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November 27,
2005 - In the brief period since President Bush announced his choice for
the new Federal Reserve Board Chairman, a number of major financial markets
have been dramatically affected. The purpose of this essay is to explore
whether the hand of Alan Greenspan or his likely replacement, Ben Bernanke, were behind them. Or, are the forces driving
these normally divergent markets in the same direction simply the result of
the investment community's expression of support and agreement at the change
of guard at the Fed, or is some other force at work?
It has been four weeks since October 24. This was
when Ben Bernanke was named the president's choice
to ascend to what is arguably the most powerful position in our nation if not
the world. No sooner did President Bush recommended his
replacement for the departing Alan Greenspan, than four of the most
significant markets began to react. The boldest and most persistently strong
one has been the U.S.
stock market. At the time, the Dow Jones Industrials were in the midst of a
decline. It began about five weeks earlier from about 10,700, and had taken
the Dow to its pre-announcement level of about 10,300. On the day of his
recommendation, the Industrials appeared to greet Bernanke
and strongly rose 170 points. The Dow then proceeded to fall for the next few
days but has since climbed nearly vertically to Friday's 10,931 closing
price. This places its upward assault within striking distance of an all-time
high.
The US Dollar Index was trading at about 89.50.
After a brief three day set-back it soared in lock-step fashion with the Dow.
Within three weeks it touched 92.50. When it bumped into strong resistance at
the 92.50 level it paused temporarily, but is now working to overcome it.
Bonds were in a sustained decline since late August.
After President Bush's announcement the bond market severely reacted, and in
three days lost 225 basis points. It then proceeded lower for several more
days, sharply reversed course, and then joined common stocks and the dollar
in their upward climb.
The gold market is the final market of this quartet.
After Bernanke's nomination it rose strongly for a
few days and then fell sharply. After posting a 458 nadir it then reversed
direction and exploded in price. It now rests on the doorstep of a major
milestone, the 500 level.
Since Ben Bernanke's
nomination, the world has experienced a rarely witnessed event. What is so
amazing is the fact that these major markets are driven by varying and
opposing forces, yet they are together trending higher. I cannot state that it
is unprecedented. However, after each had sufficiently digested the news,
these four crucial markets moved higher in tandem. By acting in this fashion
they are defying both historical market
relationships, conventional wisdom, and common sense.
The U.S. dollar and gold tend to move in opposition
to one another. This is due to gold's historic negative correlation with the
dollar. U.S.
common stocks and bonds were in defined downtrends. Yet, Bernanke's
nomination seemed to virtually simultaneously put wind behind the sails of
all of these primary American markets. This may only be a fleeting
phenomenon, but if not, how and why are we witnessing this seemingly surreal
event?
One belief is that Alan Greenspan orchestrated the
market advances. Given his long tenure as Fed chairman I am certain that he
would like to leave his watch with the markets calm. Stronger equity, bond
and dollar markets that carried through his departure,
would certainly make his exit more fitting for what the American Public would
expect of the Maestro. It would also please Greenspan as it would give future
historians few negatives to discuss when describing his legacy.
In a similar fashion, it would be to Dr. Bernanke's benefit if the markets appeared to rejoice in
his ascendency to the chairmanship of the Federal
Reserve System. If this transpired it would certainly comfort the market's
participants and onlookers on the eve of Greenspan's stepping down.
There are a plethora of potential crisis generating
conditions that are lurking in the wings of both our nation and the world's
financial and economic systems. An easy transition from a Greenspan to a Bernanke Fed would act to mitigate and assuage many
lingering fears.
After all, the derivative monsters that envelop not
only the currency and equity markets, but also the bond, credit and various
other markets, has the potential to bring down the entire financial system if
an accident emerges. This nearly occurred in1998, with Long Term Capital
Management, and possibly with the recent apparent insolvency of Refco. The break-up of the latter company appears to be
under control. However, potential derivative or undisclosed losses may yet
surface and create havoc in the markets. Little information has been reported
by the regulators or the media to reasonably explain the speed with which the
company is being dismantled. Further, no one in the company seems to be
objecting.
Other potential dangers surround the fate of common
stocks and real estate. Despite their recent impressive strength, equities
may shortly experience a continuation of their secular Bear Market decline.
Numerous indicators are signaling warnings of their
impending weakness. Additionally, the housing market may be taking a
breather, but the future of its Bull Market appears tenuous at present. If
either of these markets soften substantially, it has
the potential to snowball and not only damage the underpinnings of the other,
but also the general economy. Additionally, how long will the rest of the
world continue to desire the fiat dollars that our Federal Reserve System
creates at will? Given our unsustainable balance of trade, payments, and
budget deficits, the United States NEEDS the rest of the world to continue to
accept our dollars and purchase our Treasuries. If they eventually rebel, it
will devastate our economy and unleash a likely inflationary firestorm when
their dollars return to our shores.
The possibility of these
and other potential disasters will soon consume the waking hours of Dr. Ben
S. Bernanke. If the markets do not appear to accept
him when he takes control of the Fed, he may be forced to endure a test of
fire.
This would not be unique. Both former Fed chairmen
Paul Volker and Alan Greenspan were greeted by major economic convulsions
shortly after they each took their oath to office. Volker watched short term
interest rates soar to 20% and a recession unfold, and Greenspan presided
over the devastating stock market crash of October, 1987.
The classical methods that Alan Greenspan can
utilize to foster rising bond, stock and dollar markets are not foreign to
long-term observers of the Fed in action. The problem is that all of these
markets can't be simultaneously stimulated with these means. The Federal
Reserve routinely purchases U.S. Treasuries in the open market. This acts to
strengthen the bond market, reduces interest rates, and allows the Fed to
immediately inject a substantial number of dollars into the banking system.
Or, Greenspan can lower the Federal Reserve member banks' reserve
requirements. This action gives the banks the capacity to expand their
lending ability, which through a multiplier effect also increases the money
supply. The Fed can also manipulate the Federal Funds and Discount rates
lower, thereby suppressing interest rates. All of these actions increase our
domestic liquidity and have been primary drivers of higher stock prices.
As for the dollar, rising interest rates tend to
buoy its strength while falling rates weaken it. Also, Federal Reserve open
market sales of Treasuries withdraw dollars from the monetary system thus
increasing dollar desirability on the world's markets. If fewer dollars
exist, by supply and demand, the remaining ones will ultimately experience an
increase in their purchasing power. However, these standard market influencing
Fed actions all take time to work their way through the system. Further, as
you can see they conflict with one another in the varying effects that they
have upon these markets. They could not simultaneously, positively influence
the bond, stock and U.S. dollar markets, let alone gold prices.
While Dr. Bernanke has not
yet been installed as Fed chairman he may be operating behind the scenes with
Greenspan's guidance. Bernanke essentially came
from out of nowhere in 2002, and uttered numerous highly controversial
statements. Then, earlier this year found himself
appointed to the lead post of President Bush's personal economic advisors. In
this position he was likely personally groomed for his future Federal Reserve
position.
I believe that it is reasonable to assume that Alan
Greenspan's replacement by Ben Bernanke was made
long before the official announcement. It certainly appears that he caught
President Bush's attention with his 2002 statements if not earlier.
Unfortunately, given the fact that he will likely be
our next Fed chairman I think it was a mistake to broadcast his intentions in
advance. This will limit their effectiveness if and when they are
implemented.
If he used the conventional Fed methods to effect
monetary policy as I described above, Dr. Bernanke
would have no greater ability than Alan Greenspan to move these markets
higher in concert. For this reason, if classical Federal Reserve techniques
were solely utilized, I believe that one can eliminate Greenspan and Bernanke as the influencing forces behind the concurrent
rises in these markets.
Where does this leave us in determining the
causative forces behind the simultaneous uptrends
in all of these markets? It could be a coincidence. Yet, a few days would be
one thing, but for three weeks already is a different story.
IF IT'S NOT GREENSPAN, BERNANKE OR A COINCIDENCE, THEN WHAT ?
Upon
further evaluation of this puzzle a though occurred to me. It took me back to
Dr. Bernanke's November, 2002 statements when he
was a relative unknown. He stated that the Fed had the ability to create
dollars at will by various unconventional means. In this regard I truly
believe him.
I personally do not believe that the markets are
sufficiently convinced that Dr. Benjamin S. Bernanke
will be an able replacement for Alan Greenspan. He very well may be, but he
is as yet unproven. From my long experience observing and studying the
markets, I have found that they typically react negatively to any form of
uncertainty! And, to my mind, any replacement of the revered Alan Greenspan, would be looked upon with a questioning eye by
all national leaders and anyone concerned about the markets.
If I am correct, the uncertainty generated by any
untested, new Fed chairman would at best cause the markets to pause if not
decline. I believe that the bond market's initial sell-off was and should be
the typical response. Then why would stocks, bonds, the dollar and gold
instead simultaneously rise? To my mind, the only logical explanation would
be a concerted market intervention effort.
I for one believe in free, uncontrolled markets. I
also believe that our government recognizes the unwelcomed
fashion in which the markets greeted both Paul Volker and Alan Greenspan upon
their appointments as Fed chairmen. For this reason it seems likely that they
would do their best to smooth the path for the January, 2006, Fed chairman
transition. This truly would be to the benefit of all Americans. While I do
not agree with this action, I do understand the reasoning behind it if this
is indeed what is occurring. And, I am certain of their ability to execute
these effects, at least in the short term.
But, why would they want a strong gold price? The
answer is that they wouldn't! That to me is the most telling market
performance produced by Dr. Bernanke's nomination!
I believe that gold's powerful, positive reaction
indicates that a number of world governments and important market players
also believe Bernanke. They realize that when he
implements his stated actions the result will be an extended, substantial
decline in the dollar's value. Further, I am convinced that the Fed's recent
decision to withhold future changes in the broad measure of the U.S. money
supply, M3, has confirmed that belief in the minds of many government and
other influential leaders. Much has occurred in the four weeks since Ben Bernanke's nomination!
On November 10, the Fed announced that M3 is costly
to produce and is no longer significant in determining our nation's monetary policy.
They gave these as the reasons for its discontinuance effective on March 23,
2006. Additionally, they will simultaneously cease to publish future changes
in Eurodollar and repurchase agreement balances.
I suspect that this statement was internationally
viewed as a method for our nation to cloak a likely massive future explosion
of U.S. dollar credits. Further, I believe that Dr. Bernanke's
nomination and this announcement that shortly followed it,
were the primary influences behind the recent strength of gold that quickly
took it to a new Bull Market high. If my reasoning is sound, the stage is now
set for an increasing number of important national and international dollar
holders to begin moving into gold. As time passes, this will benefit not only
gold and gold shares, but numerous commodities and other tangible items. This
will be the result of a flight from the dollar into these investments!
I hope that it doesn't come to pass. However, if Dr.
Bernanke makes good on his word, he will likely go
down in history as the Fed chairman who was responsible for creating the
greatest flood of dollars, and the most damage to its domestic and
international purchasing power in history. In this event, gold and gold
related items will be the savior of the common man.
______________________________
By
: Dr. Richard
S. Appel
www.financialinsights.org
The
above was excerpted from the December 2005 issue of Financial Insights © November
27, 2005.
I
publish Financial Insights. It is a monthly newsletter in which I discuss
gold, the financial markets, as well as various junior resource stocks that I
believe offer great price appreciation potential.
Please
visit my website www.financialinsights.org where
you will be able to view previous issues of Financial Insights, as well as
the companies that I am presently following. You will also be able to learn
about me and about a special subscription offer.
CAVEAT
I
expect to have positions in many of the stocks that I discuss in these
letters, and I will always disclose them to you. In essence, I will be
putting my money where my mouth is! However, if this troubles you please avoid
those that I own! I will attempt wherever possible, to offer stocks that I
believe will allow my subscribers to participate without unduly affecting the
stock price. It is my desire for my subscribers to purchase their stock as
cheaply as possible. I would also suggest to beginning purchasers of these
stocks, the following: always
place limit orders when making purchases. If you don't, you run the risk of
paying too much because you may inadvertently and unnecessarily raise the
price. It may take a little patience, but in the long run you will save
yourself a significant sum of money. In order to have a chance for success in
this market, you must spread your risk among several companies. To that end,
you should divide your available risk money into equal increments. These are
all speculations! Never invest any money in these stocks that you could not
afford to lose all of
Please call the companies regularly. They are controlling
your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard Appel
and is made available for informational purposes only. Dr. Appel pledges to disclose if he directly or indirectly
has a position in any of the securities mentioned. He will make every effort
to obtain information from sources believed to be reliable, but its accuracy
and completeness cannot be guaranteed. Dr. Appel
encourages your letters and emails, but cannot respond personally. Be assured
that all letters will be read and considered for response in future letters.
It is in your best interest to contact any company in which you consider
investing, regarding their financial statements and corporate information.
Further, you should thoroughly research and consult with a professional
investment advisor before making any equity investments. Use of any
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