UPDATING INTERMARKET WORK
BOOK REVISION... As many of you may know, I wrote a book during 1990 entitled "Intermarket Technical Analysis". I've been busily engaged for the past few months in revising that earlier work. Hopefully, the newer version will be available later this year. The main reason for redoing the book was that some key intermarket relatIonships between markets have changed over the past five years. And that has been primarily due to the threat from deflation. In his testimony before Congress this morning, Mr. Greenspan said that deflationary trends started in the mid 1990s. I peg the start of the deflationary threat to the Asian currency crisis that started in the middle of 1997. In the year after the collapse of Asian currencies, commodities fell to a twenty-year low. More importantly, the link between bonds and stocks was severed. For the first time in the postwar era, collapsing interest rates didn't help stocks. That meant that bond prices rose while stocks fell. That tendency became more evident at the start of 2000 when the stock market bubble burst. More than anything else, the "decoupling" of bonds and stocks was the main signal that deflation had become a serious threat. The last time a major "decoupling" of bonds and stocks had occurred was during the deflationary 1930s. Another sign of where the deflation was coming from could be sign in the close correlation between a falling Japanese stock market and global interest rates. My recent Money Show slides in Las Vegas and Florida showed the close comparison between Japan and global bond and stock markets. They said Japanese-style deflation couldn't happen here. The fact is that it has been happening for the past five years.
USING THE DOLLAR TO CREATE INFLATION... It's no secret that the U.S. has abandoned it strong dollar policy. Actually, the dollar has been falling since the start of 2002. The Treasury Secretary just made that official this past weekend. The fall in the dollar is mainly due to the fact that U.S. rates are the lowest in the world -- with the exception of Japan whose rates are down to zero. Since the Fed can't lower rates much more, they can achieve the same effect by letting the dollar fall. The reason for doing that is partially to make our exports more affordable to the rest of the world. The other, and more important,is that a falling dollar is inflationary. What better way to fight deflation than by creating some inflation. When the dollar is falling, there are two major beneficiaries -- commodities (especially gold) and foreign currencies. That's why the gold market jumped so sharply this past week while the Euro surged to a four-year high. In the past, rising commodity prices sent off inflation warnings (like 1999) causing the Fed to raise interest rates. They've already said they won't do that because they want prices to rise. That means that the Fed wants gold and other commodities to rise. That hasn't happened in more than fifty years. Unfortunately, while the falling dollar may create a little inflation here, it creates deflation elswhere.
CREATING DEFLATION OVERSEAS... The Euro has jumped 27% against the dollar over the past year. The Japanese yen has gained only 8%. That's mainly because the Japanese have been intervening to keep their currency from rising too fast. That hurts their exports -- and it keeps prices down. That's not good in a deflationary, export-driven economy. The IMF recently put Germany on their list of countries in danger of slipping into deflation. The rising Euro not only hurts Germany's exports (in an economy with no growth) but pushes prices lower. That's deflationary. And Germany is the largest economy in Europe. So by letting the dollar fall to raise prices here, we're actually creating more deflation overseas.
THE CHINESE PROBLEM... The Chinese are the biggest global exporters. Their currency, however, is informally pegged to the U.S. dollar. That means the Chinese yuan has been falling along with the dollar. That makes Chinese goods even more competitive in world markets. The continuing supply of Chinese goods on world markets is also helping create deflation.
GOLD IS THE WINNER... In my view, gold is the primary winner in all of this -- or, more specifically, gold shares. Gold stocks rise in both an inflationary and a deflationary environment. Gold shares surged during the 1970s when gold spiked over $700. During the deflationary years from 1929-1932, Homestake Mining gained 300% -- while the market lost 90%. [Gold was set at a fixed price at the time]. There are three primary ingredients in a major upturn in gold and gold stocks. Historically low interest rates, a weak dollar, and a secular bear market in stocks. All three are now present. I believe that gold has entered into a new "secular" bull market -- just as the stock market has entered into a "secular" bear market. That should make gold (and gold shares) a big winner for years to come.
HEADING TO EUROPE... The Wall Street Journal wrote in an article yesterday that the people getting hurt the most by a falling dollar are Americans travelling to Europe. Yet, that's exactly what I'm doing. I'll be vacationing in Italy for a week. While my economic timing couldn't be worse, I console myself by knowing that the trip was planned a long time ago.
Hopefully, the preceding intermarket observations help puts things in some perspective. It looks to me like the falling dollar -- and rising bond prices -- have stopped the stock market rally right at the top of its ten-month trading range. I suspect the market will meander below those highs for the next week or two in relatively trendless fashion. Hopefully by the time I return (late next week) the market will have worked off its short-term overbought condition and will be ready for some new direction. In the meantime, CIAO.
