Here is a brief excerpt, with updated charts, from a recent commentary posted at TSI.

If you read some gold-focused web sites you could come away with the belief that movements in the gold price are almost completely random, depending more on the whims/abilities of evil manipulators and the news of the day than on genuine fundamental drivers. The following two charts can be viewed as cures for this wrongheaded belief.

The first chart compares the performance of the US$ gold price with the performance of the bond/dollar ratio (the T-Bond price divided by the Dollar Index). The charts are almost identical, which means that the gold price has been moving in line with a quantity that takes into account changes in interest rates, inflation expectations and currency exchange rates. The second chart shows that the US$ gold price has had a strong positive correlation with the Yen/US$ exchange rate. As we’ve explained in the past, gold tends to have a stronger relationship with the Yen than with any other currency because the Yen carry trade makes the Yen behave like a safe haven.

There are two possible explanations for the relationships depicted above. One is that the currency and bond markets, both of which are orders of magnitude bigger than the gold market, are being manipulated in a way that is designed to conceal the manipulation of a market that hardly anyone cares about. The other is that the gold price generally does what it should do given the performances of other financial markets. Only one of these explanations makes sense.

There’s an old saying in the financial markets that the trend is your friend, meaning that you will do well as long as you position your trades in line with the current price trend. This sounds good. The only problem is that you can never know what the current trend is; you can only know what the trend was during some prior period. How is it possible for something you can never know to be your friend?

Market ‘technicians’ often make comments such as “the trend for Market X is up” and “Market Y is in a downward trend” as if they were stating facts. They are not stating facts, they are stating assumptions that have as much chance of being wrong as being right.

A statement such as “Market X’s trend is up” would more correctly be worded as “I’m going to assume that Market X’s trend is up unless proven otherwise”. The proving otherwise will generally involve the price moving above or below a certain level, but the selection of this level is yet another assumption and the price moving above/below any particular level will provide no factual information about the current trend.

To further explain, let’s say that a market made a sequence of higher highs and higher lows over a 3-month period. It can be said that during this period the market’s trend was up. That’s a fact, since the definition of an upward trend is a sequence of rising highs and lows. However, even if this market has just made a new high it is not a fact that the current trend is up, because the high that was just made could turn out to be the ultimate high prior to the start of a downward trend. Nobody knows whether it will or won’t be the ultimate high, but some traders will assume that it was — or was very close to — the ultimate high and sell, while other traders will assume that the trend is still up. The members of the first group have approximately the same probability of being right as the members of the second group, but many members of the second group (the trend-followers) will unequivocally state “the trend is up”.

In the above hypothetical case, let’s assume that the first group was right and that the price immediately started to trend downward. Most members of the second group will have in mind price levels at which they will stop assuming that the trend is up, but the point at which their assumption changes could turn out to be the bottom. In other words, having wrongly assumed that the trend was still up after the price had just peaked, they might subsequently make the incorrect assumption that the trend has changed from up to down at the time that it is actually changing from down to up.

The impossibility of knowing the direction of the trend in real time is one of the reasons that the majority of trend-following traders end up losing money. Looking from a different angle, if it were possible to KNOW the direction of the trend in real time then every half-decent trend-follower would generate good returns, but very few of them do generate good returns over the long haul.

As an aside, the majority of non-trend-following traders also end up losing money. The fact is that regardless of what method is used, trading success over the long haul is primarily about risk management.

So, just be aware that when you read comments along the lines of “the trend is up”, the author is not stating a fact. He is, instead, announcing an opinion (making an assumption) that could be wrong.

Some analysts argue that the US economy is strong enough to handle some rate-hiking by the Fed. Others argue that with the economy growing slowly the Fed should err on the side of caution and continue to postpone its next rate hike. Still others argue that the economy is so weak that the Fed not only shouldn’t hike its targeted interest rate, it should be seriously considering a rate CUT and other stimulus measures. All of these arguments are based on a false premise.

The false premise is that the economy is boosted by forcing interest rates to be lower than they would otherwise be. It should be obvious — although apparently it isn’t — that an economy can’t be helped by falsifying the most important of all price signals.

When a central bank intervenes to make interest rates lower than they would be in a free market, a number of things happen and none of these things are beneficial to the overall economy.

First, there will be a forced wealth transfer from savers to borrowers, leading to less saving. To understand why this is an economic problem in addition to being an ethical problem, think of savings as the economy’s seed corn. Consume enough of the seed corn and there will be no future crop.

Second, construction, mining and other projects that would not be economically viable in a less artificial monetary environment are temporarily made to look viable. A result is that a lot of real resources are directed towards projects that end up failing.

Third, investors seeking an income stream are forced to take bigger risks to meet their requirements and/or obligations. In effect, conservative investors are forced to become aggressive speculators. This inevitably leads to massive and widespread losses down the track.

Fourth, debt becomes irresistibly attractive and starts being used in counter-productive ways. The best example from the recent past is the trend of US corporations taking-on increasing amounts of debt for the sole purpose of buying back their own equity. Going down this path is a much quicker way of boosting earnings per share than investing in the growth of the business, so, naturally, the increasing popularity of debt-financed share buy-backs has gone hand-in-hand with reduced capital spending.

Fifth, “defined benefit” pension funds end up with huge deficits.

The reality is that the economy cannot possibly be helped by centrally forcing interest rates to be either lower or higher than they would be if ‘the market’ were allowed to work. The whole debate about whether the US economy is strong enough to handle another Fed rate hike is therefore off base.

The right question is: How much more of the Fed’s interest-rate manipulation can the US economy tolerate?

I saw a press release today that boggled my mind. The press release is from Gold Road Resources (GOR.AX), a company in the process of exploring/developing a large gold deposit in Western Australia, and is linked HERE.

According to the press release, GOR is pleased with itself for having short-sold 50K ounces of gold and having given itself the option of short-selling an additional 100K ounces of gold.

Now, it’s one thing for a current gold producer to forward-sell part of the coming year’s production in order to ensure a certain cash-flow, but GOR is not a current producer. It doesn’t even have a completed Feasibility Study and is therefore years away from having any production. In fact, there is no guarantee that it will ever have any production.

What GOR is doing cannot be called hedging. It is an outright bet against a further rise in the A$-denominated gold price. Moreover, the bet is subject to margin calls, so GOR shareholders better hope that the gold price doesn’t skyrocket over the next 12 months.

It’s quite possible that GOR won’t be hurt by its bearish gold bet. It’s also quite possible that I won’t be hurt if I play Russian roulette, but that doesn’t mean it’s a good idea for me to play.