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.

A post at ZeroHedge (ZH) on 8th April discusses an 11th April Fed meeting as if it were an important and unusual event. According to the ZH post:

“With everyone’s focus sharply attuned on anything to do with the Fed’s rate hike policy, many will probably wonder why yesterday the Fed announced that this coming Monday, April 11, the Fed will hold a closed meeting “under expedited procedures” during which the Board of Governors will review and determine advance and discount rates charged by the Fed banks.

As a reminder, the last time the Fed held such a meeting was on November 21, less than a month before it launched its first rate hike in years.”

As explained at the TSI Blog last November in response to a similar ZH post, these “expedited, closed” Fed meetings happen with monotonous regularity. For example, there were 5 in March, 4 in February and 5 in January. Furthermore, ZH’s statement that 21 November was the last time the Fed held such a meeting to “review and determine advance and discount rates charged by the Fed banks” is an outright falsehood. The fact is that a meeting for this purpose happens at least once per month. For example, there were 2 such meetings in March and 1 in February.

Is it possible that the misinformation in the above-linked ZH post was an honest mistake? Yes, it’s possible, but it isn’t likely.