QE or not to QE?

It seems that QE2 will get a serious review during the Federal Reserve’s April meeting, and could be cut short by two months in order to send financial markets the message that they will not allow inflation to get out of control.  This assumption is taken from Federal Reserve Bank of St. Louis President James Bullard, when speaking to reporters in France on March 26, said  “If the economy is as strong as I think it is, then I think it may be reasonable to send a signal to markets that we’re going to start withdrawing our stimulus, and I’d start by pulling up a little bit short on the QE2 program… We can’t be as accommodative as we are today for too long, we’ll create a lot of inflation if we do that.”

So what could happen?

1. Some still believe that QE3 is a distinct possibility, and they have invested accordingly. These investors would be in for a rude awakening if QE2 was cut short – think in terms of Silver investors who bought at the top of the market thinking silver was destined for $50 an ounce. 
2. Others believe that QE2 will continue through to its scheduled June conclusion without any hiccups along the way. This is the more moderate camp who have parked capital in Gold, Silver and Oil, who didn`t buy at the top of the market, but had planned to reduce positions once QE2 ended in June.
3. And there are those that believe QE3 was a non starter, and QE2 would probably finish according to schedule, but wanted to front-run the selling by positioning themselves for the inevitable asset realignment by being in position in late April (after April options expiration for example).

So what should you be watching out for in April? 

1. If more hints from Fed officials regarding ending QE2 early start surfacing in the media, coupled with stronger jobs numbers, then take them as a collective indication that the time has come to cash in on some of the profits from commodity related investments.
2. An early end of QE2 would strengthen the U.S. Dollar on a short term temporary basis, and could bring headwinds to commodity-based currencies such as the Aussie and Canadian dollars.
3. GOLD – if we start to see gold fall under 1400 we may see a reversal to the base around 1320 – 1340 region (which could again be a buying zone) the Gold bull story is far from ending.

Has Reality Changed?

• The change in the Middle East is from some form of government to Chaos. Change in the Middle East is NOT positive for the West, it is a huge unknown.
• The mountain of OTC derivative paper is not going away. 
• Peak Production of Energy is behind us. Peak Oil means Peak oil is upon us. Energy will become scarcer in the future and thus more expensive.
• The Debt in Japan, Europe and the USA is NOT going away but it is getting bigger!  Consider US government revenues of $2.228 trillion (CBO FY 2011 forecast). If rates go up (and they will) 1/3 of America’s current tax take would be spent on INTEREST ONLY!  Take Japan and it could be closer to 70% just to cover the INTEREST ON DEBT!  In Europe we will have act two from Ireland and Greece with likley defaults, then there is Spain and Portugal.

US Housing

Recent reports on home sales and new home construction continue to come in below even the most conservative expectations, which has again led to talk of a double dip for housing. We have consistently downplayed the talk of a double dip because we believe it provides an oversimplified view of the housing market. There is no doubt that housing prices are falling again. Prices had previously been supported by an enormous amount of fiscal stimulus, including tax credits for first-time buyers and trade buyers, tax-loss carry backs for homebuilders, massive purchases of mortgage-backed securities by the Federal Reserve and a whole host of foreclosure mitigation programs by the mortgage providers Fannie Mae and Freddie Mac and the U.S. Treasury. Now that many of these programs have ended or are winding down, home prices are again reflecting the weakened underlying fundamentals, which are dragging prices lower.

Focus on Wind and Solar

Whenever renewable energy is mentioned, wind and solar usually get the attention. Yet, wind and solar, along with biomass and geothermal, fall within the “Other Renewables” category that makes up just 3.6% of U.S. power (See Chart Below). Most countries are similar . . .

So should one add nuclear positions to the Portfolio?  Yes in our opinion.  When is the best time to buy?  When everyone else is selling! That has happened with U308 stocks some fell 50% — huge buying opportunity is at hand. 

YEN?

Well it surged to a record high against the dollar, hitting an all-time peak of Y76.25 on March 16.  The reason why: speculation that Japanese institutions would repatriate funds to deal with the aftermath of the crisis.  The G7 stepped in (first time in over 10 years) to stabilize the Yen and a line in the sand seems to have been drawn at just over 80 yen to the US$  . . . with the massive amount of funds the bank of Japan has put into the market and the massive amount of DEBT the Japanese government will take on to rebuild this should be the turning point or perhaps tipping point for YEN strength. Now is the time to sell Yen and seek reward elsewhere.

GOLD.

Notice the correlation of gold going up as Debt goes up  . . .

While Gold is cheap relative to its inflation adjusted all time high (US$2300), Gold mining stocks are absurdly cheap. How cheap?  The Gold Miners ETF (GDX) reserves roughly $430 an ounce.

Fact: The 25 companies that comprise GDX have roughly 700 million ounces in reserves. And currently the combined market cap of all 25 companies is about $300 billion.

So the market is literally pricing this Gold at $428 per ounce, round up to $430.

GDXJ – the junior gold miners is similar —  

note above: GOLD – if we start to see gold fall under 1400 we may see a reversal to the base around 1320 – 1340 region (which could again be a buying zone) the Gold bull story is far from ending.

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A picture is worth a 1000 words – We will spare readers some of the more violent pictures we have seen of the resulting carnage as they truly are gruesome. But this is giving the markets a scare and will $100 oil cause the recession to resume? Too early to tell but by adding to energy costs, the effect of high oil prices is to reduce the amount of money for spending on other things, thereby undermining aggregate demand in the wider economy. Eventually a tipping point is reached where confidence collapses. Given what happened as recently as 2008, you would expect OPEC to be acting quickly to prevent any further explosive increase in prices.

Is worldwide inflation being casued by US Fiscal Policy? 

Because the US dollar is a reserve currency (approximately 60% of global transactions are denominated in dollars) and the US is printing money to finance its trade and fiscal deficits and many countries peg their currencies to the dollar, which still remains the hub of the global monetary system, US generated inflation is being exported to the rest of the world.  Reckless US monetary and fiscal policy is starting to create unrest in faraway places, as inflationary pressures intensify.

Consider the United States’ balance sheet. The United States is rapidly approaching the Congressionally mandated debt ceiling, which was most recently raised in February 2010 to $14.2 trillion dollars (including $4.6 trillion held by Social Security and other government trust funds). Every one percentage point move in the weighted‐average cost of capital will end up costing $142 billion annually in interest alone. Assuming anything but an inverted curve, a move back to 5% short rates will increase annual US interest expense by almost $700 billion annually against current US government revenues of $2.228 trillion (CBO FY 2011 forecast). Even if US government revenues were to reach their prior peak of $2.568 trillion (FY 2007), the impact of a rise in interest rates is still staggering.

Now think about the rest of the ring of fire.

Japan the “big one” to go next?

Moody’s Investors Service has Feb 21st changed the outlook on the Government of Japan’s Aa2 rating to negative from stable.

The rating action was prompted by heightened concern that economic and fiscal policies may not prove strong enough to achieve the government’s deficit reduction target and contain the inexorable rise in debt, which already is well above levels in other advanced economies. Although a JGB funding crisis is unlikely in the near- to medium-term, pressures could build up over the longer term which should be taken into account in the rating, even at this high end of the scale.

More specifically, factors driving the decision are:

1. The severity and persistence of the shock that the global financial crisis imparted on Japan’s government finances and on aggravating pre-existing deflationary pressures,

2. As a result, the current policy framework will not be capable of overcoming hurdles blocking a return to a path of fiscal deficit reduction,

3. Increasing uncertainty over the ability of the ruling and opposition parties to fashion an effective policy reform response to the debt and growth challenges, and

4. Vulnerability inherent in the long-time horizon of Japan’s gradual fiscal consolidation strategy to worsening domestic demographic pressures, as well as to possible, renewed shocks in a fragile and uncertain, post-crisis global economic environment.

We maintain our positioning stance of long Gold, precious metals, TBT, Uranium and other Energy.

And now a bit of fun coming up;

Ireland Fund of Japan’s annual ball
Saturday, 19th March 2011 at The Westin Hotel, Ebisu, Tokyo from 6:30 PM Till Late
JPY 25,000

Now in its nineteenth year, The Emerald Ball guarantees a wonderful evening of excellent food & drink, great company, superior entertainment, and of course, the Irish “craic”. All of this comes with the satisfaction of supporting our worthy causes.

The funds raised on the night are used to promote arts, education, cultural awareness and community development programs. The Ireland Fund of Japan supports The Japan Helpline, a student exchange program, St. Patrick’s parades in Japan and homeless reestablishment assistance.

Visit them at www.emeraldballtokyo.com Go raibh mile maith agaibh!

Things that could happen   

• A major government will go broke in Europe. Ireland came close. Portugal avoided it (so far). But for Spain or Italy, 2011 could be a fatal year. Expect higher bond yields, a falling Euro, and trouble in the streets.
• A U.S. Debt too far. The U.S. government is rapidly nearing its statutory “debt ceiling.” The Tea-Party Congress may compromise with the President to cut taxes and some spending. But the real crisis may come as U.S. cities and States (Illinois, California, and New York) approach bankruptcy and need their own bailout. Will your portfolio be positioned to profit when that day comes?
• China will tighten up. One of the main recipients of the inflation being exported by the Fed is China. It’s desperately trying to contain that inflation (in food, housing, and stock prices) before it leads to social and political instability. But if it “tightens” monetary policy too fast, it could produce a crash – leading to much lower commodity demand. Something to monitor closely.

Things we think you should do to protect yourself

1. Continue to trade paper money for precious metals and generally reduce your exposure to financial markets. Those markets are badly distorted by Quantitative Easing and government intervention and they carry a lot more risk than reward right now.
2. ONLY buy stocks tied to real asset classes like agriculture, metals, and various forms of energy including uranium. I am NOT bullish on stocks. The ones I do recommend must have an extremely compelling story. 
3. Keep your ‘contrarian hat’ on at all times! Alarm bells should ring when food and fuel prices begin causing governments to topple… and even though stocks have soared since March 2009 many are now massively overvalued. Always and at all times this year – QUESTION what you’re watching, hearing and reading in the mainstream financial media.

Gold 

The key catalyst for Goldman’s suddenly cautious view on gold (which still has a $1,690 price target): the end of QE2 in June 2011. So, presumably, when QE3 is announced in May in order to allow the continued monetization of $4 trillion in debt issuance over the next 2 years, that should be very bullish for gold, yes?

El Nino to La Nina = rising food costs . . .

The changing weather patterns from El Nino to La Nina in the Pacific, however, have been the primary driver for this round as rain patterns change due to a cooling or heating of the mid Pacific.

The world has enough food for its population currently, but after the fires in Russia last summer, the flooding in Australia this winter, and now the on-going drought in China is starting to drain the worlds reserves. If the crops of 2011 are sub-par or worse damaged due to weather related conditions, the planet could be looking at a real famine issue in 2012.

Note: BEIJING – Sunday (31st Jan) was the capital city’s 84th snow-free day this winter, making it the longest winter period without snow in Beijing since records began 60 years ago. And there is no sign of snow falling in Beijing in the next 10 days, which means the city is unlikely to enjoy a “white” Chinese New Year, which falls on Feb 3, according to local meteorologists.

It may have once been said “beware Greeks bearing gifts” today it could be said “beware of New Yorkers offering bonds” and this is indeed backed by history as the boys on wall street blew up the USA selling foreign debt to the retail public so when the debt crisis of 1931 hit anyone who was missed in the stock crash was crushed in the debt crash . . .  sounds like history is rhyming again. 

So what is happening today? Most people missed the equity run from the 2008 lows and many are still reluctant to get in and for good reason now.  Bonds have ridiculously low yields and I believe the debt crisis is coming however this time it is “the big boys sovereign solvency test” when it begins the only place of high ground is precious metals.  The other thing is when it does begin it will be ferocious and very quick so this is why I have a core position in Gold and Silver that I simply hold and do not trade. 

This link is a great reference made by the Economist showing the GDP outputs of various countries compared to its closest US state – click here to see. 

Why is that link important? It raised a question in my mind — Perhaps the only important question for 2011 is will anyone anywhere be spared from wealth destruction as the era of Quantitative Easing implodes?
It is happening already right before your eyes! Exhibit A is the fact that Irish Central Bank is printing money it doesn’t have to make loans that are secured by collateral that Irish lenders no longer possess. Irish borrowers can’t get money from the European Central Bank without collateral. So they’re getting it from the only place left, the nowhere land of fiat money.

If you read the story we’ve linked to at the Telegraph you’ll reach the same conclusion we reached: Europe’s debt problems will result in either default or increasingly absurd (and counterfeit) operations by Europe’s central banks (which were supposed to have surrendered monetary policy to the ECB upon monetary union).

How can a currency retain integrity when anyone can get permission to print more of it when times get tough? This is surely a sign that at some level, the Global Financial Crisis that began in 2007 is about to resume again. For 29 months the central bankers of the world have managed to prevent a reckoning with more loans secured by more questionable collateral. Is financial entropy beginning to reassert itself? 

Here in Japan we certianly do not see inflation why?  There is absence of inflation due to weak domestic demand but also rising currency: when the Yen softens, prices of imported goods will have to rise.  Infaltion however is being seen in other smaller countries I am sure you will see more rioting in 2011 on rising food prices – this is not simply an “Africa thing”  the next test will be in South East Asia and once infaltion takes hold it will spread.

The various powers at be tell us there is no inflation . . . Fiction: In this 60 Minutes clip Bernanke tells Scott Pelley, “The other concern I should mention is that inflation is very, very low…”

Fact: There is massive inflation!

Fiction: ‘Unemployment is 9.8%, if we didn’t take these drastic measures it would be 25% like it was during the Great Depression.’

Fact: Unemployment is, once again at “depressionary” levels – pushing 25%.

A Mess?

“By looking at Japan in the 1990′s and early 2000′s we can see the results of a Keynesian solution to a set of facts almost identical to our present situation. The “solution” caused a 15-year (1990–2005) stagnation of the Japanese economy. …

Here’s the Japanese experience which is startlingly similar to our present situation.

1. They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987.
2. Real estate and equity prices soared.
3. To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
4. The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
5. GDP grew at only 1.17% from 1992 to 2003.
6. Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
7. Consumption and investment fell dramatically.
8. Banks were not lending.

What was the response of the government to this crisis?

1. In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
2. From 1992 to 1995 they spent 65.5 trillion yen on projects and cut taxes.
3. In 1998 they cut taxes 2 trillion.
4. In 1998 they spent another 40.6 trillion on spending stimulus.
5. In 1999 they spent another 18 trillion in fiscal stimulus.
6. In 2000 they tried another 11 trillion spending package.
7. They set up a 20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
8. To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of 2.22 trillion.
9. Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
10. They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.

It is estimated that the Japanese spent about $1 trillion about (\135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP, and the yen devalued. Nothing seemed to work.

Remember some of the hallmarks of the Japanese experience? “Zombie Banks” were banks that the government allowed to keep their doors open although they were really insolvent. “Zombie Corporations” were the companies whose debt were held by zombie banks, but were allowed to stay in business because the zombie banks didn’t write off these loans. “Window sitters,” a term applied to workers of zombie companies who showed up for work every day for a paycheck, presumably gazing out the window all day with nothing to do.

The irony of it is that they are trying the same things again in this crisis, with the same results. The Bank of Japan just predicted two years more of deflation, and unemployment is up to 5.5%. Exports, the mainstay of their economy, are falling off a cliff (11 straight months of decline). It reminds me of a definition of insanity: expecting a different result to occur from the same input, over and over again.

Does the Japanese scenario sound familiar? It should since the USA is doing most of the same things as they did.

1. The Fed reduced the Fed Funds rate to 0.25%.
2. The government has hugely increased the base money supply in an attempt to create inflation.
3. The government has spent or pledged about $2.7 trillion dollars in direct loans, bailouts, debt purchases, grants, and wasteful spending projects.
4. The guarantees to Fannie, Freddie, Sallie, and the FHA, plus additional backstop guarantees by the Fed and the Treasury amount to almost $10 trillion.
5. The Obama Administration expects the national debt is to increase by almost $10 trillion over the next 10 years (a very conservative number considering the new national health care plans). This will get us to a national debt of about 200% of GDP.
6. Programs like Cash for Clunkers, Cash for Refrigerators, and Cash for houses are trying to stimulate consumer spending and increase consumer debt.
7. Like Japan, mark-to-market accounting requirements for banks have been partially suspended.
8. The Fed has been directly financing corporations through its commercial paper lending window.
9. TARP, TALF and the host of other programs were implemented to keep bankrupt institutions afloat.
10. They have been buying stock in financial and commercial companies.
11. They have been buying U.S. debt, effectively partially monetizing the deficit.

It is not surprising that these policies have led us to many of the same results as Japan experienced:

1. Deflation.
2. Collapsing real estate values.
3. A shrinking money supply.
4. Decreased bank lending.
5. Falling consumer spending.
6. Falling consumer credit.
7. Increased federal debt.
8. Falling GDP.
9. High unemployment.

One might ask, with all this faith in Keynesian policies, why aren’t they working? And, why aren’t we doing something different than Japan?

The reason the economy is not responding is that there is too much bad debt sitting on the books of lenders and companies.  Most of it is related to the real estate bubble: home mortgages, commercial real estate loans, consumer debt, and the derivatives and other products that sit on top of it.

Banks are afraid to lend or foreclose on bad debt unless they are forced to because they know they will need to come up with additional Tier 1 capital because their capital base is insufficient. Because credit is tight, home owners are finding it difficult to refinance their loans because of stricter underwriting standards while home values are falling. CRE loans are even more difficult because commercial financing has largely dried up for troubled projects.

And, consumers aren’t borrowing because they are (i) afraid of their economic future, and (ii) the big spenders, the Boomers, don’t have enough saved up to retire, so savings are going up.

This is why banks aren’t lending.  As a result, money supply is falling. This will continue until the debt situation is resolved, but the government is doing everything it can to frustrate these corrections because they know the cure (tight money) will cause more banks and business to fail. But unless the debt is removed, liquidated, or paid, banks will remain zombies.

If we are following Japan’s remedies, will we experience Japan’s economic results? This depends on a lot of factors, mainly how the government reacts to economic phenomena. But, all things being equal, I think there are several key differences and similarities between the U.S. and Japan that will determine a different outcome.

Bernanke will teach the Japanese a lesson in the proper way to run and economy? He will pump money until we have inflation because he fears deflation more than inflation. Because he doesn’t understand the real lessons of Japan, we will have stagflation, and his successor will probably try the same failed remedies to save us from that too.” By Jeff Harding

It will be a mess . . .

However let’s look at one example that is current and seems to have worked – Iceland!

You may remember, two years ago Iceland was a mess. Its banks had borrowed, lent, and speculated recklessly. At first, the government decided it would do what Ireland was doing. It would rescue the banks…that is, it would bail out the banks’ lenders with public funds.

But when the public caught on to what was going on, a referendum was held. Voters rejected the bailout, more than 90% of voters cast ballots against a taxpayer bailout. Unable to stick the voters with the losses, the government left the banks to default.

Was this the end of the world? Did Iceland slip below the North Atlantic waves…joining the Titanic on the chilly, dark bottom of the sea? Did commerce break down? Did the Icelandic money become worthless?

Nope.

“Iceland is faring much better than anybody expected,” reports Bloomberg.

Inflation fell from 18% down to 5% last year. The cost of insuring Icelandic debt fell to less than a third of the price in early 2009. Unemployment is barely 6%.

“Thanks to its rescue plan,” says the IMF, “the recession in Iceland has been less deep than expected and not worse than in the other countries deeply affected.”

The IMF in my opinion is taking glory for doing nothing!

As no one would lend Iceland any more money. And once the public revolted, after realizing that it would be left holding the bag, the Icelandic feds had no choice. They were forced to go with the following;

1. The foreign debt was consolidated into a few banks…which then went broke.
2. The remaining banks were left intact, ready to keep the country’s financial machinery in business.

Lesson learned: got too much debt? Default quickly. Make it clean. Make it fast. Make it work.

Somehow I doubt the Europeans and the Americans are going to take this route, that is until the market forces this outcome . . . time will tell.

The sinking ship of Japan

The Fed does not hold a monopoly on policy mistakes. On that account, Japan is in a league of its own, although many other countries are doing their very best to catch up. The Japanese combination of very high debt levels combined with outright deflation is a lethal cocktail, and one which the Americans are clearly desperate to avoid. I have borrowed two charts from Dylan Grice at SocGen to illustrate the enormity of Japan’s fiscal problems. Almost 60% of its tax revenues now go towards servicing its rapidly growing debt (see chart 1 below) and tax revenues no longer cover even the bare necessities – debt service, social security and education (see chart 2).

1. 1.       Debt Service in Japan

Source: SocGen Cross Asset Research, Japan’s MoF

With the savings rate in free fall, and with record low bond yields, how much longer can the Japanese finance their debt domestically? Eventually, when they have to go to international capital markets to fund their out-of control deficit, will there be any buyers of 10-year JGBs at 0.95%? I very much doubt it. On that account, I have noted that the tide has already turned. As you can see from chart 3, there has been a substantial capital outflow from Japan this year.

1. 2.       Tax Revenues in Japan

Source: SocGen Cross Asset Research, Japan’s MoF

You may ask, if investors are fleeing Japan, why is JPY not weakening? I only know one possible explanation (courtesy of Morgan Stanley). Much of the capital which is leaving Japan is finding its way into US Treasuries, and most of those investments are fully hedged, which neutralizes the effect on the currency. In short, when you take money out of Japan to invest in the US, you sell JPY against USD; when you subsequently hedge your currency risk, you sell USD against JPY.

Chart 3: Japanese Resident’s Activity in Foreign Bonds

Source: Morgan Stanley, Japan’s MoF

But the conclusion remains the same. If (when) there are no longer enough investors to buy the JGBs, or if (when) Japanese investors stop hedging their currency exposure when investing abroad, the pressure on JPY could become immense.

So get out of Yen while you can at around 80!

RMB Currency Trader. And I quote:

The Land of the Rising Sun has the dubious distinction of sporting the highest debt-to-GDP ratio of any industrialized nation in the world. Now greater than 200%, Japan’s relative debt load is bigger than that of Greece, Spain, Portugal or the US. Japan needs to borrow over 50% of GDP this year just to stay afloat, according to the International Monetary Fund (IMF), and its financing needs are expected to reach almost 60% of GDP next year. (See graph below.) Its strength has been somewhat befuddling, especially considering this growing burden of debt.

Why has the Japanese currency been so strong? Because despite all of the yen’s problems, Japan runs a trade surplus. Traders view that surplus as a source of funding which can be used to pay down Japan’s skyrocketing debt, making the yen seem like a “flight-to-quality” currency despite appearances. However, Japan’s strong currency is beginning to affect Japan’s ability to export. Competition from China and rising Asian powers such as Vietnam is also beginning to take its toll. Japanese industrial output fell 1.9% in September after dropping 1% in August.

To remind you why you should hate the Japanese currency, I’ll refresh your memory with this short list:
* With the world’s weakest major economy, Japan is certain to be the last country to raise interest rates.
* This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets.
* Japan has the world’s worst demographic outlook that assures its problems will only get worse. They’re not making Japanese any more (well just not very fast).
* The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt approaching 225% of GDP,  Japan is at the top of the list.
* The Japanese long bond market, with a yield of a scant 1%, is a disaster waiting to happen.
* You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country’s beleaguered exporters.

When the big turn is inevitably confirmed, we’re going from ¥83 to the initial target of ¥85, then ¥90, ¥100, ¥120, eventually ¥150

Make sure you have Your Own PERSONAL pension plan!

The Toronto Sun reports, Canadian Feds have $65B pension funding shortfall:

The federal government has underestimated its employee pension obligations, exposing taxpayers to a $65 billion shortfall, according to a new report released Thursday by the C.D. Howe Institute.

Using fair-value accounting, the measure used in the private sector and based on solvency, the think tank calculated Ottawa’s net pension obligation stands at nearly $208 billion. That’s $65 billion more than reported in the public accounts.

The government lists its unfunded liabilities in the country’s national debt at $143 billion.

Taxpayers could be on the hook to back-fill the funding gap, the report by Alexandre Laurin and William Robson said.

On top of that, large exposure to public sector pensions could fuel fears of sovereign default driving up the cost of borrowing.

“The larger-than-reported gap between federal pension promises in these plans and the assets that back them is a problem, both for federal employees and for taxpayers,” the pair said.

But Canada is not alone. European and U.S. governments share the problem. The United Kingdom for instance is facing a $1.8 trillion shortfall and the U.S. has $3 trillion.

GOLD;

Personally I think we are only in the early stages of the mania phase, and this phase could last many, many years dependent upon the unparalleled consistent stupidity of regulators and rulers.

The Nasdaq chart on the left is a 12 year chart while the Gold chart is a 10 1/2 year chart. Both charts are monthly.  The point in making both charts monthly is that you, I and everyone else can clearly see there is nothing close to even the beginnings of a blow-off top in Gold yet.

Give us a call on which gold fund is the best to invest in . . 03 5724 5100

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QE2 and then what?

I am still struggling as to how the Fed and/or the rest of the authorities are convincing the market on the effectiveness of further Quantitative Easing. As I commented before, it is not the price of credit, but the availability of credit is the key to an economic revival. I would take that statement a couple of steps further. The Fed can print all the money they want, but I highly question the consequences of their programs. If the money they print just piles up in the corner or it is invested in Treasury Bonds, it will not achieve any stimulus for the economy. It is preposterous to think that more credit, leverage and loose monetary policy will get us out of the mess that was created by too much credit in the first place. It was weird to see that a couple of Fed officials seem to actually agree with me.

From a fiscal point of view, of the 50 US states, we really have 20 Portugals, 10 Italys, 9 Spains, 5 Irelands, 5 Greeces, and only 1 California. And according to the International Monetary Fund, Japan’s debt accounted for 218.6% of its 2009 gross domestic product, making it the largest public debt of all industrialized nations.

 Whohoo!  GOLD  — time to BUY more! 

ALL US HOME OWNERS with a Mortgage should read this: Wondering if you are one of those paying a mortgage in limbo, with all the payments due to some non-existent mortgage note holder getting retained at the servicer banks? Well, if you can spare 3 minutes then “Where’s the Note” is for you. The website, which is on the verge of a viral break out, has a simple message: “Whether you are facing foreclosure, have an underwater mortgage, or are just a concerned homeowner, it’s important that you contact your bank and demand to see the original note on your mortgage.It only takes a few minutes using our free online tool.” Quick, simple and easy. And in a few days your mortgage bank will have no choice but to tell you if they do in fact have your original mortgage note. And if not – welcome to cost-free living, courtesy of MERS and millions of rushed and fraudulent mortgage note assignments. Yes, it will mean the end of the GSEs, but it will also mean the accelerated write downs on thousands of MBS tranches which will rapidly collapse into insolvency (there is only so much Mark to Unicorn can cover up) and eventually take the insolvent banks with them.

Mortgage Math

Some people save up their whole lives in order to have $50,000 to put down on a $250,000 home with a $200,000, 30-year mortgage at 6% so they can make 360 monthly $1,200 payments ($432,000) while maintaining the home and paying all the taxes on the land.  If they pay nothing to repair the home and just $5,000 in taxes that’s still $1,600 a month plus the $50K down.   You can play with these figures as they apply to you using this nice Bankrate Mortgage Calculator and this Compound Interest Calculator. 

If those same people could find a place to rent for $1,200 a month and put the $50K + $400 a month into something that just made 5% a year, they’d have $550,000 at the end of 30 years.   That’s at 5% compounded once.  If they got the 8% historical stock market average,  that would be over $1M!  A lot of people today have homes since the 70s that haven’t doubled, let alone gone up 4 times and I’ll bet they spent a good $2K a year on repairs minimum.  Another $200 a month added to the $50K at 8% is $1.4M after 30 years.

Another look at housing: Let’s back up for a second and review where the great bull market of 1950-2007 came from. That’s when a mere 50 million members of the “greatest generation”, those born from 1920 to 1945, were chased by 80 million baby boomers born from 1946-1962. There was a chronic shortage of housing, with the extra 30 million never hesitating to borrow more to pay higher prices.

Since 2005, the tables have turned. There are now 80 million baby boomers attempting to unload dwellings on 65 million generation Xer’s who earn less than their parents, marking down prices as fast as they can. As a result, the Federal Reserve thinks that 50% of American homeowners either have negative equity, or less than 10% equity, which amounts to nearly zero after you take out sales commissions and closing costs. That comes to 70 million homes. Don’t count on selling you house to your kids, especially if they are still living rent free in the basement.

The good news is that the next bull market in housing starts in 20 years. That’s when 85 million millennials, those born from 1988 to yesterday, start competing to buy homes from only 65 million gen Xer’s. By then, house prices will be a lot cheaper than they are today in real terms. The next interest rate spike that QEII guarantees will probably knock another 25% off real estate prices. Think 1982 again. Fannie Mae and Freddie Mac will be long gone, meaning that the 30 year conventional mortgage will cease to exist.

Isn’t this getting interesting?

If I couldn’t talk you out of buying that home and saving the extra money, I hope at least I have led you to consider buying a more affordable home and saving that extra money. 

And by the way, for all you parents out there, please consider putting $800 a month into your child’s account from the day they are born.  Saving $9,600 a year for 30 years gives them a nice $1,293,820.58 to buy their own first home with (or deposit for the next generation if, hopefully, they don’t need it).  With an 8.5% annualized return, putting just $300 a month into your child’s account until they are 18 gives them $153,595  for that first car (or one hell of a prom night!) or help going to university!  

Teach your children well and perhaps when they turn 18 you can arrange to match them 2:1 and they come up with $150 and you with $300 and you maintain that deal for 12 more years.  Using the Calculator, put the $153,266 as an initial deposit and add $5,400 a year ($450/month) for 12 more years at 8.5% and what do we get?  $523,360.75 to get your kid or grand-kid started in life at age 30.  All you have to do is commit yourself to $300 a month and, aside from the cash, perhaps you will also teach your children a very valuable life lesson in investing that will be passed down to generations of wealth builders in your family.

Call Banner today we can help 03 5724 5100

Long Term Yen: Having broken out of the symmetrical triangle in November 2008, the Yen has produced a more lethargic rally than those seen in the second half of the 1970’s, 80’s and 90’s. The April correction even managed to violate the rising parabolic index. Naturally, the high Yen makes it more and more difficult for Japanese goods to remain competitive and this is invariably helping to keep a lid on the currency. From a purely technical perspective, the currency is back challenging the best levels of December ’08 and ’09 and forming a new ‘ascending triangle’. A move through the resistance would set the stage for strength into next summer. This timing is based upon the fact that the three previous rallies took 34 to 36 months from the low prior to the breakout. However currencies have a way of surprising us and we could very well peter out here at the low 80 level the chart below show this in reverse so the 120 level could very well be the end and we will start to see a multi month reversal in the yen, we are close to the top.

Please have a look at this Yen Aug 2010 to 2011 

GOLD  

Long term I do not believe the market has topped. For one thing let’s consider other commodity markets’ tops, whether it’s gold in 1980, crude oil in 2008: the last wave up is always the steepest as wave 5 of a commodity rally is always driven by panic due to lack of supply. There are fears in the market, but I don’t think we have seen panic at all. Panic will come after the Euro is disbanded, if Japan defaults, or the USD loses 10% in one week, but certainly not on fear of inflations with a CPI which is still going to be negative YoY by December (I do not give any credibility to CPI when it comes to measuring real inflation, but it’s the benchmark…).

Support is at hand time to start adding a bit more to the gold holdings  . . . 

Quote of the month: Bob Hoye

“In noting the exceptional corruption of central banking, it is always ironical to consider that in this bizarre financial world the worst thing that can happen is an “outbreak of sound money”. 

China

Of the Middle Kingdom’s 1.3 billion citizens, only 60 million earn a $20,000 middle class annual income, while 440 million make $3-$6/day and 600 million take in under $3/day.

S&P

Think we are going lower . . . say 800 on the S&P ?

Is it Time?

Shorting the world’s most overvalued asset, the 30 year US Treasury bond, should be the big trade from here. What will be different with this meltdown is that it will be the first collapse in history of a bond market in a non-inflationary environment.

It is not soaring consumer prices that will execute the long bond. It will be the sheer volume of debt issuance. The Federal Reserve have to sell nearly $2.5 trillion of debt to cover a massive budget deficit and refund maturing paper, easily the largest cash call in history. Bring in a double dip recession and a second, larger stimulus package, and those numbers take off considerably.

Pile on top of that trillions more in offerings from states and municipalities that are also hemorrhaging debt issuance. By the end of 2010, total government debt from all sources will rocket to a staggering 350% of GDP. Throw in private debt requirements, like the rolling over of a trillion dollars worth of commercial real estate financing and your garden variety corporate offerings. The rush to borrow has started overseas too, with hundreds of billions of dollars more in Eurobonds floated by cash strapped sovereigns like the PIIGS. It’s clear that the bond markets of all descriptions are going to become very crowded places, driving rates irresistibly higher.

At some point, the world runs out of buyers, and the long bond yields will begin their inexorable climb from the current, ridiculously low 4.10% to 5.5%, 6%, and higher. Even Moody’s is talking about a ratings downgrade for the US debt, not that we should give that disgraced institution any credibility whatsoever.

ProShares UltraShort 20+ Year Treasury or TBT is a 200% bet that long bonds are going down. It has clawed its way back up from $34.80 to $37.15 since has fallen to a low of 29.77, compared to the $70 it traded at in 2008. Falling interest rates have a silver lining in that the annual cost of carry for this leveraged ETF has dropped appreciably, from about 10% to around 8%.

If short interest rates double from the current levels, a virtual certainty, so does America’s debt service, from the current 11% to 22% of the budget. This could happen as early as 2014.

If I’m wrong on this and the 30 year yield surges under 2.5% in some sort of second Great Depression scenario, the TBT will drop down to the mid $20’s. If I’m right, the final target could be as high as $200, when long rates top 13%. That’s where they were in 1981. If you want more then take a look at the 3X short ETF (TMV) with its higher cost of carry.

Let me run some numbers here. If the yield on the 30 year Treasury bond runs up to last year’s low of 3%, the TBT will fall to a new all time low of $27. If I’m right, and we move back up to the 2010 high of 5.05%, the TBT pops back to $51.50. Running a downside risk of 11% to capture a potential gain of 68% sounds like a pretty good risk/reward ratio to me. But it might get better. Don’t forget that our long term, multi-year target for this ETF is $200.

If the futures players get this right, a move in the December long bond (ZBZ0) on the CBOT from today’s high of 134.5 to this year’s low of 111.50 multiplies your minimum margin requirement from $3,375 to $23,000, a 6.8 fold return.

But wait, there’s more! If you don’t feel like making big bets until you figure out what the new normal looks like, try a limited risk position through the TBT options. The March $30 strike calls are trading at $4. A run up by the ETF to this year’s high puts these babies at $21 at expiration, a net profit of $17, a gain of 425%.

I’ll tell you some key targets to watch for to determine the timing on this: when the yen approaches \80, the S&P 500 touches 950, the 30 year yield tickles 3%, and the ten year yield slams into 2%, it will all be over but the crying. I’m still keeping my powder dry for taking another shot at this trade, but my trigger finger is getting mighty itchy.  So is it time, no not yet but it is something to watch as this will be a great trade at the correct entry point. . . which is coming soon.

RARE EARTH METALS:  

Bloomberg reports that China is cutting back 72% of its exports of Rare Earth metals. China has said that environmental issues are the reason for the cutbacks.

72% drop in availability of any commodity is important. RE’s are important. I am no expert in this but I believe that RE metals are needed in most things we make and consume. From cars to cell phones. Some more informed comments on the importance of RE would be most welcome.

Japan and the US are already protesting the ban. The rest of the world’s manufacturing base will soon follow. This could become an interesting row.

And all those folks were saying that China would be the world’s economic growth engine. Humm not so sure.

 Call to find out how these can all be added to your portfolio 03 5724 5100

There is an old saying on Wall Street that the market is driven by just two emotions: FEAR and GREED. Although this is an oversimplifica­tion, it can often be true. Succumbing to these emotions can have a profound and detrimental effect on investors’ portfolios and stock markets worldwide.

Warren Buffet is a great example of how to avoid these two emo­tions in our investing decisions and has two great quotes regarding this topic that I think are very appropriate, given our current market conditions.

The first quote goes like this:  “Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market.”

And the second one:“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

Deflation Next?

One of the concerns of both the financial markets and the Fed is the prospect for near term deflation in the economy.  Deflation can occur when consumers begin to forgo current consumption due to their expectation that prices will fall in the future.  This in turn can lead to lower investment by companies that refuse to commit capital to their businesses because of their expectation of a low rate of return due to lower prices.  This creates a vicious cycle of both falling consumption and falling investment known as the “deflationary spiral.”  This cycle can become very difficult to break out of once it takes hold, as evidenced by Japan in the ‘90s.  The Fed clearly understands this and the potential downside risks of deflation.  In addition, the market will begin to look for signs of deflation and will anticipate steps that the Fed will need to take in order to prevent it.  This, we believe, is one of the reasons why the U.S. Treasury market has rallied so strongly and will continue to do so in the near term.  While the initial move in May could be attributed to a short term flight to quality, the most recent move lower in yields appears more long term in nature.  One explanation for this is that the market is becoming aware that the economy may be entering a deflationary spiral and that the Fed may move long term rates lower through additional Quantitative Easing (“QE”).  Since short term rates are already hovering near zero, QE is one of the few mechanisms left that will allow the Fed to provide further monetary stimulus.

Global Warming

NASA has found that methane is 33 times more potent than carbon dioxide in causing global warming.

Many scientists have said that methane releases have caused past warming spells. See this, this, this, this and this. Indeed, methane has such a powerful effect on climate that scientists believe that woolly mammoth farts gaseous emissions are responsible for warming the Earth 13,000 years ago.

Guess what is streaming into the Gulf of Mexico along with the OIL. . . Tremendous quantities of methane are being emitted by the Gulf oil spill.  The methane could kill all life in large areas of the Gulf. However, rumors being spread widely around the Web claiming that the methane could bring on a doomsday catastrophe are not credible. 

Yet . .  only time will tell.

     if you have Yen sitting in the bank, it is time to move and take advantage of the current exchange rate  . . . call 03 5724 5100 we can help.

The market in quick format:

Gold ETF GLD – Daily Chart
Gold has formed a large cup & handle pattern. It has held up well during the recent weakness.

But zooming into the intraday charts I do have some concerns about a sharp sell-off in the very near future.

 Silver ETF SLV – Weekly Chart
This is a weekly chart and goes all the way back to 2008 showing a very large cup & Handle. We could technically still see silver trade sideways for several months before it reaches the apex and is forced to breakout in either direction. The upside potential for a cup and handle pattern is 100- 300% of the height of the cup. So this means $1450 gold and $29 silver using the minimum potential.

Crude Oil Fund – Weekly Chart
Oil formed a triple top over the past 10 months and has started to head south. We have seen selling volume drop during the test of resistance which is not a good thing.

SP500 ETF SPY – Weekly Chart
The SP500 along with several other indexes have formed a head & shoulders patter and appear to be in the process of breaking down through the necklines. If this unfolds then we are looking at much lower prices for stocks.

 Get in touch if you have any questions 03 5724 5100

Ever Wonder…

Why the sun lightens our hair, but darkens our skin? Why is lemon juice made with artificial flavor, and dishwashing liquid made with real lemons? Why is the time of day with the slowest traffic called rush hour? Why is it that doctors call what they do “practice”?  Why don’t sheep shrink when it rains? Why isn’t there mouse-flavored cat food?  Why are they called apartments when they are all stuck together?  If con is the opposite of pro, is Congress the opposite of progress? If flying is so safe, why do they call the airport the terminal?