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This was the main intro piece to IKN297, out Sunday. I've had some positive feedback on it so hey, what the henry, let's put it here on the blog too.
Helvetia in a handcart: Why I own gold (and why you should, too)
“We are not wholly bad or good
Who live our lives under Milk Wood”
Under Milk Wood, Dylan Thomas, 1953
When it comes to the money events in and around Switzerland last week, it’s difficult to recall an episode in recent financial times when there was such a massive, ten tonne, snorting, stomping elephant in the room and how the spectrum of Very Serious People made such a concerted effort not to talk about gold. And in the end it’s not a difficult subject nor a hard concept to grasp. It’s also one of the mainstay arguments of the hard-core goldbugs so I suspect the moment I announce my full and unequivocal adherence to it I’ll be pigeonholed and labelled as “one of those nutbars” (sorry to disappoint in advance and head y’all off at the pass; I’m not a goldbug, I’m an owner of gold).
Gold has no counterparty exposure.
But let’s not jump the gun, let’s take Dylan Thomas’s advice and begin at the beginning. The important near-term effect of the move by the Swiss National Bank (SNB) to remove its hard peg (1.2/1) against the Euro was not the price move of precious metals, particularly gold. Not in the near-term at least. The important near-term effect is found inside stories such as this one (1) and here’s an extract (IKN bold-type):
Alpari, the London-based brokerage firm that sponsors the shirt of English Premier League football club West Ham United, said it had to shut down its business.
In a statement, the firm said the majority of its clients sustained losses which exceeded their account equity. "Where a client cannot cover this loss, it is passed on to us," it said. "This has forced Alpari (UK) Limited to confirm today that it has entered into insolvency."
The scale of anger within the firm is evident in a note that its market analyst, Craig Erlam, published Friday before news of the wind-down. Bemoaning the "idiotic actions of the SNB," Erlam warned over the "longer term impact on the markets."
Alpari's demise follows that of Global Brokers NZ., a small currency trading house in New Zealand.
Its director, David Johnson, announced on the website of affiliate Excel Markets, that it could no longer meet the regulatory minimum to continue business.
"News of the impact of this event on companies and traders is just beginning to come to light," he said. "As directors and shareholders we would like to offer our sincerest apologies for this devastating turn of events."
The two could be joined by FXCM, a New York-based currency broker, which has already warned that it "may be in breach of some regulatory capital requirements" after its clients experienced significant losses. Those losses, it said in a statement, "generated negative equity balances owed to FXCM of approximately $225 million."
Traders aren't hopeful. FXCM shares are down a staggering 74 percent in pre-market trading following a 15 percent fall on Thursday.
Other firms, such as CMC Markets in London, said they can absorb the hit. Though its chief executive, Peter Cruddas, conceded that the firm sustained losses, he said the overall impact has not materially impacted the group. "It's business as usual," he insisted.
We’ve had other “non-material impacts” reported by other financial institutions, a phrase used in a context that made me laugh as the mere fact they’ve had to announce them (and will have to announce them, as there are surely more to come) makes these impacts material by nature and definition, it’s whether they’re large or small compared to the size of the shop that will make them important. Semantics aside, we’ve had Barclays and a hit in the “tens of millions”, Deutsche Bank out by perhaps $150m, Interactive Brokers having to bear the brunt of non-coverable client losses to the tune of $120m (at least IB issued an official statement and noted liabilities came to around 2.5% of IB’s net value, which as an account holder was a personal positive). And be in no doubt, there are more to come. The big shops will take their hit and move on, the medium-sized may suffer longer, some small shops may have to close. UPDATE: After writing up this note, news of the demise of a $830m hedge fund, Everest Capital Global Fund, is now doing the rounds Saturday afternoon. That’s more than just a “small shop”. Details here (1a).
And the reason for all these losses, be they paper or real or job-in-suit? A top financial executive in Switzerland, supposedly the most reliable, dependable and financially boring country in the world, went and did something unexpected. Oh, the horror! And if I’ve seen the word “stupid” used to describe Thomas Jordan (head SNB honcho and where the buck ultimately stops) and/or his decision, I’ve seen it a hundred times from the financial mainstream, e.g. it peppers this note (2) from economist Scott Sumner who then goes on and ends this way:
But there is a lesson here. Just as war is too important to leave to the generals, monetary policy is too important to leave to the central bankers. Once again we see the markets are way ahead of the central bankers. One more example of why we need market monetarism. Let markets determine the money supply, interest rates and exchange rates. Peg your currency to NGDP futures prices. And if you are not going to do that, then for God’s sake level target SOMETHING.
Sumner goes off on his personal agenda of Nominal GDP targetting (and the new NGDP futures market, in which he has a central role) and that’s his right; he’s a smart guy and he’s brought NGDP-think into the midst of macroeconomic debate largely single-handedly over the past five years, which is good. But he also touches on a point repeated in many places about central bankers and about the anchor of policy, that of trust in Central Bankers. Financial types have placed their absolute trust (up to and including their employment status, reputation and net wealth, see above) in the people who run central banks. What they’ll tell you is CBs are to “anchor” or “lock onto” or “target” their policies, what they really mean is to make money. Lots of money, lots of easy money. And now that trust has been vaporized and...oh again the horror!...by the Swiss of all people. The Swiss! Gnomes of Zurich, accurate timepieces, discreet bank accounts, enter the meeting room at 12:01 and expect a frown. Last week’s episode is big because it’s about the trust one party places in another to make the money world go round. Suddenly the people the really big moneymakers trusted, well they can’t be trusted any longer. The SNB has showed, in one quick and very painful move (for some) that risk is much higher than the mainstream financial world ever suspected. Call it the risk/reward balance, call it counterparty risk, call it VaR (value-at-risk), it’s all the same thing. “How dare a sovereign state do something that’s good for the sovereign state and not for us!”, they snort as one, to which Jordan replies (3), “SNB is an independent central bank. It is our prerogative to prepare our decisions on our own”. Jordan is now “the most hated man in finance” because he caught a very large number of self-important people off guard, causing them to lose money and look as they truly are, lazy and complacent, in the eyes of their paymasters.
Paul Krugman’s double-article take on the Swiss affair last week also caught my attention (4) (5). He too zeroes in on the aspect of trust in the Central Bank mechanisms and how that particular hull was well and truly holed, which agrees with the consensus (after all it was my own first thought, so macroeconomic minds far greater than mine are duty-bound to see the most obvious). But with Krugman, as with so many others last week, it was the subject he didn’t mention that screamed loudest. His gold-mocking credentials are well known, he even mentions the metal in his piece but in another context (FDR and the gold standard) so it wasn’t as if the aspect of what gold is and what it does and why great lumps of it sit in Central Bank vaults was a missing thought. But when the conclusion to his note arrives...
Two things to bear in mind. First, having in effect thrown away its credibility – in today’s world, the crucial credibility central banks need involves, not willingness to take away the punch bowl, but willingness to keep pushing liquor on an abstemious crowd – it’s hard to see how the SNB can get it back. Second, there will be spillovers: the SNB’s wimp-out will make life harder for monetary policy in other countries, because it will leave markets skeptical about whether other supposed commitments to keep up unconventional policy will similarly prove time-limited.
...and although he makes a spot-on point about the punchbowl, he can’t bring himself to mention the absolute obvious about gold in light of the Central Bank decision. And that brings us back to the ten tonne snorting elephant in the room, back to the Very Serious People (which of course includes Krugman, even though he uses the same phrase non-stop to mock his opponents), back to the non-counterparty advantage that gold brings to the table and why it popped hard last week. On this subject I’m in complete agreement with the most hardcore goldbug you’d care to mention. I’m two-thumbs-up with all the libertarian-leaning monetary thinkers and self-styled gurus. Jim Sinclair? Yup. That King guy whose first name eludes me that runs King World News? Count me in. Doug Casey? Yep, he’s always been right on this. On other things we disagree, but on this one Casey’s been constantly and consistently correct for decades. Don’t own gold to be rich because gold doesn’t make you rich, it stops you from becoming poor. Gold has no alpha, it’s not a vehicle for speculation and while we’re at it, if you want to know whether it’s an asset class or a simple commodity like all the other commodities (as we’re told non-stop by people without the first clue of the stuff) just check the recent price chart for nickel. And copper. And lead. And zinc. See much storing of value in those materials? No, me neither.
For sure I play the market. I speculate with the rest of them and that’s the reason this publication exists. Buying and selling mining stocks, be they copper, moly, gold, vanadium, quartz, silver, uranium, frac sand or any other miners, is speculation and the act of playing on the market. But there comes a time when the playing has to stop and you put your serious financial face on, you think about your kids, you consider what type of life you want when our charming capitalist society decrees that it has no use for you any longer so can’t you just go prune some roses or take a cruise or just get out of the way and stop blocking the road with your slow moving vehicle, please? Which is the time that gold bullion enters the scene. Owning Rio Alto is very different from owning the thing that Rio Alto produces, period. It’s not just a different set of priorities, it comes from a whole different place financially speaking. Personally my needs and wants are modest, but I still own gold because I know that even my reasonable, normal, comfortable, unobtrusive, undemanding and pleasant middle class lifestyle could be stripped away from me if I’m not careful. Owning gold is the act of being careful. And if that applies to me, what kind of magnification applies to the people who are world-level wealthy and worried that their wealth might be taken away from them (thoughts that must lie on a deep inner level of their personal circles of hell)? Those are the people who have placed their trust in Central Bank policy and last week watched as their sure thing set-up took a very hard hit. How many of them, this weekend, are asking their financial advisor why they don’t own any/much gold? These are the people who don’t need to get rich, their overriding desire is to avoid the potential of being poor. They want minimum risk, zero risk and in things such as the Swiss Franc they thought they had one. Today, for the first time ever, Switzerland is a land where negative interest rates apply to savings and even to its bonds. Give them a thousand and they’ll give you back 999, that’s not going to go down well with the serious money.
The ownership of gold removes you from the 10-1 chance, the 100-1 chance, the 1,000-1 chance the (here comes the SNB) 1,000,000-1 chance that a human being on the other end of the line does something that suits him better and suits you less, thus costing you money (the mainstream call it “stupid”, see above). Owning gold isn’t about its monetary value today, or tomorrow, it’s about its monetary value all the time no matter what system of government, what currency you buy your bread in, whether you must bow your knee to a king else get thrown in jail, whether you can call your head of state all the names under the sun in public without issue. Though some do have grey areas, the value of just about every other asset class is dependent on a calculation that involves you + thing + other person’s opinion. But not gold, with gold it’s you + thing, there’s no Thomas Jordan around to mess your relationship up.
Last week was no ordinary week for gold. We can expect the media to minimalize or even ignore the issue and hope it goes away, but this time it really is different. I have suspicions but don’t really know how it’s going to affect the price of gold in the next week or even the next month. But a year from now? Gold under U$1.3k? No way.