A Monetary Morality Tale
London, England
Thursday, March 13, 2008 --------------------- *** The worst conditions for the U.S. economy since the Great Depression…gold kisses $1,000 an ounce… *** The gods are giving the boot to the entire financial industry…what more can the Federal Reserve do? *** Your last chance to get in on the commodities super-cycle…and more! --- Less Than 12 Hours Remain --- One of the Most Elite Resource Packages Ever Offered We just finished putting together the most elite bundle of resource services that we've ever offered. It includes four great services, plus a free ticket to our world-famous symposium in Vancouver…for life. But we have to slam the door shut on this offer at midnight tonight. If not, too many people will be able to gain access to it. So check it out before you miss your chance… --------------------- Mortimer Zuckerman, co-founder of Boston Properties Inc. (NYSE:BXP), the largest U.S. office real estate investment trust, said the U.S. economy is in a recession and there's no sign of a recovery. "We are looking at the worst set of macroeconomic conditions since the Great Depression," Zuckerman said in an interview with Bloomberg Television. Yesterday, the dollar fell to a new record low. It was down to $1.55 against the euro (EUR). Oil rose to hit the $110 market…then backed off slightly. The commodities index rose three points and bonds edged higher. As you recall, we didn't like the action on Wall Street on Tuesday. Following the announcement of Ben Bernanke's plan to feed an additional $200 billion into the banking system, stocks rose strongly. Gold rose only modestly. We thought it should be the other way around. And now, something else worries us: investment advisors have turned bearish, in a big way. All over the world, they've come to think stock market prices will fall. Only in Brazil do they expect prices to go up. Oddly, the U.S. stock market is one of the world's best performers so far this year, which is to say, it is down less than most. The S&P has lost only 7%. India, Hong Kong and Shanghai are down more than twice as much. The pros are almost always wrong; when they are bearish, it usually means stocks will rise. Yesterday, U.S. stocks lost a little. Gold gained a little - plus $4.50…to close over $980. Nothing was decided. It is tempting to look at this market and come to a simple conclusion: the economy is declining…the feds are trying to stop the decline with more cash and credit. Therefore, the dollar must go down and gold and commodities must go up. That is our basic view of things; it's why we stick with our formula - sell stocks on rallies, buy gold on weakness. But it's not going to be a smooth ride. Commodities are notoriously cyclical - based on short-term supply and demand considerations - whereas cycles in the credit market are extremely long-term. Bond yields have been falling since 1981 - 27 years. They seem to us to have bottomed out, but it may be a long, long time before the 10-year Government Bond yields 15% again. Selling U.S. bonds may the best thing you can do for the long run…but in the short run, you could regret it, as people may rush into U.S. bonds - the world's safest credit, in dollar terms - as a way of avoiding the risk in the credit market. Yesterday, the Financial Times told us that three more hedge funds were in trouble. Global Opportunities halted redemptions. Drake Management said it was shutting down one of its funds. And Blue River will close down after losses of more than 80%. And here, we pause a moment…what went wrong, we wonder? One of the funds to go belly up was called "Absolute Return and Low Volatility." Gee…what could go wrong with that? But apparently, the absolute return went negative…and the volatility got out of control. How could that happen? Aren't these people supposed to be whiz kids? Can't they do projections of volatility and expected rates of return? Isn't the whole point of a hedge fund to HEDGE against these extraordinary losses? In addition to the normal sturm and drang of markets, we are witnessing a fascinating and entertaining morality tale…in which the gods are giving the boot to the entire financial industry. (More about this tomorrow…) Back to our point… As we write this, gold futures hit $1,000 an ounce before pulling back. Gold at $1,000 will probably seem a bargain sometime in the future, but in the months ahead, it could be a source of irritation. Corn, wheat…and industrial commodities…could be an even bigger disappointment. Supply and demand are always balanced on the sharp fulcrum of prices. Even a slight fall-off in demand, caused by a worldwide slowdown, could have a devastating effect on prices - even though we may be in a commodities super-cycle that will last for many years…and even though the dollar is going down. That's why if you want to get in the commodities super-cycle, there's still time to have the best and brightest in the biz on your side. Right now, you can get all of Agora Financial's commodities and natural resource services - for life. And if you sign up by midnight tonight, we'll throw in our newest addition, Gold & Options Trader, free of charge. Act now, time is running out… In the case of U.S. stocks, it looks to us that they are not a good place for your money - long-term. We would be especially eager to get rid of high fliers, such as Google (NASDAQ:GOOG). But we would also be prepared for a rally in stocks in the weeks ahead. On the other hand, we have the opposite outlook for stocks in emerging market. The United States now has a hugely disproportionate share of the world's equity value - about a third. Since the rest of the world is growing much faster than the United States and Europe, you could expect equity values in the rest of the world to rise too. So, relatively speaking, emerging markets should do better than the United States or Europe over the long run. Still, stocks in emerging markets could be disasters in the short run. Where does this leave you? What to do? *** If you want to get rich, the thing to do is to take a big position, leverage it up, and stick with it. If we were making that kind of gamble, we would choose gold stocks. Most likely, you'll make a fortune as gold reaches $2,500…or $3,000. But we don't want to get rich; we just don't want to lose money. So, we buy gold without leverage. If it goes down…we don't really care. We will still have our gold…and we can still tell ourselves that it is sure to rise "in the long run." Most people will want to stick to a more traditional formula. Usually, you want to keep about a third of your money in equities…a third in property…and a third in gold, precious metals and other tangibles. You spread money around because you never know what will happen. You may be dead certain that the price of gold will go up…but Mr. Market doesn't care what you think. He'll do what he wants…when he wants. What stocks should you own? We like Japanese stocks, because they seem like the safest, cheapest in the developed world. Our old friend Marc Faber likes tobacco, beverages, food retailers, pharmaceuticals, electric utilities, and gold, silver and platinum mining companies - in the United States and elsewhere. He notes that Wal-Mart (NYSE:WMT) is holding up well, because it sells so many non-discretionary items, such as food, healthcare items and gasoline. Even in a slump, people still have to eat. And what real estate should you own? Marc has an opinion on this subject to "My favorite asset class," he writes, "remains real estate in emerging economies. In most emerging economies, mortgage debt as a percentage of GDP is low; and with rising standards of living, home ownership and the living space per capita will increase. What is interesting is that, whereas the US accounts for 31% of global stock market capitalization, (down from over 50% in 2000!), it accounts for 47% of an index of 321 property companies around the world…. Whereas global investors have allocated significant capital to equities and bonds in emerging economies, they are grossly underweight real estate in those economies." *** "I don't know where the bottom is," continued Mr. Zuckerman, "the federal government's going to have to do a lot more to contain what I think is the potential of a perfect storm." Employers are cutting jobs and demand for housing is tumbling. On March 7, the Labor Department said payrolls fell by 63,000 in February, the most in five years, after a revised decline of 22,000 in January. "The most dangerous part in my judgment is what is going on in the housing world, where we're now running foreclosures at the rate of 2 million a year, where 9 million homes, according to the government, just slightly under 9 million homes, have either no equity in them or negative equity," he said. "That will go up to 15 million if housing prices continue to go down this year as they've done last year," Zuckerman added. "We are clearly heading down." Zuckerman said that both the Federal Reserve and the government need to take more action to stem rising foreclosures. He said that the Federal Reserve's move yesterday to lend, in return for mortgage debt, $200 billion of Treasuries to the securities firms that trade directly with the central bank, was not enough. Has the Fed not done enough? Rumor has it that they are preparing to cut a full 100 basis points off the key rate this month. Plus, they're taking the banks' bad credits - as much as $200 billion of them - in collateral. What more could they do? Our guess is that they have done more than enough already. The science of modern central banking is largely humbug - like the science of modern portfolio management. But that is what is being put to the test now. If Bernanke can rescue the U.S. economy, he will be a hero. If he messes up, he will be a schmuck. Our guess is that he will be a schmuck. Because the theory behind his intervention is as unsound as phrenology. More to come. Until tomorrow, Bill Bonner
The Daily Reckoning --- Special Offer --- RETIRE THIS YEAR… And still make more money than most doctors. You can do it - once you know the proven secrets to writing a simple letter like the one you're about to read. Imagine a job in which you set your own hours, and live where you please: at the beach, in the mountains, in Paris. And still make more money than most doctors. --------------------- The Daily Reckoning PRESENTS: There is nothing more bullish for gold than a situation where the central bank refuses to acknowledge that it is pouring gasoline on a raging fire. Forget the dollar, and oil. Those were just interim preoccupations. The newest addition to the Agora Financial family, Ed Bugos, explains… CAN THE REAL BULL MARKET PLEASE STAND UP?
by Ed Bugos Remember that old Wall Street maxim, "Don't fight the trend"? Now remember another one, "Don't fight the Fed"? Well, what happens when the Fed fights the trend, as it has been recently? Which axiom to believe? Historically, the Fed loses that fight until the trend is ready to turn back around. Admittedly, the central bank's inflationary policies will likely help this occur at a higher nominal dollar value than otherwise. Nevertheless, the historical odds favor the trend over the Fed when these two maxims collide. But putting aside my autistic wisdom for a moment, let's consider what the Federal Reserve is doing for the trend in gold prices - a trend, I am loathe to inform you, which it is not fighting. Let me sum it up: the trajectory of this bull trend shifted north when Bernanke took the helm of the Federal Reserve System, and that the policies pursued by the Bernanke Fed have confirmed the investment thesis driving the bull market in gold. As one pundit recently noted during a Bloomberg interview, "You gotta go with the inflation theme… it's the only thing still working." After upping the size of its new term auction facility from $60 to $100 billion this weekend, the Fed revealed another innovative tool that might help it manage liquidity in the banking system. The new facility, the Term Securities Lending Facility (TSLF), will offer up to $200 billion in Treasury Securities to primary dealers in exchange for a wide variety of collateral the Fed has never before accepted, including private label mortgage securities. It also eased swaps with other central banks. The controversy is that although the Fed has been allowed to accept mortgage backed securities as collateral since 1980, it has never outright bought them, and only recently enacted legislation that allows it to actually monetize them - which means to buy them without having to sell other assets. Gold bugs have followed the Fed's legislative changes with interest. This move should not surprise any of them, but it does hold a special significance in its long-term implications, and for gold prices. And even though the Fed hasn't expanded bank reserves or the monetary base much since August, it is helping the banking system postpone an increase in reserve demands triggered by criteria built into the Basel II framework, a generally accepted model for capital adequacy standards. By boosting the quality of bank reserves, even if temporarily, the Fed hopefully won't need to increase the quantity of bank reserves, which have been sufficient to fuel an $800 billion expansion in the broad US credit aggregate, MZM, since August. That is 11%, or 15% year over year. The highest rate since 2002. That is a bullish recipe for the precious metals. There is nothing more bullish for gold than a situation where the central bank refuses to acknowledge that it is pouring gasoline on a raging fire. Forget the dollar, and oil. Those were just interim preoccupations. The real bull market is about to stand up. If gold prices are going to continue to drive through $1000, they are going to do it because the central banks are all inflating madly at the worst time. This means that a good old-fashioned bear market on Wall Street is sufficient to keep central bankers' collective petal to the medal, and sustain the gold bull. So far, the precious metals stocks have bucked the general stock market trend since August. This is as it should be, and it is impressive because by most counts gold stocks are quite expensive relative to today's gold price. But, investors are complaining about the underperformance of those stocks relative to gold, and also about the lackluster performance of their junior mining assets, which haven't participated in the precious sector rally at all since August - when the current leg started. There are a few explanations for this. Perhaps John Embry said it best, at a gold conference in Vancouver recently, when he remarked that gold shares sometimes act like a bet on gold, but sometimes they just act like plain old shares. We should leave it at that…however, that is not like me. Historically, I have found that gold shares are susceptible to market declines, except occasionally during a major bull market advance in gold, when they tend toward counter-cyclicality - the more so as the bull market progresses. They will still fall during stock market panics, as all shares do, but they are likely to come back harder and hold their trends better. Still, since 2004, I've held the position that, as an asset class, gold shares would not outperform gold prices for the remainder of the primary leg. I continue to think that, with the qualification that we are talking about the average gold stock. Junior markets are wired differently. They do not correlate that well with the underlying commodity trend in the first place. In my experience, they correlate better with market attitudes toward risk. Junior and small cap markets have never fared well in a general market meltdown because they are typically risky assets, and in a selling panic the crowd is averting risk. The larger capitalization precious metal producers are different. The reasons for this are sound. But as a rule, speculative assets do well when the gambling environment is friendly. However, within the small cap resource sector there will invariably be exceptions. It remains to be seen if the junior gold miners will be able to buck the general market trend, but there is a good chance they will. Many of them are cheap now, and the supply fundamentals for gold are tightening. Production from many gold producing regions of the world is currently constrained by power shortages; and rapidly inflating development costs are causing the postponement of several otherwise promising development projects around the world. Meanwhile, gold producers need reserves! The large cap producers are on the hunt for sound mining assets. And they aren't going to be discouraged by a 20-30 percent drop in gold, or stock prices. Regards, Ed Bugos
for The Daily Reckoning P.S. I'm lining up several potential takeover targets for my first issue of Gold & Options Trader. These include small cap gold miners that have either just finished developing a new mine or soon will be, or whose assets are otherwise overlooked. And we'll be publishing option strategies to profit from swings in the large cap miners too. Regardless of which way the markets go, I'll show you how to profit from trend changes. Tune into my letter to find out when it will be time to get out, or insure your gold stock portfolio. Editor's Note: Until tonight at midnight, you can get Ed's Gold & Options Trader - free…you won't want to miss out on this special offer. Get all the details here. Before starting up Gold & Options Trader, Ed came straight from the North American heart of the gold market - Vancouver's Howe Street. During the nasty commodity bear market in the '90s, Ed still guided his clients to gold profits in Argentina Gold and Arequipa, both of which became buyout bait for Barrick. He also founded the "Bugos Gold Stock Index" which included no more than 10 stocks at any time. From December 2001 to May 2006, his index gained 200%, averaging 30% compounded annual gains. And his index was composed solely of mid to large-cap producers, not the exploration of junior companies. Back to Top | 
