DeHedging Gold Bubble?

[SeanO]

Re: DeHedging Gold Bubble?

Think of it this way. In 2002 a house H has a market value of $300,000. In 2004, due to the fact that the same payment will fund a larger mortgage, the same house has a market value of $400,000.

But in the value ratio D/H, which fundamentally changed?

I agree, clearly liquidity is an underlying factor. But once you start comparing to oil and gold I don't think the correlation is as simple as you've stated it. Both house price and payment are measured in dollars yet price has more than doubled, while payments have increased slightly. Just compare a $500k interest only pay option ARM loan with a $1666 payment to a $250k 30 year fixed loan at a $1663 payment.

To the consumer there has been little perceived change, so far, in the cost of housing. Not true with oil.

[Finster]

Re: DeHedging Gold Bubble?

I agree, clearly liquidity is an underlying factor. But once you start comparing to oil and gold I don't think the correlation is as simple as you've stated it. Both house price and payment are measured in dollars yet price has more than doubled, while payments have increased slightly. Just compare a $500k interest only pay option ARM loan with a $1666 payment to a $250k 30 year fixed loan at a $1663 payment.

To the consumer there has been little perceived change, so far, in the cost of housing. Not true with oil.

Not surprising if there's little perceived change in the cost of housing, because there hasn't been much real change in the cost of housing. It's the dollar has has lost value. Plot housing prices in terms of ounces of gold, pounds of copper, or barrels of oil and you don't see the same kind of ballistic motion.

[SeanO]

Re: DeHedging Gold Bubble?

Not surprising if there's little perceived change in the cost of housing, because there hasn't been much real change in the cost of housing. It's the dollar has has lost value. Plot housing prices in terms of ounces of gold, pounds of copper, or barrels of oil and you don't see the same kind of ballistic motion.

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

[Finster]

Re: DeHedging Gold Bubble?

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

Or so you say. You skated out onto thin ice with the perception stuff.

Let's stick with objective reality. House prices did not rise when measured in ounces of gold. They did not rise when measured in barrels of oil. They did not rise when measured in pounds of copper. Only by using as your measuring rod a currency which can be created in unlimited quantities by fiat can you eke out a huge bull market in house prices.

Why are you having such a hard time letting go of the assumption that dollars are an invariant standard of value? Perhaps it is because for your entire life they have been used as if they were? I suppose that is not so unusual, given that the average person does not start realizing currency units are variable until inflation gets well into double digits. They grow up using them as the reference against which all other values are compared. The value of a car is X dollars, the value of a loaf of bread is Y, the value of a year's salary is Z. They, like you have here, tend think that things just got more expensive. But you are on a financial web site here; shouldn't you be a cut or two more economically savvy than the average person?

Perhaps an illustration will help. When I bought my last house, I measured its size with a cotton ruler. When I got ready to sell it, I took my cotton ruler and washed and dried it at high heat, and measured it again. Presto! My house had gained 75% more square footage! Applying the exact same logic, I figured my house also must be 75% more valuable and was able to get 75% more dollars for it when I sold!

[SeanO]

Re: DeHedging Gold Bubble?

Or so you say. You skated out onto thin ice with the perception stuff.

Let's stick with objective reality. House prices did not rise when measured in ounces of gold. They did not rise when measured in barrels of oil. They did not rise when measured in pounds of copper. Only by using as your measuring rod a currency which can be created in unlimited quantities by fiat can you eke out a huge bull market in house prices.

Why are you having such a hard time letting go of the assumption that dollars are an invariant standard of value? Perhaps it is because for your entire life they have been used as if they were? I suppose that is not so unusual, given that the average person does not start realizing currency units are variable until inflation gets well into double digits. They, like you have here, tend think that things just got more expensive. But you are on a finanial web site here; shouldn't you be a cut or two more economically savvy than the average person?

Perhaps an illustration will help. When I bought my last house, I measured its size with a cotton ruler. When I got ready to sell it, I took my cotton ruler and washed and dried it at high heat, and measured it again. Presto! My house had gained 75% more square footage! Applying the exact same logic, I figured my house also must be 75% more valuable and was able to get 75% more dollars for it when I sold!

Clearly we have a failure to communicate, I think you've missed my point completely, and erronously jumped to conclusions about my beliefs.

By saying "Same situation with gold as with real estate" and "same with Oil", I just think that you've over simplified the argument which could lead to a fallacious post hoc ergo proctor hoc conclusion that these items will remain correlated to the dollar and each other in the same fashion going forward. I was simply trying to point out that each has unique drivers as well, and they are not same-same.

For example the clear prognosis here at iTulip is Oil up, Gold up, Real Estate DOWN. And in fact real estate prices are down 5-20% while oil is up 20-30% in the last 6 months. Your "same-same" argument is quickly deteriorating.

[jk]

Re: DeHedging Gold Bubble?

to date, housing has moved along with oil, gold, etc. what will separate them is the leverage at the heart of the housing sector.

[Finster]

Re: DeHedging Gold Bubble?

Clearly we have a failure to communicate, I think you've missed my point completely. By saying "Same situation with gold as with real estate" and "same with Oil", I just think that you've over simplied the argument which could lead to a fallacious post hoc ergo proctor hoc conclusion that these items will remain correlated to the dollar and each other in the same fashion going forward. I was simply trying to point out that each has unique drivers as well, and they are not same-same.

For example the clear prognosis here at iTulip is Oil up, Gold up, Real Estate DOWN. And in fact real esate prices are down 5-20% while oil is up 20-30% in the last 6 months. Your "same-same" argument is quickly deterioriating.

I may indeed have over-simplified, but in service of a crucial point. It is all too often lost on casual observers how much of price changes of almost everything are ultimately due not to changes in the value of the thing being priced, but the thing in which such price is quoted.

That notwithstanding, your observation about the divergence between real estate and commodity prices is yet a further oversimplification - that the price effects of inflation move uniformly through an economy. As I pointed out above, it has been "real estate at the head of the line in the inflationary chain".

Inflation is a uneven phenomenon. When excess money is created, the price effects move through the system in waves, first affecting one set of prices, then another, then another. And before I get accused of more oversimplification, with plenty of overlap. In the 1990's the inflation went into financial assets. It happens that in this latest episode housing was near the front of the money line, as reduced rates on mortgages imbued buyers' monthly cash flow with a larger dollar amount of purchasing power. Meanwhile, the selfsame homes that had sold for lower prices a couple years earlier provided no greater amount of shelter, no greater amount of amenities, than they did at the lower prices. I am therefore justified in concluding that the reduced interest rates had their intended effect, decreased the value of the currency, and promoted the illusion of greater economic growth as people fled the currency to move into assets that would better hold their value.

Of course, the money flow did not end there. People converted "home equity" into cash, with which they purchased more consumer goods from places like China and Japan. Torrents of dollars overflowed our borders to pile up in overseas coffers. Eventually, as those economies began to spend the dollars, the prices of oil, coal, copper, aluminum, cement - all the things they used to build up their infrastructure and that served as the raw materials for the things Americans were buying - rose in price as well. And just as the run-up in home prices in the US led the prices of foreign-sourced commodities upward, it would only stand to reason that any decline in housing prices would lead them back down.

Not that it will be that neat and tidy - by the time the full effects of that phenomenon are being felt another may well have taken hold. The Fed is apt to cut rates in an attempt to engineer a "soft landing" for the housing market and who knows how that next wave of inflation will play out. But do not make the simplistic assumption that simply because all prices do not move in lockstep that it is not inflation - because it never happens that way.

[jk]

Re: DeHedging Gold Bubble?

Inflation is a uneven phenomenon. When excess money is created, the price effects move through the system in waves, first affecting one set of prices, then another, then another.

yes, the low rates bloated house prices [which had been conveniently removed from the cpi], and the housing atm boosted spending and lowered savings below zero. now that the wave has passed housing, the question is: what next? certainly industrial commodities have been pumped up. now they've corrected a bit, but then what? up more if he world can keep growth going; if there is global growth we've got to expect commodities to continue to rise at least when priced in dollars. the wave leaves in its wake the foam [multiple small bubbles?] of increased debt. and it has required accelerating amounts of debt to to produce a unit of gdp. but like a wave at the beach, the wave comes in, the wave perhaps goes out? rip tide? can we torture this metaphor any further?

[SeanO]

Re: DeHedging Gold Bubble?

...your observation about the divergence between real estate and commodity prices is yet a further oversimplification - that the price effects of inflation move uniformly through an economy

Actually it is one part of the oversimplification you made in your same-same argument that I originally took issue with. Seems like you clearly don't think they are same-same at least with regard to timing. Perhaps had I used timing, instead of leverage, as my original example we would have come to agreement that they aren't exactly the same sooner.

[Finster]

Re: DeHedging Gold Bubble?

yes, the low rates bloated house prices [which had been conveniently removed from the cpi], and the housing atm boosted spending and lowered savings below zero. now that the wave has passed housing, the question is: what next? certainly industrial commodities have been pumped up. now they've corrected a bit, but then what? up more if he world can keep growth going; if there is global growth we've got to expect commodities to continue to rise at least when priced in dollars. the wave leaves in its wake the foam [multiple small bubbles?] of increased debt. and it has required accelerating amounts of debt to to produce a unit of gdp. but like a wave at the beach, the wave comes in, the wave perhaps goes out? rip tide? can we torture this metaphor any further?

Torture it is! :eek: The Fed is like a wind trying to blow liquidity onto the beach, with gravity trying to make it flow back out to sea. If it were not for its ability to simply create money from nothing, each wave of inflation would be followed by a corresponding wave of deflation. And the waves would be a lot smaller and non-destructive.

It turns out, however, that we can observe the waves regardless if we know where to look. If we measure prices in units that cannot be artificially inflated, we see that the deflation happens regardless. The Fed's exertions merely paper it over.

The below is a chart of global stock prices expressed in gold for the past 135 years. As you can see, prior to the founding of the Fed in 1914, stock and economic cycles were fairly brief and shallow, whereas afterwards, they became very long and very deep. We see that in the 1970's even while we had inflation in dollar terms, a deflation even deeper than that of the 1930's actually occurred. It was simply obscured by the devaluation of currency. Of more immediate import, we can also see that we are in the early stages of yet another 1970's-style paper inflation - real deflation.

[jk]

Re: DeHedging Gold Bubble?

nice chart, finster. i even sent copies to some friends. the only nit i'd pick: using gold as a measure is not quite right, though it's not bad. it's not quite right because of the uneven way the gold price lurches up and down. surely we don't want a measure of "real" prices which drops "prices" [in gold] like a stone in 1979 [because gold got so high] and then raises "prices" [in gold] sharply after 1980. a house which cost $125,000 in 1980, or 156oz of gold, might have cost $600,000 in 2000, or over 2000 oz of gold. the price in dollars makes it look inflationary enough, with a 5fold rise in nominal dollar price. over a 10fold rise in gold seems extreme. so yes, over a very long period i suppose putting prices in gold tells us something, but not quite enough, especially when we want to measure processes over mere decades.

[Finster]

Re: DeHedging Gold Bubble?

Actually it is one part of the oversimplification you made in your same-same argument that I originally took issue with. Seems like you clearly don't think they are same-same at least with regard to timing. Perhaps had I used timing, instead of leverage, as my original example we would have come to agreement that they aren't exactly the same sooner.

It is the same-same. The same phenomenon is behind the stock bubble, the housing bubble, soaring oil prices, and the rest.

Inflation!

[Finster]

Re: DeHedging Gold Bubble?

nice chart, finster. i even sent copies to some friends. the only nit i'd pick: using gold as a measure is not quite right, though it's not bad. it's not quite right because of the uneven way the gold price lurches up and down. surely we don't want a measure of "real" prices which drops "prices" [in gold] like a stone in 1979 [because gold got so high] and then raises "prices" [in gold] sharply after 1980. a house which cost $125,000 in 1980, or 156oz of gold, might have cost $600,000 in 2000, or over 2000 oz of gold. the price in dollars makes it look inflationary enough, with a 5fold rise in nominal dollar price. over a 10fold rise in gold seems extreme. so yes, over a very long period i suppose putting prices in gold tells us something, but not quite enough, especially when we want to measure processes over mere decades.

Your point about gold fluctuating is valid. Gold is a commodity that has its own supply and demand dynamics.

Yet if we are looking for something that is constant in value against which to measure other values, we are hard pressed to do better. Currency only seems as constant as it does because it's our standard reference. As you point out, gold's utility as a standard of value is especially meaningful over long periods of time. In fact I have developed an index of the value of the dollar in an attempt to create a broader based unit, which is discussed more fully on my web site.

We can at least qualitatively assess, however, the extent to which our shorter term impressions based on gold are valid by looking for confirmation from the prices of other things. Housing prices have risen roughly parallel with gold over the past few years. So have oil prices. As well as many industrial materials. This strongly suggests that most of those price movements are indeed not fundamental to the individual things, but secondary to changes in the value of the measuring unit we call the US dollar. Further support for this suggestion follows from changes in the money supply in recent years.

Also recall that prior to 1933 the USD and gold were officially interchangeable. The thing that really changed in 1914 with the creation of the Fed was the ability of the Fed to artificially expand the number of claims against gold far in excess of the available gold. So we had inflation even while nominally on a gold standard. Of course, it was only once too many of those claims came to be redeemed that it became apparent. The result was FDR's repudiation of the gold standard and the government confiscation of gold in 1933.

[jk]

Re: DeHedging Gold Bubble?

i suppose someday someone will develop some kind of market basket to measure price changes more uniformly than just using gold. we can call it "the cpi"!

[Finster]

Re: DeHedging Gold Bubble?

i suppose someday someone will develop some kind of market basket to measure price changes more uniformly than just using gold. we can call it "the cpi"!

Been there done that. The CPI suffers from huge flaws in at least two areas. One is that it has been dumbed down over the years through the use of statistical legerdemain such as "homeowner's equivalent rent" and "quality" adjustment "hedonics". The former is especially insidious because the ratio of rent to price in real estate (the "cap rate") tends to track interest rates. So whenever the Fed lowers interest rates to goose inflation, the resultant effect on homes prices gets canceled out. Now isn't canceling out inflationary influences about the last thing you'd logically do in constructing an inflation index?

The other is that the price effects of inflation are not confined to consumer prices. In fact, consumer prices are near the end of the inflationary chain, often taking years to respond to changes in the money supply. Inflation usually shows up in asset prices first. Assets like stocks and bonds. We saw this in the 1960s and again in the 1990's. So no index of price inflation can focus only on consumer prices and be considered complete.