On the ground in Iraq: something doesn’t add up here…

shutterstock 26938672 On the ground in Iraq: something doesnt add up here...

July 8, 2014
Erbil, Iraq

More than eleven years ago, I was among tens of thousands of troops baking in the hot sun of the Kuwaiti desert waiting for George W. Bush to make his ‘decision’.

Of course it was total baloney. The decision to invade Iraq had already been made. They just needed more time to spin their story about WMDs… and to promise the American media ‘Shock and Awe’.

The were right about the latter: the forces assembled in Kuwait constituted one of the most well-trained, well-equipped in the history of warfare.

And it was just a matter of weeks before CFLCC (Coalition Forces Land Component Command, pronounced ‘see flick’) had taken control of most of Iraq.

From a tactical perspective, this was nothing short of a modern miracle– the act of marshalling so many resources forward against enemy opposition is no small feat.

And as I’ve been back in this region for the last several days, I can’t shake that thought.

Because the story we’re being told now is that this militant group IS (same as ISIL, or ISIS) was able to take over nearly half of Iraq… in a matter of days.

This just doesn’t make sense.

IS rolled into Mosul with little more than pickup trucks and small arms, and they defeated a force nearly 20 times their size.

Granted, the Iraqi military isn’t exactly the world’s most elite.

A recent delegation from the United States came to Iraq a few weeks ago and judged the military to be mostly ‘combat ineffective’. Er, we can just file that one away under “no sh*t, Sherlock”…

This isn’t particular to Iraq, the entire region is in the same boat. The Saudi and Kuwaiti militaries are so undisciplined I expect they could be defeated by a crack paintball squad.

But we’re not talking about a tactically superior underdog besting an unwieldy, incompetent opponent… or some drawn-out, demoralizing guerilla war waged by clever insurgents.

We’re talking about straight up conventional warfare– an IS ‘army’ of 23-year old kids vs. Iraq’s conventional ground units, armored vehicles, militia, gunships and other air assets.

Even presuming that IS would eventually beat the pants off the Iraqi military, the speed with which they accomplished this is hardly credible, especially compared to the 2003 US campaign.

It doesn’t add up. And yet IS has taken city after city this way.

Not to mention, the Kurdish intelligence chief had even handed over reports back in January to the CIA, MI6, and Iraqi military, indicating that a large militant force would attempt to invade northern Iraq.

Bottom line, I expect there’s far more to this story than we’re being told… much in the same way that there’s far more than just the ‘chaos’ story that dominates the headlines.

In any situation, there are always winners and losers… so whether IS has plunged Iraq into ‘chaos’ really depends on who you ask.

The US government obviously holds the view that Iraq is disintegrating. But their fundamental premise is deeply flawed.

Iraq shouldn’t even exist. This country was conjured out of thin air by European bureaucrats after the first World War with no regard for ethnic or traditional boundaries.

British diplomat Sir Mark Sykes, an architect of Iraq, was reported to have looked over a map of the region and remarked, “I should like to draw a line from the ‘e’ in Acre to the last ‘k’ in Kirkuk.”

US politicians might call this chaos and insist that “a united Iraq is a stronger Iraq…”

But it only seems natural that a nation born from such imperialistic dogma should break apart.

Meanwhile, if you ask the Kurds, they’ll tell you things are going remarkably well.

From where I sit right now, IS forces are within a few dozen miles on three sides. But there is hardly a tenor of concern here in Erbil.

Aside from a few normal checkpoints, there has been no security clampdown, public or private.

Last night at a restaurant my friends and I passed through a metal detector… only to find that it wasn’t even plugged in. And I ran into a ‘guard’ armed with nothing more than a whistle yesterday morning.

Much of this stems from supreme confidence in the Kurdish militia (Peshmerga), a well-equipped, force that numbers into the hundreds of thousands. And they’re just as committed as IS militants.

It was Peshmerga that took oil-rich Kirkuk a few weeks ago after Iraqi units abandoned the city (again, IS wasn’t even anywhere near the place… quite odd).

So in just a month’s time, the Kurds have managed to assert their autonomy, increase their oil holdings, take back their traditional capital (Kirkuk), and maintain security.

This is definitely NOT chaos.

Quite the opposite. This country has some of the most compelling opportunity in the world right now. More on that tomorrow.

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Top of the market? Meet the $1 BILLION company that has zero revenue…

shutterstock 152149322 1 Top of the market? Meet the $1 BILLION company that has zero revenue…

July 7, 2014
London, England

[Editor’s Note: Tim Price, frequent Sovereign Man contributor and Director of Investment at PFP Wealth Management, is filling in today while Simon is traveling in Iraq.]

Lord Overstone said it best. “No warning can save people determined to grow suddenly rich.”

Case in point– CYNK Technology Corp, a listed company that as of this morning has a market capitalization in excess of $1 BILLION.

According to official filings, the social media development company had one employee, no website, no revenue, no product, and no assets.

What has effectively united this company with prudent investors is today’s central banker.

Andy Haldane, the chief economist for the Bank of England, conceded last week that ultra-accommodative monetary policy had “aided and abetted risk-taking” by investors.

But to the central bank, it was worth using higher asset prices to stimulate the economy:

“That is how [monetary policy] is meant to work. That’s why we did it.”

Central bankers, of course, will not be held accountable when the crash finally hits, even if the accumulated dry tinder of the boom was almost entirely of their own creation.

Last week the Bank for International Settlements, the central banker for central banks, issued an altogether more circumspect analysis of the world’s current financial situation, in their annual report.

It concluded with an entirely welcome sense of caution against monetary policy’s “diminished effectiveness and side effects.”

Translation: ZIRP (Zero Interest Rate Policy – and in the case of the European Central Bank, which has taken rates negative, NIRP) is no longer working – if it ever did.

Hyper-aggressive monetary policy has side effects. Getting out of this mess is not going to be easy, and it’s going to be messy.

In an interview with fund manager John Hussman, Professor Robert Shiller summed up the situation in the markets right now:

“I am definitely concerned. When was [the cyclically adjusted P/E ratio or CAPE] higher than it is now? I can tell you: 1929, 2000 and 2007.”

And Hussman:

“The central thesis among investors at present is that they have no other choice but to hold stocks, given the alternative of zero short-term interest rates and long-term interest rates well below the level of recent decades…”

“Investment decisions driven primarily by the question ‘What other choice do I have?’ are likely to prove regrettable. What we now have is a market that has been driven to one of the four most extreme points of overvaluation in history. We know how three of them ended.”

If one chooses to invest at all, invest on the basis of valuation. Pay money. Take choice.

As an example of the sort of valuations currently available away from the herd, consider the following. You can buy the US S&P 500 index today with the following metrics:

Price / earnings: 18.2
Price / book: 2.76
Dividend yield: 1.89%

Meanwhile, Greg Fisher in his Halley Asian Prosperity Fund (which is currently closed) is buying quality businesses throughout Asia on far more attractive valuations:

Average price / earnings: 7
Average price / book: 0.8
Average dividend yield: 4.5%.

But the realistic prospect of growth is also on the table. The fund’s average historic return on equity stands at 15%.

The conclusion seems clear to us.

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AUDIO: The last ‘dependence day’ with the US as the world’s #1 economy

shutterstock 143316811 AUDIO: The last ‘dependence day’ with the US as the world’s #1 economy

July 4, 2014
Kiev, Ukraine

In one of the most ill-timed columns ever written, Fortune Magazine published an article entitled “10 stocks to last the decade” on August 14, 2000.

The NASDAQ Composite Index was at 3849.69… and within days of the article being published, the index would begin a ruthless decline, taking a whopping 13 years to return to that level.

And as for the 10 stocks which were supposed to last the decade? Two of them (Nortel, Enron) went bust entirely.

One of them (Morgan Stanley) would have gone bust if it hadn’t been for a $107 BILLION taxpayer bailout.

Others (Univision, Genentech) were bought out at valuations substantially lower than their August 2000 levels.

The remaining ones (like Nokia) are still out there somewhere, but their stock prices have declined as much as 83% over the last fourteen years.

To put it bluntly, not a single company on Fortune’s list of titanic, unbeatable stocks managed to generate a positive return for investors. Everyone lost.

In fairness, this isn’t a dig against Fortune; nearly EVERYONE thought that Enron was a sure bet back in 2000. (Although Fortune actually named Enron “America’s most innovative company” for six years in a row from ’96 to ’01…)

Back then no one could imagine that Enron and Nortel would soon cease to exist. Or that Nokia’s brand value would be virtually wiped out by Steve Jobs and a bunch of scrappy Koreans.

This is really a fantastic example of how a herd mentality forms about the sanctity and staying power of certain institutions.

It’s human nature to believe that whoever is in the lead now will always be in the lead.

And it’s the same for countries.

Virtually everyone alive today was born into a world in which the US was “#1”, the largest and most important economy on the planet. Hardly anyone can imagine anything else.

Yet ironically, as many Americans are celebrating dependence day today, it is the last holiday that will pass with the US being the world’s largest economy.

China is set to surpass the US in a matter of months. And this shift of wealth and power is, by far, the biggest story of our time.

Let’s explore this together in today’s Podcast episode. We’ll go back in time and talk about ancient cities, kings and queens, grand palaces, epic battles, and major crises… real Game of Thrones stuff.

And when we’re finished, you’ll see that this time is absolutely NO different. Click here to listen:

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Enjoy your weekend.

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Ukrainian journalist: “Let’s borrow from the US Constitution, they’re not using it anymore”

shutterstock 171568157 Ukrainian journalist: Lets borrow from the US Constitution, theyre not using it anymore

July 3, 2014
Kiev, Ukraine

In the fall of 1239 AD, Batu Khan and his Golden Horde were making great progress in their rapid advance into Europe.

The Mongol Empire was in the midst of global conquest, and Batu’s army had been devastating cities across the Russian plain.

He stopped briefly after taking Chernihiv (in northern Ukraine) and sent his cousin Mongke with a vanguard force to probe Kiev, the capital of Kievan Rus.

At the time, Kievan Rus was one of the greatest powers in Europe, forming a loose federation of Slavic principalities that stretched from the Black Sea to the White Sea.

Kiev had been founded nearly eight centuries before, and by 1239 it was a grand capital with some 50,000 inhabitants. Mongke was quite taken with it. And, not wanting to destroy it, he sent an emissary to discuss terms for their surrender.

Apparently Kiev’s Prince Mikhail had just watched the movie 300… because he put the Mongol emissary to death.

Now, if I could paraphrase the Princess Bride, history gives us a couple of very clear rules– (1) Never get involved in a land war in Asia; and (2) Never go in against a Sicilian when death is on the line.

But only slightly less well-known is this: (3) Never slight a guy named Batu Khan, especially when his army is called the ‘Golden Horde’.

Batu responded to Mikhail’s poor manners by laying waste to the city. Martin Dimnik’s work “The Dynasty of Chernigov” describes the carnage in gruesome detail, saying that people “drowned in a pool of blood.”

To their credit, though, the Kievans fought bravely. They lacked the Mongolian weaponry and tactics, but they fought with sticks and knives… hand to hand, house to house, man to man.

Resistance is in their DNA. So it’s no surprise that, several centuries later, people were out in the streets fighting against their own government. Sticks and knives, once again, againt tanks and automatic weapons.

This time they won. Sort of.

Every 10-15 years this place has a major revolution. And each time it’s precipitated by one basic principle: money.

All people really want is to be in a place where they can improve their lives… where their children can have a brighter future than they did.

The system in Ukraine did not provide those conditions. It was designed for a tiny political and banking elite to enrich themselves at the expense of everyone else.

This revolution was borne from economic frustration, plain and simple.

Yet each time this happened in the past, all they really did was change the players… not the game. They just ended up with a different set of criminals in charge.

This time around there seems to be serious effort to at least change the rules. UkraineNewspaper1 Ukrainian journalist: Lets borrow from the US Constitution, theyre not using it anymore

Many are talking about major revisions to the Constitution (leading one local journalist to ask– “Why don’t we use the American Constitution? It was written by really smart guys, it has worked for over 200 years, and they’re not using it anymore…”)

He’s right. Much of the West, in fact, has descended into the same extractive system as Ukraine.

There’s a tiny elite showering itself with free money and political favors at the expense of everyone else.

Dow 17,000 means that a handful of people at the top are making boatloads of money thanks to quantitative easing, some upper-middle class are doing fairly well, and the average guy pays higher prices for food, fuel, education, medical care, etc.

It’s not just the US. France, for example, is simply not a place where you can work hard and expect to improve your life anymore. In Greece and Spain, half of the nations’ young men are broke and unemployed.

And along they way, they have all set aside civil liberties and turned into vast police states.

Ukraine may be in the midst of turmoil right now, but they at least hit the big giant reset button and are looking to build something new.

The West, meanwhile, continues down its path of more debt, more money printing, more regulations, and less freedom. How long can this really go on without consequence?

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The absurd reason why the government stole my parents’ savings…

July 2, 2014
Vienna, Austria

There’s an old joke here that Austria is famous for two things: convincing the world that Adolf Hitler was German (he was Austrian); and convincing the world that Beethoven was Austrian (he was German).

Frankly one of the things that Austria should be more famous for is its banking. But it probably won’t ever be because the culture here is far too discreet to shout it out for the world to hear.

Switzerland is traditionally associated with private wealth management and conservative financial stewardship. But as the saying goes, when the Swiss wanted private banking, they would come across the border into Austria.

Granted, those days are long gone. Switzerland’s banks have completely rolled over for the US government (and just about everyone else who’s come calling), and Austria has joined up to curtail banking secrecy.

But the culture of discretion and privacy here is as pervasive as it ever was.

This is one of the primary reasons why Austria excels as a place to hold certain physical assets. Because while you might not be able to have any financial privacy across the global banking system anymore, you can still securely and privately hold physical assets.

Consider gold, for example. We all know the story of how private gold ownership was criminalized in the Land of the Free back in the 1930s (a severe form of capital controls).

Would this happen today? Possibly. And there are a number of realistic scenarios which might cause this (like major foreign holders dumping US Treasuries.)

But what’s far more concerning is the prospect of civil asset forfeiture… something that has been on the rise for the past several years.

In the Land of the Free alone, there are hundreds of federal, state, and local agencies that have all the firearms and legal authority they need to kick in doors, freeze accounts, and seize assets.

You don’t even have to be doing anything wrong. Hell you don’t even need to be anywhere in the vicinity. If your ‘stuff’ just happens to be in the wrong place at the wrong time, it can be confiscated.

Almost every week, some government agency is holding an auction of other people’s confiscated property.

And at nearly every one of them is some poor guy’s collection of gold eagles and Canadian Maple Leaf coins.

This is reason enough to consider holding at least a portion of your physical assets abroad.

Think about it– gold is really an anti-currency. It’s an investment you make because you don’t have confidence in governments and central bankers.

Gold is something that cannot be printed at will or conjured out of a policy meeting. And it’s a lot easier to carry around than an acre of farmland.

But what’s the point of trading out the paper currency issued by a desperately bankrupt government if you’re just going to store your gold in the same desperately bankrupt country?

It makes a lot of sense to move some physical assets abroad. And this includes much more than gold.

I was recently reading the findings of one US government agency that was proudly listing all the items they had recently confiscated from people merely suspected of victimless crimes. And I noticed that one gentleman had been relieved of roughly $2.7 million worth of Perth Mint Certificates.

If you’re not aware, the Perth Mint in Australia stores gold on behalf of its customers, and then issues certificates that are redeemable for gold at the mint.

So this particular gentleman had the right idea to store gold overseas. Unfortunately he didn’t do the same with his certificates. So now he’s effectively had his gold stolen even though it’s 10,000 miles away.

No one ever thinks it’s going to happen to them. Until it does.

I just found out that this actually happened to my own parents; they recently had some funds frozen (wrong place, wrong time) because a guy they did business with twenty years ago (and haven’t heard from since then) ended up on the wrong side of the Treasury’s Office of Foreign Asset Control.

My pops was actually flown to New York under subpoena, and they pummeled him with questions about some obscure business transaction that took place in 1993. I can’t think of a more absurd situation.

Civil asset forfeiture is clearly on the rise. And it makes sense to take prudent steps to protect what you’ve worked for.

Gold bullion. Stock certificates. Jewelry. Rare coins. Collectibles like wine and art. Just about anything that’s physical and portable can be stored abroad.

(Das Safe remains my favorite place to do this in Vienna… though they are starting to run out of space. And there are plenty of other options in the world, including Hong Kong or Singapore.)

Rational people have a Plan B. And this is one of those things that you won’t be worse off for doing.

But if the worst happens, it just might make all the difference in the world to have a small cache of real assets stored in a safe, stable place away from your bankrupt government.

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The US government tells the whole world to go FATCA themselves

shutterstock 46461739re The US government tells the whole world to go FATCA themselves

July 1, 2014

Vienna, Austria

 

If you want to gather honey, don’t kick over the beehive.

This was how Dale Carnegie titled the first chapter of his 1936 personal development masterpiece—How to Win Friends and Influence People.

Carnegie had sensible advice: if you want to keep people on your team, first and foremost don’t piss them off. Duh. Seems pretty obvious.

I think the US government could use a little Dale Carnegie right about now (I actually just ordered a copy and had it sent to the President. You’re welcome, BO.)

Obama gift 17.02.08 The US government tells the whole world to go FATCA themselves

Because based on the way they’re acting, you’d think they were test-driving an entirely different manuscript—How to Lose Friends and Alienate People.

Exhibit A: FATCA.

Four years ago, the US government passed this absurd law requiring every bank in the world to enter into an information-sharing agreement with the IRS.

Those who don’t will be subject to a 30% withholding tax on certain funds that get routed through the United States banking system.

What’s more, every bank on the planet is somehow supposed to simultaneously keep track of every other bank in the world and know precisely who is / is not in compliance with the law.

Banks that are in compliance are supposed to withhold the 30% tax on any funds transferred with banks that are not in compliance… otherwise they risk the withholding tax penalty themselves.

The whole thing is enough to make your head spin. Needless to say, the mere thought of complying with this law is enough to drive banks crazy.

This isn’t a way to treat friends. And today’s the day it comes into force.

Exhibit B: BNP Paribas. Uncle Sam just slammed this French bank with a massive fee and threats of criminal penalties for doing business with a country they don’t like.

In doing so, the US has given BNP… and France… nine billion reasons to abandon America.  Again, this isn’t the way you treat friends.

I think politicians fail to realize how important the US banking system is to holding together the US economy.

Right now, the entire world uses the US banking system.

If a merchant in Angola wants to do business with a merchant in India, for example, that transaction is cleared through banks in New York.

This, by default, creates demand for people to hold dollars, giving the US billions of people to splay their inflation onto.

It’s the only reason why the Federal Reserve has been able to print $3.5 trillion over the last five years; nearly any other country does that and you get hyperinflation.

You’d think they would guard this dearly. You’d think the US government would treat their friends… their customers… respectfully.

But no. Instead they’ve dropped a steaming hunk of dung on the entire system, and everyone in it.

With law and behavior this dumb, they’ve gone and kicked over the beehive. No bankers want the hassle of dealing with America anymore, and everyone is looking for a better option.

It’s happening.

Chinese renminbi trade settlement is growing like a weed, constantly posting record levels. Everywhere you look there are countries and big companies looking to hold and conduct trade in renminbi.

Even Canada and the UK are now angling to become major centers of renminbi settlement. Everyone else seems to get it… everyone but the US.

With all of its debt and all of its money printing, the US banking system was one of America’s last economic competitive advantages.

But now we are going to see more and more foreigners curtailing their use of the US banking system… and by extension… the dollar.

Without that mass of people to export dollars to, inflation will really kick in back home.

It’s not going to happen overnight. But as yet another insane law comes into force today, it represents one of the final nails in the coffin for the US, and the end to one of its last remaining advantages.

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Italian government explains how we can all become $250,000 richer

shutterstock 120389911 Italian government explains how we can all become $250,000 richer

June 30, 2014
Rome, Italy

As of today, I am $250,000 richer than I was last week. And thanks to the magic of economics, I didn’t even have to do anything.

You see, following the lead of the Italian and British governments, I’ve taken the liberty of ‘rebasing’ my net worth.

In their case they decided to include proceeds from hookers, coke addicts, and meth heads in their GDP calcuations, thereby increasing the sizes of their economies overnight.

So the other day in Singapore as I was filling out an application for a new account at a private bank, there was a box where they wanted me to write in my net worth.

I decided that I would include the “street value” of some of my vital organs; after all, a kidney in a wealthy country like Singapore can fetch over $250,000.

(There was actually a case back in 2008 of a retail tycoon in Singapore who was arrested for trying to buy a kidney for roughly USD $250,000…)

The banker didn’t find my logic particularly convincing, something about ‘not being able to get that past compliance…’ Yet amazingly the market has given these bankrupt European countries a pass on their equally ridiculous idea.

It’s a testament to how absurd things have become. And the fun’s only just begun.

In the last month, I’ve put boots on the ground in four continents. Just about everywhere I’ve gone (with the exception of Myanmar), it’s pretty clear that things are slowing.

In South America, several major economies are slowing down. Chile is seeing much slower growth and much higher inflation.

Brazil is slowing down as well, and the central bank there just quietly released a substantially lower growth estimate that no one seems to have noticed amid the World Cup festivities.

Asia, which is supposed to be maintaining growth for the rest of the world, is slowing. China’s President has told his nation, and the entire world, to prepare for a new normal of slower growth.

Thailand, Southeast Asia’s most important economy, is slowing down. And inflation is rising. Even in Singapore growth is slowing.

Here is Europe, no amount of hookers and coke can put a brave face on 50%+ youth unemployment.

And of course, in North America, the US economy ground to a halt, contracting at a 2.9% annualized rate. This amid the highest rate of inflation in 18-months.

(By extension, growth rates in Canada and Mexico are slowing as well.)

Hmmmm… Slowing growth. Rising inflation. Central bankers have really backed themselves into a corner on this one.

They’ve spent years creating an ocean of credit, creating credit-junkie addicts out of everyone from governments to banks.

But these bankrupt countries are all so dependent upon cheap credit that if the central banks stop printing, the economies will all take a nose dive.

Even worse, shut off from the central bank teet, governments will lose their #1 buyer of debt and be in serious danger of default.

On the other hand, the inflationary effects of their print-at-all-costs monetary policy are starting to be felt all over the world. So if central banks keep printing, they will do even more damage to their currencies and anyone who uses them.

So at the end of the day, central banks have to pick between screwing the governments and banks which appoint them vs. screwing the people who are told to blame the weather.

Gee I wonder which one they’ll choose…

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A time of universal deceit

shutterstock 453810881 A time of universal deceit

June 30, 2014
London, England

[Editor’s Note: This column was written by Tim Price, frequent Sovereign Man contributor and Director of Investment at PFP Wealth Management in the UK]

“We are currently on a journey to the outer reaches of the monetary universe,” write Ronni Stoeferle and Mark Valek in their latest, magisterial ‘In Gold we Trust’. Their outstanding work is doubly valuable because, as George Orwell once wrote,

“In a time of universal deceit, telling the truth is a revolutionary act.”

The reality bears restating: as the good folk of Incrementum rightly point out,

“..the monetary experiments currently underway will have numerous unintended consequences, the extent of which is difficult to gauge today. Gold, as the antagonist of unbacked paper currencies, remains an excellent hedge against rising price inflation and worst case scenarios.”

For several years we have advocated gold as a (necessarily only partial) solution to an unprecedented, global experiment with money that can only end badly for money.

The problem with money is that comparatively few people understand it, including, somewhat ironically, many who work in financial services.

Rather than debate the merits of gold (we think we have done these to death, and we acknowledge the patience of those clients who have stayed the course with us) we merely allude to the perennial difficulty of investing, namely the psychology of the investor.

In addition to being the godfather of value investing, Ben Graham was arguably one of the first behavioural economists. He wisely suggested that investors should

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it – even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

Graham also observed,

“In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.”
Judgment has clearly been tested for anyone who has elected to hold gold during its recent savage sell-off.

The beauty of gold, much as with a classic Ben Graham value stock, is that as it gets cheaper, it gets even more attractive. This should be self-evident, in that an ounce of gold remains an ounce of gold irrespective of its price.

This puts gold (and value stocks) markedly at odds with momentum investing (which currently holds sway over most markets), where once a price uptrend in a given security breaks to the downside, it’s time to head for the hills.

There are only three ways of trying to handle a mountain of unsustainable debt. The options are:

1) Maintain economic growth at a sufficient rate to service the debt. We believe this is grossly unlikely.

2) Repudiate the debt. Since we also operate within a debt-based monetary system (in which money is lent into being by banks), default broadly equates to Armageddon.

3) Inflate the debt away.

At the risk of pointing out the obvious, which path do we consider the most likely? Which path does it suit grotesquely over-indebted governments and their client central banks to pursue?

But it does not suit central banks to be caught with their fingers in the inflationary cookie jar, so they now have to pretend that deflation is Public Enemy Number One.

Well, deflation is certainly a problem if you have to service unserviceable debts. So it should come as no surprise if this predicament is ultimately resolved through an uncontrollable and perhaps inevitable inflationary or stagflationary mess.

So we have the courage of our knowledge and experience. (In fact, of other people’s experience, too.

As the title of Robert Schuettinger and Eamonn Butler’s book puts it, we have ‘Forty Centuries of Wage and Price Controls’ and their inevitable failure to draw upon. We know how this game ends, we just don’t know precisely when.)

We have formed a conclusion based on facts and we know our judgment is sound. For the last two years, the crowd has disagreed with us on gold.

We think we are right because we think our data and reasoning are right. Not that we don’t see value in other things, too: bonds of unimpeachable quality offering a positive real return; uncorrelated assets; value and ‘deep value’ stocks. And we ask a final question: if not gold, then what?

Are we deceiving ourselves – or are our central bankers in the process of deceiving everyone?

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Singapore official discusses ‘uneasy calm’, tells banks to prepare for financial collapase

shutterstock 140628544 Singapore official discusses uneasy calm, tells banks to prepare for financial collapase

June 25, 2014
Yangon, Myanmar

Well, at least someone gets it.

While just about every other central bank on the planet is giving everyone two thumbs up on the economy, the deputy chair of the Monetary Authority of Singapore (Lim Hng Kiang) said last night at a dinner that “an uneasy calm seems to have settled in markets” and that “we remain in uncharted waters.”

It was pretty amazing, really, to see such pointed language from a central banking official.

Mr. Lim jabbed at the “obvious” risks and said there would be “bumps on the road” ahead. That’s putting it mildly.

Warren Buffet once said that ‘only when the tide goes out do you discover who’s been swimming naked.’ (In my mind he says it like ‘nekked’ but I seriously doubt he pronounces it that way…)

That’s exactly what happens in severe financial crises. You find out which banks have been playing it safe… and which have so mind-numbingly stupid it’s a miracle they’re still around.

There are a number of ways to judge how safe a bank is. One way is by looking at its liquidity; my preferred metric is to calculate how much cash a bank has on hand as a percentage of customer deposits.

Note- this doesn’t mean physical currency, as in bricks of paper cash stacked up in a vault. Those days went away long ago. I’m talking about electronic currency– typically deposits with central banks.

The more cash a bank has on hand, the safer it is. Because in a financial crisis, people tend to panic (hence the crisis) and want to withdraw their money.

Banks bleed cash. And if they don’t have enough of it on hand, the bleeding turns into a sucking chest wound.

It’s at this point that they’ve been caught red handed swimming naked, and they need to go raise cash from somewhere, anywhere else.

So they start selling assets– loans, securities, and even shares of the bank itself.

But this is not an orderly liquidation in a well-functioning market. It’s a distress sale brought on by a full blown crisis. Asset prices are collapsing, fear has taken hold, and it’s difficult to find a buyer.

You never get full price in a crisis (unless you’re Goldman Sachs and can call up your BFF the Treasury Secretary). So in the process of raising cash, banks end up taking heavy losses on their balance sheets.

Now, banks that have healthy balance sheets will be able to withstand these losses.

But banks with razor thin capital ratios (i.e. a bank’s net equity as a percentage of total assets) will fold. Or go to the taxpayer with their hats in their hand claiming to be too big to fail.

This is precisely what happened to the US financial system back in 2009. Lehman Brothers. Wachovia. Washington Mutual. Etc. They were all swimming naked, with very little liquidity and miniscule capital levels.

Singapore’s monetary authority is obviously concerned about financial markets. They understand that you can’t expect to conjure trillions of dollars out of thin air without creating epic bubbles and even more epic consequences.

Sure, you can shuffle those consequences out a few months… even a few years. But at some point those bubbles must be reckoned with.

Perhaps the greatest concern is how few people seem to care.

Central banks and institutional investors turn a deaf ear to obvious risks and fundamentals that are screaming out in desperation hoping some conservative steward will notice that we are tap dancing on a knife’s edge, where nearly every single financial market is simultaneous at/near an all-time high, and central bankers keep pumping money into economies that they claim to be ‘recovered’.

This is the ‘uneasy calm’ that Mr. Lim discussed– a prevailing attitude that there’s nothing to see here; keep calm and buy the all-time high.

And he’s telling banks to get ready for something to happen.

Curiously, Singapore’s banks are already better capitalized and more liquid than most western banking systems. Back in 2008, Singapore demonstrated a lot of resilience as a financial center, sidestepping most of the problems with zero bank failures.

But for a country that went from third world to first world in just a few decades, complacency is not a cultural norm.

According to Mr. Lim, Singapore’s experience with the 2008 crisis “shows how the buildup of risks can severely destabilise even the most developed and sophisticated financial markets.”

So he wants them to increase their capital and liquidity even more.

If a senior official presiding over one of the world’s safer banking jurisdictions wants his banks to become even safer, a rational person would certainly wonder– “What do these guys know about the financial system that I don’t?”

They must be expecting the mother of all busts.

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