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Understanding the Implications of QE3

How will the major asset classes react?
Tuesday, September 18, 2012, 7:06 PM

Executive Summary

  • We've now entered a new era of economic and fiscal descent; expect the next stage to be prolonged and bumpy
  • Why only two possible economic outcomes remain at this point (and one of them has a 90%+ chance of occurring)
  • How the recent liquidity measures announced by the world's largest central banks will impact:
    • stocks
    • bonds
    • gold & silver
    • other commodities
    • real estate
  • Why adopting a wealth preservation strategy is critical right now (and why so many will fail to do so)
  • Why this is not (yet) the moment to go "all in" in exchanging paper assets for hard ones (but do get started if you haven't already!)

If you have not yet read Part I: The Trouble with Printing Money, available free to all readers, please click here to read it first.

A Process, Not an Event

Okay, the ECB and the Fed are now in the game with unlimited, open-ended commitments to print as much money as necessary to get back to the same rates of GDP growth we had in prior decades. I should note that the ECB actions, at least, will be fully sterilized, meaning that they won't boost the money supply – at least that's the plan right now. Soon enough, Japan is going to have to join the fray simply because it cannot afford a stronger yen here; it will have to print because it is first, second, and last an export economy...

After that, it is anybody's guess as to how long China will put up with its massive $3.2 trillion in foreign exchange reserves being debased willy-nilly, but my vote is 'not long.'

These latest rounds of QE are certainly unnerving and may prompt many of you to want to accelerate your own private efforts at financial, emotional, and physical resilience. By all means, use these moments to focus your attention and efforts. But also be aware that we are experiencing what is certain to be a very long process rather than some dramatic event. » Read more

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Off the Cuff: The Plot Thickens

Developments are happening faster now
Thursday, September 13, 2012, 1:11 AM

In this week's Off the Cuff with Mish & Chris podcast, Mish and Chris tackle

  • The German Constitutional Court decision
    • What importance does it have? Any?
  • America is back in recession
    • More hard-to-refute data
  • Whither the Fed?
    • Why markets will be disappointed by Bernanke

Surprising to those who don't read this site, a number of notable announcements are happening this week besides Apple's unveiling of the iPhone 5...

Today, the German Constitutional Court made its ruling on the legality of Mario Drahgi's plans to flood European banks with liquidity. The court has the power to block the ECB's profligacy; but it seems that once again, politics trumps justice. Draghi will be allowed to proceed with some tissue-thin restraints. 

Meanwhile, new data show North America's economies are slowing down. Indeed, more and more analysts are coming to the conclusion that the US has slipped back into recession (even though to many it feels as if America had never left it). Jabbering of 'recovery' and slight declines in the official employment rate – which is a complete farce, as those unable to find work after a time are removed from the lists of those counted as 'unemployed' – are fooling no one at this point.

Which leads all eyes to the Fed. What will it do (or better asked, what can it do) to combat this dismal data? » Read more

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Nowhere to Go

The Fed is almost certain to disappoint tomorrow
Wednesday, September 12, 2012, 12:09 PM

All eyes are on the Fed meeting and the almost fully expected (99% chance, already priced in) round of quantitative easing (QE) that will be announced upon the conclusion of the September 12-13 Federal Open Marked Committee (FOMC) meeting. Or not. » Read more

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The March to $200+ Oil

Expected over the next 2-4 years
Thursday, September 6, 2012, 7:03 PM

Executive Summary

  • Why pressures to the downside have less impact when the global economy is weak
  • Why oil's new floor is $80
  • The 'upside risk' story for oil prices
  • Why prices will march up to the $150-175 range over the next 2-4 years (with increasing sensitivity to spikes of over $200+ per barrel)

If you have not yet read Part I: The Repricing of Oil, available free to all readers, please click here to read it first.

I encourage others to read the entire recent paper on Nominal GDP (NGDP) Targeting by Michael Woodford (recently delivered at Jackson Hole) or to simply read its coverage, either by Joe Weisenthal at Business Insider or Paul Krugman at the New York Times. In short, I take the appearance of the Woodford paper (link opens to PDF) as the inevitable next-step solution to the problem of unpayable debt and scarce resources. By loudly and flagrantly voicing a policy pursuit of inflation, Nominal GDP Targeting (which has been discussed for some time in economic circles) would be the next iteration of behavioral prodding in Western economies.

More importantly, the growing acceptance of NGDP targeting in policy circles simplifies the battle that began a decade ago: the struggle to counter emerging scarcity of natural resources with the provision of greater and greater amounts of cheap credit. Within the contours of this battle lies the answer as to whether oil’s next major move is downward, in a deflationary collapse, as global demand vanishes in a new economic crisis; or whether oil’s next major move is higher, as the five billion people in the developing world pull the OECD along in a new expansion.

Modeling the next move in oil prices is, of course, a very different task than it was ten years ago... » Read more

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Off the Cuff: Winter is Coming

Prepare for a starker investing climate
Thursday, September 6, 2012, 12:35 AM

In this week's Off the Cuff with Mish & Chris podcast, Mish and Chris discuss:

  • No wonder people are confused
    • Sloppy journalism abounds in the general media
  • The world's addiction to low rates
    • Prolonging & worsening our predicament
  • Spanish storm clouds
    • Insolvency is becoming increasingly clear 
  • Predicting the Fed's next move
    • Will there be action before the election?

Summer's calm is now ancient history, and a foreboding instability is growing in the markets. The protracted, suppressed-interest-rate environment has lasted so long that market forces are beginning to boil over in points of weakness faster than central planners can contain them (e.g., Spain). Not only have financial exchanges become addicted to low rates, they have also become dependent upon expectations of ever more liquidity. If one of these two fails to materialize, markets will go into withdrawal shock – with drastic implications. » Read more

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Off the Cuff: The Calm Breaks

Our tranquil summer is over
Friday, August 31, 2012, 1:37 PM

In this week's Off the Cuff with Mish & Chris podcast, Mish and Chris discuss:

  • Europe begins to turn on itself
    • The battle for political union has begun
  • The dangerous erosion of our human capital
    • Too many out of work for too long
  • Gold's prospects
    • Set to shine?

We're beginning to see a departure from the calm summer the world has enjoyed. With the distraction and global camaraderie of the Olympics behind us and the ever-growing mountain of unaddressed problems ahead, changes are afoot. In Europe, Germany is standing firm on its demands for more political union before agreeing to further fiscal measures – and left-leaning socialist leaders are uniting in opposition. In countries like Greece and Spain (and to a certain extent the U.S.), the protracted unemployment among younger workers threatens to create a "lost generation" where skills, aptitude, and motivation atrophy to the point where national social capital becomes permanently impaired. 

Chris and Mish discuss the prospects for the precious metals. This conversation was recorded before Bernanke's comments today in Jackson Hole – though they appear to have since proved prescient. » Read more

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Positioning for the Drought's Aftermath

Simple steps with outsized benefits
Thursday, August 30, 2012, 12:58 AM

Executive Summary

  • Why less water means higher electricity prices (and possibly reduced availability)
  • Where technology has limitations in dealing with these challenges to our food and energy systems
  • What to do about the coming higher food costs
  • Home investments to make now that will have outsized benefits later
  • Why to anticipate a more volatile end to 2012
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Why Local Control is the Best Way to Preserve Wealth

Control enterprises, not paper
Tuesday, August 28, 2012, 11:06 AM

Executive Summary

  • Why most paper assets today have substantial "phantom" value that will evaporate when another "credit event" occurs
  • Why the future of investing is Local Control (and what that means)
  • Where to look today for undervalued assets most likely to appreciate when the next downturn arrives

If you have not yet read Part I: The New Endangered Species: Liquidity and Reliable Income Streams, available free to all readers, please click here to read it first.

We began our reappraisal of scarcity, demand, opportunity cost, technology, and behavioral choice with an analysis of commodity demand in an era of declining income for labor and the decline of the ownership model of resource-intensive assets such as vehicles and homes.  This led to the thesis that reliable income and liquidity (the ability to sell assets quickly and safely for cash) will become scarce in the era ahead.

Let’s start by exploring the scarcity of reliable income streams in a recessionary, risk-averse, deleveraging environment.  In Part I, we noted the structural decline in earned income from labor, but thanks to the global financial repression of yield (that is, central banks lowering the interest rate to near zero), unearned income (i.e., interest income) has also plummeted.

The search for reliable unearned income has led investors and money managers to pile into dividend-paying stocks. This demand has pushed up valuations and price-to-earnings (P/E) ratios to levels where they are vulnerable to earnings disappointments and margin-compression; in other words, falling stock prices that drop P/E ratios.

Meanwhile, Web 2.0 stock market darlings such as Facebook, Groupon, and Zynga have been savagely revalued as the market recognizes that they lack reliable income streams.

Investors account for roughly one-third of all home sales in once-speculative real estate markets, another manifestation of the search for yield in a low-yield climate. But owning rental property is not risk-free, as I have discussed here earlier this year in some detail, and it carries the additional risks of being illiquid during a “credit event”-type crisis.  Since real estate isn't mobile like other forms of capital, the investor-owners are also at risk of becoming “tax donkeys” as local authorities raise taxes on the one class of investors who can’t easily move their capital elsewhere to escape ever-higher taxation burdens.

The potentially devastating dangers of illiquidity have driven global capital into the “safe haven” of highly liquid bonds, such as U.S. Treasury notes and Bank of Japan bonds.  So important is liquidity to professional money managers that they accept near-zero yields as the tradeoff for maximum liquidity and safety in size.  In other words, tens of billions of dollars can be moved around without distorting the market for these highly liquid financial instruments.

Others have accepted the promise of safety offered by municipal bonds, as the promise is based on the “guarantee” that irrevocable income streams will back up the bond payments.  But very little is guaranteed when crisis erupts.  Rules are changed, bankruptcy courts void claims, voters rebel, and so on.  The risk of local government promises being amended in the future may be much higher than is conventionally accepted right now.

Let’s review the risks created by central bank financial repression pushing yields to near 0% (or factoring in loss of purchasing power, negative real returns).  The policy’s explicit intention is to drive capital out of safe havens into risk-on assets such as stocks and to encourage new borrowing and speculation, with the goal being a reflation of asset valuations.

The net result of this policy is that investors are now exposed to potentially catastrophic levels of risk in terms of capital loss and declining income streams... » Read more

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Gold Breaks Out

Silver is getting pretty close, too
Thursday, August 23, 2012, 12:30 PM

Gold is currently at $1,674 per ounce, having advanced $75 over the past 5 days.  Importantly, from a technical perspective, the gigantic wedge that gold has been tracing out since last August (for over a year now) has been breached to the upside.

We've been tracking this in our podcasts with Mish for a while.  This is the most newsworthy advance for gold in...well, a year. » Read more

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The Real Story Is the Rise of the Global Powergrid

Oil's importance usurped
Monday, August 20, 2012, 9:51 AM

Executive Summary

  • Worldwide, global energy demand is beginning to shift strongly from oil to electricity
  • At the same time, developed countries are psychologically wedded to their oil-dependent infrastructure and mostly developing countries are blindly emulating their developed brethren, condemning them to suffer the same vulnerabilities
  • World demand for energy supply is proving much less elastic than demand for oil
  • Oil is likely soon going to be left to find its true (much higher) price
  • As the realization of the grid's importance dawns on economies, expect massive infrastructure investments to follow

If you have not yet read Part I: The Demise of the Car, available free to all readers, please click here to read it first.

China contains 19% of the world’s population and accounts for 21% of the world’s energy consumption. But India, while containing 18% of the world’s population, only accounts for 4.6% of global energy demand. It is not possible that India can call upon oil to fund the next leg of its industrial growth.

For even after we consider the higher marginal utility of oil in the developing world – higher prices are integrated more easily to the economy as each new consumer uses only a small amount of oil – there is simply not enough economically recoverable oil for India to replicate the Western history of car and highway development.

Furthermore, the prospect that hundreds of millions of India’s citizens, already unserved by the powergrid, would turn first to oil consumption is highly unrealistic. Perhaps the government of India wagered that the Great Quadrilateral was needed as a foundational piece of national infrastructure – not as a bet on a future built for automobiles.

Regardless, we have already seen in the data out of countries like China that the mix of energy demand starting last decade began to shift, strongly, from oil to electricity. » Read more