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For Ben Hunt, author of Epsilon Theory, the changing nature of this narrative does not have a lot to do with the primary driver of gold prices these days.
Geoff Candy: Hello and welcome to this week’s edition of Mineweb.com’s Gold Weekly podcast and joining me on the line is Ben Hunt, he is the author of, Epsilon Theory. Ben the last time we spoke to you was in July last year and we talked about the changing nature of the narrative of gold. It was a fascinating conversation and indeed based on a really interesting blog post that you put out. You’re working on another one at the moment and what I wanted to start off by asking you was...we’ve had a massive bull run in gold, we’ve had 13 years of higher prices, then 2013 comes along and it’s the first year in more than a decade that we’ve seen prices end the year lower than they started. How does that affect this narrative and the changing nature of this narrative if we suddenly see a year where gold hasn’t done as well as it has in the past?
BEN HUNT: Yes that’s a great question, something that I have spent a lot of time thinking about. I’ll give you the short answer right off the bat. I don’t think it affects it that much. I don’t think that the price decline in gold over either a long period of time, short period of time, a year, a month, a price increase in gold... frankly I don’t think it has a lot to do with the primary driver of gold prices these days... Let me give you an example of what I’m talking about, and try to work backwards into the ideas that I’ve been presenting in Epsilon Theory. Let’s look back at just last Friday, so this is January tenth, and I’m sure a lot of your listeners know, gold rocked last Friday. This was right after the jobs report comes out. The first Friday of every month the unemployment, the jobs report, comes out, and if you recall, it was a very, well I won’t say very disappointing, but it was certainly a disappointing jobs report. It was negative for growth prospects. It was negative for expectations of what was happening on the ground in the US economy. It was deflationary. It was deflationary news.
GEOFF CANDY: Exactly, it muddied the waters in terms of people thinking about what this might lead to in terms of tapering, given what happened in December...
BEN HUNT: Exactly. That is exactly the point I wanted to make. The environment we’re in today is one where every piece of news is filtered through that perception. What does it mean for what the Federal Reserve and Central Banks in general are going to do? It loses its impact in terms of its fundamental importance… and that’s at odds with what a straightforward econometric view of the world would have. So what I’m trying to present in Epsilon Theory is an application of Game Theory. And there’s a particular game, and here I’m using game in the formal sense. It’s a derivation of something that Keynes noted back in the 1930’s, he called it the Newspaper Beauty Contest, but we call it today, the Common Knowledge Game. And, the fact is that the common knowledge of markets today is that it’s the Fed, its Central Bankers in general that determine what happens in markets. It does not mean the market is always going to go up, what it means is that its Central Bank policy that determines whatever that market outcome is. So, every piece of news from earnings to monthly jobs reports gets filtered through that lens, it’s seen through that lens in terms of what it means. So, what happened last Friday - the Wall Street Journal, the blurb they run under their headlines when the jobs report came out... I record and keep track of all that stuff...the Wall Street Journal headline blurb was ‘Weak jobs report complicates Fed plans’. That seems innocuous enough right? Right that complicates the Fed’s plans...
GEOFF CANDY: Sure
BEN HUNT:...but actually that is of crucial importance when we are talking about what I call a narrative, or what we call in Game Theory, these type of drivers for Game behaviour. This is exactly on point for the notion that everything gets filtered through what it means for the Fed and if you think of gold not as an inherent store of value, but if you think of gold as essentially insurance against Fed or Central Bank policy error, then any sort of news that is seen as complicating their lives, is seen as making their decisions and their policy more difficult, less certain, less sure... well that’s going to be good for your insurance policy and that’s why gold goes up.
GEOFF CANDY: When did that shift take place, that shift from - we think of gold as a store of value to we think of it as an insurance policy against what Central Bankers are doing? Is that linked to the massive money printing that has been going on for the past few years?
BEN HUNT: You know I think it’s linked less to the money printing as it’s linked to the role that Central Bankers have played in the aftermath of the crisis… you can go back to late 2007, I think you can start looking at this where you’re seeing the very real fear that we are in fact on the precipice not of great recession but of another great depression. I believe... gold can work really great in a deflationary environment. There has to be what I call, ‘end of the world deflationary environment’. It has to be “oh my God, we’re in a real crisis of confidence, a real catastrophe”. I understand that gold can do well in both inflationary periods and deflationary periods, but that deflation really has to be associated with “oh my God we’re going down and there’s nobody who can ever pull us back up”. So, what you saw in gold prices, according to the drivers that I am talking about, you really saw it working in favour of gold. Late 2007, going into 2008, where clearly we’ve got a growing systemic problem in the global markets, starting from the US mortgage securitization market and then emanating outwards from there into the European sovereign debt and just a tremendous debt problem all around the world. But starting really in March 2009 when the Fed launched its first QE programme, you started to see some notions of “well you know what, maybe the Federal Reserve is going to have some ability here to ‘save the day’”. And I think it was really by the time you get to September 2012 when the Fed launched its QE forever programme, where you see that, at least in the media and again the things that I track for common knowledge; you’re seeing this idea that the Fed determines market outcomes. Period, end of story. It’s really right around that September 2012 time period and I don’t think that’s a coincidence that that’s when gold prices peaked. Because, the policy they implemented... we’re going to expand our balance sheet for ever and ever amen... that should be great for gold. Gold should rock on that news. But it didn’t. That is really where you started to see that longer term decline that you were talking about starting off. Let me give you one more piece of evidence on what I’m talking about, because that piece in the Wall Street Journal that came out at 9.00am telling us how to think about the Jobs report, “oh my goodness it’s going to complicate the Fed s plans”. That’s a threat. It’s a threat to the power control that the Federal Reserve frankly wants to continue having over market outcomes. Look, this is the one part of the economy they can actually do something about. I don’t think there is anyone who thinks that quantitative easing has a really large impact on the real economy. But it can certainly have an impact on financial asset prices, on market prices. So here’s what happened. By 7.00pm Friday night, you’ve got the first in a series of articles that comes out in the Wall Street Journal that saying...”oh, no, no, no, nothing to look at here, actually this won’t complicate the Fed s plans at all”. So at 7.00pm on Friday you’ve got the Wall Street Journal author, his names Jon Hilsenrath, whose reputation goes far and wide...
GEOFF CANDY: ...he’s the Fed so to speak
BEN HUNT: ...yes exactly, he’s the Feds spokesperson, or that’s the perception. So when Jon Hilsenrath writes an article, as he does after every Fed announcement, speech or the like, well they bring out Jon Hilsenrath on Friday evening to write an article and the title of his article was ‘this means nothing for the Fed...the Fed unlikely to alter course after jobs report’. That was the title of his article. That’s on Friday. Over the weekend and going into Monday you had at least three Federal Reserve governors who came out in interviews to say, ‘Jobs report - no it’s not going to impact our plans’. Now they are not talking about the jobs report itself. This was a darn disappointing report. They say nothing about that. The only thing they want to talk about is, ‘does it complicate our plans or are we on course to continue doing what we say we’re going to do?’ I think the facts… gold prices retreat, the market comes back up, and it’s all part of the same story and game that’s been played over the last four or five years.
GEOFF CANDY: Sure. You make a very interesting point. I suppose the question that follows from that is, how does that then link up to things like physical demand that we’re seeing in Asia, in India, in China as well? There does seem to be, and that’s something I’ve mentioned on this podcast before, almost a bifurcation between if you will, the paper market and the physical market at least in terms of sentiment or the drivers behind it. Would you agree with that or would you say that that narrative we’ve been talking about filters into physical demand as well?
BEN HUNT: There have been and there always will be lots of reasons why people want to buy or sell gold. You know there is jewellery demand, there’s demand for having a physical store of asset value which is driving a lot of the physical demand particularly in Asia. There’s the narrative that I’m talking about… it does make a difference particularly if you do any sort of technical analysis, it does make a difference what the trend lines are, what happens to the price of gold, what happens to the price levels. So the price of any security is always… it’s over-determined. There are lots more reasons that you can pick and choose from to say why a price went up or down at any point in time and there’s no doubt that what you're describing, physical demand of gold is real. My point is that in the west, the US and Europe, that notion of gold as a physical store of value, has not been a strong mover of market behaviour in a long time. Does it mean it doesn’t exist particularly in Asia… look I’m not saying that at all. All I’m saying is that we’re trying to gauge or weigh the different drivers of the price of any security or any financial asset. It’s important to first of all to understand that there are lots of different drivers and they can act in different directions at different points in time, but then I really do think it’s important to get a sense of which ones are more important. And I believe strongly that one way that you can do that is to not just to look at the price of anything because again that’s going to be driven by so many different forces, but look at what people are saying about it. Look at how it is being described in the media outlets that we all read and we all think is important in driving that ‘common knowledge’ around an asset, what is the belief system around a financial asset. So I don’t think that there’s a direct impact on physical demand for gold from the narrative that I’m talking about – they're kind of on different tracks. But what I’m talking about is the more relevant driver for gold price than the physical demand for gold. It’s connected but it’s a kind of weak connection.
GEOFF CANDY: It’s a valid point and I suppose it brings us full circle to some extent in that we were talking at the start about the impact of a change in the price… the fact that it was a down year for gold last year. You said initially it doesn’t have a big impact in some respects and I suppose that fits in nicely with what you're saying now. Or perhaps not that it doesn’t have an impact, but it’s a less important impact than the manner in which people are viewing it and viewing the drivers that are affecting it.
BEN HUNT: That’s right… and here’s the way I describe it. What is the fundamental value of gold… that’s the real question we’re asking if we’re saying here’s a price… is that cheap or is that expensive. Now it’s one thing if you're talking about an asset, a stock which is a percentage share of some cash flow generating corporation… there’s a long history of trying to figure out, well is the price of this stock cheap or expensive relative to the fundamental qualities, and the cash flows really of a corporation. And you don’t have the same metrics when we’re talking about gold… What does gold mean… it’s certainly not generating any cash flow so you're not able to use that toolkit that people use to say, OK this price is high or low. So is the price of gold, at any level, expensive or cheap? Well it depends on what does gold mean to you, is gold an inherent store of value… There are a lot of people in the world who still believe that. Frankly I still believe it a little, but I don’t believe it as much in a world where you’ve got central bankers who are really calling the tune for how markets behave. So then you get to the point well, there’s technical analysis that tries to look at price trends, but I’ve got to tell you, most of the technical analysis tools you look at think well, it’s not… the trend is your friend. That’s the basic way I think, to sum up technical analysis and it ain't such a great trend depending on how you define a trend and the like, but when you look at most of the trend following strategies that are out there, most of them are short gold, not long gold. You’ve always got these counter trends and other ways of measuring the same thing which is frankly why I think there are some real difficulties with technical analysis and what I call naïve empiricism on just looking at price levels, but the basic point I’m trying to make is that unless you’ve got some fundamental reason to think that a price is either cheap or expensive, a fundamental reason based on cash flows, what you're left with is trying to figure out well, how should I think about fundamental value and it’s very hard to think about what is the fundamental value of gold because it gets tied up in so many aspects of what we think about in terms of money and economics and wealth. My point is that in recent years at least, that notion of what is the fundamental meaning of gold, what is the fundamental value, has changed. It’s changed from being an inherent store of value to being insurance against central bank policy error…
GEOFF CANDY: Which indeed makes what central bankers do a lot more relevant to where gold is going…
BEN HUNT: Unfortunately…
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