A Corny Concerto
David Petch
Anyone who is a Bugs Bunny aficionado will instantly know that the theme of this editorial is based on a cartoon where Bugs is a conductor for a symphony. He whirls the different orchestra sections in all directions, and when he goes to bow, the only sound to be heard is crickets.. On that note, let me introduce you to the different sections of this article, the wind section (Wall Street), the percussion section (the FED), the String section (mutual fund managers, stock brokers) and the Brass section (the US government) and the conductor (aka Allan Greenspan).
The Percussion Section (The Federal Reserve)
The percussion section of an orchestra controls the tempo of a musical piece. All other sections base their flow of music around that of the percussion. In this band, the FED theoretically controls the orchestra (market). The FED thinks it has the ability to control market cycles (which it does not, but will be addressed at the end of this editorial) through regulation of the volume of credit and money in circulation. The FED can lower the overnight lending rates to banks, and raise or lower public interest rates to slow or expand the economy, respectively. During the stock market bubble of 2000, the FED raised interest rates to try and slow the economy. Since 2000 and a prolonged recession, the bank reduced the overnight lending rates, and has cut interest rates thirteen times the last two years to try and re-flate the economy. Going off of the gold standard completely in the 1970's has allowed the FED to infinitely expand the US dollar, to a point where it is 25% of the global money supply currently. This increased liquidity in the system caused severe inflation, a build up in credit, which drove the bull market from 1982 till 2000. The FEDs two tools for regulation of this inflation and re-inflation of an economy through raising/lowering interest rates, or lowering overnight lending rates to banks have failed. In recent interviews the FED has stated they will do everything in their power to prevent deflation. Their plan is to turn on the printing press to try and keep more money in the system than the amount exiting through bankruptcies etc. Currently there is more money leaving the system through bankruptcies etc. than is entering via the printing press causing some deflationary pressures. Deflation can soon be expected to be present in any item tied to credit, i.e. real estate, cars, appliances. There are some schools of thought that have a deflationary collapse causing a drop in commodity prices. This occurred in the 1930's, but there are significant differences from that era compared to our current day scenario.
- In the 30's, the US oil production just peaked; in fact the US was the largest oil producer at that time. Oil was not in a shortage during this time. Currently we have global oil production set to peak in 2004, with anything but excess oil
- The silver supply in the 30's was very large. The government started to purchase more silver off the market to try and stimulate the economy. The current surface silver supply has nearly been depleted from non-recoverable processes since it is an industrial metal. We are on the verge of a silver crunch.
- The price of gold was fixed at $20/ounce. After the gold was confiscated by the government from the people, the price was automatically raised to $35/ounce. There is currently a 1500-2000 ounce/year deficit of gold compared to what is mined yearly. Gold is now regulated at market, without a fixed price by government bodies.
- Less than 5% of the population was involved in the stock market. At the market top of 2000, 60-70% of the population were involved. This will make the fallout from stocks harder in this decade.
The supply shortfall in commodities is bound to increase the demand, which will put pricing pressure on them. I believe that commodities are in a battle between deflationary and inflationary forces right now. The Elliott Wave patterns of the HUI and XOI to me suggest gold and oil are in a primary uptrend respectively, and the commodity shortages will win out. The FED controlling the beat has other sections march to its beating drum.
The Wind (Wall Street) and String (Brokers) Section
When one thinks of the wind section of a band, they think of soft lush sounds that are airy. Thoughts of a string section are smooth flowing gentle, soothing music, What better section than to put the Wall Street Pundits and stock brokers (mutual funds), respectively. Wall Street makes their money by having people invested in stocks….bottom line. People buying stocks stoke the brokerage fee account, and generate possible underwriting contracts with large or new corporations. Being in a bear market is not good for Wall Street or its brokers or mutual funds. In 2000, there were more types of mutual funds than stocks trading on all North American Indices. A reduction in churning of brokerage accounts reduces brokerage fees, which reduces the number of underwriting contracts, which in turn reduces people buying mutual funds.
The other day on CNBC, the talking heads were discussing a new bull market emerging, thinking we were 20% undervalued, even with the current rally taken into account. Mass psychology is a very powerful tool…. hearing the soothing voice of someone on TV being viewed by millions, telling them not to panic only creates more bag-holders. All of the strong post bull market pundits trying to rekindle a wet fire is just creating a lot of steam. In order to help companies maintain share prices, Pro Forma numbers have been used (profits before any deducted expenses) due to net income slipping lower and lower. This was most recently replaced by EBITDA (earnings before interest, depreciation, amortization) to cook the books further. Lately, a company only losing 4 cents/share instead of 6 cents/share has lost the impact at causing stock market rallies. I am certain one of the first signs that the bear market is over will be when CNBC is no longer in existence.
The Brass Section (US Government)
A brass section of an orchestra creates power. The sound resonates above the other sections during climatic movements. This sums up the way the US government is handling foreign policy to try and create an image the US is a good safe place to store money. As mentioned in a prior article, foreigners own a significant number of US treasury bills, equities and bonds within the US coupled to the currency being 25% of all money traded globally. Currently, most global oil and gold is traded exclusively in US dollars. The US has managed to maintain a monopoly on this for the past few decades, but is now starting to face the Euro as a possible replacement for the USD. Printing the USD in the volumes that the Federal Reserve came into existence in 1913 has seen the USD lose over 95% of its value. One dollar in the 30's was exchangeable for 1/20 of an ounce of gold….now one would be lucky to get a flake of gold for it. Each year that goes by, more fiat money is produced in the US, which further reduces the value of the USD.
Sounds like a grand scheme, print more money, buy as many goods from around the globe using currency as a means of control. There is an enemy though that is lurking, the government is trying to suppress it, but in the end its patience will win…….and that is gold. Corporations are laying off thousands of people, bankruptcies are sky high, both personal and business. The wealth of America is being handed over to banks that control the credit of the country. The only way to turn Americas problem around is to strip all credit out of the system and start anew, but any foreign bank will want payment, compensation in some form. All the US can offer is more paper. When people stop accepting the USD as the major currency, and repatriating to their native currencies or gold, this is when all the government intervention in the world will not be able to control the outflow of money. The US has even thought of issuing different versions of its currency for different continents to avoid that problem. It is thought the price of gold (POG) is being suppressed until a lot of the Central Banks can cover their short positions.
The Conductor (Alan GreenSpan)
and the Central Hypothesis of this Editorial
More gold is being quietly picked up ounce by ounce, removing it from circulation that further constricts the available supply. One hypothesis the author thinks will aid in propelling gold forward is a metal that is not receiving any attention, "poor mans gold", that being silver. Silver supplies are at critically low levels. Most silver currently supplied (70%) is the result of a secondary product in the mining of other metals. There is a silver deficit each year, and mines capable of production require a minimum of $6.50-7.00/ounce just to break even. When silver supplies reach critically low levels within the next twelve months, there will be a surge in price. The FEDs main interest has been its ability to control the price of gold, but not concerning itself over a dwindling silver supply. Normally the POG moves the price of silver (POS), but under current market forces, the reverse is likely to occur. It seems the only way a break from manipulation of the POG will be an absolute physical shortage of some precious metal (PM). No amount of paper, or shorting will be able to control a price explosion in silver. Since precious metals tend to move as a group, a spike in silver would naturally trigger an increase in the price of gold. The US government should be should be worried because a spike in silver spells the end of manipulation, it simply will be unable to control the outcome. If the USD is the only currency pegged to the POG, the further their currency is allowed to expand will naturally increase the longer-term value of gold. Elliott Wave patterns suggest the USD is going to find 80-85 as a bottom within the next three to five years. It could go lower, but the current wave structure has this target.
Implications of higher gold prices will automatically undercut the value of the USD, which will start the mass exodus to other currencies, and hard assets. The huge trade deficit would quickly grind down due to import prices skyrocketing. I remember as a child the Canadian dollar being higher in value than the US currency for a short period. Currently at around 68 cents, I fully expect the currencies to be trading at parity in the coming years.
Summary
In the original "A Corny Concerto", Bugs Bunny tried to create a peaceful and cohesive combination of all orchestra sections to produce an equivalent of Handels " Water Music". Instead, he was a bungled conductor who turned all sections upside down and had sounds of 1812 Overture as the replacement music. In the end, when Bugs takes a bow, the only sound to be heard is crickets, and the one lone mosquito applauding. By time Allan Greenspan makes his bow in 2004 from exiting his position as Chairman of the FED, I think the same sort of response will be heard.
The only true conductor of the market is the market itself, or "Mister Market". Human intervention to try and control the market has proven time and time again to fail. The United States one-decade ago accused the Japanese government of the same tactics the FED is currently using to keep the United States head above water. Intervention can extend the inevitable, but not prevent its occurrence. This sort of activity will only amplify any economic downturn in the future. Having a balance of physical gold, and silver bullion, with select PM stocks is critical to protect ones capital during the coming decade. Gold and silver prices have been stretched to the maximum capacity they can be stretched. Newton's law of "for every reaction there is an equal and opposite reaction" comes to mind about now.
The market if allowed to conduct itself in a proper and orderly fashion will provide sheet music for Handel's "Water Music" to Tchaikovsky's "1812 Overture" as deemed appropriate as the concert proceeds. As a musical piece, the markets will have slow sections, fast sections, joyful, and dreary movements. To experience life without all emotions is unfathomable, and this also goes for the market.
Any comments or flames can be directed to dave@chartlook.com
David Petch
28 March 2003
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