Submitted by Mike Krieger of KAM LP
Let's Talk Markets
Chaos is not dangerous until it starts to look orderly.
- Max Gunther
I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.
- Thomas Jefferson
Anyone with eyes open knows that the gangsterism of Wall Street -- financial institutions generally -- has caused severe damage to the people of the United States (and the world). And should also know that it has been doing so increasingly for over 30 years, as their power in the economy has radically increased, and with it their political power. That has set in motion a vicious cycle that has concentrated immense wealth, and with it political power, in a tiny sector of the population, a fraction of 1%, while the rest increasingly become what is sometimes called "a precariat" -- seeking to survive in a precarious existence. They also carry out these ugly activities with almost complete impunity -- not only too big to fail, but also "too big to jail."
The courageous and honorable protests underway in Wall Street should serve to bring this calamity to public attention, and to lead to dedicated efforts to overcome it and set the society on a more healthy course.
- Noam Chomsky
The Worst Generation
Anyone that has been a long time reader of mine knows that in the past year or so I have transitioned much of my writing away from financial markets and toward social and political issues. There are several reasons for this but the primary driver is the fact that money in the bank doesn’t mean anything if we lose our freedom. The message I have been trying to get across to leaders of business in all industries is stop making these deals with the devil in order to take one more large bonus or beat EPS for another quarter. Your choices in pursuit of transitory wealth and status will be paid for by the loss of liberty and the tears of your children and grandchildren. Sadly, very few in positions of power in America seem to be listening and the lack of high profile/powerful people coming out and risking their own treasure for the long-term benefit of the Constitution and sacred values of this once great nation has been shockingly disappointing. To the so called “leaders” of America of today I send you a warning from the grave of the great Austrian economist and author of “The Road to Serfdom,” Friedrich Hayak. You will as a class be remembered as the worst generation in American history. A generation of leaders so filled with greed, hubris and selfishness that you sold out your nation without ever thinking twice about the tragedy that your silence would bring. A generation that never had the guts to risk any of their power or possessions for the good of their country. As Hayak so perfectly put it so many years ago about the rise of Nazi Germany…
The movement is, of course, deliberately planned mainly by the capitalist organizers of monopolies, and they are thus one of the main sources of this danger. Their responsibility is not altered by the fact that their aim is not a totalitarian system but rather a sort of corporative society in which the organized industries would appear as semi-independent and self-governing estates…But while the entrepreneurs may well see their expectations borne out during a transition stage, it will not be long before they will find, as their German colleagues did, that they are no longer masters but will in every respect have to be satisfied with whatever power and emoluments the government will concede them.
- Chapter Twelve “The Totalitarians in our Midst”
So in the end you will be also be made into a serf and for what? Was that last bonus really worth it?
Let’s Talk Markets
Ok, so as promised onto markets now. What is happening at the moment reminds me of 2008 in every way. We have seen tremendous inflationary pressures in the emerging world, which has now finally resulted in serious slowdowns in many nations. The China credit bubble, mal-investment house of cards that I first warned about in mid 2009 has started to unravel in earnest and this can be seen in industrial commodity prices such as copper. Europe is…well we all know about Europe. So in this type of environment the optimists will always invent a story that finds a silver lining. That’s fine, everyone is entitled to an opinion and clearly I have my own biases but I think the similarity to 2008 is what is important. Back then the spin was decoupling. Despite the blowup of the U.S. housing markets and it’s financial institutions, the spin back then was that the BRICs would keep growing and support the global economy. Of course, this is not the way it turned out and those economies plunged as well, just with a lag.
Well here in late 2011 we find ourselves in a similar situation; however, this time we are led to believe that the U.S. economy is the Atlas that will hold up the world with its strong corporate balance sheets and moderate growth. A bigger bunch of nonsense hasn’t been heard since 2008. That said, corporate earnings have held up in the U.S. better than in many other parts of the world and for the time being this makes it look better compared to the basket case situations happening in many emerging markets and in of course Europe. In a world where capital flies from one region or asset class to another in a split second we have seen U.S. equities vastly outperform most areas of the world this year. For example, the S&P 500 is down only 3% this year compared to -18% for Japan, -18% for Brazil, -17% for Germany and -22% for China. Let’s take a quick look at the Shanghai Composite.
Shanghai Composite One Year Chart
There is a huge disconnect between these two charts and in fact most of the world’s markets look like China’s. So who’s right? I think it is pretty simple. Capital has been hiding in dollar denominated assets, equities included. In my opinion, this creates a huge opportunity. That said, I think the best way to play this is not to just straight up short U.S. stocks but to long gold against it.
The Dow/Gold Ratio
I have been writing about this ratio for years saying that it would hit 1:1 by the time this massive macro cycle has run its course. All that this ratio charts is the performance of equities in real terms (it is the Dow Industrials/Price of Gold) and it has been in a consistent downtrend since the stock market bubble popped in 2000 (it has dropped from 42 to 7.6 currently). Within any trend there will be counter rallies and these should be seen as a gift to take advantage of. Due to the fact that I believe markets are now consistently manipulated by the world’s central planners, it isn’t even worth the time or effort to make short term calls as it was hard enough when there was some semblance of a free market. Nevertheless, I am also of the belief that central planners can only make markets do their bidding in the short term and that in the end markets will win. This brings me to the current opportunity.
Dow/Gold One Year Chart
This counter trend rally has now hit 32% since the mid-August low when sentiment on stocks hit a low and that for gold hit a high. This is the biggest rally in the ratio in over two years. Look at the RSI and see how overbought it is. It is also testing the 200 day moving average as we speak, a level that stopped the last counter trend rally in early July. Even if you are bullish on stocks relative to gold, this rally is extraordinarily stretched and I think people and algos will pick up on this soon enough and we will have a vicious move in the other direction. Of course this can occur in many ways. Stocks can rally and gold can rally more but this is not what I think suspect will happen. I think U.S. equities will get a reality check and join in the weakness of the rest of the world’s markets. My sense is stocks will fall and gold will generally consolidate. I rarely see opportunities like this and that is why I decided to write about markets today. Let’s not forget that despite the recent plunge, gold has once again outperformed stocks by more than 13% this year. I suspect even great outperformance in 2012, when I think the Dow/Gold ratio will hit at least 5:1. On a side note, I purchased physical gold for the first time in over a year yesterday. I rarely do that anymore since I did most of my purchasing in 2008/2009 and I only do so when I have very high conviction that the worst is over.
TF Metals Podcast
To conclude, I had the distinct pleasure of doing a podcast with “Turd Ferguson” of TF Metals. Since doing this interview I have spent quite a bit of time on his site and I have to say it is a must read for anyone in the precious metals sector. I am really pleased with how it turned out and I was able to cover some very important topics that I haven’t had a chance to in these pieces. You can listen to it here http://www.tfmetalsreport.com/podcast/3113/tfmr-podcast-8-mike-krieger . I hope you enjoy!
Peace and wisdom,