Published July 24, 2013

The Curiously Uncurious Ben Bernanke

"To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown—the first instinct is to eliminate these distressing states. First principle: any explanation is better than none.

—Friedrich Nietzsche

"Nobody really understands gold prices and I don't pretend to understand them either."

—Ben Bernanke, July 18, 2013 (6 days ago)

As Nietzsche understood, humans like to have an explanation for everything. Unknowns are stressful. Behavioral psychologists will tell you that when you come to understand a previously baffling phenomenon, your brain releases chemicals that make you feel good. Humans are chemically wired to seek knowledge for the sake of certainty, real or imagined.

That's not to say humans who don't seek answers about a particular subject have some sort of handicap. Some topics are simply of no interest. For instance, I don't know why my dog likes to lick my face, but I'm not going to spend precious time looking it up, because I don't really care.

However, if I were chairman of the Federal Reserve and didn't understand the forces that move gold, learning about them would be near the top of my to-do list, if for no other reason than a large swath of the investment community uses gold as a barometer to evaluate how good a job I'm doing.

Bernanke's clueless quote paints a stark contrast between the academic and real world. Upon observing the recent correction in the price of gold, how many asset managers do you think threw their hands up in confusion and proclaimed that no one can possibly know what's going on, so why even try? My guess is zero.

Instead, they researched, reached out to their contacts, and tried to find out what the heck was happening. Collectively, they hatched a multitude of theories—the vaunted QE taper, JPMorgan's dominance of the paper gold market, stricter gold buying laws in India—as to why the gold price fell. Some were more viable than others. The point is that human nature compels us to seek answers to pertinent questions, especially if those answers impact your wealth, your employment, or both.

Bernanke, apparently, is immune to these forces. It's curious that he doesn't even try to understand gold. Perhaps he's short on serotonin receptors… though it's more likely that he doesn't want to understand, because doing so would call into question virtually every action he has taken since becoming Fed chairman in 2006. Or maybe he does understand the connection between his printing trillions of dollars and the sevenfold rise in the price of gold, but pretends not to. Only Ben knows for sure.

Our feature article today approaches the issue of gold volatility from a broader angle by explaining why not just gold, but all commodities, are so volatile. Have you ever wondered why the price of coffee beans has dropped 34% in the past year, but the price of a venti at your local Starbucks hasn't budged?

Mark Skousen, today's featured author, has the answer.

If you aren't familiar with Mark, he is an Austrian School economist, investment expert, and newsletter editor. He's written several books, is the founder of FreedomFest (at which our own Doug Casey was a keynote speaker just a few weeks ago), and is in general a heavyweight in the combined fields of economics, investing, and freedom.

Enjoy Mark's article, and see you next week.

Dan Steinhart
Managing Editor of The Casey Report

Why Are Gold and Commodities So Darn Volatile?

By Mark Skousen, Editor, Forecasts & Strategies

Why are commodities and commodity stocks so volatile? Commodity speculating is not for the faint of heart, and many investors give up on gold, silver, and mining stocks because they can lose 40-90% of their value in a short period of time. Gold's recent drop from $1,900 to $1,200 is a case in point. You have to expect a volatile market.

The reason why commodity prices vary so much can be found in an understanding of Austrian economics, the free-market school that is endorsed by Doug Casey, Rick Rule, and many other commodity experts. As developed by Ludwig von Mises and Friedrich Hayek in the 20th century, the Austrian school of economics explains why commodity prices are so volatile.

Austrian economists call it "the structure of production." As a follower of the Austrian school, I wrote a book titled The Structure of Production (New York University Press, 1990). Rick Rule told me he loves the book and has bought hundreds of copies to give to his clients.

Austrian economists emphasize the structure of the economy—the structure of interest rates, production, employment, and inventories. It is a complex theory, but the basic idea is that price volatility depends on how far away the product or service is from final consumption. Consumer prices are the most stable, producer or wholesale prices less stable, and commodities are the furthest from final use; therefore, those prices are the most volatile. You can see this difference in the graph below, where the Consumer Price Index (CPI) is far more stable than the RBA Commodity Index.

Take oil and gasoline, for example. Oil is far removed from final use (gasoline) and has varied from $30 to $140 a barrel during the past ten years... and yet the gasoline price (final consumption) is far more stable, varying from $3 to $4 a gallon.

But there's a silver lining in this story. While commodity prices are far more volatile, it also means that commodities and commodity stocks can be much more profitable on the upside… if you buy right. And with commodity prices down 40% or more (with oil being an exception), now may be a great buying opportunity.

For example, Newmont Mining (NEM) is currently selling for book value at only eight times current earnings and sports a 5.1% dividend that is rising. It looks like a bargain to me.

Good investing, AEIOU,

Mark Skousen
Editor, Forecasts & Strategies