Inside today’s Daily Journal…

Over many years I’ve learned to listen to gold.

Gold tends to rally after credit expands rapidly. It is a harbinger of the growing risk of credit defaults. Gold is where liquidity flees when counterparty risk grows. People often mistake gold for an inflation hedge – and over time, yes, it will protect you from currency debasement. But it more accurately tracks the end of major credit cycles, not the beginning.

Gold soared last year because counterparty credit risk has grown massively – as I’ll show you in the data below.

Likewise, many people believe that Bitcoin is a hedge against currency debasement. And, again, over the long term that’s certainly true. But, unlike gold, Bitcoin isn’t a barometer of credit / counterparty risk. And it doesn’t track growth to monetary aggregates (like M2 money supply) either. Instead Bitcoin is an extremely sensitive barometer of available liquidity in the market.

Bank reserves are the cash that commercial banks hold on deposit at the Federal Reserve. They represent readily available liquidity in the banking system. When reserves grow (often from Federal Reserve actions like bond purchases), more cash flows into the economy. When reserves shrink, liquidity tightens.

The price of Bitcoin tends to track these changes very closely. (This data is released every Thursday at 4:30 pm.) Bitcoin has fallen recently because liquidity, as measured by bank reserves, has declined.

When I see gold rallying and Bitcoin declining, that indicates the beginning of a credit default cycle.

Counterparty risk up and liquidity down is a tough environment for stocks.

I wanted a proprietary way to track the worsening credit conditions, so I’ve built a custom index that’s made up of 10 leading U.S. consumer credit businesses: