Why Gold Is Rallying?

The big news in the markets last week was the continued breakout in gold prices to nearly $1500 per ounce and the continued rally in US Treasury Bonds.

Gold spiked nearly 4% last week while silver rallied nearly 5%. The yield on the 30-Year US Treasury Bond fell to 2.26% from 2.39%.

The US Dollar declined slightly.

For several years, I have been suggesting to clients that they consider accumulating gold and silver since world economic fundamentals favor metals in my view.

Not so much because metals are worth more, but because there is massive devaluation of world currencies currently taking place.

Given existing public debt levels around the globe (see below), we expect this trend to continue and for metals and other tangible assets to be a good place to store wealth in order to preserve purchasing power.

Over the long haul, this has proven to be a good strategy.

Take gold for example. 

In 2000, gold was selling for about $290 an ounce.  Today gold is selling for nearly $1500 per ounce.  In US Dollar terms, that’s an increase of about 500%.

In calendar year 2000, had you taken $1500 and put it in your sock drawer, today you’d still have $1500.  But, that $1500 would buy a lot less than it did in the year 2000. 

Here is an example to make the point.

The base price of a 2000 Ford Mustang Coupe was $16,710.  By comparison, the present base price of a new Ford Mustang Coupe is $26,395.

That’s an increase in the base price of a Mustang over 19 years of 57.96%!

However, if we price the Ford Mustang Coupe in gold, we get a completely different picture.

In 2000, it took about 57 ounces of gold to buy a base model Ford Mustang Coupe.  In 2019, with gold at nearly $1500 per ounce, it takes about 18 ounces of gold to buy a base model Mustang.

If you possess 57 ounces of gold today, the amount of gold it would have taken to buy a Mustang in 2000, you can now buy 3 Mustangs and still have about 3 ounces of gold, or $4,500 leftover.

Over the long term, over many time frames, gold has been a better place to preserve purchasing power than US Dollars and even better than stocks.

In 2000, the Standard and Poor’s 500 was about 2200.  Today, as of this writing, the S&P 500 stands at 2918, an increase of about 33% in terms of US Dollars.  By contrast, as we’ve already discussed, gold has increased by 500% in terms of US Dollars over that time frame.

According to Charlie Bilello (Source: https://kingworldnews.com/formerly-vocal-gold-bears-are-in-hiding-a-world-of-bubbles-plus-the-road-to-1800-gold/), over the last 20 years, gold has outperformed Berkshire Hathaway with Berkshire Hathaway returning 387% and gold returning 488%.

My forecast is for this trend to continue.

The current global monetary policy is currency devaluation.

Recently, President Trump labeled China as a currency manipulator alleging that the Chinese were manipulating its currency to gain a trade advantage.

The reality is that all fiat currencies are being devalued via manipulation. 

Worldwide, there is a race to the bottom as far as currencies are concerned with currencies losing absolute purchasing power as time passes.

 Each week, I track the value of the US Dollar Index.  While the US Dollar Index has held up well recently, it’s important to remember that this index measures the purchasing power of the US Dollar relative to the purchasing power of the fiat currencies of the six major trading partners of the US.

Just because the US Dollar Index rises, it doesn’t mean that the purchasing power of the US Dollar is increasing on an absolute basis. 

It’s not.

As we’ve just demonstrated, to calculate the absolute purchasing power of the US Dollar, one needs to use a tangible asset comparison.  Gold is the most commonly used and widely accepted tangible asset comparison.

In a recent piece published on “King World News” (Source:  https://kingworldnews.com/greyerz-most-people-dont-understand-the-scale-of-the-collapse-that-is-in-front-of-us/), Egon von Greyerz wrote:

Most people don’t understand that the value of their money in the pocket is deteriorating all the time. They live under the illusion that prices are going up, which is totally erroneous. It is not prices that are going up but the value of money which is declining rapidly. The example of the house above going up 50x in 48 years is a good illustration. In real terms, the house has not gone up in value at all. It is the value of the money that has collapsed in all countries since Nixon closed the gold window. 

If governments and central banks were honest, every year they would publish a table illustrating how much value the currency has lost in relation to gold, which is the only money that maintains its purchasing power. But since governments never do this, I will do it for them. Below is a table of the gold price for a selection of countries. 

Note from Mr. von Greyerz’s table that since 1971 when then US President Richard Nixon closed the gold window, world currencies have lost 90% to 99% or more of their purchasing power in real terms.

Since 2000, the best fiat currency in which to store wealth has been the Swiss Franc which has lost only 68% of its purchasing power.  The US Dollar, as evidenced by this chart and the Ford Mustang example above has lost 80% of its purchasing power.

History teaches us that currency devaluation is a slippery slope.  Once it starts it doesn’t stop until faith in the currency is ultimately, eventually and inevitably lost.

And, based on our research, there has never been a fiat currency that has lost more than 90% of its value that has ever reversed direction.

Looking at the numbers, this won’t be the first historical example of a fiat currency recovery either.

Global debt levels presently are simply staggering.

This chart suggests that global debt levels are now approaching $250 trillion, rising by $3 trillion in the first quarter of 2019.

Those debt levels cannot be paid with ‘honest’ money which leaves only two options:  one, default on the debt or two, create currency.

Since easy money and currency creation have been the preferred policies to this point, I expect that they will continue to be the preferred policies.  That is until they won’t work anymore.  Then, the reset will come.

At the reset point, tangible assets and assets with links to tangible assets will be needed to survive and prosper.

Digging Into Stock’s Decline Last Week

The Dow Jones Industrial Average declined 2.60% last week while the broader Standard and Poor’s 500 fell more than 3%. 

Market analysts blamed the decline on escalating trade war threats.  This from “Market Watch” (Source:  https://www.marketwatch.com/story/stock-futures-extend-tariff-inspired-decline-ahead-of-july-jobs-report-2019-08-02):

Stocks ended at their lowest levels in a month on Friday as investors worried that President Trump’s escalation of the trade war with China would impact economic growth, despite news that the U.S. labor market remained healthy. 

The benchmark S&P 500 index fell for a fifth straight day, to record the steepest weekly loss since last December’s selloff, closing at its lowest level since June 26.

Stocks extended losses after China vowed to retaliate against President Trump’s decision on Thursday to impose 10% tariffs on the remaining $300 million of imports from China not already subject to levies. Second-quarter corporate earnings for S&P 500 companies are now also on track to record a decline for two consecutive quarters for the first time since 2016.

While the trade war is a factor in stock’s decline, it’s far from the only factor.

One cannot deny that the trade war with China has dramatically affected trade as this chart (Chart One) from Mish Shedlock’s excellent blog illustrates (Source:  https://moneymaven.io/mishtalk/economics/import-shuffle-canada-mexico-surpass-china-as-the-us-biggest-trading-partner-ZNrLnqwLaE-aZfDIp-NfRw/).

Notice on the “Share of Total Trade with the U.S. chart that Mexico and Canada are now the biggest trading partners with the United States, displacing China as the former number one trading partner.

When examining only trade with China, one can see that year over year, US exports to China are falling significantly.

While trade wars make market participants nervous, I am of the opinion that the real cause of market decline is falling profits as indicated by the “Market Watch” article excerpt above and a couple of other factors.

To some extent, declining earnings and escalating trade wars are related having an inverse or opposite relationship.  As trade tensions rise and trade wars escalate, profits decline.  That has a negative impact on stocks.

Added to that dynamic, one has to consider that the stock market has been propped up over the past decade.  The easy money policies of the Fed has created demand for stocks.  History teaches us that whenever money is printed it will have to find a home.  Typically, newly created money finds a home in stocks and real estate.  This was true prior to the Panic of 1837, the Long Depression of 1873, the Great Depression and more recently the Great Recession.  In each of these circumstances, newly created money propped up stocks causing a bubble that eventually burst.

The policy response to the Great Recession was easy money; low interest rates and then outright money creation.  Stocks and real estate responded as they have most often historically.

As expected, the Federal Reserve cut interest rates last week.  Interestingly, stocks didn’t react positively.  Looking at stock market activity last week, the Dow advanced on Monday and Tuesday but declined precipitously Wednesday through Friday.  The Fed announced the .25% rate cut on Wednesday.

Perhaps this signals a change in the sentiment of stock market investors.  Up until this point, stock market participants reacted to a Fed rate cut by buying stocks causing the stock market to rally overall.

This time market participants seemed to finally grasp the reality of the situation.

A rate cut is really not good news.

A rate cut means that the Fed senses economic weakness.  It may well be that we just got the first honest reaction to an interest rate cut since the financial crisis.

There are a couple of other factors here as well.

The first is the noteworthy positive affect that corporate stock buy backs have had on the bullish stock market over the past couple of years. 

A recent CNBC article (Source:  https://www.cnbc.com/2019/07/31/santoli-apples-gains-are-largely-the-product-of-buyback-financial-engineering.html) describes how stock buybacks have been used by Apple (emphasis added):

Stock buybacks have gotten a bad name in many precincts over the past few years, decried as unproductive “financial engineering” that detracts from corporate investment in growth.

But Apple’s aggressive use of its copious cash resources to repurchase its shares at modest valuations in recent years has shown the power of buybacks for a maturing company in a growth lull. And, for Apple, if not the typical company, long-term shareholders have benefited without compromising the company’s hiring or spending on capital investment.

The slowdown in iPhone unit sales in the past couple of years has restrained Apple’s overall growth since its fiscal year ended Sept. 30, 2015. In fact, net income this fiscal year is projected to be almost exactly equal to what Apple booked four years earlier.

Yet Apple’s resolute plan to use a healthy chunk of its $200 billion in cash — supplemented by roughly $100 billion in low-cost debt — to buy its shares and raise its dividends has paid off well.

With flat net income, the purchase of a net 1.2 billion Apple shares means that per-share earnings are slated to rise from $9.22 in fiscal 2015 to $11.51 this year. 

Apple’s net income is flat when compared to four years ago, but because the company repurchased shares using cash and by acquiring debt with low interest rates, earnings per share have increased.

Apple is just one example of many companies that have engaged in stock buy backs.

The other factor affecting both the nominal value of stocks and reported earnings is the value of the US Dollar.  Since stock values and earnings are both reported in US Dollars, as the US Dollar loses absolute purchasing power, the nominal value of stocks and earnings reported in US Dollars increase even though on a real, absolute basis they are declining.

Back in May, Advisor Perspectives published a chart that plotted the real advance in stocks after adjusting for inflation since calendar year 2000. 

The inflation adjustments were made using the Consumer Price Index which is the most commonly accepted measure of the inflation rate.  This week’s Retirement Lifestyle Advocates Radio Program and Podcast contains an interview with noted economist, John Williams.  Mr. Williams is a consulting economist who maintains the website Shadow Stats.  (www.ShadowStats.com).  He tracks and reports economic data using methodologies formerly used by government agencies prior to changes being made to make the reported data look more favorable.

Mr. Williams estimates the true, real inflation rate to be significantly higher than the reported rate.

Nevertheless, when using the Consumer Price Index to adjust the advance in stocks for inflation since calendar year 2000, one finds the Nasdaq is only 7.4% higher.  The Standard and Poor’s 500 is 29.2% higher.

That puts the average real gain annually using the CPI for the Standard and Poor’s 500 at about 1.5%.

If we want to adjust for the real, true inflation rate rather than the CPI, we might price the S&P 500 in gold, which has historically been real money.

In March of 2000, the S&P 500 was just over 2200.  Gold sold for about $290 per ounce at that time.  That means the S&P 500 priced in gold was about 7.5.  (2200 divided by 290)

Today, as noted in the data box above, gold is at about 1440 and the S&P 500 is about twice that.  That means that today the S&P 500 priced in gold is a little more than 2.

Arguably, in real terms stocks are below their 2000 peak.

What does all this mean?

One, in real terms, my forecast is for stock to continue to decline.  In nominal terms, stocks could continue to increase for a time, although they may not.

Two, since currency devaluation is now the official world monetary policy, tangible assets like gold will likely be the ultimate beneficiary and the best place to preserve purchasing power.

The Retirement Lifestyle Advocates podcast featuring John Williams has now been posted at www.RetirementLifestyleAdvocates.com.