ERICOPOLY

50% notional deep-in-the-money FFH calls (ties up 25% of my cash) 50% TIPS (10 yr Treasury Inflation Protected Securities maturing July 2019) 50% WFC naked puts, 2011 $30 strike 25% cash The TIPS are great -- my principle rises with inflation, can't go below the original issue principle with deflation, and need barely any margin backing. And there is a little interest income that ought to defray the tax due on the CPI adjustment gains. 1) I am hedged against a pullback to $23 in WFC 2) I don't need the WFC price to rise more than like 5% in order to grab 30% gain 3) I have a decent upside potential with FFH calls 4) I am 50% hedged against inflation with the TIPS (hopefully HWIC will one day hedge the other half via FFH).

I doubt too many of them have fixed incomes of any meaningful size outside of Social Security, which is indexed to the CPI-U.

I don't think people will feel comfortable buying stocks on margin if the earnings yield is lower than their margin interest rate, and with higher interest rates I would think it would put the brakes on earnings for levered companies. But one never knows :)

I'm curious about these "goldbugs", apparently they are withholding part of the narrative, and its now time to wonder why. Who are they? What part of the narrative are they withholding? are they nefarious? are there motives impure? Are they to blame for the short run on the USD? Should they be suppressed? "They" are the people who do not look critically at the magnitude of the movements. They seem to be intellectually satisfied that the price of gold is rising in USD terms, that the US dollar is declining based on Fed monetary policies and huge deficits far out in the future, and therefore they leave it at that. "They" forget to say that "well, that being said, the price of gold is soaring in terms of ALL world currencies", and they forget to then wonder what will happen if the price of gold adjusts to the extent that it has overshot these other relatively more sound currencies. The guy in this article is such a character -- taking a relatively short time period (8 years) and explaining how much "Pricing U.S. homes in gold reveals that housing has fallen by two-thirds from its 2005 peak. ". It takes only a small amount of critical thinking to realize that most things, houses, Swiss/Austrlian/Canadian currencies for example, have fallen from their 2005 levels if you compare them to gold. For some reason he was perfectly happy in drawing such a conclusion -- maybe looking for disconfirming evidence is not interesting to him. Or perhaps for sensational effect he just wanted to find something that has risen wildly in price and use it to price houses. I personally don't see what value he gets from doing this -- you ask if his motives are impure, and who really knows. Maybe he just wanted to sensationalize the housing crash in order to draw in more readers, see how many hits he can get. They do this on the evening news -- often seeming to exaggerate a story for dramatic effect. What drives them? I can't imagine.

Here is an interesting article on a website which documents your "narrative fantasy". If gold was the ultimate sound money then this analysis documents the actual rise and fall of the US housing bubble: http://www.oftwominds.com/blogsept09/housing-gold09-09.html Cheers Fun and games with an oscillating value. The key points in the article are "For the past eight years. " Never mind the entire data set, let's just keep the conversation focused on the periods when gold has risen against the dollar. Of course, this also showcases not just housing was overvalued, but Candian dollars, Australian dollars, Swiss francs... everything that fell steeply against gold over the past 8 years. Since 1970 though, housing has become cheaper in gold. Therefore, housing must have been in a bubble in 1970 too, using the same logic in that article. The fact is that housing was in a bubble this decade -- that's not under dispute. But a narrative can be developed that gold is only rising because the USD is being debased... and that accounts for part of the rise no doubt... however when gold makes even the Swiss franc look like it's under rapid devaluation, then it's time to wonder what part of the narrative is not being told by the goldbugs.

I have been reading the book this week... apparently Davis used the maximum margin the SEC allowed, which the book describes as "the maximum the SEC allowed--slightly more than 50 percent". He owned a seat on the NYSE, so his firm had access to cheap margin rates and looser margin restrictions.

The P/E is higher than PG or JNJ. Why?

Mostly I'm worried about a rise in price level -- after all, I don't want to see my net worth being drawn down at an ever growing rate by a rising cost of living. A dropping dollar will eventually translate to a rising CPI. One strategy I thought of a short while ago is to buy TIPS in a margin account. Being a government security, the margin requirements are very little so I can leverage 2:1 without worrying about a margin call. Idea: 1) start with 100% cash in a margin account 2) deploy the cash 100% into TIPS 3) write far out-of-the-money naked puts on companies that you would normally love to own, and make it such that you can buy 100% if you get assigned from your initial cash balance This accomplishes: 1) capital gains in line with a rising CPI from the TIPS 2) income from volatility decay on the naked puts 3) protection from a falling market P/E if inflation rises and market crashes (if you get assigned the shares, the high earnings yield will give you some good earning power protection from inflation) negatives: 1) You can't achieve 100% CPI protection from the TIPS because you get taxed each year on the gains from the CPI adjustment 2) Writing out of the money puts you pay capital gains taxes, whereas if you just owned shares you get tax-deferred compounding. 3) CPI might not keep pace with the costs that matter the most to you, or government might lie in the CPI computation, etc... Anyhow, it's yet another strategy.

Actually the 1970 official price of gold (35.00 USD) was indeed manipulated.. by the US Federal Reserve.. it had for some time been over creating US dollars and unable to redeem all its dollars for gold at the fixed rate. By closing the gold window, Nixon was in fact stiffing all foreign holders of US dollars and shifting the burden of government debt to foreigners. There was a small free market for gold in Macau at that time which operated outside of the USD world... gold was traded freely then at about 75.00 per oz, and indeed within a year of the depegging, the price in the international market rose to the Macau price. When gold rose to its 1980 high of about 800 bucks, it did so in response to the fear that the US buck would implode because of dillution. There was a speculative frenzy which lasted a very short time, shorter than last year's speculative frenzy in oil. Quoting 800.00 USD as a peg price in 1980 is as accurate as pegging the price of oil at 150.00/bbl in 2008. In inflation adjusted terms (even using "official" CPI numbers which understate USD inflation), the price of gold has remained relatively stable since the initial adjustment after depegging. Mr Market set the Macau price in 1970 at $75, and Mr Market is setting the price today at $970, which is a rise of 12.93x. The 1970 median housing price of $17,000 priced in gold by Mr Market, is worth $209,100. So housing prices have actually fallen in real terms. Amazing how everyone can be so easily misled to believe that housing prices rose faster than inflation, right? Well, no. The problem is that the current price of gold is set by (as we all know) the immensely rational Mr. Market, the same level headed person that set the price in 1970, and of course also set the price under $300 earlier this decade. There are narratives to fit the prices, but beware of narrative fallacies.

Mungerville, I picked 1970 because gold was still pegged to the dollar and I knew the price of gold off the top of my head without having to look it up. In 1980 gold wasn't pegged to the dollar, it was driven by speculative/investment demand, and I don't want to use such a period as a terminal point for that reason. Instead, 1970 is a good terminal point because gold/usd wasn't manipulated by speculators. Today (similar to 1980) USD is not pegged to gold and so... are we driven by fundamentals now or investors/speculators? This is the unknown I fear, so I look to how gold is rising vs other more stable currencies (like AUD and CDN) as clues to whether gold is merely rising in USD terms, or rising absolutely against a whole basket of currencies that most of us deem fairly safe alternatives to the USD. It turns out that gold is a ballistic missile relative to those currencies.

Exactly. Volatile. People say it is the ultimate tool of maintaining your purchasing power... but tell it to the person who bought in 1980. People come up with these examples that say things like "the cost of a fine tailored suit today is about what it was 100 years ago priced in gold". Well sure, but 8 years ago that wasn't the case, it could only buy you a third or a half of that same suit. So the volatility is really crazy, such that whether you maintain 100% or 50% of your purchasing power is highly dependent on what decade you unload at, or what year within that decade -- almost like a broken clock that is exactly right a couple of hours out of 24, and off by several hours most of the rest of the time. Sure, that clock will reliably give you the accurate time again, but how long do you have to wait?

In 1970, gold was $35 an ounce and US median house price was $17,000. Today that same house costs $485,714 (priced in gold). So either housing is a screaming deal priced in real money (gold), or gold is expensive. Yes, if there is hyperinflation gold will rise in dollar terms, but so will a lot of other things (like agricultural commodities for example).

Fortunately for him: 1) he started investing that money when everyone had given up on stocks 2) his wife's family was loaded (and in government bonds) so he wasn't sweating bullets when the portfolio was down Then of course good for him for pulling it off.

Oldye has been consistently suggesting that gold is overpriced, so I think he really did mean the puts. I have been giving a lot of thought to all of this. Gold might do best in a panic, but just like Yahoo stock was once best in a panic to own tech stocks. At the end of the day, in a global inflation scenario, worldwide buying power will be limited to actual currencies (including CDN, AUD, etc...) and what people in those countries can actually afford to purchase with their currencies. So it would like agricultural commodities would be a good idea -- and in fact, the #1 idea of Jim Rogers who states that while he does own some gold, he thinks agricultural commodities will do far better. I'm in the camp that USD is going to be worth a lot less in 10 years. I just want to be smart about this and not just buy gold because it's the first thing we think of -- I want some kind of value based approach so that we preserve our buying power to the maximum. So agricultural commodities sound brilliant to me because after all, people need to eat and food prices are not already soaring as is the case with gold.

So I think Hoisington's main point (in layman's terms) is that doubling the money supply doesn't push prices up unless private credit is extended. After all, money in my pocket didn't double as a result of the Fed actions. My sister doesn't have twice the money. The people unemployed in California don't have twice the money. Unless people expand lending to these consumer folks, how is the Fed action going to push up prices? My thinking is that the Fed action is propping up financial entities so that they will be in the position to extend lending as some point in the future, and to keep them from dramatically scaling back on their existing level of lending (which would push prices down). I agree with you though that if the USD depreciates against other world currencies, then the price of basic commodities will rise in USD terms and thus not all price inflation can be averted. No free lunch, but not necessarily an immediate doubling of the price level simply because the money supply doubled.

Galbraith points out in Money: Whence It Came, Where it Went that inflation is actually good, in very small controlled doses. But you ask about Hoisington. Well, in Hoisington's essay he points out that prices are set by supply and demand, and that without private credit expansion the money simply isn't getting into the hands of people who buy things, so prices won't rise. Personally I think the currency will be devalued until this country actually produces something more than it consumes, and as I wondered out loud years ago I think the bubble in this country is incomes... people just have high incomes relative to the rest of the world and I couldn't figure it out... but you can see, that's why the jobs go overseas. So I too think incomes will need to come down to global standards, whereever that may be. The only other option I can think of is tariffs on manufactured imports, but then (in addition to a trade war) it would mean that we can't afford cheap imported goods anymore so again, falling standard of living. I like the thinking of the Austrians because if you run the country that way we'd not have gotten into this mess in the first place. But I would like to ask von Mises about the velocity of money.

The current exchange rate movements and gold vs the USD in 2009 alone do support that narrative, but it's up in the air as to whether or not it "confirms this dilution". Gold for example is also blowing away the AUD -- does this mean it is confirming a dilution of the AUD? Gold might just be going off on an overvaluation of it's own -- it would more closely support your thesis if strong currencies like the AUD were keeping pace with gold, but that clearly isn't so. The AUD has lost 1/3 of it's purchasing power against gold in the past 12 months. The other monetary currency, silver, is also getting left behind by gold this year... and we know for sure that it's no clear sign of dilution of silver 8) The USD has actually only lost a couple of percent against the AUD in the past 12 months, and if you go back 15 months the USD has actually strengthened... despite all of the bailouts and money printing. Confirmation of what then? Dilution?

Lack of credit is the reason why Hoisington doesn't believe the problem will be inflation. You also mention that the gold standard held back credit, and thus held back inflation. And so you are on the same page as him, sort of. Only you don't seem to agree that holding back credit will hold back inflation, this time. http://www.hoisingtonmgt.com/pdf/HIM2009Q2NP.pdf One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

Ultimately, all currency's REAL depreciation will be measured vs. gold. If the inflation of any sovereign currency outpaces its real ability to pay (Real economic growth), then it will devalue vs. gold. Like all calculations of net worth, the target constantly moves, sometimes in large jumps... these produce blips on the overall trend line, but at the end of the day the value of the AUD (or any currency) will reflect the amount of real inflation (real growth vs monetary inflation) of the particular currency. Historically silver has been a monetary metal as well. Shouldn't silver and gold maintain a relatively constant exchange rate over time (ignoring for a moment the fact that silver is actually getting scarcer)? Do you buy the argument that silver is money? It has been treated as such throughout history. I am trying to determine how much gold has overshot (high price for a cheery consensus), and am scratching my head as to why the same arguments that are supporting gold don't also apply to silver.

OK I'll bite... Let's pretend for argument's sake that gold is money... the ultimate store of value on the planet, the go to guy when fiat currencies fail and economic empires decline. This has been the case through recorded history, when international monetary arrangements become volatile through currency manipulation and devaluation, the flight to safety is a flight to gold. As late as 1971, all participating sovereign currencies were linked to gold at a fixed rate. This fix had many advantages.. international trade boomed in a world where money was sound. The big disadvantage (in the view of governments) was that it capped individual governments spending and set a limit on issuing credit which tended to crimp economic expansion in booming economies and penalized emerging economies for the same reason.. lack of credit. The world's dominant currency (USD) was forced to break its peg to gold in order to pay off its spending on the ruinous Vietnam War and fund its budgetary deficit. Credit was thus expanded and the USD, no longer backed by gold, but backed by its dominant economic growth engine, maintained its supremacy. At this point the USD became a promise to pay and was backed by the largest and strongest economy on the planet. Even though monetary inflation of the USD was now a given, as long the growth of national GDP, kept pace, the dollar would inflate at a low and manageable rate and was universally accepted in lieu of gold and gold backed currencies (although the Swiss Franc, which until recently was convertible to gold, remained the ultimate sound currency). Over time the price of gold reflects the accumulated inflation of the national currency, it spikes when the ability to repay is brought into question.. in highly inflationary times like the late 70s. When the US economy expanded and the money supply was constrained to funding real economic growth, the price of gold languished, but over time still reflects the decline in real purchasing power of the USD. To get a real feel for actual purchasing power, calculate prices in terms of gold ounces (or goldgrams, which are now a popular way of owning gold in Asia). The value of an ounce of gold over time has been constant, the purchasing power of fiat currencies such as the USD over time erodes. Let's look at the famous 5 cent cigar which JP Morgan (the guy, not the bank) could no longer find in 1910... today it would probably cost about 10 bucks USD or .01 ozs of gold. In 1910, .01 ozs of gold was about 21 cents, roughly the same price for a commodity whose real cost remains unchanged over the century. http://www.wisegeek.com/what-is-the-historical-price-of-gold.htm To the question at hand... the recent moves of the AUD and the price of gold. US economic growth is severely compromised through years of credit expansion which funded malinvestment... producing no real economic growth and thus diluting the value of the world default currency.. the USD. Moreover the intention of governments is to continue the dilution of the currency through record deficit spending and credit creation, which to date have only settled past bad investments without any net real wealth creation. At the same time the economy is experiencing a sever cyclical downturn which will further the erosion of GDP in REAL terms (vs. gold and sounder currencies like the AUD). If GDP as measured in USD increases, but declines in terms of the USD indexed to a basket of alternate currencies, or the USD indexed to the price of gold, we can say that US GDP has declined in REAL terms. The same argument can be made for the major stock indexes. If the S&P 500 is at the same level as it was a year ago does this mean that stocks have retained their value? Of course not, if the USD has declined against the aforementioned indexes. So the AUD and other currencies where GDP is expanding ahead of the creation of fiat currency will continue to appear to appreciate against the greenback, when in fact it is the greenback depreciating against the AUD. The real measure of the purchasing power of the AUD (or CDN or others) will always be vs. the price of gold. Since the future purchasing power of the buck is in doubt and its movements volatile, other nations are making alternate arrangements to facilitate international trade and looking elsewhere for customers and flows of capital. Barring some miraculous economic turnaround, the USD has lost its role as the world default currency, and an investor wishing to preserve his purchasing power would be well advised to own some physical gold. This offers an explanation of why USD is depreciating against AUD. It also offers an explanation of why USD is depreciating against gold. However, it does not explain the rapid depreciation of the AUD against gold.

There was also talk that gold is not inflated vs the cost of "a fine tailored suit". So I looked for the cost of what that would be -- now, where do we find data on the cost of a "fine tailored suit" 50 years ago vs 10 years ago vs today? It turns out that well, one needs to define "fine". The quality of fabric makes all the difference. So who is publishing numbers that accurately compare the same quality grade of fabric in say, 1910 vs today? As one can see, the difference can be a matter of 4x in price. http://www.askmen.com/fashion/fashiontip/34_fashion_advice.html The suit's fabric will make the difference between a $1500 suit and a $6000 one. That's why many popular designers use fabrics with a grade of 100s or 110s [quality of fabric] to cut costs and increase markups. Because you're not paying for the brand name, you can opt for higher quality grades and still pay the same price or cheaper. Anything above a grade of 110s is guaranteed to make a respectable looking and durable suit. As you may have guessed, higher grade equals better quality and an elevated price. Grades range from low 80s to high-end super 180s.

I should really be asking Broxburnboy who knows a lot about gold. I had a long discussion with him a year ago. He suggested that gold is rising vs the USD due to monetary policy. I suggested that everything still has a fair price, but that essentially led to a statement that well, gold is money. So recently I've been rethinking the topic with the recent drum pounding about gold and inflation. Cardboard for example recently suggested that gold is a good buy. So tying some other statements together, like "gold is money", well silver is also money and silver is not being debased. So why is gold crushing silver? And why is gold crushing the AUD when the argument is that gold is merely rising vs the USD monetary inflation?

If you look at it over a 6 month period (when the Fed's debasement of the USD has been most concerted) the question then becomes; Why is the Australian dollar rising so rapidly against gold? http://i163.photobucket.com/albums/t314/ripleyx/Finance/gldvsaud.jpg It's true, the closer you look the forest is invisible. I mean, if you walk within 2 inches of a single old growth douglas fir you are not going to see anything but. I went to 5 years hoping this is a bit more like viewing the forest from 1,000 feet -- it irons out the panic to the USD that took place last year. The 5 year period shows that AUD/GOLD got out of whack long before the financial crisis (the gold bugs like to say that the drop in the GOLD/USD ratio had nothing to do with fundamentals, but rather panic).

I actually thought you were drawing a distinction between fair price and intrinsic value, and that was the twist (you used those two terms which have different meanings).

Thought of something... Then there is gold vs silver (money vs money standoff): http://finance.yahoo.com/q/bc?s=GLD&t=5y&l=on&z=m&q=l&c=slv Why is gold (real money) appreciating vs silver (real money)? And silver is tracking the AUD closer, at least over the past few years: http://finance.yahoo.com/q/bc?t=5y&s=AUDUSD%3DX&l=on&z=m&q=l&c=slv