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SOVEREIGN MAN

Why we’re up 30% on our gold/euro position

May 12, 2010
Undisclosed Location

First of all, I really want to thank all the well-wishers who were kind enough to write me and wish me luck on my operation yesterday. Everything went off without a hitch, and I’m already feeling much better.

I will unfortunately need to stay in place for a few weeks while I recover and have a few follow-up visits, but I expect to get airborne again quite soon.

To be honest with you, the place I’d love to be the most right now is Greece. I think history is unfolding right in front of us, and I really want to see it with my boots on the ground.

I thought it was absolutely amazing when European leaders came to the table this week with almost $1 trillion to defend the euro against the market’s siege. Yet, by the end of the day after the initial euphoria had worn off, Europe’s support didn’t register so much as blip in the euro’s strength.

Specifically, after the announcement of the trillion dollar support package, the euro finally closed Monday afternoon at $1.27. Prior to the announcement before the weekend, the euro closed Friday at… $1.27. Not exactly much of a difference.

In other words, the market essentially laughed off the government’s trillion dollar pledge of support. Why? A few reasons-

First, no one really believes the European support truly exists, especially not in that magnitude;

Second, even if it did, investors now finally realize that these politicians are simply playing with their own worthless monopoly money;

Third, and most importantly, anyone with two brain cells to rub together recognizes that Europe’s economic woes cannot be contained with more paper money… and now the problem just became $1 trillion worse.

Battling back from an economic crisis requires hard work, savings, and minimal disruption from the government. There’s no magic pill, entitlement program, or paper money bomb that will suddenly make things better.

Instead, governments should be curtailing social benefits that encourage people to be lazy, while simultaneously stripping taxes to the bare bones in order to give entrepreneurs and investors the proper motivation to work hard, take risks, and hire employees.

These things are not happening, nor will they ever happen in the foreseeable future. And so, backed by Europe’s trillion dollar pledge, Greece will likely go back to business as usual… spending money that it doesn’t have, and making its problems exponentially worse.

Last summer, when I was in Europe, I wrote a short piece about the euro. At the time, I explained why it was overvalued (at around $1.43 back then) and that its fair market value should be in the range of $1.18 to $1.25 to achieve similar parity as the US dollar.

In the past, investors were desperate to dump their dollars, and the euro seemed like the most viable alternative. Investors paid a premium for the euro, bidding the price well beyond its fair market value to as much as $1.60.

Today, the euro is once again trading near its fair market value range that I estimated at $1.18 to $1.25. This is because the market no longer views the euro as a viable alternative to the dollar, hence it is not worth paying a substantial premium to fair market value.

Remember, due to the size of their respective bond markets and relative lack of capital controls, there are only three currencies in the world that have the capacity to absorb large institutional capital flows– the dollar, the yen, and the euro.

If you’re a small investor with a few million dollars, you can park that cash just about anywhere without affecting the exchange rate.

But if you’re a large institution with billions of dollars, only the dollar, yen, and euro can consistently absorb huge inflows/outflows of capital without drastically affecting the exchange rate.

For now, those capital flows are moving out of the euro and into the dollar. The reasons behind the ‘europremium’ are gone, so the purchasing power of the two currencies should be roughly the same.

As such, I would be uncomfortable having a short euro/long dollar position in this range unless there were a very clear signal that the euro’s collapse is imminent.

Since the PIGS have a trillion pieces of paper to burn through for the time being, I expect this won’t happen for some time.

Additionally, for the time being, I’m happy to maintain my short euro/long gold position (XAUEUR) as I continue to believe that institutional funds are starting to shun government bonds in favor of gold. This position has returned us 30% since I first mentioned it a few months ago.

About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

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Comments on this entry are closed.

  • http://www.provolife.wordpress.com jim Brown

    Simon – a nice young man such as yourself might think that Europeans are lazy and can be brought in line with American work values easily. That probably is not the case. They have totally different values than the American work ethic. Think about it- it maybe hard for Americans to understand but there are other things in life than making tons of money. A steady job, a social net, work for future generations, health care are among the things valued most – maybe because they are attainable. Europe is an old civilization and they are not used to or allowed in many cases to move beyond their social level. Yes the are always exceptions and those will always rise to the top. Look at Russia – it did not take long for some to make big money but are the average persons any better off or motivated?

  • Justin

    Simon,

    I just wanted to say thank you. I immensely appreciate the actionable information you have provided me. However, I am most grateful for the peace of mind you have given me. It has not quite yet been a year since I was introduced to Austrian Economics and shortly there after found your website. Since then it has been quite the ride and I am immensely appreciate people such as yourself who are already philosophically sound and thereby able to provide the needed intellectual support during this re-education process.

    All the best,

    -Justin

  • William Riggs

    While I know the tide can always turn and you can be the goat a month from now, I must say that you are the king of the investment newsletters, blogs or whatever form people use. I have been a subscriber since you began this project and I have come to respect your judgement and the strength of your network of contacts. Your analysis has been insigtful and useful in forecasting the events still to come. No one is 100% in this business, but you are certainly worth the price of admission!

  • William Riggs

    By the way, I understand what Mr. Brown is saying. We sometimes forget that most of the world believes they should be enslaved by someone in order for their civilization to function. All the people of Islam who wish for the Sultanate are wishing for moving the clock back 600 years and to be the serf for a single dictator at whose whim people are beheaded. The Europeans long for a King or Queen to save them from being responsible for their actions and outcomes. We forget the individual burden it is to be a free person. No one will come and tell you how to do things. There is no one to blame for your mistakes. You don’t have to take risks. What a simple and blissful life it must be. However, that cannot explain the millions who have fled for a better life in the United States. If we continue down the path, where will we escape to live free? My friends who came here from Europe are furious with the direction America is moving because they came here to escape the insanity of socialism. Those who would not risk and stayed behind make up the population today and have counted on the promises that socialism can never deliver. It will get much worse in the months and years to come as that reality must crush the hopes and dreams of generations before they can begin to find a way out of the abyss. Let us hope we are here to help them understand why our system works and can be the key to their recovery and future success.

  • http://www.targettendonitis.com Alex

    What is this XAUEUR that you’ve mentioned a couple of times? I’ve looked for it in a number of places, but can’t find it.

    Thanks.

    • William Riggs

      I just put it into Google and got pages of sites with information. It is the cross rate (X) between gold (AU) and euros (EUR). You may want to look on a forex exchange for real time charting. See the following link for historical charting:

      http://www.fxhistoricaldata.com/XAUEUR/

  • Dmadaras

    Please let us know the best firm from which to purchase physical gold and silver coins and bullion. I am a US citizen and reside in the US. I want to be more prepared but don’t know how to go about this purchase. Any information would be appreciated. I believe either you or Casey recommended Gold Money. Is that a company you would recommend?
    Thank you.
    Debra

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