Dash from Cash to Trash a Mistake?

Gold shorts smell blood per BBG:




When this occurs with the long-term chart of an asset breaking down but still up more than 5 times from its low, this is not a contrarian signal.  The shorts have been burned on the Japanese yen more than once in the past years, but recently they have been long and strong in their short position, and absolutely correct.  What's really going on with gold, IMHO, is that real interest rates have turned positive again, and gold leverages that trend in either direction.

Numerous price-deflationary and recessionary trends are now besetting the US.  The imploding Japanese yen means that there is less global competition for raw materials, such as oil.  That's a deflationary trend.  The lower price of imported oil is good, but the more effective competition from Japan Inc. may offset that.  Commodities indices such as DBC and GCC (stocks) are in clear downtrends.  Traders are suspicious that numerous Chinese pig farmers are going to soon disgorge zillions of pounds of copper.

Close to home, lumber has rapidly entered a bear market.  This too is deflationary.  Bond prices have dropped, raising costs for businesses and individuals alike.

The greatest peacetime deficit spender in US history, President Obama, is a lame duck and is on the defensive with the House and the media.  This is going to hurt his ability to resist the Tea Party's push for a balanced budget.  As old-fashioned fiscal prudence reasserts itself, the Fed will have no ability to engage in QE, with which it has been quasi-monetizing the deficit. 

As all the above occurs, nominal GDP has risen about 3.4% yoy.  Meanwhile the Fed is injecting 6% of GDP into the economy.  Quick and dirty calculation suggests that the underlying economy, net of fiscal and monetary stimulus, is contracting at about a 2-3% annual rate.

The dash from cash into trash may soon prove misplaced.  Sooner rather than later, all hail the long bond and King Dollar?

Are Bonds Going to Be the Next Investment Fad?

CNBC "reports"  (LINK):

Get Ready to Play the Coming Deflation Trade

  What seemed like economic fantasy could soon become cold reality as the global economy wrestles with deflation despite hundreds of billions in central bank money creation.Investors have been fleeing assets normally linked with economic growth such as materials stocks, energy commodities and copper...
And one prominent Federal Reserve member this week openly discussed whether the U.S. central bank needs to accelerate, rather than pull back, its asset purchase program.

 Meanwhile, the intellectual underpinnings for minimal price inflation have been updated by Lacy Hunt of Hoisington Management (LINK) in a speech given last fall.  In it, he criticizes those who call themselves Keynesians, who simply want more and more government borrowing.  He raised the question of whether Keynes himself would have approved of this policy.  In any case, he makes the argument for the possibility of debt deflation.  In Hoisington's recent quarterly update (LINK), he and Van Hoisington reiterate a point they have made before.  They differentiate between base money at the Fed as a result of quantitative easing and M2.  They point to M2 acting very differently from base money and note that M2 has not been rising lately.  Both are good reads.

They are also relevant to the recent flap about Rogoff-Reinhart's 90% level for government debt.  They bring up other research that supports the concept.  It's really not the amount of debt that counts, it's how wisely it was lent and how well the borrowed funds were spent.  That said, it makes sense that there are usually only a certain percent of a country's wealth or yearly production that allow for sound investments.  The US clearly went beyond that point last decade, resulting in the multiple insolvencies and near-insolvencies.  Since 2008, some debts were written off, but most were not.  Numerous more debts have now been incurred.

With gold the yellow canary in the coal mine, and Dr. Copper the redbird acting the same way, and with Mr. Bond now singing a bearish song, the following economic portent from Goldman Sachs comes as no surprise (LINK):

Note this is global, not US.  But as the US shrinks its deficit spending as a share of GDP, its economy begins to revert to the mean.  The US does however have two identifiable tailwinds that many other countries lack.  One is the diminution in war-fighting from the Afghan stand-down.  The other is the well-publicized hydrocarbon output upsurge.  So it may be that the US will again outperform the global economy; but Europe could go from bad to worse post-Cyprus and this could be cold comfort.

If it pans out that Europe is finally the cause of a major global recession as the US was in 2008, then the US will be part of it, debt deflation will hit again, and bonds may actually become respected and even sought after.  If so, they will trade at undreamt of yields.

When CNBC starts banging the deflation gong, it may just mean something.

Much More Than Gold Going Down

Perhaps the amazing drop in gold relates to a forced seller or sellers.  And, perhaps the Cyprus bank closures are necessitating that.  Or course, that's a speculation.  In any case, platinum is plunging, and copper and oil are following the pattern of lower rally highs ever since their 2011 peaks.

The ECB has been a deflationary force.  It has not opened the monetary floodgates, instead forcing internal deflation on the improvident borrowing, debtor countries.  Those chickens may be coming home to roost now.  If so, look out below for US stocks.  A 20% haircut would be a gift if another deflationary recession comes now to America.  50% down is possible based on fair value around 100 on the SPY.  One of these days, history suggests that stocks will actually be undervalued again.  I went virtually out of stocks last week, mostly on Friday as I took gold's plunge as suggesting price deflation and/or illiquidity problems (they are similar problems).  So stocks, which have been discounting both lower interest rates and hedging inflation may have to be stuck with lower interest rates for a good reason-- i.e. 2008 all over again.  Though, this time the acute problem is palpably the eurozone.  Just as the US problems harmed the global economy in 2008, the eurozone and Europe as an entity could be doing something similar now.

Timing of events, and certainty, is impossible.  But as we are seeing with gold, things happen on a Friday and then a Monday, and poof.  This is what happened in the crash of 1987, BTW.

ECRI Updates, Remains Bearish On The Economy

I'll have more to say after I reread this, but ECRI has responded to the many critics of its 2011 and beyond recession call with a new and interesting position paper.  Here's the LINK.  I do think it's worth thinking about.  One of the facts they adduce is that non-exchange-tradable commodity prices have lagged those listed on exchanges.  There are indeed underlying deflationary pressures that are being held at bay by leveraged speculators.

They highlight the 1927 recession and hint that we may be in for a bubble surge in stocks such as was seen into summer 1929-- and as was seen in the late '90s.  My preference is to play it safe

Trend To Lower Global Interest Rates Revives

Bloomberg.com is revealing amazing moves down in global interest rates that are already at or near record lows (LINK to UK rates, click around for those of other major countries).  Japanese JGB's have been collapsing, to 68 basis points on the 10-year and 186 bps on the 30-year.  This with the threat to create 2% inflation!  Just as happened when the US lost its AAA rating from S&P, now the UK has lost its AAA rating to Moody's and its interest rate structure has started to collapse.  Following the equivocal Italian election, German interest rates, which had been trending down anyway, moved sharply lower.

If governments were really "stimulating" anything much, interest rates would be rising in response.  This looks to me as though we need to watch out for an unwanted downturn in the global economy.

With taxes having risen beginning in January, and with about 1/2 of one percent of economic activity (annual rate) scheduled to be withdrawn from the US economy in a few days, can Treasury rates at home fail to drop in sympathy?  If rates in major countries drop, and ours stay up, that would not be good for the president's goal to double exports.

Meanwhile, I lost the link, but I saw an article on the 'Net today quoting a JPM exec that an awful lot of bad deals were being done in commercial real estate by the competition that had run out of many sound loans to make.  Of course, he (she?) said that JPM was only making good loans.

I have heard this from bankers before. The last time I personally heard this was from my Smith Barney broker, probably in 2007 (maybe in 2006), that BofA was making terrible loans, and was stealing business from Citigroup (which then owned Smith Barney).  Well, it turned out that we were near the peak of the economic cycle, and both BofA and Citi were making horrible loans by the boatload.

While I am not at all a deflationist, I still think that if the stars align as they may be doing, we could see much lower interest rates come to the US by the end of 2014.  After all, the trend is your friend until it ends.

Risk Off?

I have a new article up on Seeking Alpha.  The link is http://seekingalpha.com/article/1217911-tlt-moving-toward-a-possible-trading-buy-as-commodity-deflation-may-loom.  Per the title, it presents growing evidence that Treasuries may be moving to being not just a portfolio diversifier to consider, but actually a decent speculative trading buy.  Please note that I do not try to time these sorts of investments too precisely; and of course, nothing I ever write is actual investment advice.

The futures markets are seeing a hint of waning momentum in the risk on trade.  The article presents charts from Finviz that suggest that this trade has gone to an extreme, and that the speculators have not made much progress.  The spec long interest in crude oil, copper and platinum has hit an extreme, but the price has not responded.  They may have been pushing on a string and may rush to exit.  If so, it will be important to watch what support these prices have.  (Of course, prices may surge; there's no way to be sure.)

Let's speculate on what might happen if the (highly leveraged) longs rush for the exit.  If this occurs and is accompanied by data suggesting a "deflationary" economic downturn a la 2008, even if it is not "great", gold and silver will not rally and silver, at least, "should" drop more.  Treasuries would reliably rally.  If it is accompanied by "crisis", such as Signore Berlusconi becoming PM again, then Treasuries would likely rally for a while, but gold and possibly silver would rally also, I would guess.

Thus a guess is that the greatest contrarian trade now is to buy a long-term T-bond ETF.  The conservative way is TLT or a shorter duration fund.  An aggressive way is to buy one of the zero-coupon bond funds.  I am aware of EDV and ZROZ.  (I am long both EDV and TLT.)

Acting-Man presents at the end of his post a chart from Mark Hulbert showing a recent new record of bullishness toward the NASDAQ amongst newsletter writers:

It appears that after extreme readings, when sustained for a few months, begin to turn down, a price drop is coming soon and that the NAZ is thus, per Jim Cramer, a "Don't buy! Don't buy!".   It takes bulls to make a bull market, though, so not buying does not imply a great opportunity to go short.  Thus I would note that NASDAQ selloffs tend to be good buying opportunities for risk off assets such as Treasuries.

Hyperinflationists note:  one suggestion that QE may cease led to a big selloff in commodities.  There is so much leverage in the system, merely putting another trillion bucks in the system need not create much visible price inflation.  One more recession could kill wages, which are by far the greatest input to costs.  How long this situation can go on is another matter.  Counter-intuitive though it is, the monetary inflation is going first and foremost into bonds.  Not fighting the Fed may involve investing or speculating along with it and joining it in ownership of T-bonds.

With the world solidly off the gold standard, at least for now, Treasuries underpin the global economy.

They will, my guess is, endure with that status for the foreseeable future and perhaps beyond.

The most powerful government and its central bank desire very low borrowing costs.  I don't see why they cannot continue to achieve this for a good while longer, no matter whether "real" interest rates are zero or worse.

Inflationary Signals in More Places

While savers continue to receive, incredibly, shrinking interest rates on money market-type deposits, the money-printing that Dr. Bernanke has been pouring down the gullet of a thirsty Street has been working its usual magic. A case in point is seen in the accompanying graph of a Markit index that relates to commercial mortgage-backed securities. (Click on image to enlarge. Click on AA.4 on the linked Markit web page for this specific index, or click on any other index for a similar price-time display.)

It would appear from this and other charts available on the Markit site that commercial real estate prices, or at least prices of securitized mortgage pools, have joined gold and silver in strong uptrends, or, in the case of CRE, in the reversal of a strong downtrend. Relativistically it's sort of the same thing.

The increase in the money supply over the past few years is working its way gradually through the economy. Wages and employment are reacting slowly, given all the malinvestment that occurred in the U. S. Thus what I suggested in my Fire and Ice post of January 2009 might happen is happening. Here is a quote from that post:

. . . we must consider the possibility of a mixed inflation-deflation. Houses and municipal bonds, which you may own, can continue down in price and the cost of a haircut or cereal, which you purchase can go up. You can lose both ways.

Fire and ice.

The fire of price increases is becoming apparent in the food stores of America. There is nothing more fundamental than food and water (still mostly free) to staying alive, so of course there is no justification for excluding it from measures of living costs. And since so much food Americans eat is processed, the prices we pay for food have relatively little to do with so-called "volatile" costs of the underlying foodstuff. Increases in food prices have everything to do with packaging and transportation costs, lack of "deflation" in total compensation including taxes and benefits, and profit margins.

This blog repeatedly pointed to the "deflation" talk in the media the past months as a deliberate diversion (to use a favorite word of the President) to hide the money-printing that was going to ensue once again. How the 2-10 year Treasury complex keeps trending down in yield is incomprehensible if yields were responding to a free market or unless the "market" knows that something is going to blow, such as BofA pulling a Bear or Lehman. In which case gold is to the moon (and probably Treasuries as well), with the dollar probably moving in an opposite direction.

Once again, the broad stock averages continue in their downtrend compared to gold. Within the stock market, though, divergences in relative value have continued to appear and allow certain stocks to represent good value, it being understood that the flood of "money" that the Fed has created is so large that arguably no important financial asset is truly "good value".

Copyright (C) Long Lake LLC 2010

Irrational Apoplithorismosphobia

Brian Sack, EVP of the New York Fed, spoke today. He said:

In terms of the benefits, balance sheet expansion appears to push financial conditions in the right direction, in that it puts downward pressure on longer-term real interest rates and makes broader financial conditions more accommodative.

Elsewhere in his talk he refers to inflation as being too low.

Of course, he said much more. These points are enough, though, for a post.

Is it really correct that lower real (inflation-adjusted) long-term interest rates is a good thing?

Here's a view from DEFLATION AND ECONOMIC GROWTH (from Mises.org):

The Bureau of Labor Statistics (2004) published estimates that show CPI
was negative for 11 years in the late nineteeth century, including 1879 and
1895. The NBER chronology shows the economy was in expansion for nine
months in 1879 and 11 months in 1895 despite a negative CPI both years.

Federal Reserve Bank of Minneapolis data show CPI was negative for 13
years in the twentieth century, including 1922, 1928, 1939, and 1955. The
NBER chronology shows the economy was in expansion for 12 months in
each of these years.

Thornton (2003) defines apoplithorismosphobia as “fear of deflation.”
These examples of expansions in periods of negative CPI suggest some laboring
in the Keynesian vineyard suffer from this malady. Unless they are willing
to argue the NBER chronology is invalid they should concede deflation is not
synonymous with contraction, and differentiate between good and bad deflation.
Good deflation occurs when prices and interest rates decline, consumers
receive more purchasing power from most assets, output expands and
productivity expands due to technological innovations. Bad deflation occurs
when prices and interest rates fall yet many consumers receive less purchasing
power from most assets, output contracts and productivity declines as a
result of central bank policies.

An ideal economic world would be one in which there are such marvelous opportunities for capital to bring a real return that due to productivity, prices fall while bond returns are strongly positive. Money would truly make money because it financed economically productive efforts.

In other words, capital should be scarce enough that businesses compete to have the best business plans to utilize said capital, If for no other reasons than, perhaps, time being out of joint, capital should be able to rest while the economy rested. This is why the authorities appear to be pushing on a string. Too much unproductive activity has occurred, most notably recently the housing bubble, but before that much wasted effort occurred at the height of the tech boom.

Capital was destroyed in these bubbles; meaning, real economic activity was wasted. The Fed is printing more "capital" (a form of counterfeiting), in large part for no other reason than that its ultimate master, the U. S. government, demands that it do so because of the strategy the government has chosen, which is to cause much more economic activity (spending) than it removes from society (taxing).

For the Fed to now argue that even easier money is a virtue is to argue for more and more marginal business projects and spending decisions to be undertaken with a lower and lower threshold of return required to "justify" these decisions.

Thus there will be large continuing "malinvestments" which will distort price levels and be marginally productive or completely unproductive. Whether this distortion of price levels will lead to shortages of raw materials or consumer products remains to be seen.

If the Fed, either due to market presssures or a sudden return of fiscal prudence in Washington, returns to a program of positive real interest rates all across the yield curve, gold would probably be as poor an investment as it was from 1980 to 2000. Gold is the most controversial "commodity", because of the beguiling argument: "Gold, what is it good for?"

For nine years, the financial markets have been answering that gold has a critically important monetary value, because the Fed has acted as if it suffers from irrational apoplithorismosphobia. If the Fed gets needed intellectual therapy plus a backbone and resolves that irrational fear, then gold can cease being of financial interest and can once again just sit there while normal investing resumes.

Copyright (C) Long Lake LLC 2010

ISM Reports Upward Price Pressures

From today's August 2010 Non-Manufacturing ISM Report On Business®:

Commodities Up in Price
Bacon; Beef (5); Butter; Chicken; Coated Groundwood (2); Dairy; Diesel Fuel; #2 Diesel Fuel (2); Freight Charges (2); Fuel (8); Gasoline (2); Linen; Pharmacy Products (2); Pork; and Transportation Costs.

Commodities Down in Price
No commodities are reported down in price.

Note: The number of consecutive months the commodity is listed is indicated after each item.

Given a subpar economic "recovery" (if this a recovery be), and with immense slack in the most important cost input (labor), there should be some price declines in the above list. This smells like stag(in)flation to me.

Just a guess, but both the apparent economic facts as we have been presented them and the general cyclicality of booms and busts suggest to me that housing prices will lag the average consumer price rises that I believe are on the horizon.

Copyright (C) Long Lake LLC 2010

Mainstream Mis- or Dis-Information Campaign Intensifying?

Now that Rupert Murdoch and team own the WSJ and Marketwatch, they speak for the mainstream. A "Marketwatch" bylined article from late in the week, allegedly on gold, has so much incorrect information that I suspect provides truly contrarian investors who see matters as I do with some strategies to conserve wealth and potentially increase it. The article is titled Gold rises as world spirals toward deflation.

While I am tactically bullish over the intermediate term on long bonds for a modest portion of my portfolio, I do not expect either price deflation or "Austrian" deflation to occur in a major way.

Here is some of this apparently mainstream opinion:

Most serious economists believe the real risk facing the U.S. and other Western economies is deflation, not inflation. Unless the Fed, joined by the government, really steps up to the plate to stimulate the economy, no matter which way you cut it, deflation can't be too good for gold either, especially not compared with bonds. . .

It (not well defined in the article exactly to what that word refers) will be a mere, if classic, safe-haven bet, but no doubt gold bugs of all stripes will continue to present it in many other ways.

For some reason, with soup line photos no longer in vogue in this season of a "weakening recovery", the Establishment wants us to believe that undocumented "serious" economists--as opposed to unserious ones, one must infer--suddenly agree that the "real" risk is deflation (which we are to take as price decreases rather than direct credit shrinkage). The implied message is to buy allegedly high-quality bonds.

The obvious response is to hold onto your wallets and prepare for price increases. When? It would be a bit obvious for this to occur, say, tomorrow. The long bond may well be a good trade for the next months or even years, just as the NASDAQ was in the later 1990s. But unless you are a "paper bug", the relative valuations and chart structures suggest to me that gold has a more secure intermediate term future as a wealth preserver and even enhancer.

In 100 and 200 years, which would you rather your descendants inherit from you: Federal Reserve notes, perhaps earning interest through correlated bond issues, or gold?

Everyone needs to make their own choice, which I believe is the key investment choice. For now I am playing both sides of that trade, but while my heart is with my government, my mind makes a persuasive argument otherwise.

The more the mainstream media continues to tar gold investors as "bugs" (meaning "nuts"), the more secure I feel that there is no gold bubble, just a gold bull market. The gold bull may rest or reverse, just as stock bull markets have done, but patient money can ride those out. The bubble is in cash yielding nothing while prices rise apace; at any time, as in the WW II and Korean War eras, consumer prices may soar while allegedly safe long Treasuries yield far less than the rate of price increases. If and when that happens, the one-decision asset that never changes--gold--may finally garner the respect from the media that it has had for, oh, five thousand years or more.

The fad does not (yet) involve gold; it is actually believing in "deflation" in an era of fiat money, especially when the issuing government has always been at war with Eastasia. (Or is it the Horn of Africa? See linked NYT article about the Nobel Peace Prize winner's expansion of secret wars.)

In any case, there's far too much hype about "deflation" to suit me. I am embracing it warily, as I did the tech bubble ten and more years ago; and my long bond holdings are in my mind speculative. Strange, unfortunate times, but so it goes when governments dominate markets.

Copyright (C) Long Lake LLC 2010

Distortions Galore

I was going to write a post about one data point or another that came out today, but Calculated Risk plus Bloomberg cover them all. The bottom line is that in past years, when one economic datum after another comes out weak--ranging from ECRI's WLI growth rate dropping below 10% (a level not even reached in the severe 1981-2 recession) or the various weak reports out of new home sales (record low sales), the Dallas Fed Manufacturing Index and the like, and the widespread skepticism that the European bank stress tests are useful, the stock market usually drops and Treasuries rally in price.

Not now. Perhaps the prospect of zero interest rates forever has gladdened the hearts of valuation algorithms amongst owners of capital.

The VIX has dropped to around 23. In turbulent economic times I have noticed that it averages roughly 25. In good, stable times it is in the teens. Thus the VIX hit a record low late in the last decade's bubble period.

It appears to me that when record low governmental interest rates are widespread and are dropping, this could only fail to be a bubble in government debt if price deflation were present--and this would be "good" deflation, associated with greater supply of goods and lower real costs of production.

This is how living standards improve rapidly.

The last time the U. S. had this sort of "good" price deflation was in the latter part of the 1800s.
But guess what: there was virtually no Federal debt then. There was no central bank. There was no involuntary unemployment. Gold was not an investment; it was money. Financial paper took the place of money but was recognized as not being money. Living standards soared and immigrants flowed without restriction into this country, the only requirement being passing a medical test for public health reasons.

Now, any deflation we have is the "bad" kind: price-cutting, such as of homes, due to overproduction. But we have "underproduction" of iPads due to component shortages (presumed temporary).

An example of "good" deflation that theoretically might occur would be the simultaneous discovery near New York City and Los Angeles of massive amounts of easily accessible fields of natural gas, sufficient to displace huge amounts of imported oil.

I'm not holding my breath for any such game-changing event, however.

What I do see is rampant overpricing of financial assets all over the place, this being a sign that too much "money" has been "printed". Yet the real economy is far less buoyant. Not only is this disconnect unhealthy, but since the money is circulating in New York and its printing supports the establishment in Washington, the result is that people look around themselves in their localities and see a distorted view of the real economy.

It's sort of like trying to see what the temperature is out on the farm by putting your thermometer inside a hothouse.

But the Federal Government is locked into a Japanese-style model in that its fiscal health waxes and wanes with the economy. When the economy is weak, Federal finances weaken. Normally, the "market" would make the increasingly leveraged borrower--the Feds-- pay an increasingly higher price to borrow. Inexplicably, as default chances rise, prices have been falling on said debt. Is this due to "crowding out", manipulation, or no other good investments being perceived available to typical bond investors?

If, for one reason or another, the U. S. is going Japanese (before perhaps defaulting), then the pattern in Japan provides a good template. That template includes huge undervaluation in stocks; and, gold has moved to a record high in yen terms over the years. If one lives in Japan and thus has had roughly stable consumer prices for years, then gold has quadrupled in yen terms.

Anyone who thinks that money printing/massive deficit spending associated with a zero interest rate policy exempts the pricing of tiny minority fractional ownership of corporations (aka stocks) from traditional valuation measures may want to study the Japanese financial experience.

Of course, the U. S. is not Japan, past need not be prologue, etc. Nonetheless, isn't there a saying or two about learning from history?

Copyright (C) Long Lake LLC 2010

Financial Media Drumbeat for Money-Printing CONtinues

That's not a typo in the title. Because there's a con game going on. It's the con that the threat is imminent deflation.

In his weekly Emailed commentary today, the well-known financial man John Mauldin differentiates between good and bad deflation. In the category of the latter, he quotes insufficient demand.

You know things are loony when an American can look around him, see the obesity epidemic, and with a straight literary face, cite insufficient demand!

Let's also see-- one vehicle per capita; 20 times as much oil used per capita as in India, etc.

Excess commercial real estate and by world standards double or triple as much residential real estate as is really needed.

And so on. Some insufficiency of demand.

What ties many financial people together in their wails that we need to fear collapsing prices is that they benefit from money printing. One reason for this is obvious: more money in the financial system means more assets under management. Another reason is subtler, and relates to Uncle Warren Buffett's parable of the Gotrocks family. In this story, a family with money keeps getting sold on making the management of their savings more and more complicated, with the only winners being the financial community. Thus, if the Government were to start paying off its debts, there would a simpler system, and thus less reason for the great unwashed to pay financial types fees to invest their money.

Mr. Mauldin is on the more conservative side of the spectrum, so his major point is to keep the Bush tax cuts. Presumably he will do well with that personally, and so will his clients. Others such as Nouriel Roubini always pound the drums for eternal depression, and their solution is greater government spending.

Neither of those camps address the overriding problem of creating a stable financial system. If society wants Sweden or wants Hong Kong, it can have either, but it can't have Swedish social benefits (plus war in Eastasia) with a Hong Kong-level of Federal income (14% of GDP at latest count). Continuing the giant deficits is great for financial types and keeps the Roubini Global Economics business thriving as well.

On the other side of the financial sea from debt-based finance and money printing is gold. The media is all over that one. Barron's is out today with the Abelson article titled A Contrarian's View of Gold.

The "contrarian" works not for some small contrarian enterprise in Nowheresville, but rather for the globe-girdling Bank Credit Analyst. No evidence in the article indicates why this gentleman is called a contrarian at all. The article goes so far as to point out that the negative view on gold that Mr. Berezin espouses is not contrarian at all. To wit:

. . .he gets some support from Barclays Capital's latest commodity forecasts, which sees gold averaging $1,195 an ounce this year, $1,180 next year, $1,010 in 2012 and $850 for "the long-term."

Oh, those wild-eyed crazies at Barclays! Always taking the non-consensus point of view (NOT).

Why is Mr. Berezin negative on gold? Because he expects:

1) An increase in real interest rates, which he feels are bound to rise as the global economy continues to recover.

2) A decline in inflation expectations. Disinflation, he notes, is "gold's archenemy" and, he believes, over the next few years, deflation is the biggest risk.

We should stop right here. What actually happened to real interest rates in the U. S. at least in the Ponzi boom of 2005-7/8 was that real interest rates dropped to zero as inflation surged to at least 5%. In fact, a sign that the boom was built on sand was in fact that the economy could not even tolerate truly restrictive interest rates, unlike the economy of 1980-2. So his idea that real interest rates will rise with a boom is unlikely, given tattered balance sheets all over. Re inflation expectations, well he's a better man than anyone else if he is suggesting you invest on what expectations will be. Predicting facts is hard enough; expectations are second derivative stuff.

He also sees:

. . . the greenback as "among the best houses in a bad neighborhood" that, over time, will strengthen against the euro and the yen, sparking a reassertion of the negative trend between bullion and the trade-weighted dollar index.

My view is different. It is in line with Bill Fleckenstein, and certain bloggers such as Econophile, who see money printing and stagflation as reasonably likely.

The powers that run America financially are great powers. They say that they will do everything they can to make sure that deflation does not take root here. With the lowest short term rates in America and globally in history and 3% Treasury rates despite massive supply, you can expect either a strong economy to put all the monetary stimulus waiting in reserve to start stimulating pricing power and/or more money printing to purchase more financial assets, some of which new money will filter out to the real economy.

What would really be bad for gold, as it was 30 years ago, would be true tight money policies, plus a revival of pro-entrepreneurial policies. Since these are not likely to be forthcoming from Washington any time soon, it makes sense to resist the growing media pressure from multiple sides of the economic-political spectrum that deflation is a serious threat and prepare for a resumption of something like 2003-7.

And to be aware that as in that era, the defining characteristic was a crash.

I suspect that another crash is coming. I just don't know when.

Copyright (C) Long Lake LLC 2010

Ten Dollar Laptops Imminent?

I couldn't resist commenting on a "factoid" sort of report out of Reuters. It would appear that laptop computers are going to go the way of calculators.

When I was pre-med in the 1970s, calculators were banned from tests as they cost hundreds of dollars and thus few students could afford them. Here is the skinny on laptops:

India's Human Resource Development Minister Kapil Sibal this week unveiled the low-cost computing device that is designed for students, saying his department had started talks with global manufacturers to start mass production.

"We have reached a (developmental) stage that today, the motherboard, its chip, the processing, connectivity, all of them cumulatively cost around $35, including memory, display, everything," he told a news conference.

He said the touchscreen gadget was packed with Internet browsers, PDF reader and video conferencing facilities but its hardware was created with sufficient flexibility to incorporate new components according to user requirement.

Sibal said the Linux based computing device was expected to be introduced to higher education institutions from 2011 but the aim was to drop the price further to $20 and ultimately to $10.

As they say on the streets of Manhattan:

Ten dollar, ten dollar!?

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When Does QE2 Leave Port?

In the hilariously titled post, Let's Start Spending, Dr. Robert Frank argues for more road paving to get the economy moving again. Writing in doubletalk, he says:

The deficit hawks are killing us. No, wait! I’m a deficit hawk. So let me rephrase that: Some of the deficit hawks are killing us. Like other deficit hawks, I believe we need to start paying down the mountain of debt the federal government has been running up. But not now, not as we continue to struggle to emerge from the deepest downturn since the Great Depression. Cutting spending now is the very last thing we should do.

The only reason we’re in a downturn is that there’s not nearly enough total spending to put everyone to work. The $787 billion economic stimulus bill passed in 2009, which many economists at the time warned was too small, is running out. Its effects are being offset increasingly by massive cutbacks in state and local government spending. And now many deficit hawks want us to cut spending further.

This is lunacy. The right kinds of deficit spending not only would help speed economic recovery, they would help bolster the nation’s long-term balance sheet.

He goes on to tout the supposed economic wonders that fixing roadways can do.

Wasn't that was ARRA (last year's "stimulus" bill) was all about?

What's especially important about Dr. Frank's views is that his co-author of an economics text was Dr. Ben Shalom Bernanke. Who just spoke today about mounting signs of economic weakness.

OK. Enough hilarity. Dr. Frank wants us to start spending. As if spending $3.5 T isn't enough this year.

On another front, first it was the sainted Jeremy Grantham with a self-serving alleged switch to fearing deflation as the greater worry than inflation. Now it is the allegedly conservative Weekly Standard that is hyperventilating about the same subject in its blog today, with a post titled Deflation: A primer. Here's one quote from that post:

As awful as double-digit inflation was, single-digit deflation is worse. As triumphant as the victory over inflation was, we can't always be re-fighting the last war.

This is a country deeply in debt. Inflation reduces the burden of debt -- anonymously, impersonally, and across the board. I hope I don't sound too nationalistic when I note that a lot of that debt is held by our Chinese friends. They ran huge trade surpluses with the United States when times were good. Time now for them to contribute a little back.

Sorry. I'm not with that program. There's good deflation and bad, but the blog doesn't differentiate. Most of the 19th century was deflationary in the U. S., and the country was probably the greatest growth story for a whole century in world history. Or close to it. Falling prices due to technologic advances and opening up of inexpensive raw materials are good things. Otherwise scarcity of food would be good, because it means rising prices.

The real problem is that deflation punishes poor borrowing and lending decisions. It is tough on borrowers, but that's a private matter between them and the lenders. If the lenders need to take a haircut, so be it. If deflation were allowed to occur naturally across the entire economy the way it used it be allowed, then both borrowers and lenders would be more prudent. They couldn't count on helicopter drops of money and ZIRP to bail them out.

About stiffing the Chinese with inflation, how spoiled can you get. First the West hires the Chinese to do the tough, polluting manual labor it doesn't want to do, at rock-bottom wages to enrich the owners and managers of the outsourcing companies, and refuses to pay them in kind with an equal amount of manufactured goods; we send them promises to pay. And now we keep up our bargain after receiving the fruits of their labor for our benefit by welching on our paper.
Honorable? No. Wise? Also not.

More and more, the Establishment is laying the groundwork to persuade the sheeple that the cure for excessive borrowing and lending and attendant money creation is more of the same.

QE2, in other words: Quantitative easing 2.0.

This can only continue with declining borrowing costs if private borrowing is crowded out; in other words, if the economy continues to be anemic. The Japan scenario, in other words.

And this may be. But as per Nassim Taleb's story of the turkey, the Black Swan event from the turkey's standpoint was sudden death after a happy, easy life. The economic equivalent of that is either hyperinflation or cessation of credit being supplied by creditors, in a Greek-like scenario with true austerity being imposed from outside. So we can go Japanecian (or, Grecianese), or the hyperinflation scenario such as Argentina and Brazil did in the relatively recent past.

What we can't do is "stimulate" the economy endlessly by printing money under the pretense that we are going to repave our way to prosperity.

The laws of economics trump hopium and hokum.

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Deflation Theme Getting Too Popular

An increasing number of financial, governmental and academic types are signing on to the idea that (duh!) the economy is entering a slow spot. Jeremy Grantham has joined the crowd (see #1). The deflation argument is getting popular now that Treasuries have surged in price, lowering their yield to ridiculous levels. Where were these deflationists when David Rosenberg was one of the few such proponents 100 basis points of yield higher (10 -30 year bond)?

Supposedly according to this growing alliance of deflationists/economic gloomsters the economy needs more amphetamines, or is it opium? Or is it hopium?

Concomitantly, even the commentators on Kitco.com's commentator site are either bearish for the short term or don't comment at all on the short term, taking a long-term view that paper money devalues (thanks for the insight!).

Mark Hulbert's Gold Sentiment Newsletter Index (HGNSI) was said to be at a contrarianly bullish 9% recommended gold allocation about 2 weeks ago. Given the tone on Kitco and the price action in gold, I wouldn't be surprised if it were below zero now.

In evaluating the main asset classes, certainly cash is the most overvalued. Treasuries are in the late stages of a recovery from a horrible bear market and now are in a Neverland of manipulation. Stocks are looking worse from both a price and earnings momentum standpoint.
Silver is looking like a metal proxy for stocks.

The conditions for the recovery from the multi-year gold bear market that finally ended (for now!) in 2009, when the 1979-80 price range was exceeded for an entire year for the first time since then, are easy money and a desire to fight "deflation".

No matter that the only important deflation is that of houses and stocks, namely assets individuals own. The cost of living is undoubtedly rising in a thousand ways that are uncounted by the Bureau of Labor Statistics. But government statistics are to statistics as military music is to music.

While the Internet was new, tech advances were not new. There was no New Era in the 1990s. There was just a massive stock and investment bubble which extended to property and other lending a few years ago. The sovereign debt bubble is now on the plate in richer countries than the usual defaulters of the past 65 years.

Thus the gold vs. fiat money battle is only now getting going for real. The current fad that deflation is a serious risk is the best argument for gold right now. Short term sentiment amongst gold traders is depressed. Bonds are in fashion. Whatever you own, the financial powers that be want to destroy you if you are leveraged.

As economic activity sputters, Big Finance's potentially insolvent position will make it call once again for money-printing, which aligns with what governments trying to fit a guns and butter agenda generally do. I for one can't come close to timing this. My sense is that once again Nassim Taleb is correct, namely that big-time inflation is the underpriced "fat tail" possibility.

Traders such as Dr. Taleb can take advantage of derivatives such as futures and options, but identifying those opportunities is far beyond my capacity. Gold (and in up-moves silver) is the slow-moving investor's core hedge against these sorts of outcomes. Better to buy when traders are gloomy than when they are ebullient, yes?

And I wouldn't sell gold on a downtick when the trade is into cash yielding nothing. At least not until fiscal sanity is forced upon Washington.

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Markets Churn as Deflationists May Be Overstating Their Case

Even David Rosenberg is buying into the austerity meme. In today's note, he discusses response to bear markets and recessions and says:

So it’s an open question as to where the exogenous positive shock is going to come from this time around, especially with policy rates already at zero and fiscal policymakers more bent on austerity rather than stimulus.

Remember that he is talking about the U. S. But he has it wrong. All we have is some resistance against continuation of the massive deficits, by far the largest peacetime deficits the U. S. has ever run. Properly accounting for the costs of Fannie Mae and Freddie Mac, the deficit exceeds that of Greece, I believe. This ignores the politically contentious future liabilities of Social Security and Medicare/Medicaid/Obamacare. There is no consensus for austerity. In World War II, there was virtually no production of any consumer automobile for the duration of the war. Now that's austerity. The average American uses perhaps 25 times as much oil per capita as the average citizen of India. Austerity? With the obesity epidemic raging? Hardly!

Meanwhile, Barry Ritholtz reprinted an updated graph of ECRI's confidential Long Leading Indicator (click on graph to enlarge), which so far as have been released, has in the past few decades turned down significantly before a recession has come on. It has not done so in a pronounced or pervasive manner, and ECRI predicts no recession to begin in 2010 based on large part on this fact. The shorter index, the publicly released Weekly Leading Index, has in fact turned down sharply.

Since there is now so much concern about a new recession, it's a better time than a few months ago to think of a new up-cycle in the economy, or at least some stability. It would appear that a growth slowdown is baked in the cake, and that the powers that be will likely "stimulate" some more if a recession appeared again, which would then likely propel buying interest in gold and growth vehicles. So the game goes on . . .

So we have, as usual, cross-currents, which the powers-that-be have analyzed more thoroughly than you or I can. So how can one out-think the market? First, it helps to be able to look around you and ignore the hype and understand one's objectives and the goals of the powers that be.

The powers that be want you to trade a lot, so volatility is in their interest. They want price inflation for various reasons. One response is to own assets that defeat those purposes.

These include owning shares in financially strong companies at attractive prices, understanding that stocks as a whole are probably overvalued, but also paying heed to Jeremy Grantham, who agrees that both large-cap and small-cap U. S. stocks are about as poor investments as are U. S. long-term bonds, but that "high quality" U. S. stocks are about the best investments on a 7-year time frame amongst all his listed asset classes (GMO, free subscription).

Here are some dividend-payers that meet the DoctoRx criteria of being high quality, based on Value Line data, and that are doing well operationally. These are Tractor Supply (TSCO), Apple, TJX; and for gold-oriented investors, Newmont (NEM). Who knows, but perhaps all of these can be buy-and-hold investments that prospectively can beat buy and hold of similar quality bonds or cash.

Now that Treasury yields are at Japan level, cash is approaching trash. But anyone who shops knows that prices are rising, except for things that people own and for which buyers usually need large loans, namely houses.

Yours truly is not an investment advisor, and the above is not investment advice. For full disclosure, I bought TSCO today and after hours, it issued a major earnings and sales upside statement. So the stock is up a good deal after hours. If it is not up a great deal tomorrow, I may buy more. Based simply on the "value line" of Value Line, it is easy to see 50% price upside for TSCO within a year, similar to that which I can see as reasonable for AAPL.

Copyright (C) Long Lake LLC 2010

Why Is the 2-Year Treasury Yield Closer to Its Low for This Cycle than Its High?

Please see MarketWatch charts of the 2 year Treasury note, over the past year and 5 years. If the depr(rec)ession is over with, what on earth is the 2-year doing collapsing 30 basis points in one month?

Note the pattern of a lower high in rates in August vs. June.

Also note that the 50-day moving average (solid green line) has turned downward. My research on this over the past 20 years suggests that this has been a bullish indicator for lower 2-year (and 10-year) Treasury rates and a bearish stock market indicator.

Ed Harrison at Credit Writedowns documents more signs of a firming governmental policy toward money: click HERE for his most recent post with links to related recent posts on this topic.

Zero Hedge has a nice post with quotes from the ineffable Albert Edwards of Societe Generale. Herewith are some of his thoughts:

The problem is that after the boom there will be a bust. The issue now is one of deleveraging and the deflation that is starting to unfold. The problem is that Bernanke is a slave to Milton Friedman?s view of the Great Depression (at Friedman?s 90th birthday Bernanke promised that the Fed would never allow another Great Depression to occur). The Australian economist Steve Keen?s observation that "Bernanke?s dilemma is that he is living in a Minskian world while perceiving it though Friedmanite eyes?" explains his actions to date. It also explains why he will fail. . .

But it is collapsing core inflation that poses the greatest risk to the global economy going forward. We highlighted last week that core CPI inflation descends rapidly, with a lag, after the recession ends. If core US CPI inflation falls by around the 3% shown in the chart below over the next year, that will take the yoy rate to minus 1.5%! Hence the growth in nominal quantities (e.g. corporate revenues) is set to see disappointing ?lower highs? in this upturn after lower lows. And that, in our view, is just a prelude to a 2010 collapse into outright deflation.

Clicking to the post will also show a fascinating projection of core inflation using ECRI's data, probably its Future Inflation Gauge (which collapsed to 1958 levels this year before rebounding somewhat).

Technically and fundamentally, the argument for price deflation remains intact. However, if that occurs, it could occur in ways that cause the most pain to the most people; your house could deflate in price while the haircuts, gasoline and food you buy could rise. Or there could be "good" deflation wherein petroleum prices collapse and your dollar in the bank even at 1% interest rate gains buying power.

(Of course, the TIPS markets are pricing in inflation; that's the default solution; this post is to encourage looking at both sides of the issue.)

These are the most difficult markets to either invest in, save money in, or trade I have ever seen. Anything could happen. All the things that might happen but do not occur will simply remain perpetual possibilities that did not come into existence except in alternative universes.

If one wants the tres interessant views of another of the truly ursine economists around, one of the handful who "got it right" pre-2007, I would also recommend Steve Keen's website. (This site is a bit wonkish and is probably not for everyone. Dr. Keen is an Aussie, so a portion of his data is Australia-specific.)

Copyright (C) Long Lake LLC 2009

More Chips Join More House for the Same Number of Dollars

Courtesy of Minyanville, here's a link to a Salt Lake Tribune titled:

Your bag of chips got bigger but price stays the same.

(Ignore the ungrammatical mixing of the past tense and present tense; this is what passes for editing despite or perhaps because of "aids" such as Spellcheck and the like.)

Just in case you want to see examples of deflation at work: unit price declines in action.

This is being posted having spent a couple of hours touring a local, partly built-out housing development undergoing major price cuts.

If it's in the interest of the Government and the Fed (close to one and the same thing nowadays) to have interest rates stay low (and it is in their interest, I believe), then that means low inflation. Don't fight the Fed(s).

Copyright (C) Long Lake LLC 2009

The Deflation Argument

An erudite but understandable argument for much lower Treasury yields is put forth in Debt Acts as a Brake on the Monetary Engine. (No excerpts as it is a pdf file.)

Charts 1, 2 and 4 are especially interesting. The specific comparison to Japan is a "must read". Econblog Review has been comparing the U. S. economy to that of post-bubble Japan since EBR's inception late last year. Nothing has happened to change that hypothesis. We have the same over-optimistic government forecasts and the same sort of propping up of "too big to fail" banks that are also too weak to succeed.

At least in the most populous part of the most populous State, the economy continues to weaken: there were not even any green shoots to wither. One hears this both from businesspeople and simply from the fact that the State in its May forecast for June receipts once again overestimated the degree of economic activity that would occur in June. One wonders how long the underestimation can go on! At some point down will look like up, as the book by Richard Farina suggests.

We are entering a seasonally weak time for gold and stocks and seasonal strength for Treasury bond prices (generally declining yields). Last year was so extreme that one wonders if mentioning this historical pattern means even less than usual.

But getting back to the linked article that began this post, no matter when the current economic downturn is "officially" judged to end (perhaps already), it may well be that stock and bond prices will better track absolute employment levels than technicalities. After all, economic output that has fallen fast and far can rebound just a little and show growth, but it will still be a weak economy with great slack and many downside risks.

Copyright (C) Long Lake LLC 2009

Prices Moving Backwards in Japan

Japan once had a good deal of inflation. That was over a long time ago. MarketWatch reports in Japan's wholesale prices mark record drop in June:

LOS ANGELES (MarketWatch) -- Japan's domestic corporate goods price index, the nation's benchmark measure of wholesale prices, fell a record 6.6% in June from the year-ago period, the Bank of Japan said Friday.
The result was a heavier drop than a 6.3% fall forecast in a survey of economist by Kyodo News and a 6.4% projection in a Reuters poll. It was also the largest on-year tumble on record.
From May, the index was down 0.3%. Export prices were down 12.8% on year in June, while import prices were 32.2% lower.
"The slide in wholesale prices is highly likely to widen in July, August and September, exceeding 7% down the road," Tetsuro Sawano, senior fixed income strategist at Mitsubishi UFJ Securities, was quoted as saying in a Reuters report following the data. "Today's data would help the Bank of Japan reinforce its cautious stance on the economy."

I wouldn't be certain that the same situation could not occur in the U. S.

Copyright (C) Long Lake LLC 2009