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Global Monetary Inflation Update

On an economy-wide basis there can never be a sustained shortage of money, because the purchasing power of money adjusts to whatever the supply happens to be. Furthermore, any supply of money is just as good as any other supply of money. In other words, there is no correct supply of money, there is no need for the supply of money to grow with the economy and/or the population, and there is never any benefit to be gained by increasing the money supply. Problems, however, will often arise due to rapid changes in the supply of money. Over the past 6 years there has been substantial growth in the global supply of money, which is part of the explanation for why a sustained improvement in global economic growth has been so elusive.

The reason that there has been rapid growth in the global supply of money is that all central banks are run by people who believe that a weak economy can be strengthened by pumping in more money. This belief is so ingrained that it hasn't been even slightly dented by consistent failure. Instead, the failures are taken as evidence that even more money needs to be injected. The result is that in the face of sluggish economic performance, almost every central bank in the world is either maintaining or attempting to create 'ultra-easy' monetary conditions. The following charts show the effects of these efforts on the money supplies of the US, Japan, Australia, Canada and Hong Kong. The euro-zone's monetary situation will be dealt with separately after the ECB publishes its September data late this month.

Our first chart shows the year-over-year (YOY) percentage change in US True Money Supply (TMS). The growth rate in US TMS was 7.7% at the end of September, which is up from 7.0% in January.

This year's increase in the pace of US monetary inflation is due to faster money creation by US-based commercial banks more than offsetting slower money creation by the Fed, but it should be understood that the changes have been small. In effect, the US monetary inflation rate has flat-lined over the past 12 months at a rate that is above the long-term average, but well below the highs of the early-2000s and 2009-2012.

It's possible, but by no means certain, that the TMS growth rate has fallen far enough to usher-in the inevitable period when the mal-investments of the boom years are exposed for all to see.



Our second chart shows the YOY percentage change in Japan's M2 money supply. The growth rate in Japan's M2 has fallen from around 4.3% to 3.0% over the course of this year to date and looks set to move a little lower over the next couple of months. This means that despite popular opinion to the contrary, Japan continues to have the world's lowest monetary inflation rate. Unfortunately, the BOJ is trying hard to eliminate the saving grace of low "inflation", and Japan's government, despite a 20-year record unblemished by success, continues to apply the same old Keynesian 'remedy' that involves piling more debt onto a mountain of existing debt.



Our third chart shows the YOY rate of supply growth in the Australian Dollar, one of the world's two main "commodity currencies".

Australia's TMS growth rate is now at 13.3%, which is its highest level since Q3-2008. The difference is that in Q3-2008 the TMS growth rate was in the midst of a steep decline from a 2007 high of more than 25%, whereas it is currently in an upward trend.



The most obvious sign of Australia's high average rate of monetary inflation is the country's residential property bubble. Another sign is the high and quickly-rising cost of living. However, the following chart comparing the year-to-date performances of the CCI (in blue) and the A$ (in green) shows that the commodity price trend is still having a much greater influence on the A$'s exchange rate than the long-term fundamental negatives linked to rapid monetary inflation. This means that when the commodity price trend next reverses course and begins trending upward, the A$ will probably follow.



Our fourth money-supply chart shows the YOY rate of supply growth in the Canadian Dollar, the other main "commodity currency". Canada's monetary inflation rate has oscillated less wildly than the monetary inflation rates of most countries over the past several years.



Our final chart shows the YOY percentage change in Hong Kong's M2 money supply. The monetary situation depicted by this chart is, we think, part of the explanation for the widespread discontent that prompted hundreds of thousands of Hong Kong residents to take to the streets in protest. The primary grievances of the protestors are political, not economic, but the problems caused by the high average rate of monetary inflation over many years have almost certainly magnified the political grievances. The problems we are referring to are the ridiculously high cost of housing (to buy or to rent) and the generally high cost of living. Unfortunately, we doubt that even one in one-thousand of the protestors understands the underlying cause of these problems.

With Hong Kong's money supply having grown by 15% over the past 12 months, bigger problems lie ahead.

The Stock Market

Our view was (and is) that the S&P500 Index (SPX) made a multi-week low last week and would probably retrace 50%-100% of the initial decline from its September peak before resuming its downward trend. This implied an expected rebound target of anywhere from 1920 to the low-2000s.

With the first part of the rebound from last week's low having made it as high as 1949 on Wednesday 22nd October, an eventual move up to around 2000 is certainly possible before the resumption of the downward trend. However, there is a risk that the rebound will end sooner than expected. That's why, in a blog post prior to the start of US trading on Tuesday, we said that we would probably start establishing a new SSO (Ultra S&P500 ETF) put-option position if the stock market opened strongly on Tuesday. As it turned out, we placed an order for some SSO puts after the market opened strongly on Tuesday, but the below-the-market order didn't get filled until the early-going on Wednesday.

We therefore have a new 'starter position' in SSO put options. Since the purpose of this starter position is to provide coverage in case the market immediately reverses downward, we went for January-2015 rather than January-2016 puts. Our intention is to buy the longer-dated (January-2016) SSO puts if the overall rebound extends into early-November, which currently looks likely. Note that this is what we are doing with regard to our own money management and is not a TSI recommendation.

It isn't obvious when looking at the following daily chart, but important resistance for the SPX lies at 1972. The reason is that 1972 was the September closing level. Even if the overall rebound is destined to take the SPX back to around 2000, the October close needs to be below 1972 in order to establish consecutive down months for the first time in more than two years. This is another way that the decline from the September peak could differentiate itself from a routine bull-market pullback. In other words, to provide further validation of our bearish outlook the SPX must be lower than 1972 at the end of next week.



Gold and the Dollar

Gold

The US$ gold price broke above important lateral resistance in the low-$1240s on Monday and then pulled back to test the breakout on Wednesday.

The upside breakout by gold bullion is suspect because it hasn't been confirmed by either silver or the gold-mining indices. Silver would have to close above $17.70 and the HUI would have to close above 202 to confirm the recent strength in gold.



Gold Stocks

An early bout of tax-loss selling

This has been a dismal week for the gold-mining sector, especially considering that gold bullion broke above resistance in the low-$1240s on Monday. Wednesday in particular was bad, with several junior gold-mining stocks that had previously held up quite well suddenly falling sharply. In fact, Wednesday 22nd October was one of the worst days of the past 12 months for the junior gold stocks that we follow and own. Many were down by 5%-10%, for no fundamental reason that we could determine (the small increase in the gold price over the preceding two days actually meant that the fundamental backdrop for gold mining improved a little). Furthermore, some stocks (AAU and TGM.V) fell sharply on Wednesday after announcing positive news the preceding day.

Wednesday's substantial and indiscriminate weakness at the junior end of the gold-mining sector is probably the result of tax-loss selling. Tax-loss-selling's effect on small-cap stocks is usually most evident during December due to retail investors exiting losing positions before the end of their financial year (31st December in the US and Canada), but it can also have a significant effect in mid-to-late October due to the actions of hedge and mutual funds. This is because 31st October is the financial year-end for many funds.

Current Market Situation

The HUI dropped back to its 8th October low (its low of the year) on Wednesday 22nd October. This could turn out to be a successful test of the low, but it's just as likely that there will be some additional downside prior to a sustained reversal.

This excerpt from the latest Weekly Update remains applicable:

"We continue to believe that even if gold bullion is destined to make a short-lived move below its $1180 triple bottom during the first half of next year (anything more than a short-lived move below $1180 is unlikely), the gold-mining sector is in the process of bottoming now. The sentiment-depressing downward drift could continue for a few more weeks or it could end this week. Either way, purchases made near current levels are likely to be in profit within three months."



Mining stocks affected by the Ebola outbreak

There have been isolated cases of Ebola reported in several countries, including the US. However, at this stage only three West African countries have enough reported cases to warrant the term "outbreak". The countries are Liberia, Guinea and Sierra Leone, with Liberia being the worst affected.

We have no current interests in any mining companies operating in the aforementioned three countries, but some of the companies in the TSI Stocks List operate in other West African countries. Specifically, Asanko Gold (AKG), Endeavour Mining (EDV.TO), Golden Star Resources (GSS), True Gold Mining (TGM.V) and Resolute Mining (RSG.AX). The operations of these companies have not yet been affected by Ebola and the risk that they will be affected is small, but even if the companies' operations aren't adversely affected it's possible that Ebola-related fear will lead to further declines in their stock prices.

It's difficult to tell if any of the above-mentioned stocks have been affected to date by Ebola-related selling pressure because the entire gold-mining sector is 'down in the dumps', and these stocks, as a group, haven't fared worse than the overall sector. Having said that, the relatively poor performance of RSG.AX over the past few weeks could be related to Ebola. RSG's most important asset is located in Mali, which, as illustrated by the following map, shares a border with Guinea (one of the three worst-affected countries). Also, even though it hasn't underperformed, the stock price of EDV.TO could have been held back by Ebola-related fear. One of EDV's four mines is located in Mali, which borders Guinea, and another is located in Cote d'Ivoire, which borders Liberia and Guinea. The assets of the other companies mentioned above are located in Ghana and Burkina Faso, which means that they are further removed from the current outbreak.



At this time we have no plans to make any changes to the TSI Stocks List or to the West Africa exposure in our own accounts as a result of the Ebola situation, because we don't think the associated risk to mining operations warrants a change. However, if EDV's geographical proximity to the Ebola-affected countries concerns you and you don't want to reduce your overall exposure to the gold sector at today's depressed prices, you could switch from EDV.TO to Evolution Mining (EVN.AX). EDV.TO and EVN.AX are similar-sized gold-mining companies with similar valuations, but all of EVN's mines are located in Australia. Prior to the Ebola outbreak Australia was already the lowest-risk country for mining. Due to its geographical remoteness and low population density, the Ebola situation makes it even better from a relative risk perspective.

Currency Market Update

In the latest Weekly Update, we wrote: "Although we suspect that a short-term top was put in place on 3rd October as a result of the upward surge catalysed by irrelevant employment data, the Dollar's ability to hold above 85 leaves open the possibility that it will make a marginal new high before the short-term upward trend expires." We also wrote: "The bottom, to date, for European equities relative to US equities occurred on 8th October. If that low holds then a short-term bottom for the euro and a short-term top for the Dollar Index are almost certainly in place."

The Dollar Index tested support at 85 again on Monday and Tuesday of this week before gaining some ground, and our measure of European equities relative to US equities has moved back to its 8th October low. This price action increases the probability that the Dollar Index will make a marginal new high (in the 87-88 range during the first half of November) before its short-term upward trend comes to an end.

Updates on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html