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BILL BONNER BIDS A FOND FAREWELL TO 2008
Attempting to summarize 2008 would be the normal year-end procedure. Any such attempt this time around would fall short. Conveying a worldwide collapse in financial markets in words cannot communicate the experience. And those who experienced it -- all of us -- probably have had enough analyis paralysis. So let us look forward.
What is a prudent course of action now? Bill Bonner attempts the financial market pundit's equivalent to Robert Benchley's "Drawing on my fine command of the English language, I said nothing." This is a starting point of which a Zen master or Buddhist Priest might approve. Is there something to add from there? Humility is certainly a virtue; what can wisdom contribute? Setting aside our preconceptions, yet with an appreciation of history and human wiring, and keeping in mind that not to decide is to decide, what to do?
A Year in Review, Part I
“We are aware of the profundity of our ignorance ... giving us a little edge over most investment forecasters.”
Well, here we are. The last day of the worst year in stock market history.
At least, in a few hours it will be over. Let us bow our heads in prayer: please Lord, don’t give us another year like 2008.
What is ahead for 2009 is the subject of today's end-of-the-year reflection. Not that we know anything. In fact, Daily Reckoning readers often chide us gently after we make remarks about politics, fashion, art or other subjects: "Stick to what you know," they say.
Trouble is, we do not know anything. Beyond what we see and hear directly, it is all hypothesis, inference and conjecture. We are even a little suspicious about things that take place right under our own noses. "Did we see what we think we saw?" we ask ourselves.
As for the markets -- nobody knows nuthin'. Even the greatest economists of the 20th century were mostly wrong. But even as to that we are uncertain. Being wrong in economics is a matter of opinion. It is not science. You cannot test economic theories. Because you cannot do a controlled experiment. The conditions are always different ... and there is always more to the story. So you can never definitively prove whether they are right or wrong. All you can do is argue about them.
As for the analysts, practically all their projections, forecasts, models and formulae have proven worse than useless. We remember, in March, we went looking for a money manager. The pros gave us neat diagrams showing their forecasts for how much we would make from different asset classes ... along with probability figures showing how much we could count on the money. For example, we might expect to make 8.2% per year from emerging markets over the next 10 years ... with a probability of 68% to 85% that this would turn out to be correct. Thus could we choose an investment strategy suited to our needs.
The numbers were impressively detailed. But they were just numbers. In the event, it turned out that the analysts had no idea. Nowhere in their projections -- or even in their dreams -- was the possibility of losing half our money in emerging markets before the end of the year.
But the analysts put on a good show. And they misled an entire generation of investors into making the dumbest speculations of all time. Now, those mistakes are being corrected -- which is why we are ending a year with the greatest losses of all time.
Yes, dear reader, fair warning: It is all guesswork.
We hope and suspect that our guesses are better than those of most economists. Not because we are smarter or better informed, but because we dumber and more ignorant. We were never smart enough to understand how the theories that guide most economists could possibly be true. As to how you could get rich by borrowing money ... or how you could help a deadbeat debtor by lending him more money -- we never got the hang of it. And put the Black-Scholes Option Pricing Model in front of us ... and we go blank. Maybe those numbers mean something ... and maybe they don't.
Let us put it this way, we are unburdened by the illusion of knowledge. In other words, we are aware of the profundity of our ignorance ... giving us a little edge over most investment forecasters.
Besides, our operating metaphor is more in line with the facts. Economies are not machines. Instead, they are organic, natural phenomenon in which the principal actor -- man -- is subject to fits of brutal sanity, interspersed by long periods of hallucination in which he is trying to get something for nothing. Fundamentally, it is a "moral" system, not a mechanical system. When people make mistakes they have to pay for them.
"Find the premise that is false and invest against it," says George Soros. At the end of the last century people believed that stocks would go up forever while gold went down. We bet against it, with happy results. Then, in 2007/early 2008 there were so many false premises around that a contrarian investor was spoiled for choice. Housing, stocks, shipping, oil, copper ... debt, equity, commodities ... he could point blindfolded at the Financial Times and find a good short sale opportunity.
But what now?
What is the premise that is wrong today? Perhaps it is revealed in the following two news items:
"Consumer confidence at all-time low," reports Bloomberg.
Meanwhile, yesterday, the 10-year Treasury note was at an all-time high, with a yield of only 2.09%.
Consumers think the world is ending tomorrow. But investors imagine that U.S. government debt, and the currency in which it is denominated, will be good forever. At the present nominal rate of return on T-notes, an investor would have to wait 50 years to earn back his investment. At the real rate -- adjusted for the current rate of consumer price inflation -- people will ice skate in Hell first. The real rate of return on T-notes is negative.
The supply of U.S. government debt is soaring. Surely, you might imagine that it would go down in price. Sometime in the future, interest rates are bound to go up. When they do, investors in Treasury bonds are going to be disappointed. But when that disappointment will come, we do not know. Maybe by the end of 2009 ... maybe not until 2010 or beyond.
As for 2009, there are few signs on this highway. In all history, there have not been many crack-ups like this one. Still, judging by those few, we can see a pattern. In psychological terms, there is the shock of the initial crash. Then, the denial. Then, the pile-up ... in which the crisis affects the entire economy. Gradually, people come to realize how bad the situation really is.
Normally, that is the end of it. But this time it IS different. We think there will another stage ... one that did not happen either following the Crash of ‘29 or after Japan's crash of ‘89. We call it the Omega stage -- the last stage of a financial crisis -- which we will turn to in a moment.
In market terms, what we have seen so far is the crash. What normally follows is a rebound. If this crisis follows the pattern of 1929-32, for example, we will see a rebound of 30% to 50% in the first 6 months of 2009.
Richard Russell comments:
"Following a true crash, stocks and stock averages have a habit of recovering roughly 50% of the action lost in the crash. Robert Rhea wrote that the surest action in the market was the recovery, usually halfway back from the points lost in a crash."
Then, again if the pattern of 1929-32 holds, the market will crash again ... with the Dow going down below 7,000 ... perhaps to about 5,000. Finally, investors will begin to realize that this crisis is no temporary setback, but a fundamental change. The bull market -- and the mentality that go with it -- will be dead. Typically, assets will reach their lowest level -- with losses of 75% to 95%. And then, a new bull market can begin ... slowly, cautiously and reluctantly.
That is when you can get great deals -- solid stocks paying 10% dividends and selling at only 4-6 times earnings.
But then ... there is the Omega Stage ... the last stage of this crisis ... the climax of the world's biggest bust. In the crash of ‘29 ... and all previous crashes in modern history ... money was connected to gold. Stocks may have been suspect. Bonds may have been dubious. Assets of all sorts may have been called into question. But at least money itself was solid. You could depend on it. Cash was king.
Not now. Since 1971, cash has been just another asset -- one without fixed value ... one with no earnings ... one with no guarantees. A dollar might you a cup of coffee one day ... a few weeks later, you might need two or three dollars to buy a cup of coffee.
Or, if you were in Zimbabwe in 2008, you might find the cup of coffee that you paid $2 Zim for in May would cost you $2 million Zim dollars by September. No kidding. Consumer price inflation in Zimbabwe was running at 230 million percent by the end of the year -- so fast, statisticians could not keep up with it. And by December, that cup of coffee was almost unavailable, no matter how many pieces of paper you had. Hyperinflation destroyed the economy completely. And the money was completely worthless.
Why do we bring up Zimbabwe? Because the final stage of this crisis -- the Omega Stage -- is likely to resemble Zimbabwe.
And here is Zimbabwe's central banker, Gideon Gono, explaining why:
"Banks, including those in USA and Britain are not now just talking of, but actually implement flexible and pragmatic central bank programs where these are deemed necessary in their national interests.
"That is precisely the path that we began only 4 years ago in pursuit of our national interest and have not wavered from that critical path despite the untold misunderstandings, vilification and demonization we have endured from across the political divide."
Yes, dear reader. Central bankers have their own stages too. First they turn to the monetary stimulus of Milton Friedman. Then, when interest rates get to zero, they turn to the fiscal stimulus of John Maynard Keynes. You will see plenty of that in 2009 ... as President Obama unfurls his flag. But as it becomes clear that that will not work either -- sometime in late 2009 or 2010, we imagine -- they will turn to the printing press stimulus of Gideon Gono.
Happy New Year!
A Year in Review, Part II
Over the course of the year only two asset classes rose. U.S. Treasury bonds and gold. One of these things, we believe, is in a durable, reliable bull market. The other is a fake-out. Which is which?
A New Year's Resolution
Well ... it is over.
"I will be glad to put this year behind us," said a fellow we met at a New Year's Eve party last night.
"What a disaster. I have never seen anything like it."
The fog was thick when we set out. We had been invited to a party about an hour away ... but it was an hour of twisty roads we had never been on before ... in some of the thickest fog we have seen in years.
"Just stay on the little road ... you will see the old castle in ruins on your left. Turn there ... and take the bridge over the river ... " we had been told.
It sounded easy enough. When we got to the village, there was the castle ... a huge thing on a hill in the middle of town ... but where was the bridge? We could not find it. So, we drove around in the fog for another half an hour until finally getting our bearings. Then, walking to the house, we nearly fell into a moat.
"You did not tell us you had a moat around your house," we told our hosts.
"Well, we did not think we needed to. You can see it. You are supposed to stay on the path to the house."
In the fog, we could not see much of anything outside. But the house was warm and inviting, with a huge fireplace that must have dated from the medieval era.
"This part of the house is from the 14th century," we were told.
In the fireplace was a huge crackling fire. We stood in front of it, with our backs to the fire, to warm up. Then, we commenced explaining.
"What is going on in the financial markets?" people wanted to know. They had heard we were an economist. They thought we might know something. We did not want to disappoint them.
"Yes ... it is a rare, but typical, meltdown. Like America in 1929, but without the flappers. Like Japan in 1989, but without the sushi. Nothing to worry about really. Just the end of the world as we have known it. Asset prices will fall -- erasing trillions of dollars worth of ‘wealth.’ Millions of people will lose their homes. Millions will lose their jobs ... their pensions and retirement savings ... their self-respect. Hundreds of thousands of businesses will go broke. And the monetary system we have had since 1971 will collapse. Nothing special. And, oh yes, there will probably be a revolution in China."
"No, actually, that is the good news. The bad news is that government meddlers all over the world are making the situation much worse. They do not have any choice. They have to react. And the only things they can do are the usual claptrap remedies. More government spending. More giveaways. More bailouts. All they are doing is trying to avoid the ‘creative destruction’ that a real economy needs ... and postponing the inevitable adjustments and corrections that must be made.
"But it gets worse. Because the world's main debtor -- the USA -- is also the custodian of the currency that most of the world's debts are denominated in. And Ben Bernanke is hellbent on making sure that the U.S. does not follow the Japanese example ... or the example from the U.S. in the ‘30s. He will not stand for deflation. He will want to fight it in the worst possible way, because he wants to go down in history as the first and only central banker to beat it. What is the worst possible way to fight deflation? Print money. We call this policy ‘Gonoism,’ after Zimbabwe's top man at its central bank -- Gideon Gono. Gono did what neither the U.S. in the 1930s nor Japan in the 1990s was able to do. He made prices go up -- 230 million percent in a single year. Of course, he destroyed the economy completely ... So Bernanke will not be the first. And we may not get to 230 million percent. Maybe 20%. But even that level the destruction will be massive."
With introductions and explanations out of the way, we sat down for dinner ... said goodbye to 2008 with champagne, kisses for the ladies, and handshakes for the menfolk ... and then made our way home by 3 a.m.
Checking the news this morning, here is the low-down from the last day of trading.
The Dow rose 108 points, after being up 184 points on Tuesday.
Oil rose $3 -- to close the year at $42, which is $105 below its high for the year.
The dollar gained a little yesterday, ending the trading day at $1.39 per euro. And gold rose $14, to $884.
Thank God for gold. 2008 was a tough year for everyone ... everyone, except for those who held gold and stuck to gold. Over the course of the year only two asset classes rose. U.S. Treasury bonds and gold. One of these things, we believe, is in a durable, reliable bull market. The other is a fake-out. Which is which?
First, let us look at what happened to most investors last year.
Those who had their money in U.S. stocks lost about 40%. Those who invested in Europe were down a bit more -- about 45-50%.
Investors in Japanese stocks lost 42%.
And investors in Chinese stocks lost 70% of their money.
We interrupt to come to our first resolution for the New Year: We will stick to the basics.
Yes, Daily Reckoning readers got good advice last year. Stick to the basics; stick to the Trade of the Decade. Sell stocks on rallies; buy gold on dips. Now, we see the results for the year. The S&P is down 40%. Gold -- bless its heart -- is up 5%.
Unfortunately, good advice is easier to give than to take. Besides, we do not trust any market forecaster -- including ourselves. With the family money, we took the long view ... and decided to diversify. "In twenty years, what is most likely to have made the most money," we asked ourselves.
Gold? No. Over long periods, gold makes no gains at all. It is only valuable when other gains are fraudulent ... when there is a crash ... or inflation. That is why it is so valuable now. We face all of those things.
But over the long run, gold does nothing and goes nowhere. That makes it a bad investment usually and a good investment occasionally.
The most obvious and most tradable long term trend is probably the regression to the mean in the world labor market. Broadly, a working stiff in Shanghai ought to make about as much as his counterpart in San Francisco. That will probably mean a huge rise in consumption in the Orient ... with fast-growing economies and asset prices. Taking the long view, we invested in India and Vietnam -- believing that they would be relatively safe from the worldwide financial meltdown we saw coming. We also invested in Japan, believing that after an 18-year slump, it was unlikely to slump more.
We were wrong about both those things. In the long run, we still have faith in India. ... We are not so sure about Vietnam. And we still believe that Japan offers good value. But in the short run, we have lost money. Hence, our new year's resolution: stick with the basics.
Sell stocks on rallies; buy gold on dips.
Looking on the Bright Side
U.S. government takes over the economy ...
Not much news. Markets were closed yesterday. This morning, stocks in Asia are up. Ah ... a new year ... new hope ... This year has got to be better than 2008. It could not be worse, right?
But a friend called us yesterday and told us that our Daily Reckonings were too gloomy. So, we have made another New Year's Resolution: We will always look on the bright side.
Let's see. What is the bright side of a worldwide financial meltdown? Of course ... It is the recovery ... the rebound! After the darkest, coldest winter comes the sweetest spring.
So, maybe the Asians are right. Maybe this will be a good year. Maybe the stock first hours of trading in the Orient will give direction to the entire year.
We hope so. We have some positions we would like to sell!
There ... that is looking at the bright side. When there is a stock market crash ... typically ... you can expect a bounce. Stocks should recover 30% to 50% of their losses -- before heading down again. Heck, if you get the timing right, you could even recover all your losses from 2008 (if you have any) ... and end up ahead of the game.
If we were speculators, we would take a long position in stocks soon. If we were speculators, we would watch this position carefully ... and reverse it when the rebound seems to have run its course -- probably in April or May. And if we were speculators, we would keep put in a leveraged bet on gold too. Somewhere between now and when this crisis finally ends, gold is bound to double.
Meanwhile, let's look at another bright side. Let us look at politics. Finally, thanks to the worldwide financial meltdown that the U.S. central bank helped bring about, the politician's can take control of America's most important industries. The dreams of central planners, meddlers, world-improvers, collectivists, Bolsheviks, corporatists and fascists are all being realized -- right in the United States of America. All industries need money. And the U.S. Treasury department has it. And what it does not have, the Fed will supply. This, and an open-ended bit of panic-induced legislation -- TARP, gives the feds almost unlimited authority over the U.S. economy.
“The guidelines don't bind the government, so the lack of specifics gives President-elect Barack Obama plenty of leeway to decide who succeeds and fails when he takes office in three weeks. The bailout was originally designed to buy assets from banks and has instead become a fund for Treasury to prop up lenders, insurers, carmakers, auto-finance companies and, now, any firm that may be important to those industries. ...
“‘The further you go, the slipperier the slope becomes, the more you open the door to anyone who says, "Look, my firm is in trouble, I need help too,"’ said Lyle Gramley, a former Fed governor and now a Washington-based senior economic adviser for Stanford Group Co. ‘We don't want to go any further down that road than we absolutely have to.’
“The Treasury already has provided $6 billion in aid to GMAC, the financing arm of GM, and up to $17.4 billion in financing for GM and Chrysler, using funds from the $700 billion bank-rescue package.
“‘Treasury will determine the form, terms and conditions of any investment made pursuant to this program on a case-by-case basis,’ the Treasury said in the new guidelines. ‘Treasury may consider, among other things, the importance of the institution to production by, or financing of, the American automotive industry.’
“The government will weigh ‘whether a major disruption of the institution's operations would likely have a materially adverse effect on employment and thereby produce negative spillover effects on economic performance’ or on credit markets, the Treasury said.”
Ha ha ... get it? What major interruption of an industry's operations would not have an adverse effect on employment?
The U.S. government can now determines who shall plant, who shall reap ... and who shall bake. Americans will soon want bread, we predict. And then, the government will determine who shall eat! But that is not exactly looking on the bright side, is it? What is the bright side of a government takeover of the economy?
This morning ... we don't know. But give us the weekend to think about it.
TRUST ONE ASSET IN KILLER DEFLATION
It could not be more obvious that Treasury paper is headed for a collapse.
The current deflation has made life difficult for even those who predicted it. The fashionable method of escaping its clutches is to buy government debt. But Rick Ackerman believes that government bonds will live up to their scornful sobriquet of "certificates of guaranteed confiscation." In attempting to debauch their currencies sufficient to overcome deflation, governments will be successful at the former without achieving the later. Deflation will continue on its merry way. "It will take years to play out," says Ackerman, "and the price declines we have seen so far in the housing market are not even halfway to their bottom."
If the collapsing fiat currencies are not a safe haven from deflation, what is? Gold: "Even if it should fall to $200 an ounce, it is all but guaranteed to do better, much as it has been doing, compared to just about every other type of investment asset." Not exactly original, but gold is not going to zero. What else can one be certain that this is true of?
Financial genius that you are, you sold the tech boom at the top in 2000, presciently moved the proceeds into real estate, and then rode the speeding freight train to a brilliantly timed exit in 2007. Never one to waste time gloating about your successes, you leaped fearlessly into commodities, doubling your money in energy stocks and crude oil before selling everything at the top last July. Good thing your timing was perfect, too, since that bull market turned overnight into the most precipitous and destructive bust since the tech-stock bubble.
But your next move, into Treasury paper, was your most impressive yet, since it displayed not mere genius, but something even more rare in today's investment world: humility. All but certain that U.S. bonds would drastically underperform the investments you had made up to that point, you plunged 100% into Treasurys nonetheless, and with urgent haste. For this was no time to be greedy. The financial system looked ripe for collapse, and for the first time in three generations, you reasoned, it was time to put safety before yield. Once again, your timing and acumen was astoundiung -- as well they needed to have been, since the most stunning and profitable rally in the history of Treasury Bonds would be over (we now surmise) just six weeks after it began.
Of course, the track record above is a pure fabrication. For who could have been so smart, so prescient and so implausibly nimble? Even the redoubtable Jimmy Rogers is lucky if he got through it without catastrophic losses, since he was famously invested in commodities up to his eyeballs before they collapsed -- not to mention, extremely bearish on the dollar just in time to be impaled by the short-squeeze that drove it into a parabolic spike between July and November.
Since the late 1990s, our shrill, steadfast warnings about deflation have never failed to emphasize that it would present toxic challenges even for the wisest and most worldly financiers. That the financial system's inevitable collapse would activate an investment mine field spanning Europe, Asia, the Middle East and America was not difficult to foresee. We saw this not as an opportunity for making big bucks in a windfall, but for exercising a degree of caution that has been absent from the financial scene for at least three generations. Under the circumstances, even financial geniuses were likely to be tasked, as they clearly have been, to hold onto a fraction of their peak net worth. However, it was not until recently that we began to understand why this would be so. For not only is there no single investment asset that has come through the carnage unscathed, most of the obvious ones appear to be working as safe havens only for a relative blink of an eye.
Treasury paper, for instance. As we write these words, it could not be more obvious that this safe haven of the moment is headed for a collapse. How could it be otherwise, considering that Treasury debt is to be redeemed in "money" that itself is just more debt? We will let our colleague William Buckler, editor of The Privateer, explain:
“The U.S. Federal Reserve Note [i.e., the paper money we carry in our wallets] as issued into external circulation is on the balance sheet of the Fed as a liability -- a debt. Anybody who accepts it has de facto given credit to the issuer of the note -- has made a loan to the Fed. Americans, of course, have no choice, because they must accept the Fed Note [as legal tender]... Now the Fed is proposing to issue its own bonds and notes which will pay a rate of interest. The interest will be paid in Fed Notes, non-interest paying debt paper which the Fed [has said it will create in unlimited quantities, if necessary, to fight deflation]. To repay a debt with another debt is fraud. That is what the Fed is proposing to do.“
Just so. And that begs the question, for the canny investor, of where to leap next. Keep in mind that by the time the dim bulbs at CNBC and at the New York Times come to understand that Treasury paper has mutated into an outright swindle, it will be too late to act. Yet one more investment bubble will have collapsed, causing even more trillions of dollars in illusory wealth to vanish forever from the economy.
So where to secure one's nest egg? Let us note, first of all, that the best answer we can imagine is not the one suggested by a very astute friend of ours with whom we lunched last Friday. Our friend has long been a bear's bear, and this has made him one of the most successful stockbrokers in the business. His clients have profited hugely in recent months because he had them heavily weighted in Treasury Bonds and Notes. No longer, though. He recently cashed out of these supposedly ultra safe securities -- a decision with which we agree completely -- and has been very hastily reallocating the proceeds in municipal bonds.
His reasoning is that such bonds are a good value at the moment, having been hammered excessively by investors fleeing into Treasury paper. Crucial to his strategy is the notion that the U.S. Government will ultimately stand behind municipal bonds if the cities that issued them go bankrupt. While we would not dispute that possibility, we do not see it as a plus for investors, for one reason: If the Federal Government were to have to redeem the debt of cities and towns across America, it could only do so with hyperinflated dollars that by then would be worthless to the bondholders.
Which brings us to the one asset that we think is most likely to see investors through these extraordinarily difficult times: gold. Not that gold bugs have escaped the deflationary noose so far. Far from it. Mining stocks have been getting killed, and bullion quotes have oscillated violently in a $300 range. By now, most gold bugs must be wondering why, with the central banks of the world virtually flooding the financial system with bogus currency, gold has not soared far above the $1,050 high recorded last March, before the global monetary blowout truly began.
The reasons for bullion's so-far failure to discount the coming repudiation of fiat money are not complicated, although they would not have been intuitively obvious even as recently as six months ago. For one, there was the short-squeeze on dollar debt. Although we raised the prospect of this years ago based on our trading-floor experience, it was considered a loony-bin scenario until very recently, when it became apparent to a vocal few that the dollar could not possibly be rising so steeply merely for reasons of flight-to-safety. For gold bugs, the short squeeze rally evinced by a fundamentally worthless dollar turned logic on its head. The hard money crowd had been rightly preparing for the dollar's collapse since 1971, when Nixon closed the gold window, but here was the buck, inexplicably rising as though paper were indeed more valuable than bullion.
Another key reason gold has not soared is that deflation has yet to run its course. Tens of trillions of dollars worth of capital have been vanishing from the system, and until the deleveraging subsides, increasingly scarce dollars will be used to pay down debt, not to parlay into precious metals.
Inflation Coming, But Not in Time
We expect that to change, but not in time to rescue debtors with a flood of cheapened money. We have told you for years to tune out the inflationists because they do not know their butt from a hole in the ground. That is still true. The inflation/stagflation they have been blathering about, and which materialized only fleetingly in the form of a speculative blowoff in commodities, was just a head-fake, a seduction whose purpose was to screw any investor who thought he could outsmart the first deflation ever to take shape in the midst, paradoxically, of a global credit explosion.
It goes without saying that you should also tune out the self-aggrandizing charlatans who are saying the housing market and the economy will bottom "sometime next year." These are the same unmitigated bozos who were insisting just six months ago that the economy would avoid recession. Deflation will run its course no matter what the puny central banks attempt to throw at it next. It will take years to play out, and the price declines we have seen so far in the housing market are not even halfway to their bottom. As for gold, we will reiterate something we said here earlier: Even if it should fall to $200 an ounce, it is all but guaranteed to do better, much as it has been doing, compared to just about every other type of investment asset.
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