This week saw a major change in position from some serious market students. Chief amongst them was Richard Russell the Dow theorist from dowtheoryletters.com. I admire Richard’s work immensely so when he stands up with a big change like this, I listen.
Richard had been extremely bearish on the stock market for over five years now. Then, wham, last week he decided to reverse his stance. I believe he now expects a serious correction and then a resumption of the bull market.
Thus begs the question, are we in a secular (20yr+) bear market or is it still a bull market?
More importantly, are we still right to be long-term bullish on commodities?
The devil, of course, is in the detail and in this case, it’s how we define a bull or bear market.
Here’s what we know:
If we define markets using relative values such as P/E ratios or as we commonly do, the Dow in terms of gold, it appears that 2002 was a watershed year.
In terms of gold, the Dow broke below a 20-yr rising trend line in 2002. This caused many market students to declare the end of the Bull market in stocks and the beginning of the bull market in gold and ‘things’ i.e. commodities.
Historical P/E ratios (not shown) followed a similar pattern topping out at an S&P500 P:E of 30 in 2000, correcting to 15 by 2003 and now hovering around 20.
In other words, in terms of gold, P/E ratios and foreign currencies (most notably the Euro), the ‘real’ Dow seems stuck in a secular bear market quagmire and has failed to take out the 2000 highs by a long shot.
However, in terms of nominal nollar values (top of chart), the Dow is making new successive highs daily. And it’s the nominal Dollar highs which get the media excited and attracts all the attention. Serious market students, like Russell, believe that a nominally priced Dow will discount the effects of the nollar losing its purchasing power and it may very well be doing that now.
A higher nominal Dow coupled with contracting P/E ratios and higher gold prices smacks of growth engineering through money creation
Nowhere is this more apparent than in this chart:
The strongest of the major Fiat currencies has been the Euro and the weakest the Yen. The Euro has been on tear vs. the Yen rising over 20% in a little over 1 ½ years. A rising Euro vs. Yen gives an extreme graphical of the Yen carry trade which adds a flood of liquidity into capital markets.
Now, it’s not by chance that the Chinese stock market (green line) has gone parabolic in the face of this mass of liquidity. Yes, fundamentally there is real growth in China, the likes of which we have never seen before. But historically all markets go to extremes when a good story meets easy credit.
Secular Bull in Gold and Commodities
The biggest surprise to me is how successful central bank monetary policy has been to buoy asset prices. Add in artificially low interest rates through dollar recycling and you get a world which believes inflation is not a problem and economic growth is great.
If commentators (such as Russell) are correct and the trend will continue for years to come, then imaginary growth will support higher commodity prices and bouts of inflation scares will boost Gold prices.
If people somehow manage to look beyond the paper facade and decide to protect themselves in a hurry, gold and 'things' will have an even brighter future ahead.
As to what will wake people form their slumber, I’ll handle in subsequent letters.