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Today's Market WrapUp |
Let's Focus on Facts
Oil climbs, gold rises and stocks fall. The reason given is possible war with Iraq. "Possible" more likely means "probable." However, there is another reason that paper is falling and “things” are rising and it all relates to the dollar. Gold and commodities trade inversely to the dollar. There may be talk of war, but it is the dollar that is driving commodity prices higher. The dollar is in the process of breaking down which is bullish for gold and commodities.
As the three graphs of the dollar, gold, and the CRB illustrate, “things” are traveling in the opposite direction of paper. As I wrote in CRA$HMAKER, the last time we had problems with the dollar, which was in 1985 and in 1996, the price of commodities rose. The first to rise was gold and then the general price of commodities. Eventually interest rates climbed and the price of stocks fell. It doesn’t always work out this way sequentially since there are time delays between the dollar’s rise and fall and the inverse relationships between paper and tangible assets. However, it appears that those relationships are reasserting themselves.
The CRB Index, it is made up of six different groups—livestock, precious metals, energy, grains, industrial metals, and soft goods such as cocoa, sugar, and coffee. All of these groups are up this year so the rally in commodities has been broad based. However, some commodities have risen more than others. Some commodity groups have far outdistanced others by a wide margin, with energy at the top of the list. This group includes oil, natural gas, heating oil, and gasoline. The energy sector is up close to 60 percent this year. [See Wed. WrapUp] Close behind energy are agriculture products, which are up over 23 percent. In third place and not far behind are precious metals: gold, silver and platinum. The only weak group within the six categories that make up the index are industrial metals. This group follows more closely with the general economy and signifies weakness. [Learn More about CRB Index.]
The other groups that make up the index have a number of factors that have contributed to their rise such as weather with grains, war, OPEC and other geopolitical factors such as Venezuela. But one commonality they all share is a falling dollar. There are a number of bullish factors contributing to the rise in commodities but the dollar has to be at the top of the list.
Buckets of Money
Related to the dollar’s fall and the rise in general commodity prices are central bank injections of liquidity. Since 1971 the world’s financial system has been operating on a fiat money system with no constraints on the central bank’s ability to create money and credit other than the discipline of the market. Higher interest rates, the threat of withdrawal, and denial of access to new credit lines have been the only methods used to impose discipline on those who abuse this power to create money out of nothing. All currencies are depreciating. With the dollar’s decline, it is just a question of how much it depreciates against other currencies and collectively how much they all depreciate against a basket of commodities.
As long as markets remain open and central banks continue to create money and credit, that money is going to find a new home. As you look around the world, it is hard not to find anywhere that paper isn’t depreciating and hard goods are appreciating. This, more importantly, is what the rise in precious metals and the jump in commodity prices are telling us. With governments hell bent on avoiding deflation, they will print money continuously in an effort to avoid deflation at all costs. The recent speeches given by Fed governors and highlighted in these daily Wrap Ups tell us where central banks are taking us. They will continue to print and create more money and credit at will. Buckets of new money are going to flow somewhere and that somewhere is, I believe, in commodities.
Dance of the Honeybees
The ability of central banks to continuously create money at will means that this money will find a home somewhere. In the 90’s it found a home in technology stocks. In this new century, it has found a new home in mortgages, real estate and consumption. This hot money is like a swarm of honeybees looking for a new place to land. It appears that this new home is commodities, especially energy, grains, and precious metals. This would seem obvious with the movement in energy, grains and metals prices this year. Many now believe that we are headed for deflation. However, there are numerous cases where a rise in commodity prices and deflation has existed side by side. More importantly throughout the annals of history it has been shown that when empires go into decline, whether Roman, Spanish, British or American, they go down with inflation. Marc Faber, writing in his Gloom, Boom & Doom Report in April said, “Inevitably, empires experience inflation, rising interest rates, a depreciating currency, default on their debts, or a combination thereof.”
Only recently, in the March-April issue of Foreign Affairs has it been suggested that America become an empire. The piece entitled “The Reluctant Imperialist: Terrorism, Failed States, and the Case for American Empire” made the case that the war on terrorism would force America into becoming an empire through its efforts to fight terrorism globally. In the July/August issue, Stephen G. Brooks and William C. Wohlforth in their article “American Primacy in Perspective” wrote about a unipolar world both economic and militarily that the U.S. now finds itself in. From a military perspective the U.S. spends more money than the next 15-20 biggest spenders combined. The authors point out the country’s overwhelming nuclear superiority, dominant air force, and the only true blue-water navy in the world.
But empires cost money and it is money the U.S. does not have. America must borrow between $1.5 to $2 billion per day or 80 percent of the world’s savings to finance its trade and current account deficit. However, it does have a deflation problem and the U.S. has a central bank. This central bank in the words of Governor Bernanke “has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of dollars in circulation, or even threatening to do so, the U.S. government can also reduce the value of the dollar in terms of goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
Keep Your Eye on The Financial Markets as The Drums Beat Louder
It is perhaps in respect to maintaining its empire, fighting a war and fighting deflation, that I feel the investor should pay particular attention in the financial markets. The government and its related central bank has told the investor what it intends to do. In fact, the war drums beat a little louder today when Secretary of State Colin Powell spoke in response to the weapons UN inspectors report, “These are material omissions that in our view constitute a material breach of UN resolutions.” So it appears the U.S. is moving closer to war with Iraq. This war will cost money. The Administration estimates the cost of the war may run as high as $100-$200 billion. Wars cost money and the printing presses are now running 24 hours a day. M3 is expanding at an annual rate of over 20 percent a year. That is a lot of money, or should I say credit, even by U.S. standards. It is only one factor contributing to the dollar’s decline. This is one more reason I would direct the reader’s attention to the price of commodities and especially natural gas, oil and precious metals.
To the skeptics on energy who feel that oil will flow freely after the war is over, pay attention to a story out today on ABC that Saddam is planning a scorched–earth policy if attacked by American and British forces. The Iraqi dictator is planning to destroy Iraq’s oil fields and food supplies in the event of war and then blame the U.S. The story out today by ABC says that Hussein has plans to wreck his own infrastructure to foster a humanitarian crisis to turn the international opinion against the U.S and the U.K. Saddam lit up Kuwait’s oil fields when his armies left the country. It would take almost a year to put out those fires.
With oil and natural gas supplies dwindling and in short supply, a bad turn of events in Iraq, civil disorder in Venezuela, a cold winter and possible terrorist attacks in the U.S. against our energy infrastructure could send the energy markets and metals soaring. In any case, I don’t see how we can avoid natural gas prices that may spike as high as $10 this winter or oil prices that could rise to $50 a barrel if war begins in the Middle East.
It's Time to Move On
There is far too much complacency in the financial markets at this time. The herd is still focused along with most money managers on the last “big thing,” not recognizing that every boom is followed by a bust and new leadership. The fact that there is only a token acknowledgement of rising commodity prices and the majority of investors and institutions are still in stocks and bonds tells me that the old trend has yet to be discredited or the new trend accepted. The crowd has not acknowledged this new investment theme just beginning in commodities. The majority of investors are still chasing the last bull market themes which ended three years ago, or are sitting on tech stocks waiting to break even. Investors are still bullish on paper whether that paper is stocks or bonds. Bonds like stocks have had a 20-year bull market run. Outside a rush to safety when stocks decline, U.S. bonds are also unlikely to perform well over this next decade, especially now that the Fed is planning to reinflate the economy. The new theme of “things” despite their spectacular rise over this year, and in the case of precious metals last year as well, has been largely ignored. Wall Street and its media propaganda machines on cable TV are still pushing stocks and bonds even though fundamentals have turned against these asset classes. Only the smart money has moved in. The Buffett’s, the Soros’, and the big players buy quietly and hold their positions. Only after they have become fully invested in the new trend is the new trend disclosed to the crowd. It is when the crowd discovers this that the final rush begins. It was only during 1995-2000 that the investment public fell in love with stocks. I suppose when natural gas prices are at $10, oil is at $50 a barrel and gold is over $1,000 that “things” will become popular again.
Today's Market
All major indexes fell again, hitting five week lows. Concerns over oil, war, and earnings weighed in on the markets. Losses widened after Secretary of State Colin Powell said that Iraq totally breached UN resolutions. It now looks like war is eminent. War adds another uncertainty to a long list of uncertainties for the financial markets. Wall Street’s dream of a market bottom and another new bull market is turning out to be delusional. The Street still hasn’t gotten over the fact that the bull market in paper is over.
Another factor that doesn’t bode well for the economy is the jump in oil prices over the past five weeks. Oil prices have jumped 21 percent during this period. Rising energy and raw material prices are eating into corporate profits. Oil is used as a raw material for plastics and chemicals. Rising oil prices affect the costs for companies such as DuPont, Dow Chemical and Procter & Gamble. Shares of all three companies fell today.
It now appears unless there is miracle on 32nd Street this year, it will be the third consecutive year of double-digit losses for investors in stocks. The Dow is down close to 17 percent; the S&P 500 is down 23 percent, and the NASDAQ has plugged over 30 percent for the year. Precious metals and energy are still hot, but money still is flowing into tech. Shares of Oracle rose 37 cents to $11 after beating estimates. The company continues to see its sales and profits decline. Sales have fallen now for seven consecutive years. The good news is that they beat estimates. Energy and gold shares pulled back at the end of the day after news that a judge in Venezuela has ordered striking workers back on the job.
On the economic front, the Conference Board’s leading economic indicators rose last month by 0.7 percent. The Philadelphia Fed’s economic report showed that the manufacturing sector within the region remains sluggish. Economic figures continue to indicate a weak economy. Not strong and not weak, but just muddling through. The winners today were once gain commodity prices as the dollar fell and the CRB Index rose again. Volume was weak with only 1.04 billion shares trading on the NYSE and 1.31 billion on the NASDAQ. Breadth was negative by 8-7 on the NYSE and by 10-7 on the NASDAQ. The VIX rose 2.80 to 34.56 and the VXN fell .17 to 49.47. Sentiment is still bullish towards technology. The crowd is still chasing the last bubble.
Overseas Markets
European stocks fell, led by Allianz AG and Munich Re, after Goldman, Sachs & Co. lowered its recommendations for the two insurers. Commerzbank AG dropped after its chief executive said he sees little earnings improvement in 2003. The Dow Jones Stoxx 50 Index shed 0.4 percent to 2432.36, a two-month low. The Stoxx 600 Index lost 0.3 percent to 203.81.
Japanese stocks rose, led by banks such as UFJ Holdings Inc, after the Tokyo Shimbun newspaper said the nation's fourth largest lender will eliminate more jobs to cut costs. A UFJ spokesman said details haven't been decided. The Nikkei 225 Stock Average added 0.5 percent to 8387.57.
