Bill Baruch, president and founder of Blue Line Futures, previews E-mini S&P, Gold, Crude, and T...
Aden Sisters: Unraveling Inflation
07/23/2004 12:00 am EST
Not only do Mary and Pamela Anne Aden stand out as leading women in a generally male dominated industry, they are also unique as the only "sister act" in the advisory field. Here, they tackle the complexity of inflation and its impact on the markets.
"Short-term interest rates are rising and following long rates up as the era of cheap money is coming to an end. This will affect the other markets. The major trends remain intact; up for gold, and the metals group. Bond prices are bearish and near a crossroads and although stocks are rising, they’re very vulnerable to a renewed decline. Today for the first time since World War II, the Fed has been actively working to push inflation higher with its high-powered pumping of its monetary policy, and other countries have been joining the party. Global monetary policy is the loosest since the 1970s. And while the good news is that deflation was avoided, the bad news is that inflation is now coming back stronger than expected. Inflation has always been caused by excessive monetary expansion, often associated with wars. In the US, that’s certainly been the case with Iraq, which has become far more expensive than anyone expected.
"Whether or not you agree with the war, Iraq has been inflationary. In addition, even though the transition of power in Iraq has gone smoothly, militants have stepped up their attacks, and Saudi Arabia is becoming a real concern. Al Qaeda is determined to continue its war there, drive out Westerners, overthrow the monarchy and disrupt the oil sector. And since Saudi Arabia is the world’s largest oil producer, this alone could seriously hurt the world economy, producing chaos, soaring oil prices, and inflation. As investors, this means we have to expect the unexpected and go with the major trends. You want to be invested in markets that benefit from inflation like gold and currencies, and avoid investments that do poorly in this environment like stocks and bonds. Since last year, long-term rates have been rising and the 30 year yield is now at a crossroads since it’s very close to this important moving average at 5.50%. If the yield rises and stays clearly above this level, the mega trend would then turn up, signaling upcoming strong inflation and higher interest rates for years to come.
"As you know, gold and bonds are very sensitive to inflation. When inflation moves up, so does gold while bond prices decline.The gold/bonds ratio is an inflation barometer. The trend has been down since 1980 showing that gold was weaker than bonds, confirming inflation wasn’t a problem. But now, this 24 year trend and the moving average is being broken to favor gold over bonds. This marks an important mega trend change and it’s telling us gold is going to be stronger than bonds in the years ahead. This in turn reinforces the view that inflation will continue and it’s going to be greater than most expect. At the same time, it means the current bear market in bonds will not be like those of the past 20 years, but a major, long lasting one.
"Meanwhile, since the Fed’s been pumping monetary policy like mad, and dropping rates to historical lows, it’s been causing prices to rise in nearly all assets. Not only have commodities and oil prices been rising, but so have art, real estate, gold, other precious metals, and stocks. In the past, gold and stocks generally moved in opposite directions, but that hasn’t been the case in recent years. This divergence, however, is not going to continue indefinitely. Interest rates are going higher and when they do, it’s going to be bearish for stocks, and gold and stocks will again likely go their separate ways. It’ll also hurt real estate, which would have adverse economic effects as well. These effects could be postponed if interest rates rise gradually, but inflation would then keep rising. We’ll see what happens in the months ahead. But one thing is certain, we’re living in fascinating and historical times and we’ll do our best to keep it all in perspective as we go.
"The stock market technically remains bullish, but we just can’t get excited about it. The market simply has too many negatives facing it. Valuations are sky high, fundamentals are poor, and interest rates are rising. The stock market is very sensitive to interest rates. In every case, rising rates have preceded a drop in the stock market and several were severe like in 1974, 1987 and 2000-02. Rising interest rates will increasingly put downward pressure on stocks in the months and probably years ahead. Our technical indicators are also waving warning signals. Our leading long-term indicators are telling us the markets are on thin ice and very vulnerable. The same is true of the medium-term indicators. So if stocks move higher in the weeks ahead, this suggests the rise is unlikely to be long lasting.
"Few people realize how important interest rates are. In fact, they rarely even think about them, much less talk about them over dinner. Yet interest rates influence just about all areas of our lives. They certainly affect the markets and your investments, the economy, the way you spend your money and in many cases what you do. They can affect your income, job stability, family relations, and the list goes on and on. Basically, the interest rate influence is always hanging overhead. The markets know this. Alan Greenspan and the White House know this, which is one reason why interest rates have stayed at 45-year lows for such a long time. This has boosted the economy, held back deflation pressures, increased employment, helped propel the stock market higher, driven the dollar lower, gold and the currencies higher, it’s kept consumers buying and spending, and it’s boosted the housing market. But the era of low interest rates is coming to an end. Long-term investors should hold the Rydex Juno (RYJUX ) and Pro Funds Rising Rates Opportunity (RRPIX ) funds. Short-term traders should stay out and buy later.
"Meanwhile, the trade deficit is ballooning month after month. It hit yet another record this month and it’s now over 5% of GDP. This level has always preceded sharp currency declines and this is going to keep downward pressure on the US dollar, especially combined with the record budget deficits. Remember, the dollar moves in a free market. The Fed can’t control it. But even if it could, the US wants a weaker dollar because it’s been helping the economy. Inflation isn’t going to help the dollar either and neither are the growing geopolitical pressures. Plus, foreign central banks have tons of dollars and recently, they’ve been reducing these holdings. The dollar is literally at the mercy of our foreign friends and depending on how they react to further weakness, the ingredients are in place for the dollar to snowball down. The fundamentals are very negative.
"On the technical front, the outlook isn’t good either. The dollar’s been in a bear market decline for over two years now. Despite this year’s rise, it’s remained below its moving average meaning the major trend is down and it’s headed lower. T he euro remains bullish. The Swiss franc and British pound are looking good too. European growth is perking and these three are our favorite currencies for the months ahead. The Japanese yen also looks good and it’s now a favorite as well. Its economy is strong and Japan’s trade surplus recently hit a record high. With the economy looking good, the Japanese have cut back on currency intervention, which had pushed the yen down, but this is still a risk that could result in more volatility in the yen compared to the other currencies. Keep the Franklin Templeton Hard Currency (ICPHX) and the Prudent Global Income (PSAFX ) funds.
"A renewed rise has finally begun in gold and silver. After hitting bottom in May, they took time to back and fill as they formed an intermediate base . The fall over the past few months took its toll on investors, and it surprised and confused many. Newly found gold lovers bailed out while some hard-core investors are sitting with losses. While we could see a consolidation phase over the summer months, we don’t see a change in the bull market. In the past, major advances in gold have always followed an ongoing surge in the money supply. Consider that all the gold in the world is worth about $1.4 trillion, which is equivalent to the money currently being created in the US in just one year. It’s crazy and so out of whack it’s mind boggling. This alone is now fueling inflation and once it becomes more obvious, gold will be well on its way, as it’s always been the ultimate inflation hedge.
"Silver’s run up from last November to April caused a major trend change and silver is now stronger than gold. Silver demand continues to grow, especially out of China and the world consumes more silver than it produces. This has been the case for many years but as each day passes we have less above ground silver. Silver is now starting a renewed rise. It’s solid above $5.58, it would look very good above $6.30 and once it closes above its April high at $8.20, it’ll look great. Gold is firm above $390 and it could rise to possibly $430. We continue to recommend buying and keeping a 50% position in gold, silver, palladium and the following shares: Agnico Eagle (AEM NYSE), and Glamis Gold (GLG NYSE) continue to be the strongest and are best for buying new positions. Also looking good are: Placer Dome (PDG NYSE), El Dorado (EGO ASE) and Silver Standard (SSRI NASDAQ).
"The one commodity that best represents the world situation is oil. The high oil price reflects the tension in the world because as long as we fight a war on terrorism, worries of a disruption in supply will prevail and keep upward pressure on oil prices. We also have a world with a tremendous appetite for oil. Add China’s needs, which is the second biggest importer of oil after the US, and the demand side makes for a lop sided situation. Technically, oil has room to rise further. The major trend is up above $32.80. Plus, the leading indicator is again on the rise, signaling oil is likely headed higher. Energy stocks like Devon Energy (DVN ASE), New Field (NFX NYSE) and Western Gas (WGR NYSE) have been rising. They are due for a breather, and when that happens we would consider them to be good long term buys."
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