Thursday, September 10, 2009

Are We Still in a Gold Bull Market?; Chris Mayer Looks at the Effects of this Epic Stimulus

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The Daily Reckoning
Thursday, September 10, 2009

  • There's a time to buy gold and a time to sell it...
  • More on our new project: the Bonner & Partners Family Office...
  • Jobless ranks are swelling like a floating corpse...
  • Chris Mayer looks at the effects of this epic stimulus...and more!

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    Are We Still in a Gold Bull Market?
    by Bill Bonner
    London, England

    Gold closed at $999 on Tuesday. Then, yesterday, it closed down $2.

    There's a time to buy gold; and there's a time to sell it. Which time is it?

    The question rose with the gold price itself. It needs an answer.

    The price of gold today, adjusted for inflation, is about where it was 26 years ago. After peaking out at nearly $2,000 (again, in 2009 dollars), in 1980, the price fell to the $1,000 level (in today's money) in 1983.

    We were gold bulls back then. And we were idiots. It was the end of the gold bull cycle, not the beginning. The gold price fell for the next 17 years.

    Some people draw the wrong lesson from this experience - that gold is always a bad place for your money.

    Today's Financial Times:

    "In spite of low interest rates, that make owning gold cheap, the opportunity cost of owning it is still unattractive in the long run. Smarter ways to anticipate inflation include bricks and mortar, mineral rights or even equities, all with vastly superior historical returns."

    But we would prefer to look at it a little differently. Gold is not always a bad place for your money; and we are not always idiotic.

    What were the returns from stocks over the last 10 years? The Dow has lost about 15% in nominal terms. In real, inflation adjusted terms, it is probably down nearly 40%. Meanwhile, gold has nearly quadrupled.

    Was it smart to buy stocks or bricks and mortar during the '70s? Not at all. Stocks bounced around, but they were no higher at the end of the decade than they were at its beginning. Meanwhile, high inflation rates took a big toll on real values. Stock market investors lost 75% of their money - maybe more. As for those who bought bricks and mortar, they lost too - but it's hard to say how much.

    And meanwhile, gold went from $41 an ounce to over $800.

    Which would you prefer?

    As you can see, dear reader, timing is everything. There are times to be long gold. And there are times not to be.

    For thousands of years gold has been the money of last resort. It is the money you can trust. They can't make more of it. They can't counterfeit it. They can't put extra zeros on it and pretend it is worth more.

    But it is most useful when other money goes bad. Inflation rates in the United States during the '70s went over 10%. Clearly, gold was a better thing to own to protect your wealth than dollars. You could have bought an ounce of it (outside the United was still illegal for private citizens to hold gold in America) for, say, $45 in the early '70s. By 1982, you could have used that single ounce of gold to buy up the entire list of Dow stocks. Gold and the Dow traded at a ratio of only one-to-one that year. Then, if you'd held onto those stocks, you could have sold them in 2006 for $14,000.

    Not bad, huh? Two transactions. Forty-five bucks to $14,000. Invest $100,000 and you would have ended up with $30 million.

    But let's get back to where we are now. Still in a bull market in gold...or at the end of one? Are we idiots for holding it now...or idiots for not buying more?

    [We think you know the answer to that question...and when you can get gold for just a penny per ounce - why not take advantage of it? See how you can pad your portfolio with the money of last resort by clicking here.]

    More news from The 5 Min. Forecast:

    "Just in case you had any doubts," begins Ian Mathias in today's 5 Min. Forecast, "the US foreclosure crisis is still alive and kicking. 358,471 American households recorded a foreclosure related filing in August, RealtyTrac proclaimed this week. That's down just a smidge from July' record high, but still up 18% year-over-year.

    "In other words, one in every 357 US homes was in some stage of foreclosure last month. Ouch.

    "The usual suspects led the way... One in every 61 units in Nevada are in foreclosure, the highest ratio of any state. One in 137 Florida homes suffered the same fate. California, while still an absolute mess (one in 144 units in foreclosure) actually registered fewer foreclosure filings last month than in August 2008 - the first year-over-year decline there since the housing bubble popped. (With 92,326 foreclosure filings in August alone, by far the most of any state, we wonder if California's data perked up simply because they are running out of houses to foreclose on.)

    "So how does your state rank? Behold, RealtyTrac's nifty foreclosure rate heat map:

    RealtyTrac Foreclosure Map

    "Did someone forget to tell North Dakota about this whole generational crisis? In the entire state, there were just 33 foreclosure properties in August. That's a ratio of 1 to 9,410. They've got an unemployment rate of 4.2% - less then half the official national rate and the lowest of any state. As Chris Mayer's readers know, the Bakken Formation has suddenly gifted them with 3-4 billion barrels of oil. They are mostly Wall Street free and very land rich. And the state government has a $1 billion budget surplus! Budget surplus, in America!

    "Prevailing wisdom has those fiercely independent Texans pegged as the first state to attempt secession. We doubt North Dakota has the will to beat them to it...but with numbers like those, we wouldn't fault them for trying."

    Ian writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. It's a free service available only to subscribers of Agora Financial's paid publications, such as Resource Trader Alert. RTA's latest report details a trading strategy that will help you rake in some nice gains in a short period of time...without having to touch stocks. Get the full report here.
    And back to Bill, with more thoughts:

    As you know, we've begun a new project: the Bonner & Partners Family Office. It's our own family office that we've opened up to a few non- family members. But just as soon as the non-family members came in the door they started asking questions. Specifically, they wondered why...after all the preaching we've done about buying gold...we don't have more of it in the family portfolio.

    One our new partners wrote a very shrewd comment. We'll pass along a little of what he had to say, but first, some context. The feds are desperate to restart the economy. The only way they can imagine is by increasing the money supply...and inducing people to spend money. They want inflation, no doubt about it. And they'll get it - no doubt about that, either.

    The question is when. Our view is that they'll get more than they expect, but later than they want it. We're looking for another crack in stocks...followed by more fear and loathing in the economy. This will have two major effects. First, investors will turn to the familiar dollar for safety. Second, everyone will hoard money...speculation will cease...and prices will fall - including the price of gold. Our first writer disagrees:

    "One mistake [your editor] might be making is his belief that we are already in another Great Depression. We probably will be in a depression or some other form of economic calamity, but not yet. Every Depression (or monetary contraction) in history has followed a similar pattern - expansionary monetary policy followed by a contraction of the money supply... While we have experienced a huge monetary expansion/easy money in the '90s, we have not yet experienced a real monetary contraction (which is a scary thought). Instead, the central planners did the opposite and doubled the monetary base (keep the addict happy with more heroine). These extra paper dollars have to go somewhere, and we are seeing the results in higher prices for stocks, oil, copper, sugar, gold, so far..."

    Well, long as the economy seems to be on the mend, investors' "appetite for risk" improves. They want to speculate on the recovery. But then, when the recovery proves an illusion...they're going to run for cover.

    Then, another new partner came to help us roll our stone.

    "Bill is correct, not from money supply & credit data, but from 'black swan' type events such as: how deflationary forces will play out for lenders and holders of mortgaged backed bonds both commercial & residential, in a disruptive resetting of interest rates for Option ARMs, ALT-As and various other prime borrowers in the next 6-12 months... Will we witness another series of major bank failures from this next round of resetting? And if so, how disruptive, in a deflationary sense, will this be?"

    Either way, the result is the same. Market events - such as another big break in the banking sector - could bring a deflationary collapse. If not, the Fed itself may have to step in to protect the dollar. In either case, gold is not likely to reach its final, bubble phase until this contraction is over.

    In the meantime, our advice remains unchanged: buy gold on dips.

    [And there is still time to become a part on the Bonner & Partners Family Office - and get access to some of the world's best financial analysts, economists, and traders - all sharing with the Family Office their very best ideas and insights. Find out all the details here.]

    We continue to laugh at recovery sightings. Yesterday, for example, the Fed reported to the nation that a recovery was underway. But even the Fed couldn't ignore the fact that consumers aren't spending money the way they used to. The New York Times comments:

    "The prolonged slump in consumer spending has been one of the most serious points of worry for economists, and the Fed's warning about it deflated some of the market's optimism. About 70 percent of the economy depends on spending by consumers."

    The other sticky wicket in this game is unemployment. Jobless ranks are swelling like a floating corpse. But the jobless numbers don't tell the whole story. There are 34 million Americans who live on food stamps. One out of every nine people depends on the government for his daily bread. The Financial Times fills in the details:

    "Less attention has been paid to those still in the workforce, whose incomes are also being squeezed. The average working week is now about 33 hours, the lowest on record, while the number forced to work part- time because they cannot find full-time work has risen more than 50 per cent in the past year to a record 8.8m. Wages and benefits have decelerated.

    "The food stamp data suggest that 'the labour market problems are more significant than you would expect, given just the unemployment rate', said John Silvia, chief economist at Wells Fargo. 'For me it suggests the consumer is not going to rebound or contribute to economic growth for the next year, as the consumer would in a traditional economic recovery.'

    "Consumer spending has traditionally been the engine of the US economy, making up about two thirds of GDP. Economists fear that people may be unwilling to resume that role.

    "Food stamps are distributed once a month on electronic cards that can be spent at many grocery stores. The $787bn stimulus bill added about $80 (€55, £50) to a family's monthly allowance, which now stands at an average $290.

    Nothing very original about keeping the masses fed with government food. The Romans figured it out 2,000 years ago. You have to distract the mob with pane et circenses (bread and circuses). Otherwise, they vote you out of office...or burn down the capitol.

    "Everything, now restrains itself and anxiously hopes for just two things: bread and circuses," wrote Juvenal.

    Until tomorrow,

    Bill Bonner
    The Daily Reckoning

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    The Daily Reckoning PRESENTS: With all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? Chris Mayer explores...

    The Effects of Epic Stimulus
    by Chris Mayer
    Gaithersburg, Maryland

    What makes investing particularly difficult now is that the distortion in prices, as if reflected in a funhouse mirror. Normally market prices should reflect underlying demand and supply. As in a vegetable stand, the prices come from the buying and selling of people in the market.

    But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?

    It's hard to say, but let me give you a couple examples of distortions.

    CNN's bailout tracker reports that US government stimulus has totaled $2.8 trillion so far this year, with another $8.2 trillion in commitments. Most of this money has gone to the financial sector. Some of it has gone to infrastructure projects and to consumers (cash for clunkers, for example).

    That is a lot of money. It is hard to say how all of this spending has artificially boosted economic activity in some sectors of the economy. It is obvious that such spending cannot continue indefinitely.

    This has also been a worldwide phenomenon. There isn't an economy of size that does not have some stimulus-spending program in place. Governments are spending money they don't have. The result is widening budget deficits and higher debt levels.

    First up, take a look this graph, from The Economist, which shows the industrial production of emerging Asia compared to the United States.

    Industrial Production Back on Track

    Looks like Asia is recovering pretty well. That chart shows the "decoupling" that became such a hot topic of discussion last year. The idea was that the emerging markets would not necessarily follow lockstep with the Western countries.

    But this graph only tells a part of the story. China is one of the countries in "Emerging Asia." China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

    "The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009...The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?"
    "These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen."

    Let me remind you that GDP is a clumsy way to get at an economy's size. It is a figure that includes government spending. So, put another way, stimulus money this year is about 64% of the recorded economic activity in the first half of last year for China.

    In some ways, the Chinese government spent well - investing in the commodities it craves. It's locked down oil and gas assets, iron ore contracts, interests in rare earths and more. It's put up power plants and laid down roads and pipelines. It's made long-term investments in Africa and Brazil. Some of that will pay dividends down the road, if not already.

    For instance, in the first six months of this year China became Brazil's single largest export market. That's the first time that's ever happened. The Chinese and Brazilians are doing deals. For instance, China will lend $10 billion to Petrobras in return for 200,000 barrels of oil per day. China, in fact, has been active throughout South America, investing billions in mines, refineries, ports, and railroads.

    These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen.

    It's clear that China will have enormous needs for commodities over time. In the short-term, we are surely seeing distortions from the stimulus money. But the long-term demand is there nonetheless and the Chinese have a lot of money to spend.

    In fact, infrastructure needs - especially in the areas of water and energy - are becoming more of a headline issue than ever. Not a week goes by where I don't pick up a handful of stories of infrastructure falling apart somewhere. This, too, is a global story.

    A couple weeks ago, for instance, there was a terrible accident in a Russian hydropower plant. Eleven people were killed and 65 were missing after water burst into a turbine room. It also destroyed the turbine. Besides the irremediable loss of life, it will take hundreds of millions of dollars and years to repair the demand.

    As the FT reported, the accident "was a powerful reminder of Russia's dire need for hundreds of billions of roubles in investment in its crumbling Soviet-era infrastructure."

    Putin's government put aside $200 billion for infrastructure in two oil windfall funds, but that money is already being tapped for social spending programs and to help make up budget deficits. As in many places, including in the US, money set aside for infrastructure has been essentially hijacked by the political process and diverted to other uses.

    Another story comes from Britain. Britain faces huge deficits in energy and the risk of widespread blackouts. Its energy complex is old and strained. The Economist reports: "The nuclear stations are simply too old to carry on: most are over a quarter of a century old. Around half have already been shutdown and are being decommissioned."

    About half of its electricity comes from natural gas, a legacy of its North Sea riches. But the North Sea peaked in 1999 and has been in steep decline ever since. Britain's coal plants struggle under new pollution control rules and the effects of age. It's an ugly situation that will cost a lot of money to fix.


    Chris Mayer
    for The Daily Reckoning

    P.S. The positive for investors is that there are several firms that are right in the sweet spot of this global infrastructure crisis. We own a few in the Capital & Crisis portfolio.

    Clearly, we could face some short-term risk as the effects of the stimulus spending start to wane. But the longer-term story is still in place.

    See our full portfolio by clicking here.

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