Tuesday, July 12, 2011

Beautiful Day?

Sometimes in life, you got to get back to basics. My trainer reminded me that this morning when I hit the gym at 6 a.m. and he made me do what looked like simple exercises. I started by standing straight and lifting each leg up like a marching soldier, always trying to maintain my balance. I then held the railing bending my leg back so my shin touches my bum. Finally, he made me go down stairs (allowing me to hold the railing), do five squats, then march right back up the stairs as fast as possible without holding the railing. I ended off with a series of hard stretches.

It all looked so simple but after 45 minutes, I was exhausted. My trainer asked me how I felt and I told him that "it's embarrassing that I can't do these simple things." He replied: "There is nothing to be embarrassed of, you got to get back to basics and retrain your body. What looks daunting now will be effortless in three months. Look at how your body has transformed for the better since April." Then he added: "just stay off the bloody alcohol!"

What does this have to do with pensions and financial markets? Why did I call this post "Beautiful Day"? There was certainly nothing beautiful about the stock market on Monday and it looks even worse Tuesday morning as global shares tumbled following fears that Spain and Italy are next in line to default on their debt. Fear is back with a vengeance and algo traders have marching orders, RISK OFF!

On Monday, oil prices tumbled, the US dollar was up and gold shot up. This is an interesting dynamic. As Martin Feldstein has noted, the relationship between the US dollar and the price of oil isn't as straightforward as people think. Typically, we've seen the US dollar fall as the price of oil surges. And gold prices should be falling as fears of debt deflation mount.

So what's going on? I spoke to a commodities trader yesterday and he told me that we're seeing the "rise of systemic fear," which explains why we're seeing the disconnect between commodities, currencies and inflation. "When systemic fear rises, investors look for refuge in hard assets and precious metals." He also sent me a Business Insider article stating that there's a huge unforeseen amount of demand coming in the physical gold and silver market. Here's why: The Pan Asia Gold Exchange. As for the US dollar, the flight to safety bolstered it as global investors rushed to buy US Treasuries, bringing the 10-year bond yields down to 2.91%.

We also spoke about the debt discussions being hammered out in Washington between Republicans and Democrats. President Obama is now seeking a grand bargain on the deficit, but the truth is he'll have to negotiate some cuts on entitlement spending that Republicans are demanding. The trader and I agree on one crucial point: any fiscal tightening in the US pretty much ensures that the Federal Reserve will proceed with more quantitative easing, ie. get ready for QE3!

Why does this ensure QE3? Remember my theory: The Fed and the financial oligarchs will do whatever it takes to avoid a prolonged Japanese-style debt deflation scenario. And when I say whatever it takes, I mean whatever it takes. They want to bid up risk assets, introduce more inflation in the global economy, and kill any deflationary headwinds that might destroy their ability to make substantial profits in the future.

It's not going to be easy. This strategy could easily fail and sow the seeds of the next financial crisis, but at the end of the day, the Fed will shun Congress and counteract any fiscal tightening that increases the risk of deflation.

So while everyone is worried about Spain, Italy, Portugal, Greece, Ireland, and the US debt ceiling deal, I tell them to relax, keep buying the dips because once a debt deal is finalized (neither Republicans nor President Obama want the US to default on their watch), you're going to witness a massive relief rally in risk assets. And when I say massive, I mean MASSIVE.

How do I know this? Am I God? Will I get my head handed to me like millions did during the Great Depression? Of course not. All I know is that the power elite have too much at stake to let the global financial system implode. They will keep pumping massive liquidity into the system until they kill deflationary headwinds. And that means risks assets will continue being bid up.

Sometimes in life, you have to get back to basics. You have to take a step back and learn to take baby steps before you start walking and running. And remember no matter how ugly it looks now, the sun will keep shining and the world will forge ahead. On that note, I leave you with U2's "Beautiful Day" which they sang over the weekend at the Montreal Hypodrome. Have yourself a beautiful day. :)

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