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103 comments on DrumBeat: May 26, 2006

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tate423 on May 26, 2006 - 10:01am Permalink | Subthread | Parent | Comments top
People can't handle the psychological concept of something appreciated in value so quick.  If you really sit down and look at the value of gold, it hasn't even kept up with inflation.  

People will adjust to the new price and plan accordingly.  Once they have adjusted the demand will slowly return.  Gold is so valuable in India that banks write loans specifically for the gold lavished at Indian wedding ceremonies.  That's not going to stop.  It might get scaled back, but that's it.

Im not as sure in the middle east, but I will say that the great fortune of those in the oil kingdoms will start spending their massive windfall petrodollars on ever larger gold hedges against the dollars in their current reserves.  Think about what happens when the gold and the oil are in a few hands because the central bankers are sellers.  They want to protect the dollar, but their gold vaults will be empty and the electronic press known as M3 still "prints" cash.

I will agree it's in no countries immediate interest to abandon the dollar, but rememeber it only takes a grain of sand to start the sandpil avalanche.

Oh and we increase discretionary spending by in the US simply by leveraging.

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wstephens on May 26, 2006 - 10:31am Permalink | Subthread | Parent | Comments top
Interesting juxtaposition of comments from you two:
"The Euro will still work without Italy...."

"only takes a grain of sand to start the sandpil avalanche"

I've had the luxury of being philosophical in TOD lately due to a minor injury that has kept me from my usual exercising for the past 3 weeks. I'm gettin better, and work is picking back up, but this bull*hiting in here is really fun! I hope to keep firing away ---

#1 This grain of sand thing, I think, was in John Mauldin's weekly, wasn't it? And didn't I see somewhere that Mauldin's eletter goes out to over a million people? And these people would be largely in the financial business wouldn't they? So all of his musings may reflect very well the conditions that already exist in the market. It's possible. Try re-reading Andy Kessler's chapter in Mauldin's last book.

#2 I expect that the Saudi bigwigs will flee the country, gold included, once it's clear to them that their oil production is going to roll over. At that point they will not be net gold buyers. Furthermore, do you know for a fact that assets other than gold did worse during the various currency collapses in the past century? Do you have the data? If not, then you have a 1 variable analysis.

#3 Re inflation. This trend in "discretionary" spending has been going on for so long that you'd think the leverage would already be used up! Anyhow, if "food and energy" are going to experience what economists call a "supply shock" then this is not monetary inflation! It's still supply/demand and there's nothing that Bernanke can do about it other than crush the rest of the economy. I think he may know this fact. He may suggest that people look at "core" because he may know what's going on, rather than not know what's going on? It is possible.

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tate423 on May 26, 2006 - 10:46am Permalink | Subthread | Parent | Comments top
#1 I agree with you on this point.  I agree that there exist so much interdependancy to keep the game going that it will only take one more "grain of sand" (whatever it happens to be) to break the system.  I haven't read any of mauldin's books yet, but I do get the weekly letters.  

#2 I don't get your point about gold and currency collapse.  I was simply saying I think its possible that the Saudis would buy gold with their petrodollars.  What other assets are we talking about?  Do you want links to articles that provide the graphs that say since 1996 our currency has depreciated almost 20%?  I'll go get them.  Do you want the graphs and the like that talk about inflation adjusted (the real numbers) versus the nominal increases in the price of gold?  I'll find those too.  

#3  I agree once again.  Bernanke is simply a mouthpiece to dispell all those who question.  I agree if a supply shock occurs it would not be monetary inflation, however in the face of PO, do you see prices going up or down?  So is your money worth less or more?  Is this inflation period?

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tate423 on May 26, 2006 - 10:57am Permalink | Subthread | Parent | Comments top
Here is a link that identifies gold in terms of real price, rather than nominal including inflation and it also includes info regarding it's relationship to the DJIA.
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tate423 on May 26, 2006 - 10:57am Permalink | Subthread | Parent | Comments top
http://www.itulip.com/gold_dow_inflation.htm
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wstephens on May 26, 2006 - 11:23am Permalink | Subthread | Parent | Comments top
#2 For instance, when the Real in Brazil collapsed by half in one day you would have made 100% "instantly" with gold. But, there may be other assets for sale during these collapses for 10 cents on the dollar, so to speak -- which could return 1000%. If you don't have the data and examine these assets (which are productive assets) then you don't have the whole story. Stocks are the best historical asset class vs inflation. A lot of gold enthusiasts seem to promote the idea that gold is the best asset against inflation when the data seems to show that it is not.

#3 Gold relative to money, say, could stay the same, as "food and energy" relative to money soar. And this is not monetary inflation, the supply of money could remain the same. Bernanke is a smart guy. I think most people are smart (conspiracy theorists exempted). You can understand a lot more about what's going on, if you take the approach that people are being smart, not stupid or mouthpieces. Bernanke may know that he cannot control the price of food and energy. So why try?

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tate423 on May 26, 2006 - 11:49am Permalink | Subthread | Parent | Comments top
#3 - Your crazy if you think Bernanke is simply acknowledging he can't control the price on food and energy.  Can he control the price of toothpaste?  No but he includes that in his report of CORE inflation.  So the fact that he cant control the price of food and energy doesn't matter.  You're missing the point.  I'm not arguing with semantics and what inflation is what.  You need to understand that CORE inflation is propaganda to mask REAL inflation in the long term.

You've bought into this bizarre manipulation of the formulas used to calculate inflation.  You're crazy to think that inflation that happens to energy of food doesn't affect YOU.  Get down to the micro level and start thinking like an individual household.  If the cost of food and energy increase, you pay it.  

He knows what real inflation is.  He also knows the Core inflation is not the best barometer of inflation.  Have you not researched government reporting of data and how it's been changed, especially since Clinton?

Start with this website and you might get what I'm saying.

http://www.gillespieresearch.com/cgi-bin/bgn/article/id=340

Core inflation is simply a measure of short term inflation. Real inflation that you have to live with daily will matter in the end.

Back to #2....You're mixing Real's & dollars.  Are you trying to interject exchange rates into this?  Just want to be clear before I respond.  Oh yeh about those pesky stocks being so great....

iTulip.com Real Dow Jones Industrial Average
DJIA adjusted for inflation 1924 - 2006
Last Upate: May 24, 2006

The chart above, and the analysis behind it, is the work of an analyst who prefers to remain anonymous.  His web site and further details about the analysis behind this chart, and other compelling observations, are available at his web site here.

This chart shows the Dow Jones Industrial Average (DJIA), an index of 30 stocks also known as the DOW, from 1924 to March 2006. This DOW chart, unlike charts you are used to seeing, is adjusted for inflation.  Why adjust the DOW for inflation?  If you don't, changes in the price of the DOW over periods of years are not meaningful.  For example, the DOW was 11,000 at some time in 2001 and 11000 again in 2006.  Financial reports will often look at these two price points and state that the DOW has "stayed flat."  Not great but not bad, right?  But inflation has increased at least 2.5% per year since 2001, although there is good evidence that the average inflation rate is significantly higher.  

The author of this analysis used a DOW starting value of 8.42 for the year 1924.  Since then, that value has increased at an inflation adjusted annual rate of 1.64% per year.  Yes, you read that correctly.  The real annual rate of return on the DOW over the past 82 years has by his careful calculation been 1.64%.  That modest rate of return has had many dramatic periods of ups and downs that have given the average investor little net benefit.  But these ups and downs, known in the business as volatility, been a boon to brokers.  Still, the DOW beats the real estate market, which has stayed more or less even with inflation for the past 100 years.

Another way to look at this is in terms of the point price of the DOW as reported and use the Real DOW to make inflation adjustments. For example, the DOW averaged 11281.26 in January 2000, when the Real DOW = 100.0, and both are the all-time nominal highs.  In April 2006, 6.25 years later, the DOW averaged just 0.4% less at 11234.68, but the Real Dow is 16.4% less at 83.6.  That's because consumer prices rose 19.1% -- the Real DOW inflation index CPI-U increased from 168.8 to 201.1.   Using DOW 11281.26 in 2001 as a starting point, the purchasing power of a "share" of the DOW since then is worth 16.4% less as of the date of this report (April 22, 2006) than the average price in 2000.  That means the real DOW in terms of purchasing power is "worth" 9480 in 2000 dollars when it is reported at the 11340 closing price Friday, April 21, 2006.  In other words, think of the DOW at 11340 today the way you would have thought about the DOW at around 9480 in 2000.  

You'll notice how dramatically the inflation-adjusted DOW started to rise April 1995, about 20 months before Alan Greenspan's famous Irrational Exuberance speech.  It has adjusted down moderately since then but has a way to go to reach it's 1.64% trend line.  

DJIA adjusted for inflation 1924 - 2006
On April 22, 2006 I venture where the author of the chart does not go.  I have added to his chart three red lines marked A, B and C to represent three arbitrary potential paths of the DOW back to the trend.  Of course, no one can assign a probability to these or any other guesses at a future outcome for the DOW, and a straight line down is really unlikely.  All you can say for sure is that the real DOW will revert to the mean and that there are two ways for it to do so: deflation as occurred in the correction from 1930 to 1931 or inflation as from 1965 to 1983.  As long term iTulip.com readers will tell you, I have been solidly in the inflation camp since proposing Ka-Poom Theory in 1999.  

I throw out three paths of inflation to get the DOW back to trend: (A) rapid, (B) moderate and (C) slow.  For selfish reasons, I prefer the (A) case because it gets it over with before I'm too old to care, but it's no more likely than any other path... the market doesn't care any more about what I wish for than the moon cares what I think about its orbit.  Path (A) implies an inflation-adjusted DOW of around 50 in five or six years from its current value of 85, about a 40% decline.  Not a 40% nominal decline but a 40% real decline on top of the 15% real decline we have seen from its peak in 2000.  

One way to get there is for the nominal DOW to stay about where it is at 85 on the chart above -- that's 11,000 and change in the actual DOW index price -- and for inflation to rise around 70% for the period.  That's similar to the 1975 to 1983 scenario, but of course two periods are never quite the same.  It's not far off from the 100% six year inflation scenario I cooked up to save the average savings-less, over-indebted U.S. home owner's bacon.  Also coincides with the commodities boom that guys like Jim Rogers have been predicting since 1999.

Let's watch over the years to see which path the Real DOW takes.

Send as email

--------------------------------------------------------------------------------
Sources:

http://homepage.mac.com/ttsmyf

This is from http://www.itulip.com/realdow.htm

I apoligize to all for the length.

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BrianT on May 26, 2006 - 2:59pm Permalink | Subthread | Parent | Comments top
Good post. The guy forgot to mention that the DOW isn't a real index. Periodically over the years companies that have performed poorly are tossed out and ones that have better future prospects are put in. Most of the companies from the 1924 index don't exist any more. If you adjusted for this "fudge" factor the return would be even lower! Hilarious.
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wstephens on May 27, 2006 - 7:47am Permalink | Subthread | Parent | Comments top
Actually Jeremy Siegel's book shows that (in the case of the SP500 at least) that the opposite is true. S&P has consistently added stocks that have underperformed (over subsequent periods) the stocks that S&P threw out. The book is a detailed analysis where every stock that was ever in the S&P 500 is tracked, including dividends, spinoff, etc. Siegel's book does a lot to dispell the myths that people have about stocks. Highly recommended.
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BrianT on May 27, 2006 - 6:40pm Permalink | Subthread | Parent | Comments top
My comment only applies to the Dow-that was the arbitrary index the author had studied.
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wstephens on May 26, 2006 - 3:25pm Permalink | Subthread | Parent | Comments top
First, I try to avoid the use of the word "inflation" because it means so many different things to people. Ordinary people define this as "prices going up". Economists often separate "prices going up" from "money supply" increases. And yes, this is semantics.

So, re "prices going up". I never indicated that the price of food and energy is not experienced by people. I am just pointing out that the recent rapid increases in those prices are not necessarily a monetary phenomenon. The price of oil over the past 5 years has risen approximately 28% per year. Do you think that is mostly money printing? I don't.

I haven't "bought into anything". As I understand it institutional investors calculate their own "inflation" guages in order to evaluation their investment needs. An example of this is retirement packages for state employees which index benefits to CPI plus X% -- because they fully understand that CPI doesn't capture the specific inflation that is experienced by retirees. This is no secret. You seem to think smart people out there don't know this already.

If the author of your quoted piece has not included dividends (which it appears he has not) then he has missed most of the gain in the DOW, and has made an enormous error in calculating the return. For comparison you could look at Jeremy Siegel's lateset book where he calculates returns in stocks and painstakingly includes all the dividends -- and shows that the indexes are much less efficient at capturing the returns from stocks than other "unmanaged" portfolios. Also, Siegel shows that the return for gold is dismal over time.

All this being said, I'll refer back to my earlier comment that "discretionary" spending is the economic category that seems to be growing as a chunk of people's income over long periods of time -- not energy, not housing, not food, etc. If "inflation" is so bad then why is it that people's houses (which have grown is size and features over the decades) are full of every imaginable geegaw and gizmo made? My closets are full, and so are everybody else's -- to the extent that the rental storage business has been one of the fastest growing businesses around!

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Oil CEO on May 28, 2006 - 2:11am Permalink | Subthread | Parent | Comments top
Excellent work. You get an A+.
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wstephens on May 27, 2006 - 6:23am Permalink | Subthread | Parent | Comments top
Tate423! Tate423! This week's Barron's "INTERVIEW WITH JAMES TURK: This longtime gold authority says the yellow metal has plenty more room to rise -- possibly to $8,000 an ounce." You might want to get a copy.
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TheloniusM on May 27, 2006 - 10:28am Permalink | Subthread | Parent | Comments top
Sorry, but that analysis is 100% wrong -- because it doesn't include DIVIDENDS, only price changes. Dividend yields have averaged around 4.2% annually on the Dow stocks over the long-term (though currently only about 2.3%.) Add 4.2% to the compounded annual price change and stocks have greatly outperformed inflation over the long-term.
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fallout on May 29, 2006 - 1:24pm Permalink | Subthread | Parent | Comments top
Most stocks do not pay dividends of any kind, and those that do have severely curtailed them in recent years (the last decade or so). Obviously you guys own few or no stocks.

"Stock dividend yields, which fell' to historic lows in the last few years, remain skimpy in the 1.9 percent tc 2.5 percent range, depending on which broad market average you look at."

http://www.andrewtobias.com/bkoldcolumns/980312.html
http://www.findarticles.com/p/articles/mi_m5072/is_16_25/ai_101172680
http://www.investopedia.com/articles/03/011703.asp
http://www.cross-currents.net/archives/feb05.htm
http://experts.about.com/q/Financial-Stocks-1075/Conversely-Dividends-Value.htm

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