Market Update

New Marc Faber

2010-03-19T11:01:00.000-07:00

Marc Faber: We Have a New Gold Standard
Published: Thursday, 18 Mar 2010 | 5:53 AM ET
Text Size
By: Antonia Oprita
Web Producer, CNBC.com

The markets have created their own gold standard because of uncertainties regarding other asset classes, Marc Faber, author of "The Gloom, Boom and Doom Report," told CNBC Thursday.

Gold Bars
AP

"I think we already have now a gold standard … created by the market place," Faber told "Squawk Box Europe."

"We have the (exchange traded funds) that have proliferated and we have more and more physical buying of gold," he said.

Between 2001 and 2008, gold outperformed bonds and stocks, but starting with 2009 stocks outperformed, which means investors must own gold because generally retail investors cannot move in and out of different assets like institutional investors, Faber said.

For the next six months, the global economy will look better, particularly compared with March 2009 when the downturn was at its worst, he said, adding that he would buy oil and mining companies, especially Exxon [XOM 66.77 -0.62 (-0.92%) ], Chevron [CVX 74.28 -0.48 (-0.64%) ] and Schlumberger [SLB 64.18 -1.07 (-1.64%) ].

"I think that the oil price would rather go up than down. I think oil stocks would perform rather well, by the way also mining companies," Faber said.

Investors should have a minimum of 50 percent of their money in emerging economies because these are growing much faster than the developed world, he recommended.

Treasurys to Yield 10-20%

An extreme bubble in US Treasurys has been deflated for the moment and yields are likely to rise sharply over the next years, Faber told CNBC.com separately.

"I still think that Treasurys are overpriced," Faber said.

Yields on 10-year US Treasurys are likely to rise to between 10 and 20 percent over the next 5 to 10 years because of inflation and oversupply, he said.

Money-printing is just another way for governments to silently default on their debt Faber wrote in the latest "Gloom, Boom & Doom Report."

When a company or a government actually default on their payment obligations, the process is relatively fair because lenders get just 30, 60 or 80 cents a dollar for the money they lent, Faber wrote.

"But if a government decides to default through money printing, the burden of the default isn't shared equally," he wrote.

"Defaulting through money printing means the repayment of the creditors occurs in a currency whose purchasing power was severely curtailed through the money-printing process," Faber explained.

He said rising cost of living, a depreciating currency against other currencies or against precious metals and commodities are common symptoms of a loss in the purchasing power of a currency.

In an environment of inflation, cash and government bonds are "poison" although the current rally in stocks is partially caused by low interest rates, Faber told "Squawk Box Europe."

Investors should avoid bonds and cash over the next 10 years and choose stocks instead, he said, but warned that printing money will lead to an economic collapse in the end.

"Before we have the final collapse that will be a deflationary collapse, we will have more and more money printing."

"I think interest rates forever in the US will be at zero, by zero I mean below the rate of inflation," Faber predicted.

"It will result in a lot of inflation but inflation has a lot of different symptoms."

The financial sector, especially firms that know how to move money quickly between various asset classes, stand to gain from the increasing volatility, Faber said.

"In periods of money printing and debasing of currencies, wealth becomes concentrated in the Goldman Sachses [GS 177.00 -0.45 (-0.25%) ] of the world because they can move money quickly," he said.

There is a danger that US public debt will grow so much that "the government will need to print money just to pay the interest on the government debt," Faber wrote.

Interest payments on the US government debt could rise to between 35 percent and 50 percent of tax revenues within 10 years, from the current 13 percent of tax revenues, he also wrote.

Greece Must Be Bailed Out

In Europe, the situation is different, he told CNBC.com.

"Greece cannot print money, the US can," Faber noted. "If Greece wished to default through nonpayment of their internal debt they could devalue and exit the EU," he said.

Under EU legislation, European Union members with the exception of Britain and Denmark must all adopt the euro as their currency and those already in the euro zone cannot leave the monetary union.

But German chancellor Angela Merkel called for a change of the EU legislation to allow the expulsion of a country from the euro zone if it breaches fiscal rules repeatedly, signaling a willingness of European politicians to change the rules of the game.

"If Greece stays in, it has to be bailed out," Faber said.

"I don't regard the euro as a specifically better currency than the dollar," he also said.

Aricle from Charlie Munger

2010-02-25T10:31:00.000-08:00

Basically, It's OverA parable about how one nation came to financial ruin.
By Charles MungerUpdated Sunday, Feb. 21, 2010, at 3:30 PM ET

Wall Street.In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature's bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island "Basicland."

The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or for ordinary daily purchases.
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Moreover, almost no debt was used to purchase or carry securities or other investments, including real estate and tangible personal property. The one exception was the widespread presence of secured, high-down-payment, fully amortizing, fixed-rate loans on sound houses, other real estate, vehicles, and appliances, to be used by industrious persons who lived within their means. Speculation in Basicland's security and commodity markets was always rigorously discouraged and remained small. There was no trading in options on securities or in derivatives other than "plain vanilla" commodity contracts cleared through responsible exchanges under laws that greatly limited use of financial leverage.

In its first 150 years, the government of Basicland spent no more than 7 percent of its gross domestic product in providing its citizens with essential services such as fire protection, water, sewage and garbage removal, some education, defense forces, courts, and immigration control. A strong family-oriented culture emphasizing duty to relatives, plus considerable private charity, provided the only social safety net.

The tax system was also simple. In the early years, governmental revenues came almost entirely from import duties, and taxes received matched government expenditures. There was never much debt outstanding in the form of government bonds.

As Adam Smith would have expected, GDP per person grew steadily. Indeed, in the modern area it grew in real terms at 3 percent per year, decade after decade, until Basicland led the world in GDP per person. As this happened, taxes on sales, income, property, and payrolls were introduced. Eventually total taxes, matched by total government expenditures, amounted to 35 percent of GDP. The revenue from increased taxes was spent on more government-run education and a substantial government-run social safety net, including medical care and pensions.

A regular increase in such tax-financed government spending, under systems hard to "game" by the unworthy, was considered a moral imperative—a sort of egality-promoting national dividend—so long as growth of such spending was kept well below the growth rate of the country's GDP per person.

Basicland also sought to avoid trouble through a policy that kept imports and exports in near balance, with each amounting to about 25 percent of GDP. Some citizens were initially nervous because 60 percent of imports consisted of absolutely essential coal and oil. But, as the years rolled by with no terrible consequences from this dependency, such worry melted away.

Basicland was exceptionally creditworthy, with no significant deficit ever allowed. And the present value of large "off-book" promises to provide future medical care and pensions appeared unlikely to cause problems, given Basicland's steady 3 percent growth in GDP per person and restraint in making unfunded promises. Basicland seemed to have a system that would long assure its felicity and long induce other nations to follow its example—thus improving the welfare of all humanity.

But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland's citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called "the bucket shop system."

The winnings of the casinos eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called "financial derivatives."

Many people, particularly foreigners with savings to invest, regarded this situation as disgraceful. After all, they reasoned, it was just common sense for lenders to avoid gambling addicts. As a result, almost all foreigners avoided holding Basicland's currency or owning its bonds. They feared big trouble if the gambling-addicted citizens of Basicland were suddenly faced with hardship.

And then came the twin shocks. Hydrocarbon prices rose to new highs. And in Basicland's export markets there was a dramatic increase in low-cost competition from developing countries. It was soon obvious that the same exports that had formerly amounted to 25 percent of Basicland's GDP would now only amount to 10 percent. Meanwhile, hydrocarbon imports would amount to 30 percent of GDP, instead of 15 percent. Suddenly Basicland had to come up with 30 percent of its GDP every year, in foreign currency, to pay its creditors.

How was Basicland to adjust to this brutal new reality? This problem so stumped Basicland's politicians that they asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the "Good Father." Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions.

Among the suggestions of the Good Father were the following. First, he suggested that Basicland change its laws. It should strongly discourage casino gambling, partly through a complete ban on the trading in financial derivatives, and it should encourage former casino employees—and former casino patrons—to produce and sell items that foreigners were willing to buy. Second, as this change was sure to be painful, he suggested that Basicland's citizens cheerfully embrace their fate. After all, he observed, a man diagnosed with lung cancer is willing to quit smoking and undergo surgery because it is likely to prolong his life.

The views of the Good Father drew some approval, mostly from people who admired the fiscal virtue of the Romans during the Punic Wars. But others, including many of Basicland's prominent economists, had strong objections. These economists had intense faith that any outcome at all in a free market—even wild growth in casino gambling—is constructive. Indeed, these economists were so committed to their basic faith that they looked forward to the day when Basicland would expand real securities trading, as a percentage of securities outstanding, by a factor of 100, so that it could match the speculation level present in the United States just before onslaught of the Great Recession that began in 2008.

The strong faith of these Basicland economists in the beneficence of hypergambling in both securities and financial derivatives stemmed from their utter rejection of the ideas of the great and long-dead economist who had known the most about hyperspeculation, John Maynard Keynes. Keynes had famously said, "When the capital development of a country is the byproduct of the operations of a casino, the job is likely to be ill done." It was easy for these economists to dismiss such a sentence because securities had been so long associated with respectable wealth, and financial derivatives seemed so similar to securities.

Basicland's investment and commercial bankers were hostile to change. Like the objecting economists, the bankers wanted change exactly opposite to change wanted by the Good Father. Such bankers provided constructive services to Basicland. But they had only moderate earnings, which they deeply resented because Basicland's casinos—which provided no such constructive services—reported immoderate earnings from their bucket-shop systems. Moreover, foreign investment bankers had also reported immoderate earnings after building their own bucket-shop systems—and carefully obscuring this fact with ingenious twaddle, including claims that rational risk-management systems were in place, supervised by perfect regulators. Naturally, the ambitious Basicland bankers desired to prosper like the foreign bankers. And so they came to believe that the Good Father lacked any understanding of important and eternal causes of human progress that the bankers were trying to serve by creating more bucket shops in Basicland.

Of course, the most effective political opposition to change came from the gambling casinos themselves. This was not surprising, as at least one casino was located in each legislative district. The casinos resented being compared with cancer when they saw themselves as part of a long-established industry that provided harmless pleasure while improving the thinking skills of its customers.

As it worked out, the politicians ignored the Good Father one more time, and the Basicland banks were allowed to open bucket shops and to finance the purchase and carry of real securities with extreme financial leverage. A couple of economic messes followed, during which every constituency tried to avoid hardship by deflecting it to others. Much counterproductive governmental action was taken, and the country's credit was reduced to tatters. Basicland is now under new management, using a new governmental system. It also has a new nickname: Sorrowland.

Why I Hope Gold Falls to $1,000

2010-01-29T07:42:00.001-08:00

Why I Hope Gold Falls to $1,000
by Jeff Clark

As a self-professed gold bug, why would I possibly want my favorite investment to fall in value? Have the long hours finally caught up with me?

Au contraire; my near-constant devotion to all things gold has only served to crystallize one of the things I really want out of this. Here's a hint.

I had lunch with a reader at a recent conference, and while talking about one of my favorite subjects - gold stocks - I asked why he was invested so heavily in them. "Greed," he said bluntly and with little hesitation. I appreciated the honesty.

Let's be frank: I'm here to make money, and so are you. And that's why I hope gold falls to $1,000 again.

Let's say Bob has taken our advice and has been storing cash. I'll use $1,000 as an example. If Bob buys Yamana Gold now, he'd get about 93 shares as I write (at $10.73 per share).

Now, let's say gold drops to $1,000, about a 10% fall from here, and due to its leverage, AUY sells off by a 2-to-1 margin, meaning 20%. So with that same $1,000, Frank, who's waited for the downturn, buys 116 shares at around $8.58. Thus, instead of owning 93 shares at $10.73, he owns 116 shares at $8.58.

When Frank sells, he doesn't just make the difference between $8.58 and $10.73 (an extra 25%), he also makes 125% on the extra 23 shares he owns if Yamana doubles in a couple years, which I expect it to. So two years from now, Bob would have $2,000, but Frank would have $2,500 because he bought more shares and at a lower price. Frank makes 25% more than Bob on the same dollar investment simply by buying when gold and gold stocks fall in price.

Got $5,000 saved up? Multiply the profit by 5. And with larger amounts, you can see we're talking serious money.

I don't know if we'll see $1,000 again or not, or if Yamana will fall that low, but I would point out that corrections in the gold price can range as high as 20% (2008 notwithstanding), so a further sell-off in price would not be out of the ordinary. A 20% correction from gold's peak at $1,212.50 on December 2 would equal $970. That's not necessarily a prediction, but it shows you that price is certainly possible.

Don't like my wish? Remember, it's called a bull market for a reason; it's not a cow market or a puppy market. It's going to try and buck you off. But a correction to $1,000 or even lower can give you the chance to buy more, cheaper. Don't view sell-offs as a bad thing but rather as an opportunity.

Bring on $1,000!

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Jeff Clark
Editor of BIG GOLD
Casey Research

Grantham remarks on Supreme Court

2010-01-27T12:34:00.000-08:00

… and the Bad News
Supremely Extreme: Another “Day That Will Live in
Infamy”
Five Supreme Court justices today announced that not only
are corporations people and that their money is free speech
– this is old hat and a very ugly hat at that – but now, there
should be no limit to the money they spend to infl uence
political outcomes. This would be one thing if corporations
really were “democratic associations” of humans that the
Founding Fathers may have wanted to protect. They are,
instead, small oligarchies of top management. Thus, the
top management of major oil and coal companies can
decide what political outcomes they want to promote,
say, unlimited production of carbon dioxide (none of their
CEOs apparently has grandchildren!), utterly without
any approval of their decisions by the millions of actual
owners. The fi nancial power of corporations was already
in danger of overwhelming the democratic process in
Congress and this makes the damage potentially unlimited
and puts the Court’s seal of approval on it. So let’s do it in
style and have a name change. The U.C.A. has a familiar
look: The United Corporations of America!

Bear Index

2010-01-13T08:01:00.000-08:00

Average Investor Too Bullish

2010-01-07T11:28:00.000-08:00

By MarketWatch

ANNANDALE, Va. (MarketWatch) -- Finally, after a nearly 70% rally, a large number of bears are throwing in the towel.

And that's bad news, since it means the wall of worry that the bull market has been climbing is crumbling.

Consider the average recommended equity exposure among the shortest-term stock market timers tracked by the Hulbert Financial Digest. Over the last 24 hours it jumped another 6.5 percentage points to 65.2%.

That's the highest level since late December 2006, more than three years. As recently as early November, the average stood at just 3.2%.

A similar story is being told by the sentiment survey conducted weekly by the American Association of Individual Investors. In that survey, organization members visiting the AAII website are asked to report whether they think the stock market's trend is bullish, bearish, or neutral.

To consolidate those three percentages into a single barometer, researchers often calculate the ratio of the bullish percentage to the total percentage of those that are either bullish or bearish. That ratio currently stands at 68.2%, which is the highest level since February 2007.

Finally, consider the sentiment survey conducted weekly by Investors Intelligence, the latest of which was released this morning. That survey is based on the percentage of monitored newsletters that are bullish, bearish, or neutral.

The ratio of bulls to those either bullish or bearish now stands at 74.1%, which but for slightly higher readings in the last couple of weeks, is the highest since October 2007, the month of the stock market's all-time high.

The bottom line? Market appreciation over the coming weeks therefore will have to come without the sentiment winds blowing in stocks' sails.

Merry Christmas to the Markets

2009-12-28T11:51:00.001-08:00

'Twas the day before Christmas, when all through the land

Not a trader was stirring, and isn't that grand;

The markets were recovered from the depths of despair,

In hopes that we'd never revisit that scare;

Hedge fund managers were nestled all snug in their beds,

While visions of met high water marks danced in their heads;

And mutual funds in their performance, and I on the sell side

Had finally settled down after capital raises left us just fried.

In December in the markets there arose such a clatter,

I sprang to my Bloomberg to see what was the matter.

Away to Dubai the news flew like a flash,

Reporting debt extensions, investors feared the next crash.

The moon on the breast of the Palm Island sand

Gave the luster of guarantees from the other Emirates hand,

When, what to my wondering eyes should appear,

But a wine induced flashback of the events of last year,

The year had a poor start, with this deep deep recession,

I felt at that moment we were in a Great Depression.

But more rapid than eagles the Fed programs they came,

And Bernanke whistled, and shouted, and called them by name;

Now, TAF! Now TALF! Now CAP and low rates!

On, MMIF! On AMLF! On SCAP! There’s no time for debates!

To the stress test results! To the capital shortfall!

Now raise away! Raise away! Raise away all!

As dry dollars that before the wild hurricane fly,

When they meet with a bank stock, mount to the sky,

So up to "normalized earnings" the investors they flew,

With a sleigh full of funds for bonds and equities too.

And then in a twinkling I saw in the banks

The lifting and raising as buyers closed up their ranks.

As I drew in my bear claws and was turning around,

Down the stairs all the bankers came with a bound.

They were dressed all in suits from the heads to their feet,

And their clothes were all rumpled and they really looked beat;

Huge bundles of stock they had flung on their backs,

And they looked like peddlers opening their packs.

Investors eyes -- how they twinkled! Their demand it was strong!

Their appetites whetted! They craved to be long!

These droll great big deals were drawn up in great haste,

Since the window was open there was not a moment to waste;

The bulk of these deals were held tight by the street,

And the rally it encircled the globe like a wreath;

Hybrids and credit had a nice round rally,

That extended the move for those keeping a tally.

Things rapidly felt better, a right jolly move,

That shook out the bears who were caught in their groove;

A drop in the VIX and tightening spreads,

Soon gave me to know I had nothing to dread;

Data began to improve as liquidity went straight to work,

And sent markets yet higher, then we got a small jerk,

As Dubai meant sovereign debt widened out,

Markets had a twitched, having a moment of doubt;

The Fed sprang to its sleigh, to low rates have a bow,

And away the fears flew with new highs for the Dow

So with great joy after this year fraught with great fright

I say HAPPY CHRISTMAS TO ALL AND TO ALL A GOOD-NIGHT"

Thoughts from Wayne Jett

2009-12-17T08:25:00.000-08:00

FED PREDICAMENT EASES
Dollar Improves Slightly
By Wayne Jett © December 16, 2009
When America’s dominant elite began purging certain of Wall Street’s big players in 2008, Federal Reserve chairman Ben Bernanke stepped into the breach. He didn’t volunteer. He was taken there by the czar of purges, Treasury secretary and Goldman Sachs ex-CEO Henry Paulson. The experience must have changed his worldview, particularly his idea of the Fed’s place in the pecking order.
What Bernanke saw at the Bear Stearns tactical session was financial sausage-making. Securities & Exchange Commission chairman Christopher Cox was so shocked that he never came to another such session; something about concern on his part that he was supposed to be enforcing the securities laws.
The Purges of 2008
Bernanke was not expendable, as Cox was. Paulson needed the Federal Reserve to pump $25 billion in cash into Bear and guarantee another $29 billion or so of its financial assets before all of it was given to J. P. Morgan Chase, essentially for a big kiss. Did anyone mention that Morgan Chase is the giant international bank historically controlled by Rockefellers and Rothschilds?
Morgan Chase got fat on Bear, and Bear’s shareholders got skinned while Paulson held them upside down by their feet. Then the purge czar struck again, and again. Fannie Mae, Freddie Mac, Lehman Bros., AIG, National City (Ohio’s biggest bank), Merrill Lynch, Wachovia, Washington Mutual – each fell to his ax. The shareholders of these financial giants ate dirt as hundreds of billions of their invested capital poured into the pockets of fraudulent traders, thanks largely to “innovative” derivatives trading which counterfeited and “watered” their capital stock.
Chairman Bernanke dutifully waded from one slaughter to the next, doing as he was told, which meant providing financial backing for whatever terms the purge czar set for gifts to intended beneficiaries. Morgan Chase alone got both Bear Stearns and Washington Mutual, the Seattle-based national home mortgage lender. Morgan Chase’s CEO subsequently told his shareholders 2008 was the bank’s best year ever.
WaMu’s takedown emitted just as much stench of the purge czar as the other deals mentioned, even at the time. Recent reporting from Seattle investigators reveals FDIC’s Sheila Bair served as spearhead for the move against WaMu, which was seized when the firm had $29 billion in net liquidity, almost twice the five percent liquidity required. Subpoenas issued in bankruptcy proceedings are going after emails of others involved, including Morgan Chase and Goldman Sachs. Even without subpoena power applied by any criminal law enforcement agency, seizure of WaMu has all the earmarks of federal complicity in destruction of one private company for benefit of another.
The Fed’s Balance Sheet
As these financial purges were orchestrated, Chairman Bernanke found the Federal Reserve with a much enlarged balance sheet showing assets of an unprecedented nature. On his signature, the Fed advanced over $1.3 trillion for securities of varying nature, when the Fed’s total assets previously were $850 billion. Bernanke has been unwilling to say who sold him the securities, what prices were paid, or how prices were determined.
If the Fed were just another private bank, perhaps keeping confidences would seem acceptable. But the Fed, unlike other banks, prints the money it spends under license of the U. S. government. Every dollar issued by the Fed makes every other dollar held by Americans (not to mention people around the world) worth less than would be the case if the new dollar didn’t exist. This explains why some, even in Congress, want Bernanke to detail what he did with the $1.3 trillion before he is confirmed by the Senate for another term as Fed chairman.
When Bernanke was spending the money, he said he had no choice but to do it. Clearly someone made choices, because some banks were saved and some were slaughtered. As in Animal Farm, some banks are more equal than others, and the differences are not always apparent on their financial statements.
“De Plan, De Plan”
Bernanke also indicated he had a plan for extracting the new liquidity from the economy before the dollar’s value is swamped by it. But in a Senate hearing last week, Senator Jim Bunning revealed Bernanke told him by letter he has no such plan. Perhaps, again, the Fed chairman just doesn’t wish to talk about it.
In order to drain the $1.3 trillion in new liquidity, the Fed must dispose of the acquired assets at prices at least as high as were paid for them. If the assets were to prove worthless, the Fed simply could not drain the liquidity because it would have nothing to sell for it.
As previously reported here, the Fed bought those assets because their prices were being fraudulently manipulated lower by various maneuvers which created “toxic” images for them. The banks which owned the “toxic assets” were endangered by manipulation of their own share prices. The Fed bought in order to shield the assets and the banks from further attack, because the Fed itself was immune for naked short selling of its shares.
As previously warned, too, any sale of these “toxic assets” by the Fed might restart the bear attacks on their value and on the banks. In order for the Fed to proceed with confidence to market the assets and withdraw so much excess liquidity, fraudulent trading practices must be stopped. On this point a modicum of good news appears as a light in a tunnel.
Positive Developments
Bloomberg News reports leveraged loans rated below BBB- by S&P or below Baa3 by Moody’s have risen 49.3% in value this year, after falling 28.2% in 2008. BBB rated loans are said to be priced presently at about 55 cents on the dollar. Higher rated loans fell less, and have also recovered, rising from 69 cents to 89 cents on the dollar.
This is good news for Bernanke and the Fed, which might even sell the formerly toxic assets at a significant profit. If that were to happen, the Fed could actually strengthen the dollar by draining more dollars than it created to buy the assets. In reality, the Fed probably would not destroy those dollars, since its practice is to give excess “earnings” to the Treasury to spend. The markets noticed, of course, as the dollar recovered somewhat from above $1,200/oz gold.
The strong price recovery of collateralized debt obligations can be traced to incremental changes in market conditions which enabled their prices to be beaten down. By demand of Congress, the FASB modified or clarified its Rule 157, which had required “mark-to-market” accounting the value of these assets. The ABX.HE index was outed somewhat as an unreliable indicator of real market value of such assets. The SEC repealed its “Madoff exception” regulation which so importantly assisted bear attacks on financial shares, as it permitted market makers in credit default swaps and options to hedge by selling shares short without borrowing or delivering the shares sold within a definite time limit.
Reforms Left Undone
Each of these reforms was absolutely essential to achieve the meager amount of recovery, or slowing of the drop, seen in 2009. But so much more remains undone. Reform of oil price manipulation passed the House, but only in a larger bill containing more bad than good. By past performance of Wall Street and Congress, all of the good is likely to be stripped from the bill, assuming the Senate acts and legislation actually makes it to conference. Meanwhile, the SEC still has done nothing to stop High Frequency Trading (front-running all trades) or to restore the Uptick Rule, and is unlikely to act unless Congress requires it by statute.
Confirmation of Bernanke’s re-nomination as Fed chairman is due to be considered by the Senate on December 17, but may be delayed by request of an individual senator. A rumor is out that he may withdraw his name. Even with the positive development reported above, what he learned the past 22 months may lead him to think the predators are not finished. ~

Fidelity Comments

2009-12-09T09:50:00.000-08:00

The Great Depression was actually two depressions. It started with World War One, which essentially bankrupted Europe in the 1920's. The
U.S.—via the Fed—lent a helping hand by extending easy money to Europe, around 1925-1927. However, in a classic example of the "laws
of unintended consequences," some of this easy money ended up in our own stock market, thus contributing to the massive bubble that burst
in 1929. This episode shows that the concept of "moral hazard" is not new. It existed as far back as the 1920's.
When the bubble burst in 1929, it unleashed a wave of deflationary debt deleveraging onto the U.S. economy, much like occurred in 2008
after the housing bubble burst. However, during the 1930's the Fed was on the gold standard, which made it impossible to just open up the
liquidity spigot like it did last year. In fact, the gold standard acted somewhat like a straight jacket and the Fed actually raised rates for a while,
which is obviously the last thing you one should be doing during an economic crisis. This "policy error" undoubtedly contributed to the 87%
blood bath in stocks from 1929 to 1932.
Bernanke knows this well, which is probably why he responded with such overwhelming force in the fall of 2008 following the collapse of
Lehman. Not only did the Fed lower rates to zero, but it expanded the monetary base. We call this "quantitative easing" or more simply
"printing money”.
The idea behind quantitative easing is that the Fed creates (out of thin air) excess banking reserves. Those reserves end up on the balance
sheet of the banks, who are then supposed to lend out these new reserves to consumers and businesses. That triggers what is known as the
money multiplier, which then expands the money supply and brings the economy back to life, and creates inflation (which under those
circumstances is a desired outcome).
The problem back then was that the Gold Standard prevented the Fed from doing this, until Franklin D. Roosevelt (FDR) came into power in
1933. FDR realized that the gold standard was limiting his ability to respond to the crisis, and in April of 1933 he changed it. He did this by
making it illegal to own gold. Holders of gold had to turn in their bullion and they received the stated conversion price of $20/oz. FDR then
changed the conversion price to $35/oz, and with the stroke of a pen he increased the money supply by 60% and devalued the dollar at the
same time. That was the catalyst for a 150% rally in the stock market and several years of very strong economic growth.

Marty Whitman & Joe Huber

2009-12-04T14:21:00.000-08:00

Here’s a quick article from the great portfolio manager Marty Whitman. I sold most of the holdings I had in his fund last year because he held onto some stocks way too long. Whitman talks about the value one should pay when buying a stock. It’s not a bad way to buy stocks—provided the underlying assets don’t drop in value. They did last year. Whitman gave $25 million to my alma mater—Syracuse School of Management.

Also, I have a link to my friend Joe Huber’s mutual fund. Joe broke off from Hotchkiss & Wiley and put out his own shingle. One of his funds is up 81% year-to-date, number one according to the Wall Street Journal. If you want to talk to Joe, let me know.

http://online.wsj.com/fund/page/fund_scorecards.html?classification=106&returnTime=Daily_Tr_1Y~best&submit.x=1

StreetDogs: It will take more than a 45% loss to subdue this 85-year-old man

Published: 2009/12/03 06:47:47 AM

MARTIN Whitman, the 85-year-old chief investment officer of Third Avenue Fund, who once described it as “better than the toll booth on George Washington Bridge”, lost 45% of his fund last year.

Prior to 2007, Whitman, who is a legend at picking over the balance sheets of troubled companies in search of hidden treasures, had achieved a track record of approximately 17% a year going back to 1990.

Despite having lost 24% of the fund’s value during 1998 and 1999, Whitman — who calls himself the “safe and cheap” investor — only buys at a “big” discount to net asset value.

His definition of net asset value being what a company would sell for in a takeover or on auction.

So, how much of a discount? “Don’t pay more than 50%-60% of what a business is worth,” he advised in a 2006 interview.

“It is … crazy to pay more than 60c on a dollar for noncontrolling interests in businesses. Outsiders always face agency problems.”

Besides cheap, Whitman also wants a strong balance sheet; competent, shareholder-oriented management as well as “understandable and honest disclosure documents”. Balance sheets are much more important than the income statement, he says.

“Security analysis would be simpler if one focuses on the balance sheet while placing no emphasis on the income statement and earnings estimates.”

Whitman has developed the following rules of thumb for valuating various companies :

n Financial services: book value.

n Small banks: 80% of book value.

n Insurance: adjusted book value.

n Real estate: independent appraisal value.

n Operating companies: 10 times peak earnings or less than net asset value.

n Tech companies: twice book value, less than 10 times peak earnings, twice revenue and more cash than liabilities.

Whitman also doesn’t believe in traditional growth investing . “We are growth investors, too,” he says. “We buy into the kind of growth that is not generally recognis ed while most other growth investors buy into generally recognised growth and have to pay up for that.” The key is to figure out the value of future growth.

“Many people on Wall Street know the price of everything but the value of nothing.”

In a recent Shareholders Letter, Whitman says there are at least three lessons investors should have learned from the 2007- 08 debacle:

n Not to invest in the common stocks of companies that need continuous access to capital markets, especially credit markets. “The short sellers have become too powerful.”

n Not to borrow money to finance portfolio holdings. “Prices … are just too capricious to permit this activity to be undertaken safely.”

n Fund redemptions interfere with portfolio management, “forcing fund managers to sell precisely when they should be buying”.

Russell on Gold

2009-11-15T14:27:00.001-08:00

ring to the surge in the gold price, the quote du jour this week comes from Richard Russell, 85-year-old author of the Dow Theory Letters. He said: “America’s Fed Chairman, Ben Bernanke, is convinced he knows the secret of avoiding hard times. The Fed can halt deflation and turn the picture into asset inflation. All it takes, thinks Bernanke, is zero interest rates and the creation of trillions of new dollars - and they will come, and they will spend. This is the path the Bernanke Fed has chosen. So far, it has not worked - they are not coming, and they are not spending. The Fed’s strategy has not even succeeded in bringing down unemployment. Bernanke’s solution - more of the same: ‘Whatever it takes, and as long as it takes.’
“Thus we have a strange and ironic situation. We have world deflation, and a Fed Chairman who believes he can manipulate the primary trend. Bernanke’s strategy is leading to a weakening dollar. The more dollars that are created, the weaker the dollar. As the dollar’s very status comes into question, wise and seasoned investors move to protect their wealth. They move to the time-honored ’safe haven’: the one unit of wealth that cannot be destroyed in that it is not a liability of any government. And, of course, I’m talking about the one unit of wealth that is never questioned - gold.

“So it’s the gold bull market that I trust and believe in. I think and I ponder - what can halt the gold bull market? The only thing that can halt the gold bull market is a complete reversal by the politicians and the Fed, and that would allow the US to sink into a state of deflation and depression. Unthinkable.”

Great comments from Guild Investments

2009-11-03T10:51:00.000-08:00

Guild Investment Global Market Commentary

Written: November 2, 2009

Last week, we had a short-lived rally in the U.S. dollar predicated on the unrealistic view that a weaker U.S. economy would send gold and oil down and the dollar up. Only algorithm writers who are completely ignorant about stock and commodity markets could believe that a poor U.S. economy is actually good for the U.S. dollar.

After a few days, the dollar’s rally reversed and began to decline again while gold and oil are once again rising. In our opinion, any declines in oil and gold prices over the next few months can be used as buying opportunities.

We expect oil to trade between $60 and $100 per barrel for the next two years. After that, we expect oil prices to rise much higher.

We favor gold bullion and gold shares, oil stocks, U.S. technology companies that are poised to serve the world market through exports, and companies in emerging countries with growth potential.

INTEREST RATES

Last week, interest rates were forced up by the market, with the yield for U.S. ten year paper rising as the Treasury tried to sell $140 billion of new bonds. Buyers are demanding higher rates, but the U.S. government is not going to raise short term rates until GDP growth increases substantially and remains good for a year or more. Although the market may continue to force up longer term interest rates, we do not expect the Federal Reserve to raise short term rates.

Indeed, the U.S. Federal Reserve wants interest rates to stay low. They realize that this is necessary to support asset values (even if they only move sideways). A U.S. asset deflation occurred in 2008 and 2009, and the government is trying desperately to reverse the trend. Although the stock market has succeeded in making a turnaround, real estate, cars, and many other asset prices remain deflated.

When it comes to keeping rates low and letting asset values rise, the U.S. Government clearly has a favorite method. They prefer to depreciate the unit of measurement: the U.S. Dollar.

Most commodities are valued in dollars, so if one weakens the dollar, prices rise in U.S. terms, but many are falling in terms of strong foreign currencies, gold, oil and other stores of values. While asset deflation continues in other currencies, asset prices have been rising in dollar terms.

CURRENCY CARRY TRADE

The currency carry trade occurs when investors borrow a given currency (let’s say the dollar) at very low interest rate and use the borrowed money to buy other currencies, stocks, and commodities. It also occurs when and investors sell dollars short and later buy them back with depreciated dollars. The carry trade is dependent on both interest rates and the value of the dollar. And it has been one of the biggest factors responsible for the stock market rally in recent weeks.

The dollar’s recent rally has some believing the carry trade is winding down. Perhaps fear of the big budget deficits and the low demand for U.S. Government bonds is causing investors to expect U.S. interest rates to rise sooner. When the fear of rising interest rates pervades the markets, this causes speculators to unwind their carry trade by buying dollars back and selling their stocks and commodities. In other words, the “carry trade” and the stock market rally are being endangered by potential higher interest rates caused by the big budget deficits.

We do not know if the market has reached its highs for 2009, but we do know that a small wave of fear is once again washing through investment markets. The big decline of 2008 and early 2009 was cathartic. The rally from this cathartic bottom has been normal, so any correction in global stocks and associated commodities will be short lived. Perhaps short-term fears of a technical market correction causes speculators to cut borrowing (on which the carry trade depends), and to sell stock positions.

U.S. DEBT

The Economist magazine echoes many of our arguments regarding U.S. debt and deficits. Last week’s Economist magazine had an important article entitled “Tomorrows Burden: Americas Debt Crisis will be Chronic Not Acute, and Long Lasting.” The article elucidates many of the points that we have repeatedly made in our commentaries over the last several years. It is well written, and I will take the liberty of paraphrasing the main points.

The author makes the point that there are three things that could lead to an acute crisis:
1.) A lender’s strike (no debt available)
2.) A crash in the dollar (possible not probable immediately)
3.) A rise in inflation (this seems remote to the Economist. It does not seem remote to us.)

The authors reason that the debt crisis will be long-lasting and chronic, but not acute. That is unless one of these three issues develops. We believe that we could experience all three of the above within a couple of years. For those who would like to read the entire article, please see this link:

http://www.economist.com/displayStory.cfm?story_id=14699754

THE NEXT U.S. FINANCIAL CRISIS IS ALREADY ON THE WAY.

It will be an inflationary crisis, and it will commence about 2012.

The U.S. Government has guaranteed banks and the housing market. It has borrowed hundreds of billions of dollars to strengthen the economy at the same time tax revenues are collapsing. Social Security and health care financing will add to the burdens. The banking crisis will probably turn into a long-term government debt crisis.

The United States has been living beyond its means, over-borrowing, and engaging in other irrational, unwise, and destructive behaviors. These behaviors have been encouraged and abetted by the Congress, former Federal Reserve Chairman Greenspan, and both Republican and Democratic administrations. A less powerful country, perhaps one which was not providing a military shield for much of the world, would have seen their currency and debt markets subjected to immense scrutiny and widespread suspicion and may have been forced to default long ago.

History has demonstrated two likely outcomes for the situation in which the U.S. currently finds itself. The first is that bond and currency market speculators make default the inevitable outcome. The second is that they devalue their currency substantially in order to pay back their debts in a diminished currency. The day approaches when the U.S. dollar will meet the fate that so many other currencies have faced over the millennia…it will suffer a substantial decline and inflation will resurge. This will probably occur no later than the end of 2012.

DEBT MARKETS

Contrary to the beliefs of some efficient market theorists, financial markets can remain highly irrational for extended periods of time. Few things prove this better than the behavior of the U.S. debt market.

The reality is that investors should be scared of the U.S. debt market. The U.S. continues to go to the markets with bond offerings, financing huge sums of borrowing to feed its ravenous appetite for spending that far exceeds the means of the taxpayers…or the logic of markets.

The markets continue to support the dollar beyond a reasonable level. This support can be partially explained by the many relationships and financial activities the U.S. Government currently undertakes. Over the years, the U.S. military’s largess and the dollar’s status as a world reserve currency have helped sustain the value of the dollar. For example, the U.S. still incurs a large percentage of the military protection costs of Germany and Japan 64 years after the end of World War II.

The value of the dollar has also been preserved because the major debt holders; Japan, China, Saudi Arabia, and Britain are large exporters to the U.S. and/or those that are allied with the U.S. militarily. Below is a chart from the U.S. Treasury Department:

ForeignHoldersofUSTBILLS-1.jpg picture by gimmarketing

LEVERAGE IN THE BANKING SYSTEM

Remember the terrible banking crisis of 2008-2009 that brought down Bear Sterns, Lehman, and Washington Mutual, and threatened others in the U.S. and Europe? You haven’t forgotten, and we haven’t forgotten, but it seems that Congress has. What’s more, they are squandering an opportunity to repair and revitalize the U.S banking system. Today, the U.S. banking system continues to be dangerously speculative and interconnected. Banks deny credit needed for small business, the major driver of employment, while engaging in unproductive speculation. And although this is clearly a serious defect in the system, Congress has failed to address it.

Even more disconcerting is that the banking lobby has Congress’ ears. Instead of listening to the proven, wise, and honest former Fed Chairman Paul Volcker, Congress is listening to the folks that brought us the last crisis. So when Volcker makes the reasonable suggestion that banks and speculative trading activities should be separated, and that only banks with no involvement in trading for their own account should get government guarantees and bail outs, Congress isn’t listening. Sadly, we fear that Congress’ unwillingness to face down the banking lobby guarantees that a new crisis is on the agenda for future years.

This is in sharp contrast to Holland, where the country’s largest bank is forced to sell its U.S. Internet banking operations and its insurance company in order to attain and maintain the use of government funds. In Britain, the trend toward breaking up large banks is being pushed by the top economists at the Bank of England, and in other countries there are demands that banks stop speculation for their own account. In our opinion, disallowing speculation by commercial banks is the only effective method to forestall the next system-wide financial crisis.

Excellent Article on risk of ETFs

2009-11-02T15:02:00.001-08:00

Ban swap-based ETFs, says ex-chief of Eurizon

By Chris Newlands

Published: November 1 2009 09:14 | Last updated: November 1 2009 09:14

Swap-based exchange traded funds that target retail investors should be banned, according to former Eurizon chief executive Francis Candylaftis.

Mr Candylaftis, whose departure from Italy’s Eurizon was announced last month, believes European regulators should outlaw synthetically structured ETFs that track an index. He says they do not comply with the transparency rules or expectations Ucits vehicles claim to have. Providers, he says, should instead buy the physical assets.
EDITOR’S CHOICE
Milestone auction for European CDS - Oct-22
CDS probe opens new ‘can of worms’ - Jul-15
US probe just what the CDS sector do not need - Jul-14
Insight: Effective rules require sound knowledge - Jul-07
Insight: SEC gets tough on Wall St tribalism - Jun-25
Exchange plan for derivatives welcomed - Jul-12

“The growth of ETFs in Europe is based on the myth that ETFs are transparent whereas most ETFs in Europe – with the exception of Barclays’ – are swap-based, something completely unknown to investors,” says the former head of Italy’s largest asset manager.

According to Manooj Mistry, UK head of db x-trackers, more than 50 per cent of ETF assets under management are held in synthetically-replicated index products – a trend db x-trackers is unconcerned by. Most new providers, he adds, now only adopt this structure.

This, however, angers Mr Candylaftis. “I do not understand the distinction between structured products and ETFs. Most of the time ETFs are indeed structured products that should not have Ucits status,” he says.

“ETFs are okay for institutional investors who are supposedly aware of all these features and can evaluate them, but they are much less suitable for retail clients.”

Mr Candylaftis wants European regulators to either ban ETFs that use swaps or strictly enforce the 10 per cent counterparty-risk rule.

“It is a paradox that ETFs are meant to be very transparent instruments compared to traditional funds when, in fact, they are the opposite,” he says, adding that he wants retail-focused providers that replicate an index to actually buy the physical stocks instead of using the swap markets.

Mr Mistry, whose firm only promotes synthetically-replicated index products, disagrees. “All ETFs in Europe comply with Ucits III regulations, whether they are swap-based or not,” he says. “The question really should be which method – traditional or synthetic – works and performs best for investors, and we think that is swap-based products.”

Proponents of fully synthetic replication say it offers the advantage of being able to replicate pretty much any asset class exposure. Some areas, such as various domestic emerging debt markets, are difficult to access using physical replication because of tax disadvantages that can exist for overseas investors.

Swap-based tracking also removes the settlement and tracking error risk from investors and passes them on to a third party on the date a trade is made. When working with a liquid benchmark index and a well-tested settlement system like the DTCC in the US these concerns may seem minor, but in less developed markets this can offer real benefits to investors, experts say.

Axel Lomholt, head of product development for iShares Europe, which leans heavily towards traditional replication, says he understands these advantages but adds that his firm will always purchase the physical stocks when it can.

“Our first approach is to always try and buy the underlying assets,” he says. “It’s not always easy but you’d be surprised how far you can go with that route.

“Others will tell you it is too difficult or too expensive to buy the physical stocks but a lot of exposures can be replicated traditionally if you have the platform and the scale to do so – and we have.”

He adds: “Clients prefer ETFs that are backed by the physical assets. Research shows this to be true and that is why we go down that route when we can.”

Mr Lomholt, however, does not go so far as to agree with Mr Candylaftis that swap-based ETFs should be outlawed from the retail market. “They are an extremely useful tool,” he says. “We don’t overly rely on them like some houses because of the counterparty risk that exists but I don’t agree that swaps should be banned from the world of ETFs.”

Under European Ucits rules any counterparty exposure is limited to 10 per cent of a fund’s net asset value but, in practice, many ETF issuers manage this exposure to a lower maximum percentage of 0-5 per cent.

Nevertheless, fears over possible bank failures, stemming from the Lehman collapse last year, were sufficient to drive many investors away from swap-based ETFs in favour of the more traditional ETF structure in which the fund owns all or a representative sample of the securities in the index.

“This was a big topic when Lehman collapsed, and rightly so,” says Mr Mistry. “But we fully collateralise the majority of our funds and over-collateralise on all our equity, commodity and hedge fund ETFs. We do this to remove any fears investors might have regarding counterparty risk.

“Almost 50 per cent of ETFs are fully synthetic and so it’s not true to say people now don’t want these products.”

All iShares’ fixed income ETFs use traditional index replication but Mr Lomholt concedes Mr Mistry’s point: “Counterparty risk has been a worry since the Lehman collapse but the ETF market has not itself experienced a problem up until now, even though we have been through some extreme times. That’s important to remember.”

The Economy is So Bad.....

2009-11-02T13:28:00.001-08:00

The economy is so bad that Barack Obama changed his slogan to "Maybe We Can!"

The economy is so bad that Sarah Palin is only shooting moose for food, not for fun.

The economy is so bad that when Bill and Hillary travel together, they now have to share a room.

The economy is so bad that instead of a coin toss at the beginning of the Super Bowl in February, they will play "Rock, Paper, Scissors."

The economy is so bad that Angelina Jolie had to adopt a highway.

The economy is so bad that my niece told me she wants to dress up as a 401(k) for Halloween so that she can turn invisible.

The economy is so bad that I ordered a burger at McDonald's (MCD) and the kid behind the counter asked, "Can you afford fries with that?"

The economy is so bad that I saw four CEOs over the weekend playing miniature golf.

The economy is so bad I saw the CEO of Wal-Mart (WMT) shopping at Wal-Mart.

The economy is so bad that Bill Gates had to switch to dial up.

The economy is so bad that rapper 50 Cent had to change his name to 10 Cent.

The economy is so bad that they Pequot tribe built a reservation on the site of one of their casinos.

The economy is so bad that the Treasure Island casino in Las Vegas is now managed by Somali pirates.

The economy is so bad that if the bank returns your check marked "Insufficient Funds," you call them and ask if they meant you or them.

The economy is so bad that I bought a toaster oven and my free gift with the purchase was a bank.

The economy is so bad that the only company hiring this week is the one that sends people to scrape bankers off of Wall Street sidewalks.

The economy is so bad that I went to my bank to get a loan, and they said, "What a coincidence! That's just what we were going to ask you!"

The economy is so bad that a picture is now only worth 200 words.

The economy is so bad that Hot Wheels stock is trading higher than GM.
And the No. 1 sign how bad the economy is...

The economy is so bad that the guy who made $50 billion disappear (Madoff) is being investigated by the people who made over $1 trillion disappear (our policymakers)!

Bill Gross of Pimco

2009-10-13T15:40:00.001-07:00

The world is turning “green” – global warming or not. Electric cars, free-range chickens, and White House vegetable gardens are the wave of the future, but the defining badge of environmentalists may be none of those and might, in fact, be colored blue, as opposed to green. Dog owners would be the first to acknowledge it. Having converted reluctantly to felines nearly ten years ago, I myself am only forced to humble myself by emptying the litter box once or twice a year when Sue is visiting the relatives. But dogs? Well, Bowser has to be walked, and Bowser owners these days are being forced to subserviently follow in step, holding those little blue “doo-doo” bags at the ready that keep the neighbors’ grass green instead of brown and minimize the number of summer flies to a billion per square mile. No longer will the current generation be allowed to use pooper-scoopers; they must in fact be pooper “stoopers,” bending down, turning the bag inside out to form a glove, and then – EEECH – making the grass environmentally friendly again by picking it up, reversing the bag and hurriedly looking for the nearest neighbor’s garbage can who might conveniently be at church or shopping at the grocery store. One can only hope that Fido is mildly constipated, if you get my drift. I can recall the diaper days with my three kids. It wasn’t a pleasant experience, but those non-environmentally friendly Pampers at least afforded one-stop dropping – easy on, easy off – no touchy, no feely. In those days, a doggie bag was something you asked for in a fine restaurant to take home the steak bones. Now it’s a blue plastic reminder that the world is changing and in many respects our daily routine is becoming a dog’s life.

A similar metaphor could be applied to the 45 million citizens of the State of California. Once “golden” and the land of entrepreneurial opportunity, the state has turned from filet mignon to ground chuck and its residents are now on a short leash as opposed to masters of their own universe. Unemployment at 12.2% is near the nation’s highest and its Baa bond rating is the country’s lowest. Its schools are abysmal, competing with Louisiana and Mississippi for the lowest rating in the federal government’s National Assessment of Educational Progress. While the air is much cleaner than it was 20 years ago, the freeways are stereotypically jammed and increasingly less free – the age of the toll road serving the exasperated (or simply the Mercedes owners) is upon us.

Our canine existence has many fathers. Perhaps more than any other state, California has been affected by its perverted form of government, requiring a two-thirds vote by state legislators to effectively pass a budget. In addition, the state’s laws are almost tragically shaped by a form of direct democracy more resemblant of the Jacksonian era, where the White House furniture was constantly at risk due to unruly citizens, high on whisky, and low on morals and common sense. Propositions from conservatives and liberals alike have locked up much of the budget, with Proposition 13 in 1978 reducing property taxes by 57% and Prop. 98 in 1988 requiring 40% of the general fund to be spent on schools. Recently, much of any excess has been gobbled not only by teachers, but unbelievably by a prison lobby that would be the envy of any on Washington’s K Street.

The result has been a $26 billion deficit that was supposedly “closed” in recent weeks, but which largely was a “kick the can” accounting scheme that postponed the pain, or better yet, pled for a federal solution to self-inflicted wounds. State budgets of course are required to be balanced each year, but that has long been a fiction throughout most of the country. Still, California’s 2009 fix was perhaps the longest kick of the can in history, refusing effectively to raise taxes, superficially cutting expenses, and shaming its fading image by refusing to disburse required billions to local counties and communities, as well as using accounting tricks that couldn’t fool a grade-schooler. In the process, they managed to reinvent the IOU, paying bills in virtual scrip that then traded at substantial discounts on eBay of all places. They have issued tax anticipation notes of all sorts with a multitude of lettered configurations that anagram aficionados would revel in. Just last week the state extended its begging bowl for $8 billion of “RANs” (Revenue Anticipation Notes) at an onerous money market rate of 1 1⁄2%. Previously they had issued “RAWs” (Revenue Anticipation Warrants). “BAGs” might be next – blue BAGS, that is, full of the doo-doo that California citizens have grown used to picking up.

There are signs that California voters are ready to make some tough choices, having recently refused to pass five propositions that would have extended tax hikes and failed to address spending. Whether or not Governor Schwarzenegger and legislators will agree to a constitutional convention to address the poisonous proposition plebiscite itself is a larger question that will likely be affirmatively answered only if the state economy continues to remain in the tank, which it likely will. But California’s problems, while somewhat unique and self-inflicted, are really America’s problems, and not just because the California economy is 15% of national GDP. While California’s $26 billion deficit is not directly comparable to the federal gap of $1 trillion-plus, they both reflect a lack of discipline and indeed vision to perceive that the strong growth in revenues was driven by the same excess leverage and the same delusionary asset appreciation that was bound to approach cliff’s edge. California’s property taxes, income taxes, and sales taxes were all artificially elevated by national and indeed global imbalances as the U.S. manufactured paper, and Asia manufactured things in mercantilistic exchange. Total tax revenues have actually fallen 14% over the past 12 months in California and substantially more in other states. At some point, that Fantasyland merry-go-round had to stop and whether the defining moment was marked by Bear Stearns, Lehman Brothers, or the tumultuous week that followed in September of 2008 is really not the point.

What is critical to recognize is that both California and the U.S., as well as numerous global lookalikes such as the U.K., Spain, and Eastern European invalids, are in a poor position to compete in a global economy where capitalism is morphing from its decades-long emphasis on finance and levered risk taking to a more conservative, regulated, production-oriented system advantaged by countries focusing on thrift and deferred gratification. The term “capitalism” itself speaks to “capital” – the accumulation of it and the eventual efficient employment of it – for growth in profits and real wages alike.

What California once had and is losing rapidly is its “capital”: unquestionably in its ongoing double-digit billion dollar deficits, but also in its crown jewel educational system that led to Silicon Valley miracles such as Hewlett Packard, Apple, Google, and countless other new age innovators. In addition, its human capital is beginning to exit as more people move out of the state than in. While the United States as a whole has yet to suffer that emigration indignity, the same cannot be said for foreign-born and U.S.-educated scientists and engineers who now choose to return to their homelands to seek opportunity. Lady Liberty’s extended hand offering sanctuary to other nations’ “tired, poor and huddled masses” may be limited to just that. The invigorated wind up elsewhere.

Now that our financial system has been stabilized, one wonders whether California’s “Governator” and indeed the Obama Administration has the capital, the vision, and indeed the discipline of its citizenry to turn things around. Our future doggie bags can hold steak bones or doo-doo of an increasingly familiar smell. For now investors should be holding their noses, their risk orientation, as well as their blue bags, until proven otherwise. Specifically that continues to dictate a focus on high quality bonds and steady dividend paying stocks that can survive, if not thrive, in our journey to a “new normal” economy of slower growth, muted profit gains, and potential capital destruction via default, abrogation of property rights, and dollar devaluation.

William H. Gross
Managing Director

Uranium price

2009-10-12T14:12:00.000-07:00

John Mauldin's latest email

2009-10-12T11:29:00.000-07:00

+ Each year we allow almost 1 million immigrants into the US, mostly family of people already here. I suggest that for the next two years we stop that. Instead, let anyone who can buy a home, passes basic screening, and can demonstrate the ability to pay for health insurance immigrate to the US and get a temporary green card. If they behave, then the card becomes permanent after four years.

We almost immediately put a floor on the housing market, absorb the excess homes, and within a year the housing-construction market, along with the jobs that are now gone, will be back. That is stimulus that costs the taxpayers nothing.

+ While I can't believe I am writing this, taxes are going to have to rise, if for no other reason than this Congress is hell bent on raising taxes. But rescinding the entire Bush tax cuts, plus adding a 10% surcharge as Congress wants to do in one fell swoop, is an absolute guarantee of a recession. So do it gradually over (say) 4 years, and then reinstitute the cuts when the deficit is under 2% of GDP. Remember the negative tax-multiplier effect of raising taxes. And the definitive work on that was done by Obama's chairman of the Council of Economic Advisors, Christina Romer.

We should consider a VAT tax and a major cut/reorganization of the corporate tax. We need to encourage corporations to hire more, and you do that by taxing less. Let's make our corporations more competitive, not less. Our taxes are much higher than those of any of our major competitors. And please forget that insane carbon tax. If you want to cut emissions, do it straightforwardly by raising taxes significantly on gasoline. Don't back-door it on consumers. (And I am NOT advocating such a policy.)

+ An aggressive tax benefit for new venture-capital money that is invested in new technologies will result in new industries. The only way we can grow our way out of this mess is to create whole new industries, like we did in the late '70s and '80s. (Think computers and the internet and telecom.)

+ Unemployment is likely to continue to rise and last longer than ever before. We have to take care of the basic needs of those who want work but can't find it. Unemployment insurance should be extended to those who are still looking for work past the time for benefits to expire, and some program of local volunteer service should be instituted as the price for getting continued benefits after the primary benefits time period runs out. Not only will this help the community, but it will get the person out into the world where he is more likely to meet someone who can give him a job. But the costs of this program should be revenue-neutral. Something else has to be cut.

+ We have to re-hink our military costs (I can't believe I am writing this!). We now spend almost 50% of the world's total military budget. Maybe we need to understand that we can't fight two wars and support hundreds of bases around the world. If we kill the goose, our ability to fight even one medium-sized war will be diminished. The harsh reality is that everything has to be re-evaluated. As an example, do we really need to be in Korea? If so, why can't Korea pay for much of the cost? They are now a rich nation. There are budgetary fiscal limits to being the policeman for the world.

+ Glass-Steagall, or some form of it, should be brought back. Banks, which are subject to taxpayer bailouts, should not be in the investment banking and derivatives-creating business. Derivatives, especially credit default swaps, should be on an exchange, and too big to fail must go. Banks have enough risk just making loans. Leverage should be dialed down, and hedge funds selling what amounts to naked call options in any form, derivative or otherwise, should be regulated.

Let me see, is there any group I have not offended yet? But something like I am suggesting is going to have to be done at some point. There is no way we can continue forever on the current path. At some point, we will hit the wall. The fight between the bug and the windshield always ends in favor of the windshield. The bond market is going to have to see a credible effort to get back to a reasonable deficit, or we risk a very difficult economic environment. The longer we wait, the worse it will be.

It is not going to be easy to persuade a majority of Americans that we need to do something now. More realistically, we are going to probably have to begin to experience a crisis of some type to get politicians motivated to do something.

This last Tuesday, I spoke to the Financial Leadership Association at the University of Texas at Dallas. It was mostly undergraduates, and my assigned topic was how financial research impacts our investment decisions. In touched on the topic above, in less detail, but pointing out that at some point we are going to have to bring the deficit under reasonable control. I got some push-back, as some could not understand why we just couldn't keep running deficits, as we simply owe it to ourselves. I tried to explain, but for a few of them I was not getting through (though I think most got it). And these were the finance students! I shudder to think what the sociology department would be like.

We are not going back to normal, although it is likely we will see some form of Statistical Recovery. But we cannot get complacent. Somewhere out there is the real potential for another crisis, which will dwarf the last one. You will not want to be long much of anything when it happens, except hedged or liquid investments. Though admittedly, this could go on for a long time. I just don't know how long "long" is. Other than it will be too long and then not long enough.

Window Washer outside of office

2009-09-28T16:05:00.000-07:00

Cash for Clunkers and CPI

2009-09-21T14:28:00.000-07:00

I read that the government is going to use the $4500 for the Cash for Clunkers as a price reduction for new autos. That means that the Consumer Price Index will be reduced, as autos make up part of the index. Social security and other programs use the CPI to compute payments.
Holmes

Health Savings Accounts

2009-09-17T12:38:00.000-07:00

I keep reading about how Health Savings Accounts are going to solve health care so I did some (brief) studying. Basically, it's like an IRA. You put money in, before taxes and carry a high-deductible health insurance plan.

The problem is that most people don't save their money. This plan only works for diligent savers. As someone who is privy to people's finances, I can tell you that this would only work for a small percentage of the US population.

This plan would never work in a country where many folks have a negative net worth. You know exactly what I'm talking about.
Holmes

Supply of money

2009-09-15T07:55:00.001-07:00

Faber Says ‘High’ U.S. Deficit Will Spur Inflation

2009-09-11T08:37:00.000-07:00

By Elizabeth Campbell and Millie Munshi

Sept. 9 (Bloomberg) -- Investor Marc Faber said government spending and low interest rates will keep the U.S. deficit “very high” and will spur inflation.

Interest rates will be kept “artificially low” and remain “near zero for a long time” in the U.S., Faber, the publisher of the Gloom, Boom & Doom report, said today in a presentation broadcast on the Internet. “The deficit will stay very high and that will create some kind of more inflation down the road.”

The Federal Reserve is likely to continue to “print money” in an effort to boost the U.S. economy, and that, combined with low interest rates, will spur weakness in the dollar, Faber said. U.S. President Barack Obama has pumped up the nation’s marketable debt to an unprecedented $6.94 trillion as he borrows to spur the world’s largest economy.

“Money printing will be unprecedented because the deficit will need to be financed,” Faber said. “The weaker the economy, the more the stock market will go up because the money that is being printed will go into” speculative assets.

Faber, who recommended buying U.S. stocks in October, before the biggest rally in more than 70 years, said investors should buy equities instead of bonds or holding cash.

“If the dollar is weak, there is a very good chance that equity prices could rise quite substantially,” Faber said. A weaker dollar is “good for asset prices.”

Buying Commodities

Faber also recommends that investors buy precious metals and other raw materials to hedge against declines in the U.S. currency. Before today, the greenback slid 4.9 percent against a basket of six major currencies this year and the 19-commodity Reuters/Jefferies CRB Index climbed 10 percent.

“The dollar will continue to implode against commodities,” Faber said. “I don’t see why someone would hold dollars and not own gold. More and more people will come to the realization that they have to own some resources, some commodities, some mining companies and some physical precious metals.”

Global economic growth won’t recover to pre-recession levels, Faber said.

“I don’t think consumption will come back,” he said. “I don’t think there is much of a recovery. You have to differentiate between the stock market and economy activity.”

To contact the reporters on this story: Elizabeth Campbell in New York at ecampbell14@bloomberg.net; Millie Munshi in New York at mmunshi@bloomberg.net.

Richard Russell comments on gold

2009-09-03T07:58:00.000-07:00

Why the rush into the monetary "safe haven." Oh, by the way, they don't want you to know it, but GOLD IS MONEY! And it has been for 5,000 years. Hmmm, what paper money has lasted for 5000 years?

Comments on debt

2009-08-31T08:52:00.001-07:00

"The US national debt is now over $11 trillion dollars. The interest on our national debt is now $340 billion. This is about at 3.04% rate of interest. In ten years the Obama administration admits that they will add $9 trillion to the national debt. That would take it to $20 trillion. Let's say that by some miracle the interest on the national debt in 10 years will still be 3.09%. That would mean that the interest on the national debt would be $618 billion a year or over one billion a day. No nation can hold up in the face of those kinds of expenses. Either the dollar would collapse or interest rates would go through the roof."

From Richard Russell

Barron's article on Asia

2009-08-28T15:15:00.000-07:00

AFTER THE RECENT JUDDER IN THE ASIAN MARKETS, WHO BETTER to ask about the region's prospects than Christopher Wood? The Hong Kong-based strategist for CLSA Asia-Pacific Markets, a unit of Crédit Agricole, pens the widely followed newsletter Greed & Fear.

He was early to spot the problems in the U.S. mortgage market and their global financial implications, writing about them back in 2005.

Even earlier, he espied the troubles brewing in Thailand, before the 1997 Asian crisis.
[qa]
Darrin Vanselow for Barron's
"When I say you want to be overweight Asia and emerging markets, I'm talking predominantly about investing in domestic themes such as financial services, real estate and infrastructure." --Christopher Wood

Midway through last week, the MSCI AC Asia ex-Japan index had risen by 79% in U.S. dollar terms since the October 27 bottom, while the Standard & Poor's 500 is up just 17% over the same period. Wood acknowledges a modest correction may be in order, but believes prospects are good for a long-term bull market in Asia. To learn why, keep reading.

Barron's: You sure got this crisis right. Where are we now?

Wood: This financial crisis in the Western world will lead to a long period of anemic growth. The data that is making people more optimistic on the U.S. right now is tending to be production-oriented data like the ISM [a survey of manufacturers] or car sales. But there is very little sign to me that U.S. consumer demand is recovering or that real releveraging is taking place.

In fact, all the evidence both in the U.S. and Euroland is that the consumer is going into long-term retrenchment. Even when the banks in America and Europe become healthier in coming quarters and years, I believe demand for credit will be much less than it was in the last five, ten years. So, we are going into a long-term period of deleveraging. We'll continue to see deflation backdrops in the Western world. The best case is a long period of subpar, anemic growth.

What does this mean for equities?

My formal target has been a 1050 on the S&P 500 [versus the current level around 1,000]. But that is just a technical view. Either in the fourth quarter of this year or definitely next year, the S&P is going to have a proper correction, by which I mean declines below the technical level of 875. There is no evidence that the U.S. or British consumer is really recovering. Actually, America and Europe remain at risk of Japanese-style liquidity traps despite all this fiscal monetary policy activism you have seen in the West.

From a global equity investor's standpoint, Asia and the emerging markets stand out as a place to invest. I haven't been surprised that Asia and emerging markets have outperformed since the autumn lows. It is a very positive sign that Asia and emerging markets did not make new lows when the S&P did in March. It's also positive that trading volumes have increased for most of the period since the start of the year in the Asian stock markets' recovery, whereas trading volumes were broadly static on the S&P. Those rising volumes I attribute to growing domestic investor participation within Asia.

The biggest beneficiaries of Western monetary easing aren't going to be indebted Western consumers. The biggest beneficiary of monetary easing in the West is going to be Asia...and emerging-market asset prices. That's primarily equities and real estate, because the money generated by all this excess liquidity from dramatic monetary easing in the past year or more, is going to flow to the best story.

Which one?

When I say you want to be overweight Asia and emerging markets, I'm talking predominantly about investing in domestic themes in [Asia and emerging] markets, such as financial services, real estate, domestic infrastructure. If I was advising a big global or domestic U.S. investor that didn't have emerging-market expertise that just wanted to concentrate on three big markets, I would advise them to invest in China, India and Brazil, because they are all good stories.

Different, though.

Well, China is a weird mix of command economy and private-sector capitalism. If you invest in the blue chips, you are predominantly investing in state-owned enterprises, be they China Mobile [ticker: CHL], Industrial & Commercial Bank of China [1398.Hong Kong], China Life Insurance [LFC], PetroChina [PTR].

The advantage is that these are dominant companies without competitive threat. You're not going to have huge corporate-governance abuse, because [people who do that in China] are at risk of being executed.

The negative is, they are not pure capitalist enterprises, and you have always got the regulatory risk if they decide to change the rules of the game. That's the China story. The China index is predominantly domestic demand.

India is very different. What's good about China tends to be bad about India. And what's bad about India tends to be good about China. India is much more the U.S. model of the stock market. You have a huge number of companies, a wide diversity of sectors. In India, the question of who wins and who loses in any sector is much more important than in China. You have more than 100 years of stock-market history, and a more Western-style legal system. In other words, a real element of due process, which is not the case in any other emerging market. India is great, India is my favorite emerging-market equity story. If I was only going to invest in one, I would invest in India because of the wide diversity of companies you could invest in. But it will always have a premium, good price/earnings rating.

The other virtue about India is that export is unimportant in terms of gross domestic product. China is more about exports than India, but it's not all about exports, either. That's why both China and India this year have confounded most economists' forecasts, growing much more than most people were predicting at the start of the year despite the fact that the U.S. is barely growing.

Then there's Brazil, which I don't follow closely, because CLSA is an Asia specialist. The big story there remains the ability for real interest rates to really collapse, because they finally cracked inflation. Inflation is very low. They can bring rates to single-digits, and that will encourage the development of a middle class. Obviously, it has the resources as well.

BRICs without Russia? Why not Russia?

Russia is okay, but less diversified than Brazil and more a pure oil play.

The decoupling story, once debunked, is being revived.

I wouldn't put it that strongly. I would look at it like this: At the beginning of 2008, the investment community had basically largely embraced the notion of decoupling. By the end of '08, the investment consensus had embraced the precisely opposite notion that China and Asian emerging markets would prove to be export train wrecks correlated with the U.S. consumer.

The reality is something in the middle, what I call macroeconomic, incremental decoupling -- a boring, middle-of-the-road view. China, India growth has slowed, but not to the extent of some of the more bearish forecasts. Many were correctly bearish on the U.S. and Euroland...[while] China will grow 8% to 9% this year. It has the help of a big command economy stimulus. The natural excuse for a breather is renewed tightening concerns in China, but I don't think China will be slamming on the brakes.

India will probably grow more than 6%. In India, there's no command-economy stimulus, because the government couldn't organize one. But it's not a train wreck correlated with the U.S. consumer. Today, the trend in bank-lending in India remains healthy.

Stock-market decoupling is a different story. As of today, we have zero evidence of the stock-market decoupling. We've had dramatic outperformance by Asia and emerging markets since the October low.

When stock markets correct, Asian and emerging markets normally underperform on the downside as much as they outperformed on the upside. We can't stress-test if Asia and emerging-market stock markets have started to decouple until the next time the S&P has a proper correction -- let's say below 875. The key issue for people involved in Asian emerging markets is how resilient they prove to be. Now, if they only go down as much as the S&P in the context of the dramatic outperformance we've seen to date, that would be incredibly positive. But they've demonstrated this year their macroeconomic resilience.

You've talked about an asset bubble in Asia. How far into it are we? Valuations have expanded quite dramatically.

No way I would call it an asset bubble yet. All we've had is outperformance. And Asian valuations collapsed late last year way beyond where common sense suggested they should stop, simply because hedge funds and funds-of-funds were liquidating the one investment they still had made some money on, and didn't face lockouts in Asian and emerging-market equities. If you were a fund-of-funds with a lot of hedge funds owning garbage credit, you just redeemed what you could sell. Asian valuations are not cheap today. But in a real bubble, Asia ends up trading two or three times the P/E of the S&P.

In the very short term, frankly, Asia has outperformed so much that there's a risk of the S&P outperforming Asia. On a three-month basis, if you had not invested anything in Asia up to now and had $100 to invest, I'd only invest a third of the amount today, and the rest after a correction.

What are some of the stresses in Asia?

The big stresses remain in the West, where monetary policy remains very easy for a long time. If Western policy remains very loose, that could trigger a speculative bubble in Asia. You know, that doesn't have to happen. The Asian policy makers can counter that by tightening aggressively. But there is a remarkable lack of stress in Asia and emerging markets, because there's a remarkable lack of consumer debt, corporate debt, and government debt. There are high savings rates. They are just in much better condition than the developed world.

What themes do you like and dislike?

I like financial services, real estate and domestic infrastructure -- the three broad domestic sectors linked to a domestic demand, asset-reflation theme. If you have got the ability to buy smaller stocks, then you can buy consumer stocks. [Wood's thematic model portfolio is shown on the nearby table.] Search-engine stocks are also domestic demand proxies. I would be less aggressive investing in exporters, but there's nothing I aggressively dislike in Asia, I'd say.
[woods]

I also think Asian currencies are long-term appreciation stories, another reason to own the equities. Asian currencies are going to be relatively safe havens compared with Western currencies, because they are not going to blow up their solvent balance sheets bailing out banks. And basically, on a five-year view, I'm expecting investors to lose confidence in Western paper currencies.

Tell us about Taiwan.

This is a specific story that has nothing to do with the general Asian theme, based on political developments. Sooner or later, you will see a formal end of hostilities or tensions between China and Taiwan, which will lead to a dramatic improvement in economic links. That will lead to a huge rerating in equity prices in Taiwan, and probably also an appreciation of the [New Taiwan] dollar. Over the past year you've already seen pretty significant developments, most importantly a growing number of direct flights. On a five year view, I'd expect more integration: Chinese banks would be able to function in Taiwan and vice versa, growing investments by big Chinese companies in Taiwan, and Taiwan companies integrating their China operations into reported results. This is a very good story and people should buy Taiwan on pullbacks if they don't already own it, and take a long-term bullish view of the NT$.

How about Japan, which votes in a parliamentary election on August 30?

It isn't an emerging market. But if the DPJ [Democratic Party of Japan] does win the election as expected, that can only be a potential positive. It creates the hope of change and [of] a more domestic-demand-driven policy.

If the equity-market rally keeps going, Japan is overdue some outperformance, particularly the exporters, which are actually doing some genuine cost-cutting. But it has all kinds of structural issues that the rest of Asia doesn't have. The most interesting domestic sector in Japan is the real-estate investment trusts, like Japan Prime Realty [8955.Japan] and the Japan Retail Fund [8953.Japan]. The REITs have distressed valuations and very high yields -- 6% to 9% -- relative to very low Japanese interest rates. And the government is now supporting the sector.

Thank you.

Money Confidential

2009-08-19T14:06:00.000-07:00

I will have Wayne Jett on my show on September 2. It shoots live at Santa Monica City Hall at 2:00 pm. Let me know if you'd like to attend.

Holmes

WAYNE JETT is managing principal and chief economist of Classical Capital LLC, a San Marino CA registered investment advisor engaged in economic analysis. Since 2005, he has spoken to chartered financial analysts across the U. S. and in Canada on topics of monetary policy reform and U. S. financial markets. He speaks in support of the Fair Tax Act reform of federal taxes with comments titled “The Trillion Dollar Sure Thing.” His 2000 book A General Theory of Acquisitivity buttresses free markets with theoretical, moral and ethical underpinnings. In private law practice 1970-1999, he argued cases in the Supreme Court of the United States, the U. S. Court of Appeals, and the federal and state trial and appellate courts. He has led seminars in supply-side economics for CFA Society of Los Angeles and for Security Analysts of San Francisco, and speaks and writes on constitutional and economic topics. Classical Capital LLC sponsors a website called The Fruits of GraftTM, which is the title of his recently completed book explaining the causes of the Crash of 1929, the Great Depression and the current economic collapse. Email: wjett@socal.rr.com

Market Manipulation

2009-07-27T09:24:00.000-07:00

Karl Denniger at the Market Ticker writes that Duhigg has “blown the cover off the dark art” but thinks that the traders’ computer speed isn’t most important advantage they have. Rather, he says, the “algos,” rather than providing liquidity as they are supposed to, intentionally probe “the market with tiny orders that were immediately canceled in a scheme to gain an illegal view into the other side’s willingness to pay.” He explains:

Let’s say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40. That is, the buyer will accept any price up to $26.40.

But the market at this particular moment in time is at $26.10, or thirty cents lower.

So the computers, having detected via their “flash orders” (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) “immediate or cancel” orders - IOCs - to sell at $26.20. If that order is “eaten” the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite and the order is immediately canceled.

Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become “more efficient.”

Nonsense; there was no “real seller” at any of these prices! This pattern of offering was intended to do one and only one thing - manipulate the market by discovering what is supposed to be a hidden piece of information - the other side’s limit price!

With normal order queues and flows the person with the limit order would see the offer at $26.20 and might drop his limit. But the computers are so fast that unless you own one of the same speed you have no chance to do this - your order is immediately “raped” at the full limit price … as the fill price is in fact 30 cents a share away from where the market actually is.

A couple of years ago if you entered a limit order for $26.40 with the market at $26.10 odds are excellent that most of your order would have filled down near where the market was when you entered the order - $26.10. Today, odds are excellent that most of your order will fill at $26.39, and the HFT firms will claim this is an “efficient market.” The truth is that you got screwed for 29 cents per share which was quite literally stolen by the HFT firms that probed your book before you could detect the activity, determined your maximum price, and then sold to you as close to your maximum price as was possible.

Even if such trading isn’t illegal or inherently vile, Brett Steenbarger of TraderFeed notes, it certainly makes life hard for day-traders and others with slower access to data.

Because the high-speed algos are buying and selling quickly as a rule, their effects on the markets longer-term are unclear. A stock may still travel from point A to point B, but the computers will affect the path from A to B. This may help explain why traders I work with who are more selective in their intraday trades and who tend to hold for longer intraday swings on average have been doing better than very active daytraders.

When up to half of all stock market volume consists of these algorithmic trades, one has to wonder about the edge of very active traders. Interestingly, those that are successful may be trading new patterns that have emerged since the onslaught of the high-frequency computers. My hunch is that these new patterns would involve a keen reading of order flow, catching the shift in the bidding/offering and the location (bid/offer) of transactions in real time.

Bob Rodriguez on WeathTrack

2009-07-16T11:39:00.000-07:00

Consuelo Mack WealthTrack - July 10, 2009

CONSUELO MACK: This week on WealthTrack's "Great Investors" series: he races Porsches for fun and runs top performing stock and bond funds for his profession. What makes First Pacific Advisors' Robert Rodriguez step on the investment brakes or the accelerator? That's next on Consuelo Mack WealthTrack.
Hello and welcome to this "Great Investors" edition of WealthTrack. I'm Consuelo Mack. This week our great investor is Robert Rodriguez, a maverick money manager who has accomplished a feat no one else has. For the last 25 years, he has run not one but two top performing mutual funds, in not one but two asset classes, a stock fund and a bond fund. As widely followed personal finance columnist Jason Zweig put it, that is the investing equivalent of running two marathons at the same time, which is why Zweig calls him the best fund manager of our time.
Rodriguez is the CEO of Los Angeles-based First Pacific Advisors and co-portfolio manager of FPA Capital, a mid cap value fund, and FPA New Income, his bond fund, which just celebrated its 25th year in positive territory. Last year he and his co-manager Tom Atteberry were named Morningstar's fixed income managers of the year for their outstanding long-term stewardship. It is an honor Rodriguez has won two other times as well for both the stock and the bond fund, making him only the second fund manager to be honored three times. The first was last week's great investor, Bill Gross.
Rodriguez, who races Porsches as a hobby, has a high octane personality but a low tolerance for investment pain. He knows what it is like to lose. A first generation American, his paternal grandparents lost everything in the Mexican Civil War of 1910. His grandfather did not survive the war. His grandmother and six children nearly starved to death. It took them almost six years to come to the United States legally, a route his grandmother insisted on taking so her children could walk down the street with their heads held high.
Throughout his 39-year investment career, Rodriguez has taken the high integrity path, sometimes to his business detriment. He was one of the first to rail against the dot-com and credit bubbles, raising large defensive cash positions, early moves that lost him clients. He is an outspoken critic of the U.S. government's stimulus packages, burgeoning debt levels and business intervention. Four years ago he moved from California to Nevada to protest the golden state's budget excesses and income taxes, the highest in the nation. And he does not mince words in criticizing Wall Street and the mutual fund industry. In a wide ranging interview, I asked Rodriguez about his exceptional track record which he attributes to discipline and the ability to balance fear and greed.

ROBERT RODRIGUEZ: I think we have a healthy dose here of skepticism about our capabilities. When you've had some serious failures, it forces you to look inwardly, and I don't know of too many organizations where an investment professional puts his worst investment failure on his website. And it just tells you that no matter how skilled you are in this field, there are new ways to snatch defeat from the jaws of victory. So you have to balance these things. And we test ourselves daily on this, whether we're correct in our assumptions, but we don't want to let the day-to-day machinations in the marketplace disturb our long-term thinking.

CONSUELO MACK: You had in the Income Fund, you had your 25th straight up year, which is just unheard of. But in the FPA Capital Fund, in the stock fund, you had your worst year ever, down 35%, so what did you learn from last year?

ROBERT RODRIGUEZ: Well, we did as much as we could. I felt that by June of '08 there was nothing more we could do.

CONSUELO MACK: You had raised 45% cash?

ROBERT RODRIGUEZ: 45% cash, we're getting redeemed, you can't really take it any higher because the more higher you go, the faster the money goes out. So you have to strike a balance. And our largest exposure was to energy. We have a five and ten year horizon on, that we've been in the field for ten years after my being out of the sector for nearly 18 years. So there's the long-term view versus the short-term risk. And we did reduce our exposure in energy, prior to going into it. And we said now it's up to the gods. They went down with the market very hard and the first phase of an economic or stock market debacle, everything goes down. Then in the second phase they start to separate and in the third phase you start to see what really is going to work. Well, this year I would say what was taken away from us last year has been, a large part, has been given back to us this year for the right reasons. And so I have to think probably look at both years combined to say, all right, how did you go through this cycle, how did the others go through this? And then over the next five years, is your analysis correct? We happen to think it is, and if we are then our shareholders will be rewarded for that.

CONSUELO MACK: You've quoted in one of your speeches and one of your shareholder letters too that legendary economist John Maynard Keynes describing the long-term investor as eccentric, unconventional and rash in the eyes of the average opinion, which fits you to a tee, actually. So where does the eccentric and unconventional side of Bob Rodriguez come from? Where did you get this?

ROBERT RODRIGUEZ: I really don't like following the norm. If I follow the norm, I would never have been in this business. My last name is not a competitive advantage when I entered the field, and had to knock down a lot of doors, and you had to do things to separate yourself from the crowd, so that all started way back when I was very young. My first time I got anything to do with the investment field was writing a letter to the Federal Reserve chairman when I was ten. It was a school assignment.

CONSUELO MACK: And he wrote you back.

ROBERT RODRIGUEZ: And he wrote me back, and I said gee that's kind of neat, how many people would do that. What's the down side? So I started thinking differently about what the norm is, and then how can you turn that to your competitive advantage? So it's always been that way. I would say when I was in graduate school or just going into graduate school, I discovered Graham and Dodd during the summer before I was coming back to graduate school. And it really struck home, and I had the good fortune of meeting Charlie Munger in our investment course there.

CONSUELO MACK: Warren Buffett's kind of unknown partner.

ROBERT RODRIGUEZ: As Warren Buffett says, he's the smart one. And after the class I asked him, I said what can I do to make myself a better investor, beyond just what I'm doing here and researching, et cetera? And he said, read history. Read history. Read history. And if people had read history about the economic crises of before, not only the depression but even before then, they would have said this is an old friend, and so that helped. It's come from a number of different parts, but I think really not being afraid to fail and be different. That's what it took in order to differentiate in this business.
I had a friend of mine who was a growth stock manager who got just before the debacle of 2000, we were having lunch together in January of 2000 and he was buying all this dot com, and I said why are you buying this crap? And he says, because you have to, he says yes, if I don't buy it we won't be competitive. I said, but don't you realize, you are at the epicenter of a debacle that's going to occur? And when you get destroyed, you know, you could either have cash or you can buy these things. If you have cash, you get fired. If you buy the dot-com and it blows up, you get fired. So in both cases you're fired. What's the difference? Over here the one with the cash, where you held your investment discipline, you can rebuild your business. Over here, you've destroyed your credibility, you can never rebuild.

CONSUELO MACK: Let's talk about some of your unconventional current calls. You're describing the current economic state that we're in as a repression, which it's not as bad as the Great Depression, but it's also worse than a recession. Where is this repression taking us? What's it going to feel like?

ROBERT RODRIGUEZ: Here in the firm, we're using a new term for the economy. We're calling it the caterpillar economy. Where it goes up and goes down, goes up and goes down, but it doesn't move forward very fast, after this waterfall collapse that we had. And this is different from any other kind of economic environment that we've been in since the depression. You don't destroy the consumer's balance sheet, like what's gone on. You don't have the leverage in the system that we have and expect to come out of it the way we've come out of other periods. The president, I argue, that I think he's on the wrong road and when I compare him to let's say FDR. When he came into power, the debt to GDP was barely 17% when FDR came here, whereas now we're now at 65% going to 75, going to 90% this year.

CONSUELO MACK: IMF says 100 some odd percent?

ROBERT RODRIGUEZ: Right. And by the way, those numbers when FDR came into power did not include, because we didn't have any, entitlements. So if you add on the entitlements, it's even far larger. So as I've argued, we do not have the balance sheet flexibility today as we did in FDR's time. So if they want to go down, they being the Congress and the executive branch et cetera, and they want to build up these larger programs, they're going to come at a price. And in our opinion that price will be in the debt market, and in the Treasury market longer term. With higher interest rates.

CONSUELO MACK: Bob, you saw the credit crisis coming about five, at least five years ago. And at that time you predicted that there was a new financial system that was going to be created and a new era. So what's this new financial system that we can look forward to?

ROBERT RODRIGUEZ: I think, first of all, about four years ago we started talking about the breakdown in underwriting standards, et cetera. With the demise of Bear Stearns in March of last year, and what the response was by the federal government and the Fed, that's when we wrote "Crossing the Rubicon," that we had crossed over into a new financial era, a new system. And little did we know how far that was going to occur, within six months.
So we're still in this process of defining what this new system is. As a result, it is very difficult to define what appropriate valuation levels are going to be, because the goal posts keep getting moved. Look at Chrysler- we were extremely vehement against Chrysler and what happened there, where senior secured creditors were treated in such a shabby manner, it really ran over, you know, the sanctity of contract. So we're in a new system. That means the government is a larger percentage of GDP. The larger the percentage of GDP, the more likely GDP will grow at a substandard rate for an elongated period of time.
We're in the group, and I'm in the group, where the new world order that you were referring to, that I've referred to, is that the U.S. is going to have to change its economic system; that our foreign counterparts that have basically grown on the backs of U.S. consumer have got to turn inwardly for their growth. As a result, as they turn inwardly for their growth, such as China, the U.S. has to expand its exports. I don't see anything like that coming out of the administration or the incentives or anything else. As a result, the more the government takes a larger share of the economy, the likelihood we will be in a substandard period of growth and profit margins will also be substandard.

CONSUELO MACK: So how do you invest in an environment that is going to be substandard growth, that you don't know what the rules of the game are because you don't know what the government is going to do next, what do you do?

ROBERT RODRIGUEZ: It's going to be very hard. As a result, on the fixed income side, we're still maintaining our highest levels of quality. We haven't gone into the lower rungs of the high yield area, even though there's been big rungs there, because we think this is a head fake of what's going on in the economy and this rebound, the green shoots that people talk about. So we're going to stay high quality and let other people destroy themselves.
On the equity side, we think you have to be very focused in terms of the industries you go after. So we have a natural decline rate in, let's say energy, supplies of energy. So we think longer term- three, five, ten years. Energy prices are going to be considerably elevated from where they are today. So we have a heavy exposure there.

CONSUELO MACK: Heavy, like 55% of the FPA Capital Portfolio, is that right, is in energy?

ROBERT RODRIGUEZ: Well, about 41% of the total portfolio, about 55% of the equity. Okay. So we're looking for other areas to deploy capital that will both benefit from the international side but also from the commodities side.
So we see, you have to be rifle shooting over the course of the next five years or ten years, and that's why I gave a speech in Chicago at Morningstar that in my opinion, a highly diversified equity fund in this new order will be at a competitive disadvantage, especially if it carries management fees, et cetera, so you're going to have to do something different from the rest of the market in order to differentiate again, and that's what we're doing.

CONSUELO MACK: So let's talk about the investment industry, which you have been highly critical of, and the OPM attitude, "other people's money" attitude that you feel that the industry has been excessively greedy, not really paying attention to shareholders interests.

ROBERT RODRIGUEZ: Let's say abusive. I mean, how are mutual funds sold? They're brought out when the particular area is the hottest. So you sell what you can sell, and most of the time that is the absolute wrong time to be marketing that kind of product. So it's not investment oriented, it's marketing oriented. It's a marketing mindset, and as long as we have a marketing mindset in the industry and managers are fearful of under performing their bogey and having what we call tracking error where you deviate too far from your benchmark and god forbid you have too much volatility: all of these things will work to hit the industry. With this collapse, with the technology collapse and now with the credit collapse, the question I'm asking is: if active managers could not identify the two greatest speculative blowoffs in the last 75 years, when will they? And secondly, what are you buying from an active manager if they can't identify these things? You might as well go to an index.

CONSUELO MACK: Talk to me though about the shakeup that you think is going to happen in the mutual industry. Tell me what kind of a shakeout you expect.

ROBERT RODRIGUEZ: I just think that first of all, we have too many funds. When you sit there with 8,000 funds, and then you have 25 different share classes, it's quite complicated. And what is the investor getting for all of that? There's an expense to that, and the higher the expense in a lower return environment means you have less margin of safety for a total return.

CONSUELO MACK: So let's also talk about the fact that you are a long-term investor, but you told me that you look out-- some people say long term like a couple of years, you're really talking about five to nine years. And you made a decision about six years ago to take a sabbatical next year from your firm in 2010. And one of the reasons that you decided to take a sabbatical as well is because you looked out beyond the current crisis and you see something even bigger and scarier coming?

ROBERT RODRIGUEZ: I see another crisis coming.

CONSUELO MACK: What is that and like when?

ROBERT RODRIGUEZ: It's the explosion in the treasury debt, and the finances of this country. We still have time. But to, shall we say, become fiscally responsible. Am I optimistic about us doing that? No. You're residing in the state of California that I left here four years ago, because in my opinion, the system was fundamentally broken and the state was going to experience a devastating recession on the down side.

CONSUELO MACK: Which it is right now.

ROBERT RODRIGUEZ: Which it is right now. I believe the system in
Washington is fundamentally broken. And as a result, the explosion in dealt that I foresee in the next three years and if other programs are added on it will accelerate it, then I think we have a real problem brewing in our finances here. I'm estimating somewhere in the neighborhood of five to seven years from here.

CONSUELO MACK: Do you envision any time in FPA Income basically going out the risk curve a little bit? I mean, is there anything-- you've got about 90% in triple A rated securities in the portfolio?

ROBERT RODRIGUEZ: We are 22% in cash and we're barely over a one-year duration. We've had as much as 25% of the fund in high yield. We would love to go out on the risk curve. In the last six months, eight months, it's been highly profitable, just like the stock market has rallied. Is this sustainable? We don't think so. We think there's other dominos to fall that can disrupt this. So we don't like the odds. Plus in New Income, people come into the bond fund in New Income because they can trust it. It's when they couldn't trust virtually anything else in this country, other than Treasuries, our bond fund grew in the neighborhood of 60 to 80%. People came in because they could trust it. Well, here we are saying, how do we be good stewards going forward? Do we bet with other people's money or do we invest as if it's our money? That's what we're doing, we're waiting for that opportunity.

CONSUELO MACK: Bob, what's your advice to individual investors who have had severe wealth destruction in their investment portfolios over the last couple of years? How can they rebuild that kind of wealth loss?

ROBERT RODRIGUEZ: I wish there was an easy, nice comforting answer to it. Unfortunately, there isn't. In my opinion it will take probably upwards of eight or ten years for the S&P 500 to get back to where it was in October of '07. And thus there has been severe capital destruction, and for some it's permanent because of where they are in their life cycle. If you're in your 20s and 30s and 40s, you have the benefit of time. If you're in your 60s and you're part of the baby boom generation and you got destroyed, guess what, you better be working. You better find a job. Those things there. You move in, you may become a renter out there.

CONSUELO MACK: If can you sell your house.

ROBERT RODRIGUEZ: Well no, the house gets taken, at least if they would allow it to go. But there is no God given right to an easy retirement. It was a fool's paradise out there. My parents and grandparents did not have an easy retirement. The world is unsafe and unstable. We had in this country, I believe, a perverse view of what reality truly was, and now that veil is being lifted, and I'm sorry, but it's going to take a long time and that nice retirement home or continuous vacations may not be there.

CONSUELO MACK: You told me that you see things that other people don't see.

ROBERT RODRIGUEZ: Sometimes.

CONSUELO MACK: So what are you seeing now that other people aren't seeing?

ROBERT RODRIGUEZ: I think the difference is many of us see the buildup of federal liabilities. But there's this feeling, well, it'll be okay, we'll get through it. Well, that was the same not too long ago when the house prices were going through and people would raise the question, what happens if housing prices get hit? Don't worry about it, we'll get through it. There's always that element. So I think the question is, as you have to place the odds, what are the odds that we'll get through this with the least amount of pain? I think that's where the difference comes.
If you want to be on the optimistic side and say we'll get through it and you're wrong, your shareholders pay for it and your clients pay for it. If we're right and we've done our job correctly, we protect capital in the negative side, and if we're wrong, we just don't earn as much as our competition. I think that's a better combination than destroying your clients and saying, well, we'll go out and get some more new clients out there. I don't like that one.

CONSUELO MACK: That's a great way actually to end the interview. So Bob Rodriguez, thank you so much for giving us your time.

ROBERT RODRIGUEZ: Thank you.

CONSUELO MACK: Next week in our "Great Investors" series, we are devoting our program to the late Peter Bernstein, one of the giants of the financial world who died in June at the age of 90. Bernstein, an economist, historian and seminal financial thinker and prolific author, appeared on WealthTrack exclusively several times. Next week we share his timeless wisdom.
In the meantime, to access the collective wisdom of our other great investors, go to our website, weathtrack.com. Have a great weekend and make the week ahead a profitable and a productive one.

Ron Paul Thoughts

2009-07-16T11:21:00.000-07:00

US REPRESENTATIVE RON PAUL HAS PRUDENT THOUGHTS ON HOW TO FIX THE ECONOMY. I AGREE WITH MANY OF THE THINGS HE SAYS. HOWEVER, WE WON'T BE GOING BACK TO THE GOLD STANDARD. IF WE STOPPED PRINTING MONEY, IT WOULD ACHIEVE THE SAME THING.

How a "Very Pessimistic" Ron Paul Would Fix the Economy
Posted Jul 16, 2009 11:20am EDT by Aaron Task in Newsmakers, Recession, Banking

Long a proponent of small government and a staunch opponent of the Federal Reserve system, Paul's main point is that increased spending and higher deficits are not the solution to our problems, but their cause.

"You can take care of people, but never with a deficit, never by expanding the spending," the Texas Republican says in this exclusive video interview, taped in the Capitol Hill Rotunda in Washington D.C. "The more we do to interfere with the correction - the longer it lasts."

Had he been elected, Paul said he would be doing "a lot less" than President Obama and blames Keynesian economics - which advocates increased government borrowing and spending during times of duress -- for our nation's current ills.

While admitting a transition to what he views an "ideal society" won't be quick or simple, Paul's economic prescription includes:

* Allowing bankruptcies to occur vs. rewarding failure with bailouts.
* Stop inflation by dismantling the Fed and returning to the gold standard.
* Encourage savings and liquidate debt.
* Deregulate.
* Give tax credits to those who take care of themselves, or the doctors who provide their care.
* Cut government spending, especially on international endeavors. "We spend hundreds of billions of maintaining our empire around the world. Let's bring that money home," he says.

These recommendations will be familiar to anyone who followed (or supported) Paul's run for the Presidency in 2008. Given all that's transpired in the past year, one suspects he'd be getting a lot more votes if the campaign were happening today.

Bob Rodriguez

2009-07-15T13:37:00.001-07:00

ON GURUFOCUS.COM

Robert Rodriguez is the first one among our gurus to report his second quarter portfolio. We have just update his recent stock buys and sells and portfolio. Here we would like to point out some most le moves he had with his portfolio for the second quarter.

Who is Robert Rodriguez?

If you are not familiar with Robert Rodriguez, he is the CEO of FPA Advisors and manager of FPA Capital Fund. During the past 20 years, his fund averaged 12.85%, outperforming S&P500 by more than 5% a year.

Robert Rodriguez uses absolute value screen to pick stocks for his portfolio. When he cannot find stocks, he is willing to park funds in cash. This was proved in the years of 2007 and 2008, while he froze buying and had more than 50% of money in cash.

As a bottom up investor, Robert Rodriguez seems to have good understanding on the overall market valuation and sector allocations. In 2007 he had only 3% of his portfolio in financials, and more than 30% in energy stocks. The indicator he used was the ratio of sector total market cap relative to sector GDP. He said: “Financial service stocks represent nearly 22% of the S&P 500 and 28% of its earnings. If one adds in the financial subsidiaries of GE, GM and others, it is quite easy to get the financial share of the S&P 500’s earnings above 30%. This segment’s profitability is at risk.” (see: Robert Rodriguez's Perspective on Financial Stocks and Sub-Prime Loans )

Here we like to point out that Warren Buffett uses total market cap relative to GNP as the indicator of the overall market valuation. We have developed an Broad Market Valuation Indicator, which shows that the market is probably modestly undervalued at current level.

He wrote in 2006: “the financial-services sector currently represents over 22% of the S&P 500. After nearly 25 years of interest-rate declines and the explosion in financial derivatives and questionable lending practices, we prefer to be invested in energy rather than in financial services.” This has helped Robert Rodriguez avoided the loss in financial stocks.

Energy is by far the most weighted sector

As Robert Rodriguez discussed many times in his shareholder letters and speeches, he is very bullish with energy sector and heavily weighted in energy stocks. Since 2005, he has had energy as his largest holding, and his fund had a terrific run with the energy stocks. This is a recap of what he wrote about energy stocks over the past few years.

Experiences With Energy Stocks in 1979, Reduced Exposure From Over 40% to 3%

Robert Rodriguez: We remain very optimistic toward the outlook for energy prices. Before discussing why, I would like to take you back many years into an earlier part of my career. It was 1979, the Iran/Iraq war was taking place and oil was approaching $40 per barrel. There were many “experts” who were calling for $100-per-barrel oil within ten years. I had the good fortune to participate in a high-level corporate meeting at a former employer, where the longterm outlook for energy prices was discussed. At the conclusion of that meeting, the firm’s senior energy analyst concluded that oil would likely be at $80 in ten years. I asked a simple question as to what might be the effects of this forecast on our life, property and casualty, and consumer finance operations, should he be correct. At the end of this discussion, it was estimated that nearly 90% of the company’s operations would probably be bankrupt before we even reached the ten-year mark. My associate and I walked out of that meeting and began selling our energy holdings the following day since, if our company experienced this bankruptcy scenario, this outcome would have serious negative implications for the economy. Over the next two years, we reduced our investment exposure from over 40% to nearly 3%, just before I left the company. I revisit this period because, during this discussion, supporting documentation was presented that indicated oil production would not peak for at least another 25 to 50 years. I never forgot that chart.

After Almost 20 Years, Robert Rodriguez Revisited Energy Stocks and Bought First Energy Stock Since 1981

Robert Rodriguez: In 1997, I began pondering how the long-term outlook for oil consumption and oil prices may have changed since that fateful meeting nearly 18 years earlier. One would think that, after all this time, energy companies and investors should have a better understanding of the situation. It appears that this was generally not the case, since oil prices and share prices were low and heading lower. In thinking about this, I began to realize that, fundamentally, nothing had really changed, in that no major new fields had been discovered and that consumption had continued to grow. At the beginning of 1998, my associate, Dennis Bryan and I, began a search for an energy analyst. We were very fortunate to have found and hired Rikard Ekstrand. He joined us at the beginning of 1999 and our first energy investment entered the portfolio two months later. This was my first investment in energy since 1981. The point in reviewing this is that we consider energy to be a strategic investment area for us. We expect it to be a large percentage of your Fund for many, many years to come and, therefore, we tend to look through the short-term price variations of our holdings. If share prices rise too rapidly, we may trim a portion of our holdings, but if they decline, we will add to them, aggressively.

Why We Are So Positive About Energy Stocks

Robert Rodriguez: Why are we so positive? Despite the price runup in energy stocks during the past five years, this sector represents barely 10% of the S&P 500. This is up from a low of approximately 5%, but it is down from the 1979 peak of over 30%. Notice that the energy sector topped out at a level that was very close to where the technology sector peaked in 2000. Though it has been a strong performer these past five years, its significance, as a percentage of the major averages, is still substantially less than other periods when a sector has become “the” sector to own.

Oil Prices in the Past Century

Robert Rodriguez: When I entered the investment industry in 1971, worldwide oil consumption was approximately 45 million barrels per day versus 84 million today. The last major oil fields to be discovered were in 1968 at Prudhoe Bay , Alaska and the Shaybah offshore field in Saudi Arabia . We are on the verge of doubling consumption and yet, there have been no other major fields discovered. In the case of the Shaybah field, production began in 1998, so this has helped Saudi Arabia to maintain its daily production. After nearly forty years of searching, with the most advanced technology available and no major fields to show for it, does this not raise a question as to the likelihood of a continuation of low-cost energy prices? Between 1933 and 1970, the price per barrel of oil increased at approximately a 10% compound growth rate, from 10 cents to $3.39. With huge oil discoveries in the 1930s, 40s and 60s, oil prices were low and controlled by the U.S. For many of these years, the price was maintained between $1 and $2 per barrel. With the peak in U.S. oil production in 1970, the world entered a new era. Between 1970 and 2006, oil prices have grown at about an 8.6% annual rate. Much of this rise has occurred in short time periods. As demand grew into the available supply, oil prices began to escalate. For the entire 73-year period, oil prices have grown at approximately a 9.3% annual rate. Given that there have been no major oil discoveries since the late 1960s, this raises the question of what might the rate of growth be in oil prices going forward. If we are to be conservative, possibly a 5% growth rate might be appropriate. This would be a little more than half the rate of growth for the last 73 years. If this were to occur, a barrel of oil would cost approximately $100 in ten years. For consumers not to experience an increase in their energy spending as a percentage of total spending, either their incomes have to grow in line with energy prices or they will have to reduce their energy use. Either way, this could affect the nature and growth of the economy considerably.

World Oil Production May Have Reached Its Peak

Robert Rodriguez: In the case of supply, within the next five years, three countries may reach a peak in oil production: Mexico , China and Russia . Several analysts estimated that Mexican oil production would likely peak around 3.4 million barrels per day and that this event would occur in 2004. Mexico ’s largest oilfield, Cantarell, appears to have peaked and if this is the case, so has Mexican oil production, since six of every ten barrels produced by Mexico comes from this one field. Earlier this year, a 3% decline rate was forecast for Cantarell’s production. This has proved incorrect since it is now estimated that the decline rate is 8%. Obviously, this is likely to be of some concern to Mexico . Should this forecast of peak oil production for these three countries be correct, an additional 35% of non-OPEC oil production will have peaked, and together with the 41% from eleven major countries and others that have experienced a peak in production rates, 76% of non-OPEC oil production might have peaked by 2012. If this occurs, it will give the middle-eastern countries even more clout in the setting of oil prices. This is not a pleasant thought.

As for the possibility of Saudi Arabia and OPEC riding to the rescue, there is a major debate occurring within energy circles as to whether they will be able meet rising oil demand. Saudi Arabia says that they will have no problem meeting incremental oil demand for years to come. They estimate that they have over 250 billion barrels of reserves. This estimate has not changed since 1988, despite their producing over 3 billion barrels per year for nearly twenty years. Saudi Aramco, the Saudi state oil company, has acknowledged that its gross depletion rate is now approaching eight percent. If true, Saudi Arabia needs to bring on 800,000 barrels per day of new oil production each year to offset declines in existing fields. Several OPEC nations appear to have already peaked in their production capabilities. We wonder whether the margin of safety is as great as what Saudi Arabia would have us believe. The last independent audit of their reserves was done nearly thirty years ago and at that time, their reserves were estimated to be 110 billion barrels. It does raise a question.

The Energy Sector Will Remain a Strategic Investment Area for Us

We view the energy sector as both a store of value and a hedge against a future inflation. It is one of the few sectors where we believe the underlying fundamentals will continue to improve despite the worldwide economic contraction. With worldwide oil depletion rates of 9% annually for those fields past peak and U.S. natural gas first-year production decline rates of between 30% and 50%, these trends should be supportive of energy prices longer term.

Again, within three to five years, we believe oil prices will be back above $100 or even higher than $150 per barrel. Our recent asset deployments reflect our typical strategy of being “out of step” with the general consensus, especially with an energy exposure that is nearly 50% of all of our equity holdings.

We deployed more capital than at any other period in the last 25 years, late last year and early this year, with 67% directed into energy stocks. This added to FPA Capital Fund’s hefty energy exposure that existed prior to the market collapse. Over 50% of the Fund’s equity investments are currently in energy.

The Worry on National Debt and Inflation

I estimate that by the close of 2011, Treasury debt outstanding will be between $14.6 and $16.6 trillion and that the U.S. debt to GDP ratio will rise to between 97% and 110%. By comparison, the highest ratio ever attained was 121% at the end of WW2. Furthermore, my estimates do not include entitlement liabilities or the effective guarantee of trillions of dollars of Fannie Mae and Freddie Mac obligations. Treasury debt service will likely rise by 50% to 100% above the present $450 billion rate and this is with interest rate levels near record lows. A critical question is, “How do we finance all this debt?” Assuming consumers save an additional $650 billion in 2009, we will still be more dependent on foreign sources of financing. Should foreign investors retain their present amount of Treasury debt ownership and then let it increase proportionally to our debt growth this year, additional purchases between $719 and $862 billion are required versus last year’s $724 billion. This appears doubtful, given the deterioration in their domestic economies along with rapidly declining exports. To make up the difference, the Fed will be forced to print an additional $800 billion to $1.5 trillion of new money to buy these bonds. Unless Americans increase their personal savings per my estimates and foreign investors boost their Treasury ownership by 39% to 57% between 2009 and 2011, the Fed could be forced to print additional money. This possibility may unnerve some of our trading partners, particularly the Chinese and the oil exporting countries.

BAD NEWS FOR HIGH END REAL ESTATE

2009-07-06T10:09:00.000-07:00

THIS IS THE NEWS THAT I'VE BEEN WAITING FOR. THEY SAID THAT REAL ESTATE WOULDN'T DROP IN SANTA MONICA (WHERE I LIVE). BOY, WERE THEY WRONG.

Has the housing market scraped bottom? Not in some of the wealthier neighborhoods--places like New York City's Greenwich Village, Santa Monica, Calif. and Chicago's Lincoln Park. They held up nicely while the rest of the country slumped last year. This year such Tiffany zip codes are on track to fall 15% to 25%.

Why haven't you heard about this? Statistics lag. With relatively low unemployment, high-end addresses don't have foreclosures to hasten capitulation. If they've attracted luxury high-rise developers, these markets may be propped up by recent condo closings at foolish prices agreed to two years ago. But talk to experts who know the regions block by block--or to people who've sold (or tried to sell) a home or co-op. There is a still-growing supply of wildly overpriced, unsold homes--60,000 U.S. properties priced above $2 million listed on Realtor.com. Experts get these gloomy vibes by dividing inventory by the current monthly rate of purchases. "Any result over seven months generally means falling prices," says David Stiff, chief economist at Fiserv ( FISV - news - people ) in Brookfield, Wis. In some tony neighborhoods the level of glut is higher than the national average of ten months.

Unsold inventories in Manhattan are at their highest levels in a decade. You can't tell by looking at data about its condo market. According to Radar Logic, which generates national realty info from its New York City office, condo values fell only 4% last year--far less than the 12% drop for the city as a whole. It's been held aloft by new-construction condo sales above the $1,200-per-square-foot level, says Radar Logic founder Michael Feder, reflecting deals struck a year or two ago. Once they pass through the system, the average price of a condo will plummet to $900 a square foot, reckons Feder.
In addition to the 10,500 properties already listed, there are another 9,500 in the wings, estimates Manhattan appraiser Jonathan Miller. Some 2,500 of these shadow listings belong to sellers who have some flexibility to keep their listings off the market in hopes of better pricing. Developers hold the rest. Both groups are likely to rush their listings onto the market once it's clear prices are falling. Some folks can't wait. Françoise Pourcel, 62, listed her 2,100-square-foot Tribeca loft last August at $3.5 million, in line with the sale price of a similar unit on a lower floor of her building. In June she accepted a bid for $2.5 million.

Condo prices in Manhattan would have to fall 50% to return to values relative to rents they had in 1999, a relatively sane year in real estate. A condo owner could then lease his home and garner net rental income (rent minus property taxes, insurance and fix-up costs) equal to about 7% of the property's fair market value. The current yield is around 3.3%. Far too low.

It's a similar story in Lincoln Park, where single-family home prices slipped only 2.2% last year, far less than in the rest of Chicago. But inventory has since tripled. Wagner Appraisal Group figures there's a 16-month supply. A year ago "I was almost cocky about our position compared to the rest of the market," says Jennifer Ames. No longer. After 11 months of lowering the $2.1 million asking price on her 3,400-square-foot house, Ames sold it in June for $1.6 million.

Given the glut of unsold homes, Lincoln Park's prices may well slide at least 15% this year--as Chicago's did in 2008. If you look at Fiserv data going back many years, you find values in Lincoln Park track the rest of Chicago pretty closely with a one-year lag.

In Santa Monica's coveted "north of Montana" area overlooking the Pacific, listings are up 60% since last year and the number of days on the market for those listings has doubled to 140. Homes once sold in as little as a week here. Closer to Main Street, Bill H. Meyers has struggled for more than a year to sell his condo. In April 2008 L.A. was hurting, but Santa Monica values hovered around their peaks. So Meyers tried to unload his property for $850,000, roughly in line with what another unit in his building sold for. He turned down bids near $800,000 after he found a renter at $3,500 a month.

Now that his tenant is gone, Meyers hasn't found a replacement at that price, and getting another $800,000 bid is impossible. The data still say Santa Monica is stronger than other nearby markets. It's just 14% off peak prices, versus Los Angeles, down 38%. But the beach city's inventory of unsold homes has just crossed the 15-month level, as high as Los Angeles' were last year. By that grim logic, Santa Monica's values are likely to tumble as far as those in Los Angeles did last year, 27%.

Like Meyers, anyone who can afford to will hang on as long as possible, banking on the faith, he says, that "the market is going to come back." Meantime, excess supply is piling up.

States of Collapse?

Last year the housing crash spared some of the nation's fanciest enclaves. But mounting inventories suggest they may drop as much this year as their metros did in 2008.

-------------------

Debt Monetization

2009-06-18T13:49:00.001-07:00

What is Debt Monetization? When is it Automatic? Is it a Risk?

What is debt monetization and how does it work? How can constant interest rate rules make debt monetization automatic? Why is this a worry and how does it relate to the choice of a new Fed chair?

What it is and how it works

1. Suppose the government runs a deficit. As an example, let government spending on goods and services be $10,000. For simplicity, all transactions are in cash. Let net taxes from all sources be $9,000 so there is a $1,000 deficit.

2. The government has $9,000 in cash from taxes, but needs to spend $10,000. Somehow (print money, borrow money, raise taxes, or lower spending) it must get $1,000 more.

3. Suppose it decides to borrow – issue new debt. Then the Treasury sells a government bond to someone in the private sector for $1,000. The person gives $1,000 in cash to the government and in return gets an IOU (perhaps for, say, $1,100 in one year).

4. The government now has $9,000 in cash from taxes and $1,000 it has borrowed from the public so it can now purchase $10,000 in goods and services.

5. Now let’s do the monetization step. This can happen automatically, as explained below, but for now let’s have the Fed conduct a $1,000 open market operation to increase the money supply. To do this, it cranks up the press, loads in some paper and green ink, and prints a brand new $1,000 bill. It takes the $1,000 bill and purchases a bond from the public, for simplicity make it the same bond the Treasury just issued. Then the money supply goes up by $1,000 (and may go up more through multiple deposit expansion) and government debt in the hands of the public goes down by $1,000 since the Fed now holds the bond. The increase in the money supply is inflationary.

6. What has happened? When all paper has ceased changing hands, the $10,000 in goods and services is paid for by the collection $9,000 in taxes and by printing $1,000 in new currency. The government debt simply moves from the Treasury to the Fed (in the U.S., the Fed pays for its operations from its earnings on these bonds and remits the remainder to the Treasury; I believe the remittance is weekly, but I’m not positive on that).

Comments from friend in China

2009-06-11T08:24:00.000-07:00

THE BELOW COMMENTS ARE FROM A FRIEND IN CHINA WHO WAS RESPONDING TO ONE OF MY EMAILS. I THOUGHT YOU'D FIND IT INTERESTING. THINGS ARE NOT SO GREAT IN CHINA. READ ON....

Spot On Holmes!

I keep hearing the same garbage about Buffett too. The fact of the matter is, the current rally is going to prove very painful for the bulls. On another matter, I am currently studying for my FSA and CFA exams, while living with my Girlfriend's family in Shanghai. Immediately we arrived in Shanghai from London (last week), the economic troubles were obvious, the worry is on everyone's face over here. The Japs are divesting and moving back, the Western firms are cutting jobs (McKinsey, PWC, KPMG, you name it). Local markets have been flooded with goods previously destined for export at 50% discount. If there is a recovery underway here, I certainly cannnot see it. The shopping malls are basically deserted, apart from a few stray Americans. The people here are very smart and cautious, be it on official television or one of the many housewives I have spoken with: they know a crash is coming. As for the talk of reserve currency, I find it very interesting when people begin to check even small bills as the market has been flooded with counterfeits. Makes me pause to think very hard. This is my Third visit to China and it is indeed a wonderful place (as is India), but be sure of one thing: Most people here do not believe a recovery is likely, not in the near future. And if you talk about a V-Shaped recovery you will be laughed out of the tea shops by the housewives.

Best,

Vinay

More about Inflation

2009-06-09T08:16:00.001-07:00

Jeremy Siegel, Ph.D. The Future for Investors

Inflation, Not Default, Is Risk for Treasury Bonds
by Jeremy Siegel, Ph.D.
The headlines are scary. Standard and Poor's warns that UK gilts (British Treasury bonds) may lose their AAA rating and indicates that U.S. government bonds may also be downgraded. Bill Gross, PIMCO's "bond king," says emphatically that the U.S. will eventually lose its AAA rating.
What does all this mean? Is it possible for the U.S. government to default on its own debt?
Technically, the answer is "no." The government can always print the money to pay its obligations. But from an economic standpoint, the answer is "yes," since printing money causes inflation and pays off bondholders with depreciated dollars.
The Debt Mechanism
All U.S. treasury debt is denominated in dollars, and except for the less than 10 percent that are "inflation-protected bonds," all bonds are promises to pay a specified number of dollars on given dates. Dollars are created when our central bank, the Federal Reserve, either buys securities in the open market or lends to banks against their loans and other assets. Although Congress imposes a ceiling on the debt issued by the federal government, the Federal Reserve has no effective constraints on the amount of money it can create.
It was not always this way this way. Before 1933, the Federal Reserve could only print dollars in proportion to how much gold the government held -- the so-called gold standard. During the Great Depression, one country after another, including the U.S., left the gold standard and moved to a fiat money standard. Under this monetary arrangement, the government decrees by law (fiat) that its money (Federal Reserve notes in the U.S.) is legal tender for all transactions. There is no gold, silver, or other commodity backing the money.
In a fiat money standard, money only retains its worth because the government limits its supply. The government can limit its supply if it has other sources of revenue, such as taxes or borrowings, to cover its expenditures. But if those other sources dry up, the government may effectively borrow from the Fed, and this would result in large increases in money and rapid inflation.
There is much debate among conservatives about whether the government's decision to leave the gold standard was correct. I, like the majority of economists, believe that it was a good move. If we were still on a gold standard, it would not have been possible for the Federal Reserve to back up money market funds and other bank deposits last September when the credit crisis hit. The resulting run on banks and flight to liquidity would have likely sparked a far worse financial crisis than we experienced. But the flexibility of a fiat money standard must be weighted against its bias towards inflation.
Default Under a Fiat Standard
Although under a fiat money standard government money must be accepted as a means of payment, there is no law that says what that money is worth when it is paid. If too many dollars are issued relative to demand, inflation must result. In that case the bondholder gets shortchanged not because of a government default on its bonds but because of the loss of purchasing power of the dollars paid. (Some countries impose price controls in a futile attempt to assure their own currency won't depreciate in value. Except for limited periods during wartime, such controls have always failed.)

There is one type of Treasury bond that could theoretically default, and that is Treasury-Inflation Protected Securities, or TIPS. Since TIPS compensate bondholders for inflation by increasing the coupon payments and final principal payment by the cumulative rise in prices, the bondholder suffers no decline in purchasing power during inflation. In contrast to standard nominal bonds, TIPS cannot be inflated away, and this leaves open the theoretical possibility that the government could not marshal enough resources to pay interest and principal on these bonds. TIPs for the U.S. government are similar to issuing foreign currency bonds. Any attempt to pay them off by increasing the money supply will cause inflation, depreciate the dollar, and increase the government's dollar indebtedness.
Of course, just because the government can always technically fulfill its debt obligations does not mean that it always will. Since a large proportion of U.S. government bonds are owned by foreign investors, the government could decide that it will only default on those bonds owned by foreigners. The Russian government defaulted on its foreign-owned bonds in 1998, while still honoring domestic bonds. But such selective default would be met by wholesale dumping of dollar assets, sending the dollar crashing on international markets. Given the huge volume of goods the U.S. imports, a plunging dollar means inflation would skyrocket and render such a policy counterproductive.
Our Current Situation
Since the credit crisis began, the Federal Reserve has more than doubled the supply of its own money, and government deficits are running into the trillions of dollars. Many believe this will inevitably lead to rapid inflation.
But such a conclusion is premature. The Fed has increased the supply of money in response to the tremendous increase in the demand for such money caused by the liquidity crisis. And government borrowing is just offsetting the sharp increase in consumer saving caused by the declining value of assets and tighter credit.
I believe that the government's current economic response is right. But the government must be on guard. Once confidence returns, the Fed must pull back the money it loaned and the government must bring deficits under control. This will inevitably mean raising interest rates, and the latest increase in long-term treasury rates is a clear signal that the bond market sees this happening soon. If, by the second half of this year, the economy turns around, the Fed will have to start raising the Fed Funds rate and restrict liquidity. Otherwise the government will effectively default on its obligations -- not by missing its payments but by making those payments in a depreciating currency.

Picture of Holmes and Meg Whitman

2009-05-27T10:09:00.001-07:00

Barron's article

2009-05-26T10:47:00.000-07:00

Elliott Wave Guru Sees Dark Days Ahead
By TIERNAN RAY | MORE ARTICLES BY AUTHOR
One of America's most famous market forecasters thinks that investors should play it safe with their investments.

ROBERT PRECHTER, THE market forecaster who told investors to sell their stocks weeks before the October 1987 crash, is back in the news.

Prechter, head of market-forecasting firm Elliot Wave International and author of several books, including Conquer the Crash (available from Amazon.com), has been quoted recently as saying that the current recession could last for a long time and even force stock markets back down to levels seen at the market bottom reached in March of this year.

Barron's caught up with Prechter by phone this week to understand the technical trading signs he looks at to draw conclusions about investor sentiment.

Barrons.com: You've said that today's recession represents a very deep and prolonged decline, akin to the 1929-1932 depression. What's your reason for viewing things as so dire?

Robert Prechter: My model is that naturally occurring waves of optimism and pessimism, which result from unconscious herding, are the driver of financial and macroeconomic trends. Upon rare occasion, waves of very large degree come to an end. In the financial realm, when people get more pessimistic, they sell stocks and curtail credit. They also take fewer risks in the realm of production, which causes the economy to contract. Taken together, these changes -- at very large degree -- portended a downward revaluation of the stock market, a deflation in credit and a depression.
Manager's Bio
[RobertPretcher]
Name: Robert Prechter
Age: 60
Title: President, Elliott Wave International
Education: BA, psychology, Yale
Hobbies: No hobbies anymore, just work all the time

Q: By what measure are you judging this pessimism?

A: Aside from price patterns per se, we track waves of social mood by way of psychological indicators. At large degree, we use things such as price/dividend, price/book and bond yield/stock yield ratios, mutual fund cash percentages, the number of investors bullish vs. bearish, credit spreads, savings rates, consumer sentiment, duration of optimism, and so on. From 1998 to 2007, these measures set records. P/E is still setting records. Optimism occurs at tops, and the more extreme the optimism, the bigger the degree of the top.

Q: Some observers allege that steps taken by President Roosevelt during the early part of the Great Depression ended up prolonging the depression. Will policy decisions being enacted now ameliorate or exacerbate the current decline?

A: Governments' policy decisions hamper and ruin economies all the time, but their meddling does not affect waves of social mood. On the contrary, waves of social mood generally spur governments to act. The 1929-1932 collapse caused the government to get restrictive and separate commercial and investment banks in 1933; this was after the bust it was designed to prevent was over. The 1990s boom caused government to get frisky and repeal the act in 1999; this was just as the boom it was designed to foster was ending. These policy decisions did not cause any changes in social mood, but the social mood trends predicted the character of the policy changes. Government herds, just like everyone else, but it is at the tail end of the herd, because it takes time for a consensus to develop so extensively that government has the public support to act.

Q: While the Federal Reserve's FOMC Wednesday said the slump will be worse than originally expected in the next three years, others are convinced that the "less bad" data points could lead to a recovery in the second half of this year.

A: Social actions result from social mood change. When we recognized a temporary low in pessimism in late February/early March, we were able to predict changes that would result: stocks would rally, credit spreads would narrow, housing sales would pick up, and authorities would take bows for effective "liquidity" and "stimulus" programs. If it goes high enough, a consensus will probably develop that the bear market and recession are behind us. Then it will be time for the next wave down.

Q: You've been quoted as suggesting people invest in Treasuries, considering them "safe cash proxies," but you've also said skeptical things about Treasuries given massive borrowing and the threat of deflation. Which is it?

A: It's a matter of short rates versus long. The best investment stance for conservative investors has been simple: safety. My primary recommendation is safe-cash equivalents. This means Treasury bills, Swiss money-market claims, some New Zealand bonds, some gold and some cash. There has been no change there. Cash has been good. Today you can buy twice the house, twice the stock shares and twice the gasoline that you could a short while ago.

But long term, Treasuries are different. After 28 years of rising prices for T-bonds, the Fed announced in December that it would buy them. Part of the downturn in prices relates to an anticipated pick-up in the economy, which should in fact occur for part of this year; part is due to hyperinflation fears, which I think are misplaced; and part is due to early fears of eventual government default, which I think are not misplaced. If government rates go up, bond investors will lose money, while we bill investors will make money, at least until it's time to bail out of government debt entirely.

Q: Do you prefer dollars to other currencies?

A: My position is that the dollar is the most inflated currency in the world, so it has the furthest to deflate. In other words, because it is so sick, it is the currency most likely to rise during the deflationary period as dollar-denominated IOUs collapse. Regardless, my currency mix includes what I consider to be very safe foreign debt and some gold. You have to realize that almost everyone loses in a deflation. The key is to lose a lot less than everyone else. Market opinions are one thing; safety is another.

Q: Your remarks as quoted in the press seem to refer essentially to the U.S. economy. What is your view of the rest of the world's economic prospects?

A: It's a developing global depression. Economies and societies are so closely entwined in the modern world that social mood is much more pervasively shared than it was centuries ago. So the world had a boom together, and it's having a bust together. The canary in the coal mine was Japan, which reached impossible-to-maintain extremes of debt and investment values a decade earlier than other countries did.

Q: So in spite of this market run-up, there's more misery ahead?

A: If you stay safe, it's the opposite.

2009-05-18T09:22:00.000-07:00

List of blogs

2009-05-18T09:08:00.000-07:00

I FOUND THIS LIST OF BLOGS ON SEEKING ALPHA.COM. I HAVE WRITTEN FOR SEEKING ALPHA IN THE PAST. THE LINKS DIDN'T COME THROUGH SO YOU CAN GO STRAIGHT TO THE WEB SITE.

http://seekingalpha.com/article/138174-my-favorite-financial-blogs

* 1440 Wall Street makes me feel as if I am in the middle of the world's financial capital (for the time being.) It has matured from a blog with insider chat into something much bigger since. Check out all tabs there.
* A Fistful of Euros compiles the best of European econ blogging with many contributors from all over the old continent.
* Across The Curve delivers all the highlights from fixed income information I need for my macro view.
* Aktien Trading Austria focuses on Austria's capital market. German language
* Austrian Economists came to my attention only today. As most believers in the Austrian school of economics they deliver a steady flow of out-of-the-box thinking that makes sense.
* Beat the Press is the checkpoint to see what MSM (main stream media) got wrong.
* Bonobo at Home is written by Spain-based Brit Edward Hugh who says the best starting point for his and his syndicated writers is Global Economy Does Matter which links to all his other regionalized econ blogs. Edward excels in delivering complete current write-ups of national economies without producing information overkill. Only thing I miss is a RSS feed that aggregates his multitude of said regional blogs. One of my top 5 blogs.
* Ueber-blogger Barry Ritholtz has been producing unchanged quality for years at The Big Picture but his style changed from truly big pictures to a more snippet-like form that is nevertheless a must read.
* Burning Our Money is an entertaining, sometimes quite frothy chronicle targeting how the UK government wastes its money.
* Calculated Risk (we'll all keep a memory of the late Tanta) has evolved from the best blog about the US housing bubble to discuss a wider field of issues. One thing stays the same: When in doubt about real estate, surf there.
* Capital Chronicle entertains with sarcastic general commentary.
* Capital Markets & Economic Analysis looks at markets from a technical and fundamental perspective.
* The Capital Spectator dives deeper into the issues day after day, focusing on markets and macro economics.
* Cassandra Does Tokyo makes me chuckle with every new post. One can feel that she has to tame her rightful cynicism.
* CommodityBullMarket focuses on the coming bull market in commodities and precious metals, a stance I fully agree with.
* Controlled Greed is devoted to investing in undervalued stocks on a fundamental basis.
* Culture of Life is the best female econ blogger, compiling all important news of the day in one brilliantly written post. Among my top 5.
* The Cunning Realist is written by a Republican fed up with the folly of all politicians.
* COTS Timer scrutinizes the commitment of traders statistics in futures markets.
* Democracy Now focuses on human rights violations and the uncountable wars around the world.
* Daily Kos is my daily dose of US Democrat's issues.
* DollarDaze shares my perspective that all paper currencies will devalue to zero and expects a major commodities bull.
* EclectEcon: Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities.
* Econbrowser by economists James D. Hamilton and Menzie Chinn, two of the better writers in their guild.
* Economist's View comments the issues of the day, including more links to the respective subject.
* Economic Dreams - Economic Nightmares is most skeptical about America's economic future.
* Econom Pic Data offers "darn nice economic eye-candy." Want a graph but are too lazy to do it yourself? It's highly likely Jake has done it there already.
* The European Citizen comments daily events in the European Union.
* European Tribune is a political blog dealing with issues in the European Union.
* Finance Trends Matter offers links of the day and critical opinion on the macro level.
* Finance Round Table aggregates the A-list of econ and finance blogs.
* Finance Professor reminds us that economics is fun and has a good link collection.
* Footnoted is an expert in reading the fine print in SEC filings.
* FSK's Guide to Reality gives contrarian in-depth information on issues we all consider indisputable axioms of capital markets. His posts will make you thinking.
* Gold Chat focuses on all precious metals issues and is not endorsed by the Australian mint where the author works.
* Mish's Global Economic Trends Analysis is very often the fastest instant and thorough analysis on the web concerning macro and corporate issues. One of my top 5 blogs.
* Gadling should be visited before you have any travel plans.
* Global Voices Online watches the global blogosphere. A nice distraction between all that macro and micro that is my usually daily diet.
* Indian Economy Blog is the best I found so far about India's stock market and other issues on the subcontinent.
* Jesse's Cafe Americain not only offers insightful commentary but also mouth-watering pics from the food there.
* Jim Rogers Blog is not written by the master himself but is a reliable source picking up all of Jim Rogers' media appearances and writings.
* Jr Deputy Accountant sees it all from the common sense perspective.
* Julien Frisch is a German blogger shooting up the ranks in the German blogger scene. He writes in English.
* Learn to Trade Futures is edited by my friend Duncan Robertson on the Isle of Skye. If you have no time to surf hundreds of web pages everyday, Duncan reliably produces a complete digest of today's news all year round.
* Luxist blogs on the finer things in a material life. In step with the economic reality there are far less million dollar mansions than in 2007, replaced now by more affordable luxuries in the 3, 4 and 5 figure range.
* macroblog, once the unofficial casual style Fed voice among bloggers is still excellent in explaining macroeconomic and Federal Reserve issues.
* Mahalanobis is the only other Austrian blogger handling serious economic issues.
* Marc Faber Blog is written by the critical and often contrarian investor himself. It came to my attention because he now also twitters (@marcfaber).
* Market Skeptics, discovered yesterday, is exactly that. Their post about Dubai's gold shows they browse for the right information destined to be major fundamental events.
* Market Ticker never fails to write about current market events in an informative, sometimes rude but always entertaining style. One of my top 5 blogs.
* Maverecon is my favorite of all blogs on the Financial Times website.
* Miscellaneous Economic Ramblings - the title says it all.
* The Mess that Greenspan Made often has the same ideas and the same cycles of creativity and productivity as I do. Cheers Tim.
* Mises Economics Blog is another must for Austrian economists.
* My 1st Million at 33 are the hands-on experiences of a guy's way to wealth.
* naked capitalism is certainly among my top 5 blogs, written by various authors with expert knowledge.
* Oil Drum brings you the global outlook and discussion about energy in the future.
* Oil Drum Europe offers valuable information on - you guess what - oil and energy of course.
* Paper Economy is skeptical about the duration of the current crisis. Will it be longer than we all think?
* Past Peak takes a close look on oil (reserves) and has a daily joke as well.
* Peter Pilz is a green Austrian politician uncovering corruption affairs and other crimes done by politicians and officials. German language only.
* Price of Everything has smart economic commentary written by Tim Price who could also make his money as a comedian once the economic apocalypse engulfs us all.
* ProBlogger offers advice how to grow the readership of your blog and make money from it.
* Purple Slinky is another welcome distraction from markets.
* Robert Reich's Blog is the former 22nd Secretary of Labor and is a professor at the University of California at Berkeley. This is his personal diary on economics.
* Russian Stock Market Blog is the source for news about said subject.
* Seeking Alpha is the leading source for serious econ bloggers. I am proud to be one of their contributors.
* Simoleon Sense covers psychological aspects and other little known valuable knowledge for investors. He also has daily linkfests one should not miss out on, leading to more interesting articles concerning investing.
* Skeptical Speculator never tires. Reliable source for the global economic indicators of the day.
* Today in Silver focuses on events in the silver sector which is still neglected by most investors but may have a golden future.
* Troy Ounce: I have never seen somebody becoming a good writer in a matter of days until I found this blog.
* Truck and Barter has more thinking out-of-the-box.
* Unbiased Trading is an excellent source for technical analysis.
* Vox is full research-based policy analysis and commentary from leading economists.
* Washington's Blog is a good alternative to MSM.
* When Giants Fall written by best-selling author Michael Panzner is about the most pessimistic blog I have come across. This does not mean that he is wrong with his pessimism.
* World2Come provides an outlook into the future on very many issues.
* Your New Reality publishes those interesting stories and picture that cannot be found in MSM.
* Zerohedge: I marvel how one person can do so many detailed posts in one day. One of my top 5 blogs.

Comments from Guild Investments

2009-05-15T11:08:00.000-07:00

Guild Investment Global Market Commentary

Written: May 15, 2009

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I just returned from traveling, and upon returning was thrilled to hear of the following announcements on Wednesday May, 13th.

REGULATION OF OTC DERIVATIVES IS NEARER---A GLIMMER OF GOOD NEWS

The U.S. Treasury Secretary announced that all over-the-counter (OTC) derivative settlements need to take place in a clearing house, and dealers must meet minimum capital requirements. Regulating derivatives is a good start toward avoiding another financial system meltdown such as the one we have been experiencing; however there are lasting effects of the current melt down that must still be addressed.

The reason that so many derivatives were written, is because they were structured in a way that was extremely profitable for the seller. We will wait to see if Congress (which receives way too much funding from major financial institutions) will go for the controls on the financial institutions' most profitable products. If congress has the fortitude to regulate derivatives, it could be the start of a new era of more responsible banking. Let us hope for the best, but prepare for a politically expedient solution.

From: Telegraph.co.uk
Geithner seeking to bring derivatives market under regulation
U.S. Treasury Secretary Tim Geithner is attempting to bring the $450 trillion (£299 trillion) over-the-counter derivatives market - in part blamed for last Autumn's financial meltdown - in to the regulatory fold for the first time.

May 13, 2009
By James Quinn

In his first major revision of the US financial regulatory handbook, Mr Geithner has proposed a series of new guidelines aimed at preventing derivatives from again posing a risk that might threaten the entire financial system.

Derivatives including credit default swaps - sophisticated financial insurance products - have been blamed for exacerbating the fall-out at companies like American International Group and Lehman Brothers at the height of the credit crisis.

Such financial products have previously fallen through regulatory gaps because 90pc of them tend to be traded "over-the-counter", directly between institutions rather than through a recognised exchange.

Financial regulators including the Securities and Exchange Commission and the Commodities and Futures Trading Commission are backing Mr Geithner's proposal. He says that all over-the-counter derivatives should be cleared through regulated central counter-parties.

In addition, dealers in derivatives should be subjected to prudential supervision and regulation, and should be transparent and meet certain capital requirements.

Prices of derivatives trades will be made available on centralised computer platforms, Mr Geithner said.

His push is part of an effort to strengthen regulation in the financial markets in the wake of the credit crisis, and to increase transparency at the same time.

Unfortunately, one cannot go back and retroactively make everything correct, reversing all of the idiocy which created the current problems. So, we expect the policies of using big government spending and bailouts to continue, as this is the only alternative to deal with the derivatives which have already irreversibly melted down.

The government will have to finance these bailouts. Part of the solution may be to make the banks, which are owned partly by the government, buy the government's bonds. They may also require the pension funds of these bailed out companies to buy government bonds. Both of these will happen, but the big buyer of debt to cover the $2 trillion deficit this year and all of the huge deficits in coming years will be the U.S. government.

The Federal Reserve is committed to buying bonds. Initially interest rates fall, but the eventual long term effects will be a lower U.S. dollar, and a bond market with higher interest rates.

THE U.S. DOLLAR HAS BEGUN TO DECLINE

The U.S. dollar has fallen by about 8% from its highs, after rising by over 25% from its lows in 2008. All of this has taken place, as the balance sheet and fiscal future of the United States has deteriorated greatly over the same time frame. We remain amazed that the dollar was able to rally so much. We believe that the dollar's rise has been a function of the relatively unattractive nature of the major alternatives, the Euro and the Yen, and generalized fear which caused the uninformed to fly to the incorrectly perceived safety of the U.S. dollar.
U.S. Dollar Index -last 2 years
U.S. Dollar Index 041509

We continue to expect that the dollar has much farther to fall and recommend that all of those readers who think in terms of currencies other than the U.S. dollar exercise caution and avoid the U.S. currency.

We plan to hold foreign currencies for the cash balances of our clients, due to our pessimism about the long term future of the dollar. Our favorite currencies continue to be Canadian, Australian, Norwegian, and the Euro.

Australian Dollar versus U.S. dollar - last 2 years
AUD vs. USD 051509

Canadian Dollar - last 2 years
CAD vs USD 051509

PAKISTAN

As the news is constantly telling us, Pakistan is undergoing a fight for its survival as a secular state. We are skeptical about these reports, for according to our sources much of Pakistan is already under the control of the Taliban, and in most of the rest of Pakistan, the Taliban has an important presence. Pakistan has long been operating in a feudal manner where the rich and well connected have controlled most of the land and have rented it to landless farmers.

Education for all but the top classes has been neglected. As a result huge resentments have been formed, and the country is paying the price for this. In our opinion, Pakistan has already fallen under the influence of non-productive influences, and the U.S. is once again paying the price for supporting regimes who have no interest in bettering the quality of live of the local people. In our opinion, the U.S. and its allies should focus much more attention on India to stabilize the South Asian and eastern Mid East regions. India has shown itself to be an economically viable and responsible country and one that is moving toward a larger role in international affairs.

SUMMARY

Many technical analysts are calling for the demise of the current stock market rally. All of the capital raising by banks and other companies ($21 billion in newly issued shares were raised in the week between May 7 and May 14 2009) has caused a decline in the U.S. market this past week. We will wait to see what happens, but if new share issuance slows down, the U.S. market rally could resume its two month rally.

Many investors are bearish on the market due to this being the historically weak season for stocks; "sell in May and go away" is an old stock market axiom. The conventional wisdom is calling for a correction. The fact is that the market is about even on the year, after falling heavily in the first two months of 2009.

On the other hand, the economic backdrop is gradually improving, and the stock and currency markets are responding more to rationality, and less to fear, hence the falling value of the U.S. dollar. If we can assume that fear is receding, and that rationality is returning, we can assume that markets will be more rational about stock and currency valuations.

In our mind the Japanese, European and U.S. markets have a mediocre long term future, while many other markets are more attractive. This does not mean we will not own stocks in the U.S., Europe, or Japan. It just means that we will have to be very selective to buy only those with truly visible earnings growth.

In other parts of the world, India and China especially, the economies are growing fast, yet stock prices do not reflect the rapid economic growth, which has continued during the economic upheaval of the last year and a half...and is expected to continue uninterrupted for some time.

While it is true that some companies and industries are doing poorly in Europe, Japan and North America, other companies and industries continue to grow nicely. We see opportunity in many areas, especially in energy, precious metals, agriculture related, India, China, and currencies other than the U.S. dollar.

Thanks for listening.

Wall Street Journal Editorial

2009-05-12T12:28:00.000-07:00

THE BELOW EDITORIAL IS FROM A WELL KNOWN ATTORNEY WHO REPRESENTS CORPORATIONS IN HOSTILE TAKE OVERS. HE IS ANTI ANYTHING THAT IS SHAREHOLDER FRIENDLY AND EARNS HIS FEES FROM THE MANAGERS WHOM HE PROTECTS. LET ME BRIEFLY REFUTE HIS REMARKS.
1. IT WOULD BE WONDERFUL IF SHAREHOLDERS COULD VOTE ON EXECUTIVE PAY. AS IT STANDS,
MOST CORPORATIONS LET CEOS PUT THEIR BUDDIES ON THE COMPENSATION BOARD.
2. STAGGERED BOARDS MAKE IT IMPOSSIBLE TO THROW OUT THE BOARD ALL AT ONCE. IF ALL
BOARD MEMBERS ARE VOTED ON ANNUALLY, IT IS POSSIBLE TO REMOVE THEM.
3. THE LAWYER WHO WROTE THIS IS BLAMING THE CURRENT PROBLEMS ON EXCESSIVE SHAREHOLDER POWER. IT IS MANAGEMENT THAT BORROWED EXCESSIVE AMOUNTS OF MONEY, PAID THEMSELVES FAR TOO MUCH, AND PARTOOK IN "CREATIVE ACCOUNTING".

HALF OF THE PEOPLE READING THIS BLOG WON'T LIKE CHUCK SCHUMER. THAT'S OK. AS A PERSON WHO READS ANNUAL REPORTS, TALKS TO MANAGEMENT, AND GOES TO SHAREHOLDERS' MEETINGS, I CAN TELL YOU THAT MANAGEMENT HAS LITTLE INCENTIVE TO WORK WITH SHAREHOLDERS AND IS RETICENT IN TAKING ADVICE. THIS BILL IS A GOOD THING AND WILL PUT THE POWER BACK IN THE HANDS OF INDIVIDUAL INVESTORS, PENSIONS, AND MUTUAL FUNDS.

HOLMES OSBORNE

This week New York Sen. Chuck Schumer is expected to introduce the Shareholder Bill of Rights Act of 2009. The stated goal of the legislation -- "to prioritize the long-term health of firms and their shareholders" -- is commendable.

The trouble is that its provisions actually encourage the opposite. In its current form, the bill would require annual votes by stockholders on executive compensation. It would grant stockholders a new right to include their own director nominees in the corporation's proxy statement. The bill would put an end to staggered boards at all companies (the traditional option of electing one-third of the board each year). And it would require that all directors receive a majority of votes cast to be elected. Public companies would be forced to split the CEO and board chair positions.

Excessive stockholder power is precisely what caused the short-term fixation that led to the current financial crisis. As stockholder power increased over the last 20 years, our stock markets also became increasingly institutionalized. The real investors are mostly professional money managers who are focused on the short term.

It is these shareholders who pushed companies to generate returns at levels that were not sustainable. They also made sure high returns were tied to management compensation. The pressure to produce unrealistic profit fueled increased risk-taking. And as the government relaxed checks on excessive risk-taking (or, at a minimum, didn't respond with increased prudential regulation), stockholder demands for ever higher returns grew still further. It was a vicious cycle.

Thoughtful observers of corporate governance have recognized the direct causal relationship between the financial meltdown and the short-term focus that drove reckless risk-taking.

One key observer, the International Corporate Governance Network, issued a statement about the global financial crisis on Nov. 10, 2008. It spelled out the problem of shareholder power: "[i]t is true that shareholders sometimes encouraged companies, including investment banks, to ramp up short-term returns through leverage." It further declared that "[i]nstitutional shareholders must recognize their responsibility to generate long term value on behalf of their beneficiaries, the savers and pensioners for whom they are ultimately working." It recommended that pension funds and others seeking to hire fund managers "should insist that fund managers put sufficient resources into governance that delivers long term value."

If government really wants to encourage stability and profitability, the Schumer bill must call for measures that would promote the long-term value perspective. Providing long-term shareholders a greater number of votes per share should become a permissible option. Quinquennial rather than annual or triennial elections of corporate board members should be considered. Institutions should discontinue the practice of compensating fund managers based on quarterly performance. And corporations should follow the lead of General Electric by discontinuing the practice of issuing quarterly earnings guidance.

The stockholder-centric view of the current Schumer bill simply cannot be the cure for the disease it spawned. Though the short-term focus benefited shareholders for a time, when the meltdown happened shareholders weren't the only people hit. Employees who devoted their lives to building stockholder value felt the pain acutely. Communities, suppliers and creditors -- indeed, the whole range of constituencies who support the creation and maintenance of stock value -- were impacted. They have a legitimate stake in this debate.

Let's use the opportunity for fresh thinking that this crisis presents and restore the ability of boards and managers to run America's companies for our long-term best interest. Hopefully, the astounding losses we have witnessed over the past months will steer us back to responsibility.

Messrs. Lipton and Mirvis are partners of the New York law firm Wachtell, Lipton, Rosen and Katz. Mr. Lorsch is a professor at Harvard Business School.

Wesco's Annual Shareholder Meeting (WSC)

2009-05-08T10:18:00.000-07:00

May 08, 2009 | By Holmes Osborne

Warren Buffett's partner, Charlie Munger, spoke at the annual Wesco Financial (NYSE:WSC) shareholders' meeting. Wesco is 80.1% owned by Berkshire Hathaway (NYSE:BRK.A) and management doesn't believe in stock splits. Currently selling at close to $300 per share, Berkshire Hathaway would buy the rest of the company, but it never drops low enough due to investor interest. Munger said that the "cultists" have bid up the stock.

Wesco is the last stop for investors who go to Omaha to hear Buffett and Munger. Approximately 700 people were in attendance in Pasadena, CA. After the perfunctory business of the meeting, Munger spoke for about an hour on various subjects.

The first topic he addressed was the seriousness of the current global financial "mess". Out of step with mainstream media reports of recession, Munger said the current financial challenges are probably as severe as the Great Depression. He expressed support for the job the government is doing to get the economy back on track and he endorsed the nationalization of Fannie Mae and Freddie Mac. (For related reading, see Warren Buffett: The Road To Riches.)

Part of the problem that led to the financial catastrophe was the abuse of consumer credit. People who should have never been given credit cards or home loans were allowed to buy things they could not afford. Mortgage brokers rejoiced in "rooking borrowers with flim-flam tricks." Wall Street went crazy. And any way to earn money was rationalized.

Economic Situation
The regulatory apparatus was foolish. Some legislatures thought it was a good idea to lend to the poor. The Democrats wanted Fannie Mae and Freddie Mac to lend to everyone and to Republicans who "overdosed on Ayn Rand."

Munger advised his children never to buy an investment if the broker was paid a huge commission. Brokers would be enticed to sell "toxic sludge" if they earned a 9% commission.

In past speeches, he has railed against modern-day accounting. He said that both sides of a credit default swap would claim that they profited from a transaction. In accounting, that's impossible. But Alan Greenspan said that it was best for everyone.

The bank situation is complicated. Munger said that he is dubious of solvency tests. He doesn't like what is going to happen to Wells Fargo (NYSE:WFC). Berkshire and Wesco are long-time shareholders. He would give Wells Fargo a "flaming pass" on stress tests.

In regards to the long-term consequences of the economy on Wesco, there probably were none. Its businesses were gaining market share.

The Energy Opportunity
Munger spoke at length about global energy. In past meetings, he has said that he is not concerned about global warning and that society would learn to deal. A few years ago, he said that if water levels rose in Florida, people would merely move inland.

According to Munger, ethanol is one of the "stupidest" ideas ever. It causes a rise in food costs, which hurts the poor. Cap & trade is "insane". The Chinese "spew" out more hydrocarbons and won't stop. He is afraid we will use hydrocarbons too quickly. They are also important in the use of fertilizers.

What he is bullish on is solar and wind energy. According to Munger, Iowa gets 20% of its energy from wind. He said that people should listen to Freeman Dyson and not Al Gore. Freeman Dyson is a famous physicist who is skeptical of man's affect on global warming. (For more, see Go Green With Socially Responsible Investing.)

Long, Slow Road To Recovery
So how fast will the economic solution come? He harkened back to what Japan attempted. Deficit spending and 0% interest rates left the Japanese economy in stasis. Japan's stimulus was useless, requiring its government to fill the same pothole three times. Munger is a proponent of using the stimulus to fix the power grid, however.

As for stock prices, he thinks they will go up from this point. He said that Buffett's best year ever was during a recession. Stocks went up before the economy recovered. He is willing to buy stocks like Coca-Cola (NYSE:KO) and Wells Fargo for the longer term. (For more, see Warren Buffett's Bear Market Maneuvers.)

Banks that are too big to fail are boring and only should only do market making, stock brokering and stock issuance. Massive leverage is bad. We don't need credit default swaps. If you want to use leverage, use two-times leverage and do it in a hedge fund.

Our economy is like a huge poker game. It's not pretty to lure money away from others. We need to protect the body politic. Munger said that if you were at a country club and introduced your daughter's new fiancé and said that he is a hedge fund manager, you'd probably be embarrassed.

He ended his speech and opened up the floor to questions from reporters. In the past, the questions from the audience became stranger and stranger by the year. Munger said that journalists were smarter than the average hero, but poorer.

Bottom Line
Munger sticks to ethics and sound business practices. That's what he has spoken about at every shareholders' meeting. The stock hasn't done anything in ten years, but maybe 0% is good for a financial. He has been talking about the global economy's problems for years and, in 2008, his predictions came to fruition.

By Holmes Osborne

At the time of writing, Holmes Osborne did not own shares in any of the companies mentioned in this article.

Gold sales cost Europe’s central banks $40bn

2009-05-08T10:16:00.001-07:00

By Javier Blas in London

Published: May 6 2009 23:31 | Last updated: May 7 2009 08:55

Europe’s central banks are $40bn poorer than they might have been after they followed a British move taken 10 years ago on Thursday to shrink the Bank of England’s gold reserves, analysis by the Financial Times has shown.

London’s announcement on May 7 1999 that it would sell a large share of the Bank’s gold reserves in favour of assets offering a return, such as government bonds, was the high water mark of so-called “anti-gold” sentiment among European central banks.

GoldMany of these banks, such as those in France, Spain, the Netherlands and Portugal, decided later in 1999 to follow Britain and sell off their reserves. At that time, gold was worth around $280 an ounce, less than a third of its current level of more than $900.

European banks sold about 3,800 tonnes of gold, reaping about $56bn, according to calculations from official sales data and bullion prices.

Taking into account the likely returns from the investments in bonds, the banks have gained another $12bn. But because today’s gold prices are far higher, they are about $40bn poorer than if they had kept their reserves.

The biggest loser is the Swiss National Bank which sold 1,550 tonnes over the decade and at today’s gold prices is $19bn poorer, followed by the Bank of England, which is $5bn poorer.

The UK Treasury on Wednesday defended its decision to sell gold as a way to diversify reserves and cut risk. “As a result of the programme, a one-off reduction in risk of approximately 30 per cent was achieved,” it said. The Swiss National Bank declined to comment other than to say that it did not plan to sell more gold.

However, central bankers are confident that over the long run their move out of gold and into bonds will pay off and reduce the volatility of their portfolios, people familiar with their thinking said. Analysts also argue that because some banks had more than 90 per cent of their assets in gold, some disposals were warranted.

The proportion of European reserves held as gold remains extremely large even after years of sales, at an average of about 60 per cent, compared with the world average of 10.5 per cent.

After 10 years of steady sales, Europe’s gold sales are set to slow to their lowest levels since 1999, while central banks outside Europe have already become net buyers of gold. The US, the world’s biggest holder of gold, decided not to follow Europe’s move. Germany and Italy are the only two big European central banks which did not follow the UK, mostly because of domestic disputes about what to do with the proceeds.

Copyright The Financial Times Limited 2009

Convertible Bonds

2009-04-30T08:02:00.000-07:00

One of the most interesting speeches for investors that I heard at the Milken Conference was on convertible bonds. John Calamos, king of converts, spoke. He said that the average convertible did 5% over the last 10 years. Beats the heck out of stocks by a large margin. This might be a good place to make a buck.

Holmes

Milken Conference

2009-04-30T07:58:00.000-07:00

I just got back from the Milken Conference in Beverly Hills. It had an A list of speakers including: Rupert Murdoch, Senator John Ensign, Schwartzeneger, economist Gary Shilling, Congressman Henry Waxman, Steve Forbes, Eli Broad, Pete Carroll, and the list goes on and on. Check out the web site at http://www.milkeninstitute.org/events/gcprogram.taf?function=speakers&eventid=GC09.

Holmes

Economy

2009-04-22T15:36:00.000-07:00

I wanted to give a simplistic example of the challenges that our economy faces. Let’s pretend that there are two people—one builds tables and the other farms chickens. They trade back and forth, ten chickens for one table. That becomes cumbersome so they use gold as an intermediary. You can’t easily produce more gold so it has a high value. But it’s heavy and not divisible, so they switch to paper currency.

If ten chickens are $10 and one table is $10, every time one buys products from the other, it’s counted as gross domestic product. So over the course of the year, if 50 chickens and five tables are purchased, the GDP is $100. GDP is calculated as the velocity of money times the currency. In this example, $50 X 1 + $10 X 5 = $100. The more traded, the higher the GDP.

Then the government gets involved. The paper currency used to be backed by gold but the government ended this program. The government decided how much currency could be printed.

Then banks got involved. The banks loaned the table builder $1,000 at 10% interest. As long as he sold 30 tables, he could cover his $100 in interest. The banks got the money from the government, which created the money from thin air and selling bonds to foreign governments. The table builder was able to use additional credit and buy cheap goods from the foreigners. The foreigners paid their employees less because their countries had experienced devastating wars a few decades ago and had a less educated work force.

The problem is that demand for the tables dried up. The customers were growing older and didn’t need to buy new tables. Because sales fell, the table maker couldn’t make his payments and went into default. This in itself wasn’t a problem for the bank but for every $30 in loans it had outstanding, it had $29 in customers’ deposits. It took only a few bad loans to put the bank out of business.

The government had some ex employees of the bank in charge of government finance. There is a process called bankruptcy where the bond holders take control of the bank and the managers are fired. This didn’t happen. Instead, the government bought stock in the companies, which is rare. The management stayed on. Again, the government printed money from thin air to pull this off.

So the banks were back in business. The problem was that all of the people whom the banks were trying to loan to were in the same predicament as the table builder—their goods were not in high demand. People didn’t want them anymore.

On the other hand, we have the chicken farmer. People would come to his farm and offer their services. Foreigners wanted the chickens and would use their strong currency to compete with locals. A stock broker tried to trade financial advice to the farmer but the farmer wasn’t interested. He pointed out that the stock broker wasn’t able to predict the financial mess and the company whom he worked for couldn’t even manage its own finances. A loan broker came by but the farmer didn’t want a loan. However, a doctor was able to cure the farmer’s cough and was able to procure 30 chickens for his services.

Foreign countries were dependent on people like the table maker to buy their cheap goods. People like the table maker stopped spending, so the foreign countries had to begin trading amongst themselves. Though the foreign countries had problems, their problems paled in comparison and their foreign currencies strengthened. The stock and loan broker had to go back to school and become like the doctor whose services were valued. The government got smart and stopped printing money because it was hurting their currency and causing goods that the foreigners wanted, like chickens, to skyrocket. The government had to cut its spending and raise taxes to take care of the people who were growing older whom the government had made financial promises. Everyone eventually changed their ways but it took several years.

THE END

Monetary Supply

2009-04-22T13:45:00.001-07:00

This is from a newsletter from John Mauldin.

M2 has increased by over a 14% annual rate over the past six months, which is in the vicinity of past record growth rates. Liquidity creation or destruction, in the broadest sense, has two components. The first is influenced by the Fed and its allies in the banking system, and the second is outside the banking system in what is often referred to as the shadow banking system. The equation of exchange (GDP equals M2 multiplied by the velocity of money or V) captures this relationship. The statement that all the Fed has to do is print money in order to restore prosperity is not substantiated by history or theory. An increase in the stock of money will only lead to a higher GDP if V, or velocity, is stable. V should be thought of conceptually rather than mechanically. If the stock of money is $1 trillion and total spending is $2 trillion, then V is 2. If spending rises to $3 trillion and M2 is unchanged, velocity then jumps to 3. While V cannot be observed without utilizing GDP and M, this does not mean that the properties of V cannot be understood and analyzed.

The historical record indicates that V may be likened to a symbiotic relationship of two variables. One is financial innovation and the other is the degree of leverage in the economy. Financial innovation and greater leverage go hand in hand, and during those times velocity is generally above its long-term average of 1.67 (Chart 4). Velocity was generally below this average when there was a reversal of failed financial innovation and deleveraging occurred. When innovation and increased leveraging transpired early in the 20th century, velocity was generally above the long-term average. After 1928 velocity collapsed, and remained below the average until the early 1950s as the economy deleveraged. From the early 1950s through 1980 velocity was relatively stable and never far from 1.67 since leverage was generally stable in an environment of tight financial regulation. Since 1980, velocity was well above 1.67, reflecting rapid financial innovation and substantially greater leverage. With those innovations having failed miserably, and with the burdensome side of leverage (i.e. falling asset prices and income streams, but debt remaining) so apparent, velocity is likely to fall well below 1.67 in the years to come, compared with a still high 1.77 in the fourth quarter of 2008. Thus, as the shadow banking system continues to collapse, velocity should move well below its mean, greatly impairing the efficacy of monetary policy. This means that M2 growth will not necessarily be transferred into higher GDP. For example, in Q4 of 2008 annualized GDP fell 5.8% while M2 expanded by 15.7%. The same pattern appears likely in Q1 of this year.

The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.

Washington policy makers are now moving to increase regulation of the banks and nonbank entities as well. This is seen as necessary as a result of the excessive and unwise innovations of the past ten or more years. Thus, the lesson of history offers a perverse twist to the conventional wisdom. Regulation should be the tightest when leverage is increasing rapidly, but lax in the face of deleveraging.

World Food Suppy: BUY FARMLAND!!!!!

2009-04-16T13:09:00.000-07:00

I got this information from one of the only publicly traded ag distributors: Viterra. It's a Canadian company. Viterra gets paid to haul, ship, and store grain. The higher the price of grain, the more the farmers grow. The more that is grown, the more that is shipped. Higher prices behoove Viterra.

In 1950, there were 2.5 billion people and .52 acres of farmland per person.
In 1975, 4.1 billion people and .34 acres.
In 2000, 6.1 billion people and .25 acres.
In 2025, it's estimated that there will be 8 billion people and .16 acres of farmland per person.

BUY FARMLAND!!!!!!!!!!

Fidelity's Thoughts on Gold

2009-04-14T14:56:00.000-07:00

Diversification opportunities
Given its atypical characteristics, the performance
of gold has had little or no correlation to other asset
classes, such as stocks and bonds. As a result,
making an allocation to gold
may be an effective way to achieve diversification
benefits. So far this decade, a position in gold would
have provided a boost to a diversified portfolio, as
gold bullion prices soared 216%, while U.S. stocks
and bonds returned -36% and 75%, respectively.iii
However, gold has a history of being an extremely
volatile asset class. For example, throughout the
gold bullion bull market this decade, gold-related
stocks have had five corrections of at least 25%,
with a near 70% decline during the most recent
drawdown.iv As a result, maintaining only a small
allocation to gold might be a reasonable approach.

Mining Stocks

2009-04-06T08:24:00.001-07:00

Sometimes clients bring many accounts and some of these accounts only have a few thousand dollars. Maybe a Roth IRA or a college savings account. It is difficult to buy individual stocks, as these accounts are too small.

Today, I bought a Fidelity fund, Fidelity Mining (FSAGX). It's a no-load fund and has low fees (.86%). It has all of the big miners that I like: Goldcorp, Yamana, Barrick, etc.

People want to know when I'm getting back in the market. Technically, I'm back in. However, gold mining stocks will probably perform well if the overall market does poorly.

Holmes

Market Timing

2009-03-30T11:56:00.000-07:00

Market timing is when you jump in and out of the market. It's basically been proven impossible. When people hear that I pulled out of the market last year, they ask me if I'm a market timer. The answer is "no".

There is a difference between market timing and getting out because you for see a terrible economy. About every thirty or forty years, the stock market completely collapses. What precedes this event? Usually stocks trade at high price to earnings ratios and low dividend yields. I have never liked to buy a stock over a PE of 15.

We are in a transformational period. Stocks will be selling at lower PEs and higher dividend yields. We have not reached the bottom!
Holmes

Oil Conference in Calgary

2009-03-30T11:49:00.000-07:00

I'm off to a conference in Calgary on oil. I'll be bringing my coat--it's 25 degrees at night!!!!!

Some of the subjects include Peak Oil. The idea that we have been running out of oil since the 70s.

When I get back, I'll post my findings.

Holmes

Suckers' rally

2009-03-25T16:01:00.000-07:00

People have been calling me about the recent rally in the stock market. It's a suckers' rally. Don't be fooled. Markets don't go up and down in a straight line.

Also, I've been meeting lots of folks who are interested in variable annuities. They are looking for a "sure thing". Remember, those no such thing as a sure thing.
Holmes

Event with Warren Christopher

2009-03-17T14:54:00.001-07:00

I had the pleasure of serving as interlocutor for an event with the Chartered Financial Analysts' Society of Los Angeles with Warren Christopher. Mr. Christopher served as Secretary of State for Bill Clinton, Under Secretary for Carter, and Deputy Attorney General for LBJ. Questions ranged from our current relations in the Middle East, terrorism, to the challenges that our country faces today. Mr. Christopher was an excellent person to interview and has a wealth of experience.

Holmes

Week of March 16

2009-03-16T14:23:00.000-07:00

It's a busy week. Tomorrow I'm serving as the interlocutor for an event with former Secretary of State, Warren Christopher. Wednesday, my television show, Money Confidential, is airing. Thursday, I'm speaking to a chamber of commerce in South Los Angeles.

In regards to investing, today the market was up about 2%. It closed negative 1/10%. Gyrations like that are bad.

I looked at a company today named Horsehead (ZINC). It's a zinc smelter that has a huge amount of cash on its balance sheet. I think it will get sold off and am not in a hurry to buy at the present time.