Saturday, September 08, 2007

August NFP, Recession, Gold

So there you have it. The August non-farm payroll was -4k vs. expectation of +100k (BLS report). June and July were also revised down sharply. I expected the number to be bad, but not that bad. The markets were obviously taken aback as well. On Friday, the Dow shed 250 pts or 1.87%. The Naz and S&P gave up 1.86% and 1.69% respectively. A 25 basis point cut seems baked in at this moment at the next Fed meeting on Sept. 18, with a 50 basis point cut likely.

If we do have a recession, and the odds are definitely that we will, it will be the second based on a collapse of investment after the one in 2000-2001 following the tech bubble. Some would say both are serial versions of a credit bubble where massive resources were misdirected to a segment of the economy. This is quite different from recessions of the bygone era which were mostly caused by inventory build-up and capacity glut (of manufactured goods). Recessions from credit bubbles are much more pernicious in that what’s left behind (think dot com companies and unfinished Miami condos) has little economic value. Moreover, in this particular instance, millions of home owners will have to face evaporated house values that may not recover for years. Keep that in mind next time you hear a so called economist citing from past recessions.

The main question I have regarding the equities is whether the relief rally I was anticipating has already played out. There is at least a 50/50 chance that it has. There’ll be a lot of speculation on the Fed next week, but I won’t be distracted. As far as I’m concerned, any bump due to Fed action is a good opportunity to sell.

I pay more attention to the Russell than any other index save the HUI these days because it’s more sensitive to economic conditions and it’s more detached from the emotions surrounding the financials. This year the Russell has been one of the weakest major indexes and it is looking sicker by the day. It has lingered sideways for weeks after coming down from the July top and unable to get above the 200 DMA. Now the 50 DMA has crossed below the 200 DMA. RSI, MACD and stochastics are all pointing down at this moment. [Disclosure: long TWM, the UltraShort Russell 2000 ETF]

Gold
I couldn’t be happier with the precious metals. They have diverged from general equities in the past week while base metals fell due to growth concerns. I haven’t written about them since the last bottom on Aug 16, fearing I that might jinx their advance. But I did manage to add to what’s already my largest sector holding on recent weakness.

I want to briefly mention the latest silver COT report which shows a commercial net short of only 25,000 contracts. This unprecedentedly low short position is extremely bullish for silver.

The contraction in the ABCP market is clearly deflationary. For those investors worried about gold in such an environment I heartily recommend this post from Mish: Is Gold Safe Place to Hide? The comments are worth a read as well.

There is broad consensus that credit contraction is deflationary and the central banks around the world will fight tooth-and-nail to re-inflate. I’m agnostic about the outcome of that battle; however, a case for precious metals can be made despite, or because of, this uncertainty. Despite what Mish wrote, the accepted wisdom is that gold performs well in hyperinflation and treasuries in deflation. However, gold is far from the worst investment one can make in a deflationary environment, and I would say much better than treasuries in hyperinflation. Therefore, given the uncertainty of the outcome, a prudent investor would have allocations to both gold and treasuries. Here’s the crux: even after the introduction of gold ETFs very few investors have any gold, so any re-recognition of it as a valid asset class would send the price soaring.

Despite too many false starts to count, the precious metals appear to be finally ready to start another run. As Prof. Lewis at Minanville says: “...the gold complex reacts positively to the monetary "medicine", not the sickness.” With ample cover provided by the weak NFP number, the Fed is ready to dispense plenty of “medicine”. I’ll be traveling next week. It seems important market moves always take place when I’m away. Let’s see if that continues.