Were Mr. Obama to be judged by his golf games rather than legislative changes, he would be a roaring success. Mr. Obama has played golf 200 times, presided over at least 400 fundraisers, and yet halfway through his final term, this president's "audacity of hope" has been replaced by economic stagnation, credit bubbles, and a return to the Cold War. Still investors do not seem to care having put a large part of their faith in the continuation of the Fed's easy monetary policy. The Dow records daily highs while daily crises register nothing more than a blip, contributing to a false sense of complacency. America's financial system is mired in debt because Mr. Obama has spent more than all the previous presidents before him. This debt-fueled spending is clearly unsustainable but greed on Wall Street, multi-billion dollar fines and fraudulent markets have diminished the authority and credibility of the US financial system.

What damages trust in the United States, damages the dollar and the global financial system. In fact according to the latest CNN poll, trust in government today is now at an all-time low with only 13 percent of Americans believing government can be trusted to do what is right.

Unintended Consequences

No one of course believes the financial world is sliding into chaos. The most recent expansion of America's financial powers, added a political dimension to foreign policy which will have unintended consequences. America's moves to reassert its dominance through the control of the banking system by closing tax havens and going after the big banking behemoths like BNP Paribas and Bank of America is only the beginning.

That is why recent declines in the dollar and doubts about Obama's foreign policies have provoked challenges in a dollar-centric world order. In the past, Iran and Iraq were singled out and hit with financial sanctions. However, the sharp rise in the geopolitical temperature following the tensions in Ukraine, China's skirmishes with its neighbours and now sectarian battles in the Middle East reveal that US power is not only limited, but on the decline. The global order has changed both economically and financially.

To be sure, the risk of using America's financial weapons of mass destruction under the guise of money laundering rules or new banking regulations has consequences. Banks outside the US are more cautious following BNP's $9 billion fine and some are bristling that they have become simple extensions of the Fed. The US Department of Justice (DOJ) has also generated criminal cases against America's allies, Britain, Switzerland and now France undermining confidence in the authority of the United States. To be sure, it is not tax evasion that the US is fighting, but the continued dominance of the world's financial system.

Meantime China, has pushed for a bigger role in the international theatre and even pariah Russia has attempted to use alternatives to the dollar calling for the usage of other currencies in exchange for oil. Russia last defaulted in 1998 and sanctions are not soon forgotten. Ironically, the US will need the cooperation of its allies and financial partners to execute its foreign policy and the politicization of the world's financial infrastructure simply undermines that role. Without this system of partners and cooperation, the financial world will descend into chaos.

Cheap Money Is The Norm

Debt levels of most of the developed world, led by America are already above the threshold of sustainability. America's exceptionalism is crippled by a stretched balance sheet with gross federal debt, the highest since 1948. America is trying to inflate away its public debt. Debt ratios are higher than in 2007 but nearly every asset class, including the stock market has reached new highs as low returns caused investors to chase riskier assets. In the credit markets, securitisation is back, a tribute to the power of the Fed which has rigged the markets in spectacular fashion. Tellingly, if one combines private sector debt, the debt ratio goes over 400 percent. We recall that at the beginning of 2007, the Fed's balance sheet stood at $880 billion and currently tops $5 trillion with half in Treasuries and mortgage backed debt. Debt on debt is not good. In a debt-clogged world, not even a 1 percent bond yield has coaxed overextended debt players to consume or invest. After almost seven years, the Fed has emptied its tool chest and has even slowed down the purchase of bonds with newly created money, creating a dilemma for the central bank since those assets now make up such a larger percentage of the market that any selling would swamp the market and collapse prices.

There is little question the end of the Fed's easy money policy is in sight.

Despite fits and starts, yields remain at near record lows as investors appear to be rushing to take advantage of the so-called last ten percent of gains. However tighter regulations and higher capital requirements have resulted in less liquidity. Regulators have raised red flags with central banks' warning of excessive levels, introducing new rules like a surcharge or taxing the redemptions of the big money market funds, the keystone of America's financial system. The Securities and Exchange Commission (SEC) perhaps anticipating the rush for the exits has allowed the $3 trillion money market fund industry to introduce exit fees, if funds drop below 30 percent of liquid assets. The fees are supposed to stop a run, but that is the feedstock of financial contagion.

Signs of a Higher Rates Ahead

The markets are not braced for higher rates or even normalized rates. In the nineties, interest rates averaged five percent. In the seventies, inflation and interest rates went to double digits levels fuelled by a string of deficit spending, rising oil prices and a war with Vietnam. Today, interest rates are near zero and investors have a complacent view that normalized rates are actually just the odd percent. Wrong.

At the same time, regulators across the world have also introduced new rules requiring "bail-in" provisions making bond holders and depositors bear the cost of future collapses, limiting public money in the next "too big to fail" crisis. Depositors beware! The 848 page Dodd-Frank Act, passed in 2010 in response to the 2008 crash is still in a draft stage. Dysfunction is the reason. While governments have socialized risk, there is a war on creditors. Simply, central banks and the IMF no longer can afford to "bail-out" the huge amounts needed to stave off sovereign defaults or even a big bank. As such, the lending rules were changed (including Canada) to include bail-in provisions. Cyprus was the first where depositors were asked to finance the bank's liability. Governments are no longer the last resort.

Legal Risk Has Replaced Credit Risk

Another sign of higher rates are the spate of debt defaults such as the Argentinean default or the failure of Banco Espirito Santo, Portugal's largest bank which missed a bond payment. On balance, we believe that the monetary exit after years of unconventional monetary stimulus increases the risk of an accident. And to little surprise, after supplying hundreds of banks with free money from the discount window in 2008, the regulators led by the US Treasury have introduced new rules that have transformed their roles as lenders of last resort. By tightening the provisions of guarantee access to the discount window and the treatment of debt-holders, it raises the question of who is to choose "too big to fail" or "too big to succeed". The bottom line is that governments under pressure to avoid the next round of bail-outs have reintroduced moral hazard with all the moral risks. Legal risk has replaced credit risk.

But the big worry is that having siphoned off trillions of the world's liquidity, there is the unintended consequence of a crowding out "effect" of too little savings and too much debt. In creating its own bubble, Fed Chair, Janet Yellen worries over "signs of excess" in junk bonds and leveraged loans but no rational exuberance here. Crying inflation is likened to crying "wolf". The lack of inflation is not felt on Main Street but already exists on Wall Street which allows the central banks to keep the money spigots open whilst threatening to shut them off. Rhetoric it seems to be the Fed's policy du jour. However, we believe that the economic recovery and inevitable pickup in core inflation, as what is happening in Canada will prompt the banks finally to put those reserves to use. Borrowing rates will rise and with it financial fears over the high concentration of a relatively few "too big to fail" players. That is not a good omen.

Dollar's Hegemony Ending

While Russia's problems are largely self-inflicted, there are concerns of a damaging trade conflict with the West as the sanctions escalate. Of growing concern, however is the risk of a full-blown financial crisis as Russia must rollover its debt, at a time when western capital is no longer available. Russia cancelled fourteen debt auctions so far. To date, the Russian stock market has been in a free fall and $70 billon has left the country in the latest quarter. Russia has $730 billion of foreign debt and is heavily dependent on the West's financial system since over half of Russian revenues come from energy sales. For example, Russian state company, Rosneft will need US$42 billion over the next 12 months. In turn, Russia has increased its gold holdings by 40 percent buying 16.8 tonnes in June alone to hold 1,094 tonnes, becoming the fifth largest holder in the world. Russian foreign reserves stand at $472 billion, a sufficient enough war chest to defend the ruble, but not enough for the longer term. Western banks themselves already have a sizeable exposure and they too are susceptible to the changing political headwinds.

The shape of the modern financial system emerged after the collapse of the Bretton Woods' Agreement with the US dollar replacing the British pound to become the anchor for the global economic system. Since 1971, the world has relied on the issuance of an American led fiat reserve currency that was the basis for America's prosperity and allowed it spend more than they earned, becoming the world's largest debtor. Foreigners have accumulated those paper promises recycling them back to America at low interest rates to finance its profligate consumption and mountainous deficits.

However over the past two decades, the dollar's dominance has shifted irreversibly with the emergence of China and BRICS while America's public debt load approached 100 percent with total debt over $17 trillion excluding the trillions of unfunded entitlements. China currently has $4 trillion in reserves with a third invested in US dollar securities. Both care little about the other, however the financial architecture of yesterday does not seem to be suited for tomorrow.

Alternatives To The Dollar

China's economic ambitions have seen the renminbi became more internationalized and in becoming the world's largest creditor is utilizing its trillion dollar cash hoard to buy other currency alternatives to the dollar. And, the BRICS (Brazil, Russia, India, China and South Africa) have even established their own version of the World Bank, a $100 billion development bank headquartered in Shanghai to spur growth, forsaking traditional institutions as the IMF and World Bank. BRICS now control over 50 percent of global currency reserves and are considering the establishment of a BRICS exchange in recognition of the need for alternatives. Others may follow. Ironically, the BRICS are shaking up global economic governance and in a riskier world, gold is expected to resume its historic role as the best store of value and dollar alternative.

Here is the rub, over half of America's debt is held by offshore investors. And now, China has recently reduced its dollar exposure by purchasing other dollar denominated assets like gold and commodities. Chinese purchases of America's debt have dropped four times in the past six months. When the dollar falls in value or America's creditors decide to accept alternatives, America must pay the piper. This happened in 1971 when Nixon closed the gold window. This happened when Saddam Hussein accepted euros for oil. Ultimately creditors will dictate policy, sort of like "the tail wagging the dog".

The financial world is evolving. The renminbi is being used more and more as part of the $5 trillion a day foreign exchange market. The dollar once used for oil and major commodity transactions is being used less and less by America's trading partners as they search for alternatives. Foreigners have stopped buying US corporate debt and have not returned. US dollars now make up less than 60 percent of reserves down from 72 percent in 2001. The world's big central banks, awash in dollars and the largest holders of gold are accumulating gold, as an alternative to the dollar.

Gold Is An Alternative Currency

Alarming news spills out from the Middle East these days. The Islamic of Iraq and the Levant known as ISIS has reignited an eight century rivalry between Shiites and Sunnis promising a wave of sectarian violence. And yet, after wars in Iraq and Afghanistan, US foreign policy continues to try and put Humpty Dumpty together again. Muslims are fighting Muslims and the shifting landscape in the Middle East together with military successes by the militants has caught America on the wrong side of history. Ironically after the promising Arab Spring caused the fall of the various monarchial dynasties, the radical hardliners have filled the vacuum left by exiting western powers, who in causing regime change, were not able to create the political unity necessary for those countries to grow. The genie left the bottle. However, America's financial system is hard wired into a fiat currency in ways that tomorrow problems can't be handled. Rising tensions and western inertia will mean that the genie won't be returned to the bottle any time soon. The upshot is that gold will be a good thing to have.

We believe strongly we have entered a dangerous phase.

The Middle East has polarised the divide between the West and East. Europe is in dire shape. Argentina is this year's first default and the banking system has become more leveraged than 2007. The Argentina debt default has resulted in a squeeze on credit default swaps (CDS) as part of the $700 trillion global derivatives which is now 10 times the world's GDP. In the sphere of the shadow banking world, recent default swaps pay the holder value in exchange for the underlying securities or cash. Yet, credit default swaps almost sank the financial system in 2008 and after the failure of Banco Espirito Santo, policymakers were not able to implement needed changes to the financial system. Moreover, fresh on the heels of the Argentine default, the Ukraine has some $12 billion of $73 billion debt coming due this year and the IMF is considering raising its $17 billion standby facility by another $19 billion to shore up Ukraine's reserves. Russia itself has some $53 billion to rollover. Despite these issues, the Fed tells us that all is well.

The gold price, after rising for twelve years peaked in 2011 and subsequently pulled back 28 percent last year. Gold has been in correction phase for almost one and half years, but in December, gold reached a triple bottom and since yearend has risen almost 8 percent. At the same time, gold stocks rebound some 28 percent and still look awfully cheap. Gold in renminbi actually made new highs.

The prevailing wisdom is that all is well. It is not. 2007 was a prelude and we did not learn. Little has changed. The dollar is the world's currency but it is being debased daily. We believe that gold's role as a measure of the dollar's value will carry it ever higher. Gold is an alternative investment to the dollar. Central banks are net buyers of gold having been sellers in the previous two decades. The IMF reported eight countries added to their holdings in June and last year 19 countries bought gold. There was a time when gold was money and in today's uncertain world, gold is back in fashion. It is a store of value when everything else seems risky.

The geopolitical conflicts in the Middle East and Ukraine alone have raised the real risk to economic recovery and those frictions come at a time when newish regulations like Dodd-Frank have little effect on the global financial infrastructure with respect to cross border liabilities, fragmentation and of course contagion. Simply, globalisation underpinned by debt have masked risks with a long term threat to stability. The lessons are clear. The game is rigged and golf obsessed Obama appears to be on the 10th green, undermining confidence in America's leadership and its currency. Gold is a good thing to have.

Recommendation

Gold stocks have done better than the ETFs as investors focus on the leverage and new mantra of profitability espoused by the many executives. Gold ETFs were very popular the last couple of years, providing investors exposure to gold. However, in the last year and half, ETFs have gone sideways while bullion has gone up almost 10 percent. On the other hand, gold stocks are up almost 30 percent as leverage works both ways. In addition to mining gold at a profit, we believe that the gold miners are beginning to appreciate the inherent characteristics of the barbaric metal. We like Barrick Gold for the turnaround, Eldorado and Agnico-Eagle for their growth potential and attractively priced juniors like McEwen Mining, St. Andrew Goldfields, Richmont and Victoria Gold.

The mining industry remains in the doldrums despite a revival in the gold stocks. Financings are still sporadic, such that the mining industry has sought creative ways to finance development. BHP Billiton for example has spun off its less profitable assets into a separately traded company in order to focus on its core assets. This move creates a new, old entity which will broaden interest.

Unlike nickel or zinc, gold miners are producing a monetary asset and the in situ reserves have become increasingly valuable. Ironically, with the usage of streaming to finance precious metal companies, producers are financing development with streaming or royalty deals that see them promise future delivery of gold production which appreciates in exchange for dollars which depreciate. We believe the valuation of gold in the ground is super cheap at less than $250 an ounce. We thus believe that Barrick Gold for example which has the largest in-situ reserves, in pruning its portfolio is well situated from a valuation point of view and the fact the commodity that they produce appreciates, while costs are going down should translate into higher earnings and of course higher stock prices. Capital for the projects goes to producing monetary assets, in fact, to take that one step further, gold miners should issue more debt since they could always repay that debt with an appreciating monetary asset. After all, gold is money.

Allied Nevada Gold

Allied Nevada operates the wholly owned Hycroft open pit mine is stuck between a rock and hard place because the expansion plans at its flagship mine requires $1.4 billion in order extract a whopping sulphide resource. The expansion would produce almost 500,000 ounces of gold and 21 million ounces of silver. However, the $1 billion phase I program can be rolled out in stages using an AAO-circuit. Production in the second quarter increased 45 percent to 57,000 ounces and silver output was almost 500,000 ounces. Higher grade ore is expected to be crushed which will boost recoveries. Reserves stand at 10.6 million ounces of gold and almost 500 million ounces of silver. We like Allied Nevada Gold here and believe the project is financeable.

Agnico-Eagle Mines Ltd

Agnico reported a strong quarter of 326,000 ounces at a cash cost of $626 per ounce, reflecting the acquisition of 50 percent of Canadian Malartic. Guidance was increased by 14 percent due to higher output from flagship LaRonde which will mine deeper higher grade ore. Meadowbank had a record quarter and exploration drilling expanded mineralization at nearby IVR property. At Canadian Malartic, a new 43-101 report was filed and exploration at promising Kirkland Lake will begin. At Goldex, development at the top of D Zone (Deep Zone) is underway. Meadowbanks has turned around with positive results. Production guidance was increased to almost 1.4 million ounces at an all-in cost of $990 an ounce. We like Agnico Eagle here for its rising production profile and its pipeline of projects.

Aurico Gold Inc.

Aurico's main asset is the Young-Davidson Mine in Ontario which had a good quarter with costs under $900 an ounce. Underground mining costs will be lower, at a cash cost of $650-$750 an ounce and there have been few teething problems. Aurico however will need to show that the Northgate/Young Davidson billion dollar purchase in 2011 was worth the money since their low grade El Chanate mine in Mexico is just so so with an eight year mine life. We prefer Agnico-Eagle here

Barrick Gold Corp

Investors wanted change, and in less than six months, Chairman John Thornton has delivered that. Barrick has appointed two co-presidents, underlying the difficulty of managing more than twenty-six mines. Barrick also eliminated the corporate development department by flattening the bureaucracy and streamlined its executive branch pushing down mine management to the mines. Barrick has a book on other miners and so a corporate development group is redundant. Most significantly, as far as management, the company has also elevated a talent executive whose mandate is to solve the dearth of mining talent. Mining talent is the lifeblood of the industry. We believe Barrick's approach is innovative and sorely needed.

From an operation's standpoint, Barrick has pruned high cost assets and was able to turn previously written down Jobal Sayid (Ma'aden) asset into an asset bringing in the Saudi Arabian government as a partner. By turning a silk purse from a sow's ear, Barrick has been able to financially engineer an asset at very little cost. Meanwhile, the huge Pascua Lama project has been shelved. Barrick will look to maximize the profitability of remaining assets. Still, there is much that Barrick can do and we believe that streamlining management has only just begun. Near term, we do not expect a blockbuster deal but the logic of a longer term merger of Newmont and Barrick makes sense since it would rationalize both the Nevada assets and Australian assets. Newmont has a geographic risky base and remains stuck in the mud. Newmont is a company of yesterday, harvesting mature mines with few large-scale developments. What is different from the last cycle is that Barrick is a much slimmed down new heavyweight focussing on profitability and growth rather chest beating rhetoric. We like Barrick shares here.

Detour Gold Corp.

Detour will have a slower third quarter, due to overburden removal and development. However, the company is expected to regain its form in the last quarter making it Canada's largest producer. Mill throughput however is up and recoveries are better plus there are fewer operation problems. Detour's 100 percent owned Detour Lake gold project in northeastern Ontario has less than 20 percent of its 630 km2 land position explored. We think the company will spend excess cash flow next year on expanding its 15.6 million ounce reserve. To be sure, dilution and mine problems have been resolved and the company has sufficient capital for next year. We like the shares here for its 20 plus year mine life and 600,000 ounce potential annual production.

Eldorado Gold Corp.

High quality Eldorado had a good quarter from its seven mines with production up and costs continuing to come down. Approval was given to expand flagship Kisladag in Turkey, at a cost of about $90 million which should be completed by mid-2016. Design work is underway to expand mill throughput at Eldorado's second mine in Turkey, Efemcukuru. Eldorado is still waiting on permit approval from Eastern Dragon but the vagaries of dealing in China has caused this delay. Gold production in the second quarter was about 200,000 ounces at a cash cost of less than $900 ounce. Eldorado's Vila Nova iron ore mine in Brazil recorded a loss in the quarter of about $3 million due to low prices. Eldorado will produce some 80,000 ounces this year at a low cash cost of $495 and all in costs of $850. Sustaining capital spending is forecasted at $170 million with $1 billion plus balance sheet of liquidity.

Eldorado operates three mines in China and is giving consideration to listing its Chinese assets in Hong Kong, to broaden investor interest. Eldorado is the largest foreign owned producer in China. Headquartered in Vancouver, we like Eldorado's growing production profile, its 28 million ounces of in-situ reserves and management team. The market is not pricing in growth for its China or Greek assets. Buy.

Kinross Gold Corp.

Kinross had a strong quarter due in part to a solid contribution from its Russian assets and reduced costs at Tasiast but with nine operating mines, Kinross will have a flat production profile. Kinross' two Russian high grade gold mines will produce 690,000-730,000 ounces. However, Kinross is stuck in the mud and investors are cautious because the Company's major exposure is in Russia leaving it vulnerable to Putin's whims. Kinross has other mines in Canada, United States, Brazil, Chile and Mauritania. There was some improvement at Tasiast with a feasibility study based on 38,000 tpd mill but the jury is out on this one. We prefer Agnico-Eagle here.

Yamana Gold

Yamana Gold results reflected the acquisition of 50 percent of Canadian Malartic which will be Yamana's second largest asset. Daniel Racine was appointed Senior Vice President which is positive with a solid underground experience. We like the Canadian Malartic deal as a complement to core flagship El Penon. Jacobina in Brazil, however was a drag and costs remain a problem. Yamana has a healthy stake in Brazil. We prefer Agnico Eagle here.

Larger Image

Analyst Disclosure
Rating: 5 - Strong Buy 4 - Buy 3 - Hold 2 - Sell 1 -Strong Sell