The Bubble of Fear Pops: Thus the Gold Standard Emerges from the Shadows

by Andrew Butter

I posted something about gold early last September when the price was $1,750; the message was “Be Wary“.

As expected I got some deliciously abusive comments thrown like rotten-eggs; from behind the safe anonymity of pen-names; my favorite this time was:

“What an irrelevant article? Who cares where gold will be down the road? Right now, gold’s breaking out. Just ride the trend while it lasts. Is that complicated?”

Mm…Today, six-months later, the price touched $1,575 that’s a hit of roughly 10% unless of course you were going long on margin. Complicated or not that’s not much of a break-out; so what’s the plan now Mr. Anonymous? “BUY THE DIP” presumably?

Certainly there are plenty of people saying the same old things about why $1,575 represents the buying opportunity of a lifetime. But I’m still saying “Be Wary”. So apparently is Goldman Sachs; they revised their projections for end 2014 from $1,750 to $1,400. When those guys notice something might be going on, well didn’t everyone? Heck, in the spring of 2008 they even noticed there had been a housing bubble and it was popping…how smart is that!!!

Marc Faber once said he would go on buying gold until Ben stopped printing. Well the last message from the reading of the entrails at the Office of the High Priest is widely interpreted to be saying that Ben is contemplating doing just that; could that be a sign? Of course the ECB and the Bank of England are still winding up their presses, but even in de-valued dollars, what really matters is what America is doing.

I know, I know, gold is an inflation hedge; you could buy a first-class donkey in Roman Times with the same amount of gold it costs today to buy a Toyota Corolla. But even if you buy the numbers from Shadow-Stats; the rate of inflation in U.S.A. since 2004 has NO-WAY been 15% per year which is what it would have had to have been to get the increase in the “inflation hedge” from $400 to $1600.

Sure Ben printed a lot, sure the Goldman Sachs crowd were handed the biggest free-lunch in history, and yes the Federal Government racked up the debt to pay for yet more pork and to fund that trifling $3 Trillion-plus that went out of the window to wage the war on the long-beards and whatever “terror” means, and whatever it achieved?

But inflation is not just about printing money to pay for silly wars and reward silly bankers for their spectacular incompetence. The velocity of money matters and that’s been sinking like a stone; as was pointed out in words of two-syllables to the chattering mirth of The Anonymous Brigade; in 2009.

Perhaps what drove the price of gold; was FEAR?

Fear that governments would do something REALLY stupid, something even more stupid than going on a mind-bogglingly expensive adventure to “neutralize” non-existent WMD, something even more idiotic than hunting down the non-existent Rumsfeld bunkers, all “hundreds of them” in Tora Bora, something even more self-defeating than creating a housing bubble to buy election-candy, or something even more moronic than creating an oil bubble by buying at ever-increasing prices to top-up the SPR, just in case the environmental lobby closed down all oil exploration in the Land of the Free Lunch.

There is one big difference of opinion that I have with the few friendly Americans who comment on my posts; they say they hope my “optimism” is right, but they doubt it, they think that the American government, including the non-elected parts such as the Federal Reserve, is more stupid, and more feckless, than the government of Greece was in 2007.

Personally I don’t agree. Hey, what about Ron Paul, at least there was ONE person with half a brain chipping away at the insanity, he shall be missed. Where I disagree with Ron is that in the circumstances I think Ben did a pretty good job; given the lousy hand he was dealt, and OK you can say Obama was a “do-nothing” President, but that’s ironic coming out the mouths of Republicans and Austrians given that their big idea is that too much government, i.e. too many adventures by the President, is bad government.

Obama did at least manage to get his troops out of the Iraq adventure with some dignity, sure Afghanistan was always more difficult but he could hardly have presided over the Greatest Military Power in the history of mankind (and the most extravagantly expensive), running away with its tail between its legs, chased out by a force of no more than 10,000 bearded bandits; however lousy and un-winnable the situation was in the first place.

Like it or not, and putting all the theories of monetary incompetence aside; house prices in USA are slowly on the mend exactly as some people who could see through the fear predicted would happen, five years ago, employment is coming back (albeit at lower wages), and oil is being discovered. It’s not perfect, but a lot of places are doing much worse. So what’s to be scared of? And please don’t tell me that blathering lunatic in Iran is someone to be scared of, or that it’s worth spending a couple of trillion to teach him some manners!!

The first time I personally looked seriously at gold I noticed as other people had noticed before, that long-term, the price of oil correlates pretty much with the price of gold, the R-Squared historically was 74%, and for the statistically minded  the probability that correlation was an accident was 0.0012*. By way of reference; the probability Paul the Octopus managed to correctly predict the results of those World Cup Football games six-times-out of six was P=0.0156, in other words from that evidence, it is 100-times less likely that Paul had psychic powers, than either gold does not influence the oil price, or the other way around, or they are both not influenced by the same thing.

OK so this is a plot of the daily prices of oil (Brent) compared to the daily price of gold from January 2009, the start of the REAL BIG monetary blow-up that all the doomsayers are saying heralds the end of civilization as we know it.

Click to enlarge

So, it looks like the fractals are working, of course whether gold drives oil or oil drives gold, is un-known, most likely they are both driven by the same thing. The most likely candidate for that is how much money America has to borrow foreigners to pay so they can import energy. Forget about the legions of Chinese “stealing” American jobs, over the past ten years, 50% of the U.S. trade deficit was thanks to having to import energy.

And the way that was funded was, after the foreigners stopped accepting collateralized debt obligations lovingly crafted by Goldman Sachs…all bearing pretty AAA stamps Made in America with PRIDE, branded on their backsides by Moody’s; was by handing over U.S. Treasuries to the foreigners to pay for oil.

I know this notion flies in the face of conventional monetary theory lovingly crafted by the legions of Nobel Prizewinning economists on whose rotting skeletons we stand today, the ones that gave us the brilliant “inflation targeting” idea so loved by Alan Greenspan and George Brown, plus that great idea of Paul Krugman’s that a housing bubble was the way to go, but there is a BIG difference between giving a U.S. Treasury to a foreigner so that he hands over some oil, and selling one of those to Uncle Ben so you can go out and buy Hellfire missiles to “keep Americans SAFE”.

The main difference being that the foreigner expects to be paid back, and if that doesn’t prove he is a terrorist with LINKS bent on destruction of the Free-World…I don’t know what is!! Uncle Ben on the other hand, doesn’t really care. The other important difference is although Ben can print as much money as he likes, sadly, what he can’t do, is print oil.

How about this one for a chart, this shows the amount of U.S. Treasuries owned by foreigners (government ones and others), ever since America started living beyond her means, and picking fights with lunatics that weren’t even worth the price of the ordinance.

Click to enlarge

That works for me, what that says is there was a bit of a min-bubble; that has to pop fully before you get the break-back, eyeballing I’d say that’s under $1,500 perhaps as low as $1,475; then hey “BUY THE DIP”, even though the rate at which America is handing U.S. Treasuries in exchange for oil appears to be leveling off, it’s still going up; and it will go on creeping up until some of the newly discovered oil starts to make a difference.

But I disagree with Goldman Sachs, that chart says gold could be $1,800 by the end of 2014, which if you bought at $1,500 would give a better return that buying bonds, which are likely to devalue as yields rise, and probably better than stock markets which are currently slightly over-priced with regard to the long-term due to the low yields on 10-Year and 30-Year Treasuries. So there you have it, the guy who’s being saying don’t buy gold, is now saying that could be a buy quite soon, nothing spectacular mind, but there are not many other attractive options outside of picking up real-estate on the cheap, with all the complications that entails.

Big picture, what’s interesting is why? This is the thing, you can’t buy things with gold in Wall Mart; but you can buy things with gold outside of the borders controlled by feckless incompetent governments; those U.S. Treasuries outside of U.S.A. are effectively backed by gold; the more that are released into the space occupied by true free markets, outside of borders but still on Planet Earth; the less gold you will be able to buy with one of those.

That’s the Gold Standard, the standard that has kept the kings and queens and emperors and politicians half-way honest since the beginning of time, is the threat that if they debase the currency they use to buy what they need from others in the event they don’t chose to conquer them, well, these days, they won’t be able to buy any oil.

But keep an eye out for oil, that’s a bubble now; when the realization hits that the technology for getting oil out of the ground has changed; and that technology which currently Americans are miles ahead of everyone else with, starts to get exported; oil will pop. At that point there is a chance that America will not have to swap U.S. Treasuries to buy what they need from foreigners, when that happens; gold could go down (measured in dollars), in 2015 or 2016.