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The Daily Reckoning | Thursday, April 28, 2011 |
- Stocks become an inflation trade...at The Bernank's behest,
- Why the commodity bull ain't over yet...and how you can play it,
- Plus, Bill Bonner on central banker celebrity and something more valuable than money...
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|  | | Staying On the Right Side of the Inflation Trade
| Why the Declining US Dollar Has Been Good for Stocks and Precious Metals
| |  | | Eric Fry |
Reporting from Laguna Beach, California...
"Stocks rose to another high for the year [yesterday]," according to theAssociated Press, "after Federal Reserve Chairman Ben Bernanke said central bank officials expect the economy to continue recovering." It's true stocks soared yesterday, but we're not so sure the "recovering economy" was the primary cause.
No, we're going to stick with our working hypothesis: the stock market is soaring because the dollar is tanking. The more the dollar tanks, the more the stock market soars. This inverse correlation makes perfect sense. If you are holding a rapidly depreciating asset, why not exchange it for an appreciating asset...or at least an asset that offers the potential to appreciate?
This dynamic - falling dollar, rising stocks - is just another way of saying the stock market, in aggregate, has become little more than an "inflation trade." This particular inflation trade may contain a variety of stock symbols and may attract continuous, hyperactive blather on financial news networks, but it is still just an inflation trade.
Believing that a dollar bill will buy less tomorrow, US investors will use their dollars to buy almost anything today, including richly valued stocks. US stocks, as an inflation trade, have performed adequately so far in 2011. The S&P 500's 7.5% year-to-date gain roughly equals the Dollar Index's year-to-date loss.
Over longer time frames, however, the US stock market has delivered a much less effective hedge against the falling dollar than, say, gold or silver. During the last 10 years, for example, the S&P 500 produced a cumulative total return of 33.7%...when measured in US dollars. When measured in Australian dollars, however, this gain flips to a 35% loss!
In fact, in terms of every major world currency, as well as numerous minor world currencies, the S&P 500 has been a losing bet for the last decade. In terms of the precious metals, the S&P 500 has been a very large losing bet.
By simply exchanging dollars in April 2001 for any of the currencies or precious metals in the chart above, a dollar-phobic investor would have received a greater total return than by buying US stocks. Bear in mind that this chart does not include in its calculation the interest an investor could have earned in any of these foreign currencies. For perspective, the Aberdeen Asia-Pacific Income Fund (a closed end fund that holds Australian and Asian debt securities) has delivered a whopping total return of 289%!
So you see, inflation isn't all bad, as long as you're on the right side of the trade. The US dollar, as a store of value, has been a complete disaster for many, many years. The critical question for investors is whether this trend will continue...or reverse.
We cannot see the future, of course, but we can hear what Fed Chairman Ben Bernanke says about his future intentions. And during yesterday's press conference we heard the chairman promise to continue pursuing inflationary policies, while also dismissing the inflation he has already created as the "transitory" result of "robust global demand." In other words, the inflation problem isn't a problem.
The longer he spoke, the more the financial markets seemed to realize he wasn't kidding about this inflation stuff. The US stock market - remember, it's an inflation trade - rebounded from early morning lows to end the day at a new three-year high. Meanwhile, the classic inflation trades, gold and silver, rocketed from early morning losses to post huge gains. Silver jumped $2.36 an ounce to a new 31-year high of $47.84. (As we write, silver is flirting with $50 an ounce). Gold gained $21 an ounce to a new all-time high of $1527.35.
And what about the almighty dollar?
Bernanke declared, "the Federal Reserve believes that a strong and stable dollar is both in American interests and in the interests of the global economy." The foreign exchange markets seemed to choke on their laughter.
The dollar stumbled to a new two-and-a-half year low...and continues stumbling today. By contrast, the Australian dollar, Canadian dollar, Singapore dollar and Swiss franc are all hitting new all-time highs!
At some point, perhaps very soon, the "overbought" gold and silver markets will conspire with the "oversold" Dollar Index to embark on ferocious counter-trend moves. We should be prepared for such an eventuality, but not perplexed by it. The ending of QE2 in June would provide a reasonable excuse for such countertrend moves. But if/as/when the dollar rallies, don't forget to hit the bid.
The greenback remains a sick puppy... and inflation is its life threatening disease, as Chris Mayer explains in the fascinating column below about his milkman. No, it's not what you think...
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Will we face an American Apocalypse in 2011?
Top analyst warns:
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Is he right? View the video for free then decide for yourself.
Warning: Content may be too disturbing for some viewers.
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| The Daily Reckoning Presents
| The Milkman Indicator
| |  | | Chris Mayer |
Our family has a milkman. Yes, a milkman, just like in the old days.
He comes every Friday and drops off a crate full of cold bottles of milk, along with tubs of yogurt and butter, cheeses and sometimes meats. You place your orders online, and the milkman brings it your doorstep, fresh from a local family-owned farm not far from where I live.
I mention this because I got an interesting e-mail from the farm over the weekend, which I think sums up what we face in today's economy. The problem we face is particularly insidious because lots of people don't really understand what causes it, which allows it go on.
But before getting to abstractions, let's look at the e-mail I got from my milkman.
"We would like to take the time to tell you," it begins, "that due to some large price increases we are facing on materials we use to bottle milk...we must raise the price of our glass bottled products."
The e-mail then goes on to show, in some detail, exactly what price increases the farm sees. The milkman is a model of good disclosure and transparency. Many of our banks and corporations should use this e-mail as a model for communicating with the public.
The sources of the pain include a 4% increase in the cost of glass bottles and a 6% increase in the cost of plastic caps. The farm has also seen a 14% increase in shipping costs in just the last six months due to the rising price of fuel. There is more: a 2% increase in materials such as latex gloves and hairnets, a 5% increase in lab supplies for milk testing and an 8% increase in the chemicals used to clean the plant and equipment.
"I hope that you can all see that we have seen a huge increase in total," The e-mail continues. "This is why at this point it has become a must to increase the price of our bottled products 7%. This is always an agonizing decision for us, but sometimes can't be avoided."
We might call this the Milkman Indicator. I can tell you that this is happening across the economy right now. I follow a lot of companies, and rising raw material costs are at the top of the list of concerns facing anybody who makes anything.
Naturally, as investors, the idea would be to play those who benefit from such rising raw material costs and fade those who cannot pass on these costs to their customers. So for example, the rising cost of glass bottles makes me think of Owen-Illinois. This is the world's largest glass container company. I recommended it in my investment letter, Capital & Crisis in December. Part of the thesis there is that price increases in 2011 would help raise margins and profits. So far, the stock hasn't gained much ground, but the core idea behind owning it is still very much in play.
This has actually been something of a mini-theme in Capital & Crisis, where I have recommended several specialty producers of materials that are rising in price. Another idea is to own the producers of the commodities rising in price, like many of the energy and mining stocks I have recommended.
This phenomenon of rising raw material costs brings us around to causes. Why is this happening?
The short answer is that our Federal Reserve is printing a lot of money. It's funny how I can explain this to my 12-year-old using monopoly money - and he gets it - yet it seems economists with Ph.D.s and fancy titles in think tanks and government agencies don't get it all.
When you create a lot of money, that money loses some value. It buys less than it did before. That's what we're seeing, in essence.
The main barometer for monetary creation is the Fed's balance sheet. When it expands, so too does the amount of money sloshing around. All that money sloshing around has to go somewhere. People buy stocks, commodities and gold. There are many, many ways to show this, and I've seen many different kinds of charts that all show the same thing. But I grabbed the one below from today's Wall Street Journal to show you:
So "QE2" is the fancy name given to a very base and simple act: money printing. And you can see that as the Fed's balance sheet has swelled, so too have stocks and gold surfed the wave of cash. The dollar has also weakened (buying less), and rates on mortgages have gone up.
This is just the beginning. We know how past bouts of money printing ended. Badly.
[If you want to read up on the hazards, no book details it better than Adam Fergusson'sWhen Money Dies. Take 20% off when you buy a copy from Laissez Faire Books right here.]
Look again at that table above that shows mortgage rates. Those rates are in the 4-5% range. In the 1980s, it was rare to see new home mortgage rates below 10%. In 1982, the average interest rate on a new home mortgage was 15.12%.
These cycles often take a generation to play out from peak to trough and to peak again. Mortgage rates of 10% didn't just happen in one year. It was a slow buildup over a good two decades. The average mortgage rate in the 1970s was 8.8%, compared to 11.79% in the 1980s. In the 1960s, mortgage rates were in the 5%s.
Look at gold. It didn't jump to $1,500 in a year. It's been in a 10- year bull market.
So to wrap up here, I think we're looking at a long period when prices rise and the cost of money rises. I doubt the Fed's resolve to take back the cash it put in, until it gets really bad. Then another Paul Volcker will arrive on the scene to break the inflation and a deep recession will ensue, like a nasty hangover.
Until then, I think the Fed will keep the bar open and let the good times roll. This means gold up, dollar down, interest rates up and commodities up. And the prices the milkman charges will go up as well.
Regards,
Chris Mayer,
for The Daily Reckoning
Joel's Note: As Chris mentions above, it doesn't take a Ph.D. to understand that more money chasing the same or fewer things means higher prices. An intelligent 12-year old can grasp that...even if the concept remains beyond the nation's leading economists and central bankers. Take a look around your grocery store...the gas pump...the metals indexes. You already know what's going on. You see it every day.
But... Are you angrily suffering at the Fed's hands...or using their stupidity to your advantage? Chris mentions his "mini-theme" investment idea above, whereby he hones in on "recommending specialty producers of materials that are rising in price."
For more on the inflation story you already know...and the flipside investments you may not, feel free to check out Chris's latest Capital & Crisis presentation here.
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| | | Bill Bonner
| How to Be a Central Bank Celebrity
| |  | | Bill Bonner |
Reckoning from Baltimore, Maryland...
Bernanke spoke!
Yes, he held a press conference. Why would the world want a press conference from a central banker? Ah...good question. Because he's a celebrity... He's powerful. He moves and he shakes. He's as popular as William and Kate put together.
In the past, a central banker was meant to be anonymous...quiet...hidden away somewhere so far in the background that the ordinary man wouldn't know his name or recognize his face.
A good central banker was one you never heard of. He did his job. He made sure that the country had enough gold to cover its foreign debts and domestic currency issuance. He did not worry about full employment. Nor did he concern himself with "growth." His job was to make sure the money was good. That's all. If he did it well, he was practically a nobody.
If he did it badly, on the other hand, he might be castrated. Or, at least he would be disgraced.
Times have changed. Alan Greenspan turned central bankers into celebrities. He stood with Hillary Clinton at her husband's State of the Union address...thus signifying the union of money and power, much like the Pope and the Holy Roman Emperor standing together on the balcony of the Vatican.
And now, who wouldn't recognize Ben Bernanke's mug?
In fact, he is widely thought to be responsible for saving Christendom, Jewry and all of western civilization. Yes, he stepped in where fools feared to tread - and rescued the whole shebang.
And now what?
Well, the rescue effort has proven to be a big failure. TARP, TALF, QE1, QE2... The US feds put at risk more than $10 trillion to turn the situation around. Federal deficits alone add up to $4.5 trillion over the last 3 years.
And for what? Housing is still falling. The unemployment rate is still over 10%...unless you stop counting people who haven't been able to find work. More than 40 million people are on food stamps. And every increase in gasoline or food pinches household budgets like a tax increase.
But now, not only does the central banker play a much bigger role in the life of a modern economy, so does the government. A report earlier this week told us that more than half of "income growth" in the last 10 years comes from the feds!
Wait a minute. Where does government get any money? How can the feds give more than half US households more than half their income gains? Who pays for it?
Doesn't that money really belong to someone else? Aren't they just robbing Peter to pay Paul?
Yes, Of course they are. But Peter isn't old enough to vote. So who cares?
And now The Fiscal Times reports that US voters - as a whole - receive more in payments from the government than they pay in taxes.
The feds have turned half the population into incipient zombies...feeding off the other half of the population...and their children...and their children's children.
But let's get back to Bernanke. What did he have to say yesterday? Well...nothing!
Here's the AP report:
WASHINGTON (AP) - The US economy and job creation have strengthened enough for the Federal Reserve to end on schedule a program of buying Treasury bonds to help the economy, the Fed said Wednesday.
Fed Chairman Ben Bernanke spoke at a news conference after the meeting. It was the first time in the Fed's 98-year history that a chairman has begun holding regular sessions with reporters.
Bernanke said that as long as the Fed continues to say rates will remain at historic lows for "an extended period," rates won't rise until the Fed has met at least twice more. The Fed board meets about every six weeks.
Bernanke said he expects the economy to continue growing through next year and 2013.
He acknowledged that higher gasoline prices are creating a financial hardship for many Americans. But he said the Fed doesn't think gas prices will continue to rise at their recent pace. And more thoughts...
With Bernanke's dulcet assurances still echoing in their ears, investors went back to their errors. They bought more stocks - pushing the Dow up 93 points. They bought more gold too. The yellow metal rose $13.
One thing they didn't buy was the dollar. The greenback is at an all- time low against the Swiss franc. Against the euro, it seems to be returning to its all-time low. And against gold, of course, it passed its all time low many months ago.
And now that the economy is slowly but surely recovering - Bernanke said so! - many investors are beginning to wonder if gold may have passed its all time high too.
Let's hope people believe it.
The more who think so, the better. Yes...sell gold...please! Sell it in a panic. Sell it cheap. Sell it to the rag and bone man! Sell it to the pawnshop! Sell it at parties organized by newspaper ads! Sell it to people who put notices on eBay! Sell...sell...sell...
And then, you know what to do, don't you, dear reader?
Buy!
*** An old friend has written a delightful book. Alex Green is an investment analyst. We have never completely shared his investment philosophy; he is optimistic, capable and earnest, with little appreciation for our end-of-the-world-as-we-have-known-it perspective.
But we share an interest. His new book Beyond Wealth is about what interests us both - that is, what money can't buy.
The burden of the book is obvious, but not inconsequential. It reminds us of who we are and what we are. Making and spending money is part of what we do and much of what we care about. But it is not everything.
Getting rich is a competitive activity. We can't all be rich. Only a few can. There's no secret to it. Those who become rich tend to work harder at it than most people. Getting rich requires you to stay focused, to exclude from your life many of the distractions, idleness, chitchat and casual entertainments that make life interesting, lively, and agreeable. Rich people are often highly competitive, single-minded, and self-disciplined. That is, they are dull workaholics and terrible dinner companions.
Enjoying a rich life is an entirely different matter. You have to let your mind wander a bit. You have to be willing to "waste time" with friends, to spend time reading, thinking and amusing yourself with no apparent or immediate prospect of a reward. You have to travel, with no particular destination in mind...and be prepared for the serendipitous encounter along the way.
Where's the pay off? Well, it comes later...unbidden...unmeasured...and untaxed. It shows up on no balance sheet and no portfolio review. You will not be able to put a number on it...nor brag about how much it exceeds the benchmark. And yet, it is what you need to live a "rich life."
Alex's new book covers values, not prices. He describes the value in all manner of things - friends, long walks...hobbies...travel...philosophy...poetry...music - all the things the hard-charging wealth maximizer eschews.
The book itself is a distraction from the world of money...a delightful one. Click here to find out for yourself.
Regards,
Bill Bonner,
for The Daily Reckoning |
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