Greece and Oil, and Gold

By DoctoRx

Knowing the Greek fix was in, my view is that the traders moved markets around the past week to suit themselves. Yours truly has been calling for $90 as the first stop in an oil bear market. Oil did bottom exactly at $90, helped to go that low by the announcement of the release of a day or two’s worth of global oil use from various national reserves (which news was likely front-run from the short side by the favored few). Typical of a short-covering sneak rally, oil then shot up $5.50/bbl in the last two days on no major economic news. The Greek vote was the headline excuse, but I don’t believe that. The amounts of gasoline you and I use, and that China and Germany use, are unaffected by how much the tiny economy of Greece takes a hit. Add in Portugal and Ireland and you still have fewer people than live in Texas. I have gotten cynical about these crises in economically insignificant countries. The Greek situation is a real problem, but the losses should be small; the Europeans can print up the amount they might lose in a default in a jiffy and ultimately their markets would hardly notice it. A little more inflation, that would be all. 

I think these crises are over-hyped to garner profits for traders. You can guess which traders. Does TBTF come to mind? 

The same thing happened in the often faux“crises” in basically sound Asian countries in 1997-98 that the speculators attacked one after another. All this really did from the standpoint of an American investor back then was to gyrate markets that were going up due to balanced budgets (therefore no unusual Fed money-printing), a back-to-work emphasis (welfare reform), the peace dividend from the end of the Cold War, cheap oil, and of course the tech revolution. Eventually our giant, sub-continental economy did what it was going to do without caring how the Thai baht was faring. The same for Greece today IMHO. Deutsche Bank has already disclosed that it’s largely resolved for a Greek default. The Greek de facto default is mostly a distraction for American investors, as well as being impenetrable from the standpoint of both figuring out what’s going to happen when and then guessing what is already priced in. The Greeks took the loans and wasted/stole much of the money. Now the imprudent/unlucky lenders and the Greeks are going to do whatever they do. So be it. Again, it is a real problem, but I’m saying that it’s not a crisis that should move American markets much if at all. All this concern about contagion? It’s when they don’t advertise such a problem in advance that the major problems occur, a la summer/fall 2008. Think Lehman/AIG and the aftermath, about which no one was talking beforehand. Just wait. You’ll start hearing about Portugal, Spain, Italy etc. anyway if the traders so desire. And of course Greece has not been cured. And there are any number of other countries that could “worry” traders. 

The most important thing for US markets is, as Econophile said, that there has been no recovery. The proof, or at least strong evidence of this, is that there has also been no recovery in the stock market from its March 2009 bottom when priced in gold. The gold/stock market ratio remains near its high for the cycle, but historically has gone much, much higher during times of crisis. Watch for it. Maybe gold $3000/Dow 10K for a start? (Not that I really have a great deal of conviction about the markets given how weird the entire scene is.) 

Meanwhile, the Greek news and the rapid collapse of oil from over $110 to $90 in almost no time (a 20% move and therefore already a bear market) led to the typical move away from the US dollar and Treasurys. Risk on, in other words for the last couple of days. If my view of the macro economy is correct, eventually the markets should reacquire a taste for the US dollar and it will be “risk off”, again. August through October are classic times for that. In that case, if the real economy is decelerating and/or shrinking, and thus credit demands from private sources are also shrinking, we couldsee the trifecta of a strengthening dollar, lower US interest rates, and a rising gold price. That’s a classic “risk off” portfolio trend. It would not reflect good times, though it might be a necessary part of the healing process, just as detox is very unpleasant for the unfortunates who get hooked on alcohol or narcotics. 

The S&P 500 is up exactly 2% in price from July 1, 2008. (Of course, it was already well off its 2007 highs by then.) Add in 2% dividends per year and you get at best a 3% annual return from stocks over these 3 years. In the same time, gold is up 73%, which is 20% per year. And gold has achieved this with less volatility than stocks. Yet this outperformance by gold has only brought it to a historically normal ratio to the major averages. 

This outperformance by gold from a historically record undervaluation as of the year 2000 may continue for some of the reasons that Econophile described today in discussing Europe’s financial problems. Remember that capital deficiencies become most visible when economic activity slows a good deal. Then we start to see who’s been swimming naked, so to speak. It is my suspicion that the amazing complexity of today’s financial system exists to hide capital holes. Otherwise, why go to the trouble? It’s cheaper to keep it simple. Unless you believe that silver is money (I’m long silver but I don’t believe it is money; I believe it might become money again, though), then the only money in the world that is not simultaneously a liability is gold. Thus if the S starts hitting the F for some of Europe’s big banks, Europe has lots of fiat money that the Europeans will want to exchange for the ultimate hard currency. In this scenario, I can see a lot of demand for US Treasurys, but in financial panics due to unsound lending, people simply want gold first and foremost. Even today. Some barbarous relic (sarcasm on).

I don’t know just what happened in Greece with all the loans. I do know that less than three years ago, the unthinkable happened in the United States. The largest financial companies simply disappeared as solvent companies, though most of them were either kept alive by the authorities or were parceled out to the TBTFs to be absorbed while matters were sorted out later. And of course some of the TBTFs themselves were kept alive by all sorts of strategems. Nothing like this happened in this country even in 1929-33. The money center banks were quite sound despite massive price deflation. When the Bank of United States failed in 1930, it set off a panic. Yet despite the deflationary depression that lay ahead, depositors recovered 83 cents on the dollar. Not so bad. What would depositors in Citi have received had it been allowed to fail and had there been no deposit insurance, as was the case in 1930? I have to suspect the answer would be discouraging, especially if one adds in all the junky SIV $trillion Citigroup was keeping off the books. And what happened in America in 2008-9 happened with minimal if any net price deflation.

So, there has been no recovery because a highly leveraged system came crashing down in 2008-9 due to excessive and unsound lending during the boom, related to central bank-induced cheap money. And as bad as matters remain in this country, Europe might be even worse off, considering all the PIIGS (Italy and Spain being economically significant but still solvent) plus a financially challenged Britain. Zero interest rate policy (ZIRP) might thus persist here year after year until finally the financial recapitalization process is complete. Obviously, the whole situation is unprecedented and differs in some key ways from Japan’s ZIRP experience. To date, with limited ZIRP experience in this country, the Fed keeps getting it wrong and stops printing money after flooding the system with it, at which time of turning off the spigot the economic cycle turns down and more money needs to be injected to keep the system afloat. That’s my base case for the months ahead. As the curse goes, it should be an interesting time for us in this brave new world of capitalism lacking (enough) real capital. And meanwhile so far as the VIX (fear index) goes, happy days are here again already.

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