Wednesday August 28, 2002 Market WrapUp
Bull Market in The Making?
The Fed can create money, but it doesn’t control where the money goes. For the last decade most of that money went into the financial markets,
giving the illusion of a new era of prosperity. Now it is going into things, first real estate and now commodities. While the markets have been
focused on the new bubble in real estate, another bull market is beginning in raw materials as shown in this graph of the CRB index. The index is
up 12.6% for the year and up 15.7% from its lows of January 30th. The current leaders in this cycle upturn have been precious metals, energy,
and grains. Other commodities such as cocoa, coffee, and cotton are also showing signs of strength. I believe we are now seeing a leadership
change from paper to “things” as money is reallocated from financial assets to hard assets as the value of paper deteriorates.
The most important determinant of any asset class is demand and supply. Over longer periods of time it is demand for a good or service that
ultimately determines price. Regarding commodities, a multi-decade bear market has decimated the industry. Cocoa fields have been plowed
under, mines have been shut down, and access to energy fields have been denied. The result is as world population has grown, and as emerging
markets have industrialized, demand for commodities has grown while supply has languished.
As I view the economic landscape, this decade is looking more and more like the 1970’s. Central bankers are inflating again with almost
complete abandon as they fight deflation. The result is that we are now moving toward stagflation. This can be seen in the anemic growth rates
of all major economies around the globe and the simultaneous drop in major currencies. Economic growth rates in the US and Europe are
heading down again with most forecasts this year having recently been lowered. At the same time economic growth rates are being lowered,
major currencies continue to fall from the Swiss Frank, Japanese Yen, British Pound, to the North American dollar and Latin American Peso.
Gold in The Forecast
The rise in the price of gold may be signaling this seminal event reflecting, above all else, the loss of confidence in the financial system.
Moreover, contrary to recent reports that show there will be no fall-off in production of gold, the precious metals markets are in the same condition
as the energy markets. The industry is not expanding its reserve base while future production is heading towards decline. I read almost nowhere in
any demand forecast the impact that a rise in investment demand will have on the gold and silver markets. Most demand forecasts for gold and
silver treat them as commodities and not as real money. It is this transition from a commodity to its role as real money which will have its greatest
impact in the price of the metals. This additional demand coming from the investment side is what is going to launch the metals into outer
space.
At the moment, the price of metals is being determined like most commodity markets by derivatives. It is a market that is being manipulated by
government for the benefit of government, which wants to keep confidence in paper strong with its voter constituency. The government more than
anyone else knows that once confidence evaporates, it will be hard to bring back. That is why every effort is being made to keep confidence in
paper high. All the tools at its disposal from monetary policy, fiscal policy to moral persuasion is being used to keep the public in paper, be that
the dollar, or financial assets such as bonds or stocks.
This battle of confidence being waged between the forces of paper and gold is nearing its end. There are just too many extraneous events
domestically and internationally for the forces of paper to contend with, much less overcome. In summary, there are too many holes in the dike to
plug to keep the forces of gold contained. There is simply too much debt, too much paper, and too much fraud in the financial world to keep
gold from transitioning back to its historical role as real money.
Probabilities & Possibilities
The markets continue to slide in light trading this week, as there appears nothing out there to hold the markets up. Everyone knows the second
half recovery isn’t going to take place. The economic numbers are getting weaker and the story for corporate profits doesn’t look any better. Most
companies reporting an up-tick in profits are doing so through cost cutting. Very few companies are reporting strong revenue growth outside of
homebuilders. The prospect of disappointing earnings, weaker economic growth, the possibility for war, and the likely probability for some
unforeseen event in the geo-political realm or the financial system, is what awaits the markets this fall.
Looking at the technical picture, the momentum in the market that has helped to give us our summer rally is rapidly losing steam. Within the S&P
500 Index all 10 of the benchmark’s industry groups declined. The gains since the July 24th nadir have evaporated to only 15%. The S&P 500 is
still down 20% for the year. Furthermore, there is no sign of a pickup in investment spending by business. Add to this the recent drop in consumer
confidence and another pillar of the economy may be crumbling. At the moment, outside of housing and government spending, there are no
major catalysts to drive the economy or profits. Without any improvement in economic fundamentals it is hard to see how any second half
recovery will materialize. More companies are ratcheting down their sales and earnings forecast for the remainder of the year. According to
Thomson First Call, 361 companies have already reduced their Q3 profit forecast, up from 277 companies last quarter. In addition, the number of
companies raising estimates has fallen from 242 companies last quarter to only 167 companies this quarter.
This is the kind of news awaiting the markets following this week’s holiday. In the next few weeks we will begin the next quarterly earnings game.
Judging by the bad news that has already begun to surface, the myth of the second half recovery should begin to evaporate by mid-month. By
October the myth will be completely shattered. Traditionally, the September/October months in the markets are a lot like the Grand Banks in the
fall--plenty of bad weather, high winds and perilous seas. It looks like it is time to get your foul weather gear ready and batten the hatches.
Volume was weak once again with only 1.13 billion shares trading on the NYSE and 1.34 billion on the Nasdaq. Market breadth was decisively
negative by 21 to 10 on the big board and 23 to 10 on the Nasdaq. |
