Putting the pieces together...

Kondratieff 4

The year long lull in the long upward inflationary wave may be ending. The long wave itself bottomed from 1999 to 2003 well down from its long wave top formation of 1974-1980. The chart labeled "30 years of the US 30 Year Treasury Bond" tells the whole story visually.

Nearly all  the analysts who understood the long deflation-inflation cycle of Kondratieff have retired or died. The ones you will find at dedicated bearish web sites are derived from the revisionists of the 1980's and 90's who failed to recognize that those decades were disinflationary for interest rates and producer prices and commodities and bullish for stocks. They thought gold and oil fell due to a conspiracy instead of lack of demand and oversupply. They also thought stocks went up only because of manipulation. They ignored the rust belt, and the agriculture disaster and oil depression of the 1980's and 90's. While bonds of the highest credit ratings more than doubled in price, the long wave revisionists were lost in a desert of their own making. They still are, so ignore them if you happen to see them posting elsewhere or publishing yet another Kondratieff Wave book.

An economic cycle which lasts more than 50 years cannot be used for short term trading, but it is always wise to know which way the 25-30 year long half cycle of deflation or inflation is headed and not bet against it too long.  All you really need to know is that prices, interest rates and stocks had all bottomed by early 2003. They will be headed upwards for some years. At some point, most likely in a decade to fifteen years or so, interest rates will finally get high enough to impact corporate earnings in most sectors and stocks will top out and  trade sideways to down while everything else will continue to rise for another five to ten years.

I am not predicting that bonds will be down Monday and never trade higher again this year. But the persistence of inflation, even in the face of a short term housing price decline, and the persistent weakness of the US dollar, convinces me that the lull which began last year in commodity prices and as early as 2004 in bond rates is ending soon or has ended.

It's not an emergency, merely a reminder from the markets that we are still in a long term inflationary era which began in this decade. Financial stocks will not do as well as most other sectors, and if you need income and can't afford to lose very much capital, it will be better to stay in the lowest cost money market funds (VMMXX) or TBills, or in CD's and TNotes up to two year maturities.

I want to rephrase the stock part of my analysis and emphasize that this does NOT mean a bull market top in stocks is due. Every time stocks have a pullback it will be attributed to rising interest rates, but don't be frightened out of holding US and selected foreign stocks. They are a better long term hedge against inflation than gold. (Nor am I anti gold: I continue to own gold, but one doesn't have to own gold to profit from inflation.) See my earlier article on "61 year investments" for details. And remember that US interest rates rose from the 1940s to 1981, but stocks also went up from the 1940's until the early 1970's when interest rates finally got too high. It is when rates get "too high" that you will want to own gold or add to what you already own.

   

2000 to 2007-Part 3: Kondratieff

Within both of the 20-30 year phases of the Kondratieff Wave (disinflationary and inflationary phases), there are contra-trend sub-phases. As I have discussed several times over the past year, I believe we are now in a contra-trend correction in a long term inflationary period which began between 1999-2003 and which will last until the 2020's.

It's useful to look at the last time this happened. With the chart of the Implicit Price Deflator, the standard  of total US inflation as measured by chain-weigted real GDP, one can see in the smoothed rate of change that inflation leaped up in the late 1940's and early 1950's,  off the 1949 low, but then subsided again to a final low in the early 1960's. Then the amazing inflationary balloon began into the 1973-1974 top, on a rate of change basis, or 1980 on a nominal basis.

However, even in the early 1960's when the lull in the long term inflationary wave occurred, inflation remained higher than it had ever been during the deflationary wave in the 1930's. But I can remember my grandfather, who had lived well in the 1930's on his railroad bonds while putting three children through college and university, saying it was time to load up on bonds again. It wasn't, and he lost hugely not only from subsequent interest rate rises but also due to the collapse of the US railroads. Nevertheless there was a time from the mid 1950's to early 1960's when inflation subsided and bonds did modestly well on a trend basis. Stocks also did quite well as they always do when rates are declining somewhat and inflation is modest. While cycles never repeat exactly, I believe that's where the economies and markets are today.

In 1998 and 1999 the weekly news magazines all had cover stories on deflation, and Paul Krugman, then professor of economics at M.I T., wrote his infamous "The Return of Depression Economics". (Krugman is currently a political hack writer for the New York Times.) Gold and oil were on their lows as Krugman's book went to press in 1999, as were most commodities, and nearly everyone expected the beginning of another 1930's debacle.

Skip over to 2004 to 2007, and nearly everyone became a raging inflationist by 2006 as in the early 1950's. As in most things, most people are wrong at major turns and for a few years thereafter. Then they get wiped out again when the trend changes again just after they got comfortably onto the new bandwagon. That's human nature, and why it's ideal, although very, very hard to do, to attempt to become a contrarian. We are almost all of us, by nature, in almost all ways, like sheep following self-proclaimed shepherds and trend projections.

My impression is that Alan Greenspan saw this lull in inflation coming and that his bond "conundrum" musings of 2005-2006 were a heads-up, as had been the famous "irrational exuberance" remarks of the late 1990's. I think he was saying, if we heard, that we shouldn't get too wild for inflation and do something to monetary policy that would make the coming lull far worse.

That said, how long does this lull last? Frankly I can only guess, based on current conditions compared to  the 1950's and 1900's. On a smoothed trend basis, inflation is running at 2.5-3% now compared to under 2% in the 1950's. Plus we know that the disinflationary period from the 1970's to late 1990's was far milder, on balance, than from 1929 to 1949. These facts are due to the incredible modern inflation machine  known as the social democracy and currency debasement regime. The chart of PPI is ten years old, but  it shows the inflationary departure which began in 1933 and that was confirmed by a breakout from the 200 year range in 1949-50. There is virtually no chance that the long term trend since the 1930's is going to change any time soon, as it is due to political sentiment which still growing world wide.

 

For the current question it's sufficient to note the 250 year PPI as the reason why the current lull will not get too severe or last too long. My guess is that inflation will not get below 2% and the lull will not be more than two to three years in the absence of a major economy crashing for reasons other than "normal" economics: massive corruption or financial collapse,  revolution, or a catastrophic natural or man-made disaster. The two hundred years from 1750 t0 1950 were filled with all of those classes of events, but producer prices traded in a range. Nor is it easy to say exactly when the lull began. We sense we are in one now, but did it only start last July or what that just the last inflationary binge of the first leg up? Again, my guess is that it could last another year or two but with volatility that will keep us confused. We already see that the  markets have "inflation days" now when commodities, interest rates and forex go up, and then "deflation days" when they all go down. This past week was a classic in that regard, containing both kinds of days. I expect that will continue.

But by and large, a lull in inflation and a lull for increases in rates is bullish for stocks over the longer term as it was in the 1950's and 1960's. Even when inflation is increasing it does not kill the stock markets if it does so gradually, until it gets "too hot", as it didn't really do until 1966-69.

2000 to 2007-Part 2: Kondratieff, Smith, Eliades

Here is a further quote from the January 10, 2000 Tenorio Research Year End Review:

"Further support for this scenario [of a top in early 2000] is found in Edgar Lawrence Smith's Tides in the Affairs of Men, 1939, wherein he presented the decennial pattern of stock prices. Smith found that years III, VII, and X [or some major part of them] were generally falling years with the rest generally rising. The most bullish years were V, VIII, and IX."

"Except for 1949-50 [the start of the previous KW up trend], there has been a top in the market in year IX, or in year X, usually early but no later than July (1990), and with a major bottom no later than March of X. In several X's there was no convincing low at all as the bear market lasted longer."

"Peter Eliades has [in early 2000] posted a similar observation at http://www.stockmarketcycles.com: 'Since 1920 the market in the first two market days of January of the zero [X] year has tipped us off whether the pattern would work for that year or not. If the Dow close on the first or second trading day of the New Year is higher than the highest close of the preceding month (December), then the pattern is scheduled to work, i.e. a top of some significance should be marked by the high closee of the first two trading days.  only three zero[X] years..[did this not work]:1930, 1950, 1980.'"

"All of these observations [by Eliades and myself plus Nikkei 225 in 1989/90 and gold in 1990] suggest that the stock market could make a signiicant top in early January or by mid year at the latest."

There was both a January and mid-year top in 2000 with a major low in March. There were disparities of the Dow and SP500 and more dramatically so for Nasdaq. And finally in March 2003, in the middle of the standard KW window for a low, the stock market made its last low.

The reason to present this history at some length is the greater certainty it gives to what is happening now in early 2007 and during last year. Once the KW lows of commodities and rates and the stock market are in, as they are since 1999-2003, new lows will not be seen for 20-30 years. Odds are quite good that most markets will be on rising trends until the mid to late 2020's.

But when sentiment gets manic during rising trends, as it always does, there will be sizeable intermediate term bear markets such as we are now seeing in many commodities. The stock market had a major bear market from 1987 to the early 1990's, and it will have one or two more during this period up to the early to mid 2020's.

Given the history of the decennial VII years, 2007 "could" start an intermediate term bearish stock move, but the US economy shows no signs of being the trigger. The economy in the US is far more resilient than the usual naysayers expected, and much of the rest of the world is even stronger for the first time since the 1970's (or 1980's for Japan). It's possible, of course, that a China or India collapse could precipate a bear market in the US. I am not very knowledgeable about the internal markets of those countries, and I have seen very little written on current negatives, but my guess would be that a banking crisis or market corruption debacle in one of those two lands could be a bear market cause "at some point" over the next one to two decades.

A US stock market decline, if one even occurs this year, needn't be a large one. In fact, if we look at the slow-go market from early 2004 to last July, we may already have seen the decline in the form of an Elliott wave "running second wave" where the correction is sideways to mildly up, as shown on the chart below by the 1 and 2 on SP500 futures.

The intermediate term bear market in commodities could end in the latter part of this year; however, the CRB US Commodity Index made its last high only six weeks ago, even though oil and gold and copper did so months earlier. One thing is clear to me: it is far easier to time the very long term top and bottom formations of KW than to time the contra-trend corrections in the long term trend moves. I'll spend more time on this another time.

2000 to 2007-Part 1: Kondratieff

During the 1990's I published a gold advisory and also a 20-40 page annual recap with  an attempted prediction for the coming year. My main guide was and still is the long economic wave of Kondratieff (KW) which concentrates on interest rates, commodity prices, and general inflation. KW is only indirectly related to stock prices, and  different tools and economic series are necessary for more precise stock market analysis and prediction.

A few quotations from my January 10, 2000 "Year End Review":

"There [were] several rallies in in prices of commodities along the way (1982, 1986, 1992, 1999), but the trend is down into the trough (2002-04)."  "So on interest rates [also] we would appear to be in the late down phase of the Kondratieff wave, with the absolute bottom due in ~2002-2004 if we are to have a typical 53-54 year cycle."

"At the present time it seems most probable that the FED will raise rates once the Y2K non-event is past us and with the inflationary threat and existence of massive stock market speculation. This will be done as early as possioble in the new year so as not to be seen as a factor in the November presidential (and Congressional) elections. And the markets will respond. Bonds should rally, and commodities (on balance) and the stock market fall. This is precisely the pattern we would expect for the late phase of the Kondratieff wave, as from 1946-1949."

I must admit that I had previously very briefly thought 1999 might become the early occurrence of of the long wave trough as that was the year when deflation made the magazine covers and news.  Some commodities made very long term lows, such as hogs and gold, but the stock market rise off the 1998 low made that 1999 trough totally improbable. The trough of the ~54 year  cycle is the most dependable place for prediction since rates, stock market, and commodities all tend to bottom in a fairly narrow window of time.  This was the first trough I had lived through, and I expected it might be V-shaped, but I began to realize it could be W-shaped as in the 1890's and late 1940's. I now accept that the KW bottom can last five or more years as the top typically does (1921-29 1974-80).

From 2003 for sure, but even from 2001 with gold and oil, it became generally accepted that deflation was  behind us. By last summer  nearly eveyone was a raging inflationist, and predictions of $2000 gold and $200 oil before too long were not uncommon. I was a little early in predicting major pullbacks in that developing mania , although I had learned in 1979 not to sell everything at one time. So I gradually cut back on energy and precious metals investments. Since we are in a long term bull market for commodities, I did NOT short sell anything or recommend that anyone do so. And I kept core gold and energy holdings. 

Because the capitalization-weighted stock indexes were very heavily weighted in energy by then, and mutual fund and other pooled investments (hedge funds) even more so, I expected a stock market pullback as well. This is partly why I hedged my portfolio for a good part of last year and spent a lot of effort on volatility control. That proved to have a cost, as I have told you before, but even so my total liquid investment portfolio including gold and all cash was up 8.6% on the year. Given the dividend fad and large cap preference, the SP500 was up over 15%.

By the way, someone at MarketWatch.com mentioned the other day that energy cap-weighting of the SP500 is nearly 50%. I haven't checked this myself , but what a change from early 2000!

NYMEX crude oil in the front month fell as low as $52 this past week, which is a 35% drop since last July 14. A warmer winter than normal in the northeast US is getting blame on the news since they use so much highly polluting heating oil and have needed far less, but it's far more complicated than that. Copper, the "commodity with a PhD", is off substantially as well and gold a bit less so.

(More soon.)

Kondratieff in a Nutshell

Kondratieff in a Nutshell

"As a nation of baby boomers nears 60, an army of financial planners from Sacramento to Scituate have mobilized to guide their clients out of equities and into bonds in an effort to offer them income and stability; and why not? History is on their side. Income-oriented investors have enjoyed a secular bull market in bonds over the last 25 years. Over that time period, the 10 year Treasury rate dropped from 14.0 percent to 4.4 percent. Inflation in 1981 was over 12%. Now after flirting with deflation 5 years ago, it is comfortably situated below 3%. Clearly, the last 25 years have been favorable for bond investors. All told, a portfolio of long-term bonds returned to investors a compounded annualized return of 11.8% over that period; clearly a competitive alternative to equity investing at the time."

"What's the likelihood that the next 25 years will match the last 25? The answer's easy: zero. Investment return has just as much to do with the entry point as it does with the exit point."--Jack Ablin, CIO, Harris Private Bank, Harris Outlook, May/June 2006.

Think about 1981 to recently: inflation rates down, interest rates down, oil prices down, gold down, GDP growth rates down, wage growth rates down. Remember the deflationary crash of 1981-82 and the slow melt down and terminal crashes from 1996 to 1999 and 2000-2003?

Then look at what's happened: oil prices and gold bottomed in 1999 and there was inelastic supply to meet marginally increasing demand. Other commodities or crude goods also began making 2-3 decade bottoms. The long bond rate bottomed in 2003. GDP growth rates in the US and elsewhere began returning to rates not seen since the 1960's and 70's. Despite debates on how inflation is measured, everyone agrees it has risen.

This is the same 25-30 year half cycle which Kondratieff first described in the 1920's. Read his short and simple paper in English translation. http://www.geocities.com/deuxsous/KLW.html It is a 50-60 year cycle of business, interest rates and prices. There is no pessimistic "summer-fall-winter-spring" crash and burn message from Oswald Spengler or his modern "perma-bore" (L-V Gave) followers.

Kondratieff is a simple cycle of supply and demand whose top completed in the 1970's in final oversupply at the end of several decades of price and interest rate increases. Then came several decades of the opposite, when supply and prices and rates were run down, and now that is done too, and we're going up once more.

Not a prediction, but.....

As you know I am a firm believer that the 54 year economic cycle of Kondratieff made its low from 1999 to 2003. The previous top formation ran from 1974-1980. Based upon previous cycles, the next cycle top could be as early as 1999 + 20 = 2019 or as late as  2003 + 27 =  2030. This would depend upon the schematic wave shape of the cycle which I have shown before:

Long term bull and bear markets do, of course, have large and sometimes lengthy contra-trend moves. An example during the great stock bull market from 1982 to 2000 was the 1987-1990 bear market.

During this Kondratieff bull market the prices of crude and finished goods and interest rates will be in a bull trend for a long time to come. But they will have one or more lengthy and painful (for bulls) bearish contra-trend corrections. If we were to take 1999 as the beginning of this bullish Kondratieff cycle, as it was for gold and crude oil, we have already lived through a bit more than 25% of the total bull market for this cycle. Thus it would not be surprising if a larger correction were to occur at any time.

Although there are shorter cycles (Juglar, Kitchin, etc.) which some analysts and historians have used to time or predict these contra-trend or corrective movements within the long cycle of Kondratieff, I do not find them convincing. Also different commodities or finished goods will have different patterns within an overall bull market for physical assets. For example, cotton had four distinct bear moves in the long Kondratieff bull market from 1949 to 1980, one of which lasted four years and another which lasted five years!

There are important lessons to learn from behavior like this:

First, and most obviously, Kondratieff bull markets are not linear. They are volatile. Uptrend lines are drawn through lows. This is almost too simple  to mention, but pondering it briefly is worth while. This means there will be lows, and that there will be highs before these  lows.

Second, we shouldn't chase after rising prices since we will know that there will be contra-trend bearish periods when the market we missed becomes attractive again.

Third, when prices have risen dramatically we should take some profits from  time to time. We are not compelled to buy everything at the very lowest low and hold for two decades to sell at the exact high. We may want to keep a core position throughout, but few will want to sit through multi-month or multi-year contra-trend moves fully invested.

Fourth, for most people it will be too dangerous to short physical assets even in fairly clear cut contra-trend bear moves. The better way to play it for investors, as compared to speculators, is to consider long positions in the dollar and/or in dollar bonds during contra-trend bear moves in long term Kondratieff bull markets. If or when you have taken partial or substantial profits on gold or in energy stocks or real estate, you can begin to watch for times when bonds and the US dollar rally strongly. Normally during the Kondratieff bull market, both the dollar and bonds will be declining. By catching rallies in bonds and the dollar we are making profits during contra-trend moves and also hedging our remaining core positions on gold and other Kondratieff bull market assets.

At this time I can identify price patterns in bonds and the US dollar which could result in intermediate term bull markets for both. These patterns are usually accompanied by extremely bearish sentiment, and it's hard to find anyone who is bullish on the dollar or dollar bonds these days.

I'm showing the dollar via the chart labeled DM_EUR/USD. Western Europe (except Switzerland, Sweden, Norway, and the UK) has adopted the DM_EUR or peg their currencies to it (Denmark). Greece and new world possessions of Euro members also use the Euro.

The governing bearish pattern for the Euro (bullish for the dollar) is a four point expanding triangle **below** a long term high. On the chart the major  high was in 1995, and the triangle  ("spando" is what Don Wolanchuk calls it) is labelled in large blue numerals. A smaller degree spando below a higher low began last year and has formed its own 4th wave (small red numerals) recently. Even numbers are at the extreme contra-trend spando points and odd numbers at the  extreme trend direction spando points. Thus at 4 or 6  points a continuation of the trend which carried into point one is likely to resume. And at 3, 5,  or 7 points a reversal to a new trend is likely.

The pattern for bonds is more complex but employs the same principles.  The blue numbers of 2001-2002  heralded a continuation upwards, and the 2003 top in bonds could be labeled 5. In 2003 bonds reversed down in a new trend. Then a new 4 point spando was formed under the 2003 high. This was the first such 4 point since 1981! As such it was a very bearish setup. The subsequent small red letters show a 5 point (reversal) into the larger degree blue 4, reinforcing the bearish evidence.

However, while most (estimated at 80%)  of 4 point spandos result in a continuation of the trend, 20% do not. And now bonds have put in a smaller degree 5 point. Although it  is not required, this new smaller degree triangle or spando (red) is contained by trend lines across the extremes, and bonds have just touched the lower line at the same time as making a 6 point. In a bad week for most assets, bonds rallied two points from about 105 1/2 to 107 1/2, so there is a reasonable chance for a good rally in bonds and lower odds for a longer term reversal  upwards. The fact that the dollar and bonds are showing similar patterns while gold and other comodities are looking toppy is helpful.

A Sensible Rebuttal of Goldbug Balderdash

Generally people are content to let gold bugs rave in their specialized padded cells and internet niches. The only reason to do battle with them is that they recruit innocent but ignorant new people to join their radical visions, much as islamists recruit "martyrs". I know this because I operated on the fringe of goldbug-ism in the 1980's and 1990's. I was ignorant  and angry and attracted to gold.

Gold is still important to me, and I own it as a part of my investment portfolio, and gladly so today, but as I got deeper into economic history and the approximately half century long inflation cycle, I got a better perspective on gold as simply another inflation sensitive asset like cotton and soybeans, crude oil, and zinc, real estate and artistic collectables. Stocks and bonds are inflation sensitive too but in different ways. But gold goes up in bull markets during inflation and down in bear markets during disinflation.

Two events made me see the silliness of goldbug-ism. One was the about face performed by goldbugs after 1996 when gold went crashing down. All at once the "bugs" went from being inflationists to deflationists so they could still love gold above all else. The answer to this absurdity was that there had to be a cabal of conspirators preventing gold from pricing higher as it "should have".

One by one writers and sellers in the field of gold converted to the conspiracy theory rather than accept the fact of a disinflationary bear market that was also going on in most other commodities. Gurus and writers and sellers had to talk the talk of their rabid buyers or find a new profession. Many had put in decades on gold and simply had to mouth the new mythology in order  to make a living.

The other awakening came through re-reading 18th and 19th century history, particularly with regard to politics and economics. It became clear to me that the gold standard was part of the entire 19th century bourgeois reactionary regime which came into place on the final defeat of Napoleon and largely sketched out at the Council Of Vienna in 1815: very tight credit and very limited democracy. Credit busts were frequent and deep. Economies were easily strangled.

There was and is no way now of going back to an economic world  tied to gold in our age of social democracy and integration of the world's poor.

Dr. Eckart Woertz, Program Manager Economics, Gulf Research Center, Dubai, UAE has written a very succinct article for Financial Sense which further explains the dead and absurd concepts still propagated by goldbugs.

http://www.financialsense.com/fsu/editorials/2006/0509b.html

Crude Oil and the Kondratieff Wave

I found this chart today. Once you know what to look for, you will see examples of the Kondratieff Wave in many price, growth, incomes, interest rates and other data series.

Some observers will object that it was all due to geo-politics. But note how the drilling rig count  rose dramatically to meet demand and then fell off even more dramatically once demand was met by supply.

Then finally in 1999, when the rig count was at its lowest due to nearly two decades of downtrending prices and plentiful supply, a slight increase in demand in China and elsewhere exposed the parlous state of the whole oil supply infrastructure, and prices began to rise once more.

I needn't, but will, point out that all investors know that gold made its high also in late 1980 and its low in 1999 with a secondary or double bottom in 2001.

Long Wave websites and many books used to discuss the "why" of the Long Wave. The reasons advanced were many, including astrology and numerology, politics and sociology, but I think a simple argument for supply and demand can be made. When essential commodities are scarce, it takes a long while to get them geared up again.

First there is a period of some years before the new rising prices are taken as other than a momentary aberration in a bear market. Price didn't go down in a linear manner for the prior 20-30 years, so maybe this is merely another rally which will fizzle and die like the others did.

Then after five or more years there is realization or recognition that something must be done about shortages: by governments, industries, banks, labor and most certainly by end users and consumers. The financing of massive new supply infractructures to relieve the shortages takes time, and the phases of it are many. There are always a few projects that are ready to go, but most are not. For many crude commodities there begins a new round of the acquisition  of land for exploration, the exploration itself, the proving-up of the ore body or the gas or oil field, the financing of production and ports and pipelines and ships.

All this takes a decade or more in real market time. Engineers and laborers are in tight supply and must be trained, often housed, and paid. Government gets into the act by demanding higher payouts, taxes or outright expropriation, as we see. Environmentalists of the urban western type, as well as people living near these massive new projects, want their share an d/or try to slow the  projects.

As economic growth increases, demand rises, adding to the price pressures. Tire prices for machinery and the machinery itself rise. Labor begins to flex its muscles to share in the largesse. After 15 years the new productive structure has still not caught up to demand. Consumers/voters are angry and legislatures punish producers for their profits. These events have little effect upon  projects in the works or on the drawing boards, due to long lag times between deciding on a project and getting it into production. But gradually producers begin to pull in their horns a bit on new projects as many projects turn out not to have been as profitable as they looked, even at new higher prices.

This in turn puts more pressure on prices as investors become aware of producer reticence and shortages. Prices surge higher, and reticence is finally thrown to the winds as many new projects are undertaken at whatever the cost.

At last prices begin to show signs of stabilizing. Perhaps higher prices have finally inhibited demand, or supply has finally been able to satiate demand. Cost overruns on late projects are legion. Profits are dropping a bit.

The long down cycle is beginning with prices at historic highs, unemployment very low, wages high, GDP high and tax receipts even higher. It will take a long time for late projects to be completed, and when they do they will be selling into a saturated market at lower prices. Some will think this initial decline is just a minor correction in an even longer bull market, and this idea will persist for several years. Many people won't remember or even be aware of the last down wave. It will take a while to close down unneeded projects and get rid of them, or go through bankruptcy.

Well you get the picture. This is what happens in most crude goods categories: commodities that are necessary for new infrastucture and production, transportaion, utilities, homes, industrial buildings. And all of these have to be financed. So interest rates go up in the growth half of the cycle and go down in the slower growth phase when projects dry up. And so it goes.

So we know the commodity cycle and the bond cycle. But what about stock equities? That's what most poeople invest in.

I'll leave that mostly for another time, but here is a brief preview. In the growth phase of Kondratieff, stocks of productive companies, and services for them, do well as well as do commodity stocks. In addition many companies, whose market domination permits it, are able to raise prices a bit  faster than their expenses rise. They do well too. These companies may not all  be domiciled in your home market.

The best of the growth bull market is the first half: ten to fifteen years. After that interest rates and prices of supplies and labor begin to cut into profitability, and the stock market has a harder time. Toward the end there is almost always a rather severe bear market or two.

Notice that this runs counter to the everyday wisdom that rising interest rates are bad for stocks. Eventually that is true, but "eventually often takes quite a long time", depending upon the company and the industry and nation.

Also counter to conventional wisdom, many of the best bull markets in stocks occur during the slowdown of growth phase of 20-30 years when comomodity prices and interest rates are declining due to reduced demand and more than adequate supply: 1932-1946 and 1982-2000 are great examples. More on all this another time.

But do not be foooled into thinking that rising rates and prices always mandate a serious bear market in the near future. Reflation and inflation are good for stocks for a long time until inflation gets "too  hot". Although we can have bear markets and mini-crashes before inflation gets "too hot", the end of the current secular bull market has much longer to run than just 2002/3-2006.

Kondratieff Schematics

As long as I am on the subject, I'll present these schematic diagrams of the Kondratieff wave form. The larger diagram is of unknown origin. I found it at a website without  attribution and have edited it for my purposes.  Whoever did the original thought that stock markets followed the Kondratieff wave, a common misconception. One version of this chart appeared in early versions of Frost and Prechter's book, and an even earlier one I have in an old Julian Snyder newsletter. It's such a simple schematic diagram that it has to be as old as the concept of the Kondratieff Wave itself.

Although the schematics imply that the tops and bottoms are V-shaped, both tops and bottoms actually take about five to ten years to complete. It makes more sense to talk of momentum tops and final tops and bottoms. But there's no need to get into that just now.

The smaller schematics show how the wave form varies a bit under different longer term political/economic regimes. The periodicity of about 53-54 years has held steady since the 18th century, although my own studies and those of others have found a range of 48-72 years back to the European middle ages. The average, however was, 53.6 years.

Letter from Michael

Hello Tom,

I've read many of your articles in the past. Don't you think that real estate needs a substantial correction before rising again, especially given the gains made over the last few years? I live in Sydney (Australia) and our boom ended in 2003. Having said that, the correction so far has only been mild (about 15%). It is hardly the 1989-1991 scenario again of a sharp 25-30% drop. We're in a commodities boom and Australia is a major beneficiary, as reflected in the performance of our stock market.

However, I've always believed that excesses need to be purged before a new bull market can begin. In the case of RE, we've only had a small correction, which leads me to believe that the RE boom may not be over and that perhaps commodities will keep the economy buoyant. Without the stock market tumbling, I cannot see a crash on RE.

What worries me however the level of debt. Australia is worse that the US in the level of debt per capita. Our 10 year bond yields seem to follow the corresponding US 10 year bond yields (at least for the last 16 years) and I've noticed that the US yields have risen substantially recently. I'd tend to think that it would not take much of a rise in interest rates to really hurt home owners. Such action could well then lead to a recession.

In short, regarding your comment of 'Real estate and gold and most commodities will trend up but with negative interludes', I'm wondering whether a 'negative interlude' may arrive sooner rather than later - including the USA.

Regards

Michael

Thanks, Michael.

Both Australia and the UK have had residential real estate corrections, as you know, and we may have one starting in parts of the US. Residential real estate depends mostly upon very local factors. Our great home price increase in the past few years was a complex social event occasioned partly by "cocooning" after 9/11/2001 and the associated rapid drop in borrowing rates. However, it also occurred nearly at the exact bottom of the Kondratieff Wave itself.

With regard to Long Wave real estate investing, I really meant to refer more to commercial real estate, which also has local determinants, but where the economic situation is the primary factor for increases and decreases in values. Residential real estate can turn out to be a good investment, but in general it's best to think of it as "just home" for family and self. A person with a modest paid-for home, but who invests for the long term in stocks or other assets, will generally come out far ahead of some someone who leverages up a residence beyond his means as an "investment". Obviously some folks will at some times get lucky doing the latter, but luck isn't as controllable as other investments can be.

The concept of a "wipeout", or major debt and real estate disaster at the end of a Kondratieff down cycle, is NOT an integral part of Kondratieff's view nor my own. Such events "may occur" but are not necessary. All that is necessary is a 20-30 year decline in interest rates and prices followed by convincing rises in many price and growth data series.

That Long Wave "wipeout" concept in Kondratieff studies came from the so-called "liquidationists" in this country in the early 1930's. Andrew Mellon, who was President Hoover's Secretary of Treasury, was a vocal liquidationist. The idea arose that all "bad" investment had to be liquidated or destroyed so that "good" or intelligent investment could begin: this was often referred to as "creative destruction". The former Austrian imperial treasurer, Joseph Schumpeter, who became professor of economics at Harvard University after World War I, was a convincing champion of "liquidationism".

In my view "liquidationism" is a simplistic political slogan. Some particularly severe down cycles, like the one ending in ~1844, and in some parts of the 1929-1949 down cycle, are indeed severe liquidations. The recent one from  the mid 1970's peak to 2002-2003 was not.

The Long Wave is an economic observation, not a political or philosophical system. Many would-be Long Wave analysts missed the whole down cycle of interest rates (and slowing growth), going from nearly 20% in 1980 to nearly 1% several years ago, because they needed to see "blood in the strees" and a major credit cataclysm. Many are still waiting for this "Second Coming", as did the early Christians, long after it's finished.

The hallmarks of the down cycle are decreasing crude (commodity) and finished goods prices, falling interest rates, and decreasing rates of growth and all such things which depend upon growth such as incomes. That is truly the "bottom line" of Kondratieff.

By the way, I have been enjoying the fruits of the Kondratieff rise by investing in BHP and in Rio Tinto for the past four years, both directly and through funds which own them. I suspect, barring some mistake or odd happenstance, that they and many other Australian investments will be good holdings for at least another 15 years.

Regards and allbest,

Tom Drake

Long Wave Thoughts

From 1996 to 2003 I wrote so much  about the Long Wave of Kondratieff in newsletters and internet websites, that I am rather burned out on it. Most people never got it then or will ever do so. There is no point in presenting the history or the cycle. Commonly, people only  care about next week at best and have a gloomy opinion of the future in general.  "Eat, drink, and be wary."

Since 1999-2003, depending on the asset item, the price patterns since the 1970's through 1990's totally reversed.

Interest in stocks is always most common: they go up most of the time except when deflation is around and when hyperinflation is around. They will go up for the next 10-15 years until inflation gets "too hot". Not in a straight line of course, but trending upwards.

Bonds will trend down over the same period, and the US dollar as well. Euros and Yen and the rest of the paper chits will also trend down with variable rates to each other.

Real estate and gold and most commodities will trend up but with negative interludes.

The cyclical tops in most stuff (physical and paper assets) and the lows in bonds will not occur until 2020-2028, depending on which type of final high we have. We will have two or three major crashes in "emerging country" stuff, and at least one in US and european stuff.

Some stuff you won't want ever to sell in these two decades. Others you can trade if you're bored or need the money.

Bank it. It's as easy as buying bonds in 1981-82 and as profitable, even though the  decay of all currencies makes it harder in this phase.

This is not a prediction of the future. It is a description of the controlling cycle of economics throughout history and how investment assets react to that cycle.

Keep your eye on the ball and invest accordingly. Enjoy life and accept the fact that things change.

The Great Debate

Kate Welling interviews are always of interest, but a new one she has done with Marc Faber and Louis-Vincent Gave is a must read:

http://www.financialsense.com/editorials/2006/0112.html

Economic Long Wave:PCE(CPI)

The folks who missed the Economic Long Wave inflation peak of the mid 1970's were still insisting we hadn't seen a contraction yet, the last I bothered to look. But the curve of Consumer inflation as measured by the PCE shows the classic shape of 25 year increases and decreases in inflation.

With all the talk this week of Greenspan's legacy and Bernanke's prospects, it is well to remember that FED heads do not produce  the economic cycle. In fact they follow it as fast as they can, sometimes making its swings more violent.

I am posting this chart from Paul Kasriel, and the classic long economic schematic chart below, several hours before the Consumer Price Index comes out. My view is that hang-wringing, wishing,  and fiddling  do not make a lot of difference in  the long run. For investing and living , a grasp of the long cycle is superior to reading the tea leaves  of daily economic releases. The longer tem fact is that  consumer prices, and much else, peaked in the 1970's and bottomed in the late 1990's. That's when gold and crude oil bottomed in price as well

Click on charts for larger versions.

Gold's Bull Market

It's no secret  that Robert Prechter's persistently bearish bent since the early 1980's created a whole amateur underclass of market bears and pessimists who have made  internet chat sites their home. Less well-known is the fact that early in his public career  Prechter accepted the traditional interpretation of the Kondratieff Long Wave  cycle. In the second edition (1981) of Jack Frost's and Prechter's "Elliott Wave Principle", the "orthodox" Long Wave schematic chart is presented (page 148) with the LW inflection peak  said to be early 1970''s, the top formation "plateau " end in the early 1980's, and the final low scheduled for the early 2000's.

Here it is in Prechter 's own 1979-81   words: "As we  interpret  the Kondratieff cycle, we have now reached another plateau, having had a trough war (World War II), a peak war  (Viet Nam), and a primary recession (1974-75). This plateau should again be accompanied by relatively prosperous times and a strong bull market in stocks. According to a reading of the wave, the economy should collapse in the mid 1980's, and be followed by three or four years of severe depression and a long period of deflation through to the trough year of 2000 A.D."

This is, of course, almost exactly what did happen, and right on the time line.  The depression of the early 1980's was extremely severe for wages, employment, crude goods prices, and mining, agriculture,  and oil sector devastation, and rates of GDP growth slowed dramatically and stayed far lower that they had been from the 1950's through 1970's.

Where Prechter and his legions of intellectual followers missed the boat was that "creative destruction" of modern Kondratieff  Wave depressions happened earlier and far more effectively than in the credit-deficient 19th century. As soon as labor  unions lost their grasp  after 1980,   and both interest rates and prices began to fall, a tremendous energizing of American enterprise was set in place, led by technology. The industrial heartland became the Rust Belt and Silicon Gulches, east and west, replaced it.

So while economic growth rates remained lower than they had been until the late 1970's, interest rates and crude goods prtices continued to fall to 1999  and even later for some goods and rates. The Prechterite Kondratieff folks were (and still are!) waiting for the vicious  deflationary crash of 19th century dreams. But the initial crash was over by 1982. As one would expect there were further deflationary interludes through out the two decade period which followed, as in 1989-90   and 1996-99  and again in 2002. For all practical purposes, the Long Wave Kondratieff trough was in 2002, even though gold and other selected crude goods prices   (oil) bottomed in 1999.

The Prechterite Kondratieff folks have come up with a panoply of reasons why gold and oil and economic growth are up: mostly focused on market  "manipulation" and intervention. We began to see this remarkable rationalization develop in the gold market after 1996 when gold bugs turned deflationist and switched to market manipulation and "credit risks" as reasons for gold's bear market, never mind that nearly all commodities were down and the dollar up. I wrote a gold newsletter in the 1990's, and I was shocked to see gold bruited about by these folks as a  deflation hedge while it fell by nearly 50%.

Now that gold is but a rally away from doubling its 1999 low and crude oil up seven fold, many are nervous, and my mailbox is full of deflationary ads  for newsletters. No one who is bullish will deny that bull markets have to exhale and will do so after advances. Both gold and crude oil could reasonably be expected to have substantial pullbacks. But today I saw an analysis  of why that may not occur.

George Slezak is a self-proclaimed "perma-bear", but he is wise enough to know when bullish times are upon him. As far as stocks are conerned, he was short for most of 2000-2002, long from the summer of 2002 for two years, and he has recently turned bullish again on stocks. George's main analytical weapon is the net hedging position of the commercial portfolio managers, but in this gold and stock analysis he is using Long Wave cycles to project much higher prices for gold  after a probable pullback due to increased commercial hedging. And I agree.

Gold was a central bank fixed market for a very long time, so we have no decent price data before the late 1960's. But Slezek understands that gold went through a  rolling bear market from 1980 to 1999 just as stocks did from 1929 to 1949, and surmises that the outcome will be a much longer bull market like the stock market had fr0m 1949 to 1972. This is a "bottoms up" Long Wave analysis unlike the usual "tops down" application of derived cycles.

Read more about George's market approach at http://www.cot1.com/

I subscribe to his service.

Click on the image for a large version.

No bubbles, just a trend

The following was a reply to a poster at a Long Wave site who posts a lot on bubbles in prices and the economy generally.  My answer is a brief summary of my views on the whole issue.

Jeff,

I'd be happy to look at the reasoning and/or data for your timing
of "Jeff's Bubble Cycle" (JBC) of 24 year 3 months. It sounds
intriguingly similar to a K Wave half cycle, although out of phase by
about five years.

For what it's worth, my own view is that JBC is only the most recent
sector of what I call the Social Democratic Credit Regime (SDCR).
I've written about his before, so I hope it will suffice to condense
it by saying that SDCR was enabled by the creation of the FED in 1913
but not implemented until Franklin Roosevelt's adminsitration hit the
floor running in 1933.

Just like the Royal Mercantilist and the Bourgeois Reactionary credit
regimes it succeeded, SDCR put into action the political and economic
goals of its political wing. In the case of the SDCR, these goals were
to empower the common man in an age of unversal suffrage; favor
borrowers over and against lenders; remove gold as the restrictive
underpinning of national currencies; and expand the monetary base and
economy.

I don't want to fall into the Intentional Fallacy trap myself, so I
won't insist that FDR sat down the day after inauguration and
said, "OK boys, here are my four goals, now go get 'em done." All we
can say is that "the thing speaks for itself", and that's what
happened. Perhaps only one or two of the four principles needed to be
enacted to cause all of them to happen logically and ineluctably, but
they happened.

Two charts are the best evidence I have for the birth of SDCR. The
first is of PPI from the mid 18th century to 1996, and the second is
a closeup of PPI from 1913 (FED formation year) to present.

http://img95.echo.cx/img95/8554/ppicpcug0cu.gif

Note the blip in the 1780's as the Royal Mercantilist Regime took its
New and Old World hits. Then note 1815: inauguration of the Bourgeois
Reaction Credit Regime (BRCR), put in power at the Council of Vienna
after finally trouncing Napoleon. From thence to 1933, the trend of
PPI was flat to down. This was due to the power of BRCR with its gold
standard and "pay as you go" mentality, and New Order businessmen and
other new conservative money in charge.

Then look at the blastoff in 1933 with the sizeable US dollar
devaluation set in train (occuring in 1934 but anticipated by gold
stocks) and all the other New Deal expansions. Centuries of price
stability were blown away forever in very short order.

Before leaving this chart, note that even during BRCR the Kondratieff
peaks are clear visible in ~1814, ~1865, and ~1919. In other words
BRCR kept a lid on prices, but Kondratieff cyclic pressures couldn't
be eradicated. The K Wave modulated the tight control of BRCR and
certainly produced booms and busts and great trading segments.

The second chart is the closeup of PPI from 1913 to present, showing
a greater than twelve-fold increase in all crude goods prices since
1933. The trend was and is up. Note how PPI plateaued at the new
higher level in the 1950's and for part of the 1960's. This was
called the "Golden Era" of growth, what we now would call
the "Goldilocks Economy". This what I believe we have re-entered over
the past few years, but more on that another time.

http://img95.echo.cx/img95/300/ppi19138qn.gif

Once the price controls from the 1930's and war years were blown away
in the early 1970's, and the dollar compelled to go off gold
entirely, the acceleration wave began. SDCR was in the saddle and
running. But price pressures had existed as early as the 1950's.

Even in this chart we see that the Kondratieff Wave was still
active: unbeaten and unbowed. In a guaranteed inflationary era of
SDCR one has to look at rates of change or other price oscillator
techniques to see the waves in PPI, but they are there. PPI price
pressure bottomed in 1949 and increased up to the mid 1970's and then
tapered off into the 2002/2003 low: 26 years up and 27 down, just as
Kondratieff found from the 18th century to the 1920's under Bourgeois
Reaction's credit regime.

The pattern of the PPI itself was up, but at a less acute angle, from
1982-2002, and it looked like what Elliott Wave practitioners call
a "running correction" which ends higher than where it started. This
of course was the hook which confused and waylaid many students of
the Long Wave and convinced them that either the Kondratieff Wave was
dead and gone in this "New Era" of techology, or that we were having
an extended "plateau" of two and one-half decades instead of the
usual five to seven years. The extended plateau neo-Long Wavers were,
and some still are, waiting for that "inevitable" crash and burn 19th
century BRCR wipeout, not realizing that the corrective wave was
already under way by 1981 with revisits to lows in 1985, 1991, 1998
and 2002.

With that said, if we have a "bubble" at all, it is the unfolding of
the SDCR since 1933, a 72 year bubble to date. "Bubbles" are said, however,
to be short term unsustainable freaks of nature which are quickly
punished and corrected.

My view is that the era of the Social Democratic Credit Regime is far
from over, even at 72 years old. Apart from last gasp attempts in
Russia and China and the Arab world to derail it or turn it back.
SDCR seems likely to continue spreading. Nor is it losing any
strength in its North American, European or Asian (ex-China)
strongholds.

People everywhere can now vote and the voters want SDCR to remain in
place and expand the program. Absent wordwide political revolution
bringing back royalty, bourgeois reaction, communism, or tribal
anarchy, the 72 year old "Bubble" isn't going away. The Kondratieff
Wave will continue to modulate the trend, and there will be
recessions and crashes from time to time, but the "bubble" trend will
remain alive and well.

Jeff, if you have data or a logical theoretical framework you can
show me which contradicts the evidence of two and one-half centuries
of PPI and the 72 year "bubble" trend, I'm all ears. Mostly what I
hear in such claims is anger about the politics of the trend about
which neither of us can do anything. We might even agree about the
politics being undesirable or hateful. But in the end, we have to
live when we live. My whole lifetime has been spent in the "bubble"
trend where I have had to work, have a family, enjoy the earth while
I can, and invest. I've found it immensely useful to understand it
better so I don't bump my head as often on door sills in the dark.

Tom

Letters To & From

Hi Tom,

Below is an excerpt of a Prechter article that was posted on Xxxx today...  and though I didn't take time to read another article posted on Traders-Talk, the header was that Russell (Richard) is also looking for deflation to again rule the day:

http://321energy.com/editorials/russell/russell051605.html

..............................

--Xxx


rpccharts:  (Sun, May 15, 6:11 PM ET)
Prechter (and his ElliotWave colleague Peter Kendall) had an article in Barron's in May 2004 , laying out their vision for the coming deflation (yes, DE-flation).

Rising liquidity in a disinflationary environment is not only fuel for a rise in inflation-hedge investments, but also the lifeblood of the stock market, property investment and the economy. A recovering economy, in turn, supports the issuers of junk bonds and maintains investor optimism.

Such a confluence of effects, as we have argued over the last several years, can occur only in a disinflationary world.

Many observers say that these classes of markets will soon decouple: Either inflation will accelerate, pushing up gold and commodities, or inflation will remain moderate, benefiting the stock market and junk bonds.

We disagree. Liquidity is everything now, and it is driving the prices of all investment classes. These markets have been going up together, and we think that when liquidity contracts, they will go down together.

This outcome happens only at rare times in history when a society-wide credit expansion reaches its zenith and social psychology changes from expansive to defensive.

A change in financial market trends from up to down signals the transition -- exactly the situation we face today."

---------------------------------------------------------------------------------
Xxx,

I think of Prechter entirely as a marketer, like Bill Bonner. There are so  many ironies about Prechter, but one is that he was was a pretty darn good Long Waver early in his public writing career.

Actually this past week I have labelled as "Deflation Redux". I warned of the coming slowing late last year and early this year on various sites including xxxxxx (which I have pretty much abandoned as there is no interest in Long Wave there).

Everyone who never became convinced about the Long Wave bottom has jumped on the dollar rally finally after four months. This of course inevitable. People will
finally "get" it in about 2015. Meanwhile the marketers have a brand new theme to sell to people who never really bought the bull market OR bull market newsletters.

The dollar is up ~6.5% since New Year's Eve, about as much as the Dow is down, so all the blather last year about how the gains in stocks meant nothing with a declining dollar are reversed. But people are still thinking in terms of stock index investing instead of sector and stock picking as one needs to do in an inflationary era, within which  we are seeing a minor short or intermediate term correction. In an inflationary era one has to be very selective to get gains above the sum of the rate of inflation, the rate of increase of indexes, and the rate of currency decline. It takes some work and some portfolio management. Indexed funds and money markets won't do it.

Regards,

Tom