Hoisington Quarterly Review and

John Mauldin

Longtime readers of Outside the Box know that I am a fan of Dr. Lacy Hunt of Hoisington Investment Management. Lacy and his partner, Van Hoisington, produce a quarterly letter that is a must-read for me, as it reliably informs my thinking in a world drowning in conventional economics – economics that seem to continually miss the mark.

It almost goes without saying that Lacy will be speaking at our Strategic Investment Conference again this year, and he’s just one of a long (and still-lengthening) list of top-flight speakers. Learn more and reserve your chair, right here.

Today’s OTB is one of the most important pieces Van and Lacy have written in a long time. They establish that the proposed tax reforms will face enormous headwinds that were not there during previous tax-reform eras, which means that the benefits that Republicans think will accrue are likely to take longer to appear and be less than expected, which will mean that it is going to take more than what is presently proposed to jump-start the economy.

A few readers have asked me whether I am still a deficit hawk. The answer is, “Yes, more than ever,” because total debt has now rendered both monetary and fiscal policy much less effective. Debt, as Lacy and Van clearly show, is an impediment to growth.

There are other issues impeding growth, such as the ten million men between ages 24-64 who are not in the work force, a condition that has been steadily worsening for 40 years. It’s not just a recent phenomenon, but it must be addressed. These are men who have chosen to not participate for one reason or another and are perforce a drain on overall GDP growth.

And let’s not forget that for the last nine years we have seen more businesses close than be created, which has certainly affected GDP.

Tax reform is fine, but far more structural change is necessary if growth is to return. I will be writing on that topic over the next few weeks. But today we appreciate the work of Lacy and Van.

I find myself writing this introduction on yet another plane on my way to speak at the Orlando MoneyShow. If things work out, I will have dinner with Larry Kudlow, and I hope Art Laffer makes it as well. I’ll test out some of my recent ideas on them.

This week in Thoughts from the Frontline I’ll be looking at the good things (and there are a lot of them) in the proposed tax reforms, before we deal with the problems the following week.

Your not trying to miss the forest for the trees analyst,

John Mauldin, Editor
Outside the Box

Hoisington Quarterly Review and Outlook – 4Q2016


The 2016 presidential election has brought about widely anticipated changes in fiscal policy actions. First, tax reductions for both the household and corporate sectors along with a major reform of the tax code have been proposed. In conjunction, a novel program of tax credits to the private sector has been discussed to finance increased outlays for infrastructure. Second, provisions have been suggested to incentivize domestic corporations to repatriate $2.6 trillion of liquid assets held overseas. Third, there is talk of regulatory reform along with measures to increase domestic production of energy. Finally, various measures related to international trade have been discussed in an effort to reduce the current account deficit.

Judging by sharp reactions of U.S. capital and currency markets, success of these proposals has been quickly accepted. Such was the case with the fiscal stimulus package of 2009, as well as with Quantitative Easings 1 and 2; initially there were highly favorable market reactions. In these cases the rush to judgment was misplaced as widespread economic gains did not occur, and the U.S. experienced the weakest expansion in seven decades along with lower inflation. It could be that the fundamental analytical mistake now, like then, is to assume that the economy is “an understandable and controllable machine rather than a complex, adaptive system” (William R. White, in his 2016 Adam Smith Lecture “Ultra-Easy Money: Digging the Hole Deeper?” at the annual meeting of the National Association of Business Economists). While many of the aforementioned proposals include pro-growth features, it appears that there is an underestimation of the nega tive impact of delayed implementation and other lags. Additionally, the risks of unintended adverse consequences and outright failure are high, especially if the enacted programs are heavily financed with borrowed funds and/or monetary conditions continue to work at cross purposes with the fiscal policy goals.

Tax Cuts and Credits

Considering the current public and private debt overhang, tax reductions are not likely to be as successful as the much larger tax cuts were for Presidents Ronald Reagan and George W. Bush. Gross federal debt now stands at 105.5% of GDP, compared with 31.7% and 57.0%, respectively, when the 1981 and 2002 tax laws were implemented. Additionally, tax reductions work slowly, with only 50% of the impact registering within a year and a half after the tax changes are enacted. Thus, while the economy is waiting for increased revenues from faster growth from the tax cuts, surging federal debt is likely to continue to drive U.S. aggregate indebtedness higher, further restraining economic growth.

The key variable to improve domestic economic conditions is to cut the marginal household (middle income) and corporate income tax rates. Due to the extremely high level of federal debt, if the deleterious impact of higher debt on growth is to be avoided, then these tax cuts must be expenditure-balanced to the fullest extent possible along with reductions in federal spending (which has a negative multiplier).

Providing tax credits to the private sector to build infrastructure should be more efficient than the current system, but this new system has to first be put into operation and firms with profits must decide to enter this business. Moreover, all the various rights of way, ownership and environmental requirements suggest that any economic growth impact from the infrastructure proposal is well into the future.

However, if the household and corporate tax reductions and infrastructure tax credits proposed are not financed by other budget offsets, history suggests they will be met with little or no success. The test case is Japan. In implementing tax cuts and massive infrastructure spending, Japanese government debt exploded from 68.9% of GDP in 1997 to 198.0% in the third quarter of 2016. Over that period nominal GDP in Japan has remained roughly unchanged (Chart 1). Additionally, when Japan began these debt experiments, the global economy was far stronger than it is currently, thus Japan was supported by external conditions to a far greater degree than the U.S. would be in present circumstances.

Tax Repatriation

One of the tax proposals with wide support gives U.S. corporations a window to repatriate approximately $2.6 trillion of foreign held profits under the favorable tax terms of 10% or 15%. There is a catch, however. To ensure that all funds are brought home, the tax is due on all of the un-repatriated funds even if only a portion is brought back to the United States.

Several considerations suggest there is no guarantee that these funds will actually be invested in plant and equipment in the United States. First, the fact that they are currently liquid suggests that physical investment opportunities are already lacking. Second, the bulk of the foreign assets are held by three already cash-rich sectors – high tech, pharmaceutical and energy. The concentrated and liquid nature of these assets suggests that after an estimated $260 billion to $390 billion in taxes are paid, the repatriated funds will probably be shifted into share buybacks, mergers, dividends or debt repayments. Putting funds into financial engineering will improve earnings per share, further raising equity valuations for individual firms; however, such transactions will not grow the economy. Finally, the basic determinants of capital spending have been unfavorable, and they worsened in the fourth quarter. Capacity utilization was only 75% in November 2016, well below the peak of just under 79% reached exactly two years earlier. The U.S. Treasury’s corporate income tax collections for the twelve months ended November 2016 were 13.1% less than a year earlier, suggesting corporate profits eroded considerably last year.

A possible additional negative result of the repatriation is that those assets denominated in foreign currency, estimated to be 10% to 30%, will need to be converted into U.S. dollars. This will place upward pressure on the dollar, reinforcing the loss of market share of U.S. firms in domestic and foreign markets.
Tax repatriation was tried on a smaller scale during the Bush 43 administration in 2005-2006 with limited success. A much smaller amount of funds were repatriated, and the dollar showed strength.

Regulatory Reform

Regulatory reform could create increased energy production which would clearly boost real economic activity. This is accomplished by shifting the upward sloping aggregate supply curve outward and thereby lowering inflation. When the aggregate supply curve shifts, it will intersect with the downward sloping aggregate demand curve at a lower price level and a higher level of real GDP. The falling prices are equivalent to a tax cut that is not financed with more federal debt. Regulatory reform is a strong proposal and will benefit the economy greatly, in time, by making the U.S. more efficient and better able to compete in world markets. However, these benefits are likely to build slowly and accrue over time.
Without question, the regulatory reform is the most unambiguously positive aspect of the contemplated fiscal policy changes since it will produce faster growth and lower inflation. Since bond yields are very sensitive to inflationary expectations, this program would actually contribute to lower interest costs as the disinflationary aspects of the program become apparent.

International Trade Actions

Proposals to cut the trade deficit by tariffs or import restrictions would have the exact opposite effect of the regulatory reforms and increased energy production.
They would shift the aggregate supply curve inward, resulting in a higher price level and a lower level of real GDP. Any improvement in the trade account would reduce foreign saving, which is the inverse of the trade account. Since investment equals domestic and foreign saving, the drop in saving would force consumer spending and/or investment lower. Any improvement in the trade account would be limited since the dollar would rise, undermining the first round gains in trade.
The more serious risk is that other countries retaliate. From the mid-1920s until the start of WWII this process resulted in what is known as “a deflationary race to the bottom”.


Over the past few months interest rates and the value of the dollar have risen sharply, and monetary policy’s quantitative indicators have contracted. These monetary restrictions have worsened the structural impediments to U.S. economic growth that existed before the election and continue today. These impediments include: (1) a record level of domestic nonfinancial sector debt relative to GDP and further increases in federal debt that are already built-in for years to come; (2) record global debt relative to GDP; (3) weak and fragile global economic growth resulting from the debt overhang; (4) adverse demographics; and (5) exhaustion of pent-up demand in the domestic economy.

Monetary Restrictions

If monetary conditions are tightened and interest rates continue to rise, economic growth from tax reductions are likely to prove ephemeral. Monetary conditions have turned more restrictive in the broadest terms over the past year and a half.
The monetary base and excess reserves of the depository institutions have been reduced by $668 billion (16.4%) and $910 billion (33.7%), respectively, from the peaks reached in 2014 or as the Fed was ending QE3 (Chart 2). This reduction in reserves is in fact an overt tightening of monetary policy, which will restrain economic activity in a meaningful way in the quarters ahead.

While maintaining the existing large portfolio of treasury and agency securities, the Federal Reserve has engineered contractions in the base and excess reserves by taking advantage of swings in other components of the base. The decrease in the reserve aggregates since 2014 reflects the following developments: (a) the substantial shift in Treasury deposits from depository institutions into the Federal Reserve Banks; (b) an increase in reverse repurchase agreements; (c) a shift from currency in the vaults of depository institutions to nonbanks (i.e. the households and businesses); and (d) a rise in required reserves as a result of higher bank deposits. These changes were necessitated by the Fed’s decision to raise the federal funds rate by 25 basis points in December of both 2015 and 2016. The Fed had the power to offset the reserve-draining effects of the shifting Treasury balances as well as the need for more currency and required reserves, but they chose not t o do so. The cause of the sharp drop in monetary and excess reserves is immaterial, but the effect is that monetary policy became increasingly more restrictive as 2016 ended.

Monetary policy has become asymmetric due to over-indebtedness. This means that an easing of policy produces little stimulus while a modest tightening is very powerful in restraining economic activity. The Nobel laureate Milton Friedman held that through liquidity, income and price effects, (1) monetary accelerations (easing) eventually lead to higher interest rates, and (2) monetary decelerations (tightening) eventually lead to lower rates. (In the near-term monetary accelerations will lower short-term rates and decelerations will raise short-term rates..."the liquidity effect".) Friedman’s first proposition becomes invalid for extremely indebted economies. When reserves are created by the central bank, even if the amounts are massive, they remain largely unused, rendering monetary policy impotent. That is why M2 growth did not respond to the increase in the monetary base from about $800 billion to over $4 trillion. Plummeting velocity, which reflects too much counterproductive debt, further emasculated the central bank’s effectiveness. Thus, the efficacy of monetary policy has become asymmetric.
Excessive debt, rather than rendering monetary deceleration impotent, actually strengthens central bank power because interest expense rises quickly. Therefore, what used to be considered modest changes in monetary restraint that resulted in higher interest rates now has a profound and immediate negative impact on the economy. This is yet another example of the adaptive nature of economies possibly unnoticed by federal officials.

Friedman’s second proposition is clearly in motion. While monetary decelerations may initially lead to higher interest rates the ultimate trend is to lower yields. The Fed’s operations raised short- and intermediate-term yields in 2016. Although Treasury bond yields are mainly determined by inflationary expectations in the long run, the Fed contributed to the elevation of these yields in the second half of 2016 as well as a flattening of the yield curve. Working through both interest rate and quantitative effects, the Fed added to the strength in the dollar, which was further supported by international debt comparisons that favor the United States.
The Fed stayed on the tightening course during the fourth quarter as the economy weakened. This suggests that the Fed contributed to both the rise in interest rates and the stronger dollar. More importantly, in view of policy lags, the 2016 measures by the central bank will serve to ultimately weaken M2 growth, reinforce the ongoing slump in money velocity, weaken economic growth in 2017 and accentuate the other constraints previously discussed.

(1) Impediments to Growth: Unproductive Debt

At the end of the third quarter, domestic nonfinancial debt and total debt reached $47.0 and $69.4 trillion, respectively. Neither of these figures include a sizeable volume of vehicle and other leases that will come due in the next few years nor unfunded pension liabilities that will eventually be due. The total figure is much larger as it includes debt of financial institutions as well as foreign debt owed. The broader series points to the complexity of the debt overhang. Netting out the financial institutions and foreign debt is certainly appropriate for closed economies, but it is not appropriate for the current economy. Much of the foreign debt resides in countries that are more indebted than the U.S. with even weaker economic fundamentals and financial institutions that remain thinly capitalized.

A surge in both of the debt aggregates in the latest four quarters indicates the drain on future economic growth. Domestic nonfinancial debt rose by $2.6 trillion in the past four quarters, or $5.00 for each $1.00 dollar of GDP generated. For comparison, from 1952 to 1999, $1.70 of domestic nonfinancial debt generated $1.00 of GDP, and from 2000 to 2015, the figure was $3.30. Total debt gained $3.1 trillion in the past four quarters, or $5.70 dollars for each $1.00 of GDP growth. From 1870 to 2015, $1.90 of total debt generated $1.00 dollar of GDP.

We estimate that approximately $20 trillion of debt in the U.S. will reset within the next two years. Interest rates across the curve are up approximately 100 basis points from the lows of last year. Unless rates reverse, the annual interest costs will jump $200 billion within two years and move steadily higher thereafter as more debt obligations mature. This sum is equivalent to almost two-fifths of the $533 billion in nominal GDP in the past four quarters. This situation is the same problem that has constantly dogged highly indebted economies like the U.S., Japan and the Eurozone. Numerous short-term growth spurts result in simultaneous increases in interest rates that boost interest costs for the heavily indebted economy that, in turn, serves to short circuit incipient gains in economic activity.

(2) Impediments to Growth: Record Global Debt

The IMF calculated that the gross debt in the global non-financial sector was $217 trillion, or 325% of GDP, at the end of the third quarter of 2016. Total debt at the end of the third quarter 2016 was more than triple its level at the end of 1999. In addition to the U.S., global debt surged dramatically in China, the United Kingdom, the Eurozone and Japan. Debt in China surged by $3 trillion in just the first three quarters of 2016. This is staggering considering that the largest rise in nonfinancial U.S. debt over any three quarters is $2.3 trillion, and China accounts for 12.3% of world GDP compared with 22.3% for the U.S. (2016 World Bank estimates). Thus, the $3 trillion jump in Chinese debt is equivalent to an increase of $5.4 trillion of debt in the U.S. economy. Extrapolating this calculation, Chinese debt at the end of the third quarter soared to 390% of GDP, an estimated 20% higher than U.S. debt-to-GDP. This debt surge explains the shortfall in the Chinese growth target for 2016, a major capital flight, a precipitous fall of the Yuan against the dollar and a large hike in their overnight lending rate.

William R. White (as previously cited) describes the debt risks causally, fully and yet succinctly. By pursuing the monetary and fiscal policies in which debts are accumulated worldwide, spending from the future is brought forward to today. “As time passes, and the future becomes the present, the weight of these claims grows ever greater.” Accordingly, such policies lose their effectiveness over time. He quotes Nobel laureate F. A. Hayek (1933): “To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about.” White reinforces this view later when he says, “Credit ‘booms’ are commonly followed by an economic ‘bust’ and this has indeed been the case for a number of countries.”

(3) Impediments to Growth: Weak Global Growth

Based on figures from the World Bank and the IMF through 2016, growth in a 60-country composite was just 1.1%, a fraction of the 7.2% average since 1961. Even with the small gain for 2016, the three-year average growth was -0.8%. As such, the last three years have provided more evidence that the benefits of a massive debt surge are elusive.

World trade volume also confirms the fragile state of economic conditions. Trade peaked at 115.4 in February 2016, with September 2016 1.7% below that peak, according to the Netherlands Bureau of Economic Policy Analysis. Over the last 12 months, world trade volume fell 0.7%, compared to the 5.1% average growth since 1992. When world trade and economic growth are stagnant, and one group of currencies loses value relative to another group, market share will shift to the depreciating currencies. However, this shift does not constitute a net gain in global economic activity, merely redistribution. Thus, gains in economic performance of those parts of the world provide little or no information about the status of global economic conditions.

(4) Impediments to Growth: Eroding Demographics

Weak population growth, a baby bust, an aging population and an unprecedented percentage of 18- to 34-year olds living with parents and/or other family members characterize current U.S. demographics, and all constrain economic growth. Moreover, real disposable income per capita is so weak that these trends are more likely to worsen rather than improve (Chart 3).

In the fiscal year ending July 1, 2016, U.S. population increased by 0.7%, the smallest increase on record since The Great Depression years of 1936-1937 (Census Bureau) (Chart 4). The fertility rate, defined as the number of live births per 1,000 for women ages 15-44, reached all time lows in 2013 and again in 2015 of 62.9 (National Center for Health Statistics). The average age of the U.S. reached an estimated 37.9 years, another record (The CIA World Fact Book). Population experts expect further increases for many years into the future. For the decade ending in 2015, 39.5% of 18-to 34-year olds lived with parents and/or other family members, the highest percentage for a decade since 1900, with the exception of the one when new housing could not be constructed because the materials were needed for World War II.

Over time, birth, immigration and household formation decisions have been heavily influenced by real per capita income growth. Demographics have, in turn, cycled back to influence economic growth. If they are both rising, a virtuous long-term cycle will emerge. Today, however, a negative spiral is in control. In the ten years ending in 2016, real per capita disposable income rose a mere 1%, less than half of the 50-year average and only one-quarter of the growth of the 3.9% peak reached in 1973. In view of the enlarging debt overhang, which is the cause of these mutually linked developments, economic growth should continue to disappoint.
There will likely be intermittent spurts in economic activity, but they will not be sustainable.

(5) Impediments to Growth: Exhausted Pent-Up Demand

In late stage expansions, pent-up demand is exhausted as big-ticket items have already been purchased. At the start of 2017, the current expansion reached its 79th month, more than 20 months longer than the average since the end of World War II. At this stage of the cycle, setting new records is a reason for caution, not optimism. With regard to pent-up demand, the economy is in the opposite condition of a recession or an early stage expansion. The lack of such demand makes the economy susceptible to either slower growth or to the risk of an outright recession. Numerous signposts of this late cycle risk include low factory use, weakness in new and used car prices as well as most discretionary goods, a rising delinquency rate on the riskiest types of vehicle loans and a fall in office and apartment vacancy rates.

Bond Yields

Our economic view for 2017 suggests lower long-term Treasury yields. Considering the actions of the Federal Reserve to curtail the monetary base and excess reserves, M2 growth should moderate to 6% in 2017, down from 6.9% in 2016. In the fourth quarter, on a 3-month annualized basis, M2 growth already decelerated below the 6% pace anticipated for 2017. This is unsurprising given the fall in excess reserves and the monetary base. Velocity fell an estimated 4% in 2016 on a year ending basis. We assume there will be a similar decline for 2017, although in view of the huge debt increase and other considerations, velocity could be even weaker.
On this basis, nominal GDP should rise 2% this year, which means inflation and real growth will both be very low. A 2% nominal GDP gain for 2017 points to a similar yield on the 30-year in time, meaning that the secular downward trend in Treasury bond yields is still intact.

Van R. Hoisington
Lacy H. Hunt, Ph.D.

France could turn the populist tide

A critical mass of voters has decided that the country needs reform

by: Philip Stephens

Something has happened in Paris. Shafts of sunlight are visible through the clouds. The familiar blanket of morosité has been penetrated, if not by anything as un-French as exuberance, then at least by moments of cheer. Britain seems set on leaving its own continent. A new president in Washington is leading the US into belligerent isolationism. Every political story, it seems, has a bad ending. What if France defies the narrative?
The Brexit vote has dented badly the coherence of Europe. Donald Trump’s arrival in the White House has put in question the future of what we used to call the west. In its way, the coming French presidential election is just as consequential. A victory for Marine Le Pen, the leader of the far right and Islamophobic National Front, would read the rites over European liberal democracy. The EU can survive Britain’s departure. Not so that of France.

In an age defined by populist insurrections, it would be foolhardy to predict the outcome of the poll. France has been in the grip of economic stasis for the best part of a decade. It has been the victim of the cruellest attacks by Islamist terrorists. President François Hollande’s ratings have dropped to single figures. After Brexit and Mr Trump, it is no great feat of imagination to visualise the tumbrils piled high again with the corpses of the French political class.

Maybe. But Paris does not feel like that. Business leaders who for years have been grumbling of France’s economic sclerosis suddenly sound upbeat. Young tech entrepreneurs who may otherwise be heading for London or New York are raising funds at home. Paris’s digital hubs are, well, humming. Polls suggest the electorate’s devotion to an ever bigger state has waned.

Ms Le Pen’s base of support among the “left behind”, the elderly and the xenophobic should not be underestimated. On present trends, she is assured of a place in the second, run-off round of the election. And yet. The terrorist attacks have not seen the decisive lurch into Islamophobia that the National Front had hoped for. Mr Trump’s ugly nationalism has been a powerful reminder that France’s interests lie in a cohesive Europe. Ms Le Pen’s pledge to restore the franc in place of the euro has failed to gain traction. Maybe, just maybe, France will turn out to be the place where the populist tide is turned.
Prudently, Mr Hollande chose not to seek a second term. In his absence, his Socialist party has opted for Benoît Hamon, a standard bearer of the left. Mr Hamon bears more than a passing resemblance to Jeremy Corbyn, the leader of Britain’s Labour party. The two men prefer to head protest groups than to widen their appeal to voters. Mr Hamon will lose badly in the first round of the presidential poll. But then, as for Mr Corbyn, preserving the ideological purity of the left seems a more important task than governing.

The energy of the campaign has thus far come from Emmanuel Macron, the investment banker turned politician running at the head of a new centrist movement. The 39-year-old served as Mr Hollande’s economy minister before resigning to create En Marche! Mr Macron is a product of the elite, an alumnus of the prestigious École nationale d’administration. But, taking his cue from the populists, he has cast himself as the outsider.

En Marche! presents itself as a movement rather than a party. Candidates for elections to the National Assembly will be chosen through an open, online selection process. Thousands have turned up at rallies to hear Mr Macron’s pitch for economic modernisation at home and French leadership in Europe. There is a touch of the young Tony Blair about the campaign.
His willingness to take risks — his candidacy was initially written off by most commentators — has been rewarded with good luck. Mr Hamon will probably drive many moderate socialists into the arms of En Marche! And Mr Macron has been similarly blessed by the recent troubles of François Fillon, the candidate of the centre-right Republicans.

Until a week or so ago, the former prime minister Mr Fillon was the firm favourite to win the Elysee.

A staunch Catholic, Gaullist and advocate of radical economic reform, he was running well ahead of Mr Macron. But this is France. Mr Fillon has been laid low by allegations that he used public funds to pay his wife and children for fictitious jobs. He denies the charges, but the sight of police officers raiding his offices in the French parliament has done nothing for the standing of a candidate who had claimed the ethical high ground.

The polls say Mr Fillon is running neck-and-neck with Mr Macron in a contest to face Ms Le Pen in the second round. The scandal could prove fatal for his candidacy. Alain Juppé, the runner-up in the Republican primaries, is waiting in the wings.

What may matter more than the names on the ballot paper, though, are the signs that a critical mass of voters has decided that France needs reform — that the privileges of the middle-aged and elderly cannot indefinitely be defended against the interests of the young unemployed. Ms Le Pen cannot claim to be alone in seeking change.

Betting against the economic nationalism and identity politics peddled by populists has proved an expensive pastime during the past year. But there is no immutable law that says that anger is henceforth the ruling emotion in politics. France may surprise us — and itself.

Market Melt-up Brings Volatility to Metals

By: Chris Vermeulen & John Winston

Our recent analysis bases on a previous report of the potential for a further run in the US markets based on a number of technical and fundamental factors leads to the question of "what could happen with Gold and Silver". A broad US market rally may put some pressure on the metals markets initially, but, in our opinion, the increase in volatility and uncertainty will likely prompt more potential for upward price action in precious metals.

As with most things in the midst of uncertainty and transition, the US Presidential election has caused many traders to rethink positions and potential. As foreign elections continue to play out, wild currency moves are starting to become more of a standard for volatility. Combine this with a new US President and a repositioning of US global and local objectives and we believe we are setting up for one of the most expansive moves in recent years for the US general markets and the metals markets.

This week, alone, we have seen a flurry of action in DC and the US markets broke upward on news of the Dakota Pipeline and other Executive actions.

As we wrote week or so ago, we believe the US markets will push higher in 2017 a business investment, US strategy and foreign capital runs back into the US equity market chasing opportunity and gains. Additionally, we believe the strength of the US market, paired with continued strength of the US Dollar, will drive a further increase in global volatility and wild swings in foreign markets.

This volatility, uncertainty and equity repositioning will likely drive Gold and Silver to continued highs throughout 2017 - possibly much longer if the new trend generates renewed follow-through.

Our belief that the US markets will continue to melt-up while certain foreign markets deteriorate relates to our belief that currency variances will become more volatile and excessive over the next few months. This, in combination with a renewed interest in developing US economic solutions, will likely drive the US markets higher while the metals markets will continue to become a safe-haven for US and foreign investors to protect against deflation and foreign market corrections.

S&P Futures are setting up a clear bullish pennant/flag formation that will likely prompt an explosive price move within 2~3 weeks. This bullish flag formation is likely to drive the ES price higher by roughly 100+ pts.  Currently, strong resistance is just above 2275, so we'll have to wait for this level to be breached before we see any potential for a bigger price move.

  SP500 Weekly Chart

SP500 Weekly Chart

  SP500 Daily Chart

SP500 Daily Chart

GOLD is channeling in a very clear and narrow upward price channel and trading in the middle of a support zone. The recent reversal, near the end of 2016, was interesting because GOLD trailed lower after the US election, but then reversed course just before the new year.

The interesting fact about this move is that this new upward swing in GOLD correlates with the beginning of the Bullish Flag in the S&P Futures as well as a decrease in volatility. We believe as this Bullish Flag will prompt a jump in volatility and price action that will result in is a strong push higher in GOLD.

 GOLD Weekly Chart

GOLD Weekly Chart

Gold Daily Chart

Gold Daily Chart

SILVER is setting up in a similar manner as GOLD. Although the SILVER chart provides a clearer picture of the downward price channel that is about to be breached - and likely drive both SILVER and GOLD into a new bullish rally.  The support Zone in SILVER, between $16.60 ~ $17.40 is still very much in play. SILVER will likely stay within this zone while the Bullish Flag plays out. Yet, when the breakout begins, a move above $18.00 will be very quick and upside targets are $18.50~18.75 and $19.50~$20.00 (possibly much higher in the long run).

Silver Weekly Chart

Silver Weekly Chart

  Silver Daily Chart

Silver Daily Chart

EUR/USD correlation to the US moves should be viewed as measure of strengthening US economy/USD as related to foreign market volatility and potential. As the USD strengthens, this puts pressure on foreign governments and global transactions based in USD. This also puts pressure on the METALS markets because billions of people around the globe consume precious metals as a "safe-haven" related to currency volatility. We expect the EUR/USD levels to fall near "parity" (1.00) again and possibly dip below parity based on future foreign election results. This volatility and uncertainty will translate to increased opportunity for GOLD and SILVER to run much higher over the next few months.

 EURUSD Daily Chart

EURUSD Daily Chart

  USDMXN Daily Chart

USDMXN Daily Chart

  USDGBP Daily Chart

USDGBP Daily Chart

Right now is a fantastic opportunity to take advantage of these lower prices.  We may see rotation near to the lower support zone levels as price rotates over the next few weeks. The key to any trade in the metals market is to understand the potential moves and watch for confluence and volatility in other markets.  We believe the next few weeks/months will be very telling. If we are correct, we'll see new highs in the US markets fairly quickly and we'll see a new potential bullish breakout in GOLD and SILVER.

An Unstable Economic Order?

Mohamed A. El-Erian

LAGUNA BEACH – The retreat of the advanced economies from the global economy – and, in the case of the United Kingdom, from regional trading arrangements – has received a lot of attention lately. At a time when the global economy’s underlying structures are under strain, this could have far-reaching consequences.
Whether by choice or necessity, the vast majority of the world’s economies are part of a multilateral system that gives their counterparts in the advanced world – especially the United States and Europe – enormous privileges. Three stand out.
First, because they issue the world’s main reserve currencies, the advanced economies get to exchange bits of paper that they printed for goods and services produced by others. Second, for most global investors, these economies’ bonds are a quasi-automatic component of portfolio allocations, so their governments’ budget deficits are financed in part by other countries’ savings.
The advanced economies’ final key advantage is voting power and representation. They command either veto power or a blocking minority in the Bretton Woods institutions (the International Monetary Fund and the World Bank), which gives them a disproportionate influence on the rules and practices that govern the international economic and monetary system. And, given their historical dominance of these organizations, their nationals are de facto assured the top positions.
These privileges don’t come for free – at least they shouldn’t. In exchange, the advanced economies are supposed to fulfill certain responsibilities that help ensure the system’s functioning and stability.
But recent developments have cast doubts on whether the advanced economies are able to hold up their end of this bargain.
Perhaps the most obvious example is the 2008 global financial crisis. The result of excessive risk-taking and lax regulation in the advanced economies, the financial system’s near-meltdown disrupted global trade, threw millions into unemployment, and almost tipped the world into a multi-year depression.
But there have been other lapses, too. For example, political obstacles to comprehensive economic policymaking in many advanced economies have undermined the implementation of structural reforms and responsive fiscal policies in recent years, holding back business investment, undermining productivity growth, worsening inequality, and threatening future potential growth.
Such economic lapses have contributed to the emergence of anti-establishment political movements that are looking to change – or are already changing – long-established cross-border trade relations, including those within the European Union and the North American Free Trade Agreement (NAFTA).
Meanwhile, a prolonged and excessive reliance on monetary policy, including direct central-bank involvement in market activities, has distorted asset prices and contributed to resource misallocation. And the advanced economies – particularly Europe – have shown little appetite for reforming outdated elements of governance and representation at the international financial institutions, despite major changes in the global economy.
The result of all this is a multilateral system that is less effective, less collaborative, less trusted, and more vulnerable to ad hoc tinkering. Against this background, it should not be surprising that globalization and regionalization no longer command the degree of support they once did – or that some rising political movements on both sides of the Atlantic are condemning both concepts to win more support for their own causes.
It is not yet clear whether this is a temporary and reversible phenomenon or the beginning of a protracted challenge to the functioning of the global economy. What is clear is that it is affecting two important relationships.
The first is the relationship between small and large economies. For a long time, small, well-managed, and open economies were the leading beneficiaries of the Bretton Woods system and, more generally, of multilateralism. Their size not only made them crave access to outside markets; it also made other market actors more willing to integrate them into regional pacts, owing to their limited displacement potential. Membership in effective international institutions brought these countries into consequential global policy discussions, while their own capabilities allowed them to exploit opportunities in cross-border production and consumption chains.
But, at a time of surging nationalism, these small and open economies, however well managed, are likely to suffer. Their trading relationships are less stable; the trade pacts on which they depend are vulnerable; and their participation in global policy discussions is less assured.
The second relationship is that between the Bretton Woods institutions and parallel institutional arrangements. For example, while they pale in significance to, say, the World Bank, China-led institutions have proved appealing to a growing number of countries; most US allies have joined the Asian Infrastructure Investment Bank, despite American opposition.
Similarly, bilateral payment agreements – which, not long ago, most countries would have opposed via the IMF, owing to their inconsistency with multilateralism – are proliferating. The concern is that these alternative approaches could undermine, rather than reinforce, a predictable and beneficial rules-based system of cross-border interactions.
The Bretton Woods organizations, instituted after World War II to maintain stability, risk losing their influence, and the countries with the clout to bolster them seem unwilling at this stage to press ahead boldly with the needed reforms. If these tendencies continue, developing countries will probably suffer the most; but they won’t be alone. In the short term, the world economy would face slower economic growth and the risk of greater financial instability. In the longer term, it would confront the threat of systemic fragmentation and proliferating trade wars.

While There Was Little Action Last Week With Speculative Traders, These Moves In Germany Should Interest All Gold Investors

by: Hebba Investments

- COT speculators add to both short and long positions during the COT week.

- Over the past month, the German Gold ETF has surged in its physical gold buying.

- While Trump's upcoming tax announcement was USD-positive and gold-negative, we think that could actually be positive for gold.

- In the short-term, we expect a pull-back in gold as it is a bit overbought and we see no market-moving negative catalysts in the near-term.
After a Down Week for Gold These Three Events Loom Large Next Week for the Precious Metals
The latest Commitment of Traders (COT) report showed an increase in both speculative longs and shorts during the COT week (Tuesday to Tuesday) with gold responding with a 1.5% rise.
For the week, bullish gold sentiment was clearly in charge as other than weakness on Thursday, gold rose every day last week.
The big event concerning gold last week was the announcement by US President Trump that he will make a major tax plan announcement within 2 or 3 weeks. You heard that right - the announcement of the announcement was the big news. Evidently, this announcement caused the US dollar to rise and thus caused gold's pullback on Thursday according to traders.
We will get more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
About the COT Report

The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.
The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.
There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the exports on it.
What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
This Week's Gold COT Report
This week's report showed another rise in speculative gold positions for the fourth time in five weeks as longs increased their positions by 4,216 contracts on the week. On the other side, speculative shorts slightly increased their own positions by 556 contracts on the week. Not too much action in speculative positioning despite gold rising by 1.5% on the COT week.
Moving on, the net position of all gold traders can be seen below:
Source: GoldChartsRUS
The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders increase by around 5,000 as it ended the COT week at 76,000 net speculative long contracts. As we mentioned last week, despite the rise we are still fairly low in terms of the historical net long position.

As for silver, the action week's action looked like the following:

Source: GoldChartsRUS
The red line which represents the net speculative positions of money managers, showed a slight decrease in speculative positions for the week of less than 100 contracts. This was despite silver's rise during the COT week, which is a bit unusual. Despite the decrease, we remain at an elevated level in terms of historical long positions.
Official and Unofficial Gold Going to Germany
One of the items that didn't get too much press was the announcement from Germany that it was ahead of schedule on its gold repatriation and had already moved 583 tonnes of gold back to Germany. By the end of 2017 it expected to have half of its gold back, which is ahead of the 2020 plan. We couldn't find any official reason given for the speedier repatriation, but we think it may have to do with a lack of confidence in the Euro as French presidential candidate Marine Le Pen and Italy's 5-Star Movement are openly calling to pull out of the euro.
What may be even more interesting is the action from the German Xetra Gold ETF as it has seen a surge in buying interest.
Source: GoldChartsRUS
Over the past four week it has seen a 27% increase in gold holdings (or slightly under 1.1 million ounces), which brings the value of its total holdings to $6.2 billion. That makes it the sixth largest global gold ETF, and puts it total gold holdings at 20% of those held by the massive SPDR Gold Trust ETF (NYSEARCA:GLD) - with most of those gains coming in a little over a year.
It is obvious that many German investors are seeking the safe-haven of gold. We think it is completely rational as there are concerns about the Euro, Trump, and a host of other issues that we have mentioned before. In fact, we would not be surprised to see further growth in this ETF moving forward as we have French elections in a few months and the surging anti-Euro sentiment across the continent. It looks like GLD is not the only gold ETF that is worth monitoring for investors considering the massive increase in gold holdings in this German ETF.
Our Take and What This Means for Investors
Before we give our take on gold and silver, we wanted to quickly give our thoughts on President Trump's tax announcement. As we mentioned earlier, evidently the US dollar and gold markets moved on Mr. Trump's announcement about a future "phenomenal announcement on taxes" sometime in the next two weeks.
First, we understand why some traders think that this is bullish for the USD as the reasoning is that it will help strengthen the economy and thus US foreign investment will rise. But we think that ignores the other side of the equation where lowering taxes will lower government revenues and increase deficits, thus weakening the USD. So in our view, lowering taxes in the US is not necessarily USD-positive - we think any certainty by traders in either direction is a bit premature.
Additionally, we think this "announcement of an upcoming phenomenal announcement" is really going to turn out to be nothing more than pomp and fluff. When it comes to major tax changes, nothing happens quickly and there will need to be a lot of congressional approval from both sides of the aisle - the president cannot make unilateral decisions here without Congress. If there was already some major plan that was ready to be implemented, there would be no need for a surprise announcement as we would already be hearing initial details of the plan. In our view, this sounds like the administration has no concrete tax plan and is trying to buy time to create something - no reason to have anything more than a short-term algorithm-driven move.
Coming back to gold, we think it has no effect on gold and until we see more concrete details, it is all talk in our view.
Here is our gold and silver barometer moving forward:
For the short-term (week-long timeframe), we were wrong last week as gold rose, but we remain neutral to bearish on gold for the upcoming week. We think a lot of the recent rise due to ETF buying (rather than COT's speculators), and while we don't see that really reversing (especially in Europe), we think gold is a bit overbought here. Especially considering Trump has toned back some of his rhetoric over the past week (e.g. One-China policy will evidently be maintained), assuming no extraordinary announcement from the administration, we think weaker physical demand from Asia (see the drop in Chinese gold premiums below) will start asserting itself in the price.
Source: GoldChartsRUS
It is only a bearish leaning though, because the medium and long-term picture for gold still looks extremely bright, so the bearishness is only short-term. As for silver, we think it is very over-bought and the risk for a large silver drop is much greater than gold, thus we are more bearish on silver.
For the medium-term and longer-term pictures, we see no reason to change any our stances (you can read the details of why in our previous write-up)
Compared to Kitco's gold survey, our short-term view of gold remains a contrarian position as most of the Kitco respondents believe that gold will again rise next week:
Source: Kitco
These are our short, medium, and long-term views on gold and investors wishing to trade or invest in these prediction (or invest against) them can take the appropriate positions in physical gold (for longer term investors) or the SPDR Gold Trust ETF (NYSEARCA:GLD), and ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL). For silver, positions in the iShares Silver Trust (NYSEARCA:SLV), ETFS Silver Trust (NYSEARCA:SIVR), and Sprott Physical Silver Trust (NYSEARCA:PSLV) are all ways to invest.

Iran's Economy Is Bouncing Back

By Kamran Bokhari

A year after the U.S. agreed to lift sanctions, Iran is recovering its regional influence.

These days there is a great deal of noise over the fate of the Iran nuclear deal. It is going to be very difficult to roll back the agreement, announced a year ago. Therefore, it remains to be seen what the administration of U.S. President Donald Trump can do to limit the extent to which Iran benefits from the respite in sanctions. The issue is not a nuclear Iran or one with ballistic missile capability, but rather an economy that is improving because of the nuclear deal.

On Iran, one comes across two main types of stories, depending from where they originate – Washington or Tehran. In the United States, the newly installed Trump administration appears as though it is trying to renegotiate the nuclear deal. Meanwhile, in Iran, President Hassan Rouhani’s opponents – largely from within the clerical and security establishments – continue to claim that the country has not benefited from the nuclear deal.

Iran Tehran airport
An Airbus A321 arrives at Mehrabad International Airport during delivery of the first batch of planes to the state airline company Iran Air in the capital, Tehran, on Jan. 12, 2017. The aircraft arrived as part of an order for 100 Airbus planes after the lifting of international sanctions on the Islamic republic. ATTA KENARE/AFP/Getty Images

Reversing the deal would be difficult since it is a multilateral agreement. Undoing the agreement thus would entail a complex process where all major world powers would agree to do so. Rhetoric aside, senior members of the Trump administration, particularly Defense Secretary Gen. James Mattis, do not want to reopen the proverbial Pandora’s box. That said, the bellicose rhetoric on this issue is useful in shaping Iranian perceptions and keeping them in check.

Similarly, the claims from hawks within Iran’s various power centers also are disingenuous.

Those claims are designed to undermine Rouhani, especially ahead of his re-election bid in May. The Iranian president’s adversaries make a number of different arguments. The main one is that Iran has not benefited from the nuclear deal because sanctions relief has not led to economic benefits, especially in the life of average citizens.

Reports do suggest that ordinary citizens have yet to benefit from the financial gains of a respite in sanctions. But this is natural because a trickle-down effect takes time to materialize.

The agreement went into effect only a year ago. That said, the Iranian economy has improved, which is the most notable geopolitical development taking place in Iran.

During the 2015 Persian calendar year (from March 21, 2015 to March 20, 2016) before sanctions were lifted, Iran’s economy grew at a meager pace of 0.5 percent. In sharp contrast, economic growth in the six-month period ending on Sept. 20, 2016 was 7.4 percent (5.4 percent in the spring and 9.2 percent in the summer). The bulk of this growth was due to Iran resuming crude exports as oil sector growth totaled 61.3 percent (55.4 percent and 67.2 percent in the first and second quarters, respectively). Last week, Petroleum Minister Bijan Namdar Zanganeh announced that Tehran was producing 3.9 million barrels per day (bpd) – slightly shy of the 4 million bpd mark before the 2012 sanctions went into effect.

In December, Iran secured an exemption from OPEC whereby it did not have to cut production per an agreement that includes members of the cartel and non-OPEC producers such as Russia. Iran has significantly benefited from the easing of sanctions. Because there likely is not a way for sanctions to be reimposed, this trend is expected to continue for the foreseeable future. The Iranians are unlikely to do anything to undermine their current comfortable position.

Iran will cautiously engage in missile tests, which are not part of the agreement and help shape international perceptions. Iranian officials also will continue to issue tough statements threatening to tear up the nuclear agreement in response to attempts by the Trump administration to renegotiate it.

But it is highly unlikely that Tehran will do anything to seriously violate the agreement. Instead, Iran likely will build on gains it has made so far.

Iran was a regional power even under sanctions. However, the 2012 sanctions, which crippled its ability to export oil, created a situation in which Iran had reached the limits of how much it could support its regional allies. Sanctions also put the country’s domestic stability at risk. At the same time, its regional position was threatened by civil war in Syria.

Getting out from underneath the sanctions was critical to Iran’s national security interests. The agreement allowed Iran to regain the financial bandwidth to not only stave off potential domestic unrest, but also to play a key role in the region – especially in Iraq and Syria, where it supported allies who staged a comeback. In many ways, Iran has gone from facing threats to trying to exploit opportunities.

Unencumbered by sanctions, Iran’s ability to project power is increasing. It will be expected to better exploit crises in the Arab world. Its economy is improving while its chief regional rival, Saudi Arabia, faces a declining economic situation. Iran’s net strategic position has long been better than that of Saudi Arabia, and this disparity is expected to grow.

The Iran deal was part of the American strategy to create a balance of power in the region. With Saudi Arabia weakening and Iran strengthening, maintaining such a balance becomes difficult. It is not in the U.S.’ interest for Iran to gain a disproportionate amount of power.

Nuclear weapons or even conventional military capabilities are not the real threat, but rather an Iran on the path toward international political and economic rehabilitation. While the rhetoric from the Trump administration – like its predecessors – invokes the nuclear and missile issues, what Washington is really worried about is how to ensure Iran can be prevented from enhancing its influence in the greater Middle East.