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durhamborn

Deflationary collapse and the Reflation Cycle to Come.

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Rather than put my thoughts in other threads about how i see the end of this cycle playing out i thought a thread dedicated to this would be a much better idea.Many other posters here have some great input and knowledge to add.Those who agree,dont agree,or part agree all have thoughts to offer.

My thoughts are these.

The great deflation cycle that started around 35 years ago is about to end with a deflationary collapse.During those 35 years interest rates have fallen to lower lows and made investing in equity/property very easy (they have always gone to higher highs).However that has also caused people to go way way along the risk curve for yield.The leverage on the system is beyond extreme.The Fed (and other central banks) missed out an entire tightening cycle,and in doing so have already made sure the recession dead ahead will see massive un-voluntary debt liquidation,a financial system in free fall and wealth destruction on a scale few can even imagine.Leverage is going to destroy business and individuals on a scale not seen since the late 1920s.Once this does hit the central banks will be slow to react with the right response as they themselves will be shocked at the speed and scale.They will panic and print direct into the economy by passing money/debt to governments at 0.1% or zero coupons.This is what will kick in the first reflation cycle since the 70s.Inflation will appear,rising slowly at first but increasing for perhaps a decade until it reaches double figures.Interest rates will follow,but being behind the curve perhaps through the whole cycle.The leveraged who survived the deflationary collapse will then suffer increasing interest rates for a decade.

Before this i see gold,silver and the miners maybe having a run up through summer.The dollar index might keep falling (with a bounce or two for noise) to the 88 area.

Others thoughts on this playing out?.Why it will,why it wont?.

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I'm looking forward to following this thread (or trying to, at least), so thanks to durhamborn for starting it.

It would be helpful for me if you could quickly clarify why you characterise the last 35 years as a deflation cycle... What happened to start it off circa 1982? When was the last deflation cycle prior to this, and are they likely to be at all comparable? 

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I follow your posts with interest but I'm not always sure I understand  - either I have some knowledge gaps or you are missing some things out. Can you help me out with the implied questions in italics

  • The great deflation cycle that started around 35 years ago is about to end with a deflationary collapse because xyz means it can't go to 36 years
     
  • They will panic and print direct into the economy by passing money/debt to governments at 0.1% or zero coupons like I thought they had been doing already for years with QE

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Once debt saturation is reached they can either allow complete collapse or print then have a collapse. Well beyond the point of no return now.

Debt must increase forever or the system breaks. Timing is always difficult but outcome guaranteed. 

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47 minutes ago, LC1 said:

I'm looking forward to following this thread (or trying to, at least), so thanks to durhamborn for starting it.

It would be helpful for me if you could quickly clarify why you characterise the last 35 years as a deflation cycle... What happened to start it off circa 1982? When was the last deflation cycle prior to this, and are they likely to be at all comparable? 

The 70s to the early 80s were the last reflation/inflation cycle.The mark of the start of the deflation cycle was US treasury bond yields topping out around 1980/81.The last true deflation cycle was the late 1920s,early 30s.

I mark the last 35 years as a delfation cycle because interest rates have made lower lows in every part of it.There have been counter trend increases of course through each business cycle,but the next has seen lower lows until we reached almost zero.This means asset classes have all made higher highs each cycle.Buy and hold and leverage has paid off and investing has been easy.A lot of corporates have geared up their balances sheets because debt is almost free to buy back shares,and consumers have geared up on BTL,equity release/second mortgages etc.

I think the deflation cycle ending is already baked in.The Fed missed out an entire tightening cycle.In doing so the leverage is now at extremes never seen.Inflation is very low conidering this is supposed to be the top of the business cycle the Fed has tightened into.I think they are making the same mistake as the mid 30s,tightening into a recession.

What makes this likely to be huge is the leverage,and that is mostly because of them missing out a tightening cycle.

 

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13 minutes ago, Funn3r said:

I follow your posts with interest but I'm not always sure I understand  - either I have some knowledge gaps or you are missing some things out. Can you help me out with the implied questions in italics

  • The great deflation cycle that started around 35 years ago is about to end with a deflationary collapse because xyz means it can't go to 36 years
     
  • They will panic and print direct into the economy by passing money/debt to governments at 0.1% or zero coupons like I thought they had been doing already for years with QE

"The great deflation cycle that started around 35 years ago is about to end with a deflationary collapse because xyz means it can't go to 36 years" 

It can go to 36,or 37,or 40.However i see the Fed tightening into a recession making it being close very likely (though i dont think it starts in the US).This isnt a trading call on time,its a cycle call.With 70% falls in some assets i dont mind being early.I very much dont want to be late.

"They will panic and print direct into the economy by passing money/debt to governments at 0.1% or zero coupons like I thought they had been doing already for years with QE"

Tricky this one.In the UK they have by buying gilts with some of it,but in the US it went as base money and mostly bank balance sheets.It has been used for buying assets,not investment in the economy.Velocity has been falling.The monetary base in the US has fallen for 2.5 years.Its that base that supports the world economy and is shrinking.The printing to come will be on a scale probably 4 times what we have seen,and spending direct into the economy.Roads,wind farms,anything that can go quickly.

 

 

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1 hour ago, TheCountOfNowhere said:

Stagflation.

 

Right, next one

I dont think so Count.I think we will get a full on reflation cycle after the collapse.Stagflation wont purge the system.I think the collapse will be quick,but very deep.It will feel like a depression,but wont be.Stagflation would be more likely after the reflation i think,not before,though it is possible of course.

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4 hours ago, durhamborn said:

I think they are making the same mistake as the mid 30s, tightening into a recession.

I think this is being done rather slowly and tentatively at the moment, with every sign they are ready to reverse course at the first indication of trouble. Could I ask for your opinion on three related questions:

  1.  What makes you think the US will continue to tighten if signs of weakness show in the economy?
  2. Do you think we will see the signature of too much tightening appear as a rise in treasury yields, becasue these seem not to have broken any trends yet?
  3. A bit of a rude question, but I know you are involved in international trade. Could you comment on whether you are seeing effects on such trade already, and if so, is this part of the evidence that has led to your projection of an imminent start to the debt deflation?

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28 minutes ago, Toast said:

I think this is being done rather slowly and tentatively at the moment, with every sign they are ready to reverse course at the first indication of trouble. Could I ask for your opinion on three related questions:

  1.  What makes you think the US will continue to tighten if signs of weakness show in the economy?
  2. Do you think we will see the signature of too much tightening appear as a rise in treasury yields, becasue these seem not to have broken any trends yet?
  3. A bit of a rude question, but I know you are involved in international trade. Could you comment on whether you are seeing effects on such trade already, and if so, is this part of the evidence that has led to your projection of an imminent start to the debt deflation?

1.I dont think it matters if they tighten more now or not.The seeds are already sown and the monetary base is at a 2.5 year low.Another increase in June will just make things worse.

2.I think treasury yields will fall a lot,not rise.The 10 year to 0.5% and the 30 year to maybe 1%.TLT perhaps to $160.People will rush into treasuries as the only safe place.

3.I am seeing big effects on trade.Prices in China have gone up fast and the inflation in prices due to sterling falling is proving very hard to pass on.Margins for business are being squeezed to very low levels,but thats a UK problem.Im not sure what will start the debt deflation,but China is a candidate.

The main reasons i see for the start though are policy mistakes.The Fed tightening into a recession is a big one,as are central banks missing out a tightening cycle.Its the leverage on the system that will turn a recession into a collapse.I dont think it will last long,perhaps a year,but the wealth destruction will be huge.

When this starts is hard to say,as its a cycle call.

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So for the average UK bloke with some money is "treasuries" safer than ordinary savings account? The interest rate seems equally poor.  Are treasuries easy to get if you are not in America? 

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22 minutes ago, Funn3r said:

So for the average UK bloke with some money is "treasuries" safer than ordinary savings account? The interest rate seems equally poor.  Are treasuries easy to get if you are not in America? 

Very easy to buy.The fund TLT iShares 20+ Year Treasury Bond is as good as any.You cant hold it in an ISA,but can in a normal account or SIPP.Is it safer than a savings account depends if the US is more likely to default than a bank.Id say no chance the US will default on its debt.The main risk is currency risk of course.If the £ goes up against the $ the value will fall.I think all deposits in banks up to the protected level will be safe.I do think TLT might go up to $160 during a collapse but thats purely my thoughts and i cant give financial advice to anyone else.

Myself, il be buying some TLT once i sell my gold miners in the summer as i think sterling might get closer to $1.40 before things roll over.

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6 hours ago, durhamborn said:

The 70s to the early 80s were the last reflation/inflation cycle.The mark of the start of the deflation cycle was US treasury bond yields topping out around 1980/81.The last true deflation cycle was the late 1920s,early 30s.

I mark the last 35 years as a delfation cycle because interest rates have made lower lows in every part of it.There have been counter trend increases of course through each business cycle,but the next has seen lower lows until we reached almost zero.This means asset classes have all made higher highs each cycle.Buy and hold and leverage has paid off and investing has been easy.A lot of corporates have geared up their balances sheets because debt is almost free to buy back shares,and consumers have geared up on BTL,equity release/second mortgages etc.

I think the deflation cycle ending is already baked in.The Fed missed out an entire tightening cycle.In doing so the leverage is now at extremes never seen.Inflation is very low conidering this is supposed to be the top of the business cycle the Fed has tightened into.I think they are making the same mistake as the mid 30s,tightening into a recession.

What makes this likely to be huge is the leverage,and that is mostly because of them missing out a tightening cycle.

 

It's your terminology that I'd take issue with.But then that does depend how you look at things.

Personally,I think the last thirty years(actually the whole period post 1929) has been an inflationary cycle as the money supply has expanded even through recessions.

I agree a deflationary bust is imminent and that it would have arrived 2008/9 but for some extraordinary CB interventions.

I've read somewhere that there are two types of recessions

1) where there's a build up of inventory,prices get cut,inventroy gets cleared and then reflation occurs.

2) credit recessions where there is an actual drawdown in credit  and money supply contracts(these are much rarer,last one was 1929)

 

Fed and BoE etc should have tightened in 2003/4 and could maybe have avoided deflationary bust.As it is they have likely turned what should have been a mild credit event into a world order changing asset bubble.

 

Just my view

 

 

 

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41 minutes ago, Funn3r said:

So for the average UK bloke with some money is "treasuries" safer than ordinary savings account? The interest rate seems equally poor.  Are treasuries easy to get if you are not in America? 

With Treasuries,historically,you always get your money back.With bank failures,you get haircuts.

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8 minutes ago, durhamborn said:

Very easy to buy.The fund TLT iShares 20+ Year Treasury Bond is as good as any.You cant hold it in an ISA,but can in a normal account or SIPP.Is it safer than a savings account depends if the US is more likely to default than a bank.Id say no chance the US will default on its debt.The main risk is currency risk of course.If the £ goes up against the $ the value will fall.I think all deposits in banks up to the protected level will be safe.I do think TLT might go up to $160 during a collapse but thats purely my thoughts and i cant give financial advice to anyone else.

Myself, il be buying some TLT once i sell my gold miners in the summer as i think sterling might get closer to $1.40 before things roll over.

Strange.I've been buying in since early March.I'll be holding longer term I think.

Some of the smaller caps look overpriced but some of the $1bn plus companies look cheap

Obviously opinions are like @rseholes.

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59 minutes ago, durhamborn said:

1.I dont think it matters if they tighten more now or not.The seeds are already sown and the monetary base is at a 2.5 year low.Another increase in June will just make things worse.

2.I think treasury yields will fall a lot,not rise.The 10 year to 0.5% and the 30 year to maybe 1%.TLT perhaps to $160.People will rush into treasuries as the only safe place.

3.I am seeing big effects on trade.Prices in China have gone up fast and the inflation in prices due to sterling falling is proving very hard to pass on.Margins for business are being squeezed to very low levels,but thats a UK problem.Im not sure what will start the debt deflation,but China is a candidate.

The main reasons i see for the start though are policy mistakes.The Fed tightening into a recession is a big one,as are central banks missing out a tightening cycle.Its the leverage on the system that will turn a recession into a collapse.I dont think it will last long,perhaps a year,but the wealth destruction will be huge.

When this starts is hard to say,as its a cycle call.

In any decent size credit event it's about the return of your money rather than the return on it.

 

Edit to add,good idea for a thread

Edited by Sancho Panza

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Just now, Sancho Panza said:

It's your terminology that I'd take issue with.But then that does depend how you look at things.

Personally,I think the last thirty years(actually the whole period post 1929) has been an inflationary cycle as the money supply has expanded even through recessions.

I agree a deflationary bust is imminent and that it would have arrived 2008/9 but for some extraordinary CB interventions.

I've read somewhere that there are two types of recessions

1) where there's a build up of inventory,prices get cut,inventroy gets cleared and then reflation occurs.

2) credit recessions where there is an actual drawdown in credit  and money supply contracts(these are much rarer,last one was 1929)

 

Fed and BoE etc should have tightened in 2003/4 and could maybe have avoided deflationary bust.As it is they have likely turned what should have been a mild credit event into a world order changing asset bubble.

 

Just my view

 

 

 

We are on the same page with most of that Sancho.I think it will be a credit recession like 29,but because we missed a tightening cycle (or maybe two cycles) it will happen alongside a normal business cycle recession.Thats what will make this much worse,the leverage.

Yes you could argue it was an inflationary cycle due to credit creation/money supply,but i see the cycle as a deflation cycle as the cost of debt/falling rates is what has drove asset prices and the chase for yield.Inflation and rates have fallen through the 35 years from the starting points to lower lows each cycle.Leverage has proved risk free due to this.

03/04 was as you say where they should of tightened and the seeds were sown then and put on steroids by the CB actions in 08.

Interesting one of the charts im tracking is auto inventories in the US.They are the highest since 04 and defaults rising fast.

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6 minutes ago, Sancho Panza said:

Strange.I've been buying in since early March.I'll be holding longer term I think.

Some of the smaller caps look overpriced but some of the $1bn plus companies look cheap

Obviously opinions are like @rseholes.

I bought in last December Sancho.Some GDX,also HMY,AUY,Eldorado Gold,SBGL.I see gold getting smashed in the deflation,but i think a big counter trend rally is possible/happening into the summer as the $ sells off first.If we do get a reflation cycle kicking in id be back into the miners then and holding for the longer term,but i will be selling in the summer if they are up or down.

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7 minutes ago, durhamborn said:

We are on the same page with most of that Sancho.I think it will be a credit recession like 29,but because we missed a tightening cycle (or maybe two cycles) it will happen alongside a normal business cycle recession.Thats what will make this much worse,the leverage.

Yes you could argue it was an inflationary cycle due to credit creation/money supply,but i see the cycle as a deflation cycle as the cost of debt/falling rates is what has drove asset prices and the chase for yield.Inflation and rates have fallen through the 35 years from the starting points to lower lows each cycle.Leverage has proved risk free due to this.

03/04 was as you say where they should of tightened and the seeds were sown then and put on steroids by the CB actions in 08.

Interesting one of the charts im tracking is auto inventories in the US.They are the highest since 04 and defaults rising fast.

I thought we were,it's just the terminology.

Now you've mentioned it,you've pointed out something rather obvious and that is the massive oversupply of housing.Price wise, the cash market is the rental market,the credit market,house purchase.Rents have been going nowhere for ten years,indicating supply and demand relatively in balance.Which draws into question,the state of some house lenders balance sheet projections.

I've seen varying figures but roughly 60% of the UK's wealth by assets is in it's housing market.Excuse me for pointing out the direct correlation between credit expansion and house prices.We're one balance sheet purge away from poverty.

So yes,point taken re credit drawdown running alongside inventory recession in the housing market.

 

Which takes me to another issue and that is the nature of fractional reserve lending whereby asset inflation begets further credit expansion which begets asset inflation.Virtuous circles become vicious ones.

There's another great thread on here,Neverwhere Basel 3 thread,which discusses some of the incoming regulations which are attempting to put a finger in the dyke.Obviously doomed to fail in my opinion

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16 minutes ago, durhamborn said:

 

Interesting one of the charts im tracking is auto inventories in the US.They are the highest since 04 and defaults rising fast.

Indeed,auto lending is the new sub prime.For sure,same in the UK.Hordes of people knocking about in cars they don't own and can't really afford,but some kind financier lent them the money on the promise they'd pay it back,even if they lose their job.

Also,worth considering the student loan book.St Louis Fed has some amazing graphs on that particular catastrophe that noone can see coming.

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13 minutes ago, durhamborn said:

I bought in last December Sancho.Some GDX,also HMY,AUY,Eldorado Gold,SBGL.I see gold getting smashed in the deflation,but i think a big counter trend rally is possible/happening into the summer as the $ sells off first.If we do get a reflation cycle kicking in id be back into the miners then and holding for the longer term,but i will be selling in the summer if they are up or down.

I remember when I first came on here back in 2007.I was never a goldbug.It's only recently (since 2015) that I've been running the slide rule over them.That became active purchases in March.Sometimes,you have to be flexible and accept you may have been wrong.

When you look at a chart like GFI or Barrick that's been around forty years,you can see there's clearly more to the price of these companies than the gold price as they don't follow it in a linear manner.

I've lifted 8 reasons to buy gold as below and in my opinion,there's a raft of reasons for gold to rise and fall depending on market and geo political issues.

I'm always on the look out for trades but looking at the FTSE and S&P at the moment,they just look overpriced,over sexed and over here.

Doug Short does a regular feature on margin debt and the S&P which I find fascinating.The trap door has been lubed up imho.

https://www.advisorperspectives.com/dshort/updates/2017/05/02/a-look-at-nyse-margin-debt-and-the-market

Margin Debt

I think there are a raft of reasons that you can use to justify buying the yellow metal neatly summed up by investopedia.

http://www.investopedia.com/articles/basics/08/reasons-to-own-gold.asp

'A History of Holding Its Value

Unlike paper currency, coins or other assets, gold has maintained its value throughout the ages. People see gold as a way to pass on and preserve their wealth from one generation to the next.

Weakness of the U.S. Dollar
Although the U.S. dollar is one of the world's most important reserve currencies, when the value of the dollar falls against other currencies as it did between 1998 and 2008, this often prompts people to flock to the security of gold, which raises gold prices . The price of gold nearly tripled between 1998 and 2008, reaching the $1,000-an-ounce milestone in early 2008 and nearly doubling between 2008 and 2012, hitting around the $1800-$1900 mark. The decline in the U.S. dollar occurred for a number of reasons, including the country's large budget and trade deficits and a large increase in the money supply.

Inflation
Gold has historically been an excellent hedge against inflation, because its price tends to rise when the cost of living increases. Over the past 50 years investors have seen gold prices soar and the stock market plunge during high-inflation years.

Deflation

Deflation, a period in which prices decrease, business activity slows and the economy is burdened by excessive debt, has not been seen globally since the Great Depression of the 1930s. During that time, the relative purchasing power of gold soared while other prices dropped sharply.

Geopolitical Uncertainty
Gold retains its value not only in times of financial uncertainty, but in times of geopolitical uncertainty. It is often called the "crisis commodity," because people flee to its relative safety when world tensions rise; during such times, it often outperforms other investments. For example, gold prices experienced some major price movements this year in response to the crisis occurring in the European Union. Its price often rises the most when confidence in governments is low.

Supply Constraints
Much of the supply of gold in the market since the 1990s has come from sales of gold bullion from the vaults of global central banks. This selling by global central banks slowed greatly in 2008. At the same time, production of new gold from mines had been declining since 2000. According to BullionVault.com, annual gold-mining output fell from 2,573 metric tons in 2000 to 2,444 metric tons in 2007 (however, according to Goldsheetlinks.com, gold saw a rebound in production with output hitting nearly 2,700 metric tons in 2011.) It can take from five to 10 years to bring a new mine into production. As a general rule, reduction in the supply of gold increases gold prices.

Increasing Demand
In previous years, increased wealth of emerging market economies boosted demand for gold. In many of these countries, gold is intertwined into the culture. India is one of the largest gold-consuming nations in the world; it has many uses there, including jewelry. As such, the Indian wedding season in October is traditionally the time of the year that sees the highest global demand for gold (though it has taken a tumble in 2012.) In China, where gold bars are a traditional form of saving, the demand for gold has been steadfast.

Portfolio Diversification
The key to diversification is finding investments that are not closely correlated to one another; gold has historically had a negative correlation to stocks and other financial instruments. Recent history bears this out:

  • The 1970s was great for gold, but terrible for stocks.
  • The 1980s and 1990s were wonderful for stocks, but horrible for gold.
  • 2008 saw stocks drop substantially as consumers migrated to gold.'
 

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31 minutes ago, durhamborn said:

I bought in last December Sancho.Some GDX,also HMY,AUY,Eldorado Gold,SBGL.I see gold getting smashed in the deflation,but i think a big counter trend rally is possible/happening into the summer as the $ sells off first.If we do get a reflation cycle kicking in id be back into the miners then and holding for the longer term,but i will be selling in the summer if they are up or down.

Always remember a great RK quote that went something like

'Gold holders will end up getting burned for the very reasons they think they won't' or something similar.

Food for thought.....

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Alright let me know if I interpret your reasoning in the wrong way:

- You assume there is a massive bubble over asset categories (RE)

-When the wind turns, the repricing of those assets will crash lower than their optimal market level.

-Hence a reflation kicking in when the panic will have passed and the panic stabilised.

Anything else I am missing? 

I'll challenge the reasoning later after those assumptions have been validated

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26 minutes ago, Freki said:

Alright let me know if I interpret your reasoning in the wrong way:

- You assume there is a massive bubble over asset categories (RE)

-When the wind turns, the repricing of those assets will crash lower than their optimal market level.

-Hence a reflation kicking in when the panic will have passed and the panic stabilised.

Anything else I am missing? 

I'll challenge the reasoning later after those assumptions have been validated

I dont class it as a bubble,i class it as the end of a 35 disinflation cycle where assets are priced as far along the risk curve as possible and will crash due to a deflationary debt liquidation.We are going into a recession with inflation very low and a tightening monetary base will push into deflation quickly.Deflation will be a trigger due to leverage.I expect oil to trade up to $60 but perhaps down to $10/15 in the bust for example.

Assets will crash lower due to that in-voluntary debt liquidation mostly and a crashing financial system because of the leverage.Price discovery will be out of the picture during this time as $700 trillion of notional derivatives come into play.Assets will not be priced for the reflation cycle to follow (producers will win in that cycle not distribution).Industrial and miners will be the future winners.

A reflation will kick in because of massive money printing.The Fed might expand its balance sheet by $10 trillion+ along with other CBs.

 

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