Aubie Baltin CFA, CTA, CFP, PhD.
To begin, in order to get a clear understanding of today's true picture, we must first realize that the latest economic boom is built on a lie. Instead of a foundation of real GDP growth, it was based on a manipulated low inflation rate and tidal wave of new "out of thin air" Fiat money. That flood of cheap money did what it always does; produce a BUBBLE of risky investments and massive speculation. And as night follows day, "A house built on a weak foundation will not stand". After having just brought the world to the second worst bear market in history while almost taking down the global financial system in the process, within 2 years we have come back with another Tsunami of new money in an attempt to reverse the inevitable. The key to ask yourself, "Is there a second shoe that is about to fall and when will it fall?"
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total collapse of the currency system involved." ~Ludwig Von Mises
THE BIGGEST PONZI SCHEME
Has anyone bothered asking why banks that are so stuffed with money are refusing to lend? And if they are not lending, where are all profits of the "too big to fail" banks coming from, as 20 banks a month are closed or merged by the FDIC?
One reason is that the pendulum on risk management has swung to ultra - cautious levels. But the more logical reason is that they know that all their reported profits are really Phantom Profits and are only due to the accounting rule change that allows them to no longer mark their Toxic Assets to market, but to a model of their own choosing instead. Furthermore, they have stopped most foreclosure proceedings so they no longer have to realize their losses. Meanwhile, they are only able to continue to show profits because they are still on the FED'S intravenous feeding tube: Borrowing money from the FED at 1/2% and buying FHA (government guaranteed) Bonds yielding 5% that do not require any reserves to be maintained. Fantastic Deal If You Can Get It: Getting paid to be part of a government charade.
However, there is an ominous problem waiting in the wings: The days of commercial real estate refinancing are at hand. A good part of them won't qualify for refinancing or will be required to be refinanced on existing terms, irrespective of the huge decline in cash flow and value of the property - extending and pretending - some of the destroyed value will still exist at the next refinancing date. Sooner or later, all the Toxic Assets on their books will have to be realized. That is the real reason why they are not lending. They've got to hold on to every dollar they have to hopefully fill the lurking commercial and private real estate holes or else they, too, will be gone."
WILL WE EVER LEARN?
The powers that be have once again learned nothing from this near death experience because here we are again, printing money and monetizing debt like there is no day of reckoning, in another vain effort to paper over our problems and create prosperity with the printing press. It's too bad that our expert (Bernanke) on the 30's Depression seems to have only learned to repeat the exact same mistakes of the past without ever realizing that Past Is Prologue.
We have seemingly survived the credit crisis and all appears to be well in the world. However, looking through all the misinformation and propaganda, we soon discover that there is that age old cancer growing that is many times bigger than the one Greenspan created. Can you hear the rhyming? This cancer isn't going to show up in real estate or credit markets, those bubbles have already burst. This time our new BUBBLES are flaring up again in the Stock Markets and as inflation in the Commodity and PM markets, while Bank lending to small and medium sized business continues to evaporate as the real economy continues its slide into Depression.
THE BUBBLES OF 2010
Witness the strange resilience of Oil to $80+ despite a worldwide shrinkage in usage in the face of huge new energy discoveries and an unexpected strong dollar for the past 3 months. And YES, Gold is still holding over $1100. Sugar is at multi - year highs. Copper is less than 15% from all - time highs etc., etc. Stock markets all over the world instead of crashing are trying to break out to new highs. The fact that the world's stock markets are rising on ever decreasing volume doesn't mean anything. Don't bother us with the facts, Aubie; you're always being a KILL JOY. But what else should we expect? All that new "out of thin air" money has to go somewhere.
The commodity markets are now poised to unleash a massive inflationary storm. I think there's a very good chance that storm will strike this spring.
The dollar is now deep into its bubble rally and most likely putting in it's top at any time. It is only being kept afloat by all the other Fiat currency's race to the bottom. When it finally resumes its down trend, the flood gates could break and we will have to deal with the unintended consequences of our new FED Chairman's Socialistic actions.
THERE ARE NO PAINLESS LONG TERM CURES FOR INFLATION & RECESSIONS
There are no painless solutions for curing inflation, especially during an ongoing Recession. The only cure is to let the Free Market clean house and set the stage for the next boom (1866 - 1896, the 1920's and 1980's). The cure is to raise rates and drain liquidity (Reagan 1980) to induce a Recession or a short Depression, if that is what it takes. The alternative is a 20 year Depression as in the 1930's. Does anyone really believe our elected officials will choose that difficult but correct course of action, even if they knew what that action entailed?
On the other hand, doing more of the same leads to higher and higher inflation and running the presses faster and faster to stay ahead of rising prices, eventually culminating in a hyperinflationary spiral, and a loss of our reserve currency status, especially if government debt is allowed to spiral out of control, beyond the point of no return.
FROM THE FRYING PAN INTO THE FIRE
Unfortunately, I think it's probably too late to stop the storm. We have uncertainty all around us. What will our taxes look like over the next 12 months, especially when the Bush Tax Cuts expire? What about Health Care? Who would want to either expand or start a new business in the face of the tremendous "anti - business rhetoric" coming out of Washington and who will buy our bonds without a credible plan to reduce the deficit? Any plan that has Reid, Pelosi and Obama as its guarantors is by definition not credible.
History has been crystal clear - every time oil spikes 100% or more within a year's time, it has pushed our economy into a Recession, but since this time we started in Recession, the push will be into Depression now that we already have a spike from $32 to over $80. In checking my own heating bills, I noticed that they have increased 4 fold. What effect will that have on our economy, taking into account the normal lag effects of all our recent global warming?
AMERICANS AND GOLD
Meanwhile 99.99% of the American public continues to be totally deceived about the fraudulent nature of paper money, as Americans are not buying Gold or Silver in significant quantities. Less than 1% of paper money is being spent on Gold per year, despite all the ads there are for investing in GOLD - there are even more offering to buy all your scrap gold jewelry at record high prices.
- The US Official Gold reserves are thought to be 261 million oz. With Gold at about $1130/oz., that gives us only $295 billion of "backing" for the dollar. Dollars held in US banks amounts to approximately $14 trillion: $295 billion / $14,000 billion = 2.1% Gold backing for dollars in US bank accounts.
- The US Mint makes about 1 million, 1 troy oz. Gold Eagle coins per year. This is a good estimate for the amount of Gold being bought by Americans per year which, at $1130/oz. = $1.1 billion. Relate that to the $14 trillion in US Banks and that give us $1.1 billion / $14,000 billion = 0.007% being spent on domestically produced Gold per year.
On the other hand, Federal Reserve Notes have achieved 100% market penetration here in America and because of its Reserve Currency status, have also achieved maximum market penetration around the world as most Central Banks hold a major share of their reserves denominated in US dollars.
Business theory suggests that after achieving such market domination, the only way left to see much of a change is down, which is exactly what it has been doing since 1913 and especially since 1971 when Nixon closed the Gold Window.
A nation that lies about its money will lie about everything else to protect that lie.
It is very rare that the big money is made by following the herd, and the herd seems to be almost numb to everything that has just passed and completely oblivious to what's coming.
YOU PAYS YOUR MONEY AND YOU TAKES YOUR CHANCES
Is it to be business as usual, despite the government's clearly stated intentions to spend, spend, spend and tax, tax, tax, OR is there a serious currency crisis in our future as interest rates start to rise and the world wakes up to the fact that the U.S. is bankrupt.
Back as early as late 2005: As I was beginning to warn about the approaching Stock and Real Estate Bubbles, Bernanke went on record (August 2005) saying that the housing bubble was nothing to worry about. Should we trust him this time about his ability to reverse trend in the nick of time?
HAS THE MONETARY INFLATION TSUNAMI ALREADY BEEN LAUNCHED?
For at least a year, I have been warning you about how the current administration's policies will affect the economy, especially if the Government allows the Bush tax cuts to expire.
Expiring Tax Cuts (Jan. 1 2011) is the exact same thing as a Tax Increase and all the government has to do is stand around, argue and do nothing. The resulting sell - off could make the sub - prime shocker and the credit crunch look like child's play. Do you think it is wise to continue to buy paper assets until the inevitable happens?
REAL EARNINGS VERSUS ENGINEERED EARNINGS
The Bullish argument is that the S&P 500 should earn something on the order of $75 in 2010. Using a P/E multiple of between 17x and 20x, stocks still have great upside suggesting that the S&P could wind up at 1500 by year - end. That's a yearly gain of some 35% - NOT BAD.
While there are several flaws in this argument, I will restrict my analysis to the issue of the earnings and how they are calculated. Before the tech bubble forced analysts to create new ways to calculate valuations, earnings were earnings, companies followed GAAP (Generally Accepted Accounting Principles) guidelines when reporting earnings. But as the great Bull Market progressed, it became impossible for companies to justify their valuations using GAAP, so they invented "operating earnings." The idea was to smooth out the earnings numbers and eliminate the impact of big, non - recurring expenses or gains. Eventually the financial engineers expanded their view of one - time items and eliminated any expenses that didn't look good.
According to Ned Davis of Ned Davis Research, operating earnings have turned into financially engineered results which utilize only the "good stuff." And in Ned's words, operating earnings wind up being whatever the company says they are - i.e. they are not actual earnings.
OPERATING VS. GAAP VS. OWENER'S EARNINGS
For 2010, operating earnings are projected to be $70.86 to $75 for the S&P 500 for the year ended 9/30. If you put a 17x multiple on that, you get 1204. And if you go with at 20x multiple, you get 1500. Thus, with the S&P 500 currently sitting at 1150, it is easy to argue that stocks have some great upside.
The problem is that according to Ned, projected GAAP earnings for the same time period are only $55.85. Thus, a 17x multiple projects the S&P to trade at 950 while a 20x multiple puts it at 1117. So, with the S&P at 1150, one could argue stocks are overvalued. However, if you throw out all the financial tricks and take the idea of earnings down to what Warren Buffett calls "owner's earnings" the picture is very different.
As a value investor, it is a safe bet that Warren Buffett knows a thing or two about earnings. And as someone who likes to keep things simple, Buffett's view of earnings boils down to cash flows that can be delivered to investors as dividends or retained by the company for future use. The problem here is that these so - called "owner's earnings," which, we will admit are also subject to interpretation, are well below both GAAP and Operating Earnings. NDR went back to 1970 and calculated the 5 - year average of all three approaches to earnings: The 5 - year average of Operating Earnings for the S&P 500 was around $84; GAAP earnings are about $57; and "Owner's Earnings" are in the vicinity of $36.
PICK YOUR POISON
I am not suggesting that "Owner's Earnings" are the best and only way to look at the market from a valuation standpoint. Should Wall Street shift back to GAAP earnings? It's your money; I am simply pointing out that you need to use a very rosy (and not terribly accurate) view of Operating Earnings in order to justify a lot of upside in the stock market. However, let's keep in mind that this type of macro thinking has little - to - no use on a short - term basis and that the market can and usually does do whatever it has to do to make the majority wrong.
HOW NOW DOW
Now that we are in a new BUBBLE, there is similar stock market behavior going on today as there was back in September - October 2007. This suggests that the third leg of this Bear Market, (the second major down - leg) may be close at hand. Now that all the averages have exceeded their January 19th highs, it could possibly serve to create THE BIGGEST BULL MARKET TRAP in history. There is nothing that can change my view that we are in both a bubble and a manipulated topping phase and that a major top is due shortly. Instead of continuing to try and guess exactly when a Bubble is about to explode, I will wait until it actually convinces me that the Ball Game is over, at which time I will send out a SPECIAL BULLETIN to subscribers only. So make sure your subscriptions have been renewed. You most definitely do not want to miss this one.
In the meantime, continue to build up your cash, buy GOLD and wait. The hardest and most important attribute to being a successful trader is PATIENCE.
GOLD
There is really not much more that I can add to what you have already read over the last few weeks or so in UCCS and on Gold - Eagle.com.
Gold and the HUI are solidly within their rising trend - channels. The Bulls are snorting and the Bears have come out of hibernation: BUY
Chinese Gold reserves are now estimated as being 33.89 million ounces - or just over 1,000 tons, making it the world's sixth largest holder of Gold after the US, Germany, the IMF, France and Italy - that is excluding their 1,100 tons held in the Gold Trust ETF (GLD). Purchases over the past six years had been made by the Chinese State Administration of Foreign Exchange (CSAF) rather than by the Peoples Bank of China (PBOC) and have now been transferred to the PBOC. This transfer is particularly important in that the Gold has been added to the monetary reserves held by the Central Bank. This indicates the extent to which Gold is being rehabilitated as a monetary reserve asset, not only by the Chinese monetary authorities, but by Central Bankers around the world and suggests that monetary authorities are looking at Gold as a monetary asset with greater interest than at any time since the 1960s. All this is not surprising given that the total amount represents a relatively cautious buying program spaced out over six years, and that the Gold was all bought from Chinese domestic refiners and did not have any impact on the international Gold Market. Recently, information received from 'numerous' Central Banks suggest that more and more of them have become interested in adding Gold to their monetary reserves. This suggests that Central Banks may become net purchasers of Gold in the years ahead, rather than net sellers as they have been since the 70's.
THE PROPOSED IMF GOLD SALE
It is either a non - event or could be the trigger setting off a big rally in Gold, as has always occurred in the past (a minimum 15% explosion). India has already expressed an interest in buying, but rest assured China will NOT allow the Indian Central Bank to snatch that Gold from under their noses as they did at the IMF'S last Gold sale. Do I hear BIDDING WAR?
WHAT TO DO NOW
Continue to accumulate both Bullion and Gold and Silver stocks into weakness or on breakouts to new recovery highs. A $14 trillion injection of new money that will be increasing by a minimum of $2 trillion a year as far as the eye can see has got to go somewhere. Up until now, it has been seeping into the Stock Markets and Commodities. However, those markets are close to having run their course. My preferred bet is that we are about to see a rapid shift into precious metals. A breakout is most likely, but its timing is as impossible to predict as is the bursting of a Bubble. The really smart, big money like SOROS, PAULSON and a host of others has already started their buy programs. Follow the SMART MONEY.
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Please Note: This article is for education purposes only and is designed to help you make up your own mind, not for me to make it up for you. Only you know your own personal circumstances so only you can decide the best places to invest your money and the degree of risk that you are prepared to take. The Information and data included here has been gleaned from sources deemed to be reliable, but is not guaranteed by me. Nothing stated in here should be taken as a recommendation for you to buy or sell securities.
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