Gold, Silver, Oil: Volatility is the New Stability

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In the last 30 day period, the price of gold has swung up and down like a yo-yo between $1,340 and ounce, and $1,420 an ounce, giving it a volatility ratio of 5.6%. Silver, in the same period traded between $25.38 and 30.50, which gives it a 16% volatility ratio. Oil’s volatility range over thirty days lies between $80.28 and $90.87, or 11.65%.

For a 30 day period, those trading ranges are extremely high. For example, the volatility ratio in the price of gold in the same thirty day window 10 years ago was between $264 and $272, or 2.9%.

Oil has seen the most severe volatility of these commodities in the last 3 years, however, plunging from its high of $146 in July of 2008 to a low of under $38 in December of the same year. That’s a 75% drop in 6 months, though of course that coincides and is largely a product of the financial crisis that commenced with the destruction of Bear Stearns in the spring of 2008.

Across the board, commodity prices in everything from houses to coffee have seen an escalation in price volatility over the last 5 years, and with the new volatility ratios evident in the 30 day time frames of the main high-value commodities of oil, silver and gold, we are experiencing a new standard in global markets: Volatility is the new stability.

In other words, the ability to forecast long term price movements according to fundamental realities and technical indicators has become extremely difficult, if not impossible. The ability of the major financial institutions to manipulate and influence markets through the sheer size of their capital concentrations means that predicting where prices may move in any given commodity is largely dependent on whether J.P Morgan, Goldman Sachs, and HSBC are planning to participate in meaningful ways, and whether or not they might be colluding to launch a new ETF or other derivative product that will justify their purchase of large quantities of physical commodities, or else weigh heavily on futures prices through both long and short strategies.

J.P. Morgan’s recent single session purchase of over 50% of the London Metals Exchange’s 350,000 tonne copper reserve is a case in point. By eliminating so much copper from the available supply, J.P. Morgan single-handedly established a new price record in copper.

At the end of the day, unless you’re a trader or portfolio manager who has a direct line into these and the other less recognized but also massive capital concentrations, you’re really at their mercy. ff you do make money, it will be as much a function of luck as it will be of forecasting. You’re better off in Las Vegas, where at least you’ll get a free drink and a subsidized accommodation to offset the risk you shoulder when you walk into the casino.

To understand why there is such volatility, we have to question the motivation of the institutions that would like us all to believe that such volatility is a natural function of a free and unencumbered market. The secret to that understanding is simple: Money is made from volatility, not stability. A commodity that trades with a volatility ratio of 10% or better in any 30 day time frame means that the profit opportunity within every 30 day window is 10%. If you make 10% off of your capital position every thirty days, you’re earning 120% annually on that capital. If the market you’re in has a volatility ratio of 10% over one year, ho hum you’re looking at a maximum potential of 10% per year.

When you breathe the rarified air at the top of the financial food chain as do the Goldman Sachs, HSBC’s and J.P. Morgans, you have the added advantage of determining for yourself where and when the high will occur, and where and when the low will occur.

Understanding human nature as accurately as these big banks do, they have fine tuned the volatility machine with algorithmic precision, capitalizing on the buying hysteria that rapidly rising prices engenders in equal measure with the panic selling that ensues with sudden price degradation. If you swim in this sea, you’re just a lone small fry that these giant sharks plunge through with jaws agape just waiting to be swallowed whole like the herring balls obliterated by sharks in the open ocean.

But there is opportunity for us smaller fishes hoping to make it back to the sweet streams of our birth plump with the bounty of a stupendously overfed market. That opportunity lies within the junior markets of the companies that actually find and produce the commodities that the big banks largely ignore, exactly because they are too small to be significant to a trillion dollar balance sheet.

While thirty day volatility provides huge opportunity for fast and market-defining massive capital concentrations, the companies that provide the raw materials for these rigged plays are still largely governed by fundamental factors that make them fertile warm lagoons where smaller non-institutional fish can feed leisurely without the worry of predatory sharks. Armed with a bit of intelligence, the wise and patient investor can earn ten times the money in one year windows with astonishing predictability, thanks to the fact of the macro-growth in demand for precious metals, fuels, and industrial metals that are rising in price exactly in proportion to the devaluation of fiat instruments of trade (like money) caused by their overproduction.

But there are major risks in the junior markets which have to be factored in. When the big boys in the big sea decide to pull the plug on a carefully orchestrated short position, such as that which occurred in real estate and energy when the master puppeteers decided to pull the plug on first Bear Stearns, then Lehman Brothers, knowing that those two strategies would be sufficient to precipitate the ensuing general market crash, the waters of the warm lagoon vanished an a lot of little fish flipped and flopped their way into financial insolvency as margins were called and assets became liabilities.

All to be neatly swept up by the big banks and their affiliates, exactly as scripted by them. In the small and warm lagoons, we don’t get the phone call that says its time to leave the party because we’ve decided to clean up again. In the small pond, the next financial crisis will be precipitated without notice or predictability, thought the usual abundant hacks will come screaming out of the woodwork proclaiming that they yes they were the ones who predicted this next financial catastrophe. The random vortex of fame will descend briefly on their little franchise before whisking them back into obscurity ( a la Nouriel Roubini and Nassim Taleb) as people realize in retrospect that they aren’t the great profits the media momentarily projected them to be.

And that’s why its important to understand that Volatility is the New Stability. Free and unencumbered markets only exist where they are too small to be participated in, and thereby manipulated, by the world’s biggest capital concentrations, which now dominate, manipulate and define market and price movements. But those small markets, such as in the shares of resource developers and explorers, are still subject to the macro whims of the financial top layer, who, when they decide to, plunge the market into momentary darkness while they pluck the fruits of their nefarious labour at our expense.

So investing in these smaller markets has to be done with this reality in mind. Our approach at Midas Letter now is that we no longer plan to hold stocks into their production phase, where they become institutional stories, because there is too much risk associated in holding them til they get there. If the big institutions decide its time for another global asset harvest, positions which were growing well will suddenly be sunk underwater, and unless you have the deep equity position necessary to whether the storm, you will be relived of your assets just a baby is relieved of his candy.

In the face of the new reality, we have become opportunistic and surgical in our approach, building positions only when we think the company is very nearly on top of its discovery moment, when prices rise, on the news of a major discovery heralded by a great drill hole, when share prices double or more, depending on the magnitude and quality of a series of drill results. Once the discovery phase is finished, we are done. We take our profit, buy some silver and gold, and move on. All because volatility is the new stability.

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About James West

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