I'm sticking to posts on precious metals, as gold continues to brush against $1000. The two things that I want to mention today have to do with the commitment of traders report, and the admission by Barrick that they plan to close a large portion of their hedge book.
First the COT reports for gold and silver can be found here with nice graphic options: http://www.timingcharts.com/index.php.
Of course, we first have to realize that this is not showing over the counter positions, nor is it showing positions in GLD or other ETFs. This is purely a measure of the US futures market. Be that as it may, it is clear that the commercial short position in gold is as large as it has ever been, and the commercial short position in silver has grown but is not as large as in previous extremes.
Looking at gold, it appears that commercials are short 75,000 more contracts now than they were at similar price levels in February. Generally, commercial entities have a very good trading record with precious metals. Their strategy appears to be rather simplistic: if the price goes up, they sell and if the price goes down they buy. If the price goes up more, they sell more, and eventually I think they figure that the price will come down and then they can cover all their positions at a profit. Generally speaking, this seems to work pretty well for short-term price movements. However, there have been 2 instances in the past 5 years of commercial entities being very short at precisely the wrong time. These instances were October 2005-May 2006, and October 2007-March 2008.
Taking a closer look at these two instances, the maximum commercial short position in October 2005 was 212,000 contracts. At the price top in May, the commercials had roughly 170,000 contracts. Between the two points, the price of gold moved from $450 to $700. It is noteworthy that gold has not yet been back to the $450 level, so some commercial entity lost a lot of money covering these positions (or leaving them open.) In the second instance, the maximum commercial short position was between 240,000 and 250,000 contracts, and hovered around this level for much of the period between Oct 07 and March 08. This time the price went from roughly $750 to $1000. There wasn't the same phenomena of short covering by the commercials this time however. The commercials just basically sat on the same short position the whole way up, and then covered their positions only when prices fell in fall of last year.
Now, with gold challenging $1000 again, commercial entities have increased their short positions yet again to a new relative high of roughly 270,000 contracts. Aso, zooming in on the past three weeks, there has been a dramatic rise of both large trader AND small trader long positions to offset the commercial shorts. What does this portend for prices?
Well, generally speaking, commercials are right more often than they are wrong, so statistically it is likely that we are at a top in gold. Also, the rise in small trader positions is unusual, and generally speaking small traders have the worst track record. So this would also point to a bearish outcome.
However, the commercials have been notably incorrect in a big way a couple of times, so we can't rule out the possibility of prices moving higher. Also, it seems that the short position must be concentrated in banks rather than gold producers. Whether this is bullish or bearish, I am not sure, but it seems likely that a break higher would be made more explosive by the fact that the majority of the shorts are almost certainly banks.
What clued me in to this difference was all of the attention recently about Barrick's decision to close all of their fixed hedges this year and a portion of the rest of their gold hedge book. http://www.marketwatch.com/story/gold-miners-abandon-hedges-but-at-slower-pace-2009-09-14?link=kiosk
First of all, isn't it a bit strange that they are announcing their hedge closure in advance of actually doing the deed? When they closed a large portion of their hedges in 2006, there was no mention of it until after the fact. I'm not sure what it means, but I just found it strange that they would announce such a fact. I mean, it would be a little like telling a used car salesman that you absolutely had to walk off the lot with a car, that you had just raised a large amount of money to buy the car, and that you only had 10 minutes to make the deal. The salesman would fleece you because he knows that you are a forced buyer and knows you have a time limitation. So why are they announcing their intentions to close their hedges (i.e. buy 3 million ounces of gold?) Was it just that they were desperate to raise the money they felt would be necessary to do the deed? Are they lying? Are they really increasing their shorts even as they say the opposite? Who knows but I think it is an interesting puzzle.
The other question this news report brings up is what I already alluded to: if all the gold producers have busily been reducing their hedge positions over the past 3 and a half years, who in the world is now short 900 tons of gold in the futures market? After all we have the largest commercial short position ever seen in the COT report; and yet we are learning simultaneously that producers have been closing their hedges. So what commercial entity could be left? Banks.
My feeling is that it is an entity or group of entities who is playing the game "heads I win, tails you lose." And the firm that likes that game more than any other is GS.
HEADS I WIN: The price of gold falls, and gold shorts make 27 million times however far it falls.
TAILS YOU LOSE: Gold breaks out and never looks back, and the short holders can default through a paper settlement or some government sanctioned order. Even if the shorts could deliver, 900 tons is a lot of gold. It is more than Japan's official reserves, and almost 1/3 of the gold that the IMF holds. Is it possible that short entities hold this much gold? Yes, it is certainly possible, but if this much gold actually changed hands it would represent a huge shift in wealth. I would submit that a mining company hedging its production is a much different animal than a bank delivering its holdings of gold.
So, we will continue to wait and see what happens with gold and silver over the next few weeks. My feeling continues to be that we are in the middle of a breakout, and that there will not be any meaningful retrace below $1000 gold.
One final note about Barrick. Because Barrick is such a large percentage of the HUI, it has been dragging down its performance in the week since they made this hedge book announcement. While the rest of the index is up 2-3%, Barrick is down more than 6%. This has created a drag on the HUI of almost about 1%. Not a great deal but worthy of noting. There has been a lot of question about why gold stocks have performed badly compared to the metal itself over the past few years. These hedges have obviously played some role in the under-performance of gold stocks.
Monday, September 14, 2009
Friday, September 11, 2009
Formal devaluation is unlikely
I am coming back to this idea of devaluation today. I think that a formal devaluation is unlikely because there is nobody capable of undertaking such a devaluation who has an incentive to announce it formally. I think that the two groups that have the power to devalue the US currency are:
1) The Federal Reserve
2) Foreign countries who maintain a peg with the US dollar
There is a third group that I would group together and generally call "private investors"; this group is also powerful enough to devalue the currency. But this group is not cohesive to the point that they would make an announcement, or an overnight adjustment. Investors can affect the value of the dollar if a critical mass of them completely lose trust in the dollar and shift their preferences to exclude any sort of dollar based asset. This has happened on a microscopic scale, and could be a growing force in the coming months. But the two groups who are powerful enough to create an overnight adjustment both have incentives not to do so. Let's start by looking at the Fed.
The Federal Reserve will not announce a devaluation, even if their policy indicates that a significantly weaker currency would help the economic situation of the world. The reasons for this are complicated, but I think a short summary would be that they would find an abrupt devaluation to be too blunt and unrefined of a tool. There would also be (legitimate) worries about what such an action would do to future expectations; once a monetary authority loses the faith of its citizens it requires years, if not decades to regain that faith. I think that the Federal Reserve rightfully considers inflation expectations to be one of the most important determinants of monetary policy. Finally, the Federal Reserve, like all dominant institutions, suffers from hubris, and they will continue to think they can find a more elegant solution to continued problems. Thus far, I should note, they have been correct in that assumption. The Federal Reserve may come under political pressure should economic conditions worsen from where they are (or not get better for a long time.) But I think that it is safe to assume that the Fed will be resistant to extreme ideas such as announcing a double digit inflation target or anything else that could constitute a devaluation.
The second group, countries who peg their currency to the dollar above the market rate, could devalue the dollar simply by getting rid of the peg. Countries such as Saudi Arabia, UAE, Kuwait, and China fall into this category. These countries may abandon their peg, but I think that the most powerful devaluing effects would come from shifts in asset preferences rather than peg abandonment. If the large dollar hoders of the world switched out of dollar assets into real assets (plants, equipment, natural resources, equity in existing firms, precious metals, energy storage, commodity storage, etc.) there would be a powerful effect depreciating effect on the dollar. I believe this is the source for future devaluation of the dollar, but countries who take this strategy have every incentive to cloak their intentions and prop up the value of the dollar while they are making these purchases. As I have talked about in other posts, it appears more and more likely that China is taking exactly this tack. As the strategy becomes more clear, it could escalate in such a way that the dollar (and all other currencies to a lesser extent) could come under an incredible amount of downward pressure. This is the type of devaluation that I am watching for, but it will not be formal. It will start slowly and build in speed. It is pretty clear to me that, barring another deflationary/de-leveraging wave, we are already well underway in the process I have just described.
1) The Federal Reserve
2) Foreign countries who maintain a peg with the US dollar
There is a third group that I would group together and generally call "private investors"; this group is also powerful enough to devalue the currency. But this group is not cohesive to the point that they would make an announcement, or an overnight adjustment. Investors can affect the value of the dollar if a critical mass of them completely lose trust in the dollar and shift their preferences to exclude any sort of dollar based asset. This has happened on a microscopic scale, and could be a growing force in the coming months. But the two groups who are powerful enough to create an overnight adjustment both have incentives not to do so. Let's start by looking at the Fed.
The Federal Reserve will not announce a devaluation, even if their policy indicates that a significantly weaker currency would help the economic situation of the world. The reasons for this are complicated, but I think a short summary would be that they would find an abrupt devaluation to be too blunt and unrefined of a tool. There would also be (legitimate) worries about what such an action would do to future expectations; once a monetary authority loses the faith of its citizens it requires years, if not decades to regain that faith. I think that the Federal Reserve rightfully considers inflation expectations to be one of the most important determinants of monetary policy. Finally, the Federal Reserve, like all dominant institutions, suffers from hubris, and they will continue to think they can find a more elegant solution to continued problems. Thus far, I should note, they have been correct in that assumption. The Federal Reserve may come under political pressure should economic conditions worsen from where they are (or not get better for a long time.) But I think that it is safe to assume that the Fed will be resistant to extreme ideas such as announcing a double digit inflation target or anything else that could constitute a devaluation.
The second group, countries who peg their currency to the dollar above the market rate, could devalue the dollar simply by getting rid of the peg. Countries such as Saudi Arabia, UAE, Kuwait, and China fall into this category. These countries may abandon their peg, but I think that the most powerful devaluing effects would come from shifts in asset preferences rather than peg abandonment. If the large dollar hoders of the world switched out of dollar assets into real assets (plants, equipment, natural resources, equity in existing firms, precious metals, energy storage, commodity storage, etc.) there would be a powerful effect depreciating effect on the dollar. I believe this is the source for future devaluation of the dollar, but countries who take this strategy have every incentive to cloak their intentions and prop up the value of the dollar while they are making these purchases. As I have talked about in other posts, it appears more and more likely that China is taking exactly this tack. As the strategy becomes more clear, it could escalate in such a way that the dollar (and all other currencies to a lesser extent) could come under an incredible amount of downward pressure. This is the type of devaluation that I am watching for, but it will not be formal. It will start slowly and build in speed. It is pretty clear to me that, barring another deflationary/de-leveraging wave, we are already well underway in the process I have just described.
Tuesday, September 8, 2009
Comments for Tuesday September 8th
Gold and silver pushed higher in early morning trading, as the dollar broke to multi-month lows. However, after pushing above $1000, gold fell in New York trading, with the price closing at roughly the point where it opened. Silver and the HUI gold equity index had similar action with strong advances followed by a fall in price into the close. Usually, this type of action can indicate a price top, particularly after a strong run-up in prices. However, I am still of the opinion that there is more strength in the market, and that this will later appear as a false top. It would be particularly noteworthy if a break to new highs occurred during the Asian trading hours tonight or tomorrow night.
I have gotten a late start on the article I intended to write on dollar devaluation, but I will give my argument in a nutshell now and expand upon the argument tomorrow. I will begin by citing 2 historic cases of devaluations (America 1933, and Argentina 2001) and then compare these cases to the current situation. In both of the previous cases, the money being devalued was "pegged" to the money it was devalued against. In the case of America 1933, dollars were pegged to gold, and in the case of Argentina 2001, pesos were pegged to the dollar. Currently, the dollar is not pegged to gold or any other currency. The dollar is pegged to an ephemeral substance called faith. Therefore, any devaluation will occur due to a shift in faith.
However, this does not make an overnight devaluation any more difficult. In fact an argument can be made that such a devaluation was already announced on March 18th, 2009, when the Fed announced purchases of $1.75 trillion in US treasuries, agency debt, and mortgage backed securities. The difference lies in that the meaning of the devaluation is more difficult to gauge, and takes longer to have an effect because it must first work through the perceptions of the market.
The reason the devaluation of 1933 had an instant effect was because it allowed the holders of gold, both foreign and domestic, more purchasing power for everything else that was priced in dollars. This higher purchasing power included the price of labor. In fact, there would have been much the same effect if the government had simply confiscated gold and then ordered by decree that all prices in the economy, including labor, were to be cut by 40%. One problem with that solution is that people's perception of their worth is often tied to the number on their wage statements, and so a devaluation of the purchasing medium (gold) was more practical, more easily enforced, and more politically savvy.
Fast-forward to today. Today, people still attach a great deal of psychological value to the number on their pay-check. "5 figures, low 6 figures, high 6 figures, etc." And that number has lost all formal pegging to gold, so most Americans are oblivious to that relationship. Additionally, Americans seem to accept that there is a 2% decrease in purchasing power every year; I think that most don't realize or don't care that the depreciation acts as a seigniorage tax that benefits the government. The honest truth is that most Americans don't care simply because life is so good! The loss of purchasing power is subtle, and many of the side-effects of money debasement are confusing and can't be understood without honest and diligent study. The ultimate example of confusion came with the housing bubble in the last few years. People were buying houses that were worth 15 times their yearly salary with no money down. This to me is the best example that Americans have accepted that the relationship between money and what it can buy is esoteric. It is because of this that I think it is unlikely - very unlikely - that the dollar will debase from within because Americans are too busy and too happy to lose their faith in the dollar. The debasement of the dollar will come from abroad, as foreign countries lose their faith in the future value of the dollar. The foreign countries that matter, China, Japan, OPEC, and to a lesser degree Russian and Brazil, will want a store of value. Since they are opposed to letting their own currencies appreciate, they will look for an alternative that is not a currency. Gold is an obvious choice, as well as oil, copper, or any other commodity that can be inexpensively hoarded for long periods of time. In the long run, gold and silver will return as the most logical choices because their of their inherent monetary properties. Oil is another possibility even though the storage and transportation is much more difficult.
The productive capacity of the US is below where it needs to be in order to maintain the faith of the world. Ultimately the buck stops here: by the amount of goods and services that foreigners can purchase from Americans with their dollars. Our productive capacity has been decimated by mal-investment in houses, cars, and domestic services. Thus, the foundation for a loss of faith.
When debasement comes, it won't come as an announcement from the POTUS. It will come as foreign holders of dollars slowly and silently abandon ship.
One final note. The larger the deflationary contraction the US experiences in the near future, the better for these foreign holders of large dollar stashes. Ultimately, the worth of the dollar is tied to the productive capacity of the US. But in the short term, if holders of dollars can exit by purchasing assets on the cheap, so much the better for them. The worst possible outcome for the US as a nation would be another round of devaluation, allowing China et all to buy even more assets in their exit from the dollar. I believe that our current predicament is best characterized as a dance between the Fed and foreign holders of the dollar. The Chinese try to goad the Fed into tightening money and credit, to ensure another wave of deflation and increase the purchasing power of the Chinese hoard yet more. The Fed tries to pretend as though they might tighten money and credit in order to head off any abandonment by the Chinese and others. I think the Chinese understand the strategy of the game, but the Fed only sees the tactics of the game.
In 1933, shortly after being elected, FDR called for a bank holiday, simultaneously passing an edict that made it illegal to hold gold bullion. This type of event is highly unlikely simply because the dollar is not pegged to gold anymore. Holders of gold are seen as a curiosity but not as a force of deflation in the economy. Some sort of announcement by foreign powers is even more unlikely. After firing a few shots over the bow, foreign powers will speak with their feet and leave the dollar quietly.
I'll end today with the executive order given by Roosevelt to confiscate gold. I found this to be a fascinating historical record, even if I don't see anything similar happening during present times.
After confiscating gold and silver, he then changed the underlying relationship between gold and the dollar, from roughly $20/ounce to $35/ounce. This was a devaluation of roughly 40%.
I have gotten a late start on the article I intended to write on dollar devaluation, but I will give my argument in a nutshell now and expand upon the argument tomorrow. I will begin by citing 2 historic cases of devaluations (America 1933, and Argentina 2001) and then compare these cases to the current situation. In both of the previous cases, the money being devalued was "pegged" to the money it was devalued against. In the case of America 1933, dollars were pegged to gold, and in the case of Argentina 2001, pesos were pegged to the dollar. Currently, the dollar is not pegged to gold or any other currency. The dollar is pegged to an ephemeral substance called faith. Therefore, any devaluation will occur due to a shift in faith.
However, this does not make an overnight devaluation any more difficult. In fact an argument can be made that such a devaluation was already announced on March 18th, 2009, when the Fed announced purchases of $1.75 trillion in US treasuries, agency debt, and mortgage backed securities. The difference lies in that the meaning of the devaluation is more difficult to gauge, and takes longer to have an effect because it must first work through the perceptions of the market.
The reason the devaluation of 1933 had an instant effect was because it allowed the holders of gold, both foreign and domestic, more purchasing power for everything else that was priced in dollars. This higher purchasing power included the price of labor. In fact, there would have been much the same effect if the government had simply confiscated gold and then ordered by decree that all prices in the economy, including labor, were to be cut by 40%. One problem with that solution is that people's perception of their worth is often tied to the number on their wage statements, and so a devaluation of the purchasing medium (gold) was more practical, more easily enforced, and more politically savvy.
Fast-forward to today. Today, people still attach a great deal of psychological value to the number on their pay-check. "5 figures, low 6 figures, high 6 figures, etc." And that number has lost all formal pegging to gold, so most Americans are oblivious to that relationship. Additionally, Americans seem to accept that there is a 2% decrease in purchasing power every year; I think that most don't realize or don't care that the depreciation acts as a seigniorage tax that benefits the government. The honest truth is that most Americans don't care simply because life is so good! The loss of purchasing power is subtle, and many of the side-effects of money debasement are confusing and can't be understood without honest and diligent study. The ultimate example of confusion came with the housing bubble in the last few years. People were buying houses that were worth 15 times their yearly salary with no money down. This to me is the best example that Americans have accepted that the relationship between money and what it can buy is esoteric. It is because of this that I think it is unlikely - very unlikely - that the dollar will debase from within because Americans are too busy and too happy to lose their faith in the dollar. The debasement of the dollar will come from abroad, as foreign countries lose their faith in the future value of the dollar. The foreign countries that matter, China, Japan, OPEC, and to a lesser degree Russian and Brazil, will want a store of value. Since they are opposed to letting their own currencies appreciate, they will look for an alternative that is not a currency. Gold is an obvious choice, as well as oil, copper, or any other commodity that can be inexpensively hoarded for long periods of time. In the long run, gold and silver will return as the most logical choices because their of their inherent monetary properties. Oil is another possibility even though the storage and transportation is much more difficult.
The productive capacity of the US is below where it needs to be in order to maintain the faith of the world. Ultimately the buck stops here: by the amount of goods and services that foreigners can purchase from Americans with their dollars. Our productive capacity has been decimated by mal-investment in houses, cars, and domestic services. Thus, the foundation for a loss of faith.
When debasement comes, it won't come as an announcement from the POTUS. It will come as foreign holders of dollars slowly and silently abandon ship.
One final note. The larger the deflationary contraction the US experiences in the near future, the better for these foreign holders of large dollar stashes. Ultimately, the worth of the dollar is tied to the productive capacity of the US. But in the short term, if holders of dollars can exit by purchasing assets on the cheap, so much the better for them. The worst possible outcome for the US as a nation would be another round of devaluation, allowing China et all to buy even more assets in their exit from the dollar. I believe that our current predicament is best characterized as a dance between the Fed and foreign holders of the dollar. The Chinese try to goad the Fed into tightening money and credit, to ensure another wave of deflation and increase the purchasing power of the Chinese hoard yet more. The Fed tries to pretend as though they might tighten money and credit in order to head off any abandonment by the Chinese and others. I think the Chinese understand the strategy of the game, but the Fed only sees the tactics of the game.
In 1933, shortly after being elected, FDR called for a bank holiday, simultaneously passing an edict that made it illegal to hold gold bullion. This type of event is highly unlikely simply because the dollar is not pegged to gold anymore. Holders of gold are seen as a curiosity but not as a force of deflation in the economy. Some sort of announcement by foreign powers is even more unlikely. After firing a few shots over the bow, foreign powers will speak with their feet and leave the dollar quietly.
I'll end today with the executive order given by Roosevelt to confiscate gold. I found this to be a fascinating historical record, even if I don't see anything similar happening during present times.
Executive order: By virtue of the authority vested in me by Section 5(B) of The Act of Oct. 6, 1917, as amended by section 2 of the Act of March 9, 1933, in which Congress declared thata serious emergency exists, I as
President, do declare that the nationalemergency still exists; That the continued private hoarding of gold and silver by subjects of the UnitedStates poses a
grave threat to the peace, equal justice, and well-being of the United
States; and that appropriate measures must be taken immediately
to protect the interests of our people.
"Therefore, pursuant to the above authority, I herby proclaim that such gold
and silver holdings are prohibited, and that all such coin, bullion or other possessions of gold and silver be tendered within fourteen days to agents of the Government of the United States for compensation at the official price, in the legal tender of the Government. All safe deposit boxes in banks or financial institutions have been sealed, pending action in the due course of the law. All sales or purchases or movements of such gold and silver within the borders of the United
States and its territories, and all foreign exchange transactions or movements of such metals across the border are hereby prohibited.
"Your possession of these proscribed metals and/or your maintenance
of a safe-deposit box to store them is known to the
Government from bank and insurance records. Therefore, be advised
that your vault box must remain sealed, and may only be opened in the
presence of an agent of The Internal Revenue Service.
"By lawful Order given this day,
the President of the United States."
After confiscating gold and silver, he then changed the underlying relationship between gold and the dollar, from roughly $20/ounce to $35/ounce. This was a devaluation of roughly 40%.
Monday, September 7, 2009
If gold is money, why quote it in dollars?
Commodities are quoted in dollars out of habit and because New York and Washington command so much economic and military power. The dollar was the most stable currency for almost 200 years. For more than 100 years, the value hardly moved at all. It has only been in the past 40 years that the value of the dollar has dropped significantly. Gold is quoted in dollars because that is still the milieu de jour. Dollars have been the numeraire of world commerce for the past 70 years and so they are the de facto quote. If the dollar loses its numeraire status than people will quote the price of goods in terms of the numeraire, and the dollar will have lost its worth, unless it is somehow convincingly tied to the new numeraire. But in the meantime gold theorists would appear out of touch if they did not quote gold in terms of dollars but chose instead barrels of oil of BTUs of natural gas or some other metric. The dollar is still the most commonly used monetary metric in the world, but that does NOT ensure it has any intrinsic value. In that sense a dollar is kind of like an out of the money option. It has time value, and the possibility of intrinsic value so long as the US financial ship remains in decent condition. But if and when enough holes are poked in the financial ship of the US then the dollar will expire worthless at some unmarked point in the future.
I recently listened to a podcast from a website called Financial Sense Newshour.
http://www.financialsense.com/fsn/main.html On this podcast, the host Jim Puplava indicated one possibility for the future was a dollar devaluation. A number of his listeners called in to ask him what a dollar devaluation would look like. I have started to think about this question and will post on this tomorrow. Come back and read the post if you'd like!
I recently listened to a podcast from a website called Financial Sense Newshour.
http://www.financialsense.com/fsn/main.html On this podcast, the host Jim Puplava indicated one possibility for the future was a dollar devaluation. A number of his listeners called in to ask him what a dollar devaluation would look like. I have started to think about this question and will post on this tomorrow. Come back and read the post if you'd like!
Advantages and Disadvantages of a Fiat currency
The important distinction between gold and fiat money is that fiat money can and is created in arbitrary amounts, and is made available on a favorable basis to the government and commercial banks. Now I admit there are both advantages and disadvantages to flexible money creation. You can't meaningfully increase the supply of gold over a short period of time. Think about what happened to the Fed balance sheet last fall - in 10 weeks the Fed increased supply by more than 100%! You couldn't do that with gold.
The advantage of being able to do that is that you can manipulate the system to mitigate panics and disasters. Last fall would have definitely been a bigger mess if gold was the monetary numeraire. However, the downside is that the advantages of the credit creation are distributed unfairly - big banks vs little banks, GM and Chrysler vs. other manufacturers, etc - and generally have been rewarding failure. Long-term that isn't good. Plus, it concentrates power in Washington and New York, because that is where the money is coming from - also not good. And finally it is a common and I believe correct argument that it tends to concentrate money in the banks that are closest to the policy decisions (read Goldman and JP Morgan) - really bad! That's what I meant by available to a select few - the big banks, particularly the ones influencing policy decisions, and industries selected by the government. That couldn't happen if gold was the numeraire.
Again, the downside would be that last fall, instead of a scare there would have been a catastrophe.
The upside is that when using gold as money, failure, thievery, oligarchy, corruption, etc. get washed out of the system more regularly.
The advantage of being able to do that is that you can manipulate the system to mitigate panics and disasters. Last fall would have definitely been a bigger mess if gold was the monetary numeraire. However, the downside is that the advantages of the credit creation are distributed unfairly - big banks vs little banks, GM and Chrysler vs. other manufacturers, etc - and generally have been rewarding failure. Long-term that isn't good. Plus, it concentrates power in Washington and New York, because that is where the money is coming from - also not good. And finally it is a common and I believe correct argument that it tends to concentrate money in the banks that are closest to the policy decisions (read Goldman and JP Morgan) - really bad! That's what I meant by available to a select few - the big banks, particularly the ones influencing policy decisions, and industries selected by the government. That couldn't happen if gold was the numeraire.
Again, the downside would be that last fall, instead of a scare there would have been a catastrophe.
The upside is that when using gold as money, failure, thievery, oligarchy, corruption, etc. get washed out of the system more regularly.
How can the dollar crash without the world ending?
I would like to address a question that I have seen over the past few years that I think belies a basic misunderstanding of gold, the dollar, and their relationship. Many people in the US (and actually in many parts of the world) consider the dollar to be inviolable. Therefore, the end of the dollar is always somehow equated with the end of civilization. I have seen this sentiment voiced by friends, family, and all over the internet. Let me make an analogy: GM was the greatest car company in the world for decades. The bankruptcy of GM was inconceivable to many (including Rick Wagonner up to a month before the event.) And yet we all know that GM did go belly up, and that the world continued on much as it did before.
Likewise, the US dollar was as good as gold for close to 200 years, and to most in the world it would have been inconceivable that the dollar would be worth just a few percent of its value early last century. Fast forward to the present day, and we are in a situation where the dollar has been depreciated by a roughly 2 percent for the better part of a century, but it has been managed so well that it is inconceivable to most that it would spin out of control (and create a dollar crash.)
The following are typical of the comments that I regularly see, most recently from some intelligent posters on MarketForum:
These are attractive arguments but there are valid counter-arguments. There is a widespread belief that if the dollar was worthless, then essentially we are at the point of armageddon. I have felt the same way before so I understand the impulse, but I think taking a hundred steps back or so, it is pretty clear that this viewpoint could stem from cultural hubris. I suggest that there are items of tangible intrinsic value but that even intrinsic value is relative to circumstances. If you can't breathe, then you have no use for staying warm and dry. If you can't stay warm and dry, then you have no use for hydration. If you can't get hydrated, then you have no use for food, etc. True, you cannot eat gold or put it over your head to keep you dry. But people have valued "money" for eons now - because of the efficiency and convenience it contributes to trade. If we are talking about a survival situation then, yes, gold is useless. But we are so far from survival living that it is a joke! I was in India for four months a few years back, so I know a few things about what "subsistence" living looks like. And let me tell you - our standard of living can drop a heck of a long way and we still won't be at subsistence, let alone survival, levels of existence.
America has an incredibly productive population - we have some of the most creative, entrepreneurial, intelligent spirits in the world. Ask any foreigner that and they will tell you the same. True, the average American has dumbed down over the past couple of decades, but that is simply the result of easy living, much of it subsidized by a currency system that allows us to over-consume on the backs of future generations and on the back of a powerful currency. If the brown stuff hit the fan we would return to our hard working roots within a decade. And I seriously doubt - given the amount of capital and natural resource available in this country - that a decade is enough to get us to subsistence, much less survival levels of consumption.
Therefore, assuming we are above subsistence levels of consumption, then there will still be the existence of normal commerce, just as there exists in the backwaters of India. And from the backwaters of India to the richest chateau in France, people have always needed a convenient way of settling accounts. Gold has an intrinsic value not just because it makes pretty jewelery, but most of all because it has historically functioned as money; that is (1) a numeraire for all other goods, (2) a means of exchange, (3) a store of value (i.e. it doesn't go bad) (4) a source of liquidity (5) easy to transport and identify, (6) durable, (7) easily divisible, (8)hard to counterfeit (9) easy to store and (10) not arbitrarily available to a select few (as is fiat money.) If Americans lose their faith in the dollar which they could in any number of scenarios, they will still want something to function as money. And they won't want to carry tractors or trucks or gardens or irrigation systems around in their back pocket to negotiate business.
US dollars derive their value from the same place as gold: its use as money. However, US dollars have an Achilles heel: the US dollar has no intrinsic value if people lose faith: faith in the issuing agency (Federal Reserve) printing policies, faith in the future growth of the US economy, or faith in the political structure of the US. Therefore, I would suggest that the intrinsic value of US dollars is on a lower rung than that of gold. Gold has an intrinsic value so long as we need an efficient means to trade. The intrinsic value of the dollar also requires faith in a list of other things.
The reason that I feel, like so many others, that the US is behind the 8 ball is that our increased debt levels. Our financial situation, and particularly our net international investment position has deteriorated so much in the past 30 years. I would add to this the possibility that natural resource constraints will lower the natural rate of growth in GDP over the next decade. If the natural rate of growth is low or negative, than this affects all of the debt-GDP ratios negatively. If the natural rate of growth goes negative for a 5 year period, there could be a game changer regarding the incentive to save and invest. I think we are starting to see this in China, as the central government is focusing more on consumption and less on investment.
Likewise, the US dollar was as good as gold for close to 200 years, and to most in the world it would have been inconceivable that the dollar would be worth just a few percent of its value early last century. Fast forward to the present day, and we are in a situation where the dollar has been depreciated by a roughly 2 percent for the better part of a century, but it has been managed so well that it is inconceivable to most that it would spin out of control (and create a dollar crash.)
The following are typical of the comments that I regularly see, most recently from some intelligent posters on MarketForum:
"When I see gold's value stated, it is always stated in terms of the dollar...
If - according to the gold theorists - the US dollar is not worth anything because it is not backed by anything, then how does a gold bug come out ahead if he is investing in something that is valued in another entity (dollar) that is itself essentially worthless?
Your home, garden, tractor, truck, irrigation system... they have real value.
Gold and the dollar are worthless in the end."
These are attractive arguments but there are valid counter-arguments. There is a widespread belief that if the dollar was worthless, then essentially we are at the point of armageddon. I have felt the same way before so I understand the impulse, but I think taking a hundred steps back or so, it is pretty clear that this viewpoint could stem from cultural hubris. I suggest that there are items of tangible intrinsic value but that even intrinsic value is relative to circumstances. If you can't breathe, then you have no use for staying warm and dry. If you can't stay warm and dry, then you have no use for hydration. If you can't get hydrated, then you have no use for food, etc. True, you cannot eat gold or put it over your head to keep you dry. But people have valued "money" for eons now - because of the efficiency and convenience it contributes to trade. If we are talking about a survival situation then, yes, gold is useless. But we are so far from survival living that it is a joke! I was in India for four months a few years back, so I know a few things about what "subsistence" living looks like. And let me tell you - our standard of living can drop a heck of a long way and we still won't be at subsistence, let alone survival, levels of existence.
America has an incredibly productive population - we have some of the most creative, entrepreneurial, intelligent spirits in the world. Ask any foreigner that and they will tell you the same. True, the average American has dumbed down over the past couple of decades, but that is simply the result of easy living, much of it subsidized by a currency system that allows us to over-consume on the backs of future generations and on the back of a powerful currency. If the brown stuff hit the fan we would return to our hard working roots within a decade. And I seriously doubt - given the amount of capital and natural resource available in this country - that a decade is enough to get us to subsistence, much less survival levels of consumption.
Therefore, assuming we are above subsistence levels of consumption, then there will still be the existence of normal commerce, just as there exists in the backwaters of India. And from the backwaters of India to the richest chateau in France, people have always needed a convenient way of settling accounts. Gold has an intrinsic value not just because it makes pretty jewelery, but most of all because it has historically functioned as money; that is (1) a numeraire for all other goods, (2) a means of exchange, (3) a store of value (i.e. it doesn't go bad) (4) a source of liquidity (5) easy to transport and identify, (6) durable, (7) easily divisible, (8)hard to counterfeit (9) easy to store and (10) not arbitrarily available to a select few (as is fiat money.) If Americans lose their faith in the dollar which they could in any number of scenarios, they will still want something to function as money. And they won't want to carry tractors or trucks or gardens or irrigation systems around in their back pocket to negotiate business.
US dollars derive their value from the same place as gold: its use as money. However, US dollars have an Achilles heel: the US dollar has no intrinsic value if people lose faith: faith in the issuing agency (Federal Reserve) printing policies, faith in the future growth of the US economy, or faith in the political structure of the US. Therefore, I would suggest that the intrinsic value of US dollars is on a lower rung than that of gold. Gold has an intrinsic value so long as we need an efficient means to trade. The intrinsic value of the dollar also requires faith in a list of other things.
The reason that I feel, like so many others, that the US is behind the 8 ball is that our increased debt levels. Our financial situation, and particularly our net international investment position has deteriorated so much in the past 30 years. I would add to this the possibility that natural resource constraints will lower the natural rate of growth in GDP over the next decade. If the natural rate of growth is low or negative, than this affects all of the debt-GDP ratios negatively. If the natural rate of growth goes negative for a 5 year period, there could be a game changer regarding the incentive to save and invest. I think we are starting to see this in China, as the central government is focusing more on consumption and less on investment.
Saturday, September 5, 2009
Fed balance sheet
Thought of the day: the Fed announced in August that they would slow the pace of treasury purchases in order to last through October:
http://www.federalreserve.gov/newsevents/press/monetary/20090812a.htm
However, as of September 2nd, they already hold 288 billion in treasuries. They have been averaging 12.5 billion of purchases a week since April, and 8.5 billion/week over the past 2 weeks. With only a total of 12 billion of purchases left over the next 8 weeks, they will either
a) be purchasing an inconsequential amount (1.5 billion/week) for the remaining 8 weeks
b) will finish their purchases sooner than the end of October
c) purchase more than 300 billion total.
I'm guessing "c" is the correct answer and that they will taper down about a billion a week (8 7 6 5 4 3 2 1) and overshoot by 25 billion. That's a rounding error.
With $700 billion of purchases left in the MBS and agency debt markets, does it really matter that they are ending treasury purchases anyway? The MBS is a lot bigger deal, since that will be harder to get off their balance sheet without losses. We will see, but no matter how you count it, we are past the halfway mark on the intended Fed purchases.
To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October.
http://www.federalreserve.gov/newsevents/press/monetary/20090812a.htm
However, as of September 2nd, they already hold 288 billion in treasuries. They have been averaging 12.5 billion of purchases a week since April, and 8.5 billion/week over the past 2 weeks. With only a total of 12 billion of purchases left over the next 8 weeks, they will either
a) be purchasing an inconsequential amount (1.5 billion/week) for the remaining 8 weeks
b) will finish their purchases sooner than the end of October
c) purchase more than 300 billion total.
I'm guessing "c" is the correct answer and that they will taper down about a billion a week (8 7 6 5 4 3 2 1) and overshoot by 25 billion. That's a rounding error.
With $700 billion of purchases left in the MBS and agency debt markets, does it really matter that they are ending treasury purchases anyway? The MBS is a lot bigger deal, since that will be harder to get off their balance sheet without losses. We will see, but no matter how you count it, we are past the halfway mark on the intended Fed purchases.
Friday, September 4, 2009
Silver/gold cleared for take-off
THIS WEEK'S ACTION WAS BULLISH
There was a powerful rally in precious metals this week, with silver up close to 10% and gold up 4%. To my eye, this rally looks like the start of a much larger move. As I remarked on Tuesday, there was an unusual divergence in the first couple of days with the gold equity index (HUI) falling while silver was rising. The vast majority of the time HUI leads the markets, but in this case HUI wound up following precious metals higher - rallying 10% on Wednesday, 5% yesterday, and 1% today. So the divergence was resolved in a bullish manner, with the HUI now leading the market higher.
LOTS OF GOLD SOLD AT $1000
Gold has traded up to $1000 3 or 4 times now, so it would be very unusual to not see a significant breakout above those levels after testing it for so long. The reasoning for this? There are only so many sellers and so many ounces that are up for sale in the $950 to $1000 range. Since the market has traded into that range a number of times, there are less ounces up for sale than if this was the first or second time we traded to $1000.
SENTIMENT IS NEUTRAL
From my sample size of intelligent traders and associates, the majority are not bullish precious metals right now. My sample size is small, but I would say that roughly 1/3 are bullish, 1/3 are neutral, and 1/3 think gold and silver will trade to much lower levels. What is remarkable is that most people in my sample are normally quite bullish on gold. I have a friend who was long silver for years and has sold the majority of his physical over the past 6 months. Every retail gold/silver shop I've been to in the past couple of weeks has been bulging at the seams with bullion, and seemed to be short cash. Perhaps gold bugs have been exhausted by precious metal prices advancing less (or falling more in the case of silver) than was expected. I think there may be a subconscious feeling that if precious metals didn't perform in the past twelve months, then under what circumstances could they possibly perform? Also, the majority of intelligent market watchers are now convinced that deflation is the likely outcome and inflation is almost impossible given the capacity utilization levels. So a lot of people are on the sidelines right now.
The most convincing breakouts are (ironically) the ones with the fewest people already "on board." This makes technical sense because it means there is a lot of sidelined money that can change its mind. Neutral money in particular can easily switch to bullish, and I think that a significant break of $1000 in gold would bring in a lot of neutral money.
DOLLAR IS LOOKING SICKLY
As this week's action proved, you don't need the dollar to fall to get a big rally in precious metals. But a falling dollar would probably contribute to a rally. I've been pretty well convinced by friends and associates that the dollar will rally in a second wave of deflationary recession, but the technical appearance of the chart points in the other direction. Rallies above 79 have been rejected last week and this week. We broke an important support at 78 several weeks ago, so there isn't much to support the dollar if it starts to fall.
MANY SIGNS POINT TO A BIG RALLY
The bottom line is this: there was an impulsive move up this week (I define "impulsive" as a trend move on high volume and a low degree of variance from the trend) in precious metals. Silver led the way higher, and HUI and silver are both rallying more in percentage terms than gold. Sentiment is at a level that is consistent with a breakout as well.
The next steps to watch for in a breakout would be:
1)Gold takes out its March 2008 highs (70%)
2)The dollar falls to 75 (65%)
3)HUI and silver take out their highs from March 2008 (50%)
There was a powerful rally in precious metals this week, with silver up close to 10% and gold up 4%. To my eye, this rally looks like the start of a much larger move. As I remarked on Tuesday, there was an unusual divergence in the first couple of days with the gold equity index (HUI) falling while silver was rising. The vast majority of the time HUI leads the markets, but in this case HUI wound up following precious metals higher - rallying 10% on Wednesday, 5% yesterday, and 1% today. So the divergence was resolved in a bullish manner, with the HUI now leading the market higher.
LOTS OF GOLD SOLD AT $1000
Gold has traded up to $1000 3 or 4 times now, so it would be very unusual to not see a significant breakout above those levels after testing it for so long. The reasoning for this? There are only so many sellers and so many ounces that are up for sale in the $950 to $1000 range. Since the market has traded into that range a number of times, there are less ounces up for sale than if this was the first or second time we traded to $1000.
SENTIMENT IS NEUTRAL
From my sample size of intelligent traders and associates, the majority are not bullish precious metals right now. My sample size is small, but I would say that roughly 1/3 are bullish, 1/3 are neutral, and 1/3 think gold and silver will trade to much lower levels. What is remarkable is that most people in my sample are normally quite bullish on gold. I have a friend who was long silver for years and has sold the majority of his physical over the past 6 months. Every retail gold/silver shop I've been to in the past couple of weeks has been bulging at the seams with bullion, and seemed to be short cash. Perhaps gold bugs have been exhausted by precious metal prices advancing less (or falling more in the case of silver) than was expected. I think there may be a subconscious feeling that if precious metals didn't perform in the past twelve months, then under what circumstances could they possibly perform? Also, the majority of intelligent market watchers are now convinced that deflation is the likely outcome and inflation is almost impossible given the capacity utilization levels. So a lot of people are on the sidelines right now.
The most convincing breakouts are (ironically) the ones with the fewest people already "on board." This makes technical sense because it means there is a lot of sidelined money that can change its mind. Neutral money in particular can easily switch to bullish, and I think that a significant break of $1000 in gold would bring in a lot of neutral money.
DOLLAR IS LOOKING SICKLY
As this week's action proved, you don't need the dollar to fall to get a big rally in precious metals. But a falling dollar would probably contribute to a rally. I've been pretty well convinced by friends and associates that the dollar will rally in a second wave of deflationary recession, but the technical appearance of the chart points in the other direction. Rallies above 79 have been rejected last week and this week. We broke an important support at 78 several weeks ago, so there isn't much to support the dollar if it starts to fall.
MANY SIGNS POINT TO A BIG RALLY
The bottom line is this: there was an impulsive move up this week (I define "impulsive" as a trend move on high volume and a low degree of variance from the trend) in precious metals. Silver led the way higher, and HUI and silver are both rallying more in percentage terms than gold. Sentiment is at a level that is consistent with a breakout as well.
The next steps to watch for in a breakout would be:
1)Gold takes out its March 2008 highs (70%)
2)The dollar falls to 75 (65%)
3)HUI and silver take out their highs from March 2008 (50%)
Tuesday, September 1, 2009
Silver-interesting action today
There is a lot of interesting action in the silver market today. After two minor sell offs earlier in the session, silver has now spiked up to a daily high on high volume, with 20% of a average daily volume trading in 3 minutes.
This was unexpected, because there are many reasons to expect silver to be significantly down today.
1) Weakness in the HUI index yesterday and today
2) commodities are down today
3) the dollar is up today
This combination rarely occurs on days when silver is up.
First, the HUI index has been weak, and was particularly weak yesterday. Silver/gold and HUI are a classic case of co-integration and error correction. (Google "drunk and her dog" for an amusing presentation of what co-integrated series with error correction looks like.) The error correction terms are larger for silver and gold than they are for the HUI. This means that when HUI moves a large percentage in a given day or over a given period and silver/gold does NOT, then silver/gold will likely move in that direction in subsequent sessions/periods.
Second, silver has correlated highly with the overall commodity index for the past 12 months.
Finally, there is the long-standing and obvious inverse correlation between the dollar index and precious metals.
So a peculiar movement today, made more-so by the heavy volume buying silver into the pit close.
This was unexpected, because there are many reasons to expect silver to be significantly down today.
1) Weakness in the HUI index yesterday and today
2) commodities are down today
3) the dollar is up today
This combination rarely occurs on days when silver is up.
First, the HUI index has been weak, and was particularly weak yesterday. Silver/gold and HUI are a classic case of co-integration and error correction. (Google "drunk and her dog" for an amusing presentation of what co-integrated series with error correction looks like.) The error correction terms are larger for silver and gold than they are for the HUI. This means that when HUI moves a large percentage in a given day or over a given period and silver/gold does NOT, then silver/gold will likely move in that direction in subsequent sessions/periods.
Second, silver has correlated highly with the overall commodity index for the past 12 months.
Finally, there is the long-standing and obvious inverse correlation between the dollar index and precious metals.
So a peculiar movement today, made more-so by the heavy volume buying silver into the pit close.
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