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.

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.

The most important fundamental driver of the gold market that hasn’t yet begun to move in a gold-bullish direction is the US yield curve, represented on the following chart by the 10yr-2yr yield spread. The yield curve is bullish for gold when it is getting steeper, as indicated by a rising 10yr-2yr yield spread (a rising line on the following chart). With the 10yr-2yr yield spread having recently made a new 8-year low and not yet shown any sign of reversing upward, the yield curve remains unequivocally gold-bearish.

The yield curve is also one of the most important economic indicators to not yet warn of a US recession. Note that contrary to popular opinion it isn’t an inversion of the yield curve (the 10yr-2yr yield spread dropping below zero) that warns of a recession, it’s a trend reversal from flattening to steepening after the yield-spread has fallen to a multi-year low.

Based on what happened over the past 50 years, a trend reversal in the yield spread is not a prerequisite for a gold bull market. As long as sufficient other fundamental drivers (e.g. credit spreads and the real interest rate) are gold-bullish it is possible for gold to commence a bull market in the absence of a supportive yield curve. This is exemplified by the bull market that began during 1976-1977. However, it would be unprecedented for a US recession to begin in the absence of an upward reversal in the 10-yr-2yr yield spread.

The 15th March Financial Times article that I rubbished in a blog post last week contained the comment: “the 1970s ‘Phillips Curve’ trade-off between unemployment and inflation is alive and well“. Unbeknownst to me at the time, since I never tune in to Federal Reserve press events, Fed chief Janet Yellen said almost exactly the same thing at the 17th March post-FOMC press conference. Specifically, she said: “The Phillips Curve is alive“, by which she meant the purported trade-off between general price inflation and unemployment (the idea that lower unemployment generally comes at the cost of higher inflation and lower inflation generally comes at the cost of higher unemployment) was becoming an important consideration. This statement reveals cluelessness in three different ways.

First, the Phillips Curve and the theory behind it does NOT suggest that there is a trade-off between unemployment and general price inflation. In fact, it says nothing whatsoever about the relationship between general price inflation and unemployment. The Phillips Curve is about the relationship between changes in REAL wages and changes in employment. It is basic supply-demand stuff. As explained by John Hussman back in 2011:

“Phillips demonstrated a principle that is well-known to every economist: very simply, when a useful resource becomes scarce, its price tends to increase relative to the prices of other goods and services. That finding doesn’t need all sorts of intellectual contortions or modeling tricks to make it “work,” because it is one of the most basic laws of economics.

The true Phillips Curve, then, is a relationship between unemployment and real wages. When workers are scarce, wages tend to rise faster than the general price level. When workers are plentiful, wages tend to rise slower than the general price level.”

Second, the empirical data clearly show that there is no consistent relationship between general price inflation and unemployment. The above-linked Hussman article includes the relevant evidence in chart form. That is, even if the misrepresentation and misuse of the Phillips Curve is put aside, no economist who has bothered to check the historical data could believe in the inflation-unemployment trade-off.

Third, any half-decent economist would realise that there is no basis under sound economic theory for there to be a trade-off between unemployment and “price inflation”. The simple reason is that economic progress, which usually leads to more opportunities for employment, results from increasing productivity and, all else being equal, would therefore tend to be associated with a falling, not a rising, general price level. That is, all else being equal there should be a positive correlation rather than a trade-off between unemployment and “price inflation”. Of course, in the real world all is not equal, first and foremost because the central bank is constantly manipulating prices. Based on the fatally flawed models to which they are committed, central banks try to curtail the decline in the general price level that would naturally stem from economic progress. In doing so they falsify the price signals upon which the market economy relies, thus creating greater inefficiency.

The nicest thing I can say about Janet Yellen is that she doesn’t appear to be as stupid and dangerous as Mario Draghi, although I’ll change my mind about that if she ends up taking the Fed down the negative-interest-rate path.

Jordan Roy-Byrne recently posted an interesting video discussing gold’s Commitments of Traders (COT) data. The video was a response to numerous articles warning that the COT situation was flashing a danger signal. I agree with Jordan’s interpretation, which is that the COT data are probably not predicting a large decline in the gold price.

The main point of the above-linked video is similar to a point I’ve made numerous times in TSI commentaries over the years. The point is that there are no absolute benchmarks when it comes to sentiment indicators in general and the COT situation in particular (the COT reports are nothing more than sentiment indicators). A level that constitutes an ‘overbought’ warning in a bear market will usually not be applicable in a bull market, in that during a multi-year bullish trend the market will tend to become more ‘overbought’ and stay ‘overbought’ for longer. Of particular relevance, the speculative net-long position in gold futures that coincides with a short-term price top will generally reach much higher levels during a bull market than during a bear market. In fact, by the time a bull market has been in progress for 2-3 years the levels that marked short-term ‘overbought’ extremes during the preceding bear market could now mark short-term ‘oversold’ extremes.

In other words, sentiment must be considered within the context of the long-term price trend.

Unfortunately, in the early part of a new long-term trend there is usually no way to know, for sure, that the trend has changed. In gold’s case there is evidence that a cyclical bull market has begun, but the evidence is not yet conclusive. That’s why it is prudent to take information such as the COT data at face value.

I view gold’s current COT situation, which is reflected on the following chart from Sharelynx.com, as a valid warning that short-term downside risk is at least as high as the remaining short-term upside potential. At the same time I realise that if gold has entered a new cyclical bull market then the speculative net-long position (the red bars on the chart) is going to get much larger within the coming two years.

Judging by Ambrose Evans-Pritchard’s 15th March article in the Financial Times, which rehashes the most popular economics-related fallacies of the 1970s, the answer to the above question is a resounding NO.

Here’s an excerpt from the article that neatly encapsulates the ideas that were widely believed by economists during the 1960s-1970s, that were shown to be false during the 1970s, and that are now apparently again accepted as true:

“Every major downturn since the First World War has been caused by the Fed, determined to snuff out inflation as the credit cycle matures. Expansions rarely die of old age. They are killed.

There may have been other factors in each historical episode — the oil shocks of the 1970s, or the first Gulf War in 1991 — but the Fed has been the determining catalyst each time.

Mr Fischer could hardly have been clearer. He spelled out why the 1970s ‘Phillips Curve’ trade-off between unemployment and inflation is alive and well, and an implicit warning that prices could soon take off since the labour market is clearly approaching the electric fence of Milton Friedman’s NAIRU (non-accelerating inflation rate of unemployment).”

The fact is that the Fed does cause severe economic downturns, but not by tightening monetary policy. In the real world, every boom that occurs on the back of money-pumping and interest-rate suppression contains the seeds of its own destruction. The reason is that the falsification of prices resulting from the central bank’s efforts to stimulate economic activity leads to widespread malinvestment.

Once the malinvestment occurs, a painful period of adjustment becomes inevitable. As Mises explained about 100 years ago, the only question is whether the adjustment begins sooner as a consequence of deliberately slowing the pace of money-pumping or later as a consequence of a collapse in confidence in the money. Politicians naturally want the adjustment to happen later (after the next election or, best of all, on somebody else’s watch), but the later it happens the more painful it will be.

It seems that Keynesian economic theories have to be totally discredited every generation, because regardless of how wrongheaded they are proved to be they always make a spectacular comeback. Furthermore, it’s not like what’s now commonly known as Keynesian Economics was invented by J.M.Keynes. In essence, all Keynes did was give his name, stamp of approval and incomprehensible language to ideas that had been tried to disastrous effect as far back as ancient Roman times.

It’s not hard to understand why these wrongheaded ideas inevitably get revived. They always recapture their lost popularity because they sound good at the most superficial level (they can sound like a way to provide free lunches for all) and because they seem to provide governments with an excuse to expand their reach.

A “death cross” is when the 50-day moving average (MA) goes from above to below the 200-day MA. According to conventional wisdom death crosses are bearish, but they often occur near short-term price lows and therefore tend to be bullish.

For example, over the past 5 years the S&P500 Index (SPX) has experienced three death crosses. The first occurred near the August-2011 price bottom, which turned out to be a wonderful time to buy. The second occurred near the August-2015 price bottom, which was last year’s low. The third occurred near the low in January this year. I’ll be surprised if the January low turns out to be the 2016 low, but it was followed by a tradable rally.

A “golden cross” is when the 50-day moving average (MA) goes from below to above the 200-day MA. According to conventional wisdom golden crosses are bullish, but they often occur near short-term price highs and therefore have short-term bearish implications more than half the time.

For example, short-term tops in the gold price occurred near “golden crosses” in September-2012, March-2014 and July-2014. Also, it’s too soon to know for sure, but it seems that a golden cross marked a short-term top in the gold price during the first half of this month.

Death crosses tend to have short-term bullish implications because they often happen around the time that the market becomes stretched to the downside. Similarly, golden crosses regularly have short-term bearish implications because they often happen around the time that the market becomes stretched to the upside.

Here are 21 rules/guidelines that I try to follow when speculating in the stock market. I don’t always follow them and in such cases I usually end up regretting it.

1. Every investment must pass the “Sleep Test”

An investment should not be so large that you lie awake at night worrying about it. To be a successful speculator or investor you must be able to remain relaxed and objective. An uncomfortably large investment or trade, although offering a potentially great return, can jeopardise your ability to remain objective and can thus lead to mistakes.

2. Avoid the emotions of hope, greed and fear

Hope is often associated with unrealistic expectations and causes an investor to cling to a losing position, magnifying the losses unnecessarily. Greed causes an investor to buy at the wrong time, such as near the peak of a rally, and to risk excessive amounts of money. Fear prevents an investor from buying at a time when the market presents the best opportunities to buy and prompts him to sell at the worst possible time (at the bottom of a correction or bear market).

3. A corollary to Rule 2 is: Treat your investing/trading as a business, not a Vegas-style gamble

This involves:

a) Checking your emotions at the door. You won’t be able to make objective decisions if you get excited by profits and/or depressed by losses.

b) Following an entry and exit plan for every stock you buy.

c) Not caring what happens to the price of a stock after you sell it. If you constantly worry that a stock will rocket higher after you sell then you will never be able to exit at an appropriate time.

d) Ignoring the cheerleaders. The cheerleaders (those commentators who become progressively more bullish the higher the price goes and who focus exclusively on the potential for huge rewards as if buying into the market right now were a sure path to great riches) tend to bring out the gambling spirit in their followers.

4. Use a disciplined risk-management approach at all times

It is difficult to own-up to a mistake. There is also usually the fear that if I sell now for a small loss the price will immediately rebound and I will have lost the opportunity to profit from the rise. After all, “hope springs eternal” and that stock that keeps dropping like a stone will one day soar like an eagle; all I need to do is be patient.

A systematic approach to risk management, which may or may not include ‘stop losses’, must be used to protect your investment capital. This is a hard lesson to learn and can usually only be learnt the hard way through experience.

5. Minimise the role of luck in your investing by playing a percentage game

Playing a percentage game encompasses the following guidelines:

a) Do not try to make a killing during any given year, but, instead, follow an approach designed to generate above-average returns over several years. In this way you might actually end up making a killing, but be aware that the vast majority of people who set out to get rich quick in the stock market end up a lot poorer.

b) Never plan to buy at the bottom or sell at the top. Instead, plan to buy on those occasions when the reward/risk ratio is high and to not buy, or to sell, on those occasions when it is low.

c) Take some money off the table during periods of extreme strength so you won’t feel pressured to sell during the periodic shakeouts.

d) Do some buying during the severe shakeouts that periodically occur in long-term bull markets. Note, though, that this will usually only be possible from a financial and/or an emotional standpoint if you previously took some profits into strength.

e) Never make whole-scale buy or sell decisions. Instead, scale into positions during weakness and scale out during strength, all the while maintaining exposure to the long-term bull market of the time.

f) Don’t ‘bet the farm’ on any single forecast. Forecasts, regardless of how well thought-out they appear to be, are just opinions, and any opinion can be wrong.

g) Don’t risk a large portion of your capital on any single stock. Regardless of how attractive a stock appears to be, acknowledge the fact that ‘stuff’ sometimes happens even to the best of companies.

6. Do your buying during those times when the fundamentals AND the price action are favourable

The fundamentals are favourable if the current price of the stock is low relative to the value of the underlying business, where the value of the underlying business is detemined by the company’s assets and growth prospects.

Examples of favourable price action include consolidations or basing patterns within longer-term upward trends.

7. Don’t focus on the profit/loss of a trade while the trade is on-going

Thinking about how much money you are making or losing on a trade while the trade is on-going may cause the emotions of fear and/or greed to influence your decisions. Have an exit plan for each stock and continue to monitor the fundamentals and the price action to determine whether to hold or to sell.

8. Make sure your exit plan for a stock is consistent with your entry plan

For example, if favourable price action was your main reason for buying a stock then you should exit if the price action turns unfavourable. In this case a reasonable approach could involve setting a protective stop just below a technical support level. However, if your decision to buy was based primarily on value considerations then it would make no sense to sell simply because the price became lower.

9. Remember that there are no absolute highs or lows

It is often the cheapest stocks that fall the furthest and the most expensive stocks that show the greatest price appreciation. Also, a price level that seems low or high today might appear the opposite in 12 months time.

10. Always maintain a substantial cash balance

You must always be in a position to take advantage of any opportunities that arise and the only way to do this is to always have significant cash reserves.

11. Close an event-based trade as soon as the anticipated event occurs

For example, let’s say a company you follow is about to announce its latest earnings. You expect the company to announce earnings that surprise on the upside and purchase the stock with the aim of taking a profit in the days following the announcement. If the company subsequently announces a result that does not exceed expectations you must immediately sell because the basis for your trade has proven to be false. If, however, the company does announce higher-than-expected earnings then you must sell within a few days of the announcement irrespective of the price action because this was your plan going into the trade. A disciplined approach will prevent short-term trades from becoming unwanted long-term investments.

12. Don’t be stingy when it comes to market information and stock buy/sell prices

The speculative investor does not day-trade and does not enter a position with the aim of taking a quick small profit. The timeframe for a trade will generally range from 1 month to 24 months and the goal will generally be to achieve a return of more than 30%. As such, it makes no sense to hold out for the final few percent when making a purchase or a sale.

Market- or stock-related information that increases your chances of investing/trading success is worth paying for.

13. Be aware that when the public is either extremely bullish or extremely bearish, the risk of a trend change is high

When the vast majority is extremely bullish then almost everyone who is going to buy has already bought and there is only one direction for the market to go, and that’s down. Similarly, when the vast majority is extremely bearish then almost everyone who is going to sell has already sold and there is only one direction for the market to go, and that’s up. Beware, though, that what constitutes a bullish or bearish extreme will differ depending on the long-term trend. For instance, sentiment can become more bullish and stay bullish for longer during a bull market than during a bear market.

14. Be patient

On average, you should not realistically expect to find more than two great opportunities per year to profit from market timing (sometimes there will only be one and there will seldom be more than three). As such, it pays to be patient and to wait for the major market reversals that usually accompany extremes in mass psychology. When these opportunities occur, the speculative investor must be financially prepared (refer to Rule 10) and psychologically prepared (refer to Rule 2) to take full advantage.

15. Remember and learn; don’t regret or blame

Take full responsibility for all of your investment decisions and never fall into the trap of blaming others when things go wrong. Losses are often learning experiences and can actually be money well spent if they prevent you from making the same mistake again, but if your reaction to a loss is to look outside yourself for someone/something to blame then you’ve learnt nothing from the experience and the money was wasted.

16. Keep yourself well-grounded

This encompasses the following:

a) Never complain about losses or brag about profits.

b) When the market is trending strongly higher and your stocks are going up every day remember that you are nowhere near as smart as you think you are; and during the severe corrections when every stock you own appears to be headed towards zero remember that you aren’t as dumb as you feel.

c) Be prepared to change your opinion if the facts change. In other words, don’t become wedded to any stock or to any market view.

d) Don’t act as if the current rally will be the last great money making opportunity. It won’t be.

e) Always keep your mind open to new ideas and analysis/evidence that contradicts your current view of the financial world. Most people are quick to embrace anything that meshes with their existing beliefs and to dismiss anything that contradicts these beliefs, which is why most people never see the signs of a trend change until it is too late.

17. Know the story behind every stock you buy

It is not enough to simply follow the recommendations in any newsletter because even if these recommendations are on-the-mark you won’t be able to buy or to hold in the amidst of a selling panic unless you have the confidence that stems from having a thorough understanding of the story.

18. Know yourself

For example, if you are someone who gets antsy and has trouble sleeping whenever the stocks you own make big moves, then don’t buy volatile stocks. Or if you know you are going to be too busy to fully understand the stories behind individual stocks then allocate most of your stock-market-related capital to ETFs and mutual funds.

19. Never use margin debt

NEVER buy stocks on margin. This is because as soon as you begin using margin debt you become a ‘weak hand’ — someone who would likely be forced to sell in reaction to a sharp price decline, that is, someone who would likely become a forced seller at a time when they should probably be buying.

20. Keep in mind that the ‘market’ does not know or care about your cost basis

When deciding whether to sell, hold or add-to a position in a stock, the price you paid for the stock is irrelevant. The market is under no obligation to raise the price of the stock to the point where you are able to exit at a profit or a reduced loss, and the fact that the price of a stock has fallen a long way from your purchase cost will never be a good reason to continue holding.

When deciding what to do with an existing position it is often helpful to first consider what you would do if you didn’t have the position. For example, if your current position in stock ABC has a market value of X$, think about what you would do if you had X$ of additional cash to invest and no position in stock ABC. In this case, would stock ABC be one of your top choices for investing the X$? If your answer is an unequivocal NO, then why are you continuing to hold the stock?

21. Understand that there is no such thing as “just a paper loss”

A loss is a loss, whether you take it or not. For example, if the price of a stock you own falls by 50%, then at that point you have lost 50% regardless of whether or not you lock-in the loss by selling. To view a loss as being somehow less serious if the position hasn’t yet been closed, or, worse still, to think that you haven’t actually incurred a loss at all until you sell, is both amateurish and financially-hazardous.

Brazil, the ‘B’ in the BRIC acronym, was widely considered to be a model of emerging-market economic excellence during 2003-2011. Now it is widely considered to be an economic basket-case. What went wrong?

There are always many factors involved in a major economic turnaround, but for Brazil’s economy — and for many other economies over the past 15 years — the most important point to understand is that the impressive growth was not genuine; it was an artifact of rapid monetary inflation. Brazil’s government was just as corrupt and interventionist as ever during the period of impressive growth, but for a long time nobody noticed (or cared) because rapid domestic monetary inflation in parallel with a commodity bull market driven by rapid global monetary inflation created the illusion of increasing prosperity.

Brazil no longer has a monetary inflation problem. In fact, as depicted in the True Money Supply (TMS) chart below, it is now experiencing monetary DEFLATION.

And yet, Brazil’s central bank is still ‘tightening the monetary screws’. As illustrated by the following chart, it moved its targeted interest rate to an 8-year high of 14.25% in mid-2015 and has kept it there.

The current situation in Brazil underlines the problem of having monetary central planners. Even the smartest and most incorruptible of central planners will make the economy less efficient, because the right level for a price is the price that would exist in the absence of government or central-bank interference. However, monetary central planners tend to make matters even worse by reacting to backward-looking economic data and to the lagged effects of earlier policies.

In Brazil’s case, rather than acknowledging the extreme current tightness of monetary conditions and acting accordingly, the central bank is fixating on the CPI, which is, in turn, accelerating upward due to the lagged effects of the monetary inflation that happened years ago. This is a good example of how central bankers not only fail in their self-proclaimed mission to smooth-out the business cycle, but also greatly amplify the economic oscillations.

Brazil’s experience over the past 10 years is another in a long line of real-world demonstrations of Austrian Business Cycle Theory. Rapid monetary inflation and the lowering of interest rates results in an artificial boom, during which the GDP numbers look good at the same time as wealth-destroying investing mistakes are being made on a grand scale. The boom sets the stage for a bust, which wipes out all of the preceding gains and then some.

Although he could well be the least bad of the choices currently being offered to US voters (mainly because he would be less inclined towards “regime change” and bombing foreigners than the other choices), Donald Trump has made many ridiculous statements on the campaign trail. Examples include his proposal for a giant wall to stop Americans from escaping to Mexico (or the other way around, I can’t recall) and his idea about banning all Muslims from entering the US. The example that I’m covering in this post has to do with Trump’s comments on international trade. If he really believes what he is saying about trade deficits and tariffs (he might not — he might just be pandering to voters), then his economics knowledge is mindbogglingly inadequate.

I was prompted to write this post by the article linked HERE. This article reveals a surprisingly-good* understanding of economics. In particular, it makes the point that when it comes to trade, what’s commonly referred to as a “deficit” does not constitute a loss. A so-called deficit could actually be viewed as a benefit given that the side with the deficit is a net receiver of valuable goods in exchange for money that these days gets created out of nothing, although it makes more sense to view trade as a win-win situation.

By way of further explanation, if you shop at Walmart then you run a trade deficit with Walmart. Obviously, this is not a problem for you, otherwise you wouldn’t do it. It’s a case of you preferring some of the products on the shelves at Walmart over some of the cash in your wallet and Walmart preferring your cash to the products on its shelves. Walmart, in turn, runs a trade deficit with each of its suppliers for the same reason — one side of the transaction favours the product over the cash and the other side favours the cash over the product.

The point is that when a trade occurs it is illogical to think of the side that parts with money in exchange for goods or services as the loser.

Furthermore, despite the assertions of power-hungry politicians (is there any other kind?) to the contrary, the logic that applies to trading within national borders doesn’t magically cease to apply when the trade is conducted across borders. For example, if Bill and Fred are trading with each other, the trade doesn’t change from being a net positive or a non-issue when they are both in the US to a national problem when Bill steps across the border into Canada.

But isn’t it the case that every dollar that flows out of the country due to a trade deficit is a dollar less of spending within the domestic economy, which, in turn, leads to a weaker domestic economy and higher unemployment?

According to neo-Keynesian orthodoxy the answer is yes, but the correct answer is no. In reality, every dollar that flows out due to a trade deficit eventually returns as some form of investment. That’s why the $500B+ annual US trade deficit has not reduced the US money supply. As Joseph Salerno explains in a 2014 article, trade-deficit dollars get invested by foreigners in US stocks, bonds, real estate such as buildings and golf courses, and financial intermediaries like banks and mutual funds, with many of the dollars ultimately being lent to or invested in US businesses. These businesses then spend the dollars on paying wages and buying real capital goods like raw materials, plants, equipment and software.

The point is that the flow of spending in the US economy is not diminished by a negative trade balance, but merely re-routed. There will be a redirection of labor and capital out of export industries into industries producing consumer and capital goods for domestic use, with no net loss of jobs.

A net loss of jobs will, however, come about due to the policies such as tariffs and currency devaluation that are put in place to ‘fix’ a perceived trade-deficit problem. Tariffs simply impose an additional cost on a large group of consumers for the benefit of a small number of producers, resulting in a net loss to the economy by supporting inefficient businesses and reducing the amount that consumers can spend elsewhere.

In conclusion, the idea that the government should act to make it more expensive for its own citizens to purchase goods that are made in other countries is so transparently stupid it’s difficult for me to understand how such actions can be advocated with a straight face.

*I expect to find the application of good economic theory at sites such as mises.org and davidstockmanscontracorner.com, but I’m always surprised when I find it in articles at mainstream websites such as Yahoo Finance.