Monday, August 27, 2007

Rethinking Iraq - the George Friedman Way

27 August 2007

George Friedman at Stratfor has once again done us a worthy service.

He examines the three most plausible current options in Iraq, and finds all of them wanting.

In brief, the net effect of the American intervention in Iraq is to have won the longstanding and heretofore unsettled Iraqi-Iranian war for the Iranians, thereby creating massively escalated instability in the region, and a far more dire threat to Middle Eastern security than Saddam Hussein alone could ever have constituted.

The current link is only good for a brief time, so click
here now for Friedman's analysis and proposal for US policy in Iraq.

Here are Friedman's own words on the subject:

"All three conventional options, therefore, contain serious flaws. Continuing the current strategy pursues an unattainable goal. Staged withdrawal exposes fewer U.S. troops to more aggressive enemy action. Rapid withdrawal quickly opens the door for possible Iranian hegemony -- and lays a large part of the world's oil reserves at Iran's feet.

"The solution is to be found in redefining the mission, the strategic goal. If the goal of creating a stable, pro-American Iraq no longer is possible, then what is the U.S. national interest? That national interest is to limit the expansion of Iranian power, particularly the Iranian threat to the Arabian Peninsula. This war was not about oil, as some have claimed, although a war in Saudi Arabia certainly would be about oil. At the extreme, the conquest of the Arabian Peninsula by Iran would give Iran control of a huge portion of global energy reserves. That would be a much more potent threat than Iranian nuclear weapons ever could be.

"The new U.S. mission, therefore, must be to block Iran in the aftermath of the Iraq war. The United States cannot impose a government on Iraq; the fate of Iraq's heavily populated regions cannot be controlled by the United States. But the United States remains an outstanding military force, particularly against conventional forces. It is not very good at counterinsurgency and never has been. The threat to the Arabian Peninsula from Iran would be primarily a conventional threat -- supplemented possibly by instability among Shia on the peninsula."

In summary, Friedman suggests that the US might quickly abandon the urban regions of Iraq, but maintain an ongoing base in the peripheral and unpopulated hinterland of Iraq, serving as a police force, if you will, to contain possible conventional Iranian military action against say Kuwait or, ultimately, Saudi Arabia.

In fact, the Saudis have always been vulnerable in the region, having a tiny poplulation, a miniscule army, and little direct battle experience. There are far too few Saudis sitting on top of far too many oil and natural gas reserves.

That is, no one would welcome the Americans, but the Saudis and Kuwaitis might be quietly content to have a police force on the ground at points of vulnerability in the region. It would be up to the US to behave responsibly in the Arabian Peninsula – and that, of course, would not be easy, given the cumulative blunders of the recent past. However, Friedman's plan might yet be better than the remaining and thoroughly discredited conventional alternatives.

Thanks, George Friedman, for opening a small window of hope in a land of tragedy and despair.

Note (30 August 2008): A combination of the US troop surge and disastrous tactics on the part of Iraqi insurgents seem now to have turned the tide in the Iraq War in favour of stabilization. I admit that I was unprepared for this turn of events, but it is very pleasing now to report that my earlier pessimism appears to have been incompletely founded. Thanks to Michael Yon for being one of the first to report the favourable news - independently - from the front lines!

Night of the Comet

27 August 2007

When I'm working hard, I can't watch a Bergman, Oliver Stone or Kurosawa movie. It takes too much effort, and it can be too much like work. I haven't been able to watch a Woody Allen movie in probably a decade. I don't do angst well when I'm overworked.

By way of contrast, B movies are great when my brain is tired.

Interestingly, a good B movie can be entertaining for its creativity, as well as for an assumed level of mindlessness.

Night of the Comet, released in 1984, is a great example of that. The ability of the production team to create this classic “last people on earth” science fiction effort on a budget of $500,000-700,000 is in fact quite admirable.

The premise of the film is highly tenuous, that a comet that last visited the earth at the time of the dinosaurs’ extinction 65 million years ago is now returning, and taking out life on the planet all over again. Of course, a tenuous premise is part of what makes a B movie interesting. Where can the director/writer go with this thin thread connecting the elements of the story?

Fortunately, the film’s writer and director (
Thom Eberhardt) pulls off this feat quite successfully.

After the comet’s tail has basically turned almost all life on earth to calcium dust, Eberhardt captures the results in an imaginative low-budget fashion. Somewhat obviously, the highways of Los Angeles are deserted – in fact overly deserted, given that some people must have been driving the highway when the comet’s toxic tail swiped our planet. OK, we can suspend disbelief about that. (Mr. Eberhardt notoriously used his own Mercedes as one of the abandoned vehicles in the film.)

Then we witness a series of electronic timers setting off various bits of machinery that will operate for no one. And the sidewalks of the city are littered with piles of human clothing and reddish calcium dust. An inexpensive but potent way to portray the comet’s destructive impact.

As we would expect in a B-movie, there is no effort to explain why electrical power is flowing seamlessly, gasoline is available to operate vehicles driven by southern California's few survivors, houses are not burning due to stovetops being left on, natural gas leaks are not causing explosions, nuclear power plants are not melting down, etc. The planet, complex technological infrastructure and all, is eerily quiet, and strangely intact.

Let us disregard all of this, and maintain our brains in a state of deeply relaxed and narrowly focused alertness.

Eberhardt later acknowledged that he had no idea, as a young director, how many basic rules of movie-making he was breaking. He mixed the genres of science fiction, horror and comedy as with a blender. Like Joss Whedon, Eberhardt was interested in strong female characters, and he headed up the movie with two female leads and no primary male characters.

The leading characters, Regina (
Catherine Mary Stewart, originally of Edmonton, Alberta) and Samantha (Kelli Maroney, originally of Minneapolis, Minnesota) are airy California valley girls who are surprisingly resourceful (it just so happens, for example, that their mostly absent Green Beret father took them to target practice, instructing them in the use of automatic weapons).

Primarily interested in video games and cheerleading practice at the outset, the two girls turn out to have more than what it takes to confront evil, save the imperilled (including each other as needed), and basically preserve life (and orderliness) on earth.

Siskel and Ebert loved the film, and this was a significant boon in the early days of its release. Night of the Comet double-billed with Schwarzenegger’s unexpected early blockbuster, The Terminator, at drive-ins that year, garnering the better reviews of the two films. However, the hoped-for blockbuster, 1984, had to be released before the year was out, and this caused Night of the Comet to get bumped early at many theatres, despite its grossing many multiples of its modest production cost.

Other reviewers have noted that the film captures a unique era in West Coast culture (big hair and shoulder pads), but Eberhardt was in fact capturing some very capable and imaginative acting on-screen as well. This is particularly commendable, given that the film was so low budget that essentially every foot of film that was shot ended up in the final release of the movie.

I note that the film is often grouped with “Zombie” films, but I think this is a serious error in categorization. In this film, the “zombies” are people with apparent partial exposure to the comet who are just desiccating more slowly than the majority, who were killed instantly. The zombies don't keep coming back, in fact, they are expiring rapidly with no intervention required by our heroes.

Most importantly, the film is not really about combat with the zombies at all. Nor is it about special effects. It is primarily a dialogue-based composition, and some of the dialogue is surprisingly intelligent, heartfelt, and/or clever.

Therefore, in my view, this is a classic low budget science fiction “what if” type of movie. In this case, a familiar theme, “last people on earth,” is played out with verve, irony and imagination.

As an interesting side note, the female co-lead,
Kelli Maroney, has remained interested in and committed to the concept of doing further work based on the film. Trained originally at the esteemed Guthrie Theatre in Minneapolis, and then schooled in Shakespeare in New York City, Ms. Maroney’s film career took her unexpectedly in this direction – primarily through her roles in the present film, and earlier, in the classic “Fast Times at Ridgemont High.”

Ms. Maroney originally sought to produce a sequel to Night of the Comet, but discovered that MGM were, at least at the time, uninterested in surrendering their franchise for the movie. Perhaps fortuitously, MGM finally got around to releasing the film in stripped-down DVD version only in the spring of this year, but fairly shortly after refusing Ms. Maroney’s request to option the rights to the original film.

Ms. Maroney has spoken openly about her love for this film, conducting
interviews on many occasions over the intervening two decades, and often appearing at conventions for film buffs. Ms. Maroney acknowledges that she still keeps one of the two original cheerleading outfits in her closet, and announces proudly that it still fits her fine.

I honestly have no idea what could be done with a sequel to Night of the Comet, but it is a fun idea to play with. Hopefully, someday, somewhere, a fitting sequel might be produced. If so, let's be sure to keep the budget (and special effects) low, and the production and acting standards high, in which case, a sequel would be a nice fit with the very imaginative and entertaining original!

P.S. I must acknowledge that I have actually been minimizing how much I like this movie because of its (quite self-aware) B-movie categorization.

On reflection, a number of my lifetime favourite movies have been low-budget projects, and this perhaps because low budget movies make demands upon the imagination, rather than upon the sensory systems.

Among my all-time favourites are such works as "Happy Birthday Wanda June" (so low budget it is almost impossible to find), Alphaville (a classic Godard take on the low budget science fiction idea, much of it shot in "inter-galactic space" - in this case referring to the Ford Galaxy driven by the lead characters), Cherry 2000 (a movie about what kind of relationship you can and can't have with a robot) and Forbidden Planet (previously discussed on this site). I have also discussed "The Searchers" recently - profoundly politically incorrect by modern sensibilities, but again, more of a treat for the imagination than for the senses. So, what is wrong with the formula - low budget, big imagination?

In fact, the story-line of Night of the Comet is a highly imaginative twist on a classic science fiction theme. The dialogue is fresh. The minimal use of props and special effects maximizes the power of the imaginative dimension of the story (in such a way as a stage production might do). The heroines are blunt, lively, appealing and ultimately admirable. And, perhaps most importantly, the acting by virtually all of the characters is entirely creditable, with just the right dose of understatement or overstatement as required by each situation.

Granted, there is a liberal dose of improbability, silliness and occasional dramatic excess, but these condiments are offered unself-consciously. I don't think I'd be over-stating it to suggest that Night of the Comet is probably as good as any low budget movie can get. And that statement is made in recognition that low budget productions not uncommonly excel the quality of those made at many multiples of the cost of the shoestring effort.

There is something about the constraints of having next to no money that creates a "right attitude" in the production crew and cast of certain low budget films, and Night of the Comet has that (right) attitude in spades!

Tuesday, August 21, 2007

In a Liquidity Crisis, Take a Hard Look at What Is Being Sold, and Then Consider What Will Ultimately Be Sought After…

21 August 2007

We have been writing recently about whether quality assets will be bought or sold in a liquidity crunch.

The truth is, the answer to that question remains to be seen.

However, what is increasingly coming to the market for sale --- and sitting there unsold --- is now quite evident, and that is debt.

The interesting thing is that, until a few weeks ago, even debt of the lowest quality was easy to sell. Now, suddenly, there are no buyers even for high quality debt. Everything has turned around.

A great story on this topic is to be found on Bloomberg News Let me share a bit of the story with you:

Commercial Paper Market Roiled With $550 Billion Due (Update1)
By Mark Pittman

Aug. 21 (Bloomberg) -- Ottimo Funding LLC, whose name is Italian for ``excellent,'' has the highest possible credit rating and doesn't own subprime mortgage bonds. That made no difference to investors who refused to buy Ottimo's $3 billion of short-term debt this month as losses on home loans to risky borrowers infect the global credit markets.

``It's pretty much a straight contagion,'' said George Marshman, chief investment officer of Stamford, Connecticut-based Aladdin Capital Management, which oversees about $20 billion, including Ottimo. ``We think the assets are good enough'' to attract investors, he said.

The $1.1 trillion market for commercial paper used to buy assets from mortgages to car loans has seized up just as more than half of that amount comes due in the next 90 days, according to the Federal Reserve. Unless they find new buyers, hundreds of hedge funds and home-loan companies will be forced to sell $75 billion of debt, according to Zurich-based UBS AG, Europe's largest bank.

Those sales would drive down prices in a market where investors have already lost $44 billion, based on Merrill Lynch & Co.'s broadest index of floating-rate securities backed by home- equity loans. That may hurt the 38.4 million individual and institutional investors in money market funds, the biggest owners of commercial paper.

`Uglier and Uglier'

``We're dumping all this collateral into the market and it becomes a death spiral for the assets,'' said Brian McManus, head of collateralized debt obligation research at Charlotte, North Carolina-based Wachovia Corp., the fourth-biggest U.S. bank by assets. CDOs contain pools of mortgage securities that have been repackaged and sliced into pieces.

Instead of commercial paper -- corporate debt that comes due in nine months or less -- money fund managers are running for the safety of government securities. Yields on three-month Treasury bills plummeted to 2.9 percent from 4.95 percent at the start of the month, even though central banks injected more than $200 billion into the financial system and the Federal Reserve cut the rate it charges banks for loans on Aug. 17.

The credit crunch, sparked by the highest level of defaults on subprime mortgages in a decade, is ``getting uglier and uglier,'' said Christopher Low, chief economist in New York for FTN Financial, the capital markets unit of Memphis, Tennessee- based First Horizon National Corp.

``This has moved beyond temporary. It's gotten beyond bailing out some hedge fund and into the broad economy.''

What do investment professionals have to say on the matter. Here are the words of an experienced Swiss banker:

Jean-Pierre Roth, president of the Swiss National Bank, said market turmoil was far from over as tremors from the sub-prime debacle continued to rock the world.

"We're certainly not at the end of the story. There are question marks surrounding the development of the American economy," he said. "Something unbelievable happened. People who had neither income nor capital got credit with very attractive conditions. Now reality is striking back," he said.

My earlier point was very simple. An entire class of investment assets has just been shunned by global markets – and this is a critical asset class, known as "debt paper." I know, it doesn't sound attractive to a mainstream saver or investor – but until recently, it was a source of high yields even for relatively conservative investors. Now, this is no longer the case.

We also know what is being sought after right here, right now, as the 90-day Treasury Bill interest rate has recently collapsed due to soaring investor demand.

Sitting by the wall, towards the corner, perhaps not yet noticed by many, is the actual belle of the ball - gold. Overshadowed historically by such assets as general equities and "debt paper," and now, more recently, by 90-day Treasury Bills, gold is the true – but still overlooked – quality investment in uncertain times. Suddenly, debt paper is getting few invitations, and the attendees at the gala are looking for new dancing partners.

Here's a tip. Gold is still available, and you can have the time of your life dancing with her. Pretty soon, there will be quite a line-up seeking her out. But if you act quickly and decisively, right here, right now, she is still available for you.

Go ahead, take a few steps in her direction, and ask her to dance. Get to know her now, while she remains easily approachable. Before long, others will be tapping you on the shoulder. My guess is that you'll be glad that you were there first. She is a most pleasant companion, whether for an evening of dance and sparkling conversation, or for a long-term committed relationship….

(By the way, Streettracks Gold Trust, the ETF investment vehicle that makes gold ownership easy for mainstream investors, conitnues to see accumulation. While mainstream investors flock to Treasury Bills paying lower and lower rates of return, contrarians are continuing to accumulate gold. Read Dan Norcini's take on this trend here.)

Monday, August 20, 2007

Two Roles for Gold in a Liquidity Crunch

20 August 2007

Overleveraged investors holding spurious and repackaged paper assets consisting of promises to pay by debtors who have no means of payment in a deflating US real estate market are presently feeling the inevitable pinch. In such situations, what do these overcommitted and undercapitalized individuals and organizations do?

There are at least two models to predict their behaviour.

One model is that they sell their bad assets and purchase better ones. The implication of this model is that behaviour governed by this principle would drive gold-buying, as this would represent a flight from uncertainty and risk to quality and security.

The second model is that they sell their good assets in order to meet their immediate financial obligations, in many cases because this group are likely to be overextended speculators. This latter scenario implies gold-selling, not gold buying. Further, such financial speculators would hold no inherent respect for gold as a bulwark of safety or quality.

Joe Nicholson, known as Oroborean,
maintained the following on August 18, 2007:

"Financial market conditions did deteriorate further this week and, as expected, the metals did suffer. Readers of this update will have long abandoned the notion that gold or silver would receive flight to quality benefits in a liquidity crunch. To the contrary, metals are an excellent source of liquidity, particularly when so many hedge funds hold substantial profits in their ETF holdings, and naturally these were sold to accommodate the funding needs of a rapidly unwinding carry trade, imploding corporate debt market, and investor redemptions."

Due to various covenants assuring privacy, no one knows for sure who is buying and who is selling gold.

Certainly mainstream investors have been far more enamoured of shares in corporations and riskier derivative products than they have in gold, as businesses are seen as making money, while gold “just sits there,” not even paying interest.

Generally, it is only the contrarian minority who hold a more jaded view of the mainstream economy as out of balance and over-extended (read bloated).

Contrarians view mainstream corporate shares and more speculative derivative investments as over-valued and susceptible to unacceptable structural economic risks deriving, at root, from inflationary government policies founded on excessive debt accumulation and corresponding inordinate money-supply growth.

That is, the contrarian minority believe that the business mainstream confuses liquidity – presently manifested in the form of dramatic money supply growth – with wealth generation – which is the actual increase in the quantity and quality of goods and services. Contrarians hold that what is presently increasing is the money supply – offering an illusion of increasing wealth, but offering no enduring substance to undergird that illusion.

At this juncture, what would cause us to believe that over-extended speculators have suddenly been converted to a 180-degree inversion of worldview?

In particular, we are this year concluding our second decade of a United States Federal Reserve Board leadership which by conditioned reflex rides to the rescue at every hiccup in the market. What in this environment could possibly spark such a conversion?

It will be a slow process, and, sad to say, more pain than has yet been felt will be necessary to bring about behaviour modification and the inevitable shunning of financial excess at the government, corporate and household levels.

In the meantime, what is the evidence telling us?

1. Certainly since February 2001, there has been a visible shift in favour of gold over paper assets. Gold has outperformed virtually all of the world’s financial markets during the 2001-2007 period.

2. Gratifying though this development may be to gold bulls, the shift remains gradual, and it is surely still driven by a slim minority of gold investors. This sector – by comparison to the global equity market – is absolutely miniscule by any standard. That is, a tiny minority of investors can – and are – driving the gold market to new highs, but this group remains a negligible component of the global investment marketplace. The gold investor has not yet registered on the radar of international markets.

3. When the going gets tough, the not-so-tough don't get going to gold and silver – but to the Federal Reserve Board for a handout by way of interest rate cuts to make the cost of borrowing money cheaper – in actuality – cheaper than the hidden toll of escalating monetary inflation.

4. This enabling and ultimately self-defeating policy encourages continued dysfunctional behaviours, and among these dysfunctional behaviours is the selling of gold to cover the costs of speculation, rather than the buying of gold to assure the soundness of investment assets.

5. The evidence is before us, as in last week’s liquidity crunch, both gold and gold mining shares were sold aggressively. We simply aren't there yet, in terms of seeing mainstream investors turning to gold as a sounder alternative to “bloated” and unsound mainstream financial assets.

The above being said, there are certainly a cadre of “smart money” insiders who recognize that, by the classic playbook, lowered interest rates in an inflationary environment imply rising gold prices – and these savvy insiders can be shown to be buying gold through such “insider” sources as Commitment of Traders reports in the futures market.

To draw my argument to a close: My analysis is that we are presently at a juncture where, in a pinch, gold will be sold, but as the (gold) dust settles, gold will gradually be bought again. This assertion is based on the behaviour of the gold market since February 2001, when the collapse of the tech bubble began to turn a growing cadre of investors to the gold and silver markets.

I suggest that the present uncertainty will gradually turn more investors in this direction. It will not – not yet – be a rush to the exits from mainstream investments into gold, but a gradual, gentle flow of mainstream investors seeking diversification from the shrinking pool of investible mainstream assets.

That is – when you simply can't buy subprime mortgages anymore – you have to buy something else. I am no optimist that there will be a rush to quality in such circumstances, but the pool of investible mainstream assets is indeed shrinking, and gold remains as a survivor. Thus, the trickle will continue – and, because the precious metals market is so small, even a trickle of interest drifting our way can in fact produce outsized gains.

So, interestingly enough, and precisely because the precious metals market is so small, the almost imperceptible shift from risk to quality could potentially produce quite dramatic results in the gold, silver and precious metal mining share markets.

Keep your eyes open. There may yet be surprises in store for gold and silver investors, despite the fact that mainstream markets are far more interested in almost anything but quality. Our market is so small that even a trickle of increasing interest can produce very dramatic results.

And we remain in the very earliest stages of the precious metals bull market. There are many years and considerably more drama lying ahead than we have seen so far! In fact, there is every indication that the "tsunami" I wrote about on June 1, 2007 may now have reached the low tide that precedes its inevitable advance to shore.

(By the way, it now appears that gold may be a better catalyst to regulate hydrocarbon emissions from diesel engines than platinum. Click here for more information.)

Saturday, August 18, 2007

Gold's Value is a Derivative of Human Psychological Functioning

18 August 2007

Why is the price of gold so volatile - and gold mining shares even moreso?

The obvious answer has just now occurred to me, which is that the price of gold is a derivative value based on underlying fundamental factors driven primarily by human psychology.

John Doody, the
Gold Stock Analyst, recently commented on the derivative status of gold mining shares, as follows:

"A derivative is a financial asset that takes, or derives, its value from the value of another asset. Unlike most stocks, that solely derive their value from the underlying company and its operations, gold and silver miner shares get their value from: 1) the underlying mines and properties they own, and 2) the inherent option on price of the metal… higher prices mean higher current profits and a greater value for the unmined ounces in the ground.”

Therefore, if the price of gold itself is a derivative product, you have a recipe for a very volatile market in gold mining company shares as derivatives of a derivative.

In fact, in my early learning, the term “derivative” referred to a value in calculus, as follows: “The result of mathematical differentiation; the instantaneous change of one quantity relative to another.”

In the real world of calculus, derivatives tend to be multiplying factors, and exponential or sinusoidal behaviour is not uncommon in mathematical derivatives.

For example, in calculus, acceleration is a derivative of speed or velocity. So the instantaneous rate of change in velocity is acceleration, and acceleration creates dramatic physical phenomena and psychological responses, unlike velocity, to which we rapidly become psychologically habituated.

In physics, gravity is not measured in terms of velocity, but in terms of acceleration. Thus gravity is mathematically a derivative function. This explains why things fall faster and faster towards the earth the longer they fall, and thus, the greater the height from which they fall.

To make my point briefly, then, the behaviour of gold mining shares is more akin to the behaviour of a race car driver, accelerating into straightaways and braking at curves, or, if you will, to Newton’s mythical apple, which gains speed as it accelerates in its fall towards the earth. As you know, the apple reaches zero acceleration and velocity when it comes into contact with the earth (at which point the analogy is perhaps more descriptive of the behaviour of the market value of subprime mortgage lending companies than of gold mining shares in the present environment).

To take a step back however, let us ask, “In what sense is the price of gold a derivative of human psychological functioning?”

I wish to answer this question briefly, though I am sure a very involved study could be made of this topic.

In short, the price of gold depends primarily upon people’s general perceptions as to the stability and trustworthiness of their currency.

When people are confident in their currency – and this can occur even when inflation proceeds at a constant pace, akin to a constant rate of velocity if you will – there is generally little anxiety as to the fundamental soundness of the currency.

However, when the value of the currency adjusts rapidly, the experience is more akin to acceleration (or deceleration), and this is much more noticeable, as there is a perceptible change in the rate of inflation of the currency (this could occur in the case of either inflation or deflation of the currency).

The human brain is designed to ignore factors which are constant, whether due to the absence of change, or to a constant rate of change, but to attend to – and perhaps even be startled, disturbed or traumatized by – dramatic changes in a factor which has heretofore been stable or constant.

Thus, when people begin to notice that the value of their currency is eroding more rapidly than previously, and in recent history, that has most often been due to inflation, or loss of value of the currency, this provokes a psychological response, specifically, in most cases, feelings of insecurity. (Associated with this is an increased need to compete with others to attain protection from the ravages of inflation, for example, in annual pay-increase agreements, etc., and this factor adds further to sensations of insecurity.)

When ongoing events tend to maintain the perception of instability in the value of the currency, insecurity can grow to fear or panic – and it is in such psychological environments that the price of gold begins to adjust, and this itself appears to be a derivative function.

That is, as concern about the security of the currency grows, the human tendency is to assign an “accelerating” value to gold as an alternative or ultimate currency. In contrariwise manner, when feelings of fear and/or panic subside, there is a tendency for the price of gold to decelerate, and move again to lower levels.

Thus, changes in the price of gold tend to amplify the underlying human psychological factors related to confidence in the stability and value of their nation’s currency. When confidence begins to unwind, the price of gold begins to accelerate upwards. When confidence is not quickly restored, a longer-term rising trend in the price of gold ensues, as it did for the first time in 21 years in February 2001. That rising trend remains in effect today, and is likely to persist for years or decades to come.

When complacency returns (and all human emotions tend to ebb and flow), as it did between 2003-2007, the rate of change in the price of gold may abate or temporarily turn negative, and this was seen in May 2006, when the price of gold reached a peak, and then turned dramatically down – though this downward shift was not initiated until there had been two years of market stability.

Since early in 2007, there have been rising indications of market and currency instability, and these have been reflected in the renewed decline of the US dollar and in adjustments in liquidity due to rising defaults on US-originated mortgages, 20% of which are now in the extremely unstable subprime arena (twice their typical historical level). More recently, contamination from the subprime sector (and from exhaustion of the US real estate bubble) has begun spreading to a wider class of financial assets, and confidence in the stability of the economy and the currency is again eroding.

Mr. Bernanke's landmark August 17, 2007 decision to lower the bank credit rate in the face of rising inflation sends far-reaching signals about risks to economic growth and a willingness to sacrifice the value of the US dollar in order to attempt to preserve burgeoning economic activity within and beyond the borders of the United States.

In such circumstances, the atmosphere becomes more favourable for increases in the price of gold – and if the price of gold is a derivative, this will tend to be an accelerating function. Further, rising gold prices tend to drive the market value of gold mining and exploration companies higher, and if these too are derivative products, then there is the potential that the market value of these securities will further amplify the accelerating value of gold itself.

Thus, you have a recipe for a market with dramatic variance (defined mathematically as “the second moment around the mean; the expected value of the square of the deviations of a random variable from its mean value”).

To put the above discussion in layman’s terms – when conditions become favourable for acceleration in the price of gold, there are indicators that an even more potent acceleration in the market value of gold mining and exploration companies is at hand (though this may vary dramatically from company to company, depending upon perceived fundamental factors in each company’s sources of longer-term value).

And because gold mining and exploration shares are thus derivatives of a derivative (the mathematical term is “second derivative”), then the potential for dramatic movements in the market value of gold shares is very likely at hand.

Now – aren't you glad you did your mathematics homework, so that you understood all of this?

I will caution that much of my discussion has been general or even analogical. I cannot provide a specific set of mathematical equations to back up my work.

However, at its root, I think that derivative and second derivative functions are in fact what we are probably dealing with in the market for gold and for gold mining and exploration companies.

In experiential terms, the behaviour of second derivatives feels like a roller coaster ride. If this is true, then gold mining and exploration shares will continue to be volatile, subject to variance (which is itself a second derivative).

So, if you are an investor in this volatile but fundamentally growing and strengthening sector – buckle up, and be prepared for the ride of your life! My guess is that the price of the ticket will be worth it, so long as you have a cast-iron stomach!

Friday, August 17, 2007

Back Up the Trucks

17 August 2007

Well, Chairman Bernanke lowered the primary credit rate today to 5.75%, in the face of indisputable evidence of rising inflation. We now know he is cut from Greenspan's cloth (yellow is the colour of the stripes).

I have no idea if this will help the broad investment markets, but the move is extremely bullish for precious metals

Time to back up the trucks in the precious metals sector.

Somewhat humbly, may I add here that I commented on today's market action on March 13, 2007 - 5 months before it occurred. Sometimes by applying logic to current events, it is possible to see future directions. If you'd like to see my in-depth analysis of what happened today --- I wrote it on March 13. Click here for further analysis of "today's" events!

For a more objective view than my own - click here for an outstanding Financial Times editorial. And for the ultimate analysis of financial manias, panics and crashes - read this book! And finally, if you'd like the ultimate music video (parody) version by Dr. Glenn Hubbard of Columbia Business School, click here!

(Note: It is no secret that gold and silver do best when interest rates are rising - but that is because central banks have no other recourse when all the stops are pulled out on inflation. The present leadership of the US Federal Reserve Board are artful deniers of inflation, even when evidence that it is out of control abounds. This time will be no different. But gold and silver will be much higher by the time that Bernanke and his cronies finally get around to raising rates to tame the inflation genie. At long last, Mr. Bernanke has shown his hand, and he is an inflation denier, not an inflation fighter, as he has historically asserted. In wisdom, act accordingly.)

Thursday, August 16, 2007

Wall of Worry Becomes Wall of Panic

16 August 2007

Today's stock market sell-off hit the resource and precious metal sectors disproportionately hard, particularly mining and exploration companies.

It is true that miners are facing rapidly escalating costs due to inflating raw material and energy prices - which is of course what they are in the business of producing. Therefore, the market is punishing them for the pressure on their profit margins, rather than rewarding them for the increasing value of the products they produce - which are in fact the very types of materials that are driving up their costs (though labour shortages, increasingly complex regulatory procedures and other factors also impact the cost of the business of mining).

At some point, the paradox has to be played out one way or the other.

Given that long-term supply deficits have accumulated during the two-decade commodities bear market, my long-term prediction remains that miners will be rewarded for producing increasingly valued raw materials, and that improved selling prices will ultimately counterbalance the drag caused by rising costs.

But the market, being a psychological mechanism, always plays both sides of the equation before making up its mind. Further, the current "liquidity crunch" forces leveraged investors to sell their highest quality holdings, as well as provoking mainstream investors to panic and "sell everything."

Right now, the focus in the raw materials production sector is on the drag of high costs, and on possibly slowing global demand, should a recession come about (this is in fact a very likely scenario).

These are valid concerns, but I think that in the long run, the supply deficit for raw materials remains the primary factor that will drive the value of mining company shares - and this means that the long-term direction remains up, rather than down - though on a day like today, with the TSX down 585 points at one juncture, it is very easy to forget that the prospects for miners and explorers remain quite bright.

It is no secret that bull markets climb a wall of worry. On days like today, that wall of worry becomes a wall of panic - but it does not shift the fundamentals, which have taken 2-1/2 decades to accumulate.

Two weeks or even two months of selling does not undo the over-arching fundamental factors that are driving the value of mineral exploration and mining companies inexorably higher.

The Problem for Canadian Gold Stock Investors

16 August 2007

The following chart very simply sums up the problem that Canadian gold stock investors are facing.

On the face of it, the S&P/TSX Global Gold Index (Canada's bellwether SPTGD gold stock index, an index of the 20 largest gold mining companies trading on Canada's Toronto Stock Exchange) has dipped to levels almost as low as its May 2002 values, which were reached only 15 months following the launch of this millenium's dynamic gold bull market in February 2001. That is, based on current levels, there has been no appreciable movement in the Canadian gold stock index in over 5 years.

What is the problem?

The short version is that the Canadian gold stock index has dramatically lagged its US counterpart, the "HUI" Gold Bugs Index, which has seen over 200% appreciation since May 2002, even in the aftermath of its recent dramatic pullback.

What is amiss?

Well, the HUI index is a dynamic index, made up of unhedged gold stocks, and these have outperformed those gold mining companies who persisted with hedging policies (cheap forward sales of gold) originating in the 1980 to 2001 gold bear market.

But there is more to it than that. The Canadian dollar has appreciated over 50% during the past 5 years, making Canadian stocks valued in both currencies decline by over 33% in relative face value.

What happens when you combine these two factors?

The short version is that the Canadian Gold Miner's Index (SPTGD) has collapsed 2/3 against the Gold Bugs (HUI) Index

The chart below says it all.

Let Canadians take comfort in the appreciation of the international value of their currency. But it has aided us little at home, and our SPTGD index has underperformed the HUI by any standard.

The Canadian gold mining investor's problems are summarized very simply in the following chart, which divides the value of the SPTGD index over time by the value of the HUI index over time.

Caveat Canada:

Sunday, August 12, 2007


12 August 2007

Joss Whedon, producer of the acclaimed science fiction television series "Firefly," and of the related theatrical release "Serenity,"
commented on August 3, 2007 that strong sales for the soon-to-be-released Serenity Collector's Edition DVD could possibly spark a sequel to a very well-received movie.

The new edition is scheduled for release on August 21, 2007. This recent remark is a new tack for Mr. Whedon, who has discouraged previous talk of a Serenity sequel, though he has long acknowledged that Firefly/Serentiy is his favourite project.

Mr. Whedon does not indicate any communication on the matter with Universal Studios, but he argues that the original project is now in the black, and that a successful Collector's Edition launch would cement Serentiy the movie as a successful commercial venture. Under these conditions, Mr. Whedon felt that the studio could possibly rethink a sequel.

He also indicated that the Collector's Edition DVD includes truly new special features, including an all-new commentary, as well as an expanded "making of" featurette and the well-received River Tam sessions, produced for the internet in advance of the movie.

I will add that a sequel to the movie is more hopeful than a sequel to the television series, given Mr. Whedon's positive relationship with Universal Studios, versus his more difficult relationship with Fox Network, the producers of Firefly.

Tuesday, August 07, 2007

A B Movie 2 C

7 August 07

Here is an entirely different type of post for my blog.

Were it not for
Nathan Fillion of the Firefly/Serenity series, Susan and I would never have watched Slither last week. (Fillion can currently be seen in "Waitress.")

Abashedly, I'll admit I'm glad we did.

Fillion did not disappoint, though I doubt that he made a bundle of money for his starring role in this B-movie. We’d gladly have him back on Serenity for years more of Firefly episodes.

The budget was so slim that the monster effects had to be scaled down to what the production crew could afford. Thus, the nasty little slithery monsters had to attack the victim/survivor of the cover of the DVD on the balcony outside the house, because there were not sufficient funds to pay for the little critters to swarm through her home.

So, what was good about this B-movie? Well, director
James Gunn has a sense of humour, and is utterly reverent for some of the masters of this genre, particularly Canadian David Cronenberg.

Allusions to other films are interspersed throughout, including one that we caught – Fillion refuses the hand grenade to a deputized posse member, as he did with Jayne in Firefly (Susan noticed this, I hope I've got it right). Also, the lead character in Cronenberg's The Fly is referenced in a brand name at the supermarket, so the trivia buffs will be delighted.

Gunn prefers the “creepy” to the scary, and he has a fairly deft sense of where to draw the line between these two distinctly different genres. While the aliens take out most community members in the (I presume mythical) town of Wheelsy, it is not through the type of gruesome and mounting body count that typifies slasher movies (which hold no appeal at all for me personally).

Further, the monsters and their attack strategy to conquer planet earth are fairly imaginative, to say the least, and the actors have taken the script and run with it, including some younger children (who did very well at playing “zombies”) as well as several established actors, who are clearly quite skilful at their craft. The aliens never advance beyond Wheelsy, because the tiny band of local survivors are ultimately so capable of fending them off.

I would say that I laughed at the various permutations and mating strategies of the lead monster more than at anything else. You have to see his dangling (slithering?) arm and the queen of the colony to understand what I am talking about on this point. May I tell you that the alien beast inhabits the body of a principal character, and that the merged personatily's obsessive fixation with the previously unresponsive wife of this key character is a source of much of the film’s irony. Unfortunately for our alien-inhabited antagonist, I believe that Fillion will get the girl, though the film does not pursue this thread of the story.

Not much more to say about a B-movie of this type. If you're looking for
Kurosawa, Antonioni or Bergman – this is not it.

But if you'd like to be provoked to laugh at something that is ultimately light and imaginative, well, it might be worth two hours if you really have nothing at all else to do!