“Deflation is still the 800-pound gorilla in the room,” wrote our Jim Rickards yesterday in an exclusive dispatch for Agora Financial Reserve members.
Jim is constantly monitoring the tug of war between deflation and inflation. As he said two weeks ago here in The 5, deflation has the upper hand… at least for the time being. Six-plus years of near-zero interest rates coupled with bouts of “quantitative easing” haven’t been enough to stoke the inflationary coals, at least not to the Federal Reserve’s satisfaction.
But wait — what about the improving job numbers? Don’t those point to an inflationary turn?
After poring over last Friday’s unemployment report, Jim acknowledges “real wages rose slightly, a sign of decreasing slack in labor markets and possibly an early indicator that workers are finally in a position to demand raises from their bosses.
“Fed chair Janet Yellen has several dials on her dashboard, but real wages is the one she watches most closely. That tells her about labor market conditions and possible future inflation at the same time.”
This gets back to the Fed’s “dual mandate” of maximum employment and stable prices — although as a practical matter, Fed governors define “stable prices” as inflation of at least 2% a year.
So from the Fed’s perspective, it’s all good, right?
Hold on…
“The deflation coming from lower oil prices, reduced drilling activity, oil patch layoffs and collateral consequences has barely begun to show up in reported data,” Jim says.
“This oil price decline looks more permanent, probably lasting several years, because it is being dictated by global fundamentals that show no signs of reversing and by Saudi Arabia, which is the only producer in the world with the right combination of low costs and high potential output to dictate world prices.
“Deflation has other sources as well, including massive debt, deleveraging, technology and demographics.”
“What if inflation and employment do not move in sync?” Jim asks?
“What if job creation remains strong, but deflation persists because of energy prices, oversupply, demographics and other factors? The tighter labor markets may induce the Fed to raise rates on inflation fears. Yet the higher rates may make the dollar stronger and cause more deflation — the exact opposite of what the Fed wants.
“Deflation still has the upper hand,” Jim sums up — “which lowers expectations about price increases in consumer goods and major assets such as housing. Even the jobs that are being created are part-time and low wage — not the kind of jobs that support household formation and new home sales.”
Jim’s favorite deflation play remains U.S. Treasuries in the form of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX) — up 12% since he recommended it in November.
[Ed. note: Jim is taking part in a debate tomorrow night — part of the Intelligence Squared series that airs on nearly 250 public radio stations nationwide.
The proposition — “Declinists Be Damned: Bet on America.”
Yes, Jim will be arguing the negative… heh.
You can watch the debate live tomorrow night starting at 6:45 p.m. EST. We have a link ready to go where you can watch the live stream. You can bookmark it right now.]
The major U.S. stock indexes are registering modest gains as we write this morning. The S&P has added six points, to 2,053.
Bonds are selling off, the yield on a 10-year Treasury rising above 2% for the first time in more than a month.
Gold is losing ground ever so slightly at $1,237. Chalk that up in part to dollar strength; the dollar index is up to 94.7.
Another day, another big move in crude: At last check, a barrel of West Texas Intermediate is down nearly 4%, to $50.77.
To hear the mainstream tell it, crude’s rise since late January has been a function of a falling “rig count” in the United States. The oil services firm Baker Hughes issues its U.S. rig count numbers every Friday… and for the last two Fridays, the oil price has jumped coinciding with the falling rig count.
Fewer rigs, tighter supply, rising prices. Right?
“The rig count story doesn’t have a shred of credibility when examined closely,” says our friend Erik Townsend — who trades crude futures for his hedge fund clients.
“The financial press conveniently leave out that the last seven Baker Hughes rig count reports in a row have all shown sharp declines in operating rigs. Each time such a report has been released in the past couple of months, the result was a sharp acceleration in the sell-off, as the market interpreted the lower rig counts to mean that the oil companies know this is going to get worse.”
But crude leaped 8% on Friday, Jan. 30, and The Wall Street Journal ran with the rig count “explanation,” practically declaring the bottom in crude was in.
Here’s something else that doesn’t add up: If the rig count were the driver, we’d see a steepening “contango” in crude: That is, the price of a futures contract one year out would have been rising even faster than the spot price.
“In other words,” says Erik, “the lower rig count doesn’t mean less supply next week. It means less supply a year or more into the future. So if that were the driver, you’d expect to see an increase in the premium over spot price for crude oil futures a year into the future.
“The exact opposite happened on Jan. 30 — the one-year contango actually narrowed slightly, suggesting that traders may be buying front-month oil and simultaneously selling a year forward, with the intention of storing that oil on tanker ships in the interim. And it’s continued to narrow very slightly since then.
“I think a more likely explanation is simply that this market has been WAY overdue for a bounce,” says Erik.
“Jan. 30 was also the last trading day of the month. My guess is a big hedge fund with a losing long position started this by monkey-hammering the market higher into the close, to make their closing numbers look better. Then The Wall Street Journal declared that the soft rig count has the exact opposite meaning it had for the past six weeks, and presto! You have a classic short squeeze.
“If you look at the big oil sell-offs of the last few decades, the sucker rallies along the way down all ended at the 50-day moving average. Guess what we just hit today? You got it! And look what the market is doing.
“I think the top is in and we’re headed down toward $40 or lower from here.”
Small-business owners are still feeling good, judging by the latest Optimism Index put out by the National Federation of Independent Business.
The January number clocked in this morning at 97.9. That’s down from December’s 100.4 reading, but still in the “normal” zone based on nearly 30 years of these surveys.
As long as we’re on the subject of deflation today, we note “inflation risks” barely registered in the latest survey. “Only a net 3% of owners reported raising average selling prices,” says NFIB chief economist Bill Dunkelberg.
Inflation also barely shows up in the “single most important problem” part of the survey — a table we always find revealing…
But the insurance category is registering double digits for the first time in several years. Obamacare finally starting to bite? Hmmm…
Among the big winners from the latest skirmish in the currency wars — German prostitutes.
Specifically, prostitutes in Freiburg and other cities near the Swiss border, thanks to the Swiss National Bank’s decision last month to “de-peg” the franc from the euro.
“Those who earn wages in francs have been streaming into neighboring countries in search of bargains since the Swiss central bank ditched a currency cap,” according to Reuters, “making goods and services priced in euros almost 20% cheaper overnight.”
At a brothel in Freiburg, an employee says about half of its customers are now Swiss. Outside its building, Swiss flags fly and Swiss customers are offered a 1:1 exchange rate — better than the official rate.
“In response,” the newswire goes on, “some Swiss brothels have launched special promotions. ‘We are keeping the euro stable,’ Saunaclub FKK Basel, located in Switzerland’s capital, says on its website.”
Prostitution has been legal in Switzerland since 1942. German brothels have been allowed to advertise since 2002. Now you know.
“Our country has been addicted to borrowing and printing and just plain printing for many years now,” a reader writes on Gallup CEO Jim Clifton’s claim it would take 10 million new quality jobs to replenish the U.S. middle class.
“And since the dollar is the world’s reserve currency, it has a profound effect on the rest of the world as they try to maintain the value of their own currencies.
“As the USA has flooded the world with these dollars, other countries are forced to devalue their own currency in an effort to purchase and maintain some sort of parity with the U.S. dollar. Every day, we read that a foreign country has reduced their interest rates on reserves with the presumed intent of forcing that money into the economy and hopefully getting some inflation.
“But this has another effect on investors as they search for the most stable and safest place to invest their money, since it is losing purchasing power in the country they live in. This is responsible for the continued flow of money from overseas into the USA, and as a result, the U.S. dollar has been rising.
“Then it becomes clearer as to why the jobs are disappearing, as it becomes more profitable for goods to be manufactured overseas and shipped back to our country. If the prices of goods manufactured in a foreign country remain fairly constant, the U.S. dollar will be able to purchase more of those products, creating more demand and more jobs for those factories overseas and fewer jobs here. Of course, overregulation has a lot to do with it also, but that is another subject.”
“The simple answer is yes,” a reader writes in reply to the question “Could Steve Jobs have started Apple without RadioShack?” and the wider question of American innovation.
“Back in Jobs’ time, there were many mail-order catalog companies that sold electronic components. Digi-Key and Jameco, for example. There are still many electronic suppliers that stock components available by mail order. Your readers forget that Jobs would not have had the Internet to search for his components! The Internet we now have access to just makes it easier. As one writer put it, you just have to wait a little longer to get the parts.
“As RadioShack emerged into the failure it became, it also became worthless as a bastion of parts, rarely having stock on anything beyond batteries and cords!”
“Jobs and Wozniak might have gone to a RadioShack or two,” another reader points out, “but they were both employees of HP at the time.
“HP had a policy back then that the parts bins used by the engineers were open. Jobs and Wozniak very well could have walked out of HP with whatever small parts they needed. HP used this to spur engineers to create and experiment.
“Thanks for the good reads.”
The 5: RadioShack’s coup de grace might have come in October, when the firm took on Harry Wilson. Wilson, a corporate consultant and former senior adviser to the Obama Treasury Department, was named “chief revitalization officer” at RadioShack.
Having failed to revitalize RadioShack, Wilson announced this morning he’s nominating himself for election to the board at General Motors.
For real.
And yes, Wilson is a product of Harvard Business School.
Best regards,
Dave Gonigam
The 5 Min. Forecast
