“The two main risk factors for the average portfolio are less than expected growth and more than expected inflation.”
Ray Dalio
The first edition of the later bestseller The Black Swan was published in the summer of 2007. Former derivatives trader Nassim Taleb discusses unforeseeable events in the book (which is well worth reading), which result in extreme – both positive and negative – consequences. Shortly after the book was published, a financial crisis of monumental proportions unexpectedly broke out. In many ways, the event was deemed a quite impressive example of a “black swan”. Due to the success of Taleb’s book, the term „Black Swan“, knowledge of which was previously largely confined to academic circles, became a part of everyday vocabulary.
What characterizes a “black swan event“ is that it is not only highly improbable, but is also ex-ante unimaginable for the general public. It is therefore almost impossible to prepare for the occurrence of such events. The consequences of such events are nevertheless extreme.
Based on the “black swan” concept, analysts have for some time increasingly often talked about “gray swans”. The term describes an event that is also considered highly unlikely and has significant effects as well, but is at least imaginable ex-ante, because similar events have already occurred in the past. It is therefore possible to at least prepare along general lines for such events. All other events are white swans. White swans comprise events which it is possible to expect, regardless of whether they are relatively improbable or probable events.
The future is always uncertain. It is nevertheless possible – and sensible – to gather and interpret information in order to draw up different future scenarios and consider reasons both for and against their potential occurrence.
Generally speaking, the surge in total indebtedness and money supply aggregates has made the uncovered monetary system even more fragile than it already is based on its fundamental nature. In the wake of the many non-conventional monetary policy measures implemented by central banks, it is important that the belatedly begun normalization of US monetary policy succeeds in order to maintain investor confidence. We will examine potential scenarios that are liable to cut the normalization effort short, which would ultimately lead to systemic upheaval. Naturally, such a development would have a significant effect on the gold price.
In this context, we would also recommend Taleb’s book Antifragile: Things That Gain From Disorder, published in 2012. Moreover, in last year’s “In Gold We Trust” report, we inter alia discussed whether gold can contribute to boosting a portfolio’s anti-fragility.[1]
It is widely acknowledged that a US recession represents one of the greatest extant risk factors for international investors. In our opinion financial market participants currently display a suspiciously pronounced degree of complacency. The probability of an approaching recession is currently completely disregarded and is priced into markets as though it were a gray or black swan. The Fed publishes a monthly chart of smoothed US recession probabilities based on a model by Marcelle Chauvet[2] – at the beginning of May, it stood at a mere 0.68%.
Source: Federal Reserve St. Louis, Incrementum AG
Of 89 economists surveyed by Bloomberg, not a single one currently expects a GDP contraction in 2017, 2018 or 2019. The median expected growth rate in these years ranges from 2.2 to 2.4 percent.
Source: Bloomberg, Incrementum AG
The extremely high degree of confidence in the economy’s robustness is also reflected by various market-based risk indicators. The last time the VIX (a measure of the implied volatility of a range of S&P 500 options) was close to today’s levels was in 2007 shortly before the beginning of the crisis. In fact, recently the measure hit a new 27 year low (which in turn was one of the lowest levels ever recorded).
Source: Bloomberg, Incrementum AG
A similar message is conveyed by credit spreads, which are at historically extremely low levels, as well as margin debt, which is at a record high and far in excess of previous peaks. Numerous ratios also document the nonchalance of investors. Mutual funds hold record low amounts of cash relative to their assets, retail money market fund assets are close to a record low relative to the stock market’s total capitalization (anything that is currently merely “close” to a record low was at a record low at some point in 2015/16).
From an anecdotal perspective one sometimes gets the impression that quite a few people are actually concerned about the downside potential of the economy and the stock market. After all, the market is at one of the highest levels of valuation ever recorded – only the readings at two or three of the most momentous peaks in market history are still comparable, and this is not exactly a secret. Data related to positioning as well as assorted sentiment surveys fail to reflect any of these occasionally verbalized concerns. In fact, the sheer persistence of unheard of extremes in a number of these indicators has become one of the most astonishing hallmarks of the current asset bubble.
As an example, assets invested in bearish Rydex strategies are not only roughly 95% below their peak levels of the early 2000s, they are in fact also 60% below the lowest levels recorded at the top of the technology bubble that flamed out in the year 2000 – and current levels were already seen in 2015 for the first time (as an aside: something that is down 95% from its peak has been cut in half four times and then fallen by 20% for good measure). Funds held in Rydex money market funds are also at record lows in both absolute and relative terms. When comparing bullish assets to bearish and neutral ones, the records recorded in recent years dwarf the previous extremes of 2000 by up to 100% (incidentally, that was once considered unimaginable). While the Rydex fund universe is quite small relative to the market as a whole, it has always provided a fairly reliable snapshot of overall sentiment.
In the same vein, the weekly NAAIM survey of investment managers, which allows respondents to report their positioning in a range from “200% short” to “200% long”, showed on several occasions over the past year that the most “bearish” manager was in fact net long.
The most important message from all these data is not necessarily that everybody is wildly bullish, but rather that no-one seems to perceive any downside risk. It doesn’t really matter which indicators one cares to examine – the same picture emerges in nearly every case. It seems certainly fair to say that if the economic and investment climate were to turn hostile, the surprise would be vast.
In early 2016 we already alerted subscribers to our research publications[3] in our chart book “Who’s Afraid of Recession”[4] that a number of indicators signaled growing uncertainty regarding coming economic developments. Market pundits appeared to become increasingly nervous, as the Federal Reserve seemed unable to continue with the then just initiated rate hike cycle. Thus, the Fed faced a growing credibility problem in the course of 2016.
We believe the reason for the central bank’s inaction was the fact that nominal growth continues to be very modest, which was reflected by a sharp decline in yields on the long end of the yield curve. By hiking administered rates, the Fed would have flattened the yield curve further, putting pressure on credit creation and already weak economic growth.
Only rekindled hopes for a US renaissance resulting from a supposedly pro business, nationalistic reflation policy were able to generate the required change in sentiment. That had an impact on bond markets as well, which paved the way for further rate hikes. Ironically the presidential candidate who received no love whatsoever from Wall Street or the Fed ultimately made the resumption of the rate hike policy possible. With the tailwind of this new hope reflected in the bond markets, the steepening of the yield curve gave green light for increase #2 and #3. Most recently, this differential again has been decreasing again. The yield differential between 2 and 10 year yields is now approaching 90BP. We would recommend having an extremely close eye on this number going forward.
Source: Federal Reserve St. Louis, Incrementum AG
In particular, enthusiastic Trump voters (otherwise known as “deplorables”) contributed to the change in sentiment in the US public. The post-Lehman economic policy of the Obama administration generated no tangible benefits for many of them. Based on the rather grandiose pronouncements of “their” president, they expect no less than a return to “American Greatness”. In tandem with most market participants and the Fed they continue to expect that Trump will significantly boost economic growth and create numerous well-paying jobs. Many confidence indicators surged to new multi-year highs in the wake of the election, but to date they remain conspicuously unconfirmed by hard economic data.
It remains to be seen whether the change in sentiment will actually lead to stronger growth. In any case, the markets have bestowed a great deal of advance praise on the Trump administration, and are already pricing in a wide range of expected future measures to stimulate the economy and the resultant stronger growth. The gold price became a victim of these expectations – particularly shortly after the election. As already mentioned in the section in which we discuss the current situation, gold came under considerable pressure as a direct consequence of rising (real) yields. We will discuss the potential of massive tax cuts and economic liberalization to actually boost economic output further below.
In the following we want to examine five indications which despite the currently prevailing optimistic sentiment suggest that a recession is far more likely than is generally believed. These signs are:
As a long-term chart of the federal funds rate reveals, the vast majority of rate hike cycles has led to a recession and every financial crisis was preceded by rate hikes as well. The historical evidence is overwhelming – in the past 100 years, 16 out of 19 rate hike cycles were followed by recessions. Only three cases turned out to be exceptions to the rule.[5]
Source: Federal Reserve St. Louis, Incrementum AG
This illustrates the boom-bust cycle and its relationship with monetary policy quite well. In our opinion, the most cogent and helpful explanation of this phenomenon and the associated concatenations is provided by Austrian business cycle theory (ABCT).[6] Even positivists and economists who are not au fait with capital theory should realize that non-monetary theories of the business cycle are standing on very shaky ground, to put it mildly (and yet, they continue to be propagated, regardless of how much countervailing empirical evidence and how many sound theoretical refutations are presented – one suspects, mainly in order to ensure that no-one thinks of questioning the efficacy and sensibleness of central economic planning by central banks).
Future rate hikes should therefore be looked forward to with great interest as a matter of principle. One must keep in mind though that economic slumps occasionally only began with a lag of several quarters. As we already noted in the 2014 In Gold We Trust report[7], the turn in US monetary policy from loosening to tightening has to be dated back to the then much discussed “tapering” period. Former Fed chairman Ben Bernanke announced this soft exit from the QE program in mid 2013. During 2014 the Fed gradually lowered its asset purchases to zero. Viewed from this perspective, we are already in the fourth year of the tightening cycle. From a theoretical perspective, this is supported by the Fed’s own research, which concludes that the effect of QE was akin to the effect of lowering the federal funds rate by up to 400 basis points.[8] Empirically the idea is supported by the chart of the yield on 2-year treasury notes, which began to turn up in 2014 as well.
Source: Bloomberg, Incrementum AG
Recently it appeared as though the Fed intended to catch up with the rate hikes it neglected to implement in 2016. Considering the weak economic environment this creates the impression that the current window of opportunity is to be used in order to be able to lower interest rates again (at least by a little bit) in the next downturn.
A declared goal of the Fed’s QE programs was the inflation of asset prices, which was supposed to stimulate consumer spending down the road:
“…we made a decision back in 2008, early 2009 we were going to have a wealth affect. That was achieved, it made wealthy people wealthier but the point is, it didn’t trickle down… “[9]
Richard Fisher, former president of the Federal Reserve of Dallas
We have often pointed out that such a monetary policy represents anything but a sustainable approach. Every artificial inflation of asset prices will sooner or later end in a painful denouement for asset prices, unless the central bank decides to destroy the currency it issues rapidly rather than gradually, as is currently happening in Venezuela. In that case, asset price bubbles will persist, but end up generating negative real returns. As hedge fund manager Kyle Bass once put it quite colorfully, investors who invested in Zimbabwe’s stock market in the mid 2000s, achieved eye-popping nominal returns. In the end, they would have been able to buy three eggs with their fortune.
In the current cycle, the surge in asset prices has once again generated suspiciously extended valuations. Apart from the ratio of income to total household wealth shown earlier, the so-called “Buffett indicator”, i.e., the ratio of total market capitalization to GDP, which is reportedly the favorite valuation indicator of legendary investor Warren Buffett, is sending a clear warning signal. For the third time in slightly less than two decades, it shows that the US stock market is significantly overvalued relative to total economic output.
Source: Federal Reserve St.Louis; Incrementum AG, Kevin Duffy[10]
Numerous other valuation metrics also suggest that stocks are currently (significantly) overvalued, among them also the well-known Shiller P/E ratio (a.k.a. CAPE, or cyclically adjusted P/E ratio). The fact that rate hike cycles invariably have a negative effect on stock market valuations makes the current level of this ratio particularly worrisome – the recent reading of 29.1 is only slightly exceeded by the manic figure posted in 1929 and the sheer lunacy of early 2000.
Fund manager John Hussman published an interesting contribution on the subject of overvalued stocks in his weekly market commentary on May 1 2017. He notes that near the end of a bull market, investor decisions are increasingly driven by an irrational “fear of missing out” (a.k.a. FOMO).
Hussman attempts to identify the final stages of stock market advances by means of a wide range of indicators, taking into account both fundamental data (mainly relating to valuation) and technical signals that reveal the willingness of investors to take risks (data on market internals and trend uniformity). He has argued for some time that the market appears increasingly risky. After a period during which market internals strengthened again in the rebound following the early 2016 correction low (which mitigated immediate concerns), they have begun to deteriorate again. Recent technical evidence suggests that a strong correction once again approaches.[11] The chart below shows a special study contained in the May 1 commentary, which looks at exhaustion gaps after strong advances, both on their own and in combination with other criteria.
Source: Hussman Funds
Interest rate signals deliberately manipulated by the central bank create unnatural behavior patterns. For one thing, relatively wealthy individuals think that they are becoming richer due to surging stock market and real estate prices; but these higher prices are ephemeral, they represent phantom wealth created by the “money illusion”, which can, and eventually will, disappear faster than it was accumulated. For another thing, artificially low interest rates undermine incentives to save and promote the taking up of additional debt. In times of zero or near zero interest rates, society at large will tend to eschew long-term, future-oriented saving in favor of conspicuous consumption.
In April this year cumulative US household debt exceeded its pre-crisis level again for the first time. While we regard the new record high in debt levels as a cause for concern, the press welcomed the news as a thoroughly positive development.[12]
Source: Federal Reserve St. Louis, Bloomberg, Incrementum AG
In the current monetary system, the vast majority of the outstanding money supply is created by commercial bank credit expansion. In the US the growth rate of this credit expansion has decreased quite noticeably in recent months. This is evident both in official money supply and credit growth measures, as well as in the so-called “Austrian”, or adjusted money supply.[13]
Source: AAS Economics, Dr. Frank Shostak
Historically, slowing credit and money supply growth were always reliable indicators of an impending weakening of economic activity and a rising threat of recession, as rapid bank credit expansion is essential for both the continuation of excessive consumption and the maintenance of malinvested capital in the US.
Source: Federal Reserve St. Louis, Incrementum AG
There is usually very little consensus among economists on a great many issues: “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.” [14]. Nowadays “Lord Keynes” would probably have to be replaced with Paul Krugman, who is almost as prominent and well-known for frequently supporting completely different conclusions based on the same data points, depending on whatever pet agenda of his is in need of buttressing).[15]
In that sense, we are slightly mystified that a US recession is categorically ruled out by the vast majority of mainstream economists at present. After all, one fact is empirically incontestable: GDP growth is cyclical and the duration of economic expansions is limited. At irregular intervals, expansions are invariably followed by recessions. The following table shows the duration of all historical business cycles in the US, segmented by recessions and upswings:
Source: Incrementum AG, Wikipedia
There were 49 economic expansions since the founding of the United States, which lasted 36 months on average. Looking exclusively at the 12 post-war expansion phases, the average duration of an upswing was 61 months. As of June 2017, the current expansion has lasted 96 months, making it the third-longest in history. Should the current economic expansion continue for another 24 months, it would become the longest in US history. In light of the evidence discussed above, we believe it is unlikely that the old record will be broken.
Declining unemployment rates are an effect of economic expansions. It is frequently argued that the current low unemployment rate represents evidence of the expansion’s robustness, but we would point to the long-term characteristics of this statistic, which simply oscillates in a wide range.
From that perspective, the probability of an imminent recession appears much greater when the unemployment rate is low than when it is high. The widespread view that low unemployment rates are indicative of future economic growth can be attributed to the fact that many mainstream economists are in the odd habit of putting the cart before the horse. It is also widely held that the key to boosting prosperity is consumption rather than saving, investment and production – despite the fact that the correct answer to this particular chicken-and-egg question should be glaringly obvious.
Source: Federal Reserve St. Louis, Incrementum AG
An interesting development can currently be observed in the trend of tax revenue growth rates, which typically correlate strongly with economic growth. Federal tax receipts have recently stopped growing, which is historically quite a negative sign for the economy’s future performance. An outright decrease in tax receipts is as a rule only seen during economic contractions.
Source: Federal Reserve St. Louis, Incrementum AG
Should the current expansion fail to become the longest in history and US GDP growth indeed turn negative within the coming 24 months, we believe the consequences could be grave. The knee-jerk reaction by the government and the Fed would definitely comprise renewed stimulus measures in order to arrest the downturn, which implies a U-turn in monetary policy. Currently financial markets are almost exclusively focused on the planned normalization of monetary policy. Almost no-one seems to expect an impending recession or a return to loose monetary policy. Over the past 30 years, the Fed has implemented an increasingly asymmetric monetary policy. The extent of rate cuts routinely exceeded the extent of rate hikes. Statistically this is demonstrated by the left-skewed distribution of the effective federal funds rate.
Source: Federal Reserve St. Louis, Incrementum AG
It would be a big surprise, so to speak a black swan, if the response of the authorities to the next economic downturn were to deviate from the usual one.
Since the normalization of monetary policy hasn’t progressed sufficiently yet, renewed stimulus measures would probably shake market confidence in the efficacy and sustainability of the monetary therapies applied to date. Historical experience indicates that the crumbling of such a deeply ingrained faith is often a wonder to behold; the best thing that can be said about it is that it will sell newspapers and raise the ratings of TV news programs. Moreover, the dosage of said monetary therapies are subject to the law of declining marginal utility, in other words, the next round of QE would probably have to be significantly larger than QE3 was. If the markets were to sense that such a development was likely, the gold price would probably rally quite dramatically.
To this it should be noted that gold at times reacts to future changes in economic and monetary policy with a considerable lead time. There are of course no hard and fast rules with regard to this and the statistical sample size is small – but it is fair to speculate a bit based on past experience and logical reasoning. Both suggest that the extent of the lead time will largely depend on how vividly market participants remember the last major financial calamity. The fresher the memory, the more sensitive the market is likely to be. That explains why the gold price rallied strongly from June 2005 to mid May 2006, despite the fact that most of the important fundamental gold price drivers were bearishly aligned at the time.
As discussed above, we currently believe that the probability of a US recession is significantly higher than is generally assumed. But how would a recession affect price inflation dynamics?
Over the past several years we have witnessed one of the greatest monetary experiments in human history. The eventual outcome remains uncertain at the current juncture. However, a humble look at monetary history does tells us the following with respect to inflation: Neither mainstream economics nor central bankers can control the specific progression of price inflation momentum. The pathetic and consistently failing attempts to regulate the pace of consumer price inflation as one would regulate a thermostat merely betray hubris and a lack of knowledge and understanding of monetary history (not to mention a reliance on theories that are highly questionable). Sharp increases in price inflation as a rule occur unexpectedly and in relatively compressed time frames. As the following chart illustrates, that has already happened many times.
Source: Incrementum AG, Federal Reserve St. Louis
Contrary to the popular opinion that developed nations are characterized by very low inflation, enormous monetary inflation has already occurred. As an example: in terms of the broad true money supply TMS-2, the amount of money in the US economy is now 4.34 times the level of January 2000. Since January of 2008, the broad true money supply has increased by 141%, while consumer prices have risen by a cumulative 15%. In short, since early 2008 the money supply has grown 9.4 times faster than CPI. The effects of this monetary inflation are so far only visible in distortions of relative prices.
Thus, asset prices have increased to a rather conspicuous extent. It seems more than passing strange that rising food prices are as a rule regarded as great calamity, while rising home prices are considered a blessing. Both simply reflect a decrease in purchasing power; whether it finds expression in home prices or food prices is not relevant to the fact that purchasing power has been lost (even though it does of course matter with respect to business cycle theory that a large shift in relative prices has occurred. The non-neutrality of money is reflected in these distortions, which obviously greatly affect investment decisions and the allocation of scarce resources).[16]
A decisive factor likely to determine future price inflation dynamics will be the response of the US dollar to an economic contraction. In past recessions, the dollar tended to initially appreciate against most important foreign currencies. Then the Fed adopted an easy monetary policy and the dollar’s external value decreased again. The extent and persistence of these moves depended also on the dollar’s relative value at the outset of economic downturns, as well as on other contingent circumstances (such as dollar shortages in the euro-dollar market and similar market structural or psychological aspects). In that sense, the current situation differs markedly from that prevailing at the beginning of the last downturn, as the dollar has already appreciated considerably in recent years. Persistent further strength in the dollar would be the exception rather than the rule under these circumstances.
USD Index (30 month change.)
Source: FRED, Incrementum AG
Should a US recession strike concurrently with a devaluation in the US dollar, investors would be faced with a very difficult situation. While in 2008, it was primarily concerns about liquidity and the fear that “not enough money would be printed” were dominant (a situation known as a “deflation scare”), the markets may arrive at a different assessment in the next downturn. That would be particularly likely if confidence in the Fed’s ability to revive the economy with another round of stimulus measures were to falter before they are even implemented. As soon as market participants consider rising price inflation to be a serious possibility, a fundamental shift in general market sentiment is likely to occur. The currently still prevailing expectation that “if there are problems, central banks will implement further inflationary measures” would be increasingly questioned if inflation expectations were to rise.
Based on this we want to discuss the performance of different asset classes in a variety of price inflation environments. Apart from precious metals, inflation-protected bonds are often cited as suitable hedges against inflation. Many investors are unaware of the fact that the inflation-protection feature essentially only comes into play at maturity. Before they mature, these bonds exhibit considerable sensitivity to changes in nominal interest rates. That is not exactly an unimportant factor in portfolio construction. In particular, long term inflation-protected bonds often face headwinds once price inflation enters an uptrend, which is usually accompanied by rising nominal interest rates. If this asset class is added to a portfolio as an inflation hedge, substantial (accounting) losses may be unexpectedly recorded in some years.
As the following chart illustrates quite clearly, both stocks and bonds tend to lose ground in an environment of accelerating price inflation. Even though stocks are often considered to be suitable inflation hedges since they represent claims to real assets, historical data on this point are rather more ambiguous. Numerous studies actually show that stock prices and price inflation are negatively correlated.[17] In other words, a surge in price inflation will normally have a negative effect on stock prices.[18] Of course the effect varies greatly between market sectors. That is a major reason why gold stocks and the stocks of other commodity producers have attractive characteristics in the context of prudent portfolio diversification, as they are clearly positively correlated with rising inflation rates.
Source: Wellington Asset Management, Incrementum AG
In an environment of merely “elevated” 1970s style price inflation rates, the value of future earnings streams tends to be heavily discounted by the stock market. Many sectors will experience a sharp compression of multiples. Broad stock market indexes in developed markets are liable to decline, as most growth stocks will come under strong pressure. Lower order industries close to the consumer will suffer as well, and so will domestically focused banks, especially if real interest rates are persistently negative. Stocks of capital-intensive companies in higher order goods industries such as miners or various “smokestack” industries will tend to hold up better or even thrive.
These trends become even more pronounced if a country’s currency breaks down in a crack-up boom, and a hyperinflation episode begins. As an aside, it is possible to survive and even thrive in hyperinflation conditions, but it is not easy and one has to be constantly on one’s toes. Wealth preservation becomes a full-time job, and many traps await the unwary. Moreover, governments will often do their utmost to prevent people from trying to preserve their wealth, as the associated activities are usually blamed for exacerbating the situation (governments presiding over hyperinflation never blame themselves or their policies).
Source: www.acting-man.com
These magnified boom-bust cycles on steroids are also very dangerous because the trend is bound to eventually rapidly reverse after which a “stabilization crisis” will commence (as a rule this happens overnight, once the official medium of exchange is completely repudiated). What was valuable and sought after can become an instant liability, while assets and business sectors that were previously shunned will begin to recover and thrive again. The average citizen is probably best served by holding precious metals and foreign investments if it becomes necessary to deal with such circumstances.
Below we briefly list a number of additional gray swans, which we believe have strong potential to become relevant at some point.
There has been recurring speculation about a potential credit crisis in China for a number of years. Until 2014 China had a positive balance of payments and accumulated foreign exchange reserves. Since then the trend has reversed and the renminbi has begun to steadily decline against the US dollar. Credit expansion in China attained particularly egregious proportions after the 2008 crisis.
Source: Bloomberg, Incrementum AG
Should China’s banking system indeed experience a credit crisis, one would have to expect a strong devaluation of the yuan against the US dollar, combined with surging gold prices.
The excitement at Donald Trump’s election victory was not restricted to financial markets. A majority of the established power elite in Washington (and elsewhere) was also caught on the wrong foot by his election. The desperate efforts to somehow push him out of office by means of an impeachment procedure have intensified. His unconventional approach to politics may at some point provide his detractors with an opportunity to initiate such a step. At the time this report was being written, the probability of such a development appeared to be increasing.
The probabilities of some sort of military confrontation in the Far East have increased as well. The situation on the Korean peninsula, but also between China and Japan, China and the Philippines as well as China and Vietnam, in short the entire South China Sea, has become significantly more tense. Numerous simmering and actual conflicts in the Middle East also harbor a great deal of instant escalation potential.
The effect of such potential scenarios on the US dollar and gold will largely depend on how a given conflict will play out. It is to be suspected that the crisis metal, gold, will at least initially move higher. We nevertheless believe that the direct effect of (geo)political events on the gold price generally tends to be over-estimated. Readers interested in more details on this topic should take a look at the transcript of our last advisory board meeting.[19]
We have already discussed the non-sustainable nature of the current global debt situation extensively in past “In Gold We Trust” reports. Should the current state of chronic over-indebtedness result in a global banking or debt crisis, it would ceteris paribus have a strongly deflationary effect requiring massive countermeasures to be launched by central banks. A large proportion of deposit money would no longer be accessible and cash reserves would begin to reflect a large premium. If a hyper-deflation scenario were to actually eventuate, gold prices would be set to decline in nominal terms, but gold’s real purchasing power would either be maintained or possibly even increase.[20] For this scenario in particular it is recommended to invest in physical metal and store it outside of the banking system.
Both national and international monetary orders are regularly subject to change. The last paradigm change happened on 15. August 1971, when US president Richard Nixon suspended the Bretton Woods system that had been in force until then. Sooner or later the current post-Bretton Woods standard, i.e., the US dollar standard will be adapted as well. In our opinion the probability that gold could play a role in this new monetary order has lately increased. Even some members of president Trump’s team of advisors are well aware of the issue and speak about it publicly. In this context the exclusive interview with Dr. Judy Shelton in this “In Gold We Trust” Report is undoubtedly of great interest.
All these gray swans represent scenarios that cannot be ruled out from our perspective. We will examine several of them in greater detail in other sections of this report.
In this ornithologically tinged section we have considered a number of “swans” in different hues which could have a significant effect on the gold price. In our opinion a potential recession in the US, which would invariably lead to a U-turn in monetary policy, represents the potentially most important catalyst for the future trend in the gold price.
Source: Incrementum AG
We are well aware that as Austrian School representatives, we may be inclined to be a tad too hasty in suspecting an economic downturn to approach in fairly short order. Nevertheless, we believe that generally, the potential for such a scenario to eventuate is unduly underestimated at present. One almost gets the impression that the possibility of a recession is completely disregarded and treated as though it were a black swan. We believe there are already numerous indications which suggest that the current expansion is going to end in the foreseeable future. A recession scenario is therefore actually quite probable in our view.
If our expectation is confirmed, a monetary policy response in the form of rapid rate cuts and a renewed round of quantitative easing should be expected. In such a scenario gold should post significant price gains.
[1] See: “In Gold we Trust”-Report 2016, “Antifragile investing with gold”
[2] See http://faculty.ucr.edu/~chauvet/ier.pdf
[3] Registration possible at the following link: https://www.incrementum.li/en/incrementum-newsletter/
[4] “Who’s Afraid of Recession? – Incrementum Chartbook #4
[5] These deliberations were inspired by van Hoisington – see Hoisington Quarterly Review and Outlook, Q1 2017
[7] See “In Gold we Trust” Report 2014
[8] See: http://www.frbsf.org/economic-research/files/S04_P2_SamuelReynard.pdf
[9] http://www.realclearmarkets.com/video/2016/09/08/richard_fisher_wealth_effect_did_not_trickle_down.html
[10] Vgl. “Mr. Market flunks the marshmallow test”, Präsentation von Kevin Duffy, Grant’s Spring Konferenz 2017
[11] See: “Exhaustion Gaps and the Fear of Missing Out” – Hussman Funds
[12] See: “Household debt makes a comeback in the U.S”
[13] The narrow Austrian or adjusted money supply (AMS) calculated by Dr. Frank Shostak of AASE (Applied Austrian School Economics) excludes credit transactions, but includes items that are clearly money, which official money supply aggregates fail to include (an item of the former type are money market fund investments – these are not money – in fact, they have to be sold for money before payment for other goods and services can be effected. The latter category comprises mainly sweeps and certain memorandum items on the Fed’s balance sheet, which clearly do represent money, such as the US treasury’s general account).
[14] This quote is generally attributed to Winston Churchill – it shows that there is nothing new under the sun. Today one would have to replace John Maynard Keynes with Paul Krugman.
[15] Although this comment is a bit tongue in cheek, it is actually not merely a “partisan” assertion – it is backed by plenty of evidence, much of which can be found at a site run by Tom Woods, which is actually quite fair and meticulous in its analysis of Krugman’s economic fallacies, despite being explicitly dedicated to drawing attention to them: http://contrakrugman.com/
[16] See: “Why Keynesian Economists Don’t Understand Inflation”, Frank Hollenbeck, Mises.org
[17] See “Asset returns and inflation”, Eugene Fama und William Schwert
[18] See “The ‘Fisher Effect’ for Risky Assets: An Empirical Investigation”, Journal of Finance, Jaffe and Mandelker
[19] Advisory Board Meeting – April 2017
[20] See Austrian School for Investors, p. 147 ff
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