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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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)

We have a couple of models before us, with regard to the fate of the United States and the USDollar. First, there is the post-war experience of the United Kingdom, starting in roughly 1949. Second, there are the inflationary currency collapses of Latin America. More broadly, there are myriad other examples of post-Empire economic decline and other instances of price and systemic instability. Structurally the United States most resembles 20th C Latin American examples of countries that eventually devalued and repudiated their debt. However, as the US is the most recent of all the Empires then its reserve currency status is braking the fall as the rest of world remains bound to the dollar paradigm. The US has now reached the point where no realistic pathway of future economic growth exists to offset our liabilities, but that’s not merely our own problem, it’s everyone else’s too.

Of course, there’s a banality and tedium that often attends any discussion of the irredeemable USDollar, off balance sheet US spending, future entitlement obligations, and the growth of USTreasury supply. There have been warnings about these issues for at least three decades. What I believe has changed, however, is that the United States has lost the ability to leverage…(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)

One wonders that 80.00 dollar oil was indeed the breaking point, to a US economy struggling with collapse, depression, and 17% unemployment. There appears to have been a confluence of events and indicators in October that suggest reflationary policy finally kicked energy prices high enough, to then trigger the next bout of deflation. The question remains, however: how will the US currency behave in each successive round of deflation, as we slide down the descending wedge of the burst credit bubble?

In last week’s MacroTwits show and also in last week’s Macro Note, I allowed myself a rare bit of certitude: I stated unequivocally that US residential housing…(this article continues for subscribers through the membership gateway, on the right side of this page)

Excuse me but I’ll need to check your bag

The second group are the brittle deflationists, who see 60% of our current, sorry situation with ice-cold clarity but refuse even now to acknowledge the country’s currency as the governor to our ultimate outcome. In my own work I actually read a great deal of the analysis of many of these deflationists, because their articulation of the problem is so correct, so spot-on, so finely crenelated, if you will, that to ignore them would be a great error. And then, having paid their fine work the respect it deserves, I then move on to the other 40% of the problem to see the full picture. I don’t mind at all they they cherry-pick year-over-year inflation data from July of 2008 to July 2009, knowing full well they will silently ignore that same data series when the January 2008 – January 2009 data is published. That’s OK. Their long form treatment of dead shopping malls, permanent unemployment, and grands sweeps of history are well worth my time.

I have many questions for both these groups of people, but, as we head into next week’s gargantuan debt auctions, the most pressing one is this: what are you going to do about your Treasuries? And then further to this, what are you going to do with all your other assets should Treasuries start to run into trouble? You may not have noticed this week, but the recoiling in global equities did very little to improve the position of either Treasuries, or the US Dollar. It is wise to note such action. For a number of years I have gladly joined others in the dark joke of the Four Horsemen: Equities down, Treasuries down, Dollar down, Gold up. Did we see hints of the Four Horsemen this week? (this article continues for subscribers through the membership gateway, on the right side of this page.)

The US Dollar has enough structural problems already without the further weight of a kind of  pan-global assault unleashed in the past 60 days from various global players, but mostly China and Russia. The anti-dollar theme has actually been building all year. We started in mid to late Winter, with tons of IMF/SDR (special drawing right) chatter, but the volume has picked up this summer and seemed to culminate at the World Economic Forum last week. Martin Wolf was quite blunt: “The US is going to default through inflation,” he declared, likening the prospect to President Richard Nixon’s decision in 1971 to unilaterally pull out of the Bretton Woods system of fixed exchange rates, which some analysts argue was a de facto default on U.S. debts. The week ended with Putin of Russia criticizing the US for “an uncontrolled issue(ance) of dollars”, and this came only a day after a fairly meaningful concession to Russia on the issue of Eastern European missile shields.

Amidst all the complexity however the main thrust of the problem is quite straightforward: (this article continues for subscribers through the membership gateway, on the right side of this page.)

The reflationary blast-off continues but note that the model portfolio …(this article continues for subscribers through the membership gateway, on the right side of this page.)