Below is an excerpt from a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, June 19th, 2007.
Have we finally arrived - arrived at the point where we can say the perfect storm is unfolding before our very eyes? I don't know about you, but in my eyes it appears this may very well prove the case. Certainly one of the more important factors in this regard has got to be the inevitable war with Iran military forces appear to be preparing for that could send oil prices substantially higher. Not much will be getting through the Strait of Hormuz if war breaks out based on the arsenal Iranians are building up at present, where oil could go into triple digits, never mind $75 or $80. And even if war with Iraq is averted, it's becoming more apparent every day that simple supply side constraints set against exploding demand will eventually send crude prices skyrocketing anyway. This you can count on, and you can count on it changing the way we live in just a few years from now. That's right, in not so many years from now you will look back on today and think - those were the good old days.
And oil is not the only commodity about to become a lot scarcer in coming years. It's not news grain prices have been feeling the effects of monetary largesse for a few years, just like everything else we need to live. But now the realization that global drought conditions are worsening, a topic we have broached on these pages numerous times in recent months, is set to send grain prices through the roof. In fact just over the past few weeks alone soybean prices have risen 10-percent, corn 15-percent, and wheat 30-percent because of increasing warnings coming out of various parts of the world. Indeed, if this is not the perfect storm brewing in scare commodities needed for our very survival, current circumstances have got to be considered a squall, at a minimum.
Does it get worse in terms of one attempting to 'get by' in the future, which is of course essentially what we are talking about bottom line? As you may have already surmised, the answer to this question is 'you bet', where (not so) funny enough, a primary reason things may become even more difficult for most in this respect is because when it rains, often it pours. Here, I am referring to investing in the stock market, and the fact next to real estate, stocks are the most significant assets in people's net worth profiles. So, with home values already sliding, if stocks were to join the party, such an outcome could cause big problems in terms of maintaining one's lifestyle if on the one hand, the cost of living were rising, but one the other, one's total net worth and real income were not. Right now this is not happening with the stock market remaining buoyant, however this is exactly what is likely to happen in coming years because one way or another, stocks are an asset bubble, and need to come down at some point. This is only common sense. We discuss the potential plight of the stock market in more detail below.
But if a perfect storm is really brewing, then shouldn't gold be warning us in this respect? Shouldn't it be going through the roof as people either exit the current system, or attempt to hedge against inflation concerns? While it appears gold may be in for a near term rally due to a favorable COT profile developing, along with other obvious supply side considerations, believe it or not, the answer to the above question is not necessarily, at least not right away. Now, there are a great many people who think the only way authorities can go at present is to continue pandering global asset bubbles, with the Fed having to actually cut official rates sooner than later in this respect. In my mind however, such thoughts can only be considered 'flights of fancy', as the bond market controls the larger interest rate profile, and the steepening yield curve is telling us to expect higher rates not lower. In this respect, one should understand there is no way the Fed will cut official short-term rates with long-term market rates on the rise because a steepening curve is already a de facto easing assuming monetary debasement rates remain robust.
To do so would cause general prices to go through the roof more rapidly than is already being experienced with only the smoothing measures currently being employed (think unrecognized monetizations), where it would be all over relatively quickly, with an easily identifiable hyperinflation sequence running start to finish in no time. Moreover, it's important to understand it's the threat of rising rates in the bond market that is suppose to keep the Fed (and all economies subject to freely / properly functioning bond markets) in check. Unfortunately, and as you may already know, monetary authorities routinely travel outside these boundaries supposedly hidden from view however, with the alternative being a dollar ($) crash, which would just not do for the world's reserve currency. But this is why we buy gold of course, to escape a system fraught with deception and indefinable risk. Unfortunately again however, the gold market is heavily manipulated too, but pressure is growing, where as with easy money policies perpetuated all these years set to back-fire any day now, a perfect storm is brewing here as well.
In getting down to brass tacks then, and based on the above understanding, it should be recognized by interested observers the key to monitoring what to expect in general price trends still depends on watching monetary largesse trends until the yield curve slows it's steepening trend, after which, if liquidity appears to be drying up, only then should we be watching for a pause in asset price appreciation trends. Here, I am highlighting such a scenario because this is exactly what is happening. The yield curve may have steepened as much as it's going to for a while, with long-term rates set to be dragged back down by short-term market rates, which in the end would allow the Fed to spike the punch bowl once again. First though, it appears they need to get more serious about potentially run-away prices while a time window associated with the Presidential Cycle still exists. So, they are cutting back on monetization practices at present, as shown here with repo (M3) growth rates at multi-month lows, and set to break trend on an annualized basis. (See Figure 1)
In this respect, some traditionally conservative / well respected thinkers are hypothesizing we are on the very cusp of a collapsing credit cycle, which is of course not new material to us by any means. And while I'm not sure if timing considerations discussed here will prove correct, the logic is irrefutable, at some point we must pay the piper. What's more, at some point the fairy tales must stop, and the hard / cold facts associated with what condition our condition is really in will become apparent to all. And as alluded to above, this will be when our current system cannot grow anymore, as measured by money supply, and the credit measures within, along with resultant asset bubbles. And in case you were wondering just how closely these variables are all tied together, just take a gander at the plot below. (See Figure 2)
As proven above, there can be little doubt an extremely tight positive relationship between money supply (repos) and the stock market does indeed exist, where if one were to suffer, the other would surely not be far behind. The question then begs, if you were in control of the rate at which money supply can be influenced via direct injections of reserves into the system through repurchase operations (repos) and / or monetizations (coupon passes and direct purchase of securities in official accounts), if policy makers needed to slow things down because past efforts were already sending prices into orbit, which is the case, what can be done given the totality of constraints discussed above? Answer: Cut back on reserve injections obviously, which again, is something they must do now while Presidential Cycle timing considerations are conducive in this respect. What's more, based on the way grain and crude prices have been acting lately, failure to do so suggestive things could get out of control as 2008 approaches, with either inflation related price gains or interest rates threatening to crack things up if allowed to proceed unchecked. On this basis then, one should not be surprised to see asset prices back down considerably at some point between now and fall assuming authorities don't back away from this posture once again for fear of not being able to jump start things when desired. And this appears to be a legitimate concern considering how far down the rabbit hole, or perhaps more appropriate considering the nature of this material, how far up the flagpole things have run already. (See Figure 3)
Make no mistake about it however (don't listen to others and watch the variables), authorities intend to pull another rabbit out the hat once it appears general price levels are in enough trouble to break commodities down once again, especially considering 2008 is a big year for both the US and Chinese with the Election and Olympics. This perspective is a given in my view in knowing just how dependent the global economy has become with respect to asset prices, where at the base of the formula, the asset dependent US consumer is still king, and will remain so until the current globalization model is a thing of the past. Here are a few thoughts on this subject from Gregory Weldon's new book Gold Trading Boot Camp, the below excerpt from this must read resource piece directly commenting on this subject matter, as follows:
"In my new book, "Gold Trading Boot Camp: Master the Basics and Become a Successful Commodities Investor", I cite four 'realities' around which ALL of the current macro-market movements occur.
1) Every single day for more than thirty years, since the abolishment of the "gold standard" (and before), global imbalances that are linked to trade, savings, reserves, exports, output, consumption, income, and credit-debt, have intensified, and, have reached a new peak level of imbalance.
2) The global economy is incestuously codependent in its reliance on the US consumer, and thus the health of the global economy is now dependent on the health of the US housing market, and continued creation of credit.
3) The global economy is thus dependent on a perpetual debasement of the US Dollar, which leads all paper currencies to devaluation relative to gold, as the only means to avoid a catastrophic debt deflation, credit contraction, and global recession-depression.
4) Someday, things will change."
How will they pull a rabbit out of the hat (inferring a hidden agenda) referred to above when need be if this is all true then? The answer is above as well, where without a doubt monetization efforts in the bond market will play a significant role in signaling to equity market participants the Fed is easing again, and if you know what's good for you (in referring to US trading partners), you had better do the same. And while I am just guessing about this at present, based on the tight coils Rate of Change (ROC) indicators associated with SOMA operations are forming just above the zero line, monetization efforts across all asset categories will need be intensified or contraction will be signaled, which the Fed will attempt to avoid on a lasting basis to the end. (See Figure 4)
Obviously with the price action in precious metals over the past few days some investors are willing to bet authorities are about to back off any plans to attack input prices much further even though price inflation does not appear to be under control in the least. If this view proves true, things could soon get very interesting for gold, silver, and just about everything else that moves in financial markets. The trick is to know whether this move in the metals is sustainable, or not, as this would not be the first head fake experienced over the past year.
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Special Note: All charts above provided courtesy of nowandthenfutures.com.