Why Investors Should Fear The Permanent Portfolio

[stone]

Clive, isn't it possible that excess bank reserves drive the expected future returns of all assets down to those of the excess bank reserves? Even if people "decide" not to stop out in cash, the bank reserves have to be held by someone. Traditionally there  have only been enough bank reserves to cater for liquidity requirements. Now that there are so much more, won't they correspond to the investment bench mark with all assets getting priced so as to give negative real returns? The puzzle is what price for gold corresponds to a price expected to give negative real returns? Will it translate into totally crazy volatility if the gold bull market last for another decade?

[Reub]

Clive, I love your new, non-swirling avatar!

[tbone]

Hi Stone,

Personally, I would never save in agricultural commodities because it seems to have caused mispricings that have starved people eg:
http://www.independent.co.uk/opinion/co ... 16088.html

Tim Worstal responded to this on his blog: http://timworstall.com/2010/07/02/pleas ... economics/

t.

[AgAuMoney]

Clive, isn't it possible that excess bank reserves drive the expected future returns of all assets down to those of the excess bank reserves? Even if people "decide" not to stop out in cash, the bank reserves have to be held by someone.

At least in the U.S., excess bank reserves are held by the banks themselves, and nearly entirely deposited into the Federal Reserve.  In turn the Fed is holding trillions in U.S. Treasuries and worthless mortgages and CDS.  Most of those are worth a fraction of their book value (recently the first attempt to sell failed... a dutch auction where they tried to sell less than 1% of their portfolio and actually sold less than half of the offering, of course at the minimum bid).

And don't forget that the banks are holding reserves, cash and other assets in part because they are still not priced to market on a boat load of the same sort of mortgages and derivatives.  When/If they are forced to write them off (thru default and/or foreclosure) the assets will evaporate and suddenly the balance sheet will not be nearly to overweight as it currently appears.

In short,  I'm inclined to think those excess reserves are an accounting fiction -- all a result of priced to book instead of priced to market accounting and the reserves are just an attempt to bandage over the apparent risk in the portfolio.  Hopefully the excess reserves are sufficient.  If not, the deflationary correction will continue.

[stone]

tbone, I entirely agree that in an ideal world, wheat speculators would buy low and sell high and so provide a more even price for farmers and consumers. We don't live in such an ideal world and it is rash to pretend that we do.  My understanding is that the structure of the market is such that systemic mispricing can be induced and exploited by major speculators. If a speculator both holds options and physical wheat, it is possible to make a massive gain from the options at the expense of a modest loss from dumping/hoarding physical wheat. That is because the return from options is so non-linear with regard to the price of the physical commodity and options have set expiry dates. Major speculators also now control the warehouses for physical commodities. They use that to further manipulate supply and demand. In your link it states that for every speculator that wins, one looses. That ignors the farmers and consumers at each end of the process. The losses can all get transfered to them.

[tbone]

tbone, I entirely agree that in an ideal world, wheat speculators would buy low and sell high and so provide a more even price for farmers and consumers. We don't live in such an ideal world and it is rash to pretend that we do.  My understanding is that the structure of the market is such that systemic mispricing can be induced and exploited by major speculators. If a speculator both holds options and physical wheat, it is possible to make a massive gain from the options at the expense of a modest loss from dumping/hoarding physical wheat. That is because the return from options is so non-linear with regard to the price of the physical commodity and options have set expiry dates. Major speculators also now control the warehouses for physical commodities. They use that to further manipulate supply and demand. In your link it states that for every speculator that wins, one looses. That ignors the farmers and consumers at each end of the process. The losses can all get transfered to them.

I'll admit I'm not at all qualified to debate this! I just know of Mr. Hari and his alleged economic illiteracy via that blog so thought I'd throw it out there

[stone]

tbone, I'm also not at all qualified to have an opinion about this but the problem is that so many of the people who are qualified have a malign vested interest. On balance my fears are enough to stop me from considering saving in agricultural commodities.

[moda0306]

Here's my big question... are the derivative traders colluding, controlling the market or otherwise have some kind of unfair advantage, and does that advantage hurt the rest of us and drive up prices?

I haven't heard a good explanation of how exactly individual traders manage to control the market to their benefit.

If somebody could weigh in on this that would be great.

[AgAuMoney]

Here's my big question... are the derivative traders colluding, controlling the market or otherwise have some kind of unfair advantage, and does that advantage hurt the rest of us and drive up prices?

I haven't heard a good explanation of how exactly individual traders manage to control the market to their benefit.

If somebody could weigh in on this that would be great.

Collusion is great, but hard to maintain (first one to break makes the most money).

Momentum is a bit easier and can sometimes be created rather than discovered.

Here is an older book, quite entertaining, how one individual did it:  http://en.wikipedia.org/wiki/Reminiscen ... rator  (supposedly Livermore wrote the book, with coaching and assistance from Lefevre).  For more modern (and WAY more verbose) see the Warren Buffett 'Snowball' biography, IIRC a good example the Blue Chips acquisition.  I've also read good information on currency speculators including George Soros, but I don't recall where ATM.

[Bongleur]

I read that book.  I'd like to learn more about the anonymous author.