A New Class of Leadership
It may come as a surprise to readers of The Daily Reckoning, but the outlook on U.S. equities as overvalued and the heralding of a coming bull market in gold are not universally shared views. Robert Prechter, author of “Conquer the Crash,” for example, thinks that while the stock market is indeed overvalued, the CRB Index and the gold price are about to tumble again.
After its sharp run-up since late 2001, the CRB Index and the gold price could indeed, in the near term, be vulnerable to some further profit taking. But I very much doubt that we shall see new lows for commodity prices, since demand in Asia, and especially in China, is at present rising rapidly.
Moreover, the economic policies in the United States – which seem to be designed to worsen the existing external imbalances, weaken the U.S. dollar, and increase the budget deficit for as far as the eye can see – are more likely to lead to inflationary pressures than to outright deflation, as Robert Prechter maintains.
In this scenario, the price level in the United States will be deflated through a depreciation of the dollar, and not through outright deflation of prices in the U.S.. The fact that import prices have been rising recently, and in January were up by more than 5% year on year, would seem to support this conjecture.
Gold Bull Market: Failing to Confirm the Advance
But one point the gold bears make in order to foster their case is that, while the gold price has this year exceeded its high made in the summer of 2002, gold shares have failed to confirm the advance, since they didn’t exceed their highs reached last summer. This non-confirmation of rising gold prices by gold shares – and, incidentally, also by the price of silver, which hardly moved during the recent gold price surge – is viewed as very negative from a technical point of view.
While I am also somewhat concerned about this non- confirmation in the near term, there are three observations worth making. Although the oil price has continued to increase, oil and oil servicing shares have performed miserably and have not followed the oil price surge on the upside at all. Therefore, in the case of oil (a sector that we like), we have an even starker non-confirmation.
In this respect, investors must understand that it is not uncommon, following an extended bear market, for assets that have entered the first stage of a major advance to experience serious price setbacks and even to re-test their lows. This is because, at the beginning of a new secular bull market (in our case, for commodities), which follows a bear market lasting more than 20 years, there are always tremendous cross-currents at play.
But investors still tend to play by the ‘old’ rules of the investment game (buy the S&P 500, the NASDAQ, and the TMT sector) and are unaware that ‘new’ rules have been introduced. After the bursting of a bubble, these ‘new’ rules lead to a massive shift in leadership.
Gold Bull Market: Does Not Always run Smooth
Historically, however, the new leadership does not emerge smoothly. Following gold’s initial rise in the early 1970s, for example, its price corrected by almost 50% between 1974 and 1976 before soaring again until January 1980. Similarly, bonds rose sharply between 1981 and 1983, but almost re-tested their 1981 lows in 1984.
As a result, investors who have a longer-time horizon should not be overly concerned about the recent bout of selling in the gold market. A further decline is not a forecast, but merely a possibility which investors should consider.
Gold has risen by more than 40% since its low in April 2001 of around $255, and even a decline to around $280 would not alter its long-term significant upside potential.
For the Daily Reckoning
February 28, 2003
P.S. While I do believe we have come to a major turning point in the asset markets – which will favor hard assets like gold and commodities in the future at the expense of financial assets – this case is not so clear-cut as to indicate that all financial assets should be liquidated and only hard assets should be purchased. While U.S. financial assets may under-perform commodities in the next few years, commodity-related and basic stocks should provide superior returns in an environment of rising inflation rates and a weak dollar. In particular, equities in resource-rich emerging economies should outperform equities in the industrialized economies of the West.
P.P.S. We should also consider the fact that the recent surge in commodity prices, and especially gold, was to a great extent fuelled by hedge fund buying. And since the gold group was the second-best-performing sector in 2002, it is only natural to see some profit taking now by the hedge fund community, which tends to be very much trading- oriented. Therefore, for the reasons just outlined, I am not overly concerned by gold and oil shares’ non- confirmation of the strong performance of physical bullion and oil.
Gold fell almost $8 yesterday. And the Dow rose. Our Trade of the Decade lost money. But the decade has a long way to go…and this gives us an opportunity to get in on the trade on more favorable terms; now we get more metal for our money.
Over on the Rue Vivienne, where we buy our gold coins, we have not yet spotted Alan Greenspan…Wim Duisenberg…or Masuru Hayami. But we thought we saw Sergey Ignatiev. The Wall Street Journal reports that the Central Bank of Russia, of which Mr. Ignatiev is chairman, is shifting some of its reserves out of dollars and into euros. Every day, U.S. consumers spend nearly $1.5 billion more on foreign goods than their own industries sell abroad. And every day, the U.S. federal government runs more than $1 billion in debt. How much longer or further this will go is anyone’s guess, but individual investors and overseas central bankers alike are looking for ways to protect themselves from Bernanke’s printing presses. Gold is probably on Mr. Ignatiev’s mind as well as on our own.
Also on our mind is the curious news coming out of the U.S. economy. Jobless claims shot up last week. And oil is at a 12-year high. Both make life treacherous for consumers.
Meanwhile, “New Home Sales Plunge by Most in Nine Years,” reports Bloomberg. People who are worried about their jobs…and whose pocket-books are pinched by higher energy costs…do not buy new homes. What they do instead is refinance the homes in order to try to improve their cash flow. As expected, the refinancing business is booming.
Desperate to boost sales, automakers are extending financing over 6 years – despite evidence that default rates double from a 5-year loan to a 6-year one. GM is also offering to finance its SUVs at zero-percent interest.
But these thoughts barely crossed our mind during our recent vacation in Nicaragua. Estranged from the Information Age by distance and predilection, we were forced to think about how the world works. This was no idle past-time; always at work on your behalf, dear reader, your editor was composing the introduction to his new book. (To be published by John Wiley, September 2003.) Readers with time on their hands and masochistic tendencies are invited to read more, below…
But first, here’s Eric with more news from the street of schemes…
Eric Fry, reporting from New York…
– The Department of Homeland Security lowered its terror- alert warning from “orange” to “yellow” yesterday, giving investors the green light to buy stocks and dump gold. The Dow bounced 77 points to 7,884 and the Nasdaq jumped 20 to 1,324. Meanwhile, gold took its lumps, acting anything but precious by tumbling $7.90 to $346.20 an ounce…
– A funny thing happened recently in the New York offices of Apogee Research. First up, on January 10th, Apogee (to which your co-editor contributes) issued a negative report on Cintas Corp., a supplier of work uniforms. Apogee urged subscribers to sell short the common stock above $46.00, stating, “Cintas’ financial fundamentals are deteriorating [and it] will be challenged to meet its aggressive fiscal 2003 earnings forecast.” Specifically, Apogee cited Cintas’ tumbling net margins and return on assets.
– Next, on January 21st, your co-editor received a phone call from Robert Kohlhepp, the CEO of Cintas, requesting a private meeting with the gang at Apogee Research. “I’ve had a chance to read your report entitled, ‘The Worse for Wear,'” Kohlhepp politely explained, “and I think there may be some things that you all are overlooking.”
– He insisted that he bore no malice whatsoever toward Apogee for its report. (Kohlhepp’s a better man than I. The stock has fallen about 14 points since the original report – costing him about $50 million in “paper losses”, based on the 3.6 million beneficial shares that he holds! Your co- editor might have harbored a tinge of malice after losing only $5 million or $10 million. In which case, dropping the Apogee Research team from an airplane might have seemed like a better idea than boarding an airplane to meet with them.)
– Kohlhepp explained that he wished to share with us some facts about the company that might assist us in evaluating the stock’s prospects. We were dubious, of course, but we eagerly accepted the offer. As your co-editor explained to Kohlhepp, “Apogee is an independent research firm. So we are interested first and foremost in the truth, especially the truth that helps our subscribers make a buck in the stock market. So if you’ve got insights you’d like to share with us, we’d love to hear them.”
– One week later, Kohlhepp and Karen Carnahan, Cintas’ treasurer, boarded one of the company’s private jets and flew out to New York to visit with us. They were as cordial as promised. In fact, they were downright charming.
– Kohlhepp launched into an impressive presentation. With an evangelist’s fervor, he described Cintas’ competitive advantages and its exciting growth strategy. Neither he nor Carnahan ever argued against Apogee’s grim assessment of Cintas’ stock. They did, however, “reaffirm guidance” for 2003. In other words, they both reiterated the company’s prior per-share earnings forecast of $1.55 to $1.62 for the year.
– Kohlhepp and Carnahan concluded the face-to-face meeting by presenting us with some splendid gifts – baseball caps, sport shirts and floor mats, all emblazoned with the Apogee Research logo! We were delighted to receive the thoughtful trinkets and told them so. Still, we couldn’t shake out bearish disposition toward the stock…and we told them that also.
– After the meeting, the Apogee team convened a pow-wow to determine what each of us thought about what we had just heard. We all agreed that, despite Kohlhepp’s impressive performance, the stock was still a short. Apogee said as much to subscribers in a February 4th report, “Cintas Revisited,” reiterating its negative call on the stock and urging subscribers to maintain their short positions.
– Then on February 18th, only three weeks after the meeting with Kohlhepp and Carnahan, the company surprised investors – most investors, anyway – by cutting it fiscal 2003 revenue and earnings guidance. The company would not earn the $1.55 to $1.62 that Kohlhepp had reaffirmed just three weeks prior. Instead, it would earn $1.45 to $1.50.
– The company’s reduced forecast confirmed Apogee’s skepticism. “In scaling back its forecast,” Apogee observed last week, “CTAS cited (1) lower employment levels by its customers; (2) higher energy costs, higher employee benefit expense and unanticipated costs related to a labor dispute; and (3) pricing pressure for rental uniforms. Although we never discussed higher energy and benefit costs, our report did point out that reduced employment levels and corporate cost-cutting initiatives in a mature market would invariably lead to pricing pressure. We also observed that, in order to meet earnings guidance, CTAS would need to grow revenues and expand margins at the same time, an impossible feat, we thought, given the mature market for corporate uniforms and the sluggish economy.”
– Even on Wall Street, substance sometimes triumphs over style. Happy stories are nice, but the truth is more profitable.
– [Editor’s note: For more information on how to benefit from Apogee Research’s independent analysis, see:
Back in Paris…with lingering thoughts from Nicaragua…
*** It all seemed so logical, so obvious, and so agreeable back in the last half of the last decade of the 20th century. Stocks went up year after year. The Cold War had been won. There was a new ‘information age’ that was making everything and everybody so much smarter…and richer too.
The world was a happy place, and Americans were its happiest people. American consumer capitalism was the envy of the entire species, whose peace and freedom were guaranteed – if not by Americans’ goodness, intelligence and foresight, at least by their military arsenal…which could blow any adversary to kingdom come. Francis Fukuyama, a bit ahead of his time and perhaps overly impressed, announced that the ‘End of History’ had arrived, for it scarcely seemed that any major improvement was possible. Fukuyama was, of course, not the first to believe that perfection had been achieved. Hegel had proclaimed the End of History nearly 200 years before, after Napoleon Bonaparte imposed the benefits of French republicanism on a reluctant Europe.
But “it’s a funny old world”, as Maggie Thatcher once remarked. Ms. Thatcher might have meant ‘funny’ in the sense that it is amusing; she probably meant that it is peculiar. In both senses, she was right. What makes the world funny is that it doesn’t cooperate; it doesn’t do what people want it to do, nor what they expect it to. In fact, it often does the exact opposite.
Nor do people do what they ‘should’. Other people don’t seem to act ‘rationally’, especially those who don’t agree with us. And even we do not always follow a logical and reasonable course of action. Instead, we are all swayed by tides of emotion…and occasionally swamped by them.
The world is funnier than you think. And the more you think about it, the funnier it gets. Close inspection reveals the ironies, contradictions, and confusions that make life interesting – but also make it frustrating. Men of action despise thinking – and rightly so, because the more they think, the more their actions are beset by doubts and arrière pensées. The more a man thinks, the more modest he becomes, because he sees more clearly the limitations of his own plans. Exploring the possibilities, he sees more and more potential outcomes and problems…and he recognizes more and more how little he actually knows. If he keeps thinking long enough and hard enough, he becomes practically paralyzed…a man of action no more.
Will the stock market rise?
“I don’t know,” replies the thinking fund manager.
Can we win the war?
“It depends on what you mean by ‘win’,” answers the thoughtful general.
Here at the Daily Reckoning we write in the spirit of runaway modesty. The more we think, the less we think we know for certain. If we keep at it, we will soon know nothing at all. (There are those, of course, who think we know less than nothing already.)
We are, frankly, far too much in awe of the world…and too deeply entertained by it…to think we can really understand it today or foretell tomorrow. Like its most attractive components, love and money, life is far too complex for reliable soothsaying. Still, we cannot resist a guess.
Our approach at the Daily Reckoning is, in case you hadn’t noticed, is a little different from the typical investment advisory. Instead of econometrics or stock analysis, it is an exercise in what is known, derisively, as “literary economics”. While you will find statistics and facts, it is the metaphors that are important. Facts have a way of yielding to nuance like a Texas jury to a trial lawyer. Under the right influence, they will go along with anything. But the metaphors remain, however imperfect, ready to turn almost any set of ‘facts’ into the shape they want. People understand the world and its workings by metaphor, not by facts. As Norman Mailer put it in the New York Times last week, “there’s much more truth in a metaphor than in a fact.”
We cannot know how the world works, but we are immodest enough to think we can know how it doesn’t work. It is not, for example, a simple machine, like an ATM into which you can merely tap in the right numbers and get cash out when you need it.
Nor does the world ever work the way people think it does. This is not to say that every particular idea – or metaphor – about how the world works is wrong, but that any particular idea will prove to be wrong if it is commonly held. The trouble with metaphors is that no matter how true they may be when they are fresh and clever, when they get picked up by the multitudes, they almost immediately become worn out and false. The whole truth is always complex to the point of being unknowable, even to the world’s greatest geniuses. Only simple ideas can be held by large groups of people – so the commonly held ideas are almost always dumbed down to the point where they are practically lies…and often dangerous ones. And once vast numbers of people come to believe the lie, they adjust their own behavior to put themselves in sync with it – and thereby change the world itself. Soon, it is no longer the same world which gave rise to the original insight in the first place, and a crisis develops. People who have been guided by a lie suffer the consequences. They get, not what they expect, as we say, but what they’ve got coming. Then, they look for a new metaphor.
Thus, we cannot help but notice a pernicious and entertaining dynamic…a dialectic of the human heart, where greed and fear, confidence and desperation constantly confront each other like women mud-wrestlers: an insight about how the world works gets taken up by the masses and simplified…leading them to misdirect their efforts and ultimately getting them into trouble. A crisis then develops, which brings them to a new and different insight…one which is, ultimately, just as disappointing. In the financial markets, this pattern is well known and often described.
After reaching absurd levels in the late ’90s, investors came to believe that stocks always go up. Many were the reasons given why they should, but the main reason was simple: that was just the way the world worked. But after they had moved their money into stocks – to take advantage of the insight – there were few buyers left…and prices had risen so high that there were no longer enough profits or growth to support them.
Investors were deeply disappointed in the early ’00s when stocks fell 3 years in a row. How could this be, they asked themselves? What is going on, they wanted to know?
Mainstream economists have no answer. Paul Samuelson, popularizer of the economic profession for NEWSWEEK magazine, admitted that he and his colleagues didn’t even have words to describe this “baffling economy”.
Nor has Alan Greenspan been much help. In the late summer of 2002, the most celebrated economist in the world addressed an audience in Jackson Hole, Wyoming. He explained that he didn’t know what had gone wrong. He wouldn’t know a bubble if it blew up right in front of him. He’d have to wait, he told his fellow economists, and check the mirror for bruise markets – for only after the fact could a bubble be detected.
And what difference would it make, anyway? America’s favorite bureaucrat explained that it made none; even if he had known, he said, he couldn’t have done anything about it.
After enjoying the unqualified reverence of nearly the entire literate world, Mr. Greenspan suddenly found himself a laughingstock. He had stood by Hilary Clinton at her husband’s State of the Union address…and helped his re- election with an easy-money policy. He was the key man, along with Robert Rubin and Larry Summers, of TIME magazine’s ‘Committee to Save the World.” He was even awarded France’s highest honor – the ‘Cravate’ of the Legion of Honor…and later be-knighted by the Queen of England.
And now, the poor schmuck is treated in the press like a fool. He should have known, they say. He should have done something. At the very least, he should not have praised the boom and pretended that it was permanent.
But we do not write to carp or complain. Instead, we offer it in the spirit of constructive criticism…or at least in the spirit of benign mischief. We do not know any better than Alan Greenspan what the future holds. We only guess that we are at one of history’s crisis points – where the metaphors of yesterday no longer seem to describe the way the world works today. The financial markets are not the congenial ATM machines of investors’ fantasies, after all. Nor is the political world as safe and as comfortable as people have come to believe.
Life is always complicated, often perverse, and occasionally absurd. But that doesn’t mean that events are completely random; though unexpected, life’s surprises may not always be undeserved.