The current cheer-leading on CNBC or other TV shows would cause one to initially suspect we are on the verge of a new bull market. The problem is the basic fundamental and technical elements associated with the initiation of a new bull market just are not there. Chart 1 shows the VIX currently, with stochastics nearly set to cross. This is a sign of complacency among option writers.
Generally, when a country has a weak currency, there at some point is a sell-off of its major stock indices. In the US this has not occurred……..yet. The Federal Reserve has been suspected in lending support to prop up the stock market to prevent a repatriation to other currencies. The majority of the US currency is held by foreign banks, so a sudden drop to lower levels could be a trigger. Rather than buy back its fiat
Green lines denote tops, while red lines denote bottoms currency, the US has chosen to crank on the printing press and create money out of nothing. There will be instant money at hand, but this dilutes the value of the currency and would bring about inflation from the classical definition of more money chasing the same number of goods. So why are we seeing inflation and deflation in some items? The US has had the largest bull market in history that was fed by people, and governments taking on too much credit. This credit creates a black hole where money must eventually be sent to pay the bills. The current market situation has created a very weak unemployment situation, with all levels of US government hemorrhaging in efforts to balance the books. When people are unable to pay their debts off, they declare bankruptcy or walk away from items used as collateral (i.e. real estate). This creates a loss of money supply in the system, which is deflation (fewer dollars chasing the same amount of goods). The amount of money the FED has been injecting into the US economy has been staggering, but the net amount of money leaving the system by way of bankruptcies and home foreclosures is greater giving a net effect of deflation. To make things more complex, supply and demand must be considered. Whenever demand exceeds supply, prices rise. Commodities have been in a bear market for 20 years plus and are just beginning to enter into a longer-term bullish phase. Paper can be created out of thin air, commodities cannot. Low levels of gold, oil and silver will be a contributing factor to their rise. When we do start seeing more bankruptcies, deflation can be expected in all items associated with credit.
The FED can print money right now, but the deflationary black hole is sucking all the money into it. Deflation in the 30's occurred globally, but there were still pockets where one could protect their income. The current economy is global, linking all markets more so. Downturns in the larger economies will be felt all over in this scenario, which is occurring currently. Unemployment in Germany is 10%, Japan has been in and out of a recession for the past 14 years etc etc, yet the US economy is still buoyant. Since the US economy represents 25% of the global economy, it is the global currency of choice. This currency of choice coupled to the US's strong dollar policy made imports from other countries. China has been one of the main benefactors from the US dollar since their Renminbi is fixed to the US dollar. A drop in the USD results in an equivalent drop in their currency. 70% of the global manufacturing occurs in China right now. Major corporations are sending portions of their manufacturing and business there. This creates a form of deflation from importing lower cost goods. A recession in the US will feed back into the Chinese economy. Since the economic downturn and the US dollar index falling from 120 to 92.5 recently people are falling out of bed with the greenback. Charts 2 and 3 show the Elliott wave pattern of the US dollar Index currently. Chart 4 shows the stochastics of the US dollar index. The stocks indicate we have a ways to go before some form of intermediate or longer term bottom is in place.
The market has had a strong performance lately, frothing with the buzz and excitement of 2000 all over again. Below are three accompanying charts showing the S&P market action. People invested in the US stock market have had a double whammy the past three years. Stocks have gone down in value, but so has the relative value of the currency. A rally right now is doing nothing more than filling a partial gap of lost money due to the fall of the USD. As long as the stock market is doing well foreigners will keep throwing money into the US economy. There trade imbalance requires that people invest 15 billion dollars each day in the US. The trade imbalance is another sigh that this bear market is far from over. When the US trade imbalance returns to near zero, then we have some indication of a changing of the tide.
How will commodities fair, if we enter a deflationary cycle. Given how all currencies are linked , have little gold backing, gold is bound to rise as currency devaluations occur globally as countries fight for trying to maintain competitive edge. The 20 year bear market on gold and silver has decreased mining production while demand has been increasing. Global oil production is set to peak in 2004 according to the Hullbert curve, so supply will become an issue . With China and India importing more oil annually, and at best current production staying at current levels prices are bound to shoot up. The Canadian tar sands in Albert a will be an important source for North American oil supplies this century. Below are three charts of the Gold BUGS index (HUI) and the Amex Oil Index (XOI). The patterns in the charts paint a very bullish long term picture.
The information shown in all of the charts attempts to create a picture of the future economic landscape, and why commodities will be bullish and why stocks will fall. The stock markets are like living breathing creatures, they expand and contract with each breath. Credit expansion will be followed by credit contraction. We have not really even entered the bears lair yet with the market. Government intervention to try and stabilize the economy will not hold off the inevitable, just keep things good until they get back into office in 2004. One final note, gold has yet to break free from its link to the USD. When this does occur, expect a huge run-up in price. Until next issue take care and invest wisely.
Market Letters Digest
Volume 1, Issue 1, June 7, 2003
David Petch, Editor-in-chief
ITMmyFAV@aol.com