In early 2008, William Poole wrote (.pdf),
There is a central-banker way of thinking that can be described and analyzed.
He further states that monetary policy is positively correlated with how completely the market understands the Fed; that economists both inside and outside the Fed have studied at the same universities, under the same professors, using the same textbooks and journal articles; that a damaged reputation can send customers fleeing to competitors. Which leads me to the question: Who, or what, is a central banker’s competition? And, why is that important to investors and traders?
If you read further in Dr. Poole’s 2008 article, you will discover that he makes the oddest statement:
When I examine the federal funds futures market, a large discrepancy between market expectations and my “best guess” of the FOMC's future actions might suggest to me the possibility of a Fed Communications failure.
A predictable policy rule implies a predictable reaction to the policy action, meaning, the people can see the outcome of the action (policy response). The Fed’s objective should be clear to all: if the gap between the desired outcome and the actual outcome is too great, then people’s suspicions about the Fed are raised. Above all, the Fed designs systematic policy responses; the policymakers shape their policy actions by consciously deciding how to guide the market’s thinking.
You see, the Fed’s greatest desire is to understand and control risks; meaning, the same people should respond in the same way to the same policy no matter when it’s used. Because if it did not understand and control the risks, the public would discover just how far over their eyes the wool has been pulled.
For example, one of the Fed’s favorite policies is inflation targeting, which can be boiled down to five easy steps (these five steps are laid out in money & banking textbooks):
- Step 1: announce the numeric objective (say, 2%)
- Step 2: announce a commitment to the objective (numerous Fed officials appear in various media to reiterate the objective)
- Step 3: tell people how many variables are used in getting to the objective (Fed officials say they will use open market operations, or will mention recent treasury sales)
- Step 4: tell the public that everything is transparent (it’s all transparent, folks, can’t you see it?)
- Step 5: tell the public that accountability is taking place (this one is odd, for I never hear anyone actually taking responsibility for Fed actions and results of the same)
In the past, the Fed policymakers were assured the public, in the form of market actions, would follow docilely along. But, what happens when the Fed’s reputation is ruined? To where, or to whom, will the public turn? To the Fed’s competition: gold and silver.
For six millennia, in times of economic peril, people have turned to gold and silver. Why? Because, these precious metals do not need to announce a numeric objective, nor do they need to reiterate it dozens of times to a non-believing public, nor do they need to tell the public how transparent, or accountable they are. Gold and silver are the Fed’s competition. That’s why modern day economists cannot ever supply an alternative to the Fed or any other Central Bank. Because gold and silver work to keep an economy honest.
A central banker's biggest competition, and his biggest fear, is that the little guy, the common man on the street, begins demanding gold and silver as a way of receiving their wages and paying their debts. The world's central banks, and the Federal Reserve, are price makers in money. It serves their purpose to control money supply as well as money demand, and thus they control the common man on the street via their policies.
Tradermark illuminates the flush out of the precious metals trade on the basis that hedge funds believe inflation is around the corner. They used the inflation excuse to buy into gold and silver, when what they really feared was deflation.
The recent sell-off in gold and silver, even if generated by large hedge funds, was not driven by fundamentals. The European and U.S. debt crises are not solved. It is possible that eventually people will realize that debt cannot be eliminated by producing more debt and demand a return to the gold standard. In the meantime, central banks are still buying gold, large foundations like the University of Texas are taking delivery of gold, and large corporations like JP Morgan (JPM) now using gold as collateral. These events should be a clear indication that this sell-off is only temporary. Watch for gold and silver to rebound and exceed the $1575 and $50 marks by September.
In this uncertain monetary environment, the junior gold and silver miners (GPL, PZG, and MGH to name a few) are excellent buys, as is the bullion itself. I've been watching the minor miners I mentioned above for several years, and in the process of researching for this article, convinced myself all over again why they were good buys for me, and are even better buys since they've come off their 120- and 200-day moving averages.
Great Panther Silver, Ltd. (GPL) The May 2011 corporate presentation (.pdf) boasts four consecutive years of production growth and new discoveries at San Ignacio. The average cost per production ounce is approximately $6.50 and estimated to decrease to $5 per ounce by next year. Net Income Applicable to Shares, Net Tangible Assets, and Cash Flow are all positive and increasing. Great Panther's beta is high at 2.44, but with shares at current market price, is ripe for acquisition.
Paramount Gold & Silver, Corp. (PZG) The April 2011 corporate presentation (.pdf) boasts a market cap in excess of half a billion dollars, flush with cash, and is developing new mines North America. Their seasoned geologic and management teams work in concert to target assets for acquisition ultimately aimed at increasing share price. With a beta of 1.92, you know it's risky, but the upside payoff could be sizable.
Minco Cold Corporation (MGH) Based in Canada, MGH also owns 16 gold properties covering an area of 1,000 square kilometers of mineral rights in China. Minco's mission is to set the gold standard in China by becoming a significant gold producer and exploration partner. Minco has only 54 million diluted shares (compared to GPL's 124 million, PZG's 135 million, and SVBL's 106 million shares). Its beta stands at 1.9, and while fairly risky, is the only junior gold miner I've found so richly situated in China.
Yahoo! Finance is a good place to start your due diligence, which is where I do preliminary work.
For investors and traders, when asked, my advice is to get debt-free, buy gold and silver bullion and coins, gold and silver miners, as well as maintaining tight control of your own portfolio.
