Excerpted from the December 19th edition of Notes From the Rabbit Hole, NFTRH115
ForEx jocks make or lose coin by guessing the direction of EUR/USD. Stock pick aces ride the wave and look good while trends remain in place. Commodity bulls can't miss until the next miss is eventually driven home with a loud crash. It seems as if everybody is clinging to a conventional way of doing things, as if the world was not radically changed in and around 2001, and as if the old rules of the previous secular bull market still apply. They do not; it is the age of inflate-or-die, booms and busts.
As for deflation believers, while they may be diametrically opposed to the vast bullish apparatus that depends on ever increasing debt levels and currency depreciation, they are right there with their bull counterparts, generally playing to convention and playing by rules they think they know; following breadcrumbs laid out for them to follow as they issue dire projections about credit contraction and violent asset markdowns.
Let's quiet the noise and look at the US Treasury bond market, which is arguably the most important market on earth, as it is intimately tied to the world's reserve currency.
The following chart shows the T-Bill yield (IRX), the broad US market (SPX) and the CRB commodity index as measured against the beautiful continuum that is the well behaved yield on the 30 year Treasury Bond (grey shaded area). The continuum is of course framed by the declining 100 month exponential moving average and the lower red dotted trend line that parallels it.
As applies to the current system, convention went out the window in late 2000 as the S&P 500 took a dive (to conclude its secular bull market) and was promptly attended by a crashing T Bill yield as Alan Greenspan goosed the curve, launching gold's secular bull market in the process. After a lag, general commodities followed gold higher as did eventually, the SPX. With T-Bills at what we thought at the time was an outrageous 1%, the system was re-liquefied.
This was Greenspan's willful attempt to re-inflate the economy and we all know what eventually happened; capital was created out of nowhere, and misallocated into the most dangerous 'investments', overseen by the best, brightest and most connected on Wall Street, who of course made a killing packaging newly engineered creations. The malinvestments eventually manifested in an epic and terminal crash. The age of inflate-or-die goes hand in hand with moral hazards being routinely mainlined into the system.
Looking at the chart, the lower red dotted trend line and the EMA 100 form the backbone by which all of this surreal finance has been supported since the age of inflation onDemand began its most intense phase, in 2000. Be aware that the shaded area format of the monthly chart shows monthly closing data, so it does not show the several times the yield pinged the critical EMA 100 intra-month before reversing lower.
Heck, let's review our favorite chart below, illustrating the continuum. Pre-2000, the system ran quite well by leveraging global confidence in Uncle Sam and his Treasury, as Greenspan himself leveraged the goodwill force fed into the system by Paul Volcker, who did the heavy lifting in deciding that the inflation problem of the 70's would end on his watch, no matter the cost. Sadly, his successor at the Fed had no such resolve as he was given the gift of goodwill. The reason we now find ourselves in a metaphorical Wonderland is because Ben Bernanke has amped up the inflation ante even though his predecessor left him with no seed corn, no goodwill whatsoever. Yet still he inflates.
Post-2000, with the implosion of paper asset markets that had concluded a secular bull market, and considering the inflationary policies in response, one might have expected long term yields to become unruly as the precious metals and then the commodity complex began to rise, sniffing out the creation of 'funny munny'. Instead, the long bond yield remained well behaved within the continuum as the free enterprise dominated US and Communist China pursued a cozy relationship of convenience, which could best be described as a macro economic vendor financing scheme ('we will outsource our industry, leverage confidence and credit and become your consumer engine if you will convert your US currency reserves to Treasury bonds, helping us stay liquid').
This was an epic pyramid scheme by which the US created paper (debt) and used it to continue running its economy on the vaunted US consumer. All the while, PE ratios were calculated, rosy projections were made and bountiful bonus seasons came and went... all based on the lie that pretends productivity can be printed through debt.
In 2008, the continuum did something asymmetrical as the yield plunged into what NFTRH calls Armageddon '08. Time Magazine published a cover showing bread lines and 'Depression 2.0' headlines and the conventional herd went absolutely hysterical. This was to the benefit of the people who were able to remain calm and get bullish. The deflation event was on and the most gullible deflation believers took the breadcrumbs.
Now a mature rebound in both asset markets and the bond's yield brings us to a crossroads and a question; will another red dot appear at the EMA 100 as inflation expectations peak and the entire construct reverses into yet another deflationary episode, or will it be different this time as the inflationary horse gets out of the barn due to a saturation point at which the public no longer buys the deflation spook that Ben Bernanke keeps pulling out of the closet? This would propel an equal and opposite upside reaction to the lower channel buster that was the most recent green dot.
The script would typically call for the predictable (to contrarians) downturn into a new deflationary episode, and that may well be in store. But we have to realize that confidence has hit a saturation point, as outward signs of rebellion surface within mainstream society. Meanwhile, the Fed chief and his sycophants continue full speed ahead, scaring the crap out of most everyone with a modicum of economic acumen in the process; but people are not afraid of deflation now. Inflation fears will break out if the EMA 100 gives way. This would be uncharted territory for the current system.
Here are some money supply graphs for consideration. From the St. Louis Fed, M2:
MZM:
From the excellent website Nowandfutures.com (see the description of the mechanics involved in reconstructing M3 http://www.nowandfutures.com/key_stats.html):
As a 'bottom feeder' biased chart guy, what I see in the green M3 line is a gentle, rolling bottom. The kind of bottom I usually buy.
The US continues inflating and the bond is the confidence tool used to promote the ongoing, systematic inflation that, other than benefiting those speculators who know how to use the process, would stiff foreign creditors and tax the American people in a way they are not generally yet up in arms about; the loss of purchasing power of the US currency in which they are compensated and in which they conduct commerce.
Was the May 'Flash Crash' a surrogate 'deflation' event off of the modest peaks in MZM and M3 (and the mere flattening of growth in M2)? This event certainly provided the bullish fuel for the next leg up in markets, led by silver and the precious metals complex. Was that the afterburner needed to propel the long bond's yield into an upside channel buster? Or will the bond be rigged in new and innovative ways as the Fed does its duty as the buyer of last resort?
Are they the buyer of last resort? What about patriotic Americans and all that retirement fund money just sitting there? Surely they could buy bonds as well, for the greater good. IRA holders are in bed with Uncle Sam after all, as he sponsors these vehicles and defers their taxes. We know one thing, somebody has got to buy enough bonds to keep the pretense in place that things remain in control.
Summary: The ability to continue the inflation is centered on Treasury bonds. Ironically, the ongoing inflation depends on widespread belief that deflation can happen and must be fought. Deflation can happen all right, but it will be the FINAL deflation, with no coming back from it, at least within the confines of the current system. So it will be important to observe the yield's approach of the EMA 100 and its subsequent reaction. Will the yield turn down and continue the boom-bust continuum, or will it go channel buster up in an inflationary signal that even the most casual observers will take note of as a collective 'Rut Roh!' is emitted far and wide?
We do not have the answer yet and thus, risk is elevated for bulls and bears, inflationists and deflationists. That is because we are once again at a flash point. Ben Bernanke is trying like hell to keep the inflation going, and with the mind boggling trillions in still increasing debt, there is only one politically expedient way out. That would be to keep the scheme going as long as possible. But please do not tell me that here, on the doorstep to 2011, sublime levels of unpayable debt in tow, we have not already hyper inflated. We have, but the ongoing T Bond confidence scheme continues to cover it up... for now.
Now let's proceed to the good stuff, the investment stance and vehicles used to capitalize on this sad state of affairs...
[NFTRH then proceeds on with an extensive update of gold vs. currencies and commodities, precious metals technical analysis, portfolio structure (speculative portfolio +39% for 2010) and a sentiment view of the broad markets, which is at an extreme.]
