Deflation Of The Currencies And Eventually The US Dollar Will Boost The Ultimate Currencies, Gold And Silver To New Highs (Part 2)

As I mentioned the strong upward movement in the USD index might not be such a good sign for the world, because all other currencies are falling by the wayside. Next to that it also indicates that people are very much on one side of the trade…and therefore makes the US dollar very vulnerable to a reversal especially if the fundamentals of the US economy start to falter.

In July 2014 the move into the dollar started with the QE in Japan with the Yen declining from about 98 in August to 84, representing today a 14% decline. This was followed by the sharply falling oil price, which weakened the currencies of oil producing countries such the Norwegian Kroner. In tandem the currencies of the EM countries, which have between $5-10trn in dollar denominated debt, suffered from the stronger dollar. A double whammy, because the US repayments are getting more expensive, whilst at the same time their own currencies drop in value. And as “Icing on the cake” the ECB announced its Euro 1.1trn QE program which strongly reduced the value of the Euro and further boosted the US dollar. As shown here above in a chart the US dollar index strengthened from 80 in July of 2014 to 94 today February 6, a rise of almost 18%.

The fundamentals of the US economy are much worse than people are made to believe

For roughly 13 years after the turn of the century, the current account and fiscal deficits drove the dollar down whilst boosting the reported earnings of the S&P 500 companies. Since upwards of 40% of S&P profits are earned abroad, that beneficent headwind will now become a powerful tailwind. Next to that the strong US dollar is also not missing its impact on the commodity prices, which are all denominated in US dollars and thus inverse correlated. Though we could also argue that the US dollar got stronger because of the tumbling demand for commodities attributable to weakening economies resulting in the demand for the US dollar safe haven.

USD Index

We saw the first effects of the stronger US dollar translated in 4Q2014 reported earnings. First, we have the construction and mining equipment giant Caterpillar (CAT), who reported a lower profit that came in well below expectations.  This was due primarily to the recent drop in the price of oil and lower prices for copper, coal and iron ore. Though “The strong dollar didn't help either…it seems like when it rains it pours -- and this is one of those days.”  Next to that the Caterpillar CEO urged the Fed to hold off on any rate hikes this year.

Procter & Gamble CFO Jon Moeller told CNBC that the strong dollar was the major factor in the company's disappointing earnings report last quarter.  And we heard similar stories from 3M, Pfizer, United Tech and Amazon; just to name a few.

This is in line with the change in the aggregate expectations of analysts from year-over-year growth in earnings for Q1 2015 to now a year-over-year decline in earnings. However, expectations for earnings growth for Q1 2015 have been falling not only over the past few weeks, but also over the past few months. On September 30, the estimated earnings growth rate for Q1 2015 was 9.9%. By December 31, the estimated growth rate had declined to 4.2%. Today, it stands at  -1.6%.

Though most of the expected decline in the estimated earnings growth rate for the S&P 500 for Q1 2015 is due to reductions in earnings estimates for companies in the energy sector. On September 30, the estimated earnings growth rate for the energy sector for Q1 2015 was 3.3%. By December 31, the estimated growth rate fell to -28.9%. Today, it stands at -53.8%.

S&P500 Earnings Growth

And the only way Wall Street is keeping up this puppet game dealing with disappointing forecast is by comparing real earnings with estimates and not by comparing the real earnings with y.o.y earnings (that would be a big NO for business). Companies earnings are “topping estimates” (estimates that have been cut dramatically), but the earnings are not topping last years EPS! In other words when your y.o.y comparisons don’t work anymore you compare the earnings with the strongly reduced estimates that can be downgraded because last year earnings can’t be lowered to make the positive comparison easier. Next to that most of the earnings are so distorted by buy-backs that it is even not funny anymore! It is all a big sham, a make believe world, to keep the equity markets up. Wall Street and Hollywood have never been more intertwined!!

Goldman Sachs: "Buybacks yesterday (January 3) accounted for 17% of our total flow, at times 33%". And as a reminder, expect much more of this: as Goldman forecast two weeks ago, of the $220 billion in net inflows into equities, $450 billion, the most ever.

And in synch with the abovementioned is the fact that the employment situation is not an iota better. As I have often argued the economic statistics provided by the US Government are bogus they are highly manipulated to serve the Government’s objectives. The devil is in the detail and a lot of people don’t properly analyze the information they are being provided with.

Jim Clifton, Chairman and CEO of Gallup is being quoted saying “The official unemployment rate, as reported by the U.S. Department of Labor, is extremely misleading”.

Right now, we’re hearing much celebrating from the media, the White House and Wall Street about how unemployment is “down” to 5.7%, all for their own alternative motives.

Important things to know about the definition and thus calculation of the unemployment figures are as follows.

If you, a family member or anyone is unemployed and has subsequently given up on finding a job -- if you are so hopelessly out of work that you’ve stopped looking over the past four weeks -- the Department of Labor doesn’t count you as unemployed! While you are as unemployed as one can possibly be, and tragically may never find work again, you are not counted in the figure we see relentlessly in the news -- currently 5.7%. Did you know this? Right now, as many as 30 million Americans are either out of work or severely underemployed.

There’s another reason why the official rate is misleading. Say you’re an out-of-work engineer or healthcare worker or construction worker or retail manager: If you perform a minimum of one hour of work in a week and are paid at least $20 -- maybe someone pays you to mow their lawn -- you’re not officially counted as unemployed in the much-reported 5.7%! Did you know this?

Yet another figure of importance that doesn’t get much press: those working part time but wanting full-time work. If you have a degree in chemistry or math and are working 10 hours part time because it is all you can find -- in other words, you are severely underemployed -- the government doesn’t count you in the 5.7%! Did you know this?

It is clear from this article that the official unemployment rate, which for obvious reasons doesn’t count the long-term and often permanently unemployed as well as the depressingly underemployed as unemployed, amounts to a big lie. And you think the so-called analysts on Wall Street understand this or will point this out? Of course not, it wouldn’t benefit them.

On Friday February 6 the BLS announced that the U.S. created 257,000 jobs in January and that companies are hiring at the fastest pace since 1997, with evidence emerging that a rapidly improving labor market might finally be triggering higher wage growth. The unemployment rate, meanwhile, edged up to 5.7% from 5.6% because people looked for jobs. A healthier labor market typically draws more people into the labor force. The labor force participation rate increased from 62.7% to 62.9% in January as the number of people not in the labor force declined from 92,898,000 in December to 92,544,000 in January. The labor force participation rate is the percentage of those in the civilian non-institutional population who participated in the labor force by either having a job or actively seeking one in the past four weeks.

According to the BLS figures hiring has boomed since last fall. The U.S. has added an average of 336,000 jobs in the past three months, the fastest clip since 1997 when the Internet economy was taking root. And job creation in November was revised up to show a whopping 423,000 gain, including the biggest spurt of private-sector hiring in 18 years, government figures show.

And although the January jobs report looked strong we shouldn’t forget that the labor market is often a lagging indicator. When the U.S. entered recession in December 2007, 99,000 jobs were created (which was a seven-month high). When the U.S. exited recession in June 2009, 502,000 jobs were lost. According to the January BLS report the number of Oil and Gas Extraction workers declined from 201.4K in December to 199.5K in January a drop of only 1,900 workers whilst according to third-party tracker Challenger, Gray & Christmas, the number amounted to 21,322 job cuts in January.

In order to put things into context and see what is really happening with the US labor market we should look at the “improvement” of the level of the civilian employment to population ratio and the paltry annual increase in average hourly earnings.

This is what Hatzius Goldman Sachs said on CNBC on February 6: "The employment to population ratio is still 4% below where it was in 2006. You can explain 2% of that with the aging of the population that still leaves quite a lot of room potentially, and the wage numbers are telling us we are just not that close, although we are getting closer."

This can be confirmed by the fact that, for all the progress in the labor market, millions of Americans are still left out. Some 18 million people who want a full-time job still can’t find one, including 6.8 million workers who have been forced to work part-time instead. If those people are taken into account, the nation’s unemployment rate is 11.3%. That’s still much higher than normal for an economy soon to enter its sixth year of expansion, underscoring the agonizingly slow pace of the recovery since the end of the Great Recession.

Anyway I hope I illustrated that the corporate earnings and unemployment and therefore other government figures are a big sham and that the real economic situation is much worse than the government or Wall Street wants us to believe. And therefore that when the chicken are coming home to roost and the real situation will come to the surface the US dollar will turn out to be not the safe haven investors thought they held.

The ultimate currencies, gold and silver, the big beneficiaries after the US dollar rise is finished

It brings me back to the main question what forces there are left to lift the dollar besides the QE in Japan and the EU (lower Yen/Euro and thus stronger Dollar) and anticipated interest rate increases in the US. Though as said here above, if the Fed raises interest rates whilst the economy is much weaker than is reflected in the government statistics and the baloney representation of the corporate figures by Wall Street and CNBC it might be the nail in the coffin of the economy and the US dollar. By the way suddenly Buffett and Welch are also not so convinced any longer that the economy could withstand a rate hike.

In my opinion a hike would force the Fed to reverse is tightening stance very quickly and tarnish its credibility and that of the US dollar, which could go into a free fall and finally propel gold and silver to new highs. The US dollar as safe haven needs to be “exhausted” before gold and silver can really take off.

Historically strong rises in the precious metals have often been proceeded by the US dollar and gold and silver moving up in tandem which makes a lot of sense if you think about it. The dollar and gold are both sought for their safe haven status and especially in the context of the ongoing devaluation of the currencies. Though gold and silver are my preferred currencies because they can’t be diluted and should only become worth more with higher negative interest rates and currency devaluations. Next to that they don’t have counter party risk, gold and silver always will keep a value whilst that can’t be said of paper money.

Other factors which strongly favor gold and silver and their mining companies

Another way of looking at the potential for the gold price is the massive gap between the Fed's balance sheet and today's gold price.  This is one of the many reasons the gold price is most likely set for a historic upside surge (see chart below).

Fed Balance Sheet vs Gold Price

And with a beta twice the level of the bullion and strongly reduced energy costs smart investors are buying the gold and silver mining shares with the mining shares at an all-time historic low vs the gold price (see chart below).

Multi-Decade XAU vs Gold Ratio

When physical gold will finally win over paper gold!

A question that is often raised amongst gold bulls is when the price setting of the physical metal will overtake that of the bogus and highly manipulated paper (futures) market. One possibility is that a large and powerful party (central banks of China, Russia) asks for physical delivery and not cash settlement and the LBMA or CME can’t deliver because they just don’t have the physical to fill the order.

Though I think that the inflexion point between the paper and physical gold and silver markets will definitely happen when the US dollar turns down strongly from its recent rise and investors won’t accept cash settlement instead of the physical delivery because they don’t trust the US dollar any longer and are worried about the US dollar losing too much of its value.

There just have been too many lies and manipulations of official economic figures such as the unemployment figures as has just recently been emphasized by the CEO of Gallup. When the trust in the Fed and the US dollar evaporates and the dollar loses its status as reserve currency gold and silver could become bid only and gold and silver owners won’t accept paper money any more in exchange for real money: gold or silver. As JP Morgan said: “Gold is money and everything else is credit”.

Conclusion

I think people don’t see the danger of what is going on because they don’t understand the intricacies of the monetary manipulations, deflation and devaluation until it is too late and they can barely afford to supply their families with the bare minimum and lose the farm!

That is why I think that governments for a large part have gotten away with their irresponsible actions because most consumers don’t understand the consequences and don’t feel them yet beyond their pain threshold. Next to that the financial media keep on confirming the view that everything is honkey dory for their own moving reasons.

Well nothing is less true as is we high lightened referring to an article by Jim Clifton, chairman and CEO of Gallup, called “The Big Lie: 5.6% Unemployment”. The official unemployment rate, as reported by the U.S. Department of Labor, is extremely misleading he says. Right now, the U.S. is delivering at a staggeringly low rate of 44%, which is the number of full-time jobs as a percent of the adult population, 18 years and older. We need that to be 50% and a bare minimum of 10 million new, good jobs to replenish America's middle class. So a more reliable unemployment rate is probably more around 12%. A record 93m Americans 16 and older did not participate in the labor force in December.

I hear all the time that unemployment is greatly reduced, but the people aren't feeling it. Now you know why also the workforce participation rate of 62.9% in January 2015 is among the lowest figures ever recorded. Finally when you are presented with every next batch of employment figures look at the quality of new jobs created, the difference between real full time jobs and part time jobs. 

And those fairy tales that lower gasoline prices will be a boost for the economy? I don’t buy it! People are scarred for what is in store for the economy, there is this underlying feeling that not all is well and thus they save, they don’t spend so that the tax lowering and thus spending argument doesn’t hold ground in my point of view! If you are a household that has been spending about $2,500 per year on gasoline (roughly the national average) you might see a saving of perhaps $600-$750 annually, based on U.S. Energy Information Administration (EIA) forecasts. Though do you think people will spend that money when they are unsure about employment and the economy especially if they are making the median income in the United States or about $52,000? I wouldn’t!

Just look at the 20-year low in the homeownership to see how confident people are about the economy! It is another sign of the uncertain times we are living in. And at 559, The Baltic Dry is inching ever closer to what will be the lowest level ever (554 on 7/31/1986) for the global shipping cost indicator. Transport and for that sake worldwide trade is clearly under pressure.

Based upon the ineffectiveness of economic stimulation via lower interest rates and desperate additional liquidity injections from QE, we are faced with the conclusion that these measures not working. How many times can you cry wolf? Ask the Americans and the Japanese. Ask Draghi what the definition of insanity is! "Insanity: doing the same thing over and over again and expecting different results." (Einstein).

The facts tell me there is no confidence amongst consumers…resulting in reduced consumer spending, lower velocity of money and deflation.  We see the deflation, dropping demand/increasing overcapacity in all major commodities such as oil, copper, iron ore, lumber, the Baltic Dry index etc etc. The deflation is subsequently translating itself in increased competitive currency devaluations, through historic low interest rates and stimulus measures in order to kick-start the economies. To be sure an incredible rally in the US dollar safe haven, which in combination with the falling oil price is creating havoc in the debt and currency markets (especially the EM markets). And because people will hold out as long as possible, we haven’t seen the real effects yet. But believe me we will see them.

As a result of the ECB announcement of the Euro 60 billion a month QE, we have seen that on Tuesday February 3 a Nestlé four-year, euro-denominated bond, which matures in 2016, was yielding minus 0.008 per cent. That means investors are in effect paying to hold the bond. It is extremely rare for corporate bond yields to turn negative.  The Shell Oil Company last week briefly saw one of its bonds trade negative before returning back into positive territory according to UBS. Meanwhile, Germany’s benchmark borrowing rate dropped below Japan’s for the first time on record, confirming the deflationary trap.

QE is seen as a boon for bond issuers, particularly companies and governments, whose borrowing costs have plummeted to all-time lows. Also record volumes of government debt have moved into negative yields since the ECB became the first central bank in the world to begin charging banks to hold their surplus cash last June. More than €1.5trn of euro area debt maturing in more than a year now pays a negative yield, according to JPMorgan, compared with nothing a year ago. German debt now has negative yields on bonds with maturities up to six years, as does Denmark. The Netherlands, Sweden and Austria all have negative yields on debt up to five years while Swiss bonds are now negative up to 13 years. Taking interest rates so negative that they threaten a run on bank deposits should not be seen as success --- it is failure.

For bond yields on corporate debt issued by companies such as Nestle and Shell to turn negative is a sign on the wall. Either investors don’t mind to pay a premium for a Euro bond that is backed by a currency like the Swiss franc which “ensures” their pay back or investors don’t trust the risk free status of government bonds any longer taking into account the huge fiscal deficits and debts of certain countries.  Investors seem to focus more on the return of their capital instead of the return on their capital. In order to avoid any counter party risk I would still prefer physical gold and silver. Though in earnest the negative yield is telling me that a huge destruction of wealth is taking place in front of us. Wake up the writing is on the wall!

The ECB decision to strike Greek bonds off its list of accepted collateral rattled European markets today, sent shares into reverse…and investors back into safe-haven German bonds. Gold benefited initially prior to also seeing price declines. The euro tumbled after the ECB announcement, causing gold to rise 2% – from EUR 1,104 to EUR 1,126 per ounce in minutes. While gold rose after the ECB announcement, gold prices in Singapore gradually moved lower.  This trend continued in European trading, whilst the USD Index was down 0.60 to 93.83! Again, this doesn’t make sense at all! Gold and silver have broken out in all currencies…except the US dollar.  However, it is just a matter of time when the dollar will have to capitulate.  

As mentioned above I think that the inflexion point, the end of the manipulation, between the paper and physical gold and silver markets will definitely happen when the US dollar turns down strongly from its recent rise and investors won’t accept cash settlement any longer. Put this also in the context with the fact that some 25% of world gold production is mined in Russia and China -- and is now being bought by their own central banks for obvious reasons. The market is clearly tightening.

Last Friday oil was up 8%, while the Dow tanked by 252 points. Moreover, the 10-year went to 1.64% -0.11% whilst the Italian 10-year was 1.58%. The lower 10-year rates are really an indication how confident investors are about the future.  This tells me that investors are #$@%&#* scarred!!

Brazil’s currency is crashing.  We’ve had oil plummet more than 50% -- and various other commodities have collapsed.  And investors are leveraged to the tilt because of the historic low interest rates. These extreme moves have probably caused massive derivatives losses and are most likely currently being hidden from the public. Following the strong January job report on Friday February 6,  the 10-year  yield moved up from 1.80% to 1.96%...so some funds who were (of course) leveraged long the bonds were getting killed today. You can’t have one quadrillion dollars on either side of a market and nobody is losing money.  Somebody is losing money and the amounts are way beyond anyone’s ability to pay. For example, when Switzerland abandoned the (currency) peg, some hedge funds got wiped out in a day.  The leverage margin that’s out there is staggering…hence the incredible potential danger and ripple effect. Nobody has any idea what’s going on in these banks with their huge margin derivative positions.  Nobody knows what’s happening.

At one stage the equity markets will catch up with reality.  Consequently,  they will fall out of bed probably pushing interest yield down further before they spike to very painful levels. These huge swings in important asset classes, that represent enormous wealth, such oil the US dollar, gold etc are warning us that something is terribly out of sync -- and far from stable. Beware! Nothing goes on forever…even if it is manipulated by the Fed.

© Gijsbert Groenewegen