Well it looks like Sell-in-May is apparently a couple of weeks early this year, though without wanting to repeat myself too much, lower commodity prices will quite likely end up being a good thing. It always pays to pay attention to commodity markets – when managers feel queasy and reconsider investment plans, they pause commodity buying months before anything shows up in official statistics. The sell-off is broad based, the most spectacular facet is gold:
On the plus side this is bit of a relief – if the loony libertarians and anarchists who bought both large hordes of gold and chronic amounts of Bitcoin kept making so much money I might have had to throw in the towel and join them.
What’s the story
As always, the price is set by who’s buying and selling. In this case we have:
- 1. Central banks
- 2. Real demand (jewellery, industry)
- 3. Speculators
1. Central Wankers
In the gold market central banks have proven true to form and have screwed their populace through poor market timing (though I do think Bernanke and Glenn Stevens have done some excellent work)
UK readers may know that Gordon Brown decided to sell 60% of UK’s gold reserves in 1999-2002 at around $300 per ounce. He even told the market what he was doing before he did it. Needless to say, commodity markets tend not to rally when a government announces it’s dumping the majority of its stock. This was at a 20 year low.
Not that we can be particularly smug down under. Typically our politicians follow the political trends coming from overseas, and in this instance we certainly played by the rulebook. We sold our lot at around $360.
If central banks were selling at around $300 range, what were they doing the past few years when prices ranged between $1600-1900? Naturally, they bought more gold than at any time since 1964.
While the central banks sold at the bottom and have been buying at the top, the fact that industrial and jewellery demand (mostly jewellery) moved in opposite direction to the price restores some faith in economics, despite what you may hear about an Indian/Chinese gold rush. In terms of picking price drivers, relatively steady industrial use pales in comparison to the huge swings in speculation and the movements and hoardings of central banks.
This is where it gets interesting, as a quick inspection of the demand chart above shows what you would have assumed anyway – recent years investors have piled into ETFs and physical gold.
It’s amazing how otherwise intellectually rigorous individuals so easily accept silly notions and accept bizarre illogical statements of faith on the topic.
a) Gold does NOT protect you in a sell-off (necessarily)
Since 2001, this trade has worked very well. But nothing lasts forever, and in recent days this paradigm has completely changed. All the people who bought for this reason (e.g. Jim Cramer ‘you should always have some gold in your portfolio’) if they have any logical consistency, should now be selling.
b) Gold is NOT an inflation hedge
This oft-expounded theorem-as-fact is easy to disprove – take a look at the picture:
As you can see, while there has been some truth in the statement in the past, without overstating it there has been a considerable divergence lately. While we’ve been about as close to deflation as you can get without calling it such, the gold price has rallied strongly.
If anything that implies a negative correlation – but the reality is it has nothing to do with it. There is no mysterious hand here – the price is determined by real factors: who turns up to buy and sell each day. No rule of thumb or market is going to make up for actually understanding who these people are and why they are doing so.
c) Gold is a better and safer store of value than cash in a bank
While certainly true when the gold price is going up, in a nutshell, it simply makes no sense to hold gold when (real) interest rates are positive
When banking cash in the UK, US and Europe gets you close to zero, then perhaps it makes more sense than usual to swap it for bullion. But when rates normalise then holding gold makes no sense at all. Think about it – if rates hit 5% (and that is well within norms – you’ve been able to get that in Australia throughout the crisis), then effectively government guaranteed increase in wealth of 5% beats the hell out of (negative) storage costs.
Should inflation pick up and purchasing power erode, central banks will jack up rates. Cyprus aside, you are safer in a too-big-to-fail bank.
So in summary, all the main speculative reasons for holding gold make very little sense right now. Now imagine what would happen if the speculators chasing capital gains start to unwind their positions that have been building since ~2001…
But what about hyperinflation!
Pundits fall over themselves trying to predict the next time this will happen.
A cursory flip through the history books shows hyperinflation is actually far rarer than everyone seems to think. This is something of a cognitive bias – the results can be so horrific that it’s easy to overstate the actual occurrence.
And no matter how inclined-toward-conspiracy you are, there is no indication that the major central bankers in the world are sulkily printing cash to plea poverty while keeping full employment a la Weimar , or are as brazenly thieving and felonious as the villainous Mugabe and his cronies in Zimbabwe.
But even so, there are actually some excellent ways to deal with hyperinflation
For example you could:
- Borrow in local currency and buy real assets overseas. The currency will be on a oneway trip to hell and the value of the loan will erode just as fast.
- Borrow and buy real assets for which there will always be demand – like central housing. Again the face value of the debt will erode in real terms, but the living space will be worth something regardless of the payment terms
What you should not do is have any savings whatsoever, or even worse, be on a fixed rate pension. Apparently the much-maligned veterans of World War I (who could hardly have picked a worse time to be born) were particularly screwed by this one.
So in conclusion: sell your gold (if you have any) and keep some cash ready for the far more interesting opportunities the market is about to throw up.
Next post: Hedge Fund Villain #1: Mr Paulson.
FYI: A chemical anomaly
Gold has always fascinated, not really due to its rarity (after all, many things are more scarce) but due to its colour and lack of reactivity, that suits it perfectly for beautiful and lasting jewellery.
Apparently an (admittedly hand-wavy) explanation is that at the lower ends of the periodic table, the increasingly (positive) charge of the nucleus causes (negatively charged) electrons to approach relativistic speeds. By the time you reach Au, the energy levels have been pushed to the point where gold is coloured differently to the other metals – one of the many periodic crossovers that chemistry examiners love to probe.