Daryl Montgomery

Daryl Montgomery
Contributor since: 2009
Company: New York Investing meetup
This entire argument is bogus on a number of levels. Shutting down wells doesn't have the same impact as turning off a light switch. There is a several month lag and production in U.S. oil production is only now beginning to show up. This rising production after wells began to shut down is not being caused by some magical increase in fracking efficiency.
Good point! The Saudi's are producing more oil now, when oil is selling for between $40-$50 a barrel, than they did when it was at its price peak of close to $150 in mid-2008. It was thought in 2008 that they were at their maximum production to take advantage of high prices. They have managed to exceed that production by adding more rigs to already existing fields. This doesn't mean that they will get more total oil out of the ground, they are just be getting it out faster by over pumping (a dangerous game in old fields).
The pressure drop in the Saudi Ghawar field, the largest in the world, started in the late 1960's. This is when they began pumping water into the outer areas of the field to get oil out of the ground. Saudi production costs had to begin increasing from that time and are probably much higher than acknowledged -- and certainly much higher than the figures from 40/50 years ago that sometimes appear in print.
What companies are reporting oil "drilling costs" at $20/barrel and where are they located? This figure seems quite fanciful outside the Middle East. Any verification for those numbers? What exactly do those "drilling costs" include? I imagine overhead is not included. If so, staff employees want to be paid, landlords want their rent, and banks want debt service payments and if they don't get it, companies go out of business.
"Gold is clearly the asset to sell in a crisis, ...". This hasn't been true for 2,000 years, but I guess things are different this time. Yeah, sure.
By the way, there have been long periods of time when the U.S. dollar and gold have moved together.
You yourself say central banks are long-term holders of gold. Then, you claim the Chinese central bank will sell gold in a crisis. East Asians particularly have a long time horizon for investments. This would not be consistent with their worldview.
The Chinese government has encouraged the populace to accumulate gold over the last few years. Engaging in actions to drive it down, would prove to be politically unpopular. But politicial leaders don't need to worry about maintaining their power, do they?
Any analysis of gold must be a global analysis of supply and demand (the ultimate determinant of price in economics) since the market is global.
Gold also hit technical resistance the day before this article was published. Not surprising it went down the next day (nothing goes straight up), and no fanciful explanation needed.
Excellent article. Please publish an update in the future.
I doubt the U.S. has the gold that it claims (and that goes for some European countries as well). It is known that there was substantial selling of gold by the U.S government in the mid-1970s, and that doesn't seem to be reflected in the chart. There hasn't been a real audit in the U.S. since the mid-50s. The U.S. was the biggest holder of gold at the end of World War II. After that, gold drifted to Europe until all gold backing was removed from the dollar in 1971 (effectively in 1968). Then, the European central banks sold substantial amounts of gold from the late 1980s to the early 2000s. A lot of that gold moved into Asia. The current trend of gold moving from weak hands in the West to strong hands in Asia is merely a continuation of something that began decades ago. Although, China is certainly the big story now in that trend. Indian consumers own 20% of all gold in the world -- more than all central banks combined.
Gold mining supply has also changed significantly since the 1970s. In the early part of the decade, South Africa by itself supplied a majority of the world's gold. It now generally ranks around 5th place. Although China is now the number one producer, it doesn't have the dominant position that South Africa once had.
As for supply from scrap, this is correlated to gold price. Higher prices mean more scrap, lower prices mean less scrap. The current lower prices are also going to mean less mining supply going forward for the next few years. Miners were already starved for capital in early 2013 BEFORE the big price drop in gold. Expect a dearth of new mines for several years into the future.
South Africa wasn't just the biggest producer, but actually mined a majority of global output by itself in the early 1970s. Its fortunes have fallen so far that it now usually ranks around the 5th largest miner of gold. China is number one, but its percentage of global production doesn't remotely rival South Africa in its heyday. Gold production is in severe decline and this means more and more expensive sources have to be tapped to try to meet demand -- and this puts a floor under its price.
At the same time, demand has increased significantly because central bankers went from large net sellers to net buyers and the newly prosperous in emerging markets are buying gold with their money. Basic economics indicates the price of gold has to keep rising. Asia controls the gold market, but the mainstream media frequently focuses only on what is going on in the U.S. even though it is just a secondary player.
The markets don't trust the Fed, the markets are CONTROLLED by the Fed. When you buy huge amounts of treasuries (or other government bonds) as the Fed has been doing since 2008, you increase demand significantly. This increase in demand has been much bigger than the increase in supply. Economics 101 says under such circumstances (bond) prices go up and interest rates go down. Notice that every time the Fed has stopped buying, it quickly decided to start buying again. Econ 101 also predicts that when the Fed stops buying government bonds, interest rates will balloon and the consequences will be very ugly.
As for inflation not showing up there are 2 reasons: ONE: the government calculates the inflation figures and governments have a long history of manipulating and lying about inflation rates because gullible people can easily be tricked with numbers. TWO: there is a long lag time between pumping money into the economy and when it shows up in your bank account. It has to slowly filter through the economy. In the 1970s, maximum money supply increase was in 1971 and maximum inflation in 1980 -- and that's only because Volcker took strong measures to stop it. It could have been 15 years later.
Your point could have been made during the Credit Crisis when gold fell from 1000 to 700. The "smart" money was selling back then to. And "dumb" people who bought it made a killing. I put a buy out on gold at that time (and yes, a sell when it went to 1000 before that). I got out before the 1900 top and just bought back in. You make money in the market by buying assets when they are cheap and the "smart" money has dumped them and selling them when the "smart" money is telling you how great they are. And if the "smart" money is really so smart, they are doing the opposite of what they are telling you and you have to be pretty dumb to believe them.
Unlike, stocks commodities have minimum prices (production cost) and gold got close to the upper limit at $1350. And the demand in Asia for physical product proved to be insatiable at this level (and it was very high elsewhere as well). If the price of gold keeps dropping, there will be no physical metal left to buy. Therefore, the price won't go down too long or by too much if it does. The supply/demand picture is very bullish for gold and this is the only thing that ultimately determines the price for everything.
It is better to define inflation as a currency losing its value. While I agree that an increase in money supply that is greater than the economic growth rate will EVENTUALLY lead to this, the path to doing so may be long and winding.
And yes, inflation is a general (and that is a key word) increase in consumer (another key word) price levels. To claim otherwise is to divorce your ideas from real world experience, which is all that investors care about.
I have written four books on inflation investing and have analyzed inflation over the last 2000 years. Your article has most of the basic ideas, but needs some refinement.
All "commodities" do not behave the same in inflation and it is not very helpful to say invest in commodities. Gold and silver are in a class by themselves because they are monetary metals, whereas industrial metals are heavily influenced by the state of the economy and not just inflation (these include platinum and palladium as well as aluminum, copper, nickle, lead, zinc, etc).
Assets can be divided into primary and secondary choices. Primary ones would be gold/silver, energy, agriculture and art, antiques and collectibles. There are variations among assets in the last 3 categories though. You can also say some investments are early cycle and some late cycle when inflation hits and it is important to know which ones.
As for your idea about TIPS not being good because of taxes. That is not the problem. They are not good because they are based on government reported inflation and the U.S. understates its inflation rate substantially. See the Shadowstats chart in your article. Bonds should be shorted during inflation. Because of central bank policies this is now a late cycle investment, whereas previously it would have been an early cycle one.
Hope you will be continuing your work in this area.
Your understanding of commodity production costs is "limited". There is no ONE price. For metals, mines with higher and higher production costs come into operation as prices rise. If price falls enough, the higher priced mines close down production first. Then if it falls further the next higher priced mines close down, etc. If demand is not falling too, price can't fall much below the highest production costs for long (some short dip is possible, but not sustainable).
The easy to mine gold (ie. cheap production costs) disappeared long ago by the way. Also take a look at South African production -- a majority of global production in the early 1970s. Ranks only 5th globally now because output is drying up.
You also don't differentiate between behavior in a secular bear market (the 1980s and 90s for commodities) and a secular bull market (after 2000). The rules are different. If you were selling at the peaks in a bear market, you should be buying on the dips in a bull.
Your analysis of the supply/demand structure of the market is a bunch of random, disconnected thoughts. Central Banks were net
sellers of gold from the late 1980s to early 2000s and added to available supply. They are now net buyers and this has added to the overall demand from the jewelry, investment and industrial markets (yes, approximately 15% of gold is used in industry). Supply needs to increase substantially to meet the extra demand, but this is not possible. Production can only rise between 1% and 2% a year (it can take up to 10 years to open a gold mine). Hence prices have gone up.
Lot's of luck. On what planet are you going to get those prices?
Gold starts going out of production around $1300/oz. A great deal of production would disappear by the time the price fell to $1000. And you think the rest of the world will just sit around waiting for you to pick up a super bargain? A number of bullion dealers already ran out of supply after the drop on Monday.
Retail sales are not adjusted for inflation. As a rule of thumb, you can use the gasoline number as a gage of the inflationary impact. Almost half of the entire increase was gasoline. Is this because driving increased significantly on the blizzard-racked US roads during the month or did prices go up? Increased prices aren't an indication of a healthy economy, they're an indication of inflation.
Official inflation figures can be and are low because governments lie about the inflation rate. Argentina and Belarus are good current examples. No one in the respective countries believes the reported numbers. US is also a good example with a key difference -- a lot of gullible people believe the official numbers.
Without accurate numbers, your analysis is meaningless.
You're disbelieving of raw data, but you believe the statisitical adjustments could be correct??? Raw data is accurate, statistical adjustments are the devil's playground for govenernments who can't fix entrenched economic problems, so decide to manipulate the numbers instead (much easier to do). The story of a recovering economy is propaganda created by the government, disseminated by the media and believed by gullible fools.
Are any of these numbers adjusted for inflation? The U.S. retail reports are not. Sales going up because of inflation are not an indication of growth. It's merely an attempt to fool the public into thinking the economy is better with a money illusion.
The inflation figures themselves are grossly underestimated as well (makes GDP look a lot better as well as other figures). All of the "improvements" introduced since the 1980s to calculate the inflation statistics have all acted to lower the reported inflation rate. If you recalculate the inflation rate as it was done in the 1970s, you will find inflation is much higher now. If instead, you think the current techniques are accurate you need to recalculate the 1970s inflation numbers and you will find inflation didn't exist and everyone just imagined they were paying higher prices.
In science (not economics, that's a religion as you so aptly demonstrate with your comment) if you find one counterexample you have to throw out your theory. Can we find any examples in history of labor scarcity combined with inflation? We have to look all the way back to say around 2007 to come up with one. Unemployment in Zimbabwe was 94% (yes, almost no one in the entire county had a job, there was a massive labor surplus) and inflation was around sextillion percent.
Not enough for you? How about Weimar, Germany where unemployment was 24% when inflation reached 300 million percent. Well, you might say, that couldn't happen with normal inflation rates or in the United States. Really? How did inflation go into the double digits in 1974 when the U.S. was experiencing the worst recession since the Great Depression? No, there wasn't any "labor scarcity" in that recession like every other recession.
I could actually go on all day with counter examples, but like people
who actually do live in reality, I'm very busy.
Excellent article. Thanks for publishing it.
The list of ETFs to fight inflation is must larger than the one above.
There are 7 asset categories that need to be considered for inflation:
1. gold and silver
2.energy - oil, natural gas, coal, uranium and renewables
3. agriculture and famland
4. art, antiques and collectibles
5. strong currencies
6. industrial metals and
7. shorting bonds.
Industrial metals are dependent on the state of the economy and inflation and tend to be early inflation cycle investments. Interest rates are currently being artificially lowered by central banks, but economic forces can't be fought forever. Today, these are late inflation cycle investments.
Popular ideas on good inflation investments are filled with misconceptions (TIPS and residential real estate are not top choices). Inflation itself is also misunderstood by the average person (thanks to constant misinformation coming from central banks and presented to the public by the mainstream media).
There is a many year lag from money printing to peak inflation and this can take 10-years. Inflation does start showing up within a few years, such as the price increases in commodities from 2009 to 2011/early 2012 -- 100%, 150%, 200% or more. The U.S. government claims this only meant around 2% consumer inflation.
They should have also reported that pigs can fly. There is a long history of governments lying about inflation and things are no different this time around.
The inflation rates reported by the U.S. government are grossly understated. No one should be buying bonds and that includes all the ones mentioned in this article. They are a money losing proposition.
The reparations myth causing Weimar inflation (the view of the Nazi Party that you are repeating in your article) never seems to die. Cite the figures of exactly how much they repaid in war reparations prior to the hyperinflation peak in Nov 1923. Yes, they owed a lot, but that doesn't mean they paid a lot (reparations were due in gold-backed currency by the way, so how would printing new money help pay them?). The Weimar government ran huge budget deficits to support social spending (just like the US and EU) and that is what caused the money printing. The US tax/budget coverage in Weimar immediately postwar is similar to US in 2009.
As for Zimbabwe and its drop in productive capacity, you destroy your argument there. The U.S. is printing money to support itself because of a non-functioning economy. Resource slack does not prevent inflation - as an example check the US in 1973 and 1974 when inflation zoomed during a major recession. Zimbabwe eventually had 94% unemployment rate and the 2nd worse inflation in world history. Weimar had close to a 25% unemployment rate as the inflation rate skyrocketed. Resource slack didn't prevent hyperinflation, let alone just ordinary inflation.
The effectiveness of QE can be boiled down to one simple question: Can real wealth be created out of thin air by printing currency in greater quantities than the growth of the economy justifies (money is not really the correct word, and no actual printing is implied)? Or we could say, can straw be spun into gold? If you think so, you have not gotten beyond believing in fairy tales. The fact that top economists seriously discuss this is a testament to the the intellectual level of the profession. Why not how many angels can dance on the head of a pin?
The author has a bias? It is impossible to write an article without a perspective. And he is making the case for his point, that is why the article was written. You seem to be unaware of this general concept. And what about the bias in all of your statements (and the cirucularity of your reasoning I might add)?
As for you objection that QE1 and QE2 didn't make the stock market go up, but other things such as earnings, expected earning etc are key, no large stock rise is possible without liquidity to back it up. If earnings are the key by themselves why does the market sometimes have a PE of 7 and sometimes 22? Traders aren't always willing to pay the same amout for earnings. Historical analysis of market returns show the more liquidity available the more the market goes up.
As for you contention that the Fed isn't a corrupt institution, as we say in New York, I have a bridge in Brooklyn I'd like to sell you.
What proof do you have that the stimulus created jobs? Other than the politicians who want to get reelected claim that it did and you believe them (do they employ you as well or are you just an official of the Democratic party?). Your excuse that Obama took office after a major financial crisis is irrelevant. The article specifically states what happened after Obama took office. There has been only a 2000 net increase in jobs since that time (there are over 300,000,000 people in the U.S.). Those are the government's own figures.
As for your point about whether or not it was worth incurring yearly budget deficits aroundf $1.3 trillion for four years to get 2000 net jobs, I would say that everyone can figure that one out.
You are the one that needs to produce a set of numbers to justify your unsubstantiated claims -- "of course the stimulus created jobs". Really? Tell it to the unemployed. You are also the one engaging in political propaganda or is the correct term a misinformation campaign?
This is ridiculous. First of all, the bailout countries will need constant bond buying or their interest rates will soar to the stratosphere. So they will behave or else. Secondly, if there is no money printing, that money is coming out of someone's pocket. And that someone is the strong fiscal states in the EU. They will be paying with much higher interest rates. And this will damage their economies. Once they figures this out, I think that will be the end of Draghi's Plan B.
No, stock prices do NOT ultimately follow earnings. They follow liquidity. Otherwise the market P/E would be stable over time. Instead sometimes it's 7 and sometimes its 22.
As for the Fed and more QE, you can't print your way to prosperity. QE is good for boosting the market, but like all addictions it takes more and more to achieve the same effect over time and eventually it is needed just to maintain the status quo.
If Bernanke started QE3 at the September meeting, it would be followed by a political firestorm and would become a major issue in the presidential campaign. Does the Fed want a lot of media scrutiny into its actions? I highly doubt that.
The Fed was also supposed to be announcing QE3 in June (big news story with Goldman Sachs chief economist as source), in July/August (front page of Wall Street Journal), at Jackson Hole and NOW it will be in September. Let's consider that it's just trying to keep the market up until the election and never had any intention of doing QE before November or perhaps even then (one day it will because the economy has become dependent on printed money).
There's a key takeaway from the speech that you have totally ignored: "estimates of the effects of nontraditional policies on economic activity and inflation are uncertain". In other words, the Fed doesn't have the slightest idea of the unintended consequences of its actions.
The Fed also admitted that its money-printing backed bond buying could seriously damage the functioning of the Treasury market.
The Fed has also said dozens of times that it will do everything to support the market. What is it going to say? No, we will just sit on our hands and continue to screw up? This is not news.
As for the Fed being confident of its ability to handle the situation. Bernanke was also confident in the spring of 2007 that the mountain of subprime mortgages that existed wouldn't cause any problem for the economy or the markets. (his forecasting record isn't exactly sterling).
And no there is not going to be any QE in September, just as there was none at the June meeting, none at the July/August meeting and none in the speech at Jackson Hole. The Fed is just stringing the market along to try to try to keep it up until the election.
John Hilsenrath also was the source of the Wall Street Journal article that said the Fed was going to do QE at the July/August meeting. He was wrong about that (before that the Fed was supposed to be doing QE3 at the June meeting). And he will be just as wrong about them doing it at the September meeting. It would be considered a blatantly political act to try to help elect Obama (Romney said he is going to dump Bernanke) and he would be attacked as being partisan. The "independent" Fed image would be destroyed forever. They are not going to take that risk.
John Hilsenrath was also the source for the front page Wall Street Journal article that the Fed was going to do QE at its July/August meeting. That didn't happen. And guess what? It's not going to happen at the September meeting either. There was also supposed to be QE at the June meeting. That turned up empty also. The same story over and over and over again. How many times will the public accept these lies?
If Bernanke tried QE now before the election, the Republicans would jump all over him for trying to help get Obama relected (Romney has already said more than once he's going to dump Bernanke). The image of the supposedly independent Fed would be blown sky high.
Gold is indeed a good investment, but ultimately silver will prove to be a better one. Other key inflation investments: energy, agriculture, and art, antiques and collectibles.
As for the triple dip recession, indeed it may not be the case because there has been one long single recession. The U.S. economic numbers are maniupulated in a number of ways to make them look much better than they actually are. Even if you do believe them (and you shouldn't), why should anything that comes from money printing be considered to be real economic growth?
As for Lenin, he also had the idea that destroying the value of the currency was the key to Communism's success. Hyperinflation was purposely created in the early days in post-Czarist Russia so everyone would be impoverished and they would then be dependent on the state. You should see echoes of this today in our current politics. Investors should be paying attention to that.
There's some problems with your argument.
The biggest one is that empirical observation (ex. reality) contradicts it. Zimbabwe which had the 2nd highest inflation rate in history had a 94% unemployment rate. Yes, almost no one in the entire country had a job. According to you and the Fed Zimbabwe couldn't possibly have had inflation, but it did. And Zimbabwe is not an isolated example. Hyperinflation and very high unemployment go hand in hand.
And in case you think well that can happen in some foreign country, but not in America, consider that there was a severe recession between 1973 and 1975 in the U.S. - the worst since the 1930s Depression. What happened to the inflation rate? It zoomed.
Your other idea about prices would be valid if the "money supply" was flat and not increasing, but that's not the case.