What Debt Crisis?


— While the lull in the gold bull market continues (and the equity bear lures just about everyone into his cave for the next mauling) consider this little factoid. We came across it last night while reading the latest issue of Diggers and Drillers, by Dr Alex Cowie.

— The Doc makes the case for gold to hit US$2,000 by Christmas – and it sounds compelling.

‘The total value of every single listed gold stock worldwide is less than the value of a single oil company – Exxon Mobil, a company with a market cap of $350 billion dollars. That’s nothing!

‘Ever wonder why the mainstream sees the gold sector as “fringe”?

‘It’s because IT IS fringe!

‘And because of this, it will just take a small change in attitude from a few big fund managers for gold stocks to start performing aggressively. If one big name breaks rank and makes a small reallocation of funds in this direction, the others will follow. Gold stocks will be off and away. The value proposition is impossible to argue with and it just keeps getting better.’

— But no one cares about gold at the moment. It’s a bubble, right? And the bubble burst last month. Besides, stocks are moving and its time to jump on board.

— We reckon that’s the consensus view at the moment, anyway. And the market’s Pavlovian response to extended liquidity from the European Central Bank and another £75 billion in money printing from the Bank of England, both announced overnight, is certainly giving credence to this view.

— The market is conditioned to respond to ‘injections of liquidity’ or additional ‘quantitative easing’. But since the credit crisis, the boost from these measures is increasingly short-lived. That’s because insolvency issues are mistaken for a lack of liquidity.

— These central bank announcements generally hit the market when sentiment is at a low point. The effect is purely to boost sentiment. This can lead to a 10 per cent rally in a blink of an eye. Within weeks, ‘sentiment indicators’ turn around and the consensus view turns bullish again.

— And why? Because of a change in price. In a normal world, price is a reliable signal to base financial decisions on. In a world of unsound money, price signals are increasingly misleading.

— Printing money doesn’t create wealth. It just spreads a country’s existing wealth over an increasing base of ‘money’, which is just a representation of wealth. It’s like a company addicted to issuing shares. All it does is dilute shareholder wealth while giving management more time to pull a rabbit out of a hat.

— Providing endless amounts of liquidity is a stop-gap measure too. It props up the weak and insolvent and distorts the risk/reward structure that capitalism thrives on.

— Citizens in the US have had a gutful of the destructive policies of their central bank. For the past week or so, a protest movement called ‘Occupy Wall Street’ has been, err, occupying Wall Street.

— Most of the protesters look like your standard socialist idiots who think Wall Street represents the bastion of capitalism and needs to be brought down. Right idea, wrong reason. This young bloke appears to have been home schooled, as he nails some of the reasons for the US’s economic plight.

— What about our own central bank, the Reserve Bank of Australia (RBA)? ‘Some people say’ it’s one of the best central banks in the world. We’d say its performance is Steven Bradbury like…with apologies to Steven Bradbury.

— Like all central banks, the RBA is trying the steer the economy by looking in the rear-view mirror. Earlier this week the board elected to keep rates on hold but indicated there might be room for future easing.

— This is an about face from earlier statements. For most of the year, the RBA’s mantra was interest rates would probably rise again. It cited strong global growth, wage and inflationary pressures and a strong terms of trade.

— But when you’re looking over your shoulder you don’t see what’s in front of you. The RBA made the same mistake in 2008 when it was raising rates in the face of an oncoming credit crunch.

— This raises a few important points. Obviously, setting the price of money or credit is an impossible task for a small group of people. But that’s the system we have and we’ll have to deal with all the problems that throws up.

— More importantly, though, it just goes to show you shouldn’t take any notice of what the RBA says. While the bank was talking tough on interest rates earlier this year, market interest rates were falling. The RBA is only now coming around to the market’s view.

— Most of the economists who regurgitate the RBA’s view for a living were caught out too. The one exception was Bill Evans of Westpac, who employed independent thinking to predict a rate cut well before the mainstream. Perhaps he reads the Daily Reckoning?

— So is the RBA’s belated recognition of a weak Aussie economy a contrarian indicator? After all, the market began rallying the day after its announcement and hasn’t looked back.

— It might seem that way, but we think the RBA still has some catching up to do. Despite this week’s bounce, commodity prices are still in a noticeable downtrend (see chart below). This is a reflection of a slowing global economy, in particular China. The October lows may prove to be the bottom, but we’d be surprised to see global growth escalate rapidly in the face of a sovereign debt crisis and no coordinated stimulus as we saw in 2009.

Commodity prices still in downtrend

Commodity prices still in downtrend
Click here to enlarge

Source: Stockcharts

— These weaker commodity prices will eventually feed through to the bulk commodities, impacting the terms of trade and national income. When that happens, the RBA will lower official rates. It might not happen next month, but by December things will probably look much different.

— Not that you would think so by looking at the market now. It simply seems to be saying, ‘What debt crisis?’

Greg Canavan
for The Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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5 years 16 days ago

CRB looks good for a bounce there after capitulation on to strong support and broadening of downward channel. AUD/USD has visited strong support zone too.

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