Gold, Stocks and Stagflation

My favorite fantasy role-playing game is one I invented called, I’m Smart and I have a Time Machine! (I’m working on a better title, so step off).  The object is to develop a strategy for a given time period

My latest challenge is the 1970s.  The word stagflation is creeping back into the national vocabulary, and I heard “Disco Inferno” last weekend.  I’m not sure if these are omens, but I’m not gonna wait to see Dennis Kneale in a leisure suit before I make a plan.  So what were the right moves in the 1970s? 

Conclusion:

A great strategy for coping in the 1970s was:

1. Buy Gold
2. Smoke weed.
3. When the Fed funds rate has risen 10%, start rotating back into stocks.

If you're anything like me, you probably only got one out of three right during this era (probability not worthy of a Meatloaf song)

That was then, this is similar?

If you believe that we are watching a rerun of That 70s Show, you may want to figure out where the “YOU ARE HERE” sticker belongs on the chart.  Perhaps, a more important take-away is that monetary policy does not always work as advertised and financial “Axioms” are often false.  Stocks did not outperform inflation. Cumulative inflation for the decade was over 110% (source: bls.gov).   The notion that there is an inverse relationship between interest rates and gold begs the question, “are you high?”  It took massive, very real changes in policy to end stagflation.   Don’t expect Hawkish jaw-boning and Swiss army knife-rattling to have a sustainable impact.

Back to the Future…

So, I emerge from my time machine, back to the land of round the clock world market coverage and instant analysis by an endless parade of pundits, wondering what I should do with my gold positions.  Would anyone out there like to swap a pair of bell-bottoms for a tin foil hat?  One more thing; I think introductions are in order between Jim Sinclair and Guy Adami.

Fun Facts: Guy Adami has served as head gold trader at both Drexel Burnham Lambert and Goldman Sachs.  He now can be seen bashing gold nightly on CNBC’s “Fiat Fast Money”.

Disclosures:  Author has long gold positions, but doesn’t smoke weed anymore (honestly).

Resources:

• Historic Gold Prices 
• Effective Fed Funds Rate Historic Values
• Historic S&P 500 Values

Comments

[dieuwer:]

"When the crowd becomes enamored, act oppositely"

2008 Jun 17 08:08 AM

[buyitcheap:]

If you're concerned about gold, short the ten year, interest rates will have to rise in this environment. Once those rates go up, go back into gold AND into stocks.

2008 Jun 17 09:08 AM

[Marc Courtenay:]

Great sense of humor even though you misspelled your first name :)
Your points are well-taken and ironically it will be when the Fed starts raising short-term rates that we'll most likely see a big rally in the stock market. Right now though it would be devastating for the US economy (short-term) if they don't keep monetary policy loose and interest rates low, and we all agree that is inflationary and very good for precious metals as a hedge

2008 Jun 17 04:35 PM

[The Bear:]

I wonder what the US dollar, US central bank gold supply and US central bank gold holdings would look like superimposed on that chart. Don't suppose anyone can...

2008 Jun 17 04:52 PM

[EE:]

Don't forget about how the big boys have rigged gold and especially silver to current low levels which will explode up in the near future.READ butlerresearch.com june 16th of which follows a portion......But what happens when someone buys shares in these ETFs and the seller is selling those shares short? Does the short seller deposit metal to back up the buyer’s purchase? No. The short seller just sells the shares short without depositing metal, perhaps borrowing other shares first, perhaps not. The buyer doesn’t know who he is buying from, he gets a confirmation of his purchase from his broker, pays for it and assumes, according the representations in the prospectus, that he is buying new shares issued by the sponsor who has deposited metal, or from an existing shareholder who has decided to liquidate his shares. It never occurs to the buyer that he is buying from a short seller who is not depositing metal. In essence, the short seller is circumventing what is promised in the prospectus. That party is short-circuiting and destroying the promise clearly laid out in the prospectus that real metal backs every share sold.

Here’s the disturbing question - which buyers’ shares are left without silver backing when short sellers are involved in the transaction? Just the hapless and unsuspecting buyer who was unlucky enough to happen to have his purchase short sold, or do all SLV shareholders get shaved proportionately, like a silver coin clipped in olden times? Don’t look to the prospectus for answers, because you won’t find any.

For those who were unaware of this and don’t understand how shares can be sold with no metal backing (or doubt my contention), there is hard proof. There is a short position list reported that proves short selling exists. Currently, the SLV shows a small published short position on the American Stock Exchange of around 250,000 shares, or the equivalent of 2.5 million ounces. On March 11, this reported short position hit almost 1 million shares, or nearly 10 million ounces. So, there can be no doubt that some short selling exists, which raises all sorts of disturbing questions. In my opinion, this aspect of the metal-only ETFs wasn‘t fully thought through before their introduction. Unfortunately, the problem may be worse than just this SLV short selling; maybe much worse.

WHAT’S GOING ON?

Around this past April 15 I began to notice a more pronounced delay of silver deliveries into the SLV. This was for much larger amounts of silver than I previously observed. In fact, the amount of short selling in SLV shares began to look extreme.

Just a short word on short-selling. Please don’t confuse this discussion on the short selling of shares of the SLV (and GLD and IAU) with the short selling I continually discuss in COMEX silver futures. I know this can be a complicated topic, but it is important for you to understand it. In futures, there must be a short for every long. Therefore, the problem in silver futures is not the presence of shorts, but the documented concentrated nature of this short position, namely, an extremely large short position held by just a few traders. Less extreme concentrations in other commodities have always been considered manipulative by the CFTC in the past; just not now in silver (and gold), for some reason.

2008 Jun 17 05:16 PM

[deuxsous:]

If your gold position is paid-for physical gold stored safely by you, then just hold it and forget about it. That's what I did in the 1970's.

But if you are a modern paper gold trader, just burn the paper and move on to the next paper fad.

2008 Jun 18 01:28 PM