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Posts Tagged ‘gold’

Over the past few months the economic data has fallen off a cliff.  Personally, I think that we are seeing deflation really start to settle into the economy.  Over the past few years, it has slowly infiltrated everything.  Deflation occurs when the prices of everything decline.  Inflation occurs when the prices of everything rise.

When I say the prices of everything I mean the prices of investments, real estate, etc.  I also think that gold will be a good indicator to watch for deflation. Gold should not do well in a deflationary environment.  Gold may have seen its high. 

A debt crisis is also one of the primary contributors to a deflationary environment.  Think of deflation as the process of wiping out excess debt. 

It seems like the media is slowly catching on to the deflation theme that has been in then numbers for a long time now. I happened to catch a series of articles in the Wall Street Journal’s Ahead of the Tape column that I felt served as a great example.

June 10, 2010
Deflation is Worrisome but not a certainty.
“Yet investors shouldn’t confuse current conditions with outright deflation.”

June 17, 2010
Deflation isn’t a concern, at the moment.
“But it is only if the recovery stumbles that outright deflation becomes a real concern.”

June 30, 2010
Deflationary Mindset Makes Itself at Home
“The bigger worry is that a deflationary mindset has taken hold in the housing market.”

What we have been seeing in the housing markets for 3 years now is classic deflation.  It was the first part of the economy to get hit.  Deflation should be a real concern and should be here in full force in the event that we do fall back into a recession.  The media and most of Wall Street will not recognize it as a problem because of one huge issue.  There is no cure for the cancer of deflation except time.  The Fed has no weapons against deflation.

Stock Market

We are coming up to one of those “line in the sand” periods.  Over the next few weeks, we should quickly figure out whether this decline since April was nothing more than a correction or the start of a new bear market phase.  Stay tuned…

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We have had all types of bubbles in the history of the investment markets.  According to Jeremy Grantham, there have been 28 different types of bubbles from gold to art to real estate to stocks and even tulips.  Yes, there was an enormous tulip mania.  Bubbles are created out of a mania.  Manias are created from the notion that a great money making opportunity exists.  For example, we saw the stock market bubble that was created in the 90s due to the notion that these internet stocks were the next great thing.  These companies didn’t have any substance.  People were investing into the belief that an idea was going to be successful. 

Investors are doing the same thing today. We have an economy that has had economic growth based for the most part on one time stimulus.  We have a stock market that acts as if all of the bad news is behind us when, in reality, we have had a government that has been propping up the system. 

The underlying fundamentals are just not there for this economy.  There are serious imbalances.  However, the government wants you to believe that they are solving the problem.  The unemployment problem is on top of the list of the greatest problems we face.  This government has done nothing to fix this glaring problem minus the creation of some government stimulus jobs.  What is President Obama’s solution to the latest bad news in unemployment?  He announced Friday that he was going to create a job “summit” in December to figure out what to do.

First of all, he needs to be addressing the problems yesterday and not waiting until December to form a “study” group.  The reality is that while this bubble of hope is being created and the market is acting as if the government has everything in control, Americans are losing jobs, the foreclosure crisis is getting worse, and the landscape of our country continues to change drastically. You have states and municipalities facing bankruptcy.  The commercial real estate market is in trouble and could represent the next shoe to drop. 

In a bubble environment, reality becomes a real show stopper.  Remember just 4 years or so when people were flipping homes and acting as if home prices would never go down?  Well reality hit and you know the rest of the story.  I think that we are on the verge of seeing the same thing today with this artificially stimulated economy.  Wall Street is acting as if this is a normal cycle and the worst is behind us.  The government is arrogant enough to think that they can be this irresponsible, get away with it, and fix the economy when, in reality, that is the farthest from the truth. 

Then there is all of the mania surrounding gold.  This is all based on the assumption that we are going to get wide spread inflation when we are really facing a deflationary recession.  Don’t be fooled in thinking the price of gold cannot be cut in half.

Confidence is a fragile element that is the glue that holds everything together.  We went through a serious crisis of confidence last year.  We got some of that confidence back.  The problem is that this confidence is like the house built on sand.  Reality has a funny way of showing up.  

If the stock market were facing reality and not investing in “hope,” this market would not be anywhere near the levels that we are experiencing now.  Of course, you can make the argument that the stock market can go up with all of these imbalances present.  I would argue that we are facing serious and large imbalances.  This is not your ordinary situation.

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Did you ever wonder why mortgage rates have been so low this year?  Well, let me take you on a journey.  Mortgage rates are influenced by government bond interest rates.  Government bond interest rates are influenced by the price of Government bonds.  If bond prices go up, then interest rates go down.  In order to raise the money to pay for all of the irresponsible spending of the Government, the Treasury sells Government Bonds.  Institutions, other countries, investment firms, etc. buy the bonds from the Government.  That money then goes to work to pay for all of the spending created by the Government.

The Government has a lot riding on those government bond sales or auctions.  If they go well, the Government sells the bonds and gets the money, bond prices go up, and interest rates stay low.  Since most people don’t want to lend the US money because we are in so much debt as it is, someone had to step in and help buy those bonds.  Yes, the Federal Reserve Board has been buying bonds all year creating more debt and keeping bond prices higher and interest rates lower.  I will not even go into how incredibly irresponsible it is for the US to buy its own bonds.  That goes without saying – the problem is that program is coming to a grinding halt at the end of this week following the largest bond auction on record this week – 123 billion dollars worth of government bonds to be issued.  The Fed will get out of the way and the bond markets will be allowed to function freely again.  That might not be so good.

Interest rates started going up today and are at a 2 month high.  What happens when you suppress something that should be going up and then stop?  It is like compressing a spring.  If you let go of the spring, it takes off.  I think that the same thing could happen with interest rates.  If this happens it could disrupt the credit markets, consumer interest rates will go up, businesses will have even more trouble borrowing money, and homeowners will now have trouble getting low cost mortgages. 

The stock market would have a tough time with raising rates.  However, the rising interest rates should help the dollar. If the dollar is going up, the price of gold should take a hit.  Welcome to Deflation!  The economy might start the debt detox process that should have started when this crisis started. 

If you are looking for a catalyst, this could be it.  Interest rate risk is not something that the stock market is ready to face.  However, China and others would certainly like to see the value of our dollar go back up.

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A client of mine forwards me an e-mail from time to time that he receives from another financial advisor.  These e-mails are typically very positive on the state of the market.  I also find that they are filled with what I would refer to as market myths.  I thought I would share some of these with you.

(1)  Companies are showing strong profit reports – thus we are definitely in a strong recovery

Companies have slashed their expenses (and people) to the core.  It doesn’t take much to report strong earnings when you drastically cut your expenses.  Much of what is reported has nothing to do with actual profit growth and has more to do with the ability to cut expenses. 

(2)      Weekly jobless claims have been falling – that is a good sign

Every Thursday the government reports how many new people filed for unemployment benefits.  Over the course of the last few months those weekly numbers have marginally improved.   Does that mean that things are getting better in the job market?  I don’t think that the weekly number means much of anything at this point.  First, they should be decreasing just because companies have cut employment back just about as aggressively as they can afford to and still run a business.   Second, I would argue that the unemployment claims numbers still running this high is a negative.  As I pointed out, they should be on the decline.   Recovery in the jobs market comes as soon as companies start aggressively hiring.  This is something that we are not seeing.

(3)    The Price of Gold is signaling that we are heading for inflation

This is not necessarily true when there is nothing there to produce inflation.  Yes, we are printing money by the truckloads in this country.  However, that money is not being used to boost consumer purchases or being put together as new consumer loans.  All of that printed money is being used to absorb massive losses that would ordinarily not be there.  Remember that gold is a psychologically driven investment.  It does not have any value nor does it produce anything.  It is not a currency.  It goes up or down because people think that it should.  There is nothing to back up the price of gold.  The price of gold didn’t start going up until the dollar started having problems.  Ultimately, the government will do whatever it has to do to shore up the dollar.  However, longer-term, the dollar is in real trouble.

Economists declare that the recession is over – When the majority of economists thing one way, typically the minority is right.  Economists as a collective body rarely make the right forecast. 

This Week

It is all about earning, earnings, and more earnings.  It is very hard to predict how the market will react to earnings reports.  My guess is that companies will need flawless reports and near perfect outlooks for the near-term. Anything other than a show of strength might be tough for the market.  The stock market has very large expectations right now.   One thing for sure – this should make for an interesting week.

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Bob 

I appreciate your helpfulness & knowledge. I find it puzzling that you don’t put more emphasis on hard assets in this environment. Check out the Tocqueville funds 4 portfolios from Jan first & compare! Also, gold has been a winner each year for the last 8 to 9 years & was the only asset class to post positive returns last year!

ANSWER:
 
I realize that  Gold Bugs will strongly disagree with my opinion.  Hard assets are a good investment.  However, ultimately not in this environment.  As deflation continues to set in, gold will have a tough time continuing too appreciate. Gold does not historically do well in deflationary environments.  So, I see a few scenarios for gold.  First, Gold could go on a rampage for a few months and then go through a sell off like oil did last year or Gold could top here around 1000 (putting in a double top) and then start a decline over the balance of the year. 
 
However, longer-term we have a major inflation problem to deal with and I think that gold will be a great investment.  There is a little to much hype right now (much like oil last year) that indicates to me that we are seeing somewhat of a bubble atmosphere.  If gold does take off from here, I really do feel that we will see a similiar situation as oil.  When something seems like a slamdunk and every other commercial on cable tv is peddling gold, then there is a red flag.
Here is a good article on gold and deflation – http://www.elliottwave.com/deflation-gold-relationship.aspx
 
Actually hard assets wasn’t the only asset class to do well last year.  Bear market mutual funds did incredible last year.  This is an asset class that doesn’t get much press.
Keep the Faith
Bob

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