When allocating capital for longer than a millisecond or two, like the parasitic high frequency trading operations, one of the key metrics I use is the 200 day moving average.

WHAT IS THE 200 DAY MOVING AVERAGE

The 200 day moving average is actually fairly simple. The sum of the close from the previous 200 trading days divided by 200.

WHY THE 200 DAY MOVING AVERAGE

The decision to use 200 days instead of 199, 50 or 500 is fairly arbitrary and dependent completely on the preferences of the capital allocator. I like the 200 day moving average because (1) the numeraire par excellence is so heavily manipulated that price and value are bifurcated, (2) a static point with an undefined entity like the FRN$ is meaningless, (3) a moving average provides a dynamic figure and (4) two hundred days is long enough to filter out short term abnormalities providing objectivity.

Consequently, while gold may be extremely volatile day to day the 200 day moving average shows a completely different picture; a nice gently sloping bullish trend line. In the financial markets, the 200 day moving average exerts a force much like gravity on the current price.

HOW TO USE THE 200 DAY MOVING AVERAGE

The 200 day moving average is merely a technical tool in the capital allocator’s arsenal. For example, on 14 July 2009 in Platinum Liquidity Increases I argued the case for why platinum was undervalued, a good buy and made a recommendation to purchase it. Of course, the foundation was the market fundamentals; low worldwide production, scarcity, lack of stockpiles, durability, fungibility, industrial demand and legal tender status. Then came the technical factor, the 200 day moving average of the platinum to gold ratio.

THE RELATIVE PRICE

One way I use the 200 day moving average is to calculate the relative price of an asset which is the 200 day moving average divided by the current price. Then I look at the relative price over time to determine when an asset is cheap or expensive.

I have found that during this secular bull market, gold in relation to FRN$ is valued by the market as cheap when its relative price is around .99, average value between 1.00 and 1.25, expensive between 1.25 and 1.35 and very expensive above 1.35. This can be accomplished by looking at the relative price and using standard deviations to form trading ranges.

APPLYING THE RELATIVE PRICE AND 200 DAY MOVING AVERAGE

Back in July 2009 platinum was trading at $1,118 per ounce with a 200 day moving average of 1.21 ounces of gold per ounce of platinum and a historical ratio closer to 2.0. Thus, with bullish fundamentals and being cheap relative to gold based on the 200 day moving average relationships I purchased platinum and it is currently at $1,540 per ounce with a 200 day moving average of 1.31. The trade has resulted in the goal: an increase of net worth when measured in gold ounces, the numeraire.

CHARTS TO HELP YOU QUICKLY VALUE PRECIOUS METALS

To be honest, I got tired of having to click a few times in order to quickly determine the 200 day moving averages for the various precious metals. Consequently, I had a gold price chart, silver price chart and platinum price chart (all three charts are available on this precious metals price page) created that contains the spot price, 200 day moving average and relative price along with a legend stating whether the metal is cheap, average value, expensive or very expensive based on historical trading ranges.

PLATINUM IS CURRENTLY THE BEST VALUE

With the precious metals I recommend accumulating physical metal on a regular basis, either monthly or quarterly. I recommend using a reputable coin dealer like Gainesville Coins for smaller purchases like a single Silver American Eagle or a trusted third party vaulting service like GoldMoney for larger amounts when you do not want the headache of guarding it yourself.

But how does one quickly determine whether they should buy gold, silver or platinum? As you can see from the charts, currently gold with a relative price of 1.0366 is the most expensive relative to its 200 day moving average while silver is in the middle at 1.0267 and platinum is the cheapest at 1.0109. This is confirmed with the platinum to gold ratio which is currently 1.303 compared to 2.0. Thus, if you were to purchase any of the precious metals then I would recommend purchasing platinum because it currently appears to be the best value.

Remember, at all times and in all circumstances gold, silver and platinum remain money and currency. Consequently, you can always trade platinum for gold or gold for silver. The capital allocator’s goal is not necessarily to have the most amount of gold ounces but instead the highest net worth using gold as the numeraire.

CONCLUSION

When it comes to allocating capital I like to focus on intrinsic value. Buy low and sell high and I think money is made when you buy not when you sell. To accurately perceive value I use gold as the numeraire and the 200 day moving average to filter out daily noise and aberrations. Sure, as The Great Credit Contraction grinds on and being able to secure and multiple one’s wealth has become more difficult.

But there are always opportunities and deals to be made. The issue is whether you buy valuable assets on the cheap or when they are expensive. These precious metal price charts will allow you to quickly and easily discern the current prices of the metals and their relative value over the previous 200 days to determine whether to buy gold, silver or platinum.

DISCLOSURES:  Long physical gold, silver and platinum with no position the problematic platinum, SLV or GLD ETFs.

This is the key on which the whole article hangs. The problem is that a significant majority, if not all, of institutional forwards are already settled via unallocated. Accordingly, this move by CME is not “a massive change” in the market – OTC market transactions are primarily settled via London unallocated accounts, and will continue to be if they move to CME. No change here.

As a result this so-called “scheme” provides no support for his conclusions that it “will allow for gold demand to be shunted into gold substitute products and keep the price of gold in fiat currencies low” or “the reason for this move is that physical gold bullion is getting increasingly scarce”.

“Why the CFTC would allow supposedly gold-backed ETF shares to satisfy the physical commodity component in an exchange of futures for physical transaction” and “like settling either COMEX futures contracts or OTC forwards with GLD ETF shares”

That announcement is about Exchange of Futures for Physical (EFP) transactions, not physical settlement of a COMEX futures contract. I checked COMEX rule 113.02 and there is no mention of ETFs being allowed – only physical is allowed.

The issue with EFPs is explained better by Tom Szabo. His key point is that an EFP is an “exchange” and there is no change in the number of futures at the end of the transaction – therefore EFPs do not settle a COMEX futures contract as Trace claims. I would also refer to the comments of a retired precious metal wholesale dealer who comments on Seeking Alpha.

All financial crises are either directly or indirectly caused by the Federal Reserve’s anti-market monetary manipulations. But the government can never blame itself or its central bank—it has to find scapegoats. And who better to blame than people and institutions who deal in private and voluntary financial exchanges outside of the government’s domineering and prosperity-killing regulatory scope?

It was the “speculators” who caused AIG to fail—or at least that’s the official government story. More specifically, it was the roguish brigands who deal in the unregulated market for credit-default swaps (CDS).

The Coming Political Shakedown

Credit-default what? The official story is all the more plausible since 99% of Americans (to be generous) have absolutely no idea what a credit-default swap is. And why would they? Most of them went to government-funded schools that teach statist myths about the cause of the Great Depression and the need for strong anti-trust regulation to thwart potential “robber barons.” The real robber barons, of course, have always been the men behind the curtain writing the very regulations allegedly intended to rein them in!

With this in mind, one has to wonder what financial interests are backing Senator Tom Harkin, the Iowa Democrat who has threatened that his party might not just increase regulation of CDSs but prohibit the market altogether. On October 14, Harkin—who is chairman of the Senate Agriculture Committee, which has authority over derivatives regulation—said that CDSs “increase the risk, the systemic risk, of the whole society.” Global warming, Islamic terrorism, and CDSs: mankind’s greatest threats.

CDSs: Among the Last Vestiges of the Free Market

What anti-capitalist congressmen hate most about credit-default swaps is that they’re completely unregulated. In the wake of the Great Depression, FDR’s New Deal added a backbreaking amount of new market regulations that have served to do nothing but provide investors with a false sense of security and, in some cases, discriminate against the non-affluent by making certain asset classes off limits for them.

Even if you believe we need an SEC and “Blue Skies” regulations to “protect the public,” a similar argument cannot be made for CDSs, which are private transactions between large financial institutions. The public only assumes liability for CDSs when the government steps in to bail out firms that made bad financial decisions. No bailout; no liability.

AIG made some bad bets in the CDS market. As a result, their stockholders were decimated and some of their CDS trading partners were left in the lurch too. That’s the way things work in a capitalist economy: every transaction carries its own risk. And financial markets cannot function when the government steps in to remove the element of risk—or more accurately, to socialize it.

How do Credit-Default Swaps Work?

A credit-default swap is a pseudo-insurance agreement made between two counterbalancing traders. The reason CDSs are considered “pseudo-insurance” instead of actual insurance—something AIG might have actually known something about—is in effort to avoid the onerous regulations the government puts on official insurance products. Regardless, anything that two consenting adults do behind closed doors is their business, and the same philosophy should apply to financial institutions.

An example of a typical CDS agreement would involve one firm (Company A) with a lot of money invested in the bonds of a third party (say, GM). Company B would offer to sell Company A insurance protection against GM’s default. Perhaps Company A would agree to pay $265,000 a year to insure its $10 million in GM bonds. The terms of the agreement would spell the circumstances under which Company B would have to pay Company A and how much, but typically, payment is triggered by formal bankruptcy or failure to pay bond interest. In such a case, Company B would buy the bonds from Company A at a premium or pay Company A the difference between the bonds’ current market value and their par value.

That’s not so confusing, is it?

How CDSs Make the Financial Markets Safer

What is so sinister about such an arrangement? Nothing. Credit-default swaps let companies shift risk and efficiently allocate capital. What’s more, they work to keep the credit markets honest and to expose fraud or negligence on the part of bond rating firms like Moody’s.

For example, if a company’s credit-default swaps are trading at a high yield, and yet the firm is still rated as being credit-worthy by Moody’s, there may be a problem. Typically, the market can better assess a company’s financial health than credit-rating firms. Banning the CDS market, as some Democrats would like to do, would be a lot like the recent short-sale ban—it would merely shield unsound companies from having the reality of their situation exposed to the average investor.

Credit-default swaps emerged from the free market to meet a demand. Banning them would, like all financial regulations, only punish the honest and responsible participants in the market. Let the fraudsters go bankrupt and let the responsible parties pick up the pieces. This is the system of capitalism that served us so well for so many years—now is no time to turn our backs on that which made us great.

But hidden even deeper in the day’s news was an announcement from another government bureaucracy intended to “protect us”—the Securities and Exchange Commission (SEC). In an effort to thwart “speculators,” they banned the “short selling” of 79 financial stocks from now until October 2. There was very little (i.e. none) protest from the supposed champions of the “free market” in the Republican Party.

Speculators as Scapegoats

That’s because, as we investigated in the first installment of this series, “speculators”—and short sellers are generally considered such—are an easy scapegoat for politicians. The average man or woman with any money in the market only generates profits when stocks go up. How dare these short sellers make money as the market goes down! How un-American!

This is the reflexive, reactionary and ultimately ugly view. But the truth is that, like all speculators, short sellers perform a valuable function in capital markets. Banning them will only create a greater dislocation between the real value of a stock and its market value at any given time and create more volatility, not less.

First, we must answer the question: what is short selling? Luckily, “shorting” is easier to comprehend than “credit default swaps” or even call and put options. Most everyone is familiar with the stock-market saying, “Buy low, sell high.” Well, short selling allows traders to do things in reverse order—sell high and then buy low.

A “Main Street” Example

Let’s escape Wall Street and turn to the world of sports collectibles. Imagine it’s the summer of 2007, and the first murmurings of Michael Vick’s impending legal troubles are beginning to circulate. Your friend, a huge Atlanta Falcons fan, is going on a month-long cruise, and you ask him if you can borrow his Michael Vick autographed football. It’s a strange request, but he says, “Why not? Just be sure you return it to me, in mint condition, when I get home.”

Once your friend is on his way to the Caribbean, you immediately go on eBay and sell the ball for $500. Are you stealing? Not if you’re “short selling.”

A few weeks later, the story breaks, and the demand for Vick collectibles plummets. You buy a new Michael Vick autographed football—exactly like the one you borrowed—for $50 and return it to your friend when he comes home.

To recap, you borrowed something, sold it, bought an exact replica and then returned the replica to the original owner. So long as you “sold high and bought low,” you made a profit, and your friend is no worse for wear, either. After all, he lent you a Michael Vick football, and you returned to him a Michael Vick football—what you did with the ball is no concern of his.

Why Short Sellers are Good for the Economy

When applied to stocks, “short selling” works almost exactly the same way. The only difference is that you have an intermediary, a broker, who does the borrowing for you. The person who has their stock borrowed doesn’t even know about the transaction!

Of course, things can go horribly wrong. Imagine you shorted Apple stock at $125 right before they announced a big new product launch, and the stock jumped to $150. You could either “let it ride” and hope that the stock comes back down or buy back the shares at a $25 loss. Shorting is actually much riskier than buying stock since a stock cannot go lower than $0 (capping a short seller’s potential gains), but there’s no limit to how high it might go (meaning unlimited potential losses for short sellers).

So how does short selling make the markets safer? The answer: by putting a cap on “irrational exuberance.” After all, if a stock’s market value (current share price) becomes completely divorced from reality—as with the tech boom—short sellers can and do sell borrowed shares to push the price down. By banning short sellers, the SEC is asking for the prices of the 79 financial stocks to be kept artificially high. But they can’t fight reality forever, and eventually, the share prices and reality will have to coincide. Regulations only prevent the inevitable and make it more painful when it finally does come to pass.

Whenever there’s a financial crisis, governments like to find scapegoats. Short sellers and other speculators are blamed along with the “free market” they represent. Well, the fact of the matter is that it is the government itself, with its implicit line of credit to Fannie Mae and Freddie Mac and the moral hazard it imposes by so frequently stepping in to bail out banks and other financial institutions when they make poor business decisions, is to blame. Americans need to become more educated in the subjects of finance and economics or risk being hoodwinked by slick-talking politicians whose primary aim is to consolidate more power in their hands at the expense of individual and economic liberty.