For Signs of Stability, Look to the Price of Gold

by | published August 26th, 2011

I am based in Pittsburgh. So around this time of year, if somebody mentions “Big Ben,” my thoughts usually turn to a certain football quarterback.

That is, of course, unless the subject is the chairman of the Federal Reserve.

Ben Bernanke gave a speech this morning in Jackson Hole, Wyoming. Actually, to say that he made a few comments would be a more accurate assessment. He offered an upbeat view of U.S. longer-term economic prospects but gave no indications of any new stimulus plans.

There is a tug of war going on – between those who believe the Fed has a more active role to play and those who believe that the QE (quantitative easing) experiences were a failure. And since this is already an election cycle, the latter camp has the upper hand (whether that's based on any real understanding of economics or not).

Analysis is not driving the policy apparatus. Politics is.

Keep these two overarching matters in perspective…

First, the Fed cannot make fiscal policy decisions. That is the province of the White House, but especially of Congress.

Second, what the Fed does control – monetary policy – cannot, in itself, employ workers, renew investor confidence, or start new small businesses.

The problems faced by the U.S. economy are in those areas that Fed decisions do not (and cannot) impact. Unfortunately, that also puts them squarely in the crosshairs of a vicious partisan political war being waged inside the Beltway.

As a result, this morning the Fed's Big Ben did the only thing he could do. He gave a rousing halftime speech… and punted.

The markets, in response, initially digested the non-event and continued to look for things to short.

The weakness exhibited today on the German stock index, the DAX, is disconcerting, since as Germany goes, so goes Europe. But it may be more an expression of the latest vehicle traders are using to circumvent restrictions on shorting stock in several European markets than it is a genuine statement of sentiment on German prospects (or whether Chancellor Angela Merkel is in political trouble).

Politics aside (and yes, that is a big factor to ignore), the volatility in the current market is about half a genuine view of economic data and half a result of blatant manipulation.

This is hardly a new thing. We are not in this to reform Wall Street ethics, anyway. Frankly, we want to make money as much as they do.

But we need to recognize that the market will only recover when two thing happen.

What It Will Take for the Market to Recover

First, the market will recover when shorting does not become the option of first choice for traders looking to make a buck.

And that happens when those who do take this route are forced to cover those shorts too frequently, losing money in the process and exposing themselves to expanding downside risk.

Second, when commodities are no longer the barometer of funds remaining in the market but removed from equities, the market will begin to recover.

This one requires a bit more explanation, so bear with me…

Commodities are “fungible,” meaning they are easily tradable and carry a value than can be easily transferred into cash.

A considerable amount of cash has simply moved out of the market completely since the beginning of August. However, much of what remains has moved out of stocks and into commodities. When this happens, of course, the preferred depository is gold (with some parallel movement into silver or copper).

When instability hits and investors are looking for a safe haven, the migration is no longer to bonds but to commodities. And these days that means gold.

While an indirect indicator of value, the recent upward action in gold actually says less about what the preferable price should be for the metal and more about the uncertainty pervading the rest of the market. Gold has a supply-side constraint that underpins its normal value, but little in the way of genuine (or actual) widespread demand. That distinguishes it from silver or copper, which both do.

As a repository of value, however, gold has been a premier commodity for millennia.

And it's the best indicator to watch for a return to market normalcy.

In a normal market, gold prices change more gradually. These days, the rapid rise up in gold prices and the occasional tank (as witnessed by a triple-digit decline in one recent session) is, again, more a barometer reading of the market as a whole.

Oil, on the other hand, has a dynamic that includes both supply and demand side considerations. While it also can reflect the overall movement of the market, it marches to the beat of a different drummer. Crude must satisfy a constantly changing market of suppliers and users.

But back to gold.

The key indicator that markets are stabilizing (and, in large measure, meaning the pricing of oil will rise) will be when gold prices come down in regular increments (i.e., not giving us a chart reminiscent of the Alps!). There is a risk quotient in the current pricing, and that is unsustainable.

Gold may still appreciate in price in a stable market, but it will do so in a more predictable fashion.

The Fed's own Big Ben, therefore, can have little impact on either the fiscal policy side or the internal market division between equities and commodities. He is correct in not even trying. His predecessor Alan Greenspan was occasionally less temperate, and he ended up playing politics as a consequence.

So the current Fed chair uses (for the moment) reassuring words, but not a heavy-handed policy club.

And darn if the market isn't back into plus territory as I write this, just before noon.



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  1. Al
    August 26th, 2011 at 15:46 | #1

    Kent, some other newsletter writers believe oil will drop to about $65 before returning to previous highs. If that view has any credence at all, wouldn’t some hedge positions be warrented? As volatile as this market is – I am standing aside from all call options.

  2. Al
    August 26th, 2011 at 21:20 | #2

    I cannot see how ‘traders’ in the money market especially, benefit anyone or perhaps everyone. If trading in stocks was impossible two things would result;
    1. Investors would have to stick with a stock. No one could bail out – not even those in the know who now bail out to the detriment of those ordinary investors.

  3. Richard
    August 27th, 2011 at 08:13 | #3

    I think you have a wealth of knowledge about the oil industry, technology, process, and the business. I think there are too many forces (global) that effect the stock price of energy that are not predictable. I was up 20% for the year, now I am back to zero.
    My portfolio crashed as I am sure many others likewise.
    If you had said to sell in July, you would have been my hero.

  4. Robert Page
    August 27th, 2011 at 20:16 | #4

    Gold plunged last week because the Shanghai Gold Exchange and the Comex both significantly raised margins to trade in gold multiple times. It was increased margin requirments that caused silver’s drastic decline earlier this year. Silver has been climbing steadily since then, as will gold.

    It seems to me that when the national debt is increasing at a rate of $4.3 billion per day (and acclerating) and interest expenses consume more than $0.40 (and acclerating) of every dollar confiscated in taxes, then perhaps those who champion fiscal discipline and reduced spending are the ones who truly understand “economics.” These benighted individuals are the ones investing in gold and silver.

  5. Arthur Robey
    August 27th, 2011 at 22:35 | #5

    With so many things on an exponential curve is so surprising that Gold looks asymptotic?
    Here are a list of exponential curves.
    EROEI of oil, exponential curve down
    Population, doubling time is now what?
    Fiat money printing,
    Environmental destruction, think carbon.

    It is time to dust off “Limits to Growth, 2000 update.”
    This time it is different.
    This time endless exponential growth turns exponentially negative. Enjoy the ride.

  6. Jim
    August 30th, 2011 at 09:50 | #6

    In a democracy, taxes are not “confiscated,” and our fiscal discipline will be restored when we get the right mix of taxes AND spending. Federal taxes are at a historically low level, particularly for high income earners. Folks seem to forget that a progressive income tax, which America traditionally has had, means that you pay more as a percentage of your income (not wages), as well as the amount. As noted, the future of coming to an accommodation on increasing taxes and decreasing spending is bleak, giving rise to the downgrade in America’s debt by S&P, when one side will not come to the bargaining table.

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