A Tale Of Two Cities
Below is an excerpt from a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, April 24th, 2007.
All three, the Dow, Transports, and Utilities all closed at record highs on Friday. This is all very good from a Dow Theory perspective, providing confirmation the stock market is in a strong up trend. But how can this be with the economy in the States on the fritz? How can this be with real estate in the dumper and the threat of a credit crunch (a steepening yield curve) at the same time? Answer: It's a tale of two cities, that of Beijing with the Summer Olympics to prepare for next year; and New York, the center of Western influence, where bankers conspire to inflate the US housing slump away. Combined, these two forces, forces that both demand rapid money supply expansion, are culminating to create the biggest asset and debt bubbles in history, bubbles that when they pop, there will be no coming back for a very long time.
As alluded to above however, our central authorities are on the job, with all measures of money supply, M1, M2, MZM, all experiencing accelerating growth rates at present. What's more, we also know M3 growth rates are also accelerating because monitizations are becoming more frequent, where rates could conceivably take a run at 20 - percent this push higher. That's what's happening on this side of the pond. Over in China, where the push is on to get Beijing looking 'just so' for next year's Olympics, despite the rhetoric from central planners they intend to slow things down, money supply growth rates are already pushing 20 - percent, which if exceeded, would formally put them into a hyperinflation condition. And of course we are already there in the case of Russia and a few other examples, so don't think this kind of thing would not spread under the right conditions. It's man's human nature to desire growth you know.
So again, when you combine the cumulative efforts of central authorities in managing the global nexus at present, we get a picture of high and rising inflation rates, which is placing a great deal of pressure on commodity prices, fueling their relentless ascent. And this is particularly true in the case of those commodities whose supplies are already significantly constrained. Moving forward, and in a larger sense, it should be remembered this same condition could befall the entire spectrum of commodities, where both increasing money supply and rapidly diminishing supplies of scare resources across the board could raise living costs to levels not being contemplated by even those bullish on inflation at present. For this reason, and considering gains in commodities prices over the past 5 - years or so, it's not a stretch to believe we are currently locked into a significant inflation led commodity cycle then, the variety that normally shows up when the economy weakens sufficiently politicos must employ 'guns and butter' policy. (See Figure 1)
Source: Barry Bannister
And while a strong argument can be made we are still in the early innings of final stages of a fully mature fiat currency / credit based global economic boom, meaning the larger process (Super - Cycle Wave) still has a few more years to run, this does not mean unexpected interruptions will not accent the sequence along the way, especially considering the complex nature of variables involved. And unfortunately for most, it's very difficult to gauge future prospects in this respect, that's if one is even aware such things are possible. Here, in terms of indications that foreshadow rapid price appreciations and failures, many that attempt to divine such things think there is really only one place to look in garnering educated opinion on future prospects in this regard, that being money supply debasement rates. Unfortunately for them, things are not quite so simple. There are also market structure considerations that reflect sentiment that play a very big role within the overall formula, which we will talk about after we finish discussing the liquidity thingy.
In picking this ball back up again then, despite the fact various sources of liquidity are multiplying, along with the aspect domestic US growth rates are becoming increasing influenced by Asia as our economies integrate, meaning the formula is getting more complex on its own, it is my considered opinion this aforementioned view is too simplistic in that other factors are at play within the later equation as well, whether recognized as being 'causal' in nature, or not. Here, the only way influence of such factors could be removed from the larger equation is for authorities to implement an outright hyperinflationary policy, much like that now being witnessed in Zimbabwe at present, where the aggregate money supply is multiplied on an increasing basis. With the global economy still appearing relatively robust in total however, unlike that of Zimbabwe in isolation, such a scenario is not likely, although some degree of hyperinflation should be experienced on a global scale in the future once the credit cycle in China / India / Asia matures as well.
What's more, this should only take a relatively short time compared to the larger degree cycle experienced in Western economies because Eastern economies are in fact being drawn into the fray to feed the Western machine, which is already very large and hungry. This explains the 'break neck' speeds characterizing both economic and money supply growth rates in China these days, as western bankers are doing everything they can to increase the rate at which they are introducing their paper markets into China. As you may know, Westerners are primarily paper exporters now, where if bankers are to continue expanding their paper empires, they need fresh meat to feed on with Western consumers essentially sucked dry. And while growth rates are still relatively low compared to an example like Zimbabwe, and still somewhat self-regenerative for now, even at 10 to 20 - percent, this will not last long within the full measure of time. Here, if waves on the inflation adjusted Super - Cycle chart of the S&P 500 (SPX) have any predictive value in this respect, the larger count is suggestive of both rapidly accelerating monetary debasement rates and prices in the not too distant future - hyperinflation on a 'grand scale' if you will - possibly extending over the next 3 to 5 - years as economic conditions deteriorate from here. (See Figure 2)
Source: The Chart Store
You see if economic conditions begin to deteriorate, then even China will be forced to resort to more unhealthy means of keeping its newly ordained credit based economy afloat. And like Western economies that are already suffering from this condition, Chinese authorities will need to increasingly rely on monetary stimulus to replace credit growth after the larger cycle matures. And again, like the Western example, and implying the entire global economy will then have arrived at a 'mature state', China will have entered into the final stages of it's own liquidity cycle, meaning Western economies will be increasingly weak by this point, debasing their currencies on an accelerating basis. In this respect the Zimbabwe example is very telling in terms of what to expect. Here, with GDP halved since the year 2000 and unemployment at 80 - percent, their stock market has appreciated approximately 12,000 - percent over the past twelve months as anything that moves is sought after to hedge against inflation. And while such a performance is not expected out on a global scale, who knows just how crazy things can get? Does the SPX double to 3,000? Or more? Anything is possible in this regard.
However, as mentioned above, corrections can and will accent the price action along the way, assuming a top in stocks over the next month or two isn't something more. We have discussed this possibility many times before, so in an effort not to bore you with these details again, and in returning to the market structure / sentiment related considerations also mentioned above, boring as this topic might be to some as well, in being central to prospects for the stock market as this time, we will take the risk of losing you to a good game of Parcheesi, or whatever else distracts you at times like these. This is of course because sentiment is so important whenever a market is stretched as far as stocks in the States and China are right now. Sure, liquidity is also 'key' in terms of inflating stock prices higher, especially as this notion applies to Chinese stocks considering their derivatives markets are still in their infancy, and not a significant price support mechanism yet. Here, stocks are rising primarily due to a liquidity-induced mania, the likes of which has not been witnessed since the tech stock bubble with respect to its importance on the global stage.
In the case of the States however, where money supply growth rates remain constrained when compared to China, at least for now, sentiment, as measured by put / call ratios and short sales, are very important in determining market direction in the sense increasing liquidity may represent hitting the gas pedal alright, but without shorts to squeeze prices higher, doing so would be akin to attempting to 'lay rubber' in your roadster with no fuel in the tank. It isn't going to happen. Not unless authorities decide to start monetizing everything in sight. Incidentally, the Fed has been doing this for two days in a row now, and increasingly of late, so who knows; perhaps we have arrived at such a juncture sooner than later. In remaining on topic however, which means commenting on shorting rates right now, in getting to the bottom line quickly, while short sales figures have dropped to what we will call long - term support levels across the board, hedging related open interest put / call ratios on US indexes remain at lofty levels, implying as long as enough liquidity is hitting the system, yet another short squeeze in stocks should transpire as options expiry in May approaches. What's more, this being a short options cycle (month), derivatives related pricing support should kick in if not later next week, the week after for sure.
Diving further into the pool in this regard, a few side aspects to consider are for one, the short interest ratio is still at record highs, meaning by definition on a volume related basis the potential for a great deal of squeezing still exists, although most assuredly we must have witnessed some of this already. And secondly, although values have not bottomed yet, indicators for volume related put / call ratios (shown below) on the indexes have, opening the potential for stock market volatility to pick up in coming days. Based on the observation the Fed is in monetization mode, meaning credit markets are becoming strained (expect spreads to widen), and the fact European markets are heading lower this morning, it appears this suspicion could prove correct. As per the above analysis however, along with historical precedent in measuring market related behavior within similar circumstances (see Figure 2), at a minimum one should expect further grinding higher of stocks into May, if not longer. (i.e. think end of June as per attached historical analog comparisons.) (See Figure 3)
Source: Market Harmonics
What does this mean for precious metals? Answer: Like the stock market, a note of caution should be exercised at present; meaning unexpected volatility could descend on the sector at anytime, but that in the full measure, patience should be exercised regarding long - term 'core' positions due to a continually improving fundamental backdrop. Translated into easier English, this of course means that although volatility may pick up in the near future, and prices may decline from here shorter - term, investors should maintain strong core positions in the sector comprised of both bullion and share related holdings. Trading positions are another story of course, but you were warned to unload those last week at the top of the range. Here is a picture with a good deal of annotations presented outlining potential worst-case scenarios possible if things were to spiral out of control due to a Yen Carry Trade scare, or some other factor, and combinations thereof. (See Figure 4)
So, in adding the 'big picture' up in this regard, while we expect volatility to characterize trade in the precious metals sector short - term, as with the larger equity complex, expect to see things firm up as the third Friday in May approaches, that being equity options expiration for US securities markets. Further to this, it is my hope analysis will justify the removal of our short - term neutral view on the precious metals sector at our next meeting on Thursday in signaling traders should recommit to positions in your favorite trading vehicles. And if this is the case, we will also provide another value - based 'core' pick for those interested in longer - term accumulation at this time as well. And while some may think this view reckless at this juncture given the precarious condition in the broad markets, we cannot ignore the abundance of bullish technicals in the sector at present. This tells me that monetary authorities intend to meet the accelerating need for speed in money supply growth rates come hell or high water, so get ready. Please take a moment to review the bullish technicals of which I speak in the Chart Room, summarized for you in the three paragraphs with links attached found below.
Since we are unable to open up our Chart Room just for the purposes of this public article however, this appears to be a good point to leave you today for this reason. And of course if this is the kind of analysis you are looking for, we invite you to visit our new and improved web site and discover more about how our service can further aid you in achieving your financial goals. For your information, our new site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.
On top of this, and in relation to identifying value based opportunities in the energy, base metals, and precious metals sectors, all of which should benefit handsomely as increasing numbers of investors recognize their present investments are not keeping pace with actual inflation, we are currently covering 61 stocks within our portfolios. Again, this is another good reason to drop by and check us out.
And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.
Good investing all.