Lessons From a Kindergartener

The Daily Reckoning PRESENTS: All the Mogambo really needs to know about life…inverted yield curves…and gold, he learned in kindergarten. Read on…

LESSONS FROM A KINDERGARTENER

The yield curve is still inverted, in that investors are mysteriously demanding to be paid higher interest rates for holding short-term debt (when the risks are more easily predicted), but they will accept lower interest rates to hold long-term debt (where the risks are unknowable with any degree of precision).

This is very weird, and that is why an inversion of the yield curve is such Big Freaking News (BFN). In that regard, Bloomberg reports that European government bonds now have an inverted yield curve for the first time in six years. “A so-called inverted yield curve hasn’t been seen since August 2000 during the ECB’s previous series of rate increases,” they say.

But apparently neither the fact that the yield curve is historically uncanny in predicting recessions (and even the very few times when it is wrong, the performance of the stock market ain’t nothing to get excited about, as it is usually nothing) nor that the curve last inverted right before the crash of 2000, made any impact whatsoever on Martin Price, the director of fixed income portfolios at Sarasin Chiswell, who says, “Some people talk about recessions, but I don’t see it as a sign of one.” Hahahaha! I laugh!

Apparently Richard McGuire at RBC Capital Markets loves to hear me laugh, too, and so he obligingly adds, “I don’t think it’s a recessionary signal, it’s a bit simplistic to look at yield curves as a sign of recession.” Hahaha! Thanks for the chortle, Richard!

To add to the convivial scene, even Bloomberg seems entranced by the musical qualities of my charming laugh, and they quote, for my obvious enjoyment, Alan Greenspan, the world’s leading economically clueless bungler, saying that a yield curve inversion as a portent of Something Very, Very Bad (SVVB) is “a misconception”, and that the yield curve’s “efficacy as a forecasting tool had diminished very dramatically.”

But pay attention! What he is actually admitting is that the yield curve inversion used to have oodles and oodles of efficacy, and thus back then you could take it to the freaking bank that when the yield curve went into inversion you were going to have a tough time pretty soon because the Federal Reserve had screwed up, again, and inflation was going to eat somebody’s guts out. But nowadays it ain’t got so much, as he says, in terms of “efficacy” in forecasting economic performance.

I was, probably like you – on the edge of my seat, anxiously waiting to hear what Greenspan thought was causing an inverted yield curve that was so benign in its effects. Blabber jabber yammer. And then, when I finally found out, my contempt for Alan Greenspan went up a few notches, as he says it is a “conundrum,” which is Greenspan-speak (when you read between the lines and interpret how his lips curl in a sneer when he says the word “conundrum”) for “I refuse to believe the sheer tonnage of evidence that says I am the world’s leading economically clueless bungler, just like that stupid Mogambo idiot (SMI) says I am!

“Now I am reduced to comically saying that I somehow have no idea why the yield curve is inverted, and that yield curves are not so significant nowadays, anyway; which is probably because the world’s central banks, thanks to their own fiat currencies, fractional-reserve banking systems and outright lying and fraud, can do anything we, and they, want, including saying preposterous things with a straight face, like saying that a yield curve inversion is a ‘conundrum’ when it is obviously much, much more than that, and all of it is ugly, ugly, ugly! Uglier than even That Idiot Mogambo (TIM) envisions. And I, Alan Greenspan, cruelly laugh and impatiently await the sublime delight of hearing your screams of unbearable pain and tormented anguish as inflation eats you alive, as I am the True Living Satan (TLS)!”

Okay, I admit, I got carried away there at the end, and I made up that whole last part, and pretty much everything else too, but I think you get the drift. Conundrum! Ha!

Larry Edelson of Money and Markets apparently doesn’t care about either me or any drift, and with breathtaking brevity says, “In just the past week, the price of the 30-year benchmark Treasury bond swooned by two full points.” The upshot is that, he says, we can “expect a disaster in the Treasury bond market.”

Troy Schwensen, of The Global Speculator newsletter, has taken a look at the price of gold in Australian dollars versus inflation and interest rates during the 24 years from 1982 to 2006. “We can see that in this period where high interest rates eventually tamed core inflation, the actual price of gold fell below the theoretical value, as people regained confidence in the financial system and interest rates eventually declined. This consequently fueled unprecedented gains in financial assets.”

It’s the next part that gets our attention when he says, “We can see now in 2006 that a massive disconnect again exists between the actual and theoretical prices,” and that the difference this time is that “Actual is just 33% of Theoretical”.

So in trying to understand what is going on, it seems that somewhere along the line, the high price of gold fell to its theoretical value, and then overshot on the downside. And that’s where we are now. And now the actual price is 300% below its theoretical value!

My sensitive Mogambo Investment Opportunity Sensors (MIOS) spring to alert, and an inner voice says, “Hmmm! This reverting to the mean thing seems intriguing to me for some reason! But why? Why? Why?”

Being a real stupid kind of guy, I missed the obvious conclusion that gold will again revert to the mean by going up in price until it reaches its theoretical value. Fortunately, there was a kindergarten class taking a field trip through Mogambo Galactic Headquarters (MGH), and Larry, one of the smart-aleck little kids, saw me laboring over this an said “Hey! Stupid Mogambo Idiot (SMI)! It means gold will rise 300% and then overshoot to the upside, dork!”

My intense gratitude at learning this valuable piece of information directly offset my supreme irritation at being addressed so rudely by a little five-year-old brat that I could have easily beaten up if I wanted to (so watch it punk). Successfully throttling my rage, I ended up letting him off by sticking a “kick me” sign on his back, but he saw me and started running.

I had a big grin on my face and was just starting to take off after him when Larry’s teacher imploringly looked to Mr. Schwensen for help in controlling what appeared to be developing into another Unfortunate Mogambo Incident (UMI), who saved the day by putting it into a pithy nutshell when he went on to say, “Rising interest rates and high levels of debt are obviously not a good combination.”

Immediately spurred to action by his words, I change course, and run out of the door to get more money (probably by begging from total strangers) as my “friends” are all tapped out (so they say, the liars!), and I use the money to buy more gold. But as I am leaving, I stop in my tracks when he says that I may be making a mistake by not begging for money with which to buy platinum instead!

“Hmmm!” I say to myself! “Tell me more!” So they do, and it seems that John Ross Crooks at Money and Markets wrote, “The automotive and jewelry industries account for roughly 80% of annual demand for the metal. These days, about half of the world’s platinum goes into jewelry. Mines in South Africa and Russia account for 90% of the world’s platinum. All told, about five million ounces of the metal get hauled out of the ground annually. In case you’re wondering, that’s nothing compared to annual gold and silver production of 82 million ounces and 547 million ounces, respectively.”

I raise my hand, interrupting to ask, “Now, this is all very interesting, dude, but what is the point of it all to someone who is just interested in making a whole lot of money as fast as he possibly can so he can get out of this stupid town and away from these stupid people?”

Apparently he lives a very sheltered life, and I guess he has never seen a sociopath consumed by raw, naked greed before, but, obviously repulsed, he nonetheless graciously replies, “This year, stocks of platinum are expected to fall short of demand for the eighth year in a row”, which assumes I know how the supply/demand dynamic works. And brother, do I ever!

Until next week,

The Mogambo Guru
for The Daily Reckoning
November 20, 2006

Mogambo sez: The next question is: “They kept the market up through the election. Can they keep these markets up until January 1, 2007, so as to lock in the profits and thus lock in the taxes people must pay?”

Who knows? They’ll try. But gold and silver and oil will continue to go up, and that’s enough for right now.

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

“Well, maybe we’ll just muddle through.”

The words came tumbling on their own out of our mouths in New Orleans last week. And then were followed by our customarily modest disclaimer, “Who knows?”

We have been waiting for the real estate bust to bring the whole U.S. economy down with it. But so far, nothing much has happened. Consumers are still spending. And stocks – as measured by the Dow – hit a new record after nine straight sessions of increases. Housing prices are weak, but there is no sign of panic.

‘Tis the 20th of November and all is well, the papers seem to say.

Maybe it is a bit like the way Hurricane Katrina passed over the levees.

“It looked at first like we had dodged the bullet,” explained our guide on Friday. “As long as the wind was blowing the water of Lake Pontchartrain away from the levees, there was no problem. But then, after the eye of the storm passed to the North, the winds changed direction and the water began pushing at the dikes. Then, they gave way right by this Lakeview area.”

We had heard a lot about the devastation wrought by Katrina; we decided to have a look for ourselves.

“Lakeview is an area of middle-class housing. Normally, it sits on dry land, six feet or so below sea-level. But you can see the architectural evolution here. Back in the old part of town they were building on higher ground…but they still built up off the ground, leaving a nice crawl space under the house to allow air to circulate. And they built houses with high ceilings so the hot air could rise…and shutters to keep out the sun. But by the time they built this area…only a few years ago…they poured concrete slabs right on the ground and built directly on top of them. Now does that make any sense? What had happened was that they had come to trust the technology. I mean they’d come to rely on the pumps that keep the city dry…and the air-conditioning that keeps it cool. So they didn’t worry about building on high ground…or building up off the ground…or about shutters and high ceilings.

“And now look…most of these houses are still empty. But a few people have come back. And they’re building just like they did before – low houses directly on concrete slabs. Does that make any sense? As I said to one of them, ‘What are you doing? You’re building the Titanic two.”

More on New Orleans, tomorrow…

Meanwhile, in the rest of the country, faith in the technology of modern finance seems to be at an epic high. No one is quite sure how the pumps work, or how the levees were constructed, but everyone is sure they won’t fail. So, they run up stock prices with an untroubled mind.

And here comes a storm. Housing sales are ebbing, after a very long period of flowing. Still, what’s the worry? The dikes will hold; everyone says so. The LA TIMES reports that lenders are still writing ‘exotic’ mortgages. And prices, though sinking, are still supposed to be above those of a year ago.

But a housing market falls apart slowly. And according to our anecdotal evidence, it is still early…the winds are still getting stronger…and shifting direction.

“I bought a house in Las Vegas more than a year ago,” an old friend reports. “At that time, houses in the area were selling for $330,000 to $380,000 approximately…and there were a few for sale. Now, they’re almost all for sale…I priced mine at $270,000. Still, no takers. I want to sell the house, of course, but there are some people who really need to sell. That’s why I think this housing collapse is just beginning.”

“I saw another statistic,” said another old friend. “Half of all the houses for sale in America are empty. In other words, they were speculations. You know that many of those sellers must be very motivated.”

Last night, back in Paris, we had dinner with a Canadian woman who sold her house in Bethesda, Maryland – a suburb of Washington, D.C. – a year ag

“My agent told me that I hit the very top of the market,” she said. “I have friends who just put their house on the market this summer. They can’t get anyone to look at it.”

Prices have not collapsed. But bids are disappearing. Speculators are laying low. And genuine buyers are waiting…hoping to get a better price later.

And here comes a bad report from an important housing barometer: housing starts have fallen to a six-year low. With too much inventory already, builders are cutting back as fast as they can.

Maybe the storm will pass without major damage. But if we were you, dear reader, we’d get out of town.

More news:

———————

Kevin Kerr, reporting from Connecticut…

“Like it or not, the exchanges have shifted from open outcry pit-driven business, like when I worked on the floor, to electronic-based 24-hour global trading. It’s a simple fact that trading electronically is here and here to stay.”

For the rest of this story, see the DR site.

———————

And more views:

*** In Melbourne, the G-20, which includes a range of countries – from the United States and the United Kingdom to emerging economies like Argentina, India, and China – is meeting with bouquets – or bricks and bats, depending on your political persuasion. It’s a big bash for financial pundits and hacks from central bank officials to the director of the International Monetary Fund – with the addition this year of an unregistered pink car that mounted police quickly seized. Protestor Izzy Jones tried to explain, “We weren’t intending to drive it at all – the motor’s out, the inside of the car is full of dirt and about ten different endangered species of Australian plants. There’s also a sound system in the boot.”

It was towed anyway…the party poopers.

*** Just before leaving the investment conference in New Orleans, we watched a panel discussion between three people with very different ideas of how things ought to be – Susan Estrich, representing the liberal persuasion, Newt Gingrich, standing up for neo-conservative Republicans, and our old friend Doug Casey, with his own brand of anarcho-libertarianism.

Several leading questions were asked, followed by answers that were respectively stupid and aggravating, smart and repulsive, and intelligent but irrelevant.

Ms. Estrich has an exceedingly annoying voice. What she said was no more moronic than you’d expect from a liberal, but she said it in such ragged tones we could barely stand to listen.

Mr. Gingrich sounded smoother and smarter than we expected. He seems to have thought about things more deeply than Ms. Estrich. But the two agreed on most of the important issues – both were for public education, the war on drugs, and the war on terror. Ms. Estrich noted that marijuana was already widely available, even to 13-year-olds in all the California schools. She also remarked that drug use in prison was common. Still, both she and Mr. Gingrich believe that prohibition of outlaw compounds is a good idea.

Doug Casey had his work cut out for him. He must have felt like a farmer on an ocean cruise. The very ground, which he took for real and solid, had vanished. His position was that America ought to be a free country, where people decide for themselves what they are going to put in their bodies. He insisted that this freedom was something they should also grant to others, not meddling in anyone’s business but their own.

His points were logical, but who cared? It reminded us of our days at Georgetown Law School. We had written a paper arguing that much federal regulation was both illegitimate, in Constitutional terms, and counterproductive. Our professor looked out the window towards the capitol building. His eyes passing over acres and acres of federal buildings and thousands of employees, he raised the following objection:

“If we were to accept your thesis, half this town would have to disappear.”

That seemed like a good idea to us. But it was unthinkable to a guy who made his career showing students how to work the administrative justice system.

So is it unthinkable to Ms. Estrich and Mr. Gingrich. Both the liberal and the conservative are in agreement: it is all very well to let people alone, but only if they do what you want them to do.

For our part, we marveled at how glib, clever, and appallingly conceited the two were. Drug laws clearly don’t keep people from getting drugs. Would more people use more drugs and suffer more harmful damage if the drug laws were abolished? Neither knows any more than we do. But they are both ready to put people in prison for years…on the basis of what is nothing more than arrogant guesswork.

As to the war on terror, they are just as ignorant. How many terrorists are there? What resources have they? Would they really be out to get us if we brought our troops home and minded our own business?

*** Ooh la la…when we got back from New Orleans, we found that the rebuilding of the kitchen had begun.

Our Portuguese mason has knocked down the cabinets…torn out the sink…and pulled up the floor tiles. Where once we had a kitchen, we now have an empty room with a cement floor that looks like a highway before being resurfaced. Dust is everywhere.

A makeshift kitchen has been put together in the dining room. We do our cooking on a hot plate, and store the dishes in various boxes and jerry-rigged cabinets. After eating comes the disagreeable part.

There too the Portuguese team has pulled up all the tiles – off the floor and from the walls – from the boys’ bathroom, too. The room looks a bit like a cell at Alcatraz – with it’s bare walls, exposed wiring and pipes, and toilet in the corner. Edward decided that this would also be a good place to put the cat box. But there, yesterday, is where your editor did the dishes from lunch.

“Use plenty of soap and hot, hot water,” was Elizabeth’s advice.

“I’ve got a better idea,” we replied. “Let’s go out to dinner.”