Monthly Archives: August 2008

Sound money promotes peace

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Ron Paul is not just the lone voice of reason and honesty in Congress, he’s also a great writer. In the latest of his weekly essays, he spells out how sound money (gold and silver being tried and true examples of which) restrains governments from engaging in mischief such as wars of aggression:

 

 

“Can sound money really bring about peace?  Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade.  History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.

Can sound money really bring about peace?  Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade.  History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.

Sound money, on the other hand, simply is what it is. Removing governmental power to manipulate money, removes the temptation for government to spend, print and cheat. Sound money ensures that our government’s spending priorities would be brought into sharp focus and reduced to only what we can afford.

Sound money also limits the ability to wage wars of aggression. Imagine how much more careful Washington would have to be about starting a war if they did not have this financial sleight of hand at their disposal! Fiat currency allows government do expensive things they should not be doing while paying the bills with cheap money”.

It’s no secret that deficits and inflation are how wars are financed. Every major war fought by the US, even the Revolution, was funded by printing currency and/or selling bonds (often at great profit to bankers selling the bonds). Whenever the US had been on a gold standard before a major war, it would be dropped, as in the Civil War and WWI. All combatants in WWI dropped gold upon entering, and they again dropped it permanently by WWII. To be fair, many also ran huge deficits to pay for socialism in the 1930s, the national socialist (Nationalsozialistische, i.e. NAZI) kind and otherwise.

Vietnam, along with Lyndon Johnson’s ‘Great Society’ welfare expansion, was an immediate cause of the final severance of the dollar to gold and silver, first with the withdrawal of silver coinage in 1964, then with the default on our gold-backed bonds in 1971.

Many know that after Rome’s wars stopped paying for themselves and the welfare state got out of hand, inflation kept the game going. The silver Denarius of Augustus’s reign was slowly diluted to nearly 100% copper over the following 200 years. When merchants resisted the debased coinage, Emperors resorted to brute force to give value to their fiat money: use it, or else.

Wall Street’s pain trickles down to the beach

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This story in Bloomberg today about Montauk, Long Island’s sport fishing industry should surprise no one:

One reason why boat operators are suffering is that regular customers aren’t booking appointments. Taylor Herman, 28, an avid angler who works with structured credit markets at HSBC Investments USA Inc. in New York City, usually makes five or six charter trips every year.

Now he is fishing off the beach at Montauk Point. The cost of a fishing trip and uncertainty in an industry that has bled New York of thousands of jobs in the past year are keeping him ashore.

“What’s at the forefront of my mind is that even if there is a bonus in this industry, in this market I probably wouldn’t let it go,” Herman said. “It is almost the most luxurious thing you can do, to drop $500 on a fishing trip that is a complete gamble.”

There you have it. Frugality is in. This guy has the cash, but knows he should hold onto it.

Herman said he knows a dozen people who have lost jobs at financial companies, and only one has found work. Employment in the securities industry in New York City dropped by 10,600 jobs, or about 5.5 percent, from mid-August 2007 through mid-July, said Jim Brown, an analyst with the New York State Labor Department.

This summer the tourists have cut discretionary spending, reflecting a regional economy down 18 percent in the last year, according to the Bloomberg New York City Metro Index….

18 percent? Jeez… if that is what an honest accounting of economic activity looks like, can you blame the BEA for cooking the books to inflate GDP?

Ripple Effect

“It’s a chain reaction,” said DeFina, 47, the owner of On The Dock. “The boats are empty, the docks are empty, the parking lot is empty. When people see that, they keep going.”

Fuel sales at Montauk Marine Basin this year may total 700,000 gallons, down from about 1 million in 2007, said Darenberg, the owner. That has cost him at least $200,000 so far this year, he said. The decline comes as he faces a $1 million bill in 2009 to install new fuel tanks to meet environmental rules.

“If boats don’t move, they don’t break,” said Darenberg, who also repairs fishing vessels and has a bait and tackle shop. “We’re trying to keep the prices down so people will go fishing.”

They’re trying to keep prices down – - that’s just what they should do, and is exactly how deflation works. Fishing tackle is actually a huge industry in the US, and as a fisherman, I have noticed soaring prices in the last 20 years. A decent light rod used to cost $15, with $50 being upscale, but now the respective figures are more like $50 and $200, and the number of highly discretionary gizmos for sale has exploded. Tackle manufacturers are going to have to retool for lower budgets: think Wal-Mart’s fishing aisle, not Montauk yacht clubs.

Remember the sub-plot in Jaws about the fragile tourism-based economy on fictional Amity Island? These towns are in for the toughest of times, since they rely on an overflow of cash and the confidence to spend it. In a depression, people will still come to the beach, but businesses like marinas and upscale restaurants, caterers and boutiques will find it hard to stay afloat.

Out of the Woods? Treasury market isn’t buying it.

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30-year treasury yields in blue, S&P 500 in red:

Click image for sharper view. Source: Yahoo! Finance

Talk about a non-confirmation. Treasuries rallied on Monday when stocks tanked, but they have failed to sell off since then as stocks have rebounded. Treasuries remain solidly in their 26-year bull market, and I suspect that we will soon enter the crazy phase when a bull runs far outside of fundamentals (in this case the solvency of the creditor).

P/E’s are Nil on Dow and Russell 2000

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Click image for sharper view. Source: Wall Street Journal Online

Earnings have gone negative. How’s that for value? Remember, most bear markets end with P/Es below 12, sometimes 7. Even the value play in the group, the S&P 500, will have to fall by more than half to get there, without any further contraction in earnings.

And what kind of fools see value in equity yields under 3%, when earnings have grown above trend for years? Stocks are all risk with no reward. You can get these yields on 1-5 year treasuries right now.

Pretty Chart of the Day: Gold in Various Currencies

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Thanks to Lance Lewis at Minyanville for this image:

Mr. Lewis is an inflationist and gold bull, and his sentiments here pretty much sum up the mainstream rationale of that species: “Gold’s bull market isn’t just a weak-dollar phenomenon. It’s a function of inflation, just as oil and other commodities.”

To which I reply, gold’s bear market isn’t just a strong-dollar phenomenon. It’s a function of deflation, just as oil and other commodities. This applies in all currencies, as the credit crunch is global, just like the bear markets in stocks and real estate.

Just an Ordinary Crash: No Conspiracy to Manipulate the Silver or Gold Markets

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Source: kitco.com

It amazes me how many of the same people who clearly saw the manifestation of the credit bubble in stocks and real estate are incapable of conceiving that the same cocktail of easy money and bull-market sentiment found its way into their own favorite markets. Many hold it as a matter of faith that the precious metals bull market will end in a manic top of 1980 proportions ($2500 gold, $150 silver in today’s dollars), and are therefore blinded to the possibility that we have had our top for now. Maybe we should be grateful for a pretty darn good run, with gains of 425% for silver and 300% for gold, topping out with a spike and 98% bullishness.

With deflation setting in, the foundations of this market are being shaken, and it is a different game now – - it’s not over, but the rules have changed. Those small-timers doubling down on physical right now could be in for a world of hurt in a few months or years and decide to bail at exactly the wrong time (according to the principal of maximum pain for the maximum number).

I get tired of seeing the rants of precious metals newsletter writers about the dark forces behind every downtick in the markets. I am extremely skeptical of the feasibility of any successful long-term market manipulation, whether it is in the stock, currency or futures markets. The dollar volumes of these markets are so large that even governmental bodies find it futile to try to influence price trends by strategic buying or selling.

If such forces were able to move a market in the desired direction, that would create a golden arbitrage opportunity for sharp-eyed speculators, inducing them to step in and buy or sell at the “artificial” price and thereby push the clearing price back to its proper level. To hold a market at an “artificial” level indefinitely would require infinite resources, which not even governmental bodies posess. And according to the natural laws of markets, if one venue (such as the COMEX) became so hopelessly encumbered, participants would figure out another way to contract with one another (such as Dubai).

But this is a moot point, because manipulation just doesn’t work. As Mish points out (click for his graphic), in 2003 and 2004, the Japanese tried overtly to suppress the Yen as it rose from the low 80s to almost 100 per dollar, with a massive series of interventions totaling over $300 billion. Their efforts failed, and the Yen later just fell as the psychology of traders changed according to their own whims, as in every market.

As to why there is a shortage of retail physical gold and silver right now, I have heard from a couple of dealers that it is not an uncommon phenomenon when there is a rapid drop in prices, as it brings out demand. I am in agreement with Mish that this demand by small-timers is likely a contrary indicator. Where were the hordes of new gold bugs when gold was under $300?

I am not usually in agreement with regulatory bodies, but it is good to see that at least one of them employs someone with a grasp of how markets work. The CFTC published an excellent letter to address the conspiracy crowd as far as silver is concerned. Here’s an excerpt.:

During the past 20 to 25 years, the Commodity Futures Trading Commission (CFTC or Commission) has received numerous letters, e-mails and phone calls from silver investors alleging that the price of silver futures on NYMEX has been manipulated downward.

In 2004, Dr. Michael Gorham, Director of the Division of Market Oversight (Division) addressed silver investors’ concerns in an open letter (2004 Silver Letter) that considered the plausibility of a long-term short-side manipulation of the silver futures market and provided an analysis of activity in the silver futures market. That letter concluded that the existence of a long-term manipulation was not plausible and that an analysis of activity in the silver futures market did not support the conclusion that the market was being manipulated.

Recently, silver commentators and a group of investors that rely upon them have reasserted their allegations that the silver futures market is being manipulated downward by a small group of traders on the short side of the market. As a result, DMO staff decided to revisit this issue by taking a fresh look at activity in the silver futures market.

The analysis draws the following conclusions:

• There is no evidence of manipulation in the silver futures market.
• Silver cash and futures prices have risen dramatically between 2005 and 2007, with silver outperforming the gold, platinum and palladium markets, suggesting that silver futures prices are not depressed relative to other metals prices.
• NYMEX silver futures prices tend to track closely the price of physical silver.
• Concentration levels for the top four short futures traders in the silver futures market are comparable to those observed in the gold and copper futures markets, and generally are lower than the levels seen in the platinum and palladium futures markets.
• The composition of the traders comprising the top four short futures traders, in terms of net positions, changes over time. These traders represent a diverse group, and their futures positions are driven by an even more diverse group of customers.
• There is no observable relationship between short-futures-trader concentration levels and silver prices.
• There is a slightly positive relationship between the total net position of the large short futures traders and silver prices; this suggests that larger short futures positions are associated with higher, not lower prices.

Advocates of the short-side manipulation argument contend that silver futures prices have been manipulated downward for close to 25 years. What these advocates fail to indicate, however, is where prices should be, except to argue that prices should be higher than they have been currently or in the recent past.

With respect to the claims of silver commentators that prices are being suppressed, it should be noted that these commentators have never articulated a credible explanation as to why, for more than 25 years, buyers have not entered the market to purchase silver (at the supposedly depressed prices), thereby driving up prices to a level that these commentators believe is reasonable. In this regard, no barrier to entry has been identified that would prevent individuals or firms from buying cash silver or entering into long silver futures positions.

Given the similarities between price movements in these four metals, it appears that general market forces that have contributed to an increase in gold, platinum and palladium prices have also supported an increase in the price of silver. Moreover, the fact that the price of silver outperformed the prices of the other metals during the period, while not definitively answering the question of whether silver prices have been manipulated, calls into question the contention that silver futures prices have been manipulated downward. In short, there is nothing obvious in the silver price series between 2005 and 2007, when compared to other metals’ prices, to suggest that silver prices have been manipulated downward.

Gold and silver bugs believe that central bankers and bureaucrats care as much about precious metals as they do. To government types, the metals are just barbarous relics of ancient monetary history, and I doubt they spend much time worrying about their prices.

Resolving a difference of opinion: Treasuries rally as stocks tank

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Mama said there’d be days like this (30-year Treasury yields in blue, S&P 500 in red):

Click for sharper image. Source: Yahoo! Finance

Today’s action showed much a higher standard deviation move for Treasuries than stocks, and it may be a sign of things to come, as there has been a very strong correlation of Treasury yields with stock prices (inverse correlation of bond and stock prices) for the past couple of years:

Click for sharper image. Source: Yahoo! Finance

Note the divergence for the last month or so. Bond traders haven’t been feeling the same relief as stock market participants since July’s mini-panic. I’ve heard it said that the bond market has a Wharton MBA and the stock market has a masters from a South Florida community college. My money says the stock market chokes and comes down with bond yields right through the July and March lows in a long series of moves like today’s.

Prudent Bear’s David Tice calls for 5 more years of bear market

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Bloomberg today has an interview of the Austrian-minded founder and manager of the Prudent Bear Funds.

Some take-aways:

  • Policy makers and central bankers are to blame for blowing this bubble.
  • “Institutions and foreigners no longer trust our structures, our insurance, our ratings, etc., therefore we’re in big trouble.”
  • “Over 18 months, this market will be down 50, 60, 70 percent.”
  • This market is like a slowly boiling frog that doesn’t feel the increasing heat.
  • The technology sector is the next big shoe to drop. Multiples are still high and demand will slow dramatically. US demand has slowed and now Asia and Europe are slowing.
  • A global slowdown is in the works, since the world is so dependent on US growth, but 3-5 years out, Asian growth should dominate.
  • Tice is still long precious metals, since the dollar should “decline dramatically” and other currencies should follow in competitive devaluation.
  • He doesn’t think gold has topped, though he did cut gold and mining positions dramatically from what he held past few years. He was surprised by the depth of the sell-off, but thinks this is a “decline that ought to be purchased.”
  • He closed out some home building shorts and some consumer discretionary shorts, though consumer spending should slow dramatically.
  • Commercial real estate is another shoe that is going to drop.

As an interesting aside, Tice just sold the Prudent Bear Fund and his Global Income fund to Federated Investors Inc. for $43 million plus up to $99.5 million in contingent payments over five years. Why sell now if he thinks we are just at the start of a huge bear market that should see great returns and increased interest in his funds? It may be a bit presumptuous of me to venture this guess, but as another ultra-bearish investor, I see his timing as very prudent.

BEARX is US-based and relies heavily on short-selling, so it is subject to the whims of a hostile congress regarding this supposedly nefarious activity. And Tice’s Prudent Global Income Fund faces the risk of exchange controls emerging in a dollar meltdown.

Also, Tice is presumably prudent enough in his personal affairs to realize that the window is snapping shut for serious asset protection in this environment, so he must have felt a great compulsion to get liquid while he could. Just as he would probably not recommend 95% of an investor’s assets in his funds, he was likely nervous going into a depression with so much of his own net worth in illiquid business equity.

At any rate, he and his investors will still benefit from his management of the funds for Federated.

The Jaws of Death

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Today’s word to the wise comes from John Hussman’s weekly market comment:

Years ago, Larry Williams used to look for a situation he called the “Jaws of Death” – noting that when bond prices were weakening but stock prices were strengthening, the two differing trends opened a set of “jaws” that tended to snap shut, usually due to abrupt weakness in stocks. On that note, Bill Hester sent a chart over the weekend noting “I thought this was an interesting graph. The blue line is the 5-Yr Swap Spread, and the red line is the VIX. Credit investors are getting very nervous while equity investors are mostly whistling Dixie. It looks like a variation on the jaws of death that you’ve mentioned to me before….” Nothing like a good picture to complete the story (thanks Bill).

As Hussman notes, a compressed VIX in the face of rising Treasuries and an overbought market that has still not acknowledged the recession signals choppy waters ahead.

At last, NYC rental and condo markets softening

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Hat tip to Dima for this article in AM New York.

For this first time in a long time, rents are either holding steady or falling in Manhattan, signifying a broader weakness in the city’s rental market, observers said.

What’s more, many landlords throughout the city are getting creative (if not desperate), agreeing to pay broker’s fees, or giving away the first month’s rent free; sometimes free parking, a gym membership or moving expenses are thrown in.

“Last year at this time, there was no such thing as concessions like these,” said David Calderazzo, a broker with Chelsea-based Luxx Realty.

I can attest to that statement. My rent went up 10% a year for the 3 years I rented in Manhattan. The last hike was this past January (they let me sign for just 2 months that last time). They would always offer the option of a 2-year lease to lock in only a 15% hike, but I always went for the one-year, at first to leave my options open, and later because I thought that rents couldn’t possibly continue up at that pace.

Calderazzo found an apartment for roommates Nick Parisi and Greg Wagner. They had their broker’s fee paid for when they moved into a converted two-bedroom in The Chesapeake, a luxury building on the Upper East Side. Their rent? $3,300 a month.

For some perspective, here’s what reviewers have to say about their building. $3,300 for a 2BR in Manhattan sounds like a bargain, but it is on the edge of the wilderness, up on 94th Street by the East River, a long walk from the Subway. We were paying $3400 for a 1BR in central Midtown, but even this area is not so inviting in the wee hours.

The young professional demographic in NYC is being hit hard, as banks and law firms trim the fat. These industries are still morbidly obese from the credit binge, so I expect a lot of former structured finance and M&A hotshots to head back to the nest or consolidate living space. This is not a crowd with big savings, since taxes eat half of salaries and rent takes half the rest. Then there’s often student debt, and most of what’s left goes to enjoying NYC.

Figures from Citi Habitats show apartment prices largely steady compared to last summer. The Real Estate Group of New York found signs of declines in most categories, with two-bedrooms in non-doorman buildings dropping 5 percent to $3,968.

The NYC market is where the nationwide market was in 2006. Prices are sticky, but volume is drying up fast. The Sun reports that condo sales are down sharply:

As we approach the end of summer, the sales volume of New York City condominiums is way down, and it is harder than at any time in recent history for purchasers to qualify for residential mortgages, most developers and brokers say. Still, many are hopeful that the situation is merely a case of the summer doldrums, and that activity will pick up again in the fourth quarter of 2008.

“The indicator which sticks out most for condominium sales for 2008 is that the total number of transactions are down 21% in Manhattan and 26% from 2007,” a broker at Prudential Douglas Elliman, Christopher De Weaver, said. “The number of days on the market has blown out from 117 to 135, so it’s taking almost a month longer to sell fewer apartments which are inventory. Nevertheless, prices continue to hold up. But having said that, we are still selling at sales volume of 2006 in terms of number of transactions.”

Volume is down so much over last year because 2007 was such a blowout year for NYC, as everyone was flush with their record bonuses from ’06 and rightly expected a near-repeat in ’07. Stocks made higher highs, and deal mania was strong through the first half.

“We are selling less, and working longer with a product that hasn’t yet adjusted downward in price, while having to navigate a mortgage landscape that changes weekly and daily.”

The CEO of Coldwell Banker Hunt Kennedy, David Michonski, said, “Sales are down about 32% and open business, meaning contracts signed, is down about 40%. This means the closed sales figures will get worse.”

This guy sounds like he knows what’s coming:

“Sellers of condos in this market are coming to realize that sales are slow, and they are looking at the fall selling season as a litmus test of how much discounting they will have to do in 2009,” the president of the Troutbrook Company, Marc Freud, said.

Another broker tries to be upbeat:

“The summer makes it an unfair comparison. Let’s see what happens in September, but my gut tells me that if there is not stability in the stock market, and we continue to see the types of swings and lack of traction, people will be hesitant to pull the trigger unless they really have to.”

This is the key change, from investment mania bidding to regular living expense decisions:

This is a large shift in buyer mentality from several years ago, when potential buyers moved quickly because they feared that units would sell quickly and prices may go up.

In NYC as everywhere, credit is the culprit:

No longer can a purchaser obtain financing with as little as 5% or 10%. The bar today requires at least a 20% or 30% down payment and higher credit scores.

This reminds me of the bit in Sex and the City (circa 1999, pre-bubble) where Carrie needs to buy her apartment but doesn’t have the 30k down payment. “30 grand? Who has 30 grand?” Turns out she had 40k worth of shoes in her closet. One broker just doesn’t get that this is a big deal:

“With regard to getting a mortgage, it now takes longer and requires more paperwork. Yes, a purchaser is required to put 25% to 35% of the purchase price down. So what? So we are back to the way we did business for 30 years. It’s only a shock to those too young to remember,” he said.

So what? Well, 30 years ago Jim Rogers bought a townhouse for $10 a square foot, that’s what. He got a great deal in what was then a lousy part of town, but even Park Avenue footage could be had for $50 (about $150-200 in 2008 dollars). The good stuff is $2000 today. And household savings rates were over 10% in the ’70s. Savings have been zero to negative of late, though just last quarter they rose to a whopping 2.6% (a sign of deflationary tight-fistedness).

“On the positive side, there are plenty of buyers out there,” Mr. Michonski said. “Every week our agents tell us they have many buyers. The issue is they are not buying, but hoping to buy, or thinking of buying, or intending to buy. In other words, they lack an urgency to act. When they get that urgency, there will be a flood of buyers, as they are waiting in the wings. They all want a bargain, so unless you can convince them that something is a bargain, they don’t bite.”

The only thing that will make them bite is lower prices. Potential buyers see which way the wind is blowing, and are waiting for prices to come down. Once they start falling, they’ll feel even more incentive to wait, especially with softening rents. That is a key part of how deflation works – - a slower velocity of money. People are in no hurry to spend.

“The other good news is that bottom fishers are out in force. They are everywhere. There is no lack of confidence to buy on their part. They are relishing the prospect of buying and searching everywhere for bargains. It is not a market without buyers, a very critical distinction. Rather, it is a market full of buyers who want a bargain and can wait and are waiting. Thus, they waste a lot of time for brokers because they want to see everything and then more of everything, and they put in low-ball offers that require endless negotiations.”

Silly broker. Next year he’s going to be begging those same buyers to come back with thier “low-ball offers.” Those offers are the market, and the market is not moving up. Also, the jobs situation is still not that bad, with Wall Street layoffs so far only in the low-mid single digits, as opposed to 17% in the dot-com bust.

Finally, no discussion of NYC real estate would be complete without mention of those supposed saviors, the foreign buyers:

“The foreign buyers believe in our market and want to have a pied-à-terre or an investment property here. We also have new nationalities buying here now: Russians, Indians, Chinese.”

Yes, that’s all well and good, but how will they like getting their irises scanned and logging their trip itineraries with DHS? Our politicians and press are doing all they can to antagonise those very Chinese and Russians, for whom it is no easy thing to get just a tourist visa. And sure, NYC will retain its gritty charm, but so does Buenos Aires, a hopping market for foreign buyers after prices crashed 75% in their financial crisis. Did foreigners save that city? Only if you consider it salvation to pay under 100k for the beautiful pre-war pads of formerly middle class Portenos made desperate by banking and currency failures.