Wednesday, September 22, 2010

On the Bull Markets in Precious Metals and Bonds

Gold continues to pick up mainstream believers. That this is news is testament to the non-bubbly nature of the gold bull. When contrarians break from the consensus that everyone's got to be in gold, and that break from (possible) future orthodoxy gets reported as news, then it will much closer to the time to bail out. The latest bull is Allen Sinai, the noted Fed-watcher, as reported by Bloomberg in Sinai Says Fed's Sept. 21 Statement Means `Gotta Buy Gold'. I haven't listened to the interview from which this quote is taken and do not know precisely when he turned positive on gold. I will get into my deeper point after quoting from the article:

The Federal Reserve’s statement yesterday that inflation is below levels consistent with the central bank’s mandate for price stability means it’s time to buy gold, said Allen Sinai, chief global economist at Decision Economics Inc. in New York.

“That’s code for we don’t want to go the way of Japan so we’re going to print money,” Sinai said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “You gotta buy gold when those two central banks are doing what they’re doing.”

There is a contradiction in Dr. Sinai's second paragraph. I can't tell if he is saying the Fed is being contradictory or if he is. The contradiction comes from the fact that in saying the Fed doesn't want to go Japanese, it is printing money. However, that's just what the Japanese did. Japan's adjustment, in this humble blogger's view, to a post-boom environment, was inadequate in that what mild chronic price declines have occurred should have occurred rapidly. Boom, bust. Japan may in fact have taken this route when, I believe in 1965, every bank in Japan failed. (I am writing this from memory and some details may be a bit off; please forgive me.) In the next quarter-century, Japan nearly took over the world.

I recently read a book about China's economy from a Brit who spent years there. He pointed out that the Japanese multi-nationals have a business model in which they make most of their profits from charging high prices in the home market and accepting thin margins in their export markets. Seen in this context, the modest price declines in Japan may simply be concealed price increases, with the Bank of Japan printing enough money to prevent more significant price declines to fairer price levels.

If the same thing were to happen in the U. S., where almost all consumer nondurables such as toothpaste (which is mostly water) have gross profit margins well over 90%, why would that be bad?

In any case, Dr. Sinai is positive on gold, which is really to say that he is bearish on the U. S. dollar. Is he a contrary indicator?

I am currently differentiating gold and silver in the short term. One of the fund families I invest in has a gold fund (GTU), a silver fund (SBT_U or SVRZF.PK), and a gold-silver fund (CEF). Half a year ago, the silver fund regularly sold at or below net asset value per share (NAV). The gold fund sold perhaps 4% above NAV and the gold-silver fund sold at perhaps 8% over NAV (CEF is far better known than the others and much more tradeable). Currently, there has been a sudden shift. The silver fund has soared to 8% above NAV. This is simultaneous with a soaring silver price. Thus the market is surprisingly "saying" that this fund has much better prospects after a big, quick run in the price of its only asset than when the price was much more restrained. Meanwhile, even though gold has gone from one high to another, premia for the ETFs GTU and PHYS have shrunk markedly to the 2-3% range.

Thus I conclude that the gold ETFs GTU and PHYS have a better risk-reward ratio than Silver Bullion Trust.

This further suggests to me that this is the quietest raging bull market in a major asset (gold) that I can remember. Hardly bubble behavior.

Meanwhile, the Treasury market continues in its bubble. The only segment that is merely in a bull market is the long end. The 2-year Treasury note yields less than a total of 90 cents on the hundred dollar investment total over 2 years-- under 1/2% yearly. This is "going Japanese" without the consumer price decreases.

As with Japan, the big banks remain arguably insolvent--no one is allowed to know outside of the banks themselves and the authorities based in Washington. And the spending out of Washington financed in part by new money created on the spot by the Fed as well as by the accumulated savings of the U. S. and much of the world does not appear to be having much of a multiplier effect, if any. In other words, it's not stimulating.

Just as the NASDAQ bull run that began in 1975 or 1982 (take your pick or pick another start date) kept running until massive overvaluation stopped it, the gold bull market actually has a logical story. My base case is that it also keeps running until it dies of frank overvaluation or the authorities pull a Volcker and kill it.

Treasuries, on the other hand, are into bubble phase. Where they go, when, and why, I can't even guess.

Copyright (C) Long Lake LLC 2010

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