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Dueling Scenarios Revisited
The
following commentary is a follow-up to http://www.greenfaucet.com/energy/one-of-two-scenarios-is-developing/89995.
First,
again I would like to make clear that I do not consider myself a trader or
credentialed technician (chartist) and I prefer to focus on the longer term. But,
as I stated in the referenced commentary above which I wrote two weeks ago,
it appears that one of two patterns is emerging, and depending on which one
prevails, it could determine how you should position your portfolio over the
next few years.
Starting
with the price of gold, it did in fact run quite quickly to $925/oz. before
selling off to its breakout price, just above $875/oz. As I write this, gold
is sharply once again up in an overall down market, but finding stiff
resistance at $925. A close above $930/oz. would signal another "buy
signal" on the expectation that the March 2008 highs (over $1000/oz.)
would be challenged in short order. Goldbugs should be mindful that the a
sustained rally is not "in the clear" and a close below $880/oz.
would call into question this "pennant breakout" of which a growing
chorus of traders remind us in the financial media. As one who is long gold,
I would have preferred to have seen the breach of the pennant occur on lower
sentiment indicators (too much positive sentiment). But things tend not to
play out exactly to script.
Regarding
the popular averages last week's S&P 500 move above 850, it can be
characterized as nothing more than a false breakout. As I write this, the
average is making another attempt to pierce through the 850-level. A failure
to make it through this time, or even worse, a "lower high" would
be bearish and likely set the stage for a move back down toward 800. I don't
like tests that fail.
A failure
for gold to move through 925 coinciding with the S&P 500 stalling at 850
would call into question an "intermediate term reflation trade" and
lend support to the "resumption of the meltdown". Read below to see
why my money is still on the reflation trade.
Signs
Point Toward a Reflationary "B-Wave"
A chart
of the Dow Jones Industrial Average dating back to the 19th Century strongly
suggests that we have completed the fifth and final wave of a major up-cycle.
The two down waves, the second and fourth of the five-wave cycle, occurred in
the 1930s and 1970s, respectively. A downward "A-B-C chart pattern"
tends to occur after a fifth major up wave has completed. The first
"A-wave" seems to have been marked by the move from the highs
registered in October 2007 to the lows in November of 2008. If the
"A-B-C pattern" is to unfold as expected, then we should expect a
counter-trend "B-wave" up- rally before the final
"C-wave" down occurs. The "final C" should exceed the
previous lows established by the first "A-wave" down. C-waves have
a tendency to drop all of the way back to where the major fifth-wave began. That
would mean that the DJIA could retrace all of the gains of the last 30 years
and dip all of the way back down to 1000-level.
Here, I
wish to emphasize that a dip to that level is possible, but is not a
certainty. For those who are quick to reject this "Elliott Wave
Analysis" I would suggest that you reconsider. I know for a fact that
institutional investors who manage billions of dollars pay very careful
attention to these chart patterns (among many other technical indicators).
Turning
away from technical analysis and back to fundamentals for a moment, the
evidence for strong and sustainable rally is forming. Please note that most
who "buy-into"/participate in the anticipated rally are not
thinking "B-wave rally coming", rather they will be convinced that
"the bottom" has been reached and that they do not want to miss out
on the start of the next bull market. Otherwise, if everyone were thinking
that the rally was not long term in nature, then they would be quick to exit
and the rally would never get off of the ground. This likely explains why the
expected B-wave rally is so delayed in occurring.
But now
with money being thrown around like confetti - 2 trillion to bailout the
banks and one trillion for our politicians' favorite pet projects, all in the
name of stimulus - bond yields are moving higher once again with the
yield-curve is steepening. The Baltic dry freight index, the price of oil,
gold, grains, and other commodities are all moving sharply higher, bouncing
off their November lows. The dashboard indicators are turning bullish as Wall
Street eagerly awaits the next banking bailout plan, destined to achieve the
same miserable fait as the preceding ones. Misplaced optimism appears poised
to rear its gullible head once again and will likely lure the trillions of
dollars parked in the bond market and short-term money market accounts out
their safe harbor and into the inferno of money hell again in the form of a
bear market rally.
This
could be the beginning of "collapse of today's bond market bubble"
and signal the next phase of a "staggering rise in government debt"
as Carmen Reinhart and Kenneth Roggoff in their Wall Street Journal editorial
titled "What Other Financial Crises Tell Us" assert:
"Perhaps
the most stunning message from crisis history is the simply staggering rise
in government debt most countries experience. Central government debt tends
to rise over 85% in real terms during the first three years after a banking
crisis. This would mean another $8 trillion or $9 trillion in the case of the
U.S.... Needless to say, a near doubling of the U.S. national debt suggests
that the endgame to this crisis is going to eventually bring much higher
interest rates and a collapse in today's bond-market bubble. The legacy of
high government debt is yet another reason why the current crisis could mean
stunted U.S. growth for at least five to seven more years."
I think
it is safe to conclude that stunted growth and higher-bond yields are quite
bearish and set the stage for the final "C-Wave" down. This is not "priced-in"
as the perma-bulls continue to wrongly and tirelessly assert.
Welcome
to 'Club Goldbug'
Perhaps
one of the most compelling longer-term charts which I use to confirm my
fundamental analysis is the one provided by www.sharelynx.com below.
 
In a
nutshell this chart suggests that since the establishment of the Federal Reserve
almost a century ago, they have enjoyed success and failure in reflating the
economy: success as indicated when the Dow/Gold ratio is moving higher and
failure when it is moving lower. You can see the relative stability of the
relationship dating back to 1800 up until the 1920s. You can also see the
pattern of a megaphone forming shortly after the formation of the Fed. Extending
the line forming the bottom of the megaphone, we can expect the Dow/Gold
ratio drop to somewhere between 0.5:1 and 1:1 before turning up again. This
would undoubtedly wreak further havoc on an already broken world fiat
currency regime as money flees treauries and equities and flocks into gold. Would
it not be poetic justice were a moumnetal change in the world's monetary system
to occur on the 100th anniversary of the creation of the Federal Reserve in
2013?
We are
starting to see some mainstream economists acknowledge this looming reality. Quoting
Richard Duncan, in an essay appearing in October's Far Eastern Economic
Review titled "Time to Dump the Dollar Standard", he makes the
following points:
1. The
torrent of dollars unleashed by the U.S. trade deficit fueled ever larger
bubbles around the world as credit expanded without limit. A crisis too big
to be inflated away has inevitably arrived.
2. Why is
the global economy in danger of collapse? So far explanations have focused on
the proximate causes, like banks' imprudent mortgage lending and use of
complex financial instruments. But behind these missteps lie deeper problems
with the world's financial system, flaws that made a crisis of this magnitude
inevitable.
3. The Austrian School of Economics has long warned of the dangers of fiat money and excessive
government spending. Their warnings were mostly ignored in the Anglo-Saxon
world. The 37-year experiment in fiat money and floating exchange rates has
just come to a disastrous end. The lesson that policy makers must learn from
that experiment is that "free market" capitalism under a paper
money regime does not produce the same benefits as true free market
capitalism (free from government-created money) does under a gold standard. Instead,
it corrupts or overwhelms a country's institutions and regulators, and
ultimately ends in catastrophe.
Another
noted economi c historian, Naill Ferguson, who Pimco CEO and co-CIO of PIMCO
Mohamed El-Erian says "... has an ability to understand both current
issues and historical trends. He reminds people that a catalyst for a
significant market move can be quite small. The smart money likes to have a historical
perspective," is quoted in December's issue of Vanity Fair asking
in an essay titled "Wall Street Lays Another Egg, "Those few
goldbugs who always doubted the soundness of fiat money -- paper currency
without a metal anchor -- have in large measure been vindicated. But why were
the rest of us so blinded by money illusion?"
He spends
the next several pages attempting to answer the question -- with a unique
combined understanding of historical cycles and trends and macroeconomics. Perhaps
his answer can somewhat be summarized in the following passage:
This is
no new insight. In the 400 years since the first shares were bought and sold
on the Amsterdam Beurs, there has been a long succession of financial
bubbles. Time and again, asset prices have soared to unsustainable heights
only to crash downward again. So familiar is this pattern -- described by the
economic historian Charles Kindleberger -- that it is possible to distill it
into five stages:
(1) Displacement:
Some change in economic circumstances creates new and profitable
opportunities. (2) Euphoria, or overtrading: A feedback process sets in
whereby expectation of rising profits leads to rapid growth in asset prices. (3)
Mania, or bubble: The prospect of easy capital gains attracts first-time investors
and swindlers eager to mulct them of their money. (4) Distress: The insiders
discern that profits cannot possibly justify the now exorbitant price of the
assets and begin to take profits by selling. (5) Revulsion, or discredit: As
asset prices fall, the outsiders stampede for the exits, causing the bubble
to burst.
The key
point is that without easy credit creation a true bubble cannot occur. That
is why so many bubbles have their origins in the sins of omission and
commission of central banks.
Post
Boondoggle
Perhaps
the economists desperately trying to apply the stimulus to economies around
the world will succeed through a brew of supply-side and Keynesian solutions.
We continue to place our trust in their expertise and 'experiments'. So far
their efforts have resulted in one disappointment after another. I tend to
agree with Richard Duncan - "a crisis too big to inflate away has
inevitably arrived". Whenever I see the Treasury Secretary, Federal
Reserve Chairman, or official economic spokesmen (in both the Bush and Obama
administrations) boldly advcocate their plan, I am reminded of the phrase
"The best-laid plans of mice and men/often go awry."
In a
poignant Greenfaucet article written by Michael Pento ("Any Hope for Job
Growth?") he keenly observes that "Growth does not come from money
printing or government deficit spending. It comes from encouraging the
private sector to create new technologies and innovations that expand the
amount of goods and services available for consumption... Investors understand
real growth and they understand that some things take time and cannot be
forced or manipulated to occur by a central planning authority. They
understand that the private sector is best at creating jobs that are viable
and accretive to economic growth."
Democracies
around the world are demanding action, with riots occurring in places you
would have never imagined. Government officials and politicians are not going
to sit idlely by and allow the free market to work, despite the fact that
their solutions will likely inflict more harm. You can rest assured that we
are going to test the limits of government debt in addressing our financial
and economic travails, as professors Rogoff and Reinhart caution us.
Kurt Kasun
www.greenfaucet.com
A contributing writer to GreenFaucet.com, Kurt Kasun writes a
high-end investment timing service, GlobalMacro, which is focused on
identifying opportunities that produce returns in excess of market with
reasonable risk. He is strategically located in Washington, D.C., a key to
maintaining contacts and relationships which help Kurt understand global
policy and economic factors as they emerge. His investment approach has
always been macro in nature largely due to his undergraduate studies at the U.S. Military Academy at West Point (B. S. National Security, Public Affairs, 1989) and his
graduate studies at George Mason University (M.A. International Commerce and
Policy, 2006).
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