A simple equation

  • The best this year
  • In the mailbag

In the Financial Times, Martin Wolf writes:

One line of attack, popular among libertarians, is that it is arrogant for central banks to attempt macroeconomic stabilisation. They should be either abolished or forced to follow a mechanical rule: the gold standard, for example. The lesson of history seems absolutely clear: a democracy will not accept that money is outside purposeful control. For now and the foreseeable future, we will remain in a world of monetary policy. But, ever since the financial crisis, central banks have done unusual and unpopular things. In unusual circumstances, that was inevitable.

Inevitable, maybe. Desirable, not so much.

Yes, this newsletter takes the view that interest rates should be left to the free market.

Interest rates are simply the price of money.

For the government — through its supposedly but not in reality ‘independent’ central bank — to attempt to control the price of money is no less idiotic than the government attempting to control the price of anything else.

Unfortunately, experience and history shows that whenever governments try to implement price controls, it leads to disaster, unintended consequences, or both.

Governments try to exert price controls over gas and electricity prices. The result is higher and higher gas and electricity prices.

The government exerts price controls over private health insurance premiums. The result is the institutionalisation of higher premiums.

The government exerts price controls over taxi services. The result is a poor level of service, as taxi companies have no room to charge a premium for good service.

The government controls the price of labour through minimum wages, which results in institutionalised unemployment, the notion that 5% unemployment equates to ‘full employment’, and a generally poor level of service in the services industry.

Yet, despite all these failures, the government and the bureaucracy instead that the free market could never be left with the responsibility of setting interest rates — even though setting interest rates is probably the most natural of all free market price settings.

The equation is simple. So simple that anyone could figure it out based on human instinct. The only questions that need to be considered when setting an interest rate is for the borrower to ask: How much am I happy to pay to buy something today rather than wait to buy it in the future?

And for the lender to ask: How much am I happy to receive in exchange for postponing my purchase from today until a point in the future?

It’s not difficult. That is the free market. And yet, governments, bureaucrats, and central bankers insist on creating models and complex equations that do little more than destroy the value of money while at the same time justifying the existence of their own jobs.

End central banks. Bring back the gold standard.

Markets

Overnight, the Dow Jones Industrial Average fell 258.32 points, or 1.41%.

The S&P 500 fell 32.02 points, or 1.48%.

In Europe, the Euro Stoxx 50 index dropped 38.08 points, for a 1.26% fall. Meanwhile, the FTSE 100 lost 0.53%, and Germany’s DAX index fell 0.43%.

In Asian markets, Japan’s Nikkei 225 index is down 112.39 points, or 0.67%. China’s CSI 300 index is down 0.62%.

In Australia, the S&P/ASX 200 is down 1.78 points, or 0.03%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$45.19 per barrel. Brent crude is US$47.33 per barrel.

Gold is US$1,318 (AU$1,764) per troy ounce. Silver is US$18.91 (AU$25.29) per troy ounce.

The Aussie dollar is worth 74.73 US cents.

The best this year

What has been one of the worst performing sectors on the Aussie market this year?

If you answered ‘banks’, you’d be right. The S&P/ASX 200 Banks index is down 13.7% year-to-date. And it’s down 28.4% since March 2015.

That’s bad. What makes it worse is that so many Aussie investors have so much of their wealth tied up in one or more of the big Aussie banks.

On the flipside, what has been one of the best performing sectors on the Aussie market this year?

If you answered ‘resources’, you’d be right there too. Since the start of the year, the S&P/ASX 300 Metals and Mining index is up 29.4%.

That’s a stunning gain. More so when you consider the S&P/ASX 200 index is down 1.3% year-to-date.

Now, it hasn’t been all bright lights and superstardom for the resources sector. Even with this year’s bounce back, the index is still down 54.7% since the sector peaked in 2011.

However, despite the stunning start to the year, it’s a mistake to think that all resources stocks have performed equally well.

Looking at the subsectors of the Metals and Mining index, there is a standout performer. Across the 13 members of this subsector, the average return is 129.5%.

The biggest return was 756%. The worst return was 31.4%.

The even better thing is that, despite these stocks being among the biggest 300 stocks on the ASX, (bar one) they’re still tiddlers. Remove the biggest, which has a market cap of $16.5 billion, the next biggest stock has a $4 billion market cap.

The smallest of the stocks in this subsector has a market cap of just $417.7 million. And that’s the market cap now…after a 178.6% gain this year.

But let’s break this down further. Let’s ignore the ‘big’ stocks. Big stocks are fine, but they generally aren’t where you find the most excitement in the market.

To find that, we screened for stocks in this sector with a market cap less than $100 million. Screening in such a way is easy, but it doesn’t tell the whole picture.

For a start, by only selecting stocks with a market cap less than this amount, you’re filtering out the stocks that started smaller, but grew to be greater than a $100 million market cap.

Also, screening this way means that you include stocks that were bigger, but have fallen into this level. In other words, the data is tainted because (for want of a better expression) you’re excluding the ‘wheat’ but including the ‘chaff’.

If you get the drift.

But regardless, it’s still illustrative. Because worthy of note is the fact that they 10 best performing stocks in this sector, ranging in year-to-date returns from 224% to 740%, have market caps no greater than $51 million.

The smallest of the top 10 has a market cap of just $3.8 million…and that’s after it has already gained 250% so far this year.

These are stunning gains. But if you’re as familiar with small-cap stocks as I am, these numbers won’t surprise you.

So, just what is this sector, and why take the effort to bring this to your attention? The answer to the first is simple, and I’ll explain that today. The answer to the second is relatively simple too, but the explanation can wait until tomorrow.

The sector that we’ve put under a telescope today (we certainly wouldn’t claim that we’ve put it under a microscope) is the gold stock sector.

Gold stocks have been among the market’s best performers this year. That goes for big gold stocks and tiny gold stocks. Even gold stock giant Newcrest Mining Ltd [ASX:NCM] is up 64.6% this year.

Australia’s next biggest gold miner, Northern Star Resources Ltd [ASX:NST], is up 47%.

Both are great results.

But while those stocks may have performed well, let’s be honest, a 64.6% gain and 47% gain aren’t really the type of returns to overly excite anyone. Not that you’d sanely reject those gains if offered. It’s just that, well, when you invest in resources it’s because you’re after big triple-digit, and hopefully, quadruple-digit gains.

Gains such as the 740% from $23.2 million market capitalised Exterra Resources Ltd [ASX:EXC]. Or what about the 425% gain from $14.4 million market capitalised Golden Rim Resources Ltd [ASX:GMR].

Finally, how about the 370% gain from $17.5 million market capitalised Barra Resources Ltd [ASX:BAR].

Remember, these are the stocks’ market caps after they’ve turned in a triple-digit percentage gain. And furthermore, even after the stunning start to the year for gold stocks, none of these are trading at their 52-week high.

Sure, a bunch of the big gains in gold stocks came earlier this year as the gold price climbed and the prospects for further interest rate increases seemed unlikely.

But we’ll argue, what’s changed? The gold price has eased somewhat and gold stocks have fallen from multi-year highs, but does it really seem likely that any central bank, including the US Federal Reserve, is really in a position to raise interest rates?

We wouldn’t put our money on it. But we would put our money on rational speculation in gold stocks.

I won’t claim to be an expert on the mining industry. But, I do know gold. And I know the factors that cause the gold price to rise and fall. And furthermore, I know that issues at play in the world’s economy right now makes me believe a much higher gold price over the medium to longer term is a certainty (as I say, in my view — I could be wrong).

If I’m right about where gold is heading, even if it only gets to half of Jim Rickards’ US$10,000 target price (more on that tomorrow), it’s hard for me to believe that gold stocks, and tiny gold stocks in particular, won’t follow suit.

That’s why as publisher, I’m about to place a big bet on gold and gold stocks. Amazingly, this will be the first time in Port Phillip Publishing’s history that we’ve ever done something with a 100% focus on gold.

It’s exciting, and I’ll have more details for you tomorrow.

In the mailbag

Subscriber, Doug, writes:

I found Kris’s comments regarding bankers quite offensive and without reality. To say it is the reader that has a problem is quite wrong, as this is saying whatever any bankers do is really fine with him.

One only has to look at the last financial crisis to see Kris is talking crap, again.

Bankers really do not care for anything apart from their bottom line, and the word conscience does not exist in their business.

I am at the point of cancelling all association with your newsletters.

We think Doug writes in response to this comment from your editor in Port Phillip Insider last week:

Sure, I admit it. That is a tear you can see in the corner of my eye. I admit that I’ve just painted “hope” on one cheek, and “freedom” on the other.

Do you have a problem with that? This is the kind of freedom that Lech Walesa, Nelson Mandela, Dr Martin Luther King Jr and Mahatma Gandhi all fought for.

The right for free movement. The right for bankers to move without question from their Mayfair townhouse in London to their chalet in Switzerland, or apartment in Monaco.

What’s that, you say? Why should rich American, British, Japanese, French, and German bankers get preferential treatment? Why should they be rewarded, seeing as they were largely to blame for the 2008 financial meltdown?

I won’t even dignify that with a response. Except to say that, if you have a problem with bankers, the problem is with you — and that you’re very likely a racist.

Hats off to Mr Hammond. Bankers are people, too. They deserve to be treated with dignity and respect. The position of this newsletter is to wholeheartedly cheer the proposals enshrining the free movement of bankers anywhere within the EU.

We can only think that Doug has had ‘irony bypass surgery’. Does your editor really need to preface every sentence with stage directions for some of our readers?

Perhaps you would like the inclusion of emojis, so that you know when to laugh, cry, or be angry.

But we think not. We think you understand on which side we have buttered our bread when it comes to the financial markets and the role of banks and central banks.

Someone who clearly hasn’t been paying attention probably should cancel their subscriptions, as we fear they aren’t getting the value for money that they deserve.

Cheers,
Kris