Saturday, May 25, 2013

John Maudin: Japan Has Painted Itself Into A Corner

The following are two incredible articles from John Mauldin, author of Endgame, describing the current state of the Japanese economy and financial markets. Rather than try and summarize the details, I will provide the links for you to read them in full. The first article was posted last Saturday so it came out before the Japanese stock market crashed this week. The second was released this morning:

All Japan, All The Time

The Mother Of All Painted In Corners

For more Mauldin, one of the brightest financial minds in the world today due in large part to his constant world travels where he sees what is happening in countries by actually experiencing it, the following video provides an excellent summary of where we are today in the Endgame.

She Said Yes

Because a good precious metals portfolio needs to be diversified with diamonds, I asked the love of my life to marry me last night and she said yes.

We had a great night in Charleston, SC and we're spending the rest of the weekend on the beaches of Kiawah Island, one of the most beautiful destinations in the world if you are ever looking for a trip.

This is the newly engaged couple heading into the city:

Thursday, May 23, 2013

Japanese Stocks Crash: A Small Taste Of Things To Come

Last night the 10 year Japanese government bond touched 1%, more than doubling in just a few short months. This means the value of the bonds have plunged because bond values fall as yields rise. Here's a great visual of their bond prices, currently in free fall:

Japanese yields rising create an unlimited amount of problems which have been documented here in detail; from banks, pension funds, and Japanese citizens taking massive losses on their books all the way up to the simple fact that when yields reach about 2% in Japan the interest on the debt alone will overwhelm their entire annual tax receipts. 

In addition, higher yields create higher borrowing costs for consumers and businesses. At some point last night those that invest in the businesses in Japan through stock purchases figured this out as the Japanese market plunged 9%, ending the session with a 7% decline.

As all markets are interconnected in today's financial world this has rippled around the world because many investors borrow (short) the yen to buy all types of assets (global stocks in particular), the hottest most recently being Japanese stocks which have been on a tear for close to 6 months.

I have no idea if this is the beginning of the end, but this is a perfect preview for how the endgame will play out during the second half of this sovereign debt crisis. At some point bond and currency markets will overwhelm the current artificial fairy tale that central banks have tried to create. Then you will see all risk assets plunge simultaneously as people realize that the dream world the central banks created is actually a nightmare.

For more on the recent bond market plunge in Japan see:

Japan's Government Bond & Currency Markets Begin To Tremor

h/t Zero Hedge, MISH

Tuesday, May 21, 2013

Mark Grant On The Coming Reversal

I very rarely paste someone's thoughts directly, but Mark Grant's column this morning summed up the state of the financial markets perfectly.

Mark Grant is the author of Outside of The Box & Onto Wall Street.

Mr. Grant is a graduate of Occidental College and has been on Wall Street for thirty-seven years in various senior management positions. He has run Capital Markets for four Investment Banks and been on the Board of Directors of four Investment Banks. Mr. Grant was also the President of a public company in the telecommunications field and on its Board of Directors for several years while he continued his work on Wall Street. He currently works at a publically traded Investment Bank and is a Managing Director of the firm.

The 100% Prediction of a Reversal

A reversal will come. The odds on this are 100%. You cannot have every asset class on the planet in a bubble forever. The world does not operate this way. The disconnect between economic fundamentals and the markets continues but the odds on it continuing forever is Zero. Let us begin the postulate from here.

Corporations, banks, the housing market, borrowers and the securities markets have significantly benefited from the actions of the central banks. Money has been poured, dumped and shoved into the financial markets. The total exceeds $16 trillion to date and perhaps twice that amount if we were given accurate data to be able to count it. It was been a Tsunami of money.

Liquidity has buoyed the world as the central banks acted in concert and in a coordinated effort to provide fresh cash. The balance sheets enlarge but the money has not significantly helped anyone's economy. Europe is in a recession, America is in a muddle and the world's economies, without all of this money, would be in a sinkhole and so it continues. There is nothing else supporting the economies and the markets except the capital provided by the central banks.


The disparity is so large and so universal that something will break the bough as the weight eventually cannot be supported. When this happens it will be Katie bar the door. If you fall from ten feet you get hurt but if you fall from one thousand feet the consequences are quite different

All of this is knowable but what is not knowable is what will cause the break. It could be the rise of nationalistic political parties in the U.K. or Germany. It could be social unrest, a major bank failure, a major hedge fund blowing up, some sovereign deciding to quit the Euro or a host of other possibilities. The odds on one item are minimal. The odds that a break will happen somewhere are 100%.

The creation of all of this money also has another effect. It causes stupidity. People and institutions rush around to invest their money but when there is too much easy money, such as right before our 2008/2009 debacle, really dumb things are done with money as people search for yield and appreciation. This is another 100% prediction made by me after being in the markets nearly forty years. When too much easy money floats around; stupidity takes its course.

Then there is the made-up fantasy data numbers. Just because you do not count liabilities, or because you do not count people not in the work force or just because you claim exports, in the case of China, that bear no resemblance to reality does not mean that the consequences of the real numbers, and not the phony numbers, do not begin to have serious effects. The lies, let's call it what it really is, that are being produced in Europe, America and in China are in lock-step with the printing of newly minted paper. More money, more lies and virtually every government on the planet hands shovels out more manure and heaps it on its citizens.

Now the central banks have also entered into currency manipulation. I call it "Global Thermonuclear Devaluation." Lower the value of each and every currency so that the cost of goods and services does not cause Inflation though this game is so dangerous, and having never been tried before, you could get quite serious Deflation. No one on the planet really knows how this new game will work but I can tell you this; edgy games often end in disastrous results.

  It is quite true that we do not know the "what and the when" of it but my prediction that lacks any "If" will prove to be true. There is no longer an "If." The disparity now is just too great.

Play the game as long as you can. It has gone on to date right in line with the increase in the money and in the lies. Play the game. However if you are smart you will have an exit strategy and a defense lined up well in advance before the man with the scythe shows up and takes a swipe at you. I will tell you this. If you have no plan you will be in danger of losing your head when this fellow smiles at you and sluices in your direction.

It was January 13, 2010 when I predicted Greece would go bankrupt. I looked at the real numbers and not the drivel we were handed out and made my prediction. The yield on the Greek ten year was 4.38% on that day. This is a yield we have never seen again. Money has been made and lost here but history has borne out my prediction.

Later I predicted Ireland, Portugal and Spain. Each country, in my opinion, has gone bankrupt in one form or another. Yes, a giant ruse for Spain with money given to the banks and no admission of guilt from anyone but the charade does not change the reality. Each and every country went over the edge.

We stand on a precipice. There is an avalanche of lies, distortions and currency that has been created and is tumbling all around us. It cannot be dodged forever. Those odds are 100%. That is my prediction.

Monday, May 20, 2013

Peter Schiff - What Happens When Interest Rates Rise?

An incredibly clear and easy to understand speech from Peter Schiff at this year's Las Vegas Money Show. It reminds me of the presentation he gave to a large group of mortgage bankers in 2006 where he described what would occur to the real estate market when mortgage rates rose and the artificial lending was removed. This time around with the bubble in the bond market he discusses what will happen when bond yields rise and the artificial lending is removed.

Please forward this to anyone who thinks that the current fairy tale we live in today will end well.

Jim Rogers Interview With Reuters

Rogers discusses the situation in Japan, shorting U.S. junk bonds, buying Russia, and why he believes gold has not bottomed.


Sunday, May 19, 2013

Beyond Newton's Cradle: Looking Deeper Into Market Analysis

Last weekend, we took a big picture view of the world by putting into a very simple perspective: "yield on vs. yield off." It showed that we are currently in an environment which is a "rush for yield," where assets also known as risk assets have been bid up and bought with fury as investors around the world look for some sort of income to add to their portfolio.

This has created an environment where junk bonds are now yielding the same price as risk free bonds were only a few years ago. While this is occurring in many of the developed countries, the following shows the current mania in United States junk bonds as yields continue to plunge to record lows (creating record high prices for the bonds).

I mentioned last week that while people spend all their time, attention, and capital focused on finding the best possible risk assets to add to their portfolio, I would prefer to spend my time where no one is looking: assets that yield close to nothing. This is the world of cash or currencies.

This weekend, I'll take it a step further and show how I monitor specific opportunities within the global world of cash, while we wait for this current "reach for yield" mania to subside. I will discuss "shopping list" cash options I believe have fundamental strength, and specific currencies I believe have fundamental weakness.

I will, of course, not spend my entire life investing in non-yielding assets. The pendulum will switch direction at some point in the future and the herd, crowd, or whatever you like to them, will coming rushing out of these higher yielding assets as their value bursts.

Before we begin, to give you a primer on how we got to this general over-valuation in yielding assets and how it will impact the financial world when this coming "shift" occurs, I suggest you review:

The Complete 2013 Outlook

For a review of how this general shift works in terms of capital movement and psychological behavior from the market participants involved, as well as how I personally prepare today to buy as many higher yielding assets tomorrow, I would review:

Newton's Cradle: Visualizing Asset Prices Through Capital Movements

We'll now move deeper into where that conversation left off, and we'll find that the world of cash is not all that boring, especially when you are the only one at the party.

Up Next: The Markets Are Global: How Cash Can Take Many Forms

The Markets Are Global: How Cash Can Take Many Forms

You've heard that hedge funds, pension funds, mutual funds, or your next door neighbor are holding X percentage of their holdings in cash. Usually this number is extremely low and only rises after prices fall and people become afraid (see 2008). Then, over time, the fear slowly leaves the market and investors become more and more convinced that it is safe to tread back out into the ocean.

If you think about holding cash in your portfolio you have more options than just holding X amount of dollars down at your local bank in your local currency. We live in a global financial world today and cash can take the form of numerous currencies, many of which we will talk about today. 

What follows is a simple thought experiment that I do on a daily basis to figure out where capital will perform best within the world of none yielding cash alternatives. This thought process can be extrapolated out to any asset class you believe is attractive. For example:

If I thought stocks were undervalued and under-loved, I would spend my time deciding on the best sectors within the stock market, then the best stocks within those sectors. For example, people that recommend buying stocks today may say that American technology stocks are an attractive sector of the total market. Within that group there may be a few specific stocks they expect to be the best performers, such as Google or Facebook.

If I thought real estate was an undervalued and under-loved asset class, I would spend my time deciding on the sector within the real estate market, then the best location to purchase that type of asset. For example, people that recommend buying real estate today may say that retail property is an attractive sector. Within that group they may believe that markets such as San Francisco or Phoenix will be the best performers for the retail market.

At some point, after capital and sentiment begin to move away from stocks, bonds, and real estate (higher yielding assets), we will be having in depth conversations on the best opportunities in that area.

A normal financial adviser will recommend that you have a portfolio that consists of X amount of stocks, X amount of real estate, and X amount of bonds to give you a total of 100%. The type of thought experiment we are moving through today cannot be found in a world where your adviser only makes money if you purchase from the three above.

Today's discussion is not a recommendation that someone should own (or not own) any of the asset classes discussed. It is just another way I can try to explain how my mind works when I view the financial markets, which will hopefully open your mind to the complex layers that are involved in any portfolio decision. 

Up Next: How Capital Flows Impact Currency Movement

How Capital Flows Impact Currency Movement

We live in a bizarro world today that differs greatly from the investment landscape of the 1970's and 1980's. Today, an increase in central bank printing (supply) can be met with a large rise in the currency strength (see Europe's recent movement). A large supply of new government debt can also be met with open arms (see the U.S. dollar's recent movement). In the long term, real fundamentals have the advantage, but in the short term, that is not always the case.

The currency of a country strengthens or weakens for one simple reason: there are more buyers of that currency than there are sellers. If more people are selling their yen in exchange for another form of currency such as the US dollar or the Euro (which has been occurring over the last 6 months), then you will see the value of the yen drop in the open market vs. the dollar.

This means that the dollar now buys more yen. It also means that the dollar now buys more goods that are manufactured in yen. Imagine that you make toy boats on the beaches of Japan. After you complete your toy boat you get on a real boat and travel across the sea to the United States to sell it to an American waiting to buy it on their shores.

If the Japanese yen is valued at par with the US dollar, meaning that 1 Japanese yen = 1 US dollar, then the boat costs $1 and the American can purchase 1 boat. What happens if the Japanese yen falls to 0.5 USD in the currency exchange market? The person in America converts their 1 American dollar into Japanese yen and they find that they now have 2 Japanese yen. They can now afford to purchase two boats when the seller arrives at the port.

This simple walk through is the foundation for what is taking place around the world today called "currency wars." Countries are in the process, in some cases completely open about it (see Japan), in devaluing their currency to boost their exports.

What causes a currency to be devalued?

The first and most simple to understand is an increase of the total units of that currency in existence  We know that if 10 people live on an island and there are 1,000 shells that they use as money and someone finds a secret location holding another 1,000 shells, the total value of each individual shell on the island will fall in value. Scarcity is a key component to value, not just in currencies, but in every good on the planet.

The second part is a bit more complex. When capital enters a country, it needs to find a home. As money pours in it will likely end up in the form of real estate, stocks, or bonds (looking for a "return" on the money). The largest liquid investment opportunity in a country is usually in government bonds. If an investor believes that the government is very likely to pay back the money they lend them and they are receiving a strong return (interest rate) then it becomes more attractive to buy bonds.

A Japanese citizen may take 100 yen and get back on a boat toward the shores of Australia. They arrive and go to the local Australian currency office to exchange their 100 yen for Australian dollars (the number of Australian dollars they receive is based on the exchange rate in the open market that day). They now take their Australian dollars and invest in Australian government bonds because they are a trust worthy government who provides a strong interest return.

This process lowers the value of the yen (yen is sold), raises the value of the Australian dollar (Aussie dollar is bought) and raises the price of Australian government bonds (bonds were bought).

This does not happen today with someone taking a boat to Australia. It occurs electronically, with trillions of dollars moving around the world at the speed of light.

So, what would reverse this process? If sentiment toward Australian government bonds were to fall, which could occur because investors lost faith in the government's ability to return their money in full or they expected the underlying currency that they purchased the bonds in to fall in value.

Then the process would reverse. Aussie government bonds would be sold, Australian dollars would be sold, and the yen would be purchased (or some other currency).

This is only a fraction of what is involved when looking at why a currency should fundamentally move up or down in value, but it is enough to provide a full discussion on how each currency's financial statement looks around the world.

Up Next: The Fundamentals Behind Currency Strength & Weakness

The Fundamentals Behind Currency Strength & Weakness

The thought process that I move through when deciding when to purchase an asset is a relatively simple one. I spend time deciding on a "shopping list" within a specific asset class that I feel is attractive. The second part of the process is easy: wait for an asset on the shopping list to go on sale and sentiment to become low, then accumulate.

For this discussion, we are going to talk about currencies, or options for where/how to hold cash. There are three major components that I use to determine whether I believe a currency is a long term, fundamentally strong buy:

1. The current price and sentiment of the currency on the open exchange
2. The government debt to GDP within that country
3. Interest rates within that country

There are numerous other factors involved, but these three will provide us with a foundation for the scope of the discussion. Based on the insane nature of the currency wars taking place around the world, if you only use these three benchmarks to make your decision you will do better than almost all other investors in the long term.

We'll begin first with the currencies that are currently on my personal shopping list. I would suggest you do your own research to develop your own:

1. Canadian Dollar
2. Australian Dollar
3. New Zealand Dollar
4. South African Rand
5. Swedish Krona
6. Norwegian Krona
7. Malaysian Ringgit
8. Mexican Peso

After discussing the big three characteristics above for these 8 currencies, we will move on to the group of currencies I believe are fundamentally weak:

1. U.S. Dollar
2. Euro
3. British Pound
4. Japanese Yen

Over the next decade, I believe money will be moving from developed (bankrupt) to developing (healthy balance sheet) countries. This will not occur in a straight line process due to the fact that markets tend to act irrational for long periods then make major shifts to re-adjust. 

I like the eight currencies discussed above. I also like others. Do I recommend that someone move 100% of their cash position into those currencies today? NO! Again, this is just my shopping list, not the only currencies I own. Many of these currencies have performed well since they bottomed in 2009. This makes them less attractive at the moment. Others have not, making them stronger buys. We'll discuss the price movements for all of them.

I think the majority of a cash position today should be held in "safe cash," or pre-crisis cash, which I have discussed numerous times over the past few years. This represents ultra-short U.S. treasury T-bills. Why? The U.S. dollar, for all its flaws, is still the world's reserve currency and if there is a liquidation moment in markets there will be a scramble for liquid U.S. dollars.

This is the moment you can trade in your fundamentally flawed U.S. dollars for the items on your shopping list that are (hopefully) selling at a discount. 

I think we have one more "great" liquidation in front of us before you can feel comfortable moving 100% of your portfolio out of U.S. dollars. In the meantime the process is easy. You make your shopping list and raise safe cash. Then all you have to do is wait for the sale light to go on. We'll now review the markets discussed above and you can decide if they represent attractive assets for your personal list.

Up Next: The Canadian Dollar

The Canadian Dollar: Price, Government Debt, & Interest Rates

The following charts come from the team at Trading Economics. Their site is an incredible resource for all sorts of charts and information.

The Canadian dollar fell to a low of 80 cents against the U.S. dollar during the panic of 2008 and has since rebounded to parity and has hovered at that level for years.

Since 2000, the 10-year government bond has fallen from the 6% range in almost a straight line decline to today's 2% range.

The Canadian debt to GDP has moved from 66.5% in 2008 up to 84.6% today.

Up Next: The Australian Dollar

The Australian Dollar: Price, Government Debt, & Interest Rates

The following charts come from the team at Trading Economics.

The Australian dollar has risen from 0.50 U.S. dollars in 2002 up to over 1.0 U.S. dollars in recent months. The currency fell to as low as 60 cents during the financial crisis and hit 80 cents in mid 2010. It has the ability to plunge quickly then recover rapidly making it an excellent "shopping list" currency.

The Australian 10 year government bond hovered between 5% and 6% for 13 years before falling to the 3% level seen today.

The Australian government debt to GDP rose from 9.7% in 2008 to 22.9% in 2012. 

Up Next: New Zealand Dollar

New Zealand Dollar: Price, Government Debt, & Interest Rates

The following charts come from the team at Trading Economics.

The New Zealand Dollar rose from 0.39 U.S. dollars in 2000 to 0.83 U.S. dollars today.

The 10 year New Zealand government bond fell from a consistent 6% over the last 13 years to 3% after a recent sharp decline.

Government debt to GDP rose from 17.4% in 2008 up to 37% in 2012.

Up Next: South African Rand

South African Rand: Price, Government Debt, & Interest Rates

The following charts come from the team at Trading Economics.

 The South African Rand fell to 0.09 U.S. dollar's during the financial crisis, then rose up to 0.15, and has now fallen back to .11.

South Africa's debt to GDP rose from 28.3% in 2008 to 38.8% in 2012.

South Africa's 10 year government bond has fallen in a steady decline from 14% in 2000 to 6% today.

Up Next: Part 2: The remaining strong currencies. The weak currencies. Plus a discussion on gold and silver.