What is long-term investment?

Jeff Prestridge, in today's UK "Mail on Sunday" finance section, reports that the Personal Assets trust, controlling £188 million, has changed its weighting from 60% cash earlier this year to 100% cash now. He's sniffy about their performance over the last 5 years, contrasting them with the likes of Baillie Gifford.

Well, I'm not a respected Fleet Street money journalist, merely a no-account bearish personal financial adviser, but I'd suggest that in the exciting investment world of today, maybe a five-year period is not a good basis for comparing long-term results, or conditioning expectations for the future.

I had a client ask my opinion about investments a couple of years ago, because his bank had been showing him their fund's marvellous growth over a three-year period. I took time to explain to my client that over the five years to date (then), the graph (as for the FTSE 100) described a kind of bowl shape, and the period chosen by his bank just happened to draw a line from the bottom of the bowl to the lip.

I then showed him the five-year line in all its loveliness:

I think it's fair to say that these are not ordinary times. There has been a steady build-up of electrical charge, so to speak, over something like a decade (some would say, much longer), and there may well be some powerful bolts unleashed as a result. Where will the lightning will strike next: a steeple, an oak tree, a cap badge - who can tell?

Massive debt; changes in the balance of international trade; demographic weakening of future public finances; sneaky currency devaluation; wild financial speculation; wars and the rumours of wars; imprecisely known ecological limits to growth; declining energy resources; the desperation of the world's poor to join our fantastic lifestyle; our fear that we may lose the comfortable living we used to imagine was our birthright; the corruption, abuse and neglect of the young; the selfishness of their parents and the middle-aged; the increasing burden and growing neglect and abuse of the old.

In all this turmoil, making five-year investment performance comparisons has an air of unreality, like planning tomorrow's menu on a mortally-wounded ocean liner.

Lead, kindly light

A glimmer of hope: Citibank's new boss has opted to put liabilities back onto the balance sheet, much to Karl Denninger's satisfaction.

Perhaps, after the next election, a new US President, with the strength of a fresh mandate, will be also able to act so decisively.

Denninger: depression, but when?

Karl Denninger offers two options for the US financial regulators. The first is to get banks to put all their potential liabilities on their balance sheets - financial suicide for some.

The other is to keep the door closed until the smell is too bad, and then we have far worse problems - but it could take years. End result: deflationary depression.

Collectivized security leads to riskier behaviour

A most interesting piece by John Mauldin (Safe Haven, 8 December), relating mathematical and scientific discoveries in other fields, to the economic system.

Research into piles of sand grains showed that the timing of sudden collapses is quite unpredictable, but there is an inverse correlation between their magnitude and likelihood. As the sand piles up, "threads" of instability form, that can be triggered by the fall of a single grain in the wrong place. This is akin to the "Butterfly Effect" in catastrophe theory, I suppose.

Mauldin connects this up with a paper published last year, about uncertainty created by humans in the development of their economic structures:

...the greater the number of connections within any given economic network, the greater the system is at risk.

This underscore the concerns I hinted at in an earlier post. The potential for catastrophic change is building up, and we can't predict what will be the trigger. Therefore, all the connections we are forming with each other need to be balanced by provisions for disconnecting, or for insulating one region from changes occurring in another.

To use an analogy, the supertankers that take oil around the world's oceans are internally divided into compartments. It would be cheaper, and so more profitable, not to install the internal compartments. But without them, a large wave hitting the ship could cause a movement in the liquid cargo that would shift the balance and quite possibly sink the vessel altogether.

So there is a trade-off between efficiency and survival.

Another aspect is how human behaviour changes in relation to risk perception. For example, research shows that when road junctions are widened and vision-obscuring vegetation cleared, drivers compensate for the extra security by going faster and less carefully. I understand that each of us has his/her our own preset level of risk tolerance, and when circumstances change, will seek to bring things back to that level .

But what if you don't fully understand the new circumstances? A miscalculation as to the level of security inherent in the situation could lead to your behaving more dangerously than you realise. The complexity and obscurity of CDOs, derivatives and credit default swaps are examples in the world of finance and economics, but surely this applies to other fields, too.

Perhaps conservative instincts are not just laziness, stupidity and timidity, but survival instincts. Have you noticed how those maddeningly slow drivers don't have dents in their old, lovingly-polished cars?

Maybe I'll get a hat, for driving.

The Fed may trigger off a run on Treasury bonds, says Wallenwein

Alex Wallenwein thinks the Fed will curb its impulse to drop interest rates as much as people want, because of its fear of inflation. He expects it will backfire when people figure this out.

Wallenwein suspects that the Fed has been buying longer-term US Treasury bonds to sustain demand and so keep interest rates low, but he thinks that once others scent the Fed's fear, there will be a massive dump that will throw more on the market than the Fed can mop up. This, he thinks, will send longer-term interest rates soaring.

His conclusion is that gold will perform its usual function of a safe haven in times of uncertainty.

As I pointed out this summer, the UK has (fairly recently) become the third-largest holder of US Treasury bonds.

A run on non-banks

The Great Depression of 2006: Cash Only

Jim in San Marcos explains that it's probably not the banks we need to worry about, but the financial entitities that are NOT covered by Federal deposit insurance.

And Karl Denninger also details other areas threatened by financial contraction.

Little boxes

In India, where many people cannot read, you sign for the State pension by thumbprint. This seemed like a secure system, until a man was caught with a tobacco-tin full of thumbs.

It would have made no difference had it been a tin of cloned credit cards. You don't need to know what's in the box, or how it works; you need to know what it does, and who it's for.

Once you start thinking along these lines, things get so much clearer. For example, you don't have to be a "quant" like Richard Bookstaber, to know that derivatives are about risk. More precisely, they're for increasing risk.

Supposedly, a derivative reduces risk; but if you look at its use, it's a box that tells lenders and gamblers how far they can go. Seeing the fortunes that can be made in high finance, there is the strongest temptation to push the boundary.

My old primary school had a lovely little garden behind it, where we played at morning break. One game was "What's the time, Mister Wolf?". You went up to the "wolf" and asked him the time; he'd say nine o' clock; to the next child he'd say ten o'clock and so on, until he'd suddenly shout "Dinner time!" and chase you. Obviously, the game was not about telling the time.

So it is with financial risk models that service the need to maximise profits: always another trembling step forward. There's only one way to find out when you've gone too far.

But what if you could ask the time, and know that someone else would end up being chased? I think that explains the subprime packages currently causing so much trouble.

The bit I don't understand is why banks started buying garbage like this from each other. Maybe it's a case of the left hand not knowing what the right hand is doing, since these organisations are so big. Or maybe it's that everyone has their own personal box.

Then there's credit default swaps, and other attempts to herd together for collective security. They don't work if the reduction in fear leads to an increase in risk-taking. United we fall: no point in tying your dinghy to the Titanic's anchor-chain.

In fact, I think this opens up a much wider field of discussion, about efficiency versus survivability. In business, economics and politics we might eventually find ourselves talking about dispersion, diversity and disconnection.

Liberty update

Bernard Nothaus is retaliating and preparing for his court case.



As Chumbawumba sang:

I get knocked down
But I get up again
You're never going to keep me down
We'll be singing
When we're winning
We'll be singing

... good luck.

Better to be rich and mis?

Elmer, a Filipino living in Hong Kong, comments on insurance group AXA's "Life Outlook Index". He wonders whether being happy and optimistic holds back economic progress in the Philippines. For, of eight Asian countries surveyed, the Singaporeans had most insurance and were the most miserable.

So I'd ask whether economic progress is more important than being happy and optimistic. Read "Insurance - The White Man's Burden" and decide.

UPDATE

...and a nice little thread in Market Ticker's forums section, on rat-race dropouts who've taken to the beaches in Hawaii

The Dow is a shape-changer

A brilliantly clear and succinct essay by Nadeem Walayat for Financial Sense, showing that the Dow tends to rise long-term simply by adding winners and dropping losers. Not only that, it's vulnerable to manipulation for official "feelgood factor" purposes. And the 30 stocks are not equally weighted, so a few stars can carry a load of duds with them.

An argument for betting on the index, if you're not an attentive stock-watcher.

This, I suggest, is one to bookmark, or print and put in in your wallet.

A moment of sanity

At times of crisis, unlicensed preachers and wild-eyed prophets roam the streets, gathering their crowds. But their rule never lasts.

My grandfather used to say, things are never as good as you hope or as bad as you fear. As I reported some while ago, members of the Chicago Stock Exchange in 1934 papered their club room with what they thought were now worthless stock certificates, but within five years were steaming them off the walls again.

The Thirties crash hit debtors, unwary investors (especially those trading with borrowed money) and insolvent banks. The lessons from this are easy to learn.

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.

The Fed and King Canute

Michael Panzner directs us to John Hussman, who explains that the Federal Reserve's power to manage the financial system is very limited - the funds it provides are dwarfed by the amount out in the economy.

... the problem with the U.S. financial system ... is not liquidity, but the solvency of mortgage loans and securitized debt. The Fed's actions are not likely to have material impact on this.

This, plus Larry Lindsey's comments noted in my previous post, adds weight to Karl Denninger's continuing theme of inevitable deflation.

Larry Lindsey: extraordinary rendition

Ed Steer (Financial Sense) relates his October experience of an unusually frank speech, and answers to questions, by President Bush's former economic adviser. According to Steer (I paraphrase), Lindsey's views include:

- The Fed knew home loans were getting dumb, but didn't want to spoil the party
- Banks are going to have to revalue their property holdings realistically
- Hedge funds will have to take what comes, and probably will
- America has offloaded zillions in toxic-waste loan packages to other countries, and ha, ha !
- House prices will plummet
- Don't trust the government CPI figures
- Gold dumping is coming from European central banks, not the US
- America could handle a 20-30% dollar devaluation

... loads of beef in that burger, where's the fluffy bun?

The end of usury

In the inflation/deflation debate, Karl Denninger comes down firmly - and to me, persuasively - on the latter side.

He points out - as do others, including proponents of Islamic sharia banking - that however much money is created through credit, more must be created to cover the interest charged. Usury endlessly blows up the balloon, which must eventually pop, before the cycle begins again.

Lenders do want their money back, and so generally take security for the loans they grant. At some point - and Denninger believes it's now very close - lenders will become unwilling to lend further, and/or borrowers will retrench or become unable to service their debts. In short, borrowers will have to pay up or be ruined, together with the more reckless lenders.

Can the government print extra money to solve this? Not according to Denninger, who says that the effect of bad money will be to drive out private lenders (who would demand very high interest rates for lending in an inflationary environment). Since the government itself runs partly on borrowed money, it's not an option.

Like me, Denninger thought the bust came in 2000, but the refusal to face reality means that we now face a much bigger bust.

Conclusion: cash will be king; get out of debt now.

Ted Spread

Large Ted spread = bear market?

Michael Panzner shows a couple of ominous graphs:

One is the "TED spread" - the difference between interest rates charged by banks to each other, and short-term (and safe) Treasury bonds. A wider margin indicates that the market is charging more because it considers lending to be more risky, and the current TED spread is approaching 1987 levels.

The other shows the ratio of amount loaned out, to amounts of cash on deposit. Lenders are now very stretched.

The Angriest Guy In Economics

Supposedly "the angriest guy in economics" is Richard Daughty, aka The Mogambo Guru - but he gives his rants a comedy twist.

Karl Denninger, on the other hand, is very emphatic that our economic woes are no laughing matter. Here he calls for all the "off-book" items to be included in lenders' accounts, and if that bankrupts them, so be it: a cleansing of the financial system, condign punishment for the perpetrators and a warning to others. This is similar to Marc Faber's position: he says the crisis should be allowed to "burn through and take out some of the players". Gritty.

And concrete. Denninger supplies a photo of a customer-empty store at 6 p.m. on a Sunday evening, to underscore his point.

Now that's something we can put to the test - look at the shops in your area and work out how crowded you'd normally expect them to be at the beginning of December.

Something Golden This Way Comes

Stock traders' bonuses are calculated on the basis of profits made up to... NOW. And perhaps not entirely by coincidence, the Dow has clambered back up to 13,300 and the FTSE above 6,400.

So the books close, the champagne flows and the rest of us can start doing our own accounts. Where are the customers' yachts?, as the naive investor asked.

Karl Denninger looks at E*Trade's difficulties and reckons the 70% mark-down of their home equity lending portfolio implies a loss of $1.5 trillion on HELOCs (home equity line of credit) alone. The bad news hasn't all come out yet.

Perhaps we entering the period of "dawning realisation".

"Give me Liberty or give me debt"

Bernard von Nothaus, issuer of the "Liberty Dollar" is sounding feisty. Such people are most inconvenient for the smooth running of public affairs; it's awkward cusses like him who were the grassroots of the American Revolution (though of course, the Founding Fathers faced a far more grisly legal retribution if they failed).

There is a serious point: is America prepared to refresh its commitment to the principles of the Constitution, which Ron Paul champions; or is it "the old order changeth, yielding place to new"? In which case, when was that decided, and by whom, and with what right?

It's a burning issue for us in the UK, too: here, a thousand years of organic (and often bloody) constitutional development is to be hurriedly reshaped by lawyers and bureaucrats working for the Executive, in the name of vaguely-phrased hurray-words ("justice, rights and democracy" - the last is particularly ironic, since I don't remember voting for this ramshackle assault). Has it become the people's representatives v. the people? Perhaps our "new" Labour government has ignore its Methodist roots and relaxed the laws on drinking, gambling and sexual activity so that we will be distracted from taking an interest in more serious matters.

On a lighter note, it's fun to see that, legal currency or not, such Liberty Dollars as are still out of FBI custody are currently a good investment. Maybe better than the Fed's IOUs, if you believe the bullion-hoarders.

Jacob Shallus might have thought so. The $30 he earned for engrossing the Constitution was the equivalent of 5 weeks' worth of a Philadelphia printer's wages in 1786. What does $30 get you today?

The long-term price of gold

I referred yesterday to an article by Tony Allison, which reproduced a graph of the long-term inflation-adjusted price of gold. Here is the original article from InflationData.com.

It looks to me as if the median price of gold (in 2007 dollars) runs at around $450/oz., but I'd be glad to hear from anyone who can give a better estimate.

And the Contrarian Investor's Journal argues why, even in deflationary times, gold may still be a good choice.

I beg to differ

I seem to recall it was some Supreme Court decision, where one judge said he dissented from the view of his colleagues "for the reasons which they have given". Elegant.

Tony Allison, in Financial Sense yesterday, gives the above graph and reads it as an indication that we could be heading for a gold price spike like that in 1980; whereas I look at the inflation-adjusted trend since 1914 and think that, unless my timing in and out of that market is superbly prescient, I'm better off doing what I do now, which is trying to pay down debts and save cash.

Yes, when I've done the latter, I might well make precious metals and commodities part of my portfolio.

"Legal tender for all debts, public and private"

Karl Denninger is emphatic that there's going to be a deflation, not inflation, and investing in metals won't save us.

Part of his argument is that the money supply is determined not just by how much there is in the economy, but also by how fast it changes hands (its "velocity"). If the heartbeat of economic activity slows, the monetary pressure will reduce.

Denninger shares the growing concern that subprime losses could be of the order of $1 trillion, and believes

... we are literally weeks or a handful of months away from an utter implosion in the equity markets.

I believe we are very, very close to the precipice - and that nothing Bernanke or Paulson can do now will change the outcome. The opportunity to address this and stop it expired a few years ago, with the cumulative damage growing the longer regulators fail to act.

In which case, it's time to hold cash, which on American notes says is good "for all debts".

This reminds me of another quotation I can't source: "Would that I could be so certain of anything as he is of everything." I suspect he may be right on this one; then again, I would, since I've been feeling it in my bones for about a decade, before the official policy became to inflate our way out of all troubles.

Drinking in Last Chance Saloon

The Orient Saloon at Bisbee, Arizona

Michael Panzner alerts us to an article by Martin Hutchinson in Prudent Bear, which explains how the rotten apples in the banking barrel can affect the others. Here's a grim tidbit or two:

... If as now appears likely the eventual losses in the home mortgage market do not total only $100 billion, but a figure much closer to $1 trillion, then the subprime debacle becomes something much more than a localized meltdown...

Hutchinson suggests that in a bear market, "Level 3" assets may actually be worth as little as 10% of the banks' own declared estimates, and:

This immediately demonstrates the problem. Goldman Sachs, generally regarded as insulated from the subprime mortgage problem, has $72 billion of Level 3 assets; its capital is only $36 billion. If anything like 90% of the Level 3 assets’ value has to be written off, Goldman Sachs is insolvent. [...] Only the bonuses will survive, paid in cash and draining liquidity from the struggling company.

I observed a couple of weeks ago that "the Dow and the FTSE rise towards the end of the year, when traders' annual bonuses are calculated" and guessed that "the Dow will rise until bonus time". Watch for a rally of sorts and a final, determined suckout of bonuses, ahead of a forced, sober reassessment.

The top card's getting a mite dusty

Dimitri Speck (in Financial Sense) looks at the behaviour of gold when the stockmarket falls, and tends to the conclusion to which we've referred before: the gold price is rigged in order to allay fears when equities weaken. In short, it's a crooked card game.

That in itself is grounds for worry (nothing to hide, nothing to fear); and the desired result must be achieved by dumping bullion, which can't continue indefinitely. On this thesis, the crisis signal will be when gold stops dancing with the Dow.

Michael Panzner on Michael Panzner

Michael Panzner quotes USA Today quoting him, and I'll quote Michael too, since the advice seems sensible...

Predicting tough times ahead, Michael Panzner, author of Financial Armageddon, recommends that investors buy shares of companies that sell stuff that people need to buy no matter what's going on with the economy. Companies that sell soft drinks, tobacco, prescription drugs and toilet paper, for example.

Investors, he says, should play it safe, loading up on defensive stocks, socking away more cash and moving toward the safety of U.S. Treasury notes and bonds.

From copper nickel to gold dollar?

A lovely, cheeky idea from Antal E. Fekete in SafeHaven: have the Indian reservations switch from running casinos to minting gold coins, to rescue the integrity of the currency. Maybe PC considerations would inhibit a Liberty-Dollar-type Federal raid.

Interesting also that he echoes my "twang money" idea:

Thanksgiving 2007 is special because we are just re-learning the ancient lesson that no banking system can safely operate without gold. You cannot measure the quality and quantity of debt in terms of another, just as you cannot measure the length of an elastic band in terms of another.

Long or short crisis? Inflation or deflation?

Terry Gilliam's take on the old tale

An interesting post from Michael Panzner, commenting on the views of derivatives expert Satyajit Das. The latter thinks we're in for a 70s-style inflationary grind, whereas Mr Panzner leans towards a 30s-style deflation.

I am reminded of Borges' short story, "Pierre Menard, Author of the Quixote". In this, a modern author attempts to re-produce the 16th century novel "Don Quixote" by Cervantes: not copying - writing it again exactly, but as though for the first time ever. Since Menard is writing in a different period of history, the same words have quite different meanings, implications and associations. To pen the identical lines today, spontaneously, would involve a monstrous effort. So Borges' tale is a wonderful parable about the near-impossibility of our truly understanding the mindset of the past, and how history can never be quite repeated, because the present includes a knowledge of the past that it takes for its model.

For those reasons, we'll never have the Thirties again, or the Seventies; but we might have a retro revival. And the differences may be as significant as the similarities.

Ken Kesey's bus (named "Furthur"), and part of the commercialised modern follow-up

Why the sea is salt, and why we are drowning in cash

We are said to be heading for a recession, so I had another look at Bank of England statistics for M4 - money supply as measured by private lending by financial institutions.

Since June 1963, there has NEVER been a quarterly period when M4 contracted. In fact, here are the only times in the last 44 years when UK quarterly monetary inflation ran at less than 5% p.a. equivalent:

As you see, mostly it was the nineties, with one instance in 1975 and three times in the sixties. The average rate for the whole series up to December 2006 is 13.47%. So the hand-mill never stops grinding.

But should it? Wikipedia gives an account of recession and the Great American Depression, and notes that during the latter period the money supply contracted by a third. Great for money-holders, bad for the economy and jobs.

This page points out that we tend (wrongly) to think of a period of economic slowdown as a recession, and says that technically, recession is defined as two successive quarters of negative economic growth. By that measure, we haven't had a recession in the UK (unlike Germany) for about 15 years - here's a graph of the last few years (source):

And then there's the stockmarket. It doesn't seem to reflect the real state of the economy - until you shift the lines, when for example the S&P 500 turns out to be a fair predictor of changes in GDP, as shown in a graph in a 2005 entry from this blog ("Capital Chronicle", by RJH Adams):

The same post also provides a brilliant graph of a measure of fair value for investors, known as Tobin's Q. Look at the wonderful opportunities presented by two world wars and the economic shock (blamed on oil prices, but maybe the causality is the wrong way round) of the 70s:

Mind you, looking at Wikipedia's Tobin's Q graph, the median market valuation since 1900 seems to be something like only 70% of the worth of a company's assets. Can that be right? Or should we take the short-sighted view of some accountants and sell off everything that might show a quick profit?

Nevertheless, it still feels to me (yes, "finance with feeling", I'm afraid) as though the markets are over-high, even after taking account of the effects of monetary inflation on the price of shares. And debt has mounted up so far that a cutback by consumers could be what finally makes the economy turn down. Not just American consumers: here is a Daily Telegraph article from August 24th, stating that for the first time, personal borrowing in the UK has exceeded GDP.

The big question, asked so often now, is whether determined grinding-out of money and credit can stave off a vicious contraction like that of the Great Depression. Many commentators point out that although interest rates are declining again, the actual interest charged to the public is not falling - lenders are using the difference to cover what they perceive as increased risk. Maybe further interest rate cuts will be used in the same way and keep the lenders willing to finance the status quo.

Some might say that this perpetuates the financial irresponsibility of governments and consumers, but sometimes it's better to defer the "proper sorting-out" demanded by economic purists and zealots. History suggests it: in the 16th century, if Elizabeth I had listened to one party or another in Parliament, we'd have thrown in our lot with either France or Spain - and been drawn into a major war with the other. We sidestepped the worst effects of the Thirty Years' War, and even benefited from an influx of skilled workers fleeing the chaos on the Continent. If only we could have prevented the clash of authoritarians and rebellious Puritans for long enough, maybe we'd have avoided the Civil War, too.

So perhaps we shouldn't be quite so unyielding in our criticisms of central bankers who try to fudge their - and our - way out of total disaster.

Investing for beginners

A useful - and free! - essay by Adam Hamilton in SafeHaven, called simply Stock Trading 101.

Hussman's view: white water

John Hussman is an American fund manager and takes pains to show that his judgments are carefully weighed; so his warnings are unlikely to be Chicken Little squawks:

In July, he looked at historical "awful times to invest", and found that July 2007 fits the same criteria. The 10-year outlook for the US investor is not attractive:

Presently, the probable total return on the S&P 500 over the coming decade ranges between -4% and 5% annually, with the most likely outcome in the low single digits.

More recently (November 12), he's considered many indicators and concluded:

I expect that a U.S. economic recession is immediately ahead.

(highlights mine)

This week (November 19), he remarks that much of the money apparently being pumped into the economic system is simply a rollover of earlier loans coming to maturity: the net increase is very small compared to the total oustanding, and so the rate of monetary inflation is slowing. He quotes Jan Hatzius of Goldman Sachs as saying (in effect) that if souring subprime debt hits financial institutions directly, they are likely to call in loans in order to preserve the ratio between their lending and their reserves, which in turn will slow the economy further.

What should investors do? He quotes the view of famous investment manager Jack Bogle:

"I would say do nothing – ride it out, if your asset allocation is right. The bonds in your portfolio and the long-term growth of businesses will bail you out. Unfortunately 80% of the market is speculators now, not investors. What would I say to the speculator? I would say I'm nervous and I might even say get out.”

So I guess it's the usual couple of points: are you in for the long term, or trying to make a quick killing? And where are you on the 25:75 Benjamin Graham bond-equity balance?

Gambling with more than you've got

The world's economy is now like a huge gambling table, and the players collectively are betting several times the value of their assets.

FT Alphaville (thanks to Michael Panzner for the alert) gives the above graphs to show how much is at stake in the business of mutual guarantees known as "over the counter" (OTC) derivatives: over $500 trillion. That's not all: Wikipedia's article (last link shown) explains that there is also a separate class of Exchange-Traded derivatives.

These sums are quite unimaginable. But we can compare them with other figures: according to FT.com, the total value of the US and European stockmarkets in March this year was a mere $31 trillion. Wikipedia estimates that the total value of all stocks and bonds in the world is less than $100 trillion.

Our daily lives stand on a thin crust over this boiling financial melange. We'd sure better hope that the experts haven't bitten off more than they can chew.

(Picture source)

US debt - projected

The US Government's own (2006) long-range forecast shows an expected sixfold growth in Federal debt held by the public, expressed as a percentage of GDP, by 2075. The table above is in a section frankly entitled "An unsustainable path" (pp. 208-209).

Three card monte

(picture source)

Frank Barbera points out that Argentina's economy put itself back on track by devaluing the currency. Now,

... the place is booming, crime is way down, and foreign capital has flooded in...

All you had to do was ensure that you weren't the mark in that game:

... someone who was able to place money in precious metals avoided the collapse of the local currency, would now have that previous purchasing power intact, and could have used it in the last few years to buy back many fold depreciated assets in Argentina.

Baby boom, baby bust

Percentages of the population above age 65 in selected countries

Clif Droke (SafeHaven, yesterday) summarises Edward Cheung's work, which relates the Kondratieff cycle to demographics. The most spoiled generation in history is entering its retirement phase and starting to draw on its accumulated wealth, so creating a growing undertow in the financial tide.

Liberty Dollar video wall

Can freedom be designed?

In the late 1970s, I read a book by Stafford Beer called "Designing Freedom". Unlike other management theory texts I've seen, it used cartoons and humour, though it also occasionally used language seemingly designed to cut out the layman - one gets the impression that business professors can be a sort of Glass Bead Game hermetic elite.

And I've just been trying to watch a lecture by him, recorded on video in 1974 and released on the internet by UMIST's archive (here). Maybe it's my computer, but the material is streaming in stits and farts; nevertheless, it's very interesting indeed.

Beer was invited to Chile to set up a system for the Allende government, to help manage the economy of a strangely-shaped and very diverse country. The project was never completed, since Allende was overthrown within a couple of years, but the ideas outlined in this video and the book I've mentioned were very far ahead of their time and probably somewhat ahead of ours, too.

At a time when computers were much less powerful than today, he was advocating their use to gather and crucially, filter, information in a way that allows decision-makers to make timely, well-informed (but crucially again, not over-informed) interventions. In the Chilean experiment, a system of telex machines across the country fed real-time data to a central (the only) computer, which then fed back decision-making alerts at every level from factory to government ministry.

Two things stand out for me:

1. You don't need all the information: you need to know of any significant change. (I have heard that toads only see likely prey if it moves, not when it is sitting still.)

2. You need relevant data fast, otherwise there is a danger that, owing to information time-lag, you will make exactly the wrong move. Beer said that this was a principal cause of the stop-go British economy. In today's context, maybe that's why the economy and the stockmarkets gyrate so wildly even now.

Beer emphatically denies that his system was intended to centralise power into a dictatorship, though in "Designing Freedom" he certainly sees its potential for tyranny. Instead, the model is a set of feedback systems akin to those that living creatures need to survive and to adapt to a changing environment.

Another point I've always remembered - and I think I must have seen it in another of his books, for I can't find it here - it that both resources and decision-making must be devolved, for maximum effectiveness. You give Department X a budget and a set of objectives, and let that department work out how best to use the resources to fulfil its brief. This is a lesson that the current micro-managing British regime has apparently never understood.

He was a real visionary - look at the contrasting pair of cartoons from the book, and remember that it was published 33 years ago. And buy it, as I have just done.

(By the way, my comments are not unduly influenced by the fact that he gave up most of his material possessions and moved to western Wales, devoting himself to art and poetry.)

Assume crash positions

Paul Lamont (SafeHaven yesterday) gives sound tips on how to prepare for a serious financial crisis.

One of the points he makes is that in the USA, the Securities Investor Protection Corporation may have no more than $3.4 billion available to protect depositors' losses, compared with anything up to half a trillion potential losses in the current credit crisis.

Here in the UK, depositors are protected by the government, up to a point; but who knows what the government might do if seriously financially challenged.

Red screens

It all looked a bit woeful yesterday, but I stick with my prediction: the market will go up towards the end of the year, so that dealers can suck out a last-chance bonus. For perhaps slightly different reasons, Bloomberg reports a similar forecast.

A question

Do people actually want to be happy?

The name's Bond, Negative-Return Bond

Adrian Ash reports that pessimism has made bond prices soar, which in turn means they're a terrible investment for inflation-dodgers. He gives this graph:

Naturally he thinks this boosts the argument for gold, but I'd suggest that remorseless monetary inflation simply means that we need to store our excess wealth in a diversity of things. We just need to be careful not to pay too much, as the waves of excess liquidity temporarily make this or that asset bob high above its longer-term trend.

Winter is the growing season

Following my search for predictable stockmarket patterns ("Real Cycles"), Joseph Dancy analyses the phenomenon of winter season investment growth. It seems that "sell in May and go away" is still good advice. Dancy quotes Mark Hulbert:

[The research] implies that simply going to cash between May Day and Halloween will have only minor impact on long-term returns while dramatically reducing risk -- a winning combination that would show up in a much improved risk-adjusted performance.

Until everybody does it, of course. But what are the chances of that happening?

Off motif

Some music education howlers - though to me they seem inspired...

An opera is a song of bigly size.

A harp is a nude piano.

Find more here: Missouri School Music Newsletter

Picture(s) source

"Common Sense"

Guh-nomes

I read somewhere that in Harold Wilson's 1956 attack on Swiss bankers' alleged foreign currency manipulations, he pronounced "gnomes" with a hard G, perhaps for oratorical emphasis. Now Jim Willie thinks these shy creatures can be seen popping their heads above ground level again:

The Swiss want power to return to central Europe. Recall that the owners of the US Federal Reserve are reported to reside in both Switzerland and London, in more control of US monetary policy (if not political leaders) than people realize.

He thinks the Swiss franc is set for a rise.

Speaking of which, I speculated some while ago that Warren Buffett's currency speculation may have been in the "swissy", perhaps as a hedge against possible forex movements while negotiating a bid for the Zurich financial group. Not that I'd put any money on either of those horses, of course.

So much of European history is connected with mining: Martin Luther and Protestantism generally - maybe because digging out wealth with your own hands gave you a certain independence from government, and a taste for even more freedom. Perhaps that's the underlying theme of gold: intrinsic value that can't be stolen by rulers.

Update

... though according to this story, it can be seized by force, as we see in today's Federal raid on the Liberty Dollar. Watch out for more of this story and the call for a legal class action to follow. Governments have no sense of humour about unofficial challenges to their currency.

... but the news is no use

Ghassan Abdallah echoes what I've been thinking for some time, namely, that financial news (a) comes too late to help you make decisions, and (b) like the market charts, can be interpreted in either a bullish or a bearish way.

His advice is to get a sense of the underlying trend. I agree, though I'm unhappy about what I'm sensing.

"It's good news week"

... as the ironic (though barely intelligible) Hedghoppers Anonymous song went.

For while Japan and China are selling down their holding of US securities, the UK is gobbling up even more, according to Matt's graphs at Discursive Monologue. Maybe we want to be second in Uncle Sam's hierarchy of foreign creditors, instead of third.

And US employment is holding up, according to the official October figures - but not if you use a different measure, says Chris Puplava.

Synthetic alarm?

Gold's fallen nearly $50 dollars off its 7 November high, just as everything else seems to be taking on a crimson hue.

Is it central bank intervention in the bullion market, or gold forgetting it's a currency and trying to be a commodity, or a temporary slackening in demand because of investment houses having to pony up some cash to cover other positions?

"Danger! Danger!" to quote Robby the Robot from Lost In Space - and next episode, the meteor shower will hit the ground harmlessly.

Which banks are weakest?

Matt at Discursive Monologue compares the banks' mysterious black-box "level 3 assets" with the value of shareholder equity, to give an idea of the scale of the risk the investor in financial stocks may be taking.

Turkeys should note that Thanksgiving is on November 22 this year.

Mutts of the Dow

Greg Silberman suggests buying cheap, small-cap US stocks. Shades of Sir John Templeton's founding investment at the start of WWII?

Pioneer work ahead

Nigel Maund (November 5, republished in SafeHaven Nov. 12), after a florid beginning, concludes that gold must rise and the dollar must be defended with heavy interest rate rises:

...gold's great bull market will be the harbinger of a major global recession or, more probably, a depression brought on by a sequence of massive defensive interest rate rises required to support the dollar in its pre-eminent position as a global currency, with all the benefits, political and economic, that this brings to the USA.

Riding the waves

Eric Chevrette shows how the chartists can read the same pattern in radically different ways. His view is that the US market is due to go up, not down - though the declining dollar still makes other regions and assets look more attractive.

To what extent can one sensibly make predictions from the line alone, instead of interpreting it in the light of theorized underlying causes?

Financial liquidity for dummies

At last, somebody spells it out for us. A testy (which I like - the man is clearly genuine in his desire to communicate) article on how the Federal Reserve influences interest rates, and the important distinction between permanent and temporary cash injections. Karl Denninger ("Genesis" of Market Ticker) reads between the lines and suspects a bank has been caught short in the bad-loan imbroglio.

He also directs us to a useful blog ("The Slosh Report") on Fed Reserve liquidity operations, and the Fed's own funds site, which you can find here.

Denninger is rightly outraged at the cynical abuses of the financial system, and quite emphatic that US real estate will have to devalue by 30% - 50%. He has set up a petition, sadly limited by its nature to US citizens.

And a video, though I find the use of nuclear explosion imagery counter-productive (I've momentarily forgotten the psychological term for this, but it's a "never happen, Cap'n" response to terrible imaginings).

America will survive

Mark Twain claims not to be dead, May 1897

Wifred Hahn (SafeHaven) gives his reasons for thinking that, post-bubble-burst, American fundamentals will improve, at least for a while.

Is the US going through a bit of slow-down ... a bit of currency trashing? Yes, of course. It is deserved. But economic adjustments will now occur, feeding through to other world economies. Gradually, the trade (non-energy) deficit will shrink. Once foreign equity markets begin declining significantly in anticipation of a slowing global economy and the USD has put in a bottom, it is possible that a torrent of foreign-invested portfolio capital will return to the US. Some estimates put the value of this foreign investment at over $1.5 trillion (and rising as the US dollar falls.)

From our perch in Canada, the next few months likely present the lowest risk buying opportunity of US dollars in at least a century. US "large-cap" companies with significant overseas operations are also attractive on a relative global basis as these are best able to weather an economic slowdown. America will survive for a few years longer.

Real cycles

The number 11 bus, or Outer Circle, takes about two hours to go round Birmingham. Years ago, it was regulated by Bundy clocks at various points on the route. However early he arrived, the driver would have to wait for the correct moment, insert his key, then continue with his journey.

With any routine, selfish habits creep in: the consumer pays, but the service revolves around the provider. Even in the coldest weather, the driver, shut in his heated cab, would leave the passenger door open at each stop, including the long pauses at clock stages; this saved him having to punch the control for the door if a new fare should arrive. If the driver got hungry, he might pull up outside a fish and chip shop and get a hot meal to eat off his dashboard as he drove. On the 16 route, there was an green-painted cast-iron Victorian public urinal just off the Soho road, where the driver would stop off when he felt the need - leaving the bus door open, as usual.

"As above, so below", the alchemists said; and vice versa. I read a long time ago how British elections tend to be timed around economic boomlets; and more recently, how the American economy revives every four years to fit the fixed-term Presidential elections. Among stockbrokers, it used to be said "Sell in May, and go away", so the market suited the requirement for gentlemen to relax in summer; and see how even now, the Dow and the FTSE rise towards the end of the year, when traders' annual bonuses are calculated - the Tech boom of 2000 being an excellent example.

The doomsters don't tend to set timetables - maybe they've learned that from the Jehovah's Witnesses (I don't know how often The Watchtower showed us that the end was possibly going to come very soon - a favourite image was a runaway train heading downhill to a bridgeless chasm). So I'll my neck out instead and make a prediction: the Dow will rise until bonus time, then flutter nervously until the 2008 Chinese Olympics; then there's the US Presidential election to get through; then we'll have the reckoning. A new president will be able to say, "I've had a look at the books, gentlemen, and I hadn't realised how badly the company was managed." And at last, the corrective process will really begin.

That's my chance to join the ranks of the comprehensively wrong. Place your bets.

Measuring relative value

Fiat currency is elastic - it stetches and contracts according to the demand for, and supply of, credit. So it is an unreliable tool to measure the value of anything.

George Kleinman addresses this problem and suggests a relativistic approach: compare the historical price ratios of different asset types. He admits that you can play this game forever, but it's not his fault that governments have corrupted our traditional yardstick. All you can hope for is some sense of trend, which is what all this rune-reading is for, anyway.

His conclusions: gold looks undervalued against oil, and not overvalued against either the Dow or silver. His trend feeling: a coming economic and stockmarket downturn.

Financial Sense may be run by investment advisers, but I feel their commitment to public education goes well beyond self-interest. It's a sort of University of the Air.

Tear your eyes away from the gold watch

A sound article from Clif Droke, about psychology, avoiding the extremes of bulls and bears, and remembering that being a contrarian means going upbeat when the crowd feels down.

Sovereign wealth funds: a tidbit

Adrian Ash in Financial Sense:

BCA Research in Montreal thinks that "sovereign wealth funds" owned by Asian and Arabian governments will control some $13 trillion by 2017 – "an amount equivalent to the current market value of the S&P500 companies."

Is an irregular cycle a cycle at all?

And 'mid this tumult Kubla heard from far
Ancestral voices prophesying war!

There is a kind of thrill in contemplating destruction - it's a whorl in the grain of human nature. Jeffrey Nyquist indulges this tendency in a piece about Robert Prechter Jnr's views on mass psychology and the markets, and our facing possibly the biggest economic depression since the founding of the American Republic.

You know how everything seems so bright when you get out of the cinema?

The returning wave

Hokusai: Mount Fuji off Kanagawa

As Japanese currency is getting out of risky investments and heading home, Brady Willett lists the factors putting the dollar under downward pressure:

In recent weeks the markets have speculated that the Saudis may drop their peg, that other Gulf states and sovereign wealth funds in the area are lightening their exposure to the dollar, and that OPEC continues to eye settling in Euros instead of dollars. Also recently China and Japan dumped a combined $33 billion in U.S. Treasuries (in August), and Chinese officials have continued to discuss reducing exposure to the dollar. Suffice to say, that against an already uncertain backdrop U.S. dollar holders are coming forward threatening to fan the flames and talk of the dollar era being over is running hot is hardly encouraging. Less encouraging still is the fact that those who previously cheered the dollar’s decline are turning scared.

He wonders whether we may see an emergency support plan for the dollar.

Avast behind!

Cut-throat Jake spies danger

Pearce Financial (Financial Sense, yesterday), like Marc Faber, believes that the East is dangerously overheated and deflation could hit commodities as well as shares; also, the dollar could rise again, and the Japanese yen might break free from its moorings.

I'd like some help with understanding this last, as tides of returning dollars and yen would seem to argue inflation in their home countries.

Karl Denninger (Market Ticker, yesterday) explains it as a relativistic effect:

Our problems are bad. The problems that will be faced overseas are FAR WORSE. Overseas economies are dependant on us, not the other way around. When this sinks in the other currencies against which the DX is measured will collapse; this will appear to raise the dollar, but in fact it is the sinking of other currencies.

"Tom the cabin boy smiled, and said nothing."

Stop engines

(image source)

Julian Phillips (Financial Sense, today) explains why he thinks central banks may soon have to stop selling gold, and may even need to start buying.

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.

Red speckles

Paul Nolte (Financial Sense yesterday) strikes a more judicious note. He points out that house price drops do not hit everybody equally, since not everyone has extracted equity and not everyone needs to sell:

... real estate is not like buying 100 shares of Cisco in early 2000 and watching it drop 80% - everyone loses the same amount, very unlike the real estate market. The point – the real estate market is not like the stock market bubble and will take a much longer time to work out – our best guess is an initial bottom is likely in 2009 and we won’t see a meaningful turn higher in overall real estate prices until sometime 2011-2012.

Similarly, there is opportunity for people to cut back on energy consumption in response to higher oil prices.

He expects a bit of a pullback in commodities and precious metals, and currently tends to prefer bonds to stocks.

Tough, but believable

Read Karl Denninger's Thursday piece over at Market Ticker. Semi-apocalyptic, but with hopes for America's survival, in what he thinks will be a deflationary depression accompanied by civil unrest and regional conflict in the East.

He thinks it's not too late for the US to recover its economic base. I hope the same for my country.

Bailing out the gold traders?

Here's an interesting story from Thomas Tan in SafeHaven yesterday:

... There has been a lot of discussion among gold investors on gold manipulation by central banks... I am not quite into the old conspiracy story, but financially I see incentives and benefits for central banks to lease and loan gold to bullion banks during gold's bear market... However if gold is on [an] explosive move like right now, bullion banks will suffer heavy losses when they buy back gold in the open market. Whether this act can be called manipulation and conspiracy? Maybe, but it was probably more financial interest driven, and suppressing gold as secondary goal.

... in May 1999, the then Chancellor Gordon Brown (now Prime Minister) of Britain sold 415 tonnes of gold, almost 60% of its total reserves, leaving Britain with only 300 tonnes. 11 days earlier, Brown had requested the IMF to sell $10 billion of its gold on the open market too. So far no real reason has been officially offered for selling gold in such a hurry... According to Mr. Schoon, it is rumored that British was acting probably in a joined effort with US Fed to save a large Wall St bullion bank which had a 1,000 tonne short gold position loaned by the US government. And it was at the brink of disaster when gold took an unexpected rise at that time in 1999 and the tide was turning against them. If true, this bailout is no different than LTCM and the current subprime bailouts, except the US government had absolutely no choice in this case since it had to rescue the bank and get its gold back.

... No matter what happened then, today it seems: 1) Rise of gold is a nightmare for all CBs since they have been the net sellers; 2) All CBs have less gold than they claim to have, and will run out of ammunition to suppress gold and eventually be defenseless to protect their paper currencies; 3) At the end all CBs will have to turn themselves into net gold buyers from sellers.

The inflation race

The pound is now worth around $2.10 US, which has some advantages: I know someone who's just had two nice holidays in America this year - to Disneyland and Las Vegas. Anyone who's inclined to sniff should remember that these places, unlike so many in Europe, try really hard to make it fun for you to spend your money.

But why doesn't the pound buy even more dollars? After all, look how gold has soared against the buck. The answer is that most currencies are competing in a devaluation race, as Chris Puplava shows here. The UK is ramping up its money supply at a similar rate to the USA's, but we don't hear so much about it on this side of the water - I think middle-income Americans are generally more clued-up on finance and... is it fair to suggest that they're more patriotic?

For a long time, we've been buying from poor people around the world. They've been storing up the money - you do, when you know how hard you've worked for it and don't want your children to go back to the fields - and now they're not quite so poor. Unemployment is on the rise here, but our trading partners aren't going to pay the Social Security bill for us.

So it's more taxes, or printing more money. The difference between taxation and inflation is the difference between robbery and theft. Theft is less confrontational.

Ron Paul was talking about digital gold currencies five years ago - now watch for the progress of the gold dinar.

China starts dumping the dollar

Perhaps this is just a little jerk on the chain, to remind us who's on the collar end now.

Financial experts

Commenting on Michael Panzner's scorn for the authoritative pronouncements of some financial experts, I was thinking of a "wizard" story which I've now tracked down. It's been circulating since 1995, but it's worth retelling. Mark Oswald of The New Mexican newspaper reported:

During discussion by the Senate of a serious piece of legislationconcerning the psychology profession last week, Sen. Duncan Scott,R-Albuquerque, proposed an amendment. It says:

"When a psychologist or psychiatrist testifies during a defendant's competency hearing, the psychologist or psychiatrist shall wear a cone-shaped hat that is not less than 2 feet tall. The surface of the hat shall be imprinted with stars and lightning bolts.

"Additionally, a psychologist or psychiatrist shall be required to don a white beard that is not less than 18 inches in length, and shall punctuate crucial elements of his testimony by stabbing the air with a wand. Whenever a psychologist or psychiatrist provides expert testimony regarding the defendant's competency, the bailiff shall contemporaneously dim the courtroom lights and administer two strikes to a Chinese gong."

Usually, anything proposed by Scott - whose hard-core conservatism is like cod liver oil for the Senate's Democratic majority - goes nowhere. But his wizard-hat amendment was warmly received and passed by a voice vote. It is now part of Sen. Richard Romero's psychologist bill, as the measure moves to the House.

Jokes this good usually come with a rider. It was subsequently reported:

The bill, with the wizard amendment, passed the Senate by voice vote and cleared the house by 46-14. Unfortunately, Gov. Gary Johnson vetoed the legislation.

It's extra fun when the authorities play along for a while.

That reminds me... Back in the 1970s, a couple of Oxford undergraduates proposed the building of a full-sized pyramid in one of the University's parks, as a monument to themselves. It went to the University's Hebdomadal Council and the proposal was narrowly defeated (5-4, they say).

Musical chairs and funny hats

Michael Panzner looks closer to being vindicated as the weeks roll by. Here he quotes Nouriel Roubini on the continuing musical-chairs-type credit tightening - we're getting well beyond sub-prime territory - and castigates the financial astrologers who failed to foretell the oncoming disasters. I think many of them should be made to wear star-bedecked hats, and wave wands.

Down Jones

Dow 9,000 update: Dow at 13,660.94, gold $833.80/oz. "Gold-priced Dow" has therefore gone down since July 6, from 13,611.69 to (effectively) 10,612.71, a drop of 22% (or 52% p.a. annualised).

To put it another way, the Dow has stood still and gold has risen 29% (or 112% p.a. annualised) over the last 123 days.

Lenders should tremble

"Genesis" at Market Ticker explains that US lenders who colluded in fraudulent mortgage applications can be forced to have the properties back at their original valuation.

Gold: forget the charts

Gold is currently nearly $820/oz. and it's natural to look at the historical charts to see where this puts us. We did this yesterday.

But what use are the charts? The wiggly lines on them don't show the full context: the wild monetary inflation and cumulative trade and budget deficits of the past few years, which (if we believe the analysts) are unprecedented.

Instead of drawing conclusions from the graphs, we should be asking questions - especially, why hasn't gold zoomed more and earlier? After all, governments must feel that gold is at least a vestigial or potential measure of the worth of their currency; otherwise, they wouldn't be storing thousands of tons of the unproductive stuff in expensive facilities. So, why hasn't gold acted as the thermometer of this financial fever of the last, oh, seven years?

One answer is that the world gold market is small enough to be deliberately distorted. Frank Veneroso could be right: central banks may have been secretly drip-releasing portions of their bullion reserves. That would be to reassure us - or rather, kid us - that everything's under control. Since the gold price matters, it becomes important for officials to manipulate it, and so (according to this theory) the charts will actually tell us nothing.

Until the reserves get so low that the game can't continue. Central banks will suddenly get vertigo and freeze-cling to what they have left, and the gold market will explode, as confidence in the currency starts to collapse.

And Veneroso cottoned on early, simply because the scam worked too well. The smile was too bright, the walk a little too confident. If he's right - and I more than half suspect he is - we needn't bother with the past price data, or with worries about short-term corrections.

Start like Buffett to end up like Buffett

Great article in The Motley Fool about how Warren Buffett founded and developed his fortune, and some of us could do the same.

Gold: undervalued, or not?

Boris Sobolev (SafeHaven, today) reckons gold is still well below its inflation-adjusted high of $3,000. But the chart he refers us to from his previous article (Resource Stock Guide, June 8) could be interpreted as showing that gold (in real terms) is now around its long-term trend. In that case, surely only a speculator would hope for a new spike to make a quick killing.

Warren Buffett and derivatives

John Carney, in DealBreaker.com today, discusses Warren Buffett's recent involvement in derivatives, notwithstanding his previous publicly-announced disenchantment with the product. Does he understand the risks better this time around, or has he simply worded the contracts more carefully?

The Inflation Protection Quandary

A succinct article by Weamein Yee in Banks.com (Friday), on what to do in inflationary times:

It’s almost like everyone is holding their breath to see what happens next.

As we know, Marc Faber recently suggested we might wish to stand on the platform rather than board any of the asset trains.

Stocks will tend to fall in anticipation of higher interest rates to combat rising inflation. The price of long term bonds will fall as investors will demand higher yields in an inflationary environment.

Yee says that the investor may be forced to consider choices that would normally be regarded as rather risky or sophisticated: commodities, precious metals and shares in foreign (less inflation-prone) countries. This is the paradox: taking a risk may be the best form of playing safe.

But before that, perhaps we could increase our holdings of government-backed inflation-linked savings bonds, something Yee doesn't mention. A lot depends on how the government defines inflation for the purpose of calculating our returns, but it should be fairly reasonable, one would hope.

The writer points out a final irony: low interest rates and high inflation support real estate prices.

That's the way to do it (not)

Punch and Judy Bank

An interesting article by Tim Wood in SafeHaven yesterday, in which he argues that the market is too big to manipulate. According to him, interest rates and market movements are largely unrelated and operate on separate cycles.

Much to discuss

(Daily Mail story)

"Business was off the agenda" said the Telegraph yesterday, about the Saudis' visit to Britain. I'm not so sure: somewhere in that 22-car convoy there may be a Saudi who had quiet talks with his opposite number about economic matters, while King Abdullah distracted the cameras.

Alex Wallenwein in SafeHaven yesterday reminds us that a month ago, the Saudis refused to cut rates to match the US. He sees the dollar's resistance to collapse as having bought time for European and Eastern economies, and the Euro currency, to strengthen their position. Soon, it may be takeover time, and contrarians who expect the dollar to bounce back may find that the trampoline has been whisked away.

Veneroso: up to half the gold has gone

GoldSeek (November 1) relays Frank Veneroso's assessment that central banks may have disposed of up to 50% of their gold bullion:

... The manipulation of gold prices was first noticed in the 1990s by Frank AJ Veneroso, one of the world’s top investment strategists. As more gold bullion came onto the market depressing the price of gold, Veneroso believed the central banks were its source.

When queried, central banks denied Veneroso’s assertions. Central bank records, in fact, showed their gold reserves to be stable. But Veneroso was right and the central banks were lying. The gold moving onto the markets was indeed coming from central banks via their co-conspirators in capping gold, the investment banks.

Investment banks were borrowing central bank gold at 1 %, selling it thereby depressing gold’s price and investing the proceeds in higher yielding government debt; and, as long as the price of gold moved lower, the profits of investment banks increased (see The Manipulation of the Gold Market, http://www.gata.org/node/11).

The International Monetary Fund was complicit in this deceit as IMF regulations allowed central banks to count gold “swapped” or “loaned” as still being on deposit in their vaults. Veneroso now believes that up to 50 % of gold reserves claimed by central banks have already been sold—a fact that will be instrumental in our collective bet against central banks in their house of cards...

... Veneroso believes central banks sold 10,000–15,000 tons, equal to 320,000,000 to 500,000,000 ounces of gold over the last 20 years. Just imagine how high the price of gold would be if the central banks had not sold this staggering amount.

Today’s $800/oz. gold is a bargain—as is $2,000/oz. or $3,000 oz. gold—a bargain that exists only because central banks literally sold thousands of tons of our gold onto the market in their attempts to prove gold a poorer alternative to debt-based paper currencies.

Over a year ago, Veneroso estimated central banks had less than three years supply left to cap gold’s price. He also predicted the central banks would capitulate before then, keeping what little gold they had left. When this happens, the central bank subsidy of gold will end and the price of gold will skyrocket.

On the same site, Adrian Ash (November 2) looks at gold's disadvantages and decides that it is best defined not as a commodity, but as a currency:

Given that gold doesn't pay you anything in yield, interest or dividends – and that it does not have any real industrial value – the "investment motive" for gold can only be explained as desire to quit other assets. Or at least, to hold an asset entirely free from what drives other asset markets up and down.

... perhaps the gold market says investors are looking for protection against falling bond, real estate and equity values – as well as a falling US Dollar and slumping US economy.

So they are buying protection ahead of time. And to do that, they're buying gold – a wholly different asset from everything else.

One for the speculators. Meanwhile, perhaps the non-rich among us should take the precaution of paying off overdrafts, credit card debts and any other loans that can be called in at short notice.

Put your fingers in your ears

(Picture source)

Doug Noland at Prudent Bear (November 2) agrees that bigger bangs are coming:

... as an analyst I must contemplate the likelihood we have entered a uniquely unstable monetary environment. In short, the backdrop exists where incredible dollar liquidity flows could be released (from myriad sources) upon key things (notably energy, food, metals and commodities) already in severe supply and demand imbalance. Again, how much are the Chinese willing to pay for energy? The Russians for food? The Indians for commodities? How much will investors be willing to pay for precious metals as a store of value? How aggressively will the speculators "front run" all of them? Can the Fed afford to fuel this bonfire?

... The least bad course for the Federal Reserve at this point would have a primary focus on supporting the dollar and global financial stability.

Secondary explosion

Ty Andros (Financial Sense, Friday) repeats the point made by Jim Puplava (which we reported earlier this summer), that the credit agencies' re-rating of subprime packages have ignited an explosion inside the banking system, but this may only be the detonator that sets off the main charge:

Whereas the big banks and investment houses can hide behind tier three and pray for a market recovery, the investing community cannot. Pension funds, institutions and money market funds, have fiduciary investment covenants which direct them to sell securities which are below certain ratings levels. Once an investment falls into the lower rungs on the investment scales they are bound by their own investing rules to divest the assets.

Tens of billions of dollars of securities have been downgraded since the beginning of October and this will require that they be sold in a timely manner. Once those securities hit the markets we will know their true value, and it won’t be pretty. The super SIV will quickly become an exercise in wishful thinking as their “high quality” paper becomes junk in the maelstrom of liquidation which increases every time a security is downgraded. The super SIV’s whole reason for being was to prevent fire sales and price discovery.