The Daily Reckoning
Weekend Edition
February 05-06, 2005
Baltimore, Maryland
By Addison Wiggin and Tom Dyson
MARKET REVIEW: THE MARKET IS WRONG
Today we will commit financial heresy. We will make the
assertion that the market is wrong. Specifically, the bond
market.
George Soros, one of history's most profitable traders,
approaches every trade in this way. "Find the trend whose
premise is false and bet against it," he states in his book
'Alchemy of Finance.'
Today, your junior Baltimore-based correspondent will start
with the same assumption. We'll try to make the argument
that the market's current expectations for long-term
interest rates vis-à-vis short-term interest rates cannot
be correct.
You may have noticed: The yield curve is no longer curvy.
It's nearly flat.
At one end, we see Alan Greenspan. He's lifting. On
Wednesday, he raised his end another 25 basis points. It's
the sixth time in a row, and the market expects him to
continue lifting for the rest of the year...
At the other end, we find the bond market vigilantes,
foreign central bankers, institutional investors, carry
traders, hedge funds and other assorted lenders. They've
been pushing down yields by buying bonds.
In 2005, the 30-year T-bond yield has already decreased by
34 points. At 4.48%, yields haven't been this low since the
last week of June 2003.
On Friday, the yield spread between a 2-year Treasury and a
10-year Treasury narrowed to 80 basis points, the tightest
spread between these two since the second quarter of 2001.
The spread between 10-year and 30-year rates is now just 40
basis points, another new low.
The crux of the argument is this: the Fed will not
deliberately allow short rates to exceed long rates. It's
called an 'inverted yield curve' and it often causes
recessions.
A recession is the last thing the Fed wants to see. For the
past three years, the Fed has done its utmost to reflate
and stimulate. They've been modestly successful too. Stocks
have gone up, house prices have gone up, employment came
back, people still spend.
In 2005, stocks have been under pressure. But only 8 weeks
ago, they were making multi-year highs – both in the U.S.
and abroad. Last week, stocks went up, for the second week
in a row. The Dow gained nearly 2.7% to close at 10,716.
It's down 0.6% for the year. The Nasdaq gained 2.5% last
week, and is now down only 4.1% for the year.
Similar story with the jobs. Employment has been increasing
for over two years, but not as fast as we'd all hoped. On
Friday, we got January's number. The data showed a 146,000
gain compared to expectations of 200,000.
An inverted yield curve would undermine the Fed's efforts.
It stifles and suffocates an economy. So we have to assume
that they won't let it happen. And not only will they not
let it happen, they'll fight it.
The trend towards a flat yield curve is therefore false,
we'd argue. Or simply, either long-term rates START going
up, or short-term rates STOP going up.
How do you bet against the trend?
Buying gold would be one possibility. The yellow metal's
price is positively correlated to the yield spread. The
relationship is even stronger with gold stocks.
We found this fact at speculative-investor.com, "during
both 1986 and 2000 a large advance in gold stocks began on
almost the same day that the trend in the yield-spread (the
yield on the 30-year T-Bond divided by the yield on the 13-
week T-Bill) reversed from down to up."
Last week, the yield spread contracted and gold lost $10.50
an ounce to $414.80...
Regards,
Tom Dyson
The Daily Reckoning
P.S. The gold markets are already open in Asia, and no change
in the price so far...
In a communiqué issued yesterday, Saturday, it emerges that
the IMF will "look into using its huge gold reserves to
help finance debt relief for the world's poorest countries
on the urging of the Group of Seven rich nations," reports
Reuters.
On occasion, G7 meetings cause havoc with the markets.
Could Monday be one of those days in the gold market?
P.P.S Even if you do identify the 'trend whose premise is
false' you won't make money unless you can time the market
or, like Soros, you have deep pockets.
How do you time the market? It always helps if your buddies
work at the exchange. Take Kevin Kerr, editor of Resource
Trader Alert, as an example. He wrote this to his
subscribers on February 1,
"Did you notice that since the minute we got out of the
cotton trade, the market has been selling off? My word from
the floor was dead on. Cotton has seen fund selling and new
shorts come into the market, so we got out at the perfect
time."
Get on the inside track...
http://www.agora-inc.com/reports/RTA/tradeB00
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THIS WEEK in THE DAILY RECKONING
02/04/2005 - The Stain of Democracy
by Bill Bonner
"
They are not necessarily any better than those chosen by
other means - but at least the regime change is achieved
without violence. That is the progress of politics of the
last three centuries: force is replaced by fraud."
http://www.dailyreckoning.com/Issues/current/020405.html
02/03/2005 - Blowing Hot and Cold
by Jim Rogers
"And so, a rising commodity market would hurt many
companies and their margins, while decreasing prices for
those same goods over long periods would help them. In
theory."
http://www.dailyreckoning.com/Issues/current/DR020305.html
02/02/2005 - All Signs Point to Bubble
Kurt Richebacher
"It is undisputed that the greater part of the escalating
mortgage borrowing in the United States was for purposes
other than house purchases. In short, it boosted
consumption as a share of GDP at the expense of business
investment and the trade balance."
http://www.dailyreckoning.com/Issues/current/020205.html
02/01/2005 - Spotless Minds
by Nassim Nicholas Taleb
"He exhibits absolutely no embarrassment buying a given
currency on a pure impulse, when only hours ago he might
have voiced a strong opinion as to its future weakness.
What changed his mind? He does not feel obligated to
explain it."
http://www.dailyreckoning.com/Issues/current/020105.html
01/31/2005 - A Free Lunch on Easy Street
by The Mogambo Guru
"The lesson seems to be that a country and everyone in it
cannot continually borrow and spend their way to
prosperity, no matter how many Congressional buttheads say
that they can. But you can borrow and spend yourself into
bankruptcy and ruination."
http://www.dailyreckoning.com/Issues/current/013105.html
----------------------
HEADLINE, NEWS And INSIGHT:
02/04/2005 - Bureaucratic Gambling
by Steve Sjuggerud
"Contrary to what nearly everyone believes, you don't make
money buying an investment when it 'looks good' and
everybody knows it. It's ALREADY gone up."
http://www.dailyreckoning.com/Featured/BureaucraticGambling
.html
01/31/2005 - Winning Without Fighting
by Lord William Rees-Mogg
"China has been accused of helping some other nations, such
as Pakistan, to create nuclear programs; so Chinese
protestations should probably be treated with caution. But
there is nothing but reason and reassurance in the official
line."
http://www.dailyreckoning.com/Featured/Winningwithoutfighti
ng.html
01/31/2005 - Economic Lessons
by Dan Denning
"But the point is consumption does not lead to investment.
It is the other way around. If you have sharp increases in
investment, you have immediately rising consumption,
because the investment spending creates consumption."
http://www.dailyreckoning.com/Featured/EconomicLessons.html
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