This is exactly what I've been pounding the table for--sovereign funds are turning their back on US debt issuance because they have been burned by the US government's irresponsible monetary policy. Former Treasury Secretary Paulson was in Beijing begging for them to keep funding our debt, and they have now reached the "screw you" stage.
Here is a question that doesn't require much deductive reasoning: with a lack of buyers, who else is going to buy our US Treasury bonds? The Chinese, the Koreans, and the Saudis have explicitly said "don't expect us to bail you out anymore". The Japanese are more polite about it: they merely said "we need to bail out our own economy", but they aren't stepping up either. The Chinese, Japanese, German, British and Saudi central banks have been the biggest buyers of our Treasury bonds in the past.
With no demand, and tons of supply about to hit the auctions, what happens then? The answer is interest rates have to rise to attract investors, assuming the US government is good for it (which is more at risk every day). In other words, the credit rating on our government doesn't even have to be downgraded to make our government's borrowing costs higher--the bond market will determine it for us. Short-term bills are directly influenced by Fed policy, but the Fed has very little say in the 30-year Treasury bond market--that market is too huge and is an aggregate arbiter of inflation expectations (a bet on bonds means investors believe inflation will be in check and interest rates will NOT rise until maturity).
That's why I've been shorting 30-year T bonds (betting US Treasury prices will decline as interest rates WILL rise). Bill Gross, the world's biggest bond investor thinks rates could go to 7%, while Julian Robertson, billionaire hedge fund manager wasn't explicit, but whispered "Paul Volcker" type interest rates--or 18%. That is a doomsday prediction, because our $11 trillion dollar debt compounding at that rate would torpedo our economy, as the US Government, considered the safest investment in the world, would have have to default on their IOU's. The bond market, much bigger than the stock markets (equities) would implode, and we WILL go back to the stone age in that event. We would just be one big Iceland, only since our economy is much bigger, the financial aftershocks would be felt for decades.
I am not betting on that scenario, but I am betting that the Fed will print dollars even faster--to avert that financial armageddon. Print more money? Create more inflation, causing interest rates to soar even more? Sounds like the vicious spiral it is. At some point, rates will be high enough to crater all asset prices--again back to where they should have been all along. That's why that former million dollar house may seem cheap at $600K, but it could get even cheaper still all the way to $300K--or worse. And that's exactly why propping them up at $600K won't work.
Should we keep building these trillion dollar deficits? We are 100% on that path to destruction, probably in the 5th inning in a 9 inning game, ending sometime within 5 years. Every step we have taken is leading us toward this perfect storm. Last year's collapse in real estate and stock markets are just a harbinger of things to come in the bond market.
THAT is why bailouts are dangerous, and going deeper into debt to solve a debt problem is a game of chicken that cannot have a happy ending. But the government, along with the blessings of monetary theorists still believe trillion dollar bailouts (government "investments" in infrastructure), will solve our financial problems. Just print more dollars and everything will be fine, according to their misguided logic. To be specific, I DO believe we should make investments in the right infrastructure projects, but the bill about to pass includes 10 years of pent up pork for congressmen to satisfy their constituents. It is not based on merit.
Interest rates have already moved up more in 1 week than it ever has from its all-time low in December, when I put in the trade. The Fed will try a last-ditch effort to suppress interest rates (and mortgage rates in the process), but manipulation never works long-term--it will only cause short-term distortions before the dam breaks. The Fed won't be able to control the long end of the curve, and our $2 trillion deficits will double and triple as interest rates soar. Investors will dump bonds (as they are starting to do) because they are losing confidence in the US Government's creditworthiness and solvency. Although it is unthinkable, investors are questioning whether the US Government can pay back their debt obligations. Look up the definition of solvency and show me how the US Government deserves it's AAA credit rating. The balance sheet is bloated with debt, and that debt level is soaring by the second. Left unfettered, our national debt will eventually and terminally choke our economy.
Friday, January 30, 2009
RIP Helio Gracie
In one of my few non-financial or non-technology related posts, I just wanted to post a blog in honor of Helio Gracie, who passed away in Rio last night. Why is this important--in light of the fact that he didn't teach many of my classes, as he was more of an honorary professor at his son Rorion's Gracie Academy in Torrance, CA? Or the fact that I didn't know him well, but was taking classes with his famous sons Rorion and Royce far more often?
Simply put, the 95-year-old was a pioneer in every sense. As one of the original founders of the Brazilian jujitsu (BJJ) clan, he developed a unique fighting style which helped narrow the gap for the weak, small, and non-violent, enabling his students and followers to not only defend themselves, but also neutralize an aggressive opponent. At 120-140 pounds, he would regularly defeat the world's toughest men in the world, in a no-holds-barred challenge fight, with no rules, no gloves, and no regrets.
He often defeated opponents twice his size, in a then-unconventional fighting style that would leave opponents gasping for air, or pleading for mercy (by tapping out and declaring a loss). For 80 years, this fighting style was unknown to the rest of the world, until son Rorion raised the exposure on these underground cage fights with the creation of the Ultimate Fighting Championships, now a legitimate, multi-billion-dollar industry. Younger son Royce won 3 of the first 4 round-robin competitions, wearing down opponents despite disadvantages in weight and strength.
But as a true contrarian, Royce and the rest of the family clan continually beat their opponents, using BJJ's expert use of leverage and technique. David really could defeat Goliath--consistently. At the time, the world was shocked that these skinny Brazilian guys could subdued world-class athletes into submission. 16 years later, BJJ is now a staple of any mixed martial arts fighter, thanks to Helio Gracie, and by extension, his sons' teachings. BJJ was no longer a fringe martial art in the endless debate of which art was more effective than another--let's settle it in the ring or cage, and let the results speak for themselves. Well, BJJ spoke, and BJJ won the debate.
But Helio's impact to me is even more meaningful than learning the perfect armbar or rear naked choke. He represents the little guy who persevered into a world-beater, despite obvious disadvantages in size and strength, against a backdrop of ridicule and skepticism. He conquered the best fighters in the world at their own game.
Today, financial markets, societies and even the sovereignty of countries is at risk. If huge money centers have collapsed, what chance does the little investor have in securing his/her financial future? If the game is rigged to benefit the Goliaths--and even some of the Goliaths are bleeding, how is the David supposed to survive?
Helio Gracie has taught me a valuable lesson, and that's to approach life with vigor, independent thought, benevolence, and a thirst for learning and teaching--traits my own later father taught me also. Most importantly, he resonated with my refusal to accept conventional wisdom as truth.
If some deem you "too weak, too small, too dumb, too poor, too unskilled", do not accept that is truth--define your own path. Even if the bully outweighs you by 50 pounds, is stronger, quicker, and faster than you, you can still defend yourself and even teach him a lesson--if you have the patience and determination to learn and work to counteract his aggression. But the most important lesson of all is to somehow allow your defeated opponent to channel his aggression in a positive manner. But protect yourself at all cost. That applies in the real world of self-defense.
In the fun world of sparring, it teaches you that no matter how good you think you are, there is always someone better than you. Better to be humble in that instance. Respect your sparring partners; they could well be your best lifelong friends, and there is honor in tapping out, as well as tapping out your sparring partners. It's not so much an admission of victory or defeat, it is a show of respect for the other person.
In a tournament setting, when all eyes on you and your opponent, animal spirits take over--the fight or flight response. In that environment, there is only one option. And that's when the mind has to calm the body down, blocking out fears of injury, reinforcing strategies and endless hours of training. You tell yourself, despite attempts to moderate hyperventilation, "hey, stick to the game plan, you're prepared mentally and physically, believe in yourself, just go out and do what you do. By the way, have fun while you're at it."
Helio--thank you showing me the little guy can win if he sets his heart and mind to it. Thank you for setting me down the path of self-reliance and self-belief. Rest in peace.
Greg
Gold--due for a pause--or ready to explode again?
I questioned whether gold was due for a pause a couple days ago, as the price of gold kept spiking up, breaking resistance levels. Well, the price shot up again overnight in Asia, BUT the mining shares didn't move much this morning. So I hedged this morning, not selling my positions, instead buying a couple puts, which will profit should ABX correct. Think of it as a cheap form of insurance in case gold pauses--without having to trigger a taxable event from profit-taking.
The price of the mining shares usually lead the actual price of the underlying commodity. In other words, it's gone up too fast and is looking heavy. There's that Physics training kicking in again...:-)
Having said that, I'm still bullish on gold medium- and long-term, as the fundamentals are unimpaired, to borrow a quote from Jim Rogers. But gold mining shares do look a bit tired at these levels. More conservative investors may want to take some profits off the table--a 100% profit in two months is nothing to sneeze at.
The price of the mining shares usually lead the actual price of the underlying commodity. In other words, it's gone up too fast and is looking heavy. There's that Physics training kicking in again...:-)
Having said that, I'm still bullish on gold medium- and long-term, as the fundamentals are unimpaired, to borrow a quote from Jim Rogers. But gold mining shares do look a bit tired at these levels. More conservative investors may want to take some profits off the table--a 100% profit in two months is nothing to sneeze at.
Tuesday, January 27, 2009
The Girl Scout Inflation Indicator
Girl Scouts are known for telling the truth, so we'll believe them when they say the cost or producing cookies increased 30% last year. That's why they're keeping the price of a box of cookies the same, but they're including fewer cookies:
Girl Scout Cookie prices
It seems the Girl Scouts are a little more honest about the rising cost of goods than the US Government is with its incessantly under-reported Consumer Price Index (CPI) figures.
Girl Scout Cookie prices
It seems the Girl Scouts are a little more honest about the rising cost of goods than the US Government is with its incessantly under-reported Consumer Price Index (CPI) figures.
Gold due for a pause?
For those who missed the run up in gold from November lows, you still have time, but now is not the time to commit new money, or even add to existing long gold positions. Technically, gold is still in a secular bull market that started as far back as 2001, but like any asset, prices don't move up or down in a straight line. Last week's up move in gold was breath-taking, so it's due for a pause or a correction at these levels. That's actually healthy, as it builds a stronger demand base (buyers) without the inherent froth of manias (we will experience that later when the general public drives up prices in a buying panic).
If anything, a correction is welcome, as it enables a lower entry point for long positions later on. Once the charts and the Moving Average Convergence Divergence (MACD) turns positive again, it will re-confirm our bullish posture. Until then, keep your powder dry and wait for that next opportunity.
GLD Price Chart and MACD Indicator
If anything, a correction is welcome, as it enables a lower entry point for long positions later on. Once the charts and the Moving Average Convergence Divergence (MACD) turns positive again, it will re-confirm our bullish posture. Until then, keep your powder dry and wait for that next opportunity.
GLD Price Chart and MACD Indicator
Another chart which needs no explanation...
This chart from the St. Louis Federal Reserve Bank website (I'm not making this up) illustrates money supply expansion by the Fed in lending cash to banks in exchange for their toxic assets. Notice the spike on the right side of the graph, which represents the creation of dollars out of thin air.
Why Monetary theory doesn't work.
According to Brian Bloom, author of Beyond Neanderthal:
The “theory” of the monetarists is that if you flood the market with money then people will continue to buy the same quantity of oil. The “reality” is that if there is less stock available (for whatever reason) and/or if there is a reduction of the rate at which people are replacing what they bought before, then an inflation of the money supply causes an inflation of prices.
Another problem to which the monetarists seem blind is that wages lag inflation. First price rises and then, in response to increasing difficulties being experienced by consumers to make ends meet whilst continuing to buy the same volume of goods, they hold out their hands for more wages. Employers – who are experiencing their own problems – don’t react immediately. Thus, in the short term, consumers have no option but to buy fewer goods and services. It follows that, in an economy where 66% of GDP is accounted for by consumer purchases, any extraordinary inflation of the money supply is virtually guaranteed to exacerbate a slowing velocity of money and a concomitant slowing rate of consumer purchases. At the extreme, if the authorities drop dollars from helicopters, all that they will achieve is that they will hasten the arrival of an Economic Depression. Perhaps the following example will make it crystal clear: Today, in Zimbabwe, a loaf of bread costs somewhere around half a billion dollars and the unemployment rate is around 80%. How many of the 80% unemployed do we think can access half a billion dollars? At the extreme, when you print too much money, the economy tanks.
In summary, dear reader, if you have a robust engine powering a robust vehicle which, in turn, is pulling your 5 ton load then, by depressing the accelerator (increasing the money supply) the car will easily negotiate the next hill. But if the vintage economic vehicle is not sufficiently robust – which is what we are now facing – then you want to be very circumspect about increasing the money supply. This is one of those times when implementing monetary theory will be counterproductive. What will likely happen under these circumstances – as an example – is that the oil price will rise to $150 a barrel. Then, when it collapses again because people can’t afford to pay $4 a gallon for gasoline because wages lag inflation, what you will be faced with is a fall in demand and a consumer who has been burned. And we all know that “a burned child dreads the fire”. If you offer the consumer a box of matches after he has been burned, he will run a mile in the opposite direction. Printing yet more money in today’s environment will not give rise to the desired outcome.
The “theory” of the monetarists is that if you flood the market with money then people will continue to buy the same quantity of oil. The “reality” is that if there is less stock available (for whatever reason) and/or if there is a reduction of the rate at which people are replacing what they bought before, then an inflation of the money supply causes an inflation of prices.
Another problem to which the monetarists seem blind is that wages lag inflation. First price rises and then, in response to increasing difficulties being experienced by consumers to make ends meet whilst continuing to buy the same volume of goods, they hold out their hands for more wages. Employers – who are experiencing their own problems – don’t react immediately. Thus, in the short term, consumers have no option but to buy fewer goods and services. It follows that, in an economy where 66% of GDP is accounted for by consumer purchases, any extraordinary inflation of the money supply is virtually guaranteed to exacerbate a slowing velocity of money and a concomitant slowing rate of consumer purchases. At the extreme, if the authorities drop dollars from helicopters, all that they will achieve is that they will hasten the arrival of an Economic Depression. Perhaps the following example will make it crystal clear: Today, in Zimbabwe, a loaf of bread costs somewhere around half a billion dollars and the unemployment rate is around 80%. How many of the 80% unemployed do we think can access half a billion dollars? At the extreme, when you print too much money, the economy tanks.
In summary, dear reader, if you have a robust engine powering a robust vehicle which, in turn, is pulling your 5 ton load then, by depressing the accelerator (increasing the money supply) the car will easily negotiate the next hill. But if the vintage economic vehicle is not sufficiently robust – which is what we are now facing – then you want to be very circumspect about increasing the money supply. This is one of those times when implementing monetary theory will be counterproductive. What will likely happen under these circumstances – as an example – is that the oil price will rise to $150 a barrel. Then, when it collapses again because people can’t afford to pay $4 a gallon for gasoline because wages lag inflation, what you will be faced with is a fall in demand and a consumer who has been burned. And we all know that “a burned child dreads the fire”. If you offer the consumer a box of matches after he has been burned, he will run a mile in the opposite direction. Printing yet more money in today’s environment will not give rise to the desired outcome.
Monday, January 26, 2009
More crooks
Stephen Obie, Director of Enforcement with the Commodity Futures Trading Commission (CFTC), which oversees the futures exchanges, is on Fox Business News preaching about transparency, oversight, regulation, and enforcement, and waving his hands on TV like a Dale Carnegie salesman. He's saying how the SEC and investors didn't oversee and perform due diligence on Bernie Madoff.
What's unbelievable is that the commodity pits are rife with manipulation and corruption beyond imagination. Big commercial traders and banks have artificially suppressed prices on the futures markets for years--yet, the CFTC never investigates the commercials--they know where their bread is buttered. Naked shorting makes it possible for the commercials to dampen prices on commodities like gold and silver, with no intention for physical delivery on settlement date. In other words, they'll sell short a futures contract with no inventory, and no intention to deliver at that date. These are phantom contracts, much like the toxic credit default swaps which were uncollaterized. These naked short-selling commercials are selling vaporware, and their massive short positions alone can drive prices lower due to no other reason than market manipulation.
Instead, the CFTC goes after the small-time speculators for minor non-compliance, but they will not reveal who takes large positions on either side of a trade--including the commercials who manipulate the markets. Transparency? What a crock--Fort Knox hasn't had an independent audit for its gold reserves since the early 1950's. Many conspiracy theorists are saying half of what is reported in vaults has either been sold off or leased, yet is still counted.
Eventually, this con game will be exposed when a seller will default, unable to meet physical delivery demands. That day is approaching, as buyers in the middle east are scrambling to buy gold and dealers are unable to meet that demand.
What's unbelievable is that the commodity pits are rife with manipulation and corruption beyond imagination. Big commercial traders and banks have artificially suppressed prices on the futures markets for years--yet, the CFTC never investigates the commercials--they know where their bread is buttered. Naked shorting makes it possible for the commercials to dampen prices on commodities like gold and silver, with no intention for physical delivery on settlement date. In other words, they'll sell short a futures contract with no inventory, and no intention to deliver at that date. These are phantom contracts, much like the toxic credit default swaps which were uncollaterized. These naked short-selling commercials are selling vaporware, and their massive short positions alone can drive prices lower due to no other reason than market manipulation.
Instead, the CFTC goes after the small-time speculators for minor non-compliance, but they will not reveal who takes large positions on either side of a trade--including the commercials who manipulate the markets. Transparency? What a crock--Fort Knox hasn't had an independent audit for its gold reserves since the early 1950's. Many conspiracy theorists are saying half of what is reported in vaults has either been sold off or leased, yet is still counted.
Eventually, this con game will be exposed when a seller will default, unable to meet physical delivery demands. That day is approaching, as buyers in the middle east are scrambling to buy gold and dealers are unable to meet that demand.
New US Treasury Secretary Tim Geithner
Somewhat predictably, US Treasury Bond prices collapsed in after-hours trading as soon as Tim Geithner was sworn in as Secretary of Treasury. How's that for confidence from the markets?
Sunday, January 25, 2009
This chart says it all...
This chart by Chris Martenson compares total debt (or “credit”) in the U.S. to GDP (or Gross Domestic Product) on a percentage basis. Current total credit-market debt stands at more than 340 percent of total GDP.
As we can see on this chart, the last time debts got even remotely close to current levels was back in the early 1930s, and that bears a bit of explanation. The debt-to-GDP ratio back then didn’t start to climb until after 1929 (blue arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts. With the exception of the Great Depression anomaly, our country always held less than 200 percent of our GDP in debt (green circle). In 1985 we violated that barrier and have never looked back.
"Rich Like Them" book review
David Merkel reviewed the book "Rich Like Them", authored by Ryan D'Agostino by summarizing the following points:
* Find opportunities that others don’t see.
* So-called luck favors those who are prepared to profit from volatility.
* Love what you do. Do what you love.
* Take risks. If you work smart and hard, those risks will be reduced.
* Be humble. Realize what you can’t do, and work on what you can do.
The author interviewed mostly business owners door-to-door in the wealthiest zip codes of America, and came up with those common elements. The first point definitely favors contrarians, and as investors, the other 4 apply.
* Find opportunities that others don’t see.
* So-called luck favors those who are prepared to profit from volatility.
* Love what you do. Do what you love.
* Take risks. If you work smart and hard, those risks will be reduced.
* Be humble. Realize what you can’t do, and work on what you can do.
The author interviewed mostly business owners door-to-door in the wealthiest zip codes of America, and came up with those common elements. The first point definitely favors contrarians, and as investors, the other 4 apply.
Articles on what to do to survive 2009
Fundamental analysis of precious metals, US Treasuries, interest rates:
Tocqueville Asset Management
Technical analysis of precious metals and currencies:
http://finance.yahoo.com/q/bc?s=TBT&t=5d
Tocqueville Asset Management
Technical analysis of precious metals and currencies:
http://finance.yahoo.com/q/bc?s=TBT&t=5d
Saturday, January 24, 2009
The economy, the dollar, and Wall Street bonuses
Jim Rogers told a crowd in Hong Kong that holding U.S. government bonds is a "big mistake" and will "end badly."
"If I were you, I would be worried about the U.S. dollar," said Rogers. "The Americans are printing U.S. dollars. The Americans are going to do whatever they can to revive their economy, even if it means destroying the U.S. dollar." Rogers favors holding agriculture, power generation, Chinese stocks, and the yen.
According to analyst Porter Stansberry:
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While Americans are right to worry about the stability of the dollar, at least we don't have to worry about our currency disappearing overnight.
Over in Euroland, spreads on different European government debts are widening sharply, revealing the markets believe the euro will come unraveled as countries exit the currency union. Bonds issued from Greece are now trading at nearly 300 basis points over similar German bonds – the widest spreads between euro-member government bonds since the currency was introduced in 1999.
Less than four months ago, the 10 largest U.S. banks by asset size had a combined market capitalization of $722.73 billion, according to American Banker. As of January 20, it stood at just $237.83 billion, a drop of approximately two-thirds.
I wonder which of those numbers is closer to the real intrinsic value of those banks? It's probably good for the banks and the people who run them that nobody knows exactly what they own or has any clue what it's all worth.
At the end of 2007, the five largest U.S. securities firms paid their employees $66 billion in bonuses. All of it came from "profits" that we've since learned were horrendous losses. With the writeoffs from just these five firms now totaling much more than $100 billion, at what point do you begin to judge what these people did as not merely reckless and negligent, but calculating and criminal?
They had to have known by at least the end of 2007 that most of their mortgage securities were cooked. And yet, they took the biggest bonuses in the history of Wall Street, leaving taxpayers to pick up the mess
Free will
In research done by Baumeister, Masicampo and DeWall (2009) and Vohs and Schooler (2008), studies point out the positive effect of free will on a variety of behaviors that most people would consider beneficial. Indeed it seems that most of us already have a firm belief in free will and so we're already benefiting. For practical purposes, the danger is that our thoughts take a more deterministic turn and we move towards more aggression and cheating and away from helping behaviors.
My take is that if Obama and Congress need our participation in turning this ship around, he's going to have to encourage a sentiment of free will. The first step in doing so is to cut taxes.
My take is that if Obama and Congress need our participation in turning this ship around, he's going to have to encourage a sentiment of free will. The first step in doing so is to cut taxes.
Friday, January 23, 2009
Two charts: ABX and TBT
ABX: http://finance.yahoo.com/echarts?s=ABX#chart1:symbol=abx;range=5d;indicator=sma+volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
Up over 16% in 5 days, while my call options have tripled in 5 days. Actually, in 10 minutes, it's gone up another 8 %. This is not the ramblings of the lunatic fringe--this is a clear indication that inflationary fears are resurfacing, and that the market is climbing the wall of worry about USDollar debasing. For technical traders, it also means the gold short sellers are getting squeezed, and are scrambling for physical delivery.
TBT: http://finance.yahoo.com/echarts?s=TBT#symbol=TBT;range=5d
Up over 17% in 5 days.
What does this tell us? The markets are beginning to believe that Obama's stimulative program may work. While I agree it will "work"--we'll certainly create more jobs (temporarily), but due to high deficit spending, it'll be a vegetative recovery, and markets will remain highly volatile. I do not believe it will be a productive recovery, and asset values in equities and real estate will remain grim for at least 5 years.
The prevailing attitude will be: "well, at least I have a construction job, even though my paycheck is constantly being eroded by a weakening dollar and high inflation." With the debasement of the USDollar and every other currency due to these stimulus packages, gold will retain its real value. Every dollar spent to bailout failing industries will be one less dollar to invest in the productive private sector. This "Newer Deal" will again prove disastrous for years.
Having said that, I am protecting my capital with hard assets in the precious metals, and retaining my purchasing power by nibbling in the soft commodities.
Up over 16% in 5 days, while my call options have tripled in 5 days. Actually, in 10 minutes, it's gone up another 8 %. This is not the ramblings of the lunatic fringe--this is a clear indication that inflationary fears are resurfacing, and that the market is climbing the wall of worry about USDollar debasing. For technical traders, it also means the gold short sellers are getting squeezed, and are scrambling for physical delivery.
TBT: http://finance.yahoo.com/echarts?s=TBT#symbol=TBT;range=5d
Up over 17% in 5 days.
What does this tell us? The markets are beginning to believe that Obama's stimulative program may work. While I agree it will "work"--we'll certainly create more jobs (temporarily), but due to high deficit spending, it'll be a vegetative recovery, and markets will remain highly volatile. I do not believe it will be a productive recovery, and asset values in equities and real estate will remain grim for at least 5 years.
The prevailing attitude will be: "well, at least I have a construction job, even though my paycheck is constantly being eroded by a weakening dollar and high inflation." With the debasement of the USDollar and every other currency due to these stimulus packages, gold will retain its real value. Every dollar spent to bailout failing industries will be one less dollar to invest in the productive private sector. This "Newer Deal" will again prove disastrous for years.
Having said that, I am protecting my capital with hard assets in the precious metals, and retaining my purchasing power by nibbling in the soft commodities.
Tuesday, January 20, 2009
Time to face reality
Just like when Obama won the general election and equities tanked, the Inauguration rally many expected failed to materialized. The correct interpretation is that while Main Street hopes Obama will save the day, the smart money says his stimulative policies will fail. Artificially propping up insolvent industries may be populist, but history shows it is counterproductive in a failing economy. And history always show contrarians eventually are proved correct in predicting inflection points by going against the consensus. Even though Obama is riding a huge wave of popularity, the consensus is always proven wrong. If billion dollar deficits are bad, then trillion dollar deficits are supposed to be good?
The silver lining (or more correctly, the gold and silver lining) is that my investment theses are still intact: the US Dollar is continually being debased due to profligate credit and quantitative easing--in a desperate attempt to save the economy from further decline. But in doing so, we mortgage our future, dampening growth with high taxes, lower corporate earnings, and lower purchasing power. Interest rates have nowhere to go but up from here, while hard assets such as gold and silver will be one of the few safe havens from financial and economic turmoil. Healthcare seems to be the only other recession-resistant industry. Markets don't move up or down in a straight line, so we will experience corrections against the prevailing trend, but these trends are already paying off, so any pauses will be opportunities for me to add to my already profitable positions. In other words, I don't know how gold prices will move tomorrow, but I do know 2 years from now, a debased US Dollar almost guarantees gold will move substantially higher.
Today, despite general public optimism, equities tanked again, led by distrust in financials and their ability to get their arms around their huge portfolio losses. The disturbing fact is that the economy can't grow without a healthy banking industry, with high reserve ratios and solid balance sheets. With unemployment soaring, lending ground to a halt, and loan defaults rising, banks are in a pickle to stay solvent themselves.
Meanwhile, the price of gold surged, while yields on 30-year Treasury bonds rose (hence, our short T-bond position). All trends are behaving as I predicted, even tho I was unsure of the timing, whether the big moves start tomorrow, next month, next year. One could argue that gold has been in a secular bull market since 2001, when it was trading at $257/oz, due to the aforementioned dollar debasing. In the same vein, gold has tripled in 8 years: the sad corollary is that the US Dollar has been devalued by two-thirds. Mathematically, when you create obscene distortions in financial vehicles, you will experience painful regressions to the mean--in laymen's terms, you've created a bubble that will eventually burst. This massive credit expansion and deficit spending has been especially toxic, and now the Federal government thinks extending more credit will somehow magically cause our economy to resuscitate itself.
Today was a great day for many reasons, and shows that we have evolved as a country. But financially, it also means we have sealed our fate economically, and that we should expect another decade of negative wealth and disinvestment.
The silver lining (or more correctly, the gold and silver lining) is that my investment theses are still intact: the US Dollar is continually being debased due to profligate credit and quantitative easing--in a desperate attempt to save the economy from further decline. But in doing so, we mortgage our future, dampening growth with high taxes, lower corporate earnings, and lower purchasing power. Interest rates have nowhere to go but up from here, while hard assets such as gold and silver will be one of the few safe havens from financial and economic turmoil. Healthcare seems to be the only other recession-resistant industry. Markets don't move up or down in a straight line, so we will experience corrections against the prevailing trend, but these trends are already paying off, so any pauses will be opportunities for me to add to my already profitable positions. In other words, I don't know how gold prices will move tomorrow, but I do know 2 years from now, a debased US Dollar almost guarantees gold will move substantially higher.
Today, despite general public optimism, equities tanked again, led by distrust in financials and their ability to get their arms around their huge portfolio losses. The disturbing fact is that the economy can't grow without a healthy banking industry, with high reserve ratios and solid balance sheets. With unemployment soaring, lending ground to a halt, and loan defaults rising, banks are in a pickle to stay solvent themselves.
Meanwhile, the price of gold surged, while yields on 30-year Treasury bonds rose (hence, our short T-bond position). All trends are behaving as I predicted, even tho I was unsure of the timing, whether the big moves start tomorrow, next month, next year. One could argue that gold has been in a secular bull market since 2001, when it was trading at $257/oz, due to the aforementioned dollar debasing. In the same vein, gold has tripled in 8 years: the sad corollary is that the US Dollar has been devalued by two-thirds. Mathematically, when you create obscene distortions in financial vehicles, you will experience painful regressions to the mean--in laymen's terms, you've created a bubble that will eventually burst. This massive credit expansion and deficit spending has been especially toxic, and now the Federal government thinks extending more credit will somehow magically cause our economy to resuscitate itself.
Today was a great day for many reasons, and shows that we have evolved as a country. But financially, it also means we have sealed our fate economically, and that we should expect another decade of negative wealth and disinvestment.
Banking system insolvent
Jan. 20 (Bloomberg) -- U.S. financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is “effectively insolvent,” said New York University Professor Nouriel Roubini, who predicted last year’s economic crisis.
“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”
Losses and writedowns at financial companies worldwide have risen to more than $1 trillion since the U.S. subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.
President Barack Obama will have to use as much as $1 trillion of public funds to shore up the capitalization of the banking sector, following the $350 billion injection by the Bush administration, Roubini told Bloomberg News. Congress last year approved a $700 billion rescue fund, of which half remains to be disbursed.
Bank of America Corp., the largest U.S. bank by assets, posted a quarterly loss of $1.79 billion last week, its first since 1991, and received $138 billion in emergency government funds. Citigroup Inc. posted an $8.29 billion fourth-quarter loss, completing its worst year, and plans to split in two under Chief Executive Officer Vikram Pandit’s plan to rebuild a capital base eroded by the credit crisis.
‘Bankrupt’ System
“The problems of Citi, Bank of America and others suggest the system is bankrupt,” Roubini said. “In Europe, it’s the same thing.”
“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”
Losses and writedowns at financial companies worldwide have risen to more than $1 trillion since the U.S. subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.
President Barack Obama will have to use as much as $1 trillion of public funds to shore up the capitalization of the banking sector, following the $350 billion injection by the Bush administration, Roubini told Bloomberg News. Congress last year approved a $700 billion rescue fund, of which half remains to be disbursed.
Bank of America Corp., the largest U.S. bank by assets, posted a quarterly loss of $1.79 billion last week, its first since 1991, and received $138 billion in emergency government funds. Citigroup Inc. posted an $8.29 billion fourth-quarter loss, completing its worst year, and plans to split in two under Chief Executive Officer Vikram Pandit’s plan to rebuild a capital base eroded by the credit crisis.
‘Bankrupt’ System
“The problems of Citi, Bank of America and others suggest the system is bankrupt,” Roubini said. “In Europe, it’s the same thing.”
Monday, January 19, 2009
Peter Schiff's prediction--in 2006!
See how accurate he was--in the face of a consensus of detractors who insisted he was part of the lunatic fringe.
"The United States' (economy) is like the Titanic and I am here with the lifeboat trying to get people to leave the ship," said Schiff, president of Darien-based Euro Pacific Capital, a brokerage firm that specializes in trading foreign equities.
"I see a real financial crisis coming for the United States,"Schiff said. "I am helping my clients protect themselves."
Schiff likes the Titanic metaphor. Everyone thought the ship could never sink, just like most people think the U.S. economy can't, he said. But people were wrong about the Titantic, and they are wrong about this country's economic stability, he said.
Schiff sees a mammoth iceberg ahead that's going to obliterate the U.S. dollar. The investors' lifeboat, he said, will be to put their money into non-dollar assets and foreign currency.
Besides being down on the dollar, Schiff said U.S. equities are substantially overvalued and bond prices are on the verge of collapse.
Here's his take on real estate:
"The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only and negative-amortization mortgages, a can't-lose attitude among speculators validated by ever rising 'comps,' the complete abandonment of lending standards, widespread corruption in the appraisal industry, rampant fraud among sub-prime lenders and the moral hazards associated with loan originators reselling loans to buyers of securitized products who perceive minimal risk and an implied government guarantee, has produced the mother of all bubbles."
Soros warns US Dollar will lose reserve status
George Soros, billionaire hedge fund manager, is predicting the dollar's demise. He made a $1 billion profit in 1992 by betting against the British pound.
Mr Soros also warned that the dollar's status as the world's reserve currency was drawing to an end, thanks in part to the financial crisis on Wall Street. He said the plight of US households, who are facing major slumps in nationwide house prices for the first time in living memory, was increasing the distaste among international investors for the greenback.
He said: "The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency. Now the rest of the world is increasingly unwilling to accumulate dollars."
Sunday, January 18, 2009
Mayer Rothschild quote
Give me control over a nation's currency, and I care not who makes its laws. -- Mayer Amschel Rothschild, 1743 - 1812)
Mayer Rothschild created a banking dynasty several hundreds years ago that still exists today.
Slowly but surely, our own government is surrendering the sovereignty of our country, by debasing the dollar.
Good explanation on inflation/deflation
According to Paco Ahlgren, a financial analyst:
The majority of analysts today believe Treasury prices will fall when the appetite for risk returns. That is certainly one way to justify the fact that the price of Treasuries hovers at historical -- and dangerous -- highs. But there is another more volatile, yet less scrutinized potential outcome to this tale: Treasury prices may succumb, not because an appetite for risk drives capital to other asset-classes, but because Treasuries -- the yields of which are commonly referred to as the "risk-free rate of return" -- are finally exposed as, perhaps, the riskiest assets around.
Treasury prices move inversely to their yields, which are at record lows. How can a "risk-free" asset that returns, at best, 3% for 30 years be considered "risk free" if that asset's value will fall dramatically should interest rates even approach the historical average? Said another way: why would investors place capital in an asset that only pays a maximum of 3% per year, for 30 years, with almost no possibility of capital appreciation?
Shouldn't that mean yields are almost certainly going higher?
I'm going to digress a bit. A few days ago, a reader commented that she didn't understand why I keep insisting that inflation is not defined as rising prices, but that it is the result of rising prices. To some of you, this might seem difficult to comprehend -- probably because you are so used to the usage popularized by media and government propagandists. Let me assure you, however that rising prices are not inflation; rising prices are resultant -- universally-rising prices are merely the products of inflation, which is defined as an increase in the supply of money in an economy.
Paper money is not scarce -- governments can print it at will, and therefore it is inherently inflationary. It is difficult, however, to increase the supply of gold in the world. Yes, the supply increases marginally each year, but it cannot be created out of thin air; it must be discovered and mined, which carries tremendous costs, thereby contributing to gold's scarcity.
Let's suspend disbelief for a moment and pretend we have an economy whose base currency is gold only. In this hypothetical economy, while it might be conceivable that prices could rise because of the immutable laws of supply and demand -- within asset-classes -- it is inconceivable that gold could become less valuable because of increased supply (it is very difficult to increase the supply of gold, as we said). And this is the heart of my point: currencies -- whether based on gold, paper, or pigs -- are not immune to the laws of supply and demand. If gold is the base currency, It can certainly become more valuable with increased demand and/or decreased supply, but it cannot become less valuable because of increased supply (or not much, anyway).
When fiat paper money is printed, however, it can and does become less valuable as supply increases, because it is easy and relatively cheap to print money -- especially electronic money.
Let's put it another way. Let's say Apple (AAPL) cut the supply of iPhones in the economy over the course of a month, and the price of an iPhone doubled. Would you say that the iPhone was inflationary? Of course not! You'd say the the supply had been halved, so the price doubled!
If gold were our currency (or if we issued currency carefully backed by some appropriate amount of gold), rising prices would be strictly a product of supply and demand. "Inflation" would cease to exist -- for all intents and purposes -- because there would be no way to increase the supply of money. And this is why I say that universally rising prices in an economy based on fiat currency are not "inflation;" they are the product of increasing the supply of money. It's true that some goods and services might become more valuable as demand increases, or as supply diminishes, but universally, prices would not increase as a result of increased money supply, because there is no way to meaningfully increase the supply of gold in the world!
There is an argument that credit is part of the money supply -- that is to say, every time a person or institution uses credit, more money is created because no cash has actually changed hands. On the surface, the proposition seems sound; after all, when you use your credit card, for instance, to buy a television, the money goes into the vendor's account, and yet you haven't actually given the store any of your money, per se. You still have your money. The store has its money. More money.
This, however, is nothing more than the abuse of an obscure form of accounting called cash basis, which says that revenue is earned only when cash is received, and expenses are incurred only when cash is paid out. I'm sure cash-basis accounting has a place somewhere in the world, but the vast majority of businesses adhere to another convention called accrual-basis, which says that revenue is earned and expenses are generated at the moment of the transaction -- not when cash changes hands. The reason this is important is that it allows for convenient accounting of receivables and payables, and if you've ever tried to run a business, you know how incredibly difficult it would be to survive if you weren't using receivables and payables.
This is why I think its absurd to say credit increases the money supply. Going back to our example above: when you pay for a television with your credit card, you are actually incurring debt at the same time you acquire the television, and that balances the equation. No wealth has been created out of thin air -- the debt you owe is balanced by the equity you received when you purchased the television.
Now I'm not going to sit here and tell you that leverage isn't dangerous -- even in an economy whose currency is backed by gold. But leverage does not increase the money-supply. Leverage increases debt. Thus, I will make the argument that inflation only exists when a government prints money. And just to hammer the point home, I will remind you that the imminent subsequent rise in prices and interest rates are not inflation, but rather they are the results of inflation.
In this crisis, the Fed is printing money at an unprecedented rate to battle what it is calling "deflation." But it's not deflation; it's de-leveraging. Just like inflation is defined by the printing of money, deflation can only be defined as the removal of money from the economy. The Fed, however, wants to print enough money to stimulate prices and get people spending again. In effect, the Fed is, yet again, encouraging exactly the type of behavior that causes bubbles in the first place. It's a vicious cycle: create cheap money out of thin air, thereby encouraging spending and investment, which in turn creates artificially inflated prices, which ultimately results in a bust, which the Fed battles by creating cheap money out of thin air... and so on and so forth.
So here's the real question: how many times can the carousel go around before it falls off its axis and destroys itself with its own momentum?
And now, finally, we can complete our own little rotation and return to Treasuries. Perhaps the most unfathomable part of this game is the newest tactic the Fed is employing: quantitative easing. Essentially, the Fed intends to escalate its printing spree in order to buy longer-maturity Treasuries. The idea is this: Treasury prices are inversely related to yield, so if the Fed buys those bonds, it can drive yields lower, thereby encouraging yet more cheap loans, followed by more spending and investment. But here's the rub: the Fed -- which is nothing more than an illegitimate wing of the government -- is printing money which it will use to buy debt issued by the Treasury -- yet another wing of the government. Are you starting to see what I'm getting at?
Here, I'll simplify it: your government, through Legal Tender laws, is forcing you to use dollars to navigate the economy in which you reside. It is then printing this currency with reckless abandon. Finally, the same government is issuing more debt than ever before in history, which it will loan to itself (or borrow from itself, depending on how you look at it) by employing the nearly innumerable dollars it has printed.
It used to be that a dishonest person had to rob Peter to pay Paul if he wanted to get ahead in life. But times have changed; the old way of doing things just isn't sophisticated enough to fool, say, an entire globe. No, these days, apparently Peter must first print a bunch of cash, then borrow it from himself, and finally dump it from a helicopter in Paul's front yard.
Do you still think Treasuries are "risk-free?"
I'm done here. I'm going to go buy some gold.
Countries in default--a blueprint for the US?
Countries which have defaulted on their bond obligations: first Russia in 1998, then Argentina in 2001, Iceland last November, Ecuador last December, and Ukraine on the brink.
More emerging countries are at risk. What's important to note is that in each case, the local currency was debased due to exorbitant printing of said currency. This was done in response to governments looking to print their way out of a huge deficit problem. This monetary and fiscal easing caused hyperinflation, which then caused interest rates to soar. This further exacerbated the ballooning debt, and eventually, the countries could not meet their debt covenants. This caused the country to shut down, as the government IOU's were now worthless, and credit disappeared.
The US Treasury and Federal Reserve Bank are essentially implementing these same policies of easy money and quantitative easing--only on a much grander scale. Exactly how they expect a different outcome for the US is beyond me.
More emerging countries are at risk. What's important to note is that in each case, the local currency was debased due to exorbitant printing of said currency. This was done in response to governments looking to print their way out of a huge deficit problem. This monetary and fiscal easing caused hyperinflation, which then caused interest rates to soar. This further exacerbated the ballooning debt, and eventually, the countries could not meet their debt covenants. This caused the country to shut down, as the government IOU's were now worthless, and credit disappeared.
The US Treasury and Federal Reserve Bank are essentially implementing these same policies of easy money and quantitative easing--only on a much grander scale. Exactly how they expect a different outcome for the US is beyond me.
Friday, January 16, 2009
Warren Buffett calls these instruments weapons of financial destruction
If the imploding of credit default swaps didn't put the fear of God in markets, this should:
Derivatives Market
The Bank for International Settlements (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for central banks.
According to BIS statistics, as of June, 2008 (before the financial meltdown), interest rate derivatives totaled $458 trillion, foreign exchange derivatives totaled $63 trillion, credit default swaps totaled $57 trillion, commodity derivatives totaled $13 trillion, equities-linked derivatives totaled $10 trillion, and unallocated derivatives $82 trillion. Total worldwide derivatives market: $684 trillion!
A quick glance at the figures reveals that credit default swaps, while huge in nominal numbers, is very small relative to interest rate derivatives (stock market derivatives are even smaller). If mispriced CDS can wreak such havoc on financial markets worldwide, what would happen if interest rate derivatives (fixed-income, i.e. bond markets) implode?
To connect the dots, easy monetary and fiscal policies arguably created the tech bubble, which burst 2000-2002. Those same ill-advised policies created a real estate and mortgage bubble, which popped in 2007-2008. Today, the government is embarking on another attempt to ease the credit crisis, but the unintended consequence is the creation of another bubble--the US Treasury bond market. But this time the magnitude of the interest rate bubble is orders of magnitude larger than the toxic credit default swaps which "insure" against US homeowners defaulting on their mortgages. The problem with CDS' is that they are not backed by any collateral (hence the ability to obscenely leverage up).
When the US Treasury bond bubble collapses--and interest rates soar, God help us all.
Derivatives Market
The Bank for International Settlements (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for central banks.
According to BIS statistics, as of June, 2008 (before the financial meltdown), interest rate derivatives totaled $458 trillion, foreign exchange derivatives totaled $63 trillion, credit default swaps totaled $57 trillion, commodity derivatives totaled $13 trillion, equities-linked derivatives totaled $10 trillion, and unallocated derivatives $82 trillion. Total worldwide derivatives market: $684 trillion!
A quick glance at the figures reveals that credit default swaps, while huge in nominal numbers, is very small relative to interest rate derivatives (stock market derivatives are even smaller). If mispriced CDS can wreak such havoc on financial markets worldwide, what would happen if interest rate derivatives (fixed-income, i.e. bond markets) implode?
To connect the dots, easy monetary and fiscal policies arguably created the tech bubble, which burst 2000-2002. Those same ill-advised policies created a real estate and mortgage bubble, which popped in 2007-2008. Today, the government is embarking on another attempt to ease the credit crisis, but the unintended consequence is the creation of another bubble--the US Treasury bond market. But this time the magnitude of the interest rate bubble is orders of magnitude larger than the toxic credit default swaps which "insure" against US homeowners defaulting on their mortgages. The problem with CDS' is that they are not backed by any collateral (hence the ability to obscenely leverage up).
When the US Treasury bond bubble collapses--and interest rates soar, God help us all.
Oversold
Even tho I think financials have terrible fundamentals (too much toxic debt), I flipped Citigroup today for a one-day round trip profit of 20%. Regional banks should do okay, as they didn't leverage up on sub-prime mortgage-backed securities, like the big money center banks. But the landscape has changed for partially nationalized banks like JPMorgan Chase, B of A, Citi, and Goldman Sachs. So even tho I went against my investment principles, I repeated my flip of Morgan Stanley last quarter, doubling my money on that trade. The panic selling of Citi shares created an oversold condition, so I pounced. Probably not smart, but I'd rather be lucky than good.
I also nibbled at oil at $34/barrel with the ETF DXO, which leverages crude oil moves. No one is bullish on oil, so my contrarian instincts compelled me to dive in. This is a short-term trade for me, and if oil moves to my favor, I'll take profits. If oil keeps declining, I'll again go against my principles, sitting on it for however many months or years it takes for oil to rebound--I won't put in any stop losses. Oil is still in a secular bull market, so time is on my side.
I also nibbled at oil at $34/barrel with the ETF DXO, which leverages crude oil moves. No one is bullish on oil, so my contrarian instincts compelled me to dive in. This is a short-term trade for me, and if oil moves to my favor, I'll take profits. If oil keeps declining, I'll again go against my principles, sitting on it for however many months or years it takes for oil to rebound--I won't put in any stop losses. Oil is still in a secular bull market, so time is on my side.
Thursday, January 15, 2009
Forecast for 2009 and beyond
Equities will bottom this year, while housing may bottom 2010--best-case. The dollar will break down further, and when the market realizes that, gold will rise. When the market recovers with a false rally, inflation will kick in, prompting gold's rise. Gold is not like most commodities--it is a currency of real value--a hedge against inflation. There is usually a year lag before inflationary fiscal and monetary policies kick in. In other words, money supply M is in place for inflation, but inflation will remain subdued until banks start lending (increasing money velocity V). And banks can't lend right now, despite huge capital injections because they are hoarding cash to strengthen their crippled balance sheets. Not sure when that will happen (banks lending to each other, to businesses, to individuals, etc.), but it's gotta happen at some point. Either that, or the whole banking system collapses, and we go back to barter....maybe the muslims are right. Even in that worst-case scenario, gold will hold its value--what other paper currency will hold its value in an Armageddon scenario--the USDollar?
Either way, gold will rise--it's not a matter of if, it's a matter of when. This downturn will be worse than the 1973-74 deep recession, when gold increased 2325%. I don't think it will be as bad as the Great Depression of the 30's, when we had almost 25% unemployment. Even in that deflationary environment, gold went up 69%. So if we are closer to a repeat of the Great Depression, you are right, gold may languish around the $500/oz to $1000 range , up from its 1999 low of $253. But if a full-fledged recovery occurs, a 2325% spike translates to a price of $5882. Realistically, the 1980 $850 peak, deflated in today's dollar indicates a $2400 price.
But with the accelerated debasing of the dollar in concert with other currencies, inflation is already in place. The definition of inflation is an increase in money supply, not necessarily the Consumer Price Indicator, the official government statistic. An increase in CPI is a symptom of inflation, not the source. It is a combined result of an increase of money supply flowing into the economy. Prices increase when more money supply chases scarcer assets. Having said that, the CPI is notoriously underreported as money supply growth is in the double digits, while CPI remains under 4%. The reason why it is underreported is another topic, but it does not match money supply growth.
So the targets above will trend higher if we take into account money supply growth--the very definition of inflation. Gold has increased almost 4-fold since 2001--another way to interpret the data is that the USDollar has been devaluated by almost 75% during that period. If that trend continues (and it looks like it will accelerate as the Fed and Treasury continue to print dollars ad nauseum to the tune of trillions of dollars), the current deflation of asset values will eventually yield to inflation--perhaps even hyperinflation.
The result will be higher taxes to pay for these government-sanction bail outs, and the debasing of the USDollar. Despite rhetoric that the government is interested in a strong USDollar, their actions speak otherwise. It makes sense because inflation is a form of taxation without legislation (Milton Friedman). It is more politically expedient to slowly, stealthily tax the population than to let unemployment increase and recessions deepen. Congressmen and the Administration aim to get re-elected. Hence the bailouts. Inflation allows the government to slowly tax the population under the radar, while at the same time, lower their massive debt obligations with deflated dollars (a $10 trillion debt becomes smaller as inflation eats into the principal). If I owe someone $10, but if 10% inflation kicks in, that debt is only $90 in today's dollars a year from now--and declines going forward. Propping up failing businesses is politically populist, but ultimately detrimental to the overall economy--it lengthened the Great Depression, and it's kept Japan's economy in decline for 19 years. It's a form of rewarding bad businesses, while taxing its productive businesses--it's misallocation of financial resources. Would you rather have GM manage your investments, or Google? Well, the government is investing in the GM's of the world--or any other industry that is insolvent, and in the process, taxing its citizens and profitable industries.
The problem is that hyperinflation reduces the purchasing power of consumers and invisibly reduces corporate profits. Our standards of living decline. These bailouts just defer and exacerbate our huge debt problems, but politically, Keynesian economics is the government's only option. We are past the point of no return, as we sink into a death debt spiral. Our financial crisis was caused by overleveraged debts gone bad, by consumers, businesses, local and state governments. Now the federal government is compounding that billion dollar problem into a trillion dollar problem (their own, in this case). That solution has never worked. When interest rates rise (they are at all-time lows), that trillion dollar debt only accelerates, forcing the government to accelerate money supply again, further debasing our currency. US Treasury bondholders, bidding up prices in a flight to safety, will get crushed when interest rates rise. The biggest buyers of said bonds--Chinese and Japanese sovereign banks and funds, will be net sellers, no longer willing to prop up our deficits, while earning 0% for the privilege. Besides, they will need to prop up their own economies. The US Treasuries market will be the last bubble to burst, and this time there will be no backstop, as the US government itself will be insolvent. The Fed can control the short end of the curve, but the long-term bond market dwarfs any government reserves, and is more influenced by market expectations of inflation, not government central bank intervention. The Fed and Treasury can only prop up 30-year T-bonds for so long, before the dam breaks. We are at the mercy of China, Japan, and the Arabic petrodollars. All 3 entities have explicitly warned the US government that they will no longer be buyers of US Treasuries. The Saudis are already in the process of creating their own exchange, creating their own currency for trading oil, as they realize their reserves denominated in USDollars have been a losing proposition. The Chinese and Japanese are also retreating in US Bond purchases. Interest rates will have to rise to attract new demand.
To look at our future, see Iceland--the country imploded, their banks froze up, as their debt exploded in a massive unwinding of leverage. The US Treasury will lose its AAA credit rating, driving up interest rates further. Eventually, the government will default, unable to meet its debt obligations. Guns and gold--if you think I am joking, ammo prices have doubled in the last year. The gold market is pausing, yet holding up while equities re-test their November lows. But once reality hits, it will rise. Not sure what the trigger event will be--another big bank failure, WWIII (Israel is discussing bombing Iran), Pakistan/India posturing, California insolvency (all State employees will start receiving IOU's next month, as California has run out of cash). Arnie has been unsuccessful with the state legislature on resolving a budget expected to be $42 billion short, and if unable to receive a Federal bailout, state employees will be unpaid).
http://www.sco.ca.gov/eo/...2008/12/pr08069letter.pdf
The 1991 riots will be like a walk in the park when cities and counties cut back on basic services like law enforcement and fire protection. I know one city in LA county has lost 60% of their detectives already--even as crime is soaring. Rape case samples are already extended out to 10 years for DNA results. I visited a coin dealer who had exactly one $20 St. Gaudens double eagle to sell. Gold bullion buyers are demanding physical delivery instead of cash settlement, causing spot prices to carry a premium above forward futures delivery contracts--the first time this has ever happened on the Comex gold futures exchange. Sure, the downside is a 30% temporary drop in price, but the upside is 100 - 800% potential upside. Not one stock mutual fund gained in 2008. Gold was the only asset class that gained last year--up 6%--and that was a bad year for gold. It was also the 8th consecutive year of gains. The Nasdaq plunged 80% after the tech bubble. The S & P lost 40% again last year. Treasury bondholders did well in a false flight to quality, but once they figure out tying up your money for 30 years yielding 2.6% is a losing proposition, they will flee that market as well. T Bills yielding 0% will prove problematic as an inflation hedge. Stocks have retreated to 1998 levels, and are headed lower. What else is left? Meanwhile, gold has already quadrupled in this decade.
The reason why financial planners and brokers (gee, they've given good advice over the years) don't advocate gold is because clients purchasing gold don't generate fees for them. Gold ETF's generate some commissions, but overall, there is no incentive for investment and commercial banks to pimp gold. Having said that, many conservative advisors do recommend clients keep 10% of their portfolio in gold bullion, preferable over paper securities (ETF's, futures contracts, gold mining shares). Storing bullion is inconvenient, but it's part of a diversification strategy. Once more people realize this, some sideline cash will be deployed to purchase precious metals, base metals, soft commodities, and dividend-yielding equities. Companies with leading market share, moat-like pricing power, strong balance sheets (loads of cash, no debt), high profit margins, and increasing dividend payouts on cash flow, will thrive in a market where access to debt is increasingly difficult.
Either way, gold will rise--it's not a matter of if, it's a matter of when. This downturn will be worse than the 1973-74 deep recession, when gold increased 2325%. I don't think it will be as bad as the Great Depression of the 30's, when we had almost 25% unemployment. Even in that deflationary environment, gold went up 69%. So if we are closer to a repeat of the Great Depression, you are right, gold may languish around the $500/oz to $1000 range , up from its 1999 low of $253. But if a full-fledged recovery occurs, a 2325% spike translates to a price of $5882. Realistically, the 1980 $850 peak, deflated in today's dollar indicates a $2400 price.
But with the accelerated debasing of the dollar in concert with other currencies, inflation is already in place. The definition of inflation is an increase in money supply, not necessarily the Consumer Price Indicator, the official government statistic. An increase in CPI is a symptom of inflation, not the source. It is a combined result of an increase of money supply flowing into the economy. Prices increase when more money supply chases scarcer assets. Having said that, the CPI is notoriously underreported as money supply growth is in the double digits, while CPI remains under 4%. The reason why it is underreported is another topic, but it does not match money supply growth.
So the targets above will trend higher if we take into account money supply growth--the very definition of inflation. Gold has increased almost 4-fold since 2001--another way to interpret the data is that the USDollar has been devaluated by almost 75% during that period. If that trend continues (and it looks like it will accelerate as the Fed and Treasury continue to print dollars ad nauseum to the tune of trillions of dollars), the current deflation of asset values will eventually yield to inflation--perhaps even hyperinflation.
The result will be higher taxes to pay for these government-sanction bail outs, and the debasing of the USDollar. Despite rhetoric that the government is interested in a strong USDollar, their actions speak otherwise. It makes sense because inflation is a form of taxation without legislation (Milton Friedman). It is more politically expedient to slowly, stealthily tax the population than to let unemployment increase and recessions deepen. Congressmen and the Administration aim to get re-elected. Hence the bailouts. Inflation allows the government to slowly tax the population under the radar, while at the same time, lower their massive debt obligations with deflated dollars (a $10 trillion debt becomes smaller as inflation eats into the principal). If I owe someone $10, but if 10% inflation kicks in, that debt is only $90 in today's dollars a year from now--and declines going forward. Propping up failing businesses is politically populist, but ultimately detrimental to the overall economy--it lengthened the Great Depression, and it's kept Japan's economy in decline for 19 years. It's a form of rewarding bad businesses, while taxing its productive businesses--it's misallocation of financial resources. Would you rather have GM manage your investments, or Google? Well, the government is investing in the GM's of the world--or any other industry that is insolvent, and in the process, taxing its citizens and profitable industries.
The problem is that hyperinflation reduces the purchasing power of consumers and invisibly reduces corporate profits. Our standards of living decline. These bailouts just defer and exacerbate our huge debt problems, but politically, Keynesian economics is the government's only option. We are past the point of no return, as we sink into a death debt spiral. Our financial crisis was caused by overleveraged debts gone bad, by consumers, businesses, local and state governments. Now the federal government is compounding that billion dollar problem into a trillion dollar problem (their own, in this case). That solution has never worked. When interest rates rise (they are at all-time lows), that trillion dollar debt only accelerates, forcing the government to accelerate money supply again, further debasing our currency. US Treasury bondholders, bidding up prices in a flight to safety, will get crushed when interest rates rise. The biggest buyers of said bonds--Chinese and Japanese sovereign banks and funds, will be net sellers, no longer willing to prop up our deficits, while earning 0% for the privilege. Besides, they will need to prop up their own economies. The US Treasuries market will be the last bubble to burst, and this time there will be no backstop, as the US government itself will be insolvent. The Fed can control the short end of the curve, but the long-term bond market dwarfs any government reserves, and is more influenced by market expectations of inflation, not government central bank intervention. The Fed and Treasury can only prop up 30-year T-bonds for so long, before the dam breaks. We are at the mercy of China, Japan, and the Arabic petrodollars. All 3 entities have explicitly warned the US government that they will no longer be buyers of US Treasuries. The Saudis are already in the process of creating their own exchange, creating their own currency for trading oil, as they realize their reserves denominated in USDollars have been a losing proposition. The Chinese and Japanese are also retreating in US Bond purchases. Interest rates will have to rise to attract new demand.
To look at our future, see Iceland--the country imploded, their banks froze up, as their debt exploded in a massive unwinding of leverage. The US Treasury will lose its AAA credit rating, driving up interest rates further. Eventually, the government will default, unable to meet its debt obligations. Guns and gold--if you think I am joking, ammo prices have doubled in the last year. The gold market is pausing, yet holding up while equities re-test their November lows. But once reality hits, it will rise. Not sure what the trigger event will be--another big bank failure, WWIII (Israel is discussing bombing Iran), Pakistan/India posturing, California insolvency (all State employees will start receiving IOU's next month, as California has run out of cash). Arnie has been unsuccessful with the state legislature on resolving a budget expected to be $42 billion short, and if unable to receive a Federal bailout, state employees will be unpaid).
http://www.sco.ca.gov/eo/...2008/12/pr08069letter.pdf
The 1991 riots will be like a walk in the park when cities and counties cut back on basic services like law enforcement and fire protection. I know one city in LA county has lost 60% of their detectives already--even as crime is soaring. Rape case samples are already extended out to 10 years for DNA results. I visited a coin dealer who had exactly one $20 St. Gaudens double eagle to sell. Gold bullion buyers are demanding physical delivery instead of cash settlement, causing spot prices to carry a premium above forward futures delivery contracts--the first time this has ever happened on the Comex gold futures exchange. Sure, the downside is a 30% temporary drop in price, but the upside is 100 - 800% potential upside. Not one stock mutual fund gained in 2008. Gold was the only asset class that gained last year--up 6%--and that was a bad year for gold. It was also the 8th consecutive year of gains. The Nasdaq plunged 80% after the tech bubble. The S & P lost 40% again last year. Treasury bondholders did well in a false flight to quality, but once they figure out tying up your money for 30 years yielding 2.6% is a losing proposition, they will flee that market as well. T Bills yielding 0% will prove problematic as an inflation hedge. Stocks have retreated to 1998 levels, and are headed lower. What else is left? Meanwhile, gold has already quadrupled in this decade.
The reason why financial planners and brokers (gee, they've given good advice over the years) don't advocate gold is because clients purchasing gold don't generate fees for them. Gold ETF's generate some commissions, but overall, there is no incentive for investment and commercial banks to pimp gold. Having said that, many conservative advisors do recommend clients keep 10% of their portfolio in gold bullion, preferable over paper securities (ETF's, futures contracts, gold mining shares). Storing bullion is inconvenient, but it's part of a diversification strategy. Once more people realize this, some sideline cash will be deployed to purchase precious metals, base metals, soft commodities, and dividend-yielding equities. Companies with leading market share, moat-like pricing power, strong balance sheets (loads of cash, no debt), high profit margins, and increasing dividend payouts on cash flow, will thrive in a market where access to debt is increasingly difficult.
Sunday, January 11, 2009
Merill Lynch's take on financial assets
Merrill Lynch has revealed that some of its richest clients are so alarmed by the state of the financial system and signs of political instability around the world that they are now insisting on the purchase of gold bars, shunning derivatives or "paper" proxies.
Rich investors are spurning gold exchange traded funds in favour of krugerrands.
Gary Dugan, the chief investment officer for the US bank, said there has been a remarkable change in sentiment. "People are genuinely worried about what the world is going to look like in 2009. It is amazing how many clients want physical gold, not ETFs," he said, referring to exchange trade funds listed in London, New York, and other bourses.
"They are so worried they want a portable asset in their house. I never thought I would be getting calls from clients saying they want a box of krugerrands," he said.
Merrill predicted that gold would soon blast through its all time-high of $1,030 an ounce, and would hit $1,150 by June.
The metal should do well whatever happens. If deflation sets in and rocks the economic system it will serve as a safe-haven, but if massive monetary stimulus gains traction and sets off inflation once again it will also come into its own as a store of value. "It's win-win either way," said Mr Dugan.
He added that deflation may prove the greater risk in coming months. "It's very difficult to get the deflation psychology out of the human brain once prices start falling. People stop buying things because they think it will be cheaper if they wait."
by Ambrose Evans-Pritchard
US Treasury bonds from a European perspective
Beijing needs the money at home in any case to prop up the Chinese economy – now in trouble. Even Japan has slipped into trade deficit.
Clearly, the US and European governments cannot rely on Asia to plug the $3.5 trillion hole in their budgets this year.
Asians are just as likely to be net sellers of their bonds. Which implies that central banks may have to "monetize" our deficits.
James Montier, from Société Générale, has examined US bonds back to 1798. Yields have never been this low before, except under war controls in the 1940s when the price was set by dictate.
That episode is not a happy precedent. The Fed drove the 10-year bond down to 2.25%, much as it is doing today with mortgage bonds. It helped America win World War Two, but ended in tears for bond holders in 1946 when inflation jumped to 18%.
Mr Montier said yields have averaged 4.5% over two centuries, with a real return of around 2%. By that benchmark, the market is now banking on a decade of deflation.
Investors have drawn a false parallel with Japan's Lost Decade, when bond yields kept falling, forgetting that Tokyo waited seven years before resorting to the printing press. Mr Bernanke has no such inhibitions. He has hit the nuclear button in advance.
"Today's yields are woefully short of the estimated fair value under normal conditions. There maybe a (short-term) speculative case for buying bonds. However, I am an investor, not a speculator," he said.
by Ambrose Evans-Pritchard
Saturday, January 10, 2009
Peter Schiff's take on the economy
Peter Schiff is one of my favorite financial minds--only because he is prescient and has called this financial crisis when it was unpopular to do so. He went against the grain against conventional "expert" wisdom, and called our economy for what it is--an over-leveraged, over-consuming, and ultimately phony "wealth effect". He absolutely was correct in his assessment. And more importantly, he laid out a plausible plan to preserve wealth and enhance returns.
Here is his latest take on the Fed bailouts and the resulting outcomes:
Mr. Schiff is president of Euro Pacific Capital and author of "The Little Book of Bull Moves in Bear Markets"
Here is his latest take on the Fed bailouts and the resulting outcomes:
January 9, 2009
The Fed’s Bubble Trouble
A few weeks ago when the Fed announced a strategy designed to bring down long-term interest and home mortgage rates through unlimited Treasury bond purchases, government debt staged a spectacular rally. To the unschooled market observer, the spike may be difficult to understand. After all, why would the value of Treasury bonds rise while their underlying credit quality is deteriorating faster than Bernie Madoff’s social schedule? The move is actually a perfect illustration of the tried and true Wall Street strategy of “buy the rumor and sell the fact”.
If it is well known that Fed will be a big purchaser of Treasuries, those buying now will be positioned to unload their holdings when the buying spree begins. If the Fed pays higher prices in the future, traders can earn riskless speculative profits. If the traders lever up their positions, as many are likely doing, even small profits can turn unto huge windfalls.
The downside of course, is that all of the demand for Treasuries is artificial. Treasuries are now in the hands of speculators looking to sell, not investors looking to hold. These players are analogous to the mid-decade condo-flippers who flocked to new developments for quick profits. They did not intend to occupy their properties, but rather flip them to future buyers. Once these properties came back on the market, condo prices collapsed, as developers were forced to compete for new sales with their former customers.
This is precisely what will happen with Treasuries. Just as the U.S. government issues mountains of new debt to finance the multi-trillion annual deficits planned by the Obama Administration, speculative holders of existing debt will be offering their bonds for sale as well. In order to prevent a complete collapse in the bond prices the Fed will be forced to significantly increase its buying.
However, since the only way the Fed can buy bonds is by printing money, the more bonds they buy the more inflation they will create. As inflation diminishes the investment value of low-yielding Treasuries, such a scenario will kick off a downward spiral. But the more active the Fed becomes in their quest to prop up bond prices, the bigger the incentive to hit the Fed’s bid. The result will be that all Treasuries sold will be purchased by the Fed. But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping, such as corporate, municipal and agency debt, to fall through the floor, pushing up interest rates across the board.
In order to “save” the economy from these high rates the Fed will then have to expand its purchases to include all forms of debt. If that happens, run-away inflation will quickly turn into hyper-inflation, and our currency will be worthless and our economy left in ruins.
To avoid this nightmare scenario, the Fed should pull out of the bond market before it’s too late and let prices fall to where real buyers, those willing to hold to maturity, re-enter the market. Given how high inflation will likely be by the time this happens, my guess is that long-term Treasury yields will have to rise well into the double digits to clear the market.
But we should know that the bursting of the bond market bubble will have even more dire consequences than the bursting of prior bubbles in stocks and real estate. Significantly higher interest rates and inflation that will result will severely compound the current problems. Imagine how much worse our economy would be if we faced double digit interest rates? In addition, not only will homeowners be confronted with record high mortgage rates, but the Government will be staring at trillion dollar annual interest payments on the national debt, making interest by far the single largest line item in the Federal budget. Just like homeowners who relied on teaser rates, the Government will face a similar problem when all its low-yielding short-term debt matures.
The grim reality of course is that when the real estate bubble burst the Government was able to “bail-out” private parties. However, when the bond market bubble bursts, it will be the U.S. Government itself that will be in need of the mother of all bailouts. If U.S. taxpayers or foreign creditors are unwilling or unable to pony up, and if the nightmare hyper-inflation scenario is to be avoided, default will be the only option. If misery really does love company, Bernie Madoff’s clients might finally find some comfort.
Mr. Schiff is president of Euro Pacific Capital and author of "The Little Book of Bull Moves in Bear Markets"
Friday, January 9, 2009
Arab Nations and Chinese looking elsewhere.
The Arab nations and the Chinese government are looking to establish their own reserve currencies. This is a clear sign that they have doubts about the US Dollar remaining the world's reserve currency. Why should they continue to accept payment in USDollars, when our currency is being debased on a daily basis?
http://tyo.ca/islambank.community/modules.php?op=modload&name=News&file=article&sid=2754&mode=thread&order=0&thold=0&POSTNUKESID=688bb45320716c1f68d3dd7df7be5c02
With the establishment of both reserve currencies, sovereign banks will look to purchase massive tonnage of gold reserves to back up their currencies.
http://tyo.ca/islambank.community/modules.php?op=modload&name=News&file=article&sid=2754&mode=thread&order=0&thold=0&POSTNUKESID=688bb45320716c1f68d3dd7df7be5c02
With the establishment of both reserve currencies, sovereign banks will look to purchase massive tonnage of gold reserves to back up their currencies.
Even former Fed Governor is calling out the Fed
Former Governor of the Federal Reserve Bank of St. Louis William Poole as soon on Bloomberg TV:
"The Fed has been encouraging the bond market to think the Fed is going to be in there supporting Treasury Bond yields. That can't be because the implications of that commitment are too simply horrendous to think about."
http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vhuS.o9XrC7E.asf
He's basically blasting his former colleagues for lack of transparency on their unprecedented balance sheet blow out. He also criticizes them on mistakenly (or deceptively) trying to artificially suppress interest rates, thus hoodwinking bond buyers into stepping up and continuing to purchase US Treasuries. There's been a dearth of buyers since last September--no buyers equals higher interest rates to attract said buyers. Hence, bond prices will reverse and melt down, much like the mortgage-backed securities market.
The US government is now the debtor of last resort, and when investors stop drinking at the trough, there will be nobody to sell our massive trillion-dollar debt to. When interest rates spike to attract reticent demand, the interest on said debt will choke our country for decades, if not generations.
Poole's colleague in the dual interview, a former member of the (Federal Open Market Committee (FOMC), even goes so far as to say the recent actions by the Fed are unconstitutional.
"The Fed has been encouraging the bond market to think the Fed is going to be in there supporting Treasury Bond yields. That can't be because the implications of that commitment are too simply horrendous to think about."
http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vhuS.o9XrC7E.asf
He's basically blasting his former colleagues for lack of transparency on their unprecedented balance sheet blow out. He also criticizes them on mistakenly (or deceptively) trying to artificially suppress interest rates, thus hoodwinking bond buyers into stepping up and continuing to purchase US Treasuries. There's been a dearth of buyers since last September--no buyers equals higher interest rates to attract said buyers. Hence, bond prices will reverse and melt down, much like the mortgage-backed securities market.
The US government is now the debtor of last resort, and when investors stop drinking at the trough, there will be nobody to sell our massive trillion-dollar debt to. When interest rates spike to attract reticent demand, the interest on said debt will choke our country for decades, if not generations.
Poole's colleague in the dual interview, a former member of the (Federal Open Market Committee (FOMC), even goes so far as to say the recent actions by the Fed are unconstitutional.
Time to look up Merriam-Webster Dictionary
Out of curiosity, I looked up the definition of "counterfeiting". According to Merriam-Webster:
counterfeit - to imitate or feign especially with intent to deceive ; also : to make a fraudulent replica of.
The Federal Reserve Bank and US Treasury are printing dollars out of thin air, at an alarming rate. They've done so repeatedly. How is this any different from counterfeiting?
In fact, since the Federal Reserved Bank was formed in 1913, the dollar has declined 97% in value. In other words, today's $1 bill is equivalent to $0.03 almost 100 years ago.
Meanwhile, an ounce of gold 5,000 years ago got you some nice threads. Today, it still enables you to get a nice suit. The US Dollar? Not sure you can get a brand new Calvin Klein suit for $15 these days.
Deficit spending is essentially government-sanctioned counterfeiting. And as Milton Friedman correctly surmised, "Inflation is taxation without legislation."
counterfeit - to imitate or feign especially with intent to deceive ; also : to make a fraudulent replica of.
The Federal Reserve Bank and US Treasury are printing dollars out of thin air, at an alarming rate. They've done so repeatedly. How is this any different from counterfeiting?
In fact, since the Federal Reserved Bank was formed in 1913, the dollar has declined 97% in value. In other words, today's $1 bill is equivalent to $0.03 almost 100 years ago.
Meanwhile, an ounce of gold 5,000 years ago got you some nice threads. Today, it still enables you to get a nice suit. The US Dollar? Not sure you can get a brand new Calvin Klein suit for $15 these days.
Deficit spending is essentially government-sanctioned counterfeiting. And as Milton Friedman correctly surmised, "Inflation is taxation without legislation."
Thursday, January 8, 2009
Contango--why this dance is important
Contango is the recent buzzword in trader's vernacular. It's basically the difference between the higher-priced futures contract and the lower-priced spot price of a commodity--like crude oil, for instance. It has recently made headlines due to the plummeting price of oil, causing the spread--or contango--to widen. Hence, big oil companies and financial institutions are taking advantage of that spread, taking immediate delivery of oil at the much lower price, and storing it for sale and future delivery at the higher price (less storage, security, and insurance costs). In doing so, they've basically locked in a guaranteed profit via the contango trade. Fundamentally, a contango exists in normal market conditions, but it's been in the news lately due to its uncommonly wide spread.
But contango's antithesis--backwardation--has quietly made some news in the precious metals market (I glossed over it last month). In a contango, the spot price is lower than the forward futures contract. However, with backwardation, the opposite is true: the spot delivery price is HIGHER than the forward futures contract. How can that be? After all, doesn't taking immediately delivery incur additional inventory costs (as described above)? To answer that, let's perform a quick anatomy on the gold market, and compare it to crude oil.
On December 2, 2008, for the first time in the history of mankind, gold reached backwardation. Gold is predominantly not a consumable asset, but is stored mostly in vaults at central banks, commercial money centers, private banks, etc. Hence, it is almost always in contango. On that date, COMEX spot prices for gold were higher than December gold futures, for December 31 delivery. Backwardation exists because of perceived scarcity, which causes investors to pay a premium for guaranteed delivery. In other words, buyers insist on delivery, instead of cash settlements. By contrast, a contango exists when there is perceived oversupply, which is normally bearish when you consider demand/supply dynamics. For instance, prior to oil's meteoric peak at $147 a barrel, a contango formed, precursing the huge decline to its present levels in the $40's.
Gold, on the other hand, is not consumable, so has been in contango into perpetuity. That is, until December 2nd. Gold's backwardation is the inverse of crude oil's 2008 contango, and subsequent precipitous decline--all you'd have to do is turn the chart upside down. Therefore, backwardation--especially for gold, as it has never occurred before--has the opposite effect—and is extremely bullish for gold. In fact, crude oil had its own backwardation in 2007, foretelling its parabolic run up in price into the summer of 2008. Backwardation reflects scarcity at current price levels, and is an indicator that gold will continue its secular bull market.
Ludwig von Mises--why you should know him
The great Austrian School Economist, Ludwig von Mises wrote, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
In other words, Mises, unlike the followers of economist John Maynard Keynes, is of the opinion that governments (and central banks) should stop trying to interfere with market forces. Government intervention via fiscal and monetary policy cannot "control" markets, and cannot prevent booms or busts--they occur naturally, and hence, should be allowed to run their course. All intervention will do is compound and exacerbate said credit expansions and subsequent busts. In other words, they not only create bubbles--they make them bigger, and when they pop, they create bigger busts.
Obama, as bright and insightful as he is, is naturally bending to human nature--the consensus is to solve this huge private, corporation, and institutional debt crisis by replacing it with much larger government debt. In other words, we are compounding a billion dollar debt problem into a trillion dollar debt problem.
While stimulative short-term (public and private works, for instance), it is detrimental long-term, as our generation and future generations are saddled with huge debts and high taxation. Despite cosmetic rhetoric, we are merely deferring out debts into the future, letting them compound at an alarming rate.
The resulting inflation reduces that debt amount into the future, but inflation also punishes savers and investors. Eventually, investors will demand higher rates of return. The combination of capital flooding the markets, and said capital chasing fewer resources (commodities, crops, oil, basic metals, and precious metals), will also cause interest rates to rise.
Inflation is the furthest worry of policymakers and the general public right now, but it will eventually rear its ugly head.
In the immortal words of the recently mortal Milton Friedman: "Inflation is taxation without legislation."
In other words, Mises, unlike the followers of economist John Maynard Keynes, is of the opinion that governments (and central banks) should stop trying to interfere with market forces. Government intervention via fiscal and monetary policy cannot "control" markets, and cannot prevent booms or busts--they occur naturally, and hence, should be allowed to run their course. All intervention will do is compound and exacerbate said credit expansions and subsequent busts. In other words, they not only create bubbles--they make them bigger, and when they pop, they create bigger busts.
Obama, as bright and insightful as he is, is naturally bending to human nature--the consensus is to solve this huge private, corporation, and institutional debt crisis by replacing it with much larger government debt. In other words, we are compounding a billion dollar debt problem into a trillion dollar debt problem.
While stimulative short-term (public and private works, for instance), it is detrimental long-term, as our generation and future generations are saddled with huge debts and high taxation. Despite cosmetic rhetoric, we are merely deferring out debts into the future, letting them compound at an alarming rate.
The resulting inflation reduces that debt amount into the future, but inflation also punishes savers and investors. Eventually, investors will demand higher rates of return. The combination of capital flooding the markets, and said capital chasing fewer resources (commodities, crops, oil, basic metals, and precious metals), will also cause interest rates to rise.
Inflation is the furthest worry of policymakers and the general public right now, but it will eventually rear its ugly head.
In the immortal words of the recently mortal Milton Friedman: "Inflation is taxation without legislation."
Wednesday, January 7, 2009
Countdown to Armageddon in California
Unlike the Federal government, California cannot print its own currency. The trouble starts next month.
SOURCE: Los Angeles Times
Faced with a mounting budget gap and failed negotiations toward a solution, California may have to send out promissory notes to taxpayers owed refunds and local governments, the Los Angeles Times reports. Talks between Gov. Arnold Schwarzenegger and the Democratic legislature foundered yesterday; lawmakers sent the governor a disputed package of tax hikes and service cuts, which he promptly vetoed.
With the deficit forecast at $41.6 billion by next year, California could next month begin mailing IOUs, which look like checks but are not cashable due to “want of funds.” The bill Schwarzenegger vetoed includes many measures agreed upon previously, but the sides could not reach consensus. “The governor cannot ward off Armageddon if he keeps moving the goal posts,” one lawmaker said.
SOURCE: Los Angeles Times
Treasury Bonds tanking
Today was a watershed event in my eyes. Despite the feel-good moment the media and powers-that-be are trying to portray with today's presidential lunch, the markets reacted very unfavorably to Paulson's semi-admission that we are not out of the woods yet. For those that follow fixed-income markets (which is much bigger than the equities market, and hence, much more foretelling), the Treasuries bubble has burst, and the Fed and Treasury will no longer be able to influence the long end (30-year bonds). They have dropped short-term interest rates as low as they could, but the long-end is mostly market-driven. Buyers of bonds believe inflation will be muted going forward (either 10, 20, or 30 years). Sellers of bonds believe inflation will erode their returns. Mistakenly, bond buyers also believe they are safe havens. The future will prove this assumption false, as bond prices are subject to the soundness of the currency, inflation expectations, and supply/demand of said Treasuries.
Once the market figures out (and it eventually will) that the USDollar is about to be a toilet paper currency, they will demand higher rates of return, driving up interest rates--and basically undoing what the Fed and Treasury have worked so hard to do--lower long rates to reduce mortgage rates, and stabilize the housing market (hopefully). In other words, the gov't can only do so much--and artifically keep long rates down for only so long. The dam will eventually break, rates will soar, as will inflation eventually. The bottom line is that the Chinese and Japanese will no longer support the US deficit (our funding needs are in the trillions) and stop buying our Treasury bonds, as they retrench and try to stimulate their own economies. In other words, buyers at our huge debt financing auctions will be scarce. This is the final bubble bursting, and this time, no one will be able to step in to prop it up.
Anybody who lived thru the 70's knows how ravaging high interest rates are. To be honest, I've been shorting T bonds for a couple weeks, and with Barron's article over the weekend proclaiming the same, I actually have more conviction, as Barron's is one of the few prescient mediums. Gold is still in a secular bull market, but it is taking a necessary pause due to deflationary concerns. But even the Fed and Paulson are acknowledging the long-term risks of what they are doing--they just can't help themselves as they fear the mother of Depressions. Problem is, they are only delaying it, and exacerbating it with their monetary and quantitative easing (providing credit and injecting capital).
Despite periodic snapback rallies, we are in for a different era--and it's not going to be pretty. We are in for several years of deleveraging, with markets moving sideways with a downward bias. Gold and silver will continue their secular bull market.
I have incorporated a wave investment thesis, and firmly believe big asset moves occur approximately every 20 years. It's uncanny, and there is a reason for it: investing is generational. We have lost a whole generation of investors who will never touch stocks again, due to scandals, crises, TWO stock market bubbles, fraud, and most of all, LOST money and lost confidence that buy and hold works. They've seen their grandparents' retirement savings dissipate overnite, their parents lose their jobs, and their own job prospects bleaker than ever. THIS OCCURRED IN THE LATE60'S/EARLY 70'S, USHERING IN A DECADE OF DOLDRUMS! The former Nifty Fifty stocks collapsed, and I recall my dad's friends declaring they will never invest in stocks again. They were justified--until the 1982 bottom, when smart investors eased back into stocks, while the general public was shunning them. Previous false rallies were met with shunted resistance, causing the last bulls to throw in the towel.
A bottom was only formed because Volker said enough is enough, and raised interest rates into double digits (money market accounts were earning 12-13%!). Mortgage interest rates were 15%, because Volker shook out the excesses, and then ushered in lowered rates.
So given that this bear market began in 2000 with the tech bust, we've got another 8-10 years of crappy returns, with sawtooth volatility and sucker rallies. Warren Buffett himself warned of this 8 years ago, as he said investors needed to lower their expectations of equities going forward. Remember: between 1982-2000, stocks had their best run EVER! (Unfortunately, the average investor only earned 2.3% per annum during that span, as they are horrible market timers).
In fact, the only asset that gained in the 70's was our friend gold. I have no idea of the timing, but it is coming. Shorter-term, I'm already up 40% on my short T-bond trade (it's a double-short ETF) in a week. Despite further attempts to prop up bond prices, eventually the avalanche of sellers, and lack of buyers will usurp any attempts to prop up the US bond market.
Once the market figures out (and it eventually will) that the USDollar is about to be a toilet paper currency, they will demand higher rates of return, driving up interest rates--and basically undoing what the Fed and Treasury have worked so hard to do--lower long rates to reduce mortgage rates, and stabilize the housing market (hopefully). In other words, the gov't can only do so much--and artifically keep long rates down for only so long. The dam will eventually break, rates will soar, as will inflation eventually. The bottom line is that the Chinese and Japanese will no longer support the US deficit (our funding needs are in the trillions) and stop buying our Treasury bonds, as they retrench and try to stimulate their own economies. In other words, buyers at our huge debt financing auctions will be scarce. This is the final bubble bursting, and this time, no one will be able to step in to prop it up.
Anybody who lived thru the 70's knows how ravaging high interest rates are. To be honest, I've been shorting T bonds for a couple weeks, and with Barron's article over the weekend proclaiming the same, I actually have more conviction, as Barron's is one of the few prescient mediums. Gold is still in a secular bull market, but it is taking a necessary pause due to deflationary concerns. But even the Fed and Paulson are acknowledging the long-term risks of what they are doing--they just can't help themselves as they fear the mother of Depressions. Problem is, they are only delaying it, and exacerbating it with their monetary and quantitative easing (providing credit and injecting capital).
Despite periodic snapback rallies, we are in for a different era--and it's not going to be pretty. We are in for several years of deleveraging, with markets moving sideways with a downward bias. Gold and silver will continue their secular bull market.
I have incorporated a wave investment thesis, and firmly believe big asset moves occur approximately every 20 years. It's uncanny, and there is a reason for it: investing is generational. We have lost a whole generation of investors who will never touch stocks again, due to scandals, crises, TWO stock market bubbles, fraud, and most of all, LOST money and lost confidence that buy and hold works. They've seen their grandparents' retirement savings dissipate overnite, their parents lose their jobs, and their own job prospects bleaker than ever. THIS OCCURRED IN THE LATE60'S/EARLY 70'S, USHERING IN A DECADE OF DOLDRUMS! The former Nifty Fifty stocks collapsed, and I recall my dad's friends declaring they will never invest in stocks again. They were justified--until the 1982 bottom, when smart investors eased back into stocks, while the general public was shunning them. Previous false rallies were met with shunted resistance, causing the last bulls to throw in the towel.
A bottom was only formed because Volker said enough is enough, and raised interest rates into double digits (money market accounts were earning 12-13%!). Mortgage interest rates were 15%, because Volker shook out the excesses, and then ushered in lowered rates.
So given that this bear market began in 2000 with the tech bust, we've got another 8-10 years of crappy returns, with sawtooth volatility and sucker rallies. Warren Buffett himself warned of this 8 years ago, as he said investors needed to lower their expectations of equities going forward. Remember: between 1982-2000, stocks had their best run EVER! (Unfortunately, the average investor only earned 2.3% per annum during that span, as they are horrible market timers).
In fact, the only asset that gained in the 70's was our friend gold. I have no idea of the timing, but it is coming. Shorter-term, I'm already up 40% on my short T-bond trade (it's a double-short ETF) in a week. Despite further attempts to prop up bond prices, eventually the avalanche of sellers, and lack of buyers will usurp any attempts to prop up the US bond market.
Monday, January 5, 2009
Commentary from Peter Schiff in the Wall Street Journal
There's No Pain-Free Cure for Recession: Peter Schiff's Editorial in The Wall Street Journal
As recession fears cause the nation to embrace greater state control of the economy and unimaginable federal deficits, one searches in vain for debate worthy of the moment. Where there should be an historic clash of ideas, there is only blind resignation and an amorphous queasiness that we are simply sweeping the slouching beast under the rug.
With faith in the free markets now taking a back seat to fear and expediency, nearly the entire political spectrum agrees that the federal government must spend whatever amount is necessary to stabilize the housing market, bail out financial firms, liquefy the credit markets, create jobs and make the recession as shallow and brief as possible. The few who maintain free-market views have been largely marginalized.
Taking the theories of economist John Maynard Keynes as gospel, our most highly respected contemporary economists imagine a complex world in which economics at the personal, corporate and municipal levels are governed by laws far different from those in effect at the national level.
Individuals, companies or cities with heavy debt and shrinking revenues instinctively know that they must reduce spending, tighten their belts, pay down debt and live within their means. But it is axiomatic in Keynesianism that national governments can create and sustain economic activity by injecting printed money into the financial system. In their view, absent the stimuli of the New Deal and World War II, the Depression would never have ended.
On a gut level, we have a hard time with this concept. There is a vague sense of smoke and mirrors, of something being magically created out of nothing. But economics, we are told, is complicated.
It would be irresponsible in the extreme for an individual to forestall a personal recession by taking out newer, bigger loans when the old loans can't be repaid. However, this is precisely what we are planning on a national level.
I believe these ideas hold sway largely because they promise happy, pain-free solutions. They are the economic equivalent of miracle weight-loss programs that require no dieting or exercise. The theories permit economists to claim mystic wisdom, governments to pretend that they have the power to dispel hardship with the whir of a printing press, and voters to believe that they can have recovery without sacrifice.
As a follower of the Austrian School of economics I believe that market forces apply equally to people and nations. The problems we face collectively are no different from those we face individually. Belt tightening is required by all, including government.
Governments cannot create but merely redirect. When the government spends, the money has to come from somewhere. If the government doesn't have a surplus, then it must come from taxes. If taxes don't go up, then it must come from increased borrowing. If lenders won't lend, then it must come from the printing press, which is where all these bailouts are headed. But each additional dollar printed diminishes the value those already in circulation. Something cannot be effortlessly created from nothing.
Similarly, any jobs or other economic activity created by public-sector expansion merely comes at the expense of jobs lost in the private sector. And if the government chooses to save inefficient jobs in select private industries, more efficient jobs will be lost in others. As more factors of production come under government control, the more inefficient our entire economy becomes. Inefficiency lowers productivity, stifles competitiveness and lowers living standards.
If we look at government market interventions through this pragmatic lens, what can we expect from the coming avalanche of federal activism?
By borrowing more than it can ever pay back, the government will guarantee higher inflation for years to come, thereby diminishing the value of all that Americans have saved and acquired. For now the inflationary tide is being held back by the countervailing pressures of bursting asset bubbles in real estate and stocks, forced liquidations in commodities, and troubled retailers slashing prices to unload excess inventory. But when the dust settles, trillions of new dollars will remain, chasing a diminished supply of goods. We will be left with 1970s-style stagflation, only with a much sharper contraction and significantly higher inflation.
The good news is that economics is not all that complicated. The bad news is that our economy is broken and there is nothing the government can do to fix it. However, the free market does have a cure: it's called a recession, and it's not fun, easy or quick. But if we put our faith in the power of government to make the pain go away, we will live with the consequences for generations.
As recession fears cause the nation to embrace greater state control of the economy and unimaginable federal deficits, one searches in vain for debate worthy of the moment. Where there should be an historic clash of ideas, there is only blind resignation and an amorphous queasiness that we are simply sweeping the slouching beast under the rug.
With faith in the free markets now taking a back seat to fear and expediency, nearly the entire political spectrum agrees that the federal government must spend whatever amount is necessary to stabilize the housing market, bail out financial firms, liquefy the credit markets, create jobs and make the recession as shallow and brief as possible. The few who maintain free-market views have been largely marginalized.
Taking the theories of economist John Maynard Keynes as gospel, our most highly respected contemporary economists imagine a complex world in which economics at the personal, corporate and municipal levels are governed by laws far different from those in effect at the national level.
Individuals, companies or cities with heavy debt and shrinking revenues instinctively know that they must reduce spending, tighten their belts, pay down debt and live within their means. But it is axiomatic in Keynesianism that national governments can create and sustain economic activity by injecting printed money into the financial system. In their view, absent the stimuli of the New Deal and World War II, the Depression would never have ended.
On a gut level, we have a hard time with this concept. There is a vague sense of smoke and mirrors, of something being magically created out of nothing. But economics, we are told, is complicated.
It would be irresponsible in the extreme for an individual to forestall a personal recession by taking out newer, bigger loans when the old loans can't be repaid. However, this is precisely what we are planning on a national level.
I believe these ideas hold sway largely because they promise happy, pain-free solutions. They are the economic equivalent of miracle weight-loss programs that require no dieting or exercise. The theories permit economists to claim mystic wisdom, governments to pretend that they have the power to dispel hardship with the whir of a printing press, and voters to believe that they can have recovery without sacrifice.
As a follower of the Austrian School of economics I believe that market forces apply equally to people and nations. The problems we face collectively are no different from those we face individually. Belt tightening is required by all, including government.
Governments cannot create but merely redirect. When the government spends, the money has to come from somewhere. If the government doesn't have a surplus, then it must come from taxes. If taxes don't go up, then it must come from increased borrowing. If lenders won't lend, then it must come from the printing press, which is where all these bailouts are headed. But each additional dollar printed diminishes the value those already in circulation. Something cannot be effortlessly created from nothing.
Similarly, any jobs or other economic activity created by public-sector expansion merely comes at the expense of jobs lost in the private sector. And if the government chooses to save inefficient jobs in select private industries, more efficient jobs will be lost in others. As more factors of production come under government control, the more inefficient our entire economy becomes. Inefficiency lowers productivity, stifles competitiveness and lowers living standards.
If we look at government market interventions through this pragmatic lens, what can we expect from the coming avalanche of federal activism?
By borrowing more than it can ever pay back, the government will guarantee higher inflation for years to come, thereby diminishing the value of all that Americans have saved and acquired. For now the inflationary tide is being held back by the countervailing pressures of bursting asset bubbles in real estate and stocks, forced liquidations in commodities, and troubled retailers slashing prices to unload excess inventory. But when the dust settles, trillions of new dollars will remain, chasing a diminished supply of goods. We will be left with 1970s-style stagflation, only with a much sharper contraction and significantly higher inflation.
The good news is that economics is not all that complicated. The bad news is that our economy is broken and there is nothing the government can do to fix it. However, the free market does have a cure: it's called a recession, and it's not fun, easy or quick. But if we put our faith in the power of government to make the pain go away, we will live with the consequences for generations.
Saturday, January 3, 2009
At least the Chinese government is warning us
BEIJING (AFP) – China warned Wednesday it would not keep lending money to the US economy indefinitely, even as new data showed it had consolidated its position as the top buyer of American government bonds.
"China's increased purchase of US Treasury securities should not be interpreted as an endorsement of the assumption that the US can borrow its way out of the current financial crisis," the China Daily said in an editorial.
The warning from the state-run newspaper, an English-language daily that mainly addresses a foreign audience, came after the US Treasury Department reported a steep increase in Chinese holding of US Treasury bonds.
China held 652.9 billion dollars of US Treasury bonds at the end of October, up 11.2 percent from 587 billion dollars a month earlier, when China became the largest creditor ahead of Japan, according to the data released Tuesday.
Japan remained in second place, with total holdings of 585.5 billion dollars at the end of October.
The China Daily said that, given the global economic crisis , the consequences would be serious if China and other nations stopped channelling money into the US economy.
"Interest rates in the US would rise to undermine that government's efforts to bailout distressed financial institutions and companies," it said.
China was also constrained by a lack of other places to put its money, according to the paper.
"With few options to invest its increasing reserves safely and profitably, China may thus have to buy more US Treasury securities in spite of growing domestic skepticism that such purchases may incur huge losses later," it said.
However, as China and other nations help prop up the US economy, the United States should use the window of opportunity to undertake necessary reforms, the China Daily said.
"The current strong foreign appetite should not be taken by the US government as solid proof of the long-term value of its Treasury bonds," it said.
"Instead, it should race against time to undertake painful but critical reforms to revive its economy before such demand peaks any time soon."
"China's increased purchase of US Treasury securities should not be interpreted as an endorsement of the assumption that the US can borrow its way out of the current financial crisis," the China Daily said in an editorial.
The warning from the state-run newspaper, an English-language daily that mainly addresses a foreign audience, came after the US Treasury Department reported a steep increase in Chinese holding of US Treasury bonds.
China held 652.9 billion dollars of US Treasury bonds at the end of October, up 11.2 percent from 587 billion dollars a month earlier, when China became the largest creditor ahead of Japan, according to the data released Tuesday.
Japan remained in second place, with total holdings of 585.5 billion dollars at the end of October.
The China Daily said that, given the global economic crisis , the consequences would be serious if China and other nations stopped channelling money into the US economy.
"Interest rates in the US would rise to undermine that government's efforts to bailout distressed financial institutions and companies," it said.
China was also constrained by a lack of other places to put its money, according to the paper.
"With few options to invest its increasing reserves safely and profitably, China may thus have to buy more US Treasury securities in spite of growing domestic skepticism that such purchases may incur huge losses later," it said.
However, as China and other nations help prop up the US economy, the United States should use the window of opportunity to undertake necessary reforms, the China Daily said.
"The current strong foreign appetite should not be taken by the US government as solid proof of the long-term value of its Treasury bonds," it said.
"Instead, it should race against time to undertake painful but critical reforms to revive its economy before such demand peaks any time soon."
Friday, January 2, 2009
Bear Market Rally
Be careful--the equities market tanked 50%, already discounting all the bad news. It could test its lows again in the first quarter, but my long positions are doing quite well. Don't get caught up in the gloom and doom that's being reported. You should have been gloomy and doomy last year--before asset values plummeted thru the floor.
Again, employment and economic stats are retroactive--markets are forward-thinking. For instance, the government declared we were in a recession a year after the fact, when the markets clearly indicated we were already deep into one the year before. As usual, investing on what the government SAYS leads to disaster; it is more fruitful to invest on what the government DOES. And right now, they are printing our way towards inflation, due fears of deflation. The outrage is the pending inflation, dampening our savings and raising our cost of living (and killing our standard of living). Inflation is a "quiet" tax that the public ignores because it is slow and insiduous. But the Fed knows it can generally get away with it, especially if it creates jobs. So they drive us further into debt, when monetized debt was what goes us into trouble in the first place.
That's why oil and other commodities are soaring off their lows. And that's why T bond yields are bouncing off their bottom. As I mentioned last week, I shorted T bonds (I'm betting on interest rates rising), and it's paid off already. I've found a timing indicator which has proven uncanny, but my fundamental and subjective analysis has to be intact first. I won't just trade off of my technical charts, but I will use them to confirm my entry point into a trade.
Wall St. has an ongoing debate between the technicals (guys who strictly rely on reading price, volume and momentum charts) and guys who only do fundamental analysis (value guys like Buffett). I say do both. If my fundamental analysis tells me to either go long or short, I will read the charts before l pull the trigger. In general, the fundamental guys do better long-term, even if they mistime their entries. Buffett pulled the trigger too early, and hence is down 30% since his recent buys, but he can afford to wait it out 10 years.
Day traders try for incremental gains, which I find hard to achieve, because you have to repeat it many times. I swing trade, looking for reversals and big moves. I can be early too, but I am exercising more discipline and patience, waiting for my targets to hit their price points, and once they reverse their trend, I pile in. No one can capture the exact inflection points, but if you are close enough, you'll be able to catch the majority of the next big move up or down.
For instance, short term T bills are yielding 0%. I consider that situation unsustainable long-term. I don't know when or how hard rates will go up, but they will at some point. I'm not shorting them because the Fed can 100% influence short-term rates by setting the Fed funds rate.
The long end of the curve (30-year T Bonds) is a different animal. They also touched all-time highs, yielding an all-time low 2.5% recently. The Fed cannot control these rates--they are market-driven, and thus depend on market participants' forecast on inflation. When inflation goes up, long-term rates go up. Right now, the bet is that deflation will be upon us for the next dozen years, similar to the Great Depression. I say hogwash--because the Fed and Treasury are making sure that doesn't happen as they liquefy the markets with credit and tons of capital.
Once investors (mostly foreign) figure out tying up their money for 30 years at 2.5% is a poor investment, they will pour out of them en masse. Right now, everything else around them has collapsed, so they are fleeing INTO US Treasuries, but once they figure out other assets have a better chance of appreciating, they will vote with their dollars OUT of T Bonds, and into equities, commodities, and precious metals.
The bond (fixed-income) market is twice the size of equities, and dwarfs the commodities market. So any small change in asset allocation into equities and commodities has a levered effect on the latter--that's why you see such violent volatility in stocks and commodities (more so in commodities). Oil is up 30% from its lows already, while the prevailing public opinion is that filling up their tanks is still really cheap compared to last year. You ask the average person off the streets about the price of oil, and they'll tell you they're happy that gas prices are low. However, as a trader, if you were short oil, you would have been killed, due to the recent price spike and leverage.
That's why I ask people all the time what their opinions are on certain financial assets. I'll inevitably go against them. They are understandably bearish on stocks after the 50% haircut, while equities have started their bear market rally (the rally is unsustainable due to rotten earnings). As you know, and it's been documented, gold mining shares are up 100%, even as people consider golf a barbaric relic. I'm considering pulling some off the table to lock in profits, and have already purchased long-term call options to capture the next big move up later this year, in case gold stalls and consolidates, before resuming its incline.
But Treasuries are a screaming sell right now, assuming we don't go into Great Depression mode, resplendent with 25% unemployment. It could happen, but the probabilities are getting smaller with each printed dollar. Until then, the big move up is interest rates, commodities, and even some stocks (high cash, cash flow, market share monopoly, no debt, and a dividend if possible)...and the big move down is T-Bonds. Precious metals should resume their increase, but like I said, I've captured the big move, so I expect a pause.
So I've got the direction on certain assets down, but I am refining my market timing. These are understandably proprietary, because if everyone catches wind of it, it will arbitraged out, and I will have no longer have a competitive advantage. That's another reason why you want to be careful about bubbleheads on TV--they're not all idiots. If it's an economist or some "pundit", they probably really are stupid--or more accurately, smart, but wrong-way Corrigans. But if the guy has a stellar track record (ie he's a billionaire trader), and keeps a low profile, he may throw people off his tracks by design.
For instance, he may tell people he's selling wheat, hoping the wheat futures tank, all the while buying up the physical inventory at a lower price. That's one more reason why following CNBC of Fox business news is not only useless, it is potentially disastrous. Unless, of course, you use it as a confirming contrarian indicator.
Greg
Again, employment and economic stats are retroactive--markets are forward-thinking. For instance, the government declared we were in a recession a year after the fact, when the markets clearly indicated we were already deep into one the year before. As usual, investing on what the government SAYS leads to disaster; it is more fruitful to invest on what the government DOES. And right now, they are printing our way towards inflation, due fears of deflation. The outrage is the pending inflation, dampening our savings and raising our cost of living (and killing our standard of living). Inflation is a "quiet" tax that the public ignores because it is slow and insiduous. But the Fed knows it can generally get away with it, especially if it creates jobs. So they drive us further into debt, when monetized debt was what goes us into trouble in the first place.
That's why oil and other commodities are soaring off their lows. And that's why T bond yields are bouncing off their bottom. As I mentioned last week, I shorted T bonds (I'm betting on interest rates rising), and it's paid off already. I've found a timing indicator which has proven uncanny, but my fundamental and subjective analysis has to be intact first. I won't just trade off of my technical charts, but I will use them to confirm my entry point into a trade.
Wall St. has an ongoing debate between the technicals (guys who strictly rely on reading price, volume and momentum charts) and guys who only do fundamental analysis (value guys like Buffett). I say do both. If my fundamental analysis tells me to either go long or short, I will read the charts before l pull the trigger. In general, the fundamental guys do better long-term, even if they mistime their entries. Buffett pulled the trigger too early, and hence is down 30% since his recent buys, but he can afford to wait it out 10 years.
Day traders try for incremental gains, which I find hard to achieve, because you have to repeat it many times. I swing trade, looking for reversals and big moves. I can be early too, but I am exercising more discipline and patience, waiting for my targets to hit their price points, and once they reverse their trend, I pile in. No one can capture the exact inflection points, but if you are close enough, you'll be able to catch the majority of the next big move up or down.
For instance, short term T bills are yielding 0%. I consider that situation unsustainable long-term. I don't know when or how hard rates will go up, but they will at some point. I'm not shorting them because the Fed can 100% influence short-term rates by setting the Fed funds rate.
The long end of the curve (30-year T Bonds) is a different animal. They also touched all-time highs, yielding an all-time low 2.5% recently. The Fed cannot control these rates--they are market-driven, and thus depend on market participants' forecast on inflation. When inflation goes up, long-term rates go up. Right now, the bet is that deflation will be upon us for the next dozen years, similar to the Great Depression. I say hogwash--because the Fed and Treasury are making sure that doesn't happen as they liquefy the markets with credit and tons of capital.
Once investors (mostly foreign) figure out tying up their money for 30 years at 2.5% is a poor investment, they will pour out of them en masse. Right now, everything else around them has collapsed, so they are fleeing INTO US Treasuries, but once they figure out other assets have a better chance of appreciating, they will vote with their dollars OUT of T Bonds, and into equities, commodities, and precious metals.
The bond (fixed-income) market is twice the size of equities, and dwarfs the commodities market. So any small change in asset allocation into equities and commodities has a levered effect on the latter--that's why you see such violent volatility in stocks and commodities (more so in commodities). Oil is up 30% from its lows already, while the prevailing public opinion is that filling up their tanks is still really cheap compared to last year. You ask the average person off the streets about the price of oil, and they'll tell you they're happy that gas prices are low. However, as a trader, if you were short oil, you would have been killed, due to the recent price spike and leverage.
That's why I ask people all the time what their opinions are on certain financial assets. I'll inevitably go against them. They are understandably bearish on stocks after the 50% haircut, while equities have started their bear market rally (the rally is unsustainable due to rotten earnings). As you know, and it's been documented, gold mining shares are up 100%, even as people consider golf a barbaric relic. I'm considering pulling some off the table to lock in profits, and have already purchased long-term call options to capture the next big move up later this year, in case gold stalls and consolidates, before resuming its incline.
But Treasuries are a screaming sell right now, assuming we don't go into Great Depression mode, resplendent with 25% unemployment. It could happen, but the probabilities are getting smaller with each printed dollar. Until then, the big move up is interest rates, commodities, and even some stocks (high cash, cash flow, market share monopoly, no debt, and a dividend if possible)...and the big move down is T-Bonds. Precious metals should resume their increase, but like I said, I've captured the big move, so I expect a pause.
So I've got the direction on certain assets down, but I am refining my market timing. These are understandably proprietary, because if everyone catches wind of it, it will arbitraged out, and I will have no longer have a competitive advantage. That's another reason why you want to be careful about bubbleheads on TV--they're not all idiots. If it's an economist or some "pundit", they probably really are stupid--or more accurately, smart, but wrong-way Corrigans. But if the guy has a stellar track record (ie he's a billionaire trader), and keeps a low profile, he may throw people off his tracks by design.
For instance, he may tell people he's selling wheat, hoping the wheat futures tank, all the while buying up the physical inventory at a lower price. That's one more reason why following CNBC of Fox business news is not only useless, it is potentially disastrous. Unless, of course, you use it as a confirming contrarian indicator.
Greg
Thursday, January 1, 2009
Who is shorting gold?
Regarding the gold shorts, I've read JP Morgan, HSBC, and Goldman Sachs were shorting gold futures, artificially driving the price down, while at the same time hoarding the physical bullion on the spot market at a lower price. Ironically, JPMorgan Chase and Citigroup analysts are forecasting $2000/oz gold. Looks like manipulation, especially when you factor in a ten-fold increase in short positions. Someone on the inside knew what was going on with Fed easing and tightening.
I'm not sure if it was just big money centers--I think some of the commercial shorts were mining companies themselves. If they short it and the price plummets, they've locked in a profit as the short contracts increase in value when gold declines in price. That's why gold producers use it as a hedge in the case of falling gold prices. If they sell short the futures contracts, and prices rise against them, they are forced to cover at a higher price, but then their gold inventory also increases in value, negating the loss from short sale. In other words, they profit either way--as long as they have the gold in inventory. Without said inventory, they are "naked" and must realize the losses within 5 days--or until they deliver the physical product.
If indeed manipulation is going on, it is not only illegal, it will not be sustainable. Eventually, the Fed won't be able to save the shorts, as physical bullion becomes even scarcer, and buyers insist on delivery, instead of some "shadow" paper delivery against some vault. Gold experienced backwardation for the first time ever in December--the spot price was higher than the forward contracts. In other words, buyers wanted delivery NOW--and would not sell at ANY price, as fear has gripped the markets. Under normal conditions, a contango exists, where forward contracts command higher prices. I think this backwardation is very bullish for gold, and the fact that mints are out of inventory is indicative of that.
Also, I've read statistics where central banks, especially in Europe, are no longer selling their gold inventory. If the Chinese government steps up and purchases tons of gold like they have threatened (their ratios are much lower than the US's and Europe's), that will absorb inventory and drive prices higher also. And India is already the world's largest buyer of gold, up to 20%. With the Pakistan thing going on, I can't imagine them wanting more rupees, instead of gold, which has become the de facto currency.
Bottom line: MV = GDP, and as long as the Fed provides easy credit (interest rates can't get much lower than 0%), and as long as the Treasury prints trillions of dollars, the money supply M will be poised to catalyze inflation. But once the velocity V of capital flows thru the economy, it will provide the stimulus our economy needs, but potentially kicking off hyperinflation. In other words, once bank balance sheets have been restored, they will start lending again. We would have avoided another Great Depression, but God helps us when we get runaway inflation a la the 70's. Having an extra $8 trillion floating around in our economy will prove inflationary, and interest rates will soar. Treasury bondholders with longer maturities will get crushed, as the Fed can only influence short-term maturities (T bills). With higher interest rates, the government won't be able to pay off its huge debt obligations, and we'll have stagnant growth for years. We are experiencing a credit crisis because investment and commercial banks are insolvent. When the markets realize the US government is also insolvent, all hell will break loose. The government has compounded a multi-billion-dollar debt crisis into a multi-trillion debt crisis.
I hope I'm wrong in this logic chain, but this playbook has been repeated many times before when fiat currencies are under attack by central banks. I just don't see any other outcome when your debt is almost as large as the size of your economy.
I'm not sure if it was just big money centers--I think some of the commercial shorts were mining companies themselves. If they short it and the price plummets, they've locked in a profit as the short contracts increase in value when gold declines in price. That's why gold producers use it as a hedge in the case of falling gold prices. If they sell short the futures contracts, and prices rise against them, they are forced to cover at a higher price, but then their gold inventory also increases in value, negating the loss from short sale. In other words, they profit either way--as long as they have the gold in inventory. Without said inventory, they are "naked" and must realize the losses within 5 days--or until they deliver the physical product.
If indeed manipulation is going on, it is not only illegal, it will not be sustainable. Eventually, the Fed won't be able to save the shorts, as physical bullion becomes even scarcer, and buyers insist on delivery, instead of some "shadow" paper delivery against some vault. Gold experienced backwardation for the first time ever in December--the spot price was higher than the forward contracts. In other words, buyers wanted delivery NOW--and would not sell at ANY price, as fear has gripped the markets. Under normal conditions, a contango exists, where forward contracts command higher prices. I think this backwardation is very bullish for gold, and the fact that mints are out of inventory is indicative of that.
Also, I've read statistics where central banks, especially in Europe, are no longer selling their gold inventory. If the Chinese government steps up and purchases tons of gold like they have threatened (their ratios are much lower than the US's and Europe's), that will absorb inventory and drive prices higher also. And India is already the world's largest buyer of gold, up to 20%. With the Pakistan thing going on, I can't imagine them wanting more rupees, instead of gold, which has become the de facto currency.
Bottom line: MV = GDP, and as long as the Fed provides easy credit (interest rates can't get much lower than 0%), and as long as the Treasury prints trillions of dollars, the money supply M will be poised to catalyze inflation. But once the velocity V of capital flows thru the economy, it will provide the stimulus our economy needs, but potentially kicking off hyperinflation. In other words, once bank balance sheets have been restored, they will start lending again. We would have avoided another Great Depression, but God helps us when we get runaway inflation a la the 70's. Having an extra $8 trillion floating around in our economy will prove inflationary, and interest rates will soar. Treasury bondholders with longer maturities will get crushed, as the Fed can only influence short-term maturities (T bills). With higher interest rates, the government won't be able to pay off its huge debt obligations, and we'll have stagnant growth for years. We are experiencing a credit crisis because investment and commercial banks are insolvent. When the markets realize the US government is also insolvent, all hell will break loose. The government has compounded a multi-billion-dollar debt crisis into a multi-trillion debt crisis.
I hope I'm wrong in this logic chain, but this playbook has been repeated many times before when fiat currencies are under attack by central banks. I just don't see any other outcome when your debt is almost as large as the size of your economy.
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