Saturday, April 11, 2009

The 2% Solution of Gold

From a strategic standpoint, probably the worst current news involves confirmation that Paul Volcker has indeed been marginalized, as reported in Volcker Assumes Smaller-Than-Expected Role With Obama in the WSJ. Bottom line is that he's out of the loop.

Regarding growth in the economy, it remains to be seen if A) Bernanke's green shoots are nothing but a false "Prague spring" or even if it is springtime in America's economy, B) will we then suffer T. S. Eliot's "unimaginable zero summer".

Unfortunately, the bears on the large financial companies such as Michael Mayo, Meredith Whitney and Nouriel Roubini give no ground. The Wells Fargo pre-announcement means little given such factors as the low level of loan losses. The Fed's TALF securitization program has not demonstrated any pent-up demand. The bulls argue that unemployment has peaked, which as a coincident indicator indicates that the economy is turning. Is the economy at a bottom? Doubtful . . .

The Economic Cycle Research Indicator's Weekly Leading Index, which historically has about an 8-month lag time before the economy turns, is still below the level of 3 months ago, consistent with Nouriel Roubini's prediction that growth in Q4 will remain negative; and it is far below the level of 6-8 months ago, suggesting the potential for a lot of economic shrinkage before the bottom is hit.

How bad can things get based on extrapolations from the data, not assuming new unknowable adverse events?

Researchers at Boston University report in Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets that the degree of disruption of corporate bond spreads seen over the past half-year predicts, with a strong degree of statistical correlation
that mid-high grade credit spreads over Treasuries predicts 12-24 months forward industrial production and employment and adds significant new predictive ability over prior forward-lookings. Figure 2 on page 18 suggests employment and industrial production dropping much further, bottoming at year-end 2009, with a wide confidence interval, the best of which is "bad".

To quote the article, their models forecast:

"that over the 12 months ending in December 2009, U. S. non-farm payrolls will fall about 7.5%, while industrial production is projected to drop around 20%, declines that are four times greater than those experienced during the 2001 recession." (page 19)

Please note that this is for a further drop from a starting point one year into the "recession". Consistent with the this, the ECRI noted this week that its coincident indicators of economic activity were poor, per ECRI's managing director Dr. Laksman Achuthan:

" . . .growth in the Weekly Coincident Index fell to a record the week ending April 3. This follows the earlier plunge in WLI growth and confirms that we are in the worst recession since World War II."

After the close Thursday, both Boeing and Chevron pre-announced earnings disappointments. Boeing has been accruing negative sales gains, which is to say that cancellations have been exceeding new orders. Chevron said that both upstream and downstream business is poor. Dow often do you see that from an integrated oil?

Earnings are poor and dropping, dividends are being cut, personal and corporate income taxes to the Federal Government are down, the FOMC recently lowered its assessment of the economic prognosis (not many green shoots of spring seen in that report), and the housing market is only being kept alive by massive Government intervention. Fannie and Freddie are reportedly back to making 105-110% loans to value, but bankers actually have no idea what "value" is. The trustees of the Social Security Trust (hah!) Fund very recently drastically lowered their positive cash flow projections.

With the economy in continued decline and various accounting games being played with earnings of Big Finance, the bottom line is that the true lack of profitability of the economy absent substantial leverage is being revealed. This is not the end of the world, but likely indicates more disappointment for the bulls ahead. Given that the ECRI's largely-unnoticed U. S. Future Inflation Gauge is at 1958 levels, one can do worse than purchasing a one-year C. D. from a solid bank backed by FDIC insurance yielding 2%.

Longer term, all these deficits and promises to all sorts of constituents by the Federal Government will largely be fulfilled as necessary by printing money. No matter if or when the Oil Age will end, gold will continue to remain a store of value that will be accepted by most of the population all over the world for as far the eye can see.

Copyright (C) Long Lake LLC 2009

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