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Response to Bloomberg's 'Gold May Pay Only in Case of Maximum Despair'
I think most market commentators approach gold and silver with a certain amount of distaste, because from the offset it doesn´t appear to have any ¨real¨ value, or at least one derived from a practical use. However, people don´t even blink about spending thousands of dollars on jewelery that contains the stuff.
I´ve never been much of a gold guy, but I must say that after the bailout bill was passed, I jumped on board the precious metals train, because frankly I´m very uncertain about the dollar. Its recent rise has been truly strange as well, and I´m wondering if this might be another irrational bubble caused by panicky investors picking a safe haven. When the dollar does fall down, it´s going to be gold and silver that are going to step in.
Misinterpretation of Gold Lease Rates and Why Gold Could Rise
Although you mentioned it could create a short squeeze, that would only be if people were all nakedly shorting gold (or if their position ended in a net short on gold). However, I´m guessing that most people engaged in this carry trade are completely hedging out any risk of gold going up by buying gold futures. SInce they´re only using it to get cheap financing and take advantage of the spread between GOFO and Libor, it doesn´t make sense to open your self up for higher risk, especially since gold is seen as a reserve of value and prime for recessionary times.
I haven´t seen a huge difference in spot prices and futures prices, and I would imagine that we would see that if this was an extremely common trade. That trend would reverse at the end of the month, however.
I´m of the opinion that gold isn´t going to see its rise until people start attacking the U.S. dollar, which doesn´t look very likely to happen any time soon. However, that trend could change in a week with how volatile things have been and how merciless investors have been when they find a new ¨it¨ asset.
Is Gold As a Safe Haven Just a Myth?
I think we're going to have to see some serious threats to the dollar before gold prices go in to any sort of bull market. Right now, from everything I've been reading in major investment news sources, people aren't really concerned about the strength of the dollar, and for quite some time now if you've been holding on to dollars you've seen some pretty good returns comparable to other currencies. Because of this, I don't think anyone sees a short term benefit to holding gold vs. dollars, especially when you take in to account that dollars are far more liquid.
I think that as soon as we see a sustained drop in the dollar (i.e. week plus) and serious questions about its weakness, gold will go on a tear.
Bullion Shortage and Spot Prices Tell Two Different Gold Stories
The only real explanation that I can think of is that everyday people that aren't really hip to other ways precious metals can be traded are going out and buying physical gold and silver. However, as The Prudent Investor (ps I dig the name) indicated, physical reserves in ETCs and ETFs have grown quite immensely, which would lead me to speculate that it's not just gold bugs that are snapping up more precious metals.
I really think that if the dollar loses its forward momentum that we'll see a flight back to gold in the paper markets. Until then, I don't understand how there could be such a difference in the spot market and physical market.
Gold: The Last Carry Trade
Gold: The Last Carry Trade
(1) In a financial crisis and recession, shorting gold for financing represents an almost exponential amount of risk, since you´re shorting something that performs very well (theoretically) in a recession because it´s a store of value. Also, you would typically use this financing to buy much higher yielding debt, and during a financial crisis the risk of this debt defaulting goes up. Thus, you have gold going up in value and the value of your bond going down if things get worse, and that represents a very large amount of risk, since you could theoretically be out an infinite amount of money if gold went up in value an infinite amount (that would never happen, but it´s what could happen theoretically).
(2) The yen has been going up in value since people have been exiting carry trade investments made from japanese debt to reduce their overall risk exposure. Although the interest rate is higher on japanese debt than the lease rate of gold, you could only lose a finite amount of money, since you´re limited by the terms of your contractual obligation (you can only lose the value of the investment plus the super low interest rate if your carry trade investment defaulted). Thus, the risk is much higher with a gold carry trade at this point than with japanese debt. If people are trying to lower there risk by exiting japanese carry trades, shouldn´t they be falling over themselves to exit gold carry trades?
(3) A gold carry trade would really only make a lot of sense during a bull market, since the value of gold would be expected to go down and the market rate for bond yields would be higher as more people would be pouring their money in to equity investments. Thus, you could make a lot of money if the value of gold went down while you were leasing it, the lease rate stayed at 0.25%, and the yield on the bond you had was pretty high.
(4) You mention: ´Without the paper gold carry trade, you could argue that gold would be a few thousand dollars higher right now.´ This trully doesn´t make any sense, because if that was the case, what´s to keep someone from buying a future and holding on to it for delivery? You could then buy that gold at $850 an ounce, and sell it at $3,000 an ounce (according to your statement). That represents over a 200% return. Don´t you think if that was the case more people would be doing that? Hedge funds could make a quarter on trades like that. It´s called arbitrage, and experience indicates that if people can make money from doing nothing, they will.
Real Price of Gold Soars
They don´t talk about deflation, because if you´re in charge of the money press and you see deflation, YOU HAVE COMPLETELY FAILED as the head of the Federal Reserve. In times of deflation, no one spends any money because they know that the dollar in their back pocket will be worth more tomorrow than it is today. Thus, this is absolutely catastrophic towards trying to save a failing economy, since typically the answer is for the government to deficit spend to compensate for temporary losses in consumption (due to a lack of consumer confidence. If there´s no consumer spending, this leads to lower prices which leads to lower consumer spending which leads to... You get the point.
¨Well, let's see. Central bankers hate deflation. Governments hate deflation. Central bankers can create money out of nothing to prop up prices. Our government recently gave away money to keep prices up. But we are going to have deflation anyway?¨ Moonbat1775 is spot on. Mr. Shedlock, you provide a good article, but I think it totally misses the point about what will actually happen.
The Iceland-Dow Connection
I think people are always surprised when financial markets collapse, because they look around and wonder ¨how didn´t this happen earlier if things were so bad?¨. The thing is, banks are in the business of selling confidence. They take your deposits and lend them out at a higher rate, making their profit in the difference (and the multitude of other things they do). When you lose confidence in them, they don´t have an industry. Poor Iceland.
Great article.
Opportunity in Emerging Markets Amidst This Panic
I´m currently abroad in Argentina, and after spending a whole lot of time learning about emerging markets, it´s not really a case of whether the market that you´re investing in is in a recession, it´s more about what the people that invested in those countries are doing with their capital. Emerging markets have always been seen as a risky investment, and I can guarantee you that we´ll see huge flights of capital as people continue to panic. Economies can´t grow without capital, and that in turn fuels recession.
This is going to be the case especially in countries like Brazil that experienced huge booms in capital, since the sucking away of capital will leave that country all the more hurting (i.e. Boom Crash theories). These are export driven economies, and they can´t grow if international consumption isn´t growing. Thus, you can´t look at these markets as isolated situations. Consumer confidence in the U.S. influences these countries´ economies way more than we would like to think, and I really don´t think that people really appreciate how significant emerging market growth hinges on world capital supplies and general consumption.
At this point, calling a bottom in any market, not to metion emerging markets, is like trying to catch a falling knife. Have fun with that.