Mark Williams on the Gold Bubble and the MF Global Bust

in Academic Departments, Faculty, Finance, News
December 8th, 2011

williamsmark3Mark Williams, an expert on risk management and a master lecturer in finance Boston University School of Management, has recently written two opinion pieces for the Financial Times, analyzing both the gold bubble and the collapse of MF Global.  Williams is a former Federal Reserve examiner and the author of Uncontrolled Risk: The Lessons of Lehman Brothers.

In his October 2011 piece “Gold bugs beware – the bubble will burst,”  Williams writes,

Gold is losing its glimmer. Last month, gold prices dropped more than $300 an ounce – the largest short-term fall in more than 20 years. This suggests that a decade-long bull market is ending. Gold’s recent volatility is spooking investors and destroying demand.

The last bull market for gold ended in 1980, when prices fell by 60 per cent. For 20 years after, owning gold was dead money. In 2011, the bubble is popping again. This time, gold could drop to $700 an ounce, more than $1,000 below its peak….

In the last month, the rationale used to fuel the gold rally (with the exception of a stronger dollar) has remained unchanged. Global stock markets are volatile, central banks have not regained credibility, inflation is still a concern, and trust in the markets has not been restored. Yet gold continues to fall. Fears of a Greek default and eurozone turmoil are now prompting investors to buy US dollars – which many are starting to see as a safer bet than the euro or volatile gold.

In the last few days, despite continued economic uncertainty, gold has dropped more than 10 per cent. Silver – gold’s shadow – has dropped 22 per cent over the last month. Gold bugs attribute these drops to profit taking, increased margin requirements, and a bull that is taking a short breather. But what if they are the early signs of a fundamental market shift?

If gold is falling in a weak economy, and investors are willing to own US dollars again, imagine how it will perform when the global economy eventually moves from chaos to prosperity, and more traditional investments – those that produce products, dividends and jobs – come back in fashion. Gold has lost its shine.

Read Williams’s full opinion piece in the Financial Times.

In his November 2011 piece “MF Global gives the Fed a lesson in how to pick its friends,” Williams argues,

The collapse of MF Global…proves the Federal Reserve Bank of New York needs a lesson in how to pick its friends. The New York Fed selects an elite group of primary dealers to carry out monetary policy, distributing US debt as part of its federal open market committee operations. Those who pass the test gain a unique and profitable status….

The firm’s bankruptcy raises an important question. Had its financial soundness changed dramatically in nine months since it received New York Fed approval or were the standards flawed?

“Let us hope the New York Fed will learn a lesson and upgrade its primary dealer standards – with a focus on quality over quantity.”

From a risk perspective, its capital position was 30 times weaker than that of most primary dealers. It was also new to investment banking, a higher risk area than its core brokerage business…

Asked why MF Global was approved, Ben Bernanke, US Federal Reserve chairman, defensively responded that the central bank was not the firm’s regulator. But primary dealers play a vital role in carrying out policy and instilling market confidence. The New York Fed must set a higher approval bar – and then apply rigorous monitoring to ensure its chosen firms remain financially and operationally sound.

US capital markets are as strong only as our faith in the way the central bank conducts its day-to-day business. Let us hope the New York Fed will learn a lesson and upgrade its primary dealer standards – with a focus on quality over quantity.

Read this full opinion piece in the Financial Times.