How to Apportion a Larger Portfolio

My brother called a couple of days ago. His wife has $100,000 to invest and he wanted to know where I thought I should put it. I’ve made recommendations in the past and they’ve always made money; which I feel puts a bit of pressure on me because each time I feel I’ve got to live up to my own record.

It’s also tough because the investment market is so screwed up with the recent actions of the Federal Reserve. In the 1800s, investing was pretty simple, you just put your money in bonds and forgot about it. Since consumer prices went down for most of the 1800s (with the notable exception being the war-time inflation of the Greenback fueled Civil War) the return you received on bonds would be in addition to the additional purchasing power the money itself possessed. Few people invested in the stock market in those days; it was seen as a shady place where individuals like Jay Gould, Cornelius Vanderbilt, and Nathan Rothschild could use their deep pockets and insider information to force a stock price to be whatever suited them at the time. A stock exchange was more casino than sober investment house. Bonds were where the common man should put his money.

Of course, the advent of the Federal Reserve changed all that. Continue reading How to Apportion a Larger Portfolio

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.

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.