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COMMODITY FUTURES FORECAST
Prepared by Philip Gotthelf
Have We Survived October?
(October 30, 2014) As the month draws to a close, equity investors are breathing a sigh of relief that the “correction”: did not materialize into something uglier. As I mentioned, these market events are usually spawned by nothing and dissolve into nothing. In the case of the Great Depression, the lack of monetary flexibility has been blamed for the progressive deflation following the stock market crash and subsequent run on banks. In 2008, rapid asset devaluation combined with leverage to produce a liquidity crisis that many believe still lingers. This month’s correction was attributed to a general malaise over global events that include the Ukraine, downed or lost airliners, the Israeli/Hamas conflict, rise of ISIS, and introduction of Ebola. To be sure, nothing has substantially changed from the dramatic drop to the impressive recovery. If anything, news has been more negative than positive as the markets roared back.
Earnings for Samsung, Apple, and a host of other “name brands” have been disappointing. Banks continue to be fined and shareholder profits continue to be usurped by the government. Auto sales have been brisk, but GM is plagued by recalls as are other auto manufacturers. The drop in oil represents a boom for consumers and the transportation sector, but threatens the energy sector expansion. Most notably, the FED has finally amassed the courage to curb its monetary expansion. The reason for their confidence is improved employment. Yet, the actual employment statistics are far from impressive. Moreover, the big shock to small and medium businesses will come post election when the Affordable Healthcare Act becomes unaffordable.
More than 70% of small to medium size businesses are going to have to realign their healthcare offerings. The sticker shock that has been felt by individual policy holders is about to broaden as employers are forced to accept fines, limit hours, or change benefit contribution parameters. There is no way around the implementation… even if Republicans take control of the Senate.
Various political scientists are claiming that post midterm elections is historically bullish. I believe the coincidence is just that… an uncorrelated coincidence. When taken in context, a mid-term can go either way. Assuming Republican confidence is justified and they do win, any attempt to dramatically alter the status quo would be ill-advised. Voters do not hold Republicans in the highest esteem and the real coup remains the presidency in 2016. The market understands this and is reacting accordingly. Unfortunately, Republicans may not understand this and could easily undo the current confidence level.
The Wall Street Journal front page lead article discusses the debate over the effectiveness of quantitative easing and the FED bond-buying spree. In absolute terms, there is no discernable impact upon either employment of economic growth. The good news is that the program did not contribute to the inflation reflected in the Consumer Price Index (CPI). Of course, the CPI is a self-serving conjuration of government hacks.
As I pointed out in last weeks REPORT, raw commodity prices have surged during the alleged period of low inflation. We are looking at gasoline prices just below $3.00/gal of regular and thinking it is cheap. In 2005 it was over $1.65 and we were crying it was too expensive. I am relieved that the price of energy is down and that equities recovered from the October “dip.” I am not convinced that November will be smoother sailing to the year-end.
The Real Story
There is plenty of analysis out there from highly credentialed individuals covering the FED. What is missing from their analysis is the fact that the FED is not a transparent entity. In fact, former Chairman Alan Greenspan confessed that he purposefully made up obtuse phrases just to see how the experts interpreted his gibberish for the newspapers the next day. This was his form of amusement. Indeed, it worked. Reams of analysis was paid for and produced by “experts” who gave explanations for incomprehensible Greenspan expressions.
Look at the actual cash flow associated with the FED if you want to know the real story. Effectively, the FED has transferred trillions of new dollars from the cosmos to banks through Treasury debt purchases. This money is not cash. Rather, it represents book entries. The money is supposed to be used to stimulate the economy. The reality is that book entries are used to keep the banking system liquid. Banks are not lending to the middle tier. Consequently, the economy has not grown as a result of the bond-buying program.
Both the hiring cycle and inflation cycle are easily linked to the natural progression of time. In the case of grains, farmers planted more and Mother Nature yielded more. The same holds true for other agricultural commodities with the exception of fruits and vegetables grown in drought-ridden California. In the case of base metals, Chile, Peru, and other copper producers expanded production based upon ever higher prices and the global expansion. Now, China and Europe are slowing down while the Middle East is in chaos and African expansion is threatened by the Ebola plague. Higher capacity with stalled demand equals lower prices.
The labor market is accommodative because the largest generation in history, a/k/a/ Millennials, have hit the workforce while displaced workers have dropped out of the statistics. Unions have been weakened by the economy and a shift in labor incentives. Thus, wages have not moved in keeping with real inflation. The lack of any wage progression is another reason the economy has failed to grow in keeping with the enormous money printing project engineered by the FED and Treasury. Workers aren’t earning enough to spend the economy back to health. Millennials are living at home because they cannot afford rent, transportation, and food. The post-26 members of the new generation are being hit with a new reality… they are being forced to subsidize Baby Boomers and the welfare state under Obama Care.
Structurally, the economy is worse off than it was in 1934. The only frightening parallel is the political instability evident between Russia and Western Europe and the Middle East war on the West. It took World War II to bring the world out of recession. Hopefully, it will not take World War III to solve or intensify our current economic woes.
Gold And Silver Breach Support
Gold’s amazing resilience finally yielded to technical and fundamental pressure, taking silver along for the ride.
The two-day slide that drove October gold below $1,225 support points to a test of the October low below $1,185. Referencing the December ’13 low, we will have a triple bottom around the $1,185 level. The critical question is whether gold can bust below $1,000. If this happens, the degradation of our Dollar will have been suspended… for now.
Pressure is coming from gold ETF liquidations in favor of traditional equity purchases. Confidence is high that the stock market is back on track while the lack of inflation has become a disincentive for gold investing. A close examination of physical purchases reveals that supplies released from ETFs are quickly absorbed. Bullion demand from non-ETF sources is steady and sovereign accumulations are on the rise. The U.S. Treasury is using some of the newly printed money to buy gold. When you measure the purchases against sales of U.S. gold coins, there is an accumulating surplus. Perhaps this is the gold that will be returned to Germany.
Russia is buying, India is buying, and China is buying. There is no lack of interest in gold. What we see is a two-tier accumulation/distribution process where the ETFs accumulate as prices rise and distribute as prices decline. Sovereigns buy as ETFs distribute. The same process is taking place in silver. The difference is that silver remains a more widely consumed industrial metal.
There is a generational issue for gold and silver stemming from absence during formative years among Generation-X and Millennials. Even Boomers skirted gold and silver that were demonetized in the 1950s and severed when President Nixon closed the Gold Window. Gold was a speculative vehicle from the year it was reintroduced in 1975 through 1985, but was abandoned from 1985 up until the recent financial crisis. To be fair, there have been numerous commercials for gold and silver, but the fundamental awareness of gold and silver is diluted by two generations. Even my father who was born in 1908 only briefly encountered gold coinage…up until he was 25 years old. Gold was confiscated 81 years ago. This means that the entire generation of gold carrying Americans exceed 80 and those who actually knew gold coins are well over 90.
This may seem like an insignificant point until you consider the impact gold no longer has as a true form of currency. Instead, we are conjuring up fictitious alternatives like Bitcoin because that’s what current generations know. We live in an age of card swipes and cyber-cash. Tangible representations like gold and silver are in the history books. Even government leaders and central bank heads lack personal familiarity with gold and silver. The more significant cultural ties to gold lie with China, India, and Muslim nations.
Even with the generational distance from gold and silver, there is still enough understanding of physical symbolism to suggest that the United States could bypass Congressional approval of a debt ceiling increase by minting trillion dollar platinum coins. Why platinum? Why not print a few trillion dollar bills or mold some trillion dollar plastic Treasury debit cards? The use of platinum ties in with the concept of a tangible precious metal as symbolic backing.
Although gold and silver are now under technical influences, I believe any major slide will be contained by fundamental support. There is not enough free gold supply to bring the price below $1,000 and there are too many uncertainties that could drive the price appreciably higher. Silver follows gold, but can experience more relative weakness because it is not a pure monetary play. At some point, silver simply becomes a very inexpensive currency insurance policy.
In case we don’t remember, Republicans thought they had the Presidential election in the bag after the first Obama/Romney debate. Even after improved Obama performances in the second and third debates, Republicans felt confident presidential missteps had sufficiently eroded the Obama mystic to give Romney the edge. But, as Election Day approached, Obama support surged in the critical swing states. Are Republicans overly confident again?
Senate elections are about local politics. If incumbent Democrats are viewed as the lesser of two evils, Republicans may lose the battle to voter turnout. If there is no turnover in the Senate, expectations will be completely reversed. We do not know if markets are encouraged by the prospect of Republican victory or not, but we will know within a week. If Mitch McConnell is unseated as was Eric Cantor in the primaries, it will prove voter dissatisfaction with the lack of a Republican platform.
This brings up the point, “What does a Republican win mean?” Talk of repealing Obama Care and removing Harry Reid’s impediment to new legislation does not represent an action plan for the American people. Even FOX News expresses concern about the fragmented Republican message and the need for a cohesive platform. This has the potential to backfire on financial markets. So the bear market may have skirted October simply to wait for November.
October 30, 2014
Commodity Futures Forecast
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