Thursday, September 30, 2010

Should the Taxpayer Take AIG Off the Fed's Hands? A Response to Chris Whalen

Former New York Fed ("FRBNY") "management trainee" R. Christopher Whalen has a post up on Zero Hedge urging the public to bail out said FRBNY. In AIG: Time for Treasury Secretary Geithner to Clean Up the Mess he says:

The fact is that the “loans” by the Fed to AIG were really private equity investments and thus illegal under the Federal Reserve Act. . .

The Treasury should issue debt to the Fed in exchange for these assets and the ownership would ultimately shift to the Federal Financing Bank (FFB). The FFB is the part of the Treasury that ultimately holds all financial investments by the government, including the stakes in AIG, General Motors and Citigroup. . .

And it will show the world that the American people are starting to take ownership of a problem we all helped to create.

So let's get his point of view straight. He believes that the FRBNY acted illegally when it invested in AIG. (That would imply that the counterparty payments of tens of billions of dollars to Goldman Sachs and many other counterparties stemmed from an illegal transaction and, while I am not a lawyer, have questionable legality.)

He then asserts that "the American people" "helped" to create this mess and therefore should, through the Treasury of the government of the United States, take this mess off of the New York Fed's hands.

Who is Chris Whalen that he wants us to bail out the New York Fed, even though he believes it acted illegally in acquiring the asset he wants us to acquire from it?

A bio of him states:

In 1984, he was hired as a management trainee by the Federal Reserve Bank of New York, where he worked in the bank supervision and foreign exchange departments. He subsequently worked in the fixed income department of Bear, Stearns & Co, in London.

After returning to the United States in 1988, Christopher spent a decade providing risk management and loan workout services to multinational companies and government agencies operating in Latin America. His clients included the U.S. Export-Import Bank, Toshiba Corp, Kroll Associates and Weyerhaeuser.

Mr. Whalen went on to co-found Institutional Risk Analytics. From this perch he opines on various financial matters in a generally interesting weekly post. The core business of IRA relates to understanding the non-obvious risks in the financial system. He recently gave an interview to the hard money-oriented King World News, in which he decried what he viewed as serious financial problems in various large financial institutions.

However well-meaning Mr. Whalen is in his views, they strike this humble blogger as seriously misguided. The division of AIG ("AIGFP") that wrote the unfunded credit default swaps that are said to have nearly brought the entire company down was based in London. The American people had nothing to do with AIGFP. The American people never heard of credit default swaps till the crisis and had nothing to do with their creation, lack of oversight of them by regulators (see, Brooksley Born for more info), and have no responsibility to take even a dollar of losses from what might turn out to be an ill-timed investment in AIG by the New York Fed.

Many, and I dare say most, people are unaware that the New York Fed is a private company owned by such stockholders as J. P. Morgan Chase. It pays dividends to these stockholders.
(It is also true that Fed profits are generally remitted to the Treasury.)

Nonetheless, the bottom line is that we have what I view as an unseemly attitude here. Mr. Whalen has been banging the gong about poor lending practices. He believes that the FRBNY, then headed by Timothy Geithner, acted illegally in rescuing AIG from apparent collapse. He now wants you and me to take this asset off the New York Fed's hands. Mr. Whalen got his career start at the FRBNY. It appears in this case that he is inappropriately blaming the public for an illegal action of the New York Fed (at least, in his view) to bail out a multinational company, said bailout allowing payment of a London-based subsidiary's bets with large, sophisticated financial counterparties of tens of billions of dollars at 100 cents on the dollar in several tranches over several months. Now it's our problem?

Does Mr. Whalen, who I have followed for several years and thought was a free market-oriented person, really believe that the U. S. Government should increase its ownership in private corporations?

As far as the Fed, it made sure that Goldman, Deutsche Bank and many other fat cats received their payments in full from AIG, and since then the Fed has continued to pamper these same companies with ultra-cheap money which they can then lend out at a profit or "invest" for a spread profit in Treasuries or governmentally-guaranteed mortgage-backed securities.

My point of view is that the ultimate lender to these banks about which I am most concerned is the individual or small business. We are being hosed by a bank rate of interest on our loan to the bank (which we usually call a "deposit") that the Fed is doing its best to make sure is below the rate at which prices rise.

Since the New York Fed and the FOMC appear to have the financial institutions' interests more at heart than the interests of the public at large that supports these institutions with their loans (deposits) and investment funds, then increasingly I agree with the British journalist Ambrose Evans-Pritchard, who has now concluded a two-part essay titled Shut Down the Fed. (Click HERE for what might be Part I, the above being subtitled "Part II without a link to any Part I).

I disagree with Mr. Whalen. I believe that AIG is his former bosses' problem. What happened at the New York Fed should stay at the New York Fed. And if said action was indeed illegal, why in his post did he not call for a special prosecutor to investigate the actions of Timothy Geithner, Henry Paulson and all others involved in the bailout?

In the bigger picture, it is disappointing to see that one more supposedly independent voice is now advocating continuance and ratification of the process of socializing the losses that were generated in pursuit of private gain.

Copyright (C) Long Lake LLC 2010

Poor Economic Data Plus Poor Financial Stock Charts Raise the Question of Further Bond Rally

Please consider clicking to this linked chart of Bank of America (BAC).

This defines ugly.

Meanwhile the administration's Recovery Summer is panning out as follows.

Gallup reports U.S. Consumers' September Spending Matches 2010 Low:

Americans' self-reported spending in stores, restaurants, gas stations, and online averaged $59 per day during the first four weeks of September. Consumer spending is down from August ($63) and July ($68), and now matches its lowest level of 2010. Current spending is lower than that of a year ago and far below spending in September 2008, at the start of the financial collapse.

Click on graphic to enlarge.

Discretionary spending completely stinks. The country is getting poorer. These data are not adjusted for the obvious rise in consumer prices going back to early 2008. Thus they are worse than they appear, and they appear dismal.

Well, did small business participate in Recovery Summer?

Rasmussen on behalf of Discover(R) has an answer, having released its September survey data of small business, results of which include:

-Forty-six percent of small business owners report having cash flow issues this month, down from 53 percent in August; 50 percent said they do not have cash flow issues and 5 percent aren't sure.

-Despite this, a record 68 percent of small business owners rate the economy poor, up from 62 percent in August; 26 percent rate it fair, 4 percent rate it good and only 2 percent rate it excellent.

-In September, intentions for spending on business development in the next six months produced two record numbers. A record low 16 percent of small business owners plan to increase spending, down a percentage point from last month's then record low of 17 percent. Fifty-seven percent of small business owners report plans to decrease spending, the highest in the history of the Watch, while 24 percent report no changes to their spending plans and 3 percent aren't sure.

-55 percent of small business owners report economic conditions are getting worse for their businesses, equaling the record high percentage from last month; 23 percent expect them to stay the same and 20 percent see them getting better.

So, in addition to the widely reported U. of Michigan consumer confidence surveys, the ABC weekly confidence survey and so on, current data are ugly. This rich country is getting poorer.
Meanwhile the financial leaders at the Fed prattle on about the desirability of 2% price rises--for a country where money on deposit in the bank yields next to nothing, where except for giveaways from the government Social Security recipients receive no cost of living increases, and where the rate of price increases is systematically understated.

Almost everyone I know understands that the stock market is fully divorced from the economic reality of themselves and their friends and family. Thus, the lack of palpable economic progress and no major foreign policy successes all but ensure a major rebalancing swat on the nose to the Dems in the election.

The low expectations of the public of the Republicans they may well grant control of the nation's pursestrings to might just allow for upside surprises in the financial markets. Since the federal deficit has now moved to #1 in national concern in at least one recent poll, we might just see the pols here do the same sort of deficit reduction that the Brits achieved with their new coalition government this year. There is, after all, nothing so persuasive to a pol than a poll. Might the unthinkable happen, and the 10 year Treasury revisit its 2008 post-Lehman panic low around 2.10% in the next few months?

If anything can do that, the combination of troubles at BofA, as the chart suggests; further economic weakness (double dip or no almost does not matter) and deficit reduction measures could be a trifecta that accomplishes that while restoring some faith in and strength to the benighted U. S. dollar.

Copyright (C) Long Lake LLC 2010

Wednesday, September 29, 2010

Arguing with Mister Market

With the cost of money round the world at or near record lows, so that even the cost of borrowing for highly distressed borrowers is lower than the rates that the strongest countries borrowed at in the 1980s, distortion upon distortion exists in the financial markets.

The many of us who are greatly disappointed with the actions and inactions of the monetary and governmental authorities the past several years think we know better. Not only do we want to "argue" with Mr. Market (who may or may not be rigged beyond the acknowledged rigging of short-term interest rates), but many investors have a numerical target for, say, yield on muni bonds that they simply expect to be there. These muni investors are arguing with Mr. Market.

These people may be "dinosaurs" just as Japanese investors in the 1990s could not conceive of close to zero interest rates for an indefinite period.

In response to the money printing required to force rates near zero, many people have turned to gold as a hedge.

Then the public looks at gold at new nominal price highs and says, oh well, missed that move, the price is too high.


Yet John and Jane Q. Public probably have no idea that if they want to invest based on reversion to the mean of returns from financial instruments, if they go back 70 years, they will find that the calculated total return from stocks well exceeds the total return from gold, taxes and transaction costs excluded. So even though many people are increasingly comfortable with basically holding their stocks within their broad trading range of the past years, figuring they will rise one day, they are scared to step into the precious metals market, or if they have gotten in at much lower prices, they have not been buyers at higher prices.

Yet if one looks at the structure of large bull markets, which the precious metals market resembles (but of course may be topping out for all I know), gold and its junior partners may be at levels that will look cheap some years from now.

Assuming that gold prices are rising primarily due to free market activity, with governmental/central bank actions affecting the price only secondarily, then the normal psychology is for price breakouts to be tested. The Dow Jones 30 average (DJIA) first hit 800 in 1964. It was 778 in August 1982 when the Fed eased in light of a Mexican financial crisis. So stocks had an 18 year trading range in which P/E's shrank. Then stocks burst to new highs but retested the prior high of the trading range in 1984. But it proved to be morning in America, at least for stocks, and they more than doubled to 2700 in August 1987. From that level, when they fell by a third in that era's version of a flash crash, 1800 looked like a bargain, and then the real excitement began.

Arithmetically, recent numbers for the price of gold per ounce, which broke out past $1000 last year after falling into the $700s the prior year, are uncannily similar to that for the Dow, which was blocked for years around 1000, fell into the 700s in 1982, then burst out, never to drop under 1000 again once it quickly surpassed it a few months after the August 1982 bottom. Might gold's ultimate price peak be found within as long and strong an up-market as stocks experienced?

The many people who argued with Mister Stock Market in the 1980s, expecting the bear market to resurface, missed what was at first a rational bull market that had not yet gone to excess. My suspicion is that people who are arguing both with what I view as a rational precious metals bull market because they think prices are "too high" now are engaging in similar thinking as those who, scarred by a prolonged stock bear market, missed out on some excess returns available to buy-and-hold stock market investors who bought in after the break-out to new highs in 1983-85.

Of course, there are different ways to skin cats, financially speaking. People had plenty of ways to grow their capital in real terms in the 1980s and 1990s, or at least keep up with the rate of general price increases. Common stocks were not the only vehicle. Looking backwards from the future, we will likely see that even if gold meets or exceeds the goals of those investors who look to it to at least preserve real purchasing power, there will be other vehicles that will prove to have done the same thing.

For investors with little accumulated capital, such as young adults starting a career who cannot diversify, gold may be a sensible one-decision asset for all their eggs, for now. For retirees with more than a little capital, it's hard to see going all-in on gold or other similar assets.

The gold market has moved a great deal the past year, yet many gold stocks and gold ETFs show a remarkable apathy. I like this. It indicates that the public is not chasing investment-grade gold vehicles (though it may be chasing penny gold stocks).

Seasonally, not only is September a typically strong month for gold prices, but on average so is the rest of the calendar year. But in addition, there is the phenomenon that as with stocks in 1929, gold and oil 1979, stocks 1999, and in other cases, we have seen trends that have lasted a calendar decade reverse after the decade. (These include the deflationary 1930s giving way to the inflationary '40s and the booming 1960s yielding suddenly to the stagflationary '70s.)

No one knew in summer-fall 1979 that gold would skyrocket for the rest of the year and peak much higher in January 1980. No one knew at the end of a turbulent 1998 what would happen in 1999. So I want to sell gold only either when there is clear over-enthusiasm amongst the public or when my view of the fundamentals of fiat currency somehow change. I don't want to lose the upside potential of an unexpected massive further surge in gold prices.

Gold may falter in price for more than the typical correction that follows a large move, which it has had very recently. If that happens because central banks adopt prudent policies, great. Unfortunately, in my view, the U. S. authorities want more money printing. As the sole military and financial superpower, their printing press is more powerful than any other country's. Thus I want to hedge against the likely success of their policies by owning, one way or another, the one form of money the U. S. cannot create at will, and that Mr. Market has been favoring for some time, but not yet to excess.

To expect gold prices to enter a serious, sustained decline soon against the U. S. dollar is to argue both against Ben Bernanke and Mister Market.

Copyright (C) Long Lake LLC 2010

Monday, September 27, 2010

Sound Money Gaining Important Media Mindshare

Ambrose Evans-Pritchard, the influential British financial columnist, has issued perhaps the most thorough apology anyone can write in his piece today titled Shut Down the Fed (Part II). Here are some choice excerpts:
I apologise to readers around the world for having defended the emergency stimulus policies of the US Federal Reserve, and for arguing like an imbecile naif that the Fed would not succumb to drug addiction, political abuse, and mad intoxicated debauchery, once it began taking its first shots of quantitative easing.

My pathetic assumption was that Ben Bernanke would deploy further QE only to stave off DEFLATION, not to create INFLATION. If the Federal Open Market Committee cannot see the difference, God help America.

NO, NO, NO, this cannot possibly be true.

Ben Bernanke has not only refused to abandon his idee fixe of an “inflation target”, a key cause of the global central banking catastrophe of the last twenty years (because it can and did allow asset booms to run amok, and let credit levels reach dangerous extremes).

Worse still, he seems determined to print trillions of emergency stimulus without commensurate emergency justification to test his Princeton theories, which by the way are as old as the hills. Keynes ridiculed the “tyranny of the general price level” in the early 1930s, and quite rightly so. Bernanke is reviving a doctrine that was already shown to be bunk eighty years ago.
. .

Are the Chinese right? Are the Americans and the British now so decadent that they will refuse to take their punishment, opting to default on their debts by stealth?

Sooner or later we may learn what the Fed’s hawkish bloc of Fisher, Lacker, Plosser, Hoenig, Warsh, and Kocherlakota really think about this latest lurch into monetary la la land, with all that it implies for moral hazard and debt contracts.

If I have written harsh words about these heroic resisters, I apologise for that too.

Are the Chinese right? You bet.

Here's Professor Krugman's preferred solution, in a brilliantly-titled blog yesterday, Default Is In Our Stars:

So what will happen? In the end, I’d argue, what must happen is an effective default on a significant part of debt, one way or another. The default could be implicit, via a period of moderate inflation that reduces the real burden of debt . . .

While his brief blog is a bit noncommittal, it is known that he prefers the inflationary solution rather than the free-market solution of debtors actually paying lenders back their capital according to sound money principles as best as said debtors can. Some debts cannot be paid, just as some (many) equity investments in risky enterprises will fail. So be it. If a lender lends unwisely or unluckily, that's his or her business. But it should be the lender and the borrower who in general is the sympathetic figure. The lender worked, earned money and did not get to enjoy that money. Instead, he/she deferred gratification and let the borrower enjoy/make use of the capital. Why should the borrower benefit from official policy to debase the capital which the lender earned but never used personally/

More and more serious thinkers are moving away from the policies of those who claim the mantle of Keynes (in Evans-Pritchard's case, he wraps himself in something he says Keynes got right) but who are perhaps even more Keynesian than Keynes. They are moving in favor of sound money. If you are thinking gold, you have it right.

Because the Evans-Pritchard view remains an insurgent one, I thus continue to favor gold, which is really to say that I believe that the dollar will continue to lose value faster than the discounting rate, which sadly the Fed has determined is 0.44% or so yearly for 2-year money.

It is further my empirical observation over 30 years of following gold (but not owning it or gold shares till 2001 or 2002, when the Fed went all in for allegedly anti-deflationary policies) that when the discount rate is below the consumer price inflation rate, gold prices rise; otherwise they fall or hold steady.

If the general price level actually starts declining and there is a semi-credible plan for the government to actually repay its debts, then I will say, as Keynes did, that the facts have changed and I will change my investment views.

Gold looks to be on the move. One can look at that as bad, as it reflects a declining value of the dollar. I prefer to look at it as a positive, in that the desire of an increasing number of people for sound money is being voted on in an even more legitimate "poll" (the free market) than an off-year election.

Somehow the view has taken hold in many minds that owning or investing in gold is un-American. Au contraire. The Coinage Act of 1792, signed by President Washington, provided as follows:

SEC. 19. And be it further enacted, That if any of the gold or silver coins which shall be struck or coined at the said mint shall be debased or made worse as to the proportion of fine gold or fine silver therein contained, or shall be of less weight or value than the same ought to be pursuant to the directions of this act, through the default or with the connivance of any of the officers or persons who shall be employed at the said mint, for the purpose of profit or gain, or otherwise with a fraudulent intent, and if any of the said officers or persons shall embezzle any of the metals which shall at any time be committed to their charge for the purpose of being coined, or any of the coins which shall be struck or coined at the said mint, every such officer or person who shall commit any or either of the said offences, shall be deemed guilty of felony, and shall suffer death.

The Founders took their money seriously, it would seem.

Gradually, momentum is building for a return to financial sanity. The Krugmanites appear to have peaked. The rise of the Tea Party (Tea Parties, to be technical), which in core financial ideology appears to me to mirror the Perot movement, reflects the thinking of the center of gravity of America.

Stay tuned. Something good just may be coming. Converts such as Mr. Evans-Pritchard are valuable and do not come easily. Unfortunately Dr. Bernanke and President Obama can do lots of "stimulatory" damage before their influence wanes, but the cavalry may be out there just beyond the horizon to rescue us from the slings and arrows of their outrageous policies.

Copright (C) Long Lake LLC 2010

Sunday, September 26, 2010

Gallup Reports Real Consumer Discretionary Spending Hits or Ties Multi-Year Lows

Gallup is reporting today that self-reported discretionary spending by consumers has essentially tied its low point from March, 2009. A total of 21,000 phone interviews over the prior 14 days shows that outside of normal bills/mortgage/auto payments etc., respondents spent $55/day. The margin of error is 3%, which I take to be $1.65. The low point I can find by scrolling over the data through the beginning of 2009 is $54 in March 2009. Given that this data is not adjusted for price increases, which the government says have occurred when housing costs are excluded, real consumer spending may actually be down over almost any time period one wants to use. This apparently was not a Recovery Summer for American consumers.

The same survey showed daily discretionary spending about $75 this past spring. Not shown is the data from the first part of 2008, when the recession was on but was just a mild slowdown so far as consumers knew. My recollection from following this survey then is that this number that is now in the $50s was in the $100-130 range.

This is one of the reasons why I feel this is a depression. Yes, all the money-printing and cyclical factors, plus 1% per year population growth, help keep some economic matters growing, but in the real world, the normal vitality of the American economy has yet to show itself. And truth be told, aside from the housing and credit bubble, said vitality was lacking all through the prior decade.

(The Gallup survey apparently includes all respondents, not just ones with jobs or who are retired. In other words, it presumably includes spending due to transfer payments, including those "paid for" by expansion of governmental deficit spending. Thus the underlying trend based on real earnings is yet worse than shown.)

This data dovetails with much other data and supports the view that in the "Japanecian" duality of the U. S. economy and financial system potentially going Japanese and/or Grecian, right now it is still in the "going Japanese" mode. Unless the recent data is a true outlier, this recent collapse in spending supports the investment strategy of being long assets perceived as being very safe or non-dollar-related. This is not, however, a short-term timing tool in any way, shape or form.

Nonetheless, I continue to put cash "to work", as the talking heads like to say, in long Treasuries on price weakness for a trade, betting that the Treasury bubble has more bull market moves ahead of it, long in the tooth though said bull market is. The yield spread between 10 and 30-year Treasuries is near its all-time peak, currently 120 basis points. On a ratio basis of the 30-year yield divided by the 10-year yield, that ratio of 3.80/2.60 is clearly at an all-time high except perhaps for several days last month.

The only view one has to take to be bullish on long Treasuries for a trade is that cyclical factors plus Fed actions will keep 10-year yields relatively low, and then that reversion to the mean of the 10-3o spread will occur. Of course, assumptions such as the ones I just made led Long Term Capital and many others to failure, so there are several ways for this reasoning not to hold water. Nonetheless, I like the odds here.

Copyright (C) Long Lake LLC 2010

Money-Printing Inflationists Get More Media Play, but Nassim Taleb Gets It Right

The L. A. Times purports to make a virtue out of a bad thing, repeating the big lie that "deflation" will cause people to starve themselves to death, fail to buy diapers for their babies, not send their children to college, because they expect that, perhaps, the prices of these goods and services will fall at the rate of perhaps 1% a year as in Japan. Here is a representative sample of the article titled Trashing the dollar to save the economy from today:

If prices of many imports at your local Wal-Mart or Target rise even slightly, or at least don't fall, it could be that much harder for a deflationary spiral to take hold.

We all like paying less, but the Fed is afraid that, amid tepid demand, many consumers will begin to believe that prices can only go down if they wait to buy. That could push the economy back into recession, or worse.

So the theme that the public is supposed to buy is that we all need to buy, buy, buy before prices rise.

And presumably the tooth fairy (aka the Fed) will recharge our credit cards when we buy, buy, buy what we can't collectively afford.

The mainstream generally ignores that it takes productive work and then productively-utilized savings to create true economic growth.

Nassim Taleb gets it right, as usual. Bloomberg reports in Obama Stimulus Made Economic Crisis Worse, 'Black Swan' Author Taleb Says:

U.S. President Barack Obama and his administration weakened the country’s economy by seeking to foster growth instead of paying down the federal debt, said Nassim Nicholas Taleb, author of “The Black Swan.”

“Obama did exactly the opposite of what should have been done,” Taleb said yesterday in Montreal in a speech as part of Canada’s Salon Speakers series. “He surrounded himself with people who exacerbated the problem. You have a person who has cancer and instead of removing the cancer, you give him tranquilizers. When you give tranquilizers to a cancer patient, they feel better but the cancer gets worse.”

Today, Taleb said, “total debt is higher than it was in 2008 and unemployment is worse.”

That last sentence is quite the understatement.

Taleb, no right-winger, "gets it". A free people will produce growth as their available resources and inclinations allow. If people don't want to "grow" and instead want to consolidate their situations, there's nothing wrong with that. Instead we have central planning run amok, and without the Bush/Paulson excuse of a crisis.

The surge in the stock market this month must be related both to easy money and to optimism in some quarters that Obama-ism will be officially neutered after the elections. One gets the impression that just as the Republican Congress devolved into a parody of itself in 2006, a similar thing has been happening in Washington recently. Stephen Colbert? Puh-lease!

From a markets standpoint, the low expectations that people have for either political party admits for upside surprises should one party or the other outperform these low expectations. Or perhaps the economy will turn up of its own accord.

In the meanwhile, what we know is that the President, the Fed and Congress are united in desiring a weak dollar. Unfortunately, more than half the world also wants their own currencies to be weak.

While gold looks technically extended, only now is it getting mention from within the business press that it, and only it, is the one "currency" that can only be diluted ("printed") at the rate of mine production as a % of accumulated supplies that have taken centuries to be mined and saved. It remains the view here that stocks remain in a meandering phase within a structural bear market and only appear cheap in relation to zero interest rates, and that gold remains at least a good ways from the end of its structural bull. It is Treasuries that continue to go Japanese, until one day they may quickly go Grecian and destroy wealthy as rapidly as the NASDAQ did after its implosion. Of course, it is Japan that may in one way or another go Grecian with rapidly rising rates, but since it does not have debt to foreigners, it is plausible that it will find an intra-Japanese solution to its own debt bubble.

America needs to suck it up and cope, as Charles Munger might say. Unfortunately statism has been on the march, with promises that if we just print more money and keep bailing out the banks that lent not wisely but too well, benefits will trickle out to the real economy. If the Taleb view of facing reality and dealing with it actually gains significant traction, the world will get very turbulent for a while and end up a much better place.

Copyright (C) Long Lake LLC 2010

Saturday, September 25, 2010

Stocks Increasingly Frothy

Gallup's continuous polling is showing a continuing stagnation with a downward trend in discretionary consumer spending.

In this context, the buoyancy of many consumer stocks makes little sense. There's a difference between optimism and investing based on hope against the facts. When even a semi-free market has essentially no value placed on money for as long as two years, with Treasuries paying less than one dollar in total interest per $100 invested for two full years, then the profit outlook for reinvested profits, which is what helps drive the stock market, is poor.

Ultimately what matters in investing is value. Two standard ways to decide on the value of companies ties to their earnings and to the value of their assets. The accountant and investments expert Andrew Smithers, who loudly and contemporaneously called the stock market a bubble in 2000, has just provided another quarterly update of his estimate of the fair value of the S&P 500.

Please look carefully at the linked chart he provides on his website. His earnings-based (CAPE) estimate of fair value and his asset-based estimate (q) are in close agreement that the stock market is massively overvalued. Averaging fair value provided by CAPE with that provided by q gives a fair value of about 725. This in turn means that based on Friday's closing prices, the stock market can be estimated to be about 57% overvalued.

People point to ultra-low interest rates to justify high valuations. Unfortunately, that's circular reasoning. A dead economy is required to justify near-zero short-to-intermediate interest rates. If one carefully studies the Smithers chart, one can look at the 1930s and 1940s, as well as the early 1920s, to find times when there were low to very low interest rates and very low stock prices in relation both to earnings power and assets.

Not only are American common stocks very risky, their prices are increasingly disconnected from the experience of everyone I know and every poll or survey I see. No one I know sees business doing especially well or about to do well. The idea that stock traders know better is a dubious one. It's far more likely that ultra-cheap money is fueling the bull moves in all sorts of assets. The investor's task is to separate wheat from chaff, AIG from Chubb, Honda from GM, stocks vs. Treasuries circa 2000 and circa 2007.

The situation re stocks is reminiscent of the old punch line, "Who are you going to believe, me or your lying eyes?"

Another analogy is Wile E. Coyote suspended in midair.

Yet another analogy is a chart of the Japanese stock market since 1989. It looks like ours, about a decade out of phase. It shows several massive bull moves in a 21 year structural bear market.

This blog has argued for a long time that the best places for investment money were the trend-following ones of being long Treasuries (and implicitly other high quality bonds) and gold. Both of their structural bull markets remain intact. The gold bull is mildly extended short-term and is up about 30% year over year, which is a red flag. The 30 year Treasury is also extended, but the longer duration bonds represent the only part of the Treasury curve which I believe is not yet in bubble valuation.

The chronic weakness of consumer spending continues to support the Treasury bull, and the Fed's response is to print money, which then supports the gold bull. In that context, stocks (other than precious metals stocks) are an afterthought.

Someday the trends will change. Are they changing here and now?

I doubt it.

Copyright (C) Long Lake LLC 2010

Thursday, September 23, 2010

Relating French Strikes to America

USA Today reports France paralyzed by strikes over raising retirement to 62:

Tens of thousands of French workers took to the streets Thursday for the second day of nationwide strikes this month to protest President Nicolas Sarkozy's plan to raise the retirement age to 62. Union walkouts crippled planes, trains and schools across the country. . .

Sarkozy has indicated he is willing to make marginal concessions but remains firm on the central pillar: increasing the retirement age from 60 to 62 and pushing back the age from 65 to 67 for those who want full retirement benefits. . .

This blog has in fact argued that one way to look at the U. S. un-/under-employment problem is that perhaps we work too hard and think and play too little. Just think that if the average American worker put in the same number of annual work hours as a typical French worker, and retired at the same age, there would probably be a hue and cry about a shortage of labor here. It's all relative. Neither you nor I, nor the government, nor business leaders have any idea what the "right" level of work effort or production is for the abstraction called "the economy". Only a free people operating in free markets can properly, and should, determine those things.

America's problem is tied into debt piled upon debt, which is to say promise piled upon promise. But we have lost a great deal of faith in promises, promises the past few years.

Part of the solution, as per the motto of this blog, is equity - specifically the lack of such. Equity, both as in ownership (a true ownership society, not a faux version), and as in fairness. Has all the government intervention in society created a fairer, more equal society? No. When government was tiny and on the gold standard, as in the 1880s, America was a much more equal and fast-growing country.

In France, many think it's unfair to have to work all the way to the ages America peacefully settled on for Social Security benefits years ago. And so it may be if one hates one's job and is viciously oppressed by one's boss. I doubt that's a typical situation in France. Maybe they just like to sit around cafes and sip hot and cold beverages, and people-watch. But I digress down memory lane; the first piece of art I ever bought was of a French street scene.

Back to the U. S.: There's plenty of production to sustain every American in decent conditions. The problem stems in large measure from over-financialization, which has divorced much of production from meeting the needs of real people and real markets. A simpler, more honest and more transparent financial system, with government much less involved, would be an important first step in allowing Americans to meet their own needs and serve the needs of foreign countries via exports in a more balanced manner.

In this regard we should become less like the French, no matter how good their food and drink are.

Copyright (C) Long Lake LLC 2010

Wednesday, September 22, 2010

On the Bull Markets in Precious Metals and Bonds

Gold continues to pick up mainstream believers. That this is news is testament to the non-bubbly nature of the gold bull. When contrarians break from the consensus that everyone's got to be in gold, and that break from (possible) future orthodoxy gets reported as news, then it will much closer to the time to bail out. The latest bull is Allen Sinai, the noted Fed-watcher, as reported by Bloomberg in Sinai Says Fed's Sept. 21 Statement Means `Gotta Buy Gold'. I haven't listened to the interview from which this quote is taken and do not know precisely when he turned positive on gold. I will get into my deeper point after quoting from the article:

The Federal Reserve’s statement yesterday that inflation is below levels consistent with the central bank’s mandate for price stability means it’s time to buy gold, said Allen Sinai, chief global economist at Decision Economics Inc. in New York.

“That’s code for we don’t want to go the way of Japan so we’re going to print money,” Sinai said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “You gotta buy gold when those two central banks are doing what they’re doing.”

There is a contradiction in Dr. Sinai's second paragraph. I can't tell if he is saying the Fed is being contradictory or if he is. The contradiction comes from the fact that in saying the Fed doesn't want to go Japanese, it is printing money. However, that's just what the Japanese did. Japan's adjustment, in this humble blogger's view, to a post-boom environment, was inadequate in that what mild chronic price declines have occurred should have occurred rapidly. Boom, bust. Japan may in fact have taken this route when, I believe in 1965, every bank in Japan failed. (I am writing this from memory and some details may be a bit off; please forgive me.) In the next quarter-century, Japan nearly took over the world.

I recently read a book about China's economy from a Brit who spent years there. He pointed out that the Japanese multi-nationals have a business model in which they make most of their profits from charging high prices in the home market and accepting thin margins in their export markets. Seen in this context, the modest price declines in Japan may simply be concealed price increases, with the Bank of Japan printing enough money to prevent more significant price declines to fairer price levels.

If the same thing were to happen in the U. S., where almost all consumer nondurables such as toothpaste (which is mostly water) have gross profit margins well over 90%, why would that be bad?

In any case, Dr. Sinai is positive on gold, which is really to say that he is bearish on the U. S. dollar. Is he a contrary indicator?

I am currently differentiating gold and silver in the short term. One of the fund families I invest in has a gold fund (GTU), a silver fund (SBT_U or SVRZF.PK), and a gold-silver fund (CEF). Half a year ago, the silver fund regularly sold at or below net asset value per share (NAV). The gold fund sold perhaps 4% above NAV and the gold-silver fund sold at perhaps 8% over NAV (CEF is far better known than the others and much more tradeable). Currently, there has been a sudden shift. The silver fund has soared to 8% above NAV. This is simultaneous with a soaring silver price. Thus the market is surprisingly "saying" that this fund has much better prospects after a big, quick run in the price of its only asset than when the price was much more restrained. Meanwhile, even though gold has gone from one high to another, premia for the ETFs GTU and PHYS have shrunk markedly to the 2-3% range.

Thus I conclude that the gold ETFs GTU and PHYS have a better risk-reward ratio than Silver Bullion Trust.

This further suggests to me that this is the quietest raging bull market in a major asset (gold) that I can remember. Hardly bubble behavior.

Meanwhile, the Treasury market continues in its bubble. The only segment that is merely in a bull market is the long end. The 2-year Treasury note yields less than a total of 90 cents on the hundred dollar investment total over 2 years-- under 1/2% yearly. This is "going Japanese" without the consumer price decreases.

As with Japan, the big banks remain arguably insolvent--no one is allowed to know outside of the banks themselves and the authorities based in Washington. And the spending out of Washington financed in part by new money created on the spot by the Fed as well as by the accumulated savings of the U. S. and much of the world does not appear to be having much of a multiplier effect, if any. In other words, it's not stimulating.

Just as the NASDAQ bull run that began in 1975 or 1982 (take your pick or pick another start date) kept running until massive overvaluation stopped it, the gold bull market actually has a logical story. My base case is that it also keeps running until it dies of frank overvaluation or the authorities pull a Volcker and kill it.

Treasuries, on the other hand, are into bubble phase. Where they go, when, and why, I can't even guess.

Copyright (C) Long Lake LLC 2010

Tuesday, September 21, 2010

CNBC Doesn't "Dig" Gold

An anonymous writer for CNBC shows once again today that the media don't grok gold, in The Shocking Lack Of Gold Volatility:

Orderly commodity markets are an oxymoron - watch for a catalyst to move this market much higher or, much lower.

However, gold trades more as a currency. It has almost no industrial uses, it never gets consumer, etc. So there are no supply squeezes, since current production is not needed for consumption. (This comment ignores for the nonce the potential that "gold banks" have promised much more gold than they have in the vaults and thus there could be a run on said banks.)

As a currency or more properly a money-equivalent/alternative, is gold any more volatile against the dollar than currencies issued by other sovereign nations? I think that's the correct way to look at this matter, rather than comparing gold to consumable commodities with vastly lower stock-usage ratios. It is this fact of having massive stocks relative to actual consumption that differentiates gold from perhaps every other "commodity".

(Of course, everything that one can buy with money is a commodity, such as T-bills, which have almost no volatility to the SPY fund to natural gas futures. That's not the CNBC writer's point, though.)

Given gold's structural bull market, and the current very low premia to net asset value of Canadian gold ETFs that when gold hit important intermediate highs, this CNBC article continues to discourage me as an American who truly wants to see a strong dollar that deserves its strength. It just may be that until the dollar hitches its wagon once again to gold, at which time gold would cease to be either a "commodity" or an investment and would revert to its historic role as actual money, this trend of devaluation of the dollar against gold is, from an investment standpoint, your friend.

Copyright (C) Long Lake LLC 2010

Apple of the Public's Eye

I have more than once praised AAPL and gold as investments, such as on a Sept. 1 post. An article appeared today that indicates that Apple is playing in a different league than any of its corporate competitors, tech or otherwise. Per Secrets of Apple's customer success:

For the seventh straight year, Apple has topped its competitors in the PC industry in the University of Michigan's American Customer Satisfaction Index (ACSI), achieving a score of 86 out of 100. Its Apple's highest ranking since the annual survey began in 1995. . .

The Mac maker's nine-point lead is now the largest lead any company has over its competition in any of the 45 categories that the ACSI study surveys--including home appliances, gas stations, autos, e-commerce, airlines, and more.

AAPL is one of the few high quality large cap companies selling at a clear price-earnings ratio discount to its recent and prospective growth rate. Its growth comes with no debt, no leverage. And need anyone mention that its leadership role is in an intrinsically high-growth area, that of mobile information/communications? And that increasingly its growth is ex-U. S., and therefore it is itself an anti-dollar hedge?

If you think I like the stock, with appreciation for the substantial risks it and the overall stock market have, you are correct. Apple is sui generis. For a long time, that was a bad thing. Now it's the paragon- at a "GARP" discount to the market.

Caveat non-emptor?

Copyright (C) Long Lake LLC 2010

Stock Buybacks Getting Boring

Stock Buybacks Surge as Companies Borrow for Share Repurchases (per

“It’s so cheap to do it now in the bond market: issue debt, fix their cost of capital, then shrink the number of shares outstanding,” said James Swanson, chief investment strategist at Boston-based MFS Investment Management, which oversees about $197 billion. “The markets are almost calling for them to do it.” . . .

“Levering a balance sheet is a good idea if you want to expand your company,” said Hayes Miller, the Boston-based head of asset allocation in North America at Baring Asset Management, which manages about $44 billion. “You don’t do that unless you feel secure about 2011. It may just be the corporate outlook for 2011 is better than you would gather from economic news.”

Sorry, Mr. Miller. The right way to expand your company is to abjure financial engineering. It is NOT to borrow money with which to speculate in your company's own stock. The way to expand your company is to . . . well . . . (channel John Houseman in the old ad) . . . make money the old fashioned way: earn it. Reinvest it into other profitable enterprises with return on invested capital that well exceeds what cash will earn.

Not to be tendentious, but here's the set-up. The Fed prints lots and lots of money (which I prefer to call "money"), said money exceeds what the real economy can use and thus the money-printing drives up the prices of securities, including bonds (thus lowering interest rates); companies then try to prop their stock prices (and value of their corporate options) up, leading to the above report.

What is missing is old-fashioned American dynamism.

What's present is more of the games of the past decade. Same-old, same-old.

Somehow I don't want to think that such entrepreneurs as Mr. Goodyear, Mr. Deere, Mr. Carnegie etc. who actually contributed inventions and products that helped this country become an industrial export powerhouse focused on this sort of stuff.

We need new and better products for the real world, not more and more uncreative financial products.

Copyright (C) Long Lake LLC 2010

Monday, September 20, 2010

We Are All Speculators Now

The Federal government refuses to face the fact that its accrued liabilities, including explicit and nearly-explicit promises to current future retirees and users of governmentally-sponsored medical programs. This refusal leads everyone throughout the financial spectrum to be unable to make realistic plans.

If one is poor, and is aware of the situation, one wonders how government can continue to provide whatever aid is being provided, and one is concerned about one's future income and that of one's family.

If one is in the broad middle financially, and retired, one is being hit with no increase in Social Security payment but with large percentage increases in medical costs; and one may own one's home and have suffered loss of equity (the only real "deflation" in the economy the last few years except for typical tech pricing declines).

If one is a retiree who would have expected to be comfortable at current wealth levels as recently as 3 years ago, one now has no idea how to plan for the future. How much damage inflation will do to one's assets? What will public policy be regarding Social Security and Medicare?

If one is a young-to-middle aged employed adult, one is probably confused about what to do with income. Should it be saved? Why bother saving if government is going to tax heavily the income that the savings throw off, and in any case may inflate much of it away?

If one is truly rich (whatever that threshold is), one may be worried about the peasant-pitchfork scenario, and may be moving (more, perhaps, than one has already done) assets out of the country.

The certainty that the Federal government and many important state governments have their heads in the sand about their abilities to meet their obligations is causing sufficient uncertainty amongst the populace to be providing a negative feedback into the economy.

The blogger Calculated Risk had a (now-deceased) co-blogger who focused on the about-to-pop housing bubble known as Tanta who used to joke (not such a joke): "We are all sub-prime now!"

In 1992, tired of what then seemed like large Federal deficits and what appeared to be a once-every-50-year financial disaster (the S&L fiasco), taxpayers supported a balanced budget hawk as a 3rd party candidate for President. This Perot movement ended up being reflected in an apparently virtuous financial gridlock between the parties. The Republicans wouldn't allow President Clinton his spending priorities and he in turn would not let them cut taxes.

The public "got it" in 1992 and later in the '90s when it supported and took pride in balanced Federal budgets.

People know there is no free lunch, except perhaps in the Garden of Eden where there may have been low-hanging fruit to pick. What they need is for the President, as the official elected by all the people, to level with the American people and propose a realistic plan for government to meet all its obligations. He could propose a plan that takes Federal spending to 70% of GDP, as in Norway. Or, unlikely for this President, he could propose a plan that takes said spending to 10% of GDP, such as in Hong Kong.

The public would vigorously support the goal of a plan toward financial stability based on unaggressive projections. The political process would be charged by the President with working things out, subject of course to his veto. Then the horse-trading would begin. There is a reason why Congress has an 18% approval rating, and it comes from the public's knowledge that Washington has failed for several years to rise to Job 1:
chart a course for the future of the United States. Other countries have done so. Why can't we?

The current policy is no policy at all. It involves fighting unfunded wars; promising greater unfunded medical programs even as doctors retire young due to declining reimbursements and higher costs; "stimulating" the economy with giveaways to retirees, small and large businesses, and asphalt companies; and keeping a nominally Republican Fed chairman in place with the understanding that he will accommodate all the government's funding needs that the marketplace cannot provide at a price that the government will accept.

It is literally impossible to make logical choices one can believe in when political decisions or lack of decisions are such critical factors. Even more basic decisions such as whether to buy or sell a house are now made almost regardless of fundamental supply-demand considerations. Consider that even as unemployment came in worse than predicted in last year's "stress tests" on banks, house prices came in much higher. Who could have predicted the vast array of Fed and Federal programs to keep prices higher than expected given the relatively sluggish pace of economic growth? And will such prices and governmental support continue? Gentle Ben and governmental leaders may or may not even know. Maybe some other fiscal or military crisis will supervene.

The advent of stagflation in the 1970s threw a lot of people off balance, but the economic and financial imbalances did not become bubble-like until the energy crisis of the late 1970s sent oil prices skyrocketing for the second time in the decade. This was superimposed upon the chaos of the loss of the Viet Nam War. So the public sent Mr. Nixon packing; his plan to end the war was no plan, it turned out. Mr. Carter similarly got the boot after the "misery index" he used against Gerald Ford turned out to be much worse in 1979-80 than during Ford's tenure.

Matters turned when Messrs. Volcker (a Democrat) and Reagan laid out a coherent plan. It just may be that the fact that there was a plan that each man stuck with as long as he could was as important as the specifics of the plans. The political process put each man in place with his plans, thus the public explicitly and/or implicitly bought in, and individuals and businesses could make plans under this new set of policies.

Sorry, but health insurance reform to start after the next Presidential election, and another deficit commission due to report after the midterm elections is not a plan.

Mr. Obama started his term with a reservoir of very good will and fervent hopes, just as Jimmy Carter did. Neither one delivered what the public hoped when they elected them. Mr. Obama has time. He's wasted a year and a half from an economic perspective. Until he and Congress agree on a realistic plan that shows that Leviathan has developed strong self-assessment skills, we all all be fumbling around in the dark in America.

Exploration of new frontiers has its benefits. But nothing beats travel plans based on a good map. The country needs a good map. Blaming the prior guy does not provide that map.

Meanwhile the financial markets continue with two trends intact: falling Treasury yields and rising precious metals (and other commodity) prices. As with NASDAQ 1990s and housing 2000s, financial bodies in motion can stay in motion longer than reality-based bears can stay solvent. The third and most recent trend is truly easy money. Forget 1%- that is so last decade. Money should be free in the land of the free, right?

Well, sort of. If you're a member of Big Finance, yes, not only should it be free, but you should get to make money on the very money you put in reserve against losses. Huh?

The leaders of the United States of America are deliberately turning the country into a land where everybody has to guess as to what plan, or non-plan, they will come up with next. Thus we cannot plan our own futures.

We are all speculators now.

For the perma-bulls amongst us: precisely why will this end well before it gets worse?

Copyright (C) Long Lake LLC 2010

Is Berkshire's Charles Munger Still Making Sense? is reporting some surprising statements from Berkshire Hathaway's long-time vice chairman, Charlie Munger, in Munger Says `Thank God' U.S. Opted for Bailouts Over Handouts.

From the article:

“You should thank God” for bank bailouts, Munger said in a discussion at the University of Michigan on Sept. 14, according to a video posted on the Internet. “Now, if you talk about bailouts for everybody else, there comes a place where if you just start bailing out all the individuals instead of telling them to adapt, the culture dies.”

Bank rescues allowed the U.S. to avoid what could have been an “awful” downturn and will help the country as it deals with the housing slump, Munger, 86, said. He used the example of post-World War I Germany to explain how the bailouts under Presidents George W. Bush and Barack Obama were “absolutely required to save your civilization.”
. . .

“There’s danger in just shoveling out money to people who say, ‘My life is a little harder than it used to be,’” Munger said at the event, which was moderated by CNBC’s Becky Quick. “At a certain place you’ve got to say to the people, ‘Suck it in and cope, buddy. Suck it in and cope.’”

There is much with which to disagree in Mr. Munger's sentiments. For one, it would seem that the U. S. in fact had an "awful" downturn despite the bailouts. For another, it is difficult to see how a managed bankruptcy of Citigroup or Bank of America (or both) would have destroyed civilization as we know it. For a third counterexample, shouldn't the corporations have adapted, such as by wiping out the common shareholders as appropriate and having the bondholders convert their bonds into equity?

Come to think of it, didn't GM do just that? And somehow civilization survived?

A miracle!

Once again, let us review matters. The bailouts were bailouts of bank holding company bondholders, as well as of senior bondholders of Fannie and Freddie (as well as of mortgage-related securities). They were bailouts of counterparties of AIG. They were in many cases bailouts of common shareholders of numerous companies large and small. The bailouts have sustained all sorts of companies and individuals associated with them. The companies that took the lead in the fraud and the bubble, and their bondholders, received aid. Mr. Munger approves of such aid. Who paid for this aid? Why, it was we the people. What does he think of we the people?

In contrast, he appears to take a hardhearted viewpoint to individuals who may have believed in the media's touting of housing as a great, no-lose investment. But it's individuals and not corporations that have hunger, feel the sting of adverse weather when sleeping outdoors rather than in a home, and that ultimately built this country.

Munger applauds the bailouts of owners of stocks, bonds and mortgages who invested unwisely or unluckily. The fate of the little guy who was simply caught up in a bubble of historic proportions and that had at its root extensive mortgage fraud that the FBI stopped investigating after the 9/11 attacks changed priorities troubles him little if at all. Even though all the little guys collectively paid for the bailouts.

It's one thing to cultivate an image as a curmudgeon. That's Munger. It's another to equate the bailouts that so infuriated a nation with saving civilization. Charles Munger is 86 years old. It is certain that a brain scan would reveal that his brain is shrunken. He's "talked his book" one time too many and in an unduly offensive manner, in my humble opinion.

Time for him to suck it in and step down.

Copyright (C) Long Lake LLC 2010

Thursday, September 16, 2010

The Peso of the North

Look who's got the strong currencies, as reported by Reuters:

BOGOTA, Sept 15 (Reuters) - Colombia's central bank on Wednesday started purchasing what it said would be at least $20 million daily for the next four months to help ease the rise of its currency, becoming the latest Latin American economy to intervene in its market.

The move left the door open for more measures to curb the peso's COP=RR appreciation and followed intervention by Brazil to ease the real's climb and Peru's buying dollars to curb the sol.

The article is worth a read in its brief entirety.

Yours truly continues to be at least as comfortable with Brazilian real-denominated interest bearings debt instruments as with any multinational stock. The vehicle has the NYSE symbol of BZF, which ties to the short-term money market rate. Not nearly as easy to purchase are real-denominated Brazilian government bonds. These have a different risk-reward calculus from BZF. You may wish to consult a financial adviser and/or do some independent research to see if either of these vehicles makes sense for you.

In any case, the worm has turned. The U. S. dollar is the weak currency. Exchange controls may be more likely in the U. S. than in Brazil.

What is the Spanish word for schadenfreude?

And the Portuguese word for it as well . . .

There just may some of that emotion going on in central banks south of the equator in the Western hemisphere.

Copyright (C) Long Lake LLC 2010

Wednesday, September 15, 2010

Irrational Optimism about Housing among Experts; Continued Consumer Pessimism

ABC News reports Economic Pessimism at a Yearlong High:

For the third straight month significantly more Americans say the economy is getting worse, 38 percent, than say it’s getting better, 22 percent. The rest, 37 percent, say it’s staying the same, which for nearly all of them means bad.

The gap between pessimists and optimists has grown from 6 points in July and 11 points in August to 16 points now, its biggest since September 2009. Economic optimism is at its low going even further back, to March 2009.

Stock prices are of course much higher than in March 2009. Contrarians who want to "buy" pessimism should realize that with mutual fund cash at or near a modern record low as a % of assets under management, facts do not support that idea that the stock market is especially either oversold.

There is however some optimism, and some of it may be misplaced.

Some of the optimists who should be realists are real estate experts who should know better. reports U.S. Home Prices Face Three-Year Drop as Supply Gains and describes a hold-on-and-wait viewpoint from two interesting players:

Brandi Miner, director of marketing for the Georgia Association of Realtors, is holding back on selling her one- bedroom condominium in Atlanta’s Buckhead district because she has an underwater mortgage. She paid $155,000 for the property in 2005.

“I’m stuck,” Miner said. “I thought it was a stepping stone to a house.”

Miner pays about $1,100 a month for her mortgage plus $225 in condo dues, a higher price than she would spend for a three- bedroom house in a good Atlanta-area neighborhood at today’s prices, she said. Selling now would cost her $10,000 to $15,000, Miner estimated.

“I’m not $200,000 in the hole, thank God,” she said. “But the quarter of the country that’s underwater -- that’s me.”

Ms. Miner would not "cost" her a specific amount if she sold now, other than closing and moving costs. Her home has lost value. Another person who appears to have an optimistic point of view about prices bouncing back is even more surprising:

The slide in values and record-low interest rates may offer some bargains for property hunters. Prices have returned to historically affordable levels, said Karl Case, professor emeritus of economics at Wellesley College in Wellesley, Massachusetts, and co-creator of the S&P/Case-Shiller index. He estimates a bottom for prices in six months. . .

Case is an example of a homeowner waiting to sell because of low demand. He’s seeking to sell the A-frame on 15 acres near Cooperstown, New York, that he bought for $190,000 in 2005.

“I want to keep it if I can’t get what I want,” he said. “It’s a terrific little getaway and I’m not going to give it away.”

In the meantime, all the Fed and Federal programs (including bank forbearance) have kept housing prices above their equilibrium price. Waiting for any specific property to come back to the price you like is quite a gamble. It's like buying Oracle at 30 but it's now 2002, not 1999 and it's and 10, or 20, or whatever. It may never come back.

I am looking for housing to play the role that tech played for years following the tech bust: a deflationary or relatively disinflationary force. I also expect short-term interest rates to stay below the rate of consumer price rises for some time. This could be the 1940s and early 1950s again, with very low interest rates due both to public fear and active purchase of Treasury debt by the Fed coupled with high rate of price rises; let us hope no worse war comes along.

Under this scenario, classic inflation hedges beat general common stocks, and Treasuries are trading vehicles; and cash is trash until and unless the U. S. actually enters a sustained period of generalized price decreases.

Copyright (C) Long Lake LLC 2010

Tuesday, September 14, 2010

Mr. Softee Goes for the Big Blue Pill

The beginning of the end of Microsoft as an interesting investment has occurred. reports Microsoft Said to Plan Debt Sale, May Boost Dividend.

The opening paragraph tells us you need to know:

Microsoft Corp. is planning to sell debt this year to pay for dividends and share repurchases because too much of its cash is held overseas, according to a person familiar with the matter.

Mr. Softee (the standard Street moniker for MSFT) is going the route of the federal government and before it IBM, the stock of which has also been range-bound for, let us see-- forever! (Or so it seems.) For no good reason other than to appease constituencies that are non-core, meaning constituencies that are NOT their customers, it has now committed to the route of pumping the stock price since AAPL/GOOG and others have defeated it in the game of corporate "Go" and blocked all its growth paths. It's all over now, baby Big Blue, but the Brownian stock motion.

Copyright (C) Long Lake LLC 2010

Gold's New High and Monetization of the Debt

Here is a suggestion about why gold is at a new record high today, up about 2% in one day. It has to do with the following two "front page" article summaries from Eurointelligence (link provided, but free subscription may be required):


So much for phasing out the bond purchasing programme. The latest weekly ECB data suggest that the ECB bought €237m worth sovereign bonds last week, the highest since the middle of August, according to the FT. Still small in absolute size, the paper notes, it is a sign of continuing problems in eurozone bond markets. Irish traders last week reported that the ECB had been in the market to support Irish bonds, whose yield spread to German bunds rose to new record levels. The article suggested that the ECB was also buying Greek and Portuguese bonds.

About that ECB’s exit strategy

Ralph Atkins and David Oakley have an excellent analysis in the FT about the change in the ECB’s exit strategy. While a year ago it was the conventional wisdom inside the ECB that the banking support policy would have to be phased out, and only then could interest rates rise. That is no longer so. As banks have become dependent on generous ECB liquidity support, it is possible that the monetary tightening occurs while the liquidity policies are still in place.

The eurozone, Japan, the U. S.: the three most important currency blocs around, all have central banks busily monetizing government debt and/or central governments engaged in massive deficit spending upon a base of huge accumulated deficits. Gold cannot be printed by a central bank, and I believe that its seemingly inexorable price rise since 9/11/01 relates to the permissive monetary policies that followed in the wake of the twin wars on the post-bubble economy (fighting "deflation") and on "terror".

Unfortunately, there is little evidence that officialdom is changing its pro-money-printing views yet. Witness Dana Milbank's piece today in the WaPo, titled John Maynard Keynes, the GOP's latest whipping boy. I have no time to deconstruct what is in large part a political rather than economic article, but the article tries to make the case that Keynes remains an economic god, or perhaps the God of economists. One brief quote in the article from a Republican economist shows Mr. Milbank's argument:

"If you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics."

In other words, the point is, we are all Keynesians now. Resistance is futile. If you are not a member of the Keynesian Borg, you are just out of it intellectually.

Hmmm . . .

In my view, the idea that Wise Guys in Washington know better than individuals, businesses, non-profits etc. what level of consumption vs. saving is optimal for the inanimate abstraction called "the economy" is wrong in theory and increasingly is proving wrong in practice.

Increasingly, Keynesianism is the ancien regime, out of touch with today's realities. At the close of Milbank's piece, he talks about the "misery" people of today. Perhaps he thinks he's back in France of the 1780's, with most people living in hovels (at best) and Jean Valjeans stealing bread to support their families. Les Mis and all that. Perhaps he more mildly believes this is America of the 1930s, where a brilliant politician could credibly claim to see one-third of a country ill-fed/housed/clothed. Mr. Milbank may not have noticed that today, in contrast, we see one-third of the country obese and one-third in houses too large and fancy for them to afford.

As Shakespeare might have said, Keynesian has succeeded not wisely but too well.

Governments all over the world are dealing with a modern credit collapse of a scale that rivals that of the 1930s; and as in the 1930s, different countries are dealing with the issue differently.

The new highs in gold are evidence that market participants continue to view these efforts skeptically. The gold rally (dollar collapse) of the 1970s did not end until Paul Volcker took decisive action to make dollar-denominated investments attractive. Why should matters be different this time?

Copyright (C) Long Lake LLC 2010

Monday, September 13, 2010

Economic Reporting Sets New Low; Get Next Year's News Now

U.S. Accelerates in 2011 as Demise of Consumer Is Exaggerated

The above is the title of what is currently the lead article on (about midnight Eastern time).

I had to get this post up before the headline changes. This is what passes for news these days in the mainstream media. This article is dated September 13, but the year is 2010. This is "prequel" reporting. The Internet Age has made a further advance, it would appear.

Here is further nonsense from the article's introductory paragraphs:

U.S. Accelerates in 2011 as Demise of Consumer Is Exaggerated
By Rich Miller

Sept. 13 (Bloomberg) -- Reports of the demise of the U.S. consumer have been exaggerated.

Households are reducing their debts and building savings faster than he anticipated, said Richard Berner, co-head of global economics for Morgan Stanley in New York, giving them more room to spend in the future.

In conjunction with the intro paragraphs, the message appears to be that those wily and strong-willed American consumers are restricting their consumption this year so they can go whole hog next year. Sort of like a sine wave.

I don't think so. Does the obesity epidemic suggest that the American consumer can cut back at will unless absolutely forced to do so?

The article gets "better". Robert Doll - a man for whom "perma-bull" is almost too weak a term - makes an entrance early on in the article and is quoted as saying:

“The U.S. consumer is not dead.”

Thanks for that insight, Bob!

Regular readers of this blog need not read the entire article. Clearly the title shows that it is another puff piece, just a more idiotic one than usual. Even Michael Bloomberg has no idea what will happen with the economy next year.

When the Fed feels forced to monetize massive amounts of government debt, and said government is keeping consumer spending going with such measures as having over 40 million Americans receive food stamps and over 50 million Americans receive Medicaid, the economic times are out of joint.

It's hard enough to figure out what happened last year. Reporting this year on hoped-for good news from next year is bad "news".

Copyright (C) Long Lake LLC 2010

PHYS Oversold?

PHYS is the symbol for a Canadian gold exchange-traded fund (ETF) with about $700 MM in gold assets (U. S. dollars). It came public this year as a new fund and has typically traded at about a 12% premium to net asset value (NAV). This premium reflects confidence that all the gold is physical, with no use of derivatives; high liquidity for trading purposes; claimed ability to be taxed at a capital gains rate rather than as a commodity sale; and the ability to withdraw the equivalent of a large bar (worth hundreds of thousands of dollars) as a form of redemption of one's shares in the ETF. (Please note that the last feature is a negative for small investors due to adverse tax consequences to existing shareholders should a large shareholder actually redeem. Currently I do not think there is enough appreciation in gold's price to make this feature important.)

In any case, the more typical 12% premium to NAV has recently and fairly suddenly dropped to 6.4%. Click HERE to view the webpage that shows data on how infrequently this ETF has traded under a 7% premium to NAV.

Having sold out of PHYS recently at a double-digit premium to NAV, I am long it again as of today. It's easy to see that at some point within the next 12 months gold being 7% higher simultaneous with this ETF regaining a 10% premium to NAV; the potential 7% price gain of gold (the metal) plus a 3-4% proposed gain in the premium to NAV would imply a 10-11% total return (minus the small expenses of running the fund and minus brokerage commissions; currently the bid-asked spread is one to two pennies, so that's irrelevant).

I continue to see a financial pendulum that may be swinging to restore gold's importance or even primacy in international and possibly national finance, with a higher real value relative to Federal Reserve notes than it now has.

Copyright (C) Long Lake LLC 2010

Sunday, September 12, 2010

Protecting Capital from Fed's Activities, Part 2: Focus on Silver

In the initial part of this series, I focused on gold as a way to protect capital from loss of purchasing power due to Federal Reserve policies, but also discussed silver (which has risen about 4% in price since then) and certain foreign currencies as ways for Americans to potentially protect their wealth by ownership of these assets.

In this post, the main topic will be silver. Here's some further background discussion before getting to silver specifically.

I am presenting herein my opinions and what I believe to be facts, but the facts have not been fact-checked and there may be some inadvertent errors, including typos; apologies if such proves to be the case.

The Federal Reserve has taken and continues to take extensive actions to keep short-term interest rates below the rate of general price rises in the broad economy. It has done this in concert with the policies of the current and immediately prior administrations.

I believe that Fed-induced monetary inflation is likely to show itself via further general price increases, which will tend to accelerate under steady-state economic conditions.

The bogeyman of "deflation" has been scaring people into buying bonds after a 29 year bond bull market, and unlike Japan, where zero interest rates have taken hold with clear stability or even mild decline in consumer prices and therefore have not been adverse to savers, the same policy in the U. S. continues in force despite positive consumer price rises which are greater than the near-zero Fed interest rate policy.

The Fed has been deliberately costing savers money in real terms. It has been doing this while protecting stockholders and bondholders of financial companies.

I object to this policy (these policies) and believe that as in World War II, the full force of the government and the mainstream media has been marshalled to sell people debt instruments that the government (through a compliant central bank) intends in good measure to inflate away rather than repay in full and in good faith.

It is, of course, possible, that the U. S. will have a Japanese outcome, with less and less price increases and out-and-out deflation, with resultant continuation of the bull market in bonds. However, as I understand it, Japanese investors waited till there was actual price declines in their cost of living before driving the yield of the 10-year government bond to or near 1%.

U. S. policy has been actually been quite inflationary from 1933 onward, with the exceptions of brief periods of Fed tightening; a good part of the 1950s, when there was both peace and a president who actually believed in balanced budgets; and with the partial exception of the early Volcker years as Fed head. Further, many people also don't realize how major the Iraq-Afghan/AfPak Wars are from a direct budgetary standpoint (even ignoring the indirect costs), and as with the Viet Nam War, Congress has made no attempt to fund the war by raising additional revenues. The Viet Nam War provided the final nail in the coffin of a gold-backed dollar (see Nixon, 1971 - closing the "gold window" for a unique take and HERE for a more thorough, standard take) and it helped lead to massive inflation. The Fed had begun accommodating first President Kennedy and then President Johnson monetarily ("stimulus") before prices were noticed to rise throughout the broad economy.

I think something similar is happening now.

President Johnson pursued a guns and butter approach, but it was small beer compared to current and recent policy. When LBJ escalated in Viet Nam, there was no Medicare and no Medicaid, and Social Security took in much more in taxes than it expended. Thus the money-printing has crossed the previously unthinkable threshold of direct Fed purchase of Federal government debt, something that was only supposed to happen "elsewhere". Not in America. But it has now happened twice. 2009; 2010. Sic transit gloria.

In that context, silver may be both a sensible addition to gold and foreign currencies for the part of a financial portfolio that attempts to preserve capital in real terms. This article does not represent investment advice. It also does not look at silver as "money", in contrast to the official monetary metal, gold.

The nearby chart (click on it to enlarge) shows silver prices in both real terms and in relation to gold over the centuries, beginning with 1344. Not shown are reasons why silver became less useful. These include the mass production of stainless steel "silverware" and, more recently, the advent of digital photography.

This chart demonstrates that silver's price has lost ground in real terms over the centuries. Silver is and has been a speculative investment in a way that gold is not. However, "real" returns are a difficult metric to match when the Fed is inflating the value of "money" away at a rapid rate.

(Click HERE to link to the site that gets one to this chart and to many others, including a similar chart for gold.)

It is possible that over the intermediate term, an asset such as silver may simultaneously fail to keep up with the rate of general price increases yet rise in nominal terms more than the interest rate available to an individual with capital to loan or invest. Such a happenstance would nonetheless make it a good investment relative to most alternatives.

Whether one takes the September 8 price at which I mentioned silver as a hedge against dollar weakness or whether one takes the most recent price (Friday, Sept. 17), silver is, I believe, well-positioned to rise in fiat dollar terms faster than the general rate of price increases people will face in America over the next year or two. Here are some of the reasons I feel this way.

1. Silver has non-mainstream committed sponsorship that has gotten the price trend right. Please consider an on-line article on silver written by Adam Hamilton in 2006 (who currently writes at Please consider reading it in its entirety. Not only do these comments from 4 years ago look wise today, his bullish commentary over the more recent past has been impressive as well (full disclosure: we are totally unaffiliated).

Silver has some highly committed partisans. Some of them argue passionately that there is a cartel that has been manipulating the price of silver down, and that there are massive "short" positions that would cause a tremendous rise in silver's price should these positions have to be covered.

I have no opinion on this controversy. It is, however, helpful to less committed silver bulls to have owners of silver who are not looking simply for another 5-20% appreciation (for example) before they sell. There may be many holders of silver who are looking for much, much higher prices. Thus the more modest aspirations I have for silver prices may allow me to sell with less competition from other sellers.

2. Silver has interesting fundamentals from a supply and demand perspective (click HERE for the Silver Institute's analysis, and scout the entire website if you are interested in all sorts of facts about silver). Above-ground silver stocks are historically low, and silver is primarily produced by miners as a by-product from copper and other mining. Therefore, the pace of silver production does not vary much with the ups and downs of silver's market price. Silver production is relatively price-inelastic.

3. A specific aspect of the supply-demand aspect of silver investing is, in a circular fashion, the investment aspect itself. Not to be mysterious; this refers to the growth of exchange-traded funds (ETFs) that own silver bullion. It was only in 2006 that the first silver ETF, symbol SLV, was created. Then came SIVR. Now there is also Silver Bullion Trust (mostly traded on the Toronto Stock Exchange). Eric Sprott's folks, who came out this year with the hugely successful "PHYS" gold ETF, are in registration with another silver ETF that may come public in a few months.

The more silver ETFs there are, the more silver they will buy. Of the "flavors" of ETFs, Silver Bullion Trust and the upcoming Sprott silver ETF are different from SLV and SIVR, and unlike them, they permanently take silver out of the supply chain and hold it indefinitely, regardless of the price of silver. So the growth of those sorts of funds is more bullish for the supply side of the supply-demand ratio than is the case for SLV and SIVR, which sell silver into the marketplace when demand wanes and thus can exacerbate a bear market in silver (having helped cause the bull market by first having purchased the silver).

A further important factor is that unlike gold, which is very valuable per ounce and is also denser than silver, it is not easy to store significant investment quantities of silver in one's personal possession. It is certainly do-able, depending on one's storage capacity, but those practical difficulties have seriously inhibited silver bulls from taking personal possession of investment silver. This is in sharp contrast to gold. Silver ETFs mitigate that problem and their growth may be even more bullish for silver's price than gold ETF's have been for the price of gold.

4. Silver has been money on and off throughout history and could be money again. In India and many other places, silver is viewed as a permanent store of wealth. It has taken the United States a long time to begin to lose its faith in paper money; in India, the public never trusted paper currency. Thus silver trades as a potential monetary metal in the minds of most of its purchasers in a way that the vastly more valuable platinum or palladium do not. Should the mass media start pushing inflation and not deflation as the problem, silver will come onto the "buy" list of John/Jane Q. Public as a gold substitute, I believe.

5. Silver has important physical-chemical activities that make it medically and industrially useful, and its use in such fields as medicine will continue whether it sells for $10/ounce or $50/ounce.

6. If you are my age, you may remember when the Hunt brothers tried to corner the silver market and briefly pushed the price to $50/ounce or so in early 1980. You also may remember that the metal bounced back to almost $25 in September 1980, related to the onset of the Iran-Iraq war. So in other words, silver at $24/ounce would merely put it below where it was 30 years ago in nominal terms, without inflation adjustment (of course, $25 was very high; silver crashed to near $4/ounce in 2001). Any sophisticated bullish investor who looks, as he or she should, at a very long-term price chart on silver, will be comforted to see that a purchase around now is unthreatening from a long-term perspective. Merely to hit the September 1980 price high, which was free of the manipulation the Hunt Brothers engaged in, would in inflation-adjusted dollars put the price at least at $75/ounce. That's about a quadruple in price. It would take a tax-free 4% zero coupon bond well over 30 years to quadruple in total return. So the truly long-term investor in silver can wait a long, long time for it to outperform bonds while providing portfolio diversification.

From a trading perspective, the proprietary technical indicators I pay attention to are, in general, positive. Silver appears to be in a high-level consolidation below the 2008 high. I am looking to buy more on a dip; my assessment is that the chart suggests enough "potential energy" for silver to ascend well above its current price within the next year.

What follows is a history of silver's recent price action, followed by a detailed discussion of ways to invest in silver.

Silver hit a post-1980 peak in March 2008 at slightly above the current price; but that followed a massive move from a low of $11.67/ounce on 8/21/07 to a high of $20.92 on 3/17/08. That seven-month move saw silver's price almost double. It occurred during the last gasp of the financial bubble but at a time when the lagging effects of several years of Fed tightening (or, diminishing looseness, if you prefer) were slowing the economy. That surge was "too far, too fast". (Data from

The current move in silver has also lasted 7 months. It began with a Feb. 8 low of $15.14. The tightness of this move and the length of time silver has spent in the high teens without triggering profit-taking impresses me.

One year ago, gold also quietly moved up on its 2008 price high, consolidated at a high level below that high, and then burst through it, so far never to revisit that 2008 high. Silver may strangely be mimicking gold one year out of phase.

Income-oriented investors should be aware that both the SLV and SIVR silver ETFs allow shareholders to sell covered calls against their shares. SLV options have far more liquidity than do those of SIVR. Many people may find a "buy-write" strategy attractive. A further discussion of options is beyond the scope of this post.

Readers interested in exploring investing in SLV, by far the most popular way to invest in silver in the United States, may want to read the prospectus. Questions have been raised about SLV's use of derivatives, sub-custodians and other aspects of its structure and operations. I look at SLV as a trading vehicle and a vehicle that allows me to perform options strategies. My silver ETF of choice for longer-term investing is Silver Bullion Trust, which is a Canadian operation and which stores its silver in Canada. It trades on the Toronto stock exchange as SBT.U (SBT_U on some web trading systems) and has a relatively illiquid U. S. "pink sheets" listing with the symbol SVRZF. SBT is run by the same Spicer family that started the Central Fund of Canada (CEF) years ago. CEF is, by the way, the one investment I know that allows one to simultaneously own both gold and silver. CEF is highly liquid and fulfills an interesting market niche by being a combined gold and silver fund.

I have only bought shares in these sorts of ETFs when their premium to net asset value (NAV) has dropped to average or preferably below average. Each ETF tends to have its own premium (or discount) to NAV.

The above discussion is, again, not any sort of recommendation for anyone to purchase any security or sell any option, but perhaps it may stimulate thinking and research.

I have not mentioned stocks of silver producers. I do own stocks of gold miners but not of companies that primarily produce silver. The price of silver is volatile enough for me.

Right now I believe that the intermediate trend for silver as being up, so I'm looking for that volatility to work in favor of the owners of silver.

Regular readers of my blog know that I believe that the American investment world has become "over-financialized", as described by PIMCO's Bill Gross in his November 2009 note. This means that it is my opinion that all financial investments involve trying to choose from the best of an overvalued lot, so that I am not enthusiastic about any choices.

In owning silver, I am choosing something at the other end of the financial spectrum from most investment alternatives that mainstream financial advisers recommend to most people all (or, almost all) of the time. As does gold, investment silver just sits there. There is no promise to repay principal as with a debt instrument. There is no operational risk. In fact, it costs money to store it in the ETF. Most financial advisers will, to my knowledge, point out how speculative precious metals investing is. And of course they have a point. However . . .

I think that it now is the case that lending at today's interest rates is a speculative activity, especially to the U. S. Treasury given the rampant monetary inflation that has already occurred but has simply not shown up in consumer prices (yet).

Not to confuse anyone about bonds: I have written a few weeks ago that I believe that Treasuries have very recently crossed the line into bubble territory. Actually I sold stocks and bought some Treasuries just a couple of trading days ago on the recent yield bounceback associated with the stock rally, because I wanted to speculate that the Treasury bubble will continue. In fact, it is my current assessment that the Treasury bubble is not bursting that leads me to expect yet more inappropriate money-printing by the Fed, and that when that ceases, the financial community will find ways to keep yields low. All of which will tend to be bullish for precious metals as I see it today. (What happens with yields on Treasuries is too political to do other than speculate on.)

As a loyal American, I hope I am all wrong. I hope the Fed is making brilliant, responsible choices. I hope there is a clear plan somewhere in Washington to deal with all the Federal budgetary issues so that no further pressure is placed on the Fed to buy government debt with newly-created "money". I want living standards to rise in a non-inflationary manner. Hope is not an investment strategy, though.

I believe, though, that's its closer to the truth to say that the American monetary fish is rotting from the head down. Simon Johnson's The Quiet Coup provides an expert's view on this topic. I fear that the risks to the dollar are to the downside. I believe that's what Barack Obama, all the Congressional leaders of the Remocrat/Depublican party, and Ben Bernanke all want. And as a loyal American, I want to invest along with their desires.

Since all currencies are now fiat, precious metals help me do so.

In the final part of this series, I will discuss foreign currencies that Americans can invest in both for higher current income than U. S. Treasuries provide and that offer possible appreciation against the dollar.

Copyright (C) Long Lake LLC 2010