Friday, January 3, 2014

Gold and Backwardation or: Why to Hate Izabella de Alphaville

The faux-eastern-European sounding sub-head is to honor one of her commenters at Dizzynomics who thought that, because of her last name (technically feminine adjectival surname, I looked it up), she was an English-as-a-second-language émigré from points east.*
That's pretty funny.

The hate terminology comes from the fact that I was dithering whether to link to the piece that is the basis for her post "The time value of gold and anything" while she was using it as a take-off for some fancy commodities-and-more writing. From Dizzynomics:
Just a quick note to say that I came across this article about gold backwardation on the Safe Haven blog, critiquing the standard view by goldbugs that backwardation implies imminent fiat currency meltdown.

Anyway, I can’t speak for the rest of the site’s stuff, but I thought this series by Tim Fischer was very good. He gets it 100%. And it explains why so many goldbugs have misread the signals from the gold market.

Not only does he understand that backwardation or contango indicate the “return” over time of any particular good or commodity, he understands that the implied rate of return is meaningless unless compared to the return of the risk-free equivalent of choice.

Thus even a backwardation can be market efficient if the prevailing rate of the main risk-free is negative.
He also understands that a backwardated curve can sometimes be more indicative of lower gold prices to come and/or increased hedging demand than higher demand today.

In short, he explains why being able to sell physical gold today and buy it back at a lower rate tomorrow doesn’t necessarily represent some sort of market breakdown that should not exist, as many of Fekete’s followers maintain. (If it did then there are plenty of other commodities that should have unhinged fiat currencies by now).

The very simple point is that it only makes sense to hoard a commodity over time if someone in the market is prepared to pay you a greater equivalence in fiat currency (or any other unit that represents overall purchasing power) over time to do so....MUCH MORE
Just about every sentence above is a profundity and exhibits the interconnections between time, interest rates, commodity curves and money in almost virtuoso style. This is the way it's done kids.

Here's the article she's riffing off, "The Time Value Of Gold - Ignore It At Your Own Peril"
After the recent publication of my piece "Fekete's Arbitrage Fallacy", I had to endure the wrath of the Fekete camp. However, a week later, I received an email by one of Fekete's followers, in which an actual argument regarding one of the underlying issues - me negating that backwardation in gold meant arbitrage - was made. Since this argument was flawed, and since it had been put to me before by another person, I analyze it in this essay. To make it brief, besides their shortcomings with regards to arbitrage theory, Fekete's "New Austrians" seem to ignore the time value of gold, which they should not. Furthermore, I repeat my recent warning to researchers, investors, and hobby economists, that not all is right in Fekete's theories.

In my article "Faux Gold Arbitrage" from early September, I had given a detailed explanation why backwardation in gold forward markets had nothing to do with arbitrage. In a follow-up titled "Fekete's Arbitrage Fallacy", I pointed to the - as far as I can see - main source of this misconception, Antal E. Fekete, and explained the flaws in the definition and the use of the notion "arbitrage" in his writings. The need for this new article, for one, stems from an explanation why backwardation in gold supposedly meant arbitrage, that was given to me recently and that claims to use the standard definition of arbitrage - and not Fekete's own flawed one....MORE
*For the life of me I can't remember the post the gentleman was commenting on, I wish I could find it.