Wealth International, Limited

Finance Digest for Week of June 12, 2006

Note:  This week’s Offshore News Digest may be found here.


The world is full of people with little or no real estate experience (OK, like me) who still claim to know the business well enough to predict a crash. It is also full of real estate industry pros who, deep in denial, seem to expect a soft landing followed by another long, glorious boom. So when an actual real estate expert crosses over to the dark side, it is news. This morning I am reading through a 31-page report compiled for internal use by Colorado Santa Fe Real Estate, a company founded by a serial entrepreneur named Marcel Arsenault, one of the rising stars of the commercial real estate business.

Back in the late 1980s, Marcel was a hippy/entrepreneur in the Ben & Jerry mold who had spent the previous decade mixing up vats of Mountain High yogurt, eventually turning the brand into one of the most popular in the West and selling it Beatrice Foods for a nice profit. He then started buying up Colorado real estate. “I couldn’t have picked a worse time,” he says now. But he held on, and in a couple of years was rewarded with the mother of all fire sales. The government began liquidating the assets it had acquired from failed thrifts, and prime properties were suddenly available for pennies on the dollar. When western real estate values soared, so did Colorado Santa Fe’s portfolio. It now manages upwards of $350 million of property and is sitting on well over $100 million of unrealized capital gains.

In other words, this is a guy who has prospered in both good and bad real estate markets, which makes his current take worth noting. And right now he is excited – about the prospect of another 1990-style crash. Below are some excerpts from the previously mentioned report. As your read this, keep in mind that it is the analysis of someone who for the past 15 years has been very successfully LONG real estate. In the report’s concluding section, “Colorado Santa Fe’s action plan”, Arsenault indicates that they intend to sell most existing properties and short stocks of retail REITs, homebuilders, real estate companies, mortgage insurance companies, and suppliers (construction, copper)! “Colorado Santa Fe is both lightening up and going short. In effect, it’s morphing from a real estate developer (which buys and operates, always on the long side), into a hedge fund, capable of going both long and short with outside investors’ money. That’s a very big change in mindset, hard to pull off but exactly the right approach for what’s coming. I’m an adept buyer. Now it’s time to become an adept seller.”

In 2008-2010 he plans to return to real estate – at “cycle bottom” – by raising an equity pool of $250 million and buying distressed property on a “massive scale ($1 billion)”.

Link here.

Collapsing Bubble

“I’ve cut the price twice,e said a reader of his house in Florida. “I get plenty of people stopping by, but no one makes an offer. It’s eerie. It is as if they all suddenly knew that if they wait they’ll be able to do a lot better later on.” This morning, we read that major new condo projects are being closed down in Washington, DC, as well as Las Vegas and Miami. Nationwide, there are said to be almost four million new and used houses on the market. Reports from all over the country tell of rising inventories, slower sales, and price-cutting.

And from other readers come more worrying anecdotes. “When you mentioned Las Vegas real estate woes, I’d like to comment further,” begins a letter. “I am a Phoenix real estate agent and March 2005 there were 5,000 houses on the market, March 2006 there were 35,000 houses on the market. Today there are currently 40,000 houses on the market. Staggering!” How will it all end, we wonder. With a bang or with a whimper?

Meanwhile, the curious fact remains: consumers are still consuming their heads off. Spending and debt are still rising, despite the lag in house sales. And in surveys of consumer attitudes, the lumpen report vague presentiments of trouble coming, but no real fear. It is as if they thought they were expected to appear wary. As if it would be unseemly or lacking in gravitas to expect such fat times to roll on forever. But, queried more closely, that is exactly what they do think.

Link here.

Shrinking home equity bad for the pre-foreclosure business.

In an interview with the LA Times, Doug Duncan, chief economist of the Mortgage Bankers Association, called the industry’s new fangled interest-only fixed rate product a “very low risk mortgage”. These mortgages are very low risk, once you have become used to the alternatives, like pay option ARMs, interest-only ARMs and 125% loan-to-value mortgages. In fact, this new mortgage loan is so harmless, at least compared to those that ask so little today in exchange for so much tomorrow, that Mr. Duncan called it “essentially tax deductible rent.”

That is a great analogy for those renters who spend large chunks of their paychecks at Home Depot, who ask plumbers to unclog their sinks only to learn that their entire sewer line must be replaced, and who rather than earn interest on what ultimately will become a down payment, prefer to pay interest on principal that does not get reduced for several years. Other renters, however, may find the “tax deductible rent” analogy a stretch.

Certainly one of the benefits of the interest-only fixed rate option is certainty. As opposed to with interest-only adjustable rate mortgages, with the whizbang fixed rate interest-only loan you not only know exactly what your payment is today, but you know exactly how much higher it will be 5 or 10 years down the road when you will begin paying down principal. So you can prepare for the inevitable. But seeing a cream pie coming at your face and being able to get out of the way are two different things. For example, what if rising property taxes or homeowners insurance rates thwart your best laid plans? Well, you could sell out, pay off the loan, and do it all over again in some place cheaper, like South Dakota or Nicaragua. There is, however, the chance that by the time you decide to sell out, the price of your home will be less than the outstanding loan balance. Then the choices are: 1) sell anyway and pay the lender the difference, or 2) mail the keys to the mortgage company.

While such a scenario was not all that likely over the last several years, topping real estate prices could increase the odds, particularly for homeowners who put down skinny downpayments and/or have a mortgage that does not amortize. Lately, lots of homeowners have been increasing the odds of a flipping upside down. According to the Detroit News, 29% of those who took out mortgages last year either have zero equity in their homes, or owe more than their house in worth. This figure is almost triple the 10.6% tally for 2004. This scarcity of equity is reflected in the rising foreclosure rates.

In a pre-foreclosure, another buyer, usually an investor, contacts the distressed homeowner prior to actual foreclosure in hopes of working out a deal. While investors and pre-foreclosure specialists may be busy over the next few years, the equity shortage, while broadening the universe of those in need of a buyout, also makes it difficult for pre-foreclosure investors to make a buck. According to a recent story in the Las Vegas Business Press, a periodical that should know a thing or two about distressed sellers, pre-foreclosure investors are getting lots of phone calls, but few workable deals. “Most have no equity or are upside-down” bemoaned one investor who blamed interest-only loans and ARMs for making his life more difficult. If business gets too tough, there imay be only one thing for a pre-foreclosure investor to do. Forget the “pre-” and give the foreclosure business a try.

Link here.

Housing boom brings record loan debt.

Americans are handing over more of their income in mortgage payments than at any time in 16 years, reflecting the surge in house prices and increases in interest rates. A study published today by Harvard University’s Joint Center for Housing Studies argues that housing will continue to become harder to afford even as prices start to slow. The median U.S. household now spends 23% of its income on mortgage payments, a level last seen in July 1990, according to the National Association of Realtors.

But the problem of affordability is more acute for low-income families, where high purchase prices and a decline in the building of rental properties are both causing problems. Almost half of American households with the lowest 20% of earnings spent more than half of their income on housing costs, which include both mortgage and rent. Over the past year wage rises have been struggling to keep pace with the rising cost of living. Overall, the number of households paying more than half of their income on housing costs rose by nearly 2 million to 15.8 million between 2001 and 2004. The number of households with moderate cost burdens – paying more than 30% of income on housing – rose from 31.3 million to 35 million.

Link here.

Farewell to the flippers.

Low-ball bidders, persnickety buyers and cancellations are now the rule in once-hot housing markets. Rising interest rates and sky-high home prices have cooled real-estate investment, “particularly in high-end markets in some juiced-up parts of the country where speculation was most rampant,” said Mark Zandi, chief economist at Moody’s Economy.com. The record low interest rates and speculators that once drove prices higher are gone. Observers expect housing prices to stagnate or decline slightly, though a steep crash for housing prices is unlikely. As the market slows, both builders and buyers are getting used to the changes.

On a recent conference call, Ara K. Hovnanian, the president and chief executive officer of homebuilder Hovnanian Enterprises said that real estate investors “have largely pulled out. Investors were a bigger part of the market than many thought, including ourselves,” said Hovnanian, whose company builds primarily in the Northeast. Would-be flippers are not only not buying new properties, they are selling what they already own, adding to the record number of homes already on the market.

Stocks in the sector have fallen dramatically. Hovnanian, for instance, is trading near $30 a share, down from its 52-week high of $73.40. Rival Toll Brothers trades around $27 a share, down from a 52-week high of $58.67. Wachovia last week cut its rating on builders including Pulte Homes, KB Home and DR Horton, citing a sharper more rapid downturn in the market than expected. Developers have started canceling projects. With land prices falling in some areas, Hovnanian has walked away from about $5.6 million of deposits on land parcels it had options to buy, lopping 5 cents a share off the company’s second-quarter earnings.

Link here.

More housing markets overvalued. 39% of U.S. housing at risk for falling prices, study says.

A growing percentage of U.S. housing markets are “extremely overvalued” and are at risk of falling prices, according to a study by Global Insight and National City. In the first quarter, 71 housing markets, representing 39% of all U.S. housing, were deemed to be “extremely overvalued” based on median sales prices, median income, population and historic values. That is up from 64 markets accounting for 36% of housing in the fourth quarter. In the first quarter of 2004, just 1% of housing was considered overvalued. To be “extremely overvalued”, homes had to be valued at least 34% more than “normal”.

When prices do fall from overvalued levels, they typically fall by about half the overvaluation, DeKaser said. The correction usually takes three and a half years. The study used the most recent sales-price data from the federal government, which showed that single-family housing prices increased at a 7.3% annual rate in the first quarter, the slowest price gains since 2003. See full story. “Price appreciation is slowing but it continues at a historically high rate, boosted by especially strong increases in already overvalued markets,” said Richard DeKaser, chief economist for National City. The most overvalued markets continue to have the highest price appreciation, he said. California and Florida accounted for 17 of the top 20 overvalued markets, economists at the two firms said.

Homes in Naples, Florida, were deemed to be 102% overvalued, the economists said. Among other big cities, Miami was overvalued by 64%, Los Angeles by 61%, Oakland by 47%, Nassau and Suffolk counties in New York by 44%, and Phoenix by 43%. Of 317 markets, 88 were deemed to be undervalued. College Station, Texas, was undervalued by about 24%. Among big cities, Dallas and Fort Worth were undervalued by 19%, Houston by 16%, New Orleans by 12% and San Antonio by 11%. The number of undervalued markets has been steadily declining, DeKaser said.

Link here.

Bubble trouble in Canada and Spain.

The Globe Investor reports, “The housing market in Western Canada is showing dangerous signs of ‘bubble-like activity,’ with double-digit increases in prices that could cause an ‘ugly end to this housing cycle,’ a report warns. … Prices for existing homes in Calgary have jumped close to 30% so far this year, Douglas Porter, deputy chief economist with Bank of Montreal, observes … The average home price in Vancouver is now in the neighborhood of $500,000. … Industry experts in the West yesterday were quick to pour cold water on any talk of a bubble there. They argued that rising home prices are clearly being supported by the fundamentals of the local market, which include a massive influx of workers and huge employment growth. … Elton Ash, executive vice president with RE/MAX Western Canada, called the bubble debate ‘old hat.’ Only a jump in interest rates or a major slowdown in the energy and resource sector would cause a bust in western markets, he said. ‘That is just not going to happen.’”

I remain amazed at the number of people that think, “It can’t happen here.” They said the same thing in Florida, in Las Vegas, in Boston, and in San Diego. Now some realtor with a vested interest in the outcome says, in effect, “It’s different here.” I have news for Elton Ash, and forgive me for being blunt: It is because of clowns like him who promote such ideas that bubble mentality takes hold in the first place. The simple fact of the matter is that unless wages are rising in proportion to property values, there will be a bust. A jump in interest rates is not going to happen? Really? A slowdown in energy “can’t happen”? Really? Prices paid are irrelevant? Really? 30% annual price gains are not sustainable, and I confidently predict that 100% of that 30% will be given back, and probably much, much more.

Admittedly, I know less about Spain than Canada. Far less. But I want to share an email I received a few weeks ago. “Hello from Spain, just would like to tell you about the Spanish property bubble, but would be great if you can make a little article in your page, our bubble is bigger than yours :) … We are building about [800,000] homes a year, that is more than the sum of Germany, France, and U.K., all of these countries have more population than Spain. Our economy is now based in residential construction and tourism, in my opinion it will collapse … Housing prices grew 89% between 2001-2004, while salaries only grew 14%. Housing prices grew 150% between 1998-2005. … Family debt is by far the biggest in Spanish history, around 70% of GDP. Credit is growing around 8% in Europe, but 25% in Spain. … There are about 3 million empty houses in a country with 14 million houses, speculation is rampant. … Magazines like The Economist and institutions like the European Central Bank and even the Spanish central bank are complaining and warning us, but nobody seems to hear.”

Link here.

Housing stocks as leading economic indicator?

Charts provided by Value Line showed an interesting “head and shoulders” pattern for the housing stocks. As a fundamental analyst, I must warn that technical analysis is not my forte. On the other hand, as a long-term investor, I am well equipped to monitor a pattern that actually took several years to unfold, and therefore might have been missed by people looking at patterns over a period of, say, 200 days. There was a first peak in the stocks in late 2003-early 2004. The equities then eased back for about a year, forming a “left shoulder”. Then they spiked in mid-2005, forming a head, before retreating to pre-spike level shortly thereafter. Early in 2006, they pulled back further, beginning a “right shoulder”.

If the right shoulder had been symmetrical with the left, there would have been another secondary peak toward the end of the year, before a general retreat in 2007. This rebound was what I and others were counting on when we estimated the potential for a 30% or so bounce in the stocks last March. “Not” as the British would say. Instead, there was an abbreviated right shoulder, followed a precipitous fall immediately afterward. This suggests a deterioration in the fundamentals that is taking place much faster than the original buildup. It may be a cause and/or a metaphor for other parts of the economy as well. If, as I believe, there will be a recession (or worse) in 2007, the recent collapse of the housing stocks will have been the first clear sign.

Link here.


The terms differ slightly – a nervous sell-off, a correction, the beginnings of a bear market. But as stock markets from India to Brazil to the U.S. skidded last week, there was little doubt that investors were dumping risk from their portfolios. The question for the coming week is whether investors feel comfortable with the risk they have left. “It’s a market with no clear conviction at all except for that it’s afraid,” said William E. Rhodes, chief investment strategist with Rhodes Analytics. “There are economic fears and uncertainties. That alone pulls the market down because on a very fundamental basis you are not sure where to price the stock. And if you are the buyer, you don’t want to pay what is asked.”

Investors are facing a number of new developments that are making risky investments, particularly those in emerging overseas markets, look like a bad idea, economists say. First, the U.S. economy by most accounts is beginning to downshift to a less rapid period of growth. Second, higher interest rates are making consumers think twice about how to spend their money. “This has been a very powerful liquidity-driven market that has drawn a lot of support from low interest rates,” said Stephen S. Roach, chief economist at Morgan Stanley. “And investors are coming to the realization that the Fed is taking the candy away. They have to come down to earth.”

Adding to the market anxiety is the widespread belief that the Fed, which has said inflation is rising at an uncomfortable rate, will raise interest rates yet again when it meets later this month. “Market participants have been forced to think about, ‘Will the Fed overdo it?’” said Jack Caffrey, an equity strategist with J. P. Morgan Private Bank. “Investors are responding as they do. They’re pulling in.” Most would agree that the global economy is not in any immediate danger of faltering and that the stock market so far shows no signs that it is headed toward a protracted slump. “The fundamentals of the world economy are still O.K.,” Mr. Roach said. “They’re not terrific, but still O.K.” James Paulsen, chief investment strategist at Wells Capital Management, cautioned about overreacting to the current market dip. “Every time it swoons doesn’t mean we have a recession coming.”

Link here.

Bank for International Settlements report concludes that asset risk worries have caused markets to fall.

A swathe of markets have fallen sharply since mid-May, with Tokyo’s Nikkei 225 equity index plunging 14.2%, the FTSE Eurofirst 300 9.2% and Wall Street’s S&P 500 5.4% in a series of violent rises and falls. Commodity prices have been similarly volatile as have emerging markets, where the MSCI Emerging Markets equity index has slumped 20.9%, bond spreads over U.S. Treasuries have widened 40 basis points, according to the JPMorgan EMBI index and the Turkish lira has led a slide in currencies, falling 14.2% against the dollar. A a result the VIX index of market volatility, often called Wall Street’s fear gauge, rose to a 12-month high last week.

However research by the BIS, the co-ordinating bank for the world’s central banks, casts doubt on the popular perception that the sell-off has been caused by worries over rising global inflation and interest rates or by concerns that global growth is slowing. Many market commentators have attributed the volatility to concerns that historically high oil prices may finally be starting to feed through into broader inflationary pressures. This could force central banks to keep raising interest rates, draining liquidity from global markets and souring the backdrop for equities. However the BIS found that short-term interest rate futures have been more or less unchanged since April, “indicating that market participants did not materially revise their expectations regarding to pace of monetary policy tightening.” Furthermore yields on 10-year U.S. Treasury bonds have fallen from 5.13% to 4.985% since the market turned on May 9, while yields on 10-year bunds have fallen from 4.02% to 3.93% and on 10-year Japanese government bonds from 1.95% to 1.85%, hinting at little concern over rising inflationary pressures. Gold, a traditional safe haven in times of rising inflation, has fallen 11.6% since mid-May.

“New information was not the primary cause of the correction,” concluded the BIS. “Risk appetite would seem to have been a key driver. If the sell-off had one defining characteristic, it was that those markets that fell the most tended to be the ones that had risen the farthest in previous months.”

Link here.


Financial markets have had a rough few weeks. For Ben Bernanke, things have been even rougher. Bernanke is renowned in the economic community for his intellect and wit. Lately, investors appear to be wondering where those attributes went. The headlines have hardly been the kind a new Fed chairman would desire. Last week, the Associated Press ran a story headlined “Fed’s Warning Roils Markets”. CNN.com did a story on “The Bernanke Panic”.

Reinforcing the view that Bernanke is confusing markets was a review of his public comments by TheStreet.com, which asserted that in a fairly short span, he has moved from inflation hawk to dove and back to hawk. Bloomberg News columnist Caroline Baum captured the mood on trading floors best with last week’s piece titled, “Traders Pine for Days of Greenspan Spoon Feeding”. While all this chattering has been going on, equity markets have headed down, big time. Whenever investors lose money, they seek a scapegoat, and everyone seems to have found the perfect one in Bernanke.

All of this carping about Bernanke’s performance is unfair. The problem has nothing to do with confusing utterances. It is not the words, it is the facts. Markets are roiling because the fundamentals themselves are uncertain. The Fed has increased interest rates now at 16 consecutive meetings. During this time, the economy has grown at a rate that traditionally might be characterized as “overheated”. Now economic growth is clearly slowing, but signs of inflation are still all around us. Should the Fed tighten even more, perhaps exposing the economy to a recession risk, or should it ease up now, and trust that the deceleration already in train will soften inflation risks? No one, including the Fed, has the right answer.

The only thing we can do is wait and see how the data move. That is tough on us, and especially tough on Bernanke. It did not have to be this way. If you consider that a “neutral” federal funds rate is probably around 4.5%, and that the rate was below that all of last year, one must conclude that the Fed had its foot on the gas right up to Greenspan’s departure. We are in this difficult spot because the Fed was far too easy when growth was hot last year, leaving all of the tough work for Bernanke. If Greenspan were at the Fed right now, market volatility would be the same, because the Fed’s uncertainty about when to stop would be the same. Bernanke’s job would be a lot easier now if the Fed had simply increased the federal funds rate enough last year so they could have halted the increases in Greenspan’s last meeting in January.

So what can Bernanke do to get his groove back? Easy. Figure out what federal funds rate is the one he ultimately wants to hit, get there at the next meeting, and announce that the tightening is done. Markets will celebrate, and the days of confusion will be behind us.

Link here.

Asia may have little choice but to embark on its most aggressive monetary-tightening campaign in a decade.

Surprise interest-rate increases in South Korea and India last week were reminders of an inconvenient truth: The era of easy money in Asia is over. In recent years, Asian central-bank policies provided generous doses of liquidity, keeping borrowing costs low and putting a floor below stock prices. Until now, loose monetary policy worked marvelously. The strategy may have run its course now that inflation is accelerating. On top of pressures on wages and property values, Asia is grappling with the fallout from high oil prices. More and more, their effects are seeping into consumer prices. The question is whether Asia’s economies are ready for tighter credit conditions.

Complicating things is the specter of more U.S. Federal Reserve rate increases. For better or worse, globalization has changed the Fed. Even though it has 12 districts and acts on U.S. events, its influence has never been greater. Add the risk that the Bank of Japan will soon raise short-term rates from zero. Not only does Japan have Asia’s biggest debt market, but traders and investors for years have borrowed cheaply in yen and parked that capital in higher-returning assets from China to the U.S. The end of the “yen-carry trade” could slam Asian markets.

None of this means Asian policy makers can sit back this time and wait for Fed Chairman Ben Bernanke and European Central Bank President Jean-Claude Trichet to do their work for them. That was possible in the past, when Asian currencies were more closely pegged to the dollar and capital markets in the region were too small for local monetary-policy shifts to matter much. Now, Asia may have little choice but to embark on its most aggressive monetary-tightening campaign in a decade. The good news is that the region has done much to strengthen economies since the late 1990s. Currency reserves have been amassed, banking systems are more stable, corruption is being addressed, albeit gradually, and living standards are edging higher.

Now for the bad news: easy money and debt. As Asian policy makers act this year, investors will learn once and for all how much of Asia’s growth has been driven by ultra-low interest rates. Many economists call it the “bubble fix”, caused by central banks going too far to boost economies. Easy money reduces the need for structural change and artificially pumps up asset prices. The forces of globalization helped avert negative side effects such as economic overheating. That may be changing amid rising commodity prices, huge gains in real-estate values from Mumbai to Jakarta, and signs that production costs in key manufacturing hubs such as China are rising. The upshot could be sharply higher Asian borrowing costs.

The other problem is debt. Since the mid-1990s, growth in public debt in emerging Asia – which means most of the region – has “been particularly rapid”, IMF officials wrote in a recent report. They estimate debt rose to about 55% of aggregate GDP in 2005 from 40% in 1996. Debt levels make the region more vulnerable to rising rates. While Asia has been more careful about issuing foreign-currency debt since its 1997 crisis, high debt burdens will strain government coffers as interest rates rise. They will also limit fiscal options if growth slows.

Again, Asia is a very different place than it was in 1997, and the risks of a financial crisis are minimal. Yet the kind of risk aversion unfolding in markets is a wild card that Asian policy makers do not need. Asia’s central banks must act prudently to extend the region’s expansion. Even if it means slightly slower growth, the outlook will be brighter if Asia avoids the booms and busts of the past. It is a seemingly impossible balancing act. After all, central-bank officials in India, Indonesia and the Philippines may face a public backlash if their actions reduce GDP. What they have in common is crushing poverty that adds an element of caution that the Fed and ECB do not need to consider. It may be a necessary evil given how quickly inflation slams living standards at the lowest end of the economic food chain. Asia’s central banks may have a busy year on their hands.

Link here.


As your correspondent has pointed out on numerous occasions in the past, it is impossible to predict the direction of the gold market in the short-term. Nevertheless, our hard-working contributors seem to have nailed the trends with reasonable acuity. We will refer back to and link various articles written on the subject of the price of gold and the valuation of mining shares over the course of the last few months, but to refresh some memories and provide some context, an outline of the HUI’s performance since January 1 is provided.

This correction has been quick, and vicious, and has taken us back to the 200-day moving average on the HUI, but why does that mean that like magic, everyone will be lining up again on the buy-side in September at the latest, or sooner? No doubt there will be many bounces along the way, but all of the issues raised previously – lack of liquidity, fickle hedge funds, a mountain of 4-month hold paper – still exist. There is no reason to believe that the HUI cannot fall 10% below its 200-day moving average, or even spike to as low as 20% below the average, or that it cannot consolidate around these levels for 6 months or longer, with a concomitant lack of enthusiasm.

One additional major factor that could complicate things for owners of gold shares would be if we were to experience a correction/crash in the broader market before the year is out. In that scenario, institutional and retail players would immediately let go of their winners (metals shares), and that would drive prices lower, even in defiance of fundamentals. It would then be a considerable period of time before buying and momentum returned, and the general public/investment community came to the realization that precious metals were the best (only) refuge in a contracting economy/bear market. “Year-End” is as arbitrary a date as “end of summer” for this correction to come to an end, however maybe a little bit more realistic. It makes people who are invested in the sector feel good to say that this time it will be over quickly – like by the end of summer – but when everyone is saying the same thing, and the evidence is not there, it probably will not pan out that way.

Cash will be king for some time to come, though by the same token, quality positions, even if they are being brutalized now, will eventually reassert themselves as the underlying economics of the deals (commodity prices themselves should stay buoyant relative to developer valuations) come to the fore.

Link here.

The bullish case for gold.

At the New York 2006 Hard Assets Conference in May, Dr. Martin Murenbeeld, Chief Economist of Dundee Group of Companies, offered his bullish case for gold. See the entire presentation herein.

Link here.


Ivan Petrovich Pavlov was a brilliant Russian Physiologist whose experiments on animals led to discoveries that would make the demented doctors in World War II, in both Germany and Japan, very jealous. Some of Pavlov’s early work was done on sheep. Unfortunately for the sheep, the experiments on them were so stressful they eventually died of heart attacks. Pavlov’s work on sheep, analogous to stock market investing, is critical for this article because speculators, hedge funds, and particularly retail stock investors, do tend to act a lot like sheep.

Pavlov’s work on the conditioned reflex reaction of sheep to stimuli should be of the utmost importance to the Federal Reserve and world central banks at this juncture in a world where signs of speculative excess – even to the bubble level – clearly remain in all major risk asset classes including housing, commodities, emerging markets, and even major stock markets. Pavlov discovered that if he gave the sheep a mild electric shock, it would bother them very little and their life would go on pretty much as if nothing had happened – as long as the shocks were random. Warning the sheep in advance of a shock by ringing a bell, however, affected their behavior and it changed radically. The sheep were just smart enough to realize that if they heard the bell, the shock was coming. After repeating this exercise a few times, the poor sheep lost control of bodily functions and after a few more warning bells, they started dying of heart attacks.

What Ben Bernanke and the Fed Governors should know, and are likely to find out the hard way, is that markets driven by speculation will react just like Pavlov’s sheep. Indeed, the major market participants and speculators, particularly greedy retail investors, are there to get “sheared at market tops”. Somebody has to buy when the smart money wants to sell and take their winnings out of the casino. Moreover, to keep the herd of retail investing sheep grazing on financial investments including commodities, there needs to be a steady stream of “feel good” press for stocks while analysts and market touts are claiming, “There has never been a better time to invest.”

With fears about a rising core inflation rate and slowing economic growth, Bernanke and the Governors understand too much money was printed up over the last decade. They are not alone. The central banks in Europe are not done raising interest rates either and Japan is just beginning to raise their rates from zero to drain excess liquidity. After 16 rates hikes, the Fed announced it is not done raising rates. This “ringing of the bell” has the sheep sensing that more shocks are coming. This could be downright ugly for the financial markets! We would recommend that the Fed have plenty of tranquilizers and lots of liquidity available to bail out the markets if they keep on scaring the sheep.

The market participants that started running like lemmings for the edge of the cliff are led by the market professionals! They have been heard shouting, “Get out before the sheep panic!” Over the last few months, easy money trades are down, and some Middle Eastern markets have crashed while other emerging markets are in a bear market. Commodities are also in a serious correction, including gold and silver.

All too often central banks tighten until the financial markets suffer a significant failure. Given their behavior and what Pavlov taught us about sheep, they will more than likely create an opportunity to fight a real financial market fire. However, when the Fed has to fight a market event – and cuts interest rates in an effort to save the lives of some of the sheep – you can kiss the dollar goodbye. So, while the dollar has gotten a technical lift over the past week or so, my cash is still going into “non-dollar cash”.

While a general stock market crash may pressure all stocks (including precious metal stocks) to go lower, precious metals and precious metal stocks are being offered now at significant discounts. In the years ahead, the high prices we have all seen in gold and silver will be surpassed many times over. In addition, leaving your money in short-term cash with no price risk while receiving 5%, looks a lot better than losing money in stocks or real estate. Suddenly, risk is a four letter word and cash is not trash.

Link here.


I live in a country where I can swing by a store and pick up a bottle of water. More people than you think do not enjoy such a privilege. Water is the single most important resource on the earth. It is also the most undervalued resource on Earth. That is why a few little known water stocks posses potential for savvy investors. Over the last century, water usage on a global level has increased 6-fold – twice the rate of population growth over the same period. Demand is not about to wane. Water has been mismanaged for so long that shortages around the world are reaching alarming levels and both the public and the private sector are beginning to pay attention.

Although 70% of the world’s surface is covered by water, only 2.5% of it is potable, and most of that is trapped in the polar caps and far beneath the earth’s surface. According to the World Health Organization, less than 1% of the world’s freshwater, or 0.007% of all the water on Earth, is readily available for human consumption. Water is vital for sustaining virtually all forms of life. Aside from immediate consumption, it is a critical component in agriculture, industry, sterilization, sanitization and countless other applications. Agriculture alone accounts for 70% of all water consumption. Allocate a further 22% for industry and only 8% is left for direct human consumption.

One need not look far to find the extreme effects of water shortage already being experienced around the world. Almost one fifth the global population – about 1.2 billion people – are currently without access to safe drinking water and almost half the world’s population lack adequate purification systems. This shortage is mostly concentrated in developing countries where residents pay an average of 12 times more per liter of water than developed nations that derive their water from municipal systems. According to the UN and the WHO, 80% of diseases in developing nations stem from consumption of and exposure to, unsafe water. This contaminated water kills more than 25,000 people each day! Compare this to approximately 20,000 cancer deaths per day and the discrepancy between public awareness about the two. The 2005 tsunami natural disaster claimed over 200,000 lives throughout the Asia-Indian region. The number of fatalities caused by the global water shortage is equivalent to such a tsunami striking every eight days.

In 1998, 31 countries faced chronic freshwater shortages. By the year 2025, however, 48 countries are expected to face shortages, affecting nearly 3 billion people – 35% of the world’s projected population. Clearly, this is a crisis that deserves the utmost attention. Faced with an inexorable and intractable demand, this most precious of resources is set to attract big investment dollars in the coming years.

Link here (scroll down to piece by Joel Bowman).


The average New Yorker buys a new toothbrush every three months, but he brushes his teeth with water that flows through 100-year old tunnels and pipes. The water infrastructure in most of the rest of the nation is not much newer than Manhattan’s. It should be no surprise, therefore, that water pipes are rusting and crumbling all across this great land of ours. The nation’s alarmingly decrepit water infrastructure will require a $1 trillion overhaul over the next 20 years, according to the American Society of Civil Engineers (ASCE). This massive infrastructure spending will mean big business for many water infrastructure companies.

Repairing the nation’s water-supply infrastructure will cost hundreds of billions of dollars over the next two decades. That is bad news for the municipalities, tax-payers and rate-payers that will have to foot the bill, but very good news for the companies that will be sending the bills. Enter companies like Aqua America (NYSE: WTR), Northwest Pipe (Nasdaq: NWPX), Mueller Water Products (NYSE: MWA) and PW Eagle (Nasdaq: PWEI). Aqua America, for its part, is busily buying up municipal water systems in 13 different states, and spending millions to bring them into compliance with stringent new EPA guidelines. The EPA’s new dispensations would require many municipalities to make improvements that they cannot afford. Thanks to this assist from the EPA, therefore, Aqua America is finding itself in a buyer’s market for municipal water systems.

Meanwhile, companies like Mueller Water Products are capitalizing upon a much more rudimentary problem: many water pipes and valves are simply too old to do the job effectively. Mueller hopes its pipes and valves will provide a major part of the solution. Mueller only started trading as a public company on May 26th. But most of us – and most of our dogs – have known this company from birth. It manufactures about half of all the fire hydrants in the country. Mueller’s stock, which sells for about 27 times earnings, is hardly cheap. But all major U.S. water stocks command a premium valuation. The portfolio of the PowerShares Global Water Fund (NYSE: PHO), for example, carries an average PE of 28.

We have no idea if these water stocks are worth their premium pricing. But we have some idea that business will be booming for a very long time in the U.S. water infrastructure industry.

Link here.


Dallas Mavericks basketball team owner Mark Cuban is financing a new Web site that will investigate stock fraud and corporate wrongdoing. Cuban said he has not been a direct victim of fraud but was motivated to start the site by his approach to investing. “I’m a firm believer that out of (the more than 10,000) public companies the odds are that there are more than just a few crooks and frauds,” Cuban said. “Finding them can be rewarding and entertaining.” Christopher Carey, a 17-year St. Louis Post-Dispatch staffer, said Sharesleuth.com will launch next month and also carry work from a network of stringers that will include burned investors. Neither Carey nor Cuban would disclose how much he is investing in the site.

Cuban also said that he could use information that the site uncovers to buy and sell stock. “A journalistic conflict you say?” he wrote on his blog on May 31. “Not any more. Not in this world. It will be fully disclosed and explained. This site is for the profit of its owners and we will buy and sell stocks that are discussed, before they are made available on the site … If we can uncover companies whose stock is public and that can be bought or sold and that allows us to pay for more in depth research and effort. I’m good with that.”

Cuban, 47, made a fortune that Forbes magazine recently estimated at $1.8 billion by selling Broadcast.com to Yahoo Inc. in 1999. He bought the woeful Mavericks in 2000 and spent heavily to improve the roster. The team is on the brink of an NBA championship this week, and Cuban is soaking up the adoration of long-suffering Dallas fans. Carey, a finalist for the Loeb Award, the highest honor in business journalism, for a series about securities boiler rooms, said he pitched the idea of a stock-fraud Web site after reading a Cuban blog in February.

Link here.


The data continue to provide the best glimpse of a credit system run amuck and so far demonstrating no capacity for adjustment or moderation.

With attention understandably fixated on wild global financial market action, few will give much attention to the most recent Credit data from the Federal Reserve. That is unfortunate. The data continue to provide the best glimpse of a credit system run amuck and so far demonstrating no capacity for adjustment or moderation. Moreover, record first-quarter credit growth and the ongoing massive outflow of finance from the U.S. financial system to the rest of world go a long way toward identifying the epicenter of the destabilizing liquidity that fueled wild (“parabolic”) speculative runs in markets around the world.

The numbers have gotten so big. Total non-financial debt (NFD) expanded at an 11.0% seasonally-adjusted and annualized (SAA) pace during the first quarter, up from the 4th quarter’s 9.4% and likely the strongest quarterly pace in nearly 20 years. NFD has not posted a year of double-digit growth since 1986’s 11.9%. NFD averaged 5.4% annual growth during the (“dis-inflationary”) 1990s. In nominal (SAA) dollars, NFD expanded $2.914 trillion during the quarter. For comparison, NFD expanded $2.30 trillion in 2005, $1.945 trillion in 2004, $1.648 trillion in 2003, $1.323 trillion in 2002, $1.099 trillion in 2001, and $827 billion during 2000. Total NFD increased on average $706 billion annually during the 1990s.

Interestingly – and in “classic” credit bubble blow-off dynamic fashion – household mortgage debt expanded at a 13.6% rate during the quarter, up from Q4’s 13.4% and Q1 2005’s 11.8%. I suggest that ongoing massive mortgage credit inflation explains why general home prices have held up so well – to this point. Total household debt expanded at an 11.6% rate, up from the fourth quarter’s 11.1%.

Considering ongoing credit bubble dynamics and resulting historic credit inflation, it was only a matter of time until the markets were hit with an inflation scare. Apparently it is finally arriving, with the Fed and global central bankers talking as if they have become (belatedly) keen to heightened risks. Markets are skeptical, and there are certainly sufficient crosscurrents to keep us all guessing. Are equity markets discounting an imminent economic downturn, or is it simply a case of speculative dynamics? Not to downplay the importance of a global equity bear market or the commodities downdraft, yet global credit bubble analysis is today much more absorbed with the underlying conditions of international debt markets and credit systems generally. It is certainly difficult to glean any indication of waning U.S. credit system momentum in the Q1 Flow of Funds.

And, for now, intransigent current account deficits ensure an ongoing deluge of finance out upon the world. There is, however, the potential issue of this flow of liquidity being offset/interrupted by the collapse of leveraged trades in various global markets. To what degree derivatives and speculator leveraging fueled the first quarter global melt-up is unclear, although it certainly appears at this point to be a case of speculative leveraging fostering a disorderly spike in various markets followed by a price reversal and frantic speculative deleveraging on the self-reinforcing downside.

It is a very tough call. Highly speculative/leveraged markets in sharp decline normally infer liquidity issues and the potential for dislocation. But these times are anything but normal. The spigot of liquidity gushing out of the U.S. credit system remains wide open. Will global credit systems continue relishing in excess liquidity, or will equity market and speculator vulnerability increasingly encroach upon lending and debt issuance. Can global central bankers talk domestic credit systems into demonstrating some restraint? To be sure, we have precisely the backdrop for extraordinary uncertainty, continued market volatility, and global financial fragility. This is macro credit analysis at its most challenging, fascinating, confounding, frustrating, and inevitably humbling best.

Link here (scroll down to “Q1 2006 Flow of Funds” sub-section of page content).


On June 8, there was a post made on my board on the Motley Fool that “The U.S. dollar is toast.” I often hear the same sentiment expressed on Silicon Investor and numerous other message boards and blogs. Another often-heard theme is, “U.S. Treasuries are toast”, and indeed the overwhelming sentiment is that U.S. Treasuries are in some sort of humongous bubble. My usual response is to ask why, and, then again, ask against what. Most of the time, I do not get an answer. That, of course, means the person saying it is just repeating the common mantra of the day, just as the shoeshine boy was telling everyone to short the dollar back in March 2005. Where was the warning about the U.S. dollar two years ago or even one year ago? Big money is made on Page 16 news that is headed to Page 1. The euro was probably on Page 16 in 2002. Now look at it. “The shrinking dollar” has been on Page 1 of The Wall Street Journal for months and just made the big time with the cover of Newsweek. Is there anyone out there that is not aware of the plight of the U.S. dollar?

The dollar rallied to my target of 90 (and then some). Now what? That rally has stalled, and immediately everyone is hopping on the short dollar bandwagon again. Is this yet another “sure thing”? Following are the four most common reasons cited for the dollar being toast:

  1. The Balance of Trade
  2. The National Debt
  3. The Savings Rate
  4. Monetary Printing by the Fed

Let us take a look at each of these reasons in turn.

The following chart shows the trade-weighted exchange index of major currencies versus the balance of payments. The U.S. current account balance went negative in 1992 and has stayed there ever since. Trade-weighted currencies (a chart nearly identical with the U.S. dollar index) show no correlation (that I can see) to the balance of trade. The proper conclusion is that currency trends may have little or nothing to do with trade balances. I am not saying that the trade imbalance does not matter, I am just saying there is little reason to believe that there is going to be any correlation between the two for perhaps long periods of time. It is certainly not a tradable event.

If we superimposed the U.S. dollar index over a chart of the U.S. national debt, I am positive we would not find any meaningful correlation. However, if a sudden immediate correlation between national debt as a percent of GDP and currencies were to occur, I am confident that dollar bears would not like it very much. Consider Japan. Japan’s government debt ballooned to a record high of ¥795.8 trillion ($7 trillion) at the end of June 2005. It was projected to be ¥774 trillion for this fiscal year, so the national debt is growing faster than expected. Japan’s public debt burden is now almost 160% of its GDP, which makes it the highest in the industrialized world. Again, I do not want to dismiss the problems of the U.S. national debt, but given that Japan’s national debt is 160% of GDP and the U.S. national debt is under 70% of GDP, perhaps the U.S. debt still has a way to go before it matters. Of course, one can argue that the U.S. GDP is distorted (it is) and the debt is underreported (it probably is on the basis of future liabilities, but, then again, so is Japan’s), but the biggest objection I will probably hear will go something to the effect that Japan is a nation of savers, so it does not matter as much.

The U.S. personal savings rate has been trending down since 1992. I see little correlation to the U.S. dollar. People everywhere point out all of the foreign buying of U.S. Treasuries, then confidently predict the dollar will collapse along with U.S. Treasuries when that support is dropped. I have long maintained that support will come from U.S. buyers. I am universally laughed at. The big question is where is that money going to come from? But perhaps you can answer the question yourself. Where is the savings rate headed from here? Are people going to keep spending more than they are making forever? Are we closer to a top or a bottom on the savings rate? That spike down roughly coincides with the blowoff top in the housing bubble. For this or another reason, there was a clear unprecedented panic out of holding dollars to buying things. I confidently predict a reversion to the mean on this “time preference” away from risk, perhaps even to the point of a panic reversal to the safety of U.S. Treasuries. Please note that U.S. Treasuries can only be purchased with U.S. dollars. Once the housing bubble collapses, and people see what is happening to their only “savings vehicle”, will there be a shift away from consumption toward savings? I think so.

The next hurdle to get over is the CPI. People constantly point out that “The CPI is a joke and you are losing money at 5%.” That may or may not be the case (even I think the CPI is a crock, yet I am far from being an inflation alarmist), but what if 5% is the best you can do? Is it better to lose 20% in the stock market (on top of whatever loss in money value there is), or is it better to do the best you can and just take 5% if offered? Corporations have even been going to the junk bond market to raise money for the sole purpose of stock buybacks … after a 3-year equity run-up? Does that make any sense (except for insiders selling into those buybacks)? Is there a bubble in bonds? Yes, junk bonds. Is there a bubble in U.S. Treasuries? No way.

Various currency carry trades are blowing up all over the place. The rand is one and the Icelandic krona is another. If there is some sort of “credit event”, where do you want your money? Consider some “flight to safety” alternatives: (1) Chinese renminbi, (2) Indian rupees, (3) Malaysian ringgits, (4) Mexican pesos, (5) South African rand, (6) South Korean won, (7) Sri Lankan rupees, (8) Thai baht, (9) Icelandic krona, and (1) U.S. Treasuries. Which one would you choose?

Make no mistake about it, the Fed has been printing. But credit is currently expanding much faster in Europe and China than in the U.S. Europe also has a huge demographic problem (more advanced than the U.S.’s at this point). Not too long ago everyone thought the euro would implode and the E.U. would break apart. A few short years later (after a huge run-up in the euro), everyone is a euro bull. Is the pound the savior? The U.K. arguably has a bigger pension problem than the U.S., as well as a bigger housing bubble. What about the RMB? I have posted many times on my blog that the RMB would likely crash, as opposed to rocket up, if it were all of a sudden freely floated. My biggest reason for thinking that was near-universal sentiment in favor of the RMB versus the U.S. dollar. A second reason was massive nonperforming loans in the Chinese banking system.

After falling to negative 1.2% in March 2001, the yearly rate of growth of the Chinese central bank balance sheet (monetary pumping) relative to real economic activity climbed to 28.2% in September 2005. In February this year, the yearly rate of growth of the relative pumping stood at 22.1%. In contrast, the yearly rate of growth of the Fed’s balance sheet in relation to real economic activity fell from 11.6% in September 2001 to 0.9% in March this year. Since China’s monetary expansion relative to real economic activity has been accelerating while in the U.S. relative pumping has been decelerating, it follows that China’s yuan has to depreciate against the U.S. dollar.The euro looks about fairly valued given the present constellation of international price levels, interest rates, and inflation pressures, but the Japanese yen and other Asian currencies still appear undervalued relative to the U.S. dollar.

Over the past couple of years, I have argued strongly and repeatedly that the deep and ongoing U.S. current account deficit will compromise growth in U.S. gross domestic investment for years to come. As the size of the U.S. current account deficit gradually receives more attention, it has become an article of faith that the U.S. dollar is overvalued. Not so fast. The basic assumption of the overvalued-dollar thesis is that the current account deficit is simply an import/export problem that will go away if prices (mainly currency valuations) are right. This misdiagnoses the problem. The U.S. current account deficit is mainly a problem of woefully inadequate U.S. savings. A cheapening of the U.S. dollar relative to Asian currencies will help to “improve” the current account deficit. Unfortunately, this “improvement” will be similar to the improvement in gas mileage that a car gets when it rolls off the side of a cliff into the deep blue sea. If you think of the current account deficit as resulting from insufficient savings, then forcing the adjustment burden onto the dollar (rather than adjusting savings behavior and fiscal policy) can lead to a currency crisis.

Are any of the reasons cited above for the dollar being toast valid? No. 4 was at one time, but has it already been priced in? Did not the dollar index correct 33% from top to bottom? Did not various countries’ currencies nearly double against the U.S. dollar? How much more is left? Is the U.S. dollar going to fall in half again from here? Other than possibly gold (and that as of now is meaningless to the masses, but not gold bugs), against what currency and why?

(The newsletter editors then chimed in with an opinion that the dollar may be much closer to the bottom than the top. They think bonds EXCEPT U.S. Treasuries are in a bubble, and are bullish on Treasuries. Neither is really a dollar bull or gold bear, but are rather somewhat agnostic toward the dollar and long-term bullish on both gold and energies – but not now as various carry trades unwind. Perhaps one day gold will not correct, but this correction was true to form. Experience says that hyperbolic moonshots always correct more than anyone thinks. Nibbling on gold miners here may not hurt from a long-term perspective, but seasonality and market action are still unfavorable. Overhead resistance is also substantial. If time preferences away from current consumption and excessive risk have made a permanent change - not unlikely – things could get very ugly across many fronts, but especially equity and junk bond funds.)

The Survival Report June 14 Special Edition.


Even though most natural resource investors are vaguely aware that Russia is important in energy markets, few appreciate just how big a stick that country holds. For instance, the daily news abounds with stories on crude supply from Saudi Arabia, Iraq and Iran. As if the market lives and dies by these players. But Russia actually produces twice the oil of Iran. And four times that of Iraq. In fact, the Great Bear pumps out nearly as much oil as the Saudis, lagging the world’s top spot by only a few hundred thousand barrels a day. In natural gas, the Russians have an even larger edge. More than 25% of the world’s gas reserves lie in Russia, making the nation by far the world’s largest player in that increasingly important energy commodity.

Even fewer investors realize that Russia might be world’s largest holder of uranium. That is understandable given the country does not show up on most official lists of uranium reserves. But that has more to do with politics than geology. Our research shows that Russia contains a staggering amount of yellowcake. Although the country mined a meager 7.3 million pounds in 2005, there is much more lurking below ground. Numerous deposits containing more than 20 million pounds uranium are known within the country. But here is the kicker: the two largest established projects have hundreds of millions of pounds. Streltsovsk in the Lake Baikal region hosts 283 million pounds. And the Aldansky uranium district in South Sakha/Yakutia boasts an astonishing 749 million pounds. By contrast, Cameco’s Cigar Lake and McArthur River mines – the largest in Canada – contain combined reserves of 621 million pounds. Or just 60% the size of Russia’s two giants.

The Canadian advantage is that the Russian deposits are considerably lower grade. Which means mining operations here would likely need higher prices to be profitable. Or maybe not. Aldansky contains gold credits, which enhance the value of the rock. In fact, the Russians have recently made noise about restarting Aldansky. While it is too early to assess the impact of a major new source of uranium stepping onto the world stage, we can say that it is unlikely to do much more than dampen some of the upward pressure on prices. Even a 10-fold increase in Russian production would not be enough to offset the deficit, especially given that the long supply shortfall has caused a draw-down in stockpiles and the recyclables created by dismantling the Soviet Union’s nuclear arsenal.

So, how do we profit from Russia’s uranium riches? Opportunities may come soon. There is emerging speculation that the Russians will open up uranium deposits to foreign investment. They simply do not have the capital to develop these things themselves. Which means that a junior company – with the right team and the right financial backing – may be able to scoop a major new deposit or two. No announcements have been made yet, but deals are in the works. Getting in on the winning Russian yellowcake companies would be a windfall. Given the large market capitalizations of comparable companies with relatively small deposits in the U.S., Canada and Australia, a junior with a 20-million, or even 100-million-pound deposit could instantly vault into the upper echelon of the sector. With high-impact opportunities in uranium becoming ever harder to find, were looking at Russia as one of the best emerging investment areas.

Link here.


The month-long slide in global stocks has wiped out at least $2 trillion in wealth, leaving investors few alternatives to preserve their holdings aside from bonds and money markets. Investors have been dumping stocks, commodities and emerging market assets on growing concerns that economic growth will suffer from higher inflation and interest rates. Stock markets have been punished since the U.S. Federal Reserve raised interest rates for 16th time in a row on May 10 and issued a hawkish statement saying it may need to do so again to fight inflation. Investors had expected some sign of an end to the tightening cycle. Strategists show little agreement about how deep and how long the sell-off will go. Bonds have been the most direct beneficiary of the equities route, with benchmark U.S. 10-year Treasuries staging their longest rally of the year since mid-May.

The Dow Jones industrial average is off 8.2% since mid-May and as of Tuesday’s close had erased its gain for the year. The Nasdaq Composite Index is off 12.75% from its high for the year on April 19 and the Standard & Poor’s 500 Index has fallen by nearly 8% from its May peaks. On Tuesday, Tokyo’s Nikkei average booked its biggest 1-day percentage fall in two years, tumbling 4.14%, wiping out more than ¥16.56 trillion ($145 billion) in market value from the Tokyo Stock Exchange’s first section. It was the biggest 1-day point drop since immediately after the September 11, 2001 attacks.

Link here.

JPMorgan says stock rout could worsen.

A global sell-off in stocks that started in May is not over and may only be just starting, Abhijit Chakrabortti, global equity strategist at JPMorgan Chase & Co., said. “This is nothing compared with what we may see late in the summer and early October – once slower growth finally sinks in and expectations for higher benchmark rates, at 6 percent or even more, come out,” Chakrabortti told the Reuters Investment Outlook Summit in New York. The market correction may exceed 10 or even 15% before it abates, he said. In some sectors, such as materials, commodities and certain consumer staples, including Wal-Mart Stores and Procter & Gamble, declines may surpass 30%.

“Sectors most dependent on growth and the companies most dependent on volume and price declines, which also includes tech companies, should be avoided,” he said. JPMorgan’s model asset allocation portfolio is recommending clients to invest 20% of their holdings in cash and 25% in bonds. The remaining 55% is distributed among equities in the U.S., the UK, Western Europe and Japan. Still, the portfolio is underweight in U.S. stocks. In the U.S., according to Chakrabortti, few sectors, including telecommunications and consumer staples – except for Wal-Mart and P&G – may outperform the market.

Link here.

Fearful fund managers revert to cash.

Fund managers are shifting assets into cash because of the turmoil in global financial markets, according to the latest Merrill Lynch monthly survey. The percentage of fund managers’ assets held as cash jumped from an average 4.1% in early May to 4.5% a month later. A net 29% of managers said they were “overweight” cash – one the highest readings recorded – compared with 18% in May.

With the Turkish and Indian stock markets down 30% in May compared with a single-digit fall for the Dow Jones Industrial Average, the poll of 166 asset allocators showed that the flight from emerging markets and Japanese equities to U.S. stocks was likely to continue. A net 28% of fund managers said they expected to increase their weighting in U.S. equities over the next year as part of a move to “quality defensive stocks”. A net 12% are planning a similar cut in their emerging markets exposure. The fears underpinning the market turmoil were highlighted as three-quarters of those polled forecast that inflation and interest rates would be higher this time next year. “There has been an astonishing amount of hand-wringing about what has caused the pullback. Our survey has been very clear,” Mr. Bowers said. A net 49% thought global growth would weaken in the next 12 months, which was up from 14% a month earlier. Mr. Bowers said that, given asset managers’ near-record cash holdings, there was “ample liquidity to be put to work if inflation concerns recede.”

Link here.

Hedge fund indices turned red in May.

The emerging-market crisis and the turmoil in global stock markets are spilling over into hedge funds, as evidenced by the poor hedge fund-performance numbers for May that were released this week. The Credit Suisse/Tremont Hedge Fund Index (CSTHFI), which mimics the returns of 421 funds, is a negative 1.30% in May, the first time this year that the index has posted a negative monthly return. For the year performance remains positive at 6.40%. The Barclay Group, a hedge fund index provider, estimates that more than 70% of hedge funds lost money last month. It reports that the average loss was 3.09%. Overall, the Barclay Hedge Fund Index that tracks the performance of more than 4,700 hedge funds posted a negative 1.78% return last month.

The riskier strategies that often give hedge funds an investment edge appear to have weighed heavily on their returns. “With signs that the Federal Reserve would raise interest rates to contain inflation, emerging markets suffered as investors shunned riskier investments resulting in the worst decline of emerging-market assets since 1998,” says Robert Schulman, chief executive of Tremont Capital Management, a Rye, N.Y.-based hedge fund-asset management firm. Not surprisingly, the hedge fund strategy that performed the worst last month was emerging markets, which posted a negative performance of 5.02%, according to the CSTHFI. The second poorest strategy was long/short equity (-2.84%), as many hedge fund managers have significant positions in emerging markets, as well as long exposure to equities. “Long/short equity managers with large net and gross exposure were caught by the first sign of market uncertainty in two years,” said Oliver Schupp, president of the CSTHFI.

Another hedge fund sector that has been hit hard, according to Credit Suisse/Tremont subindices, is managed futures, a sector that took a 2.70% loss last month. That is due to the meltdown in the global commodity market with gold, silver and copper trading downward. Managers in the managed futures space also were hurt by the strengthening of the dollar last month that caught them off guard, says a Credit Suisse/Tremont analyst.

Bad performance for hedge funds often means that managers lose a great deal of revenue because the bulk of their compensation comes from performance fees, which typically represent up to 20% of their gains. In addition, if investors redeem money, hedge fund managers lose in management fees as well, as those typically represent 1% or 2% of the assets under management. In the face of adversity, some among the breed of small hedge fund players may find it compelling to shut down operations, waiting for better days to come, at which point they may reopen under a new business name. Such a pattern is not unusual in the hedge fund space and represents one of the most daunting risks incurred by hedge fund investors.

The poor performance in May could open the way for a new wave of hedge fund liquidations. Tanya Beder, chief executive of Tribeca Global Management, part of Citigroup, said that the task of retaining investors through consistent returns is particularly challenging for the smaller funds. She expects to see several thousand of them closing over the next few years.

Link here.

“Fear index” at 3-year high.

The VIX (5-year chart here), an index tracked at the Chicago Board Options Exchange measuring stock market volatility, rose to the highest level in more than three years Tuesday, as stocks extended losses, and options traders bought insurance against more declines. The index advanced 14%, to 23.81, the highest close since April 11, 2003. The index, based on options traded on the Standard & Poor’s 500 index, typically rises and falls with demand for put options, which allow buyers to sell shares at a set price and date, and function as insurance against a drop in stock prices. It commonly is called a “fear index” because an increase can indicate investors are worried about the performance of stocks.

“There is no sign right now that would indicate that this selling pressure is over with,” said Pete Najarian, an options analyst and co-founder of the Insideoptions.com commentary Web site in Chicago. Investors are using options to protect against further declines.

Link here.


Andy Brooks is angry, saddened and disappointed. He feels betrayed by executives who resorted to backdating – awarding options to mostly technology company executives at a low strike price after the fact – options to enrich themselves at shareholders’ expense. Corporate America should care about Brooks’s feelings. He is head of equity trading at mutual fund company T. Rowe Price. His hand directs the flow of millions of dollars either in or out of the stock market. “Those of us that are in the business of investing, we’re in the public trust. And when that trust is violated, it hurts everybody,” he said. The backdating scandal has erupted just as stocks have taken a nasty tumble.

Most on Wall Street blame other factors for the market slide, but options backdating is adding uncertainty to an already fearful and confused market Many of the suspect companies hail from the tech sectors, where options have traditionally been a key compensation tool. Investors have punished many of those affected firms. But they also might be wondering if they should steer clear of techs, especially with markets already selling off. The Nasdaq has dived 10.8% since May 9. The Philly semiconductor index has crashed 15.5%. That compares to the 7.1% lost by the Dow industrials and 7.2% by the S&P 500.

It is not clear that the practice of backdating options was widespread. That is part of the problem. Investors simply do not know. So far, more than 40 U.S. companies are being probed by the SEC, the Justice Department – or by themselves. They are suspected of granting options with very low strike prices to key executives. Backdating alleges that the company picked a date in the past to set the strike price, coinciding with the low point in the company’s stock. Later claims that the date and strikes were picked at random often are not credible. The illegal practice moves money into the CEO’s pocket – not as the result of an incentive plan, but as a simple, flat payment.

How much money? William McGuire, CEO of HMO UnitedHealth Group, reportedly pocketed $1.6 billion. Caremark, a pharmacy benefits management company, gave options worth $211 million to its CEO, Edwin Crawford, according to published reports. Twice in the seven years the Board granted options to Crawford, they picked the day the stock hit the low for the year. That enabled the Board to issue low-strike options, which instantly were worth millions. Many firms already face shareholder lawsuits over the issue. This week, several U.S., European and Australian pension funds sued 34 companies in which they are large shareholders.

Link here.


Coffee has dropped from its 2006 peak of $1.2590 per pound to a low this May of $0.9710 cents per pound. Now may be the time to load up on some cheap coffee. Our futures analyst sees it continuing in a contracting triangle (that is Elliott-wave “speak” for a period of range-bound trading) that will result in a thrust up to much higher levels before the end of the year.

It sounds easy to pick up a good deal in coffee or some other financial market. But although it should be no harder than choosing decaf or high test, it is not nearly as simple as buying your favorite Italian dark-roast from your local retailer for $7.50 a bag, down from the usual $12. You would not hesitate, would you? You would buy a case. But an interesting dynamic makes it nearly impossible for traders to capitalize on such good values in the financial markets. The key phrase to remember is “financial markets are not shoes.” That is how Bob Prechter likes to explain this concept when he points out that the law of supply and demand governs utilitarian economic transactions (“I would like to buy this pair of shoes that is on sale.”) but not financial market transactions.

Call it psychology, call it following the herd. Either way, we tend to think that a pair of shoes made by Ecco or Johnston & Murphy is still a good pair of shoes at either the full price or the discounted price. But this same happy shoe-buyer does not think the same way about a stock or commodity if its price is falling, creating a discounted or sale price. In fact, most traders eye such stocks and commodities suspiciously. Conversely, they eye them admiringly when their prices head up. In fact, they decide to buy because the price is heading up.

When it comes to finding good values in stocks, it helps to hold onto the idea of buying your shoes and your coffee beans on sale. Think of it as watching the real estate broker for that house you have had your eye on for the past six months adding the words “Reduced Price” to the For Sale sign. Would you snap it up at $575,000, down from $700,000? You bet you would. Try to do the same with stocks and commodities. Don’t follow the herd that sells when prices are heading down and buys when prices are heading up. Break away from the herd. That is the way good deals are found in the markets as well as in the marketplace.

Link here.


The “typical 10% correction” that was “long overdue”for global markets is rapidly turning into something much more sinister. Forget about a 10% loss for the entire correction, which some analysts have considered. How about an almost 10% loss in a single day? Just look at some of the declines global markets suffered yesterday (Tuesday June 13): Colombia down 9.5% … Russia down 9.4% … Turkey 5.7% … Austria 4.7% … India 4.4% … Pakistan 4.3% … Japan 4.0% … South Africa 4.0%. Those losses come on top of the ones these markets sustained in May. So much for investors’ “rediscovering their belief in the story … that emerging markets offer more attractive growth prospects than the developed world, and thus form a vital part of long-term portfolios” (Financial Times). By the way, Tuesday’s sell-off also puts the DJIA, the world’s benchmark stock index, in the red for the year.

Well, what can we say? None of this comes as a shock to the readers of our Financial Forecast Service and European Financial Forecast Service. For months now these publications have reminded subscribers that a number of markets around the globe have been showing a remarkably similar – and dangerous – Elliott wave pattern. We first identified this unusual correlation between various markets in March 2002 and dubbed it “All The Same Market”. We noted then and many times since that what has been driving markets higher for the past few years is a worldwide surge in liquidity. But when that liquidity dries up … watch out. For weeks now, our readers have received specific warnings about global markets that were looking especially shaky.

Is the worldwide liquidity crunch we have been warning about finally here? This is one of those moments that could make or break your portfolio, regardless of which markets you follow.

Elliott Wave International June 14 lead article.

This is one crafty voodoo doll.

Today’s topic is “inflation”, or at least “fears” of the same. Yet as a fast follow-up to the previous Market Watch, allow me to answer the question I raised: How could U.S. households go from spending ALL their disposable income (1999) to OUTSPENDING it by nearly one-third? (According to the most recent Federal Reserve data.) Simple: home equity loans, aka converting savings into debt. Home values exploded between 1999-2006, but owners’ equity as a percentage of home values did not. That actually fell from 57.9% (1999) to 56.1% (2006).

Moving right along, once again we see that “inflation fears” was the voodoo doll that sent the stock market lower. Never mind that crude oil declined 2.5% to a 3-week low, and never mind that a major inflation gauge – the Producer Price Index – came in at half the “consensus estimate” (0.2% instead of 0.4%). So facts are no match for the dark powers of this particular voodoo magic. It is even crafty enough to cast reverse spells on markets that should benefit from such fears: When really real inflation does appear, precious metals are just about the best investment of all. Alas, gold plummeted 7.5% today, its largest single-day loss in 15 years. This leaves gold down nearly 25% from its May highs; silver has decline 37% from its May highs.

Last week I noted widespread cluelessness regarding the way so many markets moved up in sync early this year, likewise to their corresponding turn down. They keep falling, yet the cluelessness only grows.

Link here.


The financial markets are sadistic and heartless, like the underside of a boy’s sneaker. That is why we investors sometimes feel like helpless ants – scurrying for cover to avoid the fatal thud of large capital losses. Occasionally, we find our ant hole before the sneaker finds us. Other times, we are not so lucky. Recent market action has crushed the life out of many of us investor-ants … or at least crushed the optimism out of us. Perhaps, therefore, buying opportunities are drawing near.

A few weeks back we issued several columns warning of excessive froth in the commodity markets. The columns entitled, “Blowoff” on April 20th, “Sell!” on May 2nd and “Oil Correction” on May 3rd all expressed more fear than greed. Immediately afterwards, most commodity markets began falling. As prices slumped, investor bravado waned. The confident smiles and high-fives of March and April eventually yielded to the agonized groans of May and June. We suspect, therefore, that buying opportunities will soon present themselves. Especially in the commodity markets.

Over the past couple of days, options pro, Jay Shartsis, has observed a number of phenomenon that indicate bullish trends will soon re-assert themselves. Put-buying is very high, for example. At the CBOE, 1.66 puts are trading for every call that is trading. “This extremely high put reading,” says Shartsis, “would ‘normally’ be associated with an outright crash, not a market that’s merely, let’s say, rather flat. This is a very high level of fear not justified by sharply dropping prices. A rally is lurking. Another indication of trader fear is the very high volume in the SPDRs (SPY) vs. the volume in its (S&P 500 stock) components. SPY short sales required no ‘up tick’ and also offer tremendous liquidity, so they are a favorite for hedging and short-selling. It is reported that over the past three weeks, there have been three trading days in which the SPY volume was more than the combined volume in its components. This has happened only twice before in the past 6 years. Those times were at the bottom following 9/11 and in July 2002 (Sentimentrader.com), both good market lows. Therefore, even if we are back in a primary bear market, there is room for a countertrend rally as took place after 9/11 and July 2002.”

Over in the resource sector, the sentiment is also quite poor, which suggests that most of the worst has passed. Shartsis notes a few hopeful signs, especially among oil service stocks and gold stocks. “In last Thursday’s dramatic plunge and reversal,” Shartsis notes, “I observed a high number of oil stocks exhibiting very sluggish action in their put contracts, even though the stocks closed lower on the session. This is a positive divergence often presaging a rally. Within the group, this action was particularly evident in the oil drilling sector.” Over in the precious metals sector, Shartsis notes, “Newmont Mining (NEM) closed down only 80 cents yesterday, with the price of gold still way down. I think I have license to call this a bullish divergence and I also note that NEM has had a lot of put trading of late, also a contrarily bullish condition.”

Admittedly, buying into a gold market that has fallen $170 in one month – and $45 in one day – requires either courage or stupidity, or both. Buying a diversified basket of commodities, like those represented in Deutsche Bank Commodity ETF (NYSE: DBC) requires somewhat less courage or stupidity. But buying a lowly valued oil stock like Chevron or ConocoPhillips requires the least courage or stupidity of all. The prices of oil company stocks are languishing, even though the oil price has been soaring. ExxonMobil is one of many oil stocks that has gone nowhere for more than a year, while the price of crude oil has advanced more than 30%. Bullishly inclined investors might want to consider buying call options on any one of a number of oils stocks. We suspect call options on gold stocks will also prove rewarding. But why bother with Newmont Mining, when ConocoPhillips is selling for 6 times earnings?

Link here (scroll down to piece by Eric J. Fry).


The right price for oil is a tough call. Crude oil inventories are the highest in 20 years. OPEC is pumping a ton to make up the difference. Oil prices at the pump should be coming down. Consumption is being hurt by high prices. Natural gas is way down and could go lower. But I have to tell you, I think that this market is one that will not go to where it should go. It will not go there because while storage is high. I continue to believe that storage is the wrong indicator.

I like to position myself to buy low and sell higher. I cannot get over the discount that oil producer and oil service companies are selling for, as opposed to the copper, coal, aluminum, steel and iron names. The latter five are all in long supply. They just have short-term problems and bottlenecks and pollution problems. That is not the case with oil. It happens to be in long supply now and short supply later – a big difference. We are discounting all commodity plays equally. To lump them all in together when oil has not even come down yet and could go up with any geopolitical or weather event just is not reflected in the price of many oil and oil services stocks now.

Oh, and it is true that we are brimming with natural gas in this country. But has anyone noticed that there is not a lot of storage space for natural gas to begin with? Storage may be full, but how much storage is there? It is so easy to sell down everything. It takes bravery to get up there and buy Nabors or Halliburton or Conoco or Chevron. Always opt for bravery at the turn.

Link here.


As of Q1 2006, the gap between household sector expenditure and income widened $100 billion to a nearly $700 billion deficit at an annualized rate. This deterioration in the household financial balance has been going on since 1997. Since early 2005, the rate of decay has accelerated noticeably. The U.S. household sector financial balance is plunging. Oddly, while many Wall Street economists decry government spending in excess of income (tax revenues), they turn a blind eye toward private sector deficit spending dynamics. Contemporary economists are trained to view household spending decisions as the aggregation of millions of individuals engaging in intertemporal utility calculations, which by definition must produce rational consumption paths over time. While it is said that ignorance is bliss, such a dramatic deepening of U.S. household deficit spending as that displayed below suggests this is at best a naïve view on the part of contemporary economists, if not a patently absurd one.

On the other hand, it has become a popular view amongst bearishly predisposed economists to claim such financial imbalances are unsustainable. Nearly a decade into unprecedented U.S. household deficit spending, this claim has worn a little thin. But debt sustainability conditions have been arithmetically known for over six decades, at least since the work of Evsey Domar on government debt dynamics while he was at the Fed.

Borrowing from public or third world debt trap equations, we know it is possible that a persistently widening private sector deficit can be sustainably financed under at least two conditions. First, the long run growth of income for the relevant sector must exceed the average interest rate on the debt held by the sector. This is a necessary condition to avoid debt trap dynamics, as otherwise, interest expense eats up an increasing share of income. Second, if some asset or group of assets held by the private sector in their portfolios continually appreciates in price, then it is at least possible sufficient collateral and capital gains are in place to service existing financial claims and justify further lending to a perpetually deficit spending sector. Strong and persistent asset price appreciation, in other words, may provide a loophole for avoiding onerous debt trap dynamics.

We find that since the Volcker 1979 interest rate shock, the critical condition for avoiding debt trap dynamics – income growth in excess of interest rates – is consistently violated. Explosive debt trap dynamics – that is, an exponential increase in the household debt/income ratio – are implied by this comparison of interest rates and income growth in the household sector. And this is exactly what we find. After a period of relative stability from the mid-‘60s to the mid-‘80s, the household debt to income ratio has persistently climbed higher, and at an accelerating rate over the past half decade

That means the sustainability of US household deficit spending is extremely dependent upon the perpetual and rapid appreciation of asset prices, especially in the key assets held by US households. However, if the rate of asset price appreciation required to sustain (or even deepen) household deficit spending is strong enough, asset prices will have to depart from fundamentals which are unlikely to grow as quickly given normal macroeconomic or monetary policy constraints. Financial bubbles will need to be sustained, or at least not interrupted, to keep household deficit spending on an ever deepening trajectory. Or alternatively, serial financial bubbles will need to be engineered. In other words, in the U.S. household sector, we have underway what the late economist Hy Minsky would recognize as a form of Ponzi finance. Essentially, household borrowing against the value of existing assets is required to service prior debt (principal and interest payment) commitments. Sustainability of deepening U.S. household deficit spending is thereby predicated on the sustainability of asset bubbles, or perhaps more realistically, the repeatability of asset bubbles.

In the late ‘90s New Economy Bubble, equities supported the onset of U.S. household deficit spending. Post the bursting of the New Economy Bubble, residential real estate holdings served that purpose as the Fed took the fed funds rate to 1%, and mortgage rates dropped to lifetime lows for most U.S. households. At the moment, home price appreciation has cooled considerably and on a y/y basis we may even already be in a period of existing home price deflation. If asset price appreciation is no longer as robust, and if a sufficiently strong serial bubble is likely to prove difficult to engineer, it stands to reason household spending growth will need to migrate toward household income growth – roughly 1.7% y/y (real), and 0.6% annualized over the past quarter. Personal consumption expenditure growth had been cruising in the 3.5-4% range. If the analysis above is correct, this pace of consumer spending is no longer possible.

For export led economies like those found in Asia, this has profound implications. BRICs, previously thought to grow to the sky, and valued as such, may be seen falling from the sky. For professional investors that have waded commodities over the past 2-3 years, this U.S. consumer downshift also has substantial consequences, given U.S. consumer spending is roughly 20% of global GDP, while the next two nations with high consumer spending shares of global GDP, namely Japan and Germany, tend to run trade surpluses (that is, they are net suppliers of goods and services to the rest of the world, not net demanders).

While it is conceivable the Bernanke Fed will throw its newly won inflation fighting reputation immediately to the wind and begin easing with the onset of any significant U.S. economic weakness, this I believe is a low odds outcome. A rendezvous with reality appears to have arrived at the doorstep of U.S. households. What does this rendezvous look like? Assume an extremely favorable transition scenario: real disposable income growth remains steady at 1.7%, and real consumer spending growth converges down to it over the next two or three quarters. Taking 80% of the U.S. economy – the consumer’s share of GDP – down from a 3.5-4% growth rate to a 1.5-2% growth imposes a pretty steady head wind on U.S. and global growth prospects, unless of course some other region or combination of regions is willing to take up the slack by pursuing domestic demand led growth. Assume a somewhat less favorable transition scenario and the implied pace of consumer spending over the next year is 0.3%, i.e., no top line growth for vendors to U.S. consumers.

If this analysis is even half right, and the U.S. consumer adjustment is underway and likely to quicken, significant asset allocation and sector selection implications flow from it. Treasury bonds should rally and the yield curve should invert. Corporate and especially mortgage spreads vs. Treasurys should widen. Equities will face earnings uncertainty, which tends to favor growth stocks and growth sectors. The old energy/materials/industrials leadership will be replaced by an odd mix of consumer staples, health care, utilities and telecoms. Commodity and emerging market positions will be tested as investors take a show me attitude toward the notion that U.S. growth and global growth can delink. Asian equities with their export dependence and Latin American equities with their commodity dependence will face challenges on this score especially. A “flight to safety” may ironically support dollar strength even though the Fed will shortly head to the sidelines.

Link here.

MONEY 9-11

An Undeclared War is being waged against your money, wealth, stock, bonds, and physical assets. The war is being fought with disinformation, easy credit, deficit spending, questionable accounting and the primary weapon: fiat currency. The deficits that have occurred since 9-11, about $2 trillion, represent roughly 25% percent of all dollar denominated Federal debt since the country began accounting for debt. This deficit financing is the proximate cause of the inflation that wreaks such financial havoc on individual investors over the long run. The Dow Jones Industrial Average (DJIA) chart for the last 5 years is pretty flat … some dips, some raises, some more dips, not a lot of change on average. It is reputed to be a very accurate indicator of the state of the economy. The DJIA is a dollar denominated statistic, thus it is not inflation adjusted.

The price of gold is immune to inflation since it is a commodity whose scarcity does not change significantly over small periods of time like 5 years. Very little of the gold produced is actually consumed so it has a tendency to accumulate over time (we are not running out of it). This data plot is dollar-denominated and as one can tell the price has steadily risen over the last 5 years, which in conjunction with the increased gold production worldwide and lack of industrial consumption indicates that the “value” of the dollar as a money equivalent is dropping precipitously. Looking at a graph of gold over the last 5 years and comparing dollars vs. Euros, we see that gold has been rising relative to the Euro but it has not been rising as fast. The Euro is not losing its value as quickly as the dollar when compared to gold. Thus European socialists are devaluing their currency slower than “conservative Republicans”.

Historically gold has been the money reserve of last resort and universal exchange. The U.S. Dollar is not in fact money. Nowhere on any dollar bill will you find the word money. This is not an accident. The architects of the Federal Reserve System understood the nature of money and have legally separated the U.S. Dollar from what economists consider as money. It is a currency and it says that is legal tender for all debts public and private.

Shortly after 9-11, I made the argument to some coworkers that the war on terror would be expensive, financed with debt, and would lead to a long term devaluation of the currency, and thus buying and holding gold or silver would be a good investment strategy. I am a software developer, and an applied mathematician by trade and training, not an economist. However, as a devotee of Austrian Economics and Ludwig Von Mises for over 30 years, this prediction was as difficult as falling out of a boat and hitting water. My coworkers thought I was cracked, they probably still do. The “War on Terror” will soon have lasted longer than American involvement in both World Wars as active combatants. If we look at it from another perspective it is just another big government program that is actually a war on the taxpayer. The inevitable casualties will be your wealth, your lifetime savings and with those possibly your future.

Link here.
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