It is the general rules which seem to be the most useful these days… buy low, sell high… neither a borrower nor a lender be… early to bed, early to rise. Etc. They are truisms, and almost forgettable when you’ve heard them so many times. But they are reliable because they’ve been tested over generations, giving them a statistical as well as empirical validity. All the specific bits of knowledge and tips are suspect, we think, because… well… at the very least, they are immodest.
Take for example the seemingly measured testimony of Reserve Bank of Australia Governor Glenn Stevens. Mr. Stevens is in Perth today, speaking to the House of Representatives Standing Committee on Economics, Finance, and Public Administration about the future. He did not, as you’ll see, confine himself to what he actually knows.
Had he done that, his testimony would probably have gone something like this, “Summer will give way to fall. It will rain less than we would like. The days of the year will pass a lot like they always have, and our papers will be full of human tragedies, comedies, farces, and weather forecasts. The sun will rise. It will set. Not much new will have happened in the world. However it will have happened to us for the first time. And that will make things interesting.”
This is a safe kind of testimony. It reflects an unashamed modesty about what we can really know about the future. Instead, Mr. Stevens read from his prepared remarks and said this, “We will, of course, see some large movements in CPI inflation in the next few quarters. It will probably fall noticeably below 2 per cent on an annual basis, as falling petrol and banana prices have their effect. After that, it will rise again, as those temporary factors fade, and we currently expect that CPI inflation will be around 2 3/4 per cent by early 2008, remaining around that rate thereafter. That is, it appears likely to be lower than recent outcomes, but closer to the top than the bottom of the 2-3 per cent target range.”
The precision of the forecast makes you think its similar to a weather forecast. Temperatures will rise by noon, before slightly cooling in the early evening, with a cold front sweeping in after 10pm and brining much needed moisture to the area. But of course neither the weather nor interest rates are as predictable as weathermen and central bankers make them sound.
Granted, central banker’s have some ability to make their own prognostications come true by altering the supply of money. But here is the thing about complex, adaptive systems: you can know the general rules by which they operate and yet still be completely baffled by their particular movements on a day-to-day basis. Just ask a weatherman, or an economic forecast.
But we don’t mean to slag off anyone willing to make a forecast. We’ve done it ourselves many times. And for the record, here is our forecast for inflation this year: it will go up, and much higher than the RBA or anyone else predicts. In an era of super-abundant global liquidity, every asset, wage, and price is lifted by the sea of money below it.
What could pull the plug? A rise in Japanese interest rates, which would slow down the carry trade, might be a start. Borrowing in a low-yield currency to invest in higher-yield currencies has certainly fueled the current speculative boom. Discouraging the behaviour through higher rates in Japan is a possibility.
But unlike the weather, financial markets are driven by a variable that’s nearly impossible to measure, namely human greed. This shows you how late in the speculative cycle we are today. Biologists and scientists will tell you that the human being is hard-wired to fear loss more than to want gain. That is, our default genetic code is defensive rather than aggressive. We fear less more than we desire lucre.
It is only in the presence of extraordinary temptation and stimulation that we can overwhelm our inclination to be risk averse. Free money has a way of disarming your sense of propriety. But when investors are prepared to throw caution to the wind, you know something important has happened in the market’s collective brain… it has made a terrible mistake.
“The amount of money borrowed from brokerages that do business on the New York Stock Exchange to buy stock reached a record US$285.6 billion last month, topping the prior high set at the peak of the so-called Internet bubble,” reports Nick Baker. The ‘so-called Internet bubble?’ How about the so-called law of gravity? Skepticism is one thing. Outright doubt in the face of the facts is either stupidity or a mental disorder.
Granted, all-time highs in margin debt don’t automatically signal a market crash is upon us. But when investors become so complacent about future risk they have no trouble setting records to borrow money, we submit their sense of risk aversion is broken. The only thing that will fix it is the intrusion of some real experience in losing money. That kind of knowledge is, as the political correctness officers in the U.S. say, a teaching moment. Class is in session.
What about actual stock market news? Well, even the data suggest we are at a crucial point in this growth cycle. Has it reached its full emotional, psychological, and financial maturity?
“BHP and Rio are expected to post record results for 2007, but the market believes they won’t be able to repeat it in 2008 when metal prices are predicted to ease towards more sustainable long-term levels,” writes Jo Clarke in today’s Australian Financial Review.
“It will be a major challenge for both companies to keep the market interested as investors worry the resources boom is nearing its end. In many metals, supply appears to be finally catching up with demand from voracious China. At the beginning of the year there were concerns about oversupply reflected in a sell-down in commodities by hedge and investment funds as they sought to realign their portfolios,” Clark continues.
Yet we also read that, “Investment in the global commodities market is predicted to rose by as much as 50% by the end of 2008, according to a survey carried out by Barclay’s Capital.” Barclay’s surveyed institutional investors who cite portfolio diversification and absolute returns as the main reason to invest in commodities. “Today commodities make up less than one per cent of the global portfolio,” says Roger Jones, the head of energy and metals trading at Barclay’s Capital.
So which will it be? Will institutions drive resource shares higher, chasing the boom with borrowed money? Or has the dream of double digit resource returns become unhitched from the reality of the physical world?
Can’t honestly say that we know. But we do know as a general rule that paper wealth comes and goes with inflationary booms and deflationary busts. Real assets stay. Gold is real, which is why we’ve decided to keep a much, much closer eye on it.
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