Trying to Value the Invaluable
Tuesday, 13 August 2013

Bill Fleckenstein –  Daily Column

Trying to Value the Invaluable

Overnight markets were once again uneventful, while the market here shrugged off an early 0.5% loss to get back to around unchanged by the end of the day. Away from stocks, the dollar was stronger, bonds were lower and oil was flat, as silver gained 4% to gold's 1.5%.

Inquiring Mines

 I received a question late last week in Ask Fleck about the recent action in gold and the miners (which were very strong today), and whether higher prices would give me more confidence that we had seen the lows. In trying to craft an intelligent and useful answer, I spent a lot of time thinking about the gold market and related ideas that I hadn't really discussed in the past.

What follows is my response, which I hope also illuminates why it is so difficult to be truly emphatic about the price of gold (as opposed to the value of a business).

Accounts Conceivable

 I feel strongly that June 30 (as I said at the time) was most likely the low for gold and the miners. But the problem with gold is that it is "just a price." It isn't like a business where you can track balance sheet items, sales, margins, channel activity, competitors and suppliers, etc., to get a very strong feeling that something important has changed or that the time to act in a big way is now (long or short).

About the closest thing we have to a "timely," nearly unequivocal, fundamental fact is that gold has been in backwardation for 26 business days and that backwardation is now out to six months. This should never happen (and rarely has: just briefly in 1999 and 2008) because it should just get arbitraged away. The fact that the market hasn't reverted to contango suggests that there isn't enough metal around in New York or London (at these prices) to allow that to happen. A potential conclusion is that there is such huge demand versus supply at current prices that the price should not be able to go lower (and stay there). If that's true, it would argue in favor of the idea that the lows in June were "it" and that this tightness, combined with the short position and prior liquidation, means that prices are poised to rocket higher at some point soon.

A Store of Guesswork

 The problem is that no one knows for sure. I have talked to several people who are close to the metals trading industry (whom I have known for a long time) and they do think that this situation is likely as I have described it, but there could be other technical explanations that could mean this thesis is wrong (mostly having to do with that fact that interest rates are near zero). We will only know for sure as time goes by and new developments occur. (All of the above is also why so many people who have opinions about gold base them solely, and often erroneously, on the chart patterns.) As for the miners, it is even harder to be certain about them, because their whole business revolves around the hard-to-determine future gold price.

The bottom line is it takes melding together lots of clues, charts, and fundamental guesswork to be able to have a correct opinion about the gold price. Obviously getting the overall trend, bull market or bear market, correct is a huge help. I did that pretty well in the bull market, but totally missed the shift to the bear market. I can't believe it, but it took me well over a year to consider the possibility that gold had slipped into a bear market. In any case, I think we are now in the process of restarting the bull market, but I don't know for sure and can't know. Until it is a bull market, it will still be a bear market, with the attendant dangers and different risk management (technique) requirements.

(In the investment business we all have periods when we are hot and when we are cold. On that subject, one has to realize in one's own investing there are periods where most everything you think and do is correct, and when that is the case it is possible to be more aggressive. And while it is easy to make money when it seems as though you are getting the Wall Street Journal a week early, the bigger trick is not to get killed when it seems that you can do nothing right. When that inevitably happens, you must spend more time sitting on your hands while waiting for your view of how the world should work to coincide with that of the masses, a.k.a., the market.)

It Should Be Worth the Weight

 To state the obvious, when the bull market resumes, life will get easier, though the gold market will still be tricky. Unfortunately, trading and investing in gold is more difficult than just investing in the stock market. It is more like managing a short position. I wish that wasn't the case, but it is. I also wish the Fed wasn't so incompetent so that we could just buy stocks or bonds and didn't have to focus on the variables we do, but we must play the hand we are dealt and we have been dealt one with central banks pursuing insane policies that force us to deal with a warped economic/financial world where the money is "no good." I hope this long discussion helps readers understand the gold market better and, more importantly, that it helps when it comes to managing positions.

Bill Fleckenstein writes a daily column for a very reasonable annual subscription price.  There is a daily column plus an “ASK FLECK” email Q&A, that provides valuable market insight.  His column has correctly guided me through many a market disaster, and is in my view, invaluable.  D.Bears

In The Wilderness by Paul Singer
Friday, 17 May 2013

In The Wilderness by Paul Singer

[T]he financial system (including the institutions themselves, products traded, and risks taken) has "gotten away from" the Fed's ability to comprehend.The Fed is primarily responsible for that state of affairs, and it is out of its depth. Former Chairman Greenspan created -- and reveled in -- a cult of personality centered on himself, and in the process created a tremendous and growing moral hazard. By successive bailouts and purporting to understand (to a higher and higher level of expressed confidence) a quickly changing financial system of growing complexity and leverage, he cultivated an ever-increasing (but unjustified) faith in the Fed's apparent ability to fine-tune the American (and, by extension, the world's) economy. Ironically, this development was occurring at the very time that financial innovations and leverage were making the system more brittle and less safe. He extolled the virtues of derivatives and minimized the danger of leverage and risky securities and dot-com stocks, all while he should have been putting on the brakes. It was not just the disappearance of vast swaths of the American financial system into unregulated subsidiaries of financial institutions, nor was it just government policies that encouraged the creation and syndication of "no-documentation" mortgages to people who could not afford them. It was also the low interest rates from 2002 to 2005, the failure to see the expanding real estate bubble caused by an unprecedented increase in leverage and risk, and the general failure to understand the financial conditions of the world's major institutions.

Under Chairman Bernanke, the combination of ZIRP and QE completed the passage of the Fed from sober protector of a fiat currency to ineffective collection of frantically-flailing, over-educated, posturing bureaucrats engaged in ever more-astounding experiments in monetary extremism.

If you look at the history of Fed policy from Greenspan to Bernanke, you see two broad and destructive paths quite clearly. One path is the cult of central banking, in which the central bank gradually acquired the mantle of all-knowing guru and maestro, capable of fine-tuning the global economy and financial system, despite their infinite complexity. On this path traveled arrogance, carelessness and a rigid and narrow orthodoxy substituting for an open-minded quest to understand exactly what the modern financial system actually is and how it really works. The second path is one of lower and lower discipline, less and less conservative stewardship of the precious confidence that is all that stands between fiat currency and monetary ruin. Monetary debasement in its chronic form erodes people's savings. In its acute and later stages, it can destroy the social cohesion of a society as wealth is stolen and/or created not by ideas, effort and leadership, but rather by the wild swings of asset prices engendered by the loss of any anchor to enduring value. In that phase, wealth and credit assets (debt) are confiscated or devalued by various means, including inflation and taxation, or by changes to laws relating to the rights of asset holders. Speculators win, savers are destroyed, and the ties that bind either fray or rip. We see no signs that our leaders possess the understanding, courage or discipline to avoid this.

It is true that the CEOs of the world's major financial institutions lost their bearings and were mostly oblivious to their own risks in the years leading up to the crash. However, as the 2007 minutes make clear, the Fed was clueless about how vulnerable, interconnected and subject to contagion the system was. It is not the case that the Fed completely ignored risk; indeed, several Fed folks made "fig leaf" statements about the risks of the mortgage securitization markets, as well as other indications that they appreciated the possibility of multiple outcomes. But nobody at the Fed understood the big picture or had the courage to shift into emergency mode and make hard decisions. In the run-up to the crisis the Fed was a group of highly educated folks who lacked an understanding of modern finance. After convincing the nation for decades of their exquisite grasp of complexities and their wise stewardship of the financial system, they didn't understand what was actually going on when it really counted.

Ultimately, of course, as the system was collapsing and on the verge of freezing up completely, the Fed shifted into the (more comfortable and much less difficult) role of emergency provider of liquidity and guarantees.

All this background presents an interesting framework in which to think about what the Fed is doing now. QE is a very high-risk policy, seemingly devoid of immediate negative consequences but ripe with real chances of causing severe inflation, sharp drops in stock and bond prices, the collapse of financial institutions and/or abrupt changes in currency rates and economic conditions at some point in the unpredictable future. However, the lack of large increases in consumer price inflation so far, plus the demonstrable "benefits" of rising stock and bond markets, have reinforced the merits of money-printing, which is now in full swing across the world. In the absence of meaningful reforms to tax, labor, regulatory, trade, educational and other policies that could generate sustainable growth, "money-printing growth" is unsound. We believe that the global central bankers, led by the Fed as "thought leader," have no idea how much pain the world's economy may endure when they begin the still-undetermined and never-before attempted process of ending this gigantic experimental policy. If they follow the paths of the worst central banks in history, they will adopt the "tiger by the tail" approach (keep printing even as inflation accelerates) and ultimately destroy the value of money and savings while uprooting the basic stability of their societies. Read the 2007 Fed minutes and you will understand how disquieting is the possibility of such outcomes and how prosaic and limited are the people in whom we have all put our trust regarding the management of the financial system and the plumbing of the world's economy.

Printing money by the trillions of dollars has had the predictable effect of raising the prices of stocks and bonds and thus reducing the cost of servicing government debt. It also has produced second-order effects, such as inflating the prices of commodities, art and other high-end assets purchased by financiers and investors. But it is like an addictive drug, and we have a hard time imagining the slowing or stopping of QE without large adverse impacts on the prices of stocks and bonds and the performance of the economy. If the economy does not shift into sustainable high-growth mode as a result of QE, then the exit from QE is somewhere on the continuum between problematic and impossible.

Central banks facing high inflation and/or sluggish growth after sustained money-printing frequently are paralyzed by the enormity of their mistake, or they are deranged by the thought that the difficult and complicated conditions in a more advanced stage of a period of monetary debasement are due to just not printing enough. At some stage, central banks inevitably realize, regardless of whether they admit the catastrophic nature of their own failings, that the cessation of money-printing will cause an instant depression. Even though at that point the cessation of money-printing may be the only action capable of saving society, that becomes a secondary consideration compared to the desire to avoid immediate pain and blame. The world's central banks are in very deep with QE at present, and the risks continue to build with every new purchase of stocks and bonds with newly-printed money.

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