But underneath the elation over Dow 10,000 lies the palpable feeling that this rally is to be “rented,” not “owned.”

As cool weather descended upon the Northeast U.S., risk appetites started to wane. At the beginning of October traders and investors finally sobered up. Were they second-guessing whether government spending could actually kick-start a sustainable recovery? Both stocks and corporate bonds sold off sharply.

Then today I woke up to these headlines:

“Stocks Climb as New Week Starts for Wall Street.”

“Hasbro 3Q profit rises 8.8 pct on cost-cutting”

“PetMed Express 2Q earnings rise 12 percent”

Here’s why you shouldn’t believe the hype…

Cost Cutting Does Not Equal Top Line Growth

Over the next several months, mainstream pundits and forecasters will start worrying about tepid hiring, even as the pace of job losses slows. As we “lap” the 2009 corporate cost cutting by early 2010, and top lines fail to rebound, earnings estimates will have to come back down. I’m amazed at how many sell-side analysts are modeling V-shaped recoveries in 2010 earnings. Most stock prices are simply disconnected from reality.

Sell-Off at the First Sign of Trouble

The bulls are now enjoying their victory lap after having bid the Dow Jones industrial average above 10,000 last Wednesday. It’s puzzling to see “investors” happy about buying into a market that’s clearly overvalued. A rational, disciplined investor would be fearful about buying today, after prices have been jacked up by an unprecedented seven-month rally.

Bulls see any cautious sentiment-that “rented rally” feeling-as a source of more untapped buying power, but I see it as a reflection of weak hands being the marginal buyers; at the first sign of disappointment, they’ll look to sell. My read of the sentiment surveys is that patient value investors are skeptical and bearish, while momentum investors are bullish simply because prices have been going up.

Fund Managers Won’t Ride to the Rescue

Despite the popular sentiment that “fund managers gotta keep buying into year-end to avoid underperforming,” which would keep this market in the stratosphere, the odds heavily favor lower stock prices in the coming weeks and months.

Data from reliable sources like TrimTabs show that not only is the labor market far weaker than advertised, but net inflows into stock mutual funds have slowed to a trickle, occasionally turning into outflows. This tends to give mutual fund managers itchier trigger fingers, since cash balances in equity mutual funds are already near record lows.

Pensions aren’t going to ride to the rescue either, since they were, with 20/20 hindsight, overinvested in stocks in 2007.

Buying Momentum Could Run Out

Momentum players face the prospect of having nobody-aside from another momentum investor-willing to buy their expensive stocks at today’s prices. Patient, disciplined investors are only willing to buy at much lower prices. This could lead to an air pocket where the market could correct dramatically and quickly, without an obvious catalyst — not that there is a shortage of bearish catalysts, ranging from bank failures to home foreclosures to a crisis in fiat money.

Some pundits point to corporate mergers and acquisitions as reasons to be bullish, ignoring that fact that most deals occur closer to the peak of markets, and most deals destroy shareholder value, because the buyer overpays.

Corporate CFOs and Treasurers are happy about the recent bull market in risk. They know much more about their prospects than outside investors, so their balance sheet management is telling. In a word, the approach toward capital structure is “defensive.” Heavily indebted companies are flooding the market with follow-on stock offerings to pay down debts. They’re also taking advantage of the Pollyannaish mood of the corporate bond market to issue risky bonds at attractive rates, as default risk seems to be a distant memory of bond buyers. Many corporate bond investors have taken the Fed’s bait to reach for yield, regardless of credit risk.

Most investors, however, have permanently dialed down their risk appetites, and therefore will not chase this expensive market. Those buying stocks at today’s valuations—especially U.S.-centric finance and retail stocks—will have a very hard time finding someone to pay an even higher price in the future.

Will Government Solve the Problem? No.

The big questions back at the beginning of the month: What kind of economic environment do we face? And more important, what’s already priced into the stock market? Here’s my view on these themes: As we see with “cash for clunkers,” government stimuli simply steal demand from the future.

Another big question is how will policymakers respond to a sluggish-to-nonexistent rebound in hiring?

The labor market is dealing with a structural imbalance fueled by government-sponsored housing and credit bubbles. Many will call for the government to “solve” this labor market problem, which will cause a new type of market dislocation. By early 2010, some will push for the federal government to start hiring the chronically unemployed in “New Deal” type of programs. [Count on this-Ed.]

But more importantly — because this is not yet a mainstream view — the real job creators in the U.S. economy, small businesses, will not expand hiring as expected. There are many reasons for subdued hiring plans; an emerging reason to avoid expansion and hiring will be heightened expectations that tax rates will soar in the future to pay for out-of-control government spending.

The economically illiterate, and those with preconceived “big government” agendas, will use any crisis as an excuse to expand government. You’ll be ahead of the game if you realize — as many in the media and academia clearly do not – that the government has no resources. It’ll take money out of one of your pockets, skim some off for its cronies, and expect you to be grateful when they put some of it-debased by the Fed’s inflation, of course-back into your other pocket.

Where you stand on this will determine your expectations for the future performance of most stocks (ignoring special situations). I certainly don’t enjoy having such a bearish outlook on the economy, but it’s the conclusion I reach after weighing all the evidence about the real economy; the credit markets; and policymakers’ damaging, distorting influence.

I’d recommend you adjust your portfolio accordingly.

Regards,
Dan Amoss

October 19, 2009

This Stock Market Rally Is Rented, Not Owned was originally featured on Whiskey and Gunpowder

According to USA Today — I know, not the most hard-hitting rag out there — contestants on shows like America’s Got Talent and Deal or No Deal have undergone a dramatic change in the past year.

Instead of dreaming of building a mansion or retiring early, the poor saps that go on those shows are now just hoping to win some kind of money to keep afloat. On Deal or No Deal, the percentage of unemployed prospective players jumped from just 5% of its total applicants to 20%.

Who Wants to be a Millionaire’s host, Meredith Vieira, claims that her contestants no long play for big prizes. They’re there to collect a few mortgage payments or to help pay off credit cards.

Apparently, the market’s recent fake recovery hasn’t ended this game show contestant trend. Vieira notes, “There’s still a sense of need, as opposed to want.”

This could spell disaster for marketing these shows. No one wants to watch desperate people cashing out early so they don’t have to move.

“Mustn’t Watch TV” aside, you shouldn’t be surprised by the still-pathetic situation out there. After all, one of the favorite buzz phrases on CNBC is “lagging indicator.” Forget that the phrase is an oxymoron for a moment. It’s applied to – more than anything else – unemployment numbers.

We have seen a slow down in job losses, which is to say that we aren’t losing jobs in this country as fast as we were. July even saw a slight increase in employment. I suspect a portion of that tiny bump is due to people giving up. If you aren’t applying for jobs, you no longer count.

We like to think of unemployment as a percentage. But it’s important to put the actual number of would-be-workers into perspective.

We have about 14.5 million unemployed people in the U.S. — at least 14.5 million reported unemployed people. Of those, we have a significant amount that has been in that situation for more than half a year.

As this chart shows, that’s the most people on the dole since the Second World War:

This begs the question: if we do ever recover, where will these new jobs come from?

Where’s Our Next Bubble?

Speculating about which industries will provide future jobs is still damned near impossible. Could Obama’s “green tech” jobs ever come to fruition? Possibly, but it won’t be in the near future. Right now, no one can even afford those kinds of products.

Even with amazing developments in turbine technology over the past few years, it still costs about 67% more for wind power than it does for coal or nuclear power. So for electrical engineers, there might be jobs in the R&D stage of this “green revolution.” For the majority of the 14.5 million unemployed, however, that’s of no help.

It’s doubtful that we’ll see a real recovery in manufacturing jobs. That’s one segment in serious trouble. We didn’t even see it recover during the boom from its 2001 lows.

Technology is one area with some potential. Americans’ need for the latest digital toy hasn’t dissipated in this rough economy. Sure, no one can afford new plasma TVs, but just take a look at AT&T’s iPhone 3G sales this summer. Pretty impressive.

We aren’t going to stash our life savings into Apple, but we are keeping our eyes peeled to see what comes next.

The energy sector, of course, needs a recovering economy to be of importance. It’s certainly not going to lead us out of our recession. Once we do recover, however, drills will once again meet the dirt and create some jobs. But right now, we’re seeing a lot of abandoned wells across our country.

We could always just pile back into the financial services industry and pretend the past two years were a dream. Unfortunately, that’s quite possible knowing how forgetful that crew is.

Wherever new jobs come from – if they come at all – and no matter which industry leads the way, we need to keep a careful watch over every sector. As you can see in one of our favorite charts, if you know which sectors are heading in which direction, you stand to make a lot of money:

There’s no doubt we’ll replace the financial bubble with another one – just like we did with the tech bubble in the 90s. So…where’s our next bubble?

Regards,
Jim Nelson

September 7, 2009

Recovery and Jobs; Where’s the Next Bubble? was originally featured on Whiskey and Gunpowder

Right now, the market has priced bank stocks for perfection, but the earnings outlook remains bleak. Investors are excited about the wide yield curve that’s enabling banks to borrow at ultra low rates and lend at much higher rates. But starting a few years ago — and going forward a few more years — losses on loans made during the bubble will matter more than the wide yield curve. More bank failures, capital shortfalls, dividend cuts and shareholder dilution are in the cards for most bank stock fans.

Because bank stocks usually act as a canary in the coal mine, a continued bear market in banks translates into a continued bear market in most other stocks. The evidence tells me we’re experiencing a bear market rally, not a new bull market. The promoters of the idea that this is a new bull market are ignoring one of the worst enemies of stocks: uncertainty. Right now, especially considering aggressive government policies, uncertainty about the future business environment is very high.

As regular readers of Whiskey & Gunpowder know, the government’s land grab is going to make things worse. It seems that there’s no end to the threats facing corporate profits, which will make corporate loans that much harder to pay back. This is not a garden-variety recession. It’s more like a depression, so the so-called economists parroting the “recession is over” message will have a rude awakening soon enough.

Let’s briefly consider the sentiment toward overall market. Aside from the investor sentiment polls, you can tell how bullish investors are by the multiples they are willing to pay for stocks. And right now, after the sharpest 5-month rally since the 1930s, the market is trading at valuations that require a strong economic recovery, and a return to credit bubble conditions. The rally was powered entirely by P/E multiple expansion, not earnings growth. That sort of rally would be justifiable if corporate revenues and earnings were about to soar, but they’re not. Most earnings surprises were due to cost cutting, rather than top-line growth, which is like burning your furniture to stay warm.

The market is not even that cheap when you consider how artificially inflated earnings were at the 2007 peak. Financial earnings made up 18% of the S&P 500’s earnings in 2007 — much more if you add the “earnings” from the finance divisions of industrial conglomerates like GE and GM. Any claims that the S&P 500 is cheap because 2007 somehow represents “normalized earnings power” are bogus. The corporate profit margins and earnings won’t return to that level for many years.

The talking heads are getting more creative in their rationale for owning stocks right now. Most money managers seem to be thinking: “I don’t believe in this rally, but I’ll ride it until it looks like it’s over, and then I’ll sell.” This is the type of dangerous crowd psychology that consumes most people during bubbles. When enough investors share this Ponzi sentiment, and nobody’s investing on the basis of sober, rational fundamental analysis, the result is sometimes a crash.

Bank Accounting: Educated Guesses about the Future

This brings us to the poor quality of earnings, particularly at commercial banks. Accounting — especially the accounting that produces income statements at banks — is more art than science. It’s as much opinion as it is fact. Bank executives have a lot of leeway in how and when they recognize credit losses. As you’d imagine, some of them have more creative imaginations than others. Some are actively engaging in “extend and pretend,” a practice in which banks refinance deadbeat borrowers to avoid reporting loan losses.

Banks make loans expecting to receive interest and principal payments in a timely fashion. Banks book revenues, expected credit and operating costs, and profits associated with every loan upfront. But as we’ve discovered, the credit costs, or losses, often wind up being much larger than originally expected. When this happens, banks must dramatically ramp up their “loan loss provision” expense, which cuts into earnings, often pushing earnings into the red.

So the ultimate credit costs associated with bank revenues often take a year or more to be reflected in earnings and capital cushions. That’s why regulators require banks to maintain an “allowance for loan losses.” This allowance is a contra account on the asset side of a bank’s balance sheet, and its purpose is to absorb credit losses from loans as they run through the default and recovery phases. Loan losses, net of recoveries, deplete the allowance. Banks can rebuild their loan loss allowance by booking larger provision expenses, but this process cuts directly into earnings.

The chart below shows how under-reserved banks are right now, so they still have a ways to go in accounting for the losses on loans made during the bubble. These numbers are the combined figures for over 7,000 U.S. commercial banks insured by the FDIC. In blue, you see the combined loan loss allowance climbed to $156 billion by the end of 2008. In red, you see that noncurrent loans — the raw material for credit losses — had soared even faster to $200 billion by the end of 2008, and are still climbing sharply. As a rule of thumb, to remain well capitalized, and to prevent their allowance from shrinking to dangerously low levels, banks should book provision expenses in line with the increase in noncurrent loans.

But since the credit crisis began, this has not been happening. As the green line shows, the ratio of loss allowance to noncurrent loans for the entire banking system has fallen below 100%. To rebuild the industry wide loss allowance back up to an adequate level, provision expenses will have to rise faster than delinquencies. Some banks can only catch up by raising new capital from investors. Those banks that are too far behind, and cannot raise capital, will be taken over by the FDIC. All of this translates into a strong headwind for bank earnings over the next few years.

Recall that bank executives have lots of control over the timing of loss recognition. Evidence that banks are delaying loss recognition is springing up all over the place. For instance, some banks that provided unsecured revolving lines of credit to highly indebted REITs have waived some restrictive loan covenants. In residential mortgages, we’ve seen lots of instances where banks are stringing along underwater homeowners with modifications that do little more than kick the can down the road.

It would make more sense to restructure mortgages on underwater properties where the bank receives a property appreciation right in exchange for a large reduction in mortgage principle. This makes more sense from a societal perspective, and would help accelerate the return to a healthier, less “zombified” banking system. But this idea is not popular among bankers, because doing so would force the bank to immediately recognize lots of losses, which could cut heavily into the bank’s capital.

This state of bank accounting is not limited to the U.S. In fact, in some instances, the accounting at some foreign banks is even more detached from reality than it is in the U.S. For readers of Strategic Short Report, I recently uncovered a non-U.S. bank that’s been especially tardy in disclosing its credit losses. It’s a very attractive short sale right now, especially because the market loves this bank, and is totally ignoring the wave of credit losses to come in the near future.

Regards,
Dan Amoss

August 13, 2009

Bank Accounting Fudges Loan Losses was originally featured on Whiskey and Gunpowder

I described how geothermal power is the beneficiary of a lot of government benefits, from renewable-energy mandates to tax breaks. Thus, the geothermal companies (including five companies in the ESI portfolio) should be doing better in the stock market. But that’s not the case, even though the deck is stacked in favor of green power, especially geothermal. Where’s the return?

The Geothermal Business Model

Let’s ask a question of almost all of the current geothermal players. Is SOMETHING WRONG with much of the current geothermal business model?

Actually, WHAT IS THE BUSINESS MODEL for the typical geothermal energy pure-play company? Let me summarize in a general fashion.

• The typical geothermal pure-play starts with one or a very few visionary people, often engineers. These guys (almost always guys) have an idea. They do some prospecting and find a couple of sites with steam vents or mud volcanoes. Very often, the site is something that other players looked at or even drilled back in the 1970s. The sites are usually out in the middle of nowhere, like some gulch in Nevada or similar jurisdiction

• Then the players acquire relatively small acreage positions — a few thousand aces here and there — often from the Bureau of Land Management (BLM) or private parties. They try not to pay big money for big acreage. Indeed, many of the current geothermal guys have a $3 per acre mentality. For overseas projects, they usually obtain a concession from the government in a developing country. Not uncommonly in the developing country, the politicians studied Marxism in their university days

• Then the companies promote their geothermal site at conferences. They give their site a name like “Hell’s Hot Springs” to make it sound like the devil bathes there in the superheated steam. They show their slides, pound the podium and raise funds from private players. Eventually, they write a fire-and-brimstone prospectus and issue stock in the Canadian junior marketplace

• Then comes a years-long cycle of burning the cash. In the U.S. or Canada, they start a long process of obtaining federal, state and local government permits to do everything. They need permits to drive trucks over wilderness roads, to remove water, to blow exhaust into the air, to drill wells, to erect towers. Every geothermal site in the U.S. or Canada involves at least 700 permits and constant renewals. No wonder they need the tax credits on the back end

• Then they identify enough funds to drill a primary steam well, and a confirmation well or two. These wells are expensive — much more so than a comparable gas well, that’s for sure. In fact, there are only a handful of drilling rigs in the U.S. and Canada that routinely drill geothermal wells. Sometimes a rig breaks down or gets stuck at one site. That impacts the drilling schedule for other customers for many months onward. Often, the geothermal companies pay for drilling wells by issuing new stock and diluting the previous investors

• Then they hire a consultant. It’s almost always GeothermEx Inc., of Richmond, Calif. GeothermEx is not just small, it’s TINY! There are eight upper-middle-aged guys who do all the work. GeothermEx does good work despite having virtually NO competition. But it goes to show how small and clubby the geothermal world is

• Once in bed with its pals at GeothermEx (whoops, I mean “once it’s retained GeothermEx”), the geothermal company tests the wells for “the report.” Then the GeothermEx consultants write up “the GeothermEx report” on the heat and energy potential of the site. The key point of “the report” is how many megawatts (Mw) the project ought to yield over how many years

• Then the geothermal company shops the GeothermEx report around to the local or regional power companies to get a power purchase agreement (PPA). The PPA is a promise that IF the geothermal company ever produces electricity, the power utility will buy it at some price. (The utility companies like PPAs because they can impress the state utility regulators and get them off their back. “See? We’re working that green energy RPS mandate.”)

• Then the geothermal company uses the PPA to borrow money from a bank or other source of funds. If a utility company will pay for future power supplies, that’s bankable. “Energy bankers,” as they fancy themselves, have been trained to kowtow to PPAs based on GeothermEx reports. “GeothermEx reports are the gold standard in this business,” is the common expression

• Then the geothermal guys use the borrowed money to pay debts and bills and to drill more wells for steam production and water injection. At the same time, the small team of geothermal players — which could hold their corporate luncheon in the back of a McDonald’s restaurant — designs and builds a generating plant. This requires large upfront costs for construction and equipment

• Sometimes, the geothermal guys farm out the power plant as a turnkey project to a publicly traded company named Ormat. “Ormat is the go-to company in this business,” is the common expression

• Meanwhile, Ormat is tightly run by a family of bright, but very quirky, upper-middle-aged people. The company growth plan gets a C- and its succession plan gets a D, in my view. (Another story.)

• Then while the geothermal people are designing and building their generating plant, they have to worry about how to get the power from the plant to the main transmission wires. This often involves permitting and building out a new set of power lines from nowhere (out in Nevada or the like) to somewhere else (such as where the electric load is, in California or the like)

• Then, about four or five years down the road from the original lease sale, the geothermal company tests its steam wells and generating plant. If the dynamos spin true, the geothermal company now has electrons moving down the wires. That is, the geothermal company is in the power-generating biz

• Finally, with electrons in the wires, based on the PPA, the utility company starts sending a check every month to the geothermal company. It’s usually the first real cash flow that the geothermal company has seen in many years.

Let’s Think This Through

Most of the foregoing applies to most of the companies (public and private) in the geothermal space. This is how it works. This is the current geothermal business model, controlling things from prospect to power line. Of course, not everything applies to everybody. But you get the idea.

Let’s think this through. If you’re a small company with a handful of employees, how can you possibly accomplish and manage all of this… and make money for your investors? You’ve got a cadre of people who do it all. They prospect for acreage, lease it, obtain permits, raise funds, drill-drill-drill, test the wells and other systems, design and engineer a power plant, procure material and equipment, build out a generating system, erect power lines, spin electrons and deal with a regulated utility.

Does it sound like there’s a lot going on? There are lots of moving parts, with lots of things that can go wrong. And it’s all going on for a long time, on borrowed money or invested funds. So it takes a lot of time and cumulative risk to see any monetization. No wonder the geothermal stock prices are in the dumps.

There’s Got to Be a Better Way

Indeed, it seems like this business model was put together by Rube Goldberg. And remember that I’m only focusing on the “big picture” aspects of running this show.

When you look closer, there are more “little pictures” in this effort. How many? Well, more than hang in the National Gallery. That is, there are countless items that are much smaller, but which add up to time, money and managerial competency (or incompetency).

Sure, running a geothermal project takes talent. You’ve got to be a jack-of-all-trades. I guess that’s why the guys at the top get the big bucks, eh? But c’mon. There’s got to be a better way. Yet it seems like everybody does it this way — or they did in the late-departed era of easy credit. But we don’t live in that era any more. There’s no more easy, patient money.

In the past five years or so, the geothermal industry has raised and spent a couple billion dollars using this business model. Can it raise another few billion in the years ahead? On this business model?

News flash to the geothermal players: Aside from insiders and a few other people who’ve been able to trade in and out of the stocks (mostly lucky, not good), nobody has made any decent return from geothermal. It’s always “next year, next year, next year.” And the business model, based on shoestring budgeting and lack of monetary return for years at a time, helps to explain why.

Stay Tuned…

Don’t get me wrong.  I still like geothermal and I’ll continue to monitor our geothermal stock positions closely.  The geothermal business is small.  It’s not something that many investors know about.  If just one or two of the companies in the ESI portfolio can make it out of the woods, that’ll hand us enough profit to make up for any others that lag behind.

For now, I want to hold all of the geothermal companies in the portfolio.  I’ll keep a close eye on the business environment, and get more information for you. I’ll check in with several of the geothermal companies in the ESI portfolio. I’ll find out exactly where they are on their project timelines.

Along the way, I’m going to see another private geothermal project. I’ll talk with other people who are working in the geothermal space. There are other business ideas out there — how to monetize the projects at earlier stages — and we need to know what they are.

That’s all for now. Thanks for reading.

Until we meet again,
Byron King

July 24, 2009

Geothermal Frustration, Part II was originally featured on Whiskey and Gunpowder

This time they’re making war on another weed, one that has been a favorite in America since before the time of Pocahontas.  The Nicotine Nazis are on the rampage and propose to turn tobacco over to the FDA to “regulate.”  The FDA intends to start by mandating the removal of all additives, including menthol, and my girlish laughter is going to dissipate as the smoke does.

Since the sound byte medical types and MSM are convinced that smoking is worse than sex was to Victorians most citizens will doubtless think prohibiting tobacco (the real proposal; regulation by the FDA is merely the first step) is a fine solution that will lower health-care-related costs even though the jihad of the last thirty years has had no effect.  The usual Liberal logic was applied:  you may not smoke, but all diseases are tobacco-caused so either you are ill because of “second hand smoke” or you took a puff behind the woodshed when you were thirteen and forty years later you got cancer because of it.   Smoking has become the easy, automatic answer for cause of death and is probably implicated in cases of suicide and car crashes.

This isn’t about making Linda snarl at the world; we’re interested in the economic effects–which will be catastrophic.  Ten years ago I spent $72/month on my two-pack-a-day habit.  Taxes have been piled on to the point that the carton of cigarettes that cost nine dollars then is well over fifty now.  Think of that as fifty buck lattes or fifty buck movie tickets.

“Sin” taxes are a favorite for revenue and those of us who enjoy a little tot of Irish or a glass or two of (heart healthy) red wine are subject to truly sinful and prejudicial new taxes–at least one raised recently by 537% by Mr. “I’m not going to raise your taxes unless you make a quarter of a million a year.”   We got the usual equal treatment before the law:  all smokers and drinkers are penalized.

Has anyone consulted the Carolinas to see what effect knocking R J Reynolds off the Big Board is going to have?

What about the shareholders there and of P. Lorillard and others?  What about my solicitous neighbors who voted a ten dollar a carton tax last year to procure more “social services” before Mr. Obama added his ten dollar a carton tax to already outrageously punitive fees?  The loss in tax revenue will be enormous and governments don’t understand about reducing spending when income falls.  Adjusted for inflation something like eighty per cent. of our cherished smokes are pure tax revenue, and guess what?  Non-smokers are going to have to “sacrifice” to make up for that loss.

A black market will surely spring up, which may account for the BATF ruling that all purchases of fifty cartons or more must be reported to them!  Even if all taxes are paid.  Seriously.  You have to fill out a form including your license plate number and full personal data.

Travel and tourism…a higher percentage of Europeans and those from the Middle East smoke and I know what my rule is:  if I can’t smoke, I don’t go.  How appreciative are New York, Las Vegas, and Miami going to be when the French and Germans say “non” and “nein?”  Who cares how good the exchange rate is if a monsieur can’t even buy a pack of Galoises or an American brand or smoke within twenty-five feet of a doorway?   Will there be revenuers, so to speak, wandering around the country hunting tobacco patches and sniffing the air?  Why not?  There are some of those jobs Mr. Obama claims he is going to create.  Will foreigners get special dispensations or will customs confiscate their cigarettes for failing to meet US standards?

Attempts to legislate morality and lifestyles always fail and always have nasty consequences.  If there hadn’t been prohibition Joe Kennedy would never have made a fortune running rum and we would have been spared Teddy in the Senate all these years.  Why not ban sugar, which is far worse for you than fat, and ban the substitutes too?  (Because the Stevia producers do not have the lobbies that sugar, Equal, and Splenda do.)  Put enough social engineers to work and we could wind up with everyone in the country loathing everyone else and set new records for assault and battery.

Most of you probably don’t smoke and don’t see what the fuss is about; you even believe my health will improve if I am treated like a toddler.  (Will I live longer if I stop smoking?  No, but it will seem that way.  Mostly, it is my choice, not the government’s.)  My bleeding ox may not move you, but how do you feel about the proposal you be taxed for every mile you drive?  I don’t drive a hundred miles a month, while lots of you drive several thousand.  Will you like having your car fitted with a device that records your mileage (at your own expense) and allows the government to track your every move?  They don’t intend to lower the incredible taxes on gasoline, either.  It will be argued that you deserve it because you are using more than your fair share of the gasoline and doing more than your fair share of wearing out the roads.

You know how it goes, people:  when you don’t protest when it happens to us, they’ll come after your butter, cheese, salt, red meat, Cokes, cell ‘phones, and roofs that are any color other than white.  In times past coffee, tea, and chocolate have all been taxed and chances are that most of you regard one of the three as an invigorating “must have.”  They look like prime targets for revenue-hungry governments once the evil weed is outlawed.

Laissez faire, people, laissez faire.  Let’s all take responsibility for our own choices and pay for our own vices and stop regulating and taxing others for theirs.

Let us hope that wiser–or more rapacious–heads prevail in the latest campaign of the war against tobacco.

Your Fuming,
Linda Brady Traynham

June 10, 2009

P.S.: Now to business.  You could call your broker this morning and sell tobacco short before it occurs to a lot of people that the proposed policy would destroy another large industry and a major source of income.  Even though I expect a fall in tobacco stocks I’m more inclined to think we should hold off until we see what sort of support Dr./Senator C can garner.  There could be some good short-hold bargains to be picked up but your timing will need to be impeccable–and keep a firm eye on your “greed” gene.  Maybe scoop up a handful when the gloom is deepest but promise yourself faithfully that you’ll dump it when you have a modest profit.

I’d have to look at current prices and what tobacco stocks have done for at least the last year, but I’d be feeling pretty antsy when I had a twenty-five per cent. profit, and I’d begin charting volumn and price daily when I was ten per cent. up.  By the time a stock had recovered half it had lost it would take a squad of Marines to keep me from selling.  Nuthin’ wrong with a quick little ten to fifteen per cent., you know, and a lot right about it.

As volatile as the market has been you can lose, get lucky, or make your decisions ahead of time.   I have never lost serious money by selling too soon; I’ve lost it by not having faith in my judgement and buying or by not paying attention and missing a major sell signal.

How about a quick identity check?  I’m a trader, the spiritual descendent of robber barons, and believe in hoisting the Jolly Roger, a quick capture, putting a prize crew on board, and on to the next opportunity.  How many of you think in terms of “investing” “for the long term?”  My bet is that most of you are traders who believe in stashing spare cash in metal or you wouldn’t be here.

Taxing Tobacco was originally featured on Whiskey and Gunpowder

Some of his early stories written in the 1930s reflect on the mood of the era. And even if you don’t care for reading about the 1930s, you’ve got to love Runyon’s way of capturing the voices of the times. For instance, “I put the old convincer on him by letting him peek down the snozzle of my John Roscoe.” That’s a pretty colorful way of saying you stuck a gun in somebody’s face.

In these stories, there is also that undercurrent of bad times. You never forget it. People view anybody who looks well with suspicion. Prosperity of any kind is seen as unreal in some way. As Runyon writes:

“You cannot tell by the way a party looks or how he lives in this town if he has any scratch, because many a party who is around in automobiles, and wearing good clothes, and chucking quite a swell is nothing but the phonus bolonus and does not have any real scratch whatever.”

There is also a macabre sense of humor. In one story, Runyon writes of being at a track in Miami. He’s having a run of bad luck. It goes on awhile and gets worse. “I wonder if I will not be better off if I buy myself a rope and end it all on a palm tree in the park on Biscayne Boulevard,” he writes. “But the only trouble with the idea is I do not have the price of a rope, and anyway I hear most of the palm trees in the park are already spoken for by guys who have the same notion.”

It was an era with an undercurrent of playful meanness, too. For example, look at the nicknames of some of the baseball players in the 1930s. Author Bill James wrote about this years ago. “In the ’30s, nicknames turned nasty,” he wrote. If you had a big nose, you were “Schnozz” — a nickname earned by Hall of Fame catcher Ernie Lombardi. If you were overweight, your nickname was “Blimp,” as in Frankie “Blimp” Hayes. Or just “Fats,” the nickname pinned on poor Bob Fothergill.

Some other nicknames used by journalists and forever affixed to players’ names in the registers: “Stinky” “Boob” “Boom Boom” (for a pitcher with a 38-69 career record) and “Suitcase” for anybody who had trouble sticking with a team. Joe Medwick walked with his toes pointed out and got stuck with “Ducky.” An outfield named Cuyler stuttered and they called him “Kiki” Cuyler. It was a brutal era.

I guess with bread lines, shantytowns and so many people out of work, no one cared about playing nice. In 1930s, you had to have thick skin.

Floyd Odlum: Making the Best of Bad Times

And more than just reading about the 1930s out of my own personal fascination with the period, there are also some practical benefits. There were people who made a lot of money in the Great Depression doing legal things. There is Floyd Odlum, for instance. He is sometimes described as the only guy to make a fortune in the Great Depression. (He wasn’t.)

I’ve written to you about him before. The reason to revisit him briefly is that James Grant also wrote a little about him in a recent Grant’s Interest Rate Observer. Grant calls him a “salvage artist par excellence.” “None of us can know the future,” Grant writes. “But like Odlum, we can make the best of a sometimes unappetizing present.”

Grant also managed to scrounge up a pretty good anecdote on Odlum. In the summer of 1933, when all the world seemed to be in pieces, Odlum strolled into his office, looked at his glum partners and said: “I believe there’s a better chance to make money now than ever before.”

Odlum liked poking around in the smoking wreckage of the 1930s. Bad times create wonderful pricing. I suspect if Odlum were still alive, he’d find himself very busy. There is a lot to look at now.

Scared? Read This

A friend of mine recently wrote to me about how he was looking at Potash (POT: NYSE) with “fear and lust.” It was a Hunter Thompson moment, and I knew exactly what he meant. Everything feels a little scary right now. At the same time, your rational brain gets excited about the great prices you see dancing on your screen.

“Fear and lust” sums up what it feels like investing in stocks these days…

Every investor will have to overcome fear to buy anything today. I hate to try to call a bottom. But remember that even in bad times, the stock market can put up stunning rallies. Jeremy Grantham at GMO makes the point about sitting on cash too long:

“In June 1933, long before all the banks had failed or unemployment had peaked, the S&P rallied 105% in six months. Similarly, in 1974, it rallied 148% in five months in the U.K.! How would you have felt then with your large and beloved cash reserves? Finally, be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before.”

Backlash From the CVR Energy Sell

I’ll end this week’s note with a quick word on CVR Energy, which we parted with after a little more than a year with a terrible loss. I always get lots of e-mail after every sell, no matter whether it was up or down.
I’ll reprint one of those e-mails… from my father:

“Your great analysis costs us $7,200 if we sell now. What happened to all that good stuff you wrote about it as far as the fertilizer plant and using its coke to run it? I thought (you thought) it was going to save it money, etc., on running the plant and make money on the fertilizer.

“Love, Dad”

Guess that will come out of my inheritance, assuming there is any. Well, a lot changed. Fertilizer prices tanked. Natural gas prices tanked, thereby making the company’s use of pet coke less appealing with all this cheap gas around. And gasoline demand fell, as did prices, thereby hurting the refinery. On top of that, there is the seeming inability of the company to get it together and deliver a clean set of results.

I suppose CVR Energy will bounce back from these lows at some point. If you want to hold out for a better price, that seems reasonable. But I’d rather own other things in this environment. Sorry, Pop. We’ll hit the next one!

Regards,
Chris Mayer

March 16, 2009

Fear, Lust and That 1930s Feeling was originally featured on Whiskey and Gunpowder

“It’s not the lie. It’s the coverup” is the old political adage.

Usually, in politics, it’s much better to admit a mistake and move on. I wish to heaven we could learn that lesson in regard to economic downturns.

Downturns are not inevitable forces of nature. They are created, and usually by bad economic policies. This one is no exception.

Most of you have been Agora Financial readers for many years, so you knew this was coming. There is no question that Fed monetary policies, combined with congressional mandates that made easy mortgage loans a virtual entitlement, caused our current economic affliction. I suspect even the people behind these mistakes know this. There’s darned little confession going on, though.

Instead, we’re watching the financial equivalent of a coverup. The politicians who defended and promoted the practice of handing out and then bundling bad loans are blaming the financial institutions that did their bidding.

I’m not saying, by the way, that financial institutions are without blame. We know that because some resisted the lure of commissions that flowed like water from the affordable housing Ponzi scheme.

I’ve told you several times about Jeff Scott, the Austrian economist whose unwelcomed Jeremiah-like lamentations kept Wells Fargo from diving into the subprime river. W.F., as a result, is the healthiest bank in the country. My guess, by the way, is that Scott, like Jeremiah, will pay the price for having been right. You know the old saying about prophets in their own land.

Regardless, my point is that this recession was caused by meddling in the market. The solution to our current distress, therefore, would be to stop meddling.

Unfortunately, our government is in full coverup mode. Those responsible are not only pointing fingers elsewhere, they’ve increased the magnitude of their meddling. Now they are propping up institutions that made bad investments.

The term for these bad investments, in the jargon of Austrian economics, is “malinvestment.” These mistakes take resources out of the self-perpetuating economy, slowing economic growth. When enough malinvestment is eliminated, our economy will grow again. This is a natural process that Austrian economist Joseph Schumpeter called “creative destruction.”

Delaying that process will not help. The healthiest thing we could do now is to let institutions that mishandled resources fail. Most would be bought by better firms. Many individuals would need help during an intense period of creative destruction, and we should probably give it. The bankers who did the bidding of Congress, however, could sell their Manhattan townhouses and weather the storm well.

On the stem cell front, at least, there’s really good news. Transformational technologies will always overcome downturns in the long run. Some countercyclicals will even do well during a downturn. Once again, however, the media are getting the stem cell story wrong. This change will have little impact on companies working on SC therapies. As I’ve said many times, the ability to create induced pluripotent stem (iPS) cells from adult cells has changed everything. The use of embryonic cells in future therapies is now unnecessary, if not foolish.

This is not to say, though, that lifting the ban on the use of federal funding will not produce winners. The reason is that stem cells have important uses beyond therapies that were stifled by the funding ban.

Theoretically, it was possible to privately fund research on unapproved eSC lines under the Bush ban. To do so, though, researchers would have had to cut themselves off from any other work involving federal grant monies. In most cases, disconnecting from the intricate network of federally funded research was a practical impossibility. You would be hard pressed to find a university or big pharmaceutical company that does not accept government grants in some form. The impact of the ban was, therefore, enormous.

The field of research that suffered most was genetic disease drug discovery. Specifically, it was research aimed at finding cures for the inherited genetic diseases that afflict millions of Americans alone. What scientists have long wanted is access to stem cells that carry the diseases they want to treat. With an unlimited number of disease-carrying cells, potential treatments could be tested and analyzed with far greater efficiency.

It is ironic, by the way, that the availability of these cells will actually lead to fewer abortions. Researchers will use stem cells carrying cystic fibrosis, breast cancer, muscular dystrophy and other diseases to produce effective therapies for those conditions. This means that parents who carry those genes will be less likely to screen and reject embryos that have those DNA markers. Obviously, those therapies are also going to make smart investors fortunes. And they will deserve them.

Now, let’s move to the thorium front…

The Thorium Energy Independence and Security Act of 2008 is sponsored by Senate Majority Leader Harry Reid and Republican Sen. Orrin Hatch, and is designed in large part to produce an alternative solution to the problem of nuclear wastes. Thorium reactor technologies fit that bill for two reasons. Not only do they produce fewer byproducts, they can be used to burn the wastes produced by other nuclear technologies.

A couple of weeks ago, President Obama dramatically moved the thorium industry forward. He announced that he would kill the Yucca Mountain nuclear waste depository project. This is despite the $9 billion already spent on the project.

Reid, of course, is bragging about his role in the decision. So where does this leave us? The Yucca Mountain project, located in Reid’s home state of Nevada, was considered critical to the future of nuclear power generation in America. Since Obama, Reid and Pelosi all promote nuclear power, this significantly increases the likelihood that thorium reactor technologies will be fast-tracked.

Sincerely,
Patrick Cox

March 12, 2009

Stem Cells, Obama and the Austrians was originally featured on Whiskey and Gunpowder

What can we discern about the incoming Obama administration? I had a long talk with an old friend who is a self-described “rabid Democrat.” Let me rephrase that. He’s a rabid Democrat in the way that Pittsburgh Steelers team owner Dan Rooney is a rabid football partisan. This friend of mine loves his Democratic Party. Just as Mr. Rooney wants his Steelers to win the Super Bowl, this guy’s focus in life is for his political tribe to do what’s right for the country. This friend of mine is also privy to the inner circles of Democratic politics. He’s just plain plugged in. He’s on a first-name basis with many on Team Obama.

So what’s on Obama’s plate? “Well, the first thing the new group has to do is stabilize the banking system,” he told me. “Things are still precarious with the banks. Liabilities exceed assets by a large margin. We will probably see more bank failures — small and even some large banks. That would hurt worldwide investor confidence and lead the stock markets down. We could test the old lows of last fall.”

This Democrat insider then got into other issues. “The housing crunch still has more rope to hang out, as well. A lot of the problem is isolated in a few states and regions of states — California, Arizona, southern Florida, the New York City metropolitan area, Massachusetts and a few other places. But it affects a lot of people. We’re dealing with populous, overbuilt places. We are also on the cusp of a lot of failures of government entities, from localities and school districts to counties. We’re going to have a lot of municipal bond defaults. We’re going to see municipal bankruptcies. Some large states are insolvent. California can’t meet payroll.”

And there’s more from this guy. “The next big wave will be that consumer spending dries up. This will lead to a failure of retail businesses all over the country. It’s going to be a huge unwinding. We spent the past 25 years spending more than we could afford. Now we as a nation have to pay some big bills. It’s time to save. It’s a good thing, in the big scheme, for people to save. But it’s going to put a lot of pain into the retail sector of the economy. We’ve overbuilt retail, and everything that goes with it. Too many stores. Too many buildings. Too much inventory. Too much shipping capacity. Too many containerships unloading too much stuff made in China and elsewhere. And a lot of people are going to lose jobs. I mean a lot of people. Everywhere.”

“The Next Two Years Are Going to Stink”

Here’s more from the Democrat insider. “The next two years are going to stink for the economy. Obama will face one financial crisis after another. He’s going to hate Wall Street. He’s going to hate bankers. Every time he turns around, the money people are going to be screwing him. He’ll try to fix one problem, and five more problems will spring up like weeds. (“Only five?” I asked.)

“The coming financial issues will test the ability of the legislative branch to act with integrity in the face of a media-driven clamor. States will be lining up to borrow money from the feds just to pay unemployment compensation, let alone to fund Medicaid and road maintenance. It will test the legal system as well. Expect more petty crime and a lot more bankruptcy. But fewer people will get divorced. Who can afford that anymore?

“And think about the foreign policy issues that the financial crises will cause. Just think in terms that when U.S. prosperity declines, it takes the world down with it. The economic contraction is going to set some societies back by decades. Will people take that lying down? Or will they riot in the streets and burn down the capitol building? Expect a rash of failed states. We’ll be surprised at some of the names that fall off the map. Wow, we might look back and wish for the days when the world hated us just because we invaded Iraq. Now they’ll blame us for stealing their future.”

“The Republicans will make political hay out of it. Unless they are totally incompetent, which you can’t rule out. Democrats will probably lose seats in the House and Senate in the 2010 elections, as well as in state legislatures and governorships. But Obama will be working his own game of building consensus. He’s from a new generation of politician. He’s not nearly as in-your-face confrontational as the Democrats of the 1960s and 1970s era, the Kennedys and Waxmans and Barney Franks. Obama will build coalitions out of whomever he can get on board. You might not like him on issues like gun control or abortion, but you’ll deal with him on tax cuts and energy investment.”

Where Do You Go From Here?

So where do we go from here? Well, here’s my post-Inaugural advice. Build up some cash reserves. Got that? Hold Cash! Cash in the mattress. Cash in the bank. Certificates of deposit. Don’t try to get too fancy. Just save some cash where you can get hold of it in case you need it pronto.

Next, buy precious metals like gold and silver. Bullion coins or bars are my favorites. But it never hurts to buy a few quality numismatic coins as well. Don’t get spooked out of precious metals if we see a price dip in the near to medium term. The dollar is in serious trouble, and eventually the precious metals will come back. Precious metals are a way of preserving your purchasing power over the long term.

As for stocks, in the near future, we could see some severe market declines. Initially, this might look like large trading spikes up and down. Unless you are a serious trader, be careful about trying to “play” the swings. Don’t be afraid to sell any stock that makes you nervous. You have to be able to sleep at night. Along these lines, I’ll keep addressing the OI portfolio in future updates.

There are certain investment ideas that will probably work over the long term, like really good precious metals miners. Kinross Gold (KGC: NYSE) and Goldcorp (GG: NYSE) come to mind. The point is that you want well-capitalized miners with solid reserves and good production facilities.

That’s all for now.

Regards,
Byron W. King

January 28, 2009

Inside The Obama Huddle: Housing, Banking, Life and Crisis was originally featured on Whiskey and Gunpowder

Yes, dear reader, the most volatile market in recent history could easily point its finger at a trader’s biology.

The conclusion will surprise you. The longer a trader’s ring finger, the more money he’ll make in the City (this study comes from across the pond in London, where top earners took home over $4 million – until just recently).  They measured the men up, and looked at their previous 20 months of P&L (profit and loss statements).  They also saw how long they’d lasted in the City.

Those with the longest fourth digit made over five times the money of their less-well endowed colleagues.  The average salary was $537k.  The long-ring group netted a healthy $828k, while the shorties had to make do with $145k.

OK, OK.  I bet you’re saying: what’s a couple of inches of bone and flesh gonna tell us about hormones?

Don’t know diddly about Darwin?  Think it’s just about DNA?  The real work of evolution starts with hormones. And the reminder of some serious prenatal hormonal action lies in the ring finger.

The Finger of Destiny: High-Stakes Day Trader or Value Investor

Measures are always relative to something. In this case, it’s the second digit: — the index finger.  They call this indicator the 2D:4D. This ratio is set before birth and stays with us throughout life.  Those with the longer fourth digit relative to the second often display rapid-fire execution ability. (See also: aggression, fertility, confidence, and sporting ability).

http://news.bbc.co.uk/1/hi/sci/tech/695142.stm

The accidental in utero testosterone junkie may well be set for high-stakes finance on the trading floor, simply because the developing brain becomes wired with a greater sensitivity to testosterone’s effects.

But before you run to get a ruler, let’s take a further look at what these 44 well-measured men reveal about the evolutionary life of Wall Street.

Testosterone, Cortisol & Your Next Investment

Coates, now Senior Research Fellow in Neuroscience and Finance at Cambridge, got a hunch while running a trading desk on Wall Street during the “dotcom” bubble.  He worked elbow-to-elbow with traders, when he noticed the change in traders’ behavior from pre-bubble methods.

Coates began to suspect a chemical was involved.  Just like Diane Fosse in the Rwandan jungle, Coates observed testosterone-related dynamics…even if the “competition” was between a trader at Goldman Sachs on 85 Broad Street and one working on the same trade, thanks to electronic trading, for Merrill Lynch halfway round the globe in Seoul.

The “winner effect” works like this.  Take two males in competition.  Testosterone rises.  They spar.  The winner comes out with even more testosterone and takes on a new opponent, while the loser skulks off with less testosterone.  Repeat.  And repeat.

Now for the end game (looking a lot like, say, former Lehman Brothers’ alpha wolf, Dick Fuld): the males, seething with testosterone, become overconfident.  Most importantly, they have increased appetite for risk.  They patrol areas that are too large (viz. commercial and residential real estate) and they pick too many fights (anyone starting another mortgage-backed securities pool in 2007).

So Coates remarked in the dotcom bubble and so we stand today.  The fact is, the dotcom bubble didn’t weed out anyone on Wall Street, because Manhattan Island is not a pure “Darwinian” island.  Instead, everyone just got shuffled around from investment bank to investment bank.  Top brass protected their own, sitting on each other’s boards and securing the “alpha wolf” salary and bonus.

And, sure, fast action juiced by higher levels of testosterone, is more likely to turn a profit — an abnormally large one at that.  But there’s one catch: cortisol.

Cortisol, a stress hormone, is seething in global traders everywhere…it comes when there’s the crash.  It’s the “fight-or-flight” friend that raises blood pressure, increases immunity, desensitizes us to pain. How does that translate into finance?  Cortisol renders the trader price-insensitive.  Monetary policy won’t matter.  He’ll see risk everywhere.

That’s because, long-term, exposure to cortisol ravages mind and body.  It affects memory recall — handicapping judgment with the shackle of fear — whether justified or no.  Like a kid who touches a stovetop for the first time, so is the trader who fears jumping back in the game that just burned him.

Is it time to fire all of Goldman’s males and change the name to Goldwoman?  The reason, in fact, Coates zeroed in on the testosterone test, was that the few female colleagues on the floor, he said, did not display the same behavior. Tellingly, the woman’s 2D:4D is almost equal and she has about 1/10 the testosterone of a man.  But she’s still got to contend with cortisol.  So the Wall Street ecosystem will remain chained to biological reflexes whose usefulness we may or may not have outlived.

Next Time You Hire: Measure Your Money Manager’s Index Finger

Here’s one more reciprocal fact.  A reverse advantage falls to those whose 2D is longer than their 4D.  It concerns a long-term market approach.

Taking a look at average finger ratios in university departments showed that the math, science and engineering-focused sport a longer index.  As you might guess it also suggest higher exposure to the opposite of testosterone – estrogen – in utero.  Estrogen helps the right side of the brain develop: good for honing sharp analytical skills.

Perhaps Mr. Madoff’s clients could have checked his pointer finger first, and those of his Florida club-hopping, dupe-hunting reps. But maybe we’d be surprised to find lengthy index fingers there…after all, the scheme was a “long-term” approach.

Most interesting of all, is that Madoff’s own sons and heirs cut short dad’s survival on the Wall Street three-ring menagerie.  He revealed the root of their inheritance, and they turned him in.  This positively Greek development in finance deserves the ushering in of the Furies from the wings.

Regards,
Sam Buker

January 23, 2009

Risk-Taking Traders Born Not Made was originally featured on Whiskey and Gunpowder

In the future there will still be profound restraints on the availability of energy and natural resources. So owning shares in firms that “do energy” or “do resources” is still a good idea over the medium and long term.

We Still Have a Big Problem

We still have a big problem. The credit system is broken (and that’s the nicest thing you can say about it). Many large banks in the world are broken too (ditto). The investment model of the modern era, starting back in the 1860s during the U.S. Civil War, has almost ground to a halt. That is, the idea and method of “floating capital” is not functioning. Indeed, capital no longer seems to float. Actually, it seems like capital has been sinking like a stone. 

The lack of capital (at least, in the forms that we’ve come to utilize it for large scale investments) means that it is difficult – impossible in some cases – to go forward with the new energy and resource projects that are designed to mitigate the present depletions in older oil fields and other resource provinces.

In the face of this, most governments of the world are trying just to look good for the TV cameras. Central banks and government treasuries across the world have been reduced simply to throwing money at whatever problems catch their collective eye. Squeaky wheels get the grease. So we see the national treasuries “recapitalizing” busted banks. We see the likes of the U.S. Big Three automakers coming hat-in-hand to Congress for a bailout, and Congress in turn acting like it knows how to run a sophisticated manufacturing business. And we hear announcements, from China to the U.S., of massive new public works programs to get the world moving again. 

It’s like if we pour enough concrete, and then everything will turn out all right. Somebody ought to ask the Japanese about that. They all but paved the island of Honshu in the 1990s, and still lived through a stagnating era.

Can things really turn out all right? Can we return to some happy past? As Heraclitus once noted, “You cannot step twice into the same river, for other waters are continually flowing on.”  

Prosperity Stolen from Fort Knox

Indeed, all rivers flow to the sea. In Asia Times Online, the always insightful Henry C. K. Liu recently wrote that the credit crash has “turned out to be a catastrophic, global, financial perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of the past two decades in which risks are socialized and gains privatized, with debt manipulated to act as phantom capital.” Yep.

A fellow Pittsburgher, financial writer Jim Willie, is even more pessimistic. He thinks that in 2008 the U.S. economy and financial structure suffered “mortal wounds.” Jim states – using a very clever turn of phrase (I wish I’d said this) — that a “decade of prosperity was stolen from Fort Knox.” That is, major elements of U.S. monetary policy in recent years involved the gold carry trade enacted by the U.S. Treasury in the 1990s. 

What is the gold carry trade? The U.S. Treasury and Federal Reserve treat the details like state secrets. But what has leaked out makes for a sordid story – treasonous, even. It’s enough to make you wish that we still executed people by firing squad in this country. Let me put it this way. Perhaps President-Elect Barack Obama thinks that his biggest surprise will come when he gets “THE briefing” and finally learns what is really out in the tightly guarded hangars near Groom Dry Lake in Nevada (a/k/a “Area 51”), and Dugway Proving Ground in Utah. Well just wait until Pres. Obama asks how much of the original Fort Knox gold still remains the unencumbered property of the U.S. government. Surprise, surprise.

The Wolf is At the Door – Say Hello to the Nice Wolf

In 2008 we all experienced the destruction of a world-wide credit bubble. This was the end of many decades of dollar-abuse and monetary malpractice by the U.S. Federal Reserve and the utterly profligate U.S. government in general. As Gresham’s Law states, “Bad money drives out the good.” And decades of bad money did not just drive out the good stuff. In turn it sowed the seeds of its own destruction. 

It was just a question of time before the wolf showed up at the door, and that time has arrived. Say hello to the nice wolf. So now it’s time to face the fact that the U.S. economy is in far worse shape than most people believe. And it will be in bad shape for a long time to come. If everything goes right, it might take a generation to clean out the stables.

But we are already off to a bad start. The 2008 credit meltdown has caused huge collateral damage. And in 2009 we will see an extraordinary attempt to re-inflate that bubble. Will it work? Probably not like people expect. 

The traditional financial system is now in the fight of its existence. The system was based on U.S. dollar hegemony and the supremacy of U.S. national power. That, and the way that the U.S. benefitted from ingrained habits of foreign monetary authorities kowtowing to Washington based on decades of living with Bretton Woods and its ghosts. It all hit the wall in 2008. But like the creatures in the Aliens movies, these critters won’t stay dead for long. The Wall Street/Treasury Axis will come back to fight hard and play dirty. 

Things to Do to Ensure Your Security

I believe that the old system is irretrievably doomed. But you cannot replace something with nothing. There is still no “new” system that has come around to take the place of the old one. Thus the big task for 2009 is to save your personal wealth from going down with the ship. So how do you ensure your security?

In the short term you can protect your financial interests by increasing your cash position as a percentage of your assets. When all else fails, add to cash. Yes, we will probably see inflation in the future, but for now more cash is better. 

Also, in anticipation of inflation you should own physical metals like gold and silver. I mean it. I’ve said it before. OWN GOLD! And I mean OWN THE METAL. Take delivery! Maybe I sound like the Mogambo Guru on this, but he’s right. Let me quote Mogambo. “Own freaking gold!”

And get out of any but the very best shares. The first requirement for share ownership is to look for companies with enough cash to fund operations and make it through some very lean times. Then you also want to invest in firms that are going to be important in the world that’s coming down the tracks. 

What kinds of firms will be important? Well, energy and resource firms for starters.

That’s all for now. Thanks for reading.

Until we meet again,
Byron W. King

December 16, 2008

Falling Prices and Scarce Energy was originally featured on Whiskey and Gunpowder