Saturday, October 25, 2014

Total War over the Petrodollar

By Marin Katusa, Chief Energy Investment Strategist

The conspiracy theories surrounding the death of Total SA’s chief executive, Christophe de Margerie, started the second the news broke of his death. Under mysterious circumstances in Moscow, his private jet collided with a snowplow just after midnight. De Margerie was the CEO of Total, France’s largest oil company.

He’d just attended a private meeting with Russian Prime Minister Medvedev, at a time when the West’s relationship with Russia is fraught, to say the least.

One has better odds of being struck by lightning at an airport then a snow plow, or any other ground support vehicles hitting a plane and killing all inside the plane, in my opinion. And I say that as someone who’s familiar with airports, having worked at Vancouver International Airport when I was in university; I was the one who would bring the plane into its parking bay.

If it weren’t for those short odds, a snowplow on the runway with an allegedly drunk driver would be the perfect crime. But who would benefit from his death?

De Margerie was one of the few business leaders who spoke out against the isolation of Russia. On this last trip to Moscow, he railed against sanctions and the obstacles to Russian companies obtaining credit.
He was also an outspoken supporter of Russia’s position in natural gas pricing and transportation disputes with Ukraine, telling Reuters in an interview in July that Europe should not cut its dependence on Russian gas but rather focus on making the supplies more secure.

But what could have made de Margerie a total liability is Total’s involvement in plans to build a plant to liquefy natural gas on the Yamal Peninsula of Russia in partnership with Novatek. Its most ambitious project in Russia to date, it would facilitate the shipping of 800 million barrels of oil equivalent of LNG to China via the Arctic.

Compounding this sin, Total had just announced that it’s seeking financing for a gas project in Russia in spite of the current sanctions against Russia. It planned to finance its share in the $27 billion Yamal project using euros, yuan, Russian rubles, and any other currency but US dollars.

Did this direct threat to the petrodollar make this “true friend of Russia”—as Putin called de Margerie—some very powerful and dangerous enemies amongst the power that be, whether in the French government, the EU, or the US?

In my book The Colder War, one chapter deals with “mysterious deaths” and how they are linked to being on the wrong side of the political equation. Whether it’s going against Putin or against the petrodollar, there are many who have fallen on both sides.

If Total doesn’t close the $27 billion financing it needs to move forward with the Yamal LNG project then we’ll know someone stepped in to prevent an attack on the petrodollar.  The CEO of Total, before his death and his CFO were both strong supporters of Total raising the $27 billion in non U.S. dollars and moving the project forward with the Russians.  But, this could all change if the financing does not complete.

How many other Western executives who dare to help Russia bypass sanctions—and turn it into an energy powerhouse—will die under suspicious circumstances?

Marin Katusa, is author of The Colder War, manager of multiple global energy-exploration hedge funds, and co-founder of Copper Mountain Mining Corporation. Click here to get a copy of his must-read new book, The Colder War. Inside, you’ll discover exactly how Putin is taking over the energy sector, how far ahead he is, and how alarming it is that no one in the US or Europe has even entered the race.

The article Total War over the Petrodollar was originally published at casey research



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Friday, October 24, 2014

Blood in the Streets to Create the Opportunity of the Decade

By Laurynas Vegys, Research Analyst

Gold stocks staged spring and summer rallies this year, but haven’t able to sustain the momentum. Many have sold off sharply in recent weeks, along with gold. That makes this a good time to examine the book value of gold equities; are they objectively cheap now, or not?

By way of reminder, a price to book value ratio (P/BV) shows the stock price in relation to the company’s book value, which is the theoretical value of a company’s assets minus liabilities. A stock is considered cheap when it’s trading at a historically low P/BV, and undervalued when it’s trading below book value.

From the perspective of an investor, low price to book multiples imply opportunity and a margin of safety from potential declines in price.

We analyzed the book values of all publicly traded primary gold producers with a market cap of $1 billion or more. The final list comprised 32 companies. We then charted book values from January 2, 2007 through last Thursday, October 15. Here’s what we found.


At the current 1.20 times book value, gold stocks aren’t as cheap as they were when we ran the numbers in June, 2013, successfully pinpointing the all-time low of 0.91 (the turning point before the period in gray). Of course, that P/BV is hard to beat: it was one of the lowest values ever. And while the stocks not quite as cheap now, the valuation multiple still lingers close to its historical bottom. Remember, we’re talking about senior mining companies here—producers with real assets and cash flow selling for close to their book values.

In short, yes, gold stocks are objectively selling cheaply.

The juniors, of course, have been hit harder. It’s hard to put a meaningful book value on many of these “burning matches” with little more than hopes and geologists’ dreams, but valuations on many are scraping the bottom, making them even better bargains, albeit substantially riskier ones.

What does this mean for us investors?

It’s no surprise to see that every contraction in the ratio was followed by a major rally. In other words, the cure for low prices is low prices:
  • The August, 2007 bottom (2.2) and the momentary downtrend that preceded it were quickly erased by a swift price rally leading to a January, 2008 peak (3.8).
  • The bull also made a comeback in 2009-2010, fighting its way up out of what seemed at the time to be the deepest hole (1.04) in October, 2008.
Stocks have been on a long slide since the ratio last peaked at 3.24 in October, 2010, with the downturn in 2013 pushing multiples to previously unseen lows.

No one—us included—has a crystal ball, and so it’s impossible to tell if the bottom is behind us. We can, however, gauge with certainty when an asset is cheap—and cash-generating companies selling for little more than book value are extraordinary values for big-picture investors.

Now let’s see how these valuations look against the S&P 500.


Stocks listed in the S&P500 are currently more than twice as expensive as the gold producers. That’s not surprising given how volatile metals prices can be and how unloved mining is—but is it rational? Note that despite the downtrend in the last month, the multiple for the S&P500 remains close to a multiyear high.

In other words, yes, the S&P 500 is expensive.

This contrast points to an obvious opportunity in our sector.

So is now the time to buy gold stocks? Answer: our stocks are good values now, and, if there is a larger correction ahead, they may well become fantastic values, briefly. Either way, value is value, on sale.

As the most successful resource speculators have repeatedly said: you have to be a contrarian in this sector to be successful, buying low and selling high, and that takes courage based on solid convictions. Yes, it’s possible that valuations could fall further. However:

The difference between prices and clear-cut value argue for going long and staying that way until multiples return to lofty levels again—which they’ve done every time, as the historical record shows.

With a long term time frame in mind, whatever happens in the short term is less of a concern. Building substantial positions at good prices in great companies in advance of what must transpire sooner or later is what successful speculation is all about. This is how Doug Casey, Rick Rule, and others have made their fortunes, and it’s why they’re buying in the market now, seeing market capitulation as one of the prime opportunities of the decade.

That’s worth remembering, especially during a downturn that has even die hard gold bugs giving up.
Bottom line: “Blood in the streets” isn't pretty, but it’s a good thing for those with the liquidity and courage to act.

What to buy? That’s what we cover in BIG GOLD. Thanks to our 3 month full money back guarantee, you have nothing to lose and the potential for gains that only a true contrarian can expect.




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Thursday, October 23, 2014

Third Quarter Review from Hoisington Management

By John Mauldin


I featured the thinking of Dr. Lacy Hunt on the velocity of money and its relationship to developed-world overindebtedness and the potential for deflation in this week’s Thoughts from the Frontline, and I thought you’d like to peruse Lacy’s entire recent piece on the subject.

Lacy takes the US, Europe, and Japan one by one, examining the velocity of money (V) in each economy and bolstering the principle, first proposed by Irving Fisher in 1933, that V is critically influenced by the productivity of debt. Then, turning to the equation of exchange (M*V=Nominal GDP, where M is money supply), he demonstrates that we shouldn’t be the least bit surprised by sluggish global growth and had better be on the lookout for global deflation.

Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington US Treasury Fund (WHOSX).

I am writing this note in a car going to Athens, Texas, where I’ll join Kyle Bass and friends at his Barefoot Ranch for a huge macro fest. October is one of my favorite times of the year to be in Texas, and the ranch is a beautiful venue. I am sure I will have some challenging conversations.

Last night in Chicago I was picked up by Austyn Crites, who drove me downtown in rush-hour traffic, which gave us a lot of time to talk about his current passion, high balloons. I have been fascinated with them for some time, but there hasn’t been a lot of reliable information.

Basically, Google and Facebook are both planning to launch very large helium balloons full of radios and cameras and float them up to 60,000+ feet. The concept is working in several remote locations now. It’s a way to get full wireless internet coverage. With about 40,000 balloons you can blanket the earth. Literally. Full connectivity. Everywhere. Austyn wants to design a new type of balloon and be the manufacturer. It’s tricky as you need a VERY thin balloon envelope (that does not leak) the size of small house in order to get enough payload that high.

But he thinks the final cost of the balloons will fall dramatically and that you might be able eventually to pull off the operation for a billion or so a year (since balloons eventually come down and need to be replaced).
But if you are Google and you get the search revenue from connecting an additional five billion people?

Chump change. Same for Facebook. But what if Apple or Samsung want to make it so that their phones are afforded free or very cheap access? A consortium of consumer companies could easily see free wifi as a tool for branding. Current telecoms will have to get in the business to compete.

I kept coming back to the costs and tech issues. There are new things that will have to be invented, but nothing as complex as some of the problems that have already been overcome. They will be rolling out in parts of the world in a few years. Coming to a region near you in 5-10 years. Total game changers. While a hundred other game changers are coming down the tunnel.

Austyn's company’s challenge is to be the little guys who don't know they can't invent a new process that the big guys are working on as well. Can he pull it off? He has the passion and drive. I love meeting young people like him doing their part to change the world. They are everywhere, too. It's why I’m optimistic about the future of the human experiment, if just a tad bearish on governments. You can follow Austyn at his website.

Time to hit the send button, as we are getting close and I don't want to miss a minute. I will report back what I can. Have a great week.

Your dreaming of really, really cheap, ubiquitous connectivity everywhere analyst,
John Mauldin, Editor
Outside the Box

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Hoisington Investment Management – Quarterly Review and Outlook, Third Quarter 2014

Faltering Momentum

The U.S. economy continues to lose momentum despite the Federal Reserve’s use of conventional techniques and numerous experimental measures to spur growth. In the first half of the year, real GDP grew at only a 1.2% annual rate while real per capita GDP increased by a minimal 0.3% annual rate. Such increases are insufficient to raise the standard of living, which, as measured by real median household income, stands at the same level as it did seventeen years ago (Chart 1).



Over the latest five years ending June 30, 2014, real GDP expanded at a paltry 2.2% annual rate. In comparison, from 1791 through 1999, the growth in real GDP was 3.9% per annum. Similarly, real per capita GDP recorded a dismal 1.4% annual growth rate over the past five years, 26% less than the long-term growth rate. A large contributor to this remarkable downshift in economic growth was that in 1999 the combined public and private debt reached a critical range of 250%-275% of GDP. Econometric studies have shown that a country’s growth rate will lose about 25% of its “normal experience growth rate” when this occurs. Further, as debt relative to GDP moves above critical threshold levels, some researchers have found the negative consequences of debt on economic activity actually worsens at a greater rate, thus becoming non-linear. The post-1999 record is consistent with these findings as the U.S. debt-to-GDP levels swelled to a peak as high as 360%, well above the critical level noted in various economic studies.

In terms of growth, it looks as if the second half of 2014 will continue to follow this slow growth pattern. Although all of the data has not yet been reported, it appears that the year-over-year growth in real GDP for the just ended third quarter period is unlikely to exceed the 2.2% pace of the past five years. Economic vigor is absent, and the final quarter of the year looks to be weaker than the third quarter.

Poor domestic business conditions in the U.S. are echoed in Europe and Japan. The issue for Europe is whether the economy triple dips into recession or manages to merely stagnate. For Japan, the question is the degree of the erosion in economic activity. This is for an economy where nominal GDP has been unchanged for almost 22 years. U.S. growth is outpacing that of Europe and Japan primarily because those economies carry much higher debt-to-GDP ratios. Based on the latest available data, aggregate debt in the U.S. stands at 334%, compared with 460% in the 17 economies in the euro-currency zone and 655% in Japan.

Economic research has suggested that the more advanced the debt level, the worse the economic performance, and this theory is in fact validated by the real world data.

Falling World Wide Inflation


In this debt-constrained environment, it is not surprising that inflation is receding sharply in almost every major economy, including China. The drop in price pressures in the U.S. and Europe is significant, and the fall in Chinese inflation to 2%, from a peak of nearly 9% in 2008, is notable.

In the latest twelve months, the CPI in the euro currency zone rose a scant 0.3% (Chart 2), the lowest since 2009, while the core CPI increased by 0.7%, near the all time lows for the series. The yearly gain in the U.S. for both core and overall CPI was 1.7%. Since 1958 when the core CPI came into existence, it and the overall CPI have increased at an average annual rate of 3.8% and 3.9%, respectively, over 200 basis points greater than the current rates. Both the overall and core personal consumption expenditures U.S. price indices rose by 1.5% in the twelve months ending August of 2014. Both of these are near the all time lows for their respective series.



The risk of outright deflation in Europe with inflation at such low levels, and the danger of similar developments in the U.S., should not be minimized as inflation has fallen in almost every previous U.S. and European economic contraction. Lower inflation is, in fact, almost as much of a hallmark of recessions as is decreasing real GDP. From peak-to-trough the rate of CPI inflation fell by an average of slightly more than 300 basis points in and around the mild U.S. recessions of 1990-91 and 2000-01. Starting from a much lower point, the CPI in Europe at those same times dropped by an average of 150 basis points. Given that inflation is already so minimal in both the U.S. and Europe, even the mildest recession could put both economies in deflation.

Japan’s recent quantitative easing has helped devalue its currency by 44% versus the dollar, since the 2011 lows. This import- dependent country has therefore seen its costs rise dramatically. This, along with higher consumption taxes, has created a current year- over-year inflation rate of 3.3%. These higher prices are an enormous drag on economic growth as incomes fail to rise commensurately. Thus negative GDP growth will result in a continuing pattern of deflation. Japan’s CPI has been zero or negative on a year over year basis in 16 of the last 23 quarters.

Declining Money Velocity A Global Event


One factor that connects poor growth with the low inflation and low bond yields evident in the U.S., Europe and Japan is that the velocity of money (V) is falling in all three areas.

Functionally, many things influence V. The factors that could theoretically influence V in at least some minimal fashion are too numerous to count. A key variable, however, appears to be the productivity of debt. Money and debt are created simultaneously. If the debt produces a sustaining income stream to repay principal and interest, then V will rise since GDP will rise by more than the initial borrowing. If the debt is unproductive or counterproductive, meaning that a sustaining income stream is absent, or worse the debt subtracts from future income, then V will fall. Debt utilized for the purpose of consumption or paying of interest, or debt that is defaulted on will be either unproductive or counterproductive, leading to a decline in V.

The Nobel laureate Milton Friedman, as well as economist Irving Fisher, commented on the causal determinants of V. Friedman thought V was stable while Fisher believed it was variable. Presently, the evidence suggests that Fisher’s view has prevailed. Fisher would not be at all surprised by the current impact of excessive debt since he argued in his famous 1933 paper “The Debt-Deflation Theory of Great Depressions”, that falling money velocity is a symptom of extreme over indebtedness.

Tracking that theory, it is interesting to note that velocity is below historical norms in all three major economic areas with existing over indebtedness. The U.S. V is higher than European V, which in turn is higher than Japanese V. This pattern is entirely consistent since Japan is more highly indebted than Europe, which is more highly indebted than the U.S. Unfortunately, broad monetary conditions (M2 money growth and velocity) are deteriorating, with 2014 displaying conditions worse than at the end of last year. The poor trend in the velocity for all three areas indicates that monetary policy for these countries is not a factor in influencing economic activity in any meaningful way.

United States. The U.S. year-over-year M2 growth has remained at about 6%, an annual growth level that has been consistent since 2008 (Chart 3), and the velocity of money has trended downward by about 3%. In the first half of 2014, V declined at a rate of 3.6%, but it is still too early to tell if this represents a new V deceleration to the downside (Chart 4).




According to the equation of exchange (M*V=Nominal GDP), the expected growth of nominal GDP is constrained to no more than a 3% increase with velocity declining by 3% and money supply expanding by 6%. However, when assessing the type of debt currently being employed (unproductive, at best) the risks are for lower growth levels. 2014 has witnessed a resurgence of consumer auto and mortgage lending that was achieved by a lowering of credit standards. The percentage of subprime consumer auto loans (31%) returned to the peak levels reached prior to 2008. Such lending has historically turned counterproductive. If this were to occur again, velocity would accelerate to the downside, resulting in a sub 3% path for nominal GDP.

Europe. V has only been available in Europe since 1995 as that is the starting date for GDP in the euro-currency zone. During the span from 1995 through 2013, V averaged 1.4, dropping from a peak of about 1.7 in 1995 to 1.03 in 2013 (Chart 5). Over that span, therefore, euro V has been trending lower at about a 2.6% per annum rate. On the money side, euro M2 increased by 2.4% in 2013, which is weaker than the average growth in the last four years (Chart 6). If the trend rate of decline in V remains intact, then nominal GDP in the euro zone could be flat. Inflation of any magnitude would result in a negative real GDP outcome.




Japan. From the start of the comparable M2 and nominal GDP statistics in 1969 in Japan, V in Japan has averaged 1.0, dropping from 1.54 in 1968 to a record low of 0.57 in the latest year (Chart 7). Thus, over this period V was falling at an average rate of 2.2% per annum. M2 in Japan increased 3.6% in 2013, which is slightly higher than the growth rate of recent years (Chart 8). If V’s downward trend remains intact, nominal GDP would be estimated to grow by 1.2%. However, inflation is currently running at 3.3%, suggesting real GDP could decline by over 2% in the next twelve months. This circumstance illustrates the double edged sword caused by a sharply depreciating currency. The weaker yen boosts exports but raises domestic inflation. Japanese inflation is already exceeding the rise in wages and household spending. These events are consistent with a contraction in economic activity and are the expectation derived from the analysis of money growth and its velocity.




Debt Research


Important new research by four distinguished economists (three in Europe and one in the U.S.) is contained in a report titled "Deleveraging? What Deleveraging?" (Luigi Buttiglione, Philip R. Lane, Lucrezia Reichlin and Vincent Reinhart, Geneva Reports on the World Economy 16, September 2014). It provides additional evidence on the role of “debt dynamics” and the state of the global debt overhang. They write, “Contrary to widely held beliefs, the world has not yet begun to delever and the global debt-to-GDP is still growing, breaking new highs.” Further, it is a "poisonous combination" when world growth and inflation are lower than expected and debt is rising. “Deleveraging and slower nominal growth are in many cases interacting in a vicious loop, with the latter making the deleveraging process harder and the former exacerbating the economic slowdown.”

This research also identifies two other highly significant trends. First, global debt accumulation was led by developed economies until 2008. Second, the debt build-up since 2008 has been paced by the emerging economies. The authors write that the rise in Chinese debt is especially “stunning”. They describe China as “between a rock (rising and high debt) and a hard place (lower growth).” In addition to China they identify India, Turkey, Brazil, Chile, Argentina, Indonesia, Russia and South Africa as belonging to the “fragile eight” group of countries that could find themselves in the unwanted role of host to “the next leg of the global leverage crisis.”

We interpret this research to mean that the monetary policy may begin to become ineffective at emerging market central banks, just as has happened in the U.S., Europe and Japan. Weaker growth conditions in the emerging markets are thus likely to accentuate, rather than ameliorate, poor business conditions in the major economies. Indeed, this year’s downturn in global commodity prices is consistent with the beginning of such a phase. The huge jump in emerging market debt is also significant because research has found the severity of economic contractions is directly related to the leverage in the prior expansion.

Asset Bubbles


Historically, in our judgment, the most important authority on the subject of asset bubbles was the late MIT professor Charles Kindleberger, author of 20 books including the one of the greatest books on capital markets Manias, Panics and Crashes (1978). He found that asset price bubbles depend on the growth of credit. Atif Mian (Princeton) and Amir Sufi (University of Chicago) provided confirmation for Kindleberger’s pioneering work and expanded on it in their 2014 book House of Debt. Chapter 8, entitled “Debt and Bubbles,” contains the heart of their insights. Mian and Sufi demonstrate that increasing the flow of credit is extremely counterproductive when the fundamental problem is too much debt, and excessive debt can fuel asset bubbles.

Based on our reading of these two books we would define an asset bubble as a rise in prices that is caused by excess central bank liquidity rather than economic fundamentals. As Kindleberger clearly stated, the process of excess liquidity fueling higher prices in the face of faltering fundamentals can run for a long time, a phase Kindleberger called “overtrading”. But eventually, this gives way to “discredit”, when the discerning few see the discrepancy between prices and fundamentals. Eventually, discredit yields to “revulsion”, when the crowd understands the imbalance, and markets correct.

Economists have commented on the high correlation between the S&P 500 and the Fed’s balance sheet since 2009. From 2009 to the latest available month, the monetary base (MB) surged from $1.7 trillion to $4.1 trillion. We ran the MB increase against the S&P 500 and found a very high correlation of 0.69. While correlation does not prove causality, the high correlation is certainly not inconsistent with the idea that the Fed liquidity played a major role in boosting stock prices. However, even as the MB has exploded since 2009 and stock prices have soared, the U.S. economy has experienced the worst economic expansion on record. In spite of a further large rise in the base this year, the GDP growth has subsided noticeably and corporate profits after taxes and adjusted for inventory gains/losses (IVA) and over/under depreciation (CCA) has declined 10% in the latest four quarters. Such discrepancy between the liquidity implied by the base and measures of economic performance could indicate the process of bubble formation. Kindleberger’s axiom that asset price bubbles depend on excess liquidity may yet face another test.

Still Bullish on Treasury Bonds


With the nominal growth trajectory extremely soft, U.S. Treasury bond yields are likely to continue working lower as similar circumstances have created declines in government bond yields in Europe and Japan. Viewing the yields overseas, it is evident that ample downside still exists for long U.S. Treasury bond yields, as the higher U.S. yields offer global investors an incentive to continue to move funds into the United States.

Another factor suggesting lower long- term U.S. Treasury yields is the strength of the U.S. dollar. In many industries, the price leader for certain goods in the U.S. is a foreign producer. A rising dollar leads to what economists sometimes call the “collapsing umbrella”. As the dollar lifts, the foreign producer cuts U.S. selling prices, forcing domestic producers to match the lower prices. This reinforces the prospect for lower inflation as nominal GDP wanes. This creates a favorable environment for falling U.S. Treasury bond yields.

Van R. Hoisington
Lacy H. Hunt, Ph.D.

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Wednesday, October 22, 2014

Mid Week Commodities Summary for Wednesday October 22nd - Crude Oil, Natural Gas, Gold, Silver, Coffee, Sugar, Euro, Dollar

Crude oil closed down $2.12 at $80.38 today. Prices closed near the session low and closed at a two plus year low close today. The bears have the solid near term technical advantage.

Natural gas closed down 5.1 cents at $3.749 today. Prices closed near the session low today and closed at a contract low close. The natural gas bears have the solid overall near term technical advantage.

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Gold futures closed down $7.20 an ounce at $1,244.50 today. Prices closed nearer the session low on profit taking after hitting a six-week high on Tuesday. Gold bears have the overall near-term technical advantage. However, a fledgling three-week-old uptrend is in place on the daily bar chart.

Silver futures closed down $0.379 at $17.17 today. Prices closed near the session low today. The silver bears have the firm overall near term technical advantage.

Todays top Dividend Plays....Stocks and ETFs

Coffee closed down 850 points at 191.10 cents today. Prices closed near the session low and hit another three week low today. It appears a market top is in place. The coffee bears have gained the near term technical advantage.

Sugar closed up 6 points at 16.50 cents today. Prices closed nearer the session low today. Sugar bears have the firm overall near-term technical advantage.

Oil Deflation, the Saudi’s Muslim Frankenstein, and the Colder War

The December Euro currency closed down 79 points at 1.2651 today. Prices closed nearer the session low again today. The Euro bears have the firm overall near-term technical advantage and are regaining downside momentum.

The U.S. dollar index closed up 0.436 at 85.840 today. Prices closed near the session high today. The greenback bulls have the overall near-term technical advantage and are regaining upside momentum.

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Tuesday, October 21, 2014

Is Gold as Dead as Florida Hurricanes?

By Dennis Miller

It’s been over 3,280 days since a hurricane hit Florida. As hurricane season comes to a close next month, only Mother Nature knows how long the streak will last.

Like many Floridians, my wife and I stayed home and rode out a hurricane—once! We’d built a home on Perdido Key, a barrier island west of Pensacola. It was engineered to withstand 150 plus mph winds, and it was a beautiful home with a master bedroom spanning the entire third floor, looking out across the Gulf of Mexico.

Hurricane Danny hit the Gulf shortly after we moved in. It was a fast moving Category I with winds gusting in the 75 - 80 mph range. Full of confidence and a bit curious, we decided to hunker down and ride it out. At the speed it was traveling, it should have been over in a matter of hours. Then, Danny caught everyone by surprise and stalled in Mobile Bay, pounding us for three days.

The waves on the Gulf were terrifying. We watched the rising tide bang boats against the rocks and sink others. Our front door had a double deadbolt with a keyhole on each side. Water shot through three feet into the room for 24 hours straight. Newly planted palm trees strained against support wires and toppled onto their sides.

We tried to get some sleep in our bedroom, but we could feel the house move with each gust of wind. We watched bits and pieces of our neighbor’s tile roof fly off and smash a few feet from our house. We were trapped and terrified for three days.

The no-hurricane record has been all over the Florida news, highlighting concern that people are becoming complacent. They don’t understand what adequate preparation entails. The storm itself can be horrific, but the aftermath can be equally disastrous, leaving people without food, water, power, and access to basic services for several days. Homes that survive a storm often have to be gutted because of mold and mildew. Without power, sewage immediately becomes a problem.

Plus, if your flood, wind, and homeowners insurance is not up to date, say hello to serious financial hardship. Many Floridians discovered too late that their policy limits had not increased with inflation and wouldn’t cover the cost of rebuilding.

Are You Crazy?—Part 1


Just for fun, I told a friend that I was thinking about selling my generator and dumping our emergency supplies. He looked at me in disbelief and finally uttered, “Are you crazy? When the next one hits, don’t try to mooch off of us. It’s every man for himself.”

Exasperated, he explained that hurricane-causing conditions had not gone away. Until the sun no longer heats the water, we no longer have large and fast temperature changes, and there are no trade winds, a hurricane is a constant threat. He was red in the face when he finished. I told him I was kidding and wanted to discuss something else: economic hurricanes.

Food, Water, a Generator, and Gold


Many financial pundits are shining the all clear signal, saying that our economy is fine. People are bailing on gold and mining stocks because they’ve dropped so low. To paraphrase my colleague, Casey Research Chief Economist Bud Conrad, gold sentiment has dropped to zero.
Take a look at the price of gold over the last decade:


Precious Metals Fall into Two Camps


High inflation (Hurricane Danny) and hyperinflation (Hurricane Katrina) are two potential threats to all of our lives. While we hope neither hits, we should still prepare.

At Miller’s Money, we put metals into two categories. The first is core holdings. This is pure insurance against a catastrophe—much the same as our hurricane survival package. Not all storms are category V. Even if we don’t have hyperinflation, during the Jimmy Carter era we experienced double-digit inflation that devastated a lot of retirement nest eggs. Investors holding long-term 6% certificates of deposit would have lost 25% of their buying power during a five-year period, even after they collected the 6% interest.

What if the storm intensifies into hyperinflation and its inevitable aftermath? Many of the items we keep for hurricane emergencies may come in handy if the food supply is interrupted, electricity is cut off, or the currency collapses. Metals will protect us from the rising tide of inflation and protect our purchasing power.
The second category for metals and metal stocks is investment. These holdings are bought with the express intent of selling down the road for a nice profit. There is quite a debate going on in this arena. Some experts are touting the terrific buying opportunity. Others say gold is an ancient relic and there are a lot of better investment opportunities available. Should you take advantage of the buying opportunity or unload?

We set strict position limits in the Money Forever portfolio. When you’re investing money earmarked for retirement, which is our focus, the speculation portion is limited because preserving capital is the overriding consideration.

Gold stocks fall into two general categories. The first is established mining companies and the second is exploration and development companies. Stock in the first group is more directly related to the current price of gold. Every dollar fluctuation in the price of gold adds or subtracts from their net profit as their costs are primarily fixed.

For exploration and development companies, it’s a combination of the price of gold, their ability to raise capital, and a heavy emphasis on the economic viability of their discovery. In a large number of cases a major mining company buys them out and takes them into the production phase.

In both cases, there are certain events that can produce spectacular results; however, the risk is also high. The real question is do you have room to invest any more capital in the speculative portion of your portfolio? That’s up to the individual investor to answer. If you do have room, there are some incredible bargains in the market today. Our metals team travels the globe and has identified many candidates selling at true bargain-basement prices.

What about your core holdings? Should you buy or lighten your portion of metals? The first question to answer is: do you have ample core holdings at the moment? We recommend holding 10% - 20% of your net worth in core holdings, depending on your comfort level. (Mining stocks are generally not core holdings; they are speculative.) A lot of investors are slowly building to that target. If you think you should add more, then the current prices present a terrific opportunity.

Once you add to these core holdings, then the daily price fluctuations are no more relevant than the price of the case of beef stew we have stored in our closet. It’s insurance for a catastrophe we hope never happens. When the big one hits, we could probably sell our stew for an astronomical sum, but we won’t because it will help us survive. We would use some of our metal holdings, priced at current value, to buy things we need.

Are You Crazy?—Part 2


The same friend who was flabbergasted by my pretend plan to dump our hurricane supplies asked if I planned to sell any of our gold. I looked at him and asked, “Are you crazy?” Then I explained that the conditions that spawn inflation have not gone away either.

The reasons to own gold have compounded over the last decade. The U.S. government has printed trillions of dollars, our country’s debts are out of sight, and the Chinese and Russians are doing everything they can to oust the U.S. dollar as the world’s reserve currency. When the world no longer needs or wants to hold dollars, they will fly out the door faster than any hurricane wind mankind has ever seen. The value of the dollar will drop like a two-ton anchor and the price of gold will soar.

Precious metals are insurance against the ultimate financial hurricane. Fiat currencies eventually collapsed; the U.S. dollar will not get a free pass. Just as sure as the sun heats the water, we have large and fast temperature changes, and there are trade winds, an overly indebted government will experience a currency collapse.

We have all had ample warning and should be prepared. Don’t be fooled by the short term thinking.

For more up to date economic analysis and time-tested tips for protecting your nest egg, sign up for our free weekly e-letter, Miller’s Money Weekly

The article Is Gold as Dead as Florida Hurricanes? was originally published at millers money


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Monday, October 20, 2014

The 10th Man....What a Correction Feels Like

By Jared Dillian


Back in the summer of 2007, when I was working for Lehman Brothers, I had a vacation to the Bahamas planned. This was unusual for me. Up until that point, in six years of working for Lehman, I had taken about five vacation days—total. But my wife and I were going to a semi primitive resort on Cat Island, the most desolate island in the Bahamas. Interesting place for a vacation. Suffice to say that it’s plenty hot in the Bahamas in August.

The market had been acting funny for a while, and I had a hunch that there was going to be trouble while I was gone, so I bought the 30 strike calls in the CBOE Market Volatility Index (VIX). I was betting that volatility was going to go up a lot in a short period of time. In fact, these options—which I spent a little over $100,000 on—would be worthless unless there was outright panic. I gave instructions to my colleagues to sell the call options if the VIX went over 35. (Note: my memory on the details of the trade, like the strike of the options and the level of the VIX, is a little hazy. The specifics might have been different, but you get the general idea.)

So there I was, sunning myself at this primitive resort on Cat Island and the world was melting down, and I was completely oblivious to what was going on back on Wall Street. Coincidentally, the local Bahamas newspaper had a picture of black swans on the cover one day. I staged a photo of me in a hammock reading the newspaper with the black swans on it. I still have that photo.

I got back to civilization and checked the markets. I saw the chart of the VIX. I could hardly contain myself. If my colleagues had executed the trades properly, I would have had a profit of over $800,000. But when I got back to work and opened my spreadsheet, I found that I’d made less than $100,000. What I had failed to consider was that if the world actually was blowing up, the guys would have been too busy to execute my trade.

So there is this whole idea of state dependence that we have to consider when we’re talking about the market. Like, you might have a plan to buy stocks when the index gets below a certain level, but when the market gets to that point, you: a) may not have the capital; and b) might be panicking into your shorts. It’s nice to have a plan, but, paraphrasing Mike Tyson, everyone has a plan until they get punched in the face.

I remember reading Russell Napier’s book about bear markets, called Anatomy of the Bear. It talked about all the big bear markets in the US, including the granddaddy of them all, the stock market crash of 1929 and the Great Depression. One of the things that I learned from this book was that if you can time the bottom exactly right, you can make a hell of a lot of money in very short order. For example, if you had bought the lows in 1932, you could have doubled your money in a matter of months.

I wanted to do that. I prayed for a bear market, so I would get my chance.

Little did I know that I would get my chance just two years later—and blow it.

When the market is down 60%, it’s scary as hell to buy stocks. Hindsight being 20/20, you can say, “What, did you think it was going to zero?” Actually, yes—in March of 2009, people thought it was going to zero.
But for those people who: a) had capital; and b) weren’t terrified, it was a once in a lifetime opportunity.

A Thousand Days with No Correction


So let’s talk about a). Does everybody have capital? Remember, the hard part of this is not picking bottoms. Many people can do this quite capably. Panic/liquidation is very easy to spot. But few people have the ability to take advantage of it, because they’re fully invested.

As for b), you tend not to be terrified if you have capital.

Everyone knows by now that the stock market is correcting. The price action is pretty terrible. Will it get worse? I think so. We’re seeing excesses (corporate credit, growth stocks, IPOs) that we haven’t seen in many, many years. It’s been over 1,000 days since we’ve had a correction of any magnitude. With the market down about 5%, nobody is particularly worried, because every other time the market was down 5%, it ended up going higher.

Back to state dependence. What is it going to feel like if the market goes down further? How will people behave if the S&P 500 gets to, say, 1,700?

I can tell you what it will be like if the S&P gets to 1,700. It’s going to be like it was in August of 2007 when my coworkers forgot to sell my VIX calls because they were buried under an avalanche of panicked sell orders from institutional money managers. Pre-algorithmic trading, the trading floor used to get pretty noisy. I used to be able to tell you what the market was doing just from listening to the floor. At SPX 1,700, trading floors will be very noisy.

It’s been so long since we’ve had a correction, I’m guessing that most people have forgotten what a correction feels like. When you go that long in between corrections, people are sitting on a mountain of capital gains. And unless the capital gains really start to disappear, there is little pressure to sell. But if you’re the owner of, say, airline stocks, and you’ve watched them evaporate to the tune of 30%, that tends to focus the mind a little bit.

As with any steep correction, there will be fantastic opportunities, but they will only be available to those who have capital. Remember, bear markets don’t just destroy the bulls’ capital, they destroy the bears’ capital, too.

Bear markets destroy everyone’s capital.
Jared Dillian
Jared Dillian

The article The 10th Man: What a Correction Feels Like was originally published at mauldin economics


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Saturday, October 18, 2014

Commodity Market Summary for Week Ending Friday October 17th - Crude Oil, Gold, U.S. Dollar, Coffee and More

Our trading partner Mike Seery brings us his take on this volatile commodities market, read in detail as Mike includes his stops and so much more......

Crude oil futures in the November contract had a wild trading week in New York currently trading at $83 a barrel after settling last Friday at 85.82 as prices actually breached the $80 mark before reversing in yesterday’s trade to settle down nearly $3 for the trading week. Crude oil futures are trading below their 20 day and $13 below their 100 day moving average telling you the trend is clearly bearish and if you are short this market place your stop above the 10 day high which currently stands at 90.75 and that stop will be lowered on a daily basis as I missed this market and am currently sitting on the sidelines as the chart structure was awful when the breakout occurred so I’m kicking myself at the current time.

I definitely am not recommending any type of long position in crude oil as I think prices will continue to head lower especially with Saudi Arabia coming out stating that they will not cut production as they are looking for lower prices to squeeze U.S output as this market still has further to go in my opinion and 79.78 in yesterday’s trade will be retested once again so continue to take advantage of any rally making sure you place the proper stop loss also maintaining a proper risk management of 2% of your account balance on any given trade. Crude oil prices have dropped from $104 a barrel in late June to today’s price levels dropping over $20 or 20% as consumers will definitely benefit when they hit their local gas stations and that should also help improve the U.S economy.

The fundamentals in crude oil are extremely bearish as worldwide supplies are extremely high while supplies here in the United States are at record highs so it’s very difficult to rally as we don’t have the spike up in price like we used to when Middle East conflicts erupted which is a good thing for the United States. TREND: LOWER
CHART STRUCTURE: POOR

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Gold futures in the December contract had a volatile trading week in New York still trading above its 20 day but below its 100 day moving average telling you that the trend currently is mixed as prices hit a 4 week high in Wednesday’s trade at 1,250 however we are down about $3 this Friday afternoon currently trading at 1,239 as the trend still remains neutral as I’m sitting on the sidelines. A possible spike bottom was created around the 1,185 level as I was short this market from around 1,278 getting stopped out at the 2 week high around 1,235 so right now I’m waiting for a better chart pattern to develop as the chart structure is somewhat poor at the current time as the U.S dollar has been pressuring gold in recent weeks but the dollar looks like its created a short term top as well.

The problem I have with gold at the current time is with all worldwide problems and the stock market experiencing huge volatility this week gold prices should be sharply higher from today’s prices levels so this tells me that this market remains weak and if you think a top has been created at 1,250 sell at today’s price of 1,239 risking $11 or $1,100 per contract, however like I’ve stated before I am sitting on the sidelines waiting for a trend to develop. At the current time many of the commodity markets are experiencing very few trends and as a commodity trader you do not want to trade just too trade so you must have patience as at the current time there have not been any new breakouts in several weeks except for a select few.
TREND: MIXED
CHART STRUCTURE: POOR

The U.S Dollar experienced an extremely volatile trading week settling last Friday at 86.00 currently trading at 85.28 up about 20 points this Friday afternoon as volatility has exploded in bonds, stocks and many of the commodities as prices hit a 2 week low this week stopping out my recommendation around 85.30 as currently I’m sitting on the sidelines. If you took my original recommendation when prices broke out above the contract high of 81.20 back on the 25th of July this trade worked out very well but now look for other markets that are trending as this market will probably consolidate as it rallied about 600 points in the last 4 months, however I do believe we are in the midst of a long term bull market as Europe and Japan continue their quantitative easing as the United States has basically ended there quantitative easing so fundamentally speaking that should keep the foreign currencies weak against the U.S dollar. The chart structure currently is poor as this market generally is one of the least volatile of all the commodities, however with the stock market swings this week that sent volatility back into the dollar while sending shock waves through the currency markets as well so sit on the sidelines and look for another market with better chart structure. TREND: MIXED
CHART STRUCTURE: POOR

Coffee futures in the December contract are trading above their 20 & 100 day moving average however prices hit a 2 week low today as prices have become extremely volatile to the fact of hot & dry weather once again in Brazil causing concerns of another poor crop as prices settled last Friday at 220.40 currently trading at 210.70 down this Friday afternoon on a forecast of rain hitting key coffee growing regions next week. At the current time I’m sitting on the sidelines in this market as prices have become extremely volatile as I will wait for better chart structure to develop however I do think prices are limited to the downside due to the fact that Brazil probably will produce another poor crop this year as coffee is grown on trees and when a drought occurs those trees can be stressed for several years unlike the grain market where you can grow a brand new crop the next year. I’ve talked to a large coffee producer down in Brazil and he still is extremely bullish stating that he thinks the crop production numbers will be lower than what is currently estimated but only time will tell but the trend is neutral to higher at the current time but look for a better market with better chart structure.
TREND: NEUTRAL
CHART STRUCTURE: POOR

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Friday, October 17, 2014

How to Invest in a Difficult Market

By Casey Research

Many experts hold dim views of the current state of the US economy—but what’s a prudent investor to do to make a profit? Find out what the blue-ribbon faculty of economists and investment pros at the recently concluded Casey Research Fall Summit thought.

Lacy Hunt, senior executive VP of Hoisington Investment Management Company and former chief economist at the Dallas Fed, says the main reason that the global economy continues to falter is that all countries borrow too much and save too little.

“275% total debt to GDP is the critical threshold. Every world economy of importance is above that level and moving higher.” He finds today’s monetary policy “impotent.” The Fed, Bank of England, and Bank of Japan are trying to solve the problem of too much debt by borrowing more, which has short-term benefits, but will be disastrous long term.

Too much borrowing, says Hunt, guarantees that we’ll get more asset bubbles. Because the United States is the least indebted of the three countries, it will continue to outperform Japan and Europe. He predicts that the dollar will rise against other major currencies and that inflation, as well as interest rates, will remain low.

Christian Menegatti, managing director of economic research at Roubini Global Economics, is convinced that we’re at the end of a supercycle and won’t see a normalization of monetary policy for quite some time.
Like Lacy Hunt, Menegatti predicts that global interest rates will stay low. On the positive side, he doesn’t believe that we will see secular stagnation; in other words, a full “Japanification” of the US is unlikely.

The current economic recovery in the US is weaker than that in the 1930s, claims Worth Wray, chief strategist at Mauldin Economics. He says while nominal interest rates are the lowest they've ever been, real rates could go lower.

When the Fed’s QE3 is over, he predicts that growth will weaken and rates will fall further. “Without another dose of stimulus, the US will likely slide into recession.”

Taking a global view, he thinks that China’s slowdown could cause the Australian housing bubble to pop, and that commodity prices will drop over the next few years, which will hurt resource rich countries like Australia, Norway, and Canada.

He recommends to buy U.S. Treasuries and to diversify across asset classes that thrive in different economic environments to strengthen your portfolio against a possible crisis.

Diversification is also the number one tip from the expert panel on “Building a Crisis Proof Portfolio” at the Casey Summit, consisting of Worth Wray and Casey editors Alex Daley, Terry Coxon, Dan Steinhart, and Dennis Miller.

They say a crisis can take one of two forms:
  1. A “standard” crisis, where stocks crash but the financial system remains intact. In that scenario, you want to own US government bonds because they’ll retain their safe-haven properties.
  1. A “reset,” meaning a complete implosion of the global financial system. Government bonds won’t save you from that type of crisis. Instead, you’d want to own real, non-financial assets, such as physical gold and silver, as well as farmland and other real estate.
For “Future Tech You Can Profit from Now,” Alex Daley, chief technology investment strategist at Casey Research, suggests to look for companies that offer game changing benefits or savings and that focus on “where businesses and people spend their time and money,” like OpenTable or Zillow.

Daley recommends three companies with great upside from his Casey Extraordinary Technology portfolio.
He says there’s no need to worry about the broader market if you can find great companies with consistent growth. “Look for 40% revenue growth over the same quarter last year; that’s the magic number.”

To get all of Alex Daley’s stock picks (and those of the other speakers), as well as every single presentation of the Summit, order your 26+-hour Summit Audio Collection now. It’s available in CD and/or MP3 format. Learn more here.

The article How to Invest in a Difficult Market was originally published at casey research


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How Can There Not Be a Currency Crisis?

By Casey Research

The Fed claims that signs of economic stress are very low, but savvy investors feel otherwise. With geopolitical unrest expanding and central banks doing the opposite of the right things, is a currency crisis barreling toward us? See what Mish Shedlock had to say about the state of world finance at the 2014 Casey Research Summit:


Even though the Summit is long over, you can still benefit from every presenter… every panel discussion… every investment recommendation. Order the 2014 Summit Audio Collection and you’ll receive all of that, plus all slides used in the presentations and a bonus highlight reel. Choose between instantly available MP3 files or CDs… or get both for maximum convenience.

Order now so that you’re well positioned to thrive in the coming crisis economy.

The article How Can There Not Be a Currency Crisis? was originally published at casey research


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Thursday, October 16, 2014

Calling into question what we are being told about ISIS, QE and Ebola

By John Mauldin


A note has been circulating among economists, calling into question the wisdom of another group of economists who wrote an open letter to the Federal Reserve a few years ago suggesting that one of the risks of their quantitative easing program was increased inflation. Since we have not seen CPI inflation, this latter group is calling upon the former to admit they were wrong, that quantitative easing does not in fact cause inflation. To no one’s surprise, Paul Krugman has written rather nastily and arrogantly about the lack of CPI inflation.

Cliff Asness has responded with a thoughtful letter, with his usual tinge of humor, pointing out that there has been inflation, it just hasn’t been in the CPI. We’ve seen it in assets instead. That money did go someplace, and it has disrupted markets. So why is Cliff’s letter a candidate for Outside the Box, when the markets seem to be bouncing all over heck and gone?

Because, come the next crisis, there is going to be another move for yet another round of massive quantitative easing. And the justification will be that increases in the money supply clearly don’t have much to do with inflation.

I should note that while I did not agree with the original letter (I thought we were in an overall deflationary environment, and I wrote that the central banks of the world would be able to print more money than any of us could possibly imagine and still not trigger inflation – views came in for considerable pushback), my reasons for believing QE2 and QE3 were problematic dealt with other unintended consequences. And ultimately, as global debt gets restructured (which will take many years) inflation will become a problem. Did you notice how Greek debt spreads blew out yesterday? It’s not just about oil. And trust me, France is going to be the new Greece before we know it. The people who think they can control markets and direct investors like sheep are going to be in for a huge surprise, but the nightmare is going to be visited upon the participants in the market.

We then move to a few thoughts from Peter Boockvar, in a letter he writes to savers, noting that the same people who brought you quantitative easing are also responsible for the demise of any income that might possibly have come from saving.

I wish I had good advice for your savings, but I can’t advise buying stocks that have only been more expensive in 2000 on some key metrics right before you know what, and I can’t recommend buying any long term bond as the yields also stink relative to inflation. With the Fed now saying that the dollars in your pocket are now worth too much relative to money in people’s pockets overseas and thus joining the global FX war, maybe you should buy some gold, but I know that yields nothing either. You are the sacrificial lamb in this grand experiment conducted by the unelected officials working at some building named Eccles who seem to have little faith in the ability of the US economy to thrive on its own as it did for most of its 238 years of existence. Borrowers and debt are their only friends. To you responsible saver that worked hard your whole life, may you again rest in peace.

And then we finish with some thoughts from our friend Ben Hunt, who takes exception to being told how to think and believe and act by “those smart people with degrees” who only want to do what’s best for us. Not just in economics but with regard to ISIS and Ebola and everything else. After reading Ben’s essay I called him and said, “Me too!”

I am tired of being manipulated, placated, spin-lied to (if it’s not a word it should be), mutilated, spindled, and folded.

We have to keep our eyes open and entertain the possibility that central banks will “lose the narrative,” that is, their ability to control markets with simple statements. The BIS recently had this to say:

Guy Debelle, head of the BIS’s market committee, said investors have become far too complacent, wrongly believing that central banks can protect them, many staking bets that are bound to “blow up” [at] the first sign of stress.

Mr. Debelle said the markets may at any time start to question whether the global authorities have matters under control, or whether their pledge to hold down rates through forward guidance can be believed. “I find it somewhat surprising that the market is willing to accept the central banks at their word, and not think so much for themselves,” he said. [Source: Ambrose Evans-Pritchard, “BIS warns on 'violent' reversal of global markets”]

The 10 year US Treasury slipped below 2% earlier today, but has rebounded somewhat to 2.06% as I write. Oddly, the yen seems to be strengthening slightly as the stock markets once again fall out of bed. Oil continues to weaken. As noted above, Greeks spreads are blowing out. Super Mario needs to get on his bike and start peddling before that concern spreads to other nations almost as insolvent. France will soon be downgraded again. Don’t you just love October?

What an interesting time to hold a midterm election. Have a great week!
Your really thinking through the implications of a stronger dollar analyst,
John Mauldin, Editor
Outside the Box

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The Inflation Imputation

By Cliff Asness, AQR Capital Management LLC

In 2010, I co-signed an open letter warning that the Fed’s experiment with an unprecedented level of loose monetary policy – in amount, and in unorthodox method – created a risk of serious inflation. Sporadically journalists and others have noted that this risk has not come to pass, particularly in consumer prices.

Recently there has been an article surveying each of us as to why; seeming to relish in, when provided, our various rationales, presumably as they sounded like excuses. It seems none of the responses provided what the authors clearly wanted, a blanket admission of error. I did not comment for that article, continuing my life long attempt not to help reporters who’ve already made up their mind to make fun of me – I help them enough through my everyday actions, they don’t need more!

More articles of similar bent keep showing up. The authors seem to find it amusing that four years of CPI data wouldn’t get people to change their economic views, while ignoring that 80 years of overwhelming evidence has not dissuaded Keynesians from the belief that this time, if they could only run everything, not just most things, they’d really get it right.

Focusing my attention, as was predestined, Paul Krugman lived up to his lifelong motto of “stay classy” with a piece on the subject entitled Knaves, Fools, and Quantitative Easing. Some lesser lights of the Keynesian firmament have also jumped in (collectivists, of course, excel at sharing a meme). Responding to Krugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like many unpleasant tasks, it’s necessary. I will, at least partially, make that error here, while mostly trying to deal with the original issue separate from Paul’s screeds (though one wonders if CPI inflation had risen in the last four years if Paul would be admitting his entire economic framework was wrong – ok, one doesn’t really wonder – and those things never happen to Paul anyway, just ask him).

Let me say up front that this essay will satisfy nobody. Those looking for a blanket admission of error will get part of what they want; a small part. Those hoping I hold the line denying any misstep will also be disappointed. I believe truth, as is often the case in similar situations, lies in the middle of these and I prefer truth, as I see it, to any reader walking away sated.

We indeed warned about the risks of inflation in 2010 and the CPI has been, to put it mildly, benign since then. First, to give the baying crowd just a bit of what it wants (I will take some of it back soon), our bad (I say “our” but obviously I speak only for myself). When you warn of a risk and it doesn’t come to pass I do think you owe the world this admission, even if you later explain what it means to warn of a risk not a certainty, and offer good reasons why despite reasonable worry this particular risk didn’t come to pass. I, and many other signatories, live in the world of economic or political prognostication, in my case money management, where if you get a bit more than half your calls right you are doing quite well, more than a bit more than half, you’re doing fabulously. I’ll put our collective record up against Krugman’s (and the Krug-Tone back-up dancers) any day of the week and twice on days he publishes.

Let’s start with the big one. We did not make a prediction, something we certainly know how to do and have collectively done many times. We warned of a risk. That’s a very specific choice people like the open letter writers, and Paul, have to make all the time, and he knows this, but that doesn’t deter him. Rather, Paul engages in the old debating trick of mentioning this argument himself and dismissing it. This technique worked for Eminem at the end of Eight Mile. But let’s not be fooled by chicanery (silly Paul, you are no Rabbit). If I had wanted to make a prediction, I would have made one. I didn’t, nor did my fellow signatories. Frankly, if there are any economists, aside from those never-uncertain-but-usually-wrong like Paul, who did not think such unprecedented Fed action represented at least a heightened risk, I think it was malpractice on their part.

An honest Paul Krugman (we will use this term again below but this is something called a “counter-factual”) would have agreed with our letter but qualified that while heightened, he still didn’t think this risk would come to fruition and that he thought it was a risk worth running. Still, I will give the critics half credit here, accept half blame, and issue a demi mea culpa. By writing the letter we clearly thought this risk was higher than others did, and wished to stress it, and it has not (as most commonly measured) as of now come to bear. Our, and my, (half) bad. I hope that makes the critics (half) happy and they can stop copying each other’s articles over and over again.

Of course being able to call out risks, not just make firm predictions, is quite important. If you believe the risk of an earthquake is 10 times normal, but 10 times normal is still not a high probability, it’s rational to warn of this risk, even if the chance such devastation occurs is still low and you’ll look foolish to some when it, in all likelihood, doesn’t happen. If you can’t point out risks you are left with either silence as an option, or overly and falsely self-confident forecasts. Perhaps the latter may work for former economists turned partisan pundits but the rest of us will have to live with the ex ante and ex post ambiguity of discussing risks.

It’s a real subtlety but I think there is truth somewhere in between the current attack meme of “you predicted inflation risk and were wrong and are now hiding behind the word ‘risk’“ and “we only said it was a risk so we cannot be wrong.” I think when you boldly forecast a risk you are saying more than “this might happen but either way I can’t be blamed” and something less than “this will happen and I stake my reputation on it.” We should all be mature enough to know the difference, but apparently that ship has sailed......

Not surprisingly, the above stress on risk jibes with my personal view of monetary policy, one that might not be shared by all my co-signatories. I tend to think it matters less than most think, and matters less often than most think. I tend to view it, for finance fans, in a “Modigliani Miller” (MM) framework, where most corporate financing transactions are paper-for-paper, mattering little. But, in the MM framework bankruptcy costs do matter. Therefore most corporate capital structure decisions are irrelevant, except to the extent they increase the chance of serious financial distress, in which everyone but the lawyers lose (in many models this risk must be balanced against the tax advantages of debt).

From this perspective, slight adjustments to the target Fed funds rate based on exquisitely sensitive perceptions of the probability of economic overheating or slowdown probably make little difference (and don’t even start me on the dots), but deflation or excessive inflation are important to avoid as their damage can be great. They are the bankruptcy costs of monetary policy. Thus, I think sounding the alarm, not making a prediction, that experimental and aggressive monetary policy raised one of these risks was appropriate. But, still, I think most people engaged on the topic spend a lot of time talking about monetary policy in the same way dogs spend a lot of time talking, yes in their secret dog language, about the cars they chase. The cars aren’t affected and generally don’t care.

Now, if you thought the above was an excuse on par with, continuing my canine fixation, “the dog ate my inflation,” and not the demi mea culpa I intended, you’re really going to hate the full blown non-conciliatory excuses about to come.

Economically, I think what everyone of any political or economic stripe missed, certainly including myself, was how little money would circulate, how little would be lent and then spent. In econo-geek, how low the money multiplier would be. Money kept by banks at low but positive interest rates at the Fed clearly isn’t doing much of anything, creating inflation as we feared, or helping the economy as they hoped. To the extent inflation worriers like us were wrong, so were those predicting great economic benefits. The Fed clearly wanted this money lent by banks and spent by companies on investment and by people on consumption.

They didn’t get that, and we didn’t get the inflation we feared. This is not to say that low interest rates, real and nominal, and high prices for risky assets (and the supposed “wealth effect” that comes with them) were not Fed goals. They clearly were. But it seems these intermediate goals have not had their desired effect on the real economy.

Quantitative easing (QE) and other inventive forms of loose monetary policy have simply been less than hoped or feared. Some may declare Fed policy a great success as we’re not in a depression, but they can’t show any counter-factual, and given that this money has largely sat dormant, albeit presumably lowering risk premia (raising asset prices), it’s likely we’d have a similar record-weak recovery with or without it. How this is a victory for one side of the debate or another is beyond me, but obviously clear to Paul and his back-up singers. Of course, it’s also clear to Paul that the 2009 stimulus package saved us from this same second Great Depression (but more stimulus would of course have been much better). Yep, and if we traded good cash for just one more “clunker” we’d be growing at 5% per annum by now with a normal labor participation rate.

By-the-way, ignored in the critics’ review of the original letter was the line, “In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program...” On this I’m unapologetic. We were right, we’re still right, and thanks to people like Paul we’ve moved in the wrong direction. But that’s a fight for another day.

In a field without a broad set of counter-factuals we all stick too much to our priors and ideologies, and perhaps I’m doing that now. But at least I see it, and that’s always step one. Paul is stuck on step zero (if he ever gets up to “making amends” I will be around but given his history he might never get to me). But, if you’d like to advance past step zero, Paul, we’re still waiting on why Keynesianism failed to fix the Great Depression (no doubt not quite enough stimulus; just one more Hoover Dam would have done it, or, as they called it back then, “Dams for Clunkers”), strongly predicted a deep post-WWII depression, didn’t predict stagflation, and generally was on a the downward spiral to the intellectual dustbin until the great recession resuscitated it, not as a workable intellectual doctrine, but as an excuse for politicians to spend on their constituents and causes.

Also remember, much like when the Germans bombed Pearl Harbor, nothing is over yet. The Fed has not undone its extraordinary loose monetary policy and is just now stopping its direct QE purchases. When monetary policy is back to historic norms, and economic growth is once again strong, a normal number of people are seeking and getting jobs, and inflation has not reared its head, I think we can close the books on this one, still recognizing that forecasting a risk and having it fail to come to bear is not a cardinal sin. But which one of those things has happened yet? Paul, and others, should by now know the folly of declaring victory too early.

At the risk of enraging a whole different group (I promise I’m not denying anything I’m just making an analogy, and one I know is very far from dead on) I’m amazed that a Paul Krugman can look at 15+ years of the earth not warming and feel his beliefs need no modification or explanation, but 4 years of the CPI not inflating is reason not simply to declare victory, but to decry those who disagree with him as “Knaves and Fools.” In fact, rather than also anger Mr. Gore and Steyer, I hope they find this paragraph supportive as I’m saying these debates are rarely settled in either direction in short time frames. Now, if I were cheekier (cheek is not denial!) I’d ask if perhaps our letter was right and the inflation we predicted is in fact occurring in the depths of the ocean? Or, maybe we should ex post relabel our letter a warning of the risk of “extreme price action” including of course the extreme stability we have experienced in CPI these last few years.

Now, while not pointing to the actual ocean it is fascinating where inflation has shown up. Don’t limit your view of inflation to the CPI. No, this isn’t a screed where I claim to have invented my own consumption basket showing inflation is rising at 25% per annum – though some of those screeds are interesting. It’s the far simpler observation that we have indeed observed tremendous inflation in asset prices since this experiment began (of course this was part of the Fed’s intent – but it was meant to stoke real activity not an end unto itself!). Stocks, the spreads on high yield bonds, real estate, you name it.

Inflation is hard enough to forecast, but where it lands is even harder. If one counts asset inflation it seems we’ve indeed had tremendous inflation. While admittedly difficult to prove, as is any of this if we’re being honest as economics rarely offers proofs, you’d be hard pressed to find many economists or Wall Street professionals who don’t see current extremely high asset prices, and low forward looking returns to investors, as at least a partial consequence of the cocktail of QE, loose monetary policy, and financial repression. I understand Paul and others wanting to avoid this as not only does it show that they have no right to crow on inflation, but that the policies they advocate, and we decried, have had little effect on the economy but instead have, at least partially intentionally, exacerbated the inequality Paul spends the other half of his columns excoriating (while of course living himself off the global median income in protest and solidarity).

By the way, again the critics somehow manage to skip another prescient forecast in this same short open letter. We explicitly worried that the Fed’s policies “will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.” That’s econo-geek for “will drive financial market prices up and prospective returns down, and create financial instability when the Fed tries to stop.” Again, while this would perhaps not surprise the Fed, which actively desired low interest rates and a “wealth effect,” it seems that a fair reading shows that this much maligned letter wasn’t as wrong as the critics say, and was very right in ways the critics ignore.

Moving on, please recall that many, not all, supporters of QE and very loose monetary policy in general, did so exactly because they thought it would create some inflation, and they thought (and many still think) that’s what the economy needs. We, we the letter signers, are responsible for our own forecasts, but you might forgive us a bit for taking the other side at their word!

Bottom line, the half mea culpa above was not a throw away. When you go out of your way to warn of a risk and after a suitable period that risk has not come to bear, at least where everyone, including you, expected it, you should admit some error, and I do. But there is a still a big difference between pointing out a risk and making a forecast (hence the half admission!). A big reason this risk hasn’t come to fruition is, while not as dangerous so far as we thought, it appears QE was only mostly useless. To the extent even that is only mostly true, where effects did show up, it actually caused rather a lot of inflation, but inflation that went straight into the pockets of those who needed it least and whom Paul wouldn’t swerve his car to avoid. That is, it inflated financial assets, benefited the rich, and enhanced inequality.

So, to those who’ve been waiting for one of us to say it, you can have half the mea culpa you clearly want, but mostly Paul is wrong, and twisting the facts, and doing so as rudely and crassly as possible, yet again.

The rest of the JV team of Keynesians who have also jumped on board are doing the same thing, just with more class and less entertainment value than the master.

Now for a real prediction: Paul will continue to be mostly wrong, mostly dishonest about it, incredibly rude, and in a crass class by himself (admittedly I attempt these heights sometimes but sadly fall far short). That is a prediction I’m willing to make over any horizon, offering considerable odds, and with no sneaky forecasts of merely “heightened risks.” Any takers?

Cliff Asness is Founding and Managing Principal of AQR Capital Management, LLC

Dear Saver, May You RIP

By Peter Boockvar, The Lindsey Group LLC

Dear Saver,
To the forgotten and misunderstood soul, may you rest in peace. There just seems that nothing can save you now. You were bloody and battered after the stock market bubble crashed in 2001 and 2002. Afterward, you stuck with stocks but also decided to play it safe in real estate. That was ok for a few years but your stock portfolio fell again by 50% and while you have a great new kitchen and wood paneled library, the value of your house is now worth much less than your mortgage. I know, renting can be so much easier! But some guy named Greenspan said something about a wealth effect.

Finally you said enough is enough. You wanted a safe, conservative place for your savings where living off fixed income of mostly CD’s and bonds was possible. Maybe you’d buy an occasional stock again but maybe not. You called your local branch banker and were told that for the privilege of being a Platinum Honors client that you would be able to secure a better rate on a money market savings account. Nice! You were told that you’d be able to get .10%, more than triple the standard rate of .03% that the average person gets! Disgusted, you went online and saw this great add on the Bank of America website, it said “With a Featured CD I can earn a fixed rate on my nest egg.” Sounds enticing until you scrolled down the page and saw it paid .08% for a fixed 12 month term. It had to be a typo but unfortunately it was not.

Questioning now how you can ever retire on your savings after working hard for the past 40 years, you decided to find out who can possibly be responsible for these pathetic yields when you know your cost of living is rising well above the 1.5-2% that these statisticians at the government keep telling you. You ask what an hedonic adjustment is? Don’t worry about it because the purchasing power of your money relative to inflation has been declining day after day for at least 6 years now. This is madness you say. I agree.

You started to read the papers and watched the news and learned that the men and women that work at the Federal Reserve, mostly economists who call themselves central bankers, sit around a large table and decide what the right interest rate should be. Ok you say, they are smart, they have models created by people that likely did really well on their SAT’s, they know what they’re doing and this can’t last. Well, I’m sorry to say to you, we’re 6 years into zero interest rates and these people have no intention of ever saving your savings. You’re screwed and even though they say it’s in your best interest because zero rates and money printing will help the economy, don’t believe them anymore because the strategy has failed. After all, If these policies actually worked, I wouldn’t be writing this letter to you.

I wish I had good advice for your savings but I can’t advise buying stocks that have only been more expensive in 2000 on some key metrics right before you know what and I can’t recommend buying any long term bond as the yields also stink relative to inflation. With the Fed now saying that the dollars in your pocket are now worth too much relative to money in people’s pockets overseas and thus joining the global FX war maybe you should buy some gold but I know that yields nothing either. You are the sacrificial lamb in this grand experiment conducted by the unelected officials working at some building named Eccles who seem to have little faith in the ability of the U.S. economy to thrive on its own as it did for most of its 238 years of existence. Borrowers and debt are their only friends. To you responsible saver that worked hard your whole life, may you again rest in peace.

Sincerely yours,
Peter Boockvar
Managing Director
Chief Market Analyst
The Lindsey Group LLC

Calvin the Super Genius

By Ben Hunt, Ph.D., Salient


People think it must be fun to be a super genius, but they don’t realize how hard it is to put up with all the idiots in the world.  – Bill Watterson, “Calvin and Hobbes”

Here is the most fundamental idea behind game theory, the one concept you MUST understand to be an effective game player. Ready?

You are not a super genius, and we are not idiots.  The people you are playing with and against are just as smart as you are. Not smarter. But just as smart.  If you think that you are seeing more deeply into a repeated-play strategic interaction (a game!) than we are, you are wrong. And ultimately it will cost you dearly.  But if there is a mutually acceptable decision point – one that both you and we can agree upon, full in the knowledge that you know that we know that you know what’s going on – that’s an equilibrium. And that’s a decision or outcome or policy that’s built to last.

Fair warning, this is an “Angry Ben” email, brought on by the US government’s “communication policy” on Ebola, which is a mirror image of the US government’s “communication policy” on markets and monetary policy, which is a mirror image of the US government’s “communication policy” on ISIS and foreign policy. We are being told what to think about Ebola and QE and ISIS. Not by some heavy handed pronouncement as you might find in North Korea or some Soviet-era Ministry, but in the kinder gentler modern way, by a Wise Man or Woman of Science who delivers words carefully chosen for their effect in constructing social expectations and behaviors.

The words are not lies. But they’re only not-lies because if they were found to be lies that would be counterproductive to the social policy goals, not because there’s any fundamental objection to lying. The words are chosen for their  truthiness, to use Stephen Colbert’s wonderful term, not their truthfulness.

The words are chosen in order to influence us as manipulable objects, not to inform us as autonomous subjects.

It’s always for the best of intentions. It’s always to prevent a panic or to maintain confidence or to maintain social stability. All good and noble ends. But it’s never a stable equilibrium. It’s never a lasting legislative or regulatory peace. The policy always crumbles in Emperor’s New Clothes fashion because we-the-people or we-the-market have not been brought along to make a self-interested, committed decision.Instead the Powers That Be – whether that’s the Fed or the CDC or the White House – take the quick and easy path of selling us a strategy as if they were selling us a bar of soap.

This is what very smart people do when they are, as the Brits would say, too clever by half. This is why very smart people are, as often as not, poor game players. It’s why there aren’t many academics on the pro poker tour. It’s why there haven’t been many law professors in the Oval Office. This isn’t a Democrat vs. Republican thing. This isn’t a US vs. Europe thing. It’s a mass society + technology thing. It’s a class thing. And it’s very much the defining characteristic of the Golden Age of the Central Banker.

Am I personally worried about an Ebola outbreak in the US? On balance … no, not at all. But don’t tell me that I’m an idiot if I have questions about the sufficiency of the social policies being implemented to prevent that outbreak. And make no mistake, that’s EXACTLY what I have been told by CDC Directors and Dr. Gupta and the White House and all the rest of the super genius, supercilious, remain-calm crew.

I am calm. I understand that a victim must be symptomatic to be contagious. But I also understand that one man’s symptomatic is another man’s “I’m fine”, and questioning a self-reporting immigration and quarantine regime does not make me a know-nothing isolationist.

I am calm. I understand that the virus is not airborne but is transmitted by “bodily fluids”. But I also understand why Rule #1 for journalists in West Africa is pretty simple: Touch No One, and questioning the wisdom of sitting next to a sick stranger on a flight originating from, say, Brussels does not make me a Howard Hughes-esque nutjob.

I am calm. I understand that the US public health and acute care infrastructure is light years ahead of what’s available in Liberia or Nigeria. I understand that Presbyterian Hospital in Dallas is not just one of the best health care facilities in Texas, but one of the best hospitals in the world. But I also understand that we are all creatures of our standard operating procedures, and what’s second nature in a hot zone will be slow to catch on in the Birmingham, Alabama ER where my father worked for 30 years.

The mistake made by our modern leaders – in every public sphere! – is to believe that they are operating on a deeper, smarter, more far-seeing level of game-playing than we are. I’ve got a long example of the levels of decision-making in the Epsilon Theory note “A Game of Sentiment“, so I won’t repeat all that here. The basic idea, though, is that by announcing a consensus based on the Narrative authority of Science our leaders believe they are stacking the deck for each of us to buy into that consensus as our individual first-level decision. This can be quite effective when you’re promoting a brand of toothpaste, where it is impossible to be proven wrong in your consensus claims, much less so when you’re promoting a social policy, where all it takes is one sick nurse to make the entire linguistic effort seem staged and for effect … which of course it was. The fact that we go along with a game – that we act AS IF we believe in the Common Knowledge of an announced consensus – does NOT mean that we have accepted the party line in our heart of hearts. It does NOT mean that we are myopic game-players, unerringly led this way or that by the oh-so-clever words of the Missionaries. But that’s how it’s been taken, to terrible effect.

I am calm. But I am angry, too. It doesn’t have to be this way … this consensus-by-fiat style of policy leadership where we are always only one counter-factual reveal – the sick nurse or the sick economy – away from a breakdown in market or governmental confidence. I am angry that we have been consistently misjudged and underestimated, treated as children to be “educated” rather than as citizens to be trusted. I am angry that our most important political institutions have sacrificed their most important asset – not their credibility, but their authenticity – on the altar of political expediency, all in a misconceived notion of what it means to lead.

And yet here we are. On the precipice of that breakdown in confidence. A cold wind of change is starting to blow. Can you feel it?

W. Ben Hunt, Ph.D.
Chief Risk Officer, Salient
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The article Outside the Box: Calling Into Question was originally published at mauldin economics


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