Saturday, August 16, 2014

Silver's Share Of Global Financial Wealth

Imagine that you hold have $100,000 in total wealth. Hypothetically you may have $30,000 (30%) in real estate equity, $30,000 (30%) in stocks, $30,000 (30%) in bonds and $10,000 (10%) in emergency cash. This seems like a pretty normal composite of how the world holds its wealth.

How much of the world's wealth is held in silver market?     0.01%


That means with each $100,000 accumulated, the world holds $10 in silver. That is half of one ounce of silver. Half of a single coin.

The following are a few of the reasons why silver remains an attractive investment to me personally:

- Global central banks are flooding the financial markets with unprecedented QE programs

- Many governments around the world will be unable to pay off their debts without diminishing the purchasing power of their sovereign currencies

- Geopolitical turmoil

- New industrial demand for silver entering the market every year

- Extremely high demand in the physical precious metals market (especially in Asia)

- Silver recently falling below the all-in cost of production (roughly $20 an ounce), which has shut down or postponed future mining projects (supply) for years. Silver rests at $19.50 an ounce as of this writing.

Beyond these basic bullish arguments for owning silver the chart above intrigues me the most. What if the world were to sell just a tiny fraction of their stocks or bonds and put just a tiny fraction of that money into the silver market?

The tiny spec of dust that is the physical silver market would experience a Bitcoin moment, just as it did back in the late 1970's.

The Islamic State (ISIS) - Full Documentary

Thursday, August 14, 2014

The New American Subprime Dream: Auto Loans

The total number of auto loan accounts surged past mortgage accounts in late 2013. Loose lending standards have opened the floodgates for buyers and there is a steady stream of liquidity looking to buy the loans.


Just like with junk bonds, investors look at the default rate over the past few years, which has been very low. They extrapolate that low default rate out forever and purchase the bonds because they provide a higher yield (just as they did with subprime mortgage loans, which had a very low default rate entering 2007).

The economy is in the fifth year of a cyclical recovery. When it naturally rolls over (there are always recessions and expansions like the ocean tides) these loans will default in large quantities.

When the subprime auto loan market implodes it should have far less of an impact on the financial system than subprime mortgages did back in 2008 due simply to the fact it is much smaller in size. The junk bond bubble's implosion? It will be far worse.

Fore more see: The Impact Of The Junk Bond Bubble Bursting

Sunday, August 10, 2014

Weekend Summary

I've been working very long days throughout the week so I've been trying to add more content on the weekend on topics I may not have had the time to immediately discuss. Thank you for your patience. This weekend we covered:

U.S. Stocks:

The U.S. Stock Market Is Now More Expensive Than The Bubble Peak In 2000

Retail Investors Move All In U.S. Stocks

U.S. Bonds:

The Impact Of The Junk Bond Bubble Bursting

Visualizing Portfolio Losses When Bond Yields Rise

Global Bonds & Germany:

10 Year Government Bonds Perched At Dangerous Price Levels In The G8

While I have posted similar videos in the past walking through this topic, the following is a new release from the updated crash course discussing how money is created. If you are not fluent with this important topic it is an excellent review:

Retail Investors Move All In U.S. Stocks

Retail investor cash holdings are now back to the lowest level since 1999. We have seen throughout every cycle in history that the the retail investor (mom and pop) sell stocks after major declines and buy stocks after major rallies. You can see the large cash holdings (red line) after the last two major stock market declines in the chart below.

Investors are going beyond 100% "all in" and leveraging up their positions to purchases more stocks. NYSE margin debt is now back at all time record high levels.

It has been 33 months since the U.S. market experienced a 10% decline. Many investors have forgotten such a decline is even possible.

Investor complacency is approaching historical lows seen in the VIX (fear) chart below.

We are now more than 5 years into the current cyclical recovery. Analysts tend to forecast a straight line higher in earnings, growth, etc. at the peak of market cycles. What would happen if we experienced a normal cyclical recession?

10 Year Government Bonds Perched At Dangerous Price Levels In The G8

The chart below shows the 10 year government bond yields for the G8 countries. They have priced in perfection over the next decade within their public bond markets.

I could write an endless amount of information on each of the markets above. Most are sitting at dangerously low yield levels and in some cases all time historically low yield levels. Japan represents is the greatest danger, by far (see Japan Is A Powder Keg Searching For A Match).

I believe bond holders in 6 of the 8 countries above will all experience major losses in the decade ahead. I think Canadian bond buyers will most likely be hurt less than the others. Russia is the one G8 market where prices are close to the point where I am very interested in purchasing shorter duration bonds denominated in Russian currency (a discussion for another day).

The German 10 year touched 1.06% during the week after data showed the recovery in Europe has stalled across the region. German 2 year bunds (Germany's government bonds) went negative for a brief period this week; meaning that investors were paying the German government to hold their money over the next two years.

German factory orders and industrial production unexpectedly went negative this week, but the real weakness in Europe came from Italy who triple dipped into recession. Italy has now wiped out all its growth since 2000.

The weakness across Europe has investors scrambling out of risk assets into the safety of German bonds. The DAX index (German stocks) crossed below its 200 day moving average this week after giving up 1000 points in just a few days.

I discussed the high yield (junk bond) market in the United States earlier this morning in The Impact Of The Junk Bond Bubble Bursting. Here is what John Hussman had to say this weekend regarding the junk bond market in Europe:

"On the subject of junk debt, in the first two quarters of 2014, European high yield bond issuance outstripped U.S. issuance for the first time in history, with 77% of the total represented by Greece, Ireland, Italy, Portugal, and Spain. This issuance has been enabled by the “reach for yield” provoked by zero interest rate policy. The discomfort of investors with zero interest rates allows weak borrowers – in the words of the Financial Times – “to harness strong investor demand.” Meanwhile, Bloomberg reports that pension funds, squeezed for sources of safe return, have been abandoning their investment grade policies to invest in higher yielding junk bonds. Rather than thinking in terms of valuation and risk, they are focused on the carry they hope to earn because the default environment seems "benign" at the moment. This is just the housing bubble replicated in a different class of securities. It will end badly."

European public debt rose from 130% of GDP in Q1 2013 to 135.6% of GDP in Q1 of this year. It is expected to cross 140% of GDP by the first part of next year. The fundamentals continue to weaken as bond prices continue to surge higher. There will be an inflection point coming, it is only a matter of when.

For more see The Fundamentals In Europe Weaken As Financial Markets Hit Record Highs

Steve Jakobsen on the complacency in the German and European markets:

Visualizing Portfolio Losses When Bond Yields Rise

After starting the year at 3%, the 10 year treasury yield made it all the way down to 2.35% on Friday afternoon. It then made a quick burst up to 2.42% where it ended the week.

After a major decline, what would rising treasury yields have on portfolios?

The following chart provides a great visual on the principal losses buyers would incur if they purchased bonds and interest rates were to rise just 1%.

For example; the 30 year U.S. treasury bond ended the week at 3.23%. You entered the market on Friday and purchased $100,000 in 30 year bonds.

If rates were to rise by 1% (bonds were being sold in the open market at 4.23% instead of 3.23%), then your bonds would now be worth $83,500 (a loss of 16.5%).

After a 33 year fall in bond prices, those loading up on bond funds in their 401ks and investment portfolios have completely forgotten there can be massive losses of principal if bond yields begin rising. The Fed hopes that bond prices rise in a slow and steady manor as the economy recovers, but what if bond prices began to rise without a full recovery in place? The is perhaps the black swan event that no one has priced into risk models, and just like the black swan collapse in home prices during the last decade, it is the most likely scenario to occur. 

The Impact Of The Junk Bond Bubble Bursting

In March of 2007 the total size of the U.S. subprime mortgage market reached $1.3 trillion. 18 months later, in the fall of 2008, subprime debt became toxic throughout the financial system when buyers realized that homeowners would be both unable or unlikely to pay back the loans.

In March of 2014 the total size of the junk bond market worldwide crossed $2 trillion. The market has doubled in size from early 2009. 

Are junk bonds more valuable than subprime mortgages? Junk bonds receive their name because they have a high risk of default. When a subprime mortgage bond defaults the worst case scenario is that the bond holder receives the value of the underlying home which can be sold for a percentage of the bond's purchase price. When a junk bond defaults the worst case scenario is that the bond holder will be left holding only a worthless I.O.U. (and maybe a letter of apology from the company they were dumb enough to lend money to?). 

We know junk bond holders will be slaughtered, but how big of an impact will it be to the financial system and surrounding markets? That is impossible to quantify because we have never been in a central bank QE induced global hysteria combined with governments drunk on deficit spending. 

My guess is that the secondary impacts will be far greater than market participants are expecting, considering the fact that many stock markets (and real estate markets) around the world are sitting at all time record high prices (Remember, it took 18 months following the peak of subprime mortgages for the markets to fully realize the damage to the financial system). 

So where are we now in the junk bond debacle? The very early stages. Investors began to sell high yield (junk bonds) slowly a few weeks ago and that trickle has turned into a flood. Yields have rocketed higher off the insane record lows (bond prices fall when yields rise). 

High yield bonds experienced record outflows this week of $7.1 billion, the fourth week in a row of massive outflows (prior record was $4.63 billion of outflows in June 2013).

Is it possible this is just a hiccup on the way to new all time lows in junk bond yields? Of course. Be mindful, however, that this market has perhaps been the greatest beneficiary of the Federal Reserve's fire hydrant of liquidity since 2009. That hydrant (we are told) will be turned off by October. 

At some point, just like with subprime mortgages, the market will have its "uh oh" moment. That moment could have arrived 4 weeks ago and the insanity surrounding junk bonds may finally be coming to its conclusion. 

Many companies have had the ability to borrow an unlimited amount of money (by selling junk bonds) and using the cash to repurchase their shares. As the cost to borrow rises (or disappears for many companies) it will become far more difficult to continue this ponzi finance. 

The U.S. Stock Market Is Now More Expensive Than The Bubble Peak In 2000

MarketWatch released an article this week that received some mainstream attention regarding a topic I have focused on throughout the year.

Back at the market peak of what is widely considered the greatest U.S. stock market mania in history (March of 2000), the overvaluation in the market was heavily concentrated in the tech sector. While the overall market was expensive, it was the small tech sub sector that was out of this world expensive.

When you look at the general market today vs. the market in 2000, you find that it is more expensive today than it was at the previous all time mania peak in 2000. Looking at the top 1500 stocks by market value, the median stock today is priced at 20 times earnings while in 2000 it was only 16 times earnings. 

The median stock today trades at 2.5 book value when in 2000 it was just 2.2. The median stock today trades for 1.8 times annual per-share revenue when in 2000 it was just 1.4. 

Here's a simple way to understand this. Imagine back in 2000 you owned 5 stocks with the following P/E ratios (I am just making up the P/E ratios for example purposes):

Coca-Cola - P/E 14
Procter & Gamble - P/E 15
Johnson & Johnson - P/E 16
Chevron: - P/E 18
Microsoft: - P/E 70

Average Price to earnings ratio: 26.6

Today you hold the same stocks with the following P/E ratios:

Coca-Cola - P/E 19
Procter & Gamble - P/E 21
Johnson & Johnson - P/E 23
Chevron: - P/E 24
Microsoft: - P/E 25

Average price to earnings ratio: 22.4

"You see!" shouts your financial adviosr, "the market is less expensive today than it was in 2000!" But is it? The median (middle number) price to earnings ratio has moved from 16 to 23.

If you strip out the insane valuation of Microsoft back in 2000 the overall portfolio is far more overpriced than it was in 2000. This is exactly what is taking place today. Investors are not cramming into one small sector, they are cramming into everything across the board. 

Does this mean the U.S. market has topped and must begin crashing tomorrow? Nope. Markets can go from extremely over priced to more extremely over priced before the laws of gravity return. When the market does decide to mean revert back to its historical norm, you just better hope you were able to exit through the small door in the burning theater before the rest of the crowd.

With the market's ability to flash crash due to high frequency trading, it will be unlikely that everyone will exit the theater alive.