Thursday, May 5, 2011

The Parable of the Cupcake Addict, Absent QE3 Commodities go into Hibernation, and the Markets attach their Bungee Cord and Plunge Headlong off a Cliff!

5/5/2011 Portland, Oregon – Pop in your mints…
We are back from a breather at The Mint to find that the numbers we follow are beginning to reach a strange sort of plateau.  Like a man who has taken to eating nothing but cupcakes for breakfast, the Feds got what they wanted in the short term with their monetary alchemy.  

Anyone who has done this knows that cupcakes taste great and wake you right up.  Unfortunately for the man, after three long years of this indulgent behavior the long term effects are starting to show up.  
The man faces a dilemma.
A raging headache is beginning to come over him.  He knows that another cupcake would give him a much needed sugar rush.  A glance down at his sagging belly, however, gives him pause.  "I will feel better for a time," he ponders to himself, "but eventually I'll need new clothing and risk diabetes and heart disease if I continue this strange habit."  
In this state of mind, the man stands frozen before the tray full of cupcakes, unable to react as his headache worsens.
In the meantime, across town, the bakery prepares to send the man a courtesy notice that he can no longer supply the amount of cupcakes at the current price.  The man will soon have to choose either pay more or accept fewer cupcakes.
The Markets take a dive, will they Hit Bottom?
In our parable, the man is the US Government and economy at large.  The cupcakes are money substitutes created by the Federal Reserve.  The Federal Reserve is the bakery.  The headache represents high unemployment and the man's belly represents increased debt obligations.
What will the man do?  The markets, from stocks, to bonds, to precious metals and other commodities, are betting that the man will call the bakery, cancel his orders, and go on a diet.
Want Proof?  A quick peek over the last 5 days in the engineered markets:
The Dow?  Down 2%
S&P 500?  Down 2.5%
Bond Yields?  Down 4%
The real evidence of this opinion, however, is in the commodity markets which operate in a relatively organic fashion:
Oil?  Down 12%
Gold?  Down 6.5%
And our favorite commodity, Silver is down a whopping 26% over the past 5 days!
What is going on?  We recently discussed the immutability of the seasonality in all aspects of life.  The advent of spring and summer tends to trigger a feeling of abundance and there is a tendency to stop hoarding and begin using stores of certain items.  This is beginning to affect commodities market in the usual way. 
Another factor that is directly affecting silver and may explain its outsized drop in price is that the Chicago Mercantile Exchange has raised the margin limits on silver contracts three times in the past week which severely impacts liquidity in this market.  The end result of this action will be further shortages of physical silver which only makes it that much more appealing as an investment.
But in a bigger sense, the longer the man stands motionless before the tray of cupcakes, the Markets, a new character in our parable who represents the clothiers, doctors, etc. who were counting on the man to continue his insane habit of consuming his cupcakes in the morning.
Now that the man appears ready to kick his habit, the markets have attached their bungee cords and have just taken a head first plunge off of a high cliff. 
Unless the bakery intervenes, they are likely to hit the bottom!
Stay Fresh!
P.S.  Please check out our latest 72 Hour Call at
Key Indicators for Thursday, May 5th, 2011

*See FED Perceived Economic Effect Rate Chart at bottom of blog.  This rate is the FED Target rate with a 39 month lag, representing the time it takes for the FED Target rate changes to affect the real economy.  This is a 39 months head start that the FED member banks have on the rest of us on using the new money that is created.