Why Gold Is Headed Much Higher

By Michael Pento
At Gold Eagle
November 24, 2014

gold price risingWhat really drives the price of gold? Some say it’s a fear gauge. Others prefer to look at the demand coming from the Indian wedding season. But the silliest of all conclusions to reach is that the dollar price of gold should be determined solely by its value vis-à-vis another fiat currency.

The truth is the primary driver of gold is the “intrinsic value” of the dollar itself, not its value on the Dollar Index (DXY). The “intrinsic value” of the dollar can be determined by the level of real interest rates. Real interest rates are calculated by subtracting the rate of inflation from a country’s “risk free” sovereign yield. Right now the level of real interest rates in the U.S. is a negative 1.55%.

A key factor is to then determine the future direction of real interest rates. The more positive real rates become, the less incentivized investors are to hold gold. And the opposite is also true. The more negative real rates become, the more necessary it is to own an asset that is proven to keep pace with inflation. The Fed has threatened to begin lift off from its zero interest rate policy in the middle of next year. However, the Fed has made it clear that it will only raise nominal yields if inflation is rising as well. Therefore, there is no reason to believe real interest rates will rise anytime in the near future.

The “intrinsic value” of the dollar is not rising; and most likely will not increase for the foreseeable future. The dollar is only rising against other currencies because the value of those currencies are being pummeled by their central banks to a greater extent than our Fed. The weightings in the DXY favor the performance of the dollar against the euro and the yen. Therefore, just because the nations of Europe and Japan are determined to completely wreck their currencies does not mean that the “intrinsic value” of the dollar is improving or that the dollar price of gold must go down. In fact, holders of the euro and yen should be more compelled to own gold than ever before.

The sophomoric view held on Wall Street is that gold must go down if the dollar is rising on the Dollar Index. Their specious argument is that it’s more expensive to buy gold because of the dollar’s strength, and therefore demand for the commodity must decrease. However, this argument completely overlooks the increased motivation to buy gold emanating from the continued attack on the yen’s “intrinsic value” by the bank of Japan. For example, real interest rates in Japan are a negative 3% and are promised by the Bank of Japan to keep falling. Japanese citizens should be scrambling to own gold in this scenario even if it will take more yen to buy an ounce of gold. And from all evidence available demand for the physical metal remains strong.

  • Supply demand metrics for gold are currently favorable.
  • Central bank demand increased to 335 tons so far this year, up from 324 tons in 2013.
  • Investment demand is up 6% YOY, while supply was down 7% YOY in Q3.
  • Nevertheless, gold is down about $100 an ounce YOY, and
  • Gold mining shares have plummeted by about 30% during the same time period.
  • This is due to short selling of gold futures by banks that wish to see the gold price lower.

In the short-term financial institutions may be able to manipulate gold prices lower, as they bring to fruition their self-fulfilling prophesies.

However, in the long run there exists three great risks to markets and the global economy in general that will be very supportive for gold:

  • A collapse of the yen that becomes intractable;
  • spiking interest rates in the United States due to the Fed’s unwillingness to get ahead of the inflation curve; or, more likely,
  • a significant weakening in U.S. economic data that puts serious doubt in the sustainability of the recovery and corporate earnings growth.

At least one of these events is guaranteed to occur because the free market price discovery mechanism has become completely abrogated and has been replaced by government manipulation of all asset prices. When these massive bubbles break it won’t be so easy to put them back together again because central banks and sovereign balance sheets are already at a breaking point. Therefore, the recovery won’t be as easy to engineer like it was back in 2009.

Equity prices have been propelled to record highs by the money-printing frenzy of central banks. And the Fed Funds Rate is near zero percent, instead of a more normal 5%. The total debt in the United States is near an all-time record 320% of GDP. U.S debt is up $7 trillion (14%) and global debt has increased over $30 trillion (40%) since 2008. Most importantly, the record amount of debt has been coupled with interest rates that have been artificially manipulated to record lows around the world for the past six years and counting.

This is why I know it will all end very badly once interest rates normalize. Regardless of bank manipulations and the BOJ’s kamikaze mission to commit Hara-kiri with its currency, gold will be an increasingly-necessary asset to own. Especially after this current illusion of prosperity comes crashing down.

You can learn more about the coming economic chaos by getting a free trial subscription to my Mid-week Reality Check podcast located at www.pentoport.com.

Michael Pento is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”

How to spend our money?

Middle Class: 10 Years Ago And Now

By Fiona Ho 29 October 2014

Once upon a time, being middle class draws on the rosy notion of a family with a nice house, who drives a Volvo, goes on beach or skiing vacations once or twice in a year, sends their kids to college, and lives a generally carefree and comfortable life.

Unfortunately, as living costs continue to rise and salaries struggle to catch up, the term “middle class” seems to have taken on a new and greyer meaning in recent years.

In Malaysia, middle class is loosely defined by those who take home a monthly income of RM3,000 and above. Government data from the year 2012 showed that 27.8% of households in the population of 30 million earned between RM3,000 and RM4,999 a month.

BIG_House Price RM v GoldAbout 39% of households fall below that income bracket. Meanwhile, the upper middle class and highest income groups – households earning RM5,000 and above, account for 33.6% of households.

Although there has been a steady increase in income, the amount is hardly significant enough to match the country’s soaring inflation rates, driven by aspects such as rising electricity costs, and subsidy reduction in fuel and sugar prices.

Prices of consumer goods are also expected to increase when the Goods and Services Tax (GST) come into force in April 1, 2015.

Economists and academics reiterate what most of us already know: the term “middle class” no longer has the same connotation as having a comfortable life as compared to 10 years ago. In fact, with many in the income stratum now struggling to make ends meet, middle class may well have become the new poor.

Let us have a look at the prices of some of our daily essentials in 2004 and now.

1. Fuel prices


A leading indicator of inflation is the hike in fuel prices. In 2004, RON92, a lower-octane petrol was available at RM 1.38 per litre.

The fuel was later found to be not environmentally-friendly and RON95 was subsequently introduced to the Malaysian market in 2009 at RM1.75 per litre.

RON95 has seen substantial incremental rises over the years. Most recently in October, the price of RON95 was raised from RM2.10 to RM2.30 per litre. This came just a little after a year it was raised from RM1.90 to RM2.20 per litre in September 2013.

The Domestic Trade, Cooperatives and Consumerism Ministry said the reduction of fuel subsidy was necessary for the Government to keep to its subsidy rationalisation plan.

But this means that Malaysians are now paying an average of 60% more for fuel compared to 10 years ago. For example, in 2004, if you own a sedan with a fuel tank capacity of 50 litres, you will need to pay just RM69 for a full tank. Meanwhile, if you own a sedan of similar tank capacity in 2014, you will need to fork out RM115 for a full tank.

Urban dwellers have it worse as highways grow increasingly congested due to rapid urbanisation and infrastructure construction works, such as the Mass Rapid Transit (MRT) project. People are also living further away from the city centre due to lower property prices and are hence, required to clock in more mileage on the road.

High-income earners with monthly income of RM10,000 and above will also have to start paying for the market price for RON95 at RM2.58 per litre once the petrol subsidy rationalisation mechanism comes into force in June. Meanwhile, those earning between RM5,000 and RM10,000 per month will get a partial subsidy, and those earning below RM5,000 will receive full subsidy.

The mechanism might involve the use of MyKad or other formal documentation, and is still being refined by the Finance and the Domestic Trade, Co-operatives and Consumerism ministries. However, details such as full and partial subsidy rates have yet to be finalised.

2. Property prices


There is no denying that the prices of property have skyrocketed in recent years. Statistics show that property prices in the Klang Valley has been rising between 15% and 18% per annum.

These days, a 1,000-square-foot condominium unit in prime locations like Petaling Jaya or Kelana Jaya can easily command the starting price of RM550,000.

With soaring home prices, coupled with dwindling purchasing power, it is no wonder that many middle-income earners are now part of the “homeless generation” – middle-class young working adults who are unable to afford their first home.

Theoretically, with RM550,000 you will only be able to purchase a property of about 1,000 square feet today. But back in 2004, you will be able to fetch a cool 2,500 square feet double-storey terrace with the same amount.

Recent adjustments in interest rates and maximum loan tenures also mean that the homebuyer now has to pay a heftier monthly home instalment. In 2014, when you purchase a RM550,000 property, with 4.45% interest over a maximum 35-year loan tenure, you will need to fork out at least RM2,539 every month.

Back in 2004, a RM550,000 property will only cost RM2,104 a month, with 3.54% interest over a maximum 40-year tenure.

The bad news is, property prices are expected to go up even more once GST is implemented. Although housing is exempted from 6%, GST will still be imposed on various aspects of property building such as land, raw material and labour cost. The hike in material prices will no doubt manifest into higher property prices.

The Real Estate and Housing Developers’ Association Malaysia (Rehda) speculates that home prices will rise by about 2.6% margin of increase in a post-GST era.

Upcoming infrastructure projects such as the new Light Train Transit (LRT) and MRT lines is also expected to drive property prices.

3. Electricity tariffs


Power tariffs rose by an average of 15% effective January 1 this year, after Putrajaya announced in December 2013 that it had approved the increase by utility firm Tenaga Nasional Berhad (TNB).

The rates were purportedly raised as a measure to reduce Government subsidy and to boost development spending.

Consequently, the average electricity tariff in Peninsular Malaysia went up by 4.99% per kWh or 14.89% from the 2011 average rate of 33.54 sen/kwH.

According to the Energy, Green Technology and Water Minister Datuk Dr Maximus Johnity Ongkili, consumers do not have to worry as 70.67% will not be affected by the tariff hike. Only consumers who use electricity at a rate exceeding 300kWh a month will be subject to the hike.

However, statistics show that the average two-storey and air-conditioned household in the Klang Valley consumes up to 714 kWh every month.

With 60% increment in power tariffs over the last decade, an average household will now have to pay an estimated RM294.04 a month compared to just RM108.79 a month in 2004.

4. Food items


We, Malaysians love our sugar. We have it in our teh tarik, our tea-time snacks, and our sumptuous and diverse assortment of sweet and savoury desserts. So it is no wonder that Prime Minister Datuk Seri Najib Tun Razak drew some bitter reactions when he announced that the sugar subsidy of RM0.34 per kilo will be abolished during Budget 2014.

Sugar prices went up from RM2.50 to RM2.84 per kilo this year – that’s a 96% increase from sugar prices in 2004, which stood at only RM1.45 per kilo!

Besides increasing public coffers, Datuk Seri Najib said the removal of sugar subsidy would help tackle some prevalent health problems faced by many Malaysians, including diabetes and heart disease.

While sugar itself is not a food item, it is a kitchen staple and input in many food products. A hike in sugar prices has no doubt, created a multiplier effect on the cost of living, as evidenced by the price increments in food and drinks following the announcement.

With the huge quantum in sugar price hikes, it is hardly surprising that your cup teh tarik that used to cost RM0.80 some 10 years ago, now costs you RM1.20.

With many already struggling to cope with the high cost of living, the subsidy cut has forced many to further tighten their belts.

With the examples highlighted above, a middle-class family today may be spending well over RM3,065 a month just on these basic essential items — car repayment, contingency saving, retirement fund, insurance premium, and other living expenses not included.

These days, given the rising prices of everyday essentials and petrol hikes, the term middle class may simply mean owning a too-small condo you can barely afford, living from pay cheque-to-pay cheque, worrying sick about putting your children through school and surviving on RM8 “economy” rice.

A Signal Of Coming Collapse

A Signal Of Coming Collapse | Gold Eagle.
Keith Weiner November 6, 2014

I proposed seven drivers of financial implosion in my dissertation. My recent writing has focused on two of them. One is the falling rate of interest on the 10-year government bond. As interest falls, the burden of debt rises. Since the falling rate incentivized more and more people to borrow, the number of indebted people, businesses, corporations, and of course governments is large. When the rate gets to zero, the burden of debt becomes theoretically infinite.

In the US, the downward trend is still in a deceptively mild phase (though there was a vicious spike down on Oct 15 to 1.87%). The rate on the 10-year Treasury is 2.3% today. In Germany, it is down to 0.82% and in Japan the metastatic cancer is much closer to causing multiple organ failures, with a yield of just 0.46%.

Two is gold backwardation, which has also been quiescent of late. Although it is worth noting that with these lower gold prices, temporary backwardation has returned. The December gold cobasis is over +0.2%).

I haven’t written much about a third indicator yet. What proportion of government bond issuance does the central bank have to buy? I theorized that when the central bank is buying all of the bonds issued by the government, that this is another sign of imminent collapse. I phrased it, as with the other indicators, as a value that is falling. Collapse happens when it hits zero, if not earlier. Here is what I wrote:

“the average amount of new Treasury bond issuance minus new central bank Treasury bonds falling towards zero (i.e. the central bank is buying a greater and greater proportion of Treasury bonds issued).”

Bloomberg recently published an article about the Bank of Japan’s announcement of a new bond-buying program. Bloomberg presents two facts. One, the Bank plans to buy ¥8 to ¥12 trillion per month. Two, the government is selling ¥10 trillion per month in new bonds. This is an astonishing development.

The Bank of Japan will buy 100 percent of the new government bond issuance.

Popular theory holds that a currency’s value falls as the quantity issued rises. In this view, the yen falls as the yen supply increases. While admittedly not scientific, here are graphs of the Japanese yen supply and the price of the yen in dollars from 1970 through present.

japan money supply

The yen has been falling since 2012, but not because of its quantity. It has been falling because the market is questioning its quality. One way to do this is to borrow yen, trade the yen for another currency, and buy an asset in that currency. This carry trade is equivalent to shorting the yen. So long as the yen is falling, and the interest rate on the bond in the other currency is higher than the interest rate paid to borrow the yen, this is a good trade.

What happens as the yen falls faster? Contrary to populist economics, it’s not good for Japanese businesses. However, it is a free transfer of wealth to those engaged in the carry trade. They can repay the borrowed yen at a cheaper and cheaper cost. When the yen goes to zero (which may take a while to play out), their debt is wiped out.

That’s what a currency collapse is. It’s a total wipeout of debt denominated in that currency. Since the currency itself is just a slice of debt, the currency itself loses all value. While on the surface it may seem good for debtors, it’s a horrific catastrophe. No one who understands the human toll, the cost in terms of the lives wrecked (and lost) would look forward to this with anything but dread.

The objective of my writing is to try to prevent it from happening. We need a graceful transition to gold, not an abrupt collapse like 476AD. It may be too late for the hapless Japanese. I hope it’s not too late for the rest of the civilized world.