Thursday, October 8, 2009

The Eternal Depression; Chris Mayer with Investment Themes from the UAE

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The Daily Reckoning
Wednesday, October 7, 2009

What if there is never a recovery? It's going to be a lean Christmas in America...and in China... As the private sector eliminates debt, the feds add to it... Chris Mayer with investment themes from the UAE...and more!

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The Eternal Depression
by Bill Bonner
London, England

Yesterday was another exciting day on Wall Street. The Dow rose 131 points...and gold shot up $25 to a new record, $1043.

Investors must be pondering the future.

What will the future look like? No one knows.. But investors thought they saw things they liked.

For one thing, there was the Federal Reserve governor from New York, who told the world that there was no risk of a rate hike anytime soon. Bill Dudley knows which way the wind is blowing. He said the Fed would hold money policy loose "indefinitely."

Indefinitely is otherwise known as "as long as it takes."

But as long as it takes for what? long as it takes until the economy appears strong again.

How long will that be? Ah...maybe longer than anyone realizes.

Yesterday, we were calculating how long it would take to get the jobless number back down to '90s levels...that is, around 5%.. There are now about 131 million jobs in the United States...and about 15 million people who would like a job but can't find one. Meanwhile, population growth adds about 1.5 million new workers every year. That means the economy has to grow at 1% (in real terms) just to stay even with population growth. Currently, the economy is going in the wrong direction - backwards. It's losing jobs...maybe 3 million this year...and maybe another 2 million or so before it finally stabilizes (who knows?)...for a total of 20 million jobs down (about 13% unemployment) by the time unemployment bottoms out.

Let's suppose, by some miracle, the economy turns around...and begins growing at 3% per year. That should be about 3 million new jobs per year. Half of those, remember, are just to keep up with population growth. So the other half - 1.5 million - gradually reduce unemployment. Now, let's get out the calculator...20 million divided by 1.5 million equals a little more than 13. By these numbers you can expect full employment again in 2022!

But what if the economy doesn't grow at 3% per year? Ooooh...that's the problem, isn't it? All the feds - and practically all other economists too - are projecting a return to normal. They expect a 'recovery.' But what if there never is a recovery?

Heck, yesterday, the central bank of Australia said it was so sure that everything was going well it raised its key lending rate by 25 basis points.

"Canberra says risk of serious retraction over," The Financial Times reports.

But they get a lot of sunshine down under. Possibly, the heads of the Reserve Bank of Australia got a little too much of it yesterday. Australia is also a supplier of natural resources to China; possibly, the sun burnt bankers failed to notice that China is a bubble.

Or maybe they failed to notice that China's biggest customer is broke.

Right under The Financial Times' article about Australia is the following headline:

"No sign of credit revival for US households."

"The latest data from the Federal Reserve show consumer credit declined at an annual rate of 10.4% in July - the fastest rate since the crisis began two years ago."

Yes, dear reader, Americans are shedding debt. They are cutting back. They are saving.

Another headline in The Financial Times tells us, "Holiday sales [are] set to fall."

Hold on. Who makes all that junk that Americans buy for Christmas? And how can China buy more raw materials from Australia when it is selling fewer finished products to Americans?

Perhaps China is focusing more sales on the domestic market; we don't doubt it. But you don't refocus the world's second or third largest economy in 12 months. It takes years. And you don't get this kind of rebirth without some kind of suffering. The big, old oak tree has to fall down before the sapling can take its place. And when the oak falls - it makes one helluva mess.

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More news from The 5 Min. Forecast:

"While you wouldn't know it from watching the stock market, the commercial real estate scene is still getting worse," writes Ian Mathias in today's issue of The 5. "The vacancy rate among offices for rent has climbed to 16.5%, a five-year high, says research firm Ries Inc. today. Meanwhile, office rents fell 8.5% in the third quarter, year over year. That's the steepest fall since 1995. Cities with big financial sectors (well, what used to be 'big') got hit the hardest... New York City, we're looking at you. Rents there are down 18.5% over the last 12 months, the most of any US city.

"But here's the part we don't quite get: Real Estate Investment Trusts (REITs) have turned in blockbuster performances this year, with REITs based in New York City leading the way.. Check out shares of SL Green, perhaps the biggest office landlord in New York:

SL Green vs The Market

"SL Green rocketed up 91% in the third quarter alone, the best performing large cap REIT on the market. These guys are Citigroup's landlords... Up 334% since March?

"That's par for the course for the whole sector. The Dow Jones Equity All REIT Index rose 33% in the third quarter, the best quarterly gain since the index's inception in 1989. According to today's Wall Street Journal, that means REITs now trade at an average 24% premium to their net asset value, about the highest level of this entire decade."

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And back to Bill, with more thoughts:

Meanwhile, President Obama is adding more gin to the party punch. He says he's considering ways to create more jobs without a new stimulus program. Among the schemes under consideration is a $3,000 new job tax credit.

Hey, why not! They had such great success with the Clunker tax credit...and with the first time house buyer tax credit. Of course, when you pay people to do things, you can't be too surprised that they do them. And then, you can't be too surprised when they stop doing them after you stop paying them. Thus, when the Clunkers program conked out in August car buyers stopped buying. And when the new house purchase tax credit expires in November, don't be surprised if house sales collapse too. So, if the feds are going to pay people to hire other people, they better be prepared to do it for a long time.

Which brings us back to our calculations. How long will it be before this economy can walk without the feds clutching both arms? A few months ago, we wondered how long it would take consumers to put their finances back in order. Five years? Ten years? There are so many assumptions required that the numbers barely make sense. Still, if you think the total debt burden is headed back to under 200% of GDP, where it was for most of the last century, that would require the elimination of debt equal to about 160% of GDP...or more than $20 trillion worth. How do you eliminate debt? Well, some of it simply disappears...through defaults, foreclosures and bankruptcies. The rest is paid off. How? By saving. Now, imagine that the United States could put an amount equal to 15% of GDP to work paying down its debts. That's savings and capital formation of all types - corporate as well as individual. It ignores government, which is going in the other direction. At 15% of GDP per year, paying America's private debt down to under 2 times annual output is still about a 7-year project.

So, prepare for a long dry spell. In the best of cases, the American public has to stay on the frugality wagon for 7 to 13 years.

And in the worst of cases? Oh, well...that's a different matter. The aforementioned US government is desperate to short-circuit the process of balance sheet repair. It is propping up the old tree every way it can. Thus, the whole period of adjustment may take much, much longer than it should. Instead of coming down with a crash, the limbs fall off one at a time. At this rate, the whole process could take nearly forever.

As the private sector eliminates debt, for example, the feds add it. The deficits are scheduled - by the Congressional Budget Office - to be monstrous, but controllable. Cash for clunkers, cash for houses, cash for jobs - it adds up. But the CBO projections are based on very optimistic assumptions, in which the economy 'recovers' quickly and grows strongly. They do not take into account the real nature of the slump. It is not a is a permanent change. The Obama administration cannot, ultimately, prevent change. But it can slow down the process so much that the depression begins to seem eternal.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Addison and Chris Mayer are currently in Dubai and will be traveling to India in the next few days. They'll be reporting back from there for the next two weeks, but in the meantime, check out a special report that details a play based in this 'wealth refuge'...but you have to act fast. After midnight tonight, the deadline for this play will close. Get in now...

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The Daily Reckoning PRESENTS: Addison Wiggin and Chris Mayer have traveled to Dubai, where they will be all week before moving on to Mumbai, India. What follows are some of Chris' notes from the early part of the trip and an early bead on some investment themes from this part of the world. Read on...

Greetings from Qatar!
by Chris Mayer
Doha, Qatar

Qatar is a red-hot economy. Last year it grew around 18% and this year it ought to grow another 16%. We saw the headlines in the Gulf Times in the lounge while waiting for our transfer to Dubai.

Qatar's greatest asset is its natural gas reserves. In fact, the largest gas field in the world is here. Its discoverers were disappointed when they found it in 1971. They were looking for oil.

The boom Qatar now enjoys is the result of some daring investments in liquefied natural gas (LNG) back when people thought doing such a thing was a little batty. Faisal Al Suwaidi, the head of Qatargas, deserves the props for his wager, which have paid off handsomely. Today, Qatar produces about one-quarter of the world's natural gas.

Qatar supplies such faraway customers as Japan, India and China. Qatargas also operates the largest LNG terminal in Europe at South Hook on the Welsh coast. This facility provides Britain with a fifth of its gas needs.

Qatar's dominant position has filled its coffers and changed the country forever. On a per capital basis, it is one of the wealthiest countries in the world. And given the world's growing energy demands and the appeal of clean-burning (and cheaper) natural gas when compared with oil, Qatar seems in a good position.

In Dubai, the story is quite different, as Dubai does not have Qatar's gas reserves, nor does it have much oil. Dubai's story is one of trade and finance.

As I write, the sun is just peeking over the horizon. It is dawn in Dubai. Out my hotel window, I can see two buildings with cranes over them and in the distance another building in scaffolding. For a city that was once booming and turned bust - as with most places - there is still a lot of construction going on.

As recently as September 2008, realtors could claim that no one had lost money in the Dubai property market. That's no longer true. In fact, now the market has too much of just about every property type. One headline story noted how 32,000 homes are about to come on the market next year, which is a big number to choke down in any city. Dubai had a huge property boom and now must suffer the flip side.

The hotels, too, are pretty empty. We are staying at the new Address Hotel downtown, which has been open for only 25 days, we are told. I'm the first person to stay in my room. It still has that new carpet smell.

I wandered down for breakfast and was alone in a cavernous dining room. The hotel is brand-spanking new and everything looks wonderful. It's just mostly empty. I think there are more hotel workers than there are guests.

In Dubai, revenue per room is down 35% from a year ago. Yet there is still an expansion going on. Next year, estimates call for a 15% increase in the number of rooms. This would mean a 40% increase in two years.

Over breakfast, I perused my complimentary copy of The National. One of the things I like to do in a foreign city is to read the local newspapers. I'm kind of a newspaper junkie anyway - I get three dailies delivered to my doorstep at home. In any event, I always find interesting nuggets from a perspective you might not get if all you read is The Wall Street Journal or Financial Times.

Today's business page carried an array of tales... There was the arrival in Doha of a new LNG tanker, fresh from Seoul's shipbuilding docks. There was a story about how UAE consumer confidence is up. Also, notes on bond issues in the Gulf, the latest figures on money supply in Kuwait (it's rising at a frighteningly quick pace of 18.7%), the price of villas in Dubai and more. All sorts of little odds and ends that help paint the picture.
"One headline story noted how 32,000 homes are about to come on the market next year, which is a big number to choke down in any city. Dubai had a huge property boom and now must suffer the flip side."

There was also a lot of chatter about infrastructure, which I found particularly interesting. Abu Dhabi, the capital of the UAE, which I will visit on this trip, is looking to raise $100 billion for infrastructure projects. From The National: "The emirate needs to fund new transport, electricity and telecommunications schemes..."

Dubai itself also has ambitious infrastructure spending plans. Last night, as we made our way to our hotel, we could see the new Dubai Metro stops along the way, which, lit up as they were in soft blue and white twinkling lights, looked like something out of the future.

Incredibly, the Dubai government last year spent about 45% of its budget on infrastructure projects - mostly on the roads and ports. But there is a lot more on tap, as The National reports:

"Dubai could invest as much as $20 billion in desalination projects in the next decade alone as it increases its water output by 2.72 billion liters a day... [There are also] plans to add 14,405 megawatts by 2017... Construction costs for those new plants amount to $11.6 billion, while infrastructure costs, including substations and transmission lines, will be about $11.6 billion."

This massive build-out is not unique to Dubai, or even the UAE. There are also big infrastructure projects of all kinds in India and China and other emerging markets.


Chris Mayer
for The Daily Reckoning

P.S. From these basic needs for water and power (and more) spin all kinds of investment ideas and implications. See more in the latest issue of Mayer's Special Situations.

Editor's Note: Chris Mayer studied finance at the University of Maryland, graduating magna cum laude. He went on to earn his MBA while embarking on a decade-long career in corporate banking. Chris is the editor of Capital and Crisis and Mayer's Special Situations, a monthly report that unearths unique and unconventional opportunities in smaller-cap stocks.

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