Gold’s Under-Valuation Is Extreme

The price of gold fell last week to the $1,200 level. The lemming sentiment in capital markets is uniformly bearish, yet every price-drop brings forth hungry buyers for physical gold from all over the world. Even hard-bitten gold bugs in the West are shaken and frightened to call a bottom, yet it is these conditions that accompany a selling climax. This article concludes there is a high possibility that gold will go sharply higher from here.

There are three loose ends to consider: valuation, economic and market fundamentals.


Adjusted gold price in USD

So far as I am aware nearly everyone is overlooking the obvious. You cannot consider the value of gold without taking account of the changes in the quantities of the currency and the above-ground stock of gold over time. The chart above shows the adjusted US dollar price of gold rebased to 100 in January 2005 when the gold price was $422. In 2005 dollars, using True Money Supply plus excess reserves as the currency adjustment, gold has risen only 13.9% to an equivalent price of $481.

TMS, or Austrian Money Supply, represents cash, checking accounts and savings deposits that can be redeemed for gold under a full convertibility regime. Excess reserves represent the funds deposited by banks at the Fed, which similarly can be redeemed for gold. The sum of TMS and excess reserves are therefore the comparable currency measure.

In 2005 we were in the sunny uplands of growing economic confidence, when systemic risk appeared to have been banished forever. We had recovered from a destabilising economic crisis the previous year, and both stock markets and house prices were rising. Today, eight years later governments are committed to monetary inflation from which there is no practical escape, yet at $1,200 gold is only 13.9% higher today.

The chart above is clear evidence that gold is mispriced to an exceptional degree given the deterioration in fundamental monetary and economic conditions.

Fundamental monetary and economic conditions

The recent episode about tapering, when it dawned on the big-wigs at the Fed that their plan to save the world was not working and that they were caught like rats in a trap with no exit, exposed an important truth. When you rely, credit cycle after credit cycle, on debasing the currency to stimulate economic recovery there comes a time when it fails to work completely, and instead you need to keep issuing new currency to avoid debt liquidation.

The Fed has begun to realise this truth applies today and is trying to find a way out of their mistake. Meanwhile prestigious economic and financial commentators, used to lapping up Fed policy statements, interpret the tapering episode as a “policy signal”, with which the Fed conditions the markets for monetary tightening. This optimistic view does not accord with a realistic assessment of economic prospects, the condition of the banking system and government financing requirements.

It has become clear in the last few months that the US economy is not recovering and if a realistic deflator is applied it is contracting in real terms. At the same time the largest economic area, the eurozone, is sinking into a deepening depression, Japan has resorted to printing yen just so the government can pay its bills, and the UK is in a similarly precarious position as the US.

The major economies have become hampered by too much debt, too much government and too much regulation. Their ability to recover and generate the tax revenues to rescue government finances and the profits to bail the banks out of their bad debts is therefore fatally impaired. It is this dawning realisation that has become every central banker’s worst nightmare.

Meanwhile, the global financial system was brought close to crisis by the mere whisper of higher interest rates, should the Fed try to reduce the pace of currency expansion. Markets were destabilised, and probably rescued only by exchange stability fund intervention.

The issue of rising interest rates is particularly sensitive because there are in Europe undercapitalised banks which cannot afford the losses on government debt from even a modest rise in bond yields, and are almost certain to collapse from the effect of unexpected interest rate increases on their interest rate swap exposure. Indeed, the parlous state of Europe’s banks was paraded before us only last week as the European Commission insensitively debated how to stick bondholders and depositors with the rescue costs.

The governments of the US, Japan and the UK have now become accustomed to financing their deficits by expanding the quantity of currency, and in the case of the eurozone, the expansion of bank credit to finance government debt. The dynamics of this debt trap on governments are concealed by manipulated and self-serving statistics misleading the governments themselves with respect to the true state of affairs. The four major currencies are now irretrievably committed to monetary hyperinflation, and this is illustrated in the chart below, using the example of USD True Money Supply plus excess reserves.

True Money Supply plus excess reserves $bn

The dotted black line is the exponential rate of growth, which is the maximum rate at which TMS can grow without destabilising the monetary system. Since the Lehman crisis the rate of growth has become hyperinflationary. Another way to consider this issue is that to revert to a stable exponential rate approximately $3 trillion would have to be withdrawn from circulation by the Fed. A monetary contraction on this scale is inconceivable, even if it is spread out over a number of years, not least because it would almost certainly collapse the whole monetary system.

The world is now committed to monetary hyperinflation, yet since 2005 gold at $1,200 today has only risen by $59 in adjusted terms.

Market fundamentals

In my preview of 2013 published by GoldMoney six months ago, I identified silver markets as a systemic danger, with the potential to create problems for gold. The problem appears to have been understood by both the central and bullion banks and partially deferred through what can only have been an engineered price slump.

Today the bullion banks have now balanced their gold derivative books on the US futures market, with the four largest actually long by 25,782 contracts on 25 June, and most probably more so on the last price fall. They have achieved this remarkable feat through a combination of increased short positions to record levels in the managed money category (hedge funds), and by producers in the Commercials category selling gold forward to protect themselves from falling prices. The extreme managed money short position is shown in the next chart, and last Friday the level of short contracts was probably even more extreme reflecting the most recent price falls.

Managed Money short position

Hedge funds’ short positions amount to about 240 tonnes, which is unprecedented.

In the last six months on the US futures market, the bullion banks – with the assistance of hedge funds – have booked enormous profits by closing their shorts and have virtually eliminated their exposure to systemic risk from rising gold prices. This can be seen in the chart below.

Gold - largest 4 net position

Silver, which I originally identified as the likely trigger point for a systemic crisis, has not been so easy to deal with and is an entirely different situation. The largest four traders (bullion banks) are still short by 18,846 contracts, but nevertheless have reduced a highly dangerous short position in illiquid conditions.

Silver - largest 4 net position

The problem in silver is that manufacturers are running long positions. Mindful of silver’s volatility they are locking in low silver prices to secure their operating margins. Nevertheless, the bullion banks have managed to stick it to the managed money category, whose short position is truly extreme.

Money managers shorts

Think about it for a moment: here is a bunch of amateurish hedge funds which has sold expecting lower silver prices and is now short of 133,000,000 ounces in an illiquid market, where the manufacturers cannot get enough physical at current prices.

Meanwhile physical is disappearing fast

If ever there was proof that gold is under-priced, it is the remarkable appetite low prices have developed for physical delivery. This is now so great, particularly from China and India, that not even the liquidation of ETF holdings has been enough to make up the difference. I wrote about this two weeks ago where I demonstrated that the western central banks must be supplying the market with bullion. Their motivation is clear: to avert a developing market crisis which was evident last year as a combination of ETF, Chinese and Indian buying led to persistent bullion shortages.

The acceleration of Asian demand from China and India alone last April and May increased the global shortage of physical bullion to record levels, requiring an increased supply to the market from central banks.

The important point to note is that it is erroneously believed in the capital markets that with respect to physical supply ETF liquidation has been sufficient to match increased Asian demand. An examination of the facts shows this to be untrue: the fall in prices has generated global demand on such a scale ETF liquidation is only a minor part of the whole supply picture, and the balance of supply can only have come from western central banks.

This is now the missing piece in the jigsaw: how much more gold will be fed into the markets by central banks? We don’t know how much they have left. We don’t know how short the bullion banks in Europe are, nor do we know the true positions of other members of the London Bullion Market. But we do know central banks are panicking, as evidenced by the tapering episode. We can surmise that they expected to quash the gold price by their actions, only to find that record and unexpected levels of global demand were generated instead.


Regulation Means The Bitcoin Gold Rush Will Not Happen In The US, Say Experts

bitcoinsEurope is better positioned as a better place to create Bitcoin-based startups than the US. That was the message coming out of Bitcoin London toay, the first major conference in London to cover startups, investors and business models. Covering the broad sweep of businesses, technologists and institutions involved in the Bitcoin space, the conference heard that the US may have made a fatal strategic mistake in classifying Bitcoin as if it were money so early on in its development.

What has emerged is that Bitcoin is being treated in many different ways: as money, as an asset class, as the first highly secure P2P global information exchange, as a technology platform and even as a if it were a startup entity in its own right.

Constance Choi, General Counsel with Payward sounded exasperated on stage at the conference: “Having to explain Bitcoin at Federal and State level is a nightmare.” She said the Treasury response was that the 50 State system is just “a fact of life”, a “a barrier to entry” and it up to the Bitcoin sector to survive.

“There is incredible potential for Bitcoin if not as a unit of exchange but as a secure global network for information exchange,” she said.

But despite this potential to be many other things, she said FinCEN (the Financial Crimes Enforcement Network) has basically said “Bitcoin is not money, but it is in the ‘money bucket’.”

“You see competing voices for jurisdiction [at government agency level]. You can call it money or a payment instrument. There are lots of different labels on Bitcoin.”

She said that although regulators in the US don’t think Bitcoin is money “it acts like money so it’s being treated and regulated in this way.”

In the UK the Financial Services Authority doesn’t consider Bitcoin to be ‘fiat’ money or eMoney.

And at a wider European level, the European central bank has taken the view that Bitcoin is not money and doesn’t require regulation yet. That turns out to be a huge advantage for Europe.

“There’s been a more reasoned approach in the EU… Because these are no regulatory regimes there is a lot of room to work out which rules might fit in and what rules should apply.”

Choi said the US is “5 years behind the EU” in payment innovation.

Her comments were backed by at the conference by Bitcoin Foundation General Council Patrick Murck, who said competition between US government agencies to regulate Bitcoin was creating barriers for the ecosystem to thrive.

Certainly there appears to be early signs that Bitcoin startups may desert the US for less regulated climes.

Speaking to TechCrunch at the Bitcoin London Conference, Jonathan Rouch, founder of Bits of Gold in Israel, said he has no plans to launch his service for creating Bitcoin liquidity in the US because of the potential for regulatory intervention.


Gold Panda – Half of Where You Live

The style of UK producer Gold Panda has always been resplendent. The emphasis that Derwin Powers has placed on melody has been obvious since “Quitter’s Raga”. He places his melodic elements higher in the mix, and the rhythms they trek, his percussive elements follow. His self-professed love for more estoric samples fits neatly into this narrative; melody can produce the same type of nostalgia a recognized sample will. The result had obvious forebears — Four Tet, Aphex Twin, etc. — but on debut record, Lucky Shiner, Powers’ more refined pleasure-rewarding dispelled easy comparisons.

Half of Where You Live, Gold Panda’s follow-up, still plays to those strengths. Opener “Junk City II” deals in Oriental-influenced plinks and square wave stomps; standout track “Brazil” steals the old “You” trick of building off a single repeated word (obviously, “Brazil”) while slipping and sliding underneath elastic synthetic strings; follow standout “Community” finds its drive in a dreamy, underwater riff of synth stabs. But the record also separates itself from Panda’s debut by trafficking in darker, neon glow melodies as opposed to some of the more sentimental sounds of his debut. Gold Panda in da club, as it were.

On those standout tracks, Powers conjures up day-lit nightclubs that are just as wont to dance with their headphones on. “We Work Nights” reimagines some English flute as a house cut; “Flinton” is the most reminiscent of “Lucky Shiner”, with a beautiful piano riff accompanied by a battered drum sample that captures the idea of a log cabin dance party tape found in the dirt. Between the beats, there are moments of ambient beauty like the plaintive “S950″, which also kind of sounds like the waiting music for the Nintendo Wii.

Half of Where You Live is a strong follow-up from a producer who’s underrated due to his patience and steadfast refusal to be ostentatious. His music is calm and self-evident, finding memorability in its creator’s confidence with a tune.