Friday, May 19, 2006

Random thoughts, roughly presented

Having been gently reprimanded for my lack of output lately (call it a golf mentality where less (strokes) is more) I've taken the lazy man's out and cobbled together some of the notes I take during my morning reads. It's rough but perhaps better than nothing...then again perhaps not.

Sticky Expectations and Gold

Anyone who has bought a stock and watched it rally can attest to the temptation of mentally booking profits at the highest recent price. When markets go on a tear, the temptation is even harder to resist. For those long Gold or Gold equity, past weeks were pure joy. On almost a daily basis, speculators could calculate their profits and reset their mental benchmarks of the price $600....$650...$700...$725. Then the correction sets in.

Prices fall back from recent highs. The small door problem (far more currency than real world deals at current prices) which led to the stunning rise of Gold and Gold equities comes into play for the sellers. As an aside, I expect the small door problem to get worse in the coming years. Margin traders will have to be even more nimble than usual.

After a $75 drop in the price of Gold, those who reset their benchmarks to $725 are likely feeling a bit low. Imagine though, assuming you are a long term holder like myself, that the price of Gold had never rallied to $725 but instead had been gently rising a few dollars a week and now sat at $655, a 56% gain on the year. That's not a bad trade.

Although I've long ago conceded my inability to guess exactly when markets get ahead of themselves, I accept that such phenomenon occur. This is not to argue that I think the current price of gold represents an durable equilibrium just that, in similar fashion to the way a person who suffers a terrible shock is likely to mentally digest the news in pieces, so too do collections of people digest reality at their own pace with lots of wishful thinking as a side dish.

To the extent one believes, as I do, that American economic dominance is giving way to an ascendant China, one should not expect a graceful transition. The last transition from Britain to the US took two world wars to sort out.

Return on investment
of military spending

A few months ago, back when I couldn't golf every day and thus had more time to write silly notes the better to amuse my 3 readers, I wrote a piece which asked when investment becomes consumption. My answer was the investment becomes consumption when returns are zero or less.

With that in mind consider US military spending, which, according to this site, is about 43% of the world total (China and Russia's defense spending accounts for 6% each, who knows they might come out of this looking pretty sharp for not trying to keep up with the Jonses). Despite this disparity in spending, which has been going on for many years, the US military cannot bring rebels in Afghanistan and Iraq to submit. Moreover the carnage caused by the US military may poison the minds of those with whom US corporates will want to do business in the future. Thus far at least, the return on investment of military spending in those two endeavors is nil.

Just as a rise in the price of oil will reduce the value of a oil importing nation's capital stock, so too will military failures reduce the value of a nation's military capital stock. While it might warm the heart of a die hard militarist, being able to blow up the world 6 times over isn't much use if the prize you seek is a functioning world.

The health of the financial system

One of the dogmas of the modern economy is the preeminent need to maintain the health of the financial system. But the financial system is not the real economy, it is but a piece with a goal of facilitating trade. To the extent the financial system is not facilitating trade but is instead inhibiting it (what economists call disintermediation) then a healthy financial system will not lead to a healthy real economy.

As the Austrians would put it, the financial system directs the real sector. When the direction is poor, the results will follow suit.