A few weeks ago, we suggested investors who get antsy about not participating in this very long bear market rally might consider buying the Dow or the S&P500 indexes. Yours truly did that for a couple of weeks in a small way. However, following the astute advice of Richard Russell, who believes this bear market rally is topping, I sold out my small position for basically a break-even result. I strongly suggest you might want to consider doing the same, in the event you have purchased one of these major stock indexes.
Richard Russell has a very enviable track record when it comes to picking major turning points in the equity markets. Still, given his many years of experience (he soon turns 80), he maintains a very humble posture when he makes recommendations. He knows that markets can and often do perform the unexpected and that no one is smarter than the collective wisdom of markets. But his intuition and numerous measures he uses to gauge market behavior strongly suggest to him that it is highly likely that this great bear market rally, which began in 1992, is nearing its end. And when the bear market resumes its nasty downward path, what he is predicting is ugly as sin. Here is what Mr. Russell said in his February 19, 2004, daily missive.
"Unfortunately, when stocks go past historic parameters, they have a habit of making up for those extremes by going past historic parameters in the opposite direction.
"Thus, once the bear market resumes, I'm afraid we're going to see stocks descend to almost unbelievable under-valuations. That will be the time when gold comes into its own. That will be the time when stocks become fabulous values -- but nobody will want them.
"The bull market of 1974 to 2000 was the greatest bull market in US history. The bear market that began in 2000 is fated, I believe, to be the worst bear market in US history. Patience, get a grip, breathe deeply -- before it's all over you'll be able to tell your grandchildren that "you've seen it all."
It would be unfair to Mr. Russell to lay out all the reasons for his current conviction. However, a very important key in his thinking, in addition to the extremely high equity valuations, has been the recent failure of the Transportation index to rise along with the rise in the Dow. Dow theory holds that when transports fail to confirm the legitimacy of the Dow's rise, or vice versa, that may be a sign that the market is topping. The longer it takes for this confirmation to take place, the likelier that it will not take place and that the direction of the market will reverse. The transports topped at 3080.32 on January 22, 2004. The Dow topped at 10714.88 this past Friday, but the transports have continued to head in the opposite direction.
Intuitively, the notion that the inability of the transports to confirm the action of the Dow is providing a danger sign for the economy makes some sense. If transport stocks are declining, that may be a sign that the prospects for companies that haul manufactured goods, farm goods, courier packages, people, etc., are in decline. In other words, the market, which discounts the future, may be suggesting that commercial activities into the future are not as bright as the Dow may be suggesting.
Remember that the equity markets, as well as the housing markets, are being driven higher to a very great extent by an enormously accommodative monetary policy-not only in the U.S., but globally. That's why prices of stocks and homes no longer make any economic sense. By economic sense, I mean return on investment. With the S&P500 P/E ratio at 30 times, that equates to an earnings yield of 3.3%, of which approximately 1.7% is comprised of "retained earnings" and 1.6% of cash dividends. In other words, assuming the 1.7% of retained earnings is really worth 1.7%, it will take you about 30 years for your investment to earn back your capital.
Why do people keep buying stocks when they are so expensive and when doing so makes little economic sense? In large part they do it because our permissive monetary policy encourages this establishment form of get rich quick gambling, rather than real savings and capital formation. The point I am trying to make is that the failure of the Transports to confirm the Dow may in fact be telling us that the legitimacy of the Dow's rise in terms of economic legitimacy may be questionable.
By the way, let me strongly suggest that you obtain a subscription to Richard Russell's newsletter. This is the one newsletter I feel I cannot be without, and I think if you subscribe, you may feel the same way. In fact, if you subscribe to The Dow Theory newsletter, you might actually figure you don't need my newsletter, although I might add that the Dow publication does not go into depth with respect to stock market recommendations the way we do. But I do also recommend visiting www.dowtheoryletters.com to order that newsletter. It is worth every penny of the $250-per-year subscription fee.
Inflation (Consumer Prices) on the Rise? Not Really.
U.S. consumer prices rose 0.5 percent in January, reflecting the largest energy-cost jump since the Iraq War started, according to our trustworthy government statistics. If you don't have to eat or heat your home or drive your car, and if you can go without lighting, prices rose "only" about 0.2 percent in December. However, the core index gained only 1.1% in 2003, which was the smallest annual increase in prices in 43 years.
We find the continued subdued price picture to be very interesting in light of the enormous growth in the money supply. And as we have said on numerous occasions, we think the failure for consumer prices to rise anything like the levels of consumer price increases we witnessed in the 1970s is due in large part to the very rapid rise in debt, which is growing much more rapidly than GDP. Once again, we show the charts that illustrate this point:
These pictures spell "insolvency" and indicate that it is only a matter of time before our phony monetary system comes tumbling down. At present, it takes approximately $7 of new debt to generate $1 of new GDP. As David Tice pointed out in our interview, the requirement of new debt to generate $1 of new GDP has grown from a ratio of about 1.5 to 1 in the 1960s to where it is now at about $7:1. The trend of needing to go deeper and deeper into debt is akin to needing to run faster and faster when you are on a treadmill that is increasing its speed. Just to stay in place, you have to run faster and faster. Eventually, if the treadmill speeds to a point beyond where it is humanly possible to maintain that speed, or if you simply tire and are unable to maintain the speed due to fatigue, you fly off the end and crash to the floor/wall behind you. As far as debt is concerned, that point when the system breaks down will take place when the debt can no longer be serviced because interest payments alone will become unserviceable for more and more people. Indeed, as we noted recently, we are experiencing a record number of personal bankruptcies. At some point in time, a threshold will be reached when bankruptcies beget bankruptcies, and no matter how much new money/debt is created, the system will spin out of control.
"So what?" you say. "The Fed can simply print more money!" "Not true," I say, because the printing of money is accomplished in a phony fiat money system by issuing more debt. Incidentally, Dave Morgan discussed this issue in my interview with him, which will be published in the March 2004 issue of J Taylor's Gold& Technology Stocks. It is my view that when this system collapses under the weight of our enormous debt load, we will begin to see outright deflation rather than the disinflationary trend that has taken consumer prices to the lowest levels in 43 years. The die is cast. There will be no turning back because politically it is impossible for the policy makers to face the truth about the disastrous course the fiat money proponents have set us on.
Unfortunately, I was unable to find an article I had read this past week that noted how much more rapidly debt was rising than income. There were a number of statistics that caused this concept to become much more real than the macro level discussion I normally apply when I talk of rapidly rising debt. I recall that one of the stats in this article noted that personal income grew last year by 2% while consumer debt grew by 10%. The article also noted that while our savings rate was somewhere around 1.5%, it is in fact negative because government statisticians impute a value from housing into the savings number. Funny how government omits housing from the CPI and then includes it in the savings numbers, but that gives you an idea about how deceptive our government is. The point is, we-both as a country and as individuals-are running ourselves into bankruptcy. As we spend more than we earn, our individual balance sheets as well as the collective balance sheet of our nation are becoming weaker and weaker. Unfortunately, it is only a matter of time before this house of cards comes tumbling down and America becomes an impoverished nation. In that condition, how will we avoid being dominated by other nations? How can we hope to maintain the freedoms we have come to think are our birthright?
Which leads me to a very interesting point made by Rick Santelli this past Friday on CNBC. Rick pointed out that despite exceptionally low interest rates, even for highly risky junk bond companies, the corporate world is not borrowing. Why not? My suspicion is that they are not borrowing because they simply do not see favorable business prospects going forward. If there were a real recovery underway - rather than the one induced by an extremely accommodative monetary policy and tax cuts, one would expect corporate treasurers to be locking in long term borrowings at rates that are at their bargain basement lows. But if transports are down, perhaps shipping is off because the business isn't there. Perhaps that is what this topping market is saying.
Greenspan Ignores Dangerous Trends
Rising Debt to GDP Ratio is a Warning
Washington, DC: In testimony before the House Financial Services Committee last week, Federal Reserve Chairman Alan Greenspan painted a rosy picture of the U.S. economy. His claim that lower interest rates have strengthened the financial condition of American households deserves closer scrutiny, however. In fact, Economist Frank Shostak of the Ludwig von Mises Institute throws cold water on the Chairman's assertion: "According to Greenspan the low interest rate policy of the U.S. central bank has strengthened consumers' and businesses' financial conditions. Our analysis, however, disagrees with this…the data demonstrates that the exact opposite took place." "Thus the household liabilities-to-assets ratio climbed to a new record high in Q3… Furthermore, the outstanding consumer credit-to-personal income ratio stood at a record…in December. This record high ratio indicates that the pace of consumption by far exceeds the pace of wealth generation. This is likely to force consumers to curtail their borrowing and in turn curtail their expenditure in the months ahead." "According to Greenspan mortgage refinancing played an important role in last year's buoyant economic growth. (But) how in the world can credit, which is not backed up by real savings, generate economic growth?" Debt is the fundamental problem that Mr. Greenspan and the central planners at the Fed will not address. The unfavorable ratio of new Treasury debt to GDP has been trending upward for decades. Between 1962 and 1982, the ratio was $1.50/$1 or less. By the mid 1990s, the ratio had grown to about $3/$1. Today the Fed must create nearly $7 of new debt to generate $1 of new GDP.
As financial analyst Jay Taylor explains, this trend illustrates that the only solution Federal policy makers know is to print more and more money. Federal debt naturally grows faster than income-while there are no limits to how fast the printing presses can run, there are natural limits to economic growth. The end may come when foreign central banks realize the dollars they receive are worthless, or when they find other places to turn for income. When that day comes, interest rates will rise, perhaps dramatically. At that point not even Mr. Greenspan will be able to save the economy from the painful correction necessitated by his easy credit, easy money policies.
GOLD
My good friend Dr. Michael Berry made the following remarks about gold in his daily missive, which he sent to his clients on Friday morning:
"Once again the $ is stronger against all major currencies except the Mexican Peso.
"This means that precious metals should be under pressure again today. This is a natural pause in the cycle. I reiterate that we are embarked upon a long-term inflationary cycle and this is a only pause to reflect. It will present an opportunity for you to take positions. U.S. Corporations with significant export business will be hurt in the short run.
"Gold is trading at $408.30 and silver at $6.58 down $.05. Please use this opportunity to accumulate shares until the dollar once again weakens."
Your editor agrees with Dr. Berry's perception that now is an excellent gold and silver buying opportunity. We can be so easily influenced by the short-term movements in markets because the here and now is what seems most real to us. But if we can step back and see the longer-term big picture, the day-to-day movements are usually not very important. Again I would like to direct your attention to the chart below, which illustrates that point and the following factors as well:
Note also that what we are looking at is a powerful bull market in gold. Like an ocean-going steamship, the direction of these major secular trends cannot turn around very quickly because it illustrates the inertia of the gold price movement.
And frankly, no matter how hard governments try to intervene to keep the price of gold from rising, it seems unlikely they will be able to do much about it. Manipulative efforts to drive the price of gold lower were very effective for a while, but as my good friend David Morgan said in our upcoming interview (to be published in our March 2004 monthly issue), there are natural limits with respect to how far governments can impose stress on markets.
Indeed, the policy makers have been able to fool Mother Nature quite significantly, judging by Frank Veneroso's model, which set gold north of $600 in 1998. And as Don Doyle, CEO of Blanchard & Company pointed out in my December 2003 interview, if gold simply rose by the consumer price index, it would be over $700. But with central banks clearly not having nearly as much gold in their vaults as they pretend they have (remember they are encouraged to deceive us by linking gold loans and gold bullion into the same account), and with countries around the world nervous about the enormous and disproportionate amount of dollars they are holding as central bank reserves, there would now seem to be mounting pressure from a monetary perspective to push gold higher. Remember, the $600 equilibrium price projected from Mr. Veneroso's work did not include any increased monetary demand for gold.
Perhaps the most bullish fundamental of all for gold now is the enormous speed with which countries around the world are running their printing presses in an effort to cheapen their currencies. This is the first time since the 1930s that we have seen a beggar-thy-neighbor competitive currency devaluation on such a large scale. What this means then is that the amount of paper money flowing around the world with which to move into real, legitimate money-namely, gold and silver-is growing very, very rapidly and as such is providing enormous new effective demand for gold.
When Will Gold Rise Against All Currencies?
As Dr. Berry noted above, gold has risen so far mostly against the dollar. The gold bears like to make this point as evidence that the rise in gold is only a temporary move against a temporarily weak currency. However, with the world printing money at a much more rapid pace than income is being generated, the global financial system is becoming more and more highly leveraged. As such, it is becoming more and more unstable. The U.S. is the biggest debtor nation of all, and I believe technically we are already an insolvent nation.
At some point in time, those major nations around the world are going to take a serious look at the balance sheets of their own central banks and realize just how rotten and unstable they are. Why will they reach that conclusion? Because they will notice that very major parts of their reserves are comprised of U.S. dollars. In other words, the truth about the phony strong dollar policy of the Clinton years will hit home, and there will be an exit out of paper money into gold. It doesn't have to be a sudden wholesale exchange of paper money for gold. Given the miniscule size of the gold markets relative to the huge amount of paper money now being created in a frenzy to keep the global economic party going, a very small and gradual exchange by central bankers out of dollars and eventually out of other currencies into gold will set the stage for the market to dictate a return to real, honest money in the form of gold and/or silver.
From our perspective, given all the fundamental reasons to own gold (and silver), we do believe now is a great time to increase your ownership of these precious metals as well as gold shares, especially given the dramatic decline in the price of gold this past Friday to $397. For that reason, we plan to add more stocks to our list over the coming weeks.
February 24, 2004
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com