|
March 27, 2005 - Recent
statements emanating from last week's Federal Reserve Board meeting roiled
the markets. Since all eyes are focused on the Fed, this is nothing unusual.
However, while the stock and bond markets responded to their inflationary
concerns as should be expected, the fashion in which various other important
markets reacted read like a chapter from "Alice in Wonderland".
The Federal Reserve stated
that, "Though longer-term inflation expectations remain well contained,
pressures on inflation have picked up in recent months and pricing power is
more evident". This statement came a day after the release of February's
Producer Price Index and the day before the Consumer Price Index was
announced.
Not surprisingly, the PPI and
CPI both showed significant price increases. February's PPI rose 0.4% which
following January's 0.8% rise. These were largely the result of soaring oil
and numerous commodity advances that had already propelled the CRB Index to a
24 year high. Further, February's CPI increased by 0.4%. All of this occurred
while bond yields were rising. They began a rapid ascent several weeks
earlier, indicating their fear of potential inflation
The above factors were already
well known by the marketplace. Yet, the Fed's belated acknowledgment of this
reality suddenly seemed to awaken the masses and move the markets into
action.
Immediately upon receiving the
judgment of the Fed, turmoil spread from market to market. Common stocks and
bonds plummeted, oil and gold were trounced, but the dollar staged a rally.
For those who understand how
inflation influences the markets, the declining actions of only bonds and
equities should have resulted from the statements uttered by our monetary
leaders. However, as if scripted directly from a fairytale, the other
inflation sensitive markets while they should have soared, were instead
hammered lower in price. The fact that the dollar strengthened only added to
the wonderment.
Under ordinary circumstances
the threat of inflation frightens certain markets while it emboldens others.
However, in this instance, all those that one would expect to be positively
influenced by the Fed's new inflationary concerns, weakened in unison. On the
other hand the dollar, which should have been aggressively sold, rose
skyward. To my mind, this created an incredible disconnect between the worlds
of reality and fantasy. I'll explain.
The primary reason why the
fear of inflation negatively influences bonds, equities and the dollar is due
to its effect upon interest rates. Rising interest rates are a byproduct of
inflation. They result when bond buyers demand a greater rate of return. They
hope this will compensate them for assuming the added inherent risk to which
inflation exposes them.
Inflation reduces the dollar's
purchasing power; it takes more dollars to acquire the same things as before,
so each dollar is worth less. This recognition drives bondholders to protect
themselves. They feel threatened that the return of their invested funds will
purchase less when they sell their bonds. This instills fear into their
hearts. It moves them to refrain from committing to purchase additional
domestic interest bearing securities. That is, until they are offered
sufficiently higher interest rates to offset their new risk.
Unrecognized by most
investors, inflation not only damages the economy and fabric of a nation, but
also the way of life of its people. Rising prices are rarely accompanied by
similar increases in wages. The higher prices place great pressure upon the
nation's masses in their effort to support themselves and their families.
This results because the increase in the general price level outpaces their
ability to pay for the necessities of life.
Further, as prices rise in a
nation state its economy falters and its citizens purchase less. They become
priced out of an increasing number of domestic markets. Business slows
further, and layoffs become widespread.
Also, their monetary unit begins
to fall on the world's markets as the demand for it weakens against other
currencies. Foreigners no longer need it to purchase their goods which could
be acquired more cheaply from other lands.
In order to return strength to
the falling currency, and to attract domestic and foreign purchasers for
their debt, the country's interest rates begin to increase across the entire
debt spectrum. This places added pressure upon the local debtors by
increasing their borrowing costs.
As their currency depreciates
against those of other countries the local cost of imported goods rises.
Similarly, commodities also increase in price, and raise the final cost of
the goods for which they are used. These events further exacerbate the rising
price structure and compound the problems that have already begun to work
their way through their society.
If prices are allowed to
spiral higher, the suffering of the country's citizens will escalate. Not
only can a business slowdown cause layoffs to soar, but the cost of living
can reach a level where life's necessities move beyond the range of an
increasing number of their inhabitants.
This will only be intensified
by the debt burdens which can become smothering. The rising monthly payments
limits people's disposable income, and must first be met before any other
expenditures are contemplated.
When prices escalate the
purchasing power of one's life savings simultaneously deteriorates. The way
of life that the country's people scrimped and saved to enjoy moves further
and further out of their reach. Retirement plans are dashed because savings
can no longer pay for the necessities and other items that they were expected
to and once could cover. Common courtesies and any concern for others fades
as their citizens become consumed by their thoughts and fears for their own
survival. This causes them to overlook those around them. Crime increases
because some suffering individuals feel compelled to take from their
neighbors in order to survive. Finally, these events enter a damaging downward
spiral.
Not a pretty picture,
inflation!
So what was so surreal about
the reaction by some inflation sensitive markets to the pronouncements of our
Federal Reserve Board members? To my mind, the only markets that reacted as
they should were the equity and bond markets. They plummeted, and rightly so!
For the others, they all went in directions that would have been more fitting
if this played out in an episode of "The Twilight Zone". Had the
Federal Reserve Board made a similar announcement during gold's great 1970's
Bull Market, the dollar would have sharply sold off and gold would have
experienced an excited rise.
The reason given by the media
for the strong dollar rally was, as a New York Times subtitle read,
"Higher Interest Rates Strengthen the Dollar". All things being
equal, it is true that higher rates will make a nation's currency more
attractive compared to competing ones. However, conditions were not equal. In
light of potentially rising inflation, the fear of the currency's reduced
purchasing power should greatly overshadow the minor positive effect that
"measured" rate increases offer. It should act to panic people into
selling their dollars for the reasons given above, not into buying them.
When the Fed made their
pronouncement, gold and oil immediately fell in after hours trading. When the
commodity markets opened the next day most followed suit and fell in price.
At the first opportunity, aggressive selling hit all of the historically
inflation benefiting markets. Simultaneously, aggressive buying entered the
dollar market and carried it higher. Given the implications of the Fed's
statements, it boggles the mind that both gold and oil immediately met
forceful selling pressure while the dollar attracted huge buying interest.
Why?
For the past few years, the
Gold Anti-Trust Action Committee (GATA.org) spearheaded by Bill Murphy, has
highlighted numerous unusual attacks on gold. These typically occurred in the
aftermath of similar bullish gold and bearish dollar news. Mr. Murphy has
repeatedly brought these disparities to the attention of his readers. He
believes that they are not normal market occurrences. It is his contention
that the Federal Reserve or the U.S. government have been managing the gold
and dollar markets in a similar fashion as they have interest rates.
Gold is anathema to
politicians. It forces them to act in a fiscally responsible fashion. Since
the beginning of civilization, whenever a government abused its monetary
unit, gold acted as a warning signal. It's rising price loudly announced that
all was not well with the country's money.
In1961, the U.S. and seven
other nations formed the "London Gold Pool". It's acknowledged
mandate was to maintain the gold price. Whenever gold rose they sold the
yellow metal into the market to return it to its fixed $35 price. They
continued in this fashion until the spring of 1968. This is when the market
overwhelmed their efforts and, in a matter of two days, drove gold from $35
to $44.25 an ounce. Inflation was in the 3% to 4% range during this period,
and the governments were more open about their gold market intervention
policies.
If Bill Murphy and GATA are
correct government sanctioned management of the dollar and gold does indeed
occur at minimum, at critical junctions. Further, it is likely that the
surreal action of the dollar, gold, and possibly oil have just witnessed the
government's hand in action.
On a positive note! If this is
truly the correct analysis for last week's dollar, gold and possibly the oil
market's price actions, it may not have entirely negative implications for
long-term investors. Certainly futures traders and margined gold holders will
be damaged. However, gold equity and physical gold investors will be given
the opportunity to increase their ultimate profits. This will occur because
the eternal metal's Bull Market will be extended by our government's
intervention. It will not only last longer but it will be driven to greater
heights. In effect, their efforts to retard gold's rise will give us a longer
opportunity to add to our positions, and to benefit from a higher gold price
than we would have otherwise. Unfortunately, we will be forced to endure the
fall-out from the causes that will drive gold to its final peak.
In any event, for all those
trading the gold and dollar markets, be forewarned. Be prepared for similar
attacks at crucial points or for announcements that are accompanied by
surreal price movements in the dollar, gold, bond and other inflation related
markets. Their repeated occurrence will likely continue.
*******
The
above was excerpted from the April 2005 issue of Financial Insights © March
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
information contained herein is at the risk of the reader without
responsibility on our part. Past performance does not guarantee future
results. Dr. Appel does not purport to offer personalized investment advice
and is not a registered investment advisor. The information herein may
contain forward-looking information within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. In accordance with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the statements contained herein that look
forward in time, which include everything other than historical information,
involve risks and uncertainties that may affect the company's actual results
of operations. © 2005 by Dr. Richard S. Appel. All rights are reserved. Parts
of the above may be reproduced in context, for inclusion in other
publications if the publisher's name and address are also included for
credit.
|
