Vagaries of a Bear Stock Market
During the early stages of bear markets, before the true capitulation phase
sets in, bear market rallies can be sharp and furious. Like Pavlov's dog
that salivated when the bell was rung, equity investors currently get
excited at the first suggestion made that we might have seen the bottom of
the market. Not wanting to be left out of the next big move, without
hesitation, they jump back in. At the same time, short sellers are then
forced to cover their positions. Together these factors combine for violent
but usually short-lived rallies during the early stages of a bear market.
By contrast, during the early stages of a bull market, there are few
believers. Again, reacting to recent experience, investors are quick to
take profits, recalling that the market in question has been in a bear
market for the past 20 years or so. They reason that if the market has not
risen in recent years, it isn't going to rise very far now. Accordingly,
investors are quick to take profits in the early stage of a bull market.
It is clear to any objective thinking investor that we are in the early
stages of what might fairly be termed a cataclysmic bear market following
what has been the greatest bull markets in history. Given the
characteristics of bull and bear markets, we should not be surprised by the
sudden reversal since early March for the dollar, the equity markets and
the gold markets.
What we are trying to do in this letter is avoid being whipsawed in and out
of the markets by short term gyrations because I agree with Richard Russell
that there are two ways to make money in the long term. First, you need to
identify and act according to the primary trends. Secondly, you compound
your earnings. It has been said and I believe it to be true that most
investors who try to trade the market end up losing money or making far
less than they would have if they simply rode the primary trends. There are
newsletters that focus on trading in and out of positions but this is not
one of them.
With the short-term trend reversals since early March, our Model Portfolio
has slipped into negative territory. Through April 9, 2003, we have lost
0.46% vs. a 1.57% loss for the S&P 500. As the chart above shows, the only
positive components of our portfolio are the Rogers Raw Materials Fund (up
2.46%) and our junior gold stocks, (up 28.99%). But with our focus
remaining on the primary trends, we do not see any reason to alter our
investment strategy at this time. In fact, we think it is entirely possible
that the secondary trends that have run counter to he primary trends since
early March may themselves now soon again be synchronized with the primary trends for these markets. Unfortunately, what we see are longer-term trends that are not kind to equities or the dollar and which as a result could lead to extreme hardships for Americans.
The Konddratieff Winter Winds Blow Colder
Of course the most profound and significant trend in place is the one
identified by our good friend Ian Gordon. That is the Kondratieff Cycle.
Ian's work demonstrates the current cycle began in 1949. Unfortunately, the excesses of this current cycle, owing to the fact that the discipline of
gold as money has been formally detached from monetary systems around the globe means that the corrective phase, which Ian has named the Kondratieff Winter, will most likely be more severe than that of the last Kondratieff winter that took place during the 1930's.
But wait a minute! Wasn't the Federal Reserve created to avoid extreme
cycles? That of course was the excuse for its creation. In fact, what we
have seen is exactly the opposite. The Fed was created in 1913. Yet, the
Depression of the 1930's was the most severe in U.S. history. And now we
have been set up for the mother of all deflationary collapses. In fact, the
Fed is an engine of inflation and thus instability, not stability. We plan
to continue providing a chapter-by-chapter weekly summary of The Creature
from Jekyll Island by G. Edward Griffin to explain how, why and by whom the Fed was imposed on the American people and how a handful of the richest men on earth conspired to consolidate power and form a banking monopoly that continues to this day and has allowed them to move America away from its democratic Republic toward a dictatorship by this ruling elite. If you want to know who and why the gold price is being manipulated, you must read The Creature from Jekyll Island. In the process of grabbing power through the printing press, these elitists have royally botched up our global monetary system for which we are about to pay dearly.
This group of powerful family interests have made enormous progress toward consolidating global political power. In fact, we are convinced the war in Iraq is certainly a part of this struggle. Certainly the U.S. prominence
around the world would not be possible were it not for the Fed's ability to
print money and the willingness, on the part of the global economy to
accept this fiat money for its goods and services. We argue that one main,
but unspoken reason for the U.S. involvement in Iraq is to bolster a
faltering U.S. economy, which no longer produces anything of significance,
and to collateralize the U.S. dollar by gaining access to inexpensive
supplies of oil and to also discourage any country from daring to demand
currencies other than the U.S. dollars as a medium of exchange for
international trade. And, we believe that as the fundamentals of the U.S.
economy and hence the dollar continue to decline, the need for similar
military conquests will become ever greater. We have little doubt that our
not so subtle means of trying to put down the Euro in favor of the dollar
is behind at least some of the resentment of the U.S. invasion of Iraq by
France, Germany, Russia and China. (Also recall what James Tu said about
China relying on the Mid east for its oil) However, notwithstanding our
military might, as the fundamentals of the U.S. economy continue to weaken,
we think the dollar's days as the world's reserve currency may be numbered
and that gold is likely to rise dramatically higher in terms of the dollar
during the months and years to come.
How is Deflation Possible With an Expansionary Fed?
In this month's interview with James Tu, he expressed the conventional
wisdom about deflation. He said we simply had so much debt that the Fed
cannot afford to allow deflation to develop. I agree with James that there
is too much debt. Where we disagree is on the notion that the Fed has
within its power the ability to avoid deflation. I believe we have passed
the threshold of lethality in the Kondratieff cycle where the weight of
debt has become so burdensome that the Fed is powerless to avoid deflation.
This is most unfortunate not only for Americans but for a global economy
that is built on the dollar as its reserve currency. Why do I fear it is
too late for the Fed to avoid a massive deflation? The following question
from Peter Vasselais of Malibu, California best summarizes my view.
Question: "I just read your excellent article at GOLD-EAGLE.com dated April 8, and I fail to understand how the exponential growth of the money supply could be deflationary. I always assumed this was inflationary, and would lead to hyperinflation. What am I missing, and is there a resource where I can learn about this phenomenon? Thank you for contributing to GOLD-EAGLE.com." Answer: What I believe you are missing is the fact that our monetary system is a fractional reserve fiat system the likes of which the entire world now is burdened with. Money in this scheme is manufactured with debt.
If you look at the growth of debt in the chart above right, you will see
that for quite a few years now, it has been growing much, much faster than
GDP. What does that mean? It means that whenever Mr. Greenspan tries to
print money to bail us out of deflation, he actually makes the situation
worse because principal and interest payments continue to eat away at
demand as debt continues to grow faster than GDP.
Why is that true? It is true because an economy's growth is limited by
natural constraints that are independent of money growth. So, as the Fed
has printed, and printed and printed, it has not only increased the money
supply but it has also increased the debt and since debt is growing much
more rapidly than income, more and more cash flow is devoted to repayment
of debt, which means less and less money is available to buy goods and
services that would stimulate the economy.
Indubitably, the Fed cannot in my view, inflate our debt away. We have seen with our Dot Com companies and a host of other "new economy" industries, how the pumping of huge amounts of new money into the economy resulted in mal investment. The debt that was used to manufacture the money supply remains on the books of our banking system. But the income generated from the economy is becoming ever less adequate to service it. And as noted above, a larger percentage of income devoted to servicing debt means less cash flow available to purchase real goods and services in the economy, such that aggregate demand grows weaker and weaker. And we have seen how income has not kept up with debt thanks to the mal investment of the 1990's. Trillions of dollars have been lost from dot com and other new economy companies. Those companies are either out of business or throwing off miniscule cash flows. Yet, the debt used to manufacture the money that went into these bad investments remains to be paid.
How does Mr. Greenspan propose the debt be serviced? Wall Street says that is easy. Just print more money. But printing more money cannot generate more income because of natural economic constraints. Yet that is what Greenspan does when he reduces interest rates. He create more debt in a system that is already strangling from existing debt.
This is why I believe the only solution to our current deflationary malaise
is to let the system fall under its own weight. Clear the deck with massive
bankruptcies and start anew. Policy makers will of course not take that
course of action. They will, like the Japanese, continue to try to print us
out of this debacle and they will try to deficit spend to stimulate the
demand side of the economy. But there is no getting around the fact that
the laws of nature as they pertain to the natural income producing
capabilities of our economy, cannot be overcome. And as we have seen from
our policy maker's "new paradigm" fantasies of the 1990's, the attempt to
think otherwise only leads us deeper into a national debtors prison.
Another factor that is reducing America's income, and thus making debt less
serviceable is the trend toward bigger government. Governments do not
create wealth. And when they become excessive, they become parasitic in the sense that they reduce economic growth by taking resources away from the productive private sector. We don't have time to discuss this now, but with government growing as a percentage of GDP from 12% in 1930 to 22% in 1947 and 42% now, the productive sector of our society has been reduced at the expense of a socialistic agenda made possible only with a willing Fed to
finance it via the printing press.
How can Gold do Well During Deflation?
Another question I and other analysts get who believe gold is a good
investment in a deflationary environment is the following question, most
recently sent to me via email from Carol Hemelt.
Question: "I am a fellow gold bug (only in the last couple years) and
follow your work and the work of others to detail and discuss the role of
gold and fiat "money" in the world in which we live. I am struggling
though with the concept that deflation will result in a price INCREASE for
gold. No one yet has been able to convincingly discuss how or why such a
thing will happen. As the Kondratieff winter takes hold, there will be
less money in circulation and in the hands of potential investors, how can
gold rise in price in such an environment? I believe that Kondratieff was
correct in the cycles of economies and that we are facing a severe
deflationary depression ahead. When the demand for gold from jewelry sales (presently 80% of world wide gold demand) slacks off and investors lose trillions in "paper" losses on their stock, bond, and real estate how can
gold increase in price? Well, if you could take the time to answer my email
I would be very appreciative."
Answer: First, it is important that you recognize that gold is money and
not a commodity. I have no doubt that demand for gold for jewelry will
decline during the Kondratieff winter. Gold demand for jewelry purposes
always declines when the price of gold rises, which is why we think the
World Gold Council has been so foolish in wasting millions of dollars of
shareholder money to promote gold as jewelry.
Why gold will be much in demand during a deflation is because it will be
(based on history it always has been) the only widely accepted medium of
exchange when paper money fails. We saw this phenomenon recently in Japan.
When proposed banking reforms would have reduced the deposit insurance,
investors realizing the Japanese banks loan portfolios were nearly
worthless, suddenly began taking their yen out of the bank and buying gold
with it. That in turn caused Japanese policy makers to renege on their
promise for reform, which means ultimately the Japanese banking system will only get worse until one day when it collapses totally. At that time
investors will demand only gold, as money because its value is not
dependent on the solvency of the banking system. We, in America may be a
number of years behind Japan but we are following in their footsteps,
notwithstanding the differences outlined by James Tu in this months
interview. But when confidence is lost in fiat money, market participants
require a currency that does not lose value because others default on their
obligations. In other words, they will always demand an asset money like
gold or silver.
The Day Baghdad "Fell"
As we were putting the finishing touches on this issue of J
Taylor's Gold & Technology Stocks, the U.S. Armed forces had moved into the center of Baghdad and a celebration began with the tearing down of Saddam's statue. We would have expected the gold market to get trashed while the dollar and equity markets soared. Nothing of the sort happened. Gold soared from $321 when Saddam's statute fell to the ground to $327 by 6:00 PM in New York. The Dow lost 100.94, the NASDAQ dropped and the S&P500 lost 12.30. One might have expected a jubilant America to assume everything was right with the world again so that gold would decline and the dollar soar.
But one day a market does not make. We need to heed the warning of Richard Russell (www.dowtheoryletters.com ) to listen to the market. The long-term averages continue to say we are in the early stages of a bull market in gold and the early stages of a bear market in equities and the dollar.
The strong performance for gold and a very weak day for equities on the
very day Baghdad fell is suggesting these major trends remain in place and
that the contra trends from early March until now may be about to change.
Yet, so far as the equity markets are concerned, according to Richard
Russell from a The Dow Theory viewpoint, we need to keep our eyes on Dow
8521.97 and the 2263.49 for the Transport. If both the Dow and Transport
averages should both rise above these recent highs, we might see the rally
in equities continue much further. However, if either or both these
averages fail to exceed those levels, then we are likely to test and move
below the October 2002 lows at which time we could see the next phase of
the bear market turn very nasty. Whatever happens in Iraq, global
deflationary forces remain in place and in our view, the will likely
overcome any positives that may result from a successful prosecution of the
Iraq war. We say that because the forces of the Kondratieff cycle are far
greater than military might, just as they are more powerful than the
Federal Reserve or any other central bank or government entity and not
withstanding any new paradigm proclamation by Alan Greenspan.
April 14, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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