Saturday, November 29, 2014

Gold's rising convenience yield

While I may have taken some jabs at the gold bugs in two recent posts, please don't take that to mean that I have it in for the metal itself. Gold is a fascinating topic with a history that is well worth studying. (See this, for instance). In that vein, what follows is some actual gold analysis.

Something weird is happening in gold markets. The future price of gold (its forward price) has fallen below the current gold price. Now in fairness, this isn't an entirely new phenomenon. Over the last year or two, the price of gold one-month in the future has traded below the current, or spot price, a number of times. However, this observation has grown more marked as both the three-month and six-month rates have also recently fallen below the spot price.

This degree of inversion is rare. Except for a brief flip in 1999 when near-term forward prices fell below zero for a day or two, future gold has almost always traded for more than current gold. See chart below, which illustrates the one-month to twelve-month forward price premium/deficit in annual percent terms:

Here's why this pattern has dominated:

Gold's forward price indicates the level at which a buyer and seller will contract to exchange gold at some point in the future. The seller must be compensated for a number of costs they will incur in holding the gold until the deal's consummation, including: 1) taking out a loan to buy the gold and stumping up interest expenses; and 2) paying to store and insure it in a vault. Together, these are called carrying costs.

The buyer of future gold needs to compensate the seller for these costs. Rather than paying the seller an up-front fee, the buyer builds a premium into the price they pay for future gold in-and-above the current spot price, say $5. The future seller of gold can use this $5 premium to cover their carrying costs, thereby coming out even in the end. So future gold trades above spot gold by the size of its carrying costs.

The current inversion of spot and future gold prices seems to break all these rules. The premium that sellers have traditionally required has not only shrunk to 0 but become a deficit. Put differently, sellers of future gold are no longer demanding a compensatory fee for storing and financing the metal. In fact, they seem willing to provide these expensive services at a negative price!

One explanation for the inversion is that with interest rates being so low, the costs of carrying gold have become negligible. This is only party correct. Minuscule carrying costs would imply a future gold price that is flat relative to the current gold price, when in actuality future prices are below present prices.

That leaves only one explanation for the inversion: there is some sort of hidden non-pecuniary benefit to holding the stuff. In futures-speak, this benefit is typically referred to as a commodity's convenience yield, a term coined by Nicky Kaldor in 1939. An analogy to oil markets may be helpful. Oil prices often invert because merchants see potential for future supply disruptions. Having oil on hand during these disruptions is immensely useful as it  spares our merchant the hassle of negotiating his or her way though an oil supply chain that may be severely crippled while ensuring that customer demand is smoothly met. So the convenience yield can be thought of as a flow of relief, or uncertainty-shielding services, provided to owners of inventories of a commodity. If that relief is sheer enough, than the convenience yield will be larger than the twin costs of financing and storage, resulting in inverted markets. (For an excellent explanation of the convenience yield in oil markets, check out this Steve Randy Waldman post).

That's what appears to be happening in gold. Gold merchants seem to be anticipating choppiness in the future supply and demand of the metal, and see growing benefits in holding inventories of the stuff in order to cope with this choppiness. The convenience yield on these inventories has jumped to a high enough level that it currently outweighs the costs of storing and financing gold, resulting in an inverted gold market.

Gold's convenience yield spikes every every few years due to market disruptions, with the last spike occurring during the 2008 credit crisis, the one prior to that in 2001, and the one before that in 1999 when central banks announced plans to limit gold sales. It just so happens that these earlier disruptions occurred when U.S. interest rates were already high enough that they continued to outweigh the metal's suddenly-augmented convenience yield. Inversions were brief and only on the 1-month horizon. Now that a disruption is occurring when interest costs are near zero, a more sharply inverted market is the result, dragging the 3 and 6-month horizons into negative territory. Going forward, all gold market disruptions could very well create sharp inversions of -1 to -2% in the 1 to 12-month horizons, insofar as we are living in an era of permanently low interest rates.

Is gold becoming money?

A number of gold bugs see the current inversion as something quite momentous. To understand why, you need to know that a gold bug's nirvana is when gold is once again 'money'. When something is money, it is highly liquid. The beauty of owning a highly liquid medium is that it can be mobilized to deal with almost any disruption to one's plans and intentions. Put differently, the convenience yield on stored money is very high. One measure of a paper dollar's convenience yield is the interest rate a government-insured certificate of deposit. Locking away cash for, say, 24 months means that the owner loses all the benefits of its liquidity. With 24-month certificates of deposit currently yielding 0.34% a year, the value of those forgone conveniences is 0.34%.

So when a gold bug's dream becomes reality and gold overtakes the dollar, yen, pound etc. as the world's most-liquid exchange medium, that is the equivalent of saying that gold is providing investors with the market-leading monetary convenience yield. And a permanently high convenience yield would result in a permanently inverted gold market (or at least a much flatter one).

Is the current inversion an indication that gold is becoming money? I don't think so. If the augmented convenience yield on gold was in fact rising due to gold's liquidity having surpassed that of fiat money, we'd expect this to be reflected not only in near-term forward prices but along the entire horizon of forward prices. Not only should the 3-month forward prices be inverted, but so should the 3-year forward price. Is this the case? Not really. If you've seen Crocodile Dundee, I'd suggest you go and check out this hilarious post by Bron Suchecki illustrating the extent of gold's inversion. If you haven't seen the movie (you should), check out the chart below.

The first data point is the spot price. Gold forward prices are inverted after that, but only over a narrow range of five or six-months. By mid-2015, forward prices return to their regular pattern of trading at a premium to current prices.

So no, gold is not becoming money. Rather, we are running into some short-term jitters, and merchants think that holding the stuff provides a few more ancillary benefits than before.

Could these short-term supply & demand problems crescendo into longer-term problems, resulting in inversion beyond 2015? I don't think so. Unlike oil and most other commodities, the supply of mined gold is never used up. Ounces that were brought out of the ground by the Romans are still in existence. This means that supply disruptions should never pose a significant problem in the gold market since gold necklaces and fillings can be rapidly melted down into bars and brought to market. While we care if Saudi stops all oil production or if the U.S. corn harvest is terrible,  if South Africa ceases to produce gold—meh.

This means that the convenience yield on inventories of gold will almost always be less than the convenience yield on stocks of oil, since the sorts of disruptions in the gold market will always be shorter and less extreme than in oil markets. Oil supply shocks can be so sharp and enduring that oil's convenience yield remains elevated for long periods of time. The result is an inverted oil market over the entire time horizon. Such inversions are fairly common events in oil markets (once again, see Bron's post).

Gold shocks can never be enduring, so the types of price inversions we'd expect will be fleeting and only appear in the near-term time horizon. Like the one we are seeing now. In sum, we've seen this all before, and no, it's not the end of the world.

Sunday, November 23, 2014

Not your father's price index: the Billion Prices Project

The price of 52 Samsung TVs gathered by the BPP, April 2008 - November 2009 (Cavallo)

In a previous post, I mentioned that the Billion Prices Project (BPP) contradicts the claims of those who believe that the government understates inflation data. The BPP crawls major US retailers' websites and scrapes them for price data, compiling an overall US Daily Index that is available on its website. The deviation between this index and the official CPI is minimal, as the above link shows.

The BPP isn't your father's price index—it shouldn't be viewed as a perfect substitute for the CPI. So use it wisely. What follows are a few details that I've gleaned from several papers on the topic of online price indexes as well my correspondence with Roberto Rigobon, one of the project's founders.

The most obvious difference between it and the CPI is in the datasets:

1) Online vs offline: The price data to generate the CPI is harvested by Bureau of Labour Statistics (BLS) inspectors who trudge through brick & mortar retailers. Rigobon and his co-founder Alberto Cavallo get their data by sending out lightning fast algorithms to scrape the websites of online retailers.

2) Wide vs Narrow: BLS inspectors compile prices on a wide range of consumer goods and services. According to Cavallo, only 60% of the items that are in the CPI are available online. The ability to track service prices online is particularly limited given the fact that most large retailers' websites only sell goods.

Let's get into some more specifics about what is included in the BPP, because there seems to be some confusion about this in the online discussion. Some commentators have mentioned that the BPP doesn't include gasoline prices. Rigobon informs me that this is wrong, gas prices are included in the US Daily Index. As for the cost of housing, my understanding is the BPP does track real estate data. It incorporates these prices using the same methodology as the BLS. So any deviation between the BPP and CPI should not be attributed to the BPP's lack of either gas prices or housing.

Lastly, despite the fact that service prices are under-represented online, the BPP's US Daily Index does include a number of services. According to Rigobon, the easiest ones to track are things like health insurance, transportation, restaurants, hotel, and haircuts. Others are hard to track, like the cost of public education. My understanding is that Rigobon and Cavallo may use proprietary methods to calculate service prices by referring to various goods' prices as proxies (see here). For instance, in this BIS comment on the BPP, it is noted that the price of education can be computed from prices of text books, uniforms, energy and construction materials, all of which represent 75% of cost of education.

3) Often vs rare: The BPP's algorithms trawl retailer websites every day. BLS inspectors stroll through the malls just once each month.

Another big difference is in the publication of the data:

4) Now vs later: The BPP is reported three days after the data has been gathered, and ten days for non-subscribers. CPI is reported with a long delay, usually the second or third week following the month being covered.

The next few differences are a little more technical:

5) Fixed vs Responsive: Both indexes measure entirely different consumption baskets. The BLS surveys U.S. households every few years in order to gather information about their spending habits. It uses this information to construct a fixed representative basket of goods & services consumed by Americans, and then proceeds to fill in the data each month. This survey approach results in a CPI basket that takes time to adjust to new products. Should a revolutionary device, say a universal mind reader, suddenly becomes popular, it won't be reflected in the CPI till the next survey.

Think of the BPP as capturing a dynamic market-determined consumption basket. The BPP basket is comprised of whatever goods retailers happen to be selling online that day in order to meet customer demand. Because retailers are constantly updating their websites, August 7's basket could be different from August 8's. This means that new goods will be quickly incorporated into Rigobon and Alvarez's inflation calculation. In other words, when universal mind readers do catch on, the BPP will incorporate this data way before the BLS will.

One of the most interesting differences is the difference in methodology:

6) Small vs Large Sample size: The BLS delicately samples offline prices whereas the BPP bulldozes through a large percentage of the entire population of online retailers' prices.

There are millions of goods sold in the US, and it would be cruel to force BLS inspectors to collect prices for all of them. To simplify the calculation, the BLS brain trust chooses individual products to serve as ideal representatives for given product categories. Take dishwashers. To represent the category, they might select the Whirlpool WTD-10 or some such model. A BLS data collector in New York City will go every month to a specific store, say Macy's on West 34th St, and grab that specific model's price. The repetitive use of the same product and location ensures that the New York City dishwasher price index is not corrupted by changes that have little to do with purchasing power. (The alternating collection of prices from Macy's on West 34th and Nordstrom's on Union Square might introduce price changes having little to do with inflation.)

Because their algorithms are whip fast and don't require salaries, Alvarez and Rigobon can afford to send them out each day to Macy's website to gather the price of every single dishwasher. They do this for each of the major online retailers, say Walmart, Target, and Best Buy. The final assemblage of prices represents something close to the entire population of online US dishwasher prices on every single day!

This segues into the thorny problem of adjusting for quality changes. They both use different techniques:

7) Statistical vs market-based quality adjustments: As I pointed out, the BLS samples one good to represent a given category rather than canvassing the full range of products within that category. This causes some difficulties in accounting for quality changes when that one good is replaced by another product.

Let's return to the Macy's example. Say Macy's stops stocking the Whirlpool WTD-10. On arriving at Macy's a few weeks later, our flummoxed BLS data collector has to find a replacement in order to keep the dishwasher price category up to date. Let's say she grabs the price of a General Electric XK-400 from across the aisle. The GE is priced $50 higher than the missing Whirlpool was during the inspector's previous visit. The problem is this: how does the BLS determine how much of that $50 increase is due to changes in quality and how much is due to changes in inflation? If the GE is the same in every way to the Whirlpool except its boasts a turbo wash option, then some portion of the $50 increase is due to the higher quality of the GE. But how much?

Because Cavallo and Rigobon's tireless algorithms regularly retrieve multiple product prices for each category rather than single monthly representatives, they can use the overlapping nature of the data to seamlessly splice in new products. Let's say that the expensive GE dishwasher is introduced to Macy's website. It is sold on the same page as the existing and cheaper Whirlpool for a few days at which point the latter is removed. On the day the GE first appears, the BPP ascribes its higher price to its superior quality. While the GE drives up the average price of dishwashers on Macy's dishwasher page, the purchasing power of a Macy's shopper hasn't been altered, rather, a given dollar buys more 'dishwashing services' than before. Only on day 2, after the GE's price has been retrieved a second time by the algorithms, is it allowed to start affecting the index, since any price change thereafter is considered to be due to inflation, not quality.

The assumption that the GE's premium is due entirely to quality is based on the idea that market prices are accurate measures of all that is known by producers and consumers about a given set of products.

Because CPI collectors have limited resources and typically only collect the price of one representative dishwasher, they usually can't rely on the overlap between dishwasher model prices to measure quality changes. One method they have developed to compute quality changes is hedonic regression. In brief, a dishwasher is conceptually broken up into a package of characteristics, including its size, time per run, energy efficiency, etc. When the Whirlpool is suddenly dropped by Macy's and the GE added, CPI data collectors try to determine what sorts of new characteristics have been incorporated in the GE and then use regression methods to determine the dollar value of that characteristic.

So to sum up, to calculate quality changes, the BPP piggy backs on the power of the market to price differences in quality. The BLS uses econometric methods (among other tools) to control for quality changes.

Here is a big one, the difference in ownership of the indexes:

8) Private vs public: The CPI is compiled by the BLS and funded by taxpayers, whereas Rigobon and Cavallo have incorporated a private company called Pricestats to compile the BPP US Daily index and its many other indexes. PriceStats work in partnership financial-giant State Street to distribute the data to paying subscribers.

Which leads into the last major difference:

9) Transparent vs opaque: There is loads of documentation on the CPI. If you have any questions, call up the BLS and a researcher will walk you through it—it's your right as a taxpayer. PriceStats can only reveal so much information because their methods are proprietary (although Dr Rigobon was kind enough to answer a number of my questions). I suspect they are hesitant to reveal too much of information because the retailers on which they have gathered data might view this as a potentially threatening action. Not so with the CPI.

So those are some of the features of each index. In the case of the BPP, the difficulty of getting public information on their methodology is probably the biggest bug, although the founders are forthcoming on general questions. Maybe if national statistics agencies start adopting BPP data collection methods, the transparency problem will be solved, since public agencies have no competitive reasons (and less legal ones) to hold back information on methodology. There seem to be rumblings in this direction: Statistics New Zealand says that they are in the early stages of a collaboration with with PriceStats to develop online price indexes (link).

For now the public is lucky to get access to the US Daily Index, even on a 10-day delay. When CPI numbers are reported, the bond market quakes. For hedge funds, getting a hint of what the upcoming government inflation print will be before anyone else is probably worth a lot of money. No doubt that's why they are willing to pay to subscribe to get PriceStat's numbers. These funds would probably prefer if the public were not privy to the US Daily Index as it reduces the information's value. The amount they'd be willing to pay PriceStats to yank the US Daily Index from the public domain would be a good indicator of the value the public gains by getting free access to it. It could be a substantial number.


Back to initial reason for writing about the BPP; the gold bugs (Gulp, you thought I'd forgotten about you, right?). Your typical gold bug will sagely mention some esoteric price that has risen at an incredible rate over the last few years, like the price of shitaake mushrooms or a 1982 GI-Joe Snake Eyes collectors action figure (here is Peter Schiff using the Big Mac). A gold bug is convinced that their preferred data series is sufficiently strong evidence to justify declaring inflation to be stratospheric and the entire CPI null and void.

What makes gold bugs think that their one or two pet prices are a superior measure of the dollar's purchasing power than the BPP US Daily Index? Crickets. That sums up the gold bug response to the BPP's existence. If not crickets, then desperate attempts to change the subject.

Gold bugs don't like to talk about the BPP because they don't want to be dissuaded from their views—they find too much comfort in them. With the BPP continuing to move in line with the CPI, the gold bug community's cognitive dissonance is growing. At some point, the squirm-level will get large enough that they'll have to do something about it. No doubt the easiest route will be to come up with a fiction that discredits the BPP US Daily index. Well, hey gold bugs, here's a conspiracy theory you can use to save yourselves some painful cognitive dissonance... the Billion Prices Index went offline for a period of time, just when it appeared to be showing a break with the CPI index. When it went back online, the two started to converge. Could it be that Rigobon and Alvarez were brought into some FBI dungeon and re-programmed, the BPP moving more in line with the party line after they emerged? Yeah, that's it.

Saturday, November 15, 2014

Sign Wars

Does a lowering of a central bank's interest rates create inflation or deflation? Dubbed the 'Sign Wars' by Nick Rowe, this has been a recurring debate in the economics blogosphere since at least as far back as 2010.

The conventional view of interest rate policy is that if a central bank keeps its interest rate too low, the inflation rate will steadily spiral higher. Imagine a cylinder resting on a flat plane. Tilt the plane in one direction —a motif to explain a change in interest rates—and the cylinder, or the price level, will perpetually roll in the opposite direction, at least until the plane's tilt (i.e. the interest rate) has been shifted enough in a compensatory way to halt the cylinder's roll. Without a counter-balancing shift, we get hyperinflation in one direction, or hyperdeflation in the other.

The heretical view, dubbed the Neo-Fisherian view by Noah Smith (and having nothing to do with Irving Fisher), is that in response to a tilt in the plane, the cylinder rolls... but uphill. Specifically, if the interest rate is set too low, the inflation rate will jump either instantaneously or more slowly. But after that, a steady deflation will set in, even without the help of a counter-balancing shift in the interest rate. We get neither hyperinflation nor hyperdeflation. (John Cochrane provides a great introduction to this viewpoint).

Many pixels have already been displayed on this subject, about the only value I can add is to translate a jargon-heavy academic debate into a more finance-friendly way of thinking. Let's approach the problem as an exercise in security analysis.

First, we'll have to take a detour through the bond market, then we'll return to money. Consider what happens if IBM announces that its 10-year bond will forever cease to pay interest, or a coupon. The price of the bond will quickly plunge. But not forever, nor to zero. At some much lower price, value investors will bid for the bond because they expect its price to appreciate at a rate that is competitive with other assets in the economy. These expectations will be motivated by the fact that despite the lack of coupon payments, the bond still has some residual value; specifically, IBM promises a return of principal on the bond's tenth year.

Now there's nothing controversial in what I just said, but note that we've arrived at the 'heretical' result here. A sudden setting of the interest rate at zero results in a rapid dose of inflation (a fall in the bond's purchasing power) as investors bid down the bond's price, followed by deflation (a steady expected rise in its value over the next ten years until payout) as its residual value kicks in. The bond's price does not "roll" forever down the tilted plane.

Now let's imagine an IBM-issued perpetual bond. A perpetual bond has no maturity date which means that the investor never gets their principle back. Perpetuals are not make-believe financial instruments. The most famous example of perpetual debt is the British consol. A number of these bonds float around to this day after having been issued to help pay for WWI. When our IBM perpetual bond ceases to pay interest its price will quickly plunge, just like a normal bond. But it's price won't fall to zero. At some very low level, value investors will line up to buy the bond because its price is expected to rise at a competitive rate. What drives this expectation? Though the bond promises neither a return of principal nor interest payments, it still offers a fixed residual claim on a firm's assets come bankruptcy, windup, or a takeover. This gives value investors a focal point on which they can price the instrument.

So with a non-interest paying perpetual bond, we still get the heretical result. In response to a plunge in rates, we eventually get long term deflation, or a rise in the perpetual's price, but only after an initial steep fall.  As before, the bond's price does not fall forever.

Now let's bring this back to money. Think of a central bank liability as a highly-liquid perpetual bond (a point I've made before). If a central banker decides to set the interest rate on central bank liabilities at zero forever, then the purchasing power of those liabilities will rapidly decline, much like how the cylinder rolls down the plane in the standard view. However, once investors see a profit opportunity in holding those liabilities due to some remaining residual value, that downward movement will be halted... and then it will start to roll uphill. Once again we get the heretical result.

The residual claim that tempts fundamental investors to step in and anchor the price of a 0% yielding central bank liability could be some perceived fixed claim on a central bank's assets upon the bank's future dissolution, the same feature that anchored our IBM perpetual. Or it could be a promise on the part of the government to buy those liabilities back in the future with some real quantity of resources.

However, if central bank liabilities don't offer any residual value whatsoever, then we get the conventional result. The moment that the central bank ceases to pay interest, the purchasing power of a central bank liability declines...forever. Absent some residual claim, no value investor will ever step in and set a floor. In the same way, should an IBM perpetual bond cease to pay interest and it also had all its residual claims on IBM's assets stripped away, value investors would never touch it, no matter how low it fell.

So does central bank money boast a residual claim on the issuer? Or does it lack this residual claim? The option you choose results in a heretical result or a conventional result.


What does the data tell us, specifically the many cases of hyperinflation? As David Beckworth has pointed out, the conventional explanation has no difficulties explaining the Weimar hyperinflation; the Reichsbank kept the interest rate on marks fixed at very low levels between 1921 and 1923 so that the price level spiraled ever upwards. Heretics seem to have difficulties with Weimar—the deflation they predict never set in.

Here's one way to get a heretical explanation of the Wiemar inflation. Let's return to our analogy with bonds. What would it take for the price of an IBM perpetual bond to collapse over a period of several years, even as its coupon rate remained constant? For that to happen, the quality of the bond's perceived residual value would have to be consistently deteriorating. Say IBM management invested in a series of increasingly dumb ventures, or it faced a string of unbeatable new competitors entering its markets. Each hit to potential residual value would cause fundamental investors to mark down IBM's bond price, even though the bond's coupon remained fixed.

Now assuming that German marks were like IBM perpetual bonds, it could be that from 1921 to 1923, investors consistently downgraded the value of the residual fixed claim that marks had upon the Reichsbank's assets. Alternatively, perhaps the market consistently reduced its appraisal of the government's ability to buy marks back with real resources. Either assumption would have created a consistent decline in the purchasing power of marks while the interest rate paid on marks stayed constant.

Compounding each hit to residual value would have been a decline in the mark's liquidity premium. When the price of a highly-liquid item begins to fluctuate, people ditch that item for competing liquid items with more stable values. With less people dealing in that item, it becomes less liquid, which reduces the liquidity premium it previously enjoyed. This causes the item's purchasing power to fall even more, forcing people to once again turn to alternatives, thus making it less liquid and igniting another round of cuts to its liquidity premium and therefore its price, etcetera etcetera. In Weimar's case, marks would have been increasingly replaced by dollars and notgeld.

So consistent declines in the mark's perceived residual value, twinned with a shrinking in its liquidity premium, might have been capable of creating a Weimar-like inflation, all while the Reichsbank kept its interest rate constant.


That's not to say that central bank liabilities do have a residual value and that the heretical result is necessarily the right one. Both possibilities make sense, and both can explain hyperinflations. But to determine which is right, we need to go in and do some gritty security analysis to isolate whether central bank money possesses a fixed residual claim on either central bank assets or future government resources. Parsing the fine print in central bank acts and government documents to tease out this data is the task of lawyers, bankers, historians, fixed income analysts, and accountants. And they would have to do a separate analysis for each of the world's 150 or so central banks and currencies, since each central bank has its own unique constituting documents. In the end we might find that some currencies are conventional and others are heretic, so that some central banks should be running conventional monetary policies, and others heretic policies. 

In closing, a few links. I've taken a shot at a security analysis of central bank liabilities in a number of posts (here | here | here), but I don't think that's the final word. And if you're curious how the Weimar inflation ended, go here.

Tuesday, November 4, 2014

Gilded cage

This blog wouldn't be around if it wasn't for gold bugs.

Many moons ago my former-employer (and friend), the truest gold bug you'd ever meet, would lecture everyone in the office for hours about imminent hyperinflation, the wonders of the gold standard, and why gold should be worth $10,000. Fascinated, but unsure what to make of his diatribes, I started to read about the history of monetary systems, all of which would eventually provide grist for this blog.

A gold bug will typically have the following characteristics. 1) An abnormally-sized portion of their investing portfolio will be allocated to the yellow metal; 2) they believe in an eventual 'day of reckoning' when gold's price rises into the stratosphere, the mirror image of which is hyperinflation; 3) their investing case for gold is twinned with strong moral view on the decrepitude of the current monetary system and/or society in general; and 4) they are 100% sure that the monetary system's collapse will lead to the flowering of a new and virtuous system, a gold standard.

One thing I discovered fairly early on from my interactions with the gold bug community is that there's no point in debating a gold bug. In any debate, you should be able to ask your opponent what evidence they'd accept as proving their idea to be wrong. Gold bugs are loathe to submit such a list. After all, to do so would open up the possibility that they might have to precommitt themselves to changing their mind, which is the last thing they want to do. A gold bug's ideas are comforting to them. They've structured their entire mental landscape around these ideas, not to mention their entire life's savings and often careers around them.

Gold bugs have a powerful set of defense mechanisms to protect their ideas from outside threat. These mechanism, I'll call them 'mental bodyguards', will kill on sight any idea or bit of evidence that runs contrary to the gold bug schema, thus saving the gold bug from the discomfort, and potential danger, of having to weigh each new bit of data on its own merit.

For instance, consider the fact that central bank money was unmoored from the gold peg in 1968 (almost 50 years ago!). The monkeys behind the wheel should have caused hyperinflation by now and all those financial Noahs who were smart enough to jump into the gold boat before the fiat flood should be fabulously wealthy. But gold trades at just $1200 or so, not far above $850 levels set in 1980. Except for a few exceptions like Zimbabwe, hyperinflation hasn't happened.

Gold bugs can rationalize this contradiction because they possess a 'mental bodyguard' that absolves them of any responsibility for the timing of their predictions. Like the Millerite movement—which predicted the second coming of Jesus Christ on March 21, 1884, only to have to push the date to April 18 when nothing happened, and when that day passed uneventfully, bumped the event to October 22—gold bugs can keep pushing the day-of-reckoning further into the future without suffering any mental dissonance. Using an even more impressive bit of mental-Aikido they turn disconfirmation into a positive. The longer gold's meteoric rise is forestalled, say gold bugs, the more time it provides true believers with an opportunity to accumulate a larger stash of the stuff.

Another powerful mental body guard is the invocation of "them". Gold bugs invariably blame vague external and impersonal forces for wreaking havoc on the noble intentions of gold bugs and the upwards trajectory of the metal's price. They  may be the Federal Reserve, the plunge protection team, or a cabal of Jewish bankers (politically-correct gold bugs just blame Goldman Sachs). When gold falls in price it's always because of the the machinations of these oppressors, without which the metal would be worth $12,000 or $13,000 by now. (Yes, gold bugs like to refer to gold as "the" metal, presumably to differentiate it from all the plebeian metals)

Thanks to the them mental body guard, the inability of gold bug predictions to be borne out in reality is never due to any inherent weakness in the ideas themselves, but to outside interference. Doubts are conveniently refocused on something external like Ben Bernanke and the Fed, upon which gold bugs regularly bestow two minute hates.

Other mental bodyguards that prove useful in protecting the core gold bug ideology include the knee jerk discredit that gold bugs level at both the economics profession and economic data. Gold bugs screen out economists by deriding them as mainstream and therefore (obviously!) puppets of the system. The shoot-first assumption of guilt spares gold bugs from having to engage with these economists' potentially contradictory ideas on a level playing field. The same goes for inflation data, which they dismiss out of hand as being 'cooked'. And if you try mentioning the MIT Billion Prices Index to them, they hum loudly and put their fingers in their ears. (Although when there's any sort of divergence between the BPI and CPI, they suddenly start to make noise).

The awful returns that gold and especially gold shares have provided over the decades have impoverished many gold bugs as well as those unlucky enough to listen to them. Yep, I've seen the year-end statements. Yet somehow the gold bug meme continues to limp on. That's because gold bugs are less concerned about making money than upholding "the cause", as they like to refer to it. The cause is a vague combination of the promotion of a gold standard and a +$10,000 gold price, where simply holding gold through all downturns is an expression of support for that cause. Mere financial losses cannot keep them down.

Now I've been tough on the gold bugs in this post, but the fact is that gold bugs would probably say that both myself and any of their many accusers harbour mental body guards of our own. And the gold bugs probably wouldn't be entirely wrong. With so much time and energy having been invested in the various things we know and believe, a bit of cognitive dissonance is only natural. I'd argue that the gold bugs having walked much further out along that plank than their critics.

This post won't change the minds of any gold bugs—as I already pointed out, they've made up their minds long ago. But if you're a busy individual with some money to invest, and you're considering a gold bug advisor, remember that the fate of your investment may take second seat to the gold bug's devotion to the cause. Be wary.