Inflationary Adventures in Extremistan

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

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

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

Copyright (C) Long Lake LLC 2011

Bad News from ECRI

In WLI Growth Drops Again, the Economic Cycle Research Institute states today that:

A measure of future U.S. economic growth fell to a 43-week low in the latest week, indicating that the pace of economic growth is about to slow, a research group said on Friday.

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index fell to 124.1 for the week ended May 28, down from 125.6 in the prior week. The index's annualized growth rate slid to a 50-week low of 0.4 percent from 5.1 percent a week ago.

As evidence that stagflation will have to wait and little pricing increase, ECRI also reports today in U.S. Inflation Gauge Falls To Five-Month Low that:

A monthly measure of U.S. inflation pressures fell to a five-month low in May as commodity price pressures ebbed, said a research group on Friday.

The Economic Cycle Research Institute's U.S. Future Inflation Gauge (USFIG), designed to anticipate cyclical swings in the rate of inflation, fell to 98.9 in May from a revised 101.8 in April. The original number reported in April was 100.8.

"With the USFIG falling to a five-month low, underlying inflation pressures appear to be ebbing," said ECRI Managing Director Lakshman Achuthan said in a statement.

The May USFIG annualized growth rate, which smooths out monthly fluctuations, fell to 12.5 percent from a revised 23.4 percent. The April figure was originally reported at 21.2 percent.

One can ignore cheerleading from the White House, as reported in Obama stresses positives in jobs report:

President Obama preferred to accentuate the positive today, citing last month's increase of 431,000 jobs but also acknowledging that the vast majority of them were temporary jobs dealing with the U.S. Census.

"This report is a sign that our economy is getting stronger by the day," Obama said during a visit to a trucking firm in suburban Maryland.

As tar balls wash up on Pensacola Beach, destroying the summer tourist season on the Gulf Coast, the economy is not getting stronger by the day. Statements like that show that this president is out of touch. Sound familiar?

We could be looking at an historic change election. More and more, the financial markets are looking like a rerun of 2008. As we enter summer fire season, we all need to remember Smokey's adage of safety first.

And to remember that Smokey was a bear . . . not a bull.

Copyright (C) Long Lake LLC 2010

The Fed Is Blowing It Again

Reuters reports in Fed official: rates to be kept low past upturn that the Fed is addicted to short-term thinking, serial bubble-blowing and a continuing war on savers:

Financial markets have not fully understood that the U.S. Federal Reserve's pledge to keep interest rates exceptionally low for an extended period means they will stay low beyond when officials normally would raise them, a top Fed official said on Friday.

"I don't think markets have really digested what that means," St Louis Fed President James Bullard said in an interview.

The Fed's strategy is aimed at promoting a future rise in inflation, which should provide an immediate boost in activity in anticipation of a future boom, but that hasn't happened, Bullard said.

The Fed has learned nothing from keeping rates too low for too long after the 2001 recession. The result was a false boom, a recent depression in manufactured goods and housing, and the first deflationary cycle in decades.

Long rates are higher than in the later 1940s, when the Fed also manipulated long-term rates. Despite all the Fed's actions earlier in this decade, ultimately both short- and long-term rates collapsed to all-time lows and multi-cycle lows, respectively.

My take from what the Fed is saying is: buy gold; buy gold; also don't forget oil, silver, copper, etc., et al., ad infinitum.

That it is a good thing to goose consumption by promising that inflation is coming is quite an amazing concept. Has the Fed learned nothing from the U. S. in the 1970s, from the most recent economic cycle, from Zimbabwe, or from Argentina, to name a small number of the many examples where cheapening the currency is a "bad thing"? The Fed should remember that for every indebted borrower there is a lender. It was the lender who earned the money and forewent the enjoyment of that money so that the borrower could use it either for enjoyment (e.g. homes, autos) or productively (business purpose). To deliberately and repeatedly favor the borrower when it was the lender who made the real sacrifice is both economically wrong and immoral.

As the greatest debtor perhaps in world history, the U. S. needs to start consuming less than it produces. That's defined as saving. The U. S. rose to economic leadership of the world that way. It cannot borrow and print money to prosperity anymore. At best, that would lead to more years of Japan-type stagnation or high inflation.

Perhaps the Fed should go back to such simple functions as assisting banks in money transfers, as well as to be a superbly-capitalized institution that can perform the Bagehotian function of providing liquidity to needy but viable banks at penalty rates to forestall runs on the bank.

We need to also consider removing the responsibility for full employment from being a co-equal goal of the Fed and go to a European approach of having it responsible for low or no inflation as its only policy mandate. Full employment is a political/social goal and truly belongs to Congress and the Executive to implement.

Meanwhile, Dr. Bernanke committed Fed malpractice from taking office in 2006 until the fall of 2008, when the patient had a preventable massive economic seizure/heart attack/stroke (take your pick). He is on the record as repeatedly having no idea of how pervasive and dangerous the credit bubble was in this country.

He has now embarked on an unprecdented PR effort to gain re-nomination. His patient was vigorous to respond to massive economic steroids, adrenaline and the like to the tune of $23.7 trillion dollars (per Neil Barofsky, who heads SIGTARP), but that does not change that he has been a disaster going back to the time when he helped persuade an aging Alan Greenspan at the Fed and the first MBA president to each sign on to the easy money, double-bubble policy that multiple observers correctly predicted would lead to the recent collapse.

It is hoped here that President Obama return to the tradition that a banker by training, not an economist, be the head of the world's most important bank. This would rule out Larry Summers, a brilliant economist but no banker. The Fed employs lots and lots of economists. But it is first and foremost a banking institution and it requires a prudent banker to get things back to a focus on restrained and prudent bank and non-bank lending in America

Copyright (C) Long Lake LLC 2009

Yves Smith Says Team Obama Uses "Big Lie" Technique, and Other Unpleasantries of the Day

Today is another busy news day.

The Economic Cycle Research Institute is out with its monthly U. S. Future Inflation Gauge.  ECRI has maintained this measure for over 60 years.  It has fallen massively over the past 18 months and is back near its lowest level in history at 79.3, at about a 51-year low.  Inflation probably averaged 1% in the next 5 years after sinking to that level, only rising after the guns-and-butter Viet Nam era (1964 onward).

ECRI also reports another marginal uptick in its Weekly Leading Indicator, which remains well below its very low level of November 2008 and still at a very severe 22% below year-ago level.  This suggests a continued slowing of the economy through year-end, with stabilization at very low levels of economic activity.  

I intend to do a post on the ECRI and its usefulness, or lack of such, to investors, in the near future.

Consistent with the above, there is truly bad news behind the headlines of the Labor Department's unemployment report.  Not headlined are two data points.  The average supervisory work week has shrunk to a record low since records began in 1964:  33.2 hours.  

And, consistent with the lack of work available and the very low USFIG, January's unemployment number was revised upward substantially, from 655,000 to 741,000.

Labor Department's broadest measure of unemployment is U-6, which can be found on Table A-12 of the basic unemployment report available at www.bls.gov, shows that almost 1 in every 6 members of the labor force is either unemployed, underemployed or too discouraged by labor market conditions to bother actively looking for work.  While comps are difficult to obtain, it would appear that the definition of unemployment used in the 1930s is more like U-6 than the headline U-3 (8.5% in March).  Given that the Obama "stimulus" program has no relation to FDR's emergency work programs, it is virtually certain that U-6 will hit 18% sooner rather than later.

(Note also that ADP's March non-farm job loss count was 742,000, exactly the current Labor Dep't count of Jan. job losses.  The ADP and Labor numbers have tracked each other very well for some months now (www.adpemploymentreport.com); expect further downward revisions in the Labor numbers for Feb. and March, I'm afraid.)

Moving along to the blogosphere, it is interesting to observe how certain passionate critics of the Bush-Paulson approach to the financial crisis have stayed objective after Mr. Obama became President, and others have kind of sort of joined "Team O" while trying at the same time to be interesting and objective.

Amongst the former, I would note Mish at www.globaleconomicanalysis.blogspot.com.  He has a series of posts excoriating the PPIP and has not fallen for Team Obama hype.  Mish is of the Austrian school of economics and has an amazing track record of forecasting the economic downturn and the low-inflation/deflation environment.  He also is a darn good market timer.

Another blogger who was definitely in the Obama hope-change camp is Yves Smith of www.nakedcapitalism.com.  She has definitively changed her tune, and her site is currently displaying a variety of well-informed opinions and reports.  Here is a quote from Yves herself from the conclusion of today's post, Treasury Trying to Defend Bank Gaming of Public-Private Partnership:

The dishonesty of this crowd is just breathtaking. The Bushies were blatantly high handed, while Team Obama prefers the Big Lie and assumes we are all too dumb to see through it.

Well!  Obama-phile no more, it would appear.

Finally, also on NC is the overlooked report that Hedge Fund Bridgewater Says No to Public Private Partnership Program:

Now illustrating our (Ed:  Yves'/NC's) latest concern, that the Treasury may turn out to be the Gang That Can't Shoot Straight, our ongoing reservation, that there may be no way to make the program work for banks and investors even with hefty government subsidies, may be coming to pass. . .

The turndown by Bridgewater is particularly significant.  (Ed: They only manage $80 B!)

Is this the beginning of the end for PPIP?

What Nouriel Roubini recently called the "Made-Off" economy, with Ponzi schemes built into the system of much greater scale than the Madoff one, is currently on a glide path to a 1995 level of economic activity, if one takes the numerical ECRI weekly leading indicator as predictive.  Given potent deflationary forces and "crowding out" of private borrowing by the massive projected Federal deficits, the outlook for business remains unexciting, and when brilliant thought leaders such as Yves Smith start describing Team Obama as using a technique associated with Team Hitler, one should watch out for the public to gradually adopt that viewpoint.

Copyright (C) Long Lake LLC 2009