By Scott Silva
Editor, The Gold Speculator
6-26-12
“Greed, for lack of a better word, is good.” So said Gordon Gekko, the
iconic corporate raider in Oliver Stone’s cynical 1987 film Wall Street.
Michael Douglas won an Academy Award for Best Actor for his role in
the film, now a classic. In the film, Gekko is ultimately imprisoned for
securities fraud after years of benefiting from insider trading. Today, many liberal legislators and left-wing
politicians associate Wall Street traders and investment bankers with the
criminal activities of Gordon Gekko, the fictional film character. Certainly
the Occupy Wall Street protesters believe Wall Street is the seat of corporate
greed and corruption. Some US Senators
conflate securities fraud with speculation, frequently referring to Gordon Gekko,
excess and greed in speeches designed to vilify speculators, who after all,
“caused the financial meltdown” or, “caused $5.00/gal gasoline prices” with
their wonton, unbridled greed.
But speculation in the commodities markets is not illegal. Nor is it
immoral. In fact, speculation is integral to operation of free markets. There
is a legitimate role for market speculation in efficient markets. Without
market speculation, prices would be less stable and price discovery more
difficult, making markets less efficient. For example, if there were no speculators in
the pork bellies market, the market would consist of producers (hog farmers)
and consumers (butchers, and those who prefer to carve up their meat
themselves). With just two participants
in the market, the market would be thinly traded, leading to large spreads
between bid and asked, which distorts prices, and makes capital investment less
efficient. As a market participant, the
speculator adds liquidity (risks his own capital) and provided a competitive
bid which narrows the spread, making the market more efficient for all
participants. Because there are two sides to a speculative trade, either the
long position holder or the short position holder will benefit from price
changes over time.
Usually, speculation in a particular market has a dampening effect on
price volatility, but there have been periods of “irrational exuberance” where
prices are bid up in exponential fashion, creating a market bubble. Speculators may participate in the
development of a market bubble, as they did in the real estate market boom of
2000-2008, but it takes more than speculation to cause a market bubble. In the
case of the US real estate bubble that burst in 2008, decades of easy money and
government intervention in the home mortgage industry via the Community
Reinvestment Act laid the foundation for the irrational boom and its ultimate
bust.
Recently, speculation has been blamed for high gasoline prices. “The oil
speculators have bid up the price of oil, so you are now paying $5.00 per
gallon at the pump!” complained a US Senator who proposes to ban speculators
from trading oil futures. “Only producers and commercial consumers who need to
hedge should be allowed to trade oil futures contracts,” say proponents of
strict regulation of the oil futures markets; “Speculators are greedy, and
greed is bad.” But studies show that oil
prices have increased steadily since 2000, with commercial and non-commercial
(speculators) holding net long into the extended bull market for oil. Even
during the period of strict regulation and position limits on the commodities
futures market, prior to the Commodities Futures Modernization Act, oil prices
tended to climb higher year after year.
Although speculators have represented a growing percentage of open
interest since 2003, the Commodities Futures Trading Commission (CFTC)
concluded in its own investigation of the oil futures market that there is no
evidence that the market was influenced by the trading behaviors of any large
group of participants. In fact, CFTC chairman Walter Lukken told a committee of
the U.S. House of Representatives in 2008 that CFTC analysis “did not find direct
evidence that speculation
was driving up
(commodity) prices.” The fact is,
global the oil market was tight, leading to the peak price of WTI at $147/bbl
in mid 2008. The futures price was a
prescient leading indicator.
If speculators did not cause the bubble in the oil market, what did? One
explanation that makes sense is the weakening Dollar. Because oil futures
settle in Dollars (or physical delivery), it takes more Dollars to buy a barrel
of oil, for a given supply, when the Dollar is weak. Conversely, the stronger
Dollar purchases more barrels per Dollar, driving down the price in the global
market. The value of the Dollar has been trending down ever since the Federal
Reserve has been printing more of the stuff in the name of US economic stimulus.
It is the time-tested economic principle known as Gresham’s Law that bad money
drives out good. Printing more money out of thin air debases the currency and
devalues Dollars in circulation.
We can see the inverse relationship of oil (West Texas Intermediate, WTI)
and the US Dollar Index (USD) in the chart below. WTI peaked just as the US
Dollar bottomed in 2008 just as the Federal Reserve added the first $700
Billion of the $3 Trillion it would add to its balance sheet under its economic
stimulus policy. The anticipated effect of spurring the economy into robust
recovery has proved elusive. But there are unintended negative consequences of
the Fed’s money printing spree, which include higher prices for
commodities. As we know from Milton
Freidman and the recently departed Anna Schwartz, may she rest in peace,
inflation is always and everywhere a monetary phenomenon.
We also know that the price of gold reflects the
strength of the Dollar. The Dollar’s drift from 2002 to 2008 helped propel the
price of gold up over $1200/oz. Of course, there are other factors that
contribute to gold’s rise. Gold is the traditional safe-haven asset that
investors seek out in times of economic uncertainly, turmoil and war. Gold has
intrinsic value, and it acts as a store of value. Unlike fiat currency, gold
maintains its value and is recognized as viable collateral for transactions in
markets around the world.
Today, oil prices have subsided a bit from the highs of over $110/bbl
earlier this year. WTI is now trading down below $80/bbl with no added supply.
Some analysts believe that the war premium has been wrung out of the price.
Iran is no longer openly threatening to close the Strait of Hormuz. Maybe so,
but the primary cause is softer demand. Double
dip recession in Europe, a slowdown in China and the continuing slow-motion, no-growth,
jobless recovery in the US has dampened demand for energy. And by the way, the
Large Speculators have been cutting back their long positions on WTI and adding
short positions; last week’s Commitment of Traders report showed bullish
sentiment for oil has dropped to 63% down from 96% in February when WTI was
trading near $110/bbl. No one seems to
complain about speculators when prices go down.
Gold is also trading below $1600/oz.
But more poor US economic data is coming for sure, and the Fed will jump
in with more quantitative easing, adding more to its balance sheet which will
further devalue the currency. So, in today’s market, take a page from Gordon
Gekko’s playbook. Buy, buy, buy gold. Because, as we all know, “Greed is good.”
Responsible citizens and prudent investors protect
themselves and their wealth against the ambitions of over-reaching government
authority and debasement of the currency by owning gold. Gold is honest money. Investors from around the world benefit from timely
market analysis on gold and silver and portfolio recommendations contained in The
Gold Speculator investment newsletter, which is based on the principles
of free markets, private property, sound money and Austrian School economics.
The question for you to consider is how are you going to
protect yourself from the vagaries of the fiat money and economic
uncertainty? We publish The Gold Speculator to help people make
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