Purchasing Power

As I reminded you the other day, Ben Bernanke isn't worried about inflation. That's good to know, but what are some other facts that we can look at to determine where prices and / or purchasing power are headed. Two indicators that are relevant to this topic are core inflation (everyone's favorite to point to, since it excludes those pesky inflationary items food & energy), and income.

Rising consumer credit means more consumption which leads to stronger economic growth.  Let me explain.  Individuals go to work to produce a good or service for which they are paid a finite amount of money for.  With that income they pay taxes which leaves them with discretionary income from which to live on.  Pay the rent, utilities, insurance and healthcare, food, clothes and put gas in the car and that pretty much consumes the majority of the paycheck.  Today, the situation is quite different and a harbinger of potentially bigger problems ahead.  The consumer is no longer turning to credit to leverage UP consumption - they are turning to credit to maintain their current living needs. Take a look at the chart of personal consumption expenditures (PCE) versus total consumer credit.  Notice in the past year as consumer credit rose you saw an increase in PCE.  In the last two months consumer credit has exploded higher but there has been virtually NO increase in PCE levels on a month over month basis.  Retail sales during the Christmas shopping season we disappointing and this was even with a large decrease in gasoline prices. This situation becomes even more apparent when we begin to look at the longer term trends of real disposable incomes, consumer credit and personal saving rates.

Mohamed El-Erian, CEO and co-chief investment officer of bond fund giant PIMCO, said investors should be underweight equities while favoring "selected commodities" such as gold and oil, given the fragile global economy and geopolitical risks. Over the long term gold will reward investors who own gold as part of a diversified portfolio. Trying to time purchases and market movements is not recommended – especially for inexperienced investors.  New research from Credit Suisse and London Business School entitled ‘The Credit Suisse Global Investment Returns Yearbook 2012’ continues to be analysed by market participants. The 2012 Yearbook investigates data from 1900 to 2011 and looks at how best to protect against inflation and deflation, and how currency exposure should be steered. The chief findings are that bonds do well in deflation and benefit from currency hedging, and equities are not a perfect inflation hedge, but benefit from international diversification.  The report shows that gold offers a timely inflation hedge and long term holders of gold should expect a positive correlation to inflation – gold is one of only two assets since 1900 to have positive sensitivity to inflation (of 0.26). Only inflation-linked bonds had more - 1.00, as expected. By contrast, when inflation rises 10%, bond returns have fallen an average 7.4%; Treasuries fell 6.2%, and equities lost 5.2%. Property fell by between 3.3% and 2%. Importantly, gold managed to increase its value across both extreme inflationary and deflationary scenarios. The academics from LBS analysed 2,128 individual years in 19 major countries (1900-2011), finding gold rose 12.2% in the most deflationary years - when average deflation was 26%.

The problem with printing money and promising to do so for years ahead of time is that the negative consequences of inflation only happen after a delay. As a result, it's difficult to know if a policy has gone too far until years down the road at times. Unfortunately, if confidence in the dollar is lost, the consequences cannot be easily reversed. One problem for the Fed itself is that it holds long-term securities that will lose value if rates rise. The federal government faces an even more serious problem when interest rates rise, as higher rates on its debt mean greater interest payments to service. Due to this federal-government debt burden, the Fed has an incentive to keep rates low, even if the long-term result is higher inflation. However, for now the Fed's statement suggests it sees inflation as "subdued," so it's putting those concerns aside for now.

The last week has offered an amusing display of the difference between the cheerleading corporate mainstream media, lying Wall Street shills and the critical thinking analysts. What passes for journalism at CNBC and the rest of the mainstream print and TV media is beyond laughable. Their America is all about feelings. Are we confident? Are we bullish? Are we optimistic about the future? America has turned into a giant confidence game. The governing elite spend their time spinning stories about recovery and manipulating public opinion so people will feel good and spend money. Facts are inconvenient to their storyline. The truth is for suckers. They know what is best for us and will tell us what to do and when to do it....  The drones at this government propaganda agency relentlessly massage the data until they achieve a happy ending. They use a birth/death model to create jobs out of thin air, later adjusting those phantom jobs away in a press release on a Friday night. They create new categories of Americans to pretend they aren’t really unemployed. They use more models to make adjustments for seasonality. Then they make massive one-time adjustments for the Census. Essentially, you can conclude that anything the BLS reports on a monthly basis is a wild ass guess, massaged to present the most optimistic view of the world. The government preferred unemployment rate of 8.3% is a terrible joke and the MSM dutifully spouts this drivel to a zombie-like public. If the governing elite were to report the truth, the public would realize we are in the midst of a 2nd Great Depression.

A week ago, we asked (rhetorically), whether "Bernanke Has Become A Gold Bug's Best Friend?" While we knew the answer, today's reponse by the market confirms it. Beginning just before 10 am, or the moment Ben's prepared remarks went off embargo, gold and silver have been on a relentless tear (chart 1), with Gold passing $1760/ounce and now just $150 from its all time nominal highs. And while risk is on elsewhere, stocks priced in gold are down 0.9% since their highs yesterday and at their lows in real terms (chart 2), even as they hit new nominal highs, confirming that fear of the coming monetary tsunami will benefit precious metals. So while the lemmings focus on meaningless nominal gains, their real purchasing power just lost another 1%. Thank you Chairsatan - you are a good man.

One of the laments of the uberdoves in the world over the past several years has naturally been the fact that interest rates are bound by Zero on the lower side, and that the lowest possible rate on new paper is, by definition, 0.000%. Which is what led to the advent of QE in the first place: in lieu of negative rates, the Fed was forced to actively purchase securities to catch up to a negative Taylor implied rate. This may be about to change, because as the just released letter from the Treasury Borrowing Advisory Committee, or as we affectionately called the JPMorgan/ Goldman Sachs Chaired committee, the "Supercommittee That Runs America", simply because it alone makes up Tim Geithner's mind on what America needs to do funding wise, demand, "It was broadly agreed that flooring interest rates at zero, or capping issuance proceeds at par, was prohibiting proper market function. The Committee unanimously recommended that the Treasury Department allow for negative yield auction results as soon as logistically practical." And what JP Morgan and Goldman Sachs want, JP Morgan and Goldman Sachs get. And once we get the green light on negative yields at auction, next up will be the push for the Fed to impose negative rates on all standing securities, which means that coming soon savers will be literally paying to hold cash. And that will be the final straw.

The headlines are crowing of the magnificent CAT earnings (channel stuffing?) which in turn is helping the Dow reach its highest point since May 2008 (CAT is responsible for 27 of the Dow's 30 point gain today alone). This must be the signal that we-the-consuming-people need to borrow-and-spend again right? Well, no. Unfortunately, as many already know, the process of indexing is implicitly flawed in many ways - most importantly survivorship bias. If we compare the performance of the components of the Dow at the start of 2008 to the actual Dow index performance, there is a very significant divergence of around 7% (or around 900 points). This is actually understating the difference (as it is an average) as we note that 5 of the 30 names from 2008 have lost more than 70% of their value (GM, AIG, C, BAC, and AA) since January 2008 (averaging -88% among those). Three names have risen by more than 70% (MCD, HD, and IBM - thank you Warren) as 18 of the 2008 Dow 30 names are lower (on average -36.5%) with the remaining 12 Dow 2008 names up on average 33%. What is worse is the realization of the dramatic loss in real purchasing power as Gold has risen by more than 100% since the start of January 2008 as the Fed continues to realize it can abuse the lemming-like focus on nominal returns.

For a new investor in gold and silver, here is the most lucid piece of advice I can offer. Identifying severe undervaluation points in gold and silver, buying gold and silver assets during these times, and not worrying about interim short-term volatility, even if the immediate volatility is downward, is much more likely to impact your accumulation of wealth in a positive manner than trying to perfectly time market tops and bottoms in the highly manipulated gold and silver game.

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...

For an update on the sad state of the hedge fund industry, we go to the FT which confirms what we had been reporting every week in 2011 courtesy of the periodic HSBC hedge fund industry report, namely that less than one third of all hedge funds in 2011 paid material bonuses to their employees (or if they did, they better have done it without the knowledge of their LPs), because "more than two-thirds of hedge funds are below their high water mark., the point at which they are able to charge investors performance fees." And since performance fees, or the 20 in the "2 and 20 part", is where the discretionary component of analyst, trader and PM compensation comes from, it is safe to say that the bulk of hedgies did not have a good year in 2011. And, in fact, for many the anger goes far back: "It can be a long way back. Credit Suisse calculates that 13 per cent of hedge funds have not earned any incentive fees since at least 2007. Most of these are small funds with assets of less than $100m, which struggle to retain staff without the income available from performance fees." One such fund was of course Citadel which after its abysmal performance in 2008 only managed to climb above its high water mark in the past week for the first time since 2007. And while this is not really news, what is far more curious is that according to Credit Suisse hedge funds have resumed levering once again.

The only thing that is as consistent as Marc Faber's message to get out of government bonds ahead of a bout of global hyperinflation which will arrive once the vicious cycle of printing to pay interest finally dawns (which in turn would happen once central planners lose control of an artificially created situation, which by definition, always eventually happens), is the passion with which he repeats it over... and over... and over, like a man possessed, if ultimately 100% correct. In an interview with Bloomberg's Sara Eisen and Erik Schatzker this morning, he does what he does best - cuts to the chase: "if you think it through and you are as bearish as I am, and you think the whole financial system will one day collapse, we don't know if in 3 years, or 5 years, or 10 years, but one day there will be a reset, and everything will be essentially started anew, then you are better off in equities than in government bonds, because a lot of government bonds will either default or they will have to print so much money that the purchasing power of money will depreciate very rapidly." When asked if he feels uncomfortable predicting a calamity in bonds again, as he did back 2009, Faber is laconically empathic: "it is true that last year the 30 year bond returned 30%, and i owe David Rosenberg a bottle of whiskey" but analogizes: "from August 1999 to March 2000, the Nasdaq doubled, but at no time in that timeframe was it a good buy. And after it people lost a lot of money. We have now a symptom of monetary inflation and this is record corporate profits, and the second symptoms is essentially a bubble in high quality bonds: people seem so insecure and so much worried, they would rather be in a US bond with no yield, than in bonds that may not repay me, or in equities that may drop 30%. But it does not make them a good buy longer term." Yep: only Faber can get away with calling the bond market the second coming of the Nasdaq bubble and look cool doing it.

Mario Draghi once again mistakes a Solvency issue for one of Liquidity

Demand in Asia continues to be strong.  China remains the world’s largest producer of mined gold. Premiums for gold bullion bars in Asia are rising again and are at their highest since October in Hong Kong and Singapore. Premiums are at $2.15/oz in Hong Kong and $1.65/oz in Singapore.  Bullion’s strength was also attributed to the euro’s 16 month low, with Fitch warning the ECB to purchase assets to try to stabilize the euro.   Spot gold was up 0.6 percent at $1,650.34 an ounce at 1009 GMT, having earlier touched a one-month high at $1,652.30. U.S. gold futures for February delivery were up $12.60 an ounce at $1,652.20.  A stronger rupee has boosted the purchasing power of gold bullion consumers in India.  This is in the run up for the Indian Wedding Season which resumes January 15th and continues until April, leaving a  few weeks break for a period that is considered bad luck for nuptials.  Chinese demand will weaken next week as many factories and businesses are set to close for the Lunar New Year’s celebrations.

One of the recurring analogues we have used in the past to describe the centrally planned farce that capital markets have become and the global economy in general has been one of a increasingly chaotic sine wave with ever greater amplitude and ever higher frequency (shorter wavelength). By definition, the greater the central intervention, the bigger the dampening or promoting effect, as central banks attempt to mute or enhance a given wave leg. As a result, each oscillation becomes ever more acute, ever more chaotic, and increasingly more unpredictable. And with "Austrian" analytics becoming increasingly dominant, i.e., how much money on the margin is entering or leaving the closed monetary system at any given moment, the same analysis can be drawn out to the primary driver of virtually everything: the inflation-vs-deflation debate. This in turn is why we are increasingly convinced that as the system gets caught in an ever more rapid round trip scramble peak deflation to peak inflation (and vice versa) so the ever more desperate central planners will have no choice but to ultimately throw the kitchen sink at the massive deflationary problem - because after all it is their prerogative to spur inflation, and will do as at any cost - a process which will culminate with the only possible outcome: terminal currency debasement as the Chaotic monetary swings finally become uncontrollable. Ironically, the reason why bring this up is an essay by Pimco's Neel Kashkari titled simply enough: "Chaos Theory" which looks at unfolding events precisely in the very same light, and whose observations we agree with entirely. Furthermore, since he lays it out more coherently, we present it in its entirety below. His conclusion, especially as pertains to the ubiquitous inflation-deflation debate however, is worth nothing upfront: "I believe societies will in the end choose inflation because it is the less painful option for the largest number of its citizens. I am hopeful central banks will be effective in preventing runaway inflation. But it is going to be a long, bumpy journey until the destination becomes clear. This equity market is best for long-term investors who can withstand extended volatility. Day traders beware: chaos is here to stay for the foreseeable future." Unfortunately, we are far less optimistic that the very same central bankers who have blundered in virtually everything, will succeed this one time. But, for the sake of the status quo, one can hope...