Tuesday, 21 May 2013

Ladies and Gentlemen, it is with great pleasure that we hereby present you with…

…what is possibly the greatest gold contrary indicator ever! Ladies and gentlemen, please welcome to the stage Mr. Ananthan Thangavel (a round of applause follows as the excited crowd cheers him on)! Apart from titillating our fantasy as we imagine the scene (we recently rediscovered our always-present and yet long-lost love for acting and performing), the objective of this post is firstly to inform our readers about the extremely high likelihood that a final bottom has been printed in the PMs market (a bottom that warrants further additions to our already very large positions) and secondly to present them with what to our eyes appears to be an extremely effective timing tool for our purchases: the short calls of Mr. Thangavel. It is not our intention to ridicule Mr. Thangavel (at least not much) as we know that investing is far from an easy business and everybody is bound to make their shares of mistakes (and we’re certainly not immune to this phenomenon, as e.g. we weren't expecting the collapse in PMs on the back of already extreme levels of pessimism). What we want to show, however, is that doing fundamental analysis using horribly wrong premises, spurious arguments and a wide array of trite fallacies vastly increases the possibility of committing grave mistakes. We are convinced that unless one is motivated to learn what sound analysis really is, then one would be better off just trading technically, without concerning (and burdening) himself with any fundamental considerations. Take Peter Brandt as an example: he obviously can’t differentiate between valid fundamental arguments and hogwash and yet he goes on to trade profitably by using simple charting techniques, prudent risk management and a multi-decade experience (and kudos to him for having been on the short side of the PMs markets for quite a while).

A brief review of Ananthan’s latest article

We intend to start with a point-by-point rebuttal of the seizure-inducing nonsense spouted in Mr. Thangavel’s latest article (which he published on May the 7th, so at least he got a couple of weeks of glory as prices collapsed!). Readers are encouraged to read it before proceeding through our post, as we’ll only quote brief passages of it or simply articulate our positions assuming that readers are familiar with the other side of the argument.
  • “we did briefly believe that the initiation of QE3 would be a positive catalyst for gold back in September 2012” : excellent, you demonstrated you know how to pick tops as well, as your long call arrived when prices where around 1760$/oz. and topping. 
  • “As can be seen from the chart, gold rose in a fairly steady pattern (with 2008 being an extended correction), from the early 2000s until September 2011. Viewing this chart, it appears the perfect picture of an asset bubble and collapse.” : if you say so… To us it seems like a powerful secular bull market experiencing a cyclical bear market correction. This chart, courtesy of Macrotrends, seems to confirm our suspicion:

Macrotrends.org_Gold_at_3000_Only_if_Bubbles_RepeatA chart comparing the percentage gains of the current gold bull market with those of other major bull markets: we can’t see any parabolic rise so far, in spite of what the hawk-eyed Ananthan says.

  • “Considering there is no "right" price for the price of gold, but rather only the price that the next buyer is willing to pay, more and more investors came around to the bullish gold thesis, and this gradual realization drove the price higher.” : congratulations, you just discovered that prices are the composite result of a myriad subjective value judgments by economic actors. Unfortunately for you, this is an insignificant platitude that is true for all goods, not only for gold. No, there is no such thing as “intrinsic value”! Quick Austrian explanation: for a voluntary exchange to occur both parties need to value the goods to be acquired more than the goods to be exchanged for them (otherwise no transaction would take place, as both parties would expect a loss, rather than a gain, from the exchange): in short, this is called a reverse valuation. From this it logically follows that all values are subjective: if goods had an objective, intrinsic value, then there could be no reverse valuation (except through error). In other words, all exchanges would have to rely on the error of one or both parties to occur and this is obviously impossible (think about the coexistence of innumerable satisfied iPhone buyers and of large Apple profits: evidently they both gained from the transaction and no “right” price for an iPhone exists). 
  • “However, by 2011, nearly every market participant knew or understood gold's appeal, and since gold could be easily purchased through an ETF or futures contract, everyone who believed in the thesis was in. The following chart shows the number of ounces of gold held by ETFs. […] We believe this massive accumulation of gold was the primary driver of the most recent leg of the bull market, punctuated by leveraged futures traders exacerbating the final spike. Moreover, ETF and futures demand for gold can be considered the marginal player, as central banks and other physical gold holders rarely trade in and out, so ETFs are setting the marginal price due to their relatively high turnover.” : here we have a powerful combo of specious arguments.
    A) It’s highly debatable whether in 2011 “nearly every market participant” had an interest in (much less an understanding of) gold’s appeal: there certainly was excessive speculative fervour and widespread bullishness, but certainly we saw no signs of a speculative mania (and at least we know that our good Ananthan had no interest in and certainly no understanding of gold). Moreover, we know that since gold does not get “used up” and a large stock of it exists (roughly equal to 50 times the annual mine supply), then it follows that all this gold has to be held by someone at all times: what matters is not whether “everyone is in” (in light of the above this sentence is meaningless), but whether at the current price there is or there isn’t an equilibrium between total stock and total demand to hold (which includes the demand to acquire gold and reservation demand to hold it) and whether the current price correctly reflects future anticipated conditions (if it doesn’t, then an adjustment is inevitable, in the form of an increase or decrease of the total demand to hold and hence an increase or decrease of the price until a new equilibrium is reached. The total stock bears little relevance as it’s almost a fixed constant). The heart of successful speculation is the ability to correctly gauge the current and the future relationships between supply and demand and identify meaningful discrepancies that could give rise to powerful trends in price (e.g. there currently is a large supply of sugar and hence prices are very low. Yet we anticipate a future situation in which this abundance disappears and hence we speculate on a meaningful price increase).
    B) The usual tripe about ETFs holdings… With 170.000 tonnes of above-ground gold what the hell does it matter whether ETFs hold 1.000, 2.000 or even 10.000 tonnes? All gold has to be held by someone, all that matters is at which price the market clears, i.e. at which price demand to hold and available stock match. Moreover, it’s evident that ETFs are tiny tiny players in the global gold market. They have no doubt made it easier for Joe Public to invest in PMs, but they’re still a minuscule source of demand. Moreover, the gold they buy is sold by someone else and that someone cares little whether the buyer on the other side is an ETF, a central bank, a large dealer or whatever: all he cares about is the price he can get (and whether that price is high enough to entice him to sell). So ETFs may be useful as a proxy for sentiment towards PMs, but their buying and selling most definitely does not influence the price. Have a look at the London Bullion Market’s size and then figure out for yourself whether GLD shedding a few hundred tons over the course of six months really matters much.
  • The paragraph titled “When bubbles burst: prices cannot catch up to unrealistic expectations” is a concentrate of gibberish. First of all, bull markets do indeed generally end when the fundamental drivers no longer are in place or when they have at the very least significantly deteriorated (reference our post on the subject).
    Secondly, as we have observed above, good luck comparing gold now with the Nasdaq in 2000 or housing in 2006…
    Thirdly, mistaking a cyclical bear for the end of a secular trend is a mortal sin amongst speculators and pretending that an asset responds in the most obvious manner to news is utterly naive: if speculation were as easy as reading the paper and then doing the most obvious thing (like buying gold on leverage the day Bernanke announces his QE program), then we’d all be Soros. Moreover, all secular bulls experience cyclical corrections: in 1987 the secular stock market hadn't ended (as the secular drivers of said trend were firmly in place), BUT the then-current circumstances warranted a temporary and meaningful correction. The same goes for gold in 1975, stocks again at the beginning of the ‘90s etc. etc. etc.
    Finally, what about his assertions that “The current fundamental problem in the gold market is that every bullish fundamental has already been revealed” and that “there is no upside surprise left for gold investors, but there remains plenty of downside surprise.”? Well, save those lines for the stock market, dear Ananthan! In our opinion, it is obvious that there are still plenty of “hidden” bullish fundamentals for gold (hidden of course only for that 90+% of people who have never heard of the Austrian School) that will not fail to make themselves evident once the current monetary madness finally delivers its results. And be assured: that will be the time to sell, as the Ananthans of this world will rush to buy! Just as obviously, it seems to us that right now there are no downside surprises left for gold, given also the recent crash (a 4-standard-deviation event): the world economy is just perfectly fine and on the road to a strong recovery, no bad consequences can possibly result from massive inflation, debts will no doubt be repaid with honest money and all the perks and amenities of the welfare state will be maintained and even increased.
  • The next paragraph is another questionable one. Gold secular bull trends tend to happen during periods of economic crisis, when stocks are generally locked in a secular bear. We have discussed the matter in a previous post. There may be periods of positive correlation between the two assets, but the overall secular trend is clear. Moreover, if the Fed stops printing, good luck with trying to keep the current global financial ponzi scheme from crumbling. In that scenario (a highly deflationary one) we seriously doubt gold would perform poorly. It may decline in nominal dollar price (not very likely and mainly dependent on whether the U.S. gov’t can remain solvent), but it is certainly going to increase its purchasing power (i.e. the amount of “stuff” like oil, houses, cars, stocks, food etc. that you could buy with a unit of it) exactly like it did in 2008. If, on the other hand, Benny keeps on inflating (a very likely outcome) then good luck with trying to keep the current “Goldilocks Economy” in place for much longer: either a bust of massive proportions or a prolonged period of significant price inflation and stagnant economic activity or even the Misesian crack-up boom would likely appear and all three scenarios are bullish for gold (with the last one being wildly bullish). We’ll tell you how gold could be hurt: if Obama were to be possessed by the spirit of Murray Rothbard, so that all at once he would abolish the Fed, repudiate the debt, stop spending, cut taxes and regulations and let the free market re-establish equilibrium (of course he would have to be exorcised before being able to re-establish the gold standard, otherwise the scenario would still be bullish).

  • “Future for gold”: another bit of gibberish about ETFs holdings coupled with the following: “At this point in time, with interest rates around the world staying low indefinitely, investors are grabbing for yield anywhere they can find it. Nearly every other asset, between stocks, fixed-income, alternative, and real estate, produces a higher current yield than gold's 0%. Given the fact that gold has not made a new high in 19 months, traders can no longer rely on price appreciation to make up for gold's lack of yield and utility. Therefore, they are selling the metal, and they have quite a bit more to get rid of before all is said and done.” Yes, you have got this one right Ananthan, although you couldn't resist mentioning the usual nonsense about the supposed bearishness of the liquidation of miserable gold holdings ( by the way, as far as we know sellers do not just throw their gold in the ocean, but rather sell it to buyers who become the new holders). Investors are indeed selling gold to chase other assets. The important question however is: is that likely to generate good returns? Personally, we wouldn't touch a junk bond yielding less than 5% with a ten-foot pole… Ditto for a stock market sporting a CAPE10 of 25 and a Q ratio above 1, both levels at which secular bull markets have ended, not begun.

  • And now hold on to your hats, dear readers, as the two last paragraphs are riddled with enough rigmarole to make us almost pass out: “Given that gold is a commodity, most commodities eventually trade to their cost of production. Those of you that have taken a basic economics class will remember that marginal cost = marginal revenue. […] If investment demand continues to decline and gold ETF holders continue to sell, we believe a gold price below $1,000/oz is a near certainty. Gold will eventually return to its true cost of production, squeezing miners' profit margins.” It seems to us, dear Ananthan, that you are the one who failed to attend a basic economics class: please show us another commodity whose available supply pretty much equals the entire cumulative production that has taken place over the course of all of human history (save for a few sunken Spanish galleons and a few other tons that got either lost or consumed). In such a situation, the price of a real commodity, like corn or oil, would no doubt plunge far below the cost of production, since such an abundant supply would mean that nobody would need to actually produce the stuff (at least for a few decades) and hence the market, via its profit and loss mechanism, would send the signal that the scarce resources employed in the production of such a good would be better employed in other lines of production (in simple words: nobody would make a frigging dime producing that commodity). So, how come that gold prices do not plunge far below its cost of production, notwithstanding the huge above-ground supply? Well, maybe after all gold is not a commodity or, more correctly, it is a commodity whose function is to act as money, no matter how emphatically Ananthan tries to explain us how gold cannot possibly be money by babbling assorted nonsense. Gold being money, reservation demand plays a fundamental role in determining its value. This demand is of course fickle and subject to continuous changes, but all that matters to the astute investor is to correctly determine the likely direction of its trend, i.e. whether it is likely to increase or decrease meaningfully over the next few years. Truth be told, he is right in saying that gold is not a commonly accepted medium of exchange, but this happens not because it does not possess the characteristics of money (i.e. not because it lacks “moneyness”) but only because of government coercion in the form of legal tender laws. Proof of this assertion can be found in the fact that when a paper money system collapses, specie money always regains its rightful role as a medium of exchange.

  • And finally Ananthan dispenses a wonderful pearl of wisdom for the benefit of the hoi polloi: “The problem with gold is that the market sets the price and there is no fundamental value. We must always be cognizant of this when investing in a psychological asset.” Ah, so now we know that gold is a psychological asset, whatever that means (we’ll no doubt interrogate a friend of us who happens to be a shrink on this and we may even put a gold bar on his couch so that he can properly analyse it)! Moreover, we also learn that gold has no fundamental value and that its price is set by the market and who cares if that is true of each and every asset on this planet (see the explanation above): certainly this only matters in the case of gold!
And with that last bit we have finished our rebuttal and we can move on to next part of the post (interested readers can spend some time overlaying the dates of Ananthan’s calls to short PMs to a chart of gold and see whether they notice any patterns). But before moving on, we want to mention that we’re not singling out Mr. Thangavel, as the drivel he spouts is usually used by a great many other analysts, nor we’re attacking him because he holds different views from us: what we’re criticising here is the shabby and shallow analysis and the careless use of specious arguments that don’t hold water. If someone were to say us that he’s short gold because the chart is bearish and there has been a breakdown, then we won’t have anything to object. We would still continue to be long (as we have our own way of investing), but we won’t engage in a debate with him: successful technical traders are very worthy of respect. But if someone comes up and says that he’s shorting gold because money printing is helping the economy and other assorted BS, then we can’t avoid dissecting his arguments and showing them for what they really are: nonsense.

The current technical and sentiment picture

Right now, after a series of endless plunges and crashes that no doubt helped clear the market from all kinds of even remotely weak hands, we see that both gold and silver have put in nice reversal candles. It is of course too early to say whether this will really be “it”. What we want to say, however, is that this time the bounce has a different feel attached to it: it just seems to us to be a bottoming process. A weekly close above 1400$/oz. for gold would most likely seal the deal in our mind. In any case, investors are now presented with an excellent opportunity to increase their exposure to this asset class. Sentiment of course is in the gutter, with newsletter writers now recommending a record-breaking average short position of 44% according to Hulbert Financial Digest and with Sentimentrader’s public opinion survey now showing widespread bearishness. Positioning shares sentiment’s place in the gutter, with small speculators almost net short in gold and with the lowest exposure ever to silver (and this does not even reflect the recent plunge). Moreover, if one spends a bit of time lurking around in forums and blogs, then he’ll certainly notice that most people there are talking about shorting PMs, increasing their shorts etc. (nobody is talking about selling their longs as they already did during the last crash).

goldA chart of gold via Stockcharts: notice the reversal, accompanied by momentum divergences.

The reversal (after fresh new lows) is even more evident in the case of silver.


We cannot possibly know whether the bottom is in or not, but we know that the fundamental arguments used to support bearish views are fallacious and that sentiment and positioning both scream for a bottom (although in all honesty they have been screaming for a while). We now have a reversal that looks convincing and we have to make do with it. We are buyers, knowing that the rewards far outweigh the risks and more importantly knowing that the secular bull market has not ended, not by a long shot, and that as such being long here is a sound proposition likely to deliver excellent returns over the coming years. Of course, readers need to remember the importance of using their own brains and of prudent risk management (read: don’t be heroes who leverage to the hilt in hope of becoming the next Paulson).

No comments:

Post a Comment