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Inflationists point to the overcapacity of money as proof that inflation is coming. They generally don't want to hear about the impact that modern mining equipment has had.
Deflationists point to the overcapacity of hard assets as proof that deflation is coming. They generally don't want to hear about the impact that modern printing presses have had.
I think that the truth lies somewhere in between. I'm a bit deflationary, but perhaps mainly out of stubbornness. I think there are way too many people who see severe inflation as a "sure thing".
Gold was $606 in 2006 and was directly on that red line (an average). M3 should be about 25% higher now than it was then (using M2 as a proxy since M3 was discontinued). About 6% more gold should have been mined (extrapolating). This would imply that the fair value of gold is roughly 19% higher now than it was then. That would be roughly $721 an ounce.
Gold is actually trading at $1,102 though. If you can believe in what this chart is trying to say, then gold may be roughly 50% overvalued.
I think it is worth noting that the increase in gold production is slowing but so is the increase in the money supply. M2 is up just 3.7% from December 12, 2008 to December 7, 2009. It is only up 0.4% in the last 6 months.
I have ignored credit and a possible China bubble in this analysis. I would argue that these topics could only help the deflationary case.
And lastly, here's a peek at aluminum.
Aluminum prices rose over the last 50 years, but not fast enough to keep up with inflation (as seen in the CPI). The sheer volume of aluminum mined is responsible for the upward trend in the chart. Aluminum prices are actually about 15% cheaper now than they were in 2006.
Source Data:
St. Louis Fed: M2
St. Louis Fed: M3
USGS: Historical Statistics for Minerals
Kitco: Gold
Kitco: 5 Year Aluminum Spot Price Chart
29 comments:
Mark - speaking from the UK, debt has to be devalued. The £ has fallen some of the way towards what will be needed. Many countries within the Euro cannot use this escape route - yet. The $ needs to fall, along with many currencies, and there's the rub. They may fall 1 by 1, only to end up in the same relative positions. Perhaps this is part of the reason that gold seems historically "overvalued". The gold price is anticipating the potential devaluation of debt on an unprecedented scale.
I think there are way too many people who see severe inflation as a "sure thing".
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Not sure I agree. The inflationists are usually those who understand how money is injected into the system, which is not many.
I work with consultants in the defined contribution business and let me tell you that the average Joe does not have inflation on his/her radar screen and it's still not anywhere close.
Every time someone in my entourage takes on a huge mortgage, I ask them whether or not they worry about higher rates at refinancing time (in Canada mortgages are usually renegotiated every 5 years max) and the answer is typically that government can't raise rates or they'll create a recession. lol! As if that stopped them in the 70s and 80s!
On top of most not even thinking about deflation or inflation, we have a huge % of inflationists who are convinced they'll see it coming and will have time to get out of their long positions.
Inflation is a decision. Whether we have inflation or not depends entirely on whether or not our leaders decide to print and by how much.
Deflationists are convinced that:
1. government will stop injecting money into the system
2. that even if it does inject money that people will pay off debt and that this money will not circulate
3. that governement has no means to make this money circulate
4. that government has qualms about creating too much money when in fact inflation is their best case scenario
Maybe our leaders will stop printing but I doubt it. I think that right now excessive printing is not timely as there is still too much hope out there that we can pull more rabbits out of the hat.
I also think that the purse strings will really come undone when the wheels start falling off. Why? Because it extreme times always call for extreme measures.
There are so many ways to distribute money without getting deleveraging. For example you subsidize the utilities. Everyone still needs to heat no? You subsidize food banks? You subsidize health care for 30 million people. You start paying social security to millions who don't work and produce anymore. The list goes on and on.
The deflationists are still clinging to free markets idealism. They have not come to grips with a Fed that has increased its balance sheet by more than 1 trillion so they can't even imagine another few trillion.
Think about it. One decade ago, world markets were freaking out about LTCM with a loss of 6 bliion or so. 2 years ago, we were told it was contained and would cost a few hundred billion. Leaders have managed to pack on trillions and the world is still expecting business as usual? It's obviouys that the world has gone mad and the Fed will be packing on a few more trillions.
They've barely written anything off for crying out loud. Logic tells us that the next batch of defaults will be taken off the banks' books and replaced with new money. They've already done it. What will be stopping them in 2010?
And with zirp, companies got 1 or 2years of respite on their debt. In 2010 we will be seeing bankruptcies because rates can not go lower. We'll see M&A, capacity destruction while the level of cash will be maintained. I think supply will drop faster than the supply of money.
All developed countries are going to hell in a hand basket so why would the US stop at 100% debt to GDP?
Stevie b.,
You could very well be right. Hey, at least I have plenty of toilet paper!
Anonymous,
You make a lot of great points.
For the record, most of my nest egg sits in TIPS and I-Bonds. I am not betting on long-term deflation. I do think there may be another downleg though (and like you, if history is any indicator it will be temporary at best).
I've also supplied a picture of my extended pantry on this blog. If you haven't seen it, picture close to 1000 rolls of toilet paper. I'm clearly not the poster child for the deflationist movement! ;)
Anonymous,
"I think there are way too many people who see severe inflation as a "sure thing"."
I should have been much more specific. I think there are way too many informed people who think severe inflation is a "sure thing". I base my opinion on China being in a bubble. I think their pain will exceed ours and I seem to be in the minority.
Of course, it is just an opinion. I could be wrong to think it.
I think there are way too many informed people who think severe inflation is a "sure thing".
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I would tend to agree. I guess my point is more in the timing.
I can't find one informed investment pro not telling us to go short long bonds. That makes me nervous.
Anonymous,
"I can't find one informed investment pro not telling us to go short long bonds. That makes me nervous."
I hear that. I see a lot of people convinced that TBT is the way to go. It seems especially popular with those who like inflation protected treasuries (as seen on Yahoo's TIP message board). As a person who owns TIPS, that makes me nervous.
Why short long bonds when you can ultra short them! Woohoo!
Um, because maybe leverage is the very thing we might still want to avoid?
Um, because maybe derivatives are financial weapons of mass destruction and the only way you can ultra short something is by using derivatives?
Um, because maybe derivatives are a zero sum game and for every winner there must be a loser?
Um, because maybe you shouldn't be playing a game if you aren't entirely positive who the patsy is?
Um, because maybe somebody actually needs to exist on the other side of that trade and maybe, just maybe, they know more than what you just read in the headline of a Yahoo article?
Just thoughts.
I am reminded of USO. It uses derivatives to track the price of oil.
http://finance.yahoo.com/q/ta?s=USO&t=5y
Oops! Not even close. Very few investors even know why. Check this out.
http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_U/threadview?m=tm&bn=51316&tid=119932&mid=119940&tof=5&rt=2&frt=1&off=1
"you remind everyone the USO is under manipulation, it does not reflecting the true value of oil.
USO should be $60 now, at least 50% under value.
oil is going up + USO is under value = Strong Buy!"
It does not reflecting the true value of oil? Forehead. Desk. Whack. Whack. Whack.
Meanwhile, they are selling 31mg (roughly 1/1000th of an ounce) gold coins on TV for $20. Sigh.
I am currently 5% commodities, 10% treasuries (about to mature that I bought in late 2006/early 2007 when I sold my equities) and the rest cash.
The way I see it right now is that if we get deflation, I still make money yet if inflation rears its ugly head, I'm ready. I'm not a boomer so I refuse to play the yield game.
I looked at what equities did in the 70s when inflation picked up and the data is not rosy. Those buying equities to protect themselves from inflation will get a nasty surprise because in early inflation days, margins get compressed and companies fail. Equities do well only once inflation expectations get priced into business plans which is not the case today.
But I think my biggest reason is that I feel there's going to be whackage part 2. My gut tells me that the yield seekers are going to get hit big time. There is still too much stupid money out there. Greed is still more prevalent than fear. And with governement bailouts, it's gone up exponentially.
"But I think my biggest reason is that I feel there's going to be whackage part 2"
In my view, those expecting another Lehman Bros. event are going to be very disappointed.
It would be nice if we could have another LBs, or maybe 10 or 20 or 50 of them. Then we could stop wasting time getting back to where we need to be and start over again. But rather we're going to be in for one long depression that is going to last and last this time.
We've been through this same repeating pattern for nearly a hundred years now and no one in charge is wised up and learning something. When the printing presses are available to .gov and the banking cartel, they will use them rather than doing the right thing.
The problem isn't with the choices made by the power elite. The problem is that they possess the power to make any choice at all.
GH:
Trillions need to be raised worldwide in 2010 to fund deficits, to refinance and recapitalize. The money is already parked so where will thes trillions come from? Printing of course.
Because it's a free for all, worldwide, I think the chances for calamities have only increased.
Iceland, Ireland, Spain, Greece, Dubai... those are only the tip of the iceberg.
My guess is that something big will hit outside the US in 2010(Europe? Emerging markets?) and money will quickly flow back to safer ground. So the US dollar would go back up for a while and long treasuries would outperform.
This would scare money out of risky assets and many coporations would have trouble refinancing leading to bankruptcies and M&A.
That scenario would kill a lot of investors.
Anon,
When you say "kill a lot of investors" I assume you mean the type buy-and-hold investors. On that I would agree with you 100%. They are fist-pumping the rebound this year but it's still a long way from simply breaking even after the fleecing they received post LBs.
I hope your guess about something big outside the US comes true and pushes USD higher the way you surmized. It would greatly help my potential UUP trade which is sizing up for a possible January entry. I'm poised on the trigger for when the 39 week line in this chart is crossed to the upside:
http://stockcharts.com/h-sc/ui?s=UUP&p=D&st=2009-01-01&id=p85294714909
For some entertaining (or maybe not) videos go to youtube and search on "Iceland" and "riots". Maybe coming to a US city near us.
Anonymous & G.H.,
I think the next major whackage might just be China and/or India, and that's especially true even if inflation is allowed room to run.
1. Food is a much bigger part of their CPI than our CPI (simply because poor people spend more of their budgets on food).
2. Food is often an early target for inflation (think rice hoarding).
3. If people don't get enough food, then people get angry.
For all of our faults, at least we aren't "officially" poor yet nor are we densely populated.
http://en.wikipedia.org/wiki/List_of_countries_and_dependencies_by_population_density
Bangladesh: 2,918 per square mile
India: 925 per square mile
Japan: 874 per square mile
United Kingdom: 657 per square mile
China: 360 per square mile (next superpower? someday?)
United States: 83 per square mile (superpower)
Russia: 22 per square mile (former superpower)
Canada: 9 per square mile (in decent shape long-term, even exports energy)
Inflation shoots up by 46pc in a month
http://www.thedailystar.net/newDesign/news-details.php?nid=118187
Inflation rate on point-to-point basis has increased by 46 percent in a month and stood at 6.71 percent in October mainly because of rising food price.
In September, the inflation rate was 4.60 percent. According to statistics of Bangladesh Bureau of Statistics (BBS), the food inflation in urban areas has reached near about double digit.
Economists and development partners said it is not yet alarming but the government would have to be cautious so that the rate does not go further up as the poor people are most hurt by the inflation.
46 percent in a month isn't alarming? Fascinating.
Soaring food prices threaten India's stability
http://business.timesonline.co.uk/tol/business/markets/india/article6960069.ece
“Unemployment and reduced wages, remittances and government services — by-products of the economic slump — threaten to add to the woes of the world’s poorest people, who already spend between 60 and 80 percent of their income on food,” the FAO said in a report.
Stag,
Think "Zambora", the amazing girl that transforms into an ape before your very eyes. The way those people run from the tent when "she/it" gets loose will be nothing compared to when the China trade hits the exits.
G.H.,
China Likely to Implement Exit Strategy in 2010
http://www.koreatimes.co.kr/www/news/biz/2009/12/123_57776.html
He didn't rule out the possibility of a fluctuation in asset and stock prices, but downplayed concerns of any steep change.
A steep change is very unlikely.
"The Chinese government is likely to enforce policy changes to keep real estate prices in check and that may lead to a temporary, but steep drop in values," said Om.
However, there may be a steep change.
From early 2008...
India bet becomes a sure thing
http://www.marketwatch.com/story/india-bet-becomes-a-sure-thing-for-global-mobile-operators
It has everything: Explosive growth, huge population, untapped customers
Oops! That "sure thing" crashed. Here we go again for another round?
From this month...
Emerging Markets Soar Past Their Doubters
http://www.nytimes.com/2009/12/30/business/global/30emerge.html
“Investors are starting to look at this asset class and realize that it is a pretty safe place,” said Kevin Daly, who manages $1.7 billion in emerging market debt at Aberdeen Asset Management.
Despite their volatile history, emerging markets strike some money managers as relatively secure places to invest. Of course, such hopes have been dashed before.
What is India’s Biggest Bubble?
http://www.moneycontrol.com/news/mf-experts/what-is-india%E2%80%99s-biggest-bubble-_430077.html
When companies come out with IPOs only to repay debt, you know there is something fundamentally wrong.
"...emerging markets strike some money managers as relatively secure places to invest."
I'm in the wrong business. How's that saying go..."...you can fool some of..."
EMs can strike back too. The only secure way to invest is protection. Call it a.......Wall Street prophylactic.
For anyone who's interested here's how to make any EM investment secure (and you won't hear this from money managers.)
First, open this chart in another window, now hone in on these two dates, 07/13/09 (buy), and 10/30/09 (sell).
Did I miss a helluvalotta run up from the bottom? Yes. Did I give up some gain since I sold? Yes. But that's what a little trend tracking will do for so-called late entries and what sell-stopping will do to protect against bear routes.
After all, all I netted was 23.51% before commissions.
Now personally I hate internet fortune telling stories like it looks like this one is. But if it makes a valid point then it's all good.
Notice how being stopped out on 10/30 was really just a head-fake or whip-saw? Such is life when you're protecting yourself from the wayward and unrestrained (read vagrancies) influences of Wall Street and potential bears.
Money managers indeed.
Investing is DIY or else.
G.H.,
My general philosophy has been to buy things off the radar screen and that have decent value. That's my version of safety. Investors can't panic sell what they don't own.
Hansen (HANS) was my best trade (other than the investment that retired me). I bought it in the late 1990s simply because I kept seeing their products at Costco and liked their financials. Once it got on many investors' radar screens (Monster Energy drinks) and turned parabolic I sold. I made about 6 times my money and using hindsight, sold WAY too early. In my defense, it was the last stock I sold in 2004. The rest were sold earlier, because I felt my profitable investment in Citigroup would soon turn into a big mistake! Hindsight shows that I was wrong to ever own Citigroup, but I wised up in time. Whew!
I do not have any desire to own assets that people currently love. Moods change.
Unfortunately, the only "sure thing" I see these days is toilet paper, not so much because I think it will explode higher in price, but because I think it can keep up with inflation and doesn't require me to pay potentially higher capital gains taxes someday on its inflationary gains.
I just heard on TV that China is being bought as "window dressing" today. As a retail investor, I can't think of a worse reason to buy. It goes completely counter to my general investing philosophy.
1. On radar screen.
2. Loved to the point mutual funds want it listed in their year end holdings.
I'll pass, thank you very much.
I see these days is toilet paper
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I started with food (and toilet paper) but I've now switched to other stuff as I realize that I don't have enough space and a lot of the food could go rancid before I use it.
My grandmother who lived through the GD and the war told me that there were smaller products that became small luxuries and people did not think of hoarding. In those days ladies' stockings were in demand!
So I'm now stocking up on smaller slightly more expensive staples. Something I cold barter for food.
Of course my better half thinks I'm nuts!
Anonymous,
I hear you. I've pretty much got anything I've bought in the last few years hoarded to some degree, not so much because I thought there might be shortages though. I just figured that it will probably keep up with inflation and there's almost no downside risk.
I hope my hoard ends up being a very bad investment. It will more than likely mean that the rest of my nest egg is doing great.
Mark "I hope my hoard ends up being a very bad investment. It will more than likely mean that the rest of my nest egg is doing great"
EXACTLY! EXACTLY!! And i'm fairly confident that if gold now goes to $600 or whatever, t-p may not be far...er.. behind as a bum investment. I know we differ on the detail re gold or t-p, but at the end of the day we're both after the same thing: Balance!
As far as gold or TP being a "BUM" investment I know that my trading looks to ensure "regularity" in my returns so to speak! HAHA
I have a new theory on where we are:
Maintaination!
Stevie b.,
I just wish oil would drop to $40 and not because the US economy fell apart again either. It could happen. China could fall from grace. Solar panels could rule the day. And there's always Mr. Fusion!
GYSC,
May your TP resemble traPUNtos and may the PUNiest of PUNishments await you, I say with PUNchy homesPUN imPUNity and extreme PUNctuation!!!!!!!
http://www.merriam-webster.com/dictionary/trapuntos
a decorative quilted design in high relief worked through at least two layers of cloth by outlining the design in running stitch and padding it from the underside
Don't (short) squeeze the trapuntos or we're likely to hyperinflate!
Oh man that was a masterpiece!
GYSC,
I don't know. The masterpiece bar is set pretty darned high these days. ;)
http://www.youtube.com/watch?v=a1zs4PPk5kg
Stag, re. your 2:27AM post,
I'm not sure if you were making a point concerning EM funds or if you were being more general but anyway...
Do you think that my UUP tracking is a form of watching the "herd" and waiting for a quasi-stampede before entering?
Bear in mind that if I were to make this trade it would have absolutley nothing to do with "fundamentals." In other words I would not care one iota about forces influencing the dollar. Rather, I would be following signals, clear unarguable signals from Mr. Market that this issue has upward momentum, has had upward momentum for some time, and when compared to the universe of other opportunities, presents a solid and logical case for committing some funds.
And of course, protecting myself with sell-stops based on highs reached after making the purchase.
Now I understand that our styles differ greatly, but I'm interested in your views of a style that removes itself entirely from "noise" and "emotion".
Nevermind that I made some statements earlier regarding world events that may have an effect on this trade one way or the other.
G.H.,
For what it is worth, I do think herd watching is a good idea. I certainly do it. I also think that estimating the herd's behavior is part of the fundamentals, otherwise I would never have bought gold in 2004.
There was no truly fundamental reason the 5-Year TIPS had to bounce off of 0% in the past. It could have just scraped along the bottom. I was/am counting on the herd to lose momentum though.
Clearly I am a believer in momentum. As such, I could hardly heckle those who ride the wave.
My issue is probably one of control. I just don't trust Mr. Market's opinions much.
I therefore don't invest in something if I don't think I could hold it forever. I therefore can't invest in UUP (either long or short). It also stops me from using options (derivatives).
My "sell stop" is based on a question. Would I buy it today at this price? If I answer no, I'll hold. If I answer hell no, then I sell. I started using this when I once held a stock to long for tax reasons. I got my wish. I never did have to pay tax on it. In fact, the IRS paid me to sell it (tax write-off, lol).
"I...think that estimating the herd's behavior is part of the fundamentals..."
This is an interesting point and I never thought to look at it that way. I guess I believe that to be able to accurately estimate, or predict, humans behavior would require much more than understanding human nature. It would require keen insights into the full spectrum of market activity cause and effect.
And that right there takes me out of territory I'm not willing to tread. If I had to rely on my "keen insights" to get me by then it's nothing but CDs for me. You see, when you play poker it helps to know who the patsy at the table is. I don't play poker on Wall Street 'cause I'll always be the patsy :-)
"I just don't trust Mr. Market's opinions much."
I hear you. Myself, don't trust them either but I carefully listen to him as he speaks. I call breaches of trust "whipsaws" or "headfakes".
The only mitigating tools I have against such misconducts of Mr. Market are, on the buy side, waiting until an uptrend has confirmed beyond a long term moving average for a few days or, on the sell side, stops.
"I...don't invest in something if I don't think I could hold it forever."
I'm going to ask you about that I-bonds auction coming up. I'll do that in another more recent blog post. I'm going to be considering it using the bank purchase route but I'll have some questions about timing.
G.H.,
About a decade ago I invested in Gillette and was planning to hold forever. They released the triple bladed razor and the stock went up 75% in 6 months. I sold. I joked at the time that investors would probably lose all those gains if another company tried four blades. I thought I was joking anyway. That's pretty much what happened. Go figure.
What a crazy world we live in. I loved Saturday Night Live's heckle. Their fake ad had 10 blades if memory serves.
Just so you know, I-Bond rates are not auctioned. The government simply decides what it wants the rate to be. The current 0.3% rate (above inflation, locked in for up to 30 years) won't reset until May 1st, and resets again on November 1st. I'm hoping real rates will be higher by November and that I can therefore get a rate that's at least half-wat decent. 0.3% is truly pathetic.
Stagflationary Mark:
I totally agree with everything you said, especially on this one:
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1. Food is a much bigger part of their CPI than our CPI (simply because poor people spend more of their budgets on food).
2. Food is often an early target for inflation (think rice hoarding).
3. If people don't get enough food, then people get angry.
For all of our faults, at least we aren't "officially" poor yet nor are we densely populated.
http://en.wikipedia.org/wiki/List_of_countries_and_dependencies_by_population_density
Bangladesh: 2,918 per square mile
India: 925 per square mile
Japan: 874 per square mile
United Kingdom: 657 per square mile
China: 360 per square mile (next superpower? someday?)
United States: 83 per square mile (superpower)
Russia: 22 per square mile (former superpower)
Canada: 9 per square mile (in decent shape long-term, even exports energy)
sakura hasegawa,
I appreciate the kind words. Thanks for commenting.
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