Zozobra | ByteTree

The annual In Gold We Trust Report has become the most keenly awaited
publication in the gold world. It is fact-filled and covers every aspect
of the market. In this issue, I edit the highlights. I also look at the
melt-up in stocks, the gold regime, the Yuan and the Yen, and so much
more.

Highlights

In Gold We Trust Report Highlights

Our friends at Incrementum produce the In Gold We Trust Report, a 415-page monster
on everything relevant to gold. It’s a big read, and I am going to cover
the highlights that I believe are the important takeaways from an
investment perspective. There are other fascinating sections covering
history, exchanges, and geopolitics, which I will leave to you. One
thing you can be sure of, the IGWT Report is reliably and
unapologetically bullish gold.

Much of this section comprises direct quotes taken from the IGWT
Report. Editing, elaboration and mistakes are all mine.

Debt and Demographics Drive Structural Inflation

Global debt levels are off the scale and nowhere more so than in the
Western developed economies. Society doesn’t discuss this much because
it is too frightening to bear. As an example, interest payments in
Germany are skyrocketing, while interest rates are still only 3.25%.

One problem has been the issuance of inflation-linked bonds, which have
become a fiscal own goal. Although inflation-linked bonds account for
only 5% of total German bond issuance, they make up 25% of total German
interest payments on government debt.

In the USA, the national debt is now USD 31.4 trillion, or 121% of GDP.
The idea that an economy can grow out of debt has always been dubious.
To ease the burden on sovereigns, central banks could soon use the
instrument of yield curve control (YCC). There is precedent in Japan.

For the federal budget of the USA, the refinancing requirements in the
coming years represent a considerable burden. According to calculations
by Horizon Kinetics, the USA will have to refinance half of its national
debt of more than USD 35trn by 2025. Should the financing and
refinancing succeed at an average rate of 4.4% and the remaining
interest on the national debt remain at around 2.4%, the interest
service would more than double to USD 1.2trn by 2025.

In the words of Mohamed El-Erian,

“The world’s most powerful central bank is now confronted with two
unpleasant choices next year: crush growth and jobs to get to its 2 per
cent target or publicly validate a higher inflation target and risk a
new round of destabilized inflationary expectations.”

IGWT showed the bond-equity relationship since 1955. When interest rates
have been low, bonds and equities have moved in opposite directions. And
when rates have been higher, they have moved together. If rates remain
high, then equities and bonds are in competition for capital, and given
only equities provide some protection against inflation, bond yields
will have to rise further.

They see inflation as structural. The demographic change where the
population is ageing means there are fewer people in jobs, and they will
demand higher wages. Zoltan Pozsar believes the labor market is
ridiculously tight, and unlike El-Erian, he doesn’t think unemployment
is going to go up much during this hiking cycle. He added,

“people go on strike not because the price of flatscreen TVs goes
up, but because the prices of food, fuel and shelter go up and you can’t
make a living… low inflation is over and we’re not going back.”

There’s also deglobalization and friend-shoring, as the West turns its
back on China. Whatever you think about China, they seem to be able to
make things more cheaply than anywhere else, meaning prices will have to
rise as the world rebuilds supply chains. This transition, including the
vast investment in green technologies, will require capital, all at a
time when geopolitical tensions remain high. According to Russell
Napier, we need to rearm, re-shore, restock and rewire. That sounds
expensive.

Bringing it back to gold, IGWT said we live in times of “Zozobra”, a
Spanish term for a specific fear, with connotations reminiscent of the
swaying of a ship that is about to capsize. The term emerged as a key
concept among Mexican intellectuals in the early 20th century. Zozobra
refers to the feeling of losing one’s footing, of feeling out of place
in the world, or of not being able to make sense of what is happening.

From West to East

This chart says it all. The central banks bought gold until the late
1960s when it played an official role in the financial system. When that
came to an end, they couldn’t unload it quickly enough. That lasted
until 2009, the aftermath of the great financial crisis, when the
central banks resumed their purchases. No one told them to buy gold, nor
was there a collaboration. They figured it out by themselves, and last
year saw record gold demand from the central banks.

Who’s buying? The list includes Egypt (47t), Qatar (35t), Uzbekistan
(34t), Iraq (34t), India (33t), the United Arab Emirates (25t), Oman
(2t), the Kyrgyz Republic (6t), Tajikistan (4t), Ecuador (3t), the Czech
Republic (1t), and Serbia (1t). The World Gold Council reported
“substantial” unreported purchases from institutions, amounting to
roughly 50% of all purchases. Not all countries report their gold
purchases regularly, including China and Russia.

Who’s not buying? The over-indebted countries in the developed world and
professional investors.

The IGWT Report told the story of how, when visiting Saudi Arabia,
China’s President Xi was met by a grander reception than US President
Biden received. This symbolizes the change in world order, and when the
Western military left the Middle East, there was peace.

Collectively, the emerging markets account for 87% of the global
population, 76% of the total land area, 44% of global GDP (up from less
than 20% in 2000), 76% of global GDP growth over the past 20 years, and
76% of global foreign exchange reserves. A respectable chunk of those
reserves will find its way into gold.

The gold is flowing from west to east. The West seems to have less
influence and less relevance. The dollar remains the reserve currency
but not everywhere. We will see more trade being carried out in other
currencies, especially the Chinese “Petroyuan” and in the CBDC that
follows.

We still think of the gold market in terms of London’s physical LBMA
market and the US Comex futures market, but new exchanges are popping up
all over the world. The center of gravity of the gold market is moving
eastward.

Digital Gold and Intrinsic Value

Incrementum, like ByteTree, proudly sits in the Bitcoin AND Gold camp.
Just as ByteTree has its Bitcoin and Gold Index (BOLD), Incrementum has
a Digital and Physical Gold Fund. Our companies were twinned at birth.

For many, it is a battle of Bitcoin OR Gold, where there can only ever
be one answer. IGWT points out that these assets are complementary, with
each having advantages and disadvantages over the other.

IGWT considers Bitcoin to be a ground-breaking monetary invention that
they expect to continue to gain significant relevance. They want to
address some of the misconceptions that gold investors hold regarding
Bitcoin, and vice versa, thereby highlighting the positive aspects of
both assets. Ultimately, they aim to strengthen the case for investing
in both assets to bridge the gap between the two communities and
contribute towards harmony and collaboration within the sound-money
camp.

Peter Schiff, the vocal gold investor, said that Bitcoin can never be
money:

“Bitcoin has all the properties, except the most important one.
Without that property, gold would never have been money. I’m talking
about value. Intrinsic value of the metal itself. You see… Bitcoin
doesn’t have any.”

In my opinion, Bitcoin has no intrinsic value if you believe the network
has no value. On the face of it, Bitcoin, the thing, the reference in
the cloud, the bunch of numbers, is worthless. That is until you realize
that many other people want that reference, deem it to be valuable, and
furthermore, there is a deep and liquid market for Bitcoin in both bull
and bear markets.

Schiff overlooks that it is much harder to create a vast and lasting
network than it is to create physical intrinsic value. Everything in the
real world (trees, cars, broken spoons) has some intrinsic value, but
only a few things can brag about having a deep and liquid market. Most
assets are hard to schifft.

To attribute gold’s value to its physical attributes is to miss the
point. Its beauty, conductivity and shine have broadened its appeal over
time, and no doubt gold the element has significant value. What makes
gold even more valuable as a monetary asset is its scarcity and its
liquidity (network). The value of gold-the-monetary-asset is
substantially greater than the intrinsic value Schiff refers to.

Gold is a hugely liquid market, which is another way of saying it has a
vast network. The gold price comprises the intrinsic value of gold in
addition to the monetary premium on top. If the world’s central banks
didn’t own gold, and its liquidity declined, the price would be a lot
lower than it currently is. Without liquidity, the price of gold would
fall until it reached its intrinsic value.

I believe Schiff is accrediting too much value to gold’s beauty and
physical qualities. Gold’s real value, just like Bitcoin’s, comes from
its network and role in the financial system.

Incrementum’s Mark Valek said, “Owning Bitcoin and Gold means being
short fiat.” I like that. There is much more in the IGWT report, and I
thank the IGWT team for yet another excellent edition. And a Happy
10^th Birthday to Incrementum AG.

Equity Boom, Bond Bust

The long-term charts of equities, bonds and gold allow us to focus on
the big picture. For bonds, I show price, as opposed to total return,
which is simply a synthetic zero-coupon bond. Over the past 60 years,
shares have risen 69x, gold 55x and bonds 1x. I agree that excluding
dividends is mean on both bonds and equities, but this is about levels
and correlations. 1x for bonds is simply saying the long bond yield is
the same today as it was back then.

The Equity Bond Spread Just Made an All-Time High

Source: Bloomberg

The red line shows equities relative to bonds. It enables us to identify
periods of excess, such as 1982, 2000 and 2018. Perhaps even today, as
it is at an all-time high. I highlight this chart because historical
extremes should not be ignored.

It also reminds us that during inflationary times, such as the 1960s and
1970s, bonds fell while gold surged. Equities fare somewhere in between,
but crucially, they outperform bonds, as seen by the red line rising at
the time. Furthermore, there are times when equities and bonds have
moved together and times they have moved apart. As said in the IGWT
report, they become correlated in a higher-rates and inflation
environment.

I hear some say inflation is over, while others think it’s just resting.
The recent US inflation data was published broadly in line with
expectations. CPI over the past year is a mere 4%.

US CPI Monthly

Source: Bloomberg

I will separate out the two types of inflation. Firstly, core, which is
services (wages) and finished goods. This appears to be sticky, as
Zoltan told us it would be.

US Core CPI Monthly with Goods and Services Shown

Source: Bloomberg

Then there’s food and energy which have fallen. CPI for food and energy
is essentially zero because commodities are in a bear market. That won’t
last forever, and the next up cycle will see them buoyant again.

US CPI Monthly with Energy and Food Shown

Source: Bloomberg

It’s going to be a long fight for the central banks. To get services and
goods prices (reshoring from China) down, they’ll need a recession. Or a
Chinese devaluation.

Yuan, Yen and Gold

A Chinese devaluation is underway, and the question is how far it will
go. China has a debt crisis and according to Ambrose Evans Pritchard who
wrote a piece in the Telegraph “Forget inflation – deflation is the real danger”.

He highlights how Chinese producer prices are falling sharply, and the
threat is that China spreads debt deflation. China needs to export their
way out of their situation and will not hesitate to devalue their
currency to sell more goods. As more gold has moved east, the
correlation between the Yuan and the Gold price has risen.

A Yuan Devaluation May Not be Good for Gold

Source: Bloomberg

He’s inevitably right about China, but I am less certain about how far
it spreads. If we get deflation, they’ll start printing money again,
which will drive a wedge between the east and west. Gold will like that.
Besides, Chinese wealth will surely buy gold in size to protect
themselves. After all, it is working in Japan, where gold is +14% this
year in local terms. Here in the UK, it’s up a mere 2%, as the pound is
on a tear.

The pound vs yen is back at a level that should frighten us. The last
time the yen was trading at a 50% discount to its purchasing power was
in 2007. Like today, the yen fell while Europe and the US hiked rates.
The emerging banking crisis saw rates collapse, and the yen smelt that
coming. By the end of 2008, the yen had rallied 89% against the pound,
and 105% by the end of 2011, when gold peaked.

Buy the Yen

Source: Bloomberg

In markets today, there are too many of these extreme relationships, and
they should rightly keep investors level-headed. Own some gold, own some
yen.

Hike ‘til Gold Breaks?

I don’t know what the Fed believes, but it could be that they want to
see gold break as evidence that they are done with the rate hikes. With
CPI down to 4% and rates at 5.25%, the real rate is 1.25%. When I
studied this a few years ago, I concluded that gold stalled when the
real rate was above 1.8%. We are close.

Gold and Rates

Source: Bloomberg

Of course, if the Fed pivots instead, then the downward pressures on
gold will subside. Gold will then break back above $2,000, and the bull
market will resume.

Right now, equities have it. The S&P 500 is inching higher, and the
ByteTrend score for gold vs equities has dropped from a 5-star trend to
a 1-star. In late 2012, this indicator gave the first warning of danger
ahead for the gold price.

Source: ByteTree Terminal

Looking at the 10-year bonds, the yield is 3.8%, while interest rates
are at 5.25%. Another sign of madness in markets. If there’s no
recession, then that 10-year yield will push above 5%, and that would
surely see not only the gold price crash but equities and the yen too.
It’s a strange thought but in keeping with the everything bubble
narrative.

Tightening Conditions

Source: Bloomberg

Of course, gold would not mind the 10-year at 5% if only inflation
expectations would follow. It’s all about long-term real rates (blue
line), which are rising. That makes gold uncomfortable.

At 43%, the gold premium to TIPS (inflation-linked bonds) is
substantial. This premium blew out as Russia invaded Ukraine, and so we
can only assume the gold premium represents a divided world.

A Divided World or a True Picture of Inflation

Source: Bloomberg

Either that or gold is telling us that TIPS are plain wrong and
long-term inflation will be 3.5% rather than 2.2%. That seems to be
quite likely, especially when you hear that inflation swaps are priced
according to Fed forecasts. Imagine that.

I believe we should assume that gold is the more accurate inflation
barometer than TIPS. But if Jerome Powell manages to hike ‘til gold
breaks, then the world will be in real trouble.

Gold on the blockchain

Congratulations to Gold Token (SA) on the relaunch of their Digital Gold
token (DGLD). DGLD is tokenized gold that provides
digital proof of ownership of gold bullion bars, starting from as little
as 0.01g. All of the gold is held physically in a vault in Switzerland,
off-balance sheet, and is fully insured. This means you can swap or
redeem your token for physical gold.

I asked James Bennett, CEO, and incidentally ByteTree’s former CEO, what
the benefits were of tokenizing gold. He replied,

“Financial infrastructure in DeFi brings efficiency to the markets.
We need to bring real assets into digital finance. Equities, bonds and
other financial securities face regulatory hurdles in being tokenized.
Gold is different because it can be held in allocated physical form.”

If you are following the chaos in crypto over the pond, caused by the
SEC, there is still much confusion as to what constitutes a security. It
has caused major firms such as Silicon Valley VC and Andreessen Horowitz
to establish their crypto operations in London. Remarkable but true that
the UK prime minister is a crypto fan (I bet he’s long DOGE). He should
send a signal to the City that crypto is real and reverse the ban on
crypto ETPs, starting with the excellent BOLD SW.

I then asked James what differentiated DGLD from the other gold tokens.

“There are lots of gold tokens out there, but they fail to recognize
the opportunities. DGLD is specifically designed to interact with DeFi
by being the simplest form of gold on the blockchain. There are no fees
for transfer or custody. We make money by being a conduit between the
physical and the digital gold, and trading operations.”

DeFi, or decentralized finance, is the future. DGLD is well timed
because London is a growing crypto hub. I believe all securities will
end up being tokenized, along with currencies (CBDCs and stablecoins).
This is the future of finance. What Andreessen Horowitz know, yet most
people still don’t, is that sooner or later, we won’t need the banks
anymore. That’s DeFi.

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Summary

Gold works well during times of Zozobra. Somehow, I can’t see that going
away anytime soon.

I have been writing Atlas Pulse since October 2012. If you wish to
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