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Macro Musings: Milestones



-- Posted Wednesday, 12 September 2007 | Digg This ArticleDigg It!

By Justice Litle

09-12-07

I have the ability to imagine configurations of the world different from today, and really believe it can happen.
 -- legendary hedge fund manager Bruce Kovner

TODAY WE MUSE on gold, but the discussion begins with oil. (With crude hitting nominal contract highs and the yellow metal besting 16-month highs, it seems appropriate to combine the two.)

When oil was cheap

Remember cheap oil? Those glory days when you could fill up at eighty-two cents a gallon off some tumbleweed patch of interstate?

Your Macro Musings editor was a commodity broker back in 1999, when internet stocks were flying too close to the sun and oil was plunging toward the $10 mark. A cherished piece of market memorabilia -- to be framed and hung on the office wall one of these days -- is a vintage ‘99 issue of The Economist, with the marvelous headline "Drowning in Oil." The cover depicts two hard-hat workers at a spraying wellhead, literally soaked in crude. Inside, the prediction is for oil to hit $5.

West Texas Intermediate never did hit $5 a barrel, of course... or even crack $10 for that matter. It bottomed soon after that Economist issue hit the stands. (Almost as if someone had rung a bell. Good old Economist...)

The more relevant memory today, though, is from the early months of the year 2000, not quite a year after oil had bottomed. That was when oil futures crossed $30 for the first time in 15 years or so (not including the Desert Storm spike).

Crude at $30 was a big deal in the year 2000. It was the kind of thing that made you rub your eyes. Crude oil? That cheap stuff we never think about? The stuff that, literally, fueled the soccer-mom-in-suburbia SUV boom of the 1990s? At thirty bucks a barrel? Really?  

Your editor recalls watching the NYMEX action tick by tick. The moment was more interesting, in its own way, than a crucial last-second Superbowl play. $29.94... $29.97... $29.99... there she goes! We always wondered how it must have felt to be the floor trader who bought $30 first. Did he save the ticket?

Never again?

Now there is legitimate question as to whether $30 a barrel crude will ever be seen again. Ever.

If you had walked into the offices of Commodity Resource Corp. seven years ago and said "guess what folks, this ceiling will turn out to be a floor in the history books," most of us would have thought you were smoking banana peels.

And of course, the $30 milestone wasn't tucked away just like that. Oil tumbled back into the $20s soon after its historic push. Then it rose into the high thirties later in the year... and tumbled back down yet again. Crude even fell all the way down to the high teens -- albeit briefly -- after the September 11th attacks of 2001.

But, finally, by the year 2003, the $30 milestone was established as a sort of base point... and, as of late 2003, that milestone was left behind for good.  

So why bring this up, apart from crude oil's fresh assault on all-time highs?

Well, surely you've noticed another interesting tidbit. After a hiatus of more than a year, gold has again cracked $700 per ounce.

Seven years on

Looking back now we can say, "gosh... remember when crude oil was $30? We'll probably never see that again."

Your editor believes that, seven years further down the road, a similar sentiment could be expressed in regards to gold. "Gosh... remember when gold was $700? We'll probably never see that again."

It's a romantic and foolish exercise, trying to peer seven years into the future. We have no idea what the world will look like  -- economically, technologically, or even culturally -- in the year 2014. (Who knows... the Chicago Cubs might even bag another World Series by then.)

Impossible predictions aside, it seems fair to say the US dollar will be a mere shadow of its former self by 2014 (if recognizable at all in its new form). If we aren't on some kind of pure gold standard by that time (an extremely tough logistical nut to crack), we could be on some type of digitized commodity standard instead, under which the currency units in one's bank account are tied to an intrinsic-value basket. One resourcebuck = a fixed allocation of 30% precious metals, 30% base metals, 20% energy, and 20% timberland. Or something to that effect.

Whatever happens, it's important to keep hold of the fact that the world does change. Many things will stay the same, but others will look quite different... including global monetary policy.  

The Austrian Endgame

Returning now to the recent past (mid August actually), your Macro Musings editor still has a sore fist from pounding the table for gold stocks. Specifically we said the following:

We feel gold stocks could put in a triple or quadruple from current levels -- over the course of months to years -- and it isn't clear when the move will begin in earnest. Given that it could be sooner rather than later, we think it's time to buy.

The timing was indeed "sooner." Gold stocks took off like a rocket within a few weeks of that call... the price of gold itself adding a none-too-shabby $50 per ounce or so.

Patting one's self on the back makes for a sprained shoulder, so we'll say little more there. It just seems prudent to add, in this discussion of golden milestones, that we are no johnny-come-lately to the bullish gold argument.

Events of the past few years have played out in classic fashion, just as the Austrian Endgame (a personal term) predicted. Here we quote from an explanatory note to readers, penned by yours truly, back in August 2005:

The [Austrian Endgame] is rooted in a basic observation of Austrian economics, articulated by Ludwig von Mises:

"There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Here is how it works:

1. In attempting to stave off recession or depression, the powers that be induce a credit boom through monetary stimulus.

2. The following boom is enjoyed at the cost of a massive debt buildup.

3.  Excesses of the credit boom eventually lead to inflationary pressures.

4.  The powers that be find their hands tied; they cannot kill rising inflation without killing the debt-laden economy at the same time.

5.  The Fed's choice thus becomes take real steps to reign in inflation and destroy the economy, or let inflation run and eventually destroy the currency.

Anchors away

We are now heading into the thick of stage five. The sharpest evidence for this is gold above $700 (on the way to new all-time highs), the dollar at fifteen year lows (bye-bye long term support), and loud clamoring for a Fed rate cut from nearly all parties, even as the greenback is getting pitched headfirst down a well. (There is plenty more evidence too of course. Those are merely the most visible symptoms.)

So where do we go from here? The short-term course depends on a number of things and, as always, is not nearly as important as the long-term course. Right here, right now, it seems clear that an important psychological shift is taking place.

One of the reasons trends unfold slowly is because markets are so dominated by psychology, and psychology does not change overnight. It takes time for market participants to adjust their worldview, especially when the necessary change is gut wrenching and significant.

Appropriately enough in light of $700 gold, there is a psychological phenomenon called anchoring that is relevant to market price points. Investors, by way of being human, tend to attach undue significance to price points they are familiar with, putting too much weight on recent experience.  They will often think of a market price as "too high" or "too low" relative to their pre-established anchor, regardless of whether that anchor has merit. Wikipedia expands:

The anchoring and adjustment heuristic was first theorized by Amos Tversky and Daniel Kahneman. In one of their first studies, the two showed that when asked to guess the percentage of African nations which are members of the United Nations, people who were first asked "Was it more or less than 45%?" guessed lower values than those who had been asked if it was more or less than 65%. The pattern has held in other experiments for a wide variety of different subjects of estimation.

This is a partial explanation as to why crude oil did plenty of backing and filling between first crossing the $30 threshold and leaving $30 behind for good. (And, of course, there was also the calendar time required for global demand to ramp up. "Inevitable" does not always mean "immediate.")

With gold we are seeing a similar script as far as investor psychology goes. The first attempt to cross $700, some 16 months ago, was rebuffed. Things weren't all that bad on the Fed front just yet, and $700 was still a ceiling relative to the anchor of what felt "too high" and "too low."

In due time, however, the inexorable logic of the Austrian Endgame means at least one thing. Gold's one-time $700 ceiling will ultimately be transformed into a floor... and, eventually, a memory.

Profitably Yours,

 jl signature

Justice

To find out more about the Consilient Circle, click here .


-- Posted Wednesday, 12 September 2007 | Digg This Article




 



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