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More Evidence to Back Our Low Interest Rate Forecast

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More Evidence to Back Our Low Interest Rate Forecast

Posted on 28 July 2014 by Kris Sayce

For some time we’ve tried to convince you that interest rates are staying low.

In fact, there’s a good chance interest rates could go lower.

It’s not a popular view.

Most people seem to think that interest rates must go higher one day.

And they will. But that day won’t be tomorrow, or next year. It won’t be five years from now either, or 10 years.

Our bet is that interest rates will stay low for at least another 20 years.

And thanks to news out last week, we figure the evidence is lining up on our side…

Last week the big four Aussie banks cut interest rates on fixed rate loans.

The mainstream press said it signalled a price war due to competition.

Not surprisingly, the mainstream has gotten it wrong…again.

The idea that there’s competition in the Aussie banking sector is laughable.

The big four banks control 84% of the Aussie mortgage market. The Aussie banking sector has favoured status. It has the gift of oligopoly from the Aussie government.

In short, it’s a legalised cartel. The banks don’t compete. They don’t have to. They know that for every customer they lose to a ‘competitor’, they gain one back from one of their ‘competitors’.

It’s the ultimate revolving door as punters go from one bank to the next. Little do they realise that each big four bank is just as good/bad as the other.

So don’t fall for the junk that competition is pushing down home loan costs. That has nothing to do with it. Here’s the real reason that banks are cutting interest rates.

Two reasons banks are cutting rates

Actually, there are two reasons for this move.

The first is that the banks know what we’ve known for the past three years — that interest rates are staying low for the foreseeable future.

By foreseeable future, we’re talking 20-plus years.

A report in The Australian quotes Clive van Horen, head of mortgage lending at NAB:

This is not about me or somebody else predicting what interest rates will do. It’s more about what the financial markets are saying. The market is saying that rates are going to be lower for longer.

Lower for longer.

Don’t fall for the bank’s coyness. It is the banks’ job to predict what interest rates will do.

If the bank can anticipate what the market or the Reserve Bank of Australia will do next, it could result in billions added to the top and bottom line.

So by cutting fixed interest rates, the bank hopes to entice borrowers into taking out fixed rate mortgages. If borrowers fall for it, the bank will get a nice profit boost if — as we expect — interest rates fall further over the next two years.

But as we said, there’s a second reason for the banks to cut interest rates.

The Australian report refers to it:

The price war has erupted just as concerns were starting to emerge that the boom in house prices — they are up 11 per cent on average over the past 12 months, according to Australian Property Monitors — poses risks for borrowers.

Unlike elsewhere in the world, Aussie house prices didn’t fall when economies collapsed in 2008.

Sure, highly leveraged and speculative markets such as the Gold Coast and parts of Perth suffered, but there wasn’t a widespread downturn.

Now, with Aussie house prices gaining 11% over the past year, the banks are no doubt worried what could happen if prices fall and if fewer people borrow to buy a home.

After all, if house prices rise, it means borrowers need to borrow more money. If incomes don’t keep pace with rising prices, it makes it harder to borrow. So, what’s the solution?

That’s right, a lower interest rate means lower repayments — or that borrowers can borrow more money and help support high house prices.

The solution to low interest rates is lower interest rates

That’s why the banks are really in a hurry to cut interest rates.

Don’t fall for the idea that it’s all about competition. That’s the last thing they have to worry about.

But whatever it means, the most important thing for you to know is that this market is playing out almost exactly as we predicted.

When interest rates stay low for an extended period, it’s important that they continue to remain low. Yes, we know that will create all kinds of problems. Low interest rates tend to result in bad investments and the misallocation of resources.

But that doesn’t really bother central banks and governments. They just want to make sure the world’s economy doesn’t go through a repeat of 2008. The one way they can ensure that is by keeping interest rates low.

Do you remember how central banks and governments responded to the problem of too much debt? That’s right, they created even more debt. It only makes sense that their solution for too-low interest rates will be to cut interest rates even lower.

This is exactly why we’re so bullish on the stock market. We’re not saying this will be sustainable forever. That’s why we don’t recommend you put all your money in stocks.

But until we see a sign that the markets have had enough of low rates and that investors are genuinely worried about the long term consequences of these policies, we’re staying the course.

Stocks are still a buy, and the Aussie blue-chip index is still on course to hit 7,000 points by early next year.


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Why the Federal Reserve Wants to Rein in the Stock Market

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Why the Federal Reserve Wants to Rein in the Stock Market

Posted on 16 July 2014 by Kris Sayce

Surprise, surprise.

The market still doesn’t get it.

We wonder if they ever will.

The odds are they won’t get it.

For some reason they can’t see the bigger picture.

They’re too busy looking at their short-term trading account.

That’s why when this stock market takes off again most investors will stand stunned, wondering why they didn’t see it coming…

What is it that has the market so worried?

It’s this comment in the US Federal Reserve’s latest policy report:

Valuation metrics in some sectors do appear substantially stretched, particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.

The Fed would know. Thanks to its money-printing policies many stocks have gone sky-high over the past six years. It’s not just small-cap stocks either.

Big US companies have soared too. The Walt Disney Company [NYSE:DIS] share price is up 443% since March 2009. That’s when the market bottomed out after the crash.

Can the Federal Reserve justify that valuation when Disney’s revenue has only increased 20%, and net profit is ‘only’ up 50%?

Maybe it can. And maybe investors can justify it too in a world of low interest rates. As we’ve argued before, investors will accept higher valuations, higher PE ratios, and lower dividend yields because interest rates are so low.

But there’s a reason the Fed singled out small-caps rather than blue-chip stocks. It’s because this is all part of the grand game we’ve talked to you about for the past year.

The Federal Reserve goal is slow and steady growth

The game is simple. The Federal Reserve and other central banks want to continue fiddling the market.

They want stocks to keep going up. But they don’t want them to go up too quickly. If they did that they would risk creating a huge asset bubble.

Instead, they want to achieve steady market growth. Annual gains of 5­–15% are probably what they’ve got in mind. That’s high enough to keep investors happy, without them worrying about a price bubble. And it’s high enough to make sure investors don’t become disappointed with stocks.

Because disappointed investors can quickly lead to falling stock prices. And the Federal Reserve doesn’t want that…unless the price falls are under the complete control of the Fed.

That’s what the Federal Reserve Bank is doing right now. After the Dow Jones Industrial Average hit a new high, the Fed wants to make sure investors don’t get too excited. If they can drag the market back during the northern hemisphere summer, it will ensure the market isn’t at a high point in October.

And you know what happens in October. That’s when every commentator and their dog start talking about a correction or a crash. It’s harder to spin that story if stocks aren’t at a high.

Central banks have a ‘good’ record

After that point, well, the market is in the home straight for the fabled end-of-year stock market rally.

Of course, some folks will claim this is just conspiratorial rubbish.

They’ll say the folks at the Federal Reserve aren’t that smart. They’ll say they aren’t that devious. They’ll say it’s not the job of the central bank to do that.

To those folks, we just look them straight in the eye and say, really?

This is exactly what central banks do. It’s not the first time they’ve tried it. And in all honesty, they’ve got a pretty good record of doing it. When it comes to central bank intervention most people tend to focus on the negatives.

They point out how the market crashed in 1929, 1987 and 2008 due to undue central bank influence. Whether that’s meddling with the Gold Standard, interest rates, inflation, or printing money.

But what they tend to ignore is the 98% of the time that central banks have ‘succeeded’. The Federal Reserve is partly responsible for the 40,000% rise of the Dow Jones Industrial Average between the early 1900s and today.

We’re not saying we approve of their policies. We’re just saying that’s how it is.

As much as we don’t like admitting it, the megatrend of American Supremacy wasn’t all about innovation and entrepreneurs. It was about governments and central banks fiddling with the economy. It created booms and it caused busts.

That, dear friend, is what central banks do. Don’t let anyone ever tell you otherwise.

Megatrend opportunity

But it’s not just America playing this game.

Everyone’s at it.

As you may know, we’ve just launched a premium investment advisory that seeks to help investors profit from the kind of megatrend that saw the Dow Jones climb 40,000% in 100 years.

Except, we don’t believe that investors will have to wait 100 years to get a payoff from the next megatrend.

This megatrend is happening now. And thanks to improved transport, communications, and technology, megatrends can happen at a much quicker rate.

Where it took the age of American Supremacy more than 150 years to run its full course, our bet is the current megatrend will deliver the same kind of riches (perhaps more so), but within 10 or 15 years.

That’s the power of the megatrend that’s building right now. The policies that emerging market economies like China are putting in to place are exactly the same as those used by Western economies over the past 100 years.

That’s not to say it’s all money-printing and stimulus. As emerging markets analyst Ken Wangdong recently revealed in an on-camera interview, there is plenty of innovation in China. It’s even developing its own Silicon Valley.

Chinese entrepreneurs are now choosing to stay and innovate in China rather than move to the US, because they know they have a competitive advantage over foreign companies when it comes to selling to the Chinese market.

This is how it is, make it work

We know. This kind of talk scares a lot of investors. We hear them say all the time that they’re prepared to sit on the sidelines and ride out the storm. They’re waiting for the market to return to normal.

Well, we’ve got some late breaking news for them: this is normal. This is how it has been for 100, 200, 300 years. Heck, manipulation of money and markets goes back millennia.

To think that things used to be different or that they will be different in the future is naïve at best and plain ignorant at worst. This is the market. It has always been like this and it always will be like this.

It’s up to investors to recognise it and take the opportunity to profit from it in any way you can.


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Here’s Why Investors Shouldn’t Worry About Stocks…

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Here’s Why Investors Shouldn’t Worry About Stocks…

Posted on 02 July 2014 by Kris Sayce

The financial world is a tale of two halves right now.

One half is optimistic about the future.

The other half is worried about the future.

You know where we stand. We’re bang at the forefront of optimism.

Not because we’re hopelessly ignorant of the world around us. Far from it.

Rather, it’s because we know exactly what’s going on. And because of that, we know the best way for investors to play it…

But it’s one thing to be optimistic. It’s something else to be downright delusional.

And trust us, there are plenty of delusional investment professionals out there.

Those are the folks who really don’t have a clue what’s going on.

They either think everything is just fine because governments and central banks have saved the day, or they think the market is going through a bit of a rough patch, but things will return to normal soon enough.

But things won’t return to ‘normal’. The world economy is changing. And if those folks don’t realise that, they’re in for a big surprise.

Don’t get lost in the ‘ennui’

Humans are naturally bad at predicting change.

That’s not to say that humans can’t adapt to change, because they can. Arguably, humans are excellent at adapting to change.

But predicting change and adapting to it are different things.

Most people find it hard to predict change because it’s hard to see things changing around you when you see them all the time.

For instance, when you see your kids every day, you don’t notice how much they’re changing. It’s only when you see a photo of them from a year ago and compare them to today that you can see the change.

That’s why — don’t be offended — most investors make lousy investors. They see that things turned out fine in the past and so they assume things will be fine in the future.

And when we say ‘most investors’ we’re not just talking about the average private retail investor.

We’re talking about investors of all shapes and sizes, including the biggest of the big fund managers.

An example of this was a report from Bloomberg quoting one of the top research boffins at HSBC:

“There is an optimism bias, largely reflecting an attachment to pre-crisis growth trends which, post-crisis, have mostly remained out of reach,” according to a report published last week by the team led by Stephen King, HSBC’s global head of economics and asset-allocation research. “Our latest projections are consistent with this sense of ennui.”

Perhaps like us, you use ‘ennui’ all the time in conversation too!

OK, we admit it. We had to look it up. Ennui means ‘a feeling of listlessness and dissatisfaction arising from a lack of occupation or excitement.

Blimey. That’s depressing. Things aren’t that bad are they?

Investing is predicting

According to Bloomberg it has been a tough few years trying to predict the markets:

‘[HSBC’s] economists found that since the crisis their industry’s average estimate of inflation proved off by at least 1 percentage point in the U.S., U.K., Sweden and Spain and by 0.7 point in German. Those are big misses given that most major central banks target 2 percent inflation.

Oh dear. The life of a forecaster.

But we shouldn’t mock. Making predictions is a big part of investing. You’ve got to predict. Otherwise, you can’t invest. Every investment you make is the result of a prediction.

You buy a stock because you predict it will go up. You sell a stock because you predict it will fall. But here’s the thing: It’s impossible to get every prediction right.

It just can’t happen. Sometimes you’ll get things wrong. That’s all a part of investing.

We don’t even need to go into detail about why they’ve got things so wrong. It’s simple. They’ve failed to see that the market is changing. They’re looking for opportunities in the wrong place.

There may be plenty of ‘ennui’ in the US, UK and Europe. But there isn’t much ‘ennui’ where we’re looking.

Things are pretty exciting in some areas of the market…

This boom hasn’t even started

It just so happens that another story on Bloomberg shows the HSBC analysts where they should really focus their attention:

Emerging-market stocks rose, posting the biggest quarterly gain since 2012, as signs of a revival in economic growth lured investors. Bulgarian stocks surged the most in the world, rebounding from last week’s five-month low.

The MSCI Emerging Markets Index advanced 0.4 percent to 1,050.78 in New York, extending its increase this quarter to 5.6 percent. The measure has risen for a fifth month, the longest rally since 2007.

Really, who cares about Swedish inflation rates when you’ve got exciting stories and opportunities to tell in emerging and frontier markets, the tech sector, biotech sector, and even energy stocks?

They would be better off forgetting the inflation forecasting game and look at exciting economies, sectors and companies. They should try to get inside these subjects to find out the strengths and weaknesses.

What is it about the economy that could make it boom? What is it that could cause it to go bust? And most importantly, if you make an investment in the market aligned to that economy, what kind of returns could you make?

If it’s a high growth emerging markets economy, such as China or India, then you’re looking for a big return. If history is anything to go by (as we’ll illustrate in the Megatrend Master Series) then the biggest gains are yet to come.

Look at the opportunities. Take China. The US economy grew for another 124 years after it gained the top spot as the world’s biggest economy from Britain in 1890.

China’s economy only really began to motor in the 1990s. It’s still only half the size of the US. How can that not be an opportunity?

And the mainstream wants you to believe China’s economic growth has ended.

Give us a break. This boom hasn’t even started.


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The Real Reason Central Banks are Buying Stocks

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The Real Reason Central Banks are Buying Stocks

Posted on 19 June 2014 by Kris Sayce

Are we wrong or is everyone else wrong?

Can we see things no one else can see?


We’ll start believing we have unworldly powers if this carries on.

Perhaps your editor is the ‘chosen one’ of financial forecasting.

OK. We don’t really believe that. We don’t really have special powers. It’s just that the rest of the market appears to have gone completely bonkers.

Despite all the clues, they just can’t see what’s really going on with this market. We don’t know why. It’s simple…

We’re not kidding. This market has taken by surprise some of the smartest minds in the financial markets.

Take this report from the Financial Times:

Like many investors, Mr Hasenstab [portfolio manager at Franklin Templeton] was wrongfooted by this year’s unexpected fall in US Treasury yields; also like many others, he has yet to find a single convincing explanation.

Is it really that hard?

What more convincing do these folks need other than the fact that central banks are using every power they have to keep interest rates low.

And by every power, we mean it.

How can this surprise anyone?

Governments and central banks simply can’t afford for interest rates to rise too high. The higher interest rates go, the more interest governments have to pay on new debt.

In the past, governments would have to grin and bear these interest rate fluctuations. As odd as it may seem now, the threat of higher interest rates forced governments to be cautious about going into too much debt.

We know that seems crazy. Because at the time government debt levels seemed high. Of course, that’s nothing compared to where they are now. Even the Aussie government is now in hock for $320 billion. Just six years ago the federal debt level was around $60 billion.

The five-fold increase in debt levels by the Aussie government is among the biggest debt increases in the Western world.

So with all this in mind, how can it surprise anyone that central banks and governments would do all they can to keep interest rates as low as possible?

As the chart shows, the US 10-year bond yield is already well above where it was from 2011 to 2013 during the height of the US money printing program:

Source: Bloomberg
Click to enlarge

Our bet is the US Federal Reserve won’t want interest rates going too much higher, as each tenth of a percentage point rise adds US$62 billion to the US government’s interest bill.

So even though all the talk is about the end of money printing, don’t let that fool you. The experiment in low interest rates isn’t over by a long shot. And now it’s taking a new turn.

‘Buying’ the entire Australian stock market

Another report in the FT reveals the extent to which central banks are going to keep interest rates low:

Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions.

The report suggests that central banks have increased stock holdings by US$1 trillion in recent years. That’s the rough equivalent of buying nearly every stock listed on the ASX.

It’s a big number.

But we dare say the report misses the mark. The inference is that central banks are buying stocks because they aren’t making enough money by holding bonds.

While that may be partially true, it’s not the real motive for central banks to buy stocks. In the world of big institutional investing, it’s important to understand the relative yields between different investments.

In investing, everything is about risk. Typically, big investors will compare the yield of a so-called ‘risk free’ government bond with that of the yield on a stock. If the difference between the bond yield and the stock yield isn’t big enough to warrant the risk, then investors may choose bonds over stocks.

If the spread between the stock yield and the bond yield is unusually large, then it may suggest stocks are cheap, and therefore the investors will buy stocks.

Can you see where we’re going with this?

It’s all about the relative yield

The simple fact is that if the central banks want to exert as much control as possible over bond yields they can’t just buy government bonds. They have to buy other assets too.

That’s why they bought mortgage-backed securities — to bring those yields down and make them less attractive investments compared to government bonds.

We dare say the central banks are directly or indirectly involved in buying ‘junk’ corporate bonds too — to bring those rates down so they are nearly on par with government bond rates.

The same goes for stocks. If the central banks can manipulate stock prices higher, and therefore manipulate dividend yields lower, it also reduces the spread between bond yields and dividend yields.

The narrow spread between the two makes the ‘risk free’ government bond a far more attractive investment for big investors compared to the riskier stocks.

Of course, what happens when investors sell stocks to buy bonds? Doesn’t that push stock prices down? Yes, it does, until stocks fall by enough to make the slightly higher yield more attractive, and then the stock price rises again.

In effect, the goal of the central banks isn’t necessarily to become big stock owners. Rather, it’s to manipulate the market and create a ‘new normal’ level for interest rates and dividend yields.

So far their plan appears to be working. Like it or not, agree with it or not, stocks have had a good run as this policy has played out. It will end in a bad way at some point. But not yet.

We see no reason why it won’t continue for years to come. And that’s why it makes sense to buy stocks during a short term dip.

It amazes us that so few others can see what’s really happening in the markets.


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How to Beat the Central Banks: Sell Cash, Buy Stocks

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How to Beat the Central Banks: Sell Cash, Buy Stocks

Posted on 17 June 2014 by Kris Sayce

There are two ways to lose money — loudly or quietly.

If we have to lose money, our preference is to lose it loudly.

If we’re losing money, we want to know about it.

We want it to be a reminder to not do something stupid.

You should feel that way too.

The worst way to lose money is quietly. So quietly that you don’t even know it’s happening.

But it’s the approach some of the world’s most influential people are lobbying for right now…

Of course, no one wants to lose money.

Given the choice between winning and losing, only a lunatic would choose losing.

The only instances we know of folks being happy about losing money is in the movies — The Million Pound Note, Brewster’s Millions and the musical Springtime for Hitler in Mel Brooks’ hit movie The Producers.

That’s the movies. Most normal people would pick winning money every time.

But then ‘normal’ isn’t a word you can use when it comes to talking about central banks.

The opportunity cost of losing money quietly

When it comes to losing money quietly there are a number of ways to do it.

One way is to buy a big blue-chip stock and then watch it slowly drift lower and lower over time.

You won’t sell it because it’s a blue-chip.

You don’t want to sell it because you’re not a ‘trader’. You’re a buy and hold investor.

And you don’t want to sell because it will cost you in commissions. In effect you decide that you’d rather lose $1,000 by staying in a dud stock than spending $20 in commission to sell the dud stock.

So you’ll stay with it…and stay with it…and stay with it.

Before you know it, over one, two or three years a big chunk of your portfolio has gone nowhere. Or worse, it’s gone down.

That’s especially bad news in a rising stock market. They have a fancy term for that in economics — opportunity cost.

The opportunity cost of holding on to a dud stock is that you potentially miss out on investing in a better stock.

That’s a bad way to lose money. But there is a worse way. It’s the way the International Monetary Fund (IMF) would like you to lose money.

A banker’s best friend

The IMF is the ‘central bank of central banks’.

It’s a United Nations organisation full of busybody economists and bureaucrats. They think they can direct the economy by pulling levers and pressing buttons.

Their favourite ‘lever’ is to print money.

Their favourite ‘button’ is to encourage price inflation.

This report in The Australian explains what we mean:

The International Monetary Fund has refreshed its call for central banks to raise their inflation targets to 4 per cent, arguing the additional inflation would come at little cost while preventing interest rates getting stuck at zero after recessions.

Inflation. It’s the silent killer…the quiet way to lose money without you even realising it.

In fact, we’d argue it’s the quietest way to lose money.

So why do central bankers and the IMF want inflation?

The real reason is that inflation is the bankers’ best friend. Inflation allows banks to lend more money and help ensure that rising asset prices cover outstanding loans.

The banks can then lend more money when the owner sells an asset at a higher price. So as long as asset prices keep going up, the banks are happy.

They don’t like it when loans are high and asset prices are low. That’s what you call negative equity. It means that in instances of distressed selling it’s much harder for the borrower to repay their debts.

That’s bad news for banks. That’s why price deflation (generally falling prices) scares them so much.

But the desire for inflation means something else too…

Priming the market for a boom

It adds more fuel to our central theme, that stocks are going much higher.

The central banks won’t openly say it, but they’re priming the market for an immense asset price boom.

Some folks will say that’s rubbish. They’ll say central bankers have learned the lessons from the past — that a boom ends with a bust.

But that’s the thing. Everyone knows that. However, remember what we said about these people. They aren’t normal. They believe they can engineer a boom and then prevent it from going bust.

Most people have short memories. But this is exactly the same talk that happened during the 1990s, when Alan Greenspan was chairman of the US Federal Reserve Bank.

The Fed thought it could engineer a ‘soft landing’. They thought they could cool the market by gradually raising interest rates.

It turned out the Fed couldn’t engineer a ‘soft landing’. The result was a hard landing as markets crashed in 2000. The same will happen again. But not before stocks complete the final stages of the stock market rally.

That won’t be for a while yet. The central bankers are more worried about stoking the growth fires at the moment. That means low interest rates, more money printing, higher inflation…and higher stock prices.

In short: sell cash and buy stocks. It’s the only way to beat the central bankers at their wealth destroying game.


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Why You Should Ignore the ‘Stock Crash Sniffer Dogs’

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Why You Should Ignore the ‘Stock Crash Sniffer Dogs’

Posted on 04 June 2014 by Kris Sayce

They failed to predict the last major crash.

But that’s OK.

Because they’ve learned a lesson.

They can now see the signs. What they missed last time is happening again. Only this time they’re ready for it.

A crash is coming, and you better be prepared.

Only a crash isn’t coming, whatever the Three Bankers of the Apocalypse may say…

Last week we wrote to you about the NAB strategist who said the lack of market volatility was troubling.

The argument was that because volatility as measured by the VIX volatility index was so low, it must mean a crash is on the way.

But as we pointed out, the analysis was junk. It was also possible to look at the historical chart of the VIX and determine that the low point in volatility occurs roughly halfway through a bull market.

In that case, the current bull market in stocks could have another five years to run — that pretty much aligns with our view that the Australian stock market could triple within the next three to five years.

Even so, the volatility sniffer-dogs are out in force. They can smell the glory of predicting a crash. It’s getting so serious that even central bankers are issuing a warning to investors.

Sniffing out the next crash

Here are the extracts from the UK’s Daily Telegraph that set the alarm bells ringing:

The Bank of England’s Deputy Governor Charles Bean says the lack of volatility is “eerily reminiscent” of the run up to the financial crisis in 2007-2008…

Italy central bank Governor Ignazio Visco issued a similar warning on Friday: “Volatility on the financial markets in the advanced economies has subsided to well below the historic norm, reaching levels that in the past sometimes preceded rapid changes in the orientation of investors.”

In America, Dallas Fed chief Richard Fisher has been warning for several weeks that the decline in the VIX index measuring volatility is an accident waiting to happen.

We won’t claim to be a dedicated central bank watcher. But we’re not sure we’ve ever seen a case of central bankers warning about an imminent asset price crash.

Their usual trick is to insist that prices aren’t high at all…and that even if prices are high, the smart chaps at the central bank can easily engineer a ‘soft landing’.

That’s the cue for a wholesale asset price collapse.

So what do we make of this unusual warning?

Mainstream and contrarians singing the same song

Well, our advice is simple.

We suggest you ignore it.

Yes, that’s somewhat controversial advice. Some may even say it’s reckless advice.

But the fact is the occupation of ‘crash predicting’ is catching. Spotting bubbles and predicting crashes used to be the realm of contrarian investors.

Contrarian investors had a pretty good record at it. They could spot the big trends, the misallocation of resources, and identify roughly when and where the problems would occur.

Unfortunately, over the past six years contrarian investors have fallen into the trap of taking every single vaguely negative event and claiming that ‘this’ would be the next big crash.

Only, that hasn’t happened, because those events were nothing compared to the crash of 2008.

But then something worse happened. The mainstream realised that they could write some pretty good headlines and make compelling stories by getting in on the crash prediction bandwagon.

The result is that they too started to take every minor event and claim that ‘this’ was the next major crash. Only it wasn’t.

So now the investing world is in the strange position where the mainstream and most so-called contrarian investors are pretty much saying the same thing — that markets will crash, and crash hard.

It’s a bank-driven rally

We prefer to see things differently.

Where most investors see nothing but trouble, we see terrific opportunities in almost every market.

Some people will look at the Australian share market and say that it’s expensive because the index is at the highest point since mid-2008. But we’ll make the point that bank stocks have driven much of that rise.

As for the rest of the market, there are still many stocks and sectors trading at multi-year low levels. Take the resources sector as a classic example, where stocks are ready for a bounceback after three years of taking a beating.

Or take retail. Stocks of Harvey Norman Holdings [ASX:HVN], Myer Holdings [ASX:MYR], and David Jones Ltd [ASX:DJS] are well below their peaks. Meanwhile, Commonwealth Bank of Australia [ASX:CBA] and Australia & New Zealand Banking Group [ASX:ANZ] recently hit record highs.

So, folks can keep talking about a coming crash all they like. Just as they’ve been talking about it for the past two years while we’ve told you to buy stocks.

Investors who sat by waiting for the crash must be feeling pretty blue now. They’ve missed out on big gains, especially among a number of fast-growing small-cap stocks.

Perhaps that’s why the bears’ voices are getting louder. They figure after missing out on these gains perhaps all they have to do is just talk louder about a coming crash, and it’s bound to happen.

We wish them luck with that. But odds are, five years from now when the market is about to top out, they’ll have missed out on even bigger gains. If they’re looking for a crash, they should save their voices until then.


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A Lesson for Queenslanders… and Stock Market Bulls

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A Lesson for Queenslanders… and Stock Market Bulls

Posted on 30 May 2014 by Greg Canavan

We read Winston Churchill’s epic book ‘The Second World War’ about 10 years ago. After Wednesday’s epic match between NSW and QLD, we remembered his famous phrase that came at the end of the book:

In war, resolution; in defeat, defiance; in victory, magnanimity

The game deserves a Churchill quote, and it pretty much sums the night up. All players were resolute, Queensland were defiant, and NSW magnanimous. And we’ll be magnanimous in victory too, if only because there are two more games to go.

But Wednesday night was a victory for the underdogs and the bears. For the uninitiated, Lang Park (Suncorp Stadium prior to corporate PR coming into play) at State of Origin time is one of the most hostile sporting environments in the world for the visiting team. It’s been more than a decade since NSW won the first game of the series there. Doing so against the odds was a truly epic performance.

Speaking to Queenslanders before the game…well, they thought they just couldn’t lose. Eight years of victory will do that to you…

There’s a lesson there for the stock market bulls too. Year after year of gains and faith in central banks makes the intellect lazy. You start driving in the rear view mirror and take less notice of the road ahead. 

The focus is on which central bank is doing what and when, rather than seeing the underlying damage that these policies are inflicting on the economy. That’s a product of the media responding to the market, which is responding to the media. Take this explanation of recent action from the Financial Times:

US stocks held close to record highs while highly-rated government bond yields fell sharply as the prospect of continued support from the world’s central banks dominated market action.

‘Expectations that the European Central Bank would unveil a package of policy measures when it meets next week were bolstered by the release of weak eurozone economic data.

Pavlov’s Dog is back…not that he ever left. He’s just left the Fed’s house and shown up on the ECB’s door step. Stronger than expected data in the US economy no longer worries the bulls…but weaker than expected data in Europe is now the catalyst to buy!

Seriously, we’re all going to look back on this period in a few years’ time and ask ourselves, ‘what the hell were we thinking?’ Well, the short answer is that not many are actually thinking. They’re just doing. Which is fine while the going is good…but then it won’t be…what’s the plan then?

Meanwhile in Australia, the housing propaganda keeps on flowing. George Orwell once said (we’re paraphrasing) that the role of journalism is to write what others don’t want you to write…everything else is just PR.

We thought of this when we saw the following headline in yesterday’s Sydney Morning Herald:

Housing affordability best in 12 years thanks to low interest rates, says index

The ‘index’ comes from the Housing Industry Association (HIA) and the Commonwealth Bank, two highly impartial observers of the housing market.

House prices have just experienced a mini boom (thanks to the RBA’s massive interest rate cutting program) and the median house price in Sydney is now around $825,000. Yet the ‘index’ compiled by the HIA and CBA says affordability is best in 12 years? What a joke.

While the HIA’s chief propagandist, economist Shane Garret, acknowledges that Sydney is the least affordable market, he still manages to come out with this…presumably with a straight face:

However, the impact of lower interest rates and continued earnings growth has ensured that home purchase affordability has improved over the past year for existing homeowners and those on the cusp of entering the market in the short term.’

Continued earnings growth? Would that be wages growth at its lowest level in 17 years, which is now below inflation and therefore negative in real terms? What about wages growth per capita?

Look, there’s nothing stopping an industry talking gibberish in order to benefit their bottom line. All we ask is that you take this index’s finding with a grain of salt big enough to choke on.

What else is happening on this victorious morning? Well, there’s a little bit of good and a little bit of bad. On the ‘bad’ front, iron ore prices just hit a new low for the current move. Yesterday the spot price fell to $96.80. The recent bounce in the iron ore majors (specifically Rio and Fortescue) won’t last.

On the ‘good’ front, the value of construction work in Australia for the March quarter beat consensus estimates, rising by 0.3%, compared to expectations of a 0.8% fall. Residential housing construction registered a big gain of 6.8%, offsetting a minor fall in engineering work completed.

But don’t get too excited…engineering construction (which largely represents work related to the mining expansion) is set to fall dramatically next year, reflecting the end of the construction phase of the nations’ various LNG projects. It is highly improbable that housing will be able to take up the slack, given the relative differences of the size of each sector.

And keep in mind that as we head into a new financial year, the stimulatory effect of the RBA’s rate cutting cycle will have largely moved through the system. Does that mean you can expect more interest rate cuts to come in 2015?

We’re leaning towards that outcome, even though consensus says the next move is up.

Our reasoning is that Australia has turned into a debt-dependent economy, and when that happens sustainable, self-reinforming growth is very difficult to achieve. We rely on growing household debt to boost house prices and bank profits, and on growing Chinese debt to underpin demand for resources.

When it becomes apparent that we’re stuck in a slow growth economic model (like our indebted foreign counterparts) the authorities will view monetary policy as the only politically acceptable growth lever.

The question is, will our foreign benefactors continue to lend to us at lower and lower interest rates? That question will become more pressing in 2015.

Greg Canavan+
Contributing Editor, Money Morning

Ed note: The above article was originally published in The Daily Reckoning.

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Satyajit Das on Economic Growth, Interest Rates and Central Banks

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Satyajit Das on Economic Growth, Interest Rates and Central Banks

Posted on 03 April 2014 by Shae Smith

Satyajit Das, a man gifted with a unique insight into financial markets, was welcomed to the stage at the World War D conference on Tuesday. Part of his introduction was a mention that he doesn’t own a mobile phone.

Yes, that’s right. Apparently it’s news if someone doesn’t own a mobile phone.

The crowd politely laughed. Das wasn’t here to talk about technology, so it didn’t matter that he doesn’t own a mobile phone.

What did matter to the audience was Das’s take on the current mess we call a financial system…

Now Das is an entertaining speaker. His turn of phrase and emphasis had the masses laughing almost every minute. But underneath every line to elicit a giggle or snort was a serious message.

As he stood in front of the attendees, he opened with ‘Problems, what problems? We’re rich. Every minute of every day the Dow makes a new high.’

He then bombarded the audience with truly frightening statistics to demonstrate the absurdity of this statement.

Like the fact that Japan’s market is almost 50% below its all-time highs, and Australia’s share market is about 20% below its all times high. ‘But,’ he paused, ‘You are rich.’

Alarming the crowd further were the inflation-adjusted figures for superannuation over the period of 2000–2013.  His calculations show we’re only up 3.51% on average. ‘But again, you ARE rich,’ Das told the room.

If anyone knows how to keep a crowd hanging, it’s Das. From here, no one dared shift in their seat…just in case they missed some valuable information from his rapid-fire presentation.

Americans on food stamps have risen to 47 million today, from 27 million in October 2007. These are essential, he argued, to keep people from rioting in the streets. He may have been joking. But that one line demonstrates two things: The rise in poverty in a ‘rich’ nation and the increasing dependency on the government to provide.

Moving on, Das wanted to ‘…look at the real economy, where they don’t shuffle papers around.’

But looking at the real economy paints a bleak picture, Das noted.

America needs US$1.6 trillion to create US$300 billion dollars of ‘growth’ in the economy. What’s more, debt levels haven’t been this high since the Napoleonic Wars.

Emerging markets, America and the other countries considered ‘rich’, financialised their economies. They spend more time shuffling assets and financial engineering rather than any real engineering.

Increases in debt levels, financial imbalances and entitlement culture were the causes of the crisis Das tells us.

‘The real solution is to reduce debt, reverse the imbalances, decrease the financialisation of the economy and bring about major behavioural changes,’ says Das.

‘But rather than deal with the fundamental issues, policy makers substituted public spending, financed by government debt or central banks, to boost demand.’

What no politician or central banker will ever tell you, expresses Das, is that we need a 30% drop in gross domestic product.

The historically low interest rates also got a mention from Das on Tuesday. This, he reasons, continues to create imbalances in the economy. However central banks have to keep fiddling with the interest rate. Simply because no one in the Western world has sustainable debt.

‘As an example’ Das explains, ‘a 1% rise in rates would increase the debt servicing costs to the US government by around $170 billion. A rise of 1% in G7 interest rates increases the interest expense of the G7 countries by around US$1.4 trillion.’

Without economic growth, you can’t pay back your debt. However, there is no economic growth. So interest rates won’t go any higher for now.

He points out when then Federal Reserve Chairman Ben Bernanke announced QE3 — quantitative easing — Bernanke said himself that it would not significantly increase economic activity directly.

This leads to the relevance, and perhaps stupidity, of central banks.

Forward guidance, he declared is an abused term in the central bankers handbook of doublespeak.

‘Nobody actually believes central banks anymore,’ he declared.

He likens their language to something similar to a Monty Python skit.

One European Central Bank member said last year, that ‘[forward guidance is] a change in communication but not in monetary policy strategy.

Or this, from the current US Federal Reserve chairwoman, Janet Yellen. ‘If I thought that was a situation we will likely encounter in the next several years we would probably have revised our forward guidance in a different way. We revised it as we did, eliminating that language because it didn’t seem at all likely.’

However, Das said, nothing ever lives up to the comments from Alan Greenspan (former Fed Chairman): ‘I know you believe you understand what you think I said, but I am not sure you realise that what you heard is not what I meant.’

Later, Greenspan added: ‘If I have made myself clear then you have misunderstood me.’

Finally, when the crowd stopped laughing, Das reminded everyone that, ‘They get paid to do this.’

After the sledging on central bankers was over, he moved on to how we get out of this mess.

And right now, there is no ‘stage left’, according to Das.

Higher interest rates will crash the economy. And the actual limit of money printing isn’t known yet. Das wondered aloud just how much more the world can handle.

Policy incompetence, ‘pointy heads in financial markets’ and plenty of people talking but not actually saying anything aren’t going to dig the world out of the ongoing financial calamity.

From here, Das reckons there’s no path to normalisation. Perhaps secular stagnation or slow global bankruptcy.

More likely, he thinks we’re looking at a life of financial repression from governments. ‘After all, isn’t the art of taxation to pluck the goose with the least amount of hissing?’

With that, he offered the crowd a tip or two on where to stick their money (hint: it’s not shares). And then told the attendees ‘there’s no way out.’

Shae Smith+
Contributing Editor, Money Morning

PS: We captured Das’s full 90 minute presentation on tape. You can find out how to watch it, plus more than 15 hours-worth of other intriguing material and financial insight from the conference, here.

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Faber, Rickards, and Duncan on Deflation, Inflation and Interest Rates

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Faber, Rickards, and Duncan on Deflation, Inflation and Interest Rates

Posted on 02 April 2014 by Callum Denness

After the discussion on Bitcoin, China and liberty at World War D, the international keynote speakers, Marc Faber, Jim Rickards, and Richard Duncan continued answering questions on delfation, inflation and interest rates.

You can read a summary of the discussion below, or go here to find out how to see video of the full discussion.

Deflation, inflation and stagflation

If the energy boom, technology boom, and globalisation is deflationary, asked Jim Rickards, how can the US pay its debts?  ‘Remember deflation increases the real burden of debt, so if you can’t pay them off today when can you?‘ The forces of deflation are powerful, the necessity for inflation is powerful, but what will happen is a near instantaneous collapse in confidence in paper money and a flight to hard assets, he said.

Faber’s diagnosis was much the same. ‘Inflation and deflation can co-exist, especially in a money printing environment.‘ For example, he argued that gold and precious metals have been in a deflationary phase, as have real wages, for the past 20 years or so. Asset prices however have been in an inflationary phase. Faber’s warning: every inflation phase will sooner or later come to an end. The question for investors is when it will happen. ‘We have a global festival of money printing,‘ he said to much laughter. ‘It’s going to end badly, we just don’t know when.

You can see and hear Dr Faber’s comments on video. Click here to find out how.

Richard Duncan agreed the outlook is uncertain. ‘This is being managed by the government. We don’t know who the government will be five years from now,‘ said Duncan, which means it’s difficult to predict what will happen.

To manage this risk, the panel agreed on the need for a diversified portfolio of cash, quality stocks, and gold. Richard Duncan added:  ‘I would borrow money at fixed interest rates to buy property. The property I would buy is land with lots of houses on them.‘ Like gold, land is scarce and as long as owners aren’t too leveraged they will always make money from rents, even in a depression.

Mark Faber also added: ‘I would choose the stock part of my portfolio very carefully. If you look hard there is always something somewhere that is depressed, and always something somewhere that is in fantasy land.

Jim Rickards also thinks buying up currencies is a good idea, naming the euro, Canadian dollar, Korean yuan and Singapore dollar. He has been a defender of the euro because it’s a de facto German currency. ‘The euro is the deutschmark in drag so to speak,‘ he said.

Interest rates

On the question of locking in fixed mortgage rates, Mark Faber argued that interest rates move in long cycles of 45-60 years – and with effective rates in the US at zero for last five years we have to assume we’re nearing the end of the interest rate downturn. Any interest rate rise will affect the value of assets. ‘I’m convinced in my life I will see the day when my asset values drops 50%,‘ he said.

Speaking on the uncertainty of data that underpins interest rate decision, John Robb argued economic conditions are much worse than central banks and governments are reporting. ‘What we’re seeing on the ground in the US is a lot more dire. Jobs are evaporating faster than they’re being replaced. That’s why so many [people] end up at retirement without any savings at all, and it’s going to get worse and worse.

I don’t find any discussion of IR [interest rates] useful unless you’re talking about real and nominal. The way I look at it IR are at an all-time high,‘ added Jim Rickards.

And that ended day one. You can catch the events from days one and two here.

Callum Denness
Roving Reporter for Money Morning at World War D

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Why Regulation from the Central Banks Never Works

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Why Regulation from the Central Banks Never Works

Posted on 28 March 2014 by Bengt Saelensminde

Like army generals, the senior financial regulators are always fighting the last war. Here’s how the game works:

The regulator recruits some low-ranking bod from London to tell them what they need to know about the dastardly banks’ various nefarious schemes…

The big London institutions recruit high-ranking bods from the regulator…

Then the new recruits tell the banks exactly what they can and can’t get away with. And exactly how they should push the envelope.

It’s a ‘revolving door’ of staff succession between the central banks and the finance industry. It means the regulator is indeed, always preparing for the last battle. The bigger chequebook offered by the banks ensures they are always one-step ahead of the shoeshine.

I was catching up with an old mate the other week and together we lamented the regulatory environment (yes, these are the sorts of conversations old bores like us have for fun!)…

Well, Bengt, surely the regulator needs to be beefed up. They need to spend bank-level salaries and get hold of the top talent to keep this industry in check!

No, no, no…‘ says I. ‘What we need is anarchy…

Regulation just doesn’t work

In the run-up to the 2007/08 crisis, regulation failed. It’s practically bound to. When it comes to banking, we’re dealing with big-money power brokers.

There’s also the nature of global capital markets. If you don’t like the regulation in one country, then shift operations to another. That’s a powerful tool oft used by the banks. London, in particular, has benefited from open financial markets. Successive governments have kept EU regulation at bay, shielding our banks from legislation emerging from Brussels.

The point is it’s extremely difficult to regulate effectively. Either the banks won’t have it, or they’ll continually adapt to new legislation.

But the worst of it all is the uncanny ability of the regulators to score own goals.

Take the highly topical annuities furore here in Britain. Regulation has long-since been established to ensure pensioners (or the pension managers) don’t whittle away individuals’ savings as they go into retirement. The regulators decreed that most retirees on a private pension will have to buy an annuity (an income for life policy).

An IFA mate was just telling me how just about everyone she’s put into annuities over the last year has opted for a non-inflation linked policy. Nobody wants to buy an inflation-linked policy paying a pitiful £3,000 a year, for every £100,000 invested. Instead, they buy fixed annuities paying something like £6,000 on £100,000 invested.

These retirees could be alive for 30 years or more. Given the central bank’s monetary experimentations, these annuities could become all but worthless.

This is the law of unintended consequences…and it has an uncanny way of popping its head round the regulators door. So I was encouraged to see MP George Osborne breaking out of this way of thinking in his budget last week.

The government’s radical move

In the light of Osborne’s budget announcement to vastly scale back annuities, the insurance industry is up in arms. But with the government’s swift action here, it seems the industry didn’t have time to dispatch its lieutenants.

The industry is crying ‘foul!’ They say retirement funds will be whittled away. ‘Regulation is there for a reason you know!’

But their argument hides the truth. And that is, regulation is used by the big boys to protect their own interests and their carefully groomed markets. It adds reams of complexity to finance, maintains the status quo and thwarts competition.

The current system of regulation strips individuals of responsibility and hives it off to an industry highly undeserving of our trust. It all too often allows the industry free rein to siphon off vast sums of our money. A) Because somebody has to pay for all the compliance staff in the first place. And B) because the regulation hinders competition in the savings market.

Explanation, not regulation

I like the idea of simplifying finance. Simplifying pensions. Making it easy for people to understand and to look after their own finances by demystifying the industry. And yes, that means less complicated regulation. Explanation, not regulation.

The NHS has a very useful online flow-chart that helps individuals identify and help treat symptoms. The government could set a similar flow-chart for the health of an individual’s finances.

Let the investing public work it out for themselves. In so doing, I suspect many will be much more realistic about their retirement savings policy too.

But, I hear you cry, ‘Who’s going to look after individuals and make sure they don’t just get ripped off?’

Now, while that’s a concern, I don’t think it’ll be as considerable as you may think. Given today’s vast information network, it wouldn’t be too difficult to weed out the industry’s nasties. If eBay can set up a decent enough system to identify shamsters, then why can’t a government website do the same?

And anyway, it’s not as if there aren’t enough investment scams going on even in today’s regulated markets. I dare say many individuals are conned into land banking schemes, diamond investment fraud and dodgy wine investments because they think that the regulators are policing the whole system. Individuals put too much faith in the system.

Better to be honest about it. Osborne needs to go further. He needs to further demystify the financial system and let individuals get on with their own investments. That would open up the financial markets to more simple investment products that investors understand. Because I firmly believe that with a little help, investing is something anyone can manage on their own. While unregulated, the system would be an awful lot safer than what goes on behind the closed doors of today’s highly regulated investment banks!

Your money. Your look out!

Bengt Saelensminde,
Contributing Editor, Money Morning

Ed note: The above article was originally published in MoneyWeek.

From the Archives…

Hashing Out the Iron Ore Price
22-03-14 – Shae Smith

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Why You Should Start Buying Into The Australian Share Market Now

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Why You Should Start Buying Into The Australian Share Market Now

Posted on 25 March 2014 by Kris Sayce

Here’s something that won’t surprise you.

Or rather, it shouldn’t surprise you.

If it does surprise you then you really haven’t been paying attention.

What’s the big non-surprise?

Stock markets are risky. And yet it seems as though some of the smartest people around are only just starting to figure that out…

It’s funny how different people react to the Australian share market.

We’ve warned for well over three years now that the stock market is risky.

But we also warned that despite the risks of investing, it was a bigger risk not to invest.

With interest rates at record lows it’s quite frankly almost impossible to get a decent return without using leverage on any investment except stocks.

And this risk in the Australian stock market isn’t about to end anytime soon, even though the central banks would have you believe that interest rates will rise within two years. That’s hogwash.

Interest rates aren’t likely to go up within the next five years. And they may not even go up in your lifetime. That’s why we’ve made a bold call for the S&P/ASX 200 index to hit 15,000 points – more than triple where it is today .

Did they miss the past six years?

And yet a bunch of commentators still can’t seem to grasp the idea that this is and has been a risky market.

It’s as though they’ve lived in a bubble for the past six years, totally unaware of everything that has happened.

Take this op-ed in the Financial Times from Mohamed El-Erian, the chair of President Barack Obama’s Global Development Council, and a former big shot at PIMCO, the world’s biggest bond fund:

Markets have been sanguine about geopolitical risk for several years now, a phenomenon illustrated by the relaxed approach they have taken to Ukraine’s crisis. There are understandable reasons for this, but contrary to a popular saying, this could well be a case where the trend is not necessarily the markets’ friend.

After just one day of extreme nervousness, global markets had little problem digesting a major change in the map of eastern Europe. And Crimea’s annexation is not the only notable development in a crisis that has repeatedly surprised quite a few experts.

We have to say it. Is Mr El-Erian kidding?

He says share markets have been ‘sanguine‘ about geopolitical risk. In other words, he’s saying that markets have been happy or satisfied about the risk in the world.

He’s got to be kidding. Didn’t he notice the hullaballoo and ruckus about Libya, Syria, Ukraine, North Korea, China, and any other number of crises that have reared up since 2008?

We listed 19 such problems just a few weeks back. Granted, they weren’t all geopolitical events, but let’s be honest, there’s a superfine line between geopolitical and economic risks. One has a nasty habit of turning into the other.

And yet, so far nothing has happened. 19 crises and counting since 2008, and the result? Most stock markets worldwide have gone up. One exception…one big exception is China.


PS: If you can’t make it to Melbourne for our World War D conference on March 31-April 1, don’t worry. We’ll be live tweeting the event throughout the two days. To get all the action live, follow us on Twitter @MoneyMorningAU

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Are Central Banks Losing Relevance?

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Are Central Banks Losing Relevance?

Posted on 05 February 2014 by Kris Sayce

‘At the same time, with resources sector investment spending set to decline significantly, considerable structural change occurring and lingering uncertainty in some areas of the business community, near-term prospects for business investment remain subdued.’

Monetary Policy Decision, Reserve Bank of Australia

After nearly six years of central banks dominating the business pages, and terms such as ‘the Fed’, ‘the RBA’, and ‘Bernanke’ getting more than their fair share of use, we can only look back on yesterday with fondness.

You may think that’s an odd reaction, seeing as the S&P/ASX 200 fell 90 points. That was the index’s biggest drop since June last year.

So what was it that brought a smile to our face even while stocks fell?

It was the possibility — however slim — that maybe things are returning to normal…

Last year we set a target for the main Aussie stock index to hit 7,000 points. Our prediction was that the index would get to that mark in early 2015 (say around January or February).

Part of our rationale was that the continued money printing from central banks and record low interest rates would provide a ‘money torrent’ of fresh cash helping to push up stock prices.

We weren’t the only one to hold that view. Dr Marc Faber, keynote speaker at our upcoming World War D conference in March, calls the US Federal Reserve’s latest round of money printing ‘QE Infinity’.

That was a reference to the fact that the plan didn’t have a fixed duration or end date.

But maybe now it’s time to change that view. That doesn’t mean we’ve ditched our 7,000 point target for the ASX — far from it. But maybe now the driving force behind the stock market’s rise is no longer the central banks.

Cashed-up Miners

At the top of this letter we printed a quote from the latest Reserve Bank of Australia monetary policy decision statement.

We’ve printed it for two reasons.

First, it supports an argument made by analyst Jason Stevenson. He’s made it pretty clear where he stands on where the mining sector is going this year.

His view is that the mining sector is moving from an investment phase into a production phase. If you read the RBA statement it sounds like that’s a bad thing. But it’s not. In fact, it’s the opposite of bad.

A shift from the investment phase to a production phase means there are a whole lot of beaten down mining stocks that will soon have stacks of cash flooding into their bottom line as explorers become producers.

This will give investors the clearest indication they’ll have gotten in 10 years on whether a company’s management is all talk and no action. One of our biggest criticisms of the mining sector is that a company’s breakthrough project always seems to be ’18 months from production’.

Just as tomorrow never comes, for many mining companies production never comes either. But if investors become fussier about where they’ll put their cash (and by investors I mean the institutions providing direct funding on projects) it likely means investment dollars will migrate towards the most viable and potentially profitable projects.

That’s actually good news for retail resource investors, and flies in the face of the mainstream rubbish about the end of the resources boom.

And that’s why Jason is focusing most of his attention on the companies that have the greatest chance of turning exploration projects into production projects.

But that’s not the only reason to be positive about the markets…

If Bad News is Bad News, Then Good News Should be Good News

As we said, there is another reason to be positive. In fact, this is what cheered us the most. It wasn’t until 2.20pm yesterday afternoon, 10 minutes before the Reserve Bank of Australia was due to release its statement, that we remembered the RBA board was meeting.

(Incidentally, the RBA decided not to change the current Cash Rate.)

How different that was to even a year ago? Back then it seemed as though everyone was waiting for the RBA decision with bated breath. We even remember a few years ago when Sky Business channel had a countdown clock as a gimmick leading up to the RBA decision.

We haven’t watched Sky Business channel in years, so maybe they still do the countdown thing. It’s a pretty sad state of affairs when the only thing driving the market is the actions and comments of the grey suits in Martin Place.

Maybe it’s just your editor who had this feeling. But if you add this to the previous day’s action on Wall Street, where bad economic news actually translated into bad stock market news, perhaps investors should see this as a positive sign.

It’s always dangerous to use one or two events in order to formulate an entire investment strategy. But you’ve got to start from somewhere. For over a year we’ve based our entire theory of a soaring stock market on the belief that central banks will keep printing money.

There is of course an alternative: rather than central banks boosting stocks to 7,000 points, what if the boost comes from investors pouring money back into the market in the belief that a genuine recovery is underway?

It’s a crazy idea. But do you know what? It might just happen…and if it does, we’re betting on mining stocks to be some of the best performing stocks on the Aussie market.


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Why the Fed Wants Inflation and the Stock Price Bubble to Continue

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Why the Fed Wants Inflation and the Stock Price Bubble to Continue

Posted on 09 January 2014 by Kris Sayce

In yesterday’s Money Morning we looked at negative interest rates.

We noted how the Danish central bank had cut the benchmark lending rate to minus 0.1% in 2012.

That means it costs banks to hold money on deposit at the central bank, thus removing the incentive for banks and consumers to save.

Instead, it encourages banks to lend money to borrowers, and it encourages borrowers to borrow money.

The Danish plan has ‘worked’, if working means that stocks have gone up. The OMX Copenhagen 20 index has climbed 160% since the 2009 low. We also mentioned how the US Federal Reserve was creating and would continue to create an asset bubble.

Based on the latest data, its plan is working too…

Yesterday we pointed out that central banks still have many more tricks up their sleeves. The idea that they can’t do anything more because interest rates are already low is false.

They can do plenty more.

One option is to follow the Danish lead and cut interest rates to below zero. That may work in what we could call a ‘second tier’ economy, but it may not cut it in one of the major economies.

After all, you’d think the one country to try such a policy after two decades of low interest rates would be Japan. But however tempted the Japanese may have been to do so, they haven’t yet cut the interest rate to below zero.

The other option, the option central banks seem to prefer, is to be more discreet (devious is probably a better word). That involves using inflation.

Two Reasons Why Central Banks ‘Print’ Money

The central bankers’ most well-known use of inflation in recent years is their policy of ‘printing’ new money in order to buy government bonds. This serves two purposes. First, it creates a guaranteed buyer for government debt.

That means the government doesn’t have to stop spending.

The second purpose is to induce inflation. If the central banks can push more money into the economy it should raise prices, which they hope will also raise incomes, which they hope will make it easier to repay loans, which they hope will make consumers more likely to take out new loans.

We say that it’s a devious trick because the truth about inflation is that it doesn’t increase wealth. In fact, it does the opposite. General price rises inflict harm on savers and income earners because, typically, wage rises lag price rises.

Furthermore, it harms people who stop working (such as retirees or those who become unemployed) because prices continue to rise even though their income earning capacity may have stopped. It’s why even in retirement, retirees still need to try to earn an income and take risks by investing because they know if they don’t inflation will gnaw away at their savings.

This is why we say investors have to invest in riskier assets (where you can get big returns) such as stocks, rather than just staying in cash. Proof of that is in the latest report from the Financial Times:

US inflation expectations have jumped to their highest since May, with central banks and investors seeking insurance against the prospect that a recovering American economy will stoke price pressures.

Inflation expectations, as measured by the difference between yields on 10-year nominal Treasury notes and Treasury inflation protected securities (Tips), have risen to 2.28 per cent from a low of around 2.10 a month ago.

Just remember that the typical US investor who would like to keep their money in a ‘safe’ bank account earns close to zero on their deposits. Thanks to the central banks, which are apparently seeking ‘insurance’ against inflation (the inflation they’ve created), savers have to take big risks in the stock market.

Stocks Go Up, What Could Possibly Go Wrong?

So, the plan is working.

Stocks are going up. Inflation is inflating. And governments can keep spending.

What could possibly go wrong?

OK. You know that’s a tongue in cheek comment. There’s plenty that can go wrong, which is why you need to be an active investor in this market, keeping a close tab on what’s happening to your investments.

The Aussie market gained 16% last year. It was a bad time to be in cash. A portfolio of individual stocks would have done even better, especially if you had bought into some good dividend payers when we told you to back in late 2011…and again when we suggested increasing your stock exposure at the end of 2012, the beginning of 2013, and mid last year.

Make no mistake. For all the stick we give central bankers, they’re working towards a plan. That plan isn’t necessarily beneficial for you or the economy.

But it is a plan that you can take advantage of to build your wealth, and fight back against the harm caused by inflation.

The way to do that is to pick a select portfolio of stocks priced at a good value, and where possible that pay a dividend.

As we pointed out yesterday and today, central banks have many tricks up their sleeves, so it’s premature to think this latest ‘Great Asset Bubble’ is about to pop anytime soon.


From the Port Phillip Publishing Library

Special Report: Five Fatal Stocks You Must Sell Now

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How Interest Rates are Like the ‘Moving Forest’ in a Scottish Play

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How Interest Rates are Like the ‘Moving Forest’ in a Scottish Play

Posted on 09 January 2014 by Nick Hubble

Actors never say the name of what they call the ‘Scottish Play’ inside a theatre. That’s because it brings down a curse on the play. Sandbags have been known to fall on actors, unoccupied cars run over people in the car park, and, according to legend, a real dagger was swapped for the retracting kind in the first ever performance. Some say the magic used in the opening scene by the three witches is real.

According to the actor Sir Donald Sinden, the truth is better than fiction. Macbeth was the default plan B of village theatre productions around England for many years. If the actual theatre production failed to draw an audience, swapping for Macb…the Scottish Play guaranteed a full house. So saying the name of the Scottish Play during a different theatre production was kind of like implying it wouldn’t be good enough and the troupe would have to use plan B.

Anyway, all this is very similar to today’s financial markets. It’s a tale of greed and delusion, and it won’t have a happy ending. The witches at the world’s central banks have brewed up a curse known as QE. Investors were sucked into the stock market hook, line and sinker, just as Macbeth was by promises of becoming king.

With the Federal Reserve’s first reduction of Quantitative Easing, we’ve reached a new act in the play. It’s the act where things get dicey. But let’s start at the beginning.

In the play, the witches tease Macbeth by saying that he can become king and his good fortune will last until the local forest comes to his castle at Dunsinane. ‘Forests don’t move’ reckons Macbeth, so he throws caution to the wind. I won’t ruin how the forest ends up moving, but I can tell you the financial market equivalent to the moving forest is moving interest rates. If interest rates begin to rise, the stock market’s good fortune will end.

Now interest rates have been in a steady downtrend since the 80s. That made debt steadily less expensive, which allowed people to borrow more and boost the economy. But, with the financial crisis, interest rates approached zero, especially once you take inflation into account. In other words, they can’t go lower.

The problem is that interest rates will rise eventually. And then all the debt incurred over the past few decades will become expensive.

So now that rates have hit zero and central banks are reducing their stimulus, the ongoing recovery is all about managing the increase in interest rates. If they rise too quickly, the recovery will stall because debt will be expensive. That would prolong the economic malaise many countries are still in. If they rise too slowly, the recovery could become inflationary. Inflation has the same effect on interest rates that screaming ‘Macbeth’ has on actors. They jump. And that leads us back to economic malaise, but with a bout of inflation mixed in.

In other words, the world’s central bankers have painted themselves into a corner. They could lose control. The lure of suppressing interest rates using QE gave them a short term gain, just as killing the king gave Macbeth his title. But now that decision could come home to roost.

So this year will be the year of watching interest rates around the world, just as Macbeth watched the forest from the top of his castle. That sounds mind-numbingly boring. But looking for cracks in a dam is probably boring too. Until it suddenly isn’t.

The most important interest rate to watch is the US 10-year Treasury bond yield. It is the rate that all others are influenced by. And it happens to be at its highest since 2011.

Did you see that tree move?

Nick Hubble +
Contributing Editor, Money Morning

Ed note: This article is an edited version of ‘A New Act in the Scottish Play’ which was originally published in The Money for Life Letter.

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Are Stocks Cheap, Fair Value or Overvalued?

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Are Stocks Cheap, Fair Value or Overvalued?

Posted on 21 November 2013 by Kris Sayce

So far it has been a bad week for Australian stocks.

The S&P/ASX 200 has lost 93 points since last Friday. That’s nearly a 2% drop.

So, what’s going on? What does this mean for our 6,000 point year-end target?

If the market doesn’t hit our target, it could leave your editor with a big dollop of egg on our face.

But wait. Outgoing US Federal Reserve chairman Dr Ben S Bernanke speaks. It turns out he’s confirmed what we’ve known all along.

You better put those eggs on hold…

We’ve gone on record throughout this year, trying to convince you that central banks have no intention of raising interest rates.

How long they’ll keep them low is anyone’s guess. Our bet is you can measure it in years. But even that may not be a long enough timescale.

It’s quite possible that the central banks think they can keep interest rates low for…well…forever.

The clue is in a comment from Fed chairman Dr Bernanke, as reported by Bloomberg News:

“The target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after” the jobless rate breaches the Fed’s 6.5 percent threshold.

OK, maybe not forever. But now do you believe what we’ve said on this?

Stocks Pause for ‘Thinking Time’

However, we’ll stop the self-congratulation for a moment.

Being right is only half the story. We’re not involved in the financial markets as an academic exercise or to score points.

We’re in the financial markets to identify trends and then recommend specific investments. And ultimately to help our readers make money.

That hasn’t happened this week as the market has fallen 93 points. So, should you get those eggs ready again? Not so fast.

Our view is the market and investors are going through the usual period of self-doubt after hitting a new high point (we’re talking specifically about the US market here).

That’s only natural. When the market breaks a record, investors begin to wonder about the sustainability of the current gains and whether it’s possible the market can go any further.

It’s quite normal to see stocks trade around a key level as investors and traders weigh up valuations – are stocks still cheap, fairly priced, or are they overvalued?

Investors ask those questions all the time, and rightly so.

You can see from the following chart that a similar dance played out with the Dow Jones Industrial Average for most of the second half of this year:

Source: Google Finance

It wasn’t until the fourth time of trying that the Dow finally broke through 15,500 points and stayed above it.

Australian Stocks Still Heading for a 10% Gain

Now the Dow is flirting with 16,000 points. This is another key psychological level. It broke through on Monday but failed to stay above it.

It traded above that level again on Tuesday. But once more it failed to stay above the line.

And while we always prefer to see stock markets going up, you shouldn’t panic when stocks have a few days of falls. Remember that the Dow has gained around 600 points – about 4% – over the past month.

So if it gives up a few points, so what?

The same goes for the Australian market. Sure it has lost 93 points in less than a week. But it’s still 150 points higher than it was in early October. And even if the market gives up that gain, the S&P/ASX 200 would still be almost 500 points higher than it was at the start of the year.

The bottom line is this: despite the volatility we still don’t see that anything has changed. Dr Bernanke has confirmed our view – interest rates aren’t going anywhere.

And when the market finally gets that, you’ll see stocks break out of this funk and move higher. So we’re sticking with the game plan.

This is Part of the Federal Reserve’s Plan

Whether you stick to the game plan of buying stocks on these dips is up to you.

We certainly are. As always it’s a risk. Even if the market rallies, not all stocks will achieve the same gains. Some may even fall. So it pays to put in the research to give you a better chance of backing a winning stock.

It was a big risk telling you to buy stocks through May and June when the market slumped 10% in a few short weeks.

But at the time our research and analysis suggested it was the right thing. And we’ve got the same conviction right now.

Remember (and this is the key point) that while the Federal Reserve and other central banks want stocks to go higher, they don’t want them going too high too soon. They’re trying to manipulate prices to achieve slow and steady price growth over time.

So far this year the US market has gained 21%. Is that enough for the Fed? Maybe they will be happy for a 30% gain this year. One thing we’re certain of is that Dr Bernanke won’t do anything to spoil his perceived legacy as he enters the last two months as head of the Fed.

As we see it, while it wouldn’t have been great to see your portfolio take a hit this week, the plus side is that if you have cash available to top up your holdings, now is as good a time as any.

It’s a punt, but if you can cope with the volatility, it’s worth the risk.


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The Economy Is On Strike

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The Economy Is On Strike

Posted on 18 November 2013 by Dan Denning

You know one of the definitions of insanity, right? It’s repeating the same action over and over but expecting a different result. Well, there’s either a lot of insane people running the world’s financial system…or they’re just simply incompetent. Either way, it’s extraordinary.

Let’s be clear: central banks are out of ideas. Their policies pump up stock prices. Meanwhile, the real economy has gone on strike. It refuses to react in the way the academics in government and finance expect. Let me just give you two quick examples.

First, Japan’s growth rate fell by 50% in the third quarter (between July and September). GDP grew at an annualised pace of 1.9% for the quarter. But it’s been slower every quarter this year. It was 4.3% in the first quarter and 3.8% in the second quarter.

The bloom is off the cherry blossom for Abenomics. Promising to double the monetary base drove down the yen for a bit, which boosted export earnings. Stocks raced ahead. But all the momentum is gone. Emerging market demand (which is not boosted by QE) hasn’t recovered.

The chart above shows that the Nikkei is at the top of the trading range it’s been in since late July. It’s not looking over-bought on a relative strength basis. But this shows me that if you’re looking for the next blue chip rally driven by QE, you’re not going to find it in Japan, at least not without some new big, bold stimulus.

US stocks, on the other hand, flew like a gaggle of drones hunting for a strike after Janet Yellen fronted the US Senate Banking Committee. The nominee to replace Ben Bernanke as Chairman of the world’s most powerful banking cartel assured the suits in Washington they could expect the same from her, only more of it. The Dow Jones Industrials are closing in on 16,000 and the S&P 500 hit 1790 (or a year after the beginning of the French Revolution, if you’re looking for historical rhymes).

To chase the US stock rally at this point would be madness. You might make some short-term gains in the next few weeks, but the rocket is nearly out of Fed fuel. And stocks cannot trade at a permanently high plateau merely on the basis of Fed money printing.

A Speculative Trade for 2014

That leaves Europe, if you’re looking to take a punt on where the next gains could come from the currency wars. In Europe, there are two pieces of evidence to suggest that money is about to flow from the European Central Bank (ECB) and into stocks.

The first item is that GDP growth in Europe is even weaker than Japan. The 17-country Eurozone grew by just 0.1% in the third quarter. That’s an annualised rate of 0.4%. And it’s so low as to be statistically inconsequential, assuming it’s not flat-out made up. The ECB now has plenty of economic justification for hitting the gas pedal (even if Japan’s experience shows that the effects of doing so are temporary).

Next is what ECB executive board member Peter Praet told the Wall Street Journal earlier this week. He said that, ‘All options are on the table‘ for the ECB to fulfil its mandate of promoting growth, stable prices, and low inflation. That’s just as ridiculous as Janet Yellen committing to 2% inflation. You can’t have stable prices if your policy is designed to increase them (you CAN have asset inflation though, which is what the finance sector loves).

But it appears that ‘asset purchases’ are now on the table in Europe. The matter may have some added urgency, given the weak GDP figures. And if the US and Japan are a precedent, the biggest beneficiary of the ECB’s next campaign ought to be large cap European stocks; hence my recommendation of an Aussie-listed ETF.

World War D and Financial Feudalism

One final note on the ‘currency wars’. Let’s not forget that low interest rates aren’t just good for the financial sector. They’re great for governments with large fiscal deficits. These days, that’s pretty much every major Western government.

Governments would face an immediate 20% increase in debt service costs if interest rates went back to 2007 levels, according to a new study from McKinsey and Co. The study shows that suppressing official interest rates has ‘saved’ governments $1.6 trillion in lower interest payments since 2007. Regrettably, while governments are winners with lower borrowing costs, savers and pensioners can go suck eggs, as the chart below shows.

Source: McKinsey and Co.
Click to enlarge

The study is a good read, if you have time. There are lots of pretty charts and graphs. But the fundamental conclusions are inescapable.

Interest rates are at 30-year lows and can’t go any lower, at least in nominal terms. They could go negative if central banks start charging interest on the excess reserves. If you were a bank, you’d have to pay to deposit money overnight with the central bank.

But really, what this means is that asset purchases are the only tool left in the central bank toolbox. They’ve tried it and it hasn’t worked. All that’s left is to try more of it and see if that works. It won’t. But they’ll do it anyway and we’ll know they’re either incompetent or insane.

Let’s not rule out devious, either. This could all be deliberate. It’s a modern version of feudalism, only the peasants and serfs don’t realise they are wage slaves who are asset poor. If you have a high definition television and a full stomach, you can stand a lot degradation in life.

Besides, who needs castles and moats and armour and crowns when you control interest rates, have the only legal printing press in town, and own all the politicians?

Where all this is headed is anyone’s guess. A financial problem (too much debt and poor risk management) has become an economic one. The economic has become political. And the political has become social and cultural. It may not end in another French Revolution. But one regime – the global fiat money standard – is about to lose its head.

These are some of the ideas we’re going to talk about in Melbourne late next summer. If you click on this link, you can add your name to a list. Once on it, you’ll be notified when the conference – what we’re calling World War D – goes live.

Dan Denning+
Editor, The Denning Report

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You Can Bank on Another Crisis

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You Can Bank on Another Crisis

Posted on 25 September 2013 by Vern Gowdie

The GFC brought into stark contrast just how vital the banking system is to the functioning of an economy.

At the height of the GFC banks did not trust each other. And people did not trust the banks.

Banks viewed each other with suspicion. Letters of credit were no longer accepted on face value. The shipping industry, which relies heavily on letters of credit, ground to a standstill.

Customers lined up outside banks (some with suitcases) to withdraw their savings.

Such was the demand for cash, the Reserve Bank of Australia came close to running out of physical notes.

Modern commerce is a function of faith. When faith in the financial system is lost, chaos follows. 

Banks are the Heart of the Financial System

Money pumps in and money pumps out. The flow of money through the system is as vital to economic health as the flow of blood is to our physical wellbeing. We all know what happens when arteries become blocked or, worse still, when a heart stops pumping.

Governments are only too aware of the need to maintain public faith in the banking sector. Government backed deposit guarantees still remain in force five years after the event – albeit the guarantees are now applied to lower dollar levels.

The first premise of my theory is governments must and will support the banking system in times of crisis. They cannot afford to have the heart stop beating. While nothing is ever certain, the prospect of government not wheeling out the defibrillator is extremely remote.

So I go with the balance of probability and assess that the banking system will be rescued. But who pays and at what cost?

Sayings like ‘safe as a bank’ refer to an era of prudence that is not reflective of modern banking.

Yet, by and large, banks are still viewed as these conservative pillars of society.

This chart from last week shows US credit growth exploding from 1980 onwards.

This graph applies equally to the rest of the western world. Who facilitated and profited (handsomely) from this debt mania? The banks. Fractional banking enabled banks to gear up by a factor of 10x or more. This highly leveraged pillar is what our monetary system rests upon.

The Impact of Shrinking Credit

After 30-years of unbridled debt expansion we have reached the stage where there are too many vested interests prohibiting the stabilisation of banking system.

Firmer foundations would require banks to reduce their gearing – lend less. Think of the ramifications of banks systematically reducing the credit flow throughout society:

  • Government tax revenues (on which all those entitlement promises have been built) would shrink faster than a wool sweater in a dryer.
  • Retail profits would fall and staff would be laid off.
  • The lay-off contagion would affect all business sectors and unemployment would rise. (And how does the government afford all this NewStart while on its Jenny Craig budget diet?)
  • Imagine the reaction from the real estate industry as property prices fall.
  • Bank profits would fall and share prices follow – member balances in superannuation would suffer and cause more pressure on the age pension to fund the shortfall.
  • Last but by no means least in a list that could go on and on, bank executive remuneration would collapse to under the $1m per annum mark. Shock, horror; imagine all those Porsches and North Shore homes that would flood back onto the market.
  • And the domino effect continues right through society.

I think you get the drift on how society is so hooked on the debt. Due to debt dependency, it is virtually impossible for anyone or any institution to voluntarily embark on the stabilisation process.

There have been token attempts at so-called banking reforms. In reality very little has changed. Bankers still get remunerated for taking risks, and not for being conservative.

The banks are even bigger than they were before Lehmann Brothers’ demise.

And the system is totally dependent upon unlimited central bank support. The system, in my opinion, is more unstable than it was in 2008. A cardiac arrest awaits.

Vern Gowdie+
Chairman, Gowdie Family Wealth

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Why You Should Be ‘Hands On’ When Investing Your Money

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Why You Should Be ‘Hands On’ When Investing Your Money

Posted on 30 July 2013 by Kris Sayce

Central banks have become the insider traders of the currency market, which is a paradigm shift that systematic traders cannot pick up as well as fundamental traders.‘ – Bloomberg News

If you had said 10 years ago that central banks were insider trading, you would have been laughed out of town.

Today everyone knows central banks trade in advance of upcoming policy decisions.

But it’s not just the central banks. The big investment banks play the same game too…

If you don’t believe us, take this story from Bloomberg back in May:

Goldman Sachs Group Inc. (GS), which generated about half its revenue from trading last quarter, posted losses from that business on two days in the first three months of 2013, compared with one day a year earlier.

If we assume there were 60 trading days in the first quarter, it means Goldman Sachs traders made profits 96.7% of the time.

In the world of trading that’s an unheard of strike rate. Most traders are happy to make profits on just half their trades.

Even if you factor in the large number of traders on Goldman Sachs’ trading desk, the law of averages would still dictate a win rate close to what an individual trader can achieve.

So there’s only one explanation – the big boys have a secret advantage compared to every other investor. But it’s not just insider knowledge. Until recently they’ve had another advantage…

Investing: Humans v Computers

Over the past few years, some folks have made a lot of noise about the influence of computer trading at the big banks and hedge funds. Another name for it is algorithmic or ‘algo’ trading.

Many worried that computers would take over the world. Some feared it would even be the end of investing as we know it.

But now it seems that computers aren’t quite so smart after all. In fact, according to Bloomberg:

Currency funds that use computer models for trading decisions made 0.7 percent this year through June, compared with 2.3 percent for those that don’t, the biggest margin since 2008.

The article says that computers haven’t yet figured out how to trade unpredictable markets. A good example was the US Federal Reserve’s about-face in May, when many thought it would start raising interest rates.

Human traders traded that move quickly as bond yields soared. It seems the computer (‘algo’) trading programs weren’t quick enough to catch the move.

(We guess we’ll find out soon enough on how many days Goldman Sachs traders and computers made profits during this rocky period.)

Saying that, the fallibility of computers and computer modelling shouldn’t surprise you. One of the big controversies during the 2008 financial meltdown was value at risk models (VaR).

Big traders used VaR to work out the potential loss for a portfolio. They use historical volatility and the expected behaviour of various asset classes in certain conditions – stress testing.

But none of this counted for toffee when financial markets collapsed. Events that the models said were a one-in-a-thousand-year’s possibility happened…and in a big way.

So, what does that tell you? For a start it tells you that even the smartest computer trading system needs a human to get involved when the computer misses something.

That’s why, as fond as we are of new technology and its ability to improve lives and drive down costs, we also know the human element is important.

‘Hands On’ Investing

In truth, as a fundamental analyst, we don’t leave anything to automation.

Because when dealing with revolutionary, breakthrough and leading-edge technology companies, the most important thing we look for is innovation.

And as far as we’re aware, there isn’t a single computer model that can identify a revolutionary change before it happens. There certainly isn’t one that can identify a company to benefit from the change.

So when it comes to finding revolutionary investments, we have no problem saying we’re old school. Call it a ‘hands on’ approach if you like.

But just as we prefer a ‘hands on’ approach with our investment research, we prefer to be ‘hands on’ when investing our own money too.

We like to know a human has complete control over our savings and investments. But not just any human. We like to have personal control over each of our investments.

That way, on any given day we can know exactly how much money is in our investment savings account. We know our shares balance. And we know the value of our precious metals.

This is vital. It’s important to know where your money is and what you’re invested in at all times. That means avoiding opaque investments. And most of all, avoid investments where you don’t have complete control.

This is the key to avoiding any nasty surprises during the next financial meltdown (whenever it arrives). Whether the cause of the next meltdown is computer trading or human traders, it’s doesn’t matter.

What matters is that you take charge of your investments today.


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From the Port Phillip Publishing Library

Special Report: The Sixth Revolution

Daily Reckoning: The Absurdity of Australian Property

Money Morning: This Stock Market Rally Hasn’t Run Out of Puff Yet…

Pursuit of Happiness: Save Now to Avoid the Government’s Retirement ‘Labour Camps’

Australian Small-Cap Investigator:
How to Make Big Money from Small-Cap Stocks

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How Central Bank Zombies Control the Stock Market

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How Central Bank Zombies Control the Stock Market

Posted on 25 June 2013 by Dr. Alex Cowie

Zombies…zombies everywhere!

Popular culture is infested with the un-dead.

No less than sixty-five zombie movies hit the silver screen in the last twelve months. Some, like World War Z are worth watching, while you can probably miss Dating a Zombie.

The infestation has spread to TV shows too, with series like The Walking Dead.

No longer are you safe on the streets either. ‘Zombie walks’ – where tens of thousands of people stumble through the streets as zombies – have erupted globally including Australian cities.

What is it with this recent obsession with zombies?

On the way home from watching World War Z at the cinema with the missus, the answer struck me.

…We can blame Ben Bernanke, and let me explain why…

In a world where apathy reigns, the zombie walk resonates as a mild mannered protest.

Take a look at this photo from the recent Brisbane zombie walk:

It’s the same demographic each time: Generation Y, the teenagers through to the ‘thirty-somethings’.

Sure, they’re out to have some fun. But why do it all, and why specifically zombies…why aren’t they dressing up as the other current horror genre: vampires for example?

Is it a coincidence that zombies are a social metaphor for a rudderless, corrupted, join-or-die culture, mindlessly consuming as it spreads?

And is it by chance that Gen Y is has found expression in the zombie metaphor over the last few years in particular, as financial turmoil has spread to economic and social turmoil?

If this is getting a bit heavy, think about it. We are all Bernanke’s zombies in the markets too.

Almost half a decade of quantitative easing has long since transformed the investing community from fresh-faced free-marketeers into the half-alive-half-dead, stumbling around for fresh QE to feed on – all the time festering and slowly rotting a bit more.

The drip feed of US Federal Reserve QE has kept the market twitching for years. But is it all about to dry up?

Bernanke is hinting so. But I don’t want to add more zombie column-inches to the pointless discussion of ‘will he or won’t he’. The messages out of separate Fed members make it clear that they couldn’t agree on the colour of an orange between them.

Let’s look further up the food-chain instead to get word from zombie central command (AKA: The Bank of International Settlements – or BIS). BIS is ‘the central bank’s bank’ and their message is clear – no more QE please:

Central banks cannot do more without compounding the risks they have already created…How can they avoid making the economy too dependent on monetary stimulus? When is the right time for them to pull back … how can they avoid sparking a sharp rise in bond yields? It is time for monetary policy to begin answering these questions.

Tough words indeed from the Zombie Central Command…

60 countries’ central banks are members of BIS.

These include the Federal Reserve, the Bank of Japan, the Peoples Bank of China, as well as the European Central Bank.

BIS has clearly aimed this not just at the Federal Reserve, which has talked about dialling back the QE, but also Japan which is in the early stages of an epic QE program planned to go for another eighteen months.

But let’s not worry about Japan for today. That’s a whole separate barrel of worms.

Front and centre for market zombies today is if the BIS is pressuring the Fed to dial back on the QE sooner rather than later.

Markets Are Crashing Everywhere On the Prospect

And it doesn’t matter what it is.

…Bonds are falling.

…Currencies are falling.

…Commodities are falling.

…Stocks are falling.

Markets in Free Fall – Across All Asset Classes

Source: stockcharts

The zombies are in full-blown panic as their life support threatens to dry up.

But it’s not just the fear of the Federal Reserve liquidity drying up.

There has been a big China scare in the last week regarding interbank lending. The rate at which banks lend to each overnight other spiked to 14%, when 1-3% is more normal.

But instead of hosing the problem down with liquidity as is the usual response, the Peoples Bank of China (PBoC) has held back, with reports of a small level of support for one bank.

What stands out is that the PBoC has put the blame on the banks, telling them to do a better job of managing liquidity, and not to expect the cavalry to come riding over the hills to the rescue every time they stuff up.

The official response read:

At present, the overall liquidity in China’s banking system is at a reasonable level, but due to many changing factors in the financial markets and also because of the mid-year point, the requirements for commercial banks in liquidity management have become higher … commercial banks need to closely follow the liquidity conditions and boost their ability to analyze and make predictions on the factors that influence liquidity.’

It’s a dangerous game to play. Once a credit bubble pops, you don’t have much, if any, opportunity to stop it. So PBoC needs good reason to respond this way.

Maybe the words from Zombie command (BIS) hit home. After all, China has been one of the biggest credit junkies in recent years.

My colleague Greg Canavan at Sound Money Sound Investments has closely followed this story for a few years, and recently put out a chilling video of how this could pan out. It’s worth a watch.

The markets have very quickly flipped from complacent to fearful in the last few weeks. Until we get a better idea of what to expect from the Fed, and from China’s central bank…watch out for attacking zombies.

Dr Alex Cowie
Editor, Diggers & Drillers

Join me on Google+

From the Port Phillip Publishing Library

Special Report: The Sixth Revolution Has Just Begun

Daily Reckoning: When it Comes to Future and Technology, Which Camp Are You in?

Money Morning: Why The ‘Asia-Zone’ Crisis Makes Australian Stocks a Buy…

Pursuit of Happiness: Don’t Blame Progress, Blame the Governments

Diggers and Drillers:
Why You Should Invest in Junior Mining Stocks Now

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Bernankenstein’s Financial Monster

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Bernankenstein’s Financial Monster

Posted on 07 June 2013 by Vern Gowdie

Just when you think central bankers are as clueless as our Treasurer, they go and surprise you. The release of minutes from the latest US Federal Reserve Advisory Panel meeting was a bit of a revelation.

The Federal Reserve’s ‘mad scientists’ appear to realize they have created a financial monster. Call it Bernankenstein’s Monster if you like. Take this extract (bold emphasis is mine):

‘There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices.’

Concern about an ‘unsustainable bubble‘? Given the Federal Reserve’s previous track record of creating bubbles (housing rings a bell), all they can muster is ‘concern’. What about fear and alarm?

Here’s another bit of genius from the minutes:

‘Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Federal Reserve’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system.’

‘Reestablish normal valuations?’  Is this Fed code for the fact we now have abnormal valuations? The minutes insinuate the ‘mad scientists’ know they have stuffed it up.

The Experiment Has Gone Too Far Now

And as for the idea that the withdrawal of stimulus ‘may be‘ painful, please spare us the ‘may be’. The market is a highly dependent ‘junkie’. When the Federal Reserve turns off the ‘juice’ (voluntarily or involuntarily), a world of hurt waits.

Haruhiko Kuroda (Bank of Japan Governor) can’t afford to be as contemplative as the Fed. He is a modern day kamikaze – if he thinks of the inevitable outcome, he would never have signed up in the first place. Kuroda is zeroing in on the battleship called ‘deflation’.

A lot of others have moved into Kuroda’s slipstream and had a free ride on the devaluing yen and rising Nikkei. But poor old Kuroda has run into severe turbulence. This is tossing the markets around like a single seater in a cyclone.

Uncertainty and volatility are the hallmarks of Japan’s experiment in printing their way to inflation. The Nikkei’s wild swings (of up to 500 points in a day) illustrate investor nervousness.
According to Wikipedia ‘about 14% of kamikaze attacks managed to hit a ship‘. I think Kuroda’s odds of achieving his mission are even lower.

Central banks believe (publicly at least) asset bubbles can rescue the global economy. History doesn’t just tell us, it shouts at us; asset bubbles don’t fix anything.

The pain of the bust far outweighs the euphoria of the bubble. Time and again this is the lesson central bankers never learn.

Andy Xie, from Caixin Online summed it up:

‘Japan and the United States are using asset bubbles to revive their economies. They are struggling to manage the speed of bubble expansion or contraction. This dancing on a pinhead brings big uncertainty to the global economy. When they fail, a global recession may follow.’

Welcome to the Real World  

Central bankers tell you they are busy conducting an ‘experiment’. But the economy isn’t a scientific research project. They can’t control it. The global economy is a complex and unpredictable ecosystem. Its evolution is a function of the decisions the seven billion people who inhabit the earth make every day.

A handful of bureaucrats and academics with computer models can’t control this ecosystem, any more than marine scientists can control the ocean.

Acknowledging this fact is a step towards understanding the gravity of the situation. Otherwise, these crackpot scientists will blow the lab sky high.

We only have to look back a dozen years to see how their previous experiments (of lesser intensity) have failed.

US fund manager John Hussmann made this observation in his latest report:

‘… the last two 50% market declines – both the 2001-2002 plunge and the 2008-2009 plunge – occurred in environments of aggressive, persistent Federal Reserve easing.’

The significant share market losses suffered during the ‘tech wreck’ and ‘GFC’ occurred when the Fed was aggressively intervening (meddling) in the economy. The Fed’s tampering only makes a bad situation worse.

If we look further back in time, Hussmann discovered:

‘…the maximum drawdown (loss) of the S&P 500, confined to periods of favorable (meddling) monetary conditions since 1940, would have been a 55% loss. This compares with a 33% loss during unfavorable (non-meddling) monetary conditions.

According to Hussman the market collapses ‘were preceded by overvalued, overbought, overbullish euphoria‘. This is what asset bubbles do. The animal spirits run strong – the need for greed drives values well above rational levels.

Anyone with a passing interest in the financial world knows the current level of meddling is without precedent. So if all the previous periods of ‘Fed intervention’ resulted in 50+% losses, what pain is in store for this market?

The following charts show the current level of disconnect between the market and the economy.

The first chart tracks US economic activity. In 2008/09 (the grey shaded area represents a recession) all measures of economic activity fell into a crater.

The important take from this graph is 2010 onwards. After the economy ‘recovered’ from its initial GFC shock, it has steadily declined. This is in spite of the US Fed spending trillions (over the past four years) ‘stimulating’ the economy. The Great Credit Contraction is proving far more powerful than the printing press.

This next chart compares the performance of the S&P 500 index with the level of margin debt (borrowing to invest) in the US. Talk about a mirror reflection. 

While the economy (Main Street) is tanking, Wall Street is gearing up and milking the experiment for all it’s worth.

The next wave down in this Secular Bearmarket will be gut wrenching. It’ll make the previous two corrections look like gentle slippery slides.

Interest rates are destined to go lower, but being in a cash bunker is still the best place to observe the inevitable detonation of this experiment.

Vern Gowdie
Contributing Editor, Money Morning

Join Money Morning on Google+

From the Archives…

Keep One Eye on Resource Stocks and the Other on the NASDAQ
31-05-2013 – Kris Sayce

Getting in on the ’99 Cent Craze’ with Crowdfunding
30-05-2013 – Sam Volkering

Buyer Beware: Japanese Government Bonds are Moving
29-05-2013 – Murray Dawes

The Best Contrarian Play on Gold I’ve Ever Seen…
28-05-2013 – Dr Alex Cowie

A Revolution in the Share Market is Coming…
27-05-2013 – Kris Sayce

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The Next Move in the Currency War

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The Next Move in the Currency War

Posted on 15 May 2013 by John Stepek

In the world of central banking, the gloves are coming off. You can blame the Japanese.

At the G7 meeting, everyone smiled politely and said that they completely understood why the Japanese were printing unprecedented amounts of money and hammering the yen.

The main reason they gave Japan a free pass is because lots of other countries are hoping to get away with doing the same.

Central banks overseeing around a quarter of the world’s GDP have cut rates this month alone, notes Bloomberg.

The currency wars are just getting started…

The Bank of Israel Joins the Currency War

The Bank of Israel has become the latest central bank to cut interest rates. The bank cut the key interest rate by a quarter of a percentage point to 1.5%. That’s a three-year low.

What was unusual is that the rate cut came outside of an official bank meeting. That meant it surprised the market, which sent the shekel down and Israeli stocks higher.

So why did they do it? Bank governor Stanley Fischer threw out a variety of excuses.

He told Bloomberg that the move came ‘in light of the continued appreciation of the shekel, taking into account the start of natural gas production from the Tamar gas field, interest rate reductions by many central banks – notably the European Central Bank, the quantitative easing in major economies worldwide and the downward revision in global growth forecasts.’

But clearly it boils down to this: if everyone else is going to print money, slash rates, and hammer their currency, then we’ve got to join in.

As Bloomberg points out, the shekel has risen by nearly 9% over the past six months. It’s one of the best-performing currencies in the world, after the Mexican peso.

Trouble is, ‘exports make up about 40% of Israel’s economy.‘ That means the Israeli economy really won’t like a rising currency. It doesn’t help that sales of natural gas will turn the shekel into a form of ‘petrocurrency’.

So the central bank also plans to buy around $2.1bn in foreign currencies (selling the shekel to do so), to offset the impact of natural gas exports.

That all sounds quite sensible. But there’s a flipside to cutting interest rates.

You see, we’ve all become really quite blasé about rate cuts. There seem to be no consequences these days (well, beyond surging stock markets at least). Much of the world has been in such a deep hole that it was hard to see whether or not all that money-printing and rate-slashing was having an impact.

But in Israel, the trade-off is more visible. The country already has a very buoyant property market, with prices up by around a fifth since 2010. Back in November, the central bank set restrictions on the amount buyers could borrow to purchase a house. First time buyers need at least a 25% deposit.

It’s hardly ideal to have your central bank trying to control a bubble with one hand while stoking the fire with the other.

The Currency War Will Not Stop Anytime Soon

It also reveals just how much power central banks have. Politicians have virtually ceded responsibility for their economies to the central bankers.

The politicians may fiddle with the national balance sheets: tweaking a regulation here and there, diverting handouts from one special interest group to more politically-friendly ones. But overall, the burden of returning economies to growth is falling on central banks.

This is nice for politicians, in that they can blame central bank policy if things go wrong. But it does not sit well with the central banks’ role as the ‘guardian’ of a nation’s currency. After all, the only real lever they have to pull to boost growth is to cut interest rates.

And with Japan’s experiment apparently working so well – in that stocks have rocketed – the pressure on central banks to follow suit will only continue.

What does it mean for your money? Well, we’d expect the flood of money from central banks to continue.

As for the US, in a world where everyone is printing money, it’s going to be hard for Ben Bernanke to keep devaluing the dollar. Everyone is getting excited about the idea that the Federal Reserve might rein in quantitative easing (QE). That seems unlikely to us.

But even if QE is simply maintained at current levels, that’s not going to look that impressive if the rest of the world’s central banks are competing to do various ‘shock and awe’ currency debasement schemes. So we reckon the US dollar is the currency most likely to benefit from this ‘race to the bottom’ for now.

John Stepek
Contributing Editor, Money Morning

Join Money Morning on Google+

From the Archives…

Why Small-Cap Resource Stocks Beat Blue Chips Hands Down
10-05-2013 – Dr Alex Cowie

Can Australian Stocks Defy Gravity if The Australian Dollar Falls?
9-05-2013 – Murray Dawes

Build Wealth Fast through the Resource Sector
8-05-2013 – Dr Alex Cowie

36% Potential Upside for Australian Stocks Over the Next Two Years
7-05-2013 – Kris Sayce

The Key to Becoming a Successful Investor
6-05-2013 – Kris Sayce

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Addictive and Irreversible: Destructive Policies Worldwide

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Addictive and Irreversible: Destructive Policies Worldwide

Posted on 26 April 2013 by MoneyMorning

After months of being under central bank-administered anaesthesia, many investors are pondering outside the repeated mantra of, ‘Money printing equals higher stocks.’

The question they’re asking now? How, exactly, swapping overvalued shares back and forth will create wealth for everybody — including those unfortunate enough to be buying late?

Masking symptoms of troubled economies with oceans of fresh money is not a good prescription for ‘wealth creation’.

But the Federal Reserve and other central banks have gone down that road, and there is no going back, even after the uglier symptoms of inflation emerge.

In the wake of the chaotic break in gold futures market, all gold mining stocks have been smashed. After two dreadful years, it looked like a final, cathartic purge. I haven’t seen sentiment and price moves like this since the depths of the 2008 crash.

Let’s examine the question of whether or not the gold bull market is over…

After spending much time re-examining gold’s fundamental drivers, my own assumptions and the views of a few dozen top analysts, I’ve come to the following conclusion: Ignore Wall Street’s clueless, half-baked opinions of the gold futures market.

Most of the banks’ opinions, including Goldman Sachs’ famous ‘short gold’ report, are based on an extremely speculative forecast: that the global economy can thrive after central banks stop printing. This cannot happen.

The only drivers of the US economy in recent years — rebounded stocks, housing and autos — owe their strength almost entirely to the Fed’s policy. Take away the policy, and all three would collapse. So the Fed simply cannot remove the policy. If it attempts to remove easy money, and the economy crashes, it will reinstate printing in a heartbeat.
The fundamental facts have not changed, so the underpinnings of gold’s bull market are intact.

The Number You Need to Know

The number you need to remember is zero.

Zero is where central banks will peg interest rates for several years into the future. Zero is also the number of times in recorded history that the “QE/ZIRP” policies in place worldwide have boosted any economy to ‘escape velocity’ (as economists say).

Such radical policies always result in destruction of the currency being printed. In other words, stagflation — not sustained economic recovery. Japan will discover that history rhymes once its financial market sugar high wears off. It offers a preview for the US.

As inflation expectations rise — the great hope of Bank of Japan governor Kuroda — Japanese investors will discover that money printing schemes are addictive, with no practical exit.

Here’s why: Once consumers buy tomorrow’s products today (ahead of expected price rises), what will they buy when tomorrow arrives? When tomorrow arrives, the howls for another round of printing will be louder than ever! We keep bringing up this question because thus far, there is no indication that any policymakers know (or admit) that Japan’s new policy is addictive and irreversible.

The real world isn’t nearly so simple and easily modelled as the professors running central banks believe. Trying to ‘boost inflation expectations’ will only trap central banks into permanent cycles of easing — both in the US and Japan. And the bigger government debts get, the harder it will be for central banks to tighten policy.

Raising interest rates a few years from now would result in interest expenses consuming an unacceptable amount of government tax revenue; so higher short-term interest rates — which would really put the brakes on gold prices — will not happen.

Finally, zero happens to be the number of fiat currencies in history that held their value.
The [US] dollar’s value isn’t going to zero anytime soon, but debasement continues, and stopping the growth federal entitlement spending — the real driver of federal budget deficits — is politically impossible.

The guardians of the paper dollar’s sanctity, rather than preserving its value with positive real interest rates and balanced budgets, are aggressively pushing it toward its ultimate destination: zero.

I’m waiting to see a strong rebuttal from the defenders of the paper money system. Thus far, I haven’t seen any cases for a strong dollar — a case that proves central banks have not trapped themselves into permanent cycles of easy money.

The gold bull market lives on…

Dan Amoss
Contributing Writer, Money Morning

Join Money Morning on Google+

From the Archives…

Why Waste Your Time on Gold When You Can Invest in Dividend Stocks?
19-04-2013 – Kris Sayce

A Trader’s Eye View of Gold’s Frightening Collapse
18-04-2013 – Murray Dawes

Why You Should Buy ‘Dirty, Grimy’ Gold Stocks
17-04-2013 – Dr. Alex Cowie

Why this Historic Fall in the Gold Price Equates to a Historic Opportunity
16-04-2013 – Dr. Alex Cowie

Beware the ‘Safety Bubble’, But Don’t Sell Dividend Stocks Yet
15-04-2013 – Kris Sayce

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gold road_lge

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Gold Bulls About to Win the War

Posted on 09 April 2013 by Dr. Alex Cowie

If you’ve ever thought about buying gold, but never quite got round to it — in the space of a week, the market just gave you three huge reasons to ‘back up the truck’.

The incredibly bullish set up is at direct odds with the poor price performance, which saw gold dip as low as US$1540 last week.

This dip in the price is our friend: after all we’re meant to buy gold ‘on the dips’.

So when gold pulled back last week, I put my money where my mouth is…

Here’s part of the latest addition to the Cowie retirement fund:

Buy Gold

And if it gets cheaper still, I’ll buy more.

Let me explain what I’m seeing that makes me think a turning point is getting close…

What to Do When Investment Banks Say Sell

Back in late 2008, institutional analysts were tripping over themselves to downgrade their forecasts on gold…right before gold started a 180% rally.

The fact is that consensus institutional forecasts on gold have been consistently wrong for the last ten years. You could trade gold perfectly by doing the exact opposite to what the big investment banks recommend.

In other words, when they say ‘sell’…you should buy.

So it’s exciting to see more and more big banks are calling gold a ‘sell’.

Last week, the gold forecast that got all the attention was from Societe Generale (SocGen), a French multinational banking company with a market cap of around $20 billion.

They called for gold to drop to $1375/ounce.

Frankly I’m surprised that the market paid so much attention to the SocGen report. But it popped up across the mainstream financial media, as well as financial blogs and other newsletters. It was emailed to me about twenty times.

Most commentators quoted it as though it was gospel! Yet no one seems to have checked out SocGen’s insanely bad track record on gold…

I’d like to share with you what I wrote about this in a snippet from the Diggers and Drillers weekly update from last Thursday:

‘The 27 page [SocGen] report was called ‘The end of the gold era’, making the case for gold to fall as far as $1375/ounce.

‘Everything about today’s gold market reminds me of late 2008: the fundamentals, the technicals, the bearishness, the institutional downgrades, and the market action.

‘And now we have Jesper Dannesboe, who co-authored this week’s Soc Gen report, who also got it tragically wrong back in 2008. I’ve dug into the archives for you to show you what he was saying back then.

SocGen sell to be a contrarian indicator to buy again?

Oct 31 2008 Context: Eight days after gold bottomed out at an intraday low of $680, and at the start of a monster rally that took gold to $1920 over the next three years:

‘The most likely scenario for gold is it goes down a lot, especially if it is trading at historically high levels … Because the fears of inflation will be replaced by fears of disinflation and that is a killer for gold … I think gold is going below $600 in this cycle.’ Source

Nov 18 2008 Context: Gold was at $740, and would jump 11% to $820 within a week:

‘The bullish story on gold based on fears of inflation is dead,’ Source

Jan 6th 2009 Context: Gold was at $840: 24% above its intraday low of $680, and at the start of a three-year rally that would see gold gain 182%.

‘Gold should be sold into rallies’ Source

‘Well…there were three years of rallies to sell into, which should have been plenty! This is what SocGen’s calls look like on the chart.

SoGen Gold

Source: stockcharts

‘Then last year they called gold to soar to $8500, and it fell.

‘So, their latest call for gold to fall could well be the best reason to buy that we’ve had so far!’

In short — SocGen taking another swing against gold with the same weak argument that it had back in 2008 is a clear warning signal that a rally could be imminent.

Since I wrote the above, the guys at Sprott Asset Management took SocGen’s argument to pieces. Part of their rationale brings me to the second big reason to start buying gold now.

(NB: you can watch my recent interview with legendary investor, Eric Sprott, by taking out a subscription with any Port Phillip Publishing paid investment service. Check out our latest offer here… )

You see, last week we heard that the Bank of Japan will DOUBLE their balance sheet over the next few years.

Where This Goes, Gold Follows

This is quite simply a game changer for the entire market: everything from bonds to foreign exchange, commodities, and equities.

But it’s gold I want to focus on today. There is a tight relationship between gold and the collective size of central banks’ balance sheets.

As balance sheets swell, gold rallies. You can see how closely the two track each other below in the chart from the guys at Sprott Asset Management.

Gold Moves With Central Bank Balance Sheets

Global Central Bank Assets Vs Gold Bullion

Source: Sprott Asset Management

Right now the major central banks have $9 trillion on their books — and Japan wants to add $1.4 trillion to that number by the end of next year.

If the relationship holds true, this would convert to a 15% increase in the gold price.

But hang on…didn’t we use the same rationale about the US Fed last year? Wasn’t the growth of their balance sheet meant to push up gold?

Well, the Fed has bought $85 billion worth of US Treasuries and mortgage-backed securities a month, and gold has gone nowhere fast. But you’ll get your explanation if you look closely at the chart above. You’ll see that the total balance sheet has actually pulled back slightly in the last few months.

Surprisingly, it’s because the European Central Bank’s (ECB) balance sheet has in fact shrunk by 10% this year.

This would explain why gold has had a rough start to the year. The ECB’s contraction cancelled out the Fed’s expansion.

However, the ECB’s balance sheet has stabilised now, and with Slovenia and the Netherlands lining up to be the next Cyprus, it could be on the way back up very soon.

Even if it shrunk at the same pace again, it would be easily exceeded by the combined growth in the balance sheets of Japan ($75bn) and the US ($85bn) of $160 billion/month.

Assuming no change from the ECB, and that the Fed and the Bank of Japan keep going at the current pace for another two years, this would equate to a balance sheet expansion of $3.8 trillion. This would add over 40% to the current global balance sheet of $9 trillion. As gold moves so closely with this, you could expect a roughly 40% rise in gold.

It’s dangerous to look exclusively at fundamental drivers, and ignore the positioning in the futures market.

And this is where we get the third major reason to buy gold today.

The Commitment of Traders Report

This report analyses the positioning in the futures market, which — right or wrong — determines the price, at least in the short-term.

And there is a keg of dynamite under the price here right now: there are a near record number of traders (‘managed money’) trying to short gold.

Just like journalists, these guys basically get it wrong every time. You can use them as a good contrarian indicator.

To show you their near perfect record of getting it wrong, I’ve highlighted (in red circles) the times they have stacked on the biggest short positions in the last five years. Then I’ve highlighted the corresponding periods on the gold chart (green circles on pink line). You can see that each spike in shorts has signalled a rally in gold.

Traders Shorting Gold — So Get Ready for a Rally

Managed Money Short Positions Gold

Take another quick look at the chart. The two big spikes in shorts back in 2008 preceded the three year rally in gold. And you can see that today’s short position is at far higher levels than back in 2008. It’s at record levels, and has been for a few weeks now. This is a highly explosive situation.

I suspect we’ll see volatility both ways at first as they defend their trade, but almost certainly this ends in a big move up.

Because there is a real chance these guys are going to have to ‘cover their positions’ if gold rallies just a little bit. Each trader doing this will raise the price, and cause another trader to follow suit. They are like a large group of mountaineers all tied together with the same rope. When one falls, the rest will follow in spectacular style. It would be enough to cause a massive move in gold.

Watching the gold price trending calmly down, you’d never imagine a war was waging below the surface of the market.

But a war it has been — and one that gold bulls are about to win.

Dr Alex Cowie
Editor, Diggers & Drillers

Join me on Google+

From the Port Phillip Publishing Library

Special Report: TORRENT SIGNAL 3

Daily Reckoning: Our Largest Asian Trading Partners Are in Trouble: China and Japan

Money Morning: A Better Inflation Bet Than Gold…Stock Market Investing

Pursuit of Happiness: Why the NBN is Dead Before it’s Begun

Diggers and Drillers:
Why You Should Invest in Junior Mining Stocks

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