In a world of uncertainty, in one sector there is a lot
of certainty. The interventionist establishment remains confident that at
some point their manipulation of rates of interest and rates of depreciation
will achieve economic utopia. And then they will quit. Sure - and bulls
always know when to get out.
School economists remain certain that at some time there will be a "crack-up
boom" - whenever and whatever that is.
remain convinced that central bankers can depreciate at will. In so many
words, they can collapse the dollar to zero.
history says that they can't.
myself, I'm only certain about two things that won't happen. They will never
publish a book called Great Moments In Disco; nor one titled Great
Moments In Macroeconomics.
serious, there is only one financial history and it repeats. A great asset inflation, otherwise known as a bubble,
climaxes and collapses. While horrendous the transition from boom to bust has
been methodical. That's on six examples from the "South Sea
Bubble" in 1720, to the "Roaring Twenties"
in 1929 and to "usual suspects" beginning in 2007.
been the greatest dislocations in financial history. All five prior to ours
marked the beginning of a Great Depression that lasted for some twenty years.
If the "Black Swan" guys were on the scene in the fall of 2
1720 they would have been surprised. At the time participants knew it to be
an ephemeral bubble. Also in 1772, 1825, 1873 or 1929 the calamity would have
been called a Black Swan Event. But, all the initial crashes occurred in the
fall, and that is methodical.
methodical is that each bubble included a frenzy of borrowing short and
lending long, of which the signature is an inverted yield curve. Then where
data are available, typically a boom will run some 12 to 18 months against
inversion and when the curve starts to reverse it signals the end of
speculation. This provided a three-month warning to the end of the Dot.Com
Mania in March 2000. And in 2007 the killer month for THE reversal in the
credit markets counted out to June. The curve began to reverse in May and in
that fateful June it began to be accompanied by widening credit spreads.
By early June
these had clocked the trend change and the observation was that the "Biggest
train wreck in the history of credit" had started.
It is not
feature of the post-bubble world has been severe recessions and weak
recoveries. There is another methodical step as the recession virtually
starts with the bear market. Usually the stock market leads the business
cycle by around 12 months. Using NBER numbers the recession started in
October 1873 and the crash started in that fateful September.
stresses were building in the summer, a leading New York newspaper
editorialized that the US Treasury System was superior to a central bank
constrained by a gold standard. An excerpt from the editorial records the
belief that the agency of the day was proof against contraction: "Power
had been centralized in him to an extent not enjoyed by the Governor
of the Bank of England. He can issue the paper representatives of a
score or more of millions ... it is difficult to conceive of any condition
or circumstances which he cannot control." In so many words,
nothing could go wrong.
similar to Harvard economist Greg Mankiw's beliefs.
In December 2007 he boasted that nothing could go wrong because the Fed and
the White House had a "Dream Team" of economists.
Eventually, the NBER decided that the recession started in that fateful
December. It became the worst recession since the 1930s.
would one expect.
Late in 2009,
and not noticing the irony, the establishment began boasting that without the
stimulus that crash would have lasted forever. This contrasts with the boast
that nothing could go wrong. The notion that markets don't clear exists only
example provides further instruction that can't be found in textbooks. As the
economy was suffering its second and severe recession in 1884 senior
economists began to call it the Great Depression. It lasted from 1873 to 1895
and was still being analyzed as the Great Depression until 1939 when
economists discovered a new one.
unsupportable econo-myth is the notion that a Fed
cut will keep a boom going. Short-dated market rates of interest go up in a
boom and down in a bust. And the most dramatic declines only occur during the
initial post-bubble crash. In 1873 the discount rate at the senior central
bank plunged by 650 basis points. During the 1929 crash the Fed cut the
discount rate by 450 beeps as was the case in 2000 and in 2007.
I guess that
the "Dream Team's" plan was to cut rates to keep the boom
the Fed's history at important tops and bottoms changes in the administered
rate have followed changes in market rates by 2 or 3 months.
So why listen
to policy announcements? Moreover, at disastrous turning points in the credit
markets it has no, repeat no, influence on the yield curve or
The Fed is
all show and no go.
There is a
reason for this, and it has to do with an old saying in Physics: "If
you keep your data-base short enough it will fit your theory".
It seems that most any crash will prompt an intellectual to have a personal
revelation on how to fix the hardships of a bust. On the other hand, traders
with experience as in a long data base learn to get out and get short.
Traders, such as Gresham in 1551, knew that nothing can be done about a
One of the
earliest of impractical revelations was made by Edward Misselden
in the 1618 to 1623 crash. That was an important one as it was one of the
steps that Mother Nature took to end a hundred years of deliberate price
1500s there seems to be two kinds of comments about interest rates. One type
is the complaint that someone, or some agency, has set them too high. The
other is the dream that some agency can willingly set them low. Treasury bill
rates are at Depression lows. Set by market forces, not by central bankers.
At the height
of the 1873 Bubble, Walter Bagehot, the highly regarded editor of The
Economist wrote that a financial crisis was a form of "neuralgia"
that could be banished by appropriate employment of central bank credit. As
mentioned, the 1873 to 1895 post-bubble contraction was called the Great
along, Bagehot's notion about discounting liberally during a crisis was
likely known by Fed and Bank of England staffers in 1929.
recent scholars of the early 1930s claim that the whole disaster was due the
Fed being "stupidly" tight, newspapers of the day
show something else. Revisionists state the Fed increase to 6 percent in
August 1929 "caused" the crash and that "caused"
With the rate
increase The New York Times explained that the Fed was tightening funds for
Wall Street while easing funds for Main Street.
crash the New York Fed bought bonds out of the market - and exceeded its
authority by a factor of six times.
in 1932 Barron's provided an indelible summary of the Fed's efforts to
provide liquidity: "The Federal Reserve policy of cheapening
credit through the purchase of government bonds has been unable to
make a dent in the conservatism of borrower or bank lender, in short,
every anti-deflationary effort has yet to provide positive results.
The depression is sucking more and more bonds into its vortex."
The reason this is not in the textbooks is that the Federal Reserve is the
perfect system. Proponents of central banking have to insist the guys running
it were stupidly tight.
Who are you
going to believe.
record of the day, or ambitious academics forty years after the crash.
Gold's behaviour through a financial mania and its disquieting
consequences has also been methodical. Typically gold's real price sets an
important low in the year the bubble climaxes as base metals set high real
prices. Then, with the general contraction, the gold sector trends up until
the Great Depression completes - some twenty years later.
While the post-bubble
world may be the worst of times for base metal miners, it is the best of
times for gold miners and exploration companies.
This has huge
influence on stock prices. From 1927 to 1929, International Nickel soared
from 8 to 72 as real base metal prices increased. On the other hand, Homestake only rallied from 7 1/2 to 11 1/2. Mainly
because gold's real price was going down - and so were Homestake's
earnings - from 73 to 52 cents.
One of the
recent concerns of the gold community has been that in 2005 gold stocks broke
the pattern of moving up with gold's dollar price. History provides an
explanation. Gold stocks were dull compared to the incredible action in base
metal miners. SPTMN is the index and in the final two years of our bubble it
doubled the gains in golds - because real prices
for base metals soared while those for gold declined. Ironical because the
dollar declined as part of the mania.
or strange in this.
prices for gold also enhance the worth of gold discoveries and while there is
plenty of 1930s history on the seniors, there is very little on the juniors.
In the early 1970s I attended a promotional meeting on a stock.
remember what it was, but the older and dapper gentleman who introduced the
"great" promoter had been a broker on the wild Montreal Exchange in
the early 1930s. When I asked him if the juniors had been hot then, he said "Sonny,
in 1933 my best customer gave me a brand new Ford Roadster - as a
thank you." Gold's methodical nature generates some fascinating
On the 1825
to 1844 Great Depression gold's real price (deflated by the CPI in the senior
currency) increased by a factor of 1.63 times.
On the 1873
to 1895 Great Depression it increased by a factor of 1.69.
On the 1929
to 1946 Great Depression it increased by a factor of 1.70.
this inspired dramatic increases in gold production. But while the price
increases were remarkably similar - production increases were not.
depression that ended in the 1840s the annual rate of gold production soared
450 percent from 14 tons to 77 tons. A few years later the number was 187.
California discoveries were very exciting.
depression that ended in 1895 production increased 107 percent from 147 to
305 tons. In a few more years it increased to 462 tons annually.
the Klondike were very exciting.
is that the great gold rushes occurred at depression bottoms when the real
price was high and so was global unemployment.
World War Two
did not alter the price increase but it prevented another great gold rush.
But from 1929 to 1940 annual production only doubled.
message is that the same price increases do not prompt similar increases in
production. This suggests that trying to determine price from analysis of
supply and demand may be frustrating.
All one needs
to know is that the real price, profitability and annual rates of production
will increase substantially over the next twenty years. Of course, the usual
business cycle will maintain, but if the past continues to guide gold mining
will become the premier sector as most industry and commerce suffer pricing
calculation of the US CPI became suspect it has been appropriate to use
gold's price divided by our commodity index as a proxy for the real price. It
also is a forecasting tool. It declined to 143 in May 2007 and turned up
three weeks before the credit market started to crash in that fateful June.
It soared to
over 500 in February 2009 and turned up some three weeks before the panic
ended in March 2009.
fall's panic it soared to just under 500 and with recovering spirits in
orthodox investments such as stocks, garbage bonds and commodities it
declined to 404 in July. The uptrend was set this week and it is anticipating
another liquidity crisis.
reliable indicator with a long history is the gold/ silver ratio which goes
down in the good times and up in the bad times. At extremes it acts like a
Britain's remarkable financial discipline after the insanity of the 1720
Bubble until the next insanity in the early 1800s, the ratio stayed around
15. In the 1825 Bubble it was at 15.8 and at the depression bottom of 1844 it
increased to 17.2. At the end of the next depression in 1895 the ratio
The long term
trend has been that the gold/silver ratio increases with each Great
Depression and it reached 91 with the distress that concluded in the 1940s.
Moving right along it reached 84 with the 2008 Crash.
Then with the
good times the ratio dropped to 32 a year ago in May, and was extremely
For making a
timely market call it has been useful to look at the ratio upside down. On
any rally for precious metals silver will outperform gold and silver really
did it on the last big rally. Momentum was spectacular as the RSI reached 92
in a April a year ago. This matched the high reached
in January of 1980.
was a lot of bullishness that needed to be wrung out of the markets.
The plunge in
gold stocks from May last year to May this year ended with the second worst
oversold in over a hundred years. Using the monthly RSI the worst was in 1924
and others almost as bad cleared in in 1942, 1948 and in 2008.
abysmal low needed testing and the test was severe and completed in July. On
momentum and sentiment an important bottom was set. It could survive this
fall's liquidity problems when conditions would be then be set for a major
advance in gold's real price and the whole gold sector. Think about
exploration stocks and Ford Roadsters.
is a long way from a powerful market, there is a reliable indicator of the
final blow-off. The inevitable mania will be close to peaking when young
operators start promoting that old property in Nevada that has so many holes
in it that when the wind blows it whistles.
Back to the
bigger picture. Not only does gold set an important low in real terms as
bubble concludes, but so do real long-dated interest rates.
senior central bank has been on gold or off, a bubble creates a lot of money
and credit that drives nominal yields down as stocks and commodities rally.
The result can be minus real rates as in 1873 or 2008 or only slightly
positive as in 1929. In the consequent contraction real long interest rates
in the senior currency have typically increased by 12 percentage points,
repeat 12 percentage points. In the initial collapse in 2008 the increase was
a severe 6 percentage points. The next collapse could accomplish more than
effectively ends the abuse of credit markets by private participants in Wall
Street and by financial adventurers in central banks - otherwise known as a
new financial era.
post-bubble relentless rise in gold's real price has been equally transformative.
This time around, the rise will become irresistible to even senior central
banks and they will want to have more of it in their reserves.
It will be
interesting to watch how they change their theories to rationalize owning a
statement inquiring minds may wonder what drives the real price up. Every
bubble takes on more debt than the global economy can service.
Steve Hanke noted that private credit is
contracting faster than policy makers can expand government credit. Another
feature of a bubble is that it not just an extraordinary expansion of normal
credit instruments, but a bubble of innovative credit instruments as well.
contrast in what can be called a great bond revulsion that is part of a
credit vacuum. Mother Nature can't tolerate a vacuum and starts to raise
gold's real price, producers respond and increase rates of gold production
and that, despite central bank intolerance to gold, begins to re-liquefy the
global banking system. It usually takes some twenty years to build to the
next party era.
make me an optimist? Only on the very long term. Near term, I'm cautiously
The theme of
this Summit is "Navigating the Politicized Economy".
first decision is to get political intervention out of everyone's life.
point has been to obtain a living from some else by messing up their lives.
This could start by getting even with the confiscatory predators who have politicized the economy. Sell all their bonds and
don't buy any new issues until they discover fiduciary responsibility.
"They" being governments around the world
including US munis.
That'll be a
lesson to them! We started this in May when we got out of our long-dated treasuries.
was on a huge technical "Sell!" signal, that was followed in July
by similar calls on investment-grade corporates and then on emergingmarket debt. Historically, the 12-percentage
point increase in real long rates could be starting and this will eventually
get the predators. But we can have some fun by being Bond Vigilantes along
The next step
is to ridicule interventionist economics. There is no there, there. The body
of interventionist theories and practices is based upon personal revelations
that some agency can raise or lower interest rates at will. As noted earlier,
this superstition dates back to the 1500s, at least.
popular notion that throwing credit at a credit contraction will make it go
away is about to be disproved - again.
denies empiricism, every time and its worse - there is no logic.
Take the idea
that a state-sponsored credit expansion will cause a business expansion,
extend a recovery or in 2008 keep a panic from running forever.
this is an example of the dreaded primitive syllogism. Scary phrase isn't it,
but the most used example is that roosters crowing in the morning cause the
sun to rise.
credit do expand together, but one does not cause the other.
reason such nonsense became dominant is because it provides the means to fund
the state through currency depreciation. Recently the US experiment in
authoritarian government has turned unusually ambitious and we all know that
unlimited government requires unlimited funding. Many think that the Fed has
the ability to do this through equally ambitious depreciation.
about printing presses and helicopters come to mind, but market forces have
something else in mind.
price of gold has turned up and that typically signals the onset of liquidity
concerns. This melancholy probability will be confirmed when the silver/gold
ration turns down. This week, on Thursday momentum reached 85 on the RSI
which is in very dangerous territory. The 92 accomplished in April 2011 was
in extremely dangerous territory.
positive side, the next crisis will provide an outstanding buying opportunity
in the precious metals sector.
The title of
this address, "Preparing For The Fall", has trading
opportunities in mind as well as something more profound. And that is what
will happen to the cult of policymaking and central banking with the onset of
another banking calamity.
First of all,
financial history provides a severe due diligence on every grand scheme ever
floated in a mania. That used to be limited to private promotions. But with
the corruption of policymaking by a couple of generations of financial
adventurers, the severe due diligence will include central banking.
case, history also provides a "Dream Team" with formidable powers
to shred the nonsense of a national economy that can be managed by economists
who seem to acquire a unique genius when appointed to the Fed.
"Dream Team" is Mother Nature and Mister Margin and this fall they
will be joined by the public's discovery that all that
taxpayer "stimulus" is not working.
By way of
closing, I'll pass on something timely from the old and dreadful Vancouver
Stock Exchange and that is the definition of a promotion: "In the
beginning the promoter has the vision and the public has the money." At
the end of the promotion, the public has the vision and the promoter has the
money." I'll leave it to this audience to determine who and what
has been the greatest promotion in history.
The opinions in
this report are solely those of the author. The information herein was
obtained from various sources; however we do not guarantee its accuracy or
completeness. This research report is prepared for general circulation and is
circulated for general information only. It does not have regard to the
specific investment objectives, financial situation and the particular needs
of any specific person who may receive this report. Investors should seek
financial advice regarding the appropriateness of investing in any securities
or investment strategies discussed or recommended in this report and should
understand that statements regarding future prospects may not be realized.
Investors should note that income from such securities, if any, may fluctuate
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Neither the information nor any opinion expressed
constitutes an offer to buy or sell any securities or options or futures
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Moreover, from time to time, members of the
Institutional Advisors team may be long or short positions discussed in our
This essay is part of Pivotal Events that was published for our subscribers August
Copyright © 2003-2008 Bob Hoye