[The following post is by TDV Contributor, Scott Freeman]
Imagine that you are the CEO and largest shareholder of Acme Nano-Widgets, a market leading widget manufacturer. Things aren’t looking so great for Acme this year, but this is not yet general knowledge. What do you do if you want to maximize the value of your stock holdings? Do you hold on and hope for the best? Or do you take an active role instead? .jpg)
If you are smart, you will opt for the active role. You arrange to short your stock through brokers not transacting in your name. In fact, you may sell even more stock than you actually own. Then you start issuing pessimistic press releases. If possible, you arrange for negative media coverage of the nano-widget market. What happens to your stock price? It crashes.
Then what? When it has gone down a good bit, far enough that it starts looking undervalued, you cover your shorts. Shortly thereafter, you slack up on the negative press releases and start to hint at a turnaround, conveniently financed of course by all of your winnings from shorting your own stock. A win-win, right? Just not for the dumb-dumbs who bought at the top and sold at the bottom.
Illegal? Maybe. But this strategy is a winner. And winning strategies tend to be popular.
The truth is all markets are manipulated in one way or another. Major stockholders manipulate the stock of companies they control. Investment funds and banks manipulate stocks and commodities in which they are investing. And governments are certainly tempted to manipulate almost everything, from equities to commodities and especially their own currencies. Some have even claimed that Alan Greenspan’s most lasting claim to fame will likely turn out to be his computerization of the gold and silver market manipulation game in the 1970s. Given that manipulation offers advance knowledge of coming events, anything else would be surprising. If you had a choice between playing in a market where you knew roughly what was going to happen and one where you didn’t, which would you choose?
If you are a true believer in the “random walk” and “perfect information” models of market behavior postulated by so many university professors, this column is not for you. According to those theories, financial markets are too vast to be controlled or manipulated by any one entity. Prices simply reflect the latest state of information modified by a randomizing factor. And besides, manipulation is illegal, and thus not typical. OK, maybe I am simplifying a bit, but that’s the general idea.
Regardless of how many charts are drawn or how many professors are on board, ample anecdotal evidence points to the conclusion that such models of reality do not yield good returns on investment. It is far more lucrative to expect manipulation, look for it and play along. So that’s what we’re going to do here: keep our eyes open for the games being played, and see how we might be able to play along profitably.
In that light, let’s take a look at some of the games which are in play at the moment.
DOWN DOWN DOWN
The general news is that since January 1st, almost all asset classes have continued to fall in value against the US dollar. I say “almost” because there is one glaring exception which we will come to in a moment. So what is falling? Oil, of course, now down about 60% since its high in mid 2014. Copper (down 4% today), wheat, corn – all down. The US S&P Index has fallen slightly. Bitcoin fell today as low as $216, which is lower than it has been in over 15 months. But also the Euro, the Canadian, Australian and NZ dollars, the Malaysian ringgit, the Russian ruble, you name it, almost all currencies have continued to fall against the US dollar, some drastically.
What’s up with gold and silver?
The big exception is the precious metals asset class – gold, silver, platinum and palladium. What’s going on there? Well, if you’ve gotten this far, I probably don’t need to tell you that gold and silver prices are not “market-driven”. They are computer-driven, and those computers are probably sitting somewhere in New York City. At any given point in time, those computers can temporarily set the “price” wherever their programmers wish to set it. Some market participants strongly object to this, because they see it as preventing honest price discovery for these metals on the market. What frequently gets overlooked, however, is that price discovery is intimately connected to scarcity of supply. Clearly scarcity is something which does NOT characterize the supply of paper gold and paper silver. These goods are available in virtually indefinite supply.
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The paper printers do nonetheless have an Achilles heel: if they maintain a low price for paper metal over a long period, sooner or later there is a risk that they will run out of sufficient real metal to satisfy the demands of paper holders who demand to see the real thing. This is what happened to the US Government in the 1960s, when governments from all around the world demanded to see their gold. This means that the paper printers cannot keep prices suppressed forever.
On Monday morning December 1st the paper silver price spiked down as far as $14.25, following a decline from over $16/ounce the previous Friday afternoon. In total, the plunge amounted to a fall of approximately 11%, immediately followed by a rebound of 18%. It didn’t last more than a few moments however, and it happened while the markets in Europe and the US were closed. This kind of Friday-Monday double punch is a fairly typical phenomenon when the gamemaker plans to reverse direction. The point of the spike down is to take out nearby stops and wipe out highly leveraged speculators, but ideally do so while minimizing the window of opportunity for new buyers to take advantage of the super-low prices.
While it is too early to say for sure whether this spike will ultimately turn out to have been the bottom, it is certainly a distinct possibility. Without access to insider information, guessing a bottom is always challenging, but at a minimum we can conclude that there is limited wiggling room left. We’ll come back to this topic in more detail another day, but for the meanwhile I would certainly recommend keeping an open long position in gold and silver – albeit one which can survive a spike down to the $10/ounce range. If you have access to a platform which allows you to borrow Euros to purchase paper gold and silver, this approach may have somewhat less volatility on the downside, because additional sell-off in gold and silver is likely to be accompanied by a continued fall in the Euro.
BITCOIN CRASH
2014 was not a great year for most bitcoin holders. The price one year ago was around $850/bitcoin, a far cry from where we are right now. So what might be going on here? Well, first we have to consider what the gamemaker’s goals might be. Even if we don’t know who exactly that person or entity is, we do know that there are some large bitcoin holders who seem to also have access to large quantities of US dollars. More specifically, billions. That narrows down range of possibilities quite a bit. In any case, in the period 2012-2013 this gamemaker did a fine job of popularizing bitcoin and convincing people that entries in a decentralized database (the “blockchain”) could be worth billions of dollars. This accomplishment was truly monumental, and regardless of all the contributions of millions of bitcoin enthusiasts worldwide, it could not have been done without the backing of at least one very well financed gamemaker.
One possibility which cannot be excluded is that the original gamemaker was in the game for short-term gain and took his earnings off the table in early 2014 – never to return, i.e. the classic pump and dump scenario. In this case those who continue to hold bitcoins and/or who buy more at today’s “low” prices are likely to be left holding the (empty) bag.
The more likely alternative scenario is that the gamemaker did not go to all this trouble just to make a few bucks in the short-term, but rather has a longer term game plan in mind. In this scenario we are now simply looking at a shake-out phase, where the gamemaker is trying to scare off the less committed players by essentially “breaking them” psychologically, while at the same time improving the short-term stability of the currency. What speaks for this scenario is the incontestable fact that the price decline of the past few months has been fairly orderly and gradual. After every fall in price there were always buyers to cushion the fall. Typically those buy offers were on Bitstamp, and they were consistently higher than those on other exchanges, sometimes up to 4% higher. Small investors might be willing to pay a premium of a few percent, but typically not larger investors. Moreover, such price differentials permit significant arbitrage, which literally costs money. Apparently this is a price that the gamemaker was willing to pay.
If we follow this scenario, what is that psychological barrier likely to be? It’s pure guesswork, but I would guess that 1-2 weeks under the 1000 RMB level (approximately $160) would be sufficient to convince a number of fair weather Chinese investors to cut their losses and sell out their remaining holdings. Such a level would also be more than sufficient to wipe out most investors who had purchased bitcoin on margin. Be that as it may, regardless of the absolute level, the time to buy is always after strong downward spikes. Remember the old adage: “Buy when there is blood in the streets.” If you want to day trade, you can even profit from a falling market by selling off part of your recently acquired stash on the rebound, which in the bitcoin market has historically been highly reliable. Today for example, the rebound took us from $216 back up to $235, a 9% jump. Not too bad for a falling market.
In any case, regardless of which scenario you choose to bet on, accept that most long-term strategies with substantial upsides involve the risk of some downturns along the way. So calculate carefully how much of a downturn you can afford (and are willing!) to ride out, while holding back some powder to buy more on those steep downturns. Will $216 turn out to be the bottom? Seems relatively unlikely, but also not impossible. So place your bets with that in mind.
[Editor's Note: For those interested in hearing from some of the most knowledgeable people in precious metals and bitcoin, including Roger Ver, the Bitcoin Jesus and Cody Wilson of Dark Wallet and the entire Mexican bitcoin community check out Anarchapulco coming up February 27th to March 1st in Acapulco. Visit us today at Anarchapulco.com.]
Questions or comments? Join us at TDV.
Scott Freeman is the CEO of the IT Group, which is a Shanghai-based group of companies focusing on information technology and financial services. He’s always on the lookout for self-starters who bring along creativity, enthusiasm and know-how. He can be contacted at [email protected].
