The War on Cash Is Still Good for Gold

Blog post by Frank Holmes, CEO and Chief Investment Officer of US Global Investors looking at the current much-promoted idea of eventually doing away with cash and its likely effect on the gold market.  Readers are also directed to an article I wrote on the same subject and published on SharpsPixley.com which suggested that thge logic behind the war on cash could also eventually be applied to gold – perhaps leading to gold confiscation.  See:Will the war on cash morph into a war on gold and diamonds

Negative Real Rates Real Positive Influence Gold

The consumer price index (CPI), a measure of inflation, came in hotter than expected Friday, registering 2.3 percent year-over-year in August on expectations of 2.0 percent. With the five-year Treasury yielding 1.19 percent, government bond investors are now receiving a negative real rate of return (because 2.3 minus 1.19 comes out to negative 1.11 percent).

This is highly constructive for the price of gold. As I’ve discussed many times before, the yellow metal has benefited when real rates have fallen below zero. This was the case in September 2011 when gold hit its all-time high of $1,900 per ounce. And last year around this time, the opposite was true—positive real rates were a drag on gold.

Although gold sunk to a two-week low on a strong U.S. dollar and fears over this week’s Federal Reserve meeting, the drivers are firmly in place to push prices higher.

Rogoffs new book calls end paper money

Maybe you’ve heard that a new book out right now is planting propaganda voice in the war on cash. In “The Curse of Cash,” Harvard economics professor Kenneth Rogoff makes the case that nixing paper money—at the very least, larger-denominated bills—“could help more than you might think” in combating criminal activities such as drug trafficking, corruption, extortion and money laundering. It could even prevent the spread of terrorism and discourage illegal immigration, Rogoff argues.

It gets even worse. Central banks, he adds, should have the latitude to drop interest rates below zero during recessions to spur spending. If the Federal Reserve tried this now, of course, many people would likely convert their savings into paper—which at least yields 0 percent—and hoard it in bedroom safes. This is precisely what many Germans have reportedly done, prompting safe manufacturers to scramble to meet demand

But in a world where nothing larger than a $10 bill exists, hoarding cash would be highly impractical. Better to buy that new boat you don’t need!

While we all agree that corruption and terrorism are things that should be stopped, killing cash is the absolute wrong way to go about it.

Instead, perhaps Rogoff should consider “The Curse of No Cash.” Does he not recall what happened in Cyprus just three years ago? The government ransacked citizens’ bank accounts to “fix” its own mistakes and mismanagement. In example after example, people’s rights to save and freely hold cash have been disrupted, with tragic results.

I’ve written about this topic before. In a cashless society, your economic liberty is forever at risk. Every transaction could be monitored, taxed and charged a fee. Capital controls would be crippling, assets could be seized. Just ask the Colombians and Venezuelans

I’m not the only one who disagrees with the ideas in Rogoff’s polemic against money. As of this writing, nearly three quarters of Amazon customers have given the book a rating of two or fewer stars. And in a scathing Wall Street Journal op-ed, respected financial writer James Grant strips away the book’s “technical pretense” to uncover its true motive. Rogoff, he writes, “wants the government to control your money,” which is the extreme form of Keynesian economics.

Gold Has Shined Brightly During Currency Crises

There’s one area where Rogoff and I both agree, though. “As paper currency is phased out,” he writes, “gold prices will rise.” Were cash eliminated and interest rates plunged underwater, gold’s role as a store of value would become even more apparent and demand for the yellow metal would turn red hot, despite its price appreciation.

This has been the case in countless past examples. Rogoff himself cites Indians’ longstanding love of and cultural affinity to gold jewelry as protection against currency uncertainty. For centuries, inhabitants of the Indian subcontinent saw continuous regime change, not to mention imperialist rule by various European forces. During all this time, the one stable and widely accepted currency was gold.

Indian Households Own More Gold Than Top Six Central BanksThe tradition carries on today. A third of Indian gold jewelry demand comes from rural farmers, who annually convert a portion of their crop revenues into the yellow metal. Whether this gold is stored or given to a female family member, perhaps a daughter, before her wedding day, its purpose is twofold: one, as a beautiful heirloom to be worn and passed down to the next generation, and two, as a form of financial security.

It’s estimated that Indian households currently holdmore than 20,000 tonnes of gold. To put that in perspective, 20,000 tonnes is more than the official gold holdings of the U.S., Germany, Italy, France, China and Russia combined.

With speculation strong that a rupee devaluation is imminent, it makes just as much sense now as ever for Indians to have at least some of their wealth in gold. When the rupee unexpectedly dipped to record lows in August 2013, the wealth that prudent Indians had stored in the precious metal was, for the time being, safe.

Indians Gold Jewelry Protect Wealth Against Currency Devaluation
click to enlarge

Although there’s little fear right now that the U.S. dollar is in trouble, I still recommend that investors maintain a 10 percent weighting in gold—5 percent in gold stocks, 5 percent in gold coins and jewelry.

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Smart Money Flowing Into Gold – the Holmes SWOT

By Frank Holmes CEO of U.S. Global Investors

Frank Holmes looks at Gold’s Strengths, Weaknesses, Opportunities and Threats as reported in the media over the past week.

Strengths

  • The best performing precious metal for the week was gold, down just -1.15 percent on a slightly stronger dollar and better than expected U.S. retail sales.  Money flows for gold are benefiting from what Bank of America is calling an “equity exodus.” The bank points out that while $7.4 billion in equity outflows have taken place over the past five weeks, $3.5 billion went into bonds and $1 billion into precious metals. In the first three months of 2016, investors snapped up gold at a record pace, and even commodities investor Dennis Gartman told CNBC that he is becoming more bullish on the yellow metal.
  • Paradigm Capital put out a research note this week, highlighting “open season for development projects.” The report discusses that Kaminak and Goldcorp have entered into a definitive agreement whereby Goldcorp will “acquire all of the issued and outstanding common shares of Kaminak,” with the shares representing a value of C$2.62/ Kaminak share.  The transaction seems a bit off from what Goldcorp had communicated to the street concerning lots of internal opportunities and is not without risk with regards to permitting and construction timelines before first gold production would take place.
  • Kenneth Rogoff comments this week in Business Standard his opinion on whether or not emerging market central banks are overweight in dollars and underweight in gold. Rogoff explains, “There is a good case to be made that a shift in emerging markets toward accumulating gold would help the international financial system function more smoothly, benefitting everyone.” Interestingly enough, China topped up its gold reserves in April, according to data from its central bank. The Perth Mint also reported that sales of Australian bullion coins and bars eased in April compared to March, but surged over the levels posted a year earlier.

Weaknesses

  • The worst performing precious metal for the week was platinum, down -2.59 percent.  Platinum fell 3.30 percent at the start of the week, as a news story from the prior week highlighted that electric vehicles will have a big impact on reduced platinum group metal’s demand.
  • Following the announcement from a Federal Reserve official that it’s fair to expect two interest rate increases this year, reports Bloomberg, gold declined for the fifth time in six days as the dollar strengthened. Bill Gross stated he believes that policymakers may act at their next meeting in June, with other analysts agreeing with his comments.
  • Thailand is set to shut down its largest gold mine by the end of the year, reports Bloomberg. The government ordered a review of the Chatree mine last year after complaints were made by local residents.   Young gold buyers in China are seeking “fresh and modern” takes on jewelry designs, reports China Daily, causing jewelry sellers in the Asian nation to face new challenges. Coupled with declining gold consumption in the first quarter, sellers will need to accommodate this post-90s generation since they have a differing view on investing in such pricey goods.

Opportunities

  • It looks as though the Comex vault does not have enough gold, reports The Daily Reckoning. The number of paper claims tied to an ounce of deliverable gold went from essentially flat in the early 2000s, to an enormous level of 542-to-1 in 2015/2016. The article notes, if even one claimant shows up to take delivery of physical gold, the cupboard will be bare.
  • Jim Bianco, president of Bianco Research, believes that gold is a “high yield asset” in a negative rate world, according to Financial Sense. Bianco points out that the argument against owning gold – that it has no yield – “doesn’t hold water when $8 trillion of government debt around the globe is yielding negative,” continues the article. In agreement with Bianco’s statements, JP Morgan’s global head of fixed income, currencies and commodities, reasoned this week in a piece by CNBC, that with so many negative interest rate policies around the world, gold will continue to be bought as an alternative currency.
  • In a BCA Research piece this week, “The End of the Debt SuperCycle: An Update,” the group details how the ease of engineering a new credit upcycle by the Fed has turned more challenging than ever before, beginning during the 2007-09 meltdown in the U.S. “Since then, even zero policy rates have been unable to trigger a strong revival in credit growth in the major developed economies.”  They noted that it has been 20-years since the Japanese debt supercycle ended and their markets have not recovered yet.

Threats

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  • Goldman Sachs raised its forecasts for bullion prices this week, reports Bloomberg, although the bank remains bearish on the metal’s prospects. Similarly, Singapore-based Oversea-Chinese Banking Corp. (another gold bear) was prompted to raise its gold forecasts this week, continues Bloomberg. The group noted a jump in fund holdings along with doubt from investors for higher U.S. borrowing costs. Billionaire hedge fund manager Paul Singer, however, thinks the gold rally is just beginning. “It makes a great deal of sense to own gold,” Singer said. “Other investors may be finally starting to agree.”
  • According to Kitco News, hedge funds’ gold positioning is reaching all-time highs. In the article, Bart Melek of TD Securities explains that this rally in gold is highly dependent on the Fed and interest rates. “While gold looks overbought on numerous metrics, speculative positioning looks similar to what it was back at the end of 2005/early 2006, before a large rally started,” Melek said. “If the Fed is more restrictive than traders currently expect, gold is due for a big correction.”
  • In South Africa, a court in the country has allowed thousands of former mineworkers to proceed with a class action seeking damages from mining companies, reports Bloomberg. The judgement opens way for nearly 500,000 people to join a suit, for suffering from lung diseases they contracted while working at their operations.