My Aftermath Outlook
If I had a gold coin for every remark or opinion I have thus far read about what hurricane Katrina will do or won't do to the strength or weakness of the US economy and what the Fed will do or won't do at their next FOMC meeting on the 20th of September in terms of raising, holding or lowering interest rates and what the effect of their having done so or not having done so will have on the gold prices, consumer confidence and the yield curves, then I would have shut down this Letter and site immediately and retired to a comfortable place in Toscana, Italy, or maybe, Tirol, for I would already be a millionaire in gold - that is the number of remarks and opinions I have read in the last nine or so days after Katrina.
I summarize for you, and myself, what I think more aptly describes the situation:
"Too many promises weakens one belief"
And we've heard a lot of promises lately: The levees will hold, no need to worry, the oil supplies are OK, no need to worry, we'll be out of Iraq in 6-8 weeks, we'll be pulling out the troops soon, the US Dollar is strong, on and on... Is anybody weakening in their beliefs yet? I certainly am assuming I ever believed those examples above in the first place. I could go off onto a foray on this subject alone citing examples from Mises, Rothbard and others on the folly of the State but I think we all get the point. Time for independent study and thinking has never been greater.
Although I'm sorry to say, one of the hollow "victories" I did have in observing the world financial markets, and I admit it's hollow and perverted in a twisted sort of way, only because it happens to have taken place and caused so much terrible pain and suffering, is that a shock to the financial system has occurred. Whether the shock was via hurricane Katrina, or had been some other event at some other location, e.g. a terrorist event, or an "Iran event", the point I was trying to make was that the world financial community has been living a rather complacent and wishful-thinking existence and that many of the financial instruments in the markets are not "shock resistant" and ever more so in an imbalanced macro world. Things are not properly risk managed. Equally, the entire fossil fuel energy complex, the true Achilles heal of the world economy, has shown itself to be vulnerable although be no means tumbling out of control yet. And that means the entire world is vulnerable - with increased demand and limited supply, I have always contended that is was only a matter of time before something of this nature might occur. Could Iran be next? What about Russia? What about a major earthquake in California? If you do not have some energy in your portfolio then I think you might ought to think about it. I still believe it is not too late to add incrementally into as long as due diligence and research in your portfolio additions is undertaken. I shall be including a number of additions which I think are reasonable in the coming months ahead.
Here are a few interesting energy and bi-lateral trade facts currently underway:
Although the recent price shocks to the gasoline prices may inevitably hurt the consumer, a recent survey showed that people in the US are still willing to buy petrol-guzzling SUVs, since 1990 the US has increased energy imports by around 60% - as you may know, the US GDP is mostly centered around personal consumption, in fact it is around 68%, Saudi has just come out and asked OPEC to pick up capacity levels (they no longer can as their fields have already peaked in production - the worlds number one supplier), Russia has now signed a deal with Germany to build a gas pipeline across the Baltic Sea to deliver natural gas - likely not a deal done in US Dollars, in March 2006 is planned the opening of the Iranian Oil Bourse and will enable transactions in both oil and gas - again, not likely to be done in USD - and in direct competition to other exchanges in the West, With Iran one of the largest holders of oil reserves, is it any wonder the US interest in the Middle East region - again, the Iraq War was a snow job about terrorism and Saddam and liberty and democracy - very simply it was and is about oil, any other considerations and I suggest attending Geopolitics 101 at your local educational institute - Empires don't operate on petrol fumes. What Iran and its partners like Russia and/or China are doing is splitting the common denominator of all commodity transactions - the Empire US Dollar. Once this happens, it reduces the need for nations to bunker USDs in order to get their raw energy goods and commodities they require to operate. This in turn reduces the need to buy US Treasuries and with the US trade and deficit overhang nowhere being addressed, it does not look good for either the USD or the US consumer, especially if consumer centric GDP must contend with rising interest rates to attract USD buyers. Therein lies the real shock potential over the horizon.
This is all happening in slow-motion. You will not read about this in the press. But it is a geopolitical puzzle happening in real-time. The "now story" may be Katrina but the real story is yet to be told as mainstream press is usually far behind. Researching hundreds of publications takes a lot of my time. Another side-story to this is the amount of trade that China and the US have with one another and thus China being export vulnerable. They have recognized the two-edged sword and thus decided to float the currency in time for diversification. Equally, a recent statement from a Chinese financial advisor is their intent to raise trade with the EU and thus diversify away from pure US consumption. This carries added risk for the US Dollar. Did you know that US and India have virtually no trade with one another? India's rise has been to a large extent internally driven and they have more trade with the EU. When and if India should get moving, then this will put more downward labour pressures on the West as "intelligent jobs" move to Madras and not Milwaukee or Madrid. They have the equivalent of engineers with MIT degrees doing sub-menial tasks - the point is simply that when western industries can migrate and take up this talent pool, they likely will. Equally, if they can penetrate markets like pharmaceuticals, where they are very competitive and successful, this also brings a new dimension into play.
What's up with the ECB and Germany?
Last week the ECB held rates at 2% in line with predictions but with the effects of Katrina blowing stiff winds into Mr. Trichet's face. Of course the big unknown remains the longer term effects of oil and gas prices as the EU struggles to interpret its own data - inflationary? stagflationary? or downright deflationary? The opinions continue to be split. With the German Bund yields dropping ever further similar to US Treasury yields in the US, the outlook certainly does not seem inflationary. Certainly pay rates have not been inflationary the last years and with the advent of more and more discounter shops, IKEAs and 99 cent shops opening I have SERIOUS doubts as to whether we can have a purely energy driven inflation. In fact, with Winter fast approaching, heating oil and petrol prices are rising and will likely be aggregate deflationary as consumers have less to spend on consumption ergo 99 cent shops everywhere. Yes, the cost of living overall is rising but is being extremely battled and dampened by static wage earners with reduced consumption and hoarding of savings - this is why retailers are failing. Angst / Fear. On top of this debate continues the job markets. The job situation is poor in many countries and if it is not poor it is because many substitute and create low-pay alternatives to improve the statistics but leaving reality unchanged - this is giving the consumer neither confidence nor earnings with which to increase or promote consumption. Wakey up politicians - these are real dependencies in the real world. Consumption and trust cannot be ordained - they must be the follow-on of logical and consequential policies and the earnest following through of legislation set in motion. I fear that politicians can and will not follow through on such forward-thinking legislation either in the energy or job sectors. The state wants its tax income regardless of rising costs elsewhere - net effect on the consumer is therefore negative.
The latest television debate in Germany between Schröder and Merkel was interesting and kept more or less to the issues. Schröder one more on the sympathy line and Merkel did surprisingly well on the economic issues. The thing to remember here is that Germany needs more and deeper reforms, especially regarding its tax policies and state welfare transfer systems. If these key items can be solved over the next few years then I suspect the German economy will rebound and provide a more positive investment environment for foreigners. Even now many continue to laud the reforms, but to my way of thinking, the one-eyed man in the land of the blind is king. More can be done even if those investors are coming from countries where reforms have been slow or where other factors require a direct foreign investment into Germany. With the scent of reforms wafting through the air, whoever wins the election would be unwise to simply stop there - the German populace and industries are now trimmed and braced for reform - it must now come and give the consumer and industry planning confidence for consumption and investment respectively. The worst thing that could happen, and which seems to be growing in likelihood, is that the election will be won by neither majority party and thus a grand coalition being formed by the two parties - this would be possibly tantamount to a draw and might be the worst thing that could happen whereby each new legislative proposal is killed or talked to death before ever reaching fruition. This really will be an election to be watched. As in most things, HOPE remains a key factor for the little man, industry on the other hand, may already be drawing up plan B if things go seriously wrong. They may not go POSTAL but rather simply may go OFFSHORE, ie. outside Germany. That will create a downward spiral of LOST HOPE, less corporate and personal tax intake, increased deficit spending, fewer job opportunities and of course less consumption. Where it ends nobody can foresee.
Amazing but true - DAX broke 5000 yesterday - highest level in 3 years.
Now, let's move on to the Fed interest rate story.
Will the Fed raise, hold or lower rates? Nobody knows, but let us look at a few items : even before Katrina happened the US economy was starting to falter as the survey of Purchasing Manager's Index showed. Hence we could extrapolate that the US economy was becoming weaker even while the "guy on the street" was / is still flipping condos and thinking how wonderful life really is. If now, in the aftermath of Katrina, we can assume that most of the foreseen after effects are likely to be priced into the markets, and the markets are standing, still, more or less robustly, today the market was up, then I have reservations on the Fed stopping their interest rates just here. I know this is a tricky call but the logic of the "big picture" may be driving Greenspan more than the isolated Katrina event. Asset prices are still high and that is what he's been eluding to in the FOMC statements. Should a rate reversal happen here, then asset prices and money accommodation will not be able to be brought under control might be the thinking. And let's face it, as bad as Katrina seems to be, the US is A LOT bigger than just New Orleans since the property / asset bubbles is widely distributed over the nation. Hence the logical thinking would be to be for the "good of the country" in reeling in the asset bubble and taking care of business as foreseen prior to Katrina. Of course the psychological factor will play a part and maybe the Bush administration will pressure the Fed to stop rate increases in order to "give the small guy a break". That is certainly on the table as the citizenry is appalled at how Bush and the Federal government seemingly botched the necessary preparations via FEMA, et. al. This is a distinct possibility. The bonds surely are not threatening inflation due to energy as oil has now pulled back and yields lowered as the 30 year bond price climbs.
As to gold and silver, they rose and have stabilized. The HUI has done nothing spectacular but the gold / oil ratio has dropped sharply. In relative terms this means that gold is cheap comparatively and may be a precursor to a Q4 rise. But the call will be made via the Fed interest rates, if they continue rising then we simply go with that for a while and assume USD strength until the higher rates take effect. When that happens we could imagine that gold will then start the next leg upwards. More on the metals aspect in upcoming Letters...
Time for a shower and breakfast. Here is an interesting article below - China economy dead? Certainly doesn't appear so...just ask the Aussies.
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Well, that's it for today... for more on this article and more charts please visit the homepage www.dinl.net in the Latest Letter box.