Anyone who cares to see who received the benefits of the stimulus needs to look no further….
Andy Sutton's Extemporania
Weekly Commentaries and Occasional Observations
Tags: silver
Chart of the Day
Dollar Slide Continues; Gold at New Record
TOKYO (AFP) – The dollar tumbled to a fresh 15-year low at 82.22 against the yen in Tokyo trading hours on Thursday on persistent fears over the US economic outlook.
The dollar fell from 82.87 in earlier trade to well below the level at which Japan last month carried out its first currency market intervention since 2004 to weaken the yen and protect an export-led recovery.
It later strengthened back to the mid 82-yen level.
The markets increasingly expect the US Federal Reserve to pump more money into the system to boost the flagging economy, even if doing so weakens the dollar and risks fanning inflation.
“The basic trend is dollar selling on the expected credit easing… The market is now sensitive to any negative news on the US economy,” said Yasuyuki Takeuchi, dealer at Mitsubishi UFJ Trust and Banking.
The Australian dollar on Thursday surged to an all time high of around 99.00 US cents, traders said, outstripping the record of 98.49 since it was allowed to float in December 1983.
The euro was trading close the key 1.40 dollar level, at around 1.3983.
“A lot of the trading community thinks this has further to go,” Daragh Maher, a senior currencies analyst at Credit Agricole in London told Dow Jones Newswires.
The greenback has been pressured after a report from payrolls firm ADP showed an unexpected drop in private sector jobs in September, highlighting fears about the lagging economic recovery.
The data added to worries that a closely watched government survey on non-farm payrolls for September due Friday may also indicate weakness.
The markets increasingly expect the US Federal Reserve to pump more money into the system to boost the flagging economy, even if doing so weakens the dollar and risks fanning inflation.
Tokyo has also repeatedly warned it is ready to step into the markets again, with Prime Minister Naoto Kan threatening further “decisive” steps if necessary on Thursday.
The yen’s continued strength follows moves by the Bank of Japan on Tuesday to adopt a near zero-rate policy and new pump-priming measures in a bid to spur growth, beat deflation and address the impact of the surging yen on the economy.
The strong yen has hurt Japan’s exporters, making their goods more expensive and eroding overseas profits when repatriated. Exports expanded at their slowest pace this year in August, with falling demand adding to their woes.
A strong domestic currency also makes imports cheaper, helping prolong a damaging deflationary cycle where consumers hold off on purchases in the hope of further price drops, clouding future corporate investment
Gold Soars to New Record
Bloomberg News
Gold rose to a record, Treasuries rallied and stocks halted a four-day advance amid a slump in German confidence and concern China will cool its real-estate market. The yen rose to a 15-year high versus the dollar on speculation Japan is less likely to weaken its currency.
Gold futures rallied as much as 1.8 percent to $1,269.20 an ounce and the 10-year Treasury note yield lost 6 basis points to 2.69 percent at 10:06 a.m. in New York as investors pursued assets believed to be the safest. The Standard & Poor’s 500 Index and the Stoxx Europe 600 Index decreased 0.2 percent. The yen appreciated against all 16 most-traded peers and the Swiss franc touched $1 for the first time this year.
The MSCI World Index of stocks in 24 developed nations dropped for the first time in five days as investor confidence in Germany fell to a 19-month low in September, according to the ZEW Center for European Economic Research, and China’s Premier Wen Jiabao cautioned that rising property prices may stoke unrest. Better-than-estimated growth in U.S. retail sales and business inventories failed to extend the equity market’s rally after the S&P 500 climbed to a one-month high yesterday.
“It’s a sloppy, mixed-data environment,” said Stephen Wood, the New York-based chief market strategist for Russell Investments, which manages $140 billion. “We had good retail sales data. However, German confidence and indications that China may continue to cool down its economy show that the economic environment continues to be very choppy.”
CESBD July Adjustment
The Division of Current Employment Statistics within the Dept. of Labor released their Birth/Death model adjustment for August, adding 6,000 fictitious jobs to the numbers. Notable in the adjustment was the removal of 32,000 manufacturing jobs. I wonder if the Politburo still thinks manufacturing is going to lead us to economic might?
For anyone who is insterested in seeing this data on a monthly basis or in looking at historial figures, Click Here.
Liberty Talk Radio Interview
Andy spent an hour with Joe Cristiano on Liberty Talk Radio discussing the global financial crisis, the problems in the Eurozone, and some of the different scenarios for our financial markets moving forward. To listen, Click Here
–flation, Bubbles, and Gold
Sometimes a picture really is worth a thousand words, even if it is only to prove a point that common sense dictates should have been won a long time ago. But common sense seems to be in short supply and not only has the point not been won, it isn’t even being discussed right now. Yes, it is the age-old debate on where price inflation comes from. It is also a foregone conclusion that the US is heading towards a Weimar style hyperinflationary depression. Left to normal circumstances, that is logical conclusion. However, there are several developments that point to the possibility of another deflationary depression, similar to the 1930’s. We’ll get to that later. For starters, let’s put to bed (hopefully) once and for all where price inflation comes from.
Inflation
There are two camps and they argue bitterly. One claims that prices rise because of supply and demand factors (which is partially true) and as a function of a healthy economy, which is patently false. The other side argues correctly that prices rise because the supply of money and/or credit has increased – effectively monetizing demand, which pushes up price levels. Some analysts have argued that there is no inflation because the price of electronics always seems to drop. In the second half of 2008 they argued that there was no inflation because petroleum prices were falling. They made the tragic mistake of substituting a single good for the concept of ‘general price level’.
It is categorically impossible for general price levels to increase in the long run without a commensurate increase in the supply of money and credit. It is important here to make the distinction between short and long run. In the short run, an increase in general prices can be absorbed without a growth in the money supply because it could, in theory, be sustained by devouring savings. But in practice, generally speaking, that isn’t how things work. People tend not to expand spending unless they feel comfortable that money and (particularly) credit are readily available. The housing bubble of the early 21st century is a prime example.
Bubbles
Out of fear of destroying a very easy point, I am going to let the three charts shown below along with a very brief narrative speak for themselves. Then you decide what fueled the housing bubble, and drove up house prices along with general price levels.
As can easily be seen in the above chart, 30-year mortgage rates dropped steadily from 1981 through the present. Not surprisingly, low rates and readily available credit led to a massive price expansion by monetizing demand.
Clearly the expansion in money had to come from somewhere to fuel lower mortgage rates and the expansion in home prices. The chart below, with brackets for the 1990-2007 period shows exactly where it came from. M3 in the US nearly tripled during that 17-year period.
Deflation??
One thing that should be utterly frightening is the recent freefall of M3 growth. Most folks understand that inflation has been responsible for the vast majority of our economic ‘growth’ over the past century. Inflation fueled the dotcom and real estate bubbles. In short, our economy is set up to run in an inflationary environment. Unfortunately, there is a predictable end to this scheme. At some point, the monetary environment devolves into hyperinflation, then a deflationary collapse. We certainly haven’t experienced hyperinflation yet in the US, and we know the Fed can win a battle with deflation because it can create as much money as is necessary to overwhelm deflationary forces. The current Chairman didn’t get his nickname because he used to fly puddle jumpers. So we’re left to ask: what exactly is going on here?
I think the answer lies in the fact that there are roughly 20 countries right now that are on the verge of bankruptcy and an outright default – the US and UK among them. The US clearly isn’t the only nation in hot water with debt. Greece is a pitifully minute example of what is really a systemic problem for much of the West. In my opinion, we are likely moving towards a coordinated outright default, which will involve the devaluation of currencies followed by central banks capping money growth, which in turn will trigger a second deflationary depression. Most people realize that we now have a fiscal gap of around $100 Trillion just in the US alone. It cannot be filled via conventional means consisting of tax increases and program cuts. I and many others wrote years ago that we needed to address those issues right then or lose our chance. We didn’t do it. There are two choices now: hyperinflation or default. While the collapse in M3 growth does not yet constitute de facto proof that we’re headed for the default scenario, it is certainly something that has to be considered. The good news in that scenario is that cash money would be worth more because it would be in short supply. The bad news is that there won’t be enough of it to maintain our current standard of living – especially in a situation where there is a concurrent devaluation.
Gold
Many will be wondering how I can be an advocate of Gold and Silver in such an environment? The benefits of precious metals are well documented in the case of hyperinflation, but not so much so in the case of deflation. It is a pretty simple and logical conclusion that if there is a shortage of cash, then the presence of cash ‘substitutes’ will be very beneficial. This is especially true in local commerce as in the 1930’s when many areas saw the widespread use of ‘co-ops’ or local trading blocs. The rationale for holding precious metals will be different than if we experience hyperinflation, and their use would be different as well, but I think it is foolish to assume that they’d be a detriment in either case.
Hopefully everyone reading this understands the importance of watching the monetary aggregates for clues as to what is coming down the road. Thanks to nowandfutures.com for providing the continuation of the M3 series depicted in the chart above. Ultimately, our monetary destiny now lies in the hands of global banking interests. We will proceed down the path that best serves them, not our national interest. Congress abdicated its responsibility for our money, as outlined in Article 1, Section 8 of the US Constitution, when it passed the Federal Reserve Act back in 1913. The best thing this Congress could do with the rest of its time is craft and pass legislation to repeal that Act in its entirety.
This tax day, April 15th, we’ll be releasing the next issue of The Centsible Investor. Our focus this month will be on the President’s Working Group on Financial Markets, aka the Plunge Team. We’ll also examine the prospects for $100 oil and analyze a company that makes its money selling electrical generation, process automation, and a vast array of other products to industries ranging from petroleum exploration and pharmaceuticals to automobile manufacturers. Don’t miss it! Click Here for more information.
Basic Financial Analysis – Part II
Last time we discussed the concept of valuation for some different types of investments and the formation of themes that can be used to help zero in on potential areas for focus. This week we’ll take a look at some ways of breaking down industries and sectors, sizing companies, then connecting the dots between economic themes and investment needs.
If you go to the NYSE website, you will be able to find what is called an Industry Classification Breakdown or ICB. There are ten major industries with varying numbers of supersectors, sectors, and subsectors under each major heading. Now let’s say for example, in your reflections on what the major economic and investing themes happened to be that you zeroed in on consumer staples as an area that is positioned for success. At this point we are assuming that you’re not interested in just finding an ETF or Closed-End Fund that gives exposure to firms that produce consumer staples, but are interested in becoming more acquainted with some of the individual firms themselves. Once you have performed your basic analysis, you’ll know which firms you’d want an ETF or other Fund to include or can purchase them outright and will be an informed shopper so to speak.
That said, when you go to the ICB listing for Consumer Goods, you will find the following:
Clearly you are not interested in examining all of these areas. Your focus as decided above is on staple goods. Immediately, the broad category of Leisure Goods can be eliminated. Automobiles can probably be eliminated as well if we’re focusing totally on staples or necessities. This leaves a wide sampling of categories. For the purposes of this discussion and in the interests of brevity, we’ll limit our analysis to a single sub sector – Food Products.
Before we continue, some limitations of this search methodology must be identified as well. The NYSE search is only going to show the firms that are listed on NYSE. It will not show international firms that are listed on other major exchanges, but not on the NYSE. The good news is that many of the larger firms are dual-listed. The bad news is that by limiting your search to only NYSE-listed issues, you will likely miss some good possibilities. Many of the other major exchanges such as the TSX also have similar search capabilities and by spending a little time, you can quickly assemble a rather comprehensive list of investment possibilities within any given sub-sector.
A look into the Food Products sub-sector reveals no less than 46 US-listed companies and their related securities. The information provided is limited to the name of the firm, the ticker symbol, last trade / trade date, volume, change($), and change(%). At this point, the biggest tendency for individual investors is to scan the list, find the name of a firm they know and start their search there. This is not the way to go; emotion has already entered the equation and in your mind you’re already playing favorites and biases have taken control of the process. At this point, you must consider your own objectives:
• When will you need this money?
• What do you anticipate eventually using the money for?
• How much money do you have to work with?
• What is your risk tolerance?
The answers to these questions will help you decide on what types of firms you’re looking for. Do you want large companies with low volatility that pay high dividends? If you’re approaching retirement, this might be the way to go. If you’re younger and are looking for capital appreciation, you might consider looking at some of the smaller companies that are more volatile, but have more room to grow. Are you risk averse? The fact that you’re looking at consumer staples to begin with might say something about your willingness to accept risk (wait, I picked that category!).
This is an important part of the process. We are now connecting the economic themes that we decided will be important with our own personal situation. The worst thing anyone can do is take his or her own themes, then just grab someone else’s prepackaged strategy without considering if it actually fits. It is the financial equivalent of buying a pair of trousers without bothering to look at the size, choosing rather to buy them because you thought they looked good on somebody else.
So in our hypothetical analysis, we decided that the economy is in recession and is likely to be there for some time, and have come to the conclusion that people will cut back on discretionary spending (which they have). We realize that inflation is a problem, and so leaving our capital in a bank account is not the greatest idea if we expect to maintain our purchasing power. Food products will certainly not be the only theme we invest in, but it is a good starting point.
Large or Small?
The next issue becomes the determination of what constitutes a large company and what constitutes a small one. Obviously, there are a number of characteristics that may be used to determine this, but one of the most generally accepted definitions is the firm’s market capitalization. Market capitalization is the share price multiplied by the number of outstanding shares. Another way of expressing market cap is that it represents the public opinion of the value of the company. The sizing of companies can generally be lumped into the following brackets:
• Large-Cap Companies $10 Billion – $200 Billion (or more)
• Mid-Cap Companies – $2 Billion – $10 Billion
• Small-Cap Companies – $200 Million – $2 Billion
• Micro-Cap Companies – Less than $200 Million
Using the Food Products sub-sector as our continuing example, of the 46 issues in that category, the breakdown is as follows:
As is evidenced by the chart above, there is a solid distribution of firms in this sector according to size as measured by market capitalization with most of the companies (33) falling in the small or mid cap range. This distribution is good news as it means that no matter what your investment goals and risk profile, you should be able to find a reasonable number of firms that are desirable for addition into a portfolio, or are firms that should be looked for when looking at ETFs and open/closed end funds.
Using this methodology it is fairly easy to drill down to potential specific investment possibilities from a variety of economic themes. What we need to accomplish next is creating a definition of value and the parameters by which we will measure it. Next time we’ll take a look at some of the popular valuation metrics and develop a few of our own as well, which we can add to our toolbox as we continue to chase the oftentimes elusive concept of value.
Individuals interested in learning more about the major macroeconomic themes should take a moment to listen to some of our informative podcasts. We’ve recently had guest experts like Laurence Kotlikoff; John Williams of shadowstats.com, and Bill Murphy of GATA appear to discuss their areas of expertise. For more information or to listen, please take a moment to visit www.my2centsonline.com/radioshow.php
"Spin Cycle" Welcomes Laurence Kotlikoff
Today’s special guest on ‘Spin Cycle’ is Laurence Kotlikoff, Professor of Economics and Research Associate for the National Bureau of Economic Research. In today’s show, we discuss the fiscal gap that exists in the United States from both a government and consumption perspective.
Professor Kotlikoff will be speaking at the Cato Institute on 6/8/2009 at 4PM and will address these issues as well as some common-sense solutions. Please contact your Senators and Representatives and urge them to attend.
The interview may be heard by clicking here
Professor Kotlikoff’s site may be visited here
Triple-A or Bust?
If you take a short walk down memory lane, it will not take you very long to find the carcass of New Century Financial along the side of the road back in March 2007. It would be a full 12 months before the word recession would be mentioned in the US mainstream media and stock markets would roar into their all-time highs six months after the disintegration of New Century. Much of the early portion of the credit crisis as it was called focused on mortgages and after that, mortgage-backed securities. Wow, haven’t heard that term in a while, have we?
Much of the scuttlebutt at the time centered around the ratings which were assigned to these mortgage bonds and people started asking questions about how all of these Triple-A rated bonds could suddenly be worthless and why bonds with this high of a rating were paying historic spreads above and beyond US government debt of the same maturities (which are also rated Triple-A).
An Example of the spread between Triple-A rated securities
Of course the foundations for this comparison in the first place are the quality and status of US government debt, which, until recently, was sacrosanct in borrowing circles. In the past week there have been headlines galore (again) that the US is in jeopardy of losing its Triple-A credit rating. Given what we already know about the government’s finances, how can a pristine credit rating and Uncle Sam be mentioned in the same sentence? And perhaps more importantly, can ratings issued by the major agencies be worth more than a defaulted mortgage tranche after the ratings fiasco of the past few years? Consider the following:
“According to the Financial Times report, “Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch Triple-A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower.” Yet the ratings were maintained at Triple-A.”
So why the big todo about the US Government and its Triple-A rating? The point is it shouldn’t have one to begin with. While I am sure this statement doesn’t constitute a revelation to anyone, it is a point that most in the main stream media are once again missing. Some big names have lost Triple-A credit ratings over the past few months. General Electric and the venerable Berkshire Hathaway are two notable examples. AIG lost its Triple-A rating in 2005, and bond insurer Ambac lost its Triple-A rating in 2008.
In the case of normal businesses, the credit rating is a reflection of the firm’s financial position and the market forces that are likely to impact the firm over various periods of time. The firm’s balance sheet is examined. Its revenues and obligations are dissected. The credit rating is then assigned based on the preponderance of these factors and indicates to investors the likelihood of default on the firm’s debt. Investors are then able to make informed decisions. At least this is how it is supposed to work.
Moody’s / S&P Default Probability Models
However, there is one major difference between a normal business and the US Government. Unlike a normal business enterprise, the US Government has a bank on retainer that can create money from nothing and is willing to lend at ridiculously low rates. It can accomplish this task in many ways, but the most direct is called monetization, which consists of the Fed buying bond issues directly from the government. Ostensibly, this is done to prevent the government from having to fund its massive appetite for funds externally. As if there is something honorable about owing your future to a private bank as opposed to another sovereign nation. Further evidence of the Fed’s willingness to monetize additional debt emerged this week:
“Some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery.”
Is an entity that requires this type of arrangement for its financial survival deserving of the highest credit rating? How about an entity that is going to have to borrow 46 cents for every dollar it spends during FY 2009? How about an entity that is institutionalizing trillion dollar deficits for the next decade? How about an entity that has a bare minimum of $53 Trillion in contingent unfunded liabilities (nearly four times GDP)?
After this most recent bevy of news headlines regarding the rating situation, Treasury Secy. Tim Geithner promptly got on TV to talk about cutting the budget deficits.
“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year.
Putting this in the context of our current situation, this would require the deficit to be cut from a projected $1.8 Trillion to just $418 Billion – which is where it was before the current blowout. This is an important distinction as promises by government officials to actually balance the budget are fading quickly into the ether. Now we’re only worried about carrying ‘sustainable’ debt. The problem is that none of these debts are ever paid back and as such, they accumulate all the while piling on interest.
In order to pay off our debt, not only would we have to stop running deficits, we’d actually have to run surpluses. If we ran could manage a surplus that was 3% of GDP each year, it would take us over 30 years to pay off what we already owe on the national debt. That is three decades of smaller government, bare essential expenditures, and the complete dissolution of the ‘cradle to grave’ mentality our government has espoused for the last half century.
Geithner, 47, also said that the rise in yields on Treasury securities this year “is a sign that things are improving” and that “there is a little less acute concern about the depth of the recession.”
This is nothing more than just economic pumping. What the rise in yields is really saying is that when the Fed doesn’t step in and buy US Government bonds that nobody else wants them either. Why would any sane individual lend to somebody that is up to their eyeballs in debt and isn’t even the least bit interested in changing their behavior? To make matters worse, why would any sane individual lend to an entity that proposes to repay the loan in currency that is losing its value?
30-Year Bond Yields
In the above chart, we can see the yield for the 30-year bond. The Fed began indirectly monetizing in the fall of 2008 as the proceeds of TAF, TSLF, etc. went directly to the Treasury window driving yields to nothing. Another spurt of direct Fed monetization in March led to a quick drop in yields, but since then they have been moving relentlessly higher. Foreigners have not stopped buying US Treasuries by any means, but they have certainly slowed their purchases. This leaves the Fed as the buyer of last resort. Certainly Secy. Geithner understands all this, especially considering he used to be the President of the NY Federal Reserve Bank.
Does any of the above sound financially virtuous and deserving of a pristine credit rating? In the end it matters not what Moody’s or S&P have to say about the creditworthiness of the US Government. Our creditors are already speaking. And they aren’t singing our praises.
In our ‘Spin Cycle’ podcast, we are currently doing a 7-part series in which we depict the factors affecting the US economy as sides of a Rubik’s Cube – independent, yet interrelated. On June 3rd, we welcome Professor Laurence Kotlikoff to discuss generational accounting and our mounting debt. To listen, visit www.my2centsonline.com/radioshow.php