Carry Trade killing the Economy?

The "carry-trade" refers to a way that financiers and speculators make money.  The premise is that one can borrow a currency (or asset) that is priced at or near 0% and then use that borrowed money to acquire another higher-yielding asset (such as long-dated treasury bonds) elsewhere and pocket the difference.  With use of leverage one can make fantastic amounts of money.

While this might seem logical the market may move to extend this scenario that benefit themselves but can damage the broader economy. 

The risk of damage comes when speculators who control disproportionate leverage in the system move en masse to protect their Golden Goose.. for example back-channel pressures can be put on politicians, policymakers ... and we know how easy the masses are led when the media creates a lot of buzz to scare them. 

Over the last few years many people, from workers to Presidents, have been conditioned to believe that the Fed lowering rates will carry the key to economic salvation.  Despite the fact that our economy continues to stagnate in the presence of very low short term rates, the screaming continues for yet more Quantitative Easing by the Fed. 

I think this is because those who benefit from the carry trade know that this will take the form of further acquisition of US Treasury Bonds by the Fed (or monetization of the debt), which will keep longer-term rates low.  And lower rates will permit more carry-trade bets. 

The knock-on effects of this ripple outwards:

• Distortions in the bond structure make weak economic policy look healthy instead of ill-advised, at least in the short-term.  This may solve temporary issues but enables further expansion of the debt... sort of like getting another credit card with a teaser rate that enables someone who is maxed out to transfer their balance and avoid paying the balance, for a short time.  If they are irresponsible then they will see the freed-up card as new money for further spending and feel 'wealthier' as a result. If more treasuries can be issued for low rates then the government may borrow and expand more since their models of relative cost are skewed by artificially low rate assumptions. 

• Race to devalue.  The currency tends to devalue since an explosion in money supply is required for monetization to proceed.  Competitor economies follow suit so as to prevent their currency from appearing to appreciate, even if it wasn't trying to appreciate.  This is because a currency that rises relative to others (or stays even while others fall) has their exports undermined.  If your foreign competitor is able to price their equivalent product lower than yours because their home currency weakened relative to yours, you both may have the same profit margins but not the same sales since buyers will go to your competitor first and you only as a last resort.  That can kill your business very fast, and governments know this so their central banks try to keep their devaluation rates more or less in the same ballpark as their export markets...  if they can.  If they fail, then that sector ceases to play a role as a job creator in the home market and the country becomes a net importer. 

• Inflation for real people becomes a problem.  In the presence of a flood of digital dollars that are printed to monetize the debt and keep rates low (which benefits further carry-trade activity), the price of real stuff appears to rise.  This is what we experience as inflation.  One extreme example is to imagine what would happen if you and everyone else in the world won the lottery... fantastic!  But who would staff the grocery stores?  The fuel stations?  The movie theaters?  No one.. at least, not at present wages.  The price of everything from apples to cars would go up to reflect a new wage structure to attract labor.  Shortly after 'winning' the new minimum wage would rise to thousands of dollars per hour, but people would still struggle to make ends meet since the cost of living would also be very very high.  Printing done to monetize the debt and permit the carry trade is causing the price of real stuff to rise at rates to levels not seen in many decades, if ever in this country. 

All of this is what we call digging a deeper hole for ourselves.  This adds undue risk to the economy since capital allocations may freeze up, preventing formation of new business, while players who otherwise should be liquidated are protected and receive the lionshare of rewards.


Will it end?

Of course.  No economic paradigm lasts forever and this situation will end.  Whether the end is sharp and sudden or slow and measured remains to be seen.  The price of metals is rising at a steep rate, as is most every other commodity, reflecting revaluation as dollars flood the system and find safe haven in real stuff.  I think the odds of a catastrophic end rise the faster the digital printing... and we are printing at faster and faster rates to keep ahead of a declining international bond position.  

 

What should I do?
 

It's easier to swim with the tide than against.  But if you time the turn wrong you could be swept out to sea.  Be adventurous but safe. 

 

Don't go all out.  Diversify just a part out of dollar assets and into real stuff, oil, metals, land, whatever.  I've had a fun turn playing a bit of the carry-trade too, playing currency pairs on Forex.com, but be careful there and practice with small amounts first as the leverage will wipe you out if you get greedy.  

 

Just remember the dollar is king but kings can topple, and the aftermath is often not pretty.  But for the time being figure out where the bets are and choose those that suit your risk tolerance, i.e. physical metal if conservative or highly-leveraged currency pair bets if you like to stake high. 

And for god's sake don't look to CNBC, Fox Business and the like for advice.. if anything use them for a pulse check on which cliff the herd is running off to next. 

Most money does not exist

If you were offered all the money in the world, you would still be ripped off.

What do you think of when you visualize US dollars?  When you hear of the printing press?  When people on TV talk about the money supply?

When you think of printing US dollars, do you visualize a literal printing press rolling bills off by the sheetload?

Most do.  This is what the media shows on almost every stock video.

This looks real, seems real, and is what we carry around in our wallets.  But note... 'all the money in the world' that exists in paper and coinage form is in reality just a small percent, literally a few pennies on the dollar.

Fact 1:  the total amount of US currency that exists is just around $1 trillion dollars.   Sounds like a lot.  But there are also a lot of people in the US, 307 million more or less.  Assuming that US citizens alone cash out all the dollars in existence (to the exclusion of all foreigners) then this averages just ~$3,000 real dollars per person.

That's it.  If every person in the United States got their fair share of money in paper and coin, there would only be enough for about $3,000 each with nothing left over.  Not even enough for a 'like new' teal green Honda.

And even that number ignores skew from concentration of wealth. The collective net worth of just six:  the Walton family (Wal-Mart), Bill Gates (Microsoft), Warren Buffet (Berkshire Hathaway), Larry Ellison (Oracle), Michael Bloomberg (da Mayor), and Oprah (Harpo) is around $190 billion dollars.  If these six decided to go to the bank and get all their money at one time, they would take almost 20% out of circulation, instantly, or about 1 out of 5 dollars, which means the take for all other billionaires, mere millionaires and people like you and me falls to around $2,500 apiece.  Everyone else has just lost 18% of their equal paper share because of the wealth held by just the top six. 

Now obviously cash outs on that scale just won't happen;  it is impossible.  Physical money is just one small part of the picture and no matter what your bank balance says there isn't enough to go around should everyone run to get it out.

First Class Money.  Second Class Money.  Third-Class Money... Home.  

Let's round the bases.  Not all money is created equal.  Our wise asses in government and economics have created different classes of money.  Being a baseball kind of guy I'll present them in terms of bases.

First Base:  M1

There is a larger class of money than physical money.  This is called "M1" by the Federal Reserve and associated economists.  The M1 class is basically made up of all physical money + checking and travelers checks anywhere in the world, and is larger than all physical money.  Much larger.  Nearly $2.1 trillion in fact.

This accounting is nearly twice physical coin and paper.  Congratulations!  If they split that all out we'd all now have just over $6,000 in your pocket... but remember only $3000 is physically available for withdrawal so you'd have to settle for an IOU on the rest.

Second Base:  M2
 
M1 is not all the money in the virtual pot, as it excludes other kinds of money on the books such as savings accounts, small CDs and money market accounts.  When those are added in the Federal Reserve calls this "M2" money.

And M2 is much, much larger, about  $9.5 trillion as of August 2011.

Congratulations your virtual share is now nearly $27,000! (but you'd only be able to get $3,000 of that in physical form)

Third Base:  M3

There is a third class called M3 but it was growing so fast the Federal Reserve decided to stop tracking it in late 2006 so they wouldn't scare the kids.

M3 is estimated by Shadowstats.org to be between $14-15 trillion, about 14-15x all the physical dollars in the world.

If you were offered all the physical US dollar money in the world, you'd be the sucker who left 14x as much on the table for someone else to claim.  

Home:  Nearly all money that exists, is unreal

Most US Dollars in existence today are just electronic accounting ledger balances.  Binary bits of electrons flipping "0" to "1" (and vice versa) on server farms throughout the world.

Money is a quantum touchstone...  we strive badly to acquire that which does not exist.  

The truth is we now could not cut down trees fast enough to create the paper stock cloth upon which greenbacks are printed.

If electronic versions in M1, M2, and M3 did not exist and we were forced to print our money like in the old days... you would see the dollar disappear in favor of the fiver, then the ten, then the yuppie-foodstamp (the $20), the hundred and so on as they added zeroes to the existing paper to keep pace with expansion.

This was the classical way inflation or hyperinflation was seen, the adding of zeroes to physical circulating currency.  Changes were obvious and noticeable to people and these fiat forms of paper did not long survive.

Electronic classes for the investing masses... the printing press is a relic... with a few keystrokes one person can now create more money than the entire Mint in a year... and we don't notice because we get pretty bank statements every month that tell us how much money we have in our accounts. 

This trend will continue.  Physical money will continue to decline as a proportional share of total money supply, however it is measured.

Keeping the perspective that money is just electronic, just digital dollars, may help you become a better investor because it will help you better assess exchange rates between assets denominated in dollars with those with other fundamental valuations that are not necessarily dollar-denominated, such as  bullion, commodities, land,oil, water, etc.  If you are able to mentally view tangible and intangible (dollar) assets on the same scale you will have an edge in being able to determine buy-low/sell-high situations, and trade advantageously between them for long run success.

Silver Bubble or Ground Floor? (Part III) - Mandatory Mass Hysteria

My conclusion

I do not believe silver to be in a bubble today.  It has had a good performance over the past 10 years, moving upwards by a factor of 8x, but this is not enough to judge whether or not silver is in bubble territory.

I want to share with you some of my rationale.

Consideration #1:  Bubble prices cannot form if fake supply is used to distort classical supply and demand pricing mechanisms for what is supposed to be a physical asset (e.g. silver).

In the silver market the price setting mechanism is the clearinghouse of the electronic futures markets, which as discussed is dominated by a few market speculators who are in a zero-sum game making bets with each other that have short-term expiration dates.  This is different from the stock market.  While it is called the ‘futures’ market it is in many respects one of the most short-sighted markets out there.  

Further the futures market is using Monopoly Money to set the price of real silver.  This is called paper silver (or as I call it, "digital silver").  As of March 2010, 100 ounces of digital silver trade for every ounce of physical available for delivery.  I suspect that ratio has grown by at least 2-3x since then, given the rapid draw-down in COMEX bullion coupled with increased volume.   

100 or more digital ounces for every physical ounce.  With no changes to the present price-setting mechanisms, does this mean one could acquire every physical ounce available for delivery and only influence 1% of the futures price?

This is irrational from a classic supply and demand perspective.  This kind of distortion is certainly not taught in econ 101 nor are these types of mechanisms clearly mapped out for investors by the financial media.  In fact when it comes to most investing stories, especially commodities, the media generally gets away with reporting daily quotations, and if you are lucky tosses out a few chummy soundbites on why something did this or that.  What a bone. 

No, in order to have a bubble we have to have a clear mechanism by which extremely high prices can be obtained, sustained, and launched into the stratosphere.

If digital silver significantly outweighs physical silver for setting price, then the means for a bubble in price takes one of two forms:

1. The exchange and regulators lose control of digital silver, reversing their present course of actions which involve raising margins for speculation, or
2. When existing physical supply is no longer able to meet demand for physical by industry +  investors, breaking the market-setting mechanism of digital silver.  In this scenario a secondary market for physical acquisition is created and the bullion trades at much higher prices to the digital, which either must adjust upwards or decline into irrelevance.  (picture, the official grocery stores in Soviet Russia that boasted low prices but had empty shelves because the black market  was the only place with the physical groceries).

Consideration #2:  Meaningful real accumulation of the asset is not possible

Nobody knows the percentage of households that own physical bullion.  I would suspect less than 10% have any silver whatsoever, and that in total maybe 1-5% hold more than 50 ounces of silver troy oz in any form. 

I come to this estimate in a reasoned but  circumspect manner.  I see many online reports that estimate only 1 billion oz of physical silver exist above ground in investable form.  If this is true and American households owned the entire world supply, an impossible scenario, then the maximum silver allocation on an equal basis would only be 10 troy oz per household (1 billion ounces / 100 million households = 10 troy oz / HH).... I'm rounding down on HH from 114 to 100 million for simplicity. 

Ten ounces is good but far from a meaningful amount. 

In capitalist systems wealth concentrates.  If just 1% of households owned the entire supply then this would average 1000 oz per household (1 billion / 1 million households = 1000 troy oz / HH).  This seems high but is just an estimated boundary.  If the hypothetical billion ounces is spread over 5 million households then the average would be 200 troy oz (1 billion / 5 million households = 200 troy oz / HH).  

200 oz is a more meaningful amount of silver for a household, but it would vaporize the above ground supply and leave none for the other 95%.  

There is very little physical out there for acquisition.  

If 10% of households acquired 50 ounces each that would consume half the above-ground supply.  If just one of their neighbors wanted to acquire their own 50 ounces they would consume the rest, leaving the other 80% high and dry.  

And all this assumes the price of silver continues to be attainable on a per oz basis, that early buyers stop when their ‘fair’ share has been acquired (i.e. no hoarding by those with more money to spend), that no one else in the world wants silver bullion except Americans, that industry declines to build stockpiles for manufacturing, and that this 1 billion oz above-ground supply, does in fact exist and is not appropriated by governments as supply vanishes.  

Consideration #3:  Silver is more rare than gold on an above-ground basis.

Almost all gold mined in human history has been recycled and retained, about 5 billion troy ounces.  Much of this sits in central bank vaults under careful lock and key, and will never circulate among regular people.  

In comparison, almost all the historic silver that has been mined has already been used up by industrial processes.  Given the lifespan of electronics and related consumables, a fair amount of mined silver now lay scattered in microscopic quantities throughout American landfills, in millions of discarded electronic devices.  

With 5x more above-ground gold than above-ground silver, one would expect the natural price of silver to be at least par with gold in a normal supply and demand scenario, instead of 1/43^rd its price,  Just a few years ago it was 1/75^th the price, so perhaps that correction is underway   

We shall see.

Consideration #4:  Bullion is mined from the earth.  Stocks and money can be printed at-will.

We keep forgetting that bullion is the end-product of an industrial process.  It is the result of lots of money and time invested by miners to figure out where it is concentrated in the earth, who then must get tons of rock lifted out of the ground for crushing and refining into bullion, often in remote parts of the world where basic infrastructure does not exist.  

Stocks can be diluted with a simple vote by the Board of Directors to issue more shares.  Money can be created out of thin air by the Federal Reserve.  They don’t even bother to print physical certificates or paper money anymore... that would be too expensive and slow it all down.   

• For the astute investor, when given the choice between two assets, choosing the one that is less able to be diluted has better odds of concentrating value than an asset that can be multiplied at will.

Consideration #5:  Mandatory mass hysteria...  in a bubble the prices have no rational connection to the supply of the given asset, which can take on unbacked synthetic forms, and credit mechanisms break down.

A bubble means price appreciation has become a self-sustaining cycle, a Ponzi Party of greed, fear and frenzy where the act of buying itself begets more buying.  The fans scream and pass out when the boyband-of-the-day just walks on the stage and says 'hello'.  The fundamentals of the underlying asset ... often plentiful in supply... fades into the background as greed takes center stage.  The Herd is mystified by each leap forward and rushes to acquire diminishing amounts before the next round of bids takes it higher still.  Breaks in price appreciation are few, if non-existent during full-blown mania phase.  Naysayers warning of a bubble are disregarded and ridiculed by the financial media, the thundering masses and the self-interested promoters in-kind.  Politicians may even get into the act, praising the newfound 'prosperity' and searching for ways to connect this democratization of wealth with whatever it was they did in office, no matter how flimsy. 

A bubble means everyone is scrapping in the streets to acquire the last bits of the asset.  A scrum.  A mad scramble.  A mania.  

We have nothing like this today.  In fact we have the opposite, where people are throwing away their bullion for a few paper Franklins.  

Without extreme demand by the masses, the markets will not invent absurd credit instruments for people to engage in leveraged buying to amplify their returns.  As that demand ramps up these credit instruments are invented, rationalized, and disbursed throughout the system, setting the stage for catastrophic knock-ons during the contractionary deflationary period.

When you see ads for "BUY SILVER ON CREDIT AT 0%" instead of "WE PAY CASH FOR SILVER".. then ... perhaps its time to start trading silver for something else. 

Acquiring Physical Silver establishes a foothold in traditional, long-term monetary solvency for you and your family.

We manage risk in all kinds of ways in our everyday lives.  None of us wants to be involved in a costly car accident, but if we are, we want to be insured.  We buy life insurance for much the same reason, to provide for loved ones in case of an untimely passing.  We stock up on food essentials when we can in case of a sudden storm that might prevent us from getting resupplied in a timely manner.

We make these kinds of choices not because we want them to occur, but we want to be prepared if they should happen.

I do not believe our elected leadership in Washington has either the capability or the interest in bringing together Americans, and explaining to them what shared sacrifice really means.  I do not believe they are capable of communicating that American Patriotism that built our country was not the result of a free lunch, it was full of sacrifice, shared purpose, and lots of backlash against progress that had to be fought for and overcome.  Politicians today pander to us and tell us we can have the good life without paying for it, can engage in military adventurism without shared sacrifice of taxation or military service.  Those that tell the truth are defunded in their campaigns and subsequently voted out of office.  We don't want to hear the bad news.  Fuck yeah we're America!  We're number one!

The world is coming to see Americans as obstinate, corrupt, incapable of change, and who insist upon living beyond their means.  Our leaders choose to exacerbate these tensions in a zero-sum game of their own.  The Tea Party Movement represents the latest incarnation of this stubbornness and their intransigence over the debt ceiling these past few weeks has caused damage to our international standing.  And they didn’t even gain politically for all their effort, polls show them having lost credibility for their bully tactics.  

Changes to our way of life are coming.  I believe it is more likely these changes will now be imposed upon us in a much more severe way, from market forces that destroy the purchasing power of the US Dollar.  These changes may be sudden and sharp, or continue along a more subtle route, but changes will occur and it will be more difficult.  These changes will not be easily countered or mitigated by our politicians, and part of our sovereignty will disappear when this occurs.  

I am by no means the most experienced traveler but I have seen enough countries, first through third world, US locations rich to poor, so appreciate what happens when people lose control of their economic fate and become stuck.  It is not pleasant:

Transportation becomes a luxury commodity, not an everyday convenience.  People become much more reliant upon local production without systems to move surplus from one place to scarcity elsewhere.  Corruption rises.  Job creation all but disappears and informal barter systems arise.  Depreciating currency is not wisely held for opportunistic investment;  instead it is traded as quickly as possible for tangible items before it falls in value more.  This leads to misallocation of capital and of course lending stops as banks refuse to accept the depreciation risk on their balance sheets.  Credit becomes scarce, and is shunned as a primary means for building commercial enterprise. 

I am not suggesting this is a pre-destined future for the United States.  But we are behaving as if the odds of this occurring are 0%.  

Reliance upon a depreciating fiat currency as the sole means for ones long-term welfare is a bit like buying a stock in a company that insists on selling new shares every quarter, diluting your stake and requiring you to buy more just to stay even.  Companies that do this don't last very long.

I hope silver never goes into bubble territory.  This is because it would probably be commensurate with full-blown monetary chaos as people flee the dollar.  The subsequent social disruption would be far more hassle than any benefits of treading water and your retained 'purchasing power'.   It would be like being glad you had the foresight to buy a sturdy boat... but without considering that you still have to weather the storm tossing you about.   

But investing, like life, is about preparing for as many circumstances as possible.  No one is immune from all setbacks all the time.  That is why we should diversify across as many uncorrelated asset classes as possible.  Don't look to the financial media as your only source of information for diversification, at least not any more than you would ask someone like Jim Cramer for advice on fixing a leaky roof.  Get the roofing guy to do that.

And if silver never goes into bubble territory, odds are strong it will continue to experience apparent price appreciation, if for nothing else because fiat is expanding at a much higher rate than bullion production.  

Learn as you go, no one's perfect.  Salt your portfolio with physical (not digital) metal.

Acquisition of bullion has been going on for thousands of years, well before stock markets and corporations themselves were invented.  As far as asset classes are concerned, I'd say the odds are pretty good bullion is a going to hang around for awhile.

Peace out. 

Something is afoul in Denmark. (and, do pigs weigh as much as a straw?)

Something is afoul in Denmark.  Or Greece.  Or Germany.  Or France.  Or US.

TED Spreads. 

http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND

If I see a lot of arm flapping in the media about something I go and check this indicator to see if it's real or just a bunch of hot air (usually it's hot air).  But this one is getting elevated.

TED Spreads spike when the markets get nervous about solvency of banks.  When banks stop trusting each other and slow down their inter-bank lending all hell breaks loose.

This is akin to being in a room full of people.  Everyone has to breathe to stay alive.  But say someone coughs and people freak out, thinking the bird flu is in the room, so everyone panics and holds their breath until they pass out.  Then once they are on the floor (breathing unconsciously) they all get sick.

This is what TED Spreads are like.  All the banks panic about bird flu (solvency of their counterparties) hold their breath at the same time (stop inter-bank lending) until they pass out and go unconscious (bankrupt), and require oxygen (bailouts) to revive again. 

I'm wide awake on this.  The media is missing the boat but this is important.  When this metric breaks out ... it's all hands on deck time to see where the fire is, and how it can be doused before it explodes.  None of us can stop it... that's a job for our elected leaders and the markets, but I don't like to be sucker punched so brace yourself.

As for cause, last time it was solvency fears triggered by crappy mortgage bonds and related derivatives.  This time I'm guessing has to do with solvency fears of fiat currency itself;  namely the Euro, the dollar, and the government bonds and related paper games denominated in those currencies to bail out the system a few years ago. 

The media are focusing on Portugal, Ireland/Italy, Greece and Spain, which they derisively call the PIIGS.  As if everyone else wasn't piggy. 

These countries represent important crises but their collective GDP just isn't that big, it's the size of the bets that market participants made on debt that they should have known was crappy is the problem (just like buying mortgage bonds made up of NINJA loans then crying  because you lost). 

No I think the PIIGS are just the bleeding edge of the whole fiat game in play coming unraveled as it resets to a devaluation scheme.  The PIIGS are the straw that is breaking the camel's back.  Or in this case maybe the Euro and the Buck. 

Digital vs. Tangible

US Money Supply (M2) has grown by a factor of six since 1980, while global production of silver from mines has only managed to double in size over that same time frame (index 1980 = 100).

Since 1980 we have created 3x as many dollars (physical currency + checking + savings + retail money markets) as we have been able to mine from the ground ounces of silver bullion. 

This does not include the other forms of money that have been created on the institutional side (M3, derivatives, excess reserves).  This is just M2. 

It also does not show the fact that almost all of the silver that has been mined has already been used for industrial purposes.  It has not been saved. 

There are no central bank reserves of silver bullion anywhere in the world, as with gold (Fort Knox, Switzerland, Fed Reserve Bank of New York).  There is no mythical stockpile waiting to be handed out.  It's gone. 

Investor implications:

1. Excessive growth in fiat money supply devalues the purchasing power of each dollar in circulation.  This is not unlike a company that continues to recklessly issue new shares of stock, whereby the initial investors suffer from loss of proportional equity value. 
2. Items that cannot be grown at comparable rates to fiat growth will eventually require more dollars to acquire.  This manifests itself as apparent price 'appreciation'.  
3. The greater the difference in growth rates, the sharper the eventual price correction as surplus fiat dollars flow into the less prevalent real asset.  The transfer rates from fiat to real may be continuous and steady, or mostly dormant with short, sharp corrective moves. 

This example is simplified, but shows one way to put relative asset classes into context with one another, especially when one is digital and the other is tangible.

Look at their relative prevalence.  Look at their rates of production.  Determine which is harder to produce.  Then look at how much remains available for mass investment, should fiat supply see any imbalance and move to correct in a rapid fashion.

This approach will enable you to find ways to identify not just which asset class is undervalued, but when to trade out as it becomes fully valued so you can roll into the next opportunity. 

Isaac Newton never could have predicted Cash For Gold

Newton the conjurer

Sir Isaac Newton is rightly regarded as one of the most brilliant minds in human history.  Newton, associated with describing the Three Laws of  Motion that underpin modern physics (inertia, motion, and action/reaction), also described the law of universal gravitation.  He was also one of the initial discoverers of what we would come to know as calculus when he was around 21-22 years of age. 

But these major advancements in thought were not what Newton himself considered his prime lifetime achievements.  In fact later in life he considered his discoveries in calculus to be a product of youthful curiosity, but not his magnum opus.

You see, later in life he was Master of the Royal Mint, responsible for setting the standards of coinage and chasing down counterfeiters and debasers of the money supply.  His knighthood was bestowed by Queen Anne in 1705 because of his devotion to the goals of the Royal Mint, from whence he became known as Sir Isaac Newton. 

As Master of the Mint Newton also believed he could deduce the process by which base metals could be transformed into gold.  He considered his works in alchemy to be superior science and encoded them in riddle to keep their secrets intact.  This was only responsible... after all, if you had deduced the secret to transforming base elements into valuable gold, you wouldn't want to exactly publish the findings.  He felt his research into alchemy would be where his fame would be more likely enshrined, not the Principia. 

The ruling classes were in perpetual pursuit for a means to expand their gold supply so as to fund their trivial pursuits of war, conquest, glory, and riches.  Notwithstanding the inflationary effects of gold supply per se, the mystical promise of alchemy held sway over centuries across many European dynasties, western and eastern, northern and southern. Anyone who possessed intellect and intellectual gravitas on the subject was amply rewarded with resources and title.

Today we look upon the elemental transformation of base metals into gold as folly, a fairy tale, failed magic.  While the specifics of alchemy in this sense have been thoroughly discredited by modern chemistry, the desire to convince the masses that worthless assets are in fact worth much more has not ceased.

In more recent decades alchemy has come full circle, in an extraordinary way.  We are witnessing one of those few times in human history when the masses have become convinced fiat currency is gold while the bullion itself is ephemeral.  People consider paper dollars the superior asset, and gold the one to be tossed away. 

Pied Piper for the Rich
The Cash-for-Gold industry has taken the popular imagination by storm.  In this business people are offered money for their gold and silver jewelry, either through the mail, on the spot at impromptu fairs set up in hotel conference rooms, or 'Gold Parties' at people's homes where they invite their friends to come for drinks, snacks, to socialize, and then sell their gold.  Brilliant.

This is wildly pounced upon by hundreds of thousands of people who are eager to cash in.

With few exceptions I find this shocking.  Bullion assets are the supreme protection for the common people against ravages of decimating hyperinflation, where cash money depreciates and becomes worthless for acquiring the basic necessities of life.

Gold and silver metals are extremely rare.  They are hard to find in the earth's crust, difficult to mine, and expensive to refine into coinage, bar, and jewelry forms.  They are a wealth reserve of considerable intrinsic value that is being extracted from the population by the moneyed interests for bits of paper that have no intrinsic value. 

Alchemy reversed.  People desire digital dollars that depreciate from inflation more than bullion assets that cannot degrade.  Incredible.

This industry, who claims to be helping people in a time a need, is being dishonest.  These shadowy companies extract from the common man his last bit of real wealth from his pocket and replaces it with rapidly depreciating paper.

Sir Isaac Newton tried to transform worthless assets into gold bullion.  Cash for gold involves helping people surrender their gold bullion for worthless assets.  My god in heaven.


A Dictator King's Dream:  convincing the world to measure gold in dollars, not dollars in gold
Seigniorage is a term that refers to the centuries old game that ruling classes would play with the money supply.  Here, the trick was to convince the people that the money they used was worth a higher value than its intrinsic metal content, and therefore usable for everyday transactions.

If you could get the people to believe that a gold coin with a value stamp of 10 units of money that had just 1 unit of gold was worth the same in practice as another gold coin that had a full 10 units of gold.. you were a very happy monarch.  You could effectively mint 10x as much money for the same amount of gold and fund lavish palaces, build your patronage, acquire more land, and conquer new nations.

Cash-for-Gold is the ultimate king's dream.  Cash-for-Gold means people are willing to exchange a fully-valued gold coin for paper that has zero gold content whatsoever.  No ruling monarch in history was ever able to pull off such a feat without severe disruptions in food supply (bread riots), civil breakdown, and rapid collapse.

But this is what is happening in the United States right now.  On the average we value dollars more than gold.  We measure gold in dollars.  We do not measure dollars in gold or silver ounces.

In 500 years the dollar may be a footnote in the annals of world history, a transient currency of a past nation-state.  But the future will still have gold and silver bullion in some form.

Just who's buying all the gold and silver anyway?

Critical thinking is not what most Americans are known for possessing in great quantity.  NASCAR, UFC, booze cruises, yes, these are emblems of our mythical 'heartland' America.  But not questioning what we're told on TV.

I don't know but... just who is paying real cash for all the gold and silver that comes across the table?  People seem stoked when they come out of these transactions with a fistful of dollars, thinking they've just scored a great deal.  They never seem to think who is on the other side of the table... if bullion is really at an all time high (as the ads claim) and poised to fall, why the FUCK would they be buying at all?  Wouldn't it make sense to NOT buy and actually be SELLING it back to people at the peak?

Here is my answer.  The interests that are behind the people paying cash see the end game coming, and it will not be pretty for those holding only cash and cash equivalents.

The Federal Reserve no longer has to print money because they have computers that can do it faster, and more is coming.  The more digital dollars that zing through the system means the dollar price of real tangible stuff that can't be e-multiplied will rise.  Bullion will be exchangeable for more real stuff later than it will today, so the smart money sees all this as a chance to buy low.

We can't mine enough gold now to meet industrial, central bank and investment demand for physical, so the deficit must come from what's called 'recycling' (e.g. cash for gold).


What would you rather have, $350 or $18,250?

Assume in 1971 you (or your parents) were sitting on a cash pile of $350. Gold was $35 per ounce.  $350 was a nice chunk of change in 1971 and could buy about as much as $2,037 would today.

You have a choice of stuffing that cash in the wall for later, or trading it for gold and stashing the gold instead.

Flash forward to 2011.  Your $350 cash pile would buy a lot less in 2011 dollars than in 1970 dollars... losing about 83% of it's purchasing power over 40 years. 

Your 10 ounces of gold today would be tradable for more dollars.  A lot more.  At $1,825 per ounce your 10 ounces would be worth $18,250 in dollar terms.

Today, what do you think will hold its value better for the next 30 years?  $1,825 cash stuffed in your wall, or one gold ounce (or 45 ounces of silver bullion) kept equally secure?


You cannot be invited to leave the herd
I would invite you to leave the herd but that would be herd thinking.  Do it yourself.  Thinking outside the box does not mean you become some hermit in the wilderness.  It just means you practice thinking about things critically, and develop immunity to talking-head syndrome.

Game?

Here's a practice pitch:  when it comes to bullion, stop thinking of it in 'dollars per oz'.  Instead think how much paper is required to trade for one ounce of bullion.  As in, "today my one ounce of gold can be traded for $1,825 pieces of paper with Washington's portrait on them."

I rather suspect.. that's how Sir Isaac Newton would have thought of it.  

Silver Bubble? Or Ground Floor? (Part II) : Thundering Herds Blow

Thundering Herds blow bubbles.  They cannot stamp them out. 

The problem with investment bubbles is that most people seem to know what they are, are scared of getting wiped out by one, but yet cannot accurately describe what makes something a bubble.

They describe bubbles as something that will cause them catastrophic loss.  Many times they get their information on the bubble of the day from .. well, the financial media.  Which as I discussed in Part I is not always objective and likes to keep you nervous, on edge, and tuned in. 

Several good writers have already summarized the main phases of a classic bubble.  I did not create the below chart but have seen it in multiple places.  I am reposting this image from Steve Blank's interesting postings, who has a series focusing more or less on VC and technology prospects.

In this chart the Smart Money moves in stealth mode to acquire the asset while Awareness gradually picks up with other Institutional players, followed by some light cashing in, followed by a rapid Mania phase as the Public moves en masse as Media starts giving it attention.  This creates a self-sustaining burst of greed and delusion/fear.  Near the peak people are convinced they have reached a New Paradigm where the old rules no longer apply, then a brief pop which people deny and are reassured by false starts before a catastrophic crash, Despair, then a final return to Equilibrium in the Blow-Off Phase. 

Question:   For extra credit, if the life of an investment bubble is so simple to identify, then why the hell do we have them?

Fear Factor 

Yes Virginia, it is true that a collapsing bubble will cause you catastrophic loss if you purchased at the peak … and especially if you used leverage to do so.  But this isn’t enough.  Fear of loss or misuse of leverage could apply to any investment. Stocks go up and down, that’s life.  But this does not mean stocks are always bubbles anymore than getting in a car guarantees you will be in a fender bender.  The fact is that nobody likes losing money.  I don’t. 

The financial industry has a cute name for Fear Factor:  “risk tolerance”.  

They can’t call it OMG RISK because people will freak out.  But hey, ‘tolerant’ is good, right?  Let’s call it ‘risk tolerance’.  Who said Marketing was a worthless degree.   

The truth is that investment bubbles are rare.  Not impossible, but rare.  The tulip mania and South Sea schemes were famous bubbles but these happened hundreds of years ago when people openly screwed each other in smoky candle-lit rooms and carried daggers (or muskets) in their pockets.  The stock market crash of 1929 was the result of a stock bubble, but we didn’t have another one of these until the dot-com/telecom meltdown of 2000, seventy years later.  Then the housing bubble that peaked in 2006 a half decade after that.

The timing of these last two actually puts Alan Greenspan, former chair of the Federal Reserve, as having the dubious distinction of presiding over the central bank and guiding its monetary policies during not just one, but two major investment bubbles. Does anyone know how the French say ‘fuckingdee fuck flippity flip fucking idiot’? 

No, I believe that most of the time the Fear people have when they talk about investing is not bubble fear but plain ole’ low risk tolerance.  Since infotainment sources are echo chambers for institutional interests, they’re not going to get any warm fuzzies about bullion investing from them.  These are people who only invest when they hear about it from 20 sources, vs. looking at the data themselves and making up their own minds. 
   
Even more absurd (to me) are when people look to their peers for information, for whatever reason assuming they represent some broader consensus, before making a move themselves. 

Ironically, this is the opposite of how ‘buy-low/sell-high’ actually works.  If everyone around you is already convinced of the value proposition and has committed money to it, then you’ve lost the low-value part of ‘buy-low/sell-high’. Party on. 

Bubbles are Three Dimensional.  Here are my Three Rules for detecting whether you are staring at a bubble. 

Bubble Rule #1:

Rule #1:  Those who pronounce a bubble is currently here must show their track record with respect to predicting the last two bubbles (dot-com and housing).  

Corollary to Rule #1:  Those who deny a bubble must show why the conditions of a bubble are not met.  

Just think about this for a minute:  of all the talking heads warning of a gold and silver bubble, where were they during the rapid inflation of the housing bubble?   Were they warning people to not buy a house?  To sell their bank stocks?  Were they jumping up and down begging people to sell their houses at the peak and move into rentals?  No they weren't.  So why the Johnny Leader routine?

In fact I seem to recall these guys pasting on make-up and waving the pom-poms for housing all the way up, then denying its decline for a good year or two after the pop had wiped out millions of people and destroyed several banks.

And by the way, just how many of these pundits, policymakers and media celebrities apologized for being wrong?  Offered a mea culpa or analysis of how and why their gold-plated analysis failed? 

Lack of insight is especially egregious for those in positions of power, who wanted that responsibility and who ought to know what bubbles are and be advising the masses when they arise, but yet couldn't see one forming right in front of their face:

"Overall, while local economies may experience significant speculative price imbalances [in housing], a national severe price distortion seems most unlikely in the United States, given its size and diversity."  

-- Recorded remarks by Federal Reserve Chairman, Alan Greenspan, Oct 19 2004.   

Chairman Greenspan gave this speech just about 18 months before the high water mark of the housing bubble was reached.  It took him years after it popped to even admit error, and even then his admissions were qualified, parsed out in bits, and equivocal.  Greenspan should at least have the decency to own up to his responsibilities and take accountability for his actions in a manner that Ayn Rand (his intellectual and philosophical mentor) would have demanded. 

The fact is that bubbles, while rare, are hard for most people to see precisely because they are either in the party or trying to get in, which leads to the second rule:

Bubble Rule #2:

Rule #2:  Thundering masses cannot see bubbles, because they are the ones who inflate them.

Corollary to Rule #2:  If the masses declare an asset to be forming a bubble, then no such bubble can form.

Just think about this for a minute.  No, I mean it.  Seriously think about it.

If the popular consensus believes something to be in bubble territory and acts in their own self interest, then this means there are not enough buyers for the asset and extreme price appreciation is not possible.  Thus, no bubble.  Bubbles by their very definition can only grow if investing mania for the asset class is triggered, pumping up the apparent face value of the asset in extremis.

In this scenario, the Thundering Herd creates radical price imbalances that the Smart Money sees and takes advantage of, buying low because no one else can see the bullion behind the bullshit. 

Bubble Rule #3:

Rule #3:  Bubbles require cheerleaders.

Corollary to Rule #3:  If the cheerleaders are not cheering the asset, they're probably sleeping with the other team.

Is any further explanation needed?

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I would love for every reader to be in the Smart Money crowd.  Don't be a follower, be dispassionate.  Search for data, look at data.  Look at who is giving you advice.  Ask what their agendas are and why you should take them seriously.

Striking out in a new direction is scary, true.  It flies against millions of years of human evolution, evolution that conditioned us to stick together and socialize our human experience.  But when it comes to money we have to be willing to be the monkey that takes a nibble at undiscovered fruit and see if it is good for us.  It is important to take chances because that is how we grow.  That is how we learn.  When it comes to money, that is how we move from being dumb money in the middle of the herd to the Smart Money that senses the opportunity.

In the final post coming up, I will be showing a few data points that show where Silver bullion happens to be in relation to its current and recent price points, supply and demand.  I believe Silver is somewhere between the Smart Money and early Awareness phases, and odds are strong it will never form a bubble.   At least not in fiat Dollar terms.

Peace out.