6 Things Precious Metals Naysayers Get Dead Wrong

by: Stefan Gleason*

Gold attracts its fair share of detractors. But the most common objections to gold as money, and as a safe-haven asset within an investment portfolio, are misplaced. Anti-gold myths are ubiquitous.

Mega billionaire Warren Buffett remarked derisively of gold that it “gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility.”

That brings us to the first thing precious metals naysayers get wrong…

Myth #1: “Gold has no utility.”

Warren Buffett is without question one of the world’s greatest investors. But he is not without biases.

Buffett’s primary business interests are in banking and insurance.

Facts vs Myths

He has literally made fortunes off the fiat monetary regime. He took part in (and benefited from) the government bailouts of the financial system. He (along with most other Wall Street and banking titans) supported Hillary Clinton for president.

So maybe, just maybe, Buffett’s hostility to gold has something to do with his deep, symbiotic connections to the political, banking, and monetary establishments!

In any event, the claim that gold has no utility is false. It’s been chosen by the market as money because of its many useful features, including fungibility, divisibility, durability, and rarity. Gold also functions as a store of value precisely because it, unlike Federal Reserve notes, has uses beyond that of a currency.

Even if gold weren’t hoarded in vaults, people would still dig it out of the ground at great cost for its uses in electronics, jewelry, art, and architecture. In an economic sense, $50,000 in physical gold is just as useful as a $50,000 sports car – as determined by the market.

Myth #2. “Gold is the money of the past. Digital crypto-currencies are the money of the future.”

Every generation comes up with some new reason to regard gold as a “barbarous relic.” Previously it was the advent of paper money. Then the creation of the Federal Reserve. Now the rise of internet-based crypto-currencies is hailed by some as a technology that will render gold obsolete as money.

The reality is that no paper or electronic or currencies ever have or ever could replicate the unique monetary properties of gold. Central banks continue to accumulate it. And new crypto-currencies actually backed by gold and silver are in the works.

A crypto-currency that combines the convenience of digital transactions with the security of metals backing could ultimately knock Bitcoin off its perch – and be a source of billions of dollars in new demand for gold and/or silver.

Myth #3. “Precious metals markets can’t go up while the Fed is raising interest rates.”

This persistency of this myth is surprising given how often in market history it has been dispelled. Gold prices hit a major bottom in December 2015 just as the Fed initiated its first interest rate hike. Gold and silver rallied big during the rate hiking campaign from 2014 to 2016. Back in the late 1970s as interest rates rose dramatically into the double digits, gold prices rose in tandem – until, finally, nominal interest rates actually exceeded the inflation rate by 1980.

The direction of the gold price is keyed into real interest rates, not nominal rates. When real rates are negative or inflation expectations are rising, that tends to be bullish for precious metals.

Gold Vs U.S. Real Interest Rate

Myth #4. “If the economy crashes, then so will gold.”

Gold is one of the least economically sensitive assets you can hold as an investor. The yellow metal exhibits virtually no long-term correlation with the stock, bond, or housing markets – and a relatively low correlation with industrial commodities such as oil and copper.

When every sector of the stock market including mining stocks crashed in 2008, gold itself managed to eke out a positive gain for the year. Gold isn’t impervious to economic shocks that may affect things like demand for jewelry, but safe-haven buying by investors is often more than enough to pick up the slack.

Myth #5. “Ordinary investors can’t win in gold and silver markets that are manipulated.”

A distinction needs to be made between physical metals markets and manipulated paper markets. Most of the manipulation that occurs in futures (paper) markets is done for short-term technical purposes – to game a few cents on bid/ask spreads, break resistance levels, force options to expire worthless, etc.

Ordinary investors absolutely should not try to trade the paper markets. They won’t beat the big banks and other institutional traders at their own game.

To the extent that paper prices are artificially suppressed, however, that’s actually an advantage for buyers of physical metal.

They can obtain it at a discount.

Meanwhile, artificially low prices serve as a disincentive to new mining production, which makes the long-term supply/demand fundamentals for gold and silver even more favorable.

Myth #6. “Gold pays no interest so it’s therefore a poor investment.”

Warren Buffett’s Berkshire Hathaway shares pay no interest or dividends. Venezuelan junk bonds yield more than 50%. Which is the better investment?

Obviously, the size of the nominal yield doesn’t in itself tell you whether a financial asset is a good investment. Even the “safe” yield provided by U.S. Treasury securities isn’t safe from inflation. Or from taxation.

Since physical precious metals aren’t debt instruments and therefore pay no interest, their inflationary upside potential is all tax-deferred growth. You owe no taxes until you actually sell (or take distributions from a traditional IRA).*

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Negative real interest rates give gold strong support

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

7 Reasons to Be Bullish on Emerging Europe

In case you haven’t already noticed, inflation has been steadily creeping up since July. In February, the most recent month of available data, consumer prices advanced at their fastest pace in five years, hitting 2.7 percent year-over-year. March data won’t be released until next week, but I expect prices to proceed on this upward trend, buttressed by rising mortgages and costs associated with health care and energy.

One of the consequences of strong inflation is that real rates—what you get when you subtract the current consumer price index (CPI) from the nominal rate—have turned negative. And when this happens, gold has typically been a beneficiary. This is the Fear Trade in action.

Take a look below. Gold shares an inverse relationship with the real 10-year Treasury yield, which is influenced by consumer prices. When inflation is soft and the yield goes up, gold contracts. But when inflation is strong, as it is now, it can push the Treasury yield into subzero territory, prompting many investors to move into other so-called safe haven assets, including gold.

Gold Expected to Continue Benefiting from Low to Negative REal Rates
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Again, I expect consumer prices to continue rising, especially if President Donald Trump gets his way regarding immigration and trade. Slowing the stream of cheap labor from Mexico and other Latin American countries, coupled with raising new tariffs at the border, should have the effect of making consumer goods and services more expensive. Although it might sting your pocketbook, faster inflation could be constructive for gold investors.

$1,475 an Ounce Gold this Year?

In its weekly precious metals report, London-based consultancy firm Metals Focus emphasized the importance of negative real rates on the price of gold, writing that “real and even nominal rates across several other key currencies, including the euro, should also remain negative for some time.” The European Central Bank’s deposit rate currently stands at negative 0.4 percent, not including inflation, and Sweden’s Riksbank, the world’s oldest central bank, will continue its negative interest rate policy as it awaits stronger economic growth. Meanwhile, the Bank of Japan left its short-term interest rate unchanged at negative 0.1 percent at its meeting last month.

This is all beneficial for gold. Discouraged by the idea of negative rates eating into their wealth, many savers might be compelled to invest in gold, which enjoys a reputation as an excellent store of capital.

Based on the near-term outlook for real rates, as well as uncertainty over Brexit, rising populism in Europe and Trump’s trade and foreign policies, Metals Focus analysts see gold testing $1,475 an ounce this year. If so, that would put the yellow metal at a four-year high.

Central Banks Still Have an Appetite for Gold

Since 2010, global central banks have been net buyers of gold as they move to diversify their reserves away from the U.S. dollar. Although 2016 purchases fell about 35 percent compared to 2015, they still remained high on a historical basis, thanks mostly to China and Russia.

These purchases are likely to continue this year, according to Metals Focus, though at a slower rate as many banks get closer to meeting their target reserves amount.

Central Banks Have Been Net Buyers of Gold Since 2010
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Because gold accounts for only 2.3 percent of China’s reserves, as of March, the Asian country might very well keep up with its monthly purchases for some time. (The U.S., by comparison, has nearly 75 percent of its reserves in gold.)

I’ve pointed out before that it’s reasonable for investors to pay attention to what central banks are doing. They’re diversifying their assets and, in a way, hedging against their very own policies. It would be prudent for every household to do the same. As such, I recommend a 10 percent weighting in gold, with 5 percent in bullion (coins and jewelry), the other 5 percent in quality gold stocks.

Frank Holmes on Resource Commodities and Currencies: Reaching an Inflection point?

Have Commodities Reached an Inflection Point?

By Frank Holmes – CEO and Chief investment Officer US Global Investors

Iceberg, Nominal Interest Rates and Real Interest Rates

Last week the Federal Reserve announced it would delay the interest rate liftoff yet again, but while everyone seems concerned about nominal rates—the federal funds rate, in this case—real rates have already risen about 5 percent since August 2011. This “invisible” rate hike is much more impactful to commodity prices and emerging markets than a nominal rate hike, which is simply the “tip of the iceberg.”

Since July 2014, the U.S. dollar has appreciated more than 20 percent. This has had huge implications for net commodity exporter countries, both developing and emerging, which typically see their currency rates fluctuate when prices turn volatile.

But why does this happen?

The main reason is that most commodities, including crude oil, metals and grains, are priced in U.S. dollars. They therefore share an inverse relationship. When the dollar weakens, prices tend to rise. And when it strengthens, prices fall, among other past ramifications, as you can see in the chart below courtesy of investment research firm Cornerstone Macro.

Dollar-Appreciation Spikes Almost Always Lead to International Currency Crises
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Indeed, commodities have collectively depreciated close to 40 percent since this time a year ago and are at their lowest point since March 2009. We might very well have reached an inflection point for commodities, which opens up investment opportunities.

Net Commodity Exporters under Pressure

The number of developing and emerging markets that are dependent on commodity exports has risen in recent years, from 88 five years ago to 94 today, according to the United Nations Conference on Trade and Development (UNCTAD). Many of these countries—located mostly in Latin America, Africa, the Middle East and Asia—have a dangerously high dependency on a small number of not only commodity exports but also trading partners.

For many suppliers, China is the leading buyer. But the Asian giant’s imports have been slowing as its economy transitions from manufacturing to services and housing, forcing many net commodity export countries to rethink their dependency on China.

China's Services Industry Surpasses 50 Percent GDP
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This is the position Indonesia finds itself in right now. As much as 50 percent of its total exports consists of crude oil, palm oil, copper, coal and rubber, for all of which China has historically been a vital importer. A stunning 95 percent of Mongolia’s exports flow into its southern neighbor, according to the World Factbook. And for Chile, commodities represent close to 90 percent of total exports, about 25 percent of which goes to China.

But countries needn’t have such a high dependency on commodities for their currencies to be affected. The Australian dollar, for instance, has a positive correlation with iron ore prices.

Australian Dollar Tracks Iron Ore Prices
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About 98 percent of the world’s iron ore supply is used to make steel. So important is the metal to the state of Western Australia, where most of the continent’s deposits can be found, that every $1 decline in prices results in an estimated $49 million budget loss.

The same relationship exists between the Peruvian sol and copper. Peru is the fourth-largest copper producer in the world, preceded by Chile, China and the U.S.

The Peruvian Sol Tracks Copper Prices
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The Russian ruble, Canadian dollar and Colombian peso all follow crude oil prices. (Russia is the third-largest oil producer in the world; Canada, the fifth-largest; Colombia, the 19th-largest.)

Russian Ruble Tracks Oil Prices
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Canadian Dollar Tracks Oil Prices
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Colombian Peso tracks Oil Prices
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It’s important that we see stability in emerging market currencies, which would help support resources demand. We’ve seen some stabilization in the Chinese renminbi after it was depreciated in August, but a few others are down pretty significantly.

Currency Depreciations Against the U.S. Dollar for the 12-Month Period
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Global Manufacturing Could Reverse Course Sooner Than You Think

I’ve shown a number of times that commodity demand depends on manufacturing strength, as measured by the J.P. Morgan Global Purchasing Manager’s Index (PMI). This indicator has steadily been trending lower. Although the reading is still above the neutral 50.0 line, commodity prices have reacted negatively.

Commodities are Highly Correlated to Global PMIs
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Cornerstone Macro believes both the Chinese and global PMI are “likely” to rise in October, leading to a full year of upside potential. If true, this is indeed welcome news, but it’s worth remembering that the PMI looks ahead six months, meaning it’ll take approximately that long for commodities to recover.

In any case, now might be a good time for investors to consider getting back into commodities and natural resources since we could be in the early innings of an upturn.

“You want to buy commodity stocks when they’re out of favor, because they are cyclical,” Brian Hicks, portfolio manager of our Global Resources Fund (PSPFX), told The Energy Report last week. “If you look out 12, 18, 24 months from now, those equity values should reflect equilibrium commodity prices and move significantly higher from here.”