The Goldenbar Report
$3 Trillion = 50%! ...Solution
A Goldenbar Editorial
In the wake of the fateful demolition of the twin towers on September 11th 2001, oil prices plummeted to US$17/bbl within weeks.
After tripling to peak at US $35 by October of the prior year (2000) they then began a year long correction that culminated in the panic sell off lasting a month past the 9-11 attacks; stoked by fears that the event would cause a recession in travel, as well as the economy – falling stock prices were after all a bearish development for economic growth and in particular “demand.”
For, it was demand that everyone was forecasting to drop off, which at the time was convenient because the market was worried over supplies even back then.
But we argued that could not happen; that putting aside the advent of alternative fuels or a dramatic change in the mode of civilization as we know it the only way you would see a demand shock (meaning a softening of final or aggregate demand, in Fedspeak) was by a price hike and that any fall off in prices caused by participants speculating on a fall off in demand would actually boost real demand especially since, we concluded, oil was too cheap already. Our conclusion from the September 27, 2001 issue of The Goldenbar Report was:
Unfortunately, oil was still trading at $22 when we published that buy, just before plummeting further to a low of about $17 on the front month Light Crude contract. In any case, our first target was $40, and it went there 16 months later even while stock prices fell, confounding all predictions for a wealth-defect related demand shock.
Those analysts predicting demand retrenchments later shifted gears and jumped on either the supply story or the Iraq story; I don’t recall that the China story was making the rounds quite as noisily yet. After peaking at $40, a top which we called on account of our target and the behavior of the market, oil prices collapsed to about $25 in Q1 2003 as the war premium deflated. Our interest shifted increasingly to gold “equities” by then but soon afterwards we put out a new target: $50.
All along our long term target has remained at US$100 / bbl., meaning that’s where this oil bull is ultimately headed, baby.
But today everyone’s talking about oil. I would be careful in that market; most commodity bull markets are very volatile – especially on the way down – and even in a bull cycle. The market could go to $35 in a heart beat and still not break the long term uptrend. Or it could pop another $10, like a tech stock.
The way it’s been trading I just don’t know which way the next $10 might be, though I would suggest that a stock market rout if not the China interest rate story would reinvigorate the demand shock theorists – overbought or oversold markets are susceptible to knee jerk reversals in sentiment.
There are three reasons that I wanted to reference our 2001 call on the oil sector besides self promotion: 1) we perceive the correction risk in oil to be high and wanted to remind our readers we don’t only make gold calls, 2) the “demand shock” talk is already coming out now in regards to China for many commodities, and if our stock market call is right it’ll be aggravated in relation to that event also, and 3) so that you can contrast how conservative our $50 oil call looks today compared with how it might have looked back in 2001.
I’m telling you, I have this history of making aggressive calls that end up looking conservative by the end of it all. I think part of the reason is that in my position, if I’m going to convince anyone about a bull market in gold when nobody wants to hear of it I won’t get anywhere forecasting $5000 or $10000 per ounce.
The same goes for brokers or anyone that deals in raising money. For this reason most people in the financial business are liable to tell you what is within the bounds of “plausibility.” They want the sale. Of course, the easiest money has always been in discovering and telling people what they really want to hear. I’ve never been particularly good at that. I prefer to see that look on your face; you know, the one that Wile E. Coyote used to get just when he realized that he missed the Roadrunner and ran past the edge of a cliff. I like the hard money!
Our long term $2,000 gold target might still look nuts today.
But I bet our $100 oil price target seems more reasonable – in fact analysts have been saying that at $80 it just gets back to where it should be on an inflation adjusted basis! Hah. Call it keeping you from panicking.
In any case, perhaps it’s as good a signal as you’ll get that the best trade now is to sell oil and buy gold.
Having said that, it is probably unlikely you’ll see an oil price correction until stock prices start heading down convincingly and even then maybe not until after the election. The noise is so loud it’s too hard to tell what all has been factored. And this week’s action is encouraging for the bearish case on stocks but far from decisive.
Oil Rally Is Already Monetized, Stupid
Note the performance of the entire commodity complex in the table to the right ranked according to three year returns. It should be clear from that alone that the oil price move is not an isolated incident even if it has the spotlight today. The common thread is not China, fundamentally.
It is the US dollar and monetary policy regardless that it is denied, or perhaps especially is a better word.
It’s like, everybody knows that an increase in the supply of something relative to demand leads to a decline in its price; but as regards the good, money, politicians and central bankers just stand there and say, no it doesn’t, fool… for one thing, our mandate ensures that any unwelcome price fluctuations in anything (caused by the volatile/irrational market of course) are stabilized according to plan:
Recall the Reserve Bank of Zimbabwe’s mission statement (where it’s quite common for prices to soar six-fold annually – wages too, nominally at least, since real wages tend to fall in any inflation):
Obviously there are plenty of differences between the two banks, and even in the statements. But there are similarities too – they both avoid taking credit for inflation and its consequences, and they both lie about the true reason for the existence of a central bank. Sorry, there is no euphemism for the word “lie.”
There are lots of reasons why the inflation in Federal Reserve Notes does not manifest as does the inflation of the Zimbabwe currency. Many of them may be related to property (or economic freedom) to the extent it unleashes productive forces that cause prices to fall and offset the effects of the inflation in the United States.
Others may be related to the structure of the banking system – the more developed the easier to hide inflation. But in no way do the advantages of the Fed and US economy in this respect change the fact that money supply expansions tend to cause the currency to depreciate (though not uniformly), because they invariably outpace any growth in the demand for money. Nor does it change the fact that most central banks would deny the fact that through interest rate policy (and other avenues) they influence credit demand and thereby indeed maintain control over the issue of notes… and that their reason for existing is not to fight deflation or facilitate elasticity, but rather to sustain inflation.
The mandate, “price stability” as is the “full employment” doctrine, is a front.
I know you know. So get the word out, in order that the Yardeni’s of the world can feel stupid denying it on TV.
Oil is a good example of something monetary officials claim certainly has nothing to do with their inflations. As a result, its affect on the economy is reasoned to be deflationary in terms of other prices and profits, which might be true if money expansions weren’t the norm. If money supply was constant an increase in some prices would come at the expense of other prices, and maybe profits.
But the Fed exists to alleviate such hard choices.
With the influx of fresh money, instead of causing other prices to fall, the oil price spike is accommodated, and more easily transmitted to other prices. Eventually such trends will overcome the productive capacity of the strongest economy, and translate into higher final prices despite offsetting competitive pressures.
The primary cause of the widening US trade deficit, for instance, is not China’s inherently better competitive position; it is inflation which just happens to be eroding America’s competitive position in the international market for goods and services.
If the value of the dollar has dropped 30 percent and wages were to rise by 30% in the US, real wages could be said to have not changed. In other words, it wouldn’t “really” cost 30 percent more to employ workers in the US than in China. The real impact on labor costs might be more or less depending on other prices and currency relationships.
However, this is only true to the extent that markets are allowed to reflect such things freely. Since China’s currency is still pegged to the US dollar, any price increases in the US economy due to inflation are going to result in a growing trade gap to the extent they are not matched within the Chinese economy. Thus we would attribute the resistance to stronger wage growth in the US to the USd-Yuan peg, which in light of the monetary trends has the effect of 1) making it more attractive for US interests to invest in (or move jobs to) China, 2) making Chinese goods cheaper to import, 3) sustaining pressure on US wages.
The blame for the thinning of capital and loss of jobs is shared equally between US-Chinese economic policies. But the fact is protectionism is on the rise in the United States; the blame has gone to the government for not “protecting” industry enough.
If the US government gives in to these political pressures America will become less competitive and lose more jobs, and then, if the government’s original policies don’t change, it will become more protectionist, and on and on. Economists can claim that unions don’t have the power they did in the seventies – we’d argue that the way things are going they will rise again. Or maybe not; but money wages will!
The Chinese economy is growing and probably will grow faster than most for years to come. More and more goods are becoming available. If money were sound, prices would fall as a result because there would invariably be more goods than money. But that’s not going on. The Chinese central bank is as profligate in its monetary policies as the Fed is, though it is clearly more willing to take a tightening position from time to time.
The point is that the global commodity boom is the result of monetary factors, not economic growth as such… the latter probably exists on some level and explains the growth in trade overall, but it is money that explains the commodity bulls. Nevertheless, consistent with its modus operandi, the China story is a convenient one for the Fed to the extent that the blame for price increases – ACROSS THE BOARD even – can be pinned on it; and it can because most people are probably convinced that economic growth is GDP and does indeed cause prices to rise.
In an interview last week on CNBC Ron Insana asked Morgan Stanley’s Stephen Roach, who I think is still bearish on everything, about the impact of oil prices on the economy… importantly, he asked him something like, “why wouldn’t the Fed just monetize the oil price rise rather than introduce a whole bunch of other complications by raising interest rates.” Now, since you know that monetary policy is partly responsible for the oil price shock in the first place this question may seem counterintuitive, because you should see the policy of monetizing oil as further increasing the pressure particularly for rates to rise. In other words, we’d see it as the cause of making the complications which he seeks to avoid inevitable and ever more forceful.
The trouble is, that’s exactly what the Fed has already done effectively. Their broadest measure of money supply has increased by $3 Trillion (or 50 percent) since January 1999 when the price of oil was bouncing around $12. That’s huge. 50 percent! Think about it.
They’ve been monetizing oil for years. And this they would call news on CNBC.
Insana pretends he does not understand that the monetary impact on prices exists and originates from an entirely independent source – the change in the quantity of money supply relative to demand – that has nothing to do with economic growth. I use the word pretend loosely. That’s just what it feels like when I watch those people tell the news these days. But in any case, such a point of view if it is representative is dangerously bullish for gold, for bond yields, and you know the rest…
The Trouble with US dollar Bulls
is that they’re Long Stocks and the Economy
That’s why the dollar’s falling. ‘Cause we live in a yellow submarine in a “sea of green.” 50 percent!!
Remember, that’s how much the total stock of money (M3) has expanded since Y2K. Maybe gold should just double, like in a month. That would hurt. I wouldn’t be surprised that my medium term targets are conservative. It’s the consequence of battle wear that I’m probably a little gun-shy. The break down out of the small triangle you see in the graph of the dollar index here in mid September has neither been confirmed (with follow through below 87) nor rejected.
The highs continue to occur successively lower and the tone (the way it reacts to news and other market events) is bearish.
Weighing on the dollar is the fateful combination of weak share prices, falling bond yields, and strong commodity markets. The news itself turned bearish for it again on Thursday with the release of yet another record trade gap. I can’t imagine that the PPI is going to be bullish for the greenback almost regardless of what it reads – nobody will believe anything less than or equal to status quo and upside surprises would be unwelcome in my assessment of the tone and chart. Maybe the best that dollar bulls can hope for there is that somehow it turns into a non event, whatever actual number or distraction that would take.
No Sell Signal for Gold in COT’s
They haven’t reached any extremes but they are rising off extremes, within a bull market, so they could stay up here for a few months. The small odd-lot positions (figuratively) in the third graph to the bottom right are up from then as well but they have yet to recover to the haute levels of early 2003 when the noise was all about the Iraq invasion. I’m not sure what it means but it can’t be bearish.
This odd-lot category has been a surprisingly strong leading indicator in gold at crucial points in the past – note for instance that it turned up before the others in 2001. Perhaps the best way to use this data is in order to gauge an entry point, once the main trend has been determined independently.
In a bull market, for instance, the COT’s would invariably cause premature sell signals but the buy signals are quite reliable. Vice-versa in a bear – the buy signals would be premature; the sell signals would probably be reliable.
On the other hand, and extending that line of thinking, if a sell signal turned out to be right on time maybe the bull should be presumed over. Okay okay, I didn’t mean to twist both our brains in a knot. I’m just hypothesizing from anecdotal experience since I devote a slight eye to these reports on occasion.
At any rate, the COT’s for the US dollar index continue to favor the bears generally, even more so than when we last reported on them in early September, while in bonds they’re moving to the bulls’ favor. In other words, if you discount the gold COT’s as neutral the data for the other “financial” markets is basically dollar bearish.
Uh, What’s A Bearish Monetary
It is truly amazing to see how stock bulls can stomach pricing earnings at levels (PE ratios and such) that are known historic extremes, even as one by one the pillars of justification crumble. One of the predominant themes that characterized bullish sentiment in the nineties was the idea of a Goldilocks Economy – low inflation and interest rates. Or, it would be more correct to say the strong dollar and low interest rates, or the “perception” of low inflation and the resulting decline in interest rates. In any case, the main feature was an ostensibly benign, or stable, monetary environment – strong economic growth amid falling commodity prices, and falling interest rates.
The monetary climate was perceived so safe that the equity risk premium fell below 1:1 (earnings yields relative to bond yields). It was this misleadingly labeled disinflation that justified low dividend yields and high PE ratios (note the inverse correlation between PE ratios and commodity returns in the graph below – this statistic in my opinion almost completely characterizes stock bull and bear cycles).
If you breezed over this chart, stop, go back, and study it. It’ll be the most important thing you do today (unless of course you already know the implications). Now, as suggested by the current upturn in the bottom statistic above, the impetus to the illusion of disinflation is disappearing. The monetary environment has changed.
The baby boomers and their governments are now in hock because their expectations were inflated throughout the nineties; technological advances did little to really improve either the predictability of earnings or their consistency; the peace dividend fund has ran out of money; most earnings gains amount to recovering past losses - the big profit gains that were expected during the new economy bull have yet to materialize in the broad sense or for those issues where they were expected to come; the thrust of the productivity benefit from the Internet climaxed years ago; and because the government itself is trying to recreate all of these things artificially it is quickly eroding the last remaining pillar of the goldilocks environment that explained the record low equity risk premiums and record high earnings multiples - the strong dollar, low inflation and interest rates. Naturally, one could conceive that if all of these things occurred and the only thing that didn’t was that interest rates stayed down, then there would be no compelling reason for the PE ratio to contract but speculation.
We have noted in the past that gold tends to lead the interest rate cycle by up to two years and that this cycle has been anomalous in that the lag between gold-CPI-interest rates is longer than most. It is irrelevant what the explanation for it is – whether productivity, hedonic accounting, or the management of inflation expectations (our favorite). The main point is that the fact that interest rates have refused to rise as fast as is usual in such an environment explains exactly why the bear market in stocks generally is progressing so slowly.
In other words, PE ratios can stay high despite their strong negative correlation to commodity returns as long as interest rates don't rise to fully reflect the inflationary facts. Nobody is in a rush to discount a bearish monetary environment without being pushed a little. So, to sum up, the bearish monetary environment needs to see confirmation from interest rate trends perhaps in order to become more manifest in stock values (earnings multiples).
It is inevitable (by most measures it is already en route) as long as the monetary environment remains bearish; but so long as higher rates can be forestalled it’s possible that high multiples sustain. A monetary environment that is typically bullish for PE ratios, on the other hand, is one where commodity prices are generally in decline and the dollar is strong.
In such an environment interest rates can stay low or fall… few opposing forces exist to disagree with the Fed’s downward interest rate trajectory
(by the way, that Goldilocks environment, as defined here, is typically what the monetarily challenged confuse with deflation).
The last remaining variable that the Fed can still control to keep the empty bull market nostalgia alive is the interest rate. As long as rates don't rise as fast as gold bulls say they should, and the dollar doesn't fall as fast as they say it should, investors can stay focused on earnings even if their dollar quality is already deteriorating.
The stock and bond markets are overvalued in light of the sort of monetary trends that have become ever more apparent and gradually more entrenched since the turn of the millennium. It’s just a matter of time before interest rates reflect it and accordingly that stocks do too. For, those trends can now only change at great cost to the stock market, and at the same time, the longer they last the more bearish they are for the bond market.
50 percent!! That’s your post 2001 earnings recovery – it’s purely inflation and debasement.
Central banks cancel gold sales
agreement; join IMF in dumping all their gold!
But there is also more pragmatic resistance, notably the political ramifications of the impact on the gold market of such a decision, at least insofar as the purpose of the move would be to help poor countries out. To be sure, if they wanted to I think they could get a mandate for it, so the pragmatic political considerations have limits.
For instance, they could elaborate a nice argument for the sterilizing economic effects, as the relief of debt obligations would offset the negative impact on gold prices from selling IMF gold. The arguments would necessarily be fallacious and indefensible but that’s par for the course.
Less cogent lobbies have succeeded in rallying democratic populations.
At any rate we’re getting ahead of ourselves.
There’s no sign of real conviction on anything like that and as of this week gold bulls were wondering why there hasn’t been an official announcement signaling the start of the second gold sales agreement which many thought would be disclosed at the G-7 two weeks ago. According to a press release in March, the agreement was definitively signed and stipulated terms, including a ceiling.
However, no minimum was announced, and only the Swiss and Holland have disclosed final intentions to sell under the agreement.
The main conclusion being drawn is that either there has been a change in policy with respect to transparency (i.e. announcing the sales ahead of time) or the banks aren’t eager to do much of anything beyond talk. Or they could be biding their time for a more convenient moment. Who knows who cares?
Just keep it simple and buy the corrections. The answer is blowing in the wind.
Although the correction risk is high, moreover, it appears as if energy prices are unwilling to relent at least until the stock market capitulates to the related pressures. Furthermore, the US dollar is behaving poorly on the charts and a break down could be imminent. Fundamental factors (stocks, yields, news) are weighing too.
Gold bounced off nearby support yesterday so we still favor our bullish runaway scenario. The structure of the market is neither bullish nor bearish; there is scope in either direction in terms of the COT’s.
The stock market, which has been stressed by the daily new highs in oil & gas prices, was hit by news yesterday that Eliot Spitzer was going to announce the details of a lawsuit on Friday against American International Group, an insurance company and Dow component. An already ailing insurance sector turned down sharply, and took the financials down with it. The weak economic news, strong oil, and the Spitzer news proved too much to bear and the Dow ended well below 10000.
Consequently, despite the recovery in gold prices even the gold shares mostly ended down on the day yesterday. There was the scent of a crash; it was faint but perhaps strong enough to jolt the PPT into action again.
I don’t want to predict a crash – unless it is event driven. But we do believe that this could be the beginning of a new bear market leg we’re witnessing. Thus, unless something happens to change the direction in the dollar, stock market, oil, and gold itself, we’re still betting on the gold shares to buck the broad market trend.
Lew makes sure that you see through the actions of politicians dishonestly crediting liberty or freedom as their ideological basis (usually republican); he undresses those private entities that benefit from government subsidies and monopoly privileges while masquerading under the pretense of free enterprise. To paraphrase a quote from Dennett that I’ve used for gold, there’s probably nothing he likes less than bad arguments for a view he holds dear. However, I believe he is trying to head off the probably inevitable attacks on capitalism bound to come when people look to blame someone or something for their growing economic misery.
In an article he published at Mises.org
last week he wrote a rejoinder to a Wall Street Journal editorial that
came to the defense of Halliburton, which the Kerry-Edwards ticket dragged
through the mud on account of Cheney’s past employment with the
firm. The Journal’s defense amounted to defending Halliburton on
the grounds that Kerry’s charges are just an example of socialist
mudslinging at free enterprising success stories.
You tell ‘em Lew!
I could not have said it better me self (note: Rockwell is not arguing whether or not the Democrats are right about Cheney’s current relationship to the company, but rather that it doesn’t matter if they are because Halliburton isn’t an example of free enterprise to begin with). The reason it’s in today’s report at any rate was that you often hear me talk about free markets and capitalism on a different plane than contemporary conservatives and conventional republicans.
And I thought it might be relevant to show that I’m not just throwing out random opinions in order to take a contrary viewpoint.
There is an army of statists out there operating under the facade that they are representing free enterprise; and whenever it falls apart, they are more than happy to come out of the closet to give their account of the evils of capitalism. It won’t matter that what is actually falling apart is the progressive era (or delusion might be more accurate) and its medieval cartel-like organizations, since because they all claim to be practicing capitalism – which to them is simply a system where greed is okay – it’ll be capitalism as always that the vast majority of populists and demagogues will blame.
Capitalism is under attack because its phony reps are losing credibility.
Lew and others of his ilk are trying to head it off as best they can.
In his concluding remarks, Rockwell says:
What people have to understand about free market capitalism is that it works through competition. No one individual or corporation could wield the kind of power that many do today if it weren’t for the special legal and monopoly privileges and other subsidies they seek in order to protect their interests from “competition.”
Capitalism, in its pure application, is still the unknown ideal even though it can be credited solely for bringing the human species so much daily satisfaction – from the toilet paper, tooth paste, and coffee you consume each morning to the car that gets you to work to the multitude of amenities in your home to the entertainment that helps you escape from the daily rat race to the cozy Simmons mattress we lay to sleep on.
No other country in the world offers as many conveniences and options to the individual than the one in which capitalism is most pronounced. Yet in most countries the state still subjugates the only basis of capitalism – the sovereign right of individuals over their own persons and property – rather than secures it. Thus cartels can exist, including labor cartels of course – it’s not just big business that rapes the state.
As the libertarian economist Frederic Bastiat said, and I paraphrase, the state is that great fiction allowing everyone to live at the expense of everyone else.
People generally just do not understand what capitalism is, which is what is dangerous.
They prefer to put faith in the state’s ability to finance their delusions rather than accept that while the market means tougher medicine in the short term, in the long run our children will appreciate it. They will not believe the market could possibly deliver cheaper healthcare, less volatility (financial and political), higher “real” wages, more job opportunities, more and cheaper everything, almost, more peace, more equality between races and sexes, and longer lives for even the laziest and least motivated members of society simply by applying the contemporary liberal idea that whatever two adults consent to is okay beyond the social sphere and into the economic one.
Before Marx branded it capitalism, it was
known as the system of voluntary exchange.
Let all businesses – banks as well – be subject to the market’s discipline. That would be fair, and would fit best into what capitalism truly is: voluntarism and free exchange – not this regulated and controlled contraption, which does not level the playing field but rather tilts it to the advantage of players like Halliburton. The world’s largest problems can all be traced to the abuses stemming from this widely misunderstood issue.
According to Rockwell:
Wake up world!
Edmond J. Bugos is the founder and editor of the Goldenbar Report - calling markets accurately since 2000. To subscribe to his letter click the link below:
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