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Fear Is In The Wind!

September 11, 2014


The James Turk Fear Index has always been interesting It is an easy concept. The Turk Fear Index is a measurement of gold’s relative value in relation to currency. The Turk Fear Index centres on the US by comparing gold’s value to money but a fear index could be calculated for any country and any currency and for that matter the world as well. The US being the world’s largest economy is most likely a good indicator for the rest of the world.

The Turk Fear Index compares the stock in gold held by the central bank with the country’s currency outstanding (money supply). The Turk Fear Index uses M3 the broadest definition of money supply. The formula is simply

Gold Reserves X Price of Gold

-------------------------       = Fear Index


Besides being a measurement of gold’s relative value it measures gold trends. In that respect, it is not a lot different from the Dow Jones/Gold ratio. When the index is rising, there is concern or fear for the stability of the country’s monetary and banking system. When it is falling, it suggests that confidence has been restored. As can be seen there was growing concern about the US’s monetary and banking stability from 2001 on. That culminated in the financial collapse of 2008 when the global banking system almost collapsed because of the weight of bad loans backed by derivatives that few understood. The world (primarily the US, EU and Japan) embarked on a massive bail out of the financial institutions and a program of quantitative easing (QE). Since 2009, the US has had three programs of QE although they are currently in the process of winding QE3 down.

Gold and the Fear Index peaked in 2011. After that, it appears as if confidence has been restored and the Fear Index has been falling (along with the price of gold). The world and the US have been going through a period of grudging slow economic growth and the financial system appeared to have returned to stability. With confidence seemingly restored, the world has gone back to its ways prior to the 2008 financial collapse.

Governments have passed legislation that would shift the burden of bailouts of the banking system at the expense of the taxpayer in the event of a financial/banking collapse to a system of bail-ins where the depositor’s and bond holders funds would be at risk (subject to the limitations of bank insurance that covers deposits). Little or nothing has been done to change governance in financial institutions. The US banking lobby has fought successfully against reinstating Glass-Steagall that limited securities activities in banks and securities firms.

In 1999, Glass Steagall was repealed and affiliations between banks and securities firms got underway. In the US a small handful of bank/securities firms dominate. They include JP Morgan Chase, Citibank, Bank of America, Goldman Sachs and Morgan Stanley and Wells Fargo Bank. Goldman and Morgan Stanley are two former securities firms who have converted themselves into bank holding companies in order to be eligible for FDIC insurance as would the banks. Canada broke down its four pillars (banks, trusts, insurance and securities) in the late 1980’s. The big five banks dominate Canadian banking and securities.

What ending Glass Steagall and breaking down the four pillars did was to allow the securities arms of the giant banking institutions to use the balance sheet of the bank for securities trading. This allowed the securities arms to leverage up the bank’s balance sheet 20, 30, 40 and 50 to 1 and sometimes higher. If things went wrong as they did in 2008 it was okay as the taxpayer through FDIC in the US and CDIC in Canada could bail out the bank. The major banks in the US received over $700 billion under a program called TARP and banks in Canada also received bailout money. It all came from the taxpayer. The money has been mostly paid back but the bank/securities firms went right back to their previous ways using the banks’ balance sheet to leverage up their securities trading operations. Leverage today is as high as it was pre-2008.

Since the financial crisis of 2008, debt has grown considerably. According to the Bank for International Settlements (BIS), global debt has grown by roughly 40% since 2007 to $100 trillion. As central banks in the western economies have suppressed interest rates, borrowing has soared. While a great deal of the debt growth has been government, individuals and corporations have also increased their borrowing. Tradable US Government debt has soared from $4.5 trillion in 2007 to over $12 trillion today. Globally corporate debt has soared roughly $21 trillion.

There has also been considerable growth once again in sub-prime type lending that was at the centre of the 2008 financial collapse. The growth has come in housing, which was the area behind the 2008 financial collapse as well as student loans and other areas such as car loans. Derivatives have also grown as debt has grown. Today it is estimated that total global derivatives outstanding exceeds $1 quadrillion although official figures show roughly $750 trillion. The major US banks noted above dominate this business in both the US and globally.


Rather than creating a system of stability and confidence, the old practices have continued and the amount of debt outstanding has soared. A shock to the financial system similar to what occurred in 2007 with the sub-prime crisis could cause a financial collapse larger than what occurred in 2008. Yet the Fear Index is not reflecting that. Has complacency that nothing could go wrong overwhelmed common sense? The perception is that the government has the banks backs and if anything does go wrong government would come to the rescue irrespective of the shift from a bailout program to a bail-in program.

The Fear Index is testing support of a rising trendline from the low of 2001. This is not dissimilar to the price of gold itself that is testing its long-term support. Yet there remains fear that gold is going to collapse even further to $1,000 to $700. Gold sentiment is close to where it was at the 2008 financial crash low although still above where it was in 2001.

With sentiment so low, (yes it could get lower) odds are more favourable for a rebound to get underway rather than another collapse. Yet the possibility of another collapse remains. The background is becoming potentially more negative. Global geopolitics are causing instability. The ramping up of the war against the Islamic State (IS) is probably not a potential flash point to trigger a financial crisis. But the war has cost the US roughly $500 billion so far and it has barely begun. The previous wars in Iraq and Afghanistan cost the US between $4 to $6 trillion. The cost of the wars are added directly to the US debt.

A possible overlooked issue concerning the war with IS is that IS is trying to change the borders of countries that have existed since the Treaty of Paris 1919 when Britain and France divided up the remains of the Ottoman Empire after WW1 with little regard to the people that lived there. IS had been operating in Syria and the war against IS did not begin to ramp up until IS crossed the border into Iraq and began to tear down symbols of the border in order to create a Sunni caliphate stretching from Syria into Iraq. If successful IS could seize the Kirkuk oil fields in the north of Iraq. These oil fields are currently under some control from the Kurds.

The crisis in Eastern Ukraine has more potential to become disruptive. Sanctions against Russia are trade sanctions. Russia is the world’s 8th largest economy and has the potential to strike back economically. Trade wars do not work. They are lose-lose and not dissimilar to the “Beggar thy neighbour” policies of the 1930’s. Those policies, many believe, contributed significantly to the Great Depression.

The financial situation in the world is tenuous. There are numerous signs that many of the EU banks are insolvent. The US banks have major liquidity concerns. The EU is planning on embarking on another round of QE. Japan has been providing QE for the better part of two decades and all it has accomplished is that their government debt to GDP ratio has jumped to the highest of all the major western economies in excess of 200%. The US government debt/GDP ratio is over 100% yet everyone is touting that the US economy is recovering even as the EU and Japan are sliding back into recession and the Mediterranean countries in the EU remain in a depression. Numerous EU countries have debt/GDP ratios over 100 and even the major EU countries (Germany, Britain, France) have debt/GDP ratio’s over 80. A debt/GDP ratio over 100 could shave at least 1% off economic growth according to most economists.

Worse, the debt ridden western economies led by Britain and the US are pressuring NATO members to ramp up their defence spending because of Russia and the crisis in Ukraine. Given that many of them are suffering under austerity measures or trying to cut back on debt, it will most likely be left up to the US, the world’s most debt ridden nation, to lead the NATO forces in Europe.

Separation movements are underway in a number of countries and this could prove to be quite economically destabilizing if they are successful. With polls showing that the Scotland separation could be successful, it has already caused the British Pound to fall sharply and British politicians to rush to Scotland to try and convince them to stay. Political careers are riding on the outcome. Economic and social instability could follow a yes vote.

In Spain, there is a referendum to be held in Catalonia. Support for leaving Spain is split.  If Catalonia were to leave Spain, it could be very disruptive to the Spanish economy where they have 25% unemployment, 50% youth unemployment, have already come close to debt default and there has been ongoing social unrest including clashes with police.

If Scotland were successful in separating from Britain (after 300 years) it could embolden other separatist movements in Europe, Asia and even North America where in Canada there have been separatist movements in Quebec and Alberta and even in the US where secession papers reached the floor of state Congress’s in a few instances. Depending on the separatist movement, it could be peaceful or it could be met with a military response as is being seen in Ukraine.

Sharply growing debt; failure to correct the excesses that were a cause of the 2008 financial crash; insolvent banks being propped up by QE programs; growing geopolitical instability with the potential for war between the Great Powers; and, separation movements in a number of countries that could cause economic, financial, social and military disruption and embolden other separation movements.

Where’s the fear? The Turk Fear Index is testing a rising trendline from the 2001 low. This appears to be not dissimilar to the test of the rising trendline in the 1970’s. When the Turk Fear Index turned up again gold soared from $100 to $850. Gold sentiment is quite negative. Stock market sentiment on the other hand is at levels seen at the 1987 and even above the tops of 2000 and 2007.  Stories of gold collapsing to $1,000 and even $700 abound and the DJI soaring to 20,000 and 25,000.

Against this background Russia and China are continuing to try to move away from use of the US$ for trade purposes. China has arranged numerous swap agreements with a number of countries in order to conduct trade in Yuan. The most recent one is with Argentina.  Yuan trading hubs are being created in a number of countries. Russia and China are in the process of building a major pipeline that will allow Russia to refocus its energy exports to Asia rather than the EU. Russia and China will conduct trade in Rubles and Yuan. Russia is starting to demand payment in Rubles from the EU. These are attacks on the hegemony of the US$ as the world’s reserve currency even though neither the Russian Ruble or the Chinese Yuan have convertibility and global acceptance as does the US$.

The world appears to be entering a potential period of economic, financial, geopolitical and social instability. Fear is in the wind. But is anyone paying attention?

Copyright 2014 All rights reserved David Chapman

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David Chapman regularly writes articles of interest for the investing public. David has over 40 years of experience as an authority on finance and investments via his range of work experience and in-depth market knowledge.

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