DeHedging Gold Bubble?

[jk]

Re: DeHedging Gold Bubble?

Been there done that. The CPI suffers from huge flaws in at least two areas. One is that it has been dumbed down over the years through the use of statistical legerdemain such as "homeowner's equivalent rent" and "quality" adjustment "hedonics". The former is especially insidious because the ratio of rent to price in real estate (the "cap rate") tends to track interest rates. So whenever the Fed lowers interest rates to goose inflation, the resultant effect on homes prices gets canceled out. Now isn't canceling out inflationary influences about the last thing you'd logically do in constructing an inflation index?

The other is that the price effects of inflation are not confined to consumer prices. In fact, consumer prices are near the end of the inflationary chain, often taking years to respond to changes in the money supply. Inflation usually shows up in asset prices first. Assets like stocks and bonds. We saw this in the 1960s and again in the 1990's. So no index of price inflation can focus only on consumer prices and be considered complete.

finster, i should have put in an emoticon. i was being ironic, implying we don't have a genuine, useful cpi. there are other threads here discussing hedonics, owner's equivalent rent, and also geometric weighting and product substitution [if steak is too expensive we can shift to dog food]. there have also been many references to john williams' shadow stats sprinkled through the discussions. in general one of the things i like about this board is the relatively high level of knowledge among the participants, including you.

[EJ]

Re: DeHedging Gold Bubble?

Oil is the underlying value of all money. Without oil, no industrialized nation has an economy. Oil is the one good that, if immediately cut off from an economy, the loss will immediately bring an economy to a standstill. You can't say that about anything else in an economy.

Oil = money.

Oil producing countries can't exchange oil directly for goods and services so they have to use an internationally recognized intermediary money, US dollars; the internationally accepted means of exchange and store of value currently used to convert oil into another form of money is currently US dollars. Putin wants it to be rubles. Some Middle Eastern nations at odds with the US, such as Syria, have announced plans to move some reserves to euros.

It is more accurate to say that oil producers exchange oil for dollars versus sell oil for dollars. When demand for oil is higher than supply, the Fed has to print more money for use in the exchange of dollars for oil. This is inflationary. To end the cycle, either oil demand has to decline or supply increase. Both happened 1980 - 1983. Cutting the demand for oil was acheived via interest rate hikes to 19%. The increase in supply took seven years of high prices that created an economic incentive to locate and drill for more oil, and develop new technologies to extract oil economically at higher prices.

That was then. Now we have oil near all time highs, even in inflation-adjusted terms. High enough, long enough to create an economic incentive to locate and drill for more oil, and develop new technologies to extract oil economically? Is the oil even there? Debate rages on the latter, but the jury is in on the former: sustained high prices are inducing more exploration and the means for getting it our of the ground. Likewise, high gold prices are creating the same incentives.

The wild card is the geopolitics, thus The Coming End of the US Foreign Investment Bubble. Most of the oil is in countries on the other side of the geopolitical divide from the US. First, high oil prices finances and thus strengthens dictatorial regimes and weakens already weak democracies... Chavez, Putin, Ahmadinejad. If the US loses economic and political influence in these countries, they will raise the price of their oil money even more and the US will have to print more of dollars to pay for it, as happened in 1970s. OPEC V2.0.

If this happens gradually, over a decade or more, and we are prepared for it, the transition need not be catastrophic, but it will nonetheless be economically quite painful as there are no economical substitutes for oil. If the US experiences a sudden military loss in the Middle East in the manner of the Vietnam War, the results will very likely be catastrophic. The amount of dollars we'll have to print will likely create near hyperinflationary conditions, and then -- yes -- gold will be a better than dollars to exchange for oil.

[jk]

Re: oil

there's a problem in getting the oil majors to further their exploration and investment. many [all?] of their contracts shift increasing revenues to host countries once certain total revenue break-points are hit. this is why the majors keep planning based on relatively low oil prices. if they assumed higher oil prices, they would also have to reduce their reserves. thus they assume low prices and can't justify more intense exploration. catch-22.

[bart]

Re: DeHedging Gold Bubble?

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

I don't think its a matter of having it both ways - you're comparing apples and oranges with perception/sentiment vs. what actually is basically a view of real inflation.

Also, if folk bought real estate or copper or whatever as frequently as oil, the perception would be quite similar.

[Finster]

Re: DeHedging Gold Bubble?

Also, if folk bought real estate or copper or whatever as frequently as oil, the perception would be quite similar.

This is an exceptionally important point worth expanding on. People seem to regard some price increases as positive, and others as negative, but net-net, for every buyer there is a seller and vice versa. Here in the USA we are more complacent when it is home prices rising, because we are as apt to be selling a home as buying one. What's more, many who own homes have effectively entered a paired trade on them versus the dollar - we borrowed (shorted) dollars and went long our real estate. By having the dollars decline relative to the houses - and not the other way around - we all expect to get rich.

Relatively few of us, however, are sellers of oil. We are mostly buyers and burners of the stuff. Therefore we are not such happy campers when our dollars decline relative to oil. Suddenly, the inflation that we relished when it was just our houses becomes our bane.

The free lunch of inflation isn't so free after all!

[hayfield]

Re: DeHedging Gold Bubble?

On Barrick and its hedges:
http://safehaven.com/article-5689.htm