Inside information

Some traders got 'no taper' decision news earlier

Well, not necessarily.  It does seem that way though.  But just suppose that someone decided right before the announcement to make a big bet on the announcement.  It's not that unreasonable to think that someone looked around and realized that the market had already priced in the taper.  It isn't unreasonable to make a bet against something if you think that something has already been priced by the market.  So... right before the announcement is made public, you place a bet that the announcement is going to be not what everyone expects.  If you're wrong, there's not much to lose.  If you're right, though, the gains can be big.  There is asymmetry between potential gains and losses.

So, some big player places their bet a fraction of a second before the announcement is made.  And the high frequency traders are all over it, since their program may assume that somebody knows something and an increase in buying means there was a leak.  They jump on the bandwagon, and they're all winners in this case, because one person (or more) decided to the potential reward outweighed the risk.

But then again, maybe it was a high frequency trader that decided to place a bet a little bit early, thinking that other high frequency traders would jump in on their buying.  Then, if the announcement was against them, their program could close their position and still make a gain.  For the first trader, the only risk is that others won't follow suit.  They know that they traded without inside knowledge, but they're the only ones that know that.

The point here is really that investors shouldn't pay an awful lot of attention to headlines.  This particular headline says that some traders got the news early.  But in order to make this trade work, all that a trader needed to do was to make it look like they had inside information.  And in a way they did.  The inside information was that they didn't really have inside information.  Or, maybe they did.

Gold and Jobs

Gold rebounds above $1,300 after jobs miss

Yeah, sorry.  Nothing to get excited about here, although the headline is, well, almost bullish.

Gold futures turned a steep loss into a small gain Friday after July payrolls growth came in short of expectations, leading analysts to say plans for the Federal Reserve to taper its bond buying could be pushed further out.

In other words, "leading analysts" say the Fed may give smart investors more time to unload their holdings before the big decline.  Oh wait, we've already seen a pretty big decline.  I expect more to come though.

“I believe gold will remain supported as long as the market believes tapering is off the table,” said Douglas Borthwick, managing director at Chapdelaine Foreign Exchange, in emailed comments.

Why would anybody continue to hold gold knowing that the Fed will inevitably begin to taper?  I mean, it's "off the table" for what, another month?  Tapering is coming.  The expected accompanying inflation never happened.  Gold is set for a precipitous fall.  There's nothing magical about gold.  It is just another form of fiat money.  The only thing that ever gave gold any fundamental value was the gold standard.  Now, gold's value works just like the much aligned fiat dollar.  Gold's value only comes from the belief that someone else will give me the same value for an ounce of gold as I give someone else.  I can tell you right now, no matter how bad things get, I will likely not give anyone $1,300 value for an ounce of gold.  Unless I happen to know someone who would give me more than that, of course.  Consequently, I'm not buying gold at $1,300.

What you're looking for

This is a new feature I’m thinking about including on the blog.  Blogspot sometimes shows search keywords that are used to find my blog, and I figured that maybe some of my readers might like it if I were to post some more commentary on those subjects.  Of course, if readers are finding my blog using those keywords, then I must have posted something about those subjects in the past, but it may be that the subject could use some updating or in some cases it may be that I merely mentioned a subject and never really delved into it before.  At any rate, I hope you find this new feature informative as well as entertaining.

Most of the searches involved a couple of items: interest rates and QE.  Then there was also a search for “why war doesn’t help the economy.”  I think that war search is particularly interesting, so I’ll talk about that first.

War

The main reason I find the war question so interesting is that I rarely, if ever, make any kind of statements that are so deterministic.  In other words, in this case, I don’t believe I have ever said that war doesn’t help the economy; in fact, I think it sometimes does.  I just don’t think it always does.  And sometimes, it does more damage than good.  But then again, it depends on how one defines “help,” or “damage,” or “hurt,” or most any other term one might use to describe an effect on the economy.  And it also depends on whether we’re talking about the long run or the short run, and what our definition of those terms is.  Not to worry, though.  I’m not going to spend a lot of time defining those terms.

The way I see it, war, at least in the short run, is mostly negative.  It removes capital, both human and otherwise, from the economy.  The removal of capital from the economy lowers potential GDP, which of course means that the economy is actually capable of producing less.  In the case where the economy has a “recessionary gap,” this could actually be seen as a positive.  As potential GDP falls, unemployment declines.  Most people would agree, though, that war isn’t a really good solution to unemployment.  Then again, while I won’t go into it here, from an economic perspective it might actually be a great way to lower unemployment.  Economics rarely takes into account the extreme difficulties that might be put on a few to benefit the many.

Then again, in the short run, war could bring about some positive economic effects.  For example, it could lead to technological advances and greater efficiencies than would otherwise have occurred.  I think World War II is a good example of this, but other wars, not so much.  It depends on how much of a threat the entity that we’re at war with actually poses to our country.  And I don’t really think our economy would benefit so much from those things until after the war, perhaps making these benefits more of a long run consideration.  Regardless, in my opinion, most wars turn out to be a drag on our economy in the short run.

In the long run, if you’re on the winning team in a war, there can definitely be some economic benefits.  If the enemy is crushed, there will be less competition and industry should flourish.  Then again, if you’re on the losing team, war might bring about some positive changes that in the long run will give your team a competitive advantage.  Once the war is lost, and your economy is in shambles, the loser is forced to become better with less and that force can lead to increased competitiveness in the future.  The act of having to rebuild, of being forced into a situation where you have no choice but to do better can lead to tremendous advances.  I think that most of the time, people perform their absolute best when they aren’t given a choice; it’s do or die.

On a global basis, in my opinion, war is a net negative.  But economically speaking, it may be that war is net neutral.  For every gain that comes from war, there is also a loss.  Whether war does or doesn’t help the economy is really a subjective question and is simply a matter of opinion.  My opinion that it is a net negative comes from the idea that the suffering brought on by war is far worse than any economic benefit that may arise from war.

Risk free rate and QE

I’ve dealt with these subjects before and fairly recently, so I’m not going to go into a whole lot of detail here.

Some of the queries are just looking for what the risk free rate is in 2013.  For most applications, there is no single risk free rate.  Since this blog is mostly about individual investing, I’ll talk about the risk free rate from that perspective.  For this purpose, I don’t care about any theoretical rate.  The only rate that matters is the least risky rate of return I can actually achieve.  Here in the U.S., that rate is the rate on U.S. Treasuries.

For the purpose of valuing investments, I use the Treasury rate that matures at the same time as my holding period is, usually a year.  I use 1 year because I think investors should at least consider rebalancing their portfolios once a year.  If I were going to rebalance more frequently than that, I might use a shorter maturity, such as the 3 month T-bill.  These days, there isn’t much difference between the two anyway.  If I were dealing with corporate finance and looking at a 10 year project, I would use the 10 year Treasury rate.  While these rates may not be “correct” from a theoretical point of view, they represent reality and the best “least risky” return I can get for my money.

I’ve also had a couple of questions about what happens when QE ends.  The short answer is that nobody really knows.  But, considering that the Fed is committed to keeping short term rates down while decreasing their purchases of longer term treasuries and mortgages, the net effect should be a widening of the spread between short and long term bonds.  Strictly speaking, this should prove beneficial to banks, but the reality is it may be beneficial and it may not.  Long term assets held by banks, if they’re classified as “available for sale” or “trading” securities, will be devalued on the balance sheet.  Depending on the bank, this could lead to some capitalization problems, although I actually think that in general banks are much better capitalized than they have been in the past.  The widening spread, though, should lead to higher net interest margin for banks, which is a good thing.

At any rate, I hope that answers at least some of your questions.  If any of you have other questions or comments, please feel free to comment here, or email quasisaneATcomastDOTnet.