Interesting. Gold will decouple and fly to the sky. Maybe. Good reason for me to control almost 8-10 million gold ounces right hhere in the USA. WGDF, QEE, CAU.
DOW THEORY ANALYSIS SAC
The Market Update
Stagflation, Bonds, and the Markets
Enrico Orlandini
7 Aug, 2006
Let's get right down to business! Something seems to be amiss and it's not the usual market problems, the bumps in the road we all encounter from time to time, that I normally see out of the corner of my eye. No, I'm talking about something so big that it absorbs my entire field of vision, and to make matters worse, I feel like I'm standing so close that it's almost impossible to focus on. I don't have a name for it, but I do know how it came about, what it's composed of and a good idea where it's headed, and that will allows me to break it down to a point where I can mentally get a grip on it. This article flows from my observations and hopefully will serve as food for thought.
One of the by-products of this perceptual problem has to do with the idea that everybody is convinced that the U.S. Federal Reserve Bank is all done raising interest rates. If I understand correctly, the culprit is a "slowing economy". My clients know by now what I always think when I see everybody moving to one side of the boat: everybody is almost always wrong! Yes, the economy is slowing and for proof all I have to do is look at the following statistics:
GDP growth for the second quarter was set at 2.5%, far less than the 3.2% consensus of opinion,
The unemployment numbers disappointed yet again,
The Leading Economic Index (LEI) has now contracted for six straight months, and
Sales of single family homes fell 3.0% in June and the six-month moving average is down 13% from its peak in October 2005.
For an accurate image of this all-important housing market, take a gander at the Weekly Chart of the Philadelphia Housing Index (HGX) below:
In spite of the current rally, it is obvious that there is absolutely nothing to cheer about in the housing sector. Notice the progression of lower highs and lower lows, the downward sloping 50-wma, the test of the 200-wma, and the generally weak rallies? Not signs of a healthy market! Given what I've said above, there is no doubt that the economy is slowing. But there is no surprise here; I've been saying that for months!
Right about now, it would be worth my while to mention that every coin has two sides. You've seen the statistical side, and now I want you to take a look at the price side. Feast your eyes on the Weekly Chart of the CRB Index:
Rembrandt would be proud of this picture! You can pull out all the tainted government statistics you want, but this chart reflects (as much as any chart can) the reality of the situation, and it's a reality that you and I face every time we go to the store or pull out our check book to pay a bill. So there you have it folks, a slowing economy and rising prices. For those of you out there who were not economically active during the late 1970's, this phenomenon is known as stagflation. Originally I thought the consumer would back off, creating a generally deflationary environment, but that hasn't been the case at all [1]. The consumer is simply acting as more fuel for the price inflation fire.
For the average company stagflation will eventually translate into increased costs and decreased sales. On the other hand, the average individual will be faced with increased costs and shrinking real wages. How will the stock and bond market react to all of this? That, Ladies and Gentlemen, depends on what the Federal Reserve does. In a normal world, the Fed would see the economy slowing, stop raising rates, and eventually lower the interest rate until business activity picks up again. Unfortunately, we do not live in a 'normal' world. We live in a world full of distortions brought about by a strange brew of Fed policies, i.e., rising interest rates (known as tight money policy) and at the same time increases in the money supply (a/k/a lose money policy). I've never seen such a mix before and if an intermediate economics student ever bothered to propose such a thing on an exam, the professor would give him an "F" for his efforts. I'm convinced that it's this very mix that has led us into stagflation and now leaves us faced with what I refer to as the Greenspan Dilemma. Does the Federal Reserve lower rates and attack a slowing economy, or does the Federal Reserve raise rates and attack rising prices?
Again, in a normal world this would be a slam-dunk! The Fed would lower rates and prop up a slowing economy, but I demure here. We don't live in a normal world here and the Fed now finds itself in a real box. The case for lower rates has a lot to do with present conditions. The United States is now bloated with debt, debt of all kinds and all levels, and that wasn't necessarily the case in the 1970's. Any increase in rates today would be devastating to millions of Americans who just manage to make their mortgage payments as it is. Most debt is of the variable interest rate variety so the payment rises with the interest rate and vice versa. As a result, Bernanke would love nothing better than to lower rates, but here's the rub, I don't think he can! Alan left him in dire straights. Here's the problem as I see it, the sale of debt in the market place depends on several key factors including supply, yield and risk. We all know by now that the US has lots of debt to sell and they'll be more of it everyday. This translates to over supply. Furthermore, I believe that the US is perceived by the rest of the world as a poor risk, and getting worse every day. So that only leaves yield and unfortunately for Mr. Bernanke, yield is being affected by the fact that Asia and Europe have recently embarked on a tight money policy. It reminds me of a line from an old rock-and-roll song from late 1960's that goes like this "if I didn't have bad luck, I'd have no luck at all". Just a couple of days ago several European Central Banks had the bad taste to raise rates. This is very bad news for the US. You see Europe and Asian are much better risks, they have limited supply since they generally live within their means, and they are raising rates all while the US has too much supply, is a poor risk, and wants to lower rates. Does any one see a problem here or is it just me? I'll bet you a dollar to a donut that Bernanke sees it, and the poor fellow wakes up at three o'clock in the morning in a cold sweat!
So what is a Fed Head to do given such a dilemma? Human nature being what it is, he'll probably try to postpone the problem hoping that it magically goes away. It's the time 'heals all wounds' philosophy. I call it trying to sing the bull to sleep, and I'm quite sure he knows it won't work. Right now the bond market gives the Fed a 26% chance of raising rates this coming week, down from almost 80% just a couple of weeks ago. I suspect the bond market is probably right; the Fed will leave rates unchanged, this time around. Then Bernanke will retire to his bunker and pray like hell that something changes for the better. I have news for Gentle Ben; his prayers will not be answered. Assuming rates are left unchanged in August, and I have my doubts, what will happen in two months assuming that we don't have divine intervention? As I see it there are three possibilities:
He can raise rates and go after the inflation that currently is in the system, thereby killing what's left of the housing market. The end result will be a debt crisis (and let me ask you a question: if the first fifteen rate hikes didn't stop inflation, what make you think the sixteenth, or the seventeenth, or the eighteenth, will make any difference?), or
He can lower rates, in an effort to prop up a slowing economy, and precipitate a crisis in the bond market, or
He can do either of the above, because it really doesn't matter, and absolutely flood the market with avalanches of liquidity. More paper money than has ever been seen in all of human history.
I'm betting on the avalanche because there simply is no other way out. The Fed is willing and able to turn the U.S. into a banana republic and simply inflate all of its problems away.
The current decline in the dollar is one indication that I may be correct in my assumption and the strength of gold is another. In the end, there is always a flight to quality and away from garbage. Eventually everything American will be included in the garbage category: stocks, bonds, the dollar, and finally the financial system itself. The efforts to suppress the rise in gold, Friday's close a case in point, are having less affect with each passing day. Likewise, efforts to support the dollar seem to be withering on the vine. It's worth remembering that it takes two to distort a market, and increasingly the US is finding less and less takers. The rest of the world's decision to engage in a tight money policy, just when the US needs massive liquidity, is more than just a shot across the bow. It's the iceberg that sinks the ship of state. Watch the dollar and gold diverge, and you'll see the house of cards come tumbling down in front of your very eyes.
Reference
[1] For confirmation of the consumers tenacity, check out the Morgan Stanley Consumer Index ($CMR) which just made a new high. You can find it on www.stockcharts.com.
5 Aug, 2006
-Enrico Orlandini
321gold.com |
