Peak Gold and more

Past week

The day after I posted my last musings, indicating that the precious metals prices just look fine, the PPT started to get into action on Monday and took the Gold and Silver price down while pushing the stock markets up (and this with rather bad news). Well as mentioned several times, the Presidents Working Group for Financial Markets aka PPT is in full motion and does whatever needed to keep the situation as much as possible under control. Treasury secretary “General” Paulson has his troops ready to fight when needed. The question is; for how long will they be able to keep the illusion that everything is OK afloat? Important as well would be to know how much it costs. I have no doubt that it is very expensive and that all this manoeuvre will end with much higher inflation. Once again, although stock market in real numbers might go up, due to inflation which is above the 10% the real, effective purchasing power of the stock holders is going down. So I think it is not really wise to get exited of new highs as long as the markets to not go up by more than the inflation on a year to year basis.


Credits

Nov. 12 (Bloomberg) -- Goldman Sachs Group Inc. held a bigger proportion of hard-to-value assets at the end of the third quarter than Citigroup Inc. and Merrill Lynch & Co., two of the firms hardest hit by subprime mortgage losses.
Goldman's Level 3 assets, for which market prices are so scarce that companies use internal models to gauge their value, accounted for 6.9 percent of the New York-based firm's $1.05 trillion total at the end of August, according to a filing with the U.S. Securities and Exchange Commission. Citigroup classified 5.7 percent of its assets as Level 3 on Sept. 30 and Merrill reported 2.5 percent.
Investors have grown wary of banks and brokerages with difficult-to-sell securities on their books, after profits at Citigroup and Merrill were crippled by at least $19 billion of writedowns, mostly from bonds backed by home loans to borrowers with poor credit histories. While Goldman officials say the firm won't report an ‘‘extraordinary'' drop in its subprime holdings, investors have remained skeptical, pushing its shares down 15 percent this month in New York Stock Exchange trading.
‘‘It's hard to believe Goldman is perfect,'' said Jon Fisher, who helps oversee $22 billion at Minneapolis-based Fifth Third Asset Management and sold his Goldman, Merrill and Morgan Stanley shares in the past 12 months. ‘‘Their losses might be smaller than others, but that doesn't mean they don't have a problem.’’
Goldman posted a 79 percent increase in third-quarter profit, the biggest on Wall Street, even after shaving $1.48 billion from the value of high-yield loans. Morgan Stanley, Lehman Brothers Holdings Inc. and Bear Stearns Cos. reported declines, and Merrill Lynch & Co. said $8.4 billion of writedowns led to a $2.2 billion loss, the biggest in the firm's history. All the companies are based in New York.
LBO Market
‘‘Just because they're in Level 3 doesn't mean we're not pricing them correctly,'' Goldman Chief Accounting Officer Sarah Smith said in a Nov. 9 interview. ‘‘We mark our positions to the point where we could exit at that moment.’’
The 33 percent increase in Level 3 assets in the third quarter was mostly due to the freeze in the leveraged buyout market, which left firms including Goldman stuck with loans, Smith said. Goldman wrote down the value of those commitments when the debt was moved to Level 3. As the buyout market recovers, the loans may be upgraded to Level 2, she said.

Goldman's Level 3 holdings totaled about $72 billion at the end of August. Stripping out stakes owned by others, Goldman's ‘‘exposure'' was $50.9 billion, or 4.9 percent of the firm's total assets. A ‘‘substantial percentage'' are private equity and real estate investments, said Goldman spokesman Lucas van Praag.
FAS 157
While those typically fall into the Level 3 category, assets such as leveraged loan commitments shift from one level to another depending on market conditions, Smith said.
‘‘We take issue with the notion that all assets in Level 3 are hard to value,'' said van Praag. ‘‘Given the disclosure rules, it is inevitable that any firm with a large private equity and real estate portfolio would have significant Level 3 assets.’’
All the firms have adopted a Financial Accounting Standards Board rule, known as FAS 157, which requires public companies to disclose a breakdown of their asset valuations.
Under the rule, Level 1 assets are those for which market prices are readily available. Level 2 holdings are valued based on ‘‘observable inputs,'' or prices of similar assets traded in the market. Assets fall into the Level 3 category when there aren't even any observable inputs, and the firm has to rely on in-house models to calculate potential gains or losses.
Prince, O'Neal
Morgan Stanley, whose Level 3 assets made up 7.4 percent of the firm's total at the end of the third quarter, said last week that it wrote down $3.7 billion in the first two months of the fourth quarter because of the declining subprime market.
Most of the writedowns were related to holdings of collateralized debt obligations based on subprime mortgage bonds. Goldman, like most firms, doesn't disclose the value of its CDOs, which are securities made up of other bonds and loans, including mortgages.
When Merrill announced its third-quarter writedown, the firm said its stake in CDOs fell by more than half to $15 billion. Citigroup reported last week that it had $43 billion of asset-backed CDOs. The company has said it may have to write down $11 billion on top of the $6 billion posted in the third quarter. All the firms are based in New York.
Shares of Citigroup and Merrill dropped more than 19 percent this month, and Citigroup Chief Executive Officer Charles O. ‘‘Chuck'' Prince and Stan O'Neal, his counterpart at Merrill, lost their jobs.
`Measurement Error'
‘‘The market does not exist for a lot of these things,'' said Edward Ketz, an associate professor of accounting at Pennsylvania State University in University Park, Pennsylvania.
‘‘Third level measures are fraught with lots of measurement error, in part because you are using assumptions.’’
Lehman, the biggest U.S. underwriter of mortgage bonds, categorized 5.3 percent of its assets as Level 3 and Bear Stearns, the second-largest, reported 4.2 percent.
‘‘Even Level 2 is hard to price,'' said Roger Lister, chief credit officer for financial institutions at Dominion Bond Rating Service. ‘‘Writedowns are coming out of Level 2 as well as 3. In the world of fixed income, prices have become less observable in the last few months. That's why Level 3 is surging.’’
A short explanation to Level 3 from http://www.dailyreckoning.com/
Quote
Level 1 is stuff you can readily sell on the open market – stocks, bonds, and so forth. Level 2 is made up of stuff you can’t sell quite so fast, but you still have models in place to tell you what it is worth. And level 3 is the stuff whose worth you don’t actually know; it is valued according to “unobservable” inputs, the press tells us
Unquote
The whole mess with these CDO papers shows clearly that traditional risk measurements/parameters are either not valid anymore or that one cannot believe the rating agencies anymore. You certainly remember that until a short time ago everybody was saying that the risk of a AAA paper to be downgraded to a CCC paper is extremely low and that such downgradings normally go by steps. Which means one would have time to go out before it falls to CCC and possibly within a short time below investment grade. Well this is not true anymore, at least for several CDO’s that until last week were rated AAA. Please see the information on following link. http://www.housingwire.com/2007/11/12/fitch-downgrades-372-billion-in-global-cdos/
Further interesting reading:
http://www.reuters.com/article/ousiv/idUSN0930692320071109?rpc=401&=undefined&sp=true



Housing

As mentioned in previous post, not only the US Housing market has been in a bubble but several other markets as well. The British market is apparently already in the correction phase as well. From the Daily Reckoning http://www.dailyreckoning.com/
Quote
The trouble with the financial world is that nothing stands still. We read in today’s paper that houses in the United Kingdom are down – for the second month in a row. During the housing bubble , British housing rose even more than in the United States; it probably has a lot further to go down.
Unquote
The US market is still in trouble, about 2 million American homeowners are set to lose their homes.
A friend of mine who knows the real estate business very well, mentioned to me that owners of real estate are not aware of the lower value of their property until it is in fact 40% below the price they believe it should be. That is the moment when they start to try to find out if they still can make their monthly interest payments and/or installments of their mortgage. If that is not possible anymore (what in many cases will be the case), this will be the moment when they start to see how they can sell the property. That means that most probably the price they might be able to sell will be way below 60% of the price a few months ago.
Cartoon of the week: http://www.time.com/time/cartoonsoftheweek/0,29489,1685047_1487641,00.html


Commercial Real Estate

According to a Financial Times article, Moody's index of commercial real estate prices is expected to reveal that prices leveled off or even fell in September, after rising 14% in the 12 months through August. In addition, the FT points out that RBS Greenwich Capital is predicting that US commercial property prices will fall 10%-15% next year. The article goes on to note that the upheaval in the credit markets is also raising the cost of commercial mortgage borrowing, as the spread on AAA-rated CMBS has more than doubled since June, reaching its highest level since Oct-98


Inflation

First of all the inflation must still be above the 10%. Furthermore if you are a holder of USD, please keep in mind that if the dollar goes down, it will take more dollars to buy things. This is certainly inflation and in that sense the real number as such does not matter at all. For the moment being, the only things that are not going down are the cost of living, all things you really need to live such as milk, meat, cereals and so on.


Money Market

Have you parked some cash in a Money Market Fund? If yes, please check the quality of the funds. Find out if they have investments in Asset backed short term papers. Keep in mind that these papers might bear the risk of losses. Please read the following links to see what could happen http://www.economicsbriefing.com/2007/11/wachovia-bails-out-money-market-fund.html
And
http://www.economicsbriefing.com/2007/11/another-money-market-fund-bailout-this.html


US economy

I do hear from time to time people saying that the USA is a rich country. I am not so convinced about that. That might have been the case until a few years ago, when the US still was the foremost creditor nation. The U.S. economy made a huge shift over the last 50 years – from savings to debt, from manufacturing to finance (or manufacturing of real “stuff” to manufacturing of some fancy financial constructions with little value if any at all), from making things to buying them. That means that what most people believe to be theirs in fact is owned by those who financed them to buy it. At some point the ones that financed them will try to take whatever they can back in order to cover their losses on credits. That means the situation only will gets worse because if the USA does not have a manufacturer sector anymore and therefore is not making things to sell it will be very difficult to get back on track. Yes so far most US citizens had a house, several cars, motorbikes, jet ski, flat screen TV, and so on. However in fact it was in some way only lend out to them because they bought it with money from others. Once these “others” want their money back it will be a rude awakening for a substantial amount of people.


Fixed Income

I do not see any reason why one should hold US Bonds. First of all the yields simply are too low, especially taking into account that the real inflation is above the 10%. Furthermore in my humble opinion, US Government bonds, Fannie Mae etc. are not worth a AAA rating. Theat means that in my opinion the "flight to safety" that some people think they do by buying Treasury bonds, is not really a flight to safety. Of course the US has the advantage that they can print as many of the green and black papers as they like but that means each of these papers in circulation will in fact be worth less. I on my side do not like to keep papers that get less value by the day. I truly believe that there are several so called emerging market countries that should have higher ratings than the US.



Central Banks

Open Bar policy. Liquids are on the house. Every financial institution that wants some liquidity can get it for basically free. For how long will the party go on? Too much liquids will have some negative effect sooner or later or maybe the next day. Well we certainly will see soon how strong the hangover will be.


Gold

Read the following article
http://www.gata.org/node/5725
The report/analysis on the below webpage is in my opinion a must read. Although the report is a lot to read, it gives an excellent overview on the real drivers regarding the gold fundamentals
http://www.gata.org/files/RedburnPartnersGoldReport_11-12-2007.pdf


Peak Gold

Yes the mining companies have more and more troubles to find and/or produce gold. South African production has been falling for some time. The South African miners have to dig deeper and deeper. That does mean that production cost in general terms are increasing. Junior companies need at least a gold price of USD 800 per oz. in order to earn money. The average cost for older mines is more or less in the 500 to 600 range if not above that already. That means that there is a natural floor for the Gold price. Once gold would fall below USD 600 some miners would not produce anymore. This is one of the reasons why I like gold as an investment. The downside risk is in my opinion limited while the upside potential is open. Of course there is the risk of a worldwide deflation (like the situation in 1929 in the US). If that is going to happen we might see a lower gold price. However I truly believe that gold will hold is purchasing power as it did in the past.
Please read the following article who is about Peak Gold: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/11/15/bcngold115.xml



Oil

It seemed that oil was on the way down to USD 75 or even USD 65 per barrel as expected. However the price holds well above the USD 90 barrel. Please take note that I believe that the correction I expect is only a technical correction and that we will see oil prices above the USD 100 next year. Personally I will buy Oil futures once we touch USD 75 (at least I hope we will see this price soon) and will increase my position at prices below USD 70. Demand and limited increase on the offer side are the real important factors in this bull market. I have been talking for years about peak oil and I mentioned several times that I believe that we passed Peak last year (2006). Of course we will only know if that was the case a few years down the road. However there are in my opinion more and more indication that my assumption might be correct. Interesting is that now more and more CEO’s of important oil companies are coming out of the wood and publicly accepting that we are at Peak or close to Peak. Please read the information on below links and keep in mind that those people just a few months ago were naysayers regarding Peak Oil
http://www.energybulletin.net/37000.html
and
http://www.ft.com/cms/s/0/3c8940ca-8d46-11dc-a398-0000779fd2ac.html?nclick_check=1


Private Equity Funds

Well if you have followed my postings you are already aware that at this point of time I do not like particularly the private equity funds (with the exceptions of well managed funds investing in important future topics such as water, energy (especially renewable) etc. If you read the report on below webpage you will understand why. These famous private equity funds certainly have used (as some hedge funds did) prices of their investments calculated either with the method mark to model or with other words mark to fantasy. Anyway although they certainly can mark or value their investments to their liking, some of them do have to bear already some losses. That certainly does not smell well.
http://news.independent.co.uk/business/news/article3155150.ece


Food

As mentioned before, I believe that food prices will go up considerably. A few months ago we had already strong protests in Mexico because the prices of the tortilla which is the basis food for the poor Mexicans, went up considerably. Now the Italians are on the street because the Pasta prices are going up strongly http://money.cnn.com/2007/11/14/news/international/pasta_prices.fortune/index.htm?postversion=2007111505
I hear from several places that it is hard to find milk to buy. Milk producing countries like Switzerland have in some regions apparently a milk shortage. Why? Well the Swiss farmers (who get possibly the highest subsidies worldwide) do export the milk, because the get higher prices in the international market. The trend of higher food prices will in my opinion go on for several years.


FOREX

The USD might have a rally sometime. However it seems clear that there are more and more people/entities that do not want to hold too many USD. Please read
http://www.gata.org/node/5740

Nov 11 (start of carnival in Europe)

Dear reader
Due to a long weekend and having been several days without access to internet or newspapers, I did not post last Sunday. I am still catching up with the information that came up during these days. Although I might have missed some important information pieces, I believe you will find some information that is of your interest in this weeks post.

FED
Well the fed cut rates a week ago. They did what the market expected. The cut in my opinion shows clearly that they are very much scared about the actual situation in the US. It is interesting to see that they use their munition although markets did hold well the days before the rate cut. Maybe they preferred to do what the market expected in order to avoid falling stock markets in the case they would not have cut the rate. These situation of course would have obliged them to cut a few days later and that would have had a negative psychological impact as they would have had to react and not act. Was the cut of “only” 25bps really enough? Markets seems to say NO. Of course the contradictory statements of several FED governors regarding rate cut or not (one says we will see more the other says not) does certainly not help neither to keep confidence up. Anyway the whole thing does not smell well. Will the FED cut further? Possibly yes. Possibly they will be forced to do so because they want to keep stock markets in positive territory and if they do not go on cutting rates equity markets most probably will head down south.
Some info about FED
http://globaleconomicanalysis.blogspot.com/2007/11/look-forward-to-more-frequent-fed-lies.html

http://www.abcnews.go.com/Politics/Vote2008/Story?id=3839318&page=1


Credits
Copy of a part of an information from a credit analyst from a Great Britain bank
Quote
Anyway, I am actually talking about the Feast and Famine generated by dodgy accounting 'rules'. If you have not yet gotten yourself up to speed on Level 3 make-believe accounting, I think it is imperative that you do so ASAP. The (reasons for the) demise of Enron are a good starting point. The thing I want to focus on is November 15th, and FASB 157. This new accounting 'rule' comes into life on the 15th. This new rule will mean that US banks/brokers will find it much tougher to use the Level 3 game to avoid marking to market 100s of billions of securities. FASB 157 is not the death of Level 3, and such FASB 'rules' tend to be more like 'strong recommendations', so some of the most shameless will still play the old game. But the heat is on, and it is - I think - inevitable that more players will have to reveal at least a decent portion of their current Level 3 assets (which are marked-to-make believe) to marks more in line with the message coming out of the ABX market.

This is a critical development, because so many players have used Level 3 in such large size. In terms of current level 3 assets to Equity, the likes of Citi (105%), Goldman (185%), MS (251%), Bear (154%) and Lehman (159%) have multiples of their total equity bases in Level 3 assets. It is not unreasonable to suggest that if ALL such Level 3 assets were marked to what ABX is telling us are observable levels, than some firms would see dramatic and extremely serious levels of capital destruction. Of course not everyone will mark everything to what is fair all at once. But the message is clear. Just from FASB 157, we could see $50bn to $100bn of addition losses across the industry. This is extremely serious. And this does not even take into account the further destruction in the housing market that I see over the next 12/18mths.

Ladies and Gents. Forget $50bn or $100bn. This credit crisis, when all is out, will see $250bn to $500bn of losses I think. And for all those who think its all priced in, Wake Up!! We are, at best, not only still in the first half of the game, I think we are still in the first 15mins of a 90 min game. And this game could go to extra time and penalties before we have resolution.
Unquote
In my previous post I informed as good as possible about the unfolding credit situation. The comment from the analyst is by far the strongest comment I came across so far. Personally I believe that the worst is not yet over. I truly hope that we will not get to the amounts mentioned above. However it is a possibility.

Housing
Foreclosure rates are increasing considerably. Some people buy at auctions and they believe that they got excellent prices. I am not so much convinced as they are. Personally I believe we will see much lower real estate prices in the US and possibly the UK, Spain and other countries with clear bubble characteristics. So far commercial real estate did hold well. However I believe we will see some troubles there as well relatively soon. My understanding is that consumers in the US are consuming less due to the fact that there is not more cash to withdraw from the mortgages and due to the fact that they are up to the limits with all their credit cards already. Sooner or later the reduction in consumption will have a negative impact on commercial real estate as well.
although the cartoon on below webpage should have been posted 1 1/2 weeks ago, I believe it is still worth to check
http://www.time.com/time/cartoonsoftheweek/0,29489,1677005_1474391,00.html

Social Security
One picture says it all
http://www.time.com/time/cartoonsoftheweek/0,29489,1680243_1479284,00.html

M3
According to John Williams at http://www.shadowstats.com/, the SGS-Ongoing M3 estimate of October annual growth tentatively is at 15.2%, the highest level since August 1971 (closing of the gold window), up from 14.7% in September and 13.9% in August. That means that the inflation will increase even more. As mentioned in previous mails, I do recommend to subscribe to the service of John Williams. Really excellent information.

Forex
"We will favor stronger currencies over weaker ones, and will readjust accordingly," Cheng Siwei, vice chairman of China's National People's Congress, told a conference in Beijing. The dollar is "losing its status as the world currency," Xu Jian, a central bank vice director, said at the same meeting.
http://www.bloomberg.com/apps/news?pid=20601080&sid=aOiMD2UBRYd8
As mentioned in previous posts, a technical correction is possible. I believe that Central Banks will try to keep the USD decline under control and thus will at some point intervene in the markets. Such an intervention might lead to a 10 to 15% correction over a few months. However for the time being I certainly do not see much long term potential for the USD. Anyway the USD is soon history. I suppose you saw already in the news the official announcement of the 3 head of states of the US, Canada and Mexico, informing us that it is decided to create the AMERO which will become the common currency of the 3 countries. I am not so sure if that is really to the benefit of the Canadians.

Gold
Please have a look at below chart. This chart shows clearly what I explained in a precious post in the sense that Gold clearly outperformed the stocks (S&P500) since 2001



Gold is doing fine just as expected. I believe we will soon see a price above the resistance at approximately USD 850 oz. and that we will see a price of Gold at USD 940 oz. soon. There might be a technical correction down to the area of USD 770 oz. from the 940 level. However if one looks at the statistic of OI (open interest) in the future market with a record high of 555286 futures it could very well be that we might see a short squeeze which could move prices up to above USD 1,000 oz. In the past high OI numbers were rather a sign that a down correction is on the way as the PPT or Gold cartel clearly was trying to bring Gold prices down. However this time it seems that strong hands want to get hold of physical Gold. Whenever prices recede a bit strong demand in the physical market shows up with the effect that prices go back up immediately. In order to keep the gold price under control the Gold cartel needs sooner or later physical Gold. According to GATA the Central Banks are running out of physical gold to support the price suppression scheme of the Gold Cartel using futures to manage prices. Please check the following link for more information on that.
http://www.gata.org/node/5275
Anyway, we definitely have an interesting time ahead of us.
For Gold versus FIAT money system please read article on below link
http://www.atimes.com/atimes/Global_Economy/IK09Dj01.html

Silver
Silver finally broke out of a trading channel. Silver really looks fine at this point. Silver is on the move up, although with huge fluctuations. I believe we will see soon a silver price of above USD 18 oz. and it will not be a surprise to me to see the price of Silver to move above the USD 20 mark until April 2008 at the latest.


Palladium
Palladium seems to be an interesting investment at actual levels. I fully agree with Sol Palha, who believes that Palladium could do very well. Please read his essay
http://www.financialsense.com/fsu/editorials/ti/2007/1106.html

Commodities
I have no doubt at all that we will have a bull market for at least another 15 years unless we enter in a worldwide situation like in 1929 in the US. Of course there will be some corrections on the way. Actually Coal, Uranium and Natural Gas look fine.

Oil
Please see my previous post

China stock market
From Enrico Orlandini on Friday June 9
Quote
With the big 4.85% decline last night, this index has clearly broken down and that is not a good sign. It is now 17 days of the high, we have a lower high and we broke decisively below the 59-dma. The RSI, MACD and histogram have all turned down but are nowhere near oversold. In short there is still a lot of room to the downside.
Unquote
Well China was one of the top performers this year. A correction certainly is possible. We will see.

Equity markets
Equity markets look shaky. The PPT is working overtime. How long will they be able to keep the markets up? Stop loss orders might be a good idea to limit a down side risk, especially if you have already some nice profits on your equity holdings.

Canadian Oil & Gas Income Trusts
On the oil and gas production side, ARC ENERGY TRUST, ENERPLUS RESOURCES, PENN WEST ENERGY TRUST, PEYTO ENERGY TRUST, PROVIDENT ENERGY TRUST and VERMILION ENERGY TRUST which together comprise the best of the trust group also posted very solid results. All of them, however, actually weakened during the week on recession concerns.
This group has had a great 12 months since last November, when the Canadian finance minister announced trusts would be taxed as corporations beginning in 2011. A lot of that has been due to the 20 percent jump in the Canadian dollar versus the US dollar.
But it’s also becoming clear that trusts backed by good businesses are in great shape to keep paying big distributions well beyond 2011, no matter how they’re taxed. And on a book value basis, they’re among the cheapest investments in the world.
Above comment found on: http://www.financialsense.com/editorials/rconrad/2007/1110.html

Hedge Funds
Hedge Funds are definitely still not my favorite investment vehicles. The performances of most hedge funds (those that survived so far) have been so so at best. I simply do not see why one should be invested in hedge funds if a top conservative investment like Gold gives better returns for the moment being. There might be some commodity hedge funds that are worth holding. However I have seen commodity hedge funds with lousy performances. A hedge fund that in general terms is long commodities would be fine. Looking at fundamentals, and believing that the bull market will go on, I do not like to be on the short side for the moment being. Of course there are from time to time opportunities to short with a limited amount. For example a small short position on oil might be doing fine over the next weeks. However to me it seems not such a good idea and I certainly do not feel well, being on the short side in a bull market.

To end today’s post, I recommend to read the essays as per below links.
http://www.financialsense.com/fsu/editorials/andros/2007/1110.html

http://www.321gold.com/editorials/russell/russell110707.html