Investment cataclysm?

The Mogambo Guru points out that the Standard & Poor's 500 Index stands at $940, but the earnings last week were $7.21, a price-earnings ratio of 130.

Historically, the p/e ratio of the S&P 500 has averaged less than 20 - whether you measure from 1881, 1900, 1945 or 1970.

If the earnings don't improve dramatically and soon, the implication is a super-crash. But even if earnings triple from last week's level, that would merely put us back to where we were in December 1999, when the S&P's p/e ratio stood at its highest-ever (up to then) level: 44.2. And as you know, the market went on to halve in value by 2003.

So the S&P earnings have to become three times better than they are now, just to match the pre-Millennium crash conditions.

The dominant feeling I have now is a diffuse sense of denial.

Recession - not even halfway there

Karl Denninger "does the math" and reckons that as Americans retrench, the economy will contract far more yet - at least 20% in total.

So anyone who has real money wants out: "The Chinese, Saudis and others with actual money that we are attempting to borrow to kick that can once again have figured out our scam and they are headed for the exits."

Coming soon: austerity, a devalued currency and high interest rates. And in the UK, it'll be worse.

A good time to save money, while you're still able to; and to bet against the crippled Anglo-American horses. No point piling up savings in our rotten fiat cash.

The Mogambo Guru continues to chirrup his commodities song.

Dow 4,000 yet again

The Mogambo Guru is off on one of his comedy riffs again, and reiterating his devotion to gold, but here's a statistic he quotes midway:

“the price-to-earnings ratio for the Dow Jones Industrial Index is now a hefty 43.1! It should be, historically, less than 20!”

Do the math, as they say. In fact, I'll do it for you now: take the Dow at close the night before Mogambo ranted (8,469.11) and multiply by 20/43.1. Result: 3,929.98.

I gues the question is, is the current low level of company earnings a temporary matter caused by recent dislocations, or is it set to continue as the economic climate darkens?

Plus, as we all know, the market can stay irrational longer than you can stay solvent. But I still think that, adjusted for what now seems inevitable high inflation, we're going to see Dow 4,000 sometime, as I graphed back in December:

The gold bugs are chittering - but don't get over-excited

Jeff Clark at Casey Research (htp: The Mogambo Guru) plays with the numbers to estimate gold's potential.

One stat is created from a comparison of all the world's cash with all the world's gold: "Total central banks reserves (including gold holdings) = $4.8 trillion, divided by 929.6 million ounces total gold reserves held by all official institutions that issue currency = $5,246 gold price." Or about £3,500 per ounce.

HOWEVER: the World Gold Council estimates that all the gold ever mined to the end of 2006 is about 158,000 tonnes, or 5,079.7 million ounces. If we round down to 5 billion ounces (to allow for some permanent loss, but offset to some extent by new mining - esp. in China - since 2006) we get a gold price of $960 per ounce - not far off where we are today. Allow a bit of cash held outside banks, and gold would be worth - what? $1,000? $1,200?

Yes, there may be a spike like in 1980 - and there may not be. But speculation/panic aside, it would seem that, globally, the current gold-to-money ratio is not quite so wrong as might seem at first sight. So the story is not really about gold, but about the weakness of the dollar in a heavily unbalanced US economy. Priced in a different, stronger currency, gold may not zoom to the moon.

Inflation bubbling up

Richard Daughty, aka The Mogambo Guru, comments on the sharp rise in raw materials prices.

Further to my recent post on whether gold is overpriced, it's worth pointing out that gold can remain for long periods above trend. Those who mock new buyers of gold may have overlooked this.

UPDATE

Marc Faber: "If I look at government debt in the US, and debt in general, I think the only way they will not default physically on their debt is to inflate." (htp: Michael Panzner)

Restoration, not revolt

"What is a cynic? A man who knows the price of everything and the value of nothing," says Lord Darlington in Wilde's Lady Windermere's Fan. That perfectly describes the man who doesn't understand inflation.

Inflation is The Mogambo Guru's bete noire, and he gives us another comedy riff on that today. His principal cure for it is gold, the stock in trade of another ranter, Jim Willie, who sees the price of the yellow metal breaking out in various currencies (it's soared in sterling, for example).

Both men habitually connect gold, the US Constitution and the decayed professional morals of the politico-judicial elite, and try to stimulate the people to restore the old, good order. In short, they are prophets, and there's plenty more out there at this time.

For it is a sign of societal stress that ranters, dreamers and revolutionaries begin to drag out their soap boxes and declaim to passers-by. We had it in the Old Testament, the English Civil War, the American Revolutionary War and most other times that the world was turned upside down.

If buttercups buzzed after the bee
If boats were on land, churches on sea
If ponies rode men and grass ate the cows
And cats should be chased to holes by the mouse
If the mammas sold their babies to the gypsies for half a crown
Summer were spring and the t’other way round
Then all the world would be upside down

There is a difference between civil war, and the revolt of colonies from their distant parent. Having said that, the crisis is now cracking the cement between the States and the Federal Government, as we see in New Hampshire and elsewhere. America, remember history and avoid secessionary talk.

The results of revolution are rarely pretty. Norman Cohn's famous book , about the horrifying aftermath of prophet episodes in the Middle Ages, shows that once the mix is brought to the boil, it becomes very volatile. The outcome is often not what the prophet expected; and always, the people suffer. Rather than overthrow our rulers, it would be far better (if possible) to make them see the danger to us all of continuing their course, and have them turn back.

But can they see it? Do they know the difference between price and value? Will they permit the theft of real wealth by inflation? Or is it, worse still, their intention?

The best we can hope for, is that our leaders are not cynics, and so do not need correction from dangerous idealists.

Taxation is inflationary, not deflationary

I've often wondered whether that's the case - now the Mogambo Guru says so. If taxes cut our take-home income, we insist on more income to make up for it.

The sixfold path to Chinese hegemony

The Mogambo Guru does a (tragi-) comedy riff on a Chinese piece he's read. Here's a list of tunes that the Chinese author is calling the piper to play:

1. The US should cancel the limits on high-tech exports to China, and allow China to acquire advanced technology and high-tech companies from the US

2. The US needs to open its financial system to Chinese financial institutions, allowing all Chinese financial firms to open branches and develop business in the US

3. The US should not prevent Europe from canceling the ban against selling weapons to China

4. The US should stop selling military weapons to Taiwan

5. The US should loosen its limits on numbers of Chinese tourists and allow them to travel freely to the US

6. The US should never restrain China’s exports to the US and force RMB appreciation in the name of domestic protectionism and employment pressure

Given the relationship between government and journalism in China, I half-suspect that the article may have had input, shall we say, from official sources. Looking at the implications of these demands, we may begin to tremble.

Below, I put in graph from the statistics quoted in that article. To my layman's mind, it's clear that bailouts transferring debt from other piles to the national pile, are a waste of time: it's debt cancellation that's needed.

Inflation-adjusted Dow

( htp: The Mogambo Guru)

As I said in my recent letter to the Spectator, "a return to 6,000 points should be unsurprising, and a low of 4,000 not impossible."

Breaking radio silence

How much debt does the USA have, compared to its income? According to Ned Davis Research, the previous all-time high was in the Depression of the 30s (265%); NDR's latest estimate is 350%, The Mogambo Guru reports.

So, inflation or deflation? The Mogambo Guru rants that only inflation (which he hates) can save us now. But in the first link above, Louis P. Stanasolovich comments:

High debt levels also have another side effect: disinflation. Because consumers and businesses have limited spending, they must retrench once they reach their saturation points. When the demand for goods and services diminishes due to the over-extension of credit, the result is disinflation.

In other words, we will have to live poorer - no matter what the currency does. We see in Zimbabwe that you can have billions and it won't buy you a square meal. What inflation can do, is disguise the problems for a while (as it did post-2000) - until the system breaks down completely. Who has the public spirit and grit to stop the charade now?

By the way (since The Mogambo Guru loves gold)... Krugerrand = going out to get more champagne.

Gold fever may return

Gold has been in the doldrums for a while, but we're now getting messages about inflation and if Fannie Mae and Freddie Mac are added to the liabilities of the US Government, we could be back in the paper-money world of pre-Revolutionary France as advised by the Scottish gambler, John Law.

The Mogambo Guru gives value, not just in comic entertainment, but also in his useful references. One of them is to Adrian Ash, who points out that gold is now worth less than 2% of world financial assets, whereas at times of "investor stress" (and as late as 1982) it has risen to 20-25%. It may be time to consider the argument for precious metals, not so much as investments as insurance against the severe loss of value of other assets.

Worrying signs

Knowing that debt creates extra money and so boosts inflation, The Mogambo Guru notes that the Chinese now have 1.58 billion credit cards! For some reason, TMG thinks we should look at gold and silver.

Karl Denninger points out that short-selling actually acts as a kind of price support in the market, since ultimately the short seller has to buy the shares he's sold to someone else; and so the new ban on short-selling selected financials has removed the floor beneath them. Jim in San Marcos found he couldn't do any short-selling in that sector for three hours yesterday, and doesn't know whether that means we're looking at free-fall or a sudden rally. Either way, it seems to prove the point that banning short-selling increases volatility, the sensible investor's enemy and the gambler's fatal siren.

If two views make a market, does silencing one leave the other free to become a whimsical dictator?

What oil hike?

The Mogambo Guru (too long absent from these pages) points out that a major factor in the increase in the price of oil, is simply the decline in the dollar. We here in the UK don't see it, because the pound is staring the dollar in the eye as both go screaming parachuteless towards the ground.

At least Richard Daughty is one who will not go gentle into that good night.

Now, isn't this what happened in the Seventies? Only we were conned into thinking it was down to wicked Arabs, when really the story was increased monetary inflation for some years pre-1974.

We have tracked the beast to his lair

Many an honourable man is underrated. Richard Daughty (aka The Mogambo Guru) takes this opportunity to show that the banks created the problems that some of them are now called upon to solve. It's like that film (Blowback) where the arsonist villain turns out to be a firefighter. Doubtless no-one will suffer condign punishment for using inflation to steal from gullible savers.

Desperate hope

"Desperate hope" is an oxymoron, which sounds like a dumb bull: mine is that we will have a tough landing rather than a complete crash. Goading the dumb bulls is The Mogambo Guru (Richard Daughty), who delivers another comical end-of-the-world sermon on inflation. He thinks dropping interest rates will encourage borrowers to take on still more debt.

However, many have already pointed out that (a) lending criteria are tightening and (b) not all of the interest rate cut is being passed on to the borrower. So lenders are trying to reduce their exposure and are also being paid more for the risk they have already assumed. And we see from this Christmas shopping season that (c) the consumer is becoming more reluctant to spend.

That's not to say that we won't get inflation (in some sectors, not housing), since falling interest rates tend to depreciate the currencies of debtor countries relative to their cash-rich trading partners. On the other hand, the latter will continue trying to hold down their currencies, in an attempt to keep the show on the road - the show being the osmosis of wealth from the lazy, spendthrift West to the hard-working, hard-saving developing world.

We're going to be buying less, but I don't know how fast the Eastern co-prosperity sphere will take up the slack. In his book "The Dollar Crisis", Richard Duncan argues for a worldwide minimum wage to stimulate demand; but maybe events have overtaken him. Certainly, China aims to expand its middle class, rapidly.

But there's another way for China to stave off depression while waiting for the sun to rise in the East. According to James Kynge, manufacturing and transportation costs account for only about 15% of the end-price of Chinese exports to the US. Some of the expanding Chinese middle class will surely go into advertising, marketing, sales, distribution and finance. As China develops its own version of Wal-Mart, Omnicom and banking, credit card and financing operations, it'll own more of the total profit in the supply chain - some of which it can sacrifice to retain market share. And they're motivated to do so by the fact that domestic consumption yields very little profit for their companies: the money's in exports. The longer this game goes on, the more the decline of capital and skilled labour at our end.

So let's worry about the effects at home first. Yes, for investors inflation may be a worry, but perhaps they should extend their concern to include the stability of the society in which they live, as unemployment and insolvency stalk through the West. The issues are no longer financial, but political and social.

And we'd better hope that we don't go for the wrong solutions. Daughty quotes Ambrose Evans-Pritchard's 12 December article in The Daily Telegraph, which concludes (amazingly), "... it may now take a strong draught of socialism to save the Western democracies." I do not think Mr Evans-Pritchard is very old. Or maybe he's just saying that to bug the squares, an expression I'll wager he's too young to remember.

Unreal

Richard Daughty (the Mogambo Guru) refers to articles by Nouriel Roubini and Sharon Kayser, giving us debt -threat vistas of $1 trillion and $1,000 trillion respectively. Then he returns to Terry Pratchett's Discworld dwarves' favourite song ("Gold, gold, gold, gold...").

Two problems: one is, I can't visualise anything with many zeroes, so it's not real for me. More importantly, if there's a major meteor-strike financial bust (i.e. deflation), I'd have thought cash in hand is what everyone will want.

Unless a crazed government opts for hyperinflation. In which case, I'd rather have pallets of canned baked beans, boxes of ammunition and many brave, loyal friends. You can't eat gold.

But as with all truly terrible imaginings, the mind bounces off this like a tennis ball from a granite boulder, and we turn back to normal life with determined optimism.

Devil take the hindmost

(Picture source)

The Mogambo Guru vents his muscular spleen on inflation-capping for pensions in Britain. Quite right. The old are spending the kids' inheritance royally. There's so much talk of the selfishness of the young, but the oldies really knock the lights out in that competition.

Out and in

Another quote, this time from Ludwig von Mises (via the Daily Reckoning Australia):

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Like any sane person, my preference is the first option.

I have no idea how much longer this expansion will continue, but we've asked to take our modest holdings today. Maybe we'll miss out on a further commodity boom in the next few weeks, though it seems that when the market gets skittish gold runs with the herd for a while. We plan to come back in soon enough, on a regular premium basis; but unless Monday sees a significant drop, we've done all right over the last couple of years. Thank you, Mogambo Guru and others.

Money and crime

The Mogambo Guru (Richard Daughty) posts a long one on The Daily Reckoning, including the text of his speech at the recent Agora Financial "Rim of Fire" conference in Vancouver. He writes and speaks like a Ranter from the English Civil War, or a Cassandra who has already dug her secret emergency escape tunnel out the back of Troy, away from the Greek lines.

But underneath the Vincent Price-like, self-parodying Gothic melodrama, I feel he's right. The answer to the question in my previous post is yes, because as money continues to be produced, of course everything will go up in nominal terms, for a time. The turning point will come when people realise that their money is going to be worth noticeably less every month, and trust in the currency will be in danger of collapse.

I also think he's right in saying that this systematic abuse suits the powerful, and their lesser friends and servants. Much of human misery is the result of people's unwillingness to do genuine work, so oarsmen will be replaced by coxes until the crew is entirely composed of steersmen and the boat stops. You do not have to be a member of the National Rifle Association to think that ever-increasing government is a problem.

Where I disagree, is the bit about looking forward to being a complacent gold bug while your neighbours suffer. Not for moral reasons, but from the practical point of view that in such a situation, your life and property would not be safe.

I remember that in the early nineties, when recession was chewing on us in the UK, one hard-working and decent small-businessman client was starting to talk, only half-jokingly, about turning to crime, just to survive. Until then, it had never occurred to me that some "stand-up guys" could be driven that way; I'd always assumed that criminals were simply a type. But I could tell he was getting serious - many a true word is spoken in jest. Fortunately for him and the rest of society, the economy improved, his house increased in value, and he sold up and emigrated to the Far East. I hope it's working out okay for him.

Back here, and in the US, I'd like to see economic reform now, not social breakdown later.

Have I got my sums wrong - or right?

Bill Bonner, in The Daily Reckoning Australia yesterday, quotes Paul van Eeden as saying that gold has kept pace almost perfectly with inflation since the 1920s.

My post of 29 July did some figures with US gold stocks, the price of gold and the money supply, and came to an arresting conclusion. A kilo of gold costs x dollars, yet at that price, all US gold could be bought for 1/66th of all US dollars. There'd be a huge pile of spare paper money left over, completely unrelated to gold.

From one point of view, the current gold price is not surprising, if gold is merely one tiny part of the overall economy governed by the dollar system. Yet the ratio in the previous paragraph - 1:66, which is the same as 1.5 cents to 1 dollar - is almost exactly what The Mogambo Guru (Richard Daughty) said is the difference in purchasing power between one modern dollar and one 1913 dollar. According to him, the modern dollar is worth two 1913 cents.

Perhaps Doug Casey is right: if trust in the dollar collapses, gold could be "going to the moon".