Do Not Trust This Market 30 comments
Kip Herriage
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Following my update, I have included an article from one of the foremost economic analysts of our time, Ambrose Evans-Pritchard. He called the subprime crisis just 6 months before it hit, and this weekend came out with extraordinary comments about the banking and currency crisis hitting Europe and parts of Asia right now.
The reasons why his warnings are important will be obvious, and it's important to remember that just as the U.S. appeared to be coming out of the Great Depression in 1932, a foreign banking and currency crisis helped to push the U.S. back into a Depression that lasted another eight years. We live in a global economy that is interconnected more than at any point in history, and as difficult as it is already going to be for the U.S. to recover from the recession / depression at hand, any kind of global meltdown will make the recovery that much more complex and lengthy.
Economic Update
I've yet to see a single economist that I respect come out and support Obama's stimulus program, and we already know that Geithner has no real plan to solve our banking crisis. As a Barron's article said this weekend, it's important to look at this crisis from the economic side as well as the financial-sector side. On the economic side, our consumer debt is now at 130% of income. In 2000 it was at 100% and 10 years earlier it was at 80% Consumer debt simply has to come down and there is absolutely nothing that the government can do to change this. They got us into this mess with a fiat currency and easy credit, so the first step now is that we have to complete the natural deleveraging process...by at least 10 to 20 percentage points…to repair the consumer's balance sheet.
In a normal economy this would take 3 years to accomplish and in the current economy it will likely take 5-7 years. This is one of those basic "laws of economic cycles" and it has to be allowed to complete its course of action. It's going to happen one way or another, and the sooner we allow it to happen the better.
We know we're in a recession, and for the first time we have respected leaders calling it a Depression (International Monetary Fund, Merrill Lynch's top economist). We may have some false starts, but believe me when I tell you that it's going to be several years before things are back to anything close to normal. Again, the more the government intervenes the worse they will make the situation.
Instead, we're seeing some very strange actions from the government….they aren't thinking about deleveraging at all. Amazingly the government is talking about jumpstarting consumer credit. Jumpstart consumer credit for what? So we can be more indebted? A third grader can understand the lack of logic behind this strategy.
The bottom line is that we have to reduce debt. If you jumpstart credit, you are just going to prolong the problem and deepen it. What we need now is the patience to "de-lever". We don't need the stimulus package. We need a savings package, but that couldn't be further from their goals at the moment. The mistake is that the government believes credit drives the economy, instead of the economy driving credit. They have got it all backwards, and this is a very dangerous time to be confused.
We're going to find out in the very near future that $3 trillion in additional debt on our backs was the exact wrong action to take, but by then it will be too late. By then the Dow Jones will be at 5000 (or lower), the U.S. dollar will be in freefall, and no one will be willing to buy more U.S. debt. This will push interest rates sharply higher, and leave our policy makers with very few options.
Precious Metals and Market Update
The article below will make this point more clearly than I ever could, but we will soon reach the day where the only trusted currency will be silver and gold (along with platinum). That's because every other currency on the planet is fiat, or backed by nothing but the full faith and credit of the government of that particular country. This was the danger of dropping the gold standard, and could ultimately result in the "sum of all fears" in the global currency markets.
While there's a chance that the stimulus and bank bailout programs could buy us some time, and help to move the economy and stock market a bit higher, I wouldn't put much confidence in this as an investment strategy. The markets will soon break their November 2008 lows on their way to much, much lower prices. I keep making this next point over and over again, but in my opinion it's the one thing that market observers should be aware of.
In 2009 the earnings on the S&P 500 will come in well below $50. Using a price/earnings multiple of 10 (which is still generous as the average bear market bottoms with a p/e of about 7), this puts the S&P at 500 by the end of the year. This indicates that we should expect a 40% drop in the overall market before the year is over. This would also mean that the Dow will drop another 3000 or so points to…you got it…just below 5000.
In light of all of this, we should expect to see a continued and sharp move higher in gold and silver in a classic flight to safety move. However, there is one point that I need to caution you on. Typically, when the stock market takes a fast and steep move lower, we also see a move lower in precious metals mining stock prices. We saw this exact thing happen in the 3rd and 4th quarter of 2008, and I fear that we could be in for a repeat of the same situation.
Since last November we have big gains in PM stocks and while I could well be wrong, I don't like to give back hard earned profits…especially as big as the ones that we have on the books. Look at it this way, if I'm wrong, all you've done is taken some very nice gains and you still have healthy positions in our favorite precious metals stocks. In the meantime, continue to add to your gold and silver coin purchases as this bull market is just getting underway…and when the time is right we will go back into the mining stocks and in a big, big way.
I simply see little chance of a significant stock market advance over the next 12-18 months; although we will continue to see bear market rallies when the markets become too oversold in the short term (we are not close to oversold for the time being).
The following link will take you to the article from Ambrose Evans-Pritchard and I highly recommend that everyone read it. If he's right, and I believe that it's likely that he is, the next surprise from this brutal bear market is about to hit home.
Disclosure: None
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This article has 30 comments:
I for one am sick of having more credit card offers shoved in my face when I go to my bank.. enough already! I do not want another credit card.. I want to pay off a good chunk of my debt, not add more debt!
Why is this so hard to understand? Is the bubble in DC that thick?
Althought I agree with many of your points, it would be helpful if you post had some data to back up your hypotheses. For example, you indicate--correctly, I think most would agree--that the central problem here was overleverage, but you neglect to consider the effect of rapid deleveraging as opposed to gradual. We see that corporate profits have cratered with a small reduction in consumer spending. Suppose that consumer spending decreased in one year by 10%, and everyone bought bullion with that. What would be the effect on corportate profits, GDP, then. Just because Obama's stimulus is a joke does not mean that all stimuli are implicitly bad.
I believe the foreign (Austrian) bank failure actually occurred in 1931.
“Typically, when the stock market takes a fast and steep move lower, we also see a move lower in precious metals mining stock prices. We saw this exact thing happen in the 3rd and 4th quarter of 2008, and I fear that we could be in for a repeat of the same situation.”
As for the dampening impact on gold stocks of a general market decline, that was noticeable yesterday, and on other occasions recently. Here's what I said in a comment last week:
"What this [sluggishness] suggests to me is that funds, anticipating redemption calls after a falling market this year, are dumping their holdings indiscriminately. E.g., if gold stocks are 5% of their holdings, they're selling them in the same proportion as they are selling all their other stocks. They aren't holding onto their winners, but are maintaining the pre-determined "balance" of their portfolios. (Dopes.) What it means is that miners are set to slingshot past gold and zoom."
Perhaps the last sentence is overly hopeful, and miners stocks won't zoom just yet. But there is little risk in holding them now, rather than gold itself, because now (as opposed to during the Dow decline in the fall of 2008), the price of gold is rising, not falling. That will keep miners rising at least a bit as well.
Eventually investors will realize, in part because of information on the Internet, that miners are a better proposition, because (1) they are undervalued in historical terms relative to the price of gold (using XAU as a proxy for miners), and (2) they are leveraged to the price of gold, so that a 20% (say) rise in the price of gold should (ideally) translate to a 200% rise in their profits.
++++++
I think the Evans-Pritchard article is on target. I have been commenting for months that the driver for gold will be fear of currency collapse and systemic risk, not fear of US inflation. It only needs moderate fund-flow from European buyers fleeing the Euro to lift the price of gold significantly.
The first step is simple. Unravel the scheme.
In science and engineering, the hard subjects in college, we were required to first define the problem. Kip is there! Well done.
Do not trust the markets until the unraveling has occurred.
In the last four years prior to the recession, mortgage equity withdrawals accounted for one or two points of reported annual growth in GNP. Absent MEW, growth was anemic.
Looking forward, MEW is gone and households will and should delever which will further challenge the economy.
By my rough math, it looks like consumers will reduced their debt by $ 1.6 trillion over a three or four year period and this can be done by only reducing spending and increasing savings.
Consumers will likely take out of the economy nearly twice what the government will inject through fiscal measures.
I cannot envision a robust scenario for the economy until this process has been completed.
Great article!
The US GDP actually rose from a low of 56.4 billion in 1933 to 126.7 billion in 1941 (before WW II had started in full for US), representing an increase of 125% in growth over 8 years. Not sure where the author got his data from, but if he can be that wrong on historical information, not sure i trust his vision for what is ahead.
Not trusting anyone in governement except maybe Ron Paul is also good advice.
Obama has no clue. He's trying to patch a busted dam with water. He was elected for us by the system because his skin is the right color and the power players really running the country thought that perhaps a minority could stop the inner city riots that are coming. There is no other excuse for him coming from obscurity to the office of president so rapidly. Personally, I don't think anyone is going to be fooled or calmed by Obama and his tax evading financial henchman Geither.
Don't underestimate the capacity of the US to twist the wrists of its partners in a way that's conform to its needs and objectives (what will these Sovereign Funds do with their piles of cash?). De leveraging will happen but not so fast. After all it took many years to create this situation and it will take many years to reverse it partially.
America has suffered fr many years from fuzzy thinking. The fact that our economy generally performed so well, though in hindsight it seems that leverage had a lot to do with that, meant that neither consumers nor politicians had to think very clearly about economics. A lot of fuzzy ideas came to become mainstream. Frankly, people no longer have a real sense of what is solid economic thought and what isn't. To listen to many writing on SA all the government has to do is bail out the US housing market by taking an equity stake in every house and problem solved.
Gold is being impacted by two drivers this time. Inflation threat and failure of fiat currencies. This is the first time in history where multiple major nations are just spinning out money and debt simultaneously. That is a big difference even with the inter-war years. There is rising distrust of paper and last week you started seeing official reprs of the ECB state that in public.
The inflation threat from all that money supply growth is also at work and recently we've seen more and more economists and fund managers start talking inflation. We will see that the current government economic team was fighting the last war.
Gold then is set for a prolonged run though there will be volatility. As for gold stocks, the price rise in gold and the decline in oil should boost their balance sheets. Currency movements and whatever nasty debt instruments they may have on their balance sheets are the risk. Any company can still go out of business if loans are called in or covenants broken at the wrong time.
I keep coming back to my amazement that the system that's imploding rewarded so many empty suits beyond anyone's wildest dreams for supposed performance. The disconnect as they attempt to alter reality to fit their dying world and maintain power and bonuses exposes the sham.
So much more could have been done by those with power and money while they had the best of times to alleviate rampant real problems that would have showed them worthy of their gains. They could have made those gains sustainable and we could have had real trickle-down. Instead we have them continuing to try to alter reality to desperately fit their world. Ill-educated masses hanging by their fingernails are still voting in more of the same.
Leadership worthy of those princely bonuses is hard to find. I appreciate the help that the information in this article provides.
The million words are not worth the 1 number in the statement, words are not real, the numbers are.
On Feb 18 09:23 AM fabien_hug wrote:
> Again .... the market tanks and the end of the world is near when
> a month ago we should have readied ourself for a new bull market.
>
> Don't underestimate the capacity of the US to twist the wrists of
> its partners in a way that's conform to its needs and objectives
> (what will these Sovereign Funds do with their piles of cash?). De
> leveraging will happen but not so fast. After all it took many years
> to create this situation and it will take many years to reverse it
> partially.
I could not agree more with your assessment that the Dow will see 5000 on this cycle. It is a breath of fresh air to see someone with credentials talk about the future and put gutsy estimates to it. I am reassured though that there are a lot of others who feel the same but just don't want to risk their reputation on a call like that. So kudos to you. I am frankly looking for gold to buy the Dow at the 3800 mark, which makes me a pessimist of the extreme but I have confidence and I think time will show this was a fair call.
Cam
Right now we are slipping from recession to depression. The reverberations are hitting all around us. Eastern Europe's financial collapse is putting terrible pressure on a severely stressed financial system.
The waves of losses in the banking system are inevitable through 2012 due to ARM's and alt-a mortgages. And as the author pointed out, the consumer must cut back spending and save to repair his balance sheet. There is absolutely no way around this fact.
Silver and Gold will be two safe havens in this financial sunami.
We will not be out of this mess until the housing market and consumer credit situation get better and on top of that the stock market is still over priced by historic standards,
As for gold, well it appears that gold is about to jump the shark today ($1000 USD), and you know how the Fonz show went after that episode. You won't get a better shorting opportunity than today, Friday Feb. 20th.
Remember the old line - Bull markets climb a Wall of Worry and Bear markets fall on a Slope of Hope.
If hope is the only reason for buying now, then forget it. By the time this bear market is over the Dow of 2012 - 2013 might have the purchasing power of the DOW(2009) at 1000!!!!
It appears with the BO administration that government is just as incompetent as it was during the 1929 - 1934 period. Forget Roosevelt, Hoover was the real villan who launched "The New Deal". He just didn't market it as such and make it huge. Don't worry. This time BO will not make the mistake of modesty.
With the government throwing caution to the wind, you might not really see Dow 1000, but through miracle of inflation it might feel like Dow 500.
For those who read it BS and care, here is my suggested portfolio
1. 30% gold and silver - take possession
2. 20% cash - spread it out among many currencies and take possession of some of it.
3. 30% fully paid for real estate
4. 20% speculative
if your resources are limited make the speculative part cash or gold.
avoid BONDS!
avoid Stocks for now