Forget the Fiscal Cliff. We may have another worrisome development on the horizon. There are three projections to be concerned with. We will look at each of these three projections in turn. Then, I will show a graph of how they are all converging on the middle of next year.
Let's start with a consideration of the dollar amount for the global debt problem. We all know it's there like a lion stalking the financial world. But what about a price tag for it? At this point, it is mostly in Europe, where the banks have about four times the assets of the US banks and are in about 10 times the trouble. There is some consensus on a price tag for all this trouble. As Don Stott of the Colorado Gold blog says in a June article "Keep On Printing",
The entire world is 'under water.' The total indebtedness of the world's governments is about $30 trillion, all of which is unpayable, other than with printing press money, or things which are similar but amount to the same thing.
And we have this assessment that I mentioned in my article Money Printing In Fractals,
In November, there was an article featured at Finance Examiner by Kenneth Schortgen Jr. "European Liquidity Crisis Has A Number: $30 Trillion According To Sarkozy." This is the total liability estimate of Olivier Sarkozy, brother of the French President.
So, $30 trillion is a debt price tag being hung around the neck of the markets. Keep that number in mind for later.
Now, for the second leg of the triangulation, let's look at a projection by David Nichols on the price of gold. It is debated on just how they relate, but the debt mountain and gold are closely linked. Nichols is a leading researcher into the fractal analysis of markets. Gold, he says, is one of the most fractal things around and is easily forecast. In his article last February here at SA, "The Next 17 Months For Gold", he noted one of the patterns in gold is a repeat of major peaks 21 months apart. He illustrates it thusly:
The last peak was last August, and 21 months from then puts us at June, 2013. A sharp run-up in gold into next June is implied.
And now for the third of the three triangulating projections, the concept of the bull market fractal. I've written a little about this (see "The 64 Month Bull Market Fractal"). You can study this fractal and other scales of the fractal in my other articles, but suffice it to say here that it shows up a lot in all kinds of major bull markets. The bull market of interest here is the one in money printing. The components of the fractal are twin parabolas separated by a downtrend of about a year.
The trickiest part of establishing a time line for the fractal is determining the "sprout point" for the first parabola. This is typically a change in trading behavior from a sleepy, sideways or gently rising pattern to a parabolic climb. We are going to apply this to money printing. Make no mistake, it is now a global bull market as The Big Picture blog of Barry Ritholtz clearly outlined back in January with "Living In a QE World". So to determine a start point for an associated fractal, I take the global eight central bank charts combined together into one graph. This has been done on an absolute basis and as a percent of world market capitalization. Because the normal condition (in a Keynesian sense) is market cap and central bank balance sheets growing in tandem, I use the percent of market cap chart to see the sprout point, where this 'natural' condition changes:
Here we see that the twin parabola fractal has formed and we are well on our way into the second parabola. Note the percentages on this chart. It is absurd to have over a third, approaching half of the world's
'free' market capitalization be central planning, central bank interference. They mean good. But so did the Soviet Union's 5 year plans.
The projection of this second parabola describing the global bull market in money printing into the future is the third shot of our triangulated gunfire at June 2013. In addition to showing up in so many past bull markets in general, the 64 month fractal has described many past episodes of runaway money printing. We like to think we are so much more sophisticated than Weimar Germany of the 1920s, but look at the way these three projections are triangulating in our day:
The 21 month time frame for the next gold peak, the $30 trillion price tag for the debt, and the 64 month bull market fractal for money printing are all coming together squarely at the same date - June 2013. Did the Mayans have all this figured out over 5000 years ago when they made their calendar stop at 2012?
The world probably won't end next year, but I wouldn't be surprised to see some major changes come about. Those major changes will likely boost speculation over inflation and deflation to a frenzy. Unlike most other opinions, Sarkozy says the ECB has been holding off monetization because of the massive inflation that will follow. Most economists you hear say deflation is the bigger threat.
Those that fear deflation fear owning gold. But to me, the whole inflation/deflation gold debate is a moot point. I think J.P. Morgan had it right when he issued his axiom "Gold is money. Everything else is credit". Think about it. Besides gold, the only other types of money are currency and credit. Currency is just an IOU from a government that can change how much they owe you with the flip of a printing press switch. In the Depression of the 30s, there was no inflation of the currency, it was the credit world that was messed up, and gold was grabbed up by the government (at a sharply marked up price) and gold miners skyrocketed while the rest of the stock market languished. In the '70s, we had no credit collapse, but the currency, unhinged from gold in '71, was eaten alive with inflation, and gold went through another massive bull market.
It is really the monetary instability that gold reacts to, whatever its form. In our present mess, one wonders if they will over-print or under-print to manage the debt write-off damage to the money supply in the economy. But does it really matter to the gold bull market? Whether it's the currency or the credit that gets whacked, the third form of money is going to benefit. Gold is money. Everything else is credit.
A prime way to avert the run-away disaster pictured above would be to simply write off big amounts of debt in a globally coordinated campaign. Global debt write-down is not a new panacea. It was a major part of the resolution of the Great Depression, and it is being talked about now as in this April article, "IMF Backs Scheme To Let Homeowners Write Off Their Debt". There is a lot of "friction" to this solution as the article notes. If you are a homeowner who has not bought beyond your means and have faithfully made all your payments, you, as a participant in the economy, will have to pay for the idiot who is hopelessly underwater. It is essentially taking from the sensible and giving to the reckless - a lot like the too-big-to-fail bailouts.
Speaking of bailouts, a recent article by Philip Booth pictures a reclining Greek philosopher telling us "We once were the cradle of western civilization. We may now be its grave." In the article, "Time To Get Real: We Must Write-Off Bad Debt", Booth states:
We really do need to start writing-off bad debt and ensuring that those who have underwritten that lending take losses. Shareholders of banks need to be wiped out if necessary. The providers of debt capital need to have their debt written down. There even needs to be mechanisms to ensure that depositors take their share of the pain. The fact is that people have taken on board debt and they are in no position to repay that debt. They should either be forced to repay, using punitive sanctions if appropriate, or the debt should be written off. This would certainly be very painful. Banks might go to the wall and people who have lent to those who cannot repay their debts might lose large sums of money. But this reality has to be recognized or major economies face years in the doldrums.
Those who are advocating a radical jubilee point to the problems of the Great Depression. Massive debt write down was done then, but in drabs and dribbles, a painful ten year peel-off of the Band-Aid. Why not rip it off and be done with it? Would this be a blow to most economies? Yes, it would be a liver punch with a lot of failed and crippled lenders. But this is exactly the kind of quick and painful cleansing that has traditionally taken place in past cycles in capitalism. How nice it would be to get the few bad players out of the way so the vast majority could plan on an approaching normality again. It has been staved off this go-around by overly clever, overly powerful central bankers who feel they are more important than the reality of the economic cycles. But the time for a fresh reset may be near. It could have a surprisingly good effect on the markets.
The angst over the global debt has a potential tidal wave of idle money pent-up in the good banks and corporate balance sheets. This money is being kept out of play until there are some dependable rules to play by. If they could get together on a global debt restructure that would not involve a systemic failure threat, the result could be a sped up version of what happened after the slower debt write-down of the Depression. From 1949-1966, the Dow went from 200 to 1000! Investors enjoyed the same kind of double digit gains year after year that were given by the market in the '80s and '90s. It was a glorious bull market that doesn't get much press. A more rapid debt write-down could mean the soon return of this kind of market. Moreover, I really don't think that corporate balance sheets and the banks had as much Fed assisted cash waiting to be unleashed in the 1940s as they do now. The release of this money could be helpful in repairing the money supply damage of the write-downs and may not present an inflation threat.
If we get to such calmer seas as a new debt-lite bull market with a coordinated debt write-off, the transition will be treacherous for investors. The obvious danger is a sudden bout of deflation or inflation. Stocks could dart up or down. Perhaps the best safeguard that comes to mind is a good hedge fund that runs a 50/50 mix of long and short positions. But those aren't outperforming all that impressively on average these past few volatile years, and for most of us that aren't qualified investors, they are a mere academic interest.
There are several new ETFs that seek to give protection against whatever inflation does, such as WIP, GTIP, OTC:TIPS, CPI, RRF, and FLOT. But these are typically very complex, hedged in all directions, and flat performing no matter what happens. Cash would be about as good. Many of these ETFs are bond based, and bonds make me nervous. If a jubilee is done, one of the lenders to be hurt would obviously be bondholders. The foolish lender list paying the price of a restructure may feature those who lent to an overspending, inept, out-of-control-government that was basically insolvent at the time. Might they have to pay for their stupidity?
If you really want something that looks like a complicated, bond based, hedged-in-all-directions investment vehicle but with returns more like that of a risk asset, look at the gold royalty stocks. There are just two big, well diversified names here, Royal Gold (NASDAQ:RGLD) and Franco-Nevada (NYSE:FNV). If you look at a performance comparison chart (such as the Yahoo Finance charts) of RGLD alongside GLD, the gold price ETF, or AGQ, the 2X silver price ETF, or the S&P 500, or any of the gold stock ETFs over the past few years, you see a smooth, big outperformance of RGLD over all of these alternatives. You can't see much evidence of any big Dow crashes or gold stock crashes for that matter in the chart for RGLD. This investment has nearly tripled the past 5 years and is currently near its all time high despite the gold stock malaise. FNV is very similar but has actually outperformed RGLD and is at a new all time high.
What is so different about these investments? They are essentially a finance company that provides capital to miners in exchange for an agreed upon percent of their future gold sales. This one simple concept accomplishes a boatload of defenses against market uncertainties. For one thing, it takes individual gold miner risk out of the equation. But why do they vastly outperform any gold stock index?
Well, they strike these deals based on a price of gold at the time and subtract some cash cost for production at the time. Then the miner uses the capital given to them to develop production over the years while both the price of gold and the cost of production go up. By the time the percent of production comes rolling in, RGLD is making a production profit that is in another ball park from the miners. Buying RGLD has been compared to buying a call option on gold with no expiration date. It's also like a twenty year gold futures contract. The income statement for the company is marked by a net profit margin that can run around 40% with the biggest single expense being income tax! Gold could drop dramatically and RGLD would be profitable. As of early 2010, most of the deals for Royal Gold's mines were struck at a $480-$780 gold price.
The gold royalty model is perfect for credit problems and deflation. In the 2008 crunch, miners who derived much of their revenue from base metals associated with their mines found both their product prices plummeting and their capital credit impaired. Royal Gold was able to strike lucrative deals with these hurting miners. Both RGLD and FNV aren't hurt by deflationary base metal problems as so many miners are who must extract many metals together for their business model. The gold royalty companies can zero in on just deeply discounted gold.
These companies are ideal for investor angst over inflation/deflation periods. And that's probably what we will have for many years if no global debt solution is found. We will have a compressed, even more dangerous period like this if a global debt jubilee is attempted.