The Gold Report: The beginning of 2015 has been volatile for global currencies, not the least of which was the Swiss National Bank removing its cap on the franc versus the euro. What precipitated that and what does it mean for the Swiss franc versus other currencies going forward?
John Mauldin: The Swiss National Bank had already expanded its balance sheet to 80% of GDP to maintain the link and would have had to buy more euros if the joint currency continued to weaken. It would be similar to the U.S. Federal Reserve having a balance sheet of $13 trillion. As late as the week before the big move, the chairman and vice chairman of the Swiss National Bank announced publicly that the peg was a cornerstone and the bank would continue to maintain it. Once it became clear that some very serious quantitative easing (QE) was coming from the European Central Bank (ECB), everything changed.
Now we see that European bond buying could be on the order of €1.1 trillion, which is a relatively serious amount, and it is open ended with €60 billion a month planned until inflation hits 2%. Given all the deflationary pressures in Europe, that could be quite a long time. Consider that Japan has had massive quantitative easing for decades off and on and its nominal GDP is roughly where it was 25 years ago. The country hasn't witnessed anything that looks like inflation, so it's not clear to me that the move by Europe is going to be able to create inflation.
The Swiss National Bank saw this reality and concluded it could be facing another $150 billion in losses and balance sheet expansion. There is only so much pain a central bank can handle. So it walked away from the whole euro mess. And it shocked the markets because Swiss financial leaders didn't want to start warning people and have it leak out. They decided to get over it and deal with getting taken off the Christmas card lists later.
TGR: Is this just the beginning of the financial moves by the Swiss?
JM: Switzerland already lowered key interest rates and has indicated it is willing to do it again. It wouldn't surprise me if we see a 1.5% or 2% negative factor in the future as the country puts a "you are not welcome here" mat out. Basically, it is charging you to hold Swiss francs.
If you're a Russian that makes a lot of sense. You can lose 75 basis points on your Swiss franc or 25–30% on your Russian ruble. Swiss francs are better than euros and dollars aren't available.
Other countries could follow. Denmark lowered its interest rates further into negative territory after the ECB announcement, and then lowered them again the next day. The Danes don't want the krone to become the next currency that everybody piles into. Negative rates have arrived in about six countries now in Europe—negative out into the four-to-five-year bond range. Europe is just upside down. It doesn't make any sense.
TGR: Will the ECB be able to buy bonds at this rate indefinitely?
JM: Sure. The Japanese are doubling down. In an October move dubbed the Halloween Surprise, the Bank of Japan announced its open-ended commitment to quantitative easing until the economy reached 2% inflation and the yen took a big drop against the euro. After the recent QE announcement by the ECB, the euro-to-yen swap rate has gone back to where it was and the yen is even stronger! This is precisely what Germany wants because the country's biggest competition in machine tools, robotics and automation is Japan. This is currency wars. Currency wars are not genteel, friends-and-family squabbles. This could get ugly.
TGR: Are we going to see more collateral damage from the currency wars?
JM: Absolutely. Korea at some point will throw in the towel trying to maintain its currency against the yen. The Chinese are going to have to allow their currency to fall against the dollar, which will send some U.S. senators into a tizzy.
TGR: What about the businesses that trade in currencies? We saw a couple close overnight. Will there be more shockwaves like that for banks that are short the Swiss franc or mortgages denominated in francs?
JM: I'm sure we'll lose a few banks here and there. Banks are always going out of business. We're certainly going to lose a lot of currency brokers. We will lose some hedge funds that were on the wrong side of the trade.
TGR: There have been shockwaves from the freefall of oil prices. That has impacted currencies around the world including the Russian ruble and the Canadian dollar. What could happen if the price of oil stays under $50 a barrel ($50/bbl)?
JM: It wouldn't surprise me if we see $30/bbl before this is over. It is down 60%. That's a pretty significant drop. I don't think oil stays down. The marginal cost of production is probably in the $60/bbl range so my guess is at some point over the next year to year and a half it gets back to that level, but it doesn't rise to $80 or $90/bbl. It's not going to get back up to where a lot of countries would like to see it. I think Saudi Arabia is perfectly fine to sell its oil at $70/bbl and take market share.
TGR: Wouldn't that have political implications in places like Russia and Venezuela?
JM: Sure. And it couldn't happen to a better bunch of terrorists. I'm not particularly worried about how difficult a time they have.
TGR: What about the impact in Canada, where oil is a big export product?
JM: The Canadian dollar lost parity already and leaders there are worried about the country slowing down. That is why the Bank of Canada cut its key interest rate in a surprise move earlier this month. The economy in Canada is getting softer. It is doing exactly what you would think a central bank would do.
TGR: Should we brace for more of these surprise announcements?
JM: Typically central banks don't do something just once. We are starting a cycle of lower rates.
TGR: With all of the problems in Europe and China, what is supporting the dollar and the U.S. stock market climb and talk here of raising interest rates?
JM: Currencies move in long cycles. The dollar was irrationally weak not that long ago. I predicted three years ago, when the dollar was dropping and some were pointing to the Chinese currency as the next reserve currency, that the dollar would remain the strongest currency in the world. People chuckled and shook their heads, but nobody's chuckling or shaking their heads anymore.
The dollar is going to get a great deal stronger. Oil production in the U.S. is part of the rising dollar. We're keeping more of our petrodollars. When oil gets back to the $65/bbl range, you're going to be surprised how much production comes back in the shale oil fields. The cost of taking oil out of the ground is falling every quarter. Lower demand is cutting the price of drill rigs and salaries are getting back to normal. It's going to get cheaper. There are silver linings to the drop in oil prices as opportunities open up. There is a lot more oil out there and at $65/bbl it will be profitable.
TGR: If oil floats between $30/bbl and $70/bbl, can the U.S. stock market continue to go up or is this a bubble and we're waiting for it to pop?
JM: No, it's not a bubble. We don't have ridiculous valuations. We could see a correction just as we see in any move, but not a serious one like 2008 or 2001 until we have another recession. I think the next recession will also be the end of the secular bear market, but you just never know what the markets are going to do. The market will do whatever it can to create the most pain for the most number of people.
TGR: What does all of this mean for gold?
JM: If you're in Japan or Europe, you probably want to be buying gold because it's a bull market in those currencies.
I have never been an investor in gold. I am a buyer and believer in insurance gold. I think you ought to own some gold in your portfolio as central bank insurance. The day will come when the dollar will turn and our central bank will start doing QE again because that's what central banks do. Then we'll have another bull market run and it will get a new resetting for a new valuation. You know what I'll do with my gold? Absolutely nothing. It'll sit there gathering dust.
My point is if I ever use my gold, that's not a good sign for me personally. It either means that something really bad is happening in my life and I need the one thing I can convert to ready cash or the world is going to hell in a handbasket. My great hope is that I give my gold to my great grandkids and they look at me and ask what those shiny coins represent because that would mean the world turned out really well. But I like the insurance just in case it goes the other way.
TGR: What about other commodities?
JM: Other commodities are telling us the world has built up too much capacity and we're in a deflationary world. Nearly all the metals have gone down. Copper is way down. That is an indication of slower global growth for 2015.
TGR: What alternative investments do you like?
JM: My biggest personal winners for the last two years have been my short yen trades. I basically took my mortgage and hedged it in terms of yen with 10-year put options. I have been killing it with that and some funds that are basically short the Japanese government (not Japanese stocks, which I like!)
TGR: When we talked last time you also were excited about biotech stocks.
JM: I am a big believer in biotech. I think we're going to see some biotech stocks just breathtakingly go through the ceiling. Now there will be more that go to zero so you have to be very selective and thoughtful about what you do.
TGR: Any final words of wisdom for our readers, investors who are trying to figure out how to protect themselves with all of these currency wars?
JM: Long-term growth in your portfolio will only come from long-term growth in the global markets. Japan, Europe, China and the emerging markets are all going to have a crisis in the next five years. In the U.S. we will have to figure out in 2016 how we want to structure our country. Debate will center on questions such as: What do our taxes look like? What does our regulatory environment look like? We're going to get to make a decision as a country. It could either be massively bullish or not.
Your core game plan has to be positioning yourself to take advantage of volatility. How can you take advantage of these rolling crises? You want to be able to have a strategy that's going to let you go long and short, move in and out on a rolling basis. You have to be long global growth.
TGR: Thank you for your time.
John Mauldin is an economist and financial writer of the New York Times best-selling books "Bull's Eye Investing," "Just One Thing," and "Endgame." His most recent book is "The Little Book of Bull's Eye Investing." Mauldin's free weekly e-letter, Thoughts from the Frontline, is one of the most widely distributed investment newsletters in the world. Launched in 2000, it was one of the first publications to provide investors with free, unbiased information and guidance.
Mauldin is also the chairman of Mauldin Economics, and president of Millennium Wave Advisors, an investment advisory firm registered with multiple states. As a highly sought-after market pundit, Mauldin is a frequent contributor to publications such as The Financial Times and The Daily Reckoning and is a regular guest on CNBC, Yahoo! Daily Ticker and Breakout, and Bloomberg TV and Radio.
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