``When the government and the banking system begin inflating, the public will usually aid them unwittingly in this task. The public, not cognizant of the true nature of the process, believes that the rise in prices is transient and that prices will soon return to “normal.” As we have noted above, people will therefore hoard more money, i.e., keep a greater proportion of their income in the form of cash balances. The social demand for money, in short, increases. As a result, prices tend to increase less than proportionately to the increase in the quantity of money. The government obtains more real resources from the public than it had expected, since the public’s demand for these resources has declined. Eventually, the public begins to realize what is taking place. It seems that the government is attempting to use inflation as a permanent form of taxation. But the public has a weapon to combat this depredation. Once people realize that the government will continue to inflate, and therefore that prices will continue to rise, they will step up their purchases of goods. For they will realize that they are gaining by buying now, instead of waiting until a future date when the value of the monetary unit will be lower and prices higher. In other words, the social demand for money falls, and prices now begin to rise more rapidly than the increase in the supply of money."-Murray N. Rothbard,The Economics of Violent Intervention in the Market
Speaking of benign inflation, the “sweet spot” of the inflation is the seductive phase where the financial and economic ambiance is characterized by an episode of rising asset prices which reinforces the perception of the strengthening of the economy’s recovery and vice versa.
This actually plays out in the manner introduced by market savant George Soros as the reflexivity theory- a self-reinforcing feedback loop mechanism where people interpret prices as signifying real events, and where real events reinforce these price signals.
In short, from our perspective, the sweet spot of inflation represents as a boom scenario for markets resulting from easy money policies.
However, since the interplay of perceptions which have been enhanced by price signals and statistical information on the real economy has been manipulated by the official policies, most people don’t recognize that price signals are manifestations of the deepening scale of malinvestments into the system. And as the boom phase draws in more of the crowd, the trend becomes entrenched until they become unsustainable...but we seem to be getting way too far.
A Global Rally Ahead?
Last week we said that equities are likely to be a “buy” once gold breaks above the 1,120-1,125 area. And perhaps the sweetspot of inflation will become more conducive once it is supported by the concomitant rise of US and Chinese markets.
The reason we opted to use gold as a major key indicator for markets is because gold has not only decoupled from the US dollar and is likely to seek its own path overtime, but importantly gold has served as a significant lead indicator for equity and commodity prices. This is because Gold apparently reflects on the state of the global liquidity.
For now, even as gold hasn’t broken above the important threshold, the ancillary conditions appear to be suggestive of an upcoming breach (see figure 4)
Figure 4: stockcharts.com: Sweet spot of Inflation?
US equities as signified by the S & P 500 (SPX), while down for the week, has brushed off the recent accounts of the volatility from the ‘Greek tragedy’ and appears to be in an uptrend.
We also see China’s Shanghai index (SSEC) as striving to move higher (see middle minor window). China’s major bellwether have been in consolidation over the past two months, after being hammered repeatedly by the formal and informal arm twisting by her government in an attempt to squeeze bubbles out of her system late last year.
Next we have the JP Morgan Emerging Markets Debt fund (JEMDX) or a bond fund which is invested in sundry emerging market sovereign debt, as sharply moving higher. These could be signs that foreign money flows could be gathering steam into Emerging Markets anew.
Combined, these market signals could presage a vigorous resurgence of global equities out of “loose monetary conditions” and the reflexivity theory ahead.
And this is likely to also be reflected in gold’s next moves.
Gold’s ‘Fundamental Change In Sentiment’
Another reason why gold should be a good benchmark is that the varying interests of global central banks appear to have created a “neutral” zone for gold.
By neutral zone, we mean that gold is likely to reflect on market forces with reduced odds of manipulation. Many emerging market governments have been increasingly playing the role of “buyer” while former sellers seem to be downscaling sales activities.
Asian Investors quotes the World Gold Council on this noteworthy shift, ``After net-selling an average of 444 tonnes of gold in the five years to 2008, central banks only offloaded a net 44 tonnes last year. In fact, after 62 tonnes of net selling in the first quarter of 2009, central banks posted three quarters of net buying. This shift may signal a "fundamental change in sentiment", says the London-based World Gold Council (WGC).” (bold highlight mine)
In other words, the “fundamental change in sentiment” has transformed central bank officials’ view of gold from a “barbaric metal” to insurance, as previously discussed.
I’d like to further add that gold prices have recently been weighed by the IMF’s proposed sale of the remaining 191.3 tons to the market.
While after a week of announcement, no nation has officially taken up the IMF’s offer, there are reports that India may suit up for IMF’s last batch of gold sales. This should stir up the gold market anew.
Many have expected China to take the counterpart of the IMF’s offer. But this may not happen. China’s gold procurement has been marked by inconspicuous domestic acquisitions since. As example, in April of last year, China surprised the market with the declaration that it had raised its gold reserves by “33.89 million ounces by the end of April” of 2009 since December 2002.
And since China is now the world’s largest gold producer, she isn’t likely to be pressured on overtly buying into IMF’s gold.
Albeit, we are quite sure that China’s interest in the precious metal remains unabated. Her huge sovereign wealth fund, China Investment Corporation (CID) had reportedly acquired an equivalent of 4.5 tonnes of SPDR Gold Trust ETF just recently, making the fund the largest holder, alongside with investing legends as John Paulson and George Soros.
Finally, should gold opt to somewhat mimic on the Euro’s moves anew, the prospects of a sharp rebound in a severely oversold Euro could also give the metallic money a boost (see figure 5)
Figure 5: Mineweb: Extremely Overbought US dollar and Severely Oversold Euro
Here we quote Mineweb’s Rhona O'Connell: (bold emphasis mine)
``The instrument shown here is the US Dollar Index position reported by the "I.C.E.", or IntercontinentalExchange, which turns over very heavy dollar trading, although the net speculative positions are comparatively low when compared with those in the euro on the CME or gold on COMEX. Nonetheless they reflect sentiment. The reported positions relate to contracts of $1,000 each, meaning that the largest recent net dollar short position, at 12,521 contracts, was equivalent to $12.5 million. The swing since then has been equivalent to $53.4 million to the long side and the latest position, a net long of $40.9 million, is almost 150 times the average since 2004.
``Meanwhile the net euro position on the CME is even more extreme. Taken over the same period, the net speculative euro position on the Chicago Mercantile Exchange has averaged a long of $4.8 billion euros. In mid-February the position was a net short of 8 billion euros; the outright long is at 71% of the average for the period, but the short is twice its average.”
So the forces which heightens the odds for an upside breakout for gold prices looks firming up, and we should gold’s breakout to likely be accompanied by auspicious sentiment for the asset markets.
Positive Foreign Trade For The Philippine Stock Exchange
I’d like to conclude with a chart of the foreign flows into the Philippine Stock Exchange (PSE) (see figure 6)
Figure 6: PSE: Net Foreign Trades
Despite the marked selling in early February, we are generally seeing net foreign inflows into the PSE on a year to date basis.
This squares with our earlier observation that despite the diminishing share of foreign trade in the markets (about 37.7%), foreign trade has accounted for a net inflow to the tune of 5.2 billion pesos (about $110 million) for 2010.
Inflationism in developed economies is likely to spur more foreign fund inflows, which should support the domestic asset markets, particularly, the equity market, the real estate sector, corporate and sovereign bonds and the Philippine Peso.
See Asia’s Policy Arbitrage, Phisix And The Bubble Cycle
See Is Gold In A Bubble?
