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The Daily Reckoning | Saturday, September 24, 2011 Operation twist hammers stock and gold investors alike, Readers weigh in on why bigger is not always better, Plus, all the week’s reckonings, archived for your free enjoyment... ------------------------------------------------------- “After living through 2 WARS... 7 RECESSIONS... and 4 stock market CRASHES...” “I’ve found one investment opportunity that could pay you every single year, no matter what happens in the economy. “It has nothing to do with the stock market...” Click here for full details. The Single Biggest Investing Story This Week... Joel Bowman From Buenos Aires, Argentina... Well, that was quite a week, eh? Stocks got hammered, the Dow ending the week down more than 700 points. Gold, too, copped a flogging, down $100 in a single 24-hour period yesterday. Markets are rattled. Investors are scared. So, what gives? It all has to do with the latest brainchild of The Federal Reserve: Operation Twist. It was the single biggest investing story this week, one Chris Mayer addresses in this week’s feature essay. Let’s dive right in... [This week’s feature essay originally appeared on September 23, 2011.] The Daily Reckoning Presents Operation Dumber Chris Mayer It’s a plan so dumb you have to have to Ph.D. to believe it will do any good. Quantitative easing was dumb. This is dumber. They are calling it Operation Twist. The Federal Reserve will buy $400 billion of long-dated Treasuries, financed by selling bonds with three years to go or less. The idea is to try to drive long- term rates lower, which the Fed thinks will help the mortgage market. The Fed unveiled its crackpot scheme on Wednesday and the market quickly registered a firm opinion, as you see in the daily chart of the S&P500: Yesterday was no better, with the stock market ending the day deeply in the red. Aren’t you glad we have the Federal Reserve to run to our rescue? What’s the old saying, “with friends like these...”? The market tanked presumably because of the Federal Reserve’s gloomy prognosis for the economy. Housing is “depressed.” (Yup, we knew that.) Unemployment will remain “elevated.” (Unfortunately, not so for central bankers and their legion of economists). Growth “remains slow.” (With the private sector under siege, it’s amazing we’ve done as well as we have.) Why people still take the Fed’s forecasts seriously is beyond me. Here is an organization that has been behind on calling every turn and yet investors still parse Fed statements as if going over the words uttered by a prophet. I can only chalk up such foolishness to a persistent belief in oracles. But back to Operation Dumber. It won’t work. It will make things worse, much worse, than they would’ve been. Let’s look at the handiwork of the Fed’s playbook so far. So far, we’ve had 33 months of near zero interest rates. And the Fed has purchased $2.3 trillion worth of debt in two rounds of “quantitative easing.” And...what? The economy, by the Fed’s own admission, is in poor shape. So, as if possessed with a kind of insanity, the Fed says “Let’s do more of the same.” And hence, Operation Dumber was born. Another $400 billion down the tubes. The economy won’t go anywhere. First, it’s doubtful that lower long-term interest rates will push mortgage rates much lower. Mortgage rates have not fallen in step with the ten-year treasury as it often does. Investors are drawing a line. You have to remember, to make a mortgage, someone has to be willing to hold the paper. The market is saying that 3-4% is about the floor. Think of it this way: If the Fed could drop interest rates to zero, do you think mortgage rates would follow? There has to be some profit for the lender, some incentive for the investor. Second, I don’t think lower rates will help much, because, as I wrote to my readers in the last issue of Capital & Crisis, much of the US mortgage market is in trouble. Here is what I wrote in the issue: “Five years into the housing meltdown, 28% of US mortgages are underwater. That is, the amount owed is more than the home is worth. About 7% are delinquent, and 10% have been foreclosed on. That’s 45% of the country’s mortgages in some state of trouble.” So, low interest rates are not going to help the mortgages that are underwater. Those people can’t refinance. They need to put more money in their homes or they need to walk away and let the bank deal with the problem. Ditto the rest of the troubled mortgage market. This is, of course, the market’s solution, which government people and debtors abhor. They’d rather take it out of the savers and the old people. Yeah, let’s stiff grandma. She’s trying to live off her life’s savings by putting her money in bank CDs to earn next to nothing. Let’s make it tougher on her. People are so eager to talk about the good of low interest rates, they forget about the bad. But the consequences are wide-reaching. Besides making it tough on savers, a climate of low-interest rates will force people to take greater risks in an effort to make something on their money. Artificially low interest rates also send false signals to markets. It distorts pricing patterns and so will bring about a lot of mistakes that will only become apparent later. (Think housing, where artificially inflated housing prices and easy money led to a huge but phony boom in housing, the extent of which we see clearly now and are still suffering from). What about the banks? The initial read in the papers is that this will be bad for banks. It will make lending less profitable by squeezing the difference between long-term and short-term rates — a source of bank profits. But, thinking about it differently, Operation Dumber is just another gift for the banks. QB Partners’ Paul Brodsky and Lee Quaintance wrote in a letter to shareholders yesterday: “This is a move to help recapitalize banks under the guise of supporting the housing market... This is all about the banks income statements.” How so? Well, QB explains that the Fed will basically buy long- duration Treasury paper from the Banks, handing them nice gains on those securities. (Remember, as rates fall, the value of the paper goes up. So banks have big gains in long-duration Treasuries). Banks get an increase in short-duration Treasuries. Net-net, they are in a less vulnerable position and will show a boost in profits. Regardless of all that, it seems clear to me that Operation Dumber will have little positive effect on the economy. At some point, we will learn that the only way out of this economic morass is to face the painful, yet common sense adjustments, needed. It’s really simple. People need to save more money, pay down debts and spend less. The nation needs to get its financial house in order. The mistakes of the prior boom need to be liquidated. If the Feds and the government would get out of the way, we’d have a quick recession and get on with life. Instead, here we are: nearly 5 years after the bubble popped, 33 months of zero interest policy and trillions of dollars of wasted government “stimulus” spending and Fed money printing — and still suffering from high unemployment and little economic growth. So, what to do? As investors, you stand pat. Or you use the opportunity to pick-up a few things. As I’ve said before, the time to prepare for times like now is before they happen. I don’t know what the market will do from here. No one does. I do know that we own some very cheap securities. I look over the back page of Capital & Crisis and just in the class of 2011 I see a bunch of stocks trading for well under ten times free cash flow. Not earnings, but real free cash flow. These are all very cheap stocks in well-capitalized companies run by owners. I’m not selling anything at these kinds of prices. And anyway, when we bought them, we didn’t buy them thinking we would flip them in months. So it is silly to get upset because the stock is down six months in or whatever. These are stocks whose stories will play out over the next year, at a minimum. I think they will all trade significantly higher in a year or two. Remember 2008, when stocks melted to hardly anything. We saw many stocks plunge — from $16 to $2, from $40 to $13 and so on... But if you just went about your business, tending to the daily affairs of your life and not your portfolio, you were well rewarded for your patience in less than two years as these stocks recovered the ground loss and then some. And that was 2008. Today stocks are cheaper than in 2008. Balance sheets are stronger. They have already been through the fire and are better prepared for a turbulent economy. And besides, we have capable owner-operators at the helms our companies. It’s usually during times like this when they distinguish themselves. We’ll be looking to do the same. Regards, Chris Mayer, for The Daily Reckoning Joel’s Note: Your editor had to laugh the other day when he read a line from one of Chris’ regular Friday Capital & Crisis alerts. “Some of the stocks on my watch list are making me salivate right now,” he wrote. This is a classic value investor mindset — seeking opportunity in crises and swooping in to take advantage of some really great bargains while everyone else is panicking. Nobody we know does it better than Mr. Mayer. If you’d like to take a peek at the back page of his Capital & Crisis portfolio — and receive his regular alerts, issues and watch list updates, here’s where to get started. Who gives a damn about America’s credit rating? I’m SICK of hearing about Keynesian vs. Austrian, fiat currency vs. Gold, US credit ratings and other BORING economic theories you have ZERO control over. “WHO CARES!?” Truth is, if you want to make money in the markets, none of that stuff even matters! Let me prove it to you by showing you. ALSO THIS WEEK in The Daily Reckoning... Why Gold Stocks Have Not Performed...Yet By Chris Mayer Gaithersburg, Maryland It’s one of the great mysteries of the market this year. For the first half of the year, the HUI Gold Bugs Index — made up of gold mining stocks — was down 9%, despite the fact that the price of gold was up 30%. What gives? Normally, gold stocks give its investors some leverage to the gold price. Historically, gold stocks move 2-3% for every 1% move in gold. Not so in 2011. There are some reasons for this. In order of importance, I rate them as follows... Buy Anti-Dollars! By Frederick Sheehan The prices of gold and silver shares are derived from the price of their reference metals. The referral method has gone astray, akin to a renegade ETF. Osiris Investment Partners L.P. in Boston, under the authorship of Principal and Managing Member Paul Stuka, wrote to clients on August 18, 2011. The XAU Gold Index was down 6% for the year-to-date, and the GDXJ Gold Stocks Index of smaller gold miners had fallen 10%. On that same mid-August date, gold — the real stuff that hardly anyone owns but of which everyone within the media’s range is expected to express an opinion — had risen 26% in 2011. Is Social Security a Ponzi Scheme? By Robert Murphy Nashville, Tennessee Ever since Rick Perry derided Social Security as a Ponzi scheme, economists and other pundits have jumped into the fray. Progressive blogger Matt Yglesias says it’s “nuts” for anyone to talk like this, because Social Security merely relies on future economic growth — just like a private pension plan. Free-market economist Alex Tabarrok responded to Yglesias with links to arch-Keynesians (and Nobel laureates) Paul Samuelson and Paul Krugman, both comparing Social Security to a “Ponzi game.” Reinventing the Wheel for Greater Energy Efficiency By Ray Blanco With fuel prices edging ever higher, engineers are scrambling to find new ways to improve the energy efficiency of vehicles. We’ve already seen a few attempts on the market. Hybrid automobiles — vehicles that combine electrical and internal-combustion powertrains — are becoming commonplace. Pure electric vehicles, such as those in development by Tesla Motors, are expected to be seen on the road in the next few years. Operation Dumber By Chris Mayer Gaithersburg, Maryland It’s a plan so dumb you have to have to Ph.D. to believe it will do any good. Quantitative easing was dumb. This is dumber. They are calling it Operation Twist. The Federal Reserve will buy $400 billion of long-dated Treasuries, financed by selling bonds with three years to go or less. The idea is to try to drive long-term rates lower, which the Fed thinks will help the mortgage market. It won’t. America 2012...Wall Street in Ashes...Main Street in Ruins... Here’s SIX ways to protect yourself and profit from the biggest lies DC, Wall Street, the Fed and your banker are telling today... Click Here To Find Out How. The Weekly Endnote... And now, it’s over to a few readers for some thoughts, ideas and rumors... First up, this one from Reckoner J.P.: Somber, very somber this current theme that you are working with, but I agree. Declining marginal utility is all around us, extra big TVs, extra big vehicles, extra pointless medical treatments. Not much additional entertainment, transport or health, but maybe a little to boast about. That may be changing too. What if boasting about having more than you need is going out of style and frugality and owning things you can really use catches on. That could be an even bigger problem. And a few kind words from Reckoner Scott W.: Right On Bill Bonner! That was a wonderful article today! Thanks. You are so right. Looks like it will collapse since they do not have the will to do what is needed. So I will just brace for it as I have been for the last few years. Moved to the country and bought a place with no home loan. Trying to be as self sufficient as possible. But as all parents do, we must worry about the kids and family who just don’t see it coming. I am sure you understand that one. I look forward to your articles; you are one of my favorite writers. I am a retired deputy county tax collector manager, so I have plenty of time to read, and I commend you on your work. It is some of the best I have read and I read many. And finally this, from a Fellow Reckoner calling him/herself “Aticus”... How about NOBODY gets to take anyone’s income — especially government. How about everyone gets to keep what he earns? Why isn’t that fair? How about the government can’t pick winners and favorites and bail out institutions with people’s hard-earned money? How about your rights as an individual as enumerated in the Constitution are held absolutely inviolate so that you don’t need to care who has wealth or power because they can’t ever use it to violate your rights? Tax people to give it to who? The government, that’s who. Who in their right mind thinks the government should have more of our money — more of anyone’s money? What more evidence does anyone need??? They lose money running casinos for God’s sake! They lost money running a [expletive] brothel in Nevada! Enough already with the call for more government, more taxes, more spending, more power, more infringement of our personal liberties. --- As always, we welcome your thoughts. Email them to the address below and... ..enjoy your weekend. Cheers, Joel Bowman Managing Editor The Daily Reckoning P.S. Did you see our special event invitation yesterday? It came with a few postcard-worthy pictures... What you see above are a couple of snaps taken at La Estancia de Cafayate, an “oasis of freedom” Doug Casey built in Argentina...a kind of “Galt’s Gulch” for like-minded, freedom-seeking souls. Why are we telling you all this? Well, we’d like to invite you along for a visit. This November, we’re going to join Addison Wiggin and a group of Agora Financial Reserve members at the estancia for a unique investment/lifestyle event. And we’d love it if you could join us. If you’ve ever wondered whether there exists a true getaway for freedom lovers...a place to really live the good life, this trip is for you. All the details you need can be found right here. ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com Give Collapse a Chance Fake Fixes for the Real US Debt Problem When Economic Growth is a Thing of the Past