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Examining the ECB QE Narrative


Should we discount the future value of all narratives?

Terry Kinder precious metals analysisBullion.Directory precious metals analysis 20 January, 2015
By Terry Kinder

Investor, Technical Analyst

Note: The bulk of this article was written yesterday.

Despite the talk of ECB QE and higher gold prices, gold reacted to leaked news with a yawn.

Despite the talk of ECB QE and higher gold prices, gold reacted to leaked news with a yawn.

Perhaps it was a case of buy the rumor, sell the news, but the gold market doesn’t appear to have reacted much to the leaked news that the European Central Bank (ECB) would enact a €50 billion per month quantitative easing program. Could it be that perhaps narrative isn’t the best form of analysis?

With so much buzz surrounding the mere possibility of QE in Europe perhaps you were expecting the gold price to react differently. For that matter, U.S. stocks didn’t get much if any perceptible lift from the leaked news either, although the FTSE apparently got a goose.

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Of course it’s events, or non-events if you will, like this that push me to understand what the numbers are saying rather than seek out whatever the narrative of the moment is. Narrative, of course, is a fancy word for story, and a story is a nice way of saying, “We’re not really sure why that just happened, but here’s a reason for you.”

But rather than just create another narrative about whether, why, or why not European QE caused gold to act in a certain way, let’s examine what price is and why it’s important through an interview with the brilliant FA Hayek.

Just to emphasize Hayek’s brilliance, the bullet points that will follow are based on what he said in only the first minute and thirty seconds of the video. First we’ll look at what Hayek said. Then we’ll examine why using pricing information and technical analysis if preferable to relying on narrative and limited personal knowledge.

Hayek on pricing:

  • We are not willing to accept the guidance of the price mechanism;
  • We learn by abstract signals – the prices;
  • We don’t possess the knowledge. The knowledge of facts is widely dispersed;
  • We want to make use of knowledge possessed by millions of individual people;
  • You can’t concentrate knowledge;
  • Signals tell you about facts which nobody knows concretely in their totality;
  • You can’t correct signals which inform you about circumstances you don’t know
  • Essentially Hayek begins by stating something fairly obvious, a good many people won’t accept the guidance of the price mechanism. We see it all the time with government meddling with issues such as health care. Few remember that much of today’s health care debacle arose out of government wage and price controls under President Franklin D. Roosevelt. In order to alleviate the ills caused by those controls, insurance was excluded in order to give businesses a way to give employees something of economic value and get around wage limits. This was a “fix” for something government broke in the first place. Over the years, government kept applying these “fixes”, breaking more things as time passed, until the latest “fix”, Obamacare, broke even more stuff. Don’t worry, some future president will come up with a “fix” for that too.

    So, a good portion of society wants to get around the pricing mechanism. However, the pricing mechanism is the only thing that allows us to tap the knowledge of millions of people. As an individual, I can’t possibly know what millions of other individuals know. Sure, I can assume I’m smarter than several million people, but it’s probably a good bet that a collection of millions of individuals knows more about oil, diamonds, coal, corn, or microchips than I do. The pricing mechanism takes this disperse knowledge and boils it down to one thing – price – which creates a signal everyone can act off of. If the price of oil drops to a low enough level, drilling will be reduced. If the oil price goes high enough, people will reduce their use of oil, gas and other products.

    Furthermore, Hayek says you can’t concentrate the knowledge (captured by prices). That’s why socialism / communism ultimately fail. A central committee of a few individuals is not able to know more than millions of people. It’s simply impossible. Price signals tell you about facts that nobody can know in their totality. Central planners think they can somehow “correct” those signals as if they know more than everybody else put together. But central planners, whether communist central committees, or central bankers, can’t know more than anyone else put together. It’s just not possible.

    Now, let’s tie in everything we have discussed above back in with narratives, such as the ECB QE one. When you read a story that states that prices are going to move a certain direction because the ECB, or some other entity is going to do something, that person is assuming they know – with certainty, or near certainty – what is going to happen. We have already discussed at length above, why that is impossible. For instance, saying gold will definitely go up or down because the ECB, the Fed or anyone else does something, or asserting that ECB QE is already baked into the current gold price, assumes the person making the statement has all of the relevant information – not just about QE, for instance – but about everything that could influence the price. It’s a tall order knowing everything. It’s more than tall, it’s impossible.

    I can write that European QE will raise the gold price to X amount. If the gold price goes to X I can say that I predicted what was going to happen. But, was I right or was I lucky? Perhaps some of both. Narratives assume too much knowledge, which is why I prefer the technical analysis of prices.

    Technical analysis is widely panned – either as some kind of modern sorcery, or incomplete because it doesn’t consider fundamentals. What are fundamentals? Are your fundamentals and my fundamentals the same? Who determines what fundamentals are? How many people determine those fundamentals? In the end, one person determines your fundamentals – you. That’s fine when you apply your analysis of the fundamentals and are willing to suffer the consequences as an individual. The danger comes when you represent your analysis as being complete and usable for all. Perhaps it is. Perhaps it isn’t. You may be correct a good deal of the time, but at some point reality (whatever that is) shifts and today’s fundamentals don’t fit tomorrow’s situation.

    How can we avoid this dilemma? We can apply technical analysis to price information as it contains both the knowledge of millions of individuals and is an abstract signal which guides people in their decision-making. Rather than relying on personal opinion regarding what is fundamentally important in any given situation, we can create price charts and use technical analysis to interpret the information price is telling us. The difficulty, of course, is putting our personal bias aside and only interpreting the abstract signals as far as they lead and no further. It’s extremely difficult.

    For instance, I would love every day to present a perfectly rosy picture of the gold price. Nothing would please me more to report that some chart said gold was going ever higher and that you and I were going to be wealthy beyond our wildest dreams. That, for better or worse, would not be an accurate reflection of where we are today. In no way does that mean it won’t be true tomorrow or at some point. Neither does it mean that it will be true ever. The point is, what I want and what can be teased out of prices through technical analysis are very often not the same. Technical analysis must go where prices lead. Too often narratives take us where the author wants us to go.

    Although I can’t prove it with certainty – because of the already mentioned fact that I can’t know more than millions of individuals – I suspect that the gold market yawning at the European Central Bank’s QE announcement is another case of a failed narrative. In the end we can’t know, ever. I can have my suspicions all day long, but my suspicions aren’t truth itself.

    Prices are the closest thing we have to the truth. Technical analysis offers the possibility of advancing beyond failed narrative and opinion and taking us a step closer to what is true rather than someone’s version of the truth.

    Postscript: In a recent post about the Canarsie Capital blowup Martin Armstrong had this to say about fundamental analysis:

    Way too many of these people really trade based upon what they simply read in the mainstream press.

    A real professional listens to the market. Amateurs trade fundamentally. This is a lesson everyone should pay attention to. Make sure you do not invest with funds that trade only fundamentally.

    I would add that trading based on what the alternative media says isn’t any wiser either. You’re always better off listening to what price is saying about any market.

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