First-hand impressions of the “Umbrella Movement”

November 10, 2014

I went to Hong Kong last weekend to get a first-hand look at the protests that are now commonly referred to as the “Umbrella Movement”. I went there believing that the protest movement had very little chance of achieving its main objective, which is to gain a ‘free and fair’ election process for Hong Kong, and came away with the same opinion.

The current protests are taking place in three parts of HK — in the streets around the central government offices in Admiralty (near Central on Hong Kong Island), along part of Nathan Road in Mong Kok (a major shopping area on the Kowloon side of HK), and Causeway Bay (a popular shopping/tourist area on Hong Kong Island). Protestors have blocked off some main streets using makeshift barricades and set up camp.

This must be one of the most peaceful mass protests ever. There are thousands of tents on the streets in the protest areas, but apart from numerous signs demanding “civil nomination” for political office and a few people giving speeches to small crowds at night-time, it doesn’t even seem like a protest. Rather, it seems as if a tent-dwelling community decided to make a home in the middle of a bustling metropolis. There are first-aid tents, covered study areas with many desks so that the students participating in the protest can keep up with their schoolwork, food and drink distribution points, and basic toilet/shower facilities. Also, the occupied areas are kept clean and tidy (there is no rubbish lying around). There was a police presence at Mong Kok (a few dozen uniformed police men and women were standing around the outside of the protest area looking bored), but not at Admiralty.

Here are some of the photos I took.

These photos show the tent cities:

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These photos show what is now known as “Lennon Wall”. The wall is part of an elevated road in Admiralty and is coated with countless thousands of messages of support.

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Finally, these photos show a first-aid tent, two covered study areas, and examples of the protestors’ artwork:

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Overall, it appears to be business as usual in HK. Most people are going about their daily lives as if nothing out of the ordinary is going on, and Hong Kong has adjusted to having no vehicular access to the parts of the city occupied by the protestors. However, the situation could turn ugly, as it did for a few days in September, if the government makes another attempt to forcibly remove the protestors.

Although I couldn’t gauge the general level of support for the protest movement within the HK population, I suspect that most HK residents do not want to ‘rock the boat’ for the sake of greater political freedom. Furthermore, there is clearly some animosity towards the protestors on the part of HK people whose businesses have been disrupted by having some main streets blocked off. In one case, this animosity took the form of a high-volume tirade from a taxi driver when he was asked by my wife for his opinion about the protests.

Hong Kong’s rapidly-rising cost of living is one of the root causes of the discontent that led to the mass protests, but this problem would almost certainly not be addressed by ‘the people’ gaining more influence over who occupies the top political offices. The reason is that hardly anyone involved in the protest movement understands that the high cost of living is due to HK being crushed between the inflationary policies of the US and China.

Thanks to the HK dollar’s peg to the US dollar, HK’s monetary authority essentially follows the US Federal Reserve. This means that despite the steep upward trend in HK prices, interest rates are still being held near zero and the money supply is still being inflated at a brisk pace (it is up by 15% over the past 12 months). At the same time, as a result of the appreciation of the Yuan relative to the US$ and the large price rises in China’s major cities courtesy of rampant monetary inflation in that country, prices in HK still appear reasonable to the mainland Chinese who continue to flood into HK to spend money.

Hong Kong’s “inflation” problem looks destined to get worse over the coming 12 months, which could lead to more widespread support for the “Umbrella Movement”. But in the absence of a general understanding of the nature of the problem, taking a step in the direction of democracy is not going to help.

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Anticipating the end of the gold-stock crash

November 4, 2014

The gold mining sector entered crash mode last Wednesday (29th October). These types of events typically last 5-6 trading days, although they are sometimes a little shorter and sometimes a little longer. Based on the typical length of a multi-day crash the most likely time for a low is therefore this Tuesday (day 5) or Wednesday (day 6).

It is not uncommon for a multi-day crash to be interrupted by one ‘up day’. For example, a 6-day crash could entail three down days followed by an up day and then two more down days to complete the decline. Monday’s bounce in the gold-mining indices and ETFs is therefore not evidence that the crash is over. However, another advance of at least a few percent on Tuesday 4th November would be evidence that the crash is over.

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Incredibly, both the Central Fund of Canada (CEF) and the Central Gold Trust (GTU) are now trading at discounts to their net asset values of almost 10%. This means that purchasing CEF near its current price is roughly equivalent to paying $1050/oz for gold and $14.50/oz for silver. The unusually large discounts at which these bullion funds are now trading is an indication that gold and silver are almost as out-of-favour as they ever get.

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Why leveraged ETFs should only ever be used for short-term trades

November 3, 2014

This topic was recently revisited at TSI due to the growing popularity of ETFs that are designed to move each day by 2 or 3 times the amount of a target index. My main point was/is that leveraged ETFs should only ever be used as short-term trading vehicles, because they tend to leak value over time. This is not a design flaw; it’s just something that anyone who trades these ETFs should be well aware of. Here is a slightly modified version of the most recent TSI coverage of the issue.


The crux of the matter is that leveraged ETFs are designed to move by 2 or 3 times the DAILY percentage changes of the target indexes. They are NOT designed to move by 2 or 3 times the percentage change of the target indexes over periods of longer than one day. Due to the effects of compounding, their percentage changes over periods of much longer than one day will usually be less — and sometimes substantially less — than 2-times (in the case of a 2X ETF) or 3-times (in the case of a 3X ETF) the percentage changes in the target indexes. For example, if you believe that the S&P500 Index is going to fall by 30% over the coming 12 months and to profit from this expected decline you purchase SDS, an ETF designed to move each day by 2-times the inverse of the SPX’s percentage change, then you will probably not make a 60% profit on this trade even if you turn out to be totally correct about the SPX’s performance. Instead, the amount of profit you make will be determined by the path taken by the SPX on its way to the 30% loss and will probably be a lot less than 60%.

The easiest way for me to explain how the relationship between the daily percentage change of an index and the daily percentage change of an associated leveraged ETF does not translate into a similar relationship over periods of longer than one day, is via some hypothetical examples that show how the math works. Here I go.

In the tables presented below, Index A is the target index (the index for which leveraged exposure is created) and 100 is the starting (Day 0) value for both the index and the associated leveraged ETF. I then move the index up on one day and down by the same amount on the next day, such that by Day 6 it is still at 100.

In the first table, Index A alternately moves up by 10 points and down by 10 points, ending Day 6 back where it started (at 100). The final column in this table shows the value of an ETF designed to move each day by twice the percentage change of Index A. Even though Index A ended the 6-day period unchanged, the 2X ETF based on Index A ended the period with a loss of 5.4%.

Index A $ Value Index A $ change Index A % change 2X ETF % change 2X ETF $ Value
Day 0 100.0 0.0 0.0 0.0 100.0
Day 1 110.0 10.0 10.0 20.0 120.0
Day 2 100.0 -10.0 -9.1 -18.2 98.2
Day 3 110.0 10.0 10.0 20.0 117.8
Day 4 100.0 -10.0 -9.1 -18.2 96.4
Day 5 110.0 10.0 10.0 20.0 115.7
Day 6 100.0 -10.0 -9.1 -18.2 94.6

In the second table the volatility is ramped up. Instead of Index A alternately moving up and down by 10 points it experiences 20-point daily swings, but still ends Day 6 back where it started (at 100). Even though Index A ended the 6-day period unchanged, in this case the 2X ETF based on Index A ended the period with a loss of 18.7%.

Index A $ Value Index A $ change Index A % change 2X ETF % change 2X ETF $ Value
Day 0 100.0 0.0 0.0 0.0 100.0
Day 1 120.0 20.0 20.0 40.0 140.0
Day 2 100.0 -20.0 -16.7 -33.3 93.3
Day 3 120.0 20.0 20.0 40.0 130.7
Day 4 100.0 -20.0 -16.7 -33.3 87.1
Day 5 120.0 20.0 20.0 40.0 122.0
Day 6 100.0 -20.0 -16.7 -33.3 81.3

In the third and final table I go back to the 10-point daily swings, but change the leverage to 3-times. In this case, the unchanged result for the index was accompanied by a loss of 15.5% for the leveraged ETF.

Index A $ Value Index A $ change Index A % change 3X ETF % change 3X ETF $ Value
Day 0 100.0 0.0 0.0 0.0 100.0
Day 1 110.0 10.0 10.0 30.0 130.0
Day 2 100.0 -10.0 -9.1 -27.3 94.5
Day 3 110.0 10.0 10.0 30.0 122.9
Day 4 100.0 -10.0 -9.1 -27.3 89.4
Day 5 110.0 10.0 10.0 30.0 116.2
Day 6 100.0 -10.0 -9.1 -27.3 84.5

An implication of the above is that the greater the volatility of an index and the greater the leverage provided by an ETF linked to the index, the worse the likely performance of the leveraged ETF over extended periods. The worse, that is, relative to the performance superficially implied by the daily percentage change relationship between the index and the leveraged ETF. So, it is fair to say that leveraged ETFs are only suitable for short-term trades and that a trade should be very short-term if it involves a 3X ETF and/or a volatile market.

My final point is that it is possible to take advantage of the value leakage inherent in the design of leveraged ETFs by shorting them rather than buying them. For example, if you want to use a leveraged ETF to profit from an expected decline in the S&P500 Index, you will generally be better served by going short SSO (ProShares Ultra Long S&P500 Fund) than by going long SDS (ProShares Ultra Short S&P500 Fund). For another example, if you want to use a leveraged ETF to profit from an expected rise in junior gold-mining stocks and you plan to hold the position for more than a few weeks, you will generally be better served by going short JDST (Junior Gold Miners Index Bear 3X) than by going long JNUG (Junior Gold Miners Index Bull 3X).

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Close to the most extreme market sentiment ever

October 31, 2014

TSI subscribers will soon receive an email alert regarding Thursday’s panic in the gold-mining sector, including brief thoughts on what it means for the days ahead and the actions that I am planning to take. The purpose of this post is to highlight the starkly contrasting long-term charts of the HUI and the US$ gold price. The relevant charts are displayed below.

There was already a dramatic difference between the HUI and gold charts prior to this week, but the price action of the past two trading days has magnified the difference. The HUI is now slightly below its 2004 and 2005 lows, and is within spitting distance of its 2008 crash low. At the same time, gold hasn’t even breached its lows of the past year and is trading about 220% above its 2004 low.

I think that the HUI’s position relative to gold equates to one of the most extreme market sentiment situations ever. It is, I think, right up there — in terms of magnitude, but at the opposite end of the sentiment spectrum — with the March-2000 upside blow-off in the NASDAQ.

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Annual gold-mine supply is just 1.5% of total gold supply

October 28, 2014

One of my readers sent me the following two-paragraph excerpt — written by someone called “Bill H” about a debate between Chris Powell and Doug Casey at a recent conference — from a commentary at lemetropolecafe.com, a web site dedicated to the idea that downward price manipulation dominates the gold market. He asked me to comment on the second paragraph, but I’ll do better than that — I’ll comment on both paragraphs. I’ll explain why the first paragraph contains a misunderstanding about economics and why the second paragraph reveals extreme ignorance of the gold market. First, here’s the excerpt:

Powell also pointed to Larry Summer’s Gibson paradox study where low gold prices also aid in low interest rates and allow for more debt and currency issuance than would otherwise be the case. He also pointed to documents from the CME that shed light on the fact the central banks are “customers” and actually receive volume discounts for trading. Chris then mentioned that just because gold has gone higher, this is not evidence of no suppression as gold would or could be much higher in price if it were not for suppression. In answer to Casey’s statement “we would never suppress the prices of gold and silver because this would aid the Chinese and Russians”, insider Jim Rickards claims a “deal” has been struck with the Chinese.

I have no proof of this one way or the other but it does make perfect sense to me. I could write an entire piece on this subject but for now a paragraph will have to suffice. If China (and India) are buying more than the entire year’s global production of gold …yet the price has been dropping during this operation …the metal HAS to be coming from somewhere. The ONLY “somewhere” this can be is from where it is (has) being stored, central bank vaults. The only possible way for prices to not rise when physical demand grossly exceeds supply is through the use of paper derivatives. It is really just this simple. In my opinion what Jim Rickards has said must have some truth behind it, some sort of deal has to have been struck which allows China/India (and Russia) to purchase increasing amounts of gold at decreasing prices. As I have said all along, once China cannot receive gold in exchange for dollars …then of what use are their dollar holdings? Do you see? The game will be up and there will be no incentive to China whatsoever to hold any dollars which will …end the game.

The misunderstanding about economics has three parts.

First, “Gibson’s Paradox” only applies in the context of a Gold Standard. It has no relevance to the current monetary system.

Second, there is actually no paradox.

As an aside, Keynesian economists sometimes arrive at what they consider to be paradoxes, the “Paradox of Thrift” being the classic case. However, this is only because they are being guided by hopelessly flawed economic theories. For example, Keynesians get the economic growth process completely backward. They think it begins with consumer spending, when in reality it ENDS with consumer spending and begins with saving. That’s why they believe that an economy-wide increase in saving (meaning: a reduction in consumer spending in the present) is bad for the economy and must be discouraged. In the case of “Gibson’s Paradox”, which revolves around the link between interest rates and the general price level under a Gold Standard, there will only be a paradox for the economist who doesn’t understand the relationship between interest rates and time preference (the desire to spend money in the present relative to the desire to delay spending (to save, that is)).

Third, if gold were being manipulated today in accordance with the relationship between gold and interest rates that existed during the Gold Standard, then an effort to create lower interest rates would involve an effort to manipulate the price of gold UPWARD relative to the prices of most other commodities (under the Gold Standard, a decline in interest rates tended to be associated with a rise in the purchasing power of gold). Strangely, this is what happened over the past 7 years, in that the gold/commodity (gold/CCI) ratio rose as interest rates fell and reached a multi-generational high in 2012 at around the same time as interest rates on long-dated US Treasury securities reached a multi-generational low.

Now, I’m not saying that gold was manipulated upward relative to other commodities as part of an attempt to suppress interest rates. These days central banks make full use of their power to manipulate interest rates directly, thus obliterating any reliable link between the price of credit and the general desire to spend/save. Central banks have even gone a long way towards obliterating any link between the price of credit and the risk of default. In a nutshell, interest rates have been distorted to the point where they no longer provide valid signals. What I’m saying is that you need to have a sub-par understanding of economics to believe that gold has been manipulated downward as part of a scheme to create lower interest rates.

I could write a lot more about the relationships between economy-wide time preference, interest rates, the general price level and gold, but I don’t want to get bogged down and this post is already longer than originally intended. Instead, let’s move on to the second of the excerpted paragraphs.

I was particularly impressed by the following sentences:

“If China (and India) are buying more than the entire year’s global production of gold …yet the price has been dropping during this operation …the metal HAS to be coming from somewhere. The ONLY “somewhere” this can be is from where it is (has) being stored, central bank vaults. The only possible way for prices to not rise when physical demand grossly exceeds supply is through the use of paper derivatives. It is really just this simple.”

These sentences reflect a very basic misunderstanding about the gold market that I end up addressing several times every year in TSI commentaries. The fact is that the supply of gold is NOT the annual amount of gold produced by the mining industry. Rather, the mining industry adds only about 1.5% to the total supply of gold every year. This is why changes in mine production have almost no effect on gold’s price trend and why it is illogical to compare the gold demand of some countries or regions with annual mine production.

The total supply of gold is around 170,000 tonnes, and over the next 12 months the mining industry will add about 2,500 tonnes to this total supply. Furthermore, the mining industry is no different to any other seller (an ounce of gold mined over the past year is the same as an ounce of gold that has been sitting in storage for the past 200 years), except that it is price-insensitive. The mining industry will sell its 2,500 tonnes regardless of price, whereas the actions of the holders of the existing 170,000 tonnes of aboveground gold will be influenced by changes in the gold price and changes in the perceived attractivess of gold as an investment or store of value.

Some existing holders (the weak hands) are likely sellers in response to price weakness, whereas other holders are likely sellers in response to price strength. Some existing holders will change their plans based on their assessments of current and likely future conditions, whereas others will be determined to hold forever. At the same time there are a huge number of potential buyers, some of whom will be planning to buy in response to lower prices, some of whom will be likely to buy in response to signs of an upward trend reversal, and many of whom will change their plans based on changes in the financial world.

The main point to be appreciated here is that it’s the urgency to sell on the parts of existing holders of the total gold stock relative to the urgency to buy on the parts of prospective new owners that determines the change in price. As noted above, the gold mining industry is just one small piece of a very big puzzle.

Finally, I’m not going to attempt to debunk the unsubstantiated claim that the US government has made a deal with the Chinese government whereby the gold price will be held down to facilitate the latter’s gold accumulation. This is just a nonsensical story.

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Economic growth causes lower, not higher, prices

October 23, 2014

This blog post is a slightly modified excerpt from a recent TSI commentary.

If you believe in the thesis that world GDP will continue to expand and that population growth will continue, then you should own natural resources. New people who are born will want to eat, drive, and build houses. This trend offers long-term support for natural resources.

The above is a comment by Rick Rule in an article titled “Are the Worst of Times Yet to Come?“. I consider Rick Rule to be a brilliant investor in natural-resource companies and agree with his investment strategy. I also agree with everything in the afore-linked article EXCEPT the above comment. If it is true that the prices of natural resources are supported by economic and population growth, then why is it that world population and world GDP have grown relentlessly over the past 200 years and yet over that entire period the real prices of most commodities have been in downward trends?

The fact is that economic growth causes prices, including the prices of most natural resources, to become LOWER, not higher. Real growth involves producing more with less. That’s why the fastest-growing industries generally have downward-trending product prices. However, the downward trend in prices that would otherwise occur due to real growth can be counteracted by monetary inflation and political intervention, and these days that’s exactly what happens most of the time. These days, monetary inflation causes prices (prices in general, not all prices) to have an upward bias even during periods of economic progress — periods when prices, on average, should be trending downward. This is because in addition to reducing the purchasing power of money, an effect of monetary inflation is to make the economy less efficient by distorting relative price signals. Political intervention also puts upward pressure on prices by placing obstacles in the way of more efficient production.

Consequently, genuine economic growth is most definitely not an ingredient for large rises in natural-resource prices. Instead, two of the three main ingredients are monetary inflation and an increase in politically-motivated/directed spending.

The third main ingredient is valuation. The relative valuations of different assets and commodities will have a big influence on which prices are affected the most by the current cycle’s monetary inflation. In particular, for commodities to be major beneficiaries of monetary inflation, commodity prices should be low relative to the prices of equities and bonds. According to the following weekly chart, commodity prices (as represented by the CCI) are currently near a 10-year low relative to the S&P500 Index, which is certainly low enough to enable a multi-quarter period of relative strength.

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Quick comments on the US stock market and some company news

October 21, 2014

From the Stock market section of the Weekly Market Update posted on 19th October, under the heading “What to do”:

We have no idea what anyone else should do, apart from maintain a substantial cash reserve. Having exited all stock-market-related put options last week, the short-term plan for our own account is to begin averaging into January-2016 SSO (ProShares Ultra S&P500) put options following some additional rebounding activity over the next few weeks. We might also average into the unleveraged, actively-managed bear funds previously mentioned at TSI (BEARX and HDGE).

This plan assumes that a multi-week low was put in place last week. If this assumption is wrong and it turns out that the initial decline from the September peak is not yet over, then we will take no action. We will not enter bearish speculations when the market is in the midst of a sharp decline.

I’m posting this brief comment to advise that if the US stock market opens strongly today (Tuesday) then I will probably take an initial position in the aforementioned SSO put options or some other puts. I want some coverage in case the rebound fails sooner than anticipated.

I also want to make readers aware that Almaden Minerals (AAU) and True Gold Mining (TGM.V) issued bullish press releases earlier today. The news will be discussed, as usual, in the next Weekly Update.

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New Lows collapsed on Thursday 16 Oct

October 17, 2014

Despite the fact that the NASDAQ Composite and NYSE Composite Indices tested Wednesday’s intra-day lows on Thursday 16th October, the number of individual NYSE and NASDAQ stocks making new 12-month lows collapsed on Thursday. The relevant charts are shown below. Across the NASDAQ and NYSE markets, the number of new lows fell from around 660 on Wednesday to around 200 on Thursday. This has bullish implications with regard to the next few weeks.

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Don’t be in the position of needing the market to do something

October 17, 2014

If you are in the position of needing a market to do something specific in the short term, such as rally or decline by a certain amount, then you are positioned wrongly. You should be positioned in such a way that you can watch the day-to-day price moves with equanimity. Furthermore, unless you make a living from scalping small profits from intra-day fluctuations, you should NOT watch the markets closely during the trading day. No good will come of it, because closely watching the intra-day price action will increase the risk that you will make a spur-of-the-moment decision based primarily on emotion. That is, it will increase the risk of making a mistake.

Before a market in which you have a financial interest opens for trading you should know the prices at which you would be a buyer and the prices at which you would be a seller. You should therefore be able to place any orders prior to the open. You can then check back later — ideally, after the market has closed — to see what happened and which, if any, of your orders were filled.

I feel fortunate to be separated by 12 hours from the stock markets in which most of my stocks trade (the US and Canadian stock markets). This separation removes any temptation that I might otherwise feel to watch the intra-day trading action, because it means that I am usually asleep during the bulk of the trading day.

On a typical day (night) I check the futures markets and company-specific news well before the start of the North American trading session and decide what, if any, new orders are appropriate. Most orders are placed prior to the open, although occasionally I watch the first few minutes of trading before placing an order. I then usually check back after about one hour to see what’s happening before switching off for the night. By the time I switch back on the markets are closed and I can calmly (most of the time) assess the day’s outcome and start thinking about what new orders make sense for the next day.

On a related matter, the majority of the orders I place are either priced well above the market (for sell orders) or well below the market (for buy orders), with the bid and offer prices usually determined by a combination of valuation and chart-related support/resistance. As a result, my orders sometimes sit around for at least a few weeks before getting filled and sometimes don’t get filled at all. I never, ever, use market orders.

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GLD has all the gold it claims to have

October 14, 2014

Due to the scaremongering of some bloggers, newsletter writers and other promoters of gold manipulation theories, there is still a popular belief within the so-called “gold community” that the SPDR Gold Trust (GLD), the world’s largest gold ETF and for a while in 2011 the world’s largest ETF of any type, doesn’t have all the gold it is supposed to have. There is supposed to be slightly less than one ounce* of allocated gold in the vaults of GLD’s custodian or sub-custodians for every 10 GLD shares, but rumour has it that GLD has put some or all of its gold bullion at risk via gold leasing or other secretive dealings.

The operative word in the above sentence is “rumour”, because there isn’t a shred of evidence that GLD has leased any of its gold or put its gold at risk in some other ‘unacceptable’ way. There is, however, definitive evidence that GLD does have the correct amount of gold. First, GLD maintains a list of every gold bar it owns. The Bar List is located HERE, is updated daily, and contains the serial number, weight and assayed purity of each bar (61,488 of them as at 13th October 2014). Second, the Bar List is audited by Inspectorate International. Specifically, Inspectorate conducts two audits every year of the gold bullion held on behalf of GLD at the vaults of GLD’s custodian. One of these audits involves a complete bar count, meaning that every single bar is inspected and checked against the Bar List. The second audit is a random sample count.

Interestingly, James Turk’s Goldmoney.com also uses Inspectorate to audit the gold in its custodian’s vaults. The latest full audit report of GLD’s gold inventory can be viewed HERE and the latest audit report of Goldmoney’s inventory can be viewed HERE.

Owning GLD is not the same as having physical gold in your possession or having ownership of allocated gold in a vault that you can take delivery of (GLD shares can only be exchanged for gold bullion in 100,000-share lots by Authorised Participants). It is simply a convenient way to trade something that is fully backed by physical gold via the stock market at very low commissions and buy-sell spreads.

If you own GLD shares and plan to maintain your position for 1-2 years or longer then you should give some thought to switching from GLD to GTU (Central Gold Trust), because GTU is currently trading at a discount of almost 8% to net asset value. At current prices, by selling GLD and buying the same dollar amount of GTU you end up with exposure to almost 8% more gold.

*There was originally one ounce of gold for every 10 GLD shares, but the amount of physical gold per GLD share falls by a tiny amount each year due to storage and insurance costs.

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