PIMCO, GOLD BULL?

2016-04-22 2pm EDT  |  #gold #PIMCO #Harley Bassman #Fed

Have you ever heard of Harley Bassman? It’s not like he is a household name, and I must admit that prior to yesterday, I had never heard of him. Harley is a Portfolio Manager at PIMCO. Maybe he is the Bill Gross’ replacement, I am not sure. But he is already miles ahead of Bill in my books.

Before I tell you why, let’s have a look at Harley’s resume:

Prior to joining PIMCO in 2014, he was a senior member of Credit Suisse’s global rates business. Prior to that, he was with Merrill Lynch for 26 years in a variety of senior roles, including creating, marketing and trading a wide range of derivative and structured products. Mr. Bassman helped create the trademarked OPOSSMS and PRESERV mortgage risk management products and helped design the MOVE Index, the benchmark interest rate volatility gauge.

I can’t help but like someone who helped create the benchmark government bond volatility index. Think about the MOVE as the VIX for bond geeks.

Apart from his interesting past experience, it’s the recent PIMCO research piece Harley penned that has me wagging my tail like a dog greeting his owner. If you haven’t read it, I suggest you go read it immediately. The article is titled Rumpelstiltskin at the Fed. The article’s synopsis really says it all:

Though it seems incredibly farfetched, a massive Fed gold purchase program could echo a Depression-era effort that effectively boosted the U.S. economy.

Harley goes through the argument of why the Federal Reserve should consider monetizing their balance sheet against gold as opposed to financial assets. At the crux of his argument is that traditional quantitative easing stays largely confined within the financial system and therefore does not alter individuals’ inflation expectations. A Central Bank’s gold purchase directly affects inflation expectations.

Harley has taken former PIMCO portfolio manager Paul McCulley’s argument that in this era of balance sheet constrained economies, a Central Bank needs to be “responsibly irresponsible” to the next level.

I have been pounding the drum on the absurdity of the popular idea Central Banks are powerless to create inflation. It is all a question of commitment. And Harley makes this point:

In coda I would respond to the argument that a central bank cannot willfully create inflation I disagree; it just depends upon how hard one tries. There are plenty of examples ranging from Weimar Germany to Zimbabwe where central banks have unleashed uncontrolled hyperinflations.

I fully agree, and find Harley’s next caveat the true question investors need to ask themselves:

The more interesting question is not whether the Fed can create a 15% to 20% price spiral, but rather can they implement policies that will result in a somewhat gentle and controlled 2% to 3% inflation rate that will slowly deleverage the U.S. debt load while simultaneously increasing middle class nominal wages.


The IMPORTANT PART

Many of you are probably shaking your heads wondering why this article is a big deal. After all, doesn’t this sound an awful lot like Jim Rickards’ (The Death of Money author and our favourite shamwow salesperson) premise? And the answer is yes, it sounds almost exactly like Rickards’ argument.

The big deal is that Rickards didn’t write it. Whether you like Rickards or not, he is generally dismissed as a gold crank (I would argue his shameless plugging of his books on late night TV doesn’t help and I wish he would stop, as I kind of like the guy).

The idea of the Federal Reserve monetizing their balance sheet against gold has so far stayed within the gold bug community. But suddenly the idea has jumped out of its cage! This isn’t Schiff, Rickards or Sprott arguing the Fed should think about buying gold. This is PIMCO! They are a huge traditional money manager.

The fact that staid money managers such as PIMCO are starting to think about the possibility of the Federal Reserve buying gold has the potential to dramatically change the gold price. Regardless of whether the Fed will realistically ever buy gold, the simple fact is that if money managers consider it a possibility, the managers will buy some gold. If you think there is a 0 in 100 chance of an event occurring, it is easy to own none of the asset. But if you change that to 1 or even 2 in a 100 chance, then all of a sudden it makes sense to buy a little gold.

Late last year in the depths of the precious metal despair, Grant Williams gave a presentation titled “Nobody Cares”. It was a brilliant piece of work, and I am going to shameless steal a slide. According to Grant, pension funds have 0.15% of their assets allocated to gold and another 0.15% in gold stocks. That’s a tiny portion of their assets and largely reflects their view that gold is nothing more than a ‘pet rock.’ But what if they doubled this? It’s not like that is an outlandish view given their minuscule weighting. A doubling of their allocation would result in $100 billion of buying. What does $100 billion do to the gold market? Grant created this great slide that shows all the gold assets you could buy for that amount:

That’s right. $100 billion buys all the stocks in the XAU index, all the outstanding GLD shares, and then to top it off, the entire GDX and GDXJ floats! And that’s only with pension funds taking their weightings from 0.15% to 0.30% respectively. It is easy to argue that 1% would not be unreasonable by any means. And that’s only pension funds! What about sovereign wealth funds, individuals and all the other savers?


Will we look back at PIMCO’s article and say that was the start?

I can’t stress enough the game changing nature of this PIMCO article. It represents a monster shot across the bow of previous thinking.

I have long complained about the insanity of the world’s Central Banks monetizing their balance sheets against equities and other financial risk assets. The Swiss National Bank buying Apple and all the other US stocks is completely asinine. Central Banks should not be in the business of affecting specific asset classes, or even specific stocks in the case of the SNB. They should be shoving money into the system and letting the market sort it out. Yeah, I know, they are running out of traditional fixed income assets to buy, so they are forced to venture out the risk curve. But isn’t Harley’s idea of buying gold worth a shot? So far with the current programs, all the Central Banks have managed to do is widen the inequality gap and stuff the banking system full of inert excess reserves. Even if the Central Banks decided to buy a little gold alongside all of their other purchases, it might have a profound effect.

A couple of years ago Harley would have never dreamed of writing this piece. Even now, he knows he is treading dangerously close to the crackpot line:

So in the context of today’s paralyzed political-fiscal landscape and a hyperventilated election process, how silly is it to suggest the Fed emulate a past success by making a public offer to purchase a significantly large quantity of gold bullion at a substantially greater price than today’s free-market level, perhaps $5,000 an ounce? It would be operationally simple as holders could transact directly at regional Federal offices or via authorized precious metal assayers.

Admittedly, this suggestion is almost too outrageous to post under the PIMCO logo, but NIRP surely would have elicited a similar reaction a decade ago. But upon reflection, it could be an elegant solution since it flips the boxes on a foreign currency “prisoner’s dilemma” (more on this below). Most critically, a massive gold purchase has the potential to significantly boost inflationary expectations, both domestic and foreign.

But he still wrote it. And this is a big deal.

Changes don’t happen overnight. The evolution from crackpot early adopter to mainstream conventional thinking takes a while to play out. This is such an exciting time for gold because it is about to enter the next stage. Harley just led the charge…


One quibble

Harley threw out the idea of the Federal Reserve buying gold, but I doubt the Fed will be the first Central Bank to broach this taboo subject. I suspect another Central Bank such as the BoJ, PBoC or SNB will be the first to openly add gold to their QE purchases.

Yet any single Central Bank buying gold would create imbalances in the currency market that would force other countries to counter. A much more stable way of monetizing gold would be for the IMF to buy it. Whether all the countries can come together enough to agree to this is another matter, but this would be easiest way to accomplish the monetization.

The specifics of any possible gold monetization are irrelevant. Right now all you need to know is that smart guys are starting to buy it. This is not some $50 up move you should ride. This is the start of a secular move higher in gold. Harley Bassman just ushered in the new era.

Thanks for reading and have a great weekend,
Kevin Muir
the MacroTourist