Don Coxe: The Real Bull Market
Don Coxe
February 26, 2004
Conference call from Chicago
jonesheward.com
Chart: Commodity Research Bureau (CRB Futures) Index
Comment: The Real Bull Market
stockcharts.com[w,a]daclyyay[dd][pc100!c200][vc60][iUb14!La12,26,9]&pref=G
This is my way of introducing to you, what I think is the really big topic and it’s a somewhat different part of the story than you’ve heard before. You will have a chance to read about it in detail in the upcoming issue of Basic Points, which goes to press tomorrow and it’s one of the longest ones I’ve ever published and I’m warning you in advance but frankly, I would hope that you would find that it was worth taking the time to go through it.
Because what I believe is happening here is something that is not being analyzed or written up, but what we’re doing is we’re changing the organizational structure of the economic world and we’re moving from a structure that although it had flaws in it, at least it existed and we had leaders, we had secretariats, we had planned meetings with agendas and communiqués and those kinds of things – and we’re moving into something that at the moment none of those organizational features apply to.
Now let’s first of all talk about what is the real bull market. The real bull market of course is commodities. And when we break through on the CRB Index, when we break through the 270 level, to stay, we will be in a very, very significant area from the chart standpoint.
And so, what I’m talking about here is something that becomes a change in history itself. Because, once we’ve gone through 270 we’re going to be be back to the peak in the late 1980’s which occurred after the Plaza Agreement and after the crash, which was the last gasp of inflation before the triple waterfall went into its final phases. And we carried it from 270 all the way down to 185, which was just terrible for the commodity industries and I don’t need to remind you of that.
What’s unfolding here is interesting because I believe we are going to get commodity-driven inflation by the end of the year. And what is interesting is at the moment, gold will trade exactly inversely to that. And that’s the relationship which it took me a while to figure out, but let me explain how it works.
First off, a couple of statistics here. Last year, the United States Treasury issued $325 billion in marketable Treasury bonds. Now, they issued lots more bonds than that but they went into the various trust funds, mostly the Social Security trust fund, the Highways trust fund, and then they were bought by the Federal Reserve for its own monetary base. So the national debt went up more than that but the marketable bonds. Now, that’s $325 billion.
Foreigners bought 293 billion. So think about that for a moment. What that means is that Americans actually bought less than 10% of the new offerings of bonds last year. And Americans would be, you know, presumed to buy them for a reason. Now in fact, Fannie Mae and Freddie have to acquire far more than that and that’s one of the reasons Alan Greenspan is raising the concerns he is because they’re such huge holders and they use them in their hedging operations.
Now, that was of course because of the massive currency interventions that are going on, lead by Japan and China with help from South Korea and Taiwan and Singapore and basically the Asian central banks which are up to the 2 trillion mark now in foreign exchange reserves, overwhelmingly in dollars.
Now, when they do that, naturally of course, they prevent the dollar from falling. Now when the dollar doesn’t fall, gold does not go up. So, what happened was last year we had a roaring commodity bull market and gold, yeah it had a good year but not a great year, because of that 293 billion dollars bet against it.
But it turned out we hadn’t seen anything yet, because, so far this year, the first seven weeks of this year, foreign holdings of Treasuries are up 67.8 billion dollars, according to today’s Wall Street Journal. So in other words, the subsidy for the dollar operation is in the area of 9 and ½ billion a week. And naturally, when the dollar goes up because of this frenetic buying, frenzied buying, gold goes down.
So, last week you remember my title was the chart of copper and I said it was better than gold. And, there’s no argument about that one now. I mean, this is just amazing if you compare the two of them over the last year. Although the last year, copper’s gone from seventy to a buck thirty-three. I mean, that’s been a huge winner. And in that same period of time, what we’ve had in gold, and you’d say this is not possible in a time of a commodity bull market, gold has gone from 325 to 395. Good move, and it got as high as 428, 429, but since the really sustained buying of Treasuries came in they’ve been able to knock it back about thirty bucks.
Now, the oddity of all this is, is that when those foreign central banks buy all these Treasuries, they have to expand their own money supply growth dramatically. So what it means when the central Bank of Japan [China?] and the Japanese central bank, the BOJ, are buying Treasuries at this rate funded by vast expansions of their money supply. Late last year, Chinese money supply growth was up 29%, fell off to 16, it’ll be back up over 20% as a result of the purchases being made recently.
Now, as we’ve known ever since Milton Friedman started writing, if you expand your money supply on a sustained basis far faster than your growth of GDP, you get inflation. And so, now remember, that was what people wanted back then because both China and Japan were suffering from deflation. So they achieved two goals at once. One of which was to prevent their currencies from rising in value so they could still continue to export to the US and indeed to Europe. But in addition, by having fast money supply growth what they could do was turn deflation into inflation. And that’s what they’re doing.
China’s gone from negative 2 ½ or thereabouts to positive 3, or 3 ½ and it’s just begun. But there’s more in this relationship. This is what I call, in this piece, Basic Points, the great symbiosis. Because what we have here is a situation where US interest rates then, by this wild buying, are held down. So we have the 10-year note, which is the benchmark, trading at 4.04.
Now just imagine if they hadn’t bought 293 billion last year of Treasuries, what would the yield be on that note. You pick your number, but it would be a lot higher.
Now, as a result of keeping the 10-year note down, what it means is mortgage rates are down. And so, what that means is that we’ve had the housing boom in the United States really, to a large extent driven off the operations of these Asian central banks. Because if US mortgage rates had gone up we wouldn’t have had the refi and if we hadn’t had the refi we wouldn’t have had fast enough monetary growth to get all the new homebuilding and that sort of thing going. That’s been the biggest contributor to growth in M2 in the US. That’s all been refinancing.
In other words, what we have here is a true symbiosis where the people with money, which is the Japanese and the Chinese, are doing vendor financing of the US and allowing US consumers to buy their goods. Now that sounds like a very healthy relationship, doesn’t it?
But, uh, with vendor financing, there comes a time at which the vendor seeks to be paid. And that’s not clear how that’s going to unfold. But long before we reach that stage, there’s a question of the sustainability of this process.
Now, meanwhile back home, when you have faster money supply growth, you have faster economic activity and that’s what’s giving us copper at a buck thirty three. You see what we have here, is a situation that the process of driving down the price of gold drives UP the price of copper, lead, nickel, zinc, aluminum, cotton, soybeans. So, what I suggest in the new Basic Points is that a barbell portfolio for this age – you can construct a barbell portfolio entirely of mining stocks - base metal stocks and gold stocks. You’re fully hedged.
Well, what looks like something that’s going to really catch people’s attention is the move of the CRB to the 275 level and right now what we have is a situation where the commodity inflation has not worked through into the inflation in finished goods.
A really good piece in today’s New York Times in the Business section, and it talks about the cost of steel. Now I’ve talked about it before, that we have the oddity that scrap steel is now selling for a higher price than hot rolled coil did nine months ago. That is what you would call commodity inflation. But what they point out in this is they were interviewing a builder who needs steel for the roofs they put in, and saying that he’s not been able to pass along these price increases. For one thing he locked himself into fixed prices on the deal.
And that’s what we’re seeing a lot more stories about anecdotally. Which is, the automobile industry’s refusing to pay any price increases to the steel companies, saying we’ve got long-term contracts. Nucor is trying to put in a surcharge of seventy-five bucks a ton and they’re being told by their customers, “Stuff it”.
Well, you know, what we learned in 1972, 73, is that when you have commodity inflation building, it gets held back for a while but then it bursts out. Now you say, “Yeah but that’s different, back then we had generalized inflation”, so I’m not predicting anything like that. What I am saying is that the inflation picture is going to start looking very different. As eventually, these commodity increases get passed through. Because demand, as long as it remains high enough, and it will as long as we have this symbiosis in place, which is creating giant commodity demand in Asia and is sustaining final demand in the United States. Cause it’s all tied in to the same process.
The problem of course is, there’s no management system here. This is not the G7 or G8, which has the Secretariat that I talked about. This piece talks about goodbye G7 or G8. It’s irrelevant now and the Boca Raton meeting was the last one we’re even going to bother taking note of.
It’s the G3 now, except they do not have the organizational structure in place which means something could go wrong. Well in 1987, of course, even with G7 in place things went wrong, we had a crash. And this time, who knows?
At some point, perhaps, Japan is going to stop buying Treasuries. Shinto Shihara (?) I talk about him, has come out and denounced Japanese policies on this and saying Japan is becoming a slave to the US.
So this is no longer something that the BOJ can do without having something to explain to their internal constituencies. So something could go wrong here. And so, what I’ve done is I’ve raised my recommended cash exposure here because we’re talking about a situation which could unravel rather quickly, because there’s no organizational structure in place.
Otherwise, what we’ve got is really a fabulous outlook for the kinds of stocks, value stocks and commodity stocks, because we’ve got a global economic recovery, we’ve got shortages and we’ve got real price increases, big real price increases, which means this is the sector that’s going to have the biggest profit growth of any sector of the market.
Meanwhile, what we’re seeing on the tech front, is that we had five straight weeks of falling NASDAQ prices. We’re having a small bounce this week, we’ll see. But people are finally starting to ask questions and it looks as if the FASB in the United States is in fact going to comulgate it’s rule which will be effective next year, these companies will have to show stock option costs and, which means that their P/E ratios will go from 45, closer to 60.
So, whatever worries you have about the overall S&P multiple, which is 20 to 24, which certainly ain’t cheap, what we got here is if you talk about the cyclical stocks and take what the earnings will be of the mining companies this year, at these prices for their products and put those against the tech stocks which are the glamour cyclicals…no comparison. No comparison. The mining stocks are a much better value.
And then, of course, we get to the oil stocks. We had oil at 35.70. Thirty-five dollars and seventy cents. Now, as I point out in this Basic Points, oil prices haven’t gone up in Europe, because of course, the Euro has done so well. And so what we’ve got is a situation where the pain of higher oil prices is being felt in the three symbiotic countries – United States, Japan and China, because they’ve got their currencies pegged.
So, the prediction in this, and it takes me many pages, I regret, to explain how we go through it, is that China and Japan will be forced to raise the value of their currencies this year because they’re in the position that their companies will not be able to make profits if the commodity boom continues, because they’re going to be paying so much more for commodities that the term of trade have turned decisively against these countries. These countries got rich by buying raw materials and exporting finished goods and having profit margins built in there.
But, what we’ve found out is when commodity prices rise that’s one of the things that I mentioned lead to the Japanese crash, their companies don’t make money. And their banking system has to bail them out. Well China will be an even worse case of that.
So they’re going to have some pressure as they see commodity prices continuing to rise, to move the European way, which is to let their currencies move up. So that they create some profits in their companies. That may still be some distance off but it’s the way we come out of this.
Now how does this story end? Well I give you various alternatives as we come to it. But in the meantime, what we got here is, this is hundreds of billions of dollars that are being spent to keep the party going without any real agreement as to how the burden is to be allotted. And we’ve even got the bizarre situation that the United States is officially opposed to that $295 billion subsidy of the US interest rates. Because, of course, it’s leading to the export of jobs. And George Bush is sinking lower and lower in the polls.
I just finished filming an interview with a CBC-TV program, they came into my office here, called Venture, about offshoring. And so, there’s no question you spend time talking to people in the Midwest, at least, I don’t know whether it’s felt elsewhere, there’s a fear here that I’ve never seen before in all the years I’ve been traveling to the US or living here. Because, this is the first time ever there’s been more unemployed college graduates in the United States than people who never went to college. Never happened before.
And so this one is a different kind of recovery, and so this is a time at which the question of jobs going to Asia is going to be the thing that, as things stand now, is going to put Mr. Kerry into the White House. He, who has contributed to economic rationality by referring to Benedict Arnold CEO’s that send jobs to Asia.
So, I think we’re going to have some very interesting times later this year. The investment conclusions are though, that the oil stocks and the mining stocks are the place to be. But what’s interesting about this concept is what you want to have is a higher weighting in gold than you would have had otherwise.
And you say “Wait a minute now, gold prices are going down. Why should I want to have a higher weighting?”. The answer is because if this thing unravels, if Japan and China decide what they need to do to create profits among their companies is to move their currencies up, it means that, at least for a while, they’ll stop buying Treasuries. I doubt that they’re just going to start to dump Treasuries, there’s nobody to sell a trillion Treasuries to, but all they have to do is stop buying and the price of gold will go to a new high very fast.
So, that is the mechanism, explored in what some of you might find odious length in Basic Points. And in the meantime, what we have, therefore, is a true bull market and that’s why I’ve called this conference call this. The real bull market is not in the equities market because it’s going nowhere, collectively.
No, the real bull market is in commodities, and that market is in itself being driven not just by the story, and Woody Brock has a wonderful word for it, in Chindia, but by the massive monetary growth from China and Japan that is being used to subsidize US interest rates and keep the party going.
We’ve never had anything like this happen before so therefore we don’t know how this story ends. As investors, what you need to do is build in some protection that something will go wrong. But if it doesn’t, what a year it will be. That’s it, any questions? |
