Business Cycle vs Shock To Shock – Walking the tightrope

Aug. 15. Hans Lysglimt

Most investors do not hold any gold, some have bought gold in the commodity boom we have just been through. Gold is not an “investment”, it is a hedge. And gold has been in a boom overpricing it seriously during the last few years. Gold fell under USD 800 last night.
Gold might well fall further, I expect it to do so. The point I am making is that sometime a serious investor should accumulate some gold. This needs to be bought sometime. This they should do in the current dip in gold prices. Trying to time this perfectly is futile, I do not know if gold will fall to 700 – 600 – 500 or less. But I do know that gold will cost several thousand dollars in our lifetime, say in 2020 or 2050, for those expecting themselves or their heirs to be around then. So the point is that the gold bubble has popped, and by the time of the next Olympic games in London in 2012 and there might be a new recovery, you should have accumulated a few dozen 1 ounce and 1/10 ounce gold coins, and some gold in your portfolio averaging out at “relatively” low prices. I will assume that you hold zero gold today. If you carefully start buying now, and over the next 2-4 years you should be able to average into your gold possition at decent levels, carefully buying say one 1 ounce coin per month until the London Olympics. Investigating how to and where to buy gold for investment now, carefully awaiting a good time to buy into some, carefully. This is also assuming that you have savings to invest, if you are financially underwater, or have a speculation approach to gold or financially hard pressed otherwise you should wait with your gold investment until you are more ready. If you are fully invested or over invested in gold you should consider selling some. There is much more to gold than just “buy” or “sell”, if you are looking at investing in gold from my advice please search for “gold” here on the site to see a fuller picture.

I am a believer in the Austrian School of economics taking a business cycle view of the economy’s development. The late Milton Friedman was not, he saw the economy developing through a series of shocks. Right or wrong? Both are oversimplified mental models to understand the world. The first verse of the Tao is “The truth can can be told is not the eternal truth.” The world is infinitely more complex than to be able to be captured in one model. At the same time they are both right as they both contribute some to our understanding. Being an economist trying to analyze and making predictions is inherently a humbling exercise.

Austrian business cycle theory tell us we are now facing a serious recession. Bubbles have been pumped up and now needs to be deflated in a painful process taking time. I have written extensively on this.

At the same time we are in a shock intense environment. Shocks come as a result to imbalances, and the response can create more imbalances. Bernanke responded in February by cutting interest rated 75 points, this was a counter shock response to the shock. But the inherent nature of shocks and counter shocks is not to instantly create calm, rather shocks create more shocks, hopefully smaller, in a wobbling fashion until you reach calm. Imagine walking a tightrope with a long balancing stick, when all is well you walk straight and fine, but when you, the rope, and the stick starts to wobble it takes many adjustments to get back to easy straight walking calm. The bigger the wobble, the more adjustments it takes. Smaller and smaller delicately fine tuned adjustments to calm down the rope. One maladjustment and the wobble increases again.
You might even fall entirely off the rope, as the Austrian Empire did in 1918. But I do not believe that the US economy, or the world, will fall off this time around, it could, but it is not likely. This is not “the big reckoning”, the world is to peaceful, USA is to strong, things are to good for that. Rather I believe this is a very serious wobbling that will require many adjustments to calm down. It might even suddenly get new shocks if any of the wobbling is not handed precisely right. Walking the tightrope is an art not a science we remind ourselves as every morning we watch the circus spectacle. I therefore expect the markets not to calm down, as seems to be an establishment consensus, but rather to continue wobbling in the time to come. And at any time the wobbling could shoot up by the slightest mishandling. I would be very surprised if this is handled perfectly and fully expect mistakes to be made.

If you are shorting the market by long maturity put options as I have recommended for the few ( limit this to a fraction say 10-20% of your portfolio) you should look for periods of booms of at least 5-10% followed by relative calm. When confidence is built up, and the sentiment is that this is now over. Buy puts on confidence, sell on fear. You are a confidence contrarian. There will be many more wobblings between confidence and fear before this is truly over.

August 15. 2008 Hans Lysglimt Oslo, Norway

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