 | | The Daily Reckoning | Thursday, August 26, 2010 |
- Investing in gold - when to buy, how much and at what price?
- The rise and rise of the Middle Kingdom's middle class,
- Plus, Bill Bonner on the government-sponsored collapse of Social Security and plenty more...
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The Falling Dominoes of American
Dominance | Reflections on the US economy that was...and where it's likely
headed | |  | | Joel Bowman |
Checking in from Meridian, Mississippi...
"How did it all come to this?"
It's a question we've asked ourselves many times along this Coast-to- Coast Correction Tour. The answers are everywhere...in Wickenberg, Arizona...Livingston, Texas...Lake Charles, Louisiana and here along the border of Mississippi and Alabama...
More on all that in a second. But first, the "noise."
The Dow Jones Industrial Average managed to eke out a 19-point victory yesterday - a triumph that landed the index about 700 points below its one-month high of 10,700, set back on August 9. The market looks to be rolling over. The government's "stimulus" effect is wearing off and investors are just now coming to realize that demand - probably for the next two years...and maybe much longer - has already been borrowed and spent. What now, they ask themselves.
Gold sank a few bucks yesterday, but still sits above $1,235 an ounce as we write. The dollar index slumped back below 83.
Meanwhile, unemployment remains at multi-decade highs. The Feds, as usual, do their part to worsen the situation. They keep the system on life-support, extending benefits out 73 weeks (beyond the state's usual 26 weeks) for the increasingly large bulge of workers who make their way from newly laid-off to long-term, jobless drifters. Even with last week's decline, the four-week average for initial jobless claims rose to 486,750 - the most since November 2009.
The housing sector, which has led the nation out of seven of the last eight recessions, is now acting as an anchor. New home sales fell 12.4% in July to the lowest level in nearly a half-century, the government reported Wednesday. Sales of previously occupied homes fell to their lowest level in 15 years after a popular homebuyer's tax credit expired at the end of April. According to the Mortgage Bankers Association, one in 10 American households with a mortgage are at risk of foreclosure this summer. In some states - Nevada, New Mexico, Arizona - that number would be a welcomed improvement.
We remember our first visit to this country, back in the year 2000. It was an eye-opening experience. Having grown up in Australia, we had always dreamed of visiting Washington DC, the power center of the free world, of taking a subway ride in New York City and eating a Philly cheesesteak (whatever that was).
"What must the kids be like in America?" we wondered of our fellow Generation Xers. After all, they were in line to inherit the greatest, most powerful nation on earth. Movies, sports stars, TV shows, fashion... Everything "cool" seemed to come from the United States. When we played video games in primary (elementary) school, all our friends wanted to be the American team. Kids who had never even been to places like Pittsburgh or Atlanta came to school in Pirates and Braves sports caps.
By the time we actually made it to the US, after a year in London, we were at least old enough to realize that Empires don't last forever. Sure, the US was at the top of its game right now, we reasoned, but that won't always be the case...
In the first summer of the new millennium, an American family we were staying with in Baltimore kindly took us to see the nation's Capitol. We wanted to see the Lincoln Memorial and the statues of men, heroes, like Thomas Jefferson. Walking alongside the reflector pool in the afternoon heat, we asked our host family how long they expected the Age of American Dominance to last.
"We're not going anywhere just yet," was the response. "We have the greatest military and the strongest economy in the world."
What would they say now, we wonder, one decade, two wars and the worst economic crisis since the Great Depression later.
"Bridge Out" reads a sign just off the Interstate on the way to Meridian, MS. Trucks carrying huge chunks of earth move slowly around the construction pit. Men, shuffle from one foot to the other, leaning on shovels and smoking cigarettes. Residents from a nearby housing project look on from their front yards.
"Putting America to Work" reads another sign. "Project Funded By The American Recovery and Reinvestment Act."
The most powerful nation of the 20th century, once the envy and dream of people from around the world, is getting busy...digging holes.
We have two guest essays for you in today's edition. One, from Chris Mayer, deals with the rise and rise of the Chinese middle class. The other, from Jeff Clark, looks at gold as an insurance policy. Both are below...
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| The Daily Reckoning Presents
| How Much Gold is Enough?
| |  | | Jeff Clark |
"Should I buy gold now, or wait for a pullback?"
I get that question a lot...and it's a valid question. For nearly two years, gold hasn't had a serious decline. There have been pullbacks, of course, but nothing assumption-challenging. In fact, since October 2008, gold's largest price drop is 10.6% (based on London PM fix prices), and yet the average of all declines since 2001 is 13% (of those greater than 5%). The biggest pullback we've seen this summer is 8.2%. Technically the summer's not over, but I'll admit I'm surprised we haven't had a better buying opportunity.
So, is now the time to buy? It depends on your honest answer to another question: "Do you own enough gold?" By "enough" I mean an amount that lends meaningful protection on your assets. By "meaningful" I mean that no matter what happens next - another financial blow-up, accelerating inflation, crushing deflation, war, a plummeting dollar, more reckless government spending - you won't worry about your investments.
Whether you should buy now is almost irrelevant if you don't already own a meaningful amount of gold. If you earn $50,000 a year, how is one gold Eagle coin going to protect you if the dollar plummets and sends inflation soaring? If your investable assets total $100,000, is your nest egg sufficiently protected owning two gold Maple Leafs? This is all akin to buying a $50,000 insurance policy for a $500,000 home.
Today we face the prospect of prolonged economic stagnation, and most governments are administering grossly abusive monetary policy as a remedy. While some of the consequences are already being felt, the full ramifications have not hit your wallet yet. But they will.
If you don't have at least 10% of your investable assets in physical gold, or at least two months of living expenses, you have your answer: Buy. Don't use leverage, don't borrow money, and don't buy with reckless abandon, but yes, get your asset insurance policy and tuck it away. And then start working toward 20% (we recommend a third of assets be in various forms of gold in Casey's Gold & Resource Report).
Back to the original question: should we buy now, or wait for a pullback?
The answer comes when you look at the big picture. If you pull up a 9- year chart of gold, what sticks out is that the price is near its all- time nominal high. One could be forgiven for thinking it looks toppy or at least ripe for a pullback. But I assert that the highs for gold have yet to be charted.
What will a gold chart look like after adding five years to it?
When projecting gold's potential price peak, there are many ways to measure it. Conservatively, gold reaching its inflation-adjusted 1980 high would have it topping around $2,400 an ounce. More radically, if the US tried to cover its cumulative foreign trade deficit with its current gold holdings, gold would need to hit about $32,000/oz.
Let's take something more middle of the road, and apply the same trough-to-peak percentage advance gold underwent in the 1970s. (I think there's a greater than 50/50 chance it does more than that, given the precarious nature of the US dollar). Gold rose from $35 in 1970 to $850 in 1980, a factor of 24.28. Our price bottomed in 2001 at $255.95; multiply that by 24.28 and you get a gold price of $6,214 per ounce.
Sound too high? Well, would it feel high if you had to pay $12.50 for a Big Mac? At $3.39 today at my local McDonald's, that's about what it would cost ten years from now if we get the same rate of inflation we had in the late 1970s.
So if gold hits $6,214, what might it look like on a chart if you bought today around $1,200?
I'm not saying there won't be pullbacks or that you shouldn't try to buy at lower prices. Just keep a big-picture perspective. Let's say gold falls to $1,100 and you're kicking yourself for having bought at $1,200...if gold reaches $6,200 an ounce, the profit difference between buying at $1,200 and buying at $1,100 is only 1.6%. If gold gets whacked to $1,000 (at which point I'll be buying with both hands) the difference is still only 3.2%.
Heck, even if gold peaks at $2,400, you still get a double from current levels. (But unless government monetary policies immediately reverse course, gold isn't stopping at $2,400.)
So there's my answer. Yes, you have to accept my projection of gold's ultimate price plateau. And you have to sell at some point to realize the profit. But if the final chapter of this bull market looks anything like the chart above, I don't think you'll be too upset having bought at $1,200.
Regards,
Jeff Clark
for The Daily Reckoning
P.S. As high as we think gold could go, it's gold producers that will gain three and four times more, bringing us potentially life-changing profits. Check out the new issue ofCasey's Gold & Resource Report, where we've identified the easiest and cheapest way to buy gold stocks, even for smaller wallets. It's only $39 per year - try it risk-free here.
| | | | Betting on the Chinese Consumer | |  | | Chris Mayer |
Anthony Bolton is making a big bet on the Chinese consumer.
You may never have heard the name before, but Bolton was one of the UK's investing wizards. For 28 years, he racked up returns of 19.5% annualized. Since he had a long and superb track record and managed money for Fidelity, people called him "the Peter Lynch of Britain." Lynch is a name you probably know. He also ran a Fidelity fund, Magellan, for many years, to spectacular success. (After he called it quits, he also co-wrote a couple of books that are now investing classics, One Up on Wall Street andBeating the Street.)
But I digress. The point is that Bolton is a heavyweight in the crowded field of investors - or was. He hung up his gloves in 2007. Nice timing, as it turned out. But now he is back in the ring, running a new fund called Fidelity China Special Situations Fund. (FCSS on the London exchange - check it out. Also, should you enjoy studying great investors, as I do: The best book about Bolton is Investing with Anthony Bolton by Jonathan Davis.)
So Bolton, Fidelity's top-ranked manager, is taking his act to China.
I think this is noteworthy because Bolton sees something that I've also been writing a lot about lately: the rise of China's consumers. "China is at a sweet spot in emerging markets," he says, "where significant amounts of people can for the first time...afford cars, apartments and other goods... The driver of China's growth is changing to domestic consumption."
I agree. And I think such changes are happening much faster - and in a much bigger way - than the general market seems to believe. Andy Rothman, of the Asia specialist CLSA, predicts consumers will drive more than half of China's economic growth this year. Investment in infrastructure will trail behind. Exports, Rothman believes, will contribute zero growth. The key point is that hundreds of millions of people will be joining China's middle class over the next five years.
So Bolton's loaded up on Chinese consumer stocks.
I also find some of China's basic consumer stocks very appealing. The market consensus seems to be that China is going to blow up. There is a housing bubble there. And there are legitimate worries about its banking system and the losses lurking in dicey loan books. It seems most observers think this will spell disaster for China, as it did for the US - with a market crash and a deep recession.
Market prices reflect these worries, however. The low prices compensate investors well for taking risks today. But that's not all. Suspicions of fraud also hover around the edges of newly minted China shares, as I wrote about in last month's letter. This cloud depresses stock prices, too. An investor can lower the fraud risk by being very picky and doing a little extra due diligence. A few rotten apples don't spoil the whole bushel.
Regards,
Chris Mayer
for The Daily Reckoning
| | | Bill Bonner
| Fighting the Correction in the Worst
Possible Way | |  | | Bill Bonner |
Reckoning from Ouzilly, France...
Want to know what is really going on?
Investors are waking up. They are wiping the sleep from their eyes. Behold! No recovery.
Analysts and the commentariat are struggling to make sense of it. With record low mortgage rates, and after eight programs designed to boost up housing, for example, sales are still plummeting. July saw the biggest monthly drop in existing house sales since the Johnson Administration.
The supply of houses for sales is growing - thanks to record foreclosures. The demand is falling. Prices will come down too.
It's a Great Recession, say some.
It's not a recession, it's a depression, says David Rosenberg.
It's a "Contained Depression," says one headline at Seeking Alpha.
The recession never ended, says another headline.
Stocks will sink to 5,000, says a headline at CNBC.
Bloomberg takes a more moderate tone:
"Durables, Housing Signal Recession Risk."
But you, dear reader, you want to know what is really going on. So we will tell you.
We begin with a detail from yesterday's news: credit card debt has dropped to its lowest level in eight years. This tells us that the de- leveraging of the private sector is real...and on-going. And as long as it lasts, you can forget about a "recovery."
Instead, you should expect more on-again, off-again recession...with high unemployment, falling asset prices (stocks and real estate), weak sales and declining incomes.
This correction is a good thing. Consumers have too much debt. They'll be better off when they get rid of half of it. But the feds want to fight this correction in the worst possible way. What's the worst possible way? Adding more debt!
While the private sector de-leverages, the public sector leverages up. Eventually, this will have the result that everyone expects...bonds will crash, and the dollar will collapse...BUT PROBABLY ONLY AFTER PEOPLE STOP EXPECTING IT.
In the near term, the stock market is probably going down...it seems to be rolling over now. Yesterday, the Dow rose 19 points - a very weak bounce after so many down days.
When stocks go down, they will drag inflationary expectations. It will probably bring down stock markets in the emerging economies...possibly causing the Chinese economy to blow up...and bring falling commodities prices and deflation too. The idea of a "bond bubble" will disappear. People will see the "depression/Great Recession" as real...and permanent. They will try to protect themselves by buying US Treasury bonds. This will permit the feds to go further and further into debt.
Thus begins the world's long day's journey into night.
The US economy will become a Zombie Economy, with more and more activity dependent on government spending and government support. Banks are already Zombie Investors. Rather than lend to viable businesses that expand the world's wealth, they borrow from the feds and lend the money back to them. We'll see private investors become Zombie Investors too - putting nearly all their savings into US Treasury paper, just as the Japanese did.
The Dow will sink down towards 5,000. The feds will announce program after program to boost up the economy. Household savings rates will head to 10%. Unemployment will go to 12%...maybe 15%. Bond yields will collapse to new record lows. Ben Bernanke will threaten to drop money from helicopters...but as long as the US remains in an orderly decline, he will not dare to do it.
Eventually, the whole system will blow up in a spectacular fireball. But not until America's investors are fully committed to US paper. Then, after having suffered huge losses in stocks and real estate, they can be finally ruined in what they thought were the safest investments in the world - dollar-based US Treasury bonds.
And more thoughts...
No discussion of the upcoming collapse of the bond market would be complete without a mention of Social Security.
At least, after they've lost their money in stocks, real estate and bonds, Americans will at least have Social Security to live on, right? Wrong!
You know all that money you pay in Social Security taxes? Where do you think it goes? Into current expenses and US bonds!
That's right, the feds just use the money to finance whatever fool scheme they've got going at the moment...and give the Social Security Administration a bond in return. In theory, the SSA has assets. In practice, all they've got is the hope that the feds can squeeze enough money out of taxpayers to meet their obligations.
Can they?
Professor Laurence Kotlikoff:
Social Security has also played a central role in the massive, six- decade Ponzi scheme known as US fiscal policy, which transfers ever- larger sums from the young to the old.
In so doing, Uncle Sam has assured successive young contributors that they would have their turn, in retirement, to get back much more than they put in. But all chain letters end, and the US's is now collapsing.
The letter's last purchasers - today's and tomorrow's youngsters - face enormous increases in taxes and cuts in benefits. This fiscal child abuse, which will turn the American dream into a nightmare, is best summarized by the $202 trillion fiscal gap discussed in my last column.
The gap is the present value difference between future federal spending and revenue. Closing this gap via taxes requires doubling every tax we pay, starting now. Such a policy would hurt younger people much more than older ones because wages constitute most of the tax base.
What about cutting defense instead? Sadly, there's no room there. The defense budget's 5 percent share of gross domestic product is historically low and is projected to decline to 3 percent by 2020. And the $202 trillion figure already incorporates this huge defense cut.
Reducing current benefits, most of which go to the elderly, is another option. But such a policy is highly unlikely. The elderly vote and are well-organized, whereas 3-year-olds can neither vote, nor buy Congressmen.
In contrast, cutting future benefits is politically feasible because it hits the young. And that's where Congress is heading, starting with Social Security. The president's fiscal commission will probably recommend raising Social Security's full retirement age to 70 from 67, for those who are now younger than 45. This won't change the ages at which future retirees can start collecting benefits. It will simply cut by one-fifth what they get. In other words, there is no question about whether the US government will default or not. It will default. The only question is how. Will it manage to slip out of its obligations by raising the inflation rate enough to slough them off? Or will it have to officially renounce them? Will it refuse to pay retirees? Or bondholders?
Any way you look at it, the situation is interesting. Retirees, employees, loafers and chiselers - all are stakeholders in the US government. They have something to lose and will fight to hold onto what they've been promised. Bondholders have something to lose too.
So far, the bondholders have been largely protected - even enriched. Stakeholders in Greece, Ireland and other countries have begun to feel the pain. In America, the class of stakeholders is actually increasing, as the public sector spends more and the private sector spends less.
Best guess: stakeholders, bondholders, placeholders, cupholders, napkin holders - they'll all take a loss.
Regards,
Bill Bonner
for The Daily Reckoning |
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