Don Vialoux: Increase in Volatility Between Now and October Seasonally Common

Friday, August 10th, 2012

by Don Vialoux, EquityClock.com

Upcoming US Events for Today:

1. Import/Export Prices for July will be released at 8:30am.
2. The Treasury Budget for July will be released at 2:00pm. The market expects -$71.0B versus -$129.4B previous.

Upcoming International Events for Today:

1. German CPI for July will be released at 2:00am EST. The market expects a year-over-year increase of 1.7%, consistent with the previous report.
2. Canadian Net Change in Employment for July will be released at 8:30am EST. The market expects an increase of 8,000 versus an increase of 7,300 previous. The unemployment rate is expected to remain unchanged at 7.2%.

Recap of Yesterday’s Economic Events:

The Markets
Equity markets ended flat on Thursday despite better than expected reports in the US pertaining to employment and international trade. Volume was once again deadly, amounting to the lowest four-day volume in 5 years. In an article posted by Zerohedge.com, the website notes that “the last 4 days have been the lowest volume for a non-Xmas holiday week since 2007 in futures and NYSE volumes are just remarkably bad compared to even normal cyclical seasonal dips.” Looking at the 4-day simple moving average of the S&P 500 ETF (SPY) volume, the last time the average was this low outside of a Christmas holiday week was October 2007, the last market high prior to the significant decline in the months and years to follow in 2008/2009. Volume confirms conviction, of which very little exists. Conviction to equities remains low as debate grows over the sustainability of the present rally that appears based solely on hope of further monetary stimulus from one of the major central banks around the world.

The divergence between price and volume can also be picked up on the NYSE Cumulative Advance-Decline Volume line, which is derived from the volume of advancing stocks less the volume of declining stocks. The NYSE recently managed to break firmly above the high of early July, yet the NYSE Cumulative Advance-Decline Volume Line has yet to accomplish the same. The pattern of this breadth indicator and price typically match each other, showing similar highs and lows, therefore this divergence just adds to the concern that conviction to equities is lacking, often a precursor to market declines should buyers fail to accumulate.

Sentiment on Thursday, according to the put-call ratio, ended bullish at 0.86. The apparent declining wedge pattern that can be derived from the ratio over the past three months is reaching a peak, which could imply a significant jump higher should the tendencies of this pattern be fulfilled. A significant move higher in the put-call ratio would likely be accompanied by an increase in volatility, a pattern that is seasonally common between now and October.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

• Closing Market Value: $12.37 (down 0.24%)
• Closing NAV/Unit: $12.39 (up 0.18%)

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* performance calculated on Closing NAV/Unit as provided by custodian

Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.

Copyright © Don Vialoux, EquityClock.com

Tags: Canadian, Canadian Market, Central Banks, Christmas Holiday, Conviction, CPI, Dips, Divergence, Don Vialoux, Economic Events, ETF, ETFs, Export Prices, Import Export, International Trade, Moving Average, Nyse, Stimulus, Trade Volume, Treasury Budget, Unemployment Rate, Volatility, Xmas Holiday
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Still in Holiday Mode (Tchir)

Monday, April 9th, 2012

by Peter Tchir, TF Advisors

With Europe effectively shut down today it looks like it will be a dull day.

Chinese CPI came in a bit higher than expected at 3.6%, and was largely a result of food inflation, tempering the hopes that China would ease more aggressively. PPI came in as expected at -0.3% signaling that the production slowdown continues.

Portuguese banks borrowed a new record from the ECB. The path and trajectory seem clear and a Greek-like restructuring seems the only likely outcome. European politicians remain afraid of letting the “contagion” spread, but the reality of the situation seems pretty obvious, let foreign banks take a loss now on Portuguese bonds, or shift more of the burden to taxpayers while Portugal continues to deteriorate – making the final cost higher, and letting the people who originally made the mistake avoid the losses.

The only thing the market here really has to focus on today is the jobs situation and what it means for QE. There is a fair amount of “spin” out there today showing that the job data wasn’t out so bad. Frustratingly, at least for me, is the number of people who denied the weather effect or seasonal adjustment problems, who are now talking about those factors as though they believed in them all along. Clearly economists didn’t believe them, or else expectations wouldn’t have been 100,000 higher than the actual number.

The job report was not horrible, but not only had expectations outpaced reality, a housing recovery had driven by the increase in jobs had become conventional wisdom. With poor housing data all year long, and this subpar jobs report, the hope for a material bounce in housing has diminished greatly – or at least it should have. The shattering of the myth of the jobs led housing recovery is having a bigger impact on the market and is more important than just missing on jobs alone.

The weird thing about March is that the weather was also great. Those who are now blaming the weakness on earlier great weather seem to be missing the point that March had a lot of great things going for it as well. The weather was great, and it should have been less affected than January and February by capital goods tax breaks that expired in year end. Thinking that March covered the “weather and seasonal adjustment” pullback is likely wrong, and the April number could be downright scary.

We haven’t heard the QE arguments yet, but that is likely to start in earnest. Big firm after big firm is likely to send out a report discussing how the masses had not only written off QE3 prematurely in any case, but this NFP number bolsters the case for early action. If Ben alone could make the decision, I would fully agree, but in spite of his power, there seems to be enough dissent to the policy that maybe, just maybe, he will need something worse than 120,000 jobs to make a compelling case for another round of balance sheet inflation and degradation (increasing the size of the balance sheet with more risky assets).

Look for a bounce at some point today. The fact that the futures haven’t really been able to bounce, and in fact have traded in a very narrow range despite the size of the initial gap lower, makes me think stocks themselves will struggle more on the open. With short covering and some real last “buy the dip” attempts, using the “not so bad” and “QE” chatter as justification, we probably see levels better than the current levels at some time today. I will be looking to add some risk around the open, particularly in SPX, IG18, and HYG.

Tags: Contagion, Conventional Wisdom, CPI, Dull Day, ECB, Economists, European Politicians, Foreign Banks, inflation, Myth, Ppi, Production Slowdown, Qe, Restructuring, Seasonal Adjustment, Taxpayers, Tf, Trajectory, Weather Effect, Weird Thing
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There is No Such Thing as Harmless Price Inflation

Monday, March 19th, 2012

This article originally appeared in the Daily Capitalist.

A “little” inflation will destroy capital, rob you of your savings, disrupt all of your long-term financial planning, create market instability, and leave you unprepared for retirement. You can protect yourself and you must.

Price Inflation

The Bureau of Labor Statistics released their official Consumer Price Index for February on Friday (up 0.4% MoM; up 2.9% YoY):

We also have the BLS seasonally the so-called “core” measure of prices ex. food and energy (up 0.1% MoM; up 2.2% YoY):

According to most economists including the Fed, this “inflation” is modest and acceptable, if not desirable. The 2.9% annual rate is more or less within the Fed’s target for “inflation.”

There is much criticism about the CPI indicators. But, you can pick other measures. In fact inflation can be whatever you want it to be.

For example, if you are wary of the BLS measures, then there is John Williams of Shadowstats who has two measures. One is based on the same methodology that the BLS used in 1990 (up 6.2% YoY):

Or, if you prefer, there is his version of the BLS’s 1980 base year methodology (up 10.2% YoY):

Or you can use the MIT Billion Price Project annual index which is up 2.8% as of February 1:

Another way to look at it is this way, the devaluation of the dollar since the creation of the Fed:

Today the value of the dollar is about 3¢ as measure from1913 when the Fed became our central bank.

Understand that there is a lot of criticism of each of these measures of prices. What each one is trying to tell us is how much our dollars have depreciated from month-to-month and year-to-year.

I don’t know which of the above is the correct measure. In fact I don’t think there is a correct measure because it is a very complex problem to measure prices over time and everyone spends differently. I think the better measure is more related to money supply, but that is a different topic. In general I personally believe that prices are higher than what the BLS reports, but I’m not a statistician.

I think the most important thing for us to know is (1) whether or not prices are constantly increasing at whichever method you choose, and (2) how fast the monthly and annual rates change. Steady price inflation will kill you over the longer term. Rapid changes in the rates of change can wipe you out.

I don’t mean to state the obvious here, but we all need to protect ourselves from the dollar’s devaluation or we will become poorer and poorer over time. I bring this up because I don’t think most people understand what a “little inflation” can do to one’s long-term financial plans. If prices rise a steady 3% per year, for example, I know my $1,000 savings is going to have to be $1,344 in ten years just to stay even (i.e., it’s worth 34% less).

And if you think assets and wages always keep up with prices, the past two recessions should dissuade you from that thought. Right now we have a situation where the dollar is continuing to devalue and workers wages are actually going down. Here is Friday’s report on real (i.e., inflation adjusted) earnings (down 0.3%):

If the Fed keeps on creating these booms and busts which first lead people down a path of wealth destruction (what’s your house worth now?) and then they devalue the dollar (i.e., “print” money) in order to try to stimulate a recovery but which further destroys capital, how can one get ahead? From the data, it seems that most people aren’t getting ahead. In fact the system is now geared more toward the One Percenters who thrive on the financialization of the economy.

The Fed knows exactly what it is doing. While the official line is that the U.S. wants a “strong” dollar, the Fed and the federal government are doing everything they can to devalue it. Chairman Bernanke believes that a little bit of inflation is an acceptable trade-off because it spurs economic growth. Why he thinks the destruction of wealth is the road to wealth is not a mystery: it is the foundation of contemporary economics of which he is an advocate. He understands that printing money causes prices to go up, and thus he is consciously devaluing the dollar.

If printing money were the elixir of prosperity, bankers would have made us all rich long ago. It is too bad that Chairman Bernanke does not understand that Federal Notes are not wealth, but economic nanobots that consume and destroy that scarce resource, savings. Only the savings from the profits of production can create wealth.

What Do I Do?

“What do I do?” is the question I am asked most often. It depends on your level of wealth, but … It is likely that the longer-term will see higher price inflation than what we are now experiencing so this is a serious question.

I’m not trying to avoid the issue on how to protect your wealth, but we don’t give investment advice here. DoctoRx who follows markets at the Daily Capitalist has an excellent track record on investments, so I urge you to pay attention to him.

I will give you some categories of investment that anyone seeking to protect themselves from price inflation should consider:

Gold. You can buy physical gold or shares in companies that hold gold. The Doc has recommended PHYS in the past. The point is that gold is money, and is a refuge against instability.

Oil and Gas. This product will be in demand until cold fusion or the perfect sun-powered battery is invented. I like the idea of actually owning production and there are reputable drilling programs one can invest in.

Agricultural production. Food will always be in demand in an unstable world. This usually means investing in ag land, but there are farming partnerships one can invest in if one isn’t a farmer.

Stocks and bonds. I’m not a big believer in buy and hold, so you’ve got to know what you are doing, or you’ve got to invest in someone who does. I personally follow DoctoRx. There are many others, but you’ve got to do the research. Be wary of “track records.” There are still more Madoffs out there. The irony is that anyone with a fabulous track record (hedge funds and investment advisers) can require millions to hundreds of millions to get in. Most of the rest who invite you in eventually go to the mean (at best) or blow up (worst case).

Offshore assets. This is a bit of a snake pit, but investing in fast growing companies in friendly economies is a way to diversify out of the U.S. You can’t hide assets from your Uncle Sam, but … you can get good returns.

These suggestions aren’t new and many advisers who follow the Daily Capitalist or sites like it (are there any?) say the same things. So I am not telling you anything new.

This is a serious game. It is no secret that most Boomers don’t have enough assets to allow themselves to retire. I fear that most retirees will be reliant on the government to take care of them (Social Security and Medicare). If you have saved, but stuck the assets in a CD, you are getting poorer and poorer as those nanobots destroy your savings. It’s not an easy task and you can thank the Fed and the federal government for that.

Here are my basic rules:

1. You’ve got to have a plan and you must save. You must not spend all of your income. This seems so simple, yet few people really do it. There are many books on the topic of planning for retirement and how much you need to save. There are retirement counselors who can help you devise a plan. Just be careful of what they are selling.
2. You’ve got to do your own research and do not accept anything on the basis of a word or promise.
3. You must check advisers out. Don’t accept a demonstration portfolio, rather ask to talk to other clients and see their real-time results. If they can’t provide the information, go elsewhere.
4. Don’t give anyone your money to invest without keeping it in a segregated account. I understand that there are partnership deals and mutual funds where this isn’t possible. Investment advisers can have discretionary authority, but the money should remain in your name.
5. Does the person or firm giving advice have deep pockets? Are they audited by a prominent company?
6. Don’t pay attention to those who sell fear. We’ve all seen the ads on the Web about the certainty of imminent collapse. I’m not exactly an optimist about the economy, but fear as a sales tool has a false ring.
7. Generally those who have been around a long time have some credibility and staying power. Of course Madoff was a Wall Street fixture, but there is a good example of accepting his word on faith.
8. Stock brokers sell what their company tells them to sell. If they were really good, they would be running their own investment firm. As we have seen even the “great” companies such as Goldman Sachs can fail to serve their clients’ interests.
9. Pay attention to the business cycle. This is one of the things we try to analyze here at the Daily Capitalist. Where you are in the cycle is one of the most important thing an investor can know. Buying a home in 2008 would have been a bad move. Buying groceries.com before the Dotcom crash would have been a bad move.
10. If it’s too good to be true, it isn’t. Of course this is the Ponzi scheme hook. My theory is that boom-bust business cycles have created a meme of constant speculation in our society. People think that “the Big Guys” always have the inside scoop and that’s why they get rich (but see Lehman Bros.). They lose out on one cycle and when the next one starts and making money seems easy, they want in. This leads to susceptibility to Ponzi artists and advisers who confuse their boom phase success with intelligence (they quickly blow up in the bust).

This is hard work. But remember that we are all in the same boat.

Good luck.

Copyright © Daily Capitalist

Tags: agricultural, Annual Index, Bls, Bureau Of Labor, Bureau Of Labor Statistics, Capitalist, Consumer Price Index, Core Measure, Correct Measure, CPI, Devaluation Of The Dollar, Economists, Financial Planning, John Williams, Market Instability, Measures, Methodology, Money Supply, Price Inflation, Shadowstats, Target
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Albert Edwards Channels Conan – All Hope Must Be Crushed For A True Bull Market To Emerge

Thursday, February 23rd, 2012

While the bulk of tangential themes in Albert Edwards’ latest letter to clients “The Ice Age only ends when the market loses hope: there is still too much hope” is in line with what we have been discussing recently: myopic markets focused on momentum not fundamentals (“It’s amazing though how the market can get itself all bulled up and becomes convinced that we are the start of a self-sustaining recovery. And funnily enough there’s nothing more likely to get investors bullish than a rising market”), short-termism (“One thing you can say for the market is that it has an extremely short memory”), and that so far 2012 is a carbon copy of 2011 (“One thing you can say for the market is that it has an extremely short memory. Let us not forget that the performance of the equity market so far this year is almost exactly the same as we saw at the start of 2011 (in fact the performance has been similar for the last 5 months”), his prevailing topic is one of hope. Or rather the lack thereof, and how it has to be totally and utterly crushed before there is any hope of a true bull market. And just to make sure there is no confusion, unlike that other flip flopper, Edwards makes it all too clear that he is as bearish as ever. Which only makes sense: regardless of what the market does, which merely shows that inflation, read liquidity, is appearing in the most unexpected of places (read Edwards’ colleague Grice must read piece on why CPI is the worst indicator of asset price inflation when everyone goes CTRL+P), the reality is that had it not been for another $2 trillion liquidity injection in the past 4-6 months by global central banks, the floor would have fallen out of the market, and thus the global economy. In fact, how the hell can one be bullish when the only exponential chart out there is that of global central bank assets proving beyond a doubt that every risk indicator is fake???

Why every last bit of hope must be crushed:

One key lesson from Japan is that an essential ingredient to the end of a long valuation bear market is revulsion. It is when “buyers-on-dips” become “sellers-on-rallies”. It is when volume dries up to almost nothing. It is the loss of hope. In Japan we saw huge rallies in the Nikkei on the back of short-lived cyclical recoveries. Each cyclical failure and further new lows in the equity market saw hope being progressively crushed. Previous US valuation bear markets typically take 4 or 5 recessions to fully play out. We have only had two.

 

The market is once again in a hope phase – hoping that the US is now in a self-sustaining recovery; hoping that China might be soft-landing; hoping that the Greece bailout and the ECB liquidity polices have settled things down in the eurozone. These bursts of hope are essential in long bear markets. Essential in the sense that hope must be crushed. It will be crushed. Hope still beats in the breasts of equity investors. The market will rip out that hope and consume it in front of investors’ eyes. Only then can the bull market begin.

On why he is not a flip-flopper:

Arielle, one of our senior salespersons e-mailed me a couple of weeks ago with a question: “Hi, any change in your views? Just checking…as I have questions from Clients.” Reading between the lines I think the question was whether I am near throwing in the towel. Bloomberg reports that “Global Strategists Abandon Bearish Views After Missing Rally” – link. Rest assured, I am not one of them. What will make me more bullish? As I believe that we are still in the grip of a valuation bear market the answer is easy – cheaper valuations.

Edwards, like Janjuah, sees no point in trying to provide policy recommendations as there is nothing that can fix the system now – implicitly it is too late, as the Keynesian end-game has taken us too far. We had a chance with Lehman in 2008 to reset the system and to bring it to a sustainable footing; it is now too late with everyone dodecatuple all in on a faulty system.

It is easy to moan that policymakers are still making a mess of things and it would be fair to say that I certainly moan more than most. I find it far harder though, when I am asked what I would do if I was standing in policymakers shoes. Let me make an admission. I do not have the clarity of view that many have about the “right” policy prescription for the current macromess. There are just bad and less bad choices. The key thing for me was not to get into this mess in the first place and I was amongst the vocal for many years about the ruinous polices that were being pursued. For me it’s a bit like the old joke when you ask a local person the way to somewhere and the extremely unhelpful answer after much intakes of breath is “Well, I wouldn’t have started from here.”

Finally, while we have covered the topic to death, Edwards nails it on corporate profits.

A flattening of the profits cycle is exactly what you might expect as the easy, early cycle productivity gains come to an end. It is worth noting that the last time this occurred was just ahead of the start of the recession which the NBER date as having started in December 2007. Back then too, both markets and policymakers all felt the economy was still quite healthy. Indeed neither non-farm payrolls nor the headline ISM signaled the economy had already entered recession at the end of 2007 - indeed like now, payrolls actually accelerated in the second half of 2007, just as profits began to slip!

Pretty much covers it.

So to recap, Conan summarizes best what is best for a bull market:

Tags: 5 Months, Asset Price, Bank Assets, Carbon Copy, Central Banks, Colleague, Conan, Confusion, CPI, Doubt, Edwards, Flip Flopper, Global Economy, Grice, liquidity, Momentum, Price Inflation, Risk Indicator, Short Memory, Trillion
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China Cuts RRR By 50 bps Despite Latent Inflation To Cushion Housing Market Collapse

Saturday, February 18th, 2012

It was one short week ago that both Australia surprised with hotter than expected inflation (and no rate cut), and a Chinese CPI print that was far above expectations. Yet in confirmation of Dylan Grice’s point that when it comes to “inflation targeting” central planners are merely the biggest “fools“, this morning we woke to find that the PBOC has cut the Required Reserve Ratio (RRR) by another largely theatrical 50 bps. As a reminder, RRR cuts have very little if any impact, compared to the brute force adjustment that is the interest rate itself. As to what may have precipitated this, the answer is obvious – a collapsing housing market (which fell for the fourth month in a row) as the below chart from Michael McDonough shows, and a Shanghai Composite that just refuses to do anything (see China M1 Hits Bottom, Digs). What will this action do? Hardly much if anything, as this is purely a demonstrative attempt to rekindle animal spirits. However as was noted previously, “The last time they stimulated their CPI was close to 2%. It’s 4.5% now, and blipping up.” As such, expect the latent pockets of inflation where the fast money still has not even withdrawn from to bubble up promptly. That these “pockets” happen to be food and gold is not unexpected. And speaking of the latter, it is about time China got back into the gold trade prim and proper. At least China has stopped beating around the bush and has now joined the rest of the world in creating the world’s biggest shadow liquidity tsunami.

First, here is a chart showing the collapse in the Chinese housing market in all its glory – without a shadow of a doubt the primary reason for the PBOC to do what it did today:

Will the PBOC be able to redirect the “Austrian” money flow into ponzi encouraging prospects? Here is Sean Corrigan with some thoughts:

Chinese Real M1 joins that of parts of Europe, the UK, India, and several other, key EM nations in dropping into negative territory and hence strangling the monetary impetus towards both dubious short-term output gains and more certain quickening of the pace of price appreciation which has driven so much of the recovery so far. This means that only the US is left creating sufficient real new money to keep things supported at present – a phenomenon not surprisingly being reflected in its run of somewhat improved macro numbers in recent months.

For China itself, this is unprecedented – at least in the last 15 years or so during which China has assumed the role of marginal buyer of inputs a fortiori – and it represents the latest stage in a jarring, screeching, airbag-triggering deceleration from 2010′s extraordinary 37.5% growth rate. You don’t have to be an Austrian to see what this must imply for all the non-remunerative, hyper-Keyensian, ‘stimulus’ projects launched to offset the Western slump, post-LEH/AIG which litter the Middle Kingdom’s landscape, both figuratively and literally.

While we must be slightly tentative in our inferences – due to the disruptive arithmetical effect of that highly moveable feast which is the Lunar New Year – it cannot be denied that several other indicators – imports, container traffic, power consumption, for example – are also flashing Hard Landing Red here.

Watch this space…

Here is the MSM take on today’s event via Reuters:

China’s central bank cut the amount of cash banks must hold in reserves on Saturday, boosting lending capacity by an estimated 350-400 billion yuan ($55.6-$63.5 billion) in a bid to crank up credit creation as the world’s second-biggest economy faces a fifth successive quarter of slowing growth. The People’s Bank of China (PBOC) is on the course of gentle policy easing to cushion the world’s fastest-growing major economy against stiff global headwinds as Europe’s debt crisis grinds on, although it has been treading warily.

The PBOC cut big banks’ reserve requirement ratio (RRR) by 50 basis points to 20.5 percent, effective from next Friday, after repeatedly defying market expectations for such a move after it first cut the ratio last November.

“It’s not a big surprise. Although they (Chinese leaders) stress policy stability, an RRR cut is necessary. Trade and monetary data in January pointed to some downward pressure on the economy,” said Hua Zhongwei, an economist at Huachuang Securities in Beijing.

“But policy easing will be gradual given the central bank sounded cautious about inflation in its fourth-quarter monetary policy report.”
…

Slower growth also has ramifications for the world economy — already hampered by decaying demand from debt-ridden Europe and still under-spending U.S. consumers — given that China now adds more each year to net global growth than any other nation.

China’s leader-in-waiting, Xi Jinpeng, assured an audience of business executives in Los Angeles on Friday that China’s growth would not falter it would continue to rebalance its economy to import more from other countries.

“There will be no so-called hard landing,” said Xi, who is almost sure to succeed Hu Jintao as Chinese president in just over a year, on the final day of his tour of the United States.

The central bank announced its first cut in RRR in three years on Nov. 30, 2011, taking the rate down by 50 bps.

Investors had expected another RRR cut ahead of the Chinese Lunar New Year in late January, but they were wrong-footed as the central bank opted for open market operations to provide short-term cash for banks.

More meaningless RRR cuts coming?

“We still see four more RRR cuts in the remainder of the year,” said Shen Lan, an economist at Standard Chartered Bank in Shanghai. “The central bank may still stress policy stability. The next cut should be in Q2.”

Oh well, if the perception of encouraging inflation is what the PBOC wants, the perception of encouraging inflation is what the Chinese gold bugs get.

Tags: Animal Spirits, Austrian Money, Beating Around The Bush, Bps, Brute Force, Central Planners, Corrigan, CPI, Gold Trade, Grice, Housing Market, Market Collapse, Michael Mcdonough, Money Flow, Pboc, Reserve Ratio, Shadow Of A Doubt, Shanghai Composite, Time China, Uk India
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Is This Recovery?

Friday, February 17th, 2012

Guest Post: This article originally appeared on The Daily Capitalist.

There is a lot of good news to buoy the markets and give cheer to the public. We hear that new jobless claims are down another 15,000 to 358,000, the ninth week of declines out of the last ten, finally breaking below the 400,000 mark. A reduction in unemployment is a very positive sign and is politically significant. Also Gallup released its latest economic confidence poll and it is up to -20, the highest in 12 months, a very solid gain from the -54 score in August and September.  We heard as well that Greece may qualify for another round of funding to stay default (we are very skeptical of that). And, the S&P is very close to its 52-week high.

There is more. The official CPI was up 2.4% last year, a very modest and tolerable amount according to the Fed. Markit reports that the combined U.S. ISM manufacturing and non-manufacturing indices were up from 56.4 in December to 58.9 in January, hitting its highest level since March of last year. New orders in both surveys were up significantly. These data were backed up by reports of durable goods orders and factory orders. Data from many of the regional Feds confirm this.

Personal income increased 4.7% in 2011 versus an increase of 3.7% in 2010. Real disposable personal income (DPI) increased 0.9% compared with an increase of 1.8% in 2010. Real personal consumption expenditures (PCE) increased 2.2%, compared with an increase of 2.0% in 2010. State tax revenues increased 6.1% YoY according to the latest report.

What could possibly go wrong?

Are we in a recovery or not? This article will deal with this issue. I will briefly recap how we got here and the problems we need to overcome before we can call it a recovery. I will look at the reasons behind our current positive data. And then I will compare the current data to see where we are.

What is holding back recovery?

Economic recovery is quite simple when you think about it: bad investments and their supporting debt need to be liquidated. These bad deals are called “malinvestment” and our recent housing boom left huge piles of them for us to clean up. Think of it as the detritus of bad economic policies that led to bad business decisions. Massive amounts of capital (consisting of real and fiat “paper” capital) were lost during the resulting bust and there is nothing anyone can do about it. Keeping bad deals alive only serves to trap valuable capital into unproductive assets and delays recovery. New capital must be created through real “organic” production to get the economy going again.

The biggest piles of detritus to clean up before the U.S. economy can recover are:

• The asset and capital structure of our local and regional banks, mostly as related to real estate loans;
• The debt of small business owners, especially in relation to commercial real estate holdings;
• The debt of households in relation to home mortgages, student loans, and consumption-related debt.

All of the above have been important contributors to the stagnation of our economy. And all of the above, except student loans, have to do with real estate.

There certainly are other major issues this country needs to deal with that will also affect economic recovery. Those issues are political in nature and will depend in large part on the outcome of the 2012 elections. They are our budget deficit and huge national debt, tax policies, social welfare entitlement programs, and regulations which negatively impact capital formation and business expansion. These issues are not within the scope of this article but we have discussed them frequently here at The Daily Capitalist.

There is one further policy matter that is political in nature and that will impact the economy, and that is Fed policy which I will discuss.

Will consumer spending drive the economy?

Most economists and analysts point to the lack of consumer demand as being the economy’s greatest hurdle, but that is a symptom of a serious underlying problem rather than the cause. The cause is what Austrian theory economists call a lack of “real savings” (real capital). That lack occurs because, as noted above, the boom-bust business cycle, which we are still in the midst of, destroyed huge amounts of real capital/savings. (Household wealth declined by $10 trillion, for example.) We need real capital in order to have new production; without it, the economy stagnates.

To get production going manufacturers need to buy capital goods and commodities in order to make things. If they haven’t been produced and you have a fistful of fiat dollars, then there is nothing to buy and nothing to produce. If we could print real savings we would already be in recovery which tells us that fiat money, the stuff that the Fed creates out of thin air, is not real wealth. Real savings can only come from the production of things that consumers, or the manufacturers of consumer goods, want. Profits saved from such production or from saved wages of workers employed to make such goods, is real capital/savings.

The bottom line is that if we had enough real capital/savings, we would have already recovered. The fact that we haven’t recovered means that we don’t have enough real capital/savings. Flogging the consumer to spend will only impoverish the consumer and destroy more capital. Consumers need to save, not spend.

Will manufacturing drive the economy?

Manufacturing is an important part of our economy, but not as important as it was. The production of goods represents only 24% of the economy (services are 47%). There is no question that recently manufacturing has been improving. It is being driven mainly by manufacturing exports and auto sales.

What is causing this?

There are two parallel functions occurring that are giving rise to the current good economic news. One is the natural forces that cause an economy to recover. The other is the Fed’s policies to devalue the dollar and keep interest rates artificially low.

When I refer to “natural forces” causing a recovery, I am talking about market forces such as the liquidation of debt related to malinvestments, the devaluation of those malinvestments, and the formation of new real capital/savings. It is occurring naturally, often despite government policies, and is clearing the way for new production. But I believe it has been a very slow process and has not been sufficient to cause most of the positive economic news. I will discuss this in some detail in another article coming soon.

Much of the recent good economic news comes as a result of the Fed’s cheap dollar policy. It does two things to stimulate manufacturing:

First, fiat money devalues a currency. This is obvious to us as we look at a constant positive inflation rate and the decline of the dollar in relation to most other currencies. That devaluation makes U.S. goods appear to be relatively cheaper on foreign markets and stimulates demand for them.  Thus a cheap dollar policy stimulates exports.

Second, the Fed’s zero interest rate policy (ZIRP) which has driven down interest rates, stimulates demand for certain big ticket goods such as autos.

Exports

Exports represent about 14% of GDP and of that manufacturing exports is about 5% of GDP: a substantial factor. So when the dollar declines it stimulates exports and this is going a long way to revive manufacturing in the U.S.

Tags: Amp, August And September, Capitalist, Cheer, CPI, Declines, Disposable Personal Income, Dpi, Durable Goods Orders, Economic Confidence, Economic Recovery, Feds, Gallup, Ism Manufacturing, Jobless Claims, Markit, Personal Consumption Expenditures, State Tax Revenues, Unemployment
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You Can’t Print More Gold

Sunday, December 11th, 2011

You Can’t Print More Gold

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

What do you get when you mix negative real interest rates with stimulative money supply efforts by global central banks?
An exceptionally potent formula for higher gold prices that could send gold to the unimaginable level of $10,000 an ounce. Negative real interest rates and strong money supply growth are two key factors of what I refer to as the Fear Trade.

Negative real interest rates occur when the inflationary rate, or CPI, is greater than the current interest rate. A quick account of the G-7 and E-7 countries shows that the majority have negative real interest rates.

Across the developed G-7 countries, British citizens are the worst off with real interest rates in the U.K. sitting at negative 4.5 percent. U.S investors aren’t doing much better with rates at negative 3.25 percent and the Fed has all but guaranteed rates will remain there. Only Japan has a positive real interest rate among the G-7 and that rate is barely above zero.

Conversely, the most populous nations making up the E-7 have mostly positive real interest rates. However, the grouping’s grandest economic powerhouses, China and India, have negative real interest rates sitting around negative 2 percent.

Simply put, investors in those countries who have parked their savings in cash and low-yielding investments, such as Treasury bills and money market accounts in the U.S., are actually losing money due to inflation.

That can be tough for any investor, but when you’re the central bank of a country with millions of dollars in reserves, it can be catastrophic. This is why central banks around the globe have sought protection by diversifying their foreign-exchange reserves into gold bullion this year.

VTB Capital’s Andrey Kryuchenkov told The Wall Street Journal this week that, “Central banks are diversifying, and it has intensified to a rate that nobody had expected.” Latest estimates predict global central banks will purchase between 475-500 tons of gold in 2011.

This amount of capital flowing into gold has the potential to push prices up a level in 2012. John Mendelson from ISI Group sees gold prices reaching $2,200 an ounce during the first six months of 2012.

While real interest rates look to remain in the red for the foreseeable future, many of these same countries are printing record amounts of “green” with accommodative monetary policies.

U.S. Global’s director of research John Derrick says central banks around the world have focused their attention on stimulating growth. Beginning with Brazil’s interest rate cut in late August through the European Central Banks (ECB) cut this week, there have been 40 easing moves by global central banks, according to ISI Group.

John says this also means we will likely see more quantitative easing in 2012. The Bank of England has already started its quantitative easing, and many experts believe the ECB and the Federal Reserve will follow in its footsteps.

Bloomberg reports that global money supply (M2) is “set to increase the most on record in 2011.” The chart below shows the year-over-year change of global money supply has been gradually moving higher and higher since mid-2010.

The reason global central banks have shifted the printing presses into overdrive is simple: they need the money. My long-time friend Frank Giustra reminded us of this new reality in an op-ed piece for the Vancouver Sun last week. Frank writes:

“The bottom line is that the money needed to bail out Europe and to fund America’s spiraling debt and future unfunded obligations is in the ten of trillions. IT DOES NOT EXIST. It has to be created by printing money in massive quantities, and despite all the rhetoric you will hear against such policies, in the end it’s the path of least resistance. Printing money is an invisible tax on savings, much easier to initiate, than, say, raising taxes or cutting back on services and entitlements.”

As central banks print money and increase supply, currencies become devalued. Whereas in the recent past, one currency may be reduced in value compared with other currencies, this time there is global competitive devaluation as excess liquidity is put into the system. Historically, this excess liquidity has made its way to riskier assets, i.e. stocks and commodities.

Gold is generally a benefactor of this flight to riskier assets as many investors see it as a store of value. This chart illustrates the interconnectivity of gold and global money supply growth.

However, this image doesn’t tell the whole story. While the price of gold has followed the same upward path as money supply over the past 14 years, it hasn’t been able to keep pace with M2 growth, says the Bloomberg Precious Metal Mining Team.

In fact, if the global money supply were backed by gold, gold prices would be much higher, according to Bloomberg. The yellow line below shows how gold would be greater than $5,000 per troy ounce if just half of global money supply were backed by gold. If all of the money supply in the world were to be backed by gold, the price of one troy ounce would need to rise above $10,000.

It’s unlikely, of course, that this will happen, but it serves as a useful illustration for the disappearing value of the world’s fiat currencies.

Frank reminded readers that we have been down this path before. Frank says, “When great nations mature and over-extend themselves, they revert to the paths of least resistance: borrow and/or print money. They all did it and they all failed; this time will be no different.”

The beneficiary of this type of event has historically been gold.

Tags: Andrey, British Citizens, Central Banks, Chief Investment Officer, CPI, Current Interest Rate, Economic Powerhouses, Foreign Exchange Reserves, Frank Holmes, Gold Bullion, Gold Prices, Money Market Accounts, Money Supply Growth, Ounce, Populous Nations, Potent Formula, Real Interest Rate, Treasury Bills, U S Global Investors, Wall Street Journal
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The Economy and Bond Market Radar (December 12, 2011)

Sunday, December 11th, 2011

The Economy and Bond Market Radar (December 12, 2011)

Long-term treasury yields ended the week modestly higher as European leaders came together on Friday to form a fiscal pact that placated the market for the time being and led to a sell off in the long end of the Treasury curve.

While there was considerable anticipation and discussion regarding the outcome of the European Central Bank (ECB) meeting on Thursday and Friday’s European Union (EU) summit, the most important piece of data may have come from the other side of the world. The chart below depicts year-over-year inflation in China, which fell to the lowest levels in 14 months. The reason this may be so significant is that this could be a precursor to full-fledged easing in China, which has been the incremental global growth driver in recent years. If China were to cut interest rates, that would be a strong signal that global reflationary policies are back in force and boosts prospects for both global economic growth as well as appreciation in risky assets.

Strengths

• The EU leaders came to an agreement, in principle, on a fiscal pact that will hopefully lead to real reform and stabilize markets in the near future.
• China’s November CPI fell to 4.2 percent and opens the door to more aggressive easing policies in China.
• The University of Michigan Confidence Index rose more than expected in the preliminary December release.

Weaknesses

• Weakness is several Chinese indicators also increases the probability of an interest rate cut as China’s export growth and service sector PMI slowed.
• S&P put negative outlooks on 15 of 17 eurozone countries and the EU may lose its AAA rating as well.
• Factory orders in the U.S. fell 0.4 percent in October and September’s data was also revised lower.

Opportunities

• The Federal Open Market Committee meets next Tuesday and, while expectations are low for a significant change in policy, the Fed could surprise the market.

Threats

• The situation in Europe remains extremely fluid and negative news is almost expected at this point; unfortunately, it is politically driven and difficult to predict outcomes and ramifications.

Tags: Bond Market, Confidence Index, CPI, European Leaders, Eurozone Countries, Federal Open Market Committee, Global Economic Growth, Global Growth, Inflation In China, Market Radar, Open Market Committee, Outlooks, Pact, Precursor, Risky Assets, Service Sector, Strong Signal, Treasury Curve, Treasury Yields, University Of Michigan Confidence
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What’s Really Driving Gold?

Friday, November 18th, 2011

Nov. 14, 2011 – I was in New York to participate on a panel at Terrapin’s Commodities Week 2011 Conference. This is one of the most important gatherings of commodities investors and traders in the world.

I had the opportunity to stop by the InvestmentNews offices to speak with Mark Bruno regarding higher gold prices. One of several key factors influencing gold’s recent price action is negative real interest rates.

Whenever a country has negative real rates, meaning the inflationary rate (CPI) is greater than the current interest rate, gold tends to rise in that country’s currency. Right now, investors are losing money on Treasury bills and money market accounts because interest rates are near zero and inflation sits just under 4 percent.

I also discuss what I think could derail higher bullion prices and discuss how emerging economies are enjoying a rising GDP per capita and how this could influence gold.

Also, read about how gold is currently in season.

Tags: Bullion Prices, Commodities, CPI, Currency, Current Interest Rate, Emerging Economies, Gatherings, GDP, Gdp Per Capita, Gold Price, Gold Prices, inflation, interest rates, Investors, Mark Bruno, Money Market Accounts, Rate Gold, Terrapin, Treasury Bills
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Guest Post: Some Thoughts On The Policy Bias Toward Inflation

Thursday, June 16th, 2011

Submitted by JM, Via ZeroHedge.com

Some Thoughts on the Policy Bias Toward Inflation

Banks fear deflation.  They should:  sustained deflation will most likely kill the banks.  Also, since banks provide high-paying jobs to Federal Reserve types as kick-backs for well-aimed support while they are at the controls, the Federal Reserve fears it as well.  As long as they keep banks going, they will be well-taken care once they are no longer with the Federal Reserve.  Also, the only thing our current central banker in chief knows how to do to stimulate a basket-case is suppress nominal interest rates, or monetize debt.

I don’t really care much about the inflation/deflation debate much anymore, because to me it is aside from the point.  What I care about is what the yield curve looks like because rates drive everything.  Not much to chase away the gloom in this, just a way to think about stuff.

If you accept these curves, then a lender probably couldn’t care less about inflation either:  steep yield curve, very high inflation, hyperinflation (CPI up 50% a month), none of it matters.  This is because they can borrow at the short end of the yield curve lend farther out, and as a secured lender, they get recovery of the underlying asset in the event of default. The latter covenant is the most compelling reason in the world own banking stocks if (hyper) inflation is on your mind.

Consider that many risky ventures are financed with three to five year notes.  The borrower may receiver a longer term amortization schedule to pay down principle more, but the bulk of the note will end up as a balloon payment at the end which will need to be rolled.  In the very high inflation scenario, more cash flow will go into purchasing inputs, and if this input cost (programmer salaries, cost of fuel for travel) increase offsets the interest cost reduction, then a risky venture is worse off.

Now consider a risky venture that faced a giant balloon payment that they can’t possibly pay out of cash flow.  A lender will offer refi terms based on market rates—rates that are expected to compensate for inflation.  The business now has lost most if not all benefit from inflation-adjusted interest costs.  It may be that the business prospects are so poor based on rising input costs and now interest burden that the terms will be adjusted for the risk, putting the business in a death-spiral.  What recourse does the lender have in the event that this risky venture cannot afford to refi or make the balloon payment when the note term expires?  The bank takes possession of the assets.  They most likely are not experts in the venture, so they have tow choices:   subsidize the venture for a while with better terms than the market requires just to keep it running, or they will have to sell the business whole or in parts to recover a fraction of their investment.  Either way they lose a chunk, but they do not lose everything.

If a bank locks at least some funding needs in long term financing at a fixed rate, then banks will benefit from the erosion of this burden.  At the same time, their costs of inputs (mainly capital) will rise much less than most business lines simply because they borrow at fed funds or some interbank lending rate like it.  All they have to do is shorten their term risk.

If the yield curve ever did look like the hyperinflation scenario above, it is of course unsustainable and short lived.  But there will be little capital left after it is over.  Lenders will recover the real assets in the event of default, because there is no point in subsidizing a business that cannot possibly turn a profit.  Then they will liquidate the asset to the highest bidder.  Liquidation on a large scale will pretty much ensure that no business can turn a profit.  A sustained yield curve like the one shown above will reduce all activity to only short-term activities and ones that increasingly reduce to barter type transactions.  Nominal recovery may be higher, but there is not much they can do with the cash, other than move out of cash.

Tags: Amortization, Amortization Schedule, Ballo, Balloon Payment, Basket Case, CPI, Curves, Federal Reserve, Gloom, High Paying Jobs, Hyperinflation, Inflation Deflation, Jm, Kick Backs, Nominal Interest Rates, Offsets, Programmer Salaries, Risky Venture, Risky Ventures, Yield Curve
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