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H. L. Quist’s
Contrarian Market View
Newsletter
Market Overview
Concern (and even fear) that the US and global economy may be headed south by the end of May jolted the markets worldwide. Anecdotal evidence from a number of sources reinforced that notion:
● The Jobs Report was dubbed horrible and ugly by pundits. Estimates of newly created jobs ranged from 130,000 to 150,000. The final number (which will be revised) from the Bureau of Labor Statistics came in at 69,000 and sent shockwaves throughout the markets. Overlooked by most was the fact that the April Report was revised downward from 115,000 to 77,000. One economist estimated that there are 18 million Americans competing for 3.7 million jobs!
● The Conference Board reported that its’ Consumer Confidence Index fell to 64.9 from 68.7 in April. Analysts had expected it to climb to 70. Consumer spending is about 70% of GDP which doesn’t bode well for the second half of 2012.
● The Dow Jones Industrial Average (Dow) lost 274 points on June 1, falling to 12,118 giving up all its’ gains for the year.
● The Conference Board Index of US Leading Indicators declined in April, the first in 7 months.
● The Philly Fed Index was also negative as the 10 Year Treasury Note plunged to a historic low of 1.46%. Germany’s comparable bund yield fell to 1.37%. Japan, still mired in a 20 year deflationary quagmire hovered around 1%. Rates that normally signal a recession – or worse.
● Greek citizens rushed to withdraw hundreds of millions of euros from their country’s banks which sent an ominous signal that this tragedy could mark the end of the world’s first Democracy. If a Pro-Bailout coalition can’t come together in the June 17th elections, chaos could accelerate.
To counter the economic “malaise” and the threat of global deflation, several events have recently taken place that contradicts this data:
● The elections in France and Greece were a referendum against austerity. European leaders gathering at a Group of Eight summit recently at Camp David agreed that there must be a “balanced approach” between growth and fiscal discipline. Austerity is out, reflation is in. Massive money printing could produce a “sugar” high.
● Manufacturing jobs are returning to the US by virtue of a debased US dollar. Whirlpool Corp. has re-opened a plant in Greenville, Ohio that makes Kitchen Aid hand mixers that were previously made in China. Ohio has made remarkable advances under the leadership of its’ Republican Governor John Kasich. The Burns Harbor steel mill, an aging 50 year-old facility in Indiana, has been rejuvenated thanks to modernization by its’ foreign-based owner ArcelorMittal of Luxembourg. Hopefully both labor and management won’t repeat their errors of the past and this trend will continue.
● Chinese officials have reversed their previous position to slow their economy and have recently announced that bank reserves margins have been decreased and interest rates have been reduced. On May 22, Premier Wen Jiabao announced that the government would aggressively seek infrastructure projects throughout the country spending $157 billion out of a total fiscal stimulus of $635 billion. China is the only country that has the cash reserves to do it.
On May 4, 2012 host Maria Bartiromo interviewed Jim Rogers, Chairman of Rogers Holdings on CNBC. Jim is a well-known author and investor who is a proponent of the Austrian School of Economics. In 1973, Rogers co-founded Quantum Fund with George Soros and when he left 10 years later the fund had amassed a gain of 4000%, while the S&P 500 advanced about 50%. Regrettably, Jim’s market savvy helped enable George Soros to create a multi-billion net worth which he is now utilizing to destroy the capitalist system that made him an exceptionally wealthy man. In 2008 Rogers moved himself and his family to Singapore where he observes a global economy that he says by 2013 will be in a “real mess.” Jim had some additional insightful comments during the interview.
As the JP Morgan’s derivative fiasco, “a terrible egregious mistake” (Jamie Dimon’s words) was the topic du jour, Maria asked Jim what his thoughts were on the subject. Without battering the proverbial eye the commodity expert said:
“...the person running their (JPM) commodity trading doesn’t know what he’s doing. I’m short the stock.”
When Maria interviewed Jim in December 2011 the “cold” topic was gold as it had plunged from a high of $1920/oz in August to a low of $1525 at that point. Maria asked, “Do you think gold will go lower?” Jim’s reply:
“I hope it goes lower and consolidates more so I can buy more.” (Ironically that was the low and Au rallied to $1785/oz within 90 days.)
Maria recalled that conversation and found it apropos to ask Jim again (as gold was at $1555/oz as they spoke) if it was going lower.
“I’m not ready to buy yet. India which is the largest importer of gold is trying to discourage gold consumption because it negatively impacts their balance of trade. All commodities are under pressure because of the strength of the dollar as a safe haven. It’s not a safe haven but people think it is. The central banks are all printing money. Get a tractor Maria! Farming is where you should be investing. Equities are not coming back!”
(The above was taken from your author’s notes and not from a transcript of the interview. CMV believes however that it captures the essence of Roger’s views. A few days later gold broke out $60/oz to close at $1,621/oz as investors sought a safe haven.)
In May the US Commerce Department levied anti-dumping duties of more than 31% against 61 Chinese solar companies and nearly 250% on some smaller outfits. US taxpayers have already absorbed nearly a billion in losses on government guaranteed loans to US solar companies and now the Administration is asking the American consumer to pay more for solar cells from China. The only winner here, according to a May 19, 2012 article in the WSJ, is Solar World AG, a German manufacturer and six other companies who filed for relief through the World Trade Organization. The Chinese must be scratching their heads in disbelief given all their current negotiations with this Administration. It comes as no surprise to Americans, however. We are accustomed to flip-flops, inconsistencies, contradictions, and flat out lies from this group in the Beltway who are in constant touch with the weatherman to determine which direction the wind is blowing – and where the votes are.
A good example of the overbearing arrogant mind set of this Administration is the case of Al “Crucify Them” Armendariz. He was the regional EPA administrator who was forced to resign after he was seen on video describing his desire to “crucify” oil and gas companies. As Senator Jim Inhofe of Oklahoma replied after seeing the video, “there are Armendarizes all over this Administration.”
JP Morgan’s Other Shoe To Drop Is Silver
Jaime Dimon, the Chairman of the nation’s largest bank ($2.3 trillion in assets) suddenly called a press conference on May 10th (that preempted his bank’s shareholder’s meeting on May 25th) to disclose that the bank had a $2 billion plus loss on a complex derivative bet blaming employee “error, sloppiness and bad judgement.” Three key executives, including Bruno Michel Iksit, known as the “London Whale” for his big positions in credit markets, were terminated for their role in the wrong way bet. It appears that this was a rare instance where Jonah devoured the whale or perhaps, the Whale was beached.
Dimon, who has been extremely vocal speaking out on the Obama Administration’s Dodd-Frank Bill and its’ restrictions and reporting requirements for US banks, has given the President ammunition to aggressively pursue additional stiffer regulations. Only four days after the revelation of the loss at JPM, the Justice Department has been called in to investigate the matter.
As painful as the $2 billion loss is to JPM and its’ shareholders (which could add up to twice that amount), it could only be a tip of the iceberg that could sink the Titanic bank. JP Morgan Chase & Co. possess another more massive derivative bet as part of its’ $71 trillion derivative position that could bring the bank to the brink if the position reverses. We are talking silver bullion here – a short position, betting that the price of silver (Ag) will continue its’ decline from its’ present $28/oz. Here’s the story. It reads like a John Grisham mystery novel, only it’s true.
When JPM acquired Bear Stearns & Co. in the Federal Reserve shotgun marriage in March, 2008, it also inherited Bear’s commodity Trading Book including a very large short position in silver bullion. At that moment Ag was about $21/oz. By October when Lehman Bros. bit the dust and there was no bailout, Ag had declined to about $9/oz – a decline of 60% and according to Peter Krauth at Money Map Report, JPM was racking in paper profit of about $200 million per day. It wouldn’t be a stretch to assume that JPM may have paid for their acquisition of Bear with the gains they made on Bear’s Trading Book in Ag.
The 60% decline in the price of Ag created huge investor losses and lawsuits claiming manipulation and control of Ag prompted the Commodity Futures Exchange Commission to initiate an investigation of the silver market and in particular JPM’s role in that market. Little headway was achieved and it appeared that, once again, investors long silver would be defeated by the manipulators. That all changed when a silver trader in London who had been employed by JPM for 40 years, blew the whistle. Andrew McGuire had all the records and all the orders from management that would substantiate that JPM and others did indeed successfully manipulate the market price of silver. The story gets, as the Brits say, “dicey.”
Six weeks after McGuire testified in New York and while driving in London with his wife, a car suddenly emerged out of nowhere and struck McGuire’s car with a crushing and potentially lethal blow! The attacker backed up and sped away striking a pedestrian and two other cars in his effort to flee. A chase scene, worthy of an Ian Flemming novel, with police cars and helicopters in pursuit finally captured and arrested the assailant. Lo and behold however, the “hit man’s” name was never revealed and no one was ever jailed! CMV”s persistent use of the term “banksters” seems to fit after all.
JPM reduced its’ Ag short position in August, 2010 and coincidentally by 2011 Ag rallied almost parabolically to close to $50/oz! Within a matter of days in early May aided by the mandate requiring long investors to post double their margin requirements. Ag began a precipitous sell-off to about $33/oz and JPM profited handsomely. In what proved to be a “dead cat bounce” silver rallied back to $43/oz by late August and then, aided by the EU crisis and the risk-off trade momentum, silver bullion collapsed to end 2011 at around $27/oz.
At the time of this writing Ag is at $28/oz and it appears that both gold (Au) and Ag have based for a significant rally that could not only challenge the $50 high but breakout to new ground. Two critical questions remain:
1. What event or circumstance could occur that would alter or end JPM’s ability to control the price of Ag? And,
2. Could Jaime Dimon and JP Morgan-Chase & Co. survive another back-to-back highly leveraged derivative bet gone bad? The present loss could be in the $2-4 billion range. A $50/oz silver price could translate to a loss of many multiples of that number assuming the bank doesn’t “cover” its’ shorts.
First, China is the “game changer.” The Pan Asian Gold Exchange (PAGE) opens in June. The Hong Kong Mercantile Exchange (HKMEX) opened a year ago in May and has already accumulated over one million contracts in Au and Ag. The HKMEX will soon introduce trading in the Chinese renminbi and this will allow Chinese citizens the ability to trade in their own currency and not the US dollar. It will also permit trading in an Ag contract of 1000 troy ounces vs. 5,000 on the US and London exchanges. For the first time, small Chinese investors will be able to trade futures in their own currency. Ag demand already exceeds supply. Now, a growing demand that JPM can’t control will push prices higher.
Secondly, as CMV has reported many times, the opening of these two exchanges represents a major shift in power and control from West to East. The London Metals Exchange, the NYMEX and the Chicago Mercantile Exchange are part of the Western-Centric (Fiat) monetary system that has enjoyed a monopoly for over a century. The US Federal Reserve’s announcement this month that it had approved the entry of three Chinese banks to locate in the US, is further evidence that the “Global Re-Balancing Program” is well underway. All of the above must be noted in the ivory tower at JPM-Chase & Co. Eric Sprott, who is one of Canada’ s leading asset managers, told your author personally that “silver will reach $150/oz within two years (from October, 2011) and the shorts will have their heads handed to them.” Remember, to cover their short position, JPM will have to buy Ag contracts at the existing market further exacerbating a rise in price. Massive inflation will add frosting to the celebration-cake that silver bulls will savor. The Lone Ranger Rides Again! Hi Ho Silver, Away!
Why Societies Fail
CMV regards James Dale Davidson’s Strategic Investment as an invaluable resource. In his May issue he introduced us to anthropologist and historian Joseph A. Tainter who is considered one of the world’s foremost experts on why societies fail. CMV subscribes to the theory that seeing the macrocosm or the big picture is essential to comprehending the microcosm or the small picture. Evidence of this approach at work is looking at America today. Tainter says in his book, The Collapse of Complex Societies:
“Once a complex society enters the stage of declining marginal returns, collapse becomes a mathematical likelihood, requiring little more than sufficient passage of time to make probable an insurmountable calamity.”
The following are a few examples how the increasing complexity by government in the US reveals declining or negative marginal returns.
1. Healthcare:
Per capita healthcare costs in the US have risen from about $1,200 in 1982 to $7,960 in 2009. The Organization for Economic Co-Operation & Development (OECD) indicates that despite the highest cost/capita in the world, the US ranks last among 17 wealthy countries in success in its’ healthcare system. The study included health indicators such as life expectancy, premature mortality, death from cancer, infant mortality and other measures. This study was conducted prior to the Obama Administration’s expenditure of $1.7 billion on healthcare without increasing the supply of services.
2. Education:
The US leads the world in total spending on education but ranks ninth in science performance and tenth in math compared to 11 other leading economies. Costs range from a low of $10,896/student in Idaho to a high of $38,896 in Washington, D.C., that has one of the worst school systems in the US. In testing 15 year-old students in 65 countries, China-Shanghai with a per capita outlay of $1,326/year leads the world in scoring. The US is throwing more and more money at solving the problems in education and getting narrower marginal returns.
Finally, there are some school systems that see the real problem Progressivism has caused and are attempting to reverse the long-term decline of education in the US.
3. US Military:
History is replete with Empires whose military costs contributed significantly to the collapse of the empire in question. The Soviet Union is a recent example. The US Department of Defense indicates that Defense spending in 2010 was $707.5 billion. When “off budget” items are included the cost is closer to double that amount. Even the lower number is 50% less than China. Tainter reveals in his book that the “Roman Empire provides a classic example how increasing complexity to resolve problems leads to higher costs, diminishing returns, alienation of a supportive population, economic weakness and collapse.” Sound familiar?
It should be quite apparent to the reader that the US has been initiating a strategy of excessive complexity that is not only providing diminished returns, it is a recipe for a collapse of the American Empire – precisely the goal of its emperor.
Davidson reports that the Obama Administration has taken action to make it virtually impossible for US citizens to leave the country. He indicates that 742 American per hour are exiting the US. That is 17,808/day or 552,048/ month! To curtail the exodus Congress and this Administration have made it now impossible to open a foreign bank account. The Foreign Bank & Financial Account Report and the Foreign Account Tax & Compliance Act imposes onerous and costly regulatory mandates on foreign banks that have American customers. That’s why Eduardo Saverin, Face Book’s Co-Founder, has revoked his US Citizenship and moved to Singapore. He cashed out, paid his taxes and got the heck out of Dodge. In addition, the Administration has proposed new regulations to make it near impossible to obtain a US passport. Davidson outlines a long list of questions to be required in an application that would be impossible for most applicants to complete. The most absurd is that men, if applicable, and without a birth certificate, would have to provide details of their circumcision. Failure to provide this and any information would allow the bureaucrats to deny your passport for reasons that you filed an “incomplete application.” The US is moving rapidly towards Totalitarianism and its’ citizens are oblivious to what’s occurring.
Updates
Enemies List:
In the May 2012 CMV (Market Overview) we highlighted Kimberly A. Strassel’s April 27, 2012 WSJ Potomac Watch column that revealed the existence of President’s Obama’s “enemies list.” Specifically one of his websites “Behind The Curtain: A Brief History of Romney’s Donors.” Amongst eight donors that the President listed who were “on the wrong side of the law” and were profiting at the “expense of so many Americans” and other shameful and derogatory claims, was Tom O’Malley, Executive Chairman of PFB Energy. Mr. O’Malley responded to his listing on the President’s ‘fecal scroll’ by the following letter to the editor of the Wall St. Journal on May 6, 2012.
Letters To The Editor
May 6, 2012
The Things I Did to Get on Obama's 'Enemies List'
Kimberley Strassel's April 27 Potomac Watch "The President Has a List" reports some serious allegations. I have not made too many lists in my more than 50 years in business, so I was quite surprised to see my name on President Barack Obama's "enemies" list.
My most recent business venture, PBF Energy, bought the closed-down Delaware City Refinery, spent $400 million to fix it and reopened it with a United Steel Workers unionized work force. More than a thousand high-paying jobs were created in a state where unemployment had become a real problem.
PBF also bought a refinery in Paulsboro, N.J., one that was scheduled to close. Thus, more high-paying unionized jobs were saved in New Jersey.
If this gets you on the enemies list, it would be good for the country if the list were expanded. It would seem that I got on the list because I gave to the Romney PAC. I have also run a fund-raiser for New York's own senator, Chuck Schumer, who I believe is still a Democrat. I hope this doesn't get me on another list, because the amount involved exceeded the Romney contribution.
I can't believe that the president has authorized such a self-destructive strategy and can only suggest that he and his administration may want to disown the author of the list, whoever that may be.
Tom O'Malley
Executive Chairman
PFB Energy
West Palm Beach, Fla.– http://online.wsj.com/article/SB10001424052702303916904577376121349763842.html
This is what American politics has become – assassins of character, uncivil, intimidating, scandalous and in this case, factually inaccurate and libelous. We are ruled by a Thugocracy where there are no rules of conduct except retention of power through any means possible. And, this tactic of fear is only a harbinger of things to come and tell-tale sign that the great American experiment is about to fail.
Global Re-Balancing
In May, CMV also featured our view that a currency deal with the US and China had already been sealed and that, to quote ourselves, “The China Era is about to begin.” Evidence that the transition has continued to unfold was the release on Wednesday, May 9, 2012 by the US Federal Reserve Bank, news that the Fed had approved plans by three state-backed Chinese banks to expand in the US including the first acquisition of a US retail-banking network by a state-owned Chinese lender! In addition, the US Treasury approved China as a “primary dealer” for the purchase and sale of Treasuries by-passing Wall St. CMV suspects but doesn’t know, that the Fed and the Treasury do not want anyone to know the activity and volume in this market between the two countries. This approval and dealer status is an indication that the currency deal with China has many ramifications. It reinforces China’s goal to have its’ currency, the yuan, recognized and traded internationally as a step to ultimately be the world’s reserve currency. Although most Americans will not grasp the significance of the Fed’s decision, to the Chinese this is a VERY BIG DEAL. They’re now a member of the Western bankers elite “club.”
The Greek Tragedy Plot Thickens
The Greek leftists, led by 37 year-old Alexis Tsipras and his Syriza party may have secured sufficient power along with the neo-Nazi, and other leftist groups in the recent elections to reject the austerity measures imposed upon the country in order to obtain additional funding from the IMF and the ECB. So, what does Tsipras and Syriza and the left want? One, it not only refuses to accept austerity measures, it refuses reform of any kind. It opposes reducing the bloated and corrupt state bureaucracy and the inept educational system. Rather than downsize its’ civil service, Tsipras has suggested hiring an additional 150,000 more people in order to reduce unemployment. The major issue is that the leftists refuse to pay Greece’s sovereign debt which would mean not only an immediate exit from the eurozone but also from the EU. Rumors have it that Greece is printing its’ own currency, the drachma, in anticipation they will abandon the euro. CNBC has been running 3 days of specials focusing on the possible outcome and its’ ramifications.
This rejection of austerity is not confined to Greece. France and the Netherlands just rejected the conservative solution also. This wave of anti-austerity will not only spread throughout the EU, a like referendum will take place in the US in November. There is, at present (and that could change), a strong possibility that Barrack Obama and his legions of leftists, will win in November. It that occurs here, HYPERINFLATION is a near certainty and EOAAWKI will follow. Plan for the worst and pray it doesn’t happen!
NOTE: Thanks to Takis Michas for his insight into the Greek situation in the May 9, 2012 edition of the WSJ.
Pension Shock
CMV has written profusely on the dilemma that faces state, county and city employees throughout the US who, potentially, face severe cuts in their pensions and healthcare benefits as there simply is not adequate funds in their plans to meet the promised benefits. Some cities like Pritchard, Alabama; Central Falls, Rhode Island; and Vallejo, California have filed Chapter 9 under the bankruptcy code for municipalities. Employees in Pritchard and Central Falls experienced a 50% cut in their pensions after the filing. Once a state, county or city seeks bankruptcy protection they loose almost all chance of securing tax-exempt bond financing. Vallejo, after successfully implementing austerity, is recovering nicely.
A new wrinkle has occurred that heightens the possibility that public employee pensions will be cut. The Northern Mariana Islands, 5,000 miles off the coast of California, is a US Commonwealth. Last month the Island’s government took a different approach. Their retirement plan filed Chapter 11 and could have set a precedent for public pension plans all over the US since the various governments themselves wouldn’t file and their bonding could ostensibly remain intact. The Mariana case is an example where employee benefits became so generous the Commonwealth couldn’t pay them. Partly at fault was a 2007 law promoted by Harry Reid and Nancy Pelosi that raised the Commonwealth minimum wage from $3.05/hour to $7.25/hour over 10 years. There’s a distinct message here for public employees like those in Wisconsin who are prepared to recall Governor Scott Walker and beef up their pensions and benefits. If they win, they lose! The future is NOW but most can’t or don’t want to see it.
Iceland – A Triumph From Despair
CMV reported on the story of the financial collapse of Iceland so well told by Michael Lewis in his latest book Boomerang. In 2008 the country was the first victim of the bankster-induced financial catastrophe but remarkably, it is the first country to rebound, which is a lesson for all to recognize – especially Americans. Iceland is a member of the European Union but it retained its’ own currency, its’ own central bank and monetary policy and did not have to rely on policy-making decisions made by a bureaucratic pyramid in the Euro-zone, which those countries in the EU are now hostage to. The Icelanders devalued their currency by 50% vs the euro, and their exports of, primarily, fish skyrocketed. Their GDP went from a minus 7% in 2009 to a plus 2.4% in 2011. Iceland, unlike any of the rest of the world, let its’ banks fail and made foreign creditors take the losses vs. their own taxpayers. To combat consumer prices increasing 26% since 2008, the Icelanders have rejected costly imports and despite the fact that their currency is 50% less in euros the fishermen take home twice as much kronur for the same amount of fish and they’re way ahead despite the inflation. Icelanders, all 325,000 of them, are unique and their experience probably can’t be replicated but Greece is a likely candidate to depart the EU and re-issue the drachma which could trade as low as six to one vs. the euro.
Author’s Note: Iceland was settled prior to the year 1000 by Scandinavian explorers who also settled Greenland and the North American continent beating Christopher Columbus by almost 500 years. Today, the Island remains almost exclusively one ethnic group whose work ethic and stoic disposition have enabled them to recover from the crisis.
California – A Day Of Reckoning
Faced with the largest state deficit ($15.7 billion) in the country, Governor Jerry Brown has made a pronouncement that he and Californians thought they would never, never, never, ever hear. He said:
“California has been living beyond its’ means. The United States of America... has been living beyond its’ means...A lot of people spend more money than they take in. Well there has to be a balance and a day of reckoning.”
Brown proposed a 5% cut in state worker’s pay, a $3 billion cut in medical care for the poor, welfare, in home services for the disabled and child-care subsidies. He also warned that there would be another $6 billion in cuts mostly to schools if voters reject another increase in taxes. Despite these reductions, state spending will increase by 5.6% to $91.4 billion next year. Herein lies the moment of truth not only for California but for other state, county and municipal governments. If Americans reject “austerity,” bankruptcies will follow and civil unrest will resemble Greece.
Fannie and Freddie
After 4 years of losses totaling $116 billion, Fannie has reported a $2.7 billion profit in the first quarter of 2012. The principal contributor to the gain is that home price declines have slowed and fewer mortgages are in foreclosure. The mortgage giant also announced that it will pay a $2.8 billion dividend to the US Treasury Department. Both Fannie and Freddie have been paying a 10% dividend on certain preferred shares despite huge losses since 2008, with taxpayer’s money! At one time, China owned $375 billion of US government debt principally of Fannie and Freddie. It appears that China’s exposure to the “evil twins” has been reduced but it would be worthwhile knowing if China has any of the Preferred Stock that has continued to pay a high dividend since the two agencies failed in 2008.
* * *
Sector Overview
1. Cash & Fixed Income
Witnessing the decline in the yield of the 10 Year US Treasury Note to 1.46% by June 1st, was ‘noteworthy’ and downright ominous. Yields that low have never been seen in the US, and raises concerns that they signal a recession or worse, a depression. Consider the fact that the 10 Year yielded 2.40% in March. This drop represents not only a flight to safety by EU investors, it also reflects a further slowdown in our domestic economy. The Germans just sold a Bund offering with a zero premium! But, as Thomas G. Donlan, Editorial page Editor of Barron’s points out (May 21, 2012), “it [the US] needs to end the government’s market manipulation that creates a popular delusion of risk free investing.” Low interest rates, in addition to the concept of too big to fail, encourages banks to take on leveraged risk that continues to create fear in the markets. Derivative exposure has not abated. It remains at $700 trillion and JP Morgan-Chase & Co has about 10% of that amount. As Rick Santelli (the bond editor) said on CNBC recently, rising interest rates, “will be catastrophic” for the bond market. This event, if and when it occurs, will also represent an incredible investment opportunity.
2. US Equities
The Axiom “Sell in May and go away” would have been a sound strategy as the Dow declined over 1,000 points to end the month (June 1st) at 12,118 and lose all its’ gains YTD. The S&P 500 followed in lockstep ending at 1,278 down from the 1,400 level but held onto a modest gain of 1.6% YTD. Remarkably, the S&P is almost exactly where it was one year ago, and if you go back to the market low of October, 2002, the gains for almost 10 years are near zero! The May malaise was due to the continued saga in the EU and the sense that the US was headed for another Recession as it did a year ago. The Jobs Report was the trigger point that sent the Dow down 274 points (2.2%) and the S&P 32.29 (2.46%) on June 1st. In the August, 1979 edition of Business Week, the cover forecast the “Death of Equities.” That theme is popping up again with market mavens predicting a new bear market. CMV believes that investors seeking positive returns in US Equities will be “challenged” going forward. For those who continue to HOLD equities in this Sector you should consider hedging your portfolio. Through an asset management firm, Dynamic Wealth Advisors offers a separate account program that hedges equity positions with options. We welcome your inquiry to learn about this program and determine qualification.
3. International Equities
At some point in time and that time could be eons away, the EU could offer significant value which is to state the obvious. Many investors don’t realize however, how the instability and economic downturn in the eurozone has impacted the global economies. The EU is China’s number one customer (20%) and exports to this region have plummeted. Six months ago China was concerned about an overheating economy, inflation and civil unrest due to wage demands. The Politburo was forced to employ a tight monetary policy to slow down the economy. Now, Chinese officials have announced a reflationary expansionist policy that includes massive infrastructure building programs. As a result China’s Pacific Rim countries like Australia, South Korea and others who feed off the spoils of the Red Empire as well as US heavy equipment manufacturers, have rallied. As CMV has emphasized, the Reflation Plan is global – the EU, China and the US are committing to the Keynesian theory of more deficit government spending and more debt. Will it work? Yes, temporarily. Another short-term fix that delays the inevitable and creates an insurmountable problem down the road. Prior to that date, however, we want to get the heck out of Dodge which simply means, to be in cash.
CMV hasn’t mentioned Japan since the devastating earthquake and tsunami over a year ago. In mid-May, the Nikkei 225 Index plunged to a four month low falling to the 8600 mark. It has declined 16% since reaching a one year high on March 27th. The Japanese yen has rallied against the USD and the euro despite the government’s attempt to weaken its’ currency by utilizing its’ own QE programs. There is a meaningful and relevant lesson to be learned from the Japanese experience. In 1989 the Nikkei 225 reached a high just short of 40,000. It has fallen 80% from that level and has never recovered despite massive government spending and attempts to stimulate their economy. Long-term government debt has consistently hovered in the one percent range and citizens have realized little or no return on their savings. The point is, Keynesianism has not worked in Japan and will not work in this global “race to the bottom” – the attempt by nations to devalue their currencies in order to increase their exports. This global “competitive devaluation” will most likely end up creating world-wide inflation and its’ evil twin, HYPERINFLATION.
4. Hard Assets
Last month US citizens were screaming for lower gas prices. They got ‘em but they’ll have to absorb the correlation that created the relief – a slowdown in the US economy and lower demand. West Texas Intermediate crude oil has fallen in price from $105/BBL to $83. Will summer vacation travel change the dynamics or will prices remain at these levels? We don’t know but CMV believes that this picture could dramatically change and prices will rise as early as early fall as a result of a currency crisis. One remarkable change in this Sector has been the rise in Natural Gas. CMV tried to find a bottom in this market but failed and capitulated last year. Recently however, the price of Natural Gas has risen from below $2.00/BTU in April to $2.60 at the time of this writing - a gain of 30%. Has this Administration and Congress finally got the message that gas is the cheapest alternative energy source in the US? Will the T. Boone Pickens Plan be adopted or is there something else at work?
The Sierra Club and the “greens” had supported Natural Gas as a clean alternative energy and bridge fuel and had received $26 million in contributions from Chesapeake Energy to support, in part, the Club’s “Beyond Coal” campaign. Now, the Club has done a 180 degree reversal and is mounting an all-out effort to kill the gas industry. Why? The greens have concluded that Natural Gas is too cheap and it would prevent the development of wind, solar and biofuel. Their goal is to reduce the supply of gas and keep its’ price as high as possible. Their real goal is to ban all fossil fuels regardless of cost and loss of jobs.
Barrack Obama and the EPA have also declared war on the coal industry. In mid-May, the US Energy Information Administration reported a shocking drop in power sector coal consumption in the first quarter of 2012. Coal-fired power plants are now generating just 36% of US electricity vs. 44.6% just one year ago. It’s the Administration’s goal to gut the coal industry and electricity prices to consumers will skyrocket. Environmental regulations that go into effect in 2015 will cause the market-clearing price for electricity to climb from the current rate of $16/megawatt to $136/megawatt! In Ohio, the price will rise to $357/megawatt. Now we know why Natural Gas is up 30% and going much higher and why Ohio voters have turned against the re-election of this President. (Thanks to Phil Kerpen and foxnews.com for this information.)
Like a number of senior large cap gold miners, the mega oils are now a value buy. Some of the names are off 30% to 50% and their dividend yield is now over 3%. The same case can be made for the pipeline MLPs. Yields are now very attractive plus they have the potential for significant capital gains.
One of the most exotic trades ever has just surfaced. Kyle Bass, the flamboyant Texas hedge fund manager, has acquired an incredible amount of nickel coins at their face value of $.05. He believes that they currently have a melt value of $.06 or 20% above the price. They may cost the US mint about $.07 to produce them and expects the Mint to end circulation of the coins along with the penny.
5. Precious Metals
After a furious rally in January and February that propelled gold (Au) from $1,535/oz in December to almost $1,800/oz, the EU crisis has created a flight to safety which caused a strong rally in the US dollar. This, in turn, has contributed to a three month sell-off since March that crashed the gold price down to near the December low – a 17% correction. In fact, the gold bullion chart exhibited a triple bottom formation in May 2011, December 2011 and May 2012 and appeared to be headed to test the lows again. The June 1st breakout changed everything. The $60/oz rally signals a major shift in market fundamentals to hard assets. The “smart money” now recognizes that massive monetary expansion in the EU, US and China is going to lead to global currency devaluation. Gold will now become the “safe haven.” QE 3 could be another match that ignites the fire. The WSJ reported on May 24th that traders have purchased $1,850/oz out-of-the money calls on GLD for August expiration totaling 360,000 contracts. In other words, traders may be expecting gold to rise over $300,oz by August, 2012, or they could be hedging their short positions. (JPM?) One trader speculated that a Greek exit from the EU could rally the euro and crash the USD benefitting Au.
Overlooked by almost all pundits, stock pickers and asset managers is the enormous value that has been created in the Au and Ag producers by this 3-headed monster of a correction in the metals. A number of the largest and highly profitable senior mining companies are selling at 30% to 50% discount and have dividend yields of over 3%. Fred Hickey, who is the top gun at the High-Tech Strategist and not a gold bug, tells Barron’s (Up and Down Wall Street, May 21, 2012) that his largest positions are in the senior producers. He says, “The gold miners are cheaper today versus the price of gold than any time in this 12-year bull market. No one wants to own them. That’s when I like to buy them.” Spoken as a true Contrarian which your author subscribes to.
CMV has introduced its’ readers to Eric Sprott who is one of Canada’s most successful asset managers and authorities on PMs. Here is critical supply and demand data that clearly establishes the fundamentals for this market going forward.
Although the paper gold price has been range-bound over the past month, the physical gold market has been undergoing staggering change. Earlier this month it was revealed that Hong Kong gold imports into China totaled nearly 40 tonnes in the month of February, representing a 13-fold increase over the same month last year. 40 tonnes annualized equates to 480 tonnes per year - a massive number in a market that only produced 2,810 tonnes of mine supply in 2011.
If there's one thing we now know for certain, it's the fact that the market has completely missed the importance of the demand-side changes currently taking place in the physical gold market. China has now imported 436 tonnes of gold through Hong Kong over the past eight months. This compares to imports of a mere 57tonnes over the same eight month-period a year earlier (July 2010 -February 2011). The net new demand implied by this increase is 379 tonnes, which when annualized equates to 568 tonnes of new demand in a market that supplies 2,810 tonnes per year in mine production. These are astounding numbers. Recent IMF data also shows that at least 12 countries increased their physical gold reserves by 58tonnes in the month of March, with Mexico, Turkey, Russia and Kazakhstan making sizeable purchases. 58 tonnes annualized equates to 696 tonnes of demand per year. We know that central banks bought 439.7 tonnes of gold in 2011, and if the pace of recent central bank purchases continues, it will equate to another 256 tonnes of net new change in the physical gold market.
The significance of this demand shift is striking. If we combine china's implied net change of 568 tonnes with the central banks' net change of 256 tonnes, we're left with a demand shift of over824 tonnes vs. an annual mine supply of 2,810 tonnes. That represents close to a 30% net change in the physical gold market in2012. If we remove the portion of global gold production produced by China and the other non-G6 central bank gold buyers (like Russia and Mexico - because we know they're not sellers), we're now dealing with over 824 tonnes of demand change hitting an annual global mine supply of a mere 2,170 tonnes - representing a 38%shift. Although we have been continually reminded that 'fundamentals don't matter' in today's marketplace, there isn't a physical market on earth that can withstand that type of demand increase without higher prices over the long-run, and the gold market is no different. There are no sellers of physical gold that we know of who can satiate that scale of new demand, and global gold mine supply has been virtually flat for over the last ten years. Even if we incorporate the estimated 1,600 tonnes of"recycled gold" that the World Gold Council insists on including in its annual gold supply estimates, the numbers above still suggest a net change of 19%. Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because we don't actually know.
We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market, the investing public would lose their minds. Could you imagine, for example, if the demand shifts described above were applied to the global oil market? What would happen if a single country came in from nowhere and increased its oil purchases by a factor equivalent to 30% of the world's annual oil supply? We are students first and foremost of the physical market, and the numbers stated above speak for themselves. We remain confident about gold for the simple reason that the demand we are now seeing for physical is completely unsustainable without higher prices, and we do not see that demand abating in the coming months. The US recovery is not happening. Europe is poised for yet another full-fledged economic crisis, and the BRICS countries continue to aggressively convert to hard assets like gold in order to protect themselves from currency debasement. The paper market for gold can continue its charade, but demand in the physical market will soon overpower it through sheer momentum -there's only so much physical to go around, and it appears that there are some very large buyers that are eager to take it.
– http://sprott.com/ Eric Sprott & David Baker, April 29, 2012
6. Commodities
As we reported last month, the “pink slime” and the mad cow disease scares raised havoc with beef prices but as we forecast, the bar-b-que season would rectify that. In late May, live cattle and feeder cattle rallied sharply over $.05/lb and the severe shortage of supply should create much higher prices this summer. Stock up now on livestock. In the Chicago futures pits prices of lean hogs are going belly up to the tune of 26% over the past 9 months. Retailers, however, are not discounting pork products which has in turn turned off consumers and reduced demand. That same phenomenon is occurring across the food spectrum keeping prices stubbornly high. Expect them to go higher this year despite recession fears.
7. Real Estate
The WSJ reported on May 23, 2012, that existing home sales were up 3.4% from March and the median home price increased from a year earlier to $177,400, the strongest year-to-year gain since January 2006. Economists say the higher median price reflects rising values and the sale of fewer foreclosed homes. Traditional home buyers are now competing with investors, which should push prices higher as interest rates reached a record low of 3.79% for a fixed 30 year loan. On May 23rd the Commerce Department reported that new home sales for April rose 3.3% over March and up 9.9% over one year ago. Prices for a new home rose to $235,700, up 5% YOY. These numbers are a far cry from historic levels but these are the best news the industry has had since 2008. Arizona is one of the country’s leaders in this Sector substantially out-performing the national averages. CMV’s forecast was premature but accurate.
On May 26, 2012 Catherine Reagor’s column in the Arizona Republic indicated that single family home inventories in the Phoenix area have declined 50% and prices have risen 30% YOY! An east Phoenix home was bought in a short sale in late September, 2011 for $218,000 and sold in late February, 2012 for $560,000 after it was completely remodeled.
8. Special Situations
The junior small and mid-cap gold and silver miners and explorers are even more under-valued than their senior cousins. Several juniors have reported outstanding production and earnings and the market absolutely ignores them. There’s a plethora of names that when bullion begins its’ move higher will suddenly become take-over candidates. Given the current depressed prices fortunes will be made. Buying this Sub-Sector now is a wise Contrarian play.
The fundamentals on Uranium (Ux) are getting exciting and the senior, junior and explorers are grossly under-valued. Globally, nuclear reactors burn more fuel than all the mines produce. It makes no difference that Germany wants to shutter its’ nukes and go green and Japan has already shut down 53 out of 54 of its’ plants. Up to this point, the supply deficit has been filled by salvaging old nuclear warheads but that ends next year. This is a long-term growth Sub-Sector. Buy now and hold.
The REEs, likewise are grossly oversold and are out of balance. Jim Dines (The Dines Letter) reports this month that, “...Rare Earths, a better set of fundamentals we’ve rarely seen; Rare Earth prices are still sky-high and rising again, yet the miners are in downtrends! Something is not right, and a major economic downturn would fit the facts in the trenches, that commodity prices are still high in the real world of day-to-day transactions albeit probably headed lower.”
Opportunities abound in natural resources. Now is the time to establish a position at discounts that we won’t see again for a long time.
Call me at (602) 840-4117 to discuss strategic planning.
-- H. L. Quist
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