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In his memoirs, US President Herbert Hoover says that he received the following advice from Secretary of the Treasury Andrew Mellon after the stock market crash of 1929:

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” According to Hoover, Mellon “insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse” and that “even a panic was not altogether a bad thing.”

In other words, if Hoover’s recollection was correct (it probably was), Mellon’s advice was for the government to stay out of the way and let the markets clear.

Paul Krugman and many others have blamed the course of action recommended by Mellon for the severity of the Great Depression of the 1930s. The problem with this line of argument is that Hoover strenuously disagreed with Mellon’s advice and chose not only to ignore it, but to do the exact opposite!

Hoover was an engineer by education who believed that the economy could be managed as if it were a giant engineering project. He was an aggressively interventionist president who thought that the economic pain that the stock market crash suggested was coming could be lessened by, among other things, preventing prices from falling and replacing private-sector demand with public-sector demand. He was a consistent critic of free (unregulated) markets and a relentless advocate for a greatly expanded role for government. He was actually a pre-Keynes Keynesian (Keynes was a prominent figure in economics at the time, but he hadn’t yet written the book that would become the bible for government economic meddling).

As an aside, during the 1932 presidential election campaign FD Roosevelt lambasted Hoover for being fiscally imprudent. In fact, FDR went as far as describing the Hoover Administration as “the most reckless and extravagant…of any peacetime government anywhere, any time.” However, after taking over the Presidency FDR quickly forgot almost everything he had said during the election campaign and greatly extended the interventionist approach initiated by his predecessor.

I strongly believe that Mellon’s advice was sound, but the point I want to make right now is that this advice cannot logically be blamed for worsening the economic downturn of the 1930s, regardless of whether or not it was sound. This is because the advice was not followed.

Here is some fascinating video footage showing Hong Kong in 1938.

The narration sounds like it was produced by the British Ministry of Propaganda and some of the narrator’s comments are patronising to the point of being funny. This mouthful is my favourite:

“Under tolerant and wise British rule, with willing oriental assistance, has grown a modern Western city in an Eastern setting, where more than a million contented Chinese dwell in harmony, merging their ancient civilisation, culture and manners with those of the 20 thousand Europeans who guide or minister to them.”

Video source: https://www.youtube.com/watch?v=hIHTrmz4hTI

This post is a reiteration of the points I made in my 16th December article and includes updated charts. The main point is that there are times, like now, when less ‘accommodative’ monetary policy is absolutely not bearish for gold.

The Fed announced the beginning of its QE “tapering” on 18th December 2013. The following charts show that within a few days of this announcement gold made a major bottom in non-US$ terms (the gold/UDN ratio is a proxy for gold’s performance in terms of a basket of important currencies excluding the US$) and an intermediate-term bottom in US$ terms.

The Fed then methodically “tapered” its QE program during 2014 and announced the completion of the program on 29th October. The following charts also show that within a few days of this announcement gold bottomed in both non-US$ terms and US$ terms.

Over the past two days gold broke out to the upside in non-US$ terms and appears to have completed a long-term base.

As I explained in the above-linked article, the critical point to understand is that gold’s perceived value moves in the opposite direction to confidence in central banking and the economy. During periods when a general belief takes hold that the central bank’s money-pumping is improving the economy’s prospects, the money-pumping turns out to be an intermediate-term bearish influence on the gold market. However, the money-pumping distorts the economy in a way that eventually leads to substantial economic weakness.

A tightening of monetary conditions will begin to reveal the distortions (mal-investments) caused by the preceding ‘monetary accommodation’, which is why the demand for gold will sometimes increase as the Fed becomes more restrictive. In such a situation gold isn’t gaining ground because the Fed is tightening, it is gaining ground because tighter monetary conditions are shining a light on the economic damage caused by the earlier money-pumping.

In simpler terms, gold gets hurt by the boom and helped by the bust, so anything that perpetuates the boom is bearish for gold and anything that helps bring on the bust that inevitably follows an inflation-fueled boom is bullish for gold.

My 3rd November blog post explained why leveraged ETFs should only ever be used for short-term trades. To set the scene, here is an excerpt from this earlier post:

“The crux of the matter is that leveraged ETFs are designed to move by 2 or 3 times the DAILY percentage changes of the target indexes. They are NOT designed to move by 2 or 3 times the percentage change of the target indexes over periods of longer than one day. Due to the effects of compounding, their percentage changes over periods of much longer than one day will usually be less — and sometimes substantially less — than 2-times (in the case of a 2X ETF) or 3-times (in the case of a 3X ETF) the percentage changes in the target indexes.”

In the earlier post I presented tables to show that the greater the volatility of an index and the greater the leverage provided by an ETF linked to the index, the worse the likely performance of the leveraged ETF over extended periods. The worse, that is, relative to the performance superficially implied by the daily percentage change relationship between the index and the leveraged ETF. I concluded that leveraged ETFs are only suitable for short-term trades and that a trade should be very short-term if it involves a 3X ETF and/or a volatile market.

To illustrate how badly a leveraged ETF can perform relative to the performance superficially implied by the daily percentage change relationship between the leveraged ETF and the market to which it is linked, here is a chart comparing the performances of GDXJ (the Junior Gold Miners ETF) and JDST (the Junior Gold Miners 3X Bear ETF) since the end of 2013. JDST is designed to have a daily percentage change that is roughly three times the INVERSE of GDXJ’s daily percentage change, so it is an ETF that someone would buy if they were bearish on GDXJ. For example, on a day when GDXJ lost 5%, JDST would gain about 15%, and on a day when GDXJ gained 5%, JDST would lose about 15%.

Given that GDXJ is presently about 15% lower than it was at the end of 2013, people who are unfamiliar with how leveraged ETFs work would likely jump to the conclusion that a JDST position purchased at the end of 2013 and held through to the present would show a healthy profit. However, this conclusion could not be further from the truth, because JDST has lost 81% of its value over the period in question.

The dismal performance of JDST is a trap for the novice trader, but it is not a design flaw. As outlined in my 3rd November post, it is a mathematical function of how the leverage works and simply means that this type of ETF should only ever be used in trades with timeframes of no more than a few weeks.

The following charts are referenced in a market update to be emailed to TSI subscribers prior to Monday 5th January.

Chart 1: Gold in US$ terms

Chart 2: Gold in euro terms

Chart 3: Gold relative to the Industrial Metals Index

Chart 4: XAU

Chart 5: Gold stocks relative to gold bullion (HUI/gold)

Chart 6: Junior gold miners (GDXJ) and juniors relative to seniors (GDXJ/GDX)

Chart 7: Natural Gas

Charts 8, 9 & 10: Asanko Gold (AKG), Endeavour Mining (EDV.TO) and Timmins Gold (TGD)

1) Rescue major banks by transferring to them, through various channels, a few hundred billion dollars of taxpayers’ money.

2) Call this money transfer the Troubled Asset Relief Program (TARP), because calling it the Bailout At Taxpayer Expense (BATE) program wouldn’t create the right impression.

3) Justify the money transfer by claiming that it is necessary to prevent a total financial collapse and massive losses to bank depositors, even though, in reality, bank deposits are not at risk and the financial system would actually be strengthened by allowing excessively indebted/leveraged financial institutions to go bust.

4) Implement monetary policies that, over the space of several years, effectively transfer trillions of dollars from savers and middle-class wage earners to the balance sheets of banks and other financial speculators.

5) When the banks, flush with the huge profits stemming from the carry-trade opportunities provided by many years of limitless access to near-zero-cost short-term credit, pay back the TARP money with a smidgen of interest, declare the whole exercise to be a resounding success for taxpayers and the economy.

The following charts are related to a market update that was emailed to TSI subscribers.

Central banks will continue to create money in response to economic weakness until blatant “price inflation” stops them. This is why the US economic situation is all but guaranteed to deteriorate.

To explain, I point out that if the Fed had done nothing in response to the bust of 2000-2002 then there would have been a severe recession, but the economy would probably have made a full recovery by 2004 and there would have been no mortgage-credit/housing-investment bubble and therefore no 2007-2008 crisis. However, the Fed, in its wisdom and at the behest of intelligent idiots such as Paul Krugman and Paul McCulley, kept interest rates at artificially low levels for years and aggressively ramped up the money supply with the aim of speeding the recovery process. In doing so it fueled a further rapid expansion of debt and a new bubble.

If the Fed had done nothing when this new bubble inevitably burst in 2007-2008 then there would have been a more severe recession, but the US economy would probably have made a full recovery by 2010 or 2011. It would certainly not now be teetering on the verge of another devastating bust.

During 2001-2004 and again since 2008, the Fed felt free to encourage rapid increases in the supplies of money and credit because there were no obvious negative “price inflation” consequences to be seen by those who fixate on price indices such as the CPI. Therefore, the lack of an obvious “price inflation” problem in the US should be viewed as a threat, not a benefit. From the perspective of the people pulling the monetary levers, it provides carte blanche for more money-conjuring in response to economic weakness.

You see, from the collective perspective of the ‘master manipulators’ at the monetary politburo, creating money out of nothing is never a problem until it causes the general price level — which, by the way, can’t be measured, but that doesn’t stop them from pretending to measure it and coming up with figures upon which policies are based — to rise faster than some arbitrary number. They appear to have no inkling that the falsifying of interest rates and relative price signals distorts investment decisions and the structure of production in a way that leads to an economic bust that wipes out all the superficial gains made in response to the so-called monetary stimulus.

If money-pumping continues to be the knee-jerk reaction to every new bout of economic weakness, then a “price inflation” problem will eventually arise. The longer it takes to arise, the greater the amount of damage that will be done in the meantime.

Men of good will should therefore be hoping for an outbreak of “price inflation”, it seemingly being the only way to end the destructive policy-making.

A couple of weeks ago I posted some information about the “Great Depression of 1873-1896″ to make the point that there was no depression, great or otherwise, during this period, but that the period did contain some financial crises/panics. Paul Krugman and others have blamed these financial crises on the Gold Standard, but, as explained in a well-researched article by Brian Domitrovic, the financial crises of the 1800s had similar causes to the financial crises of the 1900s and 2000s: monetary inflation and government meddling. Here are the last few paragraphs in the aforelinked article, dealing with the financial crisis and economic recession of the early-to-mid 1890s:

“It is perfectly clear what caused both the huge run-up in output numbers from 1890-92, as well as the tremendous stress on the banking and credit system that led to the drying up of investment and the shuttering of factories in 1893 and beyond. The United States, in 1890, decided to traduce the gold standard.

1890 was the year in which Congress made two of its most intrusive forays into monetary and fiscal policy in the years before the creation of the Fed and the income tax in 1913. It authorized the creation of fiat money to the tune of nearly five million dollars a month, and it passed a 50% increase in tax rates in the principal form of federal taxation, the tariff.

The monetary measure came care of the Sherman Silver Purchase Act, whereby the United States was mandated to buy, with new paper currency, an additional 4.5 million ounces in silver per month. The catch: the currency that bought the silver had to be redeemable to the Treasury in gold too.

Silver-mining interests in Nevada and elsewhere had conned (and surely bribed) Congress into this endeavor. Knowing that their extensive silver was worth little, what better way to cash in on it than get a piece of paper that says the silver can be exchanged for gold, government-guaranteed?

The cascade of new money caused an asset bubble, the tariff made sure the bubble was especially deformed, and the most extended recession of the pre-1913 period hit. The United States, needless to say, ran out of gold to back all the extra currency. J.P. Morgan had to float a gold loan to bail out his pathetic government. With the private banking system devoting its resources to propping up the United States, the market got starved of cash, and the terrible recession came.

In our own era, the Fed prints excess dollars without concern that they be redeemable in gold. Which means that our capital misallocation is extensive and long-term, our recessions are long and deep, our growth trend is shallow, and our complacency about how right we are in contrast to the benighted past is callow and pitiable.”

After gold and the gold-mining indices crashed during the final few days of October and the first few days of November, the most likely pattern over the weeks ahead was a rebound and then a successful test of the crash low. Gold bullion successfully tested its crash low on 1st December, but the gold-mining indices didn’t fall far enough at that time to complete a test. The reason is that by the time the North American stock markets opened for trading on 1st December, the gold price had already bounced off its early-November low and was rocketing upward.

The 1st December price action indicated that the gold-mining sector might be able to avoid a test of its crash low, but it wasn’t to be. The HUI and the XAU have just closed lower for five days in a row and are now testing their early-November lows.

I expect the next up-day for the HUI, whether it be today (Wednesday the 17th) or tomorrow or the day after tomorrow, to mark the completion of a successful test of the early-November low and the start of a larger/longer rally than the initial post-crash rebound.

Based on Cyclically Adjusted PE (CAPE), Russia’s stock market is the second cheapest stock market in the world. Its current CAPE is around 5, compared to 27.9 for the US. By this measure only the Greek stock market is cheaper, but the Greek stock market has no dividend yield to speak of. Taking into account both CAPE and dividend yield, the Russian market is clearly the world’s cheapest (refer to http://www.starcapital.de/research/stockmarketvaluation for valuation data on many stock markets around the world). This means that it will probably generate outsized returns over the next few years. However, the following chart suggests that it won’t start providing relatively good returns until commodity prices begin trending upwards, regardless of how cheap it gets.

The chart shows that the RSX/EEM ratio (Russian equities relative to Emerging Market equities) trends with the Continuous Commodity Index (CCI). Russia is in the news a lot these days, due to geopolitical issues, economic sanctions and other economic problems, and, at the time of writing this post, a desperate effort to stop the devaluation of the Ruble by hiking the official interest rate from 10.5% to 17%, but it’s the trend in commodity prices that really matters.

This post is a modified excerpt from a commentary posted at TSI a few weeks ago.

At its recent low the HUI was trading at the same price at which it traded way back in 2003-2004, when the gold price was $350-$400/oz. On the surface, this suggests that at their recent lows the senior gold-mining stocks that dominate the HUI were absurdly under-valued relative to gold, given that gold was trading at around $1150/oz at the time. Just how extreme was the under-valuation?

According to the article posted HERE, the HUI’s under-valuation was so extreme it was completely irrational. For example, the article contains the following statements:

“While gold stocks indeed should’ve been sold with gold weaker, the magnitude of selling they suffered was far beyond anything justifiable fundamentally. This ultimately culminated in the latest gold-stock capitulation where the HUI plunged to 11.3-year lows! Think about that a second. Gold stocks were just trading at prices not seen since July 2003. Pretty much the entire secular gold-stock bull had been fully erased.”

And: “… [the] entire not-widely-followed gold-stock bull was based on the massive fundamental boost to gold-mining profits that gold’s own secular bull created. So if the recent gold-stock price levels were righteous, gold too should have been pounded back down towards its mid-2003 levels. Where was gold trading back then? Merely right around $350!”

And: “Do gold stocks deserve to trade today as if gold was at just $350? Heck no! Last week when gold stocks’ latest capitulation low was carved, the gold price was up near $1150. That was 3.3x higher than the last time the gold stocks traded at recent levels! It makes no fundamental sense whatsoever for gold stocks to trade as if gold was at $350 when it was actually $1150. Their core fundamentals are now vastly better.”

The analysis encapsulated in the above excerpts is superficial and misleading, for two main reasons. First, production costs are vastly higher now than they were in 2003-2004. Second, although the stock prices of the senior gold miners are, on average, not much higher now than they were when gold was trading at $350-$400/oz, their market capitalisations are hundreds of percent higher thanks to massive inflation of share quantities. Consequently, a good argument can be made that the “core fundamentals” are now worse than they were when the gold price was $350-$400.

I’ll now consider the specific case of Goldcorp (GG) to back-up my point. During the quarter ended 30th September 2003, GG managed to achieve a net profit of $0.13/share, a net operating margin of 44% and a return on invested capital (ROIC) of 22%. These results were achieved at an average realised sale price of $364/oz. During the quarter ended 30th September 2014 GG’s average realised sale price was $1266/oz, but the company reported a net LOSS of $0.05/share and was too embarrassed to highlight the ROIC. Note that there were no large asset writedowns in the latest quarter. GG was simply not profitable at $1266/oz in Q3-2014 after being very profitable at $364/oz way back in Q3-2003. And by the way, from Q3-2003 to Q3-2014 GG’s share count rose from 183M to 814M, so although its share price is up by ‘only’ about 50%, its market cap is up by about 580% over the period in question.

I selected GG for my quick-and-dirty case study because it has been one of the best-managed of the senior gold producers and has had less company-specific problems than some of its brethren. Had I chosen either Barrick Gold (ABX) or Kinross Gold (KGC) my point could have been made even more clearly, because the amount of wealth destroyed by these companies via ill-conceived acquisitions and project developments is mindboggling.

It’s important that fundamentals-oriented speculators who buy gold-mining stocks have their eyes wide open and understand the reality of the current situation. There are some good reasons to anticipate large gains in gold-stock prices over the coming 2 years involving a rising gold price, declining production costs and improving sentiment, but at the current gold price and with their current cost structures most gold producers are NOT particularly cheap by traditional valuation standards.

Therefore, don’t be hoodwinked by superficial comparisons into believing that gold stocks are now priced for a hundreds-of-dollars-per-ounce lower gold price and, as a consequence, that massive gains lie ahead for gold stocks even if the gold price flat-lines or continues to trend downward.