Trader’s Narrative

The poor besieged dollar gets a short reprieve as the gold bull market pauses. But the gold bugs suddenly have an unexpected and persuasive ally in their camp. As an interesting addendum to what’s next for gold? in the most recent quarterly client letter, Paul Tudor Jones II builds a fundamental case for a long term bull market.

He compares the relative historical value of the precious metal to the US monetary base, crude oil and the S&P 500 index. Their econometric model declares “gold is 20% undervalued over the next 24 months”. But the rationale is not restricted to the monetary forces which are at play.

Strengthening his case, he delves into the basic demand and supply of the commodity. On the supply side, mining production has been stagnant for the past 10 years. And central bank selling has slowed to a trickle with no new sales planned in the future.

On the demand side, the physical investment allure of gold continues strong. As well, to that we can add the penchant of modern investors for digital investment in gold. Relative to the gargantuan size of the equity market, the bond market and alternative investments (real estate, timber, etc.) gold’s share continues to be lilliputian. This means that even a sliver of asset flows diverted to gold will dramatically alter the equation.

Source: Tudor Investment 3rd Quarter Letter

Gold ETF holdings as a ratio of above ground stocks has increased incrementally 4 years. And the trend, does not look like it is about to reverse.

While Paul T. Jones presents a text book case for the long term bull based on fundamental analysis, I can’t help but think it is all an elaborate window dressing to rationalize a position he has arrived at through other, shall we say, more esoteric means. Clients obviously prefer logical, well thought out reasons for why a professional is allocating their money a certain way.

No one would be comfortable to be told that their trust fund is being gambled on nothing more than squiggles and trend lines or better yet, something called Elliott Wave (which we know, by the way, that Paul T. Jones II used to make a killing on Black Monday while practically everyone else on Wall Street was busy having an aneurysm). Interestingly enough right now Elliott Wave is bearish on gold.

This is just speculation on my part, of course. I have no way of knowing exactly why Tudor Investments is bullish on gold. Maybe I’m too cynical and we can take them at face value. In any case, even if the long term gold case is solid, you might want to fine tune the entry by looking at the gold sector sentiment.

Here is a chart comparing the price of gold and the Hulbert Gold Sentiment Index, which measures a subset of newsletters which time the gold stock sector:

Source: Risk Management and Convex Return Profiles

While the Hulbert gold sentiment metric isn’t as high as we’ve seen it historically, at these levels it does not bode well for another leg up. At least not without a pause first. As I mentioned before, to me it isn’t just the altitude of the bullish sentiment, it is also the attitude: as gold has corrected recently sentiment continues to reflect the same amount of optimism.

Just a few months ago we may have still been engaged in the economic debate of whether inflationary or deflationary forces would win out. On the one hand you had the credit collapse on a global scale which sucked the wind out of the economy and on the other hand you had the immediate and collective response of the Western world to inject mind-boggling amounts of money through monetary and fiscal stimuli.

But today the debate is over. In spite of the inflationary forces unleashed to fight it, deflation has cleary won. We are seeing this anecdotally on the ground as well as trickles of econometric data coming in from North America, Europe and even China.

The US economy is akin to a patient barely clinging to life in a critical care unit (insert US health care joke here). If the Federal Reserve is imprudent enough to raise interest rates from basically zero, it is not difficult to guess what might happen. Needless to say, they are not that stupid.

Even so, the Fed is pushing against a string at this point. They are basically observers like the rest of us, helplessly watching the largest decline in consumer prices in 50 years:

The chart below shows the real interest rate (interest rate minus inflation), rather than the nominal rate, its much more famous cousin:
Continue reading ‘The Necessary Consequence Of Deflation’

Back in October of last year, I looked with awe on an economic tsunami that was about to hit us all and wondered if it would be deflation or inflation.

Today, the answer is much clearer. Despite the gargantuan amounts of money that the central banks have pumped into the world economy through their loose monetary policy and despite the equally unparalleled coordinated worldwide fiscal stimuli provided by government spending, the danger of deflation is very real.

Just take a look:

Here is a FREE 60 page eBook from Elliott Wave International about the dangers of deflation and how to position yourself both defensively and offensively to benefit.

The elite financial community labeled Prechter – the 1980s “Guru of the Decade” – an outcast, a man preoccupied with the concerns of “small children.” Experts from all schools of the economics profession said Prechter’s deflationary scenario was “utter nonsense,” and as likely to happen as “being eaten by piranhas.”

Yet … here it is. Since the real estate top in 2005, deflation has festered its way into almost all asset classes, ravaging the portfolios of millions. If you’ve been spared from deflation’s mighty jaws, you surely know someone who hasn’t.

Until today, most of the forecasts and advice in this still-prescient eBook have only been released to Prechter’s faithful subscribers. You will not find its entire contents in other books or from other sources. This is your FREE definitive Deflation Survival Guide.

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Below is an article written by Mark Galasiewski, editor of Elliott Wave International’s Asian Financial Forecast. Although it uses Australian data to illustrate its point, the same can be shown with US central bank rates and short term T-Bill rates:

The following is excerpted from Elliott Wave International’s Global Market Perspective. The full 120-page publication, which features forecasts for every major world market, is available free until April 30. Visit Elliott Wave International to download it free.

Conventional wisdom says that central banks can influence or even direct financial markets and the macroeconomy. The very existence of Elliott waves challenges such assumptions. For if markets responded to every central bank directive, how could Elliott waves exist? Parallel trend channels, Fibonacci price relationships, the similarity of form between waves of different sizes and time periods—none of that would be possible. Central bank decisions would have to coincide perfectly with turning points in Elliott waves, and we know that just doesn’t happen. But even without using waves, we can expose the conventional wisdom for the fallacy that it is.

Take, for example, this assertion in a recent article in a U.K. economic weekly: “Part of the aim of central banks in driving down interest rates is to encourage a greater risk appetite among investors.” Two key assumptions underlie that statement: a) central banks determine interest rates; and b) lower interest rates can increase society’s appetite for risk.

To see how the first assumption is false, let’s take a look at the daily chart of Australian interest rate data. It duplicates a study that Elliott Wave International has often done with U.S. interest rate data. It shows how movements in the cash target rate set by Australia’s central bank, the Reserve Bank of Australia (RBA), appear to follow those in 3-month Australian Treasury Bills. After decisive moves up in T-bills from 2006 to early 2008, for example, the RBA faithfully raised its target. T-bills have since led the RBA during the financial crisis of the past year. In fact, the record indicates that the RBA almost always follows T-bills over time.

The proper conclusion to draw is not that the RBA has orchestrated the decline in rates since the early 1980s—but that it’s been riding it. During good times, central bankers look like geniuses; during bad times, they get tarred and feathered. Closer to the truth is that their interest-rate decisions are not proactive, but reactive, and that they continually follow in the footsteps of the market for lack of any other useful guide.

Now let’s look at the second assumption: that lower interest rates increase society’s appetite for risk. A simple glance at the weekly chart shows this assumption to be false. After the 1987 crash, the ASX All Ordinaries actually rallied for two years on rising rates and then sold off through 1990 on falling rates. Stocks then rose in 1991 on continued falling rates and sold off in 1992 on even lower rates. Continue following the chart to the right and you will see that there is no consistent correlation between the direction of interest rates and that of the stock market.

The myth of central bank potency is so pervasive that conventional analysts can’t even imagine a better explanation for price trends: that the market is the dog wagging its central bank tail, not the other way around.

For more information, download Elliott Wave International’s FREE issue of Global Market Perspective, available until April 30. The 120-page publication covers every major world market, global interest rates, international currencies, metals, energy and more.

Mark Galasiewski is the editor of Elliott Wave International’s Asian Financial Forecast and member of EWI’s Global Market Perspective team covering Asian stock indexes.

Today’s Bank of Canada rate decision is being watched very carefully. Not because of any lingering doubts about what they will do; because according to the rate futures there is a 100% expectancy of a 50 basis point cut (and a 73% chance of a 75 basis point cut).

The question on everyone’s mind is what will the six big Canadian banks do?

The last rate cut decision by the Bank of Canada resulted in a huge public relations mess for the Canadian banks because they refused to pass on the full rate cut to their customers. While the central bank lowered Canadian rates on December 9th, 2008 by 75 basis points, the banks grudgingly lowered their prime rates by only half a percentage point.

They have also refused to lower mortgage rates, citing “extraordinary credit market conditions”. This in spite of the fact that all stress measures of the credit market as well as money “costs” have fallen tremendously.

For example, the Banker’s Acceptance rate is now hovering around 1%. The 5 year bond rates are around 1.58% and the 30 year at 3.6%. Compare that to 5 year mortgage rates of approximately 6.75%-6.50% and you notice that that is a huge gap. In fact, according to historical data, Canadians have never seen such a discrepancy in their financial markets.

If the banks refuse to lower their prime rate again, the Canadian banks will not only widen the gap between the central bank rate and the “real rate” available to people but they will also negate any influence which the central bank is trying to have on the Canadian economy. In the end, by their belligerence, they could be pushing Canada into a deeper and longer recession than it would otherwise have to endure.

In that case, it would be a good idea for the usually soft-spoken governor of the Bank of Canada, Mark Carney, to call a meeting with the head of all Canadian banks and throw some chairs around.

Here’s a chart showing historical central bank rates for 7 major countries (Canada, US, ECB, Japan, England, Australia and Sweden).

UPDATE:
The Bank of Canada lowered its overnight benchmark rate by half a percentage point as expected. All Canadian banks followed by lowering their prime rate by the same amount to 3%, which means they are still 25 basis points behind the central bank’s lowering agenda.