First They Came For The Socialists...

Over the past few months, there were two developments especially relevant to the TBR strategy. You may have seen them and noted their import but, if not, here are a few quick observations:

Late last year was reported that the Bank of England had refused to return $550M of gold reserves that the Venezuelan government had been storing at the BofE. The reasons given for the refusal were anti money laundering questions and concerns that Venezuela's officials would steal the gold. Such reasons ring hollow when applied to a sovereign; this is an outright refusal of a government-controlled custodial bank to honor a contract with a sovereign customer whose policies the custodian's government and its allies actively oppose. So much for the rule of law, although I expect that most people do not care for the Venezuela's socialist regime and feel that this situation has nothing to do with them or their rights. Unfortunately, it does. 

The subject line of this email came from a poem by pastor Martin Niemoller about the complacency of the German intellectuals during the 1930s:   

First they came for the socialists, and I did not speak out—
     Because I was not a socialist.
Then they came for the trade unionists, and I did not speak out—
     Because I was not a trade unionist.
Then they came for the Jews, and I did not speak out—
     Because I was not a Jew.
Then they came for me—and there was no one left to speak for me.

This is not to compare the current situation to the rise of Nazism but to point out that whenever the rule of law has been set aside to address "special situations," no one's civil and property rights have remained secure. 

Closer to home, recently, John Bolton, the US National Security Advisor, made public remarks about the risks of our debt position: “It is a fact that when your national debt gets to the level ours is, that it constitutes an economic threat to the society,” Bolton said. “And that kind of threat ultimately has a national security consequence for it.”  Mr. Bolton merely gave official voice to the obvious - our untenable debts are a threat the USD's reserve currency status and, by extension, threaten the US ability to project power and maintain geopolitical hegemony.  

Whatever one thinks of John Bolton, his current job is to advise the US President on national security threats and the tools available to deal with them. Among such tools is the IEEPA (International Economic Emergency Powers Act). If one is not familiar with this law, now is a good time to learn about it. In brief, IEEPA gives the President virtually dictatorial powers to impose capital controls, prohibit foreign exchange transactions, freeze or confiscate any assets, etc. Here is the text of the law from the US Treasury Department's website. 

IEEPA would be less troubling if it were truly an emergency measure but it is not. There are currently 27(!!!) active IEEPA emergencies, most of which have been in place for over 10 years and some for over 20 years. It is notable that six of the active emergency declarations do not target any specific countries or individuals but cover anyone, regardless of the location, believed to be engaged in terrorism, cyber crimes, transnational criminal activities, weapons of mass destruction, human rights violations, etc. And who designates someone as being subject to this law? The executive branch does, not the courts. Whether or not one is concerned about IEEPA, it pays to consider its impact on the ability to protect one's assets during a sovereign debt or a currency crisis, both of which accompanied the end of every previous debt super cycle.  

The last GFC was managed by the fiscal authorities but John Bolton's remarks suggest that the next crisis may be handled as a national security emergency. If so, the implications would be momentous. We have been warned.  

To conclude, these developments validate our core principle that systemic risks cannot be insured within the system. This is why we work hard to maintain relationships with multiple global counter parties, never rely on the banks or the government-owned mints, and diversify reserve holdings across the jurisdictions that offer geopolitical diversity. 

All we know are the facts...

By: Simon Mikhailovich

Americans of a certain age would recognize the title as a line used by Sgt. Joe Friday of the TV series Dragnet. The competent but humorless Sgt. Friday eschewed idle speculation and always demanded that witnesses stick to the facts. Focusing on the facts rather than speculation is sound advice in the era of "talking head" experts and sophisticated models that have been consistently wrong when it mattered most. They all failed to foresee the .com bust of 2000, the securitization bust of 2008 and, most recently, the outcome of the US Presidential election.  

Up until the evening of November 8, the world was certain that Hillary Clinton would be the next US President. This certainty was lauded by the media and was backed up by the multi-million dollar polling organizations and their fancy models all of which gave Hillary Clinton near 100% odds of beating Donald Trump. And yet, the press, the experts and the models were all proven to have been 100% wrong!  

Similarly, until 8:00 pm of the same day, November 8th, 1.3 billion Indians were 100% certain that their Rupee notes were cold hard cash. Then, at 8:01 pm they were proved 100% wrong as Prime Minister Narendra Modi appeared on TV to announce immediate "demonetization" of the 86% of all Rupee notes in circulation. Mr. Modi said that this way, cash held by the "anti-social elements would just become a worthless piece of paper." He also announced temporary closure of all banks and ATMs and tight limits on cash withdrawals after the reopening. There was also this: those depositing over $3,700 worth of old notes could face questions and a tax audit, i.e. the burden to prove innocence would be on them.

Both developments were met with shock and dismay but neither outcome should have been a surprise. I am not suggesting that the outcomes were easy to predict but that both were realistic possibilities in light of the well-known facts. 

For example, Mr. Trump, an unconventional candidate, had persistently defied expert forecasts by beating 16(!) conventional politicians to win the Republican nomination, despite the strong opposition from his party's establishment. Ms. Clinton, a conventional politician, had full support of her party's establishment but faced a meaningful challenge from Bernie Sanders, an unconventional politician, whose appeal also defied expert forecasts. Based on these facts alone, Trump's victory should not have been a shock, except to those who had not been paying attention. 

The same was true about the Indian war on cash. Mr. Modi came to power promising a fight against corruption and "black cash." Although no one could have predicted when or how he might start that fight, it was reasonable to expect some action. Anyone who had paid attention to Mr. Modi's priorities should not have been caught unprepared. 

What insights are to be gleaned from these unexpected, yet highly consequential events? There are many but the most useful ones are these two:

  1. No one knows the future; the experts least of all.
  2. Ignoring the facts does not mean they do not exist or that they will not have significant consequences.

How does this apply to today's situation? Same as always - all we know are the facts. As the stock market's post-election euphoria induces another round of complacency, here are a few relevant facts, whose implications are worth pondering:

  • The outcome of the election has not changed the deficits or the level of debts.  These were serious problems before the election, and they have not gone away.

  • No one knows whether Mr. Trump's policies will produce enough growth to overcome excessive debts; we do know that more spending and more debt must come first.

  • Since 2007, Federal debt rose from $9T to 19.6T whilst the average interest rate of this debt declined from ~5% to ~2%, keeping the interest costs flat as the debts rose.   

  • A bit of math: if interest costs reverted to the pre-crisis levels, federal interest expenses would go from ~10% of the budget to ~25%, assuming no new debt. Ruinous.

  • Bond yields have been rising since the election. If they continue, the US ability to keep borrowing without limits, which has not be a problem, could very quickly become one.

  • No one knows whether unfunded entitlements will be a big problem but many US pension plans are already in deep trouble; Dallas and Illinois are but two examples. 

  • The rise of populist/nationalist politics and the souring social mood are symptoms of polarization and of the economic disequilibrium, which themselves pose risks.

  • The war on cash is a global phenomenon with growing support in the US, Australia, Sweden, etc. India just put 18% of the world's population under financial martial law overnight. 

These are but a few facts and even if they can be interpreted in different ways, the risk of bad outcomes is material. The same experts and economists who missed the last two crises now argue that systemic risks are not material and will be resolved without adverse consequences. This has been conventional wisdom and is the bet that the vast majority of investors continue to make by holding the bulk of their wealth in financial assets and levered real estate. The bet may be right but it might be wrong, which is why prudent people ought to consider whether they can afford for it to be wrong. 

Which brings us to physical gold - the only liquid hard asset and a store of value that is no one's obligation, does not rely on financial institutions or markets and that governments can not devalue or render worthless, no matter how hard they might try. In fact, the US government did try to devalue gold against the dollar 45 years ago. When Richard Nixon demonetized gold in 1971, experts had predicted that without its official monetary role, gold would trade as a pure commodity and its dollar value would collapse to a fraction of the $35 pre-demonetization price. Experts got it wrong and it was the dollar that has suffered a massive devaluation. At today's gold price of $1,180, the 1971 dollar has lost over 97% of its value in gold terms. 

Those who would rather not take a chance of being "shocked and dismayed" should the experts and conventional wisdom get proved wrong yet again, ought to put in place a sensible Plan B, while it is still possible to do so. Any such plan should include an allocation to physical gold held across diversified jurisdictions and without reliance on financial institutions and markets. 



By: Simon Mikhailovich

A committed landlubber until ten years ago, I took a few sailing lessons on a dare and unexpectedly discovered the joys of sailing. When a friend later asked if I would stand in for a crew member on his 18' catboat during a Saturday race, I eagerly agreed, although his sturdy but slow boat didn't look much like a racer.  It turned out that being slow was not a problem in "one design" racing, just as it isn't in today's investment business.  When one competes within the same class, it is through relative, rather than absolute, performance that one wins a trophy. It also turned out that much like investing, sailboat racing is as exciting as it is challenging. I got hooked and started racing my own sturdy and slow catboat, while learning as much about life, teamwork and investing as sailing. 

This past Saturday, for example, we all drifted around the course hoping for a breeze. Indeed, the wind soon filled the sails, lifted spirits, and the boats started to move nicely... or so it seemed. After sailing briskly for about 15 minutes, we looked at the shore and realized we had been moving backwards! It happened because the prevailing tide was setting us back, even as our senses, the boat's wake and its speedometer were all indicating forward movement. This episode was nature's reminder that apparent progress should be never confused with making headway.  

This is why for 5,000 years, a mariner needed a clear view of the skies to gauge his true position. Without the stars as fixed reference markers, there was no way to know one's location. Similarly, for the past 5,000 years, market-set interest rates (the cost of scarce capital) and money anchored to tangible value have been financial stars that have guided capital allocation and served as a basis for setting asset values.

Today, reliance on the self-referencing economic models, epic debts, digital money printing and negligible to negative rates, have combined to blanket investors in the impenetrable fog from which no reference markers are visible. Having long forgotten how to navigate without models, investors and regulators are mesmerized by the virtual reality of computer-driven markets, where asset prices (including gold's) are based on manipulated rates and measured on a USD speedometer that conflates apparent, i.e. nominal, gains with the accretion of lasting purchasing power.  

Recently, the U.S. Navy showed that it had a lot better sense than the U.S. financial regulators. Instead of waiting for a GPS cyber attack or malfunction to imperil its fleets, the Navy, after a 20 year hiatus, has reinstated mandatory celestial navigation training for all officer candidates. As Lt. Cmdr. R. Rogers of the U.S. Naval Academy explained: "We went away from celestial navigation because computers are great. The problem is, there's no back up." 

As accurate as GPS is, economic and financial models keep proving to be anything but. Despite the Fed's perennial forecasts of imminent recovery and higher rates, neither have materialized. Yields continue to decline and the debts continue to increase. Global debts are up 40% since 2007 to stand at $200T; there are still ~$660T in derivatives; and the utterly inane $13T (and growing) in negatively-yielding debts defy history and common sense. To top it all off, unable to lift rates without crashing the markets, all major central banks keep taking turns at the digital printing presses.

Despite the present and clear dangers, the markets and the global financial system continue to navigate by the rigged markers and operate without any back ups. As stocks and bonds and the USD keep hitting all time or near all time highs, complacency rules. Neither the regulators nor the investors want to question whether the profits are real or merely apparent. My own answer was unexpectedly reinforced last Saturday afternoon - apparent returns won't fund your retirement any more than sailing against a faster current will get you where you want to go. 

Until the monetary fog lifts and un-rigged navigational markers re-emerge, physical gold remains the only hard reference point capable of providing an essential back up plan for one's nest egg.  After all, just as the Navy took protective measures after realizing that no one can hack a sextant, investors should realize that no matter how many fiat dollars get printed, no one can print gold bars. The time to take protective measures is before they are needed. Now is that time.  


Central Banks Are Trapped by the Math

By: Simon Mikhailovich

Last week the Fed intimated that it may raise rates in June after all. Then again, maybe it won't. If anyone still wonders why policymakers keep acting as indecisive adolescents, the answer lies in the basic financial math - when rates go up, asset prices go down and debt service costs rise. It is as simple as that. 

Having inflated asset prices by taking rates into the zero or even negative territory, all Central Banks have become trapped - raising rates could trigger a global market crash but, at the same time, keeping rates at the current levels is ruining pension funds and insurance companies that need meaningful investment income to meet obligations. 

This may sound like an oversimplifcation but it is not. The problem with NIRP and ZIRP boils down to the Discounted Cash Flow model, which is used by investors to value all financial assets and income producing real estate. The model relies on the Present Value calculation to determine how much future cash flows are worth today. For any given amount of future cash, current market value rises when the discount rate declines and declines when the discount rate rises.

Holders of financial assets had a great run riding the 35-year wave of declining rates and rising asset values. The return trip won't be nearly as much fun.

In the absence of growth, profits are not going up and higher rates inevitably mean lower prices. It gets worse - the nature of financial math is such that low rates increase sensitivity of asset prices to rate changes. For example, equity prices reflect the fact that a stock is a claim on a perpetual stream of future profits. The way math works is that whenever discount rate doubles, Present Value of a perpetual cash flow stream halves. In plain English, if rates doubled, which is not far fetched from the current absurdly low levels and everything else remained the same, stock prices would decline by 50% just because of the higher rates. If rates normalized and profits declined, stocks would drop even more and this is without considering leverage. 

Bonds are in the same boat - because the rates are lower than ever, bonds' sensitivity to rising rates is higher than ever. Unlike stocks, however, bonds cannot increase profits or invent a new product. Their prices are based on fixed coupons and the time left to maturity. For example, in 2006, before the crisis started, 10 year treasuries yielded about 5% vs the current yield of 1.65%. Return to the pre-crisis yield would mean a market value decline of close to 30% and we are talking about US Treasury bonds - the supposedly risk free asset! 

Finally, there are epic debts and the cost of servicing them. If the last crisis was about too much debt, the next one will be about too too much of it. Since 2007, global debts are up by $60 trillion, a 42% increase. With global debts now at $200 trillion, every 1% increase in rates would increase annual debt service by $2 trillion. If these numbers feel too big to comprehend, it is because they are.  To put $1 trillion in perspective, if one set out to spend it at a rate of $1 million per day, it would take... 2,700 years. 

If all of this is so clear and simple, why aren't investors panicking and heading for the hills?  A number of reasons.  Fed's promises to keep rates low plus 35 years of declining rates have taught investors that fighting the Fed is not a profitable idea. Also, the unnaturally low rates have been so low for so long that unnatural has started to feel natural.  And finally, there is the explanation from the former Citigroup CEO who when asked in 2007 how could Citi keep doing business that made no sense famously replied that one had to get up and keep dancing so long as the music played. 

Last night, Nathan Smith, a friend from down under, sent me a quote by a writer Steve Lagavulin that sums it all up rather nicely:

"When nothing happens for a long time, people begin to assume that nothing ever happens. But something always happens in the end."


A Golden Fairy Tale From PIMCO

By: Simon Mikhailovich

A long time friend and a TBR partner shared a PIMCO note provocatively titled "Rumpelstiltskin at the Fed". For those who do not remember the tale of Rumpelstiltskin, its eponymous character possessed an ability to spin straw into gold. 

The note is quite remarkable coming from a prominent mainstream asset management firm. It explains that gold is not an asset but an alternative currency and examines the impact and lessons of the 1934 dollar devaluation, which lifted gold price by 70% and caused moderate inflation. The author goes on to suggest that by launching a gold purchase program at, say, $5,000 per ounce, the Fed may achieve its inflation targets, as it did in the 1930s, without resorting to the politically untenable "helicopter money" strategy. 

Whether or not this idea has any legs, mere fact that PIMCO is voicing it is nothing short of remarkable. Re-emergence of gold as a monetary asset and as a mainstream portfolio holding may seem improbable to most Western investors. However, the author points out that negative rates (I would add the bailouts and money printing), were all quite unimaginable mere 10 years ago. 

My main take away from this piece is that gold's monetary role and its potential return to the forefront are starting to make way back into the mainstream institutional discourse, which is a development worth watching. 

To read the PIMCO note please follow this link: "Rumpelstiltskin at the Fed".


By now, everyone has heard about the "Panama Papers"  - a leak that exposed dealings of numerous public and private figures from around the world. The revelations came after someone, as yet unknown, delivered to the press 11.5 mm documents that were taken from the confidential database of a large Panamanian law firm. As you can see on the chart below, cyber leaks have been getting progressively larger with the Panama leak being by far the largest document leak in history.

We wanted to share a few observations about this incident hat I thought were directly relevant to the TBR strategy:

  • The leak resulted in an indiscriminate release of private records, both criminal and legitimate. Cyber attacks do not parse out innocent bystanders, which puts a high value on choosing where and with whom to place one’s assets.  

  • Criminals deserved to be exposed but not those who sought legitimate privacy. Nevertheless, not only will the innocent need to prove the legality of their dealings, they may also be called to document their sources of funds, which is neither easy nor inexpensive to do. 

  • Digitization has created new risks that require new thinking. Mass document leaks used to be impossible because of the physical limitations. For example, assuming 3 pages per document, 11.5 mm documents would take 12 years' worth of man-hours to photograph and would require 60,000 reams of paper to print. At 5 lbs per ream, the Panama Papers would weigh 140 tons - as much as two Boeing 737s! What used to be impossible has become easy. 

The attack and its immediate aftermath offer four clear lessons:

  • Digital media are acutely vulnerable to catastrophic cyber attacks. With all of the records, bank deposits and securities having been converted into digital form, the importance of managing cyber risks cannot be overestimated. 

  • Digital cash and securities are just as vulnerable as digital records. Only last month, hackers stole $100mm from the New York Fed account of the Bangladeshi government. It was done remotely and without the need to storm the physically impregnable fortress that houses the New York Fed. The money is still missing.

NY Fed building in lower Manhattan

NY Fed building in lower Manhattan

  • Whilst real assets offer effective diversification since they can be neither hacked nor easily stolen, most real assets are not readily liquid. Physical gold is the only real asset that is universally liquid, practical to own without exposure to financial counterparties and is impervious to cyber risks.  

  • The war on cash -- the hunt of over-indebted governments for additional revenues -- is making previously legitimate geographic diversification and asset protection strategies to be fraught with significant legal and reputational risks. This calls for different thinking and new solutions.

The war on cash, the cyber risks and the pressure on asset protection strategies are set to intensify further. As it is, TBR was designed to protect assets from systemic risks, in anticipation of the very kinds of problems we are already seeing around the world. This latest incident further highlights the value of our unique approach: 

  • Cyber security - TBR based its strategy for preserving liquid purchasing power on physical gold. Unlike the digitized cash, stocks and bonds, gold bars can be neither stolen nor erased electronically.

  • Privacy - As the scrutiny of individual arrangements intensifies, one has more privacy when investing through a legitimate, compliant private vehicle such as TBR than when going it alone.     

  • Property rights - TBR uses a standard Delaware/Cayman private fund structure that is used by thousands of conventional investment funds and countless institutional and HNW investors worldwide. It offers ubiquity, well-defined property rights, fiduciary protections and independence from financial counterparties.

  • Legitimacy – TBR’s structure is regulated by the Cayman Islands Monetary Authority and its domiciles, Delaware and the Cayman Islands, are routinely used by the US businesses and asset managers. Neither jurisdiction is on the Panamanian law firm's list of tax havens. 

  • Global compliance - Employing the asset administration arm of MUFG, the sixth largest global bank, to ensure TBR's global AML and KYC compliance provides strong protection against potential legal challenges and reputational risks.  

  • US compliance – TBR’s structure uniquely allows US taxpayers to ensure full compliance by keeping their TBR interest in the US tax and legal system, while having the bullion stored outside of the financial system and getting the benefit of global diversification. 

Whilst these developments pose significant risks to all investors, we are gratified that our decisions in structuring TBR and in designing its strategy are being validated. 








As the winds of the next crisis are starting to stiffen, the Swiss are rushing to absolve themselves of the responsibility for their overgrown too big to fail (TBTF) banks. Credit Suisse and UBS are being prodded by the regulators to split off the Swiss-only domestic banking from their gargantuan global assets (and liabilities).

The Swiss are still reeling from bowing to the US pressure and ending bank secrecy, which had been the cornerstone of Swiss private banking for over 80 years. This happened, in part, because the two largest Swiss banks, UBS and Credit Suisse, have grown larger than the Swiss GDP, which made these banks not just too big to fail but also too big for the Swiss government to protect or bail out.

Last fall, an obscure Credit Suisse press release described a process whereby the bank would form and float a new separate banking entity that would exclusively service Swiss businesses and individuals. A well informed Swiss source told us today that Credit Suisse was further along in the process but that UBS was working on a similar plan. Our source also mentioned that FINMA (the Swiss regulator) wanted the Swiss-only bank to have 95% of its assets coming from the Swiss ultimate beneficial owners, which would exclude all non-Swiss nationals and all of the Swiss entities owned by the foreign interests.  

What does it all mean? The Swiss have realized that the next crisis is on its way and that they would have no ability to manage the situation should UBS or Credit Suisse were to fail. Their plan is to create an old-fashioned commercial and retail banking system that would serve only Swiss citizens and Swiss-owned companies. This way, when the next crisis triggers another round of TBTF bank failures, the Swiss government would have an option to let their TBTF banks' creditors, shareholders, non-Swiss counter parties and non-Swiss depositors, fend for themselves.  No one ever accused the Swiss of not looking out for Number One!

The Swiss are making contingency plans and prudent investors should do the same. 


Originally published: Feb 29, 2016. Guest(s): John Hathaway Senior Managing Director, Tocqueville Asset Management L.P.
Kitco News speaks with the portfolio manager of the billion dollar Tocqueville gold fund, who says gold is poised to move higher in the longer term. Sitting with Kitco News at Gold Stock Analyst Investor Day, John Hathaway also looked at the correlation between the dollar and the yellow metal. Kitco News, February 29, 2016.

Click to view webpage and video on KITCO site.