Deflation Fears Gaining Ground in Europe

The following article in the London Telegraph is definitely worth a read. It confirms what I have been thinking for a while now that the primary fear facing the markets and thus the Central Banks as far as the Western economies go, is NOT inflation, but rather deflation. Try as they can, the ECB and the BOJ in particular, cannot seem to get the kind of growth they are hoping for, and more particularly, an inflation rate of 2% annually.

Dam breaks in Europe as deflation fears wash over ECB rhetoric

'We are reaching the end game in Europe. If they don’t launch real QE soon, the consequences are too awful to contemplate,' warns RBS

http://www.telegraph.co.uk/finance/economics/11154553/Dam-breaks-in-Europe-as-deflation-fears-wash-over-ECB-rhetoric.html



We have been following the Euro here in detail ever since ECB head Draghi first began attempts to talk the currency down when it reached the 1.400 level in May of this year. Quite frankly, with the problems that the Eurozone was having economically, the last thing desired in those quarters was a strong currency.

This was accomplished primarily by first raising the specter of additional monetary easing by lowering rates. Secondly it was then further reinforced by successive steps taken by the ECB which were seen as stimulative in nature by investors. I will not go into detail here as those have been covered previously here on this site.

Let me make one additional point here to refute the idea that the Euro fell primarily as a result of the sanctions imposed by the West on Russia. There is no doubt that those sanctions might have shaved some potential growth off of the Eurozone but frankly, the Eurozone has been in trouble long before those sanctions were announced or implemented.

There seem to be some who are so intent on preaching the demise of the US Dollar that they are blinded to the severe economic problems affecting the other major Western industrialized nations. The Dollar certainly has its own set of woes to contend with, but let's face it, right now the US is certainly more attractive of foreign capital flows than is the Eurozone or Japan for that matter.

Also, consider the fact that with global economic growth slowing and not rising, those nations whose currencies we have dubbed, "Commodity currencies", are having their own difficulties as well.

The Canadian Dollar, for example has fallen from 1.06 to its current .89 over the last three years. That is a decline of some 15.5%.

The Australian Dollar has declined nearly 22% in value against the US Dollar over that same three period with the currency being especially hit hard over the last month as it has plummeted some 8.5% alone!

I view the Aussie as a "Growth Currency" meaning that I look at it to try to get a sense of how the world at large sees the potential for commodity usage and thus, as a byproduct, overall world growth. Australia's close proximity to China, and its large trade in raw materials that are used in industrialized nations, infers that it is particularly vulnerable to any slowdown in growth from that corner of Asia.

Here is the currency chart:

That does not look like a currency chart showing a strong, vibrant, commodity-based economy now does it? It reflects what I and many others have been saying for a while now, that growth is slowing and deflationary headwinds are building. Those who keep with their incessant, inflation this and inflation that, are simply barking up the wrong tree.

Could we experience a currency crisis here in the US at some point? Sure we could. One never knows when the sentiment shifts in a market and suddenly something that was of seemingly little to no concern erupts into a full blown panic. Take the European Sovereign Debt crisis as an example.

It was no NEW news to the market that Greece or Spain or Portugal or even Italy had huge amounts of debt for the size of their overall GDP. The market knew that for a long time. Yet, something triggered a sudden shift in sentiment towards those nations' debt one day and on came the crisis.

What I am trying to say here is that one must deal with the present realities in the market to be successful as a trader or even an investor. Those who are handling real money and placing real trades or making real investments do not have the LUXURY of postulating theory after theory, many or even most of which will not turn out to be true. Instead they must understand the thinking or sentiment of the market. If it worries the market; it worries the trader. If the market could care less; the trader could care less. That sounds blasé but it is axiomatic due to the nature of money flows.

Standing in front of a tidal wave of money moving against you is a surefire method to be financially destroyed and left as "road pizza" ( one of my favorite analogies ) on the floor of the trading pits.

Let me shift gears here slightly and note the chart of gold priced in terms of the Euro. Eurogold has been holding much better than US Dollar priced gold on the chart, which is of course due to the sharp fall in the Euro.

Some have asked me what the repercussions to the Euro might be were the ECB to actually engage in their own version of QE to try reversing the deflationary pressures that are relentless in the Eurozone. I honestly do not know. I can make a case for a move higher and make one for a move lower.

The case for the lower Euro would be simple - the ECB creates more supply of the currency which tends to undercut the unit and thus knocks its lower. I am sure that is what they would hope the currency would do as they would thus bank on the weaker currency stimulating exports and serving to help generate some inflationary pressures.

The reverse could happen however. What if the market views the QE as sufficiently large enough in size to actually make a big impact on the economy and thus decides that the Eurozone will actually begin to grow? Could they decide that the Euro is now low enough and will move higher as the economy improves?

I don't know. The truth is I am not sure if anyone really knows. The reasons is because of something I have said many times here - we are in an era in which a monetary experiment of this size and of this nature has never been previously attempted. No one has thus ever lived through or been familiar with its eventual outcome. We are all trying to use our experience and wisdom gained over the years in deciphering the enigma presently before us. That is why I caution my readers against those who confidently ( hubristically in my opinion) proclaim with absolute certainty that "this market has bottomed" or "this market has topped" or "this event will now follow as sure as the sun rises in the East"., etc.

Let me draw some on my Texan roots and say that is pure "Bullsh*t!". They no more know the outcome or path of events that is going to transpire that the proverbial man in the moon. My advice is to ignore the wild screamers and theorist over at websites that are constantly regaling us with one sensational, dogmatic prediction after another and try to maintain a sort of quiet calm while you study developments and price action as you try to get a sense of how the markets are going to respond.

Lastly - Compare the Eurogold chart above to the weekly chart pattern of gold priced in US Dollar terms.

As you can see, that is quite a difference! This one looks abysmal compared to Eurogold. I am noting however that this week's wild swings in price have produced a Bullish Engulfing pattern on the weekly chart. That pattern has appeared at the previous double bottom level near $1180. My view on triple bottoms is well known by now - they rarely hold. But "rarely" is the key word. This one just might hold. Again, I honestly do not know. A technical chart pattern like this tends to be fairly reliable but all it could mean this time around is a halt in the ongoing downtrend, a sort of pause while the market consolidates before beginning a new leg lower. The reason for the uncertainty in my mind is that I did not see anything similar in the gold mining shares as evidenced by the HUI or GDXJ, both of which produced lousy weekly closes this week.

With the GLD disgorging the metal and with the TIPS spread continuing to fall, and with the commodity indices all dropping lower, will gold be able to withstand the headwinds coming from those negative fundamentals? Will those holding the metal ( big speculative interests ) decide to sell their gold to meet margin calls in equity markets exactly as happened back in 2008 when the crash began across nearly all asset classes except bonds? Again, I do not know. I am watching and observing however so let's do that together and see what comes next.