Wealth International, Limited

Finance Digest for Week of July 10, 2006

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


The current Fed Chairman, Ben Bernanke, has openly boasted that the Federal Reserve caused the Great Depression. Of course the Fed’s guilt is not that controversial among free-market economists, but it is interesting that most Americans still do not grasp this most basic fact of U.S. economic history … even when the Fed Chairman himself has spoken about it publicly. The Federal Reserve was forged by Senators Sauron and Aldrich in 1913 to “bring them all, and in the darkness bind them.” OK, actually it was created by a group of evil banking wizards on a 1910 duck hunting trip, as all “regulatory agencies” are always summoned into existence by the criminal elements of the industries that they “regulate”. The Fed does, however, function in much the same manner as the One Ring.

The Fed magically drains real wealth from those who use its creations. Since 1913 it has vampired 95% of the value out of the dollar, and thus out of those foolish enough to use the dollar as a “store of value”. The Fed allows the transfer of this wealth and power to the Dark Lords of foreign lands (under the Monetary Control Act of 1980). The Fed can, and does, simply print tens of billions of dollars to buy the worthless bonds of any dictatorial regime on Earth. This is called “monetizing foreign debt”, and is very helpful to many of the Orcish governments. The Fed makes the wielder invulnerable to market forces in the bond market. Anyone who knows Fed policy ahead of time gains the Fed’s power to vampire wealth from those who create it.

In 1929 and through the 1930s, as Bernanke says, the Fed hurled the entire U.S. economy into the Great Depression and kept it there for years, unemploying millions. Civilization literally went backwards, with negative economic growth. In 1933, the Fed magically stole all the gold from the bank vaults of the nation and moved it into darkness (a darkness so complete that the gold has not been audited since the 1950s). Today, the Fed detaches the military-entertainment complex from the need to openly pass war taxes through Congress. They simply print as many dollars as they want, reducing the value of all other dollars proportionately. The purpose of taxes is just to maintain a demand for depreciating dollars, since everyone needs them to send to the IRS.

The Fed performs no productive economic function. All it does is increase the fluctuations in the value of the medium of exchange. Thanks to the “fractional reserve” nature of the Fed, it cannot even accurately control its own destructive powers. Many Americans already realize that the dollar is a terrible store of value, and use it only for the shortest term that they can. Long-term savings are held in the form of stock mutual funds, real estate, and increasingly “exchange traded funds” like GLD and SLV, i.e., gold and silver, just as people have done for thousands of years. There is no barrier to people using any of these real commodities for trade.

The only reasonable solution is obvious to students of the Fed: destroy it. Once the Fed is destroyed, monetary life could return to normal. U.S. political strife would be reduced as well, since there would no longer be an all-powerful economic prize for the winning faction. Bernanke, however, wants to keep his Precious. He thinks that the only thing the Fed did wrong in 1929 was not keep printing more money. So, his response to the upcoming economic crisis caused by the Fed printing money will be to print even more Fed money. This sounds great to lots of Americans.

There are two things wrong with Bernanke’s idea of showering paper currency onto the streets to “fix” deflation. First, Bernanke ignores the damage done by inflation. In addition to simply stealing from those on fixed incomes, inflation damages the entire information flow in the economy. If no one knows exactly what money is worth, they cannot calculate profits and losses. The whole parallel-processing computer that we call “the market economy” gives inaccurate answers. Inflation and deflation make it even harder to predict the value of money years in the future. Inflations and deflations transfer ownership of real goods around, scrambling property rights (and always in favor of those who know monetary policy in advance).

Second, Bernanke knows full well that the money helicopters are not going to distribute money evenly and proportionately to all holders of dollars. The government will print money all right … and they will spend it on more Mideast wars, more corporate welfare, and more vote-buying “programs”. Even if the Fed wanted to, they could not keep the ownership of real goods from getting transferred away from ordinary working men … and they do not want to. Will Bernanke use the Fed to inflate or deflate? The only certainty is that he will do one or the other, damaging the information flow through the economy. In the meantime, best not to have all your family wealth in dollars when Bernanke’s helicopters start blaring “The Ride of the Valkyries”.

Link here.

The Omnipotent Fed: If I Ever Lose My Faith in You

The sharp declines in various markets over the last several weeks have been attributed to investors’ reactions to the Fed’s concerns about inflation. Headlines such as “The Bernanke Panic”, “Fed’s Bernanke Faces Tough Choice”, and “Bernanke’s Inflation Message Deflates Wall Street”, combined with the markets’ reactions, shown below, suggests that inflation is a very real concern. In the last few years, all of these markets have trended up together. In the last few weeks, they have all turned down together. As diligent investors, knowing that the markets always forecast the future, we must ask ourselves, “What is the market telling us now? Is this just a reprieve before the trend continues or has something changed?” We suggest that something has, indeed, changed. Normally disparate markets have floated higher on a sea of liquidity. Recently, they have all turned lower. Could this be signaling a contraction in credit?

The basic idea is that when an inordinate amount of credit is introduced to the system, it floods into normally divergent markets and forces all of them up together. For example, stocks and commodities do not usually trend together, yet they have been lately. Since we have so obviously been experiencing an inflationary environment over the last few years, and since we have seen rampant credit creation drive our markets up for the last couple decades, many assume the deflation argument lacks credibility. The foundation of contrarian investing is that the majority is usually wrong, and as such, contrarians endeavor to think opposite of the crowd. If the vast majority of all bulls and bears think that varying degrees of inflation is the core problem, and if the majority of all bull and bear arguments are built upon the presupposition that the Fed’s actions will dictate the ultimate outcome of various markets and economies, then, as contrarian, we feel compelled to explore the validity of these assumptions.

The financial culture is obsessed with Fed watching – whether or not the Fed used the word “measured” in its most recent communiqué. Yet, when we understand the true predicament of the Fed, we realize that a more appropriate comparison would be the man behind the curtain in the Wizard of Oz or the cartoon version of the Dutch boy and the dike. You know – the one where new holes keep spouting water and the dike wall begins to crack while Daffy Duck looks like he’s playing twister in an attempt to keep it all together until the inevitable happens.

The Fed has been alternatively assigned blame for the Great Depression due to it expanding credit too rapidly in the late ‘20s, triggering a speculative boom that eventually went bust, or due to it not giving enough credit to the markets and the economy when the bust set in? Was the Great Depression caused by events set in motion many years prior to the Crash of ‘29 or was it caused by events just before the market topped? A closer look at the historical record will help us answer these questions.

Link here.


If you are like most investors, you have allocated too little money to foreign stocks. Half of the world’s market capitalization belongs to companies overseas. Yet Greenwich Associates, the financial services consultant, calculates that 401(k) plans have 5% invested overseas. People may have good reason for keeping money close to home, or maybe they are just narrow-minded. Either way, they recently have missed out. Over the past three years the Morgan Stanley Capital International EAFE Index has had an annualized total return of 21% versus 10% for the S&P 500.

Okay, putting half your equity money abroad may be a bit much, but an allocation of 15% to 30% is generally recommended by the experts we have talked to. Some of your money will go into slow-growing but relatively safe economies (like Britain’s) and some into fast-growing but shaky ones (like Brazil’s). Do not overdo the emerging markets portion – 5% of your overall portfolio is about right. It is unlikely that a developed market will double in price over the course of a year, as did India and Brazil over the past 12 months, but developed markets are likely to deliver less pain when world markets undergo a correction such as the one this past spring.

Should you hedge against currency risks? Probably not. You can eliminate some risk in the short term by hedging the currency (for example, taking a short position in the euro when you buy a French stock), but you will lose the opportunity to profit from the weak dollar.

There are three ways to own foreign equities. Easiest is to have a mutual fund or exchange-traded fund do the buying. ETFs and index funds run up roughly half a percentage point in overhead costs annually. Actively managed international mutual funds cost three times that. Next easiest is to buy foreign shares via ADRs. You will not have to convert dollars into euros or convert euro dividends back into dollars. Hardest, but sometimes very rewarding, is to buy foreign shares that are not available as ADRs. You will lose a percentage point or two to transaction costs (between currency markups and sometimes two different brokerage commissions).

“We like to buy these markets when there’s little or no interest in them – when they’ve blown up, had a financial crisis, when people are shutting down these offices, swearing that they’ll never invest money in these countries again. In 1998, when Asia blew up, those were great times to buy,” says Citigroup’s Chief Global Equity Strategist Ajay Kapur. If his sentiment is right, this would be a good time to venture abroad.

Link here.


Another nasty storm season is on the way, says the National Oceanic & Atmospheric Administration. Everyone hopes it will not be as bad as last year’s, when Katrina caused $45 billion in insured losses. Fervent hopers include hedge funds, which have led the $25 billion in new reinsurance investments since the calamity. Are they crazy to take on such risk? The potential reward is good: Some reinsurance premiums for coverage in places like the Gulf Coast have doubled. The potential loss, in a bad season, is 100%.

There are several ways to play. Billionaire Kenneth Griffin’s Citadel Investment Group and other hedge funds helped back eight new reinsurance startups, at $500 million to $1 billion each, in Bermuda at the end of last year. Hedge funds have also propped up existing reinsurers and bought scads of catastrophe bonds – $2.3 billion worth of high-yielding securities that transfer hurricane risk have been issued this year. Then there are so-called sidecars, which assume a percentage of underwriting risk from reinsurers for a cut of premiums. Hedge funds have been big buyers of the $3.1 billion worth since Katrina.

But already there are signs of trouble. D.E. Shaw & Co. led a group of fellow hedge funds that recapitalized Bermuda reinsurer PXRE (NYSE: PXT) by purchasing $375 million of preferred shares last October, which converted into common priced at $11. PXRE fixed its annual pretax loss from the big storms at $477 million. Then in February it upped those losses an additional $311 million. Shares now trade at $3.74. More foul weather may lie ahead. Last month Standard & Poor’s placed $1.4 billion of catastrophe bonds on credit watch negative after risk-modeling agencies determined that warmer water-surface temperatures made serious hurricanes more probable. S&P plans to downgrade some of those bonds, already junk rated, by as much as two notches.

Link here.


What do you do next? U.S. stocks have had a rough first half, with the DJIA, S&P 500 and Nasdaq indexes flat or down. Foreign markets, particularly the emerging sector, are extremely volatile. To answer the question, let us first look at the cause. The fear of increasing inflation and higher interest rates, spurred on by lofty energy and commodity prices, are the main culprits. Inflation is spreading into such places as manufactured goods, imports and airline fares. Compounding the problem is the continued rise in employment and the pressure this puts on labor costs. Ditto capacity. Capacity utilization is at 81.7%, up from 73.9% in December 2001, which has to be taken as a warning light for rising inflation. It is a sign of heavy demand, which enables manufacturers to make higher prices stick.

In June 2004 column I predicted higher inflation and higher interest rates. They have finally arrived, and they have not run their course. Still, the fear and volatility in the marketplace today should not make you stampede for the exits. Stocks have proved to be one of the best inflation hedges, long term.

During inflationary periods since World War II the same scenario has played out repeatedly. Initially, for six months or so, fear dominates the market, and stocks swoon. Then the market bounces back with a vengeance. A classic example is the 1977-81 period, when the country flirted with hyperinflation. The Consumer Price Index rose 12.6% annually. Equities at the outset retreated 7.2% in 1977, but over the next four years stocks returned 12.3% annually, vs. 10.8% for the CPI. Even though inflation remained sky-high, stockholders more than kept up with the cost of living.

The same cannot be said of bondholders, who experienced price collapses of as much as 50% that were not fully recovered in coupon payments. Over the 5-year period the total return on bonds was in negative territory. If you consider taxes on your bond coupons at a conservative 40% rate, stocks outdistanced bonds by a significant amount. So my advice now is to tough it out. You likely will be more than rewarded for your perseverance. Conversely, long bonds are the last place you want to be. Listening to suggestions to buy them is a little like following Lord Cardigan and his Light Brigade into the Russian cannon at Balaklava.

The place to be is in domestic, not foreign, equities. U.S. stocks have far more liquidity, particularly the larger caps, and are also not as subject to the panicky reallocations of funds out of Russia and other emerging markets, where stocks have suffered sharp reversals.

Link here.


My first job was as a 14-year-old part-time clerk working over the Christmas break for my father’s stockbroker at now-defunct Bache & Co. I was paid $10 a week for tediously posting customers’ accounts, by hand. But what fascinated me about the office was the old men who came in at noon with their brown-bag lunches. They sat down in front of the ticker tape and watched it like a TV set for hours. Periodically they jumped up from their chairs and flooded the brokers with orders.

Not much changes in investing. Trend-following hedge funds, just like the old tape-watchers of a generation before, move markets. Their young traders, sitting in front of screens, were a large factor earlier this year in driving the surging prices for copper, coal, oil and other commodities, plus stocks in emerging markets, where these things are produced. And when the trend-followers panic, watch out. Commodities fell with a loud thump in May, dragging down many of the highest-flying emerging markets with them. What set off the flood of sell orders? The simple fact that cheap capital was no longer available to the traders.

The cause of this meltdown was the worldwide tightening by 17 central banks this spring, a more or less coordinated move that dramatically diminished global liquidity. The yen carry trade, which had meant borrowing in Japan at ridiculously low short rates, disappeared as the Japanese money supply imploded. In the Alan Greenspan era leveraged investors had what amounted to perfect foresight on borrowing costs. Traders behaved with the confidence of someone who could read next month’s Wall Street Journal today. As long as the Federal Reserve acted with predictability, it made sense to borrow as much as possible at the lowest rate available to buy the riskiest assets around. Then Greenspan’s successor, Ben S. Bernanke, reintroduced traders to uncertainty. Limitless capital provided at a predetermined price is no longer a given. Sharply declining commodity prices remind economists about midcycle slowdowns. The Turkish lira, perennial favorite of hedge funds and proxy for “animal spirits”, has swooned.

Another reason for the traders’ sudden bearishness is leeriness over spiraling inflation. Uncontrolled inflation is good for commodity prices, but inflationary fears on the part of central bankers are bad. They cause the banks to tighten money supplies and thus make it expensive to carry commodity positions. This time the central bankers seem to have overreacted. Our world, amid unfettered capital and wandering labor, is more likely to face a profit slump than an inflationary surge. The good news to emerge from this global risk-aversion is that international buying opportunities have arisen. So give a round of applause to the modern-day counterparts of the old tape-watchers who would stampede at a whiff of bad news.

Link here.


I am no fan of technical analysis, to say the least. This school of market-watching purports to forecast the direction of the overall market and of individual stocks by finding patterns among statistics like price trends. Sometimes it can be useful for predicting the paths of individual stocks, sometimes not. But when it comes to the market as a whole, the chartists (as the faith’s practitioners are known) have a very bad record.

I am revisiting this subject because at times like this – an early-2006 rally giving way to a sharp correction and a lot of fear in the air – chartists’ certitudes get a lot of undeserved notice. Over the dozen years I have written this column, I have several times taken technical analysts to task for their failings. They have responded with great vitriol but have never gotten around to refuting my conclusions. A recent update of my 1996 study (“The Continued Failure of Technical Analysis”) found that chartists’ efforts are bearing even less fruit lately.

Their bum steers abound. In the February 2003 issue of Stocks and Commodities, one report entitled “Houston, We Have a Technical Problem” warned of a prolonged bear market. Two months later, in the New York Times, another article was headlined “This Can’t Be a Bull Market, There Are Two Many Bulls”. The market that year was up 25%. As I read the situation, most technicians today are unenthusiastic to downright bearish on the market. Unfortunately, their underlying rationale is extremely skimpy.

Two indicators the chartists favor have limited value, in my experience. The Moving Average Convergence Divergence (MACD), which purports to identify when to trade based on comparisons of price movements. Stochastics is an index that uses a 5-day moving average to determine whether a stock is “overbought” or “oversold”. Trouble is, the Bloomberg machine has a back-test function where you can review the results of those and six other technical indicators. We found that they do not work.

Another indicator, the Advance-Decline (A-D) Line, has utility, of a very limited sort. The concept is pretty basic: When more stocks rise than fall on a trading day, then the market’s tilt is bullish, and bearish if the opposite. The typical approach has you subtracting decliners from advancers and adding the result to a running total. It works better for individual stocks, where the running total simply counts the number of days (over the past 50 days or whatever) on which the stock was up, versus the number on which it was down. In 1999 the market’s A-D Line went down all year even as the market went up 20%. As the A-D Line treats all stocks equally, regardless of their capitalizations, it failed to capture an upward movement that was concentrated on the 33 largest S&P 500 names. And every bear market has ended with the A-D Line at its absolute low, foretelling nothing whatsoever about the next day.

I do use the A-D Line for individual stocks to see where they are trending. If an A-D Line is up and the stock has fundamental merit, I buy. I examine long- and short-term moving averages (50- and 200-day) and opt for stocks where both are continually rising for at least three months. Three that qualify now: heavy equipment maker Deere & Co. (79, DE), offshore oil driller TransOcean (74, RIG) and conglomerate United Technologies (62, UTX). Chartists may venture a guess as to when the favorable trend in these stocks might end. I w ill not, but historically these are persistent, long-term patterns. So you do not have to watch them every day, but make it a habit to review their status regularly.

Link here.


The dollar is weak, definitely not good news if you are traveling overseas. The euro is hovering at 52-week highs. Investors, however, can ride this trend to their advantage. The ever-canny Warren Buffett has taken huge bets against the dollar, both by shorting the currency in futures contracts and by buying foreign stocks. For a while last year the antidollar play looked dumb, but this year it looks clever.

The case made by the dollar bears hangs on our balance-of-payments deficit ($809 billion over the last four quarters). When foreigners who are now stockpiling dollar assets like Treasury notes tire of them, so goes the argument, they will unload dollars, and dollars will sink like stones in the currency markets. Emerging Asian economies are under pressure from trade partners to allow their currencies to appreciate. The incoming Treasury secretary, Henry Paulson, seems to embrace a weaker dollar, to make American goods more competitive abroad.

You do not have to be a billionaire to speculate against our currency. Frank H. Randall Jr., 77, invests to preserve something for his grandchildren. He has put $80,000, or 10% of his portfolio, into foreign currencies. Says Randall, a former electronics engineer and two-term Colorado state legislator, “The U.S. is printing money at the speed of light, and it’s scary. I worry more about the risk our country is taking than the risk I am taking.” Randall has divided his antidollar portfolio among certificates of deposit denominated in the Thailand baht, in the Norwegian krone and in a blend of currencies (the euro, the British pound and the Australian and New Zealand dollars).

EverBank Financial of Jacksonville, Florida offers depositors CDs in 15 currencies and overnight accounts in 18. Do not expect a handsome interest rate. Five of the most promising foreign CDs, say EverBank officials, have interest rates below the 5% you can get on a one-year CD in the U.S.. In fact, the Swiss CD offers no interest because that small, perennially neutral European nation, a traditional haven of capital and an icon of stability, is seen as the epitome of safety. EverBank has gathered up $900 million for its foreign currency accounts, which are protected by deposit insurance. EverBank’s spread of 0.75% is less than one percentage point from the midpoint of the institutional bid/ask spread for your purchase and selling prices.

Tax treatment? Your net interest is taxable as ordinary income. Gains or losses on converting the CD back into dollars are capital gains and losses, eligible for the 15% federal rate if the CD is held for at least a year and a day. (EverBank’s one-year CD does qualify as long term.)

Charles Butler, president of EverBank World Markets, is a fan of the Swiss franc. It has climbed 5% against the dollar since April and historically does well during dollar panic: It was up 20% in 2002, a post-September 11 reaction. The Swedish krona one-year CD carries a yield of 0.75%. But inflation in Sweden is only 1.6%, and the central bank is determined to keep it low. If you want a speculative play, buy Mexican pesos for a yield of 4.8%, at some risk that this historically shaky currency will suffer a collapse before you can get your dollars back.

Aside from certificates of deposit, there are several mutual funds that track multiple currencies. They run up annual expenses of 1.19% to 1.30% of assets. For those seeking Asian exposure, an alternative is currency notes, trading like a preferred stock on the American Exchange. Called principal-protected notes, these things hold a melange of the South Korean won, Thai baht, Indian rupee and Taiwan dollar. If you have a lot of bucks, consider holding currency futures on the Chicago Mercantile Exchange. The British pound contract, for example, is a bet on $114,000 worth of the currency. The round-trip commission on a single contract might be $7.20, the bid/ask spread another $12.50. Gains on the future are taxed at a blended rate of a maximum 23%. For the best liquidity, David Schulz of the Chicago Merc recommends selecting a maturity three months out.

Beware of currency charlatans. Since 2001 the Commodity Futures Trading Commission has won $300 million in restitution and civil penalties from 90 enforcement actions brought against hundreds of firms, owners and employees for defrauding 27,000 customers in forex schemes.

Link here.

The hardest currency of all.

Buying euros, yen or the Swiss franc is not the only way to bet against the dollar. You could, instead, buy a really hard asset – a precious metal. Peter Schiff, president of Euro Pacific Capital in Darien, Connecticut, recommends two ETFs: StreetTracks Gold Trust and iShares Comex Gold Trust. These funds hold physical gold bullion, and the shares reflect the price of gold less the trust expenses. The funds trade on the NYSE and the Amex, respectively, and they both shave off annual fees near 0.4%. For smaller investors such costs are quite competitive with the alternative, which would be gold futures on the Comex, constantly rolled over as they mature. Gains on the ETF are taxed only when you exit, but at a maximum rate of 28% rather than the 15% long-term capital gains rate. Gains on futures are taxed every year, whether you sell or not, and are considered 40% short term (at ordinary income rates).

Gold, let us not forget, is a lot riskier than mainstream currencies. At $436 a troy ounce a year ago, it lurched to $715 in May, backed off to $545 in June, and is back up around $630 now. If volatility does not bother you, another option is the iShares Silver Trust, which launched in April to much fanfare but is down 26% thus far. The silver market is much smaller than the market for gold, so wide price swings are common.

Link here.


The concept of Peak Oil indicates we are running out of this precious resource and that the future may be grave if dramatic action is not forthcoming by the powers that be. If you doubt me ask Al Gore or read any of his eco-gibberish. The President has invaded a sovereign country, Iraq, in order to protect and secure the life and liberty of American Citizens while conferring the principles of democracy onto the grateful Iraqi people. It is possible this is not related to Peak Oil at all.

According to oil industry sources, the commonly accepted proven reserves are 1.226 trillion barrels of oil. If we consider that the world is consuming a lot of oil, and that the consumption grows each and every year, the key question becomes how long until we run out? I calculate this to be about 49 years at current consumption rates. These could actually be too low and thus we could be burning it faster than that depending on rates of consumption in growing economies like India and China.

The flaw in this argument is that every year we have more proven reserves at the end of the year than we did at the beginning, thanks to vigorous exploration and improved extraction technologies. This has been the consistent theme for as long as oil reserves have been calculated. There has never been a time that the oil industry has had less proven reserves at the beginning of the year than at the end, even with the intervening 365 days of consumption being factored in. Odd circumstances indeed for a scarce resource!

The natural production theory of oil (biotic) says that crude oil results from the trapped decay products of living organisms which get trapped under the Earth and then percolate for millions of years at elevated temperature and pressure resulting in crude oil. This theory is so well accepted that the oil industry does not even fund the research into alternative theories, even though this one goes back to the 19th century and is predicated on some pretty weak science. This always struck me as a bizarre and unlikely series of events, that deserts, fields and forests would get plowed under the earth and after millions of years become oil.

According to Thomas Gold, this theory is wrong and he has some impressive figures with which to back up his ideas. Let us do some calculations with his theory. If the outer 100 miles of the earth’s crust are biologically active as Gold suggests and the activity is uniformly distributed then there is a lot of potential oil to be found. If oil is just 0.001% of the volume of the outer 100 miles of crust, then we would have about 4000 times as much as the current proved reserves. If the oil zone goes deeper then we obviously have more. If the oil is being replenished from below via primordial reserves left over from solar system formation then a steady state might be expected in which extraction and replenishment would balance for a long time to come. Perhaps this explains why we never seem to run out and some large oil fields continue to produce regardless of extraction rates? Some oil pools actually seem to be filling from below, which supports the deep hot biosphere theory of Thomas Gold.

Why then would the oil industry cry shortage in such a period of abundance? There is nothing like a perceived crisis to suspend rational thought and behavior. This happened during the ‘70s when stagflation ruled the day and we were running out of oil (again), in spite of the proven reserve facts. If we are not running out of oil, then just what are we doing in the Middle East? We are currently spending about $150 billion/year defending about 350 billion barrels of oil of which we purchase about $12 billion/year worth for imports. This is clearly a bad bargain. We could withdraw the troops and let the price of oil quadruple and still save money and lives, theirs and ours. Clearly no one is performing cost benefit analysis on this fiasco.

The basic thesis here is that lots of eco-nuts, and policy wonks think that oil production has peaked and that doom is around the proverbial corner (as it always seems to be, no matter how many corners we safely round). I oppose these ideas for two reasons: (1) in my experience Al Gore gets virtually nothing correct in his public policy proscriptions, and (2) even if we are running out of oil the market will adjust and other forms will become available. Nothing will ration supply accurately like price, that is, market forces, and historically these are just the things not allowed to function, instead we get myriads of laws, regulations, incentives, and taxpayer funded boondoggles (Synfuel Coporation comes to mind) perverting the process. Politicians and their funding-dependent sycophants never let truth interfere with a good story, and that story is usually about picking our pickets.

Link here.


Base Metal Prices were likely to top shortly after gold and silver and it was simultaneous this time. Our index, less nickel, fell 23.7% from 779 on May 11 to 594 on June 20. While the action until May had the signature of a cyclical blowoff, which explains the size of the initial plunge, the test of the high will determine whether a cyclical bear follows or not.

A couple of things suggest a melancholy outcome. The yield curve has inverted, from which the rule is that a recession follows. The next item is that the stock market is technically very weak and, as everyone knows, the stock market leads the economy. Another indicator is that our Peak Momentum Indicator, which only registers at close to the top of a huge speculation, has given the biggest signal since 1998. The biggest indicator of a peak is the takeover mania, with Phelps Dodge coming into the nickel play. They could take on some $22 billion in debt to do the deal.

In 1980, the Secretary of Energy stated “One thing is for certain, [crude] prices will continue to rise … traditional criteria of supply and demand don’t apply.” Naturally, “Big Oil” applied this reasoning to the hitherto cyclical base metals and started the acquisitions. One involved Amax Inc., which was the biggest producer of molybdenum. The company then was the equivalent in molybdenum to what Inco was once in nickel. The offer was around $80 and Amax management advised shareholders that the company was worth a lot more. On that play, moly went from about $6.50 per pound to $30. Amax and Placer thought they had control of the market and held the price too high for too long. The steel companies pushed out the high strength light alloy steel and the price of molybdenum fell to around $2.50. From around $80, Amax stock plunged to $10, indicating that metals, earnings, and mining shares were still cyclical. Ironically enough, Amax became Cyprus Amax and was acquired by Phelps Dodge in 1999. Perhaps the word cyclical means “what goes around comes around.”

Odds are it has been a cyclical peak and the summer’s action will likely confirm that history has recorded a fabulously speculative peak. Rallies should be used by investors, producers, and traders to get defensive.

Link here.


On July 3, 2006, the United Arab Emirates’ Bin Nasser Al Suwaidi, governor of the Emirates’ central bank, announced officially that the UAE “may buy gold very soon.” This statement has been hailed in the gold investment world as a sure sign that gold will likely climb from here on forward, as the added demand together with the public announcement will drive up the price of gold. There is no question that this might indeed happen, at least initially. However, there is a very good chance this was only a head-fake designed to trap unwary gold bugs in the near-invisible net of our domestic gang of global planners and financiers.

For example, take this statement from “Mr. Al” as we shall call him here for brevity’s sake: “I don’t think it is appropriate to buy gold now – it is too expensive. The appropriate time might come very soon. We could go up to 10%.” Assuming we can take Mr. Al’s word for it, the first and most obvious conclusion anyone can draw from this is that he expects gold to fall in the near future. He wants to buy, but not now. This raises a few questions in the astute gold investor’s mind: (1) How does he know the price will drop to afford him the opportunity he seeks? (2) How will he know when it has dropped far enough, if it does, so that the time will be “right” for him to buy? Of course, these are questions any unvestor would ask himself when trying to maximize his profits. But Mr. Al is not just any investor. He is a highly placed official of an oil-rich Arab country that commands about $23 billion in forex reserves – of which he says he will invest up to 10%. That is $2.3 billion. Chump change in the world of central banking, but a lot of money in a tight market like that of gold.

Here is another question. If he wants to buy low, why is he announcing his plans? That can only serve to drive up the price of the metal – like the Bank of England’s announcement in 1999 that it would sell half of its gold doppred the price down to the $250s. Ordinarily, one would assume he would shut the hell up about his plans and start buying gold quietly so his buying will not drive up the price. He said he would do it gradually. When prices rise, subsequent purchases yield less gold for the same money. That just does not make any sense. However, nobody can call him stupid, either. He is obviously a well-educated gentleman. The suspicion presents itself to discerning minds that Mr. Al’s announcement may be one of the calculated kind.

Calculated to bring him and his country the most advantage, that is. That means, he has good reason to expect that his much desired buying opportunity will come very soon despite (or maybe because?) of his announcement. So, the trick for gold investors would lie in knowing when to get in and when to get out again – before the next engineered price drop comes around. That will be very tricky, indeed. Many will be suckered into this one as well, just as they have on past occasions. Only the well-informed, with the right allocation of gold investments and the right kind of advance intelligence will profit from this. In this crazy day and age, only wild, completely baseless, and unsupported speculation (like that exhibited in this article) has any chance of anticipating the schemes of the movers and shakers of the world of finance. And then, you need to have the good judgment to actually move on it.

When a whole string of groundless, wild speculations starts turning out to be accurate, then you know you are on to something. So, where is this going? The idea is to turn gold down as much as possible so that it will end up near the bottom of its 5-year uptrend. (Any further than that would be too difficult for “the powers”. After all, these are not the ‘90s anymore …) The bottom of that uptrend channel currently lies near $460 per ounce.

If Mr. Al’s friends will actually be able to push gold that low or not remains an open question. This prospect should not scare you. If it does, might just as well get out of gold and go back to the regular stock markets. For the gutsier souls out there, there is “gold in them thar hills.” The right kind of investment decisions can build up a nice stash of cash that can be to turned back into physical gold at the coming, far lower prices. But, remember, the “bottom” will be a very pointy one. It will be hard to pick, and it will be harder to commit money at the right time for fear of further drops – and then there can always be more head-fakes on the way. You just have to learn how the central planners of the West think. Once you have developed that skill, you can read them like a book.

Fundamentals still rule, but within the trends they impose there is lots of wriggle room for deranged attempts at micro-managing the world economy. It is those attempts that must be anticipated for individual investors to be safe in this nutty environment. Got gold?

Link here.


In the quintessential romantic comedy When Harry Met Sally, there is a pivotal scene where Meg Ryan’s character becomes hysterical upon hearing that her ex-boyfriend of five years has asked his new partner of only five months to get married. Sobbing and sniffling into the sleeve of Billy Crystal’s new cashmere sweater, Sally cries, “She’s supposed to be his transitional person. She’s not supposed to be the one.” According to Hooked on Norah Ephronics, a “transitional person” is someone you date right after a devastating break-up to pass the time BEFORE you are ready to reenter a more serious, long-term relationship.

In the world of finance, this role has traditionally been filled by one asset class in particular – CASH – the stopgap until some high yielding bond or hot stock comes along. Until recently, cash has looked like an ugly cow to just about everyone on Wall Street. Yet as investors’ affairs with assets of every kind have turned rocky, cash has started looking pretty good to some. A July 9 New York Times piece offers details: “According to a recent survey by Merrill Lynch, 40% of fund managers are holding more cash in their portfolios than they normally do.” As for why, well, the article cannot help but notice the fact that after 17 interest-rate hikes in the past two years, long-term yields are still flat to below those of short-term T-bills.

In the end, the NYT reaches the conclusion that “Professionals are enamored of cash. It’s hard to pass up a sure thing earning 5%” in the midst of a volatile bond market and many blue-chip stocks showing losses. Well, before you go and exchange the financial FLING for an engagement RING, in the July 2006 Elliott Wave Financial Forecast we present an eye-popping chart of the S&P 500 versus mutual funds’ cash-to-asset ratio over the last four decades.

One look at this picture and you will see that cash holdings have indeed reached an all-time extreme reading – a LOW reading. If professionals are “enamored” now, we would love to see what infatuated looks like. Above all though, the chart shows how each time the cash-to-asset level has penetrated levels even close to the current record, stocks have gone in one direction. A visual milestone, this close-up confirms that the performance in stocks does not PRECEDE the amount of cash managers hold, but rather, follows it. The implication is indisputable.

Elliott Wave International July 10 lead article.


In our paper, “A Recipe for a Depression”, we advanced the concept of real inflation. In this paper, we develop a formula for extracting monetarily-induced price change from total price change. We call monetarily-induced price change “real inflation”. The popular description of monetary policy may be based on a faulty understanding of inflation. In order to evaluate monetary policy, it is important to understand that inflation is only one of the components of price change. Monetary policy targets price change as expressed by the CPI. It does not target inflation.

This paper develops a process for calculating monetarily-induced price change. We also identify the goods, services, and assets that are likely to be the best available indicators of monetarily-induced price change. We test one of these items: real estate. Our test shows that real estate prices track monetarily-induced price change very close to the level that we expect and no less reliably than those prices track the CPI. In effect, our calculation of inflation may be a better predictor of long-term real estate price changes than is the CPI. Our research indicates that inflation is approximately 3% to 4% per year higher than the CPI.

Under the assumption that our mathematical description of inflation has validity, how would we reinterpret the monetary history? We will use two primary charts in this reinterpretation: real inflation; and real interest rates based on real inflation. The first measures overall monetarily-induced price change. The second measures the aggressiveness of monetary policy. We are also able to interpret these charts in comparisons to the reputations of the four Federal Reserve Chairman that have been the primary participants during the last 50 years – Chairman Martin(ending 1971), Chairman Burns(ending 1978), Chairman Volcker(ending 1987), and Chairman Greenspan(ending 2006).

The chart below shows 5-year levels of real and CPI inflation. It is important to realize that after 1998, one must add at least 1% to the CPI level in order to have a expression of price change that is mathematically equivalent to the CPI prior to 1998. Using this chart, real inflation averaged 6% during the first two-thirds of Chairman Martin’s stewardship, during Chairman Volcker’s term, and during the first decade of Chairman Greenspan’s term. Real inflation averaged 7% or more during the last few years of Martin’s term, during Chairman Burns’ term, and during the last 8 years of Greenspan’s term. Only Burns and Greenspan have had a 5 year period where real inflation compounded near 8% or higher.

The next chart shows real interest rates and provides information on the aggressiveness of Federal Reserve monetary expansion. From the perspective of interest rates in relation to real inflation, Volcker is again the most conservative Federal Reserve Chairman. Martin and Burns were equally aggressive as Federal Reserve Chairmen. Though the first decade of Greenspan’s term shows a conservative approach, the last 8 years show the most aggressive monetary policies of the last 50 years. During the last 6 years, short interest rates have averaged 5% per year less than real inflation!

There is nothing in the modern U.S. economic record that compares with the aggressive use of monetary policy during the last decade. Real interest rates based on real inflation have been lower during the last 7 years than at any other time during the last 50 years. This observation helps to explain why debt levels have risen as high and as fast as they have during the last few years.

Real inflation could provide an alternative analytical avenue for economists. It is easily converted into reliable statistics useful in developing robust economic analyses. In every way that we could determine, our statistic appears equal to or better than the CPI as an expression of inflation.

Link here.


Jan Pelligrini had been searching for her dream home for the better part of two years when she finally found it nestled on a hill in Gloucester, Massachusetts. “I walked in and I knew immediately,” said Pelligrini, 52, an entrepreneur with a bustling catering company in Beverly. “I fell in love with the soapstone sink in the kitchen and all of the home’s wonderful architectural details …” Seduced by the Victorian’s charm, Pelligrini submitted an offer, confident her waterfront condo would be snapped up quickly. Located on a quiet dead-end street, where gravel gives way to the gentle waters of Gloucester Harbor, the first floor, two-bedroom unit boasts sweeping views of Rocky Neck, bamboo floors, and a gourmet kitchen with top-notch appliances and granite countertops.

But Pelligrini’s confidence was misplaced. Real estate sales were on the decline, even in the condominium market, which had at first withstood the housing slowdown. And now, five months later, she is carrying mortgages on both properties. The decline in real estate sales, coupled with a surge in the number of available properties, is forcing some sellers into a bind. Already smitten with a new home, they must make tough decisions. Do they slash their asking price in order to unload their property quickly? Do they let their dream home slip through their fingers while they wait for the right buyer? Or, like Pelligrini, do they juggle two mortgages – indefinitely?

According to data from the MLS Property Information Network, New England’s largest real estate listing service, the number of condominiums on the market in the northern suburbs last week was up 46% over what was available at this time last year. The number of single-family homes up for sale in the region is also much higher, at 2,666 last week, compared to 1,972 a year ago. But the number of homes sold is declining.

Pelligrini said she is aware of the sobering statistics, but is still surprised that she is having such a hard time finding a buyer for her condo. She has already lowered her asking price – twice – from $435,000 to $399,000. She refuses to slash it further. “I never thought I would not sell the condo because things were selling so quickly,” she said. But real estate is a lot like the stock market. A few months can make a world of difference. A year ago, buyers in that price range might have been in a bidding war. “The market just came to a screeching halt,” said Ellen Tibbetts, who has been a real estate agent for 12 years. “We’ve gone without a pay check for six months now. It’s prompted my husband to start calling what I do ‘volunteering’.”

Link here.

Refi loans could prove costly in foreclosure.

Homeowners behind in their mortgage payments after hocking the house to pay for a major remodel or a new boat or car may be in for a rude awakening. If they previously refinanced and their lender decides to foreclose, they may not only lose their house, but the bank also may be able to go after their other financial assets including stocks, savings and their paycheck. And even if the bank does not go after their other assets, a foreclosure may mean a big tax bill from the IRS and California Franchise Tax Board for any shortfall between what the bank gets for the sale of the owner’s home and the value of the loan.

“This is going to become a hot topic,” predicts Bradford L. Hall, managing director of Hall & Co., CPAs in Irvine, who remembers the pain of foreclosures during the 1990s. “There’s very little awareness of what can happen when you can’t make your payments and are forced to sell your home for less than the mortgage balance or lose your home through foreclosure.”

Foreclosure has not been a major issue in Orange County for a decade as homeowners in recent years enjoyed low interest rates and double-digit price appreciation. Rather than a place to live, houses increasingly were seen as another source of money. Refinancing became the norm as owners cashed in on their newfound equity for such things as home remodels and expensive toys. But now as interest rates rise, home sales slow and price increases moderate, people who depended on always being able to refinance are finding themselves not only tapped out but falling behind.

Signs of trouble ahead are just beginning to appear. Recent figures do not even come close to the record default notices and foreclosures DataQuick recorded at the peak of the last downturn in the fall of 1996. But as thousands of adjustable loans adjust to higher – sometimes significantly higher – rates over the next two years, the situation is expected to get worse.

Some homeowners with little of their own money in their homes may think they will do what strapped homeowners in the ‘90s did: turn over the keys to their lender if things get really bad and walk away. But Hall and other financial experts warn that things may be different this time because so many people have refinanced. The difference is the recourse loan. In the past, when a lender foreclosed, the homeowner usually still had the original loan they got when they purchased the house. Original loans, considered purchase money, are non-recourse loans that limit lenders to recovering only what they can get when they sell the house. They cannot go after the owner to pay any difference between the foreclosure sales price and the loan balance. But in California, refinanced loans, second trust deeds and home equity lines of credit are generally considered recourse loans. In these cases, a lender can file suit and go after almost any of the borrower’s assets once they obtain a court judgment. “They can literally go after everything you have,” Hall says.

There are a few limited exceptions. Retirement accounts are excluded, and declaring bankruptcy could protect some homeowners. In the past, lenders have been reluctant to go after borrowers personally because it takes time and can involve costly litigation, but Hall says things might be different this time, especially if a borrower has substantial assets. Even if a lender does not go after a homeowner’s personal assets, a foreclosure can trigger income tax consequences: The difference between the loan value and what the house gets sold for could be considered debt relief income. The $250,000 real estate gains tax exemption for singles and $500,000 for joint filers does not apply to debt relief income. The tax owed on the debt relief is based on the homeowner’s ordinary income tax rate, not the lower capital gain rates.

Hall recommends homeowners who are getting behind to talk to their lender to see if they can restructure the loan or payment terms. At the same time, they should seek financial counseling and tax advice. If they have a recourse loan, they should consider selling before allowing a lender to foreclose to obtain the maximum sales proceeds and reduce their financial or tax exposure, Hall says. Norm Bour, owner of Priority Plus Lending in Laguna Niguel, thinks there are some homeowners who should just cut their losses now. “There are a lot of people who are homeowners who shouldn’t be, living day to day just to support the house,” he says. “My advice to them: Sell.”

Link here.

The most overpriced places in the U.S.

Ever complained about the cost of gas? Guilty. How about a movie ticket? Guilty. Utilities? Transportation? Real estate? Guilty, guilty, guilty. Every American adult gripes about the price of daily life, from a gallon of milk to a posh dinner. But in some areas, where ever-increasing living costs and real estate prices are pitted against “lackluster” salaries and job growth, complaints are more legitimate. There is no way around it. Such locales are anything but bargains. That we are talking about places like New York City, Los Angeles and San Francisco should come as no surprise. But what about Tucson and Essex County, Massachusetts? Both made our annual list of the most overpriced places in the United States.

In fact, Essex County, which lies north of Boston and comprises a host of waterfront locales, topped off the ranking. With the idyllic views come high living costs and expensive real estate. “We saw a lot of waterfront property being bought and smaller homes being torn down and replaced by million dollar mansions during the dot-com boom,” explains Sara Young, economic development manager at the Cape Ann Chamber of Commerce. “Now you’ll find a lot of those homes on the market, and they aren’t selling because nobody can afford them anymore.” The recent increase in inventory has caused the median home prices in Essex County to drop slightly, from $380,000 in the first quarter of 2005 to $373,750 in the first quarter of 2006, according to the Massachusetts Association of Realtors. But that is not enough to make real estate a steal.

Another surprise newcomer to the list is Tucson, Arizona. Though our data shows that job growth is healthy, salaries do not seem to be keeping up with the high living costs. And while housing prices may still be low compared with the hottest areas of the country, the housing boom pushed them up considerably. San Jose, San Francisco and New York are all repeat offenders, having landed on our list for four consecutive years. Because we have improved our methodology this year, it is difficult to make a direct comparison with prior lists. But we do know that the three metros rank poorly in everything except the average salary ranking, where they place first, second and third, respectively. Many would argue that such places offer tremendous lifestyle benefits – among them, high culture and active nightlife. But such things are hard to afford, much less enjoy, when basic living costs are so high. While there is no dearth of wealth in those areas, ordinary folk may be squeezed. The tropical paradise of Honolulu landed in the fourth-place spot. There is no question it is a great place to visit, be it for a week-long trip or to a second home, but residents feel the burn in their wallets. Honolulu fall in the bottom quartile when it comes to housing affordability, income and cost of living.

Link here.


Summer is full of oxymorons, from plastic silverware to healthy tans. Now Wall Street serves up its own summer conundrum: expensive value stocks. Value stocks, by definition, are supposed to be battered shares no one wants to own or at least not pay a premium for. Index providers categorize which stocks are value and which are growth. Value stocks are supposed to be less expensive because they are in out-of-favor industries or mature businesses. But stocks classified as “value stocks” have gotten so popular that they are not the deal they once were – far from it.

This week, value stocks took their biggest lead all year over growth stocks. The iShares Russell 3000 Value index exchange-traded fund is up 6.6% in 2006, while the iShares Russell 3000 Growth ETF is down 1.8%. The past five years, value stocks have gained 31% while growth stocks have fallen 2%. “It’s getting increasingly hard to find cheap stocks out there,” says Scott Black, who as president of Delphi Management has made value his specialty. The data prove his point.

Value stocks are as pricey as growth stocks by some measures. The S&P SmallCap 600/Citigroup Value index has a 17.2 price-earnings ratio on 2006 expected earnings, essentially identical to the 17.1 P-E on the S&P SmallCap 600/Citigroup Growth index. Based on forecasts for 2007 earnings, stocks in the S&P SmallCap 600/Citigroup Value index have a higher P-E than those in the S&P SmallCap 600/Citigroup Growth index. Meanwhile, the P-E of large value stocks is only 5.8 points lower than the P-E of large growth stocks, according to Wilshire Atlas, vs. being 15.1 points below those of growth stocks at the end of 2000.

Value stocks contain some of the market’s hottest stocks – and might not even be considered value anymore. Stocks of small companies viewed as value have been the market’s biggest darlings. In fact, small value-priced stocks are the only category of the six tracked by Russell, ranging from small growth to large value, to see P-Es rise from June 2000, says Russell. Formerly beaten-up stocks, such as Hewlett-Packard, Office Depot and J.C. Penney, have done so well that Russell Investment Group now classifies them mostly as growth stocks. This shift means growth stocks in many cases are better deals than value, says Dennis Jensen, senior research analyst at Russell. Value stocks are “getting a lot of attention,” he says, and “are closer to a peak relative to growth.”

Link here.


You would think that if anyone understands how top executives gorge on stocks options it would be the U.S. Securities and Exchange Commission. Too bad Commissioner Paul Atkins seems to be in the camp of the willfully oblivious. In a speech before the International Corporate Governance Network, Atkins defended making option grants ahead of good times and good news as being beneficial for shareholders. “It is cheaper to pay a person with well-timed options than with cash,” he said. He went on to say that so-called “spring loading” (a synonym for what I have termed opportunistic grant timing) “benefits shareholders because fewer stock options are granted.” Referring to the SEC, he observed, “Who are we to second- guess that decision. Why isn’t that decision in the best interests of shareholders?”

Why indeed? The short answer is that in the real world of executive pay, the determination of the number of option shares an executive is granted does not work anything like Atkins imagines. Opportunistic timing allows executives to take advantage of the information only they have, and it robs shareholders of what is rightfully theirs. Nice try, Mr. Atkins, but no cigar.

Link here.

U.S. feds to probe Silicon Valley options scandal.

Federal prosecutors and FBI agents will investigate whether stock options were “backdated” to enhance their value and mislead shareholders, Kevin Ryan, U.S. attorney for northern California, said. “We will investigate whether individuals and companies may have deliberately backdated stock options with the intent to defraud,” Ryan said in a statement. “Falsification or backdating of financial documents may call the integrity of companies’ financial statements into question, can constitute fraud on the company, shareholders, and the market, and may give rise to tax violations.”

Retroactively dating stock options allows for the purchase of a stock at an opportune time, such as when it is cheapest. The task force was formed after more than 60 U.S. firms, including technology CNET Network and Apple Computer, became implicated in stock option price manipulation charges.

Link here.


According to an expert on U.S. commodities, orange juice stands to be one of this season’s high-yield investments. A string of setbacks will put growers in a bind and send juice prices up, and the worst could be yet to come. “The orange juice situation is dire,” said Kevin Kerr, a resources expert and frequent contributor to The Daily Reckoning. “OJ is getting the life squeezed out of it by a myriad of factors, and juice prices seem destined to surge.” Kerr attributes hurricane fears, higher costs, rampant crop disease, and lack of migrant workers to the industry’s recent plight.

Many growers spent the first half of the season fighting off an outbreak of citrus canker – a crop disease that significantly reduced this year’s orange harvest. Recent legislation and an impending hurricane season have also forced out countless members of the immigrant workforce, which constricts the vice on the OJ industry even tighter. On the verge of hurricane season, one bad storm, said Kerr, “could be the last nail in the coffin for orange growers who are already struggling.” If the storm season is as violent as the previous two years, Kerr believes the orange juice yield could hit devastating lows. As the fate of orange growers is left to chance, Kerr stated that a rise in value is far more certain. “All in all, the forecast for juice prices is much, much higher.”

Link here.

Florida citrus crop among worst in decade.

For the second straight season, late-maturing oranges in hurricane-ravaged areas will leave Florida with one of its worst citrus crops in more than a decade, federal agriculture officials said. The U.S. Department of Agriculture again reduced its forecast, now projecting Florida will produce 151 million boxes of oranges, a third less than recent pre-storm seasons but slightly better than last season’s 149 million boxes. Each box contains 90 pounds of fruit. The good news for farmers is the low production has kept orange juice prices high. An estimated 90% of Florida’s oranges are squeezed into juice, while the rest are boxed up and sold fresh. Florida produces 75% of all oranges in the U.S.

Alaron Trading analyst Boyd Cruel said the updated forecast would not likely change juice prices for the next few months because investors were already expecting a smaller crop. In fact, he said most predicted the forecast would be cut by 6 million boxes, instead of 2 million as announced. Cruel said more important news would come next month, when processors lay out expectations for the next season.

Link here.


When California became a state in 1850, San Jose became its first capital. As the city flourished, its demand for water grew as well. Sensing an opportunity, an enterprising individual by the name of Donald McKenzie assembled some investors to acquire the rights to supply the city with water. The year was 1866. Such were the humble beginnings of today’s SJW Corp. (NYSE: SJW). The company now serves over one million people in six cities. The company claims it is the “most technically sophisticated urban water system in the United States.” But SJW is more than just a water utility. It is also a significant landowner. But let us first look at the utility operations.

San Jose Water operates in the heavily regulated state of California, which is probably not a good thing. In the past, public utilities have struggled to obtain rate increases. However, Governor Schwarzenegger has made utility-friendly changes to the California’ Public Utilities Commission (CPUC). If recent cases are any indication, utilities will have an easier time raising rates. Over the last few years, SJW has produced a steady increase in earnings per share and dividend growth.

But the real reason SJW stands out is for its land holdings. SJW owns an impressive portfolio of commercial real estate and undeveloped land. The company owns 7,000 acres of watershed in the Santa Cruz Mountains, which includes about 1,000 acres of timberland. It also owns warehouse properties in Florida and Connecticut and retail property in Texas. SJW acquired most of its land holdings during the 19th century. So its cost basis on these holdings is absurdly low. A low-cost basis is not a good thing, taxwise. If SJW sold its land outright, it would owe hefty taxes of around 42% of the proceeds, according to SJW’s President & CEO Richard Roth. Thus the company usually monetizes its land holdings through a 1031 exchange. This mechanism allows the company to roll the sales proceeds, tax-free, into another similar investment.

Specifically, SJW sells its land and buys water assets – as well as income-producing property around the country. SJW has already produced some stellar returns out of its land holdings. Recently it sold 5.5 acres to Adobe systems for $25 million – almost $5 million per acre. This one sale netted more for than the company in 2005 than the company’s core water utility business, which netted $21 million. Naturally, such a sale perks up the ears of investors. Asked more about the company’s land holdings, Roth declined to get specific. He did hinted that perhaps further disclosure on the company’s real estate holdings would be forthcoming, especially since the company’s real estate business contributes a much larger share of the company’s value.

Who knows exactly what SJW could eventually reap from its collection of land and properties? The enterprise value of the company today is only $550 million. So, it would not take a very large real estate transaction to boost that number significantly. The sale to Adobe alone represented nearly 5% of the value of the company. SJW’s property portfolio is like a bank they can dip into to buy water assets. They do not have to raise debt or sell more stock. They are converting non-income producing land into income-producing assets. These strategies are the added kicker that spices up an otherwise fine utility.

Link here (scroll down to piece by Chris Mayer).


Most traditional investors tend to agree that market volatility, while inescapable, is to be feared. But, increasingly, large institutions are calling in specialist active volatility management as a means of boosting returns. They do this by lifting their investment portfolio’s “efficient frontier” that charts the best trade-offs between risks and returns. According to Karlheinz Muhr, chairman of Volaris, a specialist volatility and asset management group that is now part of Credit Suisse, isolating volatility as a unique asset class is no different from identifying currency exposure as a source of risk and potential return.

Mr. Muhr, who is widely acknowledged as one of the pioneers of volatility trading, said, “What distinguishes volatility management from risk management is its shift from the middle office [trading rooms’ front line] to the front office. Active volatility management results in a traded asset, engineered to deliver risk reduction and alpha-seeking returns.” The group divides volatility management programs into three categories: risk reduction, return enhancement and active overlay.

Mr. Muhr said that, when it comes to limiting risk, volatility management acts as at least a partial hedge against adverse volatility. Return enhancement strategies, by contrast, strive to deliver better returns without taking any risks beyond those that are already being taken on in an underlying portfolio. “Active overlay” programs aim to combine the best of these two strategies. In their quest for absolute sources of return, big pension funds are increasingly allocating a slice of their portfolio to alternative assets such as long/short funds, private equity and commodities. “While these shifts may increase the policy’s expected return, they also have the effect of increasing the risk budget. By employing a volatility management program, plan sponsors may be in a position to reduce portfolio risk for the same return forecast,” he said.

Investors can also use these techniques to extract value-added returns. They do this by exploiting differences between the options market’s implicit forecast of asset volatility and their own opinions. Investors seeking the best of both worlds – risk reduction and return enhancement – can hire active volatility managers. Active volatility managers typically follow one of two styles, quantitative or judgmental. Active volatility managers are statistically based, and deliberately view volatility as separate from the underlying portfolio. They will concentrate on volatility sources of risk and return and defer management of the underlying portfolio to the client or a third party. Using this technique, “portable alpha” – returns uncorrelated to the market, and distinct from the underlying portfolio – are possible. This means the underlying portfolio can continue to be managed without taking any view on volatility, Mr. Muhr said. This process allows for the efficient management of large portfolios, which can include hundreds of stock and option positions. Judgmental volatility managers usually maintain a fundamental opinion on the underlying portfolio, on which their ultimate success depends.

Active volatility management is an emerging alternative for large institutions looking to increase the returns they can generate for an acceptable level of risk. While covered call strategies – in which managers write options to sell stock backed by stock they already hold in their portfolio – have been around for decades, what is new is the ability to hire outside volatility managers such as Volaris with the express intention of reducing risk and generating higher returns. Mr. Muhr said active volatility management is relatively transparent and – unlike some other alternative investment strategies – does not require high leverage and lengthy lock-up periods.

Link here.


Insider buying is one of the most telling market indicators you have at your disposal. When company insiders (CEOs, CFOs, major shareholders, directors, etc.) are bullish enough to spend millions of their own dollars to buy stock on the open market, it means they think stocks are cheap and worth owning. However, when those same insiders are selling stocks en masse, the market is generally overextended and stocks (on a whole) are expensive. That is when you want to exit stage left. Or at the very least, you want to sit on the sidelines and observe from a distance.

Now is one of those times when you should either be a seller or sitting on the sidelines in cash. Take a look at this chart. It shows the ratio of insider buying to selling compared with the performance of the S&P 500. Notice insider buying inversely correlates to the general market’s performance. When the market plunges, insider buying peaks. And when the market peaks, insider buying dries up. For instance, during the crash of 1987, the number of firms with insider buying almost doubled. While the mainstream was panicking (and selling for massive losses), the smart money was piling in. The same thing happened during the collapse in 2001.

The ratio of insider buying to selling spiked twice between September 2001 and September 2002. During that time frame, the S&P 500 fell from 1,155 to 800. That was a good buying opportunity. The S&P 500 is at 1,250 today. By comparison, insider buying has been all but nonexistent lately. On May 8, the S&P 500 hit a new 5-year high. There are not many bargains on Wall Street. The insiders are selling stocks at a greater pace than anytime in the last six years. The ratio of buying to selling is approaching 0.2 today, compared with well over 1.4 in 2001-2002.

This is a very telling sign. The people who are running the companies you and I are investing in are selling their own stocks right now. These are the guys who know about future orders coming in. They know specifics market trends long before you and I have a clue. They know everything about their own balance sheets, income statements and cash-flow situations. Armed with all of this information, the insiders are getting the heck out of Dodge. Yet retail investors keep buying.

Even after the recent correction from early May to mid-June, the market immediately rebounded. Your average investor was (and is) convinced that we are still in a raging bull market and that stocks (even really bad ones) will keep rising. This is a classic sucker’s rally. And I can say this with a high degree of certainty because the smart money has been eerily absent from the equation. Only fools are buying now. This situation can only end badly for the fools. Now is a good time to take profits – especially on speculative stocks that are selling way ahead of their underlying fundamentals. However, there are still a handful of stocks that the insiders think are very attractive. As an investor, I would much rather put my money in stocks the insiders are bullish enough on to invest in alongside of me – especially in this ugly market.

Link here.

How can you tell when a bear market in stocks has reached a long-term low?

When the psychology of market participants has plunged as far down as the stock prices themselves. In other words, the low is in when the mood catches up with the market. Yet this has not happened in the 6+ years since the major U.S. stock indexes turned down from their all-time highs. The facts clearly show that market participants have remained in a bullish mood all along.

The evidence has accumulated well into 2006. In the first quarter, the flow of new money into stock funds was the second highest on record for a 3-month period (exceeded only by Feb/March/April 2000). Mutual fund cash levels tell the same story. Low cash levels mean a fund is heavily invested in the market, which of course means fund managers and investors are bullish. Well, for the first time in 40 years, fund cash levels fell below 4% in late 2005, and have remained at or near that level ever since. Also, the consensus among investment advisors has tilted toward the bullish side for the past 190 consecutive weeks (according to Investor’s Intelligence).

All of this clearly IS a psychological extreme, but it is clearly NOT one that “caught up” with the market. This mood can only be described as standing in stark contrast with what the stock market has actually done – the major averages today stand at or near where they were in January 2004. What to make of this contrast? When will the mood indeed catch up? Good question: After years of complacency, developments in recent weeks show an early but tangible shift in the public mood.

Link here.


Currently, the Party uses the phrase “Gross Domestic Product” as if people were rolling up their sleeves to build machines and harvest crops. But increases in “GDP” these days come from consumption, not production. And, even worse news, the consumption is not coming from savings, but rather from credit-card debt. In a giant circle of nonsense, this ends up increasing our national “GDP”. The housing boom accounts for much of the economic “growth”, but few people realize that “home owners” have little or no equity in their homes, and that each move in the creative-financing shell game (between banks, mortgage companies and speculators) only adds to the mighty “GDP”.

About 5-10% of GDP, as it turns out, is Wal-Mart – a tsunami of cheap Asian stuff once made in the U.S. Apparently, there is money to be made hollowing out America’s middle class. The failed-but-somehow-eternal war in Iraq also gets factored into the GDP. Halliburton, arms merchants, Madison-Avenue propaganda companies – it all gets to be included. So does the Vatican-sized embassy in Baghdad (outsourced) and the permanent military bases there (outsourced).

Let’s continue to scratch the surface of the rosy statistics being promoted by the Party’s portable speakerphone, George W. The “low unemployment” figures mask a reality of millions of part-time, poorly-paid and uninsured workers. The poverty rate over the past six years has jumped to nearly 40 million people, and the number of Americans with no health insurance has risen to some 50 million people. Now, there are even indications that life expectancy is beginning to decline in the U.S., especially for adult males. Not a good sign.

Only the most partisan hack can deny that the rich are getting richer and the poor are getting poorer under the Bush regime. Why? Joseph Schumpeter recognized that free enterprise periodically gives way to “monopoly capitalism” – shorthand for clusters of oligopolistic firms earning supernormal profits, and this is especially true for industries with enormous economies of scale, like petroleum or pharmaceuticals. They begin to squeeze consumers and write laws to make that happen. It boggles the mind that some Americans are willing to believe Party-backed economic data. The Party’s manipulation of statistics is now an established fact of life. George Orwell once said, “But if thought corrupts language, language can also corrupt thought.” So it seems.

Unfortunately, free enterprise has already given way to monopoly capitalism. It is not a trend. It is a done deal. The cars you drive, the gas you buy, the food you eat, the appliances you prepare it with, the clothes you wear, and the media you watch is all traceable to a half-dozen industries in each sector.

In a final tribute to George Orwell, the Outer Party’s Dear Leader celebrated having a $300 billion deficit – lower than the politically propelled projection of more than $400 billion. It is a trick the Inner Party learned three years ago: come up with pessimistic projections and then break out the champagne when the figures come in. All of this is designed to take our eyes off the fact that the American economy is now underwritten by $9 trillion of debt and depends upon $2 billion dollar infusions of foreign capital every day, largely from China.

Link here.

Is the U.S. bankrupt?, asks Fed governor.

Is the U.S. bankrupt? Or to paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bear, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors? Many would scoff at this notion. They would point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries.

Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mispricing securities; and that financial implosion is just around the corner.

This paper explores these views from both partial and general equilibrium perspectives. The second section begins with a simple two-period life-cycle model to explicate the economic mean- ing of national bankruptcy and to clarify why government debt per se bears no connection to a country’s fiscal condition. The third section turns to economic measures of national insolvency, namely, measures of the fiscal gap and generational imbalance. This partial-equilibrium analysis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.

The world, of course, is full of uncertainty. The fourth section considers how uncertainty changes one’sperspective on national insolvency and methods of measuring a country’s long-term fiscal condition. The fifth section asks whether immigration or productivity improvements arising either from technological progress or capital deepening can ameliorate the U.S. fiscal condition. While immigration shows little promise, productivity improvements can help, provided the government uses higher productivity growth as an opportunity to outgrow its fiscal problems rather than perpetuate them by effectively indexing expenditure levels to the level of productivity.

The final section offers three radical policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy. These policies would replace the current tax system with a retail sales tax, personalize Social Security, and move to a globally budgeted universal healthcare system implemented via individual-specific health-insurance vouchers. The radical stance of these proposals reflects the critical nature of our time. Unless the United States moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion.

Link here (PDF file).


From Federal Reserve Vice Chairman Donald Kohn, we got, “The first thing to keep in mind about global imbalances is their scale. The U.S. current account deficit is enormous – on the order of $800 billion or 6½% of gross domestic product – and it is not likely to shrink substantially in the immediate future, given the current configuration of economic activity and prices around the world.” I do appreciate the candor. Yet this really is an extraordinary admission by a prominent central banker: Our current account deficit has reached the point of being completely intractable – and the Fed does not even bother. This is, by now, not even worthy of a headline and surely no revelation to readers. But ongoing $800 billion current account deficits – especially subsequent to a two-year Fed “tightening” cycle and a 30% four-year decline in the dollar index are, from a historical perspective, an incredible circumstance.

Generally, too much time and energy is spent pontificating about the unknowable future and not enough on the analyzable here and now. Last week I suggested that a confluence of sharply higher energy prices, an explosion of energy-related research and development, and environmental/climate-related spending presents an immediate, as well as long-term, potential spending “black-hole” – that is, for as long as new finance is forthcoming. In the context of a Credit system remaining stubbornly overheated in the face of a cooling U.S. housing market, a powerful inflationary bias in an arena of such potential enormity (energy/energy-related) is quite significant.

Credit inflation/bubbles innately expand and nurture fledgling bubbles to support and perhaps even supplant the aged. An appreciation of this dynamic is today analytically invaluable. It is exactly this dynamic that leaves me skeptical of the notion that the Goldilocks economy will duly cooperate, that the timorous Fed can painlessly wrap things up, and that the scrawny bond bear has had his fill. And while I keep an open mind to possible intermediate and long-term developments, the current environment is inarguably inflationary. No backing down. What I will attempt to explain is surely an all too common rehash. I am just compelled to attempt a more concise presentation.

Link here (scroll down to last subheading in page content).


Now that North Korea is firing test missiles into the Sea of Japan, and Israel is firing real missiles into Lebanon, very few investors are eager to purchase stocks. Even gold and oil stocks are finding few buyers. But these short-term (we hope) anxieties are creating opportunities for long-term investors, including the long-term investors that run some of the world’s largest natural resource companies.

Three recent takeover deals in the resource sector stand out for size and scope. At a combined $21 billion-plus, Anadarko Petroleum’s dual bids for Kerr-McGee and Western Gas Resources rank as the 8th biggest energy deal of all time. Yet, that is the smallest of the three deals recently bandied about. In base metals, Phelps Dodge has put together an even more audacious bid, worth $40 billion, for Canadian mining companies Inco and Falconbridge. And finally, Indian steel magnate Lakshmi Mittal looks to have prevailed in his protracted takeover battle for No. 2 steelmaker Arcelor, after fighting off ugly management tactics, derailing a sketchy Russian merger and upping his bid to more than $33 billion.

Wall Street is typically distrustful of large mergers and acquisitions. The ones forking out the cash wind up with the short end of the stick more often than not, and the most touted deals can wind up destroying shareholder value. The footing is not always sound: It is sometimes the case that the CEO has an ego to feed and wants a shot at climbing the Fortune 500 league tables or thinks a bigger expense account would go well with a bigger company. But on the flip side of things, when a big acquisition actually has solid strategy and skillful execution behind it, the long-term benefits can be well worth the cost. What is the rationale behind these three recent plays? In each case, the logic is unique, but the underlying theme of strategic focus is similar. These companies are looking beyond short-term results and thinking about long-term positioning.

Link here.


Celebrated contrarian investor, Marc Faber provides a unique way of looking at world stock markets. In his book, Tomorrow’s Gold, Faber asks the reader to imagine a large flat bowl perched on top of the earth. At its base, investors surround the bowl. A continuous supply of fresh water (money) flows into the bowl from a huge tap controlled by the world’s central bankers. The bowl will lean whichever way the investors tilt it. If investors were bullish on America, they would tilt the bowl towards the U.S. and money will flow into American stocks and assets. “In short, the direction of the overflow will depend on the bias of investors, which in turn can be manipulated by opinion leader, the media, analysts, strategists, politicians and economists.”

So as long as central banks supply the bowl with money, and as long as there are investors collectively tilting the bowl, there will always be assets that appreciate (those that are getting the money flow) and assets that fall (those that do not get the money flow). But what if most of that money supply flowing into the world comes from a single central bank? And what if those investors standing below it are all the same breed? Would that be too much monetary control concentrated in the hands of a few? Would such a scenario even be possible?

The central bank is the Bank of Japan and the breed of investors is Yen carry traders. Japan is the world’s largest source of capital. About $3 trillion worth of Japanese money has flowed through that bowl on top of the earth and is invested all over the world. The investors around the bowl are Yen carry traders. Carry trade is a transaction where speculations borrow money at a low interest rate and invest it at a higher rate, pocketing the difference. Japanese interest rates have been 0% for a decade. That is why the world is awash with liquidity originating in Japan. Japan is literally giving money away. In many ways, the Bank of Japan is banker to the world. As a result, carry traders borrow Yen at 0% and invest it in U.S treasuries, real estate, stocks, etc. Nice free lunch, no?

But the Bank of Japan announced recently that with an improving economy, it will no longer keep interest rates at 0%. A rate hike to 0.5% is very likely this year. The announcement has already shaken up several asset classes. A 0.5% increase in Japanese rates in nominal terms, is no big loss to a carry trader, but there is a tremendous multiplier effect here. The profitability of carry trade depends on, apart from the interest rate spread, one other factor – exchange rates. For a carry trader to make money, the Yen needs to be weak and the dollar strong. For the past two years, the opposite has been true – the Yen is appreciating against the dollar. That means, the carry trader now needs to pay back more Yen than he originally borrowed. Therein lies the problem.

Back in 1998, Yen carry trade was at its peak. Speculators were borrowing Yen at 0% and investing, among other places, in Russian debt. The Berlin Wall had fallen and Russian junk bonds had extraordinarily high yields. Borrowing Yen for nothing and investing in Russian junk bonds seemed like a foolproof idea. As long as Russia kept paying its debt, of course. But then it didn’t. Russia defaulted on its debt. Panicked speculators rushed out of their trades. As a result, the Yen appreciated 20% in just two months. Yen carry traders who were essentially short the Yen, were rushing to liquidate their positions.

Today’s global financial system is faced with a double threat. Japan is raising interest rates. And the Yen is appreciating. Both trends also seem secular and sustainable. Japanese interest rates can only go up. And with the dollar in a long-term bear trend, the Yen can only go up against it. Consider this highly probable scenari Bank of Japan raises rates to 0.5%. In the U.S., the Fed cuts rates to keep the housing bubble from bursting, causing treasury yields to fall from the current 5% to 4%. That means a Yen carry traders profits are now 4 minus 0.5, which is 3.5%. Now, a mere 3.5% rise in the Yen against the dollar will wipe out all the profits. Remember, the Yen has risen as much as 20% in just two months under precisely the same circumstances. That spells doom for Yen carry traders.

With the end of the Yen carry trade, speculators will pull out of all investments they made using borrowed yen. As a result: (1) Anything purchased using borrowed yen will fall. U.S mortgage debt, bonds, stocks, emerging market equities, Shanghai real estate have all already taken a dive due to a pull out earlier this year. (2) Carry traders repaying their yen debt will strengthen the yen in the long run. According to David Bloom, currency analyst at HSBC, “If any currency is going to appreciate over time, it will be the yen.” (3) That means businesses that have costs in dollars but revenue in yen will make higher profits. (4) Domestic demand stocks (and any business that is not export dependant) in Japan will also do well as a result. Japanese bathroom accessories maker, TOTO is worth putting on a watch list. According to Morgan Stanley, “wait for dips to buy domestic demand stocks.”

While the world frets and flees with the end of Yen carry trade, you can actually make money if you follow the macroeconomics trends. Like Marc Faber said, all that money flowing through the bowl on the top of the world needs to go somewhere.

Link here.


It takes talent to make money. It takes a certain kind of talent to get rid of it, too. Rarely do you find both talents together. A man who has little money, knows how to spend it. He buys trifles and gets some pleasure out of it. A man like Warren Buffett, on the other hand, has spent so much time making money that he lacks the time and temperament to part with it. Instead, he pays vast sums to lawyers to protect his stash for as long as possible. And then, he starts a foundation and gives it all away, anyway.

The Sage of the Plains has opined many times that he does not want to contribute to the “lucky sperm club” of people who are born rich. He forgets that the day he was born, he had already squirmed into an equally lucky club of America’s power elite. His father was a member of Congress, and one of the very few of that class, apparently, with any sense or honor. But rather than thank his own lucky stars for that bit of fortune, Warren now seeks to darken the heavens for everyone, insisting on the need for inheritance taxes so that we can all start out with our share of the national debt and little else. A “meritocracy” he calls this.

A meritocracy is a dreadfully practical system. In a free market, at least theoretically, the people who merit fortunes are those who most give other people what they want. A man who offers a computer software program that does not work, for example, is not likely to merit much profit. Microsoft products do work … at least, most of the time. And at least long enough for them to get onto your desk. And Gates has done a spectacular job of getting them onto your desk. On the other hand, an investor who buys shares recklessly does the world no favor. He puts his capital in the wrong places. He merits no reward.

June 2006 will go down in the history books as a propitious one for world improvement. Bill Gates announced his retirement from Microsoft. He will devote himself full time to doing good, he said. Then, the second richest man in the world, Buffett, said he was giving $31 billion to the project. And how could anyone carp? The papers were united in their praise of the two. After all, they offered to ease the suffering of the poor … to cure diseases … to bring technology to bear on the problems of poverty and disease – with their own money! Here were rich men headed for heaven, said the press reports. But what would actually become of Buffett’s money?

In the Financial Times we discovered that “Gates and Clinton link on African health.” And here we paused to draw breath. The two are traveling around the Dark Continent, figuring out how to spend Buffett’s money brightening the place up with health and development programs. They might as well be Thomas Aquinas and Mahatma Gandhi setting up a fireworks display – smart men, but not likely to know what they are doing.

So, what will come of all of it? We shake our head. If only Buffett had not made so much! A lesser fortune might have been squandered in the usual way: effortlessly. Women, houses, boats, art. Yes, art. Buffett might have acquired the most expensive collection of contemporary art in the world. Think of all the contemporary artists whose hearts he would have gladdened.

What surprises us is how little the two greatest capitalists of all time seem to understand of how the world of money actually works. Let us imagine that they build a brand new foundation, for example. And let us set aside our normal cynicism and further imagine that the project is not undone by corruption or incompetence. All the members of staff are saints. All the contractors are archangels. All the clients listen to National Public Radio and recycle. And yet, how does the dynamic duo know that the project is worth doing? In the absence of independent customers and freely set prices, how can they tell?

Now the world’s poor will have aid and have it more abundantly. They will get what some rich white guy – probably long dead – wants them to have. How is it any different from any other project ever dreamed up by world improvers … communists … central planners … meddlers … and equalizers, except that Buffett and Gates are so rich that they do not have to steal the money to do it?

Link here.
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