Thursday, April 18, 2013

Take a few days off and what happens?

I admit it.  I got bored.  The news was the same, day after day.  So, I took a break.  Suddenly, volatility is up, gold has its biggest drop ever, and the market shows that even QE won't guarantee that stocks won't fall.  So, what happened?

First, let me say this.  I've always been puzzled by the guys that say there are any sort of fundamentals in the price of gold.  There aren't, any more than there is in dollar bills.  I think those guys believe what they say, at least to a point, because it makes them feel better about earning a living trading worthless hunks of metal, hoping to find the next bigger fool.

This is the way I see what happened.  People have been piling into gold for years now, convinced that something REALLY bad is going to happen.  Only, nothing happens, so the rise in the price of gold gradually slows as people run out of cash and, worse, run out of borrowing capacity to buy gold.  The price begins to stagnate, and people begin losing interest.  They get bored, just like I did.

Then, something happens in a small country that the majority of people haven't ever heard of before, or at least have no idea where it is.  Cyprus says it's going to sell its gold reserves to pay its debts.  This shouldn't really be a shocker to anyone.  I mean, why do people suppose that governments own gold?  It's a store of value and how does one unlock that value?  SELL.

So, the government needs to raise some cash and decides to sell some gold, and it's as if the world hadn't thought that was possible.  Some people start selling, then the bears join in and start shorting.  Stop losses start kicking in along with margin calls, investors need to sell to cover those.  Eventually, the price of gold gets low enough, and there are enough margin calls that some gold investors start selling stocks, or other holdings.  While I can't say for sure, that's what I think happened earlier this week.

Today, now that the markets are closed, stocks are down again, and gold is up a few bucks, but still below $1,400.  10-year treasury yields are down again, showing there is some money moving back to safe haven investments.  Since gold is up a bit, it seems that there are some that still think gold is a safe haven.

The problem is, though, that gold isn't all that safe if the global economy sinks into deflation, and talk of deflation is becoming more common.  When the Fed and other central banks turned on the printing presses, I don't think anyone really thought that deflation was a legitimate concern.  All the talk was about inflation, and the price of gold skyrocketed over the years.

Of course, we may never see deflation.  If that becomes a real threat, the Fed may very well crank up the QE.  It's hard to say just how much good that would do, though.  The global economy needs to correct, and sooner or later I think it will regardless of what central banks do.  I do think that monetary policy might be able to soften the blow, but then again, it might not.  In fact, it might make things worse.

Times like this point out the importance of having a well-diversified portfolio.  Unfortunately, people don't like to diversify because, by definition, they have to invest in stuff they don't really think is going to do as well as what they really want to invest in.  So, during good bull markets, the diversified investor doesn't make quite the spectacular gains that others are.  But when the bull market ends, and it always does, they shouldn't suffer the losses either.

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