Eye of the Storm?

Not too many days ago, predictions of World War III prevailed, as Israel threatened harsh retribution for Iran’s drone and missile attack. Then the U.S., Britain and France publicly discouraged Netanyahu’s government from such a course. So, at least for the moment, rhetoric and action have cooled off. Optimists feel that we’ve entered a moment, or even a period, of calm; pessimists are convinced that the current pause is the proverbial calm before the storm.

For the United States, the Hamas attack of October 7 and Israel’s massive retaliation in Gaza, came at a bad time. Already deeply involved in Ukraine (a war that’s not going the West’s way at all), and intent on expanding its engagement in Taiwan, the last thing a strategically overextended America needs is an all-out regional war in the Middle East.

What would such a war be like? The odds are high that traditional U.S. alignments, like the ones with Saudi Arabia, the Emirates, Egypt and other Arab nations would be challenged or even end. Not a good outcome for America, nor for Israel. Also, given the importance of the Strait of Hormuz, any further escalation with Iran would send oil prices soaring, aggravating inflation patterns and further straining U.S. fiscal challenges—all in an election year.

U.S. Economic Leadership

On the economic front, too, Washington’s policies are unravelling at a rapid pace. While the American “can-do” attitude is universally admired, consecutive governments have steadily undermined entrepreneurship. Instead of stoking the engines of economic well-being, namely small and medium-sized business, Washington has enabled the emergence of massive monopolies and the concurrent shrinking of a once weighty middle class. The biggest problem is that control of the U.S. government by the monopolists is nearly impossible to reverse, especially given a system where campaign finance contributions are virtually unlimited and there are no term limits for legislators.

Another huge negative is America’s indebtedness at all levels. To be sure, other national economies have similar debt loads (at least at the government level), but their debt is mostly owned domestically. In sharp contrast, more than $7 trillion of the U.S. national debt (the orange part of the chart below) is held by foreigners—more than what is held by the country’s depository institutions, mutual and pension funds and insurance companies combined.

In the past many decades that was made possible due to the dollar’s role as the world’s reserve currency, but the future may look different. A growing number of countries have cut back their holdings of U.S. debt securities and their use of the dollar—some out of concern with America’s reckless spending habits, while others are worried about Washington’s growing use of financial sanctions. And as they contemplate dollar alternatives, the member nations of the BRIC’s block and the Shanghai Cooperation Council (which now represent the largest part of the world by several metrics) are busy discussing the launch of a currency of their own.

The two questions that are being asked by investors around the world:

  • How much further can America push its unsustainable economic, social and military platforms before those financing them lose faith?
  • Will America’s demise as the world’s hegemon play out soon and suddenly, or over a period of many years?

No one knows, but this doesn’t mean that financial markets won’t anticipate all kinds of scenarios, some of which will never manifest. But that won’t take away from the underlying problem: the U.S. and some of its key allies are in serious trouble and their governments have no good choices left.

If our politicians continue to maintain that all is well while undeniably reckless policies are left in place, inflation will reaccelerate, and so will the decline in the standard of living. And if they take remedial action, the economy and the social fabric will experience different, but equally painful shocks.

Either way, the odds are high that our investments will be affected with increasing frequency and intensity. Under such circumstances, conventional buy-and-hold strategies makes little sense. Your portfolio holdings should have a high degree of liquidity, feature strong balance sheets and have proven and sustainable business models. Importantly, there is no room for dogmatic thinking in today’s environment—be completely prepared to accept that your assumptions were wrong and adjust your portfolio accordingly. There are many imaginable scenarios in which no one wins, but pragmatism is by far the best strategy. In short: be defensive, nimble and flexible!

Portfolio Update

So far, 2024 has been a great year for us. Being selective within the stock market, very cautious about bonds and committed to our robust gold position was exactly the right formula.

The question, of course, is what will happen next?

Let’s deal with equities first. The upward trend in the S&P500 that started last fall is being challenged, but whether this is the start of a meaningful correction is far from certain. We’ve avoided sectors that are overbought and overvalued (notably tech) and stuck to more defensive and undervalued areas. As I said above, sound balance sheets are a major plus in this environment, as is sustainable strong cash flow. Throughout the past months, we’ve built positions in commodity stocks, from energy to base metals such as copper, silver and uranium.

Bonds remain in no-man’s land. As you know from our previous updates, we’ve never bought into the widely held notion of an interest rate “pivot”. We’ve also been extremely skeptical of the government’s inflation assessments, and evidently we are not alone. The only people who actually believe that U.S. inflation is at 3.5% are those far removed from the challenges “ordinary people” face in their daily life.

One thing to keep an eye on is the behaviour of foreign buyers of U.S. Treasury debt. So far, demand has held up, mainly because U.S. interest rates are highly competitive, which in turn has kept the dollar strong. Of course, that may change if the Fed submits to political pre-election pressures and materially lowers rates. That’s yet another reason we remain cautious on bonds.

As anticipated, gold reached new highs. What is truly noteworthy is that the yellow metal keeps gaining in the face of a strong U.S. dollar and in an environment of relatively muted North American demand. So, to the question of the day: where is the demand coming from and what is motivating the buyers?

Let me answer the second question first. I believe the quickly deteriorating geopolitical environment, a lack of faith in the sustainability of the dollar’s current strength, and the rapid deterioration of America’s fiscal household are all key reasons. I suspect last weekend’s passage of the REPO Act, which paves the way for the Biden administration to confiscate billions more in Russian sovereign assets that sit in US banks, will provide additional motivation to exit dollar positions and buy bullion.

Who are the buyers of gold? The easy answer is foreign central banks, but statistics on CB purchases don’t explain the totality of recent demand. I believe high net-worth individuals in places like China, the United Arab Emirates and elsewhere are also aggressively buying. In time, investors in the U.S. and Europe will join the fray, which should help the gold price further.

For now, the yellow metal is in profit-taking mode; after all, the geopolitical environment has entered a moment of calm. I expect support at around US$2,285, after which the bull market should resume. Yet, no matter what exactly gold’s short-term movements will turn out to be, I see no reason to part from the 15% position we’ve been holding for the past five years.

Cash Matters. Whenever I talk to investment managers, I am stunned by their entrenched view that cash should be avoided. On many occasions I’ve been told, “Wait a minute—cash is not an asset class.” I completely disagree. There have been several periods during my 50+ year career when the inclusion of a substantial cash hoard invested in T-bills or term-deposits provided both decent returns and portfolio protection. For now, based on my belief that the economy is weakening and that financial markets are overextended, one-year rates of 5.5% on U.S. Certificates of Deposit or 5.25% on Canadian Guaranteed Investment Certificates seem highly attractive.

Best regards,

Peter Cavelti

Dear Subscriber:

Peter Cavelti has been invited to participate in the next On The Move webinar on Tuesday May 7th at 7 pm ET, with investment experts Rich Checkan and Adrian Day.

You’ll discover the answers to the questions on everyone’s mind:

  • Five macro themes that are likely to drive financial markets
  • How to safeguard your investment portfolio?
  • Gold and silver are higher, but what’s next?
  • What advantages, pitfalls, and strategies of gold investment should you be aware of?
  • and more!

We encourage you to save a complimentary spot and set a reminder to join On The Move’s webcast on May 7th to arm yourself with the expert analysis and recommendations needed to prosper in today’s volatile markets.

Register Here

The Hosts

About Rich Checkan: As the President and COO of Asset Strategies International (ASI), Rich Checkan has been an integral part of ASI’s maturation from a precious metals and foreign exchange dealer to a full service tangible and rare tangible asset provider—to include rare U.S., world, and ancient coins. Rich is a regular contributor to ASI’s own monthly newsletter, Information Line, and a regular writer for ASI’s twice weekly news alert, Always Something Interesting. When Rich isn’t in the office, he is speaking at a conference or leading a workshop at a seminar. Each year, he speaks at conferences and seminars worldwide, and has been quoted in the New York Times as well as leading financial newsletters.

About Adrian Day: Adrian Day, London born and a graduate of the London School of Economics, heads the eponymous money management firm Adrian Day Asset Management where he manages discretionary accounts in both global and resource areas.  Day is also portfolio manager of the EuroPacific Gold Fund.  His latest book is Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks (published by Wiley & Sons).

We look forward to seeing you live on May 7th at 7pm ET! The interview will also be posted on our website, so that our overseas readers will be able to tune in at their convenience.