That keeps me searching for a heart of gold
And I'm getting old."
Note: Pretty cool to see a musician in his prime, playing instruments, singing his own lyrics, and just enjoying himself.
Something has been bothering me for some time now (OK, a lot of things bother me, or as my daughter says, "I have issues"). In this particular case what bothers me is the following graph:
Over the last 6 years Gold bullion (GLD) is up about 150%, while Gold Mining Stocks (GDX) are only up 30%.
Historically gold and gold miners would move in tandem. In fact the miners were seen as a beta play on gold, when gold went up the miners would go up more, and when gold went down the miners would go down more. Clearly something is amiss, especially over the last year. Gold miners have significantly underperformed the glittery metal they are supposed to track...why? Well, like most things in the investment world there are no perfect answers, but here are a few observations:
--In the last few years several gold ETFs have been launched, and have become the de-facto way to own gold without taking physical delivery of the metal. The GLD ETF has assets of about $70 billion, which ranks it as the worlds 6th largest holder of gold, just behind the French and ahead of the Chinese and Swiss. Historically when investors wanted to invest in gold they had to use futures, or take physical delivery of the bullion. But with the creation of gold backed ETFs investors now have an extremely liquid and inexpensive way of owning gold. With the availability of gold ETFs, gold miners have lost a major support to their stock price.
--Gold mining has always been a tough business, and it certainly hasn't gotten any easier in recent years. Increasing environmental, social, and government challenges have made it tougher and tougher to replace supply. Just look at Randgold and the recent coup in Mali.
--Gold mining isn't always very profitable. Significant increases in energy and mining costs have squeezed profit margins even while the gold price has risen.
For me gold is an insurance policy against government stupidity. We own it to protect ourselves from currency devaluation. We used to own a combination of gold ETFs (GLD) and gold mining ETFs (GDX), but since gold miners are no longer acting in unison with the gold bullion we are eliminating our mining ETF and sticking with the bullion. Gold is currently at a neutral weight of 7%.
Is Ballooning Federal Debt Killing The Feds Independence?
March saw another record fall, and unlike our beautiful weather this record was not a pretty one. Our federal government spent $369.37 billion in March, or about $1,190 for each American man, woman, and child. I know it's hard to figure out where your family of four's $4,760 went last month, but I'm sure it was put to good use.
The more troubling part of the release was that our federal government only collected $550 from each American in taxes. That means they had to borrow more than half of what they spent. It's a good thing so many around the world seek to fund our extravagant ways in return for 2% interest.
Its kind of funny to look at all the press coverage the Presidents Millionaire Tax is getting. By taxing all of those nasty millionaires at a minimum 30% the President hopes to raise $5 billion a year. That $5 billion a year in additional revenue is about 10 hours of spending!
A common man may look at this and say, "It can't continue." And he'd be right (eventually), but it has continued for a while now. Since 2000 our federal debt has grown from $5.7 trillion to $15.2 trillion currently! Thats 166% growth in debt. Over the same time period our expenditures have grown by 101%, GDP has grown by 52%, and revenues have grown by 14%.
Fortunately for our government, one expense that did not increase by much over the last decade has been interest costs. Even though debt ballooned 166%, interest expense barely moved. Thanks to the willingness of investors and the Fed to purchase Treasury securities at minuscule yields.
Here is a picture of where the growth in federal outlays has come from since 2000:
Clearly the Fed has been working overtime to keep interest rates near zero (ZIRP), that is the only part of the pie that the Fed can control. The rest of the pie is controlled by those elected officials in Washington. We all know how to balance a budget; cut your spending and increase your income. Sounds simple, but in order for cuts to be made that means promises must be broken, and broken in a big way. There are very few in Washington with the backbone to do this (except for Ron Paul). Raising revenue is also an alternative. But lets take a quick look at the following chart:
The US is aging rapidly, and with this aging comes an increase in expected benefits, and a decrease in those working to pay for them.
The economic collapse in Greece is a good case study. Employment statistics are often manipulated, sort of like corporate earnings. When analyzing corporations we often look at revenues, since it is much harder to manipulate revenues than earnings. When looking at a countries employment statistics I've found that it is far more telling to look at total employment than the governments unemployment rate. In Greece the official unemployment rate is 21.8%, while not a pretty number it pales in comparison to the actual number of Greeks employed. In Greece the number of people working is 3,880,120, out of a population of 10.8 million. That's right, only 35.9% of all Greeks are working! In other words, 35.9% are working to support the other 64.1%, and pay off their debts. No economy in the world can service a mountain of debt that is 160% of GDP with only 35.9% of the population working.
Our numbers here in the US are certainly better than in Greece, but the trend has been the same. In 2000 64.7% of Americans worked. Today, only 58.5% of Americans are employed. That 58.5% must take care of the other 41.5%, as well as service that massive $15 trillion debt. Again, the demographic graph above shows that this situation will not be improving in my life time.
Investment Implications:
The Fed, like the Central Banks in Europe, have lost a significant part of their independence. Their number one job is now to keep government interest rates as close to zero as possible. Our economy can not handle an explosion in borrowing costs. We've seen what happens when borrowing costs explode (Greece, Portugal, Ireland, Spain, Italy, etc), and it's not pretty. All the Fed can control at the moment is our borrowing costs, and they can only do that as long as foreigners are willing to accept our zero yielding bonds or our devaluing dollars. Sure we might have periods where interest rates rise because the US economy is showing signs of strength (like the move a couple of weeks ago from 2% to 2.4% on the 10 year bond), but those will prove fleeting (10 year rates are already back below 2%).
There is only one person running for President that is willing to seriously tackle our proliferate government spending, and his name is not Romney or Obama, and unfortunately the odds of him being elected are only slightly better than mine. Therefore, expect our debt situation to worsen, and expect rates to stay near zero for the foreseeable future. Financial repression will continue. Savers will be beaten until moral improves.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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