The Case for Gold and Silver: Mutual Fund Directors Forum May 2016

The Case for Gold & Silver

Dr. Thomas FranklFounding Manager Phoenix Gold & Silver Fund,

Geneva, Switzerland

‘If something can’t go on forever, it will stop’

(Herbert Stein)

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Contents• Economic Diagnosis• The Effects of NIRP / ZIRP• Fiat Money versus Physical Money• Fractional Gold and Silver Markets• Invalidating the Case for Gold and Silver• Alternative Asset Classes ?• Black Swans • When will the Tide Turn ?• Fund Management and Investment Strategy


Economic Diagnosis• Low interest rates encourage profligacy, excess, waste

and unproductive investments while punishing thrift and saving

• Fractional banking taken to extremes has created a highly unstable global financial system

• Resources are redistributed from savers to borrowers and from future generations to current voters and cronies

• Politicians and central bankers show little willingness to inform the public about the magnitude of the economic problems, the lack of solutions, and the cost of possible corrective actions


Economic Diagnosis, cont’d• The global financial system is still (+/-) functioning, yet the ever-escalating

‘unconventional’ measures by central banks and the unwillingness of governments to implement painful structural reforms has increased systemic instability to a critical level.

• Central banks have neither the means left, nor the credibility to contain the coming financial collapse.

• The collapse will require a reset of the global monetary system, similar to Bretton Woods after WW 2. Those countries that own the most gold will sit at the negotiating table.

• Nobody knows how many more snowflakes it will take to trigger the global financial avalanche.

“We all know what to do, we just don’t know how to get re- elected after we have done it.” (Jean-Claude Juncker, head of the Euro-Group, in July 2014)


The Effect of NIRP / ZIRP• Central banks, namely the Fed, expected a ‘wealth effect’ from

low/zero interest rates (ZIRP): people owning stocks would feel wealthier and consume more

• In reality, the savings rate keeps increasing as incomes stagnate and people feel more and more insecure about the safety of their jobs

• Negative Interest Rate Policies (NIRP) in CH, Denmark, Japan, etc. has led to increasing retail gold sales: – 33 metric tons of gold sold in Japan in 2015 vs. 18 in 2014– Gold bar sales climbed 35% in Q1, 2016

• Gold is the ideal store of value: NIRP has led to a shortage of bank safe deposit boxes: CH-based Cartier, Bulgari, Bucherer boutiques now rent out safe space as bank safes are all rented out


The NIRP Zone


NIR(wana) Bonds ?


The Fed’s ‘Unconventional Policies’ had only a limited, temporary effect


Social Dynamite: Income Inequality


Income Inequality & Wealth Distribution


QE cannot forever prop up markets markets


Money Printing: USA


Money Printing: Japan


Japan: Debt Crisis Looming


China: Debt Crisis Looming


Debt is unsustainable at 5% GDP growth


Fiat Money vs. Physical Money• As paper currencies, USD, EUR, JPY etc. are money

but they are based on faith and trust (‘fiat money’), having no intrinsic value. With trust comes the possibility of betrayal.

• Au & Ag is money (or relative to USD, EUR, JPY, etc. - currency) with an intrinsic value defined in relation to fiat money.

• Like all moneys / currencies, Au and Ag don’t offer any yield; they are therefore not an investment (gold miners are) but a store of value and for some, an insurance.


Fiat Money vs. Physical Money• Au & Ag are the only precious metals available in sufficient

quantity to serve as money.• They are physical money – all other currencies exist almost

entirely (less than 8% for the USD) in electronic form only.• All bank accounts carrying electronic money are themselves

also electronic entries in the accounts of borrowers and lenders – subject to power outages, infrastructure, exchange and trading platform collapses, hackers and online theft (cf. e.g. the almost successful attempt to steal USD 1 bn from a Bangladesh Bank via the New York Fed)

• Bitcoin as an alternative currency is subject to the same risks


Fiat Money Makers vs. Gold Miners• E.g. the Fed: privately owned and supervised by government

– The regional reserve banks making up the Fed are owned by the banks in each region (e.g. Citibank owns stock in the New York Fed)

– Controlled by the Board of Governors, appointed by the US President and confirmed by the US Senate

– Supplier of US electronic fiat currency– US debt of 18 trillion means that in the absence of sufficient GDP

growth Fed must create inflation to pay off or at least sustain debt • Gold and Silver miners: privately owned companies subject to

a large variety of jurisdictions with limited regulation / supervision by governments– Suppliers of the world’s two physical currencies


Five-Year Gold Price


Fractional Gold and Silver Market• Derivatives, e.g. COMEX futures, ETFs, or ‘unallocated’ or

‘eligible’ gold on the COMEX • Fractional market works if conditions are orderly and

people don’t insist on physical delivery• Derivatives > 100 times physical market volume• For every 100 people who think they own gold when a

buying panic begins, only one will own physical gold• Central banks are starting to show nerves: Germany trying

to repatriate their gold from Fed custody ( so far only fractionally successful)

• China (officially 1658 t – probably 3000t), Russia (1400 t), Iran, Turkey etc. accelerating gold purchases



COMEX Gold Deficit


COMEX Silver Deficit


Physical Gold moves to the East• UK sold half its reserves between 1999 and 2002• Canada has sold all its remaining gold in 2016• India imports 1000 t/a (mostly for jewelry)• China (world’s Nr. 1 producer) officially imports

200 t/a – in reality much more• Shanghai (physical) Gold Exchange to take over

from (paper) COMEX, marking the shift of monetary power from global Nr. 1 debtor US to Nr. 1 creditor China


Silver vs. Gold• Silver is physical money destined for daily use (cf.

‘argent’ in French stands for both ‘silver’ and ‘money’, similar in Spanish (‘plata’)

• As the most conductive of all metals its industrial use includes solar panels and electronics

• Very little recycling due to current low prices (and 20 year life of solar cells)


Silver vs. Gold

• Silver production outweighs gold production ca. 10:1• Historic gold-to-silver ratio: ca. 15:1• Current gold-to-silver ratio: ca. 75:1• Due to the low price, there are almost no pure silver

miners left: Ag is mostly a by-product of mostly gold and copper mining, hence supply unlikely to rise strongly on rising demand

• Silver/gold ratio started to normalize in 2016; however, In times of high prices (2011: USD 40), silver scrap increases supply, putting a temporary cap on prices


Events invalidating the case for Gold and Silver

• ‘Lazarus economy’ (S. Das): all skeptics are wrong and everything goes back to (pre-2008) normal

• Governments around the world are taking effective coordinated steps to avoid the collapse of the international monetary system, and to implement structural reforms to enable GDP growth


Economic events that would invalidate the case for Gold and Silver

• Growth in China resumes to >7 % levels• Transportation indices rise over several quarters• Commodity prices (industrial metals & materials)

rise over several quarters• Global debt de-leveraging occurs• Business inventories fall• Corporate bankruptcies fall• EPS (ex-corporate buy-backs) rise


Market events that would (ceteris paribus) temporarily affect the case

• Substantial increase in gold supply – Gold sales by central banks (temporary or no effect, e.g.

recent gold sales by Bank of Canada – absorbed by Bank of China buying); low probability (central banks have been net purchasers for several years now)

– Mining innovation leading to reduction in the cost of extracting gold from (poor) ores; low probability (currently no indications)

– Large investments in production and exploration; low probability (miner capex still close to historic lows as cost reduction, consolidation and deleveraging is No.1 priority).


Alternative Asset Classes to Au/Ag ?

• Government bonds: at historically high levels, can continue to rise risk is to the downside

• US and European stocks: at historically high levels, can continue to rise but risk is to the downside

• EM stocks (e.g. Brazil): stocks are cheap for a reason (commodity prices, political risk) and will be dragged down in a globalized market crash


Alternative Asset Classes to Au/Ag ?

• EM bonds: vulnerable to commodity-price induced rise in interest rates, inflation, currency risk

• Commercial and residential real estate: record high in prime locations due to ‘money chasing assets’ – vulnerable to a rise in record low interest rates and economic crisis

• Agricultural land: good soils with water supply already expensive – illiquid

• Private Equity: vulnerable to a rise in interest rates• Cash: vulnerable to further monetary debasement


The US government and the media keep reporting that the US economy is

improving. Do any of the leading indicators speak for an ongoing or even a beginning economic recovery in the US, and/or other key regions – thus invalidating the investment case for

gold and silver ?


1. Global Air Freight: Stalling


2. Global Air Freight, II: Stalling


3. US Freight Rates: Going slow


4. BDI at historic lows (04/2016)


5. Container Shipping Rates: SinkingNote: the slump in the BDI is partly caused to the current bulk shipping overcapacities – much less the case in container shipping


6. Commodity Prices Falling


7. US Business Inventories: nearing 2008 crisis levels (03/2016)


8. Global Debt Levels: No sighs of relief


9. Corporate Bankruptcies: Rising


10. Low EPS/high P/E


High-Impact Event Risk (‘Black Swans’)• Black Swans: Catastrophic events triggered by events

unforeseen by the experts, but which in hindsight were predictable, e.g. – Cyber attacks paralyzing stock exchanges or other vital financial

institutions – EU Refugee crisis leading to closure of borders, end of Schengen

Zone and possibly break-up of the union– Loss of confidence in central bank ability to steer economies out of

crisis leading to a synchronized loss in confidence in all fiat currencies (‘emperor has no clothes’ event) leading to a flight into safe havens

– Japan interest rates rising to 2 % triggering default– Large US states following Puerto Rico example and defaulting– Greece, Portugal, Spain, Italy, France debt downgrade and default


High-Impact Event Risk (‘Black Swans’), cont’d

– Systemic banks failures: • Italian banks currently carry EUR 360 billion of NPLs: newly

created ‘Atlante fund’ (EUR 4,25 bn) inadequately funded• Deutsche Bank carries EUR 461 trillion of derivatives on its books• Spanish and Portuguese banks on a lifeline

– Chinese banks defaults spreading globally before the Chinese government is able to get the crisis under control (foreign banks have USD 1 Trillion exposure to Chinese banks)

– US Auto loan crisis (NPLs at 20 year high at current 5%) – Geopolitical crisis triggered by accident


Alternative Scenarios• Japanese-style stagnation: low growth, deflation, ever

rising debt levels, zero or negative interest rates, central banks implementing ever less effective measures to prop up stock and bond markets: 70% (2016)– Gradual increase of the price of gold and silver

• Collapse of the international monetary system (gradual or sudden): 30% (2016)– Rapid, exponential rise of gold and silver – Very limited availability of physical retail Au and Ag

• Lazarus economy: < 1%– Gradual fall of gold and silver prices as improving GDP growth

is confirmed by data


When will the Tide Turn ?• The central bankers are unlikely to stop the madness and admit

their errors – they will probably continue to do ‘whatever it takes’ (Mario Draghi)

• Their arsenal of ‘unconventional’ policies is in principle limitless: more and deeper ZIRP, helicopter money, …

• The tide will turn when markets realize that:– Central bank invention does not even produce a marginal effect any more– Inflation has started to rise – Growth will stagnate for a long time

• The latest attempt by the BoJ to devalue the Yen gives a foretaste: currency markets have moved in the opposite direction

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Fund Management and Investment Strategy


Fund Management• Lead Fund Manager Dr. Thomas Frankl

– M.A., Ph.D. (magna cum laude) University of Munich; dissertations on trade and international monetary policies

– Economist with over 20 years of experience investing in infrastructure, commercial real estate, equities, currencies and commodities

– Senior management positions in Fortune 500 companies (Texas Instruments, Intel), the air transport sector (SITA) and the United Nations

– Co-founder and Managing Partner of Geneva-based investment firm Airport Development Partners SA

– Since 1/2015 manager of Phoenix Gold Fund, a customer segregated hedge fund; Performance YTD: +53%

– Professor and Head of Department at International University in Geneva (Strategy, Leadership, Entrepreneurship, Management)

Closed Gold and Silver Fund Proposal TF_DB_2016

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Investment Strategy• Global Macro strategy driven by fundamental

analysis• Risk minimization over returns maximization• No leverage• Technical aspects only (at times) taken into

consideration if indicating extreme market positioning

• Investment into gold and silver and gold and silver miners, with limited and temporary use of ETF’s with the sole intent to protect the portfolio


Asset Allocation1. Gold and Silver:

Prudent use of ETF’s (only if 100% backed by physical metal and convertible into physical metal)– If political climate indicates possibility of extreme

policy measures (confiscation of gold), move into physical gold / storage in secure vaults in Switzerland (non-banks) may be required (strategic allocation decision to be taken by Board)


Asset Allocation2. Investment into gold & silver miners based on the following key criteria:– Operationally diversified across geographies with

low/moderate country risk– Only senior miners (no exploration companies

/juniors) with no/low leverage– Among the 10 miners with the lowest AISC, i.e.

miners remaining profitable at USD 1000/oz. levels, and able to acquire weak competitors

– Top three streaming companies


‘We can only tell what the true strength of the Pound is…by knowing the amount the amount of gold we have behind our currency’ (Col. Smithers in Goldfinger)

Thank You [email protected]

Economy & Finance

The Case for Gold and Silver: Mutual Fund Directors Forum May 2016