August 2011

August 2, 2011 - Be Careful What You Wish For

Featured Trades: (BE CAREFUL WHAT YOU WISH FOR)

1) Be Careful What You Wish For. Politicians are popping champagne bottles and celebrating the end of cantankerous negotiations over the debt ceiling. I say be careful what you wish for. Let me give you my quickie, back of the envelope analysis of the debt ceiling deal in Washington.

The compromise calls for $2.4 trillion in spending cuts over ten years. That amounts to 16.6% of GDP, or 1.6% per year. If the Federal Reserve's 3.0% forecast comes true, that means our economic growth rate is about to fall to 1.4% a year. If my prediction comes true, and we grow at a 2.5% rate, that plunges to 0.9%.

There is another country where GDP growth is measured in mere basis points: Japan. Congress has just voted for ten years of austerity. To do this at this stage of the economic cycle, when growth is feeble at best, and we have just seen two back to back quarters of growth at the 1% handle, is to guarantee us a second lost decade of zero stock market returns.

Sure, the spending cuts are back end loaded. But you know what? Investors will front end load the discounts in asset prices this slow growth scenario demands. This is not good news for long term holders of risk assets of any description, be they stocks, commodities, or homes.

This may be the riot act that financial markets are reading us today. Instead of getting the short covering rally that many of us expected, we were given a cascading series of flash crashes. The (SPX) cratered 35 points, oil cracked by $5, the Euro plunged 3 cents against the dollar, copper gave back 20 cents, and even gold pared $15. In the meantime, a flight to safety bid took bonds up two points to an incredibly low yield of 2.72%.

Armchair historians out there have to be recognizing the similarity of 2011to 1937. That is when a republican congress forced Franklin D. Roosevelt to throttle back government spending too soon, throwing the country back into round two of the Great Depression. That triggered a 49% plunge in the stock market. The downturn continued until WWII delivered the greatest stimulus package of all time and ignited a 25 year bull market.

To a large extent, there is not much anyone can do to repair the economy. Possibly as much as half of the economic growth of the past 30 years was borrowed from the future. This is because it was fueled by the $3 trillion that Ronald Reagan borrowed largely from the Japanese during 1980 to 1988, and the $5.5 trillion George W. Bush borrowed from the Chinese from 2000 to 2008.

The bill is now due, but the piggy bank is empty. Decades of minimal growth will be the consequence. I doubt that there is a single business out there that can point to a new customer coming to them as a result of the debt deal. There will be tens of thousands that will moan about lost business. The republicans now own the economy. That may be something they come to regret.

See Any Similarities?

August 1, 2011 - GDP is Another Bucket of Cold Water

Diary

Featured Trades: (GDP IS ANOTHER BUCKET OF COLD WATER)

1) GDP is Another Bucket of Cold Water. Another bucket of cold water was thrown on financial markets on Friday with the shocking release of Q2 GDP of 1.3%. The whisper number prior to the release was at 1.9%, and even this figure is far short of the Federal Reserve's GDP forecast for 2011 of 3.0%.

Keep in mind that these are backward looking numbers giving us data that is three months old. Some of the drag was caused by a Japanese tsunami slowed car industry, which the Ford earnings this week are telling us is already starting to snap back. That's why we had a sudden drop in weekly jobless claims this week be 28,000 to 398,000, the lowest since April 2, and the most important coincident indicator there.

I have been trading my own book all year based on a much more modest 2.0%-2.5% growth estimate, and it has served me well. I believed that most economists were vastly underestimating two crucial factors. State and local spending would continue to be a huge fiscal drag as local authorities enforce emergency measures the staunch bleeding deficits.

Remember, for every $3 the federal government shovels into the economy, the states are taking out $1. And now the feds are going to stop pouring money into the economy. I also thought that there would be no bounce back in real estate in a deleveraging world, a major component of past recoveries. This makes a hash of sell side predictions of economic growth this year that ranged as high as 4%.

Billions of dollars is being spent to make you believe that the slowing economy is the result of excessive regulation, burdensome taxes, excessive budget deficits, and 'uncertainty.'? The truth is that the drag is being caused by deleveraging, gun shy bankers afraid to lend, paranoid corporations nervous about hiring, the retirement of 80 million baby boomers, and the disappearance of a consuming idle class. Multinationals sitting on cash mountains are investing it in China and India, not here. These are all long term structural drivers that no one can do anything about.

My long term scenario assumes that financial markets peak sometimes next year, about six months before we go into the next recession. Then the next crash ensues. If these GDP figures continue to deteriorate, I may have to move those targets forward.

-

Coming Sooner Than Expected?

August 1, 2011 - An Update on Rhodium

Diary

Featured Trades: (AN UPDATE ON RHODIUM)

2) An Update on Rhodium. I was recently interviewed by Daniela Cambone of Kitco News, a boutique firm specializing in the online research and trading of metals. I have known the Kitco people for a long time and they are one of the class acts in the hard asset arena.

To summarize, I think that rhodium (symbol XRHO in London), which is based on the Greek root for 'rose,' is a major long term buy. While gold, silver, platinum, and palladium are trading at, or close to all-time highs, rhodium is still at a lowly one fifth of its record high. It is just a matter of time before rocketing demand for platinum and palladium, driven by a recovering global car industry, spills over into rhodium which can also be used in catalytic converters.

While liquidity in rhodium has been an impediment for investors until now, the launch of a new rhodium ETF by Deutche Bank could break the logjam. Those of you willing to watch my ugly mug pontificating about the long term prospects for? rhodium, please click on this link at http://www.kitco.com/kitconewsvideo/, and then click on 'Platinum, Palladium, and Rhodium outlook, July 27, 2011.

-

Are They a Long Term Buy?

August 1, 2011 - What the Tea Party Doesn't Know About the Bond Market

Diary

Featured Trades: (WHAT THE TEA PARTY DOESN'T KNOW ABOUT THE BOND MARKET)

3) What the Tea Party Doesn't Know About the Bond Market. I have spoken to several Tea Party leaders since the movement sprung up a year ago, and have come to several conclusions. This is a genuine, grass roots movement composed of people who are unhappy about the changes that have swept the country for the last 30 years. By and large, these are simple, decent, hardworking and retired people.

Their list of complaints is long, and include the downhill slide of public education, declining standards of living, falling wages for working people, the ballooning immigrant population, and the huge losses they suffered to their retirement savings and the value of their homes in the 2008 crash. They all want their lives to return to the simplicity of decades past. To a man, they want lower taxes and for the government to get out of their lives. I sympathize with them on many of their complaints.

They are also not financially sophisticated. They have no understanding of the global financial system and its many intricate moving parts. They distrust Wall Street and bankers, having been conned or victimized in the past. This is a big problem.

It is safe to say that the Tea Party leadership could care less about what happens in the bond market. The scary thing is that they think this market is something that can be simply turned on and off again like a light switch. They do not realize that:

1) US Treasury bonds are the lynchpin of the global financial system.
2) Once you break confidence in this instrument, you won't be able to put it back together again.
3) The pricing of all debt securities and loans around the world key off of US Treasury bonds.
4) Tamper with the pricing of your benchmark instrument, and the entire global financial system goes haywire.
5) The unintended consequences are uncountable.
6) Interest rates will rise across the board. LIBOR rates have already started to creep up.
7) Since many financial institutions meet their capital requirements with Treasury bonds, any undermining of their credit worthiness forces a capital call which could trigger a secondary banking crisis.
8) Short term money markets will freeze up, starving corporate borrowers of cash. This has already started to happen.
9) Mess with Treasuries, and the value of your home is toast, if it is not already.
10) Dump 'full faith and credit' and you undermine the reserve status of the dollar, one of the greatest free lunches for America of all time.

The bottom line here is that you have a bunch of kids playing with matches in a fireworks factory. It is reminiscent of the first failed TARP vote in congress, when the same group of ideologically driven republicans ignored their party leadership and torpedoed their own president's bill.

You may recall that the Dow fell 700 points that day. I do. You may also remember that the following backlash at the polls set their party back a generation. I do. Wait until they have to explain on the campaign trail that their supporter's' IRA's dropped by half again because of a principal.

If this were any other country, the center of the democratic and republican parties would break off from their radical wings, create new parties, and then form a coalition government. But we are stuck with our 220 year old form of government, so that is not an option. But the final solution to the debt ceiling crisis may resemble something like this, subject to the confines of our own, arthritic political confines.

By the way, I want to thank the many readers who have been forwarding my letters to the White House, Senator Harry Reid's office, and John Boehner's staff. I have heard from all three. Keep up the pressure.

I am hoping for the best this weekend. But I am not holding my breath.

-

Must the Government Be Destroyed in Order to Be Saved?