Everyone needs to buckle up because there is a lot to cover as I try to do justice to the wild events that took place in markets from Thursday through today, and what I think some of the ramifications may be.
First of all, let's take a step back. Those of us who object to money printing and know that it only leads to misallocation of capital are often talking about unintended consequences, which are usually impossible to see ahead of time. One such consequence — as perverse as it is sounds — is that money printing helped cause the price of oil to break. I know that sounds absurd, but here is how that happened.
Oil Not So Well
Money printing caused the stock market to go to the moon and suppressed the level of interest rates here and around the world. It also caused the junk bond market to be completely forgiving, so anything with a pulse is once again financeable. A lot of what received financing was exploration and production companies in the shale oil business (roughly $200 billion of junk debt outstanding). This ultimately created lots of jobs and plenty of oil supply here in America.
This capacity has now come on line at a moment when the world economy is very weak and getting weaker. Thus, when the Saudis decided not to try to support the oil market and keep it rigged, along with our excess supply, the always present cheating-wherever-possible OPEC, and world economic weakness, it caused the oil price to get smashed over the Thanksgiving holiday (in addition to the prior weakness). I suspect that the price of oil will stay below $80 for quite some time, as this will require a period of a lot of corporate re-jiggering.
Despite the fact that money printing, which is a bad thing, caused the price of oil to break, the breaking itself is beneficial to lots of businesses. However, from an economic standpoint, the amount of money that consumers will save may not help the economy as much as people think, because job creation will also suffer. Still, those who believe in money printing think it is the greatest thing in the world. What it has wrought is a stock market that has soared, a dollar that has gone with it because folks misinterpret the stock market strength as a sign of economic strength, suppressed bond markets, and an oil price that is at a level where people think it is bullish for the economy.
Bleak Friday
Meanwhile, as I noted, the world economy is weak and there are no signs of any accelerating strength here in America, as GDP growth this quarter looks to be about 2% to 2.5% and retail sales over Thanksgiving were reported to be about 11% lower than last year. To be fair, that is not exactly a just comparison because so many Black Friday sales started early, but the reason those sales started early is because the retail data in October was no good. So an 11% decline year over year is probably not accurate, but the start to the holiday shopping season was not all that strong.
The bottom line is expectations are ridiculously high for everything here in the U.S. when the actual facts have only deteriorated. For example, since the low in 2008 we have added about $6 trillion to the national debt, which has gone from roughly $11 trillion to $17 trillion, and is now over 100% of GDP. Of course, that level of debt "doesn't matter" because of the Fed's monetization, which brings us to where we are now with no more monetization, along with earnings expectations for a lot companies that I believe are going to be way too high. Thus, fourth-quarter earnings reports are liable to be a recipe for disappointment. So regardless of how maniacal the stock market trades between now and the end of the year or into early January, I think it is on borrowed time, as there is no way the ridiculous expectations that folks have can be met.
All Goosed Up and Nowhere to Go
Meanwhile, if you want to know how dicey things are, the stock market has never been more expensive from a price-to-sales standpoint (thank you, Fred Hickey, for pointing that out in his most recent letter, which was fabulous, as usual), while the market-cap-to-GDP ratio, which is said to be a favorite barometer of Warren Buffett (everyone's favorite "stock guy"), was only higher in the first quarter of 2000. So the risks are obscenely high and the problems are intractable, meanwhile expectations are even higher than the risks. In short, there is no way that 2015 doesn't lead to trouble, even if the rest of 2014 continues to be a fantasyland.
Turning to the action, the Nasdaq lost 1.5% early on, as some tech names were sold off, along with about a 3% slide in the price of AAPL (which saw a 6% drop in the space of five minutes early in the day). (For those who agree with the foregoing rant, not that it impacts the market, but we ought to be rooting for higher prices to create an even better setup for put buying into the Q4 earnings reports.) The Dow and S&P lost 0.2% and 0.75%, respectively.
Away from stocks, green paper saw a wild ride over holiday weekend and today, but by day's end it was lower, which may turn out to be meaningful. A lot of times if you have a period where the markets are closed over holidays, people have time to think things through and the action on a day like today is more signal and less noise, but we'll just have to see how that goes.
Tranche Warfare
Government bonds were weak, and while we're on that subject, I think there are going to be serious problems in junk bonds. When you combine that with the fact that mutual funds promise daily liquidity, I don't think it is going be all that long before we start to see problems in the junk market, and potentially at some point even in some of the various government bond markets (last night Moody's downgraded Japan ever so slightly).
I don't really understand why people worry about defaults in countries that have printing presses. What they ought to worry about is the fact that these countries are going to monetize their debts and either destroy their currencies (although that is hard to do when other countries are doing the same thing), or have inflation eat up their paltry interest income. Nonetheless, that is more likely to be a problem for 2015 than right now.
As for oil, after trading just under $64 a barrel overnight for West Texas Intermediate, the market bounced 5% or so and closed at $69-plus. That is still a nasty decline from last Wednesday and a 30%-plus loss for the year, but given the euphoria in the U.S., I think folks are only looking at whatever positives they can think of for the price of oil declining and none of the negatives, as I noted previously.
COMEX Puts Double Black Diamond Sign Over Gold Pit
Lastly, turning to the metals market, I had expected the Swiss to vote no on its gold referendum, which they did, and I had expected bears to sell gold on the back of that simply because they sell every news event. Meanwhile, one-month GOFO rates today were nearly 50 basis points, or about six times more negative than the previous lows of the last couple of years. (To put that in perspective, the most negative lease rates had been prior to what's gone on in the last couple of weeks was minus 11 basis points.)
At any rate, I felt that the gold market would be sold following the Swiss vote and that would be the "wrong" thing and we would potentially have a great setup for the market to turn and finally rally. That thought process was scrambled with the smashing of oil Thursday and Friday, and gold along with it. I couldn't help but think that gold was being sold for two wrong reasons, the Swiss vote and the fact that oil had declined. Yes, cheaper oil takes some of the heat off of the upside price pressures throughout the food chain, but no one had really been worried about that in the first place.
Having said that, last night about an hour after the gold markets opened, I felt pretty stupid thinking anything constructive given that gold was gutted for about $20 instantly after opening and traded as low as about $1,145 before turning around and rallying about $45 in the early going to close at $1,212. Silver saw an even more violent turnaround: literally in the space of about two minutes it traded from $15.40 or so to $14.20-ish, then reversed to close at $16.50.
In the Right Case At the Wrong Time
Given the policies of the world, the bullish case for precious metals has never been stronger, yet it is perversely occurring at a time when sentiment could not be worse. (I wonder if most bears even know that despite all the "great" things that have happened, and all the hatred, gold is up about 1% in dollar terms and even more so in terms of other colored paper?) Most everyone who can fog a mirror hates gold and knows it "needs" to drop to $1,000, $800, $600 or some other made-up number, though they can't really tell you why. Usually the reason is because the stock market is higher, or the dollar is strong, or the Fed is going to raise rates. All three of those are false reference points, but any bearish case has worked so whatever the bears say is what happens.
Completely overlooked during the carnage was the fact that Friday the Indians actually scrapped the re-export requirement on the part of gold dealers, as had been rumored early last week, instead of raising the import duty, which is a bullish development. A very good case can be made that the gold market does not want to spend time below — pick a number: $1,150, $1,180, or $1,200 — but until the price of gold really gets over $1,200 and spends some time there, that idea is just a hypothesis.
The fact of the matter is, in the midst of what the market had interpreted as bad news for gold, i.e., some bullish economic reports or the recent actions I have described, the price plunged to the $1,150 area, but that was soundly rejected. I think once gold starts spending time above $1,200 folks will understand that $1,200 is not the right price and is in fact too low, but we will have to wait and see what happens. One thing I am certain of is that when people look back a year or two from now and realize how wildly bullish people were on U.S. financial assets, the dollar, the Fed, money printing, and Keynesian economics, and consequently bearish on gold, they will shake their heads and wonder how they could have been so crazy?
Some People May Have to Pull an All-Nighter
When you look at the wild, impossible outcomes that people have bought into — be it 1999, 2007, or now — it is just mind boggling that so few seem to be able to learn their lesson, with no one less able than the mainstream press. In the weekend's Financial Times, John Authers stated that, "A full-blown repeat of the bubbles and crises of the late 1990s remains unlikely." Why, you may ask? Because, "The world should have learnt enough lessons to avert that." So there you go. We should have learned our lessons, therefore we did, so everything's groovy. Like I've said often recently, if the current financial events were in a novel, no one would believe them because they're so outlandish.
Positions in stocks mentioned: none.
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