Heinz makes russells letter. and why not, russell gets half his ideas from here and CFZ HO HO HO.
July 29, 2003 -- Is there anything ethically or philosophically wrong with the central bank system of money as it has evolved? My answer is yes. As gold was systematically removed from the system, the system became a "fantasy system." I say fantasy because the central banks are able to create money at will. with no discipline to stop them. This I believe -- is immoral, even evil. The current system allows a central bank to create money out of nothing -- whereas I and my fellow Americans have to work for that same money.
Is it ethical, even logical, that I have to work my whole life to make say a million dollars when the Federal Reserve can, in a minute, create billions of the same fiat dollars that I work so hard for? The system defies logic and defies reality. It's a scam.
But because there is no limit to the fantasy-dollars that the system has created, the system has simultaneously created a giant edifice of debt. Nobody is certain how much debt has been built into the US structure, but the accepted figure is around $38 trillion. If you figure that the average interest on this debt is 5%, then you are talking about $2 trillion a year needed to service that debt.
Thus, the system now requires inflation to handle the debt. You see, inflation renders debt less onerous through time.
This explains why the Fed is so terrified of deflation. In deflation, debt become increasingly difficult if not impossible to handle. In deflation dollars become scarcer and more potent, while the debt remains constant. This, is a nutshell, is why the Fed is so frantic to thwart the forces of deflation.
The forces of deflation? What forces? During the '90s people, cities, states, the federal government, corporations -- they all borrowed heavily. A huge world of "prosperity" was created. But alas, the structure toppled over starting in late-1999. We refer to that as the "bursting of the bubble."
Why did the structure topple over? It toppled because "no tree grows to the sky." It's as simple and yet as mysterious as that.
But worse, at the same time, a number of deflationary forces came to the fore. They were --
The Internet, which allowed people to find the cheapest item.
China and Asia, which gave manufacturers and service providers a way of drastically cutting their costs.
Wal-Mart, which now accounts for 1.3% of the GDP of the nation. WMT gave people an outlet for Chinese goods. WMT is now a giant, fast-growing chain that cuts prices mercilessly.
The global economy, which allows every nation to compete for exports with every other nation. This resulted in what I call "the end of pricing power." Today nobody can raise their prices and no manufacturer can raise its wage scale.
The US negative current account, which exports tens of billions of dollars to other nations, and which has allowed Asians to built up their manufacturing facilities and thus compete with US manufacturers.
The relentless rise in unemployment, which is a fear factor for the US population -- and also a force for deflation.
All the above represent the forces that now threaten the current system of fiat money. Above all they threaten the edifice of debt that was built up during the '90s.
What is the Fed to do in the face of these forces of deflation, and the death of pricing power?
The Fed's answer is that "We will absolutely not allow deflation to enter the picture. We'll preempt deflation. Since deflation is basically 'too many goods confronting too little money,' why we'll defeat deflation by creating so much money that deflation will be swamped. We'll drown the forces of inflation with a veritable ocean of liquidity."
Can it work? Can the Fed defeat the natural forces of correction and contraction that is following the collapse of the greatest financial bubble in history?
The Russell answer -- It can work for a while, and, in truth, it has worked for a while. But what has also happened is that in its inflationary frenzy, the Fed has injected even more debt into the system. As I see it, three major problems have been rendered even worse.
First, a housing bubble has been built. Due to low mortgage rates, Americans have rushed into housing, driving home prices up to absurd prices. And with the housing boom, more debt has been built into the system.
Second, the stock market bubble has been brought back. Is the stock market a bubble? With the S&P selling at 32 times trailing earnings and providing a yield of 1.70%, I say that the stock market is now most definitely in a bubble.
Third, in driving short rates down, the Fed has created a bond market bubble. At the recent low, 10 year T-notes were yielding 3.1%, rates not seen in almost five decades. The bond bubble has now suddenly and totally burst, sending bond rates and mortgage rates higher. This morning the rate on 30-year fixed-rate mortgages rose to 5.71%.
So what lies ahead? What I see is a continued battle on the part of the Fed to thwart the forces of deflation. The more persistent the forces of deflation, the greater will be the Fed's inflationary efforts. The Fed will use every resource, every "trick in the books," to thwart deflation. I call it a "death struggle." It's a battle the Fed has vowed not to lose.
In the end, the Fed's all-out inflationary war will impact on the dollar. Too many dollars will be created (of course that's happened already), but as the dollar is systematically destroyed, bonds will become suspect, and the whole world of financials will come under suspicion.
The flow of funds will turn from the financials that are denominated in "funny money" to tangibles which possess an intrinsic value of their own. Among the financials that will stand out, I believe, will be the precious metals. Gold and silver possess intrinsic value based on 5,000 years of human history. Gold and silver are the financial equivalents of a Picasso painting or a ten carat D-color VS-1 diamond. The difference is that gold and silver are priced every minute of the day while the price of a Picasso or a diamond is ultimately determined by auction.
Enough already, let's turn to the stock market. You know I've been waiting to see whether the Dow would confirm the new highs in the Transports. A confirmation would entail the Dow closing above its June 17 close of 9323.02. So far, Industrials have not confirmed. That's the Dow Theory near-term picture. And it's a negative picture.
From Investor's Intelligence we receive the run-down on "buying climaxes." Four weeks ago we saw a record number of buying climaxes. But last week buying climaxes totaled a new record 531 buying climaxes. Buying climaxes occur when a stock rises to a 52-week high but then closes down for the week. Buying climaxes represent distributions. The 531 buying climaxes recorded last week smacks of across-the-board distributions by investors who are slowly and subtly "cashing out."
Yesterday was also the second day in which we saw the VIX close below 20. I take this as simply "too much complacency."
Then my own Big Money Breadth Index and my Most Active Stock Index appear to have topped out. You can see these charts by clicking on them on my home page. My PTI has been working its way down, and as of yesterday, the PTI was only 19 points above its moving average. A decline by the PTI below its moving average would constitute a bear signal.
So much for the stock market -- at least until today's close.
Next, I want to talk about silver. And below you see a daily chart of silver.
What we see here is the huge surge by silver out of its base, a surge that carried silver (well, actually it gapped silver) well above its previous peak recorded in June. When you see this kind of a move, you know that the item is sold out, and you know that the short sellers have been taken by surprise.
Silver today is cheap vs. stocks, and silver is even cheap compared with gold.
[Intraday Quote] Charts: [Weekly] [Monthly] [
A few facts about silver --
This months the 20-month MA of silver will cross above the 40-month MA, giving a major bull signal.
This month Sept. silver closed above its preceding important peak at 5.15.
In July 1999 one ounce of gold would buy 47 ounces of silver. Gold's relative strength continued to rise against silver until May 2003. In May of 2003 one ounce of gold would buy 80 ounces of silver. As of today, one ounce of gold will buy 70.5 ounces of silver. Silver is still very cheap relative to gold.
I continue to view silver as a cheap holding as I do the leading silver stocks including PAAS and SSRI.
Assorted general thoughts -- I think there's at least an even chance that the stock market rally from the March lows is in trouble. It's been over month since the Dow has recorded a new high. Since June 6 the Dow has had every chance to rally above 9323.02. Why, with business supposedly improving, has the Dow failed to confirm the Transports? The hard fact is that it hasn't, and I take, that as a bearish omen. The significance of the non-confirmation by the Dow is heightened by the fact that literally nobody has noticed or commented on it.
I take the record number of buying climaxes (531) last week as important evidence of distribution. The 531 includes buying climaxes on all three exchanges.
Lowry's Buying Power Index, as of yesterday, dropped to a new three months low. All that is missing to send this market lower is an increase in Selling Pressure. If the market continues to erode, I believe stockholders will become discouraged and begin to sell.
The two consecutive days of below 20 in the VIX bespeaks of extreme complacency; We have also had many months in which advisory bulls outnumbered advisory bears. A few weeks ago the bearish percentage dropped to its lowest level since 1987. Just too much bullishness for too long.
Insiders have been selling for weeks on end at a ratio of 4.1 sales for every one purchase. This is a negative.
Under the 50% Principle, as long as the Dow trades below 9504 the Dow will be in a long-term negative position. In fact, the longer the Dow remains below 9504, the more negative the situation.
I look at it this way. The Fed has been flooding the US economy with liquidity for months on end. With all the this surging liquidity, the Dow has, so far, failed to regain even half of its bear market losses. Let's see if this situation continues.
TODAY'S MARKET ACTION -- To my mind, today's feature was the continuing collapse in bonds, but more about this later.
My PTI was down 8 to 5293. Moving average was 5283, so the PTI remains bullish by 10 points.
The Dow was down 62.05 to 9204.46 and has still not confirmed the Transports.
Sept. crude was up .13 to 30.24.
There were 1228 advances and 2062 declines. Dow volume was 70% of up + down volume.
There were 138 new highs and 55 new lows. This is the most number of new lows since mid-March. My High-Low Index was up 83 to 7370.
Total NYSE volume was 1.34 billion which makes this a "distribution day."
S&P was down 7.24 to 989.28.
Nasdaq was down 3.96 to 1731.40 on 1.65 billion shares.
Sept. Dollar Index was up .15 to 95.43. Sept. euro was down .32 to 114.55. Sept. yen was down .24 to 83.63.
German DAX was up 10 to 3438. Sept. Nikkei was down 75 to 9805.
Bonds are going through about the worst collapse I've ever seen in a single month. The Sept. 30 year T-bond was down 108 points to 107.02 to yield 5.33%. Sept. 10 year T-note was down 25 ticks to 111.17 to yield 4.44%.
The 30 year fixed rate mortgage is now 5.71%.
August gold was down 3.20 to 361.70. Sept. silver was down 3 to 5.18. Oct. platinum up 1.60 to 698.00. Sept. palladium up 4.86 to 178.36.
Gold/Dollar Index ratio was down 4.20 to 378.70.
One share of the Dow buys 25.44 ounces of gold.
Gold advance-decline line was down 16 to 1212.
ABX down .80, AU down .96, DROOY down .03, GFI down .30, GG down .19, GLG down .47, HMY down .34, NEM up .46, PDG down .48, RGLD down .28.
Bonds collapsing is deflationary, and this might have affected gold today.
STOCKS -- My Most Active Stock Index was down 7 to 215.
The 15 most active stocks on the NYSE were -- NT up 3.48, PFE down .23, TYC down .73, AOL up .07, GE down.47, PCS down .17, AWE down .38, MRK down 1.33, EMC up .18, F down .05, C down .41, MCD up .84, XOM down .37, HPQ down .03, JNJ down .77.
VIX was up .30 to 20.23 -- little fear being shown here.
McClellan Oscillator was down 35 to minus 134. The market remains in oversold territory.
CONCLUSION -- Very strange day. The wide open collapse in bonds goes on, but it didn't appear to bother the stock market that much. And I wonder -- who's selling all these bonds? Could it be foreign selling? Interest rates are surging -- an event that the Fed said it would not tolerate. Where's the Fed? They couldn't be buying bonds -- or if they are buying bonds they're sure not making a difference.
Consumer sentiment out today fooled the experts by dropping from the expected 83 to 76. Are consumers becoming discouraged? Can't tell yet, and I was never taken with these polls.
The big question in my mind is whether selling pressure increases. It didn't appear to today, but this is only one day. I'm amazed that the bond smash hasn't drawn more attention. This is an historic bond collapse, and billions of dollars in bond values have been wiped out.
What a time for California which has just seen its general obligation bonds down-graded to BBB, very close to junk. For the first time in its history, the state of California is living totally on borrowed money.
Signing off for today,
Russell
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Amazing idea -- The Pentagon is setting up a commodity-style market using real investors who will put down real money -- to help it predict terrorist attacks and other turmoil and problems. In this way, the Pentagon will be able to study the wisdom of the free market on such weighty problems as the impact of US involvement on Iraq or the stability of the Saudi Arabian monarchy. The technology was developed by San Diego based Net Exchange in conjunction with DARPA and the Economist Intelligence Unit.
Using a market-style trading system, up to 10,000 investors would buy future contracts if they believe an event will occur and try to sell a contract if they believe it won't occur. The investors would be motivated by profits or losses.
Russell Comment -- A brilliant idea. Follow the money!! Wonder what the consensus would have been if they had voted prior to the Iraq incursion.
Whoops -- just heard that the above was cancelled. I don't think the brass in Washington want their orders second-guessed by a public poll. Too dangerous for these goof-balls to deal with.
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A very important piece by the one and only Dr. Kurt Richebacher, courtesy the Daily Reckoning.
AN OPEN MOUTH
By Kurt Richebächer
The people who expect a double dip or worse in the United States certainly
represent a small minority. Among policymakers and economists in America, it
is a virtual consensus view that the Great Depression of the 1930s as well
as Japan's present, protracted economic quagmire have their decisive cause
in one crucial policy mistake: both central banks were much too slow in
lowering their interest rates when the economies began to weaken.
All this really boils down to one key question: When do central banks make
their decisive mistake? Is it during the boom and the bubble? Or is it in
their aftermath?
Convinced he had learned from history, Mr. Greenspan slashed the Fed's
federal funds rate with unprecedented speed from 6.5% to just 1%.
Establishing thereby a steeply sloped yield curve, his aggressive rate cuts
had sweeping effects also on long-term rates, as investors and speculators
stampeded into highly leveraged purchases of higher-yielding longer-term
bonds.
In principle, central banks have but two instruments at their disposal to
influence money and credit growth with the ultimate aim to curtail or to
stimulate economic activity: adjustments in bank reserves through open
market operations; and adjustments in its key short-term rate or rates.
Yet there is still a third, unconventional instrument of which central
bankers have made very different or no use of at all. It has sometimes been
called a central bank's open-mouth policy. Mr. Greenspan is definitely the
world's one central banker who has practiced this extraordinary tool with
unusual abundance and aggressiveness. He, apparently, regards it as
perfectly legitimate for a central banker to bend expectations in the
economy and the markets in a direction he wants.
During America's boom and bubble years, Greenspan was effectively the most
prominent and also the most pronounced New Era Apostle. In various speeches,
he developed arguments or "theories" plainly rationalizing and fanning the
euphoria in the stock market.
In his famous Boca Raton, Fla., speech on Oct. 28, 1999, just a few months
before the stock market's crash, he suggested that the unprecedented equity
valuations seemed to be the appropriate response of investors to the
economy's advanced information technology:
"The rise in the availability of real-time information has reduced the
uncertainties and thereby lowered the variances that we employ to guide
portfolio decisions. At least part of the observed fall in equity premiums
in our economy and others over the past years does not appear to be the
result of ephemeral changes in perceptions. It is presumably the result of a
permanent technology-driven increase in information availability, which by
definition reduces uncertainty and therefore risk premiums. The decline is
most evident in equity risk premiums.
"But how long can we expect this remarkable period of innovation to
continue? Many, if not most, of you will argue it is still in its early
stages. Lou Gerstner (IBM) testified before Congress a few months ago that
we are only five years into a thirty-year cycle of technological change. I
have no reason to dispute that."
Having learned nothing from his past blunders, Mr. Greenspan is at it again.
To quote Fed mandarin Vincent Reinhart: "The Federal Reserve has always
appreciated the importance of correctly aligning market expectations."
Putting it rather more bluntly, the Fed endeavors "to manipulate market
expectations in the direction that the Fed desires."
During the late 1990s, Mr. Greenspan was keen to foster the stock market
bubble by aggressively manipulating both market rates and market
perceptions. After the equity crash of 2000, he has become keen to foster
the three new bubbles he kindled in fighting the burst of the stock market
bubble - the house price bubble, the mortgage refinancing bubble and the
bond bubble.
Together, these bubbles are plainly indispensable for maintaining some zip
in consumer spending.
But among the three bubbles, one is of crucial importance because it drives
the other two. That is the (now hard-pressed) bond bubble. Refinancing
activity tends to pick up significantly whenever mortgage rates drop below
previous lows. Importantly, Treasury yields guide the movements of mortgage
rates. In essence, it was the sharp drop of Treasury yields over the past
two years that led the simultaneous, steep decline of mortgage rates. The
recent, renewed sharp drop in Treasury yields gave mortgage refinancing
another strong boost.
Within barely six weeks, 10-year Treasury yields plunged from close to 4% to
close to 3%. In sympathy, mortgage rates fell to 5.21%, the lowest rate in
more than four decades.
The astonishing thing about this sudden decline in market interest rates was
that it happened at a time when the stock market was, on the contrary, being
carried upward by spreading hopes for the economy's imminent recovery. What
happened to make this new, sharp decline of longer-term interest rates
possible?
In its May 29 editorial, The Wall Street Journal praised the Fed chairman
for his wily gamesmanship. "Merely by talking about deflation, he's made the
markets anticipate easier money; long-term interest rates have fallen
accordingly, helping to keep housing prices afloat and to spur one more
round of home mortgage-refinancing. This in turn feeds consumer confidence
and helps keep the post-bubble economy growing. As a monetary gambit,
uttering the word deflation has so far been a great tactical success. We
suppose that's worth the price of scaring people about an economic threat
that isn't very likely."
In short, being assured by Mr. Greenspan and other Fed members that there
would be no interest rate hike as far as the eye can see, investors and
speculators, desperately hungry for big profits, stampeded into heavily
leveraged bond purchases, giving through the sliding yield a new strong
boost to mortgage refinancing.
Closer to the truth: In the guise of worrying about the evil of deflation,
Mr. Greenspan signaled to the marketplace his determination to accommodate
unlimited leveraged bond purchases. Investors and speculators complied with
enthusiasm, giving long-term rates another sharp downward tick. Implicitly,
in a country with negative national savings, any decline in market interest
rates can only come from financial leveraging.
In this way, the last bit of restraint on financial leverage and speculative
excess in the markets was effectively removed. Endless liquidity is
available for the taking by the speculating financial community. The obvious
result is a credit and bond bubble that meanwhile has vastly outpaced the
excesses of the equity bubble.
The fundamental dilemma today is that undefined by every method available -
the Greenspan Fed and Wall Street are making desperate efforts to sustain
unsustainable bubbles. Of these, the belabored bond bubble is now our
greatest fear. Its influences have pervaded the whole economy and the whole
financial system, and its bursting may have apocalyptic consequences.
Regards,
Kurt Richebächer
for the Daily Reckoning
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Dear Russell,
A friend of mine who is a subscriber to your service sent me the following excerpt from a recent market commentary of yours:
"I'm not a fan of the South African government. These are good
mines, but the S. African mines are heading for a possible strike, and the S.
African government wants to be a "partner" in the gold mines. I have a
position in Harmony and Durban, but I'm not excited about these positions. I'm
thinking about switching these stocks to Newmont. But I haven't moved yet."
As a South Africa 'veteran' (i've lived 10 years in SA and spent several of those trading on the JSE), i feel compelled to briefly comment and perhaps help to clear up the issue a bit. i'm not a big fan of the SA government either - but it is the cream of the crop in Africa. its economic policies are by and large market-orientated, and its central bank is far more conservative than Greenspan's "print as much as you can" outfit. it is true that recent legislation aimed at addressing perceived economic wrongs dating from the apartheid era amounts to a bit of social engineering that SA would probably be better off without. but the government does NOT want to be a 'partner' in the mines as you put it. it merely mandated a racial quota w.r.t. to mine ownership, and gave the mines ample time to implement it. this sounds threatening, but in reality it isn't. in fact, the major producers have all already implemented the requisite transactions, and it is important to note that those t!
Transactions were all done at fair market prices. essentially, black-owned mining consortia have taken stakes in the major producers, or alternatively entered into joint ventures with them, but not on conditions that were any different from what comparable free market transactions sans compulsory legislation would have looked like. in other words, shareholders were not cheated, which is quite different from the way things are done in e.g. Zimbabwe and many other African nations. the big rally in the SA Rand over the past year speaks for itself: foreign investors have confidence in South Africa and its economic policies.
of course the strong Rand also hurts the earnings of SA based miners in the short term. but the fact remains that these mines harbor some of the biggest gold deposits in the world, and due to the marginal nature of many of their assets they have extraordinary leverage to the gold price. just to give you an example as to why serious gold investors simply can't overlook the South Africans: one of GFI's flagship mines, Kloof, has 20 million ounces of gold 'below works', i.e. right underneath the existing infrastructure of the mine. these ounces are not mentioned anywhere as resources or reserves, but they are there. i can name 10 mid tier NorthAm producers that don't have as much gold in the ground TOGETHER as Kloof has 'below works'.
as an aside, there are few things more overstated in the course of investment history than 'political risk' in South Africa. the fact is, SA's mines have paid dividends to their shareholders without interruption since the 1880's, even through the world wars, and all sorts of political upheavals, external as well as internal. the last miners strike was in the 1980's, almost 20 years ago. the recent strike threat once again proved to be nothing but brinkmanship by the NUM, a negotiation ploy basically (just as Durban Deep ALWAYS threatens to close down its mines when wage negotiations are underway).
in my opinion, although the SA gold producers are currently out of favor with the investing public, there can be no doubt that they will regain their leadership position if/when gold continues to rally (as both you and i expect it to). one should look at the current bargain basement prices as an opportunity rather than something to be feared. leadership in bull markets changes frequently, and my hunch is that the South African stocks will come into focus again once the coming quarterly earnings reports (which will be bad due to the strong Rand, but still better than those of 90% of their North American competitors aside from perhaps NEM) are out of the way. currently these stocks are discounting the end of the world, which is basically silly. but that's how markets often are...they exaggerate both on the upside and on the downside, and these inefficiencies are what allows us judicious investors to make money after all.
best regards,
heinz blasnik
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