When bankers get nervous, watch out
As economies worldwide weaken, the pressure is rising on the world's central bankers for dramatic action that will ultimately do more damage. When that happens, the gold rally is on.
World stock markets remained under pressure over the last week due to the ongoing dysfunction in Europe and -- not to be underestimated -- the fact that the world economy is slowing down dramatically (which should not come as a shock to anyone who reads this column).
I think at this point it is worth discussing the worldwide response by central banks to this macro-deterioration. As my longtime readers know, I have absolutely no respect for any of the idiots who run central banks. They are always wrong. Repeat: they are always wrong.
Do you believe in global waning?
For the last six to 12 months, they have all felt that their individual economies were stronger than they were. And no central bank has been more off the mark, or guilty of making more mistakes, than our own Federal Reserve.
It is so incompetent that, in addition to spawning two gargantuan financial bubbles and the ensuing consequent dislocations, it is not even capable of understanding that when you have the warmest weather in more than 100 years, it skews the seasonally adjusted data. Thus, they were all patting themselves on the back this winter while I and others were pointing out that seasonal data were drastically boosted by the weather.
Now the underlying economic weakness can no longer be debated, and of course it is exacerbated by the uncertainty and chaos revolving around European government debt and the implications for Europe's financial system.
Recently, the Fed has sent signals that it is getting ready to do more easing of the money supply (beyond extending Operation Twist), and many other central banks have taken steps toward easier money as well. (We've seen this from China, Brazil, the European Central Bank and the Bank of England).
One of this week's Wall Street Journal headlines, "Fed weighs more stimulus," pretty much says it all. (The New York Times also ran a similar story).
In the journal piece, Jon Hilsenrath -- a regular outlet for the Fed's public relations spin -- makes this point regarding the Federal Open Market Committee (FOMC) meeting minutes released July 11: "The minutes portray an institution in a state of high alert over the economic outlook. Fed officials expressed worry at the meeting about risks to the American economy stemming from the euro-zone debt crisis, the possibility of a 'significant slowdown' in the Chinese economy and the prospect of deep U.S. government spending cuts and tax increases scheduled to go into effect at year-end."
The minutes are from late June -- meaning there has been even more weak data released since that bolsters the Feds' concerns.
Keep in mind, Fed governors had gotten their hopes up and now those hopes have been slammed, which is going to make them doubly uptight and more prone to panic. (Remember when Bernanke said the subprime mortgage mess was "contained" in 2008 and the extensive actions the Fed took when he found out how wrong he was?)
In any case, given the fact that the Fed has been so wrong, I expect that when it finally decides to the do next round of quantitative easing, it will be bigger and bolder and might even include some imaginative new tricks.
On Thursday, Joan McCullough of East Shore Partners, whose newsletter I have subscribed to for years, succinctly described the current Fed predicament as follows: "They blew their chance for that after the June FOMC, opting instead for a wimpy move of extending OT (Operation Twist). So they have two options remaining: get hugely creative/unconventional or fuhgeddaboudit altogether."
Really using their sinking caps
By extension, as I noted, other central banks will also be inclined to panic. That is why it is difficult to make money on the short side right now by betting stock prices will decline, even though stocks are leaking and in all likelihood may take a nasty tumble before the Fed finally panics. Stock bulls think, "Why should I sell when the Fed has my back?" But even in the four-year-old "QE era," the market still has had to get brutal enough to force out weak-handed players, thereby unnerving those who had been intent on remaining calm.
That is what has happened in the past, and it could easily happen again. But such an environment makes it tricky to be short stocks because even though some individual stocks might be working, if you try to up your exposure, it is easy to get run over by spurious rumors or more hope.
Even as the market has mostly declined over the last couple of weeks, there have been a few hellacious rallies that would make you jittery if you had just increased your short exposure. On Thursday morning, for instance, the S&P futures were lower by about 1.5% in the first hour, then cut those losses in the wake of absolutely nothing.
It might be possible to make some money on the short side if you employ guerrilla tactics, but just getting short, pressing and sitting back to collect a big payday might be rather difficult.
Yellow dog still on a short leash
Turning to the gold market, obviously it has been under pressure, too. I'm sure many folks were disappointed Thursday to see the WSJ headline noted above, combined with all the other stimulus we've seen, not only not make gold rally but see it decline. Unfortunately, that is just where we are right now. The minute "good news" for gold doesn't work, it turns into bad news, because it didn't cause the market to rally.
One of the problems the gold market has had is that demand from India has been subdued. The finance minister there has been trying to clamp down on gold purchases, and of course India's currency has been quite weak. That minister has now resigned, so we may see Indian behavior begin to revert back to what it has been. If so, we will be approaching the strong seasonal period for gold in another month, with potentially pent-up demand.
However, an additional big negative for gold (in the form of negligible demand) has been the lack of any serious U.S. buying (although the hedge fund community was a big believer last year). Now though, when you look at their view, as expressed by positions in the Commitment of Traders Report, it looks like more of the big, futures-oriented hot money (i.e., hedge funds and commodity trading advisers) is short.
More importantly, a big buyer who needs to own gold, but doesn't thus far, is the "average" wealthy American. I think that is unquestionably what has ailed gold stocks, not their own fundamentals, which have been disappointing from time to time, but not nearly as bad as the stocks' behavior would suggest.
The bottom line is that the bull market in gold has been more global than American.
Who knew mad men were so sane?
At some point, though, I continue to believe that more American investors will start buying gold, though I have no idea what the catalyst will be. Recognizing that an idea has to start somewhere, or that as the Chinese say, a journey of a thousand miles begins with the first step, Thursday's Wall Street Journal carried a two-page pullout advertisement by Charles Schwab with the banner "A different view of risk" and tagline "Bubbles, crashes, and downturns are going to happen, but you can take steps to find opportunities in risk."
The ad goes on to give a short primer on one facet of the bull case for gold, which is paid off by more big type: "All that glitters: How gold is impacted by the paper value of money." It then accurately concludes: "By printing money the Fed is actually debasing the value of its currency. This is where gold as an asset class comes in, because (Stephen) Cucchiaro (chief investment officer at Windhaven Investment Management, a Schwab affiliate) sees gold as an excellent way to measure the value of paper currency. It isn't possible to print more gold; the amount aboveground is relatively fixed, so as more money is printed, it takes more of it to purchase the same amount of gold. The result: the price of gold goes up and the value of paper money goes down."
There, ladies and gentlemen, is the bull case for gold in a nutshell, and eventually more folks are going to realize this. The reason I bring all of this up is because gold bulls feel tortured after nine months of correction (which may go on a bit longer). But in my opinion, given all I have described above, the next rally in gold, when the Fed finally acts, is going to be huge. Thus, I think gold investors need to be mentally prepared for what they might do if that is the case.
Anyone with gold exposure probably doesn't need to take that much action until it looks like the powers that be are finally panicking. But when that moment arrives, gold bulls should make sure they have the positions they want, so they can capture attractive (even if a little higher) prices, rather than paying up after the market has rallied a long way and exposing themselves to more risk.
For now, gold owners should remember the saying, "Just when the caterpillar thought the world was over, it turned into a butterfly."
Thanks to Fred Hickey, my good friend and top-notch analyst, for directing me to a number of facts in this column.
At the time of publication, Bill Fleckenstein owned gold.
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ABOUT BILL FLECKENSTEIN
This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.
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