Archive for March, 2011

• The S&P 500 Over the Last 10 Days
  Eddy Elfenbein, March 4th, 2011 at 7:33 am

  Here’s a look at the minute-by-minute voyage of the S&P 500 over the last two weeks. The index peaked right before President’s Day. The market fell sharply, bounced off 1,300, then fell through 1,300. We rallied last Friday, gave some back, then opened higher yesterday and continued to rally.

  

• Morning News: March 4, 2011
  Eddy Elfenbein, March 4th, 2011 at 7:13 am

  Berkshire Sets Up India Insurance Distribution Unit

  Korea Express Shareholders Said to Seek $1.8 Billion in Sale

  Food Prices Hit Record High, Spurring Worries About Global Unrest

  Gold Rises Towards $1,420/oz Ahead of U.S. Payrolls

  Fed’s Lockhart Says Oil Adds ‘Caution’ to U.S. Outlook

  Jobs Seen at 9-Month High in February

  Payrolls Likely Rebounded as U.S. Economy, Weather Improved

  Fed Policy Makers Signal Abrupt End to Bond Purchases in June

  Without Loan Giants, 30-Year Mortgage May Fade Away

  Wal-Mart Hikes Dividend 20.6%

  Daimler Steel Headwind Saps Profit as Rubber Hits Continental AG

  Goldman C.E.O. Could Testify in Galleon Trial

  Market Risks Far Outweigh The Rewards

  Joshua Brown: How To Beat Tooth Fairy Inflation

• Gold Hits All-Time High
  Eddy Elfenbein, March 3rd, 2011 at 9:27 am

  The price of gold recently broke out to a new all-time high of $1,440.32. To commemorate this milestone I’m re-running of my most linked-to posts ever on a possible model for how to price gold. Jake at EconomPicData was kind enough to make a longer-term chart of our model.

  One of the most controversial topics in investing is the price of gold. Eleven years ago, gold dropped as low as $252 per ounce. Since then, the yellow metal has risen more than five-fold, easily outpacing the major stock market indexes—and it seems to move higher every day.

  Some goldbugs say this is only the beginning and that gold will soon break $2,000, then $5,000 and then $10,000 per ounce.

  But the important question is, “How can anyone reasonably calculate what the price of gold is?” For stocks, we have all sorts of ratios. Sure, those ratios can be off…but at least they’re something. With gold, we have nothing. After all, gold is just a rock (ok ok, an element).

  How the heck can we even begin to analyze gold’s value? There’s an old joke that the price of gold is understood by exactly two people in the entire world. They both work for the Bank of England and they disagree.

  In this post, I want to put forth a possible model for evaluating the price of gold. The purpose of the model isn’t to say where gold will go but to look at the underlying factors that drive gold. Let me caution that as with any model, this model has its flaws, but that doesn’t mean it isn’t useful.

  The key to understanding the gold market is to understand that it’s not really about gold at all. Instead, it’s about currencies, and in our case that means the dollar. Gold is really the anti-currency. It serves a valuable purpose in that it keeps all the other currencies honest (or exposes their dishonesty).

  This may sound odd, but every currency has an interest rate tied to it. In essence, that interest rate is what the currency is all about. All those dollar bills in your wallet have an interest rate tied to them. The euro, the pound and the yen also all have interest rates tied to them.

  Before I get to my model, I want to take a step back for a moment and discuss a strange paradox in economics known as Gibson’s Paradox. This is one the most puzzling topics in economics. Gibson’s Paradox is the observation that interest rates tend to follow the general price level and not the rate of inflation. That’s very strange because it seems obvious that as inflation rises, interest rates ought to keep up. And as inflation falls back, rates should move back as well. But historically, that wasn’t the case.

  Instead, interest rates rose as prices rose, and rates only fell when there was deflation. This paradox has totally baffled economists for years. Yet it really does exist. John Maynard Keynes called it “one of the most completely established empirical facts in the whole field of quantitative economics.” Milton Friedman and Anna Schwartz said that “the Gibsonian Paradox remains an empirical phenomenon without a theoretical explanation.”

  Even many of today’s prominent economists have tried to tackle Gibson’s Paradox. In 1977, Robert Shiller and Jeremy Siegel wrote a paper on the topic. In 1988 Robert Barsky and none other than Larry Summers took on the paradox in their paper “Gibson’s Paradox and the Gold Standard,” and it’s this paper that I want to focus on. (By the way, in this paper the authors thank future econobloggers Greg Mankiw and Brad DeLong.)

  Summers and Barsky explain that the Gibson Paradox does indeed exist. They also say that it’s not connected with nominal interest rates but with real (meaning after-inflation) interest rates. The catch is that the paradox only works under a gold standard. Once the gold standard is gone, the Gibson Paradox fades away.

  It’s my hypothesis that Summers and Barsky are on to something and that we can use their insight to build a model for the price of gold. The key is that gold is tied to real interest rates. I differ from them in that I use real short-term interest rates whereas they focused on long-term rates.

  Here’s how it works. I’ve done some back-testing and found that the magic number is 2% (I’m dumbing this down for ease of explanation). Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.

  Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, gold will drop at an 8% rate.

  Here’s what the model looks like against gold over the past two decades:

  

  The relationship isn’t perfect but it’s held up fairly well over the past 15 years or so. The same dynamic seems at work in the 15 years before that, but I think the ratios are different.

  In effect, gold acts like a highly-leveraged short position in U.S. Treasury bills and the breakeven point is 2% (or more precisely, a short on short-term TIPs).

  Let me make clear that this is just a model and that I’m not trying to explain 100% of gold’s movement. Gold is subject to a high degree of volatility and speculation. Geopolitical events, for example, can impact the price of gold. I would also imagine that at some point, gold could break a replacement price where it became so expensive that another commodity would replace its function in industry, and the price would suffer.

  Instead of trying to explain all of gold, my aim is to pinpoint the underlying factors that are strongly correlated with gold. The number and ratio I used (2% break-even and 8-to-1 ratio) seem to have the strongest correlation for recent history. How did I arrive at them? Simple trial and error. The true numbers may be off and I’ll leave the fine-tuning to someone else.

  In my view, there are a few key takeaways.

  The first and perhaps the most significant is that gold isn’t tied to inflation. It’s tied to low real rates which are often the by-product of inflation. Right now we have rising gold and low inflation. This isn’t a contradiction. (John Hempton wrote about this recently.)

  The second point is that when real rates are low, the price of gold can rise very, very rapidly.

  The third point is that when real rates are high, gold can fall very, very quickly.

  Fourth, there’s no reason for there to be a relationship between equity prices and gold (like the Dow-to-gold ratio).

  Fifth, the TIPs yield curve indicates that low real rates may last for a few more years.

  The final point is that the price of gold is essentially political. If a central banker has the will to raise real rates as Volcker did 30 years ago, the price of gold can be crushed.

  Technical note: If you want to see how the heck I got these numbers, please see this spreadsheet.

  Column A is the date.
  Column B is an index of real returns for T-bills I got from the latest Ibbotson Yearbook. It goes through the end of last year.
  Column C is a 2% trendline.
  Column D is adjusting B by C.
  Column E is inverting Column D since we’re shorting.
  Column F computes the monthly change levered up 8-to-1.
  Column G is the Model with a starting price of $275 (in red).
  Column H is the price of gold. It goes up to last September.

• Morning News: March 3, 2011
  Eddy Elfenbein, March 3rd, 2011 at 7:32 am

  Arab Turmoil Hits Markets

  Oil-Tanker Contracts Gain 11% on Saudi Cargoes, Fuel Surge

  IT’S DIFFERENT THIS TIME: Why Higher Oil Prices Won’t Kill The Economy

  Harvard’s Rogoff Says Debt Restructuring `Inevitable’ in Greece, Ireland

  World Food Prices Increase to a Record, United Nations Says

  NYSE, Tokyo Stock Exchange Explore Trading Link

  Bernanke Says Stronger Recovery Would Reduce State Woes

  U.S. Treasury Expects $6.3 Billion From AIG’s MetLife Sale

  World’s Largest Commodities Trader Glencore’s Annual Profit Up 40%

  British Minister Backs News Corp. on BSkyB Deal

  Twitter Has No Plans to Go Public

  Oil Services Company Weatherford’s Shares Plunge As $500 Million Tax Accounting Errors Disclosed

  Leigh Drogen: Is The US Dollar About To Crash?

  Howard Lindzon: The StockTwits Blog Network Is In Effect!

• 26 out of 26
  Eddy Elfenbein, March 2nd, 2011 at 2:08 pm

  Gary Alexander alerts me to a fascinating stat:

  March started with another market scare, but we’ve seen the same kinds of corrections in January and February with recoveries by month’s end. In January and February of this year, the S&P 500 rose a net 5.5%, including 2.3% gains in January and 3.2% gains in February. Since 1938, the S&P 500 has risen in both January and February 26 times. Since 1938, the full-year has been positive ALL 26 times in which the S&P rose in both January and February. The average annual gain in those 26 years was +20.73%.

  Historically, March is a good month and April is #1, so we could see another couple of rising months in our near future. Over the last 50 years, according to Bespoke Investment Group, the Dow has gained an average 1.09% in March. Over the last 100 years, the average March is slightly better, +1.12%. April is historically the best month of the year, so we can anticipate another spring forward in stocks by April 30.

• Morning News: March 2, 2011
  Eddy Elfenbein, March 2nd, 2011 at 7:28 am

  German Two-Year Yields Approach 18-Month High as Producer Prices Increase

  Banco Pastor Issues Convertible Bonds as Spain Tightens Bank Capital Rules

  Bernanke Signals No Rush to Tighten When Asset-Buying Ends

  Debt Market Rebounds From the Crisis, and So Does Risk

  Regional Fed Bank Names Economist as President

  Futures Higher as Oil Rises Above $100 Per Barrel

  Gold Holds Near Record as Mideast Simmers

  Cotton Jumps by Daily Limit, Rises for Fourth Day as Supply Remains Tight

  U.S. Car Sales Jumped in February, but Here Come Gas Prices Again

  Yahoo in Talks on $8 Billion Japan Exit

  Staples 4Q Net Up 17% On Fewer Charges; Sales Roughly Flat

  Costco Quarterly Earnings Rise 16%

  Joshua Brown: Guess Who No Likey the Oil Prices…

  Howard Lindzon: Social Leverage, Social Proof and ‘Vertical is the New Horizontal’

  Paul Kedrosky: TED Time: Mesopredator Release, Coyotes and Banks

• ISM Ties for Best Reading in 27 Years
  Eddy Elfenbein, March 1st, 2011 at 10:19 am

  Today’s ISM Index report showed a reading of 61.4. That ties the reading from May 2004 for the highest level since December 1983.

  This is the 19th-straight month that the ISM has been over 50.

  

• 45,000% Profit at Seaboard
  Eddy Elfenbein, March 1st, 2011 at 9:43 am

  One of the lessons I try to tell investors is that there are good stocks to buy everywhere and that they ought not confine themselves to the popular names like Apple (AAPL) or Google (GOOG).

  One of the off-beat companies I like to follow is Kansas-based Seaboard Corp (SEB). I’m not recommending it, but I want to show you how a stock that almost no one knows about has been an outstanding performer over the years.

  For starters, the stock closed yesterday at $2,320, so that high-price will scare folks away. My opinion is that the fewer people know about my stocks, the better. Secondly, there’s zero analyst coverage for this stock on Wall Street despite having a market cap of $2.8 billion. Seaboard’s daily volume is often a few hundred shares. Every so often the volume will exceed 3,000 shares per day. That’s a heavy day for them.

  So what does Seaboard do? Here’s the description from Hoovers:

  With pork and turkey from the US, flour from Haiti, and sugar from Argentina, Seaboard has a lot on its plate. The diversified agribusiness and transportation firm has operations in some 40 countries in the Americas, the Caribbean, and Africa. Seaboard sells its pork and poultry in the US and abroad. Overseas it trades grain (wheat, soya), operates power plants and feed and flour mills, and grows and refines sugar cane. Seaboard owns a shipping service for containerized cargo between the US, the Caribbean, and South America; it has shipping terminals in Miami and Houston and a fleet of 40 vessels (12 owned, others chartered) and ships to ports worldwide. Seaboard is run by descendants of founder Otto Bresky.

  See–it’s terribly exciting. Too many investors think a great investment has to be one that discovers the twelfth dimension or cures the Bubonic Plague. That’s just not so. You should be focused on how well companies operate instead of what they do.

  In April 2007, SEB got as high as $2,699 and by March 2009, it was at $785—that’s a stunning 71% decline. But Seaboard has rallied strongly and it’s not too far from making a new all-time high.

  In 1980, the stock was going for just $17, and back in the mid-1970s it went as low as $5-1/8. That’s a nice 45,000% profit.

  

• Morning News: March 1, 2011
  Eddy Elfenbein, March 1st, 2011 at 7:32 am

  EU Raises 2011 Growth Forecast, Sees Inflation Accelerating

  UK Manufacturing Activity Maintains Record Growth Pace

  Emirates Hikes Fares Due to Rising Oil Prices

  Crude Oil Climbs From One-Week Low as Iran Protests Add to Supply Concern

  Egypt Delays Expected Reopening of Stock Market

  China SAFEly Diversifies Reserves

  Futures Exchange Giant CME Launches Pre-emptive Attack on NYSE Liffe

  Bernanke Tempers Republican Criticism With Deficit-Plan Calls

  U.S. Plans for Trade Are Stalled

  Dollar Index Hits 3½ Month Low; Bernanke Awaited

  Centro Swaps Australian Malls for Debt After $9.4 Billion Blackstone Deal

  World’s Largest Drilling Contractor Transocean Up on Deepwater Drill Permit for Gulf of Mexico

  Buffett Adds Another Name to Successor List as Rose Completes First Year

  Paul Kedrosky: Gas Prices: Not as Worried vs. Too Soon

  James Altucher: 25 Unusual Methods for Making a Trillion Dollars

  Joshua Brown: Mideast Dictators: Talk to Chuck