Revenge of the Barbarous Relic
Marc Faber's latest report written on November 1 was titled "Why Market Interventions by Governments worsen Economic and Financial Conditions!" I might have called it "Vengeance of the Barbarous Relic". John Maynard Keynes granted gold with this pejorative, giving license to governments to intervene, print, and distort to their heart's content. In the long run we are all dead...right? Wrong! The long run is now and the chickens are coming home to roost.
Keynesian economics has forced us into this mess and Austrian economics will get us out...but not willingly. Only after the world's paper currencies has been totally trashed and nations are forced back to metals-backed currencies will the transformation and adoption of sustainable economic policies occur.
Clearly we are caught in deflation for now. The correct trade was and is to short the popular indices and buy gold. You would have made money doing this. See my commentary, "The Party Is Over." When I wrote the commentary the market still had not violated its bull market trend line dating back to 1982. We have since blown through that support line and just about every other support line you can imagine. There is no more support...only more plunges to come in the market averages and, since we have become such an asset-dependent economy, we should only expect extremely hard times. Negative feedback loops between the financial markets and the real economy are going to wreak enormous havoc.
Deflation and US dollar strengthening continues for now, but two points are in order concerning this. First, this is not a positive development. Paul Kasriel, director of economic research at The Northern Trust Company hammers home the point:
"In conclusion, falling consumer prices are a symptom of weak consumer demand, not a reason for hope of a rebound in consumer demand. To be sure, if consumer demand is contracting, it is better for consumers that the supply of consumer goods and services is not also contracting. But the circumstance of falling consumer prices would only be "good" for consumers if the decline were being brought about by expanding supply. Journalists can be excused for writing articles arguing how the current decline in consumer prices is good for consumers. Journalists are not economists. But it is inexcusable that economists would be spreading this malarkey!"
Secondly, as foreigners, companies, and investors continue to accumulate cash and the government continues to owe it, the only party which is harmed from a further strengthening of the US dollar is the US Government. There is just way too much incentive for the US Government to concoct a way to squirm out of its debt obligations. It is simply the only path. It will not default, but will inflate its way out, reducing the 'real' price of current obligations.
That is why it is important to be long gold and short the market. For now gold is holding up better than the market in the current environment of asset deflation. But when the pendulum swings back to inflation (I suspect months not years) the price of gold will rocket much faster than the nominal prices of stocks. I'll place my bet alongside the 5000-year history of failed paper currencies against hubris of economists who think they have figured out a better system. I have seen some estimates that would place the price of gold north of $50,000/oz. to back all of the money in the world. However, this number could come down dramatically with a few more months or years of asset deflation and/or issuances of new currencies to replace worthless ones.
Notwithstanding the drubbing portfolios have recently experienced, I believe there is still too much optimism out there..."the Great American spirit lives on...we have overcome worse than this...we made it through the Great Depression", etc. The levels of panic and fear are not as low as they were earlier in the year when the markets began to crater in earnest. See chart from Barron's below:
I would dub this unhealthy condition as "irrational optimism" (clearly no longer irrational exuberance). There are still too many financial media experts comparing this to 1929 or 1974 and calling for a short-term bottom and "tradable bounce" going into next year. There are too many people looking to morsels of good news in a sea of bad. Just a couple of days ago when Hewlett Packard announced their better-than-expected earnings and lifted guidance, the giddiness of the "objective" financial commentators reporting the news was palpable and the knee-jerk reaction of the futures market was to rise sharply higher. Well, ultimately, the markets ended that day lower as the reality of the other 499 companies (only a slight exaggeration) are expecting their fortunes to rapidly decline set in.
This morning news that Saudi Prince Alwaleed is boosting his stake in Citigroup is giving the bulls' false hope once again. Futures have rebounded again as investors cling to their irrational optimism.
You should employ investment strategies that exploit this human fallacy to be optimistic when the evidence clearly points otherwise. Optimism is a virtue which propels society forward and moves individuals ahead in 'normal times'. The period we are entering is going to be unlike anything this country has ever experienced.