Thursday, January 14, 2010

An Inflationist's Worst Nightmare

I quite often receive many emails and comments from readers all over the world that are something to this effect:

"You are (insert preferred insult) for thinking that there could be anything but hyperinflation after the Federal Reserve increased the monetary base by 100%.  You are an even bigger (insert preferred insult) for thinking that gold or silver could dare to go down, because of (insert random exogenous occurrence that said person is attempting to apply to an already existing price movement) - you are crazy!"

Many emails as such.  Others simply suggest to me a creative means of dying or killing myself, others seem to have the "Oxford Dictionary of The Nastiest Names to Call People Who Dare to Question Your Choices, Even Unknowingly" sitting right at hand.

Of course I get the odd "nice" communication whereby someone will simply state - hey, I think you're wrong and here's why.  I appreciate those - I generally will reply to those.

Anyway, I have been picking my brain to answer a question for myself.  Even though I do provide evidence that - to my own financial decisions - is very compelling, why would someone vent off in a violent rage and resort to name calling or sending some piece of data which I have just refuted not 2 weeks ago (but it MUST be right because they send it in all caps!) to try to cancel out the existence of my argument?

I think I've got it figured out.  Sort of.

One of the largest areas of study I focus on is investor psychology, and more specifically, investor mood.  heightened/overextended levels of optimism tell me to watch out if I would think of trading to the upside, and extreme levels of pessimism tell me to look for a good long entry.

I think investor psychology has a lot to do with the type of email which I receive, and is a reflection of overall investor mood.  Think of it like this:

Generally people come to a conclusion about something very early on, and even just having such a conclusion mentally can be extremely hard to change.  However, if you add in the emotional element of money plus the innate anxiety created by lack of information in finance markets (which causes herding), and you have your answer.

The majority of people who are making such comments are those who long ago decided to commit to the long side of gold or silver - and most likely made their major entry somewhere mature in the uptrend and are hoping/relying on someone to come along after them who will be willing to pay a higher price.  Not nearly as overextended as real estate in 2006 or dot-com stocks in 1999, but the concept is similar (and please, future over-reactors, don't attempt to argue this by saying "This is nothing like those times" - No, it isn't to the same level, but the same elements of investor psychology are there).

As such, I believe that most investors are stuck in this sort of pattern:  Getting some information, drawing a conclusion on that information, making a decision (i.e. buying or selling), going to as many places as possible to validate that decision.

The majority of investors out there who read Kitco and various other online publications are not looking for a new idea - those type of people give their money to a fund manager and usually let them worry about "new ideas".  These investors are going to these places to find validation for a decision that is already concretely established in their head, and they have generally already acted on it.  I can literally feel their relief when they read yet-another-gold-bug's article on how gold will be $5,000.00 /oz by 2011.  Even if the evidence is the exact same as the evidence of the person who yesterday said "gold will be $2000.00 / oz by 2011". 

And so when some compelling evidence is presented that shows that said decisions might actually be wrong, or mis-timed, etc, the defense mechanism immediately kicks in and a reaction takes place.  Generally the reaction correspondence will include at least one of the reasons that led them to the initial decisions (in their mind) to buy or sell - i.e. "the Fed is printing too much money", or "Gold doesn't go down during depressions", etc.  That is why the reaction is very heated and defensive, even though it is not as though I have specifically directed my content towards them, only indirectly towards their idea.

In conclusion, I have come to realize that I rather enjoy receiving these emails as it simply re-affirms the overwhelming strength of the herd mentality that exists in the various markets which I study.  As such, each correspondence of such a heated degree is simply another notch of emotional-extremism which tells me that my contrarian views are thus, still contrarian.  Again, it is a small affirmation, but one that brings a smile to my face nonetheless.

And finally, I must address the title of this post, because it hasn't really been much of a nightmare for inflationists so far.

I read a very interesting article this morning about Obama proposing a new and higher tax on financial institutions.  It goes by the name of "The Financial Crisis Responsibility Fee".  The short of it is, any financial institution with over $50 Billion in assets (including insurance companies, not just banks) would have to pay this additional fee.  Even if they didn't receive TARP directly.

This is highly deflationary, just as all government interventions in banking policy eventually become.  If you add this on top of heightened FDIC fees, another new proposal linking risk (i.e. too much credit versus assets) to bank executive pay, and government forcing banks to reduce banking fees, the end result will be this:  With or without the Federal Reserve's direction or force, interest rates on loans will go up to make up for lost revenue from these government programs.  As a result, defaults will increase, total new loans will dramatically drop, and the deflation of total money will accelerate.

Come to think of it, we are already seeing some of that now.....

This will, as I have said many times previous, bolster the current USD rally which should take it over 90 on the index before a major corrective period.  If you haven't, we suggest selling all risk assets (US stocks, corporate bonds, etc) and moving them into cash for the mid-term as the largest credit contraction in human history begins its long journey.  I'm not selling my PM's, which I stopped accumulating over a year ago, but I'm sure as hell not buying right now...  When I am, you'll be the first to know (besides my metal broker!)

Be Well!


Tuesday, January 12, 2010

A (Bearish) Technicality of Silver

Don't get me wrong: I love silver - I have for as long as I can remember.  There is just something about the oft-mystically-mentioned white metal that attracts me.  Maybe I hate vampires (that new Twilight craze certainly hasn't added any vampire merit points), or maybe I just like high electrical conductivity and a pure looking luster.

There isn't really one single thing about silver that I like the most - but there is one thing about it that I don't like very much of late.

Silver is far too expensive.

Now, before you fly into a flurry of arguments about how "silver is real money" and debt denominated instruments are "worthless pieces of paper" (which is actually untrue because they are not only worthless, they are of negative worth, because they are debt), and how it is one of - if not the - most widely used metals in the world and demand for its application can only go up as the developing world's middle classes emerge and demand more electronics and such....

Before you say any of that, you have to understand what "expensive" is.

Expensive is a relative term.  A Mercedes SL500 is expensive relative to a basic Honda Civic.  Gold is expensive to silver.  A new computer relative to a ceramic mug.

Or relative strictly in dollar terms.  Sometimes something is simply expensive all on its own.  Now again this is in perspective - when I say it is expensive I could be saying "it takes too much of my labor or free resources to acquire an ounce of silver."  That is certainly part of it.

But the other part is that it is expensive when you measure it in terms of market psychology.  In terms of market psychology silver is very overpriced - not too say that people aren't buying, because they are (reading the latest C.O.T. report  should give you an idea.  You can view it HERE. - specifically, grab the number of weekly open contracts, chart them and do an overlay with the price of continuous contract.  Surprise surprise!)

One little study I did on silver recently was using RSI divergence from price.  I have used this before (our short recommendation on AIG using RSI and Money Flow), to some success.  This is of course not my primary piece of data used to determine silver is starting a multi-month downtrend that should make a lower low than October 2008, but its another piece of the puzzle that I have kept track of and is fairly compelling.

Here's an example of what I mean:

Silver has experienced a fairly large period of both RSI and MACD diverging from the price movements - as prices went higher and higher, both of these strength indicators steadily declined. Now that the uptrend has been broken with conviction, we should see a much faster and further fall in silver prices than we did in '08. 

Lucky for me, I have thought silver was too expensive for some time now (seeing as we are in a period of deflation, no matter how people clamor at the utterly temporary uselessness of the Fed's money-printing and say it is immediately grounds for silver to go to $50.00 / oz and gold to $3,000.00).

As such, the strategy is to accumulate a hefty batch of  "worthless" FRN's which I plan to exchange for said real money once silver has found a bottom.  One of the indicators I will be looking at to indicate a good buying opportunity for the precious metal is a solid price/divergence in RSI and MACD.

I'll keep you posted.

Best of luck and be safe in the cold weather.  While your teeth are chattering away, be consoled in this little tidbit of information...