Sunday, September 13, 2009
When There's No One Left to Trust
Fraud and corruption are being exposed at the highest levels of our financial markets. The integrity of our so called "free" markets has been badly damaged and rightly so. The cover up, fraud and deceit have reached biblical proportions.
When the government decides to intervene on behalf of certain market participants and ignores its own role in the previous bubble and its subsequent collapse, a dangerous precedent is set that destroys trust. When trust breaks down, paper assets become worth less in the eyes of those with money to invest and people turn to reliable asset classes like Gold instead. So far, nothing has been different this time around - history is repeating right in front of our eyes. The old shiny "barbarous relic" is the best performing asset class of the past decade with no end to the Gold bull market in sight. Gold has outperformed Buffett and Gates combined over the past decade by more than a country mile and will continue to do so.
Fannie Mae and Freddie Mac and their willful support of a housing bubble that kept housing unaffordable for most citizens, the Madoff scandal (keep in mind this guy was the chairman of the NASDAQ stock exchange and the SEC willfully ignored obvious evidence of blatant ongoing fraud), bailing out auto companies while trampling on the right of creditors and ignoring our bankruptcy laws and procedures, Hanky Paulson and his looting of the U.S. Treasury, Geithner not paying taxes he knew he owed (he ain't that stupid even though he seems like it sometimes), AIG executives partying in expensive hotels with taxpayer bailout money, the FDIC ignoring obviously insolvent banks and thus increasing taxpayer expense when they finally take over a bank, the SEC banning short selling in its favorite firms while ignoring the fact that its favored firms have illegally used naked shorting for years as a tactic to destroy small firms, etc., etc.
There will always be fraud in financial markets and government. But it has reached a feverish pitch at this time precisely because the secular credit contraction has begun and is now revealing who has been swimming naked. Unfortunately, the government is rushing to put a towel around the biggest and worst offenders, including itself. These are secular sign posts that indicate a long-term change is now well-entrenched: a lack of trust in "the powers that be."
What the government is trying to do is to delay and prolong the pain so that it can be taken over a decade or two instead of letting the chips fall where they may. The common concern is that if free markets were allowed to do their job, then the system would implode and collapse. This, of course, is ridiculous and is why the last U.S. economic depression lasted 15 years instead of 5.
But our government has gotten so large and all-encompassing that it demands to control everything. If prices go up, ban investment and chastise the speculators. If prices go down, ban and chastise the short sellers. If spending doesn't fix things, spend more then act shocked when the deficit comes in at levels higher than expected and raise taxes. If foreclosures get excessive, ban foreclosures. If industries fail, take them over and pretend you are going to make them stronger. If some firms are succeeding despite all the obstacles presented by our regulatory and taxation system, over-regulate them and increase their taxes to help out the firms that are struggling. And if none of this works, label the groups that annoy you or get in your way as "suspicious" or "unpatriotic" - maybe even throw around the "terror" word a little.
Government is a parasite on the economy. Parasites cannot succeed if they kill the host. And yet, the government is killing its economic host, the U.S. economy. The same thing happened in the 1930s in the U.S. and in Japan in the 1990s. It's not the end of the world and it's not doom and gloom, but it does create hard economic times for those not suckling on the government teat.
Stocks and corporate bonds do not thrive in such an environment. Stocks are dead for the next decade as a buy and hold investment and should be avoided unless one is a trader ready and able to play the swings. Because real estate is in a popped bubble, it is a lousy investment for at least the next 5-10 years. Commodities do poorly during a weak economy, which we undoubtedly have, unless one's thesis about rapid currency debasement is correct (i.e. the inflation vs. deflation debate).
When trust breaks down there are few places to hide. Gold and Gold stocks thrive during such times. This is not a 2-3 year general stock bear market and then we return to "the good old days" of a secular bull market for the ages (i.e. 1982-2000). This secular stock market bear has legs and needs ample time to complete. An historic 18 year stock secular bull market requires at least 12-15 years to correct. The "peek-a-boo" plunge below the 2002-3 lows in the major U.S. stock market indices was not a one time event, it was a preview of things to come.
The Dow to Gold ratio is a way to measure these "big picture" swings in the stock market from secular bull through secular bear. The Dow to Gold ratio will reach 2 and may well drop below one during this secular bear market. This is how much damage is required before people will put their trust back in paper promises made by financial markets and the government. In other words, such asset classes backed by paper will need to become this cheap before a new bull cycle in paper assets can occur. The government will fight tooth and nail to prevent this paper decline (because those backing the paper filled campaign coffers with contributions the last election cycle), which will only prolong the agony and not change the ultimate outcome.
We are now entering the hard phase of a Kondratieff Winter, a cyclical phenomenon that is alive and well. The debt must be defaulted on or paid down. The fraud must be purged. Gold must be restored to the center stage. A debt-free asset that requires no trust or economic activity, Gold is not increasing in value and never really does. It is the value of other things that fluctuate relative to Gold. Right now, paper promises and asset prices are collapsing all around Gold because those who stand behind the paper promises have lost the trust of the marketplace.
Once trust is lost, it takes a long time to restore. The only real question for those who understand such long-term cycles and don't want to trade the shorter time frames is what form of cash to hold to help weather the storm. This is the only importance of the deflation versus inflation/hyperinflation debate. Cash is king in this environment as it will outperform stocks, real estate and corporate bonds. I choose Gold as my cash because it is reliable and I live in the United States. Typically, the greatest debtor nations are at greatest risk of currency debasement/capital flight when paper promises crumble during a Kondratieff Winter. Though I could be wrong, I believe this leaves the U.S. Dollar and British Pound suspect over the longer term (I remain intermediate-term bullish and long-term bearish on the U.S. Dollar).
But in reality, the bigger overarching theme that makes this longer-term cycle just a little different than some of those in the past in the presence of an anchorless global fiat monetary system created by the U.S. when we defaulted on our Gold promise and quasi-Gold standard in 1971. I believe Gold will outperform all global currencies for the foreseeable future until this glaring monetary deficiency is corrected.
Gold will survive this mess (and the next) because it has served as money on and off for thousands of years. It will increase in value relative to stocks, corporate bonds, real estate and commodities at least until the Dow to Gold ratio reaches 2 (and quite possibly less than 1). Those betting against this long-term trend fail to understand history and why this cycle will inevitably recur. And as long as there is fiat money backed by nothing but the foul breath of costumed apparatchiks and a private, non-federal, for-profit federal reserve bank corporation, the swings in this Dow to Gold ratio will continue to get wilder and wilder.
This is why major central banks and governments around the world know to hold some Gold and keep it listed on their balance sheets as money. And this is why I recommend people invest at least some of their money in Gold stocks, as the firms that dig money out of the ground when cash is hard to come by will be handsomely rewarded. When there's no one left to trust with your money, turn to Gold.