Nothing much to talk about in the markets yesterday.
We had been expecting a bigger sell-off in the price of gold. The metal went down, about $300 if we recall correctly, but not as much as we expected.
In the last major bull market in gold, in the ’70s, the price declined by about 50% before going on to set a new record. The pullback in 1974 caused investors to question the premise of the whole bull market. Many dropped out and missed the big payoff.
Markets always test their admirers. The old-timers — such as Richard Russell — refer to the “50% principle.” A bull market can be expected to retrace as much as 50% of its gains…before going on to fulfill its destiny. If it goes down more than 50%, however, the bull market may be over.
Unfortunately, these are not hard and fast rules. Just old timers’ tales.
Still, they are useful for understanding how markets work…and for keeping you from making a big mistake.
This gold market barely corrected 20% of its gains. Is that all there is? We don’t know. Doesn’t seem like enough. We didn’t feel tested at all; did you?
That was part of the reason we thought the economy was sliding into a Rip Van Winkle slumber. It would be a real test.
Imagine that China slows down. Imagine that Europe lurches from one crisis to another. Imagine that the US economy follows Japan down that long, slow, slumpy road. What do you have?
Falling prices for almost everything — including gold. And with falling prices for other assets, investors, savers, insurance companies, pension funds all put their money into US Treasury debt. This keeps rates low and it allows the US to fund its deficits almost indefinitely. The economy never recovers, but it doesn’t die either.
Bernanke and crew may want to do something dramatic and foolhardy. But they wouldn’t have to. As in Japan, they could just bide their time…
Pretty soon, people would come to think that the world economy had entered a more or less permanent phase of low growth and low inflation. And then, what would happen to the price of gold? It would fall. People buy the inert metal to protect themselves from very ert humans. But if the humans who run central banks and Treasury departments sit still, why hold gold?
The logic of the gold bull market is that the feds have done, and will do, stupid and disastrous things to the monetary system. Perhaps they will. But as long as they are able to finance large deficits painlessly, they have no reason to do so. Instead, they will take economist Richard Koo’s advice and use deficit financing to pay for fiscal stimulus projects. Infrastructure projects…transfer programs…tax the rich…bread and circuses for the poor — this could go on for a long time.
When speculators and savers realize that they need not hold gold to protect themselves from the feds, they will sell it. The price will fall — perhaps below $1,000. Then, we will have a real test.
If the economy is stuck in a low-inflation phase, why own gold?
If the feds do not have to print money, why would they?
If prices — in dollar terms — are stable or going down, why not just stick with dollars?
We can see the headlines now:
“Investors give up on gold.”
“Even gold-bugs are disappointed by the yellow metal.”
“No need for gold as world economy enters 7th year of stable prices.”
And then, you, dear reader. What will you do? The logic of the bull market will have disappeared. Will you give up on gold too?
In the near term, things are actually looking up for gold. In fact, since it didn’t fall as much as we expected…perhaps our Japan-like disinflationary slump has been delayed…or derailed?
Right now, the central banks are all itching to meddle. Bernanke’s “twist” program is a waste of time. It merely takes the Fed’s money and switches it from short-term US Treasury debt to longer-term Treasury debt. It is a very bad idea — leaving the Fed itself exposed to huge losses. But that’s another story. But it is unlikely to have any advantage for the economy. Mortgage rates are already the lowest in half a century. Pushing them down a little more isn’t going to make any difference.
Several members of Bernanke’s FOMC group are already calling for more forceful intervention — some form of QE III. If the economy deteriorates, there is bound to be more action from the Fed.
Meanwhile, the Europeans are “recapitalizing” their banks (see below). So are the Chinese. The capital has to come from somewhere…or they have to invent it. The more new money they create, the less their old money is worth…and the more attractive gold becomes.
*** “My friends and family warned me. They thought I was making a big mistake by not buying a house.”
An Irish friend tells us what it was like for a renter during the great housing boom.
“The idea was that housing prices always went up. Ireland is a small country. There were new people coming in from Eastern Europe. There were also a lot of Irish people coming back from overseas. We were the ‘Celtic Tiger,’ after all. The land of opportunity.
“So people thought housing prices could only go one way — up. And you had to get on the escalator as soon as possible. Otherwise, you would be left behind. You had to buy a starter home…like one of these new apartments.”
We were driving by a housing development, almost in the shadow of the Wicklow mountains. On the right hand side was a very new apartment complex.
“See all those apartments. They’re empty. They can’t sell them. They were just a little late to the party, I guess. They probably started construction in 2006 and by the time they were ready to sell, the lights had already been turned off.
“You had to buy a starter home when you were in your 20s so that you could trade up to a family home when you were in your 30s. Prices were rising all the time, so if you didn’t have a starter home to trade in you’d never have the money to buy a family home. I guess that meant you couldn’t have a family and your life would be ruined.”
The Irish real estate market has gone bust. But looking in the window of a real estate agent, it appeared to your editor that the boom-time spirit had not been completely crushed. Prices — based on US equivalents — seemed reasonable.
But reasonable is what you get in the middle, not what you get at the top or the bottom. At the top, the house might have sold for twice what it sells for today. At the bottom, it should sell for about half.
In order to reach a real bottom, investors — and ordinary people, for that matter — need to repudiate the idea of the boom itself. That is, they have to come to believe that the premise that drove prices up is false. That is why it is so hard to be a real contrarian investor. It is one thing to recognize that prices go up and down. It is one thing to believe that you should buy when things are cheap and sell when they are expensive. But the person who can resist the logic of a major market trend is rare.
The idea that Ireland’s property was destined to rise was just such an idea. Was it not true that Ireland is a small island? Was it not true that its economy was growing — thanks to integration with the rest of Europe? Was it not true that Ireland had the most attractive business tax rates in all of Europe? Was it not true that people were moving to Ireland by the planeloads…and that they needed a place to live?
Of course it was true. It was irrefutable. Until it wasn’t true anymore.
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