Daily Content
Fleck's Thoughts

Debunking Deflation


Overnight markets were pretty much a nonevent, including our equity futures, which were little impacted by the bevy of companies that beat the number and/or raised guidance. Preopening, the March PPI was released, showing a gain of 0.5%. And, to illustrate how absurd government statistics are, the BLS claimed that gasoline prices were down 2.8% year-over-year in March (whereas gasoline at the NYMEX is up about 25% in the last year). Anyone pulling up to the pump knows that gasoline hasn't gone down since March 20003. I guess we must all be driving new, improved mentholated gasoline, and that's why the price went down, since it's so much better smelling than what we formerly used.

Queuing Up to Dump KLAC In any case, I found it somewhat surprising that despite all the good corporate news, the opening was rather subdued. Meanwhile, KLA-Tencor (KLAC) slid a rather noticeable 10% in the early going, after reporting last night that its orders for next quarter would be about 15% short of folks' expectations.boxscore

After a head-fake to the downside in the first half hour, the S&P blasted about 1% higher in 15 minutes The Nasdaq did the same, only on steroids. After that blast, we ground higher and closed on the high tick, in a day that saw some pretty breathtaking moves. Internet stocks sizzled, with eBay up 10% and Amazon up 6%. Housing stocks exploded, as did cyclicals. Phelps Dodge was up 3% and Caterpillar up about 4%. Financials had a decent bounce as well (as the bond market saw a modest bounce).

A Sox-Free Fiesta Unfolds The only place there was really no party was Sox land, and a few other tech stocks that disappointed, like IBM and Nokia, as well as the formerly glorious TASR, which was down about 10%. Obviously, fears about Chinese bank-tightening and Fed interest-rate jawboning were quickly washed away today, as folks decided that the aforementioned groups of stocks would protect them from the "deflation" that people puking up metals appear to fear (much more about deflation below).

Away from stocks, the euro was 0.5% higher as folks jostled their positions in the wake of Easy Al's nonsense, and in preparation for this weekend's G7 shrimp fest. Overnight and early today, base metals were under pressure again, though silver and gold were attempting to stabilize. Meanwhile, palladium and platinum were getting shellacked, as the complete shakeout of the commodity complex continues. By day's end, gold closed up 0.5% at $394, silver closed down another 2% to $6, and base metals were mixed. Both Newmont Mining and Pan American Silver bounced today. Tomorrow is going to be very interesting. I hope to be a buyer of metals if I see the right thing.

Deflation, As De Facto No-Show The discussion of commodities is a perfect lead-in to topic A of today's rant -- inflation versus deflation. I have made no secret of my belief that in a social democracy with a fiat currency, all roads lead to inflation. At every juncture in the last 20 years when folks have fretted about deflation, I have stuck to my belief -- that the fear of that eventuality gets Benny Bernanke to fly helicopters around, dropping dollar bills.

We have not seen deflation since the 1930s. We have only seen the opposite. In fact, deflation is thus far just a theory, whereas inflation is a reality -- even if the government is incapable or unwilling to calculate it correctly. I invite emails from readers, telling me what they're purchasing (other than technology products) that's gone down in price in the last year or 10. A declining price is one of the beauties of technology: Prices decline because, with no barriers to entry for most products, competitors mimic successful ones, and innovation further drives down costs.

Flagging Price as a False Reference Point I always get lathered up whenever some group of items goes down in price and folks say, See? There we have it. That's the signal deflation is about to commence. Nothing could be further from the truth. At any moment in time, any asset class or any group of asset classes may go down in price. That does not signal deflation. Deflation is when the dollar appreciates against a basket of goods and services. Or, said differently, your dollar goes further.

Since the Fed was invented in 1913, the dollar has lost over 95% of its purchasing power, a rate of loss that's only been exacerbated since the gold window was closed in 1971. There's no doubt that this piece of confetti called the dollar is going to lead us one place, and only one place -- toward more inflation. If we have a bear market in stocks, and if we have a bear market in real estate, both of which I expect, those would be just that, bear markets. They are not deflation.

That said, because we have so much personal, corporate, and government debt, because we are indebted to foreigners, and because the dollar could collapse at some point in the future, we could find ourselves in a place where all hell breaks loose on the downside. The Fed could be forced to tighten to save the dollar, debt liquidation could take over, and we could have deflation. As I said yesterday, we may have to worry about that eventually. But when that outcome gets closer, or we suspect that could happen, we can evaluate then what the right thing to do is. I think the threat (or the actual thing, God forbid) of a systemic collapse, if it gets that far, would be bullish for metals.

A Clime Not Primed for Deflation However, as I said yesterday, an environment with the Dow at 10,000 and housing prices recently at record highs; with housing stocks at record highs; with oil between $35 and $40 a barrel; and with copper at $1.22 (when its cost of production is about 60 to 70 cents) does not look to me like one in which deflation is about to get the upper hand.

Many of the base metals recently hammered had just experienced gigantic moves to the upside. Those moves could be over, or they could be setbacks in an ongoing bull market. But even if those moves are over does not mean we are headed toward deflation any time in the near future. "Deflation" must be one of the most misused words in the English language. As I noted, I have been hearing about the "fact" that deflation was right around the corner since I entered the investment business in 1979. To repeat, we have yet to see it

In sum, we have engineered the country into a position where, conceivably, a group of events could occur in the next year or so that could finally bring us to within sniffing distance of mulling a deflationary environment. But to set one's investment strategies now as though deflation were a live possibility, based on the fact that the metals have been smashed on a wave of speculative liquidation by speculators, is the height of folly to me.

Seeing Aye to Aye on the Metals . . . By the way, I know that Richard Russell holds a slightly different view on inflation/deflation, though I also know he believes that if deflation were to occur, the damage it would inflict on the financial system would be very bullish for the metals. Therefore, even though we disagree about the most likely outcome right here and now, we agree on the eventual investment conclusion. In any case, I hope that clarifies my views on the subject and answers the many related questions sent in by readers.

Going to School on 'Short Dollars' Turning to another subject that prompts reader email, I would like to opine on Russell's view that everyone is short dollars because so many people are in debt. (Therefore, he is bullish on the dollar, as I read what he says.) I would say it this way: People are short net worth. They have borrowed money to allow themselves to live beyond their means. But technically, they are not short dollars. They did not borrow dollars and sell them short. They did not sell dollars short against some other currency. They borrowed dollars, got long some dollar-based asset, and spent some money.

The way you rectify a short dollar position is to sell something and then buy dollars. The way these people close out their debt is to accumulate dollars, but they do not go into the market and buy them. However, they have one "out" that's not available to the short-seller -- reneging on their debt. In that case, certainly, the "buy-to-close" transaction never occurs. Therefore, to say that everyone is short dollars is, to my way of thinking, not quite accurate. The world is swimming in dollars. The world is also swimming in debt. But the fact that we are swimming in debt does not necessarily make us short dollars.

I continue to be very bearish on the dollar. I think that the rally we've seen in the dollar is nearing its end. I am looking, in the next five or six sessions, to see some confirmation that perhaps the worm has turned. As I've said, I am basing this on the dollar rally that we saw last fall. This one could turn out to be different and perhaps last longer. But I have absolutely no doubt in my mind that in the second half of the year, the dollar will come unstuck again. That will provide a tail wind behind the metals and an undertow for stocks and bonds.

Positions in stocks mentioned: Short IBM and Nokia. Long Newmont Mining and Pan American Silver.