China and gold mining in Alaska

China has reached her first gold target, expanding holding from 600 tonnes to 1,000 as of last month. But she has stated her intention to boost stocks by 10,000 tonnes over the next decade. This source reports on a new long-term contract to purchase gold ore from the Kensington Mine in Alaska.

The mine is about 400 miles from the Klondike, so unfortunately not quite justifying the inclusion of photos of grizzled - they always are, aren't they? - prospectors from the late nineteenth century.

Another difference - perhaps typical of the modern (what is post-modern?) age - is that this is a high-level government deal. It's not about the individual struggle for enrichment and independence. Central banks have also reversed their long-term policy of releasing gold onto the market to depress its value and are now beginning to buy, as Mark O'Byrne suspected 18 months ago.

These developments are likely to support the price of gold, even though it has quadrupled (in dollar terms) in the last 10 years. But the expansionary plan could also be seen as a straw in the wind, for those who see gold as a store of wealth in increasingly uncertain times.

Just for fun (and a little right-brain stimulus), here's a picture of Chinese gold prospectors in California:

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Keen: debt and deflation

Steve Keen, a non-mainstream economist who is one of a mere handful to have predicted the Great Financial Crisis, has put his latest academic paper on his website. It has a lot of mathematical equations and technical terms, as you'd expect, but I think it's possible to get the general drift if you don't get disheartened by all that. As a non-pro myself, I'll try to pick out some of the main points that appear relevant to investment (I am sorry that I cannot yet reproduce his graphs but in any case that might infringe his copyright).

Keen attempts to model the economy including the role of debt, which appears to be a major factor insufficiently considered by classical economic theory. Using past data, he observes that from 1920 -1940 "rising debt was strongly correlated with falling unemployment" (p.4).

But in the last 20 years private debt has risen far faster than production (fig. 5, page 5) and rising debt now appears to be associated with rising unemployment (fig. 12, page 11). Keen blames what he forthrightly calls "Ponzi finance", i.e. speculative money poured into assets, causing them to become overpriced. In the aftermath of the 1929 Great Crash, the biggest debt load was among businesses and government; now, most of the debt is concentrated in the financial sector and households (fig. 13, page 12). Running his model, Keen finds (fig. 14) that there is an inbuilt tendency for speculative debt (as opposed to debt-financed investment in production) to take off and ultimately account for almost all the debt in the economy.

Another of Keen's themes is that economics has confused the amount of money with the flow of money. This has misled the USA into supporting banks on the assumption that the latter would lend out the usual multiple of their deposits (they didn't), whereas in Australia the emphasis was on financial support to households. Consequently, unemployment in the USA has doubled to 10%, but in Oz it seems to have stabilised at around 5% (fig. 23).

It seems that as total debt reaches a critical size, there is an alteration in the way in which money and the economy interact (I think chemists call this sort of thing a "phase change"). Prior to this point, the system appears to be settling down, rather as milk does in the saucepan before suddenly frothing over and burning on the hob. Kenn quotes (p.12) Hyman Minsky: "Stability—or tranquility—in a world with a cyclical past and capitalist financial institutions is destabilizing".

In Keen's model, the first effects of the crackup are felt by workers: wages spiral around from 100% of GDP, centring towards c. 70%, but then suddenly collapse down to below 50% (fig. 33, page 43). For about 10 years in this final decline, business profits appear fairly unaffected; then they slump catastrophically into deep losses (page 44). At the same time, the banker's share of national income soars. Economic growth turns into economic contraction, and we move from an apparent settling-down of the inflation rate into a savage deflation exceeding 35%.

As with any mathematical model, there is always the question about how far it fits observed reality, and in economics it seems hard to get exact figures and generally-agreed definitions, especially where debt is concerned (see my previous post). But Keen's seems to be a model operating on strict internal logic based on clear theoretical data and correlations, with outcomes that chime with phenomena we've see so far. His model has very worrying implications for the next part of the cycle.

An unknown factor is what government will do. Whatever the economic machinery, politicians are liable to throw a spanner into it, if only to be seen to be doing something. Keen's prediction of a housing price collapse was refuted by the financial measures the Australian government introduced to help householders, and internationally it is widely feared that governments will ultimately attempt to mitigate the effects of deflation by debauching the monetary system and introducing hyperinflation; hence the shrilling of the "gold bugs".

So every economic model will have to be updated to incorporate the new cogs, axles and valves invented by our desperate leaders. The value of Keen's model is, I think, not so much to offer accurate predictions of the future as to show that the system as it stands appears to tend to equilibrium but actually is highly unstable. He is predicting the burning of the Phoenix, not its reincarnation.

UPDATE: Keen's dynamic model, with its self-reinforcing trends, has something in common with George Soros' ideas of market feedback loops. Soros terms this process "reflexivity" and set out his theories in his 2008 book "The New Paradigm for Financial Markets". In his speech at Berlin's Humboldt University last week, Soros argues that Germany would be damaged by an exit from the Euro and should be less purist about financial rectitude at a time when weaker Eurozone countries are struggling to support their banking systems.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

How bad is the debt problem?

The things we really need to know seem to be the hardest to find out, at least here in the UK. I look again and again for figures on our debt and each time get a different answer.

Sometimes, with public debt, it's because of problems of definition - for example, the "National Debt" is different from the "Public Sector Net Debt". Even then, there's the question of what has yet to be included in the accounts, and what has been designed not to appear in the accounts at all (e.g. the Private Finance Initiative, or PFI). Official statistics say "government debt" in 2009 was almost 70% of GDP. According to this source, the Bank of England put it at 60% in January 2010. But reportedly, the Centre for Policy Studies estimated that the true figure at the end of 2008 was 103.5%, including public sector pensions and PFI. Even the lower, official figure for Public Sector Net Debt is forecast to rise steeply in the years to come, to around 80% (a similar story is told here).

Then there is private debt. A couple of years ago, personal debt in the UK broke above 100% of GDP, according to Grant Thornton. In the USA, private indebtedness has soared to something like 300% of GDP (recently reconfirmed by Australian economist Steve Keen here).

But we also have to factor in business debt. This graph from Moneyweek adds business and private debt together to show the UK's figure running at around 250% of GDP. - and the graph is out of date. It's fair to guess that we're as badly off as the Americans.

Finally, we have to consider who are creditors are. How much of the debt is owed "within the family", so to speak, and how much to foreigners? 18 months ago, the Spectator magazine's Fraser Nelson reported an estimate (by Michael Saunders of Citigroup) of total "external" debt among the G7 nations:

The point of this is that not only are we very heavily in hock, but we are particularly vulnerable to pressure from foreign creditors.

In another post, I plan to consider our options, and the extent to which the recent "emergency Budget" has helped solve the problems we face.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

"Jesse" predicts gold will appreciate 500%

We've seen the price of gold in dollars quadruple since the beginning of the new Millennium. Compared to inflation, gold is above its long-term average - but still below its 20th century peak in 1980, when the American economy was under severe strain.

Some "gold bugs" think that our current and worsening problems will cause a very significant flight to the historic preserver of wealth - in my previous post I link to one who predicts $50,000 per ounce (in real terms, apparently). I find it hard to believe that you will be able to buy a 3-bed semi in Birmingham for a handful of gold weighing little more than a packet of winegums.

But the total private and public debt in the USA is now far higher than before the Crash of 1929, and similar problems affect us here in the UK and across much of Europe. In today's Daily Mail, Peter Oborne (not normally an alarmist commentator) discusses the danger of a return of recession and of the Euro collapsing, and the risks of depositing more than £50,000 with any one bank, especially Santander and its subsidiary Abbey National. Against such a background, we could see a scramble into anything that offers a secure nest for our savings.

On the internet, "Jesse" (to all appearances a technically expert and sober-minded investor) is bullish on gold without going quite as far as the most excited of the gold bugs:

Gold has been gaining, on average about 70% every three years. So what is the end point?

Just for grins, I would expect gold to hit $6,300 near the end of this steady bull run, but will the bull market will end in a parabolic intra-month spike towards $10,000. This is likely to occur around 2018-2020.

Three points I'd make:

1. There is something like 100 ounces of gold "on paper" for every ounce of gold you can hold in your hand. I now often see online comments recommending the possession of physical gold because of concerns over delivery on all those paper promises. This then gives you the challenge of getting it and storing it safely, plus being taxed on gains if it appreciates; and remember that President Roosevelt confiscated gold from private investors in 1933. (UPDATE: Note that Saudi Arabia revealed this week that it is sitting on twice as much gold as we previously thought.)

2. There are other assets that have intrinsic value - farmland, houses etc - and even if they may lose some wealth, they won't lose it all. The billionaire Duke of Westminster is in no hurry to get rid of his properties in London's Mayfair and Belgravia, the foundation of the family fortune established when Sir Thomas Grosvenor married heiress Mary Davies in 1677, so acquiring 500 acres of then-rural land near the capital.

3. If you're looking to preserve what you have, rather than beat someone else in the investment game and take their stake, there is a government-backed product designed to achieve this: the NS&I Index-Linked Savings Certificate. We can argue about what is the correct measure of inflation, and if the Russians invade all British government promises are void*; but otherwise it's a safe bet and all you have to do is give up some spending now to have its true worth again later on.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

*It's how my mother's family lost their farm in East Prussia, now a heavily-militarised sliver of Russian Federation land with access to the vital open-in-winter Baltic seaport of Kaliningrad. The Russkies threatened to base missiles there in 2008 in a Cuban Crisis-style response to US plans for missile bases in Poland and the Czech Republic. Perhaps some wealth in portable form wouldn't be a bad idea, after all - it would certainly have helped my family on their flight westwards.

"Jesse" predicts gold will appreciate 500%

We've seen the price of gold in dollars quadruple since the beginning of the new Millennium. Compared to inflation, gold is above its long-term average - but still below its 20th century peak in 1980, when the American economy was under severe strain.

Some "gold bugs" think that our current and worsening problems will cause a very significant flight to the historic preserver of wealth - in my previous post I link to one who predicts $50,000 per ounce (in real terms, apparently). I find it hard to believe that you will be able to buy a 3-bed semi in Birmingham for a handful of gold weighing little more than a packet of winegums.

But the total private and public debt in the USA is now far higher than before the Crash of 1929, and similar problems affect us here in the UK and across much of Europe. In today's Daily Mail, Peter Oborne (not normally an alarmist commentator) discusses the danger of a return of recession and of the Euro collapsing, and the risks of depositing more than £50,000 with any one bank, especially Santander and its subsidiary Abbey National. Against such a background, we could see a scramble into anything that offers a secure nest for our savings.

On the internet, "Jesse" (to all appearances a technically expert and sober-minded investor) is bullish on gold without going quite as far as the most excited of the gold bugs:

Gold has been gaining, on average about 70% every three years. So what is the end point?

Just for grins, I would expect gold to hit $6,300 near the end of this steady bull run, but will the bull market will end in a parabolic intra-month spike towards $10,000. This is likely to occur around 2018-2020.

Three points I'd make:

1. There is something like 100 ounces of gold "on paper" for every ounce of gold you can hold in your hand. I now often see online comments recommending the possession of physical gold because of concerns over delivery on all those paper promises. This then gives you the challenge of getting it and storing it safely, plus being taxed on gains if it appreciates; and remember that President Roosevelt confiscated gold from private investors in 1933. (UPDATE: Note that Saudi Arabia revealed this week that it is sitting on twice as much gold as we previously thought.)

2. There are other assets that have intrinsic value - farmland, houses etc - and even if they may lose some wealth, they won't lose it all. The billionaire Duke of Westminster is in no hurry to get rid of his properties in London's Mayfair and Belgravia, the foundation of the family fortune established when Sir Thomas Grosvenor married heiress Mary Davies in 1677, so acquiring 500 acres of then-rural land near the capital.

3. If you're looking to preserve what you have, rather than beat someone else in the investment game and take their stake, there is a government-backed product designed to achieve this: the NS&I Index-Linked Savings Certificate. We can argue about what is the correct measure of inflation, and if the Russians invade all British government promises are void*; but otherwise it's a safe bet and all you have to do is give up some spending now to have its true worth again later on.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

*It's how my mother's family lost their farm in East Prussia, now a heavily-militarised sliver of Russian Federation land with access to the vital open-in-winter Baltic seaport of Kaliningrad. The Russkies threatened to base missiles there in 2008 in a Cuban Crisis-style response to US plans for missile bases in Poland and the Czech Republic. Perhaps some wealth in portable form wouldn't be a bad idea, after all - it would certainly have helped my family on their flight westwards.

Fun with gold

As the crisis continues, the gold bugs cheerily anticipate rocketing gold prices. Some fling about wild notions like $50,000 per ounce, others try to be a bit more sober (or less drunk) and guess at $10,000. But there are so many imponderables, as I comment:

Can of worms, FOFOA. We live in a relativistic universe. How does gold relate to other things? And which other things in particular? And what is the role of debt in pricing?

Imagine a worldwide Jubilee Year: all debts paid or defaulted and no new debts contracted. What would assets be worth then? What, for example, would houses be worth if no-one had a mortgage?

Besides, in the past, far less of life was monetized. You could go into the woods, clear land, build a house, grow crops, keep animals. Money (or trade tokens like conch shells) was only to facilitate the exchange of surplus production. Now, money seem to be more important than people themselves.

Whether gold has any use depends on context. If we are hit by major ecological/economic disaster, gold may be no more than the equivalent of a word in a long-dead language.

But just for fun, let's assume everybody trades gold for productive land (arable/pasture/wood). Playing around with figures trawled on the Net I find that the ratio of gold above ground to said land is about 1 kilo to 73.5 acres, or 13.6 grams of gold per acre.

This farmer (http://thebeginningfarmer.blogspot.com/2008/02/how-much-land-do-you-need.html) reckons maybe 160 acres to support a family - though that depends on the standard of living you'd expect (Papua New Guinea would set a different standard). Say a couple of kilos of gold. At today's gold prices, that family farm would have to cost about $88,000 US.

Latest (Jan. 1) estimates from the US Department of Agriculture value US agricultural land and buildings at $2,100 per acre. The same 160-acre farm would therefore currently be priced at some $336,000, or c. 52 grams of gold per acre.

So if (as seems most unlikely) gold was simply used as a medium of exchange for farmland, gold would shoot up to 4 times its present level. Say $5,000 dollars an ounce. On the other hand, in an equalized world unencumbered by debt, maybe farmland in the US would simply drop in value by 75% as priced in weight of gold.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Email to clients, 20 June 2010

Dear Client

If you have been expecting to hear from me recently, please accept my apologies - we have had a family healthcare emergency that has taken up much of our available time and energy for many weeks. And now, for the next few days, I must devote time to answering many detailed questions for the FSA's regular periodic reviews. But I plan to re-contact you soon thereafter if you are ready to re-examine your financial plans.

In the meantime, I hear people around me saying that since house prices have dropped "so much" and the bank and stockmarket problems seem to have been sorted by the government actions of 18 months ago, things have returned to normal. I think it's too early to say that and my general approach is still very cautious. The price of our (or our leaders') follies has yet to be paid, and the economic consequences of national budget reviews here and in Europe may be challenging for some time to come.

Like many expert commentators, George Soros sees as us as between two acts in a longer drama (some describe it as "the eye of the storm") - please see my latest post on the Broad Oak Blog here: http://broadoakblog.blogspot.com/2010/06/soros-thinks-markets-still-overpriced.html

Soros is worth listening to - after all, he is personally worth some $7 billion dollars, which is slightly more than most of us - though even Warren Buffett can make mistakes (the latter recently told a Congressional committee that he hadn't anticipated the scale of the 2008 crisis).

I feel we are in a quandary. Commit new money to investment and you could be caught in another correction from which it could take some time to recover. Hold cash, and your savings could be affected by inflation if the government fails to get public finances under control.

But there are some fairly safe options still available to most of us - in particular, National Savings Index-Linked Savings Certificates. These are backed by the government and offer returns in line with RPI, plus 1% p.a. It does mean locking up money for 3 or 5 years, and yes, if the stockmarket suddenly booms you'll miss out on those wonderful, effortless gains we came to regard as normal in the 1980s.

On the other hand, the official change in RPI over the 12 months to May 2010 was 5.5%, so with an extra 1% on top that would have been a pretty good tax-free and risk-free return.

Anyhow, although this isn't a personal recommendation (we have to consider how such things fit in with your other plans) it's something to think about and possibly discuss with me. Do please call if I can help further.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.