'Tis Only My Opinion!

November 2003 - Volume 23, Number 11

Looking fore & aft

What have we learned in 2003

As I write this month's Opinion, I am in New Orleans at the Investment Conference.  I was particularly impressed by the presentation by Porter Stansbury who talked about the ten most important changes in the investment climate during this year.  While I don't agree with all of his points, here they are:

  1. The U.S. Treasury admitting that the total current debt liability of the Federal Government was $44 trillion.

  2. Stock market valuations are completely out of the stratosphere and perhaps, price to book value would return as a valid measurement.

  3. The advent of personal video recorders would change forever the TV broadcasting climate.

  4. Currency counterfeiting is becoming an increasing problem and the role of fiat currencies is undergoing review.

  5. In medicine, aspirin is gaining increased acceptance as a miracle drug in many ways despite science's inability to prove why it works.

  6. Negative real interest rates have existed all year enabling investors and consumers to increase debt loads.

  7. China's linkage of the yuan to the dollar continues to move wealth overseas from the U.S. and other countries to that country while allowing China to reduce its unemployment levels.

  8. The development of the Stirling engine may revolutionize the combustion engine world and reduce energy consumption of natural resources.

  9. The concept of rational pessimism as detailed in "Rational Pessimism: Predicting Equity Returns using Tobin's q and Price/Earnings Ratios" by Matthew Haney and Edward Tower.

  10. In Greenspan's speech at Jackson Hole, he acknowledged that the Federal Reserve did not have a clue about what they were doing.

Six of the points on Stansbury's list concern money related factors.  From an economic and market sense concerning the long-term outlook for the U.S., Stansbury has identified money factors that should be constantly monitored by astute investors in the months ahead.

The market still is acting irrationally to me.  However, at the New Orleans Investment Conference, there were many investors who were willing to grant that the "greater fool" theory was alive and well but they were ready to change investment direction at the first indication of trouble.


Does the stock market really anticipate the economy six months or more in the future?

The theory that the stock market is a forecaster of future economic activity has been studied to death and economists and statisticians using the same data have come to different conclusions.

During the period since Greenspan enticed the Fed to lower interest rates to offset the collapse of the stock market in 2000, we have seen economists continue to suggest that the future will get better each quarter.  Perhaps, they have failed to understand the countervailing forces of globalization and the deterioration of the U.S. economy as jobs and plants continue to move offshore.

Twenty years ago, it was manufacturing jobs that headed to lower cost labor countries. Today, we are seeing service and high-technology jobs undergo the same transformation. As a result, the old guidelines just may be in need of an overhaul.

There is considerable divergence between investors including myself and William O'Neil about whether this is a new bull market or just a rally in a secular bear market.  Now I am not averse to investing in bear market rallies but protecting profits in a bear market is more important than in a bull market.

The Challenger report indicating that layoffs are continuing to increase despite a lowering of new jobless claims is troubling.  In October, the number of layoff intentions was up sharply from 76,506 in September to over 171,874 in October.  Now is that a sign of an improving economy?

If this is a new bull market as O'Neil and others suggest, it will be the first time in history that a bull market began from valuation levels that were near the peak levels in 2000 when the market crashed.  In the interim, the Federal Reserve and the politicians have injected money, reduced interest rates, made new housing loans to barely breathing candidates with little prospects, and still the economy barely improves.

We hear of productivity improvements in the 7% range but that improvement is largely the result of a leaner workforce.  The number of chronically unemployed and/or underemployed persons continues to grow each month.

One recent study showed that the average wage of individuals laid off from Fortune 1000 companies was over $24 per hour including benefits.  For those that had found work and were no longer on the dole, the average wage was less than $12.83 and the benefit package was significantly lower. 

Personal bankruptcies keep setting new record levels and are running 7.8% higher in 2003 than last year.  Delinquencies on credit card debt, repossessions of automobiles purchased on 0% down, 0% interest terms as well as housing foreclosures are making new highs each money.

If this sounds like an improving economy to you, so be it.

What is happening to the money supply?

Since August, the growth of the various components of the money supply has changed direction.  Prior to August, the Federal Reserve had been increasing the money supply at a rate that was clearly unsustainable without creating major inflationary pressures and causing foreign investors anxiety about the value of their dollars.

Coupled with lowered interest rates, money supply growth found its way into the stock market, the housing market and into consumer spending via the refinancing of home equity.

However, since August, the trend has changed as shown below.

This chart was taken from Jim Puplava's website where you can also see charts of M1 & M2 as well as the definitions for M1, M2 & M3.

So far, the decline in the money supply has not resulted in a noticeable decrease in economic activity.  However, in the past, a money supply decline has affected economic growth in a negative sense.

The release of this month's Producer Price Index (PPI) has brought to the forefront the possibility of inflation increasing.  Rather than a modest 0.2% increase, the PPI increased by 0.8% in October against a 0.3% increase for September beating most analysts expectations. For the year, the official PPI increase is just over 3.0%.

Sometimes, I wonder why we even have government statistics.  The CRB index of commodities has been hitting new highs as shown in the following chart.

There is little correlation between the PPI and the CRB.  Personally, the CRB index reflects more accurately the cost pressures facing corporate America.

With harvest largely completed in the Midwest, we are seeing corn, soybean and wheat prices move into new high ground.  Meat prices are also much higher. 

China has been actively buying both food and metal commodities in world markets.  During the New Orleans Investment Conference, several speakers suggested that we have seen the  bottom of prices for many raw materials as the domestic demand for products within China will require them to import increasing levels of raw materials in the future.  As a result, stocks in raw material companies required by the Chinese manufacturing complex should benefit.  This would increase iron ore, coal, scrap steel, oil, copper as well as food commodities.

If you have not looked at the Chinese stock companies, perhaps, it is time to do your research.

Is the Fed and the PPT manipulating the stock markets?

There will always be doubters about the role of the Fed and the PPT in trying to shore up and/or boost market activity, particularly, in times of crisis and/or near election cycles.  Unless some insider writes a "tell-all" book, investors can continue to debate the issue.  However, the work of Mike Bolser in analyzing the repo pool available to certain banking houses leaves little doubt in my mind that either the Fed or the PPT can provide a nudge to the market.

During the past month, the level of the repo pool has been falling.  Perhaps, the Fed is trying to nudge the market lower.  More information on the operations of the Fed can be found at the Federal Reserve Bank of NY's website and at www.piraz.com.

You be the judge.

The trade deficit continues to be troubling.

  Last year, the U.S. had a record trade deficit of $380 billion.  This year we are on pace to smash that record.  At the current rate, we could well hit $500 billion.

It is now taking nearly $2 billion per day in foreign investment to enable the  U.S. to continue its "walk into bankruptcy."  The real question is when will foreigner's who now own almost 50% of our government debt and about one-third of our corporate debt will look at the loss in the value  of their holdings as the dollar continues to deteriorate and say, "Enough is enough!"

Watch the coverage ratio for government bond auctions to calibrate the time line.  When the coverage ratio falls below 1.4, interest rates will start moving up in earnest.  When the coverage ratio goes below 1.2, increases in interest rates won't sell bonds.  A former bond trader friend of mine mentioned the other day that he was only currently buying bonds denominated in either yen, the Euro, or Swiss francs.

Has the gold rally peaked or is it just starting?

During the past two weeks, we have seen an increase of both gold prices and shares of many gold stocks.  Some of the gains are pretty spectacular for investors who were purchasing gold shares earlier this year.  The HUI index of un-hedged gold stocks has forged into new high ground this past week.

We wrote our first technical note on gold back in May 2001 and the vertical red line on the attached chart shows the publication date of that note.  Of the stocks we pointed out as possible investments at that time, most were in the HUI index.  It has been a nice run for those who were in the gold shares early.

Since the first of November, we have fielded many calls about our thoughts on the gold shares.  To us, the price of gold and gold shares represent good value at this stage.

Gold is now within striking distance of the $400 level following the week's action and closed for the week at a new high of 397.80, the highest price in seven years.

As the price of gold increases, the historic inversion with the U.S. dollar continues as the dollar continues its slide closing at 91.38 just above its previous low for the downward move since January 2002.

During the New Orleans Investment Conference, I asked Bill Bonner of Agora Publishing who lives in Paris where he thought the U.S. dollar would bottom.  His answer was 45.  If he is correct, there is a lot of pain to be felt in the U.S. economy and by its citizens.


This market has a tired feel to me.  Whether the Fed and the wise guys have enough ammunition to punch through the 10,000 level on the Dow is questionable in my mind.

Cautious investors should remain cautious.  With the Fed reducing the money supply, will the economy continue to grow.  Remember it has been taking over $7 of M3 to get $1 in GDP growth this year.

You have to wonder whether Greenspan still is in control or are outside forces gaining the upper hand.

We remain cautious, content to ride our gold portfolio and quick to pull the trigger on stocks in the other portfolios that begin to start south.  Cash is good and allows one to sleep soundly in this market environment.

But then - 'Tis Only My Opinion!

Fred Richards
November 2003

Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27

This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in 2003.
All rights reserved. Quotation with attribution is encouraged.
'Tis Only My Opinion is intended to provoke thinking, then dialogue among our readers.

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Last updated - July 6, 2008