The intermeeting rate cut is back on the table ... maybe --->>

There's been a survey in the sidebar for a little while now about an intermeeting rate cut and it was about to be taken down until Dallas Fed President Richard Fisher showed up on Bloomberg just a little while ago. Here are the results to date:
The next FOMC meeting is on March 18th and the current tally stands at more than two-to-one in favor of another "emergency rate cut". That sounded like a good bet two weeks ago, but not so much in the last ten days - that is, until yesterday.

The headline for the Bloomberg interview read:

"Fed's Fisher Downplays Speculation of Emergency Rate Cut"

And, of course, there's a story on the same subject. Since they're talking about an intermeeting rate cut at all now (well, the plunging stock market may be somehow involved), it seemed like a good idea to leave the survey up for a while longer - it's even been moved up on the right sidebar for easier access.

Here's the Bloomberg interview:

Click to play in a new window

Geez, I don't know about you, but just watching this gave me the willies - something about it being important that the Fed keep a level head under emergency circumstances, after which the interviewer said, "Really? Are we in an emergency right now?"

Sorry, but if you've already voted, you can't vote again unless you access the survey from a different computer.

Hmmm... maybe not. I just voted again and it accepted my vote. Apparently you can vote again if sufficient time has elapsed between your votes.

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The jobs picture is getting clearer

The Labor Department released the February employment data a short time ago and, unfortunately, the jobs picture is getting much clearer.
There was a net loss of 63,000 jobs last month, the steepest decline in almost five years, along with significant downward revisions to prior month's data. December payroll growth was revised from +84,000 to +41,000 and the job loss in February increased from -17,000 to -22,000.

The steepest monthly declines were seen in the usual areas of construction and manufacturing, but there is growing weakness in retail trade within the trade, transportation, and utilities category which tumbled by 39,000 last month.

Job losses at department stores totaled 11,100 in February and, part of the continuing fallout from a deeply troubled housing market, employment at building material and garden supply stores fell by 6,800.The health care industry, restaurants, and all levels of government continue to hire. If government jobs were removed from the mix, instead of a job loss of 44,000 over the last three months, a total decline of 141,000 would result.

The unemployment rate fell from 4.9 percent to 4.8 percent as a result of 450,000 individuals leaving the labor force for one reason or another - the number of respondents reporting that they were employed during the February household survey actually fell by 257,000.

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Maybe Ben Bernanke is onto something

Today's Flow of Funds report from the Federal Reserve provides evidence that Ben Bernanke might be onto something with his idea to save the economy by having banks slash the principal owed by homeowners who are losing their home equity.
Things seem to work best in the U.S. when household assets rise faster than household liabilities - this is the very foundation of our consumption-based economy and life as we know it - so, if you can't keep asset prices rising (which seems pretty obvious now) maybe cutting liabilities at an even faster pace would be the next best thing.

If the red line could plunge down below the orange line in the chart above, then the economy will surely get a boost - things would be back to normal, sort of.

The difference would be that, instead of assets rising faster than liabilities are rising (life as we've come to know it) liabilities would be dropping faster than assets are dropping.

It would have the same effect - homeowners would feel wealthier.

For example, suppose you bought a house in California three years ago for $500,000 and then you heard that the one down street sold for $600,000. Then the bank called and wanted to increase your home equity line of credit by $100,000.

That's the way things are supposed to work.

What's been happening lately is that houses down the street have been selling for $400,000 and then banks have been calling to tell you that they've reduced your home equity line of credit by $100,000 or they've cut you off completely.

That's no way to run an economy.

Under the proposed Bernanke plan, even after the house down the street sells for just $400,000, then the bank could call to tell you that they're increasing your home equity line of credit by $100,000 because they've just reduced your outstanding principal by $200,000.

Do you see how this could work?

In a worst case scenario, this process could be repeated over and over where homeowners' outstanding principal could be reduced in $50,000 increments "freeing up" more and more home equity.

Of course, there is probably a lower bound there somewhere as the bank is not likely to call you up and tell you that they now owe you - the homeowner - money.

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You can't reconcile these two views

On the one hand, an increasing number of observers are coming to the increasingly unpleasant conclusion that real estate prices have to come down before order can be restored to the U.S. financial system and an economic rebound can take hold.

On the other hand, an the increasing number of observers are coming to the increasingly unpleasant conclusion that real estate prices can't be allowed to go down if order is to be restored to the U.S. financial system and an economic rebound is to take hold.

You can't reconcile these two views.

Is anyone even trying?

Shouldn't someone be trying?

A couple examples from earlier today help to frame the issue. Writing in the Washington Post, Robert Samuelson notes:

Home prices are tumbling. We're bombarded by somber reports. But wait. This is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall, the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last.
...
From 2000 to 2006, median family income rose almost 14 percent, to $57,612. Over the same period, the median-priced existing home increased about 50 percent, to $221,900. By other indicators, the increase was even greater.

But home prices could not rise faster than incomes forever. Inevitably, the bust arrived. Credit standards have been tightened, and the (false) hope of perpetually rising home prices -- along with the possibility of always selling at a profit -- has evaporated.

Offering the opposing view, Boston Fed President Eric Rosengren comments:

"As long as housing prices continue to fall, the decline increases the risks to borrowers, lenders, markets and the economy," Rosengren said in prepared remarks to the South Shore Chamber Economic Breakfast in Quincy, Massachusetts. "Significant further declines in home prices could greatly complicate efforts to resolve current problems."

Rosengren joined Fed Chairman Ben S. Bernanke this week in warning about the rising threat of negative home equity, where property prices drop below mortgages.
...
"Lenders could write down the loan amount to the current home value, cap losses, avoid the costs associated with foreclosure, and receive a share of any future home appreciation," Rosengren said.

The closest we've come so far to reconciling these two views is the idea above - where lenders reduce homeowners' principal so that as home prices go down, they'll be a little less eager to walk away from the property because they'll be a little less upside-down in their mortgage which, of course, will only forestall the inevitable market-based correction.

It would be nice to hear more observers ask, "You know, we really can't have an entire economy that is based on blowing one asset bubble after another because, once the bubble pops, the asset prices drop like a rock causing all sorts of problems. How do we fix that?"

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Some strange numbers in the metals market

Who knows what today or tomorrow will bring, but there's been enough excitement in the metals market after just three days this week that you'd think it's time for a little break.

The web server for Kitco is having difficulty keeping up with requests and for a very good reason - there are lots of strange looking numbers being posted these days and everyone wants to have a look.

A good example was yesterday's one dollar rise in the price of silver circled below.A number that big has been seen on more than one occasion before but, on those occasions, it's color was red, not green.

While yesterday's rebound in silver was impressive, gold wasn't too shabby either as Tuesday's sell-off was more than reversed on Wednesday when "bargain hunters" emerged at the $960 level - now that sounds strange.

Hey, they can use the phrase "bargain hunters" for stocks, why not for precious metals?
There was another snarky comment working its way around in my head relative to the chart above, but when I went to the Kitco website to look up a price, it was busy again - all my browser could come up with was one of those little activity indicators going round and round and then, finally, one of those "Connection has timed out" pages.

Whatever the thought was, it's gone now.

Oh well...

Since gold coins at your local coin shop usually command a premium to the spot prices shown above (and their websites are not nearly as busy), you can see that some dealers are already posting strange looking four digit numbers for gold.

The table below is from California Numismatic Investments in Southern California, a business that has cashed more than a few of my checks, though none recently.
If you're watching that $1,026 number more than you are watching the $1,006 number, then join the crowd (though I'm not in that crowd at the moment).

While there are other more convenient ways to buy gold bullion (e.g., the streetTRACKS Gold Trust ETF (NYSE:GLD) which flashed another buy signal by adding another 8 tonnes the other day), it really is hard to beat physical bullion over the long haul.

When you think about it, one ounce gold coins really are a pretty good deal - pay less than two percent up front (the difference between the buy and sell prices above), then stash them away somewhere, and never pay another fee again.

The Kitco site is still busy...

Full Disclosure: Long GLD, gold, and silver bullion at time of writing.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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Nixon ends gold convertibility

This blast from the past, courtesy of Thoughts on Freedom, makes you appreciate what a great 37-year run it has been.

From Wikipedia:

By the early 1970s, as the Vietnam War accelerated inflation, the United States as a whole began running a trade deficit (for the first time in the twentieth century). The crucial turning point was 1970, which saw U.S. gold coverage deteriorate from 55% to 22%. This, in the view of neoclassical economists, represented the point where holders of the dollar had lost faith in the ability of the U.S. to cut budget and trade deficits.

In 1971 more and more dollars were being printed in Washington, then being pumped overseas, to pay for government expenditure on the military and social programs. In the first six months of 1971, assets for $22 billion fled the U.S. In response, on August 15, 1971, Nixon unilaterally imposed 90-day wage and price controls, a 10% import surcharge, and most importantly "closed the gold window," making the dollar inconvertible to gold directly, except on the open market. Unusually, this decision was made without consulting members of the international monetary system or even his own State Department, and was soon dubbed the "Nixon Shock".

That sounds funny - the United States began running a trade deficit for the first time in the twentieth century.

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Paul Volcker was right!

It took a little digging, but thanks to Google, blogs, and those few newspaper websites that keep articles hanging around for years, it wasn't that difficult to find Paul Volcker's warning from back in 2004 - a warning that more people should have heeded.

Here we are, seven months into what was thought to be a two-month "credit crunch", and there appears to be little sign of anything getting any better anytime soon. Headlines beginning with the phrase "Another shoe drops ..." now appear with some regularity in financial papers and, while Congress and the White House spar over how to best save the housing market, the Federal Reserve struggles to save the entire financial system.

What did former Fed chairman Paul Volcker say back in the summer of 2004? According to this report in the San Diego Union-Tribune, he said:

"There's a 75 percent chance of a financial crisis in the next 5 years."

Without a doubt, what is upon us now surely qualifies as a crisis and, by the time it's all said and done, "financial crisis" may be too tame a characterization.

What else did Mr. Volcker have to say a few years back?

Coming about eight months later, this post from April 11, 2005 (when my writing style was distinctly different than it is today) offered up a few excerpts from his Washington Post commentary of the day before.

Has his view changed at all in recent months? Well, I guess yesterday's Washington Post article An Economy on Thin Ice answers that question:

"Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it."

Uh ... Paul, this is the second paragraph, and you're like, all gloom and doom already - come on, flip on CNBC or one of those swell Fox business shows, and get with the program. Baby boomers not saving, spending like there's no tomorrow, home ownership as a vehicle for borrowing ... la la la la la la la - I'm not listening.

Now, about half way through, Paul seems to come to his senses a bit:

"Some, such as China, depend heavily on our expanding domestic markets. And for the most part, the central banks of the emerging world have been willing to hold more and more dollars, which are, after all, the closest thing the world has to a truly international currency."

Yes, that's right - we are the hegemon, they need us, they would be nobodies without us - Japan, China, South Korea, and the rest of them. And, this will go on for as long as we say so ... end of story ... you can stop now.

"The difficulty is that this seemingly comfortable pattern can't go on indefinitely ... The clear lesson I draw is that there is a high premium on doing what we can to minimize the risks and to ensure that there is time for orderly adjustment. I'm not suggesting anything unorthodox or arcane. What is required is a willingness to act now -- and next year, and the following year, and to act even when, on the surface, everything seems so placid and favorable. What I am talking about really boils down to the oldest lesson of economic policy: a strong sense of monetary and fiscal discipline."

Well, you've really gone off the deep end now - you should have stopped when you were talking about how great we are compared to those Asian fellas. Not sure where you're going with this - "willingness to act now", "monetary and fiscal discipline"? I've read about this stuff ... just what decade are you from man? Oh, that's right, you're the guy who raised interest rates to about 20% back in the 80's when we had out-of-control oil prices, gas prices, and housing prices, and gold was like $800 an ounce ... uh ... but this is completely different now.

That's weird about the writing style changes - I guess it's a lot more fun to make fun of things when no one really understands that anything is wrong.

When people are losing their homes and both stock and bond investors are losing their shirts, it's just a little too sad to write with such glee.

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All recessions are local

There's a pretty cool interactive graphic in this story at USAToday today. They make the same point that realtors like to make these days - all recessions are local.

Just look at the farm belt - no recession there - nothin' but green.

You can mouse-over a state and they'll pop up a list of major metropolitan areas with green, yellow, and red lights to indicate the current economic conditions for each area. The entire California central valley is one, big red-light district, as is the entire state of Nevada, some areas in more ways than one.

On the campaign trail and in homes across the USA, the debate is underway about whether the U.S. economy in 2008 will see its first downturn in seven years.

Despite the recent onslaught of negative news, it remains unclear whether the current state of affairs meets the economists' definition of a recession: a widespread decline in economic activity lasting more than just a few months. As in politics, all economics is local.

Mark Zandi, chief economist at Moody's Economy.com, for example, believes the U.S. economy is in recession.

But the contraction is far from uniform. Zandi's firm estimates that in January, 30 state economies were expanding while 15 were "at risk" of slipping into recession.

Arizona, California, Florida, Michigan and Nevada were already in a recession at the start of the year. Those states account for one-quarter of the nation's total economic output.

Yes, and those states had the biggest housing bubbles (well, except for Michigan where, sadly, they got a housing bust without the preceding boom).

Just like when they said there was "no national housing bubble", maybe economists and elected officials can start saying, there's "no national recession".

No, probably not - there exists a comprehensive set of economic statistics and an entire agency tasked with the job of defining exactly when a national recession starts and stops.

Maybe if there had been a similar staff to determine when financial bubbles start and stop we wouldn't be in the current mess.

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ADP employment report goes negative

The relationships between the Labor Department's employment data, the figures tabulated in the ADP Employment Report, and the reality on the ground have always been hard to decipher, but the fact that the ADP employment report just produced a negative number for the first time since 2003 can't be a good sign.
According to this report from Bloomberg:

The decrease of 23,000 jobs followed a revised gain of 119,000 the prior month that was less than previously estimated, according to the figures from ADP Employer Services.

The deepest housing recession in a quarter century and tighter credit for companies and consumers are slowing growth and costing jobs. The report may cause some economists to lower forecasts for the government's payroll data due March 7.

"The labor market is clearly deteriorating and a sustained run of declines is just a matter of time," said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York.

The ADP report was forecast to show an increase of 18,000, according to the median estimate of 24 economists surveyed by Bloomberg News. Estimates ranged from a drop of 80,000 to a gain of 100,000.

The report also indicated that construction employment fell by 30,000 in February, the fifteenth straight month of declines. The ADP data now puts the total decline in the number of construction jobs at 236,000 since the peak of the housing boom in 2006.

The Labor Department releases the monthly jobs data on Friday.

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Look at that ... sign

Another tip of the hat to AD who always seems to come across really good stuff. This one from themot.org reminds me of the Demotivator series from Despair.com.

New from Despair: Possibilities

Here's one for Treasury Secretary Paulson:

And one for Fed chairman Bernanke:

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The world has plenty of oil ... because the Saudis say so

Today's Wall Street Journal op-ed by Nansen G. Saleri, the former head of reservoir management for Saudi Aramco, makes you wonder just how stupid the Saudis really think the rest of the world is.

The answer?

Pretty stupid.

And they're probably right.

With all the work done by the Peak Oil crowd (see Saudi Arabia's Crude Oil Propaganda) and after all the pleadings by the likes of Matt Simmons to make their reserve data available for public scrutiny, it all comes down to, "Trust us, the oil's there".

Just reading this editorial with it's four central arguments for why the world has plenty of oil - resources in place, recovery efficiency, rate of consumption, and state of depletion at peak - you have to wonder why the first argument merited only about 50 words of explanation while the other three arguments got about three times that amount.

The World Has Plenty of Oil
Many energy analysts view the ongoing waltz of crude prices with the mystical $100 mark -- notwithstanding the dollar's anemia -- as another sign of the beginning of the end for the oil era. "[A]t the furthest out, it will be a crisis in 2008 to 2012," declares Matthew Simmons, the most vocal voice among the "neo-peak-oil" club. Tempering this pessimism only slightly is the viewpoint gaining ground among many industry leaders, who argue that daily production by 2030 of 100 million barrels will be difficult.

In fact, we are nowhere close to reaching a peak in global oil supplies.

Given a set of assumptions, forecasting the peak-oil-point -- defined as the onset of global production decline -- is a relatively trivial problem. Four primary factors will pinpoint its exact timing. The trivial becomes far more complex because the four factors -- resources in place (how many barrels initially underground), recovery efficiency (what percentage is ultimately recoverable), rate of consumption, and state of depletion at peak (how empty is the global tank when decline kicks in) -- are inherently uncertain.

- What are the global resources in place? Estimates vary. But approximately six to eight trillion barrels each for conventional and unconventional oil resources (shale oil, tar sands, extra heavy oil) represent probable figures -- inclusive of future discoveries. As a matter of context, the globe has consumed only one out of a grand total of 12 to 16 trillion barrels underground.

That's all you get for resources in place - trillions and trillions of barrels - it's there - the guy used to work there, he should know.

By Mr. Saleri's math, don't look for peak oil until sometime between 2045 and 2067.

Could there be a bigger disservice to the rest of the world than the continuing claims of nearly infinite global oil reserves, much of it still under the Saudi Arabian desert?

Maybe these claims would be just a little bit more believable if Saudi oil production hadn't declined over the last two years while they've continued to frantically poke holes in the ground in an attempt to coax more of the stuff to the surface.

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Private domestic investment in a bubble economy

This is a follow-on to Friday's post on fourth quarter GDP where an anemic 0.6 annualized growth rate was reported. The chart below breaks out the private domestic investment component of GDP which accounts for roughly 17 percent of all economic activity.
While, in time, it will likely be proven that personal consumption in the U.S. (accounting for about 70 percent of GDP) was the biggest and baddest bubble of them all, spanning decades and ultimately leading to all sorts of life-changing developments, in the chart above you can clearly see the last two smaller bubbles as they peaked and popped.

Going back about a decade and working from left to right in the chart, you can see the parade of bubbles.

The big red bars above the zero axis in 1998 and 1999 are the last of the routers and fiber optic cables being purchased and installed. Then, when the red bars fall into negative territory and proceed to grow there, that's when all the dot-com jobs were slashed and investors started picking up the pieces left behind by their tech stocks.

Similarly, the expanding green bars above the zero axis from 2002 to 2005 indicate the more recent housing bubble and, now that the green bars are below the zero axis, jobs are being lost once again as prices plunge for another asset class - residential real estate.

The commercial property market, as indicated by the blue bars far to the right, is probably the next bubble that will meet its pin.

If you are wondering what will expand above the zero axis next, you are not alone.

In the near term, government spending (a separate category within the GDP data) would be a good guess.

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Why stop at reducing the principal?

Geez, they should just get right to the chase and start cutting checks for tens of thousands or hundreds of thousands of dollars for each homeowner who now owes more than their house is worth.

And what about credit cards and auto loans? Why not get out ahead of the curve on those problems that are now starting to blossom?

Reduce my outstanding balance!

Gimme some free cheese!

While we're at it, let's make health care free for everybody without raising taxes and how about increasing the minimum wage to $100,000 per year.

Pass a law that stocks can never fall on a year-over-year basis and forbid the sellers of commodities from raising prices faster than the government's official rate of inflation, which will be required by law to never increase by more than three percent per year.

Reading this report from the Associated Press about Fed Chairman Ben Bernanke's speech this morning (the Fed website appears to be too busy right now to serve up the full speech), you'd think that's where we are all headed:

Federal Reserve Chairman Ben Bernanke called Tuesday for more action to prevent distressed homeowners from falling into foreclosure, including a suggestion for mortgage lenders to reduce loan amounts to provide relief to struggling homeowners.

"This situation calls for a vigorous response," Bernanke said in a speech to a banking group in Florida.
...
On the idea of cutting mortgage values, Bernanke said, "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure. "

With low or negative equity in their home, a stressed borrower has less ability — because there is no home equity to tap — and less financial incentive to try to remain in the home, he said.

Bernanke acknowledged this idea might be a tough sell to lenders. Lenders, he said, are reluctant to write down principal. "They said that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again," Bernanke said.

Still, Bernanke suggested such longer-term permanent solutions may work better than shorter-term and temporary ones, where the distressed homeowner could find himself in trouble again. "When the mortgage is 'under water' a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure," he said.

Oh yeah! That money I lost in the stock market crash eight years ago?

I want it back.

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No reply from Tim

I just learned that a fair number of non-SPAM emails are winding up in the SPAM folder of my Yahoo! Mail account which I stopped checking a few months ago because the volume of SPAM had grown to ridiculous levels.

If you've sent me mail in the last few months or so and have not heard back from me (I try to at least send something back to acknowledge receipt of the message), well, sorry about that.

While I won't promise to dutifully sort through all the solicitations from Nigeria about some multi-million dollar account they need help unfreezing so that I can find every last correspondence from readers of the blog, at least now you know why you received no reply from me.

If you want to make sure your correspondence goes through, please use the email address at the investment website: tim-at-iaconoresearch.com.

Maybe it's time for a new email account - I've had the one from Yahoo! since sometime in the mid-1990s (late-1990s?) and it's now probably on so many lists that it should just be abandoned.

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ISM Manufacturing Index heads lower

The nation's broadest measure of manufacturing activity, the ISM Manufacturing Index, plunged back below the expansion/contraction line in February for the second time in three months, close to the five year lows reached in December.
A rebound like the one seen early last year doesn't appear to be in the cards for 2008. Given how other economic indicators have deteriorated lately, a further plunge into the low forties sometime in the months ahead seems to be the more likely outcome, as was the case early in 2001.

Recall that a level of 50 delineates expansion from contraction and noone starts to really worry about the ISM numbers until they drop below 45.

Declines were seen in production (down 4.5 points), inventories (down 3.7 points), vendor deliveries (down 2.7 points), employment (down 1.1 points), and new orders (down 0.4 points).

Prices were stable, dropping from 76.0 to 75.5 and new export orders fell from 58.5 to 56.0, the only items that remained above the 50 mark.

Those looking for good economic news this week will probably be disappointed - the most important economic report of them all, the labor report, comes out on Friday and only the most optimistic analysts are looking for a big rebound from last month's loss of 17,000 jobs.

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Dennis Gartman gives more advice on gold

Dennis Gartman of The Gartman Letter talked about gold and other precious metals during an interview on Bloomberg earlier today.

Click to play in a new window

While he is without a doubt bullish over the long-term, it's hard to make sense of his short-term outlook given that he claims to have sold half his gold when the price was about $100 lower a couple months ago. Some excerpts:

Host: Do you think that investors should be selling into some of these rally? Pocketing some of their gains?

Gartman: You've had a pretty good run haven't you. I would tell people, don't buy any more up here and if you haven't owned any, please don't buy any up here. I think that would probably be an ill-advised trade. And if you had some and couldn't sleep at night, you might want to go ahead and sell a little up here.

Host: Let's break it down a little bit more. You've got gold hitting another record, what's your outlook for gold at this point? You know the estimates out there.

Gartman: Well, a thousand really is right there, isn't it? It's the siren song, it's the siren singing to Ulysses. Markets have this terrible tendency to go to what I call the "obscene" number, which, in this instance will be a thousand. We'll probably get there. Remember how we got crude oil when we got there a month ago, we got there for just one day. We might put a thousand up there just to do it and then back off from there.

Host: Do you think gold is a safe inestment at this point? It was interesting this morning to see all these gold commercials. Everybody's telling investors to buy gold. How safe is it though?

Gartman: Well, those are the indicators that you're getting a little bit sporty in price, aren't they. I've had more calls asking me to be on TV asking me to talk about the gold market and you don't get those kind of calls when gold is trading lower, you only get those kind of calls when gold is trading higher and the public enthusiasm for gold is quite disconcerting - everybody wants to own it and, even when you walk down the street, people say, "Hey, don't you talk about gold?" It's a little frightening.

I like Dennis Gartman a lot, in large part because he talks about gold and other commodities, but I wouldn't necessarily heed his advice on the yellow metal. Below, reproduced in its entirety, is a post from almost two months ago - Last Week's Gold Commentary - where his comments at that time were discussed.

ooo

Monday, January 14th, 2008

Below are excerpts from last week's commentary in the Precious Metals section at the subscription site. After a long weekend involving some major changes to the model portfolio, little motivation can be found at the moment to write for the blog, however, that will change soon enough.

It looks like we are now a few dollars clear of the $900 level that, just six months ago, would have seemed pretty preposterous - what you see below was written two days ago on Saturday.

There were new all-time highs for gold last week as the heavily traded February futures contract saw prices go as high as $900.10 before ending the week slightly lower. The spot price reached a new inter-day high of $898. The 15-month long price weakness in the yellow metal, after making highs near $725 in the spring of 2006, now seem like an ancient memory as more and more analysts talk about $1,000 gold, at which point the nascent gold fever may really begin to catch on with retail investors.

The usual reasons are being offered for the recent strength in the gold price and, while some are starting to talk about a "gold bubble" and Dennis Gartman announced that he was selling half his gold position, I don't think there is any reason to even think about selling anything unless you are a much better trader than I have ever been. Mr. Gartman's reasoning is that there is likely to be a major correction down toward $800 before prices go appreciably higher and he remains very bullish in the longer-term.

It's hard to argue with that thinking, however, I wouldn't count on a correction.

As mentioned in this section late last year (see Volume II, Issue 49) and as shown in the chart below, there is a precedent for the sort of movement that we are now seeing where a big price move follows another big price move after a period of a few months of consolidation.

This is one of the reasons why I continue to advocate taking initial positions (10 or 20 percent of what you will ultimately buy) at any time and then either averaging in over time or buying on weakness - you don't want to be completely left behind, but at the same time you don't want to be stuck with a losing position for 15 months (as was the case between May of 2006 and August of 2007) because many investors simply can't deal with holding onto a losing position for that period of time, opting instead to exit positions at a loss.

Silver too has posted strong gains in recent weeks, rising 10 percent as compared to just six percent for gold. As discussed previously (see Volume II, Issue 52), in conjunction with the sale of equity positions in the model portfolio this week ...

To read the rest of this commentary and/or to visit the links above, you may sign up for a no obligation, FREE 30-DAY TRIAL.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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The mainstream media financial bubble amplifier

"Geez, I don't know. Walk away? We just saw it on the evening news. Maybe we should give them a call."

It seems increasingly clear to me that, if you're going to have a "bubble economy" (which is apparently what we've got, though it's not at all clear what the next bubble is going to be), you really have to control the media.

If you don't control the media, they'll just make things worse by amplifying the bubble as it is inflating and then making sure that, when the bubble bursts, it bursts good and hard.

How?

By simply reporting what's happening on the ground, which, actually, is what they're supposed to be doing.

Hmmm...

A good case in point came just a short time ago in a news segment on the ABC Evening News where they reported on the latest mortgage craze - youwalkaway.com.
No, this is not a 2005-style mortgage craze where aspiring homeowners do nutty things to get into mortgages, this is the 2008 version where existing homeowners do nutty things to get out of mortgages.

Well, not so nutty, actually, when you think about it - do the math.

Why pay $3,500 a month for a home whose value declines by at least that much over those same 30 days when you could rent a place for less than half that amount?

As reported elsewhere for about the last month or so, You Walk Away is an innovative new service that provides homeowners with a $1,000 information kit on how to walk away from a losing real estate bet.

That's good 'ol American ingenuity and free enterprise for 'ya.

How many people watched that news segment and then called friends or relatives who are behind on their mortgage to fill them in on a sensible alternative to those complicated aid programs sponsored by the government and run by mortgage lenders, both of whom probably just wish the clock could be turned back three years so every happy homeowner could once again be wealthy beyond their wildest dreams?

If we're going to have one financial bubble after another, wouldn't it make sense to reduce the amplifying effect of the mainstream media so the bubbles can inflate slower, last longer, and not cause so much damage when they burst?

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Economists need to get out more

Even Robert Shiller, noted housing bubble observer, Yale economics professor, and co-inventor of the acclaimed S&P Case-Shiller Home Price Index, sounds too much like an economist from time to time (well, he is an economist) lending further weight to the argument that the dismal set just needs to get out more.

Had they collectively pulled their noses away from studies written by other economists and mixed in with the public - just for an afternoon or two back in 2003, 2004, or 2005 - they could have asked real people relevant questions and maybe they could have spotted the housing bubble in real time.

Questions like, "Why have you camped out for the last week to buy a condo?"

Or, "Why don't you have to verify that borrower's $20,000 per month income and why don't you need a down payment from him?"

Writing in the New York Times, the good doctor attempts to explain how the housing bubble "stayed under the radar" for so long by citing the work of ... other economists.

ONE great puzzle about the recent housing bubble is why even most experts didn’t recognize the bubble as it was forming.

Alan Greenspan, a very serious student of the markets, didn’t see it, and, moreover, he didn’t see the stock market bubble of the 1990s, either. In his 2007 autobiography, “The Age of Turbulence: Adventures in a New World,” he talks at some length about his suspicions in the 1990s that there was irrational exuberance in the stock market. But in the end, he says, he just couldn’t figure it out: “I’d come to realize that we’d never be able to identify irrational exuberance with certainty, much less act on it, until after the fact.”

With the housing bubble, Mr. Greenspan didn’t seem to have any doubt: “I would tell audiences that we were facing not a bubble but a froth — lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy.”

Three economists, Sushil Bikhchandani, David Hirshleifer and Ivo Welch, in a classic 1992 article, defined what they call “information cascades” that can lead people into serious error.
...
Mr. Bikhchandani and his co-authors worked out this rational herding story carefully, and their results show that the probability of the cascade leading to an incorrect assumption is 37 percent. In other words, more than one-third of the time, rational individuals, each given information that is 60 percent accurate, will reach the wrong collective conclusion.

Thus, we should expect to see cascades driving our thinking from time to time, even when everyone is absolutely rational and calculating.

This theory poses a major challenge to the “efficient markets” view of the world, which assumes that investors are like independent-minded voters, relying only on their own information to make decisions. The efficient-markets view holds that the market is wiser than any individual: in aggregate, the market will come to the correct decision. But the theory is flawed because it does not recognize that people must rely on the judgments of others.

The theory of efficient markets doesn't seem to function very well in a "bubble economy" like we've had in the U.S. over the last 15 years or so and which we'll probably continue to have until something really bad happens.

As Eric Janszen noted in his recent article at Harpers, The Next Bubble:

Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences... Nowadays we barely pause between such bouts of insanity.

Will any of the experts spot the next bubble?

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The week's economic reports

Plunging home prices, soaring wholesale prices, stalling economic growth, and quickly eroding consumer confidence highlighted the week's economic reports. Stocks and bonds ended with the S&P 500 Index down 1.7 percent to 1,331, now down 9.4 percent for the year, and the yield of the 10-year U.S. Treasury note fell 26 basis points to 3.53 percent.
Existing Home Sales: Sales of existing homes fell 0.4 percent in January and are now down 23.4 percent on a year-over-year basis, the worst annual decline on record.

Inventory remains at a historically high level, rising from 9.7 months of supply in December to 10.3 months in January, down modestly from the recent high of 10.7 months in October.
The pace of home price declines is now accelerating as the median price fell 2.9 percent in January to $201,100, down 4.6 percent from the level of a year ago. An increasing number of bank owned properties are now coming onto the market and asking prices for these properties are starting out lower and lower as banks are only now beginning to realize that they must slash prices to move their growing inventory.

The combination of tighter credit and an increasingly skittish home buying public will continue to put downward pressure on prices for some time to come.

The sole bright spot in this report from the National Association of Realtors was that sales of existing homes actually rose 0.5 percent in January and the 6.5 percent decline in sales of condominiums, a much smaller market segment, was responsible for the overall sales volume decline.

For a colorful chart of the 20-city S&P Case-Shiller Home Price Index, see Tuesday's post "Home prices continue to plunge".

Producer Prices: Wholesale prices surged in January, up 1.0 percent after a 0.3 percent decline in December. This was far above the consensus estimate and provides further evidence of soaring commodity prices that should show an even bigger increase when the February data is reported next month. On a year-over-year basis, overall producer prices rose 7.7 percent, the biggest annual increase since 1981.

Energy prices rose sharply but other increases were broad-based. Gasoline prices rose 2.9 percent in January after a 7.6 percent decline in December and are now 48.1 percent higher than a year ago. Prices for heating oil surged 8.5 percent and natural gas prices rose 0.7 percent.

New Home Sales: The Commerce Department reported a 2.8 percent decline in new home sales during January to an annualized rate of 588,000 homes, the lowest level since 1991. On a year-over-year basis, new home sales are down 34 percent and, from the peak in 2005, sales are down an astonishing 58 percent.

Inventory remains at levels not seen since 1991, up slightly to 9.9 months of supply, and there is little reason to think that the market for new homes will improve anytime soon, though it is possible that sales may stabilize near the current depressed levels.
Remember that sales volume and sales price are two very different things and that homebuilders and real estate professionals will see some relief if sales volume begins to level out. However, until inventory is brought back to more normal levels, downward pressure on prices will continue.

Prices for new homes are now in a virtual free-fall, down 4.5 percent in January after falling 9.3 percent in December for a year-over-year decline of 15.1 percent, an all-time record decline. Recall that these prices do not include builder incentives, so actual price declines are even greater.

If home prices tumble further, which appears to be unavoidable at this point, there will be an increasing impact on the broader economy as home equity wealth has been one of the key drivers of consumer spending in recent years. Some analysts are now projecting 20 to 30 percent home price declines nationally from the 2005 peak and much more in markets that had the biggest run-ups in price.

Gross Domestic Product: In the second of three estimates for the fourth quarter, real GDP growth was unrevised at a seasonally adjusted, annualized rate of just 0.6 percent. For the full year of 2007, real GDP growth now stands at 2.5 percent.
The final reading for Q4-07 will be released in one month and then the much anticipated first look at economic growth during Q1-08 will be reported at the end of April.

There were modest downward revisions to consumer spending that were offset by a slight increase in inventories, resulting in no change to the headline figure. Tepid growth in the fourth quarter followed two relatively strong quarters in the middle of 2007, but the current quarter is expected to show negative growth.

The GDP price index, used to convert "nominal" economic growth to "real" economic growth was revised up slightly from an annualized rate of 2.6 percent to 2.7 percent. Given how energy and food prices have risen so far in 2008, real growth in the first quarter is likely to be affected by both lower nominal growth and a higher price deflator, resulting in what could be a shockingly bad headline number.

Summary: As if the dismal reports on housing, producer prices, and economic growth were not enough, there was even more bad news elsewhere last week. The mood of the American consumer is now quickly souring, the slowdown in manufacturing is accelerating, the labor market is showing increasing signs of trouble, and personal income and spending both disappointed.

The Conference Board's consumer confidence index plummeted to the lowest level since 2003 with the "expectations" component dropping to a 17-year low. Expectations for business conditions fell to a level not seen since 1972 while expectations for employment dropped to the lowest level since 1980. Also, the Reuters/University of Michigan consumer sentiment index had its largest month-to-month decline since the hurricane-effected period in late-2005, sinking to its lowest level since early 1992 as opinions of government policy fell sharply.

After providing hope for a rebound in manufacturing with a strong advance in December, orders for durable goods (a very volatile data series) gave back all of those gains in January. On the labor front, initial jobless claims, an important leading indicator for the labor market, surged by 19,000 to 373,000 last week and are now at the highest level since October of 2005.

Finally, on Friday, the Chicago Purchasing Managers' Index plunged to its lowest level since late-2001 and a report on personal spending and income showed that inflation is now wiping out all gains in consumer spending while a weakening labor market is restraining income growth. The personal saving rate (after-tax income less personal consumption), remained at minus 0.1 percent for the second consecutive month.

Broad equity markets reacted appropriately to all of this news as the Dow Jones Industrial Average plunged 316 points on Friday. The pace of the economic slowdown has quickened considerably in just the last two months and it is all but assured that, when the determination is finally made later in the year, it will be revealed that the nation is now in a recession.

The Week Ahead: The coming week will be highlighted by the ISM manufacturing report on Monday and the most important economic report of them all, the labor report on Friday. Also scheduled for release are reports on construction spending on Monday, ADP employment, productivity/costs, and ISM nonmanufacturing activity on Wednesday, pending home sales on Thursday, and consumer credit on Friday.

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