Billionaires warnings: Gold is one of the answers

By Stefan Gleason*

With each passing day, systemic risks in the financial system become greater. Smart money insiders and billionaire investors are taking note – and taking defensive actions.

Mega-billionaire Carl Icahn, whose long-term track record is unrivaled, recently warned that “there will be a day of reckoning unless we get fiscal stimulus.” Icahn’s hedge fund is betting on a day of reckoning scenario. He has gone 150% net short the stock market while holding commodity-related positions to the long side.

George Soros is now a gold bugMega investor George Soros is now a gold bug.

International currency speculator and leftist financier George Soroshas slashed his fund’s overall equity holdings by 25%. Like him or not, Soros is no dummy when it comes to the financial system. He is an establishment insider who apparently sees turbulent times ahead. He owns a not insignificant amount of gold, and his largest single equity holding now is Barrick Gold (NYSE:ABX), a major gold mining company.

“The system itself is at risk,” warns bond market wizard Bill Gross. In his latest market commentary, Gross cites “artificially high asset prices and a distortion of future risk relative to potential return.”

Prices for financial assets such as stocks, bonds, and real estate investment trusts are artificially high because interest rates are artificially low. Thanks, of course, to the Federal Reserve. Markets are floating on a sea of leverage made possible by eight years of ultra-accommodative monetary policy and the widespread belief that the Fed will step in as a buyer of last resort to support asset prices.

Former Fed chairman Alan Greenspan helped fuel a stock market bubble in the late 1990s and handed off a burgeoning housing bubble to his successor Ben Bernanke. Ironically, Greenspan has since sought to position himself as something of an elder statesman for fiscal responsibility. To his credit, he now recognizes that the biggest, most dangerous bubble today is that of runaway government debt ahead of a looming Baby Boomer retirement/entitlement crisis, and he has turned quite bullish on gold.

“We should be running federal surpluses right now not deficits. This is something we could have anticipated twenty-five years ago and in fact we did, but nobody’s done anything about it. This is the crisis which has come upon us,” Greenspan said in a recent interview. “We’re running to a state of disaster unless we turn this around.”

With some $200 trillion in projected unfunded liabilities, the federal government will have to default on some of its promises directly or by inflating away the value of those promises. That’s the big picture. The next cyclical downturn and potential crash could be triggered by a more immediate event in the economy or in the over-leveraged financial markets.

Triggering Event: Economic Recession

The front page of the May 30th Barron’s features the headline, “The Stock Market Won’t Crash – Yet.” Author Gene Epstein argues that stocks won’t crash in the near future, because “the odds of a recession are now quite low.” Not just “low,” mind you, but “quite low”!

If the real-world economic data could respond, it would beg to differ. Manufacturing activity recently suffered its biggest drop since 2009. The New York Purchasing Managers Index swooned in May to suffer its biggest monthly drop in nine years.

And the Labor Department’s most recent jobs report, released on June 3rd, revealed that employers hired the fewest new workers in nearly six years. Corporate profit margins peaked several months ago and are turning down.

These are exactly the types of conditions that presage a recession. That, in turn, could trigger massive new fiscal and monetary stimulus measures that weaken the dollar and drive safety-minded investors into precious metals.

But the same Wall Street establishment publication that tells investors recession risk is “quite low” also ran a gold-bearish headline in its January 4, 2016 issue. “Gold Likely to Stay Tarnished,” Barron’s proclaimed.

To that, I respond: Get real! Gold never tarnishes, and its price has advanced nearly 20% since Barron’sscared investors out of precious metals with facile predictions of Fed rate hikes.

Triggering Event: Rising Interest Rates

Interest rates will at some point have to go up. Escalating credit concerns and inflation fears could cause markets to drive up bond yields, regardless of whether the Fed hikes its benchmark rate.

Even just a 1 percentage point rise in bond yields from their current low levels would cause $1 trillion in capital losses, according to a Goldman Sachs analysis. Rising interest rates are disastrous for bondholders and hazardous to all financial assets.

To the extent that they are associated with rising inflation expectations, however, rising interest are bullish for hard assets. This has been proven during past rising rates cycles, the last major one being during the late 1970s.

Triggering Event: Derivatives Blow up

By one estimate, the derivatives market has exploded to a mind-boggling $1.5 quadrillion, more than double the dizzying heights of 2007.

Of course, these aren’t actual assets. Total world GDP is a mere $78 trillion; $1.5 quadrillion in wealth does not exist. Derivatives represent layers of speculative bets and hedges on actual assets.

The size of the derivatives market shows just how ridiculously leveraged the system has become. The gold market is a case in point. Physical gold now represents just a tiny fraction of the “gold” that gets traded in futures markets. Earlier this year, leverage exploded to more than 500 to 1.

A blow up in the futures market or other derivative markets could cause a “run on the bank” and the financial system to be thrown into chaos. The U.S. dollar could either crash or surge in a financial panic, depending on how it unfolds. But the official response to a financial crisis will be – as it always has been – to flood the system with more liquidity; i.e., inflation.

Among the assets that will be left standing are physical precious metals held outside the banking and brokerage systems.

Legendary investors going for gold, copper and coal

By Frank Holmes, CEO and Chief Investment Officer, US Global Investors

A few legendary influencers in investing are making huge bets right now on commodities, an area that’s faced—and continues to face—some pretty strong headwinds. What are we to make of this?

I already shared with you that famed hedge fund manager Stanley Druckenmiller made a $323-million bet on gold, now the largest position in his family office fund. It’s also come to light that George Soros recently moved $2 million into coal producers Peabody Energy and Arch Coal. Meanwhile, activist investor Carl Icahn took an 8.5-percent position in copper miner Freeport-McMoRan, which we own.

These giants of the investing world have just given huge endorsements for gold, coal, copper, and precious metals

My friend Marc Faber, the widely-respected Swiss investor and editor of the influential “Gloom, Boom & Doom Report,” is now plugging for the mining sector and precious metals. Speaking to Bloomberg TVlast week, Faber claimed that investors are running low on safe assets and suggested they revisit mining companies:

If I had to turn anywhere where… the opportunity for large capital gains exists, and the downside is, in my opinion, limited, it would be the mining sectors, specifically precious metals and mining companies… like Freeport, Newmont, Barrick. They’ve been hammered because of falling commodity prices. Now commodities may still go down for a while, but I don’t think they’ll stay down forever.

Late last month, Freeport became the first major miner to announce production cuts in response to depressed copper prices, which have slipped around 19 percent since their 2015 high of $2.95 per pound in May. This reduction should remove an estimated 70,000 tonnes of copper from global markets, according to BCA Research, and eventually help support prices.

Platinum and palladium miners in South Africa, a leading producer of both metals, also announced job cuts and mine closures, as platinum has slipped more than 16 percent this year, palladium a quarter.

But Marc sees opportunity, as I do. In my keynote speeches earlier this year I suggested that 2015 would see a bottom in cost-cutting due to divesture and slashing of capital expenditures, and that in 2016 we should see higher returns on capital.

Furthermore, using our oscillators to measure the degree to which asset classes are overbought and oversold, we find that commodities are extremely oversold right now and currently bouncing off low negative sentiment. The smart money is buying.

When asked if he thought commodities had reached a bottom, Marc had this to say:

I would rather focus on precious metals—gold, silver, platinum—because they do not depend on industrial demand as much as base metals and industrial commodities.

Marc was referring, of course, to China, the 800-pound commodity gorilla, as I’ve often described the country. The Asian powerhouse is currently responsible for nearly 13 percent of the world’s commodity demand, followed by the U.S. at a little over 10 percent.

China's demand for commodities is huge
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But as I discussed recently, China is transitioning from a manufacturing-based economy to one that emphasizes services, consumption and real estate. Commodity demand is cooling, therefore, and we can expect it to cool even further. Aside from the strong dollar, this is one of the key reasons why prices have plunged to multi-year lows.

Commodities Seeking an Upturn to Global Manufacturing

The JPMorgan Global Manufacturing PMI continues to decline as well. Since its peak in February 2014, the reading has fallen 4.5 percent. The August score of 50.7, just barely indicating manufacturing expansion, is the sixth consecutive monthly reading to remain below the three-month moving average.

I’ve shown a number of times in the past that when this is the case—that is, when the one-month reading is below the three-month trend—commodity prices have tended to trade lower. Unlike other economic indicators such as gross domestic product (GDP), the PMI is forward-looking and helps investors manage expectations. Based on our own research, there’s a strong probability that copper and crude oil prices might dip three months following a “cross below.”

The opposite has also been true: Prices have a stronger probability of ticking up three months after the one-month crosses above the three-month.

Commodities and commodity stocks historically rose three months after pmi "cross-above"
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This is why we believe prices will have a better chance at recovery after the global PMI crosses above its three-month moving average.

I have great respect and admiration for Druckenmiller, Soros, Icahn and Marc—all of whom are clearly bullish on commodities—but we would prefer to see global manufacturing growth reverse course.

In the meantime, low commodity prices are a windfall for many companies in Europe, Japan and the U.S. Metals and other raw materials are at their lowest in years, which is the equivalent of a massive tax break for the construction and manufacturing sectors.

Low gold prices are also expected to generate high demand in India as we approach fall festivals such as Diwali and Dussehra, not to mention weddings. According to estimates from Swiss precious metals refiner Valcambi, demand could reach 950 tonnes by the end of the year, compared to 891 tonnes in 2014.