The Sane Investor

Gold: The Last Carry Trade

I was thinking about it last night, and the concerns that I presented in statements (1) and (2) above could be compensated for if the person using gold as a carry trade were to sell gold on the spot market and then buy one month gold futures. However, if anything this would make it such that the spot price of gold would be much lower than the paper value of gold. This seems to directly conflict with your argument that the gold carry trade is lowering the paper value of gold.

Gold: The Last Carry Trade

Interesting article, although there are a couple of things that don´t make sense.

(1) In a financial crisis and recession, shorting gold for financing represents an almost exponential amount of risk, since you´re shorting something that performs very well (theoretically) in a recession because it´s a store of value. Also, you would typically use this financing to buy much higher yielding debt, and during a financial crisis the risk of this debt defaulting goes up. Thus, you have gold going up in value and the value of your bond going down if things get worse, and that represents a very large amount of risk, since you could theoretically be out an infinite amount of money if gold went up in value an infinite amount (that would never happen, but it´s what could happen theoretically).

(2) The yen has been going up in value since people have been exiting carry trade investments made from japanese debt to reduce their overall risk exposure. Although the interest rate is higher on japanese debt than the lease rate of gold, you could only lose a finite amount of money, since you´re limited by the terms of your contractual obligation (you can only lose the value of the investment plus the super low interest rate if your carry trade investment defaulted). Thus, the risk is much higher with a gold carry trade at this point than with japanese debt. If people are trying to lower there risk by exiting japanese carry trades, shouldn´t they be falling over themselves to exit gold carry trades?

(3) A gold carry trade would really only make a lot of sense during a bull market, since the value of gold would be expected to go down and the market rate for bond yields would be higher as more people would be pouring their money in to equity investments. Thus, you could make a lot of money if the value of gold went down while you were leasing it, the lease rate stayed at 0.25%, and the yield on the bond you had was pretty high.

(4) You mention: ´Without the paper gold carry trade, you could argue that gold would be a few thousand dollars higher right now.´ This trully doesn´t make any sense, because if that was the case, what´s to keep someone from buying a future and holding on to it for delivery? You could then buy that gold at $850 an ounce, and sell it at $3,000 an ounce (according to your statement). That represents over a 200% return. Don´t you think if that was the case more people would be doing that? Hedge funds could make a quarter on trades like that. It´s called arbitrage, and experience indicates that if people can make money from doing nothing, they will.

Real Price of Gold Soars

¨That list does not prove deflation, but it is consistent with what one would expect in deflation.¨ Probably the main task that one is charged with as Chairman of the Federal Reserve is to maintain a consistant and low rate of inflation. This is of course barring times of economic duress (i.e. now) when short term increases in inflation can be used to temporarily boost employment. Open any macro textbook, and you´ll see that it´s unexpected inflation that hurts the economy, since banks stop lending when they think they might get burned if inflation goes dramatically up (meaning they get a lower real interest rate over time) and borrowers don´t borrow if they expect inflation to go down (they have to pay a higher real interest rate over time).

They don´t talk about deflation, because if you´re in charge of the money press and you see deflation, YOU HAVE COMPLETELY FAILED as the head of the Federal Reserve. In times of deflation, no one spends any money because they know that the dollar in their back pocket will be worth more tomorrow than it is today. Thus, this is absolutely catastrophic towards trying to save a failing economy, since typically the answer is for the government to deficit spend to compensate for temporary losses in consumption (due to a lack of consumer confidence. If there´s no consumer spending, this leads to lower prices which leads to lower consumer spending which leads to... You get the point.

¨Well, let's see. Central bankers hate deflation. Governments hate deflation. Central bankers can create money out of nothing to prop up prices. Our government recently gave away money to keep prices up. But we are going to have deflation anyway?¨ Moonbat1775 is spot on. Mr. Shedlock, you provide a good article, but I think it totally misses the point about what will actually happen.