gold: underpriced, overpriced, or fairly priced?

davefairtex
By davefairtex on Mon, Jun 9, 2014 - 12:06am

Always an incendiary topic, I'm going to take a shot at it today with some monthly commodities price data I pulled from a new site I found.  While in the past I've done an analysis with annual data from USGS, here's a more close-in look at the last 20 years with some more granular monthly data.

The idea is, if we measure gold using a "fiat currency" measuring stick, it could be problematic.  However, if we use "other real things" instead, perhaps we can gain some wisdom that might otherwise elude us.

I use a basket of base metals - the idea being, they too require a great deal of energy to extract, use similar technology in many respects, and so they might be able to shed some light on gold's pricing.

So meet the basket-gold ratio.  Idea being, when the ratio is high, gold is "overpriced" relative to the basket; when the ratio is low, gold is "underpriced" relative to the basket.

So where are we?  Mostly in the middle.  Gold seems fairly priced (for the 2000-2012 timeframe) relative to the rest of the metals complex.  Its underpriced relative to the 1995-2000 timeframe.

Now then, the reason I went down this road was an article by David Stockman suggesting that China is having some serious problems specifically with iron ore, and that this is likely to affect prices of all sorts of base metals.   Here's an absolute price chart that shows what iron ore has been doing with gold alongside it.  You think gold did well during 2000-2008?  Try Iron Ore - up 1500% during that same period, with most of the move coming AFTER 2008.  But now, it doesn't look so healthy.

Going forward, if iron ore craps out - what then gold?  If the relationship continues, likely nothing good.  Which is not great to imagine with gold at 1250.

My belief: iron ore is half driven by credit creation & china, and the other half, by increasing energy cost of extraction.

32 Comments

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Thanks Dave

As long as demand for iron requires new production on an annual basis, there is a rough floor in iron price to allow for new metal to come on the market.

Right now, I feel that all the metals are highly stressed in the production profit end (silver especially). Personally I think the metals basket as a whole is at a bottom based on important trends like this... 

 

 

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Synchronizing asset prices

Synchronizing asset prices are a short-term phenomenon.

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iron ore, et al

Kugs- you said synchronizing asset prices are a short term phenomenon.  Any evidence?

WT- Brief look at iron ore costs of production: BHP and Vale seem to be producing iron ore for about $50/ton all in sustaining costs.  With prices at $90/ton, they still look profitable.

Cash cost for copper: $1.54 for FCX.

I don't think the base metal miners are in the same perilous state as the silver miners.

This says to me the pop in iron & copper through 2012 is a "crazy china phenomenon" - all that warehousing and collateralizing - the 1500% rise in iron ore might have had something to do with it, more exciting to speculate on iron ore prices than to actually produce stuff.

Regarding silver - I haven't heard stories of miners shutting down production just yet.

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Agree Kugs...

Thinking about Gold, the preeminent alternative form of non-debt, hard money around the world, as a commodity at this time of unparalleled WW monetary experimentalism, is not useful.  It needs to be thought of as what it is;  Money that cannot be debased, at least in physical form, by any government or bank.  I make the case that Gold is vastly under priced because of two factors;

1)  Official suppression

2)  Western investor obliviousness

I read this over the weekend from Dave Kranzler - don't think smart folks in high places don't know what is going on;

   http://investmentresearchdynamics.com/this-is-why-i-believe-rickards-is-...

   I’ve been told separately, independently from two different sources that the elite insiders in the Department of Defense know that the demise of the dollar is inevitable.   That there’s nothing that can be done to prevent it. 

Dave's argument above, and whole "China commodity financing" issue, informs us that there is too much stuff (commodities) and not enough money... so the commodities need to fall in value as people scramble for "money".  We are always lead to believe the opposite of what is true... so that we are docile as we get sheared.   As we get toward the end of this era of endlessly expanding debt, there will come a time when the masses, including Western investors, realize this truth... and then they are going to want some real things to invest in with their money as they take it out of stocks and bonds and paper commodities (futures).  This all may not become obvious until the physical store shelves are bare.... so I simply watch and wait, buying little bits more as I get the chance.  

When will the "panic" phase come for the Gold market?  Not sure, but I know that it's coming.

       http://www.goldscents.blogspot.com/2014/06/charts-of-day_7.html 

 

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another fun chart

China's M2 charted against iron ore prices.

Looks like iron ore prices lag changes in China's M2 by a year or so, once you pass 2005.  And right now, iron ore prices seem to be following the decreasing M2 growth right down...

Ok, by popular demand...raw M2 numbers for both China and the US.  That's quite the crossover in 2010.  Who's your money-printing daddy?  The Fed?  I don't think so.  Since 2008: 15 trillion by China.

I'm sure all this chinese money printing didn't affect either the gold market, OR the base metals market.  And if the printing slows down, that will...increase the gold the Chinese people buy.  Yeah, thats it.  Less cash means MORE gold buying!  (Somehow, goldbugs always come to the conclusion that, no matter the correlations or the evidence - every single potential outcome results in the increased buying of gold.)

I do think there is one difference between the base metals and gold, though.  Those base metals will plummet far more dramatically than gold during "problem periods."  And, the response to the current "warehouse receipt" problem will likely be credit contraction and sales of base metals - I think the opposite would be true if there was a warehouse receipt problem for gold.

However, I think Chinese credit contraction will be a drag on the gold price.  Assuming we actually GET credit contraction in China, of course.

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Silver...
davefairtex wrote:

(...)

Regarding silver - I haven't heard stories of miners shutting down production just yet.

Even if some marginal (at these prices) pure silver players shut down, it won't appreciably impact the world's supply of mined silver.

Why?

Because ~70% of all silver is a by-product of copper, zinc, lead and gold mining.  As long as those metals are still being mined profitably at their current prices, silver will be tugged out of the ground and sold for whatever the COMEX price happens to be...

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Dave...

Your's is, to me, a very one dimensional view;

I'm sure all this chinese money printing didn't affect either the gold market, OR the base metals market.  And if the printing slows down, that will...increase the gold the Chinese people buy.  Yeah, thats it.  Less cash means MORE gold buying!  (Somehow, goldbugs always come to the conclusion that, no matter the correlations or the evidence - every single potential outcome results in the increased buying of gold.)

Great chart by the way... China has for sure been the King of credit expansion.  The way I interpret your view here is that the engines (of money printing) have been running hot and everything we have seen in terms of the markets has been, well, real.  Certainly the extended bull markets for stocks and bonds have followed the path of the money printing .. but what of Gold and Silver for the last few years?  I know, I know... hyperinflation never came.  Well.. something is coming though, and my point is that if and when the engines of money printing do slow down... (less money as you suggest)... the train does not stay on the tracks.  If the money printing stops (no sign of this.. ECB taking the lead for now, mystery Belgium buyer, etc) we don't have a normal deflation... we have utter chaos.  This is why many believe that the money printing cannot actually stop.  

Bottom line is that the scenario you paint, where credit creation slows, and Gold gets sold.. is untenable.  Gold has been held down relative to other asset classes in order to make your assertion... that there is no inflation, nor inflation expectations... seem to be true.  Do I detect a widening between the Gov't index and a more true one?

        http://bpp.mit.edu/usa/

It's coming folks.  Dave does not talk about what the continuing loss of reserve currency status will do the buying power of the dollar, nor what the rising debt will ultimately do the the dollar, nor what the exposure of the central bank's folly of monetary experimentalism will do (loss of confidence).  Using charts that depict past relationships does not help I think, in an era where the future is not going to be like the past.  Gold is scarce and dollars are unlimited.  Gold is a coiled spring... my friend's brother once dislodged a stick from his snowblower and got his finger chopped off in the process as the machine discharged mechanical tension.  Beware the monetary tension that is building lest you get your savings chopped off.    

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Embry sees it too

From a KWN interview today;

Also, when you look at what is happening over in China with all the metals being rehypothecated and used to increase leverage in the Chinese shadow banking system, now they have found out that massive quantities of metal are missing.  Despite the propaganda, this is not bearish for these metals. 

Instead, this is wildly bullish because it’s just another acknowledgment of the incredible amount of paper that is being written against real assets.  Why anyone would want to own any of this paper versus real assets is an absolute mystery to me.  And I suspect that when the mystery is solved, those holding the actual hard assets will be the real winners.”

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/6/9_This_Will_Bring_The_Entire_Global_Ponzi_Scheme_To_Its_Knees.html

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Non-Linear Effects on the Margin

Think back to 2008 when the finance market was thrown into disarray.  Counter Parties did not trust each other, even in the overnight market.   At first gold went down because cash had to be raised 4qtr of 2008 but as 2009 played out gold went back up.  The FED and ECB have stepped in to flood the market (financial) with money so that has lessened the panic for now.  What will happen when counter party risk jumps again?  Me thinks that insiders will be in gold ahead of that in order to not be left out of gold delivery.  And China may be planning for disruption by backing the Yuan with gold to lessen the crash there as far as investor confidence is concerned.

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Reservations with this Model

I think I echo some of the people on this thread in that I have reservations using other metals and mining costs as a predictor of what gold price should be since it leaves out the impact of a growing money supply and gold's potential as a currency.  I think it's safe to assume that mining costs increase over time and, as such, I would recommend leaving it out of modeling simply as a means of remaining conservative.  Instead, I'd be interested to see more analysis on gold price's relationship to the overall money supply.  When I try to do this myself, and I'm no statistician, I see that M2 has increased 17.5 times since 1970 per ShadowStats data (M3 perhaps 23 times) whereas the price of gold has gone up 32 times over the same period.  I've also tried comparing to M2/capita and M3/capita, which I'm not even sure is appropriate to do, but these numbers come up even less favorable for current gold prices.  Admittedly this is an extremely narrow view and doesn't take into account Chinese demand and a whole multitude of other factors, but still it would appear the price of gold in USD has inflated more than the money supply itself.  Of course in the event of a complete monetary system failure gold at any price would be worth more than cash, but if this never happened and one simply wanted to store value I wonder if gold is over-priced...  My brain hurts when I try to figure all this out.

At the end of the day my sense tells me the price is really driven by the collective confidence of the population and I have no idea how you chart that out let alone objectively predict it.

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Jumper...

You are forgetting those dollars outside the US.. used to be partly accounted for as M3, aka Eurodollars... but alas, the FED could not afford to keep track of this anymore, so they stopped doing so around 2007.. cost pressures and all you know;

C

 

do you think M3 would be bigger now than it was then?  I recall a little thing about FED loans to Euro banks during the heat of the crisis... hmmmmm.  You may need to rethink your numbers.  

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M3

Thanks Jim.  I definitely feel like a novice trying to make heads and tails of all this.  The M3 numbers I used were those estimated by ShadowStats, which he puts at 645B in 1970 and 15,679B in 2014 (so a ~23x increase).  Are there any numbers you would suggest looking at besides M3 since the data is no longer provided?

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gold vs basket: measure of collective confidence

Jumper/Kugs/JimH-

To answer many (all?) of your objections...

Perhaps rather than being an overpriced/underpriced indicator, gold vs basket is the measure of society's collective confidence in our current system.  And when gold tracks the rest of the metals basket, that says society is relatively sanguine.  We could imagine the metals basket as the mechanism for (roughly) factoring out any overall money supply issues - as well as peak resource and energy issues, etc.

While gold is a much more concentrated store of wealth than (say) iron ore, they are both "real things" which require real energy to produce.  So that concentration and "monetary history" in gold do have value, but the willingness of people to pay a premium (or - the "multiplier" on gold's special attributes) is driven entirely by the current confidence level.

This ties in with Kugs and his observation that things go a bit nonlinear when counterparty issues start appearing.

I believe there will come a time when gold (of the physical variety) vastly outperforms the base metals - once there is a loss of confidence in our institutions.  The multiplier will explode upwards.

But in a more "normal" confidence environment, where the faith in our monetary system and its central planner guardians remains intact, China's decreasing money supply will most likely impact the enthusiasm of the Chinese people to buy gold - right along with the rest of the metals basket.  I.e. with no change in the Special Gold Multiplier, with no loss of confidence, gold will dutifully track the metals basket lower as credit in China contracts.

If it contracts, of course.

So I was wrong - its not a measure of overpriced/underpriced, its a measure of Gold's Special Value Multiplier.  And right now, its (roughly) about average.

There.  How's that?

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Hard to know Jumper...

It's not like they really keep track anymore...

http://www.theguardian.com/world/2007/feb/08/usa.iraq1

The US flew nearly $12bn in shrink-wrapped $100 bills into Iraq, then distributed the cash with no proper control over who was receiving it and how it was being spent.

The staggering scale of the biggest transfer of cash in the history of the Federal Reserve has been graphically laid bare by a US congressional committee.....

But like Dave says, Gold will probably go down against paper money soon because all those Chinese buyers of physical Gold whose increasing purchases of said physical Gold have not managed to move the Gold price in the last two years are going to stop buying due to local credit contraction, at which point the Gold price, which is set primarily by the buying and or selling of Comex paper futures, will certainly plummet.  See the connection?  This all makes sense, right?  (Yes, I am being sarcastic) 

http://www.ingoldwetrust.ch/chinese-weekly-gold-demand-highest-since-lat...

Jumper.. maybe I am not explaining it well... the price of Gold is wrong because there is much, much more paper Gold than there is real Gold.  This is the source of the coiling.. of the tension.  It is the lending, swapping, leasing, and rehypothecation of Gold.. it is the stealing of sovereign Gold held in trust  ... and of course the selling of paper Gold futures in a market that has very small amounts of physical delivery relative to trading volume.  It is all these things.  This is why I make fun of Dave's posts when he posits that there won't be enough money relative to Gold... causing the Gold price to go down more.  This may happen momentarily.. but when the ponzi is finally exposed, then it all goes Boom.  I promise, you won't get a chance to get any Gold (or Silver) after it goes Boom.  As Jesse said today;

If anyone is near to a fiduciary responsibility for the obligations for gold and silver bullion delivery, or even large positions of naked shorts in stocks, and they do not personally have title and possession of the metal or the equities, I would probably suggest that they get out or start lawyering up now, with a well thought out Plan B involving offshore accounts and domiciles.  You can always try for a Presidential pardon later on.   I suspect it will become the fashionable thing to do.

If this convoluted system of asset rehypothecation starts breaking bad it is going to make MF Global look like a church picnic.  'Everyone was doing it' is not an unassailable defense, and 'I had no idea what was going on'' only works for those with very lofty connections and office.

http://jessescrossroadscafe.blogspot.com/2014/06/gold-daily-and-silver-w...

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Starting to get more clear

Jim: Thanks - that helped clarify things.  So if I follow you correctly, in the near-term gold may go down because of decreasing demand in China, but the long-term prospects are that it could go up considerably due to the fact that there is not enough physical gold supply to make good on the promises/demand of paper gold.

So if you're only looking at M3, the true number of which is anyone's best guess, gold may appear to have outpaced monetary inflation, but once you add in all the paper-gold (the trading of which is driving price) then in fact gold is likely under-priced because supply is over-stated on paper relative to actual demand in the marketplace.

Dave: That explanation does make more sense, basically that gold would trade at a higher premium than other metals in times of low confidence and at a discount in times of high confidence, since the perceived utility of the metal goes up as confidence goes down (i.e if you had 100% faith in paper money then gold would be worthless, except of course as jewelry).

Thanks guys - There's only one thing I know for sure: that I need to know more.  These discussions are hugely helpful.

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I agree with Jim (no, really!)

That is, an agreement in principle, but perhaps not on timeframes.

I agree that at some point in the future, gold's Special Multiplier will skyrocket, and if that happens at a time when there are counterparty issues (as pointed out by Kugs), then the math that Jim talks about will all come to bear at once.  That 60:1 paper:actual gold ratio will matter very much at that point, all at once overnight, and then physical gold won't be available except at a much higher price than it closed in the paper markets the day previously.

But this event is talked about constantly, as though it was going to happen tomorrow.  Or maybe even Today!  And that's the bit I don't agree with.  Lehman took 15 months to happen.  It didn't just happen overnight.

In some sense, I picture the mainstream goldbugs all sitting on the edge of their chairs, every minute of every day, waiting with bated breath to see if Today is the Day that the COMEX will default, looking for clues in every indicator imaginable to answer that question: is Today The Day?  (GOFO rates, anyone?)  Its an incessant chorus of "are we there yet?" that you might expect from a pack of kids in the back of the car on a family trip.

No, we're not there yet.  :-)

I do believe, along with Jim, that this event will occur someday.  And that day isn't 50 years in the future, its nearer than that.  And likely it will happen once that Special Multiplier of gold gets moving northwards at a  rapid clip, due to a series of repeated blows that rock confidence in the system.  But there does need to be some catalyst.  100 years of confidence in the system doesn't get shaken by one event - except by the last one.  And looking at the VIX, and a bunch of other indicators, we don't appear to be at that tipping point right now.

And until this series of events happens, then credit and whether it is growing or shrinking will most likely rule the price of gold, right along with price of energy, ore grades, geopolitical issues, etc.

But I think his basic point does have merit - if you wait too long and try to be too fancy as the storm approaches, you might misjudge things and as Chris says, better a year early than a day too late.

But unlike him, I don't think the price of gold is wrong.  Its just indicating that "the market's" assessment of the risk is relatively low.  Just like the VIX.  The VIX isn't wrong - its just expressing the sum total view of the participants that "risk is low."  I don't happen to agree, but that's not the same thing as saying "the price is wrong."  (Who am I to say what the price should be?  A central banker?)

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Re: Starting to get more clear

IIRC M3 does not include $ money held outside USA, let's call this foreign held $ cash.   John Williams of SGS estimates this cash and near cash to be about $16 Trillion as of March 2014.   Then include the off balance sheet FED activity (audit the FED, $ value?).

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Timing is hard...

Dave said,

But unlike him, I don't think the price of gold is wrong.  Its just indicating that "the market's" assessment of the risk is relatively low.  Just like the VIX.  The VIX isn't wrong - its just expressing the sum total view of the participants that "risk is low."  I don't happen to agree, but that's not the same thing as saying "the price is wrong."  (Who am I to say what the price should be?  A central banker?)

And nothing could illustrate more clearly how far apart Dave and I are on manipulation.  Dave indicates above that he thinks that the VIX (volatility futures) is giving meaningful signals.  I don't.  I think, like so many aspects of the matrix-like markets, that VIX is actually one of the more clearly manipulated indices.. meant to "wag the dog" of algorithmic traders at critical junctures, using leverage. 

The VIX is NOT expressing the sum total view of free market participants... it is expressing what TPTB WANT you to believe about the market.  Here is one exposition of some of the recent VIX shenanigans as published on ZH;

http://www.zerohedge.com/news/2014-06-06/last-minute-vix-murder

And how does he do it? Through massive VXX selling in dark pools...

Is someone (cough Fed via Citadel) using dark pools to manage their volatility suppression - which implicitly spooks the actual markets in implied vol and thus in a "tail wags the dog" manner, juices the entire US equity market... but we do not find out about it until after hours as the dark pool unleashes its volume at VWAP pricing...

Makes us wonder if this is the fingerprints of the NY Fed's Kevin Henry hard at work managing perceptions via dark pools with as much leverage as possible via the vol markets.

just like he did here the week of The Fed Minutes

20140523_VXX1_0.png

 

As he did this week...

20140606_EOD5_0.png

 

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it must be manipulation

So - we know all of the "smoking guns" for manipulation have added up to very short term banging of the market to achieve a day-trading objective to help some banker's quarterly bonus.  And yet, we are supposed to believe that every single trading activity we don't understand is a part of some vast Fed-organized conspiracy?

Dog ate my homework.  Fed screwed up my trade.  Market isn't behaving the way I think it should.  ITS ALL MANIPULATED!  Buying puts when the market keeps making all time high after all time high - oops.  Or better yet, buying VXX, one of the single worst instruments ever created.  Take a look at a weekly chart for VXX.  That's a 97% loss over two years.  NINETY SEVEN PERCENT.  Thats worse than most junior gold miners!!

And you imagine its "the Fed" doing this?  I'd put good money on this being just some trading house that is repeatedly playing some sort of game we don't understand (a la the Flash Boy HFT game) to milk the retail people who continue buying this absurdly lame instrument.

Sheesh.  "The Fed" is turning out to be the sovereign explanation for why every trade didn't work.  Find some strange volume spike somewhere and yell: "its THE FED!"

Ever thought - maybe - its just a Barclay's Special banging of the market for reasons quite clear and known to them, but unknown to us pleebs because we're not plugged in.  Best to stay far away.

Occam's Razor: VIX is low because we haven't had a correction in years, and that's been the safe money bet for a long time, and so the put buyers have dried up.  They're tired of losing money.  Simplest explanation is most likely correct.

VXX: lamest instrument ever.  Run, don't walk.

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Cause vs. Effect

Dave said,

Occam's Razor: VIX is low because we haven't had a correction in years, and that's been the safe money bet for a long time, and so the put buyers have dried up.

No, I don't see it that way.  I see it the opposite way.. same as the ZH article;

Is someone (cough Fed via Citadel) using dark pools to manage their volatility suppression - which implicitly spooks the actual markets in implied vol and thus in a "tail wags the dog" manner, juices the entire US equity market... but we do not find out about it until after hours as the dark pool unleashes its volume at VWAP pricing...

Makes us wonder if this is the fingerprints of the NY Fed's Kevin Henry hard at work managing perceptions via dark pools with as much leverage as possible via the vol markets.

We have not had a correction because the market masters use the VIX to bang the algo's higher when there is a hint of a correction starting.

In any event... your original premise Dave was that the VIX was/is telling us something meaningful... and then you write a somewhat epic novella that does in fact convince me that the VIX is a real BS instrument.  Which is it? 

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causes and effects

Jim-

No, I don't see it that way.  I see it the opposite way.. same as the ZH article;

Yes I know.  In your past comments you have shown a tendency to have a complicated model of the world that always requires a powerful external noneconomic player to explain any activity that isn't going the way you expect it to.  [Reminds me of the ancient Greeks explaining natural forces by constructing a pantheon of deities].  Gold dropping and you think it should rise?  It's gotta be The Fed.  SPX rising, and you think it should drop?  Someone tells you it has to do with VXX and The Fed - of course you totally believe, because that's your model for how the world works.  The Fed is always the cause for any market activity that happens contrary to the way Jim thinks it should be acting.

Regarding my epic novella - there was a subtlety you missed.

VIX: volatility index, a calculated value derived from the prices of near term out-of-the-money puts & calls on SPX.  Actual prices are used to calculate this beast - so its based on real money changing hands, traders hedging their positions on one of the most liquid (heavily traded) instruments out there.  It is one number that answers the question: "how much would it cost (relatively speaking) to hedge my SPX position?"  Low number = cheap, high number = expensive.

VXX: a horrible derivative ETF that attempts to track the VIX index by buying futures contracts, but it fails due to a severe tracking error because like many similar ETF instruments that use futures, contango ends up eating away at principal over time.  Look at the chart VXX:$VIX (weekly) and you will see what I mean by a tracking error.  Perfect tracking is a horizontal line.  Given this, only an idiot would go long VXX for any length of time - unless they were psychic and *knew* the market was going to become more volatile over the very short term.

http://caps.fool.com/Pitch/VXX/5336887/vxx-is-an-etf-to-track-the-vix.aspx

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Thanks for Discussion--somewhat enlightening

Time to jump into Hard Assets Alliance, no?, with some metals out of the country?

Has anyone here had experience with said organization?   Ken

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Hard Assets Alliance
KennethPollinger wrote:

Time to jump into Hard Assets Alliance, no?, with some metals out of the country?

Has anyone here had experience with said organization?   Ken

I've been using them, although I haven't been keeping my metal outside the country.  I have a hard time grasping the benefit of keeping your metal outside the country if you a) live in the US and b) the service you're using is a US company susceptible to all the regulations that come along with it.  Overall I like their service but would rather have my metal in close geographical proximity so if I feel there is increasing regulatory/jurisdictional risk I can take delivery on it as quickly as possible.  Others may have different opinions on this that I'd be curious to hear, but I don't feel like jurisdictional risk is adequately addressed unless the vault you're storing it in isn't accountable to the US.

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VIX and insurance is cheap?

Dave,

You mentioned again that you believe the VIX is incorrect (IMO, too).  On a few occasions, you've dropped the hint that insurance is cheap if someone like me were to believe that the market is near a top and the VIX were too low.  I've researched the VIX and I haven't found a good way to bet that it will move higher over the next 0-12 months.  As you mentioned above and the "father" of the VIX himself mentions, VXX is a bad ETF for more than a few hours/days.

http://www.etftrends.com/2014/06/father-of-the-vix-issues-warning-on-volatility-etfs/

Futures, options, short/proshort index ETFs seem to be insurance plays.  The index ETFs aren't great for longer time ranges.  Volatility will likely eat up the gains.  Options seem to fit the timeframe.  Futures scare me because of margin calls but seem to have large leverage (both ways, i.e. margin calls) and favorable tax treatment.  IMO, each of these down the list require more in-depth understanding of the instrument being traded.

I have friends that can walk me through options and futures if I decide to go that route.  Are these things the "insurance" that you had in mind or are there other ways to buy insurance that are possibly simpler?

Thanks,

Brian

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davefairtex
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insurance

So the VIX basically represents a one-number thumbnail sketch of how relatively expensive or cheap out-of-the-money options are on SPY in a 1-2 month timeframe.  (You can buy options on futures, but I don't recommend it - I think options on the SPY ETF will work just as well).

Roughly speaking, SPY is like SPX, except it is 1/10 the value of SPX.  So SPX = 1950, SPY = 195.0.

So when VIX is low, you can "buy the VIX" by purchasing puts or calls - or maybe even both.  That means you are "buying volatility" - those puts & calls will increase in value if the volatility (the VIX) increases - even if the price of the underlying remains the same.

So yesterday's close in SPY was 195.60.  An Aug 2014 (193) SPY put option with 2 months (65 days) to go, is about $2.90.  What do you get for your $2.90?  You are protected against a drop in SPX of greater than 26 points, for the cost of about 1.5% of the underlying (2.90/195.60) for that two-month period.  That's about 8.9% per year.  The VIX tells you, that's the cheapest those puts have been for that level of protection since the market top in 2007.  And that "greater than 26 points" - think of that as your "deductible."  A move down of less than 26 means your puts still don't pay off.

Is that "so cheap you can't pass it up?  Its tough to get an 8.9% yield these days, which may well be why put-writers are willing to sell you those puts at that cheap price.  I leave it up to you.  But it really is a low price for downside protection.

I looked up the cost for 372 days of protection (June 2015 193 puts): they are $11.85 each, or about 6.1%.  If you really wanted to make a more secure bet (the value of puts decays quite quickly when there are less than 3 weeks left to expiration), buying a longer-dated put would be a better idea.  Just that - your break-even is then a 6.1% loss in the overall market, because they are so expensive, although if something bad happens in the next few months, you'll definitely make money, because volatility will rise dramatically along with the drop in the market, so you'll end up winning on both accounts.

Buying puts is easy.  And risk is known: you can only lose 100%, unlike futures, where leverage AND losses can be extreme.

Of course, if the market doesn't crack within that 2 month timeframe, you lose that 1.5%.  Its just gone, in the same way the fire insurance premiums on your house are just gone in the event you don't have a fire.

In my past trading endevors, puts I have bought have had this disagreeable way of expiring worthless more often than not, so if you can learn from my (poor) performance, perhaps rather than looking at this as trading advice, just note that the last time puts were priced this low was Feb 2007 - about eight months before the final top in Oct 2007.

 

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KugsCheese
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Re: insurance

And I am sure the insiders know where most of the put volume is and rig it.  Then take out short and crash it. 

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KugsCheese
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bostonJumper
bostonJumper wrote:
KennethPollinger wrote:

Time to jump into Hard Assets Alliance, no?, with some metals out of the country?

Has anyone here had experience with said organization?   Ken

I've been using them, although I haven't been keeping my metal outside the country.  I have a hard time grasping the benefit of keeping your metal outside the country if you a) live in the US and b) the service you're using is a US company susceptible to all the regulations that come along with it.  Overall I like their service but would rather have my metal in close geographical proximity so if I feel there is increasing regulatory/jurisdictional risk I can take delivery on it as quickly as possible.  Others may have different opinions on this that I'd be curious to hear, but I don't feel like jurisdictional risk is adequately addressed unless the vault you're storing it in isn't accountable to the US.

The whole point to storing gold outside US is to NOT be susceptible to US confiscation as happened to those who stored gold at banks and such in the early 1930's.  Typically countries treat foreign investors better than the natives.

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Jim H
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Markets vs. their Derivatives

Dave,  We are still talking past each other regarding what is "real", and my contention that derivatives can wag the dog so to speak in terms of being used to affect the underlying markets through use of leverage.  You see VIX as "real" because people buy and sell these options.. I see it as less than real because it is one step removed from the actual trading of the thing the bets are being made on, i.e. Stock prices.  The Dog is the market itself.. whether the stock market or the physical metals trading market.  The tails are the options/futures.  

So;

Market                       Derivative              Derivative of a Derivative    Derivative of Derivative of Derivative

-----------------              ------------------         --------------------------------      -----------------------------------------------

Stocks                        Stock options          VIX                                      VXX (ETF)

Metals                        Comex options  

--------------------------------------------------------------------------------->

Direction of higher leverage

 

Outside of arguments about dark pools, the stock market is reasonably transparent.  The metals market not so much... OTC physical trading is opaque at best.

Again, I am making the argument that markets are manipulated, usually by using leveraged futures... and that the DATA being shown in the ZH article showing odd trading patterns in VIX settlement volume suggests that these are being used in a covert way to "wag" the dog.  I realize that this is not the way the mainstream media would tend to present these things... in fact, here is a quote that supports your view Dave;

http://www.cnbc.com/id/101742157

The truth is that the VIX is not an "Index of Fear" and never has been. It's a plain old measure of premium. Premium in option products that are a derivative of the equity market. A market which, apparently is at, or near, all-time highs in many cases.

As any option trader will tell you: Pretty much most of the time when markets go up, the volatility goes down and vice versa. The VIX DOES NOT lead the equity market, it follows it.

It must be true... both Dave and CNBC said it!

   

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davefairtex
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rigging at options expiration

Kugs-

There's a pretty well-known phenomenon every month at options expiration where some instruments that have a large number of options written against them will mysteriously drop to a level where those options expire worthless.  There is a website devoted to calculating the magical crossover point which inflicts the maximum pain to option holders: http://www.optionpain.com/OptionPain/Option-Pain.php

So it is pretty well known that the big guys wang the underlying around pretty much exactly like you say, but only at or near OPEX, and only sometimes.

But note - this is the exact opposite of the thing JimH is talking about.  Jim imagines they BUY options, and thus wang around the underlying using derivatives.  Or actually, they buy an ETF that itself buys futures on the VIX index, and somehow this depresses implied vol and again somehow, this manages to keep the SPX levitated.  It makes no sense to me.  I think its far more likely that some big firm is hosing retail holders of VXX periodically, ringing the cash register on some short term shenanigan that we don't quite understand.  "Because that's what they do for a living."

The PPT is suspected of using e-mini futures at crucial junctures - which is the vehicle I'd use if I wanted to wang the larger market around.   That 16:1 leverage would come in handy for that purpose.  Not VXX, or VIX futures, or whatever.

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AaronMcKeon
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Posts: 71
Kugs, Re: Hard Assets Alliance
KugsCheese wrote:

The whole point to storing gold outside US is to NOT be susceptible to US confiscation as happened to those who stored gold at banks and such in the early 1930's.  Typically countries treat foreign investors better than the natives.

I watched a few interviews with the CEO of Hard Assets Alliance and he very explicitly stated that if the US government ever forced confiscation of gold that they would be required to comply regardless of where you had your gold vaulted, since they are a US company.  I'm pretty sure the only way to avoid this is to store it overseas either personally or with a non-US company, but I could be wrong.

davefairtex's picture
davefairtex
Status: Diamond Member (Offline)
Joined: Sep 3 2008
Posts: 5058
stored overseas

Yes, the only reason why I could imagine storing gold overseas would be useful is if something thoroughly disagreeable happened to the continental US, and you happened not to be there at the time, and wanted to access your physical gold at that overseas location which was presumably near to where you actually were.

Although likely any US-based company might be in a spot of bother at that point too.  One hopes they'd keep records at those overseas locations about who owned what.

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hammer6166
Status: Bronze Member (Offline)
Joined: Apr 30 2010
Posts: 25
Downsides to overseas storage

I have an overseas account with Bullion Vault which is a UK company.  I've been happy with the service. The buy/sell interface is simple and effective. The vaulting and transaction fees are low. 

However, I'm in the process of bringing home my money because (in no particular order):

  • Confiscation risk has increased in Europe as Cyprus has shown us.
  • Foreigners are the first targets during the confiscation.
  • In the 2008 collapse, IMO, the US muscled Switzerland to turn over some small fry hidden accounts so that Switzerland could get the Fed's bailout money.  I count as a small fry although my account is not hidden.
  • The UK banking system is a mess and is corrupt (LIBOR, gold price fixing, etc)
  • If an account is $10,000 or more in a foreign account, it needs to be declared to the US Treasury annually. Filing this form has irritated me every time I've filed it.  You should check on the requirements since they seem to change every year.
  • I don't have an easy way to get to the UK to retrieve my assets in person.
  • Signing up for the money transfers between the countries is a pain.  The stated purpose is to be able to track illegal money flows for drugs and terrorists.  If holding gold becomes illegal again, selling gold could be treated the same as selling drugs.

I'm sure there are reasons to hold gold in another country but they don't appear to apply to me.

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