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Hard Times Ahead for Assets

Tuesday, December 27, 2011, 9:38 AM

Hard Times Ahead for Assets

by Charles Hugh Smith, contributing editor
Tuesday, December 27, 2011

Executive Summary

  • Understanding the leading indicators for commodities prices
  • Either bellwether copper is cheap or stocks are expensive
  • S-curve analysis suggests we're entering a corrective phase for commodities
  • Why those long on on resource investing should take a defensive stance

Part I: Are Commodities Topping Out?

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

Part II: Hard Times Ahead for Assets

Are commodities topping out? Since we know commodities are physically limited in supply even while demand continues to rise, common sense suggests that commodities will outperform over the long term for as long as industrial civilization continues its consumption of those commodities.

However, it is also clear that the global economy is either slowing or entering an actual recessionary contraction. Thus it behooves us as investors to ask what that contraction of demand might do to the prices of commodities over the near term (i.e., the next 24 months, 2012-2013.)

In Part I, we examined the connection between stock markets and demand for commodities as reflected by the chart of the Reuters/Jefferies CRB Index, the commonly used bellwether for the commodities market. We determined that if the stock markets of China and India are indeed leading indicators of demand for commodities, then the market for commodities will likely weaken.

We also found that margin debt seems to be far more closely correlated to the US stock market than demand for commodities as reflected by the CRB, meaning the US stock market may not be an accurate leading indicator of commodity demand or pricing pressure.

In Part II, we examine a key technical correlation that has withstood the test of time, that of copper and the stock market, and explore a potential key dynamic which may exert outsized influence on the demand and pricing of commodities over the next few years.

As a side benefit, our examination of the commodities may also shed light on the direction of the stock market — another key interest for many investors.

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Off the Cuff: Trust Is Becoming a Precious Commodity

Thursday, December 22, 2011, 12:26 PM

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

  • The ECB's Latest Liquidity Move
    • What impact will the recent flood of hundreds of billions of euros have on the European debt crisis?
  • Counterparty Risk
    • MF Global's actions and the government's reaction to them are eroding critical trust in the system
  • Housing Prices
    • Does the recent admission by the NAR that it has been overstating housing values provide any signal that we're getting close to a market capitulation?

This week's theme is hidden risk. It's everywhere. The only thing keeping the financial system together right now is people's confidence in it. As more and more people realize that banks are being subsidized at taxpayer expense, client assets can be confiscated without notice, and the 'experts' guiding us have been wildly wrong for years, this critical confidence may wane to a point where there's not enough left to keep the system from seizing.
» Read more

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Get Ready for Worldwide Currency Devaluation

Wednesday, December 21, 2011, 11:03 AM

Get Ready for Worldwide Currency Devaluation

Wednesday, December 21, 2011

Executive Summary

  • The risk of cascading derivatives failures is the "nuclear option" scaring central planners into doing everything in their power to prop up the financial system
  • The loss of small investors leaves market prices more vulnerable to the growing percentage of fickle, short-term, "hot money" trading systems
  • Removal of China's 'deep pockets' from the EU and US credit markets could easily cause them to seize up
  • Why currency devaluation via inflation still seems the likely endgame
  • Recommendations for increasing your financial and personal resilience to this outcome

Part I: Worse Than 2008

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

Part II: Get Ready for Worldwide Currency Devaluation

Derivatives

You'd think that after AIG blew up spectacularly and Lehman choked on a hairball of tangled derivatives (one that is still being picked apart), the lesson would have been learned and derivatives reduced in both size and complexity.

Unfortunately, that lesson was not learned, and we have to square up to the fact that derivatives are now roughly $100 trillion larger in aggregate than they were in 2009:

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More Myths and Illusions: Corporate Cash & Debt

Monday, December 19, 2011, 7:17 PM

There are several hard things about this particular crisis, especially for the aware. One is the waiting for the other shoe to drop, as we all know it must. The vast imbalances that led to the 2008 crisis are mainly still intact, and in many cases are larger than they were before.

Another difficult thing is constantly reading all the horribly wrong and misleading information out there that is designed to shape opinion almost universally in the direction towards more profligacy and consumption. Statistics are constantly bent, and other bits of information running counter to the idea that a new round of robust consumer expansion is nearly upon us are conveniently buried or overlooked. » Read more

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Why It's Now Easier to Predict the Outcomes of the Coming Recession

Monday, December 19, 2011, 3:55 PM

Why It's Now Easier to Predict the Outcomes of the Coming Recession

by Gregor Macdonald, contributing editor
Monday, December 19, 2011

Executive Summary

  • Western economies are more sensitive to oil prices than the developing world.
  • Global oil supply is extremely tight by historical measures.
  • Oil prices will likely not go much higher in 2012, due to the failing global economy.
  • The next oil-price induced recession (coming ASAP) will have predictable outcomes on the economy and its key sector.
  • Understanding these predictable economic outcomes resulting from oil supply dynamics
  • Prediction offers more value to the investor than simply betting on oil prices (which will likely be extremely volatile).

Part I: Why Oil Prices Are Killing the Economy

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

Part II: Why It's Now Easier to Predict the Outcomes of the Coming Recession

The Oil-Sensitive West

Consumption of oil in the West started to flatten out as early as 2004. And readers of my previous essays know that after the crisis started in ‘08, both Europe and the US shed even more oil demand. Let there be no doubt: Oil demand in the OECD has been highly elastic (responsive) in the face of oil prices above $80. In the data, you could even see some early signatures of reduced demand coming in 2004, when oil prices rose above $40.

One of the paradoxes that repeatedly trips up analysts, because it’s so counter-intuitive, is the fact that the wealthy Western countries are hurt more by high oil prices than the poorer, emerging market countries.

Your average Westerner is consuming quite a lot of oil, per capita. It's embedded in shipped goods and in shipped foods, and also comes via high penetration of automobile ownership. Westerners drive lots of miles, comparatively. But people in emerging markets have only just begun to use oil. It hardly matters whether petrol is $4.00 per gallon or even $8.00 per gallon if you have just upgraded from a rural existence, and for the first time ever your family is consuming 4-6 gallons of petrol per month (enough to power a motorbike each day for a short distance). This is precisely what Bernanke is alluding to, when he allows that we have no control over emerging market oil demand.

More vexing is that emerging market economies are primarily running on coal, so they are able to produce and align their consumption with the power grid, while being more discretionary about liquid fuel use for mobility. This is really perplexing, as I said, to Western analysts but I do want to point out that its empirically true (see Stuart Stanford’s post on the subject, Wow, Just Wow, from earlier this year).

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Off the Cuff: Don't Get Pessimistic on Gold

Thursday, December 15, 2011, 3:55 PM

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

  • Where to now?
    • There's a whiff of deflation in the air as central banks posture and pontificate. Is this a harbinger of things to come, or a head-fake before the money printing resumes in earnest?
  • Gold
    • It's been a rough few weeks for holders of the yellow metal. Has there been any fundamental shift affecting the reasons for holding gold?

Cross-currents and volatility define the period we're in now. For investors, vigilance and defense should be the main priorities. But, it seems we're closer to the end of this stage than the beginning, so be positioned for action soon.
» Read more

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How Low Will Housing Prices Go?

Monday, December 12, 2011, 11:13 AM

How Low Will Housing Prices Go?

by Charles Hugh Smith, contributing editor
Monday, December 12, 2011

Executive Summary

  • The three macroeconomic factors that will suppress employment -- and in turn, housing prices -- for years to come
  • Expect an overshoot as housing prices revert to their historic mean
  • Why those who are buying now are likely "catching a falling knife"
  • Relative valuations for determining when the housing market will have hit bottom

Part I: Headwinds for Housing

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

Part II: How Low Will Housing Prices Go?

It’s a truism that “all real estate is local,” and to the degree that the ultimate price of a property is only truly “discovered” when a specific buyer purchases a specific property at a specific point in time, this is certainly true. It is also true that many key inputs to real estate valuation are locally derived, such as employment, wage levels, demand for rental housing, the attractiveness of neighborhoods, and so on.

But to say that interest rates managed by the Federal Reserve or subsidies provided by the Federal government have no influence on real estate valuation is clearly untrue. Valuation is directly influenced by global, national, and state economies, and by the policies of the central bank and government.

In attempting to answer the question When will housing hit bottom? we might start with the coarse-grained systemic inputs and then move to the more fine-grained local inputs.

Insider

Off The Cuff: Planning to Plan for the Plan

Thursday, December 8, 2011, 2:17 AM

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

  • Rescuing Europe
    • There seems little reason to have optimism that the latest announcement of a plan to save the Continent will be any more fruitful than the many previous ones. A better question is: Can Europe be saved?
  • Fuzzy numbers
    • Reports of Cyber Monday record sales and lowering unemployment are in the media. Time to break out the champagne?

The leaders of Europe are showing Herculean talent in kicking the can further down the road. The key question now is when does the road end?
» Read more

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The Framework for Predicting Our Financial Future

Wednesday, December 7, 2011, 10:11 AM

The Framework for Predicting Our Financial Future

Wednesday, December 7, 2011

Executive Summary

  • Exponential change 'speeds up'
  • When it finally happens, change happens quickly
  • Collapse progresses from the outside in
  • Complex systems will become simpler when energy is scarce
  • We fool ourselves at our peril
  • The rules will be changed
  • If you can't accurately assess the risks, don't play the game
  • Investing in a structural bear market

Part I: How to Position Yourself for the Future: Step 1 - Financial Security

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

Part II: The Framework for Predicting Our Financial Future

Okay, assuming you have the basics covered, I now want to share with you my views on the markets and how things will unfold in the future. My assumption is that you have completed the full Crash Course (or one of the shorter versions) and are familiar with the exponential function and how it permeates our everyday life.

This framework is always subject to revision as new experiences and data points become available, but its central themes have been operative for me for several years.

Again, this body of work represents my personal observations, historical readings, and faith in the idea that cultures and laws may change but humans tend to behave in predictable ways. As always, I reserve the right to change my forecasts as new information becomes available.

Exponential Change 'Speeds Up'

Understanding the nature of the systems in which we live is the centerpiece of our analytical framework. And at the heart of that is the concept that we live in a world dominated by exponential functions and curves. 

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How the European Endgame Will Be the Death Knell For Modern Economics

Monday, December 5, 2011, 2:08 PM

How the European Endgame Will Be the Death Knell For Modern Economics

by Gregor Macdonald, contributing editor
Monday, December 5, 2011

Executive Summary

  • Central banks are running out of options, leaving only increasingly desperate choices
  • Why Europe is most likely to begrudgingly print a whole lot more money soon
  • The harsh judgment day is approaching for mainstream economists
  • Why 2012 heralds the dawn of a new era of economic understanding

Part I: It's Time To Give Up On Mainstream Economics

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

Part II: How the European Endgame Will Be the Death Knell For Modern Central Banking

Central Banks Becoming Increasingly Desperate

Has Europe decided to print its way out of the crisis? The big-bang announcement last week among global central banks suggests as much. Unfortunately, the global US dollar swap solution only patches up the liquidity portion of Europe’s present dilemma and does nothing to address the solvency issue.

As readers know, I take the mildly heretical view that “money-printing” in our present debt deflation actually functions as a status-quo maintainer. It does not risk hyperinflation, but instead keeps social confidence intact -- at low levels, of course -- as the familiar institutions of Western economies are maintained. Hard defaults, on the other hand, especially hard defaults that appear out of the hands of either fiscal or monetary policy makers, risk a confidence collapse on a large scale.

In my view, hyperinflation typically begins with a broad rejection of a country’s sovereign debt. This is the initial threshold that is crossed on the path to currency rejection, as foreign holders exit first. Domestic institutions are more restricted, slower to react, often bound by investment mandates, and thus left “holding the bag,” as it were, on a country’s bonds. Eventually, domestic confidence in the currency itself is lost, as the public, having watched its institutions fail, rejects the currency.

In my view, Europe is still at very high risk for such a catastrophic outcome. No global central bank, including the European Central Bank (ECB), can change the fact that the debt of Greece, Portugal, Spain, and Italy cannot be supported realistically through economic growth. But there is still time for the ECB to change its charter and buy that debt. The coordinated central-bank actions this past week will have virtually no consequence unless the ECB conducts QE (quantitative easing) on a massive scale.

Probabilistically, I have to favor the idea that Europe was given the lifeline on the condition that the fiscal union discussed in Europe and the permission granted to the ECB to conduct QE are both forthcoming. For the sake of social stability, I hope this happens. But I am not naive. Much of the debt that the ECB would purchase under such a regime, just like much of the junk debt now on the Fed's balance sheet, will never recover its par (full price) value. Certainly not in real (inflation-adjusted) terms. But if the ECB does not “print money,” then we will move directly to hard defaults. And the hyperinflation risk that is currently masked by the common currency to the Eurozone will eventually be unveiled.