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Explaining the Chasm

February 28, 2012

Why is oil at $110 per barrel, gold near $1800 per ounce, the S&P 500 at multiyear highs and the 10-year treasury note around 1.9 percent? Who, 10 or 20 years ago, would have predicted this type of investment environment? Historically, many of these investments move inversely, so when a favored market moves up, another investment class moves down. In this current environment, why does everything keep moving together in an upward direction? By the way, the amazingly low interest rates for treasuries are created by demand. In other words, rates go down on treasuries as demand goes up. Investors are willing to buy treasuries at lower and lower rates.

Let’s take gold and stocks for instance. When one investment class is favored over another investment class, the prices traditionally act inversely. For example, if stocks are popular and the market is rallying, usually that means gold prices will be declining. One of the reasons for this is because of limited investment resources (cash to invest).  

Right now, though, it seems every asset class is climbing all at the same time, which should cause us to pause and ask why. The exception, someone may argue, is that home prices aren’t climbing. I would agree — but that is because home prices are being affected by a mass overhang of foreclosures.

So the answer to my initial question is one simple word, and anyone who has read my writings has already guessed the answer. You are correct: the answer is liquidity. Our central bankers have successfully created a “gold rush” in every asset class by infusing unprecedented levels of newly created money. They have given the illusion of a recovery by doing so, but they should be asking exactly how to extricate themselves from this experiment.

Continuing conversations with self

(Conformist) self: Don’t you have anything new to say? I have heard your liquidity theory one too many times!

(Contrarian) me: Well, am I wrong?  

Self: Well, maybe you have a point. 

Me: Really?!?!? Are you starting to understand my concerns? I always believed you would come around!!!!!

Self: Are you serious? I was being facetious, you ignoramus!!  

Me:

Self: So I have a question for you.  

Me: What’s that?

Self: Can you give me your collar and sleeve measurements?  

Me: What, are you buying me a shirt or something?

Self: Or something. 

Me: What is it?

Self: A straight jacket for when they come to lock you up! 

Me: Very funny!

Self: I’m confident of your insanity now, but I can wait until you are proven wrong! 

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