consequences• CBs have only two tools: interest rates and excess

liquidity. They are not pain-free. • Every dollar of liability is someone else’s asset.• What is saved on the liability side of the ledger is lost

on the asset side. Your mortgage is in your retirement fund.

• Pensions are emerging as a major financial risk due to low interest rates. World Economic Forum estimates a $400 trillion funding gap by 2050.

• US public employee pensions are already underfunded by nearly $4 trillion.

• CB policy destroys savings and investment.

Accommodative Monetary Policy Creates More Debt• Even if interest rates remain very low, can the debt be

serviced?• US credit market debt is now more than 350% of GDP.• To service this debt at an average interest rate of 2%

takes nominal GDP growth of 7%.• Nominal GDP growth is about 4%. At 2% real growth

we need 5% inflation.• If not, we could see a massive spike in defaults. It all

comes down to cash flow. Missing a debt payment is not like missing an earnings estimate.

Now You Know Why The Fed Is Pro-Inflation• The Fed’s growth strategy has failed. The Fed needs

to get inflation to pay for the debt or face an enormous wave of defaults. It’s one or the other. Both favour gold.

• Can the Fed keep the system going? Either you believe in magic or you believe in math.

• If you believe in math buy gold.