Chart - TA, page-2731

There should be a big sign out there saying “Welcome to the new paradigm”. Most people are unaware that we are going through a change bigger than anything seen since the end of World War II. Some will be aware that we are going through an energy shock similar to the seventies. Energy is the heart of the economy and when the price of energy changes suddenly, the repercussions manifest quickly. A change in the cost of energy necessarily means that there will be a permanent decline in the standard of living. This decline will not fall evenly across society, across the nation or across nations around the world. Those with more of the right kinds of resources will do better than those without the right kind of resources. Those who have made preparations will do better than those who have not – and by “prepared” I mean that you must at least be without debt but hopefully with some cash in the bank because cash is a call option on bargains

There are three key risks at the moment. These risks are going to be a progression of disasters because government policy will aggravate the imbalances arising from fiscal and monetary policy errors. These risks are:

1. Inflation/interest rate risk

2. Liquidity

3. Credit

The inflation/interestrate risk was ignited by the lockdown policies pursued by governments around the world supplemented with pay-packet protection programs giving free money to people forced to stay at home. Two things happened: one was that people who are confined to their homes but have an internet connection and money in the bank will shop to alleviate the boredom of being locked down. The second thing that happened was that the government programs to compensate people for being locked down increased the money supply without a corresponding increase in the base money supply. This is one of the definitions of the cause of inflation. The home shopping meant that around the world inventories were depleted and with all the factories being shut down that meant that inventories could not be rebuilt. This resulted in shortages. When items are in short supply the price goes up because those who need it most or those with the most money bid the highest prices to get it. Everyone else has to pay the same price, use less of it or find substitutes until supply returns to normal. The central wankers were hoping that a return to normal supply would see an end to high prices; hence their early view of inflation was that “inflation would be transitory”. That they did not see how sticky the higher prices would be only attests to their poor research.

Central bankers have now pivoted to lifting interest rates and withdrawing liquidity in order to dampen the demand for “stuff” (a.k.a. goods and services). This is also synonymous with a recession and it is the only way that the central wankers know how to kill inflation. As an aside, for a central banker to be successful at stopping inflation prices only have to stop rising rapidly. There is no intention that prices should revert to the levels before inflation broke out. And this is where the wheels of the crisis hit the road hard. The important thing about a liquidity crisis is that it eats leverage. Those who borrow to invest are destroyed when they are caught in a liquidity crisis.


I am quoting Kyle Bass here” “Financial conditions are tightening at lightning speed; over US$33 trillion in equity declines (paper losses for some and real losses for those who bought the top); US$2 trillion of crypto losses; largest bond market losses in history; Fed balance sheet withdrawal of US$100 billion of “risk assets” each month just beginning and University of Michigan consumer confidence at 70 year lows … Hard landing is assured”.

There is a lot of information packed into that quote. First of all, we are entering a severe liquidity crisis. Money is being destroyed faster than governments can print it. In normal circumstances money is created when banks make loans. The banks are not making enough loans to keep the bubble expanding but if the government steps in and makes the money it is highly inflationary. In the real world banks have lost or are losing confidence that borrowers can repay loans so they are lifting interest rates. This means that far fewer borrowers qualify for the loans needed to make high end purchases such as new cars or new homes or apartments. This means that both manufacturers and developers are not selling new cars or new homes or apartments at a rate needed to repay their borrowings from the banks. It is a vicious, pernicious circle that ends in insolvency, losses, unemployment and tears. Meanwhile, consumers are also losing confidence. They may be maxing out their credit cards but it is being spent on living expenses in too many cases. And central bank tightening will be the proverbial straw that breaks the camel’s back triggering a severe economic contraction. I might add that any actual tightening will most likely be for only a short period of time before a panicked reversal of policy when the unintended consequences of tightening policy into a recession are revealed.

The liquidity crisis will threaten to culminate in a credit crisis where defaults take place on a scale that overwhelms any and all provisions for losses on the balance sheets of lenders. Once the losses exceed the loan loss provisions and the shareholder capital the lenders will be insolvent. I expect that governments will intervene to change the laws or the definitions to avoid declarations of insolvency, as has happened in the past (two examples are in 1991 it was section 70B of the Australian Income Tax Assessment Act and in 2008 it was FASB 157: Fair Value Measurements). The trouble is that this is reactive policy and many businesses will fail before the “too big to fail” businesses are rescued by government. Before the government acts though, monetary policy will have revered from tightening to accommodative despite it’s inflationary consequences.

The above is the summary of the macro wave but there are wrinkles that will have serious consequences. Let me put some meat on that statement. In Japan there is a currency crisis with the Yen in a ten month slide against the US$ and down 19%. Nobody wants to invest in Japan, not even Japanese companies. In China there is a banking crisis with provincial banks closing and bank runs on ones not yet closed. The ECB has a sovereign bond crisis and if the Euro breaks below US$1.05 on a monthly basis there is no support for the Euro until US$0.88 so, with an energy crisis caused by imposing sanctions on Russia, it seems a high probability that the currency will slip and ignite a flight of capital from Europe to the US. This may be further stimulated by any escalation of hostilities. As if all of that were not enough, we also have a looming global famine with food surpluses not being able to be transported from where they are to where they are needed and many cropping regions are not going to get their crops to harvest. Crops are either failing due to drought or were delayed in planting/not planted due to flooding aftermath making it too wet to plant.

As you can see, there are some significant wrinkles. But not all wrinkles are bad for gold. Power has shifted from the financialised West to the energy and food exporters that the developed markets depend upon. As always, the dependency varies as some G20 nations are energy self-sufficient and others are not. As many of the nations in Europe cannot produce sufficient energy to supply their own needs their economies can be thrown into chaos should Russian gas be shut off. Energy will be a fruitful area in which to invest but gold will be the second derivative investment through which most individual investors will be able to play this upcoming commodities boom.

While gold does have some faults as a currency (the chief one being it is perfectly inelastic) it has the virtue of being nobody’s liability. A payment made in gold extinguishes the liability because it is not contingent. Compare that with having your US Dollar foreign exchange reserves confiscated or even cancelled should your nation lose the favour of Washington. Yes, gold is going to get remonetised and it is going to happen as the US Dollar strengthens against all currencies. But that is in the future.

For the present gold has declined from the upward trajectory and many trading desks as well as many investors think that with the Fed’s interventions gold’s bull run is over. They are certainly taking trading positions or bets (or both) that gold is going to go down and that might even be the case into the mid or the late third quarter of 2022. In addition to the bearish outlook, the cost of establishing a new mine have gone up with the inflation in energy and materials costs, making greenfield developments uncertain and brownfield expansion less certain.

Short term stuff is hard to predict but if the handle on the monthly gold chart completes then it should happen around that time period. Gold may be trading in a very choppy sideways to upward range on a daily or weekly basis but it is the monthly close that matters. On top of the traditional drivers for the price of gold it will now have the tailwinds of increased demand and shortage of supply lifting it higher.

If gold goes up against the US Dollar into the US$2,200 plus range in the near term that will increase the returns on investment for gold miners turning many marginal plays into profitable operations and profitable operations into bonanza money pits. At the same time, with more and more central banks accumulating physical bullion there will be a supply shortage which will be exacerbated by a lack of investment into exploration to find new orebodies. Gold mining companies will become the most profitable sector in the market, attracting a rush of new capital. You really want to be owning shares in gold miners, gold juniors and gold explorers when this happens.

Now, getting into the specifics of De Grey, many may be wondering about the share price performance of late. We have had a 30% fall in price since late April. Firstly, the calculations for the cost of developing the mine will have to be revised because costs for fuel and materials have gone up considerably. It is not a problem but it is an area of uncertainty. If the price of gold goes up this will more than offset this uncertainty. What may be more likely the case is that a significant shareholder may have been caught exposed to leverage. If someone borrowed heavily to buy De Grey and they are unable to roll over the short term loan used to make the acquisition then the matter must be resolved by selling the asset and repaying the loan. If this is the case then once they are through selling the price should stabilise. We should also see a “Change in substantial ownership” notice lodged with the ASX. With a turnover of some 80+ million shares over the last two weeks but there may still be a bit more selling to endure.

One final note. If the cup and handle complete and gold goes to US$2,200 an ounce while the US Dollar is chronically strong against all other currencies then shares in De Grey will be going much higher.