Weekly Musings 33 8-18-11
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For those who are new to the Musings: they are basically a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books. As always, I hope the Musings spark new appraisals and insights, and thank you for supporting the site.
Since I will be taking a few days off from the site, email and the media/news, the Week's Musings are being issued a few days early.
Gold, Silver, Inflation, Debt and Cash
There are two topics that are guaranteed to trigger waves of foaming-at-the-mouth hate mail:
1. questioning gold's rise to $2,000, $3,000, $5,000 and $25,000
2. suggesting the U.S. dollar might actually rise while all other assets drop
#2 is what I have been forecasting for months, and the fact that few analysts or players seem to agree only strengthens the notion that the market is so one-way now against the dollar that the snapback will be significant.
Because I am among friends here in the Musings, I can dare to reveal my doubts that gold will make it much past $2,000, and that perhaps silver is poised for a significant decline.
As I explain in my chapter on "hedging" in "An Unconventional Guide to Investing in Troubled Times," I think a very strong case can be made for holding some physical gold as a hedge against the eventuality of a currency devaluation/crisis.
But I am also a trader, and so I cannot help but look at markets in terms of standard deviations and the wild swings of human emotions (euphoria and fear) which are reflected in market swings.
I have no idea what the price of anything will be tomorrow, or next month or next year. My goal is to look at causal factors and attempt to discern which will take precedence over others in any given timeframe.
Here are the causal factors in play, and how I suspect they will play out.
1. Inflation caused by money printing and fiscal stimulus.
Central banks and governments flooded their economies with liquidity, money and credit for the past 3 years. Rather naturally, consumption of energy and other goods responded to the support of demand by rising.
Ironically--but not unexpectedly to skeptics--this stupendous unleashing of free money and credit did not actually spark new business growth or hiring of unemployed workers--its supposed goal--but it did spark inflation.
The spectre of out-of-control inflation will limit central bank quantititative easing everywhere from China to the U.S. to Europe. Those expecting a new flood of free money to support the stock market will be disappointed: that game has been played and lost. QE accomplished nothing of value and the political support for it has vanished.
Meanwhile, unprecedented trillions of dollars in fiscal stimulus propped up the Status Quo for a few years by replacing private debt consumption with public debt consumption. This too has failed, and the political support for unlimited fiscal stimulus has also vanished. Those expecting Central States to flood their economies with fiscal stimulus will also be disappointed.
Thus the two props under global consumption are being pulled away, and energy and other commodities will crash as demand plummets below supply. Some agricultural commodites might still rise, but oil will collapse as it did in late 2008, as it is priced on the margin. Few people believe this is possible, which is another reason I consider it very likely.
Inflation will fade once demand falls. It is simple supply and demand.
2. Printing money doesn't push this new money into the economy.
If the Fed, the ECB and China's Central Bank print trillions, this fresh money will just flow into bank reserves, as nobody wants to borrow money now that the bloom is off various bubbles (real estate in China, Australia, Canada, etc.) It is dead money, and won't spark demand or lending or inflation.
The only way to print money and get it into the economy is to literally print it (as opposed to creating credit) and send every household a check for $10,000. But even that might not do much more than enable more deleveraging, as debt is so much higher than assets for most households.
3. Incomes have stagnated/declined for most households while assets have fallen.
If we subtract all debt including mortgages from household balance sheets, most households would have negative value, as their mortgages exceed their total assets, including 401K and IRA retirement accounts.
The public is finally accepting that their incomes will be declining for the long-term, and so will their assets. In this frame of reference, what makes sense is to hoard cash and pay down debt to reduce monthly expenses.
4. Speculative bets in all assets classes have been funded by debt/margin.
As the central banks shoved trillions in free money into the global economy, players borrowed money in vast amounts to play the markets in commodities, stocks and precious metals. Now that those assets are collapsing in value, the debt remains and must be paid down.
There is only one way to raise cash, and that's to sell whatever assets still have value/can be sold at a profit.
Supporters of gold often note few people own any gold, and it is assumed that in a currency crisis, their desire to own gold will push it much higher. That dynamic may well come into play in the future, but I don't see it as a factor now for the reasons noted above: the deleveraging process and the over-riding need for cash.
Most people have few cash assets. Their financial assets are trapped in 401Ks and IRAs and can't be used to buy physical gold, only ETFs like GLD and SLV. The balance of their assets are fixed in real estate. The simple truth is most households don't have the ability to buy gold even if they wanted to.
What speculators and households alike need more than gold is cash to service their debt right now, and next month. Hedging against future disasters is a low-priority concern compared to staying solvent.
As I often note on the site, I tend to be early on trends, by years or months. Gold may continue rising along with the anxiety index, but it may be closer to topping out than most observers think.
Technical analyst Rick Ackerman has set a target of $1,893 for gold. If it easily surpasses that, then he will set a higher target. Round numbers act as attractors, and it's entirely possible that gold will leap up to kiss $2,000/ounce.
But once inflation is seen as reversing along with the cost of inputs such as oil, and as global demand plummets, then the pressure to buy gold will recede as the need to raise cash will take precedence.
Technically, silver has traced out a blow-off top and is now consolidating around $40. Technically, a retrace to the $17 level is possible if the above analysis is correct and people around the world need to liquidate assets to raise cash.
As noted previously, a technical case can be made for a target on the US dollar (DXY) of around 87, a 17.5% rise from the current level of 74. The ETF that tracks the USD is UUP, and in this scenario it might climb from $21 to around $25.
I would characterize the last three years as a global reflation with free money that has failed to spark organic economic growth but did ignite bubbles in risk assets and inflation anxiety. Commodities and risk assets leaped in response, and now they will fall as the political will to keep pushing failed policies has vanished.
This is not investment advice, it is thinking out loud about the causal dynamics at work in the global economy. I could be wrong about every factor described here; only time will tell which factors will take precedence over the other causal forces at work.
This is a thought experiment on how the consensus view of rising inflation could be wrong. The key words are "could be."
There is no From Left Field this week.
Please note I will not be collecting email for a few days. Thank you for your understanding.
Thanks for reading--
charles
