Taylor On US Markets & Gold
Financial Markets
Is the Bernanke High Tech Money Creation Machine Finally Working?
"People don't believe what they see. They see what they believe." Chris Jones - Thrivent Financial for Lutherans.
We are hearing some hopeful signs that the economy maybe speeding up a bit. Combining some good news like a 1% rise in the leading economic indicators with huge amounts of new money created out of thin air by the banking system's high-tech computers, and Bingo! You have a nice little bear market rally that is convincing more and more investors that the good times are hear again for good. Please! Don't you be deceived by this very normal bear market rally. It may look like the real thing but it highly unlikely that we are on to a new bull market.
As my good friend Chris Jones who works for Thrivant Financial for Lutherans would remind us, "People don't believe what they see. They see what they believe." And so, having spent so much time in a bull market, most investors and Wall Street touters and brokers continue to believe that somehow money actually grows on trees. Well, that isn't quite right. It actually is created from Bernanke's high tech printing presses. But whether
money grew on trees or from a high tech printing press is not the point. The point is that money creation is not the same thing as wealth creation, though it is no doubt most of the time confused as being the same. Therein lies one of the great deceptions of the American people by their government. People really don't understand that very simple fact including Keynesian and monetarist economists. And so we are doomed to continue to seek answers to slow economic growth in all the wrong places, namely from Keynesian and Monetarist economists who would simply "print" us to prosperity.
To seek some real answers to our economic malaise, the press would do well to talk to someone like Dr. Frank Shostak, an Austrian school economist. In a paper written last week at www.mises.org titled, "Has a New Bull Market Begun?" Dr. Shostak points out that stock prices may in the near term rise as a result of new money being created out of thin air and pumped into the economy. However, he points out that over the longer run, in
order for stock prices to continue to rise, real wealth has also to rise. By real wealth, Dr. Shostak means assets less liabilities adjusted for inflation. Once real wealth declines, then so does real savings which means that real funding used to fund real economic growth also declines. In other words, you can't just print money (create debt) to stimulate the economy and stock market over the longer haul.
Is real wealth increasing in America at the present time? Hardly so. Repeatedly we have been told the consumers are the backbone of the American economy. Indeed they have been, but not because of their growing wealth, but rather because they have been mortgaging their futures to live high on the hog today. Dr. Shostack pointed out key economic data raises the likelihood that the stock of real wealth is likely to be under pressure. For example, he noted that the consumer liability to asset ratio climbed to a new record high of 0.185 in Q1 from 0.182 in Q4 2002. And more shocking is the fact that year-on-year consumer's real wealth fell by 7.5% in Q1 after a fall of 5.9% in the previous quarter. This was the 4 th consecutive quarterly decline!
But it isn't only the Consumer that has leveraged himself to death. Dr. Shostack also pointed out that non financial debt-to GDP ratio jumped to a new record high of 1.965 in Q1 from 1.953 in Q4. Dr. Shostak also pointed out that the personal income to consumption ratio remains in a fee fall, with this figure now dropping decisively below that of the early 1960's.
Dr. Shostak points out that when the Fed and our banking system embark on a policy of rapid money creation, it results in those who hold the newly created money being in a position to bid valuable capital away from more efficient uses, thus leading not to a rising stock of real savings and real wealth but to an actual decline of same. Indeed, as Shostak points out, stock prices are bid higher by huge amounts of new money creation, thus sending them to nose bleed PE ratios. Hardly a week goes by but we do not remind or subscribers of this fact. The PE ratios remains in excess of 30 times which compares to 20 times which is the levels of absurdity to which stocks normally rise at bull market peaks. A PE ratio of 10 times is what we are looking for when U.S. investors finally
face the day of reckoning in the current stock bear market. We are awaiting the capitulation phase of this bear market which would shake all but he most hardy, longer term value orientated investors out of the market.
Stephen Roach is not known to be an Austrian economist, but he draws a similar conclusion as to the ineptitude of current monetary and fiscal policies being applied to our current global economic malaise. Roach said, " After more than three years after America's equity bubble popped, there is an understandable temptation to believe that it's time to move on. A massive dose of fiscal and monetary stimulus, in conjunction with a sharp rebound in the stock market, adds to the conviction. As I see it, however, the legacy of this monstrous bubble endures -not just in financial markets but also in the form of the excesses that it fostered in the real economy and in its balance-sheet underpinnings. Until those excesses are purged, I maintain my view that America still
needs to be seen through the lens of a post bubble workout. As one bubble morphs into the next one,(he is referring to how the equity bubble begat the housing bubble which in effect is driving a bond bubble) the moral hazard dilemma only deepens. And the endgame -including the risks of deflation and a dollar crisis-appears all the more treacherous.
Keep your Eyes on the Big Picture
Kondratieff Winter Watch - The views of both Dr. Roach and Dr. Shostack dovetail very well with the still longer-term Kondratieff winter views of Ian Gordon. Ian believes, as do I, that we are inevitably heading toward an economic depression and with the related decline in economic activity, prices of virtually everything will collapse. No doubt the Federal Reserve is also very concerned about that too, which is why they are promising
"unconventional" policies like "helicopter drops" of money from the sky and the potential to tax you on your savings if you don't spend it every six months or so. Clearly, the Fed is worried that the general public will catch on to the global economic pathology that Gordon, Shostack, and Roach are talking about. And indeed if people began to think like that and if they began to save rather than spend, it would be a self-fulfilling prophecy. Yet even with these extravagant money creating schemes and intervention in free markets, the attempts to fool mother nature's economic laws will, in my view fail just as surely as similar intervention in the Soviet Union failed. Why? Because as Stephen Roach noted above, every intervention begets still a greater and more
extravagant intervention that pushes markets to still more unmanageable extremes. There are physical limits to bubbles and the further they are pushed, the greater will be the implosion when they finally break down.
The kinds of intervention being suggested, whether by the Fed in its extravagant monetary policy or by forcing people to do self damaging things like spending rather than saving, is indeed more the stuff of a dictatorship than a free market economy. In the mean time, we get statistics thrown at us day in and day out, although not just any stats, but those that are bullish for the economy are most prominently mentioned. In fact, the daily
reports from places like CNBC or CNNFN really act like a Venus fly trap. They serve to suck unsuspecting investors - those who cannot see the big picture, back into a market which remains undeniably a secular bear market. Unless you are a trader, in my view it pays to simply ignore this daily noise because it distorts the reality of the bigger picture. Applying the advise of Richard Russel's Dow Theory ( www.dowtheoryletters.com
) it would indeed be possible and perhaps profitable to trade bear market rallies by buying an index like the QQQ or the DOW and then placing a stop closely below those indexes with their recent moves upward. But for those of us who would rather simply catch the primary trend of markets and gather profits over the longer term by being on the right side of the trend, it pays to take a step back from time to time to view the markets from a
longer term perspective as follows:
CHARTS
Long Term Bearish Markets
The following US Dollar Index Chart and the NYSE Composite Chart are provided compliments of www.decisionpoint.com. They illustrate long-term bearish patterns that should not be ignored simply because of recent bear market rallies.
The dollar has consolidated in the 92 to 93 range over the past week but it is clearly in a very bearish pattern that should not be ignored. It is in fact pretty much the mirror image of gold which is in an equally bullish pattern.
The recent rise in the equity markets has been fueled by huge amounts of money created by the Fed's high tech magic money making machines, not by any evidence of sustainable economic growth for reasons outlined above by Dr. Shostack. Investors believe what CNBC tells them that we are at the beginning of a new bull market. But be not deceived. Printing money is not creating wealth so the wheels of this economic wagon will most certainly come off because earnings and cash flow will be inadequate to meet surging debt service coverage requirements. What the market is responding to is an illusion of wealth that cannot help but disappoint in the future. Indeed stocks remain extremely expensive with the S&P 500 trailing PE ratio still around 33 times earnings.
But apparently Wall Street thinks concerns about fundamentals and intrinsic value no longer matter. Damn the torpedoes and full speed ahead with another new paradigm! Who cares if a PE of 33 times equates into an earnings yield (dividend + retained earnings divided by stock prices) of only 3%. The percentage of bearish investment advisors is the lowest in 16 years. That is a very bearish contrarian indicator in my view. This extreme optimism coupled with the continuing failure of the Transport Index to confirm the Dow's previous high, and what may be the end of the bond bull market all make the equity market an extremely dangerous place to be as we enter the half way mark for 2003.
Long Term Bullish Markets
The following 30-Year Bond Yield chart as well as the Gold and XAU charts that follow are provided compliments of www.decisionpoint.com. They illustrate long-term bullish patterns that should not be ignored simply because of daily CNBC chatter or short-term reversals in the equity and dollar markets.
Declining 30-year Bond rates are pictured in the chart above. We have had an enormous bull market in bonds which has helped fuel the housing market bubble. But last week we saw interest rates rise considerably, though in the long term chart above, that move is hardly noticeable. Could this be the end of the bull market in bonds?
If you believe as I do that we are destined for deflation, no matter what the policy makers do, then you might think the long U.S. bond is a good place to be. The Aden sisters pointed out in their last letter that the 30-year Treasuries dipped to about 2.5% during the 1940's. They suggested in a deflationary environment the same could happen again. The main reason I am not confident that will happen in this Kondratieff winter is that the
U.S. is now a net debtor nation while during the 1930's we were a net creditor nation. At some point, we are likely to see a major exodus from the dollar which in turn will mean an exodus from debt instruments which means interest rates will rise perhaps dramatically even as economic activity continues to slow down.
Indeed, I think my good friend Marshall Auerbach touched on this notion last week in his excellent essay titled "Argentina, not Japan." Marshall writes a weekly column for the Prudent Bear web site. I recommend you pay Marshall a visit every Wednesday to partake of his insightful work. For this specific piece go to
www.prudentbear.com/internationalperspective.asp .
Essentially, Marshall argues that the U.S. as a debtor nation is increasingly vulnerable to our creditors pulling the plug on us, much as the U.S. did to Argentina a couple of years ago. This is the main reason I have avoided including U.S. Treasuries in our Model Portfolio. I agree with the general Wall Street view that in the longer term, U.S. Treasuries rates will rise. But my view is based on a view that is 180 degrees apart from the mainstream view. CNBC's stock promoters believe or say they believe interest rates will rise because a growing economy will boost demand for funds. I say interest rates will in fact rise because the economy will not recover and thus, foreign capital will flee from the U.S. thus pushing rates much higher. The results will be the same for bondholders but from a macro-economic perspective, the reason why interest rise will make all the difference in the world. Will rates rise because the economy is strong and thus because of rising demand for capital. Or will interest rates rise because foreign savings are leave the U.S., thus leaving a savings starved America on its own to suddenly compete for a sudden decrease in capital?
In spite of obvious attempts by policy makers to knock gold down on a daily basis, the yellow metal is managing to display a very bullish long term pattern. Ditto for gold shares as evidenced by the XAU Index.
The above charts should make the primary trend for these major markets very clear. While you may trade on the opposite side of the primary trends if you like, you should be aware that doing so can be very dangerous so that stops should be placed on your trades to trigger you out of positions contrary to primary trends. As for us, we are happy to recognize primary trends and try to pick good solid companies to invest in on the long side of the market to take advantage of those trends. With gold and gold shares being so obviously bullish, the lions share of our stock recommendations are gold stocks.
GOLD
One subscriber contacted me earlier today to ask a couple of good questions about the gold market that I think are worth passing on. Specifically he was confused by what he thought were conflicting views with respect to the gold market. He recalled the fact that Frank Veneroso suggested the bull market in gold was triggered by a) Islamic buying following the events of September 11 th and b) producer short covering. But what my subscriber friend found confusing was another suggestion by Veneroso that central banks may have already agreed to accept paper in lieu of gold from the gold borrowers, thus averting a major short squeeze that would have sent the price of gold to much, much higher levels than we have seen thus far in the early stages of this gold bull market. So the question from my friend was this. If central banks had accepted paper rather than gold and if they are continuing to do the same, would this not be bearish for gold?
If Veneroso is right and if central banks have accepted paper in lieu of repayment in gold to avoid a major rise in the price of gold, I think the rise in gold thus far is all the more remarkable. If our central banks have used such clandestine deception and all they have gotten for it is the ability to contain gold to "only" a 40% rise from its bottom, then I think the picture is extraordinarily bullish for gold. Remember, gold that has been lent out by the central banks, never to have been returned to their coffers cannot be used again to suppress the price of gold in the future. And if GATA's work is correct in asserting that close to 50% of the central bank gold reportedly on their balances sheets is gone forever, never to be returned, we may indeed be nearing the end of central bank dishording, in which event the supply and demand fundamentals that Frank Venerosos has talked about could very quickly take gold up to its "commodity" value of over $600 per ounce.
Why would central banks not continue to send their remaining 15,000 to 17,000 tonnes out on to the market to keep suppressing the price of gold and thus distort the value of their paper money still more? I have to think that despite all of the misinformation fed by the Keynesians and Monetarists with respect to gold being real money, the currency markets will begin to slam this truth home even to the indoctrinated policy makers now in control. They may have regurgitated Keynes "barbaric relic" theme in their minds year after year, but if Marshall Auerbach's suggestion that the Chinese may be solidifying their national currency by hording gold before they agree to let their currency float, the hard money lesson may soon be forthcoming to central bankers of all nations. When the worthless intrinsic value of an "I.O.U. nothing" liability currency like the dollar is seen for what it actually is, countries that sold their gold hordes will not only look stupid as the price of gold rises but they will also begin to realize that without an asset money like gold providing a solid foundation of value underpinning their liability money, they could soon face national bankruptcy not unlike Argentina recently faced.
There is little doubt that with a deflationary depression becoming increasingly inevitable, the era of paper or fait money is quickly drawing to an end. This can only be bullish for gold. And with the easy purchase of gold soon being made available through an exchange traded fund over the NYSE, we think the table is being set during the next six to eighteen months for a major breakout in the price of gold. That would likely coincide in my view with the next leg down in the equity and dollar markets. The next decline in equity markets should finally be the capitulation phase when a generation of investors will give up on the notion of owning stocks and when they will switch to tangible assets rather than paper money.
June 23, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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