Wealth International, Limited

Finance Digest for Week of November 5, 2007

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


As the dollar fell to new record lows and oil and gold prices surged to new highs, Wall Street remained fixated on wholly meaningless government data that managed to report the lowest inflation in the last half century. These bizarre numbers were integral in allowing the Commerce Department to report 3.9% annualized GDP growth in the third quarter, which was heralded by the bulls as evidence that a resilient U.S. economy had shrugged off the problems in the housing and mortgage markets. However, the government’s ability to make “economic growth” magically appear is based purely on statistical finesse.

To arrive at this rate, the government had to assume that inflation during the quarter ran at an annualized rate of 0.8%. That is the lowest rate of inflation used to calculate U.S. GDP since the Eisenhower administration. With oil priced at almost $100 per barrel, gold futures trading over $800 per ounce, the dollar hitting record lows, and the Fed printing money like it is going out of style, the government has the nerve to claim that current inflation is the lowest it has been in half a century. Unbelievable!

The government adjusts nominal GDP gains using the GDP deflator, which represents the inflation rate during the time period being measured. This is done to strip inflation out of the GDP calculation so that only real growth gets counted: not nominal gains that result purely from inflation. The consensus estimate for 3rd quarter GDP growth was 3.4%. The reason we beat that number was that the government adjusted the nominal 4.7% gain by a mere 0.8%. Had the government assumed a higher rate of inflation, say 2.6% (identical to the rate used to deflate second quarter GDP,) the 3rd quarter gain would have been only 2.1%, well shy of the consensus forecast. My guess is that inflation is actually running at an annualized rate closer to 10%. Therefore using a more honest deflator, the U.S. economy is actually contracting, which would explain the recent anecdotal evidence provided by various economic polls, voter dissatisfaction and consumer sentiment numbers. In fact, if one simply measures U.S. GDP using gold or any other currency, it is clear that we are already in a recession.

Similar illusions are created in other numbers, such as retail sales, corporate earnings, and stock prices, which are all rising merely as a result of actual inflation being higher than the official reports. Corporate earnings, particularly those of multi-nationals, are padded as their foreign currency denominated earnings translate into more dollars when those earnings are repatriated. However, such gains are illusions, as companies merely earn more dollars of diminished value for the goods they sell. The actual volume of exports does not necessarily improve much, as evidenced by weak industrial production and manufacturing employment. When those additional debased dollars are paid out as dividends, they confer no real increase in global purchasing power to shareholders. Similarly, just as inflation causes prices to rise for goods and services it causes stock prices to rise as well. Wall Street takes credit for nominal gains as if they were real.

However, as ridiculous as the phony GDP number was, the biggest joke was a report on global competitiveness put out by the World Economic Forum in Davos, Switzerland, which ranked the U.S. economy as the world’s most competitive. To arrive at this conclusion, the forum has obliterated the obvious under a mountain of theory. In determining country rankings, the WEF weighed strengths in their “12 Pillars of Competitiveness”, which completely ignored the measurable results of competitiveness, notably a trade surplus and a strong currency.

It is as if the WEF decided to judge a weight loss contest without using a scale, by instead focusing only on mental attitude, dedication, perseverance, and nutritional education! As a result the prize is awarded to the fattest contestant. Based on the empirical evidence of a gargantuan trade deficit, staggering global indebtedness, and a declining currency, the U.S. is clearly not the most competitive economy in the world.

Link here.


Wall Street’s capital at risk of wipeout.

There is a mystery on Wall Street. Merrill Lynch recently wrote off $8.4 billion in its subprime mortgage business, a figure revised up from $4.9 billion, yet Goldman Sachs reported an excellent quarter and did not feel the need for any write-offs. The real secret of the difference is likely to be in the details of their accounting, and in particular in the murky world, shortly to be revealed, of their “Level 3” asset portfolios.

From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks’ balance sheets. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models.

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which is twice Goldman’s capital of $36 billion. In an extreme situation therefore, Goldman’s entire existence rests on the value of its Level 3 assets. The same presumably applies to other major investment banks – since they employ traders and risk managers with similar educations, operating in a similar culture, they probably have Level 3 assets of around twice capital. The former commercial banks Citigroup, J.P. Morgan Chase and Bank of America may have less since their culture is different.

There has been no rush to disclose Level 3 assets in advance of the first quarter in which it becomes compulsory, probably that ending in February or March 2008. Figures that have been disclosed show Lehman with $22 billion in Level 3 assets, 100% of capital, Bear Stearns with $20 billion, 155% of capital and J.P. Morgan Chase with about $60 billion, 50% of capital. However those figures are almost certainly low. The border between Level 2 and Level 3 is a fuzzy one and it is unquestionably in the interest of banks to classify as many of their assets as possible as Level 2, where analysts will not worry about them, rather than Level 3.

Not only are Level 3 assets subject to eccentric valuation by the institution holding them, but the ability to write up their value in good times and get paid bonuses based on their capital uplift brings a temptation that few on Wall Street appear capable of resisting. Given that we have had five good years on Wall Street, years in which nobody has known the amount of Level 3 assets on banks’ balance sheets, it would not be surprising if many banks’ Level 3 assets had become seriously overstated, even without any downturn having occurred.

When Nomura Securities sold its mortgage portfolio and exited the U.S. mortgage business this quarter, it took a write-off of 28% of the portfolio’s value, slightly above the 27% of the portfolio that was represented by subprime mortgage assets. Were Goldman Sachs’s Level 3 assets similarly value-impaired, it would result in a $20 billion write-off, more than half Goldman’s capital, leaving the bank severely damaged albeit probably still in existence.

Defenders of Goldman Sachs and the rest of Wall Street will insist that less than 27% of their Level 3 assets are represented by subprime mortgages, yet that is hardly the point. Subprime mortgages, estimated to cause losses of $400-500 billion to the market as a whole, though only a fraction of that to Wall Street, have been only the first of the Level 3 asset disasters to surface. There is huge potential for further losses among assets whose value has never been solidly based. These would include the following:

The capital underlying Wall Street, at the top, is not all that large – a matter of a few hundred billion. Given the piling of risk upon risk that has been engaged in over the last few years, and the size of the losses in the mortgage market alone that seem probable, it appears almost inevitable that in a bear market in which liquidity dries up and investors become skeptical, Wall Street’s capital will be wiped out. Only the commercial banks like Wachovia and Bank of America whose investment banking ambitions have been largely thwarted, and whose portfolios of Level 3 rubbish are correspondingly lower, are less likely to disappear.

Given the size of the overall figures involved and the excessive earnings that Wall Street’s participants have enjoyed over the last decade, a taxpayer-funded bailout of Wall Street’s titans would seem politically impossible, however loud the lobbyists scream for it. In the long run, that is probably a blessing for the US and world economies.

Link here.


Credit crunch starts to claim high profile victims.

That one of the world’s top financial bosses is poised to join another in quitting in the space of just a week is remarkable enough. What is even more striking is the similarities in the two cases. Both Stan O’Neal at Merrill Lynch and Chuck Prince at Citigroup sought to change entrenched business cultures, made too many enemies, lost the confidence of their staff and were finally sunk by the storms in the credit markets.

Even some of Mr. Prince’s fiercest critics agree that, when he took over from Sandy Weill as chief executive in October 2003, he was the right man for the job. Citigroup was in deep regulatory trouble, particularly over alleged conflicts of interest in its equity research, and the priority was to head off the threat of further action againstthe company and senior executives. Mr. Prince, Citi’s highly regarded former general counsel who had a good relationship with key regulators, seemed perfect.

But as the regulatory problems receded, attention focused on his perceived shortcomings. Detractors said he had little feel for the businesses, having worked as a lawyer for most of his time at the company. His management style was attacked as bureaucratic and, like Mr. O’Neal, he was accused of removing executives who challenged him. A witty, thoughtful man with wide interests, Mr. Prince became increasingly isolated and autocratic, according to people who worked with him. Some have described him as “the accidental chief executive” who happened to be in the right place at the right time.

Former colleagues say Mr. Prince is very smart and very self-confident, which may explain why he sometimes said things he lived to regret. In 2004, he dismissed the idea of banks buying hedge fund managers as “flavor of the moment” and ruled out deals that diluted earnings. 2 1/2 years later, he spent an estimated $800 million on a highly dilutive hedge fund acquisition.

But perhaps the remark for which he will, unfortunately, be best remembered came in July when he said that Citi was “still dancing” in the leveraged buy-out business just as the cheap credit party was coming to an end. Now the music has stopped for Mr. Prince.

Link here.


The gentlemen at PIMCO are, once again, the leading cheerleaders for another round of easier “money”. Calling for the Fed to cut rates to 3.5%, Bill Gross commented, “The nominal [Q3] GDP number was 4.7%. Any time you get a nominal GDP growth less than 5% the economy is basically struggling. The U.S. needs at least 5% nominal growth in order to pay its bills on a longer term basis.”

I will, once again, take the other side of their analysis. First of all, 4.7% traditional nominal GDP growth would have easily in the past “paid its bills.” It does not get it done today – even with 4.7% unemployment – specifically because of a long period of gross monetary excess. For some time now, the U.S. economy has been hopelessly finance-driven, and the greater and more protracted the credit excesses, the greater the “transformation” of the economic structure. And it is the underlying real economy that today cannot “pay its bills” and is therefore hooked on ever increasing credit inflation. This should by now be recognized as the Road to Ruin. Contemporary finance and its operators should be held accountable.

The majority of contemporary “services” economic “output” is intangible in nature. The system creates various types of new financial claims (credit), and this new purchasing power spins today’s economic wheels. It seemingly works wonders during the boom, but the end result is an endless mountain of financial claims backed by insufficient real economic wealth-creating capacity. Nominal GDP would “pay it bills” today only in the context of monetizing additional debt – or inflating the quantity of credit to inflate “purchasing power” to inflate incomes and earnings – all in order to service previous borrowing excesses.

Admittedly, the Fed has opportunely administered several bouts of “reflation”. We have, however, reached the point where another round will be self-defeating. To put the immense scope of recent credit inflation into perspective, Credit Market Borrowings expanded an average of $1.233 trillion annually during the ‘90s (see chart above). Total borrowings accelerated to $1.694 trillion in 2000, $2.013 trillion in 2001, $2.365 TN in 2002, $2.767 trillion in 2003, $3.085 trillion in 2003, $3.380 trillion in 2003, and $3.825 trillion last year. It is this degree of credit creation that is today untenable and unsustainable at any interest rate.

The legacy of years of runaway U.S. credit excess includes many trillions of dollar liquidity balances circulating around the globe. Chinese reserves, for example, have inflated almost 7-fold in just 5 years. On the back of unprecedented global credit and liquidity excess, energy, food, precious metals and other commodities now attract intense demand and virtually unlimited purchasing power. Our economy – our financially stretched consumers and vulnerable businesses – will now have no option other than to bid against highly liquefied competitors for a lengthening list of resources. Failure to recognize that this situation is a major inflationary problem is disregarding reality. The same can be said for suggesting that we can continue on this current course – with massive current account deficits and rampant speculative financial outflows to the world fueling myriad dangerous bubbles and maladjustment on an unprecedented global scale.

Today’s backdrop is unique. There are literally trillions of dollars of liquidity slushing around the world keen to hold “things” of value. Liquidity sources include the massive central bank reserve holdings as well as funds at the disposal of the sovereign wealth funds. Importantly, the more apparent becomes U.S. financial fragility, the keener they are to stockpile real “things”. There is as well a global leveraged speculating community, in control of trillions of liquid purchasing power. The speculators are also keen to acquire (non-dollar) “things” as opposed to our securities. Indeed, it should be noted that this is the Federal Reserve’s first attempt at reflation where U.S. securities are not the speculators’ or foreign central banks’ asset class of choice.

Not only is the pool of potential global buying power unparalleled in scope. It is fervidly attracted to tangible assets – as opposed to U.S. securities – and is highly speculative in character. At the same time, an unwieldy global boom is stoking unprecedented demand in China, India, Asia generally, and the other “emerging” markets including Russia and Brazil. Throw in various weather related issues and energy production constraints and the prospect for some very serious bottlenecks and shortages has developed.

Granted, these dynamics have been evolving for some time now. What has changed is the speed and breadth of financial crisis enveloping the U.S. financial system. When I read of mounting energy and food shortages and witness the unfolding run on the U.S. financial sector, as an analyst I must contemplate the likelihood we have entered a uniquely unstable monetary environment at home and abroad. In short, the backdrop exists where incredible dollar liquidity flows could be released upon key things – notably energy, food, metals and commodities – already in severe supply and demand imbalance. Again, how much are the Chinese willing to pay for energy? The Russians for food? The Indians for commodities in general? How much will investors be willing to pay for precious metals as a store of value? How aggressively will the speculators “front run” all of them? Can the Fed afford to continue fueling this bonfire?

I have so far purposely avoided the unfolding U.S. financial crisis, a historic fiasco that took a decided turn-for-the-worst this past week. I will admit that I am rather amazed that key financial stocks – including the financial guarantors, “money center banks”, and Wall Street firms – were hammered yet the market maintained its composure. NASDAQ was actually up on the week. I will assume there is a confluence of great complacency and gamesmanship, with operators determined to play aggressively through year-end (bonuses and payouts).

I would not bet on the stock market holding 2007 gains for another 8 weeks. The credit meltdown is now moving too fast and furious. Importantly, confidence is faltering for the entire credit insurance industry, including the mortgage insurers and the financial guarantors. This is a devastating blow for the securitization marketplace, already reeling from pricing, liquidity and trust issues. The credit system has lurched to the edge of meltdown, while the economy has not even as yet succumbed to recession. It is absolutely scary.

The scale of the credit “insurance” problem is astounding. The OTC market for credit default swaps (CDS) jumped from $4.7 trillion at the end of 2004 to $22.6 trillion to end 2006. The total notional volume of credit derivatives jumped about 30% during the H1 2007 to $45.5 trillion. Total U.S. commercial bank credit derivative positions ballooned from $492 billion in 2003 to $11.8 trillion as of this past June. It today goes without saying that this explosion of credit insurance occurred concurrently with the expansion of the riskiest mortgage (and other) lending imaginable. It has got “counter-party fiasco” written all over it.

The stocks of Ambac and MBIA collapsed last week. I can only surmise that part of the selling pressure emanated from players caught on the wrong side of rapidly widening credit default swap prices. Since these companies have limited amounts of bonds trading in the markets – in debt markets generally suffering acute illiquidity – those needing to hedge rising default risk in this industry had little alternative than to aggressively short the stocks. And the faster the stocks declined, the wider the CDS spreads and the more “dynamic” hedge-related selling required. This dynamic could play out throughout the financial sector and beyond. The “dynamic hedging” (shorting securities to offset increasing risk on derivatives written) of credit risk today poses a very serious systemic issue.

The general inability to hedge escalating default and market risk has become and will remain a major systemic problem. Liquidity has disappeared, and there now exists an untenable overhang of risky securities and derivatives to be liquidated and/or hedged. Most playing in the credit derivatives market lack the wherewithal to deliver on their obligations in the (now likely) event of a systemic credit bust. The vast majority were “writing flood insurance during a drought,” happy to book annual premiums while expecting to purchase reinsurance/hedge if and when heavy rains ever developed. It all happened at a pace so much faster than anyone ever contemplated. So abruptly, the flood is now poised to wreak bloody havoc the scope of which was unimaginable – and there is no functioning reinsurance market.

Unlike this summer, this week saw the credit crisis engulf the epicenter of the U.S. credit system. Not surprisingly, the Fed rate cut only seemed to exacerbate market tension, with oil, gold and commodities spiking and the dollar faltering. Those arguing that the Fed needs to cut rates aggressively to avoid recession are disregarding the much higher stakes involved. There is today no alternative to a wrenching recession. The economy is terribly maladjusted, while the financial sector is at this point incapable of intermediating the massive amount of ongoing credit necessary to keep this Bubble Economy inflated. Wall Street is today faltering badly, now leaving the highly vulnerable banking system with the task of sustaining the ill-fated boom. The least bad course for the Fed at this point would have a primary focus on supporting the dollar and global financial stability.

Link here (scroll down).
Supermodel Gisele refuses to be paid in dollars – link.


In his latest book, The Black Swan: The Impact of the Highly Improbable, Nassim Nicholas Taleb points out that dopamine regulates moods and supplies an internal reward system in the brain, and that higher concentrations of dopamine lowers skepticism. Our innate desire to understand cause-and-effect relationships makes story telling one of the most effective means of communication. For most of us, it is easier to remember and relate to a story than reams of math figures. Eventually, we create our own narrative based on our perception of experiences. As we look back, after we have assigned a cause to an eventual effect, it seems to us that our past should have been much more predictable than it was at the time we experienced it. And, the longer we find information that supports our narrative, we feel more strongly, and are less skeptical, about the validity of our assumptions. Although there is nothing inherently wrong with this, we must be careful as we continuously assess facts and form conclusions.

We are watching this unfold in one of the hottest markets in the world today – China. A June 2006 Stratfor piece on China’s non-performing bank loans noted that four international financial firms had written of their concerns about China’s banks. “A turning point has been reached that will be difficult to ignore. ... [W]hen a series of reports from highly respected, mainstream analysts all come out within a few days of each other – with each, in their own way, telling the same basic story, it becomes hard for the system to dismiss that. That means that the huge structural imbalance of China, which these debts represent, must be rectified. And that process, as in all such matters, will be painful,” Stratfor concluded. What have millions of investors done since this information was presented since this June 2006 report? See for yourself.

In January of 2006, investors opened an average of 2,708 brokerage accounts per day. By August of 2007, the average had grown to 450,000 individuals accounts opened per day. Is the difference comprised of individuals who are thoroughly investigating companies’ economic fundamentals and the sustainability of their stock prices? Are they seeking to understand when these historic leaps will end, or are they looking for any story that supports the view that China’s markets will only go up?

One would have to have lived on another planet not to realize the public’s changing views of real estate as an investment over the past two years. And yet, since China is the land of unlimited investment possibilities, I would not be surprised if many of these same people have funds in the Asian markets. It reminds me of the condo flippers a couple years ago, who knew that real estate was a bubble, but were going to get out before the decline started. With the Hang Seng exploding upwards another 33% in the last two months, have the concerns that surfaced in June 2006 been cleaned up, or has the pressure from these real financial issues only grown more intense?

No matter how smart we think we are or how large a following we have garnered by pouring tons of other peoples’ money into any market that is exploding skyward, until these manic tendencies breakdown, we would do well to ask the following question. As the dollar’s devaluation propels markets higher and bullish and bearish sentiments hit historic extremes, what is my exit strategy? Am I aggressively looking for an exit, or am I looking for more stories to support why I am on the right side of the trend?

As a derivatives expert with over 25 years of experience at the highest levels of the global capital markets, in his new book, Traders, Guns & Money, Satyajit Das reminds us how fast public behavior and prices can change. He points out that while Long Term Capital Management watched its star rise, it used leverage of up to 25 times its capital base. But, with returns in excess of 40% in 1995 and 1996, the amount of leverage was not a concern. And though the returns were lower in 1997, Merton and Scholes, two of the men at the helm of the hedge fund, received the Nobel Prize for Economics that October. For most people, this solidified their story of successful investing.

However, by the fall of the next year, the real bond market, the real Russian economy, and the real government in Indonesia had become increasingly unstable. By September of 1998, LTCM had lost 92% of its capital, which increased its leverage to over 100 times its capital. Even so, Meriwether, the head of LTCM, stated, “We have had a serious markdown but everything’s fine with us.” On October 18th of 1998, LTCM’s principal broker, Bear Sterns (which still seems to be having a hard time remembering the history of highly leverage hedge funds) was rumored to have frozen the fund’s cash account following a huge margin call. After every possibility of a buyer was exhausted, the New York Federal Reserve facilitated a recapitalization of LTCM and 14 banks invested $3.6 billion in return for 90% stake in LTCM.

After the Federal Reserve quickly cut interest rates in early October of that year, the story of LTCM became buried in the roar of the bull run that took the markets into early 2000. Even today, I wonder how many investors, depending on buy and hold strategies, know the dozens of similarities between 1998 and the events that have been unfolding since July of 2007.

With the enormous increase in leverage since 1998, the vastly more complex array of exotic financial products, and the technology that allows large trades to move much faster than the fall of 1998, should investors, advisors, and traders, be waiting for reports from the few individuals who have been invited to private weekend meetings? Or, should we prepare our finance and business strategies before we read the various explanations of what went wrong, which will be based on erroneous cause and effect relationships?

Those who are sure that human psychology and crowd behavior is different this time, and that the “dollar will only go down and most other investments will only go up,” should be asking, “what happens after the dollar collapses?” Because of the dollar decline of the last few years, we have come to believe in a linear narrative of a “dollar collapse”. But, a study of history reveals cycles, forcing us to ask, “what will happen when this trend changes?”

Link here.


Why did the Federal Open Market Committee drop its official target rate for overnight bank loans on October 31? The obvious answer is that the FOMC feared a turndown in the economy. But minor decreases in the federal funds rate will not head off the recession. Greenspan’s boom is turning into Bernanke’s bust. A fraction of a percentage point’s decline will not alter the economic fundamentals.

The Fed is the front for the banking cartel. The banks have loaned money by the hundreds of billions to borrowers who then put the money into arcane debt instruments that are now visibly unraveling. The bankers have no clue as to how they can get their money back if these debt instruments become insolvent. These instruments are part of the carry trade: borrowed short and lent long. This is what brought down the savings and loan industry in the 1980’s. It threatens to bring down the banks today.

So, Bernanke must talk calmly to Congress in order not to spread panic. He must also take symbolic steps to keep Jim Cramer from going on TV and throwing another tantrum. Why? Because if Cramer is scared, his capital management peers are scared. If his peers are scared, investors who bankroll these carry trade schemes will stop putting in their money. This will end the trade. The banks will then get stiffed.

The banks are in a situation eerily similar to the Japanese banks in 1992. They are sitting on top of visibly bad loans, but they are allowed by bank regulators to keep these bad loans on their books at face value. This lets them stay in the lending business.

What the FOMC did on October 31 is nothing less than a stock market bailout “to protect lenders and investors from the consequences of their financial decisions,” which Bernanke earlier claimed was not the Fed’s responsibility. Conclusion: “Economic effects felt by many outside the markets,” as he phrased it, were about to become very painful. The Fed is trapped by the stock market, with Cramer as its vocal spokesman. He called for a “Bernanke put” back in August, and Bernanke gave it to him. Twice.

What is the focus here? The financial markets, not the underlying economy, which is said to be “solid”. This is consistent with the FED’s real purpose in life, to protect the banking cartel. The banking cartel has loaned a lot of money to the financial markets.

The economy is facing the prospects of drip-drip-drip bad news from the housing sector. It is also facing similar bad news from what I call the carry-trade sector – borrowed short, lent long. The lure of Greenspan’s low interest rates did to the domestic debt market what the lure of Japan’s low interest rates did to the worldwide bond market. The smart money borrowed short and bought long-term income streams. Now the flow of short-term money has stopped because of fear regarding the solvency of the organizations created to serve as the middlemen.

Because the reduced flow of investment money into subprime mortgages, the mortgage market is in turmoil at the margin. The same is true of the CDO market. Nobody knows what the market value is for the high-risk portions (tranches) of these broken-up credit instruments. The investors played “street smart” for years. They never asked what the exit strategy was, or what discount the secondary market would impose when it was time to run toward the exit.

Investors are now asking about the exit strategy. There is none. There is no phone call from the New York Fed over the weekend to put together a bailout plan for a single overextended firm. There are too many overextended firms.

The Fed is now learning that fooling around with the FedFunds rate is not going to solve the solvency problem. It will be six weeks until the next FOMC meeting. If it intervenes ahead of time, this will send a loud signal: “It’s panic time!”

The Fed has shot its wad. It was a pellet gun fired at a charging elephant. Now the bears take over. The economy will not be far behind.

Link here.


Things like its skill in landing new deposits and the conservatism in its loan-loss cushion.

The recent earnings disasters at banks like Citigroup, Washington Mutual and Bank of America have put a spotlight on the industry’s exposure to falling home prices and risky loans. The upside? Bank shares are cheap. If you know how to pick through the rubble, you can find some bargains.

After falling 13% over the last year, vs. a 13% increase for the S&P 500, the largest banks are selling for 1.6 times book. Clearly Wall Street does not expect much good to come from this sector. Banks’ rich dividends, now an average 3.5% of share prices, are not tempting enough.

With home sales falling and lenders not finished writing off soured mortgages and loans – witness Citigroup’s $3 billion charge in mid-October – you need to be careful. A stock could be cheap for a good reason. Shares of Countrywide Financial were trading well below book in August. Then the bank announced it was tapping into an $11.5 billion line of credit, stoking fears of bankruptcy. Its stock plunged 30%.

The two basic measures of bank stocks are the price/earnings ratio and the price/book ratio. Small investors pay more attention to the former, merger brokers the latter. But these two are just a starting point. In this, our 13th Beyond the Balance Sheet installment (previous editions included retailing, earnings quality, capital expenditures and corporate governance), we examine banks using six other metrics. Our source is Kristoffer Niswander, a senior bank analyst at the Charlottesville, Virginia research firm SNL Financial. No single one of these metrics can tell you if you should buy or sell a stock. Together, they hint at whether a low-multiple stock deserves its throwaway price or not. The universe for these tables consists of the 100 largest U.S. banks by assets.

The first metric looks at deposit-gathering skill. The “core” deposits SNL cares about are in accounts smaller than $100,000. These are (usually) a cheap source of lending capital. Beyond $100,000, you are mostly looking at hot-money CDs that cost the bank more in interest payments. The key question: Can a bank land new deposits without running up much in the way of increased expenses?

For years Commerce Bancorp (NYSE: CBH) used perks like the added convenience of being open on Sundays and financial workshops for kids, pampering its customers so it did not have to pay competitive interest rates. Commerce ran up an additional $1.32 in higher expenses to land every $100 of new core deposits over the last year. Citigroup’s comparable measure was roughly five times that. TD Bank just paid a rich 2.9 times book value for Commerce.

Sapped appetite for mortgage-backed securities and other derivatives has meant hefty charge-offs for some banks already. Our measure here is the ratio of loans being held for sale – which usually means loans in the process of being packaged into securities – to loans held for investment – which accrue monthly interest for the bank. A high ratio suggests that a bank is exposed to risk in the less liquid secondary market. IndyMac Bancorp’s 10.7% yield is tempting. Its pile of loans for sale tells you to be wary.

“Reserves are at historic lows,” says Niswander. “Forget 10% to 20% increases. We could see reserves double next quarter.” Citigroup, for instance, ran through 99% of its reserves for loan losses in one year of charge-offs. Citi, of course, was replenishing the reserves as it went along, but the fast pace of charge-offs suggests that it will have to step up the replenishment rate, hurting earnings. Hudson City Bancorp (NASDAQ: HCBK), on the other hand, a conservatively run savings and loan (98% of its loans are first mortgages), has not booked a charge-off in six months.

You do not want to own a bank too heavily exposed to home building. At Zions Bancorporation (NYSE: ZBPRA) this ratio is 24%, with most of its construction loans going to home builders. Thus far the bank’s earnings have been terrific and it has had few problems with defaults. But Zions does significant business in the Southwest, where the hot real estate market of the past few years appears to be cooling.

The efficiency ratio is defined as a ratio of overhead costs (salaries, rent and so on) to revenue. The top spot again goes to Hudson City.

Link here.


Value trap unfolding among the bank stocks?

Imagine that you recently borrowed your friend’s car and now you cannot seem to find it. It was not stolen, nor towed. You have simply misplaced it. You are in trouble, and your friend is definitely going to be angry. Is now not the best time to also tell him any other bad news that he may have coming to him? He is already mad, how much worse could it get? Apparently this rationale is also applied by some of the country’s largest companies.

In September at the Lehman Brothers’ Financial Services Conference, Citigroup’s CEO of North American consumer operations, Steven Freiberg, boasted, “Where you think there would be a fire – in our subprime portfolio – it actually looks pretty good.” He even provided a chart showing Citigroup’s industry-beating mortgage-delinquency stats. Three weeks later, Citigroup announced that its Q3 net income would fall roughly 60% from a year earlier, blaming “dislocations in the mortgage-backed securities and credit markets, and deterioration in the consumer credit environment.” Apparently, “pretty good” in the current environment is “pretty dismal”.

Additionally, Citi disclosed that its securities and banking unit would be writing off $3.3 billion worth of losses – a large figure for even a megabank like Citi. This loss stems from its LBO-related leveraged loan commitments and the frozen CDO market. The most troubling part of this preannouncement was the $2.6 billion increase in credit costs in Citi’s global consumer business. Nearly $2 billion of this was an increase in Citi’s loan loss reserve (the bank’s estimate of the losses it expects to take on its loan portfolio). This large write-off was a clear message from Citi that the credit quality of its loans is deteriorating much faster than expected.

Many more dismal announcements from the banking industry were expected, and last week that is exactly what we got. Merrill Lynch reported a $2.4 billion loss for the quarter following its massive write-downs. Merrill was the only one of the five largest investment banks to end the third quarter in the red. This was capped off by the retirement of CEO Stan O’Neal.

Once a major asset bubble pops – and the housing bubble was one of the largest asset bubbles of all time – the companies at the center of the mess usually try to take their lumps in a single quarter, often referred to as a “kitchen sink” quarter. By cramming losses and write-offs into a single quarter, they try to give Wall Street the impression that the bad news is out of the way and nothing but blue skies are ahead.

This game works very nicely sometimes ... especially among gullible investors. But “kitchen sink” quarters have an inconvenient way of recurring. It is improbable to believe, for example, that banks will be able to cram five years of reckless lending into a single quarter of write-offs. “Kitchen sink” quarters will occur repeatedly in the financial sector, just like they did in the tech sector after the dot-com bust of 2000. Cisco, Intel and Corning reported a series of disappointing quarters.

The homebuilders are also playing the “kitchen sink” game, as Lennar and KB Home demonstrated in their most recent horrid results. Both of these homebuilders sliced large chunks off of their book values by writing off $848 million and $690 million worth of shareholder equity, respectively. These massive write-offs illustrate how much raw land inflation and irrationally priced finished homes were hiding in the homebuilders’ inventory accounts. The most indebted homebuilders will likely experience some form of bankruptcy.

A little over a year ago, I wrote an article entitled, “Are Homebuilder Stocks Actually Cheap?” in which I warned that low price-to-earnings and price-to-book multiples were deceptive: “The measure of book value for most homebuilders will be a moving target in the future, as further inventory charges and margin compression is very likely. So the argument that homebuilders are cheap rests on shaky accounting and extrapolation of the past into the future. That adds up to a ‘value trap,’ in my opinion.”

I see a similar value trap unfolding among the bank stocks. Most of the analysis I read does not extend much beyond the parroted mantra, “Bank stocks are cheap on a price-to-earnings and price-to-book basis.” Citi’s earnings preannouncement reminds us that earnings and book values only reflect past results, not future results.

But for the moment, very few investors seem to fear the uncertainties of the future. So financial stocks have rallied on the garbage rationale that “bad economic news is cause for celebration because it will bring more interest rate cuts from the Fed.” Unfortunately, negative surprises on bank balance sheets will far outweigh any benefits they receive from Fed rate cuts – benefits that tend to restimulate the credit creation process only after a very long time lag.

On the recent Fed rate cuts, the financial markets are flashing many glaring signs that monetary inflation is spiraling out of control. Fed Chairman Bernanke has received ample opportunities to establish his credentials as an inflation fighter. Despite gold and commodities soaring, and most global stock markets either approaching or blasting through July peaks, Bernanke has decided that federal rate cuts could not be put on hold any longer.

Last week the fed decided to cut interest rates by a quarter point in response to the credit and housing crises, and their potential to seep into other markets. The fed still has their eye on inflation, and has stated that further rate cuts should not be expected. Indeed, if the dollar continues sinking – and commodities continue soaring – rate cuts may be on hold permanently ... and that is when the real carnage in the finance sector might begin.

Link here.


Thought-provoking and myth-challenging, it will delight those who value liberty.

Mobs, Messiahs, and Markets (MM&M) provides insights that run counter to the propaganda spewed by the mainstream media. Thought-provoking and myth-challenging, it will delight those who value liberty. People who believe the government is “here to help you” or that the tooth fairy really does leave coins under your pillow will not like MM&M. That is their problem.

MM&M looks at how and why people do stupid things en masse. Understanding how mass manipulation works can help you avoid trotting off the cliff in a herd of lemmings, so this stuff is good to know. One of the tools of mass manipulation is the really big lie. Quite adroitly, MM&M looks at specific lies and gives them a sound thrashing.

An example of a really big lie is that Alan Greenspan did a great job as Chairman of the Federal Reserve. Anyone who has paid the slightest bit of attention to the economic data knows that is false. But prior to reading MM&M, I thought he was just incompetent. The truth is far worse. The truth is that Greenspan’s collusion with the Clintons amounted to a theft of half our assets and half our income. He accomplished this theft by undermining our currency so much that the dollar lost half its value during his reign.

Look around. Now, imagine someone barges into your home and burns half of everything you own, including half your home. While the flames are still roaring, they access your investments, retirement accounts, and any other liquid or not so liquid assets of yours and take half of those, as well. Just as the fire trucks roll up, your boss calls and tells you that from now on your wages will be 50% less, after taxes. I have just described exactly what Greenspan did to middle class Americans and the poor.

Doesn’t this make you wonder why he is not in prison? If you steal only $1,000 and use the money to feed your kids, that is grand larceny. You go to jail, and the newspapers call you a felon. But if you steal trillions of dollars (not just billions) to abet the shenanigans of a few unscrupulous people who have wheedled their way into political office, you get an excellent pension and the newspapers call you “The Maestro”. Go figure.

I personally do not enjoy the witty ripostes that permeate the book. The barbs are creative, and many people will be amused, but to me the reality is farcical enough already. What makes MM&M valuable to me is how the authors use facts and logic to debunk frauds and delusions in a definitive manner. The book should be required reading for anyone wishing to participate as a citizen. I also highly recommend it for anyone who has bills to pay.

Gold and central banking.

As I read Mobs, Messiahs, and Markets, I kept nodding in approval. Yes, these folks have done their research. Then, I got to the last chapter and things suddenly changed. The last chapter promotes the tired old “gold as a defense” notion. Accepting that particular notion as reasonable requires suspending several laws of economics, commerce, and finance. And it requires ignoring a large body of long-established basic facts. While the rest of the book was insightful, this chapter bombed in the “fundamental understanding” department. If you are stuck on the gold notion, of course, you can cherry pick what you want to “prove” you are right.

Tying a currency to any commodity is exactly the kind of central planning that the authors rail against. Instead of letting the market decide the value of the currency (with a central bank to guard against inflation), some central authority pegs it to an industrial metal (which does not guard against inflation, as history proves). Then the supply of that metal fluctuates to one rhythm while the general market fluctuates to another. This creates many wealth-inhibiting problems, which is why we do not do it anymore. If you want commerce to grind to a halt, put us on the gold standard. Watch the bread lines form, shortly thereafter.

Now that I have addressed the part of the book that should be revised (the misinformation about gold), I have to say the rest of the book is spot on. It is no exaggeration to refer to our public policies as spectacles. Or worse. The way the authors address these spectacles is great, and they provide a badly-needed counterbalance to the lies and lunacy that people are inundated with.

The book has a fairly high page count, but it is a quick read. It is divided into six Parts. Part One is titled “A Critique of Impure Reason” and contains three chapters. This presents a theme the book revisits throughout, and that is of the person who is determined to make the world a “better” place by making it conform to his/her delusions. Hitler was such a person. The book takes shots at several incompetent and/or downright crazy people who have led one nation or another into an expensive debacle or even complete ruin. Some of the blunders were monumentally stupid. And as we see, monumental stupidity is a recurring theme in government.

The first chapter of Part Two talks about the witch hunts that we look back on as examples of hysteria today as in, “We would never do that.” Don’t be so sure. The second chapter talks about how the media inflame war rhetoric and create news rather than report it. That is one reason I do not read newspapers. Nor. television. I have a machine to wash my clothes and another to wash my dishes – I don’t need one to wash my brain.

Part Three talks about the futility of war. I like the example of how France loses wars yet still is sovereign France. Winning or losing does not seem to matter. Germany lost two world wars, but what language do Germans speak today? Was any war ever worth its high cost? The authors ask why there was an American revolution. The people of India, Australia, and New Zealand were able to obtain their independence from the British Empire without firing a shot.

A particularly enjoyable area in The Flattening the Globe (title of Part Four), is where the authors take on Thomas L. Friedman. This is the guy who wrote the whacked out The Lexus and the Olive Tree and actually got it published as nonfiction. Having read relatively smarter material on bathroom walls, I never made it past the first 20% or so of the book. Bonner and Rajiva wrote counterarguments to Friedman’s absurd assertions, to illustrate some interesting points. The explanations were quite entertaining, and in themselves justify buying the book.

To understand what a Bubble King is, read Part Five. We get a good expose on the lunacy of price runups, speculation posing as investing, national fiscal policy (such that it is), and other “suckers apply here” scams that snag millions of people who eagerly line up to be fleeced. The real kicker is Chapter 15, “The Mother of the Mother of All Bubbles”. Here, we get an analysis of the most important financial topic relevant to today. Understanding it will prevent you from becoming just another donor to the ultra-wealthy.

The last chapter lurches suddenly into lala-land, as noted earlier. The book purports to tell you how to survive the public spectacle in politics and finance, but does not. However, there is still the rest of the book to enjoy and learn from. The authors poke right through the veneer of deception that seems to cover most everything that is financial or political these days. And just being able to see the reality will help you avoid following a herd of lemmings over a cliff.

Book review.


Las Vegas is all about status. The average tourists come here to “get drunk and be somebody,” the country song explains. Those who move here quickly learn that success is often determined by who you know, or who you know who can put in a good word for you. And the rich and famous who come here to see and be seen wake up everyday worrying about whether their adoring fans still think them worthy.

Author Alain de Botton examines the worry that we are not conforming to what society believes success is, in his beautifully written Status Anxiety. In de Botton’s view, “If our position on the ladder [of success] is a matter of such concern, it is because our self-conception is so dependent upon what others make of us. Rare individuals aside (Socrates, Jesus), we rely on signs of respect from the world to feel tolerable to ourselves.”

The author breaks the book into two major parts, spending roughly a third on the causes of status anxiety and the remaining two-thirds on solutions. He spends much time on expectations as a cause of status anxiety. The industrial revolution brought people in to town from the farm, and, by the late 1800s, “[g]oods and services that had formerly been the exclusive preserve of the elite were made available to the masses. Luxuries became decencies, and decencies necessities,” de Botton writes. That is what capitalism does when left to operate unfettered. But these advances bring with them expectations and the expectations bring on envy and status anxiety.

Alexis de Tocqueville titled a chapter in his seminal Democracy in America, “Why the Americans Are Often So Restless in the Midst of Their Prosperity”. “When inequality is the general rule in society, the greatest inequities attract no attention,” de Tocqueville observed. “But when everything is more or less level, the slightest variation is noticed.”

In his chapter on meritocracy, de Botton makes the trenchant point, “Once the partridge shooters had been ejected from the Civil Service and replaced with the intelligent offspring of the working class, once the SATs had emptied Ivy League universities of the witless sons and daughters of East Coast plutocrats and filled them instead with the hardworking children of shop owners, it became harder to maintain that status was the result entirely of a rigged system.”

The author offers up philosophy, art, politics, religion and bohemia as solutions to status anxiety. Ancient Greek philosophers were not worried about status, because they held themselves in such high esteem intellectually. Socrates, according to de Botton, when asked about being insulted in the marketplace, replied, “Why? Do you think I should resent it if an ass had kicked me?” Later in 1851, Arthur Schopenhauer wrote, “Other people’s heads are too wretched a place for true happiness to have a seat.”

Art, both in the written word and paintings, “can challenge society’s normal understanding of who or what matters.” Politics determines status through the prevailing ideology of the day, and religion, through churches and the social framework, serves to place spiritual matters ahead of earthly power.

The final chapter on bohemia focuses on a rather small group that, in the author’s words, “set themselves up as saboteurs of the economic meritocracy to which the early 19th century gave birth.” Never mind that many of these bohemians were rich members of the elite.

Henry Thoreau is mentioned as one of the most renowned bohemians. His famous stay at Walden Pond led him to write, “Most of the luxuries, and many of the so-called comforts of life, are not only not indispensable, but positive hindrances to the elevation of mankind.” Man has insatiable wants and constantly attempts to improve his lot in life. And for those with no spiritual or philosophical grounding, that means increasing status anxiety.

“Life seems to be a process of replacing one anxiety with another and substituting one desire for another – which is not to say that we should never strive to overcome any of our anxieties or fulfill any of our desires,” writes de Botton, “but rather to suggest that we should perhaps build into our strivings an awareness of the way our goals promise us a respite and a resolution that they cannot, by definition, deliver.”

Book review.


“New car sales fall as buyers shun debt,” says a Wall Street Journal headline. Just what we expected, but so long coming we had begun to wonder. Americans represent nearly 20% of the world’s consumption. And the U.S. economy, too, is more dependent on consumption spending than any economy ever has been. If American consumers do not spend more, the whole shebang falls apart.

We are witness to something that does not happen very often – like the eruption of a volcano, or the collapse of a bridge – the first stage of a credit contraction. So far, the effects have made the headlines, but it has not yet affected most people. So far ... Only at the top and the bottom of the credit structure are people getting pinched, squeezed and punished.

At the bottom, of course, are the ordinary homeowners. “I have got a tiny little house on the edge of London,” explained a colleague. “I’ve got to sell it, because I put a contract in on another place. But it has been on the market for three months now, and only four people have even looked at it. I’m getting very nervous. ... The problem is that it is a starter home. And the banks don’t want to lend to people who are buying starting homes. They are the worst credit risks, because they don’t earn much money and don’t have much in assets. ... But this is completely different from a couple of years ago, when the banks would lend to anyone ...”

The people at the bottom are beginning to feel anxious. Many have never, ever seen a time when house prices were not rising and mortgage credit was not readily available. Many loaded up with debt when the going was good. Now that the going ain’t so good, they regret it.

House mortgage debt in the U.S. grew by $10 trillion since 1999. As a percentage of disposable income, it rose from 64% to 100% – with more new debt added than in the previous 45 years combined. Add in consumer installment debt and the ratio rises to 131%.

Of course, when you add that much financing to a society, the financing industry is bound to make money. As a percentage of profits, more and more of America’s profits have come from “financing” as opposed to manufacturing. Wall Street got rich, handed out billions of bonuses, built mansions in the Hamptons and in Greenwich, Connecticut, bought huge collections of monstrous art ... and generally made itself obnoxious.

But now, at the upper end of the credit structure, Wall Street firms are getting sold off. After billions in losses, shareholders are giving CEOs the old heave-ho. First, Warren Spector of Bear Stearns got axed. Then, it was Peter Wuffli at UBS. He was followed by Stan O’Neal of Merrill Lynch. O’Neal made the headlines for generating two big numbers – the largest losses, at an estimated $18 billion, and the largest “golden parachute”, at $180 million. What are compensation boards thinking? Why not give the guy a kick in the pants instead? They must think shareholders are idiots; and they are probably right!

After the O’Neal story died down, along came Chuck Prince of Citigroup – America’s largest bank. The firm is expected to write down $5 billion this quarter. Chuck was chucked out. And today’s news brings a new victim – H&R Block finance chief Trubeck.

Between the honchos at the top and the householders at the bottom are thousands of deals, and millions of ordinary people. The deals are feeling the pressure. “Bond issuance plunges,” reports Bloomberg. And “default swaps” – a form of insurance against bad loans – are rising to record prices, indicating a level of fearfulness not seen on Wall Street for many, many years.

The people in the middle must be getting a little sour, too. When the financing for deals slows, so do the new projects ... the new companies ... and the new jobs. And so does the financing for new houses ... and new cars ... and all the other new things that make an economy grow ...

Let’s return to the numbers above. $10 trillion in new mortgage debt was added in the U.S. over the last seven years. That debt is another potential source of deflation. Yesterday, we looked at the bull market in gold. We wondered how and why it might come to an end. If the credit contraction were to worsen, we concluded, the price of gold – in dollars – might go down.

When credit expands, more money enters the system, and prices rise. But then, there comes a time when the debts must be paid. Then, people have to take money out of the system. They have to cut back on their expenses in order to put aside the money to pay back the loans. The credit contraction phase is typically a phase of falling prices. As more and more currency is withdrawn in order to pay debts (and, incidentally, build up savings), less and less currency is available to buy things.

But wouldn’t the financial authorities simply emit more paper money? Ah, yes, they would try. But what we learned from Japan is that once a credit contraction begins, it is very difficult to reverse. The Japanese tried monetary policy – with a central bank lending rate of “effectively zero”. They tried fiscal policy, with the largest government deficits in the developed world. Still, prices fell.

Ben Bernanke has spent years studying the Japanese example. If we ever got in that sort of jamb, he says, he would drop money from helicopters in order to break the contraction cycle. We are a long way from there. So far, we seem to be only at the beginning of a credit contraction.

The average person does not even feel it. When the squeeze begins, only the outer edges feel it first – the top and bottom of the credit structure. But will it eventually involve everyone ... and will the Bernanke Fed need to drop money from helicopters in order to get the economy moving again? Maybe ... but then we would really see the price of gold soar!

Link here.


Not that you should care about that benchmark.

Bernanke cut rates once again. Markets responded. The Standard & Poor’s 500 Index rose an admirable 1.2%. Investors cheered. The S&P, the world’s benchmark index, has returned just over 9% year-to-date – not half bad.

But how much money are you really making if your portfolio “beats the market?” Unfortunately, beating the S&P has become like a golfing handicap, a number that gets bandied about, and maybe embellished a point or two, to impress any financial “mind” polite enough to listen. The reason is simple. For most, investing has become a game ... a competition ... a proverbial fight to the finish that separates the winners from the losers.

But why does the S&P serve as the lone benchmark? When the annualized returns (in local currency) of the most world’s 23 most developed markets are stacked up against one another, beating the S&P looks about as impressive as the Pittsburgh Steelers beating the Pittsburgh Panthers. When you break down the 3-year and 5-year returns of the 23 most established world markets, the results are even more intriguing. Again, I ask: How much money are you really making if your portfolio “beats” the market?

For better or for worse, the markets are global today. Even the companies representing the S&P 500 Index now derive 49% of revenue from foreign markets, up from 30% in 2001. Meaning, a vote for the S&P also means a vote for globalization. So if the next time your broker assures you he can beat the S&P, you may want to listen. It should not be that hard. Just buy about any other developed market index but the S&P.

Link here.


Small-cap profits on a backdoor play on the solar energy boom.

The supply and demand for silicon shows a very favorable outlook in producing a bull market. I would like to start this discussion with the supply side – specifically, refineries. Silicon is the second most abundant metal on Earth. 25.7% of the earth’s crust is made of silicon. SiO2 is one of the most common ways that you find silicon. The coming shortage is not a lack of silicon per se. It is the limited refining capacity.

The process of refining silicon is rather expensive. First, all impurities must be purged. The oxygen is removed from the silicon through a reaction with carbon. This process is usually done by adding some form of coal and then heating the product in a special furnace at temperatures of 2,700-3,600 degrees Fahrenheit. This grade of silicon is approximately 98% pure.

To make semiconductor-grade silicon, the metal needs to undergo still more processing. It needs to be combined with HCl, removing some additional impurities such as aluminum and iron. The final step takes the SiHCl3 and reacts it with hydrogen for 200-300 hours at 2,000º Fahrenheit to produce a very pure form of silicon. The pure silicon is formed into rods measuring two meters in length and 30 centimeters in diameter. These rods are then sliced 0.5 millimeters thick, and you have your silicon wafer, which is the final product used for photovoltaic cells.

It is very easy to see why the energy input costs of creating semiconductor-grade silicon are very expensive. It is also very expensive to increase refiner capacity. German silicon refiner, Wacker Chemie, e.g., has undertaken a project to expand its refining capacity from 5,500 tons to 9,000 tons. The price tag on this project? Over $270 million. The high cost of refining and adding additional refining capacity can deter companies from embarking on new silicon ventures, and that is exactly what has happened. It would take a large demand shock to push the prices of silicon to sustained high enough levels to make it economical for refiners to add more capacity.

This is the fundamental idea behind a commodity supercycle. In a commodity supercycle, getting additional supply online to meet growing demand takes time and money. The market needs to be assessed, funds need to be raised, permits need to be obtained, and finally, the project needs to be started and finished. The time lag consists of a supply shortage met by higher prices. The shortage and price increase can also be judged or predicted by the size of the demand shock. And this particular demand shock is one of great significance.

So why is this demand shock going to be so noteworthy? Simple. Where renewable energy goes, the footsteps of government subsidies can be heard close behind. As proven with ethanol, government money can make a bull market out of nothing. But what happens when the market is actually economical on its own, but is then combined with taxpayer money? You get a huge, stinking demand shock.

California, for example, has recently announced a solar energy program that would make it third largest user of solar energy in the world, behind Germany and Japan. There are many other similar forms of legislation that are either already passed or in the process right now. We are seeing the green wave take hold around the globe. Silicon is also used in cell phones, computers, and MP3 players, but its greatest use is definitely in the solar market. Solar energy currently makes up approximately 50% of the demand for silicon, and that number is rapidly increasing.

From 2000-2004, the number of annual PV cell installations nearly quadrupled. In that same period, the price of silicon went from $9 per kilogram to nearly $30 per kilogram. The market for solar-grade silicon currently is estimated to be around $2.3 billion. By 2010, it is expected to rise to $10.4 billion. With solar taking up a higher and higher percentage of the silicon market, you can expect to see an even stronger correlation between the growth in the solar market and the price increase in silicon.

PV installations quadrupled from 2000-2004. The price increase in silicon over that same period was 230%. Interestingly, in 2000 there was excess refiner capacity. The increase in demand was met by spare refiner capacity, and still a 230% increase in price followed. What happens when PV installations quadruple again, but this time spare refiner capacity is not able meet the growing demand? Your guess is as good as mine, but I can promise that the shortage in silicon will result in some spectacular price action in the silicon market.

Silicon refiners are set to experience the greatest gains in the solar market. PV producers will be forced to pay higher input costs to produce their modules because of silicon shortages. With government subsidies and tax breaks, they will be more than willing to pay these higher prices, allowing for the price of silicon to continue its bull run. Although the profit for solar producers will be hurt by higher silicon prices, the refiners will be in a position to experience tremendous gains. Playing the solar market from a commodities perspective is the best and safest way to profit off the solar energy boom.

One of the refiners producing solar-grade silicon that I think is set to profit off the coming bull market for silicon is Tokuyama Corporation (Tokyo: 4043). Tokuyama is mainly traded on foreign exchanges, but you can also trade it here in the U.S. over the counter under the symbol TKYMF. These guys have experienced increased revenue from their sales of silicon, and as the price of gray gold continues to push up, look for Tokuyama’s stock price to also experience large gains. But it is not the only one set to profit from this market. We will follow this trend and bring you profit opportunities as they come.

Link here.


Last week I mentioned how silver was underperforming gold at this present time but demonstrated that this was something to be expected. Silver lags gold at the beginning of a bull leg up but as if to compensate this seeming conundrum, silver will assuredly be outperforming gold at the end of the same bull leg!

But what of a further question that may be asked? Gold has now closed above $800 for the first time since January 17th 1980. One may naturally ask what the price of silver was at that time and the answer would be $40. But of course, silver is instead just under $15, so what gives? If silver is going to emulate 1980 then it has some serious shifting to do in the next 10 months or so before this particular bull wave ends. Can silver go from $15 to $40 in a matter of months? Well it is possible since the same feat was achieved during the “Hunt Spike” in a mere matter of four months. So nothing can be excluded but neither is it assured.

But again why is silver not at $40? The answer is because we are not at the same point in the commodity super cycle that we were back in 1980. This is more like 1960 than 1980. This commodity super cycle, or the Kondratyev inflationary upwave as others call, it has a long way to go yet. Silver will reach $40 and assuredly go much higher in the years ahead but for now we take each bull leg at a time.

With that in mind, we briefly look at something we need to see if we believe this is a real silver bull market. That is silver rising in various international currencies. The charts below show the silver bull market in six major world currencies. Despite their fiat vagaries and rising values against the U.S. Dollar, silver is in a bull market in each and every one of them. All we await now is the final push onto new highs.

The only curiosity about two of these silver graphs is silver in Yens and Canadian dollars. While the other currencies made their last major highs back in April-May 2006, silver went onto make new highs in the Yen and the Loonie in February this year. That is an interesting one for Elliott Wave analysts, but for now we need only point out that the new highs were not confirmed by the other currencies and hence were false flags.

So we await the international bull market in silver to resume very soon as old highs are taken out across the globe. On our charts the Australian and Canadian dollars seem furthest behind in catching up. If you are ultra-cautious you may wait for these laggards to catch up. As for me, I am not waiting, gold is making new highs and silver will surely follow!

Link here.


Gold sets new all-time high in British pounds sterling.

Are they still waiting for a new all-time high, perhaps, even after watching the metal beat stocks and bonds for more than 6 years? Well, a new all-time high in the gold price just came for British investors. You might not think that is possible, what with the pound sterling now breaking new 25 highs against the dollar above $2.06.

You might think it laughable for me to say the pound is weak, given the absurd cost of living here in London. At current exchange rates, a pack of cigarettes cost me nearly $12 this weekend. Sure, maybe I should quit ... but do I also need to stop taking the tube (now more than $8 for a single journey), eating lunch (up to $6 for a factory-made ham and cheese sandwich), or going to the cinema (at least $20 before you buy popcorn)?

The financial media, meanwhile – even when they deigns to comment on gold, formerly the axiom of Britain’s dominant position in world trade and finance at the height of its empire – remain fixated on the dollar price of gold. Why? Because dear old Blighty is free and clear of the problems causing the U.S. dollar to sink against gold, right? But not according to gold, we ain’t ...

“Debt-ridden Britons owe £216 billion [$445 billion] on credit cards and unsecured loans, but are refusing to rein in their spending,” reports the Metro newspaper given away free on the tube today. The British nation is growing its household debts by more than $6 per day for every man, woman and child – excluding the government’s outstanding debt, valued above $1.18 trillion by the end of the 2006-2007 tax year. In short, personal debt in the U.K. – home to the “strong pound” – is now rising by $1 million every four minutes. Total household debt stands above 160% of personal income, and it has just overtaken an entire year of economic output.

Outstanding government debt, meanwhile, is equal to another 42.6% of GDP, the highest proportion in nearly a decade. It also happens to be 10 years since the British nation last managed to break even on its international trade in goods and services. Our balance of payments deficit reached more than £48 billion in 2006 (nearly $98 billion), more than 10 times the worst gap of the mid-1970s, back when the trade gap threatened “a violent withdrawal” of foreign investment, according to internal government memos. Energy Minister Lord Balogh, an economist by trade, privately warned the prime minister of a “possible wholesale domestic liquidation starting with a notable bankruptcy ... The magnitude of this threat is quite incalculable.”

The risk of a run on the pound in the mid-‘70s became so great – provoked in no small part by government debt hitting 53.8% of annual GDP – that Britain, led by a Labor government just like today, begged the International Monetary Fund (IMF) for a bailout to help it cope as unemployment and inflation reached “exceptional levels”. The pound began its long descent from $2.42 to barely $1.08 over the following decade, while unemployment rose to 10% of the working population as inflation surged above double digits annually between 1973-1982. Still, it couldn’t happen today!

“Expect a sustained knock-on impact of the recent credit crunch on the wider [U.K.] economy,” warns David Miles, chief U.K. economist for Morgan Stanley in London. He is not being alarmist, but simply summarizing the Bank of England’s own view, as stated in its recent Financial Stability Report. In particular, the BoE fears the rise in the price of credit will push far beyond the spike in short-term London money market rates. “Partly that is because risk premiums and profit margins for lenders had been squeezed to unsustainable levels,” explains Miles.

Now lenders are looking to make money by lending wisely – and at a profit – once again. Hence the collapse in new mortgage lending seen in September. New mortgage lending in fact sank by 27% from September 2006, according to the British Bankers’ Association’s latest data. First-time buyers are “potentially vulnerable” to the threat of falling house prices sparked by this collapse in new lending. Added to higher interest rates, the “sharp increase in the proportion of new mortgages with high loan to income multiples since 2004 has resulted in interest payments reaching 20% of first-time buyers’ average incomes,” says the BoE, “the highest share since 1991” – the banner year for the last crash in U.K. house prices.

Private investors playing the property market may be even worse off, however. “Net rental yields remain negative,” the BoE warns in its ironically titled Stability Report. What about the “smart money” of professional investment funds buying commercial and retail property in the U.K. – the next big thing, according to press pundits and seasoned real estate experts alike? Oops! No, again. “Recent falls in U.K. commercial property prices and the more persistent falls in yields, along with the potential for overcapacity given a large pipeline of construction, make this sector particularly prone to further shocks and to rises in the cost of finance,” says the Bank.

But surely the City of London – the powerhouse of the U.K. economy, now vying with New York as finance capital of the world – will forge ahead, no matter what? The financial services sector has been growing at a greater than 10% annual clip, but the widely respected Ernst & Young ITEM consultancy just halved that outlook in response to the credit crunch now forcing job cuts across the Square Mile. Researchers at CEBR, another London consultancy, believe 6,500 finance jobs will go as a direct result of this summer’s credit crunch.

Gold, meanwhile ... dumb, yellow, shiny gold ... says the British pound has never been worth less than it is today. In this race to the bottom, all prices are relative, of course. But the pound sterling could soon become the dollar’s poor cousin once again, just as it was during the global stagflation of the early 1980s. So while gold priced in British pounds may have lagged the dollar price for the last half decade, it has just broken a new all-time record – and it looks to be pointing higher again.

Link here.


Many commentators continue to be on recession watch. They report every new piece of economic data in an attempt to confirm, or unconfirm, whether we are in a recession.

The cause of this focus is the subprime crash. There is no question the subprime crisis was fueled by Fed money printing. Without the Fed money printing of the Alan Greenspan era, the money to fuel the subprime boom would not have existed, but I believe the crash of the subprime market is sector-specific and not the result of the end of the Fed printing. It was caused by some early on subtle changes in subprime regulations, making it more difficult for some to get subprime loans, and then, of course, we now have the ARMs starting to adjust, crushing many who had taken out subprime loans. This to me points to the beginning of and cause of the boom and bust of the subprime market.

It can be argued, though, that the Fed has slowed money printing and that this is a factor that is causing the subprime crisis. Gary North, who is one of the best money watchers around, is watching the adjusted monetary base. He writes that “the adjusted monetary base has risen at [only] about 1.6% per annum since mid-March.” This fact can not be ignored. But looking at the adjusted monetary base is looking at the ingredients of a dish before it is cooked in the oven. I prefer to look at a dish after it is cooked. For me this is the M2 (non-seasonally adjusted) Fed money number. M2-NSA is growing at roughly a 6.0% annualized rate. Ron Paul, the only presidential candidate to understand economics watches MZM money supply data. According to Dr. Paul, MZM money supply is growing at a 12% annualized rate.

Thus, only Gary North’s adjusted money growth figure can explain the subprime crash as being business cycle driven. If, indeed, M2NSA or MZM is more influential, then it suggests that the money that was going into the subprime sector is simply being redirected and we will be in for a doozie of a recession once the business cycle does hit.

Here is a quick lesson on business cycles. The Fed creates money out of thin air and this distorts the economy as this newly minted money enters the monetary system, usually headed into the capital goods sector. When the printing stops, the capital goods sector crashes. Voilà, the business cycle. Why does the Fed eventually stop printing? Because all the money printing eventually causes serious price inflation that forces the Fed to stop printing before a runaway inflation begins. We are near this point now, with oil near $100 per barrel and gold over $800 per ounce. It is business cycle bust or runaway inflation. Your choice, Mr. Bernanke.

So assuming that M2NSA and MZM numbers are somewhere in the ballpark, if the Fed starts to truly slow money growth and we are in a recession, how will you know? These are the types of headlines you will see when the downturn in the overall economy hits:

If Gary North is correct, and the monetary base is the best indicator to determine how much money is being added to the system, you will still see the same headlines ... only sooner.

Link here.


One man scorned and covered with scars still strove with his last ounce of courage to reach the unreachable stars; and the world was better for this.” ~~ Cervantes, Don Quixote

Monday November 5, was a red-letter day in the history of revolutionary politics. As you may know, it was on this day that Englishman Guy Fawkes was arrested in 1605 while attempting to blow up the bustling House of Lords during that year’s opening of Britain’s Parliamentary session ... Fawkes was part of a conspiracy launched by a handful of militant British Catholics to simultaneously assassinate King James I and most of England’s Protestant ruling aristocracy – using approximately 1,800 pounds of barreled black powder stashed in the basement of Westminster Palace. Ever since, the fifth of November has been commemorated in the U.K. and other areas strongly tied to British history, and is today perennially celebrated as Guy Fawkes Day (or Night).

In keeping with this spirit of political and religious upheaval, November 5, 2007 is when the so-named “Ron Paul Revolution” set the current record among 2008 Republican U.S. presidential candidates for campaign funds raised in a single day: $4.07 million. This prodigious sum was generated through an ingenious Web campaign tying Paul’s presidential bid to that historic attempt at fiery rebellion Fawkes nearly pulled off 402 years ago.

Undeniably, shrewd campaign gimmickry was greatly responsible for this single-day avalanche of cash, which has no doubt catapulted Paul into contention for the lead in 4th-quarter campaign funding. Coupled with Paul’s surprising 4th-best fundraising effort among GOP candidates in the 3rd quarter, Paul’s “Revolution” clearly seems clearly on a roll.

More importantly, this snowballing support serves as a revealing barometer of disunity among rank and file American Republicans. And today, I want to consider for a moment what that could mean.

In the interest of full disclosure, I must confess that I have met and spoken to Candidate Paul, heard him lecture in person, and even had the honor of being a fellow speaker at this summer’s FreedomFest in Las Vegas, where Paul was the Keynote. In my opinion, he is a sincere, bright, appealing candidate who makes a lot of sense. But that is neither here nor there for my purposes here.

Unlike with every other presidential candidate in recent memory (or in the current crop), the main question about Ron Paul is not whether he means what he says or not. By all accounts, Paul is a man of sterling character and reputation. He is clearly sincere in his stated desire to end the war in Iraq, reform, shrink or eliminate most every agency or institution of the government, restore a true laissez-faire economy, and return America to a system much closer to the one the Framers of the U.S. Constitution laid out 200+ years ago in Philadelphia.

But is this what Americans want? Do we really want a president who gives it to us straight? Carter did, in his brutal-truth “malaise” speech, and look what happened to him. And do we really want smaller government and the increased personal responsibility that comes with it?

Granted, I think these are things we should want, and so do a lot of politicos and pundits far smarter, more important and more influential than me. But that is irrelevant. Judging by poll results and past voting histories, Americans of neither dominant political party really want smaller, less invasive government. By all indications, what the vast majority of people seem to want is bigger and more powerful government – but only if it serves their party’s agenda at the expense of their political adversaries.

For example, from what I gather, most voters on the right could not care less about compromising Constitutional safeguards on personal privacy, blurring the line between church and state, and eradicating the freedom to choose who we marry, when we have our kids and how we end our bed-ridden lives. They are square with granting more power to the police and FBI to watch us 24/7 and enacting a strong-arm foreign policy – as long as all of this results in what they perceive as a safer, more secure nation of higher (translation: Christian) morality.

Conversely, many on the left seem not to care if certain Constitutionally guaranteed rights (e.g., gun rights) fall by the wayside, if agents of the government pass judgment on matters of parenting and the family, or if arbitrary Federal mandates reduce our freedom to choose how we live, what vehicles we drive, what we put into our bodies, and what we do with our own property. They also seem perfectly cool with anyone who can physically get inside the country gaining unlimited access to the public teat – as long as all of this stuff results in what they perceive as a state with a more equitable (translation: Socialist) distribution of wealth and opportunity.

All of these ends, right or left (and right or wrong), require bigger, more invasive, more costly or more oppressive government. And Republicans and Democrats who vote seem to cast their ballots for it every time.

Will we tolerate a president who reduces the scope and reach of government, if it means he eliminates some of our own pet causes in the process? Will we accept a nation in which we are more fully accountable for ourselves and our families> Or have we grown too accustomed to the guardrails and safety nets Big Brother puts in place to protect us from our freedom?

Will we have the discipline to use the tax dollars we will save with smaller government to look after our own retirement finances – or will we spend the extra cash like drunken, uh, senators? Will we embrace a downsized bureaucracy if it means fewer cushy state and federal government jobs ... and a private sector workforce that is all of a sudden flooded with incompetent boobs who are used to collecting tax-funded paychecks for doing basically no work?

Under a purist president like Ron Paul, this is the kind of stuff that would happen. In true Fawkes-esque fashion, Paul would attempt to explode into splinters (figuratively, of course) the bloated system we have built here in America. He would attempt to dismantle, reform, cut, shrink or outright eliminate whole agencies of the government. He has already said he would abolish the IRS, the Department of Education, and much more if he had the power to do it.

In my opinion, the presidency of a person like Ron Paul may be the only hope of restoring America to the greatness our founders envisioned. I am only wondering if anyone else in power from either party would allow it – or if the mainstream media would get behind it.

I am betting not. The brutal truth is that we may be too far-gone to embrace a candidate like Ron Paul. He may be sincere, but he may also be jousting at windmills in the current American political climate.

The natural progress of things is for government to gain ground and for liberty to yield.” ~~ Thomas Jefferson

Let us consider this for a minute. If Paul gets elected, every time he gets his way about anything, a bunch of career politicians and bureaucrats who currently have power will lose it, regardless of which side of the aisle they are sitting on. That would be an inevitable fact under any president whose goal is to shrink and contain government.

The hen-ish and clucking, education-meddling, tax-raising, welfare-doling, illegal-hugging and militant environmental contingents on the left would find themselves cut off at the knees by a president who cannot be bought by a sea of tax money he could use for his own agenda – or the promise of votes from millions of overnight “citizens”. That is because he likely would not have much of an agenda except the abolition of existing programs and pork, and probably would not much care about serving a second term.

On the flipside, the goals of hawkish, spread-democracy-at-all-costs (code for “kill non-Christian infidels”), bedroom-meddling, surveillance-peddling, isolationist, and militantly anti-immigration factions of the right would find their agenda mercilessly thwarted by a president they cannot literally put the fear of God into. Many of their pet causes would be squarely in the crosshairs of a president whose sole agenda is not his own party’s power, but a return to Constitutional fundamentals.

So, given that all of this is the case, how would a guy like Ron Paul ever be able to garner either party’s nomination, no matter how much 11th hour cash he raises or how much support he may have from the public? In other words: Is either party (in Paul’s case, the GOP) willing to put someone in office that is going to attempt to render large numbers of their own kind obsolete, superfluous or illegal?

I do not think so. They should, but they won’t.

... I believe the very heart and soul of conservatism is libertarianism.” ~~ Ronald Reagan, 1975, Reason magazine

Let us also consider what would actually have to happen in order for the libertarian-leaning Republican Ron Paul to be elected president – assuming for a moment that he were somehow able to secure the GOP nomination and raise enough money to mount a credible challenge.

First, he would have to get a huge number of praise-the-Lord-and-pass-the-ammunition Republicans to vote against their own Iraq war stance, or else corral the votes of a huge number of moderate anti-war Democrats to make up the deficit. Would Pauls’s anti-war message attract more moderate donkeys than it alienates conservative elephants?

Who can say? What can probably be safely said is that Paul’s staunchly pro-life stance would likely give Democrats inclined to vote for him a moment of pause. But would this neocon-friendly abortion stance be enough for far-right Republicans (who vote in huge numbers, by the way) to overlook Paul’s determination to end the war in Iraq – an issue a lot of hard-core Christians must surely perceive as “God’s will” being done with American lead?

Complex questions, all. None of it really matters, though, because the one thing a man like Ron Paul needs more desperately than anything else in order to ascend to the presidency is the one thing he will never get: Massive exposure and support in the media.

The only way Ron Paul can get elected is if he can get his message out – because that message is a persuasive one. It resonates with Americans of many different stripes. More than perhaps any other presidential candidate in recent memory, Paul’s obvious sincerity, selflessness, intelligence and focus on returning America to its own Constitution may indeed be enough to sway rank and file voters into casting a ballot against one or more facets of their core belief structure. But that message will NEVER get out in force (and it isn’t) through the typical channels.

Despite being under heavy fire from all political sides, having a funding war chest that is dwarfed by the front-running candidates (perhaps not for long, though), and enduring a near-blackout in the mainstream media, Ron Paul’s latest CNN opinion poll numbers put him 6th among Republican candidates at 5% of the vote, were the election held today. The real support numbers may be significantly higher than this. According to USAElectionPolls.com, data from a large number of “straw polls” nationwide put Ron Paul’s real-world support at between 15-20%.

Why are we not hearing about any of this from Big News? Because Ron Paul is dangerous to the system that butters everyone’s bread. People who care (not nearly enough of us do in America) can trumpet all day long about Ron Paul’s 10 consecutive terms as a Texas Congressman, his squeaky-clean reputation, his true-to-the-Constitution voting record, his common-sense platform, his consistently dominating performance in debates, and on and on and on. But unless he wins enough states in the primaries to get the GOP nomination, it is all nothing more than a footnote. He will be an asterisk in an otherwise status-quo election cycle.

I see this as a defining moment for the Republican Party, perhaps more so than any other in my lifetime. If Ron Paul succeeds in staying in the mix despite the best efforts of both political parties and the media, this election could be the first in years to truly revolve around issues and a core governing philosophy instead of money, pandering and back-room political dealings.

It remains to be seen whether the GOP far-right will vote en masse solely for whoever they think will put God first (the jury is out on who this is, but Romney is looking like the Chosen One) and kick righteous ass on the non-Christian world.

It remains to be seen whether the pro-war faction of the party can be persuaded that their votes thus far have been in error, and that a vote for Paul is not necessarily a vote for a weaker, less secure America (it may be – but only time will tell).

And it remains to be seen whether Republicans really want smaller, less invasive government, lower taxes and more freedom – even if it means more discipline, fewer jobs and pork-barrel safety nets, less ligature between church and state, and greater personal responsibility ...

The bottom line is this: Starting right now, with Ron Paul’s some-would-say-quixotic candidacy, the GOP has its best chance in decades to decide who it is, and refocus on what is supposed to be their core philosophy: Smaller government and a more strict interpretation of the Constitution.

Does the GOP have the guts to finally walk like it talks?

Waiting and debating ...

Link here.
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