He argues that bond yields are not normal and are reflective of a struggling economy.

"A normal economy would mean normal bond yields of around 4% to 5% for the benchmark 10-year Treasury, instead of the current 2.2%, or last month's 1.7%."

He seems to think the market can simply decide when higher rates are in order but that its current expectation of rising rates is somehow wrong. But what is QE? Bond buying is what it is. What does bond buying do? It drops rates. What does a lack of buying do? It raises rates. Simple supply and demand.

"But the market's expectations for much higher rates ignore just how far the economy is away from normal. In fact, right now the Fed is even further away from its dual goals of full employment and stable inflation than it was last September when it announced the QE3 bond buying program."

And just maybe Rex, the Fed is smart enough to know that pure bond buying is not the ultimate answer to getting the inflation to take. I mean, do you see the lunacy of your statement when juxtaposed against the premise of the entire article and indeed the point you are trying to make?

QE is obviously not working, so the Fed has to keep on promoting QE.

Ah, WTF? Just maybe the game is in transition and the next phase will feature that free money that the banks have ingested being marked up (by higher long term interest rates) and finally sent out into the economy. At least that makes some sort of sense. 'Keep doing what you are doing because it isn't working' makes no sense whatsoever.

http://www.biiwii.com

Taper to Carry

Last week we introduced the theoretical 'taper to carry' scenario whereby the Federal Reserve would indeed 'have the balls' to begin the end of traditional QE and transition the inflation via a new set of mechanics. Mind you, we still get inflation under this scenario, but it would be less stealth and more honest and obvious to the public. Here are the theoretical components of the play…

• Simultaneous ZIRP & QE have served to liquefy banks and maintain tepid economic growth while capping inflationary pressure, as banks hold significant reserves 'in house' until conditions are 'right' (read: profitable).

• There would be much public hand wringing about rising interest rates, which could undo the debt-leveraged economy. There would be a lot of noise in the perma-bear and gold bug camps that the Fed would not dare to taper QE.

• Yet taper they do, with the knowledge that the next 'fix' is already in. The rising long-term interest rates that would result from such action (tapering of bond purchase program, AKA QE) would immediately benefit the banks as they 'carry' the free money received from the Fed on the short end and roll it into profits by lending at higher interest rates on the long end.

• This process can be regulated as policy makers see fit. It is a "taper" after all!

All of the above imagines what could be an actual plan being promoted behind the scenes by entities far removed from this simple newsletter writer and his thoughts about what they will or maybe even should do. But I have yet to come up with (or be advised about) reasons why this scenario should be disqualified as a valid and rational 'next step' in the ongoing and systematic inflation attempt currently in progress.

I think that the last bullet point above is very important. Think about it; the smart man running the Federal Reserve has even introduced a word (taper) [edit: whether Ben Bernanke has actually used this word is irrelevant; its implication is front and center] that implies the process of transitioning the inflation from one form to another would be regulated as needed. He may be attempting control the pace of transition so things do not get too hot or too cold at any given time. Genius! If it works.

I think there may be recognition on the part of officials that the game of printing money out of old, bloated and un-payable debt while hammering gold (the early warning inflation barometer) is getting long in the tooth. Of course, this is not out of any sympathy for the gold bugs but rather a realization that a 'lukewarm and rudderless' economy against a systematic backdrop of debt monetization and money creation is not going remain politically expedient.

Enter our friends the Pigs (AKA the main players in the last doomed inflation and subsequent liquidation, the banks). This is simply the Greenspan playbook warmed over. Greenspan used different mechanics to create his credit bubble but the play was to get the banks to profitably 'carry' the spread and lend out into the economy. There is nothing new under the sun today if our 'taper and carry' thesis is viable and likely.

BKX-SPX Ratio (candlesticks) w/ TNX (blue line)

Last week the BKX ratio to the S&P 500 (candlesticks) took a hit but remained above the breakout line and this should remain a barometer to a confirmation of our would-be 'carry' play or a negation of it. So far so good. Long-term interest rates (blue line) also got through another week in breakout territory.

Against this backdrop let's remember that the Fed is only jawboning a QE taper, not an end to inflationary ZIRP. This looks like a well-scripted plan by intellectual inflators that are much more sophisticated than the great Maestro of the previous inflationary era. But then they have to be sophisticated because things are so much more leveraged in rising debt with the cost of failure a likely unwinding of the current system.

Bottom Line

'All or nothing' is the play and these players are winning (duh). Gold bugs and their quaint notions of honest money are losing (for now). Stock market bears - outside of an expected summer correction (which could play well into the script outlined above as inflation is best promoted against a worried public) may lose as well, at least for however long a new inflation cycle lasts.

If and when the banks become incentivized to get the inflated funds 'out there', asset prices are going to go up. This is what being bullish means in the current era, basically taking advantage policy designed to prop asset prices; i.e. inflationary policy.

Bear in mind that all the above is where a letter writer's logical thought process has taken him. But here is the thing, I sit down each weekend to write a letter, not make policy. I observe financial markets with an attitude of trying to find the honest answers as to what is going on in a very complex macro financial world. But I do not have the answers. I only have my own logic, which could prove to be wrong.

But for another week at least, the theory lives on. What would be even better for the theory is if in the days or weeks ahead the Fed jawbones continue to promote a 'taper' to QE, T bonds continue to drop (rates up) financial markets correct on this noise and the banks out perform the S&P 500, indicating the next inflationary solution. It's a tall order, but I'd rather have a game plan that can be revised or discredited than to be flying blind.

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I also read The Fed is NOT Printing Money by Jesse's Cafe', which offers a view into a money creation process that is more geared toward the gaming of the financial markets through intermediary banks than it is the normal inflation of old. I mean seriously, I do not call Ben Bernanke an evil genius for nothing; it seems that he and his associates have taken monetary policy to the Nth degree and figured out how to paint inflation as non-inflationary. Our hero.

The point is that I think Josh Brown is 100% right. There is no mania in stocks. In fact, stocks' worst offense right now is that they are strenuously over bought and sponsored by 'dumb money' aggregates that are equal and opposite to one year ago, when the same dumb money was exactly as bearish as it is bullish today. As he notes, the mainstream public may no longer be interested in the markets, but whoever that dumb money is, they proved a good indicator on an imminent bull phase last May. Again, we present the proof compliments of Sentimentrader.com:

Smart-Dumb money sentiment 1 year ago

Smart-Dumb money sentiment today

I have absolutely no problem being bullish on the stock market because it is made up of companies both bad and good; very good. After Memorial Day, my wife will re-start her career at a currently non-public technology company about which we are very excited. Its technology began as the founder's MIT thesis and is now rolling out into major markets and outlets. One brilliant kid, an idea, a market and voila.

I totally believe in human progress and what great companies like Microsoft, Intel and later Google and Apple have brought us. I believe in the software systems that are making the burdensome healthcare system more manageable and great companies the world over that fill a need, improve lives and win out in the markets of public opinion and financial transaction.

But the point I think the Reformed Broker is missing is what underpins the market of stocks in these corporations. Looking at the stock market as a stand-alone, I tend to agree with his viewpoint. But when policy makers are woven into the fabric of the market to this degree, they must be factored. Questions must be asked like "why on earth, with this excellent and healthy stock market and sufficiently functioning economy are they continuing to repress interest rates by buying $85 billion in bonds per month?"

Aren't those bonds debt? Where did that debt come from? Does bloated debt not imply that the economy in which the stock market's components ply their trade is a leveraged thing, as opposed to an organically thriving thing? Why can't we just let the debt float on the open market and let it get resolved by the market if things are so good beneath the surface?

I think you know the answers to those questions. That is the main point of bears questioning the stock market's fundamentals. Not the old PE Ratio canard. We are now in the post-PE world. What matters is policy because it is policy that has created the seemingly healthy stock market. So which side are you on; the side that sees the stock market and the stock market only, or the side that sees the stock market within the context of the universe in which it exists?

Biiwii.com, Notes From the Rabbit Hole, Twitter, Free eLetter

(click to enlarge)

Silver daily

Silver actually got near my target zone, which is 17-20. But there is a bump of long-term support elsewhere (noted this morning in an NFTRH update) that could hold for a rally or better. When items like gold and silver have been this badly decimated and people have come to hate a concept like honest money this vehemently (while being compelled to worship inflationary policy making), you need to give merit to the idea that the next rally could be the rally.

(click to enlarge)

Silver CoT

Silver's CoT data still shows some open interest by whatever gamers or evil interests there may be in the paper and digital markets, but its structure is very bullish. Yet until this morning, everybody hated silver.

Now, lack of follow-through and another flop would reset and extend the agony that honest money advocates have endured, but there seemed to be enough going on today in gold, silver and the associated stock indexes to stand up and take notice.

May/June is after all, the time frame we have been expecting for some pretty important changes in the macro markets. Did something happen today? We'll find out very shortly.

http://www.biiwii.com

Young FrankenMarket Lives

In failing to take a "healthy" correction to the equivalent of SPX 1350 to 1450 from the upside target zone of 1550 to 1590, the market is now running on policy and momentum. Hence we now dub thee Young FrankenMarket; Ben Bernanke's creation, sustained by government and legacy MBA debt, following Alan Greenspan's monster that was stitched together with artificially low interest rates that ultimately manifested in a huge commercial credit bubble.

Payrolls came in at 165,000 and an over bought, over loved* market popped its cork and exploded into blue sky. It had to be more than an okay 'jobs' report that did the trick. It was likely the combination of a still inflating Fed (and ECB, Europe popped hard as well) with some data that was good enough, but not so good as to call into question the Fed's systematic inflation regime. This is Bernanke's FrankenMarket, created by policy.

After making bearish patterns and/or negatively diverging from the Dow and S&P 500, the Russell 2000, Nasdaq 100 and Semiconductors all broke to new all-time (RUT) or recovery (NDX, SOX) highs on Friday. This left one notable holdout, the often-watched Transports. Since I normally do not give much weight to Dow Theory, I'll not do so now. But it should be noted that the Trannies are not at new highs… yet [edit: They are now].

So it appears that recent writing I have done about a topping process may have been incorrect or at least, early. The current period reminds me a lot of Greenspan's monster that emerged from the credit bubble early last decade, FrankenMarket as I called it in the first public article I ever wrote.

I remember wanting to be bearish [in 2004] because bearish seemed like the honest way to be. You cannot after all create (print) a bull market and a sound economy to go with it, can you? Well, yes and no.

Through interest rate manipulation, Greenspan created a bull market that really wasn't (as measured in gold, which stripped out inflation's effects and gave a 'real' and bearish view by the Dow-Gold ratio).

As noted previously, the But It Is What It Is website name came in large part due to my realization that the bull (in nominal stock prices) should not be fought as I looked around and saw (non-gold bug) perma-bears being blown up left and right. Any gold bull who was also bearish the stock market likely did just fine. But the play was long gold, and avoid or long the stock market.

Today we are challenged with a different monster. This one is more dangerous to the honest money contingent because it appears the golden shield has melted down and stopped protecting people from the obvious inflation being promoted in service to liquefying the banks, propping the economy and promoting a stock market bubble.

But here we have to take a step back and realize that it was 10+ years of bull bull bull for gold. Who are we to say what type of corrections should be suffered along the way? Stripping out the emotion, what we have is a really smart (I'd say diabolical in a way that is not entirely negative) policy maker who has somehow either engineered a 'best of all worlds' Goldilocks environment or taken the horseshoe out of his ass and hung it up on the wall of his well-appointed office.

I think it might be the latter, which in less crude terms means that it was just time for a technical adjustment. I hate to qualify the pain real people are suffering as an "adjustment", but think about it. The negative energy at the bottom of markets and the economy in 2008/2009 was incredible. This very letter reproduced the Time Magazine Depression 2.0 'breadlines' cover in support of its then bullish orientation.

Markets may need to work their way through an equal and opposite upside blow off before all is said and done. Who knows when that will come? It could be next week or it could be next year. But it is a near certainty that sentiment will play a big role.

For now, the trends are the trends, there are few signs that anyone is getting concerned about inflation and hence, the inflation continues. It is the Alice in Wonderland market:

"Nothing would be what it is because everything would be what it isn't. And contrary-wise; what it is it wouldn't be, and what it wouldn't be, it would. You see?" -Alice

* AAII (Individual Inventors) had been an inexplicably skittish exception, as its members have fled to a bearish stance at the first sign of every recent minor correction. This had been a caveat to the bear case and the market will now try to suck them and any other holdouts in before a top is realized.

Notes From the Rabbit Hole has been following events with great interest since the Fed's QE regime kicked in to its new phase (III), and technical analysis has kept us on the right side. When I named the newsletter I did so with Alice's quote above in mind. Never has the idea of accepting what is contrary and counterintuitive been so important for everyone from speculators to savers to honest money advocates.

We remain intact first, and ready for opportunity - that "contrary-wise" could be big opportunity - second.

Biiwii.com, NFTRH, Twitter, Free eLetter

Is Gold as an Investment Finished?

Before delving deeper into that question, perhaps we should see what the mainstream media thinks. In fairness to the MSM, we note there are plenty of articles on both sides of the debate. Yet there has been some media piling-on since the recent hard breakdown in gold. The aptly named Howard Gold explains:

The Case for Owning Gold Has Collapsed; Yellow metal could be headed much, much lower http://is.gd/h5KW6v.

Gold could be headed not much lower, but much much lower. This was written on April 18, when the value assigned to the monetary relic (AKA its nominal price) resided at $1391 per ounce. So be warned, Mr. Gold advises that gold could go much much lower. Gold bugs take heed; Mr. Gold himself has put the double 'much' whammy on you!

After critical support at 1524 was lost our first downside target of 1440 or so was sawn through like Balsa Wood. Okay fine. For those who micro manage every tick in the price of gold (I am not one), then here is the situation; the current little rebound must extend back up to and through the broken support level at 1440 or the next target in the low 1200's is up next.

See the weekly chart on page 3, which was produced 5 weeks ago in NFTRH 230. While not a favored outcome, recent events with gold's price are not surprising.

(click to enlarge)

Gold weekly chart

To review, the two potential points to watch for in the event of a breakdown from 1524 were the weekly EMA 200, which supported the 2008 decline and then the conservative measurement from the pattern breakdown, which is in the low 1200's, which also includes a visual support shelf from 2010. The less conservative measurement (the top at 1900 to 1524) would target around 1150.

So that is the price picture, now on to the fundamentals courtesy of Mr. Gold. From the article linked above:

"But gold's price could be headed much, much lower, said Campbell Harvey, a professor at the Fuqua School of Business at Duke University. Harvey has looked at gold prices over the centuries, and concludes that it's still trading at lofty multiples of inflation."

In the article linked above there is another link where you can download the research of Mr. Harvey and colleague Claude Erb - currently making the rounds like a good gold bug horror movie - that talks about gold's "real" price as measured by CPI and GDP. Boiling it all down, gold is historically over valued as compared to measures of the effects of inflation on consumer prices and relative to GDP.

We will steer clear of the debate about government number fudging, because it is a battle that is not necessary. The Federal Reserve and many of its counterparts around the globe are inflating, or trying their damnedest to inflate. They are using debt instruments to create money out of nowhere and pumping it into big banks, which are supposedly expected to release the money out to the public.

This could one day manifest in an out of control inflation problem (as measured by the lagging effects that Harvey and Erb call inflation, or resolve into a more intense deflationary phase as the thing that is just a whiff now gains momentum and swallows the entire spectrum of inflated assets in one big gulp of illiquidity.

The economy has depended on inflationary policy since the age of Inflation onDemand began under Alan Greenspan's oversight in and around 2000.

Ask yourself this; why are they inflating? Why are they printing money at a furious pace if the GDP is real and sustainable? The answer is likely because they know that the financial system is a leveraged thing that must not be allowed to start deflating because if it starts deleveraging, it is not going to stop until the books are cleared.

Gold vs. Commodities, What is the Message?

(click to enlarge)

Gold-CCI Ratio, weekly chart

The authors noted above measure gold's 'real' price in CPI and GDP. Here we have always measured it relative to the commodity complex, which is generally positively correlated to the global economy. Above is gold vs. the CCI commodity index.

I had originally thought that a decline to the lower moving average would come with a continued economic bump, stock bull market and inflation-fueled commodity bounce. But instead, gold has tanked vs. commodities even as a deflationary pull starts to take hold with signs of economic deceleration, commodities down and the stock market potentially in some kind of a topping process.

Yet the 'real' price is still in a secular uptrend because the ratio has held above another parameter point we noted as important. If the blue arrow is confirmed by turning green one day, the message will continue to be a secular era of economic contraction, which has thus far been fought tooth and nail by inflationary policy. That is and has been the case for gold since day one. Not the case most gold bugs root for, which is inflationary effects, the likes of which are used as data points by Harvey and Erb. See?

Of course Harvey and Erb scare the gold "community" because a majority of the "community" sees gold as a hedge against higher prices. If the above chart breaks down and makes a lower low to the spring of 2011 (the height of the last commodity/inflation blowout) then we may have to admit Bernanke wins, Draghi wins, BoJ, China Central Planning and all other inflators win. They will have managed to create sustainable economies literally out of thin air.

The alternative to that is hyperinflation, where an asset grab of epic proportions could engage with gold under performing things you can actually eat, keep warm with and use for fuel. This asset grab would come out of a debased monetary system.

More realistically however, we might look for the real price of gold to gain support in its secular uptrend. This would see economic contraction and by extension, further decline in commodities and stocks markets. We have noted all along that the nominal gold price can decline in this environment, so people should know why they own the thing. Also, getting out of the 'death of the dollar' cult might be wise as well.

The USD, as long as implied confidence in our leaders remains intact, may be pulled upward with the real price of gold as a contraction phase bites harder. This is the world's reserve currency in which a majority of global transactions are settled. As long as this remains the case, there will be claims on Uncle Buck. USD, as of the moment, is liquidity within the system. Gold by the way, is liquidity outside the system.

The average gold bug's worst enemy is… the inflation tout. It is not the government or the big banks. It is the individual's expectations of a lump of shiny metal. If they have not gotten this simple concept yet, after the recent damage, I am afraid they will never get it. And they will puke up their gold, which failed to protect them from the dreaded inflation that wasn't.

Bottom Line

The "dreaded inflation" is measured in the mainstream by prices (CPI, etc.), not policy-making actions. Gold is a barometer and the pressure it would indicate could be inflationary or deflationary.

If one day you see the gold price skyrocket, then be prepared for a coming (lagging) inflation problem that would indeed eventually show up in prices. This could propel commodities, resources, productive economies and even stock markets to new heights.

If on the other hand gold just hangs around or declines, yet the 'real' price as measured in commodities rises again, the backdrop would be one of continued economic contraction and declining asset prices.

The third alternative is the least likely; gold hangs around or declines and yet the 'real' price loses its secular uptrend. This would indicate a sustainable economic expansion, created by inflationary policy has engaged. Thus far, inflationary policy has served to build in distortions that subject the system to extreme liquidations. That right there is the continuing case for gold - and for the time being I might add - cash, lots of it.

Okay now, that's the theory. I have got a technical report to write, so lets get to it. NFTRH 235 then goes on to review the technical pictures of the precious metals, precious metals stocks, commodities and stock markets in an unbiased manner. This has kept the analysis on the right side of the markets throughout recent dynamic events. If you would like a hard-working service that does whatever it takes to be prepared for what the market throws at us, consider a subscription to NFTRH.

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