Friday Haymaker
In The Ring - August 4th, 2023
Thanks & Clarifications
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“When the winds of change blow, some people build walls and others build windmills.” -Chinese proverb
“… the U.S. carries a federal debt/GDP ratio that is triple what a typical AAA-rated sovereign is burdened with.” -David Rosenberg, in his 8/4/23 Breakfast with Dave edition.
Life is full of incongruities, but one of the more striking examples is the price of gold-miner ETFs versus the price of gold. The yellow metal itself is nearly at an all-time high and looks to be trying to break above the $2,000+ level that has been the ceiling since its big breakout in 2020. At that point, an ETF that holds the junior, or smaller, gold miners was topping out at $60. It is now $36.
In other words, it has fallen 40% despite essentially constant bullion prices. Going back further, as I have done in past Haymaker editions, is even more astonishing. When gold was in the $1,800 range in 2010, a junior miner ETF was at $172. Consequently, with gold up slightly from a peak point, this ETF has performed an almost 80% cliff dive. It’s understandable that anyone who bought it around that price in 2010 feels like this plunge has left them with a broken neck.
One problem the gold-mining sector has had is its sorry long-term earnings history. Even the senior producers like Newmont and Barrick are earning substantially less today than they were back in the 2010-2012 timeframe. By contrast, Chevron and Exxon have both materially increased their profits since then, despite oil and natural gas prices that are actually lower than they were a dozen years ago. This is one reason why I’ve preferred energy producers to the gold miners. Additionally, dividends are much higher in the energy patch than they are with the precious metals producers.
With those negatives fully disclosed, there is one powerful reason to have some exposure to gold miners: the fact that an increasing number of foreign central banks are in love with bullion. There appears to be a mega-repositioning going on by these entities whereby U.S. Treasury bonds are being offloaded while gold is enjoying strong accumulation.
A few renegade investment commentators, like me, feel that an epiphany is underway among these “blue whales” of the financial world. In our view, this reflects their growing discomfort that U.S. government debt is truly risk-free. Central banks hold enormous reserves, of course, and those, historically, have been heavily skewed toward U.S Treasurys (USTs). As noted above, however, the times, they are a changin’. If you don’t believe me, check out rating agency Fitch’s downgrade this week of U.S. government debt (and the hilarious Babylon Bee headline below).
That may or may not be a non-event, but I do think additional actions of this type are pending. What is more meaningful — and disturbing — was the Treasury’s announcement that it will be upsizing its debt issuance to nearly $1.9 trillion for the second half of the year. In fairness, this includes around $500 billion for replenishing the Treasury’s checking account (TGA) that was run down to almost nothing during the debt ceiling standoff.
Regardless, $1.4 trillion of fresh money being raised beyond the TGA refill is a stunner over a six-month timeframe. It also raises the very real possibility that, in the not-too-distant future, the Fed, or perhaps the banking system, or both, will be forced to finance the U.S. government. This is a topic I plan to cover in more detail in the upcoming Making Hay Monday edition. In the meantime, though, I’m convinced it has very bullish long-term implications for gold.
Yet, retail and professional investors, particularly in America, seem oblivious to the risks of a reactivation of the Fed’s Magical Money Machine. (By the way, I believe, as I have said on a number of podcasts, Jay Powell will resign rather than enable this… again.) Reportedly, 70% of institutional investors have zero exposure to gold. Any way you slice it, zero is a low allocation, though, I guess, if nothing else, you could say they’re not short.
There is also clearly a move by numerous countries to trade among themselves outside of the U.S. dollar’s ecosystem, SWIFT. The seizing of Russia’s U.S. dollar reserves, understandable as it was,* sent a chilling message to all but America’s closest allies about the advisability of holding large quantities of USTs. (Most dollar reserves are held by foreign central banks in USTs.)
As others have astutely pointed out, gold is an asset without counter-party risk. In other words, if you hold it — in your own vaults, that is — you don’t have to worry about a government whose bonds you own defaulting on their obligations. This includes the stealth version of reneging, also known as inflating away otherwise unserviceable sovereign debt.
The bottom line is that we may be nearing the point when gold goes vertical. Frankly, I think “nearing” is the operative word. It may take something like an announcement that U.S. banks will be required to hold increased reserves in zero earning deposits with the Fed, effectively providing zero-cost funding to the U.S. government. The Fed and the Treasury are already vectoring for the banks to dramatically boost their reserves. While it will be tough on bank profits if they do this, it will also send a highly inflationary message to the markets.