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Markets are hard. One of the main reasons they’re hard is because it’s in our nature to overthink. We’re tempted to believe deep thought is our value added, how we justify our fees. It’s also how we impress clients.

But market reality is usually far simpler. Investors chase returns. We fall for stories. We’re masters of belated overreaction. And we have a hard time sticking to a game plan in the face of the huge emotional swings that come with managing other peoples’ money. For these reasons (inter alia), trends tend to be more powerful and go much further than would seem reasonable.

It took me years to curb my impulse to fight trends. The temptation to engage in counter trend trades can be overwhelming, especially if performance is lagging and/or a trend is new or not well established. But it’s rarely worth it. It’s especially not worth fighting something that looks like it might be a new trend.

I don’t know for sure if the rise in short-end Treasury yields or the breakdown in metals constitutes a new trend. All I know is the odds are massively against you if you try and go against it.

Below is a graph of the 2 year Treasury yield. Note that unlike the long end where all the Fed buying has been taking place, the front end has been creeping higher since the Taper Tantrum of May 2013.

The 5 year Treasury yield shows a more interesting pattern: it looks like it just broke higher after a long period of consolidation. Yes, if in the short term we get more risk aversion this yield would likely tread water or pull back. But this chart tells us that the odds favor higher yields. And soon. I’m not one who fears a pernicious rise in inflation as the cycle strengthens, and I also think many market participants have mentally anchored on equilibrium levels for both policy rates and Treasury yields that are too high. But, all this notwithstanding, this is still a train I wouldn’t dare stand in front of.

The 5 year Treasury real yield tells an even more powerful story. It shot up in the Taper Tantrum and when sideways until a few weeks ago. It tells us yields are going up, and not because of inflation fears.

Then we have the metals. When we see a sustained fall in metal prices, most people think “weak global growth”. We systematically read too much about economic fundamentals into commodity price moves. Again, we overthink. The market has made this mistake time and time again. Instead, my first thought is financial liquidation/deleveraging, because financial operators have come to dominate commercial hedgers over the past 15 years.

Specifically these days, I think about Chinese financial liquidation. We know there was a boom in China. We know there was a boom in commodities. And we know Chinese entities were stockpiling commodities and in many cases pledging them as collateral. They are now unwinding. They are not alone, but they’re the most salient example.

My fundamental view is that commodities got overhyped and over loved over the 2004-2011 period and we’re going through a long period of mean reversion. Initially, the hype was based on emerging market economies plugging into the grid and consultants convincing slower money that it was its own asset class and a great diversifier. The second phase of the ramp came from misunderstanding QE.

Now, however, we’re in the down cycle. We saw the first leg of the great commodity unwind and the second one may be upon us. The first shakeout was mostly tourist dollars getting shaken out of the gold tree. Many of the investors who bought gold as protection against QE-induced inflation were forced out over 2011-2013, as it became clear they got it wrong. The second phase, will come as higher real rates drive the wooden stake the rest of the way through, shaking out the long term money, the asset allocators and the true believers. And based on the charts above, if this is not happening now, it is likely to happen very soon.

The charts below, to my mind, confirm what the charts above were suggesting. I know short term positioning is more supportive of metals, and sentiment is more bearish than bullish, but look at the charts below. If an experienced market participant were to flip these charts upside down and imagine they were stocks, I’d be hard pressed to think they wouldn’t want to do some two-fisted buying. Whatever the short term may bring, you do NOT want to step in front of the break down train.

Here’s copper:

Gold doesn’t look any better:

And silver looks to be the worst of the bunch, have arguably already broken down:

Again, there’s a chance that this is a big head fake and not a new trend. But managing money is about pressing your bets when the odds are in your favor—either the odds of being right or the odds of an asymmetric payoff, or, in a dream sequence, both. And right now—whatever the ultimate outcome—being long bonds and long metals doesn’t meet that criterion. Simple money management only gives you two choices here: be short, or get the hell out of the way.

Here’s the link to the full interview with Yahoo Finance on the ECB, the euro, and the US bond market.

Hedge funds are chopped and flat. Real money managers are more worried about getting caught out in a downdraft than missing an upside breakout. Risk positioning is light. The decline is bond yields is more about bad positioning and a shortage of AAA assets than it is about the bond market “knowing something”.

But the vulnerabilities are also there: markets have had a big run, economic fundamentals are still tepid and falling on the short side of expectations. Implied volatilities are low. Market internals are bad. Bottom line: It will take a growth breakout into escape velocity or something like it to get a resumption of the rally, or, more serious disappointment to get the washout that so many are already expecting. Unsatisfactory though this is, the right move is to be patient. The bull market is not over, but it’s not a smart time to press your bets. The longer we twist in this limbo, the more attractive the upside will become. Time heals. Keep your strategic positions and hedge out market beta as best you can. Sometimes you have to keep your bat on your shoulder—something guys collecting two percent management fees have a hard time doing.

Happy Mother’s Day.

Peter Schiff and Mark Dow do battle on gold

Peter Schiff and Mark Dow disagree on the long-term outlook for gold, but that’s not the only thing they take opposite sides on. In a passionate and charged debate on Thursday’s episode of ” Futures Now,” Schiff and Dow presented divergent views on the Fed, government data and inflation.

I guess I should have posted this interview on Gold and Silver back on December 12th when it aired. I get a lot of questions on my views, and I had been meaning to write a piece. But, because I never got around to it, my views are reflected in this interview, and it is turning out to have been more or less right, I was reminded by this tweet from Rich Ilczyszyn that I should’ve posted the video. Plus, I love their headline.

$SI_F $SILVER making moves https://t.co/trRknK41zU

— Rich Ilczyszyn (@iiTRADER) February 17, 2014

Here’s the vid:

Gold bear Mark Dow turns bullish

Gold drops on the day. Is it due for a bounceback? Has the market become too bearish, with Mark Dow, Behavioral Macro Blog, CNBC’s Jackie DeAngelis and the Futures Now Traders.

For me the EM switch flipped in 2012. We’d had inflows and bull markets for 12 years–well before QE. Now, the outflows come. Doesn’t matter what the trigger was. It’s on. It was just a matter of time.

The path, the tricky part, will be in fits and starts. Valuations won’t matter until we can tell a compelling growth story, and too many EM countries have to work through all the domestic debt they built up during the boom. Currency spasms and deleveraging raise the risk of policy errors in certain cases. EM fixed income is most vulnerable because outflows haven’t really even started there. And it would be worse if I were really bearish Treasuries, which I’m not. 

People will overstate how bad fundamentals are as price action worsens. Tourists (crossover investors), who are in control of the flows, will mostly revert to old school EM biases, even though many things, fundamentally, are different (better) this time. Gone is the fixed FX regime and the original sin. Domestic EM financial markets are deeper. Reserves are higher. But don’t try and fight the Old School and their anachronistic biases. They are bigger than you are.

Broadcast live streaming video on Ustream

Covering in this interview with FXStreet a lot of the latest macro developments–and there are a few important ones, with the recent evolution in the cyclical/secular growth debate in the US being at the top of the list.

I need to start off by saying I am a big fan of Robert Shiller’s. “Irrational Exuberance” and “Animal Spirits” were excellent books, pointing out so many of our cognitive shortcomings in all things financial. And “Irrational Exuberance”, which was strongly recommended to me by David Lipton in March of 2000, about a month before the peak of the Tech Bubble, probably saved me a good deal of money as well. Moreover, these books came at times when the reigning ideology was ‘the freer the market the better’. Shiller was certainly swimming upstream by driving home the point that markets fail. The growing relevance of behavioral finance owes a lot to his work.

At the same time we have Robert Shiller, financial evangelist. He has long been a font of ideas on how financial education and innovation might make our lives better. And this brings us to the problem: How can a man who believes human nature is magnetically drawn to stories over facts, momentum over mean reversion, believe, for example, that encouraging the average person to hedge his/her home value in a futures market will not likely, at some point, end badly? If markets do fail, and if the frequency of market failure seems to be positively correlated to financial innovation, why would anyone want to give people even more weapons with which to hurt themselves?

This at its core is really a version of the very same problem Alan Greenspan had some years back. On the one hand, Greenspan asserted that financial innovation in general and derivatives in particular would be used to dampen market risk, not increase, because banks’ were profit maximizers, and their incentives meant we could trust them to self-regulate. And we know how that turned out. On the other, however, his book “The Age of Turbulence” explained various market crises under his watch by pointing out that the psychology of crowds, when under pressure, cannot be counted on to do the rational thing. Often, he argued, this negative psychology was self-reinforcing and there was little one could do to stop it.

It is conceivable that Shiller is at some level just being naïve, and that he believes with sufficient education we can overcome our animal spirits. Personally, I think it is a bridge too far, and Robert Shiller, like Greenspan, by advocating democratization of financial innovation while arguing that human nature is hard wired to make bad decisions, has succumbed to his own little version of cognitive dissonance.

This morning’s employment data were not dramatically out of line with the current trend. They did, however, fall meaningfully short of expectations—especially at a point in the recovery where data have historically tended to surprise to the upside. And even though nothing about this crisis and recovery maps to other periods we have lived through, this has to be seen as a significant disappointment.

But it would be wrong to think that this will significantly alter the Fed’s reaction function come September 18^th.

Beyond the obvious that the Fed—unlike those of us in the market—is unlikely to overreact to one data point, there are three reasons why the Fed is likely to stick to its current course and that odds still favor a September tweak to their current policy stance (read taper).

One, the Fed thinks in balance sheet terms. We in markets are slaves to flows, but the Fed all along has said that to the extent QE has a mechanistic effect on financial conditions it comes through reducing the available stock of USTs and mortgages to financial institutions and the broader investing public. And the fact the yields have tended to go higher when the Fed initiated purchases under its series of programs, but each time to lower highs—notwithstanding improvement in the economy—supports its case. In short, the Fed doesn’t view taper as reducing accommodation.

Two, the Fed is increasingly cognizant of the data that suggest QE has passed through to the real economy much less than its staunchest proponents hoped. At the same time collateral costs—though far, far smaller than hard money advocates had forecast—have been creeping higher. At home, markets have been distorted in exchange for less benefit. And abroad, to paraphrase the famous John Connolly quote:  the Fed is our monetary policy, but your problem. Both the risk and the reward may have turned out smaller than many hoped/feared, but be that as it may the risk-reward equation still continues to drift away from more QE. And the Fed gets this.

Three, it’s all about the signal. QE has triggered significant effects in markets and indeed helped buy precious time for household balance sheets to heal and animal spirits to revive. This has been an important contribution. But it is now clearer that the primary channel through which this has taken place is psychological. Most everyone now knows that the money “pumped in” by QE has largely remained as reserves on the balance sheet of the Fed. The money that “flowed” into asset markets here and abroad came from us, not the Fed, as our risk appetites increased.

It was virtually impossible for the Fed to have gauged ex-ante the magnitude of our psychological response to its easing. But because the market response has been so large yet the economy is still far from where the Fed would have hoped to see it by this point in time, the weaning of market psychology off of the Fed teat now has to be handled in a balanced and incremental fashion. Signaling will play a central role in this process.

The Fed already took the first step in this process.  Many Fed members seem anxious for the data to let them take that next step. And this morning’s data won’t do much to alter this monetary landscape.

Here’s an excerpt from the Q2 letter to investors from John Hathaway, of Tocqueville Asset Management’s Gold Strategy Fund. All you really need to read is the first paragraph.

7/3 John Hathaway – Tocqueville Gold Strategy Investor Letter, Second Quarter 2013

Tocqueville Gold Strategy Investor Letter

Second Quarter 2013

John Hathaway

In light of the dramatic developments of the past six months, this letter addresses seven key investor concerns:

What is happening to gold?

In our opinion, the severe pressure on gold prices since April 16, 2013 has been caused by a coordinated bear raid orchestrated by large bank trading desks and hedge funds. The method used was naked shorting of gold contracts on the futures exchange (Comex), which means that physical gold was never sold, only paper. Gold was rarely, if ever, delivered to a buyer. Trades were settled in cash. The notional amounts of the transactions on many days exceeded annual mine production, absurd on the face of it. The motive was most likely to break the gold price for profit. The result is that short positions of these traders are higher than at the bottom in 2008 (chart below), after which gold rallied 167% and mining shares 256% (basis XAU).