It's again been almost two months since I posted Lance Lewis' missive. Tonight's gives a good summary of where we are.
dailymarketsummary.com
September 4, 2007
The Drumbeat For Money Printing Gets Louder And Louder
Over the long weekend, various speakers at Jackson Hole repeatedly pointed out the risks to the US economy from the housing bust and that the Fed should ease with all due haste. As we’ve been saying (and expecting), the mob is literally pounding at the Fed’s door and demanding it slash rates in order to cushion the housing bust.
First, there was Martin Feldstein, president of the National Bureau of Economic Research. He said, “The economy could suffer a very serious downturn… A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome.'' And what was his solution? …to print money of course.
Feldstein said that lowering interest rates may result in a “stronger economy with higher inflation than the Fed desires,'' but that this was the “lesser of two evils.''
Rather than a “stronger economy” with “higher inflation” if the Fed were to ease, I would argue that the US economy is likely to be extremely weak and still experience rising inflation, due to the rest of the global economy remaining firm. Thus, we get stagflation here in the US.
But the more important point behind Feldstein’s line of thinking (i.e.- that inflation is the lesser of two evils) is precisely what I believe the Fed consensus has been all along and exactly how we’ve always expected the Fed would respond to the housing bust. When given the choice between a deflationary depression and the possibility of higher inflation on down the line, the Fed will always choose to inflate, and that’s precisely what Feldstein was urging them to do this weekend.
Next, Fed Governor Frederic Mishkin reassured everyone that the financial system was in “good health” (what would we expect him to say?), but that the Fed would act if needed (much like Heli-Ben has said). As for what that “act” would be, Mishkin said Fed models show the best policy in the case of a deep slump in home prices would be to “react immediately'' by cutting rates. He said, “The federal funds rate is lowered more aggressively and substantially faster'' in the “optimal response,'' according to the Fed's economic model.
Remember, this guy is at the top of the FOMC hierarchy. Not only does he vote, but he’s a governor, a permanent voting member of the FOMC. So, if that doesn’t tell you what these guys are saying behind closed doors, I don’t know what does.
The FOMC will begin to ease at its September meeting (if not sooner). And once the cuts start, it won’t just be a couple quarter point cuts. It will likely be multiple 50 bps cuts, just as we saw in 2001. In essence, the Fed is going to inflate away the housing bust just as it inflated away the stock bubble. And the result is going to be stagflation here at home and a dramatically higher gold price.
Asia was mostly a little lower overnight. Japan fell half a percent, while Hong Kong was flat. The Shanghai Comp was also off half a percent.
Europe was up nearly a percent this morning, and the US futures were also higher.
We opened higher in the S&Ps and immediately began to rally. The August ISM fell to 52.9 from 53.8 and was roughly inline with the consensus. The S&Ps seemed to ignore that data for the most part and continued to melt up.
Around noon, the rally slowed somewhat, but the meltup resumed around mid-afternoon and took us to another new high for the day. As the last hour rolled around, the S&Ps were sitting just below the 50 dma on the charts (something we’ve been below ever since July 24th). At that point, the S&Ps turned vertical and briefly poked through that moving average to another new high for the day.
But just when it looked like things were really going to get out of hand to the upside, the rally flamed out, and we fell apart into the close to give back nearly all of the ground gained since noon. The end result was that much like we saw on Friday, the S&Ps finished near the better levels of the session but well off the highs.
Volume picked up a little from Friday’s holiday pace (1.4 bil on the NYSE and 1.9 bil on the NASDAQ). Breadth was over 2 to 1 positive on the NYSE and just shy of 2 to 1 positive on the NASDAQ. New highs expanded again and surpassed new lows on both exchanges (60 to 21 on the NYSE and 69 to 27 on the NASDAQ).
The chips were on fire and up 2 to 3 percent across the board. The equips lagged a little and were only up 1 to 2 percent. The SOX rose over 2 percent.
The momentum favorites were especially strong. For example, AAPL jumped over 4 percent to just shy of a new all-time high.
The rest of tech was basically higher across the board, with the NASDAQ and NDX both making new highs for the move since their August lows.
The financials were higher across the board but are still lagging the major indices since last week’s selloff. The BKX rose nearly a percent, and the XBD rose over 2 percent. BSC exploded for over 5 percent. GS rose 3 percent, and MER rose over 2 percent.
The derivative king rose 2 percent. C and BAC both rose nearly a percent. GE rose half a percent.
GM rose 4 percent. AIG rose a percent. ABK and MBI both rose 3 percent. The subprime consumer lenders were higher but not by much. COF rose a hair. ACF rose over a percent, and CCRT rose nearly 4 percent.
The mortgage lenders were mixed. TMA rose 4 percent after it was able to raise $1.4 bil from the securitization market in a collateralized mortgage debt transaction, the proceeds of which were used to reduce the company's borrowings under its ARM loan warehouse financing lines by $1.37 billion. However, this in no way indicates that the credit markets are freeing up. In fact, TMA’s COO said the issuance was met with a "still challenging" market where all but the most sophisticated investors remained hostile to such issues. In my view, the only way anyone would participate in this deal is if they were utterly convinced that the Fed was about to ease massively, and that’s obviously exactly what I think will happen too.
Elsewhere, LEND rose 7 percent. CFC was flat, and DSL rose a hair. NFI was the lone loser and fell 16 percent after the company cancelled a planned $100 mil offering after its auditors refused to be associated with the offering unless NFI reissued its 2006 financial statements with warnings about what was occurring in the subprime mortgage industry, as well as include a paragraph that discusses the uncertainty of whether NFI could continue as a "going concern." In other words, the auditors wanted nowhere near this lawsuit-waiting-to-happen unless they had “CYA’d” themselves in a big way.
In addition to cancelling the offering, NFI said it will "sharply" reduce retail mortgage activity, close 12 retail origination offices, and amputate about 70 percent of its workforce in the origination area, or about 275 jobs.
The mortgage insurers were higher across the board. PMI rose 2 percent. MTG rose half a percent, and RDN rose nearly 3 percent. As for the GSEs, FRE rose over a percent, and FNM rose a hair.
The retailers were interestingly mostly lower (the RTH fell a percent) ahead of Thursday’s same-store sales reports for the month of August. Given the decline in the equity market, the seizing up of the credit markets, and the deepening of the housing bust, it’s a good bet that back-to-school sales will be somewhat softer when we see those numbers on Thursday. WMT fell over half a percent. BBY was off a freckle, and TGT fell over 2 percent.
The homies were higher across the board by 1 to 2 percent, with a few 6 to 7 percent gainers thrown in as well, as was the case for HOV and BZH. Again, if the Fed begins to ease soon like I believe they will, the homies can experience a big bounce until people see that the rate cuts aren’t doing anything for the homebuilding business.
Crude oil (Brent) rose 51 cents to $73.92. The XOI rose nearly 2 percent to another new high for the move since its August low. The XNG rose over 2 percent, and the OSX rose nearly 3 percent to just shy of a new all-time high. The XLB rose over a percent to a new high for the move of its own since the August low.
The GSCI rose over a percent, and the CCI-CRB rose a percent to another new high for the move since its August low and 2 percent away from a new all-time high.
The base metals were mostly lower, with the GSCI Industrial Metals Index falling over 3 percent. Again, note that gold continues to firm relative to the base metals, as the gold/base metals ratio once again made a new high for the move today.
Dec gold opened up 70 cents in the US this morning and proceeded to melt up to the tune of over $10 to as high as $692.50, which also happened to be just shy of the downtrend on the charts since the April peak. Getting above that downtrend should open the door to testing the and eventually surpassing the April peak. For the close, the metal backed off just under a dollar but still ended up $9.60 to $691.50. Spot silver rose over a percent.
Now… we know that spot gold in dollars is trying to break out on the charts and is likely to challenge the key the $700 level once again very soon, but also note that gold in euros broke out over the 500 euro level today as well. In other words, gold is rallying not only in dollars, but also in the strongest major competitor to the dollar as well (the euro), which once again supports the idea that gold may rally with the dollar index for a while, as the yellow metal rallies in all currencies, just as was the case in 2005-2006.
The HUI melted up 3 percent to another new high for the move since its August low and has now recovered all the way back to its mid-August levels just before its “crashette” in the third week of August. The XAU/Gold ratio rose over a percent to 0.2126, and the HUI/SPX ratio rose nearly 2 percent to 0.2258. Both ratios remain short-term bullish.
Our junior basket rose nearly 5 percent. NSU was the big leaper of the group and rose nearly 8 percent. MFN rose over 6 percent. UXG and GSS both rose 5 percent. MRB was up half a percent, and CGR was flat.
So, we’re finally starting to see the juniors “catch up” to some degree to the seniors. That “catch up” should increase as the days and weeks pass and investors become more confident that they can buy the juniors but not be forced to suddenly liquidate them in a thin market due to a general equity panic.
I can hardly complain about any of the action in gold or its shares today. Despite the dollar index rallying a touch, gold rallied with it, just as we’ve been expecting. Likewise, the gold shares continue to recover their lost ground during the “August margin call” with increasing speed and once again appear to be on track to join the metal in “breaking out” above the April and July peaks, which for the major gold share indices would mean finally breaking out from the trading range that we’ve been stuck in for over a year.
Basically, I think the market is realizing that the Fed will soon be running the printing press full out in order to combat the credit crunch and the housing bust. For the moment, people are still piling into anything that isn’t nailed down, although hard assets appear to be outperforming somewhat. Given gold’s monetary characteristics, however, this should be where it finally returns to outperforming even other hard assets, just as we’re already seeing in the gold/base metals ratio. As gold outperforms these other asset classes, including equities, the real upside fireworks should begin, and that’s when more light bulbs should go off in people’s heads as to what is actually occurring (i.e.- the global monetary system based on the fiat dollar is breaking down).
Along those same lines, note that the SPX/Gold ratio appears to be close to breaking down into another down-leg on the charts, and given where we are in the credit cycle, this down-leg one should be of the larger variety like we saw during a similar point in the credit cycle back in 2001-2002.
It’s taken longer than I ever could have imagined for everything to finally set up for the gold complex, but we appear to be finally getting close to what I believe will be an upside explosion in both gold and its shares, as the market discovers that the Fed is going to be forced to run the printing presses full out in order to prevent the seizing up of the financial system and the asset-inflation-dependent US economy. Remember, gold reacts positively to the monetary medicine, not the disease. And that medicine will be coming in large doses very shortly…
And given the already high level of money growth both here in the US and in the EU, that medicine is going to exacerbate the inflation problem we already have. Consider that according to John Williams' Shadow Government statistics, US M3 growth is now at 34-year high. Williams says:
Based on reporting for 20 of 31 days for August, and assuming reported component levels for the week-ended August 20th do not change meaningfully in the balance of August reporting, the SGS-Ongoing M3 measure will show annual growth for the month of roughly 13.6%, up from 13.0% in July 2007, and at its highest level since July 1973.
I seem to recall gold doing something pretty wild from the summer of 1973 through early 1974.... Oh yea, it doubled from $90 an ounce to $180 an ounce. Coincidence? I think not...
The US dollar index rose a hair. The trade-weighted dollar fell a touch to 103.21.
The yen and euro both fell a hair, while the Aussie and Canadian dollars both rose half a percent.
When the Fed does begin to ease, it’s a good bet (although not a guarantee obviously) that the G10 central banks will act in concert and intervene if necessary in order to prevent a run on the dollar (or at least, that’s what I would do), as well as likely hold rates steady during this initial phase of crisis management by the Fed. That won’t stop gold from rallying in all currencies, just as we saw today, but it could mean that the dollar index may actually surprise many people and rally once the Fed begins to ease.
I wouldn’t necessarily want to bet on that near-term bullish outcome, but I certainly wouldn’t want to bet against it. It’s obviously just as likely that the dollar could simply jump off a cliff as the US economy stumbles and Fed is forced to ease even more than anyone currently expects. Under that scenario, the G10 would be forced to intervene after the major dollar indexes make new lows in order to simply keep the dollar’s decline orderly and gradual. Either way, the result is the same: more inflation globally. At the moment, however, the most likely scenario (given the dollar’s obvious vulnerability) is probably for the dollar to perversely rally for a while instead.
The first test of this “dollar head fake theory” should come on Thursday, where the ECB will probably “help out” the Fed by leaving its overnight rate unchanged, which could trigger some weakness in the euro. If the ECB surprises me and instead hikes, then I would take that as a signal that there is some disagreement on how to manage the current crisis among the major central banks. If so, the dollar’s more likely path in the near-term is down, and it could come in the form of a panic too.
Even if the central banks act in concert like I expect them to, it shouldn’t change anything for gold, and eventually, self interest and rising inflation should push foreign central banks into letting the dollar fall, even though that action could be a ways off yet. For now, central banks are still likely to hold hands and act together because the prospect of a dollar collapse is much worse than the risk of importing some inflation in their minds.
Treasuries were off just a touch, with the yield on the 10yr rising to 4.547%. The 2/10 spread widened 5 bps to +42 bps, and the 3M/10yr spread narrowed 32 bps to +15 bps, as the yield on the 3M T-bill rose to 4.46%, or just over 75 bps below the fed funds target rate.
The 10yr junk spread to treasuries narrowed 8 bps to 456 bps over treasuries.
The credit markets remain basically frozen for the most part, so while we are seeing the equity markets relax somewhat (and 3M bill yields rise a little), the crisis in the credit markets is by no means “over”. It’s just that the Fed’s promises to “do whatever is necessary” is giving players outside of the credit markets enough confidence to put their toes back in the water for now.
Stocks appear to be rallying based on the market’s increasing confidence that the Fed will soon be easing, but we’re getting overbought at this point too. The big question on my mind is what will happen to stocks the first time we get some weak economic data? And we’ve got lots of that data coming over the next 3 days.
Sure, weak data will make a Fed rate cut on the 18th a “lock”, but that first cut has already been discounted by the equity market to some extent. What hasn’t been fully discounted is the effect on the US economy of the deepening housing bust and the credit crunch and their effect on corporate earnings.
I’m still assuming that the major equity indices have probably seen their lows for a while because the oils and multinationals exposed to strong economies overseas will probably support them (and will probably even carry the Dow to a new high), but the domestic equities (like the retailers for example) probably won’t be so lucky, even though they could still bounce some more on a rate cut.
It’s just a hunch, but my suspicion is that one of the economic data points this week (probably Friday’s unemployment report) will produce some “separation” between the gold complex and the rest of the equity market, as equities stumble but the rally in the gold complex accelerates.
Let’s see what happens, but for the time being: “Don’t fight the Fed” seems to be the order of the day, even though what the Fed is going to produce at the end of the day is stagflation at best, and hyperinflation at worst.
Disclaimer: Lance Lewis periodically publishes columns expressing his personal views regarding particular securities, securities market conditions, and personal and institutional investing in general, as well as related subjects.
Mr. Lewis is the president of Lewis Capital, which manages a hedge fund in Dallas, Texas. This fund regularly buys, sells, or holds securities that are the subject of his columns, or options with respect to those securities, and regularly holds positions in such securities or options as of the date those columns are published. The views and opinions expressed in Mr. Lewis' columns are not intended to constitute a description of the securities bought, sold, or held by the fund. The views and opinions expressed in Mr. Lewis' columns are also not an indication of any intention to buy, sell, or hold any security on behalf of the fund, and investment decisions made on behalf of the fund may change at any time and for any reason. Mr. Lewis' columns are not intended to constitute investment advice or a recommendation to buy, sell, or hold any security.
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