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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

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


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


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


Off the Cuff: Waiting for Reality to Arrive

And it's taking its sweet darn time
Thursday, August 16, 2012, 2:28 PM

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

  • The unbearable lightness of financial markets
    • How can stocks be so high on such poor economic fundamentals?
  • California's warning signs
    • Are retail sales falling off a cliff?
  • Exiting the euro
    • What, exactly, would be the consequences for countries doing this?
  • Mining stocks
    • What's the risk/return?

Europe slipping deeper into recession, rapidly rising food prices, China headed for a soft (or maybe not-so-soft) landing, Japan struggling, oil prices still near triple digits, US unemployment stubbornly over 8% -- do these seem like the sort of fundamentals that justify a stock market within a few percentage points of its all-time highs? 

Yet here we are.

Chris brings back new evidence that institutional money managers are just as stymied, flummoxed, and nervous as we are about these ridiculously elevated markets. If you're tired of the lack of the logic and are feeling that a bad reckoning is inevitable, you're not alone... » Read more


Protecting Your Wealth

The steps and signs to focus on
Wednesday, August 15, 2012, 3:52 PM

Executive Summary

  • Be early out the door before the Ponzi scheme collapses. How? Exchange paper investments for hard assets.
  • Build your financial base with diversified cash holdings and precious metals
  • Monitor the four key indicators most likely to presage a market collapse
  • Use time to your best advantage

If you have not yet read Part I: What to Do When Every Market Is Manipulated, available free to all readers, please click here to read it first.

One lesson here is that the system is now out of control – and sometimes lacking the necessary safeguards and trust required to have confidence that one’s wealth will not simply evaporate or be stolen with the tap of a keyboard at some dark point in the future.

Confidence happens to be one of the most important assets of a Ponzi system, and it is being steadily eroded by the cumulative failures of the Fed, the SEC, the European Central Bank (ECB), the Bank of England, the Bank of Japan, and every other government body that have recently tossed caution, rules and precedent to the wind in their efforts to preserve the status quo. I think this is an extraordinary mistake.

Unfortunately, as the brokerage accidents MF Global and Peregrine Financial taught us, knowing which type of firm you have your money with (e.g., prime broker vs. broker vs. fiduciary trust), as well as being confident in your specific firm's financial health and management practices are prudent financial practices. The financial advisory firms that we recommend to people know all about these differences and will be happy to explain them to you in detail. They are also exceptionally good at managing risk in these uncertain times.

We always advocate investing in yourself and your homestead as the first course of action. This quiet summer has been a real snooze-fest for those tracking the markets with the VIX volatility gauge plumbing multi-year lows. That’s the good news. Hopefully you’ve used this time to put in a garden or fine-tune your green thumb, practice one or more new skills, and/or install energy systems. This quiet period will not last…the news out of Europe should make that abundantly clear. » Read more


Fukushima, Lies, and What Comes Next

Facts and truths will be in short supply
Tuesday, August 14, 2012, 11:29 AM

Back when the Fukushima event was unfolding, we coordinated a group effort to figure out what was happening as best we could from the sparse video evidence that was available.  Certainly there were the dramatic videos of the hydrogen explosion of Reactor #1 and then the far more exothermic and dramatic explosion of Reactor #3.  Whatever happened to #3, it was not a hydrogen explosion as claimed at the time by TEPCO.

Along the way we also uncovered some pretty compelling evidence that Reactors #1 and #2 had melted down, and we were certain that #3 had suffered the same fate.  At the time, though, the official pronouncements were still that meltdowns had not happened -- and then 'partial' meltdowns were admitted, and every step of the way, quite confusingly low temperature readings, allegedly from the vessel cores, were being released.

We accepted none of that as fact, as neither the official statements nor the data comported with what we could see with our own eyes on the video evidence, nor from other tangential evidence, such as the US military preparing for full-scale evacuation of the island.

At the time, we urged our Japanese readers as far south as Tokyo to consider leaving, because if what we were seeing was true, and the winds shifted, then potentially dangerous levels of radiation could have drifted over Tokyo with no means in place to safely evacuate the city. » Read more


Off the Cuff: Sounding Like a Broken Record

But don't tune out the recurring warnings
Thursday, August 9, 2012, 12:23 PM

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

  • Europe's Deepening Recession
    • The official GDP data worsens
  • Reckless Lending 2.0
    • The Poway, CA Ponzi 
  • Anticipating a Big Move for Gold
    • After nearly a year of range-bound trading

So far the summer has been relatively dull, especially while the world has been glued to the Olympic action in London. The same risks we've been watching all year are all still in play, but there have been few newsworthy catalysts (up or down) of late. With things becalmed, it's hard not to sound like a broken record in ringing the same warning bells that we've rung all year. But despite the lack of developments (perhaps in spite of them, given that no fundamental risks are improving), Chris and Mish are very unnerved by the current doldrums. Digging under the calm waters, they find Europe's downward slide is deepening, as well as shockingly irresponsible lending practices that show we haven't departed from the nefarious behavior that caused the 2008 credit bust.


Off the Cuff: QE Blues

Odds of a downward market correction just increased
Thursday, August 2, 2012, 10:53 PM

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

  • Dashed hopes
    • What to expect now that the Fed and ECB have disappointed?
  • Growing signs of weakness in the economy
    • A strong defense is critical at this point
  • The continuing drought
    • ​More pain from the lack of rain

Now that the Fed has disappointed AND the ECB (after this recording) followed suit, the markets are asking where's my fresh, cheap liquidity? While Chris and Mish don't think that further quantitative easing will have any sustained or constructive impact, they do expect it is still coming. But it seems that greater pain in the financial markets is needed before action takes place. Chris, in particular, now warns of an impending market downdraft -- so a defensive position is highly advised. » Read more


What Radical Measures to Expect in the Post-QE Era

By this time next year, central banks will be out of bullets
Wednesday, August 1, 2012, 9:37 AM

Executive Summary

  • Expect the 'benefits' of QE 3 to be short-lived (<9 months)
  • Expect more radical solutions to be rolled out by Capitol Hill (not the Federal Reserve) within 90 days after QE 3, including:
    • Infrastructure build-out on a massive scale
    • Military resource redeployment to civilian projects
    • Debt jubilees
    • Tax holidays
  • A weaker dollar will be pursued
  • Capitalism will be compromised for populist gain

If you have not yet read Part I: When Quantitative Easing Finally Fails, available free to all readers, please click here to read it first.

Had every US homeowner with a mortgage also held 100 ounces of gold through the rise and fall of the housing bubble, the balance sheet of US homeowners would already be repaired. Gold has at least tripled, if not quadrupled, through that time period.

We state this to illustrate a point. Quantitative easing (QE) and other reflationary policies benefit gold, global growth outside the United States, and the earnings of corporations -- not US workers.

QE largely benefits the continued dollarization of the world, as the dollar has now fully joined the yen as a cheap funding currency. But QE does not improve wages and does not help the private sector deleverage. Indeed, despite the amount of deleveraging that has occurred in the private sector, the asset side of the private sector’s balance sheet has fallen. To put this in plainer terms, Americans have indeed been paying down their credit cards and mortgages. The problem is that their assets, primarily homes and other investments, have concurrently fallen in value. (The Federal Reserve’s Z1 Report is pretty clear in this regard; see the B.100 Table on page 120 of the 7 June, 2012 FED Flow of Funds PDF).

This lack of progress will eventually express itself in a kind of exhaustion. Either America is going to have to accept much lower levels of consumption and permanently low levels of labor participation, or the country will have to explore more innovative ways to shock its economy back to life.

Let’s take a look at a few of these possibilities: » Read more