The new regime for precious metals

Today we look at long term charts of some key commodities and investigate means by which we might gain insight into the dynamics of their price movements. The methods are from a tool-set I have used for studying climate, much of which has been presented previously.

The key problem is interpreting the dynamics of a complex system from empirical observations. These observations are in the form of measurements of some parameter, like temperature, salinity (in ocean climate studies), or price. For our purposes we will consider month-end prices of gold, silver, copper, and rough rice (CBOT contract) from January 1996 to December 2012. The copper chart appears below.

The charts are most commonly studied as a plot of price vs time. There are many articles written on the statistical methods used. Is it a cup with handle? What about that wedge at the end there? Many newsletter authors have made (or have attempted to make) a business of selling their special methods. For a limited time only*, The World Complex offers its techniques for free. At your own risk, of course.

The dynamical evolution of a complex system is described by a succession of states through which the system has evolved. We have no way of perceiving the actual state of a complex system at any given time, but we may create a "reconstructed state" from empirical observations. Ergodic theory tells us that the succession of reconstructed states will be topologically similar to the succession of actual states, so that studying the "reconstructed state space" will enable us make inferences about the dynamics of the complex system under observation.

Reconstructed states can be most easily created from multiple time series (outputs) from the system, if present, by simply presenting a scatter-plot of the corresponding observations from the different time series. They can also be constructed from a single time series, an example of which we will see next time.

Rather than drawing a best-fit line through the states, we connect them by drawing a curve through them in sequence. This curve is described as the trajectory of the system, and can be said to represent the system's evolution through time.

The state is reconstructed in n dimensions by n observations, where n (the embedding dimension) is ideally chosen so that there are no crossings. Usually n > 3, which is a little difficult to display. Consequently, I normally use n = 2, which is less than ideal, but still useful.

Example 1: Gold/copper vs Silver/rough rice (gold and silver as $/oz, Cu in $/lb, rice in $ per hundred-weight)

This is a plot we have looked at before. The trajectory of the system is complex and fine details are difficult to describe, but overall, the system has largely been confined to the yellow ellipse left of centre, with the exception of three periods: 1) the run-up in copper and silver prices starting in 2006; 2) the commodity collapse in late 2008, when gold held up better than the other commodities in this chart; and 3) the excursion of the past 3 years, which either started in March 2010 (orange arrow on the right at the break-out of the ellipse) or in mid 2009 (left orange arrow at the beginning of the trend). Given its size and duration, we give greater significance to the latest excursion.

But what is the nature of the excursion? Did rice collapse? Or silver rise? Silver has been rising since 2002. Then came a rapid advance up until early 2011, which I'm sure we all remember.

Same commodities--different order.

Not too different (although in this one I had rice in cents per hundredweight). Most of the past seventeen years has been spent confined to the portion of state space within the ellipse, with the exception of the three times noted in the first example, and Buffet's purchase of silver in 1998. None of the excursions had lasting power except for the current one, which broke out of the ellipse in early 2010.

Again--did rice collapse? Or did gold suddenly accelerate in 2010?

Recombining the ratios one more time . . .

Here we see the famous "rabbit sitting in a stroller" formation, which means . . . well, you'll have to subscribe to find out.

The main difference between this graph and the others is that there is no recent excursion of any length.

The reason is that the excursion is the separation of the precious metals (which still includes silver) from the industrial metals and agricultural commodities.

Even though gold and silver have been in a bull market for over ten years, the real regime change only happened about three years ago. What happened?

This.

Data sourced from World Gold Council.

Central Banks were net sellers of gold until early 2009. That big spike is misleading, as it corresponds to China's announcement that it had purchased 454 tonnes over the preceding six years (note that China has not reported any gold purchases since that time). At that point the race was on for Central Banks to buy gold.

I believe it is the Central Bank purchases of gold that have created the new regime we observe in the Au/Cu vs Ag/rice state space.

* until the powers of darkness control the internet

Back in Canada

Back home last night. Passing through Vancouver airport, the major news story seemed to be that some guy in the NHL celebrated a goal a little more than was socially acceptable, for which he has been harshly criticized. They showed the clip a few times and then came all the commentary. They even had Don Cherry-- who in Canada has as much credibility as Bill O'Reilly or Sean Hannity--commenting on it.

It's true that the celebration may have been appropriate for an overtime goal that wins the Stanley Cup. But is this really Canada's biggest news story now?

They I realized they're finally playing hockey again. Now that's news.

The temple builders

So many of us in life start out building temples: temples of character, temples of justice, temples of peace. And so often we don’t finish them. Because life is like Schubert’s "Unfinished Symphony." At so many points we start, we try, we set out to build our various temples. And I guess one of the great agonies of life is that we are constantly trying to finish that which is unfinishable.

                             - Martin Luther King, 3 March 1968

One fact of life is that we can't fulfill all of our dreams. We have only limited time and resources. But modern life has a major additional obstacle which makes building temples more difficult than it needs to be--government. In particular, government's confiscation of resources which you might choose to use for your own benefit.

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Bali is full of temples. Not only are there large public temples and town temples, but every home has a temple as well.

Temple in a lake. Too tired to look up its name.

The family temples start off simple, using blocks cut and fabricated on a mass scale from sandstone or lava. The temples are nevertheless ornate as the blocs are combined in an exceptionally creative manner, and decorated with intricate finials. As the family becomes wealthier, they will add more finials to the gate, and the temples themselves, as well as add more (pagodas), decorate them with finials of stone or metal. It is clear that a significant portion of the family's capital and time have gone into them. Temples are key focal points for the family, and the village.

One shrine within a homeowner's temple

Lest you feel superior for not succumbing to superstition, I should remind you (as a North American or European) also devote a large portion of your income to the building of temples. However, these temples are not in your backyard, nor do you have much input into them. Instead, your income is diverted, often before you see it, towards temples built supposedly on your behalf by your elected representatives. Examples follow:

 Source: mindfrieze

Source

Here's a Canadian one. Source: Jcart1534

Did you ask for these? Did you want them built? Would you have built a different temple with your resources had they not been taken from you? Did building them fill you with serenity?

Have you seen the upkeep on them (especially the first two examples)? At least when you build a temple in your backyard, if you can't afford the maintenance, you can let it fall apart. What happens next is between you and God. But you aren't given the choice to let the Pentagon fall apart.

It's already hard to build the temples you want to build. Building a bunch of temples you don't want makes it harder.

The Gold Guarantee blowing up in Singapore? update Feb 3

Today's reminder of the importance of taking physical delivery of gold at the best price possible comes from Singapore.

The Gold Guarantee is (was?) a company based in Singapore allowing "investments" in gold. They had two separate schemes. One allowed victims to take delivery of their gold, but at an approximately 30% premium,  albeit with a monthly repayment of a small portion of the premium for as long as the gold was held (and the company remained solvent) and an option for the company to buy back the gold at a price related to the spot price. The other scheme offered a gold certificate and a higher monthly payout.

The monthly payouts amounted to over 20% p.a. I am unaware of any method by which a company could sustain such payouts through normal business practices. Were I aware of such a business, I would invest in it.

Today's Straits Times reports (unfortunately this story is not in the free online section) that the owner of the company is unreachable, and the offices have been shuttered since about January 9. The last communication most shareholders had was an email sent on January 8, announcing a merger between The Gold Guarantee and a similar company called Asia Pacific Bullion.

Customers have been dropping by the office and showing up at the CEO's home since he vanished, but to no avail. Some are facing losses of hundreds of thousands of dollars.

The latest gold price reported on the company's website is dated January 7. What appears to be an apologist blog posting for the company is dated January 3.

Here is a link to a discussion group which includes some unfortunates who bought gold from this company within the last few months. Note the advice they have received.

The scheme looks like a carbon-copy of the Genneva scam which fell apart in October.

Avoid certificates, and if you take delivery of gold, verify the spot price (it should be part of your due diligence).

Update:

Here is an article on the topic by a local financial blogger.

Update February 3

Channel news Asia reports that authorities have sized The Gold Guarantee's assets.

New scandals in gold investments occur in Singapore all the time.

Sunrise in Bali

Sometime ago we had a brief article on the geological hazards of calderas. Today we visit one--Mt. Batur, a live volcano within a pair of roughly concentric calderas.

The inner caldera represents a major blast that happened about 25,000 years ago, leaving a crater about 7.5 km across.

Google maps view of Mt. Batur, Bali.

Remember that as big as the caldera is, it doesn't represent the mouth of some supervolcano. It is a violent eruption that quickly empties a large magma chamber underground, the roof of which collapses into the chamber afterwards. So the size of the caldera reflects the approximate size of the magma chamber, not the mouth of the erupting volcano.

View from southwestern rim of the larger caldera. Much of 

the rim of the inner caldera is visible in the photo.

A view of Mt. Batur from the southeast, showing two of the volcano's craters.

The blot above the left crater is on the inside of my dimestore camera.

The black area in the foreground is a recent (1968) lava flow.

Starting very early this morning (or very late last night) I climbed this to watch the sunrise over a small volcano on the edge of the caldera crater.

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When I got off the plane on Tuesday, the first thing I saw was Indonesian news on the airport TV. I don't speak the language, but the all-caps NEWMONT and the disapproving looks of the commentators told me something was up.

Unfortunately, the Balinese don't know much about it (it is elsewhere in Indonesia), except to opine that people are unhappy with Newmont. And Newmont has issued no press releases this year, so it is unclear whether this is due to some new event or is simply ongoing discontent (perhaps this, for instance).

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The devastation of dessert

Book review: Beyond the Blue Gate

The interrogation of persons engaged in security threats and subversive conspiracies is not an invitation to a dinner, as Mao said of revolutions. It is a very serious matter. No person would implicate himself if he can help it. It is therefore necessary to break down the defences which a suspect automatically builds around himself. To discuss ISD's [Internal Security Department] methods of interrogation is to risk reducing their effectiveness. The government makes no apology for their effectiveness in uncovering the truth without torture. And they have been varied and improved from time to time.

                                   - Chin Fook Leong, in Far Eastern Economic Review, Nov. 12, 1987

Beyond the Blue Gate: Recollections of a Political Prisoner describes the arrest, interrogation, and imprisonment of the author, Teo Soh Lung, for "taking part in a Marxist conspiracy" (according to the Internal Security Department). The book also deals with the arrests of her "co-conspirators", who appear to have been arrested for making statements critical of legislation passed by the government headed by Lee Kwan Yew.

The book should be viewed as a cautionary tale--about government agencies with virtually unlimited power and no oversight.

In the mid 1980's, according to the government, Singapore's democracy was under threat of imminent violent overthrow by Marxists bent on creating a Communist government. In support, on 21 May 1987, some two dozen individuals (including the author) were arrested in connection with this conspiracy. Not a single gun, bullet, knife, or slingshot was presented as evidence--however, as we have seen in many places since, once security directorates have made such a claim, they will go to extraordinary lengths to cover up their errors. If that means that a few dozen individuals lose their reputations and businesses, the government views that as preferable to its own loss of prestige.

Ironically, the People's Action Party (which was and is the ruling party in Singapore) originally began as a socialist party allied with pro-communist trade unions.

The loss of reputation is a grievous blow, particularly when there is no chance the government will admit to a mistake. The author describes how, during her arrest, she saw one of her neighbours standing outside, but the moment they made eye contact, the neighbour disappeared inside. It is a scene reminiscent of Solzhenitsyn (though unfortunately not as well written)--the arrest in the wee hours of the morning; the neighbours pretending not to know you. And during the interrogations, the dropped hints of arrest or punishment of your friends and family--and the long days and weeks in isolation, never knowing.

I recall dimly hearing of these events at the time, and smugly thinking that such things could never happen in any North American country. I viewed it as evidence that Singapore was not a "real" democracy.

Reading this book in light of the War on Terror, and the prospects for unlimited detention (or even assassination) on the basis of an assertion by an executive authority has broken my earlier smugness. Instead there is a mounting horror of what is happening in what I used to think were real democracies.

They, too, do not apologize for the effectiveness of their interrogations.

Invasive behaviour and extinction in the retail market

The term "invasive species" has been used to describe new types of plants or animals that have been introduced to a new area, whereupon they change the local biosystem.

The sudden appearance of new lifeforms in an environment can cause rapid losses in some of the species present prior to this appearance. Biosystems are dynamic systems with considerable stability, and often the arrival of new species simply cause a slight change in the dynamics of the system, which continues on with only small cosmetic changes.

On occasion, however, the new players cause overwhelm the stabilizing factors in the system, which undergoes dramatic changes, eventually stabilizing in a new configuration that is highly detrimental to many of the original players in the system.

Which brings me to today's invasive species.

Although high-frequency trading has been around for nearly a decade, it didn't hit public consciousness until the "flash crash" of May 2010. In the past two years, the incidence of HFT flash crashes has expanded (see archive here) to the point where they are causing significant pain to the retail investors.

Much has been written about the impact of HFT, and a broad survey of the literature is so contradictory that I have to feel that some authors are not writing honestly. For every article about manipulation and increased volatility and reduced liquidity, there are academic papers like this one claiming that HFT "improves liquidity and enhances the informativeness of quotes".

Many of the characteristics of successful invasive species are shared by HFT algorithms: 1) fast growth; 2) rapid reproduction; 3) the ability to alter form (mutate) to suit current conditions; 4) tolerance of a wide range of conditions (except perhaps transparency); and 5) ability to live off a wide variety of food types. As a bonus, living in contact with humans also helps invasive species.

What in the market is going extinct? The retail investor.

How so? It comes about through the erosion in their margins brought about by HFT. In the presence of HFT, the unsophisticated investor pays a higher price on the buy and receives a lower price on the sell than would be the case otherwise. The professional traders manage to maintain their margins--the losses of the unsophisticated are the profits of the algos.

As our markets have come to resemble casinos, investment is increasingly like gambling. For a typical gambler in a casino, where winning is determined by chance, is eventually ruined. Gambler's ruin is inevitable in a fair game--but comes faster now that the bias is negative because algos are skimming a little off each one of our gambler's bets.

What a slowing world economy looks like

From Singapore.

On the beach enjoying the view.

Empty container ships floating idly offshore, two days ago. While watching, one of the ships moved a little. So there is some activity.

My in-laws tell me they have never seen it like this.

It isn't that the port is extremely busy (idle loading facilities--are those containers empty?). View from a revolving restaurant atop grain silos (advertised as the only one in the world!)