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The Daily Reckoning | Tuesday, April 20, 2010 Goldman's unbelievable "luck" runs out, Central bank actions help make the case for gold, Plus, three possible scenarios for the US...none of which look particularly  appealing...and plenty more... Goldman’s One-Sided Coin Trick Defying all logic and “winning” 90% of the time Eric Fry Reporting from Laguna Beach, California... If you flip a penny 1,000 times, it'll land "heads" about half the time and "tails" about half the time. If you bet on "Even" 1,000 times at a roulette table, you'd win a little less than half the time (thanks to the "0" and "00" slots on the wheel). These probabilities are relatively simple and intuitive. Stock market probabilities differ somewhat. Insight improves the odds. Lots of insight improves the odds greatly...over a long-term timeframe. But over the short-term, insight provides a very limited and unreliable benefit. "The markets can stay irrational," John Maynard Keynes famously observed, "for much longer than you can stay solvent." That said, successful stock market traders tend to "win" about 55% to 60% of the time. This win percentage is not so different from that of successful sports bettors. Again, these probabilities make sense. If you possess relevant insights into the "markets" you are trading - be they S&P 500 futures or professional football games - you can improve your odds of success...a little. Chance and pure, dumb luck still play a prominent role...unless you happen to be a trader at Goldman Sachs. For reasons that neither logic nor probabilities can explain, Goldman's trading desk "wins" more than 90% of the time...or at least it did during 2009. The inexplicably successful Wall Street firm lost money on only 19 trading days last year, which means it made money on 244 days out of 263. And Goldman did not simply make some money, it made lots of money. The firm booked a daily profit of more than $100 million on 131 trading days - that's almost ten times the number of $100 million days it booked in 2004. Even during the rough and tumble days of 2008, Goldman still managed to amass an implausible record of success by booking a daily trading profit 63% of the time and racking up $100 million profits on 90 trading days. A cynical observer could easily deduce that: 1) the "level playing field" on which Goldman purports to operate is as crooked as can be and that; 2) Goldman's miraculous trading success in 2009 may have something to do with the disappearance and/or emasculation of former competitors like Bear Stearns, Lehman Bros. and Merrill Lynch. "Traders are supposed to live by their wits, making judicious bets on the market," observes financial commentator, Sean Paul Kelley. "Good traders who don't have inside information tend to win about 55% of the time and lose money 45% of the time, the difference being their profit resulting from their trading acumen. "Goldman Sachs doesn't work this way," says Kelley. "They have bright people no doubt, and somewhere on the trading floor these people on occasion make good and bad judgment calls. From what it looks like, however, their traders are benefiting from two advantages: information not available to the market, and muscle. These two things give the firm an edge that almost guarantees substantial 'trading profits' quarter after quarter. "The information part comes from a variety of sources," Kelley continues. "We've seen the scandal over High Frequency Trading, where Goldman and other firms have computers positioned at the New York Stock Exchange, getting information on trades a millisecond before they are posted publicly. Goldman sees where the market is going second by second, positions itself for very short term profits, and in effect extracts a tax on trading by individual investors and mutual funds. Goldman Sachs is the biggest player in this business... For credit products, mortgage securities, and equity derivatives, Goldman Sachs extracts similar information from its clients interested in buying or selling these products... "None of these information sources or uses are illegal at this point," Kelley concludes, "but this is hardly the profile of your typical day- trader pitting his wits against the fickleness of the market; this is the profile of a hedge fund with critical information and size advantages, using them to maximize profit." As Kelley correctly observes, none of Goldman's known trading practices are illegal. On the other hand, legal trading practices have never before generated such a sustained record of improbable success. So just maybe, Goldman's brilliant trading record emerges from something other than gee-whiz computer programs and the brilliant instincts of trading jocks. Remember, Goldman generates its trading results from the activities of hundreds of traders, operating in dozens of different financial markets. And yet, somehow, the collective activities of this gun- slinging diaspora produce a daily profit 93% of the time. That's either very impressive or very illegal. The truth will come to light eventually. The Daily Reckoning Presents Rock and a Hard Place Puru Saxena The developed nations are over-extended, their debt levels are ballooning and their governments are creating copious amounts of money. Put simply, most industrialized nations are now caught between a rock and a hard place. After years of excesses, the developed world is slowly beginning to realize that you cannot continue to live beyond your means and spend your way to prosperity. Today, US national debt stands just north of $12 trillion. Its fiscal deficit for this year alone should come in around $1.6 trillion and the nation faces mind-boggling deficits for as far as the eye can see. Furthermore, demand for US government debt has begun to wane and this implies that the Federal Reserve will have to resort to creating even more money over the following years. Make no mistake; the US cannot afford higher interest rates and in order to keep a lid on the government bond yields, we are convinced that the Federal Reserve will resort to debt monetization. In other words, the central bank will create new dollars in order to fund the deficits. Needless to say, this money-creation will be extremely dilutive and end up undermining the viability of the world's reserve currency. If our assessment is correct, within the course of this decade, the interest payments on the existing government debt will become so large that the US Treasury will need to issue new debt just so that it can keep paying interest on its outstanding debt. When that happens, you can be sure that foreigners will not be eager buyers of US government debt. Therefore, the Federal Reserve will have to create additional money, just to keep the Ponzi scheme going. And when all else fails, the US will simply debase its currency, thereby repaying its creditors in significantly depreciated dollars. Although our prognosis may sound far-fetched, we want to remind you that throughout history, currency debasement has been the norm rather than the exception. Let us put it simply, the US is now left with three options: Sovereign default (unimaginable) Severe economic contraction (unlikely) Currency debasement (most probable) Due to the risk of being thrown out of power, the policymakers will certainly not admit to an outright sovereign default. For such an event would cause a revolution within the US and shock-waves throughout the economy. So, this drastic measure can be ruled out. Next, we are also sure that policymakers in the US will not swallow the bitter pill and pursue sound monetary policies. So this option is also out of the question. Finally, it is obvious to us that policymakers in the US will have no hesitation in opting for the inflation solution. By diluting the supply of money and eventually debasing their currency, policymakers in the US will create the illusion of prosperity via rising nominal asset prices. Unfortunately, severe monetary inflation and currency debasement is likely to occur in many Western nations, not just the US. Remember, a host of nations such as Ireland, Italy, Spain, Greece, Portugal and the UK are also swimming in an ocean of debt. Moreover, their populations are ageing and this trend will put further pressure on these countries' finances. So, in this 'new era', whereby most of the 'advanced' economies are on the edge of bankruptcy, various paper currencies will come under pressure. The more nations that move to debase their currencies, the more that the paper monies of the world will depreciate against hard assets such as gold. Although currency debasement and inflation are good enough reasons to hold on to some gold, the biggest bullish factor is that real (inflation-adjusted) interest-rates are now negative in most nations. Thanks to the central banks' reflationary efforts, short-term interest rates today are way below the official inflation rate. Therefore, holding cash is now a loss-making proposition and thus, forward-looking investors are turning to gold. On the supply side of the equation, it is worth noting that central- banks have now become net buyers of gold. After years of selling bullion, the public sector has done an about-face and this is very positive for the yellow metal. Currently, the creditor nations in Asia are sitting on mountains of foreign exchange reserves and in an effort to diversify out of paper, they will surely add to their gold holdings. Recently, we have seen China and India buy huge amounts of gold and you can bet your bottom dollar that they will continue to add to their tiny positions. Gold is in a secular bull-market and every investor should own some bullion as an insurance policy. At present, gold mining stocks are undervalued relative to gold bullion, so those seeking extra leverage should consider investing in dominant gold producers. Finally, in our view, the high-cost South African gold producers, who do not hedge their production, offer the maximum leverage to gold. And at current prices, these companies are being given away. Regards, Puru Saxena for The Daily Reckoniong Joel's Note: Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription here. Puru is also the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. ----------------------------------------------------------- Our peripatetic Reckoner-in-Chief, Bill Bonner, is still wandering around Argentina today. We wonder what he'll have to say about the state of the world when he returns from his travels. Stay tuned... ----------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com