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Kaiser Blog June 23, 2016: Brexit and the Bundle of Sticks


During the evening of June 23 when I realized that the Brexit referendum had unexpectedly gone in favor of leaving the EU with a 52:48 vote, I dashed off this note by email to KRO members. I have posted it below as a "blog" item:

In one of Aesop's fables a father hands a bundle of sticks to his cranky sons and asks them to break it. They fail. Then he hands them each a stick from the bundle and asks them to try again. The UK is the first son to break his stick. The rest will soon follow.

Gold has jumped sharply and asset classes apart from yen and USD are falling. The order of the universe has been disturbed. That order is the concept of globalization, which I have been warning since 2008 is destined to fall apart.

It will take a couple years for the UK to sort out its exit from the European Union. One would expect that markets will settle down once emotions start grappling with the logistics of an Exit. There may even be a rethink given the 52:48 split. But the far more disturbing implication is the boost that the Leave victory gives to the isolationist message of Donald Trump who has tapped into the seething rage of Americans coping with the realization that the American Dream lives no longer.

From the start Trump's pursuit of the Republican nomination has been treated as a joke whose humor will wear off when crunch time arrives. While the Brexit vote outcome can be dismissed as British folly that leads at a minimum to the final diminution of this former empire, about which the Germans are no doubt howling with schadenfreude, much more frightening is the momentum it bestows on the Trump vision of withdrawing the United States from the global stage as a benevolent hegemon and transforming it into a malevolent German style autarchy.

(In response to queries as to why I think the Germans are experiencing schadenfreude over the Leave vote, I selectively sent the following explanation: Brexit sets in motion the disintegration of the UK as Scotland renews its independence drive. The Leave vote was dominated by older Brits while the Remain was by younger people. A 52% majority is a slim margin to set in motion a dramatic shift towards isolation, especially since voter turnout was only 70%, with those not bothering to vote likely favoring the "remain" status quo. Brexit will tear the UK apart socially and perhaps even set the stage for a Hitler type. Germany ended up divided after it went on a malevolent rampage to secure resource self-sufficiency that resulted in WWII. The reunion after the wall came down was long and expensive. The former British imperialists have always viewed the Germans as provincial except when in the twentieth century they twice pursued imperialism. As the Germans struggle to redeem themselves as a unified nation within a broader European alliance, they cannot but laugh at the self-destruction now being pursued by their victors, a path that will leave England an inconsequential player on the global stage. Trump's goal is to retreat from the US role as the sole super-power with which come responsibilities that are sometimes at the expense of American self-interest. The price will be a rise in tension between the US and China and Russia which will likely shut down major raw material supply channels. The United States will need to replace them with sources closer to home, but its weakened position will generate pushback. This threat will force the United States to ramp up the Monroe Doctrine as its secures Lebensraum in the form of secure raw material supplies closer to home. Germany started out from a bad position during the thirties and sought greater Lebensraum. Although it is not true that America is no longer great, Trump is exploiting a general feeling among Americans that the future will be less great than the present. Just as Hitler wished to make Germany great again, so does Trump wish to make America great again. Rounding up 10 million illegal immigrants and forcibly deporting them, casting a shadow on all Muslims as potential jihadi, shutting down a critical press, these are all trademarks of a malevolent German past.)

The Brexit Leave outcome unleashes four months of pure anxiety as the world wonders, if the bookies could get the Leave outcome so wrong, why could the common sense outcome of a Hillary Clinton victory not instead be displaced by Donald Trump as the next President of the United States, a man who has distinguished himself through proud ignorance of how the Washington Consensus works?

Everything we take for granted is now up in the air. And the safest refuge is gold, of which 5.5 billion ounces exist and whose owners suddenly have no reason whatsoever to sell in order to help out those seeking an asset class where title is difficult to confiscate and whose existence it is is impossible to detonate. $9 trillion is a drop in the bucket relative to the value of the world's other asset classes. The uncertainty unleashed by Brexit and the prospect that Trump has a better than an outside chance at the American presidency no matter how badly he behaves could drive the price of gold to the 1980 equivalent peak where the gold stock represented 28% of global GDP in USD, an amount that today is equivalent to $3,000 plus.

This type of gold spike is not related to the right wing bunk about fiat currency debasement and hyper-inflation that typified gold bugs during the past decade. This type of spike is linked to pure stress and desire to reallocate wealth into a relatively small asset class. This type of gain is "real" in the sense that capital and operating costs do not need to track an increase in the price of gold. This is the type of gain that puts worthless gold deposits packaged as "optionality" plays into the money big time. It also lowers the bar for what counts as an exploration "discovery" worth developing into a gold mine.

While there may be a knee jerk reaction Friday where shareholders rush for the exits in search of liquidity, this will only really hurt the asset classes that depend on globalized trade. The real victim is globalization, the idea that anything produced in the lowest cost jurisdiction can be delivered to the jurisdiction willing to pay the highest price. It is an economic religion that trade makes everybody better off, but that theory has been undermined by a trend towards the concentration of wealth and power which has shifted reality from a mode of expansion that enriches everybody while preferentially enriching the owners of capital and possessors of lucky positions within the socioeconomic spectrum to one of calcification of a shrinking pool of winners while an expanding pool of losers dissolves into a powerlessness easily channeled into violence by priesthoods and other demagogues.

It is really naive to dismiss Trump because he offends so many, for precisely because he offends everybody, he can achieve a mantle of "wisdom" where nothing he says is literally true, just a subversive playing with language of the sort that got the deconstructionists all excited decades ago. In his stupidity he achieves Yoda like wisdom that nobody understands and precisely because they don't they give it great sway.

One of my key themes has been the idea that one can use the juniors to make leveraged bets on big picture trends, one of which is the idea that globalized trade will fall apart as the world retreats into smaller trade and security alliances, with China, the USA, Russia and Europe as the main players. The elephant in the room is Asia. Will the USA support an alliance of southeast Asia and Australia against China? Trump certainly is not keen on Obama's pivot to Asia. In fact, shutting down trade flows from Asia will force an autarchic reaction in America that reshores manufacturing even if it is in hyper-automated form.

That should be good for jobs. But what about all the raw materials in whose export China dominates, of which rare earths were the most prominent recent example? The truth is that an economic zone consisting of North and South America can supply all the raw materials needed by a global economy. The bad Brexit news is thus not just good for juniors with gold projects outside jeopardized jurisdictions such as Asia (including Russia), Saharan Africa and the Middle East. It is also good for juniors with base and critical metal projects outside those endangered jurisdictions.

Among my Spec Value Hunter picks Midas Gold Corp (MAX-T: $0.83) is an obvious go-to stock because 1) its costs are fixed in USD, 2) the USA may suffer imported goods inflation because its currency soars but the deflating effect on the GDP will keep inflation in check, 3) there is no real danger of nationalization of gold mines, and, 4) the need for antimony as a fire retardant that comes mainly from China will light a fire under the Idaho mine permitting regime thanks to the important antimony by-product credit at the Stibnite project.

With regard to everything else, I recommend just sit tight while we wait for global markets to stabilize. Stocks such as Scandium Intl (SCY-T: $0.185) are unaffected unless you think Australia will become a colony of Imperial China. Diamonds may be precarious, because when fear rules the headlines, demand for luxury goods sags. Peregrine is only a week away from delivering a PEA. I have not smelled any rats suggesting a bad PEA. If you are wondering about uranium, it might be helpful to think about which country is the world's biggest uranium producer, namely Kazakhstan, a former colony of Russia whose leader Putin tonight has to be thinking about how to carve Russia's lost territories back out of the Eurozone.

I am unhappy the Brits decided to disembowel themselves, and concerned about the momentum Brexit bestows on Trump's message, but I am taking the position that at the end of the day wisdom will prevail, but for the next 4 months the resource juniors are going to benefit from one hell of a Sturm und Drang pyschology.

John Kaiser

 
 

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