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June 30, 2008

We Have Inflation not Deflation
by David Petch

It is the end of the week and the start of a long weekend up here in the Great White North, so today's commentary will be brief. Oil climbed overnight to peak at $141.71/barrel and this is likely not set to slow down yet until something breaks. Continue to stock up on dry goods such as rice, whole-wheat flour, powdered milk, brown sugar etc. because prices are going much higher. Many of the countries around the globe with currencies pegged to the US dollar have been forced to depreciate them via interest rates and fiat expansion to keep at a preset level. This has caused prices to rise higher than anticipated and many such nations are being forced to raise interest rates. As mentioned earlier, monetary inflation often can remain dormant for some time and prices rise gradually. However, there is a tipping point by which commodity prices begin to rise as a result of monetary expansion, which directly pumps inflation right to people's doorstep (as a note, Donald Coxe has mentioned that both food inflation coupled with energy inflation are prerequisites for stagflation). I have written about inflation extensively, so simply review prior articles by title for more information in the Archives section of this site. I am going to be updating stocks I own next week, probably due out on Wednesday AM.

Probably the biggest misconception out there on the web is the thought we are in a period of deflation. Inflation is defined as monetary expansion through issuance of fiat or credit. If anyone needs any proof, visit this link. Another great site to visit or subscribe to for valuable information regarding true global M3 levels is www.shadowstats.com. Prolonged periods of inflation will see a rising trend of interest rates to soon match it. The only way to quash inflation from a monetary perspective is to raise interest rates above it...so if the true rate of inflation globally is around 12-15%, interest rates will be higher than these levels within 4-5 years. As analysis of the 10 Year US Treasury will point out, we are 5-7 months away from initiation of the an upward rising trend of rising interest rates. The present decline of the USD is a direct result of inflation and further devaluation will bring new lows...this is a "symptom" of inflation. If the US were in deflation, then the decline in the USD would be over in theory or at least stabilize at present levels...ain't gonna happen.

Some people on the web think the US is experiencing deflation. Expansion of a given currency causes it to undergo weakness at some point and this trend has been intact with the USD since 2002. Major global economies are linked, so when a major currency such as the USD expands via issuance of credit or fiat paper, it becomes transferred globally into other assets. The US currently transfers 500 billion dollars/year to OPEC nations in order to drive vehicles, which is a direct transfer of money into the global economy whether it is issued via credit or direct monetary expansion. At present, banks are not lending to each other, but credit card debt is being rapidly expanded to buy food and put gasoline in the tank, which soon will go the way of the dodo. Much of this issued credit is finding its way into other countries, which filters its way through the global network, ultimately causing prices to rise.

Rising commodity prices (which is a direct result of monetary expansion) have driven up import costs for goods to the US, which is going to cause a slight reduction in Chinese GDP (US accounts for 8% of Chinese GDP). This is not going to shut down the Asian tiger but instead inflict more pain on the US consumer. At present, many loans are going through the floor, causing banks to suffer huge losses and to make matters worse, the consumer appears to be tapped out. The FED is issuing money to banks to try and keep them solvent. Sure banks may not want to lend to each other, but this is equivalent to plugging the dike. Even if most of the monetary issuance of credit has been done, the FED is trying to keep things at a static level by absorbing credit through monetization...this has been my contention all along. Just being able to keep the money supply at the present level will see more and more of it driven from all other asset classes into gold and silver bullion and their related stocks (energy and associated energy stocks go without saying). This translocation of money from all asset classes will cause the final concentration of wealth into the precious metals and energy arena to trigger an end to the commodity bull market...this is the final requirement to end the period of inflation and it has not even really started...yet.

So, if the consumer is tapped out and even if the money supply is kept static, where will additional inflationary pressures on the USD come from? The main driver for US monetary inflation going forward is going to be the US government...this is one point that some people have a mishunderstanding about. The US government is the largest consumer of oil around the globe and this is not about to change anytime soon. IF the government needs money to fund programs such as their military presence around the globe, infrastructure, social programs, pensions, monetization of debt etc., they will simply print it digitally. The inflation torch of the US consumer recently has been transferred to the US government.

The conflict in the Middle East is all about oil and the 5% of the global elite rich population is responsible for this. It is really frustrating that they are trying to hold up their Empire presently standing as a house of cards and making the general populous of their origins look like dirty rotten scoundrels. All of the emotional behaviour occurring at present is a direct result of market psychology due to expansion of fiat currency and will continue to break down, as do their associated currencies. Continue to buy gold and silver bullion and high quality gold stocks because this is the lifeboat to get back to shore as the economy goes under. In around 5-10 years, huge parts of the US and Canada (Canada has been experiencing this for 10 years already) are going to go on the auction block and will be purchased by foreigners. In fact, I assume that between China and India, they will control between 20-40% of the major industrial complexes of Canada and the US. The roles of master/servant will soon change globally and there is nothing we can do about it. To be the individuals that survive and prosper, own gold and silver, because it will translate into your children getting a good education.

Things on the global scene are breaking down far faster than I fathomed...I thought it would be 12-18 months before we were at the present crossroads. If the appropriate steps have been taken as we have written about, there is nothing to worry about and all the above merely represents noise.

As a rebuttal for an article on the web about a lack of wage price spiral in the US at present when compared to the 70's...consider the severe erosion of the manufacturing sector during the past 30 years. Back in the 70's government workers were the first to slow things down. This was possible because the manufacturing sector soon pulled the same tricks and won. A strong manufacturing base meant that failure for companies to respond to the increases in wages meant they were not making money. Fast forward to present and any city or government at any level in the US that gives in to significantly higher wage hikes face bankruptcy due to a significant reduction in income from property taxes. Counter China where most of the world's manufacturing occurs and wage price spirals are going on at present...the manufacturers have no choice, give in or go out of business. A balance in wages between the East and West will occur and is in the process as we speak... it is not going to be an easy transition and it ultimately means that the standard of living in the US must be reduced to a point where there is a balance with China.

We have inflation, pure and simple...examination of the cause and not the symptoms is important for coming up with the right answer. One pivotal piece of information is how the 10 Year US Treasury note is expected to perform in the coming months; it is signaling a breakout in 5-7 months which is a far cry from what would be expected to happen in deflation. Most of the masses will have had their hand forced by then...the government is trying to shake as many as possible with the process of stagflation before we enter the potential scenario for hyperinflation. Back in the 1920's, some farmers were able to pay the mortgage on their property with one dozen eggs. Financial engineers are well aware of what could happen under this scenario...so their strategy is simple: make conditions as extremely difficult as possible so most of the masses are forced to give up their homes and other assets to the banks. Under this scenario, at least the banks wind up with the assets that can be sold at a later point in time, rather Joe and Joanne Sixpack getting a house for a dozen eggs. This is not fair, but then again, neither is life...be prepared.

Update of the 10 Year US Treasury Index

Fibonacci time extensions of various waves are shown at the top of the chart, with a cluster of Fib dates occurring yesterday and today, which happened to coincide with the sharp decline from yesterday. The lower 55 week MA Bollinger band is at 34.2 and requires at least 2-3 months before it is at a position to coincide with a turn in the TNX to the upside. Short-term Stochastics have the %K beneath the %D, with at least 2-3 weeks before a bottom is put in place.

Figure 1

Blue lines on the right hand side represent Fibonacci price retracements of the decline from June 2007 until the March 2008 bottom. Red lines on the right hand side represent Fibonacci price projections of downward trending waves projected off the termination point of their subsequent corrections. Areas of line overlap form Fib clusters, which indicate important support/resistance levels. Expect the TNX to bounce off the 38.6ish Fib cluster before bouncing higher within the consolidation pattern. Moving averages are in transitory state (200 day MA above the 50 MA above the 155 day MA), with the 200 day MA acting as support at 40.1. Full stochastics have the %K beneath the %D and outside of a rounding bottom pattern in place since September 2007. Based upon this chart, expect the TNX to take at least 4-6 weeks to bottom before rising higher.

Figure 2

The weekly semi-log chart of the TNX is shown below, with Fibonacci time extensions of the decline from 2000-mid 2003 and mid 2003 until August 2007 shown at the top of the chart. Notice the cluster of Fib dates occurring in mid to late December 2008, which coincides with Figure 1 indicating a turning point for the TNX around October...within this 2 month window the TNX should break out of the pattern and head higher. The lower 55 MA Bollinger band is curling up and requires at least 4-6 months before the BB width is reduced enough to trigger the next move higher in the TNX. Full stochastics have the %K above the %D, with at least 10-18 months remaining in the upper trend...unless it were to suddenly reverse.

Figure 3

The long-term Elliott Wave chart of the TNX is shown below, with the thought pattern forming denoted in green. I lowered the number of Degrees of the wave count at the request of a subscriber to show what is happening in the present structure...a non-limiting triangle is set to complete wave (Y).[Y]. Once this pattern is complete, it will represent the end of the period of disinflation from 1980 till present and will christen the launch of a massive rise in interest rates, relative to present day levels.

Figure 4

The 10 Year/2 Year US Treasury Index is shown below, with accompanying stochastics. The ratio is presently at 1.52, up from last week's value of 1.41. The trend for the ratio declining is locked in according to the first two stochastics and should see it continue over the course of the next 2-4 years.

Figure 5

A major portion of the work I do is technically oriented, but I write 2-3 editorials per week often intertwined within the analysis . For further viewing of prior work, simply click on the Archive section of this site. I update the AMEX Gold BUGS Index, AMEX Oil Index, US Dollar Index, 10-Year US Treasury Index, S&P 500 Index as well as commentary on market-related issues and new technical analysis findings. We follow some 60 stocks, with a focus on core positions and stocks that actually make up our personal portfolio. As well, the keeper of the site, Captain Hook writes 3-4 articles per week discussing macro issues, ratio analysis of various markets and an in-depth study of put/call ratios and shorting candidates.

David Petch
TreasureChests.info

Treasure Chests is a market timing service specializing in value based position trading in the precious metals and equity markets, with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven to be very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested discovering more about how the strategies described above can enhance your wealth; please visit our web site at http://www.treasurechests.info.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. We are not registered brokers or advisors. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Do your own due diligence.

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