If conventional wisdom applied–namely that the stock market is driven by prospects of economic recovery–we never, never would see this kind of weirdness:
There is a pretty close inverse correlation between the 10-year yield and the S&P. What could account for this? NOT economic recovery, in which real interest rates rise. And not expectations of lower inflation–the spread between coupons and TIPS continues to widen and commodity prices are soaring.
Eliminate the impossible, and what remains, however improbable, must be true, as Sherlock Holmes liked to say. BOTH bond and stock prices are driven by the dollar. 17.5% unemployment by the broad measure keeps wages down and keeps the CPI low, despite the surge in commodity prices, while the cheap dollar makes US assets a bargain. Well, not exactly: the enormous reserve growth on the part of Asian central banks means that the Treasury’s debt-buying program has been outsourced to America’s Asian trading partners! No-one dares pop the bubble. It’s like what Woody Allen said about death. He wasn’t afraid of it; he just didn’t want to be there when it happened.
That brings us to Ben Bernanke, who reminds us of an emergency room doctor who plays with his gameboy while bemoaning the fact that you are bleeding to death. From Dow Jones:
In a rare move, Fed chairman Bernanke spoke about the weakness of the dollar, which has fallen in value recently as financial markets have improved and global economic activity picked up. “Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability,” Bernanke said, stressing that the Fed will continue to monitor the dollar’s value closely. The euro dropped sharply in response, falling below $1.49 from $1.4970 prior to the comments.
Alan Ruskin, at RBS Greenwich, says Bernanke’s comments “should end the debate that even at current weak dollar levels, the US has an ambivalent attitude to the dollar or, a policy of benign neglect. There is some sense here, that the Fed understands that additional USD weakness is not likely to prove benign.” Having said that, don’t expect the Fed to engineer a miraculous turnaround, is Bernanke’s message: the Fed Chairman is still relying on the underlying strengths of the economy to ensure a strong dollar.
I’m hanging on to my gold position. As I wrote on Oct. 7,
What’s the price of the last ticket on last train out of Paris on the night the Germans march in? Whoever is carrying the most cash will get it, and that will be the price. Robert Merton, the great finance theorist, showed that in a multi-time-period model, investors hedge against the prospective change in the investment opportunity set. If sufficient hedges are not available the price of such hedges can be arbitrarily high. As I have tried to show in several recent articles, most recently this Sept. 15 essay at Asia Times, gold is a hedge against the collapse of America’s central role in world affairs.
What is the correct price? Central banks alone own about 4.8 million tons of gold. The world produces about 2,200 tons. Suppose that central banks wished to increase their gold holdings by 1 percent. That’s 48,000 tons or so, or more than 20 times annual mining production. What’s the price elasicity on that sort of thing? How badly do you need that ticket out of Paris?
I’ve been recommending gold since June, for the last $100 or so of the runup, and I continue to hold my own cocktail of gold mining stocks and gold futures.
If the whole world, including the Asian central banks, man the bucket brigade–except with kerosene in the buckets rather water–the prices of real assets are going to rise. The best real assets to hold are the ones most sensitive to the degradation of the dollar.