Commodities vs. The Dow
A knock-down drag-out… who will be the top dog?
Commodities and stocks are both rallying together… What’s wrong with this picture?
Since March of this year, the Dow Jones Industrial Average — that venerable symbol of American wealth — has increased from 7,500 to its current level of more than 9,400. That’s a gain of 25%… and more importantly, it marks the first major up-trend since 2000.
Meanwhile, gold has rallied a whopping 48% since hitting a low of $252 in 1999. As we go to press, gold is at $378 an ounce. And the XAU Index of gold stocks is hitting a fresh six-year high.
The funny thing is, gold and the stock market typically head in opposite directions, not the same direction. What gives? And which market is "right?"
Which of the two is in a primary bull market? And where do investors turn to pocket profits today?
The dollar has tumbled this year — down 5% against the euro since January — but the price of gold, typically a vote of no-confidence in the greenback and overall economy, remains in a primary bull market.
Commodity Bull Market: Significant Inflation
Whether Wall Street will admit it or not, significant inflation is rolling in like a massive rogue wave. When it will crash ashore can be debated, but that it will hit eventually cannot be in doubt. Let’s look at the evidence. MZM, the U.S. money supply that is M2 minus small-denomination time deposits, plus institutional money market mutual funds, has grown from $4 trillion in 1999 to nearly $6.3 trillion at the halfway mark of this year. That is a rise of nearly 60% in just four and a half years. To look at it another way, it took from 1987 to 1999 for MZM to rise from $2 trillion to $4.1 trillion. In other words, MZM has grown faster in the past four and a half years than the prior thirteen!
It is a similar story for the adjusted monetary base, or the super money that the Fed lends to banks, who in turn lend it out in multiples. The surplus cash key component of the adjusted monetary base is rising at an even more alarming pace than during the tough stagflation of the 1970s.
So with all this, there’s good reason to wonder what the heck is going on in the markets.
Clearly we have a situation where both the stock market and gold are appreciating. Yet everything we know about these two markets tells us that the convergence in trends will not continue. Therefore we have to ask ourselves, which is a better bet, the stock market or the gold market? A recollection of the 1970s, a decade in which the price of gold rose 20-fold while the stock market stagnated, is worthwhile.
In 1966, one year after the U.S. government eliminated silver from quarters and dimes, the price of silver was $1.30 per ounce, the same price that silver had traded at in 1919. The stability in the price of silver to a large part reflected the sustained purchasing power of the greenback throughout the first two-thirds of the 20th century. But inflation would change everything.
Between 1970 and 1981, M2 money supply tripled! A then-record amount of liquidity was being injected into the economy each year. But all this money wasn’t helping an economy that was just limping along. From the beginning of 1971 to the end of 1979, GDP rose by just one-third — from $3.9 trillion to $5.2 trillion (in constant 1996 dollars).
Commodity Bull Market: 6.5% per Year
As the amount of money in the economy vastly exceeded the goods and services being produced, inflation was inevitable. Consumer prices during the decade rose by a staggering 6.5% per year. By 1980 that 1970 dollar you had tucked away in your mattress would buy just 52 cents worth of goods and services.
Meanwhile, stocks traded sideways for more than a decade. In January 1966, the Dow breached 1,000 for the first time. Fourteen years later, the benchmark index was selling for only 759. After factoring in inflation from 1966 to 1980, the Dow price of 759 was actually worth only 329 in 1966 dollars.
Imagine, in real terms the Dow had lost two-thirds of its value in fourteen years. Ouch!
Commodity Bull Market: Just the Beginning
Clearly, the same inflationary trend that boosted the gold price was devastating for equities. And now, here we go again, as a new inflationary trend gets under way. In these early days, stock market investors don’t care about "a little inflation." So stocks rally alongside gold. But the lion does not often lie down with the lamb. As the new inflation takes hold, stocks will suffer and gold will thrive.
It’s just the beginning, folks… It’s just the beginning.
We are seeing the early stages of a primary bull market in gold and other commodities. If this plays out as I suspect it will, the equities market is in for a period of many years where stock prices move sideways, and investors lose money primarily because of the decline in the purchasing power of their investment.
On the other hand, gold has demonstrated for over 2,000 years that it has a built-in premium to inflation. Thus, bullion rises at a greater rate than the currency that underpins the economic system.
The bottom line is that the real primary bull market is in commodities, especially in gold. My expectation is for its price to reach $800 per ounce before the end of the decade, and I am probably being too conservative at that.
for The Daily Reckoning
October 21, 2003
John Myers — son of the great gold bug C.V. Myers — has been helping readers earn surprisingly lucrative returns in stocks largely unknown to Wall Street’s wunderkinder since his early 20s. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits — including oil, gas, energy and gold.
This just in, from the Republican National Committee:
"’Last month this economy exceeded expectations and added new jobs. Inflation is low. After-tax incomes are rising. Home ownership is at record highs. Productivity is high. Factory orders, particularly for high-tech equipment, have risen over the last several months. Our strategy has set the stage for sustained growth. By reducing taxes we kept a promise, and we did the right thing at the right time for the American economy.’
"- President George W. Bush, 10/16/03
"As The Wall Street Journal editorial board announced this morning, ‘The good economic news keeps coming,’ and a newly released report from the Federal Reserve shows that it is coming in from across the country!
* Jobless claims are at their lowest levels in eight months. * Employment grew by 57,000 in September. * Stock market values have increased $2 trillion in last ten months. * Disposable personal income is up 3.8%. * Home ownership is at record highs with a 68% ownership rate. * GDP growth is at 3.3% in the second quarter. * Productivity growth remains strong, which has bolstered profits. * Orders of manufacturing goods continue to increase. * Shipments and orders of durable goods increased this summer.
"President Bush is confident in our growing economy, but he will not be satisfied as long as there are Americans looking for work. He has urged Congress to act on his six-point plan to continue the economic growth that is already gaining momentum."
The poor man may never be satisfied; there will there always be Americans looking for work. And the number of unemployed has been rising for the last 8 quarters — there are more than a million more of them than when the ‘recovery’ was alleged to have begun. So many people are unemployed in this supposed upturn that one writer dubbed it a ‘cruel and unusual recovery.’
The Republicans might have added that the U.S. now consumes nearly 90% of the world’s capital, but produces less than half the manufactured items it consumes. In September, the number of jobs in manufacturing declined for the 38th month in a row and weekly earnings went down for the first time in 14 years. Personal bankruptcies remain at record rates — more than 30,000 go belly-up each week.
But rest assured, dear reader, if the President’s six-point plan doesn’t work, there is always a 7th or an 8th point. We have not been asked, but we offer the Republicans 2 more points for their program:
1. Free the credit market and let interest rates go where they ought to be… let the market set them, not the Fed.
2. Reduce government spending to what people are willing to pay for (currently the Federal government reduces taxes by $700 per family… but borrows an additional $1,500 per family).
Of course, our points are not likely to make their way onto the Republican’s list. Or the Democrat’s. Both parties are convinced that public officials can do a better job of directing the economy than nature herself.
The public believes it, too. Mr. Bush produces not a single new job, grows not a single grain of wheat, nor even wipes the grease from a single factory floor. Yet, people somehow believe he can master the entire economy.
So out of step are we with current fashions that we are beginning to feel as though we had walked onto the beach in a rain coat. Everyone else is enjoying the bright sun of a ‘new bull market’ and a ‘recovery.’ But we’re sure it’s going to rain.
How happy we are to spot someone else — with an umbrella!
"We are seeing very strong short-term earnings and strong short-term momentum in economic data," begins Rudolph-Riad Younes, manager of the Julius Baer International Equity fund. Despite his galoshes, Mr. Younes, interviewed in this week’s Barron’s, has raced to a 27% growth in his fund so far this year.
"We had the mother of all stimuli in the U.S. economy over the past year," he continues, "a weaker dollar, tax cuts, yields collapsing, corporate spreads collapsing, war spending, real-estate prices going higher. And stocks are up. But these measures are not sustainable. The economy is barely growing, and we are losing jobs. What more can they give us next year?
"Consumers never stopped spending, but it’s hard to see how you get them to spend more. You can’t give them any more tax cuts. You can’t get them to do any more refinancing unless interest rates go lower. State and local government are stretched. So is the federal government. We need corporate capital spending to pick up like crazy and we need foreign markets to grow. This rally is only momentum-driven. We are in a bear-market rally."
What is Younes buying?
"We have always been a fan of Carlos Ghosn, the CEO of Nissan, and we used to own Nissan," he explains. "Now, given the valuation of Nissan, which Renault owns 44% of, we sold it and we switched to Renault. If you strip out its Nissan stake, you are getting the French operations free. (You’re also getting protection from a falling dollar.) Plus, in 2005 Carlos Ghosn becomes CEO of Renault."
Despite the name, Carlos Ghosn is Lebanese. "I know him," said a Lebanese friend at dinner last week. "We went to the same boarding school. Then, we just had a reunion here in Paris. It was a Christian school and so many Christians left Lebanon… there are thousands of them here. Carlos was at the reunion. The man is amazing. He’s a ball of fire. He turned Nissan around… and now he’s going to do the same thing at Renault."
What’s Younes’ outlook for the U.S. economy?
"We created a short-term temporary sweet spot for economic recovery. Once that stops or slows down, people will once again focus on valuation and the market will correct again."
When will that be? Mr. Younes didn’t say.
Over to Eric, for the late-breaking news from Wall Street:
Eric Fry in New York…
– Yesterday, Manhattan basked in the brilliant sunshine of a glorious autumn day… but there was an unmistakable chill in the air… not unlike the slight chill that seems to be lingering over the U.S. economy.
– Meanwhile, down on Wall Street, it’s t-shirt weather. Investors are luxuriating in the balmy breezes of a macroeconomic Hawaii. They have come to trust in a stock market that is as agreeable as the waters of Waikiki and to expect capital gains as sweet as a Mai Tai. And no one ever gives a thought any more to "tiny bubbles," or to bubbles of any kind.
– The Dow added a pleasant 56 points yesterday to 9,778, while the Nasdaq Composite Index added 13 points to 1,925. The dollar and bonds also drifted to slight gains, while gold floated to a $2.20 gain at $374.40 an ounce.
– The dollar jumped in Asian trading after Treasury Secretary John Snow explained to the Financial Times of London that the Bush administration never tried to talk the dollar down… Apparently, a few hundred million investors misunderstood the Administration’s intentions…
– The stock market’s steady gains throughout the summer and early fall reflect an unwavering faith in economic rejuvenation. No price is too much to pay for a stock, the lumpeninvestoriat seems to believe, as long as the economy is growing.
– U.S. GDP growth probably topped 6% for the third quarter; nearly double the 3.3% recorded in the second quarter and far ahead of the first quarter’s 1.4%… and John Snow promises more to come. He predicts the U.S. economy will grow about 4% in 2004. The optimistic Snow may be correct, or he may simply be as optimistic as usual. In early July, a confident Snow declared that the U.S. economy was "coiled like a spring and ready to go." At the time, most folks imagined the economy to be coiled like a "Slinky," tumbling end-over-end down a stairway.
– Today, the hopeful Treasury Secretary sees nothing but blue sky on the macroeconomic horizon. "The spring has now sprung," says Snow. "I am confident that this economic recovery will now be sustained and will produce loads of new jobs."
– The Treasury Secretary also predicts rising interest rates… but that’s a good thing, he says. "The price of capital is interest rates, and there is going to be a need for a capital rationing process. Higher interest rates are an indicia (sic) of a strengthening economy. I’d be frustrated and concerned if there were not some upward movement in rates."
– Rising rates may be "indicia" of strength, but they are also a real drag on economic activity. Neither the heavily indebted U.S. consumer nor the heavily indebted U.S. government welcomes the prospect of rising rates. What debtor would? The rising rates that Snow expects could quickly snuff out the robust economic growth that he also expects, and produce the slowdown that Conference Board’s leading economic indicators anticipate.
– "The index of leading U.S. economic indicators fell in September for the first time in six months," Bloomberg News reports, "supporting forecasts that the economy will slow from the third quarter. The 0.2 percent decline in the New York-based Conference Board’s gauge of how the economy will perform over the next three to six months followed a 0.4 percent increase in August."
– The U.S. economy would not easily tolerate rising interest rates. Incurring debt is the economic fashion of the land. President Bush, a Republican, seems to spend money with the gusto of an FDR or a Lyndon Johnson. And yet, he is battling neither a Great Depression nor endeavoring to establish a Great Society. Instead, he is simply trying to spark a Great Spending Spree. And he has succeeded, as the third quarter’s spike in GDP growth attests.
– But if you spend lots of money that you don’t have, you wake up one day with lots of debts that you wish you didn’t have… and the damn things are harder to get rid of than a visiting in-law (especially when rates are rising).
– "President George W. Bush’s tax cuts will put $1 trillion dollars in people’s pockets over six years," the New York Times reported recently, "but because the government is spending far more than it is taking in, the President’s policies also mean that Americans face a much larger future tax bill — or equally large cuts in government spending — to eventually balance the government’s books.
– "From 2001 to 2006, Americans will get federal tax cuts that average $3,593 a person, while the per capita share of the national debt will increase by $13,000 from 2002 through 2007. About a fourth of this year’s record budget deficit, estimated at $480 billion, will finance tax cuts."
– In other words, for every $1 of tax cuts, federal borrowing to finance the tax cuts, the war on terror and routine government operations will total $3.60 over six years, according to the Congressional Budget Office. "The government is basically borrowing $1,000 in your name and then handing you $250 of it," said Robert McIntyre, director of Citizens for Tax Justice. "The net effect is to leave you deeper and deeper in debt."
– Perhaps Snow would consider lots of debt "an indicia of strength" as well. We would consider it a proof of unsustainable economic growth. Get out your wool sweaters; it’s getting chilly around here.
Bill Bonner, back in London…
*** Unsustainable… we keep hearing and saying that current trends are unsustainable. "During the second quarter," Clayton Bryan adds to the list of trends that are both unsustainable and apparently never-ending, "the federal government debt rose at a 24% annualized rate, and mortgage debt rose at a 14% annualized rate. We can safely assume that incomes did not keep pace…"
*** As Addison pointed out yesterday, the Nasdaq is now up 70% from its lows and technology stocks are up 76%. And so, dear reader, comes our second big opportunity in technology stocks. Had you sold the techs back in March of 2000, you could have made a fortune as some fell 90% or more in price… and many disappeared. Now, here’s another opportunity; dump them again!
But we know what you are thinking. These companies are the survivors… they’re the ones that are going to make it. Surely we don’t want to sell them, do we?
You bet we do.
Ebay is at an all-time high. The River-of-no-Return, Amazon.com, is up nearly 900% from its low. Intel, Cisco… they’re all at prices that are not only unsustainable, but unfathomable. Amazon has never made a dime. So many other techs are making losses that you can’t even compute a meaningful P/E ratio for the group. The P is there, larger than life… but there’s no E to divide into it. The result is a mathematical absurdity and an investment opportunity. Sell the techs again.
*** How far will the bull market in gold take it? "Don’t know if you caught this," begins an email from a friend, "but there was an article in Barron’s (October 13) by Sandra Ward with an interview with James Turk where he predicted gold would go to $8,000 an ounce." Our resource man, John Myers, makes a far more conservative prediction below… but still a lot higher than where gold sits today…
*** From colleague Dan Ferris: "Below are four complete 17-syllable haikus, written by Cliff Asness, principal of ASQ Capital Management, LLC, a New York hedge fund.
Asness was very bearish in the late 1990s. Needless to say, he’s bearish again today. These were on page C5 of Friday’s Wall Street Journal. They’re from a recent shareholders report…
Bubble is back big time Price does not matter once more People do not learn
Economy up But that does not make stocks cheap Math is a tyrant
Cannot believe it I am really typing this Chinese Internet
Day traders are back Like cockroaches hard to kill Unfair to roaches