Stocks and gold should be going down

Sep 13, 2011

Baltimore, Maryland

Our mother celebrated her 90th birthday on Sunday...which took us down to Charlottesville. Uncle Jules, 95, was there. So was our next door neighbor when we were growing up. He was a three years in what had been a slave shack... Almost as poor as we were.

Now he's a doctor getting ready for retirement. More below...

But first, a look at the markets. They're becoming exciting. Yesterday, for example, stocks reversed some of the losses from Friday. The Dow ended up 68 points, keeping the index above 11,000.

Going the other way, gold lost $49.

What to make of it?

In our guess...both stocks and gold SHOULD be going down. That doesn't mean they will go down of course. But at least it gives us a point of reference.

They should go down because there's a Great Correction going on. There's no secret to it. Sometimes stocks are expensive and sometimes they're cheap. When an economy is expanding, it makes sense for stocks to be expensive...companies' sales are going up...profits should increase too. But when an economy is contracting...or, more precisely, when credit is contracting...stocks should be priced for shrinking sales, followed by shrinking profits. That is, they should be cheap, not expensive. Stocks are now priced for an expansion, not a correction. They should go down.

Investors are figuring that out...little by little. As they do, stocks go down. Simple as pie.

But gold is a little trickier. By our reckoning, gold is a little expensive. It buys more stuff than usual.

Of course, it should be a little expensive. Looking ahead, the whole world's banking, credit, and monetary systems are wobbling. Gold is the only money you can trust. So smart investors, smart CEOs, smart family men, and smart central bank chiefs are all thinking the same thing - that they should lay in a supply of gold as a reserve against catastrophe. So they're buying.

But in a Great Correction...assuming things don't fall apart...the value of paper money goes up. Or, to put it another way, the price of assets and other stuff tends to go down as demand falls. Broadly speaking, it is a deflationary world. And paper money is good money in deflation. As long as the system holds together.

And since, according to our Daily Reckoning guesswork, the system will probably hold together a bit longer...we figure speculators will begin to sell gold to get cash.

Besides, gold has had a spectacular 11-year run. It's time for a rest for the metal...and a test for the metal lovers. That's just the way it works. Markets and lovers always test their admirers. Gold should be giving its fans a test...before moving in the final stage of the bull market.

Will you pass the test, Dear Reader? Will you be true?

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*** So much 9/11 remembering! On the TV. In the newspapers. Even our good pastor, saying a few words of welcome at our mother's 90th birthday party brought it up.
"We pray for Mrs. Bonner. We give thanks for her 90 years...We hope for many more. And we pray for the victims of 9/11...and for the first responders...let us remember them..."

But, frankly, we'd rather forget...

9/11 did no serious damage to the nation. As a whole, Americans were not made significantly poorer or significantly less safe. Yes, good people died on 9/11. But there have been a lot of good people murdered over the last 10 years. Every victim had his virtues. And every murderer had his reasons.

What did lasting damage to the nation was not 9/11 it was remembering 9/11. Not only did over-reaction to 9/11 play a substantial role in bankrupting the also made Americans fearful and sheepish. They're convinced the towel-heads are trying to kill them. They believe they can protect themselves by spending trillions of dollars they don't have on military campaigns that don't work.

Ten years ago, only a few fanatics wanted to do Americans harm. Now, after throwing so much military weight around, half the world would happily pull the trigger on an American tourist if he had the chance.

*** "Do you remember me," our doctor friend, 58, asked our uncle, 95.

"Are you kidding," replied Uncle Jules without a moment's hesitation.

"I remember you when you were born. I remember your mother when she was born. I remember your grandmother when she was born. And your great grandmother remembered when I was born!"

Across the road from us when we were growing up was a black family. Our two families, black and white, were connected by long, sometimes-unhappy family histories. They were related - informally - in a couple of ways from a couple of different directions, which weren't discussed in polite society. And they were united in a poverty that can scarcely be imagined today. We lived only an hour or so from the nation's capital...but the tobacco fields of Southern Maryland might have been as far away as Bombay or Timbuktu. .

"Yes, my cousins would come and visit," the doctor explained. "They couldn't believe we lived the way we did. We didn't have electricity or running water until the 1970s. I think I spent the first 10 years of my life reading from an oil lamp. I had to finish my homework early, because those lamps didn't give off much light.

"And then they'd get to teasing and rough-housing and they'd tip over the out-house. They thought it was funny. But we had to use that thing."

*** The US is in decline. This is not so much a prediction as an observation. Things could change. But the way they are headed now, Americans should get used to lower living standards. Here's the Financial Times:
Economic turmoil in the US and Europe is helping to accelerate a deeper, long term development. After three centuries of economic dominance, the west is about to be eclipsed by a rising Asian power: China. Not only may the Chinese economy soon be larger than America's - if measured in purchasing power - but the renminbi could displace the dollar as the premier, reserve currency within the next decade or soon thereafter.

Sceptics will scoff for two reasons. First, even if China's economy overtakes America's, the renminbi's rise could be delayed. America's economy surpassed Great Britain's in the early 1870s, but the dollar displaced sterling decisively only around World War II. That implies there could be a lag of about 70 years between economic dominance and currency ascendancy.

Second, China is far from creating the policy and market environment for the renminbi to become a reserve currency. China's capital account is still largely closed and the renminbi still not convertible and freely available to foreigners; its financial system is government controlled; and its markets lack the depth to provide the liquidity critical to make a currency attractive to hold and trade. In these circumstances, how could foreign governments or private players make payments in renminbi, hold renminbi assets, or denominate economic transactions in renminbi?

In other words, loyalty to the dollar and China's lack of the policy prerequisities seem to make the renminbi's rise a distant possibility. How wrong that is. First, the usual historical analogy is misleading. Great Britain ceded its economic dominance much later, and sterling its dominance much earlier, than is believed. Economic dominance, in the sense of the factors that determine reserve currency status, is affected not just by the size of an economy but by its trade and external financial strength. On this metric, the US overtook the UK not in the 1870s but only around World War I: in fact, the UK was the world's largest exporter and net financier until the 1920s.

Second, China has all but caught up with the US as an economic power. Its economy is about as large, in purchasing power, while its exports and overseas assets are much larger. If one were to draw the correct historical analagy, the potential eclipse of the dollar is just a decade away. Chinese economic strength creates the conditions for the rise of its currency.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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