Peter Schiff Shares His Offshore Strategies

By Nick Giambruno

I’d bet that most International Man readers are familiar with Peter Schiff. He is a financial commentator and author, CEO of Euro Pacific Capital, and is known for accurately predicting the 2008 financial crisis.

He also has a very keen understanding of internationalization. Peter shares with me his strategies in this must read discussion below that I am happy to bring exclusively to International Man readers. (If you are not already a member, you can join for free here.)

Nick Giambruno: Peter, do you see the potential for another financial crisis in the U.S. playing out in the not so distant future?

Peter Schiff: Unfortunately, yes. I mean, how soon is very difficult to tell. In fact, right now you’ve got a high level of complacency. The stock markets are rallying to new highs, nominal highs. People seem to be convinced that the worst is behind us, that the central banks of the world have solved their problems by papering them over. But, you know, I don’t think they’ve solved anything. I think they’ve compounded the underlying problems that caused the last crisis, and so now the next crisis will be that much worse because of what the central banks did, in particular the Federal Reserve.

The Fed is right now trying to prop the economy up, the housing market up with cheap money, and it is operating under the delusion that one day it can take that cheap money away and the economy and the housing market will just sustain on their own, but that’s not possible. The Fed is building an economy that is completely dependent on that cheap money. And so if you take it away, the economy implodes, but if you don’t take it away, then it’s worse.

Nick Giambruno: So what measures do you see coming into place—things such as capital controls?

Peter Schiff: Well, certainly as currencies depreciate, governments look to try to find ways to stop the bleeding. What’s really is going on with inflation is that you have a huge transfer of wealth from savers and lenders to debtors, and of course the US government is the world’s biggest debtor, but a lot of American voters are in debt too.

If you’re a saver and you don’t want to watch your assets confiscated through the printing press, then you’re going to try to protect yourself. You might do that by moving your dollars abroad, converting them to foreign currencies, trying to get out of harm’s way, and that’s when you have the government potentially coming in with capital controls.

Putting taxes on foreign currency transactions or maybe outright prohibiting them altogether, that will make it more difficult for you or more expensive to take protective measures. I think we’ve already got the beginnings of capital controls in the United States. The government is making it very difficult for Americans to do business abroad. Many foreign financial institutions, banks, and even bullion depositories are refusing to do business with American citizens for fear of retaliation by the IRS or other government agencies.

Nick Giambruno: So what can Americans and others living under a desperate government do to minimize this risk?

Peter Schiff: Well, the first thing that you could do is minimize your purchasing power risk. So you don’t have to get your money into a foreign bank or foreign brokerage account to get out of the dollar. I help Americans diversify globally within a US account, but their portfolio consists of foreign assets, whether it’s foreign bonds, government bonds, corporate bonds, foreign stocks, dividend-paying stocks, commodities, or precious metals. These are all things that will protect purchasing power in an inflationary time period, and things that the federal government—the Federal Reserve—can’t levy the inflation tax on.

If you’re more worried about political risk—about the US government seizing your assets—then you want to take the next step. This is not just getting out of the dollar, but getting your money out of the country. But again, the US government is making that more difficult right now.

I know personally. I set up a foreign brokerage firm as a subsidiary of my foreign bank, which I also set up, called Euro Pacific Bank. I did this predominantly for foreigners who were having trouble investing with my US brokerage firm. The securities rules and regulations are now so onerous that it almost caused me to view any foreigner as a terrorist. So if somebody in Australia wanted to open up an account with me, there was so much paperwork involved that oftentimes they would just give up halfway through the process. So what I did is I set up this foreign bank so that I wouldn’t have to operate under those confines, so I can be more competitive to a foreign investor, but I can’t offer these services to Americans.

My foreign bank is no different than many other foreign banks. In order to really protect the privacy of my foreign customers, I can’t accept American customers. And if I accepted American customers, my compliance cost would be so high that I would have to charge my foreign customers more for transactions to try to stay in business. So to mitigate all that regulation and the potential of having to share all the information on my foreign clients with the US government, I’m just not taking American customers with my foreign bank.

Nick Giambruno: So Euro Pacific Bank, where is it headquartered and why did you choose that jurisdiction?

Peter Schiff: It’s in St Vincent and the Grenadines (the Caribbean). I did it for a number of reasons: it’s close to me, but also because of the banking laws. You have secrecy, privacy, and you have no tax. They’re not going to impose any income tax on my company as an offshore bank, they’re also not going to impose any taxes, any withholding taxes on my bank’s customers’ interest income or their capital gains. And no one is going to pierce the wall of secrecy. You’re going to have to go in to a St. Vincent’s court and get a local court order to get any information from my bank.

The bank is regulated, but it’s not nearly as onerous as the type of regulations that I would face trying to do this business from the United States. In fact, some of the things we’re doing offshore might be completely impossible because they would no longer be economically viable if I tried to do them in America, but I can do them offshore because the government doesn’t impose these artificial barriers.(Editor’s Note: You can find out more about Euro Pacific Bank here.)

Nick Giambruno: Generally speaking, which countries are you particularly bullish on?

Peter Schiff: It’s kind of like a monetary or economic triage; I’m always looking around the world to see which countries are in the least bad shape, which countries are the least reckless and the least irresponsible. You really can’t find any one country that’s doing it perfectly. You just have to find the ones that are making the fewest mistakes.

And I think high on that list are Singapore and Hong Kong. Those markets are relatively free of regulation, free of taxation. I mean, it’s not nonexistent, but on a relative basis you have a lot more freedom there, and so you have a lot more prosperity there. You have much better economic fundamentals. And not just in those two places, but in Southeast Asia in general, in a lot of the emerging economies, you’ll find a lot less government and a lot more freedom. People are working harder, they’re saving, they’re producing, and they’re exporting. You don’t have these trade deficits, budget deficits, and you don’t have armies of people looking to retire on government entitlements. In Europe, we still like Switzerland even though they are making mistakes tying their currency to the euro. I think eventually they will change that policy. Scandinavia, we have been investors in Norway, we’ve been investors in Sweden. Also Australia and New Zealand have been longtime favorites. We’ve been investing down there or even closer to home in Canada. We do have some investments in South America. We’re diversifying around the world trying to get into the right countries, the right currencies, the right asset classes.

Nick Giambruno: On a different note, we’ve seen the number of US citizens renouncing their citizenship sharply increase. We have also seen high-profile people like Tina Turner and Eduardo Saverin give up their US citizenship. Would Tina be eligible to use Euro Pacific Bank?

Peter Schiff: Yes, once you renounce your US citizenship. The only people who can’t bank with me are American citizens, or green card holders. So once you are no longer an American citizen, as long as you don’t reside in the United States, then you are welcome at the bank.

I think a lot of people are doing this obviously for tax reasons, although they can’t necessarily claim it’s for tax reasons. You have to fill out a form if you want to renounce your citizenship—which, by the way, you can only get from a foreign embassy or consulate. Those forms used to be free. Now they’re $500 apiece. So think about that. If they can charge you $500 for that form, they could charge $5,000, they could charge $5,000,000. They could basically make it impossible for you to leave. And they’re trying to make it more difficult ever since Eduardo Saverin from Facebook went to Singapore.

Now the government is trying to come up with all sorts of ways to punish Americans who try to give up their citizenship, and this really is the sign of a nation in decay. Fifty years ago, nobody would want to give up American citizenship. They would cherish it. The fact that so many people are paying tremendous amounts of money to get this albatross off their neck shows you how much times have changed, that an American passport is not an asset to be cherished but a liability that people are willing to pay to get rid of.

Nick Giambruno: And what about yourself? Do you believe you are adequately diversified internationally?

Peter Schiff: I think my investments are; I own a lot of foreign stocks. I have a lot of precious metals, I have a lot of mining shares. But I still live in the United States, so I’m obviously still vulnerable here. My family is here, so I haven’t done anything about a physical exit strategy. Although I do think I have financial resources that would afford me the ability to relocate, but I haven’t actually taken any steps other than setting up a foreign business. I have the foreign bank in the Caribbean. I have a brokerage firm Euro Pacific Canada, and so I’ve got offices up there.

I’m also thinking about opening up an office in Singapore and trying to move more of my business—particularly my asset management business—to move it from the US. Not only because of favorable tax treatment outside the US, but because of the regulatory environment. If you want to be globally competitive, you need to be in an area where you can minimize these costs because if I have those costs and my competitors don’t, then I am at a disadvantage. And also because I think that over time people are going to be more and more hesitant about sending their money to the United States. So if I’m going to manage money, I might have to manage it offshore, because I think people will be worried about sending it here. They might be worried that the US government might take it.

If it ever gets really, really bad that you feel that you have to leave, by then it might be illegal to take any gold or silver out of the country. Right now you can take more than $10,000 worth of cash or cash equivalents—which would include gold bullion—out of the country as long as you tell the government that you’re taking it. And if you don’t tell them and they catch you, there’s a big fine and jail penalty. But one day it might not be the case. It might be that you are prohibited from taking any significant amount of money out of the country, and who knows what the penalty might be if they catch you. But if it’s already out of the country, then you don’t have to worry, because you’re leaving with nothing and the money is on the other side of the border waiting for you.
 
Nick Giambruno: So the idea is to preempt capital controls?

Peter Schiff: Yeah, well, you get out the window before they slam it shut. That’s the whole idea, and right now those windows are shutting all around as more and more offshore institutions are saying “no thank you” to an American customer. But the other reason that you want to act sooner too is if they impose exchange controls or fees on purchasing precious metals. They don’t ban them, but they have a big tax on the transaction or a big tax on the foreign exchange. If you want to buy Swiss francs, they can have a transaction tax. You want to get your money out of the dollar before those taxes are imposed, because if you wait until they’re imposed, then you can’t get as much money out, because a lot of it is being lost to taxes.

In getting out of the dollar, you’re trying to avoid the inflation tax, but they’re hitting you with some other kind of tax in the process because that’s really what they are trying to do. A lot of people are worrying about the income tax or the estate tax and they go through elaborate means to try to minimize those taxes, but then they leave themselves vulnerable to what might be the biggest tax of all: and that’s the inflation tax. So you have to act to protect yourself before so many people are trying to protect themselves that the government makes it almost impossible to do so.

Editor’s Note: Internationalization is your ultimate insurance policy. Whether it’s with a second passport, offshore physical gold storage, or other measures, it is critically important that you dilute the amount of control the bureaucrats in your home country wield over you by diversifying your political risk.

You can find Casey Research’s A-Z guide on internationalization by clicking here.

The article Peter Schiff Shares His Offshore Strategies was originally published at International Man

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99 Problems… And Crude Oil Ain’t One of Them

By Marin Katusa, Chief Energy Investment Strategist

America has some serious problems.


Despite the fact that the United States spends $15,171 per student—more than any other country in the world—American students consistently trail their foreign counterparts, ranking 23^rd in science and 31^st in math.

The US also spends more than twice as much on health care per capita than the average developed country, yet underperforms most of the developed world in infant mortality and life expectancy. The U.S. rate of premature births, for example, resembles that of sub-Saharan Africa, rather than a First World country. And if you think Obamacare is going to change that… I have a bridge to sell you.

K Street has a bigger influence on American politics now than Main Street, and economic key players like the TBTF banks, the insurance industry, etc., have nearly carte blanche to act in whichever way they see fit, with no negative consequences.

The US government is spending more money to spy on Americans and foreigners than ever before. Since August 2011, the NSA has recorded 1.8 billion phone calls per day (!)—with the goal of creating a metadata repository capable of taking in 20 billion "record events" daily.

More than one in seven Americans are on the Supplemental Nutrition Assistance Program (SNAP)—better known as "food stamps."

The list goes on and on.

But there is one problem that America doesn't have......getting oil out of the ground.

After decades of declining domestic production, U.S. producers finally figured out how to extract oil from difficult locations, whether that's the shale formations or deposits under thousands of feet of water… and they've kept going ever since.

Today, the U.S. is one of the few countries in the world that have seen double digit growth in oil production over the past five years.

This presents some great investment opportunities for the discerning investor.

The oil industry's new treasure trove, the legendary Bakken formation, has turned formerly sleepy North Dakota into one of the hottest places in the United States. According to the Minneapolis Fed, "the Bakken oil boom is five times larger than the oil boom in the 1980s."

Unemployment in the state with 2.7% is the lowest in the nation; in Dickinson, ND, even the local McDonald's offers a $300 signing bonus to new hires, on top of an hourly wage of $15.
Here are some more fun facts, courtesy of the Fiscal Times:

• There are now an estimated 40,856 oil industry jobs in North Dakota, plus an additional 18,000 jobs supporting the industry. Between 2010 and 2012, Williston, ND, a town with a population of only 16,000, produced 14,000 new jobs.

• While other US states are struggling, some even being close to bankruptcy, North Dakota now has a billion-dollar budget surplus.

• The number of ND taxpayers reporting income of more than $1 million nearly tripled between 2005 and 2011—and that in a state with a total population of 700,000.

• The low population numbers will soon be a thing of the past, though: the population in the oil-producing region is expected to climb over 50% in the next 20 years.

• 2,000-3,000 new housing units are built every year in Williston, ND, but it's still not enough to fill the need. Rents have gone from a pre-boom $350 per month for a two-bedroom apartment to over $2,000 today… the equivalent of a studio apartment in New York's rich Upper East Side.

The entire "energy map" of the United States has been altered by the Bakken: the Midwest, rather than the Gulf, is now the go-to area.

And who profits the most? The pipeline companies that can quickly adapt to this new situation and the refinery companies that can use this readily available domestic oil.

Though the rest of the world is trying to catch up, the United States has a huge head start over everyone else. The advancements it holds in hydraulic fracturing and horizontal drilling had been built on the back of one and a half centuries of oil and gas exploration and the thousands of firms that service the drillers and producers.

So far, other countries simply lack the experience and the infrastructure to even compete.

In fact, American companies have spent 50% more money on energy research and development (R&D) than companies anywhere else in the world. What's more, they are exporting this technology across the globe, enabling other countries to unlock their own hydrocarbon reserves.

Obviously, they're not doing this out of philanthropy; there is a lot of money to be made by licensing out their technology and "lending a helping hand."

The biggest winners, hands down, are the energy-service companies that already know how to get oil out of US fields… and that apply these methods to other fields worldwide to boost production and reduce decline rates.

As the easy-to-extract oil depletes in the U.S. and abroad, oil companies and governments are beginning to look at past-producing oil fields. As it turns out, the producing wells drilled in the 1970s and '80s weren't very good at getting every drop of oil out of the ground. With modern technology, however, it is now possible to access previously out-of-reach deposits. Even a mere 5% or 10% improvement in oil recovery rates means billions, if not trillions, more in revenues.

Rediscovering previously overlooked fields was what started the boom in the Bakken as well as the Eagle Ford formations… and other countries are beginning to catch on.

We believe that this new trend of applying new technologies to old oil fields is not a fad but here to stay. That's why our energy portfolios are stocked with companies doing just that in Europe, Oceania, and even South America.

As it's becoming clear that the era of cheap, light, sweet crude is nearing its end, the industry is adapting to this new reality of oil becoming more difficult to access. And if investors want to make profits in today's energy markets, they, too, must learn to adapt.

Read our 2014 Energy Forecast for more details on what's hot and what's not in this year's energy markets. This free special report tells you about the 3 sectors we are most bullish on for this year, and which sectors to avoid in 2014. Read it now.


Don't miss this weeks free webinar "How to Architect the Trade"

Paper Gold Ain’t as Good as the Real Thing

By Doug French, Contributing Editor

For the first time ever, the majority of Americans are scared of their own federal government. A Pew Research poll found that 53% of Americans think the government threatens their personal rights and freedoms.


Americans aren't wild about the government's currency either. Instead of holding dollars and other financial assets, investors are storing wealth in art, wine, and antique cars. The Economist reported in November, "This buying binge… is growing distrust of financial assets."

But while the big money is setting art market records and pumping up high end real estate prices, the distrust in government script has not pushed the suspicious into the barbarous relic. The lowly dollar has soared versus gold since September 2011.

Every central banker on earth has sworn an oath to Keynesian money creation, yet the yellow metal has retraced nearly $700 from its $1,895 high. The only limits to fiat money creation are the imagination of central bankers and the willingness of commercial bankers to lend. That being the case, the main culprit for gold's lackluster performance over the past two years is something else, Tocqueville Asset Management Portfolio Manager and Senior Managing Director John Hathaway explained in his brilliant report "Let's Get Physical.

Hathaway points out that the wind is clearly in the face of gold production. It currently costs as much or more to produce an ounce than you can sell it for. Mining gold is expensive; gone are the days of fishing large nuggets from California or Alaska streams. Millions of tonnes of ore must be moved and processed for just tiny bits of metal, and few large deposits have been found in recent years.

"Production post 2015 seems set to decline and perhaps sharply," says Hathaway.

Satoshi Nakamoto created a kind of digital gold in 2009 that, too, is limited in supply. No more than 21 million bitcoins will be "mined," and there are currently fewer than 12 million in existence. Satoshi made the cyber version of gold easy to mine in the early going. But like the gold mining business, mining bitcoins becomes ever more difficult. Today, you need a souped-up supercomputer to solve the equations that verify bitcoin transactions—which is the process that creates the cyber currency.

The value of this cyber dollar alternative has exploded versus the government's currency, rising from less than $25 per bitcoin in May 2011 to nearly $1,000 recently. One reason is surely its portability. Business is conducted globally today, in contrast to the ancient world where most everyone lived their lives inside a 25 mile radius. Thus, carrying bitcoins weightlessly in your phone is preferable to hauling around Krugerrands.

No Paper Bitcoins

 

But while being the portable new kid on the currency block may account for some of Bitcoin's popularity, it doesn't explain why Bitcoin has soared while gold has declined at the same time.

Hathaway puts his finger on the difference between the price action of the ancient versus the modern. "The Bitcoin gold incongruity is explained by the fact that financial engineers have not yet discovered a way to collateralize bitcoins for leveraged trades," he writes. "There is (as yet) no Bitcoin futures exchange, no Bitcoin derivatives, no Bitcoin hypothecation or rehypothecation."

So, anyone wanting to speculate in Bitcoin has to actually buy some of the very limited supply of the cyber currency, which pushes up its price.

In contrast, the shinier but less-than-cyber currency, gold, has a mature and extensive financial infrastructure that inflates its supply—on paper—exponentially. The man from Tocqueville quotes gold expert Jeff Christian of the CPM Group who wrote in 2000 that "an ounce of gold is now involved in half a dozen transactions." And while "the physical volume has not changed, the turnover has multiplied."

The general process begins when a gold producer mines and processes the gold. Then the refiners sell it to bullion banks, primarily in London. Some is sold to jewelers and mints.

"The physical gold that remains in London as unallocated bars is the foundation for leveraged paper gold trades. This chain of events is perfectly ordinary and in keeping with time-honored custom," explains Hathaway.

He estimates the equivalent of 9,000 metric tons of gold is traded daily, while only 2,800 metric tons is mined annually.

Gold is loaned, leased, hypothecated, and rehypothecated, over and over. That's the reason, for instance, why it will take so much time for the Germans to repatriate their 700 tonnes of gold currently stored in New York and Paris. While a couple of planes could haul the entire stash to Germany in no time, only 37 tonnes have been delivered a year after the request. The 700 tonnes are scheduled to be delivered by 2020.

However, it appears there is not enough free and unencumbered physical gold to meet even that generous schedule. The Germans have been told they can come look at their gold, they just can't have it yet.

Leveraging Up in London

 

The City of London provides a loose regulatory environment for the mega banks to leverage up. Jon Corzine used London rules to rehypothecate customer deposits for MF Global to make a $6.2 billion Eurozone repo bet. MF's customer agreements allowed for such a thing.

After MF's collapse, Christopher Elias wrote in Thomson Reuters, "Like Wall Street cocaine, leveraging amplifies the ups and downs of an investment; increasing the returns but also amplifying the costs. With MF Global's leverage reaching 40 to 1 by the time of its collapse, it didn't need a Eurozone default to trigger its downfall—all it needed was for these amplified costs to outstrip its asset base."

Hathaway's work makes a solid case that the gold market is every bit as leveraged as MF Global, that it's a mountain of paper transactions teetering on a comparatively tiny bit of physical gold.

"Unlike the physical gold market," writes Hathaway, "which is not amenable to absorbing large capital flows, the paper market, through nearly infinite rehypothecation, is ideal for hyperactive trading activity, especially in conjunction with related bets on FX, equity indices, and interest rates."

This hyper leveraging is reminiscent of America's housing debt boom of the last decade. Wall Street securitization cleared the way for mortgages to be bought, sold, and transferred electronically. As long as home prices were rising and homeowners were making payments, everything was copasetic. However, once buyers quit paying, the scramble to determine which lenders encumbered which homes led to market chaos. In many states, the backlog of foreclosures still has not cleared.

The failure of a handful of counterparties in the paper-gold market would be many times worse. In many cases, five to ten or more lenders claim ownership of the same physical gold. Gold markets would seize up for months, if not years, during bankruptcy proceedings, effectively removing millions of ounces from the market. It would take the mining industry decades to replace that supply.

Further, Hathaway believes that increased regulation "could lead, among other things, to tighter standards for collateral, rules on rehypothecation, etc. This could well lead to a scramble for physical." And if regulators don't tighten up these arrangements, the ETFs, LBMA, and Comex may do it themselves for the sake of customer trust.

What Hathaway calls the "murky pool" of unallocated London gold has supported paper-gold trading way beyond the amount of physical gold available. This pool is drying up and is setting up the mother of all short squeezes.

In that scenario, people with gold ETFs and other paper claims to gold will be devastated, warns Hathaway. They'll receive "polite and apologetic letters from intermediaries offering to settle in cash at prices well below the physical market."

It won't be inflation that drives up the gold price but the unwinding of massive amounts of leverage.
Americans are right to fear their government, but they should fear their financial system as well. Governments have always rendered their paper currencies worthless. Paper entitling you to gold may give you more comfort than fiat dollars.

However, in a panic, paper gold won't cut it. You'll want to hold the real thing.

There's one form of paper gold, though, you should take a closer look at right now: junior mining stocks. These are the small cap companies exploring for new gold deposits, and the ones that make great discoveries are historically being richly rewarded… as are their shareholders.

However, even the best junior mining companies—those with top managements, proven world class gold deposits, and cash in the bank—have been dragged down with the overall gold market and are now on sale at cheaper than dirt prices.

Watch eight investment gurus and resource pros tell you how to become an "Upturn Millionaire" taking advantage of this anomaly in the market—click here.


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International Buying & Your Shot at 1,000% Gains

By Jeff Clark, Senior Precious Metals Analyst

 

As a gold investor in North America, it sometimes feels like I'm living in some far off land where everyone believes in fairy tales and unicorns.


Most people around me don't seem to see anything wrong with the Fed creating $65 billion a month out of thin air, hey, it's not $85 billion anymore, what a relief! It's business as usual for the US government to spend billions more than it takes in, and a public debt hovering at $17.2 trillion—up from $7 trillion just 10 years ago—seems no more alarming than a rainbow.

No surprise then that these people don't feel any need to own assets that might help them in times of crisis. Hard assets like…..gold.

I'm reminded of a visit I made to China several years ago. One night, I awoke in the middle of the night—something was crawling under the bed sheet. I shot up like a cannonball, trampolined out of bed, and hit the light switch. I searched and searched for whatever bug had made its way under the sheet, but never did find the little vermin. Still, I was so creeped out, I spent the rest of the night on the couch.

I told the staff the next morning what happened—and they did nothing. They just stared at me. They spoke English, so it wasn't that they didn't understand me. It was just that none of them seemed to think it was a big deal. One of them even chuckled. They obviously didn't appreciate the potential health hazard and had no sense of customer service. I left bemused, wondering how people could accept bedbugs as normal—or even if they did, how they could not care about a customer's experience. It was like being on another planet.

I have some of those same feelings when I think about mainstream investors today. How can they not appreciate the potential financial hazard inherent in something as obviously dangerous as today's unprecedented levels of money printing? How can they not care that they have nothing solid, like gold, at the core of their investment portfolios? It's like these people think they live on Planet Sesame Street.

Most people seem to really believe that today's heavy-handed government interventions are not only the right course of action, but will have no negative fallout. Massive currency dilution, unstoppable tides of rising debt, and never-ending fiscal imbalances are hardly a way to cure decades of money mismanagement, and certainly aren't consequence-free. How is it that this is not obvious to all?

I honestly don't know. Perhaps people are aware at some level, but the truth is just too awful to face, and so people don't.

Very few of my friends and neighbors own any gold. Rarely am I asked about it anymore, even by those who know what I do for a living. The doctor I saw last month gave me the distinct impression I could be doing better things with my money. Most of the mainstream media ignore gold, while many of the big banks loudly proclaim their latest short position as if they had some sort of divine insight.

I'm starting to feel like the proverbial lone voice in the woods….

 

But We're Not Alone!

As deluded as most Americans seem to be, that is definitely not the case for everyone in the world—the Japanese, for example, are much more prudent and levelheaded.

I wonder if my fellow citizens would feel differently if they lived in any of these countries where people have witnessed economic insanity firsthand, and are acting accordingly:

Japan was a net importer of gold in December, the first time in almost four years. Net purchases totaled 1,885 kilograms (60,604 ounces). It was only the tenth time Japan was a net monthly buyer since the end of 2005. There are reports that Japan's pension funds, which hold the world's second-largest pool of retirement assets, are buying gold.

Dubai gold jewelers just reported the strongest gold sales in seven years. Pure Gold Jewelers, one of the largest dealers in the country, reported a 25% increase in gold jewelry sales during the Dubai Shopping Festival this year.

The state of Gujarat in India reported that silver bullion imports hit a five year record from April 2013 to January 2014. Imports were more than 450% higher than the same period a year ago. The Indian government has since hiked the import duty on silver to 15%, the same rate as gold, and official imports in January subsequently fell. Smugglers will surely add silver to all those secret luggage compartments they've been using for gold.

Australia's Perth Mint said gold sales jumped 41% and silver 33% in 2013. In January, gold demand was up 10% and silver 8%.

Mexico's pension funds are now investing in gold after strict investment regulations were recently lifted. The World Gold Council says it spoke to 10 of the country's most influential pension fund managers (with over $160 billion in assets) and was told that they began investing in gold and commodities in 2013.

Central banks were once again big buyers last year. Of those that have reported so far…

• Turkey purchased 150.4 tonnes (4.83 million ounces)
• Vietnam 110 tonnes (3.53 million ounces)
• Russia 57.3 tonnes (1.84 million ounces)
• Kazakhstan 24.16 tonnes (776,762 ounces)
• Azerbaijan 16.02 tonnes (515,054 ounces)
• Sri Lanka 6.51 tonnes (209,301 ounces)
• Nepal 6.22 tonnes (199,977 ounces)
• Ukraine 6.22 tonnes (199,977 ounces)
• Indonesia 4.04 tonnes (129,889 ounces)
• Venezuela 1.87 tonnes (60,121 ounces)

 

And of Course, There's China….

 

Last year's record import number is impressive enough, but it's the pace that's mind-blowing. 1,139 tonnes is…

• More than 2011 and 2012 imports combined.

• Over 42% of global mine production last year.

• Roughly twice as much as the amount GLD sold in all of 2013.

 

Meanwhile, Back in the Good Ol' US of A…

Gold coin demand for 2013 jumped 24%. Some headlines have pointed out that January 2014 gold and silver coin sales were down compared to a year ago—but January 2013 was the all-time record for single-month sales. Further, Eagle and Buffalo gold coin sales were more than double December's sales, and were the highest since last April. Silver coin sales in January were almost four times more than in December.

There, now I feel better.

Even if you sometimes feel like a lone wolf investing in this market, understand that worldwide demand for gold and silver bullion continues unabated. If you live in the US, realize that people in many other countries are seeing more positive headlines about gold, have more friends who own gold, and heck, could even walk into a bank to buy gold.

I don't think the people in these other countries are stupid. Whatever consequences result from the historic levels of currency dilution across the globe, they seem as sure as I do that they'll be good for gold.
What should you buy? I first recommend buying gold and silver bullion to establish a financial safety net. And then, to maximize gains on the more speculative end of your portfolio, you should look at Louis James' just-released "10-bagger List for 2014" in the February issue of International Speculator. A 10-Bagger is a stock with the potential to gain 1,000% or more—that's not a typo, we really did make 10 times our money on junior gold stocks the last time the sector rebounded, and Louis thinks that's about to happen again.

For example, one of those prospective 10-Baggers is a junior with a multimillion-ounce gold project that's run by one of our Explorers League honorees. This company is on the verge of securing the funds needed to build its exceptionally high-margin gold mine, but it's on sale. Speaking of the potential, Louis said: "If the company delivers, it'd be easy to see these 40-cent shares trading for $4" by 2015.

Investing in these stocks, and there are nine of them on Louis' list, could quite literally make you a fortune, but the opportunity to get in on the ground floor is fading fast.

Click here to learn more about Louis' 10 Bagger List for 2014 or watch the recording of our just aired one hour video event "Upturn Millionaires" to learn why the time to act is now.


International Buying & Your Shot at 1,000% Gains

Forecast 2014: The Killer D’s

By John Mauldin

It seems I'm in a constant dialogue about the markets and the economy everywhere I go. Comes with the territory. Everyone wants to have some idea of what the future holds and how they can shape their own personal version of the future within the Big Picture. This weekly letter is a large part of that dialogue, and it's one that I get to share directly with you. Last week we started a conversation looking at what I think is the most positive and dynamic aspect of our collective future: The Human Transformation Revolution. By that term I mean the age of accelerating change in all manner of technologies and services that is unfolding before us. It is truly exhilarating to contemplate. Combine that revolution with the growing demand for a middle class lifestyle in the emerging world, and you get a powerful engine for growth. In a simpler world we could just focus on those positives and ignore the fumbling of governments and central banks. Alas, the world is too complex for that.

We'll continue our three part 2014 forecast series this week by looking at the significant economic macrotrends that have to be understood, as always, as the context for any short term forecast. These are the forces that are going to inexorably shift and shape our portfolios and businesses. Each of the nine macrotrends I'll mention deserves its own book (and I've written books about two of them and numerous letters on most of them), but we'll pause to gaze briefly at each as we scan the horizon.

The Killer D's
The first five of our nine macro-forces can be called the Killer D's: Demographics, Deficit, Debt, Deleveraging, and Deflation. And while I will talk about them separately, I am really talking threads that are part of a tapestry. At times it will be difficult to say where one thread ends and the others begin.

Demographics – An Upside Down World
One of the most basic human drives is the desire to live longer. And there is a school of economics that points out that increased human lifespans is one of the most basic and positive outcomes of economic growth. I occasionally get into an intense conversation in which someone decries the costs of the older generation refusing to shuffle off this mortal coil. Typically, this discussion ensues after I have commented that we are all going to live much longer lives than we once expected due to the biotechnological revolution. Their protests sometimes make me smile and suggest that if they are really worried about the situation, they can volunteer to die early. So far I haven't had any takers.

Most people would agree that growth of the economy is good. It is the driver of our financial returns. But older people spend less money and produce far less than younger, more active generations do. Until recently this dynamic has not been a problem, because there were far more young people in the world than there were old. But the balance has been shifting for the last few decades, especially in Japan and Europe.

An aging population is almost by definition deflationary. We can see the results in Japan. An aging, conservative population spends less. An interesting story in the European Wall Street Journal this week discusses the significant amount of cash that aging Japanese horde. In Japan there is almost three times as much cash in circulation, per person, as there is in the US. Though Japan is a country where you can buy a soft drink by swiping your cell phone over a vending machine data pad, the amount of cash in circulation is rising every year, and there are actually proposals to tax cash so as to force it back into circulation.

A skeptic might note that 38% of Japanese transactions are in cash and as such might be difficult to tax. But I'm sure that Japanese businesses report all of their cash income and pay their full share of taxes, unlike their American and European counterparts.

Sidebar: It is sometimes difficult for those of us in the West to understand Japanese culture. This was made glaringly obvious to me recently when I watched the movie 47 Ronin. In the West we may think of Sparta or the Alamo when we think of legends involving heroic sacrifice. The Japanese think of the 47 Ronin. From Wikipedia:

The revenge of the Forty-seven Ronin (Shi-jū-shichi-shi, forty-seven samurai) took place in Japan at the start of the 18th century. One noted Japanese scholar described the tale, the most famous example of the samurai code of honor, bushidō, as the country's "national legend."

The story tells of a group of samurai who were left leaderless (becoming ronin) after their daimyo (feudal lord) Asano Naganori was compelled to commit seppuku (ritual suicide) for assaulting a court official named Kira Yoshinaka, whose title was Kōzuke no suke. The ronin avenged their master's honor by killing Kira, after waiting and planning for almost two years. In turn, the ronin were themselves obliged to commit seppuku for committing the crime of murder. With much embellishment, this true story was popularized in Japanese culture as emblematic of the loyalty, sacrifice, persistence, and honor that people should preserve in their daily lives. The popularity of the tale grew during the Meiji era of Japanese history, in which Japan underwent rapid modernization, and the legend became subsumed within discourses of national heritage and identity.

The point of my sidebar (aside from talking about cool guys with swords) is that, while Japan may be tottering, the strong social fabric of the country, woven from qualities like loyalty, sacrifice, and diligence, should keep us from being too quick to write Japan off.

"Old Europe" is not far behind Japan when it comes to demographic challenges, and the United States sees its population growing only because of immigration. Russia's population figures do not bode well for a country that wants to view itself as a superpower. Even Iran is no longer producing children at replacement rates. At 1.2 children per woman, Korea's birth rates are even lower than Japan's. Indeed, they are the lowest in the World Bank database.

A basic equation says that growth of GDP is equal to the rate of productivity growth times the rate of population growth. When you break it down, it is really the working-age population that matters. If one part of the equation, the size of the working-age population, is flat or falling, productivity must rise even faster to offset it. Frankly, developed nations are simply not seeing the rise in productivity that is needed.
As a practical matter, when you are evaluating a business as a potential investment, you need to understand whether its success is tied to the growth rate of the economy and the population it serves.

In our book Endgame Jonathan Tepper and I went to great lengths to describe the coming crisis in sovereign debt, especially in Europe, which shortly began to play itself out. In the most simple terms, there can come a point when a sovereign government runs up against its ability to borrow money at reasonable rates. That point is different for every country. When a country reaches the Bang! moment, the market simply starts demanding higher rates, which sooner or later become unsustainable. Right up until the fateful moment, everyone says there is no problem and that the government in question will be able to control the situation.

If you or I have a debt issue, the solution is very simple: balance our family budget. But it is manifestly more difficult, politically and otherwise, for a major developed country to balance its budget than it is for your average household to do so. There are no easy answers. Cutting spending is a short-term drag on the economy and is unpopular with those who lose their government funding. Raising taxes is both a short term and a long-term drag on the economy.

The best way to get out of debt is to simply hold spending nominally flat and eventually grow your way out of the deficit, as the United States did in the 1990s. Who knew that 15 years later we would be nostalgic for Clinton and Gingrich? But governments almost never take that course, and eventually there is a crisis. As we will see in a moment, Japan elected to deal with its deficit and debt issues by monetizing the debt.

Meanwhile, in Europe, the ECB had to step in to save Italy and Spain; Greece, Ireland, and Portugal were forced into serious austerities; and Cyprus was just plain kicked over the side of the boat.



There is currently a lull in the level of concern about government debt, but given that most developed countries have not yet gotten their houses in order, this is a temporary condition. Debt will rear its ugly head again in the not too distant future. This year? Next year? 2016? Always we pray the prayer of St. Augustine: "Lord, make me chaste, but not today."

Deleveraging and Deflation – They Are Just No Fun
At some point, when you have accumulated too much debt, you just have to deal with it. My associate Worth Wray forwarded the following chart to me today. There is no better explanation as to why the current recovery is the weakest in recent history. Deleveraging is a b*tch. It is absolutely no fun. Looking at this chart, I find it rather remarkable and somewhat encouraging that the US has done as well as it has the past few years.



As I've outlined at length in other letters and in Code Red, central banks can print far more money than any of us can imagine during periods of deleveraging and deflation. For the record, I said the same thing back in 2010 when certain hysterical types were predicting hyperinflation and the end of the dollar due to the quantitative easing of the Federal Reserve. I remain actively opposed to the current level of quantitative easing, not because I'm worried about hyperinflation but for other reasons I have discussed in past letters. As long as the velocity of money keeps falling, central banks will be able to print more money than we would have thought possible in the '70s or '80s. And seemingly they can get away with it – in the short term. Of course, payback is a b*tch. When the velocity of money begins to rise again for whatever unknown reason, central banks had better have their ducks in a row!

Deflationary conditions make debt worse. If you borrow money at a fixed rate, a little inflation – or even a lot of inflation – helps a great deal. To think that even conservative Republican leaders don't get that is naïve. Certainly it is understood in Japan, which is why the success of Abenomics is dependent upon producing inflation. More on that below.

For governments, there is more than one way to deleverage. You can default on your payments, like Greece. We're going to see a lot more of that in the next five years – count on it. Or you can get your central bank to monetize the debt, as Japan is doing. Or get the central bank to convert your debt into 40-year bonds, as Ireland did. (Brilliant move, by the way, for tiny Ireland – you have to stand back and applaud the audacity. I wonder how much good Irish whiskey it took to get the ECB to agree to that deal?)

Inflation is falling almost everywhere today, even as central banks are as accommodative as they have ever been. Deflation is the default condition in a deleveraging world. It can even create an economic singularity.
Singularity was originally just a mathematical term for a point at which an equation has no solution. Then, in astrophysics, it was proven that a large enough collapsing star would become a black hole so dense that its own gravity would cause a singularity in the fabric of space time, a point where many standard physics equations suddenly have no solution.

Beyond the "event horizon" of the black hole, the physics models no longer work. In terms of general relativity, an event horizon is a boundary in space time beyond which events cannot affect an outside observer. In a black hole it is "the point of no return," i.e., the point at which the gravitational force becomes so large that nothing can escape.

Deflation and collapsing debt can create their own sort of black hole, an economic singularity. At that point, the economic models that we have grown comfortable with no longer work. As we approach a potential event horizon in a deflationary/deleveraging world, it can be a meaningless (and extremely frustrating) exercise to try to picture a future that is a simple extension of past economic reality. Any short term forecast (less than one or two years) has to bear that fact in mind.

We Are in a Code Red World
We need to understand that there has been a complete bureaucratic and academic capture of central banks. They are all run by neo-Keynesians. (Yes, I know there are some central bankers who disavow the prevailing paradigm, but they don't have the votes.) The default response of any present day central banker faced with a crisis will be massive liquidity injections. We can argue with the tide, but we need to recognize that it is coming in.

When there is a recession and interest rates are at or close to the zero bound, there will be massive quantitative easing and other, even more creative injections of liquidity into the system. That is a reality we have learned to count on and to factor into our projections of future economic possibilities. But as to what set of econometric equations we should employ in coming up with accurate, dependable projections, no one, least of all central bankers, has a clue. We are in unknown territory, on an economic Star Trek, with Captain Bernanke about to turn the helm over to Captain Yellen, going where no reserve currency printing central bank has gone before. This is not Argentina or Zimbabwe we are talking about. The Federal Reserve is setting its course based on economic theories created by people whose models are demonstrably terrible.

Will we have an outright recession in the US this year? I currently think that is unlikely unless there is some kind of external shock. But short term interest rates will stay artificially low due to financial repression by the Fed, and there will be an increased risk of further monetary creativity from a Yellen led Fed going forward. Stay tuned.
 
To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.
© 2013 Mauldin Economics. All Rights Reserved.

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A Fed Policy Change That Will Increase the Gold Price

By Doug French, Contributing Editor

For investors having a rooting interest in the price of gold, the catalyst for a recovery may be in sight. "Buy gold if you believe in math," Brent Johnson, CEO of Santiago Capital, recently told CNBC viewers.

Johnson says central banks are printing money faster than gold is being pulled from the ground, so the gold price must go up. Johnson is on the right track, but central banks have partners in the money creation business—commercial banks. And while the Fed has been huffing and puffing and blowing up its balance sheet, banks have been licking their wounds and laying low. Money has been cheap on Wall Street the last five years, but hard to find on Main Street.

Professor Steve Hanke, professor of Applied Economics at Johns Hopkins University, explains that the Fed creates roughly 15% of the money supply (what he calls "state money"), while the banks create "bank money," which is the remaining 85% of the money supply. Higher interest rates actually provide banks the incentive to lend. So while investors worry about a Fed taper and higher rates, it is exactly what is needed to spur lending, employment, and money creation.

The Fed has pumped itself up, but not much has happened outside of Wall Street. However, the Federal Open Market Committee (FOMC), during their October meeting, talked of making a significant policy change that might unleash a torrent of liquidity through the commercial banking system. Alan Blinder pointed out in a Wall Street Journal op-ed that the meeting minutes included a discussion of excess reserves and "[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage."

Blinder was once the vice chairman at the Fed, so when he interprets the minutes' tea leaves to mean the voting members "love the idea," he's probably right. Of course "at some stage" could mean anytime, and there's plenty of room in the word "reduction"—25 basis points worth anyway. Maybe more if you subscribe to Blinder's idea of banks paying a fee to keep excess reserves at the central bank. Commercial banks are required a keep a certain amount of money on deposit at the Fed based upon how much they hold in customer deposits. Banking being a leveraged business, bankers don't normally keep any more money than they have to at the Fed so they can use the money to make loans or buy securities and earn interest. Anything extra they keep at the Fed is called excess reserves.

Up until when Lehman Brothers failed in September of 2008, excess reserves were essentially zero. A month later, the central bank began paying banks 25 basis points on these reserves  and five years later banks, mostly the huge mega banks, have $2.5 trillion parked in excess reserves. I heard a bank stock analyst tell an investment crowd this past summer the banks don't really benefit from the 25 basis points, but we're talking $6.25 billion a year in income the banks have been receiving courtesy of a change made during the panicked heart of bailout season 2008. This has been a pure government subsidy to the banking industry, and one the public has been blissfully ignorant of.

But now everything looks rosy in Bankland again. The banks collectively made $36 billion in the third quarter after earning over $42 billion the previous quarter, showing big profits by reserving a fraction of what they had previously for loan losses. The primary regulator for many banks, the FDIC, is even cutting its operating budget 11%, citing the recovery of the industry. The deposit insurer will have one short of 7,200 employees on the job in 2014.

That's a third of the number it had in 1991 after the S&L crisis, but almost 3,000 more than it had in 2007 just before the financial crisis. So with all of this good news, the Fed may indeed be thinking they can pull out the 25bp lifeline and the banks will be just fine. What Blinder thinks and hopes is the banks will use that $2.5 trillion to make loans. After all, one-year Treasury notes yield just 13 basis points, while the two-year only kicks off 31bps. Institutional money market rates are even lower.

Up until recently, banks haven't been active lenders. The industry loan to deposit ratio reflects a tepid loan environment. During the boom, this ratio was over 100%. Now it hovers near 75%. It turns out that what the Fed has been paying, 25 basis points, has been the best source of income for that $2.5 trillion. However, banks won't be able to cut their loan loss reserves to significant profits for much longer. Loan balances have grown at the nation's banks the last two quarters and this will have to continue. If the Fed stopped paying interest on excess reserves and bank lending continues to increase, those $2.5 trillion in excess reserves could turn into multiples of that in money creation.

Banks create money when they lend. As Blinder explains, Fed injected reserves are lent "creating multiple expansions of the money supply and credit. Bank reserves were called 'high powered money' because each new dollar of reserves led to several additional dollars of money and credit." Fans of the yellow metal, like Mr. Johnson who sees the price going to $5,000 per ounce, have likely been too focused on the Fed's balance sheet when it's the banks that create most of the money.

When the Fed announces it won't pay any more interest on excess reserves, and banks start lending in earnest again, the price of gold will be very interesting to watch.

And when that happens, you'll want to be prepared. 

Find out all you need to know about the best ways to invest in gold—in the FREE 2014 Gold Investor's Guide. Click here to read it now.

Thoughts from the Frontline: Interview with Steve Forbes

By John Mauldin

I'm not certain how many interviews I've done over the last decade. Hundreds? I know it is a lot. There are some interviewers who can somehow tease out what you really have in you. Tom Keene at Bloomberg, for instance, forces you to bring your A game, at whatever level you play. He brings it out of you. You know that he is smarter than you will ever be and that you should really be asking him the questions. Except that you're not smart enough to ask the questions. I have to confess that every time I walk into the room with Tom I'm a little intimidated. I try never to show it, somewhat like the new kid on the block trying to put on a brave face, but inside I keep looking for the exit doors just in case I throw up all over myself. At the end of the day I'm still a small town country boy from Bridgeport, Texas, trying to figure out how the big city works.

And then there's Steve Forbes. If I've done hundreds of interviews, then Steve has done many thousands, on the presidential campaign trail with the best of the best, and gods did he learn the craft. I've done multiple interviews with Steve, and every time I sit down with him I feel that I'm with my best friend. Maybe it's because we have a ton of shared values and I have read and admired him for years. I truly think he would've made a great president in the mold of Ronald Reagan, but for whatever reason New Hampshire did not agree. As I think even Steve will admit, while he may have a philosophical mind meld with Reagan, the Gipper had some small genetic extra, call it what you will.

But for whatever reason, Steve seems to bring out the passion in me. When I think about what central bank policies are doing to savers and investors, how we are screwing around with the pension system, circumventing rational market expectations because of an untested economic theory held by a relatively small number of academics, I get a little exercised. And Steve gives me the freedom to do it.

And so a few weeks ago, philosophically like minded old friends sat down at his offices in New York to talk about the world in general. Monetary policy, Janet Yellen, gold, stocks, commodities, the time value of money, grandchildren, and a lot of other stuff, all folded together into what I think may be the best interview I've ever done in my career. Steve gives me the room to be me and allows that passion that has always been inside me to come to the fore. And with his smile and gentle demeanor, he eggs it on.

So this week, for the first time in 14 years of Thoughts from the Frontline, I offer you  a wide ranging interview with John Mauldin, as conducted by the inimitable Steve Forbes. You can watch the video on our home page (lower right, under "Latest Video") or read the transcript below.



John Mauldin: How Central Bankers Will Ruin The Global Economy

John Mauldin, investor and co-author of the new book Code Red, recently sat down with me to discuss monetary policy, a still-lagging economy, and how he might operate the Federal Reserve if he were in Ben Bernanke's or Janet Yellen's shoes.

Steve Forbes: John, good to have you back again.

John Mauldin: Steve, it is always fun to be with you.

Forbes: You've got a new book out, called Code Red.

Mauldin: Yes.

Forbes: Hot off the press.

Mauldin: Yeah, show it up twice now. There we go.

Forbes: Code Red, Jack Nicholson, A Few Good Men. Explain first the title.

Mauldin: Well, in that movie Jack Nicholson famously felt that he had to protect America. He was in charge. And so he issued his famous "code red," and his line was, "You need me on that wall." So at the beginning of the book I paraphrased his speech as if it were Ben Bernanke talking or now Janet Yellen:

"You need me on that committee. You want me on that central bank. Yes, you work for savers and creditors, but I'm responsible for whole economies. I have greater things to worry about."

So in 2008 the central banks of the world had to issue a code red.

It's like, a patient is brought by ambulance to the hospital, and instead of operating you put him on morphine. Or it's like asking the arsonist to put out the fire. Part of the reason we had this very crisis was because of central bank policies and government regulations and the interweaving of large investment banks and politicians and central bankers. I don't want to get into conspiracy theories; I think it's just people's self interest.

Forbes: How about a stupidity theory?

Mauldin: Some of it was stupid, but some of it was just greed. Nonetheless, we had a crisis. The banking system froze up. We went to the edge of the abyss. We looked over and it was a long way down. And I believe central banks appropriately provided liquidity. That was their function, and I would argue that almost the sole true function of a central bank is to be there when the stuff hits the fan.
Forbes: To be what Bagehot called the lender of last resort.

Mauldin: Yes, the lender of last resort. That being said, they never took the patient off morphine. At your and my age, we've had the unpleasant experience of caring for friends who are in the hospital. And in today's world, my mother has a hip operation, and they have her up and walking the next day.

They just opened up her hip, put a new hip in. One of my good friends, the same thing – the next day he's up and walking. Forget this morphine stuff. Forget lying around in a hospital bed like we used to have to do. Well, the central banks are still operating with 1900s medicine, so they just kept the patient on morphine.
And now the patient is addicted. The problem is, when you want to end that addiction, whether it's alcohol or drugs or quantitative easing, withdrawal is not going to be pretty. But the Fed's hope is that somehow or other, "We can get the economy going. We can create animal spirits," and that people won't notice when they start withdrawing a trillion dollars a year of monetary easing out of the global system.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

© 2013 Mauldin Economics. All Rights Reserved.



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Are the Arsonists Running the Fire Brigade?

By John Mauldin

The true measure of a career is to be able to be content, even proud, that you succeeded through your own endeavors without leaving a trail of casualties in your wake.

– Alan Greenspan

If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.

– John Maynard Keynes

And He spoke a parable to them: "Can the blind lead the blind? Will they not both fall into the ditch?"

– Luke 6:39-40

Six years ago I hosted my first Thanksgiving in a Dallas high rise, and my then 90 year old mother came to celebrate, along with about 25 other family members and friends. We were ensconced in the 21^st floor penthouse, carousing merrily, when the fire alarms went off and fire trucks began to descend on the building. There was indeed a fire, and we had to carry my poor mother down 21 flights of stairs through smoke and chaos as the firemen rushed to put out the fire. So much for the advanced fire sprinkler system, which failed to work correctly.

I wrote one of my better letters that week, called "The Financial Fire Trucks Are Gathering." You can read all about it here, if you like. I led off by forming an analogy to my Thanksgiving Day experience:

I rather think the stock market is acting like we did at dinner. When the alarms go off, we note that we have heard them several times over the past few months, and there has never been a real fire. Sure, we had a credit crisis in August, but the Fed came to the rescue. Yes, the subprime market is nonexistent. And the housing market is in free-fall. But the economy is weathering the various crises quite well. Wasn't GDP at an almost inexplicably high 4.9% last quarter, when we were in the middle of the credit crisis? And Abu Dhabi injects $7.5 billion in capital into Citigroup, setting the market's mind at ease. All is well. So party on like it's 1999.

However, I think when we look out the window from the lofty market heights, we see a few fire trucks starting to gather, and those sirens are telling us that more are on the way. There is smoke coming from the building. Attention must be paid.

I was wrong when I took the (decidedly contrarian) position that we were in for a mild recession. It turned out to be much worse than even I thought it would be, though I had the direction right. Sadly, it usually turns out that I have been overly optimistic.

This year we again brought my now-96-year-old mother to my new, not-quite-finished high-rise apartment to share Thanksgiving with 60 people; only this time we had to contract with a private ambulance, as she is, sadly, bedridden, although mentally still with us. And I couldn't help pondering, do we now have an economy and a market that must be totally taken care of by an ever-watchful central bank, which can no longer move on its own?

I am becoming increasingly exercised that the new direction of the US Federal Reserve, which is shaping up as "extended forward rate guidance" of a zero-interest-rate policy (ZIRP) through 2017, is going to have significant unintended consequences. My London partner, Niels Jensen, reminded me in his November client letter that,

In his masterpiece The General Theory of Employment, Interest and Money, John Maynard Keynes referred to what he called the "euthanasia of the rentier". Keynes argued that interest rates should be lowered to the point where it secures full employment (through an increase in investments). At the same time he recognized that such a policy would probably destroy the livelihoods of those who lived off of their investment income, hence the expression. Published in 1936, little did he know that his book referred to the implications of a policy which, three quarters of a century later, would be on everybody's lips. Welcome to QE.

It is this neo-Keynesian fetish that low interest rates can somehow spur consumer spending and increase employment and should thus be promoted even at the expense of savers and retirees that is at the heart of today's central banking policies. The counterproductive fact that savers and retirees have less to spend and therefore less propensity to consume seems to be lost in the equation. It is financial repression of the most serious variety, done in the name of the greater good; and it is hurting those who played by the rules, working and saving all their lives, only to see the goal posts moved as the game nears its end.

Central banks around the world have engineered multiple bubbles over the last few decades, only to protest innocence and ask for further regulatory authority and more freedom to perform untested operations on our economic body without benefit of anesthesia. Their justifications are theoretical in nature, derived from limited variable models that are supposed to somehow predict the behavior of a massively variable economy. The fact that their models have been stunningly wrong for decades seems to not diminish the vigor with which central bankers attempt to micromanage the economy.

The destruction of future returns of pension funds is evident and will require massive restructuring by both beneficiaries and taxpayers. People who have made retirement plans based on past return assumptions will not be happy. Does anyone truly understand the implications of making the world's reserve currency a carry-trade currency for an extended period of time? I can see how this is good for bankers and the financial industry, and any intelligent investor will try to take advantage of it; but dear gods, the distortions in the economic landscape are mind-boggling. We can only hope there will be a net benefit, but we have no true way of knowing, and the track records of those in the driver's seats are decidedly discouraging.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – Please Click Here.

© 2013 Mauldin Economics. All Rights Reserved.

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Thoughts from the Frontline: Bubbles, Bubbles Everywhere

By John Mauldin

The difference between genius and stupidity is that genius has its limits.
– Albert Einstein

Genius is a rising stock market.
– John Kenneth Galbraith

Any plan conceived in moderation must fail when circumstances are set in extremes.
– Prince Metternich

You can almost feel it in the fall air (unless you are in the Southern Hemisphere). The froth and foam on markets of all shapes and sizes all over the world. It is an exhilarating feeling, and the pundits who populate the media outlets are bubbling over with it. There is nothing like a rising market to help lift our mood. Unless of course, as Prof. Kindleberger famously cautioned (see below), we are not participating in that rising market. Then we feel like losers. But what if the rising market is … a bubble? Are we smart enough to ride and then step aside before it bursts? Research says we all think that we are, yet we rarely demonstrate the actual ability.

This week we'll think about bubbles. Specifically, we'll have a look at part of the chapter on bubbles from my latest book, Code Red, which we launched last week. At the end of the letter, for your amusement, is a link to a short video of what you might hear if Jack Nicholson were playing the part of Ben Bernanke (or Janet Yellen?) on the witness stand, defending the extreme measures of central banks. A bit of a spoof, in good fun, but there is just enough there to make you wonder what if … and then smile. Economics can be so much fun if we let it.

I decided to use this part of the book when numerous references to bubbles popped into my inbox this week. When these bubbles finally burst, let no one exclaim that they were black swans, unforeseen events. Maybe because we have borne witness to so many crashes and bear markets in the past few decades, we have gotten better at discerning familiar patterns in the froth, reminiscent of past painful episodes.
Let me offer you three such bubble alerts that came my way today. The first is from my friend Doug Kass, who wrote:

I will address the issue of a stock market bubble next week, but here is a tease and fascinating piece of data: Since 1990, the P/E multiple of the S&P 500 has appreciated by about 2% a year; in 2013, the S&P's P/E has increased by 18%!

Then, from Jolly Olde London, comes one Toby Nangle, of Threadneedle Investments (you gotta love that name), who found the following chart, created a few years ago at the Bank of England. At least when Mervyn King was there they knew what they were doing. In looking at the chart, pay attention to the red line, which depicts real asset prices. As in they know they are creating a bubble in asset prices and are very aware of how it ends and proceed full speed ahead anyway. Damn those pesky torpedoes.

Toby remarks:

This is the only chart that I’ve found that outlines how an instigator of QE believes QE’s end will impact asset prices. The Bank of England published it in Q3 2011, and it tells the story of their expectation that while QE was in operation there would be a massive rise in real asset prices, but that this would dissipate and unwind over time, starting at the point at which the asset purchases were complete.

Oh, dear gods. Really? I can see my friends Nouriel Roubini or Marc Faber doing that chart, but the Bank of England? Really?!?

Then, continuing with our puckish thoughts, we look at stock market total margin debt (courtesy of those always puckish blokes at the Motley Fool). They wonder if, possibly, maybe, conceivably, perchance this is a warning sign?



And we won’t even go into the long list of stocks that are selling for large multiples, not of earnings but of SALES. As in dotcom-era valuations.

We make the case in Code Red that central banks are inflating bubbles everywhere, and that even though bubbles are unpredictable almost by definition, there are ways to benefit from them. So, without further ado, let’s look at what co-author Jonathan Tepper and I have to say about bubbles in Chapter 9.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

Why has it become so hard to make money as a trader?

The Great American Wall Of Worry – U.S. Stock Market

Traders and investors all around the world are having trouble climbing over the wall of worry/fear with the US stock market, and rightly so. There is a lot of things taking place and unfolding that carry a high level of uncertainty. Let’s face it, who wants to invest money into the market when it’s hard to come by (high unemployment, banks are still extremely tight with their money, companies are nowhere near wanting to hiring new staff).

The hard pill to swallow is the fact that the stock market loves to rise when uncertainty is high. It’s almost doing it just to drive investor’s nuts who sold out near market bottom or recent correction. You must overcome the urge to short the market when the economy looks so bearish in the years ahead, and continue to trade with the trend.....Read the entire story and view the charts.



Get our Gold, Crude Oil & Index ETF Trading Analysis

EconMatters: Crude Oil....A Perfect Bear Storm Despite the Euro Pop

Crude oil prices, along with world stocks, surged on Friday after euro zone leaders reached an accord on directly recapitalizing regional banks as well as measures to cut soaring borrowing costs in Italy and Spain. Brent crude jumped more than 7% in one day to close at $97.80 a barrel, while WTI also settled up 9.36% to $84.96 a barrel on NYMEX. However, for the quarter, spot Brent and U.S. oil futures still fell 20.4% and 17.5% respectively, their steepest quarterly percentage drops since the fourth quarter of 2008 post financial crisis. Looking ahead, we believe this little 'Euro pop' will soon fizz out weighted down by the reality of basic market fundamental factor.

First of all, the Euro accord bandaid does not fundamentally change what's causing the current crisis to begin with, high sovereign debt, out of control government spending, and insolvent regional banks. Add to this scenario is a slowing of European demand, parts of Europe are in a recession, and this not only affects less oil being consumed in Europe, but backs all the way up the supply chain from Ford automobiles being sold and needing to be manufactured, to Chinese factories needing to ratchet manufacturing cycles down to account for less demand out of Europe.


Macroeconomics aside, the oil inventory picture in the U.S. is also quite interesting these days, to say the least. For example, On 1/27/2012 there was 338,942 Million Barrels in US storage facilities, then on 2/24/2012 it started slowly rising to 344,868 Million, then Inventory builds started accelerating as on 3/23/2012 there were 353,390 Million on hand, then we jumped dramatically to 375,864 Million Barrels on 4/27/2012, with another sizable increase to 384,740 on 5/25/2012, and on 6/22/2012 the number stands at 387,166 Million Barrels in US Storage facilities, way above the five-year range. (See Chart Below)

Chart Source: EIA, June 27, 2012

This is taking place despite the domestic refinery run rate has increased from 85% in January to 92% in the week ending June 22 (See Chart Below). As of June 1, 2012, crude oil inventories held at Cushing, OK were 47.8 million barrels, the highest level on record, according to the U.S. Energy Dept. These are historically high numbers, but the magnitude of the rise over what is generally the stronger part of the US business cycle each year is the more compelling story.

Chart Data Source: EIA, as of June 22, 2012

With record refinery runs, we still cannot make a dent in the oil Inventories, which implies that there is a lot of oil in the market. In fact, if this trend continues, even just for the next three months, we are going to shatter previous storage records here in the US. At current rate, the inventory number could smash through the 400 Million Barrel level over the next quarter.


This does not bode well for the oil market when the slow part of the year comes around in August and September, where Gasoline demand drops off rather sharply, and is usually the slowest part of the year in terms of fuel usage, demand, and prices typically drop significantly each year. Technically, WTI could easily blow below $70/b with no major support till $60/b comes this August/September, and prices would remain challenged in the short to medium term.


What are the reasons for this glut of oil in the US? There are several, China has slowed manufacturing and exports, i.e., their economy has pulled back considerably. India is having all sorts of credit worthiness concerns, and is also growing at a slower rate. So in short, the emerging market economies are using less oil.


The demand picture in the U.S. is also quite dismal. EIA data show in the first quarter, total U.S. liquid fuels consumption fell 3.7% YoY due to high prices and record warm weather. For the second half of 2012, and 2013, EIA expects a YoY increase of only 1.2% and 0.6% respectively in liquid fuels consumption.


Furthermore, there are more domestic oil production mostly from unconventional shale plays, as there are more Capex drilling projects started during the beginning half of the year on high oil price. This has also pulled a lot more independents into drilling, and we are producing more oil each day than we actually consume or need. This has been one major contributing factor in these continuous inventory builds during the strong part of the usage cycle, as refineries are operating at record utilization levels since the recovery with the seasonal spring/summer driving season going from March with Spring Break through basically labor day, (some say July 4th is the peak of the Summer driving season).

Internationally, the Libyan oil is back on line, and other oil producing countries pumping more oil out of the ground compared to the last 5 years during this era of elevated oil prices. The Saudis are producing at the high end of their range as well. In a recent report, U.S. EIA noted that global company held oil inventories in the major industrialized nations will be sufficient to cover 57.7 days of demand at the end of 2012, the highest level in 15 years.

Basic economics plays a role in this story as well. Just ask this one question--Where are the high margin business opportunities over the last 5 years? It sure isn`t in the Banking Industry with deal-making and large scale private equity deals falling off a cliff. It hasn`t been in the real estate market either.

Market dynamics 101 stipulates that high oil prices leads to higher margins, which leads to more investment resources being directed to this sector which ultimately rebalances the market, and oil prices come back down. This is why there is often a boom and bust cycle that plays out in many investment sectors, and historically the energy and oil sectors have been the poster kids to this rule.

So essentially, five years of really high prices--higher than the actual fundamentals of the economy should dictate--have caused an artificial market scenario where longer-term demand was being stifled by currency concerns, inflation concerns, while commodity investment in general has served as a case of over investment in this area in relation to true, actual Global demand.

Throw in the fact that it seems everybody (governments as well as consumers) is in debt, nobody has any money, credit issues are becoming increasingly burdensome to deficit financing to artificially stimulate growth via the government intervention route, all these factors are forming a perfect storm for the oil market to face some major headwinds for the next 5 years.


Posted courtesy of our friends at EconMatters.Com