Monday, August 31, 2009

The Bond Market is Not Stupid

and it's not pricing in inflation. I watch the 1-2 year yields and 90 day T-Bill. If the yields on these instruments continue to fall, the stock market will follow. Here's a 2 year daily log scale linear chart of the 2 year U.S. Bond yield:

A 2 year yield of less than 1% means the bond market is fully discounting deflation. Sure, the bond market could be wrong. But they've been right so far throughout this bear market. And the 1 year yield has already broken down (2 year daily log scale linear chart):

I think da big boyz are starting to scramble for the exits and are moving into liquid short-term U.S. government debt. This is not a good sign for the bulls. Maybe the bond market is wrong and is about to do a 180 degree turn the other way, but then again, maybe not.

Sunday, August 30, 2009

No, Your Government Will Not Do the Right Thing

I have accepted this and understand it better now that I have reviewed some historical cycles and seen the previous mistakes that governments around the world are repeating through the current economic mess. What is needed is a return to fiscal sanity. No more debt, no more profligacy, no more making promises that cannot be kept.

But, alas, the opposite is what will occur. Government will rush to "fill the void" left by tapped consumers (i.e. citizens). Our government (and most around the world) will borrow even more money than it already has to "stimulate" us. More needless war, more "cash" for goods programs, more "new job" creation, etc., etc. Of course, none of it will do anything but make for a few lousy campaign slogans and drive a stake through the heart of the productive economy. Keynesian economics is blasphemy and an insult to common sense, but it persists because it allows governments and their central bankstas to maintain and expand their power.

I love charts because I think they can sometimes show things in a precise and eloquent way. Here's what we have to look forward to in terms of the personal and government debt picture in the U.S. over the next 10-20 years, based on what Japan is still going through now (data chart from Bank of Japan):

The time frame of interest in the chart above is 1990 (when their stock and real estate bubbles popped and caused a secular credit contraction) through now. The key point is that individuals will start to de-lever (and deliver) soon, whether through savings and paying off debt or defaulting on it. Government will get the country further into debt, working against their citizens by "stimulating" them and their economy. But eventually, the efforts of the citizens of the U.S. will cause our scary debt to GDP chart to decline and once we can get it to decline enough (which will take 10-25 years), a new secular bull market and credit expansion can begin. Of course, this is a painful, long process and economic growth will be anemic throughout the next decade or two while citizens gradually win the war against their government to reduce debt and restore economic health.

There will be cyclical stock and commodity bull markets throughout the now well-entrenched secular bear market, but until that debt to GDP ratio gets back to under 150% or so, there will be no new secular bull market in equities or commodities. The stock market peak in the 1929 Dow Jones Industrial Average was eventually bested - it's just that it took until 1954 to do it. If our government hadn't created "New Deals" to force citizens to borrow more money "for their own good," it might have only taken a decade to make new highs. Japan's stock market peaked in 1990 and they are still 70% below those highs almost 20 years later!

So, no, our government will not do the right thing. They will get us further and further into debt with "guns and butter" programs and policies while most of those of us spending only our own money will tighten our belts and try to reduce debt. The government will be working against the economy and its productive citizens every step of the way. It is frustrating to see the same insanity tried again and again by policy makers when history has already shown that every single time it is tried it doesn't work and in fact makes things worse.

Fortunately, there are some places one can make money in such an environment. The best thing to do for the average investor looking to take a reasonable speculative risk is to buy a basket of Gold mining stocks after the next stock market dive (but not yet). You see, Gold stocks have a way of doing well during decades when general stocks do poorly. It has been true during the 2000-2010 decade and it will be true for the next decade as well.

I continue to wait patiently for a bottom in senior Gold stock indices. I was hoping to not have to wait this long, but I know that this patience will be rewarded. Buying high is not a good option while in the middle of the worst cyclical general stock bear market any of us will likely see during our lifetimes.

Saturday, August 29, 2009

The Power Of The fed And Deflation

The non-federal, private federal reserve corporation has a no-bid contract to print money out of thin air and charge U.S. citizens money (interest) for this enormous privilege. Their so-called powers are legion and they are the cause of much distortion and inequality in our economy, to be sure.

But the belief that the fed can inflate forever in a fiat system ignores a few important concepts. First, a debt-based system requires someone to get into debt. There has to be a willing and capable borrower for a banker to acquire a new debt slave. The American public is now finally at the point of saturation and is, in aggregate, underwater and a poor credit risk. Additionally, people in the United States in aggregate are (finally) starting to become scared to take on more debt. These are new secular trends not to be taken lightly.

Now, you must understand that, in aggregate, the banking system of the United States is insolvent. This is largely due to the amount of risk taken by the largest institutions that were just bailed out by the U.S. taxpayer to no one's advantage but those large banks, but it was aided and abetted by a bull market in real estate and confidence that spread to most medium and smaller-sized banks. You also have to understand that our "modern" banking system, after the credit boom we just had and given the skimpy reserve requirements of banks these days, is unable to tolerate the real estate market crash that has already occurred and is now in full swing.

The real estate bear market is not over after 2-3 years! Anyone who says or thinks so doesn't understand the facts, market cycles or previous historical precedents (or they are just lying to you to get you to buy a house). We have a recent example from Japan in the decade after 1990. I know, I know, we're different. You know why? Because we have much more usable land and we overbuilt much more than Japan did during their boom. Otherwise, its the same, particularly the government response to help banks hide the fact that they're insolvent (which prolongs the bear market by years). Here's a chart of Japanese land price that I stole from somewhere in cyberspace (can't remember where - sorry to the creator):

Maybe we get through this mess in 6-10 years instead of 15. I don't think that's an unreasonable optimistic scenario (though it will take 20 years if the government insists on continuing to stop the free markets from functioning). So, maybe by the 2011-2012 time frame we will find a bottom in housing. If that's true, we will drag along the bottom for another 5 years as the psychology of housing as an investment or speculation turns 180 degrees in the opposite direction from a culture that actually had a popular television show about "flipping" houses. Once a bubble like this pops, it ain't coming back for a generation or two. Period.

This means that banks and debtors who hold mortgage notes are in trouble for a long, long time (in aggregate). When a bank is in trouble, it gets cautious. It doesn't want to loan money to risky borrowers. Once bitten, twice shy. Please don't forget that banks are actually in the business of trying to make money! If they don't think they can get paid back, they won't make a loan. The exception is if there is a secondary market to sell their loans to so that the banks don't have to be the ones worrying about getting paid back. This is why Freddie Mac and Fannie Mae are such nefarious organizations. They promoted (and continue to promote) unsound lending and put the risk on the taxpayers' backs with no sharing of profits when times were good!

The flip side of this is the consumer. Even if the bankers want to continue to make unsound loans and the U.S. government gave them free money to loan, the U.S. consumer, in aggregate, is exhausted. We have finally reached that point after two decades of unbelievable profligacy by the typical American. After refinancing their home, maxing out every credit card they could find and getting themselves into long term loans for vehicles, second homes, appliances and education, the final wall has been hit.

If you make $40,000/year and take out a loan for $1 billion, it doesn't matter what the interest rate is, even if it's zero. There is a mathematical limit of how much debt can be serviced by a certain income. The final stages of the credit boom required subprime debtors to take on loans with negative amortization, meaning they were paying less than interest only on housing-backed debt (i.e. Option ARM or "pick-pay" loans that are HEAVILY concentrated in bubble states like California and are now exploding on schedule) and every month their amount of debt was increasing despite making payments!

The bottom line is that Americans, in aggregate, can no longer service any more debt. They have reached their mathematical limit of debt payment and much of their debt is going bad at a staggering pace as unemployment continues to rise. That feeling of being underwater on a mortgage and coming to realize that your "asset" has become a trap is not one to be underestimated. Many folks don't have the financial ability to pay their debts down any faster, by the way.

Our government and our non-federal private federal reserve corporation are trying everything to get the party going again. Since the consumer can or will no longer borrow on their own, the government takes on more debt in their name. The federal reserve pushes credit out the door at a pace that alarms anyone who is paying attention.

It seems that many think the federal reserve can create inflation and cause markets to rise at will by throwing our currency and future savings under the bus. Cash for clunkers and cash for refrigerators both show the depths the apparatchiks are willing to go to cause inflation and take on more worthless debt. Visions of helicopter Ben Bernanke throwing money from helicopters are not heart-warming to say the least.

But is there a limit? Is there a point where the party stops and nothing works anymore? The answer is yes but the question is how this party comes to an end. Some say hyperinflation and some say deflation. Hyperinflation seems to be the obvious choice. If you keep pushing and pushing cheap money, the currency just spirals down to its intrinsic value, which is zero.

Deflation requires a different view, which is that the central bank and our government are not the only ones who have an effect on the economy. The fed is not omnipotent or omniscient. They have only one play in their playbook (though it has many twists) - create money and throw it around by getting people to borrow it and multiply it. But you see, someone has to actually borrow it and do something with it to make prices rise in the real world when the system is credit-based. The deflation argument states that at times there are not enough people left who want to borrow and not enough banks who want to lend and the net decline in credit and the credit multiplier effect in the economy more than overwhelms notions of "base" money.

This is the "pushing on a string" theory that I favor is happening right in front of our eyes. You see, government debt doesn't grow the economy. Government is a parasite on the economy. Government and its private fed bank distort the primary trend, they do not create it. I think the lack of fed power is about to be exposed and I think what's left of the free markets will teach apparatchiks a powerful lesson (again) about what they can and cannot do.

Lost in many discussions is what happens to the engine of the economy at this point in the cycle. The private sector is the economy, not the government and not its non-federal central bank. If you are a citizen in debt up to your eyeballs with no realistic ability to pay that debt back and no one left to lend you money, cash becomes very valuable. And believe me, at this point in our economic cycle and country's history, there are many, many people in this boat already. Many, many more are only one paycheck away from disaster - a family illness, job loss or some other slip on a banana peel and it's game over. When thinking in "big picture" terms, this is important.

For people who are in this situation, it doesn't matter what widdle Timmy Geithner is doing to steal all he can from the taxpayer kitty. It might make these people mad and possibly (hopefully) mad enough to do something about it, but it doesn't change their economic reality. They have to cut back, start saving, and start paying down debt. Alternatively, they can or may be forced to walk away from their debts without paying. Both of these trends are highly deflationary.

When we defaulted on the Gold standard in 1971, we basically walked away from our debt to other countries. Our currency went on a pretty serious slide over the next decade, culminating in a commodity spike that Gold and silver bugs still talk about today and hope will repeat. And please remember that I am bullish on Gold. But I want to show you another historical perspective on what could happen besides stagflation or hyperinflation.

It comes from the 1930s. The major economies were on a Gold standard to start the 1930s. As things got bad to kick off the economic depression, however, governments did what they do so well - they broke their promises. Britain, the senior economy of the time in the eyes of the world, left the Gold standard completely and abandoned it in 1931, just like we did in 1971. Want to guess what happened to their currency?

Well, here's what actually happened (chart copied from Martin Armstrong's book "The Greatest Bull Market in History" but credited to the Wall Street Journal by him):

Not what you'd expect, eh? And, no Britain did not return to the Gold standard to cause the spike in their currency back higher after the plunge in the early 1930s. So, why did their currency spike higher even after they left the Gold standard? Simple: a deflationary depression caused a bull market in cash and, additionally, every other government in the world played the same game and devalued their currency! Major European countries left the Gold standard in the early 1930s and only the U.S. stayed on the Gold standard. Even the U.S. finally changed the rules and did a one-time devaluation of its currency and switched to a weaker, watered-down quasi-Gold standard in 1934 after stealing its citizens Gold and criminalizing private Gold possession.

So, I hold Gold instead of U.S. Dollars to protect from what now seems an inevitable U.S. (and global?!) currency devaluation. But there's a good chance the U.S. Dollar won't spiral into hyperinflation, but rather a one-time rapid devaluation will help spark a weak cyclical bull market in anti-dollar plays (i.e. stocks and commodities) and then the value of cash may well rise once again (just like in Britain in the 1930s).

We won't be making new highs in stocks or commodities for several years in my opinion, as the underlying economy is too weak to support such a rise. I think the international currency Gold will outperform the U.S. Dollar and thus it is my preferred form of cash. Forget interest payments, I want my purchasing power retained and enhanced and I want protection against a one-time intentional currency devaluation or temporary capital flight from the U.S caused by economic weakness and an unrealistic fiscal policy (we are not the only country at risk, by the way!).

If you are a Gold stock bull, like I am, deflation is a wildly bullish scenario. Most Gold bugs don't understand that Gold miners can more consistently grow profits during deflation than during inflation. This is paradoxical only when you look at Gold as a commodity instead of as a form of cash. Gold is money. If Gold (i.e. cash) is becoming more valuable and the costs of mining are going down (i.e., the Gold:Commodity ratio as a proxy), miner profitability for unhedged miners goes up exponentially. This is why Gold miners did so well during the last economic depression of the 1930s.

So, not only can you make money buying Gold stocks, but your profits will be more valuable in U.S. Dollar terms relative to real estate, general equities and commodities. Though I am not interested in buying senior Gold stocks at current prices, especially since the equity bear market is about to resume, another great buying opportunity is coming and it should be welcomed and seized by interested investors.

I realize that many people think Gold will get killed during deflation but none of the deflationists who predicted this thought Gold would be within spitting distance of its all-time highs a few months after the most intense deflationary liquidation this country has seen in 30 years (i.e. the fall Panic of '08). All Gold stock investors should personally welcome a deflationary decade after seeing the table below, stolen from Ian Gordon. This table is shown because these were two of the main senior Gold stocks and this is their price action during the worst stock bear market America has seen in 100 years (i.e. the 1929-1932 bear, during which the Dow Jones lost 89% of its value).:

And believe me, Gold stocks absolutely exploded over the three years following this table's data!

Why am I harping about all this? Because I like Gold as a cash equivalent and insurance and Gold stocks as an investment, but I don't like commodities at this point in the business cycle. Most Gold bugs are just inflationists or hyperinflationists and don't understand the role of Gold as money and a hedge and they don't understand that deflation is consistently bullish for Gold miners' profits. Another good Gold and Gold stock buying opportunity is coming soon I believe, and I for one am happy to wait patiently for it.

I don't believe the fed or any other single private corporation can control everyone in the economy. The primary trends in the real economy are all deflationary and the fed cannot stop them. If you believe the fed is all-powerful and can control the value of the currency at will, then let me play along for a minute. A willful creation of hyperinflation, and it would have to be willful, would put the federal reserve franchise at risk. If you owned the for-profit federal reserve, which is not part of the U.S. government and has no allegiance to it, why would you want to end the most lucrative no-bid government contract in history?

Friday, August 28, 2009

Junk Bonds - I Mean "High Yield" Corporate Debt

are/is looking pretty "toppy." During a credit crisis/contraction, one would certainly expect to have high-risk corporate debt be a canary in the coal mine signaling a potential equity plunge (although, paradoxically, junky stocks like those that make up the U.S. financial system [despite their obvious insolvency] often rise at the end of a good bull run). The market's animal spirits are running in overdrive and bears are capitulating everywhere you look. It certainly is no fun to have a bearish outlook and/or bearish trade lately and watch the market steamroll the opposite way!

Fundamentals and short-term movements in markets are not correlated. Period. Let me repeat: fundamentals have nothing to do with daily or even weekly market price movements! I used to scour the headlines trying to figure out the news, but this is a mug's game and doesn't help traders AT ALL. One week, markets rally because oil is up, the U.S. Dollar is down or the latest doctored apparatchik report looks "better than expected" and the following week the markets tank for the exact same reason.

This is why Elliott Wave theory, technical analysis and market cycles are so interesting to many market participants. Trading the fundamentals leads to disaster over the short term and even the intermediate term. I have certainly learned a lot of expensive lessons during this bear market rally! If you think you can profit in the stock or other asset markets in the short term by trading the headline news or fundamentals, you will quickly find yourself broke and disillusioned. It doesn't work that way. The best opportunity for profit for novice investors is to figure out the long-term secular trend while it's still early, buy into it, ride it up to near the top, then switch into the next secular trend (easier said than done!).

I can tell you without hesitation that the longer-term secular trend in the Dow to Gold ratio is clear. Gold is rising in value relative to the Dow Jones Industrial Average/other major stock indices. This means that money is better spent buying physical Gold than buying general stocks until the Dow to Gold ratio gets to 2. Having said this, many don't care and want to make big money in the casino with short-term swings. Fear and greed, fear and greed...

Going long at these stock market levels makes no sense unless one is a day-trader with risk management skills, but trying to pick the exact top is very difficult and requires both skill and luck. I guessed the June highs would do it for this bear market stock rally (woops!).

Anyhoo, back to the topic at hand, which is corporate "junk" bonds, aka high risk/high yield corporate debt. When the yield is high, it means the risk is high. Remember that the next time you see a bank advertising an above-market yield on its savings deposits, money market accounts or CDs. Fortunately, the FDIC encourages moral hazard and excessive risk-taking by banks, which allows taxpayers to pay for the inevitable messes that occur via higher taxation, currency debasement, and new banking fees (thanks, big gov!). The FDIC "protects" citizens just like Homeland Security "secures" our borders and the federal reserve "fixes" financial crises.

Corporate junk bonds are looking "toppy" and demonstrate some bearish encouragement while recently failing to make new highs with the stock market. Following is a 2 year daily candlestick chart of the HYG ETF (i.e. "High Yield Growth" aka "You can trust us completely and we won't go bankrupt, but here's a higher yield just because we like you and we're running a special today"), a proxy for the junk bond market:

It will be interesting to see what happens over the next few weeks. Will junk bonds signal the next deflationary wave/next leg of the credit contraction before stocks top or will they top with equities? And what are the "toppy" looking Chinese and Indian stock markets (i.e. the drivers of never-ending global growth) trying to tell us?

Thursday, August 27, 2009

Pound Fixin' to Get Pounded

I think the British Pound broke down today. This is something U.S. Dollar bears need to keep in mind when talking about the U.S. Dollar collapsing. Because the U.S. Dollar is the reserve currency of the world, it will actually take longer to collapse than other currencies. The British Pound is a good "canary in the coal mine" situation for those worried about the long-term health of the U.S. Dollar (like me!).

This is why looking at the U.S. Dollar Index ($USD) is misleading. This index simply measures the value of anchorless U.S. paper money relative to other countries' anchorless paper money. If all fiat currencies are sinking or rising together (the latter only a theoretical construct not to be taken seriously), apparatchiks who trumpet the glory of paper promises can point to their paper index and tell you how "strong" their currency is and yet their citizens can still be losing purchasing power!

Anyhoo, here's a 30 month weekly chart of the British Pound ($XBP) using a log scale candlestick plot:

And here's the Pound's more recent price action using a 10 month daily linear scale candlestick chart to show today's breakdown:

Now, I'm not trying to pick on the British Pound, as when the U.S. Dollar is going up over the next few months, you can bet that the Euro, Canadian Dollar, Australian Dollar and Swiss Franc will all be declining. The British Pound simply had the most classic break-down chart pattern I could find in this bunch. The Japanese Yen is such a basket case and has been for so long that it will likely rise as well during the next deflationary wave (not sure).

On the flip side, this is where it gets tricky as a Gold investor when measuring your gains. If you were an American Gold holder last fall, you were probably disappointed at how Gold did. However, the Gold price chart looks different when denominated in British Pounds (I am using the U.S. Gold Price divided by the British Pound Index [i.e. $Gold:$XBP] as a proxy). Following is a 30 month weekly log scale candlestick chart of the Gold price in Pound terms:

The Gold price is not rising only because the U.S. Dollar is falling, although that's part of it. The Gold price is rising relative to all currencies (yes, including the Japanese Yen) because it is in a secular bull market relative to the global fiat currency system. It is Gold's time to shine relative to other asset classes and the ongoing secular bull market in Gold and Gold stocks has a long ways to go. I am not a commodity bull, I am a Gold bull.

Wednesday, August 26, 2009

The US Dollar Versus Gold - Flea on a Bull's Back

Gold versus paper. That's the real battle under the surface. This is the more important battle from a societal standpoint. Honest money or crooked money. Humans will always cheat, steal and lie, but when a system is set up specifically to promote cheating, stealing and lying, this is exactly what happens on a large scale. Though we were only on a quasi-Gold standard from 1934-1971 in the United States, it at least provided a modicum of restraint. Before 1933, we were on a fairly "pure" Gold standard for several decades.

Let me ask you an important question: do you think the United States was prosperous and grew like crazy as an economy on the whole from the 1880s thru 1971? Do you think that our rate of growth was too slow because we were on an archaic Gold standard?

Now, let's look at the period from 1971 through today. During this 40 year period, we had an inflationary decade that was the worst of the century for this country (the 1970s), we had rolling asset bubble manias and collapses in internet stocks and real estate, and now we are entering an economic depression that will last 10-25 years. Baby boomers have now had their life savings chopped in half (or more) in aggregate over the past decade and it's going to get worse for them if they don't get out of debt and get out of the stock market (which they won't, in aggregate, until we are near another stock market bottom and real estate has gone even lower). So, yes, a fiat system is great if you're a central banker or federal apparatchik looking to raise banking profits or expand the role of government, but not so good for the masses who sold themselves into paper debt slavery to the bankstas and still rely on the soon-to-be broken promises of government.

So don't tell me that we can't prosper as a nation on a Gold standard and don't tell me it's too restrictive and archaic for the modern world. It's bullshit and the people who say otherwise are either ignorant (the majority including most politicians) or nefarious (the central bankstas and some federal politicians). Despite my distaste for our current monetary system, I know that it is entrenched and it will take a major disaster (yes, worse than what we've already gone through) to get people seriously looking for a viable alternative.

So, it is a deflationary crash and depression for now, which will paradoxically increase the value of the U.S. Dollar despite it being backed by a bankrupt government. This increase, however, is a temporary respite from the terminal storms that await the U.S. Dollar in its current form. Though we may stay on a fiat system rather than turning to sanity initially, we certainly won't be staying on the system where the U.S. Dollar is the reserve currency of the world for the rest of our lives.

This is an important concept that Americans need to grasp to understand why Gold is so important as portfolio insurance and an international debt-free currency. Gold is money and this is why central bankers and governments own it and list it as a monetary reserve on their balance sheet. If Gold is not money, why do governments and central banksters own it and why don't they list it on their balance sheet with other assets like land? Why does government ignore its own definition of money and hoard the very form of money they ridicule and think is outdated? Do as we say, not as we do!

Gold is in a long-term bull market that has not ended. The value of Gold relative to other asset classes like stocks, corporate bonds, real estate and all international currencies is rising and will continue to do so at least until the Dow to Gold ratio reaches 2 (and possibly 1 or less). If cash is king during deflation, Gold is the best form of cash to own because cash unsecured by debt is more valuable than paper backed by promises. Also, keep in mind that trust in paper promises (i.e. those of government, bankstas and Wall Street) is breaking down. This is a social turning point that will force stocks back to a reasonable valuation (with a 12 month trailing PE ratio of greater than 120 on the S&P 500, we've got a long ways to go).

So, where are you going to put your money? Well, for the novice investor, you want to be out of stocks, out of corporate bonds, out of commodities and out of real estate. That doesn't leave many options. You're essentially left with cash and government debt (pick federal over municipal!). Where I am trying to help with this rant is by reminding people that Gold is cash and it is a better form of cash than the U.S. Dollar long term.

I actually think the U.S. Dollar is going to rise significantly from current levels over the next few months. I also think Gold is going to rise. For those who can only think in terms of "Dollar up, Gold down" and vice versa, this doesn't make sense. But for those who understand that Gold is an international currency that acts as a barometer of the health of all fiat currencies currently in existence, it makes perfect sense.

I like the potentially developing parallel with the 2004-2005 time frame when thinking about what will happen with the Gold price this fall. Gold has been building a price base for the past 17 months to get ready for its' next leg higher. The U.S. Dollar has been correcting over the past 8-9 months. My belief (not one I plan to trade) is that the U.S. Dollar is about to have a powerful intermediate-term advance. Gold will take an initial hit as traders and commodity bulls dump it, but will then stabilize and launch higher.

Here is how a similar pattern emerged in 2004-2005, using a 20 month daily chart superimposing the price of Gold (green area plot) and the U.S. Dollar Index (black linear plot):

So, I don't know exactly when the Gold correction will end, but I do believe another buying opportunity lies ahead for patient investors. Physical Gold is more valuable and more reliable than paper Gold (e.g., the GLD ETF). I also believe that Gold will break out to new highs and $1000/ounce will become the floor for the Gold price instead of the ceiling. All fiat currencies are sinking relative to true debt-free money. Gold stocks should not be bought on strength, but on weakness. We are going to start the next leg down in the cyclical general stock bear market this fall, which is far from over, and it is going to be a brutal decline.

Though Gold stocks will take a hit with general stocks when the selling gets bad, they made multi-year lows during the fall Panic of 2008 and will not be making new lows like the general stock indices. However, there is no rush to buy senior Gold stocks and I certainly wouldn't buy them right now. I continue to wait patiently for a good buying opportunity in this sector. I am hoping that Van Eck Global's junior Gold miner ETF (pending ticker: GDXJ) will come out soon, but at this point there is no news (please holler if you hear something!).

Tuesday, August 25, 2009

Peak Oil has Peaked

and the price of crude is about to roll over. My previous piece on oil allowed for the possibility of a double top in crude oil, and I think that is what we are getting. A "big picture" overview of the oil bull market follows using a 12 year weekly log scale chart of the price of crude ($WTIC):

And here's a one year daily chart of the price of crude oil (as an aside, the next chart and prior chart only include action thru last Friday's close, as they were created this past weekend):

Lastly, here's a re-visit of the divergence between oil and oil stocks using a 6 month daily plot of both oil stocks (green area plot) and oil (black line plot) up thru yesterday's close:

Though it is certainly conceivable that oil and oil stocks could go a few bucks higher, they are now all but spent. The great oil bull market is over and has been since the top last summer. The bubble has burst, not to be blown again in our investing life times. Once a bubble bursts, it ain't coming back for decades. This is what I have been trying to tell anyone who will listen about real estate - just forget real estate as an overall investment class for 5-10 years (though every market may have unique individual opportunities). When inflation is finally created in the next business cycle, it will find a new market, not the one that just imploded and burned millions of "investors." Why is this? Human nature. Once bitten, twice shy.

The next plunge in crude will hopefully put an end to all the talk about "Peak Oil" for awhile. The fact that Chevy can even conceive of offering an electric hybrid-type vehicle (the Volt) in the next few years that may get 100-230 miles per gallon shows why the peak oil dilemma is bogus even in the near term. If Chevy can conceive of it, other better managed companies can actually do it and can do it much better and faster. Take that technology and put it in all cars, trucks and military vehicles. Then add further solar technology break throughs or maybe a nuclear/hydrogen advance or two. Then throw in a global economic depression to cripple demand for the next few years while these technologies are being developed, tested and implemented. Next thing you know, we don't have to worry about oil for another 20 years.

By then, who knows? Solar or nuclear-powered cars? Maybe we "stimulate" ourselves in America (and maybe in China, too) with multi-trillion dollar high-speed rail systems that link major cities throughout the country? Declare cars that get less than 100 miles per gallon illegal? Lord knows if America cut her consumption of oil significantly, that would solve the global problem for a decade by itself.

The point is that high oil prices are a tax on everyone and motivate people to change behaviors and innovate. Don't get me wrong, I read all the articles and data on peak oil and was initially concerned. I know how China and India want their cars, too. But now that I know a little about history, market cycles and bubbles (Peak Coal and Peak Food capped a few previous commodity cycles), I am much more concerned for the citizens of major oil-producing countries when oil goes back to $20/barrel. Keep in mind that a U.S. Dollar devaluation event could certainly alter the dynamics of the oil price for Americans in the future, but the global oil price, oil stocks and the price of crude in Gold terms are both headed for another leg down in their bear markets. Only the exact timing is in doubt in my mind for oil, not the outcome.

As an aside, I also think the next bubble will be in Gold and Gold miners (of course!). Keep in mind that oil went up fifteen fold over the past 10-12 years before its price collapsed, while Gold only went up four fold. I am still waiting patiently on Gold and Gold miners to correct further before considering putting new money to work in this sector via the long side.

Monday, August 24, 2009

Japanese Yen Fractal - Path for the U.S. Dollar?

Though I keep hearing how we're different than Japan and their lost two decades of deflation (or as close to it as we seem to get in a fiat world), we are making the same foolish mistakes: protecting the financial/banking keiretsu that caused the current mess, burying the bad debt under a cloak of secrecy, and engaging in a massive quantitative easing campaign to "stimulate" the economy.

Yes, there are important differences, and unfortunately, they make the U.S. picture more grim! We have no savings to fall back on and our access to the reserve currency printing press ensures that we will abuse this privilege until the dam breaks and our currency spirals out of control.

However, one step at a time. The deflationary forces engendered by the collapse of the private credit/debt markets continue to pull Americans and their favorite bankers deeper into an asset price decline/debt morass. If you are a bank or overleveraged financial institution or individual, this is a problem that has not yet gone away (for large banks, this is true even after pillaging the world's taxpayers). While it is true that our government and its [privately held, non-federal, corporate] federal reserve central bank have caused a great deal of damage to the structure of the U.S. economy and the longer-term viability of our currency by their actions, it is also true that other countries with their fiat money machines are engaging in similar plans of taxpayer-sponsored spendthrift madness.

It is a race to the bottom for all fiat currencies and this is why I hold debt-free money (i.e. physical Gold). However, secular credit market implosions are not minor events and bureaucrats only have so much control over the economy, even in places like China and Russia. So, yes, the U.S. Dollar (just like all fiat currencies) will eventually get even closer to its intrinsic value of zero before it is replaced.

But the game is not so simple for those looking to trade the markets (as an example, please don't ask how I've done in my trading account over the past 3 months!). Despite bailing out the banks and "printing money," the Japanese saw their currency strengthen during their mighty cyclical deflationary bear market in the 1990-1993 time frame. I know, I know, we are printing more in the U.S. and we are different, blah, blah, blah. Yes, the greater government debt creation will eventually come home to roost and cause more problems down the road.

But I again believe that a rise in the U.S. Dollar on an intermediate-term basis is upon us. I found an interesting fractal in the Japanese Yen price from the 1990-1991 time frame I wanted to share to show what could happen with the US Dollar despite all of its problems. And again, keep in mind that I store my savings in physical Gold, not fiat dollars from any country. I am a [transient] deflationist who is bullish on Gold because the value of Gold relative to other assets rises during deflationary wipe outs. I also more importantly believe that we are getting dangerously close to the end game for the current global fiat currency system. This is an event one MUST be early for, as being a day late could leave you close to wiped out as a holder of U.S. Dollars.

Anyway, following is a weekly chart of the Japanese Yen during the 1990-1991 time frame. Keep in mind that this weekly candlestick chart includes the time frame following two brutal legs down in the cyclical bear market that began their lost 2 decades (which by the way haven't ended!):

And in case you haven't seen it lately, here's a 22 month weekly chart of the U.S. Dollar:

Now, for the obligatory "what happened next" chart in the Japanese Yen:

If you don't think this can happen to the U.S. Dollar, ask yourself why. Think of it this way: what caused the U.S. Dollar to rise so spectacularly last fall? Whatever your answer is, do you think that those forces cannot occur again?

The reason I keep harping on this is because I am passionate about Gold as an asset class in this environment. It seems that 90% of Gold bulls ignore the "reserve currency of last resort" function of Gold / its role as money. This means that Gold can do well during deflation by holding its value. It also means that commodities can tank while Gold can remain strong (which is wildly bullish for Gold miner profitability). Many Gold bulls are also commodity bulls, but I think the commodity bubble, if its poster child oil is any indication, has already burst. We are closer to the 1930s disaster than the 1970s disaster, though both decades are inexact comparisons.

The governments and central banks of the world hold physical Gold as a monetary asset and reserve "just in case." Well, we are now at one of those "just in case" decades where Gold's insurance function is just as important as its appreciation function. I believe Gold will rise significantly in price and possibly in a wild and exponential fashion. But if Gold just sputters along and holds its value in the $1,000/ounce range while every other asset class that a typical individual desires collapses in value, the holder of Gold has become significantly richer in real world terms.

No, I am not talking about the world coming to an end, eating Gold, or using Gold to buy groceries. Last I checked, stocks and bonds were not used to buy food or guns! I am talking about value as well as stabilization and enhancement of one's net worth in a scary investment environment. Those who plan to hold U.S. Dollars will profit from the Dollar's rise during the pending wave(s) of further deflationary panic. "Cash is king" during deflation. However, eventually the world will pull the plug on the U.S. Dollar as the reserve currency of the world. Though this could come about as an orderly process, history suggests otherwise. I don't know when this will happen and, at this point, Obama and Bernanke probably don't know either.

I think another buying opportunity in Gold is pending (still...). Once the U.S. Dollar starts rising, Gold will take an initial hit precisely because so many are holding Gold for the wrong reasons right now. When the Dollar spikes higher, you can bet the Gold bulls and momentum traders will panic, shorts will press their advantage, and a brief price spike down will allow longer-term oriented investors to pick up more Gold on weakness.

As an aside, although change often happens at the fringe, expect to see more stories like this one about the role of Gold as money throughout the world.

Sunday, August 23, 2009

Bear Market Fractal Encouragement

It's gotten mighty lonely in the bear camp and the bulls have certainly had their way with the bears since the March 2009 lows. It has been a rally for the ages and the subsequent pending drop will also have this distinction. In looking through a long-term chart of the Dow Jones Industrial Average, I found an encouraging fractal pattern for the current bear market rally. Markets don't repeat precisely, but they do rhyme.

The number of people calling for a new bull market, saying the recovery is upon us and saying that the stock market "sees" a future recovery and is discounting it is funny to me. Funny in a sad way, because I know what comes next and how upset many retail investors are going to be in a few short months. I have taken my licks and learned a lot about trading bear market rallies over the past few months, to be sure. Mr. Market never fails to humble.

But to say that this bear market is over is ridiculous in my opinion. Granted, when trading short term it really doesn't matter whether we are in a bull or bear market, it matters if you get the short-term trend right and trade it effectively. But there is a longer-term investment horizon that is of great concern to me as well, which is why I made the decision to buy physical Gold and sit this one out with a large portion of my savings.

Until the Dow to Gold ratio is back to 2 or less, general stocks are a TERRIBLE longer term investment. Though this ratio has come a long way since its peak in the 40s around the turn of the century, it has a long ways to go with the current ratio sitting around 10. In other words, if one ignores the intermediate-term swings, those who hold physical Gold will be able to buy 5-20 times the number of stocks (using the Dow as a proxy) in a few short years relative to today, using the rational assumption that the Dow to Gold ratio will bottom between 0.5 and 2.

I choose Gold over fiat currencies because it is stable and predictable, unlike the actions of governments and the apparatchiks who run them. Those who think Gold is no longer money will change their minds over the next decade, when Gold is used to re-liquefy the system and restore the confidence lost due to over-subscribed and over-issued hollow paper promises. It's Gold versus paper and Gold will win during this business cycle (paper won the 1980-2000 cycle and Gold will win in the 2000-(?)2015(?) cycle).

Anyhoo, back to the fractal pattern in the Dow. We need only turn to the last cyclical bear market from the early 2000s to get a similar appearance of a bear market rally. Here it is in context, using a 12 year weekly log scale chart:

As a close-up, here's the daily chart of the action in the Dow during the 2001-2002 time up to the day of the high for this bear market rally:

And here's a current 1 year daily chart of the Dow Jones Industrial Average:

And, of course, the obligatory chart of what came next back in 2002 on a daily chart:

I, for one, don't intend to lose the forest through the trees here. Just as bear market rallies are fast and furious, so are the subsequent declines. You don't start new bull markets with trailing 12 month PE ratios over 120 during the middle of a housing market crash and banking system collapse (and no, neither one of these trends is close to being over). Even general stock puts and shorts initiated at the June highs with an eye towards the long term will look good 6 months from now.

The Put to Call Ratio

is at an extreme level currently when using the Chicago Board of Options Equity Put to Call Ratio ($CPCE). The current spike can be put into perspective when comparing it to previous spikes over the past 3 years. Now, no one indicator is reliable in and of itself, but the put to call ratio (i.e. ratio of the number of equity puts/bearish bets bought divided by the number of equity calls/bullish bets bought) is a reasonable measure of sentiment.

Here is the raw plot of the $CPCE, which is noisy, compared to the S&P 500 over the past 3 years using a daily chart that contains a plot of the data for both:

This is the lowest spike in the $CPCE in more than 3 years! To make the $CPCE plot a little less noisy, here is the same 3 year daily chart but instead of plotting the $CPCE versus the S&P 500, following is a plot of the 8 day exponential moving average of the $CPCE versus the S&P 500 to show the statistically extreme nature of the short-term spike in call option buying relative to put buying:

The comparison to mid-July of 2007 seems reasonable to me. A spike down for a few weeks followed by a brief rally to re-test the highs in the general market averages would allow for some deterioration in breadth (90% of stocks are above their 200 day moving average right now!) and a significant momentum (and breadth) divergence on the price re-test to set up another fall disaster.

Saturday, August 22, 2009

The Imminent US Dollar Rally

is another temporary respite from the coming storms for savers who choose not to play in the market casino. Ol' Uncle Buck will again rise from the dead and astound its critics and the commodity bulls. Now, don't get me wrong, this will be just another countertrend bounce. But I believe another wave of deflation is needed before we can get to the point of a currency devaluation/cyclical inflation. The US Dollar is sick, just like the global economy and global markets. Yet that didn't stop the global stock indices from embarking on a rip your face off rally that continues to test the resolve (and pocketbooks) of bearish market participants.

Markets don't move in a straight line. After an initial thrust from July 2008 thru November 2008, the US Dollar has been correcting for roughly 10 months now. A second thrust higher is needed to complete this correction and it may have already started. Again, please don't misunderstand my long-term stance - the US Dollar is in big trouble. But I still believe a strong rally in the Dollar is imminent and that it has probably already started.

When the Dollar starts rising significantly, stocks and commodities will be toast (again). Here's what I'm seeing in the charts for the US Dollar. First, the "big picture" view using a 15 year monthly chart:

Next, here is an 18 month daily chart of the US Dollar thru Friday's close:

Finally, here is an ETF of the US Dollar (ticker: UUP) with my attempt at an Elliot Wave count:

I don't know if this count is correct, but if it is, a significant thrust higher in the Dollar is dead ahead. I do know that the Dollar is bottoming on an intermediate-term basis, not topping. I also know that when the turn comes in earnest, it will end the rally in stocks, corporate bonds, and commodities. I don't trade currencies but for those dollar bears out there, take heart: I hold the bulk of my savings in physical Gold. I am talking about a countertrend rally of less than one year for a beaten down fiat currency relative to other fiat currencies. I think the Gold price will take an initial hit when the Dollar starts rallying but will recover quickly as the credit crisis intensifies.

Friday, August 21, 2009

Reality Versus The Rally

Of course reality will win, but the rally has certainly exposed my lack of talent for picking a precise top (I erroneously voted on early June). This rally is blowing out in a phenomenal fashion before the misery of the current blossoming economic depression takes hold. The fundamentals are now deteriorating rapidly and are at levels, in combination with the requisite government interference, that guarantee a depression has started.

Now that all the bears have been stopped out, kicked, gored, defeated and wiped out, I suppose now is as good a time as any for this rally to stop. I imagine that the August monthly high will be the high for some time to come in the general stock market indices. The next leg down in the bear market will be devastating, both financially and psychologically. The March lows in the S&P 500 will be broken. To add insult to injury, once the final lows are in, a rapid currency debasement is likely going to be the catalyst for the subsequent cyclical bull market in equities (and no, the current bear market rally is not a new bull market).

So, the one-two-three punch combination will alter America for decades. First, massive asset price deflation (homes, stocks, commodities, corporate bonds), then massive unemployment (continues to rise on schedule), then right about the time that people's savings are getting low, a rapid currency debasement (whether via government decree or a capital flight).

Trying to dance in this storm as a trader creates insane opportunities for profit and loss. But before we can have the inflation that so many bulls seek, deflation will create a swath of damage through the economy that will leave it unrecognizable. Those who manage to maintain some capital will have the asset buying opportunities of a lifetime.

We have hundreds of bank failures to go. We have dividends that are going to be cut back to the bone or discontinued. We have a "true" (i.e. not operating earnings, not smoothed, not averaged, not glossed over) trailing 12 month Price to Earnings (PE) ratio of 131 that needs to get to 10 or less. We have a commercial real estate implosion so strong and so fast that even the bears are surprised by its ferocity. We have a residential mortgage crisis that is just beginning a more powerful second wave (the state of Florida, currently the worst in the nation for this statistic, now has roughly 25% of its homes with loans either delinquent or already in the foreclosure process!). We have unemployment continuing to rise with mass lay-off events spiking again (California is now in the 12% range using the tampered-with, government sanctioned headline number).

China is now the number one trade partner (in total dollar terms) of Brazil and Japan. Japanese exports and imports both have dropped by about 1/3, confirming a global trade collapse. We have total U.S. household credit market debt outstanding turning negative on a year-over-year basis (first time in 50 years and shows that "the" secular turn in consumerism and consumer credit has finally arrived).

Of course, these are only a few of the alarming trends in the underlying real economy that underpins financial markets. Short-term and intermediate-term stock market movements have nothing to do with fundamentals. Long-term, fundamentals are set to come home to roost in a big way. This does not help the speculator, but it does help the patient investor.

The U.S. Dollar is bottoming. There's a good chance it already bottomed on August 5th. Commodities (using an evenly weighted index like the Rogers Commodity Index ETF [ticker: RJI] or the $CCI) topped in June. Regional banks (using the Philadelphia Regional Baking Index [$KRX]) peaked in May. The Baltic Dry Index ($BDI) peaked in June. The Volatility Index ($VIX) is bottoming and there's a good chance the final low for the $VIX was on July 24th. And today, the masters of the universe (referring to Goldmun Sucks [ticker: GS] of course), failed to make new highs along with the general market indices.

I'll stick with holding physical Gold as my core investment despite the fact that I think it's about to get whacked to the low 900s to high 800s level. Those who don't like Gold can try their luck at holding U.S. Dollars, which are set-up for a stunning intermediate-term rise in price. Gold stocks are about to get smacked down too and will provide a good entry for a bullish trade or long-term buy (depending on the nature of the low). I just finished throwing the remainder of my speculative funds into the short side and have decided to triple my short position on the silver miner Pan American Silver (ticker: PAAS) as a short-term trade.

Thursday, August 20, 2009

Junior Gold Miner Charts

These are from a few days ago, so they are already slightly out of date, but I wanted to post these as promised. These are charts of junior Gold miners that I thought looked interesting. Please understand that I have done NO FUNDAMENTAL ANALYSIS on these firms and am going by the "rising tides lift all boats" theme. Junior Gold mining stocks are going to the moon over the next few years and should be bought on weakness, not strength.

Remember, I believe in the Gold miners because of deflation, not inflation. Deflation is consistently good for Gold miners' profits, while inflation less predictably so. If you don't understand this concept, then you can look here or here for an explanation.

The sweet spot of this cyclical bull market in Gold stocks is pending and the low for the current correction is either coming in the next few weeks or in the late October to early December time frame. Junior Gold miners, in aggregate, will outperform senior Gold mining firms but have greater risk. Diversification in this sector is MANDATORY unless you personally know management, have toured the mines/properties they own, and understand the capital structure of the firm. Some juniors will go up 500-5000% and some will go to zero (i.e. go bankrupt and cause you to lose your entire investment).

Anyhoo, since there is no adequate ETF for junior Gold mining stocks (the Van Eck Global ETF that has a pending ticker symbol of GDXJ is coming, but don't know when yet), here is a chart of some juniors that I though looked interesting. My junior mining universe of stocks is currently limited to those that trade on US exchanges and, again, these charts are now 2 days old and in no particular order (sorry...).

Novagold (ticker: NG):

Richmont Mines (ticker: RIC):

Northern Dynasty Minerals (ticker: NAK):

Gammon Gold (ticker: GRS):

Tanzanian Royalty Exploration (ticker: TRE):

Claude Resources (ticker: CGR):

Happy hunting!

Tuesday, August 18, 2009

Charting Around the Gold World

For background on my thoughts regarding the ongoing Gold stock correction, see here. I don't think the Gold mining sector or Gold price is done correcting. We are getting close to a tradeable bottom in the senior Gold stock indices, however, using the GDX ETF. I have given up trading the Gold price and I simply try to accumulate physical Gold to be held outside the financial system whenever a nice correction occurs (assuming I have capital to invest when it occurs...).

We'll start with the physical metal, but keep in mind that Gold miners may or may not leverage the gains in the price of physical Gold depending on where we are in the stock market cycles and depending on how Gold is doing relative to other commodities and the costs of Gold mining. Individual firms also move individually and may or may not follow the herd.

Here's a 2 year daily Gold price chart and my thoughts:

Again, I don't trade the Gold price, I try to accumulate physical Gold on weakness. For trading, I use the Gold mining stocks. The most tradeable senior Gold mining index is the GDX ETF. My view hasn't changed on targets and parameters for buying this index if this is one's preferred investment vehicle. I wouldn't be interested in going long GDX if it doesn't reach down to 32 and I would prefer a spike panicky low down to the 30 range.

If GDX doesn't get to a low of at least 32, then I think a lower low will occur in the fall in the mid-October to early December time frame. If we get a good spike low, then this will likely be "the" low for this intermediate-term correction. Remember that my view is that Gold mining stocks in aggregate (i.e. Gold stock indices) made their cyclical lows in the fall during the Panic of '08. They won't be making lower lows than the fall of '08 lows, while I believe the general US stock market indices will be making new lows in the next year.

For a more individualized analysis of Gold stocks, here are some charts I think may be close to a good buying point with my comments. All the charts are 1 year daily charts unless otherwise specified. For today, some medium to large sized Gold miners:

Goldcorp (ticker: GG):

Rangold Resources (ticker: GOLD) - 2 year chart to show breakout to new highs:

Kinross Gold (ticker: KGC) - [Disclosure: I own this stock]:

Agnico Eagle Mines (ticker: AEM):

Royal Gold (ticker: RGLD) - WARNING AND DISCLOSURE: I am heavily long this stock and remain bullish on it despite it failing to move higher when I asked it to. Anyhoo:

There are obviously other senior and medium-sized Gold miners out there, but other charts I looked at either didn't look as close to a buy point to me or resembled the charts shown. Keep in mind this is only my opinion and I am not recommending anyone invest in anything. Technical analysis can be used to determine buy points for stocks you want to invest in or can provide potentially lower-risk buy points for a trade.

We are still in a nasty bear market that is far from over. There is no rush to get bullish on Gold stocks here with the general stock markets in nose bleed territory, as bad downdrafts in the stock market spare few equities. Patience is key. By next spring, Gold stocks will be the darling sector and massive gains will be realized. Any intermediate-term bottom here in Gold stocks may be re-tested if the fall bear leg down in general equities turns nasty (and there's a decent chance of this).

The junior Gold mining sector is completely different and many of these stocks have already started to or will soon move significantly higher regardless of what's going on in the general markets or senior mining stocks based on positive news like mergers, acquisitions, discoveries, permits granted, starting production, etc. Of course, they can also move significantly lower when bad news comes out.

Tomorrow I will post some more junior Gold mining charts that look to me like they are near buy points. Cheers!

Monday, August 17, 2009

Mr. VIX Finally Making the Turn?

On a weekly chart, depending on how the rest of the week goes, it looks like the Volatility Index ($VIX) is trying to make the turn back to bear land. I have been anticipating this turn for quite some time and got faked out by the false push at the end of June above the declining trend line. But we have just about run out of time for the declining wedge at the terminal end of a correction for Mr. VIX, as shown below on a one year weekly candlestick chart:

A turn in the $VIX has significant implications related to the end of the bear market rally and profits for put option holders. This bear market is far from over and hard times are ahead for the bulls. A spike down, followed by a rally to re-test the highs and set-up a momentum divergence would create the ideal shorting opportunity. However, Mr. Market doesn't often give us what we crave...

As the US Dollar continues to firm, almost everything else will fall. I believe the final leg down in senior Gold stocks was confirmed today and the end of such corrections can be panic-inducing if one isn't psychologically prepared for them. I will post more on this pending buying opportunity tomorrow, but I think GDX and senior Gold miners have further to fall, as does the Gold price on a short-term basis. We are close to a potential good buying opportunity, but not there yet. Trust me, there is no rush and patience should be rewarded.

Sunday, August 16, 2009

Deflation Relative to What?

As the deflation versus inflation debate rages on, both sides present reasonable arguments that sound plausible. I am in the camp that believes stocks, commodities, corporate bonds and real estate have much further to fall. Now falling prices are not the same thing as deflation, but they are a visible symptom. To be honest, I am a pragmatist. I am not as concerned about getting my exact definitions right as I am understanding what to do with my savings.

I believe all major asset classes are deflating in value relative to Gold and will continue to do so for at least a few more years. Cash in the form of US Dollars, since it is the reserve currency of the world (for now), should do fine as well for a while but presents significant risk as the deflation grinds on. This all goes back to a concept I have embraced known as Exter's liquidity pyramid. See here for some background info and below is a reproduction of a common rendering of this pyramid floating around in cyberspace:

When you think about the end stages of this deflation/liquidity pyramid, you realize how similar deflationists and hyperinflationists are in an idealized model. When a fiat credit bubble pops, assets at the top of the pyramid decline in value and "liquidity" flees these asset classes and scrambles down the pyramid towards the apex for safety. The moves are not always orderly, but as deflation intensifies, physical cash in the form of currency notes and Gold become highly valuable relative to standard investment asset classes like stocks, commodities, real estate and corporate bonds.

This fits with the classic saying "cash is king" during deflation. The problem is that you have to hold the right kind of cash. Almost no one alive today has lived under a true Gold standard where paper cash notes could readily be converted into physical Gold in the same manner that paper dollars can now be converted into quarters and dimes. I don't mean buying Gold at a coin shop, I mean exchanging paper notes for Gold at a bank or government office without incurring fees or paying a premium.

Now many scoff at this notion and think it is antiquated/quaint, restrictive or just plain bat shit crazy as a monetary system. The fact that otherwise rational and sane people laugh at the concept of Gold as money just goes to show how truly off course and ignorant America in particular has become regarding monetary issues. There are very few who don't experience at least some cognitive dissonance when the government keeps spending more and more money it doesn't have and promising more and more things we can't afford as a nation. These things happen because we have decreed as a nation that paper promises are the same as money and indeed they function this way for day to day transactions and will continue to do so for quite some time.

And during a bad deflation, paradoxically, the value of this intrinsically worthless paper becomes more valuable. In a sense, it is a cyclical bull market for cash in the midst of a perpetual secular bear market that characterizes all fiat currencies. No market moves in a straight line. It is not so much that cash is more intrinsically valuable, it simply falls in value slower than other asset classes so that cash can buy more assets.

For the saver and investor, it is thus prudent during deflation to hoard cash, as that cash can buy a greater number of assets later. In other words, if one moved to cash before the housing crash started, then one could buy a bigger house than 2 years ago. House prices are deflating relative to cash. Again, there is monetary inflation and deflation and there is asset price inflation and deflation. While they are not the same, I am not a high level economist in the academic world. I am trying to figure out where to keep my savings and investment money. If oil goes down to $20/barrel, does it really matter if the inflationists are technically right because the base money supply continues to expand through it all?

So, unlike many who harp on the subject, I am not as concerned with getting the academic concept correct as making sure my money is betting on the right asset classes over the next 5 years. So, in a sense, I actually am more interested in the symptoms rather than the underlying disease when it comes to investing. Having said that, I still think we are in a strong net deflationary environment right now. A modern fiat system is credit based and credit was functioning as a money substitute during the previous bubble. Now that credit is contracting at a scary pace, it is overwhelming the bureaucratic efforts to "reflate" the system.

Where the argument of the deflationists and hyperinflationists come together is at the very apex of the pyramid. Those who shun the notion of Gold as money are going to feel the pain when history repeats yet again. Because in the final painful layer of deflation, people flee paper fiat notes for true non-debasable and non-debt based cash. That's where only Gold comes in handy. You see, at the apex of Exter's pyramid, paper fiat cash notes deflate relative to Gold, which is paradoxically inflationary in a sense as it requires more paper cash to buy Gold if this phase comes to fruition (and I believe it will).

In a sense, this is somewhat akin to itulip's "ka-poom" theory where a deflationary crash (they call it "disinflationary," but whatever) is followed by a currency crisis that re-ignites inflation in a hurry. This is also somewhat akin to Trace Mayer at talking about fiat currency evaporating as the credit contraction intensifies. In the 1930s (the last deflationary/credit contractionary depression the United States went through), this event occurred via a re-pegging of the US Dollar to Gold after making private Gold ownership illegal. Overnight, by government decree, people's savings we re-valued lower by 70%!

So in the end, both the deflationists and inflationists will be proven right in a pragmatic sense, but I think we have to go through further deflationary pain before the step of a one-time rapid currency debasement occurs. Now this debasement could occur intentionally by government decree or via capital flight from the United States and either is possible. One of the reasons this is predictable in my opinion is because every wave of deflation is followed by more and more intense fiscal stimulus that is less and less able to be supported by underlying economic reality. In the end, something's gotta give.

This is not gloom and doom and I don't think the world is going to end. This is an actionable thesis that is worthy of investment consideration. Gold provides portfolio insurance that is growing more valuable by the day. Maybe this time is different. Maybe Obama and Ben Bernanke are so amazing that they can go ahead and spend another $1,000 trillion and no one will care and the rest of the world will buy our paper promises with an increasingly rabid appetite. Maybe unrealistic paper promises can be made ad infinitum and all economic realities will be suspended forever. Maybe we can re-inflate the credit bubble again and everyone can have a house, a car and a plane with no money down regardless of income and plus get a $1 million signing bonus at the time of closing. I'm guessing not, though.

Switching some of one's savings into physical (not paper) Gold now, while it can still be readily found, provides insurance against what is now an almost unavoidable future currency debasement event. Only the timing is still unclear in my mind, but you can bet that such an event won't be announced in advance and you won't be able to find physical Gold as a retail investor when it happens. Cash will ultimately deflate further relative to Gold and when it happens, the move will likely be fast and powerful. I think a dip of the Gold price to the low 900s or high 800s is dead ahead and will provide another great buying opportunity.

Friday, August 14, 2009

Green Hoot - Only 5 bank failures this week

and one credit union (see here and here). Clearly things are stabilizing, as only 6 financial institutions failed this week and only one (Colonial Bank) was a $25 billion institution with 346 branches. Keep in mind that the "massive bank failures" from the last "Great Depression" were in the hundreds to thousands per year, but this was before the day of counting one bank with 346 branches as only one failure. In other words, back in the 1930s, the failure of Colonial Bank alone would mean that there were 346 bank failures this week (and that's ignoring the other 5 failed institutions and their multiple branches)!

The Greatest Depression is intensifying right on schedule. The stock market hasn't discounted any of it and is dangerously oversold in the setting of obscene complacency given the fundamentals (see the last three paragraphs of this article). People who think the stock market has discounted the next wave of residential mortgage foreclosures, the current onslaught of commercial real estate walk aways, the massive pending regional bank failures (as if the ones that have occurred already aren't enough of a concern) and the tightening of the consumer belt that has been overdue for a decade are welcome to stay long stocks, commodities and corporate bonds.

Me? I'd prefer to stay in physical Gold, long Gold miners and short anything besides cash equivalents denominated in US Dollars. And believe me, once the pending deflationary wave ends in the next year or so, I'll be looking to take every US Dollar I've got and trade it for something else (probably more Gold and Gold miners).

Green hoots and spanky boots - get shawt or get out da way!

Buying a Few Junior Gold Miners

The junior Gold mining sector is the next mania in my opinion. As the forces of deflation intensify over the next few months and stocks, commodities and corporate bonds resume their bear markets, there are few places to hide. Gold is a great safe haven. The US Dollar will be a temporary, albeit risky safe haven that must be bought and sold at the right times to avoid major losses when the inevitable Dollar devaluation comes.

Junior Gold mining companies are risky, speculative plays. In aggregate, this sector is a wonderful investment. The problem is that some companies will go up 500-5,000% and some will go to zero. A basket of companies is always needed for proper diversification in this sector unless you know how to properly evaluate an early stage mining company and its management. I personally don't. So, I am looking to scale into this sector on weakness and start buying some of these companies.

Van Eck Global, the firm that brought you the senior Gold mining GDX ETF, has filed with the SEC to launch a junior Gold mining ETF. The ticker will be GDXJ, but it is currently unknown how long it will take until this vehicle is available.

I am not interested in spending the time or research to figure out "the" junior mining companies to own. I am compiling lists of junior mining firms listed on American stock exchanges mentioned by other analysts as worthy of investigation and am buying some of these stocks based solely on technical analysis with a small portion of my speculative capital, knowing that I will hit some home runs that should more than balance the strike outs.

Two firms I am scaling into and their charts follow. Again, keep in mind that I really know nothing about these firms and they may be total scams. I am letting the charts tell the story and using the old adage that "a rising tide lifts all boats." Even a pig stock can fly when its' underlying sector moves in a big way. And believe me, junior Gold mining stocks are going to move in a big way and the move will last for at least a few years.

First up, Gold Reserve (ticker: GRZ). Following is a one year daily chart:

Next up, Pacific Rim Mining (ticker: PMU). Following is a 16 month daily chart:

Just from looking at these charts, I know that these companies are not leaders in the sector, they are weaker firms. My guess would be that their fundamentals aren't great. I am trading their charts however, looking for a longer term pay-off. These are just a few of the junior Gold miners I am following while I patiently wait for attractive entry points to scale into the next big bull market.

Couldn't resist and went short the silver miner Pan American Silver (PAAS) yesterday on strength. This is a short-term trade.

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