by Rodney C. Cook, PhD aka BigFisherman. May 17, 2004
The pundits seem most dismayed by the market action recently. Who is going to buy the 39 billion in upcoming IPO's? After all, the Venture Capitalists are just now making a little money after their worse three years in history. And, like a Cheshire cat, the proceeds from the offerings tantalize them, just out of reach. It is an Alice in Wonderland market according to one pundit. I cannot disagree, but for very different reasons.
Stocks are faring poorly, weak even on good news. And when moderately bad news hits shares plunge. Money is leaving stocks. And leaving bonds too. So the dollar is getting a nice technical boost, despite further admonitions from the G-7 regarding US debt.
Mr. Market seems to finally sense that the prices of stuff are percolating up. The press is decrying milk hitting $4.00 a gallon. Many dairies were pushed out of business by the low prices of the nineties. Hey, that sounds like what Greenspan was saying about Natural Gas. Of course gasoline is a bit much, and breaking records. Again, the experts say the oil producers like Saudi Arabia have not invested in production capability since prior to the lows of the nineties. Oil prices this high can single handedly cause recessions, and it will take a few years to get relief. So, do you think that there is a pattern here? Are we running up against certain limits in lots of stuff? Is this a harbinger of hyperinflation? Should I plant a garden this year?
But the Fed isn't worried about inflation. When Greenspan discussed metals prices before Congress recently he attributed the price surge to inventory building and premium prices based upon China demand. He considered the prices paid to be unusually high especially for steel, and did not think that they would persist. How very prophetic.
So the possibility of inflation does not even enter his mind. But does the possibility of shortages enter his mind? It certainly does for natural gas in the US. So why not other commodities? Of course it is no surprise when Snow backs him up saying there is no inflation concern. And Bernanke says that there is no need to rush to an interest rate hike. The Fed can, as always, just follow the economy and the market. So at the very least, the market should have considerable trepidation regarding its interest rate expectations in the coming weeks.
But for now we have a market reset. There has been a massive shift in market sentiment towards discounting a full fledged economic recovery and aggressive interest rate hikes. With the long anticipated change in language from the FOMC meeting, the bond market is discounting a full one and a quarter interest rate hike by the "laggards" at the Fed. And it is being very pure about the effect of such a hike, expecting that it will work flawlessly to control inflation. Cyclicals and commodities are dead for now. The uberbulls want big rate hikes now, and will blame the Fed for any stock market declines here because they are �behind the curve.�
I am not so sure about interest rate hikes. Those leveraging the carry trade need lots of time to unwind their positions in an orderly fashion. The rumors indicate that the GSE's may not pull it off, but then my readers know that I think this is expected and planned for by the Treasury. Greenspan is still worried about the debt. He restated very recently that the deficits are a risk to the economy. And not too long ago he was going out of his way to deny any structural instability in the banking industry in the face of rising interest rates. There has been one heck of a push by the Fed in the public media warning traders out of the interest rate carry trade. The Fed has been melting the telegraph wires on this message, so I expect that they are distancing themselves from those too greedily leveraged to manage the inevitable rise in Fed funds. Anyone still exposed to the carry trade should be concerned here. So too should anyone with a variable interest rate exposure. In my opinion, any debt position not hedged with hard assets is unwise at any time, but especially now.
Such wisdom appears lacking in the housing markets. Half of all mortgages have variable rates. The worry over higher interest rates seems to have been conjured away for home owners: Recent new and existing home sales figures were outstanding. The feeding frenzy continues in most residential real estate markets. Most of us home owners are much richer on paper. And consumer confidence has soared in concert: After all, with housing bubbling right along all sorts of frivolities can be forgiven in a re-financing. The pundits croon that it will take a 4 point rise to slow down this market. Most homeowners would need a healthy increase in salary to handle the increased house payments. Or they would have to reduce their consumer spending. Retail sales figures are already showing declines.
But jobs do seem to be coming back. The ISM report was decent, indicating some temporary strength in beleaguered manufacturing jobs. And while the most recent job numbers indicate excellent growth, in digging deeper it does not appear to be sufficient in either number or quality to support the blistering economic recovery and resulting interest rates that the markets seem to be discounting. There was also a little noticed report that US corporations have increased planned layoffs. But if jobs do continue to recover significantly, then labor costs will rise. And, according to Greenspan, stagnant labor costs are the major element keeping pricing pressure low. So the Fed rate is tightly tied to the improving jobs picture. But this picture is less certain than most realize. The Fed has already achieved the effect on inflation that it wanted through jawboning. It will avoid the effect on debt holdings by putting of rate increases as long as possible.
The effect on gold has been profound with a series of sharp drops over several weeks. Gold ha been pummeled in old fashioned style. Even the initial drop as "Greenspan no longer fears deflation" in his testimony before congress felt like the bad old days of the gold bear where brutal price smashing was frequent and had lasting effect. Compared to recent pull backs, the sudden drops seem overdone: More than interest rates expectations seem to be pushing gold. Like the French central band gold sales announcement. There were even pronouncements that the Rothschild camp is getting out of gold altogether. Disturbing, if you believe it. Gold was hammered yet again on "news" that China would try to cool off its economy. The gold shorts jumped all over this opportunity to get penetration of the 200 day moving average and make some quick change.
The precious metals market seemed to buy in to it all. Shares are down dramatically. Gold newsletter sentiment has dropped to what is typically a low. Gold futures advisors consensus is at an astounding low: under 10%! And gold is weakening under its 200 day moving average. Many of those in the precious metals market for technical reasons have departed. Most new positions have been devastated. Recent entrants have left for the most part, unlikely to return. It seems that gold is only good for paying bounties to cut throat terrorists these days. Of whom there are plenty.
There is an accelerating decay in geopolitical stability. So I am concerned when I see the weakness in gold. It has stopped responding to geopolitical uncertainty along with the rest of the markets. Risk levels have certainly increased; however, the markets do not appear to have priced this in. And, most fascinating, Al Qaeda magazine is saying that they and their state sponsors will be extending their activities to the sphere of economics by attacking via the metals markets. Of course we here at Obscene Prophets are not the least bit surprised by this. Only saddened and dismayed that our monetary and political authorities have created such a huge vulnerability by ignoring the basic premise of our constitutional money system: Gold and Silver. The house of debt only needs an exogenous event to begin an implosion. It appears that those who seek to destroy us understand this ancient truth, and will attempt to supply this event. And no one seems to see.
So only long term fundamental precious metal investors with a multiyear outlook are strong here. Those that have taken profits along the way are more comfortable, and are preparing for more profits ahead. Those sitting on physical gold are the most comfortable of all. They note that China has not yet become a major purchaser of gold, so the effect on the gold price of its efforts to slow their economy may be just empty speculation. That the economic recovery and interest rate scenario is less certain than the markets believe. That inflation risk may be dramatically understated. That investor sentiment is at an extreme low. That the likelihood of a major terrorist event directed at the economy is very, very high. And they quietly buy.
© 2004 Rodney C. Cook, Ph.D.
Currently Rod is the founder and manager of Bull Trout Capital, a boutique investment company, and author of the FishWrapper, a private investment newsletter. Bull Trout Capital was founded to maximize returns based upon long cycle dynamics and Austrian economic principles. Dr. Cook uses internet based methodologies to identify sectors, strategies and shares that will most likely outperform at the current point in the cycle whilst maximizing upside exposure to potential economic dislocations. The FishWrapper features Dr. Cook's personal investments, methods and strategies where he has demonstrated extraordinary returns. Before Bull Trout he founded Sightward and authored patents (now owned by InfoUSA) to forecast human behavior on the internet; co-founded Ark Interface (now owned by xSides) to develop and patent innovative computer user interfaces; founded Optimas (now owned by Media Cybernetics) for medical and scientific image processing systems; and founded BioSonics' Imaging division and developed their Optical Pattern Recognition System. Dr. Cook began his career as a Biometrician for the International Pacific Salmon Commission applying his doctoral dissertation in applied pattern recognition from the University of Washington College of Ocean and Fisheries Science.
Rodney C. Cook, PhD aka Big Fisherman | The Obscene Prophet