Golden Dreams & Global Nightmares

Tue, Apr 24, 2012 - 2:00pm

It is now time once again to pause and view the global financial picture. The gold and silver markets have chopped mostly sideways for a very long time, and we are near a capitulation phase in investor sentiment. At AFE we are all heavily invested in our own product, namely physical gold and silver; therefore, we have an interest just as our clients do in knowing if this is a final top in precious metals.

Knowing this, we continue to step back and review the factors that may indicate if gold has reached the peak of its 11-year bull market. It is important to make sure that we isolate emotion from analysis, for it is the emotions of greed and fear that drive many investors to make poor decisions with their hard-earned wealth.

“Paper money has had the effect in your state that it will ever have - to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” —George Washington

Currency Wars and Weapons of Economic Warfare

On March 17th, 2012, the unprecedented step of severing a country from the global inter-bank settlement mechanism known as SWIFT was put into force. SWIFT, the Belgium-based Society for Worldwide Interbank Financial Telecommunication, shut 30 Iranian banks out of the system completely. This is the equivalent of having all of your bank accounts frozen, as you cannot transfer funds.1

We have entered a new era of economic warfare. Make no mistake, this is warfare being conducted on a global scale, and it is no less deadly than a kinetic war. After using the tool of being severed from the international payments system as leverage, the US and European nations are all but guaranteeing that the current system will be called into question. By removing a country’s ability to conduct international bank transfers over the SWIFT system, the USA is essentially forcing nations to take a good hard look at if they want to be next. This is not an idle concern, as the US has already made threats intimating this to several other countries.2

This policy is nothing more than the equivalent of the USA shooting itself in its own foot. Instead of compliance, the USA is incurring a massive move away from the USD. What happens when countries all unofficially start settling oil purchases with gold? By using these new weapons of Economic Warfare, Western Central banks run the risk of encouraging other nations to resort to alternate payment methods and systems. The move towards alternative methods is already underway.

There has been a tremendous amount of “scurrying activity” lately as countries position themselves to completely avoid SWIFT if necessary. This entire episode is like a bully (the USA) who has long dominated a playground by ordering around all the others on the playground and using various threats of military and financial use of force as the stick. Unfortunately for the bully, the others have decided to build their own playground and simply leaving the bully behind, not inviting him to play.

BRICS Sidestep U.S. Dollar Completely and Choose Chinese Currency for Trade Settlement

In a historic move, Brazil, Russia, India, and China have conducted negotiations to utilize the RMB for settlement of international trade. South Africa has joined this group and is expected to endorse Chinese currency as the currency of trade for these emerging markets.3 World Bank President Robert Zoellick has been noted as supporting a “BRICS Bank.”4 To put into perspective why this is important, developing nations now contribute almost 50% of new global economic growth and account for roughly 25% of global GDP.5

In the meantime, China continues to position its currency as a viable alternate to the USD for settlement of international trade. China’s President Hu Jintao recently stated that China will “…improve the flexibility of the Yuan exchange rate.” This could be interpreted as saying that China will eventually move to let the Yuan float against other currencies – a move that may be required in order to play the role of reserve currency for use in trade.6

Over and over, we continue to see signs that nations of the world are choosing alternatives to the USD. China is Australia’s largest trade partner as China gobbles up resources such as coal, iron, and gas. China and Australia have just entered into $31Bln Currency Swap.7 This will allow the two nations to settle trade in other than USD. To quote the Reserve Bank of Australia:

“The main purposes of the swap agreement are to support trade and investment between Australia and China, particularly in local-currency terms, and to strengthen bilateral financial co-operation.”

This is Reserve Banker code speak for, “Oh crap, we may need another way to settle trade in case the US goes totally apeshit on us too.”

Add to these events the continuing currency war, which is the intentional devaluation of currency (printing) to stimulate the economy and pay off debts with money that is worth less than it was before, and we have the makings of much higher prices of real goods (food, fuel, gold) - especially in USD terms.

“We are not going to just sit by and watch while other countries devalue their currencies to give them a competitive advantage.” - Guido Mantega, Brazil Minister of Finance

As this trend continues, lowering demand for the use of USD to settle trade will result in a lower demand for USD. Supply of USD relative to demand will cause its value to plummet. At some point, the USA is going to experience horrible levels of price inflation, and the only people who will be protected from it are those who have assets in “other than USD” such as gold, silver, or other tangible “real assets”.

There Is No Solution to the Debt Nightmare

The huge pile of progressively uglier sovereign, municipal, corporate and household debt is still there. Since the last Gold Drivers report I wrote six months ago, very little has changed. I recently finished Chris Martenson’s excellent book The Crash Course, which I read in its entirety on my iPad Kindle App during my most recent trip to China. One concept from his book really hit me like a brick. The idea is pretty simple:

  1. Bubbles are generally uniform meaning they go up, peak, then down over generally uniform timeframes. If it takes 10 years for a bubble to peak, it will be roughly 10 years for it to bottom on the other side.
  2. Debt is the world’s largest bubble. I am not going to get into a big discourse as to why this is true, most people either get this or they don’t.
  3. The vast majority of financial professionals today, including our economists, regulators, and central bankers, assume that the next 10 to 20 years will follow the same trajectory as the last 10 to 20 years.

Once I had framed these basics, this chart proceeded to blow my mind:

Growth of US Total Credit Market Debt = Federal, State, Municipal, Corporate, Household Debt

What you are looking at is TOTAL CREDIT MARKET DEBT for the United States. Yes, these are USA specific numbers, but similar debt trends can be found throughout most of the developed world. The point to take away from this is that for the last 40 years, the debt has DOUBLED roughly every ten years

The question any rational person should be asking themselves at this point is, “Is this sustainable?”

In order for the next 10 years to be like the last 40, debt will have to DOUBLE (the assumption that most financial professionals today operate on) to a ridiculous 5.8 Trillion. In other words, within the next 10 years we have to sell ANOTHER .9 TRILLION of bonds, houses, cars, iPads, etc. to an already completely tapped out population. This is clearly a highly unlikely scenario.

This expansion of credit + energy IS THE ECONOMY. The only tool the Federal Reserve has to attempt to salvage the economy as well as the US Government is to keep printing.

In addition to this, it seems that Euro Sovereign Debt Bailouts have no projected limits either. The OECD has called for a €1 Trillion Eurozone debt fund.9 The sad reality is that it may be only enough to cover Spain, let alone the rest of the eurozone.10

The reason this is of critical importance to us is that the only way to service incredible levels of sovereign debt is to print more money. This is generally being accomplished through currency swap lines via Central Banks, which the ECB can then use to loan to private financial institutions who then buy the (near worthless) government bonds so that it appears these governments are legitimately solvent.

More importantly, we must realize and remember that every time this “Printing Money” is done, it forces the cost of real goods upwards for the common person.

All this Printing Means Prices Will Keep Rising

Regardless of how much discredit is heaped upon gold by what the masses accept as financial experts, no one can say that gold has ever caused continual and relentless inflation over time. The very fact that the masses accept these people as financial experts should probably be a warning in itself. On the other hand, the US dollar (one example out of many paper currencies today) has lost over 98% of its buying power since the Federal Reserve Act was passed in 1913. In other words, the Federal Reserve has continually and relentlessly printed paper money (and now electronic money in the form of currency swaps, bond purchased, ad infinitum) to the point that what used to take one working parent in the USA to produce a decent lifestyle for his/her family now takes two working parents who still, even with both incomes combined, have a lower standard of living.

The most important thing a person must grab if they wish to defend their hard-earned wealth in this day and age is that the value of real goods is not going up; the BUYING POWER OF THE PAPER MONEY IS GOING DOWN.

We have said many times in previous editions of the AFE Global Insider that continual printing of money has caused a relentless march to high prices in all real things such as food, fuel, and yes, gold. This effect is not limited to one country, but is a global phenomenon.

For many countries of the world, people cannot financially cope with an 8% to 22% increase in food prices each year. Soybeans rose over 16% just in the first quarter of this year. There is no way that incomes are keeping up with this. The recent “Arab Spring” Illustrates why this needs to be taken seriously. These civil uprisings were more motivated by the extreme cost of food rather than dislike for the local Dictator.11 People may be displeased with their government over many things such as high taxation, limited freedoms, a lack of representation yet still remain civil. It’s when a parent looks into the eyes of their starving children that people lose it, and that’s when you get civil unrest.

If you live in a western nation, you might be thinking, “Well, yes, that’s very sad, isn’t it? But that sort of thing could never happen here.” Don’t be so sure about that. Until there is a solution to the debt problems of the west, the Central Banks WILL CONTINUE TO PRINT, which means prices WILL CONTINUE TO RISE.

This also does not take into account the fact that governments deliberately manipulate (lie) about inflation statistics. This is not a conspiracy theory, but a well-documented process of fact.

According to the American Institute of Economic Research, by using a measurement of real things people consume such as food, fuel, and electricity, most Americans in 2011 experienced a day-to-day inflation rate of 7.2%.12 For anyone who visits the grocery store, I am certain this is clearly more accurate than the government’s CPI which doesn’t measure such things as food or fuel.

The ONLY THING that has consistently outpaced inflation in purchasing power terms over the last 11 years is gold.

“We are now taught to believe that legerdemain tricks upon paper can produce as solid wealth as hard labor in the earth. It is vain for common sense to urge that nothing can produce but nothing; that it is an idle dream to believe in a philosopher’s stone which is to turn everything into gold, and to redeem man from the original sentence of his Maker, ‘in the sweat of his brow shall he eat his bread.’” —Thomas Jefferson to Charles Yancey, 1816. ME 14:381

Yes, but Warren Buffett Says Gold Sucks

The most common urban myth among financial professionals regarding gold is actually a meme* that was started by Warren Buffet. No disrespect to Mr. Buffet, but if you had sold Berkshire Hathaway in 2003 and bought gold instead, your investment would have performed more than 350% better over the last eight years.

*Meme - Noun /mēm/

1. An element of a culture or behavior that may be passed from one individual to another by non-genetic means, esp. imitation.

To put it this way, the problem when a person like Warren Buffet says something is that people tend to take it at face value and then repeat it without necessarily thinking it all the way through. I would suggest that it is very dangerous to stop thinking in this environment.

Buffet is confusing “Money” with an “Investment.” You do not “Invest” in money; you temporarily store your wealth in it while you are deciding what you want to invest in. It is wealth in static form, un-deployed as an investment.

The urban myth is this: Gold is a poor investment, because it does not produce a return or a dividend. This is usually tossed into a conversation about gold as if it is some brilliant observation, because someone read what Buffet said recently, and they are parroting back the information. I recently spoke to a Fund Manager in China who manages a fund with over Billion, and he did exactly this. It’s shocking that someone in charge of that much money doesn’t think for himself but parrots what the “Oracle of Omaha” says.

In the end, however, it’s really great when an intelligent person says this, because it actually proves my point. There is only one other thing in the financial world that behaves in precisely the same manner, and that is money. The USD does not produce a return or a dividend either, unless you invest them or lend them to someone. This is exactly what money is supposed to do - temporarily store wealth until deployed. I have heard otherwise intelligent people belittle gold saying it has no utility; all you do is hoard it and sit on it. If I said the same thing about the USD, you would think I was an idiot, because that is exactly what everyone on the planet does with money.

The thing we must ask ourselves is pretty straightforward: For the cash or “money” part of our portfolio, does it make more sense to store it in paper money that is relentlessly being printed into worthlessness, or in gold which is a real tangible item that will continue to gain in buying power as long as the banks keep printing?

At Least We Can Trust the Banks

My father, who is now learning about gold, said to me, “Alex, I know in my heart gold is the answer, but when I tried to discuss it with a friend, the friend said to me, ’We don’t need gold; at least we can trust the banks!’”

For anyone who has studied these markets in depth, this is a clear indication of just how far gone market participants are, and the real reason we need to be buying gold right now.

It is difficult for any logical, free-thinking person to fathom how, after everything that’s happened, people still think they can trust the banks. The people who run banks have become so immune to the rule of law, so arrogant in their immortality, that CEOs of companies like MF Global are simply ordering the transfer of .6 Billion of customer funds to their buddies at JP Morgan with nothing more than a memo. The customers’ money then simply vanishes into thin air, and there is no government body capable (or willing) of figuring out exactly what happened to it.13

Perhaps worse still is the fact that markets are practically dominated by machines. For anyone who has seen the “Terminator” series of movies, you might relate to the horrifying concept of humans becoming ever more reliant on machines until one day the machines gain self-awareness and declare war on the human race.

It is estimated that as much as 70% of daily volume activity in the financial markets is now conducted entirely by computers that are running “Black Box Algorithms,” computer programs designed by physicists and mathematicians that are continually “front running” any human being who tries to trade against them. The advantage these machines have is called “High Frequency Trading,” a concept that refers to the fact that those who design these programs are competing for thousandths of a second, the time it takes for one of these algorithms to analyze the markets and then execute trades on behalf of large banks and hedge funds before any human being could hope to accomplish the same feat.14

Trying to play against these machines might be akin to gambling where the house has a ridiculously huge advantage over the player.

The following charts from an article over at Zero Hedge provides a great visual as to what it is like trying to compete with these machines.

The first image is a massive jump in price for this particular instrument. The entire “spike” took only 275 milliseconds to complete. This image represents what a human sees during this spike.

Next, we have a view into what ones of the High Frequency Trade algorithms sees during that same 275 milliseconds timeframe during the “spike” from the image above.

Finally, according to BIS, there is still over 0 TRILLION of derivatives on the books of the largest banks. These derivatives can be triggered by sovereign defaults or the failure of financial institutions. The triggering of these instruments is what led to the fall of Lehman Brothers and AIG, yet there is actually a larger amount of these derivatives now than there was during the 2008 crisis.

…But at least we can trust the banks…

No. Hold physical gold and silver. If you are protecting your wealth with gold and silver but choose to stick it in a bank that can fail overnight due to a cascade of credit derivatives in the financial system, how are you then protected? Own it in a way that it is located OUTSIDE the banking system. Although AFE was the first in our industry to do this, there are now many reputable companies in this arena that can assist you with this.

Gold Is Not In A Bubble

There is a great quote I want to share with you from a recent Zeal LLC article that once again defies the “gold is in a bubble” argument:

“Even for an aggressive speculator, a bare minimum of 5% of his capital should be in gold bullion. Are stock investors there yet? Not by a long shot! This week GLD’s total holdings were worth about b. Meanwhile the collective market capitalization of all the elite stocks of the flagship S&P 500 stock index is around ,866b. So by this measure, stock investors as a group have only 0.5% exposure to gold so far.”

Gold Is Money

Gold is interesting in that it stirs the emotions of the heart. I recently looked back at an article I wrote in 2008 and read some of the comments. I suggested that gold was money; not a currency, but a reliable way to store wealth. One of the people who responded to the post was clearly emotionally upset over the idea that I would make such a preposterous statement. A fan of Ben Bernanke, maybe, or an aspiring Central Banker or Regulator?

The degree to which the idea that gold is not money has been so hammered into the mind of economists (on purpose, I might add) that the venom dripping from the fangs is quite astonishing when people speak against it. The hatred of the concept of gold as money is so emotionally repelling to the typical modern financial expert that it completely shuts down logic.

Recently the Dutch Central Bank got a court order forcing the SPVG Dutch pension fund to sell off its gold position, claiming that it was not in line with the “prudent person rule” and had too much gold as a percentage of their portfolio, which the Central Bank claimed is unsafe, and not prudent. The Central bank was able to convince a court that a 13% portfolio position in gold was unsafe, but a 3% position was, and SPVG should reduce its holdings of gold accordingly. The hypocrisy and shameless arrogance of the Dutch Central Bank’s position is appalling, as its own portfolio of Foreign Reserves consists of 59.4% gold15.

“Do as I say, not as I do” – reminds me of the Fed’s Mandate to de-monetize gold (Federal Reserve Chairman Arthur Burns’ letter to President Ford). The question is, why would a central bank have any interest in lowering the gold price, or de-monetizing gold? Chris Martenson said it well recently:

“The price of gold has always been an object of interest for governments and central bankers. The reason is simple enough to understand: Gold is an objective measure of the degree to which fiat money is being managed well or managed poorly.
As such, whenever paper money is being governed poorly, the price of gold becomes an important barometer. And this is why the actual price of gold is a strong candidate to be 'managed.' Or 'influenced'. Or 'manipulated'. Whichever word you prefer, they all convey the same intent.”16

Once an investor comes to the conclusion that gold is currently behaving as money and not as a commodity in this global economic environment, it is then clear how gold might fit into a portfolio. Instead of comparing gold to bonds, commodities, or equities, gold should probably be compared directly against other currencies. All portfolios hold a cash component; why not hold some of this in gold? It is as liquid as any other currency with a 24-hour global market. There may be a time when it is deemed wise to lower exposure to equities and bonds and sit tight in cash. At this point we must ask the question, “Which form of money is going to hold value the best?” The current sentiment for gold and silver is extremely low, and we consider this a great buying point.


1 SWIFT use as an economic weapon:

2 US Threatens India:

3 BRICS move to unseat the USD

4 Outgoing World Bank President Backs a BRICS bank

5 BRICS form their own Worldbank

6 China to allow “two way movement” of its exchange rate, in other words become a floating currency to position it as a reserve currency:

7 China and Australia bln Currency Swap:

8 Brazil continues to threaten the use of devaluation:

9 €1 Trillion Eurozone Debt Fund:

10 Trillions of Euros will still be needed to save Europe:

11 Food Prices Continue to Rise:

12 Everyday Price Index says prices are rising 7.2%

13 MF Global CEO orders transfer of .6Billion to JP Morgan:

14 Black Box Algorithms and High Frequency Trading:

15 Dutch Central Bank loses lawsuit over gold holdings:

16 Chris Martenson on gold manipulation:

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