World Global Strategy

10 September 2009

Global Strategy Weekly
What is the Gold breakout telling us? Less than the Baltic Freight
Albert Edwards (44) 20 7762 5890 albert.edwards@sgcib.com

It’s almost as if the biggest credit bubble in history never occurred. Investors are increasingly 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!

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
Global asset allocation
% Equities Bonds Cash
Index Index neutral SG Weight

monetary and regulatory authorities that are responsible for this mess. It is not obvious in retrospect. It was obvious from the very start.
35 50 15

30-80 20-50 0-30

60 35 5

The problem is that after the boom there will be a bust. The issue now is one of deleveraging and the deflation that is starting to unfold. The problem is that Bernanke is a th slave to Milton Friedman’s view of the Great Depression (at Friedman’s 90 birthday 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 in a Minskian world while perceiving it though Friedmanite eyes” explains his actions to date. It also explains why he will fail.

Source: SG Global Strategy

Equity allocation
Very Overweight Overweight Neutral Underweight Very Underweight
Source: SG Global Strategy

US UK Cont Europe Japan Emerging mkts

Meanwhile the Baltic Freight index is some 40% off its June high, closely mirroring the recent performance of bond yields (see chart below). If anything, this series has some lead qualities. The CRB has also stalled since June. Equities are the outlier.
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 (Rhscale)

4.00

6

3.80 3.60

4

IMPORTANT: PLEASE READ DISCLOSURES AND DISCLAIMERS BEGINNING ON PAGE 4
0 O N D J F M A M J J A S O N D J F M A M J J A 2

3.40

3.20

Baltic Dry Index
3.00 2.80

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Source Datastream

the breakout above $1. Does the Baltic Freight also lead the equity market? Source: Trader’s Narrative blog 2 10 September 2009 . He believes the weakness of commodities is evidence that the Chinese commodity re-stocking cycle is drawing to an end. For a chartist. Looking at how implied inflation expectations have remained wholly unmoved I read very little into this breakout regarding fears of inflation. US 10y bond yield is still locked in a long-term bull market 10 10 Gold bullion $/oz 1050 9 9 1000 8 8 950 7 7 900 6 6 850 5 5 800 4 4 750 3 3 700 2 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 2 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 I was reading the other day the blog of my former colleague Daniel Pfaendler – link . It is purely technical. He cites Trader’s Narrative blog – link that suggests equity investors should also be watching closely (see chart below).Global Strategy Weekly Much excitement abounds this week as gold broke above $1. It broke out of that wedge to the upside some days ago.000 intraday and tries yet again to rise above the $1. 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!). who was making some interesting observations on bond yields and the Baltic Freight Index which we replicate on the cover chart. To many.000 is reflective of a surge of inflationary worries or/and the weakness of the US dollar.030 intra-day high set in March last year. 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). this could have broken either way. As with all these events. In fact.

is just a prelude to a 2010 collapse into outright deflation. And that. we suggest watching the RJ/CRB and Baltic Freight indices closely. after the recession ends. with a lag. 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. And expected to stay low despite the recovery. US Consumer Confidence stuck in a range -10 85 -15 80 -20 -25 Michigan (Rhscale) 75 -30 70 -35 -40 ABC 65 -45 60 -50 -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 55 Source: Datastream But it is collapsing core inflation that poses the greatest risk to the global economy going forward.g. the ABC weekly measure of Consumer Confidence saw a steep step down this week (see chart below). corporate revenues) is set to see disappointing ‘lower highs’ in this upturn after lower lows.5%! Hence the growth in nominal quantities (e. US Core inflation set to collapse NOW. We highlighted last week that core CPI inflation descends rapidly. But the good news is that this series has bottomed. that will take the yoy rate to minus 1. For those who are looking for a trigger for a retrenchment in equity markets. 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 no recovery has occurred. If core US CPI inflation falls by around the 3% shown in the chart below over the next year. Meanwhile in the US. This is consistent with the ‘wallowing’ in the ABC optimism series. 15 Ch in core CPI (rhscale) 1.50 1 10 5 0 0 -1 -5 -10 -2 -15 -3 -20 ECRI leading indicator (led 2 years) -4 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 -25 Source: Datastream 10 September 2009 3 . despite the better-than-expected August non-farm payrolls. in our view.Global Strategy Weekly An end of the Chinese bubble of belief will have serious consequences for the global financial markets.

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