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Bullion As An Alternative to 'Shorting', Part I

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In a recent commentary, I characterized gold and silver bullion as a “superior” asset-class, versus virtually any other investment options. In this series of commentaries, I’m going to focus upon the versatility of bullion as an investment.

Experienced precious metals investors are familiar with the many “drivers” which have been identified for the precious metals market. However, this is simply another way of saying that bullion is a good proxy for many of the dynamics in markets (and the overall economy) today.

This is a concept which is especially useful with respect to investing in a “short” position (i.e. betting that a particular investment will go down rather than up). “Shorting” a market is inevitably a much more high-risk investment than going “long”.

To begin with, there is the potential for infinite losses. Bet “long”, and you can never lose more than 100% of your investment (assuming we avoid the insanity of “margin” in our accounts). Bet “short” however, and there is no limit to potential losses, since there is no (theoretical) limit on how high any particular investment could rise (except for bonds). Add to that the further risk of being forced-out of your short-position, and we can see that this is a particularly precarious form of investing, best left to trading experts.

What makes this a frustrating reality is that investors who are strongly bullish on precious metals inevitably believe that there are many other asset-classes which are going to plunge in value – due to many of the same dynamics which will cause bullion to rise. Since many of those doomed asset-classes are U.S. investments, I will focus this discussion on some of those asset-classes.

As even the mainstream media begins to clue-in to the U.S. Treasuries market, talk increases about the massive “bubble” in this market: the highest prices in history, at a time when more supply is being dumped onto this market than at any time in history and global debt-markets were already saturated with U.S. debt before this “big dump” began. In private conversations with readers, on more than one occasion talk has turned to “shorting” this particular market.

Thanks to the large in-flux of “short” ETF’s, even ordinary retail investors can set up a short position against virtually any market. Put another way, the bankers have made a huge effort to increase investor access to the trades which have both the highest probability of losses and the potential for the greatest possible losses. And we are supposed to conduct these trades in the most “rigged” markets in the history of human commerce.

Let’s examine the potential risks facing an investor who chooses to short U.S. Treasuries. Treasuries prices are near their theoretical maximum (as previously mentioned, only bonds have a theoretically-maximum price, as interest rates move towards zero), so this would seem like the “safest” short-trade imaginable.

Perhaps the best way to identify the hidden risks to this market is to simply ask ourselves: why hasn’t this ridiculously-inflated bubble imploded already? All things being equal, the greatest “supply” in history for U.S. Treasuries implies the lowest prices in history, not the highest. Bond-pumpers will argue, however, that “all things are not equal”.

As U.S. debt spirals exponentially higher, and government revenues plummet at the fastest rate in history, the United States already has debts and liabilities exceeding those of all the rest of the planet, combined – despite only representing about 5% of the Earth’s population. It is hopelessly insolvent by any, rational measure. And still the bond-bulls trot-out the absurd argument that U.S. Treasuries represent a “flight to safety”.

The best rebuttal for this position is to refer to a somewhat generic, cartoon image. A cartoon character sees some gigantic boulder about to fall on top of him, and quickly pulls out an umbrella for “protection”. Quite obviously, U.S. Treasuries are the “umbrella”. The “boulder” is the largest debts in history, the largest liabilities in history, the largest deficits in history – combined with massive, structural unemployment and falling, real wages (i.e. no revenues to make payments on all this debt).

This again begs the question: why hasn’t this bubble burst? As with many of the “mysteries” in U.S. markets and the U.S. economy, the answer to this one lies with Federal Reserve Chairman, Ben Bernanke and his magic printing press. What makes the Federal Reserve’s printing press “magical” is that it is the only printing press among all the central banks in the world which can continue to crank-out new bills – even when the operator of that printing press insists repeatedly that it has been “turned off”.

Regular readers will be familiar with my skepticism that Federal Reserve “quantitative easing” ended on April 1st (or, as I noted at the time: “April Fool’s Day”). That skepticism can be summed-up quite easily: the largest buyer/holder of U.S. Treasuries over the past decade (China) has been steadily selling, not buying this banker-paper – and none of the other regular buyers has any money.

Bond-pumpers will point to the “official” data showing vast amounts of Treasuries being accumulated by the United Kingdom and by U.S. “households”. However, the U.S. Treasuries auctions, the actual “mechanics” by which this tidal-wave of supply enters the market, have suddenly become the least-transparent bond auctions in the world. This is akin to a cheap magician standing in front of his audience, waving his hands in the air, uttering the words “Abra Cadabra”, getting his assistant to turn off the lights, getting his assistant to turn the lights back on a short time later – and then displaying the fruits of his “magic” to the audience.

With respect to the supposed buying of large amounts of U.S. Treasuries  by the UK, I have already dealt with this subject in many previous discussions of “The Three Amigos” (the U.S., UK, and Japan). As the three worst dead-beat debtors, it becomes steadily more improbable by the day, that these “Amigos” can find enough chumps to continue to pay the highest prices in history for their debt, while supply is ramped-up exponentially.

On the other hand, the optics are terrible if you simply “monetize” these debts – i.e. pretending to pay your bills by simply printing-up vast sums of new money (out of “thin air”). With this trio of dead-beats in very similar circumstances, the solution becomes obvious: the bond-market equivalent of “musical chairs”. For example: the UK buys U.S. Treasuries, Japan buys the UK’s bonds, and the U.S. soaks-up Japanese debt.

As always, the words of Goldman Sachs alumnus, Jeffrey Christian (now a commodities “expert”) ring in my ears: when it comes to bankers manipulating markets, it always works best if you hide what you are doing. Thus, when the Federal Reserve stated that it “ended quantitative easing” (on April Fool’s Day), what really happened is that it simply stopped telling the truth about what it was doing – in order to get “more bang for its (newly-printed) bucks”. Put another way, the Fed needed to get more leverage out of its manipulations in the bond market, because it is becoming steadily more difficult to avoid a fatal “rupture” in this bubble.

The deeper we delve into this market (and the more over-priced that U.S. Treasuries appear), the more apparent that the risk to shorting this market becomes. This is a market which has already severed all connections with fundamentals and reality – and which is explicitly propped-up (over the short-term) by Bernanke’s magic printing press.

How much longer can this bond “shell game” continue? One year? Three years? Five years? No one knows. Conversely, precious metals investors will show no similar trepidation with respect to the price of gold. It’s going higher in one year. It’s going higher still in three years. And it will likely really take-off some time in the next five years.

Even if an investor only has to wait a year before beginning to earn profits on shorting U.S. Treasuries, such an investment would still almost certainly lag any holdings of bullion. Compounding the risks of shorting U.S. Treasuries is that you must hold U.S. dollars to do so.

More importantly (for the purpose of this commentary), as holders of U.S. Treasuries shrug-off the brainwashing about a “safe haven”, where will these investors turn to – for a real “safe haven”? Gold (or silver) wins by default, as there are simply no other investment vehicles accessible to the average retail investor which could possibly be seen as more of a (true) safe haven – once this bond-illusion is dispelled. In other words, bullion is the perfect “proxy” for people who want to short U.S. Treasuries, but don’t want to assume the risks commensurate with “shorting” a rigged market.

In Part II, I will conduct a similar analysis of two, other popular U.S. asset-classes.


Comments (2)Add Comment
Jeff Nielson
written by Jeff Nielson, August 20, 2010
Thanks for the support, Dave.
written by daveddawg, August 20, 2010
Once again Jeff, you have hit the nail on the head. I haven't logged in for a while, but I read your articles in various places. You are one of the best writers out there. Keep up the good work! Thanks

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