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MACRO
MUSINGS:
Milestones
by Justice Litle
Editor, Consilient
Investor
September 12, 2007
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,
Justice
© 2007 Justice Litle
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