RISING OIL CAUSES SELLING IN OVERBOUGHT STOCK MARKET AS 50-DAY AVERAGES ARE TESTED AND TRANSPORTS BREAK DOWN -- GOLD ETF HITS RECORD HIGH AS SILVER LEADS IT HIGHER -- - SILVER WHEATON BREAKS OUT
DON'T THE 1970'S QUALIFY AS RECENT HISTORY... After reading the comments by Mr. Bernanke before Congress today, I got to wondering about how much he actually knows about market and economic history. The head of the Fed is generally acknowledged to be an expert on the Great Depression of the 1930s and government efforts to stem deflation. It seems that's been his working model since the last economic crisis that started in 2007. I'm beginning to wonder if he's working from the wrong economic model and wrong time period. He said today that experience with (commodity) price gains in recent decades, along with currently stable labor costs, suggests a "temporary and relatively modest increase in U.S. consumer price inflation". Here's my question. Doesn't the decade of the 1970s qualify as "recent" experience? I remember that decade very well having had the good fortune to be a commodity trader. The decade started with huge commodity price spikes that lasted until 1980. Those price increases were accompanied by a falling dollar, flat to weak stock prices, and rising interest rates. Inflation rose to double digits. The unemployment rate rose from 4% in 1970 to 9% in five years and ended the decade above 10%. That economic environment characterized by rising inflation, high unemployment, and a generally flat economy is called "stagflation". The fed funds rate tripled from 4% in 1972 to 12% two years later even as the employment situation worsened. Mr. Bernanke's depression model suggests that inflation is not likely while there's a weak labor market. The period of the 1970s seems to contradict that economic view when we saw both rising inflation and rising unemployment. Maybe it's time for the Fed to stop relying exclusively on the "deflationary" model from the 1930s and at least consider the possibility that the current situation might more closely resemble the stagflation period of the "inflationary" 1970s. Otherwise, the Fed risks actually re-creating the conditions that could contribute to a period of stagflation with rising inflation and a stagnant economy.
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Chart 1
COMMODITY PRICE RISES ARE GLOBAL ... Mr. Bernanke also observed that commodity prices are rising when quoted in foreign currencies and not just against the U.S. Dollar. His reason for pointing that out was to defend against the view that quantitative easing was contributing to rising commodity prices by weakening the dollar. What he seems to be missing, however, is the fact that commodity price rises in all currencies is one of the signs that inflation pressures are truly global and not just the result of a weak US currency. I'm pretty sure that's exactly what happened during the 1970s. I know it's true of gold which soared against all currencies then (as it is doing now). Chart 1 shows the rising price of gold quoted in the U.S. Dollar (green line), Canadian Dollar (red line), Euro (blue line), and the Japanese yen (orange line). Chart 2 shows the CRB Index of commodity prices also rising against those same four currencies. That's the hallmark of a true bull market. It's also the hallmark of a real commodity inflation threat. A person doesn't have to wait for a raise at work to see that prices are rising all over the world (and in all currencies). Yet that seems to be the stance of the Fed. If left unchecked, the commodity price rise (especially in oil) could slow the global economic recovery and make the unemployment situation even worse. That's why stocks are selling off today.
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Chart 2
STOCKS ARE ON THE DEFENSIVE ... Last Tuesday I showed that the market had reached (or achieved) important overhead resistance barriers and that weekly market indicators were suggesting that a correction of some type was probably due. One of those upside objectives was the doubling of the S&P 500 from its 2009 low. The daily bars in Chart 3 show the S&P 500 in danger of retesting its (blue) 50-day moving average. That support line has contained the market uptrend since last Labor Day. A close below that support line would be a negative sign of a deeper market correction. The daily MACD lines (below Chart) have already turned negative. Chart 4 shows the PowerShares QQQ Trust even closer to its 50-day line. The three big red volume bars below the chart (including today) suggest some fairly heavy profit-taking going on. Chart 5 shows The Dow Transports in even worse shape. The fuel-sensitive index has already broken its 50-day average and its January low. Airlines are the biggest losers in that group. The black line along the top of Chart 5 shows oil prices (USO) surging to a new multi-year high. While surging oil prices hit transports the hardest, it's also dangerous for the rest of the stock market (and the economy). One of the best places to be at such times (besides oil) is precious metals. Another inflation hedge -- TIPS -- are holding up relatively well.
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Chart 3
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Chart 4
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Chart 5
GOLD ETF CLOSES AT NEW HIGH -- SILVER WHEATON BREAKS OUT... We've been building a bullish case for precious metals for weeks. One of the bullish factors that I pointed out a couple of weeks ago was the bullish breakout in the Silver Trust iShares (Chart 6) which suggested that gold prices would soon follow suit. Sharply higher gold prices today helped Gold Trust Shares (GLD) close at a new all-time high (Chart 7). Precious metals shares were the only winners in today's down market. Chart 8 shows the Market Vectors Gold Miners ETF (GDX) jumping to a new two-month high. Silver stocks are still leading that index higher. The line on top of Chart 8 shows Silver Wheaton (SLW) breaking out to a new high. Coeur D'Alene Mines (not shown) also achieved a bullish breakout. Bond funds bounced back today in a flight to safety. TIPS were the best performing bond group because of their better inflation protection. Chart 9 shows the TIPS iShares closing at a new three month high. Chart 10 shows the DB Commodities Tracking Index Fund (DBC) rising to a new two-year high. Rising commodity prices are one of the earliest signs of rising inflation pressures. Sooner or later those higher raw material costs will work their way through the inflationary pipeline. Several companies have already announced price hikes in the coming year. Yet, despite all of that, the Fed sees no inflationary red flags. In my view, that virtually guarantees that the inflation threat will probably get much worse. Kind of makes me wish I was still a commodity trader.
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Chart 6
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Chart 7
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Chart 8
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Chart 9
