Sunday, December 20, 2015

Is the “Easy Money Era” Over?

By Justin Spittler

It finally happened. Yesterday, the Federal Reserve raised its key interest rate for the first time in nearly a decade. Dispatch readers know the Fed dropped interest rates to effectively zero during the 2008 financial crisis. It has held rates at effectively zero ever since…an unprecedented policy that has warped the financial markets. Rock bottom interest rates make it extremely cheap to borrow money. Over the last seven years, Americans have borrowed trillions of dollars to buy cars, stocks, houses, and commercial property. This has pushed many prices to all time highs. U.S. stock prices, for example, have tripled since 2009.

The Fed raised its key rate by 0.25%.....

U.S. stocks rallied on the news, surprising many investors. The S&P 500 and NASDAQ both gained 1.5% yesterday. The Fed plans to continue raising rates next year. It’s targeting a rate of 1.38% by the end of 2016. So, is this the beginning of the end of the “easy money era?” For historical perspective, here’s a chart showing the Fed’s key rate going back to 1995. As you can see, yesterday’s rate hike was tiny. The key rate is still far below its long term average of 5.0%.


Josh Brown, writer of the financial website The Reformed Broker, put the Fed’s rate hike in perspective.

The overnight borrowing rate…has now risen from “around zero” to “basically zero.”

In other words, interest rates are still extremely low, and borrowing is still extremely cheap. We’re not ready to call the end of easy money yet.

Cheap money has goosed the commercial property market..…

Commercial property prices have surged 93% since bottoming in 2009. Prices are now 16% higher than their 2007 peak, according to research firm Real Capital Analytics. Borrowed money has been fueling this hot market. According to the Fed, the value of commercial property loans held by banks is now $1.76 trillion, an all time high. The apartment market is especially frothy today. Apartment prices have more than doubled since November 2009. U.S. apartment prices are now 34% above their 2007 peak.

Sam Zell is cashing out of commercial property..…

Zell is a real estate mogul and self-made billionaire. He made a fortune buying property for pennies on the dollar during recessions in the 1970s and 1990s. It pays to watch what Zell is buying and selling. He was one of few real estate gurus to spot the last property bubble and get out before it popped. In February 2007, Zell sold $23 billion worth of office properties. Nine months later, U.S. commercial property prices peaked and went on to plunge 42%.

Recently, Zell has started selling again. In October, Zell’s company sold 23,000 apartment units, about one quarter of its portfolio. The deal was valued at $5.4 billion, making it one of the largest property deals since the financial crisis. The company plans to sell 4,700 more units in 2016. Yesterday, Zell told Bloomberg Business that “it is very hard not to be a seller” with the “pricing currently available in the commercial real estate market.”

Recent stats from the commercial property market have been ugly. In the third quarter, commercial property transactions fell 6.5% from a year ago. Transaction volume also fell 24% between the second quarter and third quarter.

Auction.com, the largest online real estate marketplace, said economic growth is hurting the market.
Both commercial real estate transaction volume and pricing have showed signs of softening over the past few months. It’s likely that what we’re seeing is the result of reduced capital spending due to some weakness in the U.S. economy, coupled with a highly volatile economic climate in China and ongoing financial issues in Europe.

Zell is bearish on the U.S. economy..…

On Bloomberg yesterday, he predicted that the U.S. will have a recession by the end of 2016.
I think that there’s a high probability that we’re looking at a recession in the next twelve months.

A recession is when a country’s economy shrinks two quarters in a row. The U.S. economy hasn’t had a recession in six years. Instead, it’s been limping through its weakest recovery since World War II.
Zell continued to say that the U.S. economy faces many challenges.

World trade is slowing. Currencies continue to be manipulated. You’re looking at the beginnings of layoffs in multinational companies. We’re still looking all over the world for demand…
So, when you look at those factors it’s hard to see where strength is going to come from. I think weakness is going to be pervasive.

Like Zell, we see tough economic times ahead. To prepare, we suggest you hold a significant amount of cash and physical gold. We put together a short video presentation with other strategies for how to protect your money in an economic downturn. Click here to watch.

Chart of the Day

The U.S. economy is in an “industrial recession”. In recent editions of the Dispatch, we’ve told you that major American manufacturers are struggling to make money. For example, sales for global machinery maker Caterpillar (CAT) have declined 35 months in a row. In October, CAT’s global sales dropped by 16%...its worst sales decline since February 2010.

Today’s chart shows the yearly growth in U.S. industrial production. The bars on the chart below indicate recessions. Last month, U.S. industrial production declined -1.17% from the prior year. It marked the 19th time since 1920 that industrial output dropped from a positive reading to a reading of -1.1% or worse.
15 of the last 18 times this happened – or 83% of the time – the U.S. economy went into recession.


The article Is the “Easy Money Era” Over? was originally published at caseyresearch.com.


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Tuesday, December 15, 2015

Origins and Strategy of the Islamic State

By John Mauldin

Today’s Outside the Box is from my good friend George Friedman of Geopolitical Futures. George, who founded the well known Stratfor, is one of the world’s top geopolitical forecasters. I’m very excited to welcome him as a Contributing Editor for Mauldin Economics.

Starting today and every Monday, we’ll publish a regular feature from George called This Week in Geopolitics. In this weekly letter written for Mauldin Economics, George will highlight the top international events that investors and those with an interest in geopolitics should monitor. I am amazed by how quickly George slices through the media’s superficial stories to reveal what is really important.

What you read in This Week in Geopolitics will be a small sample of the research George and his team publish. His Geopolitical Futures premium service is off to a great start and I highly recommend you try it. We have a special offer for Mauldin Economics readers. Click here for details.

As a reminder, I interviewed George in last week’s Thoughts from the Frontline. He had some fascinating thoughts on the connection between politics and economics, the European refugee crisis, China’s economic future and more. Click here to read it.

Today he examines the origins of ISIS and looks at why they see their behavior as rational. It is a disturbing viewpoint, and not one that will make us comfortable, but we do need to understand this. And it highlights the almost no-win position that the United States and the rest of the world (specifically the Middle East) is in.
In order to make sure this gets out Monday evening, I need to go ahead and hit the send button without further comment so…. with that, let’s go straight to George’s first weekly contribution.

[Editor’s note: if for some reason you do not want to receive George’s new letter each week, click here and we’ll take you off the distribution list.]

Your watching the world closer with George analyst,
Each week, John Mauldin highlights a thoughtful, provocativeessay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box.

Origins and Strategy of the Islamic State

By George Friedman for Mauldin Economics
Al-Qaida struck the United States on September 11, 2001 in order to pave the way for the caliphate, a multinational Islamic state governed by a caliph. From Osama Bin Laden’s point of view, the Christian world—as he thought of Euro-American civilization—had made a shambles of the Muslim world. Most Muslim lands had been occupied or controlled by Christians. After World War I the British and French, in particular, had reshaped these lands to suit them. They invented new countries that had never existed before like Jordan, Lebanon, and (in their minds) Israel and installed rulers on others, such as the Saudis in the Arabian Peninsula.

After World War II, the United States inherited a world the British had largely created. Where the British were the architects of this world, the Americans became its maintenance men. Since the Americans were caught up in a Cold War with the Soviets, the Soviets sought to create pro-Soviets as well. A new wave of rulers arose under Soviet tutelage. These were secularists, socialists, and militarists imposing military regimes.

Men like Gamal Abdul Nasser in Egypt, Saddam Hussein in Iraq, and Hafez al-Assad in Syria were all Soviet allies. They were despised by Islamists, as were the monarchies allied with the Americans. The secular Arab rulers were simply apostates. The monarchies, like Saudi Arabia, were corrupt hypocrites—formally Muslim but clinging to the Christians (now the Americans) for power and safety.

Al-Qaida did not yet exist, but there were those who dreamed of reclaiming the lands, expelling the apostates and hypocrites, and creating the caliphate. These men had learned the art of war under American tutelage in Pakistani camps after being recruited by the Saudis. They believed they had destroyed the Soviets and, as a result, destroyed the Soviet Union. True or not, this is what they believed.

When the Soviet Union fell, Iraq invaded Kuwait and the Saudis asked the American Christians to save them. Men who had fought in Afghanistan held the Saudis in contempt and were enraged by the Americans. To a great extent, the Americans were unaware of the response. The men they had trained for war in Afghanistan now saw the Americans as an obstacle to the caliphate.

This is the soil that gave rise to al-Qaida. Al-Qaida’s primary goal was to overthrow one of the secular or hypocritical regimes, create a Sharia-based caliphate, and use it as a base for creating a broader, transnational entity. Al-Qaida actually means “the base” in Arabic. It had excellent relations in Afghanistan, given the role it played there, but Afghanistan was too backward and geographically isolated to be the caliphate’s capital. It instead became the base where al-Qaida would begin the war.

In al-Qaida’s analysis, the weak and corrupt Islamic regimes could be overthrown, but the Muslim masses were inert, beaten into submission by Europeans and Americans, and convinced of American invincibility. They had no love for the Americans outside of some of the regimes, but saw their cause to be hopeless.

Al-Qaida needed to convince the masses that America was both vulnerable and hostile to Islam. It sought to strike the United States in a way that the Muslim world would take startled note, and that would compel America to go to war in the Muslim world. Al-Qaida’s experience in Afghanistan convinced it that the United States, caught in a war of attrition regardless of casualties, would eventually withdraw. The September 2001 attacks were meant to draw the Americans into combat but, even more, to convince the Muslim world that Muslims could strike at the heart of America, and then, when the Americans invaded, encourage Muslims to rise up in a long war America couldn’t win.

Part of the strategy worked, part of it didn’t. The attacks did galvanize the Muslim world. The United States showed itself to be Islam’s enemy by invading Afghanistan and later Iraq. The Muslim world saw that Muslims could fight Americans and not suffer defeat like the Jews had defeated the apostate Nasser’s army in 1967.

What did not happen was the essential step. While war raged in Afghanistan and Iraq, there was no uprising elsewhere in the Islamic world. When there were uprisings, as during the Arab Spring, they were put down (Egypt) or left in unending civil war (Syria and Libya). There was no foundation created for the caliphate, and over time American intelligence whittled down al-Qaida.

Others stepped into the vacuum as al-Qaida declined. Their opening occurred in Iraq and Syria. The Arab Spring in 2011 created an uprising against Bashar al-Assad, son of Hafez. Like much of the Arab Spring, the public faces of the protests were secular liberals, but they were unable to overthrow Assad. The resulting chaos and stalemate opened one door to al-Qaida’s heir.

At the same time, the U.S. decision to withdraw from Iraq, first made by George W. Bush and accelerated by Barack Obama, allowed a Shiite government to take power there. This forced their enemies, the Sunnis, back against the wall. Al-Qaida was Sunni and regarded Shiite Iran as an enemy. The rise of a Shiite government in Baghdad left the Iraqi Sunnis nowhere to go. It was out of this that the Islamic State arose. Syria and especially Iraq were its recruiting office and its battle ground.

Al-Qaida wanted an uprising in an existing country, but IS had a different strategy. Rather than overthrowing an existing government, it decided to create the state in a region that paid no attention to existing borders. Its goal, unlike al-Qaida’s, was to hold territory in which the caliph could rule and from which it could expand and guide the caliphate’s extension into noncontiguous Muslim lands.

The IS goal, therefore, was not to strike at the Americans as al-Qaida did. The 9/11 strikes had done their work. Their job was to create an area ruled under Sharia law with a governmental structure, financial system, welfare system, and the other things a state needs. In addition, and before this, IS had to create a military force that could take and seize land against the weak opposition it would face in Iraq and Syria.

The first step in the Islamic State’s strategy, therefore, was to put the caliphate before everything by taking control of substantial and contiguous territory. IS did this by carrying out a series of extremely competent military operations, seizing Mosul and Ramadi in Iraq as well as Palmyra in Syria. The result was a new state, no less artificial than those countries the British and French created after World War I, and governed from the capital in Raqqa.

In carrying out this operation, IS deliberately created a series of highly publicized atrocities. There were two reasons for this. The first was to intimidate the new Islamic State’s population. This region consisted of a wide variety of groups, many potentially hostile to the new state. The ruthless acts served to make clear to the population that IS was not merely claiming control of the region, but was in sufficient control that it was indifferent to what the outside world thought.

Having fought the Americans, IS knew that apart from special operations teams (the principle threat to IS in both Afghanistan and Iraq) which could not by themselves threaten the existence of IS, the United States took months to deploy forces. IS needed to show not only how ruthless it was, but that it would not be challenged as a result.


The second reason for creating this core was to lure the Americans into attacking it. The United States had grown wary of occupation warfare that required deploying a military force against scattered and persistent guerilla operations.

The Islamic State presented, and was, precisely the type of force the United States should be comfortable attacking. First, it occupied a clearly defined territory. Second, it contained a conventional military force. IS was not a guerilla organization or terrorist group, although it had elements capable of both kinds of operations.

The size of IS’ main military force (a force large enough to seize, occupy, and defend an area as large as some countries in the region) meant it could not be a guerrilla force. It appeared to be a mobile infantry force, moving by foot and truck, armed with infantry weapons as well as some small artillery and anti-tank weapons.

The exact size of IS forces remains a mystery, and that is a testament to its skills at camouflaging its activities from the ground to the electromagnetic sphere. Estimates of the size of its armed and trained force range from 20,000 to 200,000. Based on the extent of its frontiers and the casualties it seems to have taken, I estimate the force at about 100,000.

This, of course, leaves another mystery: where this force was trained—since training even 20,000 is a conspicuous activity. Units must train together to be effective. There are many mysteries about IS for which there is no consensus save educated guesses. We know the extent of its power. We know when this frontier is attacked, the attacker tends to encounter resistance. Beyond that, IS has protected its capabilities professionally.

Given all this, it would appear to be ripe for attack by American forces, which excel at this kind of warfare. That is precisely what IS wants. There has been much talk about IS believing that an apocalyptic battle must take place in order to establish the caliphate. This is a metaphysical concept on which I have no opinion.

However, from a political and military point of view, the caliphate must be founded on a decisive battle that forces capitulation from its main enemy. This would convince the US to respect the caliphate and the caliphate’s citizens to respect the power of the state. By this I don’t mean the guerrilla wars in which the conventional force simply withdraws; I mean a battle in which the enemy is defeated in detail.

The Americans prefer conventional attacks with tanks and infantry fighting vehicles. IS engaged and destroyed a Syrian armored brigade with anti-tank weapons. The United States uses air strikes and helicopters. IS may have man-portable surface-to-air missiles (and should have them from whatever source it secured the anti-tank missiles).

IS has a major advantage in one thing: the US is casualty averse. The US has a force operating at a distance for reasons that impact national security but don’t pose a direct threat to the homeland. Therefore, the American appetite for more serious military intervention is extremely limited. IS needs a decisive battle at any cost. Weapons aside, the outcome of this battle matters far more to IS than to the United States, and therefore IS’ threshold for pain is far higher.

The caliphate, having been established, must now be defended. It must be a territory and not a hideout, it must be coherent and not scattered tracts, and it must be defensible regardless of the cost. Having established its frontiers, the Islamic State intends to use minimal force to defend against minor attacks, as the Syrian Kurds carried out recently.

Most impressive about IS is its ability to retreat, regroup, and strike elsewhere. That is the measure of a military force. For example, the Americans proved themselves at the Battle of the Bulge when having been sent reeling, they regrouped, reinforced and struck back. It is in defeat that I judge a military force, and IS has handled defeat well. But we should also remember that IS will not waste force on marginal threats.

For IS, the main threat will come from the Americans and therefore it must preserve the ability to fight U.S. forces. Some point out that IS has been under pressure from all sides. This is because its leaders understand the maxim that he who defends everything defends nothing.

But the Americans have not come. Nor have other enemies like the Iranians or Israelis. Nor for that matter have the Turks. No one wishes to engage IS while it is on the defensive and at its best. There are many reasons, but the heart of the matter is that the battle, if lost, would be devastating for Americans, and if won by them opens the door to occupation warfare, as did the defeat of the Iraqi army in 2003.

IS must hold to save the caliphate now or, if it loses this battle, wait and fight another. And if the Americans don’t come and IS holds its territory, then IS can choose the time and place for its next strategic offensive.

Assuming that IS has 100,000 troops, the US must bring a force of 300,000 to bear under the old (and perhaps obsolete) rule of 3 to 1 on the offensive. It took six months to prepare for Desert Storm and longer for Iraqi Freedom with far fewer troops than 300,000. The terrain is desert, and supply lines will run from ports that have to be secured, along with roads that could be filled with IEDs. For the Americans, the logistics would be as tough as the battle.

Logically, the best course for the United States is not to engage. IS is beginning to realize this and seemingly prefers to force a battle. That is why we are beginning to see terrorist actions flaring in Western countries. The lesson al-Qaida taught IS is that the Americans have a threshold and that if you cross it, they will react dramatically.

Therefore, it appears to me that IS is searching for that threshold and probing to see responses. Attacks like the ones in Paris last month were not in response to French involvement in the region. These attacks are unconnected to that, but are designed to be as terrifying as possible—both in their suddenness and brutality—and compel a response.

It is odd to argue that someone wants to be attacked by the US. But IS needs the attack and also believes it can at least survive and likely defeat the Americans. It is clear that other countries in the region are steering clear of IS, and it is clear that President Obama is doing everything he can not to engage IS on the ground.

And it is clear that IS is doing what it can to drag the Americans deeper into the conflict. If the Americans don’t come, and no one else comes, the psychological demonstration might not take place - but the caliphate will exist. On the whole, IS has the strategic advantage in multiple ways. It behaves in its territory as if it intends to stay a long time.

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Monday, December 14, 2015

Evaluating Brazil

By Doug Casey

Editor’s Note: Casey Research originally published this article in January 2013. We’ve updated it with new, timely commentary. Doug’s analysis of Brazil is still vital today. They are timeless lessons on what happens to a country when a currency collapses.

Let’s explore Brazil, the “B” in the BRIC countries. It’s been getting a lot of applause as the new breadbasket of the world, and Brazilians are viewed as taking their place among the world’s new rich guys. I recently spent a week in São Paulo. I’d been to Brazil a half dozen times over the years, but never to São Paulo, a gigantic city that could easily be mistaken for L.A., except that it lacks the charm, is said to have vastly more crime, and speaks Portuguese, not Spanish. I was there to play in the Brazil Series of Poker, but also because I just wanted to see the place, since it vies with Mexico City to be the biggest agglomeration of people in the Western Hemisphere and is one of the biggest cities in the world. And it’s only a two hour flight from Buenos Aires.

It’s fairly easy to generalize about the other countries in South America. They’re all quite different from one another, but, relative to Brazil, each is small and homogeneous. For an American, getting to know Brazil is much harder than for a Brazilian to get to know the U.S. For one thing, it’s vastly more difficult to get around; you’ll basically have to fly everywhere. And the country hasn’t yet been homogenized with the franchise clones making cities and towns indistinguishable from one another. Brazil is a veritable subcontinent. Let me recall a few facts that almost everybody knows (and therefore are hardly worth mentioning), and also some that relatively few know (and that may, therefore, offer you some edge).

Brazil is somewhat larger than the continental U.S., has 5,000 miles of beachfront, and 190 million people. Nearly half of them are concentrated in the southeast, in just 10% of the country’s area. The countryside there roughly resembles Georgia in the U.S. One-third of Brazil’s GDP comes from in and around São Paulo, which is the functional center of the region. That city is where the action is, but it truly has no soul. It’s almost entirely of recent construction; what’s left of the quaint old downtown is now just a hangout for beggars, bums, and pickpockets. I consider the burg devoid of attraction, unlivable, and have no urgent desire to go back.

Only businesspeople go to São Paulo; tourists go to Rio, a much more appealing place. Surprisingly, Brazil only gets about 5 million tourists a year, and most of them are from neighboring Argentina. This is a very low number. France gets 80 million, the U.S. 60 million, Thailand 20 million, and Singapore 10 million. Cuba and Uruguay get about 2.5 million apiece. Even Syria reported 5 million in 2011 - a number I find hard to credit and which may include numbers of tourists who are heavily armed. Further proof you have to take all government statistics with a grain of salt; all the bureaucrats know is what someone casually puts on a form.

The good news is that a tourist number as low as Brazil’s can only go up, which is favorable, unlike most of what I’ll have to say about the place. And it will go up, because they’re hosting the FIFA World Cup soccer contest in 2014 and then the Summer Olympics in 2016. It’s completely unclear to me, however, where they’re going to put all the sports fans or how the visitors are going to get around and get on generally, even though the government plans on spending $20 billion on stadiums, airport upgrades, and road building to accommodate the crowds. Most of the money will inevitably be frittered away on monument construction, as opposed to things that make life easier or more pleasant.

Doug Casey: You might want to read my editorial about the ongoing FIFA so-called scandal.
I haven’t found Brazil to be convenient for anything. It’s extremely difficult to find a place to exchange even dollars - forget about other currencies. Except at major hotels, where you’ll pay a 15% fee. But there aren’t a whole lot of hotels, reflecting the low number of arrivers. And the average Brazilian speaks only Portuguese, although kids are learning either Spanish or English in schools. But how well did you speak a foreign language when you got out of high school? If I didn’t have some Spanish (which is much more comprehensible to a Portuguese speaker than vice versa), I would have been reduced to hand gestures.

That’s apart from the fact that illiteracy is officially figured at 10%, although my guess is that it’s much higher.

Demography, Cities & Race

São Paulo is different from Rio in every aspect. It’s flat, as opposed to mountainous. It’s non-centered, with numerous subcities, rather than being focused on the beach. It’s purely about business and getting ahead, as opposed to having a good time. Both cities are famous for their high rates of violent crime, emanating from the favelas, which are the shantytowns that ring all the major cities. They originated in the ’50s, when poor people started moving into the cities looking for opportunity. The cities were much more pleasant and more livable before the favelas arose - but they’re actually good things. They’re the first step to urbanization. And in the Third World, that’s essential for increasing literacy, improving incomes, and slowing the production of waifs and street kids.

When you think of the favelas, you might imagine the population is swelling. Just the opposite, actually. As people move into the cities, they redirect their attention from family to work, and women take advantage of modern birth control. Women find jobs, and there are few grandparents around to help raise the kids - who are now seen as an expense, as opposed to cheap labor for the farm.

So here’s a shocking statistic. As late as 1980, the average Brazilian woman had four children; the country was in the midst of a population explosion. As of 2011, however, the average was down to 1.8. The government estimates that in 15 years, it will drop to 1.5, which is far below the replacement rate of 2.2. This is happening almost everywhere in the world now, not just in Europe, North America, China, Japan, and other developed countries. The implications of this trend - which I believe will accelerate worldwide - are profound. But that’s for another article. Brazil is now essentially an urban country, with almost 85% of its 190 million inhabitants living in towns and cities.

The degree of urbanization relates not just to the birth rate, but to other phenomena, like racism and even slavery. Brazil has long had a reputation as a non-racist society. I think that’s true, even though it was the last major country in the world where the slavery of blacks as a group was abolished, in 1888. An event which is, in my view, irrefutable proof that the U.S. War Between the States was neither necessary nor essentially about slavery.

One reason there’s little antagonism between the races in Brazil is that the country never had a Lincoln, or a war, to polarize them. I think there’s going to be ever more racial harmony as more people live in cities and almost necessarily start seeing each other as individuals, as economic units, rather than as members of a racial group. There was no racial hostility that I could see. Slavery is still said to exist in the Muslim world, but only on an individual, as opposed to a legalized and institutional, basis. That’s because it’s completely uneconomic today; it’s hard to incentivize slaves to work productively in a high-tech economy.
Doug Casey: Actually, it does exist. I spent 10 days in Mauritania in June, where it was only officially abolished in 1987. But it still exists. Mostly because the slaves are well treated, and don’t have a better alternative.
And common laborers, doing grunt work, are less and less either necessary or desirable. Within a generation from now, intelligent robots will be doing most menial labor, making human muscular input almost redundant. But that’s just the culmination of a trend that’s been in motion since the start of the Industrial Revolution, when people started moving into cities on a grand scale. In those days, London had its own versions of the favela, as New York City later also did.

The fact is that the southeast of the country - the area from Rio on down - is socially very European, while the rural and undeveloped northeast is quite African. It’s mild de facto segregation. At the poker tournament I played in, there couldn’t have been more than 10 blacks among the 1,800 players. That’s partly a reflection of São Paulo’s demographics (even though, as a national event, people were from all over the country) and partly because the 1,800 real (US$900) entrance fee was prohibitive for those who aren’t solidly in the middle class. And in Brazil, that still leaves out almost all the blacks.
Doug Casey: You’ll notice the real has lost over half of its value in only three years. This is one reason why the average person here - who saves in reals - can’t get ahead.
But a rising tide raises all boats. The question is: What’s going to happen to the economy in Brazil? And how can you profit from it?

The Economy

Brazil has, from its very beginning, been plagued with dirigiste government. When it comes to papers to fill out, stamps and approvals to garner, layers of taxes to pay, and bureaucrats to soothe, it may be the worst place in Latin America. I think anyone who runs a business in the country is both a saint and a hero, although that’s becoming the case almost anywhere. The country has done as well as it has mainly because it’s so big, and Brazilians are used to dealing with Brazilians, mostly within Brazil.

The place has a lot of native wealth. You’d think it almost couldn’t help but be prosperous. But that would be untrue, as demonstrated by the Congo, which is a basket case despite being at least as rich in resources as Brazil; and with the counterexample of Japan, which is extremely wealthy despite having no resources at all except its people. Brazil is midway between them. For what it’s worth, the largest Japanese community in the world outside Japan lives in Brazil.

Except for the very recent past, the country’s history is all about dictators, military governments, and currency destruction - but its promoters overlook these things. You might think history would have taught Brazilians a lesson and shown them what not to do, so that they don’t repeat the same mistakes. But that’s not the way it seems to work. Instead, every disaster becomes ingrained as part of the culture. I admire the makers of the surreal movie Brazil for capturing much of the essence of the place.

There’s an old saying about Brazil: It’s the country of the future - and always will be. That may be true partly because it’s a closed economy and always has been. Brazil is essentially an island, cut off from the rest of the continent by a jungle. And the southeast, the developed part of the country, is cut off from the interior by the highlands. And it’s rather unlikely that a bridge is ever going to cross the Amazon anywhere near the coast; the river’s 200 miles wide at its mouth. The place could plausibly be at least two or three different countries. Brazil’s mainland links to the rest of the continent are Uruguay and Paraguay - both small, quiet, backward countries that offer little in the way of trade possibilities but do present a language difference.

China is now Brazil’s big export destination for iron ore, soybeans, beef, and chicken. But the China bubble is overdue to burst, and the country’s imports of iron ore are going to collapse. Brazil will feel it especially, partly because of shipping costs, since it’s literally on the other side of the planet from China, and partly because producing anything in Brazil has become expensive.

Iron ore neared $200 a tonne at the peak of the recent boom, up from about $20 at the 2001 bottom. It probably costs Vale, by far Brazil’s largest producer and largest company, about $40 to produce the stuff and perhaps $20 more to ship it. The ore currently trades at around $120 in China, but I don’t see why the price couldn’t collapse to less than production cost. Further, Australia not only produces the stuff for less than $30 a tonne, but is much closer to the Orient, so the shipping cost is half of Brazil’s. Vale is a heavily touted stock today. I wouldn’t touch it, for that and other reasons covered below.
Doug Casey: This, I’ve got to say, was an accurate call.
Brazil’s second-largest trade partner is the U.S. But what’s going to happen as the U.S. economy winds down? Third is Argentina, where exports are already collapsing because of the Kirchner regime. But it’s really incorrect to think of Brazil as a major force in trading. According to World Bank data, Brazil’s exports in 2011 amounted to only 12% of its GDP. The figures for Russia, India, and China were, respectively, 31%, 25%, and 31%. A few ag sectors qualify as exceptions, but overall the country is an isolated, self-contained island.

Brazil has made real progress over the last 13 years, since the bottom of the commodity cycle in 2001. Average prices of its commodities have gone up 2.5 times, and volumes have grown 50%. National income has boomed, more than trebled, in real terms. So, of course, the country has done well. But mostly for reasons extraneous to itself.

Agriculture

Over the last two decades, Latin America has become an increasingly important supplier of agricultural commodities to the rest of the world. In 1980, Latin America accounted for 30% of global soybean exports (oilseed, meal, and oil); in 2012, it accounted for over 60%. That’s mostly Brazil, in that while Argentine production has risen, punitive taxes under the Kirchners have kept it from rising by much. U.S. producers, meanwhile, have lost half their market share. Brazilian corn exports have gone from 11% of the world total in 1980 to 29% in 2012, while U.S. export numbers have collapsed due to the insane policy of turning corn into ethanol fuel.

Brazilian export numbers have boomed for coffee, sugar, beef, chicken, and orange juice as well. So a major argument by Brazil promoters is that it’s become the world’s food storehouse, and it’s going to grow from here. Unlike many of their arguments, this makes some sense, I think. But it’s not a good enough reason to invest there anytime soon.

Over the short term, global demand for agricultural commodities is likely to increase because, despite the downturn in world economic growth, world population is still going up. But even in Africa and the Muslim world, the population growth rate is slowing radically and will soon head down. The main driver for agriculture, in the long run, won’t be rising populations but rising standards of living.

Since the 1960s, world per-capita consumption of grains has increased at 0.5% per year compounded, on top of the growth in population. Planted area per capita has been declining, however, because of the expansion of the world’s cities, most of which were founded in prime agricultural areas. To compensate, new land has had to be cleared, and most of that has been in Brazil. Fortunately, advances in plant genetics, ag techniques, fertilizers, pesticides, and the like have increased production by something like slightly over 2% per year from 1970 to 1991, but at only half that rate since then. The result has been the commodity boom, mainly reflected in grains. But grains are poor people’s food. And they’re also highly political commodities, almost on a par with oil. I’m disinclined to invest in farmland for the grains.

I’m much more interested in specialty products, like grapes, olives, and other fruits. And cattle. Interestingly, cattle producers really haven’t participated in the recent ag boom, partly because they’ve been pushed onto less productive land, reflecting the weak profits for many, many years. Because of that, herds have been liquidated, and headcounts all around the world are at their lowest levels in three generations. That’s why I’m especially bullish on cattle. But that’s another story.

In the last five years, land prices in Argentina, Uruguay, Paraguay, and southern Brazil have risen 15% to 20% per annum. That’s mostly because, of course, grain prices have exploded. In the U.S., by comparison, farmland prices have only risen 10% per annum. Land in Latin America has done better partly because infrastructure had room to improve, and partly because the market is becoming ever more global because of generally lower tariffs and bigger, more efficient ships.

Will there be a worldwide shortage of arable land? I doubt it. The demand for grain is likely to flatten out. There’s an immense amount of underused farmland everywhere (especially in Africa). And I have no doubt technology will again increase productivity. So Brazil will grow in importance for food, but that’s not the bonanza a lot of promoters seem to think.

Stocks

Around 400 companies are listed on Brazil’s main exchange, the Bovespa, for about US$1.2 trillion of market cap. By far the biggest are iron miner Vale and Petrobras, the national, state-controlled oil company.
Those two and 27 other Brazilian stocks are traded in the U.S. They’ve historically always traded at a discount to their foreign peers because of the country’s well-known problems - high taxes, intense bureaucracy, onerous import restrictions and duties, high crime rate, uneducated population, and subpar infrastructure.

As well as Brazil has done, it’s been a laggard by comparison to its peers in Latin America. In the last 10 years, corporate earnings in Latin America have grown on average by 18% annually. The countries that have recorded the highest earnings growth rates are Peru (28%), Colombia (23%), Chile (13%), and Mexico (12%). Brazil trails the list with 11% growth. During that time, Latin American stocks averaged a 10-to-1 P/E ratio. Most expensive (but deservedly so, as by far the most liberal economy in the region) was Chile, at 15, followed by Mexico, Colombia, and Peru with P/Es of 12. Brazil has historically traded cheaper, with an average P/E of 8. I attribute that to the country’s tax and regulatory structure.

According to the World Bank’s Doing Business 2011 report, Brazil is ranked 127th out of 183 countries for business friendliness. Mexico ranks 35th and Chile 43rd. Brazil scores particularly badly in categories related to starting a business, registering property, paying taxes, and closing a business. It’s Kafkaesque here, as in many other Third World countries, in that they make it nearly impossible to open a business (because they’re trying to protect those already in existence), and equally hard to close one (because they’re trying to protect the workers).

Say what one will about how screwed up Argentina is - and its economy is a real mess and getting worse - at least the country has a strong tradition of classical liberalism. There are a lot of Argentines who know who Mises, Hayek, and Rothbard are and who study their work; that offers some hope for a renaissance. That just doesn’t seem to be the case in Brazil.

Based on all of this, I can’t see buying Brazilian stocks. Actually, the place to look is Argentina, which currently has some of the world’s most tempting market statistics - a P/E ratio of 3 (whereas its average over the last 10 years has been 12); a price-to-book-value ratio of 0.9 (versus an average of 2.0 over the last 10 years); and a dividend yield of 13% (versus an average of 4.2% over the last 10 years). Argentina is a bargain. But, like most bargains, nobody wants to touch it.
Nick Giambruno: Casey Research originally published this article in January 2013, and the Argentine market went up by more than 200% over the next 33 months.

Taxes

I’ve mentioned how brutal Brazilian taxes are. They’re a major reason everything in the country is so expensive - especially imported items. I decided to find out just how Byzantine the regime might be. Suppose you decide to import something to take advantage of the country’s vaunted growth. It had better be a highly desirable, extremely high margin item, because there are six levels of tax on imports, and they compound, each tax being levied upon the previous taxes. Nothing leaves the harbor before your check clears.

I’ll list them in the order they’re applied. On top of one another. They’re generally referred to by their Portuguese acronyms, in parentheses, to avoid confusion.
  • Merchant Marine Renewal Tax (AFRMM) - 25% of the shipping and port handling costs. Used to subsidize the merchant marine and shipbuilding industries.
  • Import Tax (II) - From zero to 35%, depending on the product. The level depends largely on which domestic industry they’re trying to protect.
  • Industrialized Products Tax (IPI) - From zero to 20%. Another protectionist tax.
  • Merchandise and Services Circulation Tax (ICMS) - This is essentially a VAT, levied by the states. It averages 18%, but ranges from zero for some “essential” items, to 25% for “luxury” goods.
  • Contribution to the Social Integration Program and Civil Service Asset Formation Program (PIS/PASEP) - 1.65%.
  • Contribution to Social Security Financing (COFINS) - 7.6%.

More Taxes

But I’ve only mentioned the import duties. The Corporate Income Tax (CIT) runs from 25% to 34%. Plus there are lots of rules regarding deals with related companies, companies in low-tax jurisdictions, and outbound interest payments. This is because, living in both a Latin culture and a high-tax jurisdiction, the Brazilians have grown expert at denying revenue to their voracious government. The government, in turn, adds more layers of rules.

Of course there’s also a personal income tax ranging to 35%. Then, on top of it, is Social Security (INSS) tax of 20%, accident insurance (SAT) of 1% to 3%, Employee Indemnity Guarantee Fund (FGTS) and Education Fund (SE) of 2.5%, plus assorted other taxes adding up to another 3.3% of income. There’s even a 10% tax on the acquisition of foreign technologies. This isn’t a treatise on Brazilian tax law, so I haven’t researched the limits, exclusions, exemptions, and deductions. But if you’re going to do anything here, you’d better have a good accountant.

Total import taxes can easily add up to 100% or more. It’s actually quite insane. Countries like Cuba and Iran complain about being placed under trade embargo and suffering from the dearth of imports. But Brazil - and, for that matter, almost every country in Latin America and Africa - effectively puts itself under embargo with its own tariffs. Brazil, Uruguay, and Argentina are by far the worst self-tormentors.

Restricting purchases to things made within the arbitrary borders of one country (almost always to subsidize some inefficient local industry) makes about as much sense as limiting purchases to things made within a state, a county, or a city - or within a city block, for that matter. What’s happened in Brazil, as with all these places, is that it’s full of uneconomic industries, which turn out relatively high-cost/low-quality products. And often with a surfeit of workers - since keeping lots of workers on the payroll is considered smart public policy. That makes it very hard to make a sensible investment in these places.

It’s all happened before. Eventually reality wins out, and out of either intelligence or simple necessity, the duties come down, the protected industries collapse, and lots of workers become unemployed. The bigger and richer a country is, however, the more mistakes it can make before its eventual comeuppance. And Brazil is a rich country. In other words, Brazil has created some artificial and temporary prosperity in exchange for a very real depression sometime in the future. Neither an individual nor a country can get rich by producing inefficiently and wasting resources.

So Brazil should be doing vastly better than it is now and be on a much sounder foundation. But first it’s going to have to liquidate a lot of malinvestment and allow the severe distortions that have built up over the decades to unwind themselves. It won’t be fun, and it’s going to happen regardless of what’s going on in the rest of the world. This is a major factor that Brazil’s lately arrived cheerleaders either don’t see or don’t understand. It’s why Brazil - as with all controlled, politicized markets - has to be treated as a speculation, not as an investment.

History Equals Culture

Let’s take a look at where Brazil has been to get a better grip on where it’s likely to go.
Brazil split from Portugal in 1822 (about the time the rest of Latin America was breaking political ties with Spain), but remained a monarchy. After independence, the head of state was styled “Emperor” until 1889. (Would the U.S. be the country it is today - yes, the description is loaded with irony - if it had been a monarchy that late in its life?) The next 40 years saw political instability, with alternating military and oligarchical governments, essentially all financed with coffee exports. In 1930, a military coup installed the Vargas dictatorship, typical of governments the world over in the ’30s in its promotion of industrialization by state-owned companies. It survived coups by both pro-Communist and pro-Nazi elements while resembling both.

Another general was elected president in 1946, followed by one headstrong statist after another promising the era’s version of hope and change, by making “50 years’ progress in 5 years.” Part of that promise included moving the capital from Rio to Brasilia, a city built from whole cloth in the middle of the jungle, in the middle of nowhere, starting in 1956. Three million people now live there, so it has been construed a success by some. I think it’s better described as an ongoing disaster and a monument to the gigantic size, complexity, and cost of the Brazilian government.

Brazil was again a military dictatorship from 1964 to 1985, with all the things that have come to be expected from a banana republic ruled by generals - repression, torture, corruption, and runaway inflation. This brings us to the current era, with the ascension of Fernando Collor de Mello in 1985, then the first elected leader in 29 years. He started a trend toward liberalization - beginning the privatization of companies like Vale, Embraer, and Telebras - and toward political moderation that’s been in motion since.

Predictably, Collor de Mello was tried on corruption charges. I say it’s predictable both because enemies of liberalization wanted to punish him and because it was inevitable that, with lots of new capital being liberated, some of it would stick to the president and his cronies. That’s what politics is all about everywhere.

A big change came in 1994 with the invention of the real, the present currency, which was initially priced at US$1.25. Brazilians were overwhelmed at the thought of their currency being worth more than a dollar, even if only for a while. Surprisingly, the currency has been managed fairly prudently, losing just 60% against the dollar over 20 years. Part of the real’s comparative durability was that Brazilians were reacting against the immense inconvenience of one currency destruction after another; part was the simultaneous partial liberalization of the economy on a number of fronts, especially imports.

But when Lula da Silva (who’d run for president twice before) was elected in 2002, the real collapsed to US$0.25, because he and his leftist party had long promised to roll back what reforms had been made and return to a more closed economy. Surprisingly, da Silva proved quite moderate. And he had the singular good luck to be elected at the beginning of the great commodity boom, which brought lots of capital into Brazil, facilitated nearly full employment, and increased the value of the real to its current two to the U.S. dollar.

It was a given that his protégé, Dilma Rousseff, would easily be elected in 2011. Rousseff used to be a communist radical, but like da Silva, she’s acted in a fairly responsible and reasonable way so far. She’s even talked about freeing the economy further and reducing some taxes. These things are possible. But so far she’s been presiding over good times. When things get tough, it’s likely she’ll return to her intellectual and psychological roots, and the government will act the way it usually has.

So I wouldn’t plan my life around meaningful liberalization in Brazil. Or good times in any of its markets. One reason is that the commodity boom has already run a long way, and further gains are likely to be marginal in real terms. But a bigger reason is simply the country’s history and culture - dictators, generals, chronic inflation, and consistently destructive economic policies. When the world economy turns down in the near future, it’s not going to help Brazil. They’ll likely revert to form. Or simply act like almost every other government in the world today and “do something.” Brazil is a prime example of the wisdom of the old saw “Never invest in a country that has the color green in its flag.”

Culture and Currency

Four recently published books promote Brazil as the place to be, mainly because it’s a BRIC that has established a great “track record” since 2001. This is typical of what happens at the top of a bubble. When stocks are at a peak, people want a book about how the Dow is going to 40,000; this is true across all times, places, and markets. People are now writing books on Brazil.

But it’s almost always a mistake to buy popular investments and speculations. In order to make serious money, you have to buy while something is cheap and unwanted, even unknown - better yet, despised. Not after it’s expensive and everyone’s hungry for it. People tend to confuse investments with people. When it comes to people, track records are critical. With people, past performance isn’t just the best, it’s essentially the only predictor of future performance.

Someone who has exemplified the Boy Scout virtues in the past is likely to continue on that course; someone with a panoply of vices and bad habits is likely to carry them to a bad end. The same is true of companies, at least until management changes. But even when it does, corporate culture lingers for a considerable period. This is even more the case with countries. Change in a country’s culture takes generations, if it happens at all.

Everyone talks (quite correctly) about how totally irresponsible Argentina has been with its currency, but Brazil’s follies have been forgotten in the celebrating of its success over the last 15 years. You may find a comparison of interest.

Argentina has had only five currencies in its modern history - the peso moneda nacional (PMN), the peso ley, the peso argentino, the austral, and the current peso convertible. The PMN was used from before WWI until 1970. In its early days, it was tied to gold, and the PMN traded at about 2.25 pesos to the dollar. It started slipping after the Great Depression began in 1929 and then went from 4.2 (to the dollar) in 1947 to 15 in 1950. At that point Peronism, a peculiar blend of corporatism, populism, socialism, fascism, Keynesianism, militarism, nationalism, and other variants of statism that seemed like good ideas at various times, took over. And the ideas have never let go of the popular Argentine psyche.

In 1970, the PMN was replaced by the peso ley, for a 100-1 rollback.
In 1983, the peso ley was replaced by the peso argentino, for a 10,000-1 rollback.
In 1985, the peso argentino was replaced by the austral, for a 1,000-1 rollback.
In 1992, the austral was replaced by the peso convertible, for a 10,000-1 rollback.

This happened with the election of Carlos Menem, who greatly liberalized the economy (while facilitating grand larceny among his cronies). Menem maintained this peso’s relative value with a currency board, wherein the central bank was supposed to take in and hold one U.S. dollar for every peso it issued. They kept to that for a while, then started fraudulently issuing extra pesos, which led to the famous crisis of 2001, with a 75% devaluation.

If you’d held Argentine currency through its various replacements over the last 100 years, you’d have retained only 1/70 trillionth of its original value. At the moment, the peso has an “official” value of 4.7 to the dollar, but trades on the semi-illegal free market for 7 to 1. It’s on its way to zero again. The history of currency in Brazil is even worse, despite the Banco do Brasil mission statement’s talk of “ensur[ing] the stability of the currency’s purchasing power and a solid and efficient financial system.” But all central banks say that.

Brazil long maintained its original real from the 18th century and then replaced it with the cruzeiro in 1942, for a 100-1 rollback.
In 1965, the cruzeiro novo replaced the cruzeiro, for a 1,000-1 rollback.
In 1986, the cruzeiro novo was replaced with the cruzado, for a 1,000-1 rollback.
In 1993, the cruzado was replaced with the cruzeiro real, for a 1,000-1 rollback.
In 1994, the cruzeiro real was replaced with the real, for a 2,750-1 rollback.

Since then, the real has lost about two thirds of its value relative to the dollar. I see no reason why it shouldn’t meet the fate of its predecessors. I calculate destruction against the dollar so far at about a quadrillion to one. But numbers of this order of magnitude are academic. I fully expect that, when the pressure for revenue and economic stimulus next arises, the Brazilians will once again destroy their currency.

The Bottom Line

My view is that in today’s world, it’s extremely hard and risky to invest. You must remember the correct definition of investing: to allocate capital to produce new wealth. Essentially that amounts to buying equipment, hiring people, renting real estate, and seeing that a business is run sensibly over the long term.

Investing is all about funding successful businesses. In order for that to be possible, you need some predictability and a certain amount of stability. Unfortunately, those are ingredients that go into short supply whenever government gets involved in the economy. And today, from what are already the highest levels in modern history, governments all over the world are becoming much more virulent. And since most of them are now manifestly bankrupt but are burdened by huge promises for welfare and transfer payments to the masses who voted them in, you can expect things to get even worse.

When there are no opportunities for investing, you can only speculate, which means, look for politically caused bubbles, collapses, and distortions. Brazil should only be viewed as a speculation. As chronically and pathetically mismanaged as Brazil has always been and continues to be, it’s astonishing how well it’s done. And there’s no reason that it shouldn’t continue progressing, despite the weight of government and its seeming inability to learn from its mistakes. People will keep producing, and technology evolving.

Am I negative on Brazil? No. I highly recommend you visit, especially before FIFA in 2014. I really like the country (notwithstanding São Paulo). But it’s not a sure ticket to wealth. In fact, over the next decade, I’d recommend you stay away from Brazilian markets. But armed with this information, hopefully we’ll recognize the Bovespa’s next bottom.
Doug Casey: Hmm...maybe the bottom is close now. Or certainly closer.

Editor’s Note: Doug Casey has been warning of a currency collapse. He believes a collapse of major currencies could wipe out trillions of dollars in wealth, including pensions. Here’s Doug:
It’s going to be much more severe, different, and longer lasting than what we saw in 2008 and 2009…The U.S. created trillions of dollars to fight the financial crisis of 2008 and 2009. Most of those dollars are still sitting in the banking system and aren’t in the economy. Some have found their way into the stock markets and the bond markets, creating a stock bubble and a bond super-bubble. The higher stocks and bonds go, the harder they’re going to fall.

Unlike most people, Doug Casey has actually lived through a currency crisis. He was in Argentina when its currency collapsed in 2001 during the largest sovereign debt default ever. By making smart investments, he even managed to make a large gain on his money in the aftermath of the crisis.

We recently recorded a video presentation with Doug on this topic. In the video, Doug shares his advice on how to position your money and investments for the collapse of a major currency like the U.S. dollar. Click here to watch the video.

The article was originally published at internationalman.com.


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Saturday, December 12, 2015

If You Own These Stocks, Your Dividend Is in Danger

By Justin Spittler

Mining companies are having another horrible week. As Dispatch readers know, commodities are in a deep bear market. Over the past year, the Bloomberg Commodity Index, which tracks 22 different commodities, has fallen to its lowest level since May 1999. Many individual commodities have lost 30% or more in the last year. Since December 2014, coffee has dropped 30%, palladium has dropped 34%, and platinum has dropped 31%. Crashing commodity prices have forced many mining companies to drastically cut spending.

Yesterday, mining giant Freeport-McMoRan (FCX) suspended its dividend. Freeport is the seventh largest mining company and the second largest copper miner in the world. The suspension of Freeport’s dividend is a major event. Until recently, Freeport was one of the industry’s most generous dividend payers. It paid $4.7 billion in dividends between 2012 and 2014. Its stock yielded about 3.8% in 2014.

Click here to get a free trend analysis for Freeport-McMoran

Management hopes to save $240 million a year by not paying a dividend. Freeport will also reduce its copper production by 29%, and cut capital spending by $1 billion over the next two years.
Freeport’s stock jumped 3.7% yesterday. It’s still down 71% this year.

The price of copper, Freeport’s main source of revenue, has plunged.…
Copper has dropped 27% this year to a six year low. Crashing energy prices have also slammed Freeport. In 2013, Freeport loaded up on debt to acquire two oil and gas companies. Its timing was awful. At the time, the North American energy industry was booming. But since last June, the energy sector has entered one of its worst bear markets on record. The price of oil has plunged 66% to its lowest level since 2009. The price of natural gas has dropped 55%. Freeport’s sales have now declined five quarters in a row. The company lost $3.8 billion last quarter, after making a $552 million profit a year ago.

Investors hate dividend cuts.…
A dividend cut often signals that a company is in big trouble. Typically, a company will only cut its dividend when it runs out of other options. Companies will often shelve new projects, lay off workers, and slash executive compensation before touching their dividends.

Freeport is only one of several major commodity giants to cut its dividend this year...
Anglo American (AAL.L), the world’s fifth largest mining company, suspended its dividend on Tuesday. The company will not pay a dividend again until at least 2017.

Kinder Morgan (KMI), North America’s largest energy pipeline company, also cut its dividend on Tuesday. The company’s fourth quarter dividend will be 75% less than it planned.
The list goes on….Vale (VALE), the world’s largest miner.…Glencore (GLEN.L), the world’s third largest miner….and....

Peabody Energy (BTU), the world’s largest publicly traded coal company, all cut their dividends this year.
Widespread dividend cuts suggest that major miners are in “survival mode.” To us, this is a key sign that commodities may be near a bottom. While prices of certain commodities could easily go lower or stay low, commodities as a group may be in a bottoming process.

Oil dropped to a new six year low yesterday.…
As we mentioned, the price of oil has now dropped 66% since June 2014. This is oil’s second-worst drop since 1985. The only bigger drop happened during the financial crisis when oil plummeted 77%.
Low oil prices are crushing the “supermajors,” four of the world’s biggest oil companies. Third quarter sales for BP (BP) fell 41%, year over year. Sales for Exxon Mobil (XOM) and Chevron (CVX) both fell 37%. And sales for Royal Dutch Shell (RDS.A) fell 36%.

All four companies have announced drastic spending cuts to cope with falling revenues. BP cut spending on capital projects by about $6 billion this year. Exxon cut spending on capital projects by 22% in the third quarter. Chevron announced 7,000 layoffs after reporting poor third quarter results. And Shell abandoned a $7 billion oil project in the Arctic. Together, these companies have cut spending by more than $30 billion in just the last few months.

Even with huge spending cuts, the supermajors are still bleeding cash….
In October, The Wall Street Journal reported:
Spending on new projects, share buybacks and dividends at four of the biggest oil companies known as the supermajors – Royal Dutch Shell PLC, BP PLC, Exxon Mobil Corp. and Chevron Corp. – outstripped cash flow by more than a combined $20 billion in the first half of 2015, according to a Wall Street Journal analysis.

However, the supermajors have NOT cut dividends yet.…
For years, supermajor dividends have been one of the safest income streams on the planet. Shell hasn’t cut its dividend since the end of World War II. Exxon has increased or maintained its dividend for 33 consecutive quarters. Chevron has done the same for 27 consecutive quarters. Many investors consider these dividends untouchable. They’re often a foundational part of their holdings, like grandma’s ring or the family farm. However, if oil keeps plummeting, these companies might have to cut their dividends.

Dividend yields for the supermajors are soaring.…
Since January, Shell’s dividend yield has jumped from 5.1% to 8.1%. It’s nearing a historic high. BP’s dividend yield has jumped from 6.5% to 8.4% over the same period. Exxon’s has jumped from 3.0% to 3.9%. And Chevron’s has jumped from 3.8% to 5.0%. These yields are not going up because the companies are increasing payouts. They’re going up because these companies’ stock prices are falling.

The world’s biggest oil companies were not prepared for oil to drop below $40.…
Financial Times reported on Tuesday: Just weeks ago, BP and France’s Total each pledged to balance their books at $60 a barrel oil, saying they aimed to cover their dividends from “organic” cash flow by 2017.
Total (TOT) is another giant oil company that’s struggling. Total’s quarterly sales have dropped four quarters in a row. If oil continues to trade below $40, these companies might have no choice but to cut their dividends. In fact, their dividends might be at risk even if oil does rebound soon.

Even at $60, the three biggest European majors will need to take further cost cutting action to cover investor payouts…Total’s $6.8bn dividend would exceed its projected organic free cash flow by $800m two years from now. For BP, the cash shortfall is put at $500m. If these giant oil companies do cut their dividends, it could trigger huge selloffs. Many investors hold these companies specifically for their reliable dividends.


Chart of the Day

The bear market in oil may be far from over. Today’s chart compares the Bloomberg Commodity Index, or BCOM, to the price of oil. As we mentioned earlier, BCOM tracks 22 different commodities. Commodities and oil both peaked in 2011. BCOM entered a bear market almost immediately after. Oil, however, didn’t have a big drop until mid-2014.

In other words, commodities have been in a bear market for four years…but oil has been in a bear market for less than two years. That’s one reason why major commodity companies have cut dividends but the oil supermajors haven’t…yet. Until major oil companies begin to cut dividends, we wouldn’t bet on a bottom in oil.



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The #1 Question About 20/30 Wealth Trader

It's only been a couple days since Bill Poulos announced the official opening of The 20/30 Wealth Trader program.

But the questions are already pouring in.

"How do I know this will work for me?"

"Do I need a large account to use this system?"

"How much time do I need to use this program?"

"Can this make me rich?"

Bill made this quick video to answer your questions. Have a look:


Your Questions About The 20/30 Wealth Trader
Answered Here

See you in the markets,
Ray C. Parrish
aka the Crude Oil Trader

p.s. Be sure to mark your calendar because The 20/30 Wealth Trader program opens at 1pm Eastern on Monday, December 14th. And watch your inbox over the weekend for a surprise announcement.


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Friday, December 11, 2015

How The Best of Intentions Destroyed Liquidity

By Jared Dillian

I just got done grading the final exams for my class (took me 12 hours). It’s 100 short answer questions and two essays. One of the essay questions is about the Volcker Rule. “Paul Volcker, former Federal Reserve chairman, as part of the rulemaking process for Dodd-Frank, included a provision prohibiting proprietary trading by banks, known as the Volcker Rule. Do you agree or not agree with the Volcker Rule? Explain.”

The funny thing about asking someone what they think of a law is, if you leave the question open ended and you don’t really describe what the law does, the response is generally favorable. Out of a class of 20 students, only two or three opposed the Volcker Rule. Most of them were in favor of it, as they were in favor of Glass-Steagall when I asked them to write a paper on that.

Seems pretty straightforward. If you have these banks that you call “systemically important,” such that they could go out of business and get rescued by taxpayers, then you don’t really want them taking risks with their own capital, right?

I mean, look how this worked out in the past.

Milton Friedman once said that laws should be judged by their results rather than their intentions. Liquidity has disappeared, and it is directly attributable to the Volcker Rule. If you hear someone try to make an argument that it’s not, that person is probably a journalist or a professor with no first hand knowledge of the situation.

I remember when the Volcker Rule first passed, years ago, someone senior in the equity derivatives market asked me, “Do you really think they will have regulators going through your trades, one by one, line by line, asking you if it was your intent to make money?”

“That seems very unlikely,” I told him.....But that is what we got.

In addition to confiscating cell phones and monitoring phone conversations, chats, and emails, the vast army of compliance officers at investment banks really will go through a trader’s blotter line by line and determine if each trade was a bona fide hedging transaction or if he was trading for his own account. In single stocks, this is pretty straightforward—either you were buying GE for a client or you were buying it for yourself. But in derivatives, it’s not. If you get hit on the GE Jan 30 calls, you’re not going to be able to turn around and sell them—you have to sell something else.

For example, if you’re long too much vega, you may want to sell some short-dated stuff against it, putting on a term structure trade. Is that a hedge, or prop trading? It’s impossible to make that distinction. But the compliance guys try. The interpretation varies. In equity derivatives, traders generally get the benefit of the doubt. In credit, they don’t. You can’t sell bond B to hedge bond A. You literally have to sit there and try to sell bond A. This is why the bond market is such a mess, which we have talked about in this space before.

Of course, none of this gets us any closer to preventing an investment bank from blowing up, because the guy trading 500 call options on GE was never going to blow up the bank in the first place. On the other hand, the Volcker Rule never would have prevented Jon Corzine from blowing up MF Global with European sovereign bonds. If a CEO really wants to do something like that, is some compliance dork really going to stop him? To say that this regulation is a catastrophic failure would be an understatement. Liquidity has disappeared, with no discernible benefit. I’m a middlebrow market commentator, and I’m not supposed to say things like “This is dumb,” but this is really dumb. It doesn’t take an Austrian economist to figure out the unintended consequences.

In the old days (10 years ago), banks were the big liquidity providers. Let’s look at this a different way: do we want banks to continue to be liquidity providers, yes/no? Banks were not always liquidity providers. In the ‘90s, in equity options, it was the physical trading floors where all the risk was handled. Stocks, too. But the bond market has always been an upstairs phenomenon.

If banks aren’t going to be liquidity providers, then we need non bank entities to provide liquidity, and we need to encourage it. Some large hedge funds and some second tier (i.e., not systemically important) broker dealers are starting to do this. But it’s not enough.

The goal was to take a bank and turn it from a risk taking institution to a toll taking institution, where everything is traded on an agency basis, with a commission applied. The FX markets, which were once all risk, are starting to look like this. In equities, traders don’t do much aside from maintain relationships and plunk orders into auto trader, where they are preyed upon by the algorithms.

This is unsustainable, because how can you hire all these smart people from fancy schools and pay them all this money just to push a button—while all their communications are monitored? Nobody is happy with the current state of affairs. 10 years ago, you could sell 250,000 shares on the wire. Or $25 million of bonds.

I have two radical solutions. Here they are:
  1. Repeal the Volcker Rule
  2. End decimalization
When I came into the business, stocks still traded in fractions. On the options floor, I had to learn to add and subtract fractions in my head. Seriously—I ran drills on this, testing myself for speed. When I got to Lehman, to the program trading desk, I noticed something remarkable—we could send our orders to “wholesalers” like Spear, Leeds & Kellogg or Knight Trading. They would auto execute the orders up to 2,000 shares on the bid or the offer—for free.

Then decimalization happened. The preferential treatment lasted about another month, then they started charging us a penny a share. Market making went from being a profitable business to an unprofitable one.
Guess what—if market making is profitable, a lot of people will want to do it, and you will have a lot of liquidity. If market making sucks, nobody will want to do it, and you will have no liquidity.

Did the retail investor benefit? Maybe. Now he could go into his E-Trade account and execute something for a penny instead of 1/16. But if he was a shareholder in a mutual fund, the mutual fund portfolio manager now had to drop 250,000 shares into auto trader, getting preyed upon by the aforementioned algorithms, instead of getting it done for 1/8.

Then SEC Chairman Arthur Levitt led the charge for decimalization. More unintended consequences.
It’s not likely we’ll go back. Levitt was having conniptions about the length of time it was taking for the options market to decimalize, even though the computing power didn’t even exist.

Ask any portfolio manager today: Liquidity is the number one concern. That’s bullcrap. It’s like buying a house and having plumbing be your number one concern. It should just take care of itself.
Jared Dillian
Jared Dillian

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Tuesday, December 8, 2015

Janet Yellen: The Best Pick Pocket in the USA

By Tony Sagami

“Some of the experiences [in Europe] suggest maybe we can use negative interest rates.”
—William Dudley, President of the New York Federal Reserve Bank

“We see now in the past few years that it [negative interest rates] has been made to work in some European countries. So I would think that in a future episode that the Fed would consider it.”
Ben Bernanke

“Indeed, I would be open to the possibility of reducing the fed funds target funds range even further, as a way of producing better labor market outcomes.”
—Narayana Kocherlakota, President of the Minneapolis Federal Reserve Bank

If you are planning to travel to any major European city, you better watch your wallet because there are thousands of very skilled pickpockets looking to separate you from your valuables. Those pickpockets, however, will only get away with however much money you have in your wallet. Sure, a pickpocket can throw a major monkey wrench into your vacation, but the amount these European thieves take from you is peanuts compared to what Fed head Janet Yellen wants to steal from your bank account.

While Wall Street experts and CNBC talking heads regularly debate the "will they or wont they" interest rate liftoff, a more important question is whether or not the Federal Reserve will follow the European model of negative interest rates. Negative interest rates are nothing unusual in Europe as several central banks lowered key interest rates below 0%.


Yup, that means investors essentially pay a fee to park their money.

That parking fee just got higher last week when the European Central Bank cut its already negative deposit rate from minus 0.2% to minus 0.3%. The ECB also expanded is current quantitative easing program. The European Central Bank, the Swiss National Bank, and the Danish National Bank all have interest rates below zero. In fact, the Danes have held their overnight rates at negative 0.75% since 2012.

The Swiss, however, are the undisputed leaders of the negative interest rate experiment. The SNB first moved to negative rates in December 2014 and then dropped rates to negative 0.75% in January of this year. The Swiss National Bank, by the way, meets in a couple of days, on December 10, and is widely expected to cut rates again.

The question, of course, is how negative can interest rates go? Before the end of December, I expect deposit rates in Switzerland to be between -100bps and -125bps. Remember, we’re not talking about some backwater, third world countries here. Switzerland and Germany are two of the wealthiest countries in the world, as well as the home of major financial and political centers.

And I’m not just talking about short term paper either. Finland, Germany, France, Switzerland, and Japan are all selling five year debt with negative yields. In fact, Switzerland became the first country in history to sell benchmark 10 year debt at a negative interest rate in April.

Don’t think that negative interest rates can happen in the US? Wrong!

You may have missed it, but the United States is now also a member of the “0% club”—most recently in October, when it sold $21 billion worth of 3 month bills at 0% interest.


However, that is not the first time. Since 2008, the US government has held 46 Treasury bill auctions where yields have been zero. The next step after zero is negative… and it’s becoming a real possibility. Welcome to the European model of starving savers to death!

The implications for investors are monumental.

Ask yourself, what would you do with your money if your bank started to charge you to deposit it there? Would you pay hundreds, perhaps thousands of dollars a year just to keep your money in a bank?

Option #1: Hold your nose and pay the fees.
Option #2: Move those dollars into the stock market; perhaps into dividend paying stocks.
Option #3: Buy real estate; perhaps income generating real estate.
Option #4: Invest in collectibles, like art or classic cars.
Option #5: Stuff your money under a mattress.


The point I am trying to make is, the rules for successful income investing have completely changed. If you are living (or plan on living) off the earnings of your savings, you better adapt your strategy to the new world of negative interest rates…..or plan on working as a Walmart greeter during your golden years.


Even if you think I’m nuts about negative interest rates coming to the US, there is no doubt that interest rates are not climbing anytime soon.

According to the Federal Reserve.....
"The Committee anticipates that inflation will remain quite low in the coming months.”
“The stance of monetary policy will likely remain highly accommodative for quite some time after the initial increase in the federal funds rate.”

With the US national debt approaching $19 trillion, our government doesn’t have any choice but to keep interest rates low. Sadly, our politicians are paying for their spendthrift ways by starving responsible savers.
But you can (and should) fight back by changing the way you think about investing for income. You can start by giving my high yield income letter, Yield Shark, a risk free try with 90 day money back guarantee.

Tony Sagami
Tony Sagami

30 year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here.

To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.



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Sunday, December 6, 2015

Another Elephant Trade is Setting Up


It’s a bit unusual for us to reach out to you on the weekend during family time, but this is pretty important. We want to give you a heads up so you don’t miss out on this again. Here’s the situation. Pressure in the markets is building for a big move in the next few weeks. If it hits, this could drive the trends for the coming year.

And I can tell you firsthand that many professional traders and hedge funds will be blindsided by this. They just don’t get what’s driving the markets today. And as you know, that means this set up could be unusually intense (and potentially very profitable) as everyone panics when they discover they’re on the wrong side of the move.

Listen, if you want to grow a small account quickly, then this is the kind of move you need to catch and they only happen about once a year. Now, we want to take a minute to apologize. Here’s why. Our trading partner John Carter released a great free video [click here to watch it] then a special webinar training last week and he went into full detail about this elephant trade set up and how to ride it. And the feedback has been just amazing. Which is why we feel bad.

A whole ton of you missed out because we only sent out one email invitation to register for the webinar. So on Tuesday December 8th at 8 p.m. est John is going to do an encore training for you. Since this message is going out to everyone who missed last time, we strongly encourage you to grab your spot as soon as possible because space is limited.

Click Here to Register

This is NOT a replay. The training will be live so you can use what you learn the next day. John will cover any new market developments and tell you how he is trading them in his own account. I think you’ll agree, anyone can identify a big move in hindsight, but that doesn’t do you much good, right?

That’s why we think it’s so important to be transparent and show you John's positions and results in real time. To join us for this special training, grab your spot now.

Click Here to Register

By the way, in last week’s training John mentioned a Netflix set up that was forming and several attendees jumped on that and did very, very well. Now, quick trades like that don’t always happen in a live training, but sometimes they do. Remember though, the point of this training is really about how to grow your account fast by catching these big elephant trades.

If you missed the recent big move in the Euro, or AMZN, then you don’t want to miss what we believe will be the big trade of the next 12 months.

So Click Here to Register for this special training now before you forget.

See you Tuesday evening,
Ray C. Parrish
aka the Crude Oil Trader



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Wednesday, December 2, 2015

How Big the Gig Economy Really Is

By John Mauldin

There is growing awareness of what is being called the “gig economy.” It’s not just Uber driving or Airbnb. There are literally scores of websites and apps where you can advertise your services, get temporary or part time work, and do so from anywhere you happen to be.

Some “gigs” actually pay pretty good money, but they are for people with specialized skills who prefer to live a somewhat different lifestyle than the typical 9 to 5’er does. My hedge fund friend Murat Köprülü has been busy researching and documenting this phenomenon and regularly regales me with what he finds.

He goes and spends evenings and weekends with young gig workers, trying to figure out what it is they really do and how they make ends meet in New York City. It turns out they need a lot less to support their lifestyle than you might imagine, and they prefer working intermittent gigs, being able to do what they want, and having no boss.

A close look at the data indicates that the gig economy is indeed big and growing. But there is a great deal of debate among economists about how big it really is.

It’s Much Bigger Than the Employment Data Suggests

Gig workers don’t seem to show up clearly in the BLS employment data. Typically, we would expect those working in the gig economy to appear in the self employed category, but that category is actually drifting downward in numbers—relatively speaking.

But Harvard economist Larry Katz and Princeton’s Alan Krueger, who are working on research to document the rise of the gig economy in America, says that our current measures ignore the bulk of the gig economy.

 From a story at fusion.net:
Katz said two pieces of evidence suggest current measures of self-employment and multiple-job holding are “missing a large part of the gig economy.” The first is that the share of the employed (and of the adult population) filing a 1099 form, the tax document “gig economy” workers must file, increased in the 2000s, even as standard measures of self-employment declined in the 2000s. Other groups have confirmed this: Zen Payroll, a site that tracks the sharing economy, found increases in the share of 1099 workers across many major U.S. metros.

Mauldin-Economics-Gig-Economy
Source: Zen Payroll via Small Business Labs

And data from research group EconomicModeling.com show the share of traditional, 9-to-5 workers in the labor force has declined…..

Mauldin-Economics-Gig-Economy
Source: Fusion, data via EconomicModeling.com

… while those who categorize themselves as “miscellaneous proprietors” is climbing.

Mauldin-Economics-Gig-Economy
Source: Fusion, data via EconomicModeling.com

A recent survey found 60 percent of such workers get at least 25 percent of their income from gig economy work.

The problem with the BLS estimates is that they overlook a sizable chunk of the true gig economy.
And this report absolutely squares with what my friend Murat’s research is showing: that gig economy is not shrinking. On the contrary, it’s on the rise, and a quite rapid rise.

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Follow Mauldin as he uncovers the truth behind, and beyond, the financial headlines in his free publication, Thoughts from the Frontline. The publication explores developments overlooked by mainstream news to help you understand what’s happening in the economy and navigate the markets with confidence.

The article was excerpted from John F. Mauldin’s Thoughts from the Frontline. Follow John Mauldin on Twitter. The article How Big the Gig Economy Really Is was originally published at mauldineconomics.com.


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