Don’t Trust This Market

Following my update, I have included an article from one of the foremost economic analysts of our time, Ambrose Evans-Pritchard. He called the subprime crisis just 6 months before it hit, and this weekend came out with extraordinary comments about the banking and currency crisis hitting Europe and parts of Asia right now. The reasons why his warnings are important will be obvious, and it’s important to remember that just as the US appeared to coming out of the Great Depression in 1932, a foreign banking and currency crisis helped to push the US back into a Depression that lasted another eight years. We live in a global economy that is interconnected more than at any point in history, and as difficult as it is already going to be for the US to recover from the recession/depression at hand, any kind of global meltdown will make the recovery that much more complex and lengthy.

Economic Update

I’ve yet to see a single economist that I respect come out and support Obama’s stimulus program, and we already know that Guiethner has no real plan to solve our banking crisis. As a Barron’s article said this weekend, it’s important to look at this crisis from the economic side as well as the financial-sector side. On the economic side, our consumer debt is now at 130% of income. In 2000 it was at 100% and 10 years earlier it was at 80% Consumer debt simply has to come down and there is absolutely nothing that the government can do to change this. They got us into this mess with a fiat currency and easy credit, so the first step now is that we have to complete the natural deleveraging process...by at 10 to 20 percentage points…to repair the consumer's balance sheet. In a normal economy this would take 3 years to accomplish and in the current economy it will likely take 5-7 years. This is one of those basic “laws of economic cycles” and it has to be allowed to complete its course of action. It’s going to happen one way or another, and the sooner we allow it to happen the better.

We know we’re in a recession, and for the first time we have respected leaders calling it a Depression (International Monetary Fund, Merrill Lynch’s top economist). We may have some false starts, but believe me when I tell you that it’s going to several years before things are back to anything close to normal. Again, the more the government intervenes the worse they will make the situation. Instead, we’re seeing some very strange actions from the government….they aren’t thinking about deleveraging at all. Amazingly the government is talking about jump-starting consumer credit. Jump-start consumer credit for what? So we can be more indebted? A third grader can understand the lack of logic behind this strategy.

The bottom line is that we have to reduce debt. If you jumpstart credit, you are just going to prolong the problem and deepen it. What we need now is the patience to “de-lever”. We don't need the stimulus package. We need a savings package, but that couldn't be further from their goals at the moment. The mistake is that the government believes credit drives the economy, instead of the economy driving credit. They have got it all backward, and this is a very dangerous time to be confused.

We’re going to find out in the very near future that $3 trillion in additional debt on our backs was the exact wrong action to take, but by then it will be too late. By then the Dow Jones will be at 5000 (or lower), the US dollar will be in freefall, and no one will be willing to buy more US debt. This will push interest rates sharply higher, and leave our policy makers will very few options.

Precious Metals and Market Update

The article below will make this point more clearly than I ever could, but we will soon reach the day where the only trusted currency will be silver and gold (along with platinum). That’s because every other currency on the planet is fiat, or backed by nothing but the full faith and credit of the government of that particular country. This was the danger of dropping the gold standard, and could ultimately result in the “sum of all fears” in the global currency markets. While there’s a chance that the stimulus and bank bailout programs could buy us some time, and help to move the economy and stock market a bit higher, I wouldn’t put much confidence in this as an investment strategy. The markets will soon break their November 2008 lows on their way to much, much lower prices. I keep making this next point over and over again, but in my opinion it’s the one thing that market observers should be aware of. In 2009 the earnings on the S&P 500 will come in well below $50. Using a price/earnings multiple of 10 (which is still generous as the average bear market bottoms with a p/e of about 7), this puts the S&P at 500 by the end of the year. This indicates that we should expect a 40% drop in the overall market before the year is over. This would also mean that the Dow will drop another 3000 or so points to…you got it…just below 5000.

In light of all of this, we should expect to see a continued and sharp move higher in gold and silver in a classic flight to safety move. However, there is one point that I need to caution you on. Typically, when the stock market takes a fast and steep move lower, we also see a move lower in previous metals mining stock prices. We saw this exact thing happen in the 3^rd and 4^th quarter of 2008, and I fear that we could be in for a repeat of the same situation.

Since last November we have big gains in PM stocks and while I could well be wrong, I don’t like to give back hard earned profits…especially as big as the ones that we have on the books. Look at it this way, if I’m wrong, all you’ve done is taken some very nice gains and you still have healthy positions in our favorite precious metals stocks. In the meantime, continue to add to your gold and silver coin purchases as this bull market is just getting underway…and when the time is right we will go back into the mining stocks and in a big, big way.

I simply see little chance of a significant stock market advance over the next 12-18 months; although we will continue to see bear market rallies when the markets become too oversold in the short term (we are not close to oversold at the time being). 

The following link will take you to the article from Ambrose Evans-Pritchard and I highly recommend that everyone read it. If he’s right, and I believe that it’s likely that he is, the next surprise from this brutal bear market is about to hit home.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4623525/Failure-to-save-East-Europe-will-lead-to-worldwide-meltdown.html

Kip Herriage

Editor, VRA

Rally, But Sell the News

February 4, 2009

MARKET UPDATE

This will be a quick but important update. The Obama administration, along with our new Treasury Secretary, will be announcing their financial bailout and fiscal stimulus program early next week…likely on Monday or Tuesday.

In light of this, look for the market to trade higher in the short term. 

Longer term, absolutely nothing has changed…we are going lower, and most likely to new lows and then quite a bit more. Until the structural problems in our system are allowed to correct (massive debt going through its “natural” deleveraging process) all the bail-outs in the world will not work.

Other points of interest:

· 46 states will have a combined shortfall of over $400 billion this year, and as with most trends, the financial calamity in California will continue to work its way East.

· Record pension bankruptcies are happening now, and 50% - 60% are underwater with little chance of recovering.

· The next wave of bad debt: Alt A mortgages, corporate refinancing, commercial mortgages, and massive US and international debt issuance, will continue to pressure US Treasuries, prompting much higher interest rates here and abroad. Almost no one is expecting interest rates to rise dramatically, and when this begins, the powers that be will have few options. This is when precious metals will really skyrocket.

· The good bank/bad bank plan will fail. Banks that have run their business like a business should be allowed to survive on their own…the others should go into bankruptcy or receivership. Otherwise, we will become Japan (and worse) of the last 20 years.

Having said all of this, even during the Great Depression, there were big bear market rallies that last several months as investors believed the worst was over. Once those rallies failed, the market proceeded to hit new low after new low. Look for a very similar situation in our markets.

Kip Herriage

Editor, VRA

WHY WE ARE HEADED MUCH LOWER

Ø No one, and I mean no one, likes Obama’s stimulus package. When you see Democrats struggle to support these socialistic ideals, you know that they are a bad idea. Less than 15% of the stimulus will work its way into the economy in 2009, while the rest will go to support bankrupt social programs…a bottomless black hole. Obama came into office with a 70% approval rating, and unless he wakes up and fast, he will see his numbers go the way of George Bush. What happened to “change that we can all believe in”?

Ø Shades of the Great Depression. Have our leaders forgotten what turned a terrible recession into a Depression during the 1930’s? Protectionist international policies, massive government spending on programs that hurt the economy rather than help it, huge debt levels that cannot be supported, attacks on our own economy, class warfare, and tax increases that kill American businesses and the middle class. These exact policy mistakes devastated the US (and global) economies in the 1930’s and for some bizarre reason we seem to be hell bent on repeating them.

Ø The “good bank, bad bank” plan to save the banking system may be good for “some” banks, but for 80% of them it is the kiss of death. Obama said as much yesterday when he said “there will be a time for banks to make profits, but now is not that time”…wow. Banks that made good decisions over the last 5 years should survive, and those that ran their businesses into the ground, all while paying their top execs hundreds of billions in obscene bonuses, should fail…just as you and I would if we ran our households and businesses in a similar fashion.

Ø In the coming year, hundreds of billions in debt must be refinanced throughout corporate America, and just as its impossible to re-fill a balloon with a slow leak, applying band aids to our economy now will leave us with a sick, damaged economy much like Japan has experienced for the last 20 years. They too attempted to support banks and businesses that were failing, with stimulus program after stimulus program, and the result was a stock market that has dropped over 80% from its highs. Do we really want to go down this road? In addition, there is approximately $5 trillion in global debt that will be issued in the coming year, and if other countries apply the same US standard to fixing these problems, then we will experience a global depression of unimaginable magnitude.

MARKET UPDATE

With the lack of real leadership from Washington, this brutal bear market seems determined to go lower. The scary events happening in the global currency markets indicate a repeat of the September-November 2008 crash. I see little chance that this bear market recovery will continue and look for the next big move to be lower. 

Kip Herriage

Editor, VRA

www.vraletter.com

Planet Bizarro and Merrill Lynch Predicts a Depression

Seinfeld fans will remember the episode where Jerry refers to people that appear to be the exact opposites of George and Kramer as being from “Planet Bizarro”. Planet Bizarro comes from a comic book featuring Superman and Batman. On Planet Bizarro, everything happens exactly opposite to what we are accustomed seeing on Earth. They see bad as good and good as bad. Superman and Batman are villains instead of heroes, and morality is upside down. Sound vaguely familiar to the daily news we’re getting?

Bizarro also explains the details of Obama’s stimulus package…completely upside down.

The Congressional Budget Office (CBO) has pulled back the drapes and revealed that less than 40% of the total $800 billion will ever work its way into the economy, and that less than $80 billion will be spent in the 2009. So, over $300 billion of the stimulus will be wasted, and in the year that we need it most…2009…a paltry $80 billion will be passed around…meanwhile Citibank and AIG can get $80 billion with a simple email request. Planet Bizarro has arrived on Earth.

And, no matter how you feel about government-funded family-planning programs, it’s hard to believe they will actually help to stimulate the economy. Yet House Speaker Nancy Pelosi is defending the stimulus packages spending of hundreds of millions of dollars on these kinds of programs as economic stimulus. And this is just one example of how the proposed package will waste our hard earned tax dollars. And just in case you were wondering, the CBO is headed up by Democrats. Complete details on the proposed stimulus package can be found here: http://www.cbo.gov/ftpdocs/99xx/doc9968/hr1.pdf

Until our fearless leaders recognize the serious nature of this economic recession/depression, and cut taxes to ZERO for all businesses and individuals for one full year, the economy will continue in its decline.

Elsewhere on Planet Bizarro, Merrill Lynch handed out up to $4 billion in bonus payments to employees a month earlier than it usually does, and just three days before it was sold to Bank of America. Forget John Thain’s million dollar office expense…this is the real story. American taxpayers are funding billions upon billions of dollars to pay bonuses to corporate execs that have lost hundreds upon hundreds of billions. It gets no more bizarre than this. 

And, earnings reports so far are a very mixed bag. More from Planet Bizarro: Many of the projected earnings gains in 2009 and 2010 will come from cost cutting in the form of layoffs. Let me see if I understand this; corporate earnings will increase going forward because of a reduction in the number of employees. Sounds like a great long term business plan…and more bad news for the consumer. And this is by no means just a US problem…the global economy and corporate structure is in just as bad a shape. 

MERRILL LYNCH PREDICTS A DEPRESSION 

Well, it’s finally happened. Outside of the VRA, not many are predicting that this recession could turn into a depression, but Merrill lynch just did. In a note titled “Some Inconvenient Truths”, Merrill Lynch’s top economist, David Rosenberg, shares the following: 

Some Inconvenient Truths, By David Rosenberg

It shouldn’t come as any big surprise that with such a provocative title, we would be saddled with questions as to how an economic depression is even defined. Of course, most portfolio managers still don’t know that a recession is not defined as back-to-back quarters of negative real GDP prints (which we had neither in 2002 nor 2008) but instead the timing of the peaks in real sales activity, employment, industrial production and organic personal income growth.
 
 As for depressions, there is no official definition, except to say that they have existed in the past. There were no fewer than four in the nineteenth century, one in the twentieth century, and we are very likely enduring another one today. Though this current one is muted by the fact that most countries have an elaborate social safety net (deposit insurance, unemployment benefits, welfare, and socialized health care).
 
 Depressions are basically long recessions - they can last anywhere from three to seven years, while historically cyclical recessions last 18 months - and tend to follow years of leveraged prosperity of Gatsby-like proportions. Considering that in this most recent leveraged cycle from 2002-07, we reached a point where a record 40% of corporate profits were derived from financial activities, where household debt relative to income and assets surged to unprecedented levels and the personal savings rate briefly went negative at the height of the housing bubble, it is safe to say the down-cycle we are currently experiencing did indeed follow a classic elongated period of leveraged prosperity. It is now reverting to the mean. 

And with regards to reverting to the mean, Rosenberg provides some rather scary numbers:

$6 trillion - The amount of private sector debt that needs to be eliminated (Based on ML data that total private sector credit market debt relative to national income is still near a record-high of 140 per cent vs a long-run norm of 80 per cent).

• $1 trillion - The amount of excess capacity in the US economy.

• $13 trillion - the cumulative loss of household net worth at the end of 2008.

• 70% - The US’s share of global consumer spending/GDP, which Rosenberg predicts will now revert to its long-run average of 64 per cent.

Final Thoughts and Market Update:

Finally we have a Wall Street firm saying what most of us already suspect. This is the just the beginning rather than the end, and while this bear market rally appears to have a little ways to go before the market once again tops out, it WILL top out and head lower… sooner than later. In the meantime, gold and silver continue to show great strength. Remember, gold and silver mining stocks are still down 50-70% from their 52 week highs, while gold is essentially unchanged. If there’s a more compelling investing story to be found, I don’t know of it.

Kip Herriage

Editor, VRA

GOLD BREAKING OUT!

As I write this, gold is up $40/ounce and is preparing to blow through $900.

As you can see on the chart of gold it is also well above the 50 day moving average and has also just cracked its 200 day moving average. If we can close above $900 I look for a fast move back over $1000/ounce and new all-time highs.

In addition, Gold has crossed "par" with the S&P 500, and the last time this happened was 1973. Over the next 12 months, gold tripled in price. 

Market Update

The market continues to hold right at all-important technical levels, and with the solid earnings reports from tech leaders IBM, Apple, and Google, we have one more chance at a short term Obama bear market rally. On top of this, the beaten up financials have all reported their quarterly earnings, and as bad as they were, the market seems to want to give them (another) second chance. Remember, Obama’s economic team will be announcing their plan to save the economy in the coming week, and with this news could come a short covering rally, which might bring a quick move higher.

Nothing has changed my long term view that we are going to at least test the November lows of 7500 on the Dow, but even in a bear market it’s not uncommon to see bear market rallies.

Kip Herriage

Editor, VRA

www.vraletter.com