1) The recession IS over. But WHICH recession?
The recession is technically over. Most of us have been aware of this for quite some time. Earnings are growing, jobs are tepidly growing and the economy is growing again. Of course, this all sounds familiar to anyone who has studied de-leveraging cycles. An economy can grow while at the same time experiencing a balance sheet recession. This was clear in Japan where GDP actually expanded throughout the entirety of their lost decades:
Of course, global imbalances remain and the western world is still suffering from the damage caused by the credit bubble. While there has been much de-leveraging thus far the problems still largely remain. The continuing European sovereign debt crisis is exhibit A. The continuing troubles in the U.S. banking system are exhibit B. And the continually weak credit data is exhibit C. With U.S. housing in the early stages of a double dip itâ??s likely that the balance sheet recession in the USA will be tested again in 2011. If the housing double dip surprises to the downside we should not be surprised to be talking about the balance sheet recession for several more years as balance sheets are once again turned upside down and consumer credit problems persist. In addition, the Euro crisis appears far from resolved. And if I am correct about the banking sector it looks like Ben Bernanke is thinking ahead about bank bailout part deux. So, while the recession may have technically ended, the balance sheet recession is still very much alive.
2) What really caused the equity markets to rally since September?
In commentary yesterday David Rosenberg said the September-November rally in equities was not driven by better economic data:
â??The bottom in the equity market rally came, not on a piece of data towards the end of August, but on the back of the comments from Ben Bernanke in Jackson Hole that another round of quantitative easing was coming our way. This is why the rally ended, not on any particular piece of economic data, but right after the FOMC meeting a few weeks ago "â? a classic case of buying the rumour and then selling the fact.â?
This is factually false. The market technically bottomed on August 25th two days before the Jackson Hole speech. The market then kicked around the bottom until September 1st when China reported a strong PMI report and the ISM manufacturing report came in at 56.3 versus expectations of 53. The market rallied 3% on this news as it was clear that China was perhaps reversing several months of negative PMI reports and the USA was not going to suffer an immediate double dip. At the time sentiment was horrible and a double dip was widely expected. Over the ensuing few weeks we saw steadily improving jobless claims, improving global PMI reports, confirming ISM reports, improving PCE data, and the cherry on top was a very strong earnings season. Why is this important? Because the rally hasnâ??t been only due to expectations of QE. It has been primarily the result of improving economic conditions.
3) Is this the ultimate hedge?
In May 2010 I highlighted an interesting trade as a hedge against the Euro crisis:
â??A fascinating trade is developing in treasuries and the gold market. We have this interesting correlation between treasuries and gold prices in recent months. As the Euro worries continue to develop both gold and treasuries have become safe havens. Of course, this has shocked the inflationistas of the world "â?? many of whom are short treasuries and long gold, however, in this world of continuing low inflation treasuries continue to perform just fine. Aside from the firm fundamentals (U.S. government debt is not a concern and inflation remains low while the fundamentals for gold remain quite constructive) what's become so interesting in this environment is that gold is acting more and more like a currency. In the long-run I feel as though this is entirely unjustified as gold will never serve as a reserve currency ever again. But we have what I believe is a unique window of opportunity here to buy both gold and treasuries as risk asset alternatives. It's a beautiful hedge in a world that is grappling with the potential death of a fiat currency (the Euro) and continuing inflation or deflation. I don't particularly like either treasuries or gold at this exact moment, but I will be a tempted buyer of both on any pull-backs. If the Euro crisis hits Defcon 1 (something I say is a relatively high probability event in the next 24 months) then gold and treasuries will soar.â?
What makes this trade so interesting (still) is that they are the favored instruments of deflationistas and inflationistas. I continue to believe that we are in an environment where disinflation will continue and the risk of deflation will remain higher than hyperinflation. But that doesnâ??t mean gold canâ??t perform well in this environment. In fact, I have long said that gold is likely in the midst of an irrational bubble. The argument is simple â?? as fears of sovereign debt remain investors will continue to demand gold as a hedge against fiat currencies. Whatâ??s interesting here is that there is no solvency risk in the USA therefore we need not fear bond vigilantes in the USA. We truly are not Greece. Our monetary system is simply not the same. So, as long as the balance sheet recession continues in the western world the deflationary threat will remain and treasury yields will remain low, but the bid in gold will also remain as investors interpret the Euro crisis as a failure of fiat money.
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Again, sane heads at pragcap. A little different from the madness at ZH.
Yes, gold does not offer good protection from inflation. History demonstrates that the inverse correlation between gold and global currencies is weak: http://globaleconomicanalysis.blogspot.com/2007/02/is-gold-inflation-hedge.html
A period of very high but stable inflation in a stable economy offers myriad investment opportunities that are much more lucrative than gold, leaving gold as the ugly sister that nobody wants to dance with.
Gold is simply an *instability hedge*.
So if it looks as if the global economic situation is stabilizing then, regardless of whether we have deflation, inflation or flatulation, gold prices will decline as all the money locked in gold gains the confidence to chase higher returns elsewhere.
Have you considered the possibility of hyper-flatulation?
Instability hedge or the best performing asset class for the last 10, 5, 3 and 1 years? It depends on the conceptual frame.
Ive been somewhat disappointed with the price action in gold over the past three weeks in the context of all the sovereign fears.
Two other growing concerns I have are the lingering threats of additional disinflation, which may upend the negative real rate story and enhance the value of cash (never understood the gold wins in deflation too argument) and the global move to austerity. Both are major pillars of golds bull case.
Taking your hedge even further I like trying to capture the spread ratio compression bt long gold / short silver and long the 30 / short the 10 here.
2-3% inflation seems to be a result of a healthy economy and not the cause.
that is the window gold does not work.
tho i am not a gold buyer either right now, i do not expect to see that anytime soon.
for next 8 years we are japanâ?¦.housing and therefore the consummer must come back first.
The economic reports since September have been more positive. It is fair for people to put aside the possibility of a double dip.
However, despite that all QE are not a stimulus at all, there are still a significant amount of fiscal stimuli and other for the past 6 months
1. Transfer payment (welfare, including unemployment benefits) 2. State bailouts 3. Extra cash by withholding mortgage payments 4. Chinaâ??s excessive money supply
Would the current level of economic activities be the same without all of these? I would bet no.
With China now facing its own consequences and likelihood of further U. S. fiscal stimulus diminishing, can the stock market sustain its moment to move to new high (say 1300)?
My take is margin has topped, earning prospect is low and the market has topped around 1250 before a major pullback.
TPC,
Have you noticed that the Chinese and Russians have begun trading together directly with their own currencies, i.e., without the dollar.
As I have said repeatedly on here, doesnâ??t matter what you monetary nerds call it!!
BALANCE SHEETS MATTER!!! And if we do not control and begin to reduce our debt, it will all end in tears. Yes, perhaps 10-20 years down the road, but it will endâ?¦.
We need politicians with the will to take a frigging hatchet to entitlement programs and get out of piece of crap countries like Afghanistan and other unnecessary engagements. Not that I think these were unnecessary wars, but we are not the police force of the entire world. And how can a country that runs such large deficits continue to dole out so much in foreign aid.
THIS NEEDS TO BE ADDRESSED NOW, BEFORE THE SNOWBALL HAS PICKED UP TOO MUCH STEAM. We stay above 11k on the dow, and watch out for next year though, new highs on the Dow very likely!!!!
In other words, donâ??t be short!!! You get a drop before June and close the suckers outâ?¦
China and Russia trading with their own currencies instead of $ is irrelevant. I mean, that is what most countries do. They trade with their own currencies. Why did they need to convert everything into dollars anyway?
We need to start worrying when they will no longer accept dollars from the US. Especially, if OPEC demands that oil be paid for in gold bullion. And remember, Arabs have a great cultural affinity for gold. I mean, they just like the stuff.
One more comment on your gold thoughts buddy, gold has never acted as the â??hedgeâ? on inflation, it has soared in times of crises with regard to credit issues. In other words, it responds to imminent devaluation, not the actual occurrence of inflation. Itâ??s the canary in the coal mine and such a small market that until significant demand picks up, it can be manipulated to the core.
Second, for all those who continue to claim that a return to the gold standard would solve all of thus, just read history (as one of my favorite authors has pointed out): Greece, Byzantine, Rome all fell before the invention of paper money and had some sort of gold standard.
Yet they all fell. The problem is DEBT, not the unit of currency.
The only thing that the gold standard bugs have right is that some reference to gold may limit our idiotic politicians from driving us into so much debt (or obligations to issue FRNs TPC, in homage to you) so fast.
I agree with your first paragraph â?? gold responds well to crises.
Your second paragraph neglects to mention that the romans repeatedly debased their coinage to the point of resorting to silver dipping.
Diffused,
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