Archive for November, 2009

When to sell your gold?

Thursday, November 5th, 2009

Our long time readers know that we are very much in favour of gold. All our articles about gold are in the context of an entrance strategy into gold (e.g. our book How to buy and invest in physical gold and silver bullion).

But what about the exit strategy from gold? When is it time to sell gold?

Even though the season to disinvest in gold is still quite a long time away, investors have to be very clear in their minds when the right time for an exit is. Otherwise, they will end up like the fictional Mr Goldbug mentioned in our book.

To understand the answer to this question, we must first understand clearly the reasons for getting into gold in the first place. Our book has a very clear exposition on that. Also, when we use the word “gold,” we mean physical gold, not financial asset disguised as ‘gold’ (see Is long gold mainstream? if you do not know what we mean).

As we wrote in our book,

Remember, gold will only do well in times of economic disaster?in every other time, the investment performance of gold is mediocre.

Thus, we will repeat this point again: gold is not a hedge against common types of? price inflation. Instead, it is a hedge against the loss of confidence in fiat money (extreme price inflation is a symptom and warning of such) and the financial system (price deflation is one of the possible symptoms of such).

Each step of the path towards economic disaster will see the rising price of gold. Initially, the bull market in gold is still confined to ‘gold’ (i.e. financial assets disguised as gold). As long as the masses have yet to switch from investing in ‘gold’ to gold (i.e. physical gold bullion), it means that there’s still confidence in fiat currencies and the financial system. This is because ‘gold’ is still denominated in terms of fiat currencies, which means the yardstick to measure the value of ‘gold’ is still in fiat currencies. So, while a bull market in ‘gold’ is still in progress, the complete breakdown in fiat currencies has yet to occur.

Of course, should sound monetary policies emerge at that time, it is time to sell your gold. You can learn from what happened in the 1980s. As we wrote in Peering into the soul of Ben Bernanke,

Paul Volcker, the chairman of the Fed in the 1980s, is the anti-thesis of Ben Bernanke. He was credited with ending the US?s stagflation crisis in the 1970s by crushing the economy into the worst recession since the Great Depression. To do this, he had to raise interest rates to unbelievably high levels, to the point that in 1981, interest rates charged by banks exceeded 20 percent (Note to Australian readers: the Labor was often blamed for the super high interest rates of the 1980s. Now you know where such high interest rates come from- such high interest rates was a global phenomenon). Paul Volcker crushed severe inflation by crushing the growth of money supply.

So, should someone like Paul Volcker take the reins of the Federal Reserve and dishes out really tough medicine, you know it is time to sell your gold. Those gold bugs who fail to see this and hung on to their gold obstinately suffered serious losses.

As the economic and monetary system deteriorates further, it is only a matter of time when confidence in fiat currencies will be completely eroded. By that time, the bull market in ‘gold’ will become a bull market in gold (the real, physical ones), which will eventually become a mania at the peak of the hyperinflation. The extreme pain of hyperinflation will eventually trigger monetary reforms. Assuming that the successor of the completely broken fiat currency is based on a much sounder monetary system, then as we wrote in Is deflation inevitable?,

When that happens, confidence is finally restored to the newly introduced money, which will have the immediate effect of price deflation. Deflation will happen because people no longer fear that their money will lose value and no longer need to spend it immediately (i.e. demand for money increases), which decreases the velocity of money.

This will also be the time to sell your gold for whatever the successor money is (unless gold itself becomes money).

If the successor is another fiat currency system, then the cycle will repeat once again. Hopefully, the next breakdown will happen outside your lifetime.

Is deflation inevitable?

Tuesday, November 3rd, 2009

The inflation vs deflation debate is one of the most polarising and divisive arguments among contrarians (see Marc Faber vs Steve Keen in inflation/deflation debate- Part 1: Steve Keen?s model and Part 2). During the Panic of 2008, the deflationist camp seemed to be winning the debate. But the rally from March 2009 tilt the victory back to the inflationist camp.

During one of the debates between the two diametrically opposed camps, Marc Faber made a very interesting comment that goes something like this (we can’t remember the exact words): “Eventually, the deflationists will be right.” At first glance, if you take this phrase out of context, it may seem that Marc Faber is endorsing the deflationists’ argument. But is he?

Yes, we believe too that deflation will ultimately win. But take note, this is a trick statement. To understand, consider Zimbabwe, the ultimate modern example of hyper-inflation. Here is a surprising fact- Zimbabwe suffered its first price deflation this year. Take a read at Zimbabwe Consumer Prices Declined 3.1% in February (Update 2):

Zimbabwean consumer prices fell for the second consecutive month in February [2009], dropping 3.1 percent, indicating the central bank is beginning to bring the world?s highest inflation rate under control.

The decline compared with January?s drop of 2.3 percent, Moffat Nyoni, director of the National Statistics Office, said by phone from the capital, Harare today. Annual inflation has not been calculated since it reached 231 million percent in July.

As inflation turned into high inflation, which in turn becomes hyper-inflation, the currency becomes worthless. This will then become the final straw that will eventually trigger economic reform. In Zimbabwe’s case, foreign currencies are allowed to be circulated and replace the Zimbabwean dollar as money. In Weimar Germany’s case, the hyperinflation ended with the introduction Retenmark, an intermediate currency before the final replace with the Reichsmark.

When that happens, confidence is finally restored to the newly introduced money, which will have the immediate effect of price deflation. Deflation will happen because people no longer fear that their money will lose value and no longer need to spend it immediately (i.e. demand for money increases), which decreases the velocity of money (see Demand for money, inflation/deflation & its implication).

Once you understand this, you will then understand when is the time to sell your gold.

Stronger signs of a coming major correction

Sunday, November 1st, 2009

In this market rally since March 2009, the strongest correction so far happened in June 2009. Since then, there has been no major falls. But now, we are witnessing signs of the beginning of another major correction, with increase in volatility very likely. As Marc Faber wrote in his latest market commentrary,

As I said, I doubt we shall see new market lows [i.e. the low of March 2009] but a 20% correction from the 1101 peak for the S&P 500 on October 21, 2009 should not be ruled out.

We believe that some signs of a major correction in the financial markets are showing up:

NYSE Bullish Percent Index

NYSE Bullish Percent Index

  • As our friends in Market Club showed in Video: Has the S&P Index Topped Out for the Year?, there are technical signs that the S&P 500 are making a major top and a correction is under-way.
  • As we wrote in Will August 2009 be the top for the year in China?, we expressed our opinion that August 2009 will be top in the Chinese stock market. Up till today, the Chinese stock market has failed to exceed its August 4 high. The Chinese stock market can be seen as a leading indicator for the rest of the world’s market.
Shanghai Stock Exchange Composite Index

Shanghai Stock Exchange Composite Index

  • The down-trend in the US dollar is getting weaker. The implication for the Aussie dollar is, as Marc Faber wrote in his latest commentary,

Finally a rebound in the US dollar seems to be underway [see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar], which is consistent with weak asset markets as I have explained in the past on numerous occasions. Particularly vulnerable would seem to be commodities related currencies.

Commodity prices (including gold prices) in US dollar terms may be vulnerable. If gold cannot hold above the US$1000 line, then there is likely to be further weakness ahead, possibly to around US$800 to US$900. Should gold prices fall to such a low level, then we will be reading about symptoms of deflation in the newspapers.

Regardless of whether you believe that the March to October up-trend is a bear market rally or part of a new bull market (in nominal terms), it is time to get defensive.