Posts Tagged ‘speculation’

Suspension of demand/supply law for base metals

Sunday, March 7th, 2010

According to the economic law of supply and demand, if there is more and more supply for a given commodity, the prices should decrease if everything else remains equal. Conversely, if the supply decreases, prices should rise.

Normally this is the case for commodities like base metals. The level of stock for a given metal in the London Metal Exchange (LME) should give a good indication of the quantity supplied. So, we invite our readers to take a look at the supply/demand situation for lead, nickel, zinc, copper and aluminium. In particular look at the 5-year charts for the trend starting in January 2009. What do you see?

When? you look at the charts, you will notice something very strange. Since January 2009, the prices of these base metals rose as the supply grew as well. What is going on? Had the economic law of supply and demand being suspended as well?

Good question.

Remember what we wrote in Does rising house prices imply a housing shortage??

The belief that prices will always go up forever and ever can create its own artificial demand. The insidious thing with this belief is that it is a self-fulfilling prophecy- belief leads to increased ?demand,? which in turn leads to higher prices, which reinforced the belief, which in turn leads to increased ?demand? and so on and so forth. When this happens, higher prices lead to even higher ?demand.? Such artificial demand can act as a sink-hole for whatever quantity of supply until money runs out in the financial system (which is not possible under today?s a fiat credit system).

Indeed, this is our interpretation of what happened to base metals as well. The expectation of rising prices acts as a sink-hole for whatever quantity of supply. The most common word used to sum up this phenomenon is “speculation.” Another word that is also often used is “investment demand.”


When you look at the big picture, there is a big growth in “speculation” and “investment demand” over the past 10 years. From real estate, stocks, bonds, commodities, foreign exchange and even art-work (see Epic, unprecedented inflation). Today, with advances in financial engineering and information technology, it is possible to speculate in the global commodities market in the comforts of your home with the click of a mouse.

What is the root cause of this? As we wrote in Why oil cannot function as currency reserves?,

… 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?).

For the fundamental economic law of supply and demand to work, prices have to convey accurate market information. Prices are expressed in terms of monetary units. That means the monetary unit is the yardstick which is used to measure the relative value of things. What if the integrity of this yardstick is being compromised? As we wrote in our book, How to buy and invest in physical gold and silver bullion,

Let?s suppose you want to compare the length of two boxes. You may use a ruler to measure their lengths and from the results of your measurement, conclude which one of them is longer. A ruler can do such a job because its length is reasonably consistent for the foreseeable future.

Now, imagine that ruler is as elastic as a rubber band. Do you think it is still a useful tool to measure the length of the boxes? An elastic ruler is useless because you can always make up the measurement of the boxes to whatever you please just by stretching the ruler such that the edge of the box is aligned to any intended measurement markings in the ruler.

Now, let?s take a look at oil prices. Since oil is priced in US dollars and if the supply of money and credit (in US dollars) can be expanded and contracted by monetary inflation and deflation, how useful do you think it is as a calibration for measuring the value of oil relative to other things?

The rise of “speculation” and “investment demand” is a sign of a funny monetary system.

What to do for potential first home-owner?

Tuesday, December 1st, 2009

Recently, we had a conversation with a young bloke who is currently renting. He has a strong desire to buy a house that he can call it his own home. In other words, he is a potential first home-buyer.

But seeing that house prices are very expensive in Australia and that they are artificially inflated by easy credit and favourable tax laws for property ‘investments.’ Furthermore, he sees the corrupt State Governments’ land release policy as the cause of land ‘shortages’ in Australia. Furthermore, he believes that politicians, with all the powers and capabilities that they have, never allow property prices to crash, perhaps even encouraging further property price inflation (see What goes in the mind of the Rudd government as it extends FHOG?). With governments all over the world resorting to stimulus, bailouts and money printing, he can see that they are all hell-bent on the policy of monetary inflation.

In other words, he distrustfully and cynically sees that the property market is rigged against him. But what can he do? Should he just take the plunge and buy a property, be a debt slave and should he lose his job, hope that the government will engage in moral hazard to bail him out? Or should he wait for the house price crash that may not happen? In any case, he sees that his wages is not going up any time soon, which means he greatly fears missing out.

What should he do? It’s da*n if he do, da*n if he don’t situation.

This is an example of the harmful effects of inflation on society. The beauty of inflation for politicians is that it is a kind of invisible tax on workers. Instead of increasing tax on your salary (which is exceedingly obviously), inflation erodes the purchasing power of your wages and you degrade your standard of living through higher debt burdens and prices. As we wrote in How to secretly rob the people with monetary inflation?,

The common people on fixed salaries and who do not own any ?assets? will have to bear the brunt of price inflation. … A redistribution of wealth from the last ones in the queue to the first one in the queue! Usually, the latecomers are the most vulnerable members of society.

Unfortunately, our friend is one of the latecomers. Generation Z will be the laggards too.

The problem with inflation is that it penalise those who work hard and save. In the US, with interest rates below the rate of price inflation, the government is forcing people to speculate (and risk their savings) in order to merely stand still. As we wrote in Harmful effects of inflation,

With inflation, there is less incentive to be productive and more incentive to hoard, speculate and gamble. This in turn will reduce productivity and increase price inflation, which further increase the incentive to be less productive.

This is what one of our readers has to say,

I lived in Russia during the hyperinflation of late 80s-early90s. It was exactly as you say: people and businesses were not interested in producing goods. The only path to success was speculating. God save Australia from such times!

If property prices are going to be more bubbly in future, the only way for young people to have any chance to own a property is to speculate. If the government is committed to inflation and moral hazard to solve economic problems, young people will see that there is no point in working insanely hard to save up to buy a house. They will see that the only way will be to speculate in stocks, commodities, gold, silver, foreign currencies, CFDs, options, etc than to work hard. They will chase whatever that is liquid and goes up in price and if they are more aggressive, short whatever that is coming down in price. Some may even turn to speculating in property itself with leverage.

Monetary inflation makes it far more profitable to speculate than to work hard. That’s why our friend is saying, “I’m learning to speculate.”

Harmful effects of inflation

Tuesday, June 17th, 2008

Lately, price inflation around the world looks to be getting out of hand (see A resemblance of the beginning of Weimar-style inflation). When price inflation was affecting asset prices, nobody complained because it conveys an illusion of prosperity. But when it spills over to the prices of daily living, it provokes a reaction of kicking and screaming among the masses. Indeed, 15 months ago, before the mainstream masses had any idea that the ravages of inflation will eventually hit them hard, we warned in Have we escaped from the dangers of inflation? that

… we are very sure that as all these liquidity work its way to the rest of the real economy, it will only be a matter of time before price inflation will show its ugly head. Yet we are simply amazed with Wall Street?s obliviousness to this danger and Ben Bernanke?s incredibly sugar-coated words in his recent economic report to Congress. Can we rely on the Chinese to forever keep the price of importable things down to save us from inflation?

Make no mistake about this: central banks around the world are still inflating the supply of money and credit. With such a colossal amount of debt in the global financial system, there is no other choice but to continue inflating in order to remain solvent. As inflation worsens, we will all pay the price for the harmful effects of inflation.

Today, we will look back into history and learn how inflation nearly destroyed a country. We will turn into an old book, The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany, written by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s. In chapter 5 of that book, he wrote,

The inflation profoundly altered the distribution of social saving. It is true that at first a certain mass of “forced saving” was created. But it cannot be said that these savings became available to the most productive firms and to those entrepreneurs who were most able to employ rationally the capital at their disposal. On the contrary, inflation dispensed its favours blindly, and often the least meritorious enjoyed them. Firms socially less productive could continue to support themselves thanks to the profits derived from the inflation, although in normal conditions they would have been eliminated from the market, so that the productive energies which they employed could be turned to more useful objects.

Nowadays, the less socially productive businesses include investment banking, money shuffling (hedge funds) and home building (in the US). Inflation allow mal-investments, which consumes resources wastefully for unwanted ends. Since an economy has a finite amount of resources, such wastage means that they will not be deployed in means that really matters. Also, Constantino wrote,

Also the continual and very great fluctuations in the value of money made it very difficult to calculate the costs of production and prices, and therefore also made difficult any rational planning of production. The entrepreneur, instead of concentrating his attention on improving the product and reducing his costs, often became a speculator in goods and foreign exchanges.

Success was the lot not of him who increased the productivity of society’s efforts, thus contributing to the increase of general welfare, but to him who had the capacity for organizing and directing great speculations on the exchange and for using wisely, with the object of personal gain, the variations of the value of money.

The surging asset prices (e.g. stocks, bonds, properties, commodities and yes, even artwork!) of the past several years are not signs of a strong economy. Rather, they are symptoms of inflation, brought about by speculation (see our guide Are Australian residential properties good investments? for an example of such speculation). Indeed, the pain of rising food and oil prices were made worse by hoarding and speculating (see Who is to blame for surging food and oil prices?).

With inflation, there is less incentive to be productive and more incentive to hoard, speculate and gamble. This in turn will reduce productivity and increase price inflation, which further increase the incentive to be less productive. In addition, as we said before in How to secretly rob the people with monetary inflation?, inflation re-distribute wealth unfairly and exacerbate the divide between the rich and the poor.

As time goes by, the economy will be structurally damaged one step at a time. This process can take many decades to completely play out. Of course, with economic mismanagement, it can be accelerated, as in the case of Zimbabwe. Sadly, the world is still committed to inflation.

Connecting monetary inflation with speculation

Saturday, May 10th, 2008

One of the common explanations we find in the news media for high oil prices is that they are the speculators’ fault. In our previous article, Price fluctuations and hoarding, we have a better word to describe such speculative activity- hoarding. Speculators (or rather hoarders) are blamed for bidding up the price of oil, resulting in a global price inflation scourge. Many economists call such price inflation as ‘cost-push’ inflation.

But in reality, there is a deeper underlying cause for such price inflation. As we quoted Marc Faber in Marc Faber: Bernanke Policy Will ?Destroy? U.S. Dollar,

As the US began their aggressively loose monetary policy from September 17 2007 by cutting interest rates from 5.25% to 3% [, Marc Faber said,]

What is the result? I tell you what the result is! The stock market in September 17 by the S&P is down 10%, the US dollar is down 10%, gold and oil are up 40%. Well done Mr. Bernanke!

How does monetary inflation (see Cause of inflation: Shanghai bubble case study) lead to speculation? At the root of speculation lie human decisions for improving one’s lot in life. The ultimate aim of the economy is to satisfy infinite wants with finite resources. With all these mal-investments accrued over the years, it has come to the point that too many resources are wasted in ends that are either (1) cannot be completed or (2) unwanted. As we said before in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

Therefore, in order to put the economy back into a sustainable growth path, consumptions and investments have to slow down in order to allow for the economy to catch a breather for the rebuilding of its capital structure. The rebuilding of capital structure is necessary for the economy to replenish its resources for the future so that growth can continue down the track. Unfortunately, this rebuilding itself requires resources now. Therefore, current wasteful consumptions have to be curtailed and mal-investments have to be dismantled to make way for the rebuilding.

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

To understand this idea, put yourself in a position of a person with excess wealth in US dollars to invest in. Where can you invest your wealth to give yourself a real return in an economy that is in recession with serious price inflation? With asset price deflation and a credit crunch, there are not many financial assets to park your wealth in. At least in Australia, with rising interest rates, cash is an option. But in the US, with short-term interest rates lower than the price inflation rate, cash is not an option. Even long-term Treasury bonds are not good enough. In the end, the most attractive option would be to hoard commodities that have good supply/demand fundamentals. But if too many people are in the same boat as you, such hoarding will only result in further rise in prices.

So, is there any wonder why there are speculations (or rather, hoarding) in commodities?

Discerning a stock market bubble

Thursday, January 25th, 2007

In our previous article, Speculative fervour in the Chinese stock market, we mentioned that we were ?dismayed to see the amount of speculative fervour and volatility in the Chinese stock market? and that there were ?stories after stories of stock market ?success? and how ?investors? achieved wealth through share ?investment.??

Yesterday, from someone we know in Shanghai, we learnt that the Chinese stock market mania seems to be getting worse.

Retirees are lining up in long queues all over Shanghai?s banks. What can they be queuing up for? We learnt that many of them are withdrawing a significant part of their savings to ?invest? in managed funds, which is the latest investment fad. Many of these retirees do not even know what a managed fund is. When asked which managed fund they want to invest in, they replied, ?I don?t know. I want to invest in whichever is good.? With rampaging inflation, many of these retirees want to preserve the purchasing power of their savings. Upon seeing that scores of people are making easy money in the stock market, they want to join in the party too.

This is a classic sign of a stock market bubble. When you see people who are usually very financially conservative (and have a good reason to be) being overcome by greed, it?s time to exit the market.

Spectre of deflation

Tuesday, January 23rd, 2007

For too long, money around the world had (and still is) been too cheap. There are all kinds of asset booms around the world, from Shanghai properties to US bonds. Stocks around the world are hitting record highs, with the consequent emergence of private equity booms and hedge fund crazes. Along with that, we have all kinds of grotesque imbalances?record consumer debt, negative savings rates and massive current account deficits in the US, Britain and Australia (with the corresponding massive current account surpluses in China and the oil-producing countries).Such good times can never end right? Many financial analysts predicted that 2007 will be another year of abundant returns in the Australian stock market as the sheer weight of more local superannuation ?investments? and Chinese and Middle-Eastern money heads towards the Aussie financial markets to find a home (see More Chinese and Middle Eastern money heading Down Under: recipe for inflation?). Maybe those analysts are right. But don?t you see the absurdities? Nowadays, it seems that the path to great wealth is to be good at shuffling money in the financial markets?speculation, trading, acquisition, borrowing and charging fees for gambling other people?s money. To lubricate all these wealth ?creation? activities, central banks around the world are running the money printing press at top speed in order to conjure up the necessary liquidity grease to be injected into the financial system.

But we smell danger.

It is a danger in which many in the finance industry failed to fully appreciate?deflation. Such complacency is beyond our belief. In the 1990s, Japan experienced it, with dire consequences for their economy. At least, the ordinary Japanese had their savings to fall back on. For many Americans, with their negative savings rate, what can they fall back on? Have they not learned from the mistakes of others in the past?

Before we delve further into the topic of deflation, let us clear some misconceptions about it. Inflation is popularly misunderstood as the general rising of prices. As a result, deflation is also commonly misunderstood as the general falling of prices. But such concepts of inflation and deflation are merely the effects of a root cause. We suggest you read our previous article, Cause of inflation: Shanghai bubble case study for the background understanding of the true nature of inflation and deflation. Henceforth, we will now define deflation as the contraction of liquidity (money and money substitutes) relative to the available goods and services in the economic system.

In our previous article, Liquidity?Global Markets Face `Severe Correction,? Faber Says, we asked the thought-provoking question: Are we now ripe for a contraction in liquidity? Given the colossal leverage in the global financial system, if there is going to be a severe and sustained contraction in the amount of liquidity, the effect will be a downward deflationary spiral in asset prices, which can lead to deflation in the real side of the economy.

Why is it so?

One thing many people fail to understand is that values of financial assets can vanish as easily as they are created in the first place. It is a fallacy to believe that just because money has to move somewhere from one asset class to another, the overall valuation in the financial system cannot contract. The very fact that all the money in the world cannot buy up all capitalisation is proof of that fact. This leads us to the next question: how do financial assets derive their value?

As we mentioned in The Bubble Economy, we have to understand the principle of imputed valuation. Suppose you have a house which you bought for $100,000. What happens if one day, your neighbour decide to sell his house (which is similar to yours) for $120,000? When that happens, your house would have to be re-valued upwards to $120,000 even though you had done absolutely nothing. The same goes for stocks. All it needs for a stock to increase in value is for a pair of buyer and seller to transact at a higher price. As long as the other shareholders do absolutely nothing, that higher price will be imputed into the values of the rest of the stocks. Thus, when asset values rise, all it takes is a handful of them to trade at higher prices in order for the rest to be re-valued upwards. If assets can ?increase? in value that way, it can ?decrease? in value that way too.

What is more worrying is that assets of such imputed values are used as collaterals for further borrowing, which becomes the borrower?s liability. The borrower?s liability then becomes the lender?s asset, which in turn is being used as collateral for the next round of borrowing. Conceptually, this is how the liquidity pyramid (mentioned in Liquidity?Global Markets Face `Severe Correction,? Faber Says) is made up of. As you can see by now, if the original assets? imputed values crash (which can happen easily), it will have a cascading effect on all the other assets? values further down the chain. If this chain-effect spirals out of control, it will result in the wiping out of vast financial wealth (this is how global liquidity contracts). The outcome is a gigantic deflation of epic proportion.

Since the majority of the world?s liquidity is made up of derivatives (which obviously derive its value from another financial asset) valued at hundreds of trillions of dollars, we shudder to think what will happen if that derivative bubble burst. There is a reason why Warren Buffet calls them ?financial weapons of mass destruction.?

What can the Federal Reserve do if this happens? Should it let the bubble burst in order for a resulting depression to clean up the colossal excess? Or should it print copious amount of money for the financial system to remain solvent, thus resulting in hyperinflation?