Adam Katz

U.S. Dollar Strength and Implications for Gold

Thanks for pointing that out tb1975. My apoligies to everyone.

“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”

Just to clarify to everyone, I am referring to the trading of gold here, not the physical ownership. Over the next few months I will feel more comfortable trading gold bullishly against exporting currencies. The US has not produced anything for a while, so when we see extreme trade deflation, those countries which have been producing get hit hardest. When economic numbers come out over the next few months, we will see more evidence of trade deflation and job losses as a result. These exporting economies will purposely devalue their currency long before the USD will crash. That being said, in an absolute sense the USD is weakening from the Fed action, but other currencies are weakening MORE - thus on a relative basis the USD is strengthening and will likely continue to do so against exporting currencies.

From TradeTheNews:

Treasury nominee Geithner reaffirmed the US Goverment's opposition to currency manipulation, and view that trading partners should operate flexible currencies, under the Obama Adminstration

Gold Price and the Money Supply

Smarty Pants,

I own TBT but I am skeptical of that play for now. How is the government debt going to be monetized? By buying long term government bonds to keep the yield low. That will eventualyl blow up in their face, but unfortunately timing is very uncertain.

SWRichmond,

Recognizing our own biases is the only way to be objective. I was personally long both gold and silver last year. Gold I was out before year end and silver I exited at $21.50 (to the sound of the bugs ridiculing me). What's funny is that I bought for the exact reasons that we are talking about now and now I'm not buying even though things have only gotten worse. For me it's a value issue, not an issue of arguing the fundamentals (which are quite obvious at this point).

Alternatives are hard to come by and are different for different people. If you have a lot of money and can borrow at reasonable rates, then selectively borrowing to buy real estate could prove to be very profitable in the long term. It's one of the best ways to store long term capital and to actually get a loan only due in 30 years. I specifically would borrow to do so (although you should have the wealth to back your loans - no leverage) because you are expecting that 30 years from now the dollars that you have to repay will be worth nothing. I'm not only talking attractively priced residential real estate, but raw land and agricultural land as well. If you can get a USD loan to buy land in a foreign country, even better. That being said, be cautious on valuation and realize that in the short term these assets will likely decrease in value.

Gold Price and the Money Supply

SWRichmond,

Firstly, let me say that under normal business I believe the government's intention is to pay off debt through productivity gains. However, I agree that these aren't normal times and that the government debt has ballooned to very high levels. Let me point out two things. Firstly, timing of this implosion is impossible. You could still be sitting on seekingalpha making these claims in 10 years time when debt-to-gdp is sitting around 200%.

Secondly, my focus is on using gold to hedge this event, which I think is very much priced into the gold price already. I see the the size of the U.S debt, so does the rest of the market. We all know the problems this will represent in the future and the size of the unfunded future liabilities. The dollar bear fundamentalists have all found their way into gold, pushing up gold's value and pricing in an increased probability of the event occuring. My whole argument is to look for other ways to play the flooding of the money supply because the gold space is already quite crowded - mostly by retail specs

Gold Price and the Money Supply

cruiser,

Deleveraging has only just begun. I definitely agree that this deflation is caused by deleveraging - I just think that it has a long time to go. As equity values have come crashing down - D/E ratios have skyrocketted. On paper, companies are more leveraged today than they were before the crisis began. Cash is king during deleveraging. This gives some attraction to gold as well as it has value as a currency. However, cash, the asset being demanded in exchange for deleveraging, should outperform all other assets. Will this end with it being the peak value of cash? I don't doubt it...

Gold Price and the Money Supply

Kelly,

I'm not saying that what Bernanke is doing will work, he doesn't even know. But given current information it is a better approach than simply allowing everything to crash. Allowing everything to crash works in a system that is backed by gold in the first place. When everything was leveraged so high, allowing things to crash would set us back 50 years in terms of real wealth.

Also, the thesis of my article is that gold is already overvalued and is pricing in a lot of credit expansion because EVERYONE is buying it. I'm sorry to tell you that you are not using your own head but rather following the crowd. If it wasn't for retail investment demand last quarter, gold's price would be significantly lower.

For the record I haven't been short the dollar for a few months now but I am a long term bear.

Gold Price and the Money Supply

SWRichmond,

I rarely say this, but I think you are completely wrong. Firstly, as incompetent as the central authorities are, I do not in any way believe that there is a conspiracy to have inflation which is what you are implying. In fact, I believe the situation to be quite the opposite.

In a credit based system such as ours, the Fed actually WANTS us to expect inflation - it's the only way that we will consume today instead of saving. If the public expects inflation then there is no need for ACTUAL inflation. They'll only choose to bring about inflation when there is an actual need to stimulate short term demand.

Earlier this year there were inflation expectations. With the exception of shadowstats implied M3 (which I believe myself to be a useless measure due to it's inherent nature to double count), the money supply actually contracted violently over the summer. Had they tightened earlier this year we would be in big trouble right now. The only thing that worried me then, and now, is will foreign countries keep buying U.S debt to feed the deficit or will it have to be monetized.

Lastly, time period. Before 71 gold was fixed for 25 years and before that was a very different era. I don't doubt that in the past gold held far more monetary significance, but using that data in a time series analysis would give skewed results for current times.

We don't have a time in our recent history where we had such a serious financial and banking crisis leading to deflation and deleveraging where the Fed started printing - so I apologize if I didn't include such an event in my analysis. The closest we have is the great depression where the money supply was not expanded which lengthened the depression and Japan (Asian financial crisis) where they pumped in a fortune of liquidity and today sit with a debt-to-gdp of 180%. At the time, Japan's actions certainly seemed inflationary yet today, 17 years later, they've averaged -0.5% y/y CPI after substantial quantitative easing AND rates at 0% for years.

There are two differences with the Fed. Firstly, they are admittedly doing more than Japan because all of the liquidity Japan pumped in was still not enough to get out of deflation. Secondly, Japan bailed out ALL companies while the Fed is being slightly more selective and trying to let companies fail that pose no systematic risk.

Gold's Role Reversal

Smarty Pants,

I was expecting a quick response from you!

The truth is I am sincerely neutral. If I was living in the U.S I would convert a lot of my cash into gold, but as a Canadian I still find gold expensive in CDN dollars. I'm definitely not looking to go long with leverage like I did last time gold was at $700.

What I can tell you is that in my time working as a trader I have learned to put aside my personal beliefs and to not try to fight the market. There may very well be gold buying hysteria down the road (whether I think it's fundamentally just or not) and as a trader I hope to catch on to a piece of that. Mark my words though, at some point gold will have a 50% drop as the frenzy comes to an abrupt halt and the bubble bursts - but that may very well be from $2000 down to $1000.

As Jeremy Grantham calls it, it is the curse of the value manager. You get in too early and out too early as market swings will usually swing past fair value. I do think gold is overvalued relative to other real assets at the present time, but that doesn't mean that it won't be higher in the future.

Credit Markets and the Price of Gold

Smarty Pants,

Did some research today that you may want to see:
www.plusev.ca/gold-pri.../

Credit Markets and the Price of Gold

"I would contend that pricing changes due to supply/demand are separate from changes due to currency devaluation. Many might not agree, but I believe that using them interchangeably is misleading."

I completely agree and that;s why I think that gold is overvalued. The fact that there is a limited supply causes this when there is a rush into the asset - it then takes a while to unwind the price that was overshot due to excess demand. That's the reason why I wouldn't be shocked to see the dollar and gold both weaken simultaneously.

Credit Markets and the Price of Gold

"Normal monetary policy is not able to get money flowing"

www.telegraph.co.uk/fi...

Credit Markets and the Price of Gold

Smarty Pants,

I could reverse what you said and say that housing prices maintained their purchasing power as well (up until the recent crash of course).

If you had purchased gold in the 70's for $800 you would be down a lot in terms of purchasing power.

BUT, I must point out that you have proven my original point. I have been arguing that compared to real estate, silver, and oil, gold has not lost enough value to reflect real prices. It may simply be discounting future inflation, but that's why its over valued right now as an inflation hedge. There's far more value in the others mentioned above. Real estate has come off significantly more than gold. Should the structural demand problems continue (and I think they will for oil and housing), those two will likely continue to trend lower and there is no reason for gold to move higher while those are moving lower. That would completely distort the theoretical idea behind gold preserving value if it's purchasing power increased to an even wider spread. Alternatively if you believe gold will go up and the ratio will normalize, then real estate prices must rise at a faster rate than gold. Based on last months median home price of $218,400, that equates to approximately 300 ounces at todays prices. Gold prices have not gone down as far as they need to.

www.plusev.ca/gold-dol.../

Credit Markets and the Price of Gold

moonbat,

If I give you a gun, it doesn't mean you have to use it. The difference between interest rates being at 4% or 7% should be used by consumers as a savings tool, by buying a house of equal value regardless of current rates. The problem is that the average consumer will use slightly lower rates to buy a more expensive house. If you buy the same house regardless, you will actually have extra money in your pocket at the end of the month. In that environment you stick the savings into gold and you will ultimately be rewarded.

Boom/bust cycles exist in part due to the fixing of interest rates, but ALSO because of how consumers react to those changes. If you spend prudently, lower interest rates can actually be a savings mechanism. Obviously this doesnt apply if 1 consumer does this because other consumers will force up real estate prices and the same house will cost the responsible consumer more. Rather, this is education that the general public should be recieving.

YES too many people believed housing prices would always go up - what a stupid thing to believe. However I personally think gold bugs make the same mistake by thinking that gold must always go up.

Credit Markets and the Price of Gold

moonbat, don't over scapegoat the govt and banks.

As a Mises supporter you obviously believe in completely free markets, no govt intervention, etc. You also believe that each individual has the right to make decisions for themselves and no one else should cover the costs if they screw up. If a consumer gets into a loan that he/she knows they cannot afford, or signs a contract that they don't fully understand, they are as responsible as the lenders who misled them. They essentually assumed too much risk and as a result should fully suffer the consequences of losing their house, declaring bankrupcy, and losing all of their assets in the process.

I am not proposing this as a solution, all I am saying is that if you believe in the philosophical principles of Mises, you cannot lay all of the blame on the banks and the Fed, even if they were the root cause.

Credit Markets and the Price of Gold

Smarty Pants,

Another point that I should make is that in our discussions my original thesis has been faded out. That is that the demand for gold is keeping it above it's intrinsic value. I am sure you are smart enough to understand that just because something is priced in dollars, it doesn't mean that the asset has a perfectly negative correlation to the value of the dollar. CAT for example is subject to its own supply/demand, although the dollar value does have some implications it is not the whole story - the same with gold.

What I believe we saw in the run-up in gold prices (and oil) is that the idea of limited supply puts pressure of excessive volatility to the upside. Too much money chasing too few goods and the gold price itself over inflated. When you compare it's price to other real goods (real estate, oil, silver) those prices have come down far more than gold has. The gold market still has more inflation priced into it than a lot of other assets, purely due to short term supply and easy fundamentals to understand for retail investors.

At the same time I accept the risks to the upside and should that occur I believe it will be drastic and that's why I hold OTM calls. A flood of demand coming in from the Saudis, China, or anyone could put massive upward pressure.

From the U.S perspective, I think the clearest play is shorting long term treasuries. I just think that the most obvious outcome of all of this is that the U.S will have to pay significantly higher interest rates to borrow long term. Should they aggressively print to the point that gold goes to $2000, I can guarantee you that the long term borrow costs will be through the roof as well. Should they convince the world to keep lending to them and not be forced to print massive amounts of money in the short term, yields will go up as well as supply explodes.

Credit Markets and the Price of Gold

Smarty Pants,

The system is very flawed and one of those flaws are that the innocent people pay for the mistakes of others. I like to look at it from a Libertarian perspective where the only time that the government should get involved is where one private party's decisions infringe negatively on another private party, and civil action will either be too slow or unfair on the smaller party.

In the case of these big banks failing, we would see student loans dry up, payrolls become harder for companies to meet without selling valuable assets to free up cash, obviously the auto and real estate industries would completely dry up. Although I hate the precedent it sets, you have to step in and do something. BUT I don't agree with their strategy. What's happening is the opposite and these banks are going to be STRONGER as they gobble up smaller banks deposits aided by Fed money instead of lending it out.

My point is that the public will have high costs whether we save the banks OR if we allow them to fail and the costs would be more visible in the latter case (higher unemployment, increasing defaults, etc). It's unfair to just say that the banks were the irresponsible ones when the whole nation is in debt with a negative savings rate.