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The End Of The Gold Standard And Price Stability

The dramatic changes in the recent inflationary trend can be easily explained. During the nineteenth and early twentieth centuries, the United States, United Kingdom, and the rest of the industrialized world were on a gold standard. As described in detail in Chapter 11, a gold standard restricts the supply of money and hence the inflation rate. But from the Great Depression through World War II, the world shifted to a paper money standard. Under a paper money standard there is no legal constraint on the issuance of money, so inflation is subject to political as well as economic forces. Price stability depends on the ability of the central banks to limit the growth of the supply of money in order to counteract deficit spending and other inflationary policies implemented by the federal government. The chronic inflation that the United States and other developed economies have experienced since World War II does not mean that the gold standard was superior to the current paper money...

The pre1914 gold standard a fixed exchange system

In the pre-1914 era, most of the major trading nations accepted and participated in an international monetary system called the gold standard. Under the gold standard, countries used gold as a medium of exchange and a store of value. The gold standard had a stable exchange rate. During this period before World War I, a nation's monetary unit was defined as a certain weight of gold. The gold standard as an international monetary system worked adequately before World War I because of London's dominance in international finance. The keystone of the system was confidence in the stability of the British financial system. London was the financial center for almost 90 percent of world trade, which was organized around sterling as the sole reserve currency. Commercial transactions such as factoring receivables and discounting bills from all corners of the world took place in London. Sterling was convenient because it was universally used and convertible into gold at the Bank of England. Trade...

The Fall Of The Gold Standard

In an astounding display of institutional ineptitude, the Federal Reserve failed to provide extra reserves in order to stem the banking panic and prevent a crash of the financial system, even though the Fed had the explicit power to do so under the Federal Reserve Act. In addition, those depositors who did receive their money sought even greater safety by turning their notes back to the Treasury in exchange for gold, a process that put extreme pressure on the government's gold reserves. The banking panic soon spread from the United States to Great Britain and Continental Europe. To prevent a steep loss of gold, Great Britain took the first step and abandoned the gold standard on September 20, 1931, suspending the payment of gold for sterling. Eighteen months later, on April 19, 1933, the United States also suspended the gold standard as the Depression and financial crisis worsened. consequences of leaving the gold standard. BusinessWeek, in a positive editorial on the suspension,...

Why Gold Stocks Outshine Gold

During 1987 gold rose only 40 percent while gold shares gained 200 percent. From the fall of 1989 to January 1990, gold shares rose 50 percent while gold gained only about 16 percent. The explanation lies in the fact that gold shares offer leverage arising from the fact that mining profits rise more sharply than the price of the gold itself. If it costs a company 200 an ounce to mine gold and gold is trading at 350, the company will reap a profit of 150. If gold rises to 400, it will appreciate in value by only 15 percent ( 50 350), whereas the company's profits will appreciate by 33 percent ( 50 150). Figure 9.7 shows some gold mining shares benefiting from the leveraged affect of rising gold prices.

Gold Stocks Versus Money Center Stocks

Figure 9.19 shows a couple of other ways to monitor the relationship between inflation and disinflation stocks. The upper chart compares the S&P Gold Group Index to the S&P Money Center Group Index. Up to the fall of 1989, the Money Center banks were outperforming gold stocks by a wide margin. From October of 1989 on, however, that relationship changed abruptly and dramatically. As the Money Center banks collapsed, gold stocks began to rally sharply. Part of the explanation for this dramatic shift between commodity and interest-sensitive stocks is seen in the bottom chart which plots the ratio between the CRB Index and bonds.

The Gold Standard

Gold was officially made the standard value in England in the nineteenth century. The value of paper money was tied directly to gold reserves in America. Foreign exchange, as we know it today, has its roots in the Gold Standard, which was introduced in 1880. The main features were a system of fixed exchange rates in relation to gold and the absence of any exchange controls. Under the Gold Standard, a country with a balance of payments deficit had to surrender gold, thus reducing the volume of currency in the country, leading to deflation. The opposite occurred to a country with a balance of payments surplus. Thus the Gold Standard ensured the soundness of each country's paper money and, ultimately, controlled inflation as well. For example, when holders of paper money in America found the value of their dollar holdings falling in terms of gold, they could exchange dollars for gold. This had the effect of reducing the amount of dollars in circulation. Inevitably, as the supply of...

The Verdict Of History

Everybody Ought to Be Rich 3 Financial Market Returns from 1802 5 The Long-Term Performance of Bonds 7 The End of the Gold Standard and Price Stability 9 Total Real Returns 11 Interpretation of Returns 12 Long-Term Returns 12 Short-Term Returns and Volatility 14 Real Returns on Fixed-Income Assets 14 The Fall in Fixed-Income Returns 15 The Equity Premium 16

How The Economic Environment Impacts Stocks

Money and Prices 189 The Gold Standard 191 The Establishment of the Federal Reserve 191 The Fall of the Gold Standard 192 Postdevaluation Monetary Policy 193 Postgold Monetary Policy 194 The Federal Reserve and Money Creation 195 How the Fed's Actions Affect Interest Rates 196 Stocks as Hedges against Inflation 199 Why Stocks Fail as a Short-Term Inflation Hedge 201 Higher Interest Rates 201 Nonneutral Inflation Supply-Side Effects 202 Taxes on Corporate Earnings 202 Inflationary Biases in Interest Costs 203 Capital Gains Taxes 204 Conclusion 205

Fourmarket Sectors Currencies Commodities Bonds And Stocks

The key to intermarket work lies in dividing the financial markets into these four sectors. How these four sectors interact with each other will be shown by various visual means. The U.S. dollar, for example, usually trades in the opposite direction of the commodity markets, in particular the gold market. While individual commodities such as gold and oil are discussed, special emphasis will be placed on the Commodity Research Bureau (CRB) Index, which is a basket of 21 commodities and the most

External Rather Than Internal Data

Traditional technical work has tended to focus its attention on an individual market, such as the stock market or the gold market. All the market data needed to analyze an individual market technically price, volume, open interest was provided by the market itself. As many as 40 different technical indicators on balance volume, moving averages, oscillators, trendlines, and so on were applied to the market along with various analytical techniques, such as Elliott Wave theory and cycles. The goal was to analyze the market separately from everything else.

Classifying market participants

The second sort of case is where a company which should be using derivatives to hedge its positions starts to use them to speculate instead, In particular, companies have a tendency to overhedge, that is they buy so many derivative contracts that instead of hedging their risks they cancel out all their risk, and in addition create an exposure in the opposite direction. Sometimes they even start selling options instead of buying them. This is really just speculation. For example, Ashanti, the gold-mining company, hedged its exposure to falls in the gold price in such a way that they lost a huge amount of money when the price of gold increased. This was seen as a sign by many gold-mining companies that hedging is bad, but it was not. It was simply a sign that hedging should be for hedging not speculation.

The Bretton Woods System

Convertibility ended with the Great Depression, and the major powers left the Gold Standard and fostered protectionism. As the political climate deteriorated and the world headed for war, the foreign exchange markets all but ceased to exist. With the end of World War II, reconstruction for Europe and the Far East had as its base the Bretton Woods system.

Special Drawing Rights

By now markets were becoming increasingly unstable, reflecting confused economic and political concerns. In May 1968, France underwent severe civil disorder and had some of the worst street rioting in recent history. In 1969, France unilaterally devalued the franc and Germany was obliged to revalue the Deutschemark, resulting in a two-tier system of gold convertibility. Central banks agreed to trade gold at 35 an ounce with each other and not intercede in the open marketplace where normal pressures of supply and demand would dictate the prices. As an artificial asset kept on the books of the IMF, SDRs were to be used as a surrogate for real gold reserves. Although the word 'asset' was not used, it was in fact an attempt by the IMF to create an additional form of paper gold to be traded between central banks. Later, the SDR was defined as a basket of currencies, although the composition of that basket has been changed several times since then.

All Markets Are Related

What this means for us as traders and investors is that it is no longer possible to study any financial market in isolation, whether it's the U.S. stock market or gold futures. Stock traders have to watch the bond market. Bond traders have to watch the commodity markets. And everyone has to watch the U.S. dollar. Then there's the Japanese stock market to consider. So who needs intermarket analysis I guess just about everyone since all sectors are influenced in some way, it stands to reason that anyone interested in any of the financial markets should benefit in some way from knowledge of how intermarket relationships work.

Monetary disorder 191445 a flexible exchange system

The gold standard, as an international monetary system, worked well until World War I interrupted trade patterns and ended the stability of exchange rates for currencies of major industrial countries. The value of currencies fluctuated fairly widely in terms of gold during World War I and in the early 1920s. After World War I, the UK was not the world's only major creditor nation the USA started to emerge as a leading creditor too. Several attempts were made to restore the gold standard during the 1920s. The USA returned to the gold standard in 1919, the UK in 1925, and France in 1928. However, these attempts failed, mainly because of the Great Depression of 1929 32 and the international financial crisis of 1931. In other words, country after country devalued its currency to stimulate its exports. Governments also resorted to exchange controls in an attempt to manipulate their net exports. Of course, with the onslaught of World War II, hostile countries used foreign-exchange controls...

The Importance of Round Numbers as Support and Resistance

The gold market is an excellent example of this phenomenon. The 1982 bear market low was right at 300. The market then rallied to just above 500 in the first quarter of 1983 before falling to 400. A gold rally in 1987 stopped at 500 again. From 1990 to 1997, gold failed each attempt to break through 400. The Dow Jones Industrial Average has shown a tendency to stall at multiples of 1000.

Proposals for greater flexibility

A system of additional flexibility, or even a system of freely flexible exchange rates, has been suggested to restructure the current international monetary system so that deficit countries might solve their payments problems. It seems reasonable to assume that fixed exchange rates, which existed under the gold standard before World War I, are now practically impossible. Moreover, fixed but adjustable exchange rates could not accommodate highly diversified modern economies more than one half-century after the Bretton Woods Agreement. Countries differ too much in price levels, wage costs, monetary policies, and international capital flows to keep fixed exchange rates. The crawling band A crawling band combines a wider band and a crawling peg. In other words, this proposal is a compromise between the inflexible exchange rates of the gold standard and a system of completely fluctuating exchange rates. Each parity level would be adjusted upward or downward as a moving average of the...

Markowitz Meanvariance Portfolio

We have mentioned earlier that almost every investment is uncertain with respect to the gain obtained in the future. A natural question arises, is it possible to reduce the risk related to investment by some sophisticated procedure The answer is yes, and the method is diversification. A very old rule says that you should divide your disposable funds (wealth) into three equal parts one third put into deposits, one third invest into shares, and buy gold for the remaining third. This approach may seem to be naive but clearly it is a method for reducing risk. Here we deal with more exact, still elementary procedures, which give the investor hints how to diversify his or her funds. We deal with the classical topics concerning optimal portfolio selection, the rigorous treatment of which has been started by Markowitz 112 . In the explanation we will restrict ourselves to financial assets only (shares, bonds, derivatives) despite the fact that the ideas and results may be applied to real...

Eighteenthcentury Background

During the eighteenth century, Englishmen turned away from religious controversy to assert themselves effectively in finance and in the world beyond their shores. They became busy with warships and cargoes and ledgers. Instead of Pilgrim's Progress, they read Robinson Crusoe. (359) The population increased by two thirds. (360) Food prices were stable in the first half of the century. Roads were still primitive, and the chief highway was the sea, but canals and turnpikes were being built by privately promoted companies. Manufacture gradually became big business. All manner of men took to inventing machines, generally aimed at the application of power to work. Marine and other forms of insurance developed. There was no deliberate debasement of the coinage throughout this century, and the currency was almost always convertible. In 1717 gold was given the status of legal tender along with the traditional silver. In 1774 a gold standard was implicitly created when payments in silver were...

Securities Act of 1933 Exchange Traded Portfolios

StreetTRACKS Gold Trust (symbol GLD) is an investment trust with World Gold Trust Services LLC as the sponsor of the trust and the Bank of New York as the trustee. State Street Global Markets is the marketing agent. The investment objective is to reflect the performance of the price of gold bullion, after expenses. The trust holds gold bullion directly (not derivatives). From time to time the trust issues streetTRACKS Gold Shares in baskets in exchange for deposits of gold. The trust distributes gold in connection with redemptions of baskets. A basket equals a block of 100,000 shares of GLD.

The Problem Of Lead Time

Although the inverse relationship between both markets is clearly visible, there's still the problem of lead and lag times. It can be seen that turns in the dollar lead turns in the CRB Index. The 1985 top in the dollar preceded the 1986 bottom in the CRB Index by 17 months. The 1988 bottom in the dollar preceded the final peak in the CRB Index by six months. How, then, does the chartist deal with these lead times Is there a faster or a more direct way to measure the impact of the dollar on the commodity markets Fortunately, the answer to that question is yes. This brings us to an additional step in the intermarket process, which forms a bridge between the dollar and the CRB Index. This bridge is the gold market.

Foreign Currencies And Gold

Now another dimension will be added to this comparison. Gold trends in the opposite direction of the dollar. So do the foreign currency markets. As the dollar rises, foreign currencies fall. As the dollar falls, foreign currencies rise. Therefore, foreign currencies and gold should trend in the same direction. Given that tendency the deutsche mark will be used as a vehicle to take a longer historical look at the comparison of the gold market and the currencies. It's easier to compare the gold's relationship with the dollar by using a foreign currency chart, since foreign currencies trend in the same direction as gold.

Article 99 Monetary Policy

Item 3 refers to gold reserves, but no criterion was established for how much gold. Since the passage of this constitution, I have been assured from Zurich that the currency is no longer backed by gold. You can see from this monetary policy passage who the responsible party for this decision is the Swiss National Bank. The country's storehouse of value has been abolished, just as what happened in 1971 in the United States. This is a disturbing fact. If an initiative were put before Swiss voters asking whether they would like to keep the real value behind the Swiss franc or not the national storehouse of the country's wealth I' m pretty certain they wouldn' t have chosen to end gold backing for their currency. Why They would immediately lose. Fortunately, Swiss citizens through their direct democracy have voted down EU membership, against the will of some in the government. That's power in the hands of the people. It's too bad that the nation' s monetary policy is independently...

The Dollar Versus Interest Rates and Stocks

The problem with comparing the dollar to bonds and stocks directly, without using commodities, is that it is a shortcut. While doing so may be helpful in furthering understanding of the process, it leaves analysts with the problem of irritating lead times. While analysts may understand the sequence of events, they don't know when trend changes are imminent. As pointed out in Chapter 5, usually the catalyst in the process is a rally or breakdown in the general commodity price level, which is itself often foreshadowed by the trend in the gold market. With these caveats, consider recent market history vis-a-vis the dollar and interest rates.

Commodity Etfs DIRECT

The first ETF to invest in a commodity directly was Streettracks Gold ETF GLD . This launch in late 2004 was followed quickly by competing iShares Gold ETF IAU , which has been less well received than GLD . The latter is the result of the typical me too'' ETF investor behavior where investors go with the first offering ignoring the subsequent offerings that are less liquid and not unique enough to capture their interest. GLD has been a stunning success. Many attribute the rise in gold prices from 2004 to 2007 to the demand for the metal resulting from these funds. Previous to the GLD launch gold investing for investors was confined to futures and options trading the leverage and continuous contract rollover was off-putting to most individual investors , precious metals stocks which also could be dissatisfying due to the unreliability of various company prospects , and numismatic coin collections marked by heavy sales expenses and little liquidity . A liquid ETF tracking the price...

Gold And The Stock Market

Usually when the conversation involves the relative merits of investing in commodities (tangible assets) versus stocks (financial assets), the focus turns to the gold market. The gold market plays a key role in the entire intermarket story. Gold is viewed as a safe haven during times of political and financial upheavals. As a result, stock market investors will flee to the gold market, or gold mining shares, when the stock market is in trouble. Certainly, gold will do especially well relative to stocks during times of high inflation (the 1970s for example), but will underperform stocks in times of declining inflation (most of the 1980s).

Interpretation Of Open Interest In Futures

Figure 7.10 An example of a weak price rebound in gold futures. The price rise is accompanied by falling open interest, while the price decline shows rising open interest. A strong trend would see open interest trending with price, not against it. Figure 7.10 An example of a weak price rebound in gold futures. The price rise is accompanied by falling open interest, while the price decline shows rising open interest. A strong trend would see open interest trending with price, not against it.

Chartered Institute of Taxation

The Chartered Institute of Taxation Is the leading professional body In the UK concerned solely with taxation. The Institute was founded in 1930 and when it was incorporated four years later it had just 385 members. The Institute achieved charitable status in 1981. By 1988 membership had reached 7,500. The Chartered Tax Adviser examination is regarded as the 'gold standard', a rigorous and demanding qualification which commands respect in the profession and the wider world. The Institute received its Royal Charter in 1994 and in 1997 Institute members received the practising title 'Chartered Tax Adviser'.

Why Should Long Range Charts Be Adjusted For Inflation

Figure 8.1 The gold price peak in 1980 ushered in two decades of low inflation. Low inflation normally causes falling gold prices and rising stock prices as this chart shows. Why adjust the charts again for inflation It's already been done. Figure 8.1 The gold price peak in 1980 ushered in two decades of low inflation. Low inflation normally causes falling gold prices and rising stock prices as this chart shows. Why adjust the charts again for inflation It's already been done.

The Intermarket Roles Of Gold And

In the fall of 1989, surging gold prices (partially the result of a sagging dollar and stock market weakness) sent renewed inflation fears through the financial markets and helped keep a lid on bond prices. Unusually cold weather in December of 1989 pushed oil prices sharply higher (led by heating oil) and caused some real fears in

Example 54 FRM Exam 2000Question 4Capital Markets

On Friday, October 4, the spot price of gold was 378.85 per troy ounce. The price of an April gold futures contract was 387.20 per troy ounce. (Note Each gold futures contract is for 100 troy ounces.) Assume that a Treasury bill maturing in April with an ask yield of 5.28 percent provides the relevant financing (borrowing or lending rate). Use 180 days as the term to maturity (with continuous compounding and a 365-day year). Also assume that warehousing and delivery costs are negligible and ignore convenience yields. What is the theoretically correct price for the April futures contract and what is the potential arbitrage profit per contract

Gold Monetary Policy And Inflation

On September 20, 1931, the British government announced that England was going off the gold standard. It would no longer exchange gold for an account at the Bank of England or for British currency, the pound sterling. The government insisted that this action was only temporary, that it had no intention of forever abolishing its commitment to exchange its money for gold. Nevertheless, it was to mark the beginning of the end of both Britain's and the world's gold standard a standard that had existed for over 200 years. Despite the dire predictions of government officials, shareholders viewed casting off the gold standard as good for the economy and even better for stocks. As a result of the gold suspension, the British government could expand credit by lending reserves to the banking system, and the fall in the value of the British pound would increase the demand for British exports. The stock market gave a ringing endorsement to the actions that shocked conservative world financiers....

The Establishment Of The Federal Reserve

Periodic liquidity crises caused by strict adherence to the gold standard prompted Congress in 1913 to pass the Federal Reserve Act that created the Federal Reserve System (the Fed) to be the country's central bank. The responsibilities of the Fed were to provide an elastic currency, which meant that in times of banking crises the Fed would become the lender of last resort. In trying times, the central bank would provide In the long run, money creation by the Fed was still constrained by the gold standard since the government's paper currency, or Federal Reserve notes, promised to pay a fixed amount of gold. But in the short run, the Federal Reserve was free to create money as long as it did not threaten the convertibility of Federal Reserve notes to gold at the exchange rate of 20.67 per ounce. Yet the Fed was never given any guidance by Congress or by the Federal Reserve Act on how to conduct monetary policy and determine the right quantity of money.

Postdevaluation Monetary Policy

In the postwar period, as inflation increased and the dollar bought less and less, gold seemed more and more attractive to foreigners. U.S. gold reserves began to dwindle, despite official claims that the United States had no plans to change its gold exchange policy at the fixed price of 35 per ounce. As late as 1965, President Johnson stated unequivocally in the Economic Report of the President But this was not so. As the gold reserves dwindled, Congress removed the gold-backing requirement for U.S. currency in 1968. In next year's Economic Report of the President, President Johnson declared Although conservatives were shocked at that action, few investors shed a tear for the gold standard. The stock market responded enthusiastically to Nixon's announcement, which was also coupled with wage and price controls and higher tariffs, by jumping almost 4 percent on record volume. But this should not have surprised those who studied history. Suspensions of the gold standard and devaluations...

Postgold Monetary Policy

With the dismantling of the gold standard, there was no longer any constraint on monetary expansion, either in the United States or in foreign countries. The first inflationary oil shock from 1973 to 1974 caught most of the industrialized countries off guard, and all suffered significantly higher inflation as governments vainly attempted to offset falling output by expanding the money supply.

Mutual Funds and Electronic Traded Funds

There are all types of mutual funds and electronic traded funds, and investors often choose them as alternatives to assembling their own portfolio of securities. Of course, you could have a portfolio of mutual funds too. There are proponents of mutual funds, and then there are those who favor a careful selection of stocks to address an investor's very individual requirements. In recent years, the Gold Electronic Traded Funds have emerged, and they provide a means for trading mining stocks, not just gold stocks. They are becoming popular as an alternative form of precious metal investing or to provide greater diversification outside of possession of precious metals. Unless you wish to study individual stocks, mutual funds and ETFs are a possible answer, although they need to be analyzed just as carefully.

Another Example Opening a Gold Mine

Here is another example of how market prices can help you make better decisions. Kingsley Solomon is considering a proposal to open a new gold mine. He estimates that the mine will cost 200 million to develop and that in each of the next 10 years it will produce .1 million ounces of gold at a cost, after mining and refining, of 200 an ounce. Although the extraction costs can be predicted with reasonable accuracy, Mr. Solomon is much less confident about future gold prices. His best guess is that Unfortunately, Mr. Solomon did not look at what the market was telling him. What is the PV of an ounce of gold Clearly, if the gold market is functioning properly, it is the current price 400 an ounce. Gold does not produce any income, so 400 is the discounted value of the expected future gold price.6 Since the mine is 7We assume that the extraction rate does not vary. If it can vary, Mr. Solomon has a valuable operating option to increase output when gold prices are high or to cut back when...

Cold Versus Gold Mining Shares

The intermarket analysis of stock groups will begin with the gold market. This is a logical point to start because of the key role played by the gold market in intermarket analysis. To briefly recap some points made earlier regarding the importance of gold, the gold market usually trends in the opposite direction of the U.S. dollar the gold market is a leading indicator of the CRB Index gold is viewed as a leading indicator of inflation gold is also viewed as a safe haven in times of political and financial turmoil. One of the key premises of intermarket analysis is the need to look to related markets for clues. Nowhere is that more evident than in the relationship between the price of gold itself and gold mining shares. As a rule, they both trend in the same direction. When they begin to diverge from one another, an early warning is being given that the trend may be changing. Usually one will lead the other at important turning points. Knowing what is happening in the leader provides...

Description of a Commodity Futures Index

For example, the current initial margin for gold is 1,350. With gold selling at 250 and 100 ounces of gold being the size of the contract, one futures contract has economic exposure to gold of 25,000. A managed futures account would typically pay the initial margin of 1,350 and receive economic exposure to gold equivalent to 25,000. The percentage of equity capital committed to the futures contract is equal to 1,350 25,000 5.4 . In contrast, a commodity futures index will fully collateralize the gold futures contract. This means 25,000 of U.S. Treasury bills will be held to fully support the face value of the gold futures contract. In fact, the face value of every futures contract included in a commodity index will be fully collateralized by an investment in U.S. Treasury bills.

Comparison With United States Bond Yields

Viewed broadly, both the English and the American bond markets followed the same pattern in the twentieth century. English yields started rising in 1896, and American yields started rising in 1899. Both reached their highs in 1920 and their next lows in 1946, and both rose most of the time from 1946 to 1981, although the peak in Britain came in 1974. In both countries, therefore, there was a major bear bond market until 1920, a bull bond market from 1920 to 1946, and a second and much larger bear bond market after 1946 lasting until the 1980's. In spite of the disruption of the international gold standard and interruptions of a smooth flow of international investment between these two countries, the trends of their bond yields were usually in the same direction. In fact, the correlation over long periods of time was much closer in the twentieth century than it was in the nineteenth century.

Exchange Rate Forecasting

Mundell, who won the Nobel Prize in economics in 1999, has become conventional wisdom when money can move freely across borders, policy-makers must choose between exchange rate stability and an independent monetary policy. They cannot have both. Professor Mundell remains a fan of the gold standard and fixed exchange rates at a time when they are out of favor with most economists. You have fixed rates between New York and California, and it works perfectly, he has said. This statement implies that if the US dollar works well for 50 US states, a common currency such as the euro should also work well for its member states, the eurozone countries.

Religion And The Anesthesia Of American Populism

Areas of peak support for William Jennings Bryan in 1896, and for Franklin D. Roosevelt in 1936. These were the sections that had rallied to Bryan's attacks on Wall Street, banks, the great trusts, and the gold standard, and forty years later to FDR and his New Deal support for farmers, miners, and industrial workers against big business, Wall Street, and archetypal Rotary Clubs. If white economic populism has a historical geography in U.S. elections, that is it.

The Abandonment and Opening Decisions

Before trying to figure out the exact value of the option implicit in WOE or, for that matter, in any real option problem, it is useful to see what we can say by just applying common sense. To begin with, the mine should only be opened when the price of gold is sufficiently above the extraction cost of 350 per ounce. Because it costs 2 million to open the mine, the mine should not be opened whenever the price of gold is only slightly above 350. At a gold price of, say, 350.10, the mine wouldn't be opened because the ten-cent profit per ounce translates into 5,000 per year (50,000 ounces X 0.10 ounce). This would not begin to cover the 2 million opening costs. More significantly, though, the mine probably would not be opened if the price rose to 360 per ounce even though a 10 profit per ounce 500,000 per year would pay the 2 million opening costs at any reasonable discount rate. The reason is that here, as in all option problems, volatility, in this case the volatility of gold, plays a...

Valuing the Simple Gold Mine

Step 2 Construct a binomial tree and fill it out with gold prices. Suppose, for example, Figure 23.3 A Binomial Tree for Gold Prices With 5,000 such paths we will have a good sample of all the future possibilities for movement in the gold price. We picked these choices because they seemed reasonable and because increments of 10 for each seemed sensible. To be precise, though, we should let the threshold prices change as we move through the tree and get closer to the 100 year-end. Presumably, for example, if we decided to open the mine with one year left on the lease, the price of gold should be at least high enough to cover the 2 million-dollar opening costs in the coming year. Since we mine 50,000 ounces per year, in year 99 we will only open the mine if the gold price is at least 40 above the extraction cost, or 390. Step 5 We calculate the value of the mines for each pair of choices of popen and pclose. For example, if popen 410 and pclose 290, we use the computer to keep track of...

The Real Time Experiment

Under pressure from the financial markets (a falling dollar, falling bond and stock markets, and rising gold prices) the authorities get their act together. The dollar is stabilized at the same time as there is another round of interest rate reductions. The U.S. and the Soviet Union agree on a disarmament pact, allowing the military budget to be cut. International debt is finally recognized as a political problem and steps are taken to stimulate the economies of less developed countries.

The Link Between Commodities And The Dollar

A rising U.S. dollar normally has a depressing effect on most commodity prices. In other words, a rising dollar is normally considered to be noninflationary. (See Figure 17.4.) One of the commodities most effected by the dollar is the gold market. If you study their relationship over time, you'll see that the prices of gold and the U.S. dollar usually trend in opposite directions. (See Figure 17.5.) The gold market, in turn, usually acts as a leading indicator for other commodity markets. So, if you're analyzing the gold market, it's necessary to know what the dollar is doing. If you're studying the commodity price trend in general (using Figure 17.5 The U.S. Dollar and gold prices usually trend in opposite directions as shown in this example. Gold prices, in turn, usually lead other commodities. Figure 17.5 The U.S. Dollar and gold prices usually trend in opposite directions as shown in this example. Gold prices, in turn, usually lead other commodities. one of the better known...

Gold Leads Other Commodities

This distinction between gold and the general commodity price level may help clear up some confusion about the interaction of the commodity markets with bonds. In previous chapters, we've concentrated on the inverse relationship between the CRB Index and the bond market. The peak in bonds in mid-1986 coincided with a bottom in the CRB Index. In the spring of 1987, an upside breakout in the CRB Index helped cause a collapse in the bond market. A rising gold market can coexist with a rising bond market, but it is an early warning that inflation pressures are starting to build. A rising CRB Index usually marks the end of the bull market in bonds. Conversely, a falling CRB Index during the early stages of a recession (or economic slowdown) usually coincides with the bottom in bonds. It's unlikely that all three groups will be rising or falling together for long if the CRB index is used in place of the gold market.

Intermarket Analysis And Mutual Funds

Mining shares are closely linked to the price of gold. What's more, the related stock groups often tend to lead their respective futures markets. As a result, utility stocks can be used as leading indicators for Treasury Bonds. Gold mining shares can be used as leading indicators for gold prices. Another example of intermarket influence is the impact of the trend of oil prices on energy and airline stocks. Rising oil prices help energy shares but hurt airlines. Falling oil prices have the opposite effect.

Some Basic Relationships

Suppose you notice that gold can be bought in New York for 300 an ounce and sold in Mexico City for 4,000 pesos an ounce. If there are no restrictions on the import of gold, you could be onto a good thing. You buy gold for 300 and put it on the first plane to Mexico City, where you sell it for 4,000 pesos. Then (using the exchange rates from Table 23.1) you can exchange your 4,000 pesos for 4,000 9.438 424. You have made a gross profit of 124 an ounce. Of course, you have to pay transportation and insurance costs out of this, but there should still be something left over for you.

Risk Management Practices in the Gold Mining Industry

The evidence described in the Tufano study indicates that management incentives and tastes do have an important effect on the risk management practices in the gold mining industry. Specifically, managers who hold large amounts of their firm's stock tend to use forward and futures contracts to hedge more of their firm's gold price risk. Thus, managers who are personally the most exposed to gold price risk choose to hedge more of the risk. However, those who own relatively more stock options tend to hedge less, which may reflect the greater value of the options when volatility is increased. Tufano also found that firms with CFOs hired more recently hedge a greater portion of their exposure than firms with CFOs who have been on the job longer.

Technical Analysts And Intermarket Forces

What it all means is that technical analysts have to understand how these intermarket linkages work. What does a falling dollar mean for commodities What does a rising dollar mean for U.S. bonds and stocks What are the implications of the dollar for the gold market What does a rising or a falling gold market mean for the CRB Index and the inflation outlook What do rising or falling commodities mean for bonds and stocks And what is the impact of rising or falling Japanese and British bond and stock markets on their American counterparts These are the types of questions technical analysts must begin to ask themselves.

Example 244 Options to Expand

Here is another disguised option that might arise in a capital budgeting analysis. You are considering the purchase of a tract of desert land that is known to contain gold deposits. Unfortunately, the cost of extraction is higher than the current price of gold. Does that mean the land is almost worthless Not at all. You are not obliged to mine the gold, but ownership of the land gives you the option to do so. Of course, if you know that the gold price will remain below the extraction cost, then the option is worthless. But if there is uncertainty about future gold prices, you could be lucky and make a killing. Buying the mine gives you an option to extract the gold. The exercise price of that option is the cost of extraction. In effect, you have a call option to acquire gold for the extraction cost. If there is a chance that gold prices will increase enough to make extraction profitable, the option will have value and might justify its cost, which is the purchase price of the land.

Commodities As The Missing Link

Gold futures were introduced in 1974 and oil futures in 1983. Currency futures were started in 1972. Their impact on each other could only be measured from those points in time. Futures contracts in Treasury bonds, Treasury Bills, and Eurodollars were developed later in the 1970s. Futures markets in stock index futures, the U.S. dollar, and the CRB Index weren't introduced until the 1980s. When one considers how important each of these markets is to the intermarket picture, it can be seen why it's so hard to study intermarket analysis prior to 1970. In most cases, the data simply isn't available. Where the data is available, it's only in bits and pieces.

Exchange Rates And Inflation

Suppose you notice that gold can be bought in New York for 300 an ounce and sold in Mexico City for 4,000 pesos an ounce. If there are no restrictions on the import of gold, you could be onto a good thing. You buy gold for 300 and put it on the first plane to Mexico City, where you sell it for 4,000 pesos. Then (using the exchange rates from Table 6.5) you can exchange your 4,000 pesos for 4,000 9.438 424. You have made a gross profit of 124 an ounce. Of course, you have to pay transportation and insurance costs out of this, but there should still be something left over for you. b. Suppose that gold prices rise by 2 percent in the United States and by 5 percent in Great Britain. What will be the price of gold in the two currencies at the end of the year What must be the exchange rate at the end of the year

The Operation Of Margins

To illustrate how margins work consider an investor who contacts his or her broker on Monday, June 1, 1992, to buy two December 1992 gold futures contracts on the New York Commodity Exchange (COMEX). We suppose that the current futures price is 400 per ounce. Since the contract size is 100 ounces, the investor has contracted to buy a total of 200 ounces at this price. The broker will require the investor to deposit funds in what is termed a margin account. The amount that must be deposited at the time the contract is first entered into is known as the initial margin. This is determined by the broker. We will suppose this is 2,000 per contract, or 4,000 in total. At the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss. This is known as marking to market the account. TABLE 2.1 Operation of Margins for a Long Position in Two Gold Futures Contracts

Starc Bands And Keltner Channels

The weekly continuation chart of gold futures (Figure A. 5) is plotted with both the starc+ and stare- bands. In Feb. 1997 at point 1, gold prices slightly overshot the stare- band. Though the price action was weak, the stare bands indicated that this was not a good time to sell. By waiting, a better selling opportunity was likely to occur. Just three weeks later gold was 22 higher and at the starc+ band (point 2). Point 2 was a low risk selling opportunity. In July (point 3), gold prices dropped well below the starc-band, but instead of declining further, prices moved sideways for the next 12 weeks. Gold prices then started to move lower from November to December 1997 and touched the stare- band three times (points 4). In all instances prices did stabilize or move higher for 1-2 weeks. These bands work well in all time frames even as short as 5 to 10 minute bar charts. Stare bands can help the trader avoid chasing the market, which almost always results in a poor entry price. Weekly...

Golda Key To Vital Intermarket Links

Since the gold market has a strong inverse link to the dollar, the direction of the gold market plays an important role in inflation expectations. A peak in the dollar in 1985 coincided with a major lowpoint in the gold market. The gold market top in December 1987 coincided with a major bottom in the dollar. The dollar peak in the summer of 1989 coincided with a major low in the gold market. The gold market leads turns in the CRB Index. The CRB Index in turn has a strong inverse relationship with a bond market. And, of course, bonds tend to lead the stock market. Since gold starts to trend upward prior to the CRB Index, it's possible to have a rising gold market along with bonds and stocks (1985-1987). A major bottom in the gold market (which usually coincides with an important top in the dollar) is generally a warning that inflation pressures are just starting to build and will in time become bearish for bonds and stocks. A gold market top (which normally accompanies a bottom in the...

What Constitutes a Valid Breaking of a Trendline

If, for example, gold prices broke a major up trendline at 400, prices would have to close below that line by 3 of the price level where the line was broken (in this case, prices would have to close 12 below the trendline, or at 388). Obviously, a 12 penetration criteria would not be appropriate for shorter term trading. Perhaps a 1 criterion would serve better in such cases. The rule represents just one type of price filter. Stock chartists, for example, might require a full point penetration and ignore fractional moves. There is tradeoff involved in the use of any type of filter. If the filter is too small, it won't be very useful in reducing the impact of whipsaws. If it's too big, then much of the initial move will be missed before a valid signal is given. Here again, the trader must determine what type of filter is best suited to the degree of trend being followed, always making allowances for the differences in the individuals markets.

Exchange Rate Regimes

Throughout the nineteenth century (until 1914), and again for some time in the 1920s and 30s, a fixed exchange rate system (the Gold Standard) operated. Under this system, a country fixed its currency to be worth a certain amount of gold, which defined a system of fixed exchange rates between different currencies. Between 1945 and 1971, under the Bretton Woods system, only the dollar was pegged against gold, and all other currencies were pegged to the dollar. Since 1971, the world has experimented with flexible exchange rates and various reformulations of fixed exchange rate systems. In this section we will examine in detail how these various regimes operate and their relative advantages and disadvantages.

Value Terms

The first forward foreign exchange transactions can be traced back to the money-changers in Lombardy in the 1500s. Foreign exchange, as we know it today, has its roots in the Gold Standard, which was introduced in 1880. It was a system of fixed exchange rates in relation to gold and the absence of any exchange controls.

Offshore freedom

The second was America's decision in 1971 to end the dollar's link with the gold standard. The exchange rate of the dollar was allowed to float freely. In a few years, foreign-exchange trading and speculation had become a huge activity for banks. But the mechanics of forex trading changed little to take account of the increased volumes and the increased exposure to exchange-rate fluctuations. A wake-up call came in July 1974 when a German bank, Bankhaus Herstatt, was closed down before the end of the American business day. It had collected payments in yen, D-marks and other European currencies, but failed to honour its dollar payments in New York. This caused gridlock in the foreign-exchange markets, as banks panicked and refused to release payments for other perfectly sound transactions. The small Herstatt bankruptcy had worldwide repercussions, demonstrating how fast contagion could spread through the world financial system.

The Dollar Rules Ok

By 1960, the dollar was supreme and the American economy was thought to be immune to adverse international developments, and the growing balance of payments deficits in America did not appear to alarm the authorities. The first cracks started to appear in November 1967. The British pound was devalued as a result of high inflation, low productivity and a worsening balance of payments. Not even massive selling by the Bank of England could avert the inevitable. President Johnson was trying to finance 'the great society' and fight the Vietnam War at the same time. This caused a drain on the gold reserves and led to capital controls.


Assume that the price of gold with a one-year futures contract is 440 an ounce and that an investor chooses to go long (purchase) a gold futures contract with the one-year futures price at that level. That future price of 440 becomes a line in the sand it is the benchmark against which daily price changes in the value of gold will be measured over an entire year. At the end of one year, the investor can take delivery of the gold underlying the futures contract for 440 an ounce. However, it is important to note what happens between the time the futures contract is obtained and when it expires a year later. Let us say that the futures contract is obtained on a Monday with gold at 440 an ounce. On Tuesday, the very next day, say the gold market closes at 441 an ounce. This additional 1 value of gold ( 441 versus 440) goes into a special account of the investor (usually called a margin account8) that typically is maintained at the exchange (such as the Chicago Mercantile Exchange) where...

Market risk

Carver of Barclays observes that gold price hedging has been a one-way bet during a long period of falling gold prices. Through hedging gold projects consistently have been able to sell at above-market prices. If the gold market were to reverse and enter into a long-term price upswing, Carver wonders whether gold producers would maintain their appetite for hedging.


U.S. dollar and the commodity markets will be examined. I'll show how movements in the dollar can be used to predict changes in trend in the CRB Index. Commodity prices axe a leading indicator of inflation. Since commodity markets represent raw material prices, this is usually where the inflationary impact of the dollar will be seen first. The important role the gold market plays in this process as well as the action in the foreign currency markets will also be considered. I'll show how monitoring the price of gold and the foreign currency markets often provides excellent leading indications of inflationary trends and how that information can be used in commodity price forecasting. But first a brief historical rundown of the relationship between the CRB Index and the U.S. dollar will be given.

Swiss Franc

The United States dollar was backed by gold until Richard Nixon took the United States off the gold standard in 1971. Since then the country has had a fiat currency backed by nothing. That's right even the almighty dollar Later, when we deal with the topic of gold, we'll have a further discussion on the business of gold and money. This action alone sent the world economy spinning in the 1970s. Then maybe it's time to exchange our U.S. dollars for Swiss francs or another strong currency. But, you ask, who 's going to accept Swiss francs in America or Canada We know the grocery store won' t, but there are ways around this apparent problem, as we will see later in the book. Meanwhile, it's important to understand that the Swiss franc is one of the best currencies in the world, even though, I am sad to say, they went off the gold standard. Until a few years ago, the franc was the most stable, best-managed currency in the world. It was also backed by a basket of real assets in other forms,...

Figure 510

In September of 1989, the mark formed a second bottom which was much higher than the first. The gold market hit a second bottom at the exact same time, forming a double bottom. The pattern of rising bottoms in the mark entering the fall of 1989 formed a positive divergence with the gold market and warned of a possible bottom in gold. Needless to say, the rebound in the mark and the gold market corresponded

Figure 511

Given the close relationship between the gold market and the deutsche mark (and most major overseas currencies), it can be seen that analysis of the overseas markets plays a vital role in an analysis of the gold market and of the general commodity price level. Since it has already been stated that the gold market is a leading indicator of the CRB Index, and given gold's close relationship to the overseas currencies, it follows that the overseas currencies are also leading indicators of the commodity markets priced in U.S. dollars. Figure 5.12 shows why this is so.

Figure 513

Figure 5.13 gives a closer view of the events entering the fall of 1989. While the CRB Index has continued to drop into August September of that year, the gold market is holding above its June bottom near 360. The ability of the gold market in September of 1989 to hold above its June low appears to be providing a positive divergence with the CRB Index and may be warning of stability in the general price level. Bear in mind also that the double bottom in the gold market was itself being foreshadowed by a pattern of rising bottoms in the deutsche mark. The sequence of events entering the fourth quarter of 1989, therefore, is this Strength in the deutsche mark provided a warning of a possible bottom in gold, which in turn provided a warning of a possible bottom in the CRB Index. The relationship between the dollar and the gold market is very important in forecasting the trend of the general commodity price level, and using a foreign currency market, such as the deutsche mark, provides a...

Figure 515

Dollar peaks in June and September of 1989 (upper chart of Figure 5.16) coincided with double bottoms in gold, which may in turn be signaling a bottom in the CRB Index. In all three cases, the dollar remains the dominant market. However, the dollar's impact on the gold market is the conduit through which the dollar impacts on the CRB Index. Therefore, it is necessary to use all three markets in one's analysis.

Sensitivity Analysis

Sensitivity analysis is a very commonly used tool. For example, in 1998, Cumberland Resources announced that it had completed a preliminary study of plans to spend 94 million building a gold-mining operation in the Canadian Northwest Territories. Cumberland reported that the project would have a life of 10 years, a payback of 2.7 years, and an IRR of 18.9 percent assuming a gold price of 325 per ounce. However, Cumberland further estimated that, at a price of 300 per ounce, the IRR would fall to 15.1 percent, and, at 275 per ounce, it would be only 11.1 percent. Thus, Cumberland focused on the sensitivity of the project's IRR to the price of gold.

Junk Bonds

Since the bonds were issued in 1881, investors have seen Santa Fe go through two bankruptcy reorganizations, two depressions, several recessions, two world wars, and the collapse of the gold standard. Through it all, the company remained intact, although ironically it did agree to be acquired by Burlington Northern just prior to the bonds' maturity.

Foreign Currencies

President Richard Nixon, old Tricky Dick, dropped the final gauntlet by officially removing us from the gold standard, gutting the almighty dollar, again with the stroke of a pen. Today, our money is a fiat currency that, until recently, has endured amazingly well for decades, with no real stored value to back up the paper and ink. But for years, it's been in a gradual decline. It was only a matter of time before our weakness began to show, principally due to having a liberal monetary policy. Basically, our currency is backed by people 's perception of its strength and worth, somewhat of an illusion, and their willingness to accept it as payment for goods and services. Since there 's nothing backing it, there 's no limit to how much may be printed. If it were to be backed by 100 percent gold, the gold would have to exist and be held somewhere. But the nation would have only so much gold, or it would have to acquire more to print more money and still have it fully backed by gold. It's...

Precious Metals

Why own gold and other precious metals For decades the United States was on the gold standard. A strong currency backed by gold, in conjunction with a conservative monetary policy, helps create a solid, stable currency. It also leads to national economic stability and real economic growth and minimizes the wide fluctuations of inflation and deflation. In 1971, President Richard Nixon took the United States off the gold standard. In the same era, he devalued the U.S. dollar in two separate moves, by 10 percent each time. He may have ended the Vietnam War, but he didn 't do much for the U.S. economy. A currency with no real value, one that is not backed by gold or something of sustaining value, is basically a fiat money. In the past these countries often have inflated Today, all currencies are soft currencies, free-floating in relation to each other in the present global soft-money cycle that hopefully, one day, will change. If it does, we will enter a new hard-money cycle that the...

Hedging with ETFs

StreetTRACKS Gold Shares (symbol GLD) and iShares COMEX Gold Trust (symbol IAU) seeks to reflect the price of gold and gold bullion respectively, minus the expenses of operations. The ETFs are designed for investors who want a cost-effective and convenient way to invest in gold or short the gold market. See Chapter 15 for more details.

General Background

Economic cooperation with Britain attractive to most foreign commercial interests. Many countries imitated British monetary and financial techniques and British interest rate policies. In one way or another, they tried to fit themselves into her worldwide trading community. The rules of the game were set in London. They were built around the gold standard, free access to markets, and respect for investment.

Commodity ETFs

Commodities truly are a trading vehicle, not a long-term investment vehicle. Timing is everything. Over the last 30 years, there have been only two major runs in commodities prices. One occurred during the high inflation years of the 1970s, which coincided with the U.S. release of fixed gold prices, and the second occurred during the first decade of the new millennium. Figure 15.2 illustrates the value of gold and oil adjusted for inflation from 1977 to 2006. The two spikes

Gold and Silver ETFs

StreetTRACKS Gold Shares (symbol GLD) offer investors a way to access the gold market without the necessity of taking physical delivery of gold, and to buy and sell that interest through the trading of a security on a regulated stock exchange. The trust holds gold, issues baskets in exchange for deposits of gold, and distributes gold in connection with the redemptions of baskets. Each ETF share represents one tenth of an ounce of gold, backed by bullion held in a vault. The investment objective of the Trust is for the Shares to iShares Comex Gold Trust (symbol IAU) corresponds to one-tenth of a troy ounce of gold. The ETF's trustee, the Bank of New York, will value the trust's gold on the basis of that day's announced Comex settlement price for the spot month gold futures contract. The shares of the trust will reflect the price of the gold owned by the trust, minus expenses and liabilities. The annual management fee is 0.40 percent.

Figure 1112


Cr2 l gl

Bordo (1990) examines the changes that occurred in the United States and in the United Kingdom before and after the creation of an LLR system. Before 1866, the Bank of England tended to react by protecting its own gold reserves, which could even worsen panics. After that date, the Bank of England adopted Bagehot's policy and thus prevented incipient crises in 1878, 1890 and 1914 from developing into full-blown panics, by timely announcements and action (p. 23). Bordo compares the two countries during the 1870-1913 periods and sees striking similarities in their business cycles similar declines in output, price reversals, and declines in money growth. Still, the United States had four panics during this period while the United Kingdom had none. Evidence on

Concluding Comments

The evidence of this paper is not consistent with the thesis that financial globalization brings an end to geographical concentration of financial services, also called the end of geography (O'Brien 1992), a point that is extensively elaborated by Michael Grote (2009 Chapter 13, this volume). International financial integration is not a new phenomenon. It was a key feature of the classical gold standard from 1880 to 1914 it then receded in the inter-war years and started again after World War II but especially after the end of Bretton Woods in 1973. Over this period, international financial centers have not only persisted but prospered. A mixture of centralization and decentralization is a better description of what happens as a result of financial globalization. Retail banking is widely dispersed, stock markets and bank headquarters are concentrated (Martin 1999). The trend toward increasing concentration of capital markets is not inconsistent with the existence of local capital...

Figure A6


Figure A7


The Performance

In the chat forum, he said it was his single worst mistake trading I was holding 1,200 contracts of Comex Silver, yep the 5,000 ouncers for 6,000,000 ounces for Richard Dennis's account. This along with 500 contracts of Comex Gold. Rode it all the way up and almost all the way down accounting for a whopping -65 percent drawdown in the account. The equity swing on the high-move day for the account from the high to the low was something ridiculous, like 14 million.

Exchange Rates

The international foreign currency market has undergone vast changes since the gold standard was abolished in 1971. Prior to August 1971, the value of the U.S. dollar was tied to the value of gold (fixed at 35 per ounce) and the value of other countries' currency was tied to the value of the U.S. dollar. In other words, the world's currencies were on a type of fixed exchange rate system. Since August 1971, the values of the U.S. dollar and other currencies have been allowed to change according to supply and demand. However, the United States, like other countries, does occasionally intervene. Therefore, the U.S. currency policy is best described as a managed floating rate system.

Aggressive Growth

XLE Select Sector SPDR Energy ETF and GLD streetTracks Gold ETF gave exposure to commodity markets that also made powerful moves higher in 2006. 7. GLD streetTracks Gold ETF remains a popular investment given its role as an inflation hedge. The ETF structure makes investing in gold now easier than ever in addition to being both cost-effective and liquid.