Could I get somone with an education to decipher this response?

I am clearly over my head in a discussion with this guy. I was trying to point out my reasoning behind my bullish beliefs in Physical PM's. This was his response.




***So you are convinced that your inflation expectations are more accurate than the expectations of the market?

First off, there are a variety of direct bets on inflation that are traded in the OTC market. The simplest is just an inflation swap where you swap some interest rate for actual inflation. If you have enough credit these are zero-cost derivatives so your potential upside is unlimited. You could make a billion dollars with no initial investment. Too bad your credit isn't good enough. Then there are real rate swaps (similar) and asset swaps based on TIPS bonds and other global inflation-linked bonds. You probably can't trade any of those either.

Then there is the question of numeraire. You believe the dollar is going to collapse against what? (note that the direct inflation bets are bets with baskets of goods or GDP deflator as numeraire). So far you have the dollar collapsing against precious metals. Your buying physical metals is a very feeble way to play the collapse of the dollar against physical metals as you can get vastly more leverage in very liquid derivatives (if you want to make a billion $, you need leverage).

For differeent numeraires:

Gold:
Buy call options on gold futures. For instance, I can buy a call option on 2500 December 2012 gold futures for $4000. Say that the dollar collapses and gold goes to $5000/oz. I will have turned my $4000 investment into (5000 - 1650) * 100 = $335000. Your puny plan of buying physical gold turns $4000 into $12000 so my plan is better than your plan by a factor of 30 if the dollar is going to collapse.

Bonds:
Inflation expectations are built into bond prices. Ten year treasuries are currently trading at 2% yields. This is completely contrary to expectations of hyperinflation destroying the dollar. If you believe that inflation will be (say) 40% then expect that Treasuries will sell to yield at least 30%. Then a current treasury selling at 100 should drop in price in a year from 100 to about 14.

They don't sell put options that low but I can buy an 80 put for about $1000 on the contract a year out. If inflation really did pick up to that level, my 80 put would be worth (80 - 14)*$100000 = $6.6M so now my inflation bet of $1000 turns into $6.6M which is way better than the gold call. You want ultra-short the dollar, OTM put options on bond futures contracts is seriously ultra-short. Call up Interactive Brokers. Send them some money and they will fix you right up with some of these.

Foreign Currency:
It depends on the foreign currency and generally the typical YA poster who believes in USD collapse also believe in the collapse of all other fiat currencies, which is to say all other currencies. Again, the best way to play this (for joe retail investor) is call options on futures contracts. I'll let you figure that one on your own.

Now, for some advice here...

You don't know anything about economics or global macro trading so going all-in on an extreme global macro bet is just not a good idea. Think you are George Soros? The current global macro scenario is just not what you think it is. The current world problem is Europe. The situation over there is largely controlled by the Germans. The Germans have this collective phobia of inflation because of their inherited memory of Weimar. They won't let inflation happen even if it means destroying Europe's economy. They are so far out in left field on this it makes me ill. Meanwhile, the US Fed is sitting on an enormous pile of assets. The Fed balance sheet is like $3T or something (too lazy to go look). It's enormous. Hyperinflation doesn't happen in places where the central bank is sitting on a huge pile of assets to fight inflation (if you don't know why or understand that, you have no business making inflation macro plays). The Fed can suck down the money supply in a very short amount of time should inflation become a problem.

Really nobody smart or educated is worried much about extreme inflation. Deflation is a serious worry particularly now that govts are way over-borrowed so fiscal stimulsus is impossible. The Europeans are even trying to lock the door on fiscal stimulus if it means deficits. Monetary stimulus is about at the end of its resources.

 

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Well, I don't know what your explanation or reasoning was that got you that reply, but really, sometimes things are just opinions. Sometimes the best thing to do is just say "Thank You" and move on. That being said, I don't always follow my own advice. :grin:

 

This is a typical situation. This person is well-schooled in current economic events and thinking, and has a trader mentality. Most people who use extreme leverage eventually blow-up their portfolios, but nobody can tell them that because in their mind, they are smarter.

You can just tell him that you have no desire to use leverage, and that Jim Rogers is one of the smartest investors around and he is very worried about inflation. So just tell him that you believe Jim Rogers has more credibiltiy than he does. He'll probably respond with some negative comment about Jim Rogers, but nobody will believe him.

http://lewrockwell.com/rogers-j/rogers-j159.html

Remember, you are dealing with a diseased ego, so don't expect a polite response.

 

Sorry, can't help you either. I had a friend who played the markets and after a year of being immersed in it, he spoke like the guy you're dealing with. It's a whole different world. As Kasia said, most of the reply are opinions. Smile, nod your thanks and back away slowly.


As for my friend.... he made a killing the first year, the second year he was washing dishes at a cafe and living with his parents.

 

Ha ha, it sounds alot like a good buddy of mine who runs a hedge fund. His main focus is on the EU and on deflation and he firmly believes any inflationary pressures will come only after a serious round of deflation. You know, I think they all read the same news letters and all pay attention to the same issues which is why most of them are behind the ball when change occurs. Like Peter Lynch used to say - common people are at ground level and see what those on the 110 floor in Manhattan completely miss. Nevertheless, I see their point about deflationary pressures and the fear that all boats sink into the mud when the tide goes out. But I also know from both experience and from my readings that the Fed cannot control inflation for beans once it gets started. A quick review of the 1970's and Gerald Ford's "WIN" buttons (god, I wish I would have kept mine) which stands for "Whip Inflation Now", and in my opinion sums up the extent the Fed can manipulate the economy. Your friend is right to say the Fed has tools to use but to-date they've never been shown to be effective and are more typically a trailing indicator of out of control inflation. Yes, they can reign in the M2 money supply but what on earth will they do with all that paper? And at this point there is so much paper out there even a 50% cut in M2 will still be multiples of its historical averages.
The way I see the whole picture is this - The world economy is like a giant iceberg and the Fed is like a guy standing on the iceberg with an oar. Yes, he can use his oar in an attempt to alter the direction or momentum of the iceberg but his efforts are nominal at best. However, it does calm some people to see him paddling away since there is a clear political side to the Fed but it's all for show, the economy is far too large and far too complex for any one entity to control or manipulate.
So I would take your friends predictions with a grain of salt. Inflation or deflation or stagnation, they're all trailing indicators of a weak economy and until all this fear and dread in the markets is assuaged, any or all of these scenarios could come to pass. What is certain is that we're all in for a roller coaster ride of a lifetime!

 

I like that! Mind if I "steal" it?

 

The reply may use a lot of big words and sophisticated economic practice, but in a nutshell, it's a whimsical opinion by an educated dreamer. I have no doubt there are economists out there who are brilliant, but with the mess they got us into the past few years, brilliance is clearly not a solution to arrogance.
Guy

 

JCB, the person you are discussing with is making a few flawed assumptions in my opinion. For one, they are asserting that the market has certain expectations. The market is the sum of everybody participating in it, and to say that it has concrete expectations is impossible because not everyone participating will always be in agreement. Expectations can only be identified in hindsight, so to say that inflation expectations are more accurate than market expectations is an impossible comparison, because inflation expectations have an easy method to determine which is whether or not money supply is expanded.

Also, regarding this statement:

They are saying that they know what every smart and educated person thinks. This is an impossible generalizatoin and is ignorant to say IMO. I do think deflation is a greater concern than inflation, but that's the reason why inflation is a concern because they are determined to stave off deflation at all costs. There's no reason that monetary stimulus can't go on as long as these institutions exist because they can create more money any time they want, and realistically deflation would wipe out most banks because they are so highly leveraged. I would not expect to see deflation take hold until after hyperinflation, with mini-deflations along the way requiring inflationary responses.

Nevermind all the insults and denigrations in this person's arguments. It's not someone I would feel good about trusting the judgement of. Having precious metals is in fact the best thing you can do to prepare for collapse of the dollar, if that's what you think will happen, because their value is intrinsic and does not have the potential to become worthless. If the dollar does survive, as long as monetary policy is inflationary then metals are the best way to avoid having your wealth stolen. In a deflationary environment metals won't be as good as cash (at least for as long as the government behind that cash remains in power which in my mind would be questionable in a severe deflation which would bring out more protestors).

Lastly, to say the current world problem is Europe is just very short sighted. The problem is debt, and negative real interest rates are in effect in the US, China, and India as well. I think whoever is arguing with you either doesn't know as much as they think they do, or they have a vested interest in supporting the status quo. As I have stated somewhere before, a lot of the banks' balance sheets are holding bonds which are government debt. To refer to these as assets is only a reliable way of looking at things for as long as that government is in power, and for as long as people are willing to buy those bonds. If the bonds don't sell, then all of them take a price reduction and those balance sheet assets will do the same.

 

Economy is not the same as science there is so many factors that most economists are not even taking into account. Check out this book where the author points out how we are not factoring the changing demographics and that is what contributed to the boom and current recession (baby boomers contributed to the housing boom and as they are retiring we are seeing the fallout).


http://www.amazon.com/Great-Crash-A...1540/ref=sr_1_2?ie=UTF8&qid=1323799381&sr=8-2

 

Right now, the only hedge fund that concerns me is what I'm paying for yard maintenance.

Chris

 

Jason, as others have stated he is somewhat trying to baffle you with %$#&(*^. Like a lot of Finance and Economics, what he is saying concerning trades is true, but doesn't mean it answers the question.

Undoubtedly if you apply leverage you can increase returns, but you also increase your risk proportionately. I would counter the general inflation hypothesis that the "official" inflation number is a contrived number by an interested party, (the Fed), and does not track well a basket of goods. You are trying to track a basket of hard goods, not goods and services, so hedging versus inflation does you no good. Using leverage against PM also does you no good since such positions have time elements, and you believe you are right, you just are not sure WHEN you will be right. Time is the other half of all economic actions, and its not enough to get the movement right, you have to have the time right as well. Therefor, investing in physical PM allows you to have a lower risk position that is nearly immune to timing of the expected movement.

He sounds very much like a trader. They have attention spans of a nat. All major movements in the economy have been missed as a group by traders, they are only interested in today, this week. Next month is a far off time horizon to these people. Because they only deal with short time frames, reversion to a mean, long term dilusion of currency values, etc mean nothing to them, they physically cannot process it since its against everything they see every day.

I do not believe Buffet is god like many, but he does have wise sayings. Remember that he said he would not have made it in Finance if he had lived in NY. His greatest asset is he lives in Omaha, and if he has one good idea a year, and one great one a decade, he is doing well. Traders simply cannot grasp that, so that is why this man is throwing 30 things at you at once. They think every tiny idea they have is important, and cannot grasp how long term shifts to paradigms happen. They simply accept the paradigm they are in until its different, and completely miss the movement. Its like the proverbial frog in a kettle. He never feels the heat increasing since its gradual, so to him he isn't cooking until he's well done.

Chris

 

Personally if the author is attributing the housing fallout to demographics I would not read the book. The causes, starting with the Fed's action post 9/11, coupled with Fannie, Freddie, and the lack of oversight on the bond raters, are fairly cut and dried. I do not recall one iota of evidence of demographics really affecting this incident. Many of the participants were young people chasing a buck.

 

Well I certainly appreciate all of the responses. I take no offense from this guy. I am sorry that he took offense to my question. As much as he rides my tail, he responds to every single one of my questions in meticulous detail regarding finance/investing. I am thankful for his response, and your comments on the matter. If anyone has anything else to add, please do. Finals are over, and it would be a great time to look deeper. By the way, I've invited a few of the investing top contributors from yahoo answers to this forum, because I believe they are getting tired of not being able to have a rebuttal.

 

I haven't read the book only seen author give interviews on it but here is summary from one of the Amazon reviews:

 

This is, in my opinion, the key.

Lets arbitrarily say that inflation is going to shoot up to 20% per year three years from now.

If you had a working crystal ball that told you inflation would be 20% per year but didn't tell you when, you could buy all the calls, puts, futures, etc. you wanted and still lose all your money simply because they had expired before the affects of inflation were reflected in the value of the calls, puts, and futures.

By buying "physical" objects (be it gold, silver, stocks, or non-perishable goods), you are reducing the effect of the time element. In exchange, you are foregoing the leverage that options and futures provide.

You might find "Aftershock: protect yourself and profit in the next global meltdown" by David Wiedemer interesting.

Basically, it states we had a number of bubbles that just popped (consumer debt, housing, and a couple others) and that there are two more bubbles that are still inflating: government debt and the dollar. David notes that those two bubbles will pop sometime (causing massive inflation), and makes some rough guesses as to when, but he also points out that there are a number of parties who will mask the bubbles as long as possible, making it difficult to predict when they will actually pop.

 

I would just add that if this guy trades frequently, he may just be using his responses to you to clarify his own thinking. I know it helps sometimes to try to explain things in writing to ensure that you actually understand it yourself.

 

If the dollar and debt markets "pop," it could just as easily lead to deflation [i.e., default] as inflation. Massive inflation can only occur through a consistent policy action to cause it. This could happen, but it could also just as easily not happen depending on policy decisions that haven't been made yet.

 

I hope this isn't hijacking, but would you elaborate, please?

Thanks.

 

Not arguing, just asking, but how is the dollar a bubble about to pop? It's not a real commodity. It's value is defined basically by the laws of make-believe. So, how does it pop? Just curious.
Guy

 

When people in foreign countries invest, one of their options is to invest in dollar-denominated securities. That investment helps stimulate the US economy. Should they decide that dollar-denominated securities are too "risky" and stop investing in the dollar, then we suddenly have a lot of dollars in play that nobody wants. POP.