Thursday, February 07, 2008

Anti-Dollar's [Temporary?] Demise

I like gold, I do! I like it as I fancy "The Times Atlas of the World" in front of which I can kill an entire afternoon, a 70's Vintage Port, or a pair of dreamily-fitting Lorenzo Piano trousers. Despite this inherent attraction for something of obvious inherent quality, Gold is a speculative red herring, here and now. For each new datapoint indicating a more severe contraction, and each new lurch down in other asset prices, makes the precious metal (and sisters) - psychic allures that they may still hold - a dramatic financial non-sequitir in comparison to other non-levered or lowly geared assets with and potentially growing cashflows, or for that matter, mid-term government securities. Not that Alt-A mortgages at the other end of the spectrum provide much better comfort, nor does equity with cyclical sensitivities - with low visibility and diminishing earnings expectations - provide safer haven.

For while the fear remains inflationary hell or deflationary systemic implosion at the extremes, it is the inflationary fears that appear more canard-like as the sucking sound of all manner of wealth destruction, balance-sheet reduction, asset-impairment, price-discovery, money-velocity deceleration, higher margin requirements and haircuts, creates multitudes of overt and unseen cascades throughout all markets (and the economy) at a pace many times greater than it can be replaced with SWF contributions, cheaper money, steepening yield curves, or fiscal stimulii.And this is lkely to remain the case, irrespective of the smell of monetary napalm in the morning.

Add to this Gold's large leveraged speculative position, and huge percentage of prevailing open interest owned by fundamentally agnostic CTA's resulting from short, medium and long-term programs, and it seems likely we will soon witness a rather ugly pile-up on the exit ramp. Such is the nature of the log-normal distribution that describes speculative price advance, and decline.

Specs are still fearful of global easing and global stimulus, which is why the metal is levitating while the known financial world incinerates. Longer term, of course, who knows, the economic horrors unfolding may be granted respite, and the fear-pendulum may once again swing towards stagflation or even inflation. But that will be in the future, for at the moment the barometer is suggesting otherwise, and Gold longs would be wise take heed, and not fall in love with their position.


woland said...

Just for fun, let me weigh in on a subject about which I know but little. In my opinion gold is not a precious metal, but rather a semi precious metal,
like silver used to be. Why? First of all, it is all too
common. Fort knox supposedly holds a mere 261 million ounces, worth a paltry 235 billion, or put another way, a mere 33 Kerviel (the new standard notation for large numbers)
Second, almost all existing and newly discovered supply remains available for re-use. It is not destroyed, like oil or
other energy resources. Third, it has very limited
practical uses relative to its supply. Its principal
supports are tradition and the rampant abuse of fiat currencies.
Let me contrast it with its brother (or sister) metal
platinum. First,It is much, much rarer. Your atlas
will show you the few global sources of supply, the largest of which are a few mature mines in S.A. It
is a byproduct (albeit a highly profitable one) in
the refining of Nickel, concentrated in Canada and Russia. Remember the great nickel consolidation?

Of great future importance is a factor which will become more widely know over time: Platinum's
great potential (along with other members of the
PMG (ruthenium, iridium et al) in catalysts used to
convert one energy form to another. The two most
recent Nobel prizes in chemistry involve surface
chemistry, and Grubbs and Schrock's work on
metathesis, particularly as it relates to improvement in the fischer-tropsch process. The
need for catalysts from PMG metals, already used in petroleum refining and auto catalytic converters
is immune to changes in inflation/deflation scenarios, massive supply increases, or a sudden outbreak of monetary sanity. And as we know from Chico Marx, " Der aint a no sanity clause".

Mencius Moldbug said...

Woland, I like both your comments and your handle, but I think you're wrong about platinum.

If you are thinking about monetary transitions, the physical quantity of a metal is absolutely immaterial. What counts is the monetary stockpile in the origin currency - ie, the stockpile (global inventory) of gold as measured in dollars, versus the stockpile of platinum.

You will see that the stockpile of gold is much, much, much higher. And this is why gold, while its degree of present monetization may be debated, is certainly far more monetary than platinum.

What this means is that gold has a more inelastic supply curve than platinum. Much more inelastic.

And what this means is that in a remonetization event, equivalent amounts of diversified monetary flight aimed at the five major precious metals would distort the price of platinum far more than it distorted the price of gold.

This in turn would have a much greater effect on the supply of platinum. And this would mean the leaders in the flight are relatively more diluted in platinum than in gold. Which means their returns are higher in gold. And in that case, why diversify?

And this is why, if you follow the rational game theory of the situation, platinum is not a candidate for terminal remonetization. But that doesn't mean you kids in London or wherever can't have a little fun with it. I actually tried to buy a little PHPT the other day, but my puny E-Trade Global account does not seem to extend to, um, duh, ETFs. (Um, geeze, guys, what did you think I wanted to trade in London? Camels?)

On platinum's side is one word: Zuma.

Against platinum, there is the fact that much of the new research in nanotechnology is devoted to the increasingly profitable task of reducing the quantity of PGMs in new catalytic converters. The temperatures are very high, and this makes the problem difficult - otherwise, cat converters would use nanoparticles already. But it certainly strikes me that it will get solved this decade.

Mencius Moldbug said...


There are both long and short answers to your argument, which I find almost but not quite flawless. Since I am me, let me start with the long answer.

Your basic problem is that the phenomena you call "inflation" and "deflation" are, as I never tire of repeating, very badly named. While people know these words very well, it is very difficult to use them in reasoning about the underlying financial patterns that they correspond to, without going horribly awry.

You have a much better word for deflation. You call it "deleveraging." Leveraging and deleveraging amplifies noise. We know this. Therefore, whenever we see a signal which looks like amplified noise and we see the presence of leveraged speculation (which the Comex futures market, a design I find quite unsuited to a monetary commodity, makes implicit in all gold trading), we assume we are seeing an amplified noise bubble.

In my opinion this is not at all the case in the present gold market. And this is the short version of my response: I think a lot of those specs are stronger hands than you think. I recognize that for a quarter-century before 2002, the basic thrust of the PM markets was to at least fleece and often just flay the specs. And much of this trope has certainly persisted. I don't know that the metals tech funds are even doing that well, which is astounding in this market - and quite unsustainable.

But six years of consistent 20% y/y gains on simple hard bullion, cash in the original sense of the word, has certainly built up a class of savers whose attachment to their coin is not so fickle. Look at the stockpile growth curves of the ETFs, for example. They can shrink as well as grow. They sometimes do shrink. But their overall trend is extremely consistent and positive.

The basic question under the words "inflation" and "deflation" is how the deleveraging carnage in the fixed-income markets will affect speculators - leveraged, unleveraged, holed up in Idaho with Krugerrands, or otherwise. Will it cause them to sell? So far, it has not.

Certainly, market psychology is one plausible explanation for this omission. On the other hand, market psychology can explain anything.

My explanation is just that the kind of people who bought CDOs and the kind of people who bought Au were two very different kinds of people. I really just do not see this world in which the structured-return crowd was also stashing Krugerrands in Montana. Should I simply defer to your expertise on the matter? Probably, but not without some reassurance.

If we can assume for a moment this divergence in social networks, we can see why there are relatively few speculators with gold long positions who are panicking because their balance sheets are about to go underwater. Quite the contrary. They are all thinking about their first Bentley.

My guess is that gold is displaying early bubble symptoms, not late bubble symptoms. This is because it is largely decoupled from oscillations between asset classes in the non-gold world. If you think of gold as a foreign currency, it becomes very obvious how this can happen. From the financial perspective, all partitions or partial partitions in social networks are equivalent, whether across national boundaries or between different types of people.

Why is Bernanke throwing napalm on the markets? Because they are flooded. But they are not all flooded. Only parts of them are flooded. Other parts are on fire. And everyone gets napalm. So you do the math.

The gold market is much simpler than everyone thinks it is. Gold's competition is money. The Fed can kill gold dead, bang, shot in the head, with tight money. It happened before and it can happen again.

So the question for aurophobes and aurophiles is exactly the same one Dirty Harry asked the punk. Does Dirty Ben have any rounds left in that .45? Because he sure ain't acting like he does.

Anonymous said...


re: killing dead with tight money

The Fed may only be one part of the equation. If a lot of the world wants to get off the US control grid, the dollar has to go down a notch or three. The resulting turmoil, plus the collapse of the credit bubble, could lead to a flight to quality, and Lord only knows what that will be.

OldVet said...

Seems to be an evolution, or revolution, with a theme taking place: Dollar stays strong during recessions. This may be the instant fan that is blowing on Gold for now, the psychological phenom. Of course it's counterintuitive, but so much of trading is, isn't it? Same wind just blew on my CHF and JYN positions today while I was watching 1965 "The Loved One." Was Jonathan Winters worth $3K?

Rather than the irrational "dollar strong" story, I'd guess the better psycho reason is that "money comes home in time of turmoil" and there are a lot of footloose bucks out there. Just guessing. When heads clear, I'm betting Gold will do well; but when have heads ever been clear during confusion episodes in history? Got a better idea?

Mencius Moldbug said...


When you say something like "the dollar stays strong," you are talking about a price index - eg, USDX. This is an index of prices relative to certain other goods - eg, a currency basket.

Saying "the dollar stays strong," in other words, is like saying "apples are tasty." Sure. Apples are tasty. I will take as many dollars as you want to give me. If we interpret this phrase literally, we find that it contains no information. It is not even comparing apples to oranges. Is is just comparing apples.

Of course this is not what people mean when they say "the dollar stays strong." They mean that apples are tasty relative to the currency basket on the other side of USDX. In theory they could mean that the dollar stays strong relative to oranges, or to the Dow, or whatever. Why does it matter? Talk about the price of plums in Persia.

The Dow goes down in a recession. The Dow is priced in dollars. Ergo, in a recession, the Dow stays strong relative to dollars. Okay, we know this. What does it mean for the gold price? Why should it mean anything?

The "gold price" is the exchange rate between gold and dollars. If you want the gold price to go down, increase the number of market players who want to exchange gold for dollars. If you want the gold price to go up, do the reverse.

If there is one fact that I wish everyone in the gold market could write on the inside of their foreheads, it's that no significant fraction of gold demand is physically linked to the weight of gold demanded.

For actual industrial use, like plating the ends of Monster Cables or whatever, yes - Monster orders a gram of gold per production run or whatever. Who cares. If this was the only source of gold demand, gold would be right back at $20 an ounce.

When pretty much everyone else in the world buys gold, whether they are buying jewelry or bullion or futures or whatever, they buy by value. They don't go out and buy a one-ounce necklace. They go out and buy a $1000 necklace.

And what this means is that it is no more (and no less) difficult for the gold price to go from $900 to $1500 as it was to go from $600 to $900. There is no valuation headwind that appears.

The gold price is not the price of an industrial commodity. It is not even the price of a financial asset whose return is measured in dollars. It is a monetary exchange rate.

What sets the gold price is capital flow into and out of the "gold economy." If you think of this as a country - call it Goldistan - you can understand the situation easily.

Goldistan has no real productive industries, of course, unless you count mining stocks. On the other hand, when you move your savings out of pesos and into the First Bank of Goldistan, they seem to yield about 20% a year relative to dollars. With plenty of currency risk, of course. (And awful tax treatment.) But absolutely no entrepreneurial credit risk.

Furthermore, when we do our herd-behavior meta-analysis, we find that others are also attracted to the Bank of Goldistan. For obvious reasons. So which is more likely? That the exchange rate between Goldistan and the peso will increase in the former's favor, or the latter's? D'oh. This is strictly in the caveman economics department.

I mean, talk about a "flight to quality." As anon says, Lord only knows what that might be. But the rest of us can at least speculate.

Mencius Moldbug said...

Sorry - of course I meant "from $900 to $1350."

Anonymous said...

I own physical bullion and trade the paper but in my view it is very conceivable to see gold trade back down 650-700 by August before starting the final leg up although a clean break above 950 would change my view. Contrary to many who say Bernanke is dropping money out of helicopter I don't see it. With falling housing prices, falling equity prices, tightening lending standard, and high debt levels dollars are being vaporized which in my view be deflationary. Bernanke can cut all he wants but if banks don't lend or have credit worthy borrowers who want to borrow the game is over. The FED also doesn't drill oil wells either to my knowledge so in the end they have no control or supply consrtaints either. I do see a helicopter drop from the stimulus package and it is my belief the fiscal policy is the main cause of inflation. I'm not selling my gold as I have a very low cost of entry but I'm not ready to jump on the wagon and add more either.

aurum non vulgi said...

flight to quality...

The lifestyle in Investmenistan seems to be to stampede after different stuff in turns, be it gold, oil or whatever. Yesterdays favorite is left standing in the cold. In investmenistan the only thing that matters is that you're stampeding in same direction as others. All of this has nothing to do with value. It's not possible to live in investmenistan if you're seriously interested in value. Of course, investmenistan is full of talk about value, but that's just shop talk about the next possible target of stampede. Or on Alan Moores words: "The nature of societies is to write stories for us to live in that will be beneficial to that society, even when they are not necessarily beneficial to us. We can't live on the territory. You know, we are going to be living upon the map. Inevitably." And then he says: "We can come up with texts of our own that are more suited to human beings than these inhuman narratives such as war and economic recession that are imposed upon us from above. We should use our imagination a bit more."

Jesse said...

Probably the most gold bullish essay and set of comments I've seen this week.

When you are enthusiastically touting gold as a haven, then I shall worry.

Gold is a store of value, not dependent on another's balance sheet and agency rating. This is why gold increased in value 50% (a regrettable step function because of government regulation) during the Great Depression in the US, and shares of solid gold mining stocks with positive cashflow and dividends soared after the government sought to deter the public from seeking gold as a refuge.

Gold has barely begun to appreciate against a dollar that will be used by the Fed and Treasury to shift losses from the banks to the public and foreign investors.

OldVet said...

Well well well. Pretty interesting. But Mencius, I don't need the little talk on value relative to dollars. And I think the world of trading is more loosely tied to the world of value than you imagine. I'm trying to see inside trader's heads not figure the relative value of gold.

If the trading herd is running for a time contrary to gold, fine; if not, fine. Which way are the winds blowing today and tomorrow? I don't use "$ vs. FX index basket" for anything, just one currency at a time relative to $. And I treat gold as another currency, like Yen or CHF; nothing more nor less.

I've been holding substantial gold and expect it to do well long term too, viewed as currency or however you like. But the trading mentality is so arcane, even bizarre, that I'm truly interested in knowing if the Wall Street/Ginza crowd are going to throw masses of money in another direction for a while. That might give me an opportunity to do something other than watch Johathan Winters in the afternoon. Cheers

Mencius Moldbug said...


I must apologize for a slight case of goldbug pitbull attack syndrome - reading your post again, you were actually making the same point as me, just in a more subtle fashion. D'oh. Mea culpa.

The idea of trading gold on a short time horizon frightens me. I have no idea what gold traders are thinking. I'm not even sure I want to know.

But there are traders and traders. When you say I'm trying to see inside traders' heads, not figure the relative value of gold, I think you have the problem by the neck and are shaking it in your teeth. It is still kicking, but another good wring ought to do it.

As we agree, gold today is primarily held as a currency. It is neither a yielding asset nor an industrial commodity. What this means is that if you use the normal procedures for computing the "fundamental value" of gold as a yielding asset or as an industrial commodity, what you get is nonsense. It's crap. It doesn't compute. The numbers are quite literally meaningless.

This is why gold is so confusing to the Street. They are used to rampant speculation in all directions, noise traders, chartists, the works. But they are used to trading goods for which there is an underlying fundamental valuation algorithm. The herd has an anchor. It can make all the head fakes it likes, but it cannot defy reality.

In gold, the herd is the reality. I hope I am disappointing all the goldbugs out there who think that gold has some magical "intrinsic value." It does not. Its high price is purely the result of herd behavior. If any legitimate country in the world could get its freakin' act together and run a sound paper currency with a fixed money stock, gold would go down to $50 an ounce and stay there.

Currency competition is all about herd behavior. But the herd that interests me is not the crowd of short-horizon traders, which I get the feeling you make a living beating. I am confident that I could not play with these people, and I don't try to.

Here is my herd data point on gold: a few weeks ago I had some limestone installed in my foyer, and the tile contractor started talking about the gold standard to me. It turned out that she was a total hippiechick 9/11 Truther goofball who grew up on a pot farm in Hawaii.

Not that there isn't a time-honored great American tradition of gold-loving kooks. But that was (a) a different tradition, and (b) a dying tradition. This chick was not a Bircher. She was an Obama voter.

And, needless to say, her reasons for thinking gold was cool were totally cracked in the head. No neo-Austrian game theory for her. But does the market care? Demand is demand.

Now, for a normal financial asset, getting investment tips from your tile contractor is the biggest sell signal there is. I think a lot of pros on the Street are seeing this signal in various forms.

In gold, however, this is actually a bullish signal, because gold responds to herd behavior and nothing else. As we saw in 1980, really aggressive moves will turn the herd in the opposite direction. Could we have another dose of those 20% interest rates, please? But I am not thinking this is to happen.

So the CBs are left with one weapon against the herd, which is their gold stock. 30,000 tons is a lot. But this figure (a) includes gold receivables, ie, pieces of paper; and (b) more importantly, cannot be disposed of surreptitiously and is too small for a public, active defense. We are no more likely to see a rebirth of the London Gold Pool - more like the London Gold Drain, actually - than a second coming of Volckerism.

This leaves - what? I have no idea. But I am very confident, from a purely economic standpoint, that if gold becomes fashionable BWII is doomed. The Bircher kooks of the '70s were not exactly fashion leaders. They were a lagging indicator.

My tiling hippie is a sample size of one, I admit. But lagging she ain't. And she certainly did not come up with this gold thing on her own. I don't know where it's coming from, but it's somewhere.

OldVet said...

Mencius, agreed indeed. Most of the time I get my head handed back to me on a platter when I try and beat the short term traders. I jut do it because I'm old, and it's fun to try. My vision for what's in their heads is a sort of tornado with a mouth, spinning around and shouting.

Our friend Cass has generously tipped us to the leveraged bets in gold, esp futures, which I'd asked about a couple weeks ago. Under de-leveraging, which I expect for other reasons not related to gold, gold may also suffer pricewise in the short term. So I dumped my little hoard this p.m. and now we'll see. Like Anon above, if I'm wrong and it hits above $950, I'll likely jump back in and acknowledge lack of mind reading ability. Wouldn't be the first time! Cheers

Anonymous said...

The notion that gold is overvalued on an inflationadjusted basis is belied by the facts. check the chart.

As for manipulation, the Treasury suddenly reveresed course and gave the nod to the IMF to sell. Goldbugs we have found the smoking gun. The treasury is desperate to avert a technical breakout and this is just their latest pathetic attempt to stave off the oncoming freight train.

If only we had the logs of equity futures trading to see just how long treasury is.

Anyone who now thinks the market is not being manipulated is lost