Economists Don’t Understand Capital Markets

A week ago, the Dow Jones Industrial Average (^DJI) capped its worst week since 1914. The MSCI World Index of equities in 23 developed countries slid 20 percent, the most since records began in 1970. This week, with a modest recovery, life moved on.

That’s not to say that people are not just as anxious. Perhaps they are even more so because this week they have had the time to review their holdings and dwell on the results. Most people are emotionally injured, some overwhelmed.

Yes, we need to practice prudence; however, there is little I can do at this point for people who would like to believe dim-witted economists who are saying that the world is falling apart. Perhaps this anecdote will help in a small way.

Hello Bill, I want to thank you for all the work you do for the community. Stating your position in a clear manner and staying the course is difficult to say the least. These are indeed historic times. I am in the market as of 9/24/08, and added since. Still have some cash left. This reminds of Oct.1987, I was stockbroker and my clients were hurting. I felt terrible! We made it thru. Life goes on. Thank you. God bless. /AnonI replied,

Hi Anon,
Thank you. All the people heard this week on TV was that the world is falling apart, and that must mean my urging last weekend to get back on the horse may be seen as terrible advice — but this week 27 of 30 DJIA stocks were up, and 10 of 10 sectors. The S&P 500 (+4.60%) and NASDAQ (+4.74%) had huge gains despite a bad Friday. All I can do is try to keep people calm. Yes, there are serious problems such as with the mega-trillion dollar CDS market that has almost stopped the credit market in its tracks, and with the dramatic impact this has had on the economy. But all governments are committed to fixing that - regardless of the cost. The higher the cost, the higher PM and Oil must go. So there is always a silver lining, if we choose to look for it. Now that we have sunk to such a depth, as in October 1987, now is the time to look up.
Best,
/Bill

That man is a former stockbroker. He knows that economists, as a rule, don’t understand capital markets. People like Warren Buffett and Bill Cara do.

Buffett, you say, has an axe to grind; well, I don’t. I’m telling it like it is.

I said this a week ago, that an economist on Wall Street is considered a lower class of employee than the staff who the big hitters send out for box lunches. An economist working in the Ivory Tower is counted on for one thing only - as part of a marketing show. These people are never allowed in a sales room or near a trading floor.

Sales people and traders are paid the best money on Wall Street because they make money. If they don’t, they get fired. Economists are like government, part of the overhead.

Here’s another anecdote. Several years ago, the firm I was running had a small team of proprietary traders. If the individuals couldn’t measure up with 100% annual profit performance, they were terminated. Admittedly, profit-making is much tougher today; but I can tell you that back then, if an economist got within eyesight of the firm’s capital traders, I would have been fired.

I’m just trying to tell you the way it is; not just make enemies with economists.

What is an economist anyway? The name has been bastardized, like accountant. Anybody today can get a PhD or a CPA and call themselves whatever they want. The banks even call their sales people financial advisors for Pete’s sake.

We live in a world of make believe. I told you that the first month I started to blog, back in April 2004. Too few people want to tell the truth.

I always said that to be successful in trading you need to follow just a few simple rules: a key one is do nothing different in the management of your portfolio than you would in managing your business, career or household.

Something else you should know; if you can trade A, B or C - whatever it is - then you can trade D, E and F. Case in point: I’d like to invite the Economics Departments of Princeton, Yale and Harvard to a New York City Police lost and found auction. Disperse them through the crowd. Let them bid for any item… bicycles, watches, laptops, whatever. If any economist that day happens to buy a single item without raising laughter and ridicule from the crowd I’ll be shocked.

They could all go home and write a wonderful dissertation on the auction process, maybe even submit it for a Nobel Prize, but every one of these people would be a dismal failure at the trading process because they are not traders.

Let me hand-pick a dozen street people from that Police lost and found auction room and within a month or two I’d put them up against your pick of a dozen of the top economists from Ivy League Schools, the Fed, and the National Economic Council of the President in competition to trade a billion dollars for a month.

Head to head; I assure you, the brainiacs will lose.

We are learning a lot from this period in history. You need to learn how to trade, which means you have to dismiss all the clap-trap that salespeople and economists have taught you.

Why do you think I never refer to you as an investor? Wall Street calls you an investor - if they’re not calling you a sucker. Investors buy things like homes and cars and insurance. But a capital market doesn’t have goods and services. A capital market only has prices. The price one minute is different from the next.

In the capital market, you and I can only trade prices. That makes us traders.

Although it may appear to be, because Wall Street wants you to think that way, trading is not simple. It requires an understanding of nuances - just like the successful traders in that police auction have an understanding of street value and can sense the mood swings during the bidding there.

At the end of February this year I sent a report to well over 200 of you to say that I believed that Goldcorp (GG) should be sold at $44.71 and bought back in the low 30’s. By the end of April, the price had dropped to 34. Then, the gnomes who control these things pushed GG to a high of $52.65 on July 15. I wasn’t dismayed; I told you at the start of July and again in early September that the share prices of the major base metals companies had hit the wall, and the metals market was looking shaky. This time GG really collapsed. There was a delay in timing that you might have expected from my earlier words that “gold is the last dancer off the floor”.

Here is an interactive chart of Goldcorp (GG) vs diversified base metal miner Teck (TCK). You can see how my call to sell GG at the end of February was prescient. You can see the break-downs in July and September. You can see the relative strength in recent weeks, which showed me that GG was ready to come back. I opined that the much more important base metal miners would also need to have a come-back before any meaningful rally could happen in the goldminer stocks.

Look at the move in late April with TCK, which was similar to the ones in the rest of the base metals. That pulled GG higher, but at a slower pace, so I stuck to my guns. Btw, the TCK move at the end of August was an anomaly caused by an acquisitions deal done by Teck, so that was what I call ‘noise’.

A couple weeks ago (Sept 12 in Seeking Alpha as well as in the blog) I opined that GG should be bought at 26, following which the price zoomed the next day, lasting until precious metals prices were hit yet again, this time to a low for GG on Friday of $18.56.

But, as you know, I said in that article that the price of GG could trade down from 26, and my readers also understand that I use put writes during cycle bottom periods to pick up positions of the volatile traders, using the premiums that expire to also lower my cost base. So my price would be known, by those who appreciate the nuances, to be lower than 26, possibly down to 20-22. At $20.09, I am in the ball-park, which is the reason I am not concerned.

One of my associates wrote in the Discourse before the Friday session started that he was taking part positions in a few leading gold producers, including GG, following the early sell-off that was expected. Within an hour, the price of GG did hit $18.56; however, it closed the day higher, as I say at $20.09, where I think it represents good long-term value.

Is gold ready to fly, which is necessary for the goldminer Bull to start his run? Gold, silver and platinum prices were hammered on Friday, so I believe there will be lots more sell orders - some from margin calls - on Monday, for both the gold futures and the goldminer stocks.

On Friday, however, I noted that palladium was up almost +1.0% and copper jumped +4.2%. But, why would these economic metals be jumping when the economy is supposed to be going to hell in a hand-basket as the messages from Princeton, Harvard and even the Fed’s Bernanke are saying?

Prices move one way or another when the beliefs of the buyers or the sellers are greater. On Friday, there were believers in copper and palladium. Now, I won’t trade copper because, as you know, I don’t work in Zug Switzerland or trade at Mick’s desk in London. But, I know enough that I have to keep my eyes on the prices of the economic metals (ie, the base metals like copper) and particularly the mining giants that produce them.

As well, I keep my ears closed when economists are doing most of the talking on TV. Call it experience.

My understanding of macro-economic relationships tells me that (i) several trillions of reflation by each of the US and Europe, plus lesser but still huge amounts by other governments, must ultimately be priced into gold, and (ii) the gnomes who make these things happen (remember the FIFO rule as well as the Golden Rule, ie, those who control the gold make the rules) are awaiting the outcome early this coming week of some $400 billion in Credit Default Swaps that get presented at the closed teller window of bankrupt Lehman Brothers.

Will the US Treasury, Fed, FDIC and HB&B step up to the plate and catch the ball. I think they will, but the possibility of their dropping it has traders on edge.

I mean, what’s another $400 billion when there is already five times or more in the ante. The players will call, and then the rest of us will get to see the result. Of course, not being in the room, we don’t get the telephone call. We have to wait to see the share blocks being bid or offered by the gnomes.

Capital market prices are always on a hinge. At certain points, when trends and cycles are in the process of turning there is extra volatility when the major forces in the market duel it out. Right now the Bears are very strong in the precious metals because they have the backing of the US Administration, the Fed, and HB&B, all needing a stronger $USD to allay the fears of the public and their creditors around the world that the $USD is going to collapse because of this Paulson Reflation Program, the likes of which nobody has ever seen before.

My bet is that the Interventionists get to save the financial system at this point anyway, but the cost will be humungous.

To hedge the weaker USD, traders have been hopping on the bullion train. Paper gold, ie, ETF’s and futures, has been rejected for now by independent traders. The chosen hedge is real gold, the physical bullion. It can’t be printed from trees or made electronically out of credit and the fractional reserve system, like fiat money, ETF’s and futures. That’s obvious to the public because the bullion and coin suppliers have run out of inventory to sell you.

Something has got to break open here. If the Interventionists were to keep forcing the gold price lower, the hurting public would pawn their gold, believing the price will never return to its former glitter. But, at some point soon, the debt-free goldminers would stop production, conserve their cash and wait out the ultimate pressures of the Paulson Reflation Program, which will return gold to prices above and beyond anything seen to date.

So the system is really screwed up while the CDS problems are sorted out between finance ministers, central bankers and the heads of the major private sector banks. Independent traders are waiting for an outcome. Those who have no debt are in the fortunate position of not having to panic and kowtow to the Golden Rule. I hate to say it, but those of you who are submerged with debt are the ones who are desperate and complaining most today. [I also understand that most of you are not prepared to day trade!]

In closing this intro, I need to repeat what I believe is needed for US politicians to do in this time of financial system crisis. A week ago I wrote,

“Value-add is good. In fact, the new financial system to be developed by the G-7 needs to be built on that principle, along with the following precepts:

• eradication of self-regulation and all possible conflict of interest dealings;
• independent and separate financial services and capital markets regulation as a subset of the federal judiciary, with filings managed by Finance ministers;
• removal of central banks and Government Sponsored Entities (GSE) like Fannie and Freddie as quasi government (public) financial institutions, putting them entirely back in the private sector;
• independent private sector depositories for securities and precious metals;
• independent marked-to-market vs cost basis double accounting;
• transparent and fully-disclosed credit markets and financial services, with the elimination of non-disclosed contingent liabilities and off-balance sheet items;
• required time-stamped, on-line XBRL filing of all public data, including all parts of financial reports, notes, management discussions, speeches, and news releases, from all parts of the public as well as the private sectors in each country;
• capital markets that are operated in the best interests of the owners of capital and not for the capital managers or administrators, and
• the universal (general) agreement on currencies to start as soon as possible, and a system for five-year re-balancing.

I’d like to think these were marching orders, but I am clearly not the one in control. My pockets and influence do not even run deep enough to even influence legislation in a small way.

I am also too sensible to rely on the lawmakers to do the right thing. They will do as instructed by their masters who, unfortunately, are not the voters. As Venezuela’s Hugo Chavez stated this week, these lawmakers are too busy listening to their blue-ribbon advisors. Either that or handing over the Treasury keys to them.

My plan will be ignored because it’s not in the financial interests of these advisors to the President and to the leaders in Congress. However, every point I make here is an absolute requirement to build a foundation for global trade and investment that would best serve the world at large rather than those of the bankers who created the problems in the first place. Hence, bankers will fight this tooth and nail, fearing the public will finally have that level playing field.

The misuse of credit is at the heart of all problems facing the world today with respect to the financial system, economic situation and capital market.

Credit is the product of a banker. Bankers have over-extended it to government and the private sector alike. At an open bar, the bartender must take responsibility. In this case, however, the bankers looked the other way - in fact sought to engineer products like Credit Default Swaps to help keep their profits rolling in. That’s the problem. We all know it, including the lawmakers.

God willing, the lawmakers will acknowledge the fact that without the help of the community at large their solutions will fail. For every Paulson, Bernanke and Cox, there are a million of us who put our pants on same way. We are pissed at their bringing this economy to a state where unemployment is getting out of control, and the people are losing hope, knowing that will only bring out crime waves and violence.

I asked rhetorically a couple years ago when I saw this crisis building, how high can these bankers build the walls of their office and residential compounds. Do they wish to be driven to work in armored vehicles? There will become a point where no wall is high enough and no vehicle strong enough. The Soviets discovered that.

The message here is clear.

As I closed a week ago,

We trade as individuals to build a better life. But, there is every reason that, as a community, we should also try to do the same. We don’t have revolutions in North America; but we the people can work to the same ends. It will just take longer… God willing; we’ll get there.

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Comment by Dr. Sebastian Uremadu

2008-10-19 17:14:13

Economists Don’t Understand Capital Markets;; Comment

And this is the crux of the matter and may not be far from the truth! It was my long understanding of this fact that led me to write an article years back entitled:’Questioning Nigerian Bank Management’. In that piece I argued that some Departments of Economics in some Nigerian universities like University of Ibadan do not have a B. Sc. Degree programme in Banking and Finance, yet they run and award a professional Masters in(0f) Banking and Finance(MBF) Degree.
These graduates wth half baked knowledge in finance and banking are yearly churned out to take up management positions in banks and financial institutions. Similaar thing goes for those who graduate with a degrees in accounting( B.SC.,MBA,M.Sc.and Ph.D)with a little knowledge in corporate finance and financial management and now claim to have knowledge of finance and banking more than graduates of the profession and so take up management positions in banks. Same goes for graduates of economics, who has virtually dominated top management positionsin commercial banke,central banksand world banks and yet with shallow knowledge of financeand so how do youexpect them to perform well in such high positions of decision making that borders on core credit risk management and investment, liquidity and profitability considrations to say the the list.

An economist can never have a deeper understanding of liquidity and or profitability from the finance point of view, at best, he will have a shallow understanding of the the subject matter and naturally apply this knowledge poorly on issues in question during policy decision making situation.And since economists dominate in the world bank , at central banks and even in commercial banks, this scenario has created serious problems forthe world economy due to poor judgement that they make when it comes to critical question of banking and finance issues.Hence, liquidity problems have persisted creating financial crisis that, most often, leadto collapse of banks and other financial institutionslike the one America and the entire world are facing now. The problem I envisaged in Nigerian banking scene long ago has been confirmed once more. It is high time we allow the right professionals in their right professions!

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Comment by Dr. Sebastian Uremadu

2008-10-21 07:35:51

Thank you immensely, Editor, Dailymarkets for your appreciation of my little comments on the above subject matter. Kindly edit the piece for me. I wrote Sunday noon, 19/10/08, in a hurry and I am not very fast in typing hence a lot of grammatical and spelling errors occurred. I would appreciate it so much if the work is edited for me.

For sure I will be making time to make valuable contributions on your articles published on topical financial issues since I am an expert in virtually all areas of finance. I was trained by two University of Nigeria, Nsukka(UNN) professors: Prof.WO Uzoaga(at B.Sc & M.Sc. levels) and Prof. FO Okafor(at M.Sc & Ph.D levels). And presently I am serving under another professor of Finance, Distinguished Prof J.A.T. Ojo, Covenant University, Ota, Nigeria). With these solid training and mentorship behind me I strongly believe I always have something to say on burning finance and banking issues of our time. Thank you.

Regards, Dr. SO Uremadu

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