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  • ‘Deflation is a Central Bank’s Worst Nightmare’

    ‘Shae!’

    A voice boomed as I walked up the stairs at the Ivy Ballroom in Sydney. Last night, ABC Bullion held a gold conference there, and Jim Rickards was a key speaker. ABC Bullion kindly offered me a ticket to attend.

    The voice calling my name was Jim’s.

    He had the unfortunate experience of getting caught up in Sydney’s peak hour traffic.

    Not long after, we sat next to each other and the conference kicked off.

    The focus for the conference? Gold, of course!

    Specifically, the future of mining in New South Wales, along with Jim’s macro analysis on where and why gold is going higher.

    According to Jim, there are five key reasons for gold prices to head higher.

    In last night’s speech, he focused on how the role of real rates versus nominal rates is driving gold.

    While Jim is well-known for suggesting gold could go to US$10,000 per ounce, he actually made a strong case that that’s a conservative price. Gold may in fact move much, much higher than that.

    He added that gold will head higher as a direct result of central banks’ actions. He told the crowd, ‘Deflation is a central bank’s worst nightmare.’

    Here, Jim explains how central banking policies have failed, and why even the money managers don’t know what they’re doing anymore.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    The post ‘Deflation is a Central Bank’s Worst Nightmare’ appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • ‘It’s Not Our Fault’, Say Central Bankers

    The failures of monetary policy in the wake of the 2008 global financial crisis are manifest.

    The Federal Reserve took interest rates to zero in 2008 and held them there for six years before raising them slightly in recent years.

    The Fed also expanded its balance sheet through money printing, from US$800 billion to US$4.5 trillion from 2008 to 2014.

    That balance sheet has only been reduced slightly.

    Other central banks, including the European Central Bank (ECB) and the Bank of Japan (BoJ), used negative rates and expanded their balance sheets even more than the Fed.

    Those negative rates and bloated balance sheets are still in place.

    Elites blame their own policy failures

    These extreme forms of monetary easing were supposed to provide ‘stimulus’ to return the economy to self-sustaining trend growth.

    Nothing of the sort happened.

    The economy grew, but at the slowest pace of any recovery in history.

    Europe and Japan have suffered repeated recessions and periodic deflation while the US has suffered below-trend growth and disinflation.

    None of the central bank policies have produced the desired results, and none of the central banks have shown any capacity to escape the low rates and money printing they created.

    Since 2008, we have lived through a massive monetary experiment that has now been shown to be a massive failure.

    Rather than admit their mistakes, global elites instead seek to blame legislators and policymakers for failing to stimulate further using fiscal policy.

    Central bankers were disappointed at the inability of fiscal authorities to run larger deficits to stimulate the economy. Project Syndicate wrote:

    Both central banks – and especially the ECB under outgoing President Mario Draghi – have stressed the importance of a timely policy handoff to more comprehensive pro-growth measures.

    Yet their pleas have fallen on deaf ears. Today, neither the Fed nor the ECB is anticipating that other policymakers will take over any time soon. Instead, both are busy designing another round of stimulus that will involve even more political and policy risks.

    Now they are afraid that progressive radical solutions designed to bolster the weak economy, including Modern Monetary Theory, may emerge to discredit both fiscal policy and central banking at the same time.

    This is a clear-cut case of pointing fingers.

    The fiscal authorities have created multitrillion-dollar deficits even without special stimulus programs.

    Debt-to-GDP ratios are at the highest levels since the Second World War and high enough to slow growth independent of monetary policy.

    The extreme monetary experiments of the central bankers never should have been attempted with or without fiscal policy.

    We are now left to live with the consequences, including uncertainty and slow growth.

    Worse yet, the central banks will be unprepared to deal with the next crisis since they never cleaned up their mess from the last one.

    A central banker says don’t blame the central banks

    Raghuram Rajan is one of the top global monetary elites.

    He’s a professor at the University of Chicago and at various times has served as governor of the Reserve Bank of India, and in senior capacities at the IMF and Bank for International Settlements.

    He’s what the top elites call ‘a safe pair of hands’, which means he can be appointed to any one of a number of top positions with no fear of him rocking the boat with heterodox views.

    He recently wrote an article on the role of central banks in the economic recovery since 2009.

    Guess what?

    According to Rajan, the central banks have done everything right and fiscal authorities are to blame for weak growth, below-target inflation and other maladies from the weakest economic expansion in over 60 years.

    Rajan is correct when he says that central banks cannot create inflation or stimulate growth.

    But he runs off the rails when he says that populist politicians (such as Trump, Boris Johnson, Giuseppe Conte and Jair Bolsonaro, whom Rajan disparages) are now threatening central bank independence.

    The causality is the other way around.

    It is central bank incompetence that has given rise to populism. Central banks should have their powers curtailed and their independence limited.

    Incompetence has a cost, and in the case of central banks that cost involves exposure of their smokescreen around failure in economic management.

    Central banks are really good for one thing only: Being lenders of last resort.

    All other goals should be repealed.

    Better yet, maybe we should get rid of central banks entirely.

    All the best,

    Jim Rickards Signature

    Jim Rickards,
    Strategist, The Daily Reckoning Australia

    The post ‘It’s Not Our Fault’, Say Central Bankers appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • Peak Magellan: What Does the Share Price Mean for MFG?

    This has been a tumultuous week for the markets.

    The Aussie market copped a hiding on Thursday. It was down 2.80% for the day.

    Is the worst over, or is there more coming?

    Well, long-time readers of The Daily Reckoning Australia know I’m bearish on the Aussie economy. This week’s selloff and today’s subsequent headlines should be seen as a warning sign.

    Your regular weekend editor, Nick Hubble, is in the process of moving house. So this week, I reached out to my old colleague Greg Canavan, Editor of The Rum Rebellion.

    As markets heave and react to global news, Greg reckons there is another thing investors should be cautious of.

    Read on for more.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia


    Peak Magellan: What Does the Share Price Mean for MFG?

    Greg Canavan, Contributor

    Greg Canavan

    Markets rebounded last week as President Trump pulled back on some of his earlier tough talk on tariffs. The Wall Street Journal reports:

    Stocks, bond yields and commodities jumped Tuesday as news that the U.S. would delay some tariffs against China rekindled investors’ hopes for an eventual trade truce.

    The Trump administration announced it plans to delay and remove items from the roughly US$300 billion of Chinese imports facing tariffs on Sept. 1. The development sent investors rushing back into stocks after an extended bout of market volatility and two days of declines for major US indexes. Investors also piled into commodities, while shedding exposure to assets considered relatively safer such as government bonds and gold.

    Don’t be confused here, dear reader.

    This is pretty standard Trump fare.

    That is, he goes out hard early, then pulls it back a little.

    But the underlying theme here is that the US is in a soft war with China. It’s not going away…

    Trade tensions and a military response

    Last week, US Secretary of State Mike Pompeo made a brief stop in Australia.

    His visit included a talk and Q&A session at the State Library of NSW. As reported by The Spectator:

    Mr Pompeo was adamant that not only Australia, but the US and the West in general, had for far too long been complacent about China’s more sinister intentions; citing cyberwarfare, unfair and unprincipled business practices, the creation of large-scale debt in tiny nations throughout the South Pacific, the militarisation of the South China Sea (despite repeated promises from Xi Jinping that this would not happen) and so on.

    In particular, Mr Pompeo reminded us that we share values that are anathema to the communist Chinese, regardless of how “mesmerising”, to quote John Howard, their baubles may appear.

    The trade war relief rally is but a brief respite. Markets tumbled again on Thursday.

    As if that wasn’t enough, China has its hands full in Hong Kong, where pro-democracy protesters have shut down the airport for two days running.

    Reports suggest China is preparing a military response.

    This Twitter account shows a disturbing military build-up in the city of Shenzhen, which borders Hong Kong.

    Bringing the troops and tanks in might quell the riots, but does China really need another Tiananmen Square? The capital flight out of Hong Kong would be very destabilising for the region.

    This is the problem with totalitarianism. It rules with an iron fist. It can only shut down protests with coercive force. There is no logic to its imposition, apart from the logic of force.

    So, we watch and wait while the market gives us some respite.

    The MFG ASX share price…

    Meanwhile, in Australia, I have to ask: Is this another sign that the market has peaked?

    Or is it just peak Magellan? By that, I mean Magellan Financial Group Limited [ASX:MFG]. Have a look at the chart:

    Magellan Financial group - MFG (ASX)- 1 Day Bar Chart - AUD - 14-08-19

    Source: Optuma

    From the December 2018 low to the July 2019 peak, the stock price is up a massive 175%. It trades on a price-to-earnings (P/E) ratio of 32 times forecast FY20 earnings.

    That’s because boss Hamish Douglass has made big returns from largely investing in tech stocks, which have been in their own bubble of sorts over the past few years.

    Earlier this week, MFG took advantage of its hefty multiple to raise $275 million. When your stock is trading on a high P/E multiple, it means your cost of capital is cheap.

    For example, a P/E of 10 means the cost of equity capital is 10%. For MFG trading on a multiple of 32 times, its cost of equity capital is just 3.125% (1/32). That’s cheaper than some corporate bonds!

    Some of the capital raising will be used to invest in a new retirement income product MFG is in the process of developing.

    Now for the hubris (as reported by The Australian Financial Review):

    Looking seven years ahead, assuming its funds under management stay the same, Magellan expects to generate 7 to 9 per cent revenue growth a year. That translates to 11 to 14 per cent in total shareholder returns, including dividends, a year, Mr Douglass said, excluding new opportunities that might expand funds under management.

    There you go. In seven years, MFG expects to deliver shareholder returns of 11-14%, inclusive of dividends. That’s certainly a possibility, but not if the starting point is from where the share price is now.

    For example, MFG is expected to generate a return on equity (ROE) of around 42% in FY20. Let’s say your ‘required return’ is 8%. What would you pay for a share?

    To answer this question, a rough rule of thumb is to divide the ROE by the required return. In this case, it’s 42/8 = 5.25.

    In other words, to get an 8% return from the business, you should not pay more than 5.25 times the equity, or book, value.

    But MFG currently trades on a price-to-book value of nearly 11 times. Shifting the above equation around, that gives you a required return from the business of just 3.8%.

    What does that actually mean?

    Well, based on MFG’s current price and earnings expectations, and assuming there is no change to the current P/E multiple, the best you can expect to earn from this business is around 3.8% per annum.

    Of course, the P/E multiple won’t stay the same, so it is really just a theoretical exercise to give you some idea of the future returns the business can deliver. If the P/E multiple continues to expand, shareholders will earn a better return than the 3.8%. If it contracts, they will earn less.

    I’ll leave it for you to decide which way things will go from here.

    To me, it’s just another reason to be cautious about this market.

    Regards,

    Greg Canavan Signature

    Greg Canavan,
    For The Daily Reckoning Australia

    The post Peak Magellan: What Does the Share Price Mean for MFG? appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • Silver Rally to Catch Up With Gold

    I rarely talk about silver.

    And I should.

    Silver — more so than gold — is a crucial metal for modern society.

    It’s everywhere.

    In your phone, laptop… In fact, pretty much in any electronic device you own.

    Scratch that.

    Anything with a circuit board will have a small component of silver.

    Your microwave, washing machine, oven and camera equipment.

    All those new, shiny trucks driving past you on the freeway? Yep, their circuit boards contain silver too.

    The ‘other’ precious metal is easily forgotten about.

    At roughly AU$25 per ounce, you can buy two ounces of the stuff with a 50 buck note.

    And let’s be honest. The moves in gold are much more exciting than moves in the silver price. Gold can jump US$20-30 per ounce in a day.

    Heck, there’s been times when it moves US$100 in an hour.

    But silver would be lucky to move a buck or two in response.

    The lack of volatility — or excitement — is one of the reasons why many people never cover it.

    Right now, silver has failed to catch up to gold as it rallies.

    However, if history is anything to go by, we could be on the precipice of a new silver rally.

    By that, I mean the gains in silver could be bigger than the gains in gold.

    I’ll hand you over to Jim to show you exactly what I mean.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia


    Silver to Catch Up With Gold

    Jim Rickards

    Not many people have ever heard of the Central Bank Gold Agreement (CBGA), also called the Washington Agreement on Gold. But it’s an interesting side note to the history of government manipulation of gold markets.

    The agreement was first signed in 1999 and was renewed for five-year terms in 2004, 2009 and 2014.

    The signatories included central banks in France, Germany, Italy, the Netherlands, Belgium and the European Central Bank, as well as non-eurozone central banks in Switzerland and Sweden.

    The US was never a member of the agreement, but it did supervise the implementation of the agreement closely, as did the Bank for International Settlements (BIS).

    The CBGA is a gold seller’s cartel, similar to the notorious ‘London Gold Pool’ of the late 1960s.

    During the long gold bear market (1980-1999), central banks were active sellers of gold.

    There was some fear that the selling would spin out of control and hurt the value of remaining reserves more than was already the case.

    The CBGA set limits on total sales and individual sales by member countries as a way to allow some ongoing sales without sinking the entire market. There was only one problem.

    The sales had largely dried up by the time the agreement was put in place.

    Brown’s Bottom

    After ‘Brown’s Bottom’ — named after UK Chancellor of the Exchequer Gordon Brown, who sold about half the UK’s gold reserves at an average price of US$275 per ounce between 1999 and 2002 — there were few significant sales of gold by the CBGA signatories, except for 1,000 tonnes by Switzerland in the early 2000s and 400 tonnes by the IMF in 2010.

    There have been no sales by any signatories since 2010.

    The agreement is up for renewal in 2019, but it has long been a dead letter.

    Now, the agreement is being allowed to lapse.

    Of course, other central banks — including those in Russia, China, Vietnam, Turkey and more — have been voracious buyers of gold since 2009.

    As of now, the age of central bank gold sales is officially dead and the age of central banks as gold buyers has returned.

    This is just one more reason why gold prices have been on a tear.

    What about silver?

    Gold is up 40% in four years. Whereas the white metal, silver, has risen just 23% in the same time.

    It is time silver caught up. But how far can silver move?

    Many investors assume there is a baseline silver/gold price ratio of 16:1.

    They look at the actual silver/gold price ratio of 100:1 and assume that silver is poised for a 600% rally to restore the 16:1 ratio.

    These same investors tend to blame ‘manipulation’ for silver’s underperformance.

    I believe that analysis is almost entirely nonsense.

    There is no baseline silver/gold ratio.

    The ‘16:1 ratio’ is an historical legacy from silver mining lobbying in the late 19th century — a time of deflation, when farmers and miners were trying to ease the money supply by inflating the price of silver with a legislative link to gold.

    The result was ‘bimetallism’, an early form of QE.

    The ratio had nothing to do with supply/demand, geology or any other fundamental factor.

    Bimetallism failed and was replaced with a strict gold standard in 1900.

    This does not mean there is no correlation between gold and silver prices.

    As the gold and silver chart below reveals, there is a moderately strong correlation between the two.

    The coefficient of determination (expressed as r2) is 0.9.

    This means that over 80% of the movement in the price of silver can be explained by movements in the price of gold.

    The remaining silver price factors involve industrial demand unrelated to gold prices.

    Gold and silver prices over six months

    Source: Thomson Reuters Eikon

    Recently, a huge gap has opened up between the rally in gold prices (shown in blue with a right-hand scale) compared to silver prices (shown in orange with a left-hand scale).

    Given the historically high correlation between gold and silver price movements, and the recent lag in the silver rally, the analysis suggests that either gold will fall sharply or silver will rally sharply.

    Since we have articulated the case for continued strength in gold prices, our expectation is that silver is set for a strong ‘catch-up’ rally with gold, possibly to the US$16 per ounce level or higher.

    In this environment, gold is performing well. But looking at this chart, we can see that there is potential for significant price movements for silver.

    All the best,

    Jim Rickards Signature

    Jim Rickards,
    Strategist, The Daily Reckoning Australia

    The post Silver Rally to Catch Up With Gold appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • When safe money is no longer safe

    The markets got a little spooked last week.

    Global markets sold off and gold went up.

    What caused it?

    Was it US-China trade tensions, the Hong Kong protests, Russia’s naughty weapon, or a Trump tweet?

    I’m sure those events were all in the back of investors’ minds.

    However, the real reason markets got the jitters is because a 60-year-old market gauge turned red…

    60-year-old market indicator flashes red

    It’s been a reliable predictor of a recession for six decades.

    Today I’m talking about the ‘inverted yield curve’.

    After last week, that phrase slipped out of Wall Street and onto the lips of ordinary people.

    What’s all the fuss about the yield curve…and why does it matter to you?

    Well, it probably doesn’t affect you directly. However, it’s the implications for the broader market that matter.

    An inverted yield curve means that the US government’s 10-year Treasury bond interest rate is lower than the government’s 30-day Treasury bond interest rate.

    In other words, as of today, the bond with the longest timeframe will pay you less than the bond with a shorter timeframe.

    Traditionally, longer dated bonds are meant to pay investors a higher interest amount. This is because that money is being locked away for longer.

    However, with the 30-year US Treasury bond being worth less than the short-term one, it means investors are betting that the future is going to be worse than the present.

    Essentially, it’s a signal that future interest rates are going to be cheaper than today’s interest rates.

    And lower interest rates aren’t actually a good thing for the economy…

    Risk-free product just got risky

    Now, I get it. Talking bonds is boring.

    But that’s the point of them.

    Next to cash, they are meant to be the least risky investment product.

    Because of this, they’re perceived to be the next safest alternative to cash in the bank.

    To compliment that, bonds tend to offer a slighter higher interest rate than cash stored at the bank.

    While bonds offer only a small increase on cash stored at the bank, they have become a bellwether for how the economy is travelling.

    So when the bond yields are ‘inverted’, the US market panics.

    Because it means that the perceived safety of bonds is under threat.

    Are the jitters justified?

    Since 1962, the yield curve has inverted nine times. And in seven of those times, a US recession has followed within 24 months…

    US yield curve – 1962 to now

    Source: JPMorgan; Advisor Perspectives1

    However, there’s more to this story than just one bond rate slipping beneath another one.

    The yield curve is ‘steepening’ right now.

    Or, more plainly put, it’s falling at a faster rate than we’ve seen before.

    To make matters worse, it isn’t just the inversion or the steepness of the yield curve that’s causing concern.

    There’s a third problem.

    And an untested one at that…

    Bond holders lose money

    Grant Williams, editor of the blog Things That Make You Go Hmmm, stood up at the Sprott Natural Resource Symposium and told the room there was US$14 trillion worth of negative-yielding products worldwide.

    That was in the last week of July.

    Two weeks later, that figure has grown to US$17 trillion.2

    But let’s take a back step.

    What are negative-yielding bonds?

    Traditionally, a bond holder receives income earned through interest, at a set time. In simple terms, it’s a way of receiving money for taking the risk to lend money to a company.

    Let me put it this way.

    Imagine you lend me $10 today. And in one year’s time, I give you back $11. That means you have ‘earned’ $1 in interest for lending that money today.

    However, a negative-yielding bond is the flip side of that.

    A negative-yielding bond means the company that issued it is being paid to create debt.

    So rather than receiving income, the bond holder is now paying for the privilege of lending money to a corporation.

    In dollar terms, if you lend me $10 today, a year from now I would give you back $9.

    It’s absurd. There’s no way you would lend me money today only to receive less in a year’s time.

    Yet, there is US$17 trillion of those sorts of deals floating through the financial system today.

    It’s highly unusual and, quite frankly, unprecedented.

    Yet it’s becoming increasingly common within the global financial system as negative interest rates take hold.

    While the yield curve inversion is familiar and something the markets have seen before, negative-yielding bonds are not.

    To put all of this into context, the last time the US bond yield inverted was in 2008 after the financial crisis hit markets.

    The difference was that negative-yielding bonds didn’t exist then.

    My point is, we just don’t know the impact of this.

    Buckle up, investors. We have a bumpy couple of years ahead.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    The post When safe money is no longer safe appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

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