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In our first installment of An Adult Approach, we attempted to scrub away some misconceptions related to inflation that are embedded in the contemporary economic and financial canon. We sought to raise doubt about the incentives of central banks to share the true loss of their currencies’ purchasing power with the public. When we began to write the follow-up, “Real Relative Value”, in which we apply a forward rate of inflation to current asset values, it quickly became clear that we were spending too much space discussing proper real value. So, this piece, which is now the second in a series of three (we think), will seek to provide a truer sense of money, inflation and real value today, all of which seem grossly misunderstood in the marketplace.

Money & Banking (Cliff Notes)

US dollars and all other world currencies today are not what most people think. The game starts when a central bank (on behalf of its sponsoring government) issues physical currency to you and me through its banking system. A bank can be a bank because it has already deposited assets that qualify as reserves at its central bank, not necessarily because it has deposits. Reserves are typically assets in the form of loans. The business of the bank is to issue credit, which is ultimately claims on physical currency, theoretically in an amount up to a level that does not breach its reserve ratio with its central bank.

The Monetary Base (a.k.a. base money) is physical currency in circulation and bank reserves held at the central bank. Everything else in the monetary system is credit, even including deposit balances held at banks by you and us beyond the amount of aggregate reserves. So then, modern banking systems are fractionally reserved (as is deposit insurance, which as far as we understand has de minimus reserves and zero physical currency).

Credit, regardless of who is contracted to receive it and pay it, is ultimately backed by the physical money printing ability of the central bank. If you go to the bank tomorrow and ask for $10 billion in C-Notes that you have on deposit, your banker will call its central bank, which will then debit your bank’s reserves held there. The central bank will then literally print the C-Notes and put them on an unmarked military cargo plane destined for your personal landing strip deliver the C-Notes to your bank where you can withdraw it.

If your bank runs out of currency reserves held at the central bank, (because either depositors withdraw more than your bank has in reserve or because the value of your bank’s reserves depreciate in the marketplace), then your bank will ordinarily be subsumed by another fractionally reserved bank with enough reserves to make the new, larger entity properly reserved.

The US banking system currently has almost $20 trillion in assets (held in the US and abroad). The US dollar monetary system is supported by about $2.7 trillion in total base money, about $1 trillion of which is physical currency in our pockets and about $1.7 trillion in bank reserves held at the Fed. (The ratios are about the same globally — $95 trillion dollar equivalent bank assets and about $12 trillion in global base money.)

Thus, the global banking system holds about 8.5% of its assets in reserve at global central banks to guard against the possibility that: a) you and we ask for our “money” back, and/or; b) the value of the assets it placed at central banks depreciates. We should not worry (nominally speaking, of course) if either (or both) of these events occurs because central banks can print all the money necessary to meet the demand for money. The good news is that everything else to be learned about modern money and banking is derivative (we mean that figuratively but feel free to apply it as you wish).

Inflation for Grown-Ups

As we have argued, central banks and governments have great incentive to report inflation rates that do not fully capture the rate of purchasing power loss in the currencies they manufacture. If central banks and economic policy makers are not helpful to investors in providing reasonable inflation data, then it behooves investors to seek answers elsewhere. We believe a more accurate representation of manifest inflation may be found in Shadow Government Statistics’ Alternative 1980-based CPI Series[1] (“SGS 1980 CPI”), which calculates the CPI based on the methodology employed prior to 1980. As the graph below shows, were the 1980 methodology still being used today by the Bureau of Labor Statistics then the CPI would show an annual inflation rate of 10.57% (blue line) as opposed to its current version running at 3% (red line).

As we discussed in An Adult Approach I, the perception of “3% inflation” is still too high for the Fed’s tastes and so last month it again announced its preferred inflation benchmark would be the PCE deflator, calculated by the Bureau of Economic Analysis (BEA) within the Commerce Department. We further expect that if/when the PCE deflator no longer provides a sufficiently low public perception of inflation, then the Fed’s thinking will evolve to the point of benchmarking nominal GDP targeting as its objective. After all, who, besides savers and pensioners, will care about 3% or 4% inflation when nominal output is running at 5% or 6%? (Never mind true inflation will be substantially higher than 2% or 4%.) Such sleight of hand rivals those of illusionists who make 747s disappear.

There are real-world consequences when policy makers succumb to the perceived political imperatives of perverting economic data. The graph above provides a fascinating narrative that shows the practical inflationary impact on an economy. In July 2008 the annual inflation rate according to the SGS 1980 CPI peaked at 13.36%. This came just prior to the failure of Lehman Brothers, a credit event that acted as a deflationary catalyst for goods and service prices as well as a trigger for asset price declines. (After an economic lag, in July 2009 the SGS 1980 CPI dropped to a low of +5.4% and the BLS’s headline CPI dropped to -2.1%.)

As we know, the Fed created new base money in the fall of 2008 for the benefit of its member banks (QE, asset purchases, swap and credit lines, etc). Over the three subsequent years banks used these new reserves to profit by buying cheapened assets for themselves, and to extend credit to worthy borrowers and levered buyers of liquid financial assets. Financial markets rebounded quickly. And as the graph above clearly shows, the prices goods and services also experienced a “V-bottom” in large part, we believe, because the new dilution in the USD and other global currencies gave incentive to global commodity manufacturers to demand more currency (higher prices). Commodity prices rebounded quickly and this flowed through to goods and service input costs.

Regardless of how well it is measured, all inflation is not created equal. There is a big difference between the driver of consumer inflation and asset inflation. Changes in goods and service prices are ultimately determined over time by the growth or contraction of physical currency in float plus unreserved bank deposits (what Austrians call “checkbook money”). Changes in asset prices are ultimately determined in an over-levered monetary system by changes in the availability of credit. (After all, that’s why they call them financial markets.)

Asset holders benefitted at the time of the 2008 base money inflation because the Fed deposited newly created reserves into the creditor banking system, re-funding banks and by extension their investors, and allowing investment asset prices to rebound. In fact, the growth of the permanent money stock and where it flowed since 2008 explains much about recent returns. The table immediately below shows how markets have performed in nominal terms since the Fed began substantially increasing US base money:

And the table below shows real returns — the nominal performance in the table above deflated for the SGS 1980 CPI, a more accurate measure of goods and service inflation:

According to the BLS, cumulative CPI has risen 3.6% since August 2008. However, the table above succinctly portrays what we believe American investors know intuitively — since 2008 their asset values have not kept pace with accurately calculated goods and service inflation. In other words, US wealth and income has declined materially since 2008 in real terms regardless of popularly-accepted data to the contrary. (We are reminded of the Texas cad who indignantly demanded of his wife when she caught him in flagrante; “are you going to believe me or your lyin’ eyes!”) In short, asset holdings today are broadly perceived as a “savings pool” that will be exchangeable at current relative valuations for consumables tomorrow. This seems a faulty assumption.

US output has been shrinking in real terms too. Since September 2008, cumulative GDP growth deflated for the cumulative SGS 1980 CPI has been -29.86%. This implies the US economy shrunk in real terms by almost 30% since the Lehman bankruptcy. Does such a startling figure resonate with you or do you find it hard to believe? Before you answer, please consider the current value of your consumption and investments in 2008 dollars. The BEA suggests real GDP since then has been +1.8%. This figure does not comport with our sense of output and pricing.

It should not be considered acceptable to be in a profession – as a political economist, policy maker or investor – in which self-delusion has become a necessary requirement for success and perpetuating that delusion is harmful to the broad economy over time. Yes, but the “public good” you say? Ah, but for how long?

Inflation Perspectives

As implied, expectations of future inflation in the general economy that drive consumption patterns, (should I consume now or later?), as portrayed by the CPI and PCE deflator, should theoretically correlate most tightly with physical currency in circulation; while expectations for the Dow Jones Industrial Average, home prices, college education costs, etc. (i.e. items sponsored with explicit or implicit leverage), should theoretically correlate most tightly with bank credit dynamics.

Further, we think the common notion that prices of goods, services and assets are solely determined by a rise or fall in aggregate demand should be summarily dismissed in today’s environment. While it is true that increasing demand for goods, services and assets correlated with steady price increases from 1945 to 1971, it seems more accurate to attribute that dependable glide path to the forces behind it. Production and consumption shifted from the public sector to the private sector after World War II and there was very little private sector leverage at the onset of the peace in 1945. Monetary and credit policy makers  after the War could afford to show restraint every now and then while still allowing the economy to grow and eventually recover with new credit accommodation.

It also must be acknowledged that government spending and Fed money creation was hindered by the natural discipline of the gold-exchange standard under Bretton Woods, which greatly curtailed systemic leverage.

Then, as we know, from 1981 to 2006 asset prices rose far more than goods and service prices. A decade after the demise of Bretton Woods in 1973, balance sheets remained comparatively unlevered. Additionally, the baby-boomer bulge in Western populations had incentive to begin saving for retirement. As interest rates began their long descent in 1981, savers gradually moved out on the risk spectrum, investing directly in equity markets, indirectly in derivatives and structured financial products, and finally in levered real estate. Their more speculative actions were further validated along the way in the real economy. Productivity soared, domestically and globally, as new technologies and innovation provided greater efficiencies.

Finally, the fall of communism in the East provided a new, cheap global labor pool almost overnight. Throughout this golden age of investing from 1981 to 2006 there was also a great counter-factual at work: despite enormous productivity gains that would have otherwise greatly reduced prices of goods and services, easy monetary policies in developed economies led to ballooning balance sheets that stabilized the general price level (GPL). Global central banks led by the Fed did not stabilize goods and service prices by restricting credit, which would have tamped down price increases, but by promoting credit to levitate the price level.

For the last thirty years economic policy makers have been in the business of promoting asset prices higher through easy credit. (It seems “stable prices” being the primary objective of all central banks demands they spike the punchbowl rather than take it away?) Within this environment, price increases for goods and services badly lagged price increases of assets bought with unreserved deposits or unreserved bank credit. As asset prices rose, collateral values backing potential consumer credit rose too — a virtuous credit cycle.

Neither of these two circumstances – reemerging economies re-building their infrastructures or a virtuous credit cycle — exists today. Demand for goods and services in aging, highly-levered (i.e. “developed”) economies obviously remains intact but demand for assets has been largely replaced by the need to service and rollover debt. As these obligations come due, further pressures on asset prices should be expected. Cash on balance sheets is not net savings but, rather, quite literally encumbered credit held against obligations. To paraphrase Kyle Bass, most of the world is long things that are deflating and short things that are inflating — long levered assets (directly or indirectly) and short the necessary credit needed to support their lifestyles and asset values.

And so we think the leading indicator of inflation and real asset value today harkens back to the classic quip Milton Friedman made famous: inflation is always and everywhere a monetary phenomenon. What many monetarists like Friedman’s followers seem to have forgotten though is that the majority of what passes for money today is not money at all but rather unreserved bank credit that must someday be made whole at “par”. Otherwise it will simply vanish through repayment or default. While creating enough new money is easily achieved by central banks (without limit), there can be no “par” in real terms. There is only outstanding unreserved debt that must amortize.

Magnitude of the Problem

Central bankers struck a match under the global economy in 1981 and it continues to burn. The match began to burn their fingers in 2008 when the process of “re-collateralizing” unreserved credit got underway.

The familiar graph above shows the increase in USD base money that began to de-lever the US banking system in 2008. Though we have written in the past about total dollar-denominated debt exceeding $50 trillion, all of that debt does not have to be paid down. (Most of it is fully-reserved because its creditors are not levered.) But there is an identifiable portion of dollar–denominated debt issued by highly levered creditors – banks.

We believe the debt-to-money gap that must and will be greatly reconciled in short order is the ratio of bank assets to the monetary base. As the graph below shows, the US Monetary Base was only 13% of US Bank Assets on December 31, 2011.The banking system is the source of unreserved credit and is on the hook to use its collective balance sheet to be the transfer mechanism for economic stimulation through monetary policy. And as they have already demonstrated repeatedly, monetary policy makers feel the need to de-lever the banking system today so it may then extend credit to the rest of the economy tomorrow.

Of course, the US banking system is not alone. According to the Financial Stability Board, worldwide bank assets (including US bank assets) were approximately $95 trillion in October 2011 (USD terms). Meanwhile the IMF reported that as of December 2010 the global supply of base money was approximately $12 trillion (USD terms). These figures put the worldwide proportion of base money-to-bank leverage roughly in line with the US.

Given: 1) the exorbitant leverage currently in the global banking system, 2) current negative real output growth in developed economies, 3) current negative real interest rates, 4) uniformly poor monetary, fiscal and demographic conditions across most developed economies, and 5) already wary populations beginning to get restless; we have difficulty imagining that global banks, labor, savers, politicians and investors will be able to endure current conditions much longer before demanding the financial reset button be pressed to complete bank de-levering.

We provide the graph below merely to make it easier to conceptualize the nature of such a de-levering, as we see it. (This is not necessarily a prediction of timing or magnitude.) The takeaway is that base money (in the form of physical currency in circulation) and bank deposits will have to rise at a much steeper rate than bank assets until the banking system is more fully reserved. (At some point we think bank animal spirits will once again take over and we will have a new leveraging cycle.)

The graph above illustrates the forces behind a high-tech jubilee. The burden of repaying past systemic debt will have been greatly reduced through base money inflation, (that shifts the GPL higher, including revenues and wages), while the integrity of systemic debt remains intact (nominally). The integrity of the banking system will also remain intact, as would the creditworthiness of most debtors.

So we anticipate the sum of physical currency and bank deposits to continue to rise to stimulate nominal GDP growth and the ratio of bank credit-to-base money to contract further. Will the lines meet or cross? We don’t believe so but we do think the gap will narrow substantially before bank assets can grow materially again. Thus, we expect the rate of change of the General Price Level to equal the rate of change of the sum of physical currency and bank credit LESS some accommodation for productivity gains. It is reasonable to expect:

1)     A higher General Price Level

2)     A CPI rate higher than the rate at which the GPL rises

3)     Levered asset inflation rates that very likely will be nominally positive but negative in GPL terms and, even more so in CPI terms

Relative Real Value Today

Before we can project future asset prices according to our framework for future inflation, we must first re-price assets according to our sense of current real value, as indicated by a more accurate current inflation rate. For this

we will use the SGS 1980 CPI, discussed above, which is presently 10.57%. To simplify matters we will assume an 11% inflation rate (we are more interested here in identifying the overall potential magnitude of change using our framework than identifying targets).

The following tables adjust price and return levels of three major market benchmarks to reflect positive real returns in the current environment:

We must caution that the shocks above make many assumptions. However, the significant price declines capture mathematically the loss of value in the event asset levels adjust suddenly to reflect an inflation rate we believe to be more accurate. (We do not place a high likelihood on such a sudden event occurring.) Still, we believe such is the magnitude of general mispricing today in these asset classes when SGP CPI-U is indexed to produce contemporaneous real returns.

In our next report, we will estimate future CPI given the inflationary operations we presume major central banks will embark upon. We will also seek to apply the substantial future inflation we envision to various asset classes, in absolute and relative terms.

This month marks QBAMCO’s fifth anniversary and we have finally gotten clever enough to know what to call ourselves – a relative real value fund. We would be all set to try to market the fund except it seems few investors have a bid for such a thing. (Where is the “RRV” hedge fund bucket anyway?) Oh Well. What we lack in assets we make up for in a quantity of hope…and words. J

Kind regards,

Lee Quaintance & Paul Brodsky

pbrodsky@qbamco.com

“No gold, no wedding,” is a saying in India, indicating the importance of gold to Indian culture and tradition. Byron Pitts reports on India’s obsession with gold.

February 12, 2012 4:04 PM

Source: Precious metal: India’s love affair with gold

Mr. Norris:

It so happens our friend, Thane Rosenbaum, interviewed Larry Summers last night at the 92nd Street Y in New York. When asked about a gold standard, Summers recoiled and shrieked “a gold standard is the creationism of economics!” The crowd got a big chuckle out of that. So you seem to be in popular company with your February 3rd piece, “In a Focus on Gold, History Repeats Itself” (http://www.nytimes.com/2012/02/03/business/in-rise-of-gold-bugs-history-repeats-itself.html?_r=1&ref=business).
But please consider the following:

The stock of money does not need to be managed higher by policy makers to accommodate a growing economy, as Keynesian and Monetarist economists argue and as you seem to agree. Were the money stock (global money stock, not just US dollars) to grow at 1.5% per year (annual growth of the gold stock), all that would mean is that the price level of all aggregate global goods and services could rise only 1.5% per year (more or less). Of course, price levels within the bucket containing all-things-not-money would still shift based on preference. The point is economies could and would grow as much as they should, not as much as they were willing to leverage themselves.

All things equal, the price of gold in paper currency terms rises with paper money growth and falls with unreserved credit growth. Its “exchange rate” to US dollars is simply a function of its relative scarcity, like any other currency exchange rate. It’s not as complicated or as emotional as you and most economists suggest.

All the unreserved credit in the world today (unreserved because there is not enough base money with which to repay it, by a factor of about 7 times for US bank assets only), suggests strongly that global central banks will have to manufacture more of their currencies. Thus, the strong bid for gold today.

In fact, some would argue the current price of gold in USD terms is way too low in the current environment given the enormous leverage already in the system and the amount of money that has to be manufactured in the future to de-lever it. Based on this metric we believe gold is undervalued by as much as five times presently, even without any further Fed printing. It might interest you to know that, using this metric, gold in 1980 became extremely overvalued and so it should have fallen, and obviously it did. Sadly for your readers you did not consider relative value vis-à-vis gold’s proper benchmark – the gap between unreserved credit and base money.

So, there are some secular reasons to like gold at current prices and even to believe in a disciplined monetary system. If the fervency of gold bugs annoys you so much, why not just suggest that your fellow world improvers abolish capital gains taxes on physical bullion and let us crazy gold bugs save in a currency we think will maintain its purchasing power better? We will go away quietly and let you and Mr. Summers amass debt-based “savings”. Maybe a little balance is in order?

Kind regards,

Paul Brodsky & Lee Quaintance
QB Asset Management Company, LLC

Paul Brodsky
QB Asset Management Company, LLC

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Bloomberg’s Chart of the day (hat tip: Zero Hedge) ostensibly shows a relationship between the US debt ceiling extensions and price of Gold.

Color me unconvinced.

It has a few specific problems. First is the timing: The chart is dated August 1, 2011. Since then, the US credit rating was downgraded, and Gold took a big swan dive. Up 33% YTD at the time of that chart, it finished the year up 10% — certainly respectable, but no where near the home run it was as of August.

The second issue with this chart is that we only see a small slice of history. The correlation may or may not be spurious. We don’t see what took place prior — the pre 1997 era. Prior to this period, there was little correlation between the two. That sort of selective use of a time segment leads to questionable conclusions based upon that one time frame.

I bring this up today because last week, President Obama formally requested the raising of the debt ceiling (again). This is a different debt ceiling structure than the August debacle. Congress now has 15 days from that date to pass a resolution disapproving of this request before the limit is lifted.

David Semmens of Standard Chartered Bank gives us the details why that is unlikely to occur:

“It is important to note that a bill would have to be passed to stop the raising of the debt ceiling this time around – a far more straight forward mechanism that was built into the Budget Control Act of 2011 to ensure a relatively trouble free procedure.

The first hurdle will come in the House of Representatives which returns today (Tuesday 17^th Jan) and is expected to vote on Wednesday (18^th Jan), with the  Republican controlled legislative branch expected to pass a bill of objection which will be sent to the Senate. The Democratic majority Senate resumes after finishing its holiday break next Monday (23^rd Jan) and is expected to reject any move to block the extension, shortly after that. While we would expect that there will be some political posturing surrounding the vote with the House Republicans passing a bill to reject the extension, this would almost certainly be blocked in the Democrat controlled Senate and failing that receive a presidential veto. If the second reading of the bill were to follow a presidential veto, a two thirds majority would be required in both houses to override the presidential veto. A $1.2trn extension will see the debt ceiling raised to 16.394trn and given current projections see the US through until early 2013 before this issue is revisited.

There are plenty of good reasons to own Gold. I remain unconvinced that the debt ceiling is one of them . . .

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Source:
David Semmens, CFA
Gold vs. Debt Ceiling
Global Research, Europe
Standard Chartered Bank

Click for ginormous graphic

full graphic after the jump

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Gold is poised to complete its 11th consecutive annual gain, the longest winning streak in at least nine decades, on the brink of a bear market. George Soros, the billionaire who two years ago called it the “ultimate asset bubble,” cut 99 percent of his holdings in the first quarter, Securities and Exchange Commission data show. Betty Liu reports on Bloomberg Television’s “In the Loop.”

Gold Bubble Seen by Soros on Brink of Bear Market

Source: Dec. 29 (Bloomberg)

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See also

George Soros Says Markets Are `Always Fallible’

Billionaire investor George Soros talks about global financial markets and his philanthropy. He speaks with Francine Lacqua on Bloomberg Television’s “Eye To Eye.” (Source: Bloomberg)

Oct. 10 (Bloomberg)

As gold futures have declined 20% from their peak in September to their low this month, we thought we would reiterate some quick (albeit widely misunderstood) points that justify increasing our concentration of physical:

Gold has always been a monetary commodity and, like dollars and all other paper currencies, has virtually no practical or industrial utility

Gold is not currently a popular medium of exchange among private commercial counterparties, nor is it officially recognized by governments or central banks to be exchangeable in fixed terms with the competing paper currencies they produce

Gold is manufactured in the private sector; its annual production adds about 1.5% to its global above-ground stock (estimated to be about 175k metric tons in total)

The World Gold Council estimates that official gold holders (governments and/or central banks that manufacture competing paper money) retain about 30.7 thousand tonnes of gold, or about 18% of above-ground physical gold; are currently adding to their physical stocks

Only about 0.05% of long positions in exchange-traded gold futures contracts actually take physical delivery of gold, and exchange inventories available for delivery are less than 5% of outstanding contracts

Disaggregated private physical gold holders throughout the world tend to view their gold as strategic (rather than tactical) holdings, implying only long positions in gold futures contracts (non-manifest paper derivative claims) are susceptible to short-term funding and periodic calendar considerations

As gold futures have weakened recently, the stock of physical gold bullion among bullion dealers has depleted at a significantly faster pace (at lower and lower prices), implying buyers of bullion (private holders and central banks) view declining futures prices as an opportunity to accumulate the metal

Fundamentally, global central banks have produced much more paper currency and bank reserves (base money) than global gold production since 2008 (e.g. USDs +215% vs. gold 4.5%), and global debt denominated in paper currencies exceeds the actual stock of paper currencies with which to service and repay it by a wide margin (e.g. USD debt of $53 trillion vs. $2.7 trillion of base money)

Real interest rates (nominal rates less CPI) are negative across the majority of the largest developed and emerging economies, implying that a stable or rising gold price has positive carry

When properly accounted, global inflation is already substantially higher than common pricei baskets indicate, meaning real interest rates are even more negative than the CPI currently suggests¹

As with all currencies, gold pays its owner nothing unless it is leant, (most bullion holders choose not to lend gold for fear of not being able to retrieve it when necessary); however, in real terms gold remains vastly cheaper to hold than paper currencies and so it is a store of purchasing power

As we wrote in August (“Your Gold Teeth”), there are only two ways to safely own physical gold: take possession of above-ground bullion (and as we are seeing presently to do so outside the banking system where it can ultimately be hypothecated, pooled with financial assets and given away (The Gold “Rehypothecation” Unwind Begins: HSBC Sues MF Global Over Disputed Ownership Of Physical Gold), or own in-ground bullion through shares in precious metals miners, which have been usurped in the marketplace by popular derivative claims on precious metals (Did GLD And Other Gold ETFs Kill Gold Stocks?)

When valued in terms of Enterprise Value per Gold Ounce (EV/Gold), in-ground bullion may be owned for as little as $30/oz through shares in operating companies already in production (we will distribute a more in-depth analysis of this to Fund investors later in the month).

Conclusion: It seems highly likely that from both capital stock (money stock vs. gold stock) and capital flow (real interest rate) perspectives, the future growth rate of global paper currencies will continue to exceed gold production by a wide margin, which implies the price in paper currency terms of physical gold should continue to rise substantially. Any sell-off in gold futures or other derivative claims serve the physical gold buyer’s interest and the interest of investors in shares of gold miners looking to accumulate in-ground physical gold.

Lee & Paul

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MarketWatch – Gold quits 200-day average, first since 2009

Gold’s recent selloff pushed the precious metal through its 200-day moving average for the first time since Jan. 2009 early Wednesday. That’s usually a bad sign for an asset, as these moving averages are used to even out daily blips and signal a shift in a long-term trend…Bespoke Investment Group notes:

If it closes below $1,612.80 on Wednesday the commodity will end what has been the longest streak of consecutive closes above its 200-day moving average since at least 1975. After rallying nearly 125% since the start of the current streak to its highs earlier in the year, gold has now declined by 16% and is up 88% since the current streak began.

MarketBeat (WSJ Blog) – Will Gold’s Pain Be the Stock Market’s Gain?

The current selloff in gold prices looks like the real thing, and the safe-haven metal’s technical behavior relative to stocks suggests the breakdown could eventually prove to be a boon for Wall Street. The SPDR Gold Shares Trust exchange traded fund slid below the 200-day simple moving average on Tuesday, which many view as a dividing line between long-term uptrends and downtrends, for the first time since January 2009. That by itself suggests this decline is different than the other pullbacks of more than 10% that have occurred since then. But if that’s not enough, those previous pullbacks–starting in February 2009, December 2009 and September 2011–followed periods of sharp increases in short interest in the GLD. This time, GLD short interest as of Nov. 30 settlement dropped 31% in two weeks to a nine-month low. And Tom McClellan, publisher of the McClellan Market Report, also noted that one-month borrowing rates for gold have increased to the highest spread over one-month LIBOR in the 22-year history of gold lease rate data. This means it has become as expensive as ever to borrow gold to short it, meaning there isn’t much left in the market except long positions. When bulls look around and see nothing but other bulls, they tend to get antsy enough to leave the party.

The Financial Times – Gold’s stellar status brought to earth

When it comes to investment safety, gold has near-mythical status. Sadly, it has repeatedly turned out to be a myth that gold holds its value during periods of panic… Gold is meant to be a haven, and in periods of mild fear it does rather well. This is not mild fear. The euro tumbled below $1.30 for the first time since January, as Italian bond yields rose further and traders realised last week’s treaty was far from a done deal. But just as in 2008, when times get really tough, investors prefer cash to gold – and dollar cash at that. Goldbugs like to treat gold as a currency, and its price as an exchange rate. On that basis, gold fell against the dollar, as investors decided the greenback is safer in times of crisis.

Zero Hedge (Blog) – About Gold And The 200 DMA

Many are doing their damnedest Ph.D.-best to somehow fuse economic theory and technical charting, and state that a breach of the 200 DMA in gold is indicative of imminent price collapse. And then there are facts. Such as this nugget from Stone McCarthy which looks at previous episodes of the 200 DMA breach and concludes based on severity of trendline penetration compared to average, that “this is just one reason we see strong potential for a rebound as participants reduce short exposure.” So much for technicals. Full note from SMRA:

For the first time since January 2009, gold closed below its 200-day moving average on Wednesday. Today’s Chart of the Day puts Wednesday’s -2.8% violation of this long-term smoothing line into perspective, by comparing it to the average violation of both the general and upward sloping 200-day average since 1999.

The slope of a moving average is something that many analysts fail to address when trying to determine potential turning points on a chart. Although gold has been working lower for more than 3 months now, the current upward slope of the 200-day line reinforces the fact that gold’s long-term trend is still to the upside.

If we simply consider the general direction of the 200-day moving average since the start of the yellow metal’s secular bull move in late 1999, gold’s average distance below this line is -3.70%, with a maximum undercut of -19.2%. On the other hand, if we only consider gold’s performance when the slope of the 200-day line is higher, the average violation is -2.19%, with a maximum undercut of -10.8%.

Source: Arbor Research

Ron Griess of the Chart Store suggests that the 200 day is the wrong technical indicator to focus on regarding Gold.Looking back to this run, he suggests the 300 day is the more supportive index:

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Bloomberg.com – Death of Gold Bull Market Seen by Gartman

Gold, in the 11th year of its longest winning streak in at least nine decades, is poised to enter a bear market, according to Dennis Gartman, who correctly predicted the slump in commodities in 2008.The metal, which traded at $1,666.30 an ounce at 2:43 p.m. in London, may decline to as low as $1,475, the economist wrote today in his Suffolk, Virginia-based Gartman Letter. He sold the last of his gold yesterday. Bullion has already dropped 13 percent from the record $1,921.15 reached Sept. 6 and $1,475 would extend that to more than 20 percent, the common definition of a bear market. “Since the early autumn here in the Northern Hemisphere gold has failed to make a new high,” Gartman wrote. “Each high has been progressively lower than the previous high, and now we’ve confirmation that the new interim low is lower than the previous low. We have the beginnings of a real bear market, and the death of a bull.” The metal typically moves inversely to the dollar, which today reached a two-month high against the euro after Fitch Ratings and Moody’s Investors Service said yesterday that a European Union summit last week offered little help in ending the region’s debt crisis. Bullion is still 17 percent higher this year and holdings in gold-backed exchange-traded products are at a record, a hoard now valued at $126.5 billion.

MarketWatch.com – The gold bugs are throwing in the towel

Gold bugs over the last two weeks have become even more discouraged than they were at the end of November. And that’s saying something, since they were already quite dejected. As a result, contrarians detect a very strong wall of worry forming in the gold market, one which could very well be the springboard for bullion rallying into new all-time high territory. Consider the average recommended gold market exposure among a subset of the shortest-term gold market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). Two weeks ago, when I last wrote in this space about a contrarian analysis of gold sentiment, this average stood at 13.7%. Today it stands at 0.3%, which means that the average gold timer is essentially keeping all of his gold-oriented portfolio out of the market. To be sure, I reported two weeks ago that, on the basis of the HGNSI being as low as 13.7%, contrarian analysis was already bullish on gold’s prospects. And yet, far from rallying, the yellow metal since then has fallen by more than $100 per ounce. What assurances do we have that contrarian analysis will be any more successful this time around? We don’t, of course. But it’s worth stressing that contrarian analysis is right more often than it is wrong. For example, I have been measuring gold market sentiment for three decades, and have subjected the HGNSI to rigorous econometric tests.

The Wall Street Journal- All That Glitters…Will Not Solve Europe’s Debt Woes

Fact No. 1: European governments are among the biggest holders of gold on the planet. Fact No. 2: Massive debts owed by some of those governments are fueling a political crisis in Europe and turmoil in markets around the world.Those two facts lead to an obvious question from a lot of investors: Why don’t those governments sell gold to pay off their debts? If only it were that simple. For starters, not even the Europeans own that much gold. The borrowing needs, and subsequent debts, of countries like Italy, France and Spain are so huge, analysts say, that liquidating their gold reserves wouldn’t go far toward balancing their books for the long term. “If they sold their gold, I’m not sure it would do anything to their credit rating,” says Kenneth Rogoff, an economics professor at Harvard University who has studied official gold reserves. “This is not exactly a game changer.” Market and political realities, too, would make it challenging for Europeans to rely on a golden parachute, experts say. For one thing, there’s a risk that trying to sell the gold or use it as collateral for a loan could be seen in the market as a sign of desperation—which could drive up borrowing costs by making lenders even more wary, defeating the purpose.

Source: Arbor Research