Best of Currency Currents Past: Bubble Theory Battle Royale (November 2009)

Thru the end of the week we will be publishing some of the Currency Currents past we liked …and think still contain some thinking points for markets as we move into 2011…

From 10 November 2009

Quotable

“Oh, most excellent gold!” observed Columbus while on his first voyage to America.”Who has gold has a treasure [that] even helps souls to paradise.”

                         Peter Bernstein, The Power of Gold

Bubble Theory Battle Royale

I spoke at a conference yesterday (November 9th 2010). It shall remain nameless [major newsletter house, my last such event] in order to protect the guilty. What was most funny/incredible/nutty is a belief by said conference chief the US dollar, and in fact all paper currencies, will disappear within 10-years. We will then move to a commodity-based monetary system and Mr. Greenback will be gone.

Anxious as I was to try out the 10-year dollar disappearance idea on someone who wasn’t drinking the newsletter crowd Kool-Aid, so I called my number one son, John Ross, and shared the idea; JR asked the following right out of the gate: “Does this guy think the US currency is going to start disappearing a bit each year, then eventually vanish, or is it a 10-year date to destiny whereby someone flips a switch, then poof it goes away?” I told JR I wasn’t sure the purveyor of said lunacy had thought through the technical problems of replacing the world reserve currency. Maybe a house to house search team would be in order.

I hope you think that kind of thinking not only represents nonsense, as I do, but is a flashing yellow light exemplifying the max one-way bets against the buck [in hindsight, we now know the buck bottomed about two weeks after this farcical forecase]. But, given the implicit signal by the US Fed last week of rates on hold forever, and no bone at all thrown to the buck by the G-20 over the weekend, it seems an orderly decline in the dollar is the policy tool at hand. So further, or even much further, it could go.

There is only one problem; the dollar is tied at the hip with the stock market; negatively correlated tick by tick.

Many of us now believe stocks are in bubble territory and prone to pop. If that’s the case then the dollar is prone to stage a very big rally. Both events would throw cold water on the current policy of using the dollar to juice stock markets to enhance the so-called wealth effect of real people and thus build confidence—to stimulate the minions into doing what they do best—shop!

So, the question of the day: Is there a bubble in asset markets?

Some of our most public and lofty seers seem at odds over that question, and it is making for strange bedfellows, or tag-team, partners.

Talking their respective books over this question we have a tag-team match of historic proportion shaping up: In the red corner we have Marc “The Ponytail” Faber teaming up with Nouriel “Party Animal” Roubini; well lubricated machine these two. And in the blue corner, we have Jim “Gosh I love China” Rogers teaming up with Alan “The Maestro” Greenspan; this is a real odd couple, but their skills cannot be questioned.

If you know anything about tag-team matches, you know there is always someone lurking in the background ready to bend the rules and jump in one side of the fight…he has already identified himself, it’s none other than Frederic “The Bruiser” Mishkin (former Fed governor and expert at full body slams).

The Pony Tail gets the action started with a roundhouse punch glancing against the Maestro’s forehead:

"I would regard a failure *Gold+ to hold above the ‘upside breakout points’ in the period directly ahead with great caution. In the case of gold a decline below US$1,000 would likely lead to further more meaningful weakness, possibly down to between US$800 and US$900," Faber added. Faber has been reiterating, in various recent interviews, the notion of over-streched assets and a possible short-term dollar turnaround. Speaking in a Bloomberg interview from Istanbul on Tuesday, Faber said: "Maybe the dollar has made a turn, it can easily rebound by 10%”.

The Maestro recovers quickly, and finds The Pony Tail off-balance, and looks to end it early, going for the pile driver, a dangerous move indeed:

Nov. 9 (Bloomberg) Former Federal Reserve Chairman Alan Greenspan said a rebound in stocks is “re-liquifying” the U.S. economy and housing prices are showing early indications of ending their decline.

“We have been very fortunate that the stock markets moved back” and are “re-liquifying the whole process,” Greenspan said at an event in Edmonton, Alberta, presented by Abu Dhabi National Energy Co., the state-controlled energy producer known as Taqa.

Pony Tail shakes it off and tags up with Party Animal who leaps off the top rope, a direct hit here and the match is over:

“But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.”

Fresh off another win and well rested, “Gosh I Love China” quickly moves into the ring, helping his partner The Maestro avoid the death blow. He does. And then launches into his own with a flying drop kick to the head of the Party Animal:

How can you talk about a bubble when assets such as silver are 70% below their all-time high? Same for coffee, sugar, cotton, natural gas, and many more. I have a problem talking about a bubble when assets are this depressed from their all-time highs.

A bubble is when assets are screaming to new highs everyday, everyone is talking about them, and everyone owns them. Right now, virtually no one owns commodities. So for Mr. Roubini to talk about a bubble in commodities defies comprehension. It proves he does not understand markets.

I am flabbergasted at Mr. Roubini’s comment about bubbles because there is not a single market in the world making all-time highs except Gold, US Government Bonds, Cocoa, and the Sri Lankan stock market. That’s hardly reason to call for a bubble. So, I am most perplexed about this alleged bubble which is out there.

If an asset rises 100% in one year, that’s a great year, but not necessarily a bubble. Look at oil. It’s up huge off the bottom but nowhere near it’s old highs. Look at Citigroup. The stock is up 3 or so times off the bottom …

“… And since Mr. Roubini thought oil would stay below $40 a barrel for all of 2009, I would love for him to tell me and the rest of the world exactly where are all the oil supplies because the International Energy Agency (IEA) — which has the best global data set on energy supplies — has no idea where is the oil. Mr. Roubini should tell us where this price suppressing oil supply is hidden. All the oil possessing countries in the world have declining reserves. All the oil companies have declining reserves. So Mr. Roubini must know something the rest of us don’t.”

Ouch…that hurt Party Animal more than his usual late night last call mixer. It was a powerful kick indeed delivered by Gosh I Love China. But, the Party Animal knows how to take a blow, and has plenty of fighting experience while dazed and dreary. Even so, he’s wobbling.

Slipping under the bottom rope, from across the ring, out of sight of the referee, The Bruiser enters the ring to end it with one of his patented full body slams:

“There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.”

Wow! The Party Animal has taken a beating, and is about to be pinned…one, two…and just in time, The Ponytail applies the Thai death-lock to the referee before he can count to three…what a match…everyone’s in the ring now, flailing away. This is exciting stuff. Man, it’s a lot more than we bargained for. These guys are tough, smart, and technically gifted. Stay tuned. This battle has legs and ain’t over yet.

[Are we now in bubble territory fast-forwarding to December 2010—a case can be made. More on that next week in Currency Currents 2011…]