Archive for April, 2009

Pricing of gold forward rate

Wednesday, April 8th, 2009

Back in Pricing of futures, we discussed about the theoretical pricing of futures. But the futures price (or more technically correct, the forward price) of gold is calculated differently. This is because there is a lease rate for gold. As we mentioned before in Get paid to borrow gold and silver?,

But for a certain class of gold owners, they DO earn interests on gold. Right now, instead of receiving interest for lending out gold, they are paying people to borrow gold.

The best way to explain gold forward pricing is to use an example. To understand this, we assume that you have already read and understood Pricing of futures beforehand. Let’s suppose the spot price of gold is $1000 per ounce. The lease rate for 180 days is 2 percent per annum while the carry cost (which includes storage and interests) is 5% per annum.

So, we borrow $1000 for 180 days. At the carry cost of 5%, we have to repay $1000 * (1+.05(180/365)) = $1024.66 in 180 days time. With the borrowed $1000, we buy 1 ounce of gold and lease it out. At the end of the 180 days lease period, we expect to get back 1 * (1+.02(180/365) = 1 (1.01) = 1.01 ounce of gold.

Therefore, 1 ounce of gold has grown to 1.01 ounce in 180 days time at a value of $1024.66. Therefore, the forward price of gold will have to be $1024.66/1.01 = $1014.51. If the 180-day forward price of gold is not at $1014.51, then an arbitrage opportunity exists (see How futures price affect market price for more details).

To sum it all up with an equation, if the spot price is S, the forward price is F(T) for a time-horizon of T days, the carry cost is r, and the gold lease rate is r*, we have:

F(T) = S [1 + r (T/365)] / [1 + r* (T/365)]


Is long gold mainstream?

Sunday, April 5th, 2009

Currently, there is a lot of interest in gold from the mainstream investment circles. Someone told us that the “ratio of bulls to bears for gold is running in the low 80s at the moment.” Since we are long-time advocates of gold, does it mean we have become mainstream investors and are no longer contrarian?

Well, the short answer is, we are still contrarian. The long answer requires more explanation.

First, when the word “gold” is mentioned, what is the gold that is meant? Is it gold certificates, gold ETF, gold CFD, gold futures, gold stocks, options on gold futures or physical gold? If the ?gold? is not physical gold, then these ?gold? are just some variations of financial assets. The common denominator in financial assets is that they are always a liability on the other side. In other words, a lot of the ‘gold’ are merely financial assets disguised as gold.

So, if you want to invest in gold, you have to understand the distinction between ‘gold’ (financial assets disguised as gold) and gold (real physical gold). The whole point of investing in gold is to transfer a portion of your wealth to a form that is outside the financial system. If you invest in ‘gold,’ then your wealth is still trapped within the confines of the financial system.

So, when you hear that investing in gold is now in the mainstream, it is more accurate to understand that this merely means that investing in financial assets disguised as gold is now in the mainstream.

Can government create jobs?

Thursday, April 2nd, 2009

Recently, one of our readers wrote,

I recently voted against Anna Bligh who?s govt has sent QLD into some $74B debt. Her plans are to keep spending. I found it horrific. The other party reckoned they wouldn?t spend as much and would cut govt spending by 3%. Well, I?m not sure I believed it but voted against the emcumbant anyhow – along with some 40+% of other QLDers. Anna was returned though and now feels that she has a ?mandate? to spend spend spend. It?s an horrific state of affairs. Most QLDers like me wouldn?t have been aware of the extent of govt debt built in in the ?good times?.

If you notice, this “spend, spend, spend” slogan is very strong in United States, Britain, Japan, Australia and maybe China (Premier Wen recently killed off the idea of a second stimulus spending). But Europe are cool about such an idea. Particularly, France wants more regulations in the financial system and threatened to walk out of the G20 Summit if their demand is overshadowed by the “spend, spend, spend” brigade (see France is threatening G20 walkout).

Back in our Queensland, State Premier Anna Bligh promised to create 100,000 jobs over the next 3 years. The State Opposition was so motivated to keep her accountable that they set up a Jobometer web site to monitor her ‘progress’ in her promise. Politicians, in order to win elections, will promise anything and everything even if the promise is dubious in merit. Can the Bligh government really create jobs as they promised? We suppose they are going to achieve that by the slogan of “spend, spend, spend.”

We believe it is not the job of governments to create jobs. Yes, they may employ civil servants to work on the administrative bureaucracy, legal enforcement, national defence and so on. Beyond that, governments cannot produce goods and services. For example, the Federal government’s NBN project has to be contracted to the private sector. Also, governments often end up outsourcing some of their services to the private sector. Given that governments’ general track records on running business enterprises are either non-existent or abysmal, the private sector is still the one that keeps the economy alive and  dynamic, create jobs, innovate and produce goods and services far more efficiently than any governments can do.

How is the Bligh government going to create jobs?

Are they going to employ surplus civil servants for the sake of ‘creating’ jobs? No, that is not a way to keep the economy healthy. If they do that, Queensland will end up with a huge and cumbersome government sector that crowds out and stunt the private sector. A stunted private sector will retard the economy’s potential to innovate, produce goods and services and keep the economy alive and dynamic.

Or are they going to spend it on goods and services produced by the private sector? Well, if there is a structural flaw in the economy (as we said before in Are governments mad with ?stimulating??), then the initial impact of such spending will only serve to primarily bid up the wages of the sectors that receive the government spending and will not solve the root of the unemployment (plus over-employment and under-employment) problem. For example, a redundant financial engineer is not going to be civil engineer overnight to work in the government’s outsourced infrastructure project (structural unemployment). He/she may end up working as a checkout chick/bloke to serve the cashed-up civil engineer at say, Woolsworth (under-employment). The civil engineer, on the other hand, may end up being overworked from the flood of engineering service demand from the government (over-employment).

One day, government expenditure on that sector (e.g. infrastructure) will subside. What happens next? Will the government have to come up with another stimulus spending program to keep the economic jig running? In the previous recession, the Japanese government had to keep the economic ‘stimulus’ pumping to the extent that they were said to have ended up building roads to nowhere.

Thus, even if the government end up boosting employment in the short-term through their “spend, spend, spend” program, it may end up counter-productive in the long run. If “spend, spend, spend” is their only strategy, then many years from now, the government will end up with very little to show for and citizens will be wondering where have all these money been wasted on.