Fiscal Dominance

Nov132023

Fiscal Dominance – OCM Market Update November 13

Gold Price – What is it telling us?

The gold price has decoupled from its relationship with 10yr Tips (see chart). Higher real rates are not driving gold price movement, though higher real rates are driving gold ETF flows and sentiment toward precious metals equities. Let’s unpack what we believe is going on. Source: Dylan LeClair

Central Bank Gold Bid

Central bank buying of gold is certainly a factor in the gold price not breaking down. Central banks led by China, Russia, Czech Republic, Uzbekistan, Philippines, Singapore, and Qatar all were buyers in Q3. China’s holdings of U.S. Treasuries are trending down, while its gold holdings are increasing, up 204 tons so far in 2023. It added 23 tons in October. The National Bank of Poland (NBP) has stated its “dream” is to get to 20% gold holding in its central bank reserve. The NBP added 58 tons in Q3 to the 48t purchased in Q2. For context, Poland currently holds 334 tons of gold or 11% of its reserves. Central banks may have different agendas for purchasing gold. For countries such as China, Russia, India, and other BRICS countries, it may be setting the stage for an alternative settlement system to the U.S. dollar. For others, it may simply be the stated goal of protecting against purchasing power debasement of the main fiat currencies; US dollar, yen, and euro. Central bank buying affirms gold as a monetary asset. For the Chinese and Russians, they may be trying to follow the “Golden Rule – He who has the gold, makes the rules.”

Connecting the Dots: Higher Interest Rates Fiscally Not Sustainable

There appears to be growing understanding in the market that higher interest rates are not sustainable. As Goldman Sach said in a research note to clients on October 3^rd, “A sharp rise in long-term interest rates combined with widening deficits and heightened fiscal discord in Congress have renewed questions about the sustainability of rising government interest costs.”

Speaking at JP Morgan’s Robin Hood Conference, renowned investor Stanley Druckenmiller stated, “When the debt rolls over, by 2033, interest expense is going to be 4.5% of GDP, if rates are where they are now,” said Druckenmiller. “By 2043, sounds like a long time, but it’s really not; 20 years, interest expense as a percent of GDP will be 7%. That is 144% of all current discretionary spending.”

The Federal Reserve is clearly aware of its circumstances with a paper discussing Fiscal Dominance on its website – “Fiscal dominance refers to the possibility that the accumulation of government debt and continuing deficits can produce increases in inflation that “dominate central bank intentions to keep inflation low.”

Link: Fiscal Dominance and the Return of Zero-Interest Bank Reserve Requirements | St. Louis Fed (stlouisfed.org)

Our view is when the gold price breaks through new highs, it will reinforce a narrative that past fiscal and monetary policy failures have boxed the Fed into a policy that promotes inflation and monetization of U.S. debt by the Fed to meet fiscal obligations or face a deflationary credit collapse with a follow-on banking crisis.

Gold ETF Liquidity/Shares of Gold Mining Companies

While the gold price has held firm since the height of the regional banking crisis in the spring, holdings of gold in exchange traded funds have nose-dived. Investors continue to pull money from gold assets to participate in the Big Tech AI rally and purchase treasuries. Despite the short covering rally and positive flows in futures, ETFs in October experienced 38 tons of outflows, though the end of month showed signs of reversing.

Gold share performance appears to us to be tied to a pick-up in sentiment toward gold that will be associated with a view the Fed is unable to raise rates further, a pickup in gold ETF holdings and a rollover in Nasdaq Index. Nasdaq represents growth – holding gold assets is viewed as an opportunity cost in a period of growth. There are signs the lag effect of higher interest rates are slowing the economy as shipping volumes and oil demand collapses, while unions gain ground with strikes sustaining upward pressure on inflation.

Geopolitical Turmoil/Gold Relationship

The breakout of war between Israel and Hamas reinforces the notion the world is increasingly in conflict. With conflict comes increased military spending and the prospect of widening deficits. The path to accelerated currency debasement is enhanced. The gold market, in our opinion, only pays attention to geopolitical events more than 24 hours past a short covering rally if it views the event as having lasting impact on spending and deficits. In the case of Ukraine/Russia and now Israel/Hamas, it is clear to us both events represent lasting conflict with lasting fiscal and monetary implications.

On Watch – Dow/Gold Ratio

The Dow/Gold ratio is important to monitor as it represents a macro trend shift where gold outperforms financial assets. This chart curtesy of graddhytrading.com

Important Disclosures

Investors should carefully consider the investment objectives, risks, charges, and expenses of the OCM Gold Fund. This and other important information about a Fund are contained in a Fund’s Prospectus, which can be obtained by calling 1-800-779-4681. The Prospectus should be read carefully before investing.

The Fund invests in gold and other precious metals, which involves additional risks, such as the possibility for substantial price fluctuations over a short period of time and may be affected by unpredictable international monetary and political developments such as currency devaluations or revaluations, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries. The prices of gold and other precious metals may decline versus the dollar, which would adversely affect the market prices of the securities of gold and precious metals producers. The Fund may also invest in foreign securities which involve greater volatility and political, economic, and currency risks and differences in accounting methods. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. Prospective investors who are uncomfortable with an investment that will fluctuate in value should not invest in the Fund.
XAU Index is the Philadelphia Gold and Silver Index. It is an unmanaged capitalization weighted index composed of 16 companies listed on US exchanges involved in the gold and silver mining industry.
HUI Index also known as gold BUGS index is the NYSE Arca’s index measuring gold companies that do not hedge their gold production beyond a year and a half.

The S&P 500 Index, a registered trademark of McGraw-Hill Co., Inc. is a market capitalization-weighted index of 500 widely held common stocks. You cannot invest directly in an index.
Barron’s Gold Mining Index (BGMI) is an industry average of publicly traded gold mining stocks.

Investments cannot be made in an index. Unmanaged index returns do not reflect any fees, expenses, or sales charges.
Past performance is no guarantee of future results.

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Past performance is no guarantee of future results
“The Morningstar Rating for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.”
OCM Gold Fund: Advisors Class Best Fund out of 17 eligible investment companies for the three and five-year periods and 15 eligible investment companies for the ten-year periods ending 11/31/2022 based on consistent annualized total returns.

The Refinitiv Lipper Fund Awards, granted annually, highlight funds and fund companies that have excelled in delivering consistently strong risk-adjusted performance relative to their peers. The Refinitiv Lipper Fund Awards are based on the Lipper Leader for Consistent Return rating, which is a risk adjusted performance measure calculated over 36,60 and 120 months. The fund with the highest Lipper Leader for Consistent Return (Effective Return) value in each eligible classification wins the Refinitiv Lipper Fund Award. For more information see lipperfundawards.com Although Refinitiv Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Refinitiv Lipper

Past performance is no guarantee of future results. There is no guarantee that the Fund will achieve its objective. Diversification does not ensure a profit or guarantee against loss. The prices of securities of gold and precious metals producers have been subject to substantial price fluctuations over short periods of time and may be affected by unpredictable international monetary and political developments, such as currency devaluations or revaluations, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries. The prices of gold and other precious metals may decline versus the dollar, which would adversely affect the market prices of the securities of gold and precious metals producers. Because the Fund concentrates its investments in the gold mining industry, a development adversely affecting that industry (for example, changes in the mining laws which increase production costs) would have a greater adverse effect on the Fund than it would if the Fund invested in a number of different industries.

The thoughts and opinions expressed in the article are solely those of the author as of November 9, 2023

3553-NLD-11/10/2023

Funds are distributed by Northern Lights, LLC, FINRA/SIPC. Orrell Capital Management, Inc. and Northern Lights Distributors, LLC are not affiliated.

Investors should carefully consider the investment objectives, risks, charges and expenses of the OCM Gold Fund. This and other important information about a Fund is contained in a Fund’s Prospectus, which can be obtained by calling 1-800-779-4681. The Prospectus should be read carefully before investing. Funds are distributed by Northern Lights Distributors, LLC, FINRA/SIPC. Orrell Capital Management, Inc. and Northern Lights Distributors are not affiliated.

MUTUAL FUNDS INVOLVE RISK INCLUDING POSSIBLE LOSS OF PRINCIPAL

There is no guarantee that the Fund will achieve its objective.

The prices of securities of gold and precious metals producers have been subject to substantial price fluctuations over short periods of time and may be affected by unpredictable international monetary and political developments such as currency devaluations or revaluations, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries. The prices of gold and other precious metals may decline versus the dollar, which would adversely affect the market prices of the securities of gold and precious metals producers. Because the Fund concentrates its investments in the gold mining industry, a development adversely affecting that industry (for example, changes in the mining laws which increase production costs) would have a greater adverse effect on the Fund than it would if the Fund invested in a number of different industries.

Many of the companies in which the Fund invests are smaller capitalization companies (namely, companies with a market capitalization of $4 billion or less). Smaller capitalization companies typically have relatively lower revenues, limited product lines, lack of management depth and a smaller share of the market for their products or services than larger capitalization companies. The stocks of smaller capitalization companies tend to have less trading volume than stocks of larger capitalization companies. Less trading volume may make it more difficult for the investment adviser to sell stocks of smaller capitalization companies at quoted market prices. Finally, there are periods when investing in smaller capitalization stocks falls out of favor with investors and the stocks of smaller capitalization companies underperform.

Medium capitalization companies tend to be more susceptible to adverse business or economic events than large capitalization companies, and there is a risk that the securities of medium capitalization companies may have limited liquidity and greater price volatility than securities of large capitalization companies.

There are risks associated with investing in foreign common stocks that are in addition to the risks associated with investing in U.S. common stocks. The U.S. dollar value of foreign securities traded in foreign currencies (and any dividends and interest earned) may be affected unfavorably by changes in foreign currency exchange rates. An increase in the U.S. dollar relative to the foreign currencies in which securities held by the Fund are traded will adversely affect the Fund. The Fund may invest in stocks of foreign companies that are classified under the Internal Revenue Code as passive foreign investment companies (“PFICs”). To the extent that the Fund invests in these securities, the Fund may be subject to an interest charge in addition to federal income tax (at ordinary income rates) on (i) any “excess distribution” received on the stock of a PFIC, or (ii) any gain from disposition of PFIC stock that was acquired in an earlier taxable year. This interest charge and ordinary income tax treatment may apply even if the Fund distributes such income as a taxable dividend to its shareholders. To the extent possible, the Fund will adopt tax strategies to avoid the interest charge and the ordinary income tax treatment. Such tax strategies may accelerate the recognition of income by the Fund (without the receipt of cash) and increase the amount required to be distributed by the Fund to avoid taxation. In addition, such tax strategies may require the Fund to liquidate other investments to meet its distribution requirement (including when it may not be advantageous for the Fund to liquidate such investments), which may accelerate the recognition of gain and affect the Fund’s total return. Foreign securities markets tend to have less trading volume and are more volatile than U.S. securities markets. Less trading volume makes it more difficult to sell foreign securities at quoted prices. There is the risk that political, social or economic events in a country may adversely affect the Fund’s investments in the country. There is the risk that investors in a foreign securities market may not be afforded the same protections as investors in U.S. securities markets. This is also the risk that it may be more difficult, costly and slower to enforce legal rights of the Fund in foreign countries.