Crazy Market Thoughts Wake me up When September Ends

Gold, silver and commodities moved higher this past Wednesday on the back of confusing data about the current state of the "green shoots recovery". Gold was able to handily regain the $1,000 handle in a clear sign that this level, at least on a microscopic scale, no longer represents a psychological bulwark. Oil also surmounted $70 once again after trading as low as $65 at the end of last week. The U.S. dollar fell, but not as much as one would have thought by looking at the gold, silver and oil charts.

The confusing data came in the form of conflicting reports that showed the U.S. economy is not performing as poorly as previously expected but may be performing more poorly than currently expected. First there was an upward revision of second quarter 2009 GDP to a final minus 0.7% from a preliminary minus 1.0%. Second, there was a report that unemployment actually fell in August in 60% of the metropolitan areas surveyed. Third, the Chicago Purchasing Managers Index fell to 46.1% for September from a perfectly neutral 50.0% reading in August, indicating contraction of business activity in the Chicago area. Fourth, another jobs report that indicated companies are firing fewer people (most likely because there are fewer people left to fire). Along with recent statements by wunderbanker Bernanke that the U.S. recession is likely to have ended sometime in the third quarter, the picture is pretty much complete. Unfortunately it looks like finger painting by a rowdy group of three year olds who aren't very good at finger painting. Our interpretation is that everybody seems to be grabbing at straws in an attempt to be right -- about something in general or anything in particular-- after being so horribly wrong for so long.

The way we see it, much of the apparent economic improvement has been the result of temporary stabilizing effects from the various stimuli, rescues, bailouts and handouts of the past two years. Unlike some others, we don't subscribe to the dogma that government intervention is always a bad idea -- in this case it likely prevented (at least so far) a backslide of no less than 200 years in the socio-economic advancement of mankind.

We also cannot say with 100% certainty that things will be worse going forward than they would have been if the markets were left to reclaim equilibrium in true laissez faire fashion (and it should be noted that we are very much in favor of laissez faire). The reason for our uncertainty is simply that there are no convincing historical examples of laissez faire triumphing over the basest instincts of man, which are decidedly not laissez faire. If left to his own devices, man will not trade freely among his kind but instead simply take what he covets by force or trickery. We are speaking in general terms of course but we could put names to our argument as well: Madoff, Stanford, etc., you get the point. Besides, anybody who has observed unsupervised children on a playground should know that laissez faire capitalism occurs about as naturally as Marxism. Both require fundamental altruism in order to properly function and therefore have to be enforced at the point of a gun. We suspect that is why the United States was arguably one of the last bastions of it; Americans have a lot of guns. Meanwhile, China appears to have found a way for the two competing systems to co-exist. Yin and Yang. At peace for now.

What we can say with great confidence, however, is that the current imbroglio represents a chronic symptom of the terminal financial disease that must be eventually faced. In summary, parts of the world have amassed debt they cannot possibly hope to ever repay while other parts have saved and invested according to the mantra, "if you build it, they will come". Under these conditions, all governments can hope to do is stretch the day of reckoning out a week or perhaps a few years. But debt and capital destruction are unavoidable, one way or another. The trick, of course, is figuring out which way and investing accordingly.

Case in point is the current confusion about the state of the local and global economy. It is altogether possible that the recent "improvements" -- including some of the economic data released on Wednesday -- are already in the rear view mirror. In other words, we might be in the waning stages of an "economic upturn" that lasted from perhaps May to September, to be followed by episode two of business and consumer entrenchment. Actually, it's probably less like episode two and more like the second act of a tragedy with three more acts to go. We should all know by now that things don't actually get better. The intervening "action" between the first and last acts is just embellished space-filler that cannot possibly alter the pre-ordained course of tragic events.

Which brings us back to gold, silver, commodities, stocks, currencies and other markets. We note with some trepidation that all of these markets are currently trading on similarly upbeat sentiment and positive expectations. Not popular at all for the moment is grim reality. We find this surprising given the events of the past couple of years. Certainly market participants should easily recognize fact from fiction by now. But they don't, or rather won't, because they think they are invincible. The common mental ailment they share with all tragic figures is hubris. So they focus, for example, on the possibility that the housing market may not fall another 30% instead of focusing on the probability that 30% of homes will remain 30% underwater indefinitely (don't quote us on these figures, we are approximating for the sake of arithmetic rhythm). We can take virtually any piece of economic data out there and the odds are that the markets have cherry-picked the parts of it that don't look absolutely horrific, especially when viewed in total isolation. Back up a few steps, however, and the big picture looks remarkably like Hell. We suppose it is the eternal optimism of homo sapiens that conveniently blinds us so successfully. What else but eternal optimism can explain the time many of us waste watching golf, tweeting, counting our good fortune and cursing our bad luck, all the while mortality lurking around every corner?

It turns out that just about the only market that consistently bases expectations on reality is the bond market. This is a boorish bunch, but more than that, its denizens are clearly not human. Our version of logic dictates they must therefore be aliens. In fact, if we had more time and worried less about our own mortality, we would stake out Bill Gross of PIMCO to snap pictures of him boarding a UFO for the daily commute home. With our luck, however, the National Inquirer would beat us to it. So, we are left pondering if this time it might truly be different. Could the aliens in the bond pits be wrong? Do tepid interest rates signal a monumental misreading of the economy or inflation? Unfortunately, answers may not be forthcoming without an alien abduction. Not of us but the aliens. To be followed by water boa . . . ahem . . . enhanced interrogation techniques. On second thought, that might not work. Because of the gills.

We're near the end now, so please don't get mad at us for wasting over 1000 words to explain our simple thesis that human beings are rarely right about the markets compared to aliens. You see, we had a good reason for wasting your time. Otherwise, you might not have believed us when we warned you to beware of aliens buying gold. You still might not believe us, but we will persist nonetheless.

Perhaps we might improve our credibility if we rephrase our thesis as "the end of the world is near when the smartest of the smart money is buying gold"? Heck, who knows, you might even put up with our strange ways indefinitely when we tell you there is a tool that can reveal the precise moment when the buying starts. It is called the gold and silver basis and we will do all the work to figure it out. All you have to do is think long and hard enough to realize we are right, and then act when the time comes.

Alas, the gold and silver basis are not telling us anything smart about the smart money at this precise moment. Absent that, we'd just as well listen to something dumb about the smart money, and do the opposite. Please stay tuned*.