Graphic: “Fear Always Springs From Ignorance”

Another wonderful diagram made by the highly imaginative Ms. Jessica Hagy at the Indexed.

The diagram encapsulates one of my favorite quotes from Ralph Waldo Emerson “Fear always springs from ignorance”

The whole excerpt is from Mr. Emerson’s On the American Scholar, (bold emphasis mine)

In self-trust all the virtues are comprehended. Free should the scholar be—free and brave. Free even to the definition of freedom, “without any hindrance that does not arise out of his own constitution.” Brave; for fear is a thing which a scholar by his very function puts behind him. Fear always springs from ignorance. It is a shame to him if his tranquillity, amid dangerous times, arise from the presumption that, like children and women, his is a protected class; or if he seek a temporary peace by the diversion of his thoughts from politics or vexed questions, hiding his head like an ostrich in the flowering bushes, peeping into microscopes, and turning rhymes, as a boy whistles, to keep his courage up. So is the danger a danger still; so is the fear worse. Manlike, let him turn and face it. Let him look into its eye and search its nature, inspect its origin—see the whelping of this lion which lies no great way back; he will then find in himself a perfect comprehension of its nature and extent; he will have made his hands meet on the other side and can henceforth defy it and pass on superior. The world is his who can see through its pretension. What deafness, what stone-blind custom, what overgrown error you behold is there only by sufferance—by your sufferance. See it to be a lie, and you have already dealt it its mortal blow.

I don’t think this just applies to scholars but to anyone who undertakes the task of research and investigation.

Importantly, I would add passion to being ‘free and brave’ as ideal virtues.

My favorite marketing guru Seth Godin has a timely advice

Fear is the dream killer, the silent voice that pushes us to lose our passion in a vain attempt to seek safety.

While you can work hard to dream smaller dreams, I think it's better to embrace the fear and find bigger goals instead.

In working to attain our dreams, this means that we should become passionate with the pursuit of knowledge for us to overcome the barriers of fear and procrastination, as well as, in filtering out pretensions or politically slanted theories masquerading as reality.

Market Crash Confirms Some of My Thesis on Gold and Decoupling

The recent market meltdown confirmed many realities of the several thesis that I have been writing about.

Aside from the boom-bust cycles, the recent crisis debunks the decoupling theory.

When faced with the increased risks of a global liquidity contraction, market actions have converged to tighten correlations of the risk asset markets almost across the board.

As almost every markets fell, the US dollar and US treasuries became the temporary safehaven.

ASEAN markets, whom initially seemed defiant from the unfolding crisis in the West, has not been spared; even debt default risks, represented by prices of Credit Default Swaps (CDS), of ASEAN and Asian bond markets have begun to rise.

The US Dollar’s Temporary Role as Flight to Safety Haven

I’d like to further point out that the temporary status of the US dollar as refuge is largely due to the unraveling crisis of the Eurozone, or that the relative immediacy of the impact of the Euro debt crisis has been more than that of the US.

The US is NOT and will NOT be IMMUNE to the laws of economics as absurdly suggested by political zealots; the US also faces a prospective fiscal crisis from the continuing profligate ways of the welfare-warfare addicted government. The recent S&P downgrade[1] has been portentous of this.

The current record low or near zero rates almost across the yield curve, which for some represents as opportunity for the US government to further rack up expenditures, is not and will not be a permanent state. More welfare based extravagance ensures the erosion of the US dollar as safehaven status overtime.

Also since the US has largely been less reliant on cash transactions, thus US sovereign securities have temporarily assumed the role of moneyness or as an alter ego to cash.

Most importantly, the US dollar remains as the world’s premier foreign currency reserve as shown above where the US dollar represents about 60% of reserves held by governments and various institutions[2]. In addition, the US dollar represents 85% share of forex transaction in April 2010 down from a peak of 90% in 2001[3]. And of the $95 trillion size of global bond markets in 2010, the US accounted for the largest share at 39%[4].

This means that in a period of dramatic loan margin calls, redemptions or liquidations, and where most of the international payments and settlement system have been based on the US dollar, then it would be OBVIOUS that the US dollar becomes the de facto safe haven. The liquidations in the Eurozone only amplify on such dynamics.

It would be foolish to believe that the US is protected by some mantle of magical or supernatural powers. The only forces that has been giving the US dollar its current strength has mainly been the relatively worst current conditions of the Eurozone, global financial market’s perception of insufficient liquidity* and Ben Bernanke’s dithering on QE 3.0.

*Banking and state insolvencies are valid issues but central banks have been covering such shortcomings with the panacea of liquidity injections. Except that today, financial markets seem to discern that the current state of liquidity injections has not been enough.

Debunking Gold as Hedge Against Deflation and Fear

Another myth demolished by the present crisis is the assumed role of gold.

Many say that gold will function as hedge against deflation. Another camp says that gold functions as refuge against fear.

Both have been proven wrong.

The day Ben Bernanke inhibited the deployment of QE 3.0, gold prices along with the broad based commodity spectrum came crashing down together with global financial markets.

Where the perception that monetary expansion will not be applied, asset liquidation has dominated and gold prices had not been exempt.

So much for the deflation refuge. May I emphasize that asset deflation does not automatically suggest of consumer price deflation or an economic wide deflation-recession.

Also crashing equity markets around the world has been coincidental with falling gold prices. Essentially this discredits the idea that gold serves as refuge against fear.

True, many central banks will continue to inflate—such as the ECB, Swiss National Bank, National Bank of Denmark, Bank of Japan and others—but current state of markets suggest that their actions has not been satisfactory to warrant maintaining lofty record gold prices.

Either these central banks would have to inflate intensively, or more importantly, that team Bernanke joins the bandwagon to deliver the meat of what the market expects.

Also, while gold may be in a natural correction mode given its previously severely overbought conditions, I would think less about the importance of the technical conditions.

I believe that the Fed’s current inaction is temporary. Ben Bernanke would want to see more market pressures to justify QE in order to stave off deflation. In his recent public appearance he again raise the deflation bogeyman[5]

"If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation"

And since price trend of gold seems correlated with the actions of ASEAN markets, a wobbly gold price trend would translate to an uneasy or apprehensive markets for the Phisix or ASEAN equities.

Thus, unless I see gold prices make a substantial recovery, I am predisposed to say that ASEAN equity markets could be susceptible or vulnerable to significant price retrenchments for the time being

---

[1] See Misleading Discussion on US Debt Downgrade Crisis, August 9, 2011

[2] Wikipedia.org Reserve currency

[3] Marketwatch.com Daily foreign-exchange turnover hits $4 trillion, September 2001

[4] Wikipedia.org Bond Market Size Bond market

[5] See Ben Bernanke: Falling Markets will Justify QE 3.0, September 30, 2011

Swine Flu: The Politics of Fear and Control

The swine flu "hysteria" continues to hug the headlines where the latest Bloomberg report says,

``Swine flu, also known as H1N1, has been confirmed by laboratory tests in 1,516 patients in 22 countries, according to the WHO. Mexico has reported 942 cases, including 29 deaths, while the U.S. has 403 cases and two deaths, officials in those countries said. Canada has 165 cases."

Hysteria because fear foisted upon by media, politicians and experts has spurred irrational reactions. For instance, we read with incredulity that some of Tokyo's hospitals have reportedly refused or turned away patients exhibiting flu-like symptoms.

According to the Japan Times, ``An increasing number of patients running a fever have been rejected by Tokyo hospitals that fear they may have swine flu even though the risk of their being infected is minimal, the metropolitan government said Tuesday.

``The number of cases in which hospitals refused medical examinations for such patients totaled 92 from Saturday morning to Tuesday noon, a survey by the metropolitan government found.

``"We want hospitals to respond calmly even if they fear that patients infected with the new flu may appear or that other patients will get infected," a Tokyo official said." Those inflicted by Flu have effectively become castes.

And yet we have experts compounding these sentiments by associating flu epidemics to economic depression.

Take for instance this op-ed from Wall Street Journal by Robert Barro and Jose Ursua (emphasis added),

``Our ongoing study of economic disasters for 36 countries since 1870 suggests that this concern is well founded. In this sample, we have isolated 158 depressions -- defined as declines in a country's real per capita gross domestic product (GDP) by at least 10%. The most prominent features of these depressions are wars and financial crises. But the fourth-worst global macroeconomic event since 1870 seems to be the Great Influenza Epidemic of 1918-20. This "health shock" accounts for 13 of the depression events. In contrast, World War II is associated with 25, World War I with 23, and the Great Depression of the early 1930s with 21.

``The Great Influenza Epidemic (aka the Spanish Flu) began in spring 1918, went through three or four waves, and lasted into 1920. The spread of the disease was propelled by international travel, much of which involved troop movements in 1918 because of World War I. Estimates of world-wide flu deaths cover a wide range but are typically around 50 million.

``We have, thus far, compiled estimates of excess deaths from the flu in 1918-20 for 32 of our 36 countries. The median excess mortality rate was 0.7 per 1,000 people, with a range from 0.1 for Argentina to 4.4 for India and South Africa. (The mean rate was 1.1 per 1,000.) Spain, forever associated with the flu, had a mortality rate of 1.2 per thousand, well above the median. The United States, at 0.65, was close to the median (there were 675,000 American deaths). When applied to today's U.S. population, this rate would translate into two million fatalities....

``The troughs in macroeconomic activity that we associate with the Great Influenza Epidemic were typically in 1920 or 1921. Not all of our 36 countries showed economic declines in this period. But on average the fall in real per capita GDP from the previous peak in 1918 (or sometimes 1919 or 1920) was 6.6%. (For the 24 countries with data, the average decrease in real consumer spending per person was similar to that for real per capita GDP.) Notable declines in GDP among the 13 depression cases were Canada and South Africa at 24% and Italy at 22%. For the U.S. from 1918 to 1921, the falls in per capita GDP and consumer spending by 12% and 14%, respectively, meant that this contraction was second in size since 1870 only to the Great Depression."

The problem with looking at history is that it may be seen from a one dimensional lens.

This isn't 1918. Today's economic climate is far different from the Great Depression.

While travel and troop movements may have been accounted for as the aggravating circumstances for the spread of the disease, this hasn't been sufficient.

On the other hand, Prof. William Anderson asserts that government policies then exacerbated the pandemic. He writes (all bold highlights mine),

``Most people don’t remember 1918 as the year the flu pandemic began; they remember it as the year that World War I ended. This was the "War to End All Wars," or so it was called, when a more appropriate title might have been the "War to Permanently Expand the State." More than 10 million soldiers died on the battlefields of Europe and millions of civilians died deaths of starvation or were killed in the crossfire.

``Since war is a tool of the state, we safely and honestly can say that the calamities of World War I were state-created. Unfortunately, people did not just die from bullets, artillery shells, bombs, and even starvation. Across the globe, the war resulted in vast swaths of malnourishment as crops were diverted from civilian populations to the huge armies strung across Europe. At the same time, once-productive croplands in Europe were reduced to moonscapes as the armies obliterated the land.

``But governments were not satisfied with the sheer amount of physical and human destruction. Indeed, the government made things worse through lies, and nowhere was that more apparent that the lies told by state agents in order to "prevent panic" from the onrushing flu epidemic. As Wikipedia points out:

"The Great Influenza was the source of much fear in citizens around the world. Further inflaming that fear was the fact that governments and health officials were downplaying the influenza. While the panic from World War I was dwindling, governments attempted to keep morale up by spreading lies and dismissing the influenza. On September 11, 1918, Washington officials reported that the Spanish Influenza had arrived in the city. The following day, roughly thirteen million men across the country lined up to register for the war draft, providing the influenza with an efficient way to spread. However, the influenza had little impact upon institutions and organizations. While medical scientists did rapidly attempt to discover a cure or vaccine, there were virtually no changes in the government or corporations. Additionally, the political and military events were fairly unaffected due to the impartiality of the disease, which affected both sides alike".

``Exacerbating the crisis in this country was the crowding of American troops onto ships following the war’s end, which was guaranteed to spread the sickness and help it spread when the soldiers reached the USA. On the home front, huge war bond rallies in large cities brought people into very close proximity with each other, allowing the flu to spread rapidly. On one end, the government helped to create the conditions that spread the flu; on the other hand, agents representing the state lied about those conditions.

``By the war’s end, Germany was near starvation (and many people did starve to death during the British blockade that lasted well into 1919), and about a half-million civilians succumbed to the sickness in that country. It is estimated that 16 million people in India died of the pandemic.

``Yet, when it raises the prospect of a repeat of this very horror, governments engage in more lies. We forget that life expectancy in the United States was in the mid-50s for white males and less than 50 for black men. In countries elsewhere, and especially in Asia and Africa, life expectancy was much shorter. Medical care at that time was primitive compared to what we have today, even in poor countries, and it was not uncommon in that era for people to be exposed to epidemics that pretty much have disappeared today.

``Even with those odds, the mortality rate during the 1918–1920 pandemic was estimated at between 2.5 and 5 percent. We can be assured today that not only would fewer people become sick, but even fewer people would die. In other words, even at its worst, the current outbreak of Swine Flu, while bad, is not going to turn into a pandemic no matter what CNN and the CDC try to tell us."

In short, the swine flu seems to be more about the politics of government control than of the health hazard itself.

Professor Anderson concludes, ``I doubt seriously that any plan by government can or will lessen the impact of this current "epidemic," if we can call it that. However, I also have no doubt that if emergency plans are kicked into place, it will be much easier for the government to call for further states of emergency, with the threshold becoming lower and lower. That we should fear much more than the Swine Flu."

Swine Flu: The Black Swan That Wasn’t

``There is only one thing which causes man to look for and to organize a tool which is an instrument of compulsion and prohibition. That thing is fear. Men look to government to protect them because they fear. And virtually without exception, everything that human beings fear becomes a project for government." Robert LeFevre The Nature of Man and His Government

The Swine Flu could have been a Black Swan. And perhaps yet it could.

The Black Swan theory as proposed by my favorite iconoclast Nassim Nicholas Taleb comprises three traits:

One, it “lies outside the realm of regular expectations”,

Two, it “carries an extreme impact” and

Finally it makes people “concoct explanations for its occurrence after the fact, making it explainable and predictable”.

Since the swine flu struck, it had practically caught everyone by surprise. Next, many have been unnerved or nations have been in a state of panic; the World Health Organization (WHO), the health agency of the multilateral organization the United Nations, have raised the pandemic alarm level to 5 out of the maximum 6, which implies pandemic levels or the risks of the global spread of disease as “imminent”. (Reuters). Lastly, there have been many theories circulating in traditional media or in the cyberspace as to why and how such ailment came to be.

So this episode contains elements fitting of a Black Swan. But what seems arguable is the degree of impact.

Since the Swine Flu surfaced in the news, markets have initially been devastated, albeit not equally. Realizing the sensitivity of today’s fragile environment, I had also been tempted to undertake “crash” or defensive positions.

However, it dawned upon me that panics are always triggered by our brain’s Amygdala, which had been hardwired into our fight-or-flight responses by our primitive progenitors, who were faced with survivalship against the adverse forces of nature. Panics are actually exacerbated by the lack of information.

Hence, considering the uneven nature of the market’s responses, the underlying market trend, the most recent experiences of the world to deal with epidemics (SARS, Avian Flu) and the rapidly advancing state of our technology, I decided that it would be best to defer fear and possibly deal with this from the reverse.

Figure 1: US Global Investors: SARS Blip

A great example would be the Severe Acute Respiratory Syndrome (SARS) episode, as shown in Figure 1.

From the benefit of hindsight, the SARS was a short term dislocation or a blip or another account of Posttraumatic Stress Disorder (PTSD) for the tourism industries of key East Asian economies. From the market perspective, it served as a window of opportunity to profit from fear.

Since global markets have rallied furiously following the initial shock from the Swine Flu this implies that the pandemic risks have been digested and discounted in contrast to the headlines and the actuations of governments.

Sensationalism-Survivorship Bias: Markets versus Media and Politics

So why the flagrant disparity between the market and news headlines or from political authorities?

Because it is primarily about perspective.

In Mexico, the epicenter of the disease, the present death toll from the Swine flu has been reduced from 176 to 101 (Guardian) and now to 75 (BBC)! But even at 176, this number represents as an infinitesimal fraction relative to Mexico’s population of 110 million (CIA).

Moreover, the expanded global reach is said to cover 18 countries which had reported accounts of infections, as The Independent reported, ``The World Health Organisation said that 18 countries have now reported 766 infections. The confirmed cases include 443 in Mexico, 184 in the US, 85 in Canada, 15 in Spain, 15 in Britain, six in Germany, and smaller numbers in 12 other countries. Italy reported its first known case yesterday, a man in the Tuscany region who returned from Mexico on 24 April. He has since recovered. Almost all infections outside Mexico have been mild. In Britain, where two new cases were confirmed – one being the husband of a woman who was confirmed the day before – some 632 possibles are under investigation”.

The accounted fatalities, as of this writing, have been 17 globally, according to the same article.

To compare, the US Centers for Disease Control and Prevention (CDC) reports of 36,000 influenza associated deaths and 200,000 hospitalizations annually. This translates to 98 deaths per day and 548 people hospitalized per day from seasonal influenza in the US alone.

In addition, 115 people die from car accidents a day in the US (car-accidents.com), 38,500 People die each week around the world from the Aids virus and 1,288 is the number of British people who die from strokes in an average week (The Independent).

In other words, the actual collateral damage has hardly surpassed the average annual losses from its seasonal strain counterpart or from other common causes of deaths even based on US figures alone. Yet because the disease has reached 18 countries with 766 infections and 17 deaths, the WHO has triggered global alarm bells and international hysteria by placing the pandemic alarm level to 5!

So opposite to the survivorship bias, which usually fixates on winners, global authorities today have been entranced with sensationalism and has virtually used fears to respond on an overkill basis.

Notwithstanding, the ensuing consternation has led to divergent definitions of the disease; the Swine Flu has been reported as little to do with the Swine itself (Poor Pig- serves not only as human’s dish but as fall “guy” animal!) where according to the Reuters ``The WHO has said it would call the new virus strain Influenza A (H1N1), not "swine flu," since there is no evidence that pigs have the virus or can transmit it to humans. Pork producers had said consumers were shunning their product.”

Bizarrely too, even some US Farmers have raised concerns that their herd of pigs might be contaminated by infected humans!!!

This paradox as reported by another Reuter’s article, ``There is no evidence of this new strain being in our pig populations in the United States. And our concern very much is we don't want a sick human to come into our barns and transmit this new virus to our pigs," said National Pork Producers chief veterinarian Jennifer Greiner. If humans give it to pigs, we don't have things like Tamiflu for pigs. We don't have antivirals. We have no treatment other than to give them aspirin," said Greiner.” (bold highlight mine).

Yet many have alluded to the Spanish Flu as its origins, but the effects have been so far way way way off.

The Spanish Flu as described by wikipedia.org, ``The pandemic lasted from March 1918 to June 1920, spreading even to the Arctic and remote Pacific islands. It is estimated that anywhere from 25 to 80 million people were killed worldwide, or the approximate equivalent of one third of the population of Europe, more than double the number killed in World War I. This extraordinary toll resulted from the extremely high illness rate of up to 50% and the extreme severity of the symptoms, suspected to be caused by cytokine storms. The pandemic is estimated to have affected up to one billion people: more than half the world's population at the time.”

Perhaps lacking the expected casualty impact in the scale of the Spanish Flu pandemic, authorities have presently been downplaying its association, this from the Associated Press, ``Scientists looking closely at the H1N1 virus itself have found some encouraging news, said Nancy Cox, flu chief at the federal Centers for Disease Control and Prevention. Its genetic makeup doesn't show specific traits that showed up in the 1918 pandemic virus, which killed about 40 million to 50 million people worldwide.

``"However, we know that there is a great deal that we do not understand about the virulence of the 1918 virus or other influenza viruses" that caused serious illnesses, Cox said. "So we are continuing to learn." (all bold emphasis mine)

The irony is, if the said expert does not understand much about the virulence of the 1918 virus, how can she conclude that the genetic make up of today’s strain doesn’t resemble the specific killer traits of 1918 virus? Isn’t this a case of rationalization?

So like in the markets, we seem to be witnessing evidences of reflexivity behavior being applied to the Swine Flu incident-where the present outcome (diminished degree of impact and rising markets) seems to be influencing the public’s thinking as reflected by news accounts and backed by shifting views or sentiments of officials as cited by mainstream media.

Yet the frenzied policy responses have resulted to some unintended consequences. For instance, Egypt’s arbitrary decision to slaughter its entire pig population has spawned a religious schism between majority Muslims and Christians.

Another, Mexico’s decision to shut down stores and companies or its economy has prompted some agitation among the citizenry. According to the Reuters, ``The Labor Ministry said it would fine or forcibly close companies that stay open Monday and Tuesday as a major factory association and many small businesses say they plan to.

``"As far as I know we're coming to work next week. Unless someone comes from the government to tell us to close," said Victor Barracas, a bookstore employee in central Mexico City.”

It appears that the Mexican government prefers its population to suffer or perish out of starvation than from an overblown epidemic!

Talk about governments knowing the interest of their people.

Conspiracy Theories

Nevertheless, the compulsiveness over the Swine Flu won’t be complete without “conspiracy” theories.

Since the current strain of Swine Flu combines genetic material not only from pigs but from birds and humans, where “it has bird flu from North America, swine flu from Europe, and swine flu from Asia. Humans do not have natural immunity to this strain”, (qualityhealth.com) some have suggested that this has been a “human engineered pathogen” meant as a biological weapon for biowarfare.

Many possible scenarios have been floated; it could have been an experiment gone awry or accidentally leaked into the population, or a deliberate covert test by some government entities for political purposes (deflect attention from the economic crisis?), or from a rogue insider who could have stolen from the government’s biolabs in order to advance an unspecified cause, similar to the Anthrax tainted letters mailed to the US Congress from which an employee, Bruce Edwards Irvins, a microbiologist, vaccinologist, and senior biodefense researcher of the US Army Medical Research Institute of Infectious Diseases (USAMRIID) in Fort Detrick, Maryland was held responsible (Global Research).

Or it could also have possibly been perpetrated by vested interests aimed at creating at an atmosphere of pandemic for economic or financial interests, or worst, perhaps in cahoots with the government.

And this isn’t new, according to qualityhealth.com, ``in 2006 investigators discovered that a major pharmaceutical company knowingly dumped HIV-tainted drugs for hemophiliacs onto European, Asian and Latin American markets.”

Anyway, such plot may run across the similar lines as with the movie Mission Impossible II.

Stock Market and Pandemics-Then and Today

True enough a full blown pandemic at the scale of the Spanish Flu will result to economic mayhem.

Economic activities in heavily impacted areas will suffer most while deglobalization in trade, tourism, migration or investments will probably worsen, given today’s recessionary environment.

But we learned that such devastating pandemic don’t necessarily translate to stock market collapses.

Since the public has been obsessed with the Spanish Flu, Bespoke Invest gives a good account of how the US stock market reacted to its outbreak in 1918 see figure 2.

Figure 2: Bespoke Invest: Spanish Flu and Dow Jones Industrials

We quote Bespoke Invest, ``There were three pandemic waves from 1918-1919, with the worst coming from October to December of 1918. While fear of the flu was widespread, the market really didn't react too badly. Following the first pandemic wave, the market sold off a little bit, but then rallied during the summer months before topping out prior to the second wave. The market trended downward during the worst wave of the flu outbreak, but it only went down 10.9% from peak to trough, and then it rallied significantly during and following the third wave. World War I was also coming to an end in late 1918, so the end of the pandemic and the war probably contributed to the subsequent rally in stocks.”

Let me emphasize that despite the huge losses of human lives and massive economic disruption brought about by both World War I and the Spanish Flu, the Dow Jones lost only 11% from the Spanish Flu plague.

However, it won’t do justice to say that the Spanish Flu was the biggest driver of the markets then, as with the culmination of World War I, because there could be other possible unseen variables which may have contributed to the market action, although we also don’t deny that both factors could have provided for significant inputs.

Unfortunately, history, for the mainstream, is always seen from a single observation that had taken place.

But the point is; initial fear from a shock usually dominates the markets, which is then followed by gradual recognition of the problem and its eventual resolution-the recovery.

Today we seem to share a similar impact but at very compressed or short circuited cycle see figure 3.

Figure 3: Stockcharts.com: Swine Flu: Aborted Black Swan

Major global stock market benchmarks as seen by the Dow Jones World (DJW), Emerging Markets (EEM), Europe’s Stoxx 50 (STOX 50) and Asia (DJP1) seems to have simultaneously suffered a “blip” (circle) from the pseudo Swine Flu scare which eventually was more than recovered by most global bourses at the close of the week’s session.

Another way to look at it is that collective governments push to inflation has far larger influence than fear generated from the pandemic menace. Besides, by stoking fear governments implied action is to spur inflation by spending more for protection.

In addition, today’s environment is very much different than that of 1918. The world has been more globalized or integrated. Moreover, technological diffusion has been increasingly deepening this integration whereas monetary standards that drive the risk taking environment have been distinct.

As to how this has altered the pandemic risk environment we suggest some based on news accounts;

-the lessons from SARs and the Avian Flu have fostered stronger collaborations among global governments in dealing with potential pandemic risk by agreeing on “a sensible set of protocols for pandemic preparedness, sharing of genetic samples and other ways of coordinating a global response.” (Economist)

-technology impelled advancement in incubation and manufacturing techniques. Again from the Economist, ``It is possible, though, that new technology will come to the rescue. Gregory Poland of the Mayo Clinic, an American hospital chain, argues that thanks to SARS, bird flu and fears about bioterrorism, work has been undertaken on a range of new incubation and manufacturing techniques.

``One example is DNA-based vaccines, which are made in cell cultures, not incubated slowly in eggs. Vocal, an American biotechnology firm, has shown in early tests that its DNA vaccine for potentially pandemic influenzas, such as strains of H5N1, is safe and effective, and it claims the technology can be scaled up easily.”

-technology enabled information sharing via the cyberspace which has cultivated mass collaboration, networking and openness in the medical and science industry that may lead to faster vaccine discovery and production.

From the Reuters, ``Scientists in Mexico, the United States and New Zealand have since posted full sequences of its DNA taken from 34 virus samples in an online public library. And the list is growing.

``What this means is scientists everywhere can now use these descriptions to create new tools to fight the virus, such as rapid diagnostic test kits and vaccines.

``While the fastest conventional tests take up to two days, scientists are designing highly specific ones that can pick up this swine H1N1 flu virus in four to six hours…

``The genetic sequences have just been made available ... many laboratories are rushing to find the best test, it will take one to two weeks (for us to design one), but we need a lot of validation, we need hundreds of specimen to do that," said microbiologist Yuen Kwok-yung at the University of Hong Kong.”

Conclusion

So while the risks of pandemics will always be present in a rapidly evolving global environment, whether due to natural or lab-induced viral mutations, the world’s capability to address such risks based on global collaboration and technological adoption appears to be more enhanced than the yesteryears. Hence, conditions from the Spanish Flu, the SARS, Avian Flu or the pseudo Swine Flu have been different.

But this doesn’t guarantee immunity from other prospective tail risks.

Nevertheless, the recent Swine Flu which had the elements of surprise and rationalizations from the public almost seemed to have morphed into a full blown Black Swan risk except that the degree of impact was apparently muted in terms of collateral damage or as viewed from the financial market’s response.

The only profound impact from the present episode based on last week’s drama had been government sensationalism and its attendant overreaching political response which had been greatly amplified or inflamed by media.

Fear, as we know it, is a conventional tool of control used by governments to subvert civil liberties by coercion. Thus, considering today’s socialization trends of important segments of the global economy, it can’t be dismissed that this could be another part of the tactical socialization thrust to impose more government on our lives.

Nonetheless, the market reflecting on its inherent discounting mechanism has shattered this prism of state instituted fear and by virtue of reflexivity behavior has equally diminished its justification. The likelihood is that the threats of the pseudo pandemic will evaporate overtime.

Over the interim, global stock markets and the commodity markets will most likely continue to manifest on the concerted inflationary measures adapted by global governments.

Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy

``The danger from all forms of paper money controlled and regulated by governments or their appointed central banks is that they remain creatures of the political process, and dependent upon the knowledge and policy preferences of those who have the power over the monetary printing press. The history of paper monies is a sorry story of inflations, currency depreciations, and resulting social and economic disorder.”-Richard M. Ebeling, IMF Special Drawing Right "Paper Gold" vs. a Real Gold Standard

The recent weakness in gold prices has prompted some mainstream commentaries to suggest “fear” as the main driving force behind this.

The underlying premise is that since gold competes with every other asset class for the investor’s money, the recent surge in global stock markets may have revived “risk” taking appetite or the Keynesian “animal spirits”. And since gold has been seen as less attractive alternative, investors may have possibly sold gold and subsequently bought into the stock markets. Hence the recent selloff has had “fear” imputed on gold prices.

For me, this represents sloppy reasoning unbacked by evidence which has been “framed” in very short term horizon, the anchoring bias or the ``tendency to rely too heavily, or "anchor," on a past reference or on one trait or piece of information” in their analysis and an innate prejudice against the “barbaric metal”.

Such flawed analysis omits the following perspective:

1. Prices Are Relative.

As we discussed in Expect A Different Inflationary Environment, inflation moves in stages and would likely impact asset classes in a dissimilar mode.

From our perspective the stock markets and commodities have initially been the primary the absorber of government induced “reflationary” measures.

In other words, yes, a rotation will likely be the case, but this doesn’t imply “fear”. It simply means a pause in the trend because NO trend moves in a straight line. It is that elementary.

The same analogy can be ascribed to last year’s dreadful financial markets collapse, where many left leaning analysts have imputed “capitalism is dead”. The truism is that markets aren’t fated to move in one direction, because they always reflect on the fluid pricing dynamics by the different participants in response to perpetual changes in the flow of information as reflected by the changes in the environment.

But when markets are tweaked by governments to achieve a perennial boom, they attain the opposite outcome- a short-term euphoric boom and an equally devastating bust or the bubble cycle.

Mr. Bill Bonner in U.S. Banks Overrun by Dirty, Rotten Scoundrels eloquently describes this phenomenon, ``Capitalism is not a collection of nuts and bolts, gears and switches. Instead, it is a moral 'system.' 'Do unto others as you would have them do unto you,' is all you need to know about it. And like any moral 'system,' it rarely gives the capitalists what they hope for...or what they want. It gives them what they deserve. And right now, it's giving it to them good and hard.” (bold emphasis mine)

In short, losses are inherent features of the marketplace. Hence, they are reflected in trends or in cycles see figure 1.

Figure 1: stockcharts.com: Gold: Where’s The Fear?

Over the past three years we see some correlations among different markets, yet these correlations haven’t retained a fixed balance but instead have been continually evolving in a seemingly divergent fashion.

In 2006-2007 Gold (main window) soared along with the global stock markets (DJW), as the US Dollar index (USD) had been on a decline (see blue trend lines). So from this perspective alone, the premise that gold falls on higher stock markets simply DOESN’T HOLD. One could easily make the oversimplified case where the inflationary ramifications of a falling US dollar had fueled a frenzy over gold and global stock markets until this culminated.

But the past dynamics have been reconfigured.

Late last year, the spike in the VIX or the “Fear” index coincided with a surge in the US dollar as a majority of global stock markets went into a tailspin. Gold similarly melted. But in contrast to the stock markets, gold found an early bottom which corresponded with a peak in the US dollar and the VIX index. This apparently marked the end of an INVERSE or NEGATIVE correlation between gold and the US dollar.

In this landscape marked by FEAR, one can infer that the US dollar functioned as the sole “safehaven” from the banking meltdown triggered investor exodus in global stock markets and in gold. But apparently this dynamic appears to be a short term affair and may have signified as a ‘one-time’ event that marked the extraordinary market distress or dislocation-our Posttraumatic Stress Disorder PTSD.

In 2009, these dynamics have been rejiggered anew. From the start of the year, Gold strongly rallied but “peaked” alongside the US dollar index (see red arrows) concurrent to the decline in the fear index and a revival in global stock markets.

The falling US dollar and declining gold prices have reversed the NEGATIVE correlation to a POSITIVE correlation where both have moved in the same direction. The implication is that the US dollar, the VIX “fear” index and Gold encapsulated the investor’s negative sentiment, all of which have recently declined. And subsequently, the stock market rally has been “fueled” by the revival of the animal spirits, according to the fear believers.

Hence, the swift “rationalization” that investor’s negative sentiment has reversed course and has passed on the “fear factor” burden to “gold”.

Yet, this ignores the fact that both the US dollar index and gold are still on an UPTREND from the basis of the simultaneous lows last October. To reiterate, from their lows both had been positively correlated.

Stretching the picture, gold remains entrenched in a bullmarket since 2001, while the US dollar’s newfound virility could signify as either a cyclical rally within long term bear market or as a fledging bull.

But since gold represents as the nemesis of the paper money system (as seen by Keynesians-ergo “barbaric” metal) epitomized by the US dollar hence price action should reveal an inverse correlation. But this hasn’t been the case today, or as it had similarly been in 2005, where both the US and gold rose even amidst a milieu of rising stock markets.

Yet such positive correlation between gold and the US dollar may account for many variable reasons for the aberration. Since the US dollar index is significantly weighted towards the Euro this could mean a frailer European economy than the US, investor’s perception of Europe’s banking system as relatively more vulnerable, the deleveraging process continues to manifests of sporadic US dollar shortages in the global financial system, and etc.., but this seems likely to be temporary.

Nonetheless given that gold has been in a longer and a more solid trend of 8 years, combined with the fundamentals of the growing risks of unintended consequences by the collective money printing financed spending spree by governments, our money is on gold.

2. Governments Have Been Distorting Every Market Including Gold.

It’s quite naïve for anyone to docilely believe that the gold markets have been efficiently reflective of the genuine market based fundamentals, when almost every financial markets have seen massive scale of interventions from global governments.

To consider, the gold markets despite its relative smaller breadth (estimated at $4 trillion of above gold stocks and $150 billion gold mining stocks measured in market capitalization) has been a benchmark closely monitored by Central Bankers. For example the speech of Federal Reserve Chairman Ben Bernanke entitled as Money Gold and the Great Depression reinforces this view.

It is because gold has functioned as money for most of the years since humanity existed. So it isn’t just your ordinary or contemporary commodity.

In fact, this has been the 38^th year where our monetary system has operated outside the anchors of gold or other commodities. Alternatively, this represents as the boldest and grandest experiment of all time [see our earlier article Government Guarantees And the US Dollar Standard]. Remember, all experimentations of paper money system that has ever existed perished due to “inflationary” abuses by governments.

In other words, government distortions may cloud interim activities in the gold market, but this doesn’t suggest of a reversal of its long term trend. Thus, this isn’t fear.

The unstated overall goal of collective governments today is to revive the status quo ante environment predicated on the paradigm of borrow-spend-speculate policies. Thus an all out effort is being waged.

That’s why global central banks have geared policy interest rates towards ZERO-in the name of providing liquidity. That’s why global central banks have resorted to the printing press or in technical terms “quantitative easing” and absorbed various junks from the banking system-in the name of “normalizing” the credit process. And that’s why governments have thrown or indiscriminately spent enormous sums of money into the global financial and economic system-in the name of sustaining aggregate demand.

In essence, they want everybody to stop saving and indulge in a binge of borrowing, spending or speculating in order to drum up the “animal spirits”.

For those with common sense, we understand that these policies are simply unsustainable. And unsustainable policies eventually will unravel.

Yet why are these being practiced? Because of sundry political reasons-primarily to expand the presence of government in the system.

When gold defied the “deflationary outlook” which infected almost all asset classes, we argued that governments could have wanted a higher gold prices as signs of reviving inflation [see Do Governments View Rising Gold Prices As An Ally Against Deflation?]. With the present developments, this has changed.

Since the overall goal of governments is to revive the “animal spirits”, then rising stock markets serves as a vital instrument to project these reinvigorated investor sentiment. Now that stock markets have been sensing signs of emergent inflation, gold markets are being targeted as the traditional adversary.

Proof?

Take the publicized plan by the G-20 to sell part of IMF’s gold stash of 403 tons out of the 3,200 tons it holds which is the third largest after the US and Germany.

You’d be wondering why the efforts by the G-20 to broadcast sales, considering the substantial size, would have a negative short term impact on gold prices even prior to the actual sales.

A normal seller in the marketplace would have the incentive to get the best possible price in exchange for the goods or services being sold. Hence if the IMF aims to achieve optimum prices from its sales it should conduct its program discreetly. But this isn’t so. Obviously the announcement of proposed gold sales would result to depressed prices even prior to the action itself. Therefore, this wouldn’t account for an “economically rational” seller but one shrouded by political motivations.

Factually, this is just one of the psychological tools employed by central bankers when manipulating the currency market. They call this the “signaling channel”.

According to IMF’s Division Chief of the Research Department, in his article Turning Currencies Around, ``Through the signaling channel, the central bank communicates to the markets its policy intentions or private information it may have concerning the future supply of or demand for the currency (or, equivalently, the path of interest rates). A virtuous expectational cycle can emerge: for instance, if the central bank credibly communicates its belief that the exchange rate is too strong—and would be willing to change policy interest rates if necessary—then market expectations will lead to sales of the currency, weakening it as intended.” (bold underscore mine)

In short, G 20 policymakers have been using conventional currency manipulation tactics to put a kibosh on the gold market.

Moreover, the same article on the G 20 gold sales from CBS Marketwatch reports that the European Central bank had “completed the sale of 35.5 tons of gold” late March.

Another, there have been discussions in cyberspace on the unverified interventions by the European Central Bank to save Deutsche Bank from its short positions.

The point is you can’t ascribe fear when knowingly such markets are being cooked up for some political purposes, although the superficial nature of market manipulations ensures that the impact will be felt on a short term basis.

But even as the G-20 has been attempting to maneuver the gold markets, actions by one party appear to be offset by the actions of another.

Apparently China has been doing the opposite of the G-20. Instead of publicly airing its intent to increase gold reserves, it has tacitly been amassing gold from its domestic producers and from the domestic market (mineweb.com) to see a 75% surge in gold reserve holdings to 1,054 tonnes in 2008 from the 600 tonnes in 2003. (AFP)

While other analysts downplay the significance of this reported gold hoarding citing that China has been buying up almost everything from US treasuries, US equities to other commodities, we believe that China seems to be positioning its currency, the yuan, as a candidate to replace the US dollar as the world’s reserve currency as discussed in Phisix: The Case For A Bull Run or possibly working to provide an insurance cover on its currency against the growing risks of hyperinflation, which would translate to massive losses in its US dollar holdings on its portfolio [see Has China Begun Preparing For The Crack-Up Boom?].

In presaging for times of trouble, commodities essentially could function as the yuan’s potential “anchor”.

It makes no fundamental sense to excessively store up on gold, other metals, oil and other commodities unless severe shortages have been perceived as a potential problem.

As a political institution, China won’t be much concerned with the “convenience yield” or “the benefit or premium associated with holding an underlying product or physical good, rather than the contract or derivative product” (answers.com), even as commodities don’t generate interest income which is offered by financial assets.

Besides what’s the point of disclosing the sharp increase in gold reserves by China after 5 years of covert accumulation operations?

Thus, China’s actions can be construed as essentially more politically motivated (timed with its bleating over the increased risks of the US dollar) with economic and financial ramifications.

The other point is NOT to look at China’s holdings of US dollar assets on an absolute level but from a relative standpoint: where has China’s concentration of US assets been-in long term or short term securities? Remember although China may continue to buy US securities in order to hold its currency down, if it does so by accumulating assets in mostly short term duration, then this may be extrapolated as an attempt too reduce its currency risks exposure.

Finally, despite the ongoing official manipulations gold market isn’t just an issue for central banks as private institutions have been feverishly accumulating on gold holdings as seen in Figure 2.

Figure 2: Casey Research: Gold ETFs are rapidly catching up with top Central Banks

According to Casey Research, ``SPDR Gold Shares (GLD), an exchange-traded fund, first hit the market in November 2004 with 260,000 ounces of gold. Today, GLD is the world’s 6th largest holder of physical gold with over 35 million troy ounces in the vault. In fact, since the general market meltdown last fall, the ETF has added over 16 million ounces and ended 2008 with a 5% gain – not many investments can make that claim. Investors worldwide are sending a clear message: Gold is the safest asset in which to store wealth, not the product of the printing press.”

So even when official institutions have been attempting to control the gold markets, the interest from private investors have been strongly accelerating to possibly offset any substantial sales by top gold holders.

As Professor Gary North notes, ``Eventually, governments will run out of gold to sell, and so will the IMF. They will run out of gold to lease. While I do not think the politicians will ever catch on to the fact that their nations' gold is gone, leaving only IOUs for gold written by bullion banks that are on the verge of bankruptcy anyway, I do think that at some point the central banks will stop leasing gold.”

In short, once a substantial segment of gold from official institutions has been transferred to the investing public, governments will lose their power to manipulate gold prices.

Moreover, the relative variances in the holdings of the gold reserves among central banks underpins a possible realignment of gold distribution from crisis affected US and European nations with present heavy gold holdings to the savings and foreign currency reserve rich emerging economies.

So the potential shift likewise favors rising gold prices.

3. Ignores Seasonality Effects of Gold

Those bewailing fear have likewise been guilty of the omission of the seasonality patterns of gold see figure 3.

Figure 3: US Global Investors: Seasonal Patterns

The chart from US Global Investors manifests of the 15 and 30 year pattern of gold.

Basically, the annual trend can be identified starting with Gold’s summit during the first quarter which effectively goes downhill until the early third quarter where it bottoms, strengthens and ascends.

Even if we were to compare the movements over the last 3 years in Figure 1, the seasonality effects almost seem like clockwork but not in exactitude.

So if I were a gold trader, I’d start accumulating the benchmark precious metal during the lowest seasonal risk months of July to September and be a seller at the start of the year. Although in the interim, I should expect gold to firm up going into May where I should expect a summit and weaken into July or August.

Of course the seasonality factors have divergent depth or heights in terms of losses and gains mostly depending on the underlying long term trend. However in the present bullmarket, instead of correcting during the seasonal low months gold could simply consolidate (similar to 2007).

The point is if we understand and become cognizant of gold’s seasonality patterns, we won’t be lulled to the oversimplified anchoring of ascribing “fear” on gold prices.

Although as a caveat, considering that in the past 15-30 years gold’s annual cycle has been predicated on the demand configuration centered on mainly Jewelry (as I have shown in a chart last February), the accelerating interests on identifiable investments could diminish the seasonality effect variable.

4. Neglects the Risks of Accelerated Inflation Due To Flawed Economic Principles

Most believers of the “Fear” in gold see the risks of deflation more than the risks of inflation. That’s because they live in a simple world of known variables such as “liquidity traps”, “aggregate demands”, “animal spirits”, “current account imbalances” and “overcapacity”. On the same plane, they believe in the “neutrality” of money.

Let me remind you that the fundamental reason global governments are inflating have been due to the perceived risks of deflation, or said differently, for as long as the perceived risks of deflation is in the horizon, governments will continue to inflate, as they have been practicing what can be described as their ideology or textbook orientation-where policymaking or the decisions of a few is reckoned as better than the decisions of the billions of people operating in the marketplace.

As you can see, the irony here is that governments essentially FEAR falling prices in everything. Where falling prices are good for the individual (as it translates to more purchasing power), they are deemed bad for the society, so it is held.

And the same applies to savings; “savings” defeat consumption, so it is held, as reduced consumption equates to diminished “demand” which is equally bad for the society. Hence, to counter falling prices, means that governments and their coterie of mainstream supporters exalt on the furtherance of borrowing, spending and speculative inducing policies, the very policies that brought us this crisis.

Unfortunately the US and European banking system remains fragile as governments have kept alive institutions that needs to expire. The losses have now escalated to a sink hole-some $4.1 trillion of toxic assets, according to the revised estimates of the IMF. This means more redistributive processes is in the offing given this ideological framework, where more money especially from crisis affected nations will be used to prop up zombie institutions. The US has pledged or guaranteed a stupendous $12.8 trillion and growing (as of March 31), while UK’s support for its financial industry has already surged to a remarkable $2 trillion and counting.

Apart, every nation have been urged to do their role of printing money, borrowing and spending from which global policymakers have gladly obliged. The local crocs have been jumping with glee as Philippine stimulus spending of Php 330 billion or ($7 billion) translates to a surge in “S.O.P” (Standard Operating Procedure or other term for kickbacks).

The unfortunate part is that not every country or region has been affected by an impaired banking system. Emerging markets have primarily been affected by the transmission mechanism of the US epicenter crisis via external linkages of trade (falling exports), labor (reduced remittances) and investments. Hence, the deflationary pressures seen in nations which presently endure from busted credit bubbles and emerging markets suffering from sharp external adjustments or two distinct diseases have been administered with similar medication but in varying dosages.

Apparently, since money, for us, has relative impact on prices, these concerted government sponsored programs has begun to ‘leak out’ to the marketplace-through stock markets first then commodities next, as expected.

The recently published World Economic Outlook from the IMF gave me an eye popping jolt over the very compelling fundamentals of food!

Thus, we’d deviate from gold and discuss about food. See figure 4.

Figure 4: IMF’s WEO: Supply side dynamics for select Food

According to the WEO (p.55) , ``In the face of weaker demand from emerging economies, reduced biofuel production with declining gasoline demand, falling energy prices, and insufficient financing amid tightened credit conditions, farmers across the globe have reportedly reduced acreage and fertilizer use. For example, the U.S. Department of Agriculture projects that the combined area planted for the country’s eight major crops will decline by 2.8 percent (year over year) during the 2009–10 crop year. At the same time, stocks of key food staples, including wheat, are still at relatively low levels. These supply factors should partly offset downward pressure from weak demand during the downturn.” (bold underscore mine)

Did you see spot the fun part in the chart? Notice that the inventory cover for the world’s major Food crops (middle) has been nearly at the lowest levels since 1989!

Despite the surge in Food prices in early 2007 these hasn’t translated to a boom in the production side. Now that the crisis has been the underlying theme which has also impacted the food industry, production has further been impeded by “tightened credit conditions” which has “reduced acreage and fertilizer use”. Whereas consumption demand is expected by the WEO to be maintained at present levels (yellow line middle chart).

Remember the shelf life for food is short. Hence, surpluses are likely to be minimal.

Moreover, we have a looming structural long term demand-supply imbalance.

According to Earth Policy, ``Demand side trends include the addition of more than 70 million people to the global population each year, 4 billion people moving up the food chain--consuming more grain-intensive meat, milk, and eggs--and the massive diversion of U.S. grain to fuel ethanol distilleries. On the supply side, the trends include falling water tables, eroding soils, and rising temperatures. Higher temperatures lower grain yields. They also melt the glaciers in the Himalayas and on the Tibetan plateau whose ice melt sustains the major rivers and irrigation systems of China and India during the dry seasons.”

What is this implies is that this episode of intensive money printing on a global scale will have a tremendous impact on food prices!!! If the boom in financial markets in emerging markets does extrapolate to “reflation” then there will be a tidal wave of demand to be met by insufficient supplies!! The next crisis may even be a food crisis!

In addition, the inelasticity or poor or lagged response from the price action, possibly due to overregulation, subsidies, import tariffs, etc… , suggests of a prolonged supply side response; as I earlier noted -the boom in food prices in 2007 didn’t translate to a meaningful supply side adjustment.

So those obsessing over the “deflation” bogeyman will most likely be surprised by a sudden surge of Consumer Price Index especially when food prices hit the ceiling.

This is equally bullish for gold.

Moreover, for governments and those fearing deflation who are in support of policies operated by the printing press, it seems to be a case of “be careful of what you wish for!”