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Welcome to USAGOLD's "Gilded Opinion" pages. We invite you to browse our index of outstanding gold-based commentary. Each article or essay is selected on the basis of its long-term relevance for understanding the role gold plays in the individual's portfolio, the overall political economy, or both.
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Extraordinary Popular Delusions, The Madness of Crowds, Markets and the Gold Price
by Alan Brown
What is an Extraordinary Popular Delusion? Charles MacKay in his book written in 1841 about Extraordinary Popular Delusions and the Madness of Crowds referred to several instances of this occurrence from a historic point of view. These included the Tulip Boom and the South Seas Boom. No doubt if he was alive today he would have included the run up in stock prices in 1929, the Nikkei boom in 1989 and the current boom in world stock markets, led of course by the Internet madness of the last several years.
What he also referred to was the fact that the ingredients were always the same. A suspension of traditional valuation methods, accompanied by mass participation of the populace, a willingness to believe any old tale and an attempt to introduce a "new" system of fractional reserves so money can be freely issued. This "new" money has of course no actual redeemable reserves to back it up. Rather the acceptance level of this "money" expands at the same rate as the bubble itself, until finally, after the "game" has ended, an inquiry, official of course, is held to determine who the culprit is.
The problem with these "bubbles" or "manias" is that they get under way and gain momentum without being recognized for what they are. As they gain momentum they tend to become all- pervasive and affect the activities of the entire populace within the given region, something also noted by MacKay. From the mayor to the chambermaid, all become involved in the notion of new wealth and instant riches.
Even those opposed to the bubble usually try to make money on the other side of the equation. The "bears" become just as heavily involved and more importantly, motivated by the same bubble as do the "bulls'. One can't exist without the other and both are dependent upon the same game for their respective points of view. The all-pervasiveness of these passing moments in time is extremely efficient and not being involved is very difficult.
It is the contents of the "bubble" that provides the various individual opinions that go to make up the news of the day. Whether one is "bullish" or "bearish" it is the same game and when it ends it has a tendency (also noted by MacKay) to end badly, taking all participants with it. Both the "bulls" and the "bears" get their respective heads delivered to them on a plate. Being right and being poor is not the same as sensing that something will end badly and then doing something constructive about it. Standing in front of the bulls prior to a stampede is a mistake many bears make.
Being dependent upon a bubble for ones investment strategy, whether to the upside or the downside, means you are involved in the bubble itself. When it bursts it is of no consequence as to where you were sitting, the chances are you will get covered in something not of your own making.
Another characteristic of an "Extraordinary Popular Delusion" as noted by MacKay was the requirement for all and any alternative investments (alternative to the bubble that is) to become unpopular, publicly despised and to a lesser degree, given bad press by the media of the day. We see this today in the gold market.
While the conspiracy crowd point to manipulation of the gold market, they fail to see that, once a fully-fledged "bubble" is under way, all markets become manipulated. However, the manipulation the conspiracy crowd (themselves a product of the current delusion) refers to is as much a part of the madness and the delusion as everything else. What needs to go up, goes up, and what needs to come down, comes down during these periods. Keep the game going at all costs becomes the battle cry and some very simple basic instincts take over. Nothing too complicated, just more delusionary activity, as all participants become further involved.
Sanity is replaced by madness, a madness that sweeps all rational thinking before it. Any remembrance of a prior bubble and its after affects is conveniently forgotten. The "this time it's different" mentality--itself an ingredient of the bubble--takes over, affecting the minds of all participants. Very few are excluded from the sign of the times. This includes central bankers, regional bankers, investment bankers and any other forms of bankers.
The liabilities that are created as a result of the madness are, in most cases, difficult to escape from after the bubble has burst. Even lunatics want their pound of counter party flesh and will try to get it.
The need to restore some form of integrity into the local currency becomes a burning issue of the day and eventually the role of precious metals as the currency of choice, when all others have lost their popularity, comes back into play. The wheel turns the full circle, the guilty are led off to jail, paper currencies are now despised, that which was suppressed begins to reassert itself and the handful of people who actually saw what was coming and acted accordingly, continue to build their positions based on this new-found requirement for honest money.
The holders of paper generated as a result of the "boom" have become a much more sober crowd and the cleaners have moved in.
A review of the aftermath of the 1929 stock market crash provides some interesting insights. A comparison of RCA's (the new technology stock of the day) rise and fall to the potential rise and fall of Microsoft has been mentioned on several occasions. Certainly stocks lost a good portion of their value, and it was a long time before they returned to their previous levels. The buy and hold mentality eventually proved correct, but you certainly needed a good dose of longevity to achieve a profitable return.
One of the better performing stocks through till 1935 was Homestake Mining, the gold producer that is still around today--a fact that is remarkable in its own right. Like most stocks, Homestake declined off its peak, stayed flat through 1930 and began a rise that saw it peak at $495 (a 500%+ appreciation from 1929) in 1935. During that period it paid out $128 in dividends, including a 1935 payout of $56 per share. The rise in the price of gold from $20.67 to $35 per ounce during this period obviously was the lead contributor.
Homestake is used as an example by the gold bug community, as to why one should own gold stocks in times of currency turmoil and inflation. Certainly it was a great performer during the early thirties. That cannot be denied. But what is overlooked is that it was some time before the share price started to move up. Very few predicted the rise in the gold price and there was very little buying before the fact. Which means that buying gold stocks as a hedge is not a historical precedent. As the gold price increased so did the Homestake share price, but it was nearly three years after October 1929 that it began its rapid climb to $495.
Trying to predict this event again has cost holders of gold stocks dearly over the last few years. The more vocal the individual members of the conspiracy crowd are, the more likely they are to have lost large amounts betting on a rerun that has not happened.
What is interesting is that Homestake benefited from a rise in the price of gold that came about as a result of an official government mandated rise in the price of gold. While it is the commonly held view of gold bugs that today's Central Bankers are the enemies of a rising gold price and are doing every thing possible to suppress it, there was a time when they were regarded as the heroes of the day. Funny how things change and the wheel turns.
There is a precedent as evidenced by what happened to Homestake and the gold price during the thirties. Gold went up in price by official decree, not because gold bugs were buying it as a hedge against inflation, deflation, currency turmoil or anything else. Trying to second-guess central bankers is, certainly for gold bugs, hazardous to ones financial health. Understanding the CB's fallback position and acting accordingly may be a much more prudent course of action.
Lets not forget that private ownership of gold bullion during this period was also outlawed in the United States. Gold coins were exempt. However, the ability to move things around the universe is far superior today to what it was then, and owning gold bullion offshore would create difficulties for any administration that tried that stunt again.
What Homestake had was the ability to produce gold, sell it to a buyer, the US Government, and pay dividends to its shareholders. Cash dividends that is, the kind that were, no doubt, very welcome during a depression, a period when there was a shortage of cash and real cashflow.
It would be interesting to know how many of the "bears" of the late 1920's actually ended up owning Homestake stock during this period. Did they get it right and activate a strategy that protected them from financial chaos at the right time, or did they get caught up in the extraordinary popular delusion of the day?
Certainly today's gold mining stocks are a very different breed from the 1930's. Forward sales and complicated derivatives transactions have transformed the gold market into a form of gambling, not too different from most markets at present. Should the gold price rise many miners will have a problem. Margin calls on these often extremely complex transactions will sink them. We have already seen early warning signs of this with Ashanti and Cambior. Should the gold price either stay at these levels or decline further then the unhedged producers will have a problem making ends meet. The discrepancy between the actual cost of production and the price realized will widen...to the downside.
So why would one want to act now and buy a stock that may have more hidden liabilities than a porcupine disguised as goose down filled pillow? Being right in principle and wrong when it comes to timing is not a smart strategy, yet it is one that many "bears" have adopted.
What is interesting in the "extraordinary popular delusion" we are witnessing is that somebody is buying gold at these levels, and its not the gold bugs. Regardless of what the price is, every transaction has a buyer and a seller. Gold at these levels (even if the price does decline) is a great buy, providing of course one takes delivery of the purchase. While it is common knowledge that something funny is going on in the paper gold market, it still sets the price of physical metal; and should the shortage that shows up in the supply and demand numbers finally become a reality, then the leverage is in owning physical metal. Paper contracts will be shunned.
Perhaps the "bears" and the last remaining gold bugs should revisit their investment strategies and ascertain as to whether they are caught up in the extraordinary popular delusion referred to by Charles MacKay, or do they indeed have a strategy that allows them to keep their respective heads on their shoulders rather than have it end up on a plate.
Reprinted by USAGOLD with permission of Alan Brown. No further reproduction without permission.
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