Author Archives: Keith Weiner

 

Shubik’s Dollar Auction

I have been writing about consumption of capital, using the example of a farmer who sells off his farm to buy groceries. It’s a striking story, because people don’t normally act like this. Of course, there are self-destructive people in every society, but, not many. Most people know not to spend themselves into poverty.

To make people hurt themselves, we need to add the essential element: a perverse incentive. Consider a parlor game called Shubik’s Dollar Auction. You auction off a dollar bill, but there’s one extra rule. The second highest bidder has to pay his bid, getting nothing in return.

This game works best with a large crowd, so that several people bid before they think too much about it. Then the participants become ensnared. There is always an incentive to raise the bid by a penny. Would you rather pay $1.01 to buy a dollar, or lose $1.00 and get nothing? The same incentive works at $2.01, $3.01, and so on. There is no limit to how high the bidding will go, until someone gives up in disgust (and anger at whoever ran the game).

 

SHUBIKimpShubik auction probabilities tree (two players) – you can read more about this game theory topic here – click to enlarge.

 

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Interesting Developments in Gold

There is an exquisite setup building once again. Tight fundamentals in the gold market apply upwards pressure on the price. For quite a while, we have been saying gold’s fundamental price was around a hundred bucks above the market price. Well, the market price moved up $46 this week. What happened to the fundamental price? You’ll have to read on to see (no cheating and reading ahead!) but suffice to say it’s quite a bit higher than the market.

 

byzantine-gold-Christ-cb2081Byzantine Empire. Constantine VII Porphyrogenitus, with Romanus I and Christopher. 913-959 AD. Gold Solidus, Constantinople mint. Struck 924-931 AD.

 

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A Tight Market

For quite a while, we have been talking about scarcity in gold. The cobasis for both October and December is positive. These contracts are backwardated. The cobasis for the February 2016 contract is not far from backwardation. The gold market is tight. Why? Let’s explore.

Part of the matter is that the price has fallen. The more the price drops, the more buyers tend to come out, and sellers go away.

We do not refer necessarily to the mines. Once the capital is sunk, a mining company is a price-taker. Management has little choice but to extract what it can, and hope the quantity produced times the profit available at a given gold price is enough to pay the fixed expenses such as debt service (well, if they don’t have a proper hedging program, which I wrote about here and here). Gold is often produced as a byproduct when mining for other metals, and this production depends on the profitability of the main metal in the ore.

 

TUC2004-252sunnygoldNative gold in quartz – from the Dixie Mine in Idaho Springs

Photo via silvertongold.org

 

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Capital Consumption

If you’re an American over a certain age, you remember roller skating rinks (I have no idea if it caught on in other countries). This industry boomed in the 1970’s disco era. However, by the mid 1980’s, the fad was fading. Imagine running a rink company at the end of the craze. You know it is not going to survive for long. How do you operate your business?

 

roller discoThe birthplace of roller disco turned out to be edible, sort of

Photo via realskatestories.com

 

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Withdrawing the Gold Bid

Last week, we left off with this:

 

“Something is happening with gold…”

 

It began in Dec 2008. To understand it, it is necessary to understand two principles. The first is that gold is money and the dollar is credit, which currently has nontrivial value. A dollar is worth 28.4mg gold. To understand the second, let’s look at how markets work at the mechanical level.

 

gold-coins-and-bullionAn assortment of well-known bullion coins and bars from all over the world

Photo via reisebank.de

 

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Losing Purchasing Power

I wrote a story about poor Clarence who retired in 1979, and even poorer Larry who retired last year. I created these characters to challenge the notion of calculating a real interest rate by subtracting inflation. The idea is that the decline of a currency can be measured by the rate of price increases.

This price-centric view leads to the concept of purchasing power—the amount of stuff that a dollar can buy. It’s the flip side of prices. When prices rise, purchasing power falls. Recall in the story, Clarence retired in 1979. At the time, inflation was running at 14% but he could only get 11% interest. Real interest was -3%, and Clarence had a problem. He was losing his purchasing power.

 

powerPhoto credit: James Dick

 

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A Parade of Errors

You cannot understand gold if you think it goes up and down, that the dollar is money and therefore the measure of all things, including gold. This is a very bold statement, so let’s look a little closer.

Mainstream articles often ask the question if gold is a good inflation hedge, which means: does gold go up as much as consumer prices. You know what comes next. They trot out a chart of the Consumer Price Index with the price of gold overlaid on it. And guess what. Gold fails to protect against inflation (i.e. its price does not go up with CPI). Therefore, you should buy stocks and real estate. QED.

 

perth-gold-ingotsCast gold bars from the Perth Mint in Western Australia

Photo credit: istara

 

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The Sword of Damocles

Dear Prime Minister Tsipras,

First, congratulations for mustering the popular support to say “no” to the troika. The euro has long offered Greece a perverse incentive to borrow, and now your country is trapped in debt. By any conventional means, Greece cannot repay (I propose an unconventional way, below). The sooner everyone acknowledges this simple fact the better.

 

Parliament backing will allow Tsipras to negotiate his package of economic reforms with Greece's European creditorsWhat to do, what to do … Greek prime minister Alexis Tsipras in contemplation mode

Photo credit: Christian Hartmann / Reuters

 

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Vade Retro, Pet Rock!

For those who are speculating on the dollar—i.e. most people—there was good news this week. The dollar rose almost a milligram, to 28.3mg gold. That’s a big gain, and welcome news for those who keep all of their eggs in the one dollar basket, perhaps because they don’t want to risk any of it on pet rocks.

Yes, Jason Zweig at the Wall Street Journal actually said that. He couldn’t be more wrong—and yet he had a point. Wrong? Let me count the ways.

 

lingote-sujeta-puertas-01It’s not a pet rock, Mr. Zweig – it’s a door stop! We thought everybody knows this… (PT)

Photo via tiendasmayoristas.com

 

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Gold, the Dollar … and Batman

We can’t count how many articles we saw today, bemoaning gold going down. The price action is bad for gold (whatever that means). China under-reported their gold holdings. No, China doesn’t care about gold. No they want the price to go down so they can buy it cheap.

No, they want to convince the IMF to include the yuan (which has capital controls, by the way) into the SDR basket. No, China really intends to revalue gold (whatever that means). This is your brain on dollars. Any questions?

 

Batman knows bestAs usual, Batman knows best

Image credit:  Bob Kane

 

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