Extraordinary popular delusions
or the madness of machines
Why gold might be setting up for a big move higher
Originally posted May 9, 2012
Counter-intuitive forces are at work in the gold market. Europe is moving toward dissolution – erratically to be sure but inevitably nevertheless. Intuition tells us that gold should be moving higher under the circumstances, after all, we are talking about the beginning phases of a major currency, and perhaps economic, collapse.
But it isn’t. It is headed south. To what do we owe this curiosity?
The running conflict between rational and irrational forces has become a hallmark of the times. You see, we are increasingly giving over our thought processes in the investment market-place to external trends governed by computers and automaton traders who have nearly unlimited capital reserves they can throw in the direction their algorithmic software is telling them. Thus if the algorithm says that gold goes down when the dollar goes up and that the dollar goes up when the euro goes down, then that is the reality under which we all must live – no matter what our intuitions, or intellects, might be telling us. It used to be “don’t fight the tape.” Now it’s “don’t fight the algorithm.” Paper, not physical, trades are executed in the marketplace quite often without the intrusion of human contact, and thus the market proceeds as it is directed.
This is a hallmark of our age. And a strange age it is. What we are all witnessing, in my view, is part and parcel of the bubble psychology that dominates our times. With a bit of nuance, it is no different than the bubble thinking that preoccupied Holland during its tulip mania, or France during its South Seas investment scheme or the long list of extraordinary delusions and crowd madness chronicled by Charles Mackay in his now famous tome. Only this time it is driven by machines, a kind of madness that we have hard-coded into software that is running amuck, and no one seems inclined to understand the process, let alone stop it. Though I do not hold out much hope for the euro and the European experiment, at this juncture, I do see a bright future for gold – in the form of a breakdown in this odd, software driven marriage between gold and the euro. This breakdown, once it occurs, will have a catapulting affect on the price, as the reality sets in that the best hedge against what is going on in Europe is not the dollar, but gold.
Delusions, mania are epidemic; your portfolio needs inoculation
In Mackay’s book, Memoirs of Extraordinary Popular Delusions and Madness of Crowds, written in 1841, he perhaps unwittingly provides us one of the better templates for modern market behavior. Mackay’s mission as he described it in the original edition was “to collect the most remarkable instances of those moral epidemics which have been excited, sometimes by one cause and sometimes by another, and to show how easily the masses have been led astray, and how imitative and gregarious men are, even in their infatuations and crimes.” Delusion and mania, as it turns out, are epidemic and they can spread through the population just as insidiously and deliberately as the Asian flu. As a result, just as we inoculate our bodies against disease, we should inoculate our portfolios against the madness of crowds, or machines, if you will.
I doubt Mackay would have guessed that his book would be read, digested and taken as revelation by readers in the 21st century. At the same time, he probably would have not been surprised that the pull of the same dark gravity that caused people to throw their fortunes at tulip bulbs in Holland, or land they never had a hope of seeing in the New World, would be omnipresent in the age of computers, instantaneous communication, and the nearly infinite availability of market analysis. Yet here we are some 170 years later dealing with the same dark, inexplicable forces, the same delusional trappings and irrational behavior.
The highly successful 20th century speculator and gold investor Bernard Baruch put his blessing on this book as one of the secrets to his success on Wall Street.
“Have you ever seen in some wood, on a sunny quiet day, a cloud of flying midges — thousands of them — hovering, apparently motionless, in a sunbeam? …Yes? …Well, did you ever see the whole flight — each mite apparently preserving its distance from all others — suddenly move, say three feet, to one side or the other? Well, what made them do that? A breeze? I said a quiet day. But try to recall — did you ever see them move directly back again in the same unison? Well, what made them do that? Great human mass movements are slower of inception but much more effective.”
This is the same Bernard Baruch who just before the stock market crash of 1929 liquidated his stock holdings and put his money into bonds and cash, and then later, after the crash, dumped a good portion of his fortune into gold. When asked why he would do such a thing by the secretary of the Treasury, Baruch replied that he was “commencing to have doubts about the currency.” While others banked on the 1920’s stock mania, Baruch’s intuition was telling him that there was something amiss. He resisted the lure of the crowd. Thus, if you are commencing to have your own doubts about this odd tango being danced by gold and the euro, then perhaps you might want to distinguish yourself from the crowd.
The madness of machines and the China put
Extraordinary Popular Delusions is both complicated and timelessly revealing – a chronicle of herd behavior, delusion, mania, craftiness, and financial loss and gain. It is highly recommended reading and particularly applicable to the situation in which we find ourselves today with respect to the gold market. Solomon taught us that there are no new things under the sun. Mackay teaches us how we might recognize the signs and that the crowd gone mad is a matter to be reckoned with in almost every era – our own not to be exempted. Baruch taught, through his personal investment decisions, that with respect to the madness of crowds and their inexplicable behavior, the best recourse is to run in the other direction. If the madness of crowds, or machines in this case, allows us a buying opportunity, then perhaps we should take it. In fact there are reports this morning of a “semi-official [gold] buyer in Asia.” One immediately thinks of the China “put” in the gold market wherein it buys the dips and puts a floor under the price.
Gold protects against these occasional bouts of social madness, and to buy it in physical form – as coins and bullion – is the most effective approach. There is an historical example, directly related to Mackay’s book, which illustrates the point. Early 18th century French finance minister, John Law, who perpetrated perhaps the most notorious mania covered by Mackay (the Mississippi scheme) ruined the French currency and, with it, the French economy. Needless to say, the citizenry did whatever it could to shelter itself from the rapidly depreciating paper scrip by going to gold. In one of his final acts before fleeing the country, Law abolished gold and silver coin as a medium of exchange, made gold ownership illegal and closed down the borders to anyone hoping to escape with hard assets. Needless to say, both Law and the public understood the value of gold under such circumstances.
Epilogue: Please resolve pi as soon as possible
With respect to the growing dominance of machines on Wall Street, I recall the old Star Trek episode that involves a visit to a planet where the inhabitants seem to be living in a state of perfect bliss. Captain Kirk knows that this cannot be right. There is no such thing as perfect happiness. As it turns out, the population is controlled not by a loathsome dictator who has drugged the population into compliance, but by a computer that has evolved sufficiently to somehow gain control of their minds. Something must be done, concludes Kirk, to break its hold. Spock comes up with the solution by instructing the computer “to resolve the value of pi” – an impossibility because its resolution, as we all remember from high school math class, is infinite. The computer spends all of its time and devotes all of its resources trying to achieve the impossible and the dictatorial hold it has on the population is released – a trick we might want to keep in mind for the day computers complete their mastery of Wall Street.
– Michael J. Kosares
USAGOLD update [September 4, 2018]: If anything, the effects of algorithmic trading have become more entrenched and pervasive in financial markets over the six year period since this piece was written. JP Morgan estimates that only 10% of trading in the U.S. stock market today originates with individual investors. The gold market has not been immune to the domination of machines. Since April, 2018 programmed trading has been in a downtrend with programmed short-selling the primary culprit. Now though, for reasons covered at the link immediately below, that situation may be about to change.
Gold – A reverse bubble in search of a pin
The victim might soon find itself the beneficiary
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Michael J. Kosares is the founder of USAGOLD and the author of The ABCs of Gold Investing – How to Protect and Build Your Wealth With Gold [Third Edition]. He is also editor and commentator for USAGOLD’s Live Daily Newsletter and editor of the News & Views monthly newsletter.