How to resolve this crisis in macro-economics? The field must be revamped fundamentally. Some of its shortcomings are obvious. Before the financial crisis, most macroeconomists were blinded by the idea that efficient markets would take care of themselves. They did not bother to put financial markets and the banking sector into their models. This is a major flaw.
There is a deeper problem, though, that will be more difficult to resolve. This is the underlying paradigm of macroeconomic models. Mainstream models take the view that economic agents are superbly informed and understand the deep complexities of the world. In the jargon, they have “rational expectations”. Not only that. Since they all understand the same “truth”, they all act in the same way. Thus modelling the behaviour of just one agent (the “representative” consumer and the “representative” producer) is all one has to do to fully describe the intricacies of the world. Rarely has such a ludicrous idea been taken so seriously by so many academics…
The basic error of modern macro-economics is the belief that the economy is simply the sum of microeconomic decisions of rational agents. But the economy is more than that. The interactions of these decisions create collective movements that are not visible at the micro level.
These stories are anecdotal and suggest that China understands that she is commodity short and is trying to gain long-term control of supply. But stories don’t tell the whole picture. Analysis from the Center for Geoeconomic Studies gives us a better picture of China’s external investment weights:
This chart, along with their announced direct investments, seems a lot like the effects of a long-term investment policy that doesn’t change easily. Many of the announced investments are of the FDI (foreign direct investment) variety, which cannot be sold easily like a stock holding.
While there are some indications that China may be pulling back on their commodity demand in the short-term, don’t mistake tactical decisions with the long-term strategic picture.
As long as China is growing, it will mean a secular friendly environment for commodity bulls.
We may have seen a rare "double non-confirmation." On August 27 the Dow closed at 9580.63, a new Dow high for the rally. On the same day the Transports closed at 3714.63, which was not a new high -- in so doing, the Transports failed to confirm the Dow. Today the Transports closed at 3806.75, a new high for the ]Transports. But today the Dow closed at 9547.22, below their August 27 close -- in doing so, the Industrials failed to confirm the Transports. This is what I call a rare "double non-confirmation". First, the Transports were weak in that they could not confirm the Industrials. Today the Industrials were weak in that they could not confirm the Transports. These rare "double non-confirmations," in the past, have tended to signal the top.
There’s just some eerie things about this—it’s reminiscent of spring and summer of ‘87 when nobody believed the rally and it kept going up despite skepticism, people shorting into it. It ate them alive until it suddenly turned.
Now imagine what might happen if the world’s reserve currency became its most shorted. Carry trades are, after all, bets that the funding currency will weaken further or stay down for an extended period of time. It’s also a wager that a central bank is trapped into keeping borrowing costs low indefinitely…
Three-month London interbank offered rates, or Libor, for dollar loans are at a record low and fell below those for the yen on Aug. 24 for the first time in 16 years.
Think about the turbulence that would be unleashed by the dollar suddenly shooting 5 percent or 10 percent higher with untold numbers of traders around the globe on the losing side of that trade. It could make the “Lehman shock” look manageable.
Euro/Japanese Yen
If the USD is now the preferred currency of choice for the carry trade, then let’s look at some emerging market currencies against the greenback. The chart below of the Hungarian Forint against the Dollar remains in a healthy uptrend.
Hungarian Forint/U.S. Dollar
The Turkish Lira is also in an uptrend against the Dollar.
Turkish Lira/U.S. Dollar
Commodity prices, which is an indication of the progress of the reflation trade and risk trade, are also in an uptrend.
Until these bearish tripwires are crossed, the path of least resistance for equities is still up. My inner trader tells me it’s too early to get outright bearish. The 50% Fibonacci retracement level for the S&P 500 is roughly 1120 - and under the circumstances that may be a realistic short-term target.
On the other hand, the trigger for the 1987 decline was the Fed's August decision to raise interest rates. While I have expressed my doubts about the willingness or the ability of the Federal Reserve to effectively implement its exit stratgies, the FOMC statement on Wednesday bears watching.
They both died June 25th, 2009. One has been covered 24/7 by the media the other has been forgotten.
Travel back with me 44 years.....
You're a 19-year-old kid. You're critically wounded and dying in the jungle in the Ia Drang Valley , 11-14-1965, LZ X-ray, Vietnam . Your infantry unit is outnumbered 8-1 and the enemy fire is so intense, from 100 or 200 yards away, that your own Infantry Commander has ordered the MediVac helicopters to stop coming in.
You're lying there, listening to the enemy machine guns, and you know you're not getting out. Your family is half way around the world, 12,000 miles away and you'll never see them again. As the world starts to fade in and out, you know this is the day.
Then, over the machine gun noise, you faintly hear that sound of a helicopter and you look up to see an unarmed Huey, but it doesn't seem real because no Medi-Vac markings are on it.
Ed Freeman is coming for you. He's not Medi-Vac, so it's not his job, but he's flying his Huey down into the machine gun fire, after the Medi-Vacs were ordered not to come.
He's coming anyway.
And he drops it in and sits there in the machine gun fire as they load 2 or 3 of you on board.
Then he flies you up and out, through the gunfire to the doctors and nurses.
And he kept coming back, 13 more times, and took about 30 of you and your buddies out, who would never have gotten out.
Medal of Honor Recipient Ed Freeman died on Wednesday, June 25th, 2009, at the age of 80, in Boise , ID.
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There is real value in neglected stocks and people, regardless of anyone's opinion of the Vietnam war.
Gold and silver are behaving well but they too, are overdone. You don't have to be 100% invested all of the time. If you have some profits, take some money off the table. If you don't have profits, you haven't been reading me for the last nine months.
We probably are not at exactly a trading top but we are pretty close. Better to sell a day early than a day late.
Financial markets have not fully understood that the U.S. Federal Reserve's pledge to keep interest rates exceptionally low for an extended period means they will stay low beyond when officials normally would raise them, a top Fed official said on Friday.
"I don't think markets have really digested what that means," St Louis Fed President James Bullard said in an interview.
The Fed's strategy is aimed at promoting a future rise in inflation, which should provide an immediate boost in activity in anticipation of a future boom, but that hasn't happened, Bullard said.
If a strong recovery somehow takes hold, then rising inflation expectations should help the metals and be an even bigger tonic for mining shares. If the economy slips back into a funk, then a new round of policy responses (that we cannot afford) will gush forth, harming the dollar and thus helping the metals. The only way precious metals could really get hurt is for Bernanke and his central banking colleagues around the world to guide the global economy to a perfect, soft, noninflationary landing. If you think Bernanke and his buddies can usher in a painless return to the Goldilocks era, then avoid precious metals. Stocks, bonds, commodities, and the precious metals can all – in the short run – benefit from the liquidity provided by overly easy monetary policies. The recent positive correlations among these asset classes may be sending just such a message. Eventually, however, the asset classes will have to part ways. I think the central bankers will find a way to overstay their welcome, leaving the only monetary asset they can’t print as the asset of choice.
Think about it: you as the insurance company did your best job to estimate the risk involved. You did it assuming that policies could not be sold, whether really or synthetically. You already knew that those who were healthy in the future would surrender and seek another carrier, but thought the those who were less healthy would persist to some degree. Well, with life settlements, the unhealthy persist at a much higher level, which bites into profits.
This is the box that life insurers are in. They can’t lock in policyholders, but policyholders can hang on, refinance (so to speak), or sell off their obligations. That is a tough equation for life insurers to work through, and to the degree that life settlements are allowed, premiums will have to rise to compensate for the loss of profitability.
Others, including John L. Thornton, a member of the executive committee, spoke with equal determination against any public sale of shares, people there said. The prime fear was that a public company could never replicate the close-knit culture of a partnership, where financial rewards are measured in lifetimes instead of months…
Every company talks of teamwork, but Goldman elevated it to a commandment, bankers there say. Because partners' own money is at stake in every deal, the firm operates by consensus, with top executives often able to trust other partners implicitly. Scores of Goldman people participate in decisions that one or two bosses might make in other firms.
India's gold market, which is one of the largest sources of physical gold demand, is showing signs of lukewarm demand. What's more, I posted a few days ago that the US bond market could be poised for a rally. Could this rally in gold be the final capitulation of the bond bears (and conversely the gold bulls)?Dehedging by the world's largest gold producer, Barrick Gold Corp. (ABX), has been the driving force behind gold's move above $1,000 a troy ounce this week, a price level analysts say is unsustainable.
Barrick said late Tuesday that it will close its gold hedges at a total cost of $1.9 billion over the next 12-months...
"We have more buying to do," the Barrick spokesman said.
I recently became a member of the Board of Advisors to Qwest Investment Management, an investment management firm which specializes in identifying, structuring and managing investment products. The firm is currently focused on investments in the natural resource sector. One of my tasks is to write a monthly newsletter, known as Qwest for Returns. the first edition asks whether the US is becoming Argentina. Here is the synopsis:
In this issue we explore if the U.S. is making the same mistakes as Argentina did a century ago. Will the U.S. see its competitiveness erode, its economy weaken further and the U.S. Dollar continue its decline? A weakening of the U.S. Dollar could be bullish for commodities.
You can see the newsletter here.
Here is the Turkish Lira/Japanese Yen cross. Same story – as NZDJPY, the uptrend is intact, but barely.
Turkish Lira/Japanese Yen
What about Eastern Europe? Remember how Eastern Europeans had mortgaged their property purchase in a low yielding currency like the Swiss Franc? Here is the Hungarian Forint/Swiss Franc exchange rate. Interestingly, FX traders had been in that trade since early March. It breached its uptrend line mid-August and it appears to be in the process of rolling over.
Hungarian Forint/Swiss Franc
Finally, we visit the Mexican Peso. Mexico was the subject of an S&P warning about its debt, but that weakness appears to have been widely telegraphed in the FX market.
Mexican Peso/Japanese Yen
Are the bulls or bears in control?
I have warned about the risks of this equity rally (see examples here, here and here). Instead of trying to call the turn in the market, some of these aforementioned indicators are a clue of whether the bulls or bears are in control of this market.
Right now, it appears that they are in a tug of war. Many of the indicators are now testing their uptrend lines. If they get breached, then it is a clear sign that the bears have won the upper hand.
