1. There is no longer any correlation between bank reserves and the economy-wide money supply, meaning that the “money multiplier” taught in economics classes no longer applies.

2. In the US the government-Fed combination can increase the money supply to almost any extent independently of the private banks. That is, monetary inflation does not rely on the expansion of credit via the private banking industry.

3. The Fed is not constrained in any way by the need/desire to maintain a strong balance sheet.

4. The bulk of the central bank’s money creation involves the monetising of EXISTING assets, meaning that the central bank can increase the money supply without increasing the economy-wide quantity of debt. Furthermore, the central bank is capable of monetising almost anything.

5. A motivated central bank will always be able to increase the money supply, and growth in the money supply always leads to higher prices SOMEWHERE in the economy. For speculators and investors, the challenge is to figure out where.

6. The bond and currency markets eventually could impose practical limits on government borrowing and monetary inflation, but the government will be free to borrow and the Fed will be free to inflate as long as the bond and currency markets remain cooperative.

7. A corollary of points 5 and 6 is that the probability of the US experiencing deflation will remain low until after the T-Bond and/or the US$ tank. Putting it another way, the probability of the US experiencing deflation will remain low until after inflation is widely perceived to be a major problem.

8. There are long and variable time delays between changes in the money supply and the appearance of the price-related effects of these changes. This leads to an inverse relationship between the rate of monetary inflation and the fear of inflation, because the average person’s fears/expectations are based on the effects of previous money-supply changes as opposed to what’s currently happening on the monetary front.

9. An increase in the general price level is not the most important effect of monetary inflation. Of far greater importance: monetary inflation changes the STRUCTURE of the economy in an adverse way, by a) distorting relative prices, leading to malinvestment on a broad scale, and b) transferring undeserved benefits to the first receivers of the new money at the expense of everyone else.

10. Because monetary stimulus changes the structure of the economy, its bad effects cannot be cancelled-out by the subsequent withdrawal of the stimulus. Instead, the distortions/wastage caused by monetary stimulus will be revealed after the flow of new money is restricted. An attempt to sustain the stimulus indefinitely, and thus avoid the collapse that inevitably follows a period of inflation-fueled ‘growth’, will end in hyperinflation.

11. “Money velocity” is a redundant concept at best and a misleading one at worst. The same can be said about the famous Equation of Exchange (MV = PT), which is where money velocity (V) comes from. In the real world there is money supply and there is money demand; there is no such thing as money velocity.

12. Falling prices are never a problem — they are either the natural consequence of increasing productivity (real economic growth) or part of the solution to a problem (in the case of a bursting credit bubble).

13. A corollary of point 12 is that the central bank’s attempts to force prices to rise either counteract the benefits of increasing productivity or prevent the correction of the problems stemming from a credit bubble.

14. Credit expansion can foster sustainable economic growth only when it involves the lending of real savings by private individuals or corporations.

15. Economic growth is driven by savings and production, not consumer spending.

16. The government and the central bank have no real capital or wealth that can be used to help the economy in times of trouble. Therefore, monetary and fiscal “stimulus” programs involve stealing from one set of people and giving to another set of people. Obviously, the economy cannot be strengthened by large-scale theft.

A lot of widely held beliefs associated with the financial markets and the economy are in conflict with the historical record and/or logic. One that I have addressed many times in the past (most recently HERE) is the belief that gold tends to be relatively strong when inflation expectations are rising.

Rising inflation expectations eventually could transform into a collapse in monetary/economic confidence, at which point gold would exhibit extreme relative strength. However, the run-of-the-mill increases in inflation expectations that occurred over the past few decades generally led to weakness in gold relative to the basket of commodities represented by the S&P Spot Commodity Index (GNX).

Here’s an update of the chart I have presented in previous blog posts that illustrates the relationship mentioned above. The chart shows a strong positive correlation over the past four years between the GNX/gold ratio and RINF, an ETF designed to move in the same direction as the expected CPI. That is, the chart shows that a broad basket of commodities tended to outperform gold during periods when inflation expectations were rising and underperform gold during periods when inflation expectations were falling.

As an aside, related to the above chart is the following chart comparing the commodity/gold (GNX/gold) ratio with the yield on the 10-year Treasury Note (TNX). Given the positive correlation between the commodity/gold ratio and inflation expectations, it isn’t surprising that there is a positive correlation between the commodity/gold ratio and the 10-year interest rate.

This year, inflation expectations bottomed in March and then trended higher. That’s the main reason why, in TSI commentaries over the past seven months and especially over the past two months, I have written that it was appropriate to favour industrial commodities over gold.

I currently expect the rising inflation expectations trend to continue for another 2-3 quarters. This means that I expect continued outperformance by industrial commodities for another 2-3 quarters, of course with corrections along the way. A correction (a period of relative strength in the gold price) actually could begin soon, partly because the gold price is now stretched to the downside while the prices of commodities such as copper, zinc, oil and iron-ore are stretched to the upside.

[Below is an excerpt from a TSI commentary published about two weeks ago. This discussion is being reproduced at the blog because it updates an opinion that was outlined at the blog way back in 2015-2016.]

Goldmoney (XAU.TO) originally was called BitGold and first began trading on the stock market in 2015. We wrote about the company four times at the TSI Blog during 2015-2016 (HERE, HERE, HERE, and HERE). The general theme of these writeups was: The company has a great product, but the stock is wildly overpriced.

Here’s how we summed up the Goldmoney business in the last of the above-linked blog posts:

“From the perspective of a Goldmoney user, the business is great. Customers can store gold, use gold as a medium of exchange and even take delivery of physical gold in manageable quantities, all at a low (or no) cost. From the perspective of a Goldmoney shareholder, however, the business is not so great. Of particular significance, unlike a mutual fund that charges a fee based on AUM (Assets Under Management), Goldmoney charges nothing to store its customers’ assets (gold bullion). This means that the larger the amount of Goldmoney’s AUM, the greater the net cost to the owners of the business (Goldmoney’s shareholders).

It’s important that under the current fee structure, Goldmoney will generally lose money on customers who use the service primarily for store-of-value purposes. This is where PayPal has a big advantage over Goldmoney. Nobody views their PayPal account as a long-term store of value. Instead, they view it as short-term parking for money to be spent, and when the money is spent PayPal usually gets a commission. This results in PayPal being very profitable, with earnings of US$1.2B (US$1.00/share) in 2015. Many of Goldmoney’s customers, however, view the service as a convenient way to store their physical gold. They don’t want to spend their gold, they want to save it.

Based on what I’ve seen to date I continue to believe that Goldmoney offers a great product, but is operating an inherently low-margin business deserving of a low valuation. Use the service, but don’t buy the stock.”

Since 2016 the company has grown a lot, mainly by acquiring similar or related businesses. Most importantly, it has modified its business model and now generates revenue/earnings from precious metals storage and lending. The fee structure is outlined HERE.

Over the same period the share price has trended down from highs of C$8.00 in 2015 and 2017 to a current level of C$2.18. Incredibly, the fundamental value of an XAU share is higher today with the stock trading near C$2 than it was in 2015-2017 when speculative fervour briefly caused the shares to trade as high as C$8.

Goldmoney Inc. now owns/operates two precious metals businesses called Goldmoney.com and Schiff Gold. Revenue for these businesses is earned as a weight of precious metal each time a client buys, sells, exchanges, takes delivery or stores precious metals through one of these businesses. Also, Goldmoney owns 37% of a jewellery manufacturer called Mene Inc. (MENE.V) and earns interest (in precious metals form) through the lending of precious metals to Mene. Lastly, Goldmoney owns/operates a company called Lend & Borrow Trust (LBT) that generates income by making fiat currency loans that are fully secured by precious metals.

The bulk of XAU’s earnings is in the form of precious metals that accumulate on the balance sheet. Furthermore, balance sheet assets not allocated to current working capital, investments and intangible assets are used to purchase and hold physical precious metals, the idea being that XAU’s holdings of gold, silver, platinum and palladium ounces will grow steadily over time.

With a Goldmoney account it is easy to buy and sell physical precious metals (PMs) at very competitive bid-ask spreads, with the PMs stored in secure vaults on an allocated basis (each client has ownership of specific pieces of metal). Also, it is possible to take delivery of your metal. Therefore, it could make sense to build up direct ownership of PMs via a Goldmoney.com account.

Alternatively, as long as the shares are purchased when they are trading near book value (BV), owning XAU shares is a reasonable way to build up indirect ownership of PMs. Owning the shares has the added advantage that if the company is well-managed then the amount of physical metal per share will increase over time.

The current BV is C$2.28/share including goodwill and C$1.79/share excluding goodwill. We think the latter number is the more relevant and therefore that the shares would be very attractive for long-term investment purposes at around C$1.80. However, the current premium to the C$1.79/share BV is not excessive, so if you are interested in XAU then it could make sense to take an initial position near the current market price of C$2.18.

[This post is an excerpt from a recent TSI commentary]

This year has been nothing if not interesting. Many unprecedented things have happened, one example being the performance of the US Industrial Production (IP) Index. As shown below, IP effectively fell off a cliff during March-April of this year. During May-July it climbed about half-way back up the cliff face before stopping in its tracks over the past two months. Nothing like this ever happened before.

When we say nothing like this ever happened before we are referring to the speed of the change. In magnitude terms the IP Index suffered a similar peak-to-trough decline during the Global Financial Crisis, but what took eighteen months during 2007-2009 took only two months in 2020. And after the 2007-2009 recession it took about two years for the IP Index to recover half of what it lost, as opposed to three months in 2020. In other words, what took 3.5 years during 2007-2011 took only five months in 2020.

The reason for the unprecedented speed of this year’s collapse is that the US economy didn’t fall off a cliff; it was pushed. The government (meaning: politicians and bureaucrats at the federal and state levels) deliberately crashed the economy. Policymakers then mounted such an extraordinary rescue attempt that personal income actually rose while the economy crashed and unemployment soared, which explains the unprecedented speed of the rebound.

The economic recovery stalled over the past two months (the IP Index for September was roughly the same as the IP Index for July), mainly because the government slowed the pace at which it was doling out ‘free’ money. The pace of the government’s money distribution is bound to ramp up after the November election, which probably will enable the economy to look strong during the first half of next year. However, there is no chance of a self-sustaining recovery. The main reason is that deluging the populace with newly created money does nothing to repair the damage caused by the lockdowns. On the contrary, it leads to capital consumption and sets the stage for another plunge into recession territory.

The biggest risk, however, isn’t that the ‘stimulus’ efforts won’t work and that the US economy will be back in recession within the next two years. That’s more of an inevitability than a risk. The risk of greatest concern is that policymakers will become even more aggressive in their misguided efforts to help and that these efforts will lead to hyperinflation.

For the first time since we started publishing these reports two decades ago, we cannot write that the probability of the US experiencing hyperinflation within the next two years is close to zero. The probability isn’t high, but it is significant.

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

Moore’s Law, which is based on a comment by Intel co-founder Gordon Moore in the 1960s, states that the number of transistors on a chip doubles every two years. In effect, it states that the computer industry’s efficiency doubles every two years. Moore’s Law worked well in the semiconductor/computer industry for a few decades, but that was due to a set of circumstances that existed in that particular industry over a certain time rather than the general applicability of the ‘law’. The ‘law’ no longer works in the computer industry and can’t be applied in a useful way to technology in general. Wright’s Law, on the other hand, is more useful when it comes to explaining and predicting the effects of technology-driven improvements in efficiency. Wright’s Law pre-dates Moore’s Law by about 30 years (it was postulated by Theodore Wright in 1936) and states that for every cumulative doubling of units produced, costs will fall by a constant percentage.

The reason that Wright’s Law works better than Moore’s Law (Wright’s Law can be applied to all industries and has even been more accurate than Moore’s Law in the computer industry) is that it focuses on cost as a function of units produced rather than time. The beauty of Wright’s Law is that once an industry has been around for long enough to determine the relationship between the increase in units produced and the reduction in unit cost, accurate predictions can be made regarding what’s likely to happen over years and even decades into the future. The limitation is that a certain amount of history is required to establish the percentage reduction in cost that accompanies a certain increase in the production rate.

It should be possible to apply Wright’s Law to any growing industry. Of particular relevance to this discussion it should apply in the Electric Vehicle (EV) industry over the next several years, whereas it should no longer apply in the Internal Combustion Engine (ICE) vehicle industry. It probably won’t apply to ICE vehicle manufacturing in the future because the production rate of such vehicles appears to have peaked on a long-term basis. As evidence we cite the following chart of light vehicle sales in the US since the mid-1970s. This chart shows that the 9-month moving average of annualised light vehicle sales in the US peaked in 2005 and is lower today than it was in the mid-1980s.

Chart Source: advisorperspectives.com

Total light vehicle sales have peaked in many parts of the world, but EV sales are experiencing exponential growth. This implies that vehicle components that are specific to EVs, most notably batteries and electric motors, are going to get cheaper and cheaper. This will not only improve the economics of EVs in absolute terms, it will improve the economics of EVs relative to ICE vehicles.

Taking into account the life-of-vehicle cost, that is, the cost to buy plus the on-going costs to run and maintain, EVs already are competitive with ICE vehicles without the requirement for government subsidies, but within the next three years the economic benefits of choosing an EV over an ICE vehicle will become irresistible to most new car buyers in developed countries. This will happen with or without government incentives to buy EVs. It will happen because of Wright’s Law.

An implication is that current car and truck manufacturers that can’t figure out how to make EVs that consumers want to buy will disappear. Another implication will be a large increase in demand for the commodities that go into vehicle components that are specific to EVs. The commodities that spring to mind are the rare earth metals Neodymium and Praseodymium (NdPr), which are used in electric motors, and lithium, nickel and manganese, which are used in EV batteries.

Keep in mind, though, that the size of the EV market is limited by an overall light vehicle market that probably will be smaller in 15 years than it is today, because the combination of self-driving and ride-sharing will bring the age of personal car ownership to an end.

Wright’s Law naturally results in huge benefits for the average person, but central bankers think that they have to fight it. Even though prices naturally fall over time due to economic progress, central bankers believe that prices should rise, not fall. Therefore, they deliberately try to counteract the efficiency improvements that people in the marketplace are constantly trying to create. They do so by pumping new money into the economy or by encouraging commercial banks to lend new money into existence.

In general, the fast-growing industries that are focused on technological advancement are still able to reduce prices in the face of the central bank’s price-distorting efforts. This leads to the price rises being concentrated in industries where, due to government regulations or the nature of the industry, there is less scope for technology to drive prices downward. For example, Amazon.com was able to drive prices downward in the face of the Fed’s “inflationary” efforts, but most of its brick-and-mortar competitors were not. Other examples are the education and healthcare industries, where regulations and direct government ownership get in the way.

It’s hard to overstate the stupidity of a central bank strategy that is designed to make the economy less efficient. Currently we have the absurd situation in which the faster the rate of technological progress, the more that central banks do to create “inflation” and thus offset the benefits of this progress. They aren’t doing this because they are malicious, they are doing it because they are trapped within an ideological framework that prevents them from understanding the way the world works.

I discussed the relationship between gold and inflation expectations a couple of times in blog posts last year (HERE and HERE). Contrary to popular opinion, gold tends to perform relatively poorly when inflation expectations are rising and relatively well when inflation expectations are falling.

The relationship is illustrated by the chart displayed below. The chart shows that over the past seven years there has been a strong positive correlation between RINF, an ETF designed to move in the same direction as the expected CPI, and the commodity/gold ratio (the S&P Spot Commodity Index divided by the US$ gold price). In other words, the chart shows that a broad basket of commodities outperformed gold during periods when inflation expectations were rising and underperformed gold during periods when inflation expectations were falling.

This year, inflation expectations crashed during February-March in reaction to the draconian economic lockdowns imposed by governments and then recovered after central banks and governments tried to mitigate the lockdown-related devastation by showering the populace with money. This resulted in a crash in the commodity/gold ratio early in the year followed by a rebound in commodity prices relative to gold beginning in April.

The above chart shows that the rebound in the commodity/gold ratio from its April-2020 low was much weaker than the rebound in inflation expectations. This happened because there are forces in addition to inflation expectations that act on the commodity/gold ratio and some of these forces have continued to favour gold over commodities. Of particular relevance, the rise in inflation expectations has been less about optimism that another monetary-inflation-fuelled boom is being set in motion than about concerns that a) the official currency is being systematically destroyed and b) the private sector’s ability to produce has been curtailed on a semi-permanent basis.

Inflation expectations probably will continue to trend upward over the coming 12 months and this should lead to additional strength in industrial commodities relative to gold, but less strength than implied by the relationship depicted above. It probably will happen this way because more and more economic activity will be associated with government spending, which does nothing for long-term progress.

Eventually the relationship depicted above will be turned on its head due to plummeting confidence in both the government and the central bank, that is, at some point rising inflation expectations will start being associated with an increase in the perceived value of gold relative to commodities and pretty much everything else.

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

It is estimated that about 50% of the production costs of the average gold miner are linked to energy. That’s why the gold/oil ratio is a reasonable proxy for the average profit margin across the gold mining industry.

The gold/oil ratio peaked in April of this year and then plunged. Refer to the following chart for the details. It’s a good bet that the April-2020 peak was the major (long-term) variety since it was driven by a spectacular collapse in the oil price that almost certainly won’t be repeated within the next few years. This implies that the industry-wide gold mining profit margin peaked on a long-term basis during the first half of this year.

For two reasons, the high probability that the gold/oil ratio peaked on a long-term basis 5-6 months ago is not bearish for gold mining stocks.

The first reason is that the plunge in the gold/oil ratio from its April-2020 peak ended with the ratio at a multi-decade high. In other words, by historical standards the gold price is still very high relative to the cost of energy, meaning that gold mining profit margins remain elevated. That’s why we expect the gold mining indices/ETFs to trade at much higher levels within the next 12 months.

The second reason is that when the gold/oil ratio retains about half of its gain from a major low (in this case in 2018) to a major high, which it has done to date, the time from a major gold/oil ratio peak to a major gold mining peak tends to be 1.5-2.5 years. This implies that the cyclical advance in the gold mining sector that began in 2018 won’t end before the second half of 2021, although be aware that a sustained move below 40 in the gold/oil ratio would warn a multi-year peak was either in place or close.

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

The 4-8 year period beginning in February of this year potentially will contain three or more official recessions and come to be referred to as the Depression of the 2020s. If so, unlike the Depression of the 1930s the Depression of the 2020s will be inflationary.

The Depression of the 1930s was deflationary in every sense of the word, but the primary cause of the deflation was the performance of the money supply. We don’t have the data to calculate True Money Supply (TMS) during the 1930s, but we have the following chart showing what happened to the M1 and M2 monetary aggregates from 1920 to 1953. The chart shows that there was a substantial contraction in the US money supply during 1929-1933 and that the money supply was no higher in 1938 than it had been at the start of the decade.

Clearly, the money-supply situation today could not be more different from the money-supply situation during the early-1930s*.

One reason for the difference is that during the 1930s the Fed was restricted by the Gold Standard. The Gold Standard was diluted in 1933, but throughout the 1930s the US$ was tethered to gold.

The final official link between the US$ and gold was removed in 1971. This made it possible for the Fed to do a lot more, but as far as we can tell the Fed actually didn’t do a lot more in the 1990s than it did in the 1960s. It has been just the past 20 years, and especially the past 12 years, that the Fed has transmogrified from an institution that meddles with overnight interest rates and bank reserves to a central planning agency that attempts to micro-manage the financial markets and the economy. After history’s greatest-ever mission creep, it now seems that there is nothing associated with the financial markets and the economy that is outside the Fed’s purview.

In parallel with the expansion of the Fed’s powers and mission there emerged the idea that for a healthy economy the currency must lose purchasing power at the rate of around 2% per year. This idea has come to dominate the thinking of central bankers, but it has never been justified using logic and sound economic premises. Instead, when asked why the currency must depreciate by 2% per year, a central banker will say something along the lines of: “If the inflation rate drops well below 2% then it becomes more difficult for us to implement monetary policy.”

As an aside, because of the way the Fed measures “inflation”, for the Fed to achieve its 2% “inflation” target the average American’s cost of living probably has to increase by at least 5% per year.

Due to the central-banking world’s unshakeable belief that money must continually lose purchasing power and the current authority of the central bank to do whatever it takes to achieve its far-reaching goals, the greater the perceived threat of deflation the more monetary inflation there will be. We saw an example of this during 2001-2002 and again during 2008-2009, but 2020 has been the best example yet. The quantity of US dollars created since the start of this year is greater than the entire US money supply in 2002.

It actually would be positive if deflation were the high-probability outcome that many analysts/commentators claim it is, because deflation is relatively easy to prepare for and because 1-2 years of severe deflation would set the stage for strong long-term growth. However, one of today’s dominant driving forces is the avoidance of short-term pain regardless of long-term cost, so there will be nothing but inflation until inflation is perceived to be the source of the greatest short-term pain. This doesn’t mean that a depression will be sidestepped or even postponed. What it means is that the next depression — which may have already begun — will be the inflationary kind.

*US True Money Supply (TMS) has expanded by 35% over the past 12 months.

Since the Fed implemented its first Quantitative Easing (QE) program in 2008-2009, many analysts have claimed that QE adds to bank reserves but does not increase the money supply (bank reserves aren’t counted in the money supply). Such claims are patently wrong.

Anyone who bothered to do some basic calculations would see that when the Fed monetises securities, as it does when implementing QE, it adds to the economy-wide supply of money. Specifically, if you add-up the increases in the dollar amounts of demand and savings deposits within the commercial banking system during a period in which the Fed ran a QE program and subtract from this the amount of money loaned into existence during the period by commercial banks, you will find that the difference is approximately equal to the net dollar value of securities purchased by the Fed.

The fact is that when the Fed buys X dollars of securities from a Primary Dealer (PD), either as part of a QE program or a non-QE open market operation, it adds X dollars to the PD’s deposit at a commercial bank AND it adds X dollars to the reserve account at the Fed of the PD’s bank. Another way to look at the situation is that the Fed’s purchases of securities add covered money (money in commercial bank deposits covered by reserves at the Fed) to the economy.

The process is described at the top of page 6 in the Fed document linked HERE. Some parts of this document are out of date in that it was written well before the Fed started paying interest on reserves and before commercial banks were able to reduce their required reserve amounts to zero via the process called “sweeping”, but the mechanics of the Fed’s direct money creation haven’t changed.

The persistent claims that the Fed’s QE doesn’t boost the money supply are not only wrong, but also dangerous. The creation of money out of nothing distorts relative prices, leading to mal-investment and slower economic progress. Consequently, the failure to identify the direct link between QE and money-supply growth makes the QE seem far less harmful than is actually the case.

[This blog post is an excerpt from a recent TSI commentary, with updated charts and minor modifications]

As is the case with the natural gas price, the price of the S&P Agricultural Index (GKX) appears to have made a cycle low via a double bottom in April and June of this year. At this stage the rebound from the Q2-2020 bottom doesn’t look more significant than any of the other rebounds of the past five years (see chart below), but the combination of rampant monetary inflation, rising inflation expectations and increasingly-volatile weather due to natural climate cycles is the recipe for a much longer and larger rally.

For at least the past 12 months we have argued that owning the stocks of fertiliser producers such as Mosaic (MOS) and Nutrien (NTR) is the best way for most people to participate in the agricultural (‘ag’) commodities bull market that potentially will unfold during 2020-2022. That continues to be our view. Although the fertiliser producers only provide indirect exposure to rising prices for ag commodities, obtaining direct exposure via the stock market involves owning ETFs that usually suffer substantial value leakage due to the “futures roll”.

The following daily charts show that the aforementioned stocks have rebounded strongly from their March-2020 lows but remain well below their highs of the past 12 months.

Not evident on the above daily charts is the fact that MOS and NTR are trading at small fractions of their 2008 peaks. The following weekly charts provide some additional perspective.

We think that the risk/reward ratios of these stocks are roughly equivalent, with NTR being less risky and MOS offering greater leverage. Both companies were very profitable in the June-2020 quarter and should become even more profitable over the quarters/years ahead.