Month: November 2008

What About the Auto Industry

My friend, James, is a graphic artist and did my book design. He’s also a Socialist, but that doesn’t seem to hinder our friendship. If anything, it makes for exciting conversations. He was asking about deflation, it’s causes, and what we should do about the auto industry. I thought some of you might find our conversation interesting:

Preston: Well, regarding the auto industry, what do you expect the government to do? Bail it out? This is not the first time the auto industry has been bailed out?

James: Yea, I know.

Preston: Is the auto industry somehow of such strategic significance to America that we must defend it?

James: Well it’s manufacturing. Which means high paying jobs for people.

Preston: Well sure. But what exactly can the government do about it? I’m reminded of the comment Bill Bonner made in Financial Reckoning Day: Surviving the Soft Depression of the 21st Century regarding the hopes that America had that Alan Greenspan would be able to bailout the economy in 2002. Bill Bonner described Alan Greenspan and the Fed as being “Like a transvestite. Having all the tools needed to do the job except the essentials.” 

James: *laughs*

Preston: And really, what can the government or the Fed do? When the chips are down, businesses have to make a profit. If the businesses are unprofitable, you can throw all the money in the world at it, and the situation’s not going to change.

James: But is the industry really unprofitable?

Preston: Yes. Even in the last Greenspan inflationary boom of 2003-2007, GM did not show a profit for manufacturing cars. Instead their profit was made in the financing (GMAC) wing, and that’s obviously fallen on hard times now. When the chips are down, the combination of labor, resources, and management have to produce a product profitably on the world market or close shop. 

James: Not necessarily.

Preston: How so?

James: We could put up tariffs. 

Preston: Studies have indicated that the more protectionist societies have lived poorer compared to the societies that engage in free trade.

James: Poorer for who. 

Preston: Well, it was like what Che Guevara and what he did with Cuba. He felt that steel was a strategic industry and that Cuba needed to manufacture it domestically. They erected tariffs making foreign steel expensive and the end result was that the price of steel caused manufacturing in Cuba to suffer. The society was made poorer compared to how it would have been due to protectionist policies. 

James: But Capitalism is always focused on short term consumption. 

Preston: No it isn’t. You’re confusing the society of the last thirty years with Laissez Faire, free market Capitalism. It’s not. In a free market society, savings is a virtue. Companies and individuals save and invest and prosper. Those that borrow and spend fail, which is what we’re seeing with the auto industry. Management tended to take on large amounts of debt and engage in certain manipulation of earnings in an effort to boost short term profit at the expense of long term viability, but that’s not symptomatic of the free market system as a whole. In fact, in a free market society, the firms that allow themselves to be foolishly managed go broke and the virtuous survive. 

James: You live in the 1800s, but the world isn’t like that anymore and it’s not going to go back. 

Preston: Well I’ve studied what the thinkers were thinking back then. It makes sense to me, and it seems that their greatest fears have all been realized in our day and age. I just keep asking we can’t go back to the good ideas that seemed to work so well for us as a country. 

James: But the free market would allow for greenhouse gas emissions to run rampant. 

From there our conversation degenerated into Environmentalism. James is a good man, but he has a deeply held mistrust of the power of corporations. To him, corporations must be regulated else society will become one of the savage rich versus the many destitute and I don’t seem to be able to convince him otherwise.

You Loaned HOW MUCH?

By now, we’ve all heard about the about $750 billion bailout passed last month, but what is making news now is that Federal Reserve’s own efforts to save the banking industry. Specifically, it has been revealed that since September 14th the Fed has loaned out $2 trillion. Ponder that for a second. While the $750 bailout was kicked about back and forth between the two houses of congress and President Bush and well as both Presidential candidates weighed in on it, the Federal Reserve was loaning (i.e. making money out of nowhere) money that was far in excess of that. Who did they loan it to? They’re not telling. Bloomberg has sued the Federal Reserve under the Freedom of Information Act to see if they can get the court to force disclosure of the information. 

Let me break this down in terms we can all understand. The Federal Reserve is a privately owned institution. Who owns it? The member banks do. So the bank-owned Federal Reserve has created money out of nowhere and lent it to the banks against various form of collateral the banks provided. In essence, the Fed is merely obeying the wishes of its master, the banking industry. The American people have been convinced that the Federal Reserve works for them. In fact, most Americans believe that the Federal Reserve is part of the Federal government; it does have “Federal” in the name after all. But the Fed isn’t for the people. It is for the banks. The banks own the Fed, and the Fed is now serving them far better than anyone else could. Oh, and as for the collateral that’s been offered to the Fed for all of these loans, they’re not telling us that either. 

I’ve been studying the Fed for years, and this amazes me. Not that the Fed would do something like this, but the idea that this is allowed to go on in front of all of us and hardly anyone makes a mention of it is just astounding. And what really kills me is that all that money that the Fed is creating is the liability, not of it, but of the American taxpayer. If you write a check, then it’s your liability that your bank must make good with (ideally) the money that you have in your account. These loans that the Fed have made must be made good by everyone else. In essence, the Fed is allowed to legally counterfeit- to print up unlimited quantities of notes that are someone else’s liability. And who owns this fantastic money making machine? Not the people, but the banks. 

I guess I’d be hoping that we the people would be more incensed about all of this, but few people seem to care. In the last Presidential election, the Libertarians were the only major party to be taking about the dangers of the Federal Reserve and the fiat money system, and they got even fewer votes than Ralph Nader. The American system of government has been throughly perverted. Instead of fearing the obvious abuses of power that we are currently witnessing by the Federal Reserve, many people seem to have become seduced by the idea that Barack Obama can somehow make everything OK. This is insanity.

All I Want for Christmas is a Gold Short Squeeze

I’ve mentioned in this blog before that I feel that the price of gold is kept low through market manipulation. That conclusion seems to be the only one that makes sense given the difference in price between the COMEX spot price of gold (currently $725) and the ebay price of one-ounce gold coins (currently $940-950). As previously mentioned, the main difference between these two markets is that Ebay is a market place where buyers and sellers are getting together to exchange the physical metal coins, whereas the COMEX markets are where buyers and sellers are getting together to exchange paper claims to gold. Ideally, there should be no difference, but since I can sell a paper claim without actually having the metal itself to sell, I could theoretically flood the market with paper claims to gold to depress the price. The one catch is that the buyer has the option of notifying the seller that he would like to take physical possession of the contracted gold, at which point the seller must provide the physical stuff. 

According to COMEX, it has 5 million ounces of gold in it’s possession, whereas 18 million ounces are currently contracted for December delivery. Typically this isn’t a problem because COMEX is a traders market and traders hardly, if ever, take physical delivery but are instead content to settle up with the dollar difference between the buy and the sell. But current market situations present a unique arbitrage situation. Arbitrage, is where there is a price discrepancy between two different markets for the same good. If the price is large enough, then all one would have to do is buy the good in the cheaper market and sell it for a profit in the more expensive one. What if someone did that with gold?

When someone places a “short trade” they are selling something in the hopes of buying it in the future. If the short sale has not properly borrowed the asset they are selling then they are, in essence, just hoping that the buyer won’t ask for it before the seller places the buy order to cover their original short sale. What can sometimes happen is that the short sellers create more open orders for something than they can comfortably get their hands on because someone else is actually buying up all the open interest. When that happens, the price of the object in question keeps going up and the short sellers suddenly must scramble to buy whatever the object in question is to cover their shorts and they come to find that there simply aren’t enough available to fulfill all the short orders that needs covering. This is called a “short squeeze” and the result is that the short seller ends up broke as the holders of the object can name their price to the short seller who now must look to them to cover his short. 

A short squeeze on gold is the stuff of legend. The last time the a corner on the gold market was even attempted was in September of 1869, when then infamous “robber baron” Jay Gould lead an conspiracy of financiers to ruin in the attempt (which you can read more about in Dark Genius of Wall Street: The Misunderstood Life of Jay Gould, King of the Robber Barons). In fact, when I bring up the idea of such an event happening, most people seem to dismiss the idea of a replay of the Hunt’s attempt in the early 1980s. The key difference here is an attempt is not being made to corner the entire world gold market, but rather just to squeeze the shorts on the COMEX who have promised to deliver far more gold than they could ever lay their hands on. 

The traditional problem with attempted corners is that, if the attempt does not pay off you have a lot of over leveraged parties who have to unwind all of their buy positions which causes the market to fall ever faster back towards the old price. But, in this case, there would be no reason to sell your long positions (i.e. your buys) because you could simply take physical delivery and see it on the physical market; that is, you’re showing a profit by way of the buy anyway, and if it results in a short squeeze that hugely jacks up the price of gold, so much the better. 

This idea has been floating around the internet lately and MSN’s Professor Lewis has indicated recently that early signs of a short squeeze brewing are starting to crop up. The biggest indicator Dr. Lewis points to is that the gold leasing rates are starting to shoot up (an indication that banks are increasingly unwilling to loan out their gold). These rates have not come down as the central banks of the world have extended credit to the banks, which indicates that it’s not just a liquidity issue at stake. A huge up move in the price of gold could be in the works. As a huge holder of Barrick Gold stock (ticker symbol ABX), I must say that that would make a very welcome Christmas present indeed.

Answering Nono’s Question

Just this morning, a reader posted this comment:

In 1999 I plotted the trailing PE ratio for the DJ30 back to 1925. I have not updated it. But a quick look at the graph shows the average to be close to 15. Only two periods, once for 3 years and once for 4 years, had PE ratios below 10. So I think you are wrong.

I also made a correlation plot of PE ratio vs. following year market performance. There was not a significant correlation. In other words, forget about PE ratio when trying to decide what the market will do in the next year.

Dear Nono,

I very well could be wrong in stating that the trailing PE ratio of the broad based American stock market is around 11, but I did not actually come to that figure. That is the figure that is being used by Bill Bonner, as well as an entire group of Economists that Henry Blodget follows. So, if I am wrong, I am at least part of an entire wrongheaded crowd. 🙂 

Seriously though, I’d encourage you to follow the link for the Blodget story and see if you can research the differences between your number and the 11 figure that is more commonly used. One noticeable difference would seem to be that you plotted the Dow Jones 30 whereas the others are looking at the far broader S&P500. Also, you stopped at the year 1999, which was the market top for PE as it turned out. If you go forward through the end of this year, I’m sure that would lower your average a bit. 

In regards to your claim that buying stocks at a lower PE does not impact the level of return you get, you are contradicting other economic study regarding stocks. In John Mauldin’s book Bull’s Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market he specifically says that “, the long-term returns you get from index fund investing are very highly correlated with the P/E (price to earnings) ratio at the time you make your initial investment.”

So those are the sources I am using. I have not done the math myself, but if you point me in the right direction in terms of where I can get the dataset, I may run the numbers myself to see what I get.

Jeremy Siegel Defrauds Investors by Calling Stocks “Dirt Cheap”

Dr. Jeremy Siegel wants you to know that know is a great time to buy stocks. In fact, he says he’d be surprised if you didn’t get a 20% return on your investment in the next twelve months. Of course, Dr. Siegel’s crystal ball is proving to not be all that great. In 2007 he predicted that 2008 would be a great year for stocks and that financial stocks should do particularly well. So much for that prediction.

To understand his latest argument, Siegel is putting a fair market value on the S&P at 1380. Since the S&P closed today at 930, you can see why’d he think now was a great bargain, but how did he arrive at that 1380 number? Well he says that the long term fair market value for stocks is to trade at a PE of 15 and he then conjures up a figure for what the next 15 years of earnings for the S&P should be based on the past 15 or so- which is equal to $92 a share. $92 x 15 = 1380. Voila. I could almost hear Dr. Siegel add, “Wil-E Coyote. Super Genius!”

This article struck me as a bit fishy, and not just because I’m a bear. For one, having been a avid read of Bill Bonner, I knew from books such as Financial Reckoning Day: Surviving the Soft Depression of the 21st Century that the long term PE for stocks is to trade at 11, not 15. So I was curious as to how Dr. Siegel came up with such figure. It turns out, he made a mistake. Bonner and the bears are correct in saying that the average long term trailing PE for stocks is 11, 15 is the average PE for earnings from four years ago, not next year’s projected. Currently, stocks are trading at a PE of 18 compared to trailing earnings, as Dr. Siegel himself pointed out in the article where he calls stocks “dirt cheap”, and a PE of 18 is not cheap when the long term average is 11. The upshot is that Dr. Siegel made an error and that stocks are actually expensive on the order of 40% compared to their long term PE ratios, not 40% the cheaper as he claims they are.

The other thing that Dr. Siegel doesn’t seem to understand is that the long term average of stock PE is just that- a LONG term average. There are many bull market years where the PE is trading above 11 and many bear market years where it is trading below 11. Furthermore, these periods of over and under valuation tend to be grouped together in the time line: we see stocks priced well over the long term average through the 1920s and then under during the Great Depression of the 1930s. So if we are continuing the bear market slide that started in 2000, then we should expect stocks to be trading BELOW their long term average. Which means, if the trailing average is 11, we should expect to start seeing stocks trading at PE levels of 8 to 10 as they did in the 1970s. You’d have thought that the author of Stocks for the Long Run might have studied up on the market a bit to see just how long the “long run” can really be.

Of course, all of this bull market analysis is based on the notion that the next 50 years of American history should be more or less akin to the last 50 years or so, and that’s a claim I take issue with. American has dominated the last 50 years of world events as a titan with unmatched military, industrial and economic power. Looking forward 50 years into the future, do we really expect to see that continue? Which brings us back to Dr. Siegel; clearly he is wrong in his analysis, but it he simply mistaken or did he aim to reach for a conclusion that would make other parties happy.

Don’t get me wrong, we all make mistakes. Perhaps Dr. Siegel put less time and effort into his Yahoo columns that I put into this blog and just doesn’t get a chance to double check his math, but I don’t think so. I think Dr. Sigel fudged the numbers to arrive at a rosy outcome. If so, it wouldn’t be the first time a Macroeconomist has gone through a rather dubious trick of logic and math to reach the politically desirable conclusion. Indeed, John Maynard Keynes’s The General Theory of Employment, Interest and Money is nothing but a intellectual fraud filled with straw man arguments, shifting definitions, and math based on dubious assumptions, but it is heralded as a classic largely because it came to the desired conclusion of the day: the free market was inherently unstable unless assisted by the power of government. Macroeconomists are task masters at fudging their numbers to support the conclusions that they feel are popular. Why should we think Dr. Siegel is doing any different here?

Volatility Continues

The market sure is doing some crazy things lately. The Dow was up over 12% or so on election Tuesday. Then, after the candidate who was favored to win actually won, it fell 5% or so for the next two days in a row. I’m starting to miss the good old days when the market just moved in steps of .5% a day instead of big five and ten percent moves. Gratefully, my Barrick stock only lost a couple of percent yesterday, which was much better than the broader market. Today it did not hold up so well, losing 7.3% compared to the Dow’s 4.8%. I was expecting that the announcement of Barrick’s earnings would stabilize their stock performance, but it doesn’t seem to have had any effect. Instead, I just read some analyst writing that the lower gold price impacted Barrick’s earnings, but that’s not quite accurate. 

If you dissect Barrick’s Q3 earnings, you’ll see that their income for the third quarter was, in their words: 

In third quarter 2008, net income was $254 million, compared to $345 million in the same prior year period.  Net income includes impairment charges on investments totaling $97 million, principally due to a write-down of our investment in Highland Gold whose share price declined from $3.49 on June 30, 2008, to $1.21 on September 30, 2008, and was recently trading at around $0.76.  Excluding special items, net income was slightly higher than the prior year period, as higher gold prices were partly offset by higher gold and copper total cash costs.  Although gold production was higher than the prior year period, gold sales volumes were lower due to a temporary increase in unsold finished goods inventory at Goldstrike and Bulyanhulu due to the timing of shipments.  We expect to sell this production in fourth quarter 2008, generating an expected profit contribution of approximately $27 million. 

So it wasn’t the price of gold that impacted Barrick’s earnings as much as the dramatic drop in the price of the common stock in gold companies- specifically they lost their shirt’s in their investment in Highland Gold. But that does seem a one-off event that isn’t likely to be impacting their earnings going forward.

And what of the price of gold. Well, mining analyst and geologist Éric Lemieux has this to say about the price of gold:

The decline in gold prices flies in the face of every theory. The U.S. dollar has been appreciating and the U.S. economy is going through a recession. Gold should be increasing in value in the face of all this uncertainty. To see the price of gold going down right now is almost unexplainable in my opinion. It begs the question, is this due to some type of manipulation, either directly or indirectly?

… I believe we’re experiencing the results of probable financial industry fraud. Time will tell who was responsible. I hope we will hold the perpetrators accountable. Unfortunately, I think certain elements are trying to sweep all this under the rug.

I agree with him that the decline in the price of gold flies in the face of everything that SHOULD be happening at this time of uncertainty regarding gold prices. I also agree that there is manipulation going on and that that will probably be revealed in time. And, as previously mentioned on this site, there is an ever growing disconnect between the price of physical gold and the COMEX price of gold futures for immediate delivery (i.e. “the spot price”). Theoretically, these prices should be within $50 of each other or so because the gold coin would sell at a premium over the spot gold price reflecting the cost of minting the coin itself. Today, the COMEX price for gold for gold closed at roughly $725, while gold listings on ebay in the last week are selling for $940.

That’s a difference of over $200 between those two prices, and that’s indicates that something is just not right. Somehow, the COMEX price for gold does not reflect what people are actually paying for it. Whether that’s due to market inefficiency or outright manipulation by the banking system and their paper claims to gold is left to the reader’s discretion, but I do feel that we’re going to see a strong upward move in the price of gold in the months ahead. Let’s also not forget that the President Bush and President Elect Obama are going to be attending a multinational meeting on November 15th; this promises to be the first of many meetings regarding the current economic crisis and gold has already been mentioned by French President Sarkozy as the answer that will bring “discipline” to the market. So factor in a lot of world leaders paying lip service to gold in a couple of weeks and I don’t see how the price is going to continue to gold down, manipulation or no.

My Experience with Democracy

First an apology for not posting for a while. I lost my internet connection for a few days and it wasn’t restored until today. So I wasn’t able to follow the election results all that closely yesterday, but I was certain that Obama was going to win. For that matter, I was sure Obama was going to win back in 2006. It just didn’t seem any big mystery back then that the nation was tired of George Bush and that whichever Republican won the nomination was not going to be able to combat the last eight years of a sagging economy and an unpopular war in Iraq. There was another election I was fairly sure the result of my own. 

Yes, for those of you who don’t know, I ran for office. Specifically I ran for State Representative District 115. The Libertarian Party asked me to. I felt bad that they didn’t have a gung-ho guy in District 115, so I signed on as a “not so gung-ho” candidate of District 115. My campaign wasn’t the most inspired ever run. I printed neither signs nor buttons. In fact, I spend no money to promote myself whatsoever. I did answer a couple of questionaries sent to me by the League of Women Voters and other voter information groups and I did attend one GEICO sponsored “come meet the candidates” luncheon. Yes despite my complete lack of enthusiasm, I somehow managed to appeal to 8248 people. Yes, I won a full 19% of the popular vote in the race for State Representative against Incumbent Jim Jackson. Don’t believe me, you can read it for yourself at USA Today.

I must confess I was astounded at the number. I don’t know 8248 people. How on Earth could that many people have voted for me, without ever meeting me? Well I did get a chance to vote for me, so that’s only 8247 unaccounted for. My mother said she voted for me, and I suppose I can believe her. And an ex-girlfriend whom I hadn’t heard from in a while who saw my name on a ballot. As for the remaining 8245, I have no idea. I’m beginning to suspect that they may have voted for me without knowing me at all. 

Come to think of it, how many of Jim Jackson’s 35,599 actually knew his name before stepping into the booth? I know I’ve often gone into the booth to vote for some candidate of issue at the national or local level and then started befuddled at the array of candidate I had to chose for local elections. I think it’s highly possible that the vast majority of the roughly 44,000 voter could not pick either of us out of a line up. Let’s be frank, I don’t think those voters knew us from Adam. 

So it was with astonishment and mirth that I saw that somehow over 19% of the voters (8248) actually voted for me. Given that I was the only choice other than Republican Incumbent Jim Jackson, I think that this is a fairly good indicator of how many people just decided to vote against the Republican on sheer principle. Well, I suppose I was happy to make my name available to people so they had someone to vote for other than the Republican. 

Recently I began to have doubts that Democracy worked at all. After this experience, I feel fairly certain that it doesn’t. Until tomorrow, your steadfast candidate is signing off.