Macro Tsimmis

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Archive for December, 2011

SELL SPDR Gold Shares (GLD); BUY Sprott Physical Gold Trust (PHYS)

Posted by intelledgement on Fri, 30 Dec 11

Intelledgement’s model portfolio utilizes (mostly) exchange-traded funds to implement a macro-focused investment strategy. Consequently, we periodically review the funds relevant to any particular aspect of our overall strategy—e.g., all the funds that invest in India or agriculture, or short the dollar—to ensure that the particular fund we choose as our investment vehicle is the best choice (or at least a good one). In order to minimize potential liquidity issues, we generally eschew any fund that has less than one billion dollars under management, or trades fewer than one million shares per day on average. We occasionally make exceptions to this practice; for example when we feel strongly about the need to take a certain position and the fund choices to implement it are limited or when a fund with a large enough market cap has lower volume due to a high per-share price.

We have been satisfied investors in the SPDR Gold Shares ETF (GLD) more-or-less since the inception of the Intelledgement Macro Strategy Investment Portfolio at the beginning of 2007. (We sold our gold and silver funds in February of 2010 thinking the dollar would strengthen on flight-to-safety concerns…and got a sharp reminder that trying to outguess the market tactically is very hard to do as the price of both commodities soared. We got back in three months later, having missed a 10% rise in gold and a 17% rise in silver.) Since that time, GLD has reasonably faithfully tracked the price of gold, which has mostly gone up.

We still think gold is a good place to store some value as we explained in our original recommendation for GLD back in 2006. So we don’t want to pull any funds out of gold, but what we are doing is making a lateral move: selling the GLD ETF and rolling over all of the proceeds of that sale—our original investment plus the profits—into the Sprott Physical Gold Trust closed-end mutual fund (PHYS).

We are making this move for two reasons. First, being a closed-end mutual fund, the tax treatment for PHYS capital gains is more favorable for US investors: 15% on long-term PHYS gains compared to your ordinary income tax rate—probably 28%—for any GLD gains regardless of how long you have held the investment. Of course, this does not matter if you hold the shares in a retirement account, but for those investors working with a regular brokerage account, it is a material advantage. Secondly, so far—since the inception of the fund in February 2010—the PHYS fund has actually outperformed gold bullion by 2% as compared to the slight underperformance of GLD since its inception (November 2004). This may be a transitory effect, but there are some reasons why the market seems to prefer PHYS to GLD—for more on this see our Motley Fool weblog post—and insofar as that helps the former to outperform the latter, we are willing to let the effect work in our favor.

One of the reasons PHYS is preferred is that some investors consider that GLD is more vulnerable to systemic risk than PHYS. We believe that if the system genuinely collapses, no paper gold holdings are likely to avail one; at that point, you will need silver coins, tobacco, alcohol, and aspirin for purchasing any necessities of life that you cannot provide for yourself. The market also likes PHYS because it is the only fund that enables investors to redeem their shares for physical gold. But this is not a genuinely practical option, as you need to have about $400,000 invested in the fund to afford the tradein for a gold bar—they are not about to incur the hassle and expense of dividing up a bar for you. Anyone who seriously could afford to and wished to acquire that much gold could do so more cheaply buying from a dealer. But again, if the market bids the price of PHYS up relatively higher because of irrational beliefs that it is safer and easy to convert shares to bullion, as PHYS owners we will cheerfully accept all contributions to our share valuation.

Of course, with a marketcap of $2 billion and average trading volume of 1.5 million shares, PHYS exceeds our liquidity requirements (minimums of $1 billion marketcap and one million shares average daily volume). Sprott store all their bullion at the Royal Canadian Mint, who are responsible for auditing and issuing bar lists. Since the 2009 brouhaha over the $15 million of “missing” bullion that turned out not to be missing, the mint has tightened up their accounting procedures and now considered  one of the safest, if not the safest and most honest storehouses of gold bullion in the world. We also like the fact that—as with GLD—the gold is stored outside the USA, considering what happened in the 30s when the government confiscated everyone’s gold.

Previous gold-related posts:

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Tracking the Gold Funds

Posted by intelledgement on Fri, 30 Dec 11

If you are in the market for a paper investment in gold, there are several factors you may want to take into account in choosing among the many available investment vehicles: fund expense ratio, premium over the NAV, tax issues, who holds the physical gold underlying the fund, who audits those holdings, where they are located, and the potential for convertibility of your shares in to physical gold, to name a few. One important factor we attend to at Intelledgement is the overall performance of the fund relative to the price of gold. The following table ranks several gold funds with respect to how well they measure up:

Fund  Sym. Market Cap Volume Inception Cost 29-Dec-11 Price ROI CAGR Gold Cost Gold Price Gold ROI Gold CAGR Annualized ITR
ProShares UltraShort Gold ETF GLL 0.14 0.92 04-Dec-08 130.00 20.28 -84.4% -45.4% 767.00 1545 101.4% 25.6%  5.8
Sprott Physical Gold Trust ETV PHYS 2.00 1.48 26-Feb-10 9.59 13.72 43.1% 21.5% 1117.50 1545 38.3% 19.3%  2.2
Central GoldTrust GTU 0.97 0.13 22-Sep-06 21.95 58.07 164.6% 20.3% 588.60 1545 162.5% 20.1%  0.2
ETFS Physical Swiss Gold Shares SGOL 1.88 0.16 09-Sep-09 98.98 153.19 54.8% 20.9% 992.50 1545 55.7% 21.2%  (0.3)
iShares Gold Trust IAU 9.63 5.92 28-Jan-05 4.27 15.07 253.0% 20.0% 426.80 1545 262.0% 20.4%  (0.4)
SPDR Gold Shares GLD 72.87 9.99 18-Nov-04 44.38 150.34 238.8% 18.7% 443.70 1545 248.2% 19.2%  (0.5)
PowerShares DB Gold Fund DGL 0.50 0.13 05-Jan-07 23.49 53.87 129.3% 18.1% 605.50 1545 155.2% 20.7%  (2.6)
ProShares Ultra Gold UGL 0.43 0.28 04-Dec-08 24.27 77.31 218.5% 45.9% 767.00 1545 101.4% 25.6%  (5.4)
PowerShares DB Gold Double Lg ETN DGP 0.67 0.90 28-Feb-08 25.70 46.34 80.3% 16.6% 971.00 1545 59.1% 12.9%  (9.1)
  • MarketCap = size of the fund in billions of dollars.
  • Volume = daily average trading volume in millions of shares
  • Inception = date of first day of trading for fund (per Yahoo!)
  • Cost = closing price of a share of the fund on the first day of trading (per Yahoo!)
  • 29-Dec-11 price = closing price of a share of the fund as of 29 Dec 2011
  • ROI = return on investment for a share of the fund from the inception date until 29 Dec 2011
  • CAGR = compounded annual growth rate (a/k/a annualized ROI) for a share of the fund from the inception date until 29 Dec 2011
  • Gold Cost = closing price of an ounce of gold on the first day of trading for the fund
  • Gold Price = closing price of an ounce of gold as of 29 Dec 2011
  • Gold ROI = return on investment for an ounce of gold from the inception date of the fund until 29 Dec 2011
  • Gold CAGR = compounded annual growth rate for an ounce of gold from the inception date of the fund until 29 Dec 2011
  • Annualized ITR = the fund’s Intelledgement Tracking Rating (see below)

Basically, the higher the ITR, the better. The ITR is calculated by subtracting the CAGR of gold from the CAGR of the fund; each ITR point is equal to one percentage point of compounded annual growth rate performance. All these funds are supposed to track the price of gold; if a fund has a positive ITR, it has done better than expected while a negative ITR means the fund is underperforming gold.

The ProShares UltraShort Gold ETF (AMEX: GLL) is something of a special case; it is a fund that is supposed to perform inversely compared to the price of gold…actually, it is supposed to go up by twice the percentage decline in the price of gold in any given day that gold sells off…and go down by twice the percentage gain in the price of gold any day that gold appreciates in value. The fund has a high ITR because while gold has increased by 25.6% on a CAGR basis since the inception of the fund, GLL has declined by a CAGR of “only” 45.4%. As we would have expected a decline of 51.2%, GLL has, relatively speaking, outperformed. Of course, anyone who bought a share of the fund back on 4 Dec 2008 and held it through yesterday is still down 84.4% overall, so the good ITR rating is probably not particularly comforting.

Generally speaking, we would expect the ITR for a fund tracking the price of gold to be slightly negative, given that the cost of administering the fund—including buying and selling the underlying gold and storing it for those funds that are backed by physical metal and the transaction costs of trading derivatives and options for the funds that are not—has to be paid for out of the assets of the fund. Therefore the -0.5 ITR of GLD, -0.4 for IAU, and -0.3 for SGOL sound just about right. It does appear that the physical gold funds generally beat the paper gold funds. For example, both of the double-return long funds on the list—which utilize futures and other derivatives to attempt to double the appreciation (or decline) in the price of gold on any given day—have failed to perform as well as expected over the long run (although both are handily beating the ROI of gold). Similarly the PowerShares DB Gold Fund (AMEX: DGL)—which relies on futures contracts to track the price of gold rather than purchasing bullion like GLD or IAU—has a materially worse ITR (-2.6).

The outlier is the Sprott Physical Gold Trust ETV (AMEX: PHYS), which has a +2.2 ITR. PHYS is unique in allowing, theoretically, investors to redeem their shares for gold bars…but you have to have at least $400,000 or so because they utilize gold bars and they won’t split one up for you. It is also structured as a closed-end mutual fund that affords US taxpayers the advantage of paying capital gains taxes at the long-term rate (15%), unlike the other funds (gains from which are taxed at 28%). The fund has generally sold at a premium to the NAV—which both means it is in high demand and if you invest in it, you are in effect paying higher-than-market-rates for your gold. It will be interesting to see if the relative attractiveness of the fund enables it to sustain the better-than-expected performance.

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McRIBS Reconsidered: Taking Currency Fluctuations Into Account

Posted by intelledgement on Tue, 27 Dec 11

A few weeks ago, we published an article reviewing the performance of the stock markets of 16 nations—including all the BRICs—for the first 10 years of the 21st century…. An astute commenter pointed out that my analysis hadn’t factored in the decline of the dollar. The commenter stated that the dollar had declined 20% in value in the first 10 years of the century—it turns out that inflation from 2001-2010 inclusively actually amounted to a cumulative 21%—and thus, he complained that the chart showed the S&P 500 value as flat for the decade (a compounded annual growth rate of fractionally less than 0%) when in reality the absolute value of an investment in the S&P 500 from 2001 to 2010 would have been down by 20% or so. Now, all the bourse indexes were valued in terms of the nominal value of their respective currencies…. However, using nominal native currencies over 10 years actually does not necessarily provide a perfectly level playing field, because it ignores currency fluctuations. In looking at the changes in value for each currency relative to the dollar over the decade, these were not insignificant.

And so this sequel article published earlier today by The Motley Fool, Reconsidering the “New” BRICs, adds in the effects of ten years of currency fluctuations. Turns out some markets—e.g., Australia up 4% annually for ten years in nominal terms but up 10% annually when we take the appreciation of the Australian dollar into account—did materially better…and some did worse.

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Krugman Incinerates a Straw Man

Posted by intelledgement on Tue, 20 Dec 11

[T]here has, indeed, been a huge expansion of the monetary base. After Lehman Brothers fell, the Fed began lending large sums to banks as well as buying a wide range of other assets, in a (successful) attempt to stabilize financial markets, in the process adding large amounts to bank reserves. In the fall of 2010, the Fed began another round of purchases, in a less successful attempt to boost economic growth. The combined effect of these actions was that the monetary base more than tripled in size. Austrians, and for that matter many right-leaning economists, were sure about what would happen as a result: There would be devastating inflation…. So here we are, three years later. How’s it going? Inflation has fluctuated, but, at the end of the day, consumer prices have risen just 4.5 percent, meaning an average annual inflation rate of only 1.5 percent. Who could have predicted that printing so much money would cause so little inflation? Well, I could. And did. And so did others who understood…Keynesian economics.…

Paul Krugman

Both: We’ve been going back and forth for a century.

Keynes: I want to steer markets!

Hayek: I want them set free!

“Fear the Boom and Bust,” a Hayek vs. Keynes Rap Anthem

Keynesian economist Paul Krugman is big on predictions. He loves to make them, and he most particularly loves to crow about how accurate his predictions are…and how wrong the predictions of anyone who disagrees with him invariably (or so it seems) turn out to be.

In point of fact, it is not news that Dr. Krugman’s economic analysis tends to be colored by his political leanings. When he retired as ombudsman for the NY Times—the host of Dr. Krugman’s “Conscience of a Liberal” weblog—Daniel Okrent noted in his farewell column that “Op-Ed columnist Paul Krugman has the disturbing habit of shaping, slicing and selectively citing numbers in a fashion that pleases his acolytes but leaves him open to substantive assaults.” Basically the same point has been made by The Economist and Richard A. Posner writing in The Atlantic (as well as legions of conservative pundits and bloggers, of course).

But in criticizing Austrian School economists for bad short-term predictions, Dr. Krugman has ratcheted the chutzpah level up a notch or two.

Arguably, the single most significant point of contention between Keynesians and the Austrian School concerns the feasibility and utility of managing markets. The Keynesians claim not only that it is eminently doable but that to eschew their advice is both dumb and potentially immoral…because left to their own devices, markets will gyrate madly causing economic turmoil and human suffering. Austrian School economists profess that it is dangerously presumptive to believe that we are smart enough to “manage” markets and that attempts to do so are both dumb and potentially immoral…because misguided controls inevitably distort markets and engender malinvestment—mispriced goods and services—that leads to bubbles and boom-and-bust cycles that in turn cause economic turmoil and human suffering.

Manifestly, if it is possible to reliably predict the effect of control “x” or “y” on economic activity, then the Keynesians are right. But the Austrians’ contention is that this is not possible, in the short run, to reliably make such predictions. For Dr. Krugman to criticize them for failing to accomplish what they say is impossible is pure sophistry.

Austrian School economists would indeed argue that debasing a fiat currency eventually leads to its collapse, but there are too many independent variables in the equation to specifically predict when that will happen or, in the interim, what the particular effect of any given attempt to steer things might be. Dr. Krugman cites the average rate of inflation since 2008 as being “only” 1.5%. But we are discussing macroeconomics here, and looking at just three years does not tell you much. In fact, one of those three years was 2009, when the inflation rate was -0.4%…the first year with deflation since 1955 (when it was also -0.4%). During the first decade of the 21st Century, the inflation rate averaged 2.4%—and at the end of 2010, the dollar was worth 79 cents in 2000-dollars. If we go back to 1955—the other deflationary year—the inflation rate has averaged 3.8%.

Let’s take the middle number—2.4% average inflation, as we have experienced over the last decade—and project forward. By 2020, the dollar would be worth 63 cents in year-2000 dollars. By 2030, it would be worth 49 cents. Taking a longer and more data-rich perspective, with the average 3.8% inflation since 1955, at the end of 2010, the dollar was worth 11 year-1955 cents. Presuming 3.8% average inflation going forward, by the end of 2030 the dollar would be worth a 1955 nickel. (If annual inflation between now and then averages “only” 2.4%, make that seven cents.)

Hmm…now the Austrian School fiat-money-collapse scenario is not looking so far-fetched.

The whole Keynesian-inspired notion that “low” inflation is a normal and acceptable condition is bizarre. If I borrowed $100 dollars from you and then wanted to pay you back just $50, you would likely—and justifiably—be pretty upset and may well consider me a thief. When Keynesian-inspired central bankers do it to us, however, it’s like the weather: everyone complains about it but it’s no one’s fault.

Any inflation has the undesirable effects of distorting market values, encouraging malinvestments—which lead to potentially dangerous bubbles—and destroying the value of savings, thus discouraging people from taking a long-term view. Deliberately stoking inflation, therefore, is a dubious and problematic policy.

Which is not to say there is a lack of good reasons to be critical of Austrian School economics and their potential application to policy: for example just looking at the financial markets, if we eschew regulation, would we be better off going forward with an unregulated market for credit default swaps and other derivatives (as we had in 2008…and is still the case)? What would prevent unscrupulous naked short sellers from ganging up on vulnerable early-stage startup companies and making it hard for them to raise capital via the public markets? Would rolling back Regulation FD—as some Tea Partiers have advocated—be a good thing for investors?

But setting up straw men and incinerating them, as Dr. Krugman does here, is not advancing the ball.

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