Thursday, June 24, 2010

A Shuffling in the World

There has been an amazing shift in the world in the last three months. The idea that one can spend, borrow, and print money to reach prosperity is slowing losing clout while basic common sense of balanced budgets is starting to gain traction. Understanding what this means and doesn't mean is very important. For over two decades our world has moved full speed heading for a cliff. In many ways we have gone over the cliff. Europe is trying to pull back from the cliff now but they may have already gone over and trying to make an impossible climb back up. This effort is admirable but could be fruitless. While I support this new wave of enthusiasm for common sense, there is a distinct probability it is to late.

The new growing sense by government leaders that what has been created is not sustainable and the Keynesian effort to reflate out of the problems has failed is a tectonic shift. You now have open mockery by European leaders at what the United States has done and the road they have traveled. The new path being taken is one of austerity and an effort to balance world government budgets. This is admirable but I have said many times before that doing the right thing will cause massive human suffering and a large depressionary type outcome. The hope is that 2020 will be a good year. Not 2012.

This road should have started being traveled in 1998. Every year builds up a debt to the piper. This debt owed is human suffering. The longer it goes the higher the eventual human suffering will be. The growth in this debt is exponential. At some point the market (the piper) won't allow the debt to grow any higher. Could the world governments possibly buy another month or year? It is possible. Currently Europe is trying to start to pay off the debt. They are isolating the United States heading into the G-20 this weekend who still doesn't want to pay the debt.

What this means for asset prices is extremely bearish. What it means for society is extremely troubling.

The equity markets seem to be at a breaking point. The rally to the 1140 area came up short and at this point it seems like one should be shorting and asking questions later. Financial stress in financial markets is showing up world wide and economic data is plunging off a cliff at worst and rolling over at best.

If the new European viewpoint takes hold it will probably mean a major shift in how asset markets react. Of top importance is gold. I am becoming moderately bearish on gold. This is a short term thought (1 to 12 months) but what Europe is moving towards is full deflation. This could spell trouble for gold in the short term. Gold does well in deflation (i.e. the Great Depression) and severe inflation (1970s). Most investors do not realize how well gold does during deflation. The reason is deflation puts stress on sovereign nations and the currencies backing those nations. Even if gold goes down I am still a buyer but there is a growing risk that gold could drop 20 to 30% over the next twelve months. Like I said I am keeping and buying more gold regardless.

The other MAJOR shift that is occurring is that I think currency correlations are going to start breaking down. For 2 years if the Euro went down, basically the US stock market went up and vice verse. Even more relevant was the Euro / Japanesse cross. This correlation has been strong but is not necessarily a must. It was a risk trade signal. If the Euro went down the European stock markets went down. The same can happen in the United States. That correlation isn't a market rule. Europe is taking actions to protect their currency. While this will ultimately fail I think it is distinctly possible that the Euro still has some more rally left in it. 1.30 seems very possible to me. I won't bet on it but the reason I bring it up is that I don't necessarily think the U.S. markets will rally hard if that occurs like they have previosly. Another important point in all this is European "states" started having troubles first but their budgetary problems are just as big as U.S. state budgetary problems. This is inherrently dollar negative and U.S. economy negative. So despite being dollar negative it is also deflationary and U.S. equity market negative.

Anyway, there have been a couple of major shifts in the way the world is operating in the last few months. These changes may give 2020 a chance of being a good year but in the next couple of years it is very bearish for asset prices.

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