On Target Newsletter 2019.07.13

In this issue:

  • Exciting outlook for gold 
  • Disruptive technologies 
  • Stock markets 
  • Emerging markets 
  • Breakthroughs
  • Japan 
  • Italy 
  • Syria 
  • US bureaucracy 
  • Trade war risks
  • The American economy
  • Gold 
  • Politics and investment 
  • US border invasion

Gold Makes Its Upside Breakout

Last month I reported the forecast by precious metals specialist Incrementum that if the gold price made an upside breakout beyond $1,360/80 an ounce – a key chart resistance level – then a price of $1,800 would seem to be within reach in the medium term. It could go as high as $5,000 if things go seriously wrong with the world economy..

Well, gold did shoot through that resistance level, soon trading as high as $1,439. As I went to press it was holding steady around $1,400.

There are several reasons why gold has broken out of the trading range in which it has been trapped for five years:

►Central banks were expected to move away from easy-money policies towards normal ones. But instead, they’ve reversed direction. The US Federal Reserve is now expected to cut interest rates, perhaps twice in the next 12 months. Europe and Japan seem to have abandoned plans to start tightening credit.

►The markets expected Trump soon to end his escalating trade conflict with China, claiming a “victory.” That’s still expected to happen, eventually. But no longer soon. The differences between the two sides are proving too difficult to be resolved quickly and Xi, the Chinese president, seems to be proving a much tougher opponent than Trump expected.

Although their meeting at the Osaka summit produced some moves towards moderation – a resumption of negotiations, some easing of anti-Huawei policy – the outcome was far short of a trade war armistice. The negative consequences of punitive tariffs and the technology “arms race” continue to worsen.

►Central bankers seem to be anticipating weaker economic growth, perhaps even recession. Institutional investors, nervous about the future, are buying into the safest government bonds, even though their yields are derisory, or even negative. More than $13 trillion worth – a quarter of the world’s safest (“investible”) bonds –are now trading on negative yields.

►The US dollar has changed direction. Instead of strengthening, as it has been doing for some time, it’s now in a weakening trend as the greenback loses some of its appeal for foreign investors.

A deteriorating global economic outlook, the prospect of lower interest rates, a falling dollar, and rising risks of armed conflict in the Mideast — all reasons making gold a more attractive investment.

UBS, the Swiss bank, reckons that “the opportunity cost of holding a gold position is declining, while the case for diversification and having a safe haven is increasing.”

Demand for gold could be tempered by a reprieve in trade tension between America and China, but other factors should continue to support it. Since the first quarter of 2015 central banks in China, Russia, India and Turkey have boosted their gold holdings by two-thirds to almost 5,000 tonnes. China has just raised its pace of official gold purchases from 10 tonnes per month to 15.

The longer-term outlook for the yellow metal is encouraging, and could even be spectacular. Casey Research analyst Nick Giambruno offers these reasons why…

► Gold’s official role in the international monetary system has been upgraded for the first time in decades. In April the Bank for International Settlements introduced its updated Basel Accords, a set of recommendations for regulations that set standards for the global banking industry. Banks can now, in certain circumstances, consider physical gold they hold as a zero-risk asset. Previously, some element of risk had to be assumed and provided for.

For half-a-century central bankers and mainstream economists have ridiculed gold and tried to downplay its role in favour of fiat currencies such as the US dollar. The change in the way the metal should be accounted for “signifies the start of a reversal in attitude and policy.” It’s a step towards the remonetization of gold, recognition that it’s “real “ money… “a form of money that is far superior to rapidly-depreciating paper currencies.”

► For the first time in generations, nations are again treating gold as money. Central banks, the biggest actors in the global market, have changed from being net sellers of bullion to being net buyers. Last year central banks bought a record 651 tonnes – the highest level of net purchases since 1971 when president Nixon closed the “window” that allowed foreign holders to cash in their gold for dollars with the US Treasury at an attractive fixed price.

Russia dumped nearly $100 billion of American government securities in 2018, reinvesting most of it in gold. If this trend continues, Russia will soon become the country with the world’s third biggest holdings after the US and Germany.

A major reason for its gold purchases is to reduce reliance on US dollar assets and exposure to US politics-driven financial sanctions. It and other countries such as Turkey, Iran and Venezuela are now conducting business and settling trade contracts with gold shipments… which aren’t subject to control by the US administration.


The red dragon aims to become a golden one

► China is seeking to use gold to finance its huge imports of oil (also threatened by American sanctions). Last year a Shanghai commodities exchange introduced a crude oil futures contract denominated in Chinese yuan. For the first time since the Second World War, this allows for large oil transactions at prices not set in dollars.

China has explicitly linked the crude futures contract to ability to convert yuan credits into gold. {Shanghai is already the world’s largest physical gold market).

CNBC estimates that the amount of oil money redirected by China will eventually hit $600-800 billion (currently the world gold market is only $170 billion). At current prices, China is already importing oil equivalent to about 442,000 ounces of gold every day.

► Since 2016 the US Federal Reserve, America’s central bank, has been trying to “normalize” monetary policy by raising interest rates and buying fewer government bonds. Trouble is, this move terrified the stock market, which plunged more than 19 per cent in December. That spooked the Fed into an abrupt change in monetary policy. No more tightening; a return to “quantitative easing” (money printing); and zero, perhaps even negative, interest rates.

Such moves will weaken the dollar – and be good for gold. “The Fed has turned a major headwind for the gold market into a tailwind.”

► There’s now a takeover frenzy in the gold mining industry. The world’s largest mining companies are pouring billions into mergers and acquisitions. Blockbuster deals such as Newmont’s takeover of Goldcorp and Barrick’s buy of Randgold show that the biggest players think that gold, and gold stocks, are cheap.

► President Trump is a big fan of gold. In the past he’s made a success of investing in it. He favours bringing back the gold standard (gold backing of currencies), which he says would be very hard to do, “but boy, would it be wonderful.”


Putting gold bugs in charge of America’s financial system

He’s acting on his instincts by seeking to nominate pro-gold governors for the American central bank. “Looking to stack the Fed with pro-gold people is unprecedented in recent history.”

► Socialism is on the rise in US politics. A recent poll showed that half of all millennials now prefer it and communism to capitalism… and they’re the largest demographic group. Left-leaning economists, politicians and policy wonks all favour MMT (Modern Monetary Theory), “the same economic quackery” that’s brought misery to other countries.

“America’s embrace of socialism will lead to more money printing and currency debasement, just as it has everywhere else it’s been tried.” But the more that happens, the more it will make gold attractive.

► A new catalyst for the yellow metal is cryptocurrencies backed by gold. Dozens of them are sprouting up.

“With cryptos redeemable for gold we can now instantly send anyone anywhere in the world small or large amounts of gold, reliably and without interference,” Giambruno says. “Gold-backed cryptos are going to make using gold as money even more convenient for the average person and business. Anyone with a cell phone now can use gold in a way that was not possible before. It’s nothing short of a monetary revolution.”

Any one of these eight catalysts alone would be great news for gold. But the fact that they are all converging at the same time means “an epic gold bull market is on the menu.”

Does it make sense to invest in gold mining shares rather than physical metal? Eoin Treacy of FullerTreacyMoney deals with this point…

Gold shares massively outperformed in the early part of the last bull market. They had a lot of leverage to the gold price because mines had not been able to invest in new supply for years and were running very tight operations. The focus was on survival rather than expansion.

As profits rose and confidence improved, the majority of gold miners went on a spending spree in an effort to replace depleted reserves. That erased their free cash flow and loaded their balance sheets with debt. Gold miners’ performance relative to gold peaked in 2003 and investors moved on to ETFs and leveraged products.

The downtrend for gold prices from 2011 was disastrous for gold miners and the ratio trended downwards to post new lows by late 2015. That represented a painful process of rationalization for the mining sector, with many expansion plans being shelved.

With the nominal price of gold finding support in 2016, miners popped back to outperform for the first time in more than a decade.

This is the point in the cycle when we can expect miners to offer leverage to the gold price. They are still shy about spending on expansion and banks won’t lend them the money even if they were. As long as M&A activity predominates, the supply situation will remain relatively unchanged. It is when big spending plans appear for new greenfield projects that investors need to be particularly wary.

The ratio of gold miners to gold itself rallied over the last month to break the more than year-long sequence of lower rally highs. That suggests a period of miner outperformance is beginning again.


Investing in Disruptive Technologies

Every day I spend several hours on my laptop researching information from across the world, using programs to analyze data, and capturing in a form transmittable at touch of a key to hundreds of readers. I can undertake banking and investment without ever having to visit bank branches or my stockbrokers in Britain, Singapore or South Africa. I can do all this in the comfort of a room in which airconditioning shields me against the heat of a tropical climate. And when I venture outside, I can access instantly an encyclopaedia of knowledge and available services via my smartphone.

All of these conveniences of living did not exist when I was young. Or if they did, were at such an early stage of development that they weren’t readily available to me.

Today all of us enjoy the enormous benefits of technological breakthroughs of past generations of scientists and engineers… made over centuries. Think of the steam engine, introduced commercially in 1780, which made possible the industrial revolution; of the internal combustion engine (1860), the founding technology of road transportation; of telephony (1880); and of electricity (1894). In my lifetime we have seen the arrival of two “transformative” technologies — computers (1965) and the Internet (1984).

Several new ones are likely to change our ways of life fundamentally during the next decade or three. ARK Investment Management, an American specialist that manages several New York-listed ETFs focused on “disruptive innovation,” has identified five groups of technology that it predicts are going to change everything:

Artificial intelligence: Computer systems and systems will evolve able to crack insoluble problems, automate knowledge work and accelerate permeation of technology into all industries across the globe, bringing huge competitive advantages to companies whose business models are centred on data.

“They will transform not only retail, media and telecom, but all sectors in the economy, even those impervious to disruption, notably healthcare and financial services,” says ARK’s director of research, Brett Winton.

Energy storage: Declining battery costs should bring about a “Cambrian explosion” in supply of electricity. Electric vehicles “will become price-competitive with traditional cars within three years” and enabling aerial systems such as flying taxis, transforming city landscapes.

“As traditional automotive manufacturers and suppliers unravel,” oil demand will stop growing (reach an historic peak), “while infrastructure evolves to accommodate high electricity-consuming mobility business models.”

DNA sequencing: As the cost of doing this falls precipitously, gene-editing should transform chronic diseases such as cancer into curable conditions. This will change the economics of therapy (but destroy legacy pharmaceutical franchises). Advances will extend into agriculture and materials science.


Changing the economics of moving people and things

Robotics: Advances in software, sensors and actuators should enable robots to operate alongside humans in all sorts of environments. ARK expects unit costs to fall by more than 50 per cent. As capabilities increase, “robots should transform every business that depends on physical processes and workflows,” converting non-market activities such as food preparation and grocery shopping into services.

Robots that can move people and parcels from place to place should change the economics of physical movement, slashing costs of delivery and surveillance. “Autonomous taxi travel will become the norm and personal car ownership the exception, enabling new business models and increasing the velocity of e-commerce.”

Blockchain technology: “All money and contracts are likely to migrate on to open-source protocols that enable and verify digital scarcity and proof of ownership. The financial system will be forced to reconfigure and take advantage of more transparency, fewer capital and regulatory controls, and a collapse in contract execution costs. More of everything in the world will become money-like: fungible, liquid and quantified. Every corporation and consumer will have to adapt.”

Winton makes the important point that the early stages of transformative technologies have crushing impacts on incumbent providers (think of how motor cars destroyed the horse transportation business). Existing infrastructure has to be scrapped while large investments have to be made to employ the new technology. Electrification in the 1920s, for example, caused such radical changes in manufacturing that “it first placed a drag on the economy for more than a decade as businesses were forced to restructure to capitalize on the new paradigm.”

Transformative technologies are characterized by steep learning curves and rapid cost declines. ARK Investment has identified 14 such technologies that are “approaching tipping points as costs drop, unleashing demand… and spawning more innovation.” They should generate more than $50 trillion in business value and wealth creation over the next ten to 15 years.

ARK actively manages five ETFs listed on the NYSE Arca exchange and consisting of portfolios of listed stocks, focused on specific themes: introducers of tech-enabled new products or services; those related to energy, automation, manufacturing, materials or transportation; companies that are shifting their infrastructure to the cloud; those incorporating genomics in their businesses; and those engaged in fintech innovation. There are also two index-linked ETFs for Israeli technology and 3D printing.


Outlook for Stock Markets

If the US Federal Reserve weakens monetary policy quickly and weakens the dollar, we could have an extension of the current business cycle, predicts well-known analyst Felix Zulauf. The stock market will have “a medium-term low between August and October – and then a meaningful rally.” If central banks continue to ease, the rally could be a big one, “maybe back to the highs or even slightly higher in some markets into 2020.”

Thereafter, however, expect “a multi-year bear market with large swings… a very volatile environment.” As it will come off very high valuations and very high share ownership, investors can expect no capital growth over the next ten years, just dividends.

The investment environment will be very different from what it has been. Being a passive index-following investor, has been a game that has worked marvelously. But “that game is over… You have to be a market timer to play the medium-term swings; you have to be a good picker of stocks and sectors, because what will be lacking is economic growth and profit growth.

“We will have margin squeezes in the corporate sectors due to social pressures. More of the profits will go to the workers, and less to the shareholders.” With profits being squeezed and profits generally lacking growth, investors will need to pick sectors and companies that do have growth in profits.

We have entered a period of rising conflicts in trade and geopolitics, compounded by a rising economic power, China, challenging the dominating power, the US.

Europe heavily depends on what China does. “Half of its growth over the last ten 3years came from China, directly and indirectly.”

Nouriel Roubini, the economics professor at New York University’s Stern School of Business largely known for his prediction of the 2008 financial crisis, forecasts that the bilateral trade negotiations between America and China will eventually fail. “This divorce is going to get ugly compared to the divorce between the US and the Soviet Union.” Countries around the world will eventually have to choose whom to align with – the US or China.

[Donald Trump complains that in his battle with Chinese president Xi Jinping, Xi has the power “to do whatever he wants,” such as loosening monetary policy or devaluing the national currency].

Roubini, who was speaking at a Blockchain summit in Taipei, reiterated his scepticism towards cryptocurrencies such as Bitcoin. “There’s massive amount of price manipulation” in cryptocurrency trading. He was also scathing about Blockchain. “It’s the most overhyped technology ever; it’s nothing better than a glorified spreadsheet. Nobody’s using it, and nobody’s ever going to use it.”

Commenting on Roubini’s remarks, well-known analyst Eoin Treacy says: “We are heading towards a more polarized world, but the transition is going to take years. The global supply chain has been built up over 40 years. It is not going to be redistributed overnight. That is the primary reason the trade war is moving in fits and starts.”


Emerging Markets: Will They Outperform Again?

The fundamental reason for investing in emerging markets has been simple – they’re where the growth is. Hundreds of millions of their people are rising out of poverty to become middle-class. They are the main beneficiaries of globalization brought about by the Internet revolution. Barriers to entry of their products into the markets of the developed economies have largely fallen away.

Consequently, shares in the MSCI Emerging Market Index have delivered twice the returns over the past 30 years of the equivalent index for developed-market stocks.

But now the emerging-markets story is being challenged.

“The intensifying trade war between the US and China has shone a light on a worrying long-term trend,” reports the FT. “The forces of global growth that boosted so many emerging economies – trade, supply chains and the commodities supercycle – are petering out, leaving the developing world in search of a new growth model.”

There is much discussion that the growth story for emerging markets is now over, says Robin Brooks, chief economist at the Institute of International Finance. Over the past five years, although the two biggest emerging economies, China and India, have continued to surge ahead, the rest have struggled to grow. In equivalent purchasing-power terms their growth in per capita output has lagged behind that in developed economies since 2015.

Although changes in some global conditions – the strength or weakness of the US dollar, for example – are likely to impact on investments in all emerging markets, individual circumstances are likely to vary greatly, and probably become increasingly important. The quality of governance, for instance, in China and India, is very different from the quality in countries such as Brazil or South Africa.


Predicted Breakthrough Technologies

Some that are most likely to capture the headlines soon, says Bill Gates, are…

► A tiny swallowable pill connected to a tether that takes pictures inside the gut without needing anaesthesia.

► Personalized vaccines that trigger a person’s immune system to kill cancer cells.

► Artificial intelligence assistants trained to create more human-liked “organic” conversations and engage customers, not just obey commands.

► Sanitations without sewers: Self-contained toilets that can filter out bacteria and viruses and convert waste into fertilizer.

► ECG on your wrist: Smartwatches that can detect and warn against heart abnormalities before they cause a heart attack.

► Robots with the dexterity needed to complete a greater range of tasks such as helping a loved one out of bed, doing the laundry or building toys.

► A simple blood test warning against the risk of premature birth.

► Cheap and safe carbon dioxide capture from the air for use in making synthetic fuels, soft drinks and boosting plant growth in greenhouses.

► Miniature nuclear power reactors that can’t melt down or produce long-lasting toxic waste.

Ashley Viens of Visual Capitalist says while several inventions on this list are years away from becoming a reality, they “embody the vision and passion that humans share to create and explore.”


The American Economy

Paul Craig Roberts, a former top official in the Reagan administration, says the strength of the US economy is a “false reality” because statistics are manipulated to give a false impression.

One example: The widely-publicised unemployment rate looks good, but it’s defined so as to ignore millions of workers who could not find jobs and gave up looking. “If you have not looked for a job in the past four weeks, you are no longer considered to be in the work force… your unemployment does not count.

“The propagandistic 3.5 per cent unemployment rate does not include any of the millions of discouraged workers who cannot find jobs.” A seldom-reported measure that does include short-term-discouraged workers is 7.1 per cent. The independent statistician John Williams says if you add long-term-discouraged workers, the actual rate of unemployment is 21 per cent.

When the Trump administration pushed through the most significant overhaul of the US tax code two years ago, it expected a consequent boom in corporate investment, says the FT’s Richard Henderson. “Companies would put the savings from lower corporate tax rates – which dropped from 35 per cent to 21 per cent – towards hiring workers, updated old machinery, and expanding into new markets.”

There hasn’t been much of that. Capex did surge by 11 per cent the first year of the new tax regime, but this year it’s only expected to grow by 3 per cent. “The S&P 500 index continues to reach record highs, yet companies are failing to put money behind new ideas to expand their businesses.” Instead they’re channelling huge amounts — $806 billion last year – into buybacks of their own stocks to boost share prices.

The obvious reason why they’re doing this rather than investing in capex is concerns over global growth, underscored by the trade tension between the US and China. “Companies are reluctant to invest because tariffs may disrupt supply chains, pushing up the cost of production and eroding the effects of fresh outlays of capital.”



Predictions: Clem Sunter, the well-known South African futurist, offers these three scenarios of what the world is likely to face:

► A 50 per cent chance of “Gilded Cage.” The world remains deeply divided, but avoids catastrophes such as a war between major powers. However global economic growth remains subdued compared to the last century, when it was boosted by free trade, free movement of people and the sharing of technology.

► A 30 per cent chance of “Forked Lightning.” There’s another crash like 2008, but deeper and longer than that one, as “there are fewer options available now to governments to re-stimulate the global economy.”

► A 20 per cent chance of “Bloodbath.” Things go pear-shaped and lurch out of control. Wars break out in the Mideast and Korea. It is unlikely that the US will use nuclear weapons, but nevertheless millions of people could die.

Japan: Its government has suppressed an official report that admitted the nation’s pension fund won’t be able to meet its liabilities to an exploding population of retirees, and advised people to save their own money to pay for retirement. It warned that a notional retiree household would need extra savings equivalent to $186,000 on top of their national pensions to pay for another 30 years of living.

Already there are only two workers paying into the pension programme for every retiree and the ratio is getting worse every year as Japanese live longer than almost anyone else but have one of the lowest birthrates. Japan’s population is shrinking, but its AGED population is exploding. Already it has the world’s biggest percentage of people over the age of 70.

LNG: If the US and China do eventually conclude a trade deal, a key part of it could be big Chinese purchases of American LNG (liquefied natural gas)… “a win-win deal,” Morgan Stanley suggests. If China procures 75 per cent of its incremental LNG needs from the US in 2025 — plus/minus 40 million tons a year — it could reduce the trade deficit by about $17 billion a year. As US gas prices are “very competitive,” such a purchase could save China about $1.8 billion a year in energy costs relative to other sources of supply.

If there is no trade deal, China will probably meet its growing gas needs from existing suppliers such as Russia and Australia.

Asia: It’s where the growth is, but it’s also where true value lies, says British fund manager Tim Price. It’s possible to buy shares in fast-growing businesses “on multiples simply unavailable in the Anglo-Saxon markets.” For example, “every single one of our top ten Vietnamese company holdings generated a return on equity… last year of over 16 per cent. The best performer generated a return of 49 per cent. But every single one trades on a price-to-earnings ratio of less than ten times.”

Tim is co-manager of the VT Price Value Portfolio, a UK-registered global fund.

British politics: The House of Commons has approved an amendment to the Climate Change Act, without even voting on the issue, committing the country to net zero carbon emissions by 2050. I liked this caustic note from libertarian commentator Christopher Snowdon: “They haven’t managed to get us out of the [European Union] after three years because some of them think it might damage the economy… but they nod this trillion-pound pig-in-a-poke through on a Monday afternoon.”

Switzerland: It’s now the best place for expatriates to live and work, according to the latest annual study by HSBC bank, overtaking Singapore. It gets top marks for earnings potential – the average Swiss salary is $111,587 – and political stability.

Debit cards: There is no justifiable reason to use one, says Eoin Treacy of FullerTreacyMoney. “They offer unparalleled access to one’s bank account with no protection, and therefore the risk is simply too great relative to the benefit.”

Credit cards, on the other hand, “are insured, often have no fees for holding the card, and can be paid off automatically at the end of the month… plus, they help to build credit [rating]. If your credit card is stolen, you have recourse to the card issuer for recompense. That is a lot more difficult to do with debit cards.”

Ivanka Trump: Her father, the US president, placed her in charge of work-force training, saying she uniquely qualified for the job because she had created “millions of jobs.” Really? The FT’s Edward Luce says that in reality her accessory companies, which she no longer manages, “created hundreds of jobs… almost all of them in China.”

Wise words:

Be fearful when others are greedy, be greedy when others are fearful.

Warren Buffett.

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