From the feedback of our partners, we realised that some of you may find that even though our book (How to buy and invest in physical gold and silver bullion) looks to be interesting, you may still not be sure whether to buy that book to read.
So, we have provided a free PDF download that contains some sample pages and the table of contents. Click here to find the free PDF download (at the final paragraph of the page).
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.
In the infamous September 11 terrorist attack, everyone, including the authorities, are caught completely by surprise. Who would have thought that even box cutters would be used to hijack airliners? Even the training given to instruct pilots in the event of hijacks were outdated- previously pilots were instructed to submit to hijackers. But on September 11, this piece of instruction proved to be a big fatal mistake.
In view of the lessons learnt from September 11, authorities have changed the procedures, training and instructions to ensure that a repeat will not happen again. But do you know what the problem is? The the next successful terrorist attack is likely to be another left-field event in which the current procedures, training and instructions are not designed to prevent. In other words, the next successful terrorist attack will be a Black Swan event.
Worse still, the absence of successful terrorist attacks is not evidence that the authorities are successful in combating terrorism. As we said before in Mental pitfall: Lazy Induction, the absence of evidence is not evidence of absence. For all we know, there could be a terrorist plot brewing right now that the authorities could not detect. The only evidence of such lack of detection is a successful terrorist attack. That is, if terrorists are to strike from the left field, it can only mean that the authorities are not successful in detecting their plot in the first place.
Now, back in the world of finance. The Panic of 2008 was indeed a trauma. In response to that, regulatory requirements, risk management techniques and financial processes are overhauled to either prevent or limit the damage of a repeat. Like the authorities after September 11, our guess is that the financial system is probably getting more and more prepared against a repeat of another 2008-style shock. Indeed, many businesses have sprung up to help measure and protect against such risks, post-2008.
But do you know what the problem is? The absence of such shocks does not imply that the authorities are successful in girding the financial system. All we need is another financial shock from the left-field to prove that the authorities are not successful in detecting it when it is brewing in the first place.
You know what is worrying? From this news article, Barnaby Joyce, Australia’s opposition finance spokesman was blasted by the Prime Minister Kevin Rudd for suggesting a debate for a contingency plan against the United States government debt default. As this article reported,
Senator Joyce told Fairfax Media he did not mean to alarm the public but there needed to be a debate about Australia’s ”contingency plan” for a sovereign debt default by the US or even by a local state government.
”How would Australia go forward in a position where the dynamics of the global economy are all changed,” he said on ABC Radio today.
We think Barnaby Joyce is right in this instance (note: the word “default” is a loaded word. It does not necessarily mean a literal repudiation of US government against its debt- it can mean repudiation in the metaphorical sense of “printing” money to inflate the debt. The purpose of such a debate is to trash out such subtleties). As we wrote in What will be the next market panic?, our suspicion is that the next financial shock will have something to do with currencies.
Joyce’s idea of contingency planning is the whole point behind what we wrote in Failure to understand Black Swan leads to fallacious thinking,
First, as contrarians, we are not in the business of prediction. Rather, we prepare for Black Swans. To give yourself an idea why such preparation is important, ask yourself this question: Why do parachutists pack a second reserve parachute? Since the statistical probability of a parachute failure is extremely low, does that mean we should completely ignore such a possibility (of the primary parachute not opening)? Therefore, those people who fallaciously believe that preparing for Black Swans is ?predicting? is like believing that the parachutist who packs a reserve parachute is ?predicting? that his/her primary parachute will fail.
So, what is Kevin Rudd’s response to such a suggestion? That’s what was reported in the papers,
Mr Rudd dismissed the senator’s comments, describing them as ”not responsible economic policy”.
…
He accused Senator Joyce of engaging in a series of thought bubbles that were unbecoming of a senior economics spokesman from either government or opposition.
Barnaby Joyce was labelled as an “extremist” for even suggesting that Australia needs a contingency plan. Is there anything wrong with planning for a contingency? The military always do that because they always have to be prepared. Disaster planning is all about planning for contingency. Hospital emergency departments are in the work of contingency planning.
Our stand is that we need a contingency plan. Having a contingency plan is not predicting that it will happen. Without a contingency plan, we will be like a parachutist jumping without a backup parachute. Kevin Rudd’s response gives us the impression that Australia should be jumping without a backup parachute. That’s because, according to him, entertaining the thought that there is always the slim chance that the primary parachute may fail, is “irresponsible” and “unbecoming.”
If this is real stand of the government, than we can be sure that the government will not “see” a brewing crisis.
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).
Just to let you know, we have now joined the Twitter bandwagon. Follow us at http://twitter.com/inspiriting_cij.
In our previous article, Rating agencies doing the job of bond markets, we said that bond vigilantes are being neutered. It didn’t occur to us that we had skipped a few steps and some of our readers were wondering why is it so. Our apologies. Here, we will explain why…
First, you have to understand that bond yields and bond prices are inversely related. Why is this so? As we explained in Rating agencies doing the job of bond markets,
For example, if you pay $100 for a newly issued 10-year government bond that pays 6% per annum, you are sacrificing $100 of today?s consumption in order to receive $6 per year for the next 10 years. That 6% is your rate of return on your investment. Now, let?s say you decide to sell your government bond to Tom at $90. The rate of return for Tom is 6/90 = 6.67%. Let?s say Tom sells the bond to Dick at $110, the rate of return for him will be 6/110 = 5.45%. Thus, the rate of return of the bond is inverse to the price paid for it.
What the bond vigilantes do to keep governments accountable is that whenever they perceive governments to be too foolish with their finances (e.g. printing too much money, borrowing too much, etc), they sell off their holdings of government bonds. That in turn will depress the price of government bonds, which imply increases their yields.
The free market is supposed to determine the price of the longer-term government bonds, which implies that long-term interest rates are set by the free market. Therefore, long-term government bond yields are supposed to be an indicator of the trustworthiness of government borrowings. For example, if the free market expects high inflation, then it will be reflected in high bond yields. Conversely, if the free market expects deflation, then it will be reflected in low bond yields.
However, in reality, the price of long-term government bonds are not totally free. Central banks of major nations (e.g. Federal Reserve, Bank of England and Bank of Japan) interfered in the price of long-term government bonds by creating money out of thin air to buy up those bonds. That created additional demand for government bonds, which pushes up its price, which in turn imply lower bond yields than otherwise.
Because central banks is the only authority allowed to create money out of thin air, they can conjured up infinite quantities of money to support bond prices (i.e. “do whatever it takes” to prevent bond prices from falling). Bond vigilantes as a whole do not have infinite resources to push down the yield of bonds. That’s why they are neutered by the central banks.
What happens to the bonds that the central bank purchased? It enters their balance sheet as an ‘asset.’
Traditionally, the bond market is where governments are kept accountable. In the 1980s, after the inflation nightmare of the 1970s, we have the bond ‘vigilantes’ who watched money supply growth like hawks. Any governments that print money will be punished by the bond vigilantes selling government bonds, thus raising their yields.
Today, the bond vigilantes are neutered. Central banks (obviously we don’t have to name names here) are buying up their governments’ bonds to prop up their prices. This means government bond prices cannot fall. That in turn makes government bonds an attractive destination for those who wants to preserve their capital. The bond vigilantes cannot do their job of punishing irresponsible governments.
Long-term interests was supposed to be determined by the free market via long-term government bond prices. That is supposed to reflect the market’s belief about long-term price inflation rate and the governments’ ability to honour its debts. Today, with governments (via their central banks) sticking their dirty paws on the bond market, bond prices are useless indicators of the credit-worthiness of governments.
Now, we have to rely on credit rating agencies to do that job. This week, the Greek government was infamously downgraded by Fitch. Greek government debt is on par with junk bonds. S&P revised the Spanish government’s credit outlook to negative. Downgrades on bigger fish governments are coming. In fact, Moody is putting the US and UK governments on notice.
Lending at 3.4% for 10 years to the US government is the most mind-boggling stupid investment. Is the market that stupid? Or is it the work of the Federal Reserve?
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
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.
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):
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 (ShadowStats.com) 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.”
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