Gold bubble goes pop!

[GRG55]

Re: Gold bubble goes pop!

Another reason to avoid the Aussie, Kiwi and UK Pound. They may be paying very high interest rates right now, but they have to in order to keep attracting the capital they need to cover the current account. Any stumble and their currencies could get hammered.

I am sticking with countries that have current account surpluses only (except for the bonars I am still trying to convert to something else...)

No surprise. EJ has explained this with greater clarity, using fewer words, than I:

...During periods of global economic contraction following a global credit bubble the global purchasing power of the currencies of capital importers falls and of capital exporters rises.

It has always been thus throughout history and is again...

[GRG55]

Re: Gold bubble goes pop!

Lacking patience as I do, I was in FXE and sold it, and for reasons I can't recall now I chose not to buy any FXF, so I am "stuck" with just a 10.3% position in FXY. None of these mothers is cheap now, at least as I see it.

GRG, what, if anything, looks the least bit promising to you as far as getting more out of the bonar?

Nothing wrong with being "stuck" with a few Yen at this point in time Jim. But I would be cautious about buying more right now - explain myself below.

I wish I knew a good answer to your question, however. Buying Yen and Swissie a year ago was a much less difficult decision than now...sort of like buying gold at $375. The US$ looks so badly oversold at this point, it makes any near-term decision to exit $, in exchange for anything else, more difficult.

As I mentioned in some posts a couple weeks back, I had become wary of potential coordinated Central Bank response from the ECB & BoJ (overtly) and the Fed (maybe covertly) to support the US$. Perhaps the Fed even delivering a "surprise" by skipping one rate cut, if they got the chance, thereby sticking it to the US$ shorts and hammering down commodities, on the pretext of "inflation-fighting". At some point they will have to turn their attention to inflation, but that seems quite a bit further away after last week's credit market events.

After listening to the tone of Trichet's responses during the ECB press conference this past week, I am no longer convinced there will be ECB rate cuts or overt $ intervention by the ECB any time soon. I got the very definite impression (from the the tone and body language) that the Europeans are quite frustrated with American policy makers, and they are not going to be easily pursuaded to reward this behaviour by trying to shield the US from the consequences.

I do not have the same level of confidence that the BoJ won't interevene if the Yen continues to strengthen, particularly if at an accelerating pace. Consequently, at this moment I favour the Swiss Franc over the Yen. The Franc moves in loose correlation with the Euro, but it's also a carry-trade currency in Eastern Europe, especially for property speculation, where there is going to be a blow-up of epic proportions any time now. In other words, I have more confidence increasing my exposure to the Swiss Franc than I did before the ECB rate decision press conference last week, and I would take Francs over Yen at this time. (I continue to hold my existing Yen position, knowing full well I may temporarily give back some gains, just like I did in Dec '07/Jan '08). My long term target for the Yen is 80, and for the Swissie it was par. Now I think the Swissie will overshoot that, given the ECB's convincingly hawkish (to me) inflation/currency stance.

The chances of the Fed getting the opportunity to skip a rate cut are diminishing fast, given the deterioration in the credit situation last week, increasingly fragile consumer sentiment, and the equity market swoon - especially in an election year.

We could see this parabolic anti-US$ trade continue and go further than we can imagine right now. For the domestic US audience a falling US$ is not a political handicap, and people will be told by their unions, politicians and the media that this is "good thing" (I am sure we'll hear someone say "It must be a good thing for America, because the rest of the world, including China, doesn't like it...").

[GRG55]

Re: Gold bubble goes pop!

...As for your question about CNBC, recommending cash on a channel dedicated to the proposition that everyone should be in the market and trading all the time is pushing your luck. Folks in cash don't need to watch CNBC. I'd like to think I influenced a few CNBC viewers to not ride the bear market – the one we called at the end of Dec. 2007 when many commentators were saying "It's different this time" – all the way into the ground like the last one. Going to cash is better than staying in stocks. I'd rather recommend a portflio that includes PMs, of course, but CNBC isn't Bloomberg. It's necessary to compromise if you want to be invited back, to live to fight another day.

Awww, the Bubblevision clowns are just pissed off because their GE shares are down almost 25% from the 52 wk high last fall. They wish they were in cash..:p

[raja]

Re: Gold bubble goes pop!

You got it Raja. There can be a very big difference between a commodity and the equity shares of companies that produce that commodity.

Thank you jk and GRG for you explanations regards commodity ETFs vs. commodity-related stocks.
I have two follow-up questions, if you have a moment . . . .

Here's my understanding, which may need correcting:

With commodity-related stocks, the price of a share is set by market demand. If no one want to buy a stock, it's essentially worthless (not counting possible dividends).

However, in a commodity ETF, the fund actually purchases the commodity. So it would seem that the value of a share reflects the price of the commodity regardless of the number of shares held or the demand for shares in the marketplace. Does this mean that in a market crash, the value of commodity ETFs would not fall if the underlying value of the commodity didn't fall . . . no matter what the market demand for the ETF?

If this is the case, then the only investment considerations for commodity ETFs would the future demand for the commodity and the value of the dollar. If one thinks there will be a recession, demand for the commodity may go down . . . but counter-balancing that would be dollar depreciation which would will increase the price of the commodity. So how are you thinking about the relative strength of these two opposing factors: inflation vs. demand reduction?

[jk]

Re: Gold bubble goes pop!

Does this mean that in a market crash, the value of commodity ETFs would not fall if the underlying value of the commodity didn't fall . . . no matter what the market demand for the ETF?

the etf might hold the commodity itself or hold futures. if there was a difference between the price of the etf and the underlying commodity, a market player would arbitrage it away. [buy the cheaper version, sell the dearer.]

If this is the case, then the only investment considerations for commodity ETFs would the future demand for the commodity and the value of the dollar. If one thinks there will be a recession, demand for the commodity may go down . . . but counter-balancing that would be dollar depreciation which would will increase the price of the commodity. So how are you thinking about the relative strength of these two opposing factors: inflation vs. demand reduction?

if i knew that i'd be a rich man. i try to keep both in mind, but i don't think anyone KNOWS how this plays out. there are just guesses and models and probabilities.

[GRG55]

Re: Gold bubble goes pop!

EJ: All this implies to me that the Ka-Poom model, that applied during the FIRE-economy/Greenspan era of dis-inflationary recessions followed by successful monetary induced reflation, may need to be modified. The path back down to the 1.64%/yr curve during "X2" is unlikely to be accomplished in a single move down. That implies a series of US recessions (perhaps some deeper than others), each of which will be inflationary in character instead of dis-inflationary? That also suggests a different character to the likely policy responses to these recessions compared to the past 25 years - once everyone has moved along the learning curve after experiencing the current inflationary recession.

...The fallacy that John believes is that the only source of inflation is wage inflation. This is nonsense that has been circling among wingnut economic bloggers until it has taken on some inexplicable level of plausibility. Wages are but one potential source of price inflation but are by no means the only source. Cost-push inflation from rising import prices due to a declining currency is another and the one that has been fueling inflation in the U.S. for years. Unemployment can rise to 25% and this source of inflation will continue to exert inflationary pressures on prices; in fact, it will get worse and is getting worse.

This is the crux of the whole inflation versus deflation debate. What is occurring is unintuitive so I understand John's confusion. While this dynamic has occurred repeatedly in other countries over the centuries it has never before happened to the United States. The cognitive dissonance is palpable. Looking ahead these commentator ask, Where is our 1980s Volcker recession that crushed the unions, stripped labor of pricing power, and killed inflation for 20 years? Where is our 2001 deflation scare?

My advice to them is: look behind you. The trend that is already big is about to get a lot bigger.

The world is heading into a global economic contraction, led by the U.S., led by the collapse of the housing bubble. But the antecedents of this contraction are, for the U.S., unlike any other. Let's zoom the time scale way out for a moment to see where this contraction is going...

...The FIRE Economy bailed the U.S. economy out of the 1970s by substituting return on assets for return on capital. Hudson thinks this can go on until the U.S. absorbs 100% of the world's economic surplus. I say it goes on until the FIRE Economy breaks down and it's been breaking down for the past nine months. ...

Here's where I am having trouble.

If the "wall of dollars" begins to flow back to the USA, how is it that net flows to the US will decline? The only way I could reconcile this was unimaginable levels of inflation and dollar depreciation such that real net flows into the US are still shrinking, despite the rising flood of bonars.

...The U.S. generates 28% of world GDP ($13.4 trillion vs $48 trillion) and imports more than 75% of the world's capital flows.

If in a global contraction U.S. GDP falls at a faster rate than the GDP of its trade partners, net flows to the U.S. must decline and the dollar with it.

Each percentage point decline of flow of capital corresponds to a percentage depreciation in the value of the dollar at a ratio of at least 1:1 or higher. Think of the period going forward as a resumption of the process that started in 1971, took a detour during the rise of the FIRE Economy from 1980 until 2000, crashed from a high point of dollar strength and low inflation between 2000 and 2001, recovered temporarily from 2001 to 2007 during the housing and other asset bubbles – at a cost of $1.8M in new private and public sector debt per new job – largely financed with foreign borrowing and thus without creating as much inflation as otherwise would occur.

Now the resulting wall of dollars begins to flow back in our direction.

During periods of global economic contraction following a global credit bubble the global purchasing power of the currencies of capital importers falls and of capital exporters rises.

It has always been thus throughout history and is again. The role of the U.S. in this credit bubble contraction is the reverse of its role in the 1930s. Then U.S. trade partners' currencies crashed and they experienced high inflation as their economies went into depression while the U.S. dollar appreciated and economy went into depression.

It would be great for US wage earners if as the recession progressed that the purchasing power of their meager savings were to rise and their declining real incomes were to turn around and begin again to buy more gasoline, more tuition and health insurance, and so on.

Alas this is not to be, for that implies that the U.S. economy is growing relative to its trade partners'. U.S. trade partners can grow without a steady flow of borrowed money, so they will continue to grow albeit more slowly, or worst case will contract more slowly than the U.S., as they shift to greater internal consumption and trade among each other.

[jk]

Re: Gold bubble goes pop!

and i still don't understand why a decline in gdp means net flows to the u.s. MUST decline. clarification would be much appreciated.

[GRG55]

Re: Gold bubble goes pop!

Thank you jk and GRG for you explanations regards commodity ETFs vs. commodity-related stocks.
I have two follow-up questions, if you have a moment . . . .

Here's my understanding, which may need correcting:

With commodity-related stocks, the price of a share is set by market demand. If no one want to buy a stock, it's essentially worthless (not counting possible dividends).

However, in a commodity ETF, the fund actually purchases the commodity. So it would seem that the value of a share reflects the price of the commodity regardless of the number of shares held or the demand for shares in the marketplace. Does this mean that in a market crash, the value of commodity ETFs would not fall if the underlying value of the commodity didn't fall . . . no matter what the market demand for the ETF?

If this is the case, then the only investment considerations for commodity ETFs would the future demand for the commodity and the value of the dollar. If one thinks there will be a recession, demand for the commodity may go down . . . but counter-balancing that would be dollar depreciation which would will increase the price of the commodity. So how are you thinking about the relative strength of these two opposing factors: inflation vs. demand reduction?

This is precisely the debate that is going on in this thread (see Jim Nickerson's posting of John Mauldin's writings, EJ's response, and the other commentary from the community).

Mauldin's view (and that of the Fed) is that falling demand in a recession will once again, as it has in every cycle during the Greenspan era, cause demand for labour and materials to decline and therefore inflation (as measured by CPI or PPI) will decline. This has been the reliable, predictable experience for decades. And this, to my understanding, is exactly how the Ka-Poom model of dis-inflation followed by monetary induced asset reflation described it.

If I understand EJ's posts in recent weeks, in this cycle it's different. We've barely had the rate cutting cycle started, and already high inflation is now taking off with a vengeance. As the US$ further depreciates this cost-push inflation from rising import prices will amplify what is already underway.

1. I am uncertain that I have described this correctly (but it helped organize my own confusion);
2. Even if I did, who knows which factor, at which time, will dominate the pricing of commodities.

[GRG55]

Re: Gold bubble goes pop!

and i still don't understand why a decline in gdp means net flows to the u.s. MUST decline. clarification would be much appreciated.

Could it be the other way around jk? A reduction in net (real) capital flows into an economy dependent on imported capital, results in a decrease in GDP?

[touchring]

Re: Gold bubble goes pop!

If I understand EJ's posts in recent weeks, in this cycle it's different. We've barely had the rate cutting cycle started, and already high inflation is now taking off with a vengeance.

There's still some way to 1%, which means more upside for gold and silver?

Isn't this how the inverse relationship between the US dollar and gold works?

:confused:

[Milton Kuo]

Re: Gold bubble goes pop!

Thank you jk and GRG for you explanations regards commodity ETFs vs. commodity-related stocks.
I have two follow-up questions, if you have a moment . . . .

Here's my understanding, which may need correcting:

With commodity-related stocks, the price of a share is set by market demand. If no one want to buy a stock, it's essentially worthless (not counting possible dividends).

Not entirely true. Take the hypothetical situation where, in an irrational market, a profitable company with a non-dividend-paying stock falls to some absurdly low value due to lack of demand for the stock. Is it really worth nearly nothing? Assuming there is no chicanery, it would be very worthwhile to accumulate a controlling stake in such a company by buying the requisite number of shares of its common stock. Once enough shares are controlled, you could assign people (yourself, perhaps?) to the board of directors and issue special dividends.

However, in a commodity ETF, the fund actually purchases the commodity. So it would seem that the value of a share reflects the price of the commodity regardless of the number of shares held or the demand for shares in the marketplace. Does this mean that in a market crash, the value of commodity ETFs would not fall if the underlying value of the commodity didn't fall . . . no matter what the market demand for the ETF?

In the event of a true market crash, I believe we would temporarily see an all-assets-down scenario. This would mean that a commodities ETF would also go down, although perhaps not as much as common stock. I believe (but am uncertain) that in an all-assets-down scenario, even the commodity itself would fall. Cash, not things, is king in an all-assets-down environment.

Focusing specifically on precious metal commodities (since I do not understand the other commodities that well), I believe that in the recovery phase of a general market crash, a precious metals commodities ETF would trade at a discount to the actual commodity due to the perceived risk of owning paper. As an example, take a look at some of these risks enumerated by the streetTRACKS Gold Trust Prospectus

The sale of gold by the Trust to pay expenses will reduce the amount of gold represented by each Share on an ongoing basis irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.

That is, each share of GLD has less than 1/10 of an ounce of gold backing it. How many people bidding on (and bidding up) GLD assume that it is exactly 1/10 of an ounce of gold?

The Trust may be required to terminate and liquidate at a time that is disadvantageous to Shareholders.

Where liquidate means, "...when the Trust's gold is sold as part of the Trust's liquidation...." This may be a nearly impossible event but it is one other difference between owning paper and owning the commodity outright. In the event of a liquidation, I would imagine that many shareholders would rather take possession of the gold they own rather than the equivalent fiat currency (where there may be a selling commission). Even if the fiat currency is immediately rolled into gold again (which again incurs a commission), I suspect that a liquidation is a taxable event (which may be good or bad, depending one's purchase price).

As stated in many other iTulip forum discussions, paper and physical possession are very different things and the differences become more pronounced in times of crisis.

[Jim Nickerson]

Re: Gold bubble goes pop!

Nothing wrong with being "stuck" with a few Yen at this point in time Jim. But I would be cautious about buying more right now - explain myself below.

I wish I knew a good answer to your question, however. Buying Yen and Swissie a year ago was a much less difficult decision than now...sort of like buying gold at $375. The US$ looks so badly oversold at this point, it makes any near-term decision to exit $, in exchange for anything else, more difficult.

As I mentioned in some posts a couple weeks back, I had become wary of potential coordinated Central Bank response from the ECB & BoJ (overtly) and the Fed (maybe covertly) to support the US$. Perhaps the Fed even delivering a "surprise" by skipping one rate cut, if they got the chance, thereby sticking it to the US$ shorts and hammering down commodities, on the pretext of "inflation-fighting". At some point they will have to turn their attention to inflation, but that seems quite a bit further away after last week's credit market events.

After listening to the tone of Trichet's responses during the ECB press conference this past week, I am no longer convinced there will be ECB rate cuts or overt $ intervention by the ECB any time soon. I got the very definite impression (from the the tone and body language) that the Europeans are quite frustrated with American policy makers, and they are not going to be easily pursuaded to reward this behaviour by trying to shield the US from the consequences.

I do not have the same level of confidence that the BoJ won't interevene if the Yen continues to strengthen, particularly if at an accelerating pace. Consequently, at this moment I favour the Swiss Franc over the Yen. The Franc moves in loose correlation with the Euro, but it's also a carry-trade currency in Eastern Europe, especially for property speculation, where there is going to be a blow-up of epic proportions any time now. In other words, I have more confidence increasing my exposure to the Swiss Franc than I did before the ECB rate decision press conference last week, and I would take Francs over Yen at this time. (I continue to hold my existing Yen position, knowing full well I may temporarily give back some gains, just like I did in Dec '07/Jan '08). My long term target for the Yen is 80, and for the Swissie it was par. Now I think the Swissie will overshoot that, given the ECB's convincingly hawkish (to me) inflation/currency stance.

The chances of the Fed getting the opportunity to skip a rate cut are diminishing fast, given the deterioration in the credit situation last week, increasingly fragile consumer sentiment, and the equity market swoon - especially in an election year.

We could see this parabolic anti-US$ trade continue and go further than we can imagine right now. For the domestic US audience a falling US$ is not a political handicap, and people will be told by their unions, politicians and the media that this is "good thing" (I am sure we'll hear someone say "It must be a good thing for America, because the rest of the world, including China, doesn't like it...").

From http://www.investmentpostcards.com/2...2008/#more-628

“Contagion is moving up the ladder to prime mortgages, commercial property, home equity loans, car loans, credit cards and student loans. We have not even begun Wave Two: the British, Club Med, East European, and Antipodean house busts.

“As the once unthinkable unfolds, the leaders of global finance dither. The Europeans are frozen in the headlights: trembling before a false inflation; cowed by an atavistic Bundesbank; waiting passively for the Atlantic storm to hit.”
Source: Ambrose Evans-Pritchard, Telegraph, March 4, 2008.

and

David Fuller (Fullermoney): Little upside for US dollar
“Regarding the dollar, with US short-term interest rates declining, the economy weak and the Fed printing, I see very little upside other than periodic bouts of short covering within the overall downward trend. The next medium-term recovery for the dollar is unlikely to occur much before the US economy is firming and the Fed indicates that short-term rates will rise. However I would begin to turn bullish of the greenback in the event of multilateral intervention.”
Source: David Fuller, Fullermoney, March 3, 2008.

and

Reuters: Eurogroup not yet looking at currency market intervention

“Euro zone finance ministers and the European Central Bank did not discuss a currency market intervention at their meeting on Monday, Greek Finance Minister George Alogoskoufis said on Tuesday.

“He noted however, that the ministers and the ECB, who met in the so-called Eurogroup, have become more concerned about exchange rate developments with euro at new highs against the dollar on Monday.

“Asked if there was a discussion of a currency market intervention, Alogoskoufis told reporters: ‘No, no, there was no discussion of that.’”
Source: Jan Strupczewski, Reuters, March 4, 2008.

So, GRG, perhaps it is a game of "chicken" in which we find ourselves.

[raja]

Re: Gold bubble goes pop!

In the event of a true market crash, I believe we would temporarily see an all-assets-down scenario. This would mean that a commodities ETF would also go down, although perhaps not as much as common stock.

Thank you for your response.

If investors are pulling their money out of the market, would that necessarily change the value of the commodities underlying a commodity ETF, and thus the price of the ETF share?

It seems to me that no matter how many people dumped their shares in the commodity ETF, the price of the commodity would be the only determinant of whether the price of the share went down, since share price is not determined by demand as it is with other stocks.

I'm not sure about this, and I hope to hear from others who might know whether this would be the case . . . .

[Milton Kuo]

Re: Gold bubble goes pop!

Thank you for your response.

If investors are pulling their money out of the market, would that necessarily change the value of the commodities underlying a commodity ETF, and thus the price of the ETF share?

It seems to me that no matter how many people dumped their shares in the commodity ETF, the price of the commodity would be the only determinant of whether the price of the share went down, since share price is not determined by demand as it is with other stocks.

I'm not sure about this, and I hope to hear from others who might know whether this would be the case . . . .

I'm not sure about the other ETFs but, using GLD as an example, the GLD ETF may deviate from the value of its underlying commodity. That is, the GLD ETF may trade at a premium or discount to its underlying gold.

I suspect that other commodity ETFs have this same behavior since they are bid and offered on different exchanges from the commodities they represent. However, as jk said, arbitrageurs would come in and capture any significant spread between the ETF and the actual commodity.

[GRG55]

Re: Gold bubble goes pop!

Thank you for your response.

If investors are pulling their money out of the market, would that necessarily change the value of the commodities underlying a commodity ETF, and thus the price of the ETF share?

It seems to me that no matter how many people dumped their shares in the commodity ETF, the price of the commodity would be the only determinant of whether the price of the share went down, since share price is not determined by demand as it is with other stocks.

I'm not sure about this, and I hope to hear from others who might know whether this would be the case . . . .

Raja: First do not fall into the trap of believing that money gets "pulled out of the market" or conversely "money gets put to work", a favourite phrase of the Bubblevision crowd.

Money flows through markets, not in or out. You cannot buy anything in the market unless there is someone willing to sell. That means that just as fast as you are "putting money to work" someone else is receiving your Dollars and removing them - those $'s flow through the market.

Second do not confuse the number of shares/units being traded with the price of a commodity, ETF or common share. The former is reflected in the volume of transactions, and this volume can go up or down on any given day, without any change in price. As long as the number of willing buyers is matched by the number of willing sellers, price will be generally stable. It's when there is an imbalance one way or the other that price generally moves to try to correct that imbalance.

(Relatively) Transparent markets that are (relatively) freely traded, like the NYSE or the CBOT, are the forum for price discovery between willing sellers and buyers. It only takes one transaction to reprice all the outstanding shares/units/bushels/ounces/tonnes of common stock/ETF/commodities. You can change the apparent value of all the outstanding shares of General Electric (at least temporarily) by purchasing a single share at a price above or below the last traded price (but of course to do that you have to find a willing seller at that price).

This continuous, "real-time" mark-to-market is one of the reasons these investments have been attracting attention recently, IMO.