This blog post is a modified excerpt from a 17th February TSI commentary.

I don’t need to read/watch the news to know that the supply-demand backdrop remains unsupportive for the oil price. All I have to do is look at the spread between spot prices and futures prices in the oil market. The larger the contango, that is, the higher the futures price relative to the spot price, the more abundant the current supply and the less price-supportive the so-called ‘fundamentals’.

As recently as a few days ago, oil for delivery in July-2016 was $6.40/barrel, or about 20%, more expensive than oil for immediate delivery onto the cash market. This was very unusual. It meant that if someone could buy physical oil and store it cheaply they could make a risk-free annualised return of almost 40% by simultaneously selling July futures contracts. The reason that every man and his dog was not eager to do this trade is that the cost of storing oil is now so high that even a contango that represents a potential 40% annualised return on a physical-futures arbitrage is not very profitable. And the reason that the cost of storing oil is now so high is that there is a much-greater-than-normal amount of oil already in storage.

Unfortunately, knowing that there is an oil glut and, therefore, that the ‘fundamentals’ remain bearish doesn’t tell us what will happen to the oil price in the future. This is because the bearish fundamentals are very well known and are factored into the current price. It is also because the fundamentals are always bearish at major price bottoms in commodities markets.

I suspect that the oil price is now close to a major bottom. This is because at its recent low the “inflation”-adjusted oil price was below its 1986 bottom and almost as low as its 1998 bottom (the two lowest points of the past 40 years). It is also because if stock markets have made long-term peaks then the commodities markets are likely to be among the main beneficiaries of future monetary inflation.

However, it’s very unlikely that there will be a ‘V’ bottom in the oil market. Considering the short-term positive correlation between the oil price and the S&P500 Index (see chart below) and the well-known bearish fundamentals, it’s more likely that the oil market will build a base this year involving a Q1 bottom and one or two successful tests of the bottom.

In an old joke, a policeman sees a drunk searching for something under a streetlight and asks what he has lost. The drunk says that he lost his keys, and they both start looking under the streetlight together. After a few minutes the policeman asks the drunk if he is sure he lost them here, and the drunk replies, “no, I lost them in the alley”. The policeman then says “so why are you looking here?”, and the drunk replies, “because this is where the light is”. This joke led to the name “Streetlight Effect” being given to a psychological tendency for people to look for clues where it is easiest. Many gold-market analysts have obviously succumbed to this psychological tendency.

It is obvious that many gold-market analysts have succumbed to the “Streetlight Effect” because they fixate on a tiny fraction of the overall gold supply and they do so because this tiny fraction of the overall supply is where the well-defined numbers are. The rest of the supply, which probably accounts for at least 90% of the total, is ignored because its location can’t be pinpointed and its size can’t be accurately measured. In effect, due to a lack of definitive data they make the assumption that the bulk of the world’s gold supply doesn’t exist. No wonder their supply-demand analyses don’t make sense.

To be more specific, there are many gold-market analysts who focus on the amount of gold produced by the mining industry, the amount of gold in COMEX warehouses, the publicly-reported warehouse stocks in London and the bullion inventories of gold ETFs, as if the sum of these quantities was a reasonable estimate of the world’s total amount of gold in saleable form. This is a huge mistake. Furthermore, they assume that once gold leaves a warehouse for which there are publicly-reported numbers the gold effectively ceases to exist, as if it has evaporated into the air. However, it is far more reasonable to assume that almost every ounce of gold that leaves a publicly-reported inventory remains part of the total supply.

In any case and as I explained last week, even if the “Streetlight Effect” didn’t apply and the location of every ounce of aboveground gold was known, the information wouldn’t tell us anything about the price and therefore wouldn’t be useful from an investing/speculating perspective.

This blog post is a modified excerpt from a recent TSI newsletter.

One of the bullish arguments on the US economy and stock market involves pointing out that a) the yield curve hasn’t yet signaled a recession, and b) the historical record indicates that recessions don’t happen until after the yield curve gives a warning signal. This line of argument arrives at the right conclusion for the wrong reasons.

The bullish argument being made is that every recession of the past umpteen decades has been preceded by an inverted yield curve (indicated by the 10-year T-Note yield dropping below the 2-year T-Note yield). The following chart shows that while the yield curve has ‘flattened’ (the 10yr-2yr spread has decreased) to a significant degree it is still a long way from becoming inverted (the yield spread is still well above zero), which supposedly implies that the US economy is not yet close to entering a recession.

The problem with the argument outlined above is that it doesn’t take into account the unprecedented monetary backdrop. In particular, it doesn’t take into account that as long as the Fed keeps a giant foot on short-term interest rates it will be virtually impossible for the yield curve to invert. It should be obvious — although to many pundits it apparently isn’t — that the Fed can’t hold off a recession indefinitely by distorting the economy’s most important price signal (the price of credit), that is, by taking actions that undermine the economy.

The logic underpinning the bullish argument is therefore wrong, but it’s still correct to say that the yield curve hasn’t yet signaled a recession. The reason is that an inversion of the yield curve has NEVER been a recession signal; the genuine recession signal has always been the reversal in the curve from ‘flattening’ (long-term interest rates falling relative to short-term interest rates) to ‘steepening’ (long-term interest rates rising relative to short-term interest rates) after an extreme is reached. It just so happens that under more normal monetary conditions, an extreme isn’t reached and the reversal therefore doesn’t occur until after the yield curve becomes inverted.

This time around the reversal will almost certainly happen well before the yield curve becomes inverted, but it hasn’t happened yet.

It’s amazing how much time and effort is spent by some analysts in attempting to track the movements of gold between locations. It’s amazing because such analysis provides no useful information about price, that is, such analysis has no practical value for speculators and investors.

Regardless of whether the gold price is in a rising trend or a falling trend, some parts of the world will be net buyers and other parts of the world will be net sellers. Furthermore, the amount of gold being shifted between sellers and buyers could rise or fall during a rising price trend or a falling price trend. To put it more succinctly: transaction volume does not indicate price direction.

Consequently, even if it were possible to track all of the movements in gold that were happening throughout the world every day, the resulting data would not provide reliable clues about the future change in the gold price. In fact, the data wouldn’t even do a good job of explaining past changes in the gold price. And in any case, accurately tracking the movements of gold is not remotely close to being possible.

A common mistake is to fixate on the gold being stored in LBMA and COMEX inventories, as if these publicly-reported warehouse stocks represented the total amount of privately-held gold in saleable form. A related mistake is to assume that when gold is shifted out of a publicly-reported inventory it has effectively been taken off the market and is no longer part of the available supply.

In reality, the bulk of the world’s privately-held gold in readily-saleable form will NEVER be part of a publicly-reported inventory. That’s due to the perceived nature of gold. Many people own gold for store-of-value or financial-safety purposes and do not want to report their ownership, especially to governments. On a related point, just because gold has been removed from an LBMA or a COMEX warehouse and can no longer be tracked by the likes of Gold Fields Mineral Services (GFMS) does not mean that the gold is no longer part of the supply-demand equation. It is still available; it’s just that you, the analyst, have no way of knowing where it is.

Gold-market analysts should accept reality and stop pretending that the supply of gold is limited to the amount that they can pinpoint.