I am watching the happenings in Venezuela carefully as this might be an indication of things to come in the US. While most people naively think that “it can never happen here” I would like to warn you that every country where these things have happened uttered that exact same phrase. Whether it happens because the Federal Reserve loses control over the devaluation of the USD or because foreign debt buyers just stop buying US debt the one thing I am sure of is that it can and will happen here at some point in the future.
What I am talking about is massive devaluation of the currency which leads to inflation or, in this case, hyperinflation. I have stated that for the moment we do not have to worry about inflation, and I stand by that prediction, for now, at some point we will have to cleanse our demons and massive balance sheet. The one and only thing that is saving us right now from inflation is our pitiful employment situation, which is not getting any better I might add. Without employment there will not be wage inflation and we will continue to have subdued demand for products with the exception of food and energy.
Even though I fully believe deflation is here for the near-term, reinforced by the Fed itself, there is one caveat to my prediction, the devaluation of the USD. I have made no secret that I believe that the Fed and the current administration, along with the former administration, have had an unofficial policy of maintaining a weak dollar. The reason for the weak dollar policy is simple, it boosts GDP and earnings in a globalized world along with a host of other seemingly positive economic stimulus. However, a weak dollar is not good long-term for a country and hurts the population as dollar sensitive products become very expensive, i.e. $140 a barrel oil marks the low point of the USD in 2008, and is inflationary without the benefit of actual inflation.
Let me explain, inflation created by excess money printing usually enters the banking system and is loaned out to the population. This is called money velocity and creates too many dollars chasing too few of goods. However, without money velocity traditional inflation cannot happen, but even if the excess money printing does not enter the economy it can still devalue the currency based on the future expectation of it entering the system. This is what was happening up until the last dollar rally and I would like to point out that the last dollar rally was because, depending on who you listen to, short covering, fear about sovereign default (i.e. people were afraid of another systemic meltdown which, in turn, initiated short covering. This is the scenario I favor), or people felt the Fed was actually going to raise interest rates which is absurd, in my opinion.
The dollar devaluation that we have seen explains why oil prices are on the rise as demand simply is not there. It also explains why metals have also climbed for most of 2009 as well. What is scary about both oil and metals going up, especially in 4Q09, are the fact that these prices increased in the face of a stronger dollar which is counterintuitive. Well, it is for gold at least as oil could increase with a strong dollar if there is sufficient demand, but, frankly, there is not as much demand as the price indicates. Regardless, rising energy prices when the economy is weak, to me, is a warning sign of a problem and should forewarn you of things to come, inflation.
If we continue with our insanity that Washington and the Fed is telling us we need it is inevitable that we will end up in a situation like Venezuela where we will either willingly or unwillingly have to devalue our currency. There are pluses to devaluation as your debt, assuming a fixed interest rate, will remain static and your earnings will eventually increase allowing you to pay off your debt faster. However, the negatives outweigh the positives by a long shot as your savings are worthless. This is why we saw the people of Venezuela go out and buy everything they could because goods will be worth more than the paper money.
What is disturbing though is the fact that even though devaluation creates higher prices the Venezuelan government shutdown some stores for “price gouging” which is humorous, in a sick way. The government intentionally creates inflation to make their balance sheet look better, but because new goods will cost more stores cannot compensate by charging more for products they currently have. How in the world are these stores supposed to stay in business or id the governments point to put them out of business? The next logical question to ask is how would this type of scenario play out in the US?
While we do not really have any past history to use as a bench market I think what we see happening in Venezuela is probably a very good example. Right down to the black markets that are more than likely popping up all over the place to provide goods and services the population cannot receive from the usual sources. What I would be interested in knowing is if these black markets are using another medium of exchange, i.e. US dollars, gold, silver, Euros, whatever it might be, to pay for these goods and services. I would be inclined to believe that is what is happening, but there is simply no proof and I am willing to bet no one wants to openly talk about such things for obvious reasons.
What is usually accompanied with this type of devaluation is the government imposing its will that its citizens continue to use its currency no matter what. We saw this happen in Zimbabwe, but just like in Zimbabwe the black market switched over to an alternative payment system, gold. It is important to note that gold is being used because dollars or other currencies simply are not plentiful in the country and gold can be mined, of course gold has also been used as currency for thousands of years as well and at current prices a little bit goes a long way. Basically, forced price controls and forced use of devalued, or worthless, currencies simply do not work, that type of system never has in 4,000 years.
I am not suggesting the US or Venezuela will turn into Zimbabwe, but I am saying that we are facing certain financial Armageddon at some point in the future. All the US has managed to do is kick the can further down the road for others to manage and we are running out of road, unfortunately. We will have only a few choices in the very near future and the most obvious, because it is politically easier, is to inflate our way out of our problems. While this seems like a good idea I am thinking that the 77 million soon to be retired Baby Boomers who are about to be living on a fixed income will like this strategy. However, it is unlikely that they will like the alternative either, much higher taxes, less Social Security and steep cuts in Medicare.
We live in unique times and the one certainty we have is that there is no certainty of anything. I do not believe that there is any question of whether or not we will follow Venezuela, in my mind it is only a matter of when it will happen, not if. However, before we go down that road you will be comforted in knowing that Japan or the UK will more than likely go down that path before us as they are in worse shape than the US. Regardless, watching what happens now will give you an idea of what could happen here and is also why I am a big proponent of investing in precious metals.
So far holding gold, silver, platinum or palladium has been a very sound move on my part, but I actually hope that these investments turn out to be horrible for me because that will mean I was wrong about the future of the US monetary system. While I might be wrong what concerns me is that there are many people who are a lot smarter than I who are sounding the same alarm I am. I would also like to not be naïve enough to believe that “it could never happen here” either because I am sure there are millions of people throughout history who would tell us that you should never, ever, utter those words because no person or country is special.
This stunning statement came across the close of CNBC from Tyler Methison who apparently quickly polled strategists after the close today for confirmation. How this is not the beginning of a correction is beyond me as this week’s trading has been nothing but negative, unless you are short the market of course, however this is the stance CNBC is taking. I am afraid much like 2007 and early 2008 it will take much more for the bulls to believe that the market is overheated and ready to come back to reality.
What is causing the pullback? Pick your poison. The technical’s, today the S&P smashed through its 50 day moving average, compliments of Mark, and the transports have been signaling trouble for about a week now. There is the weak consumer confidence which suddenly sank yesterday and, frankly, should have sent the market far into the red. Then there is the weak top line earnings which I have been warning about since the second quarter as the consumer is dead broke and credit is contracting at a 15% annual rate, you cannot have an economic expansion without credit creation. Finally, there is the dollar, my personal favorite indicator lately, which has gained some strength lately which is drawing money out of equities.
Goldman Sachs was also no help today as they announced they are trimming their 3Q09 GDP estimates from 3% to 2.7%, which is really not surprising given a weak consumer. This may have been the ultimate trigger considering stocks have priced in a V shaped recovery with a strong GDP number built in. As a matter of fact, not only did the market price in a +3% GDP for the third quarter, but I have a feeling it priced in a much stronger 4Q09 and 1Q10 GDP figure as well, which is kind of crazy since may retailers are starting to warn about weaker holiday sales. Wal-Mart now has some 100 toys priced at $10 or less compared to last year at only 10 or so toys prices at $10 or less, that is Wal-Mart entering a price war, but with who exactly, The Dollar Store?
Under Armour also, in a roundabout way, warned its 4Q numbers were going to be weaker than expected. This is the shopping season and these are popular products warning that sales are going to be weak during the holidays. If this doesn’t tip you off that the recession is not over I don’t know what will. I realize that employed economists who do not leave their ivory towers much and place way too much emphasis on government transfers think the recession is over, but if they talk to real people perhaps they would realize that data points are more than just data points, they are people and they are hurting.
Some 500K a week initial jobless claims is not good news, it is horrible news and bad for the economy. Cost cutting means nothing if you are firing the very people who you depend on to buy the products you sell. That is exactly what is going on and why unemployment is a leading indicator of our problems. As long as economists are unwilling to listen to that basic fact and try to get you to believe in a jobless recovery, which is a myth I might add, then nothing will get solved.
The markets could get much, much worse in the near future, especially if unemployment or GDP numbers are slightly worse than expected. If the numbers are better than expected we will have a bounce, but I would not expect it to last very long. Traders are getting tougher to please as they are expecting more because they were told everything is better and as they see things progress in the opposite direction they will take the market lower. Yes, I am a bear and I am short, but you already knew that or should have known that as I made no secret about it and I tried to give everyone fair warning.
Disclaimer: I currently hold SPY Jan 2010 100 puts, SPY March 2010 90 puts, SPY June 2010 89 puts, SDS, SKF
The market has not been able to hold a rally as the dollar strengthens which shows that the 60% rally we witnessed was purely liquidity driven. Essentially, the Fed, in their infinite wisdom, decided to drive investors out of less risky assets into high risk assets in order to re-inflate the asset bubble. While the Fed was busy pumping money into everyone’s pocket, except for the peoples, it has cost the dollar much of its value, or so you think.
Actually, the dollar is not near its lows of 2008 yet, but when the DXY was at 89 and it fell to 75 it felt like it plunged in value and had me concerned. I am still very concerned on a long-term basis, as I see a runaway government with deficits as far as the eye can see, but since everyone and their grandmother was short the USD, it was a given it was going to go up. Since this rally was a liquidity weak dollar rally a strong dollar will drive equities down along with commodities, which I wrote about on Sunday night I believe. As predicted, we had a super rally in the dollar and stocks got clobbered along with commodities and I suspect that will continue for a little while as the dollar rally will soon turn into a fear driven rally.
Whether I or you like the dollar long or short-term is irrelevant as the US government guarantees return of principal. This explains why at one point in time people were paying negative interest rates to the US government to buy short-term treasuries during the crisis. It was worth it for the comfort to know you were going to limit your losses because at that time you did not know if your bank was going to open its doors the next day. Do any of you remember that? Anyhow, this strength in the dollar will create selling in equities, just like a weak dollar drove the risk trade.
This explains why I stopped buying gold and this explains why I got short the market well over a week ago. It is not that I am perfect or a psychic it is just that things change, quickly. The dollar is not going to go in one direction forever and stocks do not always go up. It is also clear to anyone who is paying attention to fundamentals that the market is so far ahead of itself it is bordering on insanity. Valuations do matter and we are at a point where the valuations are just way out of whack with what is real and people are setting themselves up for real pain by not realizing this now.
If you do not pay attention to the things that are happening on the fringe of the markets, like the dollar, then you will miss the things that matter the most and impact your portfolios the most. Long-term the dollar will decline unless Washington gets their act together, but they won’t, so be bearish on the dollar long-term until proven differently, by the way that long-term bearish dollar outlook is also bearish on US equities as well. However, a short-term outlook is completely different and driven by the here and now so don’t confuse the two. I could be wrong about what I think is going to happen, but so far, I am right on the money and I think we are headed for more downside pain in the very near-term.
I am a gold bug, there is no question about that, and I am a long-term bear on the USD because I know that Washington will never reverse their ways of the last 30+ years of fiscal irresponsibility. However, I feel that gold has made a huge run in the recent months and the USD has made a big move to the downside as well. This will not continue as stocks are beginning to struggle and earnings are not as good as many have expected.
This means that the dollar will more than likely see some strength in the short run which will drive stocks and commodities lower. This will certainly drive gold below the $1,000 level which will bring about a much better buying opportunity for those looking to buy. Not to mention, other metals have largely been ignored in the recent run up in gold prices, i.e. silver, palladium and platinum are well below their 2008 highs.
Whether or not this equity rally was liquidity induced or not is really irrelevant as the one true correlation that we can draw is that the dollars losses were stocks and gold’s gains. This will stop as we see a reverse in this trend in the near-term. I see this happening based on the trading patterns over the last few days and the market rally losing its ability to sustain itself. It is really unreal that the market could simply continue to move higher without much skepticism from participants on this fantastic move, but it is what happened.
The one thing we know is that at no point in history have we ever seen such a snap back in equity prices in such a short period of time while we shed jobs and credit continues to contract. Not to mention economic growth is anemic at best, subtract government activity and it is downright ugly, but buyers in the USD will come back as the bearish trend in the short-term is actually bullish. Also, its inability to maintain a new low makes me think a rally is in store in the next few days, which is bad for stocks and precious metals.
Because of this, I am not buying any metals right now with the exception of palladium, it is my favorite and, in my opinion, has the most to gain no matter what happens. My feelings on the USD in the short-term is also why I am short the market right now, a position I opened 10 days ago and added to on Monday, and will more than likely add to. No matter how I run the numbers I am coming up with a fair value of the S&P 500 of between 800-900, but that is my opinion and what makes a market. Eventually, valuations will have to matter in equities and a stronger dollar will force a revaluation quickly, on the flip side a major devaluation would do the same thing I might add.
On a long-term basis, until Washington changes its ways there is no way anyone can be bullish on the dollar. Therefore, I am a buyer of metals on a longer term basis, but I prefer to use my head and unless something happens over the next few days I see no reason to change my mind. An important note is I already have a healthy position in all metals and I am not a seller, I am just not committing new money at this time.
As stated several times in the past there is a breaking point between how low the dollar can go before it will negatively start impacting the market. As my kids ask all the time, are we there yet? I think we are close, very close. As the dollar closes in on that 75 handle and the EUR/USD crosses the 1.50 mark it is becoming a major problem.
Why? A cheap dollar is great, in the short run, for international earnings, i.e. see Intel and Google’s positive FX results. However, long-term it is horrible for the US because it boosts productivity on false pretenses. Sure, our trade deficit decreases, but did it really? No, it did not. It also increases energy costs which is a huge problem when we have wage deflation and 10% unemployment. I believe that the administration’s goal was to devalue the dollar to boost manufacturing, but like all plans there are unintended consequences and those consequences are real and devastating to the people.
In effect, the devaluation process will wipe out the middle class and the Fed will certainly lose control over the process. Also, what does it matter if companies have record profits if the value of the currency is worthless? That is the potential problem we are facing right now. If the USD breaks below the 71 handle there is no bottom, none. Computers will then take over and without severe intervention then we are in big trouble. Unfortunately intervention means the printing of more money which means a weaker currency, see the problem?
The Chinese would help because they hold dollars? Oh yeah, why? Their currency is pegged to the USD so if the USD is devalued then their currency is cheaper to making their products cheaper to their largest client, Europe. So, why would they intervene? They would not. Perhaps Japan might, but I would not hold my breath they got their own problems. Your only hope is Korea and other smaller Asian countries and they do not have the buying power to stop it, they already tried to intervene a week or so ago and it did nothing. Getting back to China, they also hold large quantities of gold and other commodities, so they are hedged they really don’t care, I don’t think anyhow.
With that said, the Dow was up and then the dollar got pounded and we are seeing a down trend as that happened. We are at the point where the value of the dollar matters and that is a very good thing, finally. While I have done very well with gold and other metals, I care about the dollar’s value and so should you because a 60% rally means nothing if the value of those dollars is reduced by roughly the same real return. Right now I believe a move in either direction is bearish for stocks, but especially a lower dollar as it moves energy higher.
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