Still not much monetary inflation in Japan

August 22, 2014

A popular view is that the Bank of Japan (BOJ) is inflating the Yen to oblivion. This view is wrong. The reality is that while there is certainly a risk that the BOJ will eventually inflate Japan’s money supply at a fast pace, it is not currently doing so.

The spectacular QE program introduced by the BOJ in April of last year did have some effect on the money supply, but the effect was nowhere near as great as generally believed. As illustrated by the chart displayed below, the year-over-year (YOY) rate of increase in Japan’s M2 money supply rose from around 3% in early-2013 to just above 4% near year-end, but 4% is a long way from the explosive growth that most analysts thought would result from the BOJ’s new Yen-depreciation policy. Furthermore, the YOY rate of increase in Japan’s M2 has since drifted down to 3% and appears to be on its way back to the long-term average of 2% (I think it will be back at 2% by October). This means that Japan is still maintaining the world’s lowest monetary inflation rate, which prompts me to ask: Why are so many analysts still blindly assuming that the BOJ is rapidly expanding the Yen supply? Why aren’t they spending the 15 minutes that would be needed to validate — or in this case invalidate — their assumptions by checking the money-supply figures available at the BOJ web site?

An implication of the above is that the supply side of the Yen’s supply-demand equation remains bullish for the Yen’s exchange rate. However, for most currency traders this doesn’t matter. The reason is that the supply side dominates very long-term trends in the foreign exchange market, but the demand side often dominates over periods of up to 2 years.

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T-Bonds are still defying almost everyone’s expectations

August 19, 2014

One of the main reasons that T-Bonds continue to rise in price (fall in yield) is that most speculators continue to bet on a price decline (a rise in long-term interest rates). In other words, the sentiment backdrop remains supportive. It’s worth noting, for example, that despite the strong and consistent upward trend of the past 9 months, there is still a substantial speculative net-short position across the 30-year T-Bond and 10-year T-Note futures markets. Therefore, higher T-Bond/T-Note prices and lower long-term interest rates probably lie in store.

That being said, the iShares 20+ Year Treasury ETF (TLT) is now a) very ‘overbought’ by some measures (momentum, not sentiment), b) within 2% of intermediate-term resistance at 120, and c) within 6% of its mid-2012 all-time high. A test of resistance at 120 will almost surely happen and a test of the all-time high will possibly happen prior to the next intermediate-term peak, but a sustained break into all-time-high territory is very unlikely.

TSI was short-term bullish on US Treasury bonds from mid-December of last year through to mid-August of this year, but turned short-term “neutral” in a report published on 17th August. I expect to see additional gains in the T-Bond price and additional declines in the T-Bond yield over the next few months, but the short-term risk/reward is no longer skewed towards reward. It is also not skewed towards risk, meaning that it doesn’t yet make sense to bet against this market.

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The coming mother-of-all economic busts

August 18, 2014

The extent to which monetary stimulus weakens an economy’s foundations and gets in the way of real progress will be proportional to the aggressiveness of the stimulus. This is because the greater the monetary stimulus, the greater the part within the overall economy that will end up being played by ‘bubble activities’ (businesses, projects, investments and speculations that only seem viable due to artificially low interest rates and a constant, fast-flowing stream of new money). That’s why the unprecedented (at that time) monetary stimulus of 2001-2005 led to the most severe economic fallout in more than 50 years, and why the even more over-the-top monetary stimulus of 2008-2013 has paved the way for an economic downturn of even greater severity than that of 2007-2009.

I’ll be writing more about the coming economic bust (aka severe recession or depression) over the next several months, especially if signs appear that it will soon get underway. For now, here are a few preliminary thoughts:

1) The next economic bust is likely to be worse than, and different from, the one that occurred during 2007-2009. What I mean is that the next bust is unlikely to be an amplified version of what happened previously. The main reason is that almost everyone, including the monetary central planners, will be prepared for a repeat of 2007-2009. Of particular relevance, whereas the Fed didn’t start to pump money into the economy until almost 12 months after the start of the 2007-2009 financial crisis and economic recession (the Fed began to cut its targeted interest rate in September of 2007, but it didn’t begin to monetise assets in a way that boosted the monetary inflation rate until September of 2008), it’s likely that the next time around the Fed will be much quicker to ramp up the money supply.

2) Due to the much quicker application of monetary ‘accommodation’ to counteract future economic weakness, the next bust could be associated with sharply rising commodity prices. This would be due to commodity hoarding in reaction to the belief that money is being trashed.

3) In the lead-up to and during the next economic bust, gold will probably be the best investment because it is the most logical commodity for large investors to hoard. It is the most logical commodity-refuge due to its global liquidity, its globally recognised value, the fact that the amount of gold used in commercial/industrial applications is trivial compared to the amount of gold held for monetary/investment/speculative purposes, and the distinct possibility that a collapse of or an existential threat to the current monetary system would result in gold returning to its traditional role as money.

4) The next economic bust won’t be caused by a geopolitical event, such as the disintegration of Ukraine and/or Iraq, but it will likely be exacerbated by restrictions placed on international trade due to increasing geopolitical tension.

5) The timing of the next bust is currently unknown. Two years ago I thought that it would be well underway by now, but it’s clear that negative real interest rates have a remarkable ability to postpone the day of reckoning. My current guess is that it will begin in 2015.

6) Three things I expect to see shortly before the start of the next economic bust are: a) the S&P500 Index dropping well below its 200-day moving average; b) evidence across the financial markets of a general increase in risk aversion (e.g. widening credit spreads, strength in gold relative to most other commodities); and c) a decline in the US monetary inflation rate to below 7%.

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Beware the “streaming” deal!

August 17, 2014

Here’s something I wrote at TSI last April:

In a market environment where debt and equity financing is often either expensive or difficult for a junior gold (or silver) miner to obtain, a streaming deal can look attractive. This is a deal whereby a miner sells the right to purchase part of its future production at a very low price (usually no more than $400/oz for gold) in exchange for an upfront payment, with the upfront payment generally being used to finance the development or expansion of a mine. The company buying the future production “stream” will typically be Franco Nevada (FNV), Royal Gold (RGLD), Silver Wheaton (SLV) or Sandstorm Gold (SAND).

While a “streaming” deal can look like a reasonable way for a junior miner to meet its short-term financing needs at the cost of reduced future profitability, the risk is that by entering into the streaming deal the junior miner has completely relinquished its opportunity to make a profit in the future. This is because most gold mines have slim profit margins after all costs are accounted for. Due to these typically-slim margins, a miner that agrees to sell 10%-20% of its future production to a royalty or streaming company at a nominal price could end up with nothing for its own stockholders even if it doesn’t encounter major operational problems. In effect, the mine could end up being operated solely for the benefit of the royalty/streaming company.

The upshot is: beware of junior mining companies that have entered into streaming deals. Before you invest in such a company, make sure that there will be plenty of money left over for the stockholders of the junior miner after the royalty/streaming company has taken its share and ALL costs are taken into account. And bear in mind that Franco Nevada, Royal Gold and Silver Wheaton have very high valuations for a reason. The reason is that they tend to get the better of these deals.

I was reminded of this by the “streaming” deal announced by True Gold Mining (TGM.V) last week. TGM is a stock I’m long. The stock market is less concerned than I am about the negatives of streaming deals, but I wish that TGM’s management had opted for a different method of financing the construction of the Karma gold mine.

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