Golden bubble

A bubble shot through by a bullet - experiment described here

Here's a counter-blast to gold-bugs and fans of other metals:

In this long and dense presentation to the World Bank, delivered in April 2007 and revised/updated in July, Frank Veneroso says that commodities, including gold, nickel and copper, are already in a big bubble. He thinks an estimated $2 trillion in hedge funds, plus leveraging, is pumping the prices:

When it comes to metals, we see hedge fund speculation, hoarding and squeezing everywhere. Not only have some metals markets been driven far, far higher in this cycle compared to all past cycles; we see the same phenomenon across all metals. It is the combination of both the amplitude and breadth of the metals bubble that probably makes it the biggest speculation to the point of manipulation in the history of commodities. (Page 50)

Short runs costs have risen, but not long run costs. New sources are being exploited. And if recession hits, demand will drop:

... the historical pattern... for all commodities, suggests that, rather than seeing well above trend metals demand growth in the years to come as the consensus now projects, we are more likely to see outright declines in global demand for these metals as demand destruction takes hold. (Page 56)

For institutional investors, the "barren breed of metal" is unproductive compared to other assets:

... it is likely that the net nominal return to portfolios from investing in physical “stuff” has not been more than 1% per annum. By contrast, in a 3% inflation environment, bonds have yielded somewhere between 5% and 9% and equities have yielded somewhere between 8% and 11%. In effect, you gave up an immense amount of yield if you diversified out of bonds and stocks into commodities. You did gain by reducing overall portfolio volatility, but that gain was not large enough to offset the loss in yield. Diversifying with “stuff” did not enhance risk-adjusted returns. (Page 57)

So prices have been boosted by the futures market. And commodities as a market are small enough to be susceptible to "manipulation and collusion".

Readers of this blog will recall that Marc Faber recently said he saw bubbles everywhere, including commodities. Even if cash isn't king, it may be a pretender to the throne.

Slow down - credit crunch at work?

Eric Fry, in today's Daily Reckoning Australia, shows that substantial tightening in the credit market has already started.

The big picture (as I see it)

Home economics: making a mint

Most of the people now managing our money - the money that we plan to retire on - are too young to remember the financial world of the 1970s. This hampers their judgement, and a debacle like subprime lending shows how they have underestimated both the likelihood and the impact of Black Swan events.

In one of George Goodman's books, the financial journalist author (aka "Adam Smith") is shown round a dealer's office by a friend, and the young people are all chirping away optimistically about how they're going to make fortunes for the company in this or that opportunity. His friend turns to him and smiles ironically. "See what I mean? Kids!" Of course, in a rising market you want optimists: the scarred old bears will tend to hang back and miss out on the bonanza. Which is why Adam Smith's friend was employing kids.

But the tide is turning.

I called it far too early (but how was I to know that governments would lose their sanity and print money as fast as their presses would work?). Here's what I wrote to a client on 21st October 1999:

As you are now around three years off the maturity date of your personal pension with XXX Life, you should be considering the security of your fund.

I went to a very interesting investment seminar yesterday, at which it was said that the American stockmarket could be as much as 50% too high, and a correction is overdue. It has already slid 20% off its highest point, by degrees, but a bigger drop could happen. If and when it does, this would have consequences for other markets around the world, since the US is the biggest stockmarket of all.

As you know, the XXX Fund is designed specifically as a safe haven for your investment in uncertain times, and I enclose a form for you to sign and forward to XXX Life, if you agree with my suggestion.

To those in the know, the crash of 2000 was not a surprise. What was your adviser telling you then? Yet the tone of that seminar was upbeat - the market's overpriced, so what?

If governments had maintained financial integrity, then following the mad tech boom, the Great Correction would have started in 2000 and the cleansing and healing process would be well under way. Instead, our politicians chose inflation.

If you were earning money in the mid-70s, you'll know what runaway inflation is like. To counter it, we had financially-motivated strikes: strikes for more money to restore real incomes, strikes to maintain pay differentials between different categories of worker, and strikes for pay parity by those who were left behind. Then settlement, paid for by inflating the currency further. Then more price inflation, and more strikes.

In the new globalized economy, strikes aren't going to work. Here in the UK (and Alan Greenspan has recently advocated the same), we simply allow the import of lots of poor people to undercut our indigenous skilled and semi-skilled workers. This keeps down wage rates and improves productivity. But it also earns little tax/National Insurance, and builds up massive obligations for Health, Education and Welfare (present, for those undercut; future, for all).

For a former Chancellor of the Exchequer keen on off-book financing, it's not a big issue: let the future take care of itself. For most of us, who have to move into the future without a bomb-proof PM's pension and lifelong special police protection, those debts will come home to roost.

I've often wondered how middle-class Germans coped when their money was wiped out by hyperinflation; and how the Russians on State pensions survived in the hinterlands, after the economy collapsed some years ago. Today I read (UK's "Mail on Sunday", page 31) an account by one of the few remaining whites in Robert Mugabe's Zimbabwe:

"The professional generation before me, the doctors and lawyers and the engineers who built Zimbabwe, are all starving to death on their pensions." (If you want to help them, please contact ZANE - they're on the Web. And there's millions of black Zimbabweans who are even worse off.)

But it's to the Sunday Express I have to turn, to get a serious warning about inflation for ourselves. Geraint Jones (page 10) notes that China is hinting at dumping the dollar wholesale; Saudi Arabia has refused to follow the Federal Reserve's interest rate cut; China and India are emerging as this century's budding supereconomies; oil's going up; food is getting pricier; the subprime disaster hasn't finished; mortgages are costing more.

The Express' Financial section wants to lock the stable door after the horse has bolted - much good a reformed Bank of England will do us now. Back in the main paper, Jimmy Young supports the suggestion that UK savers should be given guarantees for the first £100,000 of their deposits - again, too late: it's inflation guarantees we need - in the Germany of late 1923, 100,000 marks wouldn't get you a postage stamp.

The American Jim Puplava, on his excellent Financial Sense Newshour, thinks the latest desperate reflation will buy us a couple of years.

Use them.

Sovereign wealth funds: debt-for-equity swapping

A $20 American Eagle gold coin from 1914

Bill Bonner, reflecting on news from the International Herald Tribune such as this, notes yesterday that sovereign wealth funds are taking advantage of the falling dollar to buy US assets:

As the dollar goes down, Americans become poorer…and their assets become cheaper...The foreigners have huge piles of dollars which are losing value... Doesn’t it make sense for them to use the dollars to buy American assets?

The Arabs must think so... They [are] making offers on the Nasdaq…the London Stock Exchange…and the Carlyle Group, a US buyout firm.

China , meanwhile, recently took a big stake in Blackstone, another big corporate chop shop. Buying up the buyout firms is a particularly important omen, we think. It allows the foreigners to take up more and more US (and UK) assets without getting their name in the paper. And it allows Anglo-Saxons the soothing flattery of thinking that their assets are becoming more and more sought after…it takes their minds off the sour news, that foreigners are using their mountains of trashy dollars to get control over genuinely valuable assets…and that Americans will increasingly be working for foreigners…

A potentially dangerous form of debt restructuring is in progress. As small businesses yield to huge corporations, increasingly foreign-owned, could Big CEO become the new Big Brother? Will the excesses of consumerism end in our descendants serving in a modern version of bonded labour?

No easy bounce back this time, says Marc Faber

Marc Faber, quoted in The Daily Reckoning Australia on Thursday but writing in late August, anticipated the Fed's strategy of interest rate cutting, and thinks it won't work.

Unlike all the Wall Street strategists who compare the current credit crisis to the credit crisis of 1998 (Long Term Capital Management), I believe that the ongoing credit problems will be far worse and of a longer-term nature. This will make it difficult for the market to reach new highs in the near future. Moreover, even if the 1998 comparison were to hold, we would still be looking at a much deeper stock market correction than the 22% sell-off we saw in 1998....

...even if the Fed were to cut rates massively now, it is unlikely that it would stimulate credit growth, which, as I have explained repeatedly in the past, must continuously expand at an accelerating rate in a credit- and asset-driven economy in order to keep the economic plane from losing altitude. Accelerating credit growth is most unlikely now, because I cannot see how financial intermediaries will ease lending standards any time soon after the losses they have recently endured and following their dismal stock performance...

The crises that build up in international financial structures always ricochet from country to country….

...For the last several years, investors have enjoyed a massive global boom. But they should not rule out a massive global panic.

A layman's guide to economics

Outburst

From the Royal Palace of Westminster

This isn't quite on theme, but I turned on the radio for the four o'clock news in time to hear our new Prime Minister's latest proposal: a motto for the country, to show our "values". He is pretending that it has escaped his notice that we have one: Dieu Et Mon Droit. All part of airbrushing out the Monarchy, I assume. What is his suggestion - "In Gord we trust"?

Here's my suggestion: stop indulging your Ruritanian fantasies and do something to restore the economic stability of this once-great country. You've had ten years as the de facto general manager of Great Britain plc, with what results? A social security system that we can't afford and the claimants can't understand; an industrial base that is shrivelling like shrink-wrap on a bonfire; and a demolition derby of a democracy, in a country that mothered many other democracies and paid heavily in blood and gold to save Europe from fascism - twice.