The Next Bubble?

You have no idea how pleased I am that NFTRH’s first week in existence happened to coincide with historic market and economic events.  Downside events.  If it was easy anybody could do it, right?

Some subscribers have noted that my writing tends to give them confidence in their positions, in their beliefs, when things get rough.  But I do not give pep talks.  All I can do is state the fundamentals as I see them and if they sound bullish, then so be it. 

Up to this point you may have known me as a chart guy and that is still the case, but over the last several weeks you will note that the charting has taken a back seat to what is really important now; secular (big picture) fundamentals.  Technical analysis may win some short term battles, and would have preserved capital to a greater degree, but I am no longer interested in short term battles.  I am interested in winning the war.

This is a war of misperceptions and misdirection.  It is the struggle to remain true to the big picture as the great global casino empties in the face of deflation.  It is important, even for someone like myself who knew the deflation event was coming, to remember the key nugget in the investment stance; a deflation impulse – possibly extreme – is needed as a lever (think of it as a lever to a trap door) that implodes the global inflation party that got whooped up compliments of Mr. Greenspan’s previous panic policy.  As I recall there was a lot of pressure on the maestro to ‘do something’, to re-liquefy the economy.  Well, he did and that liquidity, which had to go somewhere, did; straight into a credit and mal-investment bubble that was directly responsible for the bubbles in housing, certain stock market segments and yes, commodities.  That is all being unwound in the face of Armageddon, 2008. 

The most recent ISM report was dismal and is likely to show further erosion from September’s PMI of 43.5 upon release of the next report.

See complete details on the most recent ISM manufacturing report in this blog post.

Employment data are degenerating, prices are dropping and inflation is the last thing on anyone’s mind, including a now rate cutting Fed that pretended to be concerned as recently as its last FOMC meeting.  What a difference a few weeks makes.  From the Fed itself on 10/8/08:

Joint Statement by Central Banks

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. 

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

The results on the most recently posted money base (10/9/08 courtesy St. Louis Fed) are obvious. 

The danger, according to deflationists is that no matter how much ‘money’ global authorities throw at the problem, a black hole created by decades of credit/debt (as the primary macro-economic fundamental) is going to suck it all up with a near infinite appetite to correct the mess made by a system in its death throes.

The title of the piece is ‘The Next Bubble?’ and as I see it, there are two primary candidates; a bubble in financial Armageddon as policy makers’ efforts are rendered null and void by the ‘black hole’ and all hope is lost as even the word ‘depression’ will be an understatement, or a new bubble, in some asset class, as global money supplies shot out of fiscal howizers reach their intended target, the investment community. 

I will go with number two, because inflation is the increasing supply of money and with the deflationary backdrop and inflation fears nowhere on radar, policy makers have a free pass, a directive, to print as much ‘money’ as they can as fast as they can.  This makes Greenspan look like child’s play. 

The markets, gripped in fear and panic will take whatever time they need to come around to the new inflation cycle.  In fact, they will likely not respond in force until rising prices are evident.  But what I am interested in is the first movers in a new inflation cycle – aside from physical gold, a sound holding about which value, not price is key – and those first movers are likely to be the companies that dig gold out of the ground. Given their outrageous undervaluation vs. the metal itself, when they do emerge from the global stock panic, leverage to the price of gold, the asset outperforming nearly everything except the USD of late (just as it should be) is likely to come into play in a forceful manner. 

Picture an elastic band being stretched to near the breaking point.  If it breaks, it is all done.  Nice to know ya and thank you for having been a subscriber to NFTRH for a little while but I’ve gotta go now and hunt me some squirrels to serve the family for dinner tonight.  But if the policy takes… if the money supplies continue upward, this ‘money’ will have to go somewhere and it will not go back to where it was so unscrupulously abused in the last cycle, like the credit markets or an unregulated Wall Street.

No, I have to believe that the current crisis may actually inspire a bubble in sound thinking, at least in the early part of the cycle.  The fact is the gold miners are at historic undervaluation vs. the metal and the metal, their product which is first and foremost a monetary and investment safe haven, is outperforming nearly all global assets during the deflationary impulse, including miner cost inputs like energy and industrial commodities along with human hopes for prosperity.  Not to sound callous, but a worker who is thankful to have his or her job is more productive and cost effective than one looking over his or her shoulder at the next guy in a ‘I wanna git mine’ inflationary boom.

We will look more closely at the sector, along with my technical take and Otto’s full professional fundamental write up of a junior miner later in today’s report.  The markets will do what they will, and the results have been painful.  But the big picture has not only not changed, it has improved significantly given the combination of rising money supplies and deflationary depression panic.

More analysis follows for subscribers in the October 11 edition of Notes From the Rabbit Hole.

Comments

[freefall51:]

Something does not add up here. The price of gold seems to have topped out Jan 08 and it appears to gradually break down. There is still commodity unwinding going on which elevates the $ for another year or so, ie deflation. The customers are tapped out, credit cards are at the limits, the house prices down, the 401ks destroyed. Nobody is feeling rich. Lending practices will tighten no matter how much money supply there is. The christmas business is already in the tank, and jewelry is part of it. What else can you do with gold? Oh you can bury it in your backyard. In a situation like this the consumer will keep his hands on his wallet and not be willing to spend for discretionary stuff. There is no intrinsic value for gold. It is all supply and demand. There demand destruction now. Sounds familiar? If we are really in a recession/ depression gold will go all the way back to where it was in 2002, when we came out of the last recession.

2008 Oct 13 09:08 AM

[Chris B:]

So.... any information in this post?

2008 Oct 13 09:10 AM

[whidbey:]

Stands to reason that bubbles take bubbles to be in balance. Gold and PM in general will never be overdone since it is now clear they are the standard of value, so it must be the fiat levels that will be over done, and sure enough it looks that way - look at any measure except MZN and it is bloated.

2008 Oct 13 09:32 AM

[jcrash:]

because people see the huge bounce coming in equities?

2008 Oct 13 09:35 AM

[John Pseudonym:]

"The Next Bubble?"

How can you miss it; it's short term US Treasuries!

When that bubble bursts, interest rates will jump. Sending another crushing wave through the system.

What will burst that bubble?

1. Lack of confidence in the ability of the USA to pay it's debt; ouch!

or

2. All is well and we're back on our merry way to borrow/spend ourselves into prosperity.

I'm betting on #1...

2008 Oct 13 10:01 AM

[Mac77:]

Sun Tzu (Ancient Chinese general & philosopher) said "all warfare is based on the art of deception. If strong, pretend to be week and hold out a carrot to entice your enemy".

Interesting that CNBC (who's parent company is GE...with their finance divison) didn't refer to this market sell off as a "Crash" or "Cascading Crash" till Friday. Ooops! too late for you Mom & Pop investor.

Now they keep saying "look at Gold, it's not increasing in price..why it's no save haven at all". Even Silver (poor mans gold) sold off huge last week. Interesting that precious metals are not rising with all this market turmoil. Hmmm!

Anyone want to make a bet that we all see a sudden jump in gold someday and the media will say "Wow ..were did that come from."
Yea...I wonder!

Just a thought.

2008 Oct 13 01:46 PM

[HARM:]

"There is no intrinsic value for gold."

Actually, not true. Quite a few practical uses for gold, including non-corrosive electrical contacts (your PC likely has quite a few of them). By contrast, there truly is no "intrinsic value" for fiat currency --aside from the value of the paper it is printed on.

In any case, it's not the "practical uses" for gold that has fueled its meteoric rise over the past 6 years. It is gold's perceived value as an inflationary hedge and "safe haven" for preserving your purchasing power during financial crises --such as the one we're experiencing now.

You cannot easily "debase" gold by "printing" a lot more of it at will. It has to be mined, and cannot be produced everywhere on earth. It's recent rise reflects (well justified) insecurity about the financial system and fiat currency, not speculators' sudden interest in the metal. Its inherent scarcity renders it enemy #1 of inflationists and monetarist gamblers everywhere, which is a good reason why prudent investors should always have some.

2008 Oct 13 03:50 PM

[sieraromero:]

The reason gold and silver are not going up, is that everything is being sold! The markets [ALL] have been and will continue to be manipulated for some time now. We are no longer a free market economy and are being controlled by the elitist wealthy and powerfull of the world. Time to wake up ,people!

2008 Oct 14 08:52 AM

[Carl Spackler:]

The initial winds of this market are deflationary. Like a battleship, this economy needs time to get its momentum going - in this case its inflationary momentum. Gold might fall to $700 if some of these new gold investors become worried when they do not see instant inflation. After all, many of them are anxious for instant results that we all have come to expect. Six months to a year down the line, however, they may finally have the U.S.S. inflationary battleship going strong. Then you may see Gold finally rise.

Right now, too many GoldBugs are on the train and the weight is too heavy to take it higher. Timing seems right to lighten the load by having a good selloff.

2008 Oct 15 12:46 AM