The power of incentives in an organisation

Tim Harford’s excellent The Undercover Economist looked in great detail at the power of incentives. If a society or an organisation gets its incentive structure right, its people can go on and achieve great things for themselves and for their organisation. If that incentive structure is wrong, people may act in self-interest, which is not always in the best interests of the greater good.

There are, according to economists, three types of incentive:

Financial – if you do this, I will pay you. If you do it well, I will pay you well.
Moral – You should do this because it is the right thing to do. If you do the right thing, you can expect a sense of self-esteem, and approval and admiration from your community. If you don’t, you can expect a sense of guilt, and condemnation or even ostracism from your community.
Coercive – if you do this, physical force will be used against you; you may go to prison.

How the incentive structure works in hedge funds

Let’s look at the (financial) incentive structure behind hedge funds. The strategies funds use vary hugely. Some may deal only in bonds, others in commodities; some may be long-only, while some special situations funds can do pretty much whatever they like.

But one similarity is in the way they charge. There will typically be a small annual management fee (1%-3% maybe) on top of which they take 20% of any profits – but only after making good any earlier losses. More highly regarded managers may charge a higher performance fee.

The idea behind this performance fee structure is that it rewards success, though it has been criticised for giving managers the incentive to take on higher risk and thus higher leverage than they otherwise would.

Read the full article

Source: The Real Reason Hedge Funds are Shutting Down

It is a government’s duty to provide its people with opportunity. So we must thank Alistair Darling for giving us with his wise words on Saturday what has to be the easiest money-making opportunity of the year: to sell the pound as soon as the markets opened on Monday. Not since Northern Rock a year earlier has such an obvious trade presented itself.

I said in MoneyWeek’s New Year predictions for 2008 that I wouldn’t rule out a sterling crisis later in the year. That moment is looking more and more likely. If it is the government’s intention to devalue sterling as quickly as possible, it’s hard to see how they could improve on the job they’re doing.

Then again they may just be incompetent.

The story behind the pound’s devaluation

Let’s start with some charts of sterling. Two pictures that each tell a thousand ugly words. The pound against the euro:

And against the dollar:

The downturn accelerated in October-November 2007, shortly after Gordon Brown announced that he would not be holding a November election. The horrid realisation must have dawned on forex traders that we had three more years of the bloke and they began hitting the sell button. But it was an orderly decline. ‘He can’t last three years, surely?’ they thought.

Then as August began, the grim reality hit home that not only was he coming back from his holiday, but that he had no intention of resigning, despite dire Scottish election results. We had what is known as a mad rush for the exit, punctuated by a brief moment of respite as somebody won another gold medal, then downwards into the abyss.

Just as you thought you could take a breather last Saturday – perhaps watch a bit of footy or take a stroll by the river – Darling has his Road-To-Damascus-Meets-Trisha moment and onwards and downwards went the pound.

Anything that you, me or my Aunt Joan own which is denominated in sterling has lost 15% of its value in a year in currency alone.

Devaluing sterling effectively devalues the Government’s debt, so you might think for a second it’s deliberate. But you know deep down it isn’t. It’s that old Labour favourite: incompetence.

The Government can’t hope to save the housing market

Do they honestly think they can save the housing market? With this new £175k stamp duty threshold, I feel sorry for anyone who is struggling to sell a property currently valued at £250k. Before you can say party political broadcast, they’re going to be getting a whole load of offers at £175k, plus some cash for curtains and white goods.

Interest-free loans to help low earners to get on the housing ladder! If they’re low earners, why are you trying to get them into debt? That is highly irresponsible, is it not? How will they pay that debt back? They might go on to become high earners, yes, but then they might not – and with this lot in charge of the economy the latter is more likely – and what then? This is imprudent lending – the very cause of the problem.

Read the full article

Source: How House Prices Could Fall by 75% from Here, in Gold Terms

Many of the most unemotional traders I know have been wailing like bereaved heroines from a Greek tragedy, while others have been seen approaching strangers in the street and asking them for a hug.

In typical fashion, gold and silver have not been playing to the script. A war breaks out between Russia and Georgia. You’d expect gold to rise. But the opposite happens: we get one of the most violent sell-offs in recent memory. Gold breaks virtually every technical support level. Those on margin are forced to liquidate and the decline accelerates.

Where will it end? Is the bull market over? It could be.

Then again, it could also be the daddy of all buying opportunities…

What triggered the violent sell off in precious metals

$850 an ounce was a huge number for gold, both technically and psychologically. Many traders will have had stops just below that level. It held for the weekend then on Monday gold went through it like a sharp knife through warm butter. The dam bust and a sea of stops were triggered. Worryingly, key support has now been broken.

Silver, meanwhile, as it sometimes will, has plunged to the downside with a violence that is shocking. Full dollar daily moves have become the norm. Silver never behaved with much respect for conventional technical indicators – she has regularly broken key support levels to the downside, throughout this bull run – but this last week she has been gesticulating at them like some sort of taunting leprechaun with an ASBO.

This sell-off will have hit precious metals investors in two different ways. Those who hold only physical will have raised a weary eyebrow and observed, “Oh, another August sell-off” before returning to their beach read, possibly Ian Fleming’s Goldfinger. But those who spreadbet or use CFDs or other forms of margin, if they were long, will have been bleeding behind the eyes. They won’t need any lecturing on the dangers of attempting to trade gold with margin. It is a notoriously difficult thing to do. And to trade silver with margin, as I have said before, is nigh on impossible.

But, speaking of bleeding, didn’t Baron Rothschild say that the time to buy is “when there is blood on the streets”? Well, there is blood on Margin Street.

Before we consider what should be our next move, let’s just remind ourselves what has triggered this one.

Firstly, the US dollar broke out to the upside (see below). Gold will often trade in an inverse pattern.

What caused that sudden turnaround? The dollar had reached its lowest point since April. There was no change in policy or rise in interest rates. According to James Turk, Federal Reserve reserves of US government paper, held in custody for central banks, grew by an annual equivalent of 38.4%, when the normal growth rate is 17.3%. For whatever reason, central banks – no doubt followed by speculators – had been accumulating dollars.

Read the full article

Source: Four Reasons to Buy Gold Now

I know many who are considering throwing in the towel. What’s an investor to do? Property? Toast. Commodities? In a nasty correction. Equities? See above. Cash, then? Maybe – but which currency? The dollar? Yeah, right. The pound? See the dollar. The Euro? Overvalued. The Yen? No interest. The Canadian dollar? Vulnerable to a commodities correction. Which leaves, er, Swiss Francs? Not bad. I own some.

And, of course, there’s always gold. Yes, I know it’s down almost $100 in ten days; yes, I know I’m always harping on about it, but hear me out. In my opinion, we’re near a low.

Why you should buy gold now

Here is a monthly chart for gold since 2001, when this bull market began, with arrows pointing to August. You can see that every year except 2006 the markets rallied from August to the end of the year.

(If you cannot see this image, click here)

I see no reason why this pattern shouldn’t recur this year, with a low set some time over the next fortnight or so, followed by a nice bullish move into year end.

The problem is how much further has it to fall?

Well, I have been buying more physical this week. I don’t care if it falls another five percent. I’m confident it will rise a lot more in the future. I’d rather own physical gold than just about any other asset and the fundamentals – whether it’s declining supply, increasing demand, the time of year, insolvent banks, global financial crises, money supply growth, inflation, you name it – get stronger and stronger.

That said, if you want to get really technical and bottom fish, I would suggest $850 is a likely target area. That was the old 1980 high. It was a strong point of resistance late last year, but, ever since, it’s proved a support level. What’s more, the 52-week moving average (green line) has been a very reliable bottom caller in the past and that currently lies at $855.

But it may be that we saw the low yesterday and we’ll get a straight bounce off the trend line.

The ferocity of this down move has me very nervous. But then I remind myself: don’t panic-sell gold in August. The fundamentals for gold haven’t changed.

Read the full article

Source: Why August Is a Great Month to Buy Gold

But Money Morning’s Dominic Frisby says he’d rather own physical gold than any other asset right now.

Historical trends show that August almost always marks the start of an annual rally for the yellow metal. And gold’s fundamentals mean it will reward investors that hang on. More from Dominic…

Who would be an investor in these markets? Portfolio screens across the globe in virtually every asset class are a grim, grim scarlet. Oh, for some green. Yes, the general markets rallied yesterday, but that was just noise. We all know they’re toast.

I know many who are considering throwing in the towel. What’s an investor to do? Property? Toast. Commodities? In a nasty correction. Equities? See above. Cash, then? Maybe – but which currency? The dollar? Yeah, right. The pound? See the dollar. The Euro? Overvalued. The Yen? No interest. The Canadian dollar? Vulnerable to a commodities correction. Which leaves, er, Swiss Francs? Not bad. I own some.

And, of course, there’s always gold. Yes, I know it’s down almost $100 in ten days; yes, I know I’m always harping on about it, but hear me out. In my opinion, we’re near a low.

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Why you should buy gold now

Here is a monthly chart for gold since 2001, when this bull market began, with arrows pointing to August. You can see that every year except 2006 the markets rallied from August to the end of the year.

I see no reason why this pattern shouldn’t recur this year, with a low set some time over the next fortnight or so, followed by a nice bullish move into year end.

The problem is how much further has it to fall?

Well, I have been buying more physical this week. I don’t care if it falls another five percent. I’m confident it will rise a lot more in the future. I’d rather own physical gold than just about any other asset and the fundamentals – whether it’s declining supply, increasing demand, the time of year, insolvent banks, global financial crises, money supply growth, inflation, you name it – get stronger and stronger.

That said, if you want to get really technical and bottom fish, I would suggest $850 is a likely target area. That was the old 1980 high. It was a strong point of resistance late last year, but, ever since, it’s proved a support level. What’s more, the 52-week moving average (green line) has been a very reliable bottom caller in the past and that currently lies at $855.

But it may be that we saw the low yesterday and we’ll get a straight bounce off the trend line.

The ferocity of this down move has me very nervous. But then I remind myself: don’t panic-sell gold in August. The fundamentals for gold haven’t changed.

Here’s a stat for you: since 2000 there have been huge corrections in gold on an almost annual basis. There have more than 10 corrections of 10% or more. There have been five – yes, five – of 15% or more. Typically they are fast and violent. With silver the turbulence has been ever more bone-shaking. Bull markets are volatile. They try to throw you off. Hang on.

Gold has a habit of making big six- to nine-month moves, followed by extended periods of consolidation, lasting sometimes a year or more. We had the big move from $650 to $1,020 and are now in another such period of consolidation. It’s possible we may not see new highs for some time yet, but I see us ending the year considerably higher than where we are now.

An investment that will hold its value

And what you really need in these troubled times is an investment that will hold its value. I was voicing a documentary yesterday about 1988. ‘A pint of milk,’ read the script, ‘cost just 26p and a loaf of bread 30p’. Then, driving home, I heard a wonderful fact on the radio: according to the Old Testament, during the reign of King Nebuchadnezzar, an ounce of gold bought 350 loaves of bread. If an ounce of gold today is about £450 and a loaf of bread about a pound, depending on where you shop, you can see that its purchasing power has been maintained. Yet in the UK, measured in bread, we’ve seen our pound’s purchasing power decline quite substantially – even if you shop in Gregg’s.

If you’re looking at a weekly chart, the 30-week moving average (30 wma) will show the average weekly price for the last 30 weeks; the 50 week-moving average will show the average weekly price for the last 50 weeks; and so on.

On a daily chart, people will often look at the 20-, 50- and 200-day moving averages (20dma, 50dma, 200dma). Longer-term traders concentrate on the weekly charts and shorter-term traders will look at the daily, hourly and, in the some cases, even the minute charts. But if you want to be a truly idle investor, look at the weekly charts. In a bull market they will be sloping up. In a bear market they will be sloping down.

Below is a chart of gold since 2001. Most chartists tend to use rounder numbers and the 30 and 50-week averages will work just as well here. But, because I am stubborn old goat who always has to be different, I am using 34- and 52-week moving averages. (I use 34 as it is a Fibonacci number – that’s a story for another day – and 52 because there are 52 weeks in a year). You will notice that the 34 wma is above the 52 wma and the actual price is above the 34 wma. That is the action of a bull market.

You will also notice that the price tends to return to the 52wma; the 34- and 52wmas then come closer together, and then the price breaks out again. These mark good entry points. When the price is too far above its weekly moving average (30-40%), it’s usually a sign that it has got ahead of itself and it’s time to take some profits. You will also notice that the 34 wma has never crossed down through the 52 wma during this period.

Source: How to Make Money from Markets You Know Nothing About

That problem is redemptions.

Now, his fund has done well. He’s been long oil, long gold and short the stock market (sure, it seems an obvious position now, but it’s surprising how few took it). Yet many of his investors are pulling their money out. And in funds where the performance has been less impressive, the rush for the exit has been more dramatic.

Why are investors fleeing hedge funds? Perhaps to cover bills elsewhere, or perhaps simply because they’re panicking. And as we all know, the golden rule when panicking, is to panic first.

But this rush for the exits is taking its toll on stocks that have nothing to do with the credit crunch…

Why redemptions can trigger a domino effect

When you invest in most hedge funds, there will be a ‘lock-up’ period – a period in which investors agree to tie up their money and not make withdrawals. Once that period ends, investors can usually redeem their stakes at the end of the next quarter, provided they give enough prior notice, usually 45 to 90 days. But in June we saw a major rush for the exit.

The trouble is, this can trigger a domino effect. If a hedge fund has to return significant amounts of cash, the manager may then be forced to sell assets to raise the money, even if he would otherwise hold on to them. But this sell-off then drives down the price of the company he’s selling, which hits the performance of his fund, which makes more investors want to pull out.

Let’s look at an example.

RAB Capital (LON:RAB) has about $6bn under management. Their founders, Michael Alen-Buckley and Philip Richards, were considered two of the most astute investors around. They understood the industrial revolution in China and elsewhere in Asia, they foresaw the great boom in commodities, and they got in early. Without their funding, much of the boom in junior mining companies that we saw in the early noughties would not have been possible. RAB made millions. However, the decision last year to buy Northern Rock(PINK:NHRKF) as it was in freefall put a sizeable dent in the company’s reputation, not to mention its bank balance.

RAB Special Situations (Aim:RSS) is one of their better known funds. It listed in 2005 at £1 a share. It’s a closed-end fund, which means that even if you sell the stock, they don’t then have to sell off a corresponding position in the underlying assets, unlike an open-ended fund. This means the fund will sometimes trade at a premium or and sometimes at a discount to the underlying value of the assets it holds (its net asset value, or NAV).

On July 8th, JPMorgan (NYSE:JPM) announced it had sold a million of its four million RSS shares. You can see what this selling has done to RSS. The fund has fallen off a cliff.

The fund is now trading at about 63p, even though it has a net asset value of 111p. That’s a big discount. It seems strange that JP Morgan would sell its position down so aggressively at such an obvious discount, but with the state that financials are in at the moment, the group may simply be keen to have as much cash to hand as possible.

The obvious trade for investors in RAB’s unquoted fund to make now is to redeem their position and buy RSS, the quoted fund. They’re effectively buying the same underlying assets at a big discount. But that would put even more redemption pressure on RAB.

How hedge funds are driving stock prices lower

In any case, one company that RAB had a significant position in is ICS Copper (CA:ICX), a nice little junior miner with some interesting copper assets in Zambia. But the Zambian copper plays have been badly beaten up this past year.

ICS has been on a near-relentless decline since August last year. In late June of this year ICS’s sell-off accelerated and the stock almost halved in a few weeks, going from 40c down to almost 20c. This happened to coincide with the second quarter hedge fund redemption season and with JPMorgan’s selling of RSS.

Read the full article

Source: Why the Credit Crunch Will Hammer Stocks as Well as Property

So it’s little wonder that gold has rallied sharply in the past week or so, to more than $970. But what is it about gold that actually makes people want to own it when the financial system is in turmoil? Investors say it’s a hedge against inflation; it’s the anti-dollar; or they just see that everyone else is buying it, so they pile in afterwards.

But what is the point of owning a lump of metal that doesn’t pay a dividend, isn’t edible and actually costs you money to keep safe? To understand why gold is the ultimate safe haven in this financial crisis, we have to get to the root of our current problem. And that’s money…

How it all started: a brief history of money

Why do we need money at all? The barter system had plenty of attractions – it can’t be taxed, for one thing. But it’s inefficient. Say I sell spades, and you sell dressing gowns. For any deal to happen you must want a spade at just the moment I happen to want a dressing gown. So even the most primitive societies developed some kind of payment system, or money, that was accepted by everyone in exchange for goods and services.

Money has to have two qualities. It must be portable and it must have a purchasing power that lasts, so it can be used at a later stage. Shells, cocoa beans, even feathers have been used over the years as money. At one stage Roman soldiers were paid in salt, from where we derive the word, ’salary’. These early forms of money were ‘commodity money’.

Gold and silver were widely used. Their rarity gave them value – a great deal of worth could be stored in a single gold coin – as did their immutability. Gold doesn’t tarnish. You could dig up a gold coin buried in the ground a thousand years ago and it would be more or less intact. And just as gold preserves over time, so does its purchasing power. An ounce of gold would have bought a Roman Senator a jolly decent toga and perhaps a pair of sandals; today the sterling equivalent (£500 or so) would buy your local MP a respectable suit and shoes.

To facilitate trade, gold was turned into coins of a certified weight and purity by goldsmiths. The goldsmiths, who had built vaults to store their gold safely, also began to store the gold of their fellow townsmen, issuing a certificate as receipt for the gold deposited. Over time these certificates were used in the marketplace as if they were the gold itself. World trade had slowly moved from a ‘commodity money’ to a ‘representative money’.

Seeing that very few depositors ever removed their actual gold, instead using their certificates for trade, goldsmiths realised they could make money by lending out certificates against depositors’ gold. Despite the inherent duplicity in the scheme – lending what is not yours to lend – it worked. The depositors did not lose anything. As long as there was no bank run, their gold was all still safe in the goldsmith’s vault.

Depositors, however, soon wanted their share. Rather than taking back their gold, the depositors simply demanded that the goldsmith, now in effect their banker, pay them a share of the interest. The goldsmith paid one rate on deposits and then lent at a higher rate.

But in times of panic some borrowers would demand their real gold back, instead of the paper certificates. Before long, you had the dreaded run on the bank, with the banker not having enough gold and silver to redeem all the paper he had put out. It would have been straightforward to outlaw this new lending practice, but the large volumes of credit the bankers had created had become vital to the success of European commercial expansion, so, instead, the practice was legalised and regulated. The monetary system had moved on from representative to debt.

Bankers agreed limits on the amount of loan money that could be lent out, limits still much larger than the amount of gold and silver on deposit. Usually the ratio was nine loaned units to one actual unit in gold and these regulations were enforced by surprise inspections. It was also arranged that, in the event of a run, central banks would support local banks with emergency gold. Only if there were runs on a lot of banks simultaneously would the bankers’ credit bubble burst and the system come crashing down,

Read the full article

Source: The Root of this Financial Crisis, and Why You Must Buy Gold Now

I use the CDNX, the benchmark index for the Canadian Venture exchange which is heavily weighted towards mining exploration issues, as a proxy for Canadian juniors. As you can see by the chart, after violent sell-offs it has repeatedly found support just below the 2400 mark – where we are now. Previous price action, and the fact that we are on or just below the 200-week moving average (orange line), would suggest that we are at an entry point now – for those that have the stomach for it. If we break that support, ouch.

The next chart shows the price of Oil (black line – USO) against Gold (blue line – GLD) against the CDNX. It’s apparent that as oil rises, the CDNX tends to decline and vice versa. (The rationale for this would be that as oil rises, mining costs rise and thus profits fall. As oil falls, costs fall and profits rise).

In the long-term, I am very bullish on oil, as you know. But in the intermediate term, it looks like we may have formed a top. The huge volume and extreme volatility we have seen over the last few weeks are one sign, another is that oil stocks have sold off quite brutally since the beginning of the month, as the next chart of the XLE, which is an ETF representing the major oil producers, shows:

Yesterday the sell-off in oil gathered pace. If we have formed an intermediate-term top in oil, and are about to see a few months of decline, I am looking at a potentially bullish scenario for juniors and we should get a decent rally. We can but hope.

AIM market makers kill their own market

In Monday’s Money Morning I had a go at AIM, in particular at AIM’s market makers. I was very surprised the amount of emails I got all saying, “Good for you,” “Somebody has to tell these people” and the like. A lot of people are clearly deeply frustrated by this market.

We have two examples this week of how the practices of AIM’s market makers kill AIM dead.

Last week I tipped Leyshon (AIM:LRL), a late-stage gold development play in China. Some huge buying came into the stock, the likes of which had not been seen since 2006.

What’s AIM all about? It’s the London Stock Exchange’s international stockmarket for smaller firms ranging from young, venture capital-backed start-ups to well-established, mature organisations looking to expand, says the LSE, and apparently “has been specifically designed with smaller companies in mind.” We repeatedly hear about “the success of AIM,” how companies “continue to flourish” and how it is “hugely popular with investors”.

I think it’s time for a little dose of reality.

Let’s start by looking at a long-term chart – the FTSE AIM All-share index since 1997.

It’s hardly what you’d call a ‘success’. I don’t see companies continuing ‘to flourish’. Shockingly, the index is lower than 11 years ago, despite the fact that there has been plenty of consumer price inflation in between. My crude technical analysis says that now key support around 1000 has been broken, we are on course to retest the 2003 lows below 600, with maybe some resistance en route at 800.

Let’s zoom in and look at a more recent chart.

It’s horrible. The trend is down, down, down – even with all those oil, gas and mining stocks. How can AIM be ‘hugely popular with investors’? Are all investors on the short side – i.e. they aren’t buying this stuff, they’re selling it with the intention of buying back lower down and making their profits that way? There are a few notable exceptions of course but in general, the charts show that if your firm is listed on AIM, the price of your shares is falling.

AIM’s success

So what’s the LSE so happy about? The real success of AIM has been to get a lot of companies to launch their shares on the exchange in an IPO (Initial Public Offering). There are some 1700 or so companies now listed. And it is in the listing (which comes with endless fees) that exchange, the brokers and the advisers earn their money.

Or did earn their money. Today that source of easy money looks to have dried up – new listings have plunged. Look at the Daily Telegraph chart below:

The LSE will no doubt blame this collapse on the credit crunch. And there’s no doubt these are difficult markets, particularly for small caps. But much of the blame also belongs to the market itself.

Stock exchange operators want to companies to list and there’s nothing wrong with that. The problem is with happens next. Once a company has ‘floated’, the exchange, the brokers, the advisers and so on have all made their money. While they might like to see companies thrive, financially it doesn’t matter to them whether the company sinks or swims.

As Charles Breese, founder of Armshare.com, says, the LSE is too intent on simply recruiting new Aim entrants and is not doing enough to stimulate the secondary market, where existing holders are able to sell out and new investors can get involved.

On the exchanges in Canada, if you want to sell a stock, you offer it at a set price. That offer is placed on the exchange and if somebody wants to buy, they can at that level. In short, this is a direct, transparent market. AIM has seen fit to use a different method, the market maker system, with no such transparency. It’s a consequence of this system – and the market makers operating it – that liquidity on the exchange has all but dried up.

Read the full article

Source: What’s Wrong With AIM?