Wobbly World Markets

World markets have begun to wobble.

Over the last ten days, emerging markets have had the longest stretch of selling since 1998. India’s Sensex Index collapsed 10% in a single day…officials had to close the market.

The story was the same throughout the world, with only a few exceptions — notably China.

What goes up must come down. And leading the way down were commodity producers. Commodities — especially copper — have soared this year; a correction was inevitable. Silver has given back nearly 20% of its value. Even gold is headed down, though stuck for now around $655, a loss of about 10%.

In the developed world, stock markets are shuddering too. The Dow took a big hit last week and so far has not managed a bounce. But neither has it fallen further. Here in London, the FTSE shed another 2% yesterday, bringing the total damage over the last two weeks to nearly 10%.

What next? We’re waiting to find out.

While we wait we note that markets go down as well as up. Usually a lot faster. And usually as much down as they went up…if you strip away the inflation.

Gold goes down too…even when it is in an uptrend. During the 1970s, for example, gold rose from $35 to $200. Then, just when newspaper headlines and ordinary investors were beginning to take notice, a correction began. The metal corrected over a 19-mo. period, losing 50% of its value. That shook the gold coins out of the grasp of weak and wobbly holders. It also set the stage for the next phase of the bull market, in which the metal shot up to $850 an ounce in January of 1980.

We suspected gold was ready for a major correction when we noticed Britain’s major newspapers urging readers to buy it. The mainstream press is almost always wrong about gold. It only catches on when the bull market is nearing correction or completion. It comes to the conclusion that nothing can stop the metal’s rise…just about the very moment the rise has come to an end. Then, when the bear market is finally over, it boldly announces that gold is a ‘relic of the past…worthless from an investment point of view.’ This is precisely what the British press — and the American press too — was saying in the late ’90s, as gold hit its lowest point in half a century. The Financial Times wrote a famous editorial entitled, “The Death of Gold,” in December of 1997.

Britain has the added distinction of having a central bank led by wits as dim as those in its financial press. As gold bottomed out, the Bank of England sold. If it had gone back 100 years it could not have found a worse time to do so. And if it had gone back 1,000 years, it couldn’t find a worse reason. The BOE wanted to replace gold — a tried and true financial reserve for thousands of year — with paper money! Had no one at the central bank bothered to review even the sorry history of its own paper currency since the gold backing was removed? Did they not notice that the pound has lost nearly 99% of its value?

What set off the worldwide market frisson is anyone’s guess. It appears that the same central bankers who missed the run-up in gold were becoming alarmed by it, after they finally read about it in the newspapers. They decided that it was the bud of inflation needed nipping. So, they talked up the dollar…raised rates…and tightened liquidity. Newspaper headlines tell us now that speculative money is headed into cash…particularly the dollar…as a refuge. We don’t see much evidence of it. The greenback has barely risen against the euro…and gold remains above $650.

We don’t know what happens next. But we wouldn’t mind a stronger correction in gold — so we can buy more at a better price.

Still, we feel we should repeat our caution: in the short run, markets are voting machines. They can deliver any fool result the voters want. It is only in the long run that fundamentals matter…and that vox dei is heard.

And we deliver another caution at no extra price: we’re not at all convinced that the inflation theory is correct. That is, the central bankers might be wrong about the cause of rising commodity prices, just as they are wrong about so many other things. Deflation may still be the greater danger. And clipping liquidity now might be just the thing to bring it on. American debtors might not sink in a sea of too much cheap currency, in other words. Instead, they might not have enough of it to stay afloat. More on this as we figure it out…. In the meantime, buy gold on dips…sell stocks on rallies. And watch the headlines. Whatever they urge readers to do; do the opposite.

• Investors have been uncommonly sure of themselves. The VIX is called the ‘fear index,’ because it measures investors’ attempts to protect themselves. They protect themselves by buying put options. When the market goes down, the puts pay off. When they don’t expect the market to go down, they don’t bother to buy the options. So, you can tell how fearful they are just by looking at the VIX.

Well, the fear index has been in a decline for the last three years — since April of 2003. More and more, investors think they have less and less to worry about. Until last week. All of a sudden, the VIX seemed to come alive, popping up to a 2-year high.

One of the things investors might be worried about is the fact that so few of them bother to worry at all. The market in derivatives has grown to nearly $300 trillion, says Asia Business Times. In theory, some investors are long and others are short. And in practice, there must be someone on both sides of every trade. But when shudders turn into terror…then and only then will we see what all those derivative contracts are really worth.

• “Las Vegas developers folding high-end condo plans,” says a headline on CNBC. By some estimates, the housing boom is responsible for half of all new jobs in the U.S. since 2001. The other half is in government. When the boom finally ends, we wonder, how long will the halves hold up?

This is the “new road to serfdom,” says Michael Hudson. In the odd logic of the housing bubble, he points out, “debt has come to equal wealth.” But this, he argues, is a mistake because “debt throughout most of history has been little more than a slight variation on slavery. Debtors were medieval peons or Indians bounded to Spanish plantations or the sharecropping children of slaves in the postbellum South.”

Ah, but won’t the coming inflation wipe off the debts of America’s middle classes? Isn’t that what the house speculators are praying for? Isn’t that what the central bankers are aiming for? Isn’t that what we are all betting on?

We don’t know. “As ye sow, so shall ye reap,” it says in the Bible. Neither the modern economists, nor the central bankers, nor the lumpen homeowners believe it. They think there are knobs they can turn…levers they can pull to get whatever crop they want. How about another rate cut? How about easing up on lending requirements? Yes, they have sown debt. But why can’t they reap financial liberation? Why can’t they get what they want, rather than what they deserve? Anything is possible, we admit. But we just don’t think the world works that way. And if it does work that way, we don’t want anything to do with it.

“The bubble will burst,” continues Hudson’s prophecy, “and when it does, the people who thought they would be living the easy life of a landlord will soon find that what they really signed up for was the hard servitude of debt serfdom.”

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.