Friday the 13th
Today is Friday the 13th: according to superstition, either a day of good luck or bad luck. It occurs at least once a year. The fear of Friday the 13th is a form of triskaidekaphobia, which is a phobia of the number 13. This year it has occurred in February and March and will occur again in November.
Having a Friday fall on the 13th is also an excuse to drag out yet another sequel or version of the long-running Hollywood horror slasher franchise also known as Friday the 13th. Since 1980 we have been forced to endure twelve slasher flicks featuring the ubiquitous Jason in his hockey mask, plus a television show, a novel, comic books and endless merchandise.
However, Jason, rather than slashing horny teenage counselors to death at Crystal Lake, appears to have been let loose since August 2007 on the global economy. He has been slashing everyone's retirement savings and jobs, bankrupting companies and even countries and hurling hundreds of thousands into poverty and despair. Oh, and reducing 355 billionaires to mere multi-multi-multi-millionaires.
Of course, the enemy isn't Jason. The enemy is us. This is a generational collapse. Call it the boomer generation's collapse. We can't blame our parents, who went through the Great Depression and a world war. They left us the legacy. It is the boomer generation that was in charge through the latter part of the boom that preceded this collapse. Sure, Generation X is now also moving towards the levers of power so they do get the consolation prize. The last two US presidents were boomers although the current one comes from Generation X. They will have to clean up this mess along with the generations behind them. The Fed chairman is a boomer and many of those in positions of power and CEOs of companies are boomers. The boomers gave us the counterculture of the 1960s and then quickly became more conservative over the years. Maybe George W. Bush was more representative of the generation then we care to admit.
The people charged with resolving this mess face a near-impossible task. They are trying to bail us out of a collapse that has followed the most massive build-up in debt ever known and one of the biggest bubbles ever created. It is truly massive and truly global. The growth part of the boom did take many out of poverty, lifting them into the Valhalla of middle class life, but the collapse could hurl millions of them right back into the mire of poverty and despair they left behind, even if it was a generation ago.
Because our society was built on a mountain of debt, we have always said that we were living in a world of illusion. Debt does that to you. You buy now, pay later. Except long after the thrill of having that latest widget passes or our 5,500 square foot McMansion just feels kind of empty the bills just keep coming and coming. As each crisis came along over the past thirty to forty years, we solved it by adding more debt.
We followed monetary policy that kept interest rates artificially low (thank you Alan Greenspan and Ben Bernanke); we slashed taxes, screaming that taxes were bad and only we could make the choices (bad ones, obviously); and we slashed regulations (especially in the US and Britain but thankfully not the same here in Canada, despite the efforts by many to follow the US and Britain). It allowed financial institutions to operate in a nether world where they could do almost anything. We pushed home ownership as a substitute for social policy; we created an atmosphere of anything goes, so people stopped saving and lived for today instead of planning for the future; we allowed our manufacturing to be exported to third world countries so we could obtain our widgets at low prices turning Wal-Mart into a god, ignoring the conditions that many of these workers endured; and finally we accepted their money right back to finance our prolificacy, which again discouraged savings. Why save when the Chinese (and Saudis, and others) will just lend it to us?
Of course, they said "This time it is different". Well, in the end it wasn't. The financial engineering that allowed the financial institutions to come up with more and more products instead led to everyone bidding up prices to levels far beyond what they were worth using leverage. They did the same with houses and anything else it seems that they could create out of debt air. Now the bubble has burst, the drop in the value of assets has been precipitous. Trouble is, the debt remains. And the owners of that debt - the financial institutions and investors - are in deep doo-doo. Except the politicians are trying to get us to bail out the collapsing companies using tax payer money dragging the taxpayer into the malaise.
Now CEOs names are mud; not enough of them are doing the perp walk in an orange jump suit. The scammers are all being revealed long after they Madoff with your money. (Just where did that $50 billion go? That's way too much to spend on just hookers and blow.) The politicians are all running around like chickens with their heads cut off, not having a clue of what to do (neither would we, for that matter). They figure they have to bail out every corporation and financial institution deemed "too big to fail".
At least there is some comedy as The Daily Show's Jon Stewart took on Mad Money's Jim Cramer and CNBC for their blind belief that all was well in fantasyland. Cramer was pounded. Will he and his show survive? Who cares. Rick Mercer, we await your shots at Canada's media. How do you become a millionaire? Start with $100 million.
Excessive debt is what got us in trouble, so we find it bizarre that the solution is apparently more debt. And it is rather counter intuitive that US Treasury Bonds have done so well, but when one understands that first there was a flight to safety and second that the Chinese are loath to dump their US Treasury portfolio because it would harm them, and thirdly that every central bank in the world knows that if the US goes down they all go down, then it's not so hard to understand. So they all prop up the US Treasury Bond market. But that largesse does not necessarily extend itself to lesser credits, including corporate bonds. The yields on these instruments may be attractive to many. But beware. You may regret what you are buying. Bonds can go to zero too.
Despite all the jawboning over the past several months, credit spreads remain almost as wide as ever. Government/AAA spreads today are around 255 bp, down only marginally down from highs seen in mid-December near 280 bp. Government/BAA spreads are at 535 bp; again only off slightly from last year's highs of over 600 bp.
At the short end of the curve there has been more improvement. The TED Spread (three-month Treasury Bills - three-month Eurodollars) has fallen to 83 bp, down sharply from the highs of almost 670 bp at the height of the financial crisis last October. Similarly the three-month Treasury Bills - three-month Commercial Paper spread has fallen to 112 bp, down from the 440 bp also seen last October. Credit is flowing, the markets are functioning, but lenders can't be made to lend to those whose balance sheets have been decimated in this crisis, even if they are the ones who need it most. We show some charts below.
By using more debt to prop up the market and bail out bad companies, the attempt here is really to reflate the value of those assets. Adding more debt to prop up bad assets makes little sense. Best to let the assets and the companies go bankrupt and try a different approach to restarting the economy. What the economy needs is a complete cleansing and restart, starting with rebuilding savings and providing the social safety nets and retraining that is essential. It is time-consuming and the results won't be seen for years. Instead they are trying for quick fixes that will ultimately fail. The stimulus packages at best are short-term fixes.
The massive build-up in debt required to prop up the bad companies and restart the economy could eventually imperil the US's credit rating. It has already seen a massive deterioration in its balance sheet. We have noted previously that the US's and Britain's debt ratings are under review, including gimmicks to give it a downgrade in every way but not calling it a downgrade (they call it instead tiering of AAA debt). If US debt were downgraded it would be a global disaster as the debt of the USA and Britain would collapse. Currently many institutional investors cannot hold debt unless it is rated AAA.
What got us into this mess was the massive speculation and leveraging in the economy that was ultimately not only unstable but unsustainable. So what are they doing bailing out bad banks, bad car companies, failed strategies and failed institutions and the people behind them who brought us into this crisis? The message is that failure is rewarded. So go ahead - speculate, ramp up the leverage. You keep any profits, and we will bail you out if you fail.
The US stock market rebounded sharply on Tuesday following announcements that Citigroup (C-NYSE) said it was making money in the first quarter. Oh. If they are making money, then why is the US government bailing them out? Forecasters have been coming out with an array of earnings estimates but invariably they are lowering estimates.
Does the rally have legs? Possibly. Bearish sentiment is pretty extreme and in a nervous environment any piece of good news might be jumped upon and the bears made to scurry for cover. Some short-only hedge funds have announced they have covered shorts. But bear market rallies are often rallies that seem to come out of nowhere. A real bear market ends with a whimper not a bang. We suspect that all this is is another bear market rally. Good for traders. Ultimately bad for investors.
The US economy contracted a sharp 6.2 per cent in the fourth quarter of 2008. While we do not know what the first quarter will bring, some forecasts we have seen predict it once again could be in the range of 6 to 8 per cent. Unemployment, now officially at 8.1 per cent, is according to John Williams' Shadow Stats www.shadowstats.com actually closer to 19-20 per cent. What is not counted in the numbers are discouraged workers and temporary workers who really want a full-time job.
According the Bureau of Labor Statistics, unemployment in the USA is now 12.5 million with another 7.7 million in temporary positions. In the past 12 months the unemployed rolls have grown by about 5.0 million and temporary positions have grown by 3.8 million. The BLS also lists people who work part-time for economic reasons. This number is another 8.6 million workers, up 3.7 million in the past year. Finally, about 2.1 million were marginally attached to the work force, up 466,000 in the past year. Of those some 731,000 were discouraged workers. Discouraged workers are those who want to work but are not involved because they believe there are no jobs available. Some 1.3 million of the marginally attached workers had other responsibilities including family or were going to school.
Add up all the unemployed, temporary positions, working part-time for economic reasons, discouraged workers, and suddenly we are up to 30.1 million workers or a rate of about 19.7 per cent. (Source: United States Department of Labor - www.bls.gov).
GDP declines of 6-8 per cent and unemployment of 19.7 per cent are approaching depression levels. Even the most bullish of analysts acknowledge that the official unemployment rate will probably go to 10 per cent or more. Companies are shifting to work sharing in order to avoid letting people go. All of this lowers the income pool considerably and that lowers the taxes collected even as government sharply increases spending.
The situation is not a lot different in Canada. Canada's fourth quarter GDP fell 3.4 per cent. Not as high as the US but still high. The most recent job data showed that Canada's unemployment now stands at 7.7 per cent also slightly lower than the US. Still as some point out the poorly structured employment insurance (EI) means that many do not qualify for EI and as well when it ends and they are still unemployed they do not show up in the statistics. This is not a lot different than the US methodology. Canada's unemployment we suspect is also in well in excess of 10 per cent. Unemployment is also rising sharply in Europe and unlike Canada and the US they are seeing strikes and social unrest in a number of countries particularly in Eastern Europe. There is also been seen a rise in xenophobia. This too was seen in the 1930's particularly in Europe and led directly to the rise of Nazism.
No wonder there is a hue and cry for protectionism. This would be the worst possible outcome for the global economy but it is a brutal reality that crops up during all extreme economic times. In Canada the politicians fought the inclusion of protectionist measures in Bills winding their way through US Congress. The protectionist language was removed but "Buy American" is popping up in scores of local and state spending bills; an area where the Canadian government has considerably less influence. Canadian exporting companies are understandably worried.
World trade is contracting. The IMF expects it to contract by five per cent or more in the next year. It is the first contraction in global trade since 1982. World GDP according to The Economist plunged to about zero in the last quarter of 2008. The industrial nations are all expected to show contracted economies for 2009, with at best feeble recoveries in 2010. Industrial production in most nations is almost universally negative. Budget deficits are ballooning. The budget deficits for both the US and Britain are now over 11 per cent. That is higher than some economic basket cases.
Stock markets are almost all down since the beginning of the year. A surprising exception is China, where the latest numbers showed the stock market was actually up 20.7 per cent thus far this year. Could China be leading the way out of the malaise? As we have noted, markets do not go down forever. Even in the worst of bear markets, such as 1929-32, there were numerous counter trend rallies of upwards of 20 per cent or more before the bottom was found.
If there is another widespread concern besides contracting GDP and rising unemployment, it is that money supply now appears to be contracting. Our chart of M1 is below. Recent figures showed that M1 contracted in January by 1.3 per cent (seasonally adjusted). M2 growth is slowing. And as John Williams of www.shadowstats.com shows, M3 growth is also slowing. Slowing monetary growth has often accompanied a deeper phase of the systemic solvency crisis, as Williams notes. This has also impacted the monetary base, which is also falling. This chart is also shown below. The final chart is of the money multiplier, which has fallen precipitously over the past year. This shows what is essentially a liquidity trap. The money supply has been increasing to combat the falling GDP and rising unemployment but monetary policy is actually quite ineffective. The money is not getting into the economy. Could it be that it is merely going to prop up bad companies?
The Fed is desperately trying to avoid a collapse and massive deflation. Deflation after all is the byproduct of debt collapse. So what the Fed is or has been doing is flooding the system with liquidity (sharply rising money supply), creating inflation and not worrying about the US dollar. The dollar, despite all the problems, is still seen as a safe haven but that doesn't mean it will stay that way. Despite providing huge amounts of liquidity to the system the money is not getting into the broader economy (falling money multiplier). Instead the banks just park it back with the Fed, creating excess reserves. At least to them it is safe and earns something, if only a nominal amount.
Given the devastation in the economy, the devastation of people's retirement funds (the devastation of the billionaires? - can't feel too sorry for them), the final devastation to come is of the US dollar itself. The current distortions we are seeing with money supply will eventually come to an end and confidence in the US will eventually wane. Given the massive spending plans of the Obama government, with few signs of an end to the Bush wars in Iraq and Afghanistan, and even now, rhetoric rising against Iran (would they dare? - yes, war is always a distraction), confidence in the dollar will eventually wane. Gold, already well off its recent floor near $700, will then rise further.
Gold is currency and has been currency for three millenniums despite the fact that Richard Nixon took us off the gold standard in August 1971. To now not own gold we believe is just irresponsible given all of the wealth destruction and the ongoing destruction of paper currencies. Paper is just paper whether it is stocks or bonds or la-la land paper aka derivatives. Gold, silver, platinum are real and hard. They are no one else's liability.
Let's take a look at the performance over the years of Gold vs. the Dow Jones Industrials. We will start with August 1971 when Richard Nixon took us off the gold standard. Sure there are periods to own gold and there are periods to own the DJI (Stocks - paper). This is not one of them. In January 1980 the DJI/Gold ratio was 1:1. In 1999 it was 45:1. Today it is under 8:1.
GOLD DOW JONES INDUSTRIALS August 8, 1971 * $35 +2,557% 850.61 +743% Year to date +4.6% -18.3% 1 year - 2008 +5.7% -29.8% 3 years to 2008 +71.5% -18.1% 5 years to 2008 +156.7% -16.1% 10 years to 2008 +205.5% -4.4% 25 years to 2008 +129.4% +598%* Gain since Richard Nixon took us off the Gold Standard. Price indicated is the close at that time.
Over all time frames since Richard Nixon took us off the Gold Standard only one time frame, 25 years, has the Dow Jones Industrials (stocks) outperformed Gold. That advantage, however, is slowly being whittled away. Yet Gold remains an underappreciated asset class is viewed by many as extremely risky and many portfolio managers, pension fund managers and investment advisors shun it. Rather than having gold at the top of the risk pyramid gold should actually be at the bottom of the pyramid as one of the most stable asset classes going. It should be a foundation for portfolios not considered the equivalent of venture capital mining stocks that are truly volatile and high risk. Even large cap gold stocks are a higher risk then owning Gold itself. And the ETF's and other forms of holding Gold are not a panacea as their alleged holdings are not verifiable.
We see the argument that Gold was useless in previous deep recessions and depressions. It didn't save you. Yet if Gold is a stable asset class we can only note that for example in the Great Depression Gold officially rose from a fixed price of near $20 to $35/ounce in 1933 a gain of 75 per cent. The real gains, however, came in gold stocks as measured by Homestake Mining that went up from 1929-1932 even as the DJI was losing 89%. It is not fair to measure that performance against the DJI until after August 8, 1971 when the gold standard ended. There is a period to own gold and a period to own paper. The last ten years has not been a period to own paper yet the vast majority of portfolio managers and investment advisors continue to hold paper not gold.
This is why we believe that the best is yet to come for Gold. Our chart of Gold shows that we may have completed a big wave up from the double bottom lows of 1999 and 2001. The recent correction that started in March 2008 and ended in November 2008 may have been the wave 2 correction. We cannot confirm that yet. We believe we will only confirm that once we exceed $1250 for Gold. Until that happens there is a risk of further corrective action that could retest those lows near $680. Currently we are seeing a correction in Gold after once again reaching to $1000. Once a new wave up happens it should be a spectacular one to the upside as it would be a third wave. The DJI/Gold ratio will go to a minimum 1:1 before this over. We just cannot tell what that absolute level will be though even as some have speculated that it could reach as high as $10,000.
Jason lives! He has devastated many portfolios and economies in the past year. The key to defeating Jason is to own Gold Bullion or as we say Bullion - Gold, silver, platinum. Being a gold bug is not being a wild eyed speculator. Being a gold bug is just prudence. Precious Metals stocks have a role but it is not a substitute for the real thing. Owning bullion is a low risk strategy. Owning stocks today is high risk. So why do so few have it when the evidence suggests they should? Bullion should be the foundation of portfolio management and in today's environment the asset allocation should be overweight.
Note: Charts created using Omega TradeStation. Chart data supplied by Dial Data.