Saturday, October 30, 2010
The first report provides sort-of-good "news" on the economy. It's not dead!
Even better, it's not dying!
The "news" comes in the form of an "op-ed" because it is basically just opinion. The Economic Cycle Research Institute (ECRI) has discerned timely good news for Democrats; from CNN:
The good news is that the much-feared double-dip recession is not going to happen.
That is the message from leading business cycle indicators, which are unmistakably veering away from the recession track, following the patterns seen in post-World War II slowdowns that didn’t lead to recession.
What business imperative of its own does ECRI have by announcing this prediction now, thus helping the "ins" rather than the "outs"?
After all, this "information" was provided for free. Voters have no right to timely release of such sensitive information. One would expect that ECRI's paying customers should have access promptly to new research such as the above, but ordinary investors/voters?
Since this is opinion and not fact, color me skeptical about the timing of this release.
It would seem that there can only be one good reason why ECRI released this information now at just the right time, just before the weekend before the election. Not that I'm Sherlock Holmes or even Doctor Watson, but when the impossible is eliminated, what remains, however unlikely, must be the answer. ECRI could have waited for Election Day, if it wanted to take an anti-Fed stand before the Fed meeting, or it could have waited till the Fed actually acted, which might be prudent should the Fed surprise ECRI by being restrained.
One reads the entire "op-ed" by the ECRI leadership and finds harsh criticism of the Fed-- though no recession is imminent--but no criticism of either President Obama or Congress. There is some vague criticism of "politicians" who are fighting each other, but that is politically neutral.
But of course, as we shall see, the Fed is merely doing what all captive central banks due nowadays, which is to monetize the debt of the central government to whatever extent is needed. Yet as we shall see below, the ECRI may just be another pro-deficit spending organization with good forecasting skills in what has become a semi-centrally planned economy.
Let's go back in time with ECRI.
Here is a link to Dr. Achuthan on Jan. 20 on a Reuters video just after the inauguration:
(He says that Mr. Obama has to move quickly to get the stimulus program enacted. ECRI thinks the "stimulus" is very important.)
Yet a mere 3 months later, after weeks of increasing optimism in its news releases, ECRI said:
The longest U.S. recession in more than a half-century will probably end before the summer is out, according to the Economic Cycle Research Institute.
The group, whose leading indicators have a solid track record of predicting turns in the business cycle, said on Thursday enough of its key gauges have turned upward to indicate with certainty that a recovery is coming.
"The end of this recession is finally in sight," ECRI said in a statement.
In fact, the ECRI had concluded as much in March . (See slides 17-18.)
Furthermore, while the document may have been dropped from its website, I recall that in spring 2009, ECRI revealed that its (non-publicly reported) Long Leading Indicators, which lead the Weekly Leading Index by months, was turning up either in or about January, raising questions about ECRI's initial support for the stimulus bill.
Where was ECRI in calling for the cancellation of the "stimulus" that it found so important in January, given that it was certain by April of a self-sustaining business recovery?
Obviously very little of ARRA had been spent when confirmation that a normal business cycle upturn was going to happen anyway. There was no Great Depression no way, no-how by January 20. That much ECRI knew for certain. No 2010-legislated stimulus was ever needed to ensure a "recovery", and ECRI knew it.
So I conclude they are just "Keynesians" (i.e. they like money printing) at ECRI and therefore despite being good at what they do, they are working from a faulty ideological framework which will introduce errors in their thinking.
I reject the concept that printing money stimulates anything useful, but I believe that it does transfer wealth from society at large to those who gain transactional income from said money-printing. Thus the financial class writ large has a thrill running up its leg from the immense sea of liquidity provided by the combination of Obama and Fed policies. It's go-go time again in the markets because of the money that has come into the system the past two years.
Meanwhile, Bloomberg.com is also doing its part to cheerlead as best it can to keep the good times rolling for its financial constituents. On its website yesterday, along with a picture of President Obama looking serious, it is running Poll Shows Voters Don’t Know GDP Grew With Tax Cuts.
Bloomberg & Co. should be doing well, and perhaps the Mayor and his company just can't understand that the people are not properly grateful for what the government has done for them, saying in the article:
The Obama administration cut taxes for middle-class Americans, expects to make a profit on the hundreds of billions of dollars spent to rescue Wall Street banks and has overseen an economy that has grown for the past five quarters.
Most voters don’t believe it.
I do believe it but don't think the poll is addressing the main points.
In keeping with John Kerry's recent point that voters are too stupid to deserve to have the right to vote when they are going against his party because they don't understand that the Dems are looking out for them (please excuse the liberties taken with Sen. Kerry's precise quote), we find Bloomberg reporting the following drivel in the same article:
A Bloomberg National Poll conducted Oct. 24-26 finds that by a two-to-one margin, likely voters in the Nov. 2 midterm elections think taxes have gone up, the economy has shrunk, and the billions lent to banks as part of the Troubled Asset Relief Program won’t be recovered.
“The public view of the economy is at odds with the facts, and the blame has to go to the Democrats,” said J. Ann Selzer, president of Selzer & Co., a Des Moines, Iowa-based firm that conducted the nationwide survey. “It does not matter much if you make change, if you do not communicate change.
No, the blame has to go to reality. It's not a failure to communicate. It's a failure to succeed. Where are the geniuses at Bloomberg to point out in this article that the U. S. has probably had the weakest recovery from a major economic downturn in its entire history and that untold millions of jobs have been vaporized (thus keeping the "rate" of unemployment much less threatening than the decline in the employment rate)? Where is the mention that three years or so into the beginning of the euphemistically-called Great Recession, organic per capita income adjusted for inflation is well below that seen three years ago? Isn't that more newsworthy than ECRI's "good news" that there will be no imminent new recession (and why should there be when the depression continues?)? And isn't the failure of Team Obama to "stimulate" the economy the real pre-election news? What about the recent statement by the President that hey, don't blame him, he found out too late that "shovel-ready" projects don't really exist? (And why are they fictions? Might it just be that there are immense bureaucratic blockages to getting anything done? Might not statism be to blame? What's the big deal about repaving a road?)
The Bloomberg article points out that voters (understandably) have trouble distinguishing the TARP accounting from the other bailouts. OK. But so what? Who cares if TARP per se can be given a nominal accounting profit (though far less than Walter Bagehot prescribed for the lender of last resort in a crisis) if the net effect of all the Federal and Fed bailouts, including ZIRP, were . . . bailouts? Handouts to the rich, but only the favored rich, not the upper-middle class "rich". Only the truly rich.
We'll move to the meat of the discussion:
The perceptions of voters about the performance of the economy are also at odds with official data. The recession that began in December 2007 officially ended in June 2009, making the 18-month stretch the longest since the Great Depression. . .
(And we all know that "official data" always reflects the real world experience of real people.)
The impressions of these voters also are dissonant with other signs of economic improvement.
A year and a half after U.S. stocks hit their post- financial-crisis low on March 9, 2009, the benchmark Standard & Poor’s 500 Index has risen 75 percent, and it’s up 15 percent for this year.
So we are now down to brass tacks so far as Big Finance is concerned. For Michael Bloomberg, the cheap money that has flooded into stocks and other financial markets rather than the real economy is a reliable sign of economic improvement that the benighted public somehow misses. Somehow Charlene Miller, referred to earlier in the article, who has been unemployed for two years, is supposed to care whether IBM or McDonald's is doing well in Asia? And let us say that due to the surge in poverty, the deep discounters such as Dollar Tree (DLTR) and Ross Stores (ROST) are able to both have robust sales and high operating margins; good for them, but lower margins would be better for her.
Language can be a slippery thing. Note the term "signs of economic improvement" in the above quote. "Signs" is not "proof". Unfortunately, real "recovery" has not yet occurred.
If you click on http://www.gallup.com/, you will see a form of a "crawl" at the top of the screen. This reflects Gallup's ongoing polling, which given that it is performed daily, is reliable over time and quite consistent. There, you can see that despite the "end" of the "recession", the return of jobs is at a recession level, discretionary spending is at a recessionary level, and the direction in which the economy appears to be going has appeared to the people polled to have continued downward for a remarkable length of time. People still see the economy as getting worse. This, almost a year and a half after the alleged end of the "recession"!
This type of view is supported by every poll I have seen, whether it be the Rasmussen/Discover(R) poll of consumers, ABC News' Consumer Comfort Index, various small business polls, etc.
But stocks are up!
As delineated by a non-conservative, Simon Johnson, in The Quiet Coup in May 2009, what the country endured in the third and fourth quarters of 2008 had perhaps never been seen before in a leading, financially sophisticated country. The intro to his article reads:
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund (Ed.: i. e., Johnson), is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises.
And from the article:
Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.
No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.
Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.
Private profits, socialized losses. (And I suspect that the massive private profits have in significant measure been converted from dollars to gold.)
Bloomberg's writers and pollsters must know that the American people "get it". That they don't know all the technical details does not matter.
Let's put aside the suspiciously politically-timed "op-ed" from the co-leaders of the ECRI. Let's ignore anyone such as the Bloomberg types who believe that a second stock market rally following a second crash in seven years has any predictive value for the real economy or reflects success in reconstituting a healthy economy.
Let's recognize that America no longer has a very cyclical economy in the classical sense. All the ECRI and BB discussions of cyclicality miss that point. When so much of economic activity comes from Pedro and Jane transferring some of their work effort to people they never met, and much of the rest of "the economy" (and per the action of gold, all of the gains in the stock market after the panic phase ended) comes from printing of new money above and beyond that needed to meet the demands of the marketplace, then you have an economy that can almost always show "growth". But we defeated the centrally-planned Soviet Union in good measure because of the power of the free market, right? Yes, but that was so long ago . . . In 1990, back when perpetrators of financial crime actually got investigated, prosecuted and convicted.
The problem with "growth" as measured by the ECRI and government statistics is that it does not distinguish between economic activity that meets the current and future needs of real people and real businesses and that which does not. For example, the USSR decided to grow cotton in an arid area south of a major sea. So it drained water from an inland sea and diverted the water to parched regions to grow cotton. All this counted as economic activity. But the result was disastrous. Sometimes it's better to just do nothing than do the wrong thing. No one would seriously argue that we should all break all our windows so that we can stimulate new production of windows, would we? Yet "cash for clunkers" didn't just subsidize new car purchases but it also mandated destruction of used cars that were in service. Wasn't that a version of Bastiat's window-breaking example of economic idiocy?
So as America attempts to regain a level of economic activity that "works" for its people, taking account environmental and social realities, among the worst things to do is to rely on aggregate government statistics that conceal more than they reveal.
Back to the Bloomberg article.
The politicians can claim, Janus-faced, that they have cut taxes, as Bloomberg argues the public is too uninformed or dumb to realize, while with no specific legislation the same political establishment forces prices to rise via the tax of monetary inflation, and they force incomes lower for the vast numbers of people who have money "in the bank" so that the favored banking institutions can continue in business with grossly offensive salaries paid to move the free money around despite creating no wealth other than for themselves. And this low- or no-cost money enhances the profits of multinational corporations with headquarters in the U. S. but that almost universally are planning their growth other than in the U. S.
On Tuesday, the Republicrat/Demopublican Party will win. Deficit spenders will win. Thus money printers will win. Thus Big Finance will win.
Perhaps, because the polls demand it, the pols will get together after the election dust settles and make a deeper bow toward Fiscal Responsibility, but they will not mean it. (Dr. Krugman will yell, though, which will enhance the credibility of said Fiscally Responsible words I believe we can expect to hear soon, and we might just get a bond and dollar rally out of said FR verbiage.)
While the Establishment continues its winning streak, ECRI believes that the economy will continue to suffer, though with an artificial mini-boom due to a new round of money-printing from the Fed ("QE2") that ECRI believes is coming soon.
The American economy is now so unfree, so centrally-influenced/controlled, that it has headwinds against developing real savings that allow for positive dynamics such as strongly positive return on invested capital. And it is increasingly unfree in part because supposedly politically neutral analysts such as Dr. Achuthan come out publicly for deficit spending even when they believe that the economic cycle is pointing upward.
As the antithesis to electronically-printed money that cost nothing to create and in turn creates no real wealth in America (though it may be creating real wealth in Brazil and India (for example), gold and silver are, in fashion terms, the "new black". Except for trading purposes, my view is that it does not matter precisely what the Fed does just after Election Day or which party wins the Senate (apparently the House is going Republican). Just so long as the Fed makes sure that the cost of borrowing short term is way too cheap, and Congress is focused on "jobs" in part via increasing exports and thus favors a weak dollar, I think that gold and silver will be well bid, as they say.
I see the following investment trends with political-economic context. The U. S. can by consent of many countries continue to be the "world's policeman" and for that service and for its willingness to be the importer of last resort can have the right of "seignorage" and continue to have its dollar serve as the world's reserve currency. Part of the payment to the American "policeman" is that said dollar can devalue over time vs. the currencies of exporting nations. Thus the nations that export to the U. S. partially in return for Treasury securities or dollar-denominated cash yielding nothing understand that they will be paid in depreciated dollars relative to their own currencies, which means that they realize they are not receiving stated valued for their exports. So be it. They are patient countries. Their people are grateful for any improvements in living standards. There's no rush on the parts of their country's elites to see things improve too quickly; it's better for the elites that improvement be steady and gradual. It's safer that way.
Along with military services, which may increasingly involve Yemen (and don't be surprised if huge energy reserves are eventually "discovered" there--of course if that occurs they already will have been found), the U. S. does have peaceable exports: high-tech and medical technologies as well as the combination of financial engineering expertise and various best practices management procedures. So along with the export of military equipment and services go the valuable services of industrial and financial companies.
Given the slack in the labor market in the U. S., CPI inflation can stay low for a while longer, especially as the excess dollars the Fed creates bleed away into other countries via the trade deficit, foreign wars, direct investment into the BRICs and elsewhere, and the like.
Various measures of stock buyers' optimism have reached very high levels, so I'd beware of a downturn soon. With that could come a move lower in long-term interest rates and perhaps (finally) a sell-off in silver (which because I and many others would view it as a buying opportunity may not come before another upsurge that fools all the fence-sitters). If indeed the non-USD theme is going to remain in force as a secular trend but the U. S. economy is going to temporarily accelerate due to QE2 coming when it is not needed, then I am going to add a new currency play to the three that I mentioned on September 8 (Norway, New Zealand and Brazil). That is the Canadian dollar (CAD). This can be purchased via the Rydex CurrencyShares Dollar Trust, stock symbol FXC.
ECRI is suggesting some post-election upside "surprises" in the U. S. economy. This will benefit Canada directly and perhaps in a leveraged fashion. Unlike our Fed, the Canadian central bank has already engaged in some interest rate rises, and has paused primarily due to the American slowdown that has fed back to the Canadian economy. Thus while Gentle Ben is predicted by Bill Gross to be on hold with ZIRP till 2013, his counterpart in Canada appears for now to be dealing with a less fragile economy that has a stronger banking system and thus has much less debt to monetize.
In the 1990's, the CAD was being called "the peso of the North" (when the Mexican peso was non-investment grade). Things have changed; click HERE for a detailed review, beginning on p. 14.
The CAD briefly went above $1.10 to the USD in 2008. It is now at 98 U. S. cents. It's easy to see the old high being reached and exceeded "sooner rather than later". I'm an owner of the CAD for several months and also plan to be a new buyer. I like the CAD in part because of its large fossil fuel reserves, and it seems to me that oil and gas prices have lagged the increases in precious metals at this point, so the CAD as well as the Norwegian kroner will benefit if oil joins the inflationary party in a larger way. (I would wait for the euro to descend vs. the USD, however, to favor the NOK over the CAD here, but that's just short-term timing speculation.)
As silver goes a bit parabolic upward, we just may see a sharp "catch-up" move up in somewhat left-behind hard-money-related assets as the Canadian dollar.
It should be an interesting next few days.
Copyright (C) Long Lake LLC 2010
Wednesday, October 27, 2010
With five days ’til Halloween and seven before the election, consumer confidence is looking like a horror show for the party in power.
The ABC News Consumer Comfort Index stands at -47 on its scale from +100 to -100, 7 points from its low in nearly 25 years of weekly polls. It’s been this bad just twice in the week before an election: in 2008 and 1992, both years the Republicans were turfed out of the White House.
Now it looks like the incumbent Democrats’ turn to suffer. As in the past, economic discontent is fueling broad dissatisfaction with the status quo, and it’s aimed particularly at the party calling the shots in Washington.
Meanwhile, the one bit of consumer polling I have seen that is an upside change is Gallup's daily polling of hiring-not hiring, which has broken out to what I believe is a multi-month high of +15. Let us see if that can be sustained or is a blip. (Other parameters such as discretionary spending were depressed as usual in the same poll, however.)
In other news, Bill Gross has turned bearish on U. S. bonds. Probably time to buy again.
Copyright (C) Long Lake LLC 2010
Sunday, October 24, 2010
Stimulative Fed Policy and Historical Financial Asset Analysis Good for Gold Versus Both Bonds and Stocks
This past week, the Conference Board reported a modest uptick in its monthly Leading Economic Indicators and said:
Says Ataman Ozyildirim, economist at The Conference Board: “The LEI remains on a general upward trend, but it is growing at its slowest pace since the middle of 2009. There isn’t any indication of a relapse into another downturn through the end of the year.”
Says Ken Goldstein, economist at The Conference Board: “More than a year after the recession officially ended, the economy is slow and has no forward momentum. The LEI suggests little change in economic conditions through the holidays or the early months of 2011.”
The Economic Cycle Research Institute (ECRI) reports weekly to the public on its intermediate-term leading indicators via its Weekly Leading Index. This number remains becalmed around 122. It first reached this level 12 1/2 years ago.
It turns out, however, that most of the time slow growth and easy monetary policy is a good combination in the short term for the pricing of financial assets.
Where are the values, such as they are?
It has been noted that for every percentage point for which the 3-month Treasury bill is less than two points above the consumer price index, the price of gold has risen 8% annualized. In other words, neutral has been 2 points above the CPI. Thus in the 1990s, the price of gold trended down, and a review of the data (click HERE for CPI and HERE for T-bill rates through 2000) are consistent with that. The post-9/11 monetary world has been stimulative of the gold price.
1990 is a useful year to judge return rates on various assets. It was about a decade after the inflation fever peaked as judged by the action of gold and silver prices and was, not coincidentally, the year that short-term interest rates peaked.
It was also a decade before the stock market bubble peaked and the gold price bottomed. And of course following the extremes in interest rates on the upside in 1980, we now have what would at that time been an absolutely unthinkable extreme in interest rates at the low end of about zero percent on the short end.
So, as the sports announcer Warner Wolf might have said, let's go to the tape. In 1990, a 30-year Treasury bond yielded about 8%. Gold averaged about $400/ounce. Let us say that for all of 2010, gold averages about $1250/ounce. The average annual compounded return on gold from 1990 to 2010 then can be computed as 5.9%. Thus a financial asset of infinite duration, gold, has underperformed a similar high quality, long-term asset, the plain old boring long Treasury bond, by about 2 points per year.
Let us now apply the above-mentioned 8% rule. CPI is running about 1% per year. Of course, official CPI may well understate the average rate of consumer price increases. The statistical relationship between gold and the CPI is what it is, with the imperfections in the CPI understood.
If monetary conditions as measured by the 3-month T-bill continue to be one percent below the CPI (i.e., three points below neutral) for 4 more years, then this relationship predicts that gold will rise an average of 24% yearly. I'm going to calculate matters assuming 20% appreciation yearly rather than 24$.
How can we judge whether that would put gold into the severely overpriced category.
How overpriced would gold be if goes from a suggested 2010 average price of $1250 to a 2014 average price of $2500?
To get an answer, let's go back to 1990's average price of about $400/ounce of gold.
If it rose from $400 to $2500 over that span of 24 years, the compounded yearly appreciation would compute to 7.93%.
So over that time frame, the return from gold and a long Treasury bond since 1990 would be . . . identical.
So-- there would be no bubble in gold even if its price doubled. (Louise Yamada agrees.)
Isaac Newton comes into play here. He pointed out that a body in motion tends to stay in motion until it is opposed by a force that blocks said motion. He also was involved in 1717 in Britain going on a gold standard (please excuse gold ads at the top of the link; the writeup is quite interesting and based on other reading I have done, I trust it is accurate).
So, we have a Fed that is focusing on its second mandate, that of full employment, with some Fed leaders stating that if anything, prices are not rising fast enough to allow the Fed to do its job; the President wants 2012 to be another Morning in America so he can be re-elected; and Congress always wants jobs. So all of Washington that matters wants prices to rise if that is "necessary" to help the employment situation; and so do the states, as they want more revenue.
Thus I see no special reason for the above-mentioned general relationship of a Fed that keeps rates at or below the CPI rate not to continue at least until there is a more serious question of fundamental overvaluation of gold. That gold has functioned as such a leveraged play on negative real interest rates without the owner of gold having any leverage is quite interesting.
Of course, past performance need not predict future performance, etc.
Gold bears and gold skeptics often make much of the alleged explosion in ads about it and allege a bubble. Yet anyone who sees Gordon Liddy pitch gold on TV gets the wrong impression. Gold is the metal of kings, not crooks. There is a reason why every currency the past several years has declined against gold. Something that is "golden" is good.
The more that politicians and their minions in central banks create "money" that does not tie to something physical, the more that owners of paper wealth will want to transform that to something tangible. "Uncle" Warren Buffett may prefer farmland or Exxon Mobil (which does not meet its crude oil needs via its own reserves) to gold; or he may have been dissing gold to get a chance to buy it cheaper when he addressed the topic recently. It doesn't matter. As we have seen the past few years, the pols in the Western world and very possibly in China have gotten in bed with the speculative financial interests (a charitable phrasing), which have created a worse disaster with depositors' money on a larger scale--by far-- than ever happened in the 1930s. Without knowing an MBS from a CDO, the public gets it.
The brokers want what sells easily. They want a "story". They also want something to sell that generates enough profit to make it worth their while. Who knows, but it's just possible that the new gold bull market really began just one year ago, with the validation of the breakout above $1000/ounce that briefly happened in 2008, and that stock brokers will be given more and more precious metals products they can sell. In other words, you ain't seen real selling of a financial asset until the Street and its allies in the mainstream media jump aboard.
And though I'm no Steve Jobs-- one more thing. If you want to know what a real extended bull market/bubble is, consider the NASDAQ. In October 1974, at the end of an extended bear market for risky stocks (and only a few years after NASDAQ was created as an exchange with Bernie Madoff as a co-founder), it was around 55. By the end of 1998, it was 2344. Over that 24 years, the compound annual return of the index was 17%, which far exceeded any Treasury rate available in 1974. But that was of course just prelude. The index more than doubled in the next year and two months, reaching about 5100, giving a return of almost 20% annually for that quarter century since the bear market bottom.
Even now, from its bear market bottom 36 years ago, the compound annual return of the NASDAQ is 11% annually.
Now that's a bull market!
And just one more thing. Gold ended 1974 at around $180/ounce. That gives it a mere 5.70% compound annual return since then. There was no 30-year bond issued then, but since the 10-year yield at the same time was 7.40%, we can assume that gold has substantially underperformed both long Treasuries and stocks.
That does not mean that it should "make back" that underperformance, but it rebuts the charge that gold is in a bubble, that it has gone up "too much", etc. The point is that gold is forever and is best viewed the way I have presented it here, not whether it has gone up a lot over the past year or has had one up year after another after two decades of woeful performance.
After all, when the NASDAQ fell by a full 50% from its bubble peak in 2000, it was still wildly overvalued. Sometimes time shows that assets get substantially above or below either fair value or at least a sustainable market value, and based on those criteria, gold's price might rise quite a bit in dollar terms and still be reasonably valued by multiple criteria. Not that it will do so, but I'm spilling a lot of digital ink because I think it may do so over the next several years and have invested accordingly.
Meanwhile, one final thing-- a chart (click on it to enlarge) from Andrew Smithers-- to put matters in a final perspective. At the end of 1974, traditional analysis of stocks based on asset value ("q") and cyclically-adjusted price-earnings (CAPE) ratio suggested that stocks were fully 60% undervalued. The same analysis today suggests that they are about 60% overvalued (note that the chart was drawn when the S&P 500 index was much lower; fair value was calculated at about 725 on that index).
So there's nothing intrinsic in stocks that they will do better than something as boring and unproductive as gold. Time will tell, but I continue to see gold as tracing out a chart pattern eerily similar to the NASDAQ pre-1999.
In a totally different investment sphere from gold, I continue to believe that AAPL is a unique and potentially seriously undervalued growth stock. The combination of AAPL stock and ownership of gold is quite a diverse twofer. Pure growth and innovation with financial strength; and pure money/value with no growth aspect.
Philosophically, I believe that all the Fed intervention in the economy is horribly misguided. It is Soviet-style central planning and cannot possibly work well in a nation as huge and complex as the United States; plus even if the Fed gets it "right" now and then, a free people and free banking system can do better and have the right to interact as they see fit. Whatever level of economic activity people and their businesses wish to transact is the "right" level.
(In any case, if one is fortunate enough to have investable funds, one has to separate philosophy from the "don't fight the Fed" principle of investing. So that's enough of a rant for a discussion of investments.)
As usual, this discussion represents my thinking as of the time written; accuracy of facts and calculations are intended to be of high quality but cannot be guaranteed; and nothing herein represents actual investment advice to anyone.
Copyright (C) Long Lake LLC 2010
Coalition Military Fatalities By Year
Year US UK Other Total
2001 12 0 0 12
2002 49 3 18 70
2003 48 0 10 58
2004 52 1 7 60
2005 99 1 31 131
2006 98 39 54 191
2007 117 42 73 232
2008 155 51 89 295
2009 317 108 96 521
2010 401 96 101 598
Total 1348 341 479 2168
Since most mainstream U. S. media seemed interesting in war reporting only when the U. S. was getting its butt kicked in Iraq a while ago, let's go to a mainstream Canadian newspaper, the Globe and Mail, for a current article about the Afghan War titled Canada's next battle:
The main Canadian battle group of about 1,000 troops, which once fought across Kandahar province, is now concentrated in one tough rural district, Panjwaii, fighting alongside more U.S. and Afghan soldiers in a push to clear out a few hundred hard-core insurgents in a hide-and-seek war. But locals who braced for coalition offensives earlier this month have seen Canadians clear insurgents out of Panjwaii villages such as Zangabad and Talokan several times in recent years, only to see the Taliban return after their exit.
“Many Taliban and many ordinary people were killed, many gardens and orchards destroyed, and many soldiers killed,” Door Mohammad, a 49-year-old taxi driver from Talokan said three weeks ago, before the latest offensive. “At the end, the post was empty, and the Canadians gone, we don’t know where. And now Talokan area is an important place for the Taliban ... there is sort of Taliban-like government like the last time.”
Few would bet there will be a ticker-tape parade through the streets of Kandahar city when Canadian combat troops leave next July. . .
Canada’s military will leave Afghanistan with a bitter taste in its mouth about the scope and scale of what it can accomplish . . .
How much have you heard lately about the brilliant U. S. "victory" months ago in the "city" of Marja?
Now these marvelous "successes" are apparently going to be replicated in Pakistan by what by statute is a non-combatant force, the CIA, as follows.
The Nation (Pakistani online newspaper) reports:
The United States is pressuring Pakistan to allow more CIA officers into the country to expand US secret operations aimed at eliminating militant havens near the Afghan border, a prominent American newspaper (that's the WSJ) reported Saturday. . .
US-led foreign forces have carried out a record number of airstrikes and drone attacks in Pakistan this year in violation of international law. (Emphasis added; that's the newspaper's opinion.)
One has to wonder indeed what the international legality as well as the strategic benefit of an expanding military effort in Pakistan really are. There's little doubt that almost everyone there dislikes the U. S. Sure, we may be useful to settle local scores or to spread money around, but winning hearts and minds? A dubious premise.
I thought that Americans and especially the Democrats agreed after the Viet Nam fiasco that the United States could not and should not be the world's policeman. What was that song title, Oops!... I Did It Again? Of which the last line is: I'm not that innocent.
We're doing it again and not innocently either.
Here's a lengthy excerpt from a speech given by Secretary of State J. Q. Adams to the House of Representatives on July 4, 1821:
And now, friends and countrymen, if the wise and learned philosophers of the elder world, the first observers of nutation and aberration, the discoverers of maddening ether and invisible planets, the inventors of Congreve rockets and Shrapnel shells, should find their hearts disposed to enquire what has America done for the benefit of mankind? . . .
She has, in the lapse of nearly half a century, without a single exception, respected the independence of other nations while asserting and maintaining her own.
She has abstained from interference in the concerns of others, even when conflict has been for principles to which she clings, as to the last vital drop that visits the heart.
She has seen that probably for centuries to come, all the contests of that Aceldama the European world, will be contests of inveterate power, and emerging right.
Wherever the standard of freedom and Independence has been or shall be unfurled, there will her heart, her benedictions and her prayers be.
But she goes not abroad, in search of monsters to destroy.
She is the well-wisher to the freedom and independence of all.
She is the champion and vindicator only of her own.
She will commend the general cause by the countenance of her voice, and the benignant sympathy of her example.
She well knows that by once enlisting under other banners than her own, were they even the banners of foreign independence, she would involve herself beyond the power of extrication, in all the wars of interest and intrigue, of individual avarice, envy, and ambition, which assume the colors and usurp the standard of freedom.
The fundamental maxims of her policy would insensibly change from liberty to force....
She might become the dictatress of the world. She would be no longer the ruler of her own spirit....
[America's] glory is not dominion, but liberty. Her march is the march of the mind. She has a spear and a shield: but the motto upon her shield is, Freedom, Independence, Peace. This has been her Declaration: this has been, as far as her necessary intercourse with the rest of mankind would permit, her practice.
Unfortunately for the almost non-existent peace movement in the U. S., the likely changes in the Congress in next week's election will lead to greater rather than less support for more military action in Pak-ghanistan. This will not help the economic recovery.
The hard-working troops "over there" are needed in America to help build and rebuild this country rather than spreading death and destruction and generating more and more haters of America. Back in the day, the chant was: The whole world's watching, the whole world's watching.
What happens in Pak-ghanistan does not stay in Pak-ghanistan.
Copyright (C) Long Lake LLC 2010
Thursday, October 21, 2010
Amazon says its third-quarter net income rose 16 percent as more shoppers flocked to its online retail site. The results are well ahead of analyst expectations.
For the July-September quarter, Amazon.com Inc. earned $231 million, or 51 cents per share -- 3 cents higher than what analysts polled by Thomson Reuters expected, on average. This compares with income of $199 million, or 45 cents per share, a year ago.
Yet per Yahoo, consensus analyst's estimates for the quarter were at 61 cents 90 days ago. Conveniently they quickly came down to 48 cents so there could be a "surprise" beat.
Yet AMZN traded as low as below $110 after it guided earnings lower and was around $117 three months ago. Now, it has been as high as $166 and is around $160 after hours. Yet its all-time high in the springtime was around $150.
So here we have a stock coming in drastically below prior expectations but trading well above its prior record and perhaps a full 50% above the price it hit when said expectations were in force.
This price-earnings action is a danger signal for momentum and growth stocks. It does not mean that AMZN is doomed. It does however support the view that prices are simply too high.
For the nonce, gold and silver are caught up in the downturn that I suspect is in store for Amazon (in which I have no position or financial interest).
Let's consider valuation, not whether Amazon is on an operational hot streak. Amazon's tangible book value was about $4 B as of June 30. Its market capitalization was about $74 B as of today. That's $70 B it has to earn after taxes simply to be worth on paper what it's allegedly worth. But as an ouside stockholder, one is simply a minority owner of a business that, in practice, will tend to reward insiders first. I say this as a generality, with no knowledge of how AMZN stands on the scale of fairness to outside shareholders. Certainly one looks in vain for any dividends being paid. In bad markets and if a company's business prospects look dicey, stocks can easily sell below book value. After all, who can forget that now-mighty AAPL sold for just about the value of its cash on hand (with no debt)a mere 6 years ago, said stock price having gone down from 17 years earlier.
What we do know about AMZN is that per its filings, almost 5 1/2 million AMZN shares were sold by insiders in the prior 6 months. There were no buys by insiders. Perhaps $700 M worth of shares were sold in this time frame. Except for purposes of options exercise, it doesn't look as if any AMZN insiders bought the stock any time within the past two years, even when it was under $110.
Meanwhile, gold and silver just sit there. There are no earnings expectations to manipulate. There certainly are leveraged short-covering maneuvers and leveraged sellers.
When I look at the chart of AMZN, now that it has (re-) entered the class of earnings manipulators by "beating" drastically lowered expectations, I cannot even try to guess at a proper "buy" point.
Meanwhile, using SLV as a proxy for silver, SLV based around $18 for much of the past 12 months. It recently peaked around $24, while silver the metal reached 30-year price highs. A 50% retracement of SLV toward its recent base of $18 would give about a $21 target. If that happens, that would be above the March 2008 spike high of about $20.42 and if it proves to be the bottom would strike me as uber-bullish and would mirror gold's breakout action of last year.
Less bullish would be a drop toward $19, which is roughly the midpoint of the last 12months' trading range for SLV and which is also an area of price resistance from 2008. Should this happen while gold would happen to stay well above its 2008 high, I would tend to pay no more attention to silver than to oil.
Unlike 2008, which featured a typical commodity down-cycle following years of Fed tightening (plus the exaggerated sell-offs in August-October relating to the cataclysmic events of those months), the Fed has of course been in "easy" mode ever since the cataclysm. Due to ongoing Fed accommodation of monetary conditions, I therefore now take the price "risks" in silver to continue to be to the upside.
Copyright (C) Long Lake LLC 2010
Tuesday, October 19, 2010
The first thing I notice on my most recent visit with Warren E. Buffett, who recently turned 80, is how incredible he looks. He would look terrific for 50; for 80, he looks like Charles Atlas. He's modest about it, as he is about everything. "It all works great," he says. "The eyes, the hearing -- everything works great ... which it will until it all falls apart."
The second thing you notice is that he is so smart it curls your hair.
OK. Maybe this piece, titled Warren Buffett: Forget gold, buy stocks is a bit uncritical.
Here's the whopper I caught. It's where he quotes WB as saying:
. . . "we needed a really big stimulus in the fall of 2008 -- a really, really big stimulus. We didn't get it. It was a miracle that Bank of America (BAC, Fortune 500) bought Merrill for $29 when it was probably worth 29 cents if left on its own for a few days. If that hadn't happened, everything would have collapsed. . .
Some miracle. The same emergency save of Merrill, which could have indeed been had for pennies on the dollar, was made by the same company that saved Countrywide, obviously another insolvent company.
Basically what everyone knows happened is that the larger failing institutions were parceled out to the giants. It was no miracle. It was the crisis plan in operation.
A smaller whopper in the above ties in to Mr. Buffett's partisanship. He conveniently forgets first that the Bush administration pushed through Congress a nearly $200 B stimulus program in the spring and summer of that year, and then that the up to $700 B TARP provision was passed as part of a yet larger bill:
Additional unrelated provisions added an estimated $150 billion to the cost of the package . . .
So the administration, with a Democratic Congress, put through unprecedented emergency peacetime spending in one calendar year.
Now let's address Mr. Buffett's variant of the common trope about gold that is in the same vein as Keynes' comment about how useless it was that people would go to great effort to bring gold out of the ground, refine it, and then transport it to a vault to simply let it sit there. Here is the Buffett comment:
"You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"
This rhetorical question is, upon examination, of course misleading. It's sophisticated sophistry. No one can have all the gold in the world. No one can have all the farmland in the U. S. There is only one Exxon Mobil, and no one can have it. And no one is known to be a trillionaire yet, so no one can have $1 T of cash. Etc.
Thus the takedown of gold is, from a man so smart Mr. Stein's hair style was altered by meeting him, vague.
I blogged on September 8 that gold, silver and certain foreign currencies were in my opinion useful hedges against dollar-debasing Federal Reserve policies. Since then, and after today's sharp down move, GLD is up about 5% and SLV is up over 15%. A fund that tracks the price of energy, USO, is also up about 5%. Mr. Buffett specifically named hard asset-related counterexamples. But they are in the same vein as gold. Farmland is tangible, and XOM deals in tangible assets.
In the view of billions of sentient people now alive and in the minds of probably most people who ever lived who were involved in a money-based economy, precious metals are money. Paper money was historically an anomaly.
Note the nearby chart of the NASDAQ index (click on it to enlarge). From its bottom near the end of 1974 to its peak little more than 25 years later, it rose almost 100 times. Even now it is nearly 50 times higher than at its low. Yet you can't eat the NASDAQ stocks, but you can use its products. Almost no dividends have flowed to NASDAQ stockholders. Over all these years, even the vicious 1987 bear market is seen to be nothing more than a bump on the road.
The case for physical gold in a modern portfolio is stronger than the case for the NASDAQ. Simply doing cool tech stuff doesn't mean that anyone should own shares in the corporation doing said cool stuff. On the other hand, in a world where central banks all over the world are keeping the base cost of money deliberately below the rate of consumer price increases, gold represents an asset that cannot be zoned environmentally sensitive as farmland can (and cannot produce a bad crop yield year after year) and that remains the opposite of what the NASDAQ became many years after it had risen greatly: derided and unpopular. Other measures such as low levels of funds in the trader's Rydex SGI Precious metals mutual fund suggest that no matter that gold is talked about a lot, no buying mania amongst the populace has occurred.
Uncle Warren, in my view, is speaking for the Establishment. He is pretending that it was just a stroke of good luck that Merrill happened to get purchased over a weekend at a ridiculously inflated price and he is denigrating gold by comparing it to rather similar anti-inflation hedges.
Not only is gold rare, but the economically surging people in China, India and Brazil trust gold and silver over paper. Why fight the new kids on the block?
Copyright (C) Long Lake LLC 2010
Please read it, as excerpts can't do it justice.
What's worse, this wasteful war is bringing the German army out of retirement, as the article describes.
How many domestic cutbacks is the U. S. public truly willing to endure to finance an unclear cause of chasing Afghans around their own country, simply because nine years ago the government then in power was allied with Osama bin Laden?
Ben Bernanke isn't specifically saying, but the inflation of the 1960s and 1970s was goosed tremendously by the cost of the war in Viet Nam, and the current inflationary Fed policies are very much affected by today's war efforts, which unlike "stimulus" have no "multiplier" effect on domestic economic activity.
The surge in Iraq achieved its short-term objectives. The American people intended that the troops be brought home rapidly, but excuses to not do so have been adduced, so the Bush policy in Iraq is being followed. No change from the alleged "change" prez. Adding to the confused policies in the face of the various economic troubles at home, the new, elective Obama surge in Afghanistan is a big inflationary headwind in the face of natural economic growth.
All these wars without endpoints are helping to ruin the psyche and economy of the U. S. A.
The Fed can print all the money it wants, but if the population is dismayed by ineffective domestic and foreign policies, it won't revive animal spirits. They can think of all the equations they want, but they won't work. Reality cannot be described in an economic equation.
After the U. S. recovered from the loss in Viet Nam, it was ready for two decades of amazing economic growth with, and because of, only limited overseas military action. The Soviet disaster in Afghanistan presaged its collapse. In the past nine years, unending foreign U. S. military activities in resentful Muslim countries are-- surprise-- associated with economic disappointment after disappointment. There is a relationship.
Come home, America. It was the wrong slogan for a sensible policy for George McGovern in 1972, but it might work in 2012 if matters are unchanged "over there". If Barack Obama has the courage to skeedaddle out of where we don't belong, there will be lots of upside economic surprises to come out of America. If not, the U. S. ship of state is like a sailing ship always tacking into the wind rather than one guided by propitious trade winds.
It's his choice. As a Nobel Peace Prize recipient, the choice should be obvious. But it's not happening. IMHO a war president should send the prize back to Oslo.
Unless these wars are truly won soon or the administration changes course, the bear trend in the dollar and the bull trend in gold look to be on track, countertrend moves notwithstanding.
Copyright (C) Long Lake LLC 2010
Monday, October 18, 2010
Saturday, October 16, 2010
But that's not what Dr. Evans and Dr. Bernanke think. Here is Evans:
If short-term interest rates remain near zero during this adjustment (Ed. that is, during QE2 = lots of money-printing), real interest rates would be between –2 and –3 percent. Perhaps that would be enough to improve labor markets and aggregate demand sufficiently, but I personally put more faith in analyses that suggest the liquidity trap is larger than this.
He is saying that he wants -- soon -- more negative real interest rates than -3%:
A variety of typical linear Taylor rules suggests around –4 percent. In addition, some calculations for optimal monetary policy simulations I have seen indicate that real rates of –3 or –4 percent between now and the end of 2012 would boost aggregate demand enough to deliver substantially lower unemployment by the end of 2012. . .
Over the course of this hypothetical adjustment, inflation is about 3, 4, and 3 percent from 2011 through 2013. Thus, policy can generate –3 and –4 percent real rates: This achieves a substantially higher opportunity cost of holding on to cash-like assets rather than lending and investing excess reserves in productive activities and workforces.
Of course, my concern is not how much interest a company makes on its cash reserves. Evans is saying that the average personal saver should be severely penalized because central planners such as he, and is the Comintern might have been, are unhappy with the business decisions that business people make. And the prudent savers must pay, just like road kill.
The truth, of course, is that higher prices only cause extra consumption in the form of hoarding, which sends the wrong signals to business, which has trouble distinguishing one-time increased demand such as from hoarding from organic increased demand. Also, the more that Fed policy steals real savings from savers, the more they turn to rank speculation, otherwise known as malinvestment. Hey, why not put some money into some friend of a friend's gold mine in the middle of nowhere? We're just going broke slowly with the money in the bank, anyway!
The deeper truth is that Messrs. Evans and all the other Fed bank Presidents work for a bank. Their interest is that the banks make money. So if they give the banks a continued cost of money of about zero, give them a little free money as interest on "reserves" (said reserves created when the Fed took assets off their hands at prices no one else would pay), and then, per Evans, give them the chance to charge higher and higher interest rates due to "inflation", well, then the banks can make more money, their bad loans can diminish in nominal terms, and everyone but savers and workers getting minimal to no wage increases can be happy.
It is a sick policy, but that's the plan.
Anyone who thinks that a 5-year Treasury yielding the grand total of $6 back for every $100 invested is prudent is entitled to his/her own opinion. In my humble opinion, the Fed is knowingly making all savers speculators. Why not at least keep up with Evans' high-inflation scenario with a 4% Treasury bond, with the chance for positive real returns if prices rise at 2% annually afterward, as he says he favors? And if by chance the U. S. goes Japanese anyway and we get true price stability, then one would have done OK with the 5-year note I just denigrated but one would do much better with the long bond.
Treasuries sold off on the long end last week on the above sort of talk, while the 2-year did not budge. Yet Evans and Bernanke are talking about 3+% inflation well within the 2-year time frame, so logically the short end should have sold off big-time, not the long end. Nothing has changed regarding years 11-30, though. We continue to have no idea what the future will look like then, though some of us won't be around to see it!
Thus the sell-off on the long end was speculative and can be bought speculatively. We are approaching the 4.1% intraday low of the 30-year in 2003, which may offer resistance now that we are so far into the next economic cycle.
Of course there are many risks with 30-year securities, but for quite some time I have been suggesting that gold and other hedges such as silver and foreign currency-denominated debt instruments are the best ways to deal with highly inflationary Fed policy in this era of the inherently deflationary credit collapse and its aftermath. I'm still long lots and lots of that sort of stuff, though I just sold the last of my silver yesterday on a timing basis.
The overvaluation of Treasuries-- i. e. the "bubble"-- is in the short end with 0.36% two year notes and 0.59% 3-year notes. Most bubbles go to greater extremes than to end with a rather boring 4% long bond. Let's see if we get 3-3.25%%. If it occurs at any time in the next 5 years, a buyer Monday at 4% will do just fine.
Copyright (C) Long Lake LLC 2010
To keep the Earth from absorbing warmth, we could paint roofs, roads and pavement white. We could plant lighter, more reflective grasses, or cover the deserts with reflective aluminum. Boats or planes could spray ocean clouds with sea salt to make them whiter; pumping tiny particles into the atmosphere could mimic the cooling effect of volcanic eruptions.
Then come the gee-whiz ideas.
As if covering "the deserts" with aluminum isn't "gee-whiz" enough!
How much energy will be spent doing all these things? How much benefit will there really be?
What percent of the Earth's surface consists of roofs?
How did all the financial engineering work out?
Mr. Milbank is, I'm sure, sane. However, the ideas he's espousing are fantasy on multiple levels, IMHO.
Wouldn't be better simply to tax new construction and possibly even renovations of all coastal regions at a specified level above sea level so that people would have an incentive to move to more protected areas? And, remove flood and hurricane insurance subsidies for homeowners in those regions?
The planet has been much warmer before. An Ice Age is almost certainly coming, probably sooner rather than later. Doing further experimentation with the planet could simply be adding insult to injury, even if carbon dioxide is indeed contributing to the last century's mild warming phase.
Copyright (C) Long Lake LLC 2010
Friday, October 15, 2010
It's certainly better than doing nothing.
Ineffective printing of money by central planners at the Fed can hurt, a lot.
Economic activity is moving at a pace that is almost by definition the "right" pace.
Some problems require hard work and imagination by elected officials and just cannot be solved by bankers.
Gentle Ben looks silly in criticizing policy-makers one day and then taking on the burden they have been shirking the next. He's done more than enough. Perhaps he can justify new, experimental actions should there be another crisis. For now, less is more.
Copyright (C) Long Lake LLC 2010
Wednesday, October 13, 2010
Tuesday, October 12, 2010
At Bank of America Corp., David Farrell spent his day taking calls from credit-card customers in Ireland. Now, he’s learning to sow seeds to escape the worst recession in the country’s modern history.
The 40-year-old is among a growing number of Irish workers returning to rural pursuits after the end of an economic boom that turned farmers into property developers. The group that runs Farrell’s college program in Dublin’s Botanic Gardens turned away 250 students seeking places in its agriculture- related courses last month because they were full. . .
“Farmers have become a respected profession again,” said Power, the economist. He comes from a farm in Waterford in southeast Ireland and chairs Love Irish Food, a group promoting local produce. “And there’s nothing else out there.”
That return to roots is being smoothed by a decline in the price of land. Developers pushed up prices to more than 58,400 euros ($81,140) a hectare in 2006, the highest in Europe, according to the National Institute for Regional and Spatial Analysis, citing data from property agents Savills Plc.
Last year, land prices around Dublin declined by 57 percent. The government said last month the cost of bailing out the banks may rise to as much as 50 billion euros, the equivalent to a third of gross domestic product.
“Builders, developers, architects, solicitors, they all wanted the 30 acres with a pony,” according to Bryan. “That totally inflated the price of agricultural land.”
Will what's happening in Ireland stay in Ireland?
Maybe not. Food is, after all, more important than printing press "money".
Copyright (C) Long Lake LLC 2010
The entire MERS-related structure has been questioned and has been the subject of suits.
Of course it is public knowledge that the finances of Big Finance are murky, given extensive difficult-to-value assets.
None of that is any of my specific interest, given that I sold all my financial stocks in winter/spring 2007 and paid them little attention except from the short side in 2008-winter 2009, and then did one quick trade on Wells Fargo from the long side this year (a winner, at much higher prices than today's).
What concerns me as a precious metals investor is that I have read the GLD and SGOL prospectuses more than once for each. The custodians and other major players in these entities that hold physical gold are all Big Finance companies. The prospectus for each entity is replete with all the things that can go wrong with the chain of custody of the metals. They also make clear that if some metal goes missing or is impure, investors have few protections.
The metals may have subcustodians, which themselves may have subcustodians, and these entities may lie/cheat/steal, or otherwise screw up, without the investor being able to recover damages.
Thus I am happier owning the Canadian trusts to own physical gold without actually owning the gold. The stock symbols are GTU and PHYS. Their prospectuses disclose where the gold is; there is no subcustodian. At least in the case of GTU (Central Gold Trust, run by the same team that runs CEF, the Central Fund of Canada), the directors do not even carry insurance.
Right now, the premia over NAV for GTU and PHYS are at historically low levels. This along with the slow ramp-up in assets in the Rydex SGI Precious Metals mutual fund and the utter lack of speculative froth in Newmont, Goldcorp and Barrick suggest to me that the strong bull market in gold is the most apathetic one from the public's standpoint I have ever seen in any major asset class.
Whither gold prices?
The investment guru Bill Fleckenstein somehow delivered outstanding results from his short-selling hedge fund that he started "too soon" before the stock bubble was close to peaking in the late 1990s. He brilliantly closed it right near the bottom of the bear market almost two years ago and basically became a precious metals investor in his new fund.
He wrote a column several months ago in which he only half-jokingly said that by the time the top of the gold bull market would be seen, Big Finance would have embraced the trend so much that it would be promoting all sorts of investment vehicles in precious metals and would be taking large investors to tours of out-of-the-way mining sites.
Perhaps that has now begun. Goldman Sachs is now out with a bullish upgrade on gold and silver prices. Price targets for one year from now are $1650 for gold and $27.60 for silver.
Maybe it's just wishful thinking, but maybe, just maybe, the idea of anchoring the money supply with a metal that would take away from the Fed the ability to centrally plan the money supply of a continental country (and then some) is gaining ground.
In the here and now, gold and silver prices are both extended and ripe for profit-taking at the very least. Looking one year ahead and applying the "Elfenbein rule", the Goldman price projection for gold appears quite reasonable.
Given the continued upside price potential in concert with the safe-haven reasons I invest in gold, I want to be as confident as possible that the gold in the fund I own is actually "there" and not mishandled, as it appears the documentation surrounding mortgages often became. Thus I trade away the liquidity advantage of GLD and other Big-Finance-custodied gold funds for the much less tradeable GTU and the more liquid PHYS.
Copyright (C) Long Lake LLC 2010
Monday, October 11, 2010
This piece will present the case for investing in long-term Treasuries while at the same time believing that the 5-year and under space is significantly overpriced and therefore bubble-like in valuation.A stock analogy to this argument came in the late 1990s. The average NYSE stock actually peaked in 1997-8, but the DJIA peaked at the end of 1999, the NASDAQ in March 2000 and the S&P 500 later in 2000. Yet many stocks bottomed in March 2000, such as homebuilders and many industrial companies. It was as if people ran from the port (tech) side of the ship to the starboard (anti-tech) side of the stock ship at the same time.
It appears that a milder version of that phenomenon could be set up to happen in bond-land.
Before reading on, you may wish to look at the nearby long-term chart of interest rates in Japan.
(Click on chart to enlarge.) I will refer to it later.
Please also consider an excerpt from a blog from 2005 by the then not-so-well-known blogger Calculated Risk, in which he commented on then-Chairman Greenspan's "conundrum" speech regarding the failure of long Treasury rates to increase as much as expected as the Fed engaged on its tightening regimen:
But I think the PRIMARY reason for Greenspan's conundrum is that the economy is weaker than it appears. Using GDP growth and unemployment, the US economy is healthy. But the level of debt (both consumer and government), the real estate "boom" that seems based on leverage and loose credit (see Volcker's recent comments), and the poor employment situation (especially the low level of participation) indicate an unhealthy economy. I believe this recovery is being built on a marshland of debt and the bond market is reflecting this weakness.
By the way, here is CR's below-consensus view nowadays:
I expected a sluggish recovery in 2010, so I thought the unemployment rate would stay elevated throughout 2010 (that was correct).
Going forward, I think the recovery will stay sluggish and choppy for some time and I'd guess the unemployment rate will tick up in the short term and still be above 9% later next year.
I more or less agree with CR though I may be a bit more bearish than he.
So the predicate for the following discussion is the view that while economic jiggles upward are to be expected, too many data points simply point to a general stagnant trend for the pace of business in this country for me to argue against accepting that stagnant trend as the New Normal.
Despite that New Normal and the fact that 0.5% interest rates on 3-year money are crisis lows and reflect a poor state of business affairs, let's consider how extreme the market's estimation of fair value for interest rates in the "out years" has become. As first Mr. Greenspan and then Dr. Bernanke led the Fed's long slow interest rate-raising campaign, the "conundrum" of a flattening yield curve caught their eye. At the interest rate peak in mid-2007, more or less all rates from 1 day to 30 years were identical at around 5.25%.
For historical purposes, please be aware that through much of the 1800s, short-term interest rates were generally higher than long-term rates. This reflected such factors as productivity gains, generally under a gold or bimetallic monetary system. As the Japanese experience the past decade reflects, though, prices may fail to rise even under a non-metal-based (i.e. "fiat") monetary system.
What is the message of Mr. Bond today?
Well, the 2-year bond is at 0.35% yearly, the 3-year at 0.52% and the 5-year at 1.10%. Using a simplified model of implied bond yields farther out the curve, one can calculate as follows.
The 30-year Treasury bond yields 3.75% each year for 30 years. Thus a $100 investment in this bond at "par" of $100 per bond provides a gross total of $112.50 in interest payments over 30 years.
If one were instead to purchase a 3-year Treasury note, one would receive about $1.50 gross over 3 years for every $100 invested (lent to the government), or a "grand" total of $4.50 over the 3 years. It hardly seems worth bothering (especially when credit card companies that have bank subsidiaries are offering FDIC-insured yields of 1.3-1.5% even today). Subtracting interest income over 3 years from that obtainable for 30 years gives income attributable to years 4-30, In those final 27 years, one would receive $111, spread evenly over each year. This computes to about 4.1% yearly.
Turning to a comparison of the first 5 years of the yield curve vs. the final 25 of a 30 year stretch, under current rates one accepts 1.1% a year for 5 years. Similar math to the above would imply a 4.28% yield yearly for the terminal 25 years.
Let's look at matters differently. To choose 5 year paper over 30 year has one certainty. At the end of 5 years, the investor of $100 in a 5-year note will have earned $5.50. He/she will have $105.50. The investor in the 30-year bond will have earned almost $18, or about $12 more. The first investor will be more than $12 behind the proverbial eight-ball (to mix a numerical metaphor). It will not be so easy to find the right investment for the next 25 years just to come out even with the buy-and-hold investor in the 30-year bond.
The numbers get more interesting as we go farther out on the curve. If the 20-year Treasury yields 3.2% today, then it pays $64 in interest per $100 over that 20 years. Subtracting that from the total payout to the 30-year holder implies an average yield for years 21-30 (the final 10 years of the 30-year bond) of 5.1%.
Voila! We are nearing the rates extant in 2007.
A back-of-the-envelope guesstimate is that the bond market is implying a 5.5% yield is proper for year 30 on its own.
In other words, the long bond is in no bubble whatsoever. It is the low-yielding front years that are wildly overvalued (under-yielding).
Well, all this guessing about the "right" interest rate in the out years is absolute conjecture on the part of the bond market. The truth is that the bond market has little more idea than you or I what economic conditions will be like a year or two from now, much less many years out. Japan scenario? Greece (though with a printing press)? U. S. 1970s, with bear markets for both stocks and bonds? Everything good?
The truth is that we really don't know what will happen from one day to the next. One summer day several years ago, I left home and about 10 minutes later walked into the doctors' lounge to grab some coffee before seeing my hospital patients. The TV showed that an accident had occurred in downtown New York; an airplane had just hit one of the World Trade Centers. Since that time, the Fed has almost never voluntarily pushed the Fed funds rate above CPI, in contrast to its policy of most of the prior 2 decades; and the U. S. has been on a semi-war footing even despite the election of a "peace" candidate in 2008.
The world changed during my brief commute to work. Two-three years from now could be another eternity, just as the past few years has been.
The current trend is the Japanese one. Zero interest rate policy ("ZIRP") is resorted to as an emergency measure by the central bank. The acute emergency ends, but chronic illness emerges. Zero or near-zero interest rates continue to anchor longer and longer maturities toward zero. Meanwhile, market participants continue to rationally expect a reversion to the interest rate mean. This has been the Japanese experience, and to date nothing other than hope for better times has occurred in the U. S. to differentiate us from them.
Let us look again at the chart of interest rates in Japan. After the yield on the 5-year note fell to new lows in 2001-3, the 30-year actually fell more in yield than the 10-year. Whenever the yield gap, in absolute and percentage terms, was wide, it paid to buy the 30 year.
Why should it be different here and now? Because we have nukes and they don't?
In addition, there is a specific potential catalyst for outperformance of the long bond. That is the expected "QE2", or further expansion of the Fed's balance sheet, a/k/a yet more money-printing, with the now unconcealed primary purpose (per the NY Fed's executives in recent speech(es)) of keeping financial asset prices above fair value. (In other words, trickle-down economics . . .)
It is known that the public has been rebalancing its portfolio from stocks toward bonds, but the bonds it has been buying are almost entirely short-to-intermediate term securities, or so it has been reported. Thirty years ago, bonds were known as certificates of confiscation. In my humble opinion, that's likely what 5-year notes are today. Apparently the public is nervous about the long term future for interest rates and is so nervous it is moving heavily toward the short end. Where the public is nervous, it's usually a good idea to think about being a contrarian.
Getting back to the potential catalyst for a rapid and large drop in long-term rates, what if Dr. Bernanke took a quick look at the interest rate curve, saw the record or near-record absolute and relative spread between the 2-year and the 30-year bond, and between the 10-year and the 30-year bond, and said the following any time in the near future?
"The yield curve is too steep. The Fed is going to target the 10-year yield at modestly below its current level but believes that a more appropriate level for the 30-year bond is at most 3%, which provides a positive return after targeted inflation of 2% with utmost security of principal and is thus a yield that is fair to both the lender and to the Treasury."
There would be a rush to the long bond, of course. Now here is where the arithmetic gets interesting. A drop in interest rates of 75 basis points on a zero coupon bond for a 30-year security from 4% to 3.25% (rates on zeros are higher than rates on par bonds that pay interest) gives a price change of the zero coupon security from $30.80 to $38.30; quite a percentage move.
Let us take the Japanese experience. If 5 years from now, a zero coupon security purchased yielding 4% turns into a bond (at that time a 25-year bond) yielding 2.5%, the price will be $54 (from $30.80, to remind you).
If at any time within those 5 years the yield drops that much, the annualized return will be greater, even if the price is less than $54.
Aside from Fed action, why might the long Treasury be a fundamentally attractive investment for individuals, especially for tax-deferred accounts such as IRAs?
Might the U. S. actually "walk the walk" of fiscal prudence? Might the authorities, after all the fruitless manipulation of monetary aggregates, get back to where they once belonged and accept the obvious principle that aiming for price increases is harmful to the people they are supposed to serve, and primarily only benefits the financial class?
Might some form of hard money serve as the chosen solution to ratify most of the unsupportable promises known as debt and social obligations the Feds have willing taken on?
Might the government actually go to a peace economy?
In any case, back to supply and demand, and to fundamentals of return adjusted for changes in the general price level ("real" return). Here is a link to a Morgan Stanley estimate of outstanding Treasuries by duration. There are not a lot of long-duration Treasuries. The yield spread is large. A buyer of a 5-year Treasury at 1.1% could get creamed simply by an average of 3.5% price inflation per year, whereas the buyer of the long Treasury would (pre-tax) be holding even and the buyer of the zero coupon bond would be accruing perhaps, after all is said and done, a small positive return yearly.
Thus, in conclusion, there are potential capital gains that might accrue soon to the purchaser of long-term Treasury bonds, with said possible gains being leveraged via purchase of zero-coupon instruments; and there is greater protection from inflation over the next few years by purchases of those types of bonds rather than the short-intermediate duration vehicles to which J. and J. Q. Public have reportedly been flocking.
1. Anyone reading this who is not a regular reader of my posts would not be aware that I have spent weeks and many months criticizing the monetary authorities for unfair and inappropriate printing of mass quantities of money. I have published a series of on-line articles describing various ways in which I have been investing significant portions of my financial assets to try to protect them from the ravages of all this money-printing; principal among them is gold (I have blogged favorably about gold since winter-spring of last year). Here is a link to the first of that series, on September 8
2. For taxable accounts, well-chosen tax-exempt municipal bonds may provide the optimal risk-reward for buy-and-hold bond investors rather than Treasuries. This discussion of Treasuries unfortunately is in the context of my post titled We Are All Speculators Now, from September 20.
3. Investing is risky, speculating is risky, and purchase of long-term bonds entails a commitment to, well, the long term, even if a profitable sale of the bond is hoped for in the shorter term. The potential for gain entails meaningful potential for loss, especially adjusted for possible sustained rapid rises in living costs.
4. Nothing herein or in any of my on-line posts should be construed as investment advice to any person, as opposed to simple commentary and conjecture. Reasonable efforts have been made to present economic and numerical data as accurately as possible, but please take nothing for granted and do your own math and research as appropriate to your level of interest.
Copyright (C) Long Lake LLC 2010