2015-01-23



Survival as an individual and as an investor demands that one think ahead and do what one can to insulate oneself against the potential ravages of future change. So let us briefly consider six worst case scenarios to determine how prepared we are for them:

1) The world is on an economic knife edge. Mismanagement of the global financial system has created a monetary bubble that is in imminent danger of bursting. The bubble is liable to burst at any time leading to economic crisis, a collapse of share markets and the onset of global economic depression.

2) While the bubble persists the gap between rich and poor is growing at an alarming rate ushering in “Arab Spring” type political change: Note Fergusson in the US. The fact that South Africa is overdue for such change: note a world record Genii Coefficient, corrupt government, failed social delivery systems, service delivery protest etc: in 2012 there were 38 protests a month and the figure has been rising exponentially since then.



3)  Political confrontation is escalating globally and most of the contestants are nuclear-empowered or on the verge of becoming so: Russia/Ukraine Israel/Palestine, Japan/China.

4) There is renewed fighting in Libya, civil wars in Syria, Afghanistan, Iraq and Somalia, Islamist insurgencies in Nigeria and Mali, ongoing post-election chaos in Kenya, violent conflicts in Pakistan, Sudan and Yemen, assorted mayhem in central Africa, and the situation in North Korea, described in a 2014 United Nations Human Rights report as having no parallel in the contemporary world.

5) Epidemic disease: The Ebola virus is spreading from West Africa into Central Africa with cases now in Spain, the US, Britain. If not contained at this stage it could be another Black Plague/ Great Flu event



The world’s current economic problems are blamed on the “Sub Prime Crisis of 2007 but they in fact go much further back…in fact to 1913 when the US Government began tampering with the age old monetary system of a bullion-backed currency.

More recently, in the aftermath of the Great Recession, critics of our world economic system have with very good reason been increasingly targeting the irrelevance of central banks whose only tool for driving economic policy is interest rates. But the issues are far more fundamental than that. At the heart of it is the fact that without the discipline of a bullion backed currency system, human greed will inevitably always triumph. So bear with me as I take you briefly back to the events of 1913 in the USA.

The cause of the Great Depression of 1929 was a major paradigm shift that occurred in 1913 with the passage of the US Federal Reserve Act which, in a single sweep, changed both the scope and the magnitude of government intervention in the banking and monetary systems. The newly-created “Fed” had the power to regulate the size and growth of the money supply, thereby causing inflation or deflation in the economy. Through manipulation of credit, the Federal Reserve System fuelled a credit expansion the likes of which was previously thought impossible. When the steadily-expanding credit bubble finally burst with the crash of the over-inflated stock market it had created, the consequent credit contraction was more severe than any before.

The Federal Reserve System enacted by the US Congress in 1913 was an attempt to smooth out the then little-understood business cycles that plagued the American economy and were especially troubling to the banking system. It has been a deeply-troubling century-long experiment which has led to an ever-increasing series of monetary crises and an increasing number of economists believe the experiment is long overdue for termination.

Note that the US Congress charged the newly-created “Fed” with ensuring the appropriate reserves of its member banks, lending to shaky financial institutions to prevent their closure, selling government securities, and regulating the banking industry. Throughout its subsequent history the American currency and monetary system has undergone many changes, going from a relatively pure gold standard at its inception to an adulterated standard in the 1940s and finally a total elimination of any gilded ties in the 1970s.

The 2007 world economic crisis is popularly attributed to the collapse of the sub-prime lending system which is only partially true because it was merely a consequence of a much deeper problem which is ripe for radical change and that change, if it is not properly orchestrated, will dramatically affect the lives of everyone on the planet.

To properly understand what needs to happen, I need to take you through a brief and oversimplified summary of what has been happening recently as the world races like a river in flood towards a looming cataract for which mankind appears completely unprepared.

So let’s start with the so-called 2007 “Sub-Prime Crisis” in terms of which trillions of dollars of fiat money were created within the commercial banking system by means of a mechanism of manipulation of the futures trading markets which the central banks lacked the ability to either understand or control. In effect the role of the central banks had been subverted by a rapacious few who earned unbelievable sums of money for themselves in commissions and bonuses and caused untold billions of profit to be channelled into the balance sheets of private banks which in turn became “too big to fail”

In the old gold-backed system, money represented the reward for labour and the profits of commerce and industry which in turn through thrift accumulated money surpluses which provided the means for development, growth and employment.

But this new fiat money was created out of thin air and in quantities that far exceeded the ability of commerce and industry to absorb it.

Money always seeks a profitable investment and so, once the normal and efficient economic users of loan capital were saturated at the turn of the past century, new takers had to be found. So at the turn of the new millennium millions of Americans were being persuaded to part with their savings to take on mortgages that they could not afford in order to buy homes that far exceeded their normal needs. And they were persuaded to extend these mortgages in order to take expensive holidays and even to finance bloated day to day living. And of course it was not long before the same excesses spread throughout the world.

Initially our own very well controlled banking system was prevented from heading down this disastrous path until our government in its wisdom decided to overrule the Registrar of Banks arguing that offering soft loans to the public was a desirable exercise which would help to undo the disempowerment of the apartheid years. So a similar thing happened in South Africa where millions of people were persuaded by easy credit – in part a consequence of the surplus money flooding the world – to take on loans they could never afford to pay back. The collapse of African Bank was an inevitable result and the Reserve Bank’s decision to step in and rescue it will merely perpetuate and probably even worsen the eventual impact.

Inevitably such systems collapsed when too many of these borrowers could not meet their interest instalments and in the domino effect that followed millions of people lost their savings. People could no longer spend freely and, since retail spending constitutes two thirds of US Gross Domestic Product, when their spending collapsed the US went into recession.

Effectively trillions of dollars had disappeared from the monetary system and that would have been a healthy consequence as it would have sterilised the prior surpluses. During recessions, ordinary folk tend to pull in their horns, save their money, pay off their debts and the monetary system self corrects.

But then Lehman Brothers collapsed and a series of other banks teetered on the brink. US monetary authorities judged them to be too big to fail. Jobs were being lost and the US Government faced a decline of tax revenue which threatened their source of welfare spending.

The Ben Bernanke /Janice Yellen US Federal Reserve solution was to print money and thus lower interest rates to the extent that in real terms, after deducting the cost of inflation, they were actually paying banks to borrow money from them.

The hope was that this money would rapidly permeate the financial system, restoring lost liquidity and pull the US out of recession. Bernanke was nicknamed Helicopter Ben because of his proposal that the quickest way to reflate would be to dump bundles of money from the air onto highly populate areas of the US and, as bizarre as that idea sounds, it would probably have worked better than the “quantative easing” programme that the Fed eventually embarked upon.

Indeed, Quantative Easing might have worked had the money created by that process flowed into the hands of the public whose consequent spending would have stimulated small business and created jobs. Unfortunately, the banks had to be seen to be punished for their misdemeanours and so the authorities simultaneously constrained the banks with what became known as the Basel 3 accord which had the effect of preventing them from lending their money to small borrowers.

Basel 3 was intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage. It was originally planned to be introduced from 2013 but has since been postponed until 31 March 2019. So it is still hanging over our heads and its effect has been to curb lending to productive sectors of the economy which are by definition riskier than sovereign debt with the result that massive sums have flowed into the securities market. *

So we had a monumental economic cock up. As my graph above illustrates, they doubled the US money supply between 2000 and the present which in turn flowed to the commercial banks which, because of Basel 3 were prevented from lending it on to the people who most needed it. With nowhere else to go, this money consequently flowed into the global securities market…..and since by definition the bond market is the “safest” market to invest in it suited Basel 3 and since developing nations like South Africa offered the highest bond yields, that was where the money went. Furthermore, by artificially lowering the cost of money  they massively distorted the world’s monetary systems which will have cataclysmic effects upon ordinary folk everywhere once normality is restored and they are obliged to meet the real costs of their borrowings. Note below how under this deluge of money interest rates fell until the central banks have in recent years have effectively been paying borrowers to take money from them!

All tischeap money had to go somewhere and it flowed into our stock markets. Thus, in simple terms what that means was that the rich in society have grown immeasurably wealthier. For example,  Blue chip shares have risen three-fold in value along with the three-fold rise in the money supply.

while the living costs of the poor have similarly soared: for example, wheat prices have also trebled!

Spiralling living costs (particularly food prices) and unaffordable debt repayments create an environment of desperation, which can lead to civil unrest and/or an accelerated incidence of strike action, and the emergence of new, left-leaning political parties. So it is no wonder that liberal economists are once again dusting off the theories of Karl Marx and phenomena like the Economic Freedom Fighters are manifesting themselves all over the world.

Both of these have now occurred in SA. The next step in the path to an Arab spring would be the loss of power of the current government (in SA’s case the ANC) and so regime change. This would increase the potential for further lowering SA’s credit ratings increasing the cost of money and collapsing the stock exchange.

Now the problem with all of this is that securities markets are at all time highs and analysts are agreed that it is only a matter of time before they enter a catastrophic collapse! When that happens the world will enter a new phase of economic stagnation

And since the world’s central Banks have already used up all their ammunition….You cant lower borrowing rates when they are already at zero….the million dollar question is what will the monetary authorities do to rescue us this time? Obviously, since they know no other way, they will print even more money  and the consequence must be that inflation will soar. In fact it is already soaring as my wheat price example proved, but governments have found ways of concealing the truth from the public. For example the US has repeatedly re-based its consumer price indices.

Now bring into this dangerously explosive social mixture the fact that governments of the world are massively indebted.

In case you wonder what that number represents it is 53-trillion. Most of have difficulty getting our minds around such numbers so let us look at a few visuals: Pictured relative to our standing man is $1-million..you could stuff it into a grocery bag and walk around with it.

100-million dollars fits neatly onto a standard pallet

One billion looks more impressive

Jacob Zuma’s Government will spend a Trillion Rands this year. This is what it looks like: …can you still see our standing man left front?

Worst off among indebted nations is China with a reputed 250% of Gross Domestic Product, Japan with 243% Greece with 152.4% of GNP followed by Italy with 121% followed by Britain with 97.4% and France with a public debt that represents 96.2% of their Gross National Product.

To explain that in layman’s terms, there are 260 working days in a year and so if every Japanese worked for 632 days without pay, every Greek for 397 days and if every Italian worked for 315 days, giving all their wages and salaries to their Government they could all pay off their national debts. British men and women would need to work for 253 days.

Next is France with 96.2% Canada with 86% of GNP, the US with 84.3%, Spain with 83%, Brazil with 55%, India with 52%, New Zealand with 50%, South Africa with 39% and Australia with 27%.

The problem with such debt is that at this magnitude the total income of governments from taxes etc is less than the costs of servicing the debt and so many governments are forced to borrow more and more.

The next tipping point could well be a massively indebted China which has used borrowings to stimulate its economy into a growth trajectory that at its height saw annual GDP growth figures of 22 percent annually. Unless China can restructure itself to reduce those debt and slow its growth rate to something like 3.5 percent annually it faces the certainty of a hard landing; a banking collapse.

There is only one substantial example of a government paying off its debts without going the money printing route. The US was able to pay off its massive government debt in the years that followed World War 2 but it was only able to do this by impoverishing the rest of the world. Since the Bretton Woods agreement gave the US control over the world’s currency, it simply printed dollars which it used to buy up assets worldwide until then French President Charles de Gaulle challenged the US in 1972 to pay its debts in gold bullion. That led to a worldwide demand for an accounting and the upshot was that US de-linked the dollar from gold.

President Nixon’s response to de Gaulle was to first of all raise the gold price from $37 an ounce at which it had been held from1934 to $42.22 in 1973. But that was insufficient to satisfy America’s critics who believed that the dollar was massively over-valued and Nixon soon caved in and ended the gold backing of the dollar.

The true extent of the overvaluation of the dollar soon became apparent as the dollar gold price rose 16-fold in the next few months to reach a peak of $590 in 1980. The market price for gold has been free to fluctuate since then. It has risen steadily since then and peaked at $1 905.76 in August 2011.

More interesting though is to compare the sum of US Government debt in dollars  with the gold price in dollars as the following table illustrates:

The figures to emphasise are those that record that as US debt rose by 3 691% the gold price rose by almost precisely the same amount, by 3 792%. If you care to re-phrase that statement: that is the extent to which the dollar has lost buying power since 1970. That is an effective 12.27% compound annually though the US Government actually claims an inflation average of 4.4% for the period.

And that is the heart of the matter: when governments run up debts, the only way they have of getting rid of them is to inflate their currency, thereby reducing the sum they must pay to honour their debts. So consider the graph below which traces the ratio of the gold price to the Dow Jones Stock Exchange Index over the past 214 years. Note how the volatility of the ratio increased massively after the US ended the gold standard in 1913 and how that volatility continues increasing:

Put that another way, in order to eliminate their debts they effectively eliminate the life savings of their elderly.

So how can the ordinary man protect himself and, indeed, profit from the coming inflationary crisis? One option would be to invest directly in gold bullion: in Kruger Rands.  The  graph above illustrates the ratio between Wall Street’s Dow Jones Industrial Index and the gold price in dollars over the past 214 years. Note how volatility soared after the US went off the gold standard …and it has got progressively more volatile in recent years. Noting that lower red trend line, one can calculate that at a 1-to-1 ratio ($14,500 oz.) would equate to an over 900% move left remaining in the gold bull market.

Such a move would have a dramatic impact upon South African gold shares which in any event are looking very cheap right now. And it could just prove to be the saving grace for both our mining industry and our economy. My ShareFinder computer programme suggests that the gains depicted in orange in the graph above is likely over the next 12 months simultaneous with a collapse of world share markets which might have already begun.

That said, however, the collapse of the Rand/Dollar exchange rate should have massively boosted the profitability of our gold mines over the past few years but mining costs have risen commensurately so shareholders have seen no benefit as underscored by the falling price of the JSE gold index which is the bottom graph of the composite.

Note that over the past ten years the price of gold has risen from R246 an ounce to a peak of R1 576 in October 2012 and it currently stands at R1 375.25. That is a gain of 459 percent. Meanwhile the JSE Gold Index has fallen by 21 percent.

The Collapsing Rand: A looming crisis

The gold price story points to the greatest problem this country has faced in many years.  Relative to the British Pound the Rand has lost value at a compound annual average of 5.1 percent a year over the past 30 years (the red trendlines). After the ANC came to power, that rate accelerated to 6.6 percent compound (the mauve trend line). However, during the Zuma years the rate has accelerated further to 15.2 percent compound (the green trend line) and that during a time when our trade balance has been reasonably stable due to a powerful inflow of short-term investment capital seeking the relatively high returns offered by South African bonds.

At the current rate it will need R35 to buy one pound in five years time and R72 in ten.

Now, however, that flow of money seeking high local investment returns have reversed and if we wish to counter the trend we will be obliged to significantly increase our interest rates which will have a severe adverse affect upon the economy and upon all borrowers. The extent of this impact at a time when household debt in this country is higher than it has ever been before, implies severely rising social pressure in the not too distant future.

Investec’s economists see dire troubles ahead for South Africa: “Looking ahead, the down case remains one of a marked escalation in interest rates, along with persistent and/or widespread strike action that results in recession and a deterioration in SA’s fiscal and economic metrics as % of GDP.

Specifically, the down case sees five quarter recession, where strike action in the industrial sector (mining, manufacturing, electricity and other utilities production) persists over the whole 2014 and half of 2015, resulting in potentially a further round of credit rating downgrades in 2015, and significant rand weakness. The fiscal deficit as % of GDP widens, net government borrowings as a % of GDP widens and the current account deficit as a % of GDP rises, resulting in further downgrades to South Africa’s sovereign credit rating. SA is partly running in the down case, hence the rand weakness.”

Note that the rating agencies have twice lately down-graded our sovereign debt ratings. Furthermore the investment world has been shaken last month when Argentina defaulted on its sovereign debt – the second time in 13 years that will wipe 1%—2% off Argentina’s GDP and exacerbate inflation which is already at dizzying levels. It was a chilling reminder that South Africa and a dozen or so other Developing World nations could soon follow. Officially Argentinean CPI is running at an annual rate of almost 12% but unofficial tallies peg it far higher at around 40%.

Contamination is already bringing down Developing Nation markets. A fresh global crisis could come very swiftly upon a totally unprepared world.

Now, despite the dire warnings of economic commentators, we in South Africa have been using the inflow of speculative short-term money to meet our trade deficit, pay the salaries of a bloated civil service and service the borrowing costs of power stations that have gone massively over budget. If we continue to increase the costs of the civil service and the social wage at the same rate as we have during the Zuma years it will absorb the entire budget within 10 years

So what can you do to protect the spending power of your money in the years that lie ahead? Analysts always advise that in times of hyperinflation, you need to invest in inflation hedges: in precious metals, antiques and art works.

The problem with all of these is that while they might indeed help to preserve your capital, they do not generate any income and so they are of little use to retired people. The only areas to turn to that provide both capital protection and inflation-proofed income are rent-producing property and JSE listed shares. For most folk the latter means putting their money into a unit trust. And if you take the JSE Industrial Index as a proxy for the JSE there is little doubt that this would have paid off. …though the average unit trust tends to underperform the stock exchange average because it is loaded with sales commissions and management fees.

And this growth rate far outstripped our official inflation rate.  However, when we graph the Industrial Index relative to the US dollar as illustrated in my next graph, from 1994 to 2007 you would have lost the relative Dollar purchasing power of your capital. The direct implication of this is that the Government has been destroying the value of your Rand faster than business could keep up

Only Blue Chip shares rising at 24.5 percent compound have outstripped the Rand’s losses over the past decade *

Of course it is always possible to do better. This penultimate graph illustrates the performance over the past four years of the portfolio that I maintain for readers of my monthly Prospects newsletter. It has achieved compound 34.8 percent annually since January 2011.

In 2011 we invested R1-million and today it is worth R2.27-million and in ten years time it will have reached R18 947 423 if present growth rates continue.

I usually get asked at this time what shares I would recommend one buy. So I asked ShareFinder to prepare a portfolio for someone who had the stomach for a little risk: as ilustrated above.

But what is the market outlook? My final graph indicates what my software believes is the likely future of Wall Street> *

Happily, the outlook for South African Blue Chips remains healthy!

If you would like to learn more about using the ShareFinder programme to aid your share buying and selling, please contact suport@rcis.co.za or phone 031 7647845

The seventh in a new series in The Investor

by Richard Cluver

Point and Figure Charting

…and how to look for chart patterns

Triple Tops and Bottoms

TRIPLE tops and bottoms as you saw in the previous line graph are probably the most commonly encountered technical analysis chart formations and are generally recognised as the chartist’s favourites.

The two Point and Figure examples which appear in the illustration are simple variations known as “broadening formations’’. In example A we have a penetration of three tops with a buy signal at 40 cents. In example B we have a penetration of three bottoms with a sell signal at 36. In example A, the first top occurs at 38 followed by the first bottom at 35, a second top at 39 at a higher level than the first top, then a second bottom 34 at a lower level than the first bottom, and finally a breakout at a higher top at 40.

The significance of this is the broadening price pattern which distinguishes it from the usual triple top formation. It occurs most frequently during an up-move which may already have gone a long way and is often termed by fundamentalists a blow-off or technical correction.

The bearish version illustrated at B occurs extremely infrequently. But as in the bullish version _ example A _ it is regarded as exceptionally profitable. To illustrate how such formations can be found in the more commonly-seen line type graphs, I have drawn in resistance and support lines on a chart of Shoprit shares in late 2013 and early 2014 to illustrate how a broadening formation resulted in a powerful bullish break-out on March 30 on the fifth attempt. Note too, that once the (upper) resistance line was finally broken the share price soared upwards.

Note also the second declining triple top formation which was matched by multiple bottoms: a telling series of signals warning that the “Smart Money” was trading its way out of this share.

Emerging markets: On the comeback trail?

By Brian Kantor

Emerging and developed equity markets this year are tracking each other rather closely. As we show in the chart below, this has not always been the case.

Between 1990 and 1995, emerging market (EM) equities made their first significant bow on the global capital market stage and outperformed the US S&P 500, the leading developed market benchmark, by some 80%. After 1995 and until 2000, they lost all of this ground gained and much more in relative performance. EM was again the preferred flavour after 2000 until the Global Financial Crisis, an event that took even more out of EM valuations than the out of the S&P and other developed equity Indexes. EM, then in recovery from the global recession, outperformed the S&P 500 until 2010, but then became a decided outperformer until this year.

EM equities are more risky than developed markets and therefore, in order to attract investor interest, they should promise higher returns. Such higher returns are expected to come from the stronger growth in earnings expected from EM companies participating in faster growing economies. Such earnings expectations are not always satisfied. They were not well satisfied after 2010 when the average EM company delivered significant less extra earnings than did their competitors on the developed exchanges. It was this earnings disappointment that presumably held back EM valuations.

It may also be noticed that in 2014 EM earnings have outpaced S&P earnings. This surely has had something to do with the improved relative performance of EM equities in 2014.

The earnings indicated here are one year forward earnings expected by the analysts rather than reported or trailing earnings. We show below that forward S&P and EM earnings are now growing at about the same rate while, if recent trends are sustained, the time series forecast is for EM earnings growth to outpace still satisfactory S&P earnings growth.

Such trends, if confirmed, will add to the case for EMs given their somewhat less demanding earnings multiples, as show in the next chart. A combination of decent earnings growth and less risk priced into these earnings expectations could easily attract renewed enthusiasm for EM markets generally.

Any growing investor interest in EM equities would mean additional flows towards the EM companies listed on the JSE. This in turn would be helpful to the exchange value of the rand and so help restrain SA inflation and perhaps lead to lower interest rates in SA. Such inflation and interest rate trends would help revive the much subdued SA consumer, whose willingness to spend is an essential ingredient for faster SA economic growth. Much rides, as always, on the global appetite for EM equities and bonds.

It will have been noticed in the figure above, that the SA component of the EM bench mark Index, MSCI SA, is even more demandingly valued than the average EM equity market in which SA had an approximately 8% weight. The MSCI SA Index (one that excludes the dual listed companies) however has consistently behaved very much like the average EM market. It has done so because MSCI earnings have consistently matched those of the EM average.

The SA economy may have lower economic growth rates than the average EM economy. But the average JSE-listed company has consistently increased its earnings in US dollars at about the same rate as the EM average. The close relationship between the JSE in US dollars and the EM benchmark, is thus no coincidence. It is well explained by comparative earnings in US dollars.

New York Viewpoint

by Grant Williams

About 18 months ago, I had a very pleasant chat with a gentleman by the name of Luzi Stamm.

You may detect some measure of surprise in my words, and the reason for that is quite simple: Luzi Stamm is a politician; and, as regular readers will know, I am no fan of that particular class.

But Herr Stamm was different.

An MP representing the Swiss People’s Party, Stamm was spearheading a federal popular initiative which needed 100,000 signatures in order to comply with the Swiss parliamentary system’s rigid framework regarding referendums. (OK all you “referenda” people out there, I know, OK? But I’m going with “referendums,” so pipe down).

That initiative was one of three being pursued: firstly, a motion to limit immigration into Switzerland to 0.2% per year; secondly, a drive to abolish the flat tax system and for resident, nonworking foreigners to be taxed based instead on their income and their assets; and thirdly, Stamm’s initiative… Well, we’ll get to that shortly; but before we do, we need to understand a little about how Swiss democracy works.

(Wikipedia): Switzerland’s voting system is unique among modern democratic nations in that Switzerland practices direct democracy (also called semi-direct democracy), in which any citizen may challenge any law approved by the parliament or, at any time, propose a modification of the federal Constitution. In addition, in most cantons all votes are cast using paper ballots that are manually counted. At the federal level, voting can be organised for:

Elections (election of the Federal Assembly)

Mandatory referendums (votation on a modification of the constitution made by the Federal Assembly)

Optional referendums (referendum on a law accepted by the Federal Assembly and that collected 50,000 signatures of opponents)

Federal popular initiatives (votation on a modification of the constitution made by citizens and that collected 100,000 signatures of supporters)

Approximately four times a year, voting occurs over various issues; these include both referendums, where policies are directly voted on by people, and elections, where the populace votes for officials. Federal, cantonal and municipal issues are polled simultaneously, and the majority of people cast their votes by mail. Between January 1995 and June 2005, Swiss citizens voted 31 times, to answer 103 questions (during the same period, French citizens participated in only two referendums)

In Swiss law, any popular initiative which achieves the milestone of 100,000 signatures MUST be put to the citizens of the country as a referendum, and in a country of just 8,061,516 people (according to the July 2014 count — never let it be said that the Swiss aren’t precise), that’s a pretty big ask; but the Swiss do love their votes — so much so that, since 1798, there has been a seemingly never-ending procession of issues which the Swiss people have been entrusted by their leaders to decide:

In 2014 alone there have already been three referendums concerning such diverse issues as the minimum wage, abortion, and the financing and development of railway infrastructure. (For those of you just dying to know the outcomes, the abortion referendum, which would have dropped abortion coverage from public health insurance, failed by a large margin, with about 70% of participating voters rejecting the proposal. The railway financing was approved by 62% of the voters, and the motion that would have given Switzerland the highest minimum wage in the world — 22 francs ($23.29) an hour — was soundly defeated, with 76% of the voters saying “nein.”)

One wonders what the outcome would be of a similar motion to hike the minimum wage to such lofty heights in the US. Or in Great Britain.

The bottom line? The Swiss just think (and, importantly, vote) differently.

But back to Luzi Stamm and the SPP initiative.

Immigration and taxes aren’t uppermost in Stamm’s mind. What he IS concerned about is gold.

When we spoke on the telephone last year, Stamm explained to me that he hadn’t really properly understood the part gold played in the Swiss monetary equation until he’d had it explained to him by a friend more versed in finance (Stamm is a lawyer by background but with an economics degree from the University of Zurich); but once he understood how it all worked, Stamm realized that the changes to Swiss monetary prudence which had occurred in just a few short years were (a) potentially disastrous for the country and (b) not remotely understood by his countrymen (and women).

So Stamm decided he ought to do something about it.

The Swiss had accumulated a significant gold reserve the old-fashioned way — through seemingly constant current account surpluses — over many decades, but in May 1992 they finally joined the IMF.

Once THAT little genie was unleashed, things began to change.

In November of 1996, the Swiss Federal Council issued a draft for a new Federal Constitution, and contained within that draft was an amended position on monetary policy (article 89, in case you’re wondering) which severed the Swiss franc’s link to gold and reaffirmed the SNB’s constitutional independence:

Money and currency are a federal matter. The Confederation shall have the exclusive right to coin money and issue banknotes.

As an independent central bank, the Swiss National Bank shall follow a monetary policy which serves the general interest of the country; it shall be administered with the cooperation and under the supervision of the Confederation.

The Swiss National Bank shall create sufficient monetary reserves from its profits.

At least two-thirds of the net profits of the Swiss National Bank shall be credited to the Cantons.

Spiffy.

In April 1999, the revision of the Federal Constitution was approved (how else than through a referendum?), and it came into effect on January 1, 2000.

Oh… sorry… I almost forgot to mention that in September 1999 — after the revision had been adopted but before it had been officially enacted — the SNB became one of the signatories to the Washington Agreement on Gold Sales, meaning that all that lovely Swiss gold which had been sitting there, steadily accumulating and making the Swiss franc one of the last remaining “hard” currencies on the planet, was eligible to be sold.

A single line in the Swiss National Bank’s own history of monetary policy identifies the beginning of the demise of one of the world’s great currencies:

On 2 May, the SNB begins selling gold holdings no longer required for monetary policy purposes.

And there you have it. “No longer required for monetary policy purposes.”

That’s what happens when you finally embrace the beauty of fiat. Not only do you get to sell gold, you get to call the proceeds of those sales “profits.”

The absurdity borders on breathtaking.

At the beginning of 2000, the Swiss National Bank (SNB) held roughly 2,600 tonnes of gold in its reserves. That equated to approximately 8% of total global central bank gold reserves. After the revised constitution became law, the Washington Agreement took over and… Bingo!:

Swiss gold reserves were plundered gently sold in line with the Washington Agreement, and the “profits” (the language used by the SNB themselves) were distributed amongst the Swiss cantons; so everybody in a position to raise questions ended up getting a nice, fat slug of “profit” to keep them quiet help their Canton pay the bills.

Now, does anyone notice anything particular about the period when the Swiss gold sales were at their highest? Yessss… that’s right (as with the UK’s sales), the bulk of Swiss sales were made at the lows in the gold price (between $300 and $500 per ounce — blue shaded area).

To look at it another way, the Swiss National Bank went from being one of the soundest central banking institutions on Earth to just another in the morass of apologist financial institutions that lost sight of their mandates while grasping for a Keynesian free lunch, egged on by a new breed of politicians who knew nothing of the principles of sound money or, if they did, were happy to put them to the back of their minds as they extended their hands.

Sadly, as went the soundness of the SNB, so went the soundness of the Swiss franc itself.

As you can see from the chart above, the SNB has, over the last two decades, oustripped its nearest rival in gold sales by a factor of three.

Adding to the fun and games was the decision in September 2011, at the height of the euro crisis, to peg the Swiss franc to the euro (something that obviously couldn’t have been done prior to breaking the gold peg) in order to stop it appreciating.

How? Why through literally unlimited printing of Swiss francs to stop the exchange rate breaking 1.20.

At the time, the SNB was unequivocal:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development. The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc.

All this talk of “massive overvaluation of the Swiss franc” is utter bollocks a little disingenuous. (“Surely not!” I hear you cry.)

Between 1970 and 2008, the strength of the Swiss franc was legendary. During that time, it appreciated by 330% against the US dollar and by 57% versus the Deutsche mark/euro. Consequently, a strong currency went hand-in-hand with a strong economy. How awful.

The problem was NOT in the OVERvaluation of the Swiss franc, as the SNB would have you believe, but rather in the UNDERvaluation of the competition; and the only thing the SNB could do was to join in the great devaluation race.

That move weakened the currency by about 9% in 15 minutes, and the immediate effect on the SNB’s balance sheet was obvious:

(Mitsui Global Precious Metals): As late as the end of 2009, the SNB held 38.1 billion CHF in gold out of total reserves of 207.3 billion CHF, with gold representing a touch over 18 per cent of all its reserves. At the end of July 2014, it owned 39.1 billion Swiss Francs in gold (or 1,040 tonnes) from total reserves of 517.3 billion CHF, meaning that roughly 7.6 per cent of its assets were in the form of the yellow metal.

Note that the rise in value of Swiss gold by CHF 1 billion wasn’t enough to counter the destructive nature of overt and unchecked money printing.

Like the Fed, the BoJ, and the BoE before them, the SNB became, at a stroke, another previously sound institution that unhesitatingly ripped its balance sheet to shreds:

Since 2009, the SNB has quintupled its balance sheet, making it (on a relative basis) the most prolific of the central bank printing machines. Not bad for the world’s 96th-largest nation.

Since the EUR peg was instituted just three years ago, the SNB’s balance sheet has more than doubled.

So, with the Swiss franc’s soundness under attack from within its own borders, Luzi Stamm decided to try to use the Swiss love for referendums and the rigidity of the Swiss political process to try to reinstate the Swiss franc as a sound currency.

To that end, Stamm proposed the Swiss Gold Initiative (“Save Our Swiss Gold”).

Funnily enough, the proposal was rejected by lawmakers, but Stamm gathered three like-minded MPs and, more importantly, enough signatures on his petition (100,000) to ensure that a referendum on the proposal would take place; and that vote will happen on November 30th — four weeks from now.

Stamm pulled off a masterstroke in securing the involvement in the Swiss Gold Initiative of Egon von Greyerz who, along with being one of the most highly respected figures in the gold industry, happens to be one of the world’s nicest human beings.

We’ll get to Egon’s involvement shortly, but first let’s take a look at the motions that make up the Swiss Gold Initiative, which are threefold:

1. The gold of the Swiss National Bank must be stored physically in Switzerland.
2. The Swiss National Bank does not have the right to sell its gold reserves.
3. The Swiss National Bank must hold at least 20% of its total assets in gold.

(NB. Before we get to the part of this story where the SNB tell us how big a nightmare it would be to force them to hold 20% of their reserves in gold (come on, you KNEW that was coming), I’d point you back to the chart on page 8. Remember? The one that showed the Swiss held 18% of their reserves in gold just five short years ago?)

Addressing the motions in order, let’s begin with number 1, that all Swiss gold be physically stored in Switzerland.

Switzerland has made its name over centuries as being one of the safest places on the planet to store gold. That reputation has been good enough to convince people from all over the world to entrust their gold to the Swiss for safe-keeping. However, like many other central banks, the SNB stores a certain proportion of its gold overseas. How much? We don’t know. Where exactly is it held? We have no idea (other than “in the UK & Canada”). In fact, when the finance minister was asked, in parliament, where Switzerland’s gold was stored, his answer was something of a head scratcher:

Where this gold exactly is stored, I cannot say, because I do not know, because I do not need to know, and because I do not want to know.

Riiiight… Call me old-fashioned, but if I were a Swiss national I’d want a better answer than that.

Anyway, the spurious reason commonly given by central bankers for storing gold in places like London or New York is to have it “close to the marketplace should sales be necessary.” Obviously, if the Swiss are forbidden from selling their gold and are bound to hold a minimum of 20% of their gold reserves in gold, that argument becomes moot anyway, so shipping it home should be nice and straightforward. Just find out where “in the UK and Canada” it is (I’m sure they gave you a receipt), call them up, and tell them you’d like it back. Now that you’ve sold more than 50% of the gold, it shouldn’t take too long to physically move the rest home. Surely?

Number 2 on the initiative’s wishlist is that the SNB be prohibited from selling their gold reserves. Now, THAT might be a problem for the SNB in times to come in the “ordinary conduct of monetary policy,” but as we are some ways away from a world in which “ordinary” features in any way, shape, or form where monetary policy is concerned, I don’t think this prohibition is going to matter much. However, if you think this initiative isn’t being taken seriously, you just have to look at an excerpt from a speech given by the governor of the SNB, Thomas Jordan, a matter of days after the Swiss Gold Initiative achieved the 100,000 signatures it required to qualify as a referendum.

If you lean in real close, you can smell the fear:

(Thomas Jordan, speech to general meeting of shareholders of the Swiss National Bank, 26 April 2013): The SNB does not generally comment on any political initiatives. However, the gold initiative has a very direct impact on the SNB’s capacity to act. This is why we are taking the opportunity today to present our viewpoint for the first time on the demands of the initiative.

The initiators see a high level of gold reserves as a guarantee for currency stability. They fear that the Swiss franc will decline in value and that price stability will be threatened if a large proportion of the balance sheet does not consist of gold holdings. They are also concerned that the SNB’s gold reserves held abroad are not secure and will not be accessible in critical situations.

We share the objectives the initiators put forward, such as maintaining currency and price stability and ensuring both the SNB’s capacity to act and its independence. However, the measures proposed to this effect are not suitable; in fact, they are even counterproductive. Instead, they are based on misunderstandings about the importance of gold in monetary policy and would compromise the SNB’s capacity to act in pursuing its monetary policy, which would run counter to the objectives envisaged. In other words, these measures would, in certain situations, considerably hinder the SNB in fulfilling its monetary policy mandate and be detrimental to Switzerland. We therefore consider it our duty to point out the serious disadvantages of the initiative already at an early stage.

Thomas, if I may?

The SNB’s desire to “maintain currency and price stability” can be summed up by this chart, which will be all too familiar to those who have studied the fiat currencies of the world, but it obviously needs trotting out one more time:

As for the SNB’s capacity to act in “pursuing monetary policy,” what the Gold Initiative will do is effectively stop them from printing unlimited amounts of Swiss francs in order to keep the once-mighty Swiss franc pegged to a potentially obsolete currency like the euro.

Now, I am simplifying here in the interest of expediency, and I am well aware of the restrictions that any kind of gold standard places on a central bank’s operational capability, but it’s important to understand that the Swiss franc functioned perfectly well as a partially gold-backed currency up until 1999, and the desire of the SNB to have carte blanche to debase the Swiss franc at will more flexibility in their monetary policy comes down to their wanting to employ the same tactics being resorted to by the world’s other major central banks.

If you can’t beat ’em, join ’em.

All of which leads us to perhaps the most fascinating part of the Swiss Gold Initiative: the motion to ensure that the SNB immediately acquires enough gold to back 20% of its reserves (a threshold which it must then maintain as a minimum — at a level, you know, about where they were in 2009).

Now, the numbers around this little piece of the puzzle are interesting.

In order to reach the 20% threshold, the SNB has two options open to them: they can either reduce the size of their balance sheet or buy gold.

In life, there are many limbs out onto which one should never venture, but I’m prepared to dance out onto this one like Billy Elliot:

The SNB will NOT reduce the size of their balance sheet in order to meet the 20% mandate should the motion be passed.

There. Quote me on that.

And we all know what THAT leaves, don’t we boys and girls?

Yes, in order to meet the regulations should the Gold Initiative pass, the SNB will need to buy 1,700 tons of gold at the market (assuming, of course, that they don’t expand their balance sheet further in the meantime — something that, with the increasingly weak euro, is doubtful in the extreme). That equates to roughly $70 billion or CHF 67 billion.

And we are talking physical gold. Not futures contracts or complex derivatives but the metal itself.

Put another way, 1,700 tons of gold is roughly 70% of total annual gold production.

Now, the SNB will have five years in which to reach the required 20% limit, but they will essentially need to get started immediately, because with the floor such a big buyer will put under the price and the constant expansion of their balance sheet due to that pesky euro peg, the longer they wait, the more gold they will have to buy and the less they will get for their money.

Catch Zweiundzwanzig.

How’s your attention? Grabbed yet?

OK, good.

Until now, the whole idea of this hokey little referendum has been written off as inconsequential and largely ignored by all but the most buggy of gold bugs. It was written off when Luzi Stamm announced it. It was written off when they needed to get 100,000 signatures; and, amazingly, it was ignored even once they HAD reached the magic number; but recently a number of things have happened which are making some serious waves and causing considerable unease amongst the Swiss banking establishment.

While in San Antonio recently, I was fortunate enough to chat with a displaced fellow Brit who came to meet me at the Casey Summit to talk about the Swiss Gold Initiative, and what he had to say fascinated me.

The gentleman explained a few of the nuances surrounding the framework within which the vote on the Gold Initiative will be conducted, and as I listened I realised that this little vote could potentially become a very big vote indeed.

Firstly, he noted the fact that there isn’t any “no” ca

Show more