Archive for the ‘Gold’ Category

Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market

Tuesday, May 11th, 2010

In our previous article, What if China crashes?, we wrote,

? the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst.

Will the Chinese then rush to gold should their government succeed in cracking down in property speculation? To answer this question, we must first understand some things about the Chinese mindset on property and investments. Currently, interest rates in China are pathetically low- so low that they are below the price inflation rate. Because of their currency peg, the People?s Bank of China (PBOC) is constrained from raising interest rates (see Can China raise interest rates to control its property bubble?). Also, the Chinese are known to be savers.

So, that creates a problem. Imagine you are a typical Chinese saver. What if you want to save and the cash at bank is yielding returns that are below the rate of price inflation? That results in a very great disincentive to save your money in the bank and pushes you to ?invest.?

The next question is where can you ?invest? your money? Remember, a lot of other people are facing the same problem because the Chinese government?s policy of force feeding credit into the economy is creating a gigantic rain of freshly printed money- a lot of people are having too much money on their hands. Unfortunately, in China, with its underdeveloped financial system, there is not much avenue to ?invest? your money.

The range of financial instruments in the stock market is limited. There are hardly any derivatives available for you to short the market (but currently, stock index futures are on the trial phase). Not only that, the standard of disclosure and reporting has too much to be desired. Most average mum and dad stock investors in China can only take long positions on a stock market that is highly volatile and speculative (due to lack of disclosure). No wonder investing in stocks is not that popular in China.

Thus, the only investment outlet for this mountain of freshly printed money is the property market. There are a few characteristics of the Chinese property market that most foreigners will not know. Perhaps these characteristics explain why the property bubble in China is so enduring.

Firstly, the Chinese property bubble is definitely bigger than the property bubble in Australia. But you may be surprised to learn that the consumer leverage in the residential property market in China is in fact smaller than Australia. In China, you need at least 40% deposit to qualify for a mortgage loan. As Patrick Chovanec wrote here,

According to the latest statistics I?ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks.  That?s a sharp increase from just a few years ago, when nearly all such purchases were made in cash.  In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an instalment plan!).

A lot of residential real estate transactions in China are made in cash!

Secondly, the secondary market for residential real estate in China is extremely weak. As Patrick Chovanec wrote here,

What we see in China, though, is an extremely weak secondary market.  In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25.  In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales).  Even in China?s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen.

If you combine these two characteristics together, you can conclude that a lot of real estate purchases in China are made with relatively little borrowing (or none at all) on brand new homes. As a result, the Chinese are, as Patrick Chovanec wrote,

? in that sense, the people using real estate as a store of value, a place to stash their cash?

That explains why there is a lot of idle and empty apartments in China as more and more of them are being built by property developers.

But the fact there is relatively little consumer leverage in the Chinese property market does not mean that there?s little leverage in the property sector. In China, the leverage is placed on the shoulders of property developers. In other words, the Chinese property ?investors? are de-leveraging the developers!

Now, what if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property? We will go into that in the next article. Keep in tune!

Are you a range trader or trend follower?

Thursday, April 1st, 2010

Remember, back in Explosive gold price movement ahead. But up or down?, we showed you that gold prices had been bound within a range from February 2009 to the day when the article was written (September 2009). As we showed you in the price charts, the range got progressively narrower and narrower as the months go by. That gave rise to a price formation called the ?pennant.? As we wrote in that article,

A pennant is like a spring coiled up, ready to jump [either up or down] at any moment.

Not long after we wrote that article, gold prices broke out of the range and made a record high of US$1,226.37 on 2 December 2009. Today, gold prices are range bound again.

How to buy and invest in physical gold and silver bullionIn 2005, we remembered the headline from the Australian Financial Review (AFR) screaming “gold fever” as gold prices hit US$500 for the first time in many years. As the crowd piled into gold, driving it to a then record high of over US$730 before a major correction threw it down to a low of around US$540. Then gold was range bound for about a year before making another dash to above US$1000 before the Panic of 2008 crashed it to around the US$700 level. Then it recovered, made another dash to US$1000 before being range bound again. The rest of the story you know.

Do you see a pattern? Basically, the story goes like this: range-bound, break out, dash up, correction, range-bound… rinse and repeat. You can visually see this pattern nicely in the Why gold will not make new highs or lows this year video made by our friends in Market Club (which we have an affiliate relationship with). If this pattern repeats itself, we may see gold prices becoming range bound for the rest of this year before making a record high next year.

For those who are into trading, this is a good opportunity to engage into “range trading.” The principle behind this type of trading is very simple- sell when prices reach the upper range and buy when it reaches the lower range.

For traders who engage in “trend following,” they follow a different approach. They wait for break-outs of the range and buy/sell accordingly. For example, if gold breaks out of the trading range upwards, they buy.

Is it possible to be a range trader and a trend follower at the same time? One old trader told us “No, unless you are extremely smart.” Why? When you see gold prices reach its upper range, a range trader will sell (or short sell). A trend follower, on the other hand, will buy.

What if you are trying to be both? Do you buy or sell?

Hedging against currency crisis with electronic gold

Thursday, March 18th, 2010

Back in January this year, we talked about protecting yourself against currency crisis in Protecting yourself against currency crisis. The basic idea of that article is that the time to prepare for such an eventuality is before TSHTF. Once it happens, it is too late.

For our Australian readers, this seems to be less of a worry because there is still an air of optimism (relatively) among the population. But for our American readers, the nagging feeling of fear and brooding seems to be permeating among the masses. As the author of this book, The Ultimate Suburban Survivalist Guide: The Smartest Money Moves to Prepare for Any Crisis, wrote in the introduction,

Do you have a pervasive sense of anxiety, as if our modern world is on thin ice? Do you have an uneasy feeling that Wall Street seems to be collapsing under the weight of bad debts and bad decisions- and dragging your job along with it? Or, maybe you feel our society is coming apart at the seams, and that our civilization could actually break down and collapse.

You are not alone. A lot of people are worried. In fact, there is a growing movement of people who are preparing for the end of the world as we know it (TEOTWAWKI).

That book is written in an American context. If you are an American reader, please let us know how true or accurate this is in the comments below.

Now, for this article, we will stick to the original point (currency crisis) and not venture to the theme of TEOTWAWKI (survival skills/gears, self-sufficiency, guns, supplies stockpiles, etc). We hazard a guess that the TEOTWAWKI theme is of more interest to our American readers than to our Australian readers. But if enough readers express their interests in TEOTWAWKI, we may do more research and write more about it. If not, let’s stick to the topic. (By the way, contrarians like Marc Faber are alluding to the TEOTWAWKI theme).

Okay, back to currency crisis. There are two components to hedging yourself against currency crisis:

  1. Diversify your assets overseas.
  2. Prepare a cache of physical monetary assets (e.g. physical cash and physical gold/silver).

For the second component, our book How to buy and invest in physical gold and silver bullion would cover it very well. But for this article, we will look at the first component.

One of the ideas (and note, they are ideas- nothing in this blog should be taken as financial advice) that is floating around in our mind is electronic gold. We first touched on this idea two years ago in What is the future of silver?,

Today, we have a very powerful technology that can solve the convenience and sub-divisibility problem (see Properties of good money) associated with [using] gold [as] money- computers. All we need is a trusted central repository of gold (perhaps today?s central bank can change its institutional role for this purpose) and let computer systems keep track of ownership and transfer flow of gold money. In other words, the gold is physically kept in a secure central location while the finer sub-divisions and change of ownership of gold money is recorded as bookkeeping entries on computers. No physical movement of gold is necessary.

This passage was written to refute some of the views that gold can never ever function as money again because it will be physically inconvenient (or beyond imagination) to carry minuscule amount of physical gold as money to buy small items (e.g. bread).

Well, two things against this argument:

  1. In Zimbabwe, people were already used flakes of gold to buy bread (see the video at Rural Zimbabweans are desperately panning for gold powder to ward off starvation).
  2. The same problem of inconvenience existed two hundred years ago and that’s why mankind invented the use of warehouse receipts for gold as a proxy for money (the history of money is written in more detail in our book, How to buy and invest in physical gold and silver bullion). Warehouse receipts for gold are the precursor to the paper money we have today.

In this current age of information technology, this problem can be easily solved with electronic gold. In fact, there are quite a few electronic gold solutions currently implemented today. One of them is (which we disclose that we have an affiliate interest with them).

One very important thing to remember: the whole point of owning gold is to own an asset that is nobody’s liability (if you want to understanding the reasoning behind it, please read How to buy and invest in physical gold and silver bullion). That will eliminate most gold ETFs, gold futures, gold CFDs, etc because they are basically financial assets disguised as ‘gold’ as they exist as a liability in someone else’s balance sheet. As for other types of gold that you do not take physical possession for yourself (e.g. kept in vault storage on your behalf), you have to look at them on a case-by-case basis to ensure that

  1. You own the legal title to the gold (i.e. your gold is really yours and not belong to the liability column of someone else’s balance sheet), and
  2. Trust that they are able to physically deliver your gold to you on demand.

So, if you trust, then they fulfil these two criteria. But do not let us tell you who to trust or not to trust- seek advice, do research and decide for yourself.

When we first heard of, we imagine a world whereby gold becomes money and payments can be made back and forth electronically as conveniently as PayPal. If you have a full-holding account in, you can certainly do that with their patented technology. We don’t see why it can’t be done.

But we talked to those guys and found out something interesting. Apparently, most of their clients do not use as electronic gold money (as we imagined in our fantasy). In reality, most of them link their full-holding account with their bank accounts all over the world. Why would someone do that? Here is what we think (bear in mind, this is just our opinion)…

Remember, back in Protecting yourself against currency crisis, we wrote

Personally, we feel that the best way to protect you from a currency crisis is to leave the country before TSHTF.

If you believe that all paper fiat currencies will eventually depreciate significantly against gold, then it makes sense to hold gold. Let’s say you have a cache of physical gold and you decide to leave the country? That means you have to lug your physical gold to that country where there’s always a danger of loss in transit from bandits, thieves, corrupt officials, ship-wrecks, air-crash, etc. Or maybe the custom officers in both the source and destination country may not look in favour of anyone bringing in physical gold. Whatever the reason, you may not feel comfortable having so much valuables in your physical possession while you’re on transit to another country. For a big fat filthy rich person, it is physically too demanding to lug around his large stash of gold.

GoldMoney. The best way to buy gold & silver So, here come the folks at Since you have already set up links between your full-holding account and the various overseas bank accounts all over the world, you do not have to worry about hauling physical gold around. (Of course, having some physical gold coins in your pocket will always be useful for things like paying for a space on a leaky boat to travel to that country- jokes aside, we mean it is not wise to completely do away with having some physical gold in your physical possession).

So, the next time you visit a foreign country, you may want to open a bank account over there!

Meanwhile, please vote on the poll below:

Why oil cannot function as currency reserves?

Sunday, February 28th, 2010

Not long ago, we were talking to an analyst from a pretty reputable value fund manager. He was adamant that gold is in a bubble because “everyone is buying it.” When we heard his rationale for this belief, we knew straight away that he had not clearly thought through his underlying beliefs about gold and the nature of money.

In fact, his understanding about the nature of money is closer to the level of an uninformed person on the street than what we expect from an investment professional. For example, this analyst was completely blind to the colossal difference between the rarity of gold and the rarity of rocks, citing that there are heaps of gold in the world! It is one thing to have a different opinion about gold because one belongs to the deflation camp. But it is just simply too shocking to hear a suit-wearing investment professional from a reputable fund manager sprouting such nonsense! If a person cannot see the difference between the rarity of gold and rocks, then it will be beyond his level to even understand the properties of good money, which is critical to understanding gold.

Now, if you are new to this blog, you may wonder whether gold is a bubble or not, since there is no (or rather, very limited, to satisfy the pedantic) industrial use for it. If this is your question, we recommend that you read If gold has no intrinsic value, is it a bubble?. Or better still, you may want to read our book, How to buy and invest in physical gold and silver bullion for a fuller picture.

At this point, this analyst posed a very good question. Given that everyone agrees that the US dollar is going to depreciate further in the long run, then wouldn’t oil be a better substitute (e.g. as currency reserves) for it than gold? As that analyst said, oil should be a better substitute because it is a vital commodity, whereas gold has hardly any practical and industrial use? In other words, will oil function better as money than gold?

To answer this question, first we have to understand what money is. At the root of its nature, it is a medium of exchange. From this nature, it then follows that money functions as unit of accounting, store of wealth and so on. The question then becomes, is oil a better medium of exchange than gold?

At first glance, it seems that the answer is yes. But if you think carefully, if oil ever becomes a medium of exchange tomorrow, it will bring about disaster to humanity. To understand why, let’s have a thought experiment. Remember, back in If gold has no intrinsic value, is it a bubble?, we wrote,

Now, imagine if one day the US government decree that all tooth-pastes become legal tender for payment and settlement of debt (i.e. function as money), how would you feel if you have to physically consume your money daily for the sake of oral hygiene?

Let’s say the government declares that 30 days from now, tooth-pastes will function as legal tender money. What will happen? Firstly, the prices of tooth-pastes will sky-rocket. Next, tooth-pastes will disappear from the shelves of supermarkets. People will be hoarding and stockpiling tooth-pastes. After 30 days, when tooth-paste officially becomes legal tender money, people will start to have bad breath, especially the poor, who can’t afford to consume tooth-pastes for the sake of oral hygiene. Then the demand for tooth pastes will rise to the moon, not because the demand for oral hygiene increases, but because the demand for tooth-pastes as money increases. Not only that, no matter how much tooth-pastes Colgate produces, there will always be shortages because there will be mass-hoarding of them as money.

This may be a funny though-experiment. But if oil should ever function as medium of exchange, the outcome will not be funny. There will be an acute shortage of oil, as nations will be hoarding and stock-piling oil in a frenzy. Guess what will happen if we have acute oil shortages in a Peak Oil world that is addicted to oil? The way of life as we know will grind to halt and we will all be back to travelling in horse-drawn carriages.

That is why, when governments undermine the store-of-value function of money (something that can only be done in a fiat monetary system), investors will flock to useful, vital and scarce commodities to store their wealth. This in turn will result in those scarce commodities becoming scarcer. The food riots around the world in 2008 were an example of how this can happen (see Who is to blame for surging food and oil prices?). That also explains why the housing ‘shortage’ situation in Australia is an intractable problem (see Does rising house prices imply a housing shortage?).

That is the reason why gold and silver?functioned as money historically. The free market tried using scarce, useful and vital commodities (e.g. salt, sugar, tobacco, cattle) as money before and it didn’t work out. Those that did probably did not evolve into more advanced civilisations.

Of course, just because it is stupid to let oil function as currency reserves does not necessarily mean it wouldn’t. As Albert Einstein said, two things are infinite: the universe and stupidity.

Does gold hedge against inflation/deflation?

Tuesday, February 2nd, 2010

It is often parroted by mainstream media that gold is a hedge against inflation. Sometimes, you will hear that gold is a hedge against deflation. Also, from our previous article (Will gold mining shares hedge against deflation again since the Great Depression?), we established that even though gold stocks hedges against deflation during the Great Depression, it does not necessarily apply to today’s situation. However, one of our readers said that Marc Faber reckoned that gold and gold stock hedges against deflation.

Isn’t this very confusing? How does gold hedges against inflation and deflation?

The answer is explained clearly in our book, How to buy and invest in physical gold and silver. For those who have not read that book, we will give some hints to the answer.

First, “inflation” and “deflation” are over-generalised words. Gold is a hedge against a narrow subset of “inflation” and “deflation.” The corollary is that in certain cases of “inflation” and “deflation,” you will lose using gold as a hedge. In page 20 of How to buy and invest in physical gold and silver, we have a story of Mr Goldberg who died a miserable man because he had nothing to show for his long-term commitment to gold.

As we said in How to buy and invest in physical gold and silver, the fundamental reasons for accumulating gold as a hedge are:

  1. Lack of confidence in fiat money (to function as money)
  2. Lack of trust in the financial system

Inflation is only one of the possible symptoms of point 1. Likewise, deflation is also one of the possible symptoms of point 2. The implication is that it is possible to see these two symptoms without holding those two fundamental reasons in your heart (i.e. see some forms of price inflation/deflation and yet still trust in fiat money and the financial system). Indeed, inflation has been with most of the world in the past 20 years. Deflation has been with Japan for the past 20 years. That is why there are many people (especially those from the mainstream media) who are deriding gold and gold-bugs.

But any time you have good reasons to lack confidence in fiat money and/or trust the financial system, it will be the time you will want gold as a hedge before the symptoms show up unmistakably as inflation/deflation.

To help you understand, we will give an example. During the Great Depression, banks were collapsing en masse. If your bank fails, then your cash at bank disappears into thin air. If everyone’s cash at bank disappears, then you can be sure there will be falling prices because there will be a sudden shortage of cash- everyone will want to hoard whatever physical cash they have on hand. In such a situation, if you own lots physical gold then you need not fear. You can always go to the Federal Reserve (remember, it was still the gold standard back then) and exchange your gold for physical cash. Or in theory, you can transact in physical gold only.

Today, during the Panic of 2008, banks were dropping dead like flies. That’s also a good reason to own gold or government bonds (we imagine that you can insist that the government pays you the yields with physical cash instead of depositing them at a wobbly bank). But then someone like Kevin Rudd announced that the government is going to guarantee all cash at bank. If there’s going to be falling prices (deflation) and if the financial system is going to function, then government bonds and term deposits will be better than gold. If there’s going to be mild inflation and if everything is going to be fine and benign as in the past 20 years (e.g. no currency crisis, no collapse in the financial system), then cash at high-yield bank accounts will be better than gold too.

Remember. as we wrote in our book (How to buy and invest in physical gold and silver), gold will only do exceptionally well at the extremes.

Here is a quiz question for you: if there’s going to be a collapse in the global financial system (as Marc Faber described as “deflation could only be triggered by one event: a total collapse of the existing global credit bubble”), would you rather own physical gold or gold stocks?

Will gold mining shares hedge against deflation again since the Great Depression?

Sunday, January 31st, 2010

During the Great Depression, gold mining stock prices were the only bright light in the darkness. As one of our readers found a 1931 newspaper quote,

Gold mining stocks have been among the strongest performers since year-end; earnings this year seen exceeding both 1930 and 1929; miners are benefiting from stable price as production costs decline.

As we quoted the most deeply buried Austrian School 1936 classic (originally written in German), Crises & Cycles by Wilhelm R?pk in Which industry?s profitability grew as the Great Depression progressed?,

Leaving aside the industry of manufacturing books on crises and cycles, there are two big industries likely to prosper inversely to the depression, the armaments industry and the gold-mining industry.

Does that mean that gold mining shares are going to do well in times of deflation because it did well during the deflationary period of the Great Depression?


Here, we have to be careful in applying the lessons learnt from history correctly. There is a reason why gold mining shares did well during the Great Depression. Unfortunately, that reason does not apply in today’s context. What is the difference between today and the Great Depression?

The gold standard.

You see, back in 1931, one ounce of gold was defined as approximately US$20. Back then, as we introduced the history of money in our book How to buy and invest in physical gold and silver, currencies (e.g. dollar, pound, franc) were merely warehouse receipts for physical gold. In a sense, the central bank was a government granted monopoly gold warehouse.

In other words, the Federal Reserve was the only institution in the world that would buy and sell gold at a guaranteed fixed price (because the US was the only country still under the gold standard). The were two implications:

  1. There was an infinite ‘demand’ for the produce of gold mining companies.
  2. The price of the what the gold mining companies produced had a minimum price.

As the Great Depression was a period of deflation, prices of everything were falling. That means the costs of gold mining companies were falling as well. So, if you have a business in which the things that it produces:

  1. Have infinite demand
  2. Have a guaranteed minimum price
  3. Are getting cheaper to produce

Wouldn’t that be a windfall for you business? Indeed, that was the fortunate position faced by gold mining companies back then. That’s why their share prices were rising. Today, no country is under the gold standard and thus, currencies are backed by nothing. Therefore, gold mining companies are facing an entire different situation:

  1. Their produce have finite demand
  2. Prices of their produce fluctuate
  3. Costs of producing are increasing

Even if real deflation is to happen today, falling cost of production will be accompanied by a fall in price of gold.

So, if you find any experts, tip-sheets and research reports justifying buying gold mining shares as a hedge against deflation by using the example of the Great Depression as the basis of their recommendation, then you know what to do.

Here comes the silly season for the markets

Sunday, December 20th, 2009

It’s less than one week to Christmas and we would like to wish all our loyal readers a very Merry Christmas and a Happy New Year. Enjoy your holidays and eat, drink and drive in moderation.

For us, we will be taking it easy for the next two weeks. So, you will find that we will be writing at less than our usual frequency from today till the 3rd of January. After the next two weeks of break, we will be back to our regular publication schedule. However, there will be some activities at our Twitter and Facebook page during the holidays. Of course, we wouldn’t leave you completely on the lurch- should there be any extraordinary market events, we will write about them. With that, we will leave you one little market nugget to digest…

It is the official silly season for the financial markets!

What we mean is that at this time of the year, investors should not read too much on the market movements. Traders, like everyone else, are also taking a break and taking it easy. Fund managers are squaring their books. Trading volumes are typically very low. In other words, the markets will be making strange movements that should not be over-interpreted.

Our friend, Adam at Market Club has this to say about the silly season (in the context of the gold market): It’s Official Silly Season for Gold. Adam’s bottom line is this:

I strongly recommend that if you?re not in gold [Ed’s note: to trade, not invest] to wait until we see more interest and activity coming into 2010.

If you are into trading, you may want to get 10 trading lessons FREE from Adam Hewison and MarketClub. But if you into long-term big picture invest in gold and silver, then you will want to read out book, How to buy and invest in physical gold and silver bullion.

Shift in market psychology

Tuesday, December 15th, 2009

The 4th December 2009 should be noted in your diary as the day where the market psychology has changed.

Prior to that day, any economic numbers that was better than expected will be interpreted by the market as being ‘good’ for commodity prices. The idea is that ‘good’ numbers imply economic recovery, which implies increased demand for commodities, which in turn implies rising commodity prices. As a side effect, the US dollar trends lower. The converse is true for economic numbers that was worse than expected.

After that day, there is a major shift in the market psychology. As we wrote in What happened to gold prices?, when the market believes that the economy is going to recover, it will anticipate and speculate on interest rate hikes by the Fed, which is bad for stocks and commodities and good for the US dollar. The logic, as we wrote in November 10 at Booming real economy, falling stock market?, goes like this:

A truly recovering real economy will result in liquidity draining out of the system. Since the current rally is fuelled by massive loosening of liquidity, draining liquidity will imply that the stock prices will fall and the US dollar strengthens. As the US dollar strengthens, then the short squeeze in the US dollar will happen (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which implies that the Aussie dollar and stock prices will tank.

Right now, the market is believing in the economic recovery story (which we are sceptical). This belief is not that strong yet because there is yet to be a large scale move in unwinding the US dollar carry trade.

Some of you (who are trading in paper gold) may be concerned about what’s happening to the gold price lately. But remember, the main story is the reversal of the US dollar carry trade (which will result in a rising US dollar). Gold (or whatever commodity you are trading) is not the lead actor in this story. If you notice, not all commodity prices are moving down in unison, unlike the great de-leveraging of 2008-2009. Falling commodity, gold, silver and stock prices are just the symptoms of the reversal of the carry trade. To the extent that the rise of the Aussie dollar is the result of the carry trade, this will imply a weakening Aussie dollar (see Return (and potential crash) of the great Aussie carry trade).

If you are investing in physical gold bullion, there is nothing to worry about (see our book, How to buy and invest in physical gold and silver bullion).

Is gold going parabolic?

Tuesday, December 8th, 2009

No doubt, as gold prices run up in the latter half of 2009, a lot of commentators are saying that gold is in a bubble territory. Their justification for such a claim is that when an industrially useless metal to go up in price so quickly, irrationality is the only explanation. Hence, according to them, it can only be described as a “bubble.” Even the Sydney Morning Herald, came up with an article titled, Gold a ‘useless asset to own’.

But as contrarian investors, we welcome such ignorance. That is how wealth is transferred from the weak hands to the strong hands. If you have not already, we recommend that you read If gold has no intrinsic value, is it a bubble?. Those who believe that gold is in a bubble do not understand the fundamental of what money is- they fail to see the mirror image irrationality. With that, we shall take a quote from Marco Polo in our book, How to buy and invest in physical gold and silver bullion,

With regard to the money of Kambalu the great be called a perfect alchymist for he makes it himself. He orders people to collect the bark of a whose leaves are eaten by the worms that spin silk thin rind between the bark and the interior wood is taken and from it cards are formed like those of paper all black He then causes them to be cut into pieces and each is declared worth respectively half a livre a whole one a silver grosso of Venice and so on to the value of ten bezants All these cards are stamped with his seal and so many are fabricated that they would buy all the treasuries in the world He makes all his payments in them and circulates them through the kingdoms and provinces over which he holds dominion and none dares to refuse them under pain of death All the nations under his sway receive and pay this money for their merchandise gold silver precious stones and whatever they transport buy or sell The merchants often bring to him goods worth 400,000 bezants and he pays them all in these cards which they willingly accept because they can make purchases with them throughout the whole empire He frequently commands those who have gold silver cloths of silk and gold or other precious commodities to bring them to him Then he calls twelve men skilful in these matters and commands them to look at the articles and fix their price Whatever they name is paid in these cards which the merchant cordially receives In this manner the great sire possesses all the gold silver pearls and precious stones in his dominions When any of the cards are torn or spoiled the owner carries them to the place whence they were issued and receives fresh ones with a deduction of 3 per cent If a man wishes gold or silver to make plate girdles or other ornaments he goes to the office carrying a sufficient number of cards and gives them in payment for the quantity which he requires. This is the reason why the khan has more treasure than other lord in the world nay all the princes in the together have not an equal amount.

Chapter XXVI, Paper Money Immense Wealth of the Great Khan, The Travels of Marco Polo

To understand gold, one needs to understand the history of money (which our book, How to buy and invest in physical gold and silver bullion has more information on). If we can laugh at the irrationality of the ancients as described in Marco Polo’s memoirs, then we certainly have to laugh at humanity’s irrationality today with regards to money.

But at the same time, we are not saying that gold is the cure-all for the the ills of today’s monetary system. In other words, we are not worshipping gold (see When to sell your gold?).

But if you are still worried that gold prices are running up too fast, you ain’t seen nothing yet. This speed in price increase is nothing compared to what happened in 1980. Let’s take a look at the gold price chart back then:

Gold price from 1975

Gold price from 1975

By 1979, inflation in most countries was running in double digits in most countries. Oil prices was spiking and the Iranian revolution toppled the Shahs. The Soviets was entering Afghanistan. Back then, there was a real fear that the world will end and that seemed like the end of fiat currencies (8 years after President Nixon cut the final link between gold and the US dollar). The price of gold doubled in a few weeks between December 1979 and January 1980. That’s really a parabolic movement. Today’s run up in gold prices is nothing compared what happened in 1979/1980. We have friends who bought gold in 1980 at around US$800. Back then, there was talk that gold price would be hitting US$1000. Unfortunately, gold price fell and our friends lost half their capital in a flash.

But fortunately, fiat currencies survived and the world did not end. But those who ridiculed gold used that as a basis to believe fiat currencies will still survive i.e. fiat currencies will survive because they did survive after 1979. This is an example of a mental pitfall that we call “lazy induction” (see Mental pitfall: Lazy Induction). That’s because if you take an even bigger picture view, there were many countless examples whereby all the other fiat currencies in the entire history of human civilisation failed to survive. The Mongol currency during Marco Polo’s time was such an example.

As Nassimb Nicholas Taleb wrote in The Black Swan: The Impact of the Highly Improbable, the wrong way to learn from history and looked at happened and then extrapolate it into today. It is equally important to look at what could have happened and evaluate whether it is still applicable today. In his words, we have to study the “alternative paths” of history. For all we know, fiat currencies could have died after 1979. Maybe, someone powerful back then could have made a slightly different decision and that could have set a chain reaction that would culminate in the death of fiat currencies.

We never know whether the “alternative path” of history will happen today. But it pays to be prepared.

What happened to gold prices?

Sunday, December 6th, 2009

On Friday, gold prices suddenly took a tumble of around 4% on high volume. The so-called narrative by the media of what happened goes like this (take care to read Mental pitfall: Narrative Fallacy):

  1. US unemployment data for the month turns out to be better than expected.
  2. Therefore, the US economy is on the way to a real recovery.
  3. As a result, Ben Bernanke is going to raise interest rates.
  4. Therefore, paper currencies are going to survive (one ‘expert’ interviewed for a media article really said that).
  5. Hence, gold got sold off.

There are many slight variations to this narrative. For example, “gold was sold because of a rebound in US dollars” or something like that.

But we take the media narrative with a grain of salt.

Firstly, the US unemployment figures are always fudged in the first place. In fact, this doctoring of statistics has enabled smart entrepreneurs to earn a living by setting up a web site ( selling non-doctored statistics. Secondly, the overall unemployment numbers showed a more disturbing trend, as A deeper look behind the jobless numbers reported,

The number of long-term jobless ? those out of work six months or longer ? is growing, while the number of short-term unemployed is declining.

In other words, the US job market is going through a worsening structural problem. That is, there is a growing mismatch between the skills demanded and skills supplied in the economy. As we wrote in Overproduction or mis-configuration of production?,

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments (see The first step in an economic slowdown?mal-investment in capital).

Our view is that even if the US government succeed in boosting employment by printing money (see Unemployment in Weimar Germany for an example of such) and cannibalising the private sector, it will be a sign of inflation, not prosperity. Unfortunately, the market often has the habit of being duped into thinking it is the latter as the sell-off in gold on Friday shows.

Next, is Ben Bernanke going to raise interest rates? We very much doubt so (see Permanently low interest rates for Uncle Sam?). At most, the Fed may do some token rate hikes to dazzle the market. But the main point is that the Fed Fund rate will remain low for an extended period of time.

So, will we be selling our gold? That depends on why we are holding gold in the first place. If (as we wrote in our book, How to buy and invest in physical gold and silver bullion) we are investing in physical gold bullion because of our distrust in the financial system and/or paper currencies, then there’s no reason to sell because nothing has changed.

But if we are trading in ‘gold,’ than that is a different story. To understand what’s happening, imagine a ship tilting to one side. As the ship tilts more and more, the pressure to rebalance into an upright position increases (any properly constructed ship should do that). In the same way, based on technical analysis, ‘gold’ prices are in highly ‘overbought’ territory. That is, the upward price momentum for gold is getting too high. More and more market participants are tilted to the long side of the trade. As such, a ‘rebalancing’ (i.e. correction) is overdue to get the momentum into a more balanced position.

But as in the ship analogy, there’s always a tipping point. If the ship tilts too much to one side, there will come to a point whereby its automatic stabiliser will not work and the ship will flip over. In the same way, if the momentum for gold prices keeps on increasing and go past a tipping point, it is a result of a currency crisis.

If you are a short-term trader in ‘gold,’ what should you do? So far, it is too early to tell whether this one-time correction signifies a change in trend (whereby US dollar will rebound for say, 3-4 months) or just a blip in up-trend. As we check out our cool Market Club charting tools, we find that Friday’s action barely touched the 30-day exponential moving average. In other words, so far, the up-trend still remains. But the thing to watch out for is whether the market will ‘believe’ that Ben Bernanke is going to raise interest rates (even though we all know such a ‘belief’ is ridiculous). If this belief gets entrenched, then we will see a temporary reversal in trend, which is a signal for traders to sell.

So, if you are investing in physical gold bullion because you want to sleep better at night, then Friday’s action should not concern you. If it still concerns you, then we recommend that you read our book, How to buy and invest in physical gold and silver bullion.

If you are trading in ‘gold,’ then you may want to hear Market Club’s technical update on last Friday’s action. Click here and check out the story under “2 Minute Video On What Happened To Gold Today.”