Just who is the mystery stock picker?

  • Higher taxes are coming…
  • The property bubble is here
  • Why gold is your best long term investment
  • How inflation could be caused in 15 minutes

Jason Stevenson

Vancouver, London and Stockholm rank as the cities most at risk of a housing bubble after a surge in prices in the past five years, according to a UBS Group AG analysis of 18 financial centers.

— Bloomberg, 28 September

My partner wants to buy a house.

Unfortunately, she’s stuck with me. I strongly believe there’s a housing bubble and refuse to buy. I’m not a fan of wealth destruction…especially my own!

Baby boomers have the majority of their wealth ‘trapped’ in property. Over the next five to 15 years, I believe that we will see a lot of supply hit the market. The elderly need to fund their retirement somehow. In fact, my partner’s dad just went through this process. He had to sell his house to pay for his retirement.

He’s a bit older than the average baby boomer. That makes him the proverbial canary in the housing bubble coal mine. When the majority of boomers look to retire, how will they fund their retirements? Who will look after them?

It won’t be the government. Instead, many retirees will look to cash in their biggest asset — their home. This should see housing, and many other assets, crash.

But it should be good for one asset class.

Before I explain, let’s look at the markets…

Markets

Overnight, the Dow Jones Industrial Average gained 133.47 points, or 0.74%.

The S&P 500 added 13.83 points, or 0.64%.

In Europe, the Euro Stoxx 50 index dropped 5.04 points, or 0.17%. Meanwhile, the FTSE 100 fell 0.15%. Germany’s DAX index fell 0.31%.

In Asia, Japan’s Nikkei 225 index is down 243.21 points, or 1.46%. China’s CSI 300 index is down 0.24%.

In Australia, the S&P/ASX 200 is down 2.59 points, or 0.05%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$44.76 per barrel. Brent crude is US$46.22 per barrel.

Gold is US$1,325.83 (AU$1,726.53) per troy ounce. Silver is US$19.07 (AU$24.84) per troy ounce.

The Aussie dollar is worth 76.79 US cents.

Higher taxes are coming…

Governments around the world are dead broke, saddled with a mountain of unfunded social promises. Governments simply can’t afford to pay. So logically, they’re looking at cutting spending, right?

Sorry, I thought you could use a laugh.

Of course they’re not cutting spending! Even talking about reducing peoples’ God-given entitlements is political suicide. Instead, to fund the socialist system, governments are looking to tax everything. This is extremely deflationary.

As taxes rise, the economy continues to decline. The less money in our pockets, the less money we have to spend. That hits business profits and, in turn, employee wages. If it gets really bad, employers will need to start downsize to keep the doors open.

Take France, for example. High earners had to pay more than 75% in income taxes — the highest tax rate ever in the developed world. The policy was terrible. High profiled millionaires and businesses left the country. The government had no choice but to repeal their mistake — though France still has the highest income tax in the world today, according to Statistics Canada data. Thanks to the worldwide hunt for lower taxes, we’re seeing businesses leave France. The Daily Mail reported on 20 February:

An American tycoon has refused to rescue a doomed tyre factory in northern France because its workers are “lazy, overpaid and talk too much”.

Maurice Taylor — chairman of U.S. tyre giant Titan International — issued the slur in a blunt letter to French industry ministry Arnaud Montebourg.

In the letter, Mr Taylor explained why his company would not be buying a Goodyear tyre plant in Amiens that is threatened with closure and the loss of 1,170 jobs.

He told Mr Montebourg: “I have visited the factory several times. The French workforce gets paid high wages but works only three hours. 

‘“They get one hour for breaks and lunch, talk for three hours and work for three. I told the French union workers this to their faces. They told me that’s the French way!”

Now, granted, we’re not up to a 75% income rate in Australia yet, although the top bracket now stands at 45%, not including the Medicare levy.

But the point is that governments promise the world and then see your money as their money. And politicians are desperate for more taxes to pay for their promises.

The property bubble is here…

Property will be, perhaps, the best target for taxation in the years ahead. That could see property prices take a dive.

Bloomberg reported on the story today:

House prices in the near-bubble cities have increased on average by almost 50 percent since 2011, compared with less than 15 percent in other financial centers, UBS said. Low interest rates, global capital inflows and optimism among investors about returns have helped to inflate values, the bank said.

“A change in macroeconomic momentum, a shift in investor sentiment or a major supply increase could trigger a rapid decline in house prices,” UBS said. “Investors in overvalued markets should not expect real price appreciation in the medium to long run.”

Vancouver’s ranking soared to first from fourth place in 2015. Housing prices in the Canadian city have doubled in the past decade, prompting an outcry from local families struggling to afford homes that now chew up 90 percent of average before-tax income. 

The typical detached single-family house in August was C$1.6 million ($1.21 million), according to the Real Estate Board of Greater Vancouver. The provincial government in August imposed a 15 percent tax on foreign buyers in an attempt to cool prices.

Sydney’s property boom could come to a dead end.

UBS agrees, as reported by the Sydney Morning Herald: ‘The Sydney price boom could come to an “abrupt” end due to increasing supply and further tax measures to reduce foreign housing investments.’ If Sydney’s property market goes ‘pop’, Melbourne won’t be too far behind. The amount of apartments being built is staggering!

And don’t expect these ‘further tax measures’ to be limited to foreign investors for long. The government needs money. And they have housing in their crosshairs.

You’ll remember that the Labor Party went to the election (at least briefly) looking to abolish negative gearing (a massive tax incentive). If that happens, all those happy investors — owning four plus properties — will quickly realise they aren’t that rich.

Do you think most people can afford — or want to own — a property that’s generating negative income, without a tax incentive?

Of course not!

One way or another, the government is going to claw back as much money from the property sector as they can. And that could trigger a massive property crash. 

Why gold is your best long term investment

In our view, gold is one of the best hedges against lost confidence in governments and central banks.

Once governments start defaulting on the obligations, and raise taxes through the roof, the gold price should surge. If that happens, the best gold stocks could go through the roof.

In the short term, however, you can expect plenty of volatility in the spot price of gold. The Australian Financial Review reported today:

Gold lost the most in more than a month as a surge in US consumer confidence and gains in the greenback damped demand for the metal as a store of value.

Consumer confidence rose in September to the highest since before the last recession, according to a report from the New York-based Conference Board on Tuesday. The dollar spot index climbed 0.1 per cent, on pace for the biggest gain in a week.

Improving economic data bolsters the case for the Federal Reserve to raise US interest rates this year, which would reduce the competitiveness of gold against interest-bearing assets. Bullion also fell as Democratic nominee Hillary Clinton saw her odds of winning the US presidency rise after the debate with Republican Donald Trump. Citigroup has said a Trump win in November could spur volatility in gold.

“It’s all about the dollar again, and I think the implications are for a stronger dollar and an eventual rate hike by year-end,” George Gero, a managing director at RBC Wealth Management in New York, said in a telephone interview. “I’m watching the political effects on the markets.”

We’ve got presidential debates, the Fed looking to raise rates, and more central bank policy meetings around the world. The list goes on…

The price of physical gold, and the biggest gold stocks, will react to every announcement. If the Fed looks to tighten interest rates in December, gold could plunge like it did last year. That won’t be good for the established gold producers and developers. 

There are a lot of risks.

Fortunately, there’s a way to largely ignore the gold price and still potentially make a lot of money. How? It’s through something called ‘penny gold’ stocks.

Penny gold stocks are so small, they don’t care about macroeconomics. Sure, if the gold price heads to US$1,000 per ounce tomorrow, they could take a hit. And if gold surges to US$5,000 tomorrow, ‘penny gold’ stocks could jump higher. But, generally speaking, ‘penny gold’ stocks don’t care about the gold price.

They react to fundamental news.

If your penny gold stock hits the mother lode, regardless of what happens to the gold price, the share price should go through the roof. It will increase in price to reflect the potential on offer. If the market doesn’t value the stock higher, that would present an opportunity for a bigger producer or developer to take it over. Either way, stock holders would be very well rewarded.

That’s why we’re all so excited that Port Phillip Publishing’s international strategist, Jim Rickards, has teamed up with us to launch a brand new investment advisory service.

Obviously, Jim’s not a stock picker. That’s not his thing. His skillset is completely different. He’s a skilled macro forecaster, government insider and global businessman. He doesn’t have the time to analyse every tiny gold stock.

But somebody within Port Phillip Publishing does. Who? That would be telling.

To find out more, including the identity of the mystery stock picker, and the three ‘penny gold’ stocks that are buys right now, go here.

Talking about what Jim does best, read on to see why he calls gold the ultimate ‘all weather’ asset class.

Cheers,

Jason

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How Inflation Could Be Caused in 15 Minutes

Jim Rickards

One of the conundrums of monetary policy over the past eight years is the Federal Reserve’s failure to cause inflation. This sounds strange to most. People associate inflation with misguided monetary policy by central banks, especially the Fed.

So-called ‘money printing’ is seen as a certain path to inflation. The Fed has printed almost US$4 trillion since 2008. Yet inflation — at least as measured by official statistics — is barely noticeable. With so much money around, where’s the inflation?

This conundrum has several answers. The first is that the Fed has been printing money, but few are lending it or spending it. The banks don’t want to make loans, and consumers don’t want to borrow.

In fact, the private sector on the whole has been deleveraging — selling off assets and paying off debt — even as public debt expands. The speed at which consumers spend money — technically called velocity — has been sinking like a stone.

This divergence between money creation and money use can be seen clearly in the two charts below.

Chart 1 shows the increase in Federal Reserve base money since 1996. From 1996 to 2008, it increased at a steady pace, exactly as Milton Friedman and other monetarists had recommended since the 1970s. Beginning in 2008, the money supply ‘went vertical’ with three successive quantitative easing (QE) programs of money printing. These are highlighted on Chart 1 as QE1, QE2 and QE3.


Chart 1: Increase in Fed Base Money (1996–2015)

chart image

Source: Federal Reserve Bank of St. Louis
Click to enlarge



Chart 2 shows declining velocity over the same period. In effect, the money printing from 2008 to 2015 was cancelled out by the declining velocity over the same period. The result was practically no inflation.


Chart 2: Velocity of M2 Money Stock (1996–2015)

chart image

Source: Federal Reserve Bank of St. Louis
Click to enlarge



US base money supply (shown in Chart 1) has increased from US$800 billion in 2008 to over US$4 trillion today. However, the turnover or ‘velocity’ of money (shown in Chart 2) has collapsed over the same period. Increased money supply alone does not cause inflation. The money must be borrowed and spent.

The absence of lending and spending (as shown in declining velocity) is one reason disinflation and deflation have been more prevalent than inflation.

The second reason for the absence of inflation is that the world is confronting powerful deflationary headwinds, principally demographics and technology.

The rate of increase of global population peaked in 1995. Today, populations are in decline in Japan, Russia and Europe. They are also stagnant elsewhere outside of Africa and the Middle East.

Fewer people means less aggregate demand for goods and services. Improved technology and efficiencies from predictive analytics have lowered the cost of everything from inventories to transportation. This combination of less demand and greater efficiency results in lower prices.

The final reason is globalisation. The ability of global corporations to locate factories and obtain resources anywhere in the world has expanded the pool of available labour.

Global supply chains and advanced logistics mean products like smartphones are created with US technology, German screens, Korean semiconductors and Chinese assembly.

The phones are then sold from India to Iceland and beyond. Yet many of the workers are paid little for their value-added services in these global supply chains.

These deflationary tendencies create a major policy problem for the Fed. Governments need to cause inflation in order to reduce the real value of government debt. Inflation also increases nominal (if not real) incomes. These nominal increases can be taxed.

Persistent deflation will increase the value of debt and decrease tax revenues in ways that can cause governments to go bankrupt.

Governments are therefore champions of inflation and rely on central banks to cause it.

The Fed’s ill-fated efforts to stoke inflation

In the past eight years, the Fed has tried every trick in the book to cause inflation. It has lowered rates, printed money, engaged in currency wars, used ‘forward guidance’ (promises not to raise rates in the future) implemented ‘Operation Twist’ and used nominal GDP targets. All of these methods have failed.

The Fed then shot itself in the foot by tapering asset purchases, removing forward guidance and threatening to raise rates from 2013–15. These tightening moves made the US dollar stronger and increased deflationary forces even as the Fed claimed it wanted more inflation. This two-year tightening episode is proof — not that any was needed — that the Fed does not understand the dynamic deflationary forces it is now confronting.

My expectation is that the Fed will soon reverse course and return to some form of easing — probably more forward guidance and a cheaper US dollar. If I’m wrong and the Fed actually does raise rates, deflation will get worse and a global recession will emerge.

A central bank’s worst nightmare is when it wants inflation and can’t get it. The Fed’s tricks have all failed. Is there another rabbit in the hat?

Actually, yes. The Fed can cause massive inflation in 15 minutes. It can call a board meeting, vote on a new policy, walk outside and announce to the world that, effective immediately, the price of gold is US$5,000 per ounce.

The Fed can make that new price stick by using the Treasury’s gold in Fort Knox and the major US bank gold dealers to conduct ‘open market operations’ in gold. It will be a buyer if the price hits US$4,950 per ounce or less, and a seller if the price hits US$5,050 per ounce or higher.

It will print money when it buys and reduces the money supply when it sells via the banks. This is exactly what the Fed does today in the bond market when it pursues QE. The Fed would simply substitute gold for bonds in its dealings. The Fed would target the gold price rather than interest rates.

Of course, the point of US$5,000 gold is not to reward gold investors. The point is to cause a generalised increase in the price level. A rise in the price of gold — from US$1,000 per ounce to US$5,000 per ounce — is really an 80% devaluation of the dollar when measured in the quantity of gold that one dollar can buy.

This 80% devaluation of the dollar against gold will cause all other dollar prices to rise also.

Oil would be US$400 per barrel, fuel would be US$10 per gallon at the bowser, and so on. There it is — massive inflation in 15 minutes: the time it takes to vote on the new policy.

Don’t think this is possible? It has happened in the US twice in the past 80 years. You may even know some people who lived through both episodes.

A brief history of insta-inflation

The first time was in 1933 when President Franklin Roosevelt ordered an increase in the gold price from US$20.67 per ounce to US$35 per ounce, nearly a 75% rise in the dollar price of gold. He did this to break the deflation of the Great Depression, and it worked. The economy grew strongly from 1934–36.

The second time was in the 1970s when President Richard Nixon ended the conversion of US dollars into gold by US trading partners. Nixon did not want inflation, but he got it.

Gold went from US$35 per ounce to US$800 per ounce in less than nine years, a 2,200% increase. US dollar inflation was over 50% from 1977–81. The value of the US dollar was cut in half in those five years.

History shows that raising the US dollar price of gold is the quickest way to cause general inflation. If the markets don’t do it, the government can. It works every time.

History also shows that gold not only goes up in inflation (as was the case in the 1970s), but it also goes up in deflation (as demonstrated in the 1930s). When deflation runs out of control, as it did in the 1930s and may again, the government will raise the price of gold to break the back of deflation. It has to. Otherwise, deflation will bankrupt the country.

Do I expect deflation to run out of control soon? Actually, no. Deflation is a strong force now, but I expect that eventually the Fed will get the inflation it wants — probably through forward guidance, currency wars and negative interest rates. When that happens, gold will go up.

Still, if deflation does get the upper hand, gold will also go up if the Fed raises the price of gold to devalue the dollar when all else fails.

This makes gold the ultimate ‘all weather’ asset class. Gold goes up in extreme inflation and extreme deflation. Very few asset classes work well in both states of the world. Since both inflation and deflation are possibilities today, gold belongs in every portfolio as protection against these extremes.

There are many ways to get exposure to the price of gold — bullion, futures, ETFs, royalty owners and gold miners. Investing in gold miners offers leverage, but it’s important to separate the best-run miners from those in distress.

To learn more, go here.

All the best,

Jim Rickards