Stagflation Resolutions In Mature Fiat Based Economies

By: Captain Hook | Sun, Apr 15, 2007
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Below is an excerpt from a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, April 3rd, 2007.

Stagflation best describes the prevalent condition in mature industrialized economies at present. At the same time however, Asian Tigers led by China are still industrializing and are now aggressively expanding domestic economies as their populations strive to acquire western lifestyles. For this reason, and unlike developed economies whose populations are over-indebted, growth (both economic and debt) is still brisk in this region. And because they are going about this with the help of greedy western bankers, this is all happening at breakneck speeds as developed economies attempt to feed their mushrooming paper empires, which they pass-off as economic growth. Like the 70's then, and assuming the current 'globalization model' remains in tact, aggregate money supply growth rates should remain buoyant as economies accelerate currency transactions, which should ultimately lead to a 'growth led' resolution to stagflation currently gripping macro-conditions in western economies. Translated, this means our unhealthy bubble economies should remain buoyant until the increasingly dominant liquidity cycle is exhausted along side the credit cycle. This means after hyperinflation. That's how the current state of stagflation should be resolved if signatures in nature and history are good guides.

Is there anything happening out there today that could derail this hypothesis? Up until this week the answer this question would have been 'unlikely' for most that take the time to watch. But, with Bush taking a turn down protectionist road this past week, the current 'big picture' could change if this is not just another episode of Wag The Dog designed to knock commodity prices down. Here, one must always remember that politicians of the world have their own interests in maintaining 'status quo' because life is sweet for these guys no matter which side of the pond(s) they reside. So, they meet regularly and work together on manifesting what is viewed as mutually beneficial relationships that while on the surface may appear in the best interests of their broader constituencies, in the end actually pander the status quo in attempting to not rock the boat. This is how they envision themselves getting re-elected you see, which is why they are willing to play this risky game.

Risky game - why is maintaining the status quo a risky game? Because growing economic imbalances are allowed to become too large, as they are now, leaving the financial system vulnerable. Here, the multilateral global model has brought us to a point where if foreigners do not continue buying US paper in support of the bubble economy, interest rates could rise, which would be particularly troubling for a stressed real estate market. In this regard it should be noted TIC data indicates although nobody is selling, the rate at which foreigners are buying is slowing, and if it slows enough, rates in the States could act more like those of a banana republic as opposed to that of the center of global finance, sooner than later. The question then arises, is this why Washington is threatening tariffs on the Chinese now, because they have already slowed Treasury purchases and are more actively driving commodity prices higher, including precious metals? According to China, the answer to this question would be 'what's the problem - we are buying your paper?' But as alluded to above, one does have to wonder if what is happening now is shades of Smoot - Hawley, or are we simply being treated to another episode of Wag The Dog, with price managers having to employ increasingly sophisticated means of attacking commodity prices.

By this it's implied the Chinese retaliate for tariffs by slowing Treasury purchases even more, driving rates higher in the States, making it appear the larger bubble economy is real trouble this time. Then, once more speculators have been chased out of their carry trades and leveraged positions, like magic all this tariff talk goes away, the States and China are buddies again, and the party is on into the Presidential Election and Olympics next year. You know, I have to lean in the direction of this latter scenario because these guys, the guys running the show, are just too greedy to rock the boat to the point of capsizing prior to having these two events behind them in my opinion. Are they about to voluntarily spoil the party after such elaborate preparation plans have been put in place? I'm sorry, but I just don't think so, which suggests to me banking on bubble economy maintenance is still the best investment policy these days, which again, is why I think the current episode of stagflation gripping mature western economies will be resolved in favor of hyperinflation. And naturally if this is true one should own gold, silver, and commodities to protect the purchasing power of your savings as the world's fiat currencies accelerate the competitive devaluation race to zero.

Of course we could always be wrong about this. Maybe the dog has retired to the doghouse for now - who knows? One thing I do know however is as far as precious metals and commodities are concerned it doesn't matter whether the Chinese are buying Treasuries or not because again, being so close to the election next year, monetary authorities would monetize the market in support of prices on an accelerating basis. And although volatility might pick up a notch or two, because the liquidity would be provided by this means as well, precious metals and commodities should head higher either way. Perhaps this is why the Dow / Gold Ratio is sitting on important Fibonacci related support at present, because whether it's China accelerating forex diversification plans in retaliation for shades of Smoot Hawley; or, this little protectionist episode seemingly perpetuated by the States being more Wag The Dog tactics - it does not matter in the end. The only thing that matters is the larger liquidity cycle, and that the Dow / Gold Ratio may be about to tell us another round of accelerating inflation should be expected in seeing new lows on the monthly close in April. (See Figure 1)

Figure 1

In relation to comments above the monthly plot from the Chart Room obviously better demonstrates the Dow / Gold Ratio currently resides on important Fibonacci resonance related support; but, I wanted to show you the above daily chart too because resonance signatures here are also defining the move. So, when you put the two together, one gets the picture once current support is taken out, and indicators are rolling over suggestive this is probable from a technical perspective, the next Fibonacci resonance related target is approximately 10, the psychologically important double-digit / round number support. Here, it just makes a great deal of sense to think values will bounce from such an important support, so that's the way we will play it at the time, where depending on technical circumstances in the markets it would be suggested trading positions should be faded. Of course we are ultimately looking for a Super-Cycle Degree bottom closer to unity eventually (5 to 10 years out), with gold far higher in absolute terms, but this will take years past the interim bottom at 10 if reached next year, so again it's possible this would be a good opportunity to shed profitable trading positions depending on the degree of absolute gains in gold. (i.e. selling a good portion of your holdings at the Primary III (C) top is recommended because of the potential for 5th wave failures.)

And this next chart is certainly supportive of the view the inflation cycle is about to reassert itself in attempting to resolve stagflation in western economies as we approach next year. A breakout in RSI on the chart below would be quite profound in terms of technical signals, where follow-through would be anticipated to be both lasting and significant in terms of price appreciation because of such a feat. What's more, and in terms of how a break higher in this ratio would most likely affect your portfolio, gold bulls will be happy to know such a breakout would confirm the market definitely sees accelerating inflation coming in it's relative preference for gold over bonds, and as you can see with gold returns overlaid on the plot, this relationship just so happens to be definitional in terms of tracing out anticipated trajectories for the metal. Here, it should be noticed a divergence between ratio values and gold returns has been building since the turn higher last summer, suggestive further gains are either suspect or deficient. (See Figure 2)

Figure 2

Considering the strong positive fundamentals for gold presented above in this regard; again, one is compelled to lean in favor of this divergence being suggestive of further accelerating gains for gold, even if the turn lower yesterday means bonds will outperform temporarily. Gold bulls certainly cannot mind a strong bond market at present, especially when they are getting their way with respect to the yield curve in process. And while a temporary flattening (correction) in the yield curve may be upon us now that prices have reached the 200 - day moving average (just click the button marked Yield Curve), once enough energy is rekindled, a push through this metric, along with the large round number at 1 would be very positive for precious metals, as you know from our discussion on this topic in our Garp piece a few weeks back. (See Figure 1)

In looking at the Amex Gold Bugs Index / Gold Ratio to the uneducated eye one would never know profound under-currents (pressure) is currently building in the market and it's going to blow one way or the other. Of course the bulls are of the opinion out of control inflation will result is a resolution higher. And of course history supports this view on multiple scales. Here, any weakness in broader measures of equities would be associated with Garp knocking prices down in preparation to rotate balloons once again, a trading opportunity from this perspective if you will. Only this time around, because new targets are becoming harder to rationalize, gold will be a beneficiary initially in discounting the inflation to come. Make no mistake about it however, gains will be limited if Garp has anything to say about it because politicos would be forced to pull Goldman's punch bowl if reality were allowed to be more accurately reflected. Of course this is exactly what will happen eventually, but don't tell them that as this knowledge might spoil the Christmas Party.

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Good investing all.

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Captain Hook

Author: Captain Hook

Captain Hook

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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