Bonds Down, Dollar Down, Stocks Sideways, Commodities Sideways, Gold & Silver Up
The relationship between markets is important because it can give you an idea about where major money flows are taking place. For quite some time, we have seen money flowing from bonds to stocks and from stocks back to bonds. If the stock market was down, you could almost count on the bond market being up. And if the bond market was down, you could almost count on money moving into stocks. One of the changes I have been watching for is a declining bond market that does not translate into a rising equities market.
As I was getting ready to write my comments for this weekly message, I took a look at the movements in some of the major markets we watch and it seems we may now be seeing a divergence in the pattern of money flowing back and forth between U.S. Treasuries and U.S. equities. I believe this could be very important because it could signal the start of a major move out of the U.S. fiat currency system. If that is true, we may well be at a major turning point in the markets. Following is a quick summary of general trends in the major markets over the past two weeks:
U.S. Treasuries have been obliterated over the past two weeks in one of the worst short-term routs in bond market history. The rise in interest rates resulting from this tremendous flow of money out of U.S. Treasuries is depicted in the chart below. Where did this money go?
U.S. Equities - Based on the sideways pattern in the S&P 500 chart below, it doesn't seem as though proceeds from U.S. Treasury sales flowed into equities during the past two weeks. A similar sideways pattern is also evident for the Dow and the NASDAQ as well. The failure of U.S. equities to be a net beneficiary of U.S. Treasury sales would seem to represent a departure from what we had been seeing since before the bear market in equities began early in 2000.
Commodities - Neither did bond money flow into commodities. The CRB actually fell considerably during the past two weeks, while the Rogers Raw Materials Index, basically trended sideways. We believe the Rogers Raw Materials Index is more representative of global moves in commodity prices and much more representative of the global "cost of staying alive" than is the CRB. On balance I'm assuming no significant flow of U.S. Treasury proceeds went into the commodities markets over the past two weeks so that like stocks, commodities displayed a sideways move during the U.S. Treasury bloodbath.
Gold & Silver - Both of these metals as well as the equities of companies that produce these metals were up sharply over the past two weeks. The gold market is much bigger than the silver market so more went into gold than silver, but together these precious metals appear to have gained some value at the expense of the U.S. Treasury markets. Compared to the fiat dollar denominated markets however, all markets related to gold and silver are very, very small so that the amount of net proceeds entering these markets from the sale of U.S. Treasuries during the two week bloodbath would be very small thus far. As the chart below shows however, in percentage terms, the gold price movement of the past two weeks was significant. The gold chart below as well as the silver chart also below, suggests gold and silver gained considerably as a result of money moving out of Treasuries.
Silver actually had the best move of all over the past two weeks as evidenced by the chart below. Note that Silver is near its recent highs. If it can take those highs out on the upside, we could see quite a move upward to much higher levels. Thus things are looking up for the silver stocks in our portfolio which include Excellon Resources (TSX-EXN-$0.10), Golden Goliath (TSX-GNG-$0.11), IMA Exploration (TSX-IMR-$1.02) as well as one of our essential tech stocks, namely Itronics Inc. (OTCBB-ITRO-$-0.12)
The U.S. Dollar - As Stephen Roach quite rightly points out, the price of the U.S. dollar is the most important price in the world because it is the world's reserve currency and thus is the biggest market in the world. So, while a huge move up percentage wise in the gold and silver markets are relatively insignificant in explaining major money flows over the past two weeks, the major move downward in the U.S. dollar may provide us with some insight into where most of the money that came out of the U.S. Treasuries went over the past two weeks. The weakness in the dollar may be telling us that capial is leaving America. Note the considerable move downward in the U.S. dollar over the past 10 trading sessions a the U.S. Treasury was getting whacked real hard.
Last week we noted that based on an article in the "Financial Times," it has been rumored that the European Central Bank has suggested to member countries that they should lighten up on U.S. agency debt issues like Fannie Mae and Freddie Mac. Indeed the equity and debt issues of both these quasi government institutions were weak over the past two weeks as doubt continues to grow over the legitimacy of their accounting policies and the adequacy of their equity.
The exit from these U.S. dollar denominated issues may explain in part why the dollar continued to weaken even in the midst of a growing "beggar thy neighbor" global environment where countries are trying to beat one another in the exporting game by making their currencies cheaper than the next. Specifically, the Bank of Japan has been admitting that it is printing yen which it uses to buy dollars in an effort to keep the dollar strong. Yet in spite of this global effort to weak currencies vis-à-vis the dollar, the Greenback weakened along with the bond market. We think this is potentially an ominous sign.
It has long been predicted that with the U.S. running such huge balance of payment deficits, a time would come when the world will have gotten its fill of dollars and begin selling them in mass. A loss of confidence in the U.S. economy and/or its major institutions such as Fannie Mae and Freddie Mac could provide the trigger mechanism that finally sets a flow of capital out of the U.S., causing the dollar finally weaken as predicted years ago. We shall see if the dollar, the world's most important price continues to weaken and eventually break below its 1995 Index low of 85. The importance of this move cannot be overstated in terms of the future standard of living for Americans.
Equity bulls have said last week that rising treasury rates are a reflection of a brightening outlook for the U.S. economy. True, we finally seem to be witnessing some positive effects of 13 rate cuts combined with some of the heaviest fiscal stimulus in history. This recovery however, given a real lack of top line corporate revenue growth makes claims that the U.S. economy is on the mend, highly suspect. Almost all growth in earnings has been coming from cost cutting, not increased sales. If I heard correctly yesterday on CNBC, the S&P 500 earnings are up about 16% over the easy comparison second quarter of 2002. Of that 16% only about 4% resulted from increased sales and 2% of that 4% resulted from the decline in the U.S. dollar. So where is the beef?
Meanwhile, U.S. equities remain extremely overvalued evidenced by a S&P 500 P/E ratio of 32.94 which translates into a meager earnings yield of 3.04%. By contrast you can get a 4.17% yield on 10-year U.S. Treasuries now compared to a cash (dividend) payment from the S&P 500 of just only 1.72%. I remain unconvinced that the U.S. economy is in the process of gaining any lasting traction form the huge does of monetary and fiscal stimulus. And given huge deflationary pressures that continue to exist (yes, despite an extremely inflationary monetary policy) and the enormous amount of debt that remains on our collective national balance sheet, I do not think lackluster growth will be sufficient to keep us out of the Kondratieff winter never mind justifying lofty share price multiples that have always been associated with stock market peaks in the past.
Summary of Markets
Based on what we see above, it seems we may be in the early days of a move of capital out of the U.S. Two weeks are not necessarily indicative of a longer term trend. But if this is the start of a major trend, where a savings starved U.S. sees foreign capital leave our shores, we may now be on the verge of a much colder Kondratieff winter.
If the economy is growing sufficiently such that demand is not so dependent on the housing industry and the refinancing of mortgages, then perhaps we can muddle through without any major economic downturn. But if interest rates are rising primarily because foreign money is moving out, there may be no offset to a housing and refinancing industry that have kept our economy afloat over the past couple of years. And as Richard Russell pointed out this past week, the housing and refinance prospects are not looking that strong at the moment. Fannie Mae shares have also broken down as have six home-building stocks that Richard follows, namely PHM, FWC, KBH, LEN, CMH and CTX. Assuming as most do that the markets discount the future, could we now be seeing the start of a major decline in the housing sector? And if so, what is to keep us from rolling over the edge?
Also according to Richard Russell this past week, the average 30 year fixed mortgage surged 27 points to 5.94%. According the Freddie Mac, that's the highest rate since mid-January and it's the fifth consecutive gain. The 15-year mortgage also rose 27 points to 5.27%. The one-year adjustable climbed 9 points to 3.67%. Mortgage rates generally follow the 10- year T-note. See why foreign capital flows become so important? More than 40% of our treasuries are now funded by foreign capital. What if that capital begins to flow out of the U.S. in any major way even as we experience at best lackluster growth?
The one factor that will not allow our economy to grow rapidly in the future and the factor that the Keynesians and Monetarists fail to recognize is debt. A "little" example of how debt is dragging U.S. corporations and thus the U.S. economy down is illustrated by AOL Time Warner. That company borrowed $54 BILLION dollars for the acquisition of Time Warner. It currently has to pay $2 BILLION per year in Interest Expense! This story is a clear example of "mal investment" as the Austrian economists define it. With an enormous amount of debt money created during the printing press madness of Greenspan during the late 1990's, so much money was sloshing around the U.S. economy that people did some very reckless and stupid things. One of them was the Time Warner acquisition. And now we see that AOL is not only failing to gain new subscribers but it is actually loosing hundreds of thousands of subscribers. Will AOL survive? Who can say? But with its huge debt burden and a declining subscriber base even this "blue chip" tech company may not be around far into the future. Debt is the killer in the Kondratieff winter. It is so excessive for the economy as a whole that it must be repudiated through a massive deflationary depression.
GOLD
James Turk Predicts $400 Gold by Year End
Later in the week I spoke by phone to my good friend James Turk about the gold markets in addition to the issue of where GoldMoney stores its gold. In passing I asked James about his views currently on the gold market. He provided me with one of the most bullish views I have heard in a while. James is a sensible and cautious fellow. He weighs his words carefully so I take what he says seriously. With his permission, I am passing on James' comments as follows:
"My near-term objective is for gold to break above $400 in September or October at the latest. A move above $400 should open the flood-gates, which I expect will send gold much higher after that. How much higher? Only time will tell of course, but given all of the fundamental reasons driving gold higher, one is foremost. There is an ocean of paper money sloshing around looking for a safe home. It is inevitable that more and more of this paper will end up in gold. We are witnessing the start of a monumental move away from paper promises into the real thing - gold."
Off the record James did mention a still higher number for early 2004. I will not pass that one to you because he didn't give me permission to do so except to say it was comfortably higher than $400 but not in excess of the old January 1980 high of $850. Knowing James as I do, I'm quite sure he thinks this gold bull market will ultimately see gold exceeding that old high, but he isn't looking for it in 2004 or at least not in the early months of 2004.
Richard Russell Weighs in on Gold Confiscation
This past Thursday, Richard Russell responded to the following frequently asked question and one we spent a considerable amount of time addressing last week on the prospects for gold confiscation. Here is what this wise market veteran had to say on this topic.
"By the way -- subscribers continue to ask me whether the US government might some day confiscate gold as they did in the '30s. My answer is that I don't think it will happen. What good would it do? Also, with the arrival of gold funds, with the US Treasury actively selling Gold Eagles, with gold now traded around the world, I actually believe it would be impossible for the US to call in the gold. And call in the gold stocks too? Nah, a confiscation act would be such an admission of extreme weakness that I can't see it happening.
"Furthermore, back in the '30s there was actually a lot of trust in the government -- plus the public was basically passive in 1933. Today there is very little trust in the government and the public can get very angry and aggressive.
"So gold confiscation? Forget it. It ain't going to happen."
Editor's Comment: I hope Richard is right. But who says Americans have to trust government in order to turn over their gold. Government trusts people less now too so my belief is that our government may very well hound owners of gold either to prison or the grave if we don't give it up. If the value of gold rises to thousands of dollars per ounce and the dollar goes to zero there will be a massive wealth transfer to a very small percentage of the population with he foresight to be buying gold at or near the bottom. Our government, not to mention the world government that is very much now beginning to bear down on American citizens (see the article below on Ron Paul's failed amendment) has already shown its utter contempt for private property, evidenced not only by the IRS, but the Federal Reserve which is used to confiscate wealth through inflating the money supply. And remember government now has many more sophisticated means of tracking not only our every move but also how and where we spend money than Roosevelt had in the 1930;s when Congress signed a bill that made gold ownership in America punishable by 10 years in prison and a $10,000 fine!
Stephen Roach recommends buying gold.
Jim Rogers told me it was General Patton who said, "If everyone is thinking alike, no one is thinking." Who ever said it, that would seem to be a self evident truth given the uniqueness with which God made each of us. What we seem to see is that economist after economist, schooled in Keynesian and Monetarist fail to comprehend the bigger picture of why 13 rate cuts have failed to lead to higher stock prices and any appreciable economic growth for the first time since the Great Depression. Why do they never seem to go back and examine the characteristics of the Great Depression for an answer to that question. Why to they continue to hang on to the same dogma no matter how long the old answers seem not to be working?
One of the few mainstream economists these days who does his own thinking is Dr. Stephen Roach, Morgan Stanley's chief economist. Last week Dr. Roach decried the evidence that various countries around the world were pursuing a "beggar thy neighbor" policy which some argue was one of the major contributing factors to the Great Depression in the 1930's. He is very unhappy about the continued rigging of currency rates via central bank intervention because quite correctly he points out that the "U.S. centric global economy" is on a collision course with the U.S. going deeper and deeper into debt both to itself and to foreign nations. It is nearing what Roach sees as a breaking point where the entire financial system is facing increased risk of major problems.
Here is how Roach concluded his essay published at www.morganstanley.com on July 21st.
"In the end, I worry that a dysfunctional world has opted for a strategy aimed mainly at buying time -- hoping that the longer-term perils of current-account adjustments will be ameliorated by the short-term benefits of the reflationary policy fix. The risk is that such a short-term fix may backfire. I continue to believe that policy traction will remain surprisingly elusive in a post-bubble US economy. To the extent I'm right, the external imbalances of a US-centric world can only intensify. But if I'm wrong and such policies now get traction in the US and elsewhere around the world, then suddenly there will be competing claims on global capital flows. Under such circumstances, it will be much tougher to finance America's gaping current-account deficit without offering concessions to foreign investors -- concessions that could well entail higher bond yields and/or lower share prices. Either way, I see no easy escape from the imperatives of global rebalancing. It happens either though a fundamental realignment of currencies or by a full-blown international funding crisis.
"At this point, the handwriting is on the wall: Politicians and policy makers around the world have played their cards. They are leaning forcefully against the fundamentals of currency adjustments that might otherwise be expected from the fundamentals of global rebalancing. In effect, the authorities are drawing a line in the sand against a further decline in the US dollar and a related appreciation of the yen and the euro. While that may delay rebalancing, it only heightens the possibility of a far more treacherous endgame for an unbalanced, US-centric global economy. As I see it, the longer the world avoids the imperatives of a US current-account adjustment, the greater the possibility of a wholesale flight out of dollar-denominated assets."
So where does Roach suggest you park your money? In a July 7th "Forbes" article titled "That Sinking Feeling" he was quoted as saying, "he would think seriously about putting a nontrivial portion of his portfolio into precious metals like gold." Roach who fears troubles from deflation, noted that "gold is a "safety asset" that will "attract investors during any time of economic extremes-either inflation or deflation."
You may recall that quite a few months ago, another big Morgan Stanley name, Barton Biggs suggested in a weekend missive to his clients that they might consider buying gold as protection against deflation. Apparently against his own wishes, word of that got out to the press or circulated on the Internet. The pressure from the Morgan Stanley for Biggs to recant was apparently enormous because the next business day, Biggs was on Ron Insana's show on CNBC to plead ignorance about gold and is virtues and to virtually denounce the story that had him becoming a gold bug. But Biggs is a very bright man. In this case, I think he was dumb like a fox. There is no way of knowing of course, but it wouldn't surprise me in the least, if Biggs and other big name guys at Morgan Stanley are themselves taking advantage of this still very, very weak gold price to load up on the yellow metal before the dam breaks while all along playing the game their employer dictates, namely to keep the ignorant masses in paper money.
July 28, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
http://www.miningstocks.com
