On Economic Cycles

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 |  Includes: GLD, PGB, SPY, UDN, UUP
by: Eric Coffin

From the October 2009 HRA Dispatch

David Coffin & Eric Coffin, HRA Advisories

Mayan Indian elder Apolinario Chile Pixtun has restated his belief that the world is not going to end in 2012. Or more precisely, that his beliefs don’t suggest the world should end despite it being the end of a major cycle in the Mayan calendar. According to China Daily, he is even more emphatic that he’s tired of being asked about it. 2012 is the end of a 5126 year cycle (end of the 13th of 13 Baktun). It also ends a 26800 year cycle that may relate to the Earth’s wobble, which is useful for gauging the drift of seasonal climate changes. China Daily also briefly mentions predictions by 16th century (Christian calendar) French herbalist Nostradamus that is being combined with the Mayan cycles to create buzz for a spate of movies and TV specials.

The Nostradamus’ predictions appear to be linear rather than cyclical. It’s hard to say since, like most good prophesy, they’re in code. The cycles described in Mayan calendars still have the more universal appeal. It’s comforting to think things will come around again. Mesoamericans outlined complex calendars that, we’re told, are quite accurate. That does make them useful to time planting, and also to justify the timing of power shifts. We assume feeding people generated much of the early buzz around star gazing, but as usual the technical breakthrough brought hangers-on.

Perhaps it will be 2012 when western economies at the centre of the debt/housing bubble hit that wall of resignation that creates a final bottom. That will partially depend on how the interest rate cycle plays out in each of them. Capital will continue to seek the safety of bonds for a while yet, assuming its not central banks doing all the buying. As long as yields stay low mortgage resets will keep some weaker players afloat. Bottoms are marked by capitulation, which for debt usually comes when rising interest rates submerge those still treading water. Yields would normally have to go a long way to generate this impact but this cycle features many overextended borrowers that need plenty of time to earn down debt loads.

Right now there is much confusion about whether a “typical” market cycle even applies. Asian growth economies that function somewhat differently than western markets (and differently than each other) are clouding crystal balls. These effects are skewed even more by price shifts against currencies. We seem to be between cycles, and probably are. In our little bit of the galaxy this means coming up with a new gauge for the price vs. inventories equation for copper and some other metals.

Most of the capital that flowed into copper earlier this year plans to use the stuff at some point, and sees potential for a supply squeeze. The question is whether taking a gain now will be rewarded with a lower buy-back price before the stocks are needed. Normally that would work but with metals being used as inflation hedges and pair trades against weak currencies prices (at least dollar prices) have gotten detached from the inventory cycle.

Notwithstanding last week’s new highs for gold, producer stocks move hesitantly, with plenty of traders waiting for “the other shoe to drop”, whatever that might be. Metals in general are continuing their anti-dollar rally. While we would still like to see falling inventories on the base metal side inventory levels have at least been flattening in the case of most metals and falling for zinc and aluminum. There is fear of bubbles and a multiplying list of grumpy bears now that the Dow has added a digit the way gold already had. Yes, a lot of this has to do with a flood of liquidity and speculation on what level profits (or the USD) might be at a year or two out. But, as we’ve noted several times recently its better to deal with the market that is than to try and tell it what to do.

Even though it’s considered the height of irrationality by some, renewed strength in many asset classes can continue as long as central banks flood the markets with liquidity and drive down the returns on competing assets like government debt.

The day may come when that won’t work any longer and bond yields take off so taking profits regularly continues to be a good idea. The day may come sooner when other central banks, the ECB in particular, start trying to jawbone their own currencies lower which could give the greenback a bounce and metals a correction. We expect that would be a correction however, not a panic, and those central banks will still have to prove they can back up words with actions. Jawboning is only a stop gap measure and the Dollar Index has breached several important technical levels on the downside.

There will be support for most markets as long as decent economic stats continue to be reported and there is belief that the recession is at least easing. While we agree this is mainly (but not wholly) a currency trade, the longs in commodities have reason to be skeptical that central banks will “get it right” or that some turn of events will create a new batch of Dollar bulls. Central banks do no have the best of track records when it comes to controlling liquidity flows.

It would be nice to have some magic ratio that says “metal X is a buy when inventories equal Y and the US Dollar Index is at level Z”. We would like to say we that we already know, but we can’t. Unfortunately, we left our code book in the other computer and, unlike Mayan calendars; we don’t think anything in this market is carved in stone.

Disclosure: No positions