"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, May 28, 2014

Gold versus the TIPS Spread

I posted a chart last evening showing the TIPS spread going back to the spring of 2009. I have had a bit of extra time to overlay the gold price on that chart so as to be better able to compare how the price of gold is performing in relation to the changing inflation expectations among those who comprise the market.

I am particularly interested in the gold price performance when the reality dawned on most market participants that the extraordinary monetary measures that the Federal Reserve was engaging in was not producing the kind of upward pressures on inflation that most of us had believed it would when we watched it implemented.

Interestingly enough, this sea change in sentiment and "awakening" among investors, occurred in September 2012. That month the expected inflation rate peaked out above the 2.6% level. As you can see from looking at the chart, that was also the time frame during which gold could not maintain any sort of hold above the $1800 level. As it turned out, once gold failed at $1800 it was a steady downward move until it broke support near the $1530 level and entered into its current bear market.

In looking over this chart, I am struck by how closely the gold price has been moving with this TIPS Spread since it peaked out at the secondary high near $1800.

For another look at the overall commodity sector, take a gander at this chart of the GSCI ( Goldman Sachs Commodity Index) and notice how it failed at the 700 level at the same time ( September 2012) as both the gold price failed at $1800 and the TIPS Spread peaked. It too has been moving in a range since that time.

I find none of this to be coincidental. It helps establish me in my view that the market remains quite unsure about the future of inflation in this extraordinary time in financial market history. Economic data will seem to improve, then fall, then improve once again, etc.

A quick note about the mining shares - looking at the HUI chart, unless it can reverse course tomorrow or Friday, it looks to end the week BELOW another key chart support level on the weekly chart. If it does, there is a good chance that the index will test the psychological support level of 200.

The GDXJ is threatening to lose all the gains, what little it had managed to capture, of this year. Its low print for today's session is 32.43. It closed last year ( 2013) at 31.05.

Until we see these mining shares showing some signs of life, making a case for a good bottom in gold is unwise.

That being said, I am going to be most curious at to what the reported holdings in GLD are by the end of this week. That buying yesterday was rather odd so I want to see if it was an anomaly or the start of an actual trend.

The Euro fell below the 1.36 level in today's trade which is more psychological than anything but nonetheless, it continues weak against the Dollar. There is some support on its chart near 1.356. I don't see much below that until you get closer to 1.350.

The Dollar is inching towards overhead chart resistance near 80.70 - 80.80. It can close out the week above that level, it stands a good chance to make a run at 81.40 or so.

Gold did initially hold at even number support at $1260 but as the day has worn on and the mining shares continue to sink, it fell below that level. There is psychological support near $1250. Rallies in gold are now going to be sold as losing longs will use that to get out while opportunistic shorts are going to be aggressive. Something will have to turn on the fundamental front ( currency concerns or geopolitical events ) to take gold out of its current bearish posture.

Fed Balance Sheet Size

There is a fascinating report on the Dow Jones newswire this AM detailing a paper presented by Harvard University historian, Niall Ferguson at the European Central Bank's inaugural forum in Sintra, Portugal.

The gist of the story :

The authors ( Ferguson, Moritz Schularick and Andreas Schaab) traced the history of central bank balance sheet expansion and contractions of "12 advanced economies since 1900".

"The size of central bank balance sheets has fluctuated between 10% and 20% of GDP most of the time except during WWII and the most recent crisis, which 'has eclipsed all other historical precedents.'"

The authors detail the finding that in the three decades prior to the credit crisis, central bank balance sheets had shrunk significantly when 'measured as a percentage of GDP'. 

"By that yardstick, their (recent) expansion merely marks a return to earlier levels".

The authors state that central bank balance sheets had "become small relative to the financial sector".

Here is a key part of the study:

"Central banks rarely reduce their balance sheets by selling securities; instead they shrink as a share of GDP because the economy expands".

In their own words:
"We have not recorded a single incident in which a central bank has primarily sold long-term government ( or private market) securities to unwind a long expansion in nominal terms".

The authors also note:

"there is little historical evidence that large central bank balance sheets pose ' an imminent risk to price stability'.

Here is another key quote from the story:

"Over time, the size of central bank balance sheets closely tracks the size of the public debt. But there is an important caveat: the lesson of the 1950s is that once a central bank has been buying bonds to keep long-term interest rates low, it can confront political pressures when it tries to reverse course".

Here is a link to the story: