April 12, 2024 – In today's Smart Macro segment, Financial Sense Wealth Management CIO Chris Puplava discusses the rise of the gold vigilantes—large global investors, central banks, and institutions who are increasingly favoring gold over Treasuries, reflecting concerns over the escalating levels of US debt and debt servicing costs. Chris also discusses the risk-off move in the markets as nearly everything sold off except for oil due to a confluence of factors: overbought markets, months of higher-than-expected inflation readings, and a potentially looming war between Iran and Israel.
For investment inquiries, reach out to Chris directly at 858.774.0896 or send him an email at chris[dot]puplava[at]financialsense[dot]com
Transcript:
Cris Sheridan:
Welcome everyone to our smart macro segment, where we speak with our chief investment officer here at Financial Center Wealth Management, Chris Puplava. So, Chris, it's Friday, and I'm seeing a sea of red. Almost every market is down. There's just a select few commodities that are up. Oil also up with geopolitical concerns of an imminent attack by Iran on Israel. That's lifting oil prices slightly. And it obviously has been very volatile oil market because of that. But basically it looks like a risk off day. What are you seeing from your point of view?
Chris Puplava:
You know, Chris, I kind of liken it to that old John Molden saying years ago when he used to describe Japan, he said, Japan is a bug in search of a windshield. You know, basically just looking for an accident to happen or an excuse. And that's how I describe this market. This market is a bug in search of a windshield in terms of a catalyst to sell off. And I think this recent concern over Iran is the catalyst. Essentially, when you look at positioning, and there's some really good data on this coming from Goldman Sachs, is everyone's all in. One of their chief traders was basically, I think one of his emails a week or two ago was called everyone's all in the pool. And essentially, when you look at us index futures positioning, the record longs, it's the highest position in almost 15 years. So there's, I think, a huge asymmetric risk. There's not really a lot of upside, given everyone's kind of in the pull, so to speak. And the downside risk was far greater. And that's what we're seeing is the market selling off. And you saw it internally. Right. And when you look at the small caps, they weren't confirming the markets rally internally. If you look at the Nasdaq, I mean, you had Hindenburg omens, meaning the Nasdaq was hitting new highs while you had a fair amount of securities within the index hitting new lows. So there was all the signs. I mean, we went pretty much straight up since last October. So the market was in dire need of a breather. And I think we're getting it.
Cris Sheridan:
Yeah. And while the lead up to that as well, we saw the higher-than-average inflation report for March that came in. That's the third month in a row that inflation has come up higher than expected. This is something that we've been discussing and warning that we do believe we're going to be in higher-than-average inflationary environment for the years ahead. And it does seem to be that more and more of the data coming in is lining up with that view that maybe we're going to be troughing around this three and a half, 4% range, perhaps getting higher. Commodities were not helping with that, in addition. So what's your view on some of the trends that we see with inflation?
Chris Puplava:
You know, no matter where you look, you are seeing signs of it, whether it's, you know, ism prices paid, components that are surging, it does give you wonder why the Fed is so bent on cutting rates when there's all signs that inflation may be heating up. And further, according to the non farm payroll report, jobs are not slowing significantly. So it does, as I said, beg the question of what's the Fed's agenda here when you're not seeing a massive deterioration in employment according to the payroll number? Although you and I have spoken about the weaknesses and that, but again, the industry and the Fed, everyone goes off of the headline number from the establishment survey. But with all the inflation heating back up, gold hitting over 2400 intraday today, oil prices moving back up to almost $90 a barrel, all of these things speak of higher inflation. So I think they're all definitely making the feds job much more difficult. And also that I think is another reason why the markets starting to sell off here is pushing out the first rate hike as well as the number of rate hikes for this year as those basically the hopes of that get dashed. That is definitely weighing on the market. Clay?
Cris Sheridan:
Yeah. What was it at the start of the year? Wasn't the expectation that wed see somewhere between four and six rate cuts at the beginning of the year? Thats what Wall Street was expecting. And now were what, maybe one.
Chris Puplava:
Maybe two, that's correct. The market was expecting somewhere around four to six, which was obviously more than what the Fed was saying at the time. But now the market is pricing in less than two rate cuts for this year. So we keep this up, I mean, we may not get any rate cuts.
Cris Sheridan:
Yeah, and something that Jim Bianco said in our first segment when we spoke with him. He said, the most concerning part about this most recent inflation report is it wasn't just a matter of one or two items dissecting to see what led to the hotter than expected number. It was basically across the board. I mean everything was just up. And something that we discussed on fs insider this week was electricity, and energy prices were a huge component of that as well. And as we all know, policy is continuing to lean into the energy and the electricity price component of inflation, which for the long term, I don't know about you. But it seems that electricity prices are likely to continue climbing, and I don't think we're going to see too much relief at the pump.
Chris Puplava:
And also too, adding to that, Chris, was insurance, all different forms of insurance. That was another one that had a huge spike up that weighs on a lot of people. So, you know, with more and more categories rising, it's getting harder and harder to say, well, inflation wasn't so bad if you x out this, that and all the other. So it definitely to me is a warning sign that inflation is picking up here. And the concerning part about that, Chris, is when we look at the economy, we look at the economy on a real basis or inflation adjusted. So you get inflation rising at the same time growth starts to moderate. You might see real GDP for the first quarter come in fairly weak. So that's definitely a risk for the market.
Cris Sheridan:
Trey, any other things that you're looking at that you'd like to discuss with our audience today? Perhaps some key charts or data that you've got on your dashboard?
Chris Puplava:
You know, I would say, Cris, the one chart that I see making the rounds and in a lot of articles is a comparison of gold relative to real interest rates. It's really scratching the heads of a lot of people where gold moves inversely to real interest rates. And with inflation falling until recently and interest rates rising, real interest rates have significantly risen over the last one to two years. Yet at the same time, gold has remained strong. And so that has really had a lot of people scratching their heads. And it was something that I took time to delve into in my recent client letter that's going out, is trying to explain that. I think there's other things at work than just central bank buying, which has been strong. And, you know, don't get me wrong, I think that's been a massive influence, is the huge amount of central bank buying. But you gotta ask yourself the question why? And many point to this starting in 22, when Russia invaded Ukraine and the US confiscated Russia's assets, that basically that telegraphed to others, hey, we don't get along with you, we may confiscate your dollar reserves or kick you out of the SWIFT system. And so we cannot do that with physical gold bullion. And so that kind of kicked off the start of this massive buying of gold bullion. But I think it goes deeper than that, Chris. I think that's part of it. What I feel and what I'm concerned about is that we're at that point of no return where we're darned if we do and darned if we don't. In terms of the deteriorating us fiscal position that I think is leading to a dramatic rise in gold over the last couple of months here.
Cris Sheridan:
Okay, so you touched upon the US fiscal position and of course we've seen debts just climb parabolically since 2020 with a lot of the COVID spending. I think as Jim Bianco said in our last segment, we're spending like anywhere between one and a half, 2 trillion as a deficit, are spending above what we're taking in and taxes. That seems to be structural in nature. Probably going to be continuing here. So where do you see, at least in terms of what we've seen in the gold market connected back to the US fiscal position?
Chris Puplava:
I think a lot of it, Chris, has to do with the unsustainability of our debt. For example, one of the things I show in my client letter is I look at the total debt, us public debt to GDP. So basically the size of government debt relative to the size of the economy. And I overlay that with gold. And what we saw is in the latter part of the nineties, going into 2000 2001, we saw debt relative to GDP decline, meaning the economy was growing faster than our debt growth. And with that we saw a weaker gold price. However, we had the 2001 recession and we had the 911 terrorist attacks that led to huge deficit spending here in the US, such that our debt was growing faster than our economy. Gold bottomed and gold bottomed and went up alongside our debt to GDP ratio. And then obviously in response to the financial crisis of 2008, we saw this massive surge in gold and money printing by the US and deficit spending such that our debt to GDP went from roughly 60% to roughly 100% by late 2011, when gold was peaking year 2000.
But we started to see a moderation in that where we started to do some fiscal austerity, the economy was beginning to grow faster than our debt accumulation and gold sold off. However, starting in 2019, we were starting to see our debt to GDP expand and gold was starting to advance again. And then that obviously exploded with the response to COVID, gold hit new all-time highs. It reached up to 2000 and our debt to GDP spiked to almost 135% as our GDP collapsed while our debt exploded higher. But after we came through the initial recovery, we saw a peak in gold, a peak in our debt to GDP. And our debt to GDP had declined from roughly 135% to below 120 by 2023. But we started to see Cris Gold begin to rally. And what we soon saw afterwards was this revamp of government spending it was something that I mentioned in client letters and on this podcast over the last year was that I feel part of what staved off a recession where the manufacturing recession didn't spill over to a consumer led recession was the excess pandemic savings, but also the government stepping up expenditures by over a trillion dollars. From the summer of 22 to the summer of 23, government spending ramped up by a trillion. So it's pretty hard to have a recession when you got the government throwing an additional trillion dollars at the economy. The problem with that though, Cris, is that was expanding our debt to GDP at a faster clip, pushing gold higher.
And what we're seeing is currently, I think historically something around 25% of overall debt issuance by the US treasury was t bill related, the rest being coupon bearing instruments. And what we've seen at least in the first quarter, is the government shifting towards zero coupon or zero interest bearing t bills and less in coupon interest or coupon paying bonds as a way to keep the overall interest expense low here in this country. And they're doing that, Chris, because when you look at the interest on our debt, were annualizing a trillion dollars of interest, were now well above our defense budget, were on par with Medicare, another 300 400 billion more on an annual basis, and then interest on our debt will exceed Social Security, which is already rising rapidly because of entitlement spending from the retirement of the baby boomers. So think of it, Chris, if the government wasn't issuing massive amounts of P bills, what they would be paying in interest, but you can have your cake and eat it too. If you want to issue t bills because you don't want to pay interest, well then you're going to see your debt explode at a faster rate because t bills are issued at a discount when they mature, you have to pay 100 cents on the dollar.
So if you're issuing a short-term T bill, let's say three, six months and it's 100 billion face value, you're only going to get 97, 96 billion of that when you issue it. But when it matures, you have to pay your investors back 100 cents on the dollar. So you're basically issuing debt at a discount and paying it, returning it and paying it back in full. So that means the amount of debt you're issuing is accelerating because rather than financing your debt or interest payments, you're doing it through basically zero-coupon bonds and issuing more face value once they mature. So we're seeing this escalation of US treasury issuance and it's getting to that point, Chris, where the government's darned if they do, darn if they don't.
So if they keep issuing zero coupon T bills, well, you're going to see a rapid rise of the debt relative to the economy. If you instead issue more coupon bearing bonds so that the debt is not being issued at such a fast pace, well then your interest expense goes up and that's not going to make the White House any, you know, it's not gonna be a great news story. When you see interest on us debt exceeds it becomes the highest expenditure on the US line item. So there's a problem there. And I think that's ultimately, Chris, what gold is sniffing out is no matter what, the US government is in a very tight, unfortunate position because of the massive amount of leverage that is placed upon it by all this debt issuance. Nothing's free. And we're finally coming home to realize that.
Cris Sheridan:
Yeah, and this was a topic we were discussing last week too on the big picture segment when it comes to fiscal dominance. Right. So when us debts and deficits become so large that monetary policy is going to have to acquiesce to higher inflation, the St. Louis Fed had published a paper even saying just late last year that this situation, a fiscal dominant situation where there's going to be a battle between fiscal monetary policy and keeping inflation low, that this is an imminent concern. And so I think like you said, gold has been sniffing that out.
Chris Puplava:
I would agree with that, Chris. And it's becoming more mainstream in terms of Fed governors making speeches or finance professors making speeches, that we're in the situation where the government is hampering the Fed's ability to control inflation through their efforts, where, I mean you've got the Fed putting the brakes on while the federal government is putting the gas on. I mean one of the charts I'm showing in my client newsletter is looking at net treasury issuance over the prior twelve months. And in the summer of 23, net treasury issuance briefly dipped below a trillion dollars. As of today, Chris, last twelve months we've issued 2.5 trillion.
Now you go all the way back to 2009 at the peak of the worst financial crisis since the Great Depression where unemployment was double digits in this country and people were losing their homes, losing their jobs, losing their incomes. And we had to. Our budget deficit blew out because of that. We were issuing that Treasuries over 2 trillion over that twelve month period. We're well above that right now, Chris, and we're not in recession.
So what is the government's justification for this massive debt issuance when we're not in recession because it really hamstrings our ability, Chris, to respond to recession if we have one. I mean, we're just going to blow out our deficit even more. We're at the point, Chris, where deficits matter. And Washington needs to understand that quick because we're in a serious situation. And back in the sixties and seventies when interest rates were rising, I mean essentially it was kind of the bond vigilantes protesting against government spending.
And I think what we're going to see now, Chris, instead, the bond vigilantes, I'm almost calling them the gold vigilantes. Where you're seeing gold, it skyrocket. I mean what is, what is going to be the message to this country in government when you see gold at 2500 or let's say gold at 3000? That is a negative vote on the US government in the US dollar with gold skyrocketing. And so I think what we're seeing is almost a rise of the gold vigilantes is basically people protesting not just us debt but the dollar itself by wanting to own other instruments other than us treasuries or Ust bills.
Cris Sheridan:
Yeah, and when we were speaking earlier about what's driving gold and has driven gold, I mean, especially if we think back to 2020 when we saw this new bull market emerge, something Jeff Christian has been talking about to take place over this time period as well. We've seen new record highs in the gold market. We're seeing a pullback today. It seems natural after an explosive just parabolic move to see a little bit of consolidation. But that being said, you had pointed the finger at us debts, deficits going parabolic here. The interest expense, debt servicing costs over a trillion dollars as being one of the main culprits for lifting gold prices. But then again, when it comes to central bank buying and purchasing, particularly China, the two do go hand in hand, I would say, because on the one hand central banks are looking at this problem and they are looking at the geopolitical situation. They're seeing, like you said, the risk of having their assets, their reserves confiscated or shut out of the swift banking system. And they're saying, hey, given some of these things that are looming out there, it probably makes some sense just to diversify our reserve base into gold.
Chris Puplava:
And it's not just China. I mean China is obviously the biggest buyer. But you got India, you have other countries buying and you look at it even on the retail front, local buying here in the US, it's rather significant and it's really concerning. When you look at Chris, for example, in the 1970s when gold had its huge, massive run, I mean, our debt to GDP was a fraction of what it is now. I mean, it was significantly lower.
And our ability to basically manage our finances is being taken away from us. And ultimately, Chris, I think there is a really good chance that we may have a surprise in us central bank policy, where back in 2019 we had the repo crisis. In one week the Federal Reserve is shrinking its balance sheet. Within a week it's expanding it. And that was a prelude to ultimately what happened with the money printing in 2020.
In response to COVID, we also saw that in the UK, I believe also in 2022 was you saw the UK bond market erupt where interest rates spiked and the bank of England had to step in when they were literally slated a week later to start cutting their balance sheet. They were momentarily printing money to basically support their bond market. And while were talking about Fed rate cuts and the Fed shrinking its balance sheet or tapering. I think we may be in a situation, Chris, where the Fed has to step in as buyer of last resort to calm the market because were at that point where the amount of issuance and the ability of the private sector to absorb it is really being overwhelmed by the massive amount of issuance. Its not just the US that's issuing, you know, debt.
I think the US is issuing around $9 trillion over the next twelve months. You have other developed countries, Japan, Germany, you know, England, others that are issuing large amounts of debt as well. So there is a massive amount of supply of government debt that's pressuring yields higher. And to me, I think that's ultimately what gold is basically saying in terms of its message and communicating.
Cris Sheridan:
Preston, we have been discussing the fact that we believe investors should be preparing for a higher-than-average inflationary environment for the years ahead. Head however, when we do look at gold, precious metals, number of commodities, with the big intraday reversal, there is a risk off move. One thing that you had mentioned to me before we started is that a big catalyst for that has to do with a change that was just made in the futures market. Can you tell us a little bit about that in terms of what's this proximate cause at least for the big volatility that we're seeing in precious metals right now? And then also a little bit about what you're seeing when it comes to the move of gold from the west to the east.
Chris Puplava:
So I believe I was reading, hearing that margin requirements for trading precious metals futures were increased, sparking a sell off midday where gold was on its way towards exceeding $2,450 an ounce, and with a matter of a couple of hours, it reversed $100. So that was, you know, you saw this huge sell off in the price of gold here in the US. But when you look, Chris, outside the US, and you look at, for example, gold on the Shanghai exchange, repriced in dollar terms, gold still selling for $2,437. So as of the moment that you and I are speaking, Chris, that is nearly a $100 premium. So I think the sell off in gold is going to be short lived because think about it from an arbitrage standpoint, you can buy us gold, take delivery, or essentially buy us gold and then sell it forward in China on their Shanghai exchange and hedge your currency and still make a very sizable premium.
So I think this massive premium between the Shanghai price gold and the US gold price will be closed because there is a huge arbitrage opportunity here. And so I think the sell off in gold will be limited as long as the Shanghai price of gold remains elevated.
Cris Sheridan:
And is the Shanghai price higher than what we see here in western markets because there's just such a much stronger demand in the Asian markets than what we see here.
Chris Puplava:
I think that's true, Chris, in terms of supply and demand, we're not just seeing demand come from the people's bank of China, but also domestically. So I think there's a real strong bid to purchase gold. And as long as that keeps the price of gold high in exchanges like the Shanghai Gold exchange, then that creates that arbitrage. Where we see weakness in the west, bit strength in the east, you're just going to see more and more gold transferred from west to east because of that spread.
Cris Sheridan:
When it comes to the margin requirements. Just to clarify here, for any of you that aren't familiar with how the futures market works, people that trade in the futures market, there's a large leverage position there where they borrow in order to engage in long or short positions. So as the price of a commodity goes up, in this case, if we're talking about gold, the higher it goes, very often you'll see margin requirements raised in order to cover that larger position. And so we see that here in the US, we also see that in Shanghai, this was something that was just posted yesterday, that the Shanghai gold exchange is going to be hiking gold margin requirements to 9% as prices hit record high. So when that happens, that means people either have to cover their positions and sell or fork up more money in order to cover the increase so that's kind of what we're seeing with some of the volatility.
But again, these are short term factors. And we do believe, given some of the longer-term structural issues that we discussed, the trend is likely to be higher for not just precious metals, but for commodities as a whole, which is why we have an exposure to these areas. Well, as we close today, again, Chris Palava is our CIO here at financial cents wealth management. Chris, what would be the best way for our listeners to get in touch with you or follow more of your work?
Chris Puplava:
They could either call me at 858-774-0896 or they can email me at chris[dot]puplava[at]financialsense[dot]com.
Cris Sheridan:
As always, it's a pleasure, Chris, to have you on for our smart macro segment and look forward to speaking with you in another two weeks.
