A few noted deflationists are calling for a top in commodity prices. Their argument is pretty simple: Because inflation is a function of available money plus credit (their definition), and because credit has fallen, deflation is what comes next. When looking about for things to deflate in price, commodities are an obvious candidate for attention because they have risen so much over the past decade.

In this view, three things have to be true:

1. Demand for commodities has to fall below supply. After all, as long as demand exceeds supply, prices will typically rise. (Wrong: no excess supply)

2. Money, including credit that would normally be used to buy commodities, has to shrink. That’s the definition of deflation that we’re analyzing here. (Wrong: look at M1 it is increasing; banks are not lending)

 

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. -Milton Friedman, The Counter-Revolution in Monetary Theory (1970)

3. People’s preference for money has to be greater than their preference for ‘things,’ with commodities being very obvious ‘things.’ That is, faith in money has to be there or people will prefer to store their wealth elsewhere. (I believe this is happening now, why keep cash? you get ZERO return for it)

These are all just versions of the old supply/demand argument for commodity prices, except that our consideration also includes the important element of the Austrian economic view of demand for money.

There are several reasons why I think there are serious holes in each of these conditions. Enough to warrant a healthy degree of caution in one’s certainty about what ‘must’ happen next to commodity prices.

Looking at Gold and deflation opinions over the years

1. Adam Hamilton of Zeal LLC wrote, anything typically financed by debt is likely to see its prices plunge dramatically, like houses and cars, as the ongoing Great Bear bust continues to destroy the gross excesses of debt via higher long rates. Conversely, anything not typically paid for with debt, including groceries and general living expenses, is almost certain to rise in the coming years. We are staring down a brutal environment of widespread inflation marked by various sectors witnessing falling prices as debt leverage implodes. See entire article here.

2. Castrese Tipaldi wrote on SafeHaven.com, I don’t know if in the last week we saw the last gasp of those usual subjects trying to cap gold, and I don’t know if we now have the very last possibility to get silver at a price so cheap. What makes this quote so interesting is he wrote this on April 20, 2004. See article here.

3. Dan Ascani, who wrote essentially about Professor Jastram’s very long-term study on gold, and he essentially states that Jastram studied four pronounced price deflations taking place. In all four deflations, operational wealth in the form of gold appreciated handsomely. When one sees that just by holding gold for 13 years, from 1920 to 1933 operational wealth would have increased two and a half times, one realizes that gold can be a valuable hedge in deflation however, a poor one in inflation.

4. Dr. Marc Faber one of the most respected and best followed in the industry has stated his opinion on the deflation debate as follows: Therefore, under both scenarios stagflation or deflationary recession gold, gold equities, and other precious metals should continue to perform better than financial assets. See article here.

5. Steve Saville of the Speculative Investor writes, The most important difference between then (the 1930s) and now is that gold and cash US dollars were interchangeable during the early 1930s (the deflationary period) by virtue of the fact that the dollar was defined as a fixed weight of gold. A typical effect of deflation is an increase in the purchasing power of cash. The fact that gold and cash were officially linked during the 1930s meant the deflation caused the purchasing power of gold to increase along with the purchasing power of cash. In other words, under the monetary system that was in effect during the 1930s gold was a hedge against deflation. Furthermore, under such a system the purchasing power of gold would decrease during periods of inflation; that is, when the dollar was defined in terms of gold, it would have made sense to shift investment away from gold during periods of inflation.

Currently it seems the physical markets are taking control, yet the clues are still subtle, nonetheless with Hugo Chavez asking for Venezuela’sgold to be returned we must ask is this the tipping point in the physical gold market that is the start of a trend? Likely not as Chavez is more likely trying to remove assets that can potentially be confiscated in case he loses a lawsuit for kicking out the oil companies and various others he nationalized over the years. But it did make people stand up and think for a minute and this will lead up to the tipping point in gold as the next steps are currencies.

The recent Swiss move to deflate their currency, is this the start of currency wars and the race to the bottom? The next step will be protectionism as governments suffering from falling exports will attempt to protect local champions via protective taxes, tariffs and the limiting of certain imports. Affected governments and industries will retaliate for their own loss of exports and so on and so forth. Welcome to the currency wars.  

The end result will be an eventual eroding of faith in the US government credit. The market will eventually wake up and realize that monetization is the one and only way our government can kick the can down the road without immediately collapsing the economy. Which means fixed income investors will lose ad infinitum. Imagine a pension fund or insurance company with a 5-8% real return hurdle rate. How can they possibly stay in 10yr Treasuries with a negative real yield? They can’t. The Bond vigilantes will eventually stir and move into other asset classes en masse. This shift out of public assets and in to private assets will represent a change in preferences that has lasted since 1980, over 31 years. The death of the long-term bull market in government debt will mean the nail in the coffin for the USD and the US role as sole superpower. It will also mean incredibly interesting things for the ultimate reserve currency, gold.  

Bottom line: now is a great time to get out of government paper and many miles away from the large US and European banks. I am a broken record on this but you should own gold and silver miners, fertilizer companies, oil companies and water companies. Some technology stocks could make sense and reasonable exposure to Asia and Latin America. Corporate bonds of companies providing any of the products listed above (gold/silver, fertilizers, oil and water) makes a ton of sense. I would avoid the large multi-nationals here as I think trade wars are coming and their cash flows from foreign operations are about to come under fire.

By the way the US debt ceiling has been reached again in a month!

 

Got Gold ?

“Gold’s around$1,500 now and I bought it at $1,200 (or if you were with us when we first bought way back in 2001 at $300) – should I sell it and look to buy it back when it corrects. It’s gotta correct, right?”

My answer: “What if it doesn’t with any significance?”

Yes, gold has performed incredibly well. But the point here is to understand WHY you bought it.

NEXT, silver was ripe for profit taking after a very rapid and steep climb to much higher levels. As I say, no market goes up in a straight line and we were due for some consolidation, but I thought we would hold the $40.00 level. To see silver slice through that psychological support was disappointing. It looks like it will bounce around here and if we can pick up more at between $25 to $30 we will be happy.

The word however I would use to help investors is “RELAX”. Everything is going to be just fine. These are the dip moments I have been talking about where you want to BUY.

Dan Norcini of JS Mineset had some great comments that I think reflect the true nature of why our market is reacting the way it is. Dan said, “I want to address the silver backwardation issue.  Many investors and traders feel that silver should not be dropping in price because of the backwardation structure.  They point to this fact as proof that silver is in short supply and demand is phenomenal. 

That may be entirely true, I don’t know, but the fact is that when we are dealing with the Comex silver market we are dealing with a paper market.  Keep in mind that hedge funds that trade the paper markets do not care about fundamentals.  They are pure technicians who rely solely on their computer trading algorithms to make trading decisions.  These algorithms are utterly indifferent to the realities in the physical market.

The bottom line is once these algorithms move into a sell mode, the hedge funds will unload until they’ve exhausted their selling, regardless of the physical market structure.  Meaning the paper market does not care about the physical market.”

Another factor that has affected our silver market was Wednesday’s CME announcement that they were raising silver margins. Jim Sinclair, who has been through all of this before back in the 70’s and 80’s weighed in on this and said the following:

Margins will continue to rise on the COMEX until it reaches the cash price of silver. This works for the shorts as their hammer on the silver market reduced the equity of low cost positions. The efficacy is short term and made no difference whatsoever in 1980 as the silver market made its highs. What broke silver in 1980 was a unilateral change (novation) of the silver contract which went to “sellers only.” Under contract law that is simply not permitted. They got away with a violation in 1980, but the corporate changes in structure at the COMEX that have occurred since 1980 makes the COMEX less able to pull that trick off successfully in 2011.

Silver is simply being silver. Silver did help gold therefore the 25% drop in value has to pressure the gold price.

The USDX is simply having a weak rally off a totally oversold on every internal indicator short side trade. The dollar has no future. The supply wishing to diversify is simply too big to allow any rally to have legs.

I have told you silver is a game. That being said, it is a great game. Certainly as the silver price approached the 1980 high, you might have considered selling 1/3.

The high trade on silver was $54 in 1980. Silver’s round numbers are at $50 and $100. Both will function as such in trading.

After this short play, which had to follow the spike intermediary top, silver will rise as fast as it did again.

In addition, Mr. Sinclair went on to point out what I have been saying is coming with our junior mining shares. This is a major turning point that will begin to heavily favor junior mining shares.

Jim explains in italics below:

The Hedgies are having their way with the gold shares, but logically this is coming to an end. When you can buy companies whose resources are three times the company’s present capitalization, the share is getting unreasonably cheap.

The ratio of GDX versus GDXJ is starting to favor the juniors, which is a major heads up event.

What you have witnessed is not at all shocking. If you traded 1968 to 1980 you would know this is just silver being silver.

Relax. Put a french curve on silver and you will see the bottom change in trend event.

To make truly big money in a volatile market you need to understand what you are doing. Volatility is our friend, it is not our enemy! We are being given a gift to buy silver at discount prices for a brief period of time. For those of you who wanted to buy silver but just didn’t get around to it, here is your chance to buy an oversold dip. Watch for the bottom to come rather soon and pull the trigger.

Conservatively, we absolutely believe that silver will be well north of $50 an ounce before the end of the year with gold getting ready to take out $2,000 during this same time frame.  So relax and feel confident in the positions you take now and over the course of the summer. Things are going to be just fine!

QUESTION: What would happen if the market found out that the world’s central banks have been leasing out far more gold than they actually own? 

The answer is also the reason gold could jump to anywhere between $2,000 and $5,000 an ounce very quickly in the near future.

For several decades now central banks have been ‘leasing’ gold to the market. They’ve been doing this to keep the gold price low…so they could keep conducting loose monetary policy. According to the World Gold Council, total official central bank gold reserves at December 2010 are around 30,000 tonnes. If the figures I have are accurate, well over 15,000 tonnes of gold has been lent out by central banks.

Owning physical gold means you have no counterparty risk. It’s a way of putting a portion of your wealth outside the currently flawed banking system. Owning gold derivatives comes with counterparty risk. In a benign monetary environment counterparty risk is no big deal. But in an impaired system, which is what we have now, it can become a major issue very quickly.

As long as central banks keep printing money, as long as we have a financial system built on debt, and as long as gold is allowed to freely float, the price gold will keep going up.

 Simply put: I feel we are nearing a point where physical hoarding of gold by wealth-protecting individuals and countries is going to cause a liquidity crisis in physical gold. When that happens, much higher prices will be required to lure gold away from hoarders and back onto the physical market. Only a sharp increase in interest rates by the Federal Reserve would prevent this from happening…and entice people to sell some gold. And, frankly, I don’t see that happening anytime soon.

 More Questions?

 Is it normal for the US to pass China as the largest holder of its own debt?

1. Is it normal for the Federal Reserve to purchase an estimated 70% of the new supply of that debt?
2. How can inflation be normal when a broad cross-section of food and commodities appreciate 23% in only six months?
3. Or when global inflation contributes to violent protests, revolutions, and war that spread across the Middle East and Northern Africa causing oil price shocks?
4. Can we say it is normal when the European Union bails out its third member nation in under a year?
5. Or when the Swiss Franc appreciates nearly +30% against the USD in only nine months, cancelling out a +27% gain in the Dow Jones Industrial Index from currency devaluation alone?
6. Why is it so easy for markets to return to normal after a massive disaster in Japan threatens the financial viability of the world’s third largest economy and purchaser of US debt?

Each and every one of these facts is a fire burning on the wings of the economy. The markets may be passive but not without hidden fear.

The denial of truth is the denial of volatility.

As always we invite you to call us and discuss your concerns  – 03 5724 5100

QE or not to QE?

It seems that QE2 will get a serious review during the Federal Reserve’s April meeting, and could be cut short by two months in order to send financial markets the message that they will not allow inflation to get out of control.  This assumption is taken from Federal Reserve Bank of St. Louis President James Bullard, when speaking to reporters in France on March 26, said  “If the economy is as strong as I think it is, then I think it may be reasonable to send a signal to markets that we’re going to start withdrawing our stimulus, and I’d start by pulling up a little bit short on the QE2 program… We can’t be as accommodative as we are today for too long, we’ll create a lot of inflation if we do that.”

So what could happen?

1. Some still believe that QE3 is a distinct possibility, and they have invested accordingly. These investors would be in for a rude awakening if QE2 was cut short – think in terms of Silver investors who bought at the top of the market thinking silver was destined for $50 an ounce. 
2. Others believe that QE2 will continue through to its scheduled June conclusion without any hiccups along the way. This is the more moderate camp who have parked capital in Gold, Silver and Oil, who didn`t buy at the top of the market, but had planned to reduce positions once QE2 ended in June.
3. And there are those that believe QE3 was a non starter, and QE2 would probably finish according to schedule, but wanted to front-run the selling by positioning themselves for the inevitable asset realignment by being in position in late April (after April options expiration for example).

So what should you be watching out for in April? 

1. If more hints from Fed officials regarding ending QE2 early start surfacing in the media, coupled with stronger jobs numbers, then take them as a collective indication that the time has come to cash in on some of the profits from commodity related investments.
2. An early end of QE2 would strengthen the U.S. Dollar on a short term temporary basis, and could bring headwinds to commodity-based currencies such as the Aussie and Canadian dollars.
3. GOLD – if we start to see gold fall under 1400 we may see a reversal to the base around 1320 – 1340 region (which could again be a buying zone) the Gold bull story is far from ending.

Has Reality Changed?

• The change in the Middle East is from some form of government to Chaos. Change in the Middle East is NOT positive for the West, it is a huge unknown.
• The mountain of OTC derivative paper is not going away. 
• Peak Production of Energy is behind us. Peak Oil means Peak oil is upon us. Energy will become scarcer in the future and thus more expensive.
• The Debt in Japan, Europe and the USA is NOT going away but it is getting bigger!  Consider US government revenues of $2.228 trillion (CBO FY 2011 forecast). If rates go up (and they will) 1/3 of America’s current tax take would be spent on INTEREST ONLY!  Take Japan and it could be closer to 70% just to cover the INTEREST ON DEBT!  In Europe we will have act two from Ireland and Greece with likley defaults, then there is Spain and Portugal.

US Housing

Recent reports on home sales and new home construction continue to come in below even the most conservative expectations, which has again led to talk of a double dip for housing. We have consistently downplayed the talk of a double dip because we believe it provides an oversimplified view of the housing market. There is no doubt that housing prices are falling again. Prices had previously been supported by an enormous amount of fiscal stimulus, including tax credits for first-time buyers and trade buyers, tax-loss carry backs for homebuilders, massive purchases of mortgage-backed securities by the Federal Reserve and a whole host of foreclosure mitigation programs by the mortgage providers Fannie Mae and Freddie Mac and the U.S. Treasury. Now that many of these programs have ended or are winding down, home prices are again reflecting the weakened underlying fundamentals, which are dragging prices lower.

Focus on Wind and Solar

Whenever renewable energy is mentioned, wind and solar usually get the attention. Yet, wind and solar, along with biomass and geothermal, fall within the “Other Renewables” category that makes up just 3.6% of U.S. power (See Chart Below). Most countries are similar . . .

 

So should one add nuclear positions to the Portfolio?  Yes in our opinion.  When is the best time to buy?  When everyone else is selling! That has happened with U308 stocks some fell 50% — huge buying opportunity is at hand. 

YEN?

Well it surged to a record high against the dollar, hitting an all-time peak of Y76.25 on March 16.  The reason why: speculation that Japanese institutions would repatriate funds to deal with the aftermath of the crisis.  The G7 stepped in (first time in over 10 years) to stabilize the Yen and a line in the sand seems to have been drawn at just over 80 yen to the US$  . . . with the massive amount of funds the bank of Japan has put into the market and the massive amount of DEBT the Japanese government will take on to rebuild this should be the turning point or perhaps tipping point for YEN strength. Now is the time to sell Yen and seek reward elsewhere.

GOLD.

Notice the correlation of gold going up as Debt goes up  . . .

 

While Gold is cheap relative to its inflation adjusted all time high (US$2300), Gold mining stocks are absurdly cheap. How cheap?  The Gold Miners ETF (GDX) reserves roughly $430 an ounce.

Fact: The 25 companies that comprise GDX have roughly 700 million ounces in reserves. And currently the combined market cap of all 25 companies is about $300 billion.

So the market is literally pricing this Gold at $428 per ounce, round up to $430.

GDXJ – the junior gold miners is similar —  

note above: GOLD – if we start to see gold fall under 1400 we may see a reversal to the base around 1320 – 1340 region (which could again be a buying zone) the Gold bull story is far from ending.

Worried about your pension? Unsure about your investments? Your Banner adviser can help you make sense of your finances.

More than that, they will make sure they understand your financial priorities and, drawing on their extensive experience and expertise, work with you to help you achieve them. So whatever your objectives – fund your children’s weddings, retire early, pass on your wealth to your family, enjoy the holiday of a lifetime, increase your retirement income – they will do their utmost to find solutions that work for you.

Life is not always plain sailing: your financial situation may change, as may your priorities. Yet clients know that they can trust their Banner adviser to steer them through the financial consequences of whatever life brings.

Importantly, all our advisers are independent and therefore their advice is truly impartial.

info@bannerjapan.com  or call 03 5724 5100

 

A picture is worth a 1000 words – We will spare readers some of the more violent pictures we have seen of the resulting carnage as they truly are gruesome. But this is giving the markets a scare and will $100 oil cause the recession to resume? Too early to tell but by adding to energy costs, the effect of high oil prices is to reduce the amount of money for spending on other things, thereby undermining aggregate demand in the wider economy. Eventually a tipping point is reached where confidence collapses. Given what happened as recently as 2008, you would expect OPEC to be acting quickly to prevent any further explosive increase in prices.

Is worldwide inflation being casued by US Fiscal Policy? 

Because the US dollar is a reserve currency (approximately 60% of global transactions are denominated in dollars) and the US is printing money to finance its trade and fiscal deficits and many countries peg their currencies to the dollar, which still remains the hub of the global monetary system, US generated inflation is being exported to the rest of the world.  Reckless US monetary and fiscal policy is starting to create unrest in faraway places, as inflationary pressures intensify.

Consider the United States’ balance sheet. The United States is rapidly approaching the Congressionally mandated debt ceiling, which was most recently raised in February 2010 to $14.2 trillion dollars (including $4.6 trillion held by Social Security and other government trust funds). Every one percentage point move in the weighted‐average cost of capital will end up costing $142 billion annually in interest alone. Assuming anything but an inverted curve, a move back to 5% short rates will increase annual US interest expense by almost $700 billion annually against current US government revenues of $2.228 trillion (CBO FY 2011 forecast). Even if US government revenues were to reach their prior peak of $2.568 trillion (FY 2007), the impact of a rise in interest rates is still staggering.

Now think about the rest of the ring of fire.

Japan the “big one” to go next?

Moody’s Investors Service has Feb 21st changed the outlook on the Government of Japan’s Aa2 rating to negative from stable.

The rating action was prompted by heightened concern that economic and fiscal policies may not prove strong enough to achieve the government’s deficit reduction target and contain the inexorable rise in debt, which already is well above levels in other advanced economies. Although a JGB funding crisis is unlikely in the near- to medium-term, pressures could build up over the longer term which should be taken into account in the rating, even at this high end of the scale.

More specifically, factors driving the decision are:

1. The severity and persistence of the shock that the global financial crisis imparted on Japan’s government finances and on aggravating pre-existing deflationary pressures,

2. As a result, the current policy framework will not be capable of overcoming hurdles blocking a return to a path of fiscal deficit reduction,

3. Increasing uncertainty over the ability of the ruling and opposition parties to fashion an effective policy reform response to the debt and growth challenges, and

4. Vulnerability inherent in the long-time horizon of Japan’s gradual fiscal consolidation strategy to worsening domestic demographic pressures, as well as to possible, renewed shocks in a fragile and uncertain, post-crisis global economic environment.

We maintain our positioning stance of long Gold, precious metals, TBT, Uranium and other Energy.

And now a bit of fun coming up;

Ireland Fund of Japan’s annual ball
Saturday, 19th March 2011 at The Westin Hotel, Ebisu, Tokyo from 6:30 PM Till Late
JPY 25,000

Now in its nineteenth year, The Emerald Ball guarantees a wonderful evening of excellent food & drink, great company, superior entertainment, and of course, the Irish “craic”. All of this comes with the satisfaction of supporting our worthy causes.

The funds raised on the night are used to promote arts, education, cultural awareness and community development programs. The Ireland Fund of Japan supports The Japan Helpline, a student exchange program, St. Patrick’s parades in Japan and homeless reestablishment assistance.

Visit them at www.emeraldballtokyo.com Go raibh mile maith agaibh!

Things that could happen   

• A major government will go broke in Europe. Ireland came close. Portugal avoided it (so far). But for Spain or Italy, 2011 could be a fatal year. Expect higher bond yields, a falling Euro, and trouble in the streets.
• A U.S. Debt too far. The U.S. government is rapidly nearing its statutory “debt ceiling.” The Tea-Party Congress may compromise with the President to cut taxes and some spending. But the real crisis may come as U.S. cities and States (Illinois, California, and New York) approach bankruptcy and need their own bailout. Will your portfolio be positioned to profit when that day comes?
• China will tighten up. One of the main recipients of the inflation being exported by the Fed is China. It’s desperately trying to contain that inflation (in food, housing, and stock prices) before it leads to social and political instability. But if it “tightens” monetary policy too fast, it could produce a crash – leading to much lower commodity demand. Something to monitor closely.

Things we think you should do to protect yourself

1. Continue to trade paper money for precious metals and generally reduce your exposure to financial markets. Those markets are badly distorted by Quantitative Easing and government intervention and they carry a lot more risk than reward right now.
2. ONLY buy stocks tied to real asset classes like agriculture, metals, and various forms of energy including uranium. I am NOT bullish on stocks. The ones I do recommend must have an extremely compelling story. 
3. Keep your ‘contrarian hat’ on at all times! Alarm bells should ring when food and fuel prices begin causing governments to topple… and even though stocks have soared since March 2009 many are now massively overvalued. Always and at all times this year – QUESTION what you’re watching, hearing and reading in the mainstream financial media.

 

Gold 

The key catalyst for Goldman’s suddenly cautious view on gold (which still has a $1,690 price target): the end of QE2 in June 2011. So, presumably, when QE3 is announced in May in order to allow the continued monetization of $4 trillion in debt issuance over the next 2 years, that should be very bullish for gold, yes?

El Nino to La Nina = rising food costs . . .

The changing weather patterns from El Nino to La Nina in the Pacific, however, have been the primary driver for this round as rain patterns change due to a cooling or heating of the mid Pacific.

 

The world has enough food for its population currently, but after the fires in Russia last summer, the flooding in Australia this winter, and now the on-going drought in China is starting to drain the worlds reserves. If the crops of 2011 are sub-par or worse damaged due to weather related conditions, the planet could be looking at a real famine issue in 2012.

Note: BEIJING – Sunday (31st Jan) was the capital city’s 84th snow-free day this winter, making it the longest winter period without snow in Beijing since records began 60 years ago. And there is no sign of snow falling in Beijing in the next 10 days, which means the city is unlikely to enjoy a “white” Chinese New Year, which falls on Feb 3, according to local meteorologists.

It may have once been said “beware Greeks bearing gifts” today it could be said “beware of New Yorkers offering bonds” and this is indeed backed by history as the boys on wall street blew up the USA selling foreign debt to the retail public so when the debt crisis of 1931 hit anyone who was missed in the stock crash was crushed in the debt crash . . .  sounds like history is rhyming again. 

So what is happening today? Most people missed the equity run from the 2008 lows and many are still reluctant to get in and for good reason now.  Bonds have ridiculously low yields and I believe the debt crisis is coming however this time it is “the big boys sovereign solvency test” when it begins the only place of high ground is precious metals.  The other thing is when it does begin it will be ferocious and very quick so this is why I have a core position in Gold and Silver that I simply hold and do not trade. 

This link is a great reference made by the Economist showing the GDP outputs of various countries compared to its closest US state – click here to see. 

Why is that link important? It raised a question in my mind — Perhaps the only important question for 2011 is will anyone anywhere be spared from wealth destruction as the era of Quantitative Easing implodes?
It is happening already right before your eyes! Exhibit A is the fact that Irish Central Bank is printing money it doesn’t have to make loans that are secured by collateral that Irish lenders no longer possess. Irish borrowers can’t get money from the European Central Bank without collateral. So they’re getting it from the only place left, the nowhere land of fiat money.

If you read the story we’ve linked to at the Telegraph you’ll reach the same conclusion we reached: Europe’s debt problems will result in either default or increasingly absurd (and counterfeit) operations by Europe’s central banks (which were supposed to have surrendered monetary policy to the ECB upon monetary union).

How can a currency retain integrity when anyone can get permission to print more of it when times get tough? This is surely a sign that at some level, the Global Financial Crisis that began in 2007 is about to resume again. For 29 months the central bankers of the world have managed to prevent a reckoning with more loans secured by more questionable collateral. Is financial entropy beginning to reassert itself? 

Here in Japan we certianly do not see inflation why?  There is absence of inflation due to weak domestic demand but also rising currency: when the Yen softens, prices of imported goods will have to rise.  Infaltion however is being seen in other smaller countries I am sure you will see more rioting in 2011 on rising food prices – this is not simply an “Africa thing”  the next test will be in South East Asia and once infaltion takes hold it will spread.

The various powers at be tell us there is no inflation . . . Fiction: In this 60 Minutes clip Bernanke tells Scott Pelley, “The other concern I should mention is that inflation is very, very low…”

Fact: There is massive inflation!

Fiction: ‘Unemployment is 9.8%, if we didn’t take these drastic measures it would be 25% like it was during the Great Depression.’

Fact: Unemployment is, once again at “depressionary” levels – pushing 25%.

 

A Mess?

“By looking at Japan in the 1990′s and early 2000′s we can see the results of a Keynesian solution to a set of facts almost identical to our present situation. The “solution” caused a 15-year (1990–2005) stagnation of the Japanese economy. …

Here’s the Japanese experience which is startlingly similar to our present situation.

1. They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987.
2. Real estate and equity prices soared.
3. To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
4. The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
5. GDP grew at only 1.17% from 1992 to 2003.
6. Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
7. Consumption and investment fell dramatically.
8. Banks were not lending.

What was the response of the government to this crisis?

1. In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
2. From 1992 to 1995 they spent 65.5 trillion yen on projects and cut taxes.
3. In 1998 they cut taxes 2 trillion.
4. In 1998 they spent another 40.6 trillion on spending stimulus.
5. In 1999 they spent another 18 trillion in fiscal stimulus.
6. In 2000 they tried another 11 trillion spending package.
7. They set up a 20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
8. To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of 2.22 trillion.
9. Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
10. They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.

It is estimated that the Japanese spent about $1 trillion about (\135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP, and the yen devalued. Nothing seemed to work.

Remember some of the hallmarks of the Japanese experience? “Zombie Banks” were banks that the government allowed to keep their doors open although they were really insolvent. “Zombie Corporations” were the companies whose debt were held by zombie banks, but were allowed to stay in business because the zombie banks didn’t write off these loans. “Window sitters,” a term applied to workers of zombie companies who showed up for work every day for a paycheck, presumably gazing out the window all day with nothing to do.

The irony of it is that they are trying the same things again in this crisis, with the same results. The Bank of Japan just predicted two years more of deflation, and unemployment is up to 5.5%. Exports, the mainstay of their economy, are falling off a cliff (11 straight months of decline). It reminds me of a definition of insanity: expecting a different result to occur from the same input, over and over again.

Does the Japanese scenario sound familiar? It should since the USA is doing most of the same things as they did.

1. The Fed reduced the Fed Funds rate to 0.25%.
2. The government has hugely increased the base money supply in an attempt to create inflation.
3. The government has spent or pledged about $2.7 trillion dollars in direct loans, bailouts, debt purchases, grants, and wasteful spending projects.
4. The guarantees to Fannie, Freddie, Sallie, and the FHA, plus additional backstop guarantees by the Fed and the Treasury amount to almost $10 trillion.
5. The Obama Administration expects the national debt is to increase by almost $10 trillion over the next 10 years (a very conservative number considering the new national health care plans). This will get us to a national debt of about 200% of GDP.
6. Programs like Cash for Clunkers, Cash for Refrigerators, and Cash for houses are trying to stimulate consumer spending and increase consumer debt.
7. Like Japan, mark-to-market accounting requirements for banks have been partially suspended.
8. The Fed has been directly financing corporations through its commercial paper lending window.
9. TARP, TALF and the host of other programs were implemented to keep bankrupt institutions afloat.
10. They have been buying stock in financial and commercial companies.
11. They have been buying U.S. debt, effectively partially monetizing the deficit.

It is not surprising that these policies have led us to many of the same results as Japan experienced:

1. Deflation.
2. Collapsing real estate values.
3. A shrinking money supply.
4. Decreased bank lending.
5. Falling consumer spending.
6. Falling consumer credit.
7. Increased federal debt.
8. Falling GDP.
9. High unemployment.

One might ask, with all this faith in Keynesian policies, why aren’t they working? And, why aren’t we doing something different than Japan?

The reason the economy is not responding is that there is too much bad debt sitting on the books of lenders and companies.  Most of it is related to the real estate bubble: home mortgages, commercial real estate loans, consumer debt, and the derivatives and other products that sit on top of it.

Banks are afraid to lend or foreclose on bad debt unless they are forced to because they know they will need to come up with additional Tier 1 capital because their capital base is insufficient. Because credit is tight, home owners are finding it difficult to refinance their loans because of stricter underwriting standards while home values are falling. CRE loans are even more difficult because commercial financing has largely dried up for troubled projects.

And, consumers aren’t borrowing because they are (i) afraid of their economic future, and (ii) the big spenders, the Boomers, don’t have enough saved up to retire, so savings are going up.

This is why banks aren’t lending.  As a result, money supply is falling. This will continue until the debt situation is resolved, but the government is doing everything it can to frustrate these corrections because they know the cure (tight money) will cause more banks and business to fail. But unless the debt is removed, liquidated, or paid, banks will remain zombies.

If we are following Japan’s remedies, will we experience Japan’s economic results? This depends on a lot of factors, mainly how the government reacts to economic phenomena. But, all things being equal, I think there are several key differences and similarities between the U.S. and Japan that will determine a different outcome.

Bernanke will teach the Japanese a lesson in the proper way to run and economy? He will pump money until we have inflation because he fears deflation more than inflation. Because he doesn’t understand the real lessons of Japan, we will have stagflation, and his successor will probably try the same failed remedies to save us from that too.” By Jeff Harding

It will be a mess . . .

However let’s look at one example that is current and seems to have worked – Iceland!

You may remember, two years ago Iceland was a mess. Its banks had borrowed, lent, and speculated recklessly. At first, the government decided it would do what Ireland was doing. It would rescue the banks…that is, it would bail out the banks’ lenders with public funds.

But when the public caught on to what was going on, a referendum was held. Voters rejected the bailout, more than 90% of voters cast ballots against a taxpayer bailout. Unable to stick the voters with the losses, the government left the banks to default.

Was this the end of the world? Did Iceland slip below the North Atlantic waves…joining the Titanic on the chilly, dark bottom of the sea? Did commerce break down? Did the Icelandic money become worthless?

Nope.

“Iceland is faring much better than anybody expected,” reports Bloomberg.

Inflation fell from 18% down to 5% last year. The cost of insuring Icelandic debt fell to less than a third of the price in early 2009. Unemployment is barely 6%.

“Thanks to its rescue plan,” says the IMF, “the recession in Iceland has been less deep than expected and not worse than in the other countries deeply affected.”

The IMF in my opinion is taking glory for doing nothing!

As no one would lend Iceland any more money. And once the public revolted, after realizing that it would be left holding the bag, the Icelandic feds had no choice. They were forced to go with the following;

1. The foreign debt was consolidated into a few banks…which then went broke.
2. The remaining banks were left intact, ready to keep the country’s financial machinery in business.

Lesson learned: got too much debt? Default quickly. Make it clean. Make it fast. Make it work.

Somehow I doubt the Europeans and the Americans are going to take this route, that is until the market forces this outcome . . . time will tell.

The sinking ship of Japan

The Fed does not hold a monopoly on policy mistakes. On that account, Japan is in a league of its own, although many other countries are doing their very best to catch up. The Japanese combination of very high debt levels combined with outright deflation is a lethal cocktail, and one which the Americans are clearly desperate to avoid. I have borrowed two charts from Dylan Grice at SocGen to illustrate the enormity of Japan’s fiscal problems. Almost 60% of its tax revenues now go towards servicing its rapidly growing debt (see chart 1 below) and tax revenues no longer cover even the bare necessities – debt service, social security and education (see chart 2).

1. 1.       Debt Service in Japan

 

Source: SocGen Cross Asset Research, Japan’s MoF

With the savings rate in free fall, and with record low bond yields, how much longer can the Japanese finance their debt domestically? Eventually, when they have to go to international capital markets to fund their out-of control deficit, will there be any buyers of 10-year JGBs at 0.95%? I very much doubt it. On that account, I have noted that the tide has already turned. As you can see from chart 3, there has been a substantial capital outflow from Japan this year.

1. 2.       Tax Revenues in Japan

 

Source: SocGen Cross Asset Research, Japan’s MoF

You may ask, if investors are fleeing Japan, why is JPY not weakening? I only know one possible explanation (courtesy of Morgan Stanley). Much of the capital which is leaving Japan is finding its way into US Treasuries, and most of those investments are fully hedged, which neutralizes the effect on the currency. In short, when you take money out of Japan to invest in the US, you sell JPY against USD; when you subsequently hedge your currency risk, you sell USD against JPY.

Chart 3: Japanese Resident’s Activity in Foreign Bonds

 

Source: Morgan Stanley, Japan’s MoF

But the conclusion remains the same. If (when) there are no longer enough investors to buy the JGBs, or if (when) Japanese investors stop hedging their currency exposure when investing abroad, the pressure on JPY could become immense.

So get out of Yen while you can at around 80!

RMB Currency Trader. And I quote:

The Land of the Rising Sun has the dubious distinction of sporting the highest debt-to-GDP ratio of any industrialized nation in the world. Now greater than 200%, Japan’s relative debt load is bigger than that of Greece, Spain, Portugal or the US. Japan needs to borrow over 50% of GDP this year just to stay afloat, according to the International Monetary Fund (IMF), and its financing needs are expected to reach almost 60% of GDP next year. (See graph below.) Its strength has been somewhat befuddling, especially considering this growing burden of debt.

 

Why has the Japanese currency been so strong? Because despite all of the yen’s problems, Japan runs a trade surplus. Traders view that surplus as a source of funding which can be used to pay down Japan’s skyrocketing debt, making the yen seem like a “flight-to-quality” currency despite appearances. However, Japan’s strong currency is beginning to affect Japan’s ability to export. Competition from China and rising Asian powers such as Vietnam is also beginning to take its toll. Japanese industrial output fell 1.9% in September after dropping 1% in August.

To remind you why you should hate the Japanese currency, I’ll refresh your memory with this short list:
* With the world’s weakest major economy, Japan is certain to be the last country to raise interest rates.
* This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets.
* Japan has the world’s worst demographic outlook that assures its problems will only get worse. They’re not making Japanese any more (well just not very fast).
* The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt approaching 225% of GDP,  Japan is at the top of the list.
* The Japanese long bond market, with a yield of a scant 1%, is a disaster waiting to happen.
* You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country’s beleaguered exporters.

When the big turn is inevitably confirmed, we’re going from ¥83 to the initial target of ¥85, then ¥90, ¥100, ¥120, eventually ¥150

Make sure you have Your Own PERSONAL pension plan!

The Toronto Sun reports, Canadian Feds have $65B pension funding shortfall:

The federal government has underestimated its employee pension obligations, exposing taxpayers to a $65 billion shortfall, according to a new report released Thursday by the C.D. Howe Institute.

Using fair-value accounting, the measure used in the private sector and based on solvency, the think tank calculated Ottawa’s net pension obligation stands at nearly $208 billion. That’s $65 billion more than reported in the public accounts.

The government lists its unfunded liabilities in the country’s national debt at $143 billion.

Taxpayers could be on the hook to back-fill the funding gap, the report by Alexandre Laurin and William Robson said.

On top of that, large exposure to public sector pensions could fuel fears of sovereign default driving up the cost of borrowing.

“The larger-than-reported gap between federal pension promises in these plans and the assets that back them is a problem, both for federal employees and for taxpayers,” the pair said.

But Canada is not alone. European and U.S. governments share the problem. The United Kingdom for instance is facing a $1.8 trillion shortfall and the U.S. has $3 trillion.

GOLD;

Personally I think we are only in the early stages of the mania phase, and this phase could last many, many years dependent upon the unparalleled consistent stupidity of regulators and rulers.

 

The Nasdaq chart on the left is a 12 year chart while the Gold chart is a 10 1/2 year chart. Both charts are monthly.  The point in making both charts monthly is that you, I and everyone else can clearly see there is nothing close to even the beginnings of a blow-off top in Gold yet.

Give us a call on which gold fund is the best to invest in . . 03 5724 5100

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Fund	Share Price as at 31/08/2010	Total Return to 31 August 2010			Average Annual Return Since Launch
		Last 12 Months	3 Years	5 Years
Student Accommodation Funds
Student Accommodation Fund (£) Launched 15 June 2000	£2.56	+9.87%	+33.33%	+62.03%	+9.68% p.a.

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