Thursday, October 30, 2014

Why Putin Has Been Able to Outwit America and Take Over the Global Energy Trade

By Casey Research
Vladimir Putin commands the utmost loyalty from those around him, whereas American politics is now characterized solely by infighting and self destructiveness. It’s this unity of purpose that explains how Putin and his St. Petersburg boys managed to rise to power from humble beginnings and why they’re winning the fight to control global energy trade. Putin is fiercely committed to restoring Russia’s superpower status using its vast energy resources as an economic weapon. Can American possibly compete?


Before Putin makes another move, pick up a copy of The Colder War and learn how his plans will directly affect you. You might even catch yourself admiring the man, save for the fact that all this is happening at our expense.




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Wednesday, October 29, 2014

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Monday, October 27, 2014

A Scary Story for Emerging Markets

By John Mauldin

The consequences of the coming bull market in the U.S. dollar, which I’ve been predicting for a number of years, go far beyond suppression of commodity prices (which in general is a good thing for consumers – but could at some point threaten the US shale-oil boom). The all too predictable effects of a rising dollar on emerging markets that have been propped up by hot inflows and the dollar carry trade will spread far beyond the emerging markets themselves. This is another key aspect of the not so coincidental consequences that we will be exploring in our series on what I feel is a sea change in the global economic environment.

I’ve been wrapped up constantly in conferences and symposia the last four days and knew I would want to concentrate on the people and topics I would be exposed to, so I asked my able associate Worth Wray to write this week’s letter on a topic he is very passionate about: the potential train wreck in emerging markets. I’ll have a few comments at the end, but let’s jump right into Worth’s essay.

A Scary Story for Emerging Markets
By Worth Wray


“The experience of the [1990s] attests that international investors have considerable resources at their command in the search for high returns. While they are willing to commit capital to any national market in large volume, they are also capable of withdrawing that capital quickly.”
– Carmen & Vincent Reinhart

“Capital flows can turn on a dime, and when they do, they can bring the entire financial infrastructure [of a recipient country] crashing down.”
– Barry Eichengreen

“The spreading financial crisis and devaluation in July 1997 confirmed that even economies with high rates of growth and consistent and open economic policies could be jolted by the sudden withdrawal of foreign investment. Capital inflows could … be too much of a good thing.”
– Miles Kahler

In the autumn of 2009, Kyle Bass told me a scary story that I did not understand until the first “taper tantrum” in May 2013.

He said that – in additon to a likely string of sovereign defaults in Europe and an outright currency collapse in Japan – the global debt drama would end with an epic US dollar rally, a dramatic reversal in capital flows, and an absolute bloodbath for emerging markets.

Extending that outlook, my friends Mark Hart and Raoul Pal warned that China – seen then by many as the world’s rising power and the most resilient economy in the wake of the global crisis – would face an outright economic collapse, an epic currency crisis, or both.

All that seemed almost counterintuitive five years ago when the United States appeared to be the biggest basket case among the major economies and emerging markets seemed far more resilient than their “submerging” advanced-economy peers. But Kyle Bass, Mark Hart, and Raoul Pal are not your typical “macro tourists” who pile into common knowledge trades and react with the herd. They are exceptionally talented macroeconomic thinkers with an eye for developing trends and the second and third order consequences of major policy shifts. On top of their wildly successful bets against the US subprime debacle and the European sovereign debt crisis, it’s now clear that they saw an even bigger macro trend that the whole world (and most of the macro community) missed until very recently: policy divergence.

Their shared macro vision looks not only likely, not only probable, but IMMINENT today as the widening gap in economic activity among the United States, Europe, and Japan is beginning to force a dangerous divergence in monetary policy.

In a CNBC interview earlier this week from his Barefoot Economic Summit (“Fed Tapers to Zero Next Week”), Kyle Bass explained that this divergence is set to accelerate in the next couple of weeks, as the Fed will likely taper its QE3 purchases to zero. Two days later, Kyle notes, the odds are high that the Bank of Japan will make a Halloween Day announcement that it is expanding its own asset purchases. Such moves only increase the pressure on Mario Draghi and the ECB to pursue “overt QE” of their own.

Such a tectonic shift, if it continues, is capable of fueling a 1990s-style US dollar rally with very scary results for emerging markets and dangerous implications for our highly levered, highly integrated global financial system.

As Raoul Pal points out in his latest issue of The Global Macro Investor,The [US] dollar has now broken out of the massive inverse head-and-shoulders low created over the last ten years, and is about to test the trendline of the world’s biggest wedge pattern.”

One “Flight to Safety” Away from an Earth-Shaking Rally?
(US Dollar Index, 1967 – 2014)



For readers who are unfamiliar with techical analysis, breaking out from a wedge pattern often signals a complete reversal in the trend encompassed within the wedge. As you can see in the chart above, the US Dollar Index has been stuck in a falling wedge pattern for nearly 30 years, with all of its fluctuations contained between a sharply falling upward resistance line and a much flatter lower resistance line.

Any break-out beyond the upward resistance shown above is an incredibly bullish sign for the US dollar and an incredibly bearish sign for carry trades around the world that have been funded in US dollars. It’s a clear sign that we may be on the verge of the next wave of the global financial crisis, where financial repression finally backfires and forces all the QE-induced easy money sloshing around the world to come rushing back into safe havens.

Let me explain…..

The EM Borrowing Bonanza
As John Mauldin described in his recent letter “Sea Change,” the state of the global economy has radically evolved in the wake of the Great Recession.

Against the backdrop of extremely accommodative central bank policy in the United States, the United Kingdom, and Japan and the ECB’s “whatever it takes” commitment to keep short-term interest rates low across the Eurozone, global debt-to-GDP has continued its upward explosion in the years since 2008… even as slowing growth and persistent disinflation (both logical side-effects of rising debt) detract from the ability of major economies to service those debts in the future.

Global Debt-to-GDP Is Exploding Once Again
(% of global GDP, excluding financials)

*Data based on OECD, IMF, and national accounts data.
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16th Geneva Report on the Global Economy, September 29, 2014.


As John Mauldin and Jonathan Tepper explained in their last book, Code Red, monetary policies have fueled overinvestment and capital misallocation in developed-world financial assets….

Developed World Financial Assets Still Growing
(Composition of financial assets, developed markets, US$ billion)

Data from the McKinsey Global Institute
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16th Geneva Report on the Global Economy, September 29, 2014.


… but the real explosion in debt and financial assets has played out across the emerging markets, where the unwarranted flow of easy money has fueled a borrowing bonanza on top of a massive USD-funded carry trade.

Emerging-Market Financial Assets Have Nearly DOUBLED Since 2008
(Composition of financial assets, emerging markets, US$ billion)


Data from the McKinsey Global Institute
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16th Geneva Report on the Global Economy, September 29, 2014.


These QE-induced capital flows have kept EM sovereign borrowing costs low….



… and enabled years of elevated emerging-market sovereign debt issuance….



… even as many those markets displayed profound signs of structural weakness.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

Important Disclosures



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Sunday, October 26, 2014

Total War over the Petrodollar

By Marin Katusa, Chief Energy Investment Strategist

The conspiracy theories surrounding the death of Total SA’s chief executive, Christophe de Margerie, started the second the news broke of his death. Under mysterious circumstances in Moscow, his private jet collided with a snowplow just after midnight. De Margerie was the CEO of Total, France’s largest oil company.

He’d just attended a private meeting with Russian Prime Minister Medvedev, at a time when the West’s relationship with Russia is fraught, to say the least.

One has better odds of being struck by lightning at an airport then a snow plow, or any other ground support vehicles hitting a plane and killing all inside the plane, in my opinion. And I say that as someone who’s familiar with airports, having worked at Vancouver International Airport when I was in university; I was the one who would bring the plane into its parking bay.

If it weren’t for those short odds, a snowplow on the runway with an allegedly drunk driver would be the perfect crime. But who would benefit from his death?

De Margerie was one of the few business leaders who spoke out against the isolation of Russia. On this last trip to Moscow, he railed against sanctions and the obstacles to Russian companies obtaining credit.
He was also an outspoken supporter of Russia’s position in natural gas pricing and transportation disputes with Ukraine, telling Reuters in an interview in July that Europe should not cut its dependence on Russian gas but rather focus on making the supplies more secure.

But what could have made de Margerie a total liability is Total’s involvement in plans to build a plant to liquefy natural gas on the Yamal Peninsula of Russia in partnership with Novatek. Its most ambitious project in Russia to date, it would facilitate the shipping of 800 million barrels of oil equivalent of LNG to China via the Arctic.

Compounding this sin, Total had just announced that it’s seeking financing for a gas project in Russia in spite of the current sanctions against Russia. It planned to finance its share in the $27 billion Yamal project using euros, yuan, Russian rubles, and any other currency but US dollars.

Did this direct threat to the petrodollar make this “true friend of Russia”—as Putin called de Margerie—some very powerful and dangerous enemies amongst the power that be, whether in the French government, the EU, or the US?

In my book The Colder War, one chapter deals with “mysterious deaths” and how they are linked to being on the wrong side of the political equation. Whether it’s going against Putin or against the petrodollar, there are many who have fallen on both sides.

If Total doesn’t close the $27 billion financing it needs to move forward with the Yamal LNG project then we’ll know someone stepped in to prevent an attack on the petrodollar.  The CEO of Total, before his death and his CFO were both strong supporters of Total raising the $27 billion in non U.S. dollars and moving the project forward with the Russians.  But, this could all change if the financing does not complete.

How many other Western executives who dare to help Russia bypass sanctions—and turn it into an energy powerhouse—will die under suspicious circumstances?

Marin Katusa, is author of The Colder War, manager of multiple global energy-exploration hedge funds, and co-founder of Copper Mountain Mining Corporation. Click here to get a copy of his must-read new book, The Colder War. Inside, you’ll discover exactly how Putin is taking over the energy sector, how far ahead he is, and how alarming it is that no one in the US or Europe has even entered the race.

The article Total War over the Petrodollar was originally published at casey research



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Saturday, October 25, 2014

Blood in the Streets to Create the Opportunity of the Decade

By Laurynas Vegys, Research Analyst

Gold stocks staged spring and summer rallies this year, but haven’t able to sustain the momentum. Many have sold off sharply in recent weeks, along with gold. That makes this a good time to examine the book value of gold equities; are they objectively cheap now, or not?

By way of reminder, a price to book value ratio (P/BV) shows the stock price in relation to the company’s book value, which is the theoretical value of a company’s assets minus liabilities. A stock is considered cheap when it’s trading at a historically low P/BV, and undervalued when it’s trading below book value.

From the perspective of an investor, low price to book multiples imply opportunity and a margin of safety from potential declines in price.

We analyzed the book values of all publicly traded primary gold producers with a market cap of $1 billion or more. The final list comprised 32 companies. We then charted book values from January 2, 2007 through last Thursday, October 15. Here’s what we found.


At the current 1.20 times book value, gold stocks aren’t as cheap as they were when we ran the numbers in June, 2013, successfully pinpointing the all-time low of 0.91 (the turning point before the period in gray). Of course, that P/BV is hard to beat: it was one of the lowest values ever. And while the stocks not quite as cheap now, the valuation multiple still lingers close to its historical bottom. Remember, we’re talking about senior mining companies here—producers with real assets and cash flow selling for close to their book values.

In short, yes, gold stocks are objectively selling cheaply.

The juniors, of course, have been hit harder. It’s hard to put a meaningful book value on many of these “burning matches” with little more than hopes and geologists’ dreams, but valuations on many are scraping the bottom, making them even better bargains, albeit substantially riskier ones.

What does this mean for us investors?

It’s no surprise to see that every contraction in the ratio was followed by a major rally. In other words, the cure for low prices is low prices:
  • The August, 2007 bottom (2.2) and the momentary downtrend that preceded it were quickly erased by a swift price rally leading to a January, 2008 peak (3.8).
  • The bull also made a comeback in 2009-2010, fighting its way up out of what seemed at the time to be the deepest hole (1.04) in October, 2008.
Stocks have been on a long slide since the ratio last peaked at 3.24 in October, 2010, with the downturn in 2013 pushing multiples to previously unseen lows.

No one—us included—has a crystal ball, and so it’s impossible to tell if the bottom is behind us. We can, however, gauge with certainty when an asset is cheap—and cash-generating companies selling for little more than book value are extraordinary values for big-picture investors.

Now let’s see how these valuations look against the S&P 500.


Stocks listed in the S&P500 are currently more than twice as expensive as the gold producers. That’s not surprising given how volatile metals prices can be and how unloved mining is—but is it rational? Note that despite the downtrend in the last month, the multiple for the S&P500 remains close to a multiyear high.

In other words, yes, the S&P 500 is expensive.

This contrast points to an obvious opportunity in our sector.

So is now the time to buy gold stocks? Answer: our stocks are good values now, and, if there is a larger correction ahead, they may well become fantastic values, briefly. Either way, value is value, on sale.

As the most successful resource speculators have repeatedly said: you have to be a contrarian in this sector to be successful, buying low and selling high, and that takes courage based on solid convictions. Yes, it’s possible that valuations could fall further. However:

The difference between prices and clear-cut value argue for going long and staying that way until multiples return to lofty levels again—which they’ve done every time, as the historical record shows.

With a long term time frame in mind, whatever happens in the short term is less of a concern. Building substantial positions at good prices in great companies in advance of what must transpire sooner or later is what successful speculation is all about. This is how Doug Casey, Rick Rule, and others have made their fortunes, and it’s why they’re buying in the market now, seeing market capitulation as one of the prime opportunities of the decade.

That’s worth remembering, especially during a downturn that has even die hard gold bugs giving up.
Bottom line: “Blood in the streets” isn't pretty, but it’s a good thing for those with the liquidity and courage to act.

What to buy? That’s what we cover in BIG GOLD. Thanks to our 3 month full money back guarantee, you have nothing to lose and the potential for gains that only a true contrarian can expect.




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Friday, October 24, 2014

Third Quarter Review from Hoisington Management

By John Mauldin


I featured the thinking of Dr. Lacy Hunt on the velocity of money and its relationship to developed-world overindebtedness and the potential for deflation in this week’s Thoughts from the Frontline, and I thought you’d like to peruse Lacy’s entire recent piece on the subject.

Lacy takes the US, Europe, and Japan one by one, examining the velocity of money (V) in each economy and bolstering the principle, first proposed by Irving Fisher in 1933, that V is critically influenced by the productivity of debt. Then, turning to the equation of exchange (M*V=Nominal GDP, where M is money supply), he demonstrates that we shouldn’t be the least bit surprised by sluggish global growth and had better be on the lookout for global deflation.

Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington US Treasury Fund (WHOSX).

I am writing this note in a car going to Athens, Texas, where I’ll join Kyle Bass and friends at his Barefoot Ranch for a huge macro fest. October is one of my favorite times of the year to be in Texas, and the ranch is a beautiful venue. I am sure I will have some challenging conversations.

Last night in Chicago I was picked up by Austyn Crites, who drove me downtown in rush-hour traffic, which gave us a lot of time to talk about his current passion, high balloons. I have been fascinated with them for some time, but there hasn’t been a lot of reliable information.

Basically, Google and Facebook are both planning to launch very large helium balloons full of radios and cameras and float them up to 60,000+ feet. The concept is working in several remote locations now. It’s a way to get full wireless internet coverage. With about 40,000 balloons you can blanket the earth. Literally. Full connectivity. Everywhere. Austyn wants to design a new type of balloon and be the manufacturer. It’s tricky as you need a VERY thin balloon envelope (that does not leak) the size of small house in order to get enough payload that high.

But he thinks the final cost of the balloons will fall dramatically and that you might be able eventually to pull off the operation for a billion or so a year (since balloons eventually come down and need to be replaced).
But if you are Google and you get the search revenue from connecting an additional five billion people?

Chump change. Same for Facebook. But what if Apple or Samsung want to make it so that their phones are afforded free or very cheap access? A consortium of consumer companies could easily see free wifi as a tool for branding. Current telecoms will have to get in the business to compete.

I kept coming back to the costs and tech issues. There are new things that will have to be invented, but nothing as complex as some of the problems that have already been overcome. They will be rolling out in parts of the world in a few years. Coming to a region near you in 5-10 years. Total game changers. While a hundred other game changers are coming down the tunnel.

Austyn's company’s challenge is to be the little guys who don't know they can't invent a new process that the big guys are working on as well. Can he pull it off? He has the passion and drive. I love meeting young people like him doing their part to change the world. They are everywhere, too. It's why I’m optimistic about the future of the human experiment, if just a tad bearish on governments. You can follow Austyn at his website.

Time to hit the send button, as we are getting close and I don't want to miss a minute. I will report back what I can. Have a great week.

Your dreaming of really, really cheap, ubiquitous connectivity everywhere analyst,
John Mauldin, Editor
Outside the Box

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Hoisington Investment Management – Quarterly Review and Outlook, Third Quarter 2014

Faltering Momentum

The U.S. economy continues to lose momentum despite the Federal Reserve’s use of conventional techniques and numerous experimental measures to spur growth. In the first half of the year, real GDP grew at only a 1.2% annual rate while real per capita GDP increased by a minimal 0.3% annual rate. Such increases are insufficient to raise the standard of living, which, as measured by real median household income, stands at the same level as it did seventeen years ago (Chart 1).



Over the latest five years ending June 30, 2014, real GDP expanded at a paltry 2.2% annual rate. In comparison, from 1791 through 1999, the growth in real GDP was 3.9% per annum. Similarly, real per capita GDP recorded a dismal 1.4% annual growth rate over the past five years, 26% less than the long-term growth rate. A large contributor to this remarkable downshift in economic growth was that in 1999 the combined public and private debt reached a critical range of 250%-275% of GDP. Econometric studies have shown that a country’s growth rate will lose about 25% of its “normal experience growth rate” when this occurs. Further, as debt relative to GDP moves above critical threshold levels, some researchers have found the negative consequences of debt on economic activity actually worsens at a greater rate, thus becoming non-linear. The post-1999 record is consistent with these findings as the U.S. debt-to-GDP levels swelled to a peak as high as 360%, well above the critical level noted in various economic studies.

In terms of growth, it looks as if the second half of 2014 will continue to follow this slow growth pattern. Although all of the data has not yet been reported, it appears that the year-over-year growth in real GDP for the just ended third quarter period is unlikely to exceed the 2.2% pace of the past five years. Economic vigor is absent, and the final quarter of the year looks to be weaker than the third quarter.

Poor domestic business conditions in the U.S. are echoed in Europe and Japan. The issue for Europe is whether the economy triple dips into recession or manages to merely stagnate. For Japan, the question is the degree of the erosion in economic activity. This is for an economy where nominal GDP has been unchanged for almost 22 years. U.S. growth is outpacing that of Europe and Japan primarily because those economies carry much higher debt-to-GDP ratios. Based on the latest available data, aggregate debt in the U.S. stands at 334%, compared with 460% in the 17 economies in the euro-currency zone and 655% in Japan.

Economic research has suggested that the more advanced the debt level, the worse the economic performance, and this theory is in fact validated by the real world data.

Falling World Wide Inflation


In this debt-constrained environment, it is not surprising that inflation is receding sharply in almost every major economy, including China. The drop in price pressures in the U.S. and Europe is significant, and the fall in Chinese inflation to 2%, from a peak of nearly 9% in 2008, is notable.

In the latest twelve months, the CPI in the euro currency zone rose a scant 0.3% (Chart 2), the lowest since 2009, while the core CPI increased by 0.7%, near the all time lows for the series. The yearly gain in the U.S. for both core and overall CPI was 1.7%. Since 1958 when the core CPI came into existence, it and the overall CPI have increased at an average annual rate of 3.8% and 3.9%, respectively, over 200 basis points greater than the current rates. Both the overall and core personal consumption expenditures U.S. price indices rose by 1.5% in the twelve months ending August of 2014. Both of these are near the all time lows for their respective series.



The risk of outright deflation in Europe with inflation at such low levels, and the danger of similar developments in the U.S., should not be minimized as inflation has fallen in almost every previous U.S. and European economic contraction. Lower inflation is, in fact, almost as much of a hallmark of recessions as is decreasing real GDP. From peak-to-trough the rate of CPI inflation fell by an average of slightly more than 300 basis points in and around the mild U.S. recessions of 1990-91 and 2000-01. Starting from a much lower point, the CPI in Europe at those same times dropped by an average of 150 basis points. Given that inflation is already so minimal in both the U.S. and Europe, even the mildest recession could put both economies in deflation.

Japan’s recent quantitative easing has helped devalue its currency by 44% versus the dollar, since the 2011 lows. This import- dependent country has therefore seen its costs rise dramatically. This, along with higher consumption taxes, has created a current year- over-year inflation rate of 3.3%. These higher prices are an enormous drag on economic growth as incomes fail to rise commensurately. Thus negative GDP growth will result in a continuing pattern of deflation. Japan’s CPI has been zero or negative on a year over year basis in 16 of the last 23 quarters.

Declining Money Velocity A Global Event


One factor that connects poor growth with the low inflation and low bond yields evident in the U.S., Europe and Japan is that the velocity of money (V) is falling in all three areas.

Functionally, many things influence V. The factors that could theoretically influence V in at least some minimal fashion are too numerous to count. A key variable, however, appears to be the productivity of debt. Money and debt are created simultaneously. If the debt produces a sustaining income stream to repay principal and interest, then V will rise since GDP will rise by more than the initial borrowing. If the debt is unproductive or counterproductive, meaning that a sustaining income stream is absent, or worse the debt subtracts from future income, then V will fall. Debt utilized for the purpose of consumption or paying of interest, or debt that is defaulted on will be either unproductive or counterproductive, leading to a decline in V.

The Nobel laureate Milton Friedman, as well as economist Irving Fisher, commented on the causal determinants of V. Friedman thought V was stable while Fisher believed it was variable. Presently, the evidence suggests that Fisher’s view has prevailed. Fisher would not be at all surprised by the current impact of excessive debt since he argued in his famous 1933 paper “The Debt-Deflation Theory of Great Depressions”, that falling money velocity is a symptom of extreme over indebtedness.

Tracking that theory, it is interesting to note that velocity is below historical norms in all three major economic areas with existing over indebtedness. The U.S. V is higher than European V, which in turn is higher than Japanese V. This pattern is entirely consistent since Japan is more highly indebted than Europe, which is more highly indebted than the U.S. Unfortunately, broad monetary conditions (M2 money growth and velocity) are deteriorating, with 2014 displaying conditions worse than at the end of last year. The poor trend in the velocity for all three areas indicates that monetary policy for these countries is not a factor in influencing economic activity in any meaningful way.

United States. The U.S. year-over-year M2 growth has remained at about 6%, an annual growth level that has been consistent since 2008 (Chart 3), and the velocity of money has trended downward by about 3%. In the first half of 2014, V declined at a rate of 3.6%, but it is still too early to tell if this represents a new V deceleration to the downside (Chart 4).




According to the equation of exchange (M*V=Nominal GDP), the expected growth of nominal GDP is constrained to no more than a 3% increase with velocity declining by 3% and money supply expanding by 6%. However, when assessing the type of debt currently being employed (unproductive, at best) the risks are for lower growth levels. 2014 has witnessed a resurgence of consumer auto and mortgage lending that was achieved by a lowering of credit standards. The percentage of subprime consumer auto loans (31%) returned to the peak levels reached prior to 2008. Such lending has historically turned counterproductive. If this were to occur again, velocity would accelerate to the downside, resulting in a sub 3% path for nominal GDP.

Europe. V has only been available in Europe since 1995 as that is the starting date for GDP in the euro-currency zone. During the span from 1995 through 2013, V averaged 1.4, dropping from a peak of about 1.7 in 1995 to 1.03 in 2013 (Chart 5). Over that span, therefore, euro V has been trending lower at about a 2.6% per annum rate. On the money side, euro M2 increased by 2.4% in 2013, which is weaker than the average growth in the last four years (Chart 6). If the trend rate of decline in V remains intact, then nominal GDP in the euro zone could be flat. Inflation of any magnitude would result in a negative real GDP outcome.




Japan. From the start of the comparable M2 and nominal GDP statistics in 1969 in Japan, V in Japan has averaged 1.0, dropping from 1.54 in 1968 to a record low of 0.57 in the latest year (Chart 7). Thus, over this period V was falling at an average rate of 2.2% per annum. M2 in Japan increased 3.6% in 2013, which is slightly higher than the growth rate of recent years (Chart 8). If V’s downward trend remains intact, nominal GDP would be estimated to grow by 1.2%. However, inflation is currently running at 3.3%, suggesting real GDP could decline by over 2% in the next twelve months. This circumstance illustrates the double edged sword caused by a sharply depreciating currency. The weaker yen boosts exports but raises domestic inflation. Japanese inflation is already exceeding the rise in wages and household spending. These events are consistent with a contraction in economic activity and are the expectation derived from the analysis of money growth and its velocity.




Debt Research


Important new research by four distinguished economists (three in Europe and one in the U.S.) is contained in a report titled "Deleveraging? What Deleveraging?" (Luigi Buttiglione, Philip R. Lane, Lucrezia Reichlin and Vincent Reinhart, Geneva Reports on the World Economy 16, September 2014). It provides additional evidence on the role of “debt dynamics” and the state of the global debt overhang. They write, “Contrary to widely held beliefs, the world has not yet begun to delever and the global debt-to-GDP is still growing, breaking new highs.” Further, it is a "poisonous combination" when world growth and inflation are lower than expected and debt is rising. “Deleveraging and slower nominal growth are in many cases interacting in a vicious loop, with the latter making the deleveraging process harder and the former exacerbating the economic slowdown.”

This research also identifies two other highly significant trends. First, global debt accumulation was led by developed economies until 2008. Second, the debt build-up since 2008 has been paced by the emerging economies. The authors write that the rise in Chinese debt is especially “stunning”. They describe China as “between a rock (rising and high debt) and a hard place (lower growth).” In addition to China they identify India, Turkey, Brazil, Chile, Argentina, Indonesia, Russia and South Africa as belonging to the “fragile eight” group of countries that could find themselves in the unwanted role of host to “the next leg of the global leverage crisis.”

We interpret this research to mean that the monetary policy may begin to become ineffective at emerging market central banks, just as has happened in the U.S., Europe and Japan. Weaker growth conditions in the emerging markets are thus likely to accentuate, rather than ameliorate, poor business conditions in the major economies. Indeed, this year’s downturn in global commodity prices is consistent with the beginning of such a phase. The huge jump in emerging market debt is also significant because research has found the severity of economic contractions is directly related to the leverage in the prior expansion.

Asset Bubbles


Historically, in our judgment, the most important authority on the subject of asset bubbles was the late MIT professor Charles Kindleberger, author of 20 books including the one of the greatest books on capital markets Manias, Panics and Crashes (1978). He found that asset price bubbles depend on the growth of credit. Atif Mian (Princeton) and Amir Sufi (University of Chicago) provided confirmation for Kindleberger’s pioneering work and expanded on it in their 2014 book House of Debt. Chapter 8, entitled “Debt and Bubbles,” contains the heart of their insights. Mian and Sufi demonstrate that increasing the flow of credit is extremely counterproductive when the fundamental problem is too much debt, and excessive debt can fuel asset bubbles.

Based on our reading of these two books we would define an asset bubble as a rise in prices that is caused by excess central bank liquidity rather than economic fundamentals. As Kindleberger clearly stated, the process of excess liquidity fueling higher prices in the face of faltering fundamentals can run for a long time, a phase Kindleberger called “overtrading”. But eventually, this gives way to “discredit”, when the discerning few see the discrepancy between prices and fundamentals. Eventually, discredit yields to “revulsion”, when the crowd understands the imbalance, and markets correct.

Economists have commented on the high correlation between the S&P 500 and the Fed’s balance sheet since 2009. From 2009 to the latest available month, the monetary base (MB) surged from $1.7 trillion to $4.1 trillion. We ran the MB increase against the S&P 500 and found a very high correlation of 0.69. While correlation does not prove causality, the high correlation is certainly not inconsistent with the idea that the Fed liquidity played a major role in boosting stock prices. However, even as the MB has exploded since 2009 and stock prices have soared, the U.S. economy has experienced the worst economic expansion on record. In spite of a further large rise in the base this year, the GDP growth has subsided noticeably and corporate profits after taxes and adjusted for inventory gains/losses (IVA) and over/under depreciation (CCA) has declined 10% in the latest four quarters. Such discrepancy between the liquidity implied by the base and measures of economic performance could indicate the process of bubble formation. Kindleberger’s axiom that asset price bubbles depend on excess liquidity may yet face another test.

Still Bullish on Treasury Bonds


With the nominal growth trajectory extremely soft, U.S. Treasury bond yields are likely to continue working lower as similar circumstances have created declines in government bond yields in Europe and Japan. Viewing the yields overseas, it is evident that ample downside still exists for long U.S. Treasury bond yields, as the higher U.S. yields offer global investors an incentive to continue to move funds into the United States.

Another factor suggesting lower long- term U.S. Treasury yields is the strength of the U.S. dollar. In many industries, the price leader for certain goods in the U.S. is a foreign producer. A rising dollar leads to what economists sometimes call the “collapsing umbrella”. As the dollar lifts, the foreign producer cuts U.S. selling prices, forcing domestic producers to match the lower prices. This reinforces the prospect for lower inflation as nominal GDP wanes. This creates a favorable environment for falling U.S. Treasury bond yields.

Van R. Hoisington
Lacy H. Hunt, Ph.D.

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Tuesday, October 21, 2014

Is Gold as Dead as Florida Hurricanes?

By Dennis Miller

It’s been over 3,280 days since a hurricane hit Florida. As hurricane season comes to a close next month, only Mother Nature knows how long the streak will last.

Like many Floridians, my wife and I stayed home and rode out a hurricane—once! We’d built a home on Perdido Key, a barrier island west of Pensacola. It was engineered to withstand 150 plus mph winds, and it was a beautiful home with a master bedroom spanning the entire third floor, looking out across the Gulf of Mexico.

Hurricane Danny hit the Gulf shortly after we moved in. It was a fast moving Category I with winds gusting in the 75 - 80 mph range. Full of confidence and a bit curious, we decided to hunker down and ride it out. At the speed it was traveling, it should have been over in a matter of hours. Then, Danny caught everyone by surprise and stalled in Mobile Bay, pounding us for three days.

The waves on the Gulf were terrifying. We watched the rising tide bang boats against the rocks and sink others. Our front door had a double deadbolt with a keyhole on each side. Water shot through three feet into the room for 24 hours straight. Newly planted palm trees strained against support wires and toppled onto their sides.

We tried to get some sleep in our bedroom, but we could feel the house move with each gust of wind. We watched bits and pieces of our neighbor’s tile roof fly off and smash a few feet from our house. We were trapped and terrified for three days.

The no-hurricane record has been all over the Florida news, highlighting concern that people are becoming complacent. They don’t understand what adequate preparation entails. The storm itself can be horrific, but the aftermath can be equally disastrous, leaving people without food, water, power, and access to basic services for several days. Homes that survive a storm often have to be gutted because of mold and mildew. Without power, sewage immediately becomes a problem.

Plus, if your flood, wind, and homeowners insurance is not up to date, say hello to serious financial hardship. Many Floridians discovered too late that their policy limits had not increased with inflation and wouldn’t cover the cost of rebuilding.

Are You Crazy?—Part 1


Just for fun, I told a friend that I was thinking about selling my generator and dumping our emergency supplies. He looked at me in disbelief and finally uttered, “Are you crazy? When the next one hits, don’t try to mooch off of us. It’s every man for himself.”

Exasperated, he explained that hurricane-causing conditions had not gone away. Until the sun no longer heats the water, we no longer have large and fast temperature changes, and there are no trade winds, a hurricane is a constant threat. He was red in the face when he finished. I told him I was kidding and wanted to discuss something else: economic hurricanes.

Food, Water, a Generator, and Gold


Many financial pundits are shining the all clear signal, saying that our economy is fine. People are bailing on gold and mining stocks because they’ve dropped so low. To paraphrase my colleague, Casey Research Chief Economist Bud Conrad, gold sentiment has dropped to zero.
Take a look at the price of gold over the last decade:


Precious Metals Fall into Two Camps


High inflation (Hurricane Danny) and hyperinflation (Hurricane Katrina) are two potential threats to all of our lives. While we hope neither hits, we should still prepare.

At Miller’s Money, we put metals into two categories. The first is core holdings. This is pure insurance against a catastrophe—much the same as our hurricane survival package. Not all storms are category V. Even if we don’t have hyperinflation, during the Jimmy Carter era we experienced double-digit inflation that devastated a lot of retirement nest eggs. Investors holding long-term 6% certificates of deposit would have lost 25% of their buying power during a five-year period, even after they collected the 6% interest.

What if the storm intensifies into hyperinflation and its inevitable aftermath? Many of the items we keep for hurricane emergencies may come in handy if the food supply is interrupted, electricity is cut off, or the currency collapses. Metals will protect us from the rising tide of inflation and protect our purchasing power.
The second category for metals and metal stocks is investment. These holdings are bought with the express intent of selling down the road for a nice profit. There is quite a debate going on in this arena. Some experts are touting the terrific buying opportunity. Others say gold is an ancient relic and there are a lot of better investment opportunities available. Should you take advantage of the buying opportunity or unload?

We set strict position limits in the Money Forever portfolio. When you’re investing money earmarked for retirement, which is our focus, the speculation portion is limited because preserving capital is the overriding consideration.

Gold stocks fall into two general categories. The first is established mining companies and the second is exploration and development companies. Stock in the first group is more directly related to the current price of gold. Every dollar fluctuation in the price of gold adds or subtracts from their net profit as their costs are primarily fixed.

For exploration and development companies, it’s a combination of the price of gold, their ability to raise capital, and a heavy emphasis on the economic viability of their discovery. In a large number of cases a major mining company buys them out and takes them into the production phase.

In both cases, there are certain events that can produce spectacular results; however, the risk is also high. The real question is do you have room to invest any more capital in the speculative portion of your portfolio? That’s up to the individual investor to answer. If you do have room, there are some incredible bargains in the market today. Our metals team travels the globe and has identified many candidates selling at true bargain-basement prices.

What about your core holdings? Should you buy or lighten your portion of metals? The first question to answer is: do you have ample core holdings at the moment? We recommend holding 10% - 20% of your net worth in core holdings, depending on your comfort level. (Mining stocks are generally not core holdings; they are speculative.) A lot of investors are slowly building to that target. If you think you should add more, then the current prices present a terrific opportunity.

Once you add to these core holdings, then the daily price fluctuations are no more relevant than the price of the case of beef stew we have stored in our closet. It’s insurance for a catastrophe we hope never happens. When the big one hits, we could probably sell our stew for an astronomical sum, but we won’t because it will help us survive. We would use some of our metal holdings, priced at current value, to buy things we need.

Are You Crazy?—Part 2


The same friend who was flabbergasted by my pretend plan to dump our hurricane supplies asked if I planned to sell any of our gold. I looked at him and asked, “Are you crazy?” Then I explained that the conditions that spawn inflation have not gone away either.

The reasons to own gold have compounded over the last decade. The U.S. government has printed trillions of dollars, our country’s debts are out of sight, and the Chinese and Russians are doing everything they can to oust the U.S. dollar as the world’s reserve currency. When the world no longer needs or wants to hold dollars, they will fly out the door faster than any hurricane wind mankind has ever seen. The value of the dollar will drop like a two-ton anchor and the price of gold will soar.

Precious metals are insurance against the ultimate financial hurricane. Fiat currencies eventually collapsed; the U.S. dollar will not get a free pass. Just as sure as the sun heats the water, we have large and fast temperature changes, and there are trade winds, an overly indebted government will experience a currency collapse.

We have all had ample warning and should be prepared. Don’t be fooled by the short term thinking.

For more up to date economic analysis and time-tested tips for protecting your nest egg, sign up for our free weekly e-letter, Miller’s Money Weekly

The article Is Gold as Dead as Florida Hurricanes? was originally published at millers money


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Monday, October 20, 2014

The 10th Man....What a Correction Feels Like

By Jared Dillian


Back in the summer of 2007, when I was working for Lehman Brothers, I had a vacation to the Bahamas planned. This was unusual for me. Up until that point, in six years of working for Lehman, I had taken about five vacation days—total. But my wife and I were going to a semi primitive resort on Cat Island, the most desolate island in the Bahamas. Interesting place for a vacation. Suffice to say that it’s plenty hot in the Bahamas in August.

The market had been acting funny for a while, and I had a hunch that there was going to be trouble while I was gone, so I bought the 30 strike calls in the CBOE Market Volatility Index (VIX). I was betting that volatility was going to go up a lot in a short period of time. In fact, these options—which I spent a little over $100,000 on—would be worthless unless there was outright panic. I gave instructions to my colleagues to sell the call options if the VIX went over 35. (Note: my memory on the details of the trade, like the strike of the options and the level of the VIX, is a little hazy. The specifics might have been different, but you get the general idea.)

So there I was, sunning myself at this primitive resort on Cat Island and the world was melting down, and I was completely oblivious to what was going on back on Wall Street. Coincidentally, the local Bahamas newspaper had a picture of black swans on the cover one day. I staged a photo of me in a hammock reading the newspaper with the black swans on it. I still have that photo.

I got back to civilization and checked the markets. I saw the chart of the VIX. I could hardly contain myself. If my colleagues had executed the trades properly, I would have had a profit of over $800,000. But when I got back to work and opened my spreadsheet, I found that I’d made less than $100,000. What I had failed to consider was that if the world actually was blowing up, the guys would have been too busy to execute my trade.

So there is this whole idea of state dependence that we have to consider when we’re talking about the market. Like, you might have a plan to buy stocks when the index gets below a certain level, but when the market gets to that point, you: a) may not have the capital; and b) might be panicking into your shorts. It’s nice to have a plan, but, paraphrasing Mike Tyson, everyone has a plan until they get punched in the face.

I remember reading Russell Napier’s book about bear markets, called Anatomy of the Bear. It talked about all the big bear markets in the US, including the granddaddy of them all, the stock market crash of 1929 and the Great Depression. One of the things that I learned from this book was that if you can time the bottom exactly right, you can make a hell of a lot of money in very short order. For example, if you had bought the lows in 1932, you could have doubled your money in a matter of months.

I wanted to do that. I prayed for a bear market, so I would get my chance.

Little did I know that I would get my chance just two years later—and blow it.

When the market is down 60%, it’s scary as hell to buy stocks. Hindsight being 20/20, you can say, “What, did you think it was going to zero?” Actually, yes—in March of 2009, people thought it was going to zero.
But for those people who: a) had capital; and b) weren’t terrified, it was a once in a lifetime opportunity.

A Thousand Days with No Correction


So let’s talk about a). Does everybody have capital? Remember, the hard part of this is not picking bottoms. Many people can do this quite capably. Panic/liquidation is very easy to spot. But few people have the ability to take advantage of it, because they’re fully invested.

As for b), you tend not to be terrified if you have capital.

Everyone knows by now that the stock market is correcting. The price action is pretty terrible. Will it get worse? I think so. We’re seeing excesses (corporate credit, growth stocks, IPOs) that we haven’t seen in many, many years. It’s been over 1,000 days since we’ve had a correction of any magnitude. With the market down about 5%, nobody is particularly worried, because every other time the market was down 5%, it ended up going higher.

Back to state dependence. What is it going to feel like if the market goes down further? How will people behave if the S&P 500 gets to, say, 1,700?

I can tell you what it will be like if the S&P gets to 1,700. It’s going to be like it was in August of 2007 when my coworkers forgot to sell my VIX calls because they were buried under an avalanche of panicked sell orders from institutional money managers. Pre-algorithmic trading, the trading floor used to get pretty noisy. I used to be able to tell you what the market was doing just from listening to the floor. At SPX 1,700, trading floors will be very noisy.

It’s been so long since we’ve had a correction, I’m guessing that most people have forgotten what a correction feels like. When you go that long in between corrections, people are sitting on a mountain of capital gains. And unless the capital gains really start to disappear, there is little pressure to sell. But if you’re the owner of, say, airline stocks, and you’ve watched them evaporate to the tune of 30%, that tends to focus the mind a little bit.

As with any steep correction, there will be fantastic opportunities, but they will only be available to those who have capital. Remember, bear markets don’t just destroy the bulls’ capital, they destroy the bears’ capital, too.

Bear markets destroy everyone’s capital.
Jared Dillian
Jared Dillian

The article The 10th Man: What a Correction Feels Like was originally published at mauldin economics


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Saturday, October 18, 2014

How Can There Not Be a Currency Crisis?

By Casey Research

The Fed claims that signs of economic stress are very low, but savvy investors feel otherwise. With geopolitical unrest expanding and central banks doing the opposite of the right things, is a currency crisis barreling toward us? See what Mish Shedlock had to say about the state of world finance at the 2014 Casey Research Summit:


Even though the Summit is long over, you can still benefit from every presenter… every panel discussion… every investment recommendation. Order the 2014 Summit Audio Collection and you’ll receive all of that, plus all slides used in the presentations and a bonus highlight reel. Choose between instantly available MP3 files or CDs… or get both for maximum convenience.

Order now so that you’re well positioned to thrive in the coming crisis economy.

The article How Can There Not Be a Currency Crisis? was originally published at casey research


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