Fed can't keep the rates low

[SharperDingaan]

The only people who want 30 yr bonds are the issuers paying todays interest rate, and speculators trying to short them. The buyers are either insitutions dynamically delta hedging, or life insurers - unable to CF match and avoid inflation hedging altogether. 

 

SD

Edited June 20, 2021 by SharperDingaan

[LearningMachine]

21 hours ago, no_free_lunch said:

My hunch is quite different, I would put p1=50%, p2=20%, p3=30% where p3 is below 3% inflation.

@no_free_lunch, for probabilities, looks like you are saying:

• p1=50%: Mild inflation in 3-4% range for 5 years
• p2=20%: High inflation in 5-10% or higher range at some points in the next 5 years
• p3=30%: Inflation below 3%

Let's go further and assume conservatively in the p2=0.2 scenario that gold will go to $3,528 (2x of $1,764), and that in p1+p3 scenario (0.5+0.3=0.8), gold will go down back to around $1200 (68% of $1764).  

 

Then, the expected value gold will get to is (0.2 * 2) + (0.8 * 0.68)  = 0.4 + 0.544 = 0.944, i.e. 5.6% loss

 

To get to break-even expected return on buying gold with these probabilities, you have to buy Gold at $1600 (so that downside $1200 is only 75% of paid price). 

 

If you wanted expected return to be positive on these probabilities, you have to buy Gold below $1600.   $1200 purchase price would be ideal because that's the price it stablized before, likely because that's when it started approaching production cost for high-cost miners.  

 

I understand this might not be applicable to @wabuffo and @Spekulatius as they believe minimum gold price has nothing to do with marginal cost of production.  I think marginal cost of production still matters for gold.  I do think if gold production were to shut down completely, e.g. if gold price dropped to $800, jewelry, tech & industrial uses will start to drive price up to restart production unless central banks & investors were selling at that time for those uses. 

 

 

Edited June 20, 2021 by LearningMachine

[LearningMachine]

1 hour ago, DooDiligence said:

I haven’t been reading this thread in a while so apologies if this has already been discussed.

 

The Fed isn’t printing as much money as you think - Morgan Housel

 

The article would have been more complete and accurate if it hadn't left M2 out of the picture:

 

[SharperDingaan]

The scenarios assume CB's can maintain inflation within the scenario range - when we still have a world with negative interest rates that have never happened before. CB's have no precedents to refer to, no playbook, and have to do this by the 'seat of their pants'. Very, very fragile.

 

The advantage with the commodity approach, and ongoing hedge reassessment, is that its ALSO antifragile. Somebody screws up, you make a killing. If they get it right, you still do well - just slower.

 

SD

  

Edited June 21, 2021 by SharperDingaan

[tede02]

Is anyone else worried that the central banks (the Fed in-particular) have backed themselves into a corner they can't get out? They know as soon as they start to raise rates and slow bond purchases, it's highly likely asset prices go south. If severe enough, it could impact the real economy. 

 

Additionally, some suggest there isn't enough demand in the market for treasurys without Fed purchases so they can't stop QE even if they want to without rates going up significantly. Obviously if the 10-year jumps to 5% for example, that is going to create some real problems. 

 

So does the Fed just keep right at it because they can't stop?

 

Basically it just seems like we're screwed.  LOL. 

[JRM]

1 hour ago, tede02 said:

Is anyone else worried that the central banks (the Fed in-particular) have backed themselves into a corner they can't get out? They know as soon as they start to raise rates and slow bond purchases, it's highly likely asset prices go south. If severe enough, it could impact the real economy. 

 

Additionally, some suggest there isn't enough demand in the market for treasurys without Fed purchases so they can't stop QE even if they want to without rates going up significantly. Obviously if the 10-year jumps to 5% for example, that is going to create some real problems. 

 

So does the Fed just keep right at it because they can't stop?

 

Basically it just seems like we're screwed.  LOL. 

I'm worried that the fed is dependent on inflation picking up to bail them out that they could change their mandate to start monetizing the debt or coordinate with the Treasury to force spending.  I'm sure they're thinking, if only we could give people transfer payments with a ticking clock attached.  

[K2SO]

I have no idea whether we are on the precipice of significant inflation or are about to fall back into a deflationary funk once the sugar rush ends. 

 

What I know is that tobacco stocks are a phenomenal way to play either outcome. Rates stay low, it's a yield play. Inflation kicks up, it's one of the few businesses with guaranteed pricing power demonstrated over decades. And valuations are dirt cheap. Many thanks to all the ESG investors out there. 

 

[no_free_lunch]

2 hours ago, K2SO said:

I have no idea whether we are on the precipice of significant inflation or are about to fall back into a deflationary funk once the sugar rush ends. 

 

What I know is that tobacco stocks are a phenomenal way to play either outcome. Rates stay low, it's a yield play. Inflation kicks up, it's one of the few businesses with guaranteed pricing power demonstrated over decades. And valuations are dirt cheap. Many thanks to all the ESG investors out there. 

 

A solid idea.  Which ones are you invested in?

[K2SO]

12 hours ago, no_free_lunch said:

A solid idea.  Which ones are you invested in?

PM, MO, BTI. 

[Gregmal]

 

Fed may try continuing to scare people out of the inflation trade, but you cant fight fate.

 

Edited June 22, 2021 by Gregmal

[cubsfan]

^ Love this!! Go for it!

[Gregmal]

Does 50 bps over the next two years mean anything to anyone in the non WS trading world? The real economy? Total desperation move hoping to grab headlines and push back on a narrative. Calling bs. 

[no_free_lunch]

Here is what I keep thinking. Inflation happens , prices shoot up 20-30% over the next year or two and meanwhile the fed, raises 50 BP.  Don't we need the market to actually acknowledge inflation via bond yields for this to be tradable. 

[spartansaver]

2 hours ago, no_free_lunch said:

Here is what I keep thinking. Inflation happens , prices shoot up 20-30% over the next year or two and meanwhile the fed, raises 50 BP.  Don't we need the market to actually acknowledge inflation via bond yields for this to be tradable. 

Buy gold (or gold options), then you aren't subject to the Fed distorting your price. Even if you're right about a bunch of stuff, bonds can still get manipulated. 

[TwoCitiesCapital]

30 minutes ago, spartansaver said:

Buy gold (or gold options), then you aren't subject to the Fed distorting your price. Even if you're right about a bunch of stuff, bonds can still get manipulated. 

 

You're still impacted by the Fed. You'll only do well in gold if the Fed keeps interest rates meaningfully below inflation. That is the bet - so you're probably positioned on alignment with that - but if the Fed fails to meet your expectations gold will do very poorly indeed regardless of inflation. 

 

All that matters for gold is real rates. It does well when they're negative. It's not an inflation hedge (has historically done poorly at that). It's a hedge against financial repression. 

Edited June 23, 2021 by TwoCitiesCapital

[spartansaver]

1 hour ago, TwoCitiesCapital said:

 

You're still impacted by the Fed. You'll only do well in gold if the Fed keeps interest rates meaningfully below inflation. That is the bet - so you're probably positioned on alignment with that - but if the Fed fails to meet your expectations gold will do very poorly indeed regardless of inflation. 

 

All that matters for gold is real rates. It does well when they're negative. It's not an inflation hedge (has historically done poorly at that). It's a hedge against financial repression. 

Could you point towards data around it being a poor hedge? I don’t usually watch much Damadoran as he’s a bit too theoretical for me, but I thought this was a decent study on asset classes relative to inflation.

 

 

[TwoCitiesCapital]

30 minutes ago, spartansaver said:

Could you point towards data around it being a poor hedge? I don’t usually watch much Damadoran as he’s a bit too theoretical for me, but I thought this was a decent study on asset classes relative to inflation.

 

 

 

I simply did it myself on a spreadsheet. Compare good prices to CPI data annually. The correlation to gold prices and inflation/CPI in any given year is near zero. Almost as likely to go down as it is up. 

 

But if you compare to real rates, it was  a very good hedge against real rates being negative which is where most of the strong gains for gold occur. 

[spartansaver]

10 hours ago, TwoCitiesCapital said:

 

I simply did it myself on a spreadsheet. Compare good prices to CPI data annually. The correlation to gold prices and inflation/CPI in any given year is near zero. Almost as likely to go down as it is up. 

 

But if you compare to real rates, it was  a very good hedge against real rates being negative which is where most of the strong gains for gold occur. 

 

That's a similar conclusion to Damadoran. When rates are high, inflation expectations are high. Rates are low, inflation expectations are low. Inflation goes higher than rates, real negative rates happen (inflation upside surprise - good for gold). Inflation ends up lower than rates, positive rates happen (inflation downside surprise - bad for gold). 

[LearningMachine]

I wonder if gold price has even stronger correlation with the the answer to the question whether the price is below or about same as marginal cost of production?  In other words, if you buy close to or below marginal cost of production, does it ever drop a lot from that? 

 

I thought data would be hard to get, but then I just did a Google search and found this article that I don't have full access to but was able to snap the picture and text before access went away. 

 

Normally, I wouldn't place any credibility on a SeekingAlpha article, but this article does have references to original sources of data.

 

 

 

The article goes on to state, "The gold price has always followed the marginal cost of suppliers throughout history (figure 1). The correlation between gold prices and gold mining cash costs between 1980 and 2010 stood at 0.85, which means that the correlation is quite high (source: CPM Gold Yearbook 2011)."

Source: https://seekingalpha.com/article/1472081-gold-prices-finally-hit-marginal-cost-of-production 

 

I'm wondering what would be that correlation between the answers to the two questions I posed at the beginning?  Even higher than 0.85?

 

 

 

 

Edited June 23, 2021 by LearningMachine

[spartansaver]

6 minutes ago, LearningMachine said:

I wonder if gold price has even stronger correlation with the the answer to the question whether the price is below or about same as marginal cost of production?  In other words, if you buy close to or below marginal cost of production, does it ever drop a lot from that? 

 

I thought data would be hard to get, but then I just did a Google search and found this article that I don't have full access to but was able to snap the picture and text before access went away. 

 

Normally, I wouldn't place any credibility on a SeekingAlpha article, but this article does have references to original sources of data.

 

 

 

The article goes on to state, "The gold price has always followed the marginal cost of suppliers throughout history (figure 1). The correlation between gold prices and gold mining cash costs between 1980 and 2010 stood at 0.85, which means that the correlation is quite high (source: CPM Gold Yearbook 2011)."

Source: https://seekingalpha.com/article/1472081-gold-prices-finally-hit-marginal-cost-of-production 

 

I'm wondering what would be that correlation metric to the question I posed at the beginning?  Even higher than 0.85?

 

 

 

Are increasing marginal production costs causing gold to go up or is the higher price of gold causing higher cost production to come online? I would speculate that it is the latter. 

Edited June 23, 2021 by spartansaver

[LearningMachine]

24 minutes ago, spartansaver said:

Are increasing marginal production costs causing gold to go up or is the higher price of gold causing higher cost production to come online? I would speculate that it is the latter. 

@spartansaver, that is a good point.  Turns out gold production has gone up lately, and there was also gold production boom in 1970s. 

 

Your point is taking me back to my earlier comment that there are really two different logical premises here:

 

(a) Buy gold below or around marginal cost of production for all production at the time ---> You will not lose money

(b) Buy gold below or around marginal cost of production for amount of supply needed by tech, jewelry & industry --> You will not lose money

 

I think arrow (b) is much stronger and more likely to withstand test of time than (a).  Looks like you might be implying that as well. 

Edited June 23, 2021 by LearningMachine

[JRM]

Does gold spot price track production cost, or does production track gold price?  i.e., as spot price rises more reserves become economical.

[spartansaver]

On 6/18/2021 at 8:24 PM, wabuffo said:

So why gold now?  In my view its all about the outlook for future US Treasury spending as a % of GDP as well as the possibility of both higher interest rates and taxes (both inflationary - the Fed is irrelevant, IMHO).  In my view, its insurance in case we've crossed the Rubicon.  Like all forms of insurance, its a cost that one pays hoping one never actually has to use the "product".

 

wabuffo

Thanks for giving us an economics lesson Wabuffo. Could you explain why you think higher taxes are inflationary? 

Edited June 25, 2021 by spartansaver

[wabuffo]

Could you explain why you think higher taxes are inflationary? 

 

Pretty simple.   Inflation is driven by both the supply and DEMAND for fiat.  High tax rates reduce demand.

 

wabuffo

 

Edited June 25, 2021 by wabuffo

[Guest]

53 minutes ago, wabuffo said:

Could you explain why you think higher taxes are inflationary? 

 

Pretty simple.   Inflation is driven by both the supply and DEMAND for fiat.  High tax rates reduce demand.

 

wabuffo

 

 

Bill, 

Can you expand on this? "Common sense" would seem to say that higher taxes would decrease inflation since it reduces the money supply. I'm out of my element here so your insight is much appreciated (as always).  

 

https://onlinebusiness.northeastern.edu/blog/how-inflation-impacts-u-s-tax-policy/#:~:text=By cutting taxes for individuals,likely serve to increase inflation.

 

"By cutting taxes for individuals and businesses, the ruling party hopes to foster a more robust economic expansion. But by some estimates, the American economy is already running close to full steam, and an increase in spending spurred by tax cuts would likely serve to increase inflation."