Sprott calls it a depression
Sprott: Surviving the Depression
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Surviving the Depression
MARKETS
AT A GLANCE
Eric Sprott
Sasha Solunac
Sprott Asset Management
Far be it from us to mince words. Make no mistake – we are in a Depression.
That’s right, it’s the dreaded ‘D’ word. And we are knee deep in it right now. This is
not a run-of-the-mill recession. Does anyone still believe we’re in for just a few
quarters of, at worst, low single-digit economic contraction, after which things will
return to normal? We find it shocking that most economists still do. This is far
worse than a recession. It’s a Depression. To call it anything else is to ignore the
obvious.
The official GDP data by the US Department of Commerce is, of course, woefully
unreliable, being continually revised years after the initial release. Be that as it may,
the National Bureau of Economic Research officially announced, albeit almost a
year after the fact, that the US has been in recession since the fourth quarter of
2007. But if Q4 of 2007 was an economic contraction, then Q4 of 2008 is an
outright economic collapse. All the data points are showing that economic activity,
right here and right now, is falling off a cliff in unprecedented fashion.
Auto sales in the US in the month of November were down 37% year-over-year, to
an annualized rate of 10.2 million units. This is a level not seen since 1982. Last
year at this time (during a recession) cars were being sold at a 16.4 million unit
annual rate. Throughout this decade, 16-18 million automobiles have been sold in
the US each and every year like clockwork. Now it’s 10 million. That’s a
depression-sized decline. US housing starts in the month of November were down
18.9% from October, and down 47% from November of last year, to a 625,000
annual rate. To put this in perspective, during the first half of 2006 housing starts
were running at a 2 million annual rate. Once again, this is a depression-sized
decline in economic activity. Just think of all the construction jobs being lost.
US jobless claims for the week ended December 6 were 573,000, the highest in 26
years. Mass layoffs are making headlines on a daily basis. In finance. In
manufacturing. In retail. In construction. In transportation. In services. In tech…
you name it. Challenger Gray reported 182,000 announced layoffs from big
corporations for the month of November, the worst month since the months
following the 9/11 attacks. The ADP report just released estimated that 250,000
jobs were lost in November. All sectors are in steep economic decline and laying off
workers en masse. US industrial production was down 5.5% in November over last
year, making this quarter the worst since 1980. Little wonder that consumer
confidence continues to fall off a cliff, with the RBC Cash Index falling to 15.3 in
December from 34.7 in November, and the University of Michigan consumer
sentiment index recently hitting a 28-year low. Furthermore, the company surveys
that we follow (timely measures of recent economic activity across a broad swath of
the economy) are all currently plunging, showing depression-type declines.
If Q4 2007 was the start of the recession, then Q4 of 2008 is the start of the
Depression. It’s only getting worse. We’re not aware of a single bright spot in the
economic data that would even remotely hint at things getting better anytime soon.
We are in the midst of an unprecedented global economic contraction, with no
prospect for one region to ‘save’ the others. This depression is global, pervasive,
and deep. Some may point to plunging interest rates, already at zero in the US, as
a ‘data point’ indicative that things are about to turn around soon. We believe the
opposite to be the case. Zero percent interest rates are an ominous symptom, not
the cure. In a recession, zero interest rates are highly stimulative. In a depression,
they are not. Monetary policy has been little more than a sugar-coated placebo.
Credit is neither cheap nor plentiful. Just ask the Bank of Montreal, one of the big
banks in the highly admired Canadian banking system, that recently did a bond
issue (not stock, not preferred, but straight-up plain-vanilla bond) at a 10% interest
rate. Central bank interest rate policies have become irrelevant. Once again, this is
highly indicative that we are in a depression. Corporate spreads have gone through
the roof. Not just for junk bonds, but all bonds, even AA rated.
Any belief that this will be a short and shallow recession, or even a relatively long
and deep recession (but still a recession), is, in our opinion, woefully misguided
wishful thinking. This is a depression – one that has only just begun. One that the
vast majority of us (the sole exception being those over 80 years of age) have never
experienced in our lifetimes.
From an investment standpoint, we believe survival will be the name of the game.
By all accounts, 2008 was an awful year to be an investor in the markets. The
MSCI world index, a rough proxy of the developed world’s stock markets, is down
almost 45% year to date. The developing world’s stock markets have performed
even worse. That said, in any environment, even in a depression, there are asset
classes that can prosper. What are they? Looking at 2008 through a rear-view
mirror for the moment, there were four investment strategies that paid off and
‘survived’, at least for the time being. One is cash, specifically the US dollar (and
the yen, but we won’t be discussing the yen in this article). The second is
government bonds (not munis, not state, not county, but only Treasury bonds). The
third is gold (the physical, incorruptible currency/store of wealth). And the fourth is
shorting, specifically the stock markets, but any risky asset would have done nicely.
By any measure, these four strategies have been winners in 2008. The real
question, of course, is will these investment strategies also be winners in 2009, a
year when the financial crisis will have morphed into an economic one as well?
Let’s tackle the last first: shorting. Shorting is not an ‘investment’ strategy in the true
sense of the word. After all, if money could be made in the long term by shorting,
then capital markets as we know them would cease to exist. That said, shorting has
paid dividends (pardon the pun) from an investment survival standpoint, especially
as a hedge against other asset classes. Going into 2009, we believe shorting will
continue to be a prudent investment strategy. In a depression, corporate earnings
fall off a cliff, if they exist at all. Corporate survival can become tenuous, as debts
that were incurred during more prosperous times become increasingly onerous
(especially in a deflationary environment) during not-so-prosperous times.
Financing can be very hard to come by, oftentimes being extremely dilutive to
existing shareholders. We believe the stock market can fall a lot further from here.
Although current valuations may seem reasonable by most measures, they have yet
to fall below reasonable. In a depression, stocks will become downright ‘cheap’,
and still get cheaper. Going into 2009, there is definitely further downside risk in the
stock markets. Shorting will continue to be an effective strategy to offset this risk.
Next, let’s look at the US dollar and US government bonds, also winners in 2008.
But will this continue to be the case in 2009? We doubt it. For one thing, with zero
percent interest rates, the upside for Treasuries is effectively nonexistent. They
should perform no better than cash, and potentially worse. Treasuries have
become the opposite of cheap – they are downright expensive. By historical
measures, with 10-year yields at 2.1% and even the 30-year at 2.6%, US Treasuries
are the most expensive they’ve ever been. So let’s combine US Treasuries and US
dollars into one asset class, paper assets that promise to give essentially no return.
We continue to believe that the strength in the US dollar throughout most of 2008
was completely devoid of any fundamental basis. The recent relative weakness of
the dollar in the past two weeks, having broken down against other currencies, may
be signaling that the bull market in the US dollar is now over. As we mentioned in
previous articles, the dollar has been a beneficiary of the massive deleveraging that
has occurred as the 2008 financial crisis unfolded. However, very aggressive
measures, both monetary and fiscal, currently being employed will severely put into
question the notion of the US dollar as a ‘safe haven’ store of value. With a $400
billion budget deficit in the first two months of the 2009 fiscal year (started October),
the US government is well on its way to posting a $1 trillion deficit this year, more
than double any deficit in history and the largest deficit as a percentage of GDP
ever. Furthermore, in its desperate attempts to reflate the financial system, the
ultra-aggressive policies and programs of the Federal Reserve (to date the most
aggressive central bank in the world) also promise to ultimately debase the dollar as
a store of value. At a zero fed funds rate and quantitative easing now in full force,
the Fed has entered the realm of experimentation in uncharted territory, having
gone well outside the rules. On top of bailing out financial institutions left and right,
it is now also buying CDO’s and, in the new year, programs will be implemented to
buy asset-backed securities such as car loans, consumer credit card loans, and
student loans. What’s next? The Fed may soon be the buyer of last resort for
commercial real estate, or common equities. The long-held rule that the Fed is only
to deal in the highest quality and most liquid securities has been thrown out the
window. Although they may be justified in breaking the rules, the rules have been
there for a reason; namely, to maintain a sound and stable currency that people can
trust. When central banks start breaking the rules, look out. There are always
trade-offs and unintended consequences. Hyperinflation could be around the
corner. Don’t let the dollar’s status as the world’s reserve currency lull you into
believing that it couldn’t happen here. Any fiat currency is only as good as the faith
people have in its central bank. In 2009, we believe this faith will be severely
tested, especially in a depression scenario where the desire for competitive
debasement may be too tempting to resist.
Lastly, there is gold. Having started the year at US$800, as we go to press it is now
US$860. In other currencies, gold has performed even better. Although there may
be some who are disappointed that gold hasn’t performed better still, by now there
can be no question that in the midst of the 2008 global financial crisis, gold has
done exactly what it was supposed to do. Namely, protect portfolios against the
carnage that was experienced in almost all financial assets around the world. As
readers of this article know, we have been gold bulls for several years now. Given
recent developments, we have never been more bullish. Gold has proven itself to
be one of the very few safe harbour assets of 2008. Going in the depression of
2009, gold may well be the only safe harbour asset. We would strongly advise that
people protect themselves, and survive the depression, by owning gold.
We’ll finish this article by showing what the price of gold has done in 2008 in
different currencies. In a year like 2008, this is admirable performance by any
measure!
in Canadian dollars… up 23%
in Australian dollars… up 29%
in British pounds… up 34% in Icelandic kroner…up 95% |
