In the just released May data, Australia saw a 50% leap in revenues from gold exports when compared to the prior month. While this data is noisy and volatile, it meant that Gold in a single month increased on a valuation basis from 3.5% of exports to 5.5% of Australian exports. This is a theme that I have raised several times this year, most recently in the May 30, 2010 issue of StockTwits Macro Weekly, Dig Oz. Australia is on the threshold of seeing gold head towards 10% of exports.

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I did not have to wonder for long. The surprise hike in the FED’s Discount Rate now looks nothing more than the brief flare of a technical operation. The meat of the matter, the major thrust of the FED’s intentions, were revealed this week when Janet Yellen hinted that QE of MBS could be put back on at any time. And, when Bernanke testified in his Humphrey-Hawkins appearance that the FED would need to keep rates very low, for a long time. It should also not be forgotten, in addition,  that even on the day of the FED’s surprise discount rate hike at least one FED governor made remarks that evening to broadcast the FED’s intention to keep rates low.

Because further clarity on FED policy has come at the same time as news releases on the economy, I think it bears mentioning again that housing…(this article continues for subscribers through the membership gateway, on the right side of this page)

What’s Next for the Stimulus Bill: roundtable with Grabell, Radnovsky, Baker, Riedl, Dianne Rhem WAMU Radio.

Buzzing With Coffee Beans: food commodity documentary series from ABC/BBC, ABC Australia 360 Documentary.

Debating a Nuclear Revival: roundtable with Lyman, Power, and Wilson, WBUR On Point Radio.

Freefall: America, Free Markets, and the Sinking of the World Economy: interview with Joseph Stiglitz, Democracy Now Radio.

Gold Market Update: interview with Jim Sinclair of Mineset.com, King World News Broadcasts.

Obama’s America: Simon Schama on the US recession, BBC World Service Documentary.

-Gregor

Photo: Nuclear Power Plant.

Just about every asset class including gold and silver remains on edge in the wake of the Dubai event, which I marked not as a trigger, but the start of the recognition phase to the problem of sovereign debt. Comically, Greece and Spain–hit hard this week by the ratings agencies–are small problems compared to the US, Japan, and the United Kingdom. But that’s precisely how relativity plays out in the world of rogue finance. There’s no sense in trying to gang up on the majors, when you can take down the juniors first.

Indeed, it will take time and courage before the world is ready to maul the sovereign debt of Japan, the US, and the UK. But perhaps less time, and less courage as we proceed into 2010. The US Dollar Index has still not made it to my target…(this article continues for subscribers through the membership gateway, on the right side of this page)

Gregor,

I really enjoy and learn from your writing and analysis but I was hoping you could shed a little more light into your approach to portfolio allocation and risk control. I agree with you that the arguments for PMs are sadly compelling these days but 52% allocation to precious metals and stocks strikes me as quite bold. Are you as aggressively positioned in your own personal holdings beyond the model portfolio?
I also reluctantly agree with your analysis that another deflationary collapse would only lead to more inflationary responses from governments but I am curious if you have an investment response in mind should gold get dragged down with everything else in the true debt collapse we fear or for other reasons. Would you then allocate even more resources to gold, sit tight or scale back?
Obviously I realize the difficulty of answering vague hypotheticals but I am mainly trying to get comfortable with the risk profile of a portfolio so heavily weighted towards assets that are notoriously volatile and hard to value (no matter how compelling the fundamental and technical setup may be). Thanks for your efforts,

Ben

I share alot of these concerns myself. Having watched gold and all of its intermarket relationships since earlier in the decade I have had to accept that every step of the way, gold and precious metal mining stocks (PM stocks) have remained risk assets. Not an anti-risk assets. However, when this blog and model portfolio service launched in late August I had two ideas–or questions–that I felt were worth exploring as we headed into Autumn. First, was it possible that liquidity and reflation would finally take hold, and lift assets higher despite a terrible economy? Also, was it possible that gold, if perhaps not PM stocks, would migrate back to the anti-risk category?

I conclude we only have partial answers to these questions, at this time. Yes, gold and PM stocks have blasted away to the upside and they have done so even when broader markets are weak, and, when systemic and macroeconomic concerns have been elevated. However, other global assets like emerging market stocks and junk, low quality stocks have made even larger moves since September 1st. As I have written, the coverage of gold’s move higher is quite breathless given the moves made by broad indexes such as Brazil’s, for example.

That said it does appear that gold bullion has caught on as a global solution to the very worrying structural problems facing the world, now exposed to the bursting of the debt and credit bubble in the United States. While I remain wary of the PM stocks I felt it was a decent risk-reward to own them, rather than shun them, in the portfolio. Unlike gold bullion however, they have to be watched more carefully, more skeptically. Additionally, I will assume many have noticed that gold mining companies are having a hard time making money. While some might argue this has always been the case, the physical-geological issues that affect gold mining extraction now look alot like the challenges faced by oil extraction.

Perhaps gold has only migrated half the way back from the risk category, to the anti-risk category. For, despite the dire fundamentals for the US Dollar and US Treasuries, there remains a good prospect that when global equities take their next tumble or especially when sovereign debt risk breaks out again somewhere in the world, that both of these assets will rise. But perhaps what’s changed is that gold too will rise under such circumstances. At the very least, the US Dollar may have to share some of its previous role, with gold. In the near term, subscribers know my view as to when a battle for the Dollar is likely to take place.  Now that we are below…(this article continues for subscribers through the membership gateway, on the right side of this page)

Hardly any observer of the economy was fooled into thinking that the Cash for Clunkers program represented a sustainable recovery in the automobile sector. So it has been a surprise to me this Autumn that so many composed for themselves a broader housing recovery narrative from the acute, artificial effects of FHA, Fannie Mae, and Tax Credit programs. (not to mention the FED’s operations in the MBS aftermarket). I’ve been watching 4-6 American cities for over 10 years now, starting from the time I moved back to the US from London. I have seen the entire cycle. But more important to note is that curating your own database or data sources on any subject is now quite possible for just about anyone with an internet connection, and some research skills. Thus, as we got into late October, I could see that house prices were once again coming down. More importantly, and unsurprisingly, it’s the upper end of the housing market–that sits above government infusions–that’s starting to turn downward.

My view is as follows: the American house has reliably acted as an inflation hedge for most of its history but during economic expansions a house becomes a more volatile call option on future wage growth. Given the structural changes to the US economy, and how those changes were papered over by the credit bubble, it’s now unlikely that a US house will act as a high-beta, upwardly tending call option on future wage growth–in the aggregate–because we still have a lot of heavy lifting to do before we get to the other side of this crisis. Accordingly, I now have to question whether many American houses can be priced above…(this article continues for subscribers through the membership gateway, on the right side of this page)

There are three types of opposition to peak oil theory. The first comes through the most basic misunderstanding of the concept itself. Peak oil means peak flows, not peak quantity of oil in the ground. Probably 70-80% of the people who open their mouths to speak about peak oil do not make it past this first, crucial hurdle. I have found almost no correlation at all among those who fall down at this threshold. Here, there is everyone from the most cavalier TV blatherer to the person who loves to greet all new concepts with the word “nonsense.” There’s also a fair chunk of the journalist class here as well. They tip themselves off everytime with some form of the phrase “running out of oil.” Sigh. I used to think those who wrote for newspapers actually liked to learn new things.

So to get past the first hurdle, one needs to understand peak flows because it’s central to understanding the data of the last 10 years. When I say data, I don’t mean a small amount of data either, but all world data not only on oil but also on coal and other primary energy consumption, and data on projects costs and project completion timelines. Production, Consumption, Exports, Net Exports, Substitution, Timelines, and Costs. This brings me to the second type of opposition to peak oil. There are a fair quantity of industry people and others who are well acquainted with data but it’s largely post-war data up until the start of this decade. Among this group the spare capacity/OPEC control era made the greatest impression on their careers. Also here are those who have made a career out of (what I call) the 90 day oil market–that is making calls on supply and demand over the next 90 days. What binds this type of opposition together is good, solid understanding of a world of oil production that no longer exists. They just don’t believe anything changed after 1999-2000.

Finally there is the philosophical and historical opposition to peak oil. Here we find the benign transitionists and other believers in the magical nature of self-organizing systems. Most here grant that peak oil will eventually become a reality, but whether its a reality now or later, it won’t matter. Technologists, inventors and optimists are prominent here. However, what’s not addressed in this group are the twin issues of Scale, and, previous energy transitions. Thus, the first type of opposition never really gets into the game. The second type of opposition only sees part of the problem (but with clarity), and the third type believes in a grand theory that’s not so well supported historically. For example, the previous two energy transitions, from Wood to Coal and then Coal to Oil, were notable in that humanity was moving from lower to higher density energy sources each time. Finally, it’s odd to me how many persons with math and science degrees avoid the issue of Scale. Didn’t they watch the old (Charles and Ray Eames) Powers of Ten video in first year Physics?

So why does any of this matter? Let’s say oil has peaked and the transition is going to be rough. Really rough. Well, what I’d like to address today is how this might effect what we commonly refer to as money. (this article continues for subscribers through the membership gateway, on the right side of this page)

Let’s recall that deflation leads to reflationary policy, which triggers inflationary pressures that then crush the real economy–leading to more deflation. The policy response? More reflationary policy. And so on. This is the doom-trap the United States has fallen into since the year 2000. The problem is that we keep fiddle-diddling with monetary and fiscal policy without putting into place industrial, transport, and energy policy. Adam Smith’s invisible hand which magically organizes the economy and which transitions everything smoothly between different eras does not always work. Unless, of course, one believes the Crash and Rebirth dynamic is also natural, and therefore a good thing. And maybe it is.

A significant stock market rally is a prerequisite, in a collapsed economy, to a bout of hyperinflation. While I’m still not ready to sign on to any hyperinflation call just yet, let me say two things about the phenomenon. One, an economy can easily experience a hyperinflation that is less than the magnitude of the kind unleashed in Wiemar and Zimbabwe. For example, Israel experienced just such a hyperinflation in 1982-1985 and I happened to be there to witness it. So don’t let polemical debaters snooker you with their false dilemma arguments: there is a ton of inflation risk that exists well before one reaches the most extreme historical examples of hyperinflation. The deflationistas will try to bury the discussion of inflation risk by casting everyone as silly, Weimar hyperinflationists. Don’t let them do it. Secondly, the US economy has so much spare capacity, so much unemployment, and so much classical debt deflation that the route to hyperinflation here is rather singular: it would have to come through the currency, and the currency alone. But that should give no comfort.

The model portfolio is currently positioned quite well, for these eventualities. We are now on watch, for example, to track the way in which market fear expresses itself …(this article continues for subscribers through the membership gateway, on the right side of this page)