Humpty-Dumpty: The Year The Markets Never Came Down

by: Emmet Kodesh

In the distant future, say a decade from now, 2013 will be hailed as the year the markets never came down. After the S&P's struggle in January to break the psychologically important 1450 barrier (ancient history), the stumbling, irrelevant economy finally released its clutch on the string and the index soared like a helium balloon up, up and away. It was beautiful and, as will be recorded in official lore, the S&P finished 2013 having made so many new nominal and then real highs that the bell-ringers' fingers got sore. As for the DOW: 18,000 became the new base from which we have soared to 2023's routine closes at 40k more or less. That is one view.

It was great and it was all because of my skepticism. Remember, as Sir John Templeton said, "bull markets are conceived in pessimism, grow on skepticism, mature on optimism and die of euphoria." The skepticism about the markets and the health of the economy by cranky contrarians forever reviewing grim fundamentals prompted the unprecedented and ongoing rise of the indices toward and beyond the stars. In 2013, the Fed found us a way to prosper with an employment rate of 58.7% and large doses of QE and soma. What's not to like?

Then came Thursday May 9, 2013 and the impossible occurred: a red day! The S&P tumbled six points to 1627. Millions of hearts were broken and heads confounded. It was like orange juice without Anita Bryant, like Howdy Doody without Buffalo Bob, like Stan without Ollie -- that's how bad it was. "Corrections" like this are getting hard to bear, that's how fragile psyches and nest eggs are. Uncle Ben must have gone out for coffee and assistant Igor took his paw off the digital dollar key. May 09 was a tiny reminder that dialing up new highs must not be too obvious lest some onlookers point out the Emperor's nudity.

By May 08, a day before the tiny pause, the indices showed an 89-day "buying stampede" unprecedented in the 43 year experience of Jeffrey Saut, Chief Investment Strategist for William James. The run started with consecutive days of 90% upside buying volume: in the past, this pattern has been followed by three months of at least 12.8% gains. The current run nearly matches that level. Saut believes that the 404 million shorts on the NYSE are in trouble and that the market will keep rising till late in 2Q 2013. I have been saying there will be a major re-connect with a grim economic reality in the fall and that is similar to Saut's view: he predicts a double-digit drop in the S&P in August or September.

All the basic material and industrial producers I follow in steel, mining, chemicals, construction (on ground and beneath the sea) fell, the miners most of all. Since the May 09 resurgence of the USD against its fiat peers, BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), Southern Copper (NYSE:SCCO) and Vale (NYSE:VALE) have wobbled or plunged. Of the group, BHP has been least bad and VALE weakest. Among this group, Freeport McMoRan (NYSE:FCX) has outperformed as its acquisitions look likely and its prospects as a diversified commodity producer are solid. In this group, only FCX was green on May 15. But Copper (NYSEARCA:JJC) keeps sending out distress signals: it is down 15% the past 15 weeks. The recovery in steel that had been strengthening prior to the recent and continuing DXY rise (at $84.094 on May 15, very near its 52-week high of $84.1) has sagged as seen in US Steel (NYSE:X), Nucor (NYSE:NUE) and Arcelor (NYSE:MT). The PM miners are not much worse than the major mixed commodity miners. The exception till May 15 has been Barrick Gold (NYSE:ABX) which had priced in a mountain of negativity and is shoring up its operations. This major producer might be the only PM miner that at this point is a buy and hold rather than a near-mid term trading vehicle. But Wednesday's plunge in precious metals prices hit all PM miners hard.

Beyond the fascinations of U.S. indices, the outlook is not rosy. Europe is officially into six quarters of economic decline, seven in Italy, longer than the 2008-09 collapse. "Uncertainty is on the rise again," said Joerg Kramer of Kommerzbank, quoted in the Bloomberg piece linked above. "We are at a critical juncture." That's right: the fiat Titanic, too big to sink has taken an unkind cut beneath the waterline from CB flooding its economy with debt. Economies built on massive and infinite debt expansion collapse, even a child can grasp this. Having created a fiat zone of the living dead, the ECB keeps printing to postpone a deflationary depression. Von Mises described this process precisely:

A boom brought on by the expansion of credit money [debt] cannot continue indefinitely... Either the banks continue the credit expansion and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a collapse of the money and credit system. Or the banks renounce further credit expansion and thus bring about the crisis. The depression follows in both instances." (Interventionism, 1940)

"An ever-growing orgy of speculation" sounds like this year's indices. The Fed and its fiat kin have painted world economies into a corner: either they continue creating debt and crash the system or they "taper off" and crash the markets that way. But wise men tout the liquidity mantra, like Humpty Dumpty claiming they can re-create creation. It is more likely to be an apocalypse of tragic stupidity (or malice) as in Pope's Dunciad: "like chaos o'er creation, uncreating."

French Finance Minister Moscovici says the French "need jobs, jobs, jobs" precisely what the Fed claims it wants to produce for Americans whose Labor Force Participation Rate continues to sag especially among the core 25-64 year old demographic. As for France, with 27% youth unemployment and a socialist system based on debt and transfer payments they might as well scream "sauve qui peut" and head for the ocean. Tax policy that drives out wealth hurts hiring, spending and economies. The eurozone and Japan together have $23 trillion in sovereign debt: they will never retire that sum by raising the top tax rates. For this reason as well as the suppressed value of gold, Blackrock, the largest asset manager and Wells Capital that manages $325 million are bullish on gold and buying on dips. For those with investable cash, gold and miners are today's value-contrarian play.

The May 13 Bloomberg article cited above reports that Indian gold buying topped 100 tons/month in March and April and that purchases are expected to increase. "People are still lining up in China and India to buy physical gold" commented John Kinsey of Caldwell Securities. Asians continue to pay premiums for gold.

Monday, May 13 brought bullish news on the U.S. economy and the dollar: retail sales growth was up in April, to 3.35% from 2.64% though this is still 62% below the 2Q 2011 level: the pattern is lower highs and lower lows. The DXY is rising because the euro, yen and pound are being devalued faster. When the Fed does decide to taper off or to make the markets go cold turkey, it will be to facilitate wealth consolidation, not because they believe that the economy is sound. If the economy was indeed sound, if America had growing individual and family income, savings, spending and jobs, then the USD would have good reasons for relative strength. Humpty Dumpty said that "words mean just what I choose them to mean" and like him, Fed policy and the indices they support are leaning long out a very high window.

Growing ex-USD trade plus Fed debt creation will drive down the dollar and collapse the fiat experiment as described by von Mises. We are living through a text book demonstration of his wisdom.

Do not believe the Fed will remove QE from this economy unless it is for purposes similar to April's short sell guidance and the low-ball estimate on gold by Goldman Sachs (NYSE:GS). William Kaye of the Pacific Group states that both stocks and bonds are overpriced and "will collapse." He describes, as I have the Fed's "gaming the system" with its purchases of debt (and equities) and says the agitprop against PMs (precious metals) is "like kabuki theater" in which the bullion banks collapse PM prices despite surging demand. Kaye adds that COMEX now has only 200 tons of gold to cover its liabilities so expect more games and volatility as a new world reserve system is painfully born.

Peter Schiff in "the Stimulus Trap" (March 2013) makes a good point but also a common error in assuming that the Federal Reserve Board does not perceive that its debt creation is creating a disaster:

Any talk of an exit strategy is just that, talk. Not only can the Fed not exit, but it will have to delve further into the stimulus abyss. It will repeat this mantra until a currency crisis finally forces a painful exit.

This re-states the core analysis of von Mises.

On Money Morning May 14, Schiff reiterated his view that America is "heading for a worse economic crisis that we had in 2007." He decried the signs of a "phony economic recovery" and noted that ongoing debt creation will ravage most Americans. As the market rises some people note "concerns about China" ahead: JPMorgan has cut its outlook for 2Q Chinese growth.

The Chinese decline hurts major commodity exporters like Canada and Australia (just as the EU decline hurts Russia). I have written that China will not save the global economy. I also have noted repeatedly that China, Russia and many other nations are increasing and will continue to hedge their currencies and economies with gold. That will express itself in bullion prices and mining shares sporadically but increasingly as the ability to game the system wanes with the exhaustion of PM ETFs like SPDR Gold (NYSEARCA:GLD) and Silver (NYSEARCA:SLV) that are only fractionally backed by physical metal. These ETFs will remain popular with some traders, but they had better be nimble. I also have suggested diversified currency holdings including CAD which in recent weeks has been the second best performer of the nine major fiat currencies, its 2.6% rise just behind the USD +2.7%. Today, the CAD reportedly topped the USD when America's April manufacturing output was revised down to its lowest level in eight months. Part of today's small rise in the indices, as often this past year came from "street wisdom" that industrial decline would keep QE liquidity flowing.

But the Fed does NOT "have to" do anything but retain its meager credibility (or the awe of its power) on the Street. Anyone who still believes its policies are meant to help the U.S. economy should use more sun block. The problem is not that the economists steering the Titanic fail to comprehend the result of their liquidity trap. Rather they are preparing a wealth-consolidation event to crush the middle class and thus reduce obstacles to Federal power. Nietzsche was not an economist but he was brilliant. Looking through the prism of the New Germany in 1882, he termed the modern State "the New Idol" and wrote: "whatever it says it lies, and whatever it has it has stolen." Power is the ability to manipulate people. Our ruling class which has benefited enormously during the incumbency of an ostensibly populist administration is exulting in a bonfire of the vanities that consumes its host culture.

Health and Consumer Staples still lead this manic market. After a 2-day decline on reports of lower sales in Asia and Europe, McDonald's (NYSE:MCD) has recovered: investors are buying it under $100/share. It is an excellent long-term holding for the current phase of world economies. But having followed it a long time, I would wait till a dip toward $90 to initiate or add to a position. After the y/o/y drop in its October sales, it fell below $85 before beginning its current 6 month rise. It's a great company, but wait a bit to buy.

Given economic fundamentals plus the $7.5 trillion public debt added since 2008, a significant market correction is likely to occur. The real level of the S&P remains about 25% below its 2000 top, although it is now about even with its October 2007 high. The economy is real: it is the "weight" the market must eventually find in its scale. After the joy ride of green days, it will be the weight we must obey.

PM (precious metal) miners remain the great laggards and a value play for those who can stand volatility and are willing to wait a few months. Goldcorp (NYSE:GG), Eldorado Gold (NYSE:EGO), First Majestic Silver (NYSE:AG), Silver Wheaton (SLW) and junior streamer Sandstorm Gold (NYSEMKT:SAND) all are value plays now. But even SLW, one of the soundest companies in the market and is one of the highest rated as a trading vehicle given the gaming of the system. Its price action this week proves the point.

A good trading play is IamGold (NYSE:IAG), which in the past ten days rode from $4.60/share to $6.25 and is back at $5.05. It has 11.3 million oz. Au proven and probably reserves, 28.7 million measured, indicated and inferred oz Au and has been beaten down nearly 75% in 7 months by the fall in bullion and attendant ugly sentiment. Buy it below $5/share and sell it or part of it above $6.25. Volatility in PMs (precious metals) and PM miners will continue.

On issues that affect miners and reasons to consider them mainly for trading, consider this quote from a mining executive with operations in Mexico quoted in Fraser's overview of world mining jurisdiction ratings:

After we discovered multiple, very rich and large mineral resources in a Mexican state, we were targeted by very powerful groups. This is still ongoing, so I will not name names. These groups hired Mexican and Canadian anti-mining groups to target one of our operations. They began an extortion campaign against us and we received no help from the state government. These groups tried desperately to drive us out of the state.

[from the section on Latin America]

This comment sheds light on the difficulties Tahoe Mining (NYSE:TAHO) is experiencing at its Escobal site in southeastern Guatemala with outsiders being bused in for violent protests (including burning tires and machete attacks on police). More generally, it illuminates the experience of miners with seemingly local protests funded or urged by competitors or those with diverse political and financial agendas. I have written about these matters pertaining to ABX, RIO and its subsidiary company, Turquoise Hill Resources (NYSE:TRQ) in Mongolia. Since many people follow SCCO to get a reading on copper and thus global growth, they should be aware that SCCO is about 78% owned by Grupo Mexico. Still, one should remember the comments of Lawrence Roulston on enormous values in PM miners: "you can buy cash at a discount and get gold and copper reserves for free" at current prices.

As I've suggested, it is worth participating in the positive buying sentiment via a low cost S&P proxy like Vanguard's ETF (NYSEARCA:VOO). Global Real Estate also has performed well, but given nagging fundamentals it might be better to wait for a pullback before adding to ETFs like Vanguard's Global ex-US REIT (NASDAQ:VNQI). If you add any bonds, given high prices and low yields, use a short-term investment grade ETF (NASDAQ:VCSH) and think of it as cash yielding 1.14% and with minimal downside in case of a plunge in bond asset prices. The drop in bond prices on May 14 was a sign of things to come.

Happy hunting and best of luck in the year of endless strength and helium highs: you can't fight sentiment and the markets have momentum. Make hay while the sun shines.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SLW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.