A Few Guesses…

 

Below we list a few of our views regarding what is likely to transpire in the course of 2012. These are based on the information currently available and of course amount to little more than educated guesses at this point. If new information emerges, they may need to be adapted accordingly, so take them with a grain of salt.


1.    Euro Area

Bond Markets:

The first half of the year will be a difficult time, as the front-loaded debt rollovers of Italy and Spain will continue to weigh on the euro area's government bond markets. To some extent this may be relieved by the ECB's LTRO's and other liquidity measures, but a great degree of upheaval and volatility seems nonetheless likely.

Greece will probably once again become a focus, as the government continues to fail to meet its fiscal targets. A hard default of Greece remains a high probability, even if the debt exchange talks get anywhere (so far they haven't). At some point either the IMF or the EU or both will refuse to continue to hand over bailout funds. 

Moreover, we expect Portugal to become another flashpoint. Its situation has many things in common with Greece's, most importantly the fact that the debt load it needs to service is simply too great, while recessionary conditions make  it extremely difficult to meet the fiscal targets set by the bailout conditions.

Political complications could ensue following the presidential elections in France. At the moment Francois Hollande, the socialist challenger of Mr. Sarkozy, leads in the polls. Typically secular downturns and the associated deterioration in the social mood are bad for political incumbents – even successful ones. Whether Sarkozy is seen as 'successful' in France is debatable, to put it mildly. In the course of the euro area crisis he was unable to push through any of his demands against the opposition of Mrs. Merkel –  in the few compromises he was able to get her to agree to he had to give quite a bit of ground (for instance regarding ECB involvement in the bailout and private sector haircuts for Greek debt).

On the other hand, one must not overestimate the likely changes should Mr. Hollande win. Yes, his electoral platform includes a promise to substantially renegotiate the euro area crisis response -  in essence he is saying he will try to get everything Sarkozy didn't get, but there are electoral promises and there is reality. The reality is that nothing goes in euro-land without Germany's say-so. It's as simple as that.

Mr. Hollande's biggest worry at the moment should probably be that Sarkozy could pull a Strauss-Kahn on him. The former IMF chief's exoneration and the details that have emerged in the course of the investigation strongly suggest that he was set up, and the 'cui bono' question points squarely at his political rival, who would have almost certainly lost the election against Strauss-Kahn. Against Hollande, he at least stands a fighting chance.

 


 

Currently one of the most important bond yields in the world: Italy's 10 year yield. If it breaks significantly over its recent highs, the euro area crisis will enter a new and even more acute phase – click on chart for better resolution.

 


 

A big additional problem the euro area's governments will likely have to  face in the first half of the year will be a further slew of sovereign downgrades, most notable the likely downgrade of France. Should France be pushed from its 'AAA' pedestal by Standard & Poors, then the EFSF's credit rating is likely to come under scrutiny as well. Should the EFSF lose its AAA rating on account of the second biggest guarantor of the EFSF being downgraded, then it will turn into an even bigger lead balloon than it already is. The entire bailout policy such as it now stands could keel over if that happens.


Stock Markets:

Euro area stock markets are going to remain the slaves of the developments in the sovereign debt crisis and will have to discount what seems likely to become a severe economic downturn. In spite of the ECB's monetary pumping, banks are unlikely to expand credit to the private sector and the private sector's credit demand in turn is probably going to remain weak anyway.

This means that the liquidation of malinvested capital is going to continue – a positive development for the long term, but associated with recessionary conditions in the short to medium term.

Looking at the Euro-Stoxx 50 Index, it has built a triangle that normally would argue for a continuation of the downtrend that began in May.

To be sure, some stock markets in the euro area do look 'cheap' by traditional valuation measures such as the P/E ratio. Alas, it is in the nature of bear markets that 'cheapness' does not necessarily protect one against further losses.

 


 

The Euro-Stoxx 50 Index has built a symmetrical triangle in recent months – this formation has a high probability of being a continuation formation, i.e., the trend preceding the triangle formation is highly likely to be resumed – click on chart for better resolution.

 


 

The ECB:

We expect the ECB to come up with even more interventionist measures if the debt crisis fails to abate.

As the German IFO Institute's Hans-Werner Sinn points out in a paper (download requires subscription) on the euro system's 'TARGET-2' balances (TARGET stands for „Trans-European Automated Real-Time Gross Settlement Express Transfer“), the ECB is in fact financing the current account and trade deficits of the competitively challenged  'PIIGS' ever since private sector capital flows have dried up. The Bundesbank (and to a lesser extent the central bank of the Netherlands) has therefore entered into a giant vendor-financing scheme with the other euro system central banks. At the end of August the balances looked like this:

 


 

TARGET 2 balances in the euro system as at the end of August – click on chart for better resolution.

 


 

As of end November, the Bundesbank's claims on other euro-system central banks had risen by another € 100 billion:

 


 

The Buba's claims on other euro-system central banks (mainly the 'PIIGS') under the TARGET-2 settlement system as of end November 2011 – click on chart for better resolution.

 


 

In short, the TARGET-2 imbalance grows currently by about €100 billion every quarter. This is not a problem as long as the euro area remains intact – but it will become one if it breaks apart. Moreover, this type of vendor financing with the help of central banks leads to a widening gap in base money creation between the BuBa and the rest of the euro area as can be seen below:

 


 

Euro area-wide base money creation vastly exceeds German base money creation – click on chart for better resolution.

 


 

The possibility of growing discontent between the German members of the ECB's executive board and governing council and the rest of the ECB has not been completely allayed with the resignation of Jürgen Stark. His successor as ECB chief economist, Jörg Asmussen, is held to be more open-minded about money printing, but whether this is really the case remains to be seen. BuBa chief Jens Weidmann is definitely not a great friend of extraordinary monetary pumping policies and will continue to firmly insist that the SMP ('securities market program', the ECB's bond market intervention program) must remain fully sterilized and that no direct unsterilized government debt financing occurs. As a reminder, here is the ECB's governing structure:

 


 

The ECB's board structure. In the ECB's executive board, Lorenzo Bini-Smaghi (a noted 'dove') will be replaced by a French successor (probably a dove as well) and Jürgen Stark will be replaced by Jörg Asmussen (likely to be more pliable than Stark was) – click on image for better resolution.

 


 

The ECB has already gone quite far with its recently announced measures, specifically the 36 month LTRO's and the alteration of collateral eligibility rules.  As noted before, the full effects of these interventions will only become known once the new year dawns. Should the crisis intensify, we expect that even bigger monetary pumping measures will be implemented. After all, the ECB's own survival as an institution is now at stake – if the euro area breaks apart, there will no longer be an ECB.

 

2.    USA

Bond and Stock Markets

We have had a long-standing target for the yield on the 10 year treasury note: 1.5%, the all time low seen in 1942. When we first mentioned this target a few years ago, it seemed an outlandish proposition. The US treasury bond market was the market everybody loved to hate. Today this target is only a stone's throw away. Alas, people are no longer as bearish on bonds as they once were.

 


 

The 10 year note yield has approached our long-standing target this year:  the all-time low of 1.5% made in 1942 – click on chart for better resolution.

 


 

The decline in bearishness suggests that there is limited downside left in bond and note yields, even though a further flare-up in the euro area crisis would obviously be supportive of treasury debt – at least until the markets finally lose confidence in the debt of the 'money printers' as well.

 


 

The Rydex bond ratio, which measures the amount of funds employed in the treasury bull fund compared to those in the treasury bear fund has declined precipitously from a high at over 15 to the current level of 1.24. While this means bears still predominate, it shows that their conviction has faltered a lot. All in all, the Rydex treasury bear fund has lost about two thirds of its assets this year – click on chart for better resolution.

 


 

If the treasury bond market tops out, much will depend on why it does so. One possibility is a rise in inflation expectations, which would most likely go hand in hand with growing economic confidence. US economic data have consistently surprised to the upside over the past two months or so, but we are wary of these happy news – not least because the bond market refuses to believe it. 

There are however more reasons to be wary: firstly, capital spending has been 'pulled forward' by a depreciation allowance that runs out at the end of 2011. Therefore capital expenditures should slow down significantly in early 2012 (as they always do when such tricks are employed). Secondly, the US true money supply has kept growing by leaps and bounds (the annual rate of growth of money TMS-2 as at the end of November stood at 15.4%) even after the cessation of 'QE2' and a continued reluctance by commercial banks to extend inflationary credit.

The growth in the money supply has most likely been artificially kept high by money flowing back to the US from Europe as the euro-land crisis has intensified.

This does however not mean that the growth in the money supply has no economic effects – the source of its growth is irrelevant in this context. Should it decelerate in coming months, then one of the props underneath the recent strengthening in economic activity will disappear.

Thirdly, when looking at the ratio of the production of capital goods to the production of consumer goods, we can see that the US economy is just as imbalanced today as it was in the years 2000 and 2007. In all likelihood, a great deal of capital malinvestment has occurred due to the Fed's 'ZIRP' policy and massive government deficit spending.

 


 

The ratio of spending on capital goods production vs. consumer goods production has almost reached its 2007 high again. This indicates indirectly that the monetary pumping and artificial ultra-low interest rates imposed by the Fed have led to a lengthening of the production structure that is not supported by voluntary savings – click on chart for better resolution.

 


 

As the above chart shows, this imbalance in the economy's productive structure could conceivable become even more extended – but it is close to the point where previously sharp recessions have soon begun. What is different this time is that it was not a private sector credit expansion that has contributed to this distortion, but mainly public sector credit expansion. It remains to be seen whether that makes any difference – we think it may make a difference in terms of the shape of the bust, as there may be fewer private sector debtors going to the wall, but one must keep in mind that US corporations continue to carry a very large legacy debt load. In fact, their debt is still so large relative to their often touted big cash reserves, that they can hardly be deemed immune to a future credit crunch.

 

The US stock market has been one of the world's stock markets holding up best in 2011, in spite of large volatility. This is mainly due to the combination of loose monetary policy and the resultant excess liquidity and the slightly better economic performance that has been recorded over the past quarter. However, the market also reflects expectations about future earnings growth that appear unsustainable. As John Hussman has chronicled in great detail over the past year (see his weekly archives), current profit margins are among the highest ever recorded in history, and mean reversion is the inevitable fate of such extremes. As he for instance noted in mid December:


„Thomson Reuters reports that negative earnings pre-announcements are exceeding positive ones by the largest ratio since mid-2001. Investors have eagerly accepted forward operating earnings as a basis for valuation assessments, without accounting for the fact that those earnings expectations assume profit margins about 50% above their historical norms. Unfortunately, profit margins are highly vulnerable to economic weakness, and we are beginning to observe that regularity here.“

 

A sizable reassessment of earnings expectations is probably the greatest danger to current US stock market valuations in 2012.

As to the technical position of the SPX at the end of the year, it certainly looks better than that of the European stock markets, but the index is bumping against resistance from its 200-day moving average that may prove very difficult to overcome:

 


 

The S&P 500 index is struggling with resistance from its declining 200-day moving average – click on chart for better resolution.

 


 

As our readers may recall, we believe that the rebound from the October low is  wave 2 – a corrective wave – of an ongoing primary decline. The reason for believing so is that wave 1 of the decline from the May high clearly unfolded in five waves – an impulse wave, which indicates that the direction of the primary trend is now down. By contrast, the action since the low was put in has been a jumble of overlapping waves that are clearly corrective in character.

We have refrained from producing our own e-wave count chart this time, as we have found a wave count on the web that largely agrees with our view. It can be found here, at 'Daneric's Elliott Waves' (note though that it appears that most e-wave practitioners agree with this wave count or a variation thereof, which is a bit of a 'consensus' heads-up).

One major reason to concur with this bearish wave count is the fact that very few Wall Street strategists foresee a stock market decline for 2012. In fact, going over various '2012 surprises' forecasts posted on the web in recent days, we have noticed a scary proliferation of 'new high' targets for the SPX. In the meantime however the sentiment picture for the stock market has deteriorated to the point where an imminent decline seems rather likely.

 

The Fed

As mentioned previously, in 2012 the roster of regional presidents getting a vote at the FOMC will be altered from 'three hawks and one dove' to 'one hawk (Jeffrey Lacker) and three doves'. With the governing board anyway consistently voting with Bernanke, we will likely have only one hawkish dissenter next year should more monetary pumping measures be decided upon,  instead of the three dissenters we have occasionally seen popping up in 2011.

Funny enough,  the last two FOMC decisions have only seen a noted 'dove' dissenting, namely Chicago Fed president Charles Evans. Evans evidently believes in the long discredited Phillips Curve, which holds that there is a 'trade-off between unemployment and inflation'. We will discuss and critique this concept in more detail in a future post, but for now we would merely note that like all 'economic laws' allegedly derived from empirical observations, this one certainly doesn't hold up to scrutiny.

The Fed will probably refrain from implementing 'QE3' (in the form of purchases of MBS) until a considerable amount of pain and damage has been meted out by the stock market – something that seems to us is likely to occur in the first half of the year.

The chances that 'QE3' will eventually be announced are to our mind quite high. Subsequent to such an announcement we would expect another ephemeral rally in 'risk assets' to occur, but the effect will likely be more muted than during the first two iterations of 'QE'. After all, one can't fool all the people all the time.


3.    Commodities and Currencies

There is little reason to believe that the well-worn inter-market correlations observed in recent years will suddenly change, but some of them may nonetheless be subject to a subtle alteration. In the event of a decline in economic confidence and a sell-off in stocks, commodity prices are likely set to weaken further, while the dollar is likely to rally to the upper end of its three year trading range.

However, at the moment there seems to be too big a bullish consensus on the dollar (and conversely, too big a bearish consensus on the euro), so that some sort of set-back to the dollar rally is likely in the near term. This would also jibe with the fact that sentiment in precious metals has deteriorated so much that it is now close to the extremes seen at the 2008 lows.

 


 

Commitments of traders in the euro: the net speculative short position has never been higher (via sentimentrader.com) – click on chart for better resolution.

 


 

Public opinion on silver: this indicator (an amalgamation of sentiment surveys) now sits below the lows seen at the nadir of the 2008 crisis, when silver had fallen to below $9/oz – click on chart for better resolution.

 


 

Commodities indexes are in a well-defined downtrend, but the above shown sentiment extreme in silver argues for some sort of rebound to commence soon.

 


 

The continuous commodity index CCI (the 'old CRB', an unweighted average of the major commodity groups)  is in a well-defined downtrend. A short term rebound may occur soon to relieve oversold conditions and currently overly bearish sentiment – click on chart for better resolution.

 


 

By contrast, the chart of the US dollar index looks quite constructive at the moment, but bullish sentiment on the dollar is out of proportion with the move that has been seen so far:

 


 

The dollar index, weekly. This chart suggests that there is more upside potential – eventually, DXY should retest its high of 2010. However, in the near term the bullish consensus has become too pronounced (as evidenced by speculative positioning in the futures markets) – click on chart for better resolution.

 


 

Given that both the price performance and the sentiment picture in stocks, commodities and currencies currently contradict each other -  at least in terms of the inter-market correlations that have become widely expected and accepted -  one must of course consider whether a more profound change in these correlations is now underway. It is too early to tell, but given the current situation it can not be ruled out that we will e.g. see a brief phase next year during which stocks and the dollar decline concurrently, while commodities and the euro recover somewhat.

Medium to longer term, we believe the 'dollar up, everything else down' correlation is likely to remain in place. After a short term shake-out we think the dollar will probably resume its medium term uptrend, which is likely to last at least until the Fed announces 'QE3' or is expected to do so. 

 

One reason why the recent 'decoupling'  between stocks and commodities has become noticeable is the downtrend in China's stock market and the growing fear that China is due for a 'hard landing'. Commodity traders should probably keep a close eye on the Shanghai market and the PBoC's upcoming policy decisions. A further reduction in bank reserve requirements could lead to a temporary rebound in the Shanghai stock market, which would likely be accompanied by strengthening of industrial commodity prices.

 


 

The Shanghai Composite: commodity prices are likely tied to some extent to the performance of this index, as China is the world's largest importer and consumer of raw materials – click on chart for better resolution.

 


 

US Elections

A brief comment on the upcoming US elections: unless Ron Paul actually wins the Republican nomination, there seems to be no serious contender who can hope to successfully challenge president Obama. The only trump card the Republican hopefuls possess is that they 'are not Obama'.

The only Republican in the current roster of candidates who can boast of a political program that can truly be differentiated from the centrist and statist welfare/warfare views espoused by the rest of the roster as well as  Obama himself is clearly Ron Paul.

It is precisely because no Republican except Paul is much different from Obama that it will be extremely difficult to unseat him. We would note here that in terms of 'anti terrorism' polices and the associated undermining of civil liberties, Obama is clearly out-Bushing G.W. Bush, with nary a peep from his political base. The same base that was previously outraged at such legislative and executive excesses when they were perpetrated by Obama's predecessor. It is completely vain to hope for 'change' from any candidates of the two major parties that pass the establishment scrutiny test.

Meanwhile, in all likelihood the cohabitation between the Democratic president and a Republican Congress is set to continue. This in turn won't keep deficit spending from continuing at the accelerated pace we have become accustomed to over the past few years, especially if the economy weakens in 2012.

As a reminder, the ECRI Institute too continues to hold that a recession in 2012 is almost a done deal, in spite of the recent slew of more hopeful data.


Conclusion:

2012 is likely to resemble 2011 in terms of market volatility and the difficulty to latch on to well-defined trends. The probability that volatility will increase even more relative to what has been seen in 2011 is actually quite high given the continued uncertainties. Our guess is at present that the first half of the year will see further stock market weakness, at least until the pace of monetary pumping by the major central banks, especially the Fed and the PBoC picks up.

Lastly, it is always possible that the JGB market and the US treasury bond market come under scrutiny in a similar manner to that seen in the euro area sovereign bond markets. The only thing that differentiates them is the perceived access to the central bank's printing press – a flimsy reed indeed.

 

A Happy New Year

We wish all our readers a Happy and Prosperous New Year.

We hope you have enjoyed reading our missives in 2011 and will continue to regularly visit these pages in the coming year. Interesting times no doubt await.

 


 

An 'Alex' cartoon by Peattie and Taylor – the crisis has engulfed even Santa. Oh, and forget about China bailing anyone out.

 


 

 

 

Charts by: StockCharts.com, Decisionpoint.com, BigCharts.com, Sentimentrader.com, Der Spiegel, Federal Reserve of Saint Louis Research


 

 

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18 Responses to “What To Expect In 2012”

  • worldend666:

    Hi Rodney

    Excuse me but you are talking utter bollocks. There was a hyperinflation in Poland in the early 90s, one in Bulgaria in 1997, one in Argentina in the 80s one in Zimbabwe recently.

    I don’t recall hearing about any wars.

    In my view hyperinflation is at much les risk of causing a war than a default.

    • rodney:

      Hi worldend,

      What I meant is dictatorship and/or war, not necessarily both. It is normal to see some kind of dictatorial police state to control the resulting chaos. In some cases the country was already in a dictatorship or a nominal democracy which was anything but.

      • worldend666:

        Hi again

        I think Poland and Bulgaria are proof enough that a democracy can follow a hyperinflation.

        Russia also had an 80% devaluation in the ruble in the 90s without civil strife.

        Hyperinflation allows politicians to blame externalities for their woes and at least the majority of the public are too lazy to call them to account. This is why I believe there is no viable alternative.

  • rodney:

    Pater,

    Greece had no trouble while they enjoyed low interest rates. The crisis came soon after their interest rates rose considerably. The US is now relying on low interest rates to keep spending like there is no tomorrow. It appears that 4% on 10-year yields could be the point where the authorities get nervous. Somehow miraculously, anytime we get to that point a deflationary scare hits the markets, which brings yields down.

    At some point, this game won’t be possibly sustained, and yields will breakout. At what yields does US debt enter a death spiral? Although I don’t see any of this playing out in 2012, once it happens I see only two choices: Default or hyperinflation.

    I am inclined to believe that Bernanke and Co. are evil but not stupid, i.e. they would choose default. What path do you think the US would take, faced with this choice?

    • One possibility – depending on the political imperatives at the time – would be selective default. It is something a wily president may consider – default on obligations to foreign creditors, but not the ones to domestic creditors. After all, hyperinflation is only a default by another name, but one that destroys the economy as well.
      However, we can not rule out that control over these things will simply be lost because for instance the demand for money begins to decline in non-linear fashion at some point. At this stage this is unknowable.

  • moonright:

    Can anyone explain to me why UK rates are so low given the risk of currency devaluation?

    • LRM:

      I am beginning to be convinced that the interest rate is 100% controlled by the central bank BoE etc. This applies to all countries with their own sovereign currency (a nation operating a fiat currency which involves an autonomous monetary system, monopoly supply of currency and floating exchange rates)
      For these countries, bonds do not fund government expenditures and so do not need to be “sold” in order for the government to spend. The treasury spends and all their cheques get cleared .
      With the Modern Monetary Theory, this group seems best able to explain the activities that have taken place to date during this GFC. You could check a site like http://pragcap.com/resources/understanding-modern-monetary-system to get a feel for how the activities happen.
      I am not a bond investor or an economist , but an understanding of this MMT would have rejected a great deal of the bond “vigilante” talk the last few years as applied to these group of countries that have their own fiat currency. There is absolutely no risk for a default in BoE currency as BoE can cover all UK issue.
      The interest rate is then a function of the requirements of the economy. Right now the rate is set to ease to try to stimulate economic activity.
      However, the BoE does not create new loans in the economy, the commercial banks do this. The BoE can stuff the reserve side with all the electronic issue it wants but it will not cause inflation if there is no demand for new loans from commercial banks.
      Commercial banks are never reserve constrained. They always lend first to any credit worthy customer that comes through the door. So, watch for this vs the deleveraging from defaulted and restructured debt as a better measure of potential deflation.
      This is a simple explanation from a simple understanding I may have of a complex system.
      Commercial banks do not loan deposits. When someone credit worthy obtains a loan, the money is just credited to his account. This is one of the largest sources of money creation the other being when the government deficit spends.
      When a person wants a loan for a home he exchanges his promise to pay (the new money creation) for the home . The new money created goes to the current owner/builder of the home so he has exchanged value for value.
      The buyer gives his promise to pay and this obligation over time is value for value for the home.
      The bank promises to clear the cheque issued to the former owner/builder of the home and publishes the borrowers promise to pay in the form of a mortgage document.
      So the bank, in the case where the builder and the new owner use the same bank, would first credit the borrowers chequing account for the loan amount. The borrower writes the cheque to the builder/former owner who takes it to deposit in his account. The bank clears its own cheque allowing the builder to get his money and then the bank is able to collect the payments and interest on the loan.
      Just a thought for you.
      What did the bank give up in the above exchange?

      • moonright:

        Yes I understand private sector money creation (lending comes first, reserves later) and I also get that a country with it’s own currency can force down short term interest rates and this will effect long term rates – but there is a side effect to this and that’s the risk of currency devaluation. So this is what I don’t understand, why does anyone buy debt when there is this risk of the currency it’s issued in being devalued and if they do surely there should be a risk premium for this in the same way there is a risk premium for EZ countries because of default risk.

        • rodney:

          moonright,

          Do not be misled. Take the time to read Pater’s remarks about so called MMT, just a resurrection of plain old chartalism. Among it’s greatest achievements are an inflationary crack-up boom in the Weimar Republic which led to the obliteration of the currency.

          It is not only that Germans had to resort to barter and foreign currency (those lucky enough to hold it) to survive. The worst part of hyperinflation is that except for one ocassion, it has always led to dictatorship and global wars (e.g. Napoleon after the French Revolution, Hitler after the 1922 collapse, etc.).

          The one exception of course was the destruction of the Continental currency after the Revolutionary war. The members of the Continental Congress were bright enough to acknowledge the mistake and set about to correct it. Thus, constitutional provisions for sound money were born. This is the only time in history when politicians were not so arrogant as to keep pursuing wrong policies in spite of their failure.

        • rodney:

          Answering the question, I would say that in an intermedium term timeframe markets will focus on perceptions; right now bond markets are focused on the most immediate risk, which is the risk of default in the Eurozone. Therefore funds flow to safe havens or to countries with a printing press. Currency depreciation due to the printing press is a real risk but one that will take much longer to play out.

          You can guess were this line of thought is going. In the short to medium term, for the markets perception is everything. However, if enough fundamental developments take place, perceptions can change quickly. In essence, we are in the same position as a stock analyst in 1998 saying that stocks must go down, based on fundamentals. The market did not see it that way for another two years, but eventually he was proved right.

          Fundamentals can take a long time to impact on the markets, more so when a long term trend has to reverse. This is especially true of sovereign debt markets, where cycles tend to play out over decades. The generational low in yields will not be an event, but a long process with a flat to rounded bottom. Therefore, when looking at these markets, you should be aware of the timeframe.

          • moonright:

            OK this then goes some way to answering my query. I still find it puzzling however because the UK pounds has devalued by > 20 percent since the GFC.

          • rodney:

            Another point worth remembering is that fiat currencies don’t appreciate. They simply loose their purchasing power at different speeds. So bear that in mind when considering depreciation risk. If all countries are in a race to the bottom, then you will not see much depreciation among fiat currencies. You can see that GBP/USD is generally stable and/or mean reverting, proving that both sets of monetary policies are similar.

            Of course, in a race to the bottom, fiat currencies will depreciate massively against real money, i.e. Gold.

          • rodney:

            The pound has devalued more than 20% since the GFC because it was overvalued prior to that. Open a long term monthly chart of GBP/USD and you will see that price has stabilized near its long term range.

      • MMT people are not wrong on the purely technical aspects of the fiat money system – but their’s is not an ‘economic theory’. It is a play with tautologies.
        Anway, in order to satisfactorily reply to this and related questions – i.e., how come that interest rates are so low in spite of massive monetary inflation (note in this context that the money created by ‘QE’ did NOT remain wholly sequestered with the Fed – the true money supply has increased by 55% since early 2008), I will write a separate post in coming days that will hopefully shed some light on the topic.

  • JoeBren:

    re: Sentiment on Silver & Gold

    I’m sure your sentiment indicators are accurate but I also look at the short interest on GLD, SLV & GDX. These register about one days trading to cover shorts, hardly a bearish indicator. I don’t know the reason for this diverging reading, perhaps you have an explanation.

    • Hi Joe,
      from experience, in GLD , SLV and GDX, a low short interest ratio tends to be bullish rather than bearish in its implications and vice versa – apparently it is the playground of ‘smart money’.
      By contrast, the put/call open interest ratio in GDX tends to be a contrary indicator.

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