In a blog post in March of this year I discussed the limitations of sentiment as a market timing tool. I wrote that while it can be helpful to track the public’s sentiment and use it as a contrary indicator, there are three potential pitfalls associated with using sentiment to guide buying/selling decisions. Here are the pitfalls again:

The first is linked to the reality that sentiment generally follows price, which makes it a near certainty that the overall mood will be at an optimistic extreme near an important price top and a pessimistic extreme near an important price bottom. The problem is that while an important price extreme will always be associated with a sentiment extreme, a sentiment extreme doesn’t necessarily imply an important price extreme.

The second potential pitfall is that what constitutes a sentiment extreme will vary over time, meaning that there are no absolute benchmarks. Of particular relevance, what constitutes dangerous optimism in a bear market will often not be a problem in a bull market and what constitutes extreme fear/pessimism in a bull market will often not signal a good buying opportunity in a bear market.

The third relates to the fact that regardless of what sentiment surveys say, there will always be a lot of bears and a lot of bulls in any financial market. It must be this way otherwise there would be no trading and the market would cease to function. As a consequence, if a survey shows that almost all traders are bullish or that almost all traders are bearish then the survey must be dealing with only a small — and possibly not representative — segment of the overall market.

I went on to write that there was no better example of sentiment’s limitations as a market timing indicator than the US stock market’s performance over the past few years. To illustrate I included a chart from Yardeni.com showing the performance of the S&P500 Index (SPX) over the past 30 years with vertical red lines to indicate the weeks when the Investors Intelligence (II) Bull/Bear ratio was at least 3.0 (a bull/bear ratio of 3 or more suggests extreme optimism within the surveyed group). An updated version of the same chart is displayed below.

The chart shows that while vertical red lines (indicating extreme optimism) coincided with most of the important price tops (the 2000 top being a big exception), there were plenty of times when a vertical red line did not coincide with an important price top. It also shows that optimism was extreme almost continuously from Q4-2013 to mid-2015 and that following a correction the optimistic extreme had returned by late-2016.

Sentiment was at an optimistic extreme late last year, at an optimistic extreme when I presented the earlier version of the following chart in March and is still at an optimistic extreme. In effect, sentiment has been consistent with a bull market top for the bulk of the past four years, but there is still no evidence in the price action that the bull market has ended.

Regardless of what happens from here, four years is a long time for a contrarian to be wrong.

This post is a rehash of something I wrote at TSI last September in response to the article titled “The Gold Standard and Debt Jubilee“. The article is a confused jumble of Marxist, biblical and capitalist ideas/assertions, but its gist is that we need both a debt jubilee and a gold standard. My views are that a gold standard is not a worthwhile objective and that a debt jubilee would be both an economic and an ethical disaster.

If the market for money were free then gold would probably be money. However, there would NOT be a gold standard. A gold standard is, by definition, a monetary system imposed by government, whereas in a truly free market the government would have no role in determining what is/isn’t money.

Under a gold standard the government sets the rate at which money-substitutes such as dollar notes are convertible into gold. A gold standard is therefore a type of government price-fixing scheme.

It can certainly be argued that a gold standard would be a better monetary system than the one we have today, but there’s no reason to expect that it wouldn’t eventually transmogrify into what we have today. After all, the current system evolved from a gold standard.

That’s why I say that a gold standard is not a worthwhile objective. A worthwhile objective is to get the government out of the money business and allow people to use whatever money they want.

I’ll now turn to the “debt jubilee”, which entails wiping the slate clean of ALL existing debts. Here’s how it is described in the article linked above:

“A “jubilee” is the complete renunciation of all debts. Any/all debt instruments become null-and-void. Debt Slavery is abolished. The Workers are allowed to retain the fruits of their labours, and use their productive efforts to build and improve their societies — rather than simply fattening financial Criminals.“*

And who would provide “the Workers” with all the capital equipment and education they need to be productive? And who would lend the money needed to fund new businesses, invent new products and conduct life-improving medical research? The financial criminals, perhaps?

Details, details.

There are all sorts of economic and ethical problems with the “debt jubilee” concept, but the biggest problem is that it amounts to the government stealing wealth from all lenders and giving it to all borrowers. The more profligate you were prior to the “jubilee” the more that you would ‘make out like a bandit’ as a result of the “jubilee”.

It would result in economic devastation, because many of the most productive members of society would be financially crushed and the ones who weren’t financially crushed would never lend their money again.

The dire economic consequences of a “debt jubilee” and the terrible injustice of it is why it has probably never happened in world history and probably never will happen.

As an aside, if a “jubilee” event ever occurred in the past it was during “biblical times”, but that’s hardly a selling point. These were times when there was no economic progress (there was no general improvement in living standards from one generation to the next), most people died before the age of one, the best the average person could reasonably hope for was basic subsistence, and slavery was both widespread and generally accepted.

The only type of debt for which a good-faith repayment effort is not justified is government debt. This is because government debt is repaid via theft. As the great Murray Rothbard eloquently put it: “The purchase of a government bond is simply making an investment in the future loot from the robbery of taxation.” The appropriate punishment for lending money to the government is a 100% loss on investment, so wiping the government’s debt-slate clean would be a good thing.

Fortunately, discussions about a “debt jubilee” are purely academic as it is not something that has a chance of happening. Moreover, nobody with respect for property rights and a reasonable understanding of economics would advocate it.

*Note that the “jubilee” definition used by the author of “The Gold Standard and Debt Jubilee” and that has become popular is not consistent with the way “jubilee” is described in the Old Testament. In particular, the original biblical description does NOT imply that debts are forgiven. Refer to “Five Myths about Jubilee” for more information.

1. Intellectual honesty requires that the issue be referred to as “Global Warming” and not “Climate Change”. The theory is that human-generated CO2 is causing the world to warm up, not that humans are causing the climate to change. The climate is always changing. It was changing long before humans existed and will be changing long after humans become extinct.

2. Anthropogenic Global Warming (AGW) is a hot/emotional topic because it is perceived as a potential excuse for more government intervention in the economy, that is, for a more powerful government.

3. Due to the above point, the more libertarian-minded a person the more likely that he will disbelieve the AGW theory and be on the lookout for evidence that refutes or is inconsistent with the theory, whereas the stronger a person’s belief in a big role for government the more likely that he will be a proponent of the AGW theory and on the lookout for evidence that supports the theory.

4. It should be a question for science, not politics, and the science is definitely not settled. There are very knowledgeable people on both sides of the debate, the models that link global temperature to prior changes in the amount atmospheric CO2 have generally not worked, and in any case the science is never settled (it is constantly evolving).

5. The real issue is pollution, not global warming or climate change. Pollution is a serious problem in many parts of the world.

6. Pollution is a property rights issue, or at least it should be. In countries where there is no or minimal respect for private property rights and particularly in countries with very powerful or all-powerful governments, pollution tends to be a bigger problem and the frequency of ecological disasters tends to be greater.

7. In a free country, the amount of pollution that was deemed acceptable would be determined by the law courts, not government regulation. It’s likely that the amount deemed acceptable when dealt with as a property rights issue by the law courts would generally be less than the amount allowed by current government regulations.

8. It is often the case that one side in the debate labels the other side in ways that are designed to make the other side look bad. For example, referring to AGW skeptics as “deniers” or “denialists” and AGW advocates as “alarmists” or “hysterics”. This is a form of ad hominem attack. A person who uses the aforementioned words to describe the other side may as well hold up a sign that reads “I’m not looking at the issue objectively”.

9. Characterising the issue as believers versus non-believers in climate change is a deliberate attempt to mislead (it’s a type of “straw man” argument) because there is no debate as to whether or not the climate is changing. Everyone with a modicum of general knowledge knows that the climate has always been changing and will always change. The issue under debate is the effect of man on the climate.

10. A scientist making an honest and rigorous attempt to determine the effect of man on climate must necessarily analyse the other influences on climate, chief among them being the sun. Furthermore, he must deal with questions like: Given that the Earth’s climate has always been cycling, with long periods of cooling followed by long periods of warming, and that the Earth was warmer during pre-industrialisation periods when human activity could not have had any effect whatsoever on climate, why should the latest warming cycle be attributed primarily to human activity?

11. Even if we assume that Global Warming is still happening, that it is a problem to be reckoned with and that it is caused by Man, the claim that the best solution is for the government to become more involved in policing economic activity is, at best, the triumph of hope and naïveté over experience, logic and good economic theory. If history has taught us anything it is that when the government tries to fix a problem by getting more involved in the economy it either causes the original problem to become worse or creates an even bigger problem elsewhere.

12. It is error alone that needs the support of government. Truth can stand by itself. (Thomas Jefferson)

A few weeks ago the World Gold Council (WGC) published its “Gold Demand Trends” report for the first quarter of 2017. These reports actually provide no information about gold demand and in my opinion are useless. In fact, they are worse than useless because they are misleading.

It is axiomatic that at any given time the total demand for gold equals the total supply of gold, which, in turn, equals the total aboveground gold inventory. The total aboveground gold inventory is somewhere between 150K and 200K tonnes, so at any given time the total demand for gold lies somewhere between 150K and 200K tonnes.

When new buyers enter the market they draw from the existing aboveground supply. These new buyers cannot possibly increase the total demand, because the increased demand on the part of people who add to their gold ownership will always be exactly offset by the decreased demand on the part of people who reduce their gold ownership.

A balance is maintained by the changing price. For example, if there are more buyers than sellers at a particular price or the buyers are more motivated than the sellers then the price will rise to establish a new balance. Therefore, a price rise is irrefutable evidence of a momentary rise in demand relative to supply and a price decline is irrefutable evidence of a momentary fall in demand relative to supply.

Importantly, the change in price is the ONLY reliable indication of an attempt by demand to rise or fall relative to supply. Any statement to the effect that a price rise was accompanied by reduced demand or that a price decline was accompanied by increased demand is therefore ludicrous.

The effect of the gold-mining industry is to increase the total aboveground gold supply by about 1.5% every year. Actually, as the result of gold mining both the total supply and the total demand increase by about 1.5% every year, since demand and supply must always be equal with price changing to maintain the balance.

Although gold miners are adding new gold to the total supply, the newly-mined gold is no more capable of satisfying current demand than gold that was mined in the distant past. Consequently, gold miners are similar to any other sellers. The one significant difference is that a gold miner will generally take whatever price is on offer, whereas most other owners of gold will have a price in mind at which they will sell (and below which they will not sell). In some cases this price will be a great distance above the current price and in other cases the owner of gold will intend to hold indefinitely regardless of how high the price rises. All of these intentions by the existing holders of gold contribute to the performance of the gold price.

Getting back to the WGC reports, what is being referred to as gold demand is actually just the sum of some easy-to-identify gold flows. In effect, these reports confuse trading volume with demand. Furthermore, they don’t even come close to accounting for all trading volume. What they essentially do is begin with the wrongheaded assumption that the total supply of gold equals the amount of annual mine production plus recycled gold plus producer hedging, or an amount of around 4,000 tonnes. They therefore begin with the assumption that the total supply of gold is about 1/50th of its actual amount. They then come up with a bunch of so-called (but not actual) demand figures, including the amount of gold moving into bullion ETFs and the amount of gold sold in jewellery form, that add up to about 4,000 tonnes.

As an aside, there will usually be a positive correlation between the gold price and the amount of gold moving into gold ETFs, but that’s only because the ETF inventory often FOLLOWS the price. I’ve discussed this in previous blog posts.

Summing up, the gold supply/demand reports put out by the WGC are based on numerous logical errors and misconceptions, such as ignoring the dominant role played by the aboveground gold stock, treating transfers from some sellers to some buyers as indicative of changing overall demand, and assuming that shifts in demand can be determined independently of price. Due to these deficiencies they are worse than useless.