The coming global debt-driven depression

Reality begins to set in, which inspires panic. Frantic selling across various speculative assets brings prices drastically lower. Retirements and pensions wiped out. Paper investments made effectively worthless. Sound like a repeat of 2008-2009?

The American Nightmare

This horrifying scenario is coming to fruition not because the economy is dipping back in to recession — the fact is without the bailouts, deficit spending and stick saves by the Fed, we’ve been in a depression since late 2008. All of the papering over fraud was about kicking the can down the road rather than fixing the underlying economic, fiscal and monetary imbalances.

Zero interest rate policy combined with reckless fiscal measures have sealed the fate of the US markets and the greater global economy. By implementing such a robust framework without fixing any of the underlying problems on bank balance sheets, in various governments forward debt loads or in household debt we are now looking at repeating the kind of volatility we saw in late 2008 to early 2009, but worse yet there are far greater consequences to a significant economic dislocation. Consequences that were entirely avoidable had the authorities, corporate leaders, banking executives and individual households of the world looked at deleveraging more aggressively and taking the bitter pill that is a brief, but sharp depression so that the excess could be cleared out in favor of rebuilding a more stable and sustainable economy.

Past the Point of No Returns

Now we’re nearing the cliff. The drop-off that is a near mathematical certainty given that many countries governments are reaching their upward debt limit (that is to say no party but their respective central banks are willing to buy their debt). This includes the US, Japan and much of Europe — countries that were once economic superpowers are being reduced to beggar thy neighbor debtors, hat in hand, begging for handouts.

The demographic issues in these areas may differ, but the fundamental economic, monetary and fiscal problems are all too similar. Persistent high unemployment, a highly leveraged financial sector, households that are swimming in debt (with the exception of perhaps Japan) and stock markets that are losing a decade+ in any form of gains.

Worse yet, the forecasts being foisted upon the public are overly optimistic, full of fluffy economic growth predictions that are impossible to achieve. That means that the growth which was necessary to service debt burdens and keep the overly extended economies of the world lurching forward will not occur and thus leaves a much more dire scenario. One of sovereign debt defaults, crashing stock markets, currency crises and an atmosphere of higher unemployment and more civil unrest.

Caution: Debt-Driven Depression Ahead

Let’s look towards the possible future by examining one country that’s already where many will be in the coming months and years ahead. Greece’s stock market is down 85% from its peak, their 1 year government bonds are trading at an absurd yield of about 97% and there is talk of a full scale default as early as this weekend. The Greek people have been protesting, rioting and the unemployment rate by modest measures is 16%. This is a depression, not a recession. While the media is largely ignoring the severity of the crisis, those within Greece are all too familiar with the situation. One that has the potential to become significantly worse before any improvements may happen.

All of the bailouts for Greece have only managed to make the situation worse, because they piled on debt Greece could not pay off while forcing Greece to sell off the few productive assets it has to foreign parties. The combination of these factors ensure a severe economic contraction.

Much of the rest of Europe, with perhaps the exception of Germany, Norway, Finland, Switzerland and Sweden, face the same dilemma: too much debt, too little economic growth. In the United States we face the same crisis, which has only been temporarily offset by the dollar’s reserve currency status — a privilege we may not enjoy for much longer here given the incompetent and dangerous monetary policies of the Federal Reserve. By Bill Gross’ measurement the United States has $75 trillion in unfunded liabilities. That is approximately a 500% debt-to-GDP ratio (over twice that of Japan). Some even say Gross’ measurement is too conservative and the number could be closer to $100 trillion in unfunded liabilities. The fact remains that there is no mathematical or economic scenario where this debt becomes serviceable or sustainable.

The problem is simple, though the solution has been muddled by short-sighted piecemeal bailout attempts. A debt crisis cannot be solved by piling on more debt. It is impossible to achieve economic equilibrium by bailing out corporations that do not know how to manage risk properly. Consumers, who account for 70% of US GDP, are being largely ignored and yet are experiencing significant harm from this crisis. Instead these insolvent banks need to be unwound, brought through bankruptcy and their speculative subsidiaries and divisions need to be completely separated and spun off from their depository and lending functions. We learned this lesson from the Great Depression, but somehow forgot it in the last decade as banks were once again allowed to recklessly speculate with money they did not have.

Modern Banking Is Anything But

Let us remember that banks should really only function as a basic utility for depositing funds and matching those that wish to lend money with those that are seeking interest on savings. That is the vary essential function of a bank. The speculative gambling that occurs on Wall Street has no place in conventional banking and it should never have been allowed to re-join the conventional banking industry.

Those who intentionally defrauded their clients, the government and employed criminal tactics to profit should be indicted, prosecuted and hopefully incarcerated for their crimes against society. Those reckless, greedy and immoral enough to bring down the entire world economy so that they can profit from its artificial rise and subsequent demise are the true threats to a prosperous future. So long as they remain in power we will not see any trust return to the markets nor shall we see any glimpse of true economic recovery. After all, if the rule of law breaks down, there is not much left to keep people from essentially avoiding the entire gulag casino that Wall Street has become.

We must unite around the world and demand that the crooks are prosecuted, the insolvent banks are unwound and that we, the people are not robbed blind to continue to fund these morally and financially bankrupt institutions. It is the only way that we can begin to move forward and start to rebuild our respective countries.

An exercise in reckless monetary policy

The Swiss National Bank intervened in the foreign exchange markets today, effectively devaluing the Franc by over 8% in a single day. Through a combination of an aggressive monetary policy statement and direct foreign exchange purchases of other currencies (namely the dollar and the euro) the central bank virtually collapsed a long term uptrend in the Franc.

That being said, it probably would have been sufficient for them to instead declare that they were going to pursue a more accommodating policy stance with the potential for future interest rate reductions (given the trend on the Swiss Franc charts, it would seem that it is vulnerable to any downward pressure). But, the Swiss economy is not experiencing the kind of economic slack or debt burden that justifies any of this type of inflationary policy. In fact, the Swiss economy isn’t even export-driven, so this hurts the consumers and effectively wipes away the value savers were building up in the last month. That’s not to say there was no speculation in the Franc, there was, and it was bubbling over, but this type of monetary policy is dangerous and foolish. It’s akin to trying to use a machete to perform a precision surgery.

Today’s announcement from SNB was more aimed at Swiss equities, which “rallied” over 4%. And why wouldn’t they? After all they’re being recalibrated for pricing in a weaker currency. It didn’t seem to stimulate risk appetites in the region, though, as Swiss equities were effectively alone in a sea red being painted across tickers all over Europe.

Gold and silver saw a corrective sell-off. I believe a good portion of that sell-off was margin calls happening from the move in the Franc. A lot of speculative and leveraged forex positions were absolutely smashed with the move that happened today. Over 8% downside has the capability to pancake someone employing over 12X leverage to being insolvent instantly. Margin clerks likely saw the glimmering profits in the gold and silver positions and forced holders to sell to cover the liquidity vacuum in their portfolios.

Because of that, and the strong technical support I saw in both precious metals markets today, I believe this selling presented more of a buying opportunity than a change in trend. After all, the Swiss printing an enormous amount of Francs to devalue their currency is exactly the type of central bank policy that adds a catalyst to the upward momentum in precious metals prices.

The great rotation from gold to silver

With gold pushing all time highs on a near daily basis, far exceeding its inflation adjusted highs from prior decades and pushing through several technical overbought indicators, many are concerned a correction is looming from this recent parabolic move, where gold went from the $1500s in July to $1890.00 today in late August.

Meanwhile, silver has underperformed after the correction from the peak at $50.00 — yet silver’s fundamentals look even more promising. While all the gold that’s ever been mined and produced is still above ground and available, silver is consumed as an industrial metal, and most of that usage is not recoverable or recyclable. Silver is also more difficult to extract. There are not many dedicated silver mines out there, instead silver tends to be a byproduct of other precious metals mining. In addition, silver is the best conductor of heat and electricity of any element, it is widely used for communications, medical devices, technology and military equipment.

The most interesting aspect of silver, however, is its historical ratio of 16:1. For this ratio to be achieved at today’s prices, silver would have to hit $115.00/oz, yet it currently trades around $43.50. This could be a ‘golden opportunity’ to rotate out of gold in to silver and see faster asset appreciation during a time when all signs point to the rally in gold moderating, but silver having tremendous upside potential. Many wise and experienced precious metals investors, including the legendary Eric Sprott, are moving cash out of gold and in to silver to position for this change in the precious metals dynamic.

Having just taken out major technical resistance at $41-42.00/oz, silver is poised to move towards the next major level at $50.00. Many predict silver could reach $75.00 by the end of this year on investment demand to hedge against inflation and monetary uncertainty in the US, Europe, Japan and beyond. I have long been an advocate of buying silver to protect one’s purchasing power and once again I am stating that for my investments I am continuing to buy silver funds as well as silver mining and channeling equities.

Remember that every investment strategy carries risk, and that one could potentially lose their principle if the investment strategy fails — but also remember that paper assets have a long history of catastrophic failure. Whatever path you choose, I wish you and yours the best of luck in the coming financial storm.

Risk off trade resumes after bounce

High frequency traders, institutions and retail investors pushed markets lower today, and in recent days, after a brief reprieve from the selling abated in to a liquidation frenzy. Gold made new record highs, silver stayed strong as the commodity complex crumbled. Most investors are very nervous about the prospects of another recession looming, but the reality is we’ve been in a depression for four years and a recession within a depression is looming.

We’ve been enjoying the eye of the storm since April of 2009, when the banking system no longer was obligated to mark its assets to their real values and trillions of dollars were injected in to the banking system. Unfortunately the sugar high has worn off, and now the situation is worse than before.

As the oversold correction was neutralized by short covering, opportunistic buying and technical traders the stream of bad news resumed, with more worrisome headlines about the Greek debt situation, widespread investigations in to high frequency trading firms, a spread of the European bank contagion because of their leveraged bad debt holdings, and American banks facing the prospect of the credit default swaps they sold to the EU banks being called in.

In addition, economic data has been deteriorating, with poor jobs, inflation and housing data rattling the fundamental picture from a recovery to the brink of an economic contraction. Inflation and unemployment are higher, while new home sales are flopping.

With these economic headwinds, and several market powderkegs ready to blow, the average investor is looking for a safe haven. Many are buying US Treasury bonds, pushing the yields to record lows below 2% on the 10 year and collapsing the 2s to 10s spread, making lending less lucrative for banks. Others are turning to precious metals, as we see gold, silver and even platinum have good price action and solid technicals.

At this point the likelihood that a significant further leg down in the economic picture and within the equities markets will occur has heightened significantly. The macroeconomic risks in most developed and emerging countries, ranging from inflation, social unrest, high unemployment, losses in investments and property, continue to gain momentum and appear to be converging as a catalyst towards a global risk asset sell-off, the likes of which we haven’t experienced since 2008-2009.

The likelihood of bank holidays and further government and Federal Reserve intervention in to bond markets, money markets and potentially equity markets has also heightened. Further fiscal and monetary policy that accommodates a deflationary environment will more than likely occur within the next quarter.

Gold and silver prices should head much higher because of the aforementioned situation and response. Gold is due for a correction, but when that may occur is questionable given the mood of the markets and the desire to hold tangible assets over equities or paper currencies. Silver on the other hand is poised to test the $42.50 resistance level, and if it can breach higher, potentially test the $48-50.00 area where the last high was made. Within the next 3-5 years, it is very likely that both gold and silver will be multiples higher than they are today in terms of pricing in US dollars.

Either a deflationary depression or a hyperinflationary monetary collapse would be beneficial for precious metals in the short, intermediate and long term. Whether or not such severe events occur is uncertain at this point, but currently deflationary forces are at battle with inflationary central bank policies — and it is extremely rare that either economic catalyst is balanced out perfectly with the other. Instead, massive bouts of volatility and overshooting towards deflation or inflation are a more likely scenario, as tools of fiscal and monetary policy are more like howitzers than scalpels.

Risk off panic selling, Euro collapse and more

The world markets were roiled today by panic selling. The sell off was catalyzed by negative news on Italy’s solvency, accelerated further by margin calls on major institutions, forcing a major deleveraging across the board. Many are fearing a reemergence of recessionary declines across the globe.

Europe’s outlook has significantly weakened as of late after its been revealed that the fiscal problems of the sagging debtor states are growing more severe at a rapid rate. Headlines today included major exchanges shuttering temporarily, bond issuances being suspended and civil unrest growing. The Euro lost about 1.35% of its value in a single day, a significant sell-off — and one that is likely to continue.

The downside risks for speculative paper assets are intensifying. Growth stocks lost 5-8% or more of their value in a matter of minutes. Some posted double digit losses. The selling in the US continued in to the close without much sign of short covering, indicating that many are still bracing for a negative jobs report tomorrow.

Gold, silver and other precious metals were no exception, as margin calls forced traders and investors who were employing margin to deleverage their portfolio, selling their profitable positions to cover losses, presumably in equities.

The only green on the board was primarily in the US dollar and bonds, once again finding themselves as a safe haven asset during times of panic. One has to wonder, given the underlying uncertainty regarding the US debt, and the condition of global and local financial markets, how long such a phenomenon can last — especially given the tendency for investors to migrate in to hard assets when there’s a whisper of inflation.

The most likely scenario from this point forward is more quantitative easing, probably coordinated by the G7 countries, instead of a unilateral US effort, to prop up sagging markets. Such a liquidity infusion would likely spark a significant rally in commodities and equities, at the cost of the purchasing power of various fiat currencies. Such a powerful inflationary force could cause precious metals to stage vicious upward price discovery as more paper currency is created out of thin air.

In the short term and intermediate term we are looking at a very oversold market. By just about every measure possible we are in a very dangerous zone to be selling stocks. A violent bounce is highly likely, but how sustainable that bounce is depends entirely on what the ECB and Fed say in the coming weeks.

Technically on the S&P 500 there’s a good chance that we’ll see a retest of November, 2010’s lows around 1171 if economic data and news continue to build on the negative sentiment. The 1225 area has now become resistance. This could be the formation of a new trading range or the beginning of a significant downtrend.

Gold made new highs today, but margin calls forced liquidation and brought the price down over $40 from its highs. Silver tested the $42 level, but the same liquidation brought silver down by over 7% at the lows. There’s a good chance that the correction in precious metals could continue if the liquidity vacuum effect of souring debt markets in Europe continues. If instead central banks announce additional easing and credit expansion then we may see a significant rally.

Unfortunately today’s markets are no longer primarily powered by economic growth, but instead moreso from central bank money printing and artificially low interest rates. This is the main reason that more and more investors are turning to hard assets to hedge against, if not profit from, future inflation. If the sell-off continues, with gold, silver and other hard assets seeing discounts, I would consider it an opportunity to buy such assets as the longer term outlook is higher inflation and a resulting attraction towards precious metals.

Precious metals outlook and thoughts

After the violent price swings we’ve seen in silver and the correction in gold, I remain cautiously optimistic that the precious metals sector is now in a bottoming phase and that the nominal paper values disconnect between physical values indicates that real world demand is still far beyond what virtual markets indicate. Spot prices of rounds, bars and bullion are about $4-6/oz for silver above the spot paper price. This disconnect is the result of price manipulation and will likely correct in the favor of physical prices being the real gauge of value. Silver prices of $50.00 an ounce and gold prices of $1800.00 an ounce by late summer are not out of the question.

Traditionally around central bank meetings metals prices and miners take a hit. This has been a trend for several years and can provide an excellent buying opportunity. In addition there are seasonal factors. Summers are often volatile and illiquid, leading to wider, but generally less significant movements in the gold and silver markets as well. Sometimes these swings bring about arbitraging or purchasing opportunities of precious metals stocks or physical metals funds.

Whispers of Q3, persistently high unemployment, asset disinflation, Bernanke’s legacy and Obama’s electoral hopes all speak to the notion of further easing coming later this year. It could indeed be a bumpy ride, but let’s not forget that metals are priced in dollars and the dollar has been and continues to be in a long term structural and fundamental decline due to loose monetary policy, debt-driven government spending and a tendency to inflate to cover tax shortfalls, rather than raise taxes or cut spending — and that trend does not appear to have an end in sight.

We may see volatility, we may see market dislocations, but at the end of the day I feel as though owning gold and silver positions one appropriately for the two possible scenarios we see moving forward. Either there will be a extremely sharp depression or a bout of severe stagflation. Either way a loss of confidence in the currency and financial system is inevitable and forthcoming. When that day comes the oldest form of money known to man should reign supreme once more as the remonetization of gold and silver continues, perhaps at an even faster pace.

We are essentially in a war right now. The war is between the 40 year failed experiment of fiat currency backed by nothing but faith and sound money that the world has run on for 5,000 years of human history. I feel as though investing in gold and silver puts one on the right side of that war. Indeed, many battles so far have been waged successfully and the Wall Street bankers, whose stocks have been underperforming the market and indicating a significant solvency problem, are on the run, retreating because they are aware that the ponzi scheme they rely on is in its initial stages of collapse.

Remember that no investment path is straightforward, many carry the risk of loss, some even greater than the principal investment involved. Please ensure whatever investment decisions you make suit your plan for retirement, savings and are appropriate for the level of risk you are comfortable undertaking — and always, always, always do your homework. Best of luck to everyone!

Disclosure: Long precious metals funds and miners.