Monday, March 31, 2014

Gold, the Economy and Outlook

In 2013 the price of gold bullion lost 28 percent and closed near its low for the year. It was the first annual decline since 2000 and the worst since 1981. Gold ETFs experienced record redemptions, shrinking the funds 33 percent by year end, but they were the exception. Marcus Grubb, Managing Director of the World Gold Council, reported, “2013 has been a strong year for gold demand across sectors and geographies, with the exception of western ETF markets.” While investors were leaving ETFs, demand for gold jewelry, bars and coins was increasing, as were purchases by central banks. Globally, consumer demand increased 17 percent for gold jewelry and 28 percent for bars and coins.

The World Gold Council reported:
  • 2013 saw the largest volume increase in gold jewelry demand for 16 years.
  • Demand for gold bars and coins surged to an all-time high of 1,654.1 t (metric tonnes).
  • Annual demand for gold used in technology stabilized at 404.8t, from 407.5t in 2012.
  • Net purchases by central banks increased global official gold reserves by 368.6t., the fourth consecutive year of positive demand.
The gold markets in 2013 accelerated a trend in recent years of buyers' preference for physical possession of gold. Premiums for physical delivery of gold in Shanghai jumped to a staggering $34.82 per ounce. In India the premiums for physical delivery soared above $100 per ounce. At the Comex, total gold available for delivery was drawn down 80 percent by year's end. In the spring of 2013, ABN-AMRO, the largest Dutch bank, announced it would be unable to deliver physical gold and would instead offer paper gold claims to customers. On April 26, the Chinese Gold & Silver Society in Hong Kong reported it had sold out all its inventory and placed orders in Switzerland four times larger than normal in response to demand. 

Jewelry is the largest single category of global demand for gold, accounting for 59 percent. The largest market is China, with India in second place, followed by the U.S. Jewelry demand in 2013 in China increased to 669t from 519t in 2012, and in India to 613t from 552t.

The WGC reports: “Consumers remain key drivers in the demand for gold...Across the world there were large increases for gold in both emerging and developed markets.” Demand for bars and coins in Turkey was up 113%, Thailand up 75%, China up 38%, Indonesia up 36%, and the U.S. up 26%. (The China Gold Association reported consumer demand increased 41%, not 38%.) According to Thomson Reuters GFMS, a precious-metals consulting firm, Chinese exchanges accounted for 22% of gold traded on exchanges in 2013, more than double the 10% of 2012.

Due to the popularity of gold in Asia, the following banks—most of them very large—opened gold vaults in Singapore or Shanghai in 2013: Deutsche Bank AG, UBS AG, Barclays PLC, and Australia & New Zealand Banking Group Ltd., Also, Metalor Technologies SA opened its first gold refinery in Singapore in 2013.

Technology represents only about seven percent of world gold demand, but this actually accounted for more gold in 2013 than purchases by all the world's central banks (404.8t compared to 368.6t). Moreover, this field could grow very rapidly. Historically the principal industrial use for gold was in dentistry, but this has been surpassed by use in the fast-growing electronics industry because of the metal's excellent conductivity and resistance to corrosion. Those characteristics also makes it the metal of choice for high-technology components in complex and challenging environments, such as the space industry and fuel cells. Gold's catalytic properties are also beginning to create demand in the automotive sector, in the chemical industry, and in medicine because of the metal's excellent bio-compatibility.

Platinum, palladium and rhodium are commonly used in catalytic converters in automobiles. Now a stable, effective and commercially viable catalyst can be obtained by combining gold, palladium and platinum. I don't think anyone expects the automobile industry to decline or reduce its use of catalytic converters.

The whole field of nanotechnology is just opening up. A growing number of patents relating to gold nanotechnology suggests many new catalytic applications for medicine and the environment will be developed in coming years.

Gold can be used for precise delivery of drugs to targets within the human body and to create conducting plastics and specialized pigments. Gold enables certain tests to reliably detect malaria and many other diseases. These tests can be used in developing countries without expensive equipment or supply chains. In Rapid Diagnostic Tests (RDTs), gold nanoparticles drive a color change on a test strip containing a single drop of blood, indicating whether a disease is present. According to the World Health Organization, hundreds of millions of RDTs have already been distributed globally.

Gold nanotechnology research is developing more efficient and accurate ways of delivering cancer treatments. Chemotherapy now widely used in treating cancer can damage healthy cells. Gold nanoparticles can target and destroy cancer cells while leaving healthy tissues largely unaffected. It's hard to believe this use of gold will not grow significantly in the future.

Gold's catalytic properties can be used effectively to reduce hazardous emissions to the air as well as remove pollutants from groundwater. A gold and palladium catalyst removes chlorinated compounds.

All the new uses for gold will not diminish the role of gold as a monetary metal, merely add to its value and demand. Gold's monetary importance will continue to be determined fundamentally by national and international economic factors. Of utmost significance in this regard is the misguided continuation of the U.S. policies of government spending that balloons the national debt and taxation that stymies economic growth.

The promises that Barrack Obama made to get himself elected have proven false, are counter to logic and the lessons of history, and have left this country with a bleak future. It is obvious that the U.S. can never pay all its obligations. Social Security, Medicaid and Medicare are going bankrupt, but Obama hasn't even tried to do anything about them. Instead he proposes more spending—which, together with past obligations to spend more in the future—caused the problem in the first place. He simply made it worse—much worse—and now proposes to do more of the same. The feds spent $2.98 trillion in 2008, but Obama now proposes to spend almost a trillion dollars more ($3.9 trillion) in his budget for the fiscal year beginning October 1. Spending would rise by another $1 trillion by 2020, much of it fueled by the exploding costs of Obamacare, and would reach an astonishing $6 trillion by 2024. That won't happen. A complete financial collapse will occur long before then.

It was claimed Obama's economic recovery program of 2009 would produce 4.2% average growth, based on recoveries from previous recessions. But the problem was, “the Obama program did not promote growth, it impeded it,” according to Gramm and Solon. Recovery averaged just 2.2%, less than half the norm for postwar recoveries. Worse, the Congressional Budget Office now says our long-term growth has been permanently weakened, thereby reducing our growth rate to 2.2% for the next decade! Thus, despite all the hoopla about the economy finally turning around and improving, the CBO predicts the next decade will have the same growth rate, 2.2%, as the unimpressive period 2011-2013.

Another recent CBO report shows how slower growth is bleeding the federal government of trillions in revenue. CBO's 10-year projection shows $4.9 trillion have already been lost due to slower growth since the recession began, and the losses are accelerating.

Obama has proposed about $1 trillion in new taxes over the next ten years, almost all from higher earners. He has learned nothing from the tax cuts by presidents Ronald Reagan and John Kennedy. In both cases, reductions in tax rates resulted in increased tax revenue for the government. When Reagan became president, he reduced the top marginal income tax rate to 28%, from 70%, but when he left office, tax revenues had almost doubled. During this same period, the inflation rate fell to 4% from 13%, unemployment dropped to 5.3% from 7.5%, 17 million new jobs were created, and the longest peacetime boon in our history was underway. When Reagan took office in 1981, the top one percent of income earners paid 17.58% of all federal income taxes. Twenty-five years later, in 2005, that one percent paid 39.38% of all income taxes despite the much lower rate. In the 1960s President Kennedy cut the highest income tax rate to 70% from 91% with a similar result. Obama's tax ideas are an ideological fantasy out of touch with historical evidence.

Presidents Harding and Coolidge cut federal income taxes several times throughout the 1920s, sharply lowering the top rate in steps to 25% from 73%. As the top tax rates were cut, tax revenues soared, as did the share paid by the rich. Those earning over $100,000 paid 29.9% of the total in 1920, 48.8% in 1925, and 62.2% in 1929. The share of overall taxes paid by top one percent rose from about one-third in the early 1920s to two-thirds in 1928. All this means nothing to Obama because in his view Marxist ideology trumps reality.

Pursuing Karl Marx's ideology, Obama seeks economic equality through redistribution of wealth. He has declared economic inequality is the “defining challenge of our time...That’s why I ran for president....It drives everything I do in this office.” That's why he pitches his soak-the-rich tax proposals in the Marxist terms of class warfare and the rich as enemies of the people, impediments to achieving his dream of socialism's equality.

The U.S. economy is in far worse shape than is generally acknowledged. Now in Obama's fifth year as president, the labor participation rate is the lowest in 35 years. His expensive economic stimulus and jobs programs have failed. Fifty-seven months after the official end of the Great Recession, fewer Americans have jobs than in December 2007. Furthermore, the so-called recovery has been characterized by downward mobility.  During the recession, 60% of job losses were in the middle pay range, 21% were lower.  In the recovery, only 22% of new jobs were in the middle range while 58% were in the low end of the scale.
Home sales fell again in February, to the lowest level since July. They declined in six of the last seven months.

Job creation rose in February, which was expected after the poor number in January due to extreme winter weather in parts of the U.S. Even so, the February number of 175,000 new jobs was below the prior 12-month average of 189,000. Furthermore, the average work week (now 34.2 hours) has been declining, resulting in the equivalent net loss of 100,000 jobs since September. This cannot be explained by harsh winter weather because parts of the West, Midwest and South experienced milder than normal weather, and the numbers were already seasonally adjusted. Besides, the work week decline began before winter set in, with declines in hours in September and October.

The unemployment rate is actually about 13%, roughly twice the reported rate, if you include people “marginally attached” to the workforce. At the end of 2013 there were 27.3 million part-time jobs, 18% of the workforce. The reported unemployment rate is deceptive in that it omits those who are not employed but have stopped looking for work.

Government spending has not made Americans richer. The median net worth of American adults in now one of the lowest among developed nations according to Credit Suisse Global Wealth Databook. The U.S. figure of $45,000 is less than Australia's $220,000, France's $142,000m—and even Greece's $54,000. The net worth of almost a third of American adults is less than $10,000.

The Federal Reserve has been accommodative of Obama's spending by providing whatever money is needed by simply creating more of it. There is no limit on the amount it can create because that money is backed by nothing; it is fiat money, paper not backed by gold or any material value. As a result of the Bretton Woods conference in 1944, the U.S. dollar became the world's reserve currency. Only the dollar was directly pegged to gold, and other countries were required to maintain fixed exchange rates of their currencies to the dollar. The U.S. agreed to maintain dollar-gold convertibility for foreign central banks. President Nixon ended that convertibility in 1971, after which there has been no limit on the amount of money the Fed can create.

As a result, the U.S. began producing enormous trade deficits. Other countries would send us TV sets, washing machines, refrigerators, cameras, tools and compact fluorescent light bulbs, and we would send them more paper dollars. They would send us clothes, iphones, computers, shoes, toasters, tires and just about everything else, and we would pay for them with fiat dollars created by the Federal Reserve. Those dollars would be recycled back to the U.S. by foreign governments using their accumulating dollars to buy U.S. treasury securities—in effect, the U.S. was borrowing back the dollars, which were then used for more spending and increasing the federal debt.

Economy didn't matter any more. The system facilitated any amount of uneconomic expenditures by passing the cost to future generations by simply adding it to their tab: a growing national debt. It became the ultimate way for politicians to redistribute wealth: steal it from future generations who have no vote in the matter, and distribute it now to voters who will put you in office or keep you there.

The system can not continue indefinitely. Nobody can ever get out of debt by borrowing successively larger sums to cover successively larger debts. Neither can governments. Eventually debts are repaid or the borrower goes bankrupt. According to the International Monetary Fund, meeting America's obligations will require an immediate and permanent 35% increase in all taxes and a 35% cut in all government benefits. That's not going to happen. It can't happen. Instead America will undergo a financial collapse. By 2025, entitlement spending and debt payments are projected to consume all federal revenue. And having the Fed print vastly more money to pay our obligations will not solve the problem; it will merely bring inflation that destroys the value of the dollar.

For five years the Fed has been engaging in “quantitative easing”—printing money—at rates as high has $85 billion per month—over $1 trillion per year. Recently that has been reduced to $65 billion per month. The Fed is not the only central bank engaging in quantitative easing. Central banks all over the world have been doing so to try to stimulate their economies and placate voters that they are “doing something.” The Fed, the European Central bank and the central banks of Japan, Switzerland and China have printed well over $10 trillion since 2007, more than tripling the size of their combined balance sheets.

Japan was the latest of the major central banks to reach its “Havenstein moment,” a moment already reached by the other central banks just mentioned. It is the moment when the person in charge of the money supply decides that massive printing of money is better than the alternative, that it is preferable to deflation. Rudolf Havenstein was the head of German Central Bank (Reichsbank) from 1908 to 1923 and presided over the great hyperinflation in Germany. The newly elected government in Japan stated in May 2013 that it aimed to improve the economy with 2 percent inflation by doubling the money supply. It said it will engage in “unlimited” or “open ended” printing of money to achieve that goal.

With all the fiat money being printed by central banks all over the world, it should be no surprise that people all over the world have been exchanging it for gold. They see it as more likely to retain value than paper currencies, which they fear could result in either uncontrollable inflation or a bursting of the monetary credit/debt bubble and catastrophic collapse.

The latter is what happened in 1929, following the credit expansion of the money supply in the 1920s. The excess credit found an outlet in the stock market. A similar expansion of credit in the mortgage/housing industry created a bubble that burst bringing on the Great Recession of recent years. Will the huge amount of money the Fed has been creating since 2007 find a similar outlet in those industries? The stock market has been making all-time highs, and the Fed's policy of near zero interest rates has driven money from safer investments into stocks in search of higher returns. And while the Fed was buying $85 billion per month in bonds, $40 billion of that was in mortgage backed securities in an effort to goose home buying and employment in home building. So the stock market and the housing industry may be “bubble” candidates.

There are, or course, other possibilities which could upset the precarious financial position the United States has created for itself with its spending and debt problems. The most intriguing relates to the increasing demand of gold buyers to take physical delivery of gold.

As we noted, the amount of gold eligible for delivery on Comex futures contracts was drawn down 80 percent in 2013. The Comex handles 82% of all gold futures trading, but only a very tiny percentage take delivery; it is a basically an exchange for paper trading. Physical deliveries of gold on the London Bullion Market are about nine time greater than on the Comex, but here, too, paper trading predominates.

The Shanghai Gold Exchange is the one for physical delivery. Its physical deliveries have been almost equal to world gold production. In 2013 SGE delivered 2,197 tons of gold, up 92.9% from 1,139 tonnes in 2012. In January 2014, it delivered a record 247 tons, 43% greater than the monthly record set in 2013, and greater than monthly global production of gold in the entire world.

In a previous posting we noted that Germany has had difficulty since October 2012 obtaining return of gold it owns that is stored at the New York Federal Reserve Bank. That same posting noted Alan Greenspan's testimony before the House Banking Committee, “Central banks stand ready to lease gold in increasing quantities, should the price of gold rise.” The question immediately arises whether, in fact, the Fed has leased, hypothecated or perhaps even sold gold at the Fed stored for Germany and other countries. The Fed agreed to return 300 of the 1500 tons of gold it stores for Germany but said this would require 7 years. Why so long? If the Fed does not have all the gold, it would have to buy it, at market prices, to cover shortages in its accounts; if it has the gold but has leased it or encumbered it in some other way, it would need time to unwind those commitments or let them expire. Further suspicion is aroused by the fact that in the entire year of 2013 the Fed sent a mere 5 tons of gold back to Germany.
With the growing demand from consumers worldwide for physical possession of gold, and with Shanghai deliveries consuming effectively all of mine production, the market is very tight. Suspicions have arisen that increased demand for physical delivery for futures contracts at the Comex in particular (and perhaps in London) will exceed the exchange warehouse supplies of deliverable gold. 

Paul Craig Roberts, a former assistant secretary of the U.S. treasury, says, “One day the Chinese will buy 100 tons of gold, and we won’t be able to make delivery.  That would crash the system.  It would just pop.”

In that case the exchange would be forced to settle the futures contracts for cash, which it is legally allowed to do. But the consequences to the dollar will be enormous. There will be a decoupling between paper gold and the physical metal. I believe metal will win. This means the gold price will be determined by trading in the metal itself, not in paper transactions that are subject to manipulation as explained by Alan Greenspan in order to give false value to a fiat currency by driving down the gold price.

There will be a tremendous loss of confidence in the dollar. The workings of the Fed will be exposed, and more confidence will be lost, not just in the Fed and the dollar as a currency—but in its role as the world's reserve currency.

As I explained in my latest book, The Impending Monetary Revolution, the Dollar and Gold, events have been chipping away at the dollar's reserve status for some time. In 2011 China and Russia agreed to trade with each other in rubles and yuan, rather than dollars. China has bilateral currency swap agreements with at least 13 other countries. China has trade and investment agreements with Singapore and Korea as well as faraway countries such as Belarus and Iceland. Japan agreed to hold some of its foreign currency reserves in yuan and to issue yuan-denominated bonds in mainland China. Indonesia did the same thing. I even speculated that we may see petro-yuan replace petrodollars in the oil market.

Recently the BRIC nations (Brazil, Russia, India and China) have agreed that trade among them will no longer be in dollars. These are all large countries with sizable populations and all, except possibly Russia, have growing economies.

Now let's look at possible effects of the Ukrainian situation. Russia supplies gas not only to Ukraine but to many countries in the European Union via pipelines through Ukraine. It supplies 30% of Europe's natural gas. For several countries, it is their sole source of supply, and alternative sources of supply are not available. The government in Ukraine is on the verge of bankruptcy and will need international financial aid to survive. The IMF and various nations are trying to arrange this. But most of the money Ukraine owes it owes to Russia, and if those bills aren't paid, Russia can shut of the country's imports of gas. (It has done so in the past.) Any funds that are given to Ukraine will quickly end up going to Russia for past debts.

As a result of promises made between the U.S. and Saudi Arabia back in the 1970s, the Saudis agreed that all energy contracts would be settled in dollars. The petrodollar has been a major factor in maintaining the role of the U.S. dollar as the world's reserve currency. Europeans pay for their gas from Russia with dollars.
U.S. and various other nations have imposed economic sanctions on Russia over Crimea and may impose more. Will sanctions prevent European nations from buying oil and gas from Russia? Of course not. It is in everyone's interest to keep Russian gas flowing through the pipelines.

It is unlikely sanctions will alter Putin's behavior, but if they become too onerous, they invite a devastating retaliation from him. What if he tells those gas-buying countries, “OK, you can pay for Russian gas in any currency other than dollars”? That would be the end of the dollar as the world's reserve currency. The exchange rate of the dollar would plummet, the price of gold would skyrocket, and the Fed would be powerless to defend the dollar against it as Greenspan envisioned. The effect in the U.S. would be catastrophic, particularly on the New York stock exchange.