[This blog post is an excerpt from a TSI commentary published on 19th July]

Sometimes, financial market relationships that have applied for a very long time stop working. This usually happens because the monetary system undergoes a major change or because the economy is altered in a permanent way by government and/or central bank intervention. It also can happen due to a major technological change that, for example, permanently reduces the demand for a commodity.

As a result of increasing central bank manipulation of money and interest rates, for the past 12 years gold has been getting more expensive relative to commodities that are consumed*. This is because the manipulation has been a) making it more difficult to earn a satisfactory return on investment and b) reducing the appeal of saving in terms of the official money. As central banks reduce the returns available from investing in productive enterprises and punish anyone who chooses to save cash, the demand for a store of value that central banks can’t depreciate naturally rises.

A knock-on effect is that some gold/commodity ratios appear to have been permanently elevated to higher ranges. There still will be periods when gold falls in value relative to these commodities, but the former ceilings no longer apply. In fact, in some cases it may be appropriate to view the former ceilings as the new floors. The two long-term monthly charts displayed below are cases in point.

The first chart shows the gold/platinum ratio. From the early-1970s through to 2015, gold was always near a long-term peak relative to platinum whenever the ratio moved up to 1. However, in 2015 the ratio broke above 1 and continued to trend upward.

A few years ago we speculated that gold/platinum’s former ceiling near 1 had become the new floor, that is, that the gold price would never again make a sustained move below the platinum price. The probability that this is so has since increased, although it’s likely that gold/platinum made an important high in March-2020 and is in the early stages of a 1-2 year decline.

The second chart shows the gold/oil ratio. From 1970 through to the start of 2020, gold was always near a long-term peak relative to oil whenever the ratio moved up to 30. However, during March-April of this year the gold/oil ratio reached a multiple of its previous long-term peak.

As is the situation with the gold/platinum ratio, it’s likely that the gold/oil ratio is in the process of establishing a higher long-term range that involves the former ceiling (30) being the new floor. As is also the situation with the gold/platinum ratio, it’s a good bet that the gold/oil ratio made an important high in April-2020 and is in the early stages of a 1-2 year decline.

It could be a similar story for the gold/silver ratio, although to a lesser degree. It’s likely that the gold/silver ratio has been permanently elevated, but not to the extent where the former ceiling (80-100) is the new floor. Our guess is gold/silver’s new floor is 50-60.

*That’s right, central banks are inadvertently manipulating the gold price upward, not deliberately manipulating it downward.

[This blog post is an excerpt from a TSI commentary published last week]

Gold is more money-like and silver is more commodity-like. Consequently, the relationships that we follow involving the gold/GNX ratio (the gold price relative to the price of a basket of commodities) also apply to the gold/silver ratio. In particular, gold, being more money-like, tends to do better than silver when inflation expectations are falling (deflation fear is rising) and economic confidence is on the decline.

Anyone armed with this knowledge would not have been surprised that the collapse in economic confidence and the surge in deflation fear that occurred during February-March of this year was accompanied by a veritable moon-shot in the gold/silver ratio*. Nor would they have been surprised that the subsequent rebounds in economic confidence and inflation expectations have been accompanied by strength in silver relative to gold, leading to a pullback in the gold/silver ratio. The following charts illustrate these relationships.

The first chart compares the gold/silver ratio with the IEF/HYG ratio, an indicator of US credit spreads. It makes the point that during periods when economic confidence plunges, the gold/silver ratio acts like a credit spread (credit spreads rise (widen) when economic confidence falls).

The second chart compares the silver/gold ratio (as opposed to the gold/silver ratio) with the Inflation Expectations ETF (RINF). It makes the point that silver tends to outperform gold when inflation expectations are rising and underperform gold when inflation expectations are falling.

We are expecting a modest recovery in economic confidence and a big increase in inflation expectations over the next 12 months, meaning that we are expecting the fundamental backdrop to shift in silver’s favour. As a result, we are intermediate-term bullish on silver relative to gold. We don’t have a specific target in mind, but, as mentioned in the 16th March Weekly Update when the gold/silver ratio was 105 and in upside blow-off mode, it isn’t a stretch to forecast that at some point over the next three years the gold/silver ratio will trade in the 60s.

Be aware that before silver commences a big up-move in dollar terms and relative to gold there could be another deflation scare. If this is going to happen it probably will do so within the next three months, although we hasten to add that any deflation scare over the remainder of this year will be far less severe than what took place in March.

*The gold/silver ratio hit an all-time intra-day high of 133 and daily-closing high of 126 in March of this year. This was one of the many unprecedented market/economic events of 2020.

[This blog post is an excerpt from a TSI commentary published about two weeks ago]

MMT (Modern Monetary Theory) revolves around the idea that governments with the ability to create money are not limited in the way that individuals and corporations are limited. Whereas private entities can only spend the money they have or the money that another private entity is willing to lend to them, a government with the ability to create money is only limited in its spending by the availability of real resources. As long as there is ‘slack’ (what the Keynesians refer to as “idle resources”) in the economy, the government can spend whatever amount of money is necessary to bring to fruition whatever projects/programs the majority of voters desire. MMT’s appeal to the political class is therefore obvious. The only problem is that MMT is based on misunderstandings about money, debt, and how the economy actually works.

If you read the explanations put forward by MMT advocates you could come away with the impression that the ‘theory’ is a discovery or original insight, but nothing could be further from the truth. What MMT actually does is employ accounting tautologies and a very superficial view of how monetary inflation affects the economy to justify theft on a grand scale.

Expanding on the above, when the government creates money out of nothing and then exchanges that money for real resources, it is exchanging nothing for something. In effect, it is diverting resources to itself without paying for them. This is a form of theft, but it is surreptitious because the seller of the resources does not incur the cost of the theft. Instead, the cost is spread across all users of money via an eventual reduction in the purchasing power of money.

According to the MMT advocates, the surreptitious theft that involves diverting resources from the private sector to the government is not a problem until/unless the CPI or some other price index calculated by the government rises above an arbitrary level. In other words, surreptitious government theft on a grand scale is deemed to be perfectly fine as long as it doesn’t result in problematic “price inflation”.

Further to the above, there is a major ethical problem with MMT. However, there are also economic problems and practical issues.

The main economic problem is that the damage that can be caused by monetary inflation isn’t limited to “price inflation”. In fact, “price inflation” is the least harmful effect of monetary inflation. The most harmful is mal-investment, which stems from the reality that newly-created money is not spread evenly through the economy and therefore has a non-uniform effect on prices. That is, monetary inflation doesn’t only increase the “general price level”, it also distorts relative prices. This distortion of the price signals upon which decisions are based hampers the economy.

Another economic problem is that the programs/projects that are financed by the creation of money out of nothing will not consume only the “idle resources”. Instead, the government will bid away resources that otherwise would have been used in private ventures. The private ventures that are prevented from happening will be part of the unseen cost of the increased government spending.

A practical issue is that the government’s ability to spend would be limited only by numbers that are calculated and set by the government. There is no good reason to expect that this limitation would be any more effective than the limitation imposed by the “debt ceiling”. The “debt ceiling” was raised more than 70 times over the past 60 years and now has been suspended.

A second practical issue is that it often takes years for the effects of monetary inflation to become evident in the CPI. Therefore, even if there were an honest attempt by the government to determine a general price index and strictly limit money creation to prevent this index from increasing by more than a modest amount, the long delays between monetary inflation and price inflation would render the whole exercise impossible. By the time it became clear that too much money had been created, a major inflation problem would be baked into the cake.

It’s often the case that what should be is very different to what is, so MMT being bad from both ethical and economics perspectives probably won’t get in the way of its implementation. After all and as mentioned above, it has great appeal to the political class. Also, it could be made to seem reasonable to the average person.

In fact, even though it hasn’t been officially introduced, for all intents and purposes MMT is already being put into practice in the US. We say this because the US federal government recently ramped up its spending by trillions of dollars, safe in the knowledge that “inflation” is not an immediate problem and that the Fed is prepared to monetise debt ‘until the cows come home’. Furthermore, another trillion dollar ‘stimulus’ program is in the works and there is a high probability that a multi-trillion-dollar infrastructure-spending program will be approved early next year. Clearly, there is no longer any concern within the government about budget deficits or debt levels. They aren’t even pretending to be concerned anymore.

The good news is that the implementation of MMT should accelerate the demise of the current monetary system. It means that there is now a high probability of systemic collapse during this decade. The bad news is that what comes next could be worse, with a one-world fiat currency, or perhaps a few regional fiat currencies, replacing today’s system of national currencies.

[This blog post is a modified excerpt from a recent TSI commentary]

Financial market discussions and analyses often focus on fundamental issues that don’t matter, or at least don’t provide useful clues regarding the likely future performance of the market in question. A good example is the so-called “global US$ short position”, which is regularly cited in support of a bullish outlook for the US$.

The argument is that the roughly $12 trillion of US$-denominated debt outside the US constitutes a short position that will create massive demand for dollars and thus put irresistible upward pressure on the Dollar Index (DX). There is an element of truth to the argument, but the “global US$ short position” always exists. It exists during US$ bull markets and it exists during US$ bear markets, because it is simply an effect of the US$ being the currency of choice for the majority of international transactions. Furthermore, the shaded area on the following chart shows that the quantity of dollar-denominated debt outside the US steadily increases over time and that even the 2008-2009 Global Financial Crisis resulted in only a minor interruption to the long-term trend. Consequently, the existence of this debt isn’t a major intermediate-term or long-term driver of the US dollar’s exchange rate.

Source: https://www.bis.org/statistics/gli2004.pdf

The element of truth to the “global US$ short position” argument is that a significant strengthening of the US currency relative to the currencies of other countries will increase the cost of servicing dollar-denominated debt in those countries. This lessens the ability to borrow additional US dollars and puts pressure on existing borrowers to reduce their US$ obligations. In effect, it leads to some short covering that magnifies the upward trend in the US dollar’s exchange rate. This means that while the “global US$ short position” won’t be the cause of a strengthening trend in the US$, it can exacerbate such a trend.

We mentioned above that there is no empirical evidence that the “global US$ short position” drives trends in the US dollar’s exchange rate, but that doesn’t guarantee that the pile of US$-denominated debt outside the US won’t become an important exchange-rate driver in the future. The reason it won’t become important in the future is that prices are driven by CHANGES in supply and demand. The US$12T+ of foreign dollar-denominated debt represents part of the existing demand for dollars, meaning that the demand-related effects of this debt on the dollar’s exchange rate are ‘in’ the market already. At the same time, the total supply of dollars is growing rapidly.

At this point it’s worth addressing the idea that the Fed would be powerless to stop the US$ from appreciating if a major ‘debt deflation’ got underway. This is nonsense. Until the law of supply and demand is repealed, someone with the unlimited ability to increase the supply of something WILL have the power to reduce the price of that thing.

The Fed’s power to reduce the relative value of the US dollar was very much on display over the past few months. The financial-market panic and economic collapse of March-2020 predictably resulted in a desperate scramble for US dollars, leading to a fast rise in the Dollar Index. However, it took the Fed only two weeks to overwhelm the surging demand for dollars with a deluge of new dollar supply.

The upshot is that the so-called global US$ short position is not a valid reason to be a US$ bull.

With regard to performance over intermediate-term (3-18 month) time periods, the fundamentals that matter for the US$ are relative equity-market strength and interest rate differentials. This combination of drivers has been neutral for more than a year but soon could turn bearish for the US$.