Trading Cash for Krugerrands
The Dow rose 177 points yesterday, amid a flurry of gloomy headlines.
“New homes sales fall by record amount,” says the Associated Press, referring to the 26% drop in 2007.
In Florida, housing is in a ‘death grip,’ adds the Dallas Morning News.
And the whole U.S. economy “faces the guillotine,” is how Newsweek sums up the situation.
The big battle, as always, is between greed and fear. Greed pushes up prices. Fear drags them down.
As of yesterday, fear was winning.
“Fear stalks the markets,” says the Economist.
Yes, dear reader, fear – the force of deflation – is getting the headline coverage. Recession, say the papers, is either coming…or it is already here.
As we pointed out yesterday, when Mr. Market turns to fear…it is hard for Mr. Market Manipulator to stop him. Frightened investors have knocked down stocks – wiping out more than a trillion dollars worth of implied wealth. Frightened homeowners have sold off houses – taking nearly $2 trillion off the implied value of the U.S. housing stock. The subprime crisis is said to be taking out another half a trillion. A trillion here…a trillion there…
What can the forces of inflation do against these huge attacks? Mr. Politician has come forward with a plan to pump $150 billion back into the U.S. economy. Mr. Central Bank manager has cut rates by 75 basis points…and threatens to cut more.
But the problem, as the Financial Times so elegantly put it, is that the “credit orgy” is over. The liquor ran out. The music stopped. And someone called the cops. Bush and Bernanke show up with a few more bottles of booze, but the guests are already putting on their coats and fumbling for their car keys.
If we’re right, one of two things will follow:
If Mr. Market has his way, fear will dominate the market…and stocks will fall while gold stagnates.
If Mr. Market Manipulator prevails, greed will return…but not necessarily where he wants it. Stocks will stagnate while gold soars.
Most likely, each will have his victories and his defeats as the fortunes of this war shift back and forth.
We got a hint of which way things were going yesterday. The Dow rose, but the real action was in gold, which shot up $16, to a new record of $927. Analysts mentioned that the power went off in South Africa, putting the gold mines out of commission. But a healthy boom wouldn’t care…and investors wouldn’t have cared a few years ago. A healthy boom produces rising stock prices…leaving gold behind. This is no healthy boom at all. It is a fraudulent boom and investors know it, shifting their speculations from stocks to gold.
Thus begins a new stage in the bull market in gold. Do you remember when we were able to buy gold around $300 an ounce – 7 years ago? It rose hesitantly, often giving back gains. People wondered if gold had not been made completely obsolete by sophisticated financial instruments. We at The Daily Reckoning know better. With the decline of the dollar (and indeed the worthlessness of all paper currency) gold is one thing that will always have value.
If you’re worried about a bear market, buy some put options, said the experts. If you’re worried about depreciation of the dollar, buy euros. If you want protection against defaults, buy some swaps.
The experts could not imagine that a day would come when we’d be worried about the whole dollar-based financial structure…about the ability of the biggest banks to survive…and the capacity of the biggest Wall Street firms to make good on their obligations.
But here we are…and gold is rising. And now it goes up by $10…$15…$20 in a single day. And now people are starting to read about it in the papers. And people are starting to wonder how high the price will go…and where they can buy Krugerrands.
Yesterday, Peter Munk, CEO of the world’s largest gold miner, Barrick Gold (NYSE:ABX), told the worthies at Davos that the bull market in gold had a ways to go. He said the price would go into the “$2,000 bracket” before it was over. We couldn’t agree more.
*** “The real story is the decline of America,” said David Fuller yesterday at lunch. David has been writing his Fuller Money, a careful analysis of global money trends, for as long as we can remember.
The rest of the world is in pretty good shape, economically, says David, adding that if he had to make one “buy-it and forget-it” investment for the next 10 years he’d buy stocks in India.
India (Asia generally) and much of the rest of the world have expanding economies, rising incomes, and plenty of room for growth, he says. The problems, on the other hand, are mostly concentrated in the United States.
Martin Hutchinson adds this:
“The US is currently in the position of General Motors in about 1970, splendid in its possession of a majority share of the US automobile market, and apparently invulnerable to competitive threat, yet in reality burdened with impossible welfare programs that a foolish management had negotiated during the good years. For General Motors, the future after 1970 was one of steadily slipping market share, from 60% of the US market to about 25%, of a steadily aging workforce, and of a retiree health benefit obligation that if valued appropriately is today worth far more than the value of the company itself. Had GM not undertaken its excessive pension and healthcare obligations, it would have had more capital to compete effectively, would have been less likely to lose oodles of money in every downturn, and might still retain primacy in the world automobile market today, albeit by a lesser margin than in 1970.
“For the US, the position is the same. Its workforce will be older than its competitors’ and entitled to benefits that absorb an increasing share of the national income as its relative earnings decline.”
We probably all had the same thought. Yesterday, if you were to buy a 30-year Treasury bond you would have gotten a 4.28% yield. That yield is only a few basis points from the current U.S. consumer price inflation level, as announced by the government’s own number torturers. Assuming the number is more-or-less honest, and assuming things don’t change, this means that a person who buys a long Treasury bond gives up money now for the right to receive zero return over the next 30 years. Of course, things do change. But the changes that are most likely are those that make this investment even worse. The inflation rate is likely to go up. At 10% inflation, the investor loses 5.72% per year. If the dollar falls against other major currencies, he is out even more.
The only way the bet on long bonds could work out for investors would be if the United States were to sink into such a fear-driven recession that inflation and interest rates fell substantially. Nominal prices could actually go down, for example, as they did in Japan. Real yields could rise…for a while.
But the United States of America controls the value of the currency in which the United States of America’s debts and obligations are calibrated. Even before a slump has begun, the Fed has panicked…and Washington has rushed to get the checks in the mail. A serious downturn would produce even more desperate attempts to bring prices up and the dollar down. It is the only way the feds can service their enormous debts and obligations. One way or another, they will find a way to keep inflation rates high…and sooner or later, certainly sometime with the next 30 years…they are almost sure to lose control altogether. Holders of long U.S. treasury bonds will continue receiving their coupon payments. Perhaps they will be able to buy a cup of coffee with them.
*** Colleague Horacio Pozzo in Argentina thinks investors may have gone too far in driving down prices on financial stocks. In the United States, he notes that you can buy Bank of America (NYSE:BAC) at prices 26% below its high…giving it a P/E of only 11. The bank has been recapitalized with $12 billion in bonds. He thinks the worst is behind it.
Citigroup (NYSE:C), too, looks like a buy to Horacio. Its price has been cut in half and now trades at only a fraction above book value.
We were more convinced by Horacio’s pick in his own Argentina. The United States already has plenty of credit – too much of it. We can easily imagine that these U.S. financial firms will lose ground for years – like GM (NYSE:GM). We don’t see much growth…but plenty of room on the downside.
But South of the Rio Plata, the picture is upside down. North is where the sun shines. South is where the snow flies. And credit has plenty of room to expand. Nobody has much credit in Argentina. The ratio of private credit to GDP is only 12.5%…(compared to over 150% in the U.S.)…and it’s growing at 42% per year. There is not much room on the downside…and clear skies overhead.
The banking sector in Argentina has none of the threats and problems of its U.S. peers, but banking stocks have taken a beating anyway. As a result, you can now buy Banco Macro at a P/E just above 11…and its deposits are growing at 23% annually. You can read Horacio, in Spanish of course, at Moneyweekes.com.
*** Our Sunday lunch with the boys was intended to focus on education. Where was Henry going to college? Would Edward like to go to boarding school next year?
Pater Familias laid his cards on the table even before the entrée was served.
“Look, I’m almost 60. I’ve had children around the house for the last 30 years. And for at least a quarter century, my life has been tied to the school schedule; I’m ready for a change.”
“Oh…so you want me to go to boarding school, so you can do whatever you want?” Edward saw the point immediately.
“Wait, it’s not just that,” Elizabeth entered the conversation. “We’re not sure you’re going to be able to get back into the French school in London. It would be nice to have an alternative.”
“A Plan B,” said your editor…who suspects that all Plan A’s are doomed to failure.
“Not only that,” the voice of reason returned. “I went to boarding school when I was about your age. I loved it. And I think you’re the sort of person who might like it too. The English boarding schools are very focused on sports and outdoor team-building activities. Those are the sorts of things you like. Most likely, you’ll go to the French school, but we should look at these boarding schools to see if you like them…and just in case the French school doesn’t work out.”
“But I don’t want to go to boarding school,” Edward replied. “You didn’t make any of the others go to boarding school. Why should I have to go? It’s not fair.”
“No, we’re not going to force you to go to boarding school. But you might want to go.”
“I don’t want to…”
“How do you know you don’t want to? You haven’t tried them.”
“Well, I don’t want to try…”
“Well, you might try anyway. You know, you don’t have the best grades. If you want to get into a good college, you’ll have to make yourself interesting by doing something different.”
“Maybe he should go to St. Georges in Buenos Aires,” suggested Papa. “That’s different…an English speaking boarding school in Argentina. They can’t get too many applications from there.”
“That might be over-doing it,” Momma replied. “If it’s too strange or too far off they’ll think he was a discipline problem that we wanted to get rid of.”
“Well, I wouldn’t worry about getting into a good school anyway…it doesn’t make any difference.”
“Oh no…here we go again. And you know it’s not true. People from the best universities get the best jobs.”
“Maybe…but they don’t really learn anything. Edward would be better off learning on the job. Look at this subprime crisis. Who created the crisis? It was smart guys who came out of Ivy League schools and worked in sophisticated financial firms all Wall Street. They were the ones who packaged subprime debt…who did the math and the analyses that told them this stuff wouldn’t go bad in a million years…and who also worked at the rating agencies who gave it AAA ratings…and they’re the ones who work for Citigroup and for Societe Generale. All so well educated…and so smart that they couldn’t think straight. You’re better off not getting that kind of education.”
“Maybe…but then you’d never have gotten a job at Citigroup and you wouldn’t have an expensive house on Long Island.”
The Daily Reckoning
Tuesday, 29 January 2008
The Daily Reckoning PRESENTS: As the Fed continues its attempts to prop up the economy, the Mogambo looks at the Leading and Lagging Indicators to find out what is really going on. What’s the verdict, you ask? I refer you to the Mighty Mogambo Mantra (MMM) – we’re freaking doomed. Read on…
AN INDICATION THE ECONOMY IS LAGGING
by The Mogambo Guru
As is usual for me, I was dismayed by the report from Bloomberg.com concerning the Conference Board’s latest release of their famous Leading, Coincident and Lagging Indicators. The Leading Indicator, they say, “points to the direction of the economy over the next three to six months.”
They do not, as I do, say that it is also an indicator of future profits. Either way, “the index of U.S. leading economic indicators fell more than forecast in December, highlighting the risk of recession”, as the index fell 0.2%. It was, even more ominously – as you can tell from the background soundtrack, which is the sound of ravenous wolves howling and people screaming as they are being eaten alive by their debts – the third decline in a row. The third straight decline in future profits!
This fall in the Leading Indicator seems intuitively obvious when Bloomberg explains, “The collapse in home construction, less hiring and a slowdown in consumer spending may spell the end of the expansion that started in 2001.” I say, “Well, duh!”
Gratuitous snotty remark aside, the future looks dim, according to this indicator, but you feel compelled to say, “Hmmm! This is the perfect spot to say that you, Big Doofus Mogambo (BDM), like most people, underestimate the government’s response to any and all economic crises!”, and then point to Tuesday’s “emergency rate cut” by the Federal Reserve, where they slashed the Fed Funds rate by a gargantuan 0.75%, taking the rate down 18%, dropping it to 3.5% from 4.25%! Wow! Talk about desperate!
Well, if interest rate cuts are all that is needed to cause problems and then solve them, then this brings up the philosophy of Homer Simpson, who famously said that, “Alcohol [is both] the cause of, and solution to, all of life’s problems.”
On the ho-hum side, the Conference Board’s Coincident Indicator, a gauge of current economic activity, rose 0.1% in December, which is almost nothing. The coincident index “tracks payrolls, incomes, sales and production.” Remember, this is current activity, and it isn’t doing so hot, either.
The Bad, Bad News (BBN), as far as I am concerned, is the Conference Board’s Lagging Indicator, which contains costs and inventory burdens, and thus can be thought of as an index of future inflation. So (substituting) inflation “increased 0.4 percent after rising 0.2 percent the prior month.”
And, worse, the Lagging Indicator has been outdistancing both the Leading and Coincident indicators for months and months, too, indicating that costs are going up. And they were. And they are. And they will continue to do so.
And, in an odd coincidence, the Lagging Indicator started going up at about the same time I started having nightmares about inflation, never getting any sleep, and then it got really, really weird both at home and, now everywhere else, too, as I gather from the way things are shooting up and down all over the place.
And just when we are looking at all of this volatility, here comes Jack Crooks at MoneyandMarkets.com, who writes that the charts of the last few decades show that, “Volatility in the currency markets follows a fairly predictable pattern. When crisis strikes or recession sets in, the currency markets turn erratic.”
It turns out that this has a big effect on the “carry trade”, where people borrow from places where interest rates are low, and then use the money to invest in places where interest rates are high, and then pocket the difference.
How it got to be so big was that in the last 18 years or so, Japan had the lowest interest rates in the world since their stupid economy collapsed in 1990 because their stupid central bank had stupidly created too much money and credit for too long, and instead of letting the stupid idiots and stupid crooks lose their stupid money, the stupid Japanese government forced interest rates to almost literally zero so that stupid bankrupt businesses could always borrow enough money to keep from having to declare bankruptcy! Hahaha! What racket!
Thus, the carry trade was born when everybody else piled in, too. I thought that this was so clever in saving the butts of stupid and corrupt people that I have used it several times myself, over the years, to try and save my own stupid butt and my own stupid job.
In case you were thinking of trying this at work, too, let me warn you that it is, in the real world, fraught with failure. The way it usually works is that I go into the CEO’s office and inform him that Japan has proved that taking a corporate loss because of my bungling incompetence and complete lack of attention is wrong, and that bankruptcy could have been prevented if we, like Japanese businesses, had found somebody to loan us money at zero percent to make up for the losses! So it’s HIS fault for not securing that financing!
I have found that CEOs are usually initially silent and immobile when informed of this, and kind of just stare at you with this odd look on their stupid CEO faces, like they don’t understand a word you are saying until finally, in frustration, you shout out, “So it’s YOUR fault for not securing interim financing at zero interest rates, bozo! And if you didn’t foul up, then where is the money? There is no money because you didn’t go and get any free money! That proves you screwed up! So, YOU’RE the incompetent loser moron around here, and not ME for one damned time in my whole damned life! Hahahaha! How do YOU like somebody yelling at you because YOU screwed up, moron?”
Well, Mr. Crooks is not interested in why my career has so many periods of sudden unemployment and inexplicably moving far, far away to start fresh in a new town with a new name, and merely says that there are crises erupting all over the place, and now all those carry trades that were so pleasurable when things were calm and stable are now unwinding because, “Investors and institutions inside and outside of Japan are pulling away from risk and repaying their yen loans” as the volatility increases losses and makes everyone really, really nervous.
All of this means that there is a reason to think that the yen would get really, really strong, which would mean that the dollar would get really, really weak, which means that gold would really, really go up in price, at which point I usually stop and remind everyone to buy gold, and lots of it, and right now, which nobody does, and then I get frustrated and angry and end up getting really, really drunk and laughing at them in my hazy stupor and call them bad names. And loudly, too.
Until next time,
The Mogambo Guru
for The Daily Reckoning
The Mogambo Sez: Verily I sing the praises of gold and silver, as the past few weeks and months and years prove my trust in the lessons of 4,000 years of human economic history, as it, too, sings its praises of gold and silver with example after example after example of governments gone insane with expansions of their money supply, one after another, the whole time, including right freaking now, and how they all fell into inflationary bonfires and were destroyed as a result, one after another, the whole time, including right freaking now, and how those who held gold and silver did verily prosper, one after another, the whole time, including right freaking now. Verily I sing the praises of gold and silver!
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.