The 1970s gold bull market 1 comments

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Among all metals gold retains a mystical quality, with centuries of its symbolic value behind the common perception of it being the ultimate currency. This perception means that the metal retains its real value well; one would expect its price to be relatively stable. However, in times of crisis and inflation when there is a flight to quality, gold's qualities as the ultimate inflation and currency hedge (inversely correlated to the US dollar) plus its safe haven characteristics come to the fore.

The pressure for a revaluation of gold had been building up throughout the first few decades of the twentieth century. For a long time global paper currencies operated on the gold standard, meaning that they were backed by gold reserves; paper currency was fully convertible to an equivalent amount of gold at the appropriate rate, which meant the gold price was fixed. Up till 1944 it was fixed at US$20 per ounce, then under the Bretton Woods agreement it was revalued to US$35/ounce. But as gold demand continued to rise and its gold reserves dropped due to its rising trade deficit, the US faced increasing pressure to revalue its currency downwards (in terms of gold) by the end of the 1960s. In the end, President Nixon closed the "Gold Window" in 1971, ending the dollar-gold convertibility, and leading inevitably to "floating" of the world's currencies (because there was no longer an intermediary -- gold --- to which currencies' values could be fixed, hence they could trade against each other freely to find their true value). Given that the price of gold had been artifically held back via agreements before this move, it was like the opening of a dam to release the water behind. By the end of 1974, Gold had soared from US$35 to US$195 an ounce.

The mid-to-late 1970s was of course, the stagflation years where annual inflation rates were as high as 15%, partly due to cost-push inflation caused by the rise of the OPEC cartel. The last commodities bull before the current one was during then; commodities are the best inflation hedge, and chief among them was gold, partly because of nervousness about a possible collapse of the global financial system (still adjusting to floating rates) causing a flight to safety. Despite attempts to keep gold prices down by sales of gold from the US Treasury, and aided by a drop in the US dollar's exchange rate against its main trading partners, the price of gold doubled to US$400 in the space of one year in 1979, then doubled again to US$850 by early 1980.

Anyone vested in gold in the early 1970s would have seen his investment rise >2000% within the space of a decade. Hindsight, of course, is 20/20, but while the super-inflation in the late 1970s could not have been foretold, the reformation of the dollar-gold convertibility regime in 1971 would have suggested a strong catalyst to buy into gold for the astute investor. Without an artificial peg to gold prices (to the US dollar), and given the difficulties faced by the US Treasury in maintaining the regime prior to Nixon's repudiation of the long-held policy, the demand-supply dynamics that were released into play drove gold prices inexorably upward.

As it was, 1980-81 marked the high point of gold prices for the next 2-3 decades. Gold and commodities went into a long swoon as the world went into a golden period of low inflation and high growth. As money flowed back towards equities, gold prices fluctuated between US$250-400 (rarely above). That is, until 2006, when it recently touched US$700/ounce before retracing amidst the global commodities correction.

References:
(1) The Privateer Gold Pages
(2) Wikipedia entry: Gold

Personalities: Jesse Livermore 0 comments

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The greatest trader that ever lived, they call him. I use the figure of the bear (see above) because he made his name shorting the market crashes of 1907 and 1929. More than the money that he made, it was the way he made them and lost them --- several times over --- and the immortalisation of his trading philosophies in the classic "Reminiscences of a Stock Operator" that mark him as one of the greats.

According to the book, written by Edwin Lefevre in the persona of Larry Livingston which was a pseudonym for Jesse Livermore, the man himself started his trading career at the age of fifteen, after he ran away from home to escape a life of farming his father wished him to have. He then began his career by posting stock quotes at a brokerage in Boston, where he first learnt about stocks and honed his ticker-tape reading skills, enabling him to read and predict price movements and tendencies. In the next several years, he made his money at the bucket shops (a kind of gambling outlet allowing margin trading on stocks), and then devoted his energies towards trading in legitimate markets, first on the stock exchange and then moving on to commodities as well. His life was filled with ups and downs; his big money was made in the market collapse of 1907 and Black October in 1929, which made him $3M and $100M(!) respectively, but in between he lost most of his fortune in commodities and a sideways trading market, and subsequently after 1929 again lost most of his trading capital in a depression market. He declared bankruptcy several times in his trading career, and committed suicide in 1940, having lost confidence in his abilities and suffering from depression. A sorry end to a great speculator.

I guess the ups and downs only added to the romanticism of his life story and enhanced his status in the eyes of professional traders (somehow). His teachings and trading philosophies, learnt through hard experience, are probably standard traders' rules nowadays: trend-following, buying and holding in a bull market, industry analyses, following the leaders, identifying pivot points, and of course, risk management. Speculators before him had practised some of these ideas, but he probably formalised these philosophies and profited greatly from them like no other before him, by sheer application on the markets.

One should really go and read the abovementioned classic (Reminiscences of a Stock Operator) to get a full view of his ideas and their evolution. Below are probably some of the most important ones:

- The greatest amount of money is made following the major trends - not in the day-to-day fluctuations of a stock or in a particular commodity. A useful piece of advice for the day-traders of today, from one of the all-time great speculators. "The courage of your convictions and the intelligent patience to sit tight" (in this sense he shares a certain similarity of spirit with Warren Buffett).

- While his tape-reading skills were still important, they were not as important as studying the fundamentals of each company and the credit conditions of the stock market and the economy; such studies served him well in his bear raid during the Panic of 1907 where he observed tightening of credit conditions and the bankruptcy of a number of businesses and Wall Street brokerages

- Always average up; buy more of what shows you a profit, and sell off if the price is not behaving right (ie. goes down). This is consistent with his view of trend trading and cut loss. "Always sell what shows you a loss and keep what shows you a profit".

- Do not depend your analysis solely on "insider information.", or more generally, trust your own analysis and do not rely blindly on other people's advice however convincing and knowledgeable they are. He learnt this from personal experience, most significantly in a cotton trade where he reversed his original position on the advice of an expert and consequently suffered huge losses.

- The need to continuously evolve in the stock market. Thus he was able to switch from the bucket shops to the exchange, and continuously evolve new philosophies and trading styles from his observations. He also learnt to trust his instincts (a point also emphasised, incidentally, in "The Zurich Axioms").

The 1920s to 1930s were probably some of the most treacherous times for speculators. Having thrived on one crisis (Black October 1929), Livermore then probably misread the severity of the crash and made bad calls leading to his last bankruptcy and his eventual depression and suicide. Perhaps this is the final lesson for traders: be ready to admit defeat rather than go all out .... the nature of the market might have changed.


References:
1. Marketthoughts.com: On Jesse Livermore And His Legacy
2. Wikipedia entry: Jesse Livermore
3. Wisdom of Jesse Livermore
4. Reminiscences of a Stock Operator (Edwin Lefevre)