Pivotal Events

By: Bob Hoye | Tue, Nov 24, 2009
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The following is part of Pivotal Events that was published for our subscribers Thursday, November 19, 2009.

Signs Of The Times

Recent Years:

"Yield Curve is Banks' Silver Lining"

"The impact on a bank's bottom line works as follows: it pays 4% interest on deposits, then lends that money at more profitable rates of, say, 5%."

- Wall Street Journal, September 18, 2007

"A little more than a week after the Fed slashed interest rates, signs are emerging that credit markets are improving."

- Wall Street Journal, September 28, 2007

* * * * *

This Year:

"Need to develop a way to tackle asset-price bubbles...before the whole thing comes to a catastrophic consequence."

- Bloomberg, November 5, 2009

U.K. Chancellor of the Exchequer

Since the first in 1720 great bubbles have occurred whether the currency is convertible or fiat. The culture of policymaking rests upon the notion that economies are national and being random can be managed. The main tool has been econometric modeling that assumes that expert manipulations of interest rates and money supply will avoid bad things from happening. Unresponsive to contrary evidence, this theory has endured since the formation of the Fed in 1913.

The above quote shows growing apprehension of the danger of another outbreak of financial speculation. The problem is that interventionists have no means of forecasting such events. They have spent most of the last 100 years in preventing another depression without ever taking back any "stimulus". The consequence has been a 96 percent decline in purchasing power of the senior currency.

Some think that the policymakers are insane enough to take the dollar to zero. They may be foolish enough to continue the attempt, but market forces seem to be gathering that would prevent that compulsion. They could be severe enough to drive policymakers sane.

"IMF sells 200 tons of gold to India."

- Reuters, November 3, 2009

This was the first time that the IMF has sold gold to a central bank since 2000. At the time of the LTCM failure the establishment worked hard to keep gold down and this writer frequently talked with one of the IMF honchos. At a desperate moment he said that they (IMF) had plenty of gold with which to stifle rallies. He has now retired so this can be mentioned.

Gold's real price set a cyclical low at 143 in May 2007 and perhaps the cyclical rise since (to 385) has overwhelmed official ambition to "kill" gold rallies.

Also perhaps, the establishment outside of macro-economists is becoming unusually concerned about deliberate policies of dollar depreciation.

"The global speculative-grade default rate rose to 12.4% in October, surpassing the record set in 1991 for the highest proportion of defaults since the Great Depression."

- Bloomberg, November 5, 2009


Prompted by the same old forces of credit contraction, Washington is replicating the New Deal that was started by Commerce Secretary Herbert Hoover in 1927 and pounded into America's culture by President Roosevelt. As led by Obama's "Chicago" political machine, this will be as nasty and bullying as FDR's "New York" politics. The irony is that history shows that Rome was "New Dealed" to death.

For the latter, The New Deal in Old Rome by H.J. Haskell can be read on the internet. In 2007 Amity Shlaes published The Forgotten Man, which covers the radicalism of Washington in the 1930s.

* * * * *


Clearly, the "Conundrum" of asset inflation in the midst of an historical credit contraction continues. And as we have been noting, some asset-classes have reached impetuous conditions. Within this, stock markets have reached bullish sentiment that exceeded levels reached at the top of the bull market in October 2007. Even the constantly maligned gold has reached 97 Percent Bulls, which is without precedent on this survey.

Going the other way, the dollar bears became very excited.

It is worth checking other accomplishments made by the stock market. One is the six-month rebound out of a crash, which counted to September when the 92 Percent Bulls registered. Another is the fifty-percent retracement that the Dow finally registered this week. That looks after the post-crash rebound, and as Ross has been tracking it, the Stochastic is overbought enough to limit the move. (As of yesterday it rolled over.)

On the near-term, our October 29 edition observed that week's hit and noted that there could be a rally into early November.

On the somewhat longer-term, in July we had expected credit conditions to be troubled by late in the year, and while the party continues in long-dated corporates there has been a small step to widening spreads at the shorter-maturities.

The action in credit markets and in the gold/silver ratio reminds of October 2007. Some key pieces are attached from then that show just how difficult that transition was.

In the meantime, our October 29 advice for traders to sell the November rally "aggressively" was a little early. However, speculation is again at exceptional levels, seemingly on the cusp between a correction and the discovery that policymakers have at last created the equivalent of perpetual motion.

Generally, perpetual motion has been doing poorly in the Tokyo market since 1989. This week's decline in the Nikkei is threatening the October low, and today's trade on the EWJ has taken that out and at 9.20 is threatening the July low of 9.10.

Bigger Picture: Financial markets have staged a magnificent post-crash rebound, accompanied by a recovery in business. It has also been accompanied by an heroic "stimulus", whereby the state is pre-empting spending by the private sector. It is worth adding that "stimulus" was ramped up with the Bear Stearns crisis and continuously applied through and beyond the panic's end in March.

As with the Second New Deal in the 1930s, today's political ambition is very hostile to the market and will drive capital away from normal economic calculation making any "recovery" less than optimal. Driving capital into caution also reduces liquidity.

And apparent liquidity has been the problem. Central banks have, as usual, been creating it out of thin air. In turn, this has been leveraged into an immense carry-trade in the treasury curve - thus our watching for reversal.

The same goes for long-dated credit spreads. Short-dated, as represented by the TED-Spread, have reversed to widening.

Link to Friday, November 20th ' Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1477



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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