Cause, Effect and Coincidence

Summary

Most of us are so busy making our way on a day-to-day basis that we do not focus on the Big Picture. Typically, by the time we do, it's because the Big Picture is impinging on our day-to-day existence. By then it's too late. We're in 'reactive' mode. An analysis of the Big Picture - of an 80 year chart of the stock market below (courtesy decisionpoint.com) - leads to the conclusion that, within the next couple of years, two trends that have been building since the 1929 top and the 1932 bottom will intersect.

There are three possible outcomes.

1. The markets will break up - likely leading to a hyperinflation driven exponential blow-off, and eventual systemic collapse
2. The markets will break down - likely leading to a debt implosion driven deflation, and eventual systemic collapse
3. The markets will churn sideways while we reorganise our affairs. This will require structural reorganisation - on a world-wide basis - of which, at present, there are no tangible signs.

Fortunately, structural reorganisation is possible. There are solutions!

"Models" which are used to forecast future events are typically built on historical relationships. Sometimes a problem arises when one tries to determine whether the historical relationships are cause, effect or merely coincidental. When mistakes are made in relation to an entire system, they are typically serious mistakes.

Here are two examples:

1. Have CO2 emissions caused a warming of the air which, in turn, has caused a warming of the oceans. Alternatively, has the warming of the oceans over the past 45 years caused the Earth's atmosphere to warm and, therefore, rising CO2 emissions are just a coincidence? If so, what caused the oceans - which cover 2/3 of the Earth's surface - to warm? The future performance of that variable is what we should be focussing on.
2. Has a flood of fiat cash into the world's economy 'caused' economic growth or 'facilitated' some other driver to cause it? If the latter, what will happen if the ultimate driver of economic growth goes away but Central Banks continue to pump money into the system?

Since 1968 I have had a fascination with markets. What "causes" markets to rise and fall? What "drives" markets?

In the early 1970s I read a couple of books written by Lyall Watson, a biologist. In one of those books Watson introduced the idea of a thought 'meme'. Watson's book, Supernature was published in 1973. Yesterday I looked up the word meme on Wikipedia to discover that the coining of that word was attributed to Richard Dawkins, in 1976. Mr Dawkins is also the author of a recent best seller entitled The God Delusion.

The reason I mention the names of these two individuals with an emphasis on the conflicting dates is not related to my propensity to want to stir the pot. It is related to the very meaning of the word meme, which the Wikipedia article defines as a 'unit of cultural information'.

The key to understanding a meme is this: If enough people within a particular group subscribe to a particular belief it becomes accepted by all people within that group - whether or not it is true. That is what happened in Nazi Germany. It is happening again today, but it is manifesting differently. "Chronic Fear" is one explanation why people are able to rationalise that which would otherwise be incapable of being rationalised. Denial makes life bearable, even if it makes no sense. Chronic Greed is another. There are also other explanations.

In fact, it was neither of these two gentlemen who originated the idea of 'cultural information'. The concept was originated by Karl Gustav Jung (1875-1961). He spoke about a concept called 'collective unconscious'.

As we understand the workings of the human mind, it operates at a level of consciousness and also at another level which seems to plug us - by some etheric energetic means - into a greater unit. This plug-in process may be rather like the bees and the beehives when they swarm. The beehive has its own discrete identity.

In a process where the behaviour of an entire society seems to morph, the question arises as to how the new memes which give rise to this morphing are communicated. In Lyall Watson's example of the Macaque Monkeys - which was the example he originally used to introduce the idea of a meme - the behaviour ofall the monkeys in the group changed; even that of those who were geographically remote from the main group, and who could not possibly have become aware of the behavioural changes in the main group through any visual or sound communication. He spoke of a 'hundredth monkey' phenomenon. A sort of critical mass which, when passed, gives rise to etheric existence of a Thought Paradigm across society.

Interestingly, in his most recent book, The God Delusion, Mr Dawkins unconsciously relies on this very concept of etheric ideas in his vigorous attempt to disprove their existence. This in itself goes to prove the power of the human mind to rationalise that which, at face value, is incapable of being rationalised. (I thought twice about whether or not I should leave this last paragraph in. Finally, I concluded that the principle is too important. To solve humanity's problems going forward, we have to understand in our guts that our minds have the capacity to become delusional. We all have this capacity, including Mr Dawkins. Yes, including even me. It is not my intention to disparage him. I thank him for being the facilitator).

On the stock market, there are therefore three types of behaviour:

• Rational
• Emotional
• Irrational/Delusional (Understanding the process by which etheric memes manifest gives rise to an understanding of how and why the self-destructive, lemming-like behaviour of crowds is possible)

'Fundamental analysis' on the stock market can give clues as to the conscious (rational) reasoning behind stock market price movements. For example: General Motors had a negative tangible net worth of $6.6 billion as at December 2006. Notwithstanding this, the shares closed at $31.45 on May 18th 2007. With the number of shares outstanding, GM was capitalised at $17.8 billion - thereby placing a 'goodwill' on its infrastructure of $24.4 billion.

In the March 2007 quarter, GM made a net profit of $62 million compared with previous year of $602 million because of its losses in its home mortgage division.

However, GM did report record vehicle sales in the March quarter of 2.26 million units.

From a price performance perspective, in the past three years GM's shares appear to have performed rationally relative to the Dow Jones Industrial Index, as can be seen from the chart below (courtesy bigcharts.com). It fell 30% whilst the market rose 35%

Of course, the only way your mind can accept that the above was 'rational' is if you happen to 'feel' optimistic. GM's profits and Net Assets over the past three years have been:

In the past year, as it got is act together its shares rose 30% whilst the market rose 20%.

At face value, everything appears rational. A person who is feeling optimistic would argue that the reason for this relatively superior performance of its share price was the group's record sales performance. In turn, this flowed largely from 20% growth in Asia and 17% growth in the Middle East.

Of course, GM was unable to earn significant profits on record sales and it still has negative value. An emotionally optimistic market is therefore "betting" that GM will continue to earn record profits.

Indeed, a year ago, GM's shares gave a buy signal. At face value, an optimistic investor could "rationalise" that everything is just dandy. (Chart courtesy bigcharts.com)

But here's what a pessimist could argue:

Oops! There's a problem. Those 2.26 million additional units? If you assume that they each travel around 750 kilometres a month and that they have fantastic fuel consumption of ten litres per 100 kilometres (10 kilometres per litre or 30 mpg) this will create an incremental demand for 5.25 million litres of gasoline a day. If GM's sales continue at these fantastic levels, GM by itself will have added a 21 million litres a day burden on the world demand for gasoline by the end of the year. To get some idea, that's an additional 132,000 barrels of oil a day that will need to be pumped assuming 100% retrieval. I don't know what GM's world market share is but it's probably safe to assume that all new car sales will add well over 1 million barrels a day burden to total world demand.

Oops! Again. That demand is going to come mainly out of Asia and the Middle East.

Oops! Again. 67% of the USA's domestic transport is oil dependent. The USA can absolutely not afford to allow oil supplies to be diverted away from the USA to Asia and the Middle East.

So how does one peer beyond the optimist and the pessimist to get to the reality.

The reality is that the US economy is becoming more and more vulnerable to an interruption of its oil supplies - which is precisely why countries like Venezuela and Russia and Iran are flexing their muscles. This editorial is not revealing any "new" or "secret" information. This information is available to everyone. And yet we are able to argue about what's driving George W.

Turning now to the market as a whole: If the US is so exposed, why is the Dow Jones behaving like it is? It is also a reality that the Dow Jones Industrial Market is reaching for new highs. There is no purpose to be served in arguing against that fact. Whether it "should" be happening is irrelevant.

But it would certainly be constructive to understand why it is reaching for new heights.

Well, certainly, if:

• The US continues to fight its wars, money will continue to be pumped into the economy. Wars are economically stimulative
• If Asia continues to boom, US based multinationals will experience rising profits.

Unfortunately, it is also a reality that the US consumers - who drive 66% of the US economy - are tapped out. They have excessive borrowings and their homes are starting lose equity value. April was the worst retail month since 1970.

So, if 66% of the economy has become moribund, why would the stock market be hitting new highs?

Answer: Cashed up institutional investors are rationalising their existence. If you were a 25 - 35 year old Wall Street employee would you be programmed to be buying or sell? After all, you were employed to place that mountain of money. I mean a guy can sit on his hands for just so long until his nerve cracks. "We've got all this money to invest people! Let's invest it! Don't you want to keep your jobs? Why do you think we're being paid the big bucks?"

From where this analyst is sitting, we are entering an "Irrational/Delusional" phase of the market. This does not mean the market won't rise. To the contrary, the risk - now that denial is giving way to delusion - is that it will rise too high. What it does mean is when we finally come to our senses, the higher it has risen, the harder it will fall. If it breaks up above the upper trendline to enter an exponential blow-off phase, then God help us all. We will be facing a train smash.

All of which brings us back to society's leaders. What the hell are they doing to fix the structural problems? Climate Change is still with us. The oil shortage is not going to go away, and even Alan Greenspan is saying (from the sidelines) that the US economy is facing recession.

The irony is: There are solutions! It's just that these solutions lie outside the box. They require a modification of society's Thought Paradigms and a modification of behaviour across all of society, including its leaders.

Turning now to gold

What will the price of gold do during this delusional optimistic phase?

Of course, the answer to this question revolves around what, ultimately 'drives' the gold price.

If it is 'fear', and a delusional phase of optimism kicks in, then the gold price will have no reason to rise. Investors will delude themselves into believing that fiat money is OK. The dollar will rise strongly. Under these circumstances, it could be argued that gold will pull back from its double top on the chart below (courtesy Gold-Eagle.com)

How far could it pull back?

Technically, it could pull back as far as $575 - $600 an ounce and still remain in a bull trend.

Unfortunately, the answer is not as simple as that. 'Fear' by itself is too simplistic an explanation. The gold price is driven by a complex matrix of forces. One of these is a primordial understanding by the religious segment of the world's community - all those who remain tapped in to the Intelligent Design meme - that gold has somespecial significance. (As an aside, it does not necessarily follow that all memes are false. Arguably, those that stubbornly endure are true).

What is that significance? We should not jump to conclusions here. Also of interest, 'gold' was not the medium of exchange in the Bible. Silver was. The Bible goes out of its way to record that, during the wanderings of the Hebrews through the desert after leaving Egypt, four censuses of the population occurred. The method of counting was not by head-count. Each person contributed a silver coin, and it was the silver coins that were counted. Some might argue that we are told at least four times that heads were not counted. Others might argue that we are told at least four times that silver was the medium of exchange.

And this is yet another example of why it is important to understand the difference between an independent variable, a dependent variable and a coincidence.

It appears that gold has a significance unrelated to it being a medium of exchange. If this is true, the gold price has not been rising because of a fear of collapse of the fiat currency system. If this is true, the "apparent" inverse relationship between a falling dollar and a rising gold price may be nothing more than a coincidence.

Could I be deluding myself? The evidence would suggest not.