Saturday, April 30, 2011

Metals in Motion

The question facing all investors is how to play the inflation and negative real interest rates that the Fed continues to engineer. In that vein, I have spent a good deal of time reviewing long-term price charts for gold, silver, platinum, palladium, copper and oil. Links are here (precious metals, click on historical charts), here and here (copper) and here for more detailed price charts on silver. I also included oil from memory.

The bottom line as I see it is that these varied commodities have tracked each other pretty well over time. Copper is triple its 1980-era peak, gold about double its peak, silver about equal to its peak but is about double its late-1980 peak which was unaffected by the "corner" that sent it to around $50 months earlier (Hunt brothers). Copper is up about 15 times in 50 years; it has lost a good deal of its market due to fiber-optics. Silver is up about 40-50X in that time frame, as is gold.

Oil was in the $2-3/bbl range in 1970 and is up 40-60X from then. Oil is also about 2-2.5X its 1980 peak.

Where are the metals and commodities going?

So long as the Fed is engineering ultra-low interest rates and averting its gaze from the obvious price inflation that we see all around us, especially in that most "core" of human activities called eating, I feel that the underlying trend remains higher. The "cost of carry" is negligible when money on deposit in a bank yields a whole lot of nothing. Will there be sharp declines? Sure.
But when stocks and bonds were 10 years into their bull markets by the early 1990s, the best was yet to come. Dips were buying opportunities.

Watch the Fed's actions. When and if they actually withdraw liquidity, we will see what prices are real and what are pumped up. Given the unwillingness of Congress and the President to seriously bring revenues in line with expenses, I continue to believe that the game plan of the authorities is to inflate the debt away as well as to inflate housing prices upwards so that the banks and homeowners are made whole again in nominal terms. Doing so, or attempting to do so, has "collateral damage" on the dollar. This in turn reflects in elevated trends of prices of real goods that continue to be demanded by people and businesses. I am sticking to essentials or near-essentials. In these difficult economic times, I am leery of fripperies. The metals mentioned above are "core" products to our economy and financial system. Other core commodities include sugar and cotton, which in healthy bull market-type action, have had significant declines recently following huge runs. (I don't know the first thing about trading commodities on futures exchanges, but if I did, I'd probably be looking into buying the dip in those two commodities.)

I am not spending a lot of energy trying to decide which inflation play is "better" than another. So long as the central authorities have all the power they do, I'm just riding the weak dollar policy as carefully and as long as I can in a diversified manner. Metals, energy stocks, strong foreign currencies . . . it's all one trade. It's also getting crowded, but one could have said that about techs in, say, 1997. Don't fight the Fed is a motto I have adopted years ago. It continues to be a good trader's and investor's credo. The Fed wants more inflation; my money says there's more to come.

Copyright (C) Long Lake LLC 2011

Tuesday, April 26, 2011

Another Way to Respond now that "They" Are Hitting Far Below the Belt

It's bad enough when they shrink the size of my non-butter substitute from 16 to 15 ounces. It's worse when my parents' sour cream index soars 50% or so in price in less than 8 months.

But when they shrink the width of a roll of toilet paper, they've gone too far. Talk about not playing fair!

As goes toilet paper, so goes the dollar.

Down the "drain".

To try to verify if I am being more than a bit too harsh before publishing this, I asked myself whether, if I lived in Hong Kong or Sweden, I would have any interest in gaining exposure to the U. S. dollar. The answer was so obvious that I spent no time debating the answer with myself.

I then asked myself a more difficult question. Are there any currencies that are poised to outperform gold from here, counting the interest from bank deposits or government bonds?

It's not an impossibility that fiat paper can beat gold for periods of time. The U. S. had over 20 years where government debt far outperformed gold.

Here is one candidate to watch. It is Sweden. Sweden is running government surpluses, and the government is said to actually be overstating its liabilities. It had a banking crisis about two decades ago, resolved it without coddling the crippled banks, devalued its way back to financial health, and in 2006 began a program of successive tax cuts. Its central bank is well on the way toward extending an already impressive series of post-Global Financial Crisis rate increases, its economy may currently be the strongest in the E. U., and it maintains its own currency separate from the euro.

Any time you see a socialist country repeatedly cut taxes and then see the economy start booming, I believe you see the potential for it to offer savers enough return on their capital after inflation to bring willing capital out of tangibles such as gold into the financial system.
Here is a 5-year chart of the USD vs. the Swedish kroner (SEK):

I don't know what's with the spike down at the end of 2007. I'm ignoring it. I don't think that Sweden declared bankruptcy and then suddenly said, "Never mind". It's clearly a chart error. Blame Yahoo.

In any case, the downward tilt on the chart reflects a weakening trend of the American dollar against the Swedish krona. You can investigate this pair on Yahoo Finance with the symbol USDSEK where a typical stock symbol is inputted. There happens to be a Rydex CurrencyShares security the purchase of which buys bank deposits in Sweden, so there is a yield to the investor that is currently somewhat over 1% after the 0.40% trust expense ratio. That yield appears set to rise as the Swedes tighten up after their own extreme easing cycle.

As the American standard of living continues to lag the promises of the State, other countries actually are doing what the U. S. sort of did 15 years ago, which is to either shrink the size of government or at least be honest about its size and bring in revenue equal to or greater than expenses. That sort of government offers an attractive alternative to U. S. Treasury debt right around now.

While gold remains the "gold standard" for diversification from the U. S. dollar in the opinion of many, many people, it may be wise to continue to also look for non-metallic alternatives such as higher-yielding debt instruments (and related bank deposits) of the best-run governments. I have added a significant amount of FXS to my holdings in Brazilian, Norwegian, and New Zealand currencies, and will be watching to see if it one day makes sense to go out farther than bank deposits in the Swedish bond market.

Copyright (C) Long Lake LLC 2011

Thursday, April 21, 2011

How I Learned to Stop Worrying and Lote the Stock Market

There's no typo in the title. "Lote" is a combination of love and hate. Here's a precis of why that's my current attitude toward the stock market.

By the 'stock market', I mean operating companies as opposed to funds of various sorts, preferred stocks, and other securities that would not qualify for consideration for entry into a stock index such as the S&P 500 or the Russell 2000.

From my start in the financial markets in 1979, I was always oriented toward the stock market, taking a brief timeout only in 1981-2, when bonds were very high-yielding and a severe recession raged and triple-tax exempt New York City bonds made sense for a professional couple earning the munificent combined income of $40,000 yearly.

That pro-stock posture continued until the tech-growth stock/"Nifty Fifty" stock bubble peaked in 2000, and the revelation of widespread corporate fraud at such companies as Worldcom and Enron, plus my own experience with some high-flying local companies, led me to swear that never again would I go all in with common stocks.

I did go half in in spring 2003 and then all out in the summer of 2007.

At this point, with money rates still at or below the price inflation rate in most countries, my posture toward stocks is that I would want to see what would happen if governments simply taxed as much as they spent. What would the effect on economic activity and corporate profits be? I suspect there would be a severe shrinkage of the percentage of reported corporate profits to GDP.

For example, about one out of every six dollars in the U. S. goes to the health care "industry". What would that ratio be without government support? Much less, I suppose.

In fact, the tech sector receives little in the way governmental subsidies. It has to prove its worth to businesses and its attractiveness to consumers every day. Perhaps that is why it has rebounded strongly.

So you can sense the hate part.

Now for the love.

Companies have proven to be decent stores of wealth in high-inflation states, though not as good as gold, silver, or oil. If one is in the (amazingly still small) minority that "gets" what the central authorities are up to, and especially if one is in the yet smaller minority that "gets" that central banks generally do as they are told by their political masters, one will be able to direct one's stock investments more appropriately than people who continue with traditional balanced portfolios or people who make the mistake of looking at dividend yields as indicating value.

When governments are directing their central banks to create money at below-market interest rates, that is usually the time when yield plays start to not work. Think the 1940s and the mid-1960s through January 1980.

Bulls on the stock market will tell you that historically nothing beats the stock market.

As a reliable predictor of the future, of course that statement is irrelevant. Perhaps the historical outperformance of the stock market has used up its future outperformance. Perhaps it's all a random walk. What will tomorrow bring, and tomorrow, and tomorrow? That is the question.

The government of the U. S. has changed. When the Fed was being formed, the issue of issuing currency tied to the issuance of debt was criticized. The Federal government had, after, almost no outstanding debt. Would there not be insufficient debt issuance to allow enough currency to be created?

We all know the answer to that question.

So I would paraphrase Edgar from King Lear (Act V, Scene II), to continue the Shakespearean theme. When I look at the financial markets on a tomorrow-tomorrow-and-tomorrow basis, I think that money-printing is all. Everything else is secondary.

Companies can raise prices over time to adjust for changes in the general price level, and with good fortune an investor may do OK even with companies that see shrinking margins, such as price-takers in the inflation rather than producers of the products (such as precious metals, usually) that see strong price increases.

Thus I lote the stock market.

Copyright (C) Long Lake LLC 2011

Tuesday, April 19, 2011

Vietnamization Of Libya Proceeds As the Brits Forget About Austerity

From the Air Force Times:

— Britain said Tuesday it will send about a dozen senior soldiers to Libya to help organize the country’s haphazard rebel forces, as international allies seek to aid the opposition’s attempts to break the military stalemate.

This is how American involvement in South Vietnam began. First a few soldiers/advisers . . .

Meanwhile, the semi-austerity Britain announced last year after the Conservative ascendancy appears to be dissolving due to domestic pressure and warmongering from the militarists.

Copyright (C) Long Lake LLC 2011

More Potential Outrages Regarding Libya?

From AFP:

Italian Foreign Minister) Frattini, speaking in Rome after talks with rebel leader Mustafa Abdel Jalil, also said Italy will host talks next month on allowing oil exports from eastern Libya and could provide rebels with night-vision kit and radars.

The meeting would also try to find ways of using Kadhafi regime assets frozen around the world to aid the rebels and would discuss the question of arming the rebels.

So it's come down to stealing Libya's money as well as its oil. What country is going to trust Western banks again if the West uses Libya's wealth to support the Western-affiliated revolt against the long-standing government of Libya? Note no Western nation is legally at war with Libya, and I am not sure that even a state of war allows a nation to order its banks to provide it use of a belligerent's funds.

Copyright (C) Long Lake LLC 2011

Monday, April 18, 2011

Addendum to Precious Metals Train Post

Addendum to prior post. S&P puts U. S. on list for possible credit downgrade. Gold is up, stocks are down; somehow the DXY (U. S. dollar index) is up (?!?). And somehow the 10-year note is more or less unchanged. S&P has now joined the Chinese credit rating agency Dagong in facing facts. The GAO won't even give the Feds an unqualified audit opinion, for crying out loud! How is that compatible with a AAA borrower?

Copyright (C) Long Lake LLC 2011

Is the Precious Metals Train Changing Speed or Direction?

I suspect the answer to the above question is 'maybe' for the first part and 'no' for the second.

It also may be that this weekend a well-read blogger laid down the Establishment's gauntlet in an important way regarding the inflation story. Dr. Krugman opined on April 16 in "Inflation, Here and There (Wonkish)":

I’ve taken to looking at the Billion Price Index, which looks a lot like the goods-only, but with much higher frequencies. And right now the BPP index is clearly indicating that the big price bump of early 2011 is fading away . . .
Wage growth hasn’t fallen as much as I expected a couple of years ago; it’s now clear to me that I failed to put enough weight on the downward wage rigidity literature. But there’s nothing here to suggest any reason to consider inflation a problem. (Emph. added)

You may look at the chart of the Billion Prices Project at It shows that as of April 14, the price inflation rate was 0.45% monthly. Even without compounding, that's over 5% yearly. That is down from 0.82% as a monthly price inflation rate on Feb. 18. That's of course about a 10% annual rate without compounding.

I think the average person is completely cynical about the CPI now. After all, if one is just getting by, what is more "core" to one's life than food? In human evolution, eating (and drinking) is of course the most "core" activity possible. It trumps clothing and shelter. And what was fire invented for? Primarily to cook food. Food and energy. Core. Not non-core.

So my point is that we may be nearing a tipping point. Paul Krugman, the representative of the money-printing Establishment, comes out in November with a similar pronouncement that there was to be no price inflation from QE2 (and, let us not forget, the ongoing "QE 1.5" that began, if I remember correctly, in August.
Now that this has been proven wrong, he refuses to accept that the idea of high unemployment and "output gap" has a credibility gap. He doubles down. In that same blog, he merely says that, well, he was wrong, things happen:

March core inflation came in lower than expected, and there’s been a lot of talk about that. But really, when it comes to high-frequency data, stuff happens. People who got all worked up over a bump in prices, seeing it as the harbinger of a big inflationary takeoff, were ignoring the lessons of history, which is that short-run spikes in inflation generally reverse themselves.

Perhaps PK slept through the Carter years.

We also learn today that Dr. Bernanke agrees with his Princeton colleague Dr. Krugman, from

When Federal Reserve Chairman Ben S. Bernanke convenes his first press conference next week, he may emphasize a point the markets seem to have forgotten: He’s serious about keeping interest rates low for an "extended period."

The Mayor of Wall Street's company joins in the supporting chorus by quoting only one commentator on how to invest:

Investors have two routes to profit financially from Bernanke’s determination to keep the federal funds rate near zero for an extended period, said Chris Low, chief economist for FTN Financial in New York.

“Those who think the Fed is making a mistake are tending toward the inflation trade: They’re favoring commodities, favoring TIPS,” Low said. “Those who believe the Fed is right are going for conventional fixed-income and extending in duration.”

Lowe agrees with investors who think the Fed is correct.

“If you’re confident that yields are not going to rise, the return on a five-year note at 2.12 percent is so much higher than the 0.69 percent yield on the two-year,” so extending maturity “can pick up a lot of income,” he said.

Unsurprisingly this is a bull on rates and a bear on "inflation".

What I think is happening is that the people see it one way and the powerful see it another. The people have been deleveraging and paying higher prices for almost everything after the mild price deflation rapidly ran its course. Some of the people have been investing in gold, and more have been investing in "the poor man's gold", which is to say silver.

With both political parties committed to large Federal deficits for years to come, but also committed to tax increases only on "the rich", if that much, the funding for those deficits will either come from savers or from central banks that print new money out of the thin electronic air. To the extent that it is the latter, it does not matter all that much as to whether the creator of the money is the New York Fed or the central bank of a friendly or client state such as Saudi Arabia. The money will find its way into the markets and act like counterfeit money, bidding up the unchanging supply of goods and services.

My sense therefore is that the precious metal bull market remains intact and may strengthen. This is similar to the rise of high-tech to rise from a negligible part of most people's lives to an essential part of mainstream America. Unfortunately, of course, a gold bull market reflects anxiety and panic. It reflects the opposite of virtuous cycle of the disinflationary/deflationary second half of the '90s. It's a thumbs down on the U. S. dollar.

The people and the powerful were on the same side of the tech boom. Now, the Establishment is facing a more difficult challenge. As I have demonstrated above, it is trying to convince people that the tide of rising prices is transient, but it cannot back that assertion up with tight money as it had the resources to do periodically in the 1970s and finally was able to definitively do in the early 1980s with Volckerism/monetarism. Rather than fighting the price inflation it was responsible for with real monetary actions, it is left to fight with words.

I suspect that every day, every week, and every month more and more people are tuning Bernanke-ism out and are taking a fresh look at the world. American investors who do this have been turning to precious metals and foreign currencies as ways to diversify away from the dollar, and I think that the gold train remains a body in motion that will stay in motion in the same direction, and may even hit a downhill grade and pick up speed.

Remember: It took a true dollar crisis, with the U. S. for the first time in the 20th Century issuing bonds denominated in foreign currencies ("Carter bonds") and near-hyperinflation, for the Fed to be forced to raise interest rates well above the rate of price increases. We are not there yet, as the headlines still relate to Greece and Portugal, not the U. K. and the U. S. So I don't see the major trend as being imperiled yet, though of course one truly never knows.

"Don't fight the Fed" is generally a wise strategy. The Fed is holding short-term interest rates way below the rate of price increases. It is increasingly difficult for its acolytes to explain away the reality of what you and I see in our daily lives, and so the Krugmans of the world do what believers in the old paradigm do: they admit small errors (he didn't give enough weight to the "wage rigidity literature" LOL) and tweak formulae. So to not fight the Fed means, to me, not to go short Treasuries but instead to go long assets which tend to appreciate when real interest rates are negative.

I think that more and more real people are realizing that their Federal Reserve Notes are "unreal" money that is losing value at a rapid and perhaps accelerating rate, and that one of the few places they (we) can go to try to protect our alleged wealth is physical assets, as well as shares of companies that can survive and perhaps even prosper in inflationary times.

A closing "addendum". One of the strange things about blogging in the morning is how much markets can change during the time it takes to write the blog. I was going to comment on how, surprisingly, gold was down over $7 in the futures market. That was the story an hour ago, when I began this blog. I was going to point out how illogical that appeared, given today's headlines. Now gold is up $4. Go figure. Did the market come to the same conclusion I have been propounding here? Dunno, but it's time to find out.

Staying tuned . . .

Copyright (C) Long Lake LLC 2011

Saturday, April 16, 2011

Libya: You CIA You Want a Revolution

The Jerusalem Post reports:

US Secretary of State Hillary Clinton said the NATO allies were searching for ways to provide funds to the rebels, including helping them to sell oil from areas they control.

"The opposition needs a lot of assistance, on the organizational side, on the humanitarian side, and on the military side," she said.

It looks as though the U. S. has moved from nation-building to revolution-building.

Meanwhile, two factoids.

First, the news showed video yesterday of Muammar Qaddafi standing in an open vehicle being driven around Tripoli, leading a pep rally, in an area of buildings any of which could have housed a sniper. Is it possible that security forces could have cleared or vetted every apartment, office and passageway to have guaranteed his safety? When was the last time an American President did that sort of thing? November 22, 1963?

Second, a Wikipedia search of Libya reveals that it ranks first in Africa in the Human Development Index. First? One would have thought from the MSM's unquestioning acceptance of the "rightness" that Qaddafi is worth fighting to remove that they would be near the last.

The Balkans, Afghanistan, Pakistan, Iraq, Libya . . .

Do you think 4-star General and then President Eisenhower had a point when he singled out the military-industrial complex in his farewell address?

I'm for a strong defense, but what the U. S. has been doing since the late '90s is looking more and more problematic.

Copyright (C) Long Lake LLC 2011

Saturday, April 9, 2011

On Treating Economic Crises the Way We Treat Heart Failure

It's past time for beta blockers rather than stimulants for the economy, based on the following analogy.

Let's take Ben Bernanke as the doctor on the case of the U. S. economy, having succeeded Alan Greenspan while the mid-decade "boom" was beginning to arise from the tech wreck of 2000-2002. Let's further posit that Dr. Bernanke committed economic malpractice. He failed to properly diagnose the patient as suffering from a surfeit of poor lending practices, with massive misallocation of capital and an amazingly leveraged set of financial companies betting their entire shareholder capital on the chance that housing would avoid a collapse.

Let us segue to a more directly medical analogy. Come 2007, when small finance companies had been blowing up and then Bear Stearns developed problems with some of its deals, Dr. B made a small therapeutic step of cutting the cost of "discount window" rate of credit allocation a bit. But the patient worsened and by the following year, Bear Stearns itself was in critical condition. Nonetheless, the good doctor insisted that the housing market was in solid enough condition that any recession that might be underway would follow an ordinary course. Conservative therapy was continued.

But instead the patient developed worsening chest pains. Rather than order a high-tech treadmill stress test or an angiogram, the doctor continued on course. Finally, in late summer/early fall 2008, the patient suffered a massive myocardial infarction (i.e. a "heart attack").

Now was the time for heroics. Indeed, the Bernank rose to that occasion. He defibrillated the patient and brought in specialists from around the world to get the patient over the crisis. In medicine, very weak hearts may need their pumping function supported by providing intravenous adrenaline. This was done for the financial system. Nonetheless, so much damage was done that a case of congestive heart failure (i. e., a severe economic downturn) occurred. Extensive economic adrenaline was administered in late 2008 and 2009.

The problem is the following. Adrenaline and its analogues are only beneficial during the acute phase. Paradoxically, the way the heart heals best and improves its pumping function is by giving, as soon as possible, medicine that initially weakens the pumping function of the heart.

The pharmaceutical industry spent a good deal of time in the 1980s and 1990s developing phosphodiesterase inhibitors to treat congestive heart failure. These stimulants indeed strengthened the heart as a pump, and most patients on them had more energy and felt better.
Truly unfortunately, treated patients tended to die sooner than patients on placebo. What was happening was that the same medicine that stimulated the heart to pump harder also overstimulated the "electrical" system of the heart that controls the timing of the heartbeat. This led to an unacceptable incidence of sudden cardiac death from irregularities of the heart rhythm (ventricular fibrillation).

This is about as direct an analogy to the current practice of treating a crisis caused by too much cheap credit with even more and even cheaper credit that I can find. It feels good, but it introduces tons of risk. The risk is now on the sovereign, not merely on corporations that could have been liquidated without the sovereign or society as a whole being greatly impaired for very long.

It also turns out that the treatment of weak hearts following myocardial infarctions may point to a better method of recovering from the crisis.

A type of medicine called a beta blocker was developed decades ago to treat a variety of cardiovascular problems including high blood pressure, coronary artery disease, and rapid heart beats. Beta blockers tend to slow the heart rate and weaken the force of contraction of the heartbeat. Therefore it was against all principles of American medicine to give a beta blocker to treat a weak heart.

In Scandinavia, however, physicians had a different point of view. As early as the 1970s, they had reasons to think that beta blockers were beneficial for weak hearts. Lo and behold, they persisted and by the late 1990s, with numerous setbacks along the way, they began to pick up adherents and organized clinical trials to prove their case.

As it happens, beta blocker treatment of weak hearts and the clinical syndrome of congestive heart failure both decreases the incidence of sudden cardiac death and allows the heart to heal and actually increase its pumping function over time. Slow and steady wins this race, not the short-term fix of stimulants except as the latter are needed during the acute crisis.

The economic analogy that I see supports the Austrian view of credit collapses. If credit is allowed to get scarce following a credit boom, the economy will tend to heal by handling the prior malinvestments appropriately. New expenditures will have to meet a high hurdle rate to go forward. Those new capital and other expenditures will therefore tend to succeed and by the standard miracles of capitalism, will tend to allow additional capital to be created, which so long as capital is kept scarce enough, will then also be handled with care.

As with the proper use of capital after the collapse of a credit boom, this is how beta blockers in fact work in heart failure. They are given in mini doses initially. As the heart recovers, the dose is gradually increased, always blocking the effects of adrenalines (our naturally-produced stimulants). The cardiac cells learn to function more efficiently as they are freed from the adrenergic stimulation that in healthy hearts is normal but in weakened hearts has deleterious effects. The heart ends up both stronger and more resistant to ventricular ayrrhythmias.

Eventually the Scandinavian view of the proper treatment of weak hearts won. It took a while, but all doctors were united in their desire to do right for their patients, and most thought leaders knew enough to be open to new approaches. Also, the pharmaceutical companies were looking for new uses for old drugs and were willing participants in searching for a new paradigm to treat heart failure.

The challenges for Austrian-oriented thinkers in the field of national economic policy are profound, but there is reason for hope. Outmoded intellectual paradigms such as pre-Copernican astronomy tend to fail due to their inability to explain newer, contradictory data without excessive complexity. We have just been through a decade in which the financial system has lurched from the extremes of record-high stock valuations (a false "new paradigm) to record-high money valuations (i. e. global money yields near zero). None of this wildness makes sense, just as the bizarre paths that astronomical bodies had to follow for the earth-centric view of the solar system to be followed also came to look ridiculous.

I believe that a growing number of people are therefore deciding that something is fundamentally rotten in the state of Keynesianism, as the real world refuses to follow the predictions of the money-printers.

As ideas that were proposed to solve the economic crisis of eight decades ago are twisted and mutated into more and more bizarre forms and work less and less well, I become more and more hopeful that economic common sense will eventually prevail. Per Gandhi:

First they ignore you, then they laugh at you, then they fight you, then you win.
Copyright (C) Long Lake LLC 2011

Friday, April 8, 2011

Stagflation Update: Focus on the U. S. and Brazil

On February 28 of this year, I wrote a post for The Daily Capitalist titled "Getting Real". Its focus was the bullish case for the Brazilian real. Since that time, the real has appreciated about 1% a week. The closed-end fund that tracks the value of the real vs. the U. S. dollar, stock symbol BZF, was $26.88 then and may open around $28.40 today. The real is near its 2008 high against the USD.

Yet the case for the real may still be quite strong, at least against the USD. Interest rates in the U. S. are collapsing on the short end. They are a negligible 0.03% and 0.11% annualized for 3- and 6-month T-bills respectively as I write this at 8 AM Eastern Daylight Time. Meanwhile, the monthly price inflation rate in the U. S. as measured by MIT's Billion Prices Project is running around 0.48% monthly. Compounded over one year, this is well over 6% yearly. So the U. S. is running hugely negative interest rates. Brazil, on the other hand, has a flattish yield curve and interest rates in the low double digits while price inflation is running around 6%. Thus their interest rate structure is strongly positive. Brazil received a credit upgrade from Fitch this week to BBB. Brazil is also not a net importer of oil and is expected to be a net exporter later this decade, so the current oil price trends should be real-friendly on the margin.

On the budgetary side, the pro-life and pro-choice wings of the Republicrat/Demopublican party (AKA the Establishment) take turns posturing that they are fiscally responsible, except when they seize complete control of the government, at which point they always find some emergency requiring massive deficits and credit expansion. Part of the emergency spending always involves the military. The view from foreign shores is of a floundering country that purports to be the world's leader. Yet it can't even pass a budget, more than halfway through a fiscal year. None of this is dollar-friendly.

In contrast, the new leader of Brazil, Dilma Rousseff, recently addressed her country's budget deficit by doing such measures as canceling a major order for fighter jets that Brazil had been looking into for quite some time. Good for Dilma. Brazil has no natural enemies. They should spend on education, not the military, so they can move up the economic food chain.

So, strictly on interest rate differentials, it's hard to see a reason for the real to drop against the USD. If the real stays unchanged vs. the USD, ownership of BZF should yield at least a 10% return in USD terms over one year. That's a powerful lure in favor of the real.

In the broader sense, the ultra-low velocity of money that current U. S. T-bill rates imply does not bode well for the short-term future of the U. S. economy, in my opinion. These rates also suggest that a lot of capital would (to be anthropomorphic) rather receive essentially no interest payment than take the risk of today's stock and bond prices. Whether commodities, which are on a roll again, are included in that calculation is unclear.

With the average of Brent crude and West Texas Intermediate around $118/barrel this morning, oil importing countries are facing significant headwinds. Thus, the message of the markets I see for the U. S. involves a sea of troubles. So much funny money has been electronically printed in the past few years that it's hard to say what oil price is the tipping point for the American economy, but given how little wage increases have occurred, I'm nervous right about now.

Fed policy may be back to that of the 1940s, controlling short rates to an extreme level below that of price increases, but geopolitically, it looks more like the stagflationary 1970s to me, with the U. S. dollar having nowhere to go but down. Thus economic constraints can suddenly appear, leading the economy to slow and financial markets to turn on a dime.

Caution is especially prudent at times such as this. As is, in my opinion, continued exposure to precious metals vehicles and oil stocks.

Copyright (C) Long Lake LLC 2011

Tuesday, April 5, 2011

Inflationary Adventures in Extremistan

The Fed's policies are in Nassim Taleb's "Extremistan" and may finally be leading us to a Pied Piper inflationary cliff.

In a recent post, I posited that people have gotten so used to the "temporary" emergency measure of (more or less) zero interest rates (ZIRP) that behind the seeming stability of this policy, one should prepare for extreme market moves. (This is a corollary of Hyman Minsky's thinking: false sustained stability tends to lead to later significant instability.) One such extreme move may have restarted, as g0ld busted out to yet another all-time high today. Gold rose 29% in price in 2010. It is now up 28% in price year on year as its weakest quarter, Q1, has now passed into history with no serious harm to the gold bull market having been done.

A correlation of the rate of gold price increases with the degree to which the Fed holds short-term interest rates too far below the rate of price inflation suggests a $2000/ounce price of gold in one year (the "Elfenbein rule" from Eddy Elfenbein of

Let's temper that for reasons such as reversion to the mean and project about $1750 per ounce.
Even under that scenario, there is lots and lots of room for gold stocks to break out and outperform bullion; and of course a 20% appreciation in gold would be quite a successful investment on its own right.

In a recent post, I noted that high-quality gold stocks had record earnings but non-record stock prices and thus were probably better investments than gold bullion itself. In line with my theme to expect extreme moves, several senior miners such as Barrick (ABX) and Goldcorp (GG) rose 5% today. Quite a move! (That's more than the total interest one would get over 3 years by lending money to the Treasury for that time period.) ABX and GG are now each within a fraction of point from their 2008 highs. Assuming gold trends higher, the trend for these two stocks is much higher.

The big financial institutions have not yet made much of a commitment to gold stocks and thus can be major sources of buying power; they will certainly start any program of investing in gold stocks with the dividend-paying major miners (a term that Joseph Heller would have loved). Further, my information is that at least until today, gold-oriented hedge funds have been actively shorting the stocks while owning bullion as part of a paired trade. That trade may have been put to bed - or in the grave - today.

My market optimism on this sector is further supported by the price action of the junior miners and the even more speculative gold explorers, who are generally not yet producers. These can be "played" via the ETFs GDXJ and GLDX. GDXJ is about 5% below its prior high of December 6, 2010 despite gold bullion now trading at a record. GLDX is within its trading range, as well. No special froth in either fund can be discerned from their price charts.

Premiums of various physical gold or gold/silver funds are also low, also something atypical for a bubble.

I believe the above demonstrates that there is no bubble in the gold market. (Of course, the absence of a bubble does not mean an asset is a good investment.)

An interesting set of low-risk investment strategies can be undertaken if one presumes that gold will continue to rise in price faster than money is losing purchasing power.

One could, for example, put most of one's money in cash or cash equivalents and put a minority of one's money in a precious metal vehicle, the stablest being gold bullion and the riskiest being a group of junior silver exploration and mining stocks. One possibility is that 80% of one's money could be in cash, losing purchasing power, while the other 20% could be directly invested in various precious metals vehicles and could rise enough to allow the total portfolio to rise, say, 6%, which may be the next-year's rate of price inflation. Most of the money is "safe"; the rest is not going to go to zero unless it is invested amazingly imprudently.

Of course, if one is young and has a career of earnings ahead, one may wish to roll the dice and put all one's savings into speculative metals vehicles, as the life-style downside should the entire investment be lost may not be all that great, whereas the upside is large and might for example quickly allow a house purchase that would otherwise be out of reach. Older retirees, on the other hand, may have no need to have their nest egg keep its purchasing power stable, at the other extreme, and may just ignore gold and silver entirely.

Gentle Ben thinks the rise in prices is transitory. I think this is more likely a case of sic transit gloria Ben. How long can he go on being wrong about almost everything almost all the time and still be invited back to 60 Minutes?

The weight of the evidence of basic economics and the message of the markets in late 2007 and throughout 2008 made me more and more scared that what was happening in sub-prime was unlikely to stay in sub-prime, and that due to the refusal of the authorities to take preventative action, that likelihood had an unacceptable chance of ending in a deflationary implosion. The opposite- an inflationary "boom" leading to a bust- may well be going on right now.

Central planning of large economies is a bad policy. When the central planners get it wrong, it compounds the problem. The blind mice in Washington may be forcing us into an inflationary explosion; today's price action may be one more bit of evidence that the unseen but inferred cord is a lit one.

Evasive action may indeed be called for.

Copyright (C) Long Lake LLC 2011

Saturday, April 2, 2011

Oil Over Ivory

The incoherence of the alleged reason for US military intervention in Libya is demonstrated both by the well-reported unrest in Syria, but also in the Ivory Coast, per

The International Committee of the Red Cross reported the massacre of at least 800 people in the western Ivory Coast town of Duekoue as neighboring Ghana offered incumbent leader,Laurent Gbagbo, political asylum as fighting continued in the commercial capital, Abidjan.

Could it be that the "international community" is watching this situation from the sidelines because the Ivory Coast has little or no oil?

Copyright (C) Long Lake LLC 2011