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When Insiders Start Buying Gold

Start Buying Gold When...

Written by Geoffrey Pike
Posted October 3, 2014

We often try to predict investments based on events that happen. But what if it should be the other way around? What if we should be using investments to predict events?

A recent Forbes article discussed gold as being a great predictor of news events. The author pointed out that markets often move days before important news is released.

He used the events in Ukraine as an example.

In early 2014, gold rallied from about $1,200 per ounce to well over $1,300 per ounce. Once things erupted with the Russian government and Crimea and tensions were high, gold started heading back down.

In other words, the author is saying that the markets are responding to events that haven’t happened yet or are at least not fully known by the public. He speculates that it is insiders taking advantage of the information before it is public knowledge.

Obviously this must happen in some circumstances. Whether it is enough to drive large markets is another question. Maybe this is just a case of “buy on the rumor and sell on the news.”

But there is another possible explanation here that we shouldn’t overlook. In fact, it is quite an important factor in determining not only world events but also economic conditions.

The Wisdom of Crowds

When you get a bunch of people together, sometimes it drains away the power of people to think. As George Carlin said, “Never underestimate the power of stupid people in large groups.”

I suppose voting may serve as a good example of this, but that is a topic for another day.

But in terms of voting, people don’t really pay a price for their decisions. You could say everyone pays a price, but each individual’s decision doesn’t really matter, and they know it. Since there are no consequences for their individual actions, they don’t have to give it much thought.

Things change when people have their own money on the line, when there isn’t any propaganda or incentive to go along with the crowd, and when people give some individual thought to something.

There is an old experiment where you have a jar full of jellybeans and ask a group of people to guess how many jellybeans it holds. Most people are way off on their guesses. Even with a large number of people, almost nobody will get it right, and few will be close.

But an interesting thing happens when you tally up all of the results and take the median guess. If you have a large enough group of people, then the median will end up being very close to the correct number.

There is wisdom in the crowd. But it is important for each individual to guess on his or her own without being influenced by what others are guessing.

There is another interesting use for this technique. Prior to the presidential election in 2012, I was telling people that I thought Obama would win. Some people mistook that for me wanting him to win. Rather, I thought he was going to win because that was where the money was.

At that time, there was a website called Intrade, which has since been effectively shut down by the government. On Intrade, you could bet with real money on the results of events in the world, which included U.S. elections.

Intrade was showing that Obama would win just days before the election. Even the breakdown of the electoral votes by each state was almost completely accurate at the end. The website also correctly predicted that the Democrats would maintain the Senate and the Republicans would maintain the House.

But it wasn’t really Intrade that predicted this — it was the thousands of people who were betting with their own money on the line. While everyone else was trying to analyze news reports and the latest polls, I just looked at Intrade, which was a much better indicator than most polls.

It is hard to say why this works so well, but each individual has some little piece of knowledge that he is applying to his decision. No one individual has all of the knowledge, but when you combine the little pieces into a huge group, the overall consensus is often right.

So while it is possible that insiders were buying gold knowing that things were about to erupt in Ukraine, it is also possible that investors as a group foresaw something happening.

Using Investments to Predict Other Investments

Investments don’t always react the way we think they should when certain events happen. If there was any hint of a possibility of the event happening beforehand, then it may have already been priced into the market.

In our world of virtually instantaneous trading today, it doesn’t do much good to try and make investments based on events that are already known. It is not a good idea, for instance, to buy gold just because things are chaotic in Ukraine or the Middle East. You should only buy gold on this if you think things will get worse while most other people don’t foresee that.

Not only do events not predict investment markets, but we can also now be reasonably sure that investment markets often do predict events.

Stocks tend not to be a good measure of crowd wisdom. Sometimes it is the reverse. A lot of people will invest in stocks just because stocks are going up. There are also a lot of people with retirement accounts on autopilot that continuously contribute to mutual funds.

The bond market tends to be a much better predictor of events, particularly when it comes to economic events. Whenever we see an inverted yield curve — meaning long-term rates are lower than short-term rates — it is almost a perfect indicator that a recession is close at hand.

We are not going to see an inverted yield curve now because short-term rates are almost at zero. But I have been watching long-term rates closely. The 10-year yield has been moving down again recently. And since the Fed is not buying up as much government debt, it is not solely the Fed that is pushing it down.

If the 10-year yield gets down to 2% or less, then this will be a strong indication that a recession is not far away. The bond market tends to be a good predictor of economic events, especially when the Fed isn’t interfering in the market as much.

If longer-term rates go down and we hit a recession, then it is a good bet that stocks will tumble. In other words, in this scenario, we can use the bond market as a predictor of a weak economy and a major downturn in stocks.

I don’t know why the crowd is currently buying bonds and driving rates down, but I’m not sure I would bet against this crowd.

Until next time,

Geoffrey Pike for Wealth Daily

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