(This post is an excerpt from a commentary published at TSI late last week. Note that an explanation of why a hike in the Fed Funds rate no longer entails monetary tightening can be found in a March-2015 post at the TSI blog.)

In early-November of last year we predicted that a tradable gold rally would begin near the mid-December FOMC Meeting as long as the Fed did what almost everyone was expecting and implemented its first rate hike in more than 8 years. Our reasoning was explained as follows in the 4th November Interim Update:

“Looking beyond the knee-jerk reactions to the news of the day, we see a gold market stuck in limbo. In this no-man’s land between a definitively-bullish and a definitively-bearish fundamental backdrop for gold, the US$ gold price works its way higher during periods when it seems that the start of the Fed’s rate-hiking is being pushed out and works its way lower during periods when it seems that the start of the Fed’s rate-hiking is being brought forward.

To get out of this ‘limbo’ and into a situation where a more substantial gold rally is probable, it appears that one of two things will have to happen. Either the Fed will have to take the first step along the rate-hiking path, or the economic/stock-market situation will have to become bad enough that additional monetary easing will be the Fed’s obvious next move. In other words, the Fed will have to stop vacillating and move one way or the other.

Although counterintuitive, there are two good reasons to expect that a Fed rate hike would usher-in a more bullish period for gold. The first reason is that it would potentially be a “sell the rumour buy the news” situation. We are referring to the fact that when a market sells off in anticipation of ostensibly-bearish news, the arrival of the actual news will often lead to a wave of short-covering and an upward price reversal. The second and more interesting reason is that it would spark the realisation that in the current circumstances a Fed rate hike does not entail monetary tightening.”

As it turned out, the Fed went ahead and implemented its first rate hike in mid-December and a strong upward trend in the gold price got underway less than 48 hours later.

The reason for bringing this up isn’t to brag about getting something right; it’s to point out that gold now appears to be stuck in a similar situation to the one we described on 4th November. As was the case back then, to ignite the next tradable gold rally it appears that the Fed will have to stop vacillating. Either the Fed will have to take its second step along the rate-hiking path or the economic/stock-market situation will have to become bad enough that all thoughts of a 2016 rate hike are wiped out.

On 19th April the Shanghai Gold Exchange (SGE) began quoting a twice-daily gold-price ‘fix’ in Yuan terms. Some pundits claimed that this would give the gold price a large and sustained boost. My view was that beyond short-lived fluctuations driven by the vagaries of speculative sentiment, it was irrelevant*. It was, in my opinion, just another in a long line of distractions from gold’s true fundamental drivers.

I went on to marvel, in a blog post on 26th April, at the inconsistency of those who regularly complain about gold-market manipulation by banks and also cheered the news that the Chinese government and its subservient banks had implemented a “Yuan gold fix”.

Is the manipulation-fixated pro-China camp totally oblivious to what happened over the past 10 years? It would have to be to not realise that modern-day China has been one of the greatest forces for global price distortion the world has ever known. The idea that China could be responsible for honest price discovery for any commodity gives stupid a bad name.

Anyhow, there is no evidence that the gold price is lower than it should be considering this market’s true fundamental price drivers. Of course, to know that this is the case you have to know what the true fundamentals are. You can’t, as many gold commentators do, blindly assume that gold’s fundamentals are always bullish regardless of what’s happening in the world. If you want to be logical you also can’t determine anything useful about the gold price by analysing the shifts in gold from one location to another.

If the implementation of the “Yuan gold fix” had been followed by the price explosion that some promoters were forecasting it would have been a lucky coincidence. As things turned out, the gold price has dropped a little over the past month, which is not surprising considering the fundamentals that matter.

*In a report posted at TSI on 17th April I wrote: “…the Yuan gold fix will have no effect on gold’s true fundamentals and will therefore have no effect on gold’s intermediate-term or long-term price trends. It shouldn’t even have an effect on gold’s short-term price performance, although whether it does or not will largely depend on the vagaries of speculative sentiment.”

The following chart shows that the US$ oil price, the Canadian Dollar and the Yuan (represented on the chart by the WisdomTree Yuan Fund – CYB) have tracked each other closely over the past 15 months. When divergences have happened, they have always been quickly eliminated.

An interesting divergence has been developing over the past few weeks, with the Yuan having turned downward in mid-April, the C$ having turned downward at the beginning of May and the oil price having continued to rise. Either the currency market is wrong or the oil market is wrong. My money is on the oil market being wrong.

One reason to suspect that the oil market is wrong and that the divergence will therefore be eliminated by a decline in the oil price is recent history. In the second quarter of last year the C$ turned downward about 6 weeks ahead of the oil price and in the first quarter of this year there was an upturn in the Yuan followed by an upturn in the C$ and lastly an upturn in the oil price. That is, the currency market has been leading at turning points.

“Nobody Knows Anything” is a new book written by Bob Moriarty, the proprietor of the 321gold.com web site. It’s close to the book that I would write about investing, but Bob is a better writer than I so it is just as well that he wrote the book before I got around to it.

Achieving good returns by trading/investing in the stock market and other financial markets isn’t complicated. While a certain amount of information gathering and historical knowledge is required, achieving good returns has a lot to do with common sense. However, this doesn’t mean that it is easy. The problem is that we are most comfortable when running with the herd, but herds never have common sense and the investing herd always ends up losing money.

In the chapter on contrarian investing, Bob rightly points out that one of the keys to long-term investing success is not following the herd as it careens from one wealth-destroying blunder to the next.

Many people want to be told what the markets are going to do in the future and especially want to be given specific information about future crashes and spectacular price rises. This creates money-making opportunities for self-styled gurus.

As Bob explains in his book, there are no gurus. Nobody knows exactly when prices will rise, fall, peak and trough, but there is no shortage of people who will happily take your money in exchange for pretending to give you this extremely useful information. What these people are actually giving you are guesses dressed up to look like scientific analyses.

The fact is that in order to consistently buy low and sell high you don’t need to know, or even have an opinion about, when and at what level a market will peak or trough, but advice that helps you manage money prudently will not attract new readers/followers anywhere near as quickly as a big forecast such as “the market will peak on Date X and then plummet by 50%”. As I’ve noted in the past, there is an asymmetric risk/reward to making the big, bold forecast, because failed forecasts are soon forgotten whereas a single correct forecast (guess) about a dramatic market move can be used for promotional purposes forever.

There are many real-life examples in Bob’s book that are directly or indirectly related to the veritable industry that has grown up over the past 18 years around gold and silver manipulation. After explaining that all markets have always been manipulated, Bob delves into some of the silly stories that have been concocted and the terms that have been invented to promote the idea that the gold and silver markets have been subject to a successful multi-decade price-suppression scheme. Because it’s a fact that all financial markets are always manipulated to some extent, it is not difficult to find information that can add a ring of plausibility to a manipulation story that is not only wrong, but would be irrelevant to an investor or trader even if it were right.

Read the book to find out what Bob thinks about the “gold derivatives time bomb”, the possibility of a “commercial signal failure” in the gold market, the risk of a COMEX default, the notion that the “commercials” in the gold futures market are constantly trying to limit up-moves in the price, “naked shorts”, gold-plated tungsten bars, and the story that the 1998 Fed bailout of Long Term Capital Management (LTCM) was at least partly due to LTCM’s short position in gold.

The most important chapter in the book is probably the one titled “When to Sell”, because failing to take money off the table at an appropriate time gets many investors into trouble. Even in cases where an investor does a good job with the buy side of the equation and gets into a position where he has a large profit, dreams of the even greater profits to come will often prompt him not to sell. Instead, he hangs on…and hangs on…until eventually the large profit turns into a loss.

Bob draws on his experiences in the military (he was a fighter pilot during the Vietnam War) and in casinos to illustrate some of the points he wants to make about investing. These personal reminiscences from outside the world of investing are colourful and relevant.

At around 120 pages the book is short, but at the same time it is long on practical information. It is a stream of investing common-sense interspersed with historical examples and personal experiences. I think it would be an enjoyable read even if you aren’t involved in the financial markets, but it should be an especially enjoyable and useful read for anyone who speculates in the shares of junior gold, silver and other natural-resource companies.

This blog post is a modified excerpt from a TSI commentary published a week ago.

Among other things, good money management involves trading around a core position, with the core position being in synch with the long-term trend. In particular, during a strong intermediate-term rally it involves 1) maintaining core exposure in line with the long-term bull market and 2) methodically scaling back to core exposure as prices move sharply upward.

BOTH of the aforementioned tactics must be used to mitigate the risk of suffering a large loss AND the risk of suffering a large opportunity cost. For example, if you don’t sell anything during a strong rally then you are guaranteed to suffer a large loss once the inevitable ensuing decline occurs and you won’t have either the financial or the emotional capacity to take advantage of future buying opportunities. For another example, if you sell everything when you think that the market is close to a top then it will just be a matter of time before you find yourself on the sidelines with no exposure as prices move much higher than you ever thought possible.

In more general terms, good money management involves embracing the reality that while it is possible to measure — by looking at sentiment and momentum indicators — when a market is stretched to the upside or the downside, it is not possible to RELIABLY predict market tops and bottoms. It is not even possible to reliably identify important market tops and bottoms at the time they are happening. Fortunately, and contrary to what some self-styled gurus will tell you, achieving well-above-average long-term performance does not require the reliable prediction of tops and bottoms.

With regard to my own money management, this year’s rally in the gold-mining sector was the first rally in years that was strong enough to prompt scaling back all the way to ‘core’ (long-term) exposure. This entailed selling almost half of my total position.

I might do a small amount of additional selling if there’s another leg higher within the next few weeks, but I have built up as much cash as I want so my next big move will be on the buy side. However, I will not do any buying into extreme strength. I will, instead, wait as long as it takes for the market to reach a sufficiently depressed level, secure in the knowledge that my core exposure covers me against the possibility of ‘surprising’ additional short-term strength.

Here are a few of the charts that currently have my attention.

1) The Canadian Dollar (C$). The C$ usually trends with commodity prices, so the owners of commodity-related investments should view the C$’s recent performance as a warning shot.

2) The Dow Trucking Index. The huge rebound in this index from its January low is a little strange given the evidence that the trucking industry is in a recession that is a long way from complete.

3) The gold/GYX ratio (gold relative to industrial metals). This ratio is a boom-bust indicator and an indicator of financial crisis. In January of this year it got almost as high as its 2009 peak (its all-time high) and remains close to its peak, so its current message is that an economic bust is in progress and/or that a financial crisis is unfolding.

I think that gold will weaken relative to industrial metals such as copper for at least 12 months after the stock market reaches a major bottom, but in the meantime a new all-time high for the gold/GYX ratio is a realistic possibility.

4) The HUI with a 50/20 MA envelope (a 20% envelope around the 50-day moving average). Although I think that the current situation has a lot more in common with the first half of 2001 than the first half of 2002, the way the HUI has clung to the top of its MA envelope over the past few months looks very similar to what it did during the first half of 2002.

5) The HUI/SPX ratio (the gold-mining sector relative to the broad US stock market). Over the course of this year to date the performance of the HUI/SPX ratio has been similar to its performance from November-2000 through to May-2001.

6) The S&P500 Index (SPX). The SPX is standing at the precipice. The probability of a crash within the next two months is almost zero, but a tradable decline looks likely.

7) The SPX/USB ratio (the broad US stock market relative to the Treasury Bond). Notice the difference between performance following the 2014 peak and performance following the major peaks of 1999-2000 and 2007.

A TSI subscriber recently reminded me of an indicator that I regularly cited in ‘the old days’ but haven’t mentioned over the past few years. The indicator is the bond/dollar ratio (the T-Bond price divided by the Dollar Index).

The bond/dollar ratio not only does a reasonable job of explaining trends in the US$ gold price, it does a much better job of explaining trends in the US$ gold price than does the Dollar Index in isolation. As evidence, here is a chart comparing the bond/dollar ratio (USB/USD) with the gold price followed by a chart comparing the reciprocal of the Dollar Index with the gold price. The first chart indicates a closer relationship than the second chart.

From a practical speculation standpoint, an inter-market relationship is most useful when it has a lead-lag aspect, that is, when one market usually reverses trend in advance of the other market. Unfortunately, that’s not the case here, in that gold and the bond/dollar ratio usually change direction at around the same time. For example, they both reversed upward late last year. The simple relationship does, however, help foster an understanding of why the gold price does what it does.

At the risk of casting aspersions on a good manipulation story, I note that the first of the above charts points to the US$ gold price generally having done what it should have done each step of the way over the past 10 years.

Now that Donald Trump has managed — against the odds and much to the chagrin of ‘war party’ loyalists — to become the Republican Party’s nominee in the Presidential election to be held in November, it is worth considering what a Trump presidency would mean. Here are some preliminary thoughts.

First, I expect that with the Primary campaign out of the way Trump will start to downplay some of the most hare-brained ideas he has spouted to date, such as building a giant wall along the US-Mexico border and banning all Muslims from entering the US. It’s unlikely that these wildly foolish ideas will ever be turned into actual policies, and in any case even if President Trump tried to implement them it’s unlikely that he would obtain the required parliamentary approval.

Second, I doubt that President Trump would go ahead with his threat to implement hefty tariffs on imports from China, because I don’t think he is stupid enough to believe that imposing such restrictions on international trade could possibly benefit the US economy. My guess is that when he uttered the protectionist nonsense he was pandering to voters who are struggling economically and willing to believe that their problems could be quickly fixed by someone capable of doing smart trade deals with other world leaders. But if I am over-estimating his acumen and he genuinely believes what he is saying on this matter, then President Trump would effectively be pushing for similar trade barriers to the ones that helped make the Great Depression greater than it would otherwise have been.

As an aside, just because someone relentlessly promotes himself as a great deal-maker, doesn’t mean he actually is. Also, the problems facing the US have almost nothing to do with poor deal-making in the past and could not be solved by good deal-making in the future.

Third, I doubt that the result of the November Presidential election will have a big effect on the US economy. The way things are shaping up, whoever gets elected this November will end up presiding over a sluggish economy at best and a severe recession at worst. This is baked into the cake due to what the Fed and the government have already done.

Furthermore, both Trump and Clinton appear to be completely clueless regarding the causes of the economic problems facing the US, which means that economically-constructive policy changes are unlikely over the years immediately ahead irrespective of the election result. For example, Trump has expressed a liking for currency depreciation and artificially-low interest rates, which means that he is a supporter of the Fed’s current course of action even though he would prefer to have a Fed Chief who called himself/herself a Republican. Trump has also said that he would leave the major entitlement programs alone, even though these programs encompass tens of trillions of dollars of unfunded liabilities.

Fourth, it currently isn’t clear that any major financial market will have an advantage or disadvantage depending on who is victorious in November. For example, regardless of who wins in November it’s likely that evidence of an inflation problem will be more obvious during 2017-2018 than it is today, resulting in higher bond yields (lower bond prices). For another example, how the stock market performs from 2017 onward will depend to a larger extent on what happens over the next 6 months than on the election result. In particular, a decline in the S&P500 to below 1600 this year could set the stage for a strong stock market thereafter. For a third example, gold is probably going to be a good investment over the next few years due to the combination of declining real interest rates, rising inflation expectations and problems in the banking industry. This will be the case whether the President’s name is Trump or Clinton.

Fifth, based on what has been said by the two candidates and on Hillary Clinton’s actions during her long stretch as a Washington insider, every advocate of peace should be hoping for a Trump victory in November. The reason is that a vote for Clinton is a vote for the foreign-policy status quo, which means a vote for more humanitarian disasters and strategic blunders along the lines of the Iraq War, the destruction of Libya, the aggressive deployment of predator drones that kill far more innocent people than people who pose a genuine threat, the intervention in Ukraine that needlessly and recklessly brought the US into conflict with Russia, the inadvertent creation and arming of ISIS, and the haphazard bombing of Syria. Based on what he has said on the campaign trail, a vote for Trump would be a vote for foreign policy that was less concerned about regime change, less eager to intervene militarily in the affairs of other countries, and generally less offensive (in both meanings of the word).

Summing up, a Trump presidency would probably be a significant plus in the area of foreign policy (considering the alternative), but there isn’t a good reason to expect that the US economy and financial markets would fare any better or worse under Trump than they would under Clinton. At least, there isn’t a good reason yet.

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

The amount of gold flowing into and out of the SPDR Gold Trust (GLD) inventory is often portrayed as an important driver of the gold price, but it is nothing of the sort. As I’ve previously explained*, due to the way the ETF operates it can reasonably be viewed as an effect, but not a cause, of a change in the gold price. In any case, the amount of gold that shifts into and out of the GLD inventory is trivial in comparison to the overall market.

Since the beginning of December last year the average daily change in GLD’s physical gold inventory has been about 3 tonnes, or about 0.1M ounces. To most of us, 0.1M ounces of gold would represent huge monetary value (at US$1250/oz, 0.1M ounces is worth US$125M), but within the context of the global gold market it is a very small amount.

To give you an idea of how small I point out that over the same period (since the beginning of December last year) the average amount of gold traded per day via the LBMA (London Bullion Market Association) was around 20M ounces. Also over the same period, average daily trading volume on the COMEX was roughly 250K gold futures contracts. A futures contract covers 100 ounces, so the average daily trading volume on the COMEX was equivalent to about 25M ounces.

Very roughly, then, the combined average amount of gold traded per day via the facilities of the LBMA and the COMEX over the past few months was 45M ounces. This amount is 450-times greater than the average daily change in the GLD inventory and still covers only part of the overall market.

As an aside, over the past few months the average daily trading volume in GLD shares has been about 15M. A GLD share represents slightly less than 0.1 ounces of gold, so this equates to about 1.5M gold ounces. The volume of trading in GLD shares is therefore an order of magnitude more significant than the volume of physical gold going into and out of the GLD inventory, but it is still a long way from being the most influential part of the overall market.

Once you understand the scale of the overall gold market you will realise that many of the gold-related figures that are carefully tracked and often portrayed as important are, in reality, far too small to have a significant effect on price. For example, the quantity of gold that trades via the combined facilities of the LBMA and the COMEX on an average DAY is about 45-times greater than the quantity of gold sold in coin form by the US Mint in an average YEAR.

An obvious objection to the above is that I am conflating physical gold and “paper gold” (paper claims to current gold or future gold). Yes, I am doing exactly that. When considering price formation in the gold market it makes sense to consider the ‘physical’ and ‘paper’ components together because they are tightly linked by arbitrage-related trading. In particular, in the major gold-trading centres the price of a 400-oz good-delivery bar of physical gold is always closely related to the prices of futures contracts and the prices of other well-established paper claims to gold.

So, don’t be misled by analyses that focus on relatively minor shifts in physical gold location. Just because something can be counted (for example, the daily change in the GLD gold inventory) doesn’t mean it is worth counting, and just because something can’t be counted (for example, the total amounts of gold traded and hoarded by people throughout the world) doesn’t mean it isn’t important.

*My last two blog posts on the topic are HERE and HERE. The crux of the matter is that neither a rising gold price nor a rising GLD share price necessarily results in the addition of gold to GLD’s inventory. Additions of gold only happen if GLD’s share price rises relative to its net asset value and deletions of gold only happen when GLD’s share price falls relative to its net asset value, with the process driven by the arbitrage-trading of Authorised Participants.

321gold.com’s Bob Moriarty recently took someone to task for making the wrongheaded assertion that there was a high risk of the CME (usually still called the COMEX) defaulting due to the amount of paper claims to gold being orders of magnitude greater than the amount of physical gold in store. Bob makes the correct point that a default isn’t possible because the COMEX allows for cash settlement if necessary. However, the assertions being made by the default fear-mongers aren’t just wrong due to a failure to take into account the cash settlement provision; they would be complete nonsense even if there were no cash settlement provision. I’ve briefly explained why in previous blog posts (for example, HERE). In this post I’ll supply a little more detail.

I suspect that when it comes to the idea that a COMEX default is looming, ZeroHedge.com is “fear-monger zero*”. Every now and then ZeroHedge posts a chart showing the total Open Interest (OI) in COMEX gold futures divided by the amount of “Registered” gold in COMEX warehouses. An example is the chart displayed below, which was taken from the article posted HERE. The result of this division is supposedly the amount of gold that could potentially be demanded for delivery versus the amount of gold available for delivery, with extremely high numbers for the ratio supposedly indicating that there is a high risk of a COMEX default due to insufficient physical gold in storage. I say “supposedly”, because it actually indicates no such thing. The ratio routinely displayed by ZeroHedge — and other gold market ‘pundits’ who spout the same baloney — is actually meaningless.

One reason it is meaningless is that the amount of gold available for delivery is the amount of “Registered” gold PLUS the amount of “Eligible” gold, meaning the TOTAL amount of gold at the COMEX. It is true that only Registered gold can be delivered against a contract, but it is a quick and simple process to convert between Eligible and Registered. In fact, much of the gold that ends up getting delivered into contracts comes from the Eligible stockpile, with the conversion from Eligible to Registered happening just prior to delivery.

Taking a look at the ratio of COMEX Open Interest to total COMEX gold inventory via the following chart prepared by Nick Laird (www.sharelynx.com), we see that it has oscillated within a 3.5-6.5 range over the past 7 years and that nothing out of the ordinary happened over the past three years.

Another reason that the OI/Registered ratio regularly displayed by ZeroHedge et al is meaningless is that the total Open Interest in gold futures is NOT the amount of gold that could potentially be demanded for delivery. The amount of gold that could potentially be demanded for delivery is the amount of open interest in the nearest contract. For example, when ZeroHedge posted its dramatic “Something Snapped At The Comex” article in late-January to supposedly make the point that there were more than 500 ounces of gold that could potentially be called for delivery for every available ounce of physical gold, in reality there were about 15 ounces of physical gold in COMEX warehouses for every ounce that could actually have been called for delivery into the expiring (February-2016) contract.

Although it provides no information about the ability of short sellers to deliver against expiring futures contracts when called to do so, it is reasonable to ask why the ratio of total OI to Registered gold rose to such a high level. I can only guess, but I suspect that the following chart (also from www.sharelynx.com) contains the explanation.

The chart shows the cumulative stopped contract deliveries, or the amount of gold that was delivered into each expiring contract, in absolute terms and relative to open interest. Notice the downward trend beginning in late-2011. Notice also that the amount of gold delivered to futures ‘longs’ over the past two years is much less in both absolute and relative terms than at any other time over the past decade.

It is clear that as the gold price fell, the desire of futures traders to ‘stop’ a contract and take delivery of physical gold also fell. In other words, the unusually-small amount of gold maintained in the Registered category over the past two years reflects the unusually-low desire on the part of futures ‘longs’ to take delivery.

It’s a good bet that if a multi-year gold rally began last December (I think it did) then the desire to take delivery will increase over the next couple of years, prompting a larger amount of gold to be held in the Registered category.

In conclusion, the fact is that at no time over the past several years has there been even a small risk of either a COMEX default or the COMEX falling back on its cash settlement provision. However, this fact is obviously not as exciting as the fiction that is regularly published by scare-mongers in their efforts to attract readers and separate the gullible from their money.

*The equivalent of Patient Zero in an epidemiological investigation.

The US$ gold price is testing important resistance defined by last year’s high, which opens up the possibility that a useful price signal will soon be generated. There are two ways that this could happen.

One way is for the price to achieve a weekly close above last year’s high of $1308. This wouldn’t necessarily point to immediate additional upside, but it would suggest that the overall advance from last December’s low was set to continue for another 1-2 months. The other is for the price to trade above last year’s high of $1308 during the week but fail to achieve a weekly close above this level. This would warn that the overall advance from last December’s low was over (meaning: a multi-month correction was probably getting started).

Note that not all price action contains clues about the future. For example, during the first two days of this week the US$ gold price consolidated below last year’s high, which doesn’t tell us anything useful.

Gold’s true fundamentals* turned bullish early this year but are currently about as neutral as they get, with half of them bullish and the other half bearish. Moreover, of the two fundamental drivers that exerted the greatest influence over the past 12 months, one (the relative strength of the banking sector) recently turned bearish while the other (the real interest rate) is still bullish. This suggests that an additional large short-term rise in the gold price will depend on increased speculation in the futures market. Interestingly, Keith Weiner comes to a similar conclusion from a very different assessment of gold fundamentals.

*The gold market’s six most important fundamental drivers are the real interest rate, the yield curve, credit spreads, the relative strength of the banking sector, the US dollar’s exchange rate and the general trend for commodity prices.

This will be the shortest TSI blog post to date. I just wanted to point out that newsletter writers, bloggers and other posters on the internet who claim knowledge of what was discussed in secret conversations between high-level policy-makers are just making up stories. If you take this BS at face value, more the fool you.

The main reason that monetary inflation (creating new money out of nothing) is an economic problem isn’t the effect it has on the economy-wide purchasing power of money. The general decline in money purchasing-power is very much a secondary negative. The primary negative revolves around the fact that new money does not get evenly spread throughout the economy. Instead, it gets injected at specific points, causing some people (the early recipients of the new money) to benefit at the expense of others and causing some prices to rise relative to others. One consequence is an undeserved transfer of wealth to the early recipients of the new money and another consequence is the falsification of price signals. I’ve discussed both of these consequences in detail in the past, but I have never homed-in on the question: Who gets the new money first?

The answer to the above question will depend on whether the new money is created by the private banks or the central bank, and in the case where the private banks are doing the bulk of the money-pumping it will vary from one cycle to the next. A comprehensive answer to the question would therefore require a lot more words than I want to use in this blog post, so rather than trying to cover all the possibilities I am narrowing-down the question to: Who gets the new money first when the Fed implements QE (Quantitative Easing)?

By the way, if you think that the Fed’s QE adds to bank reserves and doesn’t add to the total quantity of money available to be spent within the economy then you do not understand the mechanics of the QE process. An explanation of how the Fed’s QE creates money can be found HERE.

Since about 60% of the assets monetised in the Fed’s various QE programs were US government debt securities it could superficially appear that the government was the first receiver of most of the new money created by the Fed, but this was not actually the case. The government benefited from the Fed’s QE programs to the extent that these programs lowered the cost of debt*, but it’s unlikely that QE resulted in the government borrowing more than it would otherwise have borrowed. In other words, the amount of money borrowed by the government probably wouldn’t have been materially less if QE had never happened. It’s therefore more correct to view the government as an indirect beneficiary of the Fed’s QE rather than as an early receiver of the new money.

It helps to answer the question “who got the new money first in the Fed’s QE programs?” by re-wording it thusly: As a result of the Fed’s QE, who initially found themselves with a lot more money than would otherwise have been the case?

The answer is the group called “bond speculators”. This group comprises institutions and individuals, including banks, hedge funds and mutual funds, who invest in and trade large dollar-amounts of debt securities.

To explain, the government issued about $2.5T of debt that was purchased by the Fed with newly-created dollars. If not for the Fed, the issuing of this debt would have necessitated the transfer of $2.5T of money from “bond speculators” to the government. It is therefore fair to say that the Fed’s monetisation of Treasury debt left “bond speculators” with $2.5T of extra money. This money was naturally ‘invested’ in other financial assets, giving the prices of those assets a boost.

Under its QE programs the Fed also monetised (purchased with newly-created dollars) about $1.7T of mortgage-backed securities (MBSs). In this case the fact that “bond speculators” ended up with a lot of extra money is obvious, since the Fed replaced existing MBSs owned by “bond speculators” with cash created out of nothing.

In total, “bond speculators” found themselves with about 4.2 trillion additional dollars** courtesy of the Fed’s QE programs. The average productive salary-earner found himself with a negative real return on savings and negative real earnings growth courtesy of the same programs. And yet, Bernanke and Yellen appear to genuinely believe that the Fed’s actions were righteous.

    *The Fed’s debt monetisation not only lowered the interest rate on all new debt issued by the government, for the $2.5T of Treasury securities bought by the Fed the interest rate was effectively reduced to zero. This is because interest paid on government debt held by the Fed gets returned to the government.

    **Just to be clear, the Fed’s QE didn’t directly create $4.2T of additional wealth for “bond speculators”, since the Fed replaced bonds with money. Bond speculators initially had more money and less assets as the result of Fed asset monetisation, but the new money was a proverbial ‘hot potato’ and was quickly used to bid-up the prices of other bonds and financial assets.

The usual suspects made a big deal out of evidence that the banks involved in the London “gold fix” had used the ‘fixing’ process to clip unwarranted profits. As I explained last week, this evidence did not in any way support the claims that a grand price suppression scheme had been successfully conducted over a great many years, but unsurprisingly that’s exactly how it was presented in some quarters. Anyhow, the purpose of this post isn’t to rehash the reasons that manipulation related to the London “gold fix” could only have resulted in brief price distortions and definitely could not have been used to shift the directions of multi-month trends. Rather, the purpose is to marvel at the inconsistency of those who loudly and relentlessly complain that the gold market is dominated by the manipulative actions of a banking cartel.

The latest example of the inconsistency is the collective cheering by the aforementioned complainers of last week’s introduction of a twice-daily ‘gold fixing’ process in China. The “Yuan gold fix” will be implemented by a group of 18 banks (16 Chinese banks and 2 international banks) and will be subject to exactly the same conflicts of interest and abilities to clip unwarranted profits as the traditional London ‘gold fix’.

So, are we supposed to believe that manipulation of the gold price by Chinese banks would be perfectly fine, or are we supposed to believe that the average Chinese bank, which, by the way, has non-performing loans (NPLs) of greater than 20% but claims to have NPLs of less than 2%, is a paragon of virtue? It would be impossible for a rational and knowledgeable person to hold either of these beliefs, but those who regularly complain about gold-market manipulation by banks and also cheered the implementation of the “Yuan gold fix” must hold one of them.

At this time last year there was a lot of talk in the financial press about the huge US$ short position that was associated with the dollar-denominated debts racked up over many years in emerging-market countries. This debt-related short position supposedly guaranteed additional large gains for the Dollar Index over the ensuing 12 months. But now, with the Dollar Index having drifted sideways for 12 months and having had a downward bias for the past 5 months it is difficult to find any mention of the problematic US$ short position. Did the problem magically disappear? Did the problem never exist in the first place?

Fans of the US$ short position argument needn’t fret, because the argument will certainly make a comeback if the Dollar Index eventually breaks above the top of its drawn-out horizontal trading range. It will make a comeback regardless of whether or not it is valid, because it will have a ring of plausibility as long as the Dollar Index is rising.

I’m not saying that the argument for a stronger US$ driven by the foreign-debt-related US$ short position is invalid. I’m not saying it yet, anyway. The point I’m trying to make above is that if the argument was correct a year ago then it is just as correct today (since debt levels haven’t fallen) and should therefore be just as popular today. It is nowhere near as popular, though, because most fundamentals-based analysis is concocted to match the price action.

I actually view the “global US$ short position” as more of an effect than a cause of exchange-rate trends. Major currency-market trends are caused by differences in stock-market performance, real interest rates and monetary inflation rates. When these factors conspire to create a downward trend in the US dollar’s foreign exchange value it becomes increasingly attractive for people outside the US to borrow dollars. And when these factors subsequently conspire to create an upward trend in the US dollar’s foreign exchange value, debt repayment becomes more costly for anyone with US$-denominated debt outside the US.

So, if the Dollar Index resumes its upward trend later this year then anyone outside the US with hefty US$-denominated debt will have a problem, but the deteriorating collective financial position of these foreign US$ borrowers won’t be the cause of the dollar’s strength. It will just be a popular justification for the strength.

In general, fundamentals-based analysis will look correct and achieve popularity if it matches the price action, even if it is complete nonsense. A related point is that if fundamentals-based analysis is contrary to the recent price action then hardly anyone will believe it, irrespective of the supporting facts and logic.

It was reported last week that Deutsche Bank has settled lawsuits over allegations it manipulated gold and silver prices via the “London Fix“. This is not really news, in that experienced traders would already be aware that banks and other large-scale operators regularly attempt to shift prices one way or the other in most financial markets to benefit their own bottom-lines. I just wanted to point out that this “news” does not, in any way, shape or form, constitute evidence that there has been a successful long-term price suppression scheme in the gold and silver markets.

As far as I can tell, the banks that were involved in setting the twice-daily levels for the London gold and silver fixes had two ways of using or manipulating the ‘fix’ to generate profits. The first is that the participants in the fixing process were privy, for two very brief periods (10-15 minutes, on average) each day, to non-public supply-demand information, making it possible for them to obtain a very brief advantage in their own trading. For example, if the volume of gold being bid for was significantly greater than the volume being offered near the start of a particular day’s fixing process, a participant would know that the price was likely to rise over the ensuing few minutes and could enter a long position with the aim of exiting at around the time the ‘fix’ was announced.

The other way of using or manipulating the ‘fix’ to generate profits is more sinister, as it essentially involves the ‘fix’ participants stealing from their clients. I’m referring to the fact that although the ‘fix’ is primarily a market price, in that it is designed to reflect the bids and offers in the market at a point in time, the participating banks would have the ability to nudge the price in one direction or the other. Situations could arise where a participating bank could improve its bottom line at the expense of a client by influencing the ‘fix’ in a way that, for example, prevented an option held by the client from expiring in the money or allowing the bank to purchase gold from the client at a marginally lower price.

I don’t know that the participants in the London ‘fixing’ process sometimes used the process to increase their own profits at their clients’ expense, but I wouldn’t be the least bit surprised if they did. There was certainly a huge conflict of interest inherent in the way the ‘fix’ was conducted.

Anyhow, it’s important to understand that price distortions resulting from the ‘fix’ would have existed only briefly (for less the 20 minutes in all likelihood) and could not have affected the price trends of interest to anyone other than intra-day traders. In particular, there is simply no way that a multi-month price trend could have been shifted from bullish to bearish or bearish to bullish by manipulating the London gold or silver fix.

Last November I entered the crash-forecasting business. As explained in a blog post at the time, my justification for doing so was the massively asymmetric reward-risk associated with such an endeavour. Whereas failed crash predictions are quickly forgotten, you only have to be right (that is, get lucky) once and you will be set for life. From then on you will be able to promote yourself as the market analyst who predicted the great crash of XXXX (insert year) and you will accumulate a large herd of followers who eagerly buy your advice in anticipation of your next highly-profitable forecast. Furthermore, since a crash will eventually happen, as long as you keep predicting it you will eventually be right.

My inaugural forecast was for the US stock market to crash during September-October of 2016. The forecast was made with tongue firmly planted in cheek, since I have no idea when the stock market will experience its next crash. What I do know is that it will eventually crash. My goal is simply to make sure that when it does, there will be a written record of me having predicted it.

That being said, when I published my crash forecast last November I gave a few reasons why it wasn’t a completely random guess. One was that stock-market crashes have a habit of occurring in September-October. Another was that the two most likely times for the US stock market to crash are during the two months following a bull market peak and roughly a year into a new bear market, with the 1929 and 1987 crashes being examples of the former and the 1974, 2001 and 2008 crashes being examples of the latter. The current situation is that either a bear market began in mid-2015, in which case the next opportunity for a crash will arrive during the second half of this year, or the bull market is intact, in which case a major peak will possibly occur during the second half of this year. A third was that market valuation was high enough to support an unusually-large price decline.

A fourth reason, which I didn’t mention last November, is that if the bull market didn’t end last year then it is now very long-in-the-tooth and probably nearing the end of its life. A fifth reason, which I also didn’t mention last year because it wasn’t apparent at the time, is that the monetary backdrop has become slightly less supportive.

So, I hereby repeat my prediction that the US stock market will crash in September-October of this year, but if not this year then next year or the year after. My prediction will eventually be right, at which point I’ll bathe in the glow of my own prescience and start raking in the cash from book sales.

When the oil price was bottoming at around $26/barrel in February, most fundamentals-oriented oil-market analysts were anticipating additional weakness due to the likelihood of a continuing supply glut. In most cases they have remained bearish throughout the price recovery from the mid-$20s to the low-$40s due to the same supply-glut belief. Regardless of whether or not a sustainable oil price bottom was put in place in February*, this line of reasoning was/is wrong.

The line of reasoning was/is wrong because in the commodity markets the fundamentals always appear to be lousy at major price bottoms. In fact, as far as I can tell there has never been a major price low in the commodity markets when there did not appear to be excessive supply relative to demand for as far as the eye could see. Similarly, there has never been a major price high in the commodity markets when there did not appear to be either abundant price-boosting demand or inadequate supply for as far as the eye could see. The markets work this way because at some point during a bearish trend or a bullish trend the supply-demand story underpinning the trend becomes so well known that it is more than fully discounted by the current price.

Was the oil market’s bearish supply-demand situation more than fully discounted by the current price when oil was trading in the mid-$20s in February? Quite likely, because a) in real terms oil was near its lowest price of the past 40 years and b) at that point there was hardly anyone who didn’t know about the oil glut and who wasn’t well-versed in the argument that the glut would persist for years to come.

*I think that the oil price bottomed in February and thought so at the time, as evidenced by comments in TSI reports in mid-February and at the blog a little later. The price action hasn’t yet definitively signaled a reversal, but it’s possible that an intermediate-term reversal signal will be generated at the end of this week.

Contrary to the opinions of some hard-money advocates, money should not be backed by gold. In fact, money should not be backed by anything.

Money is the most commonly used means of final payment in an economy. Consequently, something cannot be money (a means of FINAL payment) and at the same time be backed by something else, because in that case it’s the thing that does the backing that is actually money. For example, during the period in which the US was on a Gold Standard the US dollars in circulation were not money; they were receipts for money (gold). To put it another way, during the Gold Standard period the US dollars in circulation were not money backed by gold. Rather, gold was money.

Criticism of today’s money on the basis that it is not backed by anything therefore contains a fundamental misunderstanding of money. Money (the general medium of exchange) can be almost anything, but if something is money then it cannot, by definition, be ‘backed’ by something else.

On a related matter, the Gold Standard is not a good idea. This is because it necessarily involves the government fixing a price (the price of an ounce of gold or the price of a currency unit). When the government has the power to manage/control something in accordance with certain rules, the government will always be able to change the rules to suit itself. A successful attempt to return to a Gold Standard would therefore inevitably be followed by rule changes that led back to where we are today.

What would be a good idea is to get the government completely out of the money business.

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

The COT (Commitments of Traders) data for gold is portrayed by some commentators as an us-versus-them battle, with “them” (the bad guys) being the Commercials. Whether this is done out of ignorance or because it makes a good story that attracts readers/subscribers, it paints an inaccurate picture.

As I’ve explained in numerous TSI commentaries over the years, the Commercial position is effectively just the mathematical offset of the Speculative position. Speculators, as a group, cannot go net-long by X contracts unless Commercials, as a group, go net-short by X contracts. Furthermore, we can be sure that Speculators are the drivers of the process because most of the time the Speculative net-long position moves in the same direction as the price.

With Speculators becoming increasingly long as the price rises, it will always be the case that the Speculative net-long position will be near a short-term maximum when the price is near a short-term high. This means that the Commercial net-short position must always be near a short-term maximum when the price is near a short-term high, creating the false impression that the Commercials are always right at price tops.

The reality is that the Commercials are neither right nor wrong, since they generally don’t bet on price direction. In some cases they are selling-short the futures to hedge long positions in the physical, but in the gold market the dominant Commercials are the bullion banks that trade spreads between the physical and futures. If trading and other costs are low enough and volumes are high enough, the bullion banks can guarantee themselves profits — regardless of subsequent price direction — by buying/selling gold for future delivery and simultaneously selling/buying the physical metal.

Consider, for example, the situation where Speculators increase their collective demand for gold futures. If this additional Speculative demand causes the futures price to rise relative to the spot price it can create an opportunity for a bullion-bank Commercial to simultaneously sell the futures and buy the physical, thus locking-in a profit equal to the spread (between the futures price and the spot price) less the costs of storage, insurance and financing. At a time when the official interest rate is near zero, even a tiny futures-physical spread in the gold market can create the opportunity for a profitable trade.

I’m going back over this old ground to make sure that TSI readers aren’t taken-in by the popular, but wrongheaded, conspiracy-centric us-versus-them characterisation of the COT information.