Happy New Year! As I write this, it’s January 1, 2014. This is my annual Reflections article, my opportunity to write less formally and talk about what I am thinking as I look back over an entire year. This piece is much longer than my typical article, less focused and definitely less edited.
2013 was a year of accomplishments. Most of the time, we’re too busy, well, accomplishing new things to step back, pause, and reflect on what we’ve done. I am as guilty as anyone on this charge, so I like to take the opportunity once a year to reflect.
In January, my company launched the first of its kind gold fund. This fund owns bars of metal, and trades to produce a return in gold. Its goal is to increase ounces of gold owned. It is the only fund to keep its books in gold, and the only fund in which the performance fee is measured based on an increase in gold ounces rather than an increase in the dollar value. Also in January, I went on the Capital Account show with Lauren Lyster, which was, as it turned out, the final episode of the show.
I made bold predictions, stuck my neck out in a video, and in several articles that went out to Zero Hedge and Seeking Alpha. Around Jan 23, I said that the rumors of an alleged shortage in silver were rubbish. Silver will fall in gold terms. I said the ratio would certainly rise over 60 and maybe hit 70. At the time, the dollar price of silver was around $33 and the gold:silver ratio was 52. The goldbugs were vehement there was a shortage, and the gold price would shoot up but silver would really outdo gold and the ratio would fall back towards 30 again. Well, the price fell to $18 and the ratio hit 67.5.
In February, we launched the company’s blog at www.monetary-metals.com. This is where my market analysis, gold conspiracy debunking, and commentary on current events in the gold and silver space are published. We also publish the Supply and Demand Report, providing the data and analysis to show the true picture of the monetary metals markets. We started doing videos, where I could use a different media to cover topics better suited to verbal presentation.
In March, Cyprus banks collapsed. People thought it was a case of the government stealing depositors’ money. It was, but not how they thought. The Greek government stole that money over the prior years. They didn’t call it stealing, they called it “borrowing” but they had neither means nor intent to repay. Cyprus banks bought plenty of these counterfeit bonds. When Greece defaulted, that blew gigantic holes in the balance sheets of the Cyprus banks. Before this event, Cypriots thought of gold as something to buy in the hopes its price will go up. After, some learned that the real reason to buy gold is that gold has no counterparty risk. Cypriots who had euros locked in the banks couldn’t access what’s left of their money. Those few who had gold could carry it in their pockets, get on a boat, and go to the mainland.
Also in March, I introduced the broader gold community to the concept of backwardation. Amusingly, at first several notable names in the space tried to school me and insisted that no such thing was occurring. They were armed with bad definitions and unreliable data. I wrote a short article to set the record straight. I wrote several more pieces on backwardation, and by the end of Spring the situation had reversed. Then everyone wanted to jump on the backwardation bandwagon and some even tried to use it to make some pretty rash predictions of the gold price. Sorry guys, there’s a theory behind the word.
In the Spring, I began collaborating with several other people to launch the Gold Standard Institute USA. This culminated in an exhibit at Freedomfest in Las Vegas in the summer, but I get ahead of myself.
Of course, on April 12 and 15 the prices of gold and silver crashed. Of course, the conspiracy theory mongers came out and said that it showed that “the powers that be” had smashed gold and silver. I did a forensic analysis which showed the opposite. Some time after this, I noticed a bizarre phenomenon. Perhaps it had been occurring all along and I just didn’t see it, or it may have been a new thing. In any case, gold bug commentators began to speak of an alleged fracture, a split between what they called the “paper price” and the “physical demand”. They implied that the price of futures was much lower than the price of gold bars and coins. I am sure that most of the people who used this curious turn of phrase in their writing knew better, but I certainly encountered a number of earnest readers who believed precisely that. I always answered the same way, “please tell me where I can sell physical bars of gold for $1900 or $1600 or whatever it is that you feel is the market price of “phyzz”, because I can buy it for a small spread over the official price of spot that you see on every screen.” In fact, the price of spot gold and the price of COMEX futures remained within a buck or two even at the height of backwardation.
Speaking of which, I began chronicling the onset of temporary backwardation of each future as it neared expiry. The date of first onset was getting earlier and earlier relative to the future itself. By August 1, the December contract went into backwardation 67 days before the start of the contract month. Reuters wrote a few articles about it, included my data and quoted me. And then, it all dried up. Supply loosened up, and now there is no backwardation in silver at all and in gold it is de minimus (not that any backwardation in a monetary metal should be casually dismissed).
In April, I began publishing what turned out to be a seven part series on my theory of interest and prices in an irredeemable currency. No, it’s not just rising money supply –> rising prices. That’s like the Medieval view that if you throw a rock, it flies straight until it runs out of force, then falls straight. Convenient, tempting—and wrong.
When I discuss the reason to own gold, I always explain it in terms of counterparty risk and debt default. Gold is no one else’s liability. When gold bugs discuss it, they say the dollar is going to zero like all other fiat currencies. Though they attribute this to what they predict will be an infinite quantity of dollars, they get to what I assumed was the same conclusion (if very different timing). But it kept striking me that gold bugs are so upset at the falling gold price. Why would they be upset that the dollar isn’t collapsing right now? Then it clicked. They use this story as the reason to buy gold, but they don’t really buy it. They want the gold price to rise so they can sell gold and get “profits” (more dollars). If you buy an ounce of gold and the gold price doubles, you still have an ounce worth of money. Sure it exchanges for twice as many dollars as before, but each of those dollars are worth half as much. And the taxman will take many of these dollar “gains” from you. The gold bugs picture the same world we have now, with luxury cars driving around, and private jets, celebrity chef restaurants, jewelry, etc. Only when the gold price hits $5000 or $50,000 or whatever, they will be the fat cats who own it all. They are sadly mistaken. When the gold price hits those numbers—if it hits those numbers before it goes into permanent backwardation—there there will be some very ugly things going on out there. It won’t be a pleasant world, and those with gold won’t want to reveal their wealth, for fear of kidnapping or worse.
Another thing that struck me is how—suddenly, it seems—people became enamored of Chinese central planning. The Chinese are smart, they are wise, they think far ahead into the future. They will issue a new currency, that is “backed” by gold. Ahah, this must be it. They are buying gold. Salvation! Their relentless buying of gold will bail the goldbugs out of their losing positions, by driving the price up to new records and all losses will turn into gains once again.
By the way, it is not possible to reverse cause and effect. The cause is trust, credit extended, and gold deposits into the banking system. The effect is the issuance of a paper bank note that is redeemable in gold. One cannot declare that a previously-irredeemable currency is now redeemable, lest one find that one runs out of gold in one’s ill-fated and short-lived gold price fixing scheme. Unlike the alleged bullion bank naked shorting of gold, such a gold “backed” currency would be a price fixing scheme. It would last no longer than the central bank’s gold reserves.
I had a chance to write about most of the mechanical aspects of the gold market: COMEX open interest, COMEX inventories, GLD inventories, and negative GOFO. I also addressed several episodes of what I called the QTM Gap. Typically, Bernanke would go on TV and promise more QE (or back away from a promise to reduce it). BANG the price of gold would smash upwards, breaking a downtrend it had been in prior to the announcement. One could plot the time to rise, the time the price remained elevated, and the time to fall back to where it had been. My hat’s off to those speculators who must have had orders to buy keyed in, with their finger hovering over the ENTER key waiting for Bernanke to say the word. As to the fools who bought off those early speculators 5 or 10 minutes later, when the price had maxed out, well your losses speak to you more loudly than my words. Once and for all, the price of gold does not depend on the quantity of dollars. You’d think that would be bloody obvious by now, with the money supply rising all year and the gold price, well, not.
In July, Gold Standard Institute exhibited at Freedomfest. I had a chance to meet a few fans, and to moderate a debate on whether we should end the Fed and adopt a free market in money.
In October, I had a chance to attend the annual CMRE monetary policy conference. In November, I went to the Cato annual monetary conference. I was at Cato in 2012 as well. This year, it was a better event, because of the influence of new Cato president, John Allison.
As I write this, the gold price is around $1205 and silver is $19.50. Everyone has been asking me, what do I predict? Let me back up to cover the massive rise in the prices of the metals from 2009 through 2011. As with many other assets, it began with a genuine shortage and the reason to buy was real. More and more people began to buy, and momentum begat momentum drove more momentum. Soon enough, the original story is no longer true, but few know or care. A rising price is its own story.
And the narrative developed that with a massive increase in the money supply due to the Fed’s Quantitative Easing, that will lead to a massive increase in prices especially gold and silver. So buy not only for price gain, but to protect yourself from the dreadful losses in wealth that will be coming to those who hold dollars.
By 2012, it was obvious that the “inflation” story wasn’t working out in reality. There was no massive spike in prices, much less the hyperinflation predicted by some goldbugs. When the story collapsed, it was only a matter of time before the prices of the metals did. The “inflation” trade was busted.
That brings us to the present. I’ve been discussing in recent editions of the Supply and Demand Report that it looks like speculators in gold have basically capitulated. But in silver, they still cling to hope on hope. I suspect there is another leg down in the price, in part because I see much more abundance of silver metal to the market than there is in gold. I also think that this stubborn hope is causing people to hold silver out of false premises. Assuming that we get this last leg down, then both gold and silver are at or near multiyear bottoms. Then what?
There is no driver for a sustained price rise right now. The question is: what will bring it? I think the answer will not likely come from the US but from somewhere else. Right now, numerous credit markets, some of them large, are teetering. Major currencies like the Indian rupee and Brazilian real (remember the “BRICs will save the world from recession” story?) not to mention Japan and several others are at risk. The winding path towards final default is one of debtors getting crushed under the burden of their liabilities. This is likely to be a period of downward pressure on prices, or at most flat prices. But what happens in the final default?
Creditors lose their money. If the creditors are banks, then they will be unable to honor their obligations to depositors (see Cyprus). If this happens on a large enough scale, then it will trigger another wave of gold buying. Unlike the last one, this will be a flight into coins and bars—along with rising prices, we’ll see a rising cobasis. That is one big sign that the price rise is real and permanent. The impetus will be a desire to avoid exposure to struggling counterparties. Only real metal will do.
As I said earlier, this is not likely to be a happy time for gold bugs or anyone else. There will likely be bankruptcies, unemployment, supply chain failures, and all manner of bad things. These events may be more muted in the US than elsewhere.
There is no particular limit to how high this could drive the gold price. That’s assuming this is not the pell-mell rush into permanent backwardation, when gold goes off the board and there is no more gold price! Assuming not, it could easily go to $3000 in gold and $60 in silver. If this is driven by fear of depositor haircuts, then the dollar will get astonishingly strong compared to other paper currencies. And after the dollar the rush will be into gold more than into silver. So I estimated a gold:silver ratio of 50, as a first guess.
I will end on a more positive note. There is a way to avoid permanent gold backwardation. The way is to transition to a proper gold standard. With Forbes publishing some of my articles recently, and other Gold Standard Institute activities planned for the future, we may build a movement for the gold standard into a groundswell. In 1950, very few people thought that Jim Crow could be brought to an end. What they didn’t realize was that, by then, a growing majority had come to regard it as unconscionable.
I think we are close to the point where a majority regards the legal tender laws and capital gains taxes that force us to use the Fed’s paper scrip as money as unconscionable.
Happy New Year Keith and thanks for the great posts this last year!
Thanks for this. Is there a flow of gold from west to east, as often reported? If so, is this eagerness to sell not due to high dollar prices, but to help keep the dollar afloat?
Doug, thanks for your comment. Gold bars will go move from where the price is lower to where the price is higher. I concluded they were moving East in this article: http://monetary-metals.com/what-drives-negative-gofo-and-temporary-gold-backwardation/