Warning: Rant Ahead
Eric Fry reporting from Manhattan
Several days ago, the editor of Outstanding Investments,
Justice Litle wondered aloud about the curious correlations
that have been cropping up on Wall Street lately.
Throughout August and September, for example, the oil price
climbed, but so did the stock market. Yesterday, they all
tumbled together…That’s not supposed to happen.
Historically, crude oil and the stock market have tended to
head in opposite directions. But the close relationship
between these two asset classes is only one of several
curiosities that Justice has observed lately. He
highlighted this very phenomenon last week in an email to
his Outstanding Investments subscribers:
“A recent Wall Street Journal cartoon depicts four
flamingos. Three of them are standing on one leg in the
shallow water, as flamingos tend to do. The fourth is
floating in midair, both legs folded under, contented
expression of enlightenment on his face. The third
flamingo, intensely irritated by this lack of respect for
gravity, demands that his levitating brother, ‘Stop that.’
“That cartoon reminded me of recent market action for some
reason. Making demands of the market is pointless – but one
can’t help notice the strange abundance of levitation these
days. As the consumer crumbles, a surprising number of
things have gone up and stayed up, in seeming defiance of
– Crude oil, natural gas and energy stocks across the board
– Gold and gold stocks
– The U.S. dollar index
– The Amex Securities Broker/Dealer Index (XBD, as noted
– Speculative bellwether Google (and various Internet
“This situation recalls the old Sesame Street ditty, for
those of us who remember the mismatch game: ‘One of these
things is not like the others…One of these things just
doesn’t belong.’ How can these competing sectors and asset
classes, traditionally hostile to each other, be displaying
strength at the same time?
“The bullish explanation is to say that energy’s strength
is temporary and to argue that gold’s vigor will also wane
as energy prices ease and inflationary pressures recede.
Indeed, the cheery liquidity and speculative fervor that is
pushing both Google and the dollar higher depends on some
version of this same happy argument — the belief that
energy will back off and the economy will pull through and
everything will turn out OK. But that belief is resting on
an increasingly shaky foundation.”
Indeed, yesterday’s market action illustrated just how
shaky the foundation might be. Oil stocks crated, but so
did the rest of the market. Justice doubts that the
remarkably similar price trends of crude oil and the stock
market will persist for much longer.
Oil deserves a correction, he has been arguing, but a
decade of easy monetary policies and fiat money have
created a much friendlier backdrop for commodities than for
stocks…and that’s exactly what gripes him about another
of the crazy correlations unfolding in the financial
markets: Goldman Sachs and Gold!
Believe it or not, they’ve been rallying together. This
simply must end, Justice insists. Read on to find out
how…and why we should care.
WARNING: RANT AHEAD
by Justice Litle
“One of the driving forces of this boom – and perhaps what
really differentiates it from previous cycles – is the
continued environment of low long term interest rates,
which has flooded the financial markets with liquidity.”
-Financial Times, ‘A Favorable Wind for Investment Banks’
Muted applause is in order for Goldman Sachs, which
recently turned in record quarterly earnings – up a
pleasing 84% from last year’s results. And it’s not just
Goldman that’s faring extraordinarily well. White-shoe firm
Lehman Brothers is breaking records too, with Bear Sterns
and Morgan Stanley in hot pursuit. The Amex Broker Dealer
Index (XBD) is powering to new heights.
Hooray for the investment bankers, minting cash in their
Savile Row suits and Hermes ties. These natty boys have the
world on a string…But they also have a tiger by the tail.
At the same time that Goldman shines, so does the
“barbarous relic” known as gold. At 17-year highs, the
atavistic yellow metal is within sprinting distance of
$500, even as the investment bankers cash registers are
ringing. Strange, that.
It is stranger still that gold would rise from the ashes at
the very apex of worship for that august institution, the
Federal Reserve. This past summer, graduate student Erin
Crowe opened an informal gallery of 18 sketches and
portraits she had done of the great man himself, Chairman
Alan Greenspan. After CNBC picked up the story, the phone
rang off the hook. All pieces were sold at prices ranging
from $1,000-4,000. According to The Washington Post,
several visitors to the gallery were “telling stories of
how they adored the Fed chairman, how he had saved the
world and made them millions.”
Gold’s ascent to 17-year highs would seem to signal that
inflationary pressures are also on the rise. If so, we all
know what comes next: Rising interest rates and market
pain, which means hard times for the investment banks. But
this time around, for this strange interlude, both are
sharing an upward trajectory. One or the other – Goldman or
gold – is due for a fall from grace. But which?
The investment banks have long been riding a wave of
persistent – and deliberate – asset inflation. When excess
liquidity is pumped into the system, those who truly
prosper are the ones best placed to dip their hands in the
river. As the Greenspan cash sloshes and flows throughout
the U.S. asset markets, savvy players divert the cash flows
toward themselves…just like a farmer irrigating a field.
The investment bankers, masters of prestidigitation, divert
cash from many different activities, usually in the name of
“advising.” They massage the cash and trade it and hedge
it; whisper in the ear of corporations deluged by it; and
profitably surf the growing swells of debt created by it.
There’s no business like flow business.
It’s an establishment-sanctioned rip-off, of course.
Aggressive asset inflation is portrayed as a good thing,
all the more so with John and Jane Doe participating via
manic housing appreciation. But the real estate pump is a
Ponzi scheme, designed to sustain the unsustainable via
lines of credit. The government does its part by rewarding
reckless borrowers (tax-advantaged home equity lines of
credit [HELOCs]) even as it punishes modest savers (capital
gains taxes, hidden erosion, paltry returns on interest).
Like a home electricity meter steadily ticking over, life
grows more costly by the hour, if not the day. But as asset
values are pumped up with abandon, inflation measures are
kept “benign” by the damping effects of stagnating wages
and the quirks of our government’s inflation-measuring
mechanisms. And as asset values continue inflating, the
bankers “make the middle” with big smiles on their faces.
Yet while optimists swear the sky is still blue, an ominous
buildup of offshore debt is the dark counterpart to this
falsely created prosperity. None of this paper happiness is
free; the piper’s payment is simply delayed and delayed and
delayed some more. When the center finally gives way, the
man on the street (you and I) will find himself on the hook
for it all – in the form of sharply higher taxes, sharply
lower purchasing power or both – and facing the possibility
of jarring societal disruption to boot.
When it happens, it will not be “just one of those things”
that could not be foreseen or prevented. It will be the
inevitable result of a deliberate policy – reckless asset
inflation for dubious purposes – that has enriched the few
at the expense of the many, with the many playing along out
of greedy shortsightedness and an ignorance of history.
This rant is not anti-capitalist or anti-free market, by
the way. Capitalism shuns redistribution in all forms, and
heavily managed markets are not free. The policies of the
Federal Reserve and the gross failings of government,
however, qualify on both counts.
But back to the original topic: If the investment bankers
are riding high on an asset-inflation wave, gold is
cresting on a far more ominous one. Those who buy gold
anticipate the day when this supposedly benign asset
inflation turns malignant. The inevitability of the coming
mess might be “good news” for gold investors, but bad news
for the world economy at large.
The investment bankers might already sense the gathering
thunderclouds that threaten to darken their sunny day. You
can call them many things, but you certainly can’t call
them stupid. They see the writing on the wall, and they are
taking appropriate action. Along with record profits,
Goldman announced a buyback of $7.1 billion worth of
shares, the largest in history by a Wall Street firm. The
Financial Times opines that this is actually a sign of
weakness, not strength – a tacit admission by management
that the good times are not sustainable. A massive share
buyback will offset the dilution of hefty employee stock
option bonuses, likely to be followed up by hefty duty
cash-outs. From cash to stock to cash again, with a
smoothly orchestrated change of hands. Time to get when the
getting is good.
Whether or not the investment bank stocks have peaked,
their latest victory lap comes at an especially delicate
time for Fed Chairman Greenspan. He would not be keen to
see asset values wither just as he is exiting his office.
Greenspan no doubt fears for his legacy, and may grow more
bitter as his means of defending it slips away. How ironic
to sustain the illusion all these long years, only to
stumble in the home stretch. One almost feels sorry for the
In the end, the inflationary triumvirate of profligate
government, accommodative Fed and self-serving bulge-
bracket banks, so long a united front, will be carping
loudly and blaming each other bitterly before all is said
and done. And gold will be looking on…and cheering
Rant over – the chipper, mild mannered observer who
normally writer under the name of Justice Litle has now
And the Markets…
WTI NYMEX CRUDE