Taylor On US Markets & Gold
Financial Markets
This Week's Moves - Making sense of them
As the charts below reveal, we had a huge loss of value last week in the dollar and a huge move higher in the U.S. bond markets. We are now looking at the lowest interest rates for U.S. Treasury instruments in many decades. Why so, especially with the dollar getting weaker as a result of foreigners selling their U.S. investments and in given any significant decline in stock prices last week?
Charts courtesy of www.decisionpoint.comWhy the Weak Dollar? What was the Strong Dollar in the First Instance?
I have believed all along that the strong dollar policy of the Clinton
Administration was largely a hoax. Remember how frequently Treasury
Secretary O'Neil and now Treasury Secretary Snow have been critiscized for "talking down" the dollar. Remember how frequently former Treasury
Secretaries Rubin and Summers "talked up" the dollar. How I wonder, can
talk over the longer term cause a dollar to rise unless something more
fundamental isn't there to support it.
Given my skepticism about the Clinton "strong dollar", I have been long
awaiting the dollars decline. Indeed, the dollar defied natural laws of
economics during the second half of the 1990's because the more of the
currency that was created out of thin air, the higher it rose in value!
Check out the charts. It was exactly starting with the Mexican bail out and
subsequent events like the Asian crisis, the Russian crisis, Long-Term
Capital Management Crisis and Y2K, that the Fed increased the supply of
money at a rate of speed far greater than the official GDP stats. It was
exactly then that the Clinton folks began to "talk up" the dollar. Any high
school course in economics or college level economics 101 course teaches
kids that if all other things are equal, an increase in supply results in
lower, not higher prices.
To explain how the dollar could be rising at the same time its supply was
rapidly increasing (as bailout after bailout were enabled) Greenspan and
the Clinton folks fabricated what was, as it turns out, largely phony
productivity numbers. Given that we now know the productivity numbers put
out by our government were largely a myth during the second half of the
1990's and given that the dollar is now tanking even though Treasury
Secretary Snow says the Bush administration is continuing to pursue a
strong dollar policy, how can we help but want Fed Chairman Greenspan and
the U.S. Treasury officials to tell us just how they did orchestrate a
strong dollar policy.
If The Dollar is so Weak, Why are Bonds so Strong?
With the dollar weakening, it would be normal to expect Treasury interest
rates to begin to rise as foreigners take their marbles home. Yet as the
charts above show, exactly the opposite is taking place. Bonds remain in
the most powerful bull market in decades, and as such have continued to
defy all the experts. Why so?
I think a big part of the answer is that we now facing the deflationary
pressures of the early days of the Kondratieff Winter. With incomes shrinking in relation to debt loads, people are now looking to their investments for cash flow rather than for some vague promise of riches in
the future as they did in the late 1990's. In other words, a growing
number of people really want and really need INCOME NOW! They are also
buying corporate debt and yes, acting upon Warren Buffet's advice they are
even buying junk bonds to gain even more income. In affect, what we now
have is a bond bubble which will also run its coarse as the winds of the
Kondratieff winter blow colder. In fact, it will be through breaks in the
riskiest bonds - the junk bonds- where the air of the bond bubble is likely
to first escape when that bubble also is extended to its limits. The folly
of investing in junk bonds is likely to become apparent as the Kondratieff
winter begins to ratchet up corporate defaults.
I also note that Richard Russell pointed out last week that his Big Money
Index indicates the smart money - the big money - is once again coming out
of the stock market. No doubt much of this is going into the debt markets,
including the Treasuries, which are of course the safest place to be.
No doubt still another reason why the bond markets have been so strong even
as the dollar weakens is because our policy makers, especially those at the
Fed have been talking about their willingness if need be, to buy longer term U.S. Treasuries to pump money into the economy to fight deflation. (See Alan Greenspan's testimony below)
These are some of the more apparent reasons why the Treasury markets and
debt markets in general have been in a bull market. But how long can it last? It could last for a while, but eventually, before the Kondratieff winter ends, I think confidence even in the U.S. Treasury markets will be shattered, such that no matter how much pumping the Fed does, interest rates on Treasuries will rise dramatically and huge losses will be suffered there as well. Initially, as defaults begin to rise along with a decline in credit quality in the private sector, we will see a mass exodus from junk bonds and then higher quality bonds. The end will come for the Treasuries I think, when people simply no longer want dollars in any form.
The notion that people will not want dollars in any form of course appears to be an absurd assumption to most Americans at this time, even though talk of deflation is becoming ever more common among our establishment. But making me even more skeptical about the strength of the dollar is the more
and more frequent talk about deflation in one sentence followed by an
immediate insistence that deflation is so remote that you don't have to worry about it. It reminds me of the old days when countries defended their
currencies under the fixed rate regime. The more a central bank insisted it
would not devalue its currency the more you could be sure it would do so.
I am also reminded of remarks made this past week by Alan Greenspan who
said before a joint economic committee that the central banks had seemingly
mastered the art of managing fiat money such that it is now acting very much like gold. Congressman Paul then pointed out (see below) that if that
were true it would indeed be quite an accomplishment since fiat currency
management has been a failure for over 6,000 years. In fact, as we have been pointing out week after week, it is the exponential rise in debt in
relation to the linear growth of GDP (if it is growing at all now) that causes us to be ever more confident that it is just a matter of time before our highly leveraged, derivative encumbered global economic system topples over. And when it does, who is going to want dollar denominated assets, be
they treasuries, junk bonds or Municipal bonds? When that woeful day
arrives, it is not a matter of how high U.S. Treasury rates climb, but
whether rates approaching infinity will suffice to find any takers of dollars.
The Equity Markets
"Most People don't believe what they see. The see what they believe." Chris
Jones - Thrivent Financial for Lutherans
With regard to the equity markets, the words above which my friend Chris
Jones passed along to me this past week seem to be especially relevant.
People still think this thing is going to come back. As another friend and money manager Wistor Holt suggested last week, most Wall Street folks
simply can't afford to see it any other way. They can't afford to admit they are wrong or they will be out of a job or lose all their clients. So they hang in there and use all manner of body language to try to convince themselves and their clients that the market is heading higher. But the trailing GAAP PE ratio according to www.decisionpoint.com was over 30 times this week, which is still higher than it was before the 1929 crash. What we are looking for to tell us the bear market is over or at least that stocks have hit bottom is a PE ratio below 10 and dividend yields in the 5% to 10% range for the strongest companies. At that point, if we still have a private sector in America left in which to invest, we will begin searching for the best "mainstream" equity ideas. But those values are seemingly a long ways off.
We not this past week that the Dow and the S&P 500 have broken below their respective ascending wedge patterns. Could this mean that as we approach the weakest six months for stocks, that the market could be poised for another major decline? Could it be that for the first time since 1929-1932 we could see a 4th year of declining stock prices? On another note, Richard Russell, the Dow Theory expert reminds his readers that the Dow is refusing to confirm new recent highs in the Transports. The longer this non confirmation takes, the more likely we are to test the old lows of last October.
I believe a 4th consecutive down year for stocks is definitely a possibility, though you can be sure the Bush administration and Wall Street in general will do their best to sucker people into the stock market to try to keep that from happening. Will they be successful? Only God knows. In His time, He will also tell us. But from my human vantage point, I think the odds seem to be better than 50/50 that before 2003 is over, the October 2002 lows will be taken out and we could finally witness the capitulation phase of this bear market and as a result, the 4th consecutive down year for stocks. That would likely be a disaster for our President's reelection hopes because when the capitulation phase of this bear market finally arrives we are also likely to witness a plunging dollar, dramatically higher interest rates, rising bankruptcies and unemployment and a skyrocketing gold price. None of those conditions would be good for our President's chances of re-election. Even though the seeds were largely planted during Clinton's watch, Bush will be blamed and the American people will buy it. But here is the big question in my mind. If we get a Democratic Administration, which is likely to throw all free market policies out the window following such a devastating scenario, will there be anything left of our free market economy? More importantly, will there be any freedom at all left in America?
GOLD
No doubt about it, gold is looking very, very strong. And as Richard Russell points out, with the price of gold now more than 10% above its 200 day moving average, we might expect a bit of consolidation below $370. Indeed some of the GATA folks have been speculating that $370 is a very crucial level for the Hannibal Lector short sellers, namely the bullion banks.
What we do know is that the prospects for gold have not looked this good in
a long, long time. Here are some obvious reasons to be bullish about gold at this time:
Evidence that the gold cartel as GATA calls it, is finally reaching its limits. We think the fact that gold has risen so far above the $330 level at a time when crony capitalist companies like Barrick and Placer Dome and the gold bullion banks are so, so short the yellow metal, suggests the gold manipulation scheme is now about to get away from the Cartel. How much gold is left? As Jim Rogers pointed out in my interview with him, we don't know because the government won't allow an audit. But based on the supply and demand work provided by Frank Veneroso and other work carried out by GATA, there is every reason to believe there is far less - (the best estimate is approximately ½ less) than the government is reporting. Thus we think the
day or reckoning for our ESF gold suppression policy makers may be at hand.
Indeed, we think this issue may well be at the heart of the reason why
Treasury Secretary Snow has been stumbling and bumbling in his public
statements about the strong dollar and perhaps why former Treasury
Secretary O'Neil resigned. If as we believe, the gold manipulation was the
real force behind the strong dollar and if the Treasury is running out of a
supply of gold ample enough for it to continue to dishord, the handwriting
may now be on the wall for the person who is exclusively permitted to
inhabit the office of the Exchange Stabalization Fund, namely the U.S.
Treasury Secretary. If it is true that the Treasury believes it can no
longer spare any golden "bullets" to defend the dollar, as the recent rise
in the price of gold suggests to me, then I think we could be very close to
seeing an explosion in the price of gold up to at least $600/oz. which the
work of Frank Veneroso suggests is a non-panic equilibrium price for gold.
Mining Companies are unable or unwilling to deliver gold to bullion banks
The pressure on the Treasury is of course now being increased by the
policies of all the big mining companies to unwind their hedges and things could get very interesting when mining companies refuse or are unable to
make good on their obligations to deliver gold back to the bullion bank cartel. Along that line of thinking, check out the following story from GATA this past week.
Newmont is Telling J.P. Morgan to "Take a Hike!" The following was reported from GATA Thursday: "The big gold news of the day concerns gold derivatives. There is a commotion going on behind the scenes in the bullion-banking world. Word has it that Newmont Mining is taking it to one of the Hannibal Cannibals, JP Morgan Chase. It has to do with their Yandal operation in Australia, which Newmont inherited when it took over Normandy. That property has 3 million ounces of gold reserves with a 3.7 million ounce hedge on - one that is going underwater as the gold price soars. Morgan has called Newmont for a margin call. Supposedly, Newmont is telling Morgan to stuff it, or more appropriately, if you insist on the margin call, the property is yours. I'm told that Newmont is willing to buy back their hedges from Morgan, but only for so many cents on the dollar. In other words, they are playing hardball. Newmont can walk because the property is "fully encircled," meaning it is a stand-alone project. Of course, it won't do much for their bullion-banking relationships.
"The following was filed yesterday with the SEC:
http://www.sec.gov/Archives/edgar/data/891088/000095013003003747/d6k.htm "Newmont Yandal Operations Limited ("Yandal") advises that on May 21, 2003, it received a notice from a gold hedge counter party alleging a right to terminate a gold hedge counter party contract with Yandal before its scheduled maturity, based on the alleged occurrence of an early termination event under the contract. Yandal estimates the payment required to be made under the contract would be approximately U.S. $46 million based on an assumed spot gold price of A$560 per ounce. "In addition, Yandal also received notice today from Newmont Mining
Corporation (NYSE: NEM) ("Newmont") that it intends to make an offer to
acquire all of the 8 7/8% Senior Notes currently not owned by Newmont, in
addition to all of the gold hedge counter party contracts entered into
between Yandal and counter party banks. "-END-
"The problem is not a small one for Morgan if Newmont walks. The hedge is
700,000 ounces more than their reserves and that's if someone is mining
them. 700,000 times $370 gold is $259 million. At $470, it's $329 million.
If the mine somehow becomes inoperable, the problem could become
catastrophic. It serves Morgan right for allowing that kind of hedge in the
first place. That's not a hedge, it's a speculation, put on back in the Hay
Day of the gold rigging operations. What goes around comes around. Chase
influenced Newmont to put on a big hedge at the bottom of the market around $265 gold, right before the Washington Agreement was announced.
"The ramifications for the gold industry could be dramatic if Newmont
sticks it to Morgan. Gold is only at the $370 level. What happens when gold
rises hundreds of dollars per ounce? There is liable to be one counterparty
risk problem after another. Ever hear this one before?
Institutionalization of Pro-gold Policies
Potentially very significant also is the fact that on June 1st a change in
Chinese law will make it legal for Chinese people to buy, sell and own
gold. Also the institutionalization of exchange traded gold bullion
accounts should also spur demand for gold as an investment as the
Toqueville Funds John Hatheway recently discussed.
Declining Confidence in the Dollar. The declining level of confidence in
the dollar is perhaps the most important of all forces behind my bullish
view on gold. The decline in the dollar is still fairly well controlled. But as the truth becomes every more recognized, that the strong dollar policy was largely a hoax in the first place, we could witness a massive and very rapid rise in gold, which would be the mirror image of a decline in dollar confidence.
Congressman Paul's Dialog with Alan Greenspan
Time will not permit me to analyze the exchange between Congressman Ron
Paul and Alan Greenspan that took place in the joint economic hearings this
past week. I typed it up just as it was recorded. No attempt was made to
clean it up for grammar or to improve sentence structure in their exchange.
What you see is what you heard if you watched/listened to this most
interesting exchange between these two men, both of whom have an
intellectual understanding of why gold is money and why it should be money
while only one of them has remained true to his convictions.
"Dr. Paul: Good morning Mr. Greenspan. I have two questions. One is
generalized and it deals with the dollar system and the monetary system
that you are required to operate. And then one more specific factor that
affects the strength of the dollar.
"The big debate now in financial circles is the strength of the dollar,
whether it is good or bad vs. what a strong dollar should do to us or for
us. And I would like to suggest is that there should be another alternative
rather than arguing the temporary case for a strong dollar to help us, as
it seemed to in the latter part of the 1990's vs. whether the weak dollar
will now help us in our exports, rather than this manipulation of the dollar.
"I hope someday we will talk about a stable dollar. One that does not
fluctuate so readily. We deal in the world today with fluctuating exchange
rates and all currencies are inflated at different rates. Nobody advocates
that we have 50 different currencies in this country. That would be totally
chaotic and yet the world is required to operate that way. But there is no
soundness to it, no restraint on the monetary authorities.
"And the other challenges we have to look at some day is whether or not we
should continue to accept this notion that we can achieve positive central
economic planning through the monopoly control of money and credit and the
setting of interest rates, which is really contradictory to true capitalism. I think that is where part of our problem is. The Austrian economists for years, Mises, Hyek and Rothbard have argued that this is the source of our problem. That the manipulation of interest rates too low causes the boom and then eventually the bust has to come. And we see this over and over again.
"We talk about productivity and other events that are important, but we
fail to talk about the initial cause of the mal investment, the over capacity which then requires the correction. Because we operate the reserve
currency of the world we have the advantage of others taking our money and
our dollars and holding them. But currently the expectations are that our
current account deficit may soar to $600 billion next year. And we do know
that throughout history, and most economists agree that these kind of
current account deficits cannot be maintained and that they will eventually
lead to a weaker dollar and higher interest rates.
"So I think you are under the gun. On the one hand you want to stimulate
the economy with low interest rates which weakens the dollar. At the same
time the weak dollar will eventually push up the interest rates. My question then is, when or do you think we will ever talk about a sound, stable currency? And the other question is more specific. Even though what
the Fed does in the creation of new money is the key element, there are
other factors too like jawboning the so-called speculators for a day or two. But that really can't change things. Jawboning doesn't work. Ultimately in 1979 interest rates had to go to 21% to restore some order to the dollar.
"But you talked about the war and the supposed benefits after the war was
over and after it started. But I think what has not been recognized is the
ongoing foreign policy of our adventurism and our plans - those same people
who argued the case for Iraq are arguing the case of Syria and they are
arguing the case for Iran. At the same time we don't have our allies close
to us. We don't have people pouring into dollars like we did in the 1990's.
So that by its self it has a subjective relationship to the perceived value
of the dollar. And I want to know whether you think that element in foreign
policy today specifically has affected the future perceptions of the
dollar's value is going to be?"
Greenspan: "Dr. Paul, let me address the last question first. As I think
you may remember we in the United States government have made a decision in which the value of the currency will be discussed only by our chief
economic spokesman, which is the Secretary of the Treasury. And we at the
Fed have adhered to that for quite a long period of time. I think it is
important to have one voice speaking on that issue.
"With respect to the more general question about sound stable currencies.
This as you know is a very fundamental debate among economists. You point
out quite correctly that there is a single currency in the 50 states of the
United States. The reason why we are able to function in a manner that
others are not is because an exchange rate that is a unit specific currency
tends to bring together all of the imbalances in an economy in an exchange
rates price. In other words, at the boarder, an exchange rate essentially
rebalances all the imbalances between two contiguous countries or it might
have been in the United States between two states.
"If you lock the currency in and you cannot adjust the currency at the
border. Then the adjustment must occur in capital flows or labor flows. The
only two other ways you can get major adjustments that are required between two disequilibria economies. The advantage of the United States is that because we have stripped out all barriers to interstate commerce (I should say "most") we are able to get equilibrium adjusted solely through capital and labor market flows and we have a fixed currency. The reason why it is feasible at this moment in a lot of other areas of the world is that
capital and labor flows are not adequate to pick up the full adjustment
process. In and endeavor to fix exchange rates in the face of imbalances
induces financial breakdowns as have occurred.
Dr. Paul: "May I just interject. I'm not talking about fixing these rates.
I'm talking about a single currency that could be universalized."
Greenspan: "That's the algebraic equivalent of fixing currency rates. In
other words, if you lock in legally all rates, its irrelevant what you call the currency in one nation or another. It's the lock that matters and if you have for example as we did, the gold standard for a very substantial period of time, was the single currency of the world. It didn't matter what you called the other currencies because they were all locked into specific units of gold. And so the notion of a stable world currency requires a degree of flexibility in capital and labor flows which we have not yet achieved."
Second Round of Questioning for Congressman Paul
Dr. Paul: "I wanted to follow up on your comments about not being able to
talk about the value of the dollar. I find that rather ironic. The Federal
Reserve is in charge of the monetary system and you as Chairman have a lot
to say about what monetary policy is and how much money will be printed and
how much interest rates will be. So we find it a bit ironic that you can't
comment on the value of the dollar and that you defer to Treasury. Now
Treasury can play a role by intervening in the exchange markets but that's
very temporary. But I understand the policy and we don't expect you to
change that but in a way you are really in charge and it is too bad that we
can't get comments on the value of the dollar.
"I did want to remind you about the follow up on the question of foreign
policy, how foreign policy anticipation about what we might be doing around
the world might affect fiscal and monetary policy and trade policy and how
that effects perceptions of the dollar and whether or not that is
important. But on the currency issues, I'm still not interested in going
back to fixed currency rates such as the Breton Woods Agreement. That's not my interest because even then Henry Hazlet wrote very correctly that Breton Woods would break down with that so called gold exchange standard.
"But if you have achieved what you hoped, that is that central banks now
have done such a good job in managing paper money that it is starting to
act like a gold standard, now that would be an historical achievement You
realize that? Because it has not been done in 6,000 years of recorded
history. And history is on my side of this argument that paper money
doesn't work very well. Paper money ends badly. We may be seeing some signs today around the world that paper money is a very shaky system.
"But I have a more specific question in dealing with that. In a return to
commodity money, if we have a third world nation that destroys its currency
and they don't have the advantages we have politically, if they destroy
their currency and they want to link their currency to gold, because they
know history, they are not allowed to do it. The IMF prevents them from
doing it. There is an IMF rule that says they can't do it. So wouldn't this
be a good time for us to become more neutral and not antagonistic toward
gold and say to the IMF 'our position is that if you choose to go back and
get stability and soundness to your currency by linking it to gold, we ought to permit that?'"
Greenspan: "I believe a country has the capability of doing that. I'm not sure what the rule is in the IMF. If they were to link their currency to gold and they believed it was going to stabilize their system, they wouldn't need the IMF."
Dr. Paul: "But there is a prohibition if they want to stay in the IMF. What
about the foreign policy question."
Greenspan: "I don't feel I can answer that without breaching the agreement
about not taking about the currency. I don't know how to phrase an answer
to your question without implicitly doing that."
Dr. Paul. "O.K. I yield back."
May 27, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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