Fed cracking the whip will no longer work to keep the tiger sitting on its stool

by Michael J. Kosares

Yesterday’s Fed announcement is a distinct break with the past and a watershed moment for the markets psychologically.  The Fed will no longer be able to simply crack the rhetorical whip in order to keep the market tiger sitting on its stool. We will probably get a taste of what this all means in the near term, but, in my view, the Fed will find itself on the defensive with little left in the quiver, save the ultimate rate hike, to discourage speculative bubbles.  Since it will be hard-pressed to actually snap the whip on Wall Street’s nose (in the form of aggressive rate hikes), the door is open to all sorts of renewed reckless behavior – a hey day for speculators of every description until the bubble ultimately bursts.  The importance of a hedge in gold is now more important than ever.

In the June edition of NEWS & VIEWS, I wrote the following observation on current market behavior – a piece that might be particularly relevant in view of yesterday’s Fed announcement.

On lemming-like algos and distinguishing yourself from the crowd

Back in 2012, I wrote, “It used to be ‘Don’t fight the tape.’ Now it’s ‘Don’t fight the algorithm.’ Well, algos and the madness of machines have become even more entrenched and more influential since those days.

“Real money funds investment people just aren’t playing the gold market. Central banks, the whole lot of them aren’t trading the gold market the way they used to,” says David Govett, head trader at Marex Spectron in a Financial Times article. “It’s created thin nervous markets — the algos can jump in and push it around and make a mess of it.” Of course, Govett is talking about derivative trading, not the acquisition and/or sale of physical metal itself.

Eventually circumstances change. Assumptions are overturned. Algo’s are re-written and we suddenly find ourselves in an entirely different ball game. The algo driven bear can quickly become the algo driven bull. Best way to weather the madness of machines? Own the physical metal, sit back and wait for the lemming-like machine traders to see the light.

While thinking about the algo problem for the gold market, I recalled a story told by an old friend – an engineer who worked at a major engineering firm here in Denver. Our connection was a mutual interest in gold, but that’s another story.

The team had a tight project deadline when all of a sudden a power outage took out the lights, the computers – everything electronic. My engineering friend was old school – the kind of guy that wore a bow tie and kept his pens and a slide rule in the ever-present plastic holder residing in his shirt pocket (Some of you may remember the type).

The younger engineers stood around looking at each other – panic in their eyes. But my engineering friend, like all good engineers, had a back-up plan. He pulled out his slide rule, a number 2 mechanical pencil, found his yellow legal pad, sat by a window and completed the final project calculations without a hitch.

Don’t know why I like this story with reference to algo trading, but I do.

True story, by the way . . . . . .

Epilogue

Bernard Baruch, the famous early 20th century stock speculator, in explaining the behavior of markets:

“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. There are times when it pays to distinguish yourself from the crowd – the midge that flies in the other direction.

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