The financial mania climaxed as a complete bubble in 2007. Virtually, this replicated
the conclusion of all of the great bubbles since the first in 1720. As with
the 1929 and 1873 examples, its culmination was anticipated by the treasury
yield curve reversing from inverted to steepening. In 2007 this key reversal
counted out to that June and the curve reversed in that fateful May.
The features of the post-bubble contraction include severe recessions and
weak recoveries. This has, indeed, been the case and the first business expansion
and first bull market out of the Crash have become mature. The next cyclical
decline for both could be discovered in the fall.
In which case, when will the "18-Year Bull Market in Commodities" resume its
rightful course?
Another feature of the post-bubble condition has been the senior currency
being chronically strong relative to most currencies and most commodities for
most of the time.
We have been noting this possibility for some time and that it contrasts with
central bank inflation ideology. It also contrasts with the main theme of gold
commentators. Policymakers also have a theory that implementation now becomes
effective a couple of years later. This claim was difficult to discuss during
the collapse of the 2007 Bubble. What policy change
"caused" the collapse?
Inflation bulls remain convinced that all of the reckless "stimulus" injected
into the markets since early in 2007 will eventually ignite a fabulous bull
market in all commodities - particularly in precious metals.
Nowadays, as the title suggests inflation is instantaneous with policy. It
is not something that is
"bottled-up" and will erupt at a later date. But, before detailing this there
was a time when the possibility of inflation actually preceded a distinctive
rise in the rate of inflation in consumer prices (CPI). This writer started
in the business with Canada's premier investment dealer some 50 years ago.
While working as an assistant resource analyst in 1965 CPI inflation was beginning
to threaten the 2 percent level and the VP of the Bond Department was asked
about this. The measured response was that chronic and rampant inflation was
only possible in lesser countries in Europe or in South America. Canada and
the US had too much integrity to indulge in deliberate depreciation. What's
more, long-dated Canada bonds were trading at a 5.15% yield and would soon
get back to levels below 5 percent. They reached 19 percent in 1981.
An early proponent of gold and soaring prices was James Dines who began publishing
his letter in 1960. It took until the late 1960s before aggressive Fed policy
began to drive prices higher. Perhaps institutional inertia constrained the
price advance due to dollar depreciation until later in the 1960s when the
first "Operation Twist" was imposed. That was the US scheme to keep long rates
from rising above 6 percent by buying bonds out of the market. Such rates soared
to 15 percent in 1981.
To be methodical, there are particular aspects to rising prices that need
review. One is due to demand pushing up price to prompt supply. This is not
inflation. In the case of a relatively free market it is a very sophisticated
conveyance of information.
And then there is the price rise due to currency depreciation. Interventionist
policymakers believe that it causes a business expansion and vigilant gold
bugs believe that currency depreciation causes inflation in commodities. Including
gold which is not a commodity.
If such considerations of cause and effect were valid then prices would have
soared, without interruption since the Fed opened its doors in 1914. However,
there have been serious liquidity crises as over-speculation crashed. Besides
that, there have been times when the Fed has been very accommodative and commodities
did not go up. The lengthy bear market for the CRB that ran from 1980 until
1999 is one example and the bear that started in 1Q2011 is another. The latter
is in the face of the most reckless central banking - ever.
The attached update on our "Momentum Peak Forecaster" reviews that since the
late 1970s the outstanding crashes have been due to speculative surges, not
to Fed conspiracies, or blunders.
Financial history provides some explanation. The classical definition of inflation
has been "An inordinate expansion of credit". This has been and still is practical
as soaring prices can involve two different asset classes. Tangible assets
such as commodities and real estate. And never to be overlooked - financial
assets.
Inflation in tangible assets has been around ever since governments learned
to depreciate coinage. Financial assets have been around since the latter part
of the 1600s when there were enough companies and players to create a stock
market. The potential for "modern" depreciation started with the formation
of the Bank of England in 1694. It had the power to issue currency.
Even over the long span of when the BoE was disciplined by gold convertibility
great speculations in tangible and then financial assets were recorded and
then lamented.
So, if that has been the pattern for some 300 years it is tempting to conclude
that when the current inflation in stocks and bonds completes commodities will
be the next big sector.
It is not as simple as that.
In 1981 we expanded our service from mining companies to financial institutions
with the concept that commodity inflation had blown out and would be followed
by inflation in financial assets. That was controversial and the way it was
phrased may have been perplexing. By this time the investment establishment
had finally concluded that the Fed was the culprit in "inflation".
Using history's reliable patterns the conclusion was that the Fed would continue
to accommodate but the public would choose the new game. Stocks and bonds.
The line was "No matter how much the Fed prints, stocks will outperform commodities".
This has been the feature of each "New Financial Era" until it completes in
a classic bubble, much the same as in 1929, 1873, 1825, 1772 and 1720, to list
all of the great bubbles.
All were followed by post-bubble contractions that lasted for around twenty
years.
Within the framework of the usual 3 to 4-year business cycle there are times
when no matter how much the senior central bank tries to print both tangible
and financial assets go down. The crash that terminates a new financial era
is very severe, and followed by weak recoveries.
The action leading to a raging mania has included speculation in some commodities
and real estate. The mania in residential real estate completed in 2006 and
assisted by the tout about "Peak Oil" the CRB set its big high in June 2008.
As that fateful month was completing our technical research on crude identified
it as a possible cyclical and secular peak. The high for crude was 147 and
the high for the CRB was 473.
In 1997 we developed an indicator based upon a series related to credit spreads.
When it soars up to a spike it is close to the end of a surge of speculation.
We've called it the Momentum Peak Forecaster. It doesn't register that often
and the last signal was in April 2011. As the big action was in commodities
we concluded that when speculation exhausted it would likely set a cyclical
high.
From a high of 502 in April 2011, the base metals index (GYX) set a series
of lows such that the last one at 333 a few weeks ago set the bear market.
Agricultural prices (GKX) set their big high at 571 in March 2011. Even the
worst drought in 50 years did not drive it to new high in 2012. That high was
533 and the index continued down to 413 in April. Taking out the 381 level
set just before drought would set the cyclical bear market.
The main thing is that many commodities as well as precious metals have not
been soaring "to the moon" with the most reckless central banking in history.
Instead the "to the moon" action has been in financial assets.
And this is the big issue. But last week the esteemed Paul Volker expressed
concern about
"inflation", meaning soaring commodities and CPI. The world is still fixed
on the impractical concept of "inflation". The practical description is that
inflation is an inordinate expansion of credit.
Which makes "deflation" a credit contraction and this melancholy condition
has been the feature of all post-bubble contractions.
And as with the pre-bubble world, both the private and coercive sectors need
a business expansion to have credit expand. The theory that an arbitrary increase
in central bank credit will "cause" a business expansion is another example
of a primitive syllogism. The best-known one is that roosters crowing in the
morning cause the sun to rise.
Before getting to our theme that "Inflation is Instantaneous" some additional
discussion about the nature of credit is required.
Actually credit expands with business and one does not "cause" the other.
However, at the end of a boom the relation between credit and prices becomes
clear. Eventually, the rise in prices becomes compelling and too many become
aggressively leveraged. Then Mister Margin forces liquidation of suddenly unsupportable
positions. And, typically, this overwhelms arbitrary attempts to keep the boom
going. Sadly, as in 2007, the establishment will insist that judicious manipulation
of credit will keep the boom going, or at least, prevent a depression.
One of history's ironies is that the esteemed editor of the The Econoomist,
Walter Bagehot, provided the recipe right at the top of the 1873 Bubble. In
reviewing the severity of the recessions that followed, in 1884, economists
coined the term "Great Depression". It was appropriate to the senior economy
(England) and it lasted until 1895.
That was a lengthy contraction that overwhelmed the ability of the senior
central bank to foster boom conditions. That was the case on the post-1929
contraction until World War II stabilized basic prices.
This fits financial history whereby, since the late 1600s, a dynamic business
expansion culminates with sensational speculation in tangible assets. Following
a severe recession the economy stagnates for a few business cycles when a huge
speculation in financial assets erupts. That this has been accompanied by firming
prices for most tangible assets including real estate is essential to the completion
of a great bubble.
This was not the case with the mania in tech stocks in the Dot.Com Bubble
that completed in March 2000. Action in basic commodities and real estate was
minimal and one of the economists on CNBC keep touting that you had to be in
the stock market "because there is no inflation". That was a "new" discovery
that expanding credit was not driving commodity inflation.
It is best to consider speculations as intense hoarding.
As history mandates, each long dynamic expansion matures with a period of
inflation in tangible assets when "real" things are hoarded.
This segues into a "New Financial Era" when it becomes compelling to hoard
stock and bond certificates.
In the US, the cycle for such certificates seems to have climaxed recently.
Those who have been banking upon a Fed-driven "inflation" in commodities may
conclude that it is, once again, time for the action to favour commodities.
The "Eighteen-Year Bull" market will resume. After all the Fed will never quit
ambitious policies of dollar depreciation.
Regrettably, this is outside of the abilities of today's central bankers.
While they have always considered such a prerogative as constant, the truth
is that the credit cycle permits the Fed to look good in a natural credit expansion
and, then, to look hopeless and perplexed during the natural contractions.
By way of summary, the basic pattern has been to "hoard tangible assets",
get burned out.
Then it is
"hoard financial assets", get burned out. Then, and there are five previous
examples since the start of modern markets and central banking, when the game
changes to "hoarding cash".
Back to our theme that "Inflation is Instantaneous". Throughout market history
Mother Nature has raised basic prices to prompt increases in supply and essentially
that increase is not asset inflation. It is reasonable to conclude that the
transfer of market information is instantaneous. Also, when not dislocated
by arbitrary policy, this is also continuous.
Moreover, the ability of central bankers to raise prices is readily understood,
now. No delays in this regard, but the ability to increase prices still depends
upon the business cycle, which signals are instantaneous and continuous.
On the aspect of price increases due to deliberate depreciation it is best
to consider that even with the most reckless senior central banking in history,
a classic bubble developed and climaxed, as in 1929, The consequent collapse
was the most severe since - the 1930s. The first business cycle out of the
crash has been the weakest since the one that completed in 1937.
The instruction is clear, financial history is in a post-bubble contraction
and outside of the typically weak economy, the other feature has yet to happen
and that is the great bond revulsion. The world learns that in a poor economy
it is virtually impossible to service the debt taken on in the raptures of
a financial mania.
Naturally, the issue of debt during the frenzy that completed in 2007 was
dauntingly immense. The amount issued during the vain attempt to make the contraction
go away has been without precedent.
This great bond revulsion, which is becoming irresistible, could also be without
precedent. So will be the hoarding of cash, and gold is the best kind of "cash" that
one can hold or find.
In real terms most commodities set an important high as a financial bubble
completes. And gold in real terms sets an important low. Typically the contraction
has prevailed for some twenty years and this has been accompanied by a bear
market in the real price of most commodities. This translates into a long bull
market for gold's real price.
It seems that as the normal and abnormal instruments of credit contract Mother
Nature works to provide real liquidity through significant increases in gold
production. Every time.
Momentum Peak Forecaster, Updated
(June 2013)
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The straight up occurs with increasing speculation.
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Rising through 1.20 indicates the action is becoming impetuous. The last
peak reading was April 2011.
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In most instances the speculative frenzy peaked some 3 months later.
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That counted out to July 2011, give or take a few weeks.
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The "Forecaster" does not apply to major lows.
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In July and August, 2006 we published a couple of articles on the Florida
real estate bubble of 1926, as well as on the post-1929 real estate debacle.
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On the pending discovery of another liquidity crisis, the investment demand
for gold will soar.
Base Metal Mining And Smelting Stocks
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Base metal prices boomed in the 1860s and rallied with the 1873 Bubble.
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Base Metal Mining & Smelting stocks were outstanding performers, as
they were in 1929 and in 2007.
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The Index soared from 150 to over 450 in a year and a half.
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At the top of the bubble, the leading New York newspaper editorialized
that nothing could go wrong. The US did not have a central bank and was
not on a gold standard.
"True, some great event may prick the commercial bubble of the hour,
and create convulsions; but while the Secretary of the Treasury plays
the role of banker for the entire United States it is difficult to
conceive of any condition of circumstances which he cannot control.
Power has been centralized in him to an extent not enjoyed by the Governor
of the Bank of England. He can issue the paper representatives of gold,
and count it as much as the yellow metal itself. [He has] a greater
influence than is possessed by all the banking institutions of New
York." - New York Herald, 1873
- In the long decline in the real price of base metals, the Index eventually
declined to 20 in 1895.
Base Metal Miners: 2002 - 2009
Base metal mining stocks have been outstanding performers in a number of Great
Bubbles.
We have charts on the 2007, 1929, 1873 and 1825 examples.
The 1825 and 1929 examples have yet to be digitized, but they were straight up
and straight down.
Typically, gold mining and exploration companies have been outstanding performers
during the lengthy post-bubble contractions.