Sunday, March 18, 2012

Deflation #Winning !

(Sorry couldn't resist the Charlie Sheen reference.  Now, he would be the perfect official spokesman of the Idiocracy).

As you know, I like charts a lot, because they are objective, and therefore preclude me from for example having to watch CNBC with the sound turned on, and other excruciating experiences.  In my last post, I mentioned some key divergences in the markets that bear watching closely.  As always, I am looking for data points that either confirm or refute the deflationary crash thesis.  Right now, stocks are pointing strongly toward a reflation of the economy.  However, more than any other market, the stock market is the key (short-term) barometer of social mood, therefore it's volatile, emotional and prone to manipulation.  Other markets are less speculative and therefore can serve as reliable indicators of what is really going on in the economy.

For example, long term Treasury bonds have yet to confirm the economic reflation signal indicated by the rising stock market.  The chart below is a 20 year view of long-term Treasury yields (red/black candlesticks) with the stock market line chart behind.  A few observations are in order:  1) The stock market is far more volatile and has been a roller coaster over the past 20 years, whereas bond yields (interest rates) have trended downwards relentlessly for 20 years.  2) The divergence between the stock market and bond yields is at its widest level ever, with bonds signalling deflation and stocks signalling reflation  3) Not withstanding $7 trillion of Central bank liquidity added in the past 3 years, bond yields are currently at the bottom of the trading range and hovering around the record low levels experienced during the Lehman crisis in 2008.

So clearly, bonds and stocks strongly disagree over the direction of the economy.  Optimists believe that this situation will resolve in stocks' favour with bond yields spiking higher to "catch up" with stocks.  I hear that all the time now, for example in this recent article on MarketWatch.  Clearly, I am not in the "stocks right/bonds wrong" camp, as usually the bond market is a more reliable indicator than the stock market, but why take my word for it?  Let's see what Dr. copper has to say...

Copper is often referred to as "Dr. Copper" because it supposedly has a PhD in economics (not sure if that is good or bad).  In any case, it is the base metal most strongly correlated with the global economy and therefore an often reliable indicator.  The chart below of copper v.s. stocks is extremely illuminating.  This time I show stocks as red/black candlesticks v.s. copper as the black line chart.  The red trend lines show copper's topping process in 2011 and again now, the blue trend lines follow stocks  1) First off, notice that in 2011, copper topped out and began downtrending before stocks (red line fell, while blue rose).  That is exactly what you see happening today on the right hand side - red falling, blue still rising.  2) Second key point - look where copper was last year in early 2011 v.s. where it is today i.e. it was much higher back then than now.  Not exactly confirming global reflation.

Lastly, China has been the marginal driver of global growth for the past 20 years and yet as you see in the chart below, China's stock market can't get out of its own way right now.  So, are we to believe that Europe will go through recession, China will have its first growth slowdown in 20 years, but the U.S. will borrow its way to growth?

[UPDATED: 3/20/2012]
So what does the Idiocracy say about all this?  Here is an article in which Hulbert asserts that inflation is "beating" deflation (of course, offering no proof whatsoever) - and therefore stocks are outperforming gold now.  Excuse me?  But then he totally contradicts himself by rightly saying that gold outperformed in the 1970s due to high inflation.  Everyone knows that the whole reason people buy gold is to protect against inflation, because it's the one asset Central Banks can't just "print" out of thin air.
On a separate note then he says that the threat of deflation has lifted, so gold can go down again.  Yet when deflation flared up in 2008 post-Lehman, gold tanked.  It was only in the years after (2009-2011) during the reflationary phase that gold soared.  But why am I doing this guy's job for him?  I don't even believe his underlying thesis (inflation beating deflation).  I just read this and it made so little sense that I just thought I would throw it in as the latest example of contorted logic emanating from the Idiocracy, which has now gone Full Retard.

As Prechter has said for years now - regardless of what machinations and debt monetization schemes Central Banks conjure up, deflation will eventually prevail - it's inevitable.  There is far too much debt outstanding and deflation is as much a mindset as it is an economic phenomenon.  We have entered a negative feedback cycle from a societal mood perspective.  To date, the Central Banks have done yeoman's work propping up the illusion formerly-known-as-the-economy, but as these charts show, time is running out on the grand delusion and all signs point down.  Very few today believe or even understand the deflation thesis, because the last time deflation manifested itself was in the 1930s before most of us were even born.  Today's "old sages" always use the 1970s as their reference point and therefore they see inflation as the ever-threatening boogeyman.  In short, the Idiocracy will be standing on the tracks looking for the inflation train one way, only to get steamrolled by the deflation juggernaut coming from the other direction.