When we chose to name this publication Turbulent Times Investor, we knew the name would be apt. But lately it has been proving even more apt than we could have imagined, as the world undergoes rapid changes that threaten to upend the existing financial order. In the very recent period—with the war in Iran adding fuel to the fire—it feels as if the pace of change has been accelerating, and in just the past few weeks there have been developments with big implications for the U.S. economy, the country’s place in the world, and, not so incidentally, for investors.
The accompanying article (originally a TTI update) focuses on one of these events: the bond auction last month in which the U.S. was forced to offer interest topping 5% on 30-year bonds, a nearly unheard-of level. It was a clanging alarm bell signifying the pressures mounting on the U.S. and on the dollar as our enormous debt continues to climb. But it has been followed in rapid succession by other notable developments.
For investors, it adds up to a compelling message: Your paramount concern has to be safety. This isn’t the time for heedless greed and chasing after the biggest short-term gains, a pursuit we think will boomerang. Rather, it’s essential that you position yourself to withstand the toughest economic environment—whether that ends up being inflation, deflation, or stagflation, any one of which could emerge—and a sharp market setback. We can’t give a precise timeline, and we can’t say just how severe the market downturn will get. But we expect that a lot of people will experience a lot of pain, and we want to make sure you’re not among them.
We continue to believe that the No. 1 way to protect yourself is by owning gold, any short-term setbacks or volatility in the metal—which would not be surprising—notwithstanding. Recent developments further bolster the case for the metal, as they point to the world getting closer to a gold-backed monetary reserve system that will circumvent the dollar as the primary currency for international trade.
One significant recent development was the announcement in late May by Hong Kong officials of a July launch for a new government-backed gold-clearing system. This looks to be a very big deal in the realm of gold and gold trading.
The new Hong Kong system will be a direct challenge to the London LBMA (London Bullion Market Association), which has long dominated gold trading and pricing. But there are significant differences between the Western and Eastern systems. On the London exchange, as is true as well of the U.S.-based Comex gold exchange, gold prices are set based on paper trading, with no physical gold having to change hands. Among other things, this has made it possible for gold’s price to be manipulated, as it has been in the past. The new Hong Kong clearing house—like the Shanghai Gold Exchange, with which it has signed a multifaceted cooperation agreement that allows it to benefit from that exchange’s advanced technical expertise—will be based on the exchange of physical gold, i.e., it will reflect actual demand for the metal.
In case you’re wondering, this doesn’t mean that traders in the Hong Kong system need to literally scoop up gold bars in their hands when they make a trade (although, in effect, they can if they want to). Rather, they have a call on the appropriate portion of physical gold that is stored in the Hong Kong vaults. By contrast, gold trading in the West essentially equates to simply placing a bet on the future price of gold.
To implement its new system, Hong Kong plans to massively expand its capacity to store gold reserves. Currently it has capacity for just 200 tonnes (metric tons) of gold. Within three years, it plans to increase this by more than 10-fold, to more than 2,000 tonnes. These vaults will complement the network of vaults that the Shanghai Gold Exchange maintains in China and selected other locations.
Emerging economies are the biggest buyers of gold. Last year, more than half of total worldwide demand for the metal came from China and India. The new clearinghouse system in Hong Kong, in conjunction with the Shanghai Gold Exchange, means that pricing power for gold is moving to the part of the world where most of the metal is bought and sold. Essentially, China will be the country setting the price of gold.
In addition to the news about the July launch for the Hong Kong gold clearinghouse, something else we’re following is new security architecture emerging in West Asia. Backed by China and Russia, so far it involves four Sunni countries: Saudi Arabia, Pakistan—the only nuclear-armed Islamic nation—Bahrain, and the UAE. Last September, Pakistan and Saudi Arabia signed a mutual defense pact, and now the other two countries, potentially eventually followed by others, are integrating within it.
What it shows is that this strategically critical part of the world is recognizing that its half-century-long reliance on the U.S. as its protective shield is no longer a meaningful guarantee. The war in Iran has driven this home in a very big way. It’s not that the U.S. has “lost” the war in the traditional sense of having to say “we surrender” and lay down arms. But whatever your view of the war and of Iran, it’s an astounding fact that Iran, a country of some 90 million people and whose economy has been pummeled for years by sanctions, was able to keep the U.S., with its close to $1 trillion military budget, at bay. Moreover, as Iran attacked countries with U.S. bases, it has exposed the vulnerability resulting from their ties to the U.S.
Does this mean that the petrodollar is in its death throes? The petrodollar arose from the arrangement that Nixon entered into in the 1970s with the Saudis, in which they agreed to price oil in dollars in exchange for U.S. protection. The deal was critical to keeping the U.S. dollar as the world’s reserve currency for all these years despite its connection to gold having been severed. At the very least, that rationale has certainly now been undermined.
And if—when—more oil is traded in something other than the dollar—as already is being done between China and Russia, not to mention that Iran with its control over the Strait of Hormuz has been accepting yuan as payment for oil —it will circle back to the loss of faith in the dollar that will be so damaging to the U.S. economy burdened by our enormous and rising government debt.
A final development in late May we’ll touch on briefly here relates to Russia and the Ukraine war. Russia has sharply ramped up its aggressive language towards Europe, and as evidence of the seriousness of its purpose, recently launched an Oreshnik hypersonic nuclear-capable missile that exploded within miles of Kiev. It’s not clear, of course, what will follow. But as events unfold, and coming on top of the Iran war, we think it will raise further questions about the relative strength and reliability of the U.S. and our military. It’s definitely a scenario that screams to investors: safety first.
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