In the Eye of the Hurricane

Gold sold off a bit today; the Comex spot price was down $25 or so to $880, which is close to where it started the year. The talking heads are see this kind of action and come up with the headline that “Gold falls on speculation rally went too far.” Of course, I wonder how they came up with that conclusion. It’s not much over where it opened this year or the last. So what rally are they really talking about?

Sure, gold has come back a lot from when the central banks where elephant stomping it with paper gold claims back in October, but when you see headlines such as “Treasury needs to borrow $493B in current quarter” (which is two trillion dollars annualized) I’d expect to see gold going a lot higher than that. But I can’t say I’m surprised. In fact, I was hoping for it.

Since I’m actively trading a portion of my shares of Barrick Gold (ticker symbol ABX), the volatility helps me to make money. It just becomes basic at that point: buy low, sell high. If you buy and it dips lower, just hold it. You can’t keep gold down in an economy that is running trillion dollar deficits; it’ll come back up, just be patient. But in terms of exploding off the charts like we saw in the late 1970s through early 1980s, the central banks are doing their level best to keep that from happening. That means you have gold going ever higher, only to be pushed down in a flurry of Comex future contract selling. I mean hey, if you know the powers that be are doing all they can to play hell with your favorite commodity, you might as well try to profit from it- right?

I spent some time looking over the blogs I wrote back in October. When I read them I almost question who wrote them. I know it was me, but the day to day events I’m describing is almost too fantastic to be believed. The Dow Jones Industrial Average having one days swings in excess of 10%. Gold falling down to $745 only to make it all the way up to $920 soon thereafter, only to give most of it back up… only to rise again. The volatility of that period seems to have given way to the complacency of this one. People seem to have accepted the idea that deflation is upon us, but that the magnitude of the inflationary policies of the US Government and the Federal Reserve will ameliorate what’s going on. Furthermore, many people seem to also believe that the Federal Reserve will then be able to mop up all of that liquidity once inflation rears its ugly head and that we’ll somehow end up alright.

In that way, I suppose we see ourselves as a being in the eye of the hurricane. We know that we just went through a bad storm. It’s pretty clear that it’s still raging, but we feel safe in this weird pressure pocket between the forces of high pressure and low pressure. We know that eventually we’re going to have to endure the other end of the storm, complete with its ferocious eye-wall, but things are OK for now. For that matter, people believe, they will eventually be OK again. I suppose they are right in that way, but the long term eventuality they are thinking of is much father away than they’re thinking.

The truth is, we’re not talking about things go back to normal in a year or two. That’s just not going to happen. Instead, this crisis is only going to get worse, and we will have episodes of volatility just as we did last year. It’s not going to get better next year, or the year after. This crisis is going to drag on year after year after year until, eventually, the whole system crashes. It’s just like I told the church congregation on Saturday, we aren’t witnessing a recession. We are witnessing the death of our financial system. You see, we one had productive industries in this country, but we decided to replace them with a printing press. It defied common sense, but the Keynesians told us it would work out… but it’s not working out… and here we are.

So gold is down a bit today. Fine. I hope it goes a bit lower, because that’s where I have my next buy order in for Barrick Gold stock. Gold and gold mining stocks are experiencing constant upward pressure, but they keep getting knocked about by a financial system that won’t accept its own demise. The bankers sell gold short in an effort to keep its price down while those of us who know better, keep buying more. The strain between the two has resulted in larger premiums between the price for physical gold and the Comex spot price. Right now the premiums seem to be around $100 or so. Not as high as they were in October and November, but still high enough to show the strain between the demand for physical gold and the forces at work in the market for paper gold.

Then there are the bystanders just sitting around and hoping that everything works out OK, that they will get to keep their job, and that they might someday be able to pay off those credit cards. They don’t know what the future holds, but they hope. Unfortunately, when gold breaks lose and the system collapses, these are the people who are going to be absolutely devastated. In the song lyrics of Aimee Mann, “It’s not going to stop, ’til you wise up.”

Props to Obama’s First Two Days

I have to say that it’s nice to have a Democrat in power again. I have some Republican readers out there (just embrace it, Kevin; talk to Taylor — he’ll help you) who I know will find it very annoying for me to be joining in the celebration of Obama’s first couple of days. But, I have to say, that I like what Obama’s done so far: moving to close Guantanamo and the CIA’s secret prisons is simply awesome. The very existence of these programs is not only Un-American, but, I believe, unconstitutional.

Where, in our Constitution, does it say that the United States can take people into custody and detain them for years at a time without bringing them up on charges? I was hoping that the justice system would actually reject Bush’s programs, but the years went on and nothing happened. It seemed that someone in the Bush Administration decided to leave the people detained in Guantanamo for the next President to sort out. (I felt this even before Bush got re-elected in 2004.)

For that matter, Iraq seemed little more than a talking point in the “War on Terror” in Bush’s second term; other than sending some additional troops into Iraq, what really changed there? For that matter, what did the additional troops accomplish other than to give John McCain something to ramble on about during his campaign for President? I love what The Daily Reckoning’s Bill Bonner said about the Iraqi journalist throwing a shoe at Bush: “What’s wrong with our American journalists? Have they no shoes?”

Indeed, I wondered the same thing about a lot of people. How could we allow the Bush administration to rewrite the power of the executive branch before our very eyes and have so little outrage? So, I am pleased to see Obama’s first acts being so definitive to curtail the obvious abuses of the prior administration. Although, Wall Street doesn’t seem quite so happy about it.

As Taylor pointed out in his last comment,

“The percentage decline is the worst ever for the Dow on a president’s first day in office. That would break the old record, 2.9%, set on Nov. 22, 1963, when Lyndon Johnson took over after John F. Kennedy’s assassination.”

Of course, there’s a maxim on Wall Street that the first two years of a new Presidency will be down years and the last two will be good ones.

Still, that was a particularly violent reaction to Obama’s first day.

Although, I made money. As you can see in the chart below, Barrick Gold has been doing just fine over the 3 months since Obama was elected President. On that fateful day of which Taylor spoke, when the Dow was down 4%, Barrick was up some 5.8%. What can I say? Gold’s been treating me well.

That’s not to say that I think this stock isn’t going to see some rocky times ahead. I do think the forces of liquidation are taking a breather — for now. The volatility of this week is more the Wall Street traders showing their displeasure at the forces of Socialism that Obama represents. But I expect it to stabilize over the next few weeks. In fact, I’m expecting a bit of a rally. It’s going to be a sucker’s rally, though; but I still expect it’s going to trap a lot of people who are thinking that the worst is behind us.

Barrick will probably be taken down a peg or two in the upcoming collapse, but it’ll come back. I can’t say the same for the rest of the stock market. We’re making the bitter transition from a consumer-driven economy to a producing one. The first stage is that the businesses that catered to consumer spending need to leave the scene to clear the field for the new companies. That means you can expect a lot of companies going bankrupt this year.

As for me, I’m doing a bit of trading. As you can see from that chart of Barrick, it seems to be hovering between a range of $31 and $36. That’s a pretty healthy trading range to buy in at the bottom and sell at the top, and that’s what I’ve started doing. I’ve turned some extra profit from it so far. I expect that all my profits will be taken out by the upcoming collapse, but those profits should help to cushion the blow. It’s the buying at the bottom where you can expect to make some real money.

I can only hope that these easing up on the powers of the executive branch may indicate that, perhaps, my fears of him being the next FDR and implementing a lot of BS controls — such as gold confiscation — may prove false.

Mercifully, false.

My Investment Scorecard for 2008

I just went through and reviewed how my investments did throughout 2008. I will now reveal my result. Drumroll, please.

In 2008 … my ROI was …

25%!!!

That’s right. While everyone else went broke, I was makin’ bank. How on earth did I do it? Okay, okay, okay — I’ll tell you. But only ’cause I’m a nice guy; I had three investment accounts: a ROTH IRA, a traditional brokerage account, and a Variable-Universal Life Insurance Policy. At the start of the year, my accounts were invested as follows:

* My VUL Policy had roughly $3500 invested in Gold Mining Stocks through the Rydex Precious Metals Fund. (RYPMX)
* My Roth IRA had roughly $17,000 invested in Water Mining Companies (PHO) and gold bullion (GLD).
* My traditional brokerage account has roughly $1500 invested in the Prudent Global Income Fund (PSAFX)

As you can see from the start, I was invested to profit from a falling dollar. Let’s take a quick step back into the recent past; last fall, to be specific.

It’s October, 2007. The stock markets have recently reached their peak with the Dow Jones closing at 14,100 on the 9th, and I just don’t see how stocks will possibly hold any value with all the bad news now coming out. At the dawn of 2008, I want to try and steer as clear of the main stock market as I can; as February ends, I liquidate both of my Roth positions, basically breaking even.

Springtime, and the market’s begun to heavily swoon; I want to reposition myself to profit from the short side. I put my Roth money into the Prudent Bear Fund, (or BEARX) since it’s 70% short the market, and 30% long on gold mining stocks. Now it’s June; I’m investing another $5,000 into my Roth, (my 2008 contribution), and also continuing to invest in Prudent Bear.

Here comes a September to remember. We see the bankruptcy of Lehman, and the stock market rallying on the news. I’m basically sitting flat in my portfolio for the whole year — quite frustrating. I’d positioned myself well to profit from all of the bad news, and despite the copious amount of it, I’ve yet to show a profit. In fact, the stock market’s flaunting its irrationality by rallying strongly on Lehman’s failure. Over the next couple of days, it’ll proceed to fall, only to rally again as a Keynesian trifecta of Paulson, Bush, and Bernanke totally blow my mind announcing the TARP program.

Now, I’m in totally uncharted territory. I knew the period of history I was living in would show a stock market deflation in comparison to gold, but I wasn’t sure if it would from stocks falling, or gold rising. At the time, it seemed the Powers That Be would be combating the falling market with inflation, and so betting the market would fall, wouldn’t be a winning choice. Going forward, I figured that either: inflation would take hold, raising all boats, (favoring gold particularly), or the market would crash, causing people to then rush to gold in the panic. So, either way, gold was the way to go.

But here is where I made a critical error, choosing to liquidate my short positions just prior to the October crash. I wasn’t sure where to put my money, so half of it went into Barrick gold mining stock (ABX) @ $37, and the other, just sat in cash. A week later, the market’s started crashing, as the credit markets freeze. Barrick’s up to $38, but everything else is uncertain. Volatility has overtaken the market, values bouncing all over the place.

The now frozen credit market prompts me to look into bonds; and, sure enough, I find some South Trust, rated AAA, maturing six weeks from the day I bought them, yielding an annualized 30%. Having done my homework, I knew South Trust, recently acquired by Wachovia, had now been taken over by Citigroup. Seemed pretty clear from all of the TARP madness that Hank, George, and Ben were peddling that Citi wouldn’t be allowed to go bankrupt. So, I sold most of my Barrick stock (for a small profit) and put the $20,000 into the South Trust bonds.

Turned out, it was a great move. Not only did I make $800 in six weeks when they hit maturity, but I say out the bulk of the decline in Barrick. I’d been actively trading it up and down in my traditional brokerage account, pretty much breaking even once all was said and done. But, as the bonds matured, I was still able to scoop up a ton of Barrick Gold close to the bottom. It was a decision at the time, trying to figure out if I should put the whole $21,000 to work in Barrick, or only half, instead. At this point, Barrick was range-bound between $20 and $25, so I decided to invest $11,000 into Barrick at $20.50, leaving the rest in cash to buy more, should it have fallen any further.

Of course, this was a decision I’d come to regret as Barrick took off — and never looked back.

But, by year’s end, Barrick would be trading in the neighborhood of $36 a share, my $11,000 investment now worth $20,600; had I bought in with everything, knowing I would’ve made even more.

Ah, well. It beats losing money.

As 2008 came to a close, I broke even in my traditional brokerage, (funded up to $9,000), my VUL had fallen to $2,200, or so, with my Roth sitting pretty at $32,000.

Okay, I know my math isn’t exact here, because I’ve not annualized any of these figures to correct for the fact that a lot of the money was added mid-year. If I did, my ROI would be even higher. But why be greedy?

All that being said, my final scorecard was:

Start 2007            Money Added         Subtotal          Year-End
Roth IRA                   $17,000                           $5,000                          $22,000                       $32,000
Traditional                 $1,500                           $7,500                           $9,000                         $9,200
VUL                            $3,500                             $260                           $3,750                          $2,250

Totaling up the subtotal field, I get $34,750 and a year-ending of $43,450. That’s right at 25%. As I mentioned, if I’d have corrected the ROI by factoring in the added money only being used for half the year, that ROI would be even higher.

Furthermore, since the major gains all came in the Roth account (which is TAX FREE, don’t forget) that means that my “tax equivalent yield” is even higher. That’s just a fancy way of saying, that since I don’t have to pay taxes on the gains in the Roth, the return is the same as making a greater amount that I would pay taxes on.

All in all, it was a profitable year.

Inflation Concerns Return to the Market

Barrick Gold finished up today 9.48%, a beautiful move. COMEX gold finished at 4.44% to close at $798 an ounce. Meanwhile, here are a couple of interesting headlines today: Fed Weights Debt Sales of Its Own and U.S. Treasuries Fall as Demand Drops at Three-Year Note Auction. Both stories provide very tellings signs of the time.

The first story is that the Federal Reserve wants to be able to issue bonds- a bizarre notion for an entity that can create as much money as it wants at any time. The reason a money creation entity such as the Federal Reserve would want to start borrowing money is because it’s worried that if it continues to run the printing presses to fund of its bailout programs then it would create excessive inflation. The later story says that yields are starting to creep into longer term US debt obligations because concern is developing that, as the article says, “the government will flood the market with securities to pay for a financial rescue.”

Put the pieces together, and what happened today is that the market started to react to inflationary expectations based on concerns about all of these bailouts and stimulus packages. Those inflationary expectations are causing bond yields as well as the price of gold. Hence, for today at least, inflation is replacing deflation as the investor watch word of the day. Gold, the traditional inflation haven, should perform very well if this investor mindset continues. For those who had the fortitude to buy into companies such as Barrick Gold close to the bottom (as I was fortunate enough to do) we have seen a 50% return (or more) in roughly six weeks.

I have some cash to put to work in the market right now and Barrick Gold is a company that I believe will continue to do quite well. I took some profits today because the gold market should remain volatile and so it should bounce around quite a bit in both directions. Consequentially, I’d like for it to decline back to $25 a share or so before I buy more. Meanwhile, the profits I took will allow me to go Christmas shopping and pay off some debts.

Incidentally, I’m working with some investment professionals to help investors protect themselves from the falling dollar. Interested parties are encouraged to contact me.

Till next time. Keep your powder dry.

Fire or Ice

Some say the world will end in fire;
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To know that for destruction ice
Is also great
And would suffice.

– “Fire and Ice” by Robert Frost

Cat, an old friend and new reader, recently posted this comment:

Hi Preston,

I read yesterday that Bush was moving into Preston Hollow in Dallas. Suddenly, I wondered, “What happened to Preston Poulter?” I was pleasantly surprised to see that you had a blog and had even run as a Libertarian for Texas Rep.

I enjoy this blog and the Libertarian perspective. You write plainly and with great focus. You write without much malice. It’s nice to find a blog that is about a person’s passion for betterment rather than an attention grab or a vehicle for invective.

I hope your find the Argentinian’s words interesting. He’s living the best he can in a world that went from prosperous to dangerous gradually. So that’s a mild blessing — economic collapses don’t often happen to an entire population overnight. You can kind of see them coming if you’re looking. This gives you time to spread your message about how to prepare for a period of increased self-reliance.

Aside from economic collapse, I am concerned about infrastructure collapse for various reasons. Avian influenza (H5N1) is probably on a collision course with mankind. It’s endemic in bird populations now. Every farmed chicken/duck/turkey that is raised and consumed is a living flu laboratory that is gradually mutating the virus into something that can potentially be transmitted to humans. Once that happens, we will likely see a global pandemic that cripples our import markets and results in critical supply shortages as people become reluctant to leave their homes.

This is a decent book to read about bird flu: http://birdflubook.com/toc.php Take note of his personal affiliations with animal rights groups as a potential conflict of interest. The science and history of pandemic influenza as he describes them are still sound (if a bit simplified). I found it to be a good primer. Everyone’s obsessed about the economy while this monster slumbers somewhere in the world.

Either way — economic collapse or influenza like in Stephen King’s The Stand, people have much to gain by preparation for harder times.

Thank you for the kind wishes. I hope my chatter isn’t clogging up your blog. I enjoy having intelligent people to talk to.

– Cat

I did not know Bush was planning on moving to the Preston Hollow division of Dallas, Texas but apparently it is so. As for my running for Libertarian State Representative in the last election, you can read about my experience here. As for the Argentinean’s experience with hyperinflation, it’s interesting to hear that gold jewelry became a currency and that all gold was treated as scrap gold on the black market.

In my book, “What Do You Mean My Money’s Worthless?” I recommend that people purchase and keep a fair number of Silver Eagle’s on hand. They are each verified to become ounce of 99.9% pure silver which makes them a known quantity should we have to deal with a black market scenario and, as they have roughly comparable value to a $20 bill, they represent the right amount of wealth to go shopping.

As for your concern regarding Avian Flu, you aren’t the only one to be worried about that. In James Howard Kuntsler’s book, The Long Emergency he discusses the likelihood of a epidemic that wipes out a large portion of the population as well as the famines that he feels are inevitable given how expensive energy is going to be. Kuntsler’s hypothesis is that we have exceeded the carrying capacity of the planet and that we are going to start see the human population forced to shrink by various means in the next few decades.

I don’t spend any time worrying about scenario’s like that. I feel that being a being a Wall Street bear takes up enough of my time, so I really don’t have time to worry about other scenarios such as disease wiping everyone out. And the real problem with that kind of thinking is that it seems there’s not much that can really be done about it. If the “Spanish Flu” really does make a come back, there’s not much that can be done about it. Being a Wall Street bear, on the other hand, means you can take steps to protect yourself and profit from market declines. Then you can make fun of permabulls like Ben Stein and Jeremy Sigel.

Speaking of, the Dow finished down today 2.72% while the stock of Barrick Gold (ticker symbol=ABX) went up a good 1.83%. That’s what I like to see as a bear market investor: stocks down, gold up. That’s a trend I’d like to see continue. I talk about the ratio of the Dow Jones Industrial Average to the price of an ounce of gold in my book and how certain I am that that ratio is going to decline in the near future. When I wrote that book, the ratio was at 17. Today it’s roughly 11.3. In the next couple of years, we should see it decline all the way to three or lower, and that’s a lot of profit to be had. And making money off of economic downturns if far better than making them off of market upswings because it means you’ve got money when everyone else is broke, which is what we bears fantasize about.

The Not-So-Efficient Market

There is a theory in stock circles called the “Efficient Market Hypothesis.” It was first proposed by a student of famed mathematician Benoit Mandlebroit (who proposed Chaos Theory) named Eugene Fama. The theory is easy to understand; markets such as the stock market have so many players that it reacts instantaneously to process all known information about a given security. A corollary of this theory is that because all information about the market has already been “priced in”, that it’s impossible to beat the market because any actionable information about a given security is already reflected in its price. This theory was popularized in books such as A Random Walk Down Wall Street. It has been attacked in a number of books including Benoit Madlebroit’s The Misbehavior of Markets as well as my book, What Do You Mean My Money’s Worthless.

I’ve found that some of my biggest investing mistakes are caused by giving any credence to the notion that the market has priced in any information at all. Case in point, for much of this year I was an investor in the Prudent Bear Fund (ticker=BEARX) which is a mutual fund that is short the market, yet, despite many of my predictions of doom and gloom coming true, the stock market continued to hold its value in the face of more and more bad news. Then came October. Paulson and Bush announced that they were going to do a massive bailout of all troubled assets on bank balance sheets after allowing Lehman Brother to fail, and the stock market rallied strongly.

At that point I lost faith that the stock market was going to decline. It seemed that the Federal Reserve and the US Treasury were simply going to inflate the problem away, and the market was responding in just such a direction. So the logical move to me seemed to be to invest in gold in order to protect from inflation and away from shorting. I figured that, with all the bad news that has come out, if the stock market was going to crash it would have already done so. I closed my short positions just before one of the most violent stock market collapses ever based on the belief that knowledge of the credit freeze and oncoming recession were already “priced into” the market. I’m still up on the year (which few people can say) but I missed out on a great opportunity to profit due to my putting ANY credence in the notion that the market was efficient.

Now I’m realizing that the key to investing is not to predict the tomorrow’s headlines, but rather to figure out which of yesterday’s headlines will the have staying power to shape market movements in the future. That’s what I’m trying to do today. Call it the “Slow Market Hypothesis”- which significant piece of news will the market take the longest to get through its thick head? A question that is very much on my mind today.

The headline that’s dominated the last couple of months has been that “Deflation is Coming. Run to Cash!” Call me crazy, but I think that headline’s played out now. The headline of today was that “Dollar slides as Obama vows stimulus.” Gold moved strongly up and Barrick Gold, my personal investment vehicle of choice, closed the day up 8.39%. I think that the headlines going forward are going to become more focused on inflation rather than deflation as markets react to the new ending stream of new dollars being cranked out by the Treasury and the Federal Reserve. Just today, it seems that Congress and Bush are dipping into the bailout goody bag for $15 Billion to loan the auto industry. The hard figures on M2 straight from the Federal Reserve says that our money supply has expanded by 7% over the course of year, which is not nearly as alarming as the “Adjusted Monetary Basis” (a measure which accounts for changes in the reserve requirements as well as changes in foreign exchange market intervention) which the St. Louis Federal Reserve Bank publishes. Here, take a look at it yourself:

http://research.stlouisfed.org/fred2/data/BASE_Max_630_378.png

That’s a rather astounding rise in the monetary base (1400% annualized), and it’s only going to get worse. The next stimulus package that’s being proposed by Barack Obama is roughly $1 trillion.

The rise in the value of the dollar was caused because liquidation was forcing people to sell their assets in order to meet margin calls that were written in terms of US dollars, but that’s going to be a short lived phenomenon. As the full impact of these monetary shenanigans start to sink in, the market will seek a safe haven that isn’t being grossly tampered with, and that’s going to lead them back to gold. That’s my prediction anyway, we’ll see how it turns out.

BARRICK!!!!

It’s days like today that I live for; Barrick was up 31.31% over the course of today’s trading session, and I made over $6,500 today. It feels really nice.

I’m not a huge market technician, but I pick up a few tricks here and there. You look at a chart like that, and a technician would tell you that Barrick was in a trading range over the course of the month from lows in the $17’s to highs in the $25’s. Then, it suddenly breaks out in one huge burst on high volume, and the stock seems poised to go even higher. If you happen to have loaded up on the stock near the bottom of the trading range, then you’re suddenly transformed from a rational person into a spectator at a horse race: screaming, “GO, BABY, GO!”

Putting all that aside for a minute, I felt the whole week was pretty strong for Barrick. The stock market as a whole was reaching new lows over the last couple of days, but Barrick was holding steady in the low $20’s and not budging. That’s an encouraging sign because, as I wrote in prior posts, it indicates that the stock is starting to no longer follow the broader market trends. The reason I feel that’s important is because I feel that the overall stock market still has further to fall, while gold has nowhere to go but up.

Next week I’ll be interested to see if Barrick falls back into its old trading range or if it continues to move higher into a new one. Obviously, I would be elated if that happened. Here’s hoping Santa Claus is coming early.

Disclaimer: If anyone out there is stupid enough to follow what I’m doing with their own money and you end up with losses — don’t blame me. I’m not advised as to your situation and I’m certainly not legally in a position to be making recommendations to anyone.

All I Want for Christmas is a Gold Short Squeeze

I’ve mentioned in this blog before that I feel that the price of gold is kept low through market manipulation. That conclusion seems to be the only one that makes sense given the difference in price between the COMEX spot price of gold (currently $725) and the ebay price of one-ounce gold coins (currently $940-950). As previously mentioned, the main difference between these two markets is that Ebay is a market place where buyers and sellers are getting together to exchange the physical metal coins, whereas the COMEX markets are where buyers and sellers are getting together to exchange paper claims to gold. Ideally, there should be no difference, but since I can sell a paper claim without actually having the metal itself to sell, I could theoretically flood the market with paper claims to gold to depress the price. The one catch is that the buyer has the option of notifying the seller that he would like to take physical possession of the contracted gold, at which point the seller must provide the physical stuff.

According to COMEX, it has 5 million ounces of gold in it’s possession, whereas 18 million ounces are currently contracted for December delivery. Typically this isn’t a problem because COMEX is a traders market and traders hardly, if ever, take physical delivery but are instead content to settle up with the dollar difference between the buy and the sell. But current market situations present a unique arbitrage situation. Arbitrage, is where there is a price discrepancy between two different markets for the same good. If the price is large enough, then all one would have to do is buy the good in the cheaper market and sell it for a profit in the more expensive one. What if someone did that with gold?

When someone places a “short trade” they are selling something in the hopes of buying it in the future. If the short sale has not properly borrowed the asset they are selling then they are, in essence, just hoping that the buyer won’t ask for it before the seller places the buy order to cover their original short sale. What can sometimes happen is that the short sellers create more open orders for something than they can comfortably get their hands on because someone else is actually buying up all the open interest. When that happens, the price of the object in question keeps going up and the short sellers suddenly must scramble to buy whatever the object in question is to cover their shorts and they come to find that there simply aren’t enough available to fulfill all the short orders that needs covering. This is called a “short squeeze” and the result is that the short seller ends up broke as the holders of the object can name their price to the short seller who now must look to them to cover his short.

A short squeeze on gold is the stuff of legend. The last time the a corner on the gold market was even attempted was in September of 1869, when then infamous “robber baron” Jay Gould lead an conspiracy of financiers to ruin in the attempt (which you can read more about in Dark Genius of Wall Street: The Misunderstood Life of Jay Gould, King of the Robber Barons). In fact, when I bring up the idea of such an event happening, most people seem to dismiss the idea of a replay of the Hunt’s attempt in the early 1980s. The key difference here is an attempt is not being made to corner the entire world gold market, but rather just to squeeze the shorts on the COMEX who have promised to deliver far more gold than they could ever lay their hands on.

The traditional problem with attempted corners is that, if the attempt does not pay off you have a lot of over leveraged parties who have to unwind all of their buy positions which causes the market to fall ever faster back towards the old price. But, in this case, there would be no reason to sell your long positions (i.e. your buys) because you could simply take physical delivery and see it on the physical market; that is, you’re showing a profit by way of the buy anyway, and if it results in a short squeeze that hugely jacks up the price of gold, so much the better.

This idea has been floating around the internet lately and MSN’s Professor Lewis has indicated recently that early signs of a short squeeze brewing are starting to crop up. The biggest indicator Dr. Lewis points to is that the gold leasing rates are starting to shoot up (an indication that banks are increasingly unwilling to loan out their gold). These rates have not come down as the central banks of the world have extended credit to the banks, which indicates that it’s not just a liquidity issue at stake. A huge up move in the price of gold could be in the works. As a huge holder of Barrick Gold stock (ticker symbol ABX), I must say that that would make a very welcome Christmas present indeed.

Volatility Continues

The market sure is doing some crazy things lately. The Dow was up over 12% or so on election Tuesday. Then, after the candidate who was favored to win actually won, it fell 5% or so for the next two days in a row. I’m starting to miss the good old days when the market just moved in steps of .5% a day instead of big five and ten percent moves. Gratefully, my Barrick stock only lost a couple of percent yesterday, which was much better than the broader market. Today it did not hold up so well, losing 7.3% compared to the Dow’s 4.8%. I was expecting that the announcement of Barrick’s earnings would stabilize their stock performance, but it doesn’t seem to have had any effect. Instead, I just read some analyst writing that the lower gold price impacted Barrick’s earnings, but that’s not quite accurate.

If you dissect Barrick’s Q3 earnings, you’ll see that their income for the third quarter was, in their words:

In third quarter 2008, net income was $254 million, compared to $345 million in the same prior year period. Net income includes impairment charges on investments totaling $97 million, principally due to a write-down of our investment in Highland Gold whose share price declined from $3.49 on June 30, 2008, to $1.21 on September 30, 2008, and was recently trading at around $0.76. Excluding special items, net income was slightly higher than the prior year period, as higher gold prices were partly offset by higher gold and copper total cash costs. Although gold production was higher than the prior year period, gold sales volumes were lower due to a temporary increase in unsold finished goods inventory at Goldstrike and Bulyanhulu due to the timing of shipments. We expect to sell this production in fourth quarter 2008, generating an expected profit contribution of approximately $27 million.

So it wasn’t the price of gold that impacted Barrick’s earnings as much as the dramatic drop in the price of the common stock in gold companies- specifically they lost their shirt’s in their investment in Highland Gold. But that does seem a one-off event that isn’t likely to be impacting their earnings going forward.

And what of the price of gold. Well, mining analyst and geologist Éric Lemieux has this to say about the price of gold:

The decline in gold prices flies in the face of every theory. The U.S. dollar has been appreciating and the U.S. economy is going through a recession. Gold should be increasing in value in the face of all this uncertainty. To see the price of gold going down right now is almost unexplainable in my opinion. It begs the question, is this due to some type of manipulation, either directly or indirectly?

… I believe we’re experiencing the results of probable financial industry fraud. Time will tell who was responsible. I hope we will hold the perpetrators accountable. Unfortunately, I think certain elements are trying to sweep all this under the rug.

I agree with him that the decline in the price of gold flies in the face of everything that SHOULD be happening at this time of uncertainty regarding gold prices. I also agree that there is manipulation going on and that that will probably be revealed in time. And, as previously mentioned on this site, there is an ever growing disconnect between the price of physical gold and the COMEX price of gold futures for immediate delivery (i.e. “the spot price”). Theoretically, these prices should be within $50 of each other or so because the gold coin would sell at a premium over the spot gold price reflecting the cost of minting the coin itself. Today, the COMEX price for gold for gold closed at roughly $725, while gold listings on ebay in the last week are selling for $940.

That’s a difference of over $200 between those two prices, and that’s indicates that something is just not right. Somehow, the COMEX price for gold does not reflect what people are actually paying for it. Whether that’s due to market inefficiency or outright manipulation by the banking system and their paper claims to gold is left to the reader’s discretion, but I do feel that we’re going to see a strong upward move in the price of gold in the months ahead. Let’s also not forget that the President Bush and President Elect Obama are going to be attending a multinational meeting on November 15th; this promises to be the first of many meetings regarding the current economic crisis and gold has already been mentioned by French President Sarkozy as the answer that will bring “discipline” to the market. So factor in a lot of world leaders paying lip service to gold in a couple of weeks and I don’t see how the price is going to continue to gold down, manipulation or no.

Ben Bernanke’s Kick…. It’s Good!

Today the Fed announced that it was lowering the Fed Funds rates to 1%. The market rallied strongly late in the day, and then gave it all back to close at a loss. Barrick Gold, the stock I follow and am an investor in, announced that they were doubling their dividend and rose nicely to close the day up some 12% or so. Combined with a similar rise where Barrick mirrored the entire stock market in a 10% rise and I’ve had a couple of good days. The strange thing is that, outside of the announcement of this dividend today, Barrick has not had any newsworthy events or announcements for the entire month yet their stock has fallen from $37.36 on October 1st to trade at $18.14 on October 27th. When a company with a good balance sheet loses 50% of its value on absolutely no news, you know it’s a volatile market.

I feel the stock’s going to make it all back though, so I’m not particularly worried. Still, as someone who’s been watching stocks for ten years or so, I’m not used to this kind of volatility. Usually if a stock loses 50% of its value, it’s because it announced it was being investigated by the SEC or something, but in today’s market it seems like anything goes. To try to understand what’s happening, you have to understand that basically the price that a stock trades at is really just a game being played by various players. Everyone comes to the game with money, but they borrow a lot more because that’s how big profits (and loses) get made. When someone in a leveraged position (i.e. they bought stock with borrowed money) takes a big loss they will often face having to liquidate their entire position just to pay off their creditors, and I believe we are seeing some of that happening with Barrick’s gold price.

In Edward Chancellor’s Devil Take the Hindmost: A History of Financial Speculation he discusses the stock market of the late 1800s- the so-called “Gilded Age of the Robber Barons.” This was back before the days of the SEC; in fact, the SEC was created in part to stop the very activities that these guys would engage in. The market had various players, men like Jay Gould or JP Morgan, and each was playing with plenty of leverage. These men would often take interests in thinly-traded stocks because their stock price was easier to manipulate. Such stocks came to be known as “footballs” because they would be kicked by the various players to almost whatever price was desired. Fortunes where made and lost on these manipulated stock prices of these footballs.

Fast forward more than a century, and it seems like the rules have changed, yet the game remains the same. Except now, instead of thinly traded stocks, the world market for everything from the price of oil to gold to the stock market seems to be kicked about by the various players of hedge funds, central banks, and governments. So I wasn’t too worried much about the loses I’d taken on Barrick this month. I figured it would only be a matter of time before one player or another would kick the stock back into play, and along came Ben Bernanke to cut the Fed Funds rate to 1%. Thanks Ben! I needed that.

Of course, I’m not sure that was the right now for the American economy as a whole. Fundamentally, we just need to get our house in order. Both our government and our people need to start spending less money than they take in for starters, and I’m afraid your interest rate cut is actually just an attempt to get them to do just the opposite. Making it easier for people to borrow money by lowering the key interest rate just discourages savings, and that’s actually the opposite of what needs to be happening now. But, what’s bad for the US Dollar is good for gold. It also seems to be good for the sales of books related to the collapse of the American Dollar.