Big Brother’s stock & commodity crash – Sept. 7, 2008

Sorry for so many articles lately but, events are happening at an accelerating pace.

Friday’s report from Don Coxe, BMO’s Global Financial Strategist was very interesting. Don is as old as dirt, has been around since Adam met Eve and fire was young and he’s seen a lot. He said we have witnessed “…the most massive intervention of government into the capital markets since Roosevelt closed the banks back in 1933.” That was during the Great Depression. And, he said this before the announcement of the U.S. government takeover of Fannie and Freddie (more on that later.) He was referring to the crashing prices of commodities, oil, gold and other precious metals. If you want to know why your stocks are crashing and what the future holds for all of us, investors and others, read on.

            In earlier articles, I said that the U.S. financial authorities were caught between a rock and a hard place, On one hand they need to keep interest rates low to stimulate the weakening economy. On the other hand, they need to raise interest rates to fight inflation caused by massive increases in the money supply – increasing at about 16% this year. They can’t do both. Instead, they’ve kept rates low and manipulated a slide in commodity prices. Earlier, higher commodity prices (oil +140, corn +7.5, soybeans +14, gold +1,000, etc.) were contributing to price inflation. I won’t get into a lengthy discussion of monetary inflation VS price inflation, but suffice to say that by hammering the price of commodities, the Fed’s Ben Bernake and Treasury Hank Paulson managed an amazing feat of coordinated intervention. The next paragraph is a somewhat technical description of how they pulled it off. You can skip it if you want.

            First, the SEC spanked naked financial short-sellers whose short-covering i.e. closing positions by going long, drove up the price of financial institutions which allowed them to refinance. This took pressure off the financials and put pressure on commodities which spanked the hedge funds who had to unwind leveraged long positions in commodities which further depressed commodity prices. Plus, the rain stopped in the Midwest which ensured a good crop and put further pressure on grain prices. As well, foreign central banks began propping up the U.S. dollar which drove down the price of gold. Also, the U.S. had been buying massive quantities of oil to top-up their strategic oil reserves which originally contributed to the earlier spike in oil prices, all the while blaming the usual scapegoats: speculators. Once they stopped buying oil, it reduced demand which started the fall in oil prices which again spanked hedge funds into unwinding leveraged positions which put further pressure on oil prices as well as the price of gold. You can also bet that the Treasury, through their bullion bank stooges, were shorting various markets and manipulating others. Stock market losses this past year has reduced market liquidity so commodity buyers have been absent and big players like BHP are tied up buying Rio Tinto while other boards of directors are paralyzed and shitting their pants. Link to Don’s message: http://events.startcast.com/events/199/B0003/code/eventframe.asp

            Gold bugs beware. Earlier this year, Paul Van Eeden bailed out of most of his stocks – except Altius, Kaminak and Miranda (probably because they were already deep under water which is why he keeps touting them.) According to his calculations, gold was overbought and should be worth $760 an ounce. Furthermore, since gold is a monetary metal and a substitute for fiat currency, it should rise only by the same percentage as monetary inflation i.e. 16%. A fair price for gold at the end of this year would be $880 according to Paul. Other events may conspire to change this, i.e. stock market crash, WW III, peace breaking out in the muddle east, etc.

            By the way, bank failures are being announced Fridays after the market closes but because of the attention paid to the nationalization of Fannie and Freddie, hardly anyone noticed that Silver State Bank of Nevada has gone belly up to join the illustrious ranks of the ten previous banks this year. There’s only 106 more banks left on the FDIC’s list of problem banks but that may be wishful thinking since IndyMac which sank earlier wasn’t even on the list. Earlier in the week, the Ospraie hedge fund closed after massive losses to join the ranks of about 80 hedge funds that have imploded over the last year. 

This brings us to the two mortgage giants, Fannie Mae and Freddie Mac which, thanks to the generosity of the American taxpayer and future generations thereof, have finally been put out of their misery amidst decades of corruption, mismanagement and Congressional bribery, oops, I mean lobbying. Their takeover was inevitable. It was only a matter of when, not if. Since this is a U.S. election year, it was deemed politically expedient to do it well before the November election. Stockholders have been wiped out although they’ve already lost more than 80% before the takeover. Fannie & Freddie bondholders (China $300 billion, Russia $100 billion, and other foreigners) will be supported by those ever generous U.S. taxpayers, or, at least by those who haven’t yet lost their jobs, cars or homes. Since banks are stockholders of Fannie & Freddie ($80 billion,) it’ll be interesting to see how Ben and Hank intervene on their behalf next week. No doubt, those generous U.S. taxpayers will be all too glad to help. The media tell us that the taxpayers are on the hook for tens of billions of dollars. Now that auditors are poring over the books (both mortgage giants for years refused to issue financial statements) I’m sure those generous taxpayers are in for some expensive surprises.

So, have we solved all the world’s problems?  Alas, no. Why am I so negative? Because reality bites! The bailout of Fannie and Freddie are simply Ben and Hank plugging the dike with their fingers while the water keeps building up until eventually it overtops the dike and washes everything away. Nothing is being done to lower the water level because this is an election year and painful medicine is never applied in an election year. Hank is gone next year so someone else will take the fall. Ben will go down in history as doing more than anyone thought possible. However, we are still headed for a depression which will make the 1930’s look like a walk in the park. Keep reading.

Unemployment keeps rising. The U.S. actually needs 150,000 new jobs to keep pace with the population increase. As well, the Labor Bureau’s numbers include a fictitious 150,000 new jobs as a result of their “birth/death ratio” model which refers to new, unreported businesses. They estimate new jobs in the mortgage industry which is actually cutting jobs, new jobs in home construction (yeah, sure,) new jobs in auto manufacturing which is actually laying off, and so on. Revisions to June and July job numbers tacked on another 58,000 lost jobs. In the first eight months of 2008, on average 76,000 jobs have been lost each month. The real unemployment rate is probably closer to 12% than the official 6.1%. 

The ass media keep talking about the sub-prime mortgage crisis. However, sub-prime is so yesterday and the media don’t know its bung-hole from a hole in the ground. Consider an ice berg, 9/10th of which is under the waterline. 1/10th is visible. Consider a snowball on top of the ice berg. That’s sub-prime. The rest of the visible ice berg is alt-A mortgages which are just beginning to reset at rates two to three times what these “liar loans” were paying until now so we can expect another wave of home foreclosures, plus defaulting student loans, plus defaulting car loans, plus credit card defaults, plus CDS’s (I just couldn’t resist alphabetized instruments) aka Credit Default Swaps to the tune of $60 trillion (yes, that’s Trillion with a “T”) and that’s just above the waterline. Below the waterline we have DERIVATIVES which I capitalize because now we’re talking real money to the tune of $1.114 quadrillion (yes, that’s Quadrillion with a “Q”) of which 90% are worthless. Merrill Lynch recently re-capitalized by selling $30 billion in derivatives and got $6 billion, of which they had to finance 75% which means their derivatives were worth 5 cents on the dollar so, ok, 95% are worthless, not just 90%. Lehman, another huge U.S. investment bank, turned down a ten cents on the dollar bid from South Koreans, then went back to them later only to find out that they had lost interest.

More bad news: former Fed Chairman, Paul Volker is calling the current mess “the Mother of All Financial Crisis.” Bloomberg reports: Former Federal Reserve Chairman Paul Volcker said the US financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930s. “‘This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,’ Volcker said today at a banking conference in Calgary. ‘Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.’ “The former Fed chief projected ‘a lot’ more losses from the collapse in the mortgage-backed debt market, after the more than $500 billion tallied so far, should the US, European and Japanese economies fail to pick up. He urged changes in financial regulations, echoing calls among sitting officials and legislators. “‘It is the most complicated financial crisis I have ever experienced, and I have experienced a few,’ said Volcker.

  The Herald Tribune reports “More than a year since the credit crisis erupted, Sheila Bair believes the worst is yet to come. Bair…the chairwoman of the Federal Deposit Insurance Corp., expects third-quarter bank profits will be lower than the ‘pretty dismal’ numbers from three months earlier. ‘We’re anticipating that it will be worse,’ she said. ‘We haven’t seen the bottom of the credit cycle yet.’”

Stock markets are still in a long term bearish decline. Recent DOW spikes of 300 are indicative of bear market rallies and not typical of bull markets. Increasing volatility is reminiscent of market action before the stock market crash of 1929

Analysts are forecasting U.S. house prices will continue to fall for the rest of this year. They said that last year, too. I expect them to keep falling next year as well. Look at a graph of real estate prices that have risen exponentially the since the dot-bomb crash and you’ll see that prices have at least 20-30% left to fall. The only good news, that house sales have increased, overlooks the fact that a foreclosed home that’s sold counts as two sales – the foreclosure to the bank is counted as a sale also.

Banks have written off only a fraction of their anticipated losses. There’s much more to come. LIBOR – London Interbank Offered Rates remain higher than “policy” rates indicating that liquidity is worse than a year ago when the credit crisis began. The authorities still believe we have a liquidity crisis when in fact we have too much liquidity but it’s in all the wrong places. The monetization of debt has resulted in too much liquidity which is why markets have become so volatile. Banks keep borrowing from central bank “begging bowl” windows but they refuse to lend to one another. Loans to businesses are drying up which sends us further into depression territory. We have a crisis of confidence: lack of regulation, lack of transparency and too much fraud. The U.S. Federal Reserve has lost most of its respect (and confidence is the foundation of paper money) because of government bailouts and crony capitalism – what’s being called “socialism for the rich” – while stockholders and taxpayers are being hung out to dry.

This is not happening just in the U.S. because the U.K., Europe and Japan are all in recession and the rest of the world is racing to the bottom. The U.K.’s housing bubble is proportionately larger than the U.S. and Spain is right behind. Canada will not escape unscathed but at least the pain will be less. Our biggest trade partner, the U.S. will drag us part way down with them.

Chris Laird of the Prudent Squirrel paints two scenarios for the future. Scenario 1 is a deflationary, deleveraging (i.e. unwinding) long and painful recession i.e. depression. Scenario 2 is a catastrophic, inflationary depression with bank panics, stock market crash, currency collapse, social breakdown and war. Lets examine each one because we are already in Scenario 1 and you need to know what could happen if things get worse. “Expect the best but prepare for the worst” is a good motto to adopt. If the authorities lose control, then Scenario 1 leads to Scenario 2. Already, events are happening at a faster pace.

Scenario 1 – For example, if the world slows relentlessly into a several years deep recession, and the US Dollar stays intact, and the stock markets drop but don’t crash, and the banking system, while half paralyzed doesn’t outright crash, then one might be advised to hold onto cash in general. Most of the main currencies would survive, albeit world deflation would take hold. One would want to take advantage of this to buy some more gold or silver coins, after prices dropped… etc. Foreign exchange controls likely would not be instituted (in a severe sense) and the savings we have are more or less intact, and financial survival becomes basically preserving your savings, and living frugally. No emergency measures, such as fleeing into another currency, trying to get your money out of tax deferred retirement accounts, etc, buying gold in a panic…In other words, the moderate scenario, that the world as we know it does not end, but merely suffers through a terribly deep recession worldwide. I hope this is the scenario. Painful, but not the end of the world. And I gather that many of you innately tend to believe that this is the more likely scenario. In a way, I might agree.”

Scenario 2 – big crashes then world depression, and foreign exchange restrictions This is the worst case scenario. In this case, we start with the credit crisis continuing to worsen. Possibly within several months from today, a banking panic sweeps the West. The Fed and the ECB and the BOJ and all the other majors lose control. Banks close. Stock accounts are locked. Foreign exchange controls are imposed and you are not allowed to try and flee into a safe haven, if one nation has a particular problem emerging, like a run on its currency….gold is either outlawed, or is simply not available because whoever has some won’t sell it… basically gold’s price in such an emergency skyrockets by ten or more times – if you can find it. The world stock markets crash and in two months are worth ¼ what they were…”

I vote for door number 1. Unfortunately, my vote doesn’t mean much. One other thing for investors to keep in mind: many funds are faced with quarter end redemptions so expect more stock selling pressure before the end of September. Good time to buy if we have any money left.

And so it goes.

Gerold

Sept. 7, 2008

Your comments are WELCOME! Lengthy comments may time-out before you’re finished so consider doing them in a word doc first then copy and paste to “Leave a Reply” below.

About gerold

I have a bit of financial experience having invested in stocks in the 1960s & 70s, commodities in the 80s & commercial real estate in the 90s (I sold in 2005.) I am appalled at our rapidly deteriorating global condition so I've written articles for family, friends & colleagues since 2007; warning them and doing my best to explain what's happening, what we can expect in the future and what you can do to prepare and mitigate the worst of the economic, social, political and nuclear fallout. As a public service in 2010 I decided to create a blog accessible to a larger number of people because I believe that knowledge not shared is wasted.
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