Posts filed under “Commodities”
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.
Investing in gold is tough because it challenges the investor to come to terms with the faults of his or her government, and then to act upon them. It requires the admission that there is risk in holding cash. This is counter-intuitive to this generation’s vintage of financial asset investor accustomed to thirty years of a credit build-up alongside declining interest rates.
There is certainly much more chatter in the press than in years past surrounding gold, and there certainly is more US retail investment (through ETFs) than there has been. That has been reflected to some degree in its rising price, no doubt. An ounce of gold has risen from about $250 in 1999 to current levels, having moved higher in each year and making it one of the best performing assets over the last ten years. So then, is a person that pays $1,100 an ounce today top-ticking the market by entering a crowded trade that has little upside and great downside?
We don’t think so.
Do your own research. Call your investment advisers and ask them what percentage, if any, they recommend investors allocate towards precious metals. Ring up prominent friends with substantial portfolios and ask them how much gold they have as a percentage of their portfolios. What about your fund managers overseeing, say $50 billion? Are they actually long $2.5 billion to $5 billion in precious metal plays? Our guess is that the figures in both cases will be very small, say 5% to 10% (if any at all).
Let’s extend this thinking. If people you know have only dipped their toes in the water and are doing more watching than investing in gold, then the past ten years of price appreciation must have come from elsewhere. Did it come from institutional investors? No, not in any great way. Most mutual and pension funds that report their holdings don’t own any gold – zip – other than very minor positions in precious metal mining stocks (and these stocks usually comprise less than 1% of their holdings). Hedge funds? Yes, it seems hedge funds have been buying gold but of those that have, most have less than 10% of their holdings in precious metals.
What about foreign central banks, Middle-East sheiks, Russians, ultra-wealthy families around the world? Yes, we would argue they “get the joke” and have been diversifying their wealth out of their home currencies and fiat currency-denominated assets into this scarcer currency.
Currently there is about $55 billion in global gold and silver ETFs – that’s it. (Does that qualify to be in the top ten of the any single issue in the DJIA?) It is estimated that all the gold mined in the last 5000 years is about 130,000 metric tons (each tonne converts into about 35,274 ounces). It’s a cube that would be roughly the size of a tennis court.
So let’s say there are 4.6 billion ounces of gold above ground, which means that at about $1,100/oz, the total global market value of all mined gold is currently worth a little over $2 trillion. By comparison, US Treasury debt was approaching $13 trillion, last we looked and we believe total US equity market capitalization is about $11 trillion. And then there are other bond markets (at least $8 trillion) money market funds, etc. There is also real estate.
In the US alone there is estimated to be about $65 trillion in present value private sector credit outstanding and trillions more in unfunded government obligations. And then there are the financial assets (stocks and bonds), real estate and public sector obligations for the rest of the world.
Global central banks are trying to keep it all afloat by printing even more money (by making more debt). The response by central banks to declining velocity has been and will continue to be the same as their responses to credit deflation – they will continue to print money. They may give it to their fractionally reserved banks that may then use the money multiplier to distribute more credit and in turn raise systemic velocity, or they may give it directly to debtors in the hope they will spend like drunken sailors again.
There is enormous embedded inflation already and more to come. The high-powered money has already been created; it is leveragable and it is there to increase velocity. Higher prices must follow.
Will the Fed and other central banks withdraw liquidity? No, never. They never have and they never will regardless of how many tools they proclaim are in their toolbox to do so. If money velocity picks up leading to rising consumer prices, it will also lead to rising market-priced interest rates. They may decide to cut back their monetization, but they will not drain money.
We can look at price inflation contemporaneously or we can throw the ball ahead of the receiver. The result will be the same. The defense is blitzing; Jerry Rice is standing all alone in the end zone; Joe Montana is going to get sacked….but the ball is already in the air.
At current valuations the gold market is a tiny speck in relation to where perceived global wealth is being housed. The fundamental issue is one of ratios and relative future value. Our bet is that the gold-to-everything-else spread will narrow substantially. We are indifferent to whether gold rises to $10,000/oz. while the DJIA stays at 10,000 or gold stays at $1,100 while stocks and bonds crater. (In fact, we would love it if gold stayed at current levels while financial assets fell because then we would greatly increase our purchasing power vis-à-vis the rest of humanity and wouldn’t owe any capital gains tax!)
Further, we think that fundamentally gold is worth many multiples of its current price. Remember, it rose from $35/oz to $880/oz in a matter of nine years from 1971 to 1980, and the piece de resistance came in the last few months when everyone had to own it and its price went parabolic (it became a bubble).
There is chatter and there are fundamentals. (Consider that 250,000 people watch CNBC on a good day and 10 million people regularly watch Good Morning America. And remember CNBC and most business media focus on financial assets, not commercial business.) We think the gold chatter is a bunch of financial asset predators talking up their businesses. Needless to say, we don’t think gold is a crowded trade.
Recent substantial increases in the price of crude oil and other energy products have had a significant impact on American consumers. These increases have been, and continue to be, a matter of intense focus at the Commission due to the key role that futures markets play in the critically important price discovery and risk transferal processes. The CFTC shares the concerns of Americans and Congress, and is committed to ensuring that the nation’s futures markets operate fairly and efficiently, and that the price of crude oil and other energy products is determined by the fundamental forces of supply and demand. The CFTC has undertaken a wide-range of actions to ensure that the energy futures markets are operating free of distortion.
One of the many actions taken by the CFTC to study the effect of speculation on energy prices was to reclassify its Commitment of Traders (COT) data. The old data used to offer a look at the net positions of Hedgers/Commercials, Large Speculators, and Small Traders. As the markets evolved throughout the years, these classifications became blurred by hedge funds, index traders, and swap dealers. For this reason, the CFTC now offers its COT data in a different classification format. As the second chart below shows, this same COT data is now broken down by Managed Money, Producer/Merchant, Swap Dealers, Other Reportables, and Small Traders. For a complete explanation of what is included in each category, see the following CFTC link.
By classifying the data in this way, the CFTC hoped to offer more insight into the effect of speculation on market prices. Unfortunately, as the highlighted quote in the story above suggests, the data has been somewhat underwhelming so far in this aspect.
Charts after the jump . . .
The Quote of the Day comes to us via Bloomberg’s Alice Schroeder: “We’re in the midst of a deflationary trend that is temporarily being masked by inventory restocking and free lunches like Cash for Clunkers. Consumers are done with borrowing. They’ll keep refueling the deflation by going through their attics and garages to find stuff…Read More
Those who believe the rally in gold is sending the wrong message on inflation might take comfort from the fact that the price of the yellow metal relative to that of the 30-year Treasury bond is approaching a 30-year high. Perhaps not coincidentally, the earlier run-up marked the peak of hysteria about inflation — and a multi-decade top in…Read More
While everyone remains focused on Gold, I suggest checking out other Precious metals. Over the past year, Palladium, Platinum and Silver have been kicking Gold’s shiny yellow ass! > > Chart courtesy of Ron Griess of The Chart Store.
Here’s a interesting take: Marc Faber says that Gold has permanently eclipsed the $1,000 level: “Gold won’t fall below $1,000 an ounce again after rising 27 percent this year to a record as central banks print money to help fund budget deficits, said Marc Faber, publisher of the Gloom, Boom & Doom report. The precious…Read More
Wow, that’s an impressive number. Our intermediate target for the yellow metal is $1350 > Chart via CBOT > Previously: Gold Passes $1,000 (September 8th, 2009) http://www.ritholtz.com/blog/2009/09/gold-passes-1000/ Gold Inflation Adjusted (October 7th, 2009) http://www.ritholtz.com/blog/2009/10/gold-inflation-adjusted/ The Recent History of Gold, 1954-2009 (February 10th, 2009) http://www.ritholtz.com/blog/2009/02/the-recent-history-of-gold-1954-2009/