Foreign Currencies, Commodities and Gold and the Stock Market

Today, I examine the performance of the stock market, in terms of foreign currencies, commodities and gold. By these metrics, stocks are performing less well since their April high, than in nominal terms. Since increases in commodities and foreign currencies have an positive influence on US stock prices, some of the effect of these asset classes increasing in value, will serve to impact the price of US stocks, in an offsetting manner. Stocks, however, are down 80%, in gold terms, since their top in 2000, and by every other metric, stocks have been systematically underperforming gold, from the top in Oct, 2007, and from the recent high in April. The best way to capture some of this underperformance is to own gold.


* Things are really how you look at them, and what your are looking for. For most people, rising stock prices are purely measured in terms of the dollar price they are at. For others, they like to measure returns relative to other asset categories they own, or consume as a basis for living their lives. 


I have long held out that we are in the midst of a multi-year depression. Thanks to our government, they have managed to alleviate the impression that we are in a depression, by their quickness to make good bad debts of our financial sector, and infuse so much cash into our economy, that it is not a problem when looked at in terms of nominal US dollar terms. For most people living in the US, this is the correct way to look at things, because how they live their lives, (denominated in dollars).


I have contended over the past couple of years, that stock prices will eventually sink to new lows. The one caveat I had to this contention, was to consider what would happen if the Fed managed to engineer some form of hyper-inflation, or dollar debasement. As I discussed last week, the weakness in the housing market will continue to keep inflation subdued. Nonetheless, this is not preventing the Fed from printing more dollars, and ultimately, that plethora of dollars is going to cause the real (non-dollar) value of the stock market to decline.


But that leaves open one significant question: If the inflation rate is going to remain subdued, should I care? And to this I will answer YES. The part of the inflation rate which is going negative is housing, and unfortunately, this comprises a decent amount of the average household’s net worth. Offsetting a drop in housing prices, you will have commodity prices which are likely to rise due to the weakening dollar, which is evident today.


This discussion brings me to a graphic essay of what the S&P looks like when denominated by a variety of metrics. On the attached graph, I start out with the S&P in nominal dollar terms. As the chart shows, the S&P is doing a nice job getting close to its April highs, but over-all, still looks like it is correcting the sell-off from October 2007 to March 2009. Nonetheless, given the strength in the market, it is quite possible that the S&P makes a new high above April’s high. In support of such a possible outcome, I will suggest that the 4 year cycle which I thought would have bottomed by now, might have come early in July or August, and if that is the case, there could be some bullish influences on the price of stocks for the next few months, if not 1 to 2 years. That is not my main forecast, but given how I and many others have been WRONG about an October wash-out, I need to look at plan B. Many technical indicators remain over-bought, but that does not mean the markets have to turn on a dime. And when they do turn, it is not certain that they need to collapse right away, as I had been predicting, but instead could correct lower, before staging another rally higher (and then collapsing). In other words, I remain open to a variety of scenarios, which in turn, has me trying to understand what the real performance of the stock market has been (and will be) when measured by other, non-dollar yardsticks.


The second graph on the attachment shows the S&P in terms of the dollar index (DXY), which is a basket of 6 leading currencies: the euro, British pound, Canadian dollar, Japanese yen, Swedish krona and the Swiss franc. This basket of currencies has fluctuated in a 20% range against the dollar for the past few years, (see the 3rd graph), so the S&P in DXY terms does not look very different from the nominal S&P index. In terms of the S&P in Swiss Franc terms, see 4th graph, the rally from the low looks far less impressive than in DXY or nominal dollar terms, in part, because the dollar has been devaluating relative to the swiss franc. 


One additional feedback loop which makes a foreign currency a less relevant measure of evaluating stock market returns, is the reliance on foreign business to support the valuation of US stocks. In other words, when the dollar is weak, the influence from foreign earnings increases, which in turn, should support US stock prices, when the influence of a cheaper dollar makes a foreigners dollar investment in US stocks perform worse.


Another metric is to look at things from the perspective of commodities. While this is a good intuitive way to look at things, sincecommodity price changes do affect what “things” cost, there is a fair amount of correlation between commodity prices, and US stock performance. A look at the CRB index going back to 2006, see next graph, shows that the CRB had its own crash, starting in the summer of 2008, a couple of months ahead of stocks. The S&P, in terms of the CRB, bottomed well ahead of nominal stock prices, aided by the depressed value of commodities.


The common thread amongst all these relative comparisons, is that the S&P made a top in April, and has been under-performing all these measures since. That does not make the S&P rally since the recent lows, any less real, but does leave me with a level of suspicion, as to what is really going on.


The final metric by which to measure the S&P’s performance is to evaluate the S&P in terms of gold, which is the last two graphs attached. The first graph, since 2006, shows that the S&P used to equal over 2 ounces of gold, while it now is selling for less than 1 ounce of gold. Looking back to 1975, or even earlier, when gold was a static $35 an ounce, the S&P sold for as low as 0.135 ounces of gold. To the extent that gold is real money, and I contend that it IS the truest form of money, which cannot be printed, then you can conclude that stocks have been in a sell-off since 2000. In fact, since its peak in 2000, stocks are down over 80% when measured in gold terms. And by the looks of the last 30 years of history, the trend is towards even a lower valuation for stocks, in gold terms.


As far as investing nominal dollars in the stock market, which most of us own plenty of, I cannot buy into it. The deflationary forces which I continue to view as a threat still remain, and I do not think the Fed and government can engineer a solution to these problems. However, that does not mean they cannot engineer some impressive rallies along the way. But the stock market correction, and on-going depression, is a multi-year process, which I still think has many years to run. All this does not mean that stocks cannot rally further, but this rally will likely come only in nominal terms, and in terms of gold, stocks are likely to continue to under-perform. The best way to remedy this situation is to own some gold as a hedge against the monetary debasement which the Fed is engineering.