For over a month we have watched with keen interest the various market events – from US credit downgrade, gyrating equities and European bond crisis and to platinum trading under gold. Without a doubt, volatility is no longer an intellectual topic, but rather a real force. Just like the old physics equation (F=MA) where mass and force have a relation, the amount of money you have invested in the market defines the force of market volatility. Even in strange times, the sun rises in the east and sets in the west. Try not to confuse the normality of things with the extraordinariness – US downgrade, European bond crisis, and new life-of-contract highs in gold are not ordinary. Furthermore, as we head into the US presidential campaign, the rhetoric will increase and the differences highlighted. “Kumbaya” will not be sung before the election, much less afterwards
US Credit downgrade & Aug 2nd deadline– unlike other downgrades, the downgrade of the World’s reserve currency destroys capital and the resulting global capital market sell-off was and is appropriate. Perhaps compiling a forecast is as simple as comparing the amount of money printed under QE versus the projected capital recalled vis-a-vie S&P downgrade. It could be as a simple as comparing repo market credit haircut knock-on effects with overall percentage change in capital markets. Regardless, the average pedestrian may not understand current events and continue “business as usual” – this could be the correct approach. On the other hand, the average pedestrian does not hold billions of bonds that changed from risk free to not risk free – with seemingly compensation coming from a rally in bond prices!? Any and all questions dealing with return, yield, and cost of capital – fundamentally tie back to the issuers reputation. All risks are summed up in reputation risk and it is the reputation that is being considered on a going forward basis. (Reputation = market + credit + operational + liquidity + etc….)
The August 2nd deadline, and subsequent economic headlines appears to have the market considering a double dip. At a high level, decreases in government spending during recessionary periods add to the problem – this is the reason why many economist say deficit spending is “ok”, nothing to worry about. Keep in mind that the presupposition to this argument is that American ingenuity & enterprise requires big government. This may have been true in the 1930’s, and it remains to be seen if it is true today.
European bond crisis - In summary, the market likes clarity and the proposals have too many moving parts and are too complex for an immediate fix. Turning European unity into financial reality is fraught with complexities. Suffice to say that the impediments are known – more than solutions. Markets remain jittery after it was rumored that the ECB re-established swap lines with the Fed to source dollars. News articles make reference to foreign banks within US borders impacting dollar sourced funding – but not to the degree or magnitude of 2008. Nonetheless, this is one of the reasons offered up relating to yesterday’s Dow sell off.
New highs in gold – Not to be silly, but explaining the strength in gold appears easy – the world is melting. Even Hugo Chavez announced that his nationalizing Venezuela’s gold mining industry - surely this is a top! On the other hand, let’s pretend the market is right, that gold deserves to be making new highs. Unfortunately, any attempt to make sense quickly intercepts with the world of paranoid |black helicopter | doom & gloom. Wealth destruction & re-distribution rhetoric is increasing. Let’s first dive into the world of black helicopters and satellite eavesdropping.
Warren Buffet, in the New York Times, says his billionaire friends are being coddled and should pay more taxes - never mind it is a free country and he can voluntarily pay more taxes to alleviate his guilt ridden free-ride syndrome. Another story caught my eye - in the personal finance column of the Houston Chronicle, columnist Scott Burns quotes Robespierre, makes reference to a “scent of tear gas” and concludes that “it is better to redistribute wealth and income with taxes than with guillotines”. Sounds like the table is being set to take more from people who have more, so taking wealth off the table and putting it into gold seems reasonable.
On the other hand, an analysis of the financial crisis with strong consideration for quantitative easing and the European debt crisis will most likely conclude with the anticipation of “value destruction” – either the printing money and subsequent devaluing, or inflating consumer prices. As a “store” of value, buying gold makes sense. As a footnote, over the last 20 years or so, gold has not kept up with inflation. So which is it?
Not to be incredibly simple, but the intersection between the doomsday and the devaluation analysis is reflected in the gold to platinum spread. Normally, platinum trades at a premium to gold – yet this week, gold traded over platinum. Owning gold is a bet on value. Owning platinum is a bet on the economy/manufacturing. Simply said, owning gold and selling platinum is a doomsday-like trade. Platinum falls as industrial demand fails to materialize, gold rallies as devaluation & contagion appear more likely. Selling gold and buying platinum is a bet on normality, the market will return to the mean. Only thing bad about both trades is that the market can be irrational longer than you can be solvent. I mention this not as a trade idea or recommendation, but rather as a broad based indicator regarding underlying market trends. Directions markets take simply point to the directions we should consider. The wealth momentum is not something to get in front of – keep in mind, there are always bigger fish.
Regarding marketing timing and other rampant ideas – I believe it all comes down to reputation. History is riddled with examples of inflation tied to the loss of confidence in a currency and/or government. At this point, given the rise in Treasuries, the US reputation appears to be intact. I would venture to say that the rise in gold isn’t considering US specific concerns. However, given that cost of insuring German bonds against default “printed” above UK bonds , given the situation with the PIIGS and the knock-on complexities – it stands to reason that the new highs in gold are “continental” based.
I think it is worthwhile to discuss the idea behind a reserve currency and in particular what it means in terms of behavior. In my mind’s eye, reserve currency is mattress money. It earns the title because of the history. Much of that history is linked via stories, parents and personal familiarity. Tying back my earlier point on reputation with one of familiarity & history – in 1999 the Swiss voters narrowly approved a new Constitution that eliminated the requirement that the country’s currency be back by gold. Does 12 years of history build-out the reputation to concentrate personal wealth? Recent news articles have headlined the notion that the SNB will weaken its currency to help Swiss business. Is the Swiss franc a reserve currency, the best eurozone alternative, or best US dollar alternative? Perhaps we can begin to understand the strength in gold.
Thank you for reading my newsletter. Good day & good weekend!