Euro Pacific Brokers’ Corner

Germany Under Pressure To Create Money

europac admin — Tue, 07 May 2013 18:05:35 +0000

By:

John Browne

Tuesday, May 7, 2013

Currently, central banks around the world are walking in lock step down a dangerous path of money creation. Led by the Federal Reserve and the Bank of Japan, economic policy is driven by the idea that printed money can be the true basis of growth. The result is an unprecedented global orgy of currency creation. The only holdout to this open ended commitment has been the hard money bias of the German-dominated European Central Bank (ECB). However, growing political pressure from around the world, and growing dissatisfaction among domestic voters have shaken, and perhaps cracked, the German resolve. While German capitulations in the past have been welcome occurrences, in this instance the world would be better served if the Germans could stick to their guns.

Last week the statement issued by the Federal Open Market Committee (FOMC) put to rest any expectations that Quantitative Easing in the United States would be coming to an end anytime soon. With an ambiguous, but decidedly dovish statement, the stage appears to be set for an expansion of the $85 billion per month program. The statement further obscured the criteria that the Fed is supposed to rely on to begin a winding down of the program, leaving market participants increasingly uncertain.

Trying to outdo the Fed itself, the new leaders of the Bank of Japan have thrown all monetary prudence to the wind. Also, in just a few months Canadian Mark Carney, a dyed-in-the-wool Keynesian, is set to take the helm at the Bank of England. Taken together, these intentions would suggest that the world is set to take monetary expansion to a new level. The odd man out has been the ECB, which had long been dominated by the Germans. Over the past few years, the ECB has elicited the ire of Keynesian economists by offering to deliver fresh liquidity only in exchange for promises of fiscal restraint by the troubled Eurozone members. However, the massive pressure currently being placed on Germany appears to be overwhelming its resistance.

Within the seventeen member nations of the Eurozone, there are now some nineteen million unemployed, or 12.1 percent. In Greece, the unemployment rate is 27.2 percent; in Spain 26.7 percent; and in Portugal 17.5 percent. On the other hand, unemployment in Luxembourg is 5.7 percent; in Germany 5.4 percent and in Austria, 4.7 percent. This disparity is clear and increasingly affects politics. These tensions have resulted in a string of electoral victories by left wing parties in the southern tier. However, despite their resentment of the ECB, IMF and Germany, all have expressed a strong wish to remain within the Eurozone. (They seem to know which side of their brioche is buttered).

But the peoples of the northern core countries have begun to chaff at the yoke. The average German sees continued bailouts as a means to reward and support what they believe to be a slothful, and politically corrupt, southern fringe. As the crisis drags on, their previously ‘liberal’ impulses of support are giving way to deep resentment. Political parties calling for strict controls of bailout funding and immigration are growing in Germany, the Netherlands and even France.

However, the German elite has long seen the EU as an opportunity for acquiring the empire Germany has for so long desired. Historically, empires are paid for in treasure and blood. The carnage of two world wars may have dimmed their enthusiasm for blood, but it appears that the German elite are prepared to pay for a Eurozone empire with treasure alone. But with their own population unwilling to pay more for direct bailouts, and the indebted countries unwilling to tighten their belts, increased monetary flexibility may be the only means open to the Germans to maintain union.

Last week, EU growth projections were reduced by a further 0.1 percent to a negative 0.4 percent. Facing this grim reality and shrinking resistance from the dominant Germans, the EU bureaucracy appear to be becoming more lenient. Mr. Olli Rehn, the EU’s economic chief, had been expected to grant waivers of one or even two years for Spain, France and even the Netherlands to reduce their debt to less than three percent of GDP. And right on cue, the French finance minister declared just this past weekend that the “era of austerity” had come to an end by announcing that France would no longer abide by prior Eurozone debt limits in exchange for ECB bailout funds.

As a result, it appears likely that the ECB will begin falling into step behind the Fed and the banks of England and Japan to dispense substantial QE. With all of these central bank oars pulling in the same direction, I would expect an asset boom with financials, commodities and real estate rising strongly once again. Should that boom continue, expect the financial elite to celebrate unabashedly. This week, Bill Gross, the head of the massive Pimco investment firm nicely summed up the sentiment, "Pimco's advice is to continue to participate in an obviously central-bank-generated bubble.''

I would remind all who would follow such advice to recall that the last two central bank-financed booms (Dotcom and Real Estate) were brought to an end by spectacular collapses. The chances are that the next asset class to experience a similar trajectory could be fiat money itself. The fall of currency will be much more significant than falls in stocks or real estate.

Although we may all be very glad that the Germans of 70 years ago could not hold the line in Normandy, we may regret that their grandchildren could not resist similar international pressure on their monetary empire in Frankfurt.

John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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Gold Recovers Amidst Uncertainty

europac admin — Thu, 02 May 2013 18:37:30 +0000

By:

John Browne

Thursday, May 2, 2013

The selloff in gold that captured the world's attention in mid-April has revealed some truths about how the market trades and the sentiments of many of the investors who have piled into the trade over the past few years. While the correction does highlight a higher degree of uncertainty than many of the most ardent gold advocates had anticipated, it does not represent the historic "end of an era" reversal that the many in the media have so gleefully suggested. In many ways, the market has shown a resiliency that its detractors do not understand.

Traditionally, investors buy gold for three primary reasons: as a hedge against inflation, as insurance against economic catastrophe and as a medium for speculation. Lately the mainstream investment establishment, and the media outlets that slavishly follow their pronouncements, have attempted to make each group question their resolve. During the attack many blows were landed, but fortunately no knock outs were scored.

In most developed countries inflation has been reported to be far below the predictions made by the monetary hawks. Keynesian worries about deflation have even shouted down the risk of inflation as the most imminent monetary threat. Simultaneously, surges in stock markets in the United States and Japan, and improvements in the U.S. housing market, have boosted consumer confidence and have convinced many that the global economy is in the midst of a strong and stable recovery. Lastly, after more than a decade of largely steady gains, a cessation of gold's upward momentum created a variety of technical patterns that convinced short term speculators that a gold sell off was imminent. These predictions became self-fulfilling when the largest Wall Street firms lowered their mid-term price targets. Media outlets descended upon these developments like a pack of hungry wolves, resulting in the most serious sell off in gold in nearly five years.

Between April 1 and April 15, gold declined more than 18%. Many observers had pointed to the generational collapse that occurred to gold in 1980 and ignored similar gold sell offs in 2006 and 2008 that led to fairly rapid recoveries. However, the metal stubbornly refused to follow the script that was being written. The fall stopped abruptly and gold has recovered almost 10% since mid-April. So are we seeing a "dead cat bounce" of a dying asset class, or will gold resume its ascent?

Today, we are witnessing an epic, international struggle between the natural forces of a deflationary recession pitted against the inflationary forces unleashed by the monetary expansionism by three of the world's most important central banks: the Fed, the Bank of Japan, and the ECB. This struggle is reflected in market volatility and uncertainty, which I believe will persist for some time.

Global Quantitative Easing (QE) initiatives have now injected a staggering $10 trillion of new fiat currency into the global economy. By definition, these moves are inflationary but the economies of the debtor nations are so unpromising that the bulk of QE cash has been hoarded as bank deposits, thereby blunting the inflationary impact. The camouflage that low official inflation statistics currently provide has blinded investors to the likelihood of future inflation.

In March, the gold market received another unforeseen shock. The sovereign crisis in Cyprus raised the prospect that the country would be forced to sell its gold reserves to meet its debt obligations. Although Cyprus has only 14 tons of gold, investors fear that such liquidation sales could herald larger sales by troubled Eurozone nations like Portugal (382 tons), Italy (2,452), Greece (112), Spain (282) and even France (2,435 tons). Taken together, these countries account for some 18 percent of all central bank held gold. This potential overhang encouraged further sales by speculators. However, as Peter Schiff pointed out in an article earlier this month, fears of a central bank sell off fail to consider the potential actions of emerging market central banks.

Central bank QE targets continue to twist and change creating added investor uncertainty. Furthermore, the U.S. Bureau of Economic Analysis (BEA) announced future changes in its method of calculating GDP (see commentary). By including corporate expenditures on R&D, TV, movies and Government 'promises' of future pensions as 'investments', GDP will be boosted synthetically. This will help serve to maintain the illusion of health, thereby keeping the gold market off balance.

Meanwhile, the Fed has 'persuaded' the Central Bank of Japan to enact limitless QE. In July, Mark Carney, reputed to be a Bernanke style monetary expander, takes the helm at the Bank of England. This adds to the political pressure being brought on Germany to drop or at least dilute its austerity medicine in favor of possibly even more massive QE by the ECB. Finally, rumor indicates that Janet Yellen, a super Keynesian, will succeed Ben Bernanke as Chairman of the Fed.

It appears that the major central banks will follow the Fed in creating limitless synthetic fiat currency. Like inflating a balloon, at some stage, the skin is stretched to the point where a rupture is inevitable. The trust placed by the world's savers is analogous to the skin of this particular balloon. Should it burst, both the price increases and economic uncertainty long heralded by gold investors may arrive with stunning force. Should that happen, the momentum traders will pile back into the market and gold may reach new heights.

If confidence in the current monetary system persists intact, and is combined with continued evidence of economic weakness (and seemingly antithetical stock market momentum), it is possible that the price of gold will suffer another leg down. Under the right circumstances it could fall below $1,300. While the tug of war between inflation and confidence in fiat money may persist for some time, the weight of history will eventually come down against paper. It always has, and it always will.

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Cypriot Chaos Assists EU Centralization

europac admin — Tue, 09 Apr 2013 18:47:42 +0000

By:

John Browne

Monday, April 8, 2013

Remarks by members of the European Union's elite suggesting that banking deposit seizures may become standard practice appear to have heightened the risk of a European bank run and perhaps even a catastrophic collapse of the euro. Any threat to the euro is a threat to the European public's conception of the Union's manifest destiny. As such, I believe members of the EU elite may be purposefully leveraging the crisis to push for a centralized European banking system to cement the political framework of an EU superstate.

Don't be fooled by the haphazard developments of the ongoing eurozone crisis; anyone with an economics background can see how this crisis will broadly play out. But rather than pursue policies to restore fiscal sanity, the EU leadership has made moves to continue its policy of the past two decades: bring as many Europeans as possible into the sphere of a centralized EU superstate. Under the pretense of democracy, the EU has expanded to 27 member nations, mostly through democratic referendums (though not without considerable backlash from wealthier, northern European nations). Some may wonder why so many countries would yield their sovereignty to a remote body of bureaucrats in Brussels.

The truth is that many of these countries (especially the ones on the periphery of Europe, with relatively little experience with democracy) received vast so-called "development" funds upon joining the EU, mostly provided by northern European nations like Germany, Great Britain, and the Netherlands. The German Constitutional Court referred repeatedly to the "democratic deficit" within the EU even as membership grew, and last year it urged the German government to make German taxpayers increasingly liable for the economic shortcomings of fellow member states.

This is unsurprising, given the fact the German citizens never even had a referendum on the EU constitution. They are thus more subjects than citizens of the EU.

When it came to the euro, Germany only accepted the currency provided it was run as soundly as their steadfast Deutsche Mark. While the euro did quickly prove weaker than the Deutsche Mark, Germans were somewhat assuaged by the boost to their exports. However, for countries like Portugal, Italy, Spain, or Greece that had been used to endless currency devaluations, the relative strength of the euro highlighted severe problems.

For years, member-states papered over these problems by borrowing money based upon the credit rating of the EU. But some of the EU banks that bought government debt became far too over-leveraged, so that in the financial meltdown of 2007-08, both European central banks and their host governments began to suffer from the toxic debt. This has continued as a serial crisis in the intervening years, and with each subsequent incident, the European Central Bank (ECB) stepped in at the eleventh hour with a solution that strengthened its grip over not only the eurozone, but every member-state of the European Union.

Ultimately, it appears the EU would like a controlling influence over the Treasuries and taxpayers of all member-states within its purview. To the frustration of the EU elite, citizens of the productive northern member-states have repeatedly resisted this subjugation. In my home country, for example, Prime Minister David Cameron has long grappled with an unhappy parliament clamoring for a referendum on EU membership.

This struggle seemed to be turning against the power-mad of Brussels... then along came Cyprus. What better way to unite the EU than a potentially catastrophic collapse of the euro?

Cyprus is small, but it has a banking system nearly five times the size of its economy. Many of its deposits are suspected of being owned by the Russian mafia, and so losing 60-100% of these deposits would cause little resentment outside Russia. However, the simple fact that such a seizure could be approved by central banks has engendered a fear of bank runs throughout Europe.

In the midst of all this, the world was astounded when Jeroen Dijsselbloem, president of the Eurogroup consortium of finance ministers, declared publicly that the Cypriot solution of making depositors and bank bondholders liable would become a "template" for future bank bailouts. After a quick and fierce backlash, Dijsselbloem officially back-peddled. But the damage was done.

In spite of Dijsselbloem's recantation, a significant amount of smart money was scared out of eurozone debt. While the Cypriot crisis appears to have been held in check, a lot of capital was transferred into US dollars and banks. You see, today, major bank runs happen for the most part not on the street, but electronically and often within minutes. They attract minimal public attention, are easily kept quiet, and the aggregate amounts transferred are known only to finance ministries and central banks.

The true magnitude of any run on Cypriot or eurozone banks is hard for outsiders to clearly ascertain. This can be used as a major weapon in cajoling EU leaders into accepting greater banking "unity" in both the eurozone and the greater EU.

Should the Cypriot crisis prove an inadequate threat to further centralize the EU banking system, then there are a number of brewing crises that might do the trick. Both Slovenia and Luxembourg have disturbingly vulnerable banking sectors worth about 130% and 2,200% of GDP respectively. And then there's the recent report from the IMF showing major selling of euros by central banks in emerging markets, where euro holdings have dropped to 24% from 31% in 2009.

All of these threats to the euro have two major impacts. In the short-term, they boost the US dollar in spite of its shockingly weak fundamentals. In the bigger picture, they become a cudgel to beat the last vestiges of sovereignty from the member-states of the EU.

In the mid- to long-term, both reserve currencies are risking losing their status to alternatives - notably gold and silver.

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Spending Patterns Paint Half Truth

europac admin — Tue, 19 Mar 2013 20:38:19 +0000

By:

John Browne

Tuesday, March 19, 2013

On March 13th, the Commerce Department announced a 1.1 percent increase in food and services retail sales, doubling a prior Dow Jones survey of economists that forecast an increase of just 0.6 percent. This new data has led to a fresh wave of enthusiastic commentaries that the US economy is set for a strong recovery. Less examined were the underlying factors that supported the increase.

Through the persuasive powers of its Chairman, Ben Bernanke, the US Federal Reserve has convinced the world’s three other key central banks – the Bank of England, the ECB, and the Bank of Japan – and many others to adopt its policies of quantitative easing (QE) to spur economic growth. By lowering the cost of borrowing and lessening the rewards of saving, I believe that these policies have led to increases in spending. But to call it a success involves only looking at one side of the balance sheet. The supposed benefits come at a high cost.

Gasoline prices rose by nearly 15 percent from January to February of this year. Spending also rose in grocery stores, which are considered to be a gauge of necessity spending. On the other hand, declines in department store, restaurant, and furniture spending would seem to indicate that consumers are cutting back in areas that economists deem to be “discretionary.”

Four years of annual trillion-dollar-plus government deficits and the Fed’s creation of more than $2 trillion of synthetic money since the crisis beganhave injected almost unimaginable amounts of “stimulus” into the US economy. In addition, the Fed’s downward distortion of the rates of interest, inflation, and unemployment is cynically designed to encourage a false sense of economic growth and economic optimism.

In view of all of this, it is absolutely amazing how listless overall consumer spending has been. I see it as evidence that other forces are holding the lid down on real increases in economic growth.

But investors are loathe to ignore such a wave of buoyancy in official government figures. The result has been an impressive recovery in US equity indices of some 125 percent since the market lows of 2009.

Bernanke has indicated that the Fed will maintain both zero percent interest rates and massive QE into the foreseeable future. We must assume that such moves will continue to create dubiously impressive trends in spending and stocks.

Prudent investors are faced with a scenario where consumers may be persuaded to extend their purchasing of necessities and replacements to more discretionary items. If that happens, it could provide welcome short-term growth to the US and other economies in the world. Also, it may justify selective investment in domestic equities, particularly necessary commodities.

However, beneath the false enthusiasm of the markets will lurk threats to the US dollar, and of a potentially dramatic rise in US interest rates. These dangers demand extreme caution, especially in light of recent double-digit percentage rises in the stock market.

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Gentlemen, Start Your Presses

europac admin — Wed, 06 Mar 2013 13:23:17 +0000

By:

John Browne

Wednesday, March 6, 2013

In his Congressional testimony last week in Washington, Fed Chairman Ben Bernanke took time to downplay the significance of the few dissenting voices on the Fed's Open Market Committee (FOMC). Those statements, combined with an even more dovish statement by Fed Vice Chairman Janet Yellen earlier this week, clearly reaffirm the Fed's indefinite commitment to $85 billion of monthly quantitative easing. (It is surprising that those figures failed to invoke the attention drawn by the $85 billion in annual cuts detailed in the "sequester"). But the stock markets have gotten the message loud and clear and are setting records on a daily basis. The apparent triumphs of the Federal Reserve in pumping up stock and real estate prices, without triggering a sell-off in the dollar or easily visible inflation, have not been lost by observers around the world.

Many have dubbed the last decade or so to be an era of easy money. As it turns out, that characterization may have been premature. Based on the new crop of central bankers who are primed to take control of the world's financial system, the age of truly easy money may be just getting started.

Many expect that when Bernanke's term expires in January 2014, he will be succeeded by the dovish Yellen. But that's just the beginning. In short order, a host of serial money printers will take up the reins at the world's most important central banks.

In January of this year Canadian banker Mark Carney, a committed Keynesian, was selected to replace Mervyn King as the Governor of the Bank of England in July 2013. Despite a native population of some 63 million people to draw from, the UK's so-called Conservative government has now, for the first time in its history, selected a foreigner to run the Bank. At a salary of some $1,200,000 a year, he will be earning more than that of the heads of the Fed and the ECB combined. Undoubtedly Carney can command such a salary because he can be relied upon to create synthetic Sterling along the lines of Bernanke. Already he is talking of increasing the UK's two percent upper inflation limit.

In a further effort to distort the value of money, the Deputy Director of the Bank of England, Paul Tucker, spoke recently of his idea to engineer negative interest rates. All this is to hold reality at bay.

Plagued by over a decade of economic stagnation, Japan has recently elected Shinzo Abe as prime minister, who has virtually promised the most expansionist monetary policy in the developed world. Shinzo made good on his campaign promises by selecting Mr. Haruhiko Kuroda as the next Governor of the Bank of Japan. He is yet another major Keynesian monetary expansionist in the Bernanke mold. The likelihood of extraordinary policy moves in Japan increased with the subsequent nomination of Kikuo Iwata for deputy governor. This week Mr. Iwata told legislators that he favors revisions to Japanese law that would require the Bank of Japan to achieve inflation targets set by the government, or face revocation of its charter. With a national debt already accounting for more than 200 percent of GDP, Japan is prepared to go into uncharted territory.

At the ECB, the well-known Keynesian monetary expansionist and creator of limitless synthetic euros, Mario Draghi, remains firmly ensconced in office. Indeed, he appears to be overcoming German-inspired austerity measures in the Eurozone. Further, the so-called 'Troika' of the International Monetary Fund, the European Commission and the ECB, appears to be retreating from its initial Germanic demands for economic austerity and stronger banks.

In retrospect, events of the past few months illustrate a serious spread of Bernanke's policies across the entire developed world. I believe that we are headed for a period of massive asset booms, followed by a debt and bank collapse of unprecedented ferocity.

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Singapore A Wise Owl Among Currency Snakes

europac admin — Wed, 27 Feb 2013 19:39:30 +0000

By:

John Browne

Wednesday, February 27, 2013

As China enters the “Year of the Snake,” Singapore stands as a beacon of sound currency in a world gone mad. China's renminbi remains pegged to the US dollar, while even steadfast Switzerland has followed the US, UK, EU, and Japan into an impoverishing strategy of currency debasement. Singapore, alone, has been able to sustain genuine economic growth in the context of a strong national currency.

The Currency Snakes

In most major economies, a corrective recession has become politically unacceptable. In order to conceal negative real economic growth, politicians and their central bankers have resorted to the irresponsible policy of excessive government spending. This is financed by unsustainable borrowing,excessive taxation, and/or currency debasement. The result is the progressive impoverishment of citizens and increasing government intrusions, dressed as ‘help’ for the needy. This places government in an ever-more dominant position over its citizens, reducing them to subjects.

The Fed’s massive QE programs, now virtually unlimited, have been imitated by the stewards of the world's other reserve currencies – and the result has been stagflation.

The EU, the world’s largest economy, saw its combined economy shrink by 0.3 percent last year, and it is forecast to fall an additional .3 percent this year. Unemployment is estimated to reach 12.2 percent in 2013. With youth unemployment in Greece at 62 percent and the mighty German economy shrinking by 0.6 percent in Q4 of 2012, Europe is primed for deep recession,possibly even depression.

The UK saw contraction for 3 of 4 quarters of 2012. Though it saw an uptick in Q3, economists are bracing for a “triple dip” recession.

Japan remains stagnant, with 3 quarters of no growth. While growth is forecast to pick up in 2013, this may simply be economists' rosy excitement over the massive stimulus announced by Prime Minister Shinzo Abe. [Read Peter Schiff's analysis of Japan's stimulus shock & awe planand what it means for the US dollar.]

USA: The King Cobra

Among the major developed economies, only the US shows positive economic growth. But official US inflation figures have been massaged covertly to the downside. Even after deflating GDP growth with the official CPI inflation rate of 1.6 percent, the US economy grew at only 2.2% in 2012.

However, Shadow Government Statistics (SGS), which calculates government figures on a basis consistent with pre-Clinton methodology, shows US inflation running between 5 and 7 percent. Averaging this to an assumed 6 percent, the US economy is shrinking by approximately 3.8 percent. [See more on the true inflation rate from Peter Schiff here.]

The Fed’s economic recovery is in fact non-existent!

Meanwhile, SGS estimates US unemployment at 22.9 percent, or some 33 percent higher than the official U-6 figure of 14.7 percent. The number of Americans on food stamps, the politically correct version of soup kitchens, stands now at 47.7 million.

Some role model...

The Wise Owl

Unlike most other developed nations, Singapore pays high salaries to its political leaders – but expects results. In 2011, when Singapore’s economy shrank, the salaries of its President and Prime Minister were cut correspondingly, by 51 and 36 percent respectively.I believe this encourages leaders to act in the national interest and eschew graft. For Singaporean politicians, it is 'no gain, no pay.'

The result? Singapore’s economy is outperforming. GDP grew by 1.3 percent in 2012, while the Singapore dollar was up 6.5% against the US dollar for the year. Unemployment has actually remained down since the start of the financial crisis, pushing below 2 percent in 2012. This figure would be a pipe dream in the West.

What's more, Singapore remains a creditor nation, with a current account balance that has remained on an uptrend for over two decades.

Clearly, currency devaluation is not a winning strategy, especially for a country with a strong balance sheet.

Bucking The Trend

The monetary doves want all nations to join the currency war. That way, they will share the same disastrous fallout without the risk of comparison. By bucking the trend, Singapore is showing the world that Keynesian stimulus and devaluation is not the true route to economic salvation.

I have no doubt that Singapore's neighbors in the Orient are taking note. If more of them lay down their printing presses and quit the currency war, the US and EU will become increasingly isolated. Neither Western bloc can afford to tighten monetary policy without an outright sovereign debt default.

As recent events unfold at increasing speed and volume, the question of financial catastrophe may not be if, but when.

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Investing In a World of Make Believe

europac admin — Thu, 07 Feb 2013 14:35:57 +0000

By:

John Browne

Thursday, February 7, 2013

In recent years, a high degree of economic, financial, and political uncertainty has resulted in acute volatility in stocks, real estate, commodities and precious metals. I believe that another aggravating factor has been the increasing skepticism through which the investing public views government statistics and statements.

To make prudent decisions, investors need to know key economic indicators such as economic growth, inflation rates, unemployment levels and the real cost and value of money. For the past 20 years or so, the key assumptions behind the calculation of these figures have been changed, or more accurately distorted, in favor of government image.

Perhaps the most important government statistic for investors is the inflation rate. The precise degree to which money is depreciating is the bedrock upon which all other financial determinations rest. The inflation rate is the prime input that determines the discount rate used for calculating the real present value of investment returns.

The basic U.S. inflation rate is published in the form of the Consumer Price Index (CPI). This purports to represent items selected to represent the spending of the average U.S. citizen. But a closer look reveals some troubling distortions. For example, health care expenditures are weighting at just one percent of spending. Americans who are struggling with obscenely high medical costs will recognize this as absurd on its face.

In addition to weightings, the actual price increases are largely arbitrary. For example, if the price of an automobile rises by 20 percent, but is 'assumed' to have added technology that equated to three quarters of the higher price, the price is deemed to have risen by only 5 rather than 20 percent. (See Peter Schiff's mid January article that shows, among other things, that the government reported newspaper and magazine prices to have risen just 35 percent over the past 12 years while actual prices rose by more than 130 percent.)

For the past few years, the Fed has maintained that the U.S. inflation rate, which is represented by the Consumer Price Index, or CPI, has hovered around two percent. Most consumers who buy food, goods and services such as health in the real world, will find this figure derisory.

However, Shadow Government Statistics (SGS), an independent data service published by John Williams, calculates key U.S. Government statistics according to the methodology used during the years before the election of President Clinton. Using those yardsticks, SGS shows the U.S inflation rate over the past few years has hovered around six percent, or three times the declared Government rate.

The inflation rate is key also to calculating the key economic growth rate, or GDP. By deflating the nominal GDP by the Government's 'official' 2 percent inflation rate, the U.S. economy shrank by some 0.5 percent in the last quarter of 2012. But if a higher, and I believe more accurate 4 percent inflation rate had been used, the U.S. economy would have been seen to regress by 2.5 percent. At that rate of inflation the paltry yields paid on bank deposits, and by 10-year U.S. Treasury bonds, are currently in deeply negative territory.

Regarding stock markets, the Dow passed 14,000 last week, to great acclaim. However, if discounted by the 'official' CPI of approximately two percent per year the Dow would have to reach about 15,400 to equal its October 9, 2007 high of 14,165. But discounted at a 4 percent per year inflation rate, the Dow would have to stand at more than 17,500 to pass its all time high in real terms.

Of course, the low inflation rate also provides the government with breathing room on the fiscal side. Low inflation keeps a limit on the increases that federal agencies are required to pay out to beneficiaries of programs such as Social Security. With the budget so tightly constrained by huge deficits, the low inflation data is essential to government planners.

More chicanery can be seen on the unemployment front. The government currently claims the unemployment rate to be at just 7.9 percent. But when calculating unemployment using the pre-Clinton methodology, SGS finds it to be around 22 percent. SGS does not exclude, as the government does now, all those who have left the workforce out of despair of finding a job, or those who who have accepted part time jobs in lieu of full time employment.

A world of politically manipulated 'official' statistics and misleading Government statements makes investment decisions more difficult. The result is that, despite falsely negative 'real' short-term interest rates and an abundance of debased cash, consumers and corporations continue to hoard cash. While the Dow has in fact surged in nominal terms, the leading U.S. equity funds continue to show significant outflows of investment funds. Rising stock prices have not convinced many Americans to get into the game. This should provide needed perspective on the current media euphoria.

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EU Financial Tax Portends Loss of Market Leadership

europac admin — Tue, 29 Jan 2013 19:53:11 +0000

By:

John Browne

Tuesday, January 29, 2013

Although it was barely noticed by the American press, on January 22nd, EU finance ministers approved a new “Financial Transactions Tax” (FTT) that has implications for market competitiveness around the world.

The move was conceived as a Franco-German initiative and was supported by seven other EU nations, including the entire bloc of highly indebted southern tier nations, to reach the minimum nine nations required to press ahead under the EU’s so-called, ‘enhanced co-operation procedures’. If at least one of the transacting parties involved is an EU resident, the tax will impose a one tenth of one percent tax (on both sides of a financial transaction) on secondary market trades in equities, bonds, securities and REPOS. Derivatives will be taxed at a lower one hundredth percent.

Although limited presently in scope and at an apparently low rate, the tax will nevertheless provide an extra layer of financial bureaucracy that will dissuade some market participants from transacting in the Eurozone. It should be patently obvious that transactional fluidity is supportive of efficient markets and ultimately of economic growth. It is only in the poisonous, anti-capitalist, post-crisis environment that such a measure could be passed. More importantly, the measure is a “supra national” tax that helps to pave the way towards a global taxation system. Not only will such a system be economically damaging, but it will be devoid largely of effective democratic accountability.

In its March 2011 tax meeting in Brussels, the EU had originally proposed a “Financial Activities Tax” (FAT), a more comprehensive, and potentially more destructive, EU-wide measure. The opposition to the tax was so fierce, most notably from Great Britain, that the FTT was proposed as a compromise.

Ignoring the role of the central banks in the financial debacle, the German Finance Minister commented lamely that, “The financial sector must appropriately participate in bearing the cost of the financial crisis.” According to the EU’s Tax Commissioner, Algridas Semeta, the FTT decision was a “major achievement for EU tax policies.” Those who believe, as I do, that the EU’s covert intent is to erode the traditional independence of the world’s financial markets, particularly the dominance of London and New York, certainly share those sentiments.

In an economic impact analysis running to over 1,000 pages, the EU Commission estimated that the FTT would raise $76 billion annually. The commission admitted that this would cause a 10 percent drop in securities transactions, a 70 percent fall in derivatives trading and result in a loss to the EU’s GDP of some 0.53 percent. All this in an EU economy struggling now to prevent a recession falling into a depression! Of course, the Commission failed to consider any resulting lost tax revenues implied by a fall in GDP.

On its face, it was clear that the idea for both the FAT and the FTT was a product of left wing ideology of soaking the so-called rich, but devoid of any real understanding of how free markets operate.

If such a tax were imposed in single country market, in the UK for instance, it would encourage a massive flow of business to other national markets. The EU must feel that its size and status will protect it from such an eventuality. Few suspect that the FTT will offer economic benefits that would outweigh the harm it will impose. But that is not the criteria by which the measure will be judged by EU leadership. What if FTT is designed not as a tax to encourage more responsible investing, but as a covert weapon to win political control of Europe?

FTT is a supra national tax imposed on top, and independent of, national financial taxes. Once the infrastructure to enforce and collect the tax is established, the tax rates can be raised relatively easily. Most importantly, once such supra national taxes are established, they suffer from very little if any democratic supervision.

EU Tax Commissioner, Algirdas Semeta, has said that the Commission has arrived at a means of levying a tax that prevents investors from relocating. The tax will be imposed on both the buyer and the seller of a financial instrument so long as either of the two parties is based within any participating EU country. This means that even investors in London or New York accustomed to paying only their domestic taxes may not escape the new tax completely.

At a time when governments should be encouraging the free flow of capital, this measure moves us exactly in the wrong direction. Combined with the heightened regulatory scrutiny in the United States (President Obama’s appointment last week of the first former federal prosecutor to head the Securities and Exchange Commission), the move bolsters the belief that the West will likely cede financial market leadership to the freer and more vibrant markets in the Pacific.

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German Gold Claw Back Causes Concern

europac admin — Tue, 22 Jan 2013 22:00:05 +0000

By:

John Browne

Tuesday, January 22, 2013

Last week the Bundesbank (the German central bank) surprised markets around the world by announcing that it will repatriate a sizable portion of its gold bullion reserves held in France and the United States. To many, the news from the world’s second largest holder of gold signaled a growing, if clandestine, mistrust among central banks, possibly fueled by diverging policy goals. The Germans have attempted to tamp down the alarm by highlighting the myriad of logistical, practical and historical reasons that qualified the announcement as unremarkable. But the size, scope, and timing of the move makes it hard not to draw more strategic conclusions.

Coming during a time of supposed central bank cooperation, the decision to withdraw billions of dollars of bullion was bound to raise eyebrows. At present, Germany has official gold holdings of some 3,396 tonnes. 1,500 tonnes resides in New York and 374 tonnes in Paris. Between now and 2020, Germany will repatriate 674 tonnes of gold – 300 from the Fed in New York (valued at $17.9 billion) and the entire 374 tonne allotment from Paris (valued at $22.3 billion). Although financial leaders like Fed Chairman Ben Bernanke have said that gold “is not money” and senior investors like Warren Buffet have described it as “a barbarous relic,” the movement of gold nevertheless makes a strong emotional impact. Is such a response justified?

Coming during a time of supposed central bank cooperation, the decision to withdraw billions of dollars of bullion was bound to raise eyebrows. Although financial leaders like Fed Chairman Ben Bernanke have said that gold “is not money” and senior investors like Warren Buffet have described it as “a barbarous relic,” the movement of gold nevertheless makes a strong emotional impact. Is such a response justified?

Following World War II, the threat of a sudden Soviet invasion convinced many Western European nations to diversify their gold holdings abroad, particularly overseas to the U.S and the UK. Today, Germany holds only 31 percent of its gold within the Bundesbank. Of the remainder, 45 percent is held at the Federal Reserve Bank in New York, 11 percent with the Banque de France in Paris, and 13 percent with the Bank of England in London. But now that the Russian military threat has dissipated, the Germans have rightly reevaluated its dispositions.

For decades, central banks have been secretive about their gold holdings. Despite this, few doubt the published aggregate gold holdings of central banks. But serious questions arise as to the precise ownership of the gold held in the vaults of central banks and some commercial banks. To the astonishment of many German citizens and international observers, the Bundesbank admitted some years ago that it had not held an audit of its gold holdings for decades, if ever. (See my prior commentary on this subject)

The developed nations of the world have adopted a form of Keynesian economics that has created a world awash with debased fiat currency supported by seemingly unsupportable mountains of official debt. In such a world, it is understandable that German citizens feel their nation’s gold should be held at home. Such sentiment could spread. Holland’s CDA Party already has asked that their nation’s 612 tonnes, or metric tons, of gold be repatriated from the U.S., the UK and from Canada.

Some question whether such sentiments will spread and expose even a shortage of physical gold in hitherto trusted vaults. In addition, in a world where trust in central banks is waning fast, central banks themselves may become mistrusting of each other.

At the same time, central banks in the developing world, particularly in China and Southeast Asia, are accumulating gold, as are nations like Russia, Turkey and Ukraine. China is now the world’s largest producer of gold worldwide, but she retains her production and even buys more on the open market. This has occurred even while no major central banks are selling significant amounts of gold. The Bank of England’s disastrous selling campaign in the early years of the current century, in which it sold hundreds of tons below $300 per ounce, is no doubt a controlling factor.

The unwillingness of central banks to part with their hoarding of gold, highlighted by Germany’s repatriation, contrasts starkly with the central bank policies of the 1970s and 1980s, when concerted efforts were made to de-monetize gold, which could only be done through active selling. Does this change reflect a growing and shared distrust of fiat currency by sophisticated private investors who hoard gold?

The repatriation of even a part of Germany’s central bank gold holdings, especially if followed by other nations such as Holland, should be regarded with concern. Today, no central bank would dare to risk rocking the central banking boat. But as the Keynesian economies have slid towards financial disaster, any increase in central bank gold repatriation could indicate a real fear by the great insiders — central banks.

A particularly interesting aspect of the announcement that has been largely ignored is the extraordinarily lengthy seven year time period in which the Germans expect to receive back their gold. The 300 tons they’re repatriating from the New York Fed reflects just five percent of the more than 6,700 tons held there. It strikes many as unusual that the Fed would need so much time to deliver what should be a manageable withdrawal.

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France and the UK Could Be the Lynchpins of Europe

europac admin — Fri, 18 Jan 2013 21:05:53 +0000

By:

John Browne

Friday, January 18, 2013

Over the past two months, Europe’s problems seem to have disappeared from the headlines. However, the new French Socialist government is pushing ahead with policies that favor significantly higher government spending, greater regulation of business and commerce, and severely higher taxes on high earners. The long term effects of these policies, which I believe will lead to further economic decline, may be given fresh scrutiny if France is drawn into a lasting conflict in West Africa as a result of its surprise intervention in Mali last week. The financial discussions that will certainly accompany a longer term strategic commitment to the region may finally make clear that one of Europe’s largest economies is heading down a dangerous fiscal path.

The pressures on France are coming at a time when internal British politics point towards increasing chances that, for the first time, the people of the United Kingdom will be given a referendum vote on their continued membership in the European Union (EU). France is a partner with Germany in the two-nation Axis which effectively runs the EU. Second only to Germany, the UK is a key provider of funding for the EU. If either France faces an economic bailout or the UK votes to leave, the EU likely will begin to disintegrate. Despite massive central bank support, the euro would threaten collapse and cause panic in many markets.

These issues should be looming large on national economies. Instead, investors and the media are focused on some signs of economic recovery in the U.S. Encouraged perhaps by the impact of the Federal Reserve’s unprecedented quantitative easing policies, which have kept interest rates near all-time lows, consumers have spent more freely in recent months. This, possibly combined with government propaganda and misleading statistics particularly regarding inflation and unemployment, has persuaded corporations to spend more. Automobile sales are up and real estate prices appear to be recovering slightly.

This seemingly good news has tabled fears of an imminent crisis. At the same time, and with fantastical schemes like the trillion dollar platinum coin attracting attention, more observers are coming to grip with America’s intractable financial shortfalls. These concerns appear to outweigh ECB president Mario Draghi’s promises to create as much synthetic euro currency as is necessary to support the sovereign debt obligations of all Eurozone member nations. As a result, the euro has staged a remarkable “return to normal” rally, gaining 7.5% against the dollar in the second half of 2012. At present the euro currency is nearing a 10 month high.

Fearing debasement of the U.S. dollar and the Japanese Yen, the euro has become a de facto second reserve currency. Indeed, the fact that the euro exhibited such strength in 2012, when the future of the Eurozone and even that of the EU was threatened, suggests the global insistence that the euro survive. But the situation in France and the UK may test this resolve.

French President Sarkozy was a Europhile. He conducted French policy in lock step support of German initiatives. However, his successor, President François Hollande, is an ardent Socialist. His policies are leading France towards a possible economic disaster on par with those facing Portugal, Italy, Greece and Spain (PIGS). Intimating that France was a potentially mortal threat to the EU, the Economist’s cover for the November 17th - 23rd 2012 issue carried the headline,‘The time-bomb at the heart of Europe.’ An open ended commitment to defend France’s former West African colonies against Islamist incursions from the Sahara could fast track a fiscal crisis. Whereas the economies of most of the PIGS were small enough to be bailed out, France has the world’s sixth largest economy. It is far too big for a bailout without threatening the economies of Germany and the UK.

The UK is a major funding source for the EU, second only to Germany. However, despite the fact that the UK is not a member of the Eurozone, the recent Eurozone banking bailouts have involved payments by British citizens via membership of the ECB and the IMF. Naturally this has proved very unpopular. Today, anti-EU feeling is running high. The United Kingdom Independence Party (UKIP) under Nigel Farage, its dynamic leader, now has taken over from the Liberals as the third political party in the UK. Indeed, it looks set to be the first UK party in the next European elections with a platform offering the UK’s withdrawal from the EU.

So while the problems of Europe appear to be contained, under the surface the problems are getting more dire by the day.

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Washington Squanders its Gift of Time

europac admin — Wed, 02 Jan 2013 15:39:07 +0000

By:

John Browne

Monday, December 31, 2012

As the clock winds down on 2012, the Fiscal Cliff is all anyone seems capable of discussing. Right now it appears that some sort of narrow deal has just emerged that will include raising tax rates on family income over $450,000 a year, increasing the estate tax rate, extending unemployment benefits for one year, and delaying spending cuts. But the prospect of higher taxes and the great uncertainty that has surrounded this fiscal fiasco has been acting like sand in the gears of the complex but sputtering U.S. economy. If additional taxes are not matched by real cuts in government spending, the economically crippling tax increases will serve merely to increase the size and intrusive power of big government. In other words, the pain will yield no gain.

But the damage to the U.S. economy will result not so much from the actual cuts and tax increases that the Cliff would involve, but from blatant dereliction of duty on display in Washington which will diminish national prestige.

To some, a loss of reputation may seem to be an ephemeral and ultimately insignificant economic cost. However, the spectacle of American politicians failing to agree on budgets, spending limits, or any type of fiscal discipline can affect the credit rating of the U.S. Over the longer term, a major fall in the credit rating is likely to increase U.S. interest rates. This would add further to the pressure on U.S. debt and render the U.S. Treasury bond market as one of the greatest financial bear traps in history.

Even more threatening than the Fiscal Cliff is the far higher and steeper Entitlement Cliff, which dwarfs the Fiscal Cliff in almost every dimension. America’s massive baby boom generation began entering retirement last year. As increasing numbers of workers retire over the next decade, significant strains will be placed on Social Security and Medicare, America’s entitlement monoliths. It is no understatement to say that if the finances of these programs are not brought into balance, the United States will be brought to its knees financially. Yet both parties in Washington appear content to ignore these problems. A very modest proposal by Republicans to trim Social Security expenditures (by cravenly tinkering with inflation calculations) was withdrawn almost as soon as it was introduced.

But in truth, anything short of a comprehensive resolution of the Entitlement Cliff threatens to sap the economic prospects of the United States for generations to come. At present, however, the U.S. dollar, despite its inherent fatal flaws, continues to be perceived by many as the ‘currency of refuge’. In contrast, the euro, although protected somewhat by central banks, does not enjoy the full status of an international reserve currency. Therefore, the Eurozone has been forced by the financial markets to jump off the cliff and endure economic austerity.

This privileged position has conferred on Washington the vital element of time to organize viable revisions to its entitlements. As a result, plans could be made to coordinate the restructuring and reduction of government spending, borrowing and taxation. A wise government could be looking to make an orderly descent from the top of the cliff, making provisions for solid footing and safety lines. But alas, this opportunity has been left unexplored.

Though a short-term fix may have been reached, the Entitlement Cliff still looms large and descending down this precipice could seal the fate of the U.S. dollar. As a result, the ability of U.S. politicians to deal with entitlement spending will have global economic consequences of the highest order.

The shockwaves of miscalculations if made by American politicians could reverberate around the world, affecting international financial markets and threatening the continued viability of fiat currencies.

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Republican Sellout Invites Stagflation

europac admin — Fri, 21 Dec 2012 19:25:24 +0000

By:

John Browne

Friday, December 21, 2012

While it may not be a surprise that the Republicans are preparing to yield on their vow to oppose tax hikes, it should raise investor concerns the world over that an upcoming budget agreement will likely involve a Congressional surrender of its authority to set the federal debt ceiling. In exchange for this, it appears that the Republicans have simply done nothing to halt, or even curb, the dangerous federal spending trajectories or the current drift towards greater state control of the economy. President Obama has politically outmaneuvered the Republicans, even going as far as evoking the Newtown massacre as a reason for quickly concluding a deal. As a result, it is likely that the GOP will bear the blame for any breakdown in fiscal cliff negotiations. They could wear such an outcome as a badge of honor, but nothing indicates that they have the political courage to do so.

Given the drift in Washington, those who had hoped for a significant improvement in the United States fiscal prospects will have nothing but lumps of coal in their Christmas stockings. At the same time, the Fed continues to hold its foot to the floor with increased quantitative easing that will pump massive liquidity into the system (see Peter Schiff’s latest commentary for more on this). The combination can lead to stagflation and a debased U.S. dollar.

Republican House Speaker John Boehner has indicated a willingness to accept new taxes of $1 trillion, despite his party’s pledge to halt tax increases. Diverting a trillion dollars out of the wealth-generating private sector into the government’s coffers can only hurt corporate investment, particularly the venture capital sector that is so vital to the flow of new ideas and technology that stand at the core of America’s highly profitable international technological lead.

But far more momentous than his capitulation on taxes is his agreement to pass debt limit power to the president. This decision removes any chance that the United States will ever do anything meaningful to address its fiscal imbalances.

Following the establishment of the Federal Reserve, the House of Representatives’ approval of the Federal debt limit was needed to restrict a profligate government from endangering the credit of the United States and encumbering future generations with an unbearable level of debt service. But in order to pander to voters, both Republicans and Democrats have paid little heed to this important duty and have rubber-stamped continued increases in debt. In recent years, when Federal debt began exceeding GDP, Republicans finally withheld the stamp in order to force a real budget discussion. But a combination of their own hypocrisy and political mishandling has rendered those attempts futile.

In the meantime, both parties have avoided making any meaningful cuts in government spending and have instead offered accounting gimmickry as a poor substitute. Neither party appears willing to risk votes in order to curb the profligate and economically suicidal growth in out of control entitlement expenditures.

Last week, The Economist magazine published a list of 80 countries, ranked in order of quality of life as determined by such elements as economic well-being, intrusive government and crime. The United States has now fallen to sixteenth position (with Switzerland in first position). The combination of $1 trillion of new taxes and the likelihood of increased financial and commercial regulation will likely push the U.S. further down the list.

It is time for politicians, and particularly Republicans, to put the nation before their individual careers. Should they fail in this great patriotic call, they will be sentencing their fellow Americans to a future of falling living standards, currency decline and poverty.

But while the US struggles with its political and economic morass, other regions of the world do present more promising opportunities for investors. Due out early next month, Euro Pacific’s Global Investor Newsletter will feature a wrap-up of global markets in 2012 and a preview of 2013. Subscribe for free today.

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Budget Farce Suggests Term Limits Needed

europac admin — Mon, 10 Dec 2012 21:59:40 +0000

By:

John Browne

Monday, December 10, 2012

Put simply, the fiscal cliff debate is an illustration of staggering political cowardice. Politicians of both parties are unwilling to ask voters to pay for all of the big government promises that they made on the campaign trail. They would rather risk the country's long term future than risk losing the next election. As a former elected legislator, I can assure them that their offices are not worth the price they are asking us, the voters, to pay.

Big government is hugely expensive. Beyond the costs in money, the regulations and political intrusions of an all-controlling nanny-state government create economic disincentives. Already, the fiscal cliff debates have inflicted severe damage on the U.S. economy by magnifying an existing general sense of uncertainty. In addition, they have delayed any prudent curbs on taxation and debt, which has led to the loss of America's prized triple 'A' credit rating. Another political pantomime that exhibits a massive lack of political will and integrity will only further diminish America's leadership.

The Democrats have proposed tax increases that would drain a further $1.6 trillion out of a sputtering U.S. Economy. Breaking their agreement with their supporters, even some moderate Republicans appear ready to agree to taxation increases of some $800 billion. At the same time, they have refused to put any specific spending cuts on the table. Out of fear of taking ownership of any potentially unpopular proposals, both sides refuse to make the first move.

When America was growing ever more prosperous, politicians acted more from a sense of duty than agenda, as politics was not seen as a lucrative career path. Today it offers a substantial career accompanied by very considerable wealth and great privilege. For example, Congress has encumbered ordinary Americans in an Obama health system, which is not at all likely to deliver the promised services and low cost, while retaining their own separate and privileged health system.

Given the entrenchments created by a two party system and revolving door lobbying industry, it appears impossible to persuade politicians to put the country before their privileged political careers. The only logical alternative would be to foreclose on the possibility of re-election by amending the Constitution to require single term limits for all politicians. This would finally encourage politicians to think about something beyond politics... posterity perhaps? These decisions are too important for career politicians to make. We must send citizens to Washington instead. However, turkeys do not vote for an early Thanksgiving. As such, the institution of term limits likely will not come from within the Congress as presently constituted.

Knowing that their politicians are abusing their democratic power and enslaving them potentially in abject poverty, it falls to American citizens to stand up for themselves. They should not demand details such as a freeze on tax increases or spending cuts, but a general overall demand for single term limits. Without cause to fear retribution at the polls, legislators could perhaps place the interest of the country ahead of their own personal careers.

Big government is the culprit. It will not be reduced effectively without term limits that will require concerted grass roots action to implement. Hopefully the resentment likely to be felt from an increasingly massive transfer of private wealth to the state can engender citizen anger sufficient to force such a change. It would provide a turning point not only for the United States but would also set an example for many democracies around the world.

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Central Banks Hedge Their Bets

europac admin — Tue, 04 Dec 2012 16:09:08 +0000

By:

John Browne

Tuesday, December 4, 2012

Gold appears to be headed for an impressive price appreciation for the second half of 2012. Since the beginning of July, gold is up almost 10 over the same time frame. What is noteworthy here is that in recent months, fears of a worldwide recession have increased markedly. It used to be considered axiomatic that recession created adverse conditions for commodities (a reality that has helped push down the price of crude oil thus far in 2012). How then can we understand the movement in gold?

Reports have recently been released that throw particular light on the degree to which central banks around the world are accumulating gold. These activities must be playing a significant role in keeping the heat turned up when it may be otherwise cooling down. Given the extraordinary degree of insight that central bankers are expected to have, what do they see that drives them to buy gold when classically the metal should be falling in times of recession?

As we have said many times, there are two fundamental investment reasons to buy gold. The first is as a hedge against the loss of purchasing power of fiat currency, caused either by inflation or currency debasement. The second is as insurance against political and financial uncertainty or collapse. Central bankers are not giving either scenario much lip service.

By the latest analysis, it appears that the European Union (EU) is headed toward depression. After twelve years of stagnation, the Japanese economy remains flat at best. With an Obama victory at the polls, Obamacare, and massive tax increases threatened, the U.S. economy looks set increasingly for recession. If recession hits the world’s two largest economies, the EU and U.S., the international economy, including that of China and its prime raw material suppliers such as Australia, Brazil and Canada, can’t be expected to grow robustly. Runaway inflation, according to the models to which most central bankers subscribe, would then be considered a distant risk. Is it possible that these individuals, at the apex of the economic and financial worlds, don’t trust their own policy papers?

Perhaps they understand the net effect of massive quantitative easing and the distortions being made by the ultra-low interest rates that have been held far too low for far too long. The unconventional monetary policies unleashed on the world since the beginning of the Great Recession have upended the financial rule book. But don’t expect central bankers to openly acknowledge this change. Instead, they will talk loudly about the threats of deflation while quietly expanding gold reserves.

At present, these loose monetary policies are actively debasing currencies like the U.S. dollar and euro. In order to protect their exports into those economies, other hard-currency countries have engaged in competitive currency devaluation. Examples would include Switzerland, Japan and China.

Even in the absence of high inflation, currency debasement has contributed to a higher gold price. This, in turn has encouraged some central banks to increase the proportion of the gold content and decrease the amount of fiat currency in their reserves. This is somewhat surprising given that many countries had agreed to sell gold under the Central Bank Gold Agreements (CBGA’s) I and II.

Russia, Ukraine, India, Turkey and the Kyrgz Republic have all increased their gold holdings recently. Turkey has even gone so far as to demand an increase in the proportion of gold held by its commercial banks as part of their reserves. Perhaps most important of all, James Rickards, a CIA and Pentagon senior advisor, released data recently showing that, in 2009, China secretly possessed gold holdings of 1,054 tonnes, or some 450 tonnes more than previously disclosed. This places China as the seventh largest holder of gold, or some 14 tonnes ahead of Switzerland. Perhaps this explains the recent news that gold is now the #1 Australian export to China, passing coal this year.

China’s gold holdings amount to a relatively small 1.8 percent of her foreign currency reserves. This is far behind the largest holders. The U.S. has 8,133.5 tonnes, or 78.3 percent of its reserves; Germany has 3,412.6 tonnes, or 69.3 percent, the IMF 3,217 tonnes; and even Italy, in fourth place, has 2,451.8 tonnes or 66.5 percent.

Clearly, China has a long way to go before challenging the United States’ vast holdings. However, China appears to be set upon a course of serious gold accumulation. Now the world’s largest gold producer, China retains all its domestic production and buys additional tonnage on the international market.

The crucial message that many central banks are buying gold has not been lost on the private sector. The Exchange Traded Fund (ETF) SPDR has some 1,120.6 tonnes, making it the world’s sixth largest holder and excludes other privately held accumulations.

Central banks are at the epicenter of the apparently coordinated unconventional monetary policies of quantitative easing and distorted low interest rates. The fact that many of them are buying gold surely carries a generally bullish message for the yellow metal, despite the increasing signs of worldwide recession or even of depression.

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Gold Forecast 2013: Accelerating Long-Term Trend

ted — Wed, 28 Nov 2012 20:47:20 +0000

By:

Dima Kash, Associate

Wednesday, November 28, 2012

Gold is experiencing an accelerating trend, represented by a difference in the price level between the 50WMA and 200WMA. The price gap between the two averages is plotted below, overlaid with a curve which visually demonstrates its exponential growth rate.

An accelerating trend has resulted in a gold market which has made new highs every year since 2001, while doubling in price every 4 years. The following table displays maximum yearly prices for the yellow metal:

Year	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012
Yearly Highs ($/oz)	296.0	351.5	418.4	458.2	543.0	728.0	848.0	1,033.9	1,227.5	1,432.5	1,923.7	?

In 2012, the question remains whether we will we see this pattern of higher highs continue. So far the high for this year has been $1,798.1/oz, or 7% below the 2011 high. With a little over a month remaining before the end of this year, there is definitely a chance that we could see a strong year-end rally. If we do not break above $1,923.7/oz by the end of this year, we would expect the breakout to occur on or before Q1 2013 (Milestones Section – Page 6).

In keeping up with the long-term trend, the following table identifies support and resistance levels which are deemed of critical significance. They represent key junctures in gold’s price action and ultimately define the trend’s direction.

Level Type	Support ($/oz)	Resistance ($/oz)
Critical	1) 1,364* 2) 1,530	1) 1,800

The first level of critical support is the exponential 200WMA, currently at $1,364/oz. Since gold has not touched this moving average in over 10 years, its violation would signal a fundamental change in the market’s behavior. If there is a line in the sand to be drawn between bulls and bears, the 200WMA would

be it. A break below the 200WMA would serve as bearish confirmation for as long as prices remain below this average.

The second level of critical support at $1,530/oz is based on gold’s current sideways consolidation, which was been in place since September 2011. This level is critical because it has been tested three times over the last 13 months and held on all three occasions.

Completing the consolidation range is a critical level of resistance at $1,800/oz, which has also been tested three times and held successfully on each occasion. The following chart plots critical support and resistance levels, including the exponentially rising 200WMA.

Read the complete analysis here >>

TREND ANALYSIS
- Accelerating Long-Term Trend
- Range Bound Intermediate-Term Trend
FORECAST: 2013
- Methodology
- Assumptions
- Price Target Analysis
- Milestones
- 2013 Forecast Chart

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Euro Crisis: Major Implications For Investors

europac admin — Mon, 19 Nov 2012 19:50:17 +0000

By:

John Browne

Monday, November 19, 2012

The euro crisis has begun to feel like an everlasting steeplechase with high hedges and water obstacles blocking the path to economic resurgence on the Continent. Each time a hurdle has been cleared another problem emerges to potentially block the track. The latest developments involve ugly anti-austerity riots across the southern tier and open rifts emerging among the creditors, most notably between the International Monetary Fund and northern nations. Despite the difficulties, I believe that ultimately the horse will pass the finish line; the Continent has too many economic bright spots to simply slip into irrelevance. The big question should be whether the monetary jockey (the euro) will be thrown off the mount before that happens. Investors should prepare for both eventualities. But while the race is ongoing, the uncertainty over the euro currency is galvanizing the push for full political union of the Eurozone and providing effective camouflage for the weakness of the world’s reserve currency, the U.S. dollar.

Future historians of the European Union likely will ponder how democratically elected governments of once proud empire nations willingly surrendered their sovereignty without full and open discussions. The answer lies in greed and fear. By 1950, Western Europe had been ravaged by two horrific Continental wars in 35 years and had been tossed about like a tennis ball in the Cold War match between the United States and the Soviet Union. In light of the situation, the impulse for greater European unity and cooperation was natural.

The key founders of a united Europe were France and Germany. The French sought security by attaching themselves to Germany, while the Germans saw an opportunity for the political hegemony that the two wars could not deliver. But had the idea of European Union been originally presented as a means to empower Germany, few European peoples would have accepted it, least of all the British.

To that end, Jean Monet, one of the early architects of the Union, is alleged to have said, “Europe’s nations should be guided towards the superstate without their people understanding what is happening. This can be accomplished by successive steps each designed as having an economic purpose, but which will inevitably and irreversibly lead to political union.” He suggested patience in waiting for “opportunities” to progress the idea. As a Member of the UK Parliament, I witnessed such deception first hand.

Gradually, the innocent sounding European Coal and Steel Community (EC&SC) evolved into the European Common Market (ECM), European Economic Community (EEC), the European Community (EC) and now the European Union (EU), a budding superstate, dominated by Germany.

In perhaps one of the most foolhardy moves in recent decades, the euro currency was launched in 1999, long before the political or fiscal unification had taken hold in earnest. In retrospect, the creation of a currency in the absence of a unified state with coordinated fiscal policies seems doomed to failure. And failing it appears to be.

With each stumbling block, the invariable solution offered has been increased political integration and austerity. On November 7^th, German Chancellor Angela Merkel flew to London apparently to ‘persuade’, if not compel, Prime Minister Cameron to tone down or delay his objections to increased EU budget expenditures. She felt so confident that, for the first time, she exposed the covert plans for the European Superstate.

According to the UK Telegraph, Merkel said, “Of course, the [unelected] European Commission will one day become a government, the [unelected] European Council a second chamber and the European Parliament [which currently has no effective power] will have more powers.”

Clearly, a failing euro provides all the ingredients needed to knock down barriers to unity. As evidenced by massive public demonstrations in Portugal, Italy, Greece and Spain, the southern tier is desperate for rescue funds. In order to preserve bloated pensions and early retirement, many citizens would gladly accept lost sovereignty.

The failure of the euro also has provided cover for the severe debasement of the U.S. dollar. Prior to the crisis, the euro had established itself as the world’s second currency. Its threatened failure has resulted in massive flights of capital into U.S. dollars. The result is that the colossal currency and debt crisis threatening the U.S. dollar and Treasury markets has been largely obscured. Today, most investors appear to be blissfully unaware that the United States faces debt problems that are worse than many countries in Europe.

However, if European politicians are successful in imposing the political unity needed to save the euro, money will flow out of the U.S. dollar. Alternatively, should the euro fail, other currencies such as a reconstituted deutsche mark could rise in its place. Either way, a resolution of the euro problem likely will signal a weaker U.S. dollar and higher interest rates.

Those investors who are overweight in U.S. Treasuries (or the government securities of other debtor nations) could likely suffer when either resolution is reached. Investors should prepare by acquiring assets that will stand and fall on their own merits. Being the least ugly contestant at a beauty pageant is not a strategy for long term success.

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Report Raises Questions About Central Bank Gold Holdings

europac admin — Tue, 06 Nov 2012 22:53:41 +0000

By:

John Browne

Tuesday, November 6, 2012

For years I have cautioned that changes in the ownership of gold held in the vaults of key central banks around the globe may not have been accurately reported. A report issued last month in Germany has once again brought these issues to the fore. In today's environment of rampant money creation and questioning of central bank activities, such uncertainty is bound to spark the curiosity of an increasing number of investors.

Since the depths of the 2008 financial crisis, central banks around the world have increased their gold holdings. As of January of this year, the International Monetary Fund estimated that official reserves had hit a six year high. Most of this growth has come from emerging and developing nations who are estimated to have swollen their gold reserves 25% by weight since 2008. Just a few years ago, India purchased 200 tonnes on offer by the IMF.

This increase may surprise those who have been led to believe that central banks do not traditionally accumulate gold during recessions. The fact that they are doing so could carry an important message for private investors.

The United States, which has gold holdings of some 8,133.5 tonnes as of 2010 (currently valued at some $420 billion), is still by far the largest holder of gold. Perhaps with deep memories of the social scars of its Weimar Republic, Germany is the world's second largest, with some 3,396 tonnes. Oddly, Germany keeps its horde largely abroad with an estimated 66 percent at the New York Federal Reserve and 21 percent at the Bank of England. The gold was moved out of Germany during the Cold War in the 1950s due to concerns of a potential Russian invasion of West Germany.

In late October, Ambrose Evans-Pritchard reported in the UK's Daily Telegraph that the German Court of Auditors told legislators in a redacted report that the German gold held abroad had 'never been verified physically' and ordered the Bundesbank to secure access to the storage sites. The report included the surprise revelation that Germany had slashed the amount of gold held at the Bank of England by two thirds back in 2000 and 2001. At that time, active gold selling by the UK government had apparently made the Germans nervous. Further, Evans-Pritchard reported that the Court called for the repatriation of 150 tonnes of German gold over the next three years to test its weight and quality. The report added fuel to the political movement within Germany to bring back all of its gold reserves. From my perspective, the report also sheds light on three fascinating issues.

First, Germany has increased its gold holdings significantly between 2000 and 2009, more than doubling the percentage of its foreign exchange reserves held in gold. According to 2010 figures of the World Gold Council, Germany's gold reserve now constitutes nearly 74 percent of its foreign exchange reserves. This increase came despite rising storage costs and the massively reduced threat of Russian invasion. What caused Germany to accumulate so much gold? This question should not be lost on investors.

Second, the report details a level of central bank cooperation and trust that staggers the imagination. Allied governments appear to have "trusted" one another with the stewardship of hundreds of billions of dollars worth of unallocated, and in some cases uninventoried, gold bars. This policy borders on financial negligence.

Third, some central banks, such as the Fed, publish the total amount of gold held in their inventories. However, they provide no details as to its ownership. It is well known that some countries keep considerable portions of their bullion reserves with the U.S. Fed and with the Bank of England. But the details are lacking.

From 1999 to 2009 central banks drafted and executed three Central Bank Gold Agreements that have the stated intention of coordinating the sale of gold on a global basis. Many private investors see these agreements as simply an attempt to "demonetize" gold by creating strategic price volatility, and thereby investment uncertainty. The massive trading required to achieve these desired price movements must have resulted in relative changes to central bank holdings. But as banks do not reveal the owners of their gold deposits, the data is unavailable to prove this.

In the coming years, we expect general interest in gold as a store of value to increase while confidence in fiat currencies declines. If this trend is energized by increasing uneasiness over the safety, security, and ownership of the gold held by the world's central banks, much greater volatility could result. If the general breakdown of trust in fiat money is increased suddenly by a sovereign debt crisis like we have seen in Southern Europe, the next action could be a move by central banks to lay more formal claims to their deposits held abroad. Such an eventuality could finally drag the shadowy central bank gold market into the light of day.

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Banks Punished For Central Bank and Political Errors

europac admin — Wed, 17 Oct 2012 16:49:10 +0000

By:

John Browne

Tuesday, October 16, 2012

In recent decades politicians have increasingly followed the Keynesian prescription of economic growth through continued government borrowing and the creation of undreamt of amounts of fiat money by central banks. To facilitate this process, the larger commercial banks have acted as the central banks' de facto distribution system, and as a result have grown ever larger while accepting progressively greater risks.

In 2008, potential catastrophe loomed as the entire international financial system was challenged with collapse. But, as the 'darlings' of the central banks, the "too big to fail" banks were saved by taxpayer bailouts so that they could continue to play their role in the stimulus engine. But as a result of these distortions, the environment for those banks outside of the exclusive "too big to fail club" has been increasingly challenging. In the United States, the financial services industry is changing radically and many fear that the days of U.S. dominance will be coming to an end.

Public ire resulting from the 2008 financial crisis largely missed politicians and central bankers and landed squarely on "Wall Street." As a result, bankers have become easy political targets. Increased regulation of the banking sector has become the rallying cry for the political left.

In addition to direct assaults on the banks, the ill-designed 2010 Dodd-Frank financial overhaul law has raised considerably the cost of entry to small entrepreneurial financial companies. Already, it is forcing the business of smaller financial companies offshore to the benefit of other countries.

Daniel Tarullo, an influential executive at the Federal Reserve Board, has suggested curbing bank growth by demanding a limit on the non-deposit liabilities of banks. Too often, short-term debt comprises the majority of these liabilities and is a source of potential vulnerability in a credit crunch. Meanwhile, some politicians have urged higher capital requirements in order to curb increasing bank size. Even ex-bankers such as Sandy Weil who led the lobbying effort to abolish the Glass-Steagle Act are now calling for its effective restoration. As a result, many corporations are deciding to leave the banking sector.

Companies for whom banking services provide an added benefit to their non-bank clients are fearful of the threat of increased capital requirements and of new, as yet to be clarified, Federal Reserve banking regulations. As such, it is a classic example of how excessive and uncertain regulations are hurting American business and employment. A specific example is that of tax preparation firm H&R Block. Years ago the company launched a service that provides some banking services to its customers. Recently they re-evaluated that strategy and have engaged advisors Goldman Sachs to help them "evaluate strategic alternatives." In other words, they are looking to shed the unit.

Those large banks that remain, firmly entrenched and supported by government guarantees, see little reason to provide cost effective services for retail clients. Most people with bank accounts in the United States will likely agree that in recent years banking fees have gone up while the level of service has gone down. This has resulted in private enterprise proposing innovative solutions. Recent moves by retail giant Walmart provides one example.

The Federal Deposit Insurance Commission (FDIC) pointed out some weeks ago, some 51 million Americans are "under banked". Worse, about 17 million are "unbanked". This implies a massive potential need for banking services for individuals at the lower end of the socio-economic spectrum. Many such Americans do a great deal of their shopping at Walmart, which purveys a wide variety of merchandise at extremely low prices.

To provide a service to these potential customers, Walmart has announced an agreement with American Express to issue a prepaid debit card entitled 'Bluebird'. This will enable less well-off consumers to purchase products from Walmart without surrendering their paychecks to a bank, thereby exposing themselves to high banking fees, or to put their purchases on conventional credit cards, which are notorious for high fees. As the service involves no extension of credit, Bluebird should provide cost effective service to the poor while involving no financial risk to either Walmart of American Express.

While Walmart's efforts may be timely and successful, the move will not reverse the fading glory of the U.S financial services sector. In order to perpetuate its system of massive money distribution, the Fed has insured that American banking will become as competitive domestically and globally as American manufacturing, which is to say, not at all.

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The Muni Minefield

europac admin — Wed, 10 Oct 2012 14:33:44 +0000

By:

Neeraj Chaudhary

Wednesday, October 10, 2012

Municipal bonds have long been viewed as a staple asset class for conservative, income-seeking investors. “Munis,” as they are known, are a large, liquid market of credit-rated securities that provide tax-exempt (from Federal taxes) income to millions of American investors. Towns, school districts, and other public sector authorities across the country have issued an estimated $3.7 trillion dollars worth of these bonds.

But so far this year three municipalities in California (San Bernadino, Stockton, and Mammoth Lakes) have declared bankruptcy and are now asking their bond investors to take reductions in the principal and interest payments they are owed. Just last week, that club appears set to welcome another member as Atwater, a central California city with a population just under 30,000, declared a fiscal emergency and put itself on a path toward bankruptcy. After the Atwater announcement, NBC news reported that one public finance expert had described municipal bankruptcies in California as “spreading like a disease.”

According to recent reports from Moody’s and Fitch’s these recent bankruptcies may only be the beginning. They warn that after decades of steady performance, municipal bonds (and by extension municipal bond funds) may see higher default rates and poorer performance in the years to come.

If the economy continues to languish in the years ahead municipal bond holders may find themselves in a tight spot. Their financial claims may increasingly compete with the pension claims of retired municipal workers. It’s easy to envision a scenario whereby “rich” bond investors are asked to take a haircut so that retired policemen, firefighters, teachers, and other blue-collar employees can be made whole on their pension expectations. The brewing class warfare currently playing out in the US presidential campaign may accelerate if the US economic pie continues to shrink.

Given the uncertainty over domestic bond issuers, investors seeking income may want to consider assets in countries and sectors that offer stronger fundamentals. See the Euro Pacific Capital Global Investor Newsletter. Our October edition was released just last week.

The current crunch in municipal finances is particularly troubling given the surge in muni bond investing over the past several years. In the wake of the stock market crash of 2008, and the subsequent loss of faith in American economic resiliency, many investors appear to have sought the stability of munis. In addition, as short-term interest rates are expected to remain near 0% for years to come, and tax rates are expected to rise for wealthy investors, demand for these tax-free securities would be expected to remain high. As a result, any hiccups in the muni market in the years ahead could make a significant impact in the investment world.

In truth, municipalities all around the country – not just those in California – are already experiencing stresses like never before. Professor Joshua Rauh of Northwestern University recently estimated that unfunded pension liabilities are as high as $4.4 trillion – that’s nearly $30,000 for every household in America (bear in mind, these unfunded liabilities are beyond the commonly-discussed federal obligations of Social Security and Medicare).

Concerns about municipal bonds are not limited to academia. Nearly two years ago, Meredith Whitney – who previously gained fame by making a bearish call on Citigroup stock – began warning of a “tidal wave” of defaults amongst municipalities. She predicted that there would be between 50 and 100 major municipal bond defaults (at least 42 actually occurred in 2011 alone). In a sign of just how high the stakes are, Whitney was later called to testify before Congress in regards to her prediction.

Bond insurers – who pay investors in the event that a municipality goes bankrupt – have also come under pressure. Shares of insurer MBIA Inc. traded over $70 in 2006 but now languish below $12 (with a PE ratio of just 5). Shares of its primary competitor, Assured Guaranty Ltd., have fared little better, trading at just half its peak value from 2007 (also with a PE of 5). Clearly, equity investors are unconvinced that these companies have bright prospects.

Last month legendary investor Warren Buffet terminated certain contracts that his firm (Berkshire Hathaway Inc., made in the municipal debt market. As reported by the Wall Street Journal, under the contracts, Berkshire would have been required to make payments in the event of bond defaults. By cancelling these contracts, Berkshire is no longer on the hook.

Whether it’s the university professor, the renegade analyst, or one of the most respected investors in the world, it’s clear that there are significant concerns about the health of the nation’s muni bond market.

Of course, there is another alternative to default (though one that would be equally injurious to investors’ portfolios). It’s not hard to imagine that if municipal finances got much worse, that municipal bonds could be bought by the Federal Reserve under its new perpetual QE program. Professor Rauh has stated that the municipalities could go to the US Treasury for a bailout. From there, it’s just a hop, skip, and a jump to the Federal Reserve announcing that it will add muni bonds to its list of assets that it intends to buy (in addition to Treasury and mortgage-backed securities). Muni investors would then be made whole, but at the cost of more inflation, which would then surreptitiously reduce the real value of their portfolios.

In light of the brewing circumstances of municipal finances, investors would be well-advised to review their holdings of municipal bonds and determine whether their portfolios face heightened risk. Wise investors seeking reliable income should look to diversify their asset allocations.

Neeraj Chaudhary is an Investment Consultant at Euro Pacific Capital’s Los Angeles Branch.

Peter Schiff's new book, The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country is now available. Order your copy today.

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Rare Earths Could Be Pawn in Island Spat... Again

europac admin — Tue, 09 Oct 2012 19:57:22 +0000

By:

Heiko Ihle

Tuesday, October 9, 2012

We've written before about rare earth elements (REEs): the futuristic sounding group of 17 minerals with unpronounceable names that play a critical role in everything from hybrid cars to flat screen TVs. Of course, "rare" is something of a misnomer, as the minerals that make up the group are not all that rare. They are, however, difficult to mine in profitable concentrations.

As of now, China controls over 90 percent of the world's rare earth mining concerns. In the past, this near monopoly has allowed them to exert a significant influence over both price and supply. In 2010 and 2011, China used its position to send prices on a roller coaster ride, causing some individual minerals to quadruple in price. In 2011, prices for some elements doubled again, hitting record highs.

The catalyst that caused China's use (or misuse) of its near-monopoly power in 2010 was a dispute over some seemingly meaningless rocks in the South China Sea. Though currently uninhabited, many believe that the islands sit on top of valuable oil and gas reserves. Beyond that, both countries view the territory as an issue of sovereignty in the East China Sea. Until very recently, the islands, while officially controlled by Japan, were privately held. In September of that year, Japan arrested a Chinese fishing crew whose boat had collided with two Japanese Coast Guard vessels near the contested Diaoyu Islands (called the Senkaku Islands by Japan). The islands have been claimed by China but are under official Japanese control. The boat captain's 16-day incarceration ignited long simmering tensions between the two Asian powers.

Over the course of the dispute, China took the gloves off and hit Japan where it hurts: It halted shipments of rare earth elements to Japan, the world's largest importer. Japan had traditionally bought 60% of China's rare mineral supply for its high tech manufacturing industries. Predictably, prices spiked around the world.

The embargo even spread briefly to the United States and Europe after US officials announced plans to investigate China for possible WTO violations. Through it all, China stuck with its official stance, stating that no countries were being targeted but, rather, the shipment slowdowns were a result of increased regulation in the rare earths industry. But as many experts have suggested, China's unofficial embargo served as an effective ploy to manipulate prices (and punish international rivals) without implementing a policy change that would have exposed her to withering World Trade Organization (WTO) complaints from rival nations. Even without an overt policy change, the US, EU, and Japan did ultimately file such a complaint.

After simmering down for a year or so tensions over the islands have flared up again. This time around, things could get worse. In mid-August, Japan arrested 14 Chinese activists for planting a flag on the disputed islands. While the protesters were quickly sent home, their arrest reignited tensions. To make matters even more volatile the Japanese government just announced plans to buy the islands (which had been privately held even while they have been under Japanese political control).

The announcement has produced a stronger reaction from China than the arrest of its citizens. According to the FT, China's news organization, Xinhua, reacted to the decision by saying, "that Tokyo had thrown bilateral relations into the scalding pot" and by warning that Japan's actions would have "serious consequences." It is unclear what, exactly, Beijing will do in response to the move, but the official government position views it as a violation of China's sovereignty and a breaking of long-held-if essentially unspoken-agreements between the two countries. What's more, a new crop of Chinese leaders is currently taking the helm in Beijing, and taking a tough line with Japan may be seen as a rite of passage.

Since tensions first broke out in August, it has been almost impossible to read media coverage of these events that didn't hark back to the 2010 embargo. Price spikes in 2010 and 2011 caused many companies to stock up on the resources, leading to price drops and lower Chinese exports. At this point, some analysts are unsure whether rare earth prices have hit a floor yet. Still, it is impossible to tell what China will do. With such power and unpredictability concentrated in a few hands, many understandably view REE investing as gambling at best. That may be true, but the best gamblers always look for an edge.

One major result of dicey diplomacy in the South China Sea and the rare earth price spikes over the past few years has been the desire to diversify away from the current near-monopoly held by Chinese producers. In 2012, Chinese exports dropped significantly, and even fell below the country's quota. At the same time, various rare earth consumers scrambled to set up new mining operations in places like Australia, the US, and Malaysia. In August of this year, Japanese technology concern Toshiba announced that it would replace a Chinese-sourced rare earth with one found in Australia and the US in a new motor.

The dispute between Japan and China should only speed up this process. The fight over a few small islands stands as more bad news for Chinese rare earths producers, but it may be great news for companies producing rare earths elsewhere.

Heiko Ihle is a Senior Research Analyst with Euro Pacific Capital.

This article is taken from the October 2012 Global Investor Newsletter. Click here to sign-up and view the latest issue.

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Gold Glitters

europac admin — Fri, 28 Sep 2012 13:57:59 +0000

By:

John Browne

Friday, September 28, 2012

Just a few weeks ago, Mario Draghi, President of the European Central Bank (ECB), announced that he would do anything required to bailout the weakest members of the Eurozone and in so doing prevent the euro currency from dissolution. Investors who may have been previously positioning themselves to withstand a euro crisis seem to be anxious to believe that such bold actions will prevent the worst. Consequently, many unwound positions in U.S. dollars and bought back euros. In the wake of the announcement, the euro rose from $1.22 to $1.30.

Two weeks ago, as signs of recession increased, Fed Chairman Bernanke announced he would do anything required to stimulate the U.S. economy, real estate, and the financial markets. Investors, who may have been previously concerned that the U.S. stock market was set for a correction (having risen approximately 20% over the past year), took heart and sent stocks up once again.

But the biggest winners thus far that may have resulted from these newly communicated intentions are not the euro or the broad stock markets but rather gold and gold-related investments. In fact, in the month of September, gold approached its highest price for this calendar year and came within five or six percentage points of its all time nominal high. The GDX Index of gold miners increased nearly 12% and hit a six month high.

From my perspective, there are five main reasons that help explain the current attraction to gold.

First, is the perception that central bank activism will spark inflation. Although inflation still is ‘officially’ low, the size and scope of the printing campaigns just announced is creating an increasingly strong conviction that inflation soon will break out.

Second, with tensions finally ebbing in Europe and with the Federal Reserve now so plainly committed to a policy of quantitative easing, there is an increasing concern that the dollar could trend lower. A weaker dollar would help push up the price for all internationally traded commodities, including gold.

Third, the American government appears to have lost some of its influence on the perceived escalation in Israeli-Iranian tensions. War risk, particularly in the Middle East is rising. In the Pacific, tensions continue to rise dramatically between China and Japan over disputed islands. Gold has traditionally risen during periods of geopolitical uncertainty.

Fourth, central banks that were once huge sellers of gold, such as those of India and Russia, are now accumulating it, together with China. Savvy investors pay close attention to central bank actions.

On the other side of the ledger, there are two important items that normally would indicate a falling gold price. First, the EU, with the world’s largest economy, and the U.S., with the second largest economy, together with that of Japan, appear headed for recession. Even the Chinese economy is slowing. The possibility is rising of a worldwide recession, which normally tends to push down asset prices, particularly for stocks dependent on corporate earnings. As stocks fall, margin calls and other demands for cash result in gold holders liquidating portions of their portfolios. Also in recessions, cash becomes increasingly scarce and real assets, including commodities, fall in price. As a commodity, gold should fall in price as recession becomes manifest.

However, some investors may have overlooked an important consideration. Despite falsely low interest rates, most of the trillions of dollars created by the Federal Reserve are sitting in bank deposits or in the bond portfolios of banks. As such, these synthetic funds have not been the cause of significant increases in consumer prices. It is not until the banks start lending on the basis of these vast deposits of funds, will they become an inflationary factor.

If recession were to take hold more broadly, those who bought gold as a near-term inflation hedge may become significant sellers as inflation fears take a back seat to margin calls. At some point, if debt problems re-emerge in Europe, the euro’s basic viability may be threatened. Simultaneously, continuous action from the Federal Reserve may finally, and justifiably, bring the U.S. dollar under heavier scrutiny. Under such conditions gold may be looked upon as a more reliable store of value than discredited and devalued currencies.

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Fed Puts the Pedal to the Metal

Fri, 14 Sep 2012 21:19:56 +0000

By:

Jim Nelson, CFA

Friday, September 14, 2012

Yesterday, the Federal Reserve went pedal to the metal on monetary policy by announcing an open-ended bond buying plan. The past few weeks’ rally in asset prices was vindicated by the announcement. Last minute doubters who believed that the FOMC would remain on hold were proven wrong. With the doubters on the sidelines, equities and resources have responded with strong upside moves. The important lesson to learn is that the real economy is playing less of a role in asset price performance as monetary policy offsets deleveraging forces.

The details of the plan were bold; the Fed has committed to buy $40 billion in mortgage-backed securities (MBS) each month until conditions in the labor market improve and will hold interest rates near zero through mid-2015. Additionally, the Fed will continue its Operation Twist program through the end of this year, in which it is selling its short-dated Treasuries and buying longer-dated Treasuries. The net impact of this buying will be to increase the long-term holdings of the Fed by $85 billion each month through 2012. The Fed also suggested it would “undertake additional asset purchases” until labor conditions improve and said that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” Essentially, the plan amounts to an open-ended asset purchase program and zero interest rate program. This is what we at Euro Pacific have long anticipated the end game would be.

What are the implications of such a plan for investors? We think it should become increasingly obvious that a large component of asset price performance is being driven by monetary policy - not economic recovery. We all know the economy has seen difficulties this year, as even the Fed recently reduced its growth forecast. Since the beginning of the third quarter, the S&P 500 has risen 7.71% while analysts have reduced their estimates for the index’s third quarter earnings by 4.6% (Bloomberg, 2012). As the private sector deleverages through defaults on mortgages, paying down debt, job loss, and higher lending standards, the Federal government is offsetting this trend by running a large deficit and using monetary policy to dampen its effect on the Treasury market. The chart below displays this effect clearly by showing year-on-year credit growth on a quarterly basis for consumers and the federal government.

Total Credit Market Growth in Households and Federal Government, 2006-2012

Source: Federal Reserve Flow of Funds Data, 2012

But while easy money and large fiscal deficits might be offsetting the force of deleveraging pressures in the household sector for now, the cost will be an upsurge in prices as inflation takes hold. What can we expect in terms of monetary policy from the Fed when this happens? As we’ve said in the past, it’s likely that the goal will be to keep inflation abnormally high for some time in order to reduce the debt burden that the Federal government has built up. In our opinion, these conditions stand to benefit investors in foreign stocks, currencies, and commodities.

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Germany Extracts Stealth Victory Over the ECB

europac admin — Tue, 11 Sep 2012 20:14:52 +0000

By:

John Browne

Tuesday, September 11, 2012

Last week the European Central Bank (ECB) announced what many around the world had hoped it would: A plan that would allow the Bank to “do all it takes” to support the euro. Not surprisingly, stock markets in the EU and U.S. rose strongly based on the feeling that the ECB has now joined the Fed in a massive drive to reflate their respective economies by means of money creation. Many mainline observers and commentators heralded the new ECB position as a fundamental defeat for the Bundesbank, Germany’s central bank and a strong believer in sound money. Reality, however, appears to be a little different.

The deal actually contains many concessions to the German point of view. Perhaps the most important of these was the dropping of the ECB’s previous aim to ‘cap’ the bond yields of Eurozone members. Instead, the previously openended ‘buyer of last resort’ commitment, to keep bond yields low of troubled Eurozone member nations, was replaced by greater selectivity and far stricter conditions—German style. There were other major concessions as well.

First, any Eurozone member nation that seeks ECB support for its bonds in the secondary market will have to make a formal application. Naturally, such a public application will likely come with political costs, embarrassment and even stigma. Given that asset prices, for stocks and bonds for instance, are so influenced by perception, these pressures will dissuade many member states from going down this road.
Second, any applicant country will have to agree to Germanic-style deficit reduction and economic restructuring programs,which likely come with huge political costs and short term economic pain.
Third, ECB secondary market support will be granted only if the somewhat underfunded European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) commit their funds in parallel. The Bundesbank has long held that the ECB should not be permitted to abuse its power to create synthetic money without spreading the cost to the rest of Europe and internationally, via the IMF.
Fourth, the ECB’s support is limited to bonds with a maximum of three-year maturities. Eurozone members in trouble will never overcome their excessive debt problems by solely borrowing short-term.
Finally, all ECB bond purchases will be executed exclusively in the secondary market, thereby achieving the German aim to preserve the ECB that forbids direct financing of any Eurozone member by other members.

While many have surmised that Germany has yielded to the easy money Keynesian demands of its fellow members, it appears that she has been singularly successful at imposing its financial will on the rest of the Eurozone.

The significant concessions Germany received have gone largely unreported in the mainline media. Far from offering an instant reprieve to the debtor countries of the Eurozone, the new package will make German-inspired austerity more likely. This would therefore make continued recession for Europe as a whole more likely, at least in the short term. This, in turn, will make central banks both in Europe and the America’s more likely to continue to flood their economies with synthetic money. This should be good news for precious metal investors.

Economic weakness that persists in Europe may in turn encourage European politicians and even voting populations to accept ever greater German political control in return for what will be seen increasingly as direct ‘survival’ funding from Germany. The main short-term implication of Germany’s success is likely continued recession as austerity takes its toll. The long term results of greater German control of the Continent are much harder to predict.

Any investor trying to understand the political, economic and financial machinations of the Eurozone and the European Union would be well advised to focus on German actions, often hidden under pronouncements by the ECB. Most often the positions and actions that really matter are overlooked completely in the mainline media.

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European Central Bank’s Bond Buying Changes Nothing

europac admin — Thu, 06 Sep 2012 20:46:35 +0000

By:

Jim Nelson, CFA

Thursday, September 6, 2012

Today investors were sent into an unjustified optimistic frenzy by a new bond buying plan announced by the European Central Bank (ECB). While some liken the plan as a bold gambit that will save the European Monetary Union (EMU) from certain dissolution, from our perspective it seems likely that without significant fiscal support from the surplus nations (like Germany and the Netherlands) the bank will accomplish little more than spinning its wheels. And while there is no certainty that such support is forthcoming, any support that does materialize will likely not be in a form that will provide any short-term boost for the stock market.

ECB President Mario Draghi said that the Bank could now buy unlimited quantities of bonds of member states on the secondary market in a maturity band of one to three years. The important stipulation, however, is that such activity will occur only if there is the possibility of parallel bond buying on the primary market through the European Stability Mechanism (ESM) or European Financial Stability Facility (EFSF). The ECB is signaling that it is unwilling to put its neck on the line unless there is some type of guarantee from EMU member states that either the ESM or the EFSF will finance the repayments of the interest and principal on the debt the ECB acquires. Without this primary market financing, the ECB’s bond buying will do nothing to address the fundamental crises of the beleaguered countries and would needlessly expose the ECB to large losses. This clumsy workaround results from the prohibitions of Article 123 of the EU’s Lisbon Treaty, which imposes clear restrictions on the direct ECB financing of member states. There is a broad consensus that direct ECB purchases of bonds would violate these provisions.

In addition to the conditionality above, Mr. Draghi also said that under the new program, buying would commence only if country-specific deficit reduction targets are designed and monitored by the International Monetary Fund. That is decidedly not a positive for equities. If there are austerity conditions attached to aid, the nations receiving the assistance will almost certainly remain in, or slip back into, recession. This has been the base case for the European economy all along, and it appears nothing has changed.

In summary, the ECB has now agreed to buy European bonds on the secondary market if member states agree to finance their peer’s deficits, and if the states receiving aid agree to austerity. This keeps the problem, as it always has been, an issue of fiscal policy not monetary policy. It’s important to note that nothing has changed on that front. Surplus nations still maintain the conditions that will be attached to any assistance, and deficit nations are reluctant to agree due to the pain such requirements will impose on their economies. Whether the two sides will be able to settle their differences remains to be seen, but in either case, a clear way forward is far from solved.

We can assume that, in the end, assistance will be given. But it will come with the types of attached strings that lead to slower than trend GDP growth over the many years it will take before the excesses that have been built up in the past are cleared. Ultimately this is healthy for Europe, and a long-term positive for the currency and economy. In the short-run however, it’s likely negative for European stocks and will likely have an adverse impact on GDP growth.

Jim Nelson, CFA, is Portfolio Manager with Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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September 12th Looms Large for Germany

europac admin — Wed, 05 Sep 2012 21:34:46 +0000

By:

John Browne

Wednesday, September 5, 2012

The German economy is undoubtedly the powerhouse of Europe. As a result, an understanding of the developments within Germany can offer a strong indication of the path that the rest of Europe is likely to take. Until recently, Germany stood as a bastion of sound money against those Keynesian led regimes in the developed nations that favor continual currency debasement as an economic panacea. Throughout much of the past decade the German monetary bias was upheld by the Frenchman Jean Claude Trichet, the president of the European Central Bank. During Trichet’s tenure, the ECB’s policies so closely mirrored the philosophy of Berlin that many considered him to be German in everything but accent. But the arrival of the Italian central banking technocrat Mario Draghi as head of the ECB, and the changing tone from Germany herself, indicate that a new monetary era had dawned.

Recently, German politicians, led by Chancellor Angela Merkel, have begun signaling greater comfort with monetary debasement, even while the top bankers at the German Bundesbank remain firmly committed to sound money. All eyes turn now to the long awaited ruling of the German Constitutional Court on September 12th. Simply stated, the Court will rule as to whether it is constitutionally permissible for Germany to finance the debt of other nations. Before it abandons its preference for sound money, German leaders would do well to consider the long term consequences.

The UK and the U.S. were once the two richest nations on earth. Today, having followed Keynesian money debasing policies, they are among the world’s largest debtors with their economies approaching possible deep recession. Indeed, today the U.S. Treasury’s debt exceeds $16 trillion. America has joined Portugal, Iceland and Greece with a Treasury debt larger than its GDP. Nevertheless, the Anglo-Americans have established a considerable following of central banks around the world that are engaged in monetary debasement.

Having experienced the ravages of the 1920’s Weimar economic collapse, Germans have been dedicated followers of the Austrian School of sound money. As the leading exponent of sound money, Germany has garnered sympathy with Switzerland and the Netherlands. More recently, resource-rich nations such as China and Russia have joined this loose grouping and are calling for a replacement for the U.S. dollar as the international reserve currency.

We have referred repeatedly to the fundamental struggle taking place between the Anglo-American led money debasers and the German led sound money nations. Now, it appears increasingly that a major split is occurring within Germany itself. This has the potential to set the world on a downward spiral towards a hyper inflationary currency crisis.

Facing the difficult task of calling for continued austerity while holding together a tenuous political coalition, Chancellor Merkel looks ready to cave into expediency. Facing external political pressure from Anglo-American led Keynesians, Merkel appears ready to ask the German public to finance the rescue of their less successful Eurozone partners. It could also be that German politicians see this expensive course as a costly but rewarding path to their eventual political control of the European Union.

Unfortunately for Merkel and Draghi, the powerful Bundesbank, led by Jens Weidmann, does not agree that the benefits of debasement outweigh the risks. In particular, Weidmann objects to Draghi’s preference for American style quantitative easing of Eurozone bonds. He believes, quite correctly, that purchases of sovereign debt of insolvent nations would put at risk the savings of German citizens. In addition, hehas indicated that the policy would be in direct contravention of the European treaty.

If the German Constitutional Court rules against German rescue plans for other nations, the Bundesbank and all believers in sound money canbreathe again. However, it could imply an urgent and possibly terminal threat to the euro. Likely that would imply considerable short-term monetary volatility involving a short-term price spike in the U.S. dollar and a longer-term increase in precious metals prices.

Given the almost unprecedented monetary and economic implications and the resultant wall of Keynesian political pressure being brought to bear, most observers may judge that the German Court will succumb under the cover of some form of legal camouflage language. However, it is important to remember that in the past, the German Constitutional Court has not shown itself to be a political pushover. Nevertheless, this time its decision could be literally earth shattering. It represents an awesome responsibility.

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