What is this?

By: Hans J Lysglimt

We have been watching the rally from the sidelines, in disbelief. Still diversified mainly into gold, gold stocks and diversified cash we have not been part of the March-June rally. We have been preparing to short it for close to two months now – but we are beginning to doubt if the shorting moment will arrive. (Remember that I told you to go short massively if I should ever turn around and recommend buying share long this year. How is that for contrarian advice… trust yourself first.)

A shorting call in April/May would have been to easy a call. Markets are never easy, that’s the thing. Markets tend to do what you don’t expect.
Right now the markets broadly seems to expect a continued rally, and some contrarians expect a new bust (like yours truly) – no one expects the markets to calm down at present levels and coast there for 2-5 years – so maybe therefore that’s exactly what the markets will do.

As gold surged up towards 990 we thought we missed the last chance to get into gold on the cheap, but here we wore again today at USD 929, anyway we are not selling a speck.

The big question now of course is if this wave of renewed confidence is sustainable. What this new wave of confidence actually is. I think about this long and hard, but can’t seem to tame the beast. What is this? A bear market rally, inflationary money, a real recovery? It seems on the surface of it that we are at the beginning of another inflationary wave, markets are up. Last years crash already seems like a distant bad dream to many.
Watching the fundamentals however we are confident that this is not the real thing, this is not a real productivity lead prosperity wave. It might be a wave of expected inflation, maybe (we doubt this to), but it is not the real deal and therefore not sustainable.

Tomorrow the Norges Bank, Norwegian central bank will set interest rates, and publish their inflation report. The interesting thing is that they will actually need to call this beast, in order to set interest rates “correctly”, up or down or steady. Or maybe they don’t call it, maybe this is the wrong way to view it. They will need to call it, but they call it within the limits of the “model” they follow. And this model is far from perfect. The model is full of assumptions and actually quite short sighted. Central banks assume a Keynesian view of the world, they assume a reversal to mean the assume the political situation as legitimate and stable. Their model input data is mostly statistical backward looking material, quantitative stuff for quantitative modeling. They do quantify forward looking material as well, confidence indicators, investing budgets and so on, but this material is as good or bad as the estimations that went into it.
A lot of the material is self reinforcing, high confidence gives a stock market boom and this gives more confidence and so on. How are the central banks to look through this? They can’t.

What is lacking is the deep qualitative reasoning, and ability to take radical steps based on it, if needed. One has to realize that this approach to analysis is not the central banks job.

This is why we are quite confident that is actually is possible to operate rationally in the markets. Because the actors in the markets aren’t necessarily that… rational. for lack of a better word. It is possible to do a better qualitative analysis than the central bank arrives at, because you are not constrained by a model. The elephant in the room, the central bank that behaves more like a predictable animal than a cunning unpredictable human adversary.
Being in the markets, being up against the central bank is much more like fighting a bull than sword fighting another human being. The bull is predictable in that it is a bull. It will charge for the red wail instead of the man holding the wail.

I am however convinced of the central banks commitment and will to follow their mandate. What one has to do is to clearly think about what that mandate actually is, and how they aim to follow it.

There is little in the central banks models that is able to pick up when the fiat money inflationary secular boom has come to a once in three generations stop. There is little in the central banks models that can pick up when the general public has been spooked into a different weltanschau.

This takes a deep qualitative approach.

So this turns into the biggest of economic spectacles. I am convinced this bust is real and that we will need a serious readjustment of the capital structure in the economy. The central banks are committed to their Keynesian models, that they can re inflate the economy with lower interest rates and new money.

Right now it seems the central banks are perhaps getting it right, that they are about to blow the thing up again. But, remember – they MUST think that, it is built into their core. It they are wrong it will fall apart spectacularly, much more spectacularly than what happened last year.

The amazing thing is that we will live to see the answer to this.

Hans J Lysglimt
June 16. 2009
Oslo, Norway

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