Taylor On US Markets & Gold
FINANCIAL MARKETS
Prices Keep Falling
Despite an enormous amount of fiscal and monetary stimulus and despite a
declining dollar, prices in the U.S. continue to fall. While we still have a positive CPI and PPI number, it is the overall decline in prices which,
under the surface, no doubt has the Fed worried sick. We quote from the
June 2003 issue of one of our favorite newsletters, "The Aden Forecast."
"We all know the Fed's already cut interest rates 12 times to revive the
economy and it hasn't worked. But this month, the Fed's worst fears started to emerge.
"Import prices plunged at a shocking 32% annual rate in the largest one
month drop in history. The next day, producer prices plummeted nearly 23%
annually in its biggest drop on record. This was followed by the first
decline in consumer prices since 2001 with core inflation hitting a 37-year low."
Not surprisingly, we have not heard much about those numbers in the U.S.
press which is increasingly serving as a cheerleading force for Wall Street
and the politicians rather than a truth seeking service so necessary for
the defense of our Republic. But the lack of response to both fiscal and
monetary policy are the reasons the Fed is becoming ever more desperate in
its attempts to avoid moving into the painful but necessary Kondratieff
winter. In fact, it should be obvious by now that monetary and fiscal
policies do not work, once we have reached the winter phase of the
Kondratieff cycle. I say that in confidence having reached the conclusion
that both fiscal and monetary policies were tried and failed during the
1930's. And both were also tried over the last decade in Japan where again
they failed. In fact, the Kondratieff winter serves the constructive
purpose of wiping excessive debt off of the books and readjusting markets
back toward equilibrium so that a new cycle of growth can begin. The
winter takes place at a point in time in the cycle when, repaying debt
becomes a mathematical impossibility. Debt which grows exponentially late
in the cycle can no longer be paid with income which grows in a linear
fashion. It is at that point when monetary and fiscal policy not only fails
to stimulate the economy, but actually worsens the problem by making debt
even more excessive in relation to income.
A Desperate Fed Offers Desperate Solutions
The desperate moves being suggested by the Fed to avoid deflation are in
our view incredible. First Bernanke has talked about "helicopter drops."
The picture he hopes to create is that the Fed can always stimulate prices
by pumping money into the economy. That as we know is a lie because money
creation in a fiat system is always accompanied by debt. And debt, which is
growing much faster than income, is at the very heart of deflationary
dynamics.
The other equally outrageous idea being floated by the Fed is that in order
to keep Americans spending their money rather than saving, one apparently
serious academic paper provided by establishment paid academics has
suggested that the savings of the American people should be taxed any time
they hold their money in the bank for more than six months or so!
OUTRAGOUS! And lest you think Congress would never pass such a measure what you need to know is that Congress does not have to pass such a measure. Our nation has traveled so far down the path toward dictatorship that the President can simply proclaim an "emergency" and decree it law overnight! Moreover, the record of Congress standing up to withhold the Constitution in the face of "emergencies" in the past has not been very good as evidenced by their willingness to allow Roosevelt to make gold ownership a
crime in the 1930's.
The Bond Markets are Pointing Toward Deflation
Although the dollar has gotten weaker and although the equity markets and
enjoying a typical secular bear market rally, investors have continued to
pump money into the bond market. That suggests that the markets are not at all fearful of deflation. In fact, you could and we do argue that the U.S.
Treasury markets are telling us outright deflation (as opposed to
disinflation) lies ahead of us.
Chart provided compliments of www.decisionpoint.comThe fact that interest rates are plunging (Treasuries surging in value)
despite the fact that the banks are "printing" money like mad is evidence of a powerful underlying deflationary force at work in the U.S. and global
economies. With reference to the sudden plunge in 30-year Treasury rates
starting in May 2003, I would again like to quote the Aden Sisters in their
June 2003 monthly issue.
"Since the bond market is very sensitive, it looks ahead and it's a reliable leading economic indicator. Bonds, for example, have done very well over the past three years because the economy has stayed weak, while inflation and interest rates have stayed low. Bonds anticipated this and that's been the driving force behind the bull market in bonds. But now that bonds have strongly broken out to new highs, they're telling us much more.
"This breakout is the strongest sign yet we're heading into either a
recession or deflation. It's signaling that the economic tug of war we've
often discussed between inflation and deflation is over, and deflation now
has the upper hand. In other words, inflation is not a problem and despite
the inflation sights we saw a few months ago, it's moved to the back burner."
An Ominous Sign - "Beggar thy Neighbor" Pressures Build
We have noted how the Clinton Administration ushered in a phony strong
dollar policy in the past by dishording gold and thus driving the dollar up
vis-à-vis gold. This "strong dollar policy" of the Clinton Administration
resulted in the following:
- Growing Imports because imported goods were extremely cheap for Americans.
- A Major decline in U.S. exports because U.S. produced goods were very, very expensive for foreigners to buy.
- Massive movement of capital into the U.S. markets, thus creating the massive dollar, equity, bond, and housing bubbles that have only slightly, in the overall scheme of things begun to deflate.
Perhaps out of ignorance, or wishful thinking, most people in the U.S.
loved this phony dollar strength because we could consume things very
cheaply and our rising stock prices provided an illusion of wealth that
made us feel great. But Wall Street's elite - the folks who really control
American policy - could not "give a hoot" if American jobs were being lost
to China or India or Mexico. Yet now as the Bush politicos begin to plan
for the next presidential elections, they are becoming very, very concerned
about he continuing destruction of real, wealth creating jobs in America.
The manipulated overvalued Clinton strong dollar policy, which benefited
Wall Street so much has caused America to loose thousands upon thousands of real wealth creating jobs in manufacturing, mining and agriculture. By
contrast, service jobs are parasitic, living off the wealth created from
the production and creation of new tangible goods.
But alas, the Wall Street Journal is FINALLY addressing a major reason why U.S. manufacturing is in decline. That reason is related to the phony
Clinton strong dollar policy which led to its horrendous overvaluation,
especially vis-à-vis the Chinese Yuan. We have spoken frequently of Dr.
John Whitney's views that much of the imported goods into the U.S. were
coming from China, not because of any commercial advantage the Chinese had but because in effect they were "cheating" with a weak currency. So it was refreshing to see that on Thursday of this past week, the Wall Street
Journal's article, "U.S. May Push to Sever Yuan-Dollar Peg" discussed how
in the view of the "Economist" the U.S. dollar is overvalued by a full 56%
on a trade weighted basis!
Talk about real companies in America having both hands tied behind their
backs! Yet a Wall Street dominated press slammed former Treasury Secretary O'Neil when he first came into office for saying the dollar was overvalued. And they and the Clinton Administration crucified new Bush folks for saying the economy was already on the skids when they took over in 2001. But monetary intervention and manipulation of the dollar have created so many severe global imbalances, that we will have no choice but to suffer through some gut wrenching adjustments back to equilibrium by way of the
Kondratieff winter. The strong dollar mirage could only last for a period
of time. Eventually the laws of nature must prevail.
So now the Administration is trying to have its cake and eat it too. Bush
knows he must have a weak dollar to give the American economy a chance to
survive. Yet, the whole global economy has been based on a strong U.S.
dollar that encourages Americans to spend, spend, spend and go deeper into
debt. What happens to the global economy if a stronger U.S. dollar suddenly
changes this dynamic? What we fear is that President Bush like President
Hoover may well be leading the world toward a "beggar thy neighbor" foreign
currency devaluation scheme that can spiral out of control, much as it did
during the Great Depression. Smaller competitive currency battles have
been waging (China and Japan for example) but now with the holder of the
world's reserve currency suddenly switching from policies that created an
overvalued currency upon which the rest of the world generated export
income, deflationary forces may have been unleashed on a level far beyond
comprehension. Perhaps that is why the bond market has been surging
(interest rates falling) even as the dollar has gotten weaker! Unfortunate
though it may be, we are more and more confident in Ian Gordon's prediction
of a Kondratieff winter.
But, why are Stocks Up so Sharply?
If things are as gloomy as I suggest, why have stocks had such a good run?
Why do I choose to believe what the bond markets are saying while ignoring
what the rise in stock prices are saying? Here are a couple of reasons I
think the bond market, not the stock market is right.
- CEO's who are the closest to the fundamentals of the American business prospects are selling $3.10 of stock in their companies for every $1 they buy. This is one of the most bearish postures by insiders for over a year. And this has been typical throughout this bear market. Wall Street keeps saying how great things are while CEO's constantly paint a more pessimistic picture. So far, CEOs not Wall Street have been right.
- The Bond markets are more sophisticated than the stock market - Bond markets are almost entirely entered into by professionals while common folks without knowledge of financial matters continue to buy mutual equity funds, which are buying the equities no matter what the earnings prospects are for equities because that is what they are mandated to do.
- Equities remain hugely overvalued. Even before the recent rise in equities, the S&P 500 PE ratios remained well over 30 times. Through history, a PE ration of 20 was considered high and in the area of market peaks. Traditionally, at the bottom of bear markets we get PE ratios of under 10 and dividend yields in the 5% to 10% range. We have a loooong way to got to get there.
- In secular bear markets, the kind of rally we have had in equities is entirely normal. Typically bear market rallies can move upward by 30% to 60%. What we MUST see before a new bull market begins is capitulation to the point where you will find it extremely difficult to find anyone walking on the face of the earth who is bullish on stocks. And at bear market bottoms, this "throw in the towel" attitude lasts for years, not months. In fact we are now seeing bullish sentiment among advisors among its highest levels EVER! That is just one more sign that we have not yet experienced capitulation.
Warning: What we really want to emphasize is that you avoid this bear
market trap. If you fear a new bull market is underway and fear you could
"miss that train moving out of the station" we think Richard Russell's
advice is very sound. Buy the QQQ's or SYP 500 index but put a stop loss
under it so that you avoid suffering substantial losses when this market
finally begins its next leg down.
A Transportation Non-Confirmation - As pointed out by Richard Russell, the
Dow Theory expert, we currently have a non-confirmation of the latest Dow
high by the Dow Transports. Specifically what we need to see is a move above 2556.4 by the Transports. As this was being written earlier this
morning, the Transports were down 40.7 points to 2464.58. A failure of the
Transports to confirm the legitimacy of the Dow's recent high paves the way for a return to a decline in equities. What could lead a market decline?
Who knows? But one candidate could very well be Freddie Mac where some
apparent dishonest accounting policies could very quickly lead to a
pricking of the housing bubble.
GOLD
In a Canarc sponsored conference call, Frank Veneroso recently suggested
that two events have been largely responsible for the price of gold leaping
out of the grasp of the manipulating hands of our policy makers. Those two
events were: 1) The 9-11 tragedy and 2) gold producer short covering.
With the events of September 11th, the U.S. began to freeze bank accounts
of Muslims they thought could in any way be connected to terrorist groups.
Venerosos believes that many Muslims then began to convert their currency
to gold for the purpose of safe storage.
Once the short selling gold mining firms understood that the price of gold
had bottomed, a massive move was underway by major producers to cover their short positions. We have seen major companies like Newmont and Anglogold cover their shorts. And now we are even hearing that Barrick Gold, who has acted as a short selling accomplice for U.S. policy makers are covering their short positions. Given Barrick's huge short position, that could mean quite a lot more short covering could be in the works for some time to come.
As the weekly chart above illustrates, gold remains in a very bullish
pattern. Its spot price is considerably above its long term moving average
and it has broken decisively above its five year downward trend.
Gold is negatively correlated with the dollar, stocks, bonds and even real
estate especially in a deflationary environment. Given our long term
bearish views on all of those markets, we remain convinced we are still in
the very early days of a major secular bull market for gold, that should
last for 5 to 10 years.
June 16, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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