A Very, Very Interesting Year
Don Coxe, Chairman, Coxe Advisors LLC.
For the past year, we have rarely written on gold, because there were too many other investment opportunities, and the good old S&P was just going up month after month. This was, for most equity investors, Voltaire’s “best of all possible worlds.” The economy was of Goldilockian temperature and moderation, politicians were behaving the way cynics expected and optimists despised, and the Fed was successfully injecting massive doses of “financial heroin” into the US—and global—economy without any signs of ill effects… or any remarkable enthusiasm for risk-taking.
Some of us were disconcerted that an increasing proportion of the work force were leaving it for a life of disability benefits, food stamps, and other confections from the government’s banquet table. Meanwhile, bankers were happily absorbing the financial heroin of zero interest rates and a continuously fattened Fed balance sheet. They loaned, but not in ways that stimulate the economy. They were simply lending back to the Fed at a big markup and levering up their balance sheets with short-term, low-risk paper issued by other institutions.
We couldn’t help noticing the resemblance to the land of the lotus eaters in Homer’s The Odyssey. When Odysseus and his sailors landed among the lotus eaters, they enjoyed their floral diet and drifted into a state of dreamy satisfaction, refusing to return to the risks of “the wine-dark sea”—even though they swore they’d like to go home… sometime. Eventually, Odysseus and his most loyal followers lashed their lassitude-loving shipmates to boards and dragged them back to their ship.
In this dreamy financial world, the need to own gold became increasingly irrelevant. “Give us this day our daily Fed” was the bankers’ prayer, which was answered with monetary injections delivered with near-divine consistency. Why own the best protection against a financial catastrophe when the managers in Washington, London, and Frankfurt had apparently found the magical formula to eliminate risk?
No surprise, then, when The Financial Times disclosed in January that its regular poll of the world’s leading gold investment experts revealed an overwhelming consensus for another grim and ghastly year for gold.
Among the prognosticators were some who predicted that the gold price was headed for just three digits; they only disagreed on whether the front number would be nine or seven. The “must-own” metal of this millennium had lost its urgency and relevance, replaced in what remains of metallic stardom by platinum, which is needed to clean car exhausts. Global warming, says the new consensus, is something real, whereas gold is headed back to “barbarous relic” status.
Some of us who had been sitting on the sidelines decided that the Grecian Chorus of Gloom had overstayed its time on stage. Enough already!
Gold is just as relevant as ever, and the indispensable portfolio protector is on sale at a deep discount. That’s why in January, we sharply boosted gold stock exposures in the commodity equity portfolios we advise.
Some others apparently shared our view, because gold has not traded below its year-end close and is up 10% YTD at this writing. Gold stocks in the GDX are up 24.7%, and the GDXJ junior gold stocks are up an astonishing 41.8%. Chrysophilia could soon be back in vogue, although Paul Krugman and other “progressive” economists would surely label it “financial necrophilia.” (Is this a new age of gold or a dead-cat bounce?)
When Harold Macmillan was UK premier, he once gave a speech to a Tory audience about all the great things the government was doing for the people. The crowd loved it. Then a young man asked, “So what could possibly go wrong that would lead to your government’s defeat?”
“Events, dear boy, events,” the premier replied.
Events will, we suggest, bring gold back to center stage from its two years of languishing backstage. We cannot predict which “events” will trigger the next monster rally, but with all that paper money and all those debts and all those bad bank balance sheets, something will assuredly go wrong sometime.
Gold is that unique element that is priced not just by the interaction of the classic opposites—fear and greed—but by the shifting winds and storms of those emotional and intellectual opposites. Gold was languishing at $275 when a new kind of global war began on 9/11. When the US economy emerged from recession in 2002 and embarked on a real-estate-driven boom, gold soared all the way to the $1,000 level before being sucked into the bank collapse vortex and declining to $716. But while most equities were still plunging, gold and gold stocks entered into a new bull market and soared to $1,911. Two fears drove that golden bull: fear of Fed monetary policies and fear of a collapse of Eurozone banks and economies.
When those fears began to evaporate, gold investors looked down, saw no safety nets—and began bailing out. No inflation? No euro crisis? No reason to hold gold.
We think most investors are missing the point: nearly six years of unprecedented money printing, unprecedented subsidization of big banks with zero-cost money, and massive government intervention into the economy have not delivered even a soupçon of robust, inflation-generating growth.
Heroin was the battlefield anesthetic of choice for severely wounded soldiers. The crucial medical decision was not whether to deliver the heroin: that was easy. The tough part—for doctor and patient—was deciding on and enforcing its withdrawal before the soldier became a hopeless addict.
The Fed has been lulled into the economically perilous belief that capitalism should be stimulated with sustained injections of a potent narcotic long after the patient is out of the emergency ward. Zero-cost money and an underpriced mid-to-long Treasury market most certainly will make the economy rebound, not subside into languid repose.
This mechanistic assumption ignores the guts component of capitalism: hard work and taking risk for reward. The Fed’s long-term recovery is, in effect, based on the unstated premise that risk is a four-letter word that has, like another four-letter word beginning with “f,” little place in genteel company.
Mr. Bernanke must sense this, because nearly a year ago he began to warn that “tapering” was coming and “unconventional monetary policies” would not last forever. For that warning to the addicted patients—the big, bad, bonused bailout banks—he was greeted with screams of anguish and sharp stock market selloffs.
His successor is committed—at least for now—to continuing the tapering. Since the Fed has quadrupled its balance sheet without triggering worrisome inflation, that component of Fed policy should easily survive a gradual return to normalcy.
But the zero interest-rate policy (ZIRP), as our friend John Mauldin recently noted, is having serious effects on the economy and should be scheduled for early abandonment.
Meanwhile, the rest of the world is becoming more restless about President Obama’s apparent “de-risking” of American commitments abroad. Whether it is Syria, Benghazi, Mali, Egypt, Israel, or Iran, he seems to be giving signals that blights will produce merely barks. His secretary of state says that from here on, all American treaties will include commitments on climate behavior, because climate change is as great a risk as starvation, pandemics, or terrorism. (He left out locusts.)
With the increasing tensions between China and its neighbors—notably Japan—any misunderstandings about America’s commitment to its allies could prove disastrous. (Those with an interest in how misunderstandings about commitments to allies can lead to catastrophe should read Margaret MacMillan’s magisterial The War That Ended Peace: The Road to 1914.)
Investors should assume that the awe-inspiring oceans of liquidity already produced by central banks should be enough to avert a recessionary slide—if not to stimulate a heavy flow of capitalist juices.
What can we say of the post-taper Treasury market? Six years of massive support mean that the Fed is—by far—the biggest holder of the national debt. The Fed’s relationship to the Treasury could become an area for other radically new policies in coming years:
Why does the Fed need to hold all the debt it has bought? What would be wrong with shipping lots of it back to the Treasury to reduce the national debt?
What—if any—changes will be made to the Treasury’s policy of ignoring the nation’s hoard of gold while pricing it at Nixonian levels? For that matter, why is the Fed finding it so inconvenient to return Germany’s gold? On the present, somewhat theoretical schedule, the last of the gold will finally reach Frankfurt sometime during President Hillary Clinton’s second term.
The only thing about all of the above of which we can be reasonably certain: long before then, gold is going to be worth much more than $1,300 an ounce.