US Economy
Taking into account that in the US the top 5% have all the money, while the bottom 95% seem to have all the debt we can, in my opinion, safely assume that now with doors closed for new credit lines and the 95% struggling to meet ends, the consumption will come down considerably. It is simply a fact that for the most part US consumers are in a hopeless position. Their debt obligations stretch as far as the eye can see. Their ability to honor these promises rest upon an economy that can only be sustained by even more debt. Their assets are pledged; their homes, their cars, everything. They have become slaves to the borrowers. Vast portions of their incomes are paid out in interest payments and debt reductions. Will they ever recover? Possibly not. There might be many who will loose everything.
Well that is the US. I once mentioned that there are still many people who believe that the US is a rich country. The above is just about consumers but the situation on a government level does not look much better.
Of course the same can be said for other economies as well. There are other countries with similar problems. Countries with positive savings (especially as well the broad public) will do better over the coming months. To invest in an economy a positive saving rate is needed. Using credit might give a boost for a certain time but has no success on a long term basis at least that is what history tells us.
Kondratieff Cycle
Below you find a relative short overview. I gathered the information basically from 2 excellent reports (one a 99 page report about gold http://www.gata.org/files/RedburnPartnersGoldReport_11-12-2007.pdf and the second report is a 31 page report from http://www.thelongwaveanalyst.ca/pdf/07_12_04_News.pdf) there is a lot of very good information in both reports. Therefore if you have time it’s worth reading it.
The Kondratieff Cycle is a long-wave cycle in the economic activity of the capitalist system focusing in particular on the price level (inflation) and debt. It is named after the Russian Nikolai Kondratieff, who published his findings in a 1922 paper. Visions of his cycle had already been observed by earlier economists.
Kondratieff analyzed 21 economic statistics for the major economics (US, Britain, France, Germany etc.) including price level, interest rates, wages, production, employment, imports and exports etc. In 15 of the 21 statistics he claimed to identify a long-wave cycle with an average length of 54 years. Kondratieff began his analysis in the late eighteenth century which he believed was the beginning of the “broad development of industrial capitalism”.
When Kondratieff completed his work in 1922, he had identified two full cycles and part of a third cycle which subsequently ended in 1948 when a fourth cycle began. Analysts disagree slightly on the exact timings but the following list reflects the consensus:
First cycle: 1789 to 1844 (55 years)
Second cycle: 1845 to 1896 (51 years)
Third cycle: 1897 to 1948 (51 years)
Fourth cycle: 1948 to today (59+ years)
Interesting is that he brought together the inter-relationship between the behavior of economics and financial markets with social and political issues (including wars, revolutions and innovation).
In general terms the Kondratieff cycle is essentially an economic cycle of boom and bust. There are a multitude of different cycles which are closely linked and responsive to the principal cycle. The principal cycles contained within the Kondratieff economic cycle are an investment cycle, an interest rate cycle, a credit/debt cycle, an inflation cycle and a crowd confidence cycle. Each full Kondratieff cycle last about 60 years, which is effectively one lifetime. During the Kondratieff cycle there are four seasons, because each Kondratieff season shares characteristics similar to the climatic seasons. The Kondratieff spring constitutes the birth of the economy (June 1949 to February 1966). The summer is when the economy bears fruits (February 1966 to August 1982). Autumn is the season of satisfaction (August 1982 to 2007?). During the Kondratieff winter the economy (partly) dies. In terms of time each of the Kondratieff seasons last approximately 15 years. Spring and Summer in the current cycle both covered about 16 years. \
So what are the characteristics of the four seasons:
Spring:
Confidence: Fear of return to depression – fragile confidence
Inflation: Begin inflation – gradually increasing
Credit: Slow increase in credit
Interest Rates: Rates start from very low levels, gradually increasing
Best investments: Stocks, real estate
Summer
Confidence: Growing confidence
Inflation: Inflation rate quickens to peak at end of summer
Credit: Increasing credit principally to corporations
Interest Rates: Pace of increase picks up, peaks at summer end
Best investments: Real estate, commodities, Precious metals
Autumn
Confidence: Increasing confidence – extreme confidence- euphoria
Inflation: Falling inflation throughout Autumn
Credit: Massive increase in credit, principally to consumers
Interest Rates: fall throughout autumn
Best investments: stocks, bonds, real estate
Winter
Confidence: concern, fear, panic, despair
Inflation: fall of inflation quickens to outright deflation
Credit: following credit crunch, virtually no credit
Interest Rates: rates fall, then rise in credit crunch, then fall lower
Best investments: Gold, Cash and Bonds (but after credit crunch)
From an investment side the seasons have the following characteristics.
Spring represents the birth or rebirth of the economy. Accordingly, it stands to reason that the best investment in this initial season of the cycle are those which benefit most from a developing economy; that is common stock an real estate
Summer has always been the inflationary season of the cycle, because there has been a war in each of the four K cycle summers, which always were financed by excessive monetary expansion. Real estate, commodities and precious metals are appropriate investments during the inflationary summer and real stuff like art, diamonds, antiques, coins etc.
Autumn is always the season during which there is massive speculation, particularly in stocks, bonds and real estate. Investment returns generated by these markets are a once in a lifetime experience.
This happens because monetary inflation does not stop once the summer war ends. In autumn, the availability of easy credit, based on falling interest rates and large infusions of the money supply to the banks, promotes speculation, principally in stocks and towards the end of the cycle, real estate. Rising equity prices attract more and more money for investment until, near the top, a feeding frenzy of mass speculation captures the imagination of the entire country.
In each of the four K cycles, the autumn period has always followed a significant summer-ending recession, which led to a speculative boom based on an inordinate excess of credit.
Winter which might be at our doorsteps will be a different story. Are you prepared for the possible winter? With all the excesses we witnessed lately the coming winter might be an ugly freezing one. Holding precious metals and land is certainly not such a bad idea.
Before going a bit more into detail regarding equity markets I’d like to give you some information from writings from Ludwig von Mises.
Quote
The causes of all panics crashes and depressions can be summed up in only four words: the misuse of credit. When credit is not covered by tangible assets it becomes fiat credit. The final years of the long wave plateau (autumn) are characterized, not only bey a reckless expansion of credit, but by the widespread delusion that there is no limit to the availability of such credit.
All these massive speculative markets, whether it is the four autumn Kondratieff markets, the South Sea Bubble, John Law’s Mississippi scheme or even the Tulip bulb mania, are utterly dependent upon an abundant supply of money. Most of this money takes the form of credit. The opposite side of which, of course, is debt.
Unquote
Never in the history of the world has there ever been a credit bubble of the recent magnitude. All made possible by a worldwide fiat monetary system, which has been grossly mismanaged by the exorbitant use of the printing press.
Now the chickens are coming home to roost. The credit bubble is rapidly losing air. It can not be re-inflated, much as the Fed will try. The sheer size of the bubble and the attendant speculative excesses makes the taks impossible. These speculative excesses include derivatives market valued at above USD 600 trillion, a US stock market valued in excess of USD 17 trillion, a housing market still more or less valued at USD 21 trillion (but rapidly depleting in value) a host of packaged debt instruments with little or no value.
Above from
http://www.thelongwaveanalyst.ca/pdf/07_12_04_News.pdf
Equity markets
The Saturday Evening Post:
“Oh, hush thee, my babe,
Granny’s bought some more shares
Daddy’s gone to play with the bulls and the bears
Mother’s buying on tips, and she simply can’t lose,
And baby shall have some expensive new shoes”
The Times
One of the most striking features of the present chapter in Stock Market history is the failure of the trading community to take serious alarm at portents which once threw Wall Street into a state of alarm bordering on demoralization. In particular, the recent disregard of the succession of smashed high records for brokers’ loans (margin) astonishes the older school of market operators. Undoubtedly the heavy margins required of traders by the commission houses have much to build up this assurance. Traders, who would formerly take the precaution of reducing their commitments just in case a reaction should set in, now feel confident that they can ride out any storm which may develop. But more particularly, the repeated demonstration which the market has given of its ability to “come back” with renewed strength after a sharp reaction has engendered a spirit of indifference to all the old time warnings. As to whether this attitude may not itself become a danger-signal, Wall Street is not agreed.
Readubg these two news pieces above, to me it sounds very familiar. Doesn’t it? Well let’s guess when the 2 pieces were written. Having mentioned the K-cycles before, I suppose you have guessed correctly. Yes it was written in 1929 just shortly before the crash.
Talking about 1929 one can say as well that contrary to popular opinion, stocks do not always discount the future, at least not at major bear market peaks and bottoms.
Fed
One more about 1929. Just like today, the Fed at that time attempted to save the day. Administered interest rates were cut dramatically down by Nov. 14th. And the banks were inundated with money. “If the Fed had an inflationist attitude during the boom, it was just as ready to try and cure the depression by inflating further. It stepped in immediately to expand credit and bolster shaky financial positions. In an act unprecedented in its history, the Fed moved in during the week of the crash – the final week of October – and in a brief period added almost USD 300 million to the reserves of the nation’s banks. During that week the Fed doubled its holdings of government securities, adding over USD 150 million to reserves, and it discounted about USD 200 million more for member banks. Instead of going through a healthy and rapid liquidation of unsound positions, the economy was feted to continually bolstered by government measures that could only prolong its diseased state. This enormous expansion was generated to prevent liquidation on the stock market and to permit NY city banks to take over the brokers’ loans that the “other” non-banks, lenders were liquidating. The great bulk of the increased reserves-all ‘controlled’ – were pumped into NY. As a result, the weekly reporting member banks expanded their deposits during the fateful last week in October by USD 1,8 billion (a monetary expansion 10 per cent in one week) of which USD 1,6 billion were increased deposits in NY City banks and only USD 0,2 billion were in banks outside NY. The Fed also promptly and sharply lowered its rediscount rate. Acceptance rates were also reduced considerably.
The above is copied from http://www.thelongwaveanalyst.ca/pdf/07_12_04_News.pdf
Well dear reader this sounds so, but so familiar it’s almost unbelievable.
Furthermore keep in mind that today we do not talk about millions but trillions. Outstanding derivatives are approximately USD 525 trillion. At least some 80% of it is related to some kind speculation only. Casino at its best.
To finish the examples from 1929:
The Wall Street crash in 1929 was followed by the implosion of the debt bubble and the subsequent banking crisis. The first stage of the crisis saw a panic out of collapsing securities, both stocks and bonds and into short-term financial assets like banks deposits, T-bills and even paper currency. Note that this is happening now
As the crisis deepened (between April 1931 - March 1933) and the bank failures multiplied there was a huge rush to own gold. “Foreigners cashed in not only their American stocks and bonds, and also their dollars and hauled American gold away by the boatload. Americans converted their paper dollars and bank deposits into gold coins and stashed them in mattresses hid them in basements or attics or took them on one way trips to Bermuda or the Bahamas.
Well dear reader, this time history might be different (this is what we hear all the time). It very well might be the case. However I do believe it is certainly helpful to know what happened in previous similar occasions and possibly it might not be such a bad idea to take some precautions.
A few weeks ago I was asked by somebody if I had already red Greenspans book. No I did not and will not do it in any case. Why? I do not see why I should pay something for a book that puts a guy, responsible to a very high degree of our today’s mess, almost up in heaven. The outcome of what we just start to feel will cost already truckloads, boatloads and helicopterloads of money. Knowing that, I decided not to read the book and thus I will avoid donate money (by buying the book) to the person that I feel is THE main responsible. Sounds harsh? Maybe it is.
Writing about books, there is one book I am actually reading. The book is called The Black Swan and the topic is the events one does not expect until it happens. A very interesting book indeed. I might mentioned a few remarks from the book from time to time. Today I'd like to mention the example about the Turkey.
Consider the turkey that is fed every day. Every single feeding will firm the bird's belief that it is a general rule of life being fed by a friendly member of the human race (it is quasi the bird's right) until one day shortly before Thanksgiving something unexpected happens. Well it would certainly incur in a revision of belief.
This example reminds me very much of the situation at today's markets. To me,in todays market environment, the turkey seems to be basically most of the equity investors (as equity markets always will go up), some of the investors invested heavily in those fancy hedge funds (as they did have more or less excellent results over the past years and, at least some believe, they are hedged which of course is nonsense) and finally all those having taken excess credits to buy real estate as an investment.
The theory of the Black Swan so far fits into my belief of contrarian investing. If everybody believes something to be true, I believe it is time to consider surprises. If everybody is already invested in something that is already overvalued it needs always a greater fool to buy more of the same in order to have prices rising.The point where the fools do not have anymore money to invest is a question of time, as simple as that (the greater fool theory).
Well anyway, as always, everything has bright sides and some that are not so bright. I do believe that the costs of what is at the doorsteps will be very high however if one is position correctly at least one will have a lot of opportunities as well. Important is not to be with the herd of lemmings.
As mentioned in previous posts, gold is not on the radar screen of most investors yet. My experience is that practically everybody is still scared with the experience of the 80ies and 90ies. Those that did not have these experiences simply do not know about this investment and therefore there is no interest at all. This is positive news for all of us who hold gold. When everybody talks about gold at cocktail parties or wherever people meet, it will be time to change into something else. We are still far away from that point.
Commodities
Please read essay on the following link
http://www.financialsense.com/fsu/editorials/delta/2007/1221.html
With all the infrastructure projects in construction or planned the demand for industrial metals should stay high, unless China, India or Russia would stop all their projects or reduce them considerably.
Talking about industrial metals, copper is certainly an interesting case. I do like the way the writer of the following essay sees the copper issue.
http://www.financialsense.com/fsu/editorials/ti/2007/1219.html
Deflation or Inflation/Hyperinflation
For more than 3 years I am reading essays discussing this topic. Of course as always there are several possibilities. Personally I do believe that we possibly will see hyperinflation as the Central Banks are willing and have shown it already, to create tons of new papers with green and black ink on it (in the case of the Dollar). Certain things will certainly fall in value (houses and so on). However with all the discussion I believe we should not forget to see the whole issue a bit in a different light. We should in my opinion no so much look at absolute prices but rather at what a unit of gold for example can buy. I am convinced that with one ounce of gold more goods can be purchased in the future than what can be bought today with one ounce. One of the best essays I have seen over the past years regarding deflation or inflation is Peter Schiff’s piece on the following weblink
http://www.financialsense.com/fsu/editorials/schiff/2007/1221.html
Credits
Well dear reader, as you certainly recall, I have insistently been advising that the problem is not over yet. In fact it feels like we only can see the very top of the iceberg. The means we can not even see the whole part of the iceberg that is above the water and much less what lays below the water.
Apart from the banks, communities, pension funds and so on, the companies to join the growing list of casualties, are the ones that so far did guarantee bond issues and in doing so helped the issuer to get a good rating and lower costs (lower interests). These companies will have to make huge write downs themselves and they will loose their good ratings soon. This will have a huge impact on all lower quality issuers who so far were able to get better conditions due to the guarantee of these companies. Without the good rating they will have higher costs and in a lot of cases might not even be able to place the bond issues anymore. Imagine all the municipal bonds that might be difficult to place in the future. From where will the municipals get their much needed money to replace/update old infrastructure (bridges, electricity grids etc.)
http://www.reuters.com/article/marketsNews/idUKN2016880920071220?rpc=44
http://www.nytimes.com/2007/12/21/business/21bond.html?ref=business
http://biz.yahoo.com/bizwk/071220/dec2007pi20071219212621.html?.v=1
Talking about the rating agencies; these guys were really willing to provide the fraudsters with what the needed. Now they are starting to feel the heat as well
http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=ajdL7eUHeUro
One more about the same topic. Just forgot is it credit or fraud or maybe both. Well the information which follows give indications that fraud was involved.
http://www.house.gov/apps/list/hearing/financialsvcs_dem/bass.pdf
Quote (taken from http://www.lemetropolecafe.com/)
This text has been "making the rounds". It was written by hedge fund manager J. Kyle Bass, who has been bearish housing & related derivatives since mid-2006, and evidently made a killing thereby. Did a bit of research on the author. Turns out he named his fund Hayman Advisors "for the private island off Australia where he spent his honeymoon", according to http://www.bloomberg.com/apps/news?pid=20601170&refer=special_report&sid=adp5UMQkZfwc
Also, he testified before the House of Representatives on this subject in more temperate language than the investor letter below
http://www.house.gov/apps/list/hearing/financialsvcs_dem/bass.pdf
From another member of lemetropolecafe
I recently spent some time with a senior executive in the structured product marketing group (Collateralized Debt Obligations, Collateralized Loan Obligations, Etc.) of one of the largest brokerage firms in the world. This individual proceeded to tell me how and why the Subprime Mezzanine CDO business existed. Subprime Mezzanine CDOs are 10-20X levered vehicles that contain only the BBB and BBB- tranches of Subprime debt. He told me that the "real money" (US insurance companies, pension funds, etc) accounts had stopped purchasing mezzanine tranches of US Subprime debt in late 2003 and that they needed a mechanism that could enable them to "mark up" these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!!!! He told me with a straight face
1) massive trade surpluses with the US in USD,
2) petrodollar recyclers.
These two pools of excess capital are US dollar denominated and have had a virtually insatiable demand for US dollar denominated debt…until now. They have had orders on the various desks of Wall St. to buy any US debt rated "AAA" by the rating agencies in the US. How do BBB and BBB-tranches become AAA? Through the alchemy of Mezzanine-CDOs.
With the help of the ratings agencies the Mezzanine CDO managers collect a series of BBB and BBB- tranches and repackage them with a cascading cash waterfall so that the top tiers are paid out first on all the tranches – thus allowing them to be rated AAA. Well, when you lever ONLY mezzanine tranches of Subprime RMBS 10-20X, POOF…you magically have 80% of the structure rated "AAA" by the ratings agencies, despite the underlying collateral being a collection of BBB
The Moral Hazard of HOT Potatoes
The key reason the Subprime problem exists as it does today has to do with the wanton disassociation of risk inherent in the machine that churns out Subprime loans. Unlike the S&L crisis of the 1980s, the mortgage lenders of today aren’t taking their own balance sheet risk when underwriting loans. These brokers get paid for quantity REGARDLESS of quality. The balance sheet risk is transferred through three entities in less than 90 days from origination. The originator will originate ANYTHING he can sell to a whole loan buyer to pass the hot potato on. Whole loan buyers are simply the aggregators of loans at the Wall St. firms that aggregate, package, tranche, and sell as quickly as
Buyers are now BEWARE
During and after the rout these investors are about to shoulder, how excited do you think they are going to be to purchase the next "AAA" rated piece of structured finance paper?!!?!?!? These same investors and global pools of liquidity have been funding the Leveraged Buyout (LBO) boom by purchasing the debt that funds the Collateralized Loan Obligations (CLOs) which in turn, buy 60%+ of the LBO debt used to finance these transactions. I also recently spent some time with one of the largest CLO issuers in the world. They had just returned from Japan where they were marketing a new CLO in order to be one of the buyers for new LBO debt. Needless to say, their marketing efforts fell on deaf ears. They were told by the Japanese investors that they have lost confidence in the ratings agencies (you think?) and that in an election
And this part is part of the letter to investors by the previous mentioned fund manager
Credit Markets and Where we are today in SubprimeLast week, I spent some time in the "Inland Empire" of California on a diligence trip to survey the actual damage. As many of you already know, 55% of all Subprime loans were made in California and Florida. The inland empire of California can be described as the central valley that extends from the southern part of the state all the way to the northern part of the state at least 1-hour inland from the coast. Let me start by saying it is MUCH WORSE than even I thought it could be. I met with various mortgage lenders, originators, economists, and capital markets professionals. The overriding theme that I got from them was that "Everyone committed fraud and everyone is responsible for the problem".
They told me that they believe that 90% of all Subprime loans that were made contained some kind of fraud. Either borrowers lied about their incomes or mortgage brokers fudged numbers on the applications to make them pass muster with the needed ratios in order to get loans approved. They also said that of the borrower frauds, 50% of applicants overstated their income by MORE THAN 50%!!! As Kindleberger put so well in his book, Manias, Panics, and Crashes:
The implosion of an asset price bubble always leads to the discovery of frauds and swindles. The supply of corruption increases in a pro-cyclical way much like the supply of credit. Soon after a recession appears likely the loans to firms that were fueling their growth with credit declines as the lenders become more cautious about the indebtedness of individual borrowers and their total credit exposure.
In the absence of more credit, the fraud sprouts from the woodwork like mushrooms in a soggy forest.
In California today, home prices are down between 25%-40% in the central valley. From San Bernadino to Stockton, home prices are in free-fall and their physical condition is actually worse than their price decline. The borrowers are locked out of the financing market and there is no logical buyer for these homes outside of the original borrower. The foreclosure wave will hit these neighborhoods like the Asian Tsunami. If you plug in 15% depreciation in housing prices and 50% loss severities into our Subprime model, the capital structure is wiped out all the way to the "AA" tranches.In the Subprime Credit Strategies Funds, we continue to hold our initial positions and have not taken any profits yet. In Hayman, we are short credit in the US (both Subprime RMBS and corporate credit) and long non-US equities and debt. We are short US consumer based equities, preferreds, and debt. I think the world is going to begin to decouple from the US and realize that currency appreciation coupled with the globe’s best growth is an attractive alternative to fraudulent ratings, US dollar depreciation, and financial inventions used to export risk.
Sincerely,J. Kyle BassManaging Partner
As mentioned the above is copied from the http://www.lemetropolecafe.com/ (a recommended newsletter which is not only for gold bugs)
Predictions for 2008
I found the essay on the following link with 10 predictions for 2008. On the first 8 predictions I can certainly agree (although I would have gone higher with my gold and oil price prediction). Anyway interesting indeed
http://www.safehaven.com/article-9112.htm
Peak Oil
It always takes some time until the integrated big oil companies understand that the oil bull will last for a considerable time and that therefore they should invest heavily in finding new reserves. Chevron seems to be the first big one to realize that huge investments are needed. They recently announced that they would spend USD 22,9 billion in 2008 alone. Well part of it is simply because everything costs more (Rig rates, steel prices, labor cost and so on). Just these increasing cost should be enough a fact to accept that we possibly never again will see really low oil prices. One of the easiest ways to increase reserves is to take over smaller companies. Any mid size oil&gas company is in my opinion a takeover candidate.
Oil prices. As you certainly remember I was mentioning that I expect a minor technical down correction in the oil price. My price target was in the low USD 80 level or maybe down to USD 75. We did see USD 87 but the price did not move down to the expected 80 mark. Short term it is difficult to foresee the exact prices. Yes we did see a minor correction but not to the expected level. Have we seen the correction or will we see USD 75 a barrell? I do not know. What I do know is that I do expect higher prices in 2008. It would not surprise me to see a price up to USD 150 per barrell. So maybe it is a good idea to take long positions whenever there are corrections
USD
As expected the USD got stronger over the past months. Does the movement keep on? Again, difficult to say. Long term I rather believe we will see a lower Dollar. Therefore the same investment tactic as with oil might be a wise one.
Gold
2007 closed with a gold price nicely above the USD 800 ounce mark, as expected. We now should move towards the USD 930 level, where one of the newsletter writers I read on a regular basis does expect a minor correction (up to 10%). However we should see much higher price in 2008. By the way did you realize that gold had again an outstanding performance in 2007? Well gold was at around USD 630 an ounce at the beginning of the year. Making the performance calculation there is one word that comes into my mind. Yes the word is WOW (again). Will we see further similar performances or will we see an acceleration of the increases? Who knows. I do expect to see a performance above the 20% mark for 2008 anyway. Well holding gold feels good, at least to me. In that sense I do very much like the text I found last year on a postcard in Switzerland
I wish you a truly successful start into the new year and lot of fun.
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