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The Daily Reckoning Tuesday, December 15, 2009 Stocks fly as Abu Dhabi comes to Dubai's (temporary) rescue, Banks repay the Fed with one hand...and rob it with the other, Bill Bonner on gold dipping back into that "buy" range, and more... Joel Bowman, connecting a few dots from his post in Taipei, Taiwan... The news always lends itself to an array of varying interpretations. Today is no exception. People will glean from the headlines what they want to hear, of course...and then pimp the data points out to arguments that support their own point of view. In other words, they will come to believe what they must, when they must. To illustrate our point, consider briefly the following three headline-grabbing trends: 1. Banks are repaying their TARP loans... ...as good news: Last night Wells Fargo joined Citigroup Inc. in pledging to repay in full their loans from the Troubled Asset Relief Program. Stocks rallied to fresh 14-month highs on the news. Or... ...as bad news: Those same institutions are unloading mortgage backed securities and other toxic assets - almost dollar-for-dollar - onto the Fed's balance sheet at an increasing rate. Now they can hammer the government (ahem, taxpayer) for more wiggle room AND unshackle their highflying CEOs from those pesky salary cap provisions included in the TARP. 2. Sovereign debt fears abate after Abu Dhabi backstops Dubai debt... ...as good news: Oil-rich Abu Dhabi flung a $10 billion check Dubai's way after the latter, rascal emirate logged up more debt than it could ever hope to repay. Or... ...as bad news: Sheikh Mohammed bin Rashid Al Maktoum, the silk dishdasha-clad ruler of Dubai, still has to find a way for his gaudy emirate to meet some $80 billion in other debts and liabilities. Oh yes, and the place still has next to no oil and a surplus of everything expendable in a crisis...from indoor ski slopes to Swarovski-encrusted license plates and island real estate projects slowly eroding into the Gulf... 3. Gold continues correcting and stocks continue soaring... ...as good news: Daily Reckoning readers can continue following our trade of the decade - buying gold on dips and selling stocks on rallies... Or... ...as bad news: Those same readers must continue to suffer the pervasive recovery rhetoric dolled out by unthinking neckties in the mainstream media...for now... Please enjoy today's "punchy" DR edition as our contributing editors flesh out these and other important news bites for your consideration, below... First up, Ian Mathias of The 5-Minute Forecast highlights the buyout of XTO Energy as the start of a takeover boom: Exxon Mobil agreed to buy XTO Energy yesterday for $31 billion in XOM stock. Exxon, the worlds biggest oil company, paid a 25% premium for XTO, a big player in domestic energy, especially the shale oil and shale gas that has garnered so much attention lately. Exxon certainly isn't hiding what it's going after... In a report last week, Exxon forecast energy demand to rise 35% by 2030, with over half of that new demand met by natural gas. "If there is one prediction I feel confident about for 2010," writes Chris Mayer, "it's that mergers and acquisitions (M&A) are going to heat up again. Companies have lots of cash - more, as a percentage of assets, than at anytime since 1960. Yet, there are fewer opportunities to invest that cash and fewer opportunities to grow. So that means that takeovers are a quick and easy path to growth. Also, the M&A market has been dead since the Lehman bankruptcy and it's not a market that usually stays dull for long. Monday, we got a big signal that the feeding frenzy is on. For investors, this means we could see a new wave of takeovers, which could provide nice payoffs. "I've repeatedly pointed out that the energy sector is ripe for deal- making, because the cost of acquiring oil and gas reserves in the stock market is cheaper than finding them from scratch by exploring and drilling. ExxonMobil is taking out XTO, America's largest natural gas producer, for a 25% premium. It's a stock deal, but it makes the point that buying oil reserves on Wall Street makes economic sense. "The XTO takeover also sends a bullish signal for natural gas. Exxon is no dummy. It sees the carbon emission stuff coming down the pike and cheap clean-burning natural gas is going to be good asset to own." [Joel's Note: We think Chris is no dummy either. Last week his Special Situations readers got a fat payday - up to 350% gains - when one of their mining companies got a similar buyout offer. There are many more worthy buyout targets in this portfolio... you should really check it out.] Next up, James Turk at The Free Gold Money Report accuse the Federal Reserve of debasing the dollar...and they have the pictures to prove it: The Federal Reserve is pursuing a pernicious policy that is insidiously debasing the dollar. This policy has generally been met with indifference, if it has even been noticed at all. The Federal Reserve is debasing the dollar by purchasing inferior assets of poor quality. These assets are mortgage-backed securities issued by federal agencies like the insolvent, and for all practical purposes bankrupt, Fannie Mae. These are assets neither the banks nor private investors want. If there was a legitimate, real-world demand for these assets, the Federal Reserve would not need to buy them. But it is. Thus, instead of acting in its historical role as the "lender of last resort," the Federal Reserve has on its own expanded its mandate to become the "buyer of last resort." By purchasing mortgage-backed securities, the Federal Reserve is debasing the dollar. Just how pervasive - and therefore serious - this debasement has become is apparent from the following chart prepared by BusinessInsider: According to its latest report, the Federal Reserve now owns over $1 trillion of mortgage-backed securities, which is 45.6% of all assets on its balance sheet. One year ago mortgage-backed securities were only 0.6% of the Federal Reserve's total assets! [Eric's Note: Furthermore, even though the folks at Citigroup and the other big banks have been making headlines about repaying their TARP borrowings, the Federal Reserve continues to supply massive "backdoor credit" to these very same institutions. Yes, the banks are repaying TARP loans, but the banks are also continuing to sell their toxic mortgage-backed assets to the Federal Reserve. And you will notice that the pace of MBS buying by the Fed has accelerated, matching almost dollar-for-dollar the funds the banks have been repaying to the TARP and other credit facilities. In other words, the banks are merely repaying the government with one hand while borrowing from the government with the other hand.] The Federal Reserve is very highly leveraged, much more than most banks. It is carrying $2.15 trillion of debt on $52.8 billion of capital, giving it a leverage of 40.8-times more debt than capital. The Federal Reserve's mortgage-backed securities alone, represent 19-times its capital, meaning that if the true value of these assets is 5.3% less than their book value, the Federal Reserve's capital is wiped out, effectively making it another insolvent institution. Given that Fannie Mae is itself insolvent and most other mortgage generating federal agencies are not far from perilously sliding down to that same dire financial condition, it is reasonable to assume that the true value of these mortgage-backed securities is less than 94.7% of their book values. Therefore, on a strict accounting basis, the Federal Reserve is probably insolvent. That said, the Fed could always remedy its "insolvency" by creating more dollar bills for itself. And, in fact, the Fed is already in the process of doing this exact thing. How else could its assets have mushroomed from $800 billion last year to more than $2 trillion currently? We call this "inflation." --- Outstanding Investments Special Metals Report --- From Hulbert's #1 Ranked Advisory Letter Over a Five-Year Period... Even if Gold hits $2,000 by the end of this year... Here's a hidden way you can get in for less than one cent per ounce. Over the next two years, you'll witness the greatest surge in gold prices in market history - at least 119% above where gold sits today, as I write this. But even better, I've just discovered a way for you to sneak into the soaring gold market for next to nothing, with what I call "penny-per- ounce" gold. That is, doing this is a "backdoor" way to own as much of a position in gold as you like... for the equivalent of paying a single cent per ounce. --------------------------------------------------------------- And now it's over to Bill Bonner with today's reckoning from London, England... Poor Silvio Berlusconi. He was hit in the face with a heavy statuette of the Duomo - Milan's famous cathedral. To our knowledge, this is the first time the image of a major religious building has been used to try to assassinate a head-of-state. In the West, no president or prime minister has been murdered for many years. In Italy, it has been 31 years since Aldo Moro was kidnapped and killed by Red Brigade terrorists. In America, Reagan was shot in the '80s...but survived. The last US president to be gunned down in office was John Kennedy in the '60s. And it's been more than 200 years since France cut off the head of Louis XVI. Seems like much too long to wait for another one. After all, the best form of government is benign tyranny, as George Bernard Shaw reminded us, tempered by assassination. Meanwhile, the financial world keeps working its way through this period of great confusion and uncertainty. Nobody knows what to think. Nobody knows what anything is worth. Nobody knows what to do. It's always this way...to some extent. But this time it's worse. Financial authorities are to blame. Instead of letting the chips fall where they may...and where they could be picked up, weighed and re- organized...they caught the chips, wrapped them in gauze of cash, and tossed them back into the air. Now we don't know what they're worth. We don't know what anything is worth. The price of stocks went up yesterday to a 14-month high. The Dow rose 29 points. Gold, meanwhile, put in a positive performance. It was up $3.90. Is the correction in the gold market over? Our answer...which is just a guess...is that the correction probably hasn't really even begun. But we'll return to that in a minute. First, let's look at the economy itself. We look at the economy because it is the source of wealth for us all...it is the thing that gives value to our investment assets. If companies can't make a profit, they are not worth owning - at any price. If, on the other hand, their earnings rise, so should their capital values. So what's happening in the economy? Well, the recession is said to be over. But what does that mean? Again, with so many phony indicators and so much fraudulent information around, nobody knows. The malls are still moving the merchandise, but only by offering "deep discounts," says the LA Times. A survey of shoppers shows that they intend to cut their buying by 15% this holiday season. Let's see, 15% is about the limit of the profit margin for most retailers. Take away 15% of gross, and they may be losing money. And then take away 15% all the way up the chain from retail to wholesale to manufacturer. Not a situation that is likely to increase employment or stock prices. This year will see a record number of corporate defaults worldwide - with most of them in the US. One in five college borrowers defaults. And New York governor Paterson says the state will end the year with negative cash for the first time ever. Unemployment is increasing. Retail sales are decreasing (despite recent data that seem to show the contrary.) Thrift is coming back into style. It's a depression, after all. It won't stop being a depression until some major adjustments have been made; specifically, consumers have about twice as much debt as they can comfortably carry. That debt needs to be defaulted on, paid down, worked out, inflated away, or otherwise written off. Don't worry...it will happen. All in good time. And more thoughts... Cleaners provide society with more value than bankers, says a report on the BBC. The news item cited a group called New Economics Foundation, whose study showed that hospital cleaners create $10 of value for every $1 they are paid. Bankers, on the other hand, DESTROY $7 for every dollar they earn. While we are sympathetic to their conclusion, the New Economics Foundation must be a bunch of imbeciles. How do they know how much 'value' a profession adds? There ain't no such thing as an objective measure of value. All we have to go on is the price. Each of us has to figure out the value for himself. But everybody is jumping on the bankers' case. Good ol' Paul Volcker is giving them hell. He told a group of bankers that the only innovation they came up with that actually added value was the automatic teller machine. England and France are imposing surtaxes on bankers' bonuses. An update on how these work (we had it wrong when we first reported it): in the UK, the tax is levied on the bank. The banker still has to pay regular tax rates. It's designed to stop banks from giving bonuses...so the government won't look quite so stupid for having given the banks money in the first place. In America, the president is getting tough on bankers too, at least according to the papers. He calls them "fat cats" and has asked them to make "extraordinary commitments" to lend money and help the economy recover. What does that mean, exactly? We don't know. Why would anyone encourage bankers to lend against their better judgment? It's just one of the many mysteries of our time. And here comes Tim Geithner with more smoke. Yesterday, he gave out the news that the TARP program earned a profit for the federal government. Let's see, how does that work? You lend banks money below the real cost...so they can borrow for practically nothing. Then, they lend the money back to you for a cool 300 basis point spread. Then, you buy from them the speculative investments they made that didn't pay off. They keep the ones that go up. And you pump money into their counterparties so they don't take the losses they richly deserve. And then, you "invest" in them through the TARP program...and when their stocks go up...well, you've made a profit! We have to hand it to the Geithner/Bernanke team. They are financial geniuses after all. We take back every word of doubt. We eat our words of criticism and take a bite out of our hat too. We were wrong. But such is the mixed message sent by the feds' meddling in the marketplace that no one really knows whether the US lost money or made money. You create enough funny money, and even keeping score becomes impossible. So, let's return to gold. Nothing funny about gold. It is what it is. No more. No less. But is it a buy or a sell? Is it correcting in a bull market...settling into a bear market...or is it just as confused as the rest of us? It's hard to say. On the one hand, the feds are still pumping in liquidity. And there is Paul Krugman, recent winner of an award from the same group that gave Obama a "peace prize," who urges the Fed to expand credit by buying a further $2 trillion in assets... Whew! It wasn't enough to multiply excess reserves 500 times...or to put $12 trillion on the line in a bet on Keynesian economic theory...or to add more to the Fed's monetary base in 18 months than had previously been accumulated in 96 years...now Mr. Krugman wants another 150% increase. The Fed saved wrecked banks...it should save wrecked lives too...says Krugman. What would that do the dollar? To gold? To the world monetary system? No one knows. Here at The Daily Reckoning headquarters in the building with the golden balls, we don't even want to find out. But we probably will. Because Krugman is right about one thing... The depression hasn't gone away. It will be with us for a long time. And the feds will try to fix the situation with every fishy means available. In their simpleminded, neo-Keynesian way of understanding economies they have no choice. They'll probably keep adding to the monetary base until the whole system blows up. In the meantime, the dollar is going up...and gold is correcting. Our old friend Jim Rogers: "Over the past couple of months I have been accumulating US dollars...because there are too many bears." We've been thinking about this situation as deeply as we can. After a night of heavy drinking and light prayer, we're beginning to understand it more clearly. Later this week we hope to have something worth saying about it. --------------------------------------------------------------- And that's all we have for today's reckoning. If you have any thoughts you'd like to send us please direct them to us at the address below. We'll be publishing a selection in upcoming issues, so be sure to watch this space over the coming weeks. Until next time... Cheers, Joel Bowman Managing Editor of The Daily Reckoning joel@dailyreckoning.com   The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the