Reality

Let’s cut the BS here. The Fed has maintained a more than highly accommodative stance for three years now and U-16 unemployment, food stamp usage, home prices, and virtually every other economic metric indicate that they’ve done little to boost the US economy in any meaningful way. QE has and always will be about boosting asset prices in the hope that the Fed can stimulate a recovery by getting the S&P 500 to some level.

It seems self-evident. The government can debase the currency and thereby be able to pay off its astronomical debt in cheaper dollars. But as I will explain below, things don’t work that way. In order to use the debasement of paper currencies to repay the debt more easily, governments will need to issue and use the gold bond. The paper currencies will not survive too much longer. Most governments now owe as much or more than the annual GDPs of their nations (typically far more, under GAAP accounting). But the total liabilities in the system are much larger. The US dollar game is a check-kiting scheme. The Fed issues the dollar, which is its liability. The Fed buys the US Treasury bond, which is the asset to balance the liability. The only problem is that the bonds are payable only in the central bank’s paper scrip! Meanwhile, per Bretton Woods, the rest of the world’s central banks use the dollar as if it were gold. It is their reserve asset, and they pyramid credit in their local currencies on top of it. It is not a bug, but a feature, that debt in this system must grow exponentially. There is no ultimate extinguisher of debt. In reality, stripped of the fancy nomenclature and the abstraction of a monetary system, the picture is as simple as it is bleak. Normally, people produce more than they consume. They save. A frontier farmer in the 19th century, for example, would dedicate some work to clearing a new field, or building a smokehouse, or putting a wall around a pasture so he could add to his herd. But for the past several decades, people have been tricked by distorted price signals (including bond prices, i.e. interest rates) into consuming more than they produce. In any case, it is not possible to save in an irredeemable paper currency.  Depositing money in a bank will just result in more buying of government bonds.  Capital accumulation has long since turned to capital decumulation... I propose a simple step. The government should sell gold bonds. By this, I do not mean gold “backed” paper bonds. I mean bonds denominated in ounces of gold, which pay their coupon in ounces of gold and pay the principal amount in ounces of gold. Below, I explain how this will solve the three problems I described above.

Last week we pointed out the seemingly bizarro strategy that by now must have become mainstream mantra that buy-and-hold is dead but buy-the-dips-in-the-most-hated-stocks is a winning strategy. Since we pointed this out, our index of the 30 most shorted stocks has surged by 5% compared to a measly 2% (Fed-assisted) gain in the S&P itself. It appears the break with reality started on Tuesday morning (pre-empting the Fed high beta ramp?) and today's sell-off is seeing the index of the shortest-of-the-shorts give some gains back from an open over 6% to around 5% currently. For most managers, their year is done - a 300bps outperformance - for others, we suggest perhaps reducing size a little. It appears the man behind the curtain may just have removed some of the juice for more bizarro strategies (and maybe take those hard-earned gains and buy gold) as even with ZIRP extended, QE's nominal surge will likely remain absent until we see some market (otherwise known to Bernanke as the economy) disruption (and we suspect the names to suffer will not be the Utilities - that have outperformed handily post FOMC - and remember high beta up and higher beta down).

"All markets trade their way to Perdition" is how TrimTabs' CEO Charles Biderman concludes a rather clear and factually full exposition of the reason we have gone up and the reality of why a drop is inevitable. Between the outsize number of investment vehicles relative to investable assets, the trend bias that every wealth manager seems stuck with that we will grow our way out of this mess (which Biderman suggests means a long-term rate of 5-10% GDP growth for the US - which seems obviously beyond our reach). He takes on the irony of the Wall Street vs Main Street arguments and warns of the inevitable plunge in the stock market (further believing that the winner of the next election is irrelevant given the cash vs special needs imbalance that exists). The US economy, if marked to market, is broke. Take home pay for all taxpayers is now only $6.2tn, down from $7tn at its peak in 07, and additionally we have created $5tn of new debt since the start of QE1 and owe a PV of $50tn in 'unfunded' liabilities leaving the future looking quite grim in his view. Perdition indeed appears to be looming given the Fed's far from sanguine view of reality.

And so the volatility continues: initial claims go from 402K to an upward revised 356K, to 377K, on expectations of 370K. The swings in this data series are getting as big as those in the stock market on those rare occasions when reality sets in. The miss is in line with the Fed perceived weakness in the economy. Continuing claims also missed coming at 3554K up from an upward revised 3466K, higher than expectations of 3500K. A whopping 146K dropped out of extended claims: in fact, in the past year the unemployed collecting post 6 month benefits either EUCs or Extended Benefits have plunged from 4.6 million to 3.4 million. As for last week's massive drop of nearly 50K initial claims, we learn that somehow it was New York to thank for this, with 27.7K less claims than the week before due to "Fewer layoffs in the transportation, educational, and construction industries." How about layoffs in the financial services industry, and also how much do those jobs pay vs "transportation, educational and construction" jobs?  What however does not justify the Fed's ZIRP through 2015 or so, is the Durable Goods number which came at 3.0%, on expectations of 2.0%, down from an upward revised 4.3%. The bulk of this was in airplane orders thanks to Boeing as noted previously. However what was surprising is that Durable Goods ex transportation came in at a blistering 2.1% on Exp of 0.9%, and Capital Goods Orders ex Non-Def and Aircraft which rose 2.9% on expectations of 1.0%. However since the Fed has made it clear it will boost its balance sheet, and as of today the implied increase is over $800 billion, at the smallest whiff of trouble, the risk bubble is in full on mode as bad news is good news, and good news is better news.

It’s in their blood.

Year-to-date, Gold is up an impressive 9.4%, significantly outpacing the S&P 500 at +5.6% and the disappointing 2% loss (in price) for the 30Y bond.

Treasuries sold back off initial knee-jerk rally low yields into the close but the EUR kept going (holding above 1.3100) as Gold and Silver were the big winners on the day (+2.9% and 3.4% on the week now). Stocks and credit roared higher after an initial stumble post FOMC. Financials lagged among all the S&P sectors (and Utilities outperformed post FOMC statement +0.75% vs financials -0.25%). Right up until the close, credit and equity markets were on a tear but very soon after cash closed, futures limped back and HY credit snapped lower (quite dramatically) which makes some sense given just how ridiculously rich it had become to fair-value.

Our discussions (here, here, and here) of the dispersion of deleveraging efforts across developed nations, from the McKinsey report last week, raised a number of questions on the timeliness of the deflationary deleveraging process. David Rosenberg, of Gluskin Sheff, notes that the multi-decade debt boom will take years to mean revert and agrees with our views that we are still in the early stages of the global deleveraging cycle. He adds that while many believe last year's extreme volatility was an aberration, he wonders if in fact the opposite is true and that what we saw in 2009-2010 - a double in the S&P 500 from the low to nearby high - was the aberration and market's demands for more and more QE/easing becomes the volatility-inducing swings of dysphoric reality mixed with euphoric money printing salvation. In his words, perhaps the entire three years of angst turned to euphoria turned to angst (and back to euphoria in the first three weeks of 2012?) is the new normal. After all we had angst from 1929 to 1932 then ebullience from 1933 to 1936 and then back to despair in 1937-1938. Without the central banks of the world constantly teasing markets with more and more liquidity, the new baseline normal is dramatically lower than many believe and as such the former's impacts will need to be greater and greater to maintain the mirage of the old normal.

This is just getting better and better:

• FOMC: 2012 GROWTH AT 2.2%-2.7% VS 2.5%-2.9% IN NOV. FORECAST
• ELEVEN OF 17 FED OFFICIALS SEE MAIN RATE ABOVE 0.25% IN 2014
• SIX OF 17 FED OFFICIALS SEE NO RATE INCREASE BEFORE 2015
• FOMC DOESN'T SET SPECIFIC LONG-RUN GOAL FOR EMPLOYMENT LEVEL

Japan is now seriously blushing. As for the reality of the Fed's forecasts, they are absolutely worthless, so no point in even spending one minute on them.

If we learn nothing, then we deserve to lose. This is not a popular concept in America at this point in its history, when monumental errors are denied, excused, rationalized or quickly absolved by those who committed them. As a small-fry investor, when I veer away from my discipline and system, I predictably lose money. As I sift the ashes of the trade, I always remind myself: if I learn nothing from my studies and experience, then I deserve to lose. What exactly has America learned since January 1, 1999, 13 years that included two stupendous financial/credit bubbles, two hot wars and an explosion in public and private debt? If we examine the policy changes and institutional changes since the 2008 global financial meltdown, then we have to conclude that we've learned a very few things...

In all, the President's speech was reminiscent of George Clooney’s in Ides of March. We’ve heard it all before, maybe with slightly different words: America lost 4 million jobs before I got here, and another 4 million before our policies went into effect, but in the last 12 months, we added 3 million job. We must reduce tax loopholes, and provide tax incentives to businesses that hire in America. We must reform taxes for the wealthy (though he signed an extension of Bush’s tax cuts.) We must train people for an apparent abundance of expert jobs. We need more clean energy initiatives.  We created regulations (big sigh of relief he didn’t use the word ‘sweeping’) to avoid fraudulent financial practices. We will help homeowners. Wall Street must ‘make up a trust deficit.”   Like Jamie Dimon cares. In other words, Obama gave Wall Street a pass, while waxing populace. Don’t get me wrong. I expected nothing different. I will continue to expect nothing different, when he gets a second term, given the lame field of contenders all around.

Humans are a flawed species. Our minds are easily manipulated. We don’t like pain. We prefer instant gratification. We are susceptible to mass delusion. We will often choose hope over critical thought. Those with higher IQs will regularly attempt to take advantage of those with lower IQs. Fear and greed are the two motivations used by the minority in power to control and manipulate the majority. The American people have been led astray by a small group of powerful men. We were herded through a door in the wall of perception that promised an American dream of material goods, entitlements and pleasure with no obligations or responsibility to future generations. There is only one choice that can save this country from ruin. Each individual must make a choice to either to continue supporting the manipulative, corrupt status quo or coming back through the Door in the Wall.

“The man who comes back through the Door in the Wall will never be quite the same as the man who went out. He will be wiser but less sure, happier but less self-satisfied, humbler in acknowledging his ignorance yet better equipped to understand the relationship of words to things, of systematic reasoning to the unfathomable mystery which it tries, forever vainly, to comprehend” – Aldous Huxley

At some point, the market will force the issue of whether or not the ECB is going to be monetizing everything or not. Germany, having already seen the ultimate outcome of monetization (Weimar) has already made it clear that it will not tolerate this.

Much has been said about the secretive vault situated 80 feet below ground level at 33 Liberty street, which contains over 20% of the world's gold (allegedly*), currently estimated at over $350 billion. Some have even robbed it: with the barrier between fantasy and reality a blur, courtesy of the total farce we live in which has rendered the IPO of TheOnion impossible, there is nothing wrong with actually believing Die Hard With A Vengeance did in fact happen. But if your knowledge of the vault is limited to the perspective of one John McClane, you are missing our on a lot. Which is why the new York Fed, in those rare occasions when it is not monetizing debt, and/or telling Citadel which securities to buy, has been courteous enough to put together "The Key To The Gold Vault" - the official brochure of the warehouse where more gold is stored than at any other place in the world.

Just Smile ... It Will Protect You from All Radiation!