Trading Manias

Manias are great counter trades, because premiums are so exaggerated on the way up (though you have to be careful because the upside is, by definition, irrational). This makes trading manic options particularly profitable, as written premiums (short contracts) are irrationally high, and long prices (meaning buy-to-open, either puts or calls) anticipating the flip side of the mania are markedly depressed, right up to a sharp turning point.

As Justice Potter Stewart once said, I can't define pornography but I know it when I see it. I think the same applies to manias, but they usually have a few things in common:

1) They are often counter fundamental, or heavily overshoot the fundamentals

2) In EW terms , they usually manifest in extended 5th waves

3) There is virtually 100% consensus that it is not a mania

The reason I bring this topic up now: the gold mania.

This is one I am particularly fond of, as many know, because I helped create it by riding the upside for a long time. Riding the upside is important, because you get a much better sense of the price action--how labored the gains come when the bandwagon is mostly empty, and how easily they flow in the later stages of the the mania, as the majority try to squeeze in.

I suppose that is a good secondary theme to this post: don't marry your positions.

With the very first paragraph in mind, let's look at the PM mania by the numbers I've outlined above--before it enters consensus breakdown, that way I'm not a just another Monday morning quarterback like all the big financial sites.

For the purpose of the next few paragraphs, gold = silver = gold.

1) I think I've beaten the deflationary fundamentals of our depression to death, but as a quick recap: crumbling commercial bank leverage is extinguishing paper currency at an alarming rate. The PAPER to ASSET ratio = the PRICE.

No, the Fed can't print paper without creditworthy borrowers to launder it. Saying they can do so is a load of crap to retain their "Wizard of Oz" status while prices plunge. Oh, but not as much as they would have plunged without men behind curtains. Yeah right, gee, thanks a lot.

This is illustrated by a few things that gold follows in macro terms: (a) real estate prices which are in free fall and accelerating; (b) the proverbial price of mens business attire; and yes (c) street prices on the multi-$trillion global heroin/coke black market.

1a) Three months in a row, RE starts down 50% YOY. Foreclosures hit another all time high. Banks have stopped lending, not because they want to stop, but because there are so few worthy borrowers relative to yesterday. That forces lower overall leverage ratios (the amount of counterfeit cash they can print) which means they may be much more discriminating on the margins lent out. In high leverage markets, like CA, prices are down 50-60% state-wide with big losses to come. To figure your home's price in 2020, take a zero off the 2005-6 peak.

1b) The traditional gold ounce to a man's suit/belt/shoes is nothing more than an excellent gauge of business/banking activity.

http://www.josbank.com/IWCatSectionView.process?IWAction=Load&Merchant_Id=1&Section_Id=1000&ViewAll=1

A $1000 (peak) suit is solidly down 50% to 67%, which very roughly equates to $350 to $500 per gold ounce at this point in our depression.

1c) It is no coincidence that HSBC is the GLD ETF bullion key master. This is nothing more than a way for them to monetize gold with paper. GLD ETF shenanigans are a strong contributing factor to the gold price run-up, in my opinion. In other words, HSBC and cohorts in crime can sell GLD shares at increasing premiums but with an increasingly small fractional bullion reserve. In this way, they loot the underlying metal while making a mint on the paper (which they will short harder than any of us) like any ponzi scheme. A close reading (more like legal parsing) of the GLD prospectus essentially admits they do this.

China still does business the old fashioned way, for payment in specie. HSBC and friends need the hard money. Do the math. That is why the China historically possess a lot more gold than "analysts" think they have, and why western banks fronting to them almost always possess less.

Some will say this should make the gold price soar, and they are right, it already has. Like any ponzi, as it breaks down, shares become worthless because supply of paper pricing the stuff is discovered to be way higher than the supply of the underlying stuff itself. That is ideal for the GLD runners, because as share prices are shredded, they can afford to reset their scheme without discovery.

A sharp increase in drug violence south of the US border is a good indicator of financial stress in shady circles, which will flow right back through the gold price. In case you aren't sure what I'm saying: lower street prices for heroin = lower gold prices since a pound of 70% opium on the Hong Kong black market traditionally commands an ounce of gold. Less drug money = less gold demand. Leave it to the black market, actual capitalism, to retain a functional gold standard.

2) In EW terms, gold best counts as a very large 5 wave cycle starting in in the early '70s. This coincides rather exactly with the 5th of the 5th in the macro inflation bull. The early 1980s spike is the 3 peak. The 2008 spike is the 5 peak, albeit only a 1.26 fib higher than wave 3.

Many g-bugs like to point out that the price of gold today should be in the $2000-3000 range, accounting for inflation, but that just goes to show what a poor inflation hedge gold really is. Over the same time period, paper stocks gained 13,000 Dow points, about 1300%. Paper assets are obviously the place to be to hedge paper inflation--hard money, not so much.

At any rate, it's a long bull, so chances are it will take a little while to fully unwind. The basic guideline for any mania break down is an initial stop in the vicinity of sub-wave 2 of the previous 5th. Or more generally, the previous 4.

That is about a $680 target for the fifth wave, which is why I picked $680 as the intital stop as I called the top in gold in early 2008. That has already been achieved. A wave B of some lower degree is likely in place:


Next stop, albeit not instantaneous by any means, should be the next higher degree wave 2 of 5, plucked from the 1980s chart, below. That said, we could certainly get a high wave 2 of C rise in the short term, especially if stocks dip. That is no big deal to those who account for the possibility. The more likely scenario is a quick breakdown.



The EW guideline is a good match to the other fundamental guestimates, $400-450 (the price in Jan-04).

A related, common question is how do you to call the top. The best way is to count out the 5ths of ever-diminishing degree. As RNE states, the turn happens at the 5th 5th of diminishing degree, and it almost always does. That doesn't guaranty a jump off at the highest price, just at the orthodox high.

3) No discussion required.