Archive for November, 2008

It’s a beautiful, long holiday weekend. I’ve been celebrating Thanksgiving with my family, and I’m sure many of you are also busy with relatives and friends. So I’m going to keep this week’s column short.

Specifically, I’m going to highlight three big questions we should all be thinking about — and offer up my best answers. I feel these are the most important three questions to ask right now because the answers will determine the next big moves in the market and the U.S. economy.


First, is the Citigroup rescue the end of the financial crisis?

We gained 494 points in the Dow Jones Industrials a week ago and another 397 points on Monday. The dollar also gave back some of its recent gains, and the large rally in Treasury bonds petered out. Clearly, Wall Street greeted the bailout of Citigroup with a big sigh of relief.

Will the rally stick? I hate to sound jaded. But haven’t we heard after EVERY SINGLE ONE of these bailouts: “This is it. This will put the floor under the financials. Now is the time to buy, buy, buy?”

We heard it after Bear Stearns was rescued.

We heard it after Fannie Mae and Freddie Mac were taken under the government’s wing.

We heard it after AIG was bailed out.

And we heard it when the TARP plan was originally rolled out. In fact, this rally so far looks A LOT like the one we got on September 18 and September 19. The Dow surged 410 points on the eighteenth and another 369 points on the nineteenth after news of the government’s TARP plan first leaked.

But just like every other short-term rally before it, that rally quickly failed — and the market soon set new lows. So forgive me if I sound skeptical about this being the “end” of the financial crisis. It’s more likely just another way station on the road to lower stock prices.

Second, will an economic stimulus plan work?

President-Elect Barack Obama’s revised stimulus plan looks a lot more aggressive than what had been talked about previously. It’s also much larger than the tax refund plan that was put into place in the spring. So it’s definitely worth paying attention to exactly how the plan — and the prospects for its passage — evolves.

But is the stimulus plan a reason in and of itself to get bullish on the market? I don’t think so.

Several hundred billion dollars is a lot of money. But the economic challenges we face as a country are extremely large. And the losses our financial institutions are piling up — both here and abroad — are much larger.

This plan could buy the economy some time, keeping it stronger than it would otherwise be. Still, if the underlying economy can’t heal … if the credit market problems don’t get better … then we’ll be right back to square one when the impact of the stimulus wears off.

Indeed, the very real risk is that NO amount of stimulus can prevent the de-leveraging process from running its course.

Japan’s experience in the 1990s is instructive. The government there passed repeated “bridge to nowhere”-type infrastructure plans, and the central bank slashed interest rates to zero in an attempt to help the economy recover from twin busts in the stock and real estate markets.

End result: The economy struggled through a “Lost Decade” anyway.

Third, how in the holy heck are we going to pay for it all?

My daughters are three and six. They wouldn’t know Treasury Secretary Henry Paulson or Fed Chairman Ben Bernanke if they ran into them at the grocery store.

But the decisions that Paulson and Bernanke are making today are going to bury them … and maybe even THEIR children … under a mountain of debt the likes of which the world has never seen.

Do you know how much we have committed as a country to rescue the financial system and credit markets? How does the number $7.8 TRILLION … half the country’s GDP … sound to you? That’s the price tag The New York Times put on all the bailouts and credit plans recently.

Included in its tally:

  • The Fed’s $2.4 billion program to buy commercial paper, 

  • The $1.4 trillion commitment from the FDIC to backstop interbank lending, 

  • The $29 billion bailout of Bear Stearns, 

  • The $306 billion in guarantees of Citigroup assets, 

  • The Term Auction Facility, 

  • The Money Market Investor Funding Facility, and 

  • All the other programs the Fed and Treasury have implemented.

It also includes yet another pair of programs just announced this week. The Fed has agreed to buy up to $800 billion in Fannie Mae and Freddie Mac bonds, mortgage-backed securities and securities backed by credit cards, auto loans, and small business debt.

I simply cannot figure out how we’re going to pay for it all without borrowing an astronomical amount of money — and sticking future generations of American citizens with the bill.

For now, flight to safety buying is bolstering Treasury bond prices. But that effect will fade at some point. And when it does, you will likely see the price of Treasuries tank — and interest rates surge — due to the nation’s profligacy.

So be sure to keep your head when investors around you are losing theirs. I do NOT think the answers to these key questions are as clear-cut as the bulls would have you believe. And I DO think focusing on safety remains the best course of action.

Until next time,

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Last week, I wrote about how our oil-rich friends in the Middle East are buying gold hand over fist. It turns out they’re not the only ones. The latest figures from the World Gold Council show a frenzy of activity in the most recent quarter.

And gold ended last week with a bullish move to the upside that set off “buy” alarm bells for technical traders around the world.

But you know what? I think the best is yet to come for gold. Because it’s likely that the WORST is yet to come for the U.S. economy.

And these economic forces could send investors charging even faster into gold just as fundamental forces also align for a move much higher.

I’ll get to some of those fundamentals in just a bit. First, let’s look at what Washington’s insane clown posse is doing to make gold look good.

I Remember When a Trillion
Dollars Was Real Money

1) The Fed Pledges $7.2 Trillion of YOUR Money. Bloomberg News reports that the U.S. government is prepared to lend more than $7.4 trillion — approximately half the value of everything produced in the nation last year — to rescue the financial system, which has been in cardiac arrest since the credit markets seized up.

How much is that? The pledged money is equal to $24,000 for every man, woman and child in the country. And $2.8 trillion of that has already been spent, according to Bloomberg.

Now brace yourself for the bad news …

2) The Government Has Already Spent $4.3 Trillion Bailing Out Wall Street. According to CNBC, as of last week, the Federal government had already spent $4.3 trillion in bailouts, from $900 billion for the Term Auction Facility … to $112 billion bailing out AIG … to $540 billion backing up Money Market funds … to $700 billion for the Treasury Asset Relief Program (TARP), and more.

$4.3 trillion — that’s more than America spent on World War II, adjusted for inflation. And it’s all going down a black hole created by Wall Street bankers.

The Federal government has already spent $4.3 TRILLION in bailouts and has hardly made a dent in the financial crisis.
The Federal government has already spent $4.3 TRILLION in bailouts and has hardly made a dent in the financial crisis.

All that money has to come from somewhere. Investors are stuffing their money into Treasuries with no yield, and the government still has to go out and borrow more. The U.S. Treasury is on course to borrow $1.5 trillion this year, and it’s still not enough! Next year’s budget deficit will easily top $1 trillion; more than double this year’s deficit.

The overall impact of what the bailout will cost ultimately should be very negative for the U.S. dollar … and that should be bullish for gold.

3) Wall Street Is Probably Going to Need $Trillions More! The financial crisis is really the death of a thousand cuts. Let’s take the Citigroup fiasco as an example. You may have heard that Citigroup is getting a $20 billion equity injection on top of the $25 billion it got in October.

But Citi will also carve out $300 billion in troubled assets, which will remain on its balance sheet.

  • The first $37-$40 billion in losses on those assets will go to Citi.

  • The next $5 billion in losses will hit Treasury.

  • The next $10 billion in losses will go to the FDIC.

  • Any more losses will go to the Fed.

These assets are crap-tacularly bad, so basically Uncle Sam is on the hook for another $260 billion in assets, in addition to the $45 billion in liquidity poured onto the desert of Citi’s balance sheet.

And do you notice that the clowns on Wall Street are balking at giving Detroit a $25 billion bridge loan to save America’s auto industry (and prevent a chain of dominos as all of the Big Three’s suppliers, finance units and vendors go belly up) but Citi — a zombie of a bank that is probably lurching towards failure — gets $45 billion without even a debate.

That brings me to point #4 …

#4) Obama’s Administration: More of the Same? Treasury Secretary Hank Paulson has set the bar pretty low as he limbos past barriers of logic and fairness to bail out his fat-cat friends. So you might think that the new administration, and Obama’s nomination for Treasury Secretary, New York Fed President Tim Geithner, would be a welcome change from the crony capitalism at work now.

The widely respected Big Picture blog has a post by institutional risk analyst Chris Whalen titled: “What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup.” I highly recommend you read Whalen’s post. He makes the following point:

By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG’s resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.

Read the whole thing. If Whalen is right, the crisis of confidence already shaking the financial markets is nothing compared to the tsunami of trouble that will follow.

Is Tim Geithner – President-Elect Obama's choice for Treasury Secretary – a welcome change or more of the same?
Is Tim Geithner – President-Elect Obama’s choice for Treasury Secretary – a welcome change or more of the same?

And What If the Doom-Sayers Are Wrong?

I’d be happy — very happy — if financial calamity is averted. But then we’ll still have to deal with a system thrown off balance by trillions of dollars in newly created money. The hundreds of billions of dollars in a new stimulus package for Main Street — Obama’s job #1 when he gets into office — will be icing on the inflationary cake. Once you start flooding money into the system, it’s very difficult to know when to stop. We are in deflation now, sure, but I think government-fueled inflation is sure to follow.

That Brings Us to Gold
And the Dollar

The U.S. dollar has its problems, but so far it has been winning a beauty contest in a leper colony. Emerging markets are falling into a ditch. Europe’s economy is in the tank — Germany’s business climate has dropped to the lowest level in over 15 years — and the European Central Bank will probably lower its benchmark interest rate by at least 75 basis points at its next meeting on December 4.

So far, the U.S. dollar has not been shaken by the massive amounts of bailout and stimulus money that Washington is throwing at America’s problems. But again, $7.4 trillion is real money. And the financial world may be waking up to the fact that, no matter how many hundreds of billions of dollars you throw at companies like AIG and Citigroup, it’s good money after bad.

Last week, the euro/U.S. dollar currency pair barely budged even as stocks sold off sharply. This is a change from recent months, when the euro had come under pressure as equities sold off.

I don’t think the mighty U.S. dollar’s bull run is over. But the U.S. dollar could move lower as it consolidates its recent gains.

And downward pressure on the U.S. dollar would only add to upward pressure on gold, powered by fundamentals.

Gold’s Fundamentals Are
Shining Even Brighter

I covered some of those bullish fundamentals last week, including new and massive buying in the Middle East, rising demand for gold in China in the first six months of the year, and a downward trend in global gold mine production.

And just last week, we got the latest third-quarter figures on global gold demand from the World Gold Council. Here are some of the highlights …

  • Global demand rose 18% to 1,133.4 metric tonnes from 963.3 tonnes a year earlier.

  • In dollar terms, the jump in demand was even bigger. Dollar demand for gold reached an all time quarterly record of $32 billion in the third quarter, a whopping 45% higher than the previous record … set in the second quarter.

  • Identifiable investment, which includes purchases through exchange traded funds and of bars and coins, climbed 56% year over year to 382.1 tonnes.

  • Retail investment blasted off. It rose 121% to 232 tonnes in the third quarter, with strong bar and coin buying reported in Swiss, German and U.S. markets. Gold inflows into ETFs surged to a record 150 tonnes. Gold ETFs added to their treasure troves at a rate that was 7.5% higher than the second quarter and up 31% from a year earlier.

  • Jewelry demand gained 7.6% to $18 billion. Jewelry demand in India soared by 65% in dollar terms. The Middle East, China and Indonesia all saw jewelry demand in dollar terms rise by 40% (10% to 15% in tonnage terms).

  • Sales to India, the world’s largest gold consumer and jewelry buyer, jumped 29% to 249.5 tonnes from 190.8 tonnes. Meanwhile, demand increased by 18% in China and 15% in the Middle East.

If there was a party pooper for gold, it was the United States. U.S. demand for gold jewelry dropped 9% in value and 29% in tonnage terms. Great Britain also saw its demand slacken by 5% in value and 26% in tonnage terms.

In all, global consumer demand for gold rose 31% from a year earlier to 250 metric tonnes.

So we have this combination of forces: Powerful fundamentals on the one hand, and the potential for more financial chaos on the other. Put them together and you can see that gold could go much higher.

Gold's fundamentals and the potential for more financial chaos make the yellow metal your best bet for profits going forward.
Gold’s fundamentals and the potential for more financial chaos make the yellow metal your best bet for profits going forward.

I’d expect some overhead resistance around $900 an ounce. If gold can break through that level, it could be on a rocket ride for the New Year.

Add Some Leverage
To Your Gold Picks

Gold’s path higher will not be a straight line. In fact, I expect some corrections that could knock the yellow metal right on its shiny butt. But that’s short term. Longer term, gold should march higher.

The way things are going in Washington, I like physical gold, and silver, too. Certainly, with the holidays around the corner, gold is the gift you don’t have to make excuses for … and, as the old timers remind us, it can always pay your way to sneak past the border guards.

Last week, I talked about two funds that hold physical gold, the SPDR Gold Shares ETF (GLD) and the Barclays iShares Comex Gold Trust (IAU). They are fixed at 1/10th the price of gold, minus a small amount to account for fees.

That means if gold is trading at $800 an ounce, you can buy the GLD or the IAU for about $80. And they are backed up by gold bullion in a vault.

To them, I would add the PowerShares DB Gold Double Long ETN (DGP). It targets TWICE the return of the Deutsche Bank Gold Index, or basically twice the short-term percentage move in gold.

In these fast and furious markets, a leveraged fund is not for the faint of heart. But it can give you extra firepower for when gold takes off to the upside.


Best Luck and God Bless;


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With the upcoming holiday rapidly approaching, we should all start thinking about what we’re thankful for. You know, just in case someone at the dinner table puts us on the spot.

I’ve previously told you about the beauty of Roth IRAs.

To quickly recap: They give most working Americans the ability to sock away money, watch it grow, and never have to pay another cent in taxes on any of the funds as long as certain conditions are met.

And unlike regular IRA accounts — which are taxed at withdrawal time — you do not have to begin taking minimum distributions at age 70 ½.

In fact, so long as you have earned income (or alimony) you can continue making contributions for the rest of your life.

And here is perhaps the best feature of Roth IRAs, one that I rarely hear mentioned (even by financial professionals) …

You Can Use a Roth IRA to Pass
Along Massive Wealth to Your Heirs

Let me explain how it works …

Because you are not required to take minimum distributions, you can leave every single penny of your Roth IRA intact for your designated beneficiary. That’s great.

Even better is the fact that your heir will face a choice upon your death: Either withdraw the whole amount by December 31 of the fifth year after your death OR begin receiving minimum distributions based on his or her life expectancy.

Under either choice, all the proceeds should be tax-free (with the exception of estate taxes).

Here’s an example:

Say you leave your Roth IRA to your son who is 53 at the time of your death.

If your son decides to take minimum distributions, the IRS will use its actuarial tables (available in IRS pub. 590) to figure out roughly how long your son is likely to live.

Then the IRS will divide the value of your account by that number (31.4 in 2008) to arrive at a dollar amount for yearly distribution.

In the case of a $100,000 portfolio, your son would have to withdraw $3,289 in 2009 ($100,000/30.4).

Important: While your son is taking those minimum distributions, the value of his inherited investment account can continue to rise!

I’m sure you can see the appeal of this approach, especially since you’re well aware of the effect of compounding.

A Roth IRA is a great way to pass along wealth to your heirs!
A Roth IRA is a great way to pass along wealth to your heirs!

Think about what would happen if you loaded up that Roth IRA with stocks that steadily increase their dividends. And imagine what would happen if you were reinvesting those dividends back into more shares!

You’d be combining complete tax efficiency with multiple layers of compounding interest. Heck, with enough time, you could leave behind a nest egg that was rising faster than the rate of your heir’s mandatory withdrawals!

That brings me to another point. While this strategy would be great for a son or daughter, it would be even better for a grandchild or a great-grandchild.

After all, those minimum distributions are calculated on the recipient’s age. The lower the number, the less money coming out every year and thus the longer the account can grow.

Obviously, the lynchpin in this whole plan is absolute agreement on the part of the original account owner and the beneficiary on opting for taking the minimum distribution route.

But if you have an heir you can count on, I consider this one of the smartest moves you can possibly make.

If you’re eligible for a Roth IRA, take advantage. And even if most of your money is currently in a regular IRA account, it may very well be worth your while to roll it into a Roth.

Although you’ll take a big tax hit in the process, if your goal is leaving that money to someone far younger, the Roth could still prove the smarter wealth builder over the long haul. That’s definitely something to be thankful for!

Best wishes,


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Thursday was a historic day for the market. The Standard & Poor’s 500 Index plunged by 6.7% to 752.44. The bear market low of October 2002 was 768.63 — and we sliced through it like a hot knife through butter.

Stated another way, every last penny of profit an investor earned — even if he bought at the absolute low six years ago has been wiped off the map. And if you bought the S&P just over a year ago? You’ve lost more than HALF your money.

I wished these days would never come. But we did not allow those hopes to deter us from predicting them. Indeed, just a few short months ago — in our Safe Money Report and here in Money and Markets — we warned that the market would AT LEAST fall to its 2002 lows. Now that has happened.

Why? All the powerful forces we have been warning you about have converged in one time and one place. The slumping economy. The debt market crisis. Huge financial sector losses. Crashing corporate earnings. And most importantly, a deepening crisis in housing.

Speaking of which … everyone knows the housing market is hurting. I’ve been talking about a meltdown scenario for more than three years. And unfortunately, many of my warnings have come true.

What you may NOT be aware of, though, is just how suddenly — and how severely — the market has downshifted … AGAIN. The very latest, hot-off-the-presses numbers are so amazingly bad … so horrendous … that I wanted to make sure they didn’t get lost in the clutter.

Indeed, if you’re trying to buy or sell a house, or if you’re an investor who owns any stock even tangentially tied to the housing market, you need to know what’s going on.

Housing Disaster #1:
Builder Confidence,

Buyer Traffic Falling off the Table

Every month, the National Association of Home Builders (NAHB) surveys builders on the front lines of the industry. It asks them about sales, buyer traffic, and expectations about the future. And then it produces indices that sum up the results. Get a load of what the November numbers showed …

In November, the NAHB builder's confidence index hit its lowest level … ever.
In November, the NAHB builder’s confidence index hit its lowest level … ever.
  • The overall index plunged to 9 in November from 14 in October. Not only is that a 36% decline — in just one month — it also leaves the NAHB index at the lowest level ever (the data goes back to 1985).

  • Among the sub-indices, the one that tracks current single family home sales dropped to 8 from 14 … the one measuring expectations about future sales held steady at a record low of 19 … and the one measuring prospective buyer traffic fell to 7 from 11. In other words, the details of the report are just as ugly as the headline.

  • Regionally, builders couldn’t catch a break. The Northeast index dropped to 11 from 16, the Midwest index slumped to 7 from 13, the South index fell to 11 from 16, and the West index plunged to 6 from 11. There was no sign of strength anywhere in the country. 

Bottom line: Anyone looking for a glimmer of hope for the housing market won’t find it in the latest figures. Builders are universally gloomy about the state of their business across all regions of the country. Readings on buyer traffic and current sales fell sharply, while expectations for future sales held at their record low from October

The credit crunch is part of the problem. But so too is the broad deterioration we’ve seen in the U.S. economy in recent months. Some consumers can’t afford to buy homes because they can’t access mortgage financing or because they have lost their jobs. Others don’t want to purchase because they’re worried home prices will fall further.

Housing Disaster #2:
Purchase Loan Applications Plunge

Most buyers don’t pay cash to purchase homes. They take out mortgages. So naturally, the volume of applications for loans to buy homes can be used as a LEADING indicator of future home sales. And the news there points to shockingly bad future sales.

The MBA's weekly loan index shows that the demand for mortgages is drying up.
The MBA’s weekly loan index shows that the demand for mortgages is drying up.

The Mortgage Bankers Association’s (MBA) weekly purchase loan index plunged 12.6% in the week of November 14. At 248.50, it’s the lowest since the week of December 29, 2000.

Now here’s the thing: The MBA figures do some crazy things around the holidays. You often see big increases and big decreases in the weeks around Christmas and New Year’s because of the difficulty of seasonally adjusting the figures. For example, the 12/29/00 week I mentioned above showed a 21.4% drop in purchases … but the week of 1/5/01 showed a 33.9% rise.

If you EXCLUDE the December 2000 spike down to adjust for that fact, you’d have to go all the way back to … another holiday week, the week of 12/31/99, to find a lower reading. And if you exclude THAT holiday-distorted number, you won’t find a lower purchase applications reading since March 1999 — almost a decade ago!

Bottom line: Demand for home purchase mortgages is drying up. That means home sales are going to take another big leg down.

Housing Disaster #3:
Home Construction, Building Permit Issuance
Hits Lowest Level in Recorded U.S. History

The Census Bureau began tracking home construction and building permit issuance in 1960. Back then, Dwight Eisenhower was the president of the U.S. … the book “To Kill a Mockingbird” was first published … and the Dow Jones Industrial Average began the year trading at 679.35.

And according to the latest numbers, the housing industry is now building fewer American homes than it was back then. The full details

In October, housing starts hit their lowest level in recorded history.
In October, housing starts hit their lowest level in recorded history.
  • In October, housing starts were running at a seasonally adjusted annual rate of 791,000. That was down 4.5% from September, down 38% from the year-earlier reading, and down 65.2% from the January 2006 peak. This is the lowest level in recorded U.S. history.

  • Building permit issuance is a future indicator of construction activity. After all, you can’t build a house until you’ve pulled a permit. In the month of October, permitting activity plunged even more than housing starts — down 12.1% to 708,000 units at a seasonally adjusted annual rate. That’s a whopping 40.1% off the year-ago level, down 68.7% from the September 2005 peak, and also the lowest level ever found.

  • Breaking it down by property type, single-family starts dropped 3.3% to 531,000. Multi-family starts dropped 6.8% to 260,000. Single-family permitting activity dropped 14.5% to 460,000, while multi-family permitting dropped 7.1% to 248,000. 

Lower construction activity is necessary to bring supply back in line with demand. And builders have made some progress in reducing new home inventory for sale.

But with unemployment on the rise, mortgage credit harder to get, and the broad economy slowing, housing demand is sliding. That should necessitate an even lower level of starts — hard to imagine given that we are already seeing the lowest level of activity in recorded U.S. history.

Quit listening to the Pollyannas —
Listen to the DATA

I’ve been hearing “bottom” calls on housing for the greater part of the past two years from the Pollyannas on Wall Street and in Washington. Every single one has proven to be wrong … dead wrong. And this latest data tells a very grim tale.

Indeed, every single indicator — starts, permits, mortgage purchase applications, builder confidence — indicates that the already struggling industry has taken a header in the past couple of months.

So if you’re looking to buy a house, drive a hard bargain. You definitely have the upper hand.

If you’re looking to sell, be realistic. The market stinks. You have to price your property accordingly.

And if you’re holding stocks in the construction sector, the mortgage lending sector, or any other sector tied to building and lending, what are you waiting for? If you didn’t listen to the initial, urgent “sell” recommendations more than two years ago, get the heck out now!


Good Luck, and God Bless;


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I came across a study that confirms just how tightly tied the markets have become. According to James Bianco, president of Bianco Research LLC:

Over the last six months, seven separate assets have maintained an 85%, or better, correlation with the S&P 500.

That means, at least 85% of the time these assets moved the same direction as the S&P 500.

Included in that group of assets is the Reuters/Jefferies CRB Index (a global commodity index), emerging-market bond spreads, and not surprisingly, the euro.

I’ve been consistently discussing the tight correlation between the currencies and stocks.

The reason: As risk ebbs and flows, the buying of U.S. dollars ebbs and flows … in an opposite direction.

On Thursday, stocks tumbled to lows not seen since 2003.
On Thursday, stocks tumbled to lows not seen since 2002.

And as witnessed earlier in the week, when the S&P 500 tested new lows and bounced sharply, the U.S. dollar did the opposite — tested new highs and fell back sharply.

Then on Thursday, stocks collapsed again. They tumbled to new lows not seen since 2002, and dragged down the euro right alongside. And once again, the U.S. dollar index broke out to a new high.

These tight correlations are often simply risk ebbing and flowing. But maybe we should look deeper to understand the true driving forces behind recent trends, and ultimately, why these correlations are more dollar-bullish than you might think.

Tight Coupling —
The Values of Bad Assets and
Good Assets Deteriorate Together …

Tight coupling exists throughout the financial markets nearly every single day. A good example would be the recent subprime mortgage fiasco.

Before the entire credit system went ka-boom, the trend was to issue subprime mortgages, bundle them up and sell them to investors.

But then …

  • Home prices started falling …

  • Borrowers were no longer able to afford loans …

  • Bundled loans became less attractive …

  • The market for this newly-created product froze up …

  • Losses swelled, and …

  • Finally, investors isolated from these assets began experiencing losses as the tightly coupled financial industry became unwound and the values of bad assets and good assets began deteriorating together.

Decoupling Loses Out
To Tight Coupling …

A year ago, the consensus was that the global economy would be fine without the U.S. economy, should the U.S. fall into a nasty recession.

Emerging markets became the story. The growth potential was huge.

The global economy was chugging along …

  • The developed world was more than willing to buy China’s cheap stuff …

  • China was demanding raw material …

  • Small resource-focused economies were thrilled to meet China’s appetite, and …

  • The developed world supplied the global capital necessary to keep the party going.
Microcosm of Global Economy.

As it was, emerging economies invested heavily in their export-centric, cheap labor model.

This gravy train was paying off in spades. But then, a wrench got thrown into the mix …

United States Loses the
Ability to Absorb Surpluses …

As emerging markets, including China, invested primarily in their export-centric growth model, they neglected to invest in their domestic sectors. And instead, they took their left-over capital — the capital not already put towards building exports — and shoveled it into the U.S. in exchange for safe investment returns.

The problem arose when the U.S. financial markets could no longer find places to channel this flood of money.

All sorts of new-fangled investment products were created, including derivatives, in hopes of allowing liquidity to flow efficiently. But of course, as is the case with tight coupling, the complexity of the new initiatives opened the door for disaster.

Asset bubbles inflated and popped. And investors realized they had little understanding of the new financial instruments.

And now …

  • Consumers are watching their stocks and housing wealth evaporate …

  • Spending across developed nations is retreating, and …

  • Export-centric growth models are suffering as global liquidity vanishes.

This is a process that cannot be stopped effectively. Naturally the cycle will find its end. And unnaturally “officials of last-resort” will try to come in and stem the unraveling. But that just makes things more complex and increases the likelihood of unintended consequences.

Risk-aversion supports the beginnings of a long-term dollar bull market.
Risk-aversion supports the beginnings of a long-term dollar bull market.

It is for all these reasons that so many markets — dependent upon the continued flow of liquidity — have become so extremely correlated now that global capital flow has morphed. What this has done is create a trend primarily away from risk-taking and towards risk-aversion.

I’m of the opinion that the United States maintains the world’s largest capacity to produce wealth. And risk-aversion will continue to steer capital back to the U.S.

This supports the beginnings of a long-term dollar bull market in the making.

Best wishes,


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Citigroup, the nation’s second largest banking conglomerate, is on the brink of failure.

Its stock price collapse is the canary in the coal mine, wiping out over nine-tenths of the company’s market cap since its 2007 peak, decimating two-thirds of its value just last week alone.

At the same time, the collapse in its market cap is also the bank’s nail in the coffin, making it virtually impossible for it to raise the capital it desperately needs to save itself.

If it fails, it will be, by far, the largest banking disaster in history, involving $2 trillion in assets. That makes it approximately six times larger than Washington Mutual and three times bigger than Wachovia.

Moreover, the prospect of a failure by Citigroup poses far greater challenges to regulators than a typical large bank. Due to its massive derivatives holdings — side bets on interest rates, currencies, and the probability of defaults by other large corporations — it could be extremely difficult to save Citigroup without serious disruptions, raising serious questions about the global banking system and the world economy.

At mid-year, June 30, 2008, the Office of the Comptroller of the Currency (OCC) reported that Citi’s primary banking unit, Citibank NA, held $37.1 trillion in total notional value derivatives, including $3.6 trillion in credit default swaps, which, in recent months, have proven to be the most dangerous category.

In contrast, Wachovia bank, bought out by JP Morgan Chase in a deal brokered by the regulators, had only $4.4 trillion in derivatives, among which $404 billion were in credit default swaps, or only one-ninth the size of Citigroup’s.

Thus, whereas it was possible for the authorities to arrange buy-outs for banks like Wachovia and Washington Mutual, there is no buyer big enough in the United States to absorb Citigroup. Nor is it likely that an international consortium of banks would want to squander the precious capital they have left on a sinking titanic the size of Citigroup.

What will happen next? No one can say with certainty. However, it’s likely that:

  1. The Treasury Secretary, the Fed Chairman, as well as FDIC and Citigroup officials are currently holding tense and intense discussions in a desperate attempt to somehow stem the megabank’s demise.

  2. They will soon announce a massive federal bailout that could make the $150 billion AIG rescue seem small by comparison.

  3. And, ultimately, these kinds of bailout efforts will fail.

It is preposterous to assume that any government, no matter how powerful it may seem, can save the entire world. It is naive to believe that a few government bureaucrats, with a grab-bag of gimmicks and tricks, are a match for billions of consumers in revolt, millions of investors desperate to sell, and thousands of banks pulling in their horns.

The government cannot repeal the law of gravity and stop markets from falling. Nor can it turn back the clock to reverse our financial blunders.

My recommendations are unchanged:

Recommendation #1. Keep up to 90% of your money in the highest rated, most liquid safe haven in the world — short-term U.S. Treasury bills, bought through Treasury Direct or a money market fund that invests exclusively in Treasury securities.

Recommendation #2. If you have substantial assets or securities held in any other venue — a brokerage account, insurance company, or bank — pull away a reasonable portion of those funds for safekeeping in Treasuries as well.

Recommendation #3. Above all, stay out of the stock market. Do not be lured back in by so-called “bargains” or temporary rallies like Friday’s. Our next target for the Dow is 5500, and it could get there very quickly.

Good luck and God bless!


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Our oil-rich friends in the Middle East are scared. How do I know?

Because they are buying gold like crazy!

First, we got the news that Saudi investors spent $3.47 BILLION on gold in a recent two-week period. On a ratio-to-GDP basis, that’s like investors in the U.S. spending $131 BILLION.

Why are they doing this? The only explanation I’ve heard is that the Saudis are turning to gold as a safe haven in the midst of the global financial crisis. And since the financial crisis kicked into high gear in August … something must be scaring them quite a bit more right now.

Second, Reuters reports that Iran is converting some of its foreign currency reserves to gold. Iran has $120 billion in foreign currency reserves … there’s no details on just how much was shoveled into the yellow metal.

Gold dealers in Dubai reported running low on gold during the recent Indian holiday, the Festival of Lights, a traditional time for Indians to buy gold.
Gold dealers in Dubai reported running low on gold during the recent Indian holiday, the Festival of Lights, a traditional time for Indians to buy gold.

Third, gold dealers in Dubai reported running low on gold during the recent Indian holiday, the Festival of Lights, a traditional time for Indians to buy gold. More than 50% of the population of Dubai originally comes from India. And about 20% of the world’s gold is traded in Dubai.

The world is in the grip of economic hard times — over 40 countries are officially in a recession. Japan just joined that unhappy club. And the euro-zone nations are already there. We also know that the forces moving the market now seem to be deflationary, not inflationary. That means the value of the U.S. dollar is going up, and the price of gold is trending lower.

But could our friends in the Middle East be thinking beyond the current deflationary spiral? Gold is traditionally a hedge against calamity. So I ask again, what are the oil sheiks afraid of?

While gold prices are going lower in the short-term as deflationary forces tighten their grip, there are also longer-term forces that are quite bullish for gold …

  • Chinese investors’ demand for gold is rising. Investment demand hit 38.4 metric tonnes in the first nine months of this year against 24 tonnes for the whole of 2007.

  • Demand for gold jewelry in China reached 241.6 tonnes in the first nine months of 2008, compared with 302 tonnes for all of 2007, when gold jewelry demand grew by 26%. China is the world’s second-largest gold consumer.

  • Sources in the Indian market and preliminary data on Indian imports point to a strong revival in Indian jewelry demand during this year’s third quarter.

  • In South Africa, gold mining output plunged 17.7% in September compared to a year earlier.

  • Global mine production of gold declined by 4% year-on-year in the second quarter to 590 tonnes, bringing output in the first half the year to 1,133 tonnes, 6% below the same period a year earlier.

Still, this long-term good news is cold comfort when prices are trending lower in the short-term. So it must be other things driving the Saudis and Iranians into gold. For example …

Shipping costs are sinking as ships sit idle

The Collapse of the
Global Cargo Trade

The Baltic Dry Index sounds like a weather report, but what it really does is track the price of shipping bulk cargo — such as coal, iron ore, cotton and grain. And recently, the Baltic Dry Index has fallen through the floor.

In real dollar terms, at the peak of the market, a 170,000-tonne Capesize bulk carrier cost $234,000 to rent. Recently, it was $5,600 — that’s a crash of over 90%.

Why is this happening?

Two reasons …

  1. The falling demand for products like cars. Auto sales are falling in the U.S., Germany, France, Japan and more. The pace of car sales growth is also slowing down in China.

  2. International shipping works on “letter of credit.” These financial guarantees are issued to buyers of bulk cargo by their banks. This system has greased the wheels of global trade for the last 400 years. With the collapse of the credit market — and banks now sitting on their hands, refusing to lend — the wheels of global shipping are grinding to a halt.

How bad is this?

Peter Kerr-Dineen, chairman of Howe Robinson shipbrokers, didn’t mince words when he described the crisis to the British press:

“This is a nuclear bomb in the freight market and in world trade. Liquidity has to return because if there is insufficient money to provide standard finance, world trade will be sharply cut back and economic growth will implode.”

Or as the London Banker blog put it:

“If cargo trade stops, a whole lot of supply chain disruption starts. If the ore doesn’t go to the refinery, there is no plate steel. If the plate steel doesn’t get shipped, there is nothing to fabricate into components. If there are no components, there is nothing to assemble in the factory. If the factory closes the assembly line, there are no finished goods. If there are no finished goods, there is nothing to restock the shelves of the shops. If there is nothing in the shops, the consumers don’t buy. If the consumers don’t buy, there is no Christmas.”

World trade has collapsed because the demand for goods has plummeted and available credit has dried up.
World trade has collapsed because the demand for goods has plummeted and available credit has dried up.

In my view … and perhaps the view of the Saudis who are buying gold … there is an even worse risk.

If bulk shippers can’t buy cargoes, then a lot of U.S. grain could end up rotting in warehouses while big portions of the world go hungry.

The Saudis, by the way, are the biggest importer of food in the Middle East. They probably have the money to pay cash for their food shipments.

But for the approximately 2.7 billion people in the world who spend 80% of their income on food, a disruption in the global shipping trade could mean the difference between quiet poverty and all-out rioting.

In addition, the Saudis are also worried about …

The Collapse of
U.S. Oil Imports

The oil producers are used to a world where U.S. oil imports always go up. But that world has been turned on its head. In September, crude oil imports dropped to 8.4 million barrels per day, down a whopping 16.5% from the average of 10.1 million barrels registered a year earlier.

U.S. crude oil tumbles.

This is helping the U.S. trade deficit, but for all the wrong reasons. I’ve often said the way to get lower oil prices is through conservation. Now though, Americans are being forced to conserve by economic hardship.

And since the U.S. uses one-fourth of the world’s oil, our falling imports are a major driver of cratering oil prices …

There is strong support for oil at $50. But you know that the Saudis, Iranians, Venezuelans and other OPEC heavyweights made their budget plans based on much higher prices. And cheap oil means the only way they can make up revenue is by pumping more oil … which should weigh on prices even more.

Looking forward, it gets worse for the oil producers …

Crude broke a major uptrend

Just last week, the Energy Information Agency projected that OPEC could earn $595 billion in 2009. That’s way, way down from projections of $979 billion of net oil export revenues in 2008, and even lower than the $671 billion it earned in 2007.

Saudi Arabia earns 29% of OPEC’s total revenues. If their revenues go back to 2006 levels, what will that do to the political situation in a country that is already sitting on a fundamentalist Islamic powder keg?

Yeah, that might be a really good reason for the Saudi fat-cats to buy gold!

These are just two of the world-class problems that may be scaring Middle East investors into gold.

I could go on. There are plenty of good reasons people might want to buy gold. Sure, deflation is putting downward pressure on gold … on paper. But just try buying physical gold anywhere near the paper price.

Pricing in a
Government Default?

While gold is traditionally a haven of safety, that’s not how it played out over the past couple months. Instead, we saw risk-adverse investors dump gold along with other asset classes and flee to the safety of cash.

Maybe the mighty dollar has more upside. But remember that the U.S. dollar is backed by “the full faith and credit of the U.S. government.”

Do you have a lot of faith in the U.S. government? I’d say the faith of the world has been shaken by recent events.

And apparently I’m not the only one who thinks that. Take a look at my next chart, which shows the 10-year credit default swap spread on U.S. Treasuries — a form of insurance contract against issuer default.

U.S. 10 year cds spread

The cost of insuring against a U.S. government default is soaring. And similar trends exist in the bond markets of Germany and Britain.

I think this is because investors are pricing in the massive bailouts that central banks are throwing at their markets. For instance, the U.S. bailouts will add enormously to our country’s already staggering national debt. According to CNBC data, the cost of all the bailouts that have been going on for months has now hit a total of $4.2 TRILLION!

In fact, Morgan Stanley recently estimated that the 2009 fiscal deficit in the U.S. would reach 12.5%. That’s more than twice the previous record of 6% set in 1983.

As a percentage of GDP, the U.S. national debt should pass 70% next year. That’s lower than the 122% at the end of World War II. Yet we aren’t fighting World War II, are we? That ended rather abruptly — this crisis won’t. And the odds are our fiscal picture will get worse, not better.

Under the circumstances, maybe investors in Saudi Arabia and Dubai may just be ahead of the curve. Maybe having some gold — the ultimate safe haven against troubled times — is the right thing to do.

I’m not saying the U.S. government is going to default … I’m saying the possibility of that happening could be priced in more ways than one. And that’s the kind of environment where gold could really shine.

Consider Buying Gold on Dips …
And Hold for a Wild Ride

Physical gold is always nice. But exchange-traded funds have made gold buying a lot easier.

I’m talking about the SPDR Gold Shares ETF (GLD) and the Barclays iShares Comex Gold Trust (IAU). They are fixed at 1/10th the price of gold, minus a small amount to account for fees.

That means if gold is trading at $730 an ounce, you can buy the GLD or the IAU for about $73. And they are backed up by gold bullion in a vault.

There are scary forces on the march in the global economy. A little golden insurance may help you sleep a whole lot better.

All the best,


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