Taking the Bull by the Horns

Global stock markets, long-dated government bonds and commodities usually move in very long-term trends, often lasting for a generation. David Fuller shows us where the United States is, in terms of secular bull and bear trends…

Global stock markets, long-dated government bonds and commodities go through cycles that can last for a while since it takes a long time for the crowd, which participated in a market bubble, to realize that it is not returning after a few years.

Instead, they experience a rolling sequence of medium-term bearish and bullish phases, which persist for at least several months, but seldom more than three years. This ex-bubble environment leads to a gradual reassessment in which people become more cautious, leading to valuation contraction before those who remain are joined by a whole new generation of investors, who participate in the next cycle of valuation expansion. Generally and logically, the bigger the bull, the longer the subsequent bear, and vice versa.

So, where are we today, in terms of secular bull and bear trends? Two mega-trends became apparent over two-and-a-half years ago – industrial resources (including precious metals) and emerging markets. They overlap in a number of instances because the economies of many developing countries are primarily exporters of commodities.

Natural resources experienced one of the biggest and longest secular bear markets in modern history, particularly if one adjusts prices for inflation. The main reason was overcapacity, which understandably led to caution by producers. When demand not only picked up once again, but also surged as the economies of China, India and other developing countries grew rapidly, supply inelasticity drove resources prices higher, particularly among industrial metals. Following historic lows in 2001, prices for the major industrial commodities subsequently formed secular uptrends.

Secular Bull and Bear Trends: The Energy Sector

Of these resources, the most important in terms of economic implications is the energy sector – from oil to coal and uranium. Arguably, crude oil’s bull market was not really underway until it maintained a break above $40 (NYME), completing a massive base formation.

Understandably, some analysts do not accept that oil is in a primary uptrend, because this has not happened before. While the price of oil will certainly fluctuate, as we have seen with the recent reaction following the move over $70 as Katrina struck, there are two crucial differences between the current overall uptrend and spikes in the 1970s. The spikes in the 70s were caused mainly by OPEC price hikes and production cutbacks. Prices subsequently fell back because there was no real shortage so additional supplies soon flooded the market. Today, the key driver of prices is demand and OPEC production is near capacity.

I have little doubt that additional supplies will emerge from Russia, Canada, Venezuela, Nigeria and some other producers. Moreover, refining capacity for the so-called light sweet crude currently in short supply will certainly increase. Combined, these factors could put crude oil prices in a ranging corrective phase for one to three years, at some point. However, we may not see $40 again and more importantly, the very long-term trend is extremely likely to remain upwards.

Consider this: 3.4 billion Asians currently consume slightly less oil than the 22 million barrels per day used by the United States. Developing Asia’s demand for oil is rising rapidly. The world currently consumes approximately 82 million barrels of oil a day and rising. At the current rate, the world needs to find 30 billion barrels of extra oil per year to avoid depletion of known reserves. There has not been a significant new oil discovery for many years. Some petroleum industry specialists question the ability of producers to increase supply in line with the demand trend. So we have supply inelasticity and a demand driven secular bull market for oil and its alternative sources of energy.

This is also true of industrial metals, where the China-led increase in demand is much greater than for oil. No doubt China’s economy will experience an economic slowdown at some point, if not now as some predict, in the not too distant future since all nations experience business cycles. Nevertheless, consider this: China’s Government estimates that somewhere between 300 and 500 million people will move from rural areas to the cities by 2020. This unparalleled migration will require massive urban building, requiring according to some estimates, the equivalent of two metropolises the size of New York City or Greater London every year for the next fifteen years. India’s infrastructure and urban development requirements are also massive. This has changed the demand trend for industrial metals, some of which are in scarce supply, for at least a generation.

Secular Bull and Bear Trends: Precious Metals

Scarcity, supply inelasticity, and rising demand are also apparent for precious metals. And while industrial usage has not, and will not take off to the same extent as we have seen with industrial metals, Asia’s newly and increasingly affluent consumers ensure a rising trend in demand for jewelry. However, what is likely to be the biggest source of demand, which we are only beginning to see, will occur as gold and other precious metals are increasingly remonetized in the eyes of investors.

This is occurring, evidenced by new multiyear highs for the price of gold in U.S. dollars, sterling, euros and yen, because no country wants a strong currency. Why? First and foremost, it is due to intense competition in manufacturing due to globalization and the accompanying fear of deflation.

How does a country keep its currency from appreciating? It prints more of it, literally, and electronically through credit creation. The United States certainly did plenty of this in 2001 and 2002, to weaken an overvalued dollar. Today, we live in a world of fiat (paper money) currencies, an exceptional situation in the long history of monetary systems. And there is no going back to a gold standard. Because there isn’t enough of the yellow metal, without adding at least two noughts to the price, which won’t happen. So, we live in a world of stealth inflation, where the amount of paper money in circulation is increased faster than the rate of GDP growth – sometimes a lot faster.

Consider the United State’s liquidity infusions after the Asian crisis in 1997, with more following the Russian debt default and LTCM collapse in 1998, then because of the Y2K misinformation and paranoia. The Federal Reserve pulled a little of this back in early 2000, only to flood the system again following the NASDAQ collapse. The next monetary infusion came in response to 9/11, with more added for wars in Afghanistan, Iraq and the new Homeland Security Department. And now we have the Hurricane Katrina aftermath, not to mention myriad pork barrel projects – 10 billion here, 30 billion there, which are sacred to Congress.

Perhaps much of this liquidity and spending is humane and therefore justifiable but it certainly torpedoes the U.S. Government’s budget. And how does the United States pay for it? It issues more long-dated bonds and then has every incentive to inflate away much of this debt over its duration.

America has plenty of company. Wal-Mart and numerous other companies spend billions on goods produced in China and other low-cost manufacturers. And what does China do with all those dollars? The government prints more renminbi, which it gives to the Chinese companies in exchange for their dollars. China’s government then buys U.S. Treasuries, to maintain their currency peg, and more recently, the PRC has also embarked on a spending spree for technology and oil. This sequence of borrowing, printing and inflating is now endemic among countries. Those who resist the temptation, and few do, soon find that their currency has risen to punishing levels in terms of export earnings.

And there is also the cost of energy to consider. Governments can’t control the rising price of oil imports, which push up inflation in the short-term but create a longer-term deflationary risk. What is the most tempting way to deal with this risk? Increase the amount of money in circulation.

Secular Bull and Bear Trends: The Seeds of a New Inflationary Cycle

Consequently, the seeds of a new inflationary cycle have been sown, increasingly since 1997. It takes time for them to germinate and unlike the pre-globalization 1970s, competition in manufacturing has benefited consumers and kept official statistics of inflation low. This has encouraged governments to inflate even more. We see the consequences in asset inflation, from commercial property and houses to stock markets and raw materials. And anyone who pays the household bills knows that many prices have surged, including insurance, property/council taxes, food, restaurant bills and education.

Pockets of deflation will persist for years, mainly in manufacturing, which restricts wage increases in many industries. However there is little doubt, although much denial, that a new inflationary cycle is underway. Punctuated by periods of rising interest rates and economic slowdown, as governments temporarily attempt to rein in prices, inflation will gradually increase in rolling waves rather than linear fashion. Governments still fear deflation more than inflation and this is unlikely to change significantly, until inflation is fully in the public consciousness and regarded as public enemy number one. This is more likely to occur from 2010 to 2020, rather than in the current decade. No wonder the price of gold is rising against all currencies.

As a rule of thumb, the bigger the bear, the greater the subsequent bull. Thereafter, in addition to a fairly well known supply/demand story, the key variables will be government policies, not least regarding liquidity and interest rates, plus crowd psychology.

I suspect this will be a very big secular bull market for industrial resources and precious metals. And as with all long-term trends, when advances accelerate too rapidly, there will be significant corrections lasting from a few months to possibly up to three years, although the latter would be a rare occurrence. Currently, price data shows that most industrial metals are in lengthy medium-term corrections, with nickel and tin leading a pullback towards support levels prior to the next upward moves of consequence. Oil, post Katrina, is experiencing a consolidation that could last for a few weeks.


David Fuller
for The Daily Reckoning

October 04, 2005

David Fuller is a career analyst, writer, lecturer and investor/trader. He is one of the world’s most experienced and highly regarded independent market commentators, and is frequently quoted by the international press.

David Fuller is a director of Stockcube Research Ltd, where he is Global Strategist and producer of Fullermoney, his unique and highly regarded online investment service. His informative Comment of the Day is read by thousands of institutional and internationally oriented investors throughout the world.

The Canadian ambassador says the Bush administration is "dysfunctional."

And in today’s International Herald Tribune, columnist Bob Herbert says the war in Iraq is both un-winnable and deplorable. "Brave troops died for the mindless fantasies spun by a gang of dissembling, inept politicians," he writes.

Here at The Daily Reckoning, even from the get-go, we thought the war in Iraq would turn into a mess. What we didn’t realize was that it was supposed to be a mess.

"Fish gotta swim," we told our audience in London on Friday.

We gave a speech to the World Money Show group and described our view of the big picture.

Birds gotta fly. Dogs gotta bark. What do empires gotta do?

The answer came from a surprising source last night. We were reading a recent biography of one of the world’s greatest empire builders, Genghis Khan.

There is one thing all empires must do, the book tells us: Expand. We tried to think of a counter example; except for the very odd case of the Austro-Hungarian Empire…we could think of none. A nation-state has more or less fixed borders. Italy is Italy. Bulgaria is Bulgaria. The nation-state maintains an army to protect its borders. It does not, normally, seek to conquer neighboring states. It does not, normally, maintain foreign colonies, lackey governments in foreign countries, or vassal states and territories.

Empires expand…or contract…because that is what makes them empires. If they minded their own business and stayed within their own borders, they would not be empires. And once they take it upon themselves to have a ‘homeland’ as well as overseas possessions, territories and tributaries there is no natural limit. It is as though they had become an aggressive virus that spreads throughout the population – as far as it can go – and then goes away.

The other thing an empire must do is go broke. We read in the paper that spending under George W. Bush has increased more than under any president since Lyndon Johnson. Bush is a "Big Government conservative," which is to say, he manages to combine the worst elements of two appalling creeds – military adventures overseas with bread and circuses at home.

But we’re not complaining. A true empire cannot help itself. It must engage in such extravagant "imperial overstretch" that it can no longer pay the costs. Even the primitive Mongol empire had to reward its troops and pay its administrators. It did so by stealing the wealth of conquered peoples and demanding tribute from them. This forced the Mongols to undertake ever more distant and more ambitions campaigns – because they had already robbed the cities under their control.

The Anglo-Saxon empire is a commercial enterprise, rather than a larcenous one. The Romans had their armies and engineers as the source of their hegemonic power. The Mongols had their horses and bowmen. The Anglo-Saxons had factories – originally, those in England and New England. But every imperial advantage is eventually dulled, worn out, emulated or rendered obsolete. Eventually, the empire expands until reaches beyond its limits…then, it either goes broke, is defeated, or both.

The Anglo-Saxon industrial advantage exhausted itself first in England and then in America. England’s economy reached its competitive peak before the end of the 19th century. Then, America took the lead, and was able to compete effectively for most of the next century, achieving a positive trade balance until the 1970s. It has been downhill since then, financed no longer by commerce, but by debt. American men earn hardly a penny more, in real terms, per hour, than they did in 1971. They feel richer, but only because they owe more, work longer hours, and put their wives to work.

America still has the world’s reserve currency. It can sell U.S. Treasury bonds to finance its imperial expenses, with the Fed holding rates conveniently low. The result of such easy credit has been a sharp increase in asset prices all over the world. Stocks all over Europe are rising strongly. Natural gas is hitting new records. Oil has risen seven times since 1997…17% in the last quarter alone. Unleaded gasoline rose 40% last quarter. And house prices in America – though no longer in Britain – continue to soar, with the average house in California selling for $569,000.

A quarter of a century ago, you could have bought the typical house in California for 200 ounces of gold. Today, you will need 1200 ounces.

The real question is not what is ahead (every empire must decline…along with the price of its assets) but when and how it happens. Already, we notice ominous portents. In 2003, the amount of U.S. Treasury bonds in foreign hands rose by $175 billion. In 2004, the increase came to $295 billion. But during the first seven months of 2005, only $2 billion more has been added.

We do not know what will happen next, but we hope to enjoy the spectacle.

More news from our friends at The Rude Awakening…


Eric Fry, reporting from New York City:

"Your editor’s colleagues continue debating the implications of $70 oil. Despite debating the consequences of ‘peak oil’ for several days, these guys have failed to exhaust either themselves or their supply of worthwhile investment insights."


Bill Bonner, back in London with more views…

*** Gold declined (Dec. contracts) to under $470. We’re moving our buying target up to $450, and hope to see a correction below that amount. As we said above, we don’t know what will happen, but we think we will enjoy the show more holding gold rather than holding California houses or Wall Street stocks.

"Precious metals are currently the in-form sector, having recently emerged from lengthy consolidations over the previous eighteen months or more," our friend David Fuller tells us.

"This up leg should be quite strong because gold was previously regarded by many investors as ‘just a U.S. dollar story’. Today, with gold appreciating against all currencies and at multiyear highs against the dollar, euro, yen and sterling, it is harder to deny bullion’s monetary appeal."

*** Some of the new taxis in London have television sets in them. Friday, while en route to Westminster, we watched an amazing show. A group of Indians in Mumbai were learning how to speak English with a Midwestern American accent. They held their chins down in order to get the ‘aahhh’ sound sufficiently broad and lazy. Then, they practiced moronic conversations:

"Aahh wuz down at the Wahllmart yestahday…"

"Oh yeeaah…whut did you buyyye?"

"Well…maah husband wanted a new fishin’ pole…but Aahh tol’ hiymm…"

The show was frightening. These poor people…they are working so hard to take jobs from Americans.

You don’t get what you want out of life, we keep saying; you get what you deserve. Surely, these people deserve whatever they get.

*** We went home to the garage – ooops, the "coach house" – last night. We are still trying to understand how things get so out of whack that you have to spend $10,000 a month to live in such a place here in London, while in other cities, you could get a much better place for half the price. Everything reverses to the mean, but it can take a long time.

We recall visiting London in 1983. The dollar was nearly equal to the pound. The city seemed cheap back then, and a bit dowdy: Hotel rooms were shabby; apartments were simple, drafty, and poorly furnished; restaurants were few, simple and affordable.

Now, there is hardly a square meter of South Kensington that has not been fixed up and rented out. Restaurants overflow onto the sidewalk…ever so chic. Walking to the tube station, we pass one Ferrari dealership and another Lamborghini monger.

Times change. The world turns. Means are regressed to…and overshot.

Whence this cometh, we recalleth not. But it makes our point: The world turns.

The Daily Reckoning