Russell On Stocks & Gold
DEBT - First, what's happening - and I'm not talking about the markets, I'm talking about the fundamentals. I've been talking about the monster edifice of debts in the US - debts in the cities, the counties, the states, the corporations - consumer debt, mortgage debt, credit card debt, you name it, you look anywhere, and all you see is debt. The nation is up to its eyeballs in debt.
Recently the government reported that consumer prices rose 0.6 percent in March, the fourth straight increase. This is inflation at an annualized rate of 6 percent. The bond market had already suspected as much, and it didn't like it. Rising levels of debts tend to be inflationary. But at some point, rising debt levels reach a peak, and next - the edifice of debt topples over. At that point the debts become deflationary.
Do you remember a few weeks ago I made a strange statement? I said that the US's huge mountain of debt amounts to a "synthetic short position" against the dollar. What does that really mean? It means that to pay off debt you need dollars. Much of the US debt (thanks to the Fed's 1% short rates) has been built on a structure of low rates. But now, with rates rising, we're beginning to see a squeeze on debt, particularly on variable-rate mortgages. This is setting off a rush to raise dollars.
You can't print dollars the way the Fed does. So to raise dollars what do you do? To raise dollars you've got to borrow more or you've got to sell something, and by something I mean "anything" of value. So I believe what we're seeing now is the very beginning of a LIQUIDATION of assets. If it's got a market, it's being sold. We're seeing the early beginning of a move to raise dollars - to raise dollars to carry, to finance, and to pay off debt. Debt's "short position" against dollars is beginning to operate. Commodities, stocks, bonds, anything that is liquid is being sold to raise dollars.
How about gold and silver? Gold is cash, but over the last few days gold is being sold as a commodity. This is stupid, but it's happening. I never argue with the markets, even when I believe they're being irrational and emotional.
Silver may be a different story. Silver is a chameleon. In an inflation, silver becomes a "precious metal," and a monetary metal, and silver goes up with inflation. But in a deflationary situation silver is viewed as an industrial metal. In a deflationary environment, silver is not, as in the case of gold, viewed as money. If we're going into a deflationary economic collapse, holding gold doesn't worry me. But holding silver would worry me.
Anyway, above are some of the fundamentals that I see operating in the economy. How about the markets themselves? The chart on page 2, I believe, is one of the keys to the situation. This is a chart of the 30-year Treasury bond, and as the price of this bond declines, long-term interest rates rise. The chart doesn't need much explaining. What we see here is a type of "head-and-shoulders top," with a subtle "left shoulder" being formed during February and March, then a rise to a "head" during March and April, and most recently a very weak "right shoulder," and then a big break. The break has taken the bond below both its 50-day and 200-day moving averages. This has pushed long interest rates up to a high for the year. The "bond vigilantes" have arrived. They always do when they fear inflation coming to the surface.
I talked about weekly charts at the beginning of this section and below we see a weekly chart of the Dow. Note that the Dow is holding above its 40-week moving average (red line) and sitting right on its 10-week MA (blue line). At the bottom of the chart we see the histograms, which have been negative and below zero for ten weeks running. But the histograms are now contracting toward zero. It will be instructive to see whether the Dow can muster enough strength to turn the histograms positive, and if so how far the Dow can carry on the upside. Of course, if the histograms turn down again prior to climbing above zero, that will be a very bearish turn of events.
This pits the forces of deflation directly against the forces of inflation. This impending battle of inflation vs. deflation is going to be one of the most critical economic confrontations seen in decades. Frankly, I don't know how it's going to turn out - and neither does anyone else. In fact, I'd say 99 percent of the US population is unaware that it's even happening. The inflation-deflation battle will express itself in waves - of first inflation, then deflation.
These are two mighty forces militating towards deflation. First - Overproduction brought on by the entrance of China, India and much of Asia into the global economy. Second - Massive US and world debt which must be carried with the help of low interest rates, if indeed this debt (particularly the US debt) can be successfully carried at all.
And of course, we have the forces of inflation working to reduce the power of overproduction and deflation via the printing presses of the Federal Reserve and the central banks of the world. Without the discipline of gold, the central banks can create any amount of money they want any time they want. However, the central banks cannot control the "bond market vigilantes." When the vigilantes become frightened about inflation, they dump bonds and rates go up (which is what's happening now).
The price of real money, GOLD, will fluctuate wildly as the inflation-deflation battle goes on. In the end, the great casualty will be intrinsically worthless, paper money. In the end, irredeemable paper money will be distrusted, and it will go down. The only power evil has is the power to destroy itself. I call paper money evil. In the end, it will destroy itself as it has done all through history. And in the end, what I've warned about all along will come to pass. "In a bear market everyone loses, and the winner is the one who loses the least."
Question - Russell, assuming your scenario, your predictions, come true, what do we do?
Reply - I wish I had the perfect answer. But I don't. My instinct tells me at this stage of the game, be in dollars and gold coins. Why gold coins? Because only gold coins are "bankrupt proof." Why dollars? Because at this time, the trend is up for the dollar. Remember, the greatest debt edifice in history has, so far, been "held up" by manipulated low interest rates. And now that's beginning to change.
And there is that little-understood thesis that I mentioned at the start of this letter. Debt is a "synthetic short position" against the dollar. You need dollars to pay off debt. As things stand, everybody's got debt, and nobody's got liquidity, which in the US is dollars. If a real squeeze on debt materializes, we could see a panic for dollars. The first broad wave of bear market deflation will see a panic for dollars. The second broad wave of the bear market could see a collapse of paper money and a panic for real money - gold.
Editor-in-chief - DOW THEORY LETTERS
April 19, 2004
The inimitable and venerable Mr. Russell gained wide recognition via a series of over 30 Dow Theory and technical articles that he wrote for Barron's during the late-'50s through the '90s. Through Barron's and via word of mouth, he gained a wide following. Russell was the first (in 1960) to recommend gold stocks. He called the top of the 1949-'66 bull market. And almost to the day he called the bottom of the great 1972-'74 bear market, and the beginning of the great bull market which started in December 1974.