Energized

Here I am in silence
Looking 'round without a clue
I find myself alone again
All alone with you
--Information Society

Following up on last weekend's thoughts, I was fairly active today in the commodity space. As anticipated, commodities caught some wind today, with many ETF charts showing near term breakouts.

My primary focus today was oil and energy. Inflationary pressures appear to be building much more so than I was formerly anticipating. While this is affecting commodities broadly and particularly the ags, my growing sense is that oil may be ready to move north with some power. Combine current tensions + Fed's paper blizzard + energy geopolitics (as reflected in the map below taken from this MV article), and, well, you have the sum of my current thought process.

After initiating energy ETF positions early, I was already adding to them mid-day higher in 'pyramid' fashion as prices moved higher. I plan to add more on further strength.

Not typically the way I roll. But pyramiding can be an effective way to enter a trending market while still managing risk. Essentially, I want to use gains from lower priced shares to buffer risk of acquiring higher priced shares. Stops are employed to manage the downside if prices reverse and head south.

positions in DBE, DBO, RJA, RJI

The Fed, Food, and Chaos

There's a room where the light won't find you
Holding hands while
The walls come tumbling down
When they do, I'll be right behind you
--Tears for Fears

Thoughtful piece linking Fed policies to uprisings around the world, with Egypt the current focus. We've been noting it for a long time: central bank policies gut wealth over time. Those impacted the most are those with lower incomes since they have little means to protect themselves against inflation.

In an interconnected world, the effects of the Fed's policies are not confined to US borders. Via stimulus, QE2, and other money printing programs, we are exporting inflation to the world. Inflationary effects are exacerbated because the US dollar remains the world's reserve currency. On a beggar-thy-nation planet where all countries want weak currencies in order to gain an edge in trade, as the Fed prints...so does the world.

Commodity prices worldwide have been shooting higher since last summer--none more so than agricultural commodites. One representative ETF above, DBA, is up about 50% since last summer.

Naturally, the effects of higher food prices are felt in developing countries first. Poor people begin to have trouble affording food. And when citizenry can't eat, they riot. Thus the situations in Kuwait, Tunisia, Egypt, et al.

Blend inflation w/ worldwide proclivity toward socialism, and you've mixed yourself a massive chaos cocktail. 

position in commodities

Pharoah Value

If they move too quick
Oh whey oh
They're falling down like a domino
--The Bangles

The three general macro scenarios that I constantly assign probabilities to are 'big' inflation, 'average' inflation, and deflation. Due to massive worldwide debt and leverage, I've favored the deflation scenario for years and have been tilting my asset allocations appropriately.

When the Fed announced QE2 late last summer with intent to achieve inflation targets regardless of cost, that gave even deflationistas like me cause for pause. Since then risky assets like stocks and commodities have taken off in anticipation of the print fest.

It feels like the market is at an important juncture. Either risky assets run out of upside gas and begin a new deflationary leg lower. Or, after a brief siesta, and perhaps ignited by darkening skies in the Middle East, they sprint higher.

While I still favor the former, I must say that I've been eyeing commodities (again) as a hedge in case we climb the latter ladder.

Have re-established small positions in gold and general commodity ETF positions. Depending on how the Egypt picture shapes over the weekend, I may be a buyer of energy early next week. If commodities get their groove on, I may be prone to pyramid (!) higher.

position in GLD, RJI

No Savings, No Investing

"It's easy to get in. It's hard to get out."
--Gordon Gekko (Money Never Sleeps)

Following up on yesterday's post, how does one know that today's government programs constitute spending rather than investing?

An income of economic resources, earned from productive activity, can be used in one of two general ways. It can be consumed, thereby facilitating today's standard of living. Or it can be saved, thereby facilitating tomorrow's standard of living.

From those resources that are saved, some fraction may be put at risk toward improving productivity in the future. That fraction put at risk is called investing.

More consumption facilitates higher standard of living today. To elevate standard of living beyond the level obtained by consuming 100% of income (let's call this ultra high consumption), economic resources must be borrowed from someone else.

Borrowing resources for consumption today burdens future standard of living. To pay back the lender and still maintain today's living standards, future productivity must increase to a level that enables ultra high consumption plus repaying debt. This is very difficult to do, and this difficulty increases in direct relationship to the quantity of economic resources borrowed.

When debt is high, it is likely that future consumption will have to be curtailed while income is diverted toward paying back lenders. Moreover, it is likely that there will be little residual income left over for savings--and by extension investment.

For years, the United States has been indulging in ultra high consumption. We have borrowed huge amounts of economic resources to treat ourselves to a living standard far beyond what is possible from consuming our income alone. Stated differently, we have been consuming our income, plus some of the incomes of others.

Now, our savings rate is essentially negative as we divert ever higher portions of our income toward debt service. Our problem, however, is that we don't want to give up ultra high consumption. So we keep borrowing from those creditors willing to lend.

This cycle can only persist until creditors refuse to lend.

While we do not know when this state of affairs will end, we do know two things. It will end. And until it ends, our capacity for investment is tiny, since we have no real savings to invest with.

On its best day, government's capacity for allocating savings toward prudent investment alternatives is miniscule. Government is more apt to deploy savings toward programs that consume those resources rather than invest them. This is called capital consumption.

Our current field position suggests that most capital has long been consumed.

Investing in Propaganda

But I'm a substitute for another guy
I look pretty tall but my heels are high
The simple things you see are all complicated
I look pretty young but I'm just back-dated, yeah
--The Who

One characteristic of propaganda is that it often employs 'positive substitute symbols.' Let's say that you're the president of the United States, and that you want to increase spending on government programs.

Flatly stating that 'we need to spend more' could be a problem, however, because a large portion of the country (very much to your chagrin) has been catching on to the reality that government spending is thru the roof and that the nation already shoulders a crushing debt burden.

So you open your dog eared copy of Rhetoric for Government Propogandists in search of a word that could replace 'spending'-- one that would be more palatable to an increasingly austere citizenry. Let's see...ah yes, here it is: 'investing.' Investing connotes optimism and building for the future. By proposing investment programs rather than spending programs, then perhaps the public will be more prone to get behind your proposals.

Investing, therefore, becomes a positive substitute symbol for spending.

Let the spin begin.

Will it work? Politicians spew spin because they know that it often works. On the other hand, level of public engagement in political happenings has been increasing. Engagement means active minds.

And active minds are the propagandist's worst nightmare.

Baltic Breakdown

So we sailed on to the sun
Till we found a sea of green
--The Beatles

The Baltic Dry Index (BDI) is a price index of international oceanic shipping rates. When the BDI goes up, it implies generally higher prices to ship stuff via cargo vessels around the world.

Many market participants regard the BDI as an indicator of global trade. Higher BDIs imply stonger trade patterns.

During the 2008 credit market collapse, the BDI experienced a jaw-dropping decline--falling from over 11,000 to under 1000 in just a few months.

Over the past few months, the BDI has been weakening. Thus it represents a divergence in the thesis that economies are generally strengthening worldwide.

Another metric that may be worth watching...

Inflation Gyrations

Now that ain't workin'
That's the way you do it
Let me tell you
Them guys ain't dumb
--Dire Straits

This article touches on why inflation, as measured by the Consumer Price Index, is chronically under-reported.

Did you know that the dominant definition of inflation has not always been linked to 'change in prices?' A century ago, inflation was commonly defined in terms of the quantity of money and credit.

You can decide which definition makes more sense...

Silver Streak

So hold on here we go
Hold on to nothing we know
I feel so lonely way up here
--The Motels

A couple weeks back we noted that SLV was close to breaking its uptrend line. This has since occurred.

Am now eyeing the support line in the $24-25 range created from last November's gap higher. Technicians like to say that all gaps are meant to be filled. SLV is about a buck away from the gap. May represent interesting trade if/when...

no positions

Divergence Emergence

And if I should falter
Would you open your arms out to me?
--Erasure

Small cap stocks have been leading domestic markets higher. The Russell 2000 (RUT) is up well over 100% since the early 2009 lows.

Over the past week, the RUT has shown some weakness. In fact, the multi-month uptrend line in place since last summer was violated last week.

On the other hand, larger cap stock indexes such as the S&P 500 (SPX) continue to show strength. Uptrends are still technically in place.

This is an example of a 'divergence.' Divergences occur when market indicators that are 'supposed' to move together fail to do so. Often, divergences portend a change in market character. Perhaps investors are rotating out of small caps because they see relative value in large cap stocks. Maybe weak small caps reflect declining risk tolerance among investors.

Of course, perhaps this divergence is just a random phenomenon that merits no meaningful interpretation...

In any event, I've found it useful to look for divergences and keep them in mind when making sense of the tape.

position in SPX

Shovel Ready

Here comes the rain again
Falling in my head like a tragedy
Tearing me apart like a new emotion
--Eurythmics

Nice article from John Mauldin on our fiscal situation. I found the data on govt vs private sector jobs particularly interesting. Check out that USA Today table showing avg salary difference govt vs private sector.

As John notes, the old assumption was that govt jobs paid less but were more secure. Private sector jobs paid more but were more volatile. The old risk:reward axiom.

Bureaucrats seem to think they can obsolete that axiom. Market forces will likely beg to differ...