Juggling Dynamite

Everywhere I go today people want to know what I think of gold. My kids came home from their elementary school the other day saying that some kids in the play ground were running around telling people they should “buy gold, ’cause it only goes up.”
Just before I gave this interview in Toronto last week, I ran into my plumber who told me he was at the resource conference to do some research and networking as he was thinking of becoming a precious metals broker. “I’ve got my precious metals, and I am convinced they are going higher…I am not wavering from that. ” he said. HuMMMMMMMMM….

The Fed is accountable for the excesses of what led us into this crisis pre-subprime, according to Stephen Roach, Morgan Stanley Asia non-executive chairman, who says the lessons from Japan, is that the economy did not respond to quantitative easing and the same thing is happening in the U.S. We have not learned the lessons from Japan.

Stephen Roach is a good thinker and a very experienced and honest commentator on the global economy. Always worth the listen. But I find his arguments on why China may not correct significantly to be weak. Having been a ‘Asia bull’ for years I find that Roach tends to love the region and especially China at the expense of recognizing shorter-term investment risks. David Rosenberg makes a similar error about Canada in his optimism over the past many months for continued strength in the loonie and the Canadian economy, despite the onset of the next global recession and cyclical bear market in stocks. The evidence of the last 12 years simply does not support any of these theories or hopes. Global markets are incredibly correlated. They may lag each other in weeks or months, but they do not decouple from one another.

This point is reaffirmed this morning as the Canadian dollar tumbles below .97 US and in a global sea of red the Canadian stock market falls harder than most off nearly 4% today. It is true that Canada has lots of natural resources, and a more regulated banking system. It is true that China has more than 1 billion people all trying to move up the socioeconomic ladder. But from an investment perspective we must never lose sight of price risk and interim cycles. Everything depends on the relative price of these assets and the credit cycle. The Chinese stock market peaked out at 6,000 in 2007, crashed to 1700 in 2008, recovered to 3400 in 2010 and is today back at 2400. Being a China bull throughout this period would have meant a capital loss of 60% over the last 4 years with mind-boggling volatility that no sane person could stick.

The Canadian broad market is today back at the level it first reached in 2000, and some 25% below where it peaked last expansion in June 2008. The Canadian resource-rich venture exchange is today still down 52% from where it peaked in 2008, and is up just 13% in total since its 2000 peak–11 years later. So much for the secular bull in commodities;  good in theory, but not as an investment approach.

Be very leery of financial advice based on long-term bullish demographic, country or sector-specific arguments. It is much more likely to harm you (repeatedly) than help you.

All the breathless reports on the “Fed watch” today remind me of how nonsensical thoughts are not only a waste of time and energy they are net negative as they hold us back from getting on to productive steps and meaningful solutions.  I am reminded of one of my favourite John Galbraith quotes: 

” It is far easier to be firmly anchored in the sea of nonsense than it is to set out on the sea of meaningful thought.”

(I miss JKG who passed in 2006, no one could cut to the meat of the matter faster.)

My friend Barry Ritholtz offers this excellent summary this morning on the prospects of more Fed magic: Pushing on a String, to wit:

Rather than repeat the usual blah blah blah, I thought I might raise a few points that might otherwise be overlooked:

1. Zero: With Fed rates pressing at the zero boundary, there is only so much ANY central bank can do to help the economy.

2. Not the usual cyclical recession: The Credit Crisis creates a specific recession recovery cycle. It is markedly different than a regular recession, and characterized by consumer de-leveraging. Hence, low rates are ineffectual to stimulating growth.

3. Fiscal vs Monetary: Problems with unemployment and weak growth will eventually be repaired via the elapsing of time. The alternative is concerted, targeted, intelligent stimulative action from Congress and the White House, unlikely to occur due to ideological rigidity, partisan posturing, and lack of economic intelligence in DC.

4. Wealth Effect: Is widely misinterpreted by economists, including those at the Fed. (It is more correlation than causation). Hence, the Fed’s focus on asset prices such as equities is utterly misguided, and doomed to disappointment (as we have already seen).

5. Liquidity vs Solvency: Central banks can provide a gusher of liquidity to prevent the financial system from seizing. They cannot make insolvent banks whole; they cannot turn debtor nations into creditors; they cannot spin dross into gold.

6. Bailouts: Do not resolve the underlying problems, they merely paper them over. Hence, the 2008 rescue plan, now 3 years old, is fading, once again revealing the underlying problem with a finance sector that still has too much debt, too little capital.

7. FOMC Transparency = Central Bank Failure. The Fed’s moves to be more transparent is an admission that their prior policies have failed to gain the traction they hoped. Interest Rates are totally transparent, the time period they will stay where they are has been unequivocally stated. More jawboning is not a solution.