The Crystal Ball
It has been a year since I started this blog and to those of you that have read my musings and still return, I would like to say thank you. As I had announced in the beginning, I have written many articles that incorporate my economics back ground into the financial thinking process which I employ to survive and strive in the financial market place. To that extent, I think most of the theories have been explained in detail and now is the time to focus on finance and game changing events rather than theory. As a consequence, the frequency of my posts will depend on the flow of events that are worthy of discussion and action.
In the past month, the financial markets have been extremely calm. I want to use today’s post as a personal outlook to what lies ahead in 2014. In the end, this is a finance blog and as an active trader who participates in all major markets, I have an opinion that I want to share. Having said that, be careful to follow my advice. The financial market is a set of “moving targets” and what I think today is based on today’s facts. If I change my mind tomorrow due to changing fundamentals, things may look different. I shall revisit this article in a year to see how my “crystal ball” has performed and if the name of the blog should be changed to “market mole”…
As I have written in my latest post “Surfing the Elliot Wave”, the developed world’s stock markets have been the best performers in any investment class in 2013. Corporate balance sheets are relatively healthy, government policy remains friendly and fixed income yields little to zero. Looking at the chart of the S&P500, you can see a healthy uptrend in which both the 50 day moving average(medium term trend) and the 200 day(long term trend) point up with the 50 day above the 200day MA. This is a very healthy chart and I don’t expect a trend reversal below the 200day average anytime soon. A correction of 7% to the 1650 level is possible and even likely at some point but as long as (government) bonds yield little and interest rates have no place to go but up, the trend in stocks will continue to be up. If economic numbers should improve I would not rule out a stock mania in a year or two.
The seed of the next financial crisis lies here. Governments all over the world are hopelessly indebted and the future pension obligations alone cannot be honored. As you can see below, the Federal Reserve now holds roughly 30% of all long term US debt. Needless to say, this situation is unsustainable and will be at least a $4 trillion dollar issue down the road. Considering $4 trillion is roughly 25% of the entire economy’s annual output, the next crisis will surely be a big one. On top of that, this is the US situation alone. Add Europe, Japan and emerging market indebtedness to the mix and the consequences will surely be historical. Therefore, stay away from long term bonds, if you need security, you are better off holding short term debt or stocks that yield about the same as government debt.
Now, take a look at the chart below and you can see the opposite trend as in the stock market. Both 50 and 200 day moving average are trending down and the 50 day is below the 200 day average. Stay away.
Considering the monumental money creation on a global scale it is truly baffling why the gold price has gone down considerably this year. That is until you realize that gold has gone up 12 years in a row and needed a break from hot money flows. While my opinion on gold as essential financial insurance hasn’t changed, AU too, is in a confirmed down trend as the chart below shows. Unlike bonds however, the future is likely to be rosier for the shiny metal. After all, average mining cost is $1250 an ounce and with the gold price right there, many mines are reducing production and/or shutting down and thus, future supply is decreasing. Lower future supply will lead to higher prices eventually. For the next 12 months, I wouldn’t be surprised to see a capitulation phase in which gold craters to $1000 or so which will wipe out any hot money interest in the metal. That should mark the end of the down trend and I do expect significantly higher gold prices a few years into the future as the government bond crisis unfolds.
Despite $1,000,000,000,000 trillion of money creation by the Federal Reserve in 2013 alone, the dollar’s value has only declined marginally against the rest of the world’s currencies. The main reasons for only a minor decline are to be found in the fact that most global central banks are creating currency at mind-boggling speed. Furthermore, the US economy enjoys an energy revolution that has led to a fast shrinking of the trade deficit which supports the US $. The most interesting currency to me remains the Japanese Yen. It has fallen 25% in 2013 alone yet Japanese bondholders are happy being paid less than a per cent a year to hold Japanese debt, for now… At some point, the decline in the yen will accelerate and a Japanese bond crisis will emerge. I’ll keep you posted.
As for trading the currency market, I would like to refer to Kyle Bass’ recent suggestion of which trade he would initiate for the next 10 years if he only had one option: Buy Gold in(short) yen. I concur.
In conclusion, I want to point out that I expect 2014 to be a largely benevolent year to stock investors but do not forget about the underlying seeds for the next crisis which will surely be upon us within a few years. For now, happy holidays and enjoy the New Year celebrations.