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Richard Russell

Richard Russell

Richrd Russell began publishing Dow Theory Letters in 1958, and he has been writing the Letters ever since (never once having skipped a Letter). Dow…

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Market Comments

I've been looking at financial statistics for half a century, so I seldom gasp when I see a new figure. But I gasped today when I saw the latest statistic on the broad M-3 money supply. For the week ended June 20, M-3 exploded to the tune of $63.1 billion. Adding that to the two previous weeks of $20 billion each, and you have a bit over $100 billion added to M-3 over the last three weeks. That's at an annualized rate of around $1.7 trillion. Greenspan must be in a panic, because he's opening the liqudity-spigot wide and then some.

I must be the only jerk who still follows the money supply figurers. Or are the figures just too "embarrassing" for others to mention?

What's behind the veritably explosion in the US money supply? The answer is that Greenspan obviously believes that deflation is a continuing threat. So let's face it, the creation of money in the US has gone totally wild.

And Greenie could be right. Today the latest figures on the Producer Price Index was released. The "core" rate was down 0.1% -- this was the second "unexpected" decline in the last three months.

In the meantime, the US trade deficit widened to $41.8 billion, close to its widest ever for a third straight month -- the US demand for imported good continues to rise. Thus, the negative US trade deficit is running on an annualized basis of almost half a trillion dollars.

Does China care? Sure China cares -- China loves it. Beijing announced yesterday that Chinese industrial production had surged a dizzy 17 percent in the year to June amid a 33 percent rise in exports. The announcement brought predictable alarm about competitive threats to the rest of Asia.

Headline in today's Financial Times -- "Schroeder Calls For Action on Euro. German Chancellor wants central bank intervention to weaken European currency against dollar."

The battle for exports continues, and one of the weapons is competitive devaluations. It's a strange series of economic events. The idea is to keep your country's currency "cheap" against the dollar. So you reduce interest rates, thus making your currency less attractive to hold. Or your central bank buys dollars to keep the dollar strong against your own country's currency.

To buy dollars your central bank has to create more of your own currency, and this is inflationary. On top of this, selling your products to the US means dollars coming into your country. As the billions of dollars build up in foreign nations, these nations build factories and other sources of production. World production (particularly in Asia) continues to rise, and this global increase in production means world over-production. World over-production gives way to world deflation, since the world can't digest all the "stuff" being produced.

Thus we have the pressure of world deflation as nations produce an ever-increasing amount of goods and yes, services. To offset the forces of deflation, the US floods the system with liquidity. Can the US stave off deflation? That's what the battle is all about today.

So far, I see it as a stand-off. The ultimate winner -- inflation or deflation? We don't know yet.

What signs are Greenspan looking for, signs which would tell him that he's winning the battle against deflation? Greenspan would like to see the yield spread between the bonds and the TIPS spread apart. He'd like to see asset inflation continue, meaning rising home prices and a rising stock market. And he's like to see gold rising, maybe to a price of 375 or even higher. He'd like to see anything that was signalling to him that deflation was defeated and inflation was back in the saddle.

What does the stock market think? My take on the stock market is that it's lapsed into a trading range. On an historical basis, stocks today are expensive, The price/earnings ratio for the S&P is better than double the historical average of about 14. Historically, yields are ridiculously low. In the past, bull markets have topped out when average yields on the Dow or the S&P reaches a low of around 3%. The yield on the S&P is now 1.6%. I might add that earnings on the S&P are suspect, since too many stocks have not expensed options and unfunded liabilities.

The stock market sees the twin forces of world over-production which is deflationary -- and the build-up of world liquidity, which is inflationary.

The stock market thinks the verdict is still out on which way the various economies will go. So the stock market in the US lapses into a trading range.

The bond market may be in the same position. It's waiting to see how it all works out. Will long bonds hold? Will the Fed really buy the long end of the bond market?

The US dollar, after its long decline from its March high, has stabilized with the Dollar Index at around 96. And of course, the dollar is being propped up by Asian countries who are buying dollars to keep their own currencies down. Competitive devaluations -- it's what's happening.

Gold is pondering the situation, wondering how to react to the global deflationary forces as against the steady build-up of liquidity. It's obvious that the US is awash with dollars. Shouldn't that cause gold to rise? Probably, but gold at this point takes it's lead from the trend of the dollar. The September Dollar Index bottomed on June 16 at 92.37. Today the September Dollar Index was priced at just over 96.

The action now seems to be moving to silver. Silver had risen on eight of the nine last days. The upside target for silver is its May 3 closing high of 4.88 on September silver. As I write September silver is trading at 4.81. On any comparison, silver is cheap. Back in March 1994 one share of the Dow would buy 628 ounces of silver. Today one share of the Dow will buy 1,883 ounces of silver. This is a decline of 66% in terms of the Dow. Silver today is dirt cheap, and the market is slowly beginning to recognize that fact. One problem with silver -- it's expensive to store. A 1000-ounce bar of silver weighs 80 pounds. That's a load -- too much for me to carry home. A roll of Silver Eagles is fun and pretty. And there are always silver futures.

30 year fixed mortgages this week 5.61%, up 0.11 from last week.

Question -- At what point will rising rates impact on housing and refinancing? Answer -- I wish I knew, nobody knows.

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