No. of Recommendations: 12
In the twenty five years that I have been studying the economy and markets I have been struck by the fact that situations never really repeat. That is, the equilibrium in the markets is always supported by a new set of juxtaposed criteria, constantly evolving as events shape the recent past and influence the immediate future.

That said, I believe it's also true to say that the complexity of the situation varies between extremes. For example, at one time or another the overwhelming paradigm might be the question of if and when the Fed will lower interest rates, and other factors recede into irrelevance. At another time interest may be focussed on overseas events and their impact here as during the Asian Contagion. And there are times like the present when there is no general consensus at all as to what is or should be the driving force affecting the market. At such times, there are many paradigms operating simultaneously with consequent confusion and contradiction, or paradox, in the markets. And usually at such times general discussion is concentrated on the main factors of influence from the last period, which is now over.

These are the times of greatest opportunity, as great adjustments are made when the dominant forces have their way. For instance, since March 2000 outstanding investments have included the low-risk interest bearing instruments such as preferred stocks, convertibles, REITs, all kinds of Treasuries, and investment-grade corporates. However, bonds have not been the dominant topic at all throughout this period. While the various arguments have raged about whether to go long or short growth stocks for this or that reason the real driving forces of the market have been in the bond and currency arena, and this has been the area to concentrate on.

Now the situation is as opaque as ever. Popular topics include the bond bubble, real estate bubble (not my terms), possible fed moves, tax cuts and of course the inflation/deflation controversy. People are also concerned about SARS, Chinese dominance in manufacturing, Japanese bank insolvency, perceived international instability, and worldwide slow growth.

I think that we should do as Richard Russell advises, and try to see what the market is telling us. What is the dominant recent new trend? It is the falling dollar. My local radio station has started reporting the gold price (that is, the value of dollars) in its market updates at last. People are starting to notice the trend in the dollar against other currencies, but have not yet become concerned that gold going up is the same thing as the dollar going down in absolute terms rather than against a foreign currency index. Further, interest rates are the third way of measuring the value of a dollar, and people are willing to pony up much less in the way of interest payments for the use of a dollar lately. So, whichever way you measure it, the dollar has been in a strong decline, with all the forces still in place to exacerbate it, and some new ones like foreign repatriation of investment funds and both fundamental and momentum trading into gold and the 480 billion and rising govt. deficit and the State budget crises
and renewed American interest in overseas investment and rising foreign central bank interest in Euro and gold reserves and rising foreign perception of us as warmongers and Iran coming into our sights and tax cuts all joining together at the same time to induce people to at least diversify out of the dollar to some extent. (Oh, and I forgot old George S. telling the world that he is now short the dollar)

So, considering all this, it seems that some of the current market parodoxes might be resolved soon by relatively strong adjustments as follows.
Paradox 1) The bond market rising due to fears of deflation and slowdown while the stock market is rising in a tide of optimism that the economy will speed up.
Adjustment: The stock market will fall because it is denominated in dollars, which are getting less popular. The bond market will also fall (with the possible exception of TIPS) as bond markets usually do when their currencies take a big hit.

Paradox 2) Commodity prices have been rising during a worldwide business slowdown.
Adjustment: They will continue to rise. It's the dollar, stupid!

Paradox 3) Inflation is falling while the dollar is falling, M3 has been growing quite strongly for years, and our trade imbalance is past generally recognised danger limits.
Adjustment: Inflation will rise as money loses its value. Inflation has been subtly with us for years, but has been disguised by the strong flow of cash into Wall Street. As soon as stocks and bonds take another hit flows will reverse and start going into the usual inflation hedges - real assets.


As to Govt. intervention to save the dollar, I don't believe they have enough gold or foreign reserves to stand up to the wide array of forces currently lined up in opposition to them.


When the new exchange traded gold bullion fund (symbol: GLD) is approved, it would seem logical that it will grow so fast that it will affect the price of gold just by itself.


Good luck,

Ed.


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