Scorching The Snake

This note was originally published at 8am this morning, October 21, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We have scorched the snake, no killed it.”

-Shakespeare (Macbeth)

The proverbial snake in the common man’s wallet is inflation. In this day and age of globally interconnected prices, governments can scorch it, but they can’t kill it - not when Western Fiat Fools wake up every morning trying to debauch their currencies for short-term stock market pops.

China scorched the serpent on Tuesday when it raised interest rates. The way that this works is very simple. Use monetary policy as a blow-torch on the way up (rate hikes) like Greenspan and Bernanke have used it as a blunt instrument on the way down (rate cuts). Glenn Stevens at the Reserve Bank of Australia is a modern day king cobra killer in this regard. He doesn’t get paid to be willfully blind. That’s why his citizenry trusts him.

Sadly, one day of snake scorching this week doesn’t a TRADE or TREND make. As soon as bad US economic data rolled through the leg hump machine yesterday, US stock market cheerleaders were right back at it begging Bernanke for more Quantitative Guessing. The Burning Buck went straight back down and commodity and stock prices went straight back up.

For all of you “deflation” fans out there, here’s a New Hedgeye Economics equation to jot down in your notebooks:

QG = i

That’s it. It’s that simple. Quantitative Guessing = global inflation.

Score this like you would scrabble points and mark-your-score-to-market at the end of every day by measuring what asset prices do on an inverse basis to the Burning Buck.

1. Tuesday: US Dollar UP +1.7% = CRB Commodities Index DOWN -2.0%
2. Wednesday: US Dollar DOWN -1.4% = CRB Commodities Index UP +2.4%

Cool, eh?

Not so much if you are part of the starving people in this world who the perma-bulls are quick to point out demand a lot of what their favorite companies in their portfolios make. But very cool for Wall Street and Washington types who really could give a damn about anything other than where the US stock market closes at month-end ahead of a mid-term election. It’s all about the short-term bonus baby.

Enough about the Fiat Fools who have mortgaged America, let’s go back to the leader in this global macro game of Monopoly: China.

Last night, the Chinese reported more of what our Hedgeyes have been calling for since Q1 of this year – a Chinese Ox In A Box (economic growth slowing as the Chinese focus on proactively tightening the screws on speculative lending and price inflation).

Here’s a Chinese data check:

1. GDP growth slowed sequentially (quarter-over-quarter) to 9.6% in Q3 versus 10.3% in Q2 (versus +11,9% in Q1)
2. Industrial Production growth slowed sequentially (month-over-month) in September to +13.3% from +13.9% in August
3. Consumer Price Inflation accelerated again sequentially (month-over-month) in September to +3.6% from +3.5% in August

Net, net, what this means is that both economic lines in our model (Revenues = GDP and Cost of Goods Sold = inflation) continue to go the wrong way. Chinese economic growth has slowed to a 1-year low as inflation has accelerated to a 2-year high.

Ok. So what do you do with that?

1. Realize that it’s not new “news” – Chinese growth has been slowing and inflation accelerating since Q1.
2. Respect that, despite the slowdown, the Chinese government still has the political backbone to fight inflation and raise interest rates
3. Stay long the Chinese currency because it, unlike America’s currency, has credibility (we have a 12% long position in Chinese Yuan, CYB)

Can you imagine Ben Bernanke raising interest rates as GDP growth is slowing and inflation accelerating? Can you imagine anyone in Congress understanding that a strong currency and positive rate of return on a citizenry’s savings gives more spending dollars to those conservative savers? Can you imagine anyone in a position of power on Wall Street or in Washington Scorching The Snake?

Here’s a brain Teaser for Timmy Geithner for his plane ride to Seoul, Korea and this weekend’s G-20 meetings:

If China has 1-year interest rates at 2.50% and the US has 1-year interest rates at 0.21%, which country has the higher probability of empowering their citizenry of savers with more money in 1 year?

I’m in Maine at a non-Groupthink Inc. conference for the next few days. This morning’s 9AM session is called “Thinking Wrong” … At a bare minimum, America’s snake oil salesman “economists” can’t accuse me of thinking inside the economic box they’ve put their people in.

My immediate term support and resistance lines for the SP500 are now 1173 and 1186, respectively.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer