Jim Rickards: Thoughts on the US Economy, Section 232 and the Gold Price

American lawyer, author and economist Jim Rickards recommends investors allocate about 10 percent of their portfolio to gold.

“A trade war is coming,” says American lawyer, author and economist Jim Rickards. His most recent book is called “The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis,” and he took the time to chat about it with the Investing News Network at the Sprott Natural Resource Symposium. 

In the interview above, he explains that the US has delayed imposing tariffs on Chinese steel and aluminum because President Donald Trump wanted China’s help in persuading North Korea to drop its nuclear and missile programs. “It’s now clear that China is not able to help or is not willing to help. Either way it doesn’t matter. China is not going to help us with North Korea,” he states.

Rickards says the US economy is “fundamentally weak,” and he believes there is data to support his view, including “strong trends in disinflation” plus a decline in retail and auto sales. Rickards expects the Fed “to flip back to easing mode later in the year.” Instead of cutting rates, he thinks the Fed could ease through forward guidance. “That’s very bullish for gold. [It] could actually give stocks a lift even though in my view the market is overvalued and in bubble territory. One thing we know about bubbles is they can get bigger before they crash.”

He’s also bullish on the euro as he expects Fed easing to weaken the US dollar. He recommends that investors increase their cash allocation and cut their stock exposure “because equities look like a bubble to me.” He sees gold passing $1,300 per ounce in the next few months on the Fed’s flip to ease and says, “you could see a very strong gold rally back up to the levels just prior to Trump’s election, which were kind of in the $1,320 range.”

Rickards mentioned that upcoming US Q2 GDP data will offer insight into how the economy has performed during the entire first half of the year. The market will certainly be anticipating the release of the data, which is expected on Friday (July 28). 

The transcript for this interview can be viewed below.

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INN: I’m here with Jim Rickards, editor of the Financial Newsletters Strategic Intelligence. Mr. Rickards is a lawyer, economist, investment banker, and New York Times special author. His latest book is “The Road to Ruin”. What are some of the key points you discuss in the book?

JR: The key points I discuss in the book, it’s a couple of things. First of all, my models and my way of analyzing global capital markets and risks in global capital markets using several branches of science, which have not been applied by Wall Street. So, Wall Street sell side research, Central Banks for that matter, finance ministries are using variations of what they call dynamics to cash with general equilibrium models, regressions, correlations and a lot of tools, that are first of all obsolete, and secondly are not good reflections of how markets actually work. Markets operate in much more in accordance with the branch of science called complexity theory. So, I use complexity theory, network science, behavioral psychology, actually is history, great teacher and a branch of applied math, mathematics called Bayesian statistics, base rule, base theorems just by different names, by combining all of these to forecast markets. So, I talk about that, a little bit my personal adventure. How I got there, my work with the intelligence community, my work with centers of excellence such as the Los Alamos National Laboratory.

I also talk about my personal experiences in a couple meltdowns. In 1998 there was the emerging markets long term capital management Russia crisis but I was the chief lawyer, general counsel of long term capital management. So, I not only lived through that but I negotiated that bailout. So, that was a front row seat on how markets can collapse. And out of that experience, I then pursued, I really accounted personal odyssey ten years of working all these scientific areas to learn more about how risk actually work. One thing I knew that after a realty scam was risk doesn’t work the way I’d learned thought it did. We had the smartest people on the world. We had two Noble Prize winners, 16 PhDs, great people, nice people, but with IQs 160 and up. So, no shortage of brainpower. But that ended disastrously. And the reason was it’s not because we didn’t have smart people working in good faith, but because they had the wrong models. So, I set out to not only prove that, and find out what’s wrong with those models, but also to come up with models that do work. And so, this is actually all connected to a new company I’ve started and some other research I’m doing. But the point being, it’s a blend of economic history, So, I take the reader to a couple of these crises, personal experience, and science, and history. So, hopefully it’s very interesting for the reader.

INN: So, what kind of changes have we seen in the US under President Donald Trump in terms of fiscal policy and trade, in particular what’s been in the news a lot recently is the Section 232 review regarding the US steel industry.

JR: Right, so I think we need to separate what Trump did and said on the campaign trail on some of his early statements from what has actually happened and that’s a very big deal. Because if you go back to election night of November 8th and into the morning of November 9th after some initial jitters and the kind of shock of Trump’s election, the stock market just took off and rallied very significantly in November, December, January, it flattened in February March, but has rallied again strongly this spring and summer in May, June and July. Measure indices are up over 20 percent, about 20 percent since Trump was elected. Now what was the basis of that? It was based on him saying we’re going to have tax cuts, we’re going to have infrastructure spending, we are going to repeal Obamacare, reduce regulation, etc. That was viewed very positively by the markets. In fact, none of these has happened. Lots of noise, lots of storm and stress, lots of votes, lots of the days on legislative calendar used up, but they haven’t repealed Obamacare, they haven’t enacted tax cuts, they haven’t put forward an infrastructure spending bill, so to some extent the market looks like it’s floating on thin air. I mean, I understand the earnings have it good – I don’t put much stock in earnings beating expectations because the expectations are managed down so that’s kind of a fool’s game. Year-over-year earnings look strong, but 2016 was a weak base year. So, I think there’s a lot less there than meets the eye, in terms of why stock markets are so strong.

Meanwhile, I see a lot of storm clouds the Fed raising rates into weakness. I think the US economy is fundamentally weak. I say I think, again there’s a lot of data to support that up strong trends in disinflation, auto sales down, retail sales down. Disinflation as I say, coming on very strong. All this I think will cause the Fed to flip back to easing mode later in the year. Very bullish for gold among other things, but specifically, on your point about the tariffs, yeah there is a trade war it’s coming it’s starting right about now, literally as we speak. The president has a trade troika, as I call them. This is Robert Lighthizer, US Trade Representative, Wilbur Ross, Secretary of Commerce and Peter Navarro, Special Counsel, head of the White House Trade Council. They’re all hawks. They all believe in tariffs, they all believe that China is dumping steel and aluminum. Not just China but the other countries around the world. They are ready to impose tariffs. They have been holding off so far because the president was trying to get Chinese help with the North Korean situation and that took some months to resolve. It’s now clear that China either is not able to help or or is not willing to help. Either way it doesn’t matter, China is not going to help us with North Korea. So, the president is kind of unleashing his troika. You’re going to see some very strong trade sanctions, and to the point you mentioned, they are not just going to use standard anti-dumping tools. They are going to use national security as a lever and that’s very important because it not only increases the number of tools in the toolkit but in some ways it makes it immune from the challenge in the World Trade Organization, WTO, review. Because WTO has exceptions for national security. So, if you use national security, you can get out from under WTO review to some extent. So, a trade war is coming. It’s literally starting in real time now. The timing is the result of China’s failure to help with North Korea.

INN: Is that just something that will affect steel imports or is that something that’s kind of more protectionist in other ways?

JR: I think it’s protectionist in other ways. Obviously, it’s kind of bullish for U.S. steel companies, United States Steel, US Steel, Nucor. Some other should get a lift from this. That’s pretty clear, or hurt Chinese steel companies, but I don’t expect the Chinese to take this lying down. I certainly don’t expect the Chinese to end their subsidies, as a result of our tariffs. Because there is a global market, they can still sell steel to anyone else in the world, you know Mexico, Latin America, Africa, Europe, anyone else who might need it. This is a global problem and it is a global market. But I would expect China to retaliate. By the way, in addition to the steel and aluminum sanctions, or tariffs really, which we mentioned, there will be financial sanctions imposed on Chinese banks, that are helping North Korea to pay for imports to conduct its missile and nuclear weapons program. So, my point being, there is a connection between North Korea and national security, financial warfare trade sanctions. None of these stand in isolation. So, I will look for the US to hit China with tariffs in steel and aluminum but also financial sanctions on banks that are helping North Korea. I will look for China to hit back, not take it lying down. But impose limits on direct foreign investment in China, the ability of our financial institutions to expand in China. A lot of other ways and you know, theft of intellectual properties, cyber warfare, there are many ways this could escalate. So, I think it is much much broader and more dangerous and potentially more detrimental, than just tariffs on steel.

INN: You touched on the Fed tightening rate cycle a little bit. So, there is meeting this week with the Fed as well, but they’re not expected widely to raise rates. The rate increase most people have said is coming next year and then at the same time we’ve had Bank of Canada, who just recently raised the rates as well. So, can you just maybe touch on that. And you mentioned the US economy potentially being a little bit weaker, then perhaps it could withstand with these rate hikes.

JR: Right, so the Fed has been in tightening mode since May, 2013. That’s when Ben Bernanke gave the taper talk speech, and what he said at the time- he didn’t actually do anything. He didn’t raise- it was far from raising rates and did not actually start the taper but he said I’m thinking about starting the taper. That enough, that alone rather was enough to start an emerging market’s melt down. Capital fluidity- left hot money, capital outflows came from emerging markets as markets went down, etc. Then there was a whole sequence of events. They started to taper in December 2013, finished the taper in November 2014, removed forward guidance in March 2015, raised rates for the first time in December 2015, and a couple more rate hikes December 2016, March and June, 2017. So, that’s the sequence. So, a lot of people thing the lift off started in December 2015 with the first rate hike, but really accelerated in December 2016 with the sequence of three that we’ve just seen. But I would make a point that no, the tightening goes all the way back to May, 2013. Now, the reason that’s important is because as we know, monetary policy acts with a lag. It takes a year to two years for these steps to actually flow through to the real economy. Now the initial steps were mostly in the form of talk. I realize that and the actual tightening didn’t begin until December of 2014 with the beginning of, or 2013 rather with the beginning of the taper, and then accelerated from there. But come to two years forward, it’s no surprise that here we are, you know, looking at data late 2016 early 2017, we’ll have second quarter 2017 GDP data coming out in a few days, we’ll be able to look at the entire first half.

It looks like US growth is even weaker than the lousy growth we’ve had since the expansion began in December of 2009. None of these should be a surprise because, as you say, the tightening started a long time ago. Now, you’re right the Fed not tightening rates at this meeting, this July meeting, July 26 and 27. But they might say something about inflation, which would indicate that they are not in any hurry to raise them any time soon. And they might talk about balance sheet normalization, which is a separate form of tightening independent of rate hikes. This has to do with not rolling over maturing positions in US treasuries and at the margin that should increase intermediate term rates a little bit. So, my forecast is no rate hike in September for the reasons we just discussed, which is the US economy is slowing down. The problem is, once again the Fed has blundered. What we are seeing now is the impact of some things that happen in 2014, 2015, early 2016 with a 2-year lag. Well, they kept tightening, you know, in 2017, that has yet to play out. So, that’s going to be even more of a headwind for the US economy.

INN: So, in light of all of these things that we’ve just talked about, what advice do you have for investors?

JR: It’s a very dangerous time. I think we will see more of what we’ve seen for the last four years, which I call the Fed flip-flop. In other words, there’s no question the Fed wants to tighten. They want to tighten. Whether they can or not, given the real economy is a separate issue. Now, why do they want to tighten up? The economy is weak or it even looks like it might be weak. Why on earth would you tighten? The Fed never does that. The Fed has not done that since 1937. Typically, they tighten into a very strong economy that’s trying to get a little hot in terms of inflation, low unemployment, etc., but here they are tightening into weakness. The reason is they didn’t tighten when they should have, meaning 2010, 2011, 2012, early in the recovery, that was the time to tighten. That was the time to tighten. That’s when the Fed normally would have re-tightened under a normal business cycle, which this isn’t by the way. This is more of a depression that we’re living through right now since 2007. So, the point being, the Fed didn’t tighten when they should have. They’re desperate to raise rates now, not because they think that’s good for the economy, but because they’re getting ready for the next recession. Research shows that it takes about 300 basis points of rate cuts to get the US economy out of a recession. If we went into a recession tomorrow, or even next year, how could you cut rates 300 basis points, if there’re only 100 basis points. The answer is you can’t. You’ve got to raise them so you cut them and that’s what the Fed is doing. They’re trying to raise them now so you can cut them later. The danger is, will they, by raising them now, will they cause the recession that they’re actually preparing to cure. And the answer is that they might. And that may be playing out kind of in front of our eyes. So, when they see this disinflation, this weakness that we’ve talked about, they will flip back to easing. How do they ease? Well, they’re not gonna cut rates at this point. Their pretty far from that. But they can ease through forward guidance. They can say, you know, “Hey, just kidding. We’re not gonna raise this September, we’re not gonna raise in December. We don’t know when we’re gonna raise. It could be a long time.” That’s forward guidance. That will be a form of easing through words. That’s very bullish for gold. Could actually give stocks a lift even though might be the market is overvalued and in bubble territory. One thing we know about bubbles is they can get bigger before they crash. So, this is risk on, risk off, you know, easing on easing off, flip-flop that’s going on eight or nine times since 2013. We could see that again.

My advice for investors is increase your cash allocation just because the uncertainty it doesn’t mean you are out of the market forever. But it means that when we get a little more visibility or the economy is in a recession, which should might be, or the Fed flips back to ease, you can pivot. Personally, cash is the person who A, is not suffering loses, and B, can get into asset classes once we hit more visibility. I recommend about 10 percent gold. I think gold is gonna have a very strong second half of 2017 for the reason I mentioned, which is ironically a weak US economy disinflation, which is normally bad for gold. Could be good for gold if it forces the Feds to flip back to ease, which I do expect. And I would cut my stock exposure because equities look like a bubble for me. Most are very bullish on the Euro because ease by the Fed will weaken the dollar that will strengthen the Euro, so I think the Euro is a good play as well.

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INN: Do you have a forecast for the gold price?

JR: I am not a technician. I look at charts and I look at inflection points. So, I do use charts but I don’t consider myself a technician in the formal sense of the word. But I’m actually impressed with how strong gold has been given the headwinds. Given everything we just discussed about the Fed tightening, and the strong dollar until recently the dollar is getting weaker right now, but the dollar was on a very strong trend in 2014, 2015. Given those headwinds, I’m surprised gold is not lower. It’s been kind of hanging in there. I think that’s attributable to physical supply and demand. You know the price of gold is not set like a normal commodity based on normal physical supply and demand. It is easily manipulated by large sales of paper gold in the Comex future’s market. So gold’s had headwinds, it’s had flash crashes, it’s had manipulation-style selling of, you know, there’s one sales equivalent of about 60 tons of gold, sold in paper form. There was no actual gold involved. It took the price down very steeply. This happened a couple times in June and early July. Try finding 60-tons of physical gold. You can’t do it. If I sold you 60-tons of gold and you called me up “Hey Jim deliver the gold.” You couldn’t do it. I mean, no amount of money could scrounge off 60-tons of gold in short notice. There’s just not that much gold. I know that because I visit, I talk to refineries, I talk to gold miners, I talk to gold dealers, I visit vaults, I talk to the people who handle the physical gold. You couldn’t. I don’t even know how long it will take to get your hands on that much gold. But, if I sell paper gold in the future’s market, it’s child’s play to take down a market. So, my point being the fact that gold has done well, without many headwinds, tells me that as soon as the headwinds are removed, which I do expect as the Feds flips to ease later this year, which I do expect, gold should get a very strong lift. I would, based on that, I will expect that a strong second half will pass $1,300 per ounce in the next couple of months. Once it does that, that will have an important knock on psychological effect. And you can see a very strong gold rally back up to the levels just prior to Trump’s election, which were in the time of $1,320 range. So, I look for a strong rally of $1,300, maybe beyond that, as high as $1,320 by the end of the year.

INN: So, while we are on the subject of forecasting, you have a new project that you’re working on. Can you talk a little bit about that?

JR: There is a company I formed a year ago with some partners, who put together a great team. The company is called Meraglim, M-E-R-A-GL-I-M. We have a website, meraglim.com. So, there is a lot of information for people who are interested there. But what we are doing basically is taking the kind of forecasting analytics that we’ve been talking about in this interview, putting them into models, and then working with a team of cognitive scientists and developers and creative designers at IBM with the Watson capability behind us. Watson is a computer system that can, apart from high-speed processing and super computer capability, it can also read and speak languages. I think it speaks about seven languages, it can talk to you. People may have seen our commercials. So, we’ve got top cognitive scientists from IBM, a team that includes top PhD, applied mathematicians, seasoned market individuals, a couple of us with intelligence backgrounds. These are things I learned as CIA and my partners learned in Army Intelligence about how to solve problems with insufficient data. And putting out a predictive analytic platform. Again, a lot available on our website, but we’re very far along in the development. I was on a team call this morning. Very very enthusiastic and excited about this.

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Securities Disclosure: I, Melissa Shaw, hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

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