The River of Losses

The trends that could put oil at $50 per barrel this year haven’t gone away. But the risks created by the "reflation rally" threaten EVERY asset class today. Beware you don’t get wiped out in 2004/05…

"I was leaning toward the view that some assets would continue to increase in value in 2004. I am now increasingly concerned that sometime soon ‘everything’ could begin to unravel. When interest rates rise, it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time."

– Marc Faber, in the Financial Times

This is the most important advice I’ve ever given. And, chances are, you don’t want to hear it.

In fact, after you read this essay, you might never want to hear from me again. But it’s a chance I’m willing to take.

So here it is: Very soon, you could lose a lot of money.

Right now, the way I see it, it will be extremely difficult over the next year – at least – to make money ANYWHERE in investing.

I think Marc Faber is right. The fact that interest rates have been at multi-generation lows for a very long time has caused investors to chase anything and everything higher. The obvious result is that everything has been bid up. Stocks and bonds were first. But now commodities and real estate have been bid up as well.

As I’ll show, I think many markets are close to their peaks. I now see the stock market (and most investable assets) like a river, working its way from the mountain peak to the sea. There are occasional "flat" sections of the river, where things appear calm and the current isn’t very strong. And then there are some wild rapids heading down. There are even the occasional eddies along the river banks that flow against the grain.

And while the river has all three of these states (flats, rapids, and eddies), the inexorable flow is down. I see investments as that river today. The inexorable flow in investment values is down. You can see how difficult it can be over the next year (or couple of years) to fight that current.

Economic Downturn: Looking at the Major Asset Classes

Let’s consider some of the major asset classes (like stocks, real estate, and commodities), and see what may happen in the coming months and years. And then we’ll talk about the eddies – which investments, if you’re ambitious enough to consider them, might flow against the current.

By most measures, stocks are expensive right now. But the Fed is still accommodating investors by keeping rates low, and the overall trend in stocks still seems to be up – for the moment. However, the writing is on the wall…at least right now, it appears fairly certain that the Fed will raise rates by the end of this year. When it does, stocks will likely take a significant hit.

At the same time, in the housing market, the fundamentals I’ve written about for years are still in place. With the extremely low mortgage rates, real estate is still "affordable," when you compare monthly payments to family incomes. So I still believe in the bullish case I’ve made for years now.

But there is a major change. I believe an international housing bubble is finally getting underway in the rich countries of the world. Like all bubbles, this one started out on a solid premise. Enjoy it while it lasts, but be aware…know that a speculative bubble is being created, on a pile of debt, and the end will likely be ugly.

Meanwhile, the sales promotions for commodity-related investments pile up in my mailbox…"Why Natural Gas is Hotter than Ever" is the cover of one. "New Oil & Gas Discovery Rewrites the Energy Story for 2004" is on the cover of another.

I am very bullish on commodities over the rest of the decade, as you probably know. But I’m starting to think that the story is getting too popular. You know it’s getting overheated when CNBC is taking helicopters out to the oil sands area in Canada. CNBC is just going where the hype is, as usual. It is simply giving the advice you want to hear…

Economic Downturn: More Oil Demand Than Supply

Earlier this month, I touched base with my most trusted contact in the commodities business. Simply put, nobody trades commodities better than Canadian broker Chris Foster of Scotia-McLeod in Toronto.

Chris eased my fears. "The hype is worrisome," he told me, about oil. "But the story is simple, and real…there is simply more demand than supply."

Chris explained that, contrary to popular opinion, "the Saudis are maxed out" right now in their oil production. The Saudis are already using output-enhancing techniques just to keep their production up. Chris went through a laundry list of oil-producing countries, and why their production can’t keep up. It sure is a motley bunch… Venezuela, Nigeria, etc.

Making matters worse, there is apparently not enough exploration – the source of future supply – going on. Chris wondered aloud what price oil would have to reach to get exploration in high gear again. Then he said, "It wouldn’t surprise me to see the market meander its way to $50 a barrel."

In the near term, Chris is probably right. Nevertheless, if you want to play the commodities bull, caution is in order. There is a big story hidden in here…the story of a bubble in the midst of bursting, that could possibly drag commodity prices down with it: China.

The Chinese government now admits it has a credit bubble on its hands. But China has made the mistake that Japan made in the late 1980s, of not acting fast enough to slow the growth of the bubble. It may already be too late.

The bust of China could lead to a bust in commodity prices as well, for a while. To compound the probability of the commodity boom, it appears that hedge funds have been big buyers of commodities over the last six months or so, also. Hedge funds can, and do, dart in and out of positions. If hedge funds are moving out of commodities at the same time the China bubble is bursting, it could be ugly. The moves could be exacerbated, as hedge funds often make leveraged bets.

Economic Downturn: Hard to Make Money Investing

Given the conditions I’ve outlined above, and to reiterate what I said earlier, it will likely be extremely difficult over the next year to make money through investing. I see today’s markets as a giant river flowing downhill, sweeping up unwitting investors – and their money – in the process.

You might choose simply to get out of the river…then you wouldn’t go down with it. The other, more ambitious, and more risky, approach is to try and find the little sections of the river, right on the edges, where the river occasionally flows in the wrong direction. There, you might find a pocket that will rise, maybe for a brief moment, against the current.

Admittedly, the ‘eddies’ I’m talking about are hard to find. You’re not likely to hear about them from your broker. His main concern, of course, is selling you stock and mutual funds…and taking a healthy commission.

But I don’t work on commission. I don’t have an interest in whether you buy, sell, or hold. And so, unlike your broker, I am free to tell you – this next year could be devastating to many "traditional" investments.

If you do nothing else, I recommend you get out of the markets right now. Cash may turn out to be the best-performing asset of the next year.


Steve Sjuggerud,
for The Daily Reckoning
April 22, 2004

P.S. If, however, you’re more ambitious…if you don’t like to sit on the sidelines, and you want to find out about the few opportunities that remain where your wealth will likely be safe (and could possibly even double), I urge you to read my latest issue of True Wealth.

If you already subscribe to True Wealth, you should have received a copy of this issue by e-mail already.

Editor’s Note: Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. An international currency and emerging markets expert, he is also the editor of:

True Wealth

Tout casse. Tout passe.

Everything breaks. Everything passes away.

The French expression came to us yesterday as we were making our way along one of the smaller canals of Venice yesterday. The fashion seems to be to let the plaster fall off the exterior walls. Little by little, the brick is exposed…and then, that too breaks up and erodes.

The effect is pleasing, rather like a beautiful woman aging well. There is a whiff of graceful decay around every street corner in Venice; it is part of the charm of the place. But Venice is not just getting old, it seems to be dying. The crowds of tourists come to gawk like poor relations saying goodbye to a rich uncle they never knew.

We Americans tend to think everything gets better all the time. Our houses become more valuable with each passing day. Our stocks – if held for the long run – invariably make us richer. Science…democracy…and modern, dynamic capitalism take us towards a better world – where disease and disorder will be forever vanquished. Even the occasional slip-up is thought to a good thing. Our wars leave us bigger and stronger. Our financial crises lead to useful reforms. Our economic setbacks bring forth new innovations. Every day, things just get better.

Yesterday, Alan Greenspan barely mentioned deflation. He hardly spoke of inflation either. Thanks to productivity and enlightened central banking, he led listeners to believe, neither inflation nor deflation is any longer a cause for concern.

But reports from all over the country suggest that there’s still a whole lot of ‘flation going on. Cold, rolled steel has risen 68% since December. Gasoline is hitting new highs regularly. Home sales in the Bay Area of California are rising at a 25% rate. In many resort and second-home areas, prices are rising at 50% per year!

"Milk prices harder to swallow," says a Dallas headline.

But the most reliable indicator – the price of gold – is not signaling more inflation, but less. Gold deflated another $6.90 yesterday, bringing the price down to $391.40. So much for our ‘bottom’ guess of $400.

The hot money seems to be guessing that U.S. interest rates will go up, which would take the dollar up further. We don’t know what will happen, but we wouldn’t want to be betting on a higher dollar, nor a lower gold price, nor higher stock prices…not when a huge correction is waiting to happen. Maybe the world is becoming a better place. Maybe it is not. But we warn readers: tout casse, tout passe. The current boom in debt will have to correct sometime; we doubt it will do so gracefully.

More news from Wall Street:


Eric Fry, on the scene in Manhattan…

– Motorola "blew away the number" Tuesday evening, which blew fresh life into the tech sector Wednesday morning. Motorola reported a tripling of first-quarter net profit – causing its shares to leap more than $3.00 to a three-year high of $19.30, and sparking a frenzy of "sympathy-buying" in other tech stocks. The tech-infused Nasdaq gained nearly 1% to 1,996.

– But the Motorola pick-me-up failed to inspire the Dow Jones Industrial Average, as the big blue-chip index continued to labor under the gloomy specter of rising interest rates. The Dow added a mere three points to 10,317. Government bonds rebounded a trifle from their 4-week shellacking, as the yield on the 10-year Treasury note dipped to 4.43% from 4.46%. The dollar also gained ground – hitting a five-month of high of $1.1835 per euro.

– Motorola’s sales surged 42% in the first quarter, thanks largely to soaring sales of cell phones. In retrospect, no owner of a Motorola phone should have been surprised by the report. Every time a Motorola cell phone rings on a crowded New York City train, a dozen passengers reach into their pockets to see if the offending phone belongs to them. Motorola’s ubiquitous "clamshell" handsets have become "standard equipment" on regulation-issue New York yuppies, while also becoming a de rigeur fashion accessory among the under-20-somethings…In short, the phones are everywhere…How could Motorola NOT make lots of money?

– Motorola’s stellar earnings report was but one of several pleasant surprises yesterday from a cadre of companies that routinely disappoint investors. Ford Motor shocked its long-suffering shareholders by reporting a near doubling of earnings, while Dow-outcast Eastman Kodak presented a pleasing picture for the quarter.

– Meanwhile, up on Capital Hill, Chairman Alan Greenspan testified before Congress for the second straight day. The earnest bureaucrat assured the politicians in attendance that inflation is of little concern, then promised to fight the inflation about which he is not concerned by raising rates "at some point."

– "What does the prospect of rising interest rates mean for the stock market?" Rhonda Schaffler asked your New York editor during his appearance yesterday on CNNfn. "Should investors be worried about it?"

– "Remember 1994," he answered. "Greenspan hiked rates in the spring of that year and stocks struggled for the next several months…Expect a repeat of sorts. The interest-rate sensitive sectors of the market will almost certainly struggle, at least relative to other sectors of the market. Financial stocks and commodity stocks are struggling already."

– Greenspan’s promise to raise interest rates has cut a path of devastation through the commodity markets reminiscent of the scorched earth left behind by Sherman’s troops on their March to Atlanta.

– Gold fell nearly $7.00 yesterday to $391.40 an ounce, while silver plummeted 77.5 cents to $6.17 an ounce. The sliding precious metals prices dragged the Philadelphia Gold and Silver Index down by 1.5 percent to its lowest level since late August. Other casualties of the new interest rate regime included copper, which tumbled 6.3% to $1.227 a pound, palladium, which tumbled $21.10 to $295.25 an ounce, and platinum which fell by $31.20 to $884.50 an ounce.

– Commodity prices needn’t necessarily collapse at the first sign of rising interest rates, but somehow they always do. The question before the House is whether investors ought to "back up the truck" to buy gold and other commodities, as Doug Casey argued yesterday…or move out of the way lest the truck run them over. The answer, unfortunately, is unclear.

– The price of copper fell about 10% immediately after Greenspan first started hiking rates in the spring of 1994, but it quickly reversed course and nearly doubled by the end of that year. Gold, on the other hand, fared less well. The precious metal drifted lower after Greenspan’s first rate hike and never recovered, as gold stocks tumbled about 30% between March 1994 and the end of the year.

– The textbook explanation for sliding commodity prices during a rate-hike cycle is that rising rates choke of the inflationary pressures that contribute to rising commodity prices, while also slowing the economy, and hence, the demand for commodities. Will this time be different? We wish we knew…The U.S. dollar is the principal wild card. Rising rates may prop up the greenback for a while, but the dollar’s many structural disadvantages – like a combined $1 trillion current account and federal deficit – will continue to weigh it down.

– The dollar may be as good as gold – or better – for a few days or weeks or months, but we’d still bet that gold will be better than the dollar for the next few years, despite Greenspan’s magical interest rate adjustments.


Bill Bonner, back in Venice…

*** In many ways, Venice peaked out 500 years ago. Since then it has been living on little more than reputation, tourism, and the accumulated wealth of its dead people.

It is an improbable city, built in an improbable place in an improbable way. The city founders were said to have taken refuge on these low, marshy islands when barbarian tribes invaded Italy in the 5th century. They shored up the ground, dug canals and drains, and drove wood pilings into the mud to build their stone palaces. The city flourished making luxury goods and trading with the East. But it peaked out in the 15th or 16th century, increasingly by-passed after vessels began using the Cape of Good Hope route around Africa…and manufacturers in the south of France began to offer competition.

Tourism has been an important industry in Venice for the last 300 years. But even that has gone downhill, as the quality of tourist has degraded. The city was once a magnet for artists, poets, and aristocrats from all over Europe. Wagner, Proust, Ruskin, Ezra Pound…all came to admire the city and soak up whatever inspiration they could leech out of her old stones. Now it is the discount tourist who arrives, appalled by the high prices…and looking for a funny hat at a gee-gaw vendor. They move in huge crowds preceded by a small flag to help stragglers follow. They walk through the Basilica San Marcos as if through Disneyland…eating ice cream cones while gaping at the crucifixion…wondering vaguely how a Zen chapel came to be in a Christian church.

You can practically hear the stones sigh.

*** Reading the history of Venice is not much different from picking up the newspaper: lies, fraud, delusions – they are all there, just as if you were reading the International Herald Tribune.

President Bush claims to be building a better world…but he seems to be rehearsing the story of Doge Dandolo in the 12th century, or the Doges Michiel before him. American voters think they are participating in the world’s finest democracy…but the government of Venice in the 13th century was at least as democratic and just as dysfunctional. Venetian soldiers setting out to clash with the civilization of the East…were they not providing a useful lesson to the Coalition of the Willing 800 years later? (More on that tomorrow…)

*** Great institutions, like great bull markets and great cities, have a way of degrading over time. People gradually learn how to rig the system to their own advantage…and usually contrary to the interests the institution was meant to serve. Paul Jacob offers this "Common Sense" comment on modern American democracy:

"Republicans believe in certain things and Democrats believe in certain other things. But, once in office, they both believe in one thing above all else: incumbency.

"A case in point is the April 27th Republican U.S. Senate primary in Pennsylvania, between Senator Arlen Specter and U.S. Representative Pat Toomey. Both men are Republicans, but the similarities end right there.

"Toomey went to Congress to put Washington on a diet. His voting record shows he has kept his word. The National Taxpayers Union ranks him seventh best in the House on taxation and spending issues. Anti-incumbent Toomey pledged to serve no more than three terms in the House and he’s keeping that pledge, too.

"Specter, on the other hand, has been in the Senate for the last 24 years. He’s a Republican, but most famous for voting against Reagan’s nomination of Judge Bork for the Supreme Court. If reelected, Specter will take over the Judiciary Committee.

"The National Journal rates Specter nine points more liberal than conservative on economic issues and three points more liberal on social issues. Meanwhile, Toomey was rated more conservative than liberal on economic issues by 47 points and on social issues by 32 points. Quite a gap.

"Not to mention that Specter is being funded by many of the same folks, such as George Soros, who are funding the effort to oust President Bush. Why then is President Bush traveling to Pennsylvania to promote Specter over Toomey?

"Specter is the incumbent and, in the rulebook of Washington, incumbency comes first."

*** Modern degenerate capitalism is as fraudulent as a senate primary. Wall Street sells shares pretending they will make investors rich. Ordinary people gamble money in stocks and pretend they are investing. Public companies sell shares pretending they are using it to make investors money. This from colleague Porter Stansberry:

"Most of the profits made in technology stocks during the 1990s ended up in the hands of as few as 100 corporate insiders, instead of the millions of investors who actually owned these firms.

"Take Cisco for example – one of the largest, most profitable and best-known technology companies of the 1990s. Between 1995 and the end of 2003, Cisco reported to have earned $3.3 billion in profits. However, as only the footnotes to its financial statements revealed, the firms spent over a billion dollars in stock options on its employees. Cisco spent $1.5 billion on employee stock options during this seven-year period – 53.4% of all the money it made.

"In simple terms: Cisco spent more than half of its total profits on extra compensation to its employees. The vast majority of these stock options went to a handful of senior executives, like CEO John Chambers. Chambers regularly received total pay packages in excess of $100 million per year, with most of his pay coming in the form of stock options that depended on the stock price staying high. Thus, it’s no surprise that as late as December of 2000, Chambers told the financial media that he didn’t see any deterioration in Cisco’s business, despite the collapse of the "" businesses, which had been large buyers of Cisco’s Internet routers. In 2001, only a year later, Cisco would record a loss of nearly $3 billion dollars – about as much money as the company had made during the previous two years combined.

"Even for the very best and most profitable company in the Internet sector then, the Internet boom was only a mirage, at best. On closer inspection the boom looks like an enormous fraud. And these are the results from the best company in the sector. The other companies fared much, much worse: the vast majority never made a profit at all, and in
fact lost billions when you included stock options expenses.

"And yet, no one on Wall Street or in the mutual fund community or in the press said anything about these abuses until years after the fact and only when they were forced to by congressional investigation or shareholder lawsuit."

The Daily Reckoning