TOCQUEVILLE BULLION RESERVE (TBR)
UNDERLYING SYSTEMIC RISK
Just four “mega-banks” now control 69% of total U.S. bank assets, – and the TBTF (Too Big To Fail) concept has expanded to include over-indebted sovereigns like Greece, Spain, Portugal, Cyprus, etc. Similarly, the outstanding volume of derivatives remains at the pre-GFC level. As of June 2013, the Bank for International Settlements reported global outstanding notional amounts of over-the-counter derivatives at $693 trillion, which is almost 10x larger than global GDP.
Instead of fixing structural, economic problems and dealing with excessive leverage and opaque derivatives, governments adopted money printing or "Quantitative Easing" (QE) and “bailouts” as the main policy tools for dealing with private and sovereign TBTFs. “Bailout” is a nautical reference to bailing water from a boat. A sailor on a leaking boat without a bucket may borrow one from a nearby vessel, but if a rogue wave comes along, both boats will sink – one because it already has a hole and the other because it no longer has a bucket.
SHIFTING RESOURCES FROM THE STRONG TO THE WEAK
Financial bailouts increase systemic risk by transferring resources from the strong to the weak and making the entire system susceptible to failure. Bailout policies have numerous other side effects: investors take excessive risks expecting further bailouts, governments take on excessive debts, monetary authorities create excessive liquidity, debase currency and suppress rates to lower debt burdens and inflate the prices of risky assets.
The new macroeconomic paradigm poses other complex and underappreciated risks. The market convention for cash-flow based asset valuation is the discounted cash flow model, (DCF) whose output, the price, is only as good as the quality of the inputs, cash flow and discount rate. Currently, deficits and QE subsidize cash flows, the “risk-free” rate is contrived, risk premiums are artificially suppressed, and the resultant asset prices are grossly distorted. The subprime debacle was the ultimate example of models gone wild. Today’s broad-based reliance on faulty valuation metrics lays the foundation for another painful re-pricing.
4 MEGA BANKS CONTROL 69% OF TOTAL US BANK ASSETS
In 20 years, 37 major financial institutions (liquidity providers) have become 4 TBTFs
A WORLD OF VIRTUAL MONEY
Financialization, intermediation and “virtualization” are other new realities. Impairment used to be associated with the willingness and ability to meet obligations (credit risk). Today, in a world of virtual money and electronic securities held by and titled in the name of financial proxies, cash deposits and entire portfolios can be impaired or frozen for reasons unrelated to the assets themselves (systemic risk).
NEW SECURITIES ACCOUNT RISKS
As we have learned from Refco, Lehman Bros., MF Global, and Cypriot and Swiss banks, securities accounts can be treated like bank deposits and subjected to the same risks. Most investors no longer hold securities in their name, and recent legal precedents highlight that even “segregated” investment accounts can be seized, swept into the bankruptcy estate and subordinated to claims of senior creditors. Investors must recognize that current laws, such as Dodd Frank, materially weaken their claim to pooled assets held by financial intermediaries.
EXCESSIVE BORROWING AND MONEY PRINTING
Structural problems that led to the crisis remain unresolved, but excessive borrowing and unrestrained money printing have lulled investors by creating an illusion of sustainable prosperity. However, the capacity to fund bailouts and subsidies is finite, and as debts grow unabated so do the risks. Still, the vast majority of wealth remains concentrated in the financial system where cash flow-based asset prices are inflated and highly correlated, currency debasement is steadily eroding purchasing power, and depository and custodial arrangements are more vulnerable to catastrophic disruptions than ever before.
GOLD: A VERSATILE HEDGE WITH NO ASYMMETRIC UPSIDE
- Gold has soared during deflation (1930s), inflation (1970s) and systemic instability (2000s).
- Price is levered to confidence – whenever confidence wavers, demand soars and supply dries up.
- Bullion is heavily under-owned in the West; the East is aggressively accumulating.
- Overwhelmingly bearish sentiment creates asymmetry at current levels.
Neither the information, nor any opinion contained in this message constitutes a solicitation or offer by TERA Management and/or Tocqueville Bullion Reserve L.P. or any affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. Any data included in this communication is obtained from sources believed to be reliable but cannot be guaranteed by TERA Management and/or Tocqueville Bullion Reserve L.P. Any opinions expressed herein are those of the TERA Management and/or Tocqueville Bullion Reserve L.P. and cannot be solely relied upon as representations.
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