Gold confiscation has been a hot topic at various times, and amid the coronavirus crisis, some are worried that it could happen again. In his April letter, which was reviewed by ValueWalk, Crispin Odey suggests there’s a small chance the government could confiscate gold again in an extreme situation. Despite that, a sizable chunk of his fund is in gold and gold-backed assets.
Q1 2020 hedge fund letters, conferences and more
Odey Asset Management was down 9.9% in April following an impressive 23.6% return in March amid the steep selloff.
Conjectures
In his April letter, Odey quoted Catherine the Great, who said running Russia was like dealing with “circumstances, conjectures and conjunctures.” He said the current situation is much like a time of forming conjectures because it’s unclear how we will “put our lives back together.” He said such a time is a good time to “listen to those who have radically different ideas about the future and are also regarded as not being madmen.”
While most economists expect the world to get back to some semblance of normality when the world’s economies spring back into life, the monetarists think differently. He noted that the correlation between the growth in monetary aggregates and inflation has broken down, which is a problem for monetarists.
Monetarists on gold
The world’s central banks have been pouring stimulus into their economies to deal with the fallout from the pandemic, but there is very little sign of inflation. Monetarists explain that by explaining that the Japanese government’s budget deficit was funded by quantitative easing, and it didn’t cause inflation because the spending only made up for the excess savings in the system. If the government hadn’t spent 11% of GNP, the economy would have shrunk that that amount.
Odey said monetarists look at the world system and analyze it from the outside, taking their cue from 1971 when the world stopped using the gold-based Bretton Woods system to settle trade balances. Like with the gold standard, the Bretton Woods system meant no economy could grow faster than its innate productivity. He said if the economy grew too fast, it pulled in imports while gold flowed out.
To pull the gold back in, the government had to raise interest rates, depressing its own economy. He added that the system didn’t stop fractional banking, which started with the Federal Reserve, but it did rein lending in.
Ballooning debt and staggering inflation
After 1971, the trading system became dollar-based, which encourages the Fed to expand its balance sheet “because there is a delicious multiplier effect globally as the liabilities of the Fed become assets to be levered by the emerging market economies,” he said.
Due to this structure, he said it’s no surprise that global debt has ballooned to 330% of world GNP before the COVID-19 pandemic. Because of all that debt, interest rates must be kept at 3% or lower because interest expenses larger than 9% of GNP become unserviceable.
“So even before COVID came along this was an extremely delicate balancing act in which keeping the system going was competing with the demands of maintaining a stable medium of account — the dollar,” he said.
He added that the monetary aggregates have now “careened out of control.” During previous crises, quantitative easing offset weak loan growth at banks, but now, it’s reinforcing a strong trend in loan growth. He explained that loan growth is running at about 16% year over year, and one of the only other times that happened was in the early 1970s, resulting in inflation in the late 1970s.
Monetarists expect that within 12 months, the purchasing managers indices will be at all-time highs, and within 15 months, inflation will be between 5% and 15%. Odey added that it may seen strange to talk about inflation even though consumption is running at 70% of where it should be. However, he added that many companies won’t emerge from the lockdown, and many industries will have to reprice their services to account for social distancing, and many businesses will have to build profitability.
Crispin Odey: How gold confiscation could happen
Some believe central banks will tighten quickly if faced with inflation, but Odey said that doesn’t fit with the need to keep interest rates low and hold sufficient liquidity. It also doesn’t fit with the nature of the quantitative easing that has taken place.
He also pointed out that there have been plenty of examples of rules who resorted to debasing their currency during times of crisis. Further, he warned that the markets don’t seem to understand the potential consequences of everything that’s been happening.
“Economics came out of alchemy, the endless hope that lead could somehow be turned into gold,” he wrote. “We are at just such a moment but without any sense of its consequences.”
He added that the government could decide to confiscate gold, but only in an extreme situation.
“As Voltaire writes, individuals are tempted to bury their coins,” Odey wrote. “In this case it is no surprise that people are buying gold. Buy the authorities may attempt at some point to de-monetise gold, making it illegal to own as a private individual. They will only do this is [sic] they feel the need to create a stable unit of account for world trade.”
A warning about positioning and inflation
Odey also warned that if inflation does start to occur, few portfolios are positioned correctly. He noted that a chart from Mike Howell shows that all financial assets do fine as inflation rises toward 4%, but after that point, financial assets perform poorly while physical assets do OK.
“In such an environment it is difficult to do well, which is why index linked bonds are already showing negative real yields,” he explained.
He added that long duration assets will really be hurt in such a situation, which means both long-dated bonds and growth stocks, which is “just where everybody is currently hiding.” He expects officials to fight these trends fiercely, but he expects them to lose the fight.
A look at Odey’s top 10 holdings indicates just how much he expects gold to outperform in the coming months. Much of his top holdings are gold or gold related. His biggest position is a short of long gilt futures for June delivery. In second place is a long of gold 100 ounce future for June. He’s also shorting Japanese 10-year bonds and Tesla stock. Odey has long positions in Barrick Gold, BT, Barclays, SLC Agricola and Sibanye Stillwater. He’s also shorting Credit Acceptance.
This article first appeared on ValueWalk Premium.
