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Deflation Scare Dead Ahead

Economics / Deflation Jun 14, 2010 - 12:20 PM GMT

By: Captain_Hook


Best Financial Markets Analysis ArticleAccording to John Williams of, although the Employment Report to be released this Friday will appear robust on the surface, May payrolls could contract net of the temporary census boost, setting up a buy the rumor sell the news trade in the stock market. So this, combined with positive seasonality and the fact stocks are technically oversold on a short-term basis suggests gains should be expected into Friday, or Monday at the latest, however afterwards a resumption of the downtrend established over the past few weeks should return, potentially yielding significantly lower prices. Heaven knows the fundamentals support such a view, and have for some time, but now we also have bearish speculators exhausted as evidenced in falling US index open interest put / call ratios, where the bureaucracy’s price managers are unable to squeeze our faulty and fraudulent stock markets higher anymore.

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, June 1st, 2010.

And who knows, stocks may not even make it to Friday considering all that’s going on these days. There’s a worsening ecological disaster in the Gulf of Mexico that is the worst ever threatening to decimate economies on an unknown scale. There’s another volcano in Iceland threatening to erupt that would shut down Europe in more ways than one. And most importantly there’s a global credit contraction contagion on the brink of being triggered. In fact, when you boil it down to important factors in a fiat currency economy, it could be said money supply is the most important factor of them all, because theoretically, if you throw enough of the green stuff at any problem it’s suppose to go away, at least temporarily. At least that’s the way it was until lately, where because of sheer magnitudes of debt and deficits stimulus spending of this variety has reached a state of plunging diminishing returns replacing marginal declines previously.

That’s why it would take hyperinflation and accelerating debt monitization past already witnessed extremes to keep the economy from imploding at this point, and this, along with falling conventional money supply measures (see below), has many observers worried about deflation at the moment. And they should be, because although the Fed can print copious amounts of new money anytime it wishes in theory, with the public so enraged about all the fraudulent bailouts over the past few years, and now doing something about it, sapping the political will in Washington for repeat performances, the future is now uncertain in this regard, especially since Bernanke and company are now under investigation. So as you can see, it’s understandable why some are very worried about a meltdown moving forward, again, especially with conventional money supply measures signaling trouble ahead.

In looking at M1 below, while off the highs it’s still expanding, meaning the currency component continues to be debased, albeit at a decelerating rate. Thus far however, this is not a picture of deflation – not yet. (See Figure 1)

Figure 1

This next chart of the M1 Multiplier is however, given it’s plunging and remains at depressed levels, however one must realize this is because the monetary base (monetization practices) has been expanding so rapidly these past few years with all the bailouts, being measured in the monetary base, which is the denominator in the equation used to calculate this measure. Or in other words, the multiplier is a lie, and could in fact rise if for example politicians stopped bailing out failing financial institutions, which could cause deflation if the Fed’s response to such circumstances was not substantial. (See Figure 2)

Figure 2

That’s the risk moving forward you see, where growing numbers of Tea Party constituencies makes such a risk very real since this thinking is essentially the basis of the party’s platform, this and the removal of unfair taxes that result from such policy. And as alluded to above, this is the message plunging growth rates in M3, M2 (featured below), and other conventional money supply measures are throwing off right now, given because of their make-ups, the true money supply situation cannot not be ascertained by these representations. Therein, because of definition changes and the need for government obfuscation, these measures cannot be taken as being representative of true money supply. (See Figure 3)

Figure 3

No, in this respect, the only measure besides gold that should be taken seriously is in fact True Money Supply (TMS) (defined here), as produced by the Mises Institute. As you can see below, like M1 TMS is still growing (at approximately 10%), which is definitely not a deflation signal, making other less forthright money supply measures redundant. This of course does not mean it cannot fall into contraction mode too, which is a real possibility moving forward, however until it does, as per the title of this study, falling equity prices would constitute nothing more than another deflation scare for mass consumption designed to keep those with a conscience bearish on stocks. (See Figure 4)

Figure 4

You see the hope by the bureaucracy’s price managers in experiencing volatility (which they cannot control if the trade is not increasingly bearish) is that a fresh round of unsuspecting speculators / hedgers will run out and buy a bunch of puts because they become scared, allowing any increase in money supply to maintain the perpetual short squeeze in stocks that has lifted prices all these years. This is the other central element that has a primary influence on prices in our fault and fraudulent markets, that being speculator sentiment. And this is why bad news about the economy can come out and stocks go higher anyway, because if a large enough percentage of speculators are short stocks, with the most effective measure in this regard being high and rising US index open interest put / call ratios, discussed here (because positions are held overnight evidencing speculator conviction), buoyant money supply has generally had the effect of squeezing prices higher even with the increasing volatility we have been experiencing recently.

If however bearish speculators (put buyers) remain out of the market on an extended basis despite bearish news and falling prices because they are exhausted, which is the situation at present, then stocks can crash, which would be signaled this week if the May lows are taken out in the indexes before a higher high is witnessed. Of course even if this occurs (higher highs) this week, as per our opening comments, this does not guarantee the sell-off in stocks directly ahead will not be bad (i.e. 20% plus); however if this does not occur, then you can count on the present sell-off developing into a crash (see Figure 2) fairly quickly. Here, I would expect 10,000 on the Dow to be broken to the downside on a lasting basis, not that it wouldn’t necessarily be tested again as volatility associated with prices attempting to push through the significant round number at 1000 on the S&P 500 (SPX) is experienced.

Based on the way US index futures and foreign markets are down this morning, unless a bounce can be engineered by price managers today, a bearish signal might in fact be generated this week much to the surprise of most speculators who are (still quick to cover puts and bold in buying calls) expecting prices to be gamed higher into the Employment Report on Friday. This is not surprising to us however because we know US index open interest put / call ratios (see above) have been trending down and for the most part are at six-month lows. And we also have further confirmation such a possibility could occur directly in this next series of charts as well, where indicators / stochastics are pointing to losses in stocks against gold / precious metals shares, the latter measure being the Philadelphia Gold and Silver Index (XAU). First we have a look at the Gold / Dow Ratio, which although it’s the flipside of the Dow / Gold Ratio looks quite different in terms of how much further the move(s) have to go in their larger degree wave configurations. (See Figure 5)

Figure 5

You will get an idea of what is meant when I say the Dow / Gold Ratio doesn’t appear to have far to travel to the target in looking at the SPX / Gold Ratio featured next, where like Figure 3, indicators / stochastics appear poised to plunge as well. The reason I am showing you the SPX / Gold Ratio instead of the Dow / Gold Ratio this morning is not just for this reason, but to make the point it’s threatening to break a standard deviation at unity (not shown on this chart in the Chart Room due to clutter considerations), which would also be a crash signal. (See Figure 6)

Figure 6

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. As you will find, our recently reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

And if you are interested in finding out more about how our advisory service would have kept you on the right side of the equity and precious metals markets these past years, please take some time to review a publicly available and extensive archive located here, where you will find our track record speaks for itself.

Naturally if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

By Captain Hook

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities, as we are not registered brokers or advisors. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Do your own due diligence.

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