Investor Alert: Disinflation And Slowing Monetary Growth

We released earlier this year the minutes of the first two Advisory Board meetings by Incrementum Liechtenstein in these two articles: Will Inflation Make A Comeback In 2014 When The Consensus Worries About Deflation and Outlook for Gold, Stocks, Economy. Incrementum Liechtenstein is running the “Austrian Economics Golden Opportunities Fund,” a fund that takes investment positions based on the level of inflation based on their proprietary “Incrementum Inflation Signal.” Incrementum Liechtenstein has Ronald Stoeferle, author of In Gold We Trust, as managing partner, and Mark Valek as partner.

In the latest Advisory Board which took place earlier in October, the investment landscape driven by the disinflationary forces were discussed. Based on the Incrementum Inflation Signal, it seems that the inflation/deflation-tug-of-war is very intense these days.

The signal switched to “neutral” at the beginning of August and then very quickly it indicated “disinflation” once again. A rather dramatic move in the USD, commodities, gold and silver followed. As can be seen on the following chart, the signal works well in real-time.

Development of Incrementum Inflation Signal and HUI Mining Index:


The second chart is the Commodity index (based on Incrementum Inflation Signal and Bloomberg Commodity Index):


Growth of monetary inflation is currently slowing down dramatically, as can be seen in the next chart. The bars in the chart represent the combined balance sheets of the Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, People’s Bank of China and the Bank of Japan.


One can also see that monetary inflation is losing momentum in the broader monetary aggregates:


Finally, High Yield spreads are actually widening.


These are all signs that this current disinflationary move is fully intact right now. The pace of monetary inflation is cooling down, according to several metrics. Could there be a significant correction/crash looming for asset markets?

Heinz Blasnik thinks that, by its very nature, a crash is a very low probability event. However, if we look at what central banks have done since 1987, they have become much more activist and have continually increased the size of their interventions. This means: Not only has the amplitude of asset bubbles increased, but also the probability of crash-like events.

The money supply metric that is most important is US money supply. Every other market is – to some extent – following the US. If we look at the broader money supply growth, it has slowed quite a lot recently but it is still historically high. In detail, narrow money supply (AMS) has actually increased recently, as banks have increased their lending, while the Fed has tapered QE. Therefore, US money supply growth is not that negative.

However, we have to consider that in an inflationary bubble, it is bad news when the momentum of monetary growth is slowing down. Moreover, we cannot state a priori what level of money supply growth is necessary to support an asset bubble. So, the demand to hold money has increased considerably. However, I believe that it is decreasing slightly in the US, as general economic activity has increased recently.

Investor sentiment is extremely bullish. However, we do not have a situation like in 2000 when everyone became a day trader, simply because retail investors have been hurt too much by the bubbles. First, they lost a lot of money in stocks in 2000 and then in stocks and houses combined in 2008. So they are not as easily enticed to invest in stocks anymore. However, investor sentiment amongst professional traders is very positive at the moment. I think this is a very strong warning signal, but definitively not a timing indicator.

With regards to leverage of investors, it’s at a record high. The likes of margin debt and hedge fund leverage are at record highs. Having a look at the Shiller P/E, valuations are at the 93rd percentile since 1870. In terms of price/sales, the market is the most overpriced ever.

Regarding the recent weakness in high yield bonds: central bank policy has led to another yield-chasing rally. These bonds pay interest that is not really rewarding the holders for the risk that is taken. But investors are taking these risks anyway, as according to rating agencies, the expected default rate is at an all-time low! So investors feel that they are actually not taking too much risk.

The most important point: banks are no longer making the market anymore, because of legislation, the likes of Frank Dodd, etc. Banks do not do any prop trading in high yields anymore. This means that it has become a very vulnerable market. While there has been a huge amount of issuance, liquidity levels have fallen. This will have a major influence if the market goes down.

And the last point; the market internals. Small cap stocks (Russell 2000) have started to underperform and break down and this suggests that market liquidity is not high enough anymore to lift all boats. So, the danger of a severe market correction has increased further. This is clear. When it is going to happen, I am not sure. But it’s probably not too far away.

Currency wars update in the current disinflationary trend

(by Jim Rickards)

The market expects interest rates to be raised by mid 2015. This leads to all kinds of dynamic outcomes, including a strong dollar, capital outflows from emerging markets, unwinding of the carry trade, weak commodities and so on. So those are the expectations. We are seeing growing deflationary pressure in the Incrementum Inflation Model and in my own model. From my point of view, the only reasonthe Fed will raise rates is inflationary pressure. We don’t have to agree with her opinion, and my opinion is irrelevant, but I try to think like Janet Yellen does. She wants to address the labour issues in the US. If there would be one economic number that is most important for the Fed at the moment, it would be real wages. She looks at real wages as the thermometer of inflation. If labour markets are tight, wage pressure should increase and this would be a leading indicator for the Fed. Right now, real wages are not going up and labour market participation continues to decline.

So let us put all that together: the market is discounting that the Dollar will continue to strengthen, deflationary pressure is increasing and the data suggests that the Fed has tightened into weakness. Remember, Janet Yellen didn’t start the taper. Ben Bernanke started to taper as he wanted to leave with a legacy.

Right now, we have the most hawkish FOMC in a very long time, but in January this will change. The two hawks Fisher and Plosser come off the FOMC and will be replaced by super-doves Evans and Lockhart. So hawks will be replaced by doves among the presidents. Moreover, president Obama will replace the vacancies with Stanley Fischer, who was Janet Yellen’s mentor. And, lastly, Yellen will have been in the job for one year in January and she will feel that she’s in charge and that it’s her board.



So, you have a very hawkish FOMC today and we will have a very dovish FOMC starting in January. So the whole world is set up for a stronger dollar, a strengthening US economy and rising rates. The data and politics are showing deflation, a very weak recovery, a dovish board. So my expectation is that the Fed will launch QE4 in spring 2015 or little later. That will not only be a reversal of policy, but it will come as a shock! This will result in a rally in US stocks and emerging market stocks, a weakening USD and rising commodities.

There is no chance that they will raise interest rates in 2015. Tapering has failed twice and it will fail again. For the next four months, I would expect a continuation of the current trend: very weak gold, higher rates, strong dollar, weak emerging markets and further deflationary trend. But at the first meeting in January 2015, the FOMC will signal for the next two or three meetings that they might reverse their strategy. This may come as a shock to the market, as the market will realize that the Fed has no way out.

They will not rest until they get inflation. Therefore, they will have to print a lot more, which will be quite positive for gold.

Gold update

If gold goes back to the 1,200 level a fourth time, then it could get dangerous as it might fall to 1,050. This should bring in some major support. But currently gold is still in an ongoing bear market. It is not given that gold has found its bottom yet.

There is a seasonal correction. Is it going to develop into a major crash? Fact is, that money is parked, malinvestments are built up and if the economy weakens, then the “magic hand” will come up and help us to some more malinvestments further down the track. So it’s a very kaleidoscopic world, where the mixture of technical and fundamentals makes absolute return investors think that having lots of cash is not the worst idea. If you don’t find a decent risk-return, don’t do it.

Read the full transcript


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