The Seeds of the Next Bust Are Closer to Sprouting
The price of gold was up this week, by $10 and that of silver by ¢6. Something is brewing in the fundamentals that we haven't seen since… last year. We will show a picture of this, below.
There are many problems with assuming a rising stock market means a growing economy. We've written many times about the much-greater growth of debt, i.e., borrowing to consume, which adds to GDP.
S&P 500 Index, monthly - the huge rally since 2009 was accompanied by the weakest economic recovery of the post-WW2 era. Evidently, the stock market does not necessarily reflect economic growth. Very often numerous other factors prove to be far more important drivers of stock prices. A pertinent example is Venezuela's soaring stock market, which is up by 88,500% in the past year alone (this is not a typo). Meanwhile, the country's economy has been contracting since 2014, with the slump accelerating to a stunning -16.5% y/y in both 2017 and 2018. The S&P 500 Index is an island of sanity by comparison, at least superficially (the ceteris are of course not paribus). [PT]
Today, we just want to note that stock prices can rise faster than earnings. We will ignore the so called wealth effect - a feedback loop in which higher stock prices drive greater spending, and hence earnings - and its temporary boost to earnings. Even so, the stock market gains since the start of the year have been due to traders being willing to give stocks a higher multiple (to earnings).
Or, as we look at it, lower yields. Yield is the inverse of price (something Keynes trusted to lure the capitalists on board his plan to overthrow the capitalist order). For four months, we have had a big drop in the earnings yield of the S&P 500. It went from 5.16% to 4.5% so far, a drop of 13%.
The word for someone who thinks that if earnings go up, they must go down is a pessimist. The word for someone who thinks that if the earnings yield goes down, it must go up again is a student of history.
The bear market in earnings yields (i.e., the bull market in P/E ratios) began in September of 2011. We note this date, because something else began at that time. The bear market in the price of gold (i.e., the bull market in the price of the dollar).
Of course, correlation does not prove causality. And there is no law of the universe that says the same thing will happen again. We should note that the price of gold had reached an epic high by 2011, after running up massively in a decade-long bull market. In 2019, that is just not the case.
That said, there is something here to ponder.
Demand for money may decline during times of rising optimism. By demand, we don't mean the rubbish "X" chart of supply and demand, by which most people think to understand money in terms of quantity. We mean the desire to opt out of the financial system.
By money, we mean the most marketable commodity, the one financial asset which does not have default risk. By optimism, we mean when the market bids up the price of a dollar of earnings, squeezing the earnings yield lower and lower.
Who would want to own gold - which gold vendors too often promote as a bet on its rising price - and in so doing, miss out on the obvious bull market in stocks? Who has need of monetary insurance when optimism is rising (and most people assume the economy is healthy)?
To counterbalance this, we note that the stock bull market is about 8 years staler than it was in 2011. Much destruction of capital has occurred, and the seeds of the next bust are 8 years closer to sprouting.
Anyway, let us look at the supply and demand picture of silver (and gold too). But, first, here is the chart of the prices of gold and silver.
Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio rose.
Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.
The scarcity (i.e., the co-basis) dropped a bit, not what one would hope for if this is to be a bull market in gold.
The Monetary Metals Gold Fundamental Price is down a whopping $53, to $1,373.
We promised above to look at a picture of the fundamentals of last year compared to this year.
The similarities, of both the magnitude and timing, are hard to miss. What does it mean? Well, for starters, if you are paying attention to some myth or whispered rumor of a Big Gold Event to come, don't pay it much heed.
Regardless of last year's outcome, the trend of the fundamental price this year is not looking like it should if the price was about to go bananas.
Is this just a picture of the old words "sell in May and go away"? Perhaps, but it should be noted that in the prior year we had a rise in the fundamental price from December through September.
A similar drop up to December 2015, and then a rise through mid-April 2016 occurred, though there was a second peak in August. The year before that, there was a more modest rise in the fundamental price from late December to January, of about $90.
We think these things can sometimes become self-fulfilling. Traders trade based on their expectations of a price move. If lots of people know what will happen, they trade and it becomes so.
But as they say, "the trend is your friend until the end." This trend will surely have an end. The gold market is driven by factors other than trading expectations. When some of those factors reassert themselves - and they will with a vengeance - then historical price charts will be irrelevant.
Now let us look at silver.
The scarcity of silver (i.e., the co-basis) rose a hair.
The Monetary Metals Silver Fundamental Price was down another 19 cents to $15.65.
Charts by: StockCharts, Monetary Metals
Chart and image captions by PT
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.