Sunday, December 8, 2013
QE is not Producing Inflation here in the US
In response to some private emails, I wanted to post up a chart detailing why, in spite of the massive amount of money created through the Federal Reserve's Quantitative Easing, there simply does not seem to be a massive wave of inflation building here in the US. Some may be wondering why I tend to focus on this thing termed, "Velocity of Money" but in my view, even though at times it may seem to delve into the realm of the esoteric, nothing can be more important in determining the future direction of the gold price.
Many will recall that when the first QE program was instituted ( late 2008) commodity prices and stock prices both bottomed out. The view of the majority of investors/traders was that the creation of such enormous sums of money through bond buying and mortgage backed security buying was going to result in a sharp jump in inflation. Almost as if on cue, commodity prices began to rocket higher as hedge funds jumped in on the long side of that asset class.
As the initial QE I began to near expiration, the Fed announced round 2 and thus QE II was born. More commodity buying ensued with gold soaring higher, eventually reaching a peak above $1900.
A strange thing began to happen however after QE II wound down - after that was replaced by QE III, Operation Twist, and then QE IV, gold continued to move lower along with most of the rest of the commodity complex. The US equity markets continued to ascend however.
I am not an economist nor do I make any such pretense of so being. What I am is a trader and traders have to notice when markets no longer respond in the manner to which one expects or assumes that they will respond.
Something had changed and for whatever the reason ( we can leave that to those who are more sophisticated about such matters ) a general wave of deflationary pressures surfaced in the commodity complex. I maintain that most of the "money" being created by the QE programs has not and continues to NOT make its way into the broader economy. It has gone primarily into the hands of speculative forces which have directed into equities. In other words, while these QE programs have not resulted in the widespread outbreak of inflation that most market participants originally expected them to produce during rounds I and II, one thing I think we can say with absolute certainty, is they have indeed produced a MASSIVE WAVE OF INFLATION in the US EQUITY MARKETS.
Such huge sums of "money"/ liquidity cannot be conjured into existence WITHOUT SOME CONSEQUENCES SOMEWHERE. To believe otherwise is to suspend all economic common sense and logic.
Let me interject one note here when it comes to general commodity prices. Many who read this site have seen me use ( to the point of disabuse ) the phrase, " the best cure for high prices is high prices". What is meant by this is that high prices encourage those entities engaged in the creation/manufacture/production/growth of the various commodities that are rising in price to INCREASE their production in order to maximize their profits as they take advantage of this increase in the price.
This is capitalism at its finest - the market gives the signal and the industry responds to the signal. As the supply then increases due, it eventually overwhelms the demand at that level and price then falls to balance the new increase in supply with the current level of demand.
During the run up in commodity prices during QE I and QE II, producers/growers, etc. responded to the higher prices by ramping up the supply. As there is always a lag time between the rise in price and the subsequent increase in supply, we are now seeing that. One can merely look at the corn and soybean markets as an example. I had quipped to some newswire writers and some friends that these extreme prices for both of these commodities was going to send growers in both S. America and here in N. America down to their local Home Depot/Lowes to buy clay pots and other assorted window boxes so as to have even more space/"land" to plant these crops. Lo and behold, we put in a record corn crop this year and an extremely large bean crop. Ditto for S. America.
So now we have two forces that have been working against any rises in commodity prices ( in general ). The increase in supply resulting from higher prices a couple of years ago combined with an outflow of speculative money in SEARCH OF YIELD in this NEAR-ZERO interest rate environment.
This has been a bit of a digression from my main point here but I felt it was important enough to note this. Here is that chart again:
Note how in spite of the QE programs, this key indicator, has continued to fall. Again, not being an economist I cannot get into all the when, where's and why's about this indicator but suffice it to say, my understanding of the inflation phenomenon, in the sense of sharp jumps in inflation, requires that money be changing hands in the general economy at an INCREASING RATE. That is clearly not happening.
What is rather startling is that this indicator has fallen to its lowest level since this data set was collected. That was over 50 years ago!
Look closely at the last grey area on the chart indicating a recession. Can you see how the Velocity of Money plummeted during the onset and into the depth of the credit crisis that erupted in 2008? Then look at the brief blip higher on the right edge of that grey region. Velocity of Money shot up rather sharply when QE I was announced. However it did not last in that uptrend for long. The graph peaked in the second half of 2010 and has been moving lower ever since.
Here is a closer look:
It continued moving higher for nearly a year after the Velocity of Money turned lower. Some of this is the result of the sharp fall in the US Dollar that began at precisely the same time that the Velocity of Money chart peaked.
Here is a chart of the US Dollar index peaking at the same time VoM turned lower:
We then had the outbreak of the European Sovereign Debt crisis which triggered another huge round of gold buying but once that crisis was "contained" ( not solved ) there was nothing left to support gold based on the "inflation is inevitable" prognosis as the Velocity of Money continued moving lower.
Note how gold turned lower after the ECB took actions to stem the bleeding in the European sovereign debt market:
It seems to me that gold is now basically mirroring the Velocity of Money at this point. Outbreaks of confidence-rattling episodes have brought buying into the metal, but once that issue(s) is(are) resolved, or better, removed from the forefront of trader/investor's minds, the path of least resistance takes over and gold heads downwards once again.
This now brings me full circle to why I believe any sort of SUSTAINED RALLY in the price of gold will not occur until either CONFIDENCE in the ability of the monetary masters is shattered or rattled, or INFLATION EXPECTATIONS begin to arise. The latter is tied directly to the Velocity of Money in my opinion. When/if we see that indicator turn higher, gold prices should respond. I do want to note however that it will be important to also watch the bond/interest rate market to confirm market sentiment in that regards.
As always, we can posit a theory but until the market confirms it and sentiment shifts in that direction, a theory is simply that, a theory, or better, an opinion.
Many will recall that when the first QE program was instituted ( late 2008) commodity prices and stock prices both bottomed out. The view of the majority of investors/traders was that the creation of such enormous sums of money through bond buying and mortgage backed security buying was going to result in a sharp jump in inflation. Almost as if on cue, commodity prices began to rocket higher as hedge funds jumped in on the long side of that asset class.
As the initial QE I began to near expiration, the Fed announced round 2 and thus QE II was born. More commodity buying ensued with gold soaring higher, eventually reaching a peak above $1900.
A strange thing began to happen however after QE II wound down - after that was replaced by QE III, Operation Twist, and then QE IV, gold continued to move lower along with most of the rest of the commodity complex. The US equity markets continued to ascend however.
I am not an economist nor do I make any such pretense of so being. What I am is a trader and traders have to notice when markets no longer respond in the manner to which one expects or assumes that they will respond.
Something had changed and for whatever the reason ( we can leave that to those who are more sophisticated about such matters ) a general wave of deflationary pressures surfaced in the commodity complex. I maintain that most of the "money" being created by the QE programs has not and continues to NOT make its way into the broader economy. It has gone primarily into the hands of speculative forces which have directed into equities. In other words, while these QE programs have not resulted in the widespread outbreak of inflation that most market participants originally expected them to produce during rounds I and II, one thing I think we can say with absolute certainty, is they have indeed produced a MASSIVE WAVE OF INFLATION in the US EQUITY MARKETS.
Such huge sums of "money"/ liquidity cannot be conjured into existence WITHOUT SOME CONSEQUENCES SOMEWHERE. To believe otherwise is to suspend all economic common sense and logic.
Let me interject one note here when it comes to general commodity prices. Many who read this site have seen me use ( to the point of disabuse ) the phrase, " the best cure for high prices is high prices". What is meant by this is that high prices encourage those entities engaged in the creation/manufacture/production/growth of the various commodities that are rising in price to INCREASE their production in order to maximize their profits as they take advantage of this increase in the price.
This is capitalism at its finest - the market gives the signal and the industry responds to the signal. As the supply then increases due, it eventually overwhelms the demand at that level and price then falls to balance the new increase in supply with the current level of demand.
During the run up in commodity prices during QE I and QE II, producers/growers, etc. responded to the higher prices by ramping up the supply. As there is always a lag time between the rise in price and the subsequent increase in supply, we are now seeing that. One can merely look at the corn and soybean markets as an example. I had quipped to some newswire writers and some friends that these extreme prices for both of these commodities was going to send growers in both S. America and here in N. America down to their local Home Depot/Lowes to buy clay pots and other assorted window boxes so as to have even more space/"land" to plant these crops. Lo and behold, we put in a record corn crop this year and an extremely large bean crop. Ditto for S. America.
So now we have two forces that have been working against any rises in commodity prices ( in general ). The increase in supply resulting from higher prices a couple of years ago combined with an outflow of speculative money in SEARCH OF YIELD in this NEAR-ZERO interest rate environment.
This has been a bit of a digression from my main point here but I felt it was important enough to note this. Here is that chart again:
Note how in spite of the QE programs, this key indicator, has continued to fall. Again, not being an economist I cannot get into all the when, where's and why's about this indicator but suffice it to say, my understanding of the inflation phenomenon, in the sense of sharp jumps in inflation, requires that money be changing hands in the general economy at an INCREASING RATE. That is clearly not happening.
What is rather startling is that this indicator has fallen to its lowest level since this data set was collected. That was over 50 years ago!
Look closely at the last grey area on the chart indicating a recession. Can you see how the Velocity of Money plummeted during the onset and into the depth of the credit crisis that erupted in 2008? Then look at the brief blip higher on the right edge of that grey region. Velocity of Money shot up rather sharply when QE I was announced. However it did not last in that uptrend for long. The graph peaked in the second half of 2010 and has been moving lower ever since.
Here is a closer look:
Here is a chart of gold:
It continued moving higher for nearly a year after the Velocity of Money turned lower. Some of this is the result of the sharp fall in the US Dollar that began at precisely the same time that the Velocity of Money chart peaked.
Here is a chart of the US Dollar index peaking at the same time VoM turned lower:
We then had the outbreak of the European Sovereign Debt crisis which triggered another huge round of gold buying but once that crisis was "contained" ( not solved ) there was nothing left to support gold based on the "inflation is inevitable" prognosis as the Velocity of Money continued moving lower.
Note how gold turned lower after the ECB took actions to stem the bleeding in the European sovereign debt market:
It seems to me that gold is now basically mirroring the Velocity of Money at this point. Outbreaks of confidence-rattling episodes have brought buying into the metal, but once that issue(s) is(are) resolved, or better, removed from the forefront of trader/investor's minds, the path of least resistance takes over and gold heads downwards once again.
This now brings me full circle to why I believe any sort of SUSTAINED RALLY in the price of gold will not occur until either CONFIDENCE in the ability of the monetary masters is shattered or rattled, or INFLATION EXPECTATIONS begin to arise. The latter is tied directly to the Velocity of Money in my opinion. When/if we see that indicator turn higher, gold prices should respond. I do want to note however that it will be important to also watch the bond/interest rate market to confirm market sentiment in that regards.
As always, we can posit a theory but until the market confirms it and sentiment shifts in that direction, a theory is simply that, a theory, or better, an opinion.
Here are some gold charts once again to take a look at where things stand in that market.
Let's start with the Daily....
Note I am only using the ADX on these charts as I am trying to discern a TREND change.
The first thing to notice is that the ADX line has now turned down from a high level (above 43). That tells us that the downtrend has been temporarily halted. I have noted previous downturns in the ADX by ellipses. Note that the market has experienced some upward moves in price that followed such events. Therefore, the POSSIBILITY exists that we could see a relief rally in gold.
In my view, this will only occur IF the bulls can take price through the overhead resistance line I have noted. If that were to occur, you could see enough short covering to take the price up towards the 50 moving average which is currently moving lower ( the trend has been down) and which comes in near the $1292 level.
While the ADX has turned down indicating that the current leg lower has stalled out, the Negative Directional Indicator ( Red Line ) remains above the Positive Directional Indicator ( Blue Line) indicating that the Bears are still in control of this market on the daily time frame. I do not see any bullish divergences among those indicators at this time.
Let's shift now to the Weekly Chart...
Can you see the difference in the ADX line on this time frame? While it did turn down late in July indicating the disruption of the intermediate term downtrend, it HAS NOT TURNED DOWN at this time. Actually it is NOW RISING. Translation - on this intermediate time frame, the downtrend in gold appears to be resuming. That is in stark contrast to the daily chart.
Keep this in mind - all trend changes will FIRST be detected on the Daily Chart. Later action will then determine whether or not such a trend change is occurring as well on the intermediate or Weekly Chart or whether this is just another move higher in an ongoing bear market. One really has no way of knowing this at this stage. Only viewing subsequent price action can determine this. It is important to note however that the longer the time frame used, the more important the trend. What this means is that the onus is on the bulls to prove that control of the market by the bears is in jeopardy.
Note that the Negative Directional Movement Indicator ( Red Line ) is firmly above the Positive Directional Movement Indicator ( Blue Line ). The Bears are firmly in charge on the intermediate time frame.
Generally speaking, rallies in gold will thus be sold until proven otherwise.
Let's start with the Daily....
Note I am only using the ADX on these charts as I am trying to discern a TREND change.
The first thing to notice is that the ADX line has now turned down from a high level (above 43). That tells us that the downtrend has been temporarily halted. I have noted previous downturns in the ADX by ellipses. Note that the market has experienced some upward moves in price that followed such events. Therefore, the POSSIBILITY exists that we could see a relief rally in gold.
In my view, this will only occur IF the bulls can take price through the overhead resistance line I have noted. If that were to occur, you could see enough short covering to take the price up towards the 50 moving average which is currently moving lower ( the trend has been down) and which comes in near the $1292 level.
While the ADX has turned down indicating that the current leg lower has stalled out, the Negative Directional Indicator ( Red Line ) remains above the Positive Directional Indicator ( Blue Line) indicating that the Bears are still in control of this market on the daily time frame. I do not see any bullish divergences among those indicators at this time.
Let's shift now to the Weekly Chart...
Can you see the difference in the ADX line on this time frame? While it did turn down late in July indicating the disruption of the intermediate term downtrend, it HAS NOT TURNED DOWN at this time. Actually it is NOW RISING. Translation - on this intermediate time frame, the downtrend in gold appears to be resuming. That is in stark contrast to the daily chart.
Keep this in mind - all trend changes will FIRST be detected on the Daily Chart. Later action will then determine whether or not such a trend change is occurring as well on the intermediate or Weekly Chart or whether this is just another move higher in an ongoing bear market. One really has no way of knowing this at this stage. Only viewing subsequent price action can determine this. It is important to note however that the longer the time frame used, the more important the trend. What this means is that the onus is on the bulls to prove that control of the market by the bears is in jeopardy.
Note that the Negative Directional Movement Indicator ( Red Line ) is firmly above the Positive Directional Movement Indicator ( Blue Line ). The Bears are firmly in charge on the intermediate time frame.
Generally speaking, rallies in gold will thus be sold until proven otherwise.
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