Archive for October, 2008

First, some important news no one else is telling you: The Dow is now trading at the equivalent of the 2,500 level, down a whopping 77% from its high.

Yes, you read that right. In terms of “honest” money — gold — the Dow Jones Industrials has already lost 77% of its value!

Now, how could that be, you ask.

Simple: It’s because the world no longer uses “honest” money and instead economies — and asset prices — float on variable currency exchange rates with nothing but “a promise to pay” backing them.

So to really understand what’s happening to values — the nominal prices that you see in the markets whether they be for stocks, bonds or commodities — you must look at them in terms of the one asset that always holds its purchasing power: Gold.

For instance …

In 1999, when the Dow hit its real inflation-adjusted peak of 11,210, it bought 44 ounces of real money, gold.

Today, the Dow buys less than 10 ounces of gold.

That means the Dow now buys 34 ounces less gold, a purchasing power loss of 77%. That essentially means the Dow is already trading at the equivalent of 2,578.

Now, you might argue, as others do, that it’s mostly because the price of gold has soared so much over the last eight years.

But that argument actually reinforces my point: Your money, even after the recent rally in the value of the greenback, is worth a whole lot less than it was a year ago, two years ago, five years ago, eight years ago, even ten years ago. And so on.

This is a hard concept to understand at times, but it’s so important that you do. Why? Because only then will you know how to position your portfolio to profit in the months and years ahead.

Savvy investors like Warren Buffet, Jimmy Rogers, Mark Mobius, and Barton Biggs understand it.

Smart investors like Barton Biggs, Jimmy Rogers, Warren Buffett, and Mark Mobius look past fear toward opportunities.
Smart investors like Barton Biggs, Jimmy Rogers, Warren Buffett, and Mark Mobius look past fear toward opportunities.

Indeed, just a few days ago, Warren Buffet wrote the following in The New York Times

“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.”

He’s right.

Of course, Buffet has the capital and staying power to jump into the markets now and buy, whereas many investors don’t. So for most of you, I think holding cash and gold right now are the best and safest investments for almost all your capital.

Even so, that shouldn’t change your view or understanding of the world and what’s happening.

And it certainly should not prevent you from preparing for some of the greatest buying opportunities of a lifetime in all types of assets.

To see how assets inflate over time, ask yourself the following questions …

Arrow If you could go back to the depths of 1932 and buy stocks or commodities, would you? You bet you would.

Arrow If you could roll back time to the severe 1973 — 1975 recession and buy stocks or gold, would you? You bet you would, especially gold, which soared from the $130 level to $850 by January 1980.

Arrow If you could buy stocks after the 1987 stock market crash, would you? You bet you would!

Arrow If you could turn back the clock and buy stocks or commodities during the 1990 S&L crisis, would you? You bet you would!

Arrow If you could go back to the Long-Term Capital Management and Asian currency crises of 1997 and 1998 and buy assets, even real estate, would you? You bet you would!

Arrow If you could go back to the year 2000, or even 2001 post-9/11, and buy gold, other commodities, even real estate, would you? You bet you would!

The ONLY difference between the current crisis and past crises is, yes, that this one is larger and more severe in scope.

But that doesn’t mean it will be resolved differently. Quite to the contrary, it will be resolved the same way all past financial crises have been resolved, through inflating away debt. Because no matter how you slice it, the historical record shows that without gold backing currencies, inflation is baked into the cake via monetary policy.

Another market that’s quickly
becoming a huge bargain: China

In fact, I see five major reasons why China continues to offer excellent long-term potential …

Reason #1: Contrary to popular opinion, China’s exports continue to grow!

The talking heads in the media want you to believe that China’s exports are getting hammered. But that’s simply not true.

While exports to the U.S. are down 10% this year, all told China’s exports through September are up an astounding 21.5% over the same period last year.

Where are all the exports going, if exports to the U.S. are declining? They’re going to Vietnam, Thailand, Indonesia, Malaysia, and more.

In other words, China’s exports within Asia and Southeast Asia are up, big time.

That’s a testament to rising consumption within Asia as much as it is to China from a purely export point of view.

And speaking of consumption …

Reason #2: Retail sales are exploding higher.

Retail sales over the Chinese New Year holiday jumped 16% over 2007 even while bad weather crippled the nation’s transport infrastructure during the holiday period.

More recently, during its week-long national holiday between September 29 and October 5, China’s retail sales surged 21% year-on-year.

That’s not all. In September alone retail sales soared 23% over last year — that’s close to the fastest pace in at least nine years!

What’s more, January through August retail sales volume in China rose 14.3% versus 12.9% for all of 2007, while the value of the retail sales rose to a 12-year high.

And in the months ahead, retail sales and domestic consumption appear set to rise even more as Beijing cuts interest rates … slashes taxes … and lowers the downpayment requirement for first-time homebuyers from 30% to 20%.

Also announced on October 22, a reduction in the property deed tax to 1% from 3%-5% for first-home buyers and for those who purchase properties smaller than 90 square meters … plus, a whopping 30% discount on mortgage interest rates!

That is sure to help propel retail sales growth in the months ahead.

Reason #3: Government Spending. Having nearly $2 trillion in its piggy-bank is a nice way to weather this global financial storm.

It’s why growth in urban fixed-asset investment in China is 27.6% higher in the first nine months of this year from a year earlier.

And it’s why up to $400 billion in new investment has been earmarked for rural China with a growth objective of doubling rural incomes of 750 million Chinese within the next three years.

Reason #4: Monetary policy is being relaxed. Inflation has cooled a bit in China, so monetary authorities are loosening up their grip, cutting interest rates and bank reserve requirements for the first time since 2002. And more cuts are in the offing.

Reason #5: China’s stock market is trading at dirt-cheap price-to-earnings ratios.

China’s market has been hammered hard and it’s now trading at almost unheard of levels, with P/E valuation multiples as low as 5 to 1.

Cheap? You bet they are. Can they get cheaper? In this panic environment, of course they can.

So what does all this mean and what should you do? You have to see through the panic to the profits. Once-in-a-lifetime bargains are going to be popping up all over the world.


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When people ask me if I think crude oil is going to $50 or $150, I nod sagely and say: “Yes, probably.”

I’m not being flip. I’m simply giving both the short-term and the long-term timeframes.

Short-term, crude oil is probably heading lower, even though it’s nearly 60% off its highs.

The last chance to hold the line on oil prices was at OPEC’s emergency meeting. And the oil cartel choked like a cat on a hairball. They cut 1.5 million barrels per day of production when they needed to cut about 3 million barrels per day.

The OPEC meeting was the last obstacle in the way of deflationary forces that are driving oil prices lower in the short-term. Long-term, there are forces that should drive oil much higher. And one of the paradoxical things about the oil market is the longer that prices stay lower, the harder, faster and more furious the rebound will probably be.

OPEC members choked like a cat on a hairball at their recent emergency meeting.
OPEC members choked like a cat on a hairball at their recent emergency meeting.

The good news is you can make money on both sides of the market.

We’ll get to the long-term forces in a minute, as well as potential trading opportunities. First, let’s look at the short-term forces.

Short-term Force #1:
Economic Weakness

The prices of commodities and stocks are down across the board as investors resign themselves to some form of global recession. Economies from Boston to Beijing are grinding into low gear. And demand for crude oil and gasoline is falling off a cliff.

Here in the U.S., Americans are using around 18.6 million barrels of oil a day, a drop of 1.8 million barrels year over year. Demand for gasoline is decelerating rapidly.

Vehicle Miles Driven

Take a look at this chart from Calculated Risk and you’ll see what I mean.

Americans drove 15 billion fewer miles this past August compared with the same month a year ago — a drop of 5.2% and the biggest single monthly decline since 1942, the first year data was collected.

Short-term Force #2:
Hedge-Fund Selling

Hedge funds were responsible for much more of oil’s climb to $150 than I or a lot of other analysts thought possible. Now, hedge funds are being hit by heavy redemptions as investors cash out and run for cover. One report concludes that investors pulled $210 billion out of U.S. hedge funds during the third quarter, forcing the funds to dump assets, including oil, thereby driving down prices.

The good news is that hedge funds can’t sell forever. And in fact, the worst of it should be over by the end of this year as investors square their books and take their lumps.

Short-term Force #3:
The Rising U.S. Dollar

As investors flee for safety, they sell risky assets and go into U.S. dollars. This has pumped up the dollar’s value. And since oil is priced in dollars, a higher greenback tends to push crude oil prices lower.

With the economy on the skids, why is the U.S. dollar looking like a safe haven?

U.S. Dollar and Crude Oil

The reason is that Europe has been hit by the credit crisis even harder than the U.S. And Eurozone countries are responding to the crisis separately — not working as a group.

This undermines confidence in the euro, and makes the U.S. dollar shine by comparison. Also, many foreign banks need dollar financing. That’s all the worse for them, because they can’t get loans from U.S. banks as the credit crunch worsens.

Looking at this chart, you can see that crude oil and the U.S. dollar are mirror images of each other now.

But the U.S. dollar is due for a pullback in its rocket ride. That said, crude could easily go to $50 a barrel before its correction is over — becoming as deeply oversold on the downside as it was overbought on the upside.

Now, Let’s Look At Some Long-Term Forces
That Could Push Oil Much Higher

Long-term Force #1:
Mexican Production Is Falling Off a Cliff

Yes, this has been going on for a long time. But it’s getting worse, despite the Mexican government’s frantic efforts to reverse the trend.

Mexico is using more of its own oil and cutting exports to the U.S.
Mexico is using more of its own oil and cutting exports to the U.S.

For the month of September, Petroleos Mexicanos (Pemex), the state-owned oil company, said monthly crude output fell to the lowest since November 1995.

Production fell to 2.7 million barrels a day in September, a decline of 14% from a year ago. What matters to us, though, are exports — Mexico is the #3 supplier of imported oil to the U.S. And since Mexico uses more and more of its own oil, exports to the U.S. fell to 845,000 barrels a day, the lowest since October 1995.

And it’s not just Mexico — production is also falling in Russia, Kazakhstan and other oil exporters.

Long-term Force #2:
Production in the U.S. Gulf of Mexico
Is Trending Lower

Hurricane season is nearly over, but we’re still feeling the impacts of Hurricanes Gustav and Ike. The Minerals Management Service recently said approximately 38.6% of the production in the Gulf was still shut-in, for a total of 32 million barrels of crude oil and 165 billion cubic feet of natural gas production in the month of September.

We can expect more drops in Gulf of Mexico production in the future in the wake of future hurricanes, because hurricanes are becoming both more frequent and more powerful.

Since 1995, there have been 207 named storms in the Atlantic basin, which includes the Gulf of Mexico — a 68% increase from the previous 13 years, according to statistics from the National Oceanic and Atmospheric Administration. Of those storms, 111 were hurricanes, a 75% increase over the previous period.

Long-term Force #3:
Investment in New Oil Wells
Is Threatened by Lower Prices

The good news is that oil services companies, including Halliburton and Schlumberger, are reporting no slowdown in demand for their services. But if oil prices stay low for too long, it’s likely that the oil majors will reconsider developing costly projects.

Close to a dozen companies have already announced cuts to 2009 budgets. For example, Brazil’s Petrobras is pushing back development of some of its new underwater oil fields by years.

The longer oil prices stay low, the more expensive new projects will be delayed. And when the recession ends and fuel demand increases again, those new projects won’t be there to meet new demand. And that supply/demand crunch could light a fire under oil prices.

Long-term Force #4:
We’re Only Seeing a Pause
In the Commodity Supercycle

Research by Morgan Stanley indicates that commodity markets tend to move together …

Commodity prices are cyclical and move in unison

This chart shows the cyclical trends in commodities prices. The upswings, or commodities supercycles, can last 20 to 25 years, according to Morgan Stanley’s research. And if the current one follows the pattern, we have many years to go before it plays out. The key drivers are the rapid economic growth in China and infrastructure spending in other large emerging markets.

The fact is, commodity bull markets can see corrections that will make your head spin.

Other commodity bull markets in modern history — roughly spanning 1906 to 1923, 1933 to 1955 and 1968 to 1982 — lasted more than twice as long as the current run. They included some sharp corrections before they ran their course, suggesting that the current drop, however sharp, could be temporary.

Short-Term Blues, Long-Term Bulls …

Yes, deflationary forces are at work. And they are growing in momentum. The good news is that, considering the potential magnitude of the declines ahead, the downdraft in commodities should be over and done quickly — as short as it is dramatic. And the end of deflation will clear the way for the subsequent bull market.

So if you made money in the prior phase of the bull market in resources and emerging markets, wait till you see the kind of money you can make in the next phase, with massive opportunities in gold, silver, oil, other natural resources, and emerging markets.

2 Ways to Play This Wild Market …

If you want to play the potential downdraft in crude oil — a move that could take it to $55 or even $50 a barrel, here’s how to do it …

The PowerShares DB Crude Oil Double Short ETN, symbol DTO, is an exchange-traded note (ETN) that gives investors twice the inverse performance of the DB benchmark crude oil index, plus the monthly T-Bill index return.

However, the DTO is not heavily traded, so there is a gap between bid and ask that is larger than I’d like. So you might consider the UltraShort Oil & Gas ProShares ETF, symbol DUG. It is very liquid and targets twice the inverse of a big basket of energy sector stocks.

And when oil bottoms and starts to head higher …

You could consider the PowerShares DB Crude Oil Double Long, symbol DXO. This exchange-traded note backed by Deutsche bank gives investors exposure to twice the monthly performance of the DB optimum yield crude oil index, plus the monthly T-Bill index return.

DXO is more liquid than the DTO — the DXO recently traded about a million shares a day.

But for real liquidity, consider the Ultra Oil & Gas ProShares (DIG). It recently traded 20 million shares per day. And it’s a mirror image to DUG — DIG targets twice the performance of a basket of energy stocks including Apache Corp., Chevron, Devon Energy and more.

These are incredibly volatile times in the commodity markets, and crude oil is no exception. But this painful pullback will lead to some amazing opportunities, and clear the way for the next leg up.


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Alan Greenspan and Ben Bernanke will go down in history as two of the most incompetent Federal Reserve chairmen our country has ever had. Like Mr. Magoo, they blindly drove the stock market and then the real estate market into some of the biggest bubbles our world has ever seen.

Now, however, they are dead right about just how bad the situation has gotten. So you should believe every word of warning that is coming out of their mouths. And let me tell you, these are some of the most dire warnings you will ever hear from a central banker.

Last week, Greenspan told Congress:

“Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment.”

He also called the credit crisis a “once in a century credit tsunami” and said “[it is] much broader than anything I could have imagined.”

Meanwhile, Federal Reserve Chairman Ben Bernanke told the House Budget Committee that he expects the economy to stay weak for a long time and urged Congress to consider a new stimulus package. His words:

“With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate.”

House Speaker Nancy Pelosi loved the idea and pledged her support to spend up to another $150 billion saying:

“I call on President Bush and congressional Republicans to once again heed Chairman Bernanke’s advice and as they did in January, work with Democrats in Congress to enact a targeted, timely and fiscally responsible economic recovery and job creation package.”

That is on top of the previous $170 billion plan, which gave out approximately $600 per person in a household.

Nancy Pelosi is in favor of yet another stimulus package.
Nancy Pelosi is in favor of yet another stimulus package.

And don’t forget about the $700 billion bailout … $85 billion rescue of AIG … and $25 billion Chrysler corporate care package, either.

Our politicians aren’t the only ones throwing billions at the problem:

  • South Korea has given out $100 billion.

  • Russia has spent $120 billion.

  • Germany has earmarked $65 billion.

  • And the United Kingdom has pledged $50 billion so far.

Those are just some of the governments throwing massive amounts of money at failing institutions.

China, however, hasn’t spent a dime bailing out its banks. Instead, it is ensuring future economic growth!

Chinese banks own a very minor amount of our toxic mortgage bonds.

It’s not because the Chinese are more brilliant than the rest of the world. It’s because the government severely limited how much money Chinese banks and corporations could invest in non-Chinese securities.

Because of those policies, China doesn’t have to worry as much about its banks. Instead, it can focus on keeping its economy chugging along.

Heck, the country is taking very aggressive actions to keep its economy from being affected by what is happening in the U.S. Take a look:

China will lower down payments and cut interest rates on mortgages starting next month. Effective November 1, the down payment requirement for those buying their first home will be lowered from 30% to 20%. Potential home buyers will also be able to get mortgage rates that are 70% of the country’s key benchmark rate rather than the current 85%.

It also eliminated the transaction tax and value-added tax on home sales. That’s another step to keep real estate markets moving. And sure enough, Chinese real estate stocks jumped on the news. China Vanke, China’s largest real estate developer, gained 4.4%, China Overseas Land jumped 8.1%, and Poly Real Estate Group rose 6.4%.

China will refund value-added tax paid by exporters of labor-intensive industries like textiles, clothing, furniture, electronics, plastics, and toys from 13% to 14%. In all, 3,486 types of products — about one-quarter of exports — will be covered.

It pledged to increase spending of big bucks infrastructure projects like roads, airports, nuclear power plants and hydro power stations.

And remember, unlike our economy, which is quickly sinking into a recession, China is still growing at a pace that makes the rest of the world jealous.

Much of Chinas growth is coming from domestic demand.
Much of China’s growth is coming from domestic demand.

The National Bureau of Statistics reported that China’s gross domestic product expanded 9.9% in the first nine months of 2008!

Much of that economic strength was from strong domestic demand and from Asian neighbors, too.

Retail sales in China rose 23.2% in September, and by 22% in the first three quarters of the year. Trade with India has increased by 54.9% so far this year.

Yet despite those extremely strong fundamentals, the Chinese stock market has been punished for the credit problems in our country!

Fair or not, Chinese stocks are down.

While I didn’t think that China (and the rest of Asia) could go completely unscathed while the U.S. market tanked, I did believe that its strong economy would limit the damage.

Investors all over the globe, however, are simply selling their Asian holdings regardless of the underlying fundamentals.

In short, Chinese stocks are being treated like U.S. stocks. So what should you do?

If you’re a long-term investor and can stomach the volatility, I suggest holding on because Chinese stocks will recover and ultimately move much higher.

As I just explained, the Chinese economy remains strong and the Chinese government is taking the right steps to keep things rolling.

It may, however, be a very rough ride so be prepared.

And if you’re more of an active short-term trader, you’ll have plenty of opportunity to sell on rallies and buy on dips. For the immediate future, I think that will be the best way to make money in this challenging market.


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“Widespread property foreclosures have led to bank failures, and further to much unemployment and a disastrous decline in manufacturing and agricultural production.” Sound a tad familiar?

No, it is not another of my dreary “ripped from today’s headlines” quotes. Rather, it is a contemporaneous description of the chain of events that lead to, and resulted from, the Panic of 1819.

And while the storyline may be some 189 years old, the circumstances are eerily familiar. Washington (the place, not the man – our first president had passed away 20 years earlier) had borrowed heavily to finance the War of 1812, severely depleting bank reserves.

Free Money and Real Estate Bubbles, 19th Century Style

To cope, Washington and Wall Street did what they have done so many times since: they simply changed the rules. This time around they suspended specie payments – a complete violation of depositors’ contractual rights.

With the onerous restriction of actually repaying debt with real coin lifted, most every ambitious soul with a pen and a checkbook rushed into the banking business. The sudden increase in the “money” supply encouraged the most insane sort of speculations (real estate being a particular favorite).

Soon, the whole deal was snowballing out of control. When the Second Bank of the United States finally tried to take away the punchbowl, this hollow economy collapsed in on itself… leading to the aforementioned 1819 crash.

A Haunting Refrain

As you can see, today’s dire warnings of market collapse and recession are not quite as unique as we might hope. Rather, they are simply the latest refrain in a long, long (long) ballad.

Cold comfort, perhaps, to know that our forefathers were just as inclined as we toward such feats of over-stimulation, overextension, and excess speculation. Still, there is some comfort to be found reading through our long tale of financial foolishness.

Over the past 210 years or so, we have “enjoyed” 17 recessions, lasting anywhere from a few months to more than two decades. While the worst, the “Long Depression” of 1873-1896, lasted some 23 years, the average duration has been a mere four and a half years.

Damned Modernism

Now don’t go reaching for the bourbon just yet. We’ve put all sorts of systems in place since those bad old days. Many of you like to curse the day in 1913 that saw the birth of the US Federal Reserve, and are wont to describe Fractional Reserve Banking as “the tool of the Devil” (or at least Joe Stalin).

Damned or not, these institutions do exist. One could even argue their arrival on the scene marks the beginning of our “Modern Economy.” If we were to restrict our list of recessions to said “modern” period only, the average breakdown is reduced to just under three years.

Now dial the clock forward again. If one were to begin counting with the day in 1971 that Richard Nixon finished off the remaining tatters of the gold standard, the average duration of recessions is reduced to a year and three quarters.

Rounding Second and Halfway Home

The history may be a tad twisted, but my point here is straightforward enough. While there is certainly no guarantee that we could not invent a way to extend our little debacle another year or six, the odds are that we are already a third – if not halfway – through “the crisis of 2007-2009.”

Which brings us to what I like to call the “Window of Serenity.” Near-term, things do still look quite dreadful. And long-term, I have no doubt that we are embarked on the path of monetary ruin described so exquisitely by the Austrians.

But if you look in the middle, beginning some 18 months out, one can see where the ramp-up to the next major bubble ought to be taking place. The question is: how do you navigate the choppy waters between here and there?

How to Stay In the Game

Once again, I have to tell you that mere “trading stops” won’t work. If that’s the limit to your methodology, then perhaps you really ought to just sit things out until the next cycle is obviously underway.

But what if you are intrigued by the values that are out there (and I will grant that the survivors of this current trough are apt to double many times over come said ramp-up – especially in its earliest days)?

If that’s the case, then there is only one tactic I know of that will allow the safe accumulation of shares in current circumstances. And that is the careful matching of put option contracts on weak players to share purchases of strong players.

Buying Survivors

For example: Let’s say you wish to invest in a venerable old retailer like Macy’s (M: NYSE), currently trading under $10 for the first time since 1995.

Heck, they’ve been around in one form or another since 1924, and have weathered seven of the recessions on my list. That fact alone reassures you that they ought to still be here in another 18 months.

Now, I’m not saying you’re right or wrong with this trading theorem. But I can tell you how to survive Macy’s going to $5 while you find out.

A Cure For the Pain

Simply buy some put options on a real deadbeat low class player like, say, Kohls (KSS: NYSE). While Macy’s shares were getting cut in half over the past few weeks, select Kohl’s puts gained as much as 200%.

Your gains on Kohls’ pain become your safety line against losses on Macy’s shares. Heck, you could even use your profits to buy more shares.

These are admittedly hard times, friends. Fortunes are being lost daily. But situations like these, when everyone else has their head buried in the sand, are possibly the most potentially lucrative trading set ups you will ever see.

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The petrocrats were richly rewarded as crude oil climbed to new heights. Now a sharp decline in the price of oil threatens to tear their world apart. A time for drastic action could be at hand…

But today I want to talk about a situation that feels like a ticking time bomb — a time bomb that could go off sooner rather than later. It starts with this chart…

Crude Oil Nearest Futures

After climbing to nearly $150 a barrel earlier this year, the price of crude oil has fallen. A lot.

Crude’s big drop is good news for consumers, who won’t have to spend as much on gas and groceries. US prices at the pump recently fell ten cents to $2.92 a gallon, according to the AAA auto club. When the cost of fuel falls, the cost of transported goods falls too.

It’s also good news for the Federal Reserve. Thanks to falling oil prices — and falling commodity prices in general — the Fed doesn’t have to worry as much about inflation these days. They can flood the system with paper money to their heart’s content, knowing that the “early warning system” of rising commodity prices has been shut down. (At least for now.)

Big Trouble for the Petrocrats

In sharp contrast, falling oil is very bad news for men like Vladimir Putin and Hugo Chavez. You could even say it’s a flat-out disaster.

One or both of these men may have to take drastic measures in the only way they know how… and they may have to do it soon.

First a little explanation: As you likely know, these “petrocrats” were huge beneficiaries of the oil price run-up. Both had the good fortune of timing their political rise to a period of fast-rising oil wealth.

In Russia, Vladimir Putin amassed vast amounts of power, money and prestige as crude climbed to great heights. In Venezuela, Hugo Chavez used his gusher of funds to bribe the citizenry and spread influence throughout Latin America.

But that was then, and this is now. With the price of crude nearly cut in half from its 2008 highs, the roof is caving in on both men’s heads.

Evaporating Oligarchs

We’ll take a quick look at Russia first.

Though Putin has become extremely popular with average Russians, his real power base is concentrated with the oligarchs and the siloviki.

The oligarchs are Russia’s new class of billionaires — men who amassed great power and wealth in the chaos and turmoil of Yeltsin’s Russia in the 1990s. The siloviki (a Russian term) are the kingmakers and the lever pullers… the men in the shadows who decide Russia’s fate.

The two groups are deeply intertwined. The oligarchs have the money… the siloviki have the power… and Putin holds court over both.

Now, as the price of crude declines, the oligarchs’ fortunes are falling apart. As the New York Times observes, “perhaps no community of the super affluent has fallen as hard, or as fast, as the brash Kremlin-connected insiders whose wealth was tied up in the overlapping bubbles of the Russian stock market, commodity prices and easy credit.”

The numbers are staggering. Bloomberg calculates that the top oligarchs — the 25 richest Russians on the planet — have lost a collective $230 billion over the course of the recent market decline. (This is partly due, too, to a Russian stock market crash. Russia’s benchmark stock index, the RTS index, is down more than 70%.)

Too Much Leverage, Comrade

To make matters worse, many of the oligarchs ran their affairs as if they were one-man investment banks. Huge quantities of leverage and debt were the norm. During boom times, it was no big deal for an oligarch to borrow many multiples of his net worth. The borrowed capital would then be put to work in even more speculative ventures. Now all that leverage is killing them.

This is a deadly serious problem for Vladimir Putin (a man reputedly worth tens of billions himself) because it leaves his power base badly fractured. If the oligarchs go down the drain, Putin could too.

Russia as a country is in a little better shape, thanks to a huge currency surplus war chest. Russia has upwards of $530 billion in reserves by some estimates. That’s rainy day money that can be spent as needed to keep the people calm and Moscow on its feet.

But none of that will matter to Putin if his hidden power network, a large part of which depends on the oligarchs, is destroyed. If something isn’t done to stop the bleeding, Vlad could wake up to anarchy in the Kremlin… or a new challenger risen up from the ranks… or even a dollop of Polonium 210 in his borscht.

Too Much Credit, Amigo

Hugo Chavez, Venezuela’s fiery leftist President, has arrived in a similar place by a different route.

Chavez didn’t make the mistake of leveraging up or staking his power on a group of rich insiders. Rather, he made the mistake of giving away his most precious resource for free… forgoing hundreds of billions in revenues in an aggressive effort to buy friends.

As it turns out, Venezuela only has one big customer who pays full price for oil: the United States. Most everyone else gets it at a huge discount.

In 2005, Chavez formed something known as the “Petrocaribe” club. He might as well have called it the “Chavez will bribe you to be his friend” club, for reasons you’ll soon see.

The 18 Latin American countries in the Friends of Chavez club — er, excuse me, Petrocaribe club — suck down roughly half the oil Venezuela produces. (That’s 1.2 million barrels out of 2.4 million barrels per day total… a 25% decline since Chavez rose to power.)

The upshot is that Venezuela, a country whose output should be rising but is instead declining, gives away half its oil for next to nothing. Chavez charges Petrocaribe members 30 percent of the market price up front, on 90-day terms, with the balance paid in installments spread out over 25 years.

Thirty percent down, 90 days same as cash and a 25-year repayment plan. What a deal!

If that deal sounds like a steal, that’s because it is. Chavez fancies himself a great liberator… the hope and salvation of Latin America… and he will grease the palm of anyone who agrees with him and stands against The Evil United States. (Never mind that The Evil United States is Venezuela’s only big customer paying cash on the barrelhead.)

Venezuela on the Precipice

Not only does Chavez give away half Venezuela’s oil to outsiders, he gives it away at home too. Thanks to mass subsidies, Venezuela has the cheapest gas prices in the world. You can fill up for your tank for twelve cents a gallon in Caracas… and that’s only the tip of the subsidy iceberg.

Not to put too fine a point on it, Chavez is a self-styled “revolutionary” with no concept of basic economics. He assumed the oil gusher would last forever, and spent money accordingly.

As if all the spending weren’t enough, Chavez has grossly neglected the maintenance and upkeep of PDVSA, the state-owned oil company. Rather than investing in technology and engineers, Chavez has ordered PDVSA to waste its time on hare-brained community schemes. He has installed political cronies in important positions, driven out key employees, and generally let the whole apparatus go to pot.

Now, like Putin, the falling price of crude is delivering the mother of all wake-up calls. Various sources estimate that if oil stays below $80 for long, Venezuela will have trouble paying its bills. Chavez is the type of guy who needs a frying pan to the face to see the error of his ways… and he is about to get it.

An Old Play From the Dictator’s Handbook

So what are Putin and Chavez going to do? Both men are in dire straits, and a ramp-up in oil production is not the answer.

Expanded oil output won’t help the oligarchs at this point. They need a higher price per barrel to shore up market values on their battered and bleeding holdings. And Chavez couldn’t expand production even if he wanted to. (Mazhar al-Sheridah, an oil expert with the University of Venezuela, says his country will need $32 billion and five years’ construction time to raise output.)

One option for both men is to lean hard on OPEC, and hope a round of deep cuts does the job of pushing oil higher. We’ll talk more about that in a minute. But there is another, older, more reliable play too… one that’s proven its effectiveness time and again in recent years.

Putin and Chavez can stir up turmoil on the cheap.

If there were such thing as a “dictator’s handbook” (or maybe a petrocrat’s handbook), you would find this play early on in the list of basic maneuvers. When things are going to hell at home, distract the populace (and the world) by starting a firestorm elsewhere.

It’s hard to solve a pressing problem with long-range tools like diplomacy and fiscal policy… but much easier to light a match and drop it in a drum of kerosene.

Return of the Fear Premium

For the past few years, crude oil traded with a hefty “fear premium” built in. The thought was that, with the supply and demand balance so tight, even the smallest conflict or disruption could have big ripple effects on the price and availability of oil.

Now that the markets are worried more about slowdown than runaway global growth, the fear premium in oil prices has gone away. If anything, it’s been replaced by a new deflationary mindset as “demand destruction” takes hold.

But “fear in the hearts of men” is back in the ascendant… in the hearts of Putin and Chavez anyway. As the walls crumble down around them, both could easily be on the verge of panic. Both know that oil prices must move higher if their regimes are to be saved from oblivion. And both are willing to do whatever it takes to save their own skins.

This is why falling oil is a geopolitical time bomb. Putin and Chavez could already be considered two of the most dangerous men on the planet. Now both men find themselves backed into a corner like wounded animals. And remember, the most dangerous animal of all is not the one hunting for its supper. It’s the one fighting for its life.

Whither OPEC?

We can’t know what’s taking place behind the scenes… what Putin and Chavez are saying to their closest advisers in their most urgent moments and so on. But we can know there’s a real powder keg brewing here. And OPEC is potentially a part of that mix too.

All I know is, if I were a ruthless petrocrat trying to save my regime from a downward spiral in crude oil prices, I would think big. I would try to set off the biggest, most explosive tinderbox possible, just to make sure my message gets through and the new “fear premium” takes full effect.

And if I could time that action with the actions of another powerful group, so much the better. That would just mean more bang for the geopolitical buck.

That’s where OPEC comes in…

In case you weren’t aware, OPEC is meeting later this week to discuss an emergency cutback in crude production. (Russia is not officially a part of OPEC, but Venezuela has long been a member.)

The market has been a tad jittery ahead of the OPEC meeting, but general expectations seem tame. Wall Street analysts are predicting a one million barrel per day production cut. There is also a general consensus that one million barrels won’t be enough to keep the price of oil from falling further.

Remember, too, that it isn’t just Russia and Venezuela who are hurting here. Many of the OPEC countries — not least Iran — have a lot riding on a high oil price. I suspect that OPEC will have to engage in a little “shock and awe” this week if they really want to get their message through. In 1973 they really took the gloves off, and we saw what happened the rest of that decade. Who’s to say they won’t do it again.

So there you have it. Mix geopolitical TNT with a paper currency fuse, and you’ve got a good chance of seeing energy prices spike higher before too long. Possibly much, much higher.


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It’s a popular notion when the financial winds are blowing unfavorably:

Money is being printed uncontrollably … inflation is the only option … fiat currencies are doomed.

The thing is, if you’re buying into this idea, you’re mostly perpetuating a misconception. Actually, inflation isn’t as simple and certain as it’s cracked up to be.

Until the global economy recently got tossed on its rear end, prices were rising in most every part of the world. The focus, of course, was on the cost of energy, food and various other raw materials. Central banks in a position to stand firm on monetary policy did so at all costs. Inflation was the real threat.

But did that idea get turned around in the blink of an eye or what?

Prices for natural resources have collapsed and continue lower still. Economies, developed and emerging, are feeling the pain of a U.S.-led slowdown. Global capital flow is shifting direction and composition. In other words, money is escaping risky assets and making a beeline to safer U.S.-dollar based assets and cash.

The majority is starting to agree that deflationary forces are becoming strong. And at times when recession spans much of the globe, any upward pressure on prices nearly vanishes.

But even those joining the deflation camp now have no idea what to expect in the future. They see all the money being pumped into the system and feel as though that seals the deal on a nasty wave of inflation not far down the road.

To That I Say, “Not So Fast”

Simply printing money can be the cause of inflation, but that is not always the case in a sophisticated economy where money and credit combine to produce wealth. Money must be spent, or make it down into the real economy where real people buy real stuff, otherwise it won’t do the trick for those harboring inflation expectations — i.e. it does not provide economic stimulus in the form of rising prices. The best recent example of this comes from Japan.

When the stock market bubble burst in Japan back in 1989, then the real estate bubble burst a couple of years later, the Bank of Japan pumped massive amounts of yen into the financial system. In fact, the bank pushed interest rates to zero in Japan. If it was all about money, then Japan should have experienced runaway inflation. But the money pumped into the system never made it to the real economy because, even at zero percent interest rates, no banks wanted to lend and few showed up to borrow.

Why? Japanese banks had a massive amount of bad debts on their books. And they were using the Bank of Japan in providing liquidity to save themselves first and worry about lending later. Japanese consumers, after being crushed by the stock market crash and watching real estate investments crumble, weren’t interested in borrowing anything at any rate. And many had no collateral left to borrow even if they wanted to. Does any of this sound eerily familiar?

There was a major sentiment shift in Japan when the bubbles broke. Despite all the money the Bank of Japan continued to pour into the system, and no matter how much fiscal stimulus the government provided, real people shunned borrowing, lending, and investing.

When the Japanese stock market burst, fiscal stimulus packages failed to boost borrowing, lending or investing. Sound familiar?
When the Japanese stock market burst, fiscal stimulus packages failed to boost borrowing, lending or investing. Sound familiar?

The bottom line: Japan became locked in the bear hug of 14-year long deflation. Many believed they finally emerged from this grip, thanks to a positive 1% print in the Japanese consumer price index. But the credit crunch that is morphing into a threat to the global financial system, is pulling Japan back into the vortex of deflation. In the final analysis, all that money didn’t matter.

Sayonara, Conventional Wisdom

This example proves that despite the best efforts of government officials to eliminate the business cycle and fight against the forces of the market, they usually end up prolonging the problem. Had Japan allowed for a huge wave of bankruptcies, effectively clearing the deck of all the dead wood and debris, they would likely have shortened this deflationary period considerably and set the stage for the strong, well-managed companies to prosper.

This is a critical point, because if we think of a world with unlimited resources, it is the most efficient use of those resources that provides healthy growth for the entire system. It is why poorly managed institutions that waste resources should be allowed to fail, and the best managed allowed to profit without being hampered by competition that otherwise wouldn’t exist if it weren’t for the best intentions of government.

The question is, will the weight of all this money become inflationary at some point?

The answer is maybe. We are in the midst of a major global debt implosion. Writing off bad loans is deflationary because resources (money and credit) that could otherwise be used to create real value in the economy in the form of loans to businesses and entrepreneurs, are basically poured down the rat hole of past malinvestment.

The question of when inflation returns may be more social or psychological than anything purely quantitative. Until real people are willing to borrow and lend again, in what we consider a rational risk-taking approach, it is unlikely monetary stimulus will do anything than allow the economy to muddle through at best.

So inflation returns when sentiment shifts back to a world with a healthy risk appetite. The two key sentiment and wealth drivers for most investors in the developed world is their house and their investments for retirement — both have been ravaged and continue to be. It means a return of healthy risk appetite may be further down the road than is now expected.

Writing off bad loans is deflationary because resources that could create real value in the economy are poured down the drain of past malinvestment.
Writing off bad loans is deflationary because resources that could create real value in the economy are poured down the drain of past malinvestment.

What Does This Mean for the Dollar?

My long-term view has been, and continues to be, that the U.S. dollar has entered a multi-year bull market. That view is only validated in this environment.

The U.S. dollar is the raw material, or fuel, for risky asset investing around the globe. When people want to target higher returns, they move money offshore to the periphery, to emerging and developing markets of the world that grow the fastest when money and credit are abundant. Thus, think of the dollar as greasing the wheels of financial markets around the globe.

And despite what you hear from so-called gurus, the buck is the world reserve currency; a status that is not in jeopardy. Thus, as sentiment concerning risk taking continues to spiral lower and lower, more and more funds flow back from the periphery to the center where capital markets are deepest. U.S. capital markets are the deepest by far. It’s why you see U.S. Treasuries rallying as big pools of money run to hide. So in this deflationary, risk-adverse world, the U.S. dollar is king once again.

Commodities Index/US$ Index Weekly

There is one chart I think best expresses this reality. It is the commodities index divided by the U.S. dollar index.

When global growth is humming and money is flowing, investors want to be involved in emerging and developing economies that benefit mightily from commodities demand.

As you can see on the chart, that sentiment has run its course and is diminishing fast — and that’s very bullish for the dollar.

Best wishes,

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Back in 1997, a minor currency crisis in Thailand rattled a few regional market players. But the rest of the world ignored it … at first. They said it wouldn’t matter to the U.S. and would be just a blip on the radar screen.

But soon the decline in Thailand’s currency, the baht, accelerated. It went from a gentle slide to a full-scale rout. Before long, currencies in the Philippines, Indonesia, and South Korea began to fall out of bed.

Then regional stock indices later crashed. Our Dow suffered what was then one of the largest point declines on record. And the International Monetary Fund was forced to step in and bail out several economies — to the tune of tens of billions of dollars.

It was a scary time. But compared to what is happening now, the 1997 crisis looks like a day at the beach. Right now … in far-flung corners of the world as diverse as Iceland, Hungary, Argentina, India, and elsewhere …

Currencies aren’t just declining. They’re crashing.

Stock markets aren’t just falling. They’re collapsing.

Foreign investors aren’t just walking for the exits. They’re running … and trampling anyone in their paths.

You may not keep a chart of the Hungarian florint, that nation’s currency, on your screen. You probably don’t look at Argentina’s Merval Index very often, if ever. And you may have never touched an Icelandic krona in your life.

But if you could look at charts of all of these obscure indicators, like I have, or if you studied the fundamental behind the moves, as I have, you would conclude the same thing that I did a while ago: The virulent credit virus has spread worldwide. And that has serious implications for you and your portfolio. Here’s more …

Crisis in Hungary, Argentina, Iceland, oh my!

In Hungary, the currency has been plunging for weeks on end as global investors pare risk and withdraw funds from higher-risk emerging markets. The forint recently traded at 214 against the dollar, a huge decline from the 143 level back in July. In other words, one U.S. dollar buys many more forints than it did a few months ago.

The Hungarian florint has been plummeting in value as global investors flee higher-risk emerging markets.
The Hungarian florint has been plummeting in value as global investors flee higher-risk emerging markets.

That prompted a serious reaction from the Magyar Nemzeti Bank, Hungary’s central bank this week. It jacked up the nation’s benchmark rate to 11.5% — an increase of a full three percentage points — to defend the currency and stem the flight of capital.

Meanwhile, in Argentina, the country said it plans to seize $29 billion of private pension funds. This caused bond yields in the country to surge. The Merval stock index plunged 11% on Tuesday, then another 10% on Wednesday. It is down more than 55% on the year.

The government last raided pension fund investments to service its debt in 2001. But it didn’t help. Argentina then defaulted in a move that sent shockwaves throughout the global capital markets.

As for Iceland, the market has all but collapsed. The country’s three biggest banks have been nationalized. Its currency has lost more than half its value in the past two years. It’s being forced to pursue a multi-billion dollar bailout from its Scandinavian neighbors and the IMF.

The most shocking of all: Its benchmark stock market gauge, the OMX ICEX 15 index, has plunged 89% year to date! To put that in perspective, if our Dow did the same thing this year, it would be trading around 1,460.

Even bigger countries, like India, are running into trouble. Overseas funds dumped a record $12 billion of Indian shares so far this year. Foreign exchange reserves have dwindled by $42 billion as the Indian rupee has imploded. It recently slumped from 39.20 against the dollar to 49.50 — a record low.

Bottom line: The credit virus is now spreading its sickness to the four corners of the world.

Iceland's stock market has all but collapsed as the credit virus spreads worldwide.
Iceland’s stock market has all but collapsed as the credit virus spreads worldwide.

What it means back home

Some pundits have made a big deal about the recent improvement in certain domestic and developed market credit indicators. The gains stem from the Federal Reserve’s and Treasury’s largesse, as well as the banking bailouts being put into effect in continental Europe, the U.K. and Canada, among other places.

But the improvements have been minor when compared to the hundreds of billions of dollars in aid that has been thrown at the markets. There are also disturbing signs that the aid isn’t getting at the core of the problem — the housing market.

One indicator of ongoing weakness there: The latest Mortgage Bankers Association figures on home loan applications. The group’s index, which tracks demand for home purchase and refinance loans, plunged 17% in the most recent week. The purchase application sub-index is now plumbing depths not seen since October 2001, a sign that housing demand remains anemic.

All of these problems are now coming home to roost — again — in the U.S. stock market. The Dow plunged 232 points on Tuesday and another 514 points on Wednesday. Despite yesterday’s bounce, it appears to be headed much lower over time.

I hope this underscores the message Martin and I have been preaching for months on end …

Tune out the B.S. coming from Wall Street.

Stop listening to the happy talk out of Washington.

Understand this is a dangerous, treacherous economy — and a market with many potholes, time bombs, and hazards ahead. You have to come at it with a clear head and a realistic approach.

Stay the heck away from vulnerable stocks. Maintain high levels of cash in safe investments like short-term Treasuries or Treasury only money funds. Or, if you’re a more aggressive investor who’s willing to go on the offensive, consider shooting for big profits using vehicles like inverse ETFs and put options. They’re making some investors a killing in this market.

Until next time,


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