A look at the real value of gold on an historical basis.

I like making random gold ratio charts in stockcharts.com since it lets you chart the ratio of anything: gold:oil, gold:copper, gold:SPX, etc:


If you do this kind of analysis on a longer-term basis, you see that gold is getting a bit expensive relative to other commodities, capital goods or labor (or you could say that each of those things is getting cheap when priced in gold). What is clear is that gold is no longer cheap by any measure. I don’t think this type of analysis has anything to do with where gold price goes in the near-term (technicals and sentiment drive that), but it’s helpful to think about where gold is on an historical basis.

  • The Gold:Oil and Gold:Copper ratios are moderately high, and would be off the charts if oil and copper were to crash.
  • Rent on a nicer 1BR apartment in Manhattan has fallen from 8 ounces in 2001 to 2 ounces today. This is about what it cost in the 1920s-60s.
  • 10 ounces in 2001 bought a 12-year-old Honda Civic, and now it gets you a brand new one with extras. A Model T Ford cost 15 ounces by the 1920s. The VW Beetle cost 30-50 ounces in the ’50s.
  • Median family income in was about 50 ounces in 1920, 90 ounces in 1955, over 100 in 1965, 70 in 1975, 75 in 1985, 95 in 1995 and way over 100 in 2000. Today, it’s about 30.

On a purchasing power basis, gold is adequately priced – it is certainly no longer cheap. Of course, markets don’t care about this on anything but the longest term – gold was overvalued at $500 in 1979, but it still spiked over $800 and then fell to a ridiculously low level in 2000. In the scenario where the dollar goes to zero, everything will soar in dollars, not just gold, so you’d still have to evaluate gold in terms of goods and services.

I’m still in the dollar bull camp for the foreseable future. Treasuries are pointing the way (record low 10-year yields, 3.5% on the 30-year, almost like Japan), and it looks like another bout of deflation is underway, if you define deflation as a contraction in money and credit (if credit is marked to market). Europe’s soveriegn debt implosion is deflationary. The same goes for the Australian real estate collapse and the pending RE collapses in China and Canada, and the US muni and junk market troubles.

I don’t see the dollar as any worse fundamentally than the euro or yen, and much better technically. Japan’s history since ’89 is proof that printing and spending and running up huge public debt doesn’t necessarily kill your currency. When there is too much private debt going bad but not being written off, it overwhelms the mismanagement of the currency and props it up. It doesn’t matter what you think of the fundamental value of the dollar if you’re in debt and can’t find enough dollars to make your payments. And until asset and labor prices and demand for goods and services can justify borrowing costs, there’s no credit expansion so no inflation.

Sentiment-wise, we’ve still got a great long-term case on the long-dollar trade. Fear of the dollar has been widespread since early 2008, but the DXY has just bounced around sideways – no crash. The crash happend from 2000-08, while nobody but old-school Austrians noticed.

Inflation, deflation & the dollar – where do we stand?

We have had inflation since late 2009, using my favored definition of inflation as an increase in money supply and credit from Mish. By the way, commodity prices change with the speculative whims of of the financial markets, and are not a good definition of inflation (commodities fell from 1980 to 2000, as we experienced credit & monetary inflation and the price level doubled).

Since 2007, the monetary base has of course soared (see below), but in 2008 and 2009 its increase was overwhelmed by the decrease in private debt (marked-to-market), and the mood of risk-aversion. Since then defaults have eased and new debt issuance has grown, so we have had significant inflation.

Monetary base:


Monetary Aggregates:


The world is still laden with too much debt to sustain, so we will likely be back into deflation and de-risking before long. The following debtors in particular have yet to have their come-to-Jesus moments:

  • US cities & states (muni-bonds)
  • Canadian and Australian homeowners (record high prices, prices too high relative to incomes and rents, absurd loan-to-value ratios).
  • Several European nations (Portugal, Spain, Italy, much of Eastern Europe). Actually even Greece and Ireland will have to default before long, since their bailouts were just extensions and added to their debt.

The Kondratieff cycle is not perfect, but its main point is that debt cycles are generational, since they have as much to do with attitudes as with numbers. The deflation/de-leveraging phase (winter) can last over a decade, and this one certainly looks like it will.

Previous recent generations were as follows, off the top of my head:

  • Winter: 1929-1940 (decrease in debt, falling assets, low interest rates, falling to stable prices)
  • Spring: 1940-1966 (early debt growth, rising assets, rising interest rates, moderately rising prices)
  • Summer: 1966-1982 (continued debt growth, falling assets, high interest rates, rapidly rising prices)
  • Autumn: 1982-2007 (rapid debt growth, rapidly rising assets, falling interest rates, slowly rising prices)
  • Winter: 2007- (decrease in debt, falling assets, low interest rates, falling to stable prices)

The dates are approximate – some say that winter began in 2000 when we first faced deflation. Also, all nations are not in sync. Japan went into winter in 1990, and is still in it despite massive and repeated central bank printing.  What clears the way for spring is the reduction in debt, and the west is making the same mistake that we criticised the Japanese for making, propping up failed institutions and not allowing the market to clear.


Bonus chart: US dollar index since 1985 – in classic form, by the time everyone started worrying about a dollar crash (2007), it had already happened.


Despite its central bank’s profligate ways, the Japan’s currency has risen dramatically since the 1990s. Don’t count the dollar out just yet. This chart shows yen per dollar (downward slope = rising yen):




Thoughts on P3 and the secular bear

Hi guys.

Sorry for being so quiet on the blog lately. I’ve been busy trying to take my mining site out of beta among other things, and not following the day-to-day action much.

In response to comments about Elliott Wave and EWI, I actually don’t read EWI anymore except for Prechter’s monthly essays. I don’t see that the short-term stuff offers much of an edge over just following basic technical and sentiment indicators. Trying to force the market into fitting a specific pattern has just not been a good way to go, but the intermediate-term technical indicators have been doing quite well.

For instance, put:call, vix and weakening RSI have nailed the tops in November, January and March-April. The last was just screaming SELL as loud as the market ever does, and we got the follow through we deserved.

Short-term oversold conditions in late May and July were marked by the VIX and weakening selling as indicated by RSI.  Constantly anticipating a hard 1930-style P3 is just a bad way to play. Of course you don’t want to be caught long without protection at any point in this environment, credit crunch and depression that it is, but there is a tremendous degree of speculative enthusiasm and stubborn optimism among traders that is making this a long slog down.

Of course I think this is a secular bear market that won’t end until there is real value restored in stocks and real estate, which means solid after-tax yields high enough to compensate scared investors for the risk of further capital losses. But there is no reason why we have to get there in 3-4 years — this could go more like ’66-’82 in the US or post-’89 in Japan.

That said, we have not had full-on recognition of the extent of the economic problems within the financial community, with most analysts and economists clinging to the hope of Keynesianism. Trading horizons are so short-term among the big players that these considerations hardly matter. The technicals are all that drive the machines and guys like Paul Jones, Cohen, etc.

This is a deflation though, no doubt at all. Credit is contracting hard, and prices of everything not directly traded as futures or set by the government are falling. This includes private sector wages, groceries, capital goods, etc. In this environment we do not have the same set-up as for the rolling sideways market of ’66-’82 (only in nominal terms was that a sideways market – in real terms it was a 75% loss). The ’30s and Japan are still the corollaries to watch.

Also remember that the public sector has gotten itself into huge trouble, which is just starting to take effect with austerity measures in Europe and pending bankruptcies in US municipalities. US states are also broke and will have to finally deal with their union problems. Shrinking government worker salaries, if not payrolls, will put further pressure on demand for goods and leave banks with more bad loans. None of this is inflationary. Remember, in the ’70s private debt was low and growing, and companies were increasing their revenues and profits so that by ’82 Dow 1000 was a bargain. Now we’re in a generational de-leveraging, frugality-restoring mode, Kondratieff winter for lack of a better term.

The last couple of years should give deflationists confidence that we’re able to correctly assess the situation. Where is that dollar crash? What about $200 oil? What, in 2010 China still owns trillions in treasuries? Bernanke has tripled the US base money supply but a dozen eggs is still $1.50 and the long bond yields 4%? Obama spent how much, and unemployment is 17% ?

We make it way too hard on ourselves trying to get every squiggle right. Stocks and real estate are expensive and cash is still the way to go. Gold is still increasing in purchasing power. This is not bizarro world, it’s so far just a very big dead cat bounce after a 60% crash. US stocks are about where they were 12 months ago, and other markets are much lower, so clearly momentum is broken and bears should be confident so long as they’re not over-levered.


PS- In response to Roger, upon first glance VXX looks like a fine vehicle for trading volatility. It seems to have tracked the VIX without much error since launch. Of course VIX futures and long-term OTM puts are also fine for going long vol.

Don’t count on a big rally in commodities.

Yes, the “inflation/risk trade” is moderately oversold, but when oil, copper and the like start to fall, they can just slide straight down for months. I believe that the commodity rally of the past 15 months was just a dead cat bounce correcting the crash after the massive 2007-2008 bubble.

Now that we’ve had that correction (and then some when it comes to the metals), there is little reason for prices to remain elevated. The supply/demand situation today certainly doesn’t justify $3.00 copper or $1.00 nickel or zinc, and demand will be even weaker in a year when the construction bubbles in China, Australia and Canada are over.

Here’s a pattern I see in crude. Now that the uptrend (higher highs, higher lows) is busted (we made a lower low), all rallies may be short and weak:

TD Ameritrade

Copper’s uptrend is still technically intact but very weak(see RSI), and it could play out the same way:


Of course, if a large rally does develop, it will just be more fodder for the bears. I’ve entered a short on copper at $3.13 today, and am prepared to add to the position. I’ve also just picked up some July puts on crude futures (expiry June 17). I don’t like near-term options, but these got cheap today and will pay off 25:1 if oil is $55 three weeks from now.

If another broad-based rally in risk assets develops, I’m covered with longs on stock futures. However, I would not be surprised to see stocks (and the Euro) rally for a while here while commodities decline. When trends start to exhaust correlations can break apart.

Prechter interview: Fed may be ended within his lifetime.

From Yahoo! Tech Ticker last week. Lots of market talk, then Prechter makes the case for truly free banking, in which banks could decide for themselves what to use as money. He beleives that most banks and savers would chose gold, as they have for most of human history. The first segment below is mostly on the markets — the comments on the Fed are in the second:

EDIT: Sorry, I didn’t realize that there are actually two segments to this interview. The comments on the Fed are in the second half:

At the end, Prechter makes a key point about the gold standard: it is not a free-market solution, because it is a “standard” set by the government. Essentially, a gold standard is redeemable paper money, but as we saw in the early years of the Federal Reserve (and actually in older times with many other central banks), the exchange rate between paper and specie is set by the government. Paper money remains legal tender and the primary unit of account, so citizens are forced to use it and the banking cartel can still inflate.

A much better solution is no standard at all. Under such systems, the unit of account was typically a weight of gold or silver. Hence the British pound sterling, which was exactly that (sterling is 92.5% pure silver). Under these systems, there were safe banks that earned money by simply storing metal and clearing payments. Interest was low, but inflation was lower or negative, since the growth of human productivity from improved infrastructure and technology meant that goods and services became more abundant over time, while the money supply grew only as fast as new gold was mined.

This is why the price level fell steadily during the 1870s in the US while the economy grew at its fastest pace in history, and why the price of a postage stamp in England remained the same for 100 years, even as the country grew rich. There were booms and busts and banks failed, but because even big ones were allowed to fail, bubbles remained contained and the busts freed up capital for productive uses.

Such periods will come again. This is not the end of civilization, just the end of a long credit inflation.

Commodities crash underway: straight down or choppy?

Commodities did spectacularly well from winter 08-09 to winter 09-10. Many tripled in price, such as oil, copper and palladium. The world seemed convinced that another great phase of inflation was underway or would start real soon now.

The reality is that demand is anemic and that there has been little or no economic growth. The only exceptions are property bubbles in China, Australia and Canada that are just running on fumes, where America’s was circa 2006. The commodity bounce was purely a technical reaction from an extremely oversold condition, exacerbated by mistaken faith in Keynesian policies deployed worldwide. The rally began to stall out from mid-autumn to this March, and is now starting to roll over in force.

Here’s a 3-year chart of copper, a very liquid and widely followed market. Many believe it is an economic guage, but this is nonsense IMO, since it was trading well under a dollar as the economy was booming a decade ago, and like a lot of other commodities was very expensive in the stagnant 1970s (and right now of course). Prices are driven first and foremost by fads. Why else would you expect it to trade at $3.50 in the middle of a deflantionary depression when stockpiles are huge?


I don’t like to brag, since I get plenty of timing wrong, but back in April I noted the divergence in RSI and MACD right as copper made its top around $3.60.

Another favorite guage of risk appetite is the silver:gold ratio, which has remained stalled for the better part of a year now, and looks set to decline again:


Also check out the palladium:gold ratio, since palladium experienced a major speculative bubble lately which has started to crash very hard:


Here’s oil, West Texas Intermediate… in all of these commodity charts, note the severity and unrelenting nature of the last drop in 2008. There were few rallies where one could safely get on board for a short sale — you were either short from the top for the ride of your life or just had to watch.


I’m not expecting a lot of chop in these markets. I’d love a nice rally here to increase short positions, but it’s not the nature of commodities to take their time on the way down. Traders had months to see this trade coming and set up shorts, but for those who don’t over-leverage themselves it is by no means too late to get on board.

By the way, the commodity currencies (Australian, New Zealand, Canadian dollars, Brazilian Real and South African Rand) have also started to fall hard but have a long way to go to correct their rallies from last winter.

Want to see one commodity market that we’re definitely not too late to short? Gold and silver mining stocks (GDX ETF below). The gold bugs have been extremely confident and their ranks have swelled lately, so a deep set-back is much needed in this sector. After all, mining stocks often have a greater correlation with the S&P 500 than with the gold price (which I expect to fall, though not as much as stocks).


Ironically, I’m part of a group that’s building a huge database and stock screener in this space, called the Mining Almanac. Launching our beta site right at the top of a commodities bubble couldn’t be worse timing, so I’m trying to make lemonade and using it to search not for value stocks (what I designed it for) but the opposite so that I can short them!

For safety, don’t buy gold stocks, which are a financial asset with value contingent upon stock market conditions, tax laws (seen in Australia lately as their leftist government has slapped an extra tax on the mining industry) and myriad operational concerns. Along with plenty of cash and treasury notes, buy gold itself, either stored in your name in a vault oversees or in your personal posession. Gold is money, and in a deflationary depression with undertones of currency crisis, you want the very best.

Prechter in the morning (King World News interview)

Eric King is one of the best financial interviewers out there, so he gets the best guests of anyone I know.

Listen to the MP3 here, recorded last Saturday, March 20.


The last of the bears are capitulating, just as the last of the bulls turned bearish last winter. Everybody loves stocks after a 73% rally, and there is huge psychological pressure to be bullish.

The market only gives away free money for so long (unbroken strings of up days often come near the end, as in Spring 1930).

The last two times that the market made a double top (July/Oct 2007 and the 2000 top), the Nasdaq surged at the very peak, leaving the Dow and SPX behind. SPX has just barely made a new high, but it feels like it’s much higher than in January.

GDP expansion is very weak compared to the stock rally, bank lending and jobs are still trending negative.

This is not a recession that has ended. This is a depression that has had a big countertrend rally.

States are all bankrupt, because they always spend too much. Governments always go bankrupt in the end. (Interesting factoid: Nebraska’s constitution outlaws borrowing by the state, so they are in the best shape).

All of the dollar-denominated IOUs are going to be worthless in the end. The government’s backstop has delayed this, but the debt will still go bad. The central banks will not take on all the bad debt, so the governments are trying, but they will ultimately default themselves.

Hyperinflation is not an option with all this debt. Default (deflation) is inevitable. Government defaults are deflationary.

Cycles are part of the human social experience. Muni defaults haven’t happened since the 1930s, but that is only because that was the last time we were at this point of the debt cycle. Munis will end up as wallpaper — no way the states can pay them off.

Conquer the Crash was released in 2002, but the stock market rose for 5 more years and the credit bubble got even crazier before finally topping in 2007, but the extra debt is just making things worse now that we’re at the point of no return.

We have a return of confidence. AAII (American Association of Individual Investors) survey shows about 25% bears, same as October 2007 and May 2008 tops. This is not a good buying opportunity.

Every investing group (individuals, pensions, mutual funds, etc) has been overinvested for 12 years. Mutual funds are only holding 3.5% cash. They have never given up on stocks, even in March 2009, which was nothing like in the 1970s and early 1980s.

Very few people think we can end up like Japan, and keep breaking to new lows for 20 years. Everybody always has a “story,” a narrative as to why the market is going to keep going down (at bottoms) and up (at tops).  (Story today, IMO: PPT manipulation and money printing will drive stocks up forever). The story is often exactly wrong at the top and bottom.

Interest rates do not drive stocks. Lower rates are not bullish (just look at the 1930s or 2007-2008). Rates went up from 2003 – 2007 as the market rallied. People’s logic is always incorrect at the turns. Nor do earnings drive prices: stocks fell 75-80% in real terms from 1966-1982 as earnings rose.

Oil and stocks have a correlation that comes and goes – sometimes none, sometimes very positive, sometimes very negative. No predictive power.

Markets have a natural ebb and flow that arises from herding processes in a social setting. Reasoning about causation is a waste of time.

Economists jabber on about all kinds of causation, but they never offer statistics that pass muster.

Bond funds are going to slaughter the masses. The public always buys the wrong thing at the wrong time, and a wave of defaults is coming.

The dollar is likely starting a major rally (up 9% since fall, 11% vs euro). Prechter was early on that call but it still was a good one. Might be the start of a renewed wave of deflationary pressures.

The message in the new edition of Conquer the Crash remains, “get safe.” Find a safe bank, hold T-bills or treasury-only mutual funds, cash notes, and some gold and silver. No downside to safety.

Deflation explained in two simple charts

The charts below come via Mish’s post today on why it doesn’t matter that Bernanke wants to eliminate bank reserve requirements. The quick answer: Greenspan already did that in 1994 when he allowed overnight sweeps on checking accounts to free them from reserve requirements just like savings accounts. In this era, banks lend first and look for reserves later.

Anyway, way back in 2007 I first became convinced that this would be a deflationary depression because of this simple equation: there was $52 trillion in outstanding debt in the US, and only (at the time) $850 billion in base money (all the “cash” that the Fed had created since it was founded in 1913). As defaults and write-downs started to reduce the amount of debt, the Fed was likely to create new money to bail out banks and monetize deficits. It was plain to see that the difference in scale betwean the two pools, debt and cash, would tip the scales in favor of deflation, along with a shift in attitude towards frugality and a new respect for the value of a dollar.

Well, here we are in 2010, and the Fed has indeed created a fresh $1.2 trillion, but the debt pile has stopped growing over the last year, even taking into account the massive issuance of treasury debt. This chart comes from Karl Denninger:


I suspect that if properly marked to market, the private debt figures (household, business credit and financial instruments) would be considerably lower. There is a lot of pretending going on at banks, since they do not want to take write-downs. How much of that household credit card and mortgage debt will really be paid off?How much of those financial instruments are junk (and even investment-rated) bonds that will be defaulted on in the next few years? How many business loans are in arrears or just barely being made?

On the other side of the equation, here is the base money supply since 1999:


If reserve ratios mattered, wouldn’t debt have at least doubled (or more if you believe in the multiplier effect)? The fact is, nobody who can handle a loan wants one, and nobody who wants one can handle it.

Credit conditions and risk appetite are what drive lending, not reserves. Banks simply don’t hold reserves anymore, which is why bubbles get so out of hand and why they are always a few bad loans away from bankrupcy. If bankers’ asses and depositors’ funds were on the line like in the 1800s, you better believe banks would hold reserves. Depositors would sniff out those that tried to scimp, and take their funds elsewhere, nipping any trouble in the bud. Busts were frequent and localized, and freed up capital for productive hands. That’s why that era produced the greatest improvement in living standards and real GDP growth of 3-4% while prices were steady to falling for decades.


Here’s another chart that shows our state of debt saturation from Nathan’s Economic Edge. GDP no longer grows with debt — this is the point of no-return where interest can no longer be serviced with production, so the whole thing starts to collapse.