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A.I. Garamba!

By Jon Nadler       Printer Friendly Version Bookmark and Share
Mar 17 2009 3:45PM

"Due to travel schedules there will be no afternoon commentary today. We will return with the daily commentaries on Wednesday, March 18th"

Good Morning,

Asian equities rallied an average of 3% overnight, boosted by perceptions of incipient signs of a recovery in the global economy. Over in Europe, the German investor surprised economic pundits by unexpectedly rising -albeit it remains in negative territory- and it also revealed anticipatory optimism among respondents. Something the same economic pundits are not so sanguine about. The euro benefited from the rising tide of positive feelings about the eurozone economy, climbing to $1.2988 against the dollar and to a near three month high against the Japanese yen.

The same conditions prompted more gold selling in Asia's overnight markets, but the metal -thus far- refused to yield at pressure near the $915 level, in a repeat of Monday's action. Scrap dealers reported all quiet on the Chinese front, deafening silence in India's gold shops, and orders lining up along divided lines between would-be sellers and buyers.

Most scrap holders are now targeting the $920 zone for pending sales orders, while buyers are showing interest in picking bullion up only when/if gold touches down somewhere between $875 and $905. The lower the price, the more they plan to acquire. Rising equity markets are still seen as diverting some portions of the investment funds previously earmarked for gold.

New York spot precious metals markets opened lower once again on Tuesday, with gold taking second place to platinum's $8 drop to $1048. Silver lost 4 cents to start at $12.85 per ounce, palladium was (still!) unchanged at $198 per ounce. Spot gold was off $5.00 per ounce, opening at $918.10 per ounce. Participants were seen awaiting housing and inflation data and watching a turnaround in the dollar as market opened.

Gold might break out (down) from the recent congestion and test towards the $900 - 905 area, unless a major bit of news changes the tenor of the day. Marketwatch's Mark Hulbert took the temperature of the average gold timing newsletter and found a major bailout has taken place among those who write the same for a living. Bullion's inability to convincingly vault above the four-digit marker last month, has soured a large number of such writers.

Of course, for Mr. Hulbert's gauge, this is seen as a bullish sign for the metal - it is a contrarian gauge after all. Yes, but there is always Nick Guarino of the Wall Street Underground. He sees $200 gold on the basis of complete and utter asset destruction during a deflationary spiral. Now, that, is what is to be called "bearish." Not $730, $640, or $515. Not even close.

The greenback rose to 87.08 in the index, not a feat to send up fireworks over, but a rise nonetheless, in an environment where risk appetite and the evidence of its comeback should make for weaker values for it. Crude oil stabilized somewhat, quoted near $47 per barrel, as indications that OPEC's call for compliance of production cuts appeared to have gained some traction. Let's see if the cartel members can trust each other on that one.

The AIG bonus brouhaha continues to make most of the headlines, and is fast becoming the political firestorm of the week. Jumping up and down in opposite corners of the ring, the fighters who point to the 'sanctity of contracts' and the Cuomonites who clamor for some -any- heads to roll over this one. President Obama made it clear on Monday that he intends to block the big fat bonus cheques at any cost. Don't know where AIG got the idea that it is contractually obligated to 'spit in the face of taxpayers' as Minyanville puts it.

The ringside bell has rung, subpoenas have now been issued, and Round 1 is underway. Let's see how many Hamptonites choose not to accept the millions lest their name makes it onto the front pages of the NY Times. Ahhh, once again, to be an attorney in the world of finance these days. Yipee.

Minyanville's Kevin Depew pulls out the big magnifying glass and takes a fresh look at this 'thing' that is circling the world economy, called deflation. We bring you excerpts from his analysis that appeared late last week on the Minyanville site. You are certainly invited to read all the gory details therein, if you have the time:

Kevin:  "Ominous news today from the National Inflation Association:

"The United States today is in a short-term deflationary phase caused by forced liquidations, de-leveraging, going out of business sales, and other temporary factors."

You might be surprised to learn that I completely agree with the National Inflation Association... except for the parts about this deflationary phase being "short-term" and "temporary." But other than that, we're on the same side, in total agreement.

Having come of age in the post-World War II era of inflationary excess, a deflationary debt unwind seems so utterly foreign as to be practically unimaginable. After all, in my lifetime, there has never been this kind of sustained period of forced de-leveraging, forced asset liquidation, voluntary debt payment, rising savings and economic contraction - all occurring simultaneously, and creating a negative feedback loop which reinforces the collapse in aggregate demand.

Consequently, the magnitude of the deflationary forces at work continues to be underestimated by pundits and policymakers. Take a look at two charts below updated from the Federal Reserve's Flow of Funds report. These charts show, one, the rate of destruction of household net worth we are seeing and, two, the annualized rate of destruction in real estate owners' equity.

Household Net Worth Year-over-Year Percentage Change

Real Estate Owners' Equity Annualized Percentage Change

No wonder most of us don't much feel like "getting out there" to the shopping malls and "doing our patriotic duty." These declines in household net worth are staggering. Household "wealth" fell by $5.1 trillion in the fourth quarter alone.

To put that amount and its economic impact into perspective, let's look at it alongside President Barack Obama's $787 billion stimulus package that was signed into law last month. If you consider the magnitude of the loss on an individual basis, it's the equivalent of losing $5,100 at the racetrack one day, vowing to give up gambling forever, but finding $787 in your glove box and rushing back to get it all down on the next race.

The reality is there's nothing short-term or temporary about this "deflationary phase."

2) U.S.(Zimbabw)A.?

The National Inflation Association's ominous report continued:

"It is our belief that the monetary policies of the Federal Reserve and United States Treasury will soon put an end to this deflationary phase, and we will see massive inflation in the U.S. that could ultimately lead to Zimbabwe-style Hyperinflation

Going back to 1934, whenever the Federal Reserve has made credit available the world has accepted it. While it is true the Fed and global central banks are making record amounts of credit available, as those anticipating hyperinflation argue, that is only one side of the credit equation.

The assumption is that this record-breaking credit expansion means risk assets (stocks, commodities, etc.) will all skyrocket and the U.S. dollar will get destroyed. But what hyperinflationists fail to realize is that for an inflation (of either the tame or hyper variety) to take place, one must have both the means (credit from the Fed and banks) and the motive (the desire to take on more debt) for credit expansion. For over a year now we have had record amounts of the former, but none of the latter.

Additionally, in order for hyperinflation to even be a remote possibility here there would have to be at least one economy that is both stronger than the U.S. during a global economic downturn, and larger in size than the state of Ohio's or even California's economy.

Ironically, while smaller emerging markets could potentially find themselves facing a Zimbabwe-esque hyperinflation, that would only make the U.S. dollar and U.S. debt more attractive and secure. Emerging markets are at this point the only place where it seems a possibility that credit could find a willing home and debt an eager taker, but even that is not a certainty. It is more likely that the creeping protectionism that is developing, as countries begin to wake up to the fact that the global system is too big to save, results in a more severe credit contraction globally.

Make no mistake, this is not to say that we won't again experience inflation. We most assuredly will. But there are two critical errors being made by those currently warning of  either aggressive inflation or hyperinflation; one, a failure to recognize the severity of the deflationary forces at work and, two, a failure to appreciate the duration of this deflationary debt unwind.

3) When Doing Things Right Turns Out Wrong

Kevin -

Here's what I really don't understand. I just can't get my head around this:
if there are those people who did the right thing, still have their jobs and are still making the same amount of money, why does it seem everyone is so strapped for cash these days?

Good question. Going back to today's number 1), the primary reason everyone feels strapped is that a broad array of assets have declined in price; homes, apartments, stocks, investments.

Many people spent anticipating these things would only go up in value. but now that they have declined in value, even people who "did the right thing" have seen their debt relative to their assets increase. In short, people feel more strapped because they are more strapped.

But there's another complicating factor at work: leverage. Many people with good jobs, sound income and what at one time probably felt like very little debt load are discovering that they were in reality far more leveraged than they realized.

Many of these people may have borrowed against their homes, which had seen rich appreciations in value from the late 1990s to 2005, and used that money to finance other investments. Now that those assets have declined by as much as 20% in some cases, much more in others, they are discovering the downside to hidden leverage.

Consider the following very reasonable scenario. A couple in the first half of his decade is sitting on a 250,000 mortgage on a house valued at 500,000. They have 50% home equity, good income, some savings and investments and are considering possibly purchasing a weekend getaway in the mountains, or near a lake. They aren't millionaires. They just want to find a modest little cabin in the woods near a lake or hidden deep in the mountains somewhere.

They have plenty of cash on hand, having recently taken out a 50,000 home equity line of credit (bringing their mortgage total to 300,000 on a 500,000 valued house), so they find a small cottage near a lake for a pretty reasonable price, say, 150,000. They want to be safe so they put a full 20% down, 30,000.

Now, let's revisit this situation a couple of years later. They owe 300,000 on their primary residence, which after a 20% hit is worth only 400,000. They owe 120,000 on their cabin, which is now worth 120,000. All told, in a little less than three years, this couple with a good job, sound income and relatively little debt relative to their assets has gone from having 50% equity in their primary residence to 25%, added 120,000 to their overall debt load and have zero equity in their weekend getaway.

What did they do wrong? Not much. If they had embarked on that path 15 years ago this would be cause for discomfort, not cause for despair. But because they were misled by monetary policy makers as to the true underlying demand for assets, and consequently made what appeared at the time to be very reasonable investments based on those policies, they have gone from having a very healthy debt ratio to living on the wire, without any margin for error in the event of job loss, health issue or other unforeseen financial mistake."  

In so many words, people continue to make potentially harmful investment decisions based on erroneous expectations, and are motivated by what their neighbors might be doing, or what the latest newsletter told them they must do, more than by their little (emphasis on 'little')  inner voice of reason. Well, no surprise there. As reliable a pattern as one could ask for. Ahhh, to be a psychiatrist or Suze Orman these days....

Happy Bargain-Hunting. 


Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.