Wednesday, February 29, 2012

The Gold Leap Year Massacre

While many have speculated that the Fed indirectly manipulates true money (gold &silver) through prime brokers such as JP Morgan to keep a cap on its value while it devalues the dollar through quantitative easing and massive Repo financing to Europe, I prefer to focus on what can be quantified. Today’s massive decline in gold and silver was a massacre regardless of whether it was the free market at work (doubtful) or a Fed backed take down. Instead of speculation, I’d like to compare today’s gold action to large moves in the past.
First, to put things in perspective, even after today’s large loss, gold is still up about 5% since the start of the year.  Secondly, large moves like this in gold are not unheard of.

I looked at the prices of GLD, the exchange traded fund that matches the price of gold, going back to 2004. When I examined the daily moves in percentage terms I found there were many times, most notably in 2008 during the financial crisis, where large moves occurred both down and up. Let’s look at some of these moves in relation to today’s move:


As you can see, in 2008 we had large moves both directions. The large down days in 2008 were thought to be large hedge funds that sold gold ETF’s to meet margin calls when all other assets other than T-Bills were declining in value.

That’s not to say that today’s move wasn’t important. Today’s move was almost four standard deviations. Using the data going back to 2004, the standard deviation, which measures volitility is 1.35%. Three standard deviations would be plus or minus 4% on any given day.  In a standard normal distribution, 99% of all outcomes would fall within three standard deviations. So, four standard deviations should be extremely rare.

Given the historic events of 2008 its not surprising that we would see this kind of “tail risk”. After all, the entire world financial system was on the precipice. But what about today? Certainly much of the problems in banking still exist and many problems have been kicked down the road. But not even the gloomiest among us would say that on February 28th, 2012 we were about to see the world financial system collapse on this day. Was there any major market making news today? Well, Ben Bernanke did say we had a slow to moderate recovery. Not exactly earth shattering news.

So where does that leave us?

Nothing has changed, except gold is almost $100 cheaper. Greece is still defaulting on their bonds. The ISDA is still meeting to determine if this is a default which will trigger credit default swaps. The US is still pumping out liquidity like crazy (though now mostly to Europe instead of the US). Great Britain is still in the middle of their own quantitative easing.  Global growth is still woefully low to pay all the debt incurred around the world. The western economies and Japan are still strategically devaluing their currencies trying to stay competitive relative to each other. A single day’s market action is merely noise. If you believe gold is a long term store of value, today is just a chance to buy the same gold at a temporary discount. Today an ounce of gold is still the same as an ounce of gold yesterday. Wealth preservation is not a trading strategy but a long term approach to keeping what you have earned through your labors.

Finally, I leave you with Dr. Paul speaking today to Ben Bernanke (Ignore the old fuddy duddy in the first one minute of the video).

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