A letter from a reader takes me to task for my
missive “Bull in Bear’s Skin?” saying that I am an “ultracrepidarian” out of my depth. This little-used
English word covers a person who exceeds his competence in passing judgment
on matters about which he knows little or nothing. The etymology of the word
goes back to the story of a cobbler who, while standing in front of a
painting in a gallery, made loud and disdainful remarks about the sandals in
the picture. Unaware that he was overheard by the painter Apelles standing
nearby, he went on to finding faults with the legs, too. He was upbraided by
Apelles who said: “Ne sutor ultra crepidam judicaret” (let not the cobbler criticize
anything above the sandal). My correspondent Mr. Northeast, who is an
off-the-floor professional speculator, suggests that I, too, have
transgressed the limits of my competence when I called the shorts in monetary
metals “arguably the smartest lot on earth” for they could what
Aristotle had said was impossible to do: making gold beget gold. I quote his
Your latest commercial promoting the “smartest
traders on the planet” is badly off the mark. Here is a recent headline
from REUTERS: Fertilizer producer Agrium slips into red on natural gas
all due respect, if I were you, I would take back the admiring words you have
heaped upon commercial traders. You simply haven’t got sufficient
experience as a trader in the markets to be making these remarks. I have seen
far too many examples of commercial floor traders who short the market
habitually on every rally, only to get their heads handed to them on a
platter in the end when the supply/demand fundamentals ultimately assert
themselves. So, forgive me, but I can’t take anyone with such
outpourings of adoration seriously.
may say that bona fide hedgers, as distinct from naked shorts, do not
often miscalculate. But this is far cry from the glowing praises you heap
upon the shorts ad nauseam in your essay.
man of your intellect stands to lose credibility in no small measure whenever
he makes unwarranted statements about something of which he knows nothing.
Stick with economic theory and leave market analysis to us traders.
Dear Mr. Northeast:
Your point is well-taken that an ultracrepidarian
is running the risk of becoming the laughing stock of his peers. However, you
yourself are in danger of becoming the pot that calls the kettle black. You
are a commodity speculator who know about live
cattle and frozen pork belly futures trading. That is your competence. I am a monetary scientist who know about monetary commodities
such as gold and silver. That is my competence. You analyze the supply and
demand for oxen and pigs before you make a trade. That is all very well. But
it is incumbent upon me as a monetary scientist to warn people (those who
have ears to hear and brains to think anyway) that gold and silver are not at
all like live oxen or dead pigs. They are monetary commodities to which the
so-called supply and demand equilibrium model does not apply. If you
criticize me for saying so, then my answer to you has to be: Ne sutor ultra crepidam.
understand the dynamics of the gold and silver market you need a different
kind of model and you must employ different concepts than supply and demand.
You want to know about basis and backwardation. If you trade the gold and
silver markets, then you ignore the teachings of monetary science at your own
peril. You may suffer heavy losses, no matter how bullish you are in the
midst of a bull market. For example, if you assume that all short covering
takes place in desperation by naked shorts and none in calculation by shorts
acting on behalf of principals holding the stuff, then you are a pig-headed
bull ready to have your head to be handed to you on a platter. You see, in
addition to pig-headed shorts there are also pig-headed longs, and you may
suit yourself to decide which are more numerous!
is not my business to pass moral judgement on the shorts who
deceive the market pretending that they sell naked and foster bearish
sentiment deviously. Science is not concerned with moral considerations. But
I reiterate my considered opinion that the shorts who sell covered calls and
puts, whether on their own account or on that of others, act more intelligently
that the longs who jump in and out of the long side of the market on signals
generated by stochastic oscillators, or take refuge behind their
delta-hedges. Blind faith in the Black-Scholes formula for option pricing
will not save them. Theirs is a fair-weather system: it
breaks down under stormy market conditions, that is, when they need it most.
It is not unlike a compass that only works in calm seas, but gives false
readings in ship-wrecking storms.
the shorts in gold and silver are certainly not geniuses. I carefully distinguish between
naked shorts and others. A commercial who shorts the gold or silver market on
behalf of his principal who owns the physical, but wishes to remain
anonymous, cannot be considered a naked seller (even though he is represented
as such in the COT reports). Nor can the trader who shorts the market against
the unreported physical in his own possession, paying full commission rather
than taking advantage of the reduced commission available for hedgers, in
order to conceal his true identity as a bull. The bottom line is that the COT
reports can in no way reveal the true size of net short positions in gold and
silver futures, if some bulls are determined to pose as bears.
am also dubious about the conspiracy theory of Ted Butler, according to which
the shorts collude and act as a “wolf-pack” in dumping paper
silver in order to massacre the bulls. While it is not impossible, this
theory leaves a plausible explanation out of consideration. The idiosyncracies of the regime of irredeemable currency are
such that the smartest traders (and only the smartest) can read the mind of
policy-makers, treasury officials, and central bankers, and come up with the
same conclusion. Then, as a result, they act in unison without deliberate
observation does not make me a sycophant of the bears. But you have to give
credit where credit is due.
Antal E. Fekete
is a different kind of comment on my missive.
Dear Mr. Fekete:
Thank you for your thoughtful essay on Kitco
entitled “Bull in Bear’s Skin?”
I have been fully invested in gold since 1997. For most of that time I
have been perched on the edge of my chair waiting for gold’s meteoric
rise that will wipe out those evil shorts for good.
Now you have made the whole picture much clearer. The parties that
represent the short side of the market covet the gold, and covet it badly...
all of it... yours, mine, and everybody else’s... And the longs have
been meekly and foolishly giving it to them... at bargain prices... with
buckets of tears and disbelief... for a long time...
I am curious to know why you have waited so long to present such a
compelling hypothesis? I would be interested to read
more of your essays if they are available for public consumption. If so, then
could I please ask you to provide a weblink for
Thank you, Sir. Best to you.
Dear Mr. Southwest:
you for your kind words. A much more detailed paper on the same subject
entitled “What Gold and Silver Analysts Overlook”, one of my
lectures in the Gold Standard University series, was put on the Internet just
over two years ago, see e.g.
For your information, the Gold Standard University lecture series will
resume publication under the aegis of the Lips Institute in Switzerland,
starting in September next, as part of the inaugural celebrations. Stay tuned
for further announcements.
Central to my thesis is the critique of Keynes’ theory of
speculation and Friedman’s monetarism. In spite of Keynes, the markets
are not symmetric. There is an inherent bias favoring
the bulls at the expense of the bears. The limited risks of the former are
contrasted with the unlimited risks of the latter. This explains the
shorts’ fox-like quality of cunning, deception, and wiliness, acquired
in consequence of the Law of the Survival of the Fittest. On the other hand
the longs may become complacent, even obtuse, pampered as they are by the
inherent bias of the market favoring them. This is
convincingly demonstrated in the present situation by the profit/loss
statement of the bullish tech-funds.
The market bias just described goes under the name
“price-risk”. It is well-known. Less well- known is the
“basis-risk”, the fact that even hedged
producers carry unlimited risk. Let me elaborate. The basis, much like the
price, varies. But whereas the variation of the price is bounded from below
(as the price cannot be negative), the variation of the basis is bounded from
above. It can be negative (in case of backwardation), but it cannot exceed
the upper limit set by the carrying charge (interest plus storage plus
insurance costs). If it did, warehousemen could reap riskless profits. It
would be cheaper for them to carry the commodity in their warehouses than in
the form of futures and, accordingly, they would keep selling the futures
while buying the physical until the contango
dropped back to the level of the carrying charge.
there is no lower limit to contain the variation of the basis so that all
the producers hedging their production face what is known the basis
risk, which is unlimited. This fact is extremely important if you want to
understand the gold market. Ask Barrick how they
could have forgotten about the fundamental law of the markets, the unlimited
basis risk. I do not speak for Barrick, but
if they deigned
to answer your
inquiry, their answer would probably run along the following lines.
basis, like all economic indicators, is subject to the Rule of Mean Reversal.
In the long run, even after extreme swings, the basis must revert to its
mean, and if you are well-heeled financially, as Barrick
is, then you can weather the storm. Remember, Barrick
can never get a margin call for fifteen years.”
Barrick is wrong. Gold is a monetary metal and its basis
is not subject to the Rule of Mean Reversal. The basis-risk is unlimited. Barrick may have to wait till doomsday for the gold basis
to return from negative to positive territory. Let’s see the reasons
Rule of Mean Reversal is valid for ordinary commodities because the shrinking
(or negative) basis acts as a very powerful incentive for warehousemen to
sell the cash commodity and replace it with futures. They can take profits
and wait for the new crop to come out of the pipelines with which to
replenish their inventory. It is precisely this selling by warehousemen that
makes the basis to revert to the mean. What makes gold a monetary metal is
precisely the fact that its basis is exempt from the Rule of Mean Reversal,
and the basis risk is in no wise mitigated. The gold basis behaves
perversely: the greater its fall,
the more certain it is that further falls will follow. The longs take
delivery and will decline to recycle their holdings in the futures market
however attractive the terms are. Owners of gold will refuse to exchange it
for futures, no matter how cheap the latter may be relative to cash. As the
gold futures market is not designed to make deliveries on 100 percent of the
outstanding futures, it will go belly-up. And, incidentally, so will Barrick, as it will not be able to lift its hedges, not
now, not in fifteen years, not ever. Unless Barrick
is a front for a government (a hypothesis that cannot be ruled out) its name
will go down ignominiously in the annals of gold mining.
perverse gold basis constitutes the self-destroying mechanism of the regime
of irredeemable currencies. Previous descriptions of hyperinflation
purporting to explain the descent of a paper currency into the abyss of
worthlessness do so in terms of the quantity theory of money, trying to
explain a non-linear phenomenon in terms of a linear model. My theory of the
self-destruction of irredeemable currency is very different. Backwardation in
gold explains how it is possible that, in spite of the huge stocks of
monetary gold in existence, zero supply confronts infinite demand.
officials will declare “liquidation only” policy to offset long
positions in gold futures. The shorts are absolved of their obligation to
deliver as contracted. At that moment all offers to sell cash gold will be
withdrawn. Gold is not for sale at any price. Producers of essential
commodities such as grains and crude oil will refuse payment in dollars and
demand gold in exchange for their product. The dollar, and all other
irredeemable currencies along with it, will go the way of the assignat and mandat.
theory of monetarism won’t tell you when it will happen. Nor will the
COT reports give you a clue. The gold basis will. I hereby challenge
all gold and silver analysts to start educating the public on this subject. I
challenge all PM websites to run yearly, monthly, weekly, daily, and
hourly charts showing the variation of the gold and silver basis.
add your voice to reinforce this challenge of mine. Thank you.
Antal E. Fekete
May 9, 2006.
Antal E. Fekete is
Professor Emeritus at Memorial University in St. Johns, Newfoundland. Born
and educated in Hungary, he emigrated to Canada
after the Hungarian Revolution in 1956 and taught for 35 years in the field
of mathematics. Over the years, he has been a visiting professor or Fellow at
Columbia University, Princeton University, and Trinity College of Dublin. He
worked in the Washington office of Congressman W.E. Dannemeyer
on monetary and fiscal reform for five years in the nineties; and in 1996, he
won first prize in the prestigious International Currency Essay contest
sponsored by Bank Lips Ltd. of Switzerland. He is the author of Gold and
Interest and Monetary Economics 101. In addition, his scholarly articles have appeared on
numerous Internet sites throughout America.