Note that I hold options positions with 1-3 month windows, and when I comment here, I am assessing the risk situation for my options positions. Do not day trade with anything I say here. Indeed this is not investment advice; this is risk analysis.
One of the fundamental philosophies of this Company is that asset prices are not efficient; rather, they are driven by investor emotion.
I. MACRO EVENTS
On Wed Jul 13th we saw an exuberant reaction to Bernanke. However if we look at his words carefully (and Bernanke is an academic like myself, not a politician, so Bernanke “says it like it is” in a very carefully worded manner, rather than political non-speak of, say, Greenspan) his message was this: the economy is undesirably weak, but inflation is such that he cannot respond. That was the main message. In other words, the main message was that no change in policy is likely in the near future. It will likely take a few days for people to digest Bernanke’s words sufficiently to realize this. Emotionally, everybody (traders) is looking for QE3 and any even vaguely accommodative statement (which is what we got, a very vague “we stand ready” statement, which means nothing, it just means they’re going to the office and doing their job and will continue to do it) caused trader euphoria.
The FMOC minutes had this wording:
“Participants also discussed the medium-term outlook for monetary policy. Some participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate and if inflation returned to relatively low levels after the effects of recent transitory shocks dissipated, it would be appropriate to provide additional monetary policy accommodation.”
However note the “if inflation” part, and then Bernanke’s comments, the sum of which were, again, that 4% inflation is too high for the Fed to take action. The failure of the SPX to follow through with the gold and silver rally on Jul 13 indicates that at least large traders were paying some attention to Bernanke’s words.
The Chairman has said that QE3 is not going to happen (barring economic disaster) so many times, in so many ways, that some day investors will actually hear him.
Further, the sharp mind of Gavyn Davies writes,
It is worth remembering that if nothing is done to change US fiscal policy in the next few months, there will be a tightening of the budgetary stance amounting to more than 2.5 per cent of GDP in 2012. This tightening, the largest in the past 40 years, would come from the ending of the temporary reduction in the payroll tax, and the extension of emergency unemployment benefits, which were given a 12-month lease of life last December. The scheduled ending of these measures would hit the labour market when it is still very weak – bad timing, to say the least.
Any tightening is bearish for precious metals.
At the moment we have the risk of sovereign default in the US and Europe driving precious metals higher.
The Company has been short silver with Aug puts for several reasons, primarily the illogic of the rally, stemming from the facts that the Fed does not print money. QE2 was not money printing. It was not debt monetization. It will not cause high inflation or hyperinflation. It will not cause a dollar collapse. And indeed, though volatile, the dollar has been slowly rising. There is also no relation between the value of the dollar and the size of the balance sheet. The following graph from Pragmatic Capitalism says it all:
As Roche writes, “As you can clearly see – there is no real correlation between the size of the balance sheet and the USD. None at all. This has all been proven correct despite my repeated ramblings, yet the inflationists and fear mongerers still garner all of the attention. Clearly, people prefer to be scared as opposed to being told the truth.”
And we return to the threat of US default (Aug 2) and European default (no resolution date), which is causing high emotion among investors, the result of which on Wed Jul 13 we saw massive buying in gold and silver, buying in treasuries, and a big drop in the dollar. The Swiss franc is also at absurd unsustainable levels.
In particular, with the Swiss franc, 24/7 Wall St correctly observes, “There is just no way that the currency shift can go on endlessly before the Swiss have to intervene themselves against their own currency. If the move continues in this direction, the country will not be able to do any business outside of its own country other than buying foreign assets on the cheap.”
Conclusion #1: The big money would be made by correctly gauging investor emotion post-Aug 2.
Conclusion #2: The dollar will continue to rise.
Conclusion #3: A lot of money could be made by shorting the Swiss franc at the right moment.
Conclusion #4: QE3 is extremely unlikely and once this fact is actually digested, commodities prices will resume their decline.
Conclusion #5: If US monetary policy is not changed, and if there are no sovereign defaults, you can make a fortune shorting gold and silver. Gauging the timing and the “if” factor is the tricky part.
II. PRECIOUS METALS AS MONEY
There is a lot of nonsense, even on CNBC, that “gold is money”. This is not so. Gold is a commodity. It is also an asset. To assert otherwise belies a fundamental misunderstanding of how our economic system works. But let’s get down to basics. The important thing is whether you can take a piece of gold to, say, the grocery store and pay for your pop-tarts and Gatorade with it.
You can’t.
Gold is not money. All this misinformed discussion of gold as money makes me mental.
How does this affect investor emotion? Well, it doesn’t really except in so far as gold is treated (mistakenly) as a safety currency like the Swiss franc. Point being, gold is emotionally regarded as a currency, despite the fact that this is just not so. Thus, let’s examine the relation between gold and the dollar and the euro:
Gold moves in relatively high correlation to the euro and in relatively high inverse correlation to the dollar, though note in Jul the correlation with the euro broke. It may remain broken given the eurozone crisis. Now with the Swiss franc we have a different story. The Swiss franc is regarded as a safe store of value (this in itself is not true either; its value fluctuates), and observe the almost perfect correlation between the Swiss franc and gold:
While there is a correlation between the Swiss franc and silver, it is not as elegantly clear:
And as with gold, silver has a fairly high correlation with the euro and a fairly high inverse correlation with the dollar:
Gold and silver (and copper to a lesser extent) are correlated:
You will note that the moves of silver are more hyperbolic than gold, and copper even more so.
CONCLUSION: Gold and silver will fall at the same time people stop putting money into Swiss francs.
POTENTIAL PROBLEM WITH THIS CONCLUSION: the likelihood of the Swiss treasury intintervening without regard to investor sentiment.
