Gold Bullion is not a commodity; it's a currency that trades against all the world's paper monies...
WORKING at the center of money management for many years, Donald Luskin launched MetaMarkets, the world's first transparent mutual fund, in the 1990s and also created and patented LifePath, the first target-date portfolios.
Now is chief investment officer at Trend Macrolytics, he speaks here Olivier Ludwig – managing editor of Hard Assets Investor's sister site, Index Universe – about the current state of the US economy and markets. Because Luskin expects ultra-low interest rates to go on for awhile in what he calls the "expansionless recovery"...and so sees Gold Investment to be an increasingly valuable form of money at a time when many other currencies have been cheapened by the economic crisis.
Index Universe: Regarding gold, what do you make of views that say prices are being increasingly supported by investment demand? Is the gold market headed for a correction?
Donald Luskin: I don't really think of gold in terms of the traditional jargon – investment demand or jewelry demand. I think of gold as just basically a form of money. It's different than Dollar bills; you can fashion pretty jewelry out of gold and you can't do that with Dollar bills. Gold throughout history, and still now, is considered money. Gold should be thought of as a competing currency, right up there with the Dollar and the Euro and the Yen and the Yuan and the franc and all the others. And the price of gold in any one of those currencies is simply the exchange rate. We're certainly comfortable talking about the Dollar-Euro exchange rate, and yet when we talk about the gold-Dollar exchange rate, we call it the price. I would argue that that is wrong – it is an exchange rate.
IU: As long as we're talking about gold as a currency, can you talk about your Dollar outlook?
Donald Luskin: We all know there hasn't been a Dollar story at all; it's been a Euro story. The Euro went through weakness and that looked like Dollar strength. It had nothing to do with the Dollar. I don't really have a particular opinion about the Dollar vs. the Euro. I feel like all of the large economies of the world are kind of acting the same way. They are all doing everything they can to stimulate flagging economies and prop up their creaky financial sectors, and that involves a great deal of debt creation and money creation. And all of those things, whether they're happening in the United States or Brussels or wherever, they tend to cheapen, demean and corrupt all currencies.
So let's not worry about the Dollar against the Euro, let's worry about all of them together vs. gold – because we cannot make more gold by printing it, you can't make more gold by borrowing it.
IU: How do you view what is going on in the US economy?
Donald Luskin: Where we are right now – until some energy comes along to change it, is the US economy is neither in an expansion nor a contraction. The little slogan we've come up with when we communicate this to our clients is "expansionless recovery." That's a way of saying we're not in a recession anymore.
IU: And what sectors in this "expansionless recovery" are now prospective, apart from going into something like Pimco's MINT, which is basically like holding cash?
Donald Luskin: What was the best thing you could have done in the fixed-income market in the last two months? Buy Greek bonds. What's the best thing you could have done in the equity market in the last two months? Buy Greek bank stocks. So this is exactly what we're telling our clients. We're saying: "Any time the fire alarm goes off and there's a fire drill, go over and buy." And so that's the pattern: Not only do you not want to pay up for quality, you want to be bold and buy low quality at a discount.
IU: If you're saying "risk-on" even in the fixed-income market, even longer out on the yield curve, then you see deflation more than inflation now, right?
Donald Luskin: It doesn't take a genius to look around in the world and see that if left to our own devices, we'd be in a deflationary situation.
However, because of his studies of the Depression, Ben Bernanke is very sensitive to deflation. He loathes deflation the way Paul Volcker loathed inflation. Volcker showed us in the '70s and '80s that the way to fight inflation was with deflation. And Bernanke, if necessary, will show us that the way to fight deflation is with inflation. So the more kinds of deflation you see, the more you can be sure you'll end up with inflation.
IU: So you do see inflation over the long term?
Donald Luskin: If your test is when inflation will show up in something like the consumer price index, you might have to wait a long time for that, because of how big and complex that index is and how long it takes for signals to filter through a big, complex economy like ours.
However, all you have to do is look at the Gold Price, which has quintupled in the last 10 years and nearly doubled in the last two years to see that inflation is happening. It's obvious.
IU: How might this affect you as a bond investor?
Donald Luskin: The paradox here is that normally if you were expecting inflation ultimately, like I am, the last thing you want to do is buy a long-term bond like a 30-year Treasury. This time it's different, and the reason is that when the Federal Reserve has the overnight rate stuck at zero, the only bullet left in its gun is to start trying to hold down the whole rest of the yield curve. And Bernanke said this. This is not a secret. The "Helicopter Speech" in 2002 was all about that. Now he's just simply doing it. Nobody's denying it.
So the irony here is that by holding down bond yields, that becomes the instrument through which he creates the inflation that he wants. The weird thing about that is that normally the bond market is your vigilant fire alarm against inflation, and yet he's using that itself to create inflation. It's almost like putting out a fire by going to Costco and buying 1,000 fire alarms and throwing the fire alarms on the fire to fight it.
IU: Is he playing with fire in terms of the magnitude of the inflation that could materialize?
Donald Luskin: Oh sure! The central banker's task is impossible in the best of times, and he's dealing with a very unpredictable, high-energy system using tools no modern central bank has ever had to use. Are they going to screw it up somehow? Count on it.
IU: Apart from central bankers, how are politicians, like Obama, doing in Washington DC?
Donald Luskin: I think Obama has been a disaster for the economy. In any environment of fear, where no one is willing to put capital at risk except in cash, fear is a synonym for uncertainty. And what a leader ought to be doing is creating an environment of certainty, not exacerbating uncertainty.
Obama and the Congress, together, have created a very uncertain economic environment. Nobody knows what tax rates are going to be, nobody knows what the structure of the healthcare industry is going to be, nobody knows what rules banks are going to have to play by. Everything's in play.
These are all things that put capital on the sidelines. We kind of saw the same thing in 1937 and 1938 when we were trying to recover from the Depression and Franklin Roosevelt went on a similar anti-business tirade. And in 1937 and 1938, for 13 months we had a Depression within the Depression.
IU: What would you tell Obama that he needs to be doing differently?
Donald Luskin: I would tell him to lay off the anti-business rhetoric. Stop demonizing Wall Street. Stop demonizing the energy industry. That alone would work wonders. And I would absolutely urge him to extend the existing level of tax rates rather than letting them roll off at year-end and all go up.
IU: What is your view about the most favorable asset classes?
Donald Luskin: One sector that we like that may sound odd based on all I've said is consumer discretionary stocks. Now Pimco will tell you the consumer is the dim spot. In their model, this recession was the consumer's fault. They say we're now in this new era of scrimp and save of deleveraging, blah, blah, blah; you've heard it a million times.
With all that out there, you can be sure that any consumer discretionary stock is going to be undervalued. So the consumer is going to continue to surprise on the upside.
IU: Any other sectors?
Donald Luskin: Going back to gold for a second, the basic materials and commodities sectors – essentially the ones closest to gold are absolutely our best conviction idea. You'd rather have a gold miner than a silver miner; you'd rather have a silver miner than a zinc miner sort of thing.
IU: And what about the commodities story in general?
Donald Luskin: From my standpoint, I think all commodities are a buy here, because all commodities to some extent are monetary – some more than others. Throughout a lot of human history, food was used as money – grains and rice were used as money in Japan as recently as 350 years ago. It's all part of the gold story.
The oil story in particular though, is especially interesting because I think there's an unintended backfire that could be happening here. You know that China just conceded to US diplomatic pressure and started revaluing its currency. They'd been doing that for three years between 2005 and 2008 also in response to diplomatic pressure. They suspended it during the credit crisis, and now they've just basically picked up where they left off. It's a gradual, creeping revaluation.
If they have a stronger currency, they can buy more of stuff from the outside world. Now, what is it that they want to buy? No. 1 is definitely oil. Oil is priced in Dollars.
During the period of Yuan appreciation between July 2005 and July 2008, two-thirds of that appreciation was in the last 12 months. Now go look at an oil chart and you'll see that oil went from $65 to $147 over that exact same period.
IU: So there's a monetary subtext to that last oil price spike that took prices up to $147?
Donald Luskin: Right, but there's also demand. While I don't believe literally in the peak oil theory, I believe it takes more effort and risk – as we've just learned – to go out and get more oil. It's not free. It's not going to just drop out of the sky. And the demand can run ahead of the supply for certain periods, so we certainly saw that. One of the things that happens with oil is that when you use it, you want to use more of it. Your first application of oil grows your economy, then when you have a larger economy, you need more oil. It's a virtuous cycle if you're measuring it in terms of growth; but it becomes a vicious cycle if you measure it in terms of oil scarcity.
IU: Do you see a danger that a new price spike could end this "expansionless recovery" as you put it, and send the economy into recession again?
Donald Luskin: I would go so far as to say that the peak oil price back in July 2008 occurred about a week before Fannie and Freddie were put into conservatorship and the world really started to blow up on the banking side. But I'd be willing to wager that at $147 a barrel for oil, we would have had a pretty big recession even if there hadn't been any banking problems at all – even if Fannie and Freddie were fine, even if Lehman were fine.