What's Happening (cont.)

Over the past month, we've had oil up, stocks up, commodities rebounding (a little), emerging markets on a tear, gold selling off, and Treasuries up on good news days, and down on bad news days? How is this possible?

The action in Treasuries shows that the market is expecting deflationary economic news, such as large job losses, to be answered by Ben and Tim with more bailouts and printing. Corporate and other bonds are all still showing high expected default levels. Rail traffic started to rebound, but has since fizzled out again. The Baltic Dry Index has collapsed again, to under 1,500. Here's the rail traffic chart:

In fact, the chart shows that the bounce is probably just seasonal.

Oil, stocks, emerging markets, and commodities up can be explained by a couple possibilities. The most likely ones are fear of inflation and/or devaluation of the U.S. dollar.

So far, I'm happy with my explanation for these different asset classes. But what about gold? Ever since inflation expectations have come back in the past couple of months, gold has been sliding. However, gold did rally strongly when Ben announced his money-printing plan. So, what's driving gold? Inflation, deflation, flight to safety, dollar weakness? Out of this list, the one that seems the easiest to answer is the flight to safety question. Maybe the rush into risky assets over the past couple of months has been greater than dollar weakness for gold. I don't know for sure. However, my instinct tells me that 0% interest rates and money printing must be good for gold.

We now have two questions to answer. One about inflation, and the other about the dollar. Let't try to answer the inflation question first: Will we get inflation soon?

What is the mechanism for inflation? Bank reserves have to be lent out to people who will buy goods or assets. Can that happen? It is possible because bank reserves are enormous right now (over $824 billion, up from $42 billion a year ago). However, that's only half the picture. The other half of the supply story is the demand story. Is there any demand for loans? No. Overall, most people and companies are either paying down debt or saving, not borrowing. So, we are still trapped in what Richard Koo calls a "balance sheet recession" in "The Holy Grail of Macroeconomics." Professor Prag said that whether their reserves are borrowed or not shouldn't matter to banks lending money. However, my suspicion is that the collateral that they've posted for the borrowed reserves is not Treasury bonds. I think a lot of it is default-prone loans. Maybe the banks are worried about their continued ability to borrow against this collateral.

The next question is about the dollar. Will the dollar collapse or strengthen? All the bailouts, fiscal deficits, and money printing are weakening the dollar. However, economic stabilization has propped up the dollar recently, as news was better than expected. Also, the value of the dollar is relative to the rest of the world, which is still doing poorly.

And here's why I read Rosenberg every day.

Did you know that the trailing year P/E ration for the S&P 500 is 100? 100! Maybe stocks are in a bubble... Not really. But when earnings fall 82% and prices only fall 57%, and investor bullishness goes from 18% to 42%, it sounds like the rally is fizzling out.

Bottom line: I'm staying put. In fact, after doing this analysis of my portfolio, I think I am positioned EXACTLY the way I want to be. I will be looking to short more oil via DIG if it hits a new yearly high. I will also look at more gold companies, especially those that aren't tied to copper, which is at a four-month high.