Something to Consider

Ever since the Fed embarked on its journey with Quantitative Easing, we have all been getting an education in how the markets are responding to this grand experiment. Now that they are scaling back their bond buying program, we are also getting an education in how the markets are responding to that as well.

Most of the longer term readers here at the site will know that during the initial years of QE, nearly every asset class began moving higher. Some moved in response to ideas of liquidity injections while others moved higher in response to anticipated currency weakness.

This rising tide continued in near perfect sync until sometime in early 2012. That is when the commodity sector in general divorced itself from the rising equity markets.

As you can see from the chart that follows, stocks have moved relentlessly higher while the overall commodity sector has continued to sink. Just today it notched a 27 month low.

Yet in spite of this, we still have some telling us to prepare for runaway inflation any day now and of course with that, soaring precious metals prices.

The question one should pose is "WHY?". What evidence is there to suggest that a soaring move higher is just around the corner in precious metals?

Let's consider what this comparison chart is telling us. It is my contention that the reasons equities continue to rise is because they have become the only game in town when it comes to large speculators obtaining yield in a near zero interest rate environment. Also, something to consider is that US Dollar strength is attractive to foreign investors looking not only to obtain yield but also to capitalize on currency gains. In an environment in which the Dollar is generally strengthening against the majors, a foreign investor can move money into the US markets, not only obtaining a capital gains but also getting more "bang for their buck" when they finally cash out and make the currency exchange.

So not only do we have domestic-based firms and funds buying equities, we have strong inflows of foreign capital also feeding the equity bull.

That being said, a rising stock market does not necessarily equate to a strong and healthy overall economy. We have come to see this over the many years that this experiment in QE has been ongoing. When investors are looking for yield, they go where the bulk of the action is and that has been equities. Ask any competent money manager and they will tell you that they will not long be in the business if they are not producing solid gains for their clients. In a sense, they have no choice but to buy equities. I might add that I believe this is precisely what the Fed intended by driving interest rates to extremely low levels and providing so much liquidity. That money had to go somewhere and into stocks it has gone.

Central Banks want rising equity prices to feed consumer and business sentiment and they got just that!

The shortcoming of this experiment has been growth, while it has leveled off here in the US is not strong. As a matter of fact, one can see that whether through falling demand or rising supply or a combination of both, hard asset prices, aka, commodities, are falling in price.

I have long maintained and continue to maintain that this is evidence of a deflationary wave that Central Banks have not been able to reverse. They have succeeded somewhat in blunting its worst effects but reverse it they have not. Consider the fact that the ECB might yet be forced to effectively go the way of both the Bank of Japan and the Fed and implement its own version of QE if their recent measures fail to generate any strong growth in the Eurozone.

I have said all the above to come to this point - I will not argue whether stocks are overpriced or not. Frankly I do not care nor does the market at this point. Stocks are where the gains and have for the last few years, especially compared to commodities in general since 2012. Once that is understood, whether or not one likes it or approves of it is immaterial, one is on their way to understanding something about the nature of our modern markets. Money flows to where it can obtain a yield. It is that simple.

However, and this I believe is most important, if the economy was actually growing as robustly as the soaring equity markets would seem to indicate, commodity prices would NOT BE FALLING. I think that is axiomatic and needs no further explanation. Look at the comparison chart and tell me that they are not going one way while equities are going the other. What this does tell is however is that current levels of demand are not strong enough to absorb the current supply.

Along that line, I have maintained also that inflationary pressures cannot break out here in the US, or elsewhere for that matter, unless and until WAGES MOVE HIGHER. They remain stagnant however.

Many of those who oppose my current outlook on gold will bring up the fact that the cost of many basic items seem to be going up and that this is evidence that inflation is present. They also maintain that the rise in prices is threatening the middle class and its way of life. They cite that as a reason to buy gold - to protect their purchasing power. I will only comment on this insofar as to say, that for the last few years, gold has been a pathetic investment to "protect one's purchasing power". The metal has collapsed in price from $1900 all the way to its current price of $1250, much like the vast majority of individual commodity prices have collapsed lower. What is so sad is that many of those advocating such things are generally much more in tune with what is happening in the broader global and national economy that the average Joe and Jill, who stuck with stocks and did nothing. The latter looks like investing geniuses while the former look like dolts. It is said that "Ignorance is Bliss" ( a saying that I personally do not ascribe to ) yet in their case, it sure seems like that is the truth! 

I sincerely believe that is not the point, at least as far as investing or trading goes. What is the point, and this is assuming that their claim is true, is that wages are failing to keep up with the rise in services or goods and thus that is crimping peoples' disposable income.

After all, one has only so much money to spend, based on their take home pay, which has been relatively stagnant for many years now. If a larger share is given to buying "essentials", it is mathematically simple to understand that leaves less money available to spend on "wants". My question is, in such an environment, in which wages are flat, and growth is slow, and disposable income is tied up in essentials, where are the pressures going to come from to launch this long-heralded wave of inflation that will drive gold and silver prices inexorably higher? I maintain that the ingredients are therefore missing.

To me it goes back to Wages and thus back to the Velocity of Money. Until wages move higher it is my contention that inflation of the scope great enough to attract the attention of market participants of size will not occur. Currently the TIPS Spread is falling, not rising. That is the best source to measure the sentiment of those who watch this sort of thing most closely. Any open-minded, objective survey of the chart will show FALLING INFLATION EXPECTATIONS are currently in ascendency.

I have said it before and will so say again - falling commodity prices are not conducive to bull markets in gold and silver. It will take a geopolitical occurrence at this point to change the bearish sentiment that is currently dominant in both markets.