Friday, September 13, 2013

What's Up With Gold?

It's hard to know exactly what you're looking at - when it's sitting right smack in front of you.

There's a complexity up close that could be confused with many different things. 

Fractals - you ask?

No - we're talking about deflation, disinflation and inflation. 

When the Fed floated the taper trial balloon last May, we had speculated it was akin to lighting an escape fire from the disinflationary tide that was starting to uncomfortably rise throughout the markets. 
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"Whether lighting the brush in the bond market here was a sign of desperation, brilliance or causal coincidence is hard to say at this point. We are reminded of the true story of the Mann Gulch Fire, that although tragically took the lives of thirteen young firefighters in Montana in 1949, rewrote the training protocols for dealing with a fire that was imminently about to overtake its handlers.  
To make a long but fascinating story short, a creative and desperate smokejumper named Wagner Dodge lit a fire directly in front of him before the rapidly approaching forest fire overtook him and his crews position. After lighting the fire, he then motioned for his men to step into the newly lit area. Unfortunately, likely believing he had lost his mind - they refused and attempted to outrun the fire, which was burning quickly up the hillside. In the end, Dodge survived nearly unharmed - while the fire killed thirteen of his men.   
Reigning in expectations of stimulus by the Fed in the face of inflation data flirting with historic lows and a global economy dangerously close to stall speed might appear reckless at face value. With that said, the Fed perhaps succeeds at killing two birds with one stone by reigning in risk appetites at large, while also changing the perception from one of disinflation to inflation's right around the corner.  
Reflexivity burns bright - assuming we don't perish in the fire. - Lighting an Escape Fire
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Today, standing with several months of perspective between the Fed's first lit matches - the embers have started to cool. 

Is the economy still breathing? 

Yes. 

In fact, we would argue that to a greater degree participants and economists concerns with disinflationary trends and the specter of deflation will soon abate and be replaced with rising inflation expectations. 

The escape fire worked.  

Below is a good explanation of that dynamic, from the astute folks at The Wall Street Journal - MoneyBeat desk:
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Could the Fed's Taper Prove Inflationary?  
Could the Federal Reserve’s decision to slow the pace at which it provides the economy with new liquidity–the so-called taper–force up global inflation? 
Paradoxical as this seems, there are a couple of mechanisms by which it can happen. 
In emerging markets, the inflationary taper effect has already kicked in. The currencies of many developing economies have been overvalued during the past few years, boosted by hot money inflows. This hot money was a product of central bank liquidity–primarily provided by western central banks trying to shore up their flagging economies–desperately seeking out extra return. But as the hitherto limitless expansion of central bank liquidity winds down, those hot flows have reversed. The upshot has been collapsing emerging market currencies and sudden inflationary spikes in those economies. 
Inflation, meanwhile, has been well behaved in big western economies, held down by large rates of unemployment and plenty of spare capacity. 
Insofar as the taper anticipates a return to more normal rates of growth, inflation should also start to return to normal. If, as seems likely, the financial crisis destroyed capacity, then inflation should kick in at higher rates of unemployment than in pre-crisis years. 
But the taper could well accelerate that growth. As businesses and households anticipate rising interest rates they’ve pulled forward their investment decisions. This, process could well prove to be lumpy. U.S. house prices have jumped this year, though mortgage demand has been hit by the recent rises in market interest rates. 
The degree to which credit growth fuels itself will be interesting. As the economy picks up, so too does credit demand. The banking sector’s massive reserves held with the Fed becomes a base against which new loans can be made. Lending begets growth begets lending. - WSJ Allen Mattich 9/5/13
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...Begets inflation. 

So we ask:

Despite the air pocket that the precious metals sector encountered this week, do market participants really expect that gold and silver will continue to move lower in an economic environment - both here and abroad - that finally encounters rising inflation in the shadow of the greatest world-wide monetary experiment ever attempted? 

(Remember, this is coming from someone who was a precious metals bear from the spring of 2011 to the spring of this year.) 

Despite its limited ability to affect real growth in our economy, from a purely psychological perspective QE has always introduced a level of hysteria and uncertainty that has driven certain markets to unfounded extremes. 

2004 - Hyperinflation is coming! 
2007 - Hyperinflation is coming!
2010 - Hyperinflation is coming!

Regardless of the idea's validity, when the needle starts moving across the continuum towards the inflationary side of the field - where do you think market psychology will take the precious metals sector this time around? How about the currency of the editors and authors of our monetary manuals?

Perhaps those ghosts have been exorcized by the considerable crowds that remained on the wrong side of the tracks over the last few years - but we doubt it. 

They'll likely be back with a vengeance this time - and with a tailwind. 
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Below are several updates from our precious metals and US dollar index series. 
For further explanation of the rationale behind these charts - see our most recent notes:


Quoting Mr. Mattich again, he succinctly sums up the relationship expressed in the chart above and the comparative we have contrasted between the financials and the precious metals sector. 
"As the economy picks up, so too does credit demand. The banking sector’s massive reserves held with the Fed becomes a base against which new loans can be made. Lending begets growth begets lending." 
...Begets inflation

As we pointed out in the past and what led us to expect the disinflationary tide before most this past winter - the miners lead spot prices - which lead inflation expectations. Both on the way down and on the way up.    

What does oil, Apple and the gold miners have in common?

Growth - or lack there of. 

It isn't a coincidence that Apple and the precious metals sector have trended together over the past year and that their respective structures and momentum profiles have correlated quite closely with our historic comparative with oil, circa 2008/2009. 

Like the recovery in oil and inflation expectations in the back half of 2009, we see both assets rekindling growth into next year.
As always - Stay Frosty.
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*  All stock chart data originally sourced and courtesy of www.stockcharts.com 
*  Subsequent overlays and renderings completed by Market Anthropology