On March 16th 2011, five days after the Tohoku earthquake, the Yen against the US dollar went overnight from 80.83 to 76.25. In Yen quotation, ‘down’ is up: the Yen had strengthened, by 5.66%. A rather odd move, you’d think, for a country that had just suffered major earthquake, catastrophic tsunami, nuclear disaster, and the shutdown of industry along its eastern seaboard.

The Yen became a strong currency as Japan recovered form war, and its economy rose powerfully on its export-backed earnings. The consequent rise of the Yen was a multi-decade move. Well-documented, comprehensible, well-deserved even.

In the financial meltdown of 2008, the Yen acquired the reputation of being a strong currency in a crisis. The notion of the Yen strength for reasons apart from Japan’s historical export performance is puzzling when you consider Japan has the world’s worst ageing demographics, and the highest national debt to GDP ratio: 220%, and rising. Estimated at 250% by 2016, and no those bickering, rudderless politicians are not going to do anything to control their national debt’s inexorable increase.

The fundamental reason for Yen appreciation 2008-on was the unwinding of the carry trade. The Yen that the Bank of Japan had printed and thrown at the economy were not used in Japan for productive investment—Japan’s current problems go back to overcapacity at the end of the eighties and the inability to employ further capital. With interest rates on Yen at almost zero and pre-2008 on US, Australian, any kind of dollars you care to name, exceeding 5%, it was a lucrative ploy for banks and hedge funds to borrow Yen and switch them into a higher-yielding foreign currency. But when foreign-currency interest rates dipped towards zero in the maelstrom of 2008, these foreign currency positions were closed out and the money returned to the lenders, i.e. switched back into Yen.

With this vast repatriation of surplus capital, hey presto rising Yen (again)—but this time not as a result of export performance. Japan’s balance of trade is tipping to neutral, courtesy of the economic disruption of the quake, and the rise of China as a manufacturer. Yen strength post 2008 is based on a historical misconception. A Yen this strong is a symptom of a world economy out of whack.

Meanwhile the elephant in the room: that 220%-and-rising government debt to GDP ratio. In the international tables, guess who’s next. Greece, at 143%. And then Italy at 119%. Figures that have been putting them in the news recently. And seeing their borrowing costs at least double within a very short space of time, pushing debt management past the point of no return.

The interest rate Japan has to pay on its national 10-year government bond bobbles in the 1% to 2% range. Which is roughly what it has been since the mid-90s and the inception of the zero interest rate policy. The trouble is that at the size of 220% of GDP, close on 40% of annual budget goes to servicing the interest rate on the debt. If the interest rate on 10-year Japanese Government moved back above 4%, it would require the entire national tax take to service it. Back in 1993, the 10-year government bond rate was 4% (in 1989, it exceeded 8%), but in 1993, the national debt being serviced was an affordable 50% of GDP.

So perhaps you can see an endgame developing? When Japan is no longer able to sell more government bonds domestically to fund its ballooning budget it will have to go to the international capital markets to make up the shortfall—and the international capital markets won’t be quite so accommodating about 1%-2% repayments on a debt of elephantine size. 3%? 4%? These things tend to move very quickly once they start happening, as we have been seeing with Southern Europe (e.g. Italy 6-month rates went from 3.535% at the October 2011 auction to 6.504% in the November 2011 auction). If—which is a when—Japan is forced to pay 4% on its debt repayments, there won’t be any money left over for the expenses of government. And all the time the demographics are making things more difficult: fewer young productive workers footing the bill for out-of-control spending and borrowing.

How will this affect you? Well, civic bankruptcies, basic infrastructure neglect, a rising and more aggressive personal tax-take, guttering national pension payouts. A swift reversal of Yen strength—the last time the Yen went through 80 to the US dollar, in 1995, it was back at 147 three years later. And probably, in the end, no matter how hard they try to fight it, hyper-inflation.

Recommendations: at ‘strong’ Yen rates available, diversify into other currencies: diversify meaning several (because who knows the fate of the Euro, of the US dollar etc.). Invest in emerging, demographically healthy economies. If you want to own hard assets here, buy high-end land, against the inflationary possibility. But make sure it is high end, as a declining population will mitigate against land value. Buy gold. And make sure you have your own personal pension plan outside Japan, offshore if you wish. It’s perfectly legal. Indeed a personal pension plan outside Japan can, in its range of holdings, accomplish all these investment objectives (land excepted) in a single package.

For more information on starting a personal pension plan and lump sum investing too, please get in touch on 03-5724-5100 or info@bannerjapan.com

GOLD

A longer look at the S&P and a guess at the direction

A few noted deflationists are calling for a top in commodity prices. Their argument is pretty simple: Because inflation is a function of available money plus credit (their definition), and because credit has fallen, deflation is what comes next. When looking about for things to deflate in price, commodities are an obvious candidate for attention because they have risen so much over the past decade.

In this view, three things have to be true:

1. Demand for commodities has to fall below supply. After all, as long as demand exceeds supply, prices will typically rise. (Wrong: no excess supply)

2. Money, including credit that would normally be used to buy commodities, has to shrink. That’s the definition of deflation that we’re analyzing here. (Wrong: look at M1 it is increasing; banks are not lending)

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. -Milton Friedman, The Counter-Revolution in Monetary Theory (1970)

3. People’s preference for money has to be greater than their preference for ‘things,’ with commodities being very obvious ‘things.’ That is, faith in money has to be there or people will prefer to store their wealth elsewhere. (I believe this is happening now, why keep cash? you get ZERO return for it)

These are all just versions of the old supply/demand argument for commodity prices, except that our consideration also includes the important element of the Austrian economic view of demand for money.

There are several reasons why I think there are serious holes in each of these conditions. Enough to warrant a healthy degree of caution in one’s certainty about what ‘must’ happen next to commodity prices.

Looking at Gold and deflation opinions over the years

1. Adam Hamilton of Zeal LLC wrote, anything typically financed by debt is likely to see its prices plunge dramatically, like houses and cars, as the ongoing Great Bear bust continues to destroy the gross excesses of debt via higher long rates. Conversely, anything not typically paid for with debt, including groceries and general living expenses, is almost certain to rise in the coming years. We are staring down a brutal environment of widespread inflation marked by various sectors witnessing falling prices as debt leverage implodes. See entire article here.

2. Castrese Tipaldi wrote on SafeHaven.com, I don’t know if in the last week we saw the last gasp of those usual subjects trying to cap gold, and I don’t know if we now have the very last possibility to get silver at a price so cheap. What makes this quote so interesting is he wrote this on April 20, 2004. See article here.

3. Dan Ascani, who wrote essentially about Professor Jastram’s very long-term study on gold, and he essentially states that Jastram studied four pronounced price deflations taking place. In all four deflations, operational wealth in the form of gold appreciated handsomely. When one sees that just by holding gold for 13 years, from 1920 to 1933 operational wealth would have increased two and a half times, one realizes that gold can be a valuable hedge in deflation however, a poor one in inflation.

4. Dr. Marc Faber one of the most respected and best followed in the industry has stated his opinion on the deflation debate as follows: Therefore, under both scenarios stagflation or deflationary recession gold, gold equities, and other precious metals should continue to perform better than financial assets. See article here.

5. Steve Saville of the Speculative Investor writes, The most important difference between then (the 1930s) and now is that gold and cash US dollars were interchangeable during the early 1930s (the deflationary period) by virtue of the fact that the dollar was defined as a fixed weight of gold. A typical effect of deflation is an increase in the purchasing power of cash. The fact that gold and cash were officially linked during the 1930s meant the deflation caused the purchasing power of gold to increase along with the purchasing power of cash. In other words, under the monetary system that was in effect during the 1930s gold was a hedge against deflation. Furthermore, under such a system the purchasing power of gold would decrease during periods of inflation; that is, when the dollar was defined in terms of gold, it would have made sense to shift investment away from gold during periods of inflation.

Currently it seems the physical markets are taking control, yet the clues are still subtle, nonetheless with Hugo Chavez asking for Venezuela’sgold to be returned we must ask is this the tipping point in the physical gold market that is the start of a trend? Likely not as Chavez is more likely trying to remove assets that can potentially be confiscated in case he loses a lawsuit for kicking out the oil companies and various others he nationalized over the years. But it did make people stand up and think for a minute and this will lead up to the tipping point in gold as the next steps are currencies.

The recent Swiss move to deflate their currency, is this the start of currency wars and the race to the bottom? The next step will be protectionism as governments suffering from falling exports will attempt to protect local champions via protective taxes, tariffs and the limiting of certain imports. Affected governments and industries will retaliate for their own loss of exports and so on and so forth. Welcome to the currency wars.  

The end result will be an eventual eroding of faith in the US government credit. The market will eventually wake up and realize that monetization is the one and only way our government can kick the can down the road without immediately collapsing the economy. Which means fixed income investors will lose ad infinitum. Imagine a pension fund or insurance company with a 5-8% real return hurdle rate. How can they possibly stay in 10yr Treasuries with a negative real yield? They can’t. The Bond vigilantes will eventually stir and move into other asset classes en masse. This shift out of public assets and in to private assets will represent a change in preferences that has lasted since 1980, over 31 years. The death of the long-term bull market in government debt will mean the nail in the coffin for the USD and the US role as sole superpower. It will also mean incredibly interesting things for the ultimate reserve currency, gold.  

Bottom line: now is a great time to get out of government paper and many miles away from the large US and European banks. I am a broken record on this but you should own gold and silver miners, fertilizer companies, oil companies and water companies. Some technology stocks could make sense and reasonable exposure to Asia and Latin America. Corporate bonds of companies providing any of the products listed above (gold/silver, fertilizers, oil and water) makes a ton of sense. I would avoid the large multi-nationals here as I think trade wars are coming and their cash flows from foreign operations are about to come under fire.

By the way the US debt ceiling has been reached again in a month!

Got Gold ?

“Gold’s around$1,500 now and I bought it at $1,200 (or if you were with us when we first bought way back in 2001 at $300) – should I sell it and look to buy it back when it corrects. It’s gotta correct, right?”

My answer: “What if it doesn’t with any significance?”

Yes, gold has performed incredibly well. But the point here is to understand WHY you bought it.

NEXT, silver was ripe for profit taking after a very rapid and steep climb to much higher levels. As I say, no market goes up in a straight line and we were due for some consolidation, but I thought we would hold the $40.00 level. To see silver slice through that psychological support was disappointing. It looks like it will bounce around here and if we can pick up more at between $25 to $30 we will be happy.

The word however I would use to help investors is “RELAX”. Everything is going to be just fine. These are the dip moments I have been talking about where you want to BUY.

Dan Norcini of JS Mineset had some great comments that I think reflect the true nature of why our market is reacting the way it is. Dan said, “I want to address the silver backwardation issue.  Many investors and traders feel that silver should not be dropping in price because of the backwardation structure.  They point to this fact as proof that silver is in short supply and demand is phenomenal. 

That may be entirely true, I don’t know, but the fact is that when we are dealing with the Comex silver market we are dealing with a paper market.  Keep in mind that hedge funds that trade the paper markets do not care about fundamentals.  They are pure technicians who rely solely on their computer trading algorithms to make trading decisions.  These algorithms are utterly indifferent to the realities in the physical market.

The bottom line is once these algorithms move into a sell mode, the hedge funds will unload until they’ve exhausted their selling, regardless of the physical market structure.  Meaning the paper market does not care about the physical market.”

Another factor that has affected our silver market was Wednesday’s CME announcement that they were raising silver margins. Jim Sinclair, who has been through all of this before back in the 70’s and 80’s weighed in on this and said the following:

Margins will continue to rise on the COMEX until it reaches the cash price of silver. This works for the shorts as their hammer on the silver market reduced the equity of low cost positions. The efficacy is short term and made no difference whatsoever in 1980 as the silver market made its highs. What broke silver in 1980 was a unilateral change (novation) of the silver contract which went to “sellers only.” Under contract law that is simply not permitted. They got away with a violation in 1980, but the corporate changes in structure at the COMEX that have occurred since 1980 makes the COMEX less able to pull that trick off successfully in 2011.

Silver is simply being silver. Silver did help gold therefore the 25% drop in value has to pressure the gold price.

The USDX is simply having a weak rally off a totally oversold on every internal indicator short side trade. The dollar has no future. The supply wishing to diversify is simply too big to allow any rally to have legs.

I have told you silver is a game. That being said, it is a great game. Certainly as the silver price approached the 1980 high, you might have considered selling 1/3.

The high trade on silver was $54 in 1980. Silver’s round numbers are at $50 and $100. Both will function as such in trading.

After this short play, which had to follow the spike intermediary top, silver will rise as fast as it did again.

In addition, Mr. Sinclair went on to point out what I have been saying is coming with our junior mining shares. This is a major turning point that will begin to heavily favor junior mining shares.

Jim explains in italics below:

The Hedgies are having their way with the gold shares, but logically this is coming to an end. When you can buy companies whose resources are three times the company’s present capitalization, the share is getting unreasonably cheap.

The ratio of GDX versus GDXJ is starting to favor the juniors, which is a major heads up event.

What you have witnessed is not at all shocking. If you traded 1968 to 1980 you would know this is just silver being silver.

Relax. Put a french curve on silver and you will see the bottom change in trend event.

To make truly big money in a volatile market you need to understand what you are doing. Volatility is our friend, it is not our enemy! We are being given a gift to buy silver at discount prices for a brief period of time. For those of you who wanted to buy silver but just didn’t get around to it, here is your chance to buy an oversold dip. Watch for the bottom to come rather soon and pull the trigger.

Conservatively, we absolutely believe that silver will be well north of $50 an ounce before the end of the year with gold getting ready to take out $2,000 during this same time frame.  So relax and feel confident in the positions you take now and over the course of the summer. Things are going to be just fine!

QUESTION: What would happen if the market found out that the world’s central banks have been leasing out far more gold than they actually own? 

The answer is also the reason gold could jump to anywhere between $2,000 and $5,000 an ounce very quickly in the near future.

For several decades now central banks have been ‘leasing’ gold to the market. They’ve been doing this to keep the gold price low…so they could keep conducting loose monetary policy. According to the World Gold Council, total official central bank gold reserves at December 2010 are around 30,000 tonnes. If the figures I have are accurate, well over 15,000 tonnes of gold has been lent out by central banks.

Owning physical gold means you have no counterparty risk. It’s a way of putting a portion of your wealth outside the currently flawed banking system. Owning gold derivatives comes with counterparty risk. In a benign monetary environment counterparty risk is no big deal. But in an impaired system, which is what we have now, it can become a major issue very quickly.

As long as central banks keep printing money, as long as we have a financial system built on debt, and as long as gold is allowed to freely float, the price gold will keep going up.

 Simply put: I feel we are nearing a point where physical hoarding of gold by wealth-protecting individuals and countries is going to cause a liquidity crisis in physical gold. When that happens, much higher prices will be required to lure gold away from hoarders and back onto the physical market. Only a sharp increase in interest rates by the Federal Reserve would prevent this from happening…and entice people to sell some gold. And, frankly, I don’t see that happening anytime soon.

 More Questions?

 Is it normal for the US to pass China as the largest holder of its own debt?

1. Is it normal for the Federal Reserve to purchase an estimated 70% of the new supply of that debt?
2. How can inflation be normal when a broad cross-section of food and commodities appreciate 23% in only six months?
3. Or when global inflation contributes to violent protests, revolutions, and war that spread across the Middle East and Northern Africa causing oil price shocks?
4. Can we say it is normal when the European Union bails out its third member nation in under a year?
5. Or when the Swiss Franc appreciates nearly +30% against the USD in only nine months, cancelling out a +27% gain in the Dow Jones Industrial Index from currency devaluation alone?
6. Why is it so easy for markets to return to normal after a massive disaster in Japan threatens the financial viability of the world’s third largest economy and purchaser of US debt?

Each and every one of these facts is a fire burning on the wings of the economy. The markets may be passive but not without hidden fear.

The denial of truth is the denial of volatility.

As always we invite you to call us and discuss your concerns  – 03 5724 5100