QBAMCO - Locked & Loaded

7/29/2019 QBAMCO - Locked & Loaded

1/16

QB ASSET MANAGEMENT www.qbamco.com

1See Important Disclosures at the end of this report.

February 2013

Locked & Loaded

February marks QBAMCOs sixth anniversary and we are grateful for the interest our views have

generated. In the coming months we will be assessing the platform on which we offer investmentservices and our policy of distributing our views externally. Your thoughts are welcomed. This piece

addresses the following issues:

Currency War Theory & Practice: We argue one should not necessarily mistake rotating currency

devaluations presently for the threat of a belligerent global currency war. Monetary authorities are

likely to continue managing the timing and magnitude of discrete, coordinated relative currency

weakness so that the appearance of a stable global monetary system remains intact.

Cause for Concern: While we do not expect a breakdown in global monetary oversight, we do expect

fiat currency debasement to continue to mask the driver of real economic malaise and contraction

global bank de-levering; and we do expect this process to lead to a popular loss of confidence in todays

major currencies as savings instruments perhaps beginning in the global capital markets in 2013.

Lambs to Slaughter: We do not expect an overt crash in global stock, bond and real estate markets, or

one that would last very long. They are already crashing in real terms and there is a well-structured

mechanism in place to support nominal pricing. Any future flight of public sponsorship would be met

with central bank credit support working through bank intermediaries. For those not part of the support

mechanism, however, the monetary market putdoes not necessarily argue in favor of investing broadly

in implicitly levered financial markets.

The 1998 Committee to Save the World & Centralize Global Economic Control (and their Legacy

Beards): We think the smart play is to bet with these guys and the power of their institutions.

Reasonable Contrarianism: The pain of holding an inflationary bias over the last six years has been

intense, and the pain has only increased exponentially over the last two years. The good news is that we

believe for the first time there are important macroeconomic events signaling a fundamental shift in the

global monetary system is finally approaching. We expect discussion of Fed, ECB and BOE inflation

and/or nominal GDP targeting to become louder and more frequent in 2013, and we expect markets to

begin adjusting asset prices accordingly.

The Pain Trade: All the Sturm and Drang in the financial press about a revival of the US housing market

is bologna. We provide a short idea.

Bad Science: On February 1, a large multinational bank published a report that called the end of the bullmarket in gold, claiming; the 2011 high will prove to have been the peak for the USD gold price in this

cycle. While no one knows the future and the dollar price of gold may rise or fall, we are quite certain

golds future path will have nothing to do with the arguments included in this report. Sadly, it was a case

study in false identities leading to wayward causations and, in our view, a diametrically wrong

conclusion.

The True Lesson of JMK: The most important takeaway from John Maynard Keynes many views is that

sometimes change for changes sake is necessary to jumpstart popular confidence.


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The Play:We think that what will eventually (or soon) occur will be the rare occasion when return-on-

savings trounces return-on-investment, implying precious metals will outperform the great majority of

financial assets (except for shares in precious metals miners and natural resource producers).

*

The big macro questions: Will global central banks raise rates, withdraw bank reserves or tighten credit

policies in any way before the global economy experiences significant price inflation? No. Will they

continue threatening to tighten? Probably. Will they continue to de-lever bank balance sheets via bank

reserve creation? Absolutely. Will global central banks continue to be significant net purchasers of

physical gold in 2013 and beyond? Bank on it. Will big global wealth holders convert increasing amounts

of fiat currency into physical precious metals, resources and other beneficiaries of global price inflation?

Highly likely. Will Western financial asset allocators figure out what all this implies for stocks and bonds

in 2013? We think so, probably after a significantly higher-than-expected CPI print.

Higher global goods and service inflation is a tail event currently unforeseen by the great majority of

investors and unexpressed, or expressed improperly, in the great majority of investment portfolios. And

yet we see it as a lock, perhaps asserting itself in 2013.

Currency War Theory & Practice

All seem to agree now that global monetary authorities are fully engaged in trying to protect their

currencies from relative appreciation. The fundamental question remains: is there a growing likelihood

of a messy sovereign currency war in which monetary authorities compete to beggar their neighbors

or are treasury ministries (in fact, central banks) collaborating with one another to devalue their

respective currencies in a sequentially, but orderly fashion? By identifying the answer we should gain

insight into the nature and timing of significant changes in economic output and market valuations.

We do not think current whack-a-mole currency devaluations imply a belligerent currency war, now or inthe future. Lets follow incentives. Who does a cheap currency ultimately benefit? It theoretically helps

indebted governments fund themselves with foreign investment from entities with stronger currencies,

and it benefits cheap currency-based exporters deliver cheaper goods and services than exporters that

report earnings in domiciles with stronger currencies. On the first score, most indebted sovereigns have

come to rely predominantly on their central banks for funding (i.e., QE), rather than foreign funding.

Regarding global exporters, most have set up foreign manufacturing capabilities where their products

are consumed, better matching costs with revenues. Further, swap markets and trade receivables allow

exporters to adequately manage their currency exposures. Everyone knows the enormity of the swaps

market and it has recently come to light that trade receivables have become the largest credit market in

the world (see graphic on following page). At $17 trillion, it is larger than the mortgage and corporate

markets. That exporters must report earnings in their native currency by converting all margins back is a

direct problem for corporate treasurers and their shareholders, not domestic employees (at least

directly), which means strong currencies are not directly a problem for politicians.

For these markets to break down, the banking system would have to break down, which leads us to our

final point about the potential for a global currency war. Modern currencies are created by banks and

their central banks not by governments or by domestic exporters that would benefit from cheaper

currencies. This suggests a trade war is not a decision for politicians or exporters to make. Ultimately,

SIFI banks control the game.


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When push comes to shove, the primary

mission of central banks is to keep their

banking systems solvent in times of

stress. (Should this effort be claimed to

support economic objectives like price

stability or full employment, all the

better.)

A monetary food fight would risk the

demise of a major currency, which, with

todays cross-levered, cross-funded bank

balance sheets, would further suggest

mutually-assured global bank system

destruction. As bank deposits are now

highly concentrated within very large SIFI

banks, one major global bank failure

anywhere in the world arising from one

economy winning a currency race tothe bottom would impact all global

banks and, by extension, the broad

perception of bank failures.

SIFI banks are the controlling shareholders of the most influential central banks. Central bankers

controlling over 75% of global GDP, in turn, gather every two months at the BIS in Basel, Switzerland to

discuss and coordinate policies. We think this implies a continuation of managed, discrete currency

takedowns. Beggar-thy-neighbor attitudes and rhetoric among sovereign politicos may spring up from

time to time but we do not expect such attitudes in the global banking system, where it counts.

Share prices of the worlds largest banks are lagging the general market even though their revenues andearnings are soaring. Some argue the market fears that one day central banks will reverse their loose

monetary conditions, in turn decreasing bank net interest margins. We do not think narrowing loan

margins is a valid reason to be concerned. The cash flows of most large banks are almost certainly

hedged against higher market rates, if not with each other than with their central banks. The real

problem, as we see it, would be the value of their loan books, which would decline materially were rates

to rise coincident with a decreasing appetite for new bank assets (loans). This fear, in itself, provides the

fundamental reason not to be concerned that central banks will withdraw from the markets, letting

interest rates rise, before adequately reserving SIFI banks. We expect no interest rate surprises.

So by our way of thinking there is very little risk of a belligerent global currency war. This is not to say we

think central banks will stop methodically cheapening their currencies. They must continue to satisfy

their principal aim of de-levering bank balance sheets to maintain bank loan book valuations. Consistent

with domestic optics central banks will continue to destroy their currencies in a coordinated fashion that

avoids a global currency event.

From a trading perspective, we speculate it is wise to play reversals at extremes of cross-rate FX ranges.

The risk of major currencies breaching well-established ranges seems remote as long as major central

banks work together to preserve their currency oligopoly. In light of this theory, consider the significant

bounce of the EURUSD since July 2012, from 1.21 to 1.35, against almost universal sentiment believing it

would see parity to the USD. Should FX traders now apply this theory to the universally accepted demise

of JPYUSD?

Source: The Receivables Exchange


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Cause for Concern

From a longer term wealth perspective, the net result of coordinated central bank fiat currency

management would be a continuation of current trends: increasing real economic malaise amid an

environment of decreasing currency values. If we are right, all currencies will lose their exchange value

to goods, services and assets vis--vis the exchange value that could be maintained by bartering goods,

services and assets for each other. This implies that it is better to own stuff outright stuff consumed

today and valued tomorrow at price levels that do not rely on the future purchasing power of currency

holders (a well-worn theme of ours).

As it stands, existing claims on wealth far exceed existing wealth to claim, and the decreasing absolute

value of currencies is destroying perceived wealth. As an example, consider that most people are

unlikely to sell their homes when: a) the bid suddenly drops by 20%, or b) selling homes at whatever

clearing prices happen to prevail does not provide homeowners with incentive to act. Simply,

homeowners will not provide supply at the market price because tomorrow, or the day after that,

they think someone will offer more. The same is true for goods and service producers. They will not

provide supply at the market price because the proceeds from such sales would bring them decreasing

wealth. The more currency that global monetary authorities create, the less supply of goods andservices will ultimately be created at prevailing prices.

Most economists and investors do not seem to conflate asset acquisition with goods and service

consumption, yet we think they should. (Perhaps this goes a long way in explaining why most people do

not presently fear goods and service inflation?) As we discussed in Macro Polo, bank system levering or

de-levering first drives asset prices higher or lower and is necessarily followed by price inflation,

disinflation or deflation. The growth rate of money and credit is the leading indicator of investment

returns, goods and service inflation and, in (and only in) an economy expanding in real terms, aggregate

wage growth. Where there is no realeconomic growth there can be no wage growth in combination with

stable or rising employment. (Employment, like unit production, is a real variable, not a nominal one.)

Soon, we think, most people will begin to see this relationship not because policy makers, economists

or market strategists proclaim it but because they will not be able to make ends meet. The

unemployed and the employed will both experience decreasing wealth versus their current purchasing

power regardless of the size of their wages or financial asset portfolios. Trees, real wages and the

returns of stocks and bonds do not grow to the sky. Japanese, European and American nationals cannot

exploit each other over time because producers lose their taste for amassing any of their currencies. We

expect producers, not consumers, to exert their will by demanding money in excess of consumers

ability to provide it. The necessary policy solution will be to put more money in the hands of consumers.

Thats where goods and service inflation begins. The wealth of investors keeping cash in their home

currencies, or in most financial assets denominated in those currencies, will decline in real terms

regardless of which currency it is. (AAPL better use their $137 billion quickly!)

Lambs to Slaughter

With interest rates at or near zero across sovereign bond markets and with official monetary policies

now targeting inflation at higher rates, one must question the soundness of investing directly in fixed-

income duration products or using benchmark interest rates to justify the real relative value of tertiary

bonds and equities. Most professional investors and wealth managers seem to agree that central banks

and state-sponsored Interests have taken control of public market asset pricing, and yet most are

ploughing ahead, abiding their investment mandates to allocate funds to public financial asset markets.

Investors are no doubt clinging to hopes of past higher debt and equity (stocks and real estate) returns.


5/16



Economic policy makers are solving for higher nominal output and inflation rates and, like lambs to

slaughter, investors are solving for higher nominal asset prices. These are easy missions. Raising nominal

statistics and prices could not be easier; all it takes is more systemic credit and promotion. Increasing

capital and real value wealth is the hard part.

We do not expect an overt crash in global stock, bond and real estate markets, or one that would last

very long. They are already crashing in real terms and there is a well-structured mechanism in place to

support nominal pricing. Any future flight of public sponsorship would be met with central bank credit

support. For those not part of the support mechanism, however, this monetary market put does not

necessarily argue in favor of investing broadly in implicitly levered financial markets.

We believe the wrong way to position wealth in todays environment is the way most are presently

doing so: under the presumption that financial asset markets will generally trend higher over time and

that nominal price appreciation will imply wealth creation. Positive real returns cannot be generated

broadly over time by unlevered investors investing in levered public capital markets and real estate.

Generally, the higher credit-supported markets climb, the less a dollar of gains will buy. Serious

investors should reject nominal economic and market valuation metrics.

There are only two ways current and future pensioners can maintain their wealth by participating in

todays capital markets: nimbly position assets well or abstain from investing. The former requires either

being agile or concentrating wealth strategically accurately and resolutely in capital market assets that

would benefit from inflation (e.g., QB). Market abstention requires either saving in scarce forms or

investing in private enterprises producing innovative or demand-inelastic goods or services.

The opposite of love is apathy, not hate; something to ponder when considering the prospects for highly

levered assets like most stocks, bonds and real estate. They are not savings vehicles long-term investors

should love or hate. If the ultimate objective for financial market participants is to maintain wealth

relative to society, then markets should deliver (but at a cost of absolute wealth). If the ultimate goal isto increase wealth relative to society, then financial asset markets are sure to disappoint for the

majority of society relying on them.

The great majority of institutional investors allocating investment capital using a conventional (ergo

fiduciarally acceptable) investment model today, as well as individual investors and their counselors

longing to be as sophisticated as these institutions by trying to replicate the same flawed adherence to

popular markets regardless of real valuation, ensure that nominal prices will rise as real purchasing

power declines.

The 1998 Committee to Save the World & Centralize Global Economic Control:

Robert Rubin Alan Greenspan Larry Summers

And their Legacy Institutional Beards:

Resolute central bankers Active trade negotiators Calculating politicians Extrapolating academics

We think the smart play is to bet with these guys and the power of their institutions.


6/16



Reasonable Contrarianism

The pain of holding an inflationary bias over the last six years has been intense, and the pain has only

increased exponentially over the last two years. The good news is that we believe for the first time there

are important macroeconomic events signaling that a fundamental shift in the global monetary system

is finally approaching. These events should be very supportive to precious metals and precious metal

miners. First, it is important to be mindful of the following realities:

The de-levering process is the dynamic that drives gold higher and it has not yet begun.Leverage has merely migrated from banks and households to governments and central banks.

Bank credit and broad measures of money are not expanding to the extent required to supportrelative leveraged asset pricing.

Central banks are reported to be substantial net buyers of gold. A higher gold price ultimately is a global policy solution, once gold is owned ubiquitously by

official accounts (and banks are further de-levered).

So what is happening now that leads us to think market recognition of these realities is approaching?

Late last year, Japanese Prime Minister Shinzo Abe began preparing the market for inflation targeting in

2013. General consensus was that the BOJ would begin aggressive QE until the Japanese annual inflation

rate reached 2%. Sure enough the news hit the tape on January 21 the BOJ would target a 2% rate by

purchasing Japanese government notes and bills, but it would begin later than expected, in January

2014. The Yen, which had been weakening against the

dollar, traded stronger on the day but its temporary

strength had no chance of being sustained against the

power of intervention hanging over the market.

The Yen trade shows two fundamentally critical points

related to the global monetary system. The first is

timing. Japan was the first major economy to blow itself

up on unreserved credit and it was the first to suffer

from it. Benchmark Japanese interest rates were

dropped to literally 0% in 1999 and Japan was the first

to begin QE in the 2001 far in advance of the US and

the Eurozone.

Japans economy was able to grow nominally from 2000 to 2007 through its exports to economies

where consumers were willing to borrow to consume. In fact, consumption of Japanese exports

increased in emerging markets too (also ultimately fueled by leveraging in the West). This came to a

screeching halt in 2007. Since then, Japan has been self-funding its government by monetizing debt,

promoting a global Yen carry trade, and levering domestic public and private balance sheets further.

Japans Debt-to-GDP and Debt-to-Base Money ratios are now in a class by themselves among advanced

economies.

Against this backdrop, the importance of outright inflation targeting by Prime Minister Abe cannot be

understated for holders of all global currencies and precious metals.Japans policy treatment of the Yen

continues to show the future for Dollar and Euro policy makers . In fact, there have already been

USDJPY

Source: Bloomberg


7/16



unofficial discussions in the US and Europe about inflation targeting or its fraternal twin of sorts,

nominal GDP targeting. As we have argued over the years, there is no other choice: goods and service

price inflation must rise as currencies must be destroyed through dilution in order to reserve and

reconcile existing bank credit/leverage. By threatening inflation targeting today, Japans economic triage

placed the world on notice that it and all other currency policy makers are willing to stop at nothing

to cheapen their currencies.

Masking this reality is the appearance of alternating strength in major currencies. Consider the strength

of the Euro recently which surprised the great majority of FX traders, sure that it was going to find parity

with the USD when it was trading around 1.20 (it is now around 1.35). The USD Index of major

currencies (DXY) seems stable, but underneath this stability lies great strength in EURUSD and weakness

in USDJPY (feet in the fire, head in the freezer => average temperature just right).

There may be periodically strong currencies but there are no currencies one should feel good about

holding over time. As noted above, the state of play is rotating currency devaluations, coordinated by

treasury ministries and central banks and executed by central banks.

As investors in precious metals plays, whether or not these managed FX machinations keep the different

trade blocs nominally afloat is not our primary area of interest. We were actually most excited by Japan

announcing it would delay inflation targeting by a year, our inference being Abe was counseled by US

and Euro authorities that by merely announcing the plan (as was done on January 21) Japan would

ensure a weaker Yen in the interim, but that more time was needed to coordinate a final, more

comprehensive global currency solution.

We expect discussion of Fed, ECB and BOE inflation and/or nominal GDP targeting to become louder and

more frequent in 2013, and we expect markets to begin adjusting asset prices accordingly.

As far as reading political tea leaves, it is the second term of a US presidency, a bank-friendly US

Treasury Secretary was replaced, and the economic conversation among US politicians is ideological

whether or not to raise debt ceilings. Global economic power resides almost solely in the hands of

central bankers. Ben Bernanke has a year remaining on his term, Fed-compliant John Carney takes the

seat at the BOE, and pragmatist Mario Draghi has established credibility among European banks and is

ready to print. To own precious metals and precious metals miners is to bet with central banks.

DXY (USD Index)

Source: Ameritrade


8/16



The Pain Trade

It has been absolute misery to look at the screens every day, having built a short position in

homebuilders as their shares have risen over the past four months. Our rationale has been based on a

few major reasons. Beyond all our views on nominal economic growth (possible) vs. real economic

growth (virtually impossible), and the waning bid for more leverage among home speculators, and aging

demographics implying more and more potential homebuyers will be downsizing, and the diminished

ability of mortgage lenders and brokers to fund and service mortgages, and the significant percentage of

homes currently worth less than their mortgages (which reduces current home sale liquidity), and

mortgage rates that imply no future advantage for potential home purchasers (which reduces future

home sale liquidity), and the recent uptick in home sales derived from block purchases by a few private

equity buyers in targeted markets at distressed levels1

-- beyond all that there is the graph below:

Source: St. Louis Fed

1Blackstone has been the largest investor in single-family homes to manage as rentals, acquiring properties innine markets, from Miami to Phoenix, where prices surged 22 percent in the 12 months through October. The firm,

along with Thomas Barracks Colony Capital LLC and Two Harbors Investment Corp. (SBY), is seeking to transform a

market dominated by small investors into a new institutional asset class that JPMorgan Chase & Co. (JPM)

estimates could be worth as much as $1.5 trillionCitigroup extended a $245 million line of credit to Waypoint in

October, enabling the investment firm to multiply its initial $150 million in capital from GI Partners, a Menlo Park,

California-based private equity fund. American Residential Properties, which has 1,500 homes in five states,

received a line of credit from Wells Fargo & Co. (WFC)in June 2010. The company announced plans for an initial

public offering of shares as early as the first quarter of this year, depending on market conditions. [Ref:

http://www.bloomberg.com/news/2013-01-09/blackstone-steps-up-home-buying-as-prices-jump-

mortgages.html]


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Simply, all the Sturm and Drang in the financial press about a revival of the US housing market is

bologna. While Asians, Russian and Greek multimillionaires may be actively buying $20 million homes,

there has been no fundamental rebound in the US housing market, perhaps for some or all of the

reasons we cite above. The inventory and shadow inventory of existing homes for sale far outweighs the

market for them. Since there is no improvement in the market for existing homes, we do not understand

how investors could get excited by owning shares in companies determined to build more of them.

And there is one more thing about homebuilding stocks worthy of mention. The dynamic that would

drive the housing market higher would be the general sense that tomorrow homes and everything else

will cost more than they do today (i.e., inflation). Inflation would apply not only to homes but to

materials needed to build them. We think that when goods and service inflation begins to take hold, the

costs of lumber, copper, drywall, labor, etc. are sure to rise at least as much as the rate of newhome

prices and sales. So, while inflation might eventually fix the housing market, we think homebuilders

will be left behind. Their product should be uncompetitive for a generation.

Against this backdrop, a graph of recent homebuilder share performance, as expressed in a homebuilder

ETF, shows they have appreciated almost three times since the summer 0f 2011. (Go ahead, squeeze us

more, but you better cover before it turns.)

Source: StockCharts.com


10/16



Bad Science

On February 1, the Head of Precious Metals Research and the Head of Strategy for Commodities,

Foreign Exchange and (curiously) Asia at a SIFI bank published a report that called the end of the bull

market in gold, claiming; the 2011 high will prove to have been the peak for the USD gold price in this

cycle, and that (the) the beginning of the end of the current golden era comes sooner than the Q3 we

forecast in January.2

We believe the timing of the report makes sense, given its provenance, and that it may be followed by

more such reports from SIFI banks, especially those likely to be short physical bullion vs. outstanding

claims for it they may be obligated to fill.

While no one definitively knows the future and the dollar price of gold may rise or fall (you know our

view and rationale), we are quite certain golds future path will have nothing to do with the arguments

included in this report. Sadly, it was a case study in false identities leading to wayward causations and, in

our view, a diametrically wrong conclusion. Below, we briefly annotate two broad examples:

Claim: The Lehman event in 2008 began an inflationary fix that led to a flight to quality amonginvestors that included Treasuries and gold.

Reality: The year-end trough in USDXAU (the dollar price of gold) came in 2000, eight years before the

Lehman event. From year-end 2000 to 2007, spot gold increased over 200%, from about $272 to about

$836 per ounce. Further, in 2008 the year of the Lehman collapse gold rose only about 4% to about

$870/oz. Since then, gold rose another 90% to $1,664/oz. through year-end 2012. In fact, gold has risen

each year for 12 successive years, from 2001 to 2012.

Source: Kitco

By any reasonable measure it does not seem that the price of gold subsequent to the Lehman collapse

had anything to do with the event per se. In fact, a strong case may be made that since 2000 gold had

been pricing in the fundamentals that led to the Lehman collapse, that being the record build-up of

unreserved leverage in the banking system and the future need to de-lever it.

2Credit Suisse; Tom Kendall, Ric Deverell; Gold: The Beginning of the End of an Era; February 1, 2013.


11/16



Finally, conflating gold and Treasuries in an investor flight to quality displays a very incomplete

understanding of the fundamental forces behind each, and the incentives of the marketplace and official

entities to sponsor them. The global financial system has been using Treasuries as a surrogate for gold

reserves for over four decades. Is this surprising? No. Is it sustainable? Doubtful. Treasuries are in the

process of demonstrating they are available in near infinite supply while golds physical stock struggles

to grow more than one-percent per annum. Gold is thus a threat to the perpetuation of this peculiar,

self-referencing system not an ally. Gold and Treasuries are like oil and water in this regard. Holding

gold is a hedge to holding Treasuries. If one is a safe-haven, the other is a time-bomb. History bears this

out. In fact, when thought through logically and cohesively, being long goldis being short Treasuries, in

real terms.

Claim: Given its historical role as a store of value, it was not surprising that investor demand for gold

increased substantially. Now, however, with the acute phase of the crisis likely to be behind us, we think

the peak of the fear trade has now also passed . The analysts continue; against any sensible

benchmark gold still appears significantly overvalued relative to the long run historical experience.

Reality: Whether it has been government-sanctioned money or not, golds role has empirically been thesame as moneys to store purchasing power. Sometimes, societies may collectively believe, correctly,

that there is more purchasing power to be gained by converting their money into levered financial

assets over some period of time. However, when levered financial assets are further denominated in

unreserved currencies, then it would seem highly likely that at some point scarcer gold would protect its

holders purchasing power better than money or financial assets. Golds quantity is relatively static while

moneys quantity must be greatly inflated tomorrow in response to credit inflation today.

Such is the store of value to which the analysts refer. By implication, they are asserting that the future

rate of money growth will be less than the future rate of the gold stock. With global central bank

Quantitative Easing in full flare, this assertion is quite confusing. We would agree that the shock of

recognition of bank system leverage has passed, but we would not agree that the acute phase of thecrisis likely is behind us or that the peak of the fear trade has now also passed. We do not believe the

analysts understand the driver of gold prices in the US or around the world. The fundamental reason

USDXAU has risen since 2000 has been the anticipation and ongoing confirmation of global base money

stock inflation.

As we have discussed, we believe the central bank mission to de-lever banks through reserve creation is

in place so bank balance sheets will be strong enough to endure necessary economy-wide price

inflation, which in turn would de-lever government and household balance sheets. We think the Fed and

other central banks expect the following economic sequencing: banks de-lever further via bank reserve

creation => goods and service price inflation rises naturally as global producers demand more monetary

units (higher prices) for their production => economic activity slows, creating a stagflationary global

environment => by then well-reserved banks will buy or lend to borrowers willing to purchase distressed

assets => asset prices rise and banking systems and economies begin to re-lever => wage levels rise

relative to household debt levels, reducing the burden of grass roots debt repayment. (The wheel in the

sky keeps on turning.)

In other words, we believe central banks in advanced economies are united in pursuing inflation as a

remedy for economic leverage. (We further believe they will succeed, but will be forced by the market

to greatly condense the sequence above into policy-administered currency devaluation.) If our analysis

is correct, then the peak of the fear trade is ahead of us, not behind us, and the magnitude of the fear

trade is substantially larger than implied by past USDXAU gains.


12/16



The True Lesson of JMK

John Maynard Keynes was truly deserving of his stature as one of the greatest economic thinkers of the

twentieth century. He got it, as they say; consistently demonstrating what seems to be complete

knowledge of the organic forces of economics and the power of government forces to twist them to its

aims. What might JMK say today about saving ones wages in the currency in which it was earned or

investing them in todays financial asset markets? Perhaps this:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch

the currency. By a continuing process of inflation, governments can confiscate, secretly and

unobserved, an important part of the wealth of their citizens. By this method they not only

confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually

enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but

at confidence in the equity of the existing distribution of wealth. Those to whom the system

brings windfalls, beyond their deserts and even beyond their expectations or desires, become

'profiteers,' who are the object of the hatred of the bourgeoisie, whom the inflationism has

impoverished, not less than of the proletariat. As the inflation proceeds and the real value of thecurrency fluctuates wildly from month to month, all permanent relations between debtors and

creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to

be almost meaningless; and the process of wealth-getting degenerates into a gamble and a

lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of

society than to debauch the currency. The process engages all the hidden forces of economic law

on the side of destruction, and does it in a manner which not one man in a million is able to

diagnose.3

JMK was of such a mind in 1919 amid the turbulence following the Great War, concurrent withreparation debates, and just prior to the Great Weimar inflation. And now consider this insight mere

months after the October 1929 stock market crash amidst the onset of the Great Depression:

When the accumulation of wealth is no longer of high social importance, there will be great

changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral

principles which have hag-ridden us for two hundred years, by which we have exalted some of the

most distasteful of human qualities into the position of the highest virtues. We shall be able to

afford to dare to assess the money-motive at its true value. The love of money as a possession

as distinguished from the love of money as a means to the enjoyments and realities of life will

be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-

pathological propensities which one hands over with a shudder to the specialists in mental

disease ... But beware! The time for all this is not yet. For at least another hundred years we must

pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is

not. Avarice and usury and precaution must be our gods for a little longer still. For only they can

lead us out of the tunnel of economic necessity into daylight. 4

3The Economic Consequences of the Peace; (1919); Chapter VI, pg.235-236.

4"The Future", Essays in Persuasion (1931) Ch. 5, JMK, CW, IX, pp.329 - 331, Economic Possibilities for our

Grandchildren (1930); as quoted in "Keynes and the Ethics of Capitalism" by Robert Skidelsy.


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Keynes diametrically diverging opinions in the space of ten or so years is reminiscent of Alan

Greenspans, who in 1966 authored a Libertarian screed that to this day is one of the most eloquent

cases for maintaining the gold standard.5

Of course, as Fed Chairman, he seemed to stretch unreserved

fiat credit money to its limit (before Chairman Bernanke went even further).

Modern economists may think of such transformations as growth from principled positions based on

natural economic function to more practical macroeconomic problem solving. In fact, as we have noted

in the past, this practical political economic mindset dominates current thinking and policy.

But here is where modern political economic theory will fail (listen up Misters Goolsbee and Krugman).

The issue is not one of principle; it is one of perceived fairness. Politics will follow perceived fairness and

so political economics will be dragged with it too just as Misters Keynes and Greenspan were. Indeed,

Lord Keynes knew and was happy to elucidate the great difference separating what was useful and what

was fair (we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful

and fair is not). He knew in 1930 that fairness and the perception of it were two very different things.

Our purpose here is not to directly debate morality or fairness but to focus on the near-term

sustainability of avarice and usury as Keynes said lets call it the focus on money, per se as centralto economic functioning. Should Keynes at least another hundred years projection in 1930 be seen as

a scientific reality, implying there is no need to begin worrying until 2030? Or, should we heed his advice

in general terms, knowing he was partial to dramatic pronouncements, and consider his prediction in

light of the inevitability it implies in relation to current events?

The point is this: periodically there is a need to change the system, if only for changes sake, because

there comes a need for the masses to believe truly believe that change equals more fairness. The

answer is not in which direction it changes, only that indeed it changes.

In Macro Polo last month we sought to make a general case for the inevitability of monetary system

devaluation. Were he alive and active today we believe Lord Keynes would also argue for the sameinevitable solution he knew was necessary in the 1930s administered currency devaluation. Why? Not

only is devaluation necessary and already underway in the marketplace, thereby giving it a sense of

inevitability, but its proclamation would legitimize its public claim on fairness.

We think JMK would say it is time to devalue and reconcile accounts and he would use the same

arguments today that he used in 1930 for government intervention.

Policy Administered Gold Monetization

Currency devaluation may be achieved through rotating currency interventions by treasury ministries

and central banks or through a one-time coordinated asset monetization. (Current debt monetization in

the form of QE is NOT asset buying. To the contrary, it is central bank credit extension.) When it comes

to asset monetization, gold rather than corporate shares, real estate or consumable commodities is

clearly the most established, convenient and socially acceptable medium for fiscal agents and monetary

authorities to endorse. Why? First, gold is equity already held on official balance sheets treasury

ministries and/or central banks. Second, the purchase of gold through a currency devaluation process

would not necessarily be an unfair confiscation of popular wealth, which is critical in democracies where

governments and their agents are not supposed to take ownership of private property.

5The Objectivist; Gold and Economic Freedom; Alan Greenspan; 1966


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Through policy-administered currency devaluation, fiscal agents and monetary authorities would bid for

gold in terms of their currencies. Imagine the following pronouncement, if you will:

Today, the Federal Reserve System announces a program of gold monetization in which the Fed

offers to tender for any and all gold in qualifying forms at a price of US $20,000 per troy ounce.

The program will be conducted through participating U.S. chartered banks, which will be

instructed to properly assay gold and exchange it for U.S. dollars to be placed in customer bank

accounts as deposits. Deposit holders will be entitled to make withdrawals in the form of dollars

or gold at the fixed exchange rate.

By establishing the fixed exchange rate substantially above past market prices for spot gold, the

Board of Governors believes enough gold will be tendered to produce a supply of new base

money sufficient to adequately reserve the stock of U.S. dollar-denominated deposits in the

global banking system. The Fed will monitor the tender process to ensure the soundness of the

exchange rate and the ongoing viability of the US dollar.

Done. The trillions in net unreserved bank obligations, including those appearing and not appearing on

bank balance sheets, would be fully reserved. Banks would be healthier than ever and ready to lend. Thedebt on the balance sheets of businesses, homeowners, consumers, college graduates and car owners

would still be there but would pale next to their new incomes, which would multiply more or less by the

same amount as the currency devaluation. Tax receipts would multiply in kind without raising marginal

income tax rates swiftly closing budget deficits without cutting spending (seriously). With coordinated

and administered monetary devaluation all balance sheets would once again be leverage-able. The

global economy would be almost immediately ready to grow. It would be economically stimulative.

We think administered currency devaluation must and will occur, as it is already occurring less formally.

Banks and central banks would endorse it; their profitability would soar as lending soars and interest

rates would remain low and stable. Politicians would happily champion it, as it would seem to the

majority of the indebted and increasingly under-employed electorate to be a windfall solution.

Okay Smarty-Pants, When?

765...

The Play

We think there are two almost riskless investment schemes to consider presently for levered portfolio

managers that cocktail with central bankers and fiscal agents:

1) Mismatched duration carry trades (requires the knowledge that short term funding will neverexceed the yield on portfolio longs)

2) FX cross rate positions (requires knowledge related to intervention timing and targets)And there are two general investment areas to consider for the great unwashed investment class:

1) Long stocks/housing and other beneficiaries of leverage (only for those that think the globaleconomy can lever more from current levels)

2) Long precious metals (if one does not think the global economy can lever more).


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We think there is one play unlevered investors should avoid unambiguously:

1) Long cash and/or bonds as a secular holding.Our overwhelming preference for precious metals and consumable inelastic resources stems from our

view that the global economy is not yet in the process of de-levering (leverage is merely shifting), but

that the markets will soon understand that it must de-lever soon through highly inflationary gold

monetization. We believe such a portfolio is the least risky, best risk-adjusted portfolio construction in

the current environment because:

the general performance of financial asset markets has become contingent upon maintaininglow nominal (and negative real) global interest rates

interest rates can be maintained at current levels only by growing central bank balance sheets the pricing of precious metals, precious metal miners, and consumable resource producers are

significantly more undervalued within this context.

We think the table is set for certain precious metal mining stocks to begin outperforming most all other

instruments in 2013. Not only have they been thoroughly discarded by investors over the last two years

in spite of what we believe is a building perfect storm to send them much higher, but; 1) they have

streamlined their resource targets and fortified their balance sheets; 2) marginal US capital gains tax

rates were set in January at lower-than-collectible tax rates (including bullion and ETFs); and 3) it seems

the worlds most sophisticated investors have already begun taking a decent slug of their market caps.

The fundamentals of their underlying product could not be better. Central banks cannot stop growing

their balance sheets via debt monetization because higher nominal rates would force governments into

bankruptcy and would kill the banking system before it is better reserved. The cost of this ongoing

bailout is the slow death of un-levered savers and fixed income investors in real terms.

Through negative real rates, bond holders are effectively being cordially invited to sell their bonds to

central banks, and to place the proceeds into equity in the form of corporate shares and real estate.

Meanwhile, savers are being given the clear message to convert their cash from Dollars, Euros, Yen, etc.

to precious metals. We think that what will eventually (or soon) occur will be the rare occasion when

return-on-savings trounces return-on-investment, implying precious metals will outperform the great

majority of financial assets (except for shares in precious metals miners and natural resource producers .

As the song goes: you gotta know when to hold em; know when to fold em; know when to walk away

and know when to run. Most investors, by definition, will hold em. Wealth has already flowed from the

great majority holding unreserved paper claims to those that helped them leverage their balance sheets

in return for fees. Bonds at current valuations are certainly not safe-havens, nor are the great majority

of stocks the new gold. Looking forward, we think windfall profits real profits adjusted for necessary

currency devaluation will flow to savers of scarce treasure and ownership shares in it.

Kind regards,

Lee Quaintance & Paul Brodsky

pbrodsky.qbamco.com
http://www.qbamco.com/http://www.qbamco.com/http://www.qbamco.com/


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FOR INFORMATIONAL PURPOSES ONLY

THIS MATERIAL IS NOT AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO PURCHASE

SECURITIES OF ANY KIND.

THIS REPORT MAY CONTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF

THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD-LOOKING

STATEMENTS INVOLVE INHERENT RISKS AND UNCERTAINTIES, AND WE MIGHT NOT BE ABLE

TO ACHIEVE THE PREDICTIONS, FORECASTS, PROJECTIONS AND OTHER OUTCOMES WE MAY

DESCRIBE OR IMPLY. A NUMBER OF IMPORTANT FACTORS COULD CAUSE RESULTS TO DIFFER

MATERIALLY FROM THE PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS

WE EXPRESS IN THESE FORWARD-LOOKING STATEMENTS. WE DO NOT INTEND TO UPDATE

THESE FORWARD-LOOKING STATEMENTS EXCEPT AS MAY BE REQUIRED BY APPLICABLE

LAWS.

NO PART OF THIS DOCUMENT MAY BE REPRODUCED IN ANY WAY WITHOUT THE PRIOR

WRITTEN CONSENT OF QB ASSET MANAGEMENT COMPANY LLC.

QBAMCO - Locked & Loaded

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