The British government has set in motion this week a future overhaul in the way that individual banks do business. British banks will be required to separate their basic lending and deposit operations from investment activities involving trading and speculation on behalf of clients and the banks themselves. This should mean that the deposits of retail customers will be shielded and protected from bank investment and trading ventures.
The plans were announced by Chancellor of the Exchequer George Osborne earlier this week and, when put into law, has the potential to significantly strengthen banking in England.
We support this British step forward and hope for similar action globally, including in the United States, to cleanse and detoxify what has become a destabilizing and dangerous banking practice.
It is just the kind of sorely-needed reform that has been long championed by former U.S. Federal Reserve Chairman Paul Volcker and which is being challenged in the U.S. by the banking industry.
China Watch: Diversifying Reserves From Bonds Into Hard Assets
Over the years, China has invested about $3.2 trillion of its excess reserves into U.S. and European government bonds. The returns, however, have been paltry and painful. Initially, the Chinese bought many U.S. bonds only to see the dollar fall into a prolonged slide versus the Chinese Yuan. In a decade, it has dropped by about a third. In an attempt to diversify, the Chinese then started moving some reserves into European bonds. Now, low and behold, Euro bonds make up about
$800 billion of their foreign exchange reserves fund. But, like the U.S. dollar, the Euro has fallen versus the Yuan – by nearly 14 percent in the last three years.
Recent investment activity indicates that Beijing has decided that real assets make better investment sense than the bonds of their trading partners. The central government has clearly taken notice of how major state-owned enterprises have successfully bought into energy and mineral properties throughout the world and how the value of oil and minerals has risen sharply during this time. The government is now following the lead of these companies, adding gold, copper, energy, and other important commodity holdings to its reserve portfolio. To accomplish this, it is creating a sovereign wealth fund with initial capital of $300 billion. This latest shift is a blow to a Europe that desperately needs buyers for its ailing bonds. For the Chinese, however, this is smart business that best serves the national interest.
China’s shift should serve as a warning to Washington, which has not gotten its financial house in order. The U.S. has not cut spending or raised taxes. The deficit continues to grow and remains a huge problem. Currently, the attention is on Europe, but crisis time is coming next to the U.S. It has become obvious that Congress will not do anything to anger its favorite special interest groups. So, we expect nothing more than meaningless baby cuts and lots of rhetoric, campaigning, other-party blaming, and prolonged foot-dragging. It’s very sad to see such dysfunction and self-destructive behavior. For America, this is dumb business that does not serve the national interest at all.
As we have been reporting lately, China continues to import and consume more. At the same time, speculation-driven real estate prices have stalled and food inflation has eased.
In effect, the economic news from China is good. China is continuing to steadily diversify its industrial base. The economy is no longer so export driven and is more driven by domestic consumption.
How can we monitor this? One way to monitor import and export trends is to monitor the shipping rates from various locations to and from China. Many of China’s imports come from Canada and South America. Now more are coming
from the U.S.. In the last year, shipping rates from Shanghai to the Los Angeles/Long Beach ports are down 26.8 percent—meanwhile shipping rates from Los Angeles/ Long Beach to Shanghai have risen by about 30 percent. Container shipping rates are now higher going from the U.S. to China than going in the reverse direction. These revealing shipping numbers reflect the rising value of the Yuan as well as a rising standard of living in China, two developments that create a high demand for many raw materials including among other things hardwood, minerals, and food.
Guild Investment Management’s contacts and correspondents in China represent a wide range of observers, including business people, company employees, independent consultants, employees of real estate developers, professionals, professors, doctors, lawyers, and investment managers. From them, we hear that the demand for housing continues strong, particularly from the middle class, and from families that want to own a home. This point may seem obvious to you, but it represents an important victory for Chinese housing policy. The fact is that in recent years, speculation by small and mid-sized companies stoked a housing bubble. Many of these Chinese companies were motivated by the prospect of greater profits from housing speculation than from their regular business activities. Thus, many of these companies cut back on their business and pursued real estate speculation. Even local governments got into the act; some local governments built vanity projects, or big, showy real estate projects to make themselves look more important. In order to combat the speculation, the central government raised interest rates and down payment requirements. The strategy has worked and the market has returned to the legitimate buyers, people who want homes for the long term. The prevalence of speculation is abating.
Very recently, Chinese interest rates have begun to decline. We believe the lower rates will generate increased domestic economic activity by mid-2012. Domestic consumption is already expanding rapidly. The middle class is scooping up technology products and brand names familiar to Westerners. Look around and you see iPhones and iPads all over, and these aren’t cheap in China. Men and women alike are buying consumer electronics, sporting goods, clothes, jewelry, fancy food, and eating expensive meals away from home. Hotels and high-end restaurants are bustling with business.
Elsewhere In Asia: The Declining Interest Rate Trend Continues
In the last two years, India, like many fast-growing Asian nations, has been frightened by rising food inflation. To combat inflationary pressures, the Indian government has raised interest rates many times. However, concern has emerged recently that GDP growth would suffer because of the higher rates. Fortunately, food inflation has begun to ease, allowing the government to put its foot on the brakes and halt the interest hikes.
In India and other developing Asian nations, inflation levels are dropping as exports drop. Expect to see interest rates soon come down, a long-term positive influence for Asian stocks. Historically, falling interest rates have heralded stock market surges.
Asian stocks have been held down by fear of declining exports. Such a fear is somewhat well-placed and we expect a slowdown in emerging world exports to the developed world. When the positive influence of lower interest rates overcomes the negative influence of lower exports in these markets, look for a big rally in the Asian growth market.
The U.S. Bailout Saga – How Much Did It Cost?
Washington has declared that U.S. taxpayers have not lost a penny. This is technically true. The Treasury got most of its money back from the banks; that which has not been repaid may be repaid, and the trillions in deposit guarantees for money market funds were not triggered. However, the operation cost plenty when you consider that the dollar has depreciated in value because of the bailout and the Quantitative Easing that was implemented to create demand for bonds.
Yes, the symptom was relieved, but the disease is still there, and it is a Made-in-the-USA disease. The cause is the spendthrift ways of current and previous U.S. Administrations and Congress – and that means both political parties. Since the bailouts began in 2008, it seems that trillion dollar-plus-sized deficits have now become “acceptable.”
Gold Watch: What’s Ahead
Gold has been snared in a corrective phase since peaking last September. Recently, a major long-term historian of gold predicted a correction through January 2012 to be followed by a rally, from a much lower level, beginning in February. Some technical analysts, meanwhile, look for support at $1,560 and $1,450 per ounce.
We aren’t sure what scenario will play out, but we are sure that gold will go much higher over the long term. What will be the catalysts for the coming advance?
Here are two of them:
- Money printing on a grand scale as the most probable solution to the European banking crisis
- Continued head-in-the-sand reluctance of many countries, the U.S. at the top of the list, to cut operating deficits
In our opinion, the continuing instability in Europe, combined with banking problems in Japan and the U.S., will keep the pressure on world central banks to create liquidity and this will be accomplished by quantitative easing (QE, aka money printing). QE leads to inflationary pressures. Such pressures may occur within an economic expansion, and create inflation, or they may occur within an economic contraction, creating an inflationary recession. In either case, gold benefits.
If you review history, you find many examples where nations opted to solve similar problems we face today in the world via the creation of liquidity by the means of QE. During the great bull market of the 1970s, for instance, gold went from $35 to over $850 per ounce. In that spectacular rise there were several 50 percent corrections in gold’s price. We don’t see anything of such magnitude on the horizon, but we do think that using periods of pessimism and panic as a buying opportunity has been, and will continue to be, a good yardstick for action. If you are frightened, you may want to scale your purchases; perhaps adding to your holdings with every $50 decline, or some other equally mechanical approach.
The Guild Basic Needs IndexTM And CPI Decline In November
Inflation is percolating on the back burner. While it may not be boiling over or whistling in alarm, the temperature builds nonetheless. Many prices of commodities and assets have been in decline recently, but in our opinion, the basic necessities of life will soon resume their long trend upward, at a rate exceeding the traditional inflation measures.
In the U.S., the population spends a large portion of its income on many superfluous, non-essential goods and services. Because of this, the rising costs of basic needs like food, clothing, shelter, and energy can be masked by the falling prices of technology goods and consumer services. At some point however, these basic needs impact of the ‘cost of living’ will be felt, especially in an environment with falling wages…as the U.S. has been experiencing for almost a decade.
When the realization hits that monetary debasement will be employed over and over in the coming years to spur growth and paper over debt crises, we expect countries, companies, and people will rush to hoard real assets, especially those that are basic to survival. That behavior will have a profound upward effect on the Guild Basic Needs IndexTM.
An Exciting And Important Offer To Our Readers
For some time you have received our weekly analysis of the global events and markets that can impact your investment portfolio. As a reader of this commentary, you will have noticed that over the past year we have expanded the content of the letter. It now includes periodic buy and sell recommendations on countries, commodities, and currencies as well as new discussion topics like the Guild Basic Needs Index and how traditional inflation data should not be taken at face value.
We continue to get a lot of feedback and requests from our readers as to how we may constantly improve the quality of the letter. Beginning in 2012, we plan to offer more of what our readers have been asking for. We plan to include more in depth research on countries, industries, and companies, and offer more specific timely investment ideas. Providing these expanded features involves a good deal of more work on our part, so as we revamp the Guild Global Market Commentary in January 2012, the additional content will now be available as part of a new paid Premium Guild Global Market Commentary Subscription Service.
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We remain bullish on gold, U.S. stocks, wheat, and Canadian, and Singapore dollars. The logic behind these picks is simple.
Wheat and other grains will rise in price long term due to 1) wealth creation in the emerging world increasing the demand for more protein and a more substantial diet, and 2) historically low carried forward storage [inventories] of grains worldwide.
The Singapore and Canadian economies are more rationally managed than the U.S. dollar. Their currency values should reflect their better management by appreciating against the U.S. dollar. The U.S. dollar temporarily rises during coming periods of fear as some see it as a relative safe haven. Eventually, investors will realize that the U.S. Government is doing nothing to address the deficit spending and taxation issues plaguing the country. As attention increasingly focuses on this fundamental failure, we believe that the US dollar will decline against these two currencies.
Gold should rise as investors come to the realization that gold is a valuable asset to store and protect wealth during periods of inflation or recession. Whichever economic environment persists, the value of gold will be driven by the efforts of central banks to create liquidity and debase fiat currencies.
Presently, the developed world has a deleveraging banking system. The deleveraging is very painful. So, in order to impress voters and stimulate economic activity, politicians and central bankers are under heavy pressure to create liquidity via various mechanisms. Most of these mechanisms create money and thus create excess currency. Excess currency creation drives gold higher. As we learn in basic economics, an increase in supply while demand stays constant will lead to a lower value for whatever has increased in supply. To say it another way is that as the supply of world currencies increases, their values fall…and gold rises.
Today, some investors believe that the U.S. dollar is rising in price. This is not correct; the U.S. dollar is rising in price only versus even weaker currencies. The dollar’s buying power is falling, and has been falling for decades. In this situation, demand for gold is buoyed as gold is used as a mechanism to maintain the buying power of one’s assets.
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We want to take this opportunity to thank all of you, our readers for your attention and valuable input in 2011. We wish each of you a wonderful holiday season and a happy, prosperous new year, and we look forward hearing from you in 2012.