Inflation, Stocks and Gold
The following are extracts from recent commentary that appeared at The Speculative Investor web site.
It's official - inflation is not a problem!
Here are extracts from a 4th June Bloomberg article, with our comments shown in brackets:
"Inflation is not a significant problem," Greenspan told delegates at the International Monetary Conference in Singapore. Inflation among the 12 nations sharing the euro is likely to drop below 2 percent next year, from 2.9 percent in April, Duisenberg said at the same conference.
[As we've said before, there will be no reason for us to stop focusing on inflation until the central bankers start focusing on it. As long as they are ignoring inflation and putting all their efforts into stimulating growth, the markets will most likely continue to 'bid up' the investments that benefit from higher inflation.]
The euro region's inflation rate has been above the ECB's 2 percent ceiling for 11 consecutive months, reaching 2.9 percent in April. Economists expect a report on June 18 to show inflation rose above 3 percent in May. Inflation will probably ease in the second half of the year, economists said.
[Who are these economists and why do they think that? With inflation clearly trending higher, on what objective evidence are they basing this conclusion?]
The strength of the dollar is evidence that inflation is not a short-term concern in the U.S., Greenspan said. The Fed's trade- weighted dollar index, which measures the dollar against a basket of currencies from the country's largest trading partners, is at its highest level in two months.
"Obviously our exchange rate is firm and rising and that is not the type of thing one would ordinarily envisage in the context of inflationary pressures," Greenspan said.
[We certainly agree that a rising exchange rate is not the type of thing one would ordinarily envisage in the context of inflationary pressures, but there is nothing ordinary about the greatest credit bubble in the history of the world. Greenspan's willingness to continually switch indicators until he finds one that supports his argument is almost laughable. Two year's ago the change in labour costs included within each quarter's productivity report was one of Greenspan's favourite measures of inflationary pressures. However, now that labour costs are rising at the annualised rate of 6.3%, the highest rate of increase in more than 10 years, this indicator has apparently disappeared from the Fed Chief's radar screen. In fact, now that almost all the US Government's own inflation indicators are finally revealing worrisome price increases we should, according to Greenspan's latest words of wisdom, ignore them. We should, instead, consider the Dollar's exchange rate to be proof that inflation is not a problem.]
Money Matters
Based on the P/E ratios of the major stock market indices valuations are, to say the least, unattractive. However, despite these unattractive valuations we expect the major indices to move higher over the next several months. The reason for our bullish stance has been, and continues to be, the strong growth in the supply of money.
The rate of money supply growth has a big effect on the stock market as the following chart demonstrates (the chart shows the 13-week rate-of-change of M3 versus the 13-week rate-of-change of the NASDAQ Composite). This relationship between M3 and the NASDAQ was the main reason for our early-April forecast (just as the stock market was bottoming) that the NASDAQ Composite would reach 2500 by July. The NASDAQ still has some distance to travel to reach our target, but it was clear that if the relationship that had worked so well for many years continued to hold then the divergence that had built (the NASDAQ had not, at that time, responded to the surge in the money supply) would have to be closed by a substantial stock market rally.
The only problem with relying on relationships that have worked well in the past is that they sometimes decide to stop working at the most inconvenient of times. In the case of the M3-NASDAQ relationship, we still think 2500 is achievable by July and would not be surprised if the NASDAQ Comp. actually popped its head above 3000 later this year before a deteriorating monetary environment causes this cyclical bull market to collapse into a pile of rubble next year. However, we suspect that the relationship will soon out-live its usefulness due to the changing focus of investment. Whereas an increase in the money supply was previously a shot-in-the-arm for the tech stocks that dominate the NASDAQ indices, more of the additional money is now moving towards the sectors that benefit from a depreciating currency.
The Trend
The underlying trend for gold has been positive since last November, although on some days it certainly doesn't feel like it. Around November 2000 the following trend changes occurred:
a) Gold stocks, as represented by the XAU, bottomed and began trending higher.
b) The XAU, which had been dramatically under-performing the S&P500 up until that time, began to dramatically out-perform the S&P500.
c) Long-term interest rates began trending higher relative to short-term interest rates, indicating that the market's expectations for future inflation were increasing relative to its expectations for future growth.
d) The European currencies stopped falling relative to the US$ (for this to continue to be the case the SF and the euro need to hold above their October-2000 lows).
The below chart illustrates the changes that occurred during the final quarter of last year. This chart paints a picture of an environment that is conducive to a rising gold price. The gold price itself, of course, has barely moved, but the pressure continues to build.
Steve Saville
Hong Kong
11 June 2001
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