For months I’ve explained that eventually all central banks will lose the faith of investors.
I’ve explained that large amounts of capital rushing out of bonds will search for yield and that small amounts of that capital will be the catalysts for sustainable new highs in the price of gold and silver.
This process will take years to play out but the process is in motion and it’s critical to understand that of the three major central banks, the U.S. will be the last to be forced into the structural reforms that all three central banks will have to undertake.
Before those reforms however, the same economists, analysts, newsletter writers, speculators, and investors who have been calling for the death of the dollar and the U.S. stock market for years are in for yet another beatdown courtesy of the dollar.
A beatdown which has begun. The dollar is up almost 4% in the past two months and hit a seven-month high on Wednesday.
A recent Bloomberg article outlined how firms such as Alcoa Inc. cite a stronger dollar more often than any other impediment to profit growth, according to an analysis by Pavilion Global Markets Ltd.
That same article showed that of 25 conference calls held by companies through October 12, 2016, at least 15 mentioned the stronger dollar as a threat to earnings growth.
Dollar strength is a trend that I believe will accelerate and cause the break in the bond markets. A rising dollar increases the likelihood in major sovereign defaults among emerging markets that issued their debt in dollars.
If the Fed doesn’t raise interest rates quickly, it’ll be forced to make interest rates negative in the next recession.
But if the Fed does raise interest rates, it’ll cause a massive decline in asset prices and add to the likelihood of a U.S. recession. So how does it play out?
There will be volatility, a lot of it.
Stock market volatility however, will be violent but brief. Why brief? Because when the rush out of bonds accelerates globally, central banks will not be able to control what capital considers safety. What central banks will be able to control is how it reacts to the volatility.
Japan and Europe are further along in the creative process but the U.S. is laying the groundwork for the next set of tricks.
We got a preview when South Carolina Republican Mick Mulvaney recently asked Janet Yellen before the House Financial Services Committee about the Fed’s authority to buy stocks to stimulate the economy. Mulvaney asked:
“There’s been some attention in the last few months about the recent decision by the Bank of Japan to start purchasing equities and my question to you is fairly simple. Is the United States Federal Reserve looking at the possibility of adding the purchase of equities to its tool box as it looks at monetary policy?”
“Well, the Federal Reserve is not permitted to purchase equities. We can only purchase U.S. treasuries and agency securities. I did mention in a speech in Jackson Hole, though, where I discussed longer term issues and difficulties we could have in providing adequate monetary policy. Accommodation may be somewhere in the future, down the line that this is the kind of thing that Congress might consider, but if you were to do so, it’s not something that the Federal Reserve is asking for.”
The Bank of Japan already uses the purchase of equities as a policy tool. The European Central Bank will be forced to as it runs out of options. When the U.S. stock markets throw a tantrum in response to the coming rate hike, low-growth, and incompetent government, you can bet that Congress will ask Ms. Yellen to expand the balance sheet to include the purchase of U.S. equities.
You’ll see new highs in the dollar, the U.S. stock markets, and gold. The returns in the quality juniors will be absolutely phenomenal.
We’re nearing the end of what Bridgewater’s ($160 billion hedge fund) Ray Dalio calls the end of the long-term debt cycle, characterized by a lack of spending despite interest rates near zero or even negative.
He said at a seminar last week at the Federal Reserve Bank of New York that while central banks around the world will probably extend bond-buying programs, making higher-yielding assets seem attractive relative to bonds and cash, those investments are still expensive relative to their inherent risk.
“If that persists, betting on gold could prove preferable,” he said.
Distortions in the financial markets are reaching very delicate levels.
Bond price sensitivities have been rising, so much so that the developed markets (EFA) could see a 9% loss in bonds for every 1% increase in interest rates, according to Dalio. This bond price sensitivity to interest rates hasn’t been seen in recent decades.
Dalio added: “it would only take a 100 basis point [1%] rise [in interest rates] to trigger the worst price decline in bonds since the 1981 bond market crash.”
In a world where currencies are becoming more and more underwritten by debt instead of growth, companies with real assets, assets like gold and silver, will become increasingly important for wealth preservation.
To your wealth,
Gerardo Del Real