Saturday, December 19, 2009

Seven Days Of Christmas

You are probably sitting at home today watching some college basketball thinking to yourself, "What is the Tuna going to bring me this year for Christmas?"

I've thought long and hard and come up with the ultimate gift.

You've been hearing relentless talk during the current gold pullback about why the bubble has finally burst. This talk is nothing new for long-time gold holders, but for most new comers, it might be a bit startling.

I've decided to gift you 7 reasons why this bull market is still young and the current pull-back is one of many to come over the next few years.

I began buying gold back in the $500's, so this is my third gut-wrenching pull-back. I even warned about the strong possibility of a correction a few weeks ago in my December 1st post: "Adjustable Rate Time Bomb" .

Below is my in-depth argument explaining why gold has only just begun its long term rise; presented in 7 points over the 7 days leading up to Christmas.

I wish you and your family a happy holiday season. Let's begin with Day 7 and Day 6:

Day 7: Money Printing With Increased Debt

This past year we have seen money printing from Central Banks around the world that can only be described as biblical. The following chart shows the year over year balance sheet growth of some of the world’s major Central Banks:

The Fed has embarked on a program known as Quantitative Easing, which is a fancy word for printing money and buying US treasury bonds (government debt). The total debt purchased through this program was $300 billion.

It has also created a program to buy mortgages. Bernanke has told us the buying spree will total $1.3 trillion and end in March 2010.

Along with these two monsters, they have injected endless amounts of liquidity into the financial system - specifically agents like AIG, GMAC, and Citigroup, who are now government money pits.

The Fed has told us all year that they have an “exit” strategy to remove this extra money from the system, just as they told us back in 2006 that the subprime problem would only create $200 billion in losses and it would not effect the overall economy.

A closer look at the numbers and the future shows that not only will Bernanke not have an exit strategy, but that the Fed’s balance sheet has only begun its exponential growth.

For fiscal 2010, Obama will run a $2 trillion deficit based on rosy projections of economic growth. They will also have another $2 trillion of short term government debt that will have to be rolled over and re-financed. That leaves $4 trillion in government debt to be financed next year in order to keep the USA from declaring bankruptcy.

The governor of the Bank Of China this week said, "It is getting harder for governments to buy United States Treasuries because the US's shrinking current-account gap is reducing the supply of dollars overseas."

What this means in simple terms: over the past few years our economy, which has been based on borrowing and spending to buy foreign products, is now self-combusting.

Why? Because our citizens are no longer able to stomach additional debt. They have all they can handle and are now starting to save money.

Previously, we would purchase the foreign goods and run large trade deficits. This means they would send us the products and we would hand them dollars that we borrowed. In turn, they would take those dollars and re-invest them back into the United States. This kept inflation low in their countries and also kept our currency strong allowing us to buy more of their goods.

It is obvious that this situation is unsustainable and eventually must change. We have reached that point.

Because we are buying fewer of their goods, we are giving them less dollars. This means they have less money to purchase Treasury bonds.

This does not take into account that over 50% of the foreign treasury holdings are concentrated in China and Japan. Both countries have not only stated that they do not want to purchase more, but they are looking to sell what they already have.

The following Chart shows China's purchase of debt leveling off in some areas, and in most cases falling tremendously:

Any bonds foreign countries sell add to the $4 trillion that must be sold next year. It is a tidal wave of supply.

Three things have happened during 2009 that have kept our bond sales running smoothly:

1. The Federal Reserve has been making direct purchases of bonds (the $300 billion just discussed).

2. The Federal Reserve has been making indirect purchases of bonds.

Here is how they accomplished the second strategy:

You probably have heard the term 'Federal Funds Rate', currently at 0%. This is the rate which the Federal Reserve lends money to banks. This year, the large banks have borrowed an enormous amount of money at 0% and then invested that money in treasury bonds at 3-4%. It is clearly obvious how easy this strategy is to making money. A 5-year old can do it.

The total purchase from banks into treasuries this year is over $250 billion. This has been an enormous portion of the demand.

The second strategy the Fed has used has been a sleight of hand trick with the $1.3 trillion mortgage purchase program.

Foreign central banks accumulated large quantities of mortgages during the US housing boom years. For obvious reasons, they now wish to unload that toxic debt. The Federal Reserve has approached those banks and bought their mortgage holdings in exchange for freshly printed cash. The central banks have taken that cash and used it to purchase Treasury bonds.

This can be seen every week at the Treasury auctions through a term called “indirect bids.”

The Federal Reserve has promised to not only stop these programs next year, but remove the liquidity with their “exit strategy.” They have not yet explained what their exit strategy is.

The reason for this is because an exit strategy does not exist. The programs will not only continue, but grow as we move forward.

As foreign countries are no longer able to purchase our debt due to a lower trade imbalance AND lower demand, our government is running up debt at a rate the world has never seen.

I will discuss all government debts around the world in a future day of Christmas, but the point of this day was to show you why the money printing will not stop due to increased American debt.

We are currently in the eye of the storm for housing loan resets and foreclosures. The Fed knows this. They understand that there is no way they can stop buying mortgages without the housing market collapsing.

Fannie Mae, Freddie Mac, Ginnie Mae, and the FHA are heading for SERIOUS insolvency problems in the years ahead. Not oBoldnly will the Fed have to purchase the majority of their bad loans, but they will have to help with bail outs of these toxic monsters.

This does not even take into effect the bail outs that will be needed for the FDIC, commercial real estate, credit card debt, and state and local governments. These are looming crisis triggers that can emerge at any moment.

To summarize, the Fed has boxed itself in and its only hope of exit will be to expand the money supply.

As investors realize this, they will move toward gold. The gold bull market is young.

Day 6: Major Default Risk In Financial System

It's amazing that one year ago, as we were celebrating Christmas, most Americans were just realizing that our financial system was insolvent.

Today most Americans believe that everything is okay.

I have to give it to Obama, Geithner and their team. They have pulled off of the greatest confidence games in world history.

How did they do it? Here’s how:

The most important part of their con was to change the accounting rules. Up until March of last year, the banks had to mark their assets to market. This means that if a loan fell in value by 20%, they had to take a loss of 20%. The same is true for the opposite side, if an asset rose in value by 20% they could book that is profit - this is what led to the gross bonuses and share price growth during the 2000’s.

Today a bank marks an asset to myth. This means they can say a piece of real estate is worth the full amount of the loan they lent it out at in 2006. This allowed them to stop taking write downs, and thus stop taking losses.

Of course the losses are still there, hidden in the balance sheets, but they do not have to show them.

In addition to this, while most of the banks have given back their TARP gift, it is now clear that they are backstopped by the government should they run into future problems. They have all become wards of the state.

Thirdly, as discussed during Day 7, they can now borrow money at 0% from the Fed and purchase treasury bonds from the government at 4%. This is an easy way for the banks to make money.

There is an unintended consequence for this action. As you’ve probably heard, it is impossible for anyone to get a loan for anything today. Someone trying to start a business or a real estate investor trying to purchase an investment cannot get a loan at any price no matter how good their credit is.

The money flows have moved toward unproductive government spending, thus stifling the growth of American business and American investment - which create real economic growth and jobs in a country.

This distortion of capital concentration leads to a weakening currency.

At some point the real losses on the balance sheet will have to surface. The banks now have $1 trillion in reserves (they had $2 billion total in 2006) to prepare for the write downs.

I do not think $1 trillion will be enough once the ship begins to break. Remember, the derivatives market is now over $600 trillion in size. This is the dark off-balance sheet world where losses must be paid with dollars in the real world.

The banks problems have only just begun.

As investors realize this they will move toward gold. The gold bull market is young.

Wednesday, December 16, 2009

Fed Minutes

No new information from the Fed today. They left rates unchanged and said they would be ending their treasury and mortgage purchases early next year.

With $4 trillion in treasury debt that needs to be sold next year and no buyers for mortgages in the market, it will be interesting to see when he announces that those purchase programs will be continuing.

He has until about March so I wouldn't worry, he has plenty of time to break the news.

Until then just watch the Fed's balance sheet grow and grow and grow.

Congratulations Ben

Congratulations to Ben Bernanke as Time Magazine's Person of the Year. No, this is not a joke. I think history will put this award in the top three all time worst. Rounding out the top 3......

Ben Bernanke:

Adolf Hitler:

Joseph Stalin:

Tuesday, December 15, 2009

Brace Yourself Again

The New Storm Approaches

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Ludwig Von Mises

The stock market hit new highs for the year yesterday as Wall Street cheered on America's new bull market and economic miracle. Streaming across the news was more excitement over the recent announcement of banks across the board paying back their TARP bail out money now that all the problems are behind us.

A poll this week showed the number of bears (people worried about the economy and stocks) at a 6 and 1/2 year low and close to the time record low that was set 21 years ago.

This means, once again, the Tuna is alone with worries about the economy.

When I began writing these articles in the Fall of 2007, my focus was on the coming disaster in the financial sector based on the troubles in the real estate market. I became curious during 2006 when trying to figure out how the people would pay for the homes that I was selling.

After a lot of reading I found out about how loans were packaged and terms like CDO's and Credit Default Swaps. I began writing about my concerns during that fall as a way of helping me remember and understand the topics I was reading about.

For 12 months readers could feel that there may be a problem but dismissed the notion using terms such as "chicken little" and "far too extreme."

Then in the fall of 2008 the financial markets collapsed. (Far worse than I imagined or forecasted.)

Since then my focus has been on the impact of the decisions made during that fall. Decisions that continue to be made today.

The government decided at that point that they would bail out everyone and that they would except no short term pain for the mistakes previously made.

Fannie, Freddie, Citi, Bank of America, Goldman Sacs, JP Morgan, AIG, and General Motors all were nationalized overnight. The notion that the money is being given back to the government today is laughable. All these companies are bankrupt and walk around today as zombies due to accounting gimmicks and the full backing of our tax dollars.

What happened during the fall of 2008 was that the government decided to put the full pressure of every loss moving forward on the back of the American public debt. The deficit this year which was initially projected to be $400 billion, topped $1.9 trillion including off balance sheet items such as TARP. It makes no difference whether you want to call something "off balance sheet" because the interest still needs to be paid on it every month.

Obama is already in the works to prepare a second stimulus package due to the complete failure of the first to create jobs. The Obamacare bill appears to be moving along nicely and other plans of destruction such as cap and tax appear to have legs as well.

I believe that by the end of next year or early 2011 the United States is going to face a crisis in funding its debt. This will change the complete landscape of the country we live in today.

The Federal Reserve will have to decide who it wants to save with its printing press. As the dollar begins to plunge, they will be limited on their ability to save everyone as they are today.

One of the least likely sectors I believe they will look to protect is commercial real estate, which is why I am preparing today to be a buyer in that market. Another market is residential real estate. People buying homes today will be slaughtered when the Fed is no longer able to function as the mortgage market. The "bottom" in the housing market you hear about has now become the selling opportunity of a lifetime for current homeowners.

The exact details of how it will play out are impossible to see because you cannot forecast how much damage Bernanke will ultimately achieve with his printing press. If he backs away as he should, then you will see stocks and real estate plunge as we enter the long overdue deflationary depression.

If he does as he has promised and turns the money printing on full steam then we will experience the worst case scenario.

Until then, enjoy the world we live in today because we are currently in the eye of the storm. What we experienced last year was just a warm up for what is on the way.

Monday, December 14, 2009

Jim Rogers

Legendary investor Jim Rogers, who co-founded the Quantum Fund with George Soros, takes some time to speak with Maria about the financial markets.