Tuesday, September 7, 2010

Buy High, Sell Low: Gold and the Efficient Market Hypothesis

So I’m going to go on record, and place conservatives’ gold fetish squarely in the Pantheon of Kookery (effectively squaring the circle). Gold spot price today . . . $1256/oz. Let’s check back in a year and see how this all plays out.

The Acolytes of Aurum are a diverse group. There are the Harbingers of Doom: Cassandras who foresee (or desire?) a complete collapse of world currencies. These people aren’t buying gold futures – they actually want bullion. These are the “get your guns and gather the women and children” crowd, and most of them are listening to Glenn Beck. Or maybe they don’t actually believe in utter catastrophic ruin. Maybe they just disagree with the Administration’s pro-deficit policies, and buying gold is a way to register their intense dissatisfaction with said policies. Personal investment as a form of political protest. Now that’s putting your money where your mouth is.

Then there are the Austrian Dogmatists (e.g. Lew Rockwell), who harbor a deep-seated, lasting hostility for “fiat currency.” They have always believed that control of the unit of exchange by the Treasury poses an irresistible temptation – the monetary equivalent of the fox guarding the hen house. Whatever the merits of their case in principle, with the Administration bandying words like “Trillion” in relation to the fiscal deficit, and Biden reassuring the left-wing faithful that “we can do something really big” probably means the case in fact warrants some serious consideration. But to be clear, the case under consideration is a case for restraining the Treasury (reverting to a gold standard being one popular proposal) - not a case for investing in gold. In the minds of some, the gold conversation has become so dominant that they fail to maintain this distinction. "Monetary expansion bad. Gold good. Buy gold."

Lastly, there are the Arbitrage Cynics. They’re not betting on the basis of fundamentals. This is not T. Boone Pickins’ argument about BRIC development and long-term demand driving oil above $100/barrel. It’s not even a bet about the consequences of fiscal policy and debt. It’s a bet about people’s perception of these things, and the flight to gold for security. It’s about anticipated moves in the market, not about the relative worth of the assets in consideration. This group essentially admits that there’s an anomaly in the market, and they intend to exploit that anomaly.


You’ve got to at least admire the raw guts and audacity of this position.

“I absolutely believe it’s heading into a bubble, but that’s why you buy it,” said Charles Morris, who manages $2.5 billion at HSBC Global Asset Management’s Absolute Return Fund in London.

Basically, Mr. Morris is admitting it’s a game of musical chairs, but he intends to get out before the music stops. Hope you can, too.

Who knows? Maybe some of these people are right. Maybe all of them are right. But the thing they share in common (and it’s remarkable to see George Soros and Glenn Beck in such amicable agreement) – the thing that you would especially not expect to see from advocates of the free market, is that all of these people are betting against the efficient market hypothesis. I guess, in a way, any attempt to time moves for individual securities is a bet against market efficiency, but I mean something more particular than that.

The efficient market hypothesis postulates that the crowd effectively assimilates available information to determine a market-clearing price; an optimal price that induces the most sellers into the market to meet the demand of the most buyers. The price in the market reflects whatever information is available, more or less. In this sense, there is something refreshingly Aristotelian about the efficient market hypothesis. It recognizes a kind of wisdom in common experience and interaction, and uses this as a beginning point. This doesn’t mean that every price is always “right.” There is still plenty of room for “asset bubbles,” and human greed will always inspire the hope that there is a sucker out there who will overpay. But that is the basis for asset bubbles: a hope in the stupidity of the other guy, and therefore a hope in the temporary suspension in the rules of an efficient market.

The Harbingers of Doom aren’t really betting on a probable run-up in the price of gold in the case of catastrophic economic collapse. If their vision comes to fruition, ammunition, livestock, firewood, and a vegetable garden are probably more prudent investments. Shiny yellow metal won’t keep you warm at night.

The Austrian Dogmatists aren’t betting on 30-year Treasury yields. If they were, they would just take a short position or buy another currency. Their concerns might be based on macro-economic fundamentals, but there’s nothing fundamentally valuable about gold, except its performance as an efficient conductor of electricity. It’s malleable, has a known molecular weight, doesn’t oxidize, and is a solid at room temperature. So what? The bet, here, is not that it should run up with increased risk of inflation, but that the insecurity and fear of others will drive it up. It’s a bet on panic, not on intrinsic value.

At least the Arbitrage Cynics have the most intellectually honest (although the most morally perverse) position. With a shrug of their shoulders, they say, “eh . . . lemmings. What can you do?” Might as well make a quick buck if everyone is going to be stupid, right?

Any time the driver of an asset price is a bet on the stupidity of the other guy (whether it’s paying an exorbitant price for a home or an ounce of gold), that seems, to me, a risky proposition, not a safe one. I am not going to bet that the market will be able to continue on the basis of irrational greed and fear. True Conservatives should know better . . . and Catholics should behave better.

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