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Money Monitor: Breaking Down Deflation


...a return to a disinflation-dominant macro-environment might be the end-result of the utter collapse in the US housing market.

Professor Bennet Sedacca is on fire with his recent musing as relates to the intensifying risk that a return to a disinflation-dominant macro-environment might be the end-result of the utter collapse in the US housing market. Naturally, the housing scene presents a dynamic we have, and continue to spotlight, specifically in terms of the historic tsunami of unsold supply that is now laying waste to home builders and threatens to flood the US economy with a disinflationary tide.

I know that Bennet is aware that the 3-Month Rate of Core Finished Goods PPI has already fallen back into outright deflationary territory as defined in the chart below (courtesy BLS). The latest plunge into a 3-month rate of deflation is eerily reminiscent of the 2000-2001 period, which provided the catalyst for the infamous Bernanke Monetary Helicopter speech.

Taking it to the next logical 'step,' observe the chart below plotting the year-over-year rate in the Industrial Goods Producer Price Index, which had been one of the most virulently reflated sectors in 2005. We spotlight the triple-top-like formation in the 10% y/y rate level and a pending head and shoulders topping pattern, in line with the downside pressure being applied to the uptrend line that could be drawn connecting the 2002 and 2004 lows.

Within the context of a decline in petroleum products, we also spotlight a deep (-) 1.4% month-to-month deflation in the PPI price of Coal.

Feeding off the PPI decline in Coal, my firm offers a simple but unique perspective on the price of Crude Oil exhibited in the longer-term daily chart below. We spotlight two moving averages; the short-term 21-Day Exponential MA (red line) and the longer-term 200-Day MA (dark blue line); and also highlight the bearish cross-over which has thus 'ended' a three-year bullish trend.

Subsequently, a similar dynamic that is extending into the industrial metals arena becomes all the more 'interesting' from the macro-message viewpoint. This is exhibited in the same moving average based chart as pictured for Crude Oil, on display below, plotting the averages for LME 3-Month Aluminum, revealing a move towards a bearish cross-over.

Indeed, the LME 3-Month Aluminum contract is teetering and clinging to a technical precipice as evidenced in the daily chart on display below, amid a potential downside violation of the longer-term 200-Day EXP-MA by price of the underlying metal.

And then there is...Copper.

Again, I still believe that Copper simply cannot 'escape' the horror-show that has become the US Housing market, particularly as defined by an expected deepening contraction in new home building. Observe the teetering price as relates to the underlying support offered by the most recent double low ($3.265-3.275) and the med-term 100-Day EXP-MA.

But most telling, just as it was with the energy complex, my firm observes a collapse in the forward spreads, as pertains to Copper.

Note the chart below in which I plot the 100-Day Exponential Moving Average of the Cash-to-Three Month Spread for Copper, traded on the London Metal Exchange. Copper's spreads are in free fall, and this spread has completely wiped out all of its HUGE $200+ per tonne backwardation and has collapsed into contango, indicating an amply supplied market for the first time since the 4Q of 2003.

And finally, most bothersome is the likelihood that things are setting up to get worse, disinflation-wise, as is strongly suggested by a dissection of the most recent money supply figures offered by the Fed. Note the details as relates to the data released last Thursday:

13-Week Rate-of-Change in Narrow M-1 money supply, contracting at a (-)5.5% pace, extending the decline posted in the week of Aug-21 at (-)4.5%, the decline of (-)3.4% seen in the week of Aug-14, and the decline of (-)1.9% in the first week of August.

Note the entire string by week since June:

Sep-04: down (-)5.5%
Aug-28: down (-)5.5%
Aug-21: down (-)4.5%
Aug-14: down (-)3.4%
Aug-07: down (-)1.9%
Jul-31: down (-)1.4%
Jul-24: down (-)1.7%
Jul-17: down (-)0.6%
Jul-10: up +0.1%
Jul-03: up +0.3%
Jun-26: up +2.1%
Jun-19: up +2.8%
Jun-12: up +3.8%

In short, the growth of Narrow money supply has vaporized on a short-term basis and fallen into overt deflation.

Similarly, basis the monthly figures provided by the Fed, the 3-Month Rate-of-Change in Narrow M-1 money supply has also collapsed into an outright contraction. Note the details on the 3-Month ROC of M-1 money:

Mar-06: up +4.8%
Apr-06: up +2.3%
May-06: up +5.0%
Jun-06: down (-)4.9%
Jul-06: down (-)5.2%
Aug-06: down (-)7.1%

Bottom line, see the chart below, revealing a decline in the y/y rate of change in the Narrow M-1 monetary aggregate into a contractionary rate of deflating money supply.

And the y/y rate of change in headline M-2 money supply, ex-Money Funds, has fallen below +4% for the first time since before 1998, having collapsed from a peak near +12% yr-yr expansion in the 2003-2004 monetary reflation period.

A breakdown in Copper would be a confirming signal, and 'should' provide the proverbial 'next shoe to drop,' in terms of a broadening disinflation becoming increasingly dominant in the entire commodities sector.
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Positions in crude oil, copper
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