September 26, 2003

Three Little Charts, the End of the World as We Know it, and a Brave Newer World

Earlier this morning I had my heart set on giving you an irrefutable case proving that the “financial” economy created by the debt and loose Fed money is a) real, b) dangerous, and c) about to be destroyed by a sinking dollar. I was going to make this case because I realized that a lot of you may have not heard my basic investment position. And so the various comments I make on the Insider that show one or another aspect of this idea would lack a context…if you didn’t know I was talking about the end of the American dollar standard and how to survive it. But I’ve been a bit heavy handed all week. So I will spare you a long march through the numbers and show you just three little charts. They show how the financial economy, like Saddam Hussein, has found refuge in a sector or asset class, then been “smoked out,” causing a fall in that asset class and a new bubble somewhere else. It’s now on its last legs, and then end is picking up speed. First is the Philly Semiconductor index from 1997 to now. You can see how it went parabolic at the height of the bubble in tech stocks. Semiconductor stocks still lead bullish rallies…on the ever-present hope that the glory days will come back. They won’t. First it was tech stocks... Next is the bond bubble. Investors figured if stocks weren’t going to go up 40% each year, it was time to get in bonds. And in they went. But when the Fed said this summer that it was more afraid of deflation than inflation, and would keep rates low for a “considerable” time, the bond market cratered. Then it was bonds... And now, we have one last sector of the market that is supported by lower rates, housing. The chart below shows the iShares Dow Jones U.S. Real Estate Index Fund. It’s designed to mimic the performance of the Dow Jones Real Estate Index. The fund holds a basket of real estate investment trusts. It’s been a big beneficiary of the confidence investors having in rising real estate values and a strong housing market. And now it's real estate and housing... Of course there are other sectors of the market that have benefited from the low-rate environment. Financial and bank stocks have used the low rates to borrow and invest heavily in the stock market, especially in derivatives. There are a lot of “stealth financial” stocks that derive a good chunk of their earnings from operations completely unrelated to the part of their business in which they have a durable competitive advantage. But for the better part of the last 10 years, it has paid to turn your company into a quasi-hedge fund. Take on debt. Take on leverage. When your cost of servicing it is low, and the market returns are high, it’s a good trade. Not anymore. And that’s why the new trade of the decade is to sell the dollar…and buy gold. When financial economies collapse…. They look a lot like this… You can see that even in Japan, there were two or three false rallies in the middle of a brutal bear market. And it's true, even in a secular bear market, you get powerfull rallies. You can profit from those as a trader. But don't mistake them for new bull markets. In other words, when you see a chart like the one below, remind yourself to look the one at above. Following in Japan's Footsteps To find the new bull markets, you have to recognize the big shifts when they're happening. And right now, we're shifting away from the dollar and into a brave new world of gold and Asia. Go east. Get gold.


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