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Address to the Spring Dinner of the Committee for Monetary Research and Education ( May 17, 2012
Policymakers Are Getting Margin Calls

Bob Hoye
Institutional Advisors
Posted May 22, 2012

Many in this assembly would agree that policymaking has been the biggest promotion in history and in recent desperation became unusually reckless. Since the crisis began in 2007, Mother Nature has been issuing margin calls on governments. What's more, even with the most complacent of taxpayers governments will not be able to meet the margin calls on their own folly. But to be fair, the establishment has had some moments of glory.

The feature of the 1970s was a horror show of soaring inflation for commodities, wages and consumer prices. Eventually, many in Wall Street realized that inflation had something to do with money supply and the critical numbers were released late on each Friday. Repeat "late on each Friday". Often the numbers would prompt big moves in the bond market so traders had to stay at their desks – until late on Friday. No early weekends.

Then the Fed changed the release day to Thursday. This has been one of the most brilliant of policy moves, ranking right up there with the New York Stock Exchange ending trading on Saturday mornings.

The rest of the history of policymaking has been "same old, same old" to the point where I recently had a startling revelation. Ninety percent of all central bankers who have ever lived are alive today.

Daunting isn't it?

It gets worse. Ninety-five percent of all the reckless central bankers in history are alive today.

If that isn't bad enough, 90 percent of all of the gold bugs in history are alive today.

To be serious, the gold bug original assessment of central bankers has been appropriate as is current condemnation.

However, we are at a fascinating point in history when Mother Nature and Mister Margin take apart all the schemes of financial promoters. Actually, financial history provides an impartial due diligence on all of the grand promotions – including interventionist economics and central banking.

Also financial history indicates that the massive experiment in government intrusion is coming to an end – thankfully.

Why do I state this?

In the past 2,000 years there have only been three great experiments in authoritarian government and each was accompanied by deliberate currency depreciation. Of interest, is that each ran for around one hundred years and can be called a Century of Tyranny.

Then a major change in politics ended the game. The mechanism has been simple. Essentially, the state spent, borrowed, inflated and taxed away all of the wealth. Consequent hardship became widespread and forced folks to tighten their belts, who in turn, forced local and federal governments to tighten theirs.

The last such century ended with the financial contraction that began with the 1618 crash. Details are fascinating and even amusing, but time only permits one important irony. The hardship prompted intellectual concerns such that Edward Misselden theorized that throwing credit at a credit contraction would make it go away.

That was in 1622 and any number of intellectuals have since had the same revelations. John Law was the next big name to make the personal discovery as he was becoming the first reckless central banker during the first huge bubble that blew out in May-June of 1720.

In London this was labeled as the South Sea Bubble and in Paris it was the Mississippi Bubble. This extravaganza set the pattern on all five subsequent great bubbles – right out to the 2007 example.

The climax of each bubble has had enough common features to conclude they are methodical.

  • Government has a vested interest and will do anything to keep the boom going. In 1720, England was on a bi-metallic standard but quasi- government agencies such as the South Sea Company and the Bank of England provided plenty of ease to accommodate speculators. Also, politicians were bribed. In France there was no restraint upon currency issue and John Law had some eight printing presses running and he could not keep that bubble from lasting past its "best before date".

  • This one is worth repeating – real printing presses could not keep a mania going.

  • Typically in the year the bubble maxed out, gold's real price set a significant low. And then increased for some twenty years.

  • Since the calculation of the Consumer Price Index became compromised we have used a proxy and that is the price of gold deflated by our commodities index. This set a low of 143 in May 2007 and turned up as the credit markets turned down. Eventually to disaster.

  • Another example of methodical is that most booms run for 12 to 16 months against an inverted yield curve. In early 2007 we counted the reversal to steepening out to June of that fateful year. Along with gold, the change began in May and that included spreads reversing to widening.

In bringing this up to date, the panic ended in 2009 and liberated the first business cycle out of the crash. This has become mature and, globally, the economy is rolling over right now. This will prove that all of the stimulus was in vain. Particularly so, with the knowledge that the fundamental post-bubble condition is severe recessions and weak recoveries.

Policymakers did not prevent the bubble from climaxing, did not prevent a financial collapse, could not restore a "normal" business cycle and haven't a hope in hell in preventing this recession.

In which case, central bankers have not materially altered financial history, and in taking a larger perspective they have played an important role in assisting a great bubble. Beyond this, it will become evident that their main function has been to fund another experiment in unlimited government through depreciation. What's more, it is unwinding in the same old way.

Relatively high unemployment that hurts, especially with the governing classes still living well. This is a classic – what's new is the extortionate monopoly of unionized workers at local, state and federal levels.

Similar dissatisfaction with the governing classes in Eastern Europe in 1989 brought down one of the most murderous police states in history. The state had tanks, AK 47s and the Berlin Wall. The public will prevailed.

The current administration is pushing America's experiment in authoritarian government to an alarming level. Or, according to David Alinsky, to the ideals of his father's Rules for Radicals, which intends to transfer all power to a community-organized mob.

In this case, all the administration has is propaganda on how good Obama's ambition for change is and that won't fly.


The economy can't afford existing levels of government take, let alone a massive increase.

The irony is that while the administration has been building the regulatory equivalent of the Berlin Wall, the opposing political will is beginning to take it apart – brick by brick.

When will it get exciting and what has this to do with gold?

Credit markets have been likely to be benign into May and then reverse to another disaster later in the year. With this, many asset classes will decline with some suffering forced liquidation, and this will again curb the ability of the Fed to print. The old pushing on a string problem.

Another methodical feature of the post-bubble world is that the senior currency eventually becomes chronically strong relative to most commodities and most currencies for most of the time. One explanation has been that during the mania most of the debt issuance is due and payable in the senior currency in the financial capital. It used to be sterling and London, now it is dollars and New York. Such debt service represents a huge short position.

Technically, the Dollar Index has been in a pattern that is leading to a major advance. This is confirming the historical imperative of a firming senior currency.

Now, as we can all imagine an outbreak of sound money will be disquieting to central bankers as well as to those "banking" upon the status quo of depreciation. Don't toss out your gold positions because of the resumption of another liquidity crisis. Gold stocks are unusually cheap relative to bullion and have recorded a significant departure from the longer trend of the stocks correlating well to the advance in the dollar-price of gold. That pattern ended during the completion of our late bubble in 2007.

This has been frustrating as base metal mining stocks were outstanding performers into 2008 and 1Q2011. Particularly as they outperformed metal prices when gold shares were underperforming bullion prices. This is typical of the conclusion of a bubble. The best time for the gold sector has been during the post-bubble contractions when the mechanism is the equally long advance in real prices for gold. Reliable copper data are available since the 1830s and the real price has generally declined through the three subsequent Great Depressions.

For traders, market historians and supply/demand researchers, this becomes very interesting. On three Great Depressions when sterling was the senior currency and the calculation of the CPI was reliable, gold's real price increased by a factor of 1.7 times. No matter what was going on in domestic politics or foreign affairs, gold's price went up by the same factor.

Despite the consistency of each advance, the associated increase in gold production varied all over the place. In the 1825 to 1846 Great Depression annual World gold production increased by a factor of ten times. With the same price increase during the 1873 to 1895 Great Depression gold production only doubled, which was the case during the post-1929 Great Depression. This suggests that trying to determine gold prices from even a thorough analysis of supply and demand may not be practical. This, of course, includes all of the informed comments about the Indian monsoons and the number of camels in the Arab souks.

To be serious, there is a methodical and obvious reason why Mother Nature increases gold's real price during a Great Depression. She wants production to increase.


During a great financial mania normal instruments of credit expand inordinately. As if this isn't bad enough, new and weird instruments are created. In our own new financial era the madness created derivatives, such as "credit default swaps", and even "contingent credit default swaps". In the 1720 madness a bewildered participant wrote "The poor English nation run a madding after new inventions, whims, and projects [promotions] ... They can ruin men silently, undermine and impoverish, fiddle them out of their money by strange, unheard of engines of interest, discount, transfers, debentures, shares, projects, and the Devil and all of figures and hard names."

Then, both normal and innovative credit instruments contract within a brutal disappearance of liquidity, otherwise known a crash. This in turn inspires policymakers to throw credit at a credit contraction to make it go away, which never worked in the past.

Fortunately, Mother Nature has had a methodical way of restoring liquidity to the global banking system. She raises gold's real price such that mine profitability improves and production increases. Gold companies make money when most industry and commerce are having trouble staying alive.

For example, Homestake was the premier producer and its earnings were hit in 1929 largely due to the weak real price that goes with a bubble. Gold was fixed at 20.67 per ounce then and until the end of 1932. The stock soared by 130 percent as earnings increased by a similar amount. All with no change in the dollar price of gold. Then Roosevelt got in line with history and assisted the natural increase in gold's real price.

Homestake stock could have been accumulated during 1930 at 9 dollars. It soared to 65 during the mid-1930s and was paying 4.50 per share in dividends. Canada's big producer Dome Mines soared as well, as did many, many juniors.

My own experience in the exploration business began with a degree in Geophysics and a couple years in the field. Then, like a fool, I made money on my first stock purchase and thought I was a genius. No more living in the bush as I got an indoor job with a large investment dealer in Toronto. In 1965 I noticed that on any given day when New York and Toronto were strongly up, gold stocks would be strongly down, and vice versa. I asked a veteran on the equity desk "Why?". He said "That's the way it works".

It wasn't until the 1970s when the historical research was really advancing that I realized that gold miners did well in a depression and that was still driving the action. Then for a couple of decades such opposing action was barely evident.

Last September, gold set a high of 1900 and, for example, Royal Gold registered an Upside Exhaustion. That's technical talk for a buying panic.

September also recorded selling pressures in orthodox stocks with the selling panic in sovereign debt. The point to be made is the opposite action came in as gold stocks went up as the big board went down.

Move ahead to this spring when opposing action was again in play. Orthodox stocks up as gold stocks declined. Now both are down, but with the distinction that the golds are really down.

How much?

In a hundred years of data, starting with Homestake and changing to the XAU in 1983 there was only one selloff to a monthly RSI worse than now. That was a reading of 21 in 1924. Now its plunged to 23.9 and the "terrible" lows were few in number. 24.8 was clocked in 1942, 27 in 1948 and 25.3 in 2008. That's the list and all were followed by outstanding rallies – virtually immediate to the reading.

Action in the gold/silver ratio has provided an outstanding guide to important tops and bottoms. This worked very well a year ago in April and silver's action now is accomplishing the opposite extreme.

The S&P is nowhere near such a severely oversold condition.

Market history is poised for the start of the next stage of a lengthy bull market for the gold sector and within a global recession – an even more compelling condemnation of policymaking.

As welcome as this would be to many in our assembly, it is worth noting in closing, that there is no guaranty that financial history will continue along the path that accomplishes another Great Depression. On the other hand, there is no guaranty that it won't. It is prudent to consider the odds.


May 17, 2012
Institutional Advisors

321gold Ltd