04 July 2013

Gold is a pure Epsilon/Narrative asset

I came across this gem of a blog from a reader sending me Mauldin Economics' latest.

I think I could argue the case that gold is almost all Epsilon and little Alpha or Beta, because it is a Monetary asset, because of its massive stocks to flow ratio. As I said here "It is actually supply - the withholding of supply - that matters most." What those holders think matters, and that "think" is what the blogger calls a Narrative.

What we see going on in the goldbug internet is an attempt to construct a Narrative around gold. However, as the blogger says, it is not necessary for the Narrative to be true, "it is only important for a Narrative to sound truthful." Truth is not relevant because the point of the Narrative is to serve the interests of the powerful/those who are communicating it. How true - truth doesn't matter as long as it generates clicks and sells newsletters and coins.

It seems my, at times, crusade for truth in the blogosphere is in vain because what matters is "the more Common Knowledge in play at any given time, the more that market behaviors will be driven by the rules and logic of the Common Knowledge Game than by fundamentals or traditional factors."

Certainly I would have to concede that the current goldbug Narrative (a group of various memes) is all pervading in the gold blogosphere and I'm not really making a dent. There is a catch however. What the goldbugs don't realise is that their Narrative is not the Narrative that the rest of the world is using. Indeed in this post the blogger says that gold doesn't have a Narrative:

"In some periods of history gold is money. In other periods of history gold is not. But gold is always something, and that something is defined by the Common Knowledge of the day. To be an efficient gold investor in any period, I believe it’s crucial to identify and measure the relevant Narrative that is driving the Common Knowledge regarding gold. Only then can one construct an informational surface that predicts how the equilibrium price of gold will respond to new information ... There is no stand-alone Narrative regarding gold today, as there was in 1895. Today gold is understood from a Common Knowledge perspective only as a shadow or reflection of a powerful stand-alone Narrative regarding central banks, particularly the Fed … what I will call the Narrative of Central Banker Omnipotence. Like all effective Narratives it’s simple: central bank policy WILL determine market outcomes."

The result is that those who operate under the blogosphere Narrative will make the wrong decisions:

"You may privately believe that J.P. Morgan is still right, that gold has meaning as a store of value. But if you participate in the market on the basis of that belief, then you will buy and sell gold in an incredibly inefficient manner. You would be a smart gold investor in 1895, but a poor gold investor today."

This is a challenging statement for goldbugs - it doesn't matter if you think gold is a store of value, or if it should be one, what matters is what most people think gold is. I first came across this idea when reading The Social Construction of Reality (see this blog post of mine for background on this idea). When making investment decision what matters is what is, not what ought to be. I think most blogosphere Narratives are about the Ought, not the Is. That's fine, just don't buy and sell on that basis.


  1. Many thanks for the link to Epsilon Theory which looks most interesting - particularly the Just so story about Gold.

    I had never heard of the epsilon component of return before. I've just bought a pile of your certificates so I'm keen to discover whether I've been clever or foolish.

  2. Keep not making a dent. Straight talk from a mint staffer is worth a thousand coin spruikers.

  3. you're just being prudent, but that does mean keeping an eye on us :) - trust but verify

    Offline comment from a reader who disagrees with "Narratives tend to die with a whimper, not a bang" who believes the Central Bank/Fed narrative will die with a Bang as aptly detailed by Rogoff and Reinhart.

    I would agree with that.

  4. I relate to what you have said through a simple market wisdom that I have come to see is true. That is "The market can stay irrational longer than you can stay solvent".

    It's not that the truth doesn't matter, because in the end it does, it's that the time it takes to matter can be on a timeline that is greater than we can survive.

  5. Bron,

    You linked to an interesting read, "How Gold Lost its Lustre", with a curious mistake.

    The statement 'gold is money' is as true today as when JP Morgan made his similar but always mis-quoted statement in 1912, which is now no longer true: "Money is gold". Gold, to some, is a form of money today, so yes 'gold is (still) money'. Money today, has other forms, which may indeed "all be credit", (which itself is a tortured paraphrase of one of Morgan's answers to Congress), so "Money is (no longer) Gold".


    In an unintended way this confirms the writer's point regarding the narrative of gold. In my own words, people just make shit up. Or as William Goldman more memorably said it "Nobody Knows Anything", referencing Hollywood's inability to know in advance if a film will be a flop or a hit, is much the same as gold commentators inability to ascribe the reasons for gold price movements...before, and no doubt surprisingly to some, after the fact. Essentially, price makes news and most people search under the lamplight for convenience sake.

    Yet, the writer argues as if he has quoted Morgan correctly, that money is no longer gold, and goes on to ascribe gold's recent price decline to Central Bankers, specifically Ben Bernanke as the current Common Knowledge. This may be, but I think a lot of gold's price support comes from the doubt over Central Bankers Omnipotence and therefore this Common Knowledge narrative, if it is that, will go the way of the last.

    Whether that is because the price of gold goes up due to Carney and Draghi (Central Bankers) on July 4th, and Abe for the last few months, or whether the leverage in gold derivatives and the unwinding of the collateral chain due to deflation takes over as the new narrative, remains to be seen.

    My own view has evolved to the point that I am very wary of narratives, even of ones so interestingly presented as the one you linked to.

  6. Good points. My aim with this post is just for people to realise there are Narratives, that is the first step.

  7. Here is a worthwhile alternate narrative for gold from Grantham (GMO)that posits that the US centric view is presently wrong, and always was wrong:


    Emerging market demand largely drives precious metals...both ways!

    Worth a read to add to the many narratives.

  8. ...and before we get too far down the Gold-Price-as-Narrative path, (I can identify nine), for we are really looking at various hypotheses usually offered as theses that correlate to the price movements in gold, here is the daddy of all correlation-to-financial-market theses: Butter Production In Bangladesh, updated (!):


    Take it for what it's worth.

  9. Thanks for those links. The GMO paper raises and interesting idea - has much of the bull market been a western fear but emerging markets love trade?

  10. Hey Bron

    Haven't visited your site for a while but just read your May 31 post.

    Have you seen any changes since then, particularly in light of the recently publicized 'backwardation' & negative GOFO?

    I'm skeptical about reading much into this spread in futures markets but any discount on unallocated v physical strikes me as a different story.

  11. Well Bron! Seems that you have been suckered.
    Ever heard of Aesops fable - the man, the boy and the donkey
    All just vested interest market chat.
    At least I still have the (useful) donkey.

  12. My current view on negative GOFO is that it is reflecting the shift by specs to the short side, so as more shorting happens you need to ultimately lease gold, which drives up the lease rate (thus GOFO goes down). I think liquidation by specs out of long positions has also restricted supply of gold to lease (as the gold has been sold to those unable or unwilling to lease their gold out).

    I have also seen comments that increased physical demand has resulted in more metal being tied up in the value chain, so that results in more demand for leasing (or inventory to hedge).