Thursday, December 3, 2009

Gold Prices & Quantitative Easing/ISM/Sour Predictions from John Hussman/More On Parallels with the 1930s/

1. Gold and Quantitative Easing: I discussed in a few posts recently how the current monetary policy by the Federal Reserve has contributed to the rise in gold prices. With the surplus of liquidity, the appetite for risk assets has grown, which has increased the demand for gold, and the abnormally low interest rates have allowed speculators to borrow funds in dollars to buy gold. I would add the following to that previous discussion. It simply does not cost an investor anything to own gold, compared to say buying a 3 month treasury bill. Gold has no yield and the same can be said for short term money due to the Federal Reserve's monetary policy. If the Fed raised the federal funds rate to 2 1/2% say, and even if the dollar did not strengthen, some investors would refrain from buying gold and opt for a secure investment that actually pays a yield. So the abnormally low yields on safe investments like treasury bills has caused a spike in demand for gold in many ways.

A recent article in the WSJ suggests that the price spike in gold may be due to quantitative easing. I would submit that is just one factor among many. Still, in the last analysis, gold has no value other than what humans attach to it at any given moment, and humans can be fickle on such matters as shown by what happened after the last parabolic spike in gold prices to $850 in January 1980. Still, I am a long term investor in gold as a hedge against Financial Armageddon or some similar disaster that causes most other assets to collapse in value. { Gold (GLD) and Dangerous Parabolas; Item # 4: Bought 100 Activision/End of the Carry Trade-Not Likely/Sysco/Euro vs. U.S. Dollar; Item # 3 U.S. Dollar and the Carry Trade/Gold & Inflation}

I would anticipate that the dollar would rise with a federal funds increase to 2 1/2% which could knock the legs out from using the dollar as the source of the carry trade, thereby causing those using the dollar in the carry trade to pay back their dollar loans and to use another currency as the borrowing source such as the Yen or Swiss Franc. This would take some selling pressure off the dollar.

Gold seems like a crowded trade to me with a boatload of speculators all leaning in the same direction, possibly many of them also selling the dollar and buying resource currencies like the Canadian and Australian dollar. I did note that gold recently had a net speculative long position on the Comex of over 270,000 contracts, one helpful piece of data courtesy of David Rosenberg. (Dave: at pp. 5-6). If gold trades up today, I may go ahead and add my second hedge position for my physical bullion.

2. ISM Manufacturing Survey: The ISM report for November released on Tuesday showed that the manufacturing sector continued to expand but at a slower rate than October. Any reading over 50 indicates expansion in this index, and the reading for November was 53.6, down from 55.7 in October. ISM The new order component, however, did rise to 60.3 from 58.5.

3. Societe Generale/John Hussman & The Coming Armageddon?: For anyone interested in a post Halloween scare, this report from SocGen may give you a nice fright. Soc I picked up the SocGen treatise from a YF Tech Ticker story which also contains an assertion from John Hussman that there is in his view a 80% chance of a market crash next year. Yah Fin Hussman has two mutual funds: HSGFX & HSTRX It does nothing for the morale of the Old Geezer to read those opinions. He is still after all a little bit jumpy from the events of last October. The OG needs to hear nothing but Happy Talk. In fact, that is what the nation needs now.

The LB likes Hussman's commentary, since it can plug in some points into the infinite number of variables the LB churns in its endless mind numbing and boring computations. LB agreed with the observation that investors have a "reckless myopia". Since the Headknocker owns some bank bonds, the staff at HQ is not in favor of Hussman's advocacy of an American version of the European Commission burden sharing policy for bondholders, see page 5. LB is not surprised that Hussman quotes extensively from fellow ghoul David Rosenberg who spends a great deal of time these days trying to explain away, minimize and devalue the positive indications of an economic recovery.

{One way to buttress a perma bear case is to pick the data series that supports the ordained negative opinion. For example, if mortgage applications are increasing over the most recent months, and that is a positive indicator, the perma bear would emphasize the negative number year over year, which would contain months during the worse part of the recession, and then mention that negative comparison to buttress the bear case. Or, if the mortgage applications started to trend down for a few months, and were positive year over year, then the perma bear would not mention year over year but reference the recent decline, and so on.}

One final note about the Hussman letter. LB is going to use Hussman's argument that the Q ratio and the 10 year cyclical P/E (see p. 3) show that the market is currently about 40% overvalued, in an effort to convince the HK about using cash flow to buy some hedges in the coming weeks. Tobin's q This overvaluation thesis comes from an analysis by Andrew Smithers: (subscription). RB responded that if LB had gone all in, as RB recommended on March 3rd (Fed Is Less Gloomy), we would not need any stinking hedges, and the HK could be sunning himself on some tropical island purchased with all of the profits which would have existed but for that nerd LB. RB added for good measure that the HK could also then surround himself with a bevy of those Playboy bunnies that are attracted to older rich guys, even really old ones with hair loss and a tad overweight the RB emphasized for effect, making what it considered an open and shut argument against the LB's stinking models and its overabundance of caution.

This is a link to the returns for one of Hussman's funds compared to the S & P 500:

4. The Great Depression and Inflation vs. The Great Recession and Inflation: The economic downturn which occurred after the 1929 stock market crash was marked by a sharp drop into deflation. Here are the numbers for the early years of the depression:


These numbers are from the Minneapolis Federal Reserve Bank: Consumer Price Index, 1913- | The Federal Reserve Bank of Minneapolis

In spite of these inflation numbers the stock market took off in late 1932 after bottoming in July 1932 at around 41. The rally into 1937 was huge, with the DJIA hitting 194.4 (StockCharts) before starting its whipsaw pattern up and down pattern to 1942. While some may have feared inflation then, usually members of the GOP tribe who opposed everything FDR did, the abrupt turn in the market can fairly be attributed to the quantitative easing undertaken by the Federal Reserve Bank starting in 1933 ( and the start of the stimulus programs under FDR's administration. Another factor is just the magnitude of the fall from 1929 to 1932, losing about 89% top to bottom.

There is just no comparison with the CPI numbers at the start of the Great Depression and the numbers that we are see now. While there has been a few months this year where the year over year CPI was negative, the CPI number for 2008 was a positive 3.8 and may end up being down 1% or so in 2009. With the upcoming report for November 2009, the year over year number will probably turn positive again.

What does this mean? I am certainly no expert but it suggests to me that the downturn will not be a deflationary one. Just a hiccup of deflation for a few months rather than a few years. Another possible explanation is that inflation started to turn up in the 1930s after the Fed embarked on its quantitative easing program in 1933:


Unemployment was higher in those years than now.

Another issue is the actual amount of resource slack in the economy and the difficulty in measuring it. This is the point that the Philly Fed President has been making in speeches recently. Speech: Monetary Policy and the Wisdom of Wayne Gretzky (December 1, 2009) - Philadelphia Fed Also, a study by the staff at the San Francisco Fed suggests that core inflation would have been lower since the onset of the great recession if the amount of the output gap estimated by the government and economists was correct. FRBSF Economic Letter: How Big Is the Output Gap? (2009-19, 6/12/2009)

Bernanke may be obsessed with what happened in the 1930s after the Federal Reserve ended its quantitative easing and accomodative monetary policy. The economy went back into the hopper, an event discussed in this Federal Reserve publication: (see also excerpt of Christina Romer article about the Fed tightening in 1937, Romer is currently Chairman of Obama's Council of Economic Adivsors) I suspect that Bernanke is fearful that taking his foot off the monetary accelerator too soon now will have the same result, a relapse back into a recession. He believes that a primary cause of the depression was the action of the Federal Reserve between 1929 to 1932 to allow the M2 money supply to shrink by one-third. (Bernanke, Essays in the Great Depression at p. 6). The Fed also allowed some large banks to fail in the early 1930s that caused widespread panic, the contagion effect, which resulted in more bank failures. That was a valuable lesson to keep in mind last year.

Maybe the danger now is slavishly comparing the two economic events. If I had to pick a scenario now, it would not be the one suggested by Niall Ferguson in his Newsweek opinion piece, where inflation falls and nominal interest rates rise, the nightmare scenario for a heavily indebted nation unable to control its spending. Instead, with the U.S. and other major economies other than Japan recovering, led by accelerating growth in several emerging markets, the European and U.S. central banks will keep their foot on the accelerator way too long, causing a spike in inflation.

The Beige Book released by the Fed yesterday gave further credence to an American economy on the mend: FRB: Beige Book--Summary--December 2, 2009

5. Dividends and Interest: The Nuveen CEFs declared dividends yesterday, including several that I own which pay quarterly dividends. JQC and JPC are paying .$175 and $.17 respectively in quarterly dividends giving these two similar CEFs the same 9.5% yield at current prices, according to the WSJ dividend page. I also own JDD in the Roth which is scheduled to pay a $.235 quarterly dividend for a 9.82% yield, Bought 100 JDD in Roth. I also own JSN in the Roth, which has not been discussed in this blog, with a cost basis of $9.03 with reinvested dividends, and it is scheduled to pay a dividend of $.336 for a 10.42% yield at the current price. This JSN close yesterday at $12.86. This CEF attempts to replicate the movements of a 75%/25% combination of the S & P 500 and the Nasdaq 100 Index, and sells call options on those indexes in an effort to moderate volatility. It is currently selling at a slight discount to NAV. JSN - Nuveen Equity Premium Opportunity Fund JTD, previously discussed, will pay a 26 cent dividend which translates to a 9.49% yield at the current price used by the WSJ. I also own JRO and JGT. Nuveen Closed-End Funds Declare Quarterly Distributions - Yahoo! Finance JGT has a $.377 quarterly dividend, which results in about a 9.15% yield at the current price, and it is a short term government government currency fund selling at a small discount to NAV: JGT - Nuveen Multi-Currency Short-Term Government Income Fund JRO is a bond fund, mostly in floating rate loans: JRO - Nuveen Floating Rate Income Opportunity Fund The CEFs are part of a simple strategy to generate a constant stream of income to reinvest in income producing securities, and the CEFs will at times be sold when that can be done profitably.

Two of the TCs that I own containing a junior Aon bond (a TP), KTN and KVW, are set to go ex interest in late December. The other Aon TC that I own, DKK, has an earlier ex date, on 12/16. PJR, a TC containing a senior Unum bond, declared its semi-annual interest payment with a 12/10 ex date. MJH, one of my better buys with a yield of around 25% at my cost of $7 and change, goes ex with its quarterly payment. That security is up about 300% since my purchase a few months ago. JWF, another excellent buy, goes ex with its quarterly interest payment, a TP from Wells Fargo bought at less than $10 during the meltdown.

The WSJ shows the 4 Aon TCs, which are functionally equivalent, all containing the same bond, with the four following yields: 8.04%, 8.31%, 8.21% and 8.37%. If you were going to buy one, which one would it be?

I placed several buy orders yesterday below the market and none were filled.

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