Is there really no alternative?

August 19, 2016

This post is a brief excerpt from a recent commentary posted at TSI.

In the late stages of every long-term bull market there has been a widely-believed, simple story for why prices will continue to rise despite high valuations.

In the early-1970s the story was the “nifty fifty”. The belief was that a group of 50 popular large-cap NYSE-traded stocks could be bought at any price because the quality and the growth-rates of the underlying companies virtually guaranteed that stock prices would maintain their upward trends. The “nifty fifty” not only collapsed with the overall market during 1973-1974, most members of the group under-performed the overall market from 1973 to 1982.

In 1999-2000 the story was the “technology-driven productivity miracle”. The belief was that due to accelerating technological progress and the internet it was reasonable to value almost any company with a web site at hundreds of millions of dollars and it was reasonable to pay at least 50-times annual revenue for any company with a decent high-tech product. Most of our readers will remember how that worked out.

In 2006-2007 there were three popular stories that combined to explain why prices would continue to rise, one being “the great moderation”, the second being the brilliance of the current batch of central bankers (these monetary maestros would make sure that nothing bad happened), and the third being the unstoppable rapid growth of the emerging markets. Reality was then revealed by the events of 2008.

The story is always different, but it always has two characteristics: It always seems plausible while prices are rising and it always turns out to be completely bogus.

The most popular story used these days to explain why the US equity bull market is bound to continue despite high valuations is often called “TINA”, which stands for “There Is No Alternative”. The belief is that with interest rates near zero and likely to remain there for a long time to come it is reasonable to pay what would otherwise be considered an extremely high price for almost any stock that offers a dividend yield. There is simply no alternative!

We can be sure that the TINA story will turn out to be bogus and that the high-priced dividend plays of today will go the way of the “nifty fifty”. We just don’t know when.

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English language pet peeves

August 17, 2016

There are certain phrases or ways of using/displaying words in written English that I find annoying. Here is an incomplete list of these minor annoyances:

1) Saying “literally” when what is really meant is “figuratively”

For example: “When Jim’s boss found out that the report was a week late, he literally exploded.” No, he didn’t literally explode (the room didn’t end up being covered in the boss’s blood and body parts); he got very angry. For another example: “Jane was literally swept off her feet by the charming man.” No, the man didn’t assault Jane with a broom; he used words to figuratively sweep her off her feet.

2) Saying “could” when “couldn’t” is what’s really meant

This is something that people from North America tend to do, most often in the “could/couldn’t care less” context.

When someone says “I could care less” they are saying that they care at least a little bit, which is the opposite of what they mean. The correct wording is: “I couldn’t care less”.

3) Writing “the proof is in the pudding”

This makes no sense. The correct saying is “the proof of the pudding is in the eating”.

4) Writing “personally, I”

Although it is probably not grammatically incorrect, I find it slightly irritating when someone writes “Personally, I…” or anything else that involves putting the word “personally” before or after “I” or “me”. As soon as you use “I” or “me”, the “personally” is implied.

5) Writing “she” to mean “he/she”

Writing “he/she” is a little clumsy. The correct alternative is to write “he”. Using “she” as the abbreviation for “he/she” is a blatant attempt by the author to be politically correct, and political correctness in all of its guises is annoying.

6) Replacing letters with asterisks

I have no problem with swearing. Words are just sequences of sounds and no sequence of sounds is inherently more offensive than any other sequence of sounds. Also, social conventions are constantly changing such that words that were considered profane in the past are no longer considered so and words that are considered profane today will not be considered so in the future. For example, the terms “dark meat” and “white meat” in reference to parts of a chicken or turkey started being used in Victorian times because in that period the words “breast” and “thigh” were widely viewed as vulgar.

That being said, many people are offended by swear words. That’s why I never swear in blog posts and rarely swear in my private life. However, some people apparently believe that they can swear without really swearing by simply replacing some of the letters in the ostensibly offensive word with asterisks. But if the word that is being ‘concealed’ with asterisks is still obvious, which it always is, then how is using the asterisks anything other than an insult to the reader’s intelligence?

Either swear properly or don’t swear at all. Don’t insult my intelligence by inserting asterisks in part of what you believe to be an offensive word.

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Increasing speculation in “paper gold”

August 15, 2016

An increase in the amount of gold bullion held by GLD (the SPDR Gold Shares) and other bullion ETFs does not cause the gold price to rise. The cause-effect works the other way around and in any case the amount of gold that moves in/out of the ETFs is always trivial compared to the metal’s total trading volume. However, it is reasonable to view the change in GLD’s gold inventory as a sentiment indicator.

Ironically, an increase in the amount of physical gold held by GLD and the other gold ETFs is indicative of increasing speculative demand for “paper gold”, not physical gold. As I’ve explained in the past (for example, HERE), physical gold only ever gets added to GLD’s inventory when the price of a GLD share (a form of “paper gold”) outperforms the price of gold bullion. It happens as a result of an arbitrage trade that has the effect of bringing GLD’s market price back into line with its net asset value (NAV). Furthermore, the greater the demand for paper claims to gold (in the form of ETF shares) relative to physical gold, the greater the quantity of physical gold that gets added to GLD’s inventory to keep the GLD price in line with its NAV.

Speculators in GLD shares and other forms of “paper gold” (most notably gold futures) tend to become increasingly optimistic as the price rises and increasingly pessimistic as the price declines. That’s the explanation for the positive correlation between the gold price and GLD’s physical gold inventory illustrated by the following chart.


Now, speculation in “paper gold” is both an effect of the gold price and an important short-term driver of the gold price. It is therefore fair to say that although changes in GLD’s gold inventory don’t cause anything, they often reflect changes in speculative sentiment that at least on a short-term basis do have a significant influence on the gold price. At the same time it is also fair to say that the influence of speculative buying/selling in the futures market is vastly greater (probably at least an order of magnitude greater) than the influence of speculative buying/selling of GLD shares. Refer to “The scale of the gold market” for details on relative size an influence.

The speculative demand for “paper gold” has certainly ramped up over the past several months. This is partly reflected by the increase in the GLD inventory shown on the above chart, but it is primarily reflected by the rise to an all-time high in futures-related speculation. This is illustrated below.

Chart source:

The extent to which short-term speculators are bullish on gold is a risk. An unusually-elevated level of speculative enthusiasm will never be the cause of a reversal in the price trend from up to down, but it will exacerbate the decline that happens after the price-trend reverses for some other reason.

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How to deal with crappy people

August 11, 2016

James Altucher wrote a blog post several years ago that has stuck with me. The gist of the post was that the best way to deal with crappy people is to not engage with them in any way under any circumstances. Do not argue with them, do not attempt to give them advice, and do not make any effort to get them to like you. Just ignore them.

Altucher’s message has saved me a lot of aggravation over the years. Once in a while I fall into the trap of interacting with someone I should ignore, but I’m usually successful at preventing crappy people from disrupting my peace of mind — by essentially blotting them out.

I don’t have any crappy people in my personal life. At least, I don’t at the moment. However, as someone who publishes stuff on the internet I regularly attract emails from crappy people I don’t know. In the distant past these emails would sometimes annoy or disturb me and occasionally I would get sucked into a ‘tit for tat’ exchange, but no longer. I’ve learnt that there is no point trying to mud-wrestle a pig, because you both end up dirty and the pig enjoys it.

Just to be clear, I have no problem with polite criticism. In fact, when I write something that is logically or factually incorrect I am grateful if someone takes the trouble to explain where I went wrong. Crappy people, however, do not disagree in a polite and well-reasoned manner; instead, they launch insults.

Nowadays when I receive an email from a crappy person, I never respond. As soon as I realise the nature of the email, I delete it and add the sender’s address to my “blocked senders” list, thus ensuring that I will never hear from them again.

The best emails sent to me by crappy people are the ones that have an insult in the subject line, because I don’t have to waste time opening these. For example, last week someone sent me an email with “You are a moron” as the subject line. I don’t know what the email contained, because I never opened it. I just added the sender’s address to my “blocked” list and then deleted it. My guess, however, is that it was a reaction to a post I had published a day earlier ( The post in question debunked the claim that the Fed routinely props up the stock market by purchasing stocks, ETFs and/or futures, and I’ve discovered over the years that the surest way to provoke a vitriolic response is to write something that casts aspersions on a popular market-manipulation story or that expresses anything other than unequivocal optimism about gold and silver.

It has become easy for me to ignore emails from crappy people I don’t know, but it’s a lot more difficult, and not always possible, to ignore such people in our personal or business lives. However, if there are certain crappy people you can’t completely blot out, for example, if your boss is one or your sister is married to one, then you should at least minimise your interaction with them. Life is too short to do otherwise.

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Gold remains hostage to small changes in the expected FFR

August 9, 2016

Here is an excerpt from a commentary posted at TSI on 6th August.

The monthly US employment reports have no relevance except for their influence on the Fed and market expectations regarding future Fed actions. The moderately strong employment data reported last Friday, for example, provides no information about the current or likely future performance of the US economy, but was noteworthy because it led to a slight increase in the expected level of the Fed Funds Rate (FFR).

The change in the expected level of the FFR in response to Friday’s employment news is illustrated by the following daily chart. The last bar on the chart shows a fall of 0.09 in the price of the January-2018 Fed Funds Futures (FFF) contract, which means that the expected level of the FFR in January-2018 rose by 0.09 (9 basis points) last Friday.

Now, under more normal circumstances a 0.09% change in the expected level of the FFR in 17 months’ time would not have a significant effect on the gold market, but these aren’t normal circumstances. These are circumstances in which the actions and expected future actions of central banks are dominating all other considerations. Consequently, just as a minor decrease in the expected FFR during the final week of July and the first two trading days of August propelled the gold price from around $1310 to the $1370s, a minor increase in the expected FFR on Friday predictably had the opposite effect.

Does this mean that if the expected FFR builds on Friday’s gain over the days/weeks ahead then the gold price will probably trend downward over the same period? Yes, that’s exactly what it means. It also means that if something happens in the world to cause the expected FFR to move below the lows of the past few weeks then the gold price will probably move to a new high for the year.

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Does the Fed support the stock market?

August 3, 2016

The answer to the above question is yes and no. If the question is does the Fed use the combination of monetary policy and ‘jawboning’ in an effort to push equity prices upward then the answer is definitely yes. However, if the question is does the Fed buy index futures or ETFs in an effort to elevate the stock market then the answer is almost certainly no.

It is no secret that today’s Fed considers the performance of the stock market when deciding on what monetary measures to implement. In fact, over the past 8 years the Fed has overtly targeted higher stock prices based on the erroneous belief that higher stock prices lead to greater consumer spending and a stronger economy. It is also clear that the public utterings of senior Fed representatives are often influenced by the stock market’s recent performance. For example, soon after the stock market takes a tumble you can safely bet your life on at least one Fed governor coming out with a public comment suggesting easier monetary policy. However, the idea that the Fed brings about higher stock prices by directly purchasing futures contracts or ETFs is just an appealing fantasy.

An obvious retort is that some other central banks, most notably the BOJ, are known to have bought ETFs as part of their efforts to boost economic activity, so why shouldn’t we believe that the Fed has gone down the same path?

My response is: How do we know that the BOJ et al have made these stock-market-related purchases? We know because the purchases have not happened in secret. They have been openly declared.

Doing it openly is the only way that a central bank such as the BOJ or the Fed could ever directly intervene in the stock market, especially if the intervention is designed to be large enough to have a significant effect on the overall market. A central bank trying to surreptitiously support the stock market via direct purchases would be akin to an elephant trying to surreptitiously make its way through your living room. That is, the evidence of the central bank’s actions would be blatant. There would be an obvious paper trail and a lot of people (a lot of potential whistleblowers) would have to be involved.

Another retort is that the Fed does its purchasing of equity-related instruments via an intermediary such as a major private bank.

Yes, if the Fed made stock-market purchases then it would, of course, act through an intermediary, but this doesn’t enable the purchases to be kept secret. For example, all of the Fed’s bond purchases have been made through intermediaries, but the evidence of the purchases is as plain as day on the Fed’s balance sheet and most people involved in the markets know exactly what the Fed has done.

The belief that the Fed secretly buys and sells in the stock market as part of a largely-successful effort to keep the stock market in an upward trend is therefore ridiculous. However, the idea that the Fed will eventually intervene directly in the stock market is not farfetched. Actually, there’s a high probability that it will happen in the future. But if/when it does happen there will be no need to make wild guesses regarding the central bank’s actions, because the actions will be publicly announced ahead of time in the same way that the bond-buying programs were publicly announced ahead of time.

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There will never be a “commercial signal failure” in the gold market

August 2, 2016

Some commentators have been anticipating a “commercial signal failure” in the gold market for more than 15 years. Moreover, whenever the gold price experiences a large rally the same commentators routinely cite the potential for a commercial signal failure (CSF) as a reason to maintain a full position, the argument being that the coming CSF is bound to result in massive additional price gains. The reality, however, is that whereas a CSF is an extremely unlikely event in any commodity market, in the gold market it is an impossibility.

A CSF theoretically becomes possible in a commodity market after the price has been trending upward for some time, and speculators, as a group, have built-up an unusually-large net-long position in the commodity futures. Naturally, if speculators have a large net-long position then “commercials” have an equivalently-large net-short position, since one is a mathematical offset of the other.

Commercials are generally hedging or spread-trading, so once they have established a position they will usually be indifferent with regard to future price direction. Whatever they lose on the futures they will make in the physical, and vice versa. However, in some commodity markets it is possible for the supply or demand in the physical market to undergo such a sudden and dramatic change that exploding margin requirements on the futures side of a commercial-trader’s hedge or spread-trade could force the commercial to exit (buy back) the short futures position, even though the short position in the futures is ‘covered’ by a long position in the physical. For example, take the case of a wheat farmer who has locked in the price of his yet-to-be-harvested crop by selling wheat futures. If extreme and unexpected weather suddenly causes a moon-shot in the wheat price then the farmer might — depending on how his price hedging has been structured — be faced with a huge margin call on his futures position and forced to exit his hedge, even if his own crop is unaffected by the extreme weather. Exiting the hedge would involve buying wheat futures into a sharply rising market, which would only exacerbate the price rise.

If it happens on a market-wide scale, the hypothetical case of the wheat farmer described above could be part of what’s called a “commercial signal failure”. The so-called signal failure involves commercial traders being forced, en masse, to cover their short futures positions at large losses despite the short futures positions being offset by long positions in the physical commodity. By definition, it can only happen when speculators have built up a large net-long position in the futures market (meaning, when commercial traders have built up a large net-short position in the futures, thus generating the bearish warning signal), a situation that will usually only arise after the price has been in a strong upward trend for several months. Due to the CSF, speculators on the long side make more money more quickly than they were expecting.

However, even in a market where a CSF is technically possible, a prudent speculator would never bet on it. The reasons are that 1) a CSF requires a sudden and totally UNPREDICTABLE change in either supply or demand, and 2) CSF’s almost never happen. In the rare cases when a CSF happens it tends to be the result of an unexpected supply disruption. In agricultural commodities, the most likely cause is an unforeseeable bout of extreme weather.

Major supply disruptions are possible in the markets for all agricultural and industrial commodities, but they are not possible in the gold market. This is primarily because almost all the gold ever mined still forms part of the supply side of the equation, which means that shifts in the current year’s mine production will always be trivial relative to total supply. In other words, in the gold market there is no chance that a CSF could be caused by a major supply disruption.

Although a major supply disruption is not possible in the gold market, there could at some point be a large and unanticipated demand disruption (note that the bulk of the world’s gold is demanded (held) for investment, store-of-value, speculative or monetary purposes). However, such a disruption would not cause a “commercial signal failure”; it would be the EFFECT of a total monetary-system failure.

A “commercial signal failure” is, by definition, an event that results in bullish futures speculators making large and rapid gains, but bullish speculators in gold futures could not profit from a total monetary-system failure. In fact, they would be big losers because the futures market would shut down in such an outcome.

The bottom line is that it is not a good idea to bet of a “commercial signal failure” in any market, because the probability of it happening is extremely low. It is, however, a particularly bad idea to make such a bet in the gold market because in the gold market the event has a probability of zero.

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Helicopter Money

July 29, 2016

Here is an excerpt from a recent TSI commentary about another absurd course of action now being seriously considered by the monetary maestros.

Once upon a time, the concept of “helicopter money” was something of a joke. It was part of a parable written by Milton Friedman to make a point about how a community would react to a sudden, one-off increase in the money supply. Now, however, “helicopter money” has become a serious policy consideration. So, what exactly is it, how would it affect the economy and what are its chances of actually being implemented?

“Helicopter money” is really just Quantitative Easing (QE) by another name. QE hasn’t done what central bankers expected it to do, so the idea that is now taking root is to do more of it but call it something else. Apparently, calling it something else might help it to work (yes, the people at the upper echelons of central banks really are that stupid). The alternative would be to question the models and theories upon which QE is based, but such questioning of underlying principles must never be done under any circumstances. A Keynesian economist calling into question the principle that an economy can be made stronger via methods that artificially stimulate “aggregate demand” would be akin to the Pope questioning the existence of god.

The only difference between QE as practiced by the Fed and “helicopter money” is the path via which the new money gets injected. Under the Fed’s previous QE programs, new money was created via the monetisation of debt and ended up in the accounts of securities dealers*. Under a “helicopter money” program, new money would still be created via the monetisation of debt. However, in this case the new money would be placed by the government into the accounts of the general public, via, for example, tax cuts and welfare payments (handouts), and/or placed by the government into the accounts of contractors working for the government.

If promoted in the right way, “helicopter money” could have widespread appeal among the general public. Unlike the Fed’s traditional QE, which had the superficial effect of making the infamous top-1% richer and the majority of the population poorer, the average member of the voting public could perceive an advantage for himself/herself in “helicopter money”. Unfortunately, regardless of who gets the new money first there is no way that an economy can be anything other than weakened by the creation of money out of nothing. The reason is that the new money falsifies the price signals upon which economic decisions are made, leading to ill-conceived investments and other spending errors.

Due to the distortions of price signals that they bring about, both traditional QE and “helicopter money” are bad for the economy. However, an argument could be made that “helicopter money” is the lesser of the two evils. The reason is that with “helicopter money” the effects of the monetary inflation will more quickly become apparent in everyday expenses and the popular price indices. That is, “helicopter money” will quickly lead to inflationary effects that are obvious to everyone. This limits the extent to which the policy can be implemented.

Putting it another way, traditional QE had by far its biggest effects on the prices of things that, according to the average economist, central banker and politician, don’t count when assessing “inflation”, whereas the effects of “helicopter money” would soon become obvious in the prices of things that do count. A consequence is that a “helicopter money” program would be reined-in relatively quickly and the long-term damage to the economy would be mitigated.

With regard to the chances of “helicopter money” actually being implemented, we think the chances are very good in Japan, very poor in the euro-zone (due to there being a single central bank ‘serving’ a politically-disparate group of countries) and somewhere in between in the US.

Although it presently seems like the more extreme policy, the US has a better chance of experiencing “helicopter money” than negative interest rates within the next two years. This is because a) the next US president will be an economically-illiterate populist (regardless of who wins in November), b) the average voter will likely perceive a financial advantage from “helicopter money”, and c) hardly anyone outside the halls of Keynesian academia will perceive anything other than a disadvantage from the imposition of negative interest rates.

In summary, then, “helicopter money” is QE by a different name and path. It would inevitably reduce the rate of economic progress, but it has a reasonable chance of being implemented in the US the next time that policy-makers are desperate to do something.

*Every dollar of Fed QE adds one dollar to the commercial bank account of a Primary Dealer (PD) and one dollar to the reserve account at the Fed of the PD’s bank, meaning that every dollar of QE adds one reserve-covered dollar to the economy-wide money supply.


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Bearish on T-Bonds

July 22, 2016

Here is an excerpt from a commentary posted at TSI last week. Not much has changed in the interim, so it remains applicable.

The US Treasury Bond (T-Bond) entered a secular bullish trend in the early-1980s. As evidenced by the following chart, over the past 30 years this trend has been remarkably consistent.

There is no evidence, yet, that the long-term bull market is over. Furthermore, such evidence could take more than a year to materialise even if the bull market reaches its zenith this month. The reason is that for a decline to be clearly marked as a downward leg in a new bear market as opposed to a correction in an on-going bull market it would have to do something to differentiate itself from the many corrections that have happened during the course of the bull market. In particular, it would have to result in a solid break below the bottom of the long-term channel. This is something that probably wouldn’t happen until at least the second half of next year even if the bull market just reached its final peak.

However, we don’t need to have an opinion on whether or not the bull market is about to end to see that the risk/reward is currently favourable for a bearish T-Bond speculation. What we need to do is look at a) future “inflation” indicators, which point to rising price inflation over the coming months, b) sentiment indicators, which suggest the potential for a large majority of speculators to be caught wrong-footed by a T-Bond decline, and c) the position of the T-Bond within its long-term channel.

With regard to the channel position, to become as stretched to the upside as it was at the 1986, 1993 and 1998 peaks the T-Bond would have to move about 5 points above this month’s high, but it is already at least as stretched to the upside as it was at the 1996, 2003, 2008, 2012 and 2015 peaks.

Needless to say, we continue to like the bearish T-Bond trade.

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You can make statistics say whatever you want

July 19, 2016

A chart similar to the one below was included in a blog post under the heading “Bank C&I Loan Charge-Offs Soaring Again”. This chart caught my attention because it seems to indicate that bank C&I (Commercial and Industrial) loan charge-offs are happening at one of the fastest rates of the past 30 years — the sort of rate that would be consistent with the US economy being in recession.


The problem is that the above chart shows the percentage change of a percentage, which opens up the possibility that what is in reality a small increase is being made to look like a large increase. For example, an increase from 1% to 2% over the course of a year in the proportion of loans charged-off would be a 100% increase if expressed as a year-over-year percentage change in the percentage of charge-offs, whereas all you’ve actually got is a 1% increase in the total proportion of loans that have been charged-off.

The next chart is based on exactly the same data, but instead of displaying the year-over-year percent change in the percentage of C&I loans that have been charged off it simply displays the percentage of C&I loans that have been charged off. This is not just a more correct way of looking at the data, it is a way that has not given any false recession signals over the past 30 years.


The first chart’s message is: an economic recession is either in progress or imminent. The second chart’s message is: the US economy is not in recession and is presently not close to entering recession.

The same data, opposite messages.

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