EconBlog Review

Winning the (Afghan) Future

2011-11-26T17:42:00.002-05:00

How you going win this one? The WaPo reports:

To grasp the severity of Lt. Gen. Michael D. Barbero’s $40-fertilizer-bomb problem, it helps to consider some much bigger numbers.
Barbero heads a U.S. military command, with an annual budget of about $2.8 billion, that was created to stem U.S. casualties from insurgent bombs. In just the past few months, he has shelled out $24 million for a new hand-held ground-penetrating radar, $33 million for mini-surveillance robots and $19 million for bomb-resistant underwear.
The insurgent’s weapon of choice in Afghanistan is at the other end of the price spectrum: a plastic jug filled with ammonium nitrate fertilizer. So far this year, these cheap, hard-to-detect bombs have wounded about 3,200 U.S. soldiers and Marines, up 22 percent from 2010, according to the Pentagon. . .

Note the focus on underwear, as genital injuries are common now.

With Osama bin Laden dead and few al-Qaeda reported left in Afghanistan, for whom and what are the U. S. fighting in Afghanistan?

Austrian Economist Robert Wenzel Predicts T-Bill rates to Jump at Least 100 times in One Year; Is This Likely?

2011-07-05T15:25:00.008-04:00

The well-known economist-blogger Robert Wenzel is out today with a post that predicts that T-bill rates will hit at least 7% within one year. Currently, on a day when gold is up 2% in price, the 6-month T-bill rate is 0.07%.

This is the cut and paste from the relevant blog post:

Investors won't want to own short-term Treasury securities paying less than 7
percent to 10 percent (The 6 month yield is currently only one-tenth of a
percent) . At some point after that things will move very rapidly and the United
States government will be paying interest rates comparable to those paid by
banana republics.

This rate has dropped today even though gold and oil are both up
about 2% today.

And it's not just ultra-short rates that have dropped
today in the face of what appears to be buying pressure in multiple commodities.
The 5-year bond is down to 1.69% from 1.77%.

Think of what a 0.07% annual rate means for a 6-month bill. It means that if you lend the government $1000 for 6 months, you are owed the grand total of 3 cents plus a ha'penny (3.5 cents).

A 1.7% or so 5-year note rate means that the lender gives away the thousand, not
to see it again for 5 years, and in return accepts $1.70 a year from the gov't as a sign of its good
faith that it appreciates the thou.

You need to understand that it is
not retail money that is rushing into the money markets to snap up these
securities the way it rushed into condos 6 years ago or tech stocks 12 years
ago. This is smart, sophisticated institutional and banking money that does not
much like stocks or real estate at these prices. It wants better deals on these
and other assets. This is not money that expects to realize a loss on its 5-year
notes within one year that far exceeds the total interest owed. This is
money that not only is very well-connected but has a significant say about what
the Federal deficit is going to be. When this money talks, Presidents, Treasury
Secretaries and Congressmen listen. This is also money that is part of the
"game". My guess is that this money does not want the chaos that the Wenzel scenario would
envision. I suspect that this money would prefer a Japan scenario for the US
than a Greek one.

Who of us can be sure in advance, of course? It is
always wise to recognize that "it's always something". But I'm taking the
"under" on interest rates vs. the above view.

I propose a friendly wager on the Wenzel prediction. I say he's wrong. This will be a negative wager. Loser has to eat crow.

Copyright Long Lake LLC 2011

Is Silver a Short-Term Buy Again?

2011-07-04T01:07:00.000-04:00

I want to focus on longer-term matters here most of the time, but it's also important to stay on top of trading calls I have made on the record. Thus I want to provide an update on silver, as I posted "Silver Is Probably Overpriced" on June 2. At that time, the ETF known as SLV was at $36. I thought that was a brave call, given that silver had recently plummeted and looked oversold to many.

That bearish post came from the longer term context of several bullish mentions on silver when it was around $20/ounce last year, which call I did not reverse until this spring. A longer-term context regarding precious metals comes from my market calls at econblogreview.blogspot.com, where I was speaking favorably of gold as an investment beginning in spring 2009, with one well-timed "sell" call at the intermediate-term top in early December 2009 and then a buy-back call. I always thought silver was too speculative to bother with until last summer and thus rarely commented on it till then. But after QE 1.5 began in August last year, my views changed a good deal and I thought, correctly as it turned out, that the greater volatility of silver than gold had suddenly become a good thing for investors.

Over the last two days, I have seen evidence that the "smart money" on the Comex futures market has now turned relatively bullish on silver as of mid-week last week, just as silver was bottoming for the week. Silver has now formed a 2-month horizontal base at current level. It is off about 8% from June 2. It is off by about 33% since its highs of late April. Over the last several years, these 1/3 off sales on silver have all been great entry points for traders, the one exception being the liquidation phase of all markets in summer-fall 2008. Even then, silver fell one-third from its then-recent high, rested a couple of months, then fell another third in the panic in the fall (all ratios are approximate for verbal convenience). That final fall, to under $10, may prove to be its all-time low. Even if one had bought too soon after the first 1/3 off sale, around $14/ounce, and grimly held, and kept holding till now, one would have about a 36% annualized total return from that $14 price. This compares with a few percent a year from stocks from those pre-Lehman days.

In order to look at long term valuations and be sure they were in line, I looked at prices of silver, gold and oil 55 years ago. Since gold did not trade freely, I adjusted its price to $40/ounce from the official $35. The rationale for this was that FDR raised gold from $20.69 to $35 in 1934, and the consumer price index rose far more than that large percentage increase between 1934 and 1956. So I think that $40 is probably too low for what gold's free market price would have been in 1956, but there's no way of being sure, so I think I'm being conservative using $40.

In any case, since 1956, silver is up 6.8%, gold 6.8% (using $40), and oil 6.4%, all on a per year basis. Not a dime's worth of difference between them. And I suspect that 6.4%-6.8% is also all you need to know estimate the true price inflation rate since then as well. So, there's nothing to suggest that silver is overpriced on a very long-term basis.

So, my evolving views on silver are that short-term, it may well have now fallen too far/too fast so that I am canceling my bearish call, and that long-term, it remains a sound investment with periodic great selling opportunities when the crowd gets really excited and great buying opportunities after plunges. I am however concerned about the intermediate term, meaning a period of months, and in fact I am not bullish on any commodities right now on a multi-month time frame except for trading opportunities. (Of course multi-month views can change as prices and facts change.)

There is no chart here, deliberately, as different people look at charts different ways. However, I do look at charts a lot. If the 2-month base upon which silver is precariously placed (and which is pointing bearishly down) breaks down, I expect that a lot of determined selling will come in and will take aim at the next support level, which is ill-defined but appears to be in the high $20s up to $30.

Please note that as usual these are my personal thoughts and not investment advice, and again that I am long silver and may take any or no action to increase or decrease said holdings at any time.

Afghanistan Messier than Ever for Obama

2011-06-26T13:58:00.002-04:00

First, please note that several posts have gone up by me on The Daily Capitalist. You may click HERE, HERE and HERE for them or go to the first 'HERE' and scroll down.

Next, several news items are out showing how uphill the Obama surge is in Afghanistan. First, from Reuters:

Afghanistan's political crisis worsened Saturday with lawmakers voting to sack the five most senior judicial officials and international consternation growing after a presidential tribunal threw out a quarter of parliament.

The special court, set up by a decree of Afghan President Hamid Karzai after parliamentary elections last year were marred by fraud, ruled Thursday that 62 lawmakers would have to be replaced because of alleged poll fraud.

Karzai did not immediately comment, perhaps because he is in Iran attending a security conference. Hmmm . . .

And speaking of Iran, they're quite the wonderful country with which and in which to feel secure. Here is today's news out of Iran from the Guardian:

Prison guards in Iran are giving condoms to criminals and encouraging them to systematically rape young opposition activists locked up with them, according to accounts from inside the country's jail system.

A series of dramatic letters written by prisoners and families of imprisoned activists allege that authorities are intentionally facilitating mass rape and using it as a form of punishment.

And getting back to Afghanistan, of course there are many reasons for lack of military success (perhaps the main reason is that military force can't defeat a popular insurgency), but here's one that would have been utterly marvelous news 70 years ago:

German Soldiers Can’t Shoot

Leaked reports question the competence of the German army, which has thousands of troops serving in Afghanistan.

June 26, 2011 10:30 PM EDT

“German soldiers mostly don’t know how to use their weapons.” They “have no or little experience driving armored vehicles.” For German field commanders, “the necessity and ways [to protect their units from roadside bombs] are to a large extent either unknown or incorrect.”

These are quotes from a series of secret internal reports on the German army, the Bundeswehr, whose 5,000 soldiers in the northern Kunduz sector of Afghanistan were supposed to help the U.S. rout the Taliban and stabilize the country over the past 10 years.

Out now.

Two New Posts on The Daily Capitalist, and Comments on President Obama's Leadership

2011-06-22T15:25:00.005-04:00

Click HERE and HERE for the last two posts. Message of the second (more recent) one: Gold miners represent good relative value in what remains a generally overvalued financial marketplace. Message of the first one: financial stocks are pointing downward, and that has tended to be a poor portent for the economy.

I also want to comment politically. It is not clear what is motivating Barack Obama. He is maintaining a large military presence in Afghanistan. Do the polls tell him that a partial withdrawal, to a troop level that exceeds the level it was at when he took office, will win him votes?

Economically, not long ago the Senate rejected the Ryan plan with about 40 votes in favor. But it rejected the President's budget with no votes in favor.

It's not clear to me that this president is a leader. With FDR, it was clear that he (at least in posture and headline actions) favored the common man, who was a poor man in those days. With Mr. Obama, he favors the poor- but he also favors the rich, and he has turned out to be far more corporation-friendly than almost anyone expected. So he favors everyone. But he and the country are only what they are. And there are no tall aliens with the ability to serve man by making the deserts fertile. So, choices must be made. This business of trying to please all, which in my field of interest, finance, I correlate to pleasing both the stock and bond markets, simply is not working. It worked for Lula of Brazil, but that followed a prolonged period of hyperinflation. There was public and private support for conservative, growth-oriented policies. And who knows what Lula swept under the rug to get to 70+% approval ratings?

Unfortunately I am getting an LBJ-Carter feeling of a failed president. LBJ and BHO are both guns-and-butter-oriented. Both led the economy into big-time price inflation as the central bank obediently helped to monetize the resulting deficits. But no one would mistake LBJ for other than a leader. Mr. Carter, who may have been well-meaning, ended up looking unfocused and indecisive, and chose (was "forced" to) move to the right giving near-hyperinflation toward the end of his tenure. The world is not ending, and as I have noted recently, a number of headlines are overly histrionic. So what is "priced in" in the markets is impossible to know, especially given the vast amount of money the Fed has printed that has been seeping into the real economy. We do not need a QE3 for lots and lots of price inflation to occur.

Got gold? (And shares of gold miners?)

Dealing with Financial Repression

2011-06-20T01:44:00.001-04:00

Given the article posted today by Econophile on the WSJ and inflation, I thought it timely to submit some quantitative considerations for anyone with savings who has to deal with interest rates on savings that are below the rate of price increases for consumer goods and services.

The WSJ writer's view is that the authorities "should" inflate away debts. I fully agree with The Daily Capitalist's different viewpoint about what "should" be done. It is further my view that what Mr. Arends of the WSJ advocates has in fact been "the plan" ever since the economy began collapsing in 2008. I believe that the Consumer Price Index understates price inflation and that if one removes housing from the CPI (because houses are financial assets rather than costs for most adults), the real cost of living has been rising at least at 5% per annum for the past year for the "average" American. I further believe that this policy of imposing negative real interest rates on savers, which is being called "financial repression", will continue for some time.

Thus gold ownership in various forms remains appropriate in my view even for small savers unless they may need access to those savings soon (e.g. retirees or people who are not able to save from their income). To review the reasonableness of current gold prices, which are around $1540/ounce, I have gone back to 1976 prices and interest rates, when gold was in the $100-140 range.

I chose that year because it allows time for the legalization of gold ownership by Americans, which was made legal again on Dec. 31, 1974, to have taken effect and for the post-Viet Nam War dislocations and severe recession of 1973-75 to have worked their way through the system. I also looked at the 10-year bond rate present in 1976 and the 10-year rates present in 1981, 1991 and 2001.

It turns out that depending on exactly what price one uses for gold in 1976, the rate of gold's price appreciation is about that of the average return from Treasurys for that 35-year span. In other words, gold's price "inflated" roughly at the same rate of return that fiat money paid on itself.

Coincidence? I think not.

So I think it's conservative to project that 10 years from now, gold will increase in price by 3% per year, which equals the current 10-year Treasury bond rate. That gets one to $2000/ounce in 2020. Now of course, Treasury interest is taxable, whereas the appreciation from personal ownership of a gold coin may lead to an untaxable transaction, or the coin could perhaps stay in one's possession, and one's family possession, indefinitely.

Given the policy propounded by the WSJ, though, I think that most of the "risks" to this gold price are to the upside, potentially dramatically so.

Even in the $2000/ounce case by 2020, my recent review of multiple gold mining companies suggests that after taking account of extraction and refining costs, taxes, etc., gold in the ground can on average be purchased a good deal more cheaply through the stock market than gold bullion. Please however be aware that whatever competence I might have in certain financial matters does not extent to the gold mining business. And of course, a stock is a thoroughly different type of asset than a gold coin or bar in one's hand.

Continuing on the subject of currency debasement and investing, it is relevant to consider quantitative stock market predictions from qualified people. I receive free E-mailed updates from Jeremy Grantham, who is known for multiple accurate asset allocation calls that look 7 years into the future and thus pay no heed to predicting the unknowable intermediate fluctuations. (His letters can be E-mailed to you; one can sign up by starting HERE.) He has very recently projected a 7-year average annual return from the US stock market of 2.5% per year, which is equal to his projection for price inflation. This projected zero real return from stocks includes dividends. This in turn means that the 7-year Treasury bond interest rate of 2.6% for a zero coupon bond is by his model equal to the return from stocks, and with less risk (other than the inflation/default risk that gold should provide a hedge for).

Second, the fund manager and Ph.D. economist John Hussman puts out an erudite weekly market letter accessible HERE (from which see "Weekly Market Comment"). His calculations, which include the effects of monetary inflation, project a 10-year return from stocks of 4.0% per year. Of course, this is approximately that available from a zero-coupon 10-year Treasury bond.

We do tend to seek out and emphasize opinions and facts that support our bias. So perhaps I have presented the opinions of an overly-gloomy duo of financial prognosticators.

When I put my own thinking cap on and consider matters as objectively as possible (a necessity as I am investing my own money based on my thinking), I come up with the idea that the best way to keep up with monetary debasement is through a trade or business with pricing power. From an investment perspective, I see the stock market as lacking an appropriate margin of safety over "safe" fixed-income vehicles. I therefore think that for taxable accounts, muni bonds and other properly-selected bonds have a better risk- reward profile than does the stock market as a whole. But because it looks as though the US authorities are not rushing toward financial prudence, I continue to (unhappily) believe that gold and gold mining stocks are substantially under-weighted in the holdings of almost all Americans who are fortunate enough to have financial assets. I also believe that from exploration companies all the way up the quality spectrum to the majors, gold miners that are "real" companies tend to represent better fundamental value than does gold bullion. This happens to represent the first time I have believed this ever since I became interested in gold and weak dollar-oriented investments after Alan Greenspan responded to the 9/11 attacks by forcing interest rates yet lower.

Nothing herein or in my other blog posts constitutes financial advice. Also please be aware that the concepts I have described in this post are not related to my views on short-term investment decisions. I have no (public) interest in predicting day-to-day movements in financial markets, but nothing has changed in my view that for weeks to months ahead, investors and speculators are likely to have to accept that the "establishment" predictions for US and global economic growth for the rest of 2011 remain too high (even though they have begun to come down lately). In my humble opinion this phenomenon, if indeed it proves out, will continue to pose a headwind for the price of most stocks and almost all commodities, and will have conflicting and unpredictable net effects on gold.

New Articles on TDC

2011-06-18T00:05:00.002-04:00

Articles on gold and Treasurys, and on general topics, are up on The Daily Capitalist.

Romney Looking a Likely Winner as Economy Bad and Worsening

2011-06-16T21:32:00.004-04:00

First, I have a new post up on The Daily Capitalist; click on that link or cut and paste the link below.

http://dailycapitalist.com/2011/06/16/worsening-wealth-disparities-reflect-downside-of-excessive-money-creation/

Since I don't discuss politics at that site, I wanted to prognosticate a bit. Yesterday, Lakshman Achuthan, the face of the Economic Cycle Research Institute, told Fox Business News that their US "long leading" indicators have not turned up yet, having turned down in January. Since these are supposed to lead downturns in the economy by a year or so, he said that he foresees the best case-- a lucky case-- that a cyclical slowdown/stagnation in the economy will last until the end of this year. My thought is that it is therefore reasonable to presume that economic activity will be stagnant until at least the end of Q1 next year.

Following from this, the Republicans will see the Presidency ripe for the taking on economic grounds. In that case, they will rally behind their alleged economy guy, Mitt Romney. He will reiterate that so long as he gets a cooperative House and Senate, his first official action will be to repeal Obamacare. (His support of Romneycare will be forgiven in the names of victory and getting the economy moving again.) My further guess is that he will choose a polished social conservative as VP, due to his health care issue vulnerability and for other reasons such as his Mormonism and positions he may have taken as Governor of Massachusetts.

Between the worsened financial status of average Americans as the country apparently heads into a cyclically worsened state of economic stagnation, my guess is that all other things being equal, there will be a President Romney in January 2013.

It goes without saying that there is many a slip twixt the cup and this lip (yet I said it nonetheless).

Copyright (C) Long Lake LLC 2011

Thoughts on the Failure of Yesterday's Turnaround Tuesday Rally

2011-06-16T01:01:00.001-04:00

As I write this at 2:10 PM Eastern time, yesterday’s “turnaround Tuesday” rally has been reversed. We are finally seeing the beginnings of capitulation in stock traders, as the volatility index with the symbol VIX finally break above 20. Last year, it surged above 45, and I use 25 and above as a rule of thumb of when to trade stocks from the long side if I am liking the bullish case.

We are seeing the deflationary market events occur that I recently suggested were most likely. One of several recent posts on this topic was titled Goldman Wrong on Rates, Zero Hedge Wrong on Oil As Deflationary Side of Biflation Begins Its Ascendancy. Next-month oil prices on the futures market have dropped to a multi-month low around $95/bbl. Gold, Treasurys and the US dollar are safe havens for the moment, and I suspect will be so for a while yet.

Short-term interest rates up to the 6-month range remain lower in the US than in Japan. If you, along with the great majority of investors, think that interest rates here have nowhere to go but up, you might be interested in perusing a multi-year chart of Japanese interest rates in the 5-30 year range. This is linked to from freely available data from the consultancy www.KShitij.com, which specializes in Forex.

To summarize, the Japanese have been locked since the 1990s into a near-zero interest rate policy. It is clear that investors did not want to believe that there could be such a persistence of this policy. Investors in the 10 year bond, and in the 30 year bond that was introduced during the time frame of the chart, apparently “knew” that rates had to rise. But they did not.

What is being called a “credit collapse” is a reasonable title for the dissipation of real capital in the booms, first of the late ’90s and then in the aughties, but it is a bit too gentle. The amazing leverage of companies’ capital bases led to insolvency when that limited real capital vanished. Until the stock market gets real with its valuation of operating companies, I remain unconvinced that a Japanese-type fate does not await, meaning a multi-decade stagnation/decline of prices of these pre-owned equities. There simply is a fundamental difference between stocks and bonds. Low rates on the latter is historically consistent in the US as well as Japan with low valuations on the former. To the extent that stocks are an inflation hedge, got gold? To the (more important) extent that stocks reflect the current value of the assets of the companies plus the (unknowable) present value of future profits, it just might be that today’s low interest rates are forecasting below-trend and below-expectations growth of said profits.

Today’s outside reversal (so far) of yesterday’s rally in stocks and oil is, as stated, finally beginning to get some bulls to throw in the towel. With no (public) interest in suggesting what tomorrow or the next day will bring, I think the most likely course is for more disappointing economic news in the months ahead, and that gold and only gold is the optimal hedge against a new round of money creation by the Fed.

COpyright (C) Long Lake LLC 2011

The Answer is None

2011-06-13T11:35:00.002-04:00

The Christian Science Monitor is out with a brief review of the Obama "surge" in Afghanistan, titled "As troop drawdown nears, is NATO surge working in Afghanistan?"

Here is the article's conclusion, which refers to an interview with Chairman of the Joint Chiefs of Staff Mike Mullen:

For now, the Pentagon will be working closely with the White House in the months to come to determine how best to bring an end to the surge that marked the moment Obama made the war in Afghanistan his own.

For now, America's top military adviser acknowledges that there are no clear answers to precisely how many US troops should remain on the ground.

"We don't know what the answer is," he says. "I can honestly say that no one knows what the answer is yet."

Yours truly has never been to Asia, but given the lack of success the surge has produced and the apparent fact that there are almost no al Qaeda left in Afghanistan, the answer appears obvious.

None. Support the troops. Bring them home.

New Post on the Stock Market at The Daily Capitalist

2011-06-12T16:59:00.002-04:00

A new post has gone up on The Daily Capitalist on the stock market, click on the link or cut and past the link below. Due to formatting problems, work of this nature is not transferrable to the Blogger format.

http://dailycapitalist.com/2011/06/12/why-bill-russell-would-be-a-bear-on-the-stock-market-now/

The Administration Is a Lost Wolf

2011-06-09T22:10:00.005-04:00

Pre-P. S.: Note please that as stated last year, I have been blogging at The Daily Capitalist. As that is a WordPress site and this site uses Blogger, there are interoperability problems with dual posting. I will continue posting here on various topics and in the future will place links here to those posts.

Now to today's effort. Barack Obama looks to me like a warlike Jimmy Carter, floundering at home and aborad.

Gone are the days when his critics called him 'Bambi'. Now he sends his Defense Secretary to posture, his strategy in Afghanistan having failed so far. Here is Robert Gates' latest:

KABUL, Afghanistan – In a last farewell to US and international forces in Afghanistan, Defense Secretary Robert Gates says they are on track to deliver a decisive blow against the Taliban.

Sorry, it was over a year ago that we heard that the victory in the non-city of Marjah was a prelude to a major, successful takeover of Kandahar city. What Gates and his boss should have done is what corporations learned to do years ago: underpromise and overdeliver. First rout them, then everyone will see the victory and you can be modest. Assuming the reporting is correct, Gates was engaging in puffery. Unattractive.

Not that I favor this effort at all. My sense is that 'Bambi' is in league with the neocons. I prefer the Reagan years. The only foreign military aggression I remember US troops performing was the minor thing in Grenada. Peace through strength. The last decade of all war, all the time with the latest, Libya, being an obvious war of choice.

Anyway . . . as with the ongoing military effort in Afghanistan, so with the economy. It's not yet falling off a cliff, and let's hope it does not, but as with Afghanistan, the administration has overpromised and underdelivered. And as the economic course was set in 2009 and 2010 with no Republican support, it was the Dems who were the lone wolf party and their president whose electoral fate is likely going to be decided next year based on the choices they unilaterally made one and two years ago.

It's time to let freedom (economic) ring. That's the solution. As we saw in 2009, the administration had no creative ideas for the economy, and so they ran up a multi-trillion dollar debt for little if any lasting benefit. At least FDR had the CCC and built some structures that are still in use today.

When the latest round of "Keynesianism" fails, which people will start to notice by this fall at the latest, there will be that many more adherents to the historical American position that that government is best that governs least.

BTW I put 'Keynesianism' in quotes because we are in a post gold-standard world with deficits so profound that it is impossible to know what John Maynard himself would be advocating were he around today. We have moved to an economic Extremistan that is sui generis in American history.

Copyright (C) Long Lake LLC 2011

Market Comments for the Week Ahead

2011-06-06T01:24:00.001-04:00

New post on The Daily Capitalist . . .

How to Invest in the New Era of Stag-Biflation

2011-06-05T12:30:00.006-04:00

Move over stagflation, and as for Nouriel Roubini's stag-deflation, we hardly knew ye. The U. S. economy is suffering from stag-biflation.

During the 1970s, the prices of everything, from houses to oil and labor, rose. Economic stagnation plus inflation gave rise to the new term, stagflation. This is not the same environment. The U. S. had been scared into a (temporary) era of fiscal prudence following the 1930s and then the debt "binge" of World War II. But none dare call this prudence (see chart, plus LINK):

Unlike the 1970s, home prices are dropping and unlike the 1965-81 era, Treasury and other bond yields remain in the downtrend channel that was established in the 1980s. This era is different, therefore, from the 1970s, and I believe it's time we helped clarify our thinking by refining 'stagflation' into what I have somewhat inelegantly proposed as stag-biflation.

Many of the largest financial institutions in the country were found to have little or no real capital after all their bad loans, bad assets, etc. were properly valued.

Most of the nation's largest banks are, as standalone entities, too weak to expand credit much (LINK):

Moody's has affirmed the C- (C minus) standalone bank financial strength rating (BFSR) of each of Bank of America and Citigroup, and affirmed the C+ (C plus) BFSR of Wells Fargo.

It is a race against time for such a weakened financial system to sustain other than a continued deleveraging of housing finance. At the same time, the economy is two years from the trough of economic activity and is decelerating, with housing activity having dropped yet again. However, all the new money creation of the past few years that has largely financed the exploding Federal spending documented above has found its way into prices for almost every that people buy regularly without resorting to large bank loans (e.g. home mortgages and, secondarily, cars).

This is a scary period, because "money in the bank" is not safe. If the banking arms of BofA and Citi are C minus already, what capital will be available to support deposits if it turns out that their assets decline in value from here, such as from another deflationary recession?

What may await us in the financial markets in the months ahead? Here are some thoughts.

In the U. S., the weakened financial institutions may well be "encouraged" to "improve" their balance sheets by adding massive amounts of Treasurys to them. The bank regulators will point out to bank management that Fannie and Freddie are now strict rather than loose with their money, commerical real estate is glutted, and the Fed is on hold with a zero interest rate policy for an increasingly extended period. Thus, shouldn't the banks bite the bullet and invest in 10-year Treasurys at 3%, at a time when they are paying more or less nothing to their depositors? After all, a spread is a spread. And, there are no loan committees needed to evaluate each loan case by case. So, it's all profit for the banks. There are no costs: no tellers, no need for branches, etc. I think it will happen and for a while allow the Fed to keep its promise of no QE3 per se.

Short-term Treasurys yield next to nothing, but if that circumstance can continue year after year, one loses less to price inflation by owning a longer-term security.

The only other major asset class that makes sense for me to have a substantial allocation of financial resources in today's environment is gold. All government-mandated money is based on debt issuance, and gold is thus the only monetary asset that is no one's liability. It is wealth in an idealized form that individuals and governments worldwide both agree has enduring value. At several different times in the 20th Century, and as recently as 1980, gold bullion and mining shares have had an order of magnitude greater weighting in global financial asset valuations than today. I have seen number of 30% of the entire value of financial assets being gold-related in 1980 compared with under 2% today. Gold therefore has vastly more upside potential relative to other financial assets. Relative to alternative investments, gold is not even close to being fundamentally in bubble valuation territory. It's basically only doubled compared to its high price of 31 years ago. Not.A.Bubble.

Stocks, though, look to be challenged here as the stock market tends to move with acceleration or deceleration of economic activity, though I have begun loading up on McDonald's again, a stock which I have praised a number of times on this blog beginning in spring 2009. MCD has for several years traded with a dividend yield that tracks the 10-year Treasury yield. If that relationship continues, and if the 10 year Treasury yields 2.5% late this year (same as in 2010) while MCD raises its dividend 10% as it has been doing year after year, then its stock price could go from about $80 today to about $100. MCD has been a beneficiary of rampant monetary inflation and the stock should benefit should commodities do what they should do after the massive cash-out profits the Glencore (commodities firm once controlled by Marc Rich) crew took out of their recent IPO (i. e., commodities should trend down in price)

Other stocks, almost all dividend payers, make sense but MCD is my favorite, and I think that most investors should wait for lower stock prices before allocating much capital to the "market". One of these days, there likely will be another period of revulsion toward stocks, which is when brave investors move in to seize bargains. As we have seen in Japan, stocks cannot rely on ultra-low interest rates to keep share prices high. A 20-50% drop in stocks from here in the setting of an "ordinary" recession is quite a reasonable assumption. How many years of today's sub-2% dividend yield on the S&P 500 does it take, again, to make up for even a 20% drop in prices, even if dividends rise 5% a year? (I don't know exactly, but the answer is "too many" to suit me.)

In summary, the months ahead look likely to hihglight the deflation side of biflation, with a "healthy" dose of stagnation added on to too much recent excitement in commodities while the smart money a la the Glencore folks has been on the sell side. Supply-demand characteristics suggest that the U. S. financial system will absorb the supply of Treasuries and that Treasury bond prices can easily reach those of last year, allowing traders who jump in now to look at possible large percentage profit months out. While gold remains the optimal investment for the years ahead, it may have trouble rising further if oil and copper tumble.

In the scenario laid out above, cash is not as much "trash" as it has been for some time.

Silver Is Probably Overpriced

2011-06-02T10:26:00.007-04:00

Silver prices are quite vulnerable right now.

Despite being almost 30% off their recent high, they are slightly more than double their price of one year ago, which in turn was nicely up from one year before that. When I last did a post praising the investment qualities of silver, on September 12, 2010, the fund "SLV" was trading around $19.50. SLV is now pushing $36.

More to the point, there are clear signs of froth in the silver community. In that post, I stated:

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

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

I did sell most of my silver "too soon", that's for certain, though I replaced it with other "hard money"-type assets that also appreciated. I continue to hold some physical and some paper silver, because I do think that it is a more-or-less permanent part of a sound money-oriented investment portfolio.

I grew up in a house with pounds of silver sitting around in the basement, as my father was an inventor in the silver field. To quote him, "Silver is a junk metal". Silver is mostly produced as a by-product of mining of other metals, such as gold or copper.

The silver space is replete with allegations of market manipulation, and if some of them are correct, its price could indeed skyrocket soon. However, I am skeptical, because a major paper silver trading vehicle, the Sprott Physical Silver Trust (PSLV), trades at a 17.1% premium to its net asset value. Why anyone would pay that much of a premium for a fund that holds silver, even with a redemption policy into physical for very large holders, is beyond me. I called up a local coin dealer yesterday and was informed that I could buy and sell physical silver at less than a 5% spread between bid and asked. There are no shortages for a retail investor, and the dealer was talking about a substantial $25,000+ cost for a bag of silver. I thus suspect that more likely, the small investor has ended up on the wrong side of a trade involving an asset whose price is too high for a challenging economic environment.

Every day that I look at the futures market and continue to see $100/barrel oil, as is the depressing case again today, the more I anticipate the stereotypical response of the U. S. economy to very high oil prices, which is an economic downturn. Given that silver is basically an industrial metal and is a monetary metal primarily in the minds of its partisans (though it may become one again), we just may find out that there has been a lot of double ordering of silver by its users in order to guarantee supplies. Should business demands unexpectedly blindside those users, watch for a glut and plummeting prices. Silver has no, I repeat no, price stability.

Silver may well be the hard money asset of the decade, as Eric Sprott has stated. It may however do that by first presenting a materially better buy-in price than we see today.

Copyright (C) Long Lake LLC 2011

Too Much Complacency in the Stock Market

2011-06-02T00:05:00.006-04:00

I picked up two vibes today during the midst of the stock market downtrend that made me add to my short positions and, with more firepower, add to my Treasury holdings.

Here we were past midday, down over 1.5% on the Dow and SPY, with clear global deceleration in economic activity, a highly valued stock market, and the major negative for the developed countries of continued $100/bbl oil, yet the VIX was only 17.5. For newbies, the VIX is a volatility index, and a low VIX reliably measures low fear of a stock market downturn via certain stock options trading computations. During the 2007-10 period, I observed that a VIX under 20 reflected too much optimism, and a VIX over 30 reflected too much pessimism. During good economic times, such as the 1995-99 period, the VIX can stay low for a very long time, but when the economy is not performing well, one does not see that pattern.

You may click on the nearby chart of the VIX for the past 5 years to enlarge it.

(Some people prefer a somewhat different measure of volatility, with the symbol VXO.)

It seems to me that the newsflow has turned rapidly enough to justify more anxiety than I was seeing, as would be signified at a minimum by a VIX of over 20 and preferably over 25.

The second sign I did not like was a series of comments on a well-known financial blog that appeals to those of the ursine point of view. Nonetheless, several of these comments were to the point that Gentle Ben was protecting their bullish stock positions. This comes from all the uninformed talk that the Fed now has a third mandate, after its Congressionally mandated goals of balancing low inflation with full employment, which third mandate (allegedly) is to keep the stock market up. Talk about LOL that these commenters had no idea what the Fed's true first mandate is. That mandate is to keep the Treasury funded. If Congress determines it is going to run trillion dollar annual deficits as far as the eye can see, and if the real economy cannot fund that amount at rates acceptable to Treasury, then it is up to the Fed and a more-or-less captive post-2008 banking system to accommodate enough money and credit creation to fund the deficit. So if the real economy is cyclically about to falter, and the Fed has to choose between high interest rates (as demanded by the free market given high monetary and price inflation) and letting the pols fund the deficit, IMHO it is nolo contendere. The Fed will have no choice. It and its cronies will drop their support of the stock market like a hot potato and herd the once-inflation phobic crowd into Treasuries. If necessary, they will do what it takes to scare people out of risk assets in order to support Treasuries. They will do whatever it takes. Treasuries uber alles. Catch my drift? I want to make one thing perfectly clear. Making sure the Federal deficit is funded is Job 1 at the Fed. All the other goals must be subordinated to the prime imperative.

Now, if Congress and the President engage in ineffective or wasteful deficit spending, the Fed can honestly deflect blame where it would belong, which is to the elected officials. All the Fed can do is certain banking functions, after all. It does not send people to war and does not set industrial or farm policy, the level of subsidies the poor and elderly receive, etc. Once the Fed has done its best to provide funds to the government if "requested", it has met its primary obligation in a Keynesian financial system.

What we see in the U. K., with already chronic 4% price inflation and pitiful o.5% policy rates, is what the bankers will do here if necessary. They will make savers pay any price they can extract to recapitalize the banks via negative real interest rates. They will use their power to create and maintain a seemingly illogical interest rate structure. This occurred in the U. S. throughout the 1940s and into the 1950s. Interest rates on the short end in the 1940s were around 1% despite average CPI increases of 7% annually for that decade. The long bond was capped well under 3%. Was this "fair"? Who can say, but that's the way it was. It wasn't till the early 1980s that savers caught a break.

Meanwhile, as I write this on Wednesday night, Asian markets are down a bit less than the U. S. stocks were, setting up for a rally attempt Thursday. A common pattern would be a rally Thursday, perhaps successful and perhaps "faded" at the close, and then traders would be all over the Friday jobs report.

On the other hand, short term contrarian sell signals aside, I have already begun seeing a number of hysterical headlines suggesting that the financial world is ending soon. LOL again. Remember that going into this week, stocks have been down 4 weeks in row. This week would make 5. Maybe BofA does eventually go down into Dodd-Frank-type receivership and the markets pull a 2008-style major meltdown, but that setup is not happening next week. The financial world is not ending quite that fast, the overly advertized Greek fiasco is not going to blow up the European financial system, and Barack Obama has many levers left to pull in his re-election effort (and these include economic psy-ops).

If we get a sharp break again in the markets sooner rather than later, and the VIX finally shoots up, and if all that happens to cause that is a weak jobs report and perhaps some scary news from some small insolvent European country with fewer people than live in the Los Angeles metropolitan area, my current plan is to cover all my shorts, perhaps book what would then be decent profits in Treasuries, and play stocks for a short-term rally. (Intermediate-term, however, I'm not bullish on stocks, but as always traders must be flexible.)

Right now we are seeing a textbook segue from a 2-year post-recession (depression) rally into at best a growth slowdown scare and at worst another cyclical economic downturn. Unlike the chaos that began in late August 2008, this time we appear at least to have some ground rules.

We are being cursed with interesting times.

Copyright (C) Long Lake LLC 2011

Merrily Rolling Down the Yield Curve

2011-05-31T23:58:00.004-04:00

Your humble and chronically bemused blogger drank the Kool-Aid today and added a substantial amount of a specific type of bond to his IRA holdings, transforming zero-yielding cash into a zero-coupon Treasury bond of 8 years duration. This was done while continuing to hold a substantial percentage of our family savings in gold and while being aware that the MIT Billion Prices Project is showing a price inflation rate that makes my 2.64% implied annual yield a loser in real terms.

(Do I contradict myself? Very well, then I contradict myself.)

Here is the thinking behind my latest speculative foray into bonds.

Basically this is a play for modest capital gains.

First, one must understand that when one buys a bond, one's broker will quote you a yield. But the reality is that the transaction is one in which price is the reality. The yield you are quoted is, forsooth, a derived value. It is not a toxic derivative as in CDO-squared sorts of derivatives, but it is a derivative value. In the case of most bonds, which pay coupon interest periodically before the borrower is supposed to return the invested principal, computation of effective yield is more complex than most people realize. One has to make assumptions about such matters as reinvestment returns on the interest payments, for example. Furthermore, standard bond tables assume that the interest is reinvested at the coupon rate of the bond. In a world where short-term money yields nothing, however, that calculation ends up overestimating the real return that a lender receives.

If one's goal in purchasing a bond is to attain a capital gain, the purest bond is one that pays no interest and thus does away with the reinvestment problem. This bond, commonly called a zero-coupon bond, trades at a price with a yield that can be computed with a compound interest calculator. Here is how to make lemonade with zero coupon bonds. First, one should have a non-callable bond. You have to be confident of the maturity date.

This is where Treasuries are almost unique in bond land.

Next, you want a positive yield curve, which is one in which the annual yield is higher as the duration of the bond increases.

So when I called up the broker today, I asked for the prices and yields on 7 and 8 year Treasury bonds. They were about 84 and about 81 respectively, correlating with yields of 2.44% and 2.64%. I purchased some 8 year (2019 maturity) bonds at around 81. What this means is that assuming los Federales are still in business in 8 years, they promise to pay me $100 for each $81 worth of bonds today, but they will pay me nothing till then. Annualized that's about 2.6% yearly. However, if I want to make a similar investment but want $100 back in 7 years rather than 8, I will have to fork over $84 today.

Let's now look forward one year. Let us say that for whatever reasons, the yield curve is unchanged. In that case, I will then be the owner not of an 8 year bond, but rather I will own a 7 year bond. All things being equal, the value of my bond will have risen from 81 to 84. Taking the fractions into account, my 2.6% bond today will rise 4.0% in value (from 81.18 to 84.47). It's a form of financial alchemy, in a sense. All I need to get a 1-year return almost equal to the return from lending money to the government for 30 full years is for the interest rate structure to simply not change.

This sort of activity is called rolling down the yield curve. It is one of the SOPs among bond portfolio managers.

In making this bet, I am taking the point of view that the Economic Cycle Research Institute is correct in its call for Treasuries rather than stocks or industrial commodities as preferred investments in the months ahead. In this scenario, we should remember that as recently as November last year, the 5-year Treasury traded with a yield below 1.1%. And that was merely in the setting of a growth slowdown, at a time when gold and silver prices had already been surging for months. What if there is a full-blown global industrial downturn, with oil in the $60-80/barrel range and copper at $3/pound or less? And perhaps silver at $25/ounce again, or lower? Who knows where the herd will take Treasury prices in the seemingly unending cascade of financial asset inflation that has been occurring for decades?

In that (quasi-)recessionary scenario, there is the potential for this boring debt instrument to return 5-10%, possibly in as little as 6 months.

Of course, there are numerous risks to this approach, most obviously the one that price inflation makes this 2.6% yield look trivial. My answer to that is ownership of gold so long as interest rates are at or below the general price inflation rate, no matter what the economic cycle is doing. I would then supplement that by adding economically sensitive, "weak dollar" assets when economic activity appears to be troughing or accelerating. But in a world where there are central authorities who are determined to make savers pay to recapitalize financially weak financial institutions by forcing them to receive rates on money in the bank that are below the rate of price inflation, one thing is mathematically certain.

Pitiful as a yield of 2.6% may be, it is greater than zero.

In a world where little except the air we breathe is cheap, beating zero with the chance for capital gain due to a possible major deceleration of economic activity seems reasonable to me.

Copyright (C) Long Lake LLC 2011

Gold and Bonds

2011-05-29T23:23:00.006-04:00

It's hard to see the fundamental case for gold vs. the U. S. dollar (USD) as other than strong when a flawed currency, the New Zealand dollar (NZD), has just now broken to an all-time high against the USD. Why is the NZD a flawed currency?

Because the policy interest rate is 2.5% while the latest inflation rate is 4.5%. The Prime Minister of NZ is a former Merrill Lynch banker. These guys do like printing money, that's clear. So if a country that is rebuilding after the Christchurch earthquake is doing it with cheap money, then gold should be appreciating against the NZD, all things being equal. (Please note that the NZD was one of the three currencies I highlighted last summer when I made the case for the following weak dollar plays: gold, silver, and foreign currencies. The other two courrencies I listed were those of Brazil and Norway.)

Except for countries near default, such as Greece, and with some exceptions such as Brazil and Chile, most of the world continues to operate with negative real interest rates. Sweden, for example, has a 3.3% inflation rate but only a 1.75% policy rate. All this is gold-bullish. Just last week, gold hit all-time highs in euro and British pound terms.

Is gold "too high"? Maybe, but given how depressed gold miners are, my sense is that a bull market as long and strong as gold's has been will generally end with public participation in the usual manner, namely in stocks. Instead of gold, the public has been indulging its dreams of easy money via momentum stocks of various flavors. I continue to look for $2000/ounce gold next year based on the "Elfenbein correlation" between percentage appreciation of gold and the positivity or negativity of "real" short term interest rates.

Understanding that there is a significant potential for summer weakness in all resource stocks, I also think that on a 6-12 month horizon, certain gold stock vehicles look better than bullion to me.

The big fly in the ointment, however, is the Economic Cycle Research Institute's adamant call for an important top in the global industrial economy soon. Primarily because of this, I am avoiding resource stocks except those related to gold (which has few industrial uses) and resource currencies.

As a consequence of a global industrial recession, at some point I would see capital being diverted to bonds. In that vein, I would note that the long-term downtrend line in U. S. interest rates survived the inflation scare of this winter. The chart of the same bond in New Zealand is similar at least for the past decade. (Click on chart to enlarge.)

On a trading basis, I am therefore long various U. S. Treasury debt instruments. I thus have a barbell strategy: gold as my core holding to hedge against more money-printing to make the impaired balance sheets of the TBTFs whole, and Treasuries as speculative vehicles expecting that potentially sharp downtrends in the prices of industrial commodities in association with a global industrial recession (or fears thereof) will leave capital searching for the least bad alternatives.

I also own some defensive stocks and certain specialty financials.

I intend to discuss some ins and outs of Treasury investing (speculating, really, given that I don't expect the debts to ever be repaid in other than greatly devalued dollars) in the future. In the meantime, you may wish to review a November 2010 post on the topic in which I suggested that we could then have been within months of a major top in long term rates if we were not there already (which we most assuredly were not, as it turned out).

I read lots of gold-oriented blog sites, articles on gold, etc. I don't know if I am unique, but I think it's rare to be a bull on gold and a tactical bull on intermediate to long-term Treasuries at the same time. Let's see how the months ahead go. It looks interesting, to say the least.

A Case of Scurvy and Financial Vitamin C

2011-05-25T20:19:00.005-04:00

One of the benefits of being a certain age is having had several different experiences while still being young enough to remember them. With that intro, I'd like to recount a diagnostic coup I observed and relate it to the financial matters mentioned in the title.

When I was an intern rotating through the Bronx Veterans Administration Hospital, I performed a history and physical exam on a newly admitted patient. He was clearly unwell, but the nature of his diagnosis was obscure in the extreme. I discussed the case with my senior resident, still a doctor in training but a year or two above me. I was puzzled; he was quite interested.

The next morning, the resident had quite the self-satisfied look. He announced that the patient had scurvy (a disease due to severe deficiency of vitamin C). Had the resident ever seen anyone with scurvy before? No. How did he know? He had correlated the symptoms with the patient's dietary habits. The patient basically lived on sardines. There was no vitamin C in sardines.
The patient was discharged on vitamin C and we all learned that there is no substitute for careful, case-by-case evaluations along with encyclopedic knowledge and an open mind.

That said, I wanted to correlated the above example with a post from Mish today titled Hyperinflation Nonsense in Multiple Places. This lengthy post is of special interest because not only is Mish one of my very favorite bloggers, but he approvingly quotes Jeff Harding of The Daily Capitalist from last fall on the prospects for hyperinflation in the U. S. As regular readers may know, I have agreed with Jeff about stagflation being the likely outcome for the foreseeable future.

I also agree with Mish that hyperinflation is not imminent, but I am mindful of the case of scurvy. Does the U. S. have the financial habits that can lead to hyperinflation, just as my patient had the dietary habits that led to the rare case of scurvy in New York City?

In a word, yes. Central bank monetization of large amounts of Federal spending is the key.
The politics of the day are in favor of this policy. The Democrats refused to raise taxes when, for two years, they controlled both Congress and the White House. Then they were all too happy to keep taxes as they were after the midterms, at least till the next election. Now they are happy to complain about the Republicans' position on Medicare while not saying how they will fund it. Presumably money will arrive from the tooth fairy AKA the Federal Reserve or a coalition of the unwilling and coerced. Net-net, my take is that the irresponsible fiscal and monetary policies that were followed when Bush the second was president have simply gotten worse in the Age of Obama.

So if the prediction of a significant global industrial downturn starting no later than summer is correct, there will be a cyclical factor working to restrain prices. But the trend in consumer prices is up, and with returns on bank deposits yielding much less than the rate of consumer price inflation, the hoarding mentality that can quickly lead to high and accelerating rates of inflation may take hold rapidly. Most Americans have never experienced anything approaching hyperinflation and are not as savvy as the brilliant doctor who sniffed out scurvy. In practice, all this continues to argue for possession of a significant and permanent holding of gold. Had the patient simply eaten some fruit or taken a vitamin pill, he would have had better health status. Similarly, gold and only gold is the classic way to hold long-term purchasing power when a government goes out of fiscal control, as the government of the United States may do sooner rather than later. There is no financial VA Hospital you can go to should the rate of loss of purchasing power vs. money rates paid by banks get worse. There may only be the Internet, depending on the point of view of any financial advisor(s) you may have.

I don't know anything about future choices that the authorities will make. Whether the U. S. goes in and out of deflation, as Mish predicts, is above my pay grade. All I can do is ask whether the U. S. is as deficient in financial prudence as my scurrilous patient was before he got sick enough to come to medical attention. Thus, my equivalent of financial vitamin C is gold.

BTW, in follow-up of my recent posts, I reversed trading course this AM and covered most of my shorts and also added more longs. The reason was that too many headlines were gloomy, and bearishness does not love company.

Copyright (C) Long Lake LLC 2011

Another Non-Barking Dog

2011-05-24T15:06:00.004-04:00

A dog that did not bark today was the stock market. After Monday's drubbing, bulls wanted to stage a "Turnaround Tuesday". Instead, with less than an hour to go in the regular stock trading session, stocks are flat with the VIX down (a lower VIX indicating less fear in the marketplace as judged by certain options activity). However, Treasuries reversed from down in price to up in price, joining gold in the plus column.

Meanwhile, my favored proxy group for the fundamentals of the economy, namely large financials, are depressing. JPM, generally considered the best of the TBTFs, is weak again today. BofA stock looks horrible, as do C and AIG. A high-quality not-quite TBTF, the President's banker (Northern Trust) also has a failing chart. DE and CAT don't have hot charts, either.

I recently read an erudite piece out of Cumberland Associates that "sell in May and go away" historically has not applied when some circumstance or another that in my approaching dotage I cannot remember is present, as it was when the writer wrote that. But at least for industrially sensitive stocks and commodities, today's action is more consistent than not with the thesis that for the next few months, investors' trading accounts are better off on defense than offense.

Disclosure: I am short BAC and NTRS, though I am long a much greater quantity of offsetting longs in a similar investment niche. I am also long gold in various forms and have certain other longs and shorts. My major recent asset allocation change has been to sell out of almost all foreign currency positions and energy stocks as soon after the reported "hit" on Mr. bin Laden occurred and silver and oil began crashing, and replace much of those positions with long Treasury bonds and most of the rest with cash.

Copyright (C) Long Lake LLC 2011

Exited, Pursued by a Bear

2011-05-22T20:19:00.009-04:00

We may be on the verge of learning more about how much capital has been wasted by the malinvestments of the past decade. I believe that the single most important stock group is the financial group. It is the financials that reflect whether the "marks" that are assigned to assets are accurate, and if they are inaccurate, in which direction the inaccuracy is. As Shakespeare might have said, leverage is all (unfortunately), and the financial stocks reflect this modern reality.

When economic activity is increasing and especially when it is accelerating, financial institutions have strong capital bases and compete with each other to lend funds. When there is a sound base for economic expansion, as in the 1980s and 1990s, the lenders have lots of good credits to consider, and in return, the good credits are able to provide substantial collateral and/or down payments to the lender. So the loans tend to be net profitable to the lender.

Internet 2.0 and weak dollar matters aside, and government spending (i.e. Fed "money") notwithstanding, there are no signs of that happier situation in the country as a whole as we approach two full years since the trough of economic activity. The top tier "Too Big to Fails", namely JPM and WFC, have uninspiring stock charts and have continued to underperform a rising stock market. This is just what happened in 2006 and 2007. On the other end of the quality scale among the TBTFs, here is a 5-year stock chart of BofA. A renewed bear market in the stock is threatened. (Please be aware there is no prediction here of what the stock price will do, especially in the short term.) But I will disclose that I have sold the stock short, creating my own micro-mini hedge fund considering I own a considerable amount of offsetting but not very liquid long positions in a similar place but with, I feel, better value for the price.

To a somewhat lessened degree, Goldman Sachs and Morgan Stanley have stock charts that look like BofA's.

There has also been no sustained sign of life in the truly moribund giant financials, Citigroup/AIG/Fannie/Freddie, all of whom were saved from some form of bankruptcy by direct support from the central authorities.

I take this as a bad fundamental sign. If matters go well in the economy, one will look for sustained outperformance in these companies. Right now, I prefer not to fight the tape. And since the Fed is scheduled to end QE 2.0 imminently, a cautious or bearish stance toward stocks is no longer fighting the Fed. If the Economic Cycle Research Institute (ECRI) is correct in their prediction of a significant global industrial downturn beginning this summer, these global financial companies should see their own business both diminish overall and switch more toward less profitable segments, such as fixed-income trading rather than M&A and stock trading.

There are also valuation metrics which resemble those extant at the 2007 peak. To wit, here is a chart from the Andrew Smithers website. Please note that the S&P 500 is up from where it was when this chart was created. Click HERE for an explanation of both independent valuation measures this graph utilizes.

The averages are at similar degrees of overvaluation as have rarely been seen in the past 11 decades.

People protest that current values are "OK", because interest rates are so low. My response is a "Yes, but" type of response. Interest rates are low because organic credit demand is lacking. This is the problem of our current biflation.

The nominal price of homes is flat to down. Housing grew to be such an important source of non-revolving credit that it became the animal that could sit wherever it wants. When housing went down and continues to stay down, significant percentage upticks in credit demand in much smaller sectors (smaller from a credit standpoint) fail to replace housing's importance. Thus, capital was credited to savers such as myself, but there is a surfeit of capital relative to users of capital. So, the weak credit environment explains the low interest scenario (without justifying the extremism of the zero interest rate policy of the Fed), and that goes hand in hand with weak economic growth prospects. These weak prospects are, in my view, enough to be consistent with much lower stock prices.

It is my view that all the money-printing, bailouts, happy talk from the media, and the like, have lulled investors to sleep. However, how many investors realize that from their respective bottoms in fall 2008 and winter 2009, gold has has a somewhat greater appreciation than the Dow Jones Industrial Average, dividends included? In other words, since the stock market bottomed in nominal terms in March 2009, it has actually declined further in terms that I prefer, namely gold.

Meanwhile, not only is housing double dipping, but autos are dipping as well, and at a much lower annual rate than was the case at the peak in the aughties. From J. D. Power and Associates:

High Gas Prices and Lower Incentive Levels Contributing to Dismal Start for May New-Vehicle Retail Sales

" . . .Retail sales in May are being hit by several negative variables—specifically, high gas prices, lower incentive levels and some inventory shortages," said Jeff Schuster, executive director of global forecasting at J.D. Power and Associates. "As a result, the industry will likely be dealing with a lower sales pace at least through the summer selling season, putting pressure on the 2011 outlook.'"

It is clear from the title, the above excerpt, and the whole text of the press release (which makes clear that most U. S. and global auto manufacturers have no exposure to Japanese parts and thus can make all the cars the market can afford), that the automakers' main problem is that when they tried to raise prices (by removing or decreasing incentives), buyers could no longer afford their merchandise, in view of the economy in general and gas prices in specific.

Because homebuilding and the industries that feed off of new home sales and home resales are so depressed, the ongoing depression in those industries will not be enough to cause a new recession. It will however be enough to eventually cause the accountants to lose patience with unrealistic valuations of real estate owned by banks (REO) and the value of mortgages, especially second liens. This is why I highlighted BofA above.

Finally, real people are feeling just like the stock market when the stock averages are adjusted for gold's price. They are seeing and feeling no improvement in their lives. Here are two examples. Gallup.com runs a daily crawl on its website that tracks a measure of employment levels and discretionary spending. Currently, the average respondent is spending $62/day. My recollection is that 3 years ago, when I started following the same website, spending was about double that. And this is not adjusted for the general increase in prices. Thus, people are truly squeezed. On the same site, the hiring/not hiring differential is only +12 today. It was +25-30 3+ years ago, when unemployment was rising, so this level is at best consistent with employment growing in line with population growth (in my very humble opinion).

The second example is Bloomberg's Consumer Comfort Index. This has sunk to 9-month lows:

So when I think of the intersection of markets and the economy, I think that the American people have it right. They know what's happening in their jobs, communities and bank accounts. For the first time in memory, a technical recovery in the economy and a surge in the stock market has left almost all people behind. There is no magic to this. It simply reflects an amazing amount of money printing. It is my supposition that all this new base money has been created by the Fed because the amount of capital that was destroyed (misallocated/malinvested) was massive. The weakness in the dollar, which commentators usually wrongly describe as strength in gold, simply reflects that the country was never really as rich as it was measured as being in the late 1990s till the Great Recession finally brought the reality home. One of these days, the stock market will resume being a weighing machine rather than a voting machine. What the nominal pricing will be is unpredictable, but one of these days, a look at the 110 years of the Smithers chart suggests that the stock market will be depressed as far below its average as it is now above.

That's why, for what may be a summer of negative economic news, I have fled growth-oriented investing and weak-dollar investing and have circled the wagons around the basic investments of gold, cash, and Treasuries. Barring general systemic collapse, the worst that can happen to me in this posture is that I do not participate in some up-moves. But I can sleep a lot better that way than if capital is destroyed by what I view as the stock market reverting to normal pricing of pre-owned securities.

Copyright (C) Long Lake LLC 2011

Evidence of How Difficult It Is to Garner Excess Returns in the Stock Market

2011-05-19T23:58:00.005-04:00

In January 1995, the Republicans took over Congress for the first time in, almost, forever. Quickly a form of gridlock took place that helped the stock market levitate. The R's wouldn't let President Clinton spend, and he wouldn't let them cut taxes. So the cash budget balanced soon enough, capital gains taxes were cut, and the prior record of three consecutive years of 20%+ stock market gains gave way to five years- 1995-99 inclusive. And then the S&P 500 hit a new record late in 2000. It was an amazing run. Since January 1995, the U. S. economy has only been in recession for about 8 quarters out of the 65 completed quarters since then. This is a historically better than average performance. So one would think that stocks have been fine performers overall.

Here are the stats. The S&P 500 has risen from 470 to 1340 (approximate numbers). This is a compound annual return of 6.60%. Adding in dividends brings the annual return to about 9%.
If one invested in a low cost index fund to mirror the index, fund expenses would bring the total return lower. And of course, assuming the fund is not held in a tax-exempt vehicle, taxes on dividends and capital gains would have been taken.

Also at the beginning of 1995, 10-year Treasuries yielded 7.2%, and 30-year T-bonds yielded 7.7%. Given a typical discount, that suggests that high-grade muni bonds would have yielded about 7% for long-term bonds. So, munis would have been as good as stocks for taxable accounts from then till now.

For retirement accounts, where tax rules for the unrealized appreciation inherent in zero coupon bonds are not relevant, the total return from a zero coupon 30-year Treasury bond (non-callable) can be calculated as follows.

At an annual yield of 7.7%, the price for a $1000 face value bond would have been $108. In other words, $108 in 1995 would be promised to turn into $1000 in 2025, with no interest payments for all that time. Today, 16.4 years later, this bond would now be a 13.6 year zero coupon bond, which I am estimating would be trading around $620 to give a yield to maturity of something over 3.4%. Thus the bond would have risen from $108 to $620 in 16.4 years, which my interest rate calculator says is about an 11.2% per year annualized return. This return is from the starting interest rate of 7.7% enhanced by a decline in market interest rates, further enhanced by the upward slope of the yield curve.

In other words, a time period that began with the greatest 5-year surge in stock prices in the history of the United States (at least since the dawn of the 20th Century) has led to equal stock market performance to that of plain vanilla municipal bonds for taxable accounts and to significant underperformance to that of a plain vanilla zero coupon Treasury bond for tax-deferred accounts.

In my view, this example should "put paid" to the idea that most people should put most of their investment funds in the stock market all of the time.

Copyright (C) Long Lake LLC 2011

More a Stock Market than a Market of Stocks: Playing Defense or not Playing at All

2011-05-18T23:08:00.002-04:00

Why begin a post on stocks by mentioning that I purchased a 5 year 'A' quality muni bond today yielding 4%?

Perhaps because I feel the risk-reward is better for this than for the stuff I've been buying lately in my stock accounts. And I hasten to add that in my retirement I am far from earning enough to even come close to the high tax brackets, so that I don't really need the tax-free nature of muni interest payments very much.

Nonetheless, having closed out almost all my weak dollar, growth-y financial assets except gold-related matters shortly after the hit on bin Laden, I have reviewed the 2007-8 investment scene as well as the 2000-3 post-bubble period and have found some asset classes that by those precedents look better than cash heading into what appears to be a cyclical industrial slowdown.

First, let's review what two conservative strategists think of the stock market as a whole. The Ph.D. economist and fund manager John Hussman has updated his views this week. He sees an average return for stocks over the rest of this decade as little better than 3% annually. So in his view one could just buy a 10-year Treasury for the same yield and wake up a decade later (the Rip van Winkle approach). He also refers to the more senior strategist Jeremy Grantham, who is famous for making uncannily accurate 7-year projections, and who is even more bearish about U. S. stocks than is Hussman.

Finally, there is the less well-known Andrew Smithers, who bravely published a book in 2000 calling out the stock market as a huge bubble. He soldiers on, every 3 months updating a chart valuing the stock averages both by his estimate of fair value based both on earnings (10-year average earnings) and asset value ("q"). According to his estimates, stocks are at least 75% over fair value, and are similar to their valuations at their mid-1960s and 2007 peaks.

But all these considerations are in the face of the seemingly permanent zero interest rate policy (ZIRP). So if cash is trash, and the powers that be have a somewhat illogical commitment to price inflation of pre-owned equities that is in aggregate called the stock market, then most portfolio theorists recommend some exposure to stocks, and I agree. And in truth, much as have been a proponent of gold investing since 2009 and was in and out of gold beginning in 2002, so long as I live in a "fiat" world where gold is not money in the transactional sense, and I have bills to pay, I need to think of fiat dollars and think that I can do a bit better than Hussman's 3+% with stocks for the short run.

Therefore, taking the Economic Cycle Institute's (ECRI) warnings about a major global industrial business cycle to heart, I have invested funds in the following stock groups: electric utility, health insurance, and defense. Admittedly I have primarily negative feelings toward the latter two groups of companies, but the only stocks that I have always refused to buy are cigarette stocks. (In fact, 30 years ago I refused to buy Bic stock because they made lighters in addition to pens; it soared without me on board.) I have also been buying into closed end muni bond funds, as these funds are able to use leverage to enhance yield with reasonable safety, and an individual cannot accomplish this.

On the other hand, interim kickback rallies notwithstanding, I look askance at the charts of energy, materials and even most tech stocks. Japan's history with ZIRP is that major bear markets can indeed occur without the central bank lifting interest rates. Cyclical industrial downturn such as that which may be approaching soon can teach a severe lesson to both veterans and noobs alike who trust in the central bank to prevent asset prices from falling in nominal terms.

If ECRI is correct, there will be continued important shifts in the pricing of different sectors of the stock market with more movement within the market than the averages will reflect, unless and until another systemic crisis a la late 2008 comes upon us and babies get tossed out with bathwater. One may need Biblical fortitude to resist the blandishment of tantalizing rallies in risk assets, however, to follow this cautious strategy through to its conclusion, which could very easily end (or not yet be ready to end) with the CNBC crew putting their Dow 10000 hats on backward.

Copyright (C) Long Lake LLC 2011

Whither the Markets?

2011-05-15T23:06:00.009-04:00

Yours truly has been following the news and much Internet/blog commentary lately with interest and calmness. On The Daily Capitalist website, we have seen Econophile opine about a stagflationary outcome, and Keith Weiner provide a futuristic view of some sort of hyperinflationary "crack-up boom", a term used by von Mises.

My view is more toward Econophile's but with some differences in the short term. Here's why. Mr. Weiner suggests that we watch, some years from now, for gold to trade at a higher price in the near-term months on the futures market than in the more distant months (i.e. "backwardation"), and that this will be a warning sign of what he calls a coming financial Armageddon. Without beating a theoretical horse that may or may not occur, I can think of a number of reasons why gold could go into sustained backwardation without leading to a breakdown of trust in the financial system. Reasons could include demonetization of gold, manipulation, mania, off-market contracts for gold delivery, and a general deflationary trend in prices of tangible goods, as well as the possibility of centrally-dictated negative interest rates.

In any case, perhaps a hyperinflationary depression is in our future, as Mr. Weiner posits. Shorter-term, I think we truly need to worry about a global industrial recession. My read of the commodity markets is consistent with that.

There is one very interesting topic in Econophile's linked post that I will address. That point relates to his statement that not all capital was consumed by the crash. I wonder. Certainly the physical structures of the United States were not damaged. There were no enemy bombs bursting in air, no giant toxic radioactive leaks, etc. But what if all banks, more or less, were bankrupt? Then, all the fiat claims and counterclaims tied into worthless bank deposits.

The way I am putting the Armageddon-lite events of the 2008 era together is as follows. The U. S. and Britain suffered a collective financial major myocardial infarction following Fannie and Freddie going into receivership in late summer 2008. This was followed by Lehman's collapse, Sunday evening panicky special broadcasts starring Hank Paulson and the like, President Bush admitting he was violating capitalist principles to save capitalism, and crony capitalism the likes of which America had not seen for many decades. The serial bailouts and intense subsequent money-printing just might be because the authorities took a look at the 40:1 leverage of the investment banks, the (perhaps) 100:1 leverage of the GSEs, and the unknown but high leverage of the other large financial institutions and realized that there was no equity left.

Therefore they just decided to create enough new dollars ("fiatscos") as were needed to begin the cycle anew. Of course, under a debt-based system of money creation, this could only be accomplished with ultra-low interest rates. Thus, "ZIRP". Thus, the Bank of England and "the Bernank" were charged with inventing any excuse to not see price inflation that the whole world sees, or to call it transitory. Thus, periodic endings of money printing, QE 1, QE1.5, QE 2.0, etc., in order to see if the economy was self-sustaining yet. Sort of like a cook taking a dish out of the oven to see if it needed more cooking. If no self-sustaining recovery, well, OK, let's cook it some more (i.e. print more money).

Thus, biflation, as the massive and leveraged capital that went into building too many homes, and too expensive homes, had perhaps destroyed all financial capital in the country, after accounting for debts to foreigners, and without selling the physical country and its mineral rights etc. to the foreigners.

Of course, this is just a theory, and I'm interested in comments. To me, it fits the facts as I see them, and it explains why hyperinflation has not happened and why we may be entering into a period of general disinflation and commodity price deflation as an industrial recession looms. The human, physical and intellectual capital exists, but when the accounting is/was done properly, perhaps the value of all those assets expressed in terms of the money stock that existed as of the summer of 2008 was zero.

If I am correct that the cyclical economy is on the rocks, stocks that will rise or at least hold steady will be few and far between over the next months. These may include utilities, McDonald's and retail discounters. Personally I have taken several short positions to offset my few longs, but mostly I am in cash with a reserve of gold. If I am correct, oil could easily hit $80/bbl on the downside this summer/fall and perhaps could go much lower. $60 has very strong support if $80 decisively fails. If we see $60/bbl, watch for gold to test $1000/ounce before, perhaps, doubling in short order to $2000+. If oil hits $80 and holds, then rebounds on an economic rebound plus QE 3.0 or its equivalent, then gold might hold above $1400 at its worst and then head to new highs by year-end.

Thus I am presenting a somewhat different potential scenario for the months ahead. Let's see what happens. As always, I am data-driven. Anybody who has a high degree of confidence in any sort of prediction and who lacks inside information is in my view overconfident.

Copyright (C) Long Lake LLC 2011

Changing on a Paradigm

2011-05-08T22:58:00.004-04:00

Last summer, I embarked upon a series of three posts explaining why I was committing our funds substantially into a weak dollar set of investments; click for links to the first, second and third of the series, which delineated three ways to invest on that theme: gold, silver, and foreign currencies. I also wrote favorably of stocks, with emphasis on those with substantial international exposure.

All these investment classes have done quite well.

I believe that for a multi-month horizon, it's time for a new paradigm.

As might have been expected given an economy that merely had a growth slowdown last summer and fall and then rebounded on its own in association with a simultaneous huge injection of government spending "paid for" by newly-created Fed "money", there has been a massive speculative top in silver a week (plus) ago, wild speculation in certain "Internet 2.0" stocks, such factors as the one-sided coverage of this past Friday's employment reports (with the media mostly ignoring the negative household survey in favor of the positive establishment report), the increase in new unemployment claims, the return of the Consumer Comfort survey (now a Bloomberg report, formerly ABC News) to near-2009 lows, and (last-not-least), the reported double dip in housing. The stage is set for another growth slowdown at best, eerily similar to that of last year, but perhaps ending worse.

The major reason I am reversing the summer 2010 decision I made to go heavily into the "risk on" assets is, however, seen in the video linked to HERE. This should be seen in conjunction with the charts on the left side of the current home page of the Economic Research Institute (which may change).

ECRI raises the possibility of a global industrial recession, and the likelihood of a significant deceleration of industrial activity. It is the second derivative of growth that traditionally most affects markets, meaning unexpected acceleration or deceleration away from the prior trend.

Given where market prices are today compared to where they were when I wrote the above articles, it's risk off in the DoctoRx investing world. Anybody who monitors bloggers and other commentators who complain about Comex "hits" on virtuous silver buyers may wish to consider that silver was roughly $20/ounce when I wrote my linked piece.

For those familiar with investment lingo, last week I sold in May and went away. The only significant non-bond, non-cash assets that remain in our portfolios are gold and some public but illiquid undervalued equities, which I have hedged with short positions in more liquid investments which may be fundamentally worse values. If ECRI is correct, the only weak dollar hedge one needs is gold.

None of the above represents a short term timing call in any way, shape or form. After last week's carnage, my trading sense would suggest that silver and oil, for example, are due for a bounce higher in the upcoming week. It's also not a bear call on stocks per se, given that many stocks are "defensive" and given that capital rightly continues to seek alternatives to cash.

Much more to follow as the Obama deficits continue to meet Helicopter Ben.

Copyright (C) Long Lake LLC 2011

Stock Vs. Precious Metals Rates of Return

2011-05-03T17:03:00.004-04:00

Since 1985, gold has returned 5.5% annually, silver 7.5%, and stocks 9% plus dividends. The relative trends suggest that there is at least as much chance that stocks are overvalued than are the metals.

Copyright (C) Long Lake LLC 2011

Reflections on a Less-than Golden Dollar

2011-05-03T13:42:00.004-04:00

The image nearby reflects the St. Louis Fed's very long term chart of the US dollar vs. major currencies. It shows a downtrend which I am confident is statistically significantly different from stable. In that time frame, the price of gold and oil are each up 30-40 times. The Dow Jones Industrial Average is up about 13 times, but in those about 38 years from the beginning of the chart, dividends are significant. Perhaps the total return of the DJIA is very similar to that of gold.

What does the future hold? Who knows, but it appears to me that in a period of large governmental debts and negative demographics, one can simply hold gold for an extended period of time in one form or another rather than bothering with stocks, unless one is very "good" at choosing stocks. And if one likes stocks, precious metals stocks look OK to this observer.

I'd also like to get just a bit snarky, because some of the most prominent bloggers do what the MSM does, and pretend to give you the big picture while often merely providing concealed propaganda. I'm all for proselytizing, but I'm against presenting selective data. To that end, please consider a dollar chart presented by Barry Ritholtz recently. For some reason, perhaps the annotation on the chart, I am unable to upload that graph to this post, but rather than showing the Carter-era bear market in the USD and then the incredible surge in the first years of the Volcker-Reagan era, including the post-1982 period when interest rates plunged (but price inflation fell faster than rates), he chooses to begin in 1983 or so, after the broad dollar index had already risen by about 33%. Huh?

This by itself is unobjectionable, but consider the point of his post, which states that it is to provide a longer-term view of the dollar than a prior 15 year chart he had presented in a previous blog post. So anyone looking at this more comprehensive 38 year chart he presents gets to see two epic collapses, one under Ronald Reagan, the other under "W". Anyone who recalls Mr. Ritholtz's ardent embrace of candidate Barack Obama in fall 2008 and his attacks on those who disagree with him on the Fannie-Freddie-Community Reinvestment Act issue may wonder as I do if it is unlikely that the brilliant and well-informed Mr. Ritholtz simply inadvertently left out the evidence that the USD had two sustained periods of outperformance in the last 38 years, and both had much to do with Republicans. One period was in Reagan's early years (when the R's also held the Senate), so that the average of the dollar in his 8 years was much higher than when he took office. The other began on or about January 1995. That date is significant. It is when the candidates from the "change" election of November 1994 took office. You will note that despite a very large increase in interest rates in 1994 (not shown), the dollar was weak that year. It was only when the Republicans took office with a mandate from the people to shrink the size of government and balance the budget and actually began to act serious about that mandate that the dollar rose. It then kept rising throughout the rest of the Clinton (gridlock period) years and continued for the beginning of the GW Bush presidency. Then came 9/11/01 and a guns and butter policy, and the rest is history.

My take is that the politicians hire central bankers to take the fall for inflationary policies when the inflation becomes a sore spot with the public, and then the pols can take the credit for the natural vigor of the economy when an up-cycle occurs. That the long-term trend of the dollar has been down against the other major currencies has some significance, but I think the major point is that all currencies are politically managed in this era of fiat money. Please do not fall prey to price illusion, which is a mainstay of "Keynesian" economics. Please also be aware that adjusted for the price of gold, and even including dividends, the stock averages have not moved at all from their 2009 lows. I take that as a worrisome sign. Just as was the case in the summer of 2007, when the public felt that the country was already in a recession, the public has never after felt the love that the stock market appears to feel lately. They don't care if, their cost of living is rising 4% while their pay package is unchanged, rather than their living costs rise 10% while their pay goes up 6%. In other words, the money illusion doesn't really work anymore. Been there, done that. People "get it" after all these years of price inflation.

Terms of trade have moved against the US lately, as other nations ("emerging" and otherwise) have mostly not suffered from the massive malinvestment the US made in housing and related "stuff" to fill up the more numerous and unaffordably large homes that were created using Ponzi finance. The piper is now getting paid via a relatively lower standard of living, just as Austrian economists predicted. This will likely pass, but right now I see no reason for the 38-year trend toward relative dollar weakness against other fiat currencies to reverse, short-term fluctuations notwithstanding.

Metals in Motion

2011-04-30T20:27:00.003-04:00

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

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

2011-04-26T21:50:00.008-04:00

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

How I Learned to Stop Worrying and Lote the Stock Market

2011-04-21T21:26:00.004-04:00

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

Vietnamization Of Libya Proceeds As the Brits Forget About Austerity

2011-04-19T15:07:00.003-04:00

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.

More Potential Outrages Regarding Libya?

2011-04-19T14:58:00.004-04:00

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.

Addendum to Precious Metals Train Post

2011-04-18T09:40:00.004-04:00

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?

Is the Precious Metals Train Changing Speed or Direction?

2011-04-18T08:33:00.003-04:00

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 bpp.mit.edu/daily-price-indexes. 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 Bloomberg.com:

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 . . .

Libya: You CIA You Want a Revolution

2011-04-16T08:17:00.007-04:00

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.

On Treating Economic Crises the Way We Treat Heart Failure

2011-04-09T06:46:00.009-04:00

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.

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

2011-04-08T08:04:00.006-04:00

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.

Inflationary Adventures in Extremistan

2011-04-05T17:41:00.005-04:00

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 CrossingWallStreet.com).

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.

Oil Over Ivory

2011-04-02T11:08:00.003-04:00

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 Bloomberg.com:

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?

San Onofre and Sunset: Persistence of the Past

2011-03-31T17:36:00.004-04:00

At Haggerties and Swamies
Pacific Palisades
San Onofre and Sunset
Redondo Beach L. A.
All over La Jolla
At Wa'imea Bay.

Everybody's gone surfin'
Surfin' U.S. A.

-Brian Wilson, 1963 (credit also to Chuck Berry as tune is that of Sweet Little Sixteen)

Times have changed. Now, even landlocked 80 year olds surf, but is from their computer, and it is cyberspace rather than the waves they enjoy. Now as then, a young Democratic president engages in deficit spending to get the economy moving again. Then, San Onofre was merely an isolated beach in northwest San Diego County.

Now, it has two functioning nuclear power plants sitting oddly by the popular beach/surfing spot as well abutting I-5, the same site also including a decommissioned plant that is used to store "spent" nuclear fuel.

An entrepreneur has proposed a "green" project that would, his company asserts, cleverly use power from the tides to generate more electricity than the two plants generate, while saving costs by tying into the power lines the nuclear plant uses. This modest proposal has excited opposition from surfers and fishermen, among others. Environmental damage is feared.

Will the surfers still rule at San Onofre?

I don't know, but it strikes me that something as allegedly simple as meeting California's energy needs and desires via the uber-renewable source of tidal power ought to be relatively noncontroversial. The fact that such is not the case strikes me as indicative of how difficult it is to effect change in settled situations.

Let's take a walk down recent memory lane.

Financial Armegeddon in 2008?

No problem, let's just react using existing tools. And make sure we defend all our actions leading up to the financial myocardial infarction. Take a fresh look at new (different) paradigms? Heavens forfend?

Rampant abuse of public corporations for insider gains?

No problem, the "market" must continue (resume) its upward course. (Why that is important is not explained.)

Economic activity not fast enough to suit the central authorities?

No problem, just force-feed the goose. It always produced delicious foie gras in the past.

Recovery still slow?

Just print (electronically) even more money. Output gap? It must be filled. By order of: the authorities.

Isn't all this money issuance unfair to savers, by diluting out their savings, just as the California Gold Rush made existing gold worth somewhat less?

Sorry. Don't save: speculate.

Even if you are a well-meaning statist (if that's not inherently an oxymoron), you will tend to identify with Hamlet:

You tend to want to bear the ills you have than fly to others that you know not of.

And so the government flails on, doing whatever Big Finance wants every day, and trying to buy off or at least placate most other constituencies with one-offs as needed: one day making the unemployed happy with enhanced benefits, another day making high earners happy with continuation of current tax rates, another day making Big Pharma and Big Insurance happy with corporatist-oriented health care "reform", another day making the military-industrial complex happy with expanded wars in non-core parts of the world, the next day making the bond guys happy by keeping interest rates in their 30 year downtrend, another day making perverts know where to get a fun job by mandating nude scanning or intrusive patdowns simply for wanting to fly from LA to NYC, and so on.

A government that is simply trying to please enough constituencies by promising and giving money so promiscuously is one that is planning to bear the ills of inflation rather than some other pain.

The financial markets see through the fiction that quantitative easing is anything other than the central bank buying its creator's debt because no rational market participant would want to do so it at the price (interest rate) the government requires to issue so much of it. Whatever shifting explanations the central bank gives for its rationale can, at a first cut, be ignored: As John Mitchell of the Nixon administration said, watch what the Fed does over what it says. The Fed is not independent by statute and from its operational onset in 1914, it was immediately squeezed between the twin powers of Treasury and the big banks. This remains the case. The government means to inflate the debt burden away, and it has tremendous powers to do just that. From an individual investment standpoint, resistance is futile, no matter how much one may believe that this policy is improper, unfair, and counterproductive.

Just as it is hard to get away from burning hydrocarbons to obtain energy even with renewable sources such as tidal power, it is hard to get away from the global memory that gold is a store of wealth independent from the tyranny of governments that impose one and only one currency system on an entire society.

Thus I "like" gold because I see the U. S. government making numerous promises it does not mean to keep. I also "like" hydrocarbon producers that have leverage to a "high" price of oil and gas, and I "like" such companies to have borrowed a lot of money at existing rates to develop resources at today and tomorrow's nominal costs, because then I have double-barreled leverage to the potential for much higher nominal hydrocarbon prices in not-too-many future years.

In medicine as in finance, the DoctoRx rule is that tomorrow is usually more like today than it is different, and patterns of the past persist more often than not. I expect that surfers will continue surfing at San Onofre (and Sunset) no matter whether tidal power is harnessed beneath the waves, and I also expect that as the effects of rampant base money creation percolate through the economy, traditional ways to sustain purchasing power as described above will likely prove to be better investments than cash, bonds or "conservative" stocks.

Simultaneously, I am well aware that the superstructure of our financial system is unstable. Might it crash? Yes. Might that crash be deflationary? Yes. Am I confident I can predict such in advance to take evasive action? I hope so. Currently, though, I believe that the powers that be want growth and they want inflation. So, I'm putting new money flows alongside what I believe is the government's intention, all the while resenting their power.

So it goes.

Fortress America

2011-03-30T08:39:00.005-04:00

Fortress America might be a sensible approach now.

There is no expanding Japanese empire as in the 1930s. There is no Germany seeking "lebensraum". There is simply a local dictator in Libya, and there is opposition. Both the ins and the outs want control of their share of the oil revenue. Are the outs "better" than the "ins"? Who is to say? The U. S. has no dog in this fight.

It would be enough to say to both sides that if either one commits atrocities, then the U. S. and its allies will put boots on the ground and find and prosecute the perps.

It may not have occurred to the Peace Prize President that such a threat might have forestalled the violence that he claimed required the use of American force.

Remember that Reagan ingloriously pulled out of Lebanon when all those Marines were blown up in their barracks. His reputation easily survived that embarrassment. As for Reagan, so for Obama. War is bad for children and other living things. Stopping NATO's aggression in Libya would be the right thing. If atrocities incite the American people to support an invading force, then Congress can so authorize, and a Blackhawk down-type setback will not in that case force a retreat.

As with Libya, so with Pak-ghanistan. Peace is the default, best answer. When in doubt, don't bomb. It's hard to kill innocent people from the air when you're peacefully putting your full energies to improving the US of A at home, where we live and need better times.

It's time to build, and rebuild, more shining cities on more hills at home rather than killing Muslims abroad.

Stagnation Plus Inflation Equals What Again?

2011-03-28T09:33:00.004-04:00

Some random economic news of the day:

First, from the gov't, the key part of the incomes report that Bloomberg ignores:

real DPI fell 0.1%.

Next, courtesy of edegrootinsights.blogspot.com:

Massachusetts job fair canceled because of lack of jobs

Economic spin reaches only so far.

A Massachusetts employment organization has canceled its annual job fair because not enough companies have come forward to offer jobs. Richard Shafer, chairman of the Taunton Employment Task Force, says 20 to 25 employers are needed for the fair scheduled for April 6, but just 10 tables had been reserved. One table was reserved by a nonprofit that offers human services to job seekers, and three by temporary employment agencies.

Source: usatoday.com

Nice pick-up, Eric.

Combine the above with the drooping real income status of Americans and you can see that stagflation is here. It is not "coming". It is here. What the future holds will be known in due time. I expect that until "inflation" becomes public enemy number one, investments should continue to be oriented to sectors that "benefit" from it rather than cash, bonds, or defensive stocks.

Updates from Pak-Ghanistan, as Obama's Efforts There Founder

2011-03-27T21:57:00.005-04:00

Meanwhile, while Libya implodes/explodes, things ain't looking so hot in Pak-ghanistan.

From the Pakistani newspaper Dawn:

Pakistan’s Foreign Secretary Salman Bashir on Saturday said that efforts made by the international community to establish peace in Afghanistan were failing, DawnNews reported.

He said a clear solution to the Afghan problem was no longer visible.

Also from Dawn:

Taliban insurgents abducted around 50 off-duty Afghan policemen in an ambush in a volatile province in northeastern Afghanistan, the militant group and provincial officials said on Sunday. . .
The policemen were abducted by militants in the Chapa Dara district of remote northeastern Kunar province after returning from neighbouring Nuristan province where they had travelled to collect their salaries, Nuristan governor Jamaluddin Badr said.
“The policemen were in civilian clothes and had no weapons with them,” Badr told Reuters from Nuristan.
Then, from a different Pakistani paper, The Nation:
Pakistan is beefing up its arsenal of long-range missiles by embracing China as its new strategic arms partner and backing away from the US, analysts have told Fox News.
Also from The Nation:
- The United States is considering various options including typical hardcore solutions based on its carrot and stick policy in repairing strained relations with Pakistan by demanding military operation in North Waziristan Agency without any further delay.
Well-placed diplomatic sources told The Nation on Sunday that Washington had been weighing various options in response to Islamabad’s March 17 strong protest with the United States over its inhuman drone hit on a peace congregation in North Waziristan Agency.
The US drone attack on a peace congregation, which killed at least 39 innocent people, had drawn a strong and rare condemnation both from civilian and military leadership of Pakistan which led to serious friction in relations between the two countries.
It appears to me as though things are going badly for the U. S. in this region.
This being a modern age, let's do some relativistic thinking. According to President Obama, it's justified for the U. S. to engage in extrajudicial killings of "militant" in Pakistan from the air, even though we are not at war with Pakistan and never have been. If an unknown number of civilians die from American-fired missiles, it's OK, it's war. However, when a rebellion occurs in Libya, and is repelled, and the leader of Libya says that anyone who surrenders will not be harmed, the U. S. is supposed to intervene. And of course, candidate Obama sponsored a resolution in the Senate insisting the "W" Bush gets Congress' approval before any military action in and against Iran, a country with which even Jimmy Carter launched a military operation without Congress' overt consent. But when it comes to Libya, which apparently buried the hatchet with the U. S. 8 years ago, it's the imperial presidency all over again.
It appears at Econblogreview that the U. S. should clean up its own act regarding civilian killings in Pak-ghanistan. The easiest way to do that is by declaring "victory" and leaving.
Copyright (C) Long Lake LLC 2011

US on the Offense in Libya, Reportedly Favoring Islamist Rebels

2011-03-27T18:03:00.005-04:00

The Telegraph.co.uk reports that the story that all the "coalition" was doing in Libya was protecting the innocent from a massacre cannot be defended. The "coalition" has likely been in league with the "rebels" all along, and was forced to act when, to general surprise, the government refused to cave. This report follows yesterday's Telegraph report that the "rebels" contain a significant al-Qaeda contingent, as Col. Qaddafi has claimed from the start. Here is the relevant part of today's report:

Meanwhile Sirte on the Mediterranean coast was pounded overnight intensively by allied warplanes, it was claimed.

"The city has become a ball of fire," the resident said. "The doors in our house were flung open from the force of the blasts."

"Most of the residents have fled into the desert terrified by the air strikes."

Having cooperated (apparently) with the anti-al Qaeda posture of the US since its 2003 deal with the Bush administration, why is the US turning its back on that deal in favor of unknown "rebels" who apparently are Islamists?

Update: The West now attacks Tripoli. Clearly a declaration of war by the US Congress should be required to initiate regime change. (From Reuters):

TRIPOLI - At least six explosions resonated in the Libyan capital Tripoli on Sunday, possibly signaling renewed air strikes by Western coalition forces.

The explosions were followed by sustained bursts of anti-aircraft gunfire by Libyan forces.

Invading Extremistan

2011-03-25T08:31:00.003-04:00

With the U. S. engaging in increased military activities under a "peace" president, it appears apt to use a military metaphor to our Washington-directed economic/financial policy.

As with storage of nuclear fuel and Palestinian refugee camps, often there is nothing so permanent as that which is "temporary". So it seems with ZIRP, the famous zero interest rate policy that was introduced as an emergency measure late in 2008. In Talebian terms, the U. S., via the central authorities working through the Federal Reserve Board of New York as the implementer, has invaded monetary Extremistan and looks to be building an embassy there. The authorities mean to stay a while.

Just as the pace of price increases collapsed from double digits to low single digits rapidly following the reintroduction of high interest rates in late 1980 through 1982-3, with a resulting double dip and severe recession, so may price increases surge surprisingly rapidly as stimulative fiscal and monetary policies continue apace. A sudden and substantial rise in price inflation has happened many times before in America. I cannot think of one reason why it will not happen again, and I think it is happening now. (This is not the same as hyperinflation.)

I think that people who expect important price declines in housing and stocks are correct in real terms, but I think that's a dubious (but possible) proposition in nominal terms.

We simply may have entered a period where, even with an ounce of gold above $1400/ounce, a saver is taking more risk with a (say) 2-year certificate of deposit than with ownership of gold in a cost-efficient manner.

The occupation of financial Extremistan has been going on so long that the natives are beginning to accept ZIRP as normal. It is not normal at all. The old rules simply may not apply. The War on Savers began in 2001 and except for a brief period in 2006-8, continues.

Resistance is not, however, futile.

Libran Rebels Not Worth Fighting For

2011-03-24T17:25:00.004-04:00

The Independent, from the UK, tells us all I think we need to know to decide that America doesn't really have a dog in the civil conflict in Libya. The headline of today's report pulls no punches. It is:

The resistance has foundered on its own indiscipline and farcical ineptitude

. . . Rather than press home their advantage and retake Ajdabiya, the rebel fighters – known as the Shabaab – were too busy having their pictures taken with the wreckage or looting anything left intact from the supply trucks. A desultory attack late in the day was easily repulsed by the regime's forces which then dug in around the city.

The bombardment by the US, France and Britain was meant to break the regime's forces and galvanise the rebels. Extraordinarily, it appears to have had the opposite effect, with the Shabaab retreating yet again in the next 48 hours.

There is little sign of leadership on the issue from the political hierarchy at the opposition's capital, Benghazi, where the provisional administration, with the prize of international recognition seemingly within reach, has been enmeshed in a bout of internal rivalry. . .

To date the Shabaab has wasted at least three times the ordnance than it has fired in anger by shooting into the air in celebration of often non-existent victories. It has blown up guns by using the wrong type of ammunition, crashed its few tanks into each other and shot down two of its own planes. . .

The "best" part of the article is the end, which is straight out of Catch-22:

The rebels' operations are further undermined by an absence of command and control. On Monday two men standing within a hundred yards of each other, "Captain" Jalal Idrisi and "Major" Adil Hassi, claimed to be in charge of the fighters who were meant to be attacking Ajdabiya. A brief advance soon turned into a chaotic retreat. Major Hassi then claimed that the misjudgement in going forward had been Captain Idris's idea. But why didn't they liaise? "We haven't got communications equipment" he responded. But the Captain is standing just over there, journalists pointed out. "I don't talk to him," said Major Hassi.

In addition, the pro-war camp needs to explain the following. In 2003, Libya came to terms with the US and agreed to dismantle its nuclear weapons program and cooperate against al-Qaeda. Perhaps it has done something egregious to violate the terms of that agreement. If not, and if the US simply turned against Libya after striking a deal to let bygones be bygones, what hostile nation will every again trust America after it has, only 8 years later, turned to regime change by force of arms against the regime it willingly dealt with?

Congress should invoke the 1973 War Powers Act and should explicitly either cut off funds for all offensive and clandestine activities in Libya, absent a showing of appropriateness from the White House.

As the Independent points out, the issue is not whether the Libyan regime is "good". But the North Korean regime tortures and executes its own people. Syria has just killed about 25 protesters in the past few days. Supporting the Karzai regime in Kabul is bad enough. What's so hot about the Libyan rebels that we prefer them to the existing government enough to go to war?

Since President Obama has set a goal of doubling exports, perhaps what he should do is hire the US military out as mercenaries, with the goal of deposing all "bad" regimes worldwide. Since there are so many of them, that could be a real money-maker. But the Libyan intervention is on our dime, which means it is done with newly printed money, which is a further blow to savers and investors in the US markets. It is, however, good for many campaign contributors such as those in the oil and military industries. It couldn't be that the new Chief of Staff, Daley, has thought of that, could it?

This Cannot Be Good (Fuku-shima update)

2011-03-23T22:42:00.002-04:00

Steam rising from 4 reactors at Fukushima plant

An NHK helicopter crew has confirmed what appears to be steam rising from No. 1, 2, 3 and 4 reactor buildings at the troubled Fukushima Daiichi nuclear power plant.

This is the first time that steam has been seen coming out of the No.1 reactor.

The helicopter crew was filming from a location more than 30 kilometers from the plant shortly before 7:00 AM on Thursday.

The Tokyo Electric Power Company says that black smoke seen rising from the No.3 reactor building on Wednesday was no longer visible as of 6:00 AM Thursday.

Thursday, March 24, 2011 09:31 +0900 (JST)

THE above is from the Japan Broadcasting Company's NHK World.

The health situation in the Fuku-shima region is far worse than the authorities have been letting on. As in the 2007-8 financial crisis in the U. S., the truth gradually is dribbling out. Nonetheless, people in California etc. will not start glowing in the dark. Japan, however, may be in a Chernobyl-type situation, at least for areas around Fuku-shima prefecture.

Miner Leagues

2011-03-23T08:00:00.002-04:00

In the unending search for relative investment value in this overpriced neighborhood we call today's markets, yours truly has, following some indecision, to sink some real money into certain gold mining stocks. Criteria I have used include standard criteria that would apply to any company, such as rising profits and free cash flow, and preferably dividends. Just having gold in the ground is not good enough for me to invest in a company.

I also like to see good, or better than good, relative strength of the stock compared to its peers. In other words, I like to see that Mr. Market has been on my side. I also need to be absolutely convinced that a reasonable base case provides for adequate total return in a defined time frame.

Why is it worth the trouble to risk capital and spend time in these matters, given how picked over the stock market is by people smarter and better informed than I, and who work with the aid of immense computing power, inside information and other advantages? (I am talking large cap investing here.)

The answer comes from having an economic philosophy that the market has not priced in.

The many insights of the Austrian school of economics, which I recognize as at base simple common sense, have not been accepted by the investment mainstream. Thus when I invest in gold (unhappily, given that gold is the anti-dollar and I am a loyal American), I feel that no matter what surges its price has, I can see that the miners are themselves buffeted by rapidly rising costs of mine development, so I know that there is reality behind the nominal price of gold. This would change if the authorities in Washington either lost power or pursued policies of decades ago (not to mention those of the post-Civil War era).

Much more speculative than large cap dividend paying stocks are the junior miners and yet more speculative are the explorers. My sense is that at some point, "the Bernank" will have a "von Havenstein moment (lite, I hope)" and this (prolonged) moment will be associated with huge moves in said speculative stocks, mirroring the NASDAQ of the late 1990s. I fervently hope that this does not come to pass, but since hope is not an investment strategy, I will disclose that I own some of these highly speculative securities as well. Not enough to get hurt if they revert to what may be a lower fair value, but enough to provide some juice should things explode upward.

Large caps meeting my criteria include ABX, GG, and FNNVF. The GDXJ and GLDX funds are good enough for me right now, as they respectively cover junior (producing) gold mining companies and exploration (non-producing) companies, with some silver exposure included.

Stop the Nuclear Spin Cycle

2011-03-22T17:02:00.004-04:00

The American media misses the tip of the nuclear power plant issue.

We don't get much of the following information:

Reuters reports:

"We continue to see radiation coming from the site ... and the question is where exactly is that coming from?" James Lyons, a senior official of the International Atomic Energy Agency (IAEA), told a news conference in Vienna on Tuesday. . .

Senior IAEA official Graham Andrew said that the overall situation remained "very serious" and that the U.N. atomic watchdog was concerned it had not received some information from Japan about the Fukushima nuclear plant.

"We have not received validated information for some time related to the containment integrity of unit 1. So we are concerned that we do not know its exact status," he said.

The IAEA also lacks data on the temperatures of the spent fuel pools of reactors 1, 3 and 4, he said . . ."

Meanwhile, Bloomberg.com has for some reason decided that radioactive cesium inside the body is safe, quoting an "expert":

Cesium, with a half life of 30 years, isn’t a cause of concern in the water, said Lam Ching-wan, a chemical pathologist at the University of Hong Kong’s medical school (what precisely is a chemical pathologist?).

“Cesium doesn’t cause many problems with cancer because it’s mainly concentrated in the muscles and not other organs,” he said. “Muscles aren’t dividing cells. Even if there’s a mutation, it cannot stimulate cells and grow and produce cancer.”

Yet here is the Argonne Nat'l Lab on cesium radioactivity, from 2005:

"While in the body, cesium (-137) poses a health hazard . . . the main health concern is the increased likelihood for inducing cancer."

This physician will go with Argonne.

While the US media is downplaying matters, as may well be the Japanese media, such is not the case everywhere. The UK's Telegraph reports:

"Radiation 1,600 times higher than normal levels was detected 12 miles from the power station, the limit of the evacuation area.

While radiation at that level is not considered high for a single burst, it could harm health if sustained."

Back to DoctoRx. Talk about British understatement! Yes it "could" harm health! Let's add a few more exlamation points. !!!

The Telegraph also reports:

"The pool at the Fukushima Daiichi nuclear plant heated up to around boiling point, and with water bubbling away there was a risk that more radioactive steam could spew out."

Apparently the utility, TEPCO, that operates the Fukushima plants, is classifying this incident as a 'Level 5', the same as Three Mile Island of 1978. A quick search for TMI will show that is ridiculous. Massively more radiation has been released in this incident than in TMI, just based on the quotes contained in this little blog.

Meanwhile, pro-nuclear sources are already on the offensive. I read yesterday about a proposed scheme to put small-scale nuclear reactors in cities.

These people don't get it. What they don't get is that almost everyone knows that the electricity production from U-235 is safe. However, at least in the US, there is no plan on where to put the toxic fuel once it has reached its useful life.

Here's an analogy. You don't go into an investment without an exit plan. A surgeon doesn't begin a non-emergency operation without a plan on closing the wound and recuperation of the patient. You don't bring a puppy into the house unless you have a plan on where the poop is going to go (you housebreak the pet, of course).

Where oh where is all the nuclear waste, currently and massively stored throughout the US in "temporary" receptacles, going to go?

Without an agreed-upon plan for waste disposal, I don't care how safe the operation of the plant is.

And So the U. S. Comes to Lib(erate)-Ya, with Predictable Results

2011-03-22T14:53:00.004-04:00

Foraging for firewood in Afghanistan 3 weeks ago, nine Afghan boys aged 9-15 were killed by Americans from the air. Allegedly they were mistaken for terrorists. Now Barack Obama., not satisfied with military intervention in three Muslim countries (at least), feels it is in the American national interest to intervene in a civil war in a Muslim country in Africa. To no one's surprise, allegations already appear that the U. S. has shot more civilians there. From Telegraph.co.uk today (Libya Live blog):

16.15 The US Joint Task Force Commander has just refused to comment on our reports that six Libyan civilians were shot by US rescuers. Admiral Locklear said that an investigation into the rescue mission had been launched and he would say nothing until it was complete. When pushed, he also refused to comment on whether any shots had been fired. He was fielding questions during a US press briefing.

15.59 Events are moving fast so let's clear up any confusion. This is what we know now. Two pilots crash landed in a field near Benghazi this morning. One was handed over to rebels and then given to US officials before being taken to the USS Kearsarge in the Mediterranean. During the rescue of the second pilot a US heliocpter shot and injured villagers. This pilot is believed to be "safe in American hands" at an unknown location.

It's time to break out 1960's folk songs. When will they ever learn?

Neocon (Uh-Oh Version)

2011-03-20T10:32:00.004-04:00

It's one thing to run for president because you opposed the Iraq War and then turn neocon. It's another to be burned by the Arab League within 24 hours of offensive action in the first war you did not inherit from your predecessor. From Telegraph.co.uk (Libya Live blog):

"13.58 Rather worryingly the Arab League has criticised the air strikes against Libya despite being at the forefront of calls for a no-fly zone. Arab League secretary general Amr Mussa said:

What has happened in Libya differs from the goal of imposing a no-fly zone and what we want is the protection of civilians and not bombing other civilians...From the start we requested only that a no-fly zone be set up to protect Libyan civilians and avert any other developments or additional measures.

This appears to show that the Arab League believes report from Gaddafi that civilians have been killed during Coalition air strikes. It begs the question whether Britain, America and France will continue with their military plans without Arab support. A press conference has been scheduled in about two hours where we will be seeking further clarification."

Neocon

2011-03-20T09:33:00.006-04:00

Barack Obama won the Democratic nomination over Hillary Clinton because he (correctly) opposed military intervention in Iraq and she favored it. Now, he is reported to have swung to her support of war in Libya against the advice of the Republican Secretary of Defense, Bob Gates. Here is early reporting from the Telegraph.co.uk (its real-timeg blog) on the results so far:

13.16 Russia is calling for an end to 'indiscrimate use of force' by foreign states in Libya claiming that they have led to civilian casualties. Foreign Ministry's spokesman Alexander Lukashevich said in a statement:

In that respect we call on countries involved to stop the non-selective use of force. . .

113.07 It is of course an irony that the UAE have come to the side of the rebels in Libya while they have also sent forces into Bahrain to help crush the uprising there.

13.00 Libya's government has begun distributing arms to more than one million people and will complete the operation within hours, the state news agency reports today. Jana news agency quoted sources in Libya's defence ministry as saying they "expected the operation to end in the next hours to arm more than a million men and women."

12.56 German Foreign Minister Guido Westerwelle dismissed allegations that Berlin is internationally isolated after refusing to join its NATO allies in staging military strikes on Libya. He said:

The impression that Germany is isolated in Europe or the international community is completely wrong. Many other countries in the European Union not only understand our position, not only respect it, but also share it.

12.54 A Libyan health official said the number of people killed as a result of Western air strikes overnight had risen to 64 from 48, a figure given by the government.

"People died from their wounds so the death toll has risen," said the official, who did not want to be identified. The figure could not be independently verified.

The much-reviled "W" got approval from a Democrat-controlled Senate for intervention in Afghanistan and again for war with Iraq. Subsequently, when sabers were being rattled against Iran in 2007, MSNBC reported:

"Democrat Barack Obama introduced a Senate resolution late Thursday that says President Bush does not have authority to use military force against Iran, the latest move in a debate with presidential rival Hillary Rodham Clinton about how to respond to that country's nuclear ambitions. . .

'We wish to emphasize that no congressional authority exists for unilateral military action against Iran,' it says."

Here is the beginning text of a Nixon-era law, which was passed despite a Nixon veto. What part of Section 2(c)(3) applies in the current case of war with Libya?

The War Powers Act of 1973

Public Law 93-148

93rd Congress, H. J. Res. 542

November 7, 1973

Joint Resolution

Concerning the war powers of Congress and the President.

Resolved by the Senate and the House of Representatives of the United States of America in Congress assembled,

SHORT TITLE

SECTION 1.: This joint resolution may be cited as the "War Powers Resolution".

PURPOSE AND POLICY

SEC. 2. (a): It is the purpose of this joint resolution to fulfill the intent of the framers of the Constitution of the United States and insure that the collective judgement of both the Congress and the President will apply to the introduction of United States Armed Forces into hostilities, or into situations where imminent involvement in hostilities is clearly indicate by the circumstances, and to the continued use of such forces in hostilities or in such situations.
SEC. 2. (b): Under article I, section 8, of the Constitution, it is specifically provided that the Congress shall have the power to make all laws necessary and proper for carrying into execution, not only its own powers but also all other powers vested by the Constitution in the Government of the United States, or in any department or officer thereof.
SEC. 2. (c): The constitutional powers of the President as Commander-in-Chief to introduce United States Armed Forces into hostilities, or into situations where imminent involvement in hostilities is clearly indicated by the circumstances, are exercised only pursuant to (1) a declaration of war, (2) specific statutory authorization, or (3) a national emergency created by attack upon the United States, its territories or possessions, or its armed forces.

To Lib(ya) and Let Lib(ya): Not

2011-03-19T11:16:00.003-04:00

Invoking the name of France's state-owned oil company, Carla Bruni's husband has stated that "Our determination is total" and has begun an unprovoked attack against Libya.

All about oil?

D-oh.

Ig-Nobel

2011-03-17T23:25:00.002-04:00

The United States is preparing hostile military action against a weak country that neither attacked, threatened to attack, or harbored terrorists who had recently attacked the U. S.

In addition, the constitutional lawyer who is President is so far giving no indication that he thinks Congress needs to approve of this oncoming act of war.

One wonders if the Nobel Peace Prize-givers regret their choice.

Helicopter Drops

2011-03-16T23:12:00.001-04:00

Almost a decade after Ben Bernanke gave his speech that pointed out that a determined central bank could almost literally drop money from helicopters in case of threatened deflation, we are seeing the horrifying spectacle of real helicopters dropping water onto pools of water (or what once was watery) designed to cool down spent nuclear rods. This in a technologically sophisticated nation. This in a nuclear complex located directly by the sea.

This whole business of running out of power and running out of water is as disconcerting as finding out that almost all financials institutions were, more or less, bust in September-October 2008, just a couple of months after being reassured by Gentle Ben, Tall Hank et al that what was happening in subprime was staying in subprime. I am a cardiologist. Many of my patients wore tiny, internal lithium-powered pacemakers just under their skin. These devices lasted year after year without a recharge. How can it be that an entire nuclear complex only had back-up battery power that would last only for a fraction of a day?
Who'd of thunk it?

If these rods in the "pond" explode, or if some other catastrophe occurs in this nuclear complex, various stock markets may implode in their own uncontrollable chain reaction. Whether that would be unjustified in the larger scheme would not matter if panic sets in. The "Keynesian" money-printers have gone beyond anything Keynes specifically advocated. Thus we have a financial system that is perhaps even more prone to meltdowns than the troubled nuclear facility in Japan. Nassim Taleb was a lonely voice the past few years calling for the financial system to be "robustified". Instead we got "extend and pretend".

Helicoptered money has not worked to reliquefy the housing market. Let us hope that the real helicopters in Japan, or some other emergency expedients, prevent something that invites direct comparisons to Chernobyl.

In today's and tomorrow's markets, I reiterate my comment from earlier in the week: Safety first.

Copyright (C) Long Lake LLC 2011

SAFETY FIRST

2011-03-16T08:55:00.002-04:00

In case you have not noticed, the evolving horrors in Japan have merged with the disorder in the Mideast and cycles in the U.S. (probable peaking of economic momentum) to cause a decline in numerous asset prices lately. In what strikes me as not a coincidence, the 10 and 30 year Treasury bonds have peaked in yield right around their long-term trend lines.

The Treasury bond bull lives on, in a sort of repetition of the 1940s experience. In that decade, during peace, then war, then peace, then war, interest rates stayed insanely low relative to the decade’s average price increases of 7%. Adjusted for inflation, the stock market did not do very well, but nominally, it was one of the best games in town. And we live in a nominal world, something one can forget if one reads too many exegeses written by economists. Of course, the market began and ended the 1940-49 decade with far lower fundamental valuations than it has today (meaning it was undervalued then), and thus had a margin of safety that I believe is lacking today.

So far as I can see, the major trends that have been in force for years remain in force. An aging and manipulated Treasury bond bull market is coexisting with and, in a sense that strikes me as a crucial sense, is driving the gold (and silver) bull market. In that context, the price of second-hand stocks (i.e. “the market”) is secondary in importance to the authorities keeping the government funded and, except for precious metals stocks, is of at most secondary importance to true “bugs” on precious metals.

Based both on average price-earnings ratios for the past 10 years and on replacement costs for the assets of the S&P 500, both as judged by Andrew Smithers, the stock averages are as of this writing near their 1929-level of overvaluation and are similar to their 1965 and 2007 overvalued states. By this analysis, a 50% off sale of the stock market would leave it only somewhat undervalued. Unfortunately, the factors that take markets from highly valued (i.e. overvalued) to undervalued essentially always involve fundamental deterioration that destroys actual value as well as it simultaneously destroys confidence and optimism. It also destroys liquidity. Thus at true market bottoms, as in 1932-3, 1974, and 1982, most people with cash are too scared to get in near the bottom.

So far as stocks go, space in this blog does not permit a full explanation, but it is important to emphasize that if one wants income, one should not think first of common stocks. Dividends are both not guaranteed and payment of a dividend results in the equivalent drop in the stock’s price. For example, several drug stocks are “high” dividend payers. Yet the stocks sell at high multiples of book value and price-sales ratios. They were hot growth stocks in prior decades. Thus they really are simply busted growth stocks but without physical resources that can hold their real value as central banks destroy the value of savings by creating unlimited new money at unfairly low yields.

In contrast, mature companies that own natural resources and that pay out significant dividends while yet retaining much of their cash flow may be especially attractive in the current environment of muddled finances, central bank money-printing, and a global “growth” agenda. Integrated oil stocks and some natural gas stocks fill that bill.

Unlike drug stocks, no one thinks of the major oils as fast growing companies, so their prices never get bid up far too high due to the delusion that they can save the world the way a drug stock can get wildly overpriced. The dirty not-so-little secret of the connected, wireless age is that it is an energy hogging world. With the increasingly uncertain future of nuclear, there is no technology to replace hydrocarbons to allow the world to “grow”. High-yielding energy stocks and precious metals stocks are the only major asset classes of stocks that appeal to me in the here and now. Lower stock prices, such as for owners and operators of base metals, and for top-tier tech and other companies, would change that assessment. No matter what happens in Japan in the days and weeks ahead, Chindia and Brazil want to achieve Western standards of living. They continue to be willing to save to get there to a degree that the West except for Germany has forgotten how to do. The marginal value of a gallon of gas is clearly greater to an Indian getting his first car or motorcycle that lets him get to a good job a distance from home than it is to an American who does a good deal of pleasure driving.

For some time, I have been feeling as I did in 2007, on the one hand that the 3rd year of a presidential term was bound to be a good one in the stock market–and so it was in 2007 from start to finish; but I exited financial stocks in the winter in 2007 and exited virtually all stocks in the late summer. That the averages hit new highs after I sold out was surprisingly not bothersome to me. I was confident that a recession had arrived and that the risk-reward for stocks was poor.

This was without forecasting the disaster of 2008 or the “Keynesian” lunacy that subsequently”solved” the crisis. Just as the surprises with Bear Stearns funds in the spring of 2007 began to explain the underperformance of financial stocks over the prior year, the increasing comparisons of Barack Obama with Jimmy Carter suggest to me that Mr. Obama’s inexperience and his laid-back manner (i.e. lack of leadership skills) can allow negativity to surge as it did during Mr. Carter’s tenure as people sense drift at the top during difficult times.

I think the American economic system and related financial markets have a malaise that in some ways is similar to that of the extended Johnson-Nixon-Carter era and that in some ways is quite different. Thus, both equal (in some ways) and opposite (in other ways), in fine Newtonian thermodynamic fashion. With 3-month T-bills collapsing to new lows of 7-8 basis points, the markets are again going “Japanese” (pre-earthquake sense), and thus there are no imminent signs of hyperinflation from the markets.

As I said from the time I began blogging in late 2008, “stimulus” was not going to stimulate. The Austrian economists got it right. The money-printers got it wrong. Other than technical advances in some gadgets, what has really been accomplished in the economic “expansion” of the past almost two years? Extend and pretend, that’s mostly the extent of it.

Compare the current situation to the manifest improvement in real economic conditions and in psychology by mid-1984, with disinflation the order of the day and reversal of the sense that the Soviets were unstoppable. Or to 1993, when employment surged massively just a bit too late to help Bush 41 and when it was apparent that the system was putting numerous S&L malfeasors in jail and was rapidly liquidating the associated malinvestments. This time it’s different. It’s the first American credit collapse since the Great Depression, and it’s playing out with just as hollow a recovery as occurred in the FDR era. It’s simply not easy to get out of a credit collapse, and it’s typical for stock prices to get ahead of the economy and then, unpredictably, again reflect reality and sink back as the economy does its difficult thing of adjusting to years of unsound allocations of capital.

As I write this (early Tuesday morning New York time), gold and oil are down in price, futures on American stocks are plunging, and Treasuries are continuing their surge up in price (down in yield). The non-barking dog is that the U.S. dollar is unchanged against the basket of currencies comprising the widely-followed dollar index, DXY.

In the Reagan-thru-Clinton period, the buck would be surging in the aftermath of the Mideast turmoil and then the disaster in Japan. This non-barking dog is in my mind the greatest tragedy of all, and the blame has to go primarily to the political leadership in Washington and to the Fed, along with their enablers in Big Finance and the lapdog media.

What maddens me the most about today’s financial system and our markets is that since the world’s fiat money is a debt instrument (in contrast to a gold standard where money has its own value and also in contrast to true helicopter drops of paper currency), the process of inflating the base money supply involves selling more debt. The extra money created goes, nowadays, in large part to purchasing the debt the issuance of which created the money. If that seems circular to you, then you now understand the essence of Bernanke-ism. The implications of this mean, in part, that the pricing of bonds can increasingly become divorced from positive real returns, and the market can stay irrational longer than you can believe; again, think 1940s. Add all the opaque derivatives and unknown status of bank balance sheets, and one cannot really know what’s going on in the financial markets.

As with nuclear power plant design and seawall height in tsunami-prone zones, so it should be with capital. Safety first, especially so when valuations are stretched. Even more so when the government has abandoned sound economic principles but brooks no financial diversity, maintaining its monopoly on money within a largely unfree command and control structure guiding several of the critical sectors of the economy.

Buyer beware; seller beware; owner beware.

Risk off, in other words, till it’s risk on again. But eventually the public may just “fuggedaboutit” and let the insiders trade with each other. If and when that happens for real, you will see asset prices get cheap in a hurry, because true insiders buy low. Personally, given the reflex of the Bank of Japan to create massive amounts of additional money in the face of a deflationary disaster, I can sleep at night owning gold, because while you can’t eat gold, neither can you eat yen, and central banks can’t print metal out of thin air; nor can they provide adequate levels of electricity without uranium or hydrocarbons.

A back to basics mentality may be coming in financial markets, and money and energy are, along with food, basics of any semi-modern economy. If investors keep their focus on what’s vital rather than what’s peripheral, I think they will be well prepared for the times ahead, whether they be good or bad.

(Note: This was written early AM March 15 and posted later March 15 on DailyCapitalist.com. Posted here March 16 . . .)

Indian Poker

2011-03-14T22:02:00.001-04:00

In college, probably our crowd’s favorite two indoor games were Risk (the game of world domination, in retrospect a funny fave for a group of aggressively anti-war counter-cultural types) and Indian Poker. We all know about risk on and risk off in the financial markets, but Indian Poker has its place.

For those unfamiliar with the term, Indian Poker is played by placing a single playing card on one’s forehead facing outward, visible to the other player or players.

Betting then ensues, with high card winning. The suit is irrelevant.

The game is also known in polite company as blind man’s bluff. In college, among the more printable names by which we knew it were Bullsh-t and One-Card Schm-ck. Gambling is done with faux or real money.

Here’s how one game might evolve, with follow-up reference to financial markets.

Let’s say for simplicity that you are in a two-person game, which was our favorite way to play. Mano a mano or, more properly, forehead a forehead.

Let’s say you pick a 2. With aces high, you’re in trouble. Your opponent knows he can’t lose. 48 times out of 51, he’s got you beat;

3/51 times he will also have a 2 and the round will be a draw. It’s in his interest to make you think you have an ace rather than a pitiful deuce. He thus may play possum to get you to bid him up to a high level. Then he closes the trap.

When you see your card, you realize he’s been slinging the sh-t and that you were the schm-ck. Thus our terms for the game.

As in Indian Poker, so in financial markets. The insiders don’t necessarily hold all the cards, but they see them more comprehensively and earlier than you.

One of the examples of this came in the second half of the 1990s. The insiders knew that most of the tech stocks were overpriced, and the fact that the media and financial community induced a mania by pushing prices illogically higher was just like your opponent letting you push the stakes higher and higher when in fact your deuce had no chance of winning. The housing scam of the aughties was similar. In each case, large amounts of money were made by the connected class on the way up and also on the way down.

Nowadays, I think that there is also a scam going on. The scam is called fighting deflation. The authorities are playing the game of Bullsh-t with the public. They are trying to convince them of the opposite of what is really happening, on plan and on schedule, which is worsening inflation.

MIT’s Billion Prices Project is showing a 3% year-on-year rate of price increases from its survey of online retailers. Since this survey covers neither houses (stable to downward pricing) nor oil products nor food (soaring pricing), let’s say that the true CPI is in fact 3%. Thus pricing short-term interest rates near zero is wildly inappropriate.

Eddy Elfenbein of CrossingWallStreet.com has calculated that a short-term interest rate Fed strategy that produces stable gold prices is one in which the 3-month T-bill rate is 2 points above CPI. For every point above or below that metric, the price of gold moves down or up 8% over the next year. Thus if CPI and interest rates were both 3%, the correlation he has discovered would project that gold prices would rise at a 16% annual rate. Right now the Fed is behind the Elfenbein curve by about 5 points. This would project a 40% price increase for gold this year should conditions stay as is. That would translate to about a $2000 gold price within a year. (There is of course no guarantee that this a posteriori relationship will continue to hold.)

We are seeing a form of a rerun of the inflationary booms or boomlets of the late 1960s and 1970s. The authorities are blasé. I am not.

What happens in the Mideast is of little importance to the general price level. If oil is more plentiful, then pricing power will move to other sectors, but Austrian economic theory states that the net effect is the same. The central bank is creating a great deal of base money at vastly inflated price (overly low yield, in other words). The Federal government is using its command and control structure to force-feed the economy to grow. Of course, much of this Federally-induced spending is malinvestment and is wasted from the standpoint of providing the capital needed for legitimate future growth. Thus a true, durable boom appears unlikely.

One way to be the winner in the game of One-Card Schm-ck that Dr. Bernanke and the Feds are playing with the public is to watch what they do, not what they say. The Treasury is selling overpriced securities to its captive central bank, with the Primary Dealers acting as middlemen to keep the form of the circular debt monetization proper.

It is true that as in 2008, the system can crash and there can be a brief period of true deflation. I see that as a low probability event for the months ahead. To base one’s investing on the possibility or even probability of another 2008 is indeed a rational strategy, but one that requires the patience to lose ground steadily to the money-printing in the hope of jumping in during a panic.

In this particular case, you can avoid being the schm-ck by seeing that the Feds are holding deuces. You probably don’t want to buy their patter or their inventory. Eventually, there will come a time when they will be forced to truly “fight inflation” and when the gold bugs will be pushing overpriced merchandise. I can’t wait for that future game of Indian Poker, but I’m not holding my breath for it to begin any time soon.

Taking the Prophet Seriously

2011-03-10T21:17:00.000-05:00

As was reported by me here just a few days ago, the head prophet of U. S. and global financial markets, named Ben S. Bernanke, is said to favor an end to debt monetization aka QE2 by the end of June. As if on cue, any lesser prophets such as Ray Dalio of Bridgewater Associates or Bill Gross of PIMCO were ignored. Dalio was bullish on stocks for 2011? Yesterday's news. Gross hates Treasuries? Fuggedaboutit: mark 'em up, buddy; so stocks sold off and Treasuries soared. Risk off.

Let me offer a "Yes, but" to today's market "wisdom".

It is the third year of a president's first term; he hopes for four more years. It is the first year that the allegedly reformed and reforming Republicans are back in control of the House. Both those powers want an economic boom so voters forget the recent 'change' elections and endorse the 'ins'.

Ben's reappointment as Fed Chairman by Mr. Obama likely came with a commitment to accommodate the Obama agenda, which clearly involves large deficits as far as the eye can see. These will get financed, sure as shooting.

Since 1935, there has been a recession in America on average every 5 1/2 years. The last one began 3 years and 3 months ago. Thus we can target mid-2013 for the next one, just by the averages, of course with a wide error range. I'm aware of bear markets, but no recessions, with this sort of massive stimulation out of Washington. (Of course, many of us feel that we are really in an ongoing depression and that the recession never truly ended, with a cyclical upturn underway due in large part to global insane money printing rather than a sensible purging of the malinvestments of the prior several years.) But we're talking mainstream terminology for now.

2011 will mirror 2010, with the Fed turning off the liquidity pump to see what happens. The Fed has printed a huge amount of electronic dollars. In chemistry, when a medium or reagent is in excess, it is simply in excess. More can't affect matters for the better. So it is with dollars: they are in excess, and the other players in the national and international bond market have a say, and they in fact do say: We don't need more blankety-blank dollars. And Dr. B needs to operate by consensus as the central banker to the largest seller of bonds to foreigners in the world. Thus the Fed would like to see private lenders and foreign central banks pick up the money creation slack from it, with the Saudis and others also financing our debt by drawing down savings (heavens forfend Americans do that for their (our) own sake!) without printing more money. If this happens, it can be back to "risk on", as in most prior economic expansions. Gold did fine in 2001-7 without big-time Fed debt monetization, after all.

Currently I continue to see a bubble in short-term debt and a general overpricing in almost all financial assets, though not so much in gold or a growing number of houses that are below depreciated replacement value. Now, it's time for recent large profits to be taken, with the fundamental excuse being not a day of rage in Saudi Arabia Friday but instead being a bleat that the Fed will take away the punchbowl.

To restate my views, the Fed will only keep the booze away if another bartender, such as the banking system collectively and/or kind strangers, make sure the party keeps going long enough to give the pols the best odds of staying in their chosen jobs after next year's election. If those other enablers don't do their job, the Fed will do what Ben B must have assured all the President's men and women before securing the renomination. The show will go on.

In this scenario, fIscal and monetary laxity (stimulus) tend to make buying the dips the right thing to do rather than fight the clear intent of the central authorities.

Overvaluation alone rarely kills a bull market, even one built on such sandy and even stony soil as the current stock, commodity and (longer-term focus) bond bull markets are all rooted in. It usually takes enemy action, such as, to continue the analogy, a gardener with a mission to thin the foliage. (Of course, gardeners Alan G and Ben B were often loath to trim at all and then often over-did the thinning; such are the downsides of central planning.)

Thus I look at Thursday's ugly market action as follows. Because cash is being trashed, I'm buying the dip rather than sitting long-term in cash; timing and asset class to be determined. Given the intensity of the stock and commodity rises the past half year, this dip could be panic-inducing. I'm thinking of the sharp, short down-moves in muni bonds and gold during the past few months and thinking that stocks could well do the same thing.

A warning, though. I do sense more complacency about events that might happen in Saudi-land or Kuwait than I feel is warranted. Thus a core investing focus of mine involves companies that own important energy assets in the Americas, as well as gold in the ground also in politically stable areas. If events get out of hand there, the dip will be a bear market of significant proportions, though probably it would be good for gold and appropriate energy stocks.

I'm looking forward to an interesting Friday.

The Great Immoderation

2011-03-06T09:22:00.000-05:00

In both 1960 and 1980, the American people were enduring their fourth recession in about 12 years. Each time they elected as President a man who pledged to get the economy moving again. Each had a program of tax cuts, Federal deficits, debt monetization, and increased military spending. In JFK's case, his Keynesian economists followed the theorizing of the Phillips curve that more inflation would imply more growth/lower unemployment. The decade-long boom was prolonged by the Vietnam War and increasing dollar-printing. The country then began its second cycle of four recessions in a dozen years and, now faced not with the price stability that Kennedy inherited but wild price instability, embarked on a more monetarist program of more predictable, lower inflation. Thus began "The Great Moderation".

One of the keys to the American economic successes of the 1983-2000 period was that the only important foreign war the U. S. engaged in, the 1991 Gulf War, was paid for by client states and thus required no money-printing. Combined with the collapse of the Soviet Union and the shift to state capitalism in China, the U. S. was able to go back to its historical roots and accept a balanced Federal budget. A decline in military spending meant that the decade was deflationary in certain ways. The price of gold began 1990 at $400. It ended 1999 at $300. This 25% decline was mirrored by interest rates, which averaged about 8% in 1990 and about 6% in 1999 and 2000.

The Establishment boasted that this period, extending into 2007 in their eyes, was The Great Moderation.

Unfortunately, this was all an illusion. We have now entered The Great Immoderation. Actual Federal outlays, both on-budget and off-budget (think Fannie-Freddie losses and student loans for the latter) will be about $2 T greater than revenues in 2011. This is a far greater irresponsibility ratio than seen even in WW II. This is being handled by manipulating interest rates toward zero. Amazingly, Federal interest expense is said to be little different from that of 30 years ago. Meanwhile, disparate sources such as Shadow Government Statistics and MIT's Billion Prices Project show the true pace of price increases is currently in the 7-10% range.

The Continuous Commodity Index has been making one all-time high after another.

Meanwhile, wages stagnate in the U. S. as prices rise, but they keep up with or beat inflation in Brazil and Malaysia. Moguls such as Ray Dalio (Bridgewater Assoc., the world's largest hedge fund other than the Fed), Sam Zell (the "Gravedancer"), and Charlie ("suck it up") Munger (Berkshire Hathaway) advise us to get used to a lower standard of living. This is of course simply a reprise of presidential candidate Obama's comment that the rest of the world wasn't likely to allow America to utilize such a large proportion of the world's resources as it had before.

If oil prices behave, so much new "money" has been created that the illusion of a healthy economy can continue a good while longer. Stock market valuations may already have reached their cyclical peak when properly adjusted for prices of consumer goods. The immoderately elevated price (call it a bubble) of short-term debt, with one-month T-bills selling at about 1000 times "earnings", which keeps on keeping on against all logic, appears fated to end unpleasantly. This is analogous to the tectonic forces that produce earthquakes. The imbalances will be resolved; timing is unpredictable.

The U. S. dollar is the non-barking dog of the recent Arab crises. To wit, the dollar's decline rather than its historical strengthening during this sort of event fits the above thesis. The world recognizes there is no safety in a currency tied to negative real interest rates. Even if the Fed stops expanding its balance sheet in June, other dependents of the State such as certain financial institutions and the Saudi/Kuwaiti rulers may be found to pick up the Federal budgetary void.

Gold, the anti-dollar debasement asset, continues to appreciate against the dollar at a rapid pace, reflecting the increasingly implausible spread between interest rates and behavior of prices in the real world; the same can be said for oil. Silver is gold on steroids. Bidding wars for houses are starting up again in Silicon Valley.

Just as Austrian economists predicted and as the Helicopter announced a while ago, a determined central government can guarantee no deflation. Doing so, however, could produce the final collapse of the currency system. How high the inflationary moon? The rise could be, over time, be quite immoderate.

The die is not, however, cast. There is time for change we can believe in.

Will the current cast of leaders effect such change?

It is quite possible that we ain't seen nothing yet.

QE To Infinity: Not?

2011-03-04T07:34:00.002-05:00

Bloomberg.com surprised me this AM with its lead story, as follows:

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month.

Central bankers, who next meet March 15, are about half way through their second round of bond purchases. To bring the program to a full stop in June, they must be confident that the economy is strong enough to endure higher long-term interest rates and rising expectations of an exit from the most expansive monetary policy in Fed history, said Dan Greenhaus at Miller Tabak & Co. LLC in New York.

“If this is a self-sustaining recovery that can withstand higher interest rates, then why not get the hell out?” said Greenhaus, Miller Tabak’s chief economic strategist. “Still, I am nervous about their ability to withdraw from this policy without broader disruptions.”

The Fed announced in November that it would buy $600 billion of Treasuries through June in a bid to boost the recovery and reduce an unemployment rate lingering near a 26- year high. The program, known as QE2 for the second round of so- called quantitative easing, followed $1.7 trillion of asset purchases that ended in March 2010.

Stock Versus Flow

Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman.

“We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.”

Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”

The bolded paragraphs (my doing) above are key. We can hope that this signals that the parties in Washington have agreed, at least in principle, on significant deficit reduction, so that ordinary debt market mechanisms can finance the Federal deficit without the central bank adding to the money supply as it has been doing with quantitative easing. Presumably, it is a show of confidence in the economy. Of course, a year ago a similar show of confidence gave way to the summer slowdown and QE2. Will past be prologue?

I don't know the answer to that, but we can hope this is a return to prudence, and that in turn there could be reason to abruptly rethink the entire weak dollar investment theme. After all, the markets sometimes are a lot smarter than any individual. "Rethink" does not necessarily mean "alter" or "abandon", however. In the prior economic cycle, the Fed did not overtly monetize the deficits, which of course were much smaller, but the private sector went wild with credit creation. Soaring commodities prices and a weak dollar were the speculative result; then the Fed began withdrawing liquidity, and the whole shebang came tumbling down. For now, leaving the important Mideast disturbance and all the known other issues aside, the cards look increasingly aligned for a traditional "sweet spot" year for economic activity. Low interest rates, lots of labor slack, a good deal of unused manufacturing capacity, and tons of fiscal stimulus. Plus lots of skepticism.

Interesting times.

New Site

2011-03-02T07:44:00.002-05:00

I am now blogging at The Daily Capitalist, URL http://dailycapitalist.com. Right now I am posting about three times weekly. The format is better than at Blogger. I may mirror post or resume posting at this site as well, but do not intend to do so at this time.

Ireland Going the Greek Way; Will We Follow?

2010-11-11T18:56:00.004-05:00

“It was the banks doing crazy loans, it was borrowers taking crazy loans and a failure by government and regulators to do their jobs properly,” said Sean Kay . . .. “There was no adult supervision.”

Sounds like the U. S.

Instead it's Ireland, in a Bloomberg article about Ireland on the Brink.

Right now the U. S. is in a "Japanese" phase of my concept of a duality I have dubbed going or being Japanecian (or, Grecianese). The Irish are going Grecian. They are accepting austerity (a depression with debt deflation and high real interest rates) to stay in the good graces of lenders. So long as the U. S. can keep adding to its debt with central bank money created out of thin air, a la Japan, said debt replacing income to the government coming the traditional way from private sector taxes, then interest rates can continue to trend down. If that happens, then the long end of the yield curve will break to very low levels, no matter how high traders price the yields now. With 3-month T-bills at the same level as Japan's, at a trivial 0.12% annualized yield, that's my working hypothesis now.

At some point, however, the Grecian phase of a debt crisis can come to America.

Got gold?

Copyright (C) Long Lake LLC 2010

Will the Next Recession Look Different from the Last One? (Assuming the Last One Has Ended)

2010-11-10T02:13:00.005-05:00

Mish has a post up involving a discussion with a Cerdian economist named Ed Leamer. I am going to comment on one point:

Leamer: Dips come from collective postponement of the postponeable purchases: homes, cars and equipment. But all three of these are at record lows relative to GDP after all the postponement that has already occurred. (After having falling to the floor, the economy has to at least get back to its knees before it can fall again.)

The dip Dr. Leamer is referring to is a new recession.

I wonder if his thinking reflects conventional thinking. I also wonder if when the next recession occurs, it will again fool the experts who are thinking as Dr. Leamer things and thus will not foresee it because it occurs on the less cyclical consumer spending side of the economy.

Meanwhile, we had a turnaround Tuesday today. Gold and silver reversed, and perhaps the record or near-record spreads on the yield curve out to 30 years have peaked. In the meantime, given the collapse in the fraction of the potential labor force that is actually working, we may simply see a combination of a continued retrenchment in consumer spending (especially that which is not due to government transfers/money-printing) and a government in financial straits pulling back on its support of housing. Plus, oil prices have been known to spike unpredictably. What would that event due to auto sales, travel and the like.

In the meantime, BofA ("BAC" symbol) fell 2 1/2% today, sadly once again hitting resistance at its declining 50 day moving average. The nearby chart tells the tale. It is one thing when gold or AAPL, in confirmed structural bull markets with prices that have been bid up fast and high, sell off. It is another thing when a laggard in a lagging industry helps lead the market down following a surge to overbought and over bullish levels. Informed people such as Chris Whalen of Institutional Risk Analytics have been stating that BofA is insolvent and needs to be taken under government protection with its bondholders taking haircuts. The government presumably would make great efforts to avoid this, given the effect on confidence such an action would have at this stage of the so-called recovery.

If Mr. Whalen is more or less correct, then the "Japanification" of the United States continues with seriously impaired major financial instutions existing as zombies ("too big to fail"). The 5-7 year notes are at or near all-time record low yields except for the past week or two. Who knows, but as the banker to the world, all the U. S. has to do is stop importing all elective things and the world will run short of new dollars. Thus I suspect that for all the moaning elsewhere about QE2, overall most of the rest of the world is happy to see America poorer and getting ready to ship its products to them rather than taking the fruits of their labor in return for our depreciating paper. Barack Obama predicted that the world would not let us live in our big homes wasting carbon-based fuels during his campaign. Meanwhile, though, there simply is no other currency ready to take the dollar's place as a reserve currency. (Gold will have to wait. The world is not ready for it yet.)

If he was correct on that in one way or another, please don't be surprised if the U. S. joins Japan and suffers a new recession despite zero interest rates.

Copyright (C) Long Lake LLC 2010