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Big Trade, Little Door

In ordinary times, the terrorist attack at the finish line of the Boston Marathon (officials are being careful not to call it “terrorism,” but I’m not an official so I can operate in the reality sphere) would absolutely trump anything that happened in the markets today and, in fact, would likely have been the cause of any market movement that actually occurred. That’s because most of the time markets echo the framework of the rest of reality: most of the universe is space, and most market activity is just empty noise.

This is the reason that traders who are continuously transacting in the markets are called “noise traders.”

But on Monday, there was plenty of market action and it had nothing to do with Boston, nor with the slightly-earlier ultimatum from North Korea to South Korea, which stated that military action would “start immediately.” (N.b.: There were many losers today, but one of them surely must be reckoned as Kim Jong-un. A tin-pot dictator makes a threat, and is almost immediately knocked off the front page of the New York Times by events in Boston. That must really annoy him.)

Before the attack in Boston, however, there was already plenty of financial pain. The carnage in the precious metals pits came right on cue after the negative sell-side reports of late last week had a chance to work on the psyches of investors. Gold fell 10%, and silver nearly 14%. This represents the worst two-day fall in gold in thirty years. And, while yesterday I pointed out that the commodity “super-cycle” certainly doesn’t look like one, I can understand how the picture of gold in real terms looks like it may be completing something big (see chart of gold expressed in December 2012 dollars using CPI, source Bloomberg).


There is considerable concern tonight that these losses may provoke selling in related markets as investors raise funds to meet margin calls. This is possible, although significant thumpings in the past in precious metals (it isn’t like this is the first time we’ve seen volatility in a commodity) didn’t provoke dramatic related-market action. To be sure, the avalanche is much more loaded now than it has been in the past, with equity markets sharply overvalued and investors already reaching a level of disgust with commodities. But I don’t think it goes too far. (Those may be my famous last words!)

What happened in gold and silver is a function of the big trade/little door syndrome, more than anything else. News outlets blamed the weak data yesterday in the U.S. and the small miss in Chinese GDP (7.7% versus 8.0% expected, but keep in mind that we all know these are made-up numbers) for setting off the wave of selling, but that’s just the latest straw. The break of technical levels on Friday, combined with the suddenly-burning desire of hedgies to not be the last one through the little door, is what led to such a dramatic move today. It may well continue until everyone who wants to get through the little door has done so. Or, it may not – but I would admonish an investor who wants to buy gold here to think like a trader rather than a playground monitor: don’t try to break up the fight. If the hedgies want to eat each other in a fight to get to the door, let them.

And, incidentally, remember that the big trade/little door syndrome is not limited to gold and silver. Think about equity exposures too. If you’re long by policy, fine. But if you’re long stocks and feeling uncomfortable about it, then “sell down to the sleeping point” at least.

The irony of the timing of the gold rout is potentially juicy, with CPI tomorrow. The decline in precious metals is happening partly because so many investors are abruptly convinced that inflation has truly been defeated. It is incredible to me that this belief is so widespread, but perhaps this is the sine qua non for the next washout in financial markets and the setup for the long-awaited up-move in commodities (for, although the “super-cycle” is evidently just now ending according to some observers, commodities prices have been in general decline for the last two years).

Growth is falling short of expectations, but that doesn’t have any implications for inflation. Tomorrow’s CPI is forecast to be flat and +0.2% on core, holding core inflation constant at 2.0%. Sentiment appears to be favoring a shortfall in those figures, but it is my belief that we are on the cusp of the next sustained move higher in core inflation, to be led by housing. Remember that the last two CPI figures haven’t exactly been soothing. Two months ago, core inflation was +0.3% when the market was expecting +0.2%. Last month, all eight major subgroups of CPI accelerated on a year-on-year basis, the first time that has ever happened since the current 8 subgroups have been in existence. I am loathe to pick the month where we’re going to see Owners’ Equivalent Rent finally break higher, because econometric lags are not written in stone. But it ought to be soon.

When it happens, expect sell-side economists and pundits of all stripes, to say nothing of the Federal Reserve, to downplay the significance of it. I wouldn’t expect a sudden rally in commodities or a rebound in breakevens (10-year breakevens are at the lows of the year, mainly because rates on the whole are declining – 10y TIPS yields are also within 3bps of the year’s low), but it might help stop the bleeding.

  1. Jim H.
    April 15, 2013 at 7:52 pm

    ‘The picture of gold in real terms looks like it may be completing something big.’

    Probably so. Five years ago, I jokingly projected a secular bull market high of $2,222 for gold, simply by indexing the $850 high in 1980 by a quarter century of CPI inflation, and projecting a bit more. The actual high was just over $1,900, so even the $2,000 round number failed to serve as an attractor. That should have been a warning to all of us. But being thick-headed to a man, we just wouldn’t listen.

    Since gold was de facto commoditized in 1971, it has behaved like a commodity — meaning a long-term price pattern of spike highs, rather than the spike lows which stocks characteristically print.

    In sentiment terms, some ideological gold advocates are still staunchly advocating buying the dip, as they denounce the bullion bank conspirators. That should work out about as well as buying the tech stock dip in early 2001. JDS Uniphase shall rise again!

    It would not be surprising if gold is in for a couple of boring decades. When it’s hot, it’s hot. When it’s not, it’s not.

    Gold used to be inversely correlated to bonds. Does the gold crash portend another leg of the bond bull market? Hard to imagine, but markets don’t have to make sense.

  2. Eric
    April 15, 2013 at 9:43 pm

    I’d be curious to see a chart of the XAU going back that far in CPI dollars. Quick back of the envelope says its up about 29% in real dollars since 2000, which is pretty close to the low point on that chart. That’s about a 2% real annual return–if you picked the bottom perfectly. (though that doesn’t include dividends.)

    • April 15, 2013 at 10:00 pm

      Looks better than that to me. The low on a month-end basis was 43.87 in Oct 2000, and it closed today at 105.23. When I divide both by the price level, I get a 79.8% aggregate real return ex-dividends. So actually not too bad. However, it has now had two 55% declines in the last 6 years, so it comes with some volatility!


  3. Eric
    April 15, 2013 at 10:11 pm

    Sorry, I was eyeballing about 60 on Jan 1, 2000, but yeah, it went down quite a bit over the next 10 months. Still, the metal itself (again just eyeballing the chart) is up about 300% in real terms over the same period. I think of mining shares as options to buy gold with a strike price equal to the mining cost. Now, I guess that mining costs have risen faster than inflation. But that much faster?

    I’m not trying to be pig-headed. I’m just trying to understand why (or in what sense) mining shares aren’t pricing in a decline in gold to below 1000, at least.

    • April 15, 2013 at 10:41 pm

      a huge cost of mining is energy, and energy costs have multiplied an order of magnitude since then!

      But at some level I agree…although our models have avoided mining shares because they’re equities and our models all hate equities, those equities aren’t pricing in near the euphoria that most are. Still, I’d hate to own them unless they’re cheap to assets on the balance sheet…because when inflation starts to rise above 3%, equities are going to get killed, and although meals ought to do well in that environment it would suck to get the equity massacre.

      Once real interest rates are a good bit above zero, I’ll be more interested in buying equities. But the next movement in rates is just really gonna hurt.

  4. Eric
    April 16, 2013 at 12:59 am

    I take your point about equities. I generally hate them at these prices. And not only because inflation will kill them. But it hadn’t occurred to me that inflation surprises would be bad for mining shares. Do you feel strongly about that? Again, this is all eyeballing, so I may have this wrong. But it looks to be like inflation really popped in ’74 and again in 79-80. Those were pretty blan years for the DOW, to be sure. But they were pretty great for the Barron’s Gold Mining index. (That’s the only index I can find data for that old right now.)


    again–really not trying to be pig headed. I just want to pick your brain on this. I’ve taken some big losses, obviously, in my mining shares in teh last week.

    • April 16, 2013 at 6:18 am

      No, I probably said that the wrong way. I think that thoseequities will outperform equities generally, but I just mean there will be a natural drag on their performance. Although you’d think that there has been enough P/E compression that it’s a much better bet now than it was a year ago!


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