Tuesday, August 6, 2013

Another reason for Gold's decline ...

An article from the Wall Street Examiner regarding a piece by Rick Santelli on CNBC as well as Kopin Tan's weekly roundup in Barron's this past weekend is the motivation for this blog post.

In spite of my rosy predictions about the direction of stocks which I generally still adhere to, many of my readers know I still have many concerns about the disinflationary trends that are manifesting themselves in this country and the deflationary juggernaut that still holds the world in its grip.  Central banks have been able to hold these deflationary pressures in abeyance for the past five years in spite of some close calls with the result that asset prices (save commodities) have exploded.

At this point, the stock market is running on sentiment (contrarian) as much as anything else.  Certainly, earnings have been steadily weakening and the only arguments we here in defense of this incredible rally is mediocre economic stats and that stocks are the only game in town because the return on fixed income is all but non existent.

Here are two charts that tell a story of the financial markets since those dark days of 2008:

(click on chart for larger image)
chart courtesy of The Wall Street Examiner
 
The above chart reflects of the effects of the Fed's POMO (Permanent Open Market Operations) on the stock market.  Here's the definition of POMO straight from the New York Federal Reserve's website:
 
The purchase or sale of Treasury securities on an outright basis adds or drains reserves available in the banking system. Such transactions are arranged on a routine basis to offset other changes in the Federal Reserve’s balance sheet in conjunction with efforts to maintain conditions in the market for reserves consistent with the federal funds target rate set by the Federal Open Market Committee (FOMC).   

It's clear from the chart that Fed cash to primary dealers and the levitation of the stock market are closely correlated and this is nothing new to those involved in the financial markets.

However, as I've repeatedly pointed out in the past, the effects of POMO and QE have not had the same effect on commodities .  Here's a chart of the Dow Jones UBS Industrial Metals Index ($DJAIN) with the S&P 500 (white line) superimposed upon it and the highlights of the FED's liquidity operations over the past five years:

(click on chart for larger image)
 
The chart is busy but it highlights the recent actions by our central bank and its effect on stocks and commodities.  The divergence is apparent. 
 
In last weekend's edition of Barron's Magazine, Kopin Tan quoted Bank of America's chief investment strategist Michael Hartnett who stated, "Significant monetary stimulus, the end of fiscal austerity, a booming housing market, a cheap dollar, record corporate-cash balances...if the U.S. economy does not significantly accelerate in coming quarters, it likely never will,"  Mr. Hartnett's statement highlights the concern I have. 
 
The market is obviously pricing in a better than tepid economic recovery six to nine months out.  But what if the US is descending into the malaise the Japanese economy has been trapped in for the past twenty plus years?  I've written about this in a recent commentary (http://equitymaven.blogspot.com/2013/07/of-central-banks-asset-bubbles.html) and admittedly, I must concede it is a minority scenario for a number of reasons that time will not allow me to explain.  But consider this.  Last week's FOMC statement emphasized disinflationary concerns while the GDP report showed the price deflator fall below 1% and the manufacturing ISM price component fell below the 50 boom/bust level.
 
And gold seems to be resuming its downtrend this morning.   The prevailing view is that the weakness in gold is signaling that there's little to no inflation in the global economy (true) and that the extreme tail risk of the past five years is melting away (true again).
 
What the street isn't talking about and what the Fed is downplaying (save Jim Bullard from the St. Louis Fed) is the disinflationary pressures that are ever present in the US economy on top of the very clear deflationary pressures elsewhere on the planet.
 
Food for thought ...