The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Yesterday, we noted that the Fed seems to have declared the end of the recession based upon Industrial Production (Federal Reserve Declares Recession Over).

The folks over at Tableau Software took another swipe at the data, and found the answer is less clear cut then the Fed suggests.  A breakdown by sector is somewhat are far less conclusive than Industrial Production

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Sector Analysis of Industrial Production

Chart courtesy of Tableau Software

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Construction is the obvious laggard, with consumer goods 2nd to last . . .

Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.

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Investing in gold is tough because it challenges the investor to come to terms with the faults of his or her government, and then to act upon them. It requires the admission that there is risk in holding cash. This is counter-intuitive to this generation’s vintage of financial asset investor accustomed to thirty years of a credit build-up alongside declining interest rates.

There is certainly much more chatter in the press than in years past surrounding gold, and there certainly is more US retail investment (through ETFs) than there has been. That has been reflected to some degree in its rising price, no doubt. An ounce of gold has risen from about $250 in 1999 to current levels, having moved higher in each year and making it one of the best performing assets over the last ten years. So then, is a person that pays $1,100 an ounce today top-ticking the market by entering a crowded trade that has little upside and great downside?

We don’t think so.

Do your own research. Call your investment advisers and ask them what percentage, if any, they recommend investors allocate towards precious metals. Ring up prominent friends with substantial portfolios and ask them how much gold they have as a percentage of their portfolios. What about your fund managers overseeing, say $50 billion? Are they actually long $2.5 billion to $5 billion in precious metal plays? Our guess is that the figures in both cases will be very small, say 5% to 10% (if any at all).

Let’s extend this thinking. If people you know have only dipped their toes in the water and are doing more watching than investing in gold, then the past ten years of price appreciation must have come from elsewhere. Did it come from institutional investors? No, not in any great way. Most mutual and pension funds that report their holdings don’t own any gold – zip – other than very minor positions in precious metal mining stocks (and these stocks usually comprise less than 1% of their holdings). Hedge funds? Yes, it seems hedge funds have been buying gold but of those that have, most have less than 10% of their holdings in precious metals.

What about foreign central banks, Middle-East sheiks, Russians, ultra-wealthy families around the world? Yes, we would argue they “get the joke” and have been diversifying their wealth out of their home currencies and fiat currency-denominated assets into this scarcer currency.

Currently there is about $55 billion in global gold and silver ETFs – that’s it. (Does that qualify to be in the top ten of the any single issue in the DJIA?) It is estimated that all the gold mined in the last 5000 years is about 130,000 metric tons (each tonne converts into about 35,274 ounces). It’s a cube that would be roughly the size of a tennis court.

So let’s say there are 4.6 billion ounces of gold above ground, which means that at about $1,100/oz, the total global market value of all mined gold is currently worth a little over $2 trillion. By comparison, US Treasury debt was approaching $13 trillion, last we looked and we believe total US equity market capitalization is about $11 trillion. And then there are other bond markets (at least $8 trillion) money market funds, etc. There is also real estate.

In the US alone there is estimated to be about $65 trillion in present value private sector credit outstanding and trillions more in unfunded government obligations. And then there are the financial assets (stocks and bonds), real estate and public sector obligations for the rest of the world.

Global central banks are trying to keep it all afloat by printing even more money (by making more debt). The response by central banks to declining velocity has been and will continue to be the same as their responses to credit deflation – they will continue to print money. They may give it to their fractionally reserved banks that may then use the money multiplier to distribute more credit and in turn raise systemic velocity, or they may give it directly to debtors in the hope they will spend like drunken sailors again.

There is enormous embedded inflation already and more to come. The high-powered money has already been created; it is leveragable and it is there to increase velocity. Higher prices must follow.

Will the Fed and other central banks withdraw liquidity? No, never. They never have and they never will regardless of how many tools they proclaim are in their toolbox to do so. If money velocity picks up leading to rising consumer prices, it will also lead to rising market-priced interest rates. They may decide to cut back their monetization, but they will not drain money.

We can look at price inflation contemporaneously or we can throw the ball ahead of the receiver. The result will be the same. The defense is blitzing; Jerry Rice is standing all alone in the end zone; Joe Montana is going to get sacked….but the ball is already in the air.

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At current valuations the gold market is a tiny speck in relation to where perceived global wealth is being housed. The fundamental issue is one of ratios and relative future value. Our bet is that the gold-to-everything-else spread will narrow substantially. We are indifferent to whether gold rises to $10,000/oz. while the DJIA stays at 10,000 or gold stays at $1,100 while stocks and bonds crater. (In fact, we would love it if gold stayed at current levels while financial assets fell because then we would greatly increase our purchasing power vis-à-vis the rest of humanity and wouldn’t owe any capital gains tax!)

Further, we think that fundamentally gold is worth many multiples of its current price. Remember, it rose from $35/oz to $880/oz in a matter of nine years from 1971 to 1980, and the piece de resistance came in the last few months when everyone had to own it and its price went parabolic (it became a bubble).

There is chatter and there are fundamentals. (Consider that 250,000 people watch CNBC on a good day and 10 million people regularly watch Good Morning America. And remember CNBC and most business media focus on financial assets, not commercial business.) We think the gold chatter is a bunch of financial asset predators talking up their businesses. Needless to say, we don’t think gold is a crowded trade.

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I have a few quotes in Matt Taibbi’s no holds barred look at Wall Street’s profits and bonus culture.

It is classic Taibbi, full of righteous indignation and fury over the bailed out banks quick transformation from near bankruptcy to record profits. He details 7 scams the various TARP recipients have pulled.

Here’s a taste of the article:

“The nation’s six largest banks set aside a whopping $140 billion for executive compensation last year, a sum only slightly less than the $164 billion they paid themselves in the pre-crash year of 2007.”

The question everyone should be asking, as one bailout recipient after another posts massive profits — Goldman reported $13.4 billion in profits last year, after paying out that $16.2 billion in bonuses and compensation — is this: In an economy as horrible as ours, with every factory town between New York and Los Angeles looking like those hollowed-out ghost ships we see on History Channel documentaries like Shipwrecks of the Great Lakes, where in the hell did Wall Street’s eye-popping profits come from, exactly? Did Goldman go from bailout city to $13.4 billion in the black because, as Blankfein suggests, its “performance” was just that awesome? A year and a half after they were minutes away from bankruptcy, how are these assholes not only back on their feet again, but hauling in bonuses at the same rate they were during the bubble?

The answer to that question is basically twofold: They raped the taxpayer, and they raped their clients.”

Every now and again, you spend some time with a journalist, trying to push them down a particular path of discovery. Sometimes you influence a story a bit, end up with a quote or two, but otherwise are a minor factor.

I am thrilled with how much of our conversation ended up in this article. Regular TBP readers will see my fingerprints all over this one . . .

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Source:
Wall Street’s Bailout Hustle
MATT TAIBBI
Rolling Stone, Feb 17, 2010
http://www.rollingstone.com/politics/story/32255149/wall_streets_bailout_hustle

“People believe that municipal debt is safe based on assumptions that are no longer true.”
-Kenneth Buckfire

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The above quote comes from the CEO of Miller Buckfire & Co., an investment bank that is currently advising cities on municipal restructurings. Technically, these are called Chapter 9 reorganizations.

The WSJ notes:

“The seldom-used part of U.S. bankruptcy law gives municipalities protection from creditors while developing a plan to pay off debts. Created in the wake of the Great Depression, Chapter 9 is widely considered a last resort and filings under it are more taboo than other parts of bankruptcy code because of the resulting uncertainty for everyone from municipal employees to bondholders.

The economic slump, however, is forcing debt-laden cities, towns and smaller taxing districts throughout the U.S. to consider using Chapter 9. As their revenue declines faster than expenses, some public entities are scrambling to keep making payments on municipal bonds. And that is causing experts to worry about the safety of securities traditionally considered low risk.”

There have been but 600 cases since this chapter of the bankruptcy code became law in 1934. The largest Chapter 9 filing was back in 1994, when Merrill Lynch bankrupted Orange County, California via a form of unsuitable investments that lost a billion plus dollars on a form of Interest Rate Swaps.

Given the various pressures states and cities are under, a surge in municipal bankruptcy filings is all but unavoidable . . .

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Source:
Muni Threat: Cities Weigh Chapter 9
IANTHE JEANNE DUGAN And KRIS MAHER
WSJ, FEBRUARY 18, 2010
http://online.wsj.com/article/SB20001424052748704398804575071591602878062.html

Good Evening: U.S. stocks closed higher once again on Wednesday, though with quite a bit less zest than they displayed yesterday. Though they are still reflected in racy news stories, anxious editorials, and cautionary market letters, worries about Greece have receded for the time being. Investors, it seems, wish to focus on things like corporate earnings while leaders in both Greece and the EU wrestle to find a mutually acceptable way forward.

Perhaps it’s appropriate that the nation that gave birth to the Olympic Games should have its financial issues fade into the background during the winter edition of the ancient Olympiad. The fortnight of competition in Vancouver may not bring Greece any closer to stability, but the Games will be more pleasant to watch if the political wrangling takes a back seat for a while. Soon enough will Greece know its fate; it’s unfortunate that more than a decade of budgetary comedy will likely lead to the tragedy of fiscal stringency. How long will the U.S. and U.K. be able to avoid a similar comeuppance?

This morning’s economic data (housing starts, industrial production, capacity utilization, etc.) was mixed and a non factor. Deere’s frisky earnings report, however, did lend a bullish backdrop as the opening bell rang in New York. But after opening 0.2% to 0.4% higher, the major averages spent the rest of the day in a narrow range. Not even the release of the minutes from last month’s FOMC meeting could jostle Mr. Market from his slumber today. Oh, the Fed did once again talk about getting tough some day, but few market participants took the words as a sign of clear and present danger. The indexes went out just about where they opened, with gains ranging from the Dow’s 0.4% to the Russell’s 0.6%. Treasurys were weak, and yields rose between 3 and 7 basis points. The dollar was firm all day before it closed 1% higher, but the greenback’s levitation didn’t much affect commodity prices. The precious metals slipped, but the CRB index fell a mere 0.3% on Wednesday.

During the Christmas holidays, my youngest son prevailed upon me to take him to see the movie, “2012″. This escapist disaster movie didn’t threaten to enter my personal top ten list, but I did find two aspects of the movie interesting. The violent shifts in the earth’s crust depicted in the movie and the resulting super-tsunamis that washed up on shores across the globe were an interesting metaphor for the huge tide of debt sloshing around the world here in 2010. I also found it fascinating that the writers of the screenplay decided that salvation for John Cusack and the rest of humanity lay in long range planning — and some vital assistance by the Chinese.

I don’t want to push this comparison too far, but avoiding a financial version of 2012 will be difficult for many governments during the next couple of years. The focus may be on Greece for the moment, but Iceland and Ireland preceded them in the debt wringer months ago. Spain, Portugal, and Italy are also lined up for the same treatment, but how many investors really believe such a fate could one day befall Great Britain, or even the United States? Given the latest news on international capital flows, it doesn’t look like Uncle Sam can count on China to keep supporting its debt habit (see below). Japan has stepped into the breach by upping its Treasury purchases in recent months, but Japan has huge and growing budgetary problems of its own to contend with as its society ages and saves less. It seems only a matter of time before the U.S. must start facing the same painful realities facing Greece and the others right now.

The final two articles you see below reach similar conclusions, though they each tackle the problem from slightly different perspectives. Niall Ferguson’s “A Greek crisis is coming to America” depicts the daunting fiscal challenges looming for both the U.S. and U.K. For Mr. Ferguson, there is “no such thing as a Keynesian free lunch.” To him, deficits do matter, and for the U.S. to continue on its present course is sheer folly.

“We’re All Austrians Now”, by Paul Brodsky and Lee Quaintance of QB Partners, examines the same issues with a perspective more sensitive to the impacts of monetary policy and the investment implications of our financial woes. One of the authors’ keenest insights is that investors should rank asset classes from “least risky” to “most risky” not only in nominal terms, but in real terms as well. Since the authors believe our political system is poorly equipped to administer the medicine of liquidation and debt deflation, they see monetary inflation and currency debasement as the ultimate outcome. They even prescribe their own “cure” for the problem, one for which any holder of precious metals and their related equities will have sympathy.

Since there is no way I can do either piece justice in these paragraphs, please read them for yourselves. You may not agree with every word, but you will find yourself thinking these issues will require the type of leadership, responsibility, and shared sacrifice that have been increasingly hard to find in Washington D.C. during the post-WWII era. You will also find yourself wondering where you’ve heard warnings like these before. And then you’ll remember how many thoughtful individuals (Jim Grant, Bill Fleckenstein, Barry Ritholtz, and Jeremy Grantham leap to mind, but there are others) offered warnings about the dangers of crazy mortgage lending during the housing bubble. Like the authors below, many of these same folks now see some variety of a funding crisis washing up on these shores some day soon. Suddenly, 2012 doesn’t seem all that far off, does it?

– Jack McHugh

Stocks, Dollar Advance on Economy Outlook as Treasuries Decline
International Demand for U.S. Financial Assets Slowed
In Ireland’s deep budget cuts, an omen for a heavily indebted United States?
Moody’s Says U.K., U.S. Aaa Ratings Relatively Weaker
A Greek crisis is coming to America
We Are All Austrians Now

Leave it to The Onion to speak the Truth:

The U.S. economy ceased to function this week after unexpected existential remarks by Federal Reserve chairman Ben Bernanke shocked Americans into realizing that money is, in fact, just a meaningless and intangible social construct.

What began as a routine report before the Senate Finance Committee Tuesday ended with Bernanke passionately disavowing the entire concept of currency, and negating in an instant the very foundation of the world’s largest economy.

“Though raising interest rates is unlikely at the moment, the Fed will of course act appropriately if we…if we…” said Bernanke, who then paused for a moment, looked down at his prepared statement, and shook his head in utter disbelief. “You know what? It doesn’t matter. None of this—this so-called ‘money’—really matters at all.”

“It’s just an illusion,” a wide-eyed Bernanke added as he removed bills from his wallet and slowly spread them out before him. “Just look at it: Meaningless pieces of paper with numbers printed on them. Worthless.”

According to witnesses, Finance Committee members sat in thunderstruck silence for several moments until Sen. Orrin Hatch (R-UT) finally shouted out, “Oh my God, he’s right. It’s all a mirage. All of it—the money, our whole economy—it’s all a lie!

Source:
U.S. Economy Grinds To Halt As Nation Realizes Money Just A Symbolic, Mutually Shared Illusion
The Onion, February 16, 2010 | Issue 46•07
http://www.theonion.com/content/news/u_s_economy_grinds_to_halt_as

The power of counterfactual reflection on life’s pivotal moments. According to new research by management professors Laura Kray and Philip Tetlock, counterfactual thinking — considering a ”turning point” moment in the past and alternate universes had it not occurred — heightens one’s perception of the moment as significant, and even fated. Armed with a sense that life may not be arbitrary, counterfactual thinkers, the study suggests, are more motivated and analytical in organizational settings. (04:44)

Some items that caught my eye today:

• How to walk the fiscal tightrope that lies before us (FT)

• Wall St. Helped Greece to Mask Debt Fueling Europe’s Crisis (NYT)

• Tougher financial regulations not coming fast or easy for SEC’s Mary Schapiro (WaPo)

• Banks step up spending on lobbying to fight proposed stiffer regulations (LA Times)

• Use of temps may no longer signal permanent hiring (Yahoo)

• Why Orwell Endures (NYTimes Reiew of Books)

• U.S. Supports New Nuclear Reactors (NYT)

• Caring for Pets Left Behind by the Rapture (BusinessWeek)

• Vice Over IP: The VoIP Steganography Threat (IEEE)

• Tea Party Lights Fuse for Rebellion on Right but see also:  Majority Of Tea Party Group’s Spending Went To GOP Firm That Created It

What are you reading?

Interesting data set from Dave Rosenberg:

• Households own $18.2 trillion of residential real estate, even after the value destruction of the past three years.
• Households own $18.1 trillion of equities, despite the vicious bear market.
• Households own a near-record $7.7 trillion of deposits and cash — earning next to nothing in yield.
• Households own $4.6 trillion of consumer durable goods.
• Households own $3.5 trillion of corporate bonds and municipal/agency paper.
• What do households own in Treasury notes and bonds? Try $800 billion.

Pretty fascinating stuff . . .