Turning business cycle in cards sets gold a global frontrunner
Several recession indicators have flashed warning signals in recent days. There are cyclical highs in consumer confidence when the spread between “present situation” and “expectation.” In the 1970s, this spread was as extreme as it is today, just before the burst of the tech bubble and the 1973-4 recession.
It may just be a coincidence, but the S&P 500 tech sector is almost as overvalued compared to the overall market as it was in 2000 when the tech bubble was at its height. It is worth noting that the ratio matched the exact level we saw in March 2000 right before technology companies suffered from a bear market in the next two years. According to our view, this sector will not lead equity markets in the near future, and these companies are at a significant risk of being rerated at significantly lower prices relative to their fundamentals.
Equity markets have adopted insanely speculative stance
A combination of easy-money policies and excess liquidity has led to one of the biggest distortions in asset valuations in history. Fundamental multiples across almost every market index we follow are currently very high. To reach peak Tech Bubble levels, the US market cap to GDP ratio will need to fall another 15%.
Various research indicates that the S&P 500-to-gold miners ratio will continue to decline. There has never been a more compelling macro and fundamental argument for owning precious metals companies over overall stocks.
Why bullions can make a difference this time around?
There are many parallels between today and the period 1968 to 1971 with which we have been in a de facto Bretton Woods system for the last several decades. The possibility of moving away from Western central bank cooperation is real, as it was then. A global supply shortage of commodities is making it difficult for the world to deleverage debt-to-GDP globally by devaluing fiat currencies.
As a result of the coordination between western central banks, gold has been suppressed against dollars, euros, yen, etc. In addition, these countries have created historical debt-to-GDP levels that put a tremendous strain on the system. Here is the best macro academic paper on the Collapse of the London Gold Pool and end of Bretton Woods: https://economics.ucdavis.edu/events/papers/copy2_of_417Bordo.pdf. It is a must-read because it discusses the bigger issues surrounding “central bank cooperation”.
The failure of the Bretton Woods system was not caused by deflation as posited by the Triffin dilemma, but rather by inflation. We face the same problem today. A set of unsustainable macroeconomic extremes has led to inflation that has become unhinged and is likely to spiral even further. We will find many people slow to give up their conviction that too much debt in the world inevitably leads to deflation. At this point, we believe people would benefit more from realizing inflation is the most straightforward means of deleveraging debt to GDP.
Inflation is taking off and history will repeat itself
In 1968, when De Gaulle departed the London Gold Pool, France repatriated gold from the UK. Even though the dam had already begun to leak in 1971, it was not until that year that it actually broke. Investors who think ahead may be able to stay ahead of the curve, but within what timeframe?
Investors, financial institutions, and central banks themselves will be forced to abandon Western sovereign debt systems in a short period of time. It is our experience that the inherent problem with central bank cooperation is a “prisoner’s dilemma”, a game theory problem that will ultimately lead to the system’s collapse. We believe we are finally at the precipice of change after a long and difficult journey.
It does not mean that we will see the end of the Western banking system, nor will we see the rise of authoritarian governments and their fiat currencies as much as we have been led to believe. This does not necessarily mean the rise of intangible currencies not backed by governments. These systems will still be subject to government control and legal authority. Individuals and businesses will use those currencies.
As long as advanced economies adhere to the principles of liberty, justice, democracy, entrepreneurship, and free markets, fiat currencies are likely to thrive. In today’s macro environment, inflation is expected to deleverage the global economy, including a definitive step-function devaluation of all fiat currency systems relative to gold, a persistent feature throughout human history.
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