Search This Blog

Sunday, May 19, 2013

No inflation yet? Wait and see.....

For those disappointed about the continued absence of substantial US price inflation, it is beneficial to recap a little bit of Economics 101.

Below is one a classic piece of economic analysis, courtesy of It is called the Philips curve, after the economist who invented it. This particular chart is plotting the relationship between Unemployment and Inflation (a proxy for the latter is Rate of Change of Money Wage Rates), for the United Kingdom every year between 1913 - 1948.
File:Phillips curve.jpg
In short, the Philips curve states that high unemployment in an economy corresponds with low inflation, and vice versa. There has since Philips published his work been numerous refinements of the theory surrounding the Philips curve, however, there seem to be broad agreement on the key principles behind it.

Simply put: When general unemployment is above what economists define as the equilibrium unemployment rate, wage growth tends to slow, as the unemployed are competing for jobs. When unemployment is below, jobs are competing for the unemployed, bidding up wages. 

What the equilibrium unemployment rate is for an economy is dependent on a range of different factors. Unemployment benefits, minimum wages, laws that regulate hiring/firing, general ease/difficulty of doing business, quality of labor in a work-force etc, are general factors influencing supply and demand for labor. Generally, the more efficient/ the less restricted the labor market is, the lower is the equilibrium unemployment rate. Labor market rigidities explain why for example Spain was experiencing material wage inflation when it had 10% unemployment, while similar unemployment rates in the US on average led to declining wages.

Several analysts have estimated the US equilibrium unemployment rate to be north of 6%. This is up from its long term average between 4-5%, and reflects that long-term unemployment in the US have left more people less employable.

Currently, the US unemployment rate is 7.4%. This is still well above 6%. Hence, there is still higher supply of deplorable labor than there is demand, and on average no sign of inflationary pressure in wages.

As Uncle Ben Bernanke has promised us that he will keep printing money until US unemployment reaches 6%, he will not stop until he creates inflation. At the going speed of unemployed being hired, this point should be reached in about 12 months time.

Wednesday, May 15, 2013

Portfolio up 40%. Some reflections.

My model portfolio has in this moment an implied return of 40% since its initiation in November (see below).  Which, I presume, is quite good by any benchmark.

The position which continues to disappoint in the model portfolio, is long gold. After having reached an intra-day low of $ 1321/oz on April 16th, only to rebound to reach intra-day prices of $1490/oz around May 3rd, it has now broken through the bottom of its 4 week trading range, signalling further short-term decline. Chartists will probably start seeing "head-shoulder" formations if the price reaches 1350 (which I expect it to do), creating further self-fulling expectations about price declines.

Furthermore, price declines now seem to be expected even among the most stubborn gold bulls, which have a history of impacting the buyers sentiment (Marc Faber has become more quiet after his predicted stock market crash did not materialize in April, and after he proclaimed gold was a good buy at 1600, only to see it becoming an even better buy at $1400/oz a few weeks later, Jim Rogers, recently proclaimed he has buy orders on gold all the way down to the $1100/oz mark. Previously, before the decline, he advocated $1200/oz as a possible floor).

Support from physical gold buyers is unlikely to show the same strength around a second dip, at least not retail demand. To use myself as an example, I was among those that took the opportunity to load up on physical metal right after the floor bottomed out in mid-April (my entry point was $1380/oz, to be exact). Now, I have less cash to deploy when a similar opportunity comes along again, and need even lower prices to engage. A similar rush to buy, with the $1400/oz mark in fresh memory of physical gold buyers, is unlikely to materialize unless gold falls to around $1250/oz.

Paradoxically, the fundamentals for owning gold have not been as good as they are now for as far as I can remember. South African cash cost for gold production is around the $1400/oz mark (with China, US other producers ranging between $900-1300/oz). Should the gold price fall to the $1250/oz mark, many of these will be in a lot of financial pain, impacting market expectations about supply, and thus both the sentiment of buyers and sellers. Not to forget (if at all possible) that all the major central banks in the world seem engaged in a competition about who can add most to their currency supply.

The long-ago expected (but still missing) trigger to revive the secular bull market in gold would be signs of inflation finally materializing in the US (as other economies experiencing substantial inflation, China, India, and Iran, who is buying via Turkey, have been the key buyers of gold).

With US un-employment still hoovering north of 7.4%, general inflation, as measured by the CPI, is unlikely to materialize at least for another 12 months, and will be subsequent to statistics showing sizable development in credit expansion, and increases in the velocity of money. Until this point is reached, the gold price is likely to go sideways, my guess is with a solid floor around $1150/oz, $1400 to form the upper range of the band.