Friday, April 17, 2009

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.

http://goldprice.org/images/monthly_dollar.gif

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.

28 comments:

  1. FDR, question please.

    Would you recommend shorting gold by way of DZZ? If so, why? If not, why not?

    Thank you.

    ReplyDelete
  2. FDR, this guy also uses EW, comes to a different conculsion in the longer term, although hew appears to agree with s sub-$700 bootom on Gold, Your thoughts & comments?

    http://www.usagold.com/gildedopinion/alf_field.html

    ReplyDelete
  3. FDR wrote: "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."

    And yet, I've never seen you explain here how reduction of leverage actually *reduces* existing currency.

    My understanding is that it reduces its *growth*, which is not the same thing. There's a difference between less inflation and deflation.

    We'll certainly see demand deflation, as prices are forced to come down in order to meet reduced demand, but that's a very distinct and different thing from currency deflation, which is the result of the reduction of the currency supply.

    Unless banks go under AND TAKE THE DEPOSITS WITH THEM (as happened during the Great Depression), how can we have actual currency *deflation* in any way except for loans to actually be paid off? After all, the money that was initially issued as a result of the loan coming into existence is still in circulation, and if it's still in circulation then it hasn't disappeared.

    And so, I still fail to understand why you say we're seeing currency deflation happening right now, because for that to happen, money in depository accounts MUST disappear, either as a result of being used to pay off loans or as a result of the deposit accounts themselves disappearing when the bank fails. And the latter hasn't happened yet because the FDIC thus far has backstopped all U.S. bank deposits to date (or nearly all: there's that $250K per account limit, of course).

    ReplyDelete
  4. Well I guess your gold call seems prescient recently, but you've been calling for gold to retrace in price since it was around $720/oz.

    Also, do you still think the Federal Reserve is limited in currency creation in spite of their decision to buy long-term Treasuries? This seems to be monetization of debt in its most blatant in-your-face way.

    ReplyDelete
  5. "Would you recommend shorting gold by way of DZZ? If so, why? If not, why not?"

    Not.

    Why not: http://fdralloveragain.blogspot.com/2009/04/msm-stocks-up-25.html

    Look at SKF, it's lower today that at the peak of the financial mania. Shorting financials without its supposed 2x leverage have produced stunning gains.

    ReplyDelete
  6. "since it was around $720/oz"

    I rode the gold bull from about $350 to the low $700s, then on and off, from the low order triangle at $800 into the low to mid $900s. I called the top at $985.

    ReplyDelete
  7. Regarding:
    http://www.usagold.com/gildedopinion/alf_field.html

    As I've characterized my count above, I won't recap. I think he is missing the big picture. The gold bull started at $20/ounce, not the mid 300s.

    Gold is a lump of dead metal, there are no fundamentals to speak of other than the size of the paper pile.

    If one thinks we are are still in an accelerating paper inflation, they should buy paper assets/stocks, RE, and gold, etc.

    ReplyDelete
  8. FDR,
    I know this has nothing to do with this post on gold, but here is a question:

    Is it even theoretically possible to pay off the national debt? I don't think it is mathematically possible, even if the Fed would allow us to do so and even if the number wasn't large beyond comprehension.

    Here's my thinking. The Fed is in charge (illegally, but let's set that aside), of issuing currency. When the Fed issued its first, say, $100 of FRNs, Federal debt was incurred. The only way to pay the interest on that first $100 of debt was to create another debt for the interest. So let's say the rate was 3% on the initial $100. Since the Fed is in charge of creating the currency, the government would need $3 of FRNs to pay the debt on the first $100 after year one. Thus, the debt is now $103.

    I my mind, interest payable in the very notes that are only issued by the Fed monopoly makes it such that there are never enough dollars actually in existence to pay off both the principal and interest on the debt. So, even if all the political stars aligned, and we decided to make paying off the national debt our first and only priority, it couldn't be done. It seems mathematically impossible. Do you agree?

    ReplyDelete
  9. 11:33 am

    I know your post was directed towards FDR, but some points. if you were the FED, wouldn't that be the ideal model to keep your system of fraud intact? Incur more debt? = more interest in perpetuum?

    With all these acts to "save" homeowners, for example, courtesy of our savior himself, is it really an act of kindness or a more sinister way of keeping americans working their tails off to make payments for a home that will continue to depreciate in price? I'm sure in some instances it may help, but still...

    And unfortunately, the "political stars" are aligned with the FED and it will continue this way until Americans wake up.

    ReplyDelete
  10. Sure it is possible to pay off the national debt, it's been done before. Certainly you can't do it using more debt from the central bank, you have to declare them forever abolished, as was done in 1776 and again 1836.

    I have for a long time suggest the chief law enforcement officer simply declare the CB a fraudulent corporation, seize all of their shareholders assets, and move on. That is harder to do now that they own the US Treasury, congress, the presidency and the judiciary. But an honest prez could do it quickly as a policy matter, assuming people were more important to him than money.

    ReplyDelete
  11. "Sure it is possible to pay off the national debt, it's been done before. Certainly you can't do it using more debt from the central bank, you have to declare them forever abolished, as was done in 1776 and again 1836"

    I know what you are saying. What I am trying to get at is this: Under the current system, even before the debt got radically out of control....back to the first $100, was it even mathematically possible to pay off the debt? Do you agree with my assessment that it was not possible even then?

    I think the point is crucial because there is absolutely no fixing a system that violates the rules of mathematics, it must be scrapped. Unfortunately, that will involve a period of nearly zero currency in circulation.

    ReplyDelete
  12. I love this line:

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

    Some goldbugs make my skin crawl. Their utter lack of ability to differentiate between an uptrend and downtrend and their fixation on owning a rock causes them to say and do just about anything. Retarded logic and annoying condescending arrogant attitudes all rolled into one worthless egghead of an investor who panic buys at the top of every gold market.

    must ..... buy ...... more........ gold ....... my precious......

    ReplyDelete
  13. "3) There is virtually 100% consensus that it is not a mania"

    That was meant to apply to all manias of course, not just gold. Like I said, I consider myself an expert gold trader, but I'm not married to any trade (I hope not anyway).

    That said, I always have and still do advocate holding some physical gold as insurance against systemic breakdown. I have no idea if it would help but it can't hurt. There is a measurable chance things could downhill really, really fast.

    Like any insurance policy, you should buy physical gold with the full intent and understanding that you want to lose money on the deal. I'll say it again, if you intend to make money on insurance or a hedge then you are neither hedged nor insured.

    That doesn't mean paying for a reasonable amount of insurance is unwise.

    And all that said, paper assets with gold in the name certainly do not count as insurance. Only metal in the safe.

    ReplyDelete
  14. I hope gold goes back to $700/oz.

    I need a little more.

    ReplyDelete
  15. "I hope gold goes back to $700/oz.

    I need a little more."

    Case in point....There is virtually 100% consensus that it is not a mania. Remember the line, "It does well during BOTH inflation and deflation."

    ReplyDelete
  16. Gold value does better during deflation than inflation, but not its price. Gold's highest value occurs when it is priced the lowest.

    As I say all the time, someone might you for a $20/oz gold piece; few care at $1000/oz.

    ReplyDelete
  17. FDR
    "Gold value does better during deflation than inflation, but not its price"

    WHHHHHAAAAAAATTTTTT???????

    ReplyDelete
  18. ""Gold value does better during deflation than inflation, but not its price"

    WHHHHHAAAAAAATTTTTT???????"


    Value not price. Price goes down, value goes up.

    ReplyDelete
  19. Bottom line: The Fed must be killed.

    ReplyDelete
  20. "WHHHHHAAAAAAATTTTTT???????"

    I put a "Read me First" on the right panel for those unfamiliar with the concepts of value and price.

    ReplyDelete
  21. This market will not see the 6,000 range again this year. We will trade from 7,500-10,500 the rest of the year.

    ReplyDelete
  22. Gold was around 250 in 1999, it is at 850 now. At which time was it more valuable? People could have cared less about gold in 1999, and they certainly wouldn't have killed over it. But now?

    ReplyDelete
  23. "Gold was around 250 in 1999, it is at 850 now. At which time was it more valuable? People could have cared less about gold in 1999, and they certainly wouldn't have killed over it. But now?"

    You are making a common mistake of limiting your analysis to your memory. 2000 was the inflationary bull market high, not the low. See: http://fdralloveragain.blogspot.com/2009/02/dow-800.html

    After a market top, we should expect a return to approx wave 2 of the previous 5th wave, so we should look there as a preview of where we are headed. That was actually trading range between 1978 and 1981 where stocks went nowhere so it is hard to pluck a day. It has gold in a wide range between $180 and $700 spot, so let's look at the whole range:

    At $180/oz spot gold bought 1/3rd of the Dow, the equivalent of $2700/oz today.

    At $700/oz spot, gold bought 1.5x the Dow, the equivalent of $12,000/oz ounce today.

    Neither of these is a good point to draw conclusions, because they compare to today instead of to the inflation peak in 2000. In 2000, at $250/oz gold bought about 1/50th of the Dow.

    1978's $180/oz was about 16x more valuable.

    As another reference, in 1932 gold bought 1/2 the dow at $21/oz, but that was only for a very short period of time because the dollar peg that tried to hold it there was under severe stress and quickly broke.

    In fact, gold had become so valuable at its $21/oz peg, that FDR's thugs seized all of it at gun point, going door to door searching homes.

    ReplyDelete
  24. I'd sell my gold instantly, if I had faith in the government, capital markets, and international situation regarding the reserve status of the dollar.

    With FDIC warning us to prepare for an ass-reaming--but bring your own lubricant-- I have no confidence whatsoever that my investments can't be Madoff'd away.

    ReplyDelete
  25. I am not disagreeing with you on what is basically a dow/gold ratio value explanation. But I do disagree on price. One ounce of gold could just as easily buy the Dow at 5000 (or 1000) in the future and be more valuable than it is today. You assume that the price has to be lower for gold to be more valuable, which I'm sure you know is not true.

    ReplyDelete
  26. "You assume that the price has to be lower for gold to be more valuable, which I'm sure you know is not true."

    Do you think real estate is more or less valuable, now that so few can afford to buy it?

    ReplyDelete
  27. "You assume that the price has to be lower for gold to be more valuable, which I'm sure you know is not true."

    The less currency that is available the more valuable money becomes even though it's price is dropping.

    ReplyDelete

The USA's political-economc system is best described as:

On Nov 2, 2010, I plan to vote (FOR or AGAINST) my incumbent congressman

 
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