Financial history is
marked with times when populations took collective leave of their senses and
succumbed to delusions of ever-expanding wealth. Times of rampant speculation
have been enthralled by the introduction of new technologies, that are used
to justify pumping-up market valuations, - not just for the present, but also
for the near future, and far over the horizon as well. Quite often, the new found
wealth is nothing more than a mirage. The wild enthusiasm for the stock
market is often overtaken by speculative froth and emotional mania. As such,
spectacular rallies deliver massive gains for one generation of lucky
investors, but also create massive overvaluations that plague the next
generation.
In the case of central
banks, - they usually ignore stock market bubbles that expand as a result of
liquidity conditions that have been "too easy for too long." In
today's markets, central bankers in England, Japan, and the US have
jettisoned the principles of free markets, and instead, are working overtime
at the behest of the ruling politicians, to artificially inflate the value of
their local equity markets, - deploying unorthodox tools such as massive liquidity
injections and locking borrowing costs near zero-percent. "The tools we
have involve affecting financial asset prices, to the extent that consumers
feel wealthier, they'll feel more disposed to spend," Fed chief Ben
Bernanke explained.
Never mind that 82% of
US-listed equities are owned by just 10% of the US-population. The Fed's
theory of "trickle down" economics, - that is to say, inflating the
money supply in order to inflate the stock market, will somehow enrich the
lives of greater society, - is nothing more than a pipedream at best, or
rather an act of purposeful deceit at its worst. "By this means
government may secretly and unobserved, confiscate the wealth of the people
and not one man in a million will detect the theft. And while the process
impoverishes many, it actually enriches some," observed John Maynard
Keynes, in 1920. In other words, the US-central bank's policy is strictly
designed to enrich the fortunes of the Ultra-wealthy.
Last week, the Dow Jones
Industrials soared to as high as 14,850, its highest level in history. The
Dow's four year advance "has prompted plenty of catcalls and profound
skepticism about whether equities have gone too far, too fast in what is the
least-loved Bull market in history." Moreover, the rally highlights the
vast disconnect between the bleak economic and social conditions facing
working people and the staggering rise in corporate profits, inflated stock
and bond prices, and the rapidly rising wealth of the corporate - financial
elite in the US and around the world. Even as national and international
bodies have issued one dismal report on the global economy after another, the
US-bankers and CEO's have celebrated ever-rising stock values. The rise in
corporate profits is chiefly the result of an unrelenting drive to lower
workers' wages and benefits, while ratcheting up workers' output.
Nowadays, there is
widespread understanding that the Fed's ultra easy
money policies (dubbed QE) have gotten a lot of bang for the buck. By
increasing the quantity of the high-octane MZM money supply in circulation,
by $1.1-trillion since the start of 2012, the Fed was able to engineer a
powerful rally, - increasing the market value of the shares listed on the
NYSE and Nasdaq by $3.7-trillion. Today, the value
of the US-stock market stands at a record $20.5-trillion in April, and it
would require a steady stream of QE-injections into the future to support today's
lofty valuations, and to lift the stock market into higher ground.
Yet at the same time,
Gold Bugs are licking their wounds, and asking why the vast money printing
operations of the bank of Japan and the Fed aren't have the same beneficial
effect on the price of Gold or Silver. Instead, to the extreme contrary, -
the price of Gold suddenly collapsed in recent days, suffering its worst rout
in 30-years. The "Black April" Crash of the Gold market comes on
the heels of a 19-month roller coaster ride, in which the price of the yellow
metal swung widely, but eventually landed at the border-line of Bear market
territory at $1,560 /oz. However, once this key horizontal line of support
was penetrated - huge sell orders kicked-in. The Gold market was suddenly thrust
into a panicked free-fall, spiraling -13% lower until finding support at
$1,320 /oz, where bargain hunters emerged.
Still, there were advance
warning signs of trouble for the Gold market. Since mid-November, the market
value of the Dow Jones Industrials - compared to the price of Gold (the
Dow-to-Gold ratio), was moving steadily higher. Traders figure the best way
to profit from the Fed's QE-schemes, is through purchasing US-stock market
index futures and ETF's. Today, 1-share of the Dow Jones Industrials can
fetch 10.7-ounces of Gold, compared with only 7.35-ounes last November. Given
that the Dow peaked at 42-oz's of Gold in 1999, there's still plenty of room
for the Dow to regain lost ground against the yellow metal.
When speaking of the
Dow-to-Gold Ratio, - no matter which way the wind blows on Wall Street, the
Dow is likely to gain further ground compared to the price of Gold. One big
advantage that the US-stock market has over the precious metals is the
widespread perception that the Fed will always ride to the rescue of Wall
Street whenever risky bets go sour - dubbed the "Bernanke Put." Yet
there's another underlying dynamic at work that might explain why the Dow is
soaring while at the same time, the price of Gold is unable to sustain a
sizeable rally and worse yet, - sliding sharply lower. There is a new
technology at work in the global economy that might explain these diverging
trends.
In the view of the Global
Money Trends newsletter, the "Shale Oil" Revolution, - still in it's infancy, might be the
catalyst that's fueling the Dow's spectacular gains versus the price of Gold,
and more than just another mirage. Two new innovative technologies - called
horizontal drilling and "Fracking" - can
provide the US-economy with an abundant source of relatively cheap energy for
decades to come. As such, the Shale Oil Revolution has the potential to hold
down the US-inflation rate, and at the same time, enable the Fed to continue
printing money for longer periods of time, thus inflating equity prices.
US-oil output has already
risen for four straight years, and last year was the biggest single-year gain
since 1951. The boom has surprised even the experts.The
Energy Department forecasts that US-production of crude and other liquid
hydrocarbons, which includes bio-fuels, will average 11.4-million barrels per
day (bpd) this year. That would be a record for the US and just below Saudi
Arabia's output of 11.6 million barrels. Citibank forecasts US-production
could reach 13-million to 15-million bpd by 2020, helping to make North
America "the new Middle East." Increased drilling is fueling an
economic boom in states such as North Dakota, Oklahoma, Wyoming, Montana and
Texas, all of which have unemployment rates far below the national average of
7.6-percent.
The major factor driving
domestic production higher is a newfound ability to squeeze oil out of rock
once thought too difficult and expensive to tap. Drillers have learned to
drill horizontally into long, thin seams of shale and other rock that holds
oil, instead of searching for rare underground pools of hydrocarbons that
have accumulated over millions of years. To free the oil and gas from the
rock, drillers crack it open by pumping water, sand and chemicals into the
ground at high pressure, a process is known as hydraulic fracturing, or
"fracking," that has unlocked enormous
reserves of shale oil and natural gas.
Production from US-shale
formations is expected to grow from 1.6-million bpd this year to 4.2-million
bpd by 2020, according to Wood Mackenzie.That means
these new formations will yield more oil by 2020 than major oil suppliers
such as Iran and Canada produce today.Given that
US-oil output had been in decline for more than two decades, this is a
remarkable turn of events. And in another stunning turnaround, by the end of
this year, US-crude oil imports will be lower than at any time since 1992, at
41% of consumption.The US imported nearly 60% of
the oil it burned in 2006, meaning the US could soon become a net exporter of
energy.
Should the potential of
"fracking" materialize, it could have the
most significant long-term impact on oil prices of any supply event in recent
decades. Until recently, the growth in US-shale oil output wasn't sufficient
to meaningfully weaken global oil prices. However, it's had a notable impact
on long-term price expectations. For instance, thefutures
price of North Sea Brent, for delivery in December 2018, has been holding
fairly stable at around $92/barrel (bbl) for much
of the past year, and closed at $90.16 /barrel on April 16th. That's about
$10 /barrel below the current spot market price at $100 /barrel.
This inverted price curve
signals that traders expect a gradual erosion of oil prices over the next
five years, regardless of the amount of paper money that central bankers are
printing under their QE-schemes. The inverted price curve also differs
considerably from most of the prior decade when the back end of the oil
market closely followed spot prices higher. In 2008, in particular, the
five-year forward price of oil rallied to $140 per barrel as the front hit
$140, because no new supply source was evident to anchor expectations.
Since the first week of
February however, the price of Brent crude oil has been tumbling from as high
as $119 per barrel to as low as $98 /barrel on April 15th. Likewise, the
slide in crude oil prices chipped away at the underpinnings of the Gold
market. The apparent trigger for Gold's stunning collapse of roughly $230 /oz to $1,330 /oz was a warning
by Goldman Sachs, which predicted on April 10th that Gold would tumble
towards $1,350 /oz sometime in 2014. But in today's
world of lightning fast computerized trading, what GS expected to happen over
the next 12-months, was instead condensed into just a few days. Combined with
sharp declines for the prices of base metals, gasoline and agricultural
commodities, such as corn and sugar, the baseline of support for the Gold
market became un-hinged.
Even central banks were
caught wrong footed by Gold's downward spiral. Last year, central banks were
net buyers of 532-tons of Gold - their largest investment since the mid-1960's. Before the 2008 financial crisis, central
banks were net sellers of 400-to-500-tons a year.InDecember,
Russia added 20-tons to raise its gold reserves to 958-tons, propelling the
country up two places to sixth in the world gold holding rankings. Over the
last decade Russia's central bank acquired 570-tons of Gold, and now makes-up
10% of the Kremlin's foreign currency reserves. Turkey raised its hoard by
46-tons to 360-tons. In November, Korea upped its gold holdings by 14-tons to
84-tons.Still,traders watch the economies ofChina
and India - the top consumers of Gold, generating 55% of global jewelry
demand and 49% of global demand,
News that China's economy
grew by +7.7% in the first quarter, far less than its double-digit pace in
the past three decades, pummeled commodity markets, especially industrial raw
materials, such as aluminum, crude oil, copper, and rubber. China is the
world's top consumer of nearly all major commodities in its race to build
factories, offices and roads, voraciously consuming everything from copper to
coal. Thus, a slowdown in Chinese economic growth, together with the
deepening recession in the Euro-zone, led to a huge build-up of unsold
supplies of commodities in Shanghai warehouses, including those for copper,
and rubber.
Traders have deep doubts
about the credibility of China's economic statistics. Part of the reliability
problem is Beijing's near-total control over economic numbers, in some cases
meaning an outright ban on all others collecting competing data. China's
economic data is now coming under even greater scrutiny, since China's
growing clout in the global economy, means that its
reporting of key data can roil global commodity and equity markets.
Still, traders can
observe the price of key industrial commodities trading at the Shanghai
Futures Exchange, and the size of unsold inventories, to draw more reliable
appraisals of the health of the Chinese factory sector. On April 15th, the
price of natural rubber, dropped by more than -5%, skidding to 19,520-yuan
per ton, coming under pressure from a -10% slump in Tokyo rubber prices to
¥249 /kg. Inventories of rubber in top importers China and Japan are at multi-year
highs and demand from the automobile sector, the major rubber-consuming
industry, is slumping. This suggests that Chinese and Japanese rubber users
may choose to use up existing inventories in coming months rather than
continue importing.
The sharp slide in rubber
prices is all the more remarkable, considering that Thailand, the world's
biggest producer and exporter of natural rubber, together with Malaysia and
Indonesia agreed last year to cut exports by 300,000-tons between October and
March. The three nations account for 70% of the world's exports of natural
rubber. Aluminum prices fell to their lowest level in 3-½-years, tracking
falls across base metals tumbling to $1,818 /ton.
If commodities prices
continue to drop much below current levels, some high-cost producers would
start losing money, forcing them to shut down production. Moreover, base
metal miners and shale oil producers could respond to the drop in prices by
curtailing their expansion projects. For example, analysts estimate that the
highest cost Canadian heavy-oil producers need US Light crude to be trading
at least at US$85 a barrel to cover their costs, triggering talk in the
market of imminent output cuts. In due course, lower capital outlays would
translate into less supply growth, and eventually lift prices higher.
Until then, the Fed and
other G-7 central banks are sitting in the drivers' seat, enjoying the renewed
slide in commodity prices and subdued inflation pressures. Meanwhile, the
meltdown in the Gold market, -21% year-to-date
(y-t-d) has sent shockwaves through the commodity markets. So far this year
alone, Silver is -28% lower, Platinum is -10% lower, Copper fell to its
lowest level in 1-½ years, and is -11% lower, while aluminum hit a 3-½-year
low. Unleaded gasoline plunged 45-cents /gallon from a month ago to $2.76
/gallon today. Wheat is -11% lower, and sugar is
-8.8% lower, and Arabica coffee fell to $1.34 /lb,
a three-year low.
Weighed down by an across
the board sell-off, the Rogers Int'l Commodity Index (RICIX), is -5.6% lower
today, compared with a year ago. The RICIX remains mired in negative
territory, despite the doubled barreled money printing binges by the Bank of
Japan and the Fed, that's expected to pump as much as $2-trillion of freshly
printed paper currency into the world markets in the year ahead. Instead, the
deepening economic recession in the Euro-zone, the world's largest trading
bloc, and stalling economies in Canada and Russia is trumping the effects of
QE, and weakening the demand for industrial commodities.
Although a majority of
analysts profess to be wary of a dangerous bubble that's brewing in the in
G-7 bond markets, - the Fed has successfully enforced its policy of
"Financial Repression," with purchases of $45-billion per month of
US T-notes. Offered at a yield at 2.88% today, the Treasury's 30-year bond is
yielding -25-basis points less than a year ago. The Fed is simply following
the blueprints of the Bank of Japan. Although the US T-bond market is a
ticking time bomb that could explode at anytime,
for now, the Fed is doing a masterful job of rigging the T-bond market at
ultra-low yields, a job that is made a lot easier because of "fracking." In turn, America's transformation into an
energy exporter is expected to enable the Dow Jones Industrials and the
Transportation index to significantly outperform the Gold market, - no matter
which way the winds blow, - in the years ahead.
Gary Dorsch
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