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Global Strategy

10 September 2009

Global Strategy Weekly

What is the Gold breakout telling us? Less than the Baltic Freight

Albert Edwards It’s almost as if the biggest credit bubble in history never occurred. Investors are increasingly
(44) 20 7762 5890
albert.edwards@sgcib.com convinced that a sustainable global recovery is emerging out of the wreckage. All praise to the
central bankers (and Gordon Brown) for saving the world! I’m waiting till someone writes
about the return of The Great Moderation and suggests Ben Bernanke is the new Maestro.
Then I’ll know the lunatics have taken over the madhouse…..yet again!

Q When you look at the ever shrinking rate of bank lending to the private sector around the
world it is clear as the nose on my face that the global economy is still very, very sick. As we
have repeatedly highlighted, one key lesson from Japanese boom and bust is that banks are
not the problem. Bankers’ bonuses are not even the problem. The pigmies that populate the
political and monetary elites prefer to genuflect to the court of public opinion in a pathetic
attempt to deflect blame from their own gross and unforgivable incompetence. It is the
monetary and regulatory authorities that are responsible for this mess. It is not obvious in
Global asset allocation retrospect. It was obvious from the very start.
Index SG
% Index
neutral Weight
Q The problem is that after the boom there will be a bust. The issue now is one of de-
Equities 30-80 60 35
Bonds 20-50 35 50 leveraging and the deflation that is starting to unfold. The problem is that Bernanke is a
th
Cash 0-30 5 15 slave to Milton Friedman’s view of the Great Depression (at Friedman’s 90 birthday
Source: SG Global Strategy Bernanke promised that the Fed would never allow another Great Depression to occur). The
Australian economist Steve Keen’s observation that "Bernanke’s dilemma is that he is living
Equity allocation in a Minskian world while perceiving it though Friedmanite eyes” explains his actions to
Very Overweight date. It also explains why he will fail.
US
Overweight
UK
Q Meanwhile the Baltic Freight index is some 40% off its June high, closely mirroring the
Neutral Cont Europe
Japan recent performance of bond yields (see chart below). If anything, this series has some lead
Underweight
Emerging mkts qualities. The CRB has also stalled since June. Equities are the outlier.
Very Underweight
Source: SG Global Strategy
Baltic Freight Commodity Index recently leading bond yields (…and also equity markets)
000'S
12 4.80

4.60

10
4.40

4.20
8
10y bund yield
4.00
(Rhscale)
6 3.80

3.60

4
3.40
IMPORTANT: PLEASE READ
3.20
DISCLOSURES AND DISCLAIMERS 2
Baltic Dry Index
3.00
BEGINNING ON PAGE 4
0 2.80
O N D J F M A M J J A S O N D J F M A M J J A

www.sgresearch.socgen.com Source Datastream

 Global Strategy Weekly

Much excitement abounds this week as gold broke above $1,000 intraday and tries yet again
to rise above the $1,030 intra-day high set in March last year. To many, the breakout above
$1,000 is reflective of a surge of inflationary worries or/and the weakness of the US dollar. As
with all these events, there is so much ex-post justification for random market moves (I have
even seen a press report citing the weakness of the dollar because gold had been so strong!).
In fact, chartists had been flagging up a major “event” for gold for some weeks as it got
trapped in a nice wedge pattern (see right-hand chart below). It broke out of that wedge to the
upside some days ago. For a chartist, this could have broken either way. Looking at how
implied inflation expectations have remained wholly unmoved I read very little into this
breakout regarding fears of inflation. It is purely technical.

US 10y bond yield is still locked in a long-term bull market Gold bullion $/oz
10 10 1050

9 9 1000

8 8
950

7 7
900

6 6
850

5 5

800

4 4

750
3 3

700
2 2 O N D J F M A M J J A S O N D J F M A M J J A
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Datastream

I was reading the other day the blog of my former colleague Daniel Pfaendler – link , who was
making some interesting observations on bond yields and the Baltic Freight Index which we
replicate on the cover chart. He believes the weakness of commodities is evidence that the
Chinese commodity re-stocking cycle is drawing to an end. He cites Trader’s Narrative blog –
link that suggests equity investors should also be watching closely (see chart below).

Does the Baltic Freight also lead the equity market?

Source: Trader’s Narrative blog

2 10 September 2009
 Global Strategy Weekly

An end of the Chinese bubble of belief will have serious consequences for the global financial
markets. For those who are looking for a trigger for a retrenchment in equity markets, we
suggest watching the RJ/CRB and Baltic Freight indices closely.

Meanwhile in the US, despite the better-than-expected August non-farm payrolls, the ABC
weekly measure of Consumer Confidence saw a steep step down this week (see chart below),
remaining in the tight trading range it has been caught in since March of last year! This is
entirely consistent with somewhat weaker Michigan confidence measures. But the good news
is that this series has bottomed, but no recovery has occurred. Some point out that the lack of
any recovery at all in average weekly hours worked in manufacturing (which normally precedes
a bottoming of the jobs market) suggests the labour markets remain far weaker than recent
payroll data suggest. This is consistent with the ‘wallowing’ in the ABC optimism series.

US Consumer Confidence stuck in a range

-10 85

-15
80

-20

-25
Michigan 75
(Rhscale)
-30

70
-35

-40 65
ABC
-45
60
-50

-55 55
S O N D J F M A M J J A S O N D J F M A M J J A

Source: Datastream

But it is collapsing core inflation that poses the greatest risk to the global economy going
forward. We highlighted last week that core CPI inflation descends rapidly, with a lag, after the
recession ends. If core US CPI inflation falls by around the 3% shown in the chart below over
the next year, that will take the yoy rate to minus 1.5%! Hence the growth in nominal
quantities (e.g. corporate revenues) is set to see disappointing ‘lower highs’ in this upturn after
lower lows. And that, in our view, is just a prelude to a 2010 collapse into outright deflation.

US Core inflation set to collapse NOW. And expected to stay low despite the recovery.
15 1.50
Ch in core CPI
(rhscale) 1
10

5
0

-1
-5

-10 -2

-15

-3
-20
ECRI leading indicator
(led 2 years)
-25 -4
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Source: Datastream

10 September 2009 3
 Global Strategy Weekly

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4 10 September 2009