In Gold We Trust Report – Key Takeaways
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The current inflation peak is over. But inflation isn’t finished yet. The consequence of easy money at near-zero per cent interest rates won’t disappear overnight. Misallocation of funds already clear after 2022’s technology rout. The Incrementum Inflation Signal signals changes in inflation dynamics. It has been at a maximum level since April 2023, which implies rising inflation tendencies. Page 93 includes a list of inflationary and deflationary dynamics over the short, medium, and long term.
Gold ATH in various other currencies. Is this a sign of things to come for gold in USD? Strong risk-off performance from USD in 2022 limited gold’s gains. Most market participants rushed to the dollar for returns because their usual options of tech and crypto weren’t providing the returns. Worded alternatively, the purchasing power of these currencies measured in gold has reached all-time lows. The report states the USD will follow suit and begin the next cycle of gold.
Flooding markets with liquidity provide artificial booms in assets that do very little to justify the valuation and growth. The herd-like mentality is a clear sign of bubbles. Even companies with no revenue become distorted. When the liquidity is withdrawn, the extremes are exposed.
Price stability vs economic activity vs financial market stability is the “showdown” in monetary policy.
Share of global GDP: G7 vs BRICS. BRICS has overtaken the G7. BRICS is growing in importance. The BRICS Contingent Reserve Arrangement (CRA) and New Development Bank (NBD) are alternatives to the Bretton Wood Institutes the IMF and the World Bank.
The trend of resource nationalism - Chile & Lithium, Indonesia & Nickel. A contributor to energy inflation due to limited supply and investment will still be a contributor to a commodities super cycle in the future.
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Changes in the relationship between USD and energy. Since the US became a net energy exporter, rising energy prices have improved the USD. This goes against the usual negative correlation between the USD and commodities prices. The BIS argues the correlation has become positive. Commodity importers will be hit with a double impact if both rise together.
The tech boom at the start of 2023 is down to investor optimism. They hope a recession will lower inflation and the Fed can pivot and ease. Then stock and bond prices can rise again. In the 2000,2006, and 2018 hiking cycles, the S&P dropped between the last hike and the last cut in all three instances.
When debt levels are high, you can repay by declaring bankruptcy or devaluing the currency. 51.7% of US debt matures before January 2026. Refinancing will be a burden.
The era of the peace dividend has ended since the onset of the Ukraine war. An increase in military/defence spending as a percentage of GDP will be necessary.
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The geopolitical showdown will impact bond yields. Nations that are geopolitical rivals will have no incentive to purchase the debt of their rivals. Especially US debt, or risk confiscation just as occurred in Russia. As a result of fewer bond purchases, prices will fall and yields will rise. And with US debt burdens growing in a high-interest rate environment, their options will be to cut rates back into an easy money environment, buy their own debt, or hope US-friendly states buy enough US debt to make up for a lack of purchases from geopolitical rivals.
Central bank demand and buying are at their highest levels ever. A lot of this is coming from BRICS, SCO, China’s BRI, and countries closely aligned with BRICS. In an IMF article titled “Gold as International Reserves: A Barbarous Relic No More?”, the two major reasons for gold buying are gold is a safe haven in uncertainty which we are in a period with different aspects of uncertainty. Secondly gold is a safe haven from sanctions and asset freezes. It is worth noting the USA still holds the largest gold reserves of any country in the world. The largest 2022 purchaser was Turkey, which is struggling with soaring inflation and a weak currency. One key growing trend is unreported gold purchases by central banks.
GSCI Commodity Index/S&P500 ratio stands at 0.87. The long-term median (since 1970) is 3.98. Large peaks in this chart occurred in the 1970s oil crisis, the 1990s gulf war, and 2008. Countries will have to pour heavy investment into commodities due to an increase in defence budgets, reshore manufacturing with the trend towards domestic manufacturing in some countries, restock commodity reserves such as the SPR which has been emptied as a deflationary measure, and the green energy transition.
Recession indicators and the chance of a recession within 24 months. We’ve seen inversion in the yield curves of the 10Y-3M. An inversion of the magnitude seen in the 10Y-3M has always resulted in a recession within eight months up to this point in time. ISM manufacturing is in recessionary territory. Services however are not at the time of writing. Consumer confidence from the University of Michigan reached its lowest level in its 70-year history in June 2022. In housing, the mortgage payments as a percentage of median household income are rapidly rising, and the housing affordability index is contracting. Finally, the exposure of small banks to commercial real estate is an area that could bring further contagion to the banks.
Leading Economic Indicator < -4% Year-over-year: Occurred 8 times, 100% probability of recession within 24 months. Occurred in November 2022.
2Y10Y Inversion: Occurred 10 times since 1950, 90% chance of a recession within 36 months. Occurred in July 2022.
3M10Y Inversion: Occurred 4 times since 1990. 100% chance of a recession within 24 months. Occurred in November 2022.
ISM New Orders < 47: Occurred 12 times. 100% chance of a recession within 24 months. Occurred in December 2022.
Federal Reserve Rate Hike Cycle: Occurred 8 times since 1970. 85% chance of a recession within 24 months of the cycle ending.
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The trend of money flowing into money market funds continues. This started as money left the banks after the banking crisis. Interest rates offered by banks are lower than those offered by money market funds also. Another reason to make the move.
Are we finally seeing labour market weakness? Overtime hours in February 2023 hit -18%. This level has only been seen in the COVID-19 pandemic and 2008/09. Tech layoffs and companies with layoffs are also increasing from Q1 2022 to Q1 2023.
Incrementum Recession Phase Model
Phase 1: Run-Up (6 Months Before Recession) – Burgeoning volatility on financial markets. Market prices in a recession.
Phase 2: Beginning (First 3 Months of Recession) – Transition between increased uncertainty and the peak of the economic slowdown.
Phase 3: Middle – Marks the trough and turning point of the recession.
Phase 4: End (Last 3 Months of Recession) – The economy begins to stabilise. Optimism returns.
Phase 5: Recovery (6 Months After Recession) – Positive growth returns.
Different assets are more successful in different stages of the recession model. Stocks and indices perform better in phases 4 and 5. Gold provides lower but positive average returns in phases 2-5.
Zoltan Pozsar Interview Key Takeaways.
China is using swap lines to settle international trade. Hence trade can occur in the renminbi without countries holding high levels of reserves.
A surplus doesn’t mean a currency can’t become a global reserve currency. The US ran a surplus post-WW2.
In a multipolar reserve-currency world, the dollar will be challenged by the renminbi and the euro. These currencies aren’t reserve currencies but will be used more to settle trade. Gold could also play an increased role.
Zoltan believes central bank stockpiling of gold will accelerate due to geopolitics and living through “a period of great power conflict.”
The dollar isn’t vanishing, but different parts of the world will rely less on the dollar. There is too much risk associated with the dollar. For example, legal risk, sanctions risk, and geopolitical risk. Those countries who don’t feel safe managing this risk, i.e. those unaligned with the West, will distance themselves from the dollar to protect from these risks.
Why central banks hold FX reserves: to import what you don’t produce at home, and this is priced in dollars. To backstop dollar liabilities. The trend will be to accumulate other currencies as some areas of international trade won’t be paid only in dollars.
China is increasing the weight of euros in its currency basket. China knows Europe is part of the world island. The world island it hopes the Belt and Road Initiative can span every corner of. Eurasia will be in a renminbi bloc, and the G7 will be in a dollar bloc. The rest of Europe is up for question. A pivot zone perhaps?
The gold window with the Shanghai Gold Exchange allows the convertibility of offshore renminbi into gold.
China is not blocking capital outflows with capital controls.
War can be a good thing for innovation and higher productivity. However, the risk of it spilling over into something uglier isn’t zero. The focus will be rearming, reshoring, friend shoring, and energy transition. Self-interest and self-sufficiency will be key factors.
Inflation isn’t going back to 2%. Commodities markets are tighter. OPEC+ keeps cutting production for higher oil prices. Baby boomers are retiring. The current workforce is less productive. Too few jobs for too many people. Food and energy prices are caught up in the geopolitics. The price of necessities going up will contribute to higher wage inflation.
20/40/20/20 portfolio. For cash, stocks, bonds, and commodities respectively.
The Five Phases of De-Dollarisation
2000-2009: Growing discontent over the one-sided benefits for the US that the dollar provides. Some countries rebel, such as Iraq and Libya, but are suppressed.
2009 – 2013: Asia, Africa, and South America gain more say and real power. China tries to exert pressure to reform institutions such as the IMF. The US makes minimal concessions.
2013-2022: Alternative payment systems emerge (CIPS) and bilateral currency agreements to limit the use of USD.
2022: Freezing of Russian currency reserves drastically changes attitudes towards the safety of the USD.
2023: Active resistance against the old system re-emerges and re-intensifies.
20. Russian Response
Russia relies less on Euro and more on Yuan.
Russia plans to use stablecoins tied to gold and Bitcoin for international payments.
BRICS currency is wanted.
Gold Ruble 3.0
Moscow World Standard for Gold Trading
Photo by Egor Filin on Unsplash
21. China’s Key Developments
Xi’s Third Term even against the traditions put in place by Deng Xiaoping.
Is China preparing for war? They want to expand their nuclear weapon numbers from 400 to over 1500 by 2035.
China-Saudi Arabia relations were a key event in the global restructuring in this current iteration of geopolitics. This has led to the Petroyuan. The yuan is tempting as they insist on not putting the yuan into government bonds. So gulf states can put Chinese money into government bonds, buy goods and services from China, or convert them into Gold.
Currency swaps are playing a huge role in spreading Renminbi’s global use. The m-CBDC bridge project is also a discussed prospect. The mBridge project allows real-time cross-border foreign exchange using CBDCs.
The Saudi Arabia-Iran peace deal is a huge win for the Middle East. Peace in the Yemeni Civil War could yet emerge from it.
Jan Nieuwenhuijs: “The PBoC holds more than twice the amount of gold officially disclosed.” This would put China second in Gold Reserves, just behind the US.
22. 60% of all loans granted by China under BRI are now nonperforming.
23. The UN is currently wagered in a narrative battle. This narrative has cracks. 141 countries support the UN resolution of March 2nd, 2022, which is a critical defence against the erosion of international law, and the Russian invasion of Ukraine. Among the 40 countries that didn’t vote are India and China. These two countries represent more than half of the world’s population. So many aspects of the current global state of play have narrative issues. The dollar, gold, Bitcoin. The biggest narrative is that of persistent inflation versus an interest rate cut. The narrative will become clear.
The Cycle of Currencies. A crack-up boom refers to a period of hyperinflation and stock market rallies as trust in a currency is lost and flight into real value occurs. This also affects supply chains. The average lifespan of a currency is 74 years. Today, we are seeing a monetary invention experiment with Bitcoin. How can currencies die? Firstly at the conquest of a foreign power. Secondly, a currency may die due to a political replacement, such as when the Euro was created. Finally, the last is currency failure from hyperinflation.
Zombification of the Economy. Artificially inflating the money supply leads to ultra-low interest rates. This makes projects appear profitable even if they aren’t, and very loose lending standards. All this creates a façade of strong economic growth. This is the zombification of the economy. The theory is that sooner or later, correction to this will come. It will be difficult to service debt. More QE to artificially imply economic growth and extreme levels of credit expansion will lead to the crack-up boom commencing. The rush to “real” goods leads to money becoming scrap paper.
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Bitcoin and Gold are complementary, not competitive, as stores of value. Gold has physical qualities. Bitcoin has digital properties that increase its transferability at affordable costs. Noninflatable monetary assets at a time such as this are vital. Gold investors see Bitcoin as highly volatile and hence isn’t stable. Also, Bitcoin is new and has a much shorter tested time period than Gold. But the In Gold We Trust paper debates we should bury the hatchet in the Bitcoin vs Gold debate.
The Regression Theorem. Proposed by Ludwig von Mises in 1912, the theory discusses the following: “Any type of money must initially be commodity money, traded in barter, because only then do people have an idea of what the initial purchasing power of this commodity is. Additional purchasing power is added to it as this commodity is also demanded for the first time as a medium of exchange.” Bitcoin has market value, and by this definition could become money, or already is a form of money.
Silver. Silver has two key aspects vying it towards higher prices. Firstly, the supply problems hitting most commodities, of which silver is especially feeling with net supply dropping in 2021 and dropping further in 2022. But Silver also has high industrial demand, especially in the green energy transition. Nonindustrial silver demand also remained strong in 2022. If Gold has a run, silver usually follows. Silver “works” when government policy towards it is favourable. Silver demand for photovoltaics is sharply rising and is set to rise further (13% of total silver demand for 2021). Silver is also used in EVs but to a much lower amount of total global demand (1.3% including recycled). 60% of global EV sales in 2022 occurred in China. For silver to run, there needs to be a collective increase from all governments in renewables. The one caveat to consider is silver’s volatility and hence the difficulty to time an entry. Using the recession model, on average Silver performs positively in phases 1, 4 and 5. In recessions, industrial demand falls. Hence when we’re out of the recession and demand increases again, it makes sense silver reacts accordingly with positive returns on average.
Key Silver Facts
Silver global mine production fell by 0.6% YoY in 2022.
Peru had the greatest decline in output.
Recycling of Silver rose by 3%.
Total silver demand jumped 18% in 2022.
Physical investment rose for a 5th straight year.
30. Mining. The market is still largely ignoring the rediscovered profitability of gold mining stocks. It’s clear that mining stocks are susceptible to equity market risk. Inflation contributed to all-in-sustaining costs rising 18% YoY. But at higher gold prices, the gold miners will continue to generate high-profit margins despite inflationary pressures. Large cash flows (FCF) will lead to M&As in the gold and copper sectors. Especially explorers and developers with significant deposits in safe jurisdictions. The top 10 gold producers only account for 28% of the market share. In iron, the top 10 producers account for 70%. The reserves held by the top 10 miners have also been falling since 2011. The major companies have also been reducing debt over the last few years and building cash, positioning them even better for this period of M&As.
31. The Lassonde Curve In Mining. The curve demonstrates the life cycle of a mining project. It details the years-long process with many costs and risks along the way. The steps are as follows:
The Concept: The mining company begins from scratch and devises a plan and obtains prospecting rights.
Pre-Discovery: Fieldwork initiated on the acquired property.
The Discovery: Drilling begins to investigate deposits.
Feasibility: Economic studies are conducted.
Development: The mine is constructed, and necessary permitting and financing are obtained.
Startup: The mine is completed, and production begins.
Depletion: The mineral resources are extracted from the mine and the reserves in the mine begin to decrease.
Photo by Dominik Vanyi on Unsplash
32. The Social in ESG. Gold mining companies need to demonstrate a strong commitment to sustainability in order to attract investment to the sector. Part of this is serving the communities in which these companies operate. We are also seeing automation gearing up and its potential applications within the mining industry. This could negatively impact communities through the loss of jobs and economic inequality. The paper proposes community-part ownership as a potential solution.
33. The Commodities Cycle Bullishness. This is based on three pillars: geopolitical conflict, CAPEX-led cycle, and supply risk. The supply dynamics will cause commodity prices to rise until the “threshold of attractiveness”, where CAPEX is fully enticed. Deglobalisation will make access to critical minerals more difficult. But higher levels of investment will continue to be needed, especially in green energy commodities such as copper, silver, nickel, cobalt, and lithium. Innovation could solve these problems but it’s debatable if it will be in time, with supply issues already existing. Commodity prices have never been this cheap relative to the Dow Jones apart from in 1929, the late 1960s, and the late 1990s. In each of these situations, the S&P GSCI dropped below 50, and a commodities bull market followed.
Russell Napier Interview Key Takeaways
Debt-to-GDP levels in the developed world are at historically high levels.
Financial repression has been used to reduce debt-to-GDP levels in the past.
Government guarantees in the event of bank collapse lead to greater government debt and more government involvement in the assets of banks and the flow of credit to areas they want it to go to.
Governments also take greater control of the savings system to fight their debts.
In an inflationary environment, the strategy of throwing money to solve problems can’t work.
The Inflation Reduction Act is another way of capturing the financial system by creating good incentives and cash flows in certain private sector companies. The banks are then encouraged to lend to them.
As a consequence of “successfully” managing the biggest GDP decline since 1707 at the onset of COVID, banks lend money and create money and hence we have inflation.
Russell predicts we are heading to a stage where we see yield curve control. Then they control the quantity and price of money.
In tough times, often innovation can act as a deflationary force. However, with the level of debt in today’s system, Russell doesn’t see how this innovation could be financed without more money.
“The first casualty of war is truth, and the second casualty of war is price stability.”
“The next time you hear a politician cite an emergency, think to yourself, what’s the answer to that emergency? Because I think you’ll find its capex.”
Defence spending is unproductive capex because it destroys, it doesn’t build.
If there is a cold war with China, everything the US gets from China will need to be produced domestically. This would be a huge capex boom. Labour markets are tight and so more robotics and automation can help cope with this. More capex. But countries won’t use their own money to finance this, they will use the banking system.
Countries are transacting in renminbi, but will they hold them? It’s not transacting that makes a reserve currency but owning it. Renminbi holdings are actually dropping. For now, it’s still the age of the dollar, but the trend is clear.
So where does the money go? More goes to the dollar in Russell’s opinion. He pushes back on de-dollarisation.
Deflation with a recession was deemed impossible in the 1990s. But the period of deflation in the 1990s came with defaults, write-downs in the bank and corporate assets, and corporate earnings regularly halved due to a changed business cycle.
Bank credit is still expanding. Any recession that comes isn’t going to be one where corporate earnings will collapse, but it will be one with higher inflation. Hence why the market is going up. More risk on the public balance sheet is good for private-sector assets. So Russell sees a return to recessions like the ones between 1945-1990. The average EPS decline in these recessions was 11%.
Technical Analysis
The Coppock indicator is signalling buy but has formed a divergence with price.
The KST turned upwards in winter 2022 and could signal a breakout.
Sentiment on gold, silver, and minders is unnotably flat. But gold is near all-time highs. This is interpreted as positive.
Seasonality implies a muted summer for gold prices from the end of May to the beginning of July. So gold is likely to correct its impressive rally from the previous few months. Silver shows the same seasonal downtrend.
Relevant Material
· https://ingoldwetrust.report/regression-theorem-explains-why-gold-equals-money/?lang=en
· https://www.federalreservehistory.org/essays/bretton-woods-created
· https://www.imf.org/external/np/exr/center/mm/eng/mm_sc_03.htm
· https://european-union.europa.eu/institutions-law-budget/euro/history-and-purpose_en
· https://www.gold.org/goldhub/research/gold-demand-trends
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