Today we take a break from doom-and-gloom liquidity analysis to bring you some truly fascinating questions from a group of the smartest people I know, the Sure Money and Money Morning commentariat.
A big thanks to all of you…but especially Lawrence, Joe, Ben, and Carson… for keeping things interesting. (Marijuana and gold, whatever else you can say about them, are very rarely boring.)
Lawrence: I really just have one question: what effect is this [Fed tightening] going to have on California’s pot stock market in 2018? I am planning to take several positions in that market in the next few days hoping to make a good run over the next 12 months. Would you consider that a long-term position considering the Fed’s report on draining billions from the banking system?
Lee: This is an interesting question. Will tight money adversely impact the ground floor of a new industry?
I don’t have a direct yes or no answer to this one. When we look at the Internet bubble topping out in 2000, I don’t know of a single stock that didn’t get dumped. But a few did survive and go on to become viable companies, that either survived independently or were acquired. And one became Amazon.com. After its stock price was initially decimated in the crash of the internet bubble, today it sells for many multiples of its high price before the bubble collapsed in 2000-2002.
In a bear market, the saying goes that investors throw the baby out with the bathwater. That means that even the good stocks get dumped. It can take them years to recover. Given that I expect a bear market to begin in 2018, and last a couple of years, as is the norm, I would expect pot stocks to get smoked along with everything else.
A scaled deployment of cash might be in order, but this will be a stock picker’s environment as many of the new companies won’t survive. This is where the expertise of our pot stock expert Michael Robinson will come in handy.
I got several comments on my post on gold. This one needs an answer.
Joe: It sounds like people are looking for the dollar to weaken and the Fed not to raise rates: are you looking at any other factors?
Lee: Hi Joe! When it comes to gold and the mining stocks, I stick strictly to technical analysis. The motivations of buyers and sellers and market manipulators are far too arcane and subjective to be of much use.
But I do have opinions on the dollar and interest rates that flow directly from my research. If the Fed is pulling cash from the system, and the Treasury increases the amount of dollar denominated debt it issues, the demand for dollars will be increasing as the supply decreases. That’s not a recipe for weakening the dollar. But if foreigners decide that they don’t want to hold dollars, it would be an offsetting factor.
That raises the question of whether gold can strengthen if the dollar strengthens. I don’t have the answer, which is why I rely on the charts to simply identify the trend, and likely trend turning points.
On interest rates, I’ll reiterate what I’ve covered here on my reports about Fed policy. Rates don’t matter. Prices of everything have always risen along with rising interest rates, until late in the cycle when rates actually reach a level that is punitive relative to the inflation rate or the rate of increase of the asset in question. We’re a long, long way from reaching that threshold.
Furthermore, the real issue is the tightening of the money supply. The Fed’s current tool for raising rates by increasing the interest it pays the banks on excess reserves (IOER) is actually a subsidy to the banks. It lowers their cost of funds, and increases their free cash flow. It really loosens bank liquidity, but nowhere near enough to offset the tightening action of the scheduled reductions in reserves under the “normalization” program.
The bottom line is that the liquidity factors are not bullish for gold. In fact, they would be inherently bearish under normal circumstances. And the charts don’t look all that hopeful yet. If they turn unequivocally bullish, I’d be more than happy to say so.
Here’s another good observation from Lawrence, though I’m not sure if it’s the same Lawrence. If it is, two for one, my friend! You are on a roll.
Lawrence: The Fed hasn’t been shrinking their balance sheet yet. They announced their schedule but haven’t followed it yet – this may delay in impact on stocks/bonds.
Lee: Hi (again?) Lawrence. This is a good point, especially at the inception of the “normalization” AKA “draining” program. The Fed’s MBS purchases are on a 30-60 day forward basis, so there’s a built-in lag there. The first reductions in purchases in October are only now being felt, and they’re too small to be noticeable. Cuts in Treasury holdings depend on the maturity schedule of the Fed’s holdings. That was very light over the past couple of months, but it will pick up substantially in Q1, and throughout 2018. I think that the impacts will first be truly noticeable by the end of Q1.
An update: As of the Fed’s H41 weekly balance sheet statement for the week ended January 3, the Fed’s balance sheet had indeed shrunken by $26 billion since October. That amount will grow exponentially in the months ahead.
Now, here’s an excellent question about foreign central bank money printing.
Ben: Will Japan’s and the Bank of Japan’s inflationary, money printing policies replace a sufficient amount of Fed and ECB funds being withdrawn from the Primary Dealers to provide an offset?
Lee: Hi Ben – The BoJ and ECB have definitely been funding the current rally in US stocks. Banks holding funds in Europe and Japan are penalized for doing so by the respective central banks’ negative interest rate policies (NIRP) and the negative yields on many sovereign bonds. So when they get a cash windfall from the ECB and BoJ when those central banks buy assets from them, the immediately send some of those funds off to Wall Street where they normally purchase US Treasuries, but may also buy stocks directly. Also, as the money from the purchase of the Treasuries enters the accounts of the selling dealers or investors, that money can be, and is, redeployed to purchase stocks.
So yes, I do believe that the BoJ and the ECB in particular, were funding the US stock rally. We see the evidence in the European banking data that I track. But that they will be reducing their purchase rates in 2018. The ECB has already announced that it will cut its purchases in half, to €30 billion in January. The BoJ announced in December that it is drastically cutting its purchases as well. The scuttlebutt is that both will end QE later this year.
At the same time, the US Treasury will issue more and more debt. Other governments will also continue to issue new debt. The supply of paper will increase. The printed money that helps absorb all that paper will be decreasing. That’s a recipe for liquidation of other assets to fund the government debt issuance. Prices for all financial assets should decline.
And finally, a pithy comment about the Fed’s loquaciousness in its various policy speeches, and official announcements. Not really a question, but it was so good I included it anyway.
Carson: Self-serving rhetoric based on malicious falsehoods coming from pigheaded morons.
Lee: Carson, you can ghostwrite for me any time. I could not have said that any better. Although I don’t think they are morons. I just think that they are delusional, especially when colluding together for their groupthink propaganda pronouncements.
On that cheerful note, I’d like to wish everyone a happy weekend. Back to our regularly scheduled analysis on Monday.
And please keep the great comments coming.