first majestic silver

The Chickens Come Home to Roost

It never ceases to amaze me how pervasive the level of economic ignorance is in this country and perhaps in the rest of the world as well. The media is full of journalists posing as being knowledgeable, if not exactly analysts at least experts, often passing themselves off as Economists without ever having taken a course in economics; all ready to give unshakable opinions, often based on wrong numbers and assumptions, yet lecturing the FED chairman as to what he should and must do. They, too, also suffer from what most Politicians and Economists suffer from and that is “Causality” the confusion between cause and effect. To be more specific, let us examine the sub-prime crisis and use it as an example. It is now being blamed for just about everything, especially falling home prices. In actual fact, it is the falling home prices that have brought about the financial and credit crises. But even that is NOT completely correct. For the 60 years since the end of WWII, home prices have appreciated at an average 6% per year. During most of that time, the cost of owning a home was approximately equivalent to renting. When the cost of owning fell below the cost of renting, buying became the compelling choice. But when the cost of buying soared to over 4 times the cost of renting, what in the world could have possessed anyone to buy instead of rent? In a world of soaring prices, everyone was encouraged especially by government to get in on the American dream. Never mind if you could not afford the home, prices were soaring, interest rates were falling and in 6 months you could refinance and cash-out about 10% to 15% of the original price of the home. With interest rates down around 1% and prices appreciating as much as 25% a year, everyone was getting paid to speculate and get as much credit as they wanted with no documentation. BUT trees don’t grow to the sky and even the best parties eventually must come to an end. And end it did.

THE REAL PROBLEM is not the credit crunch, nor is it jumbo mortgages or any other nonsense and excuses that are being paraded around. The Real Problem is the massive inventory of homes caused by overbuilding of overpriced homes which is a naturally occurring phenomenon associated with a massive speculative bubble that the average American could never afford regardless of the interest rates being charged. Sure he could afford to pay the interest only for a year or two, but then he soon discovered how much the taxes, insurance and maintenance amounted to and as soon as the refinancing and taking equity out game was over, the party was over as well. I warned you all back as early as December 2005 in “When Will “IT” Happen” and in March 2006 in “Denial” and in March 2007 in “A Black Swan” that the debacle will not be limited to sub-prime and is even now spilling over to A-1a and Prime arenas as well, which have not yet hit the front pages. All the monkeying around by the Politicians, aspiring Presidential hopefuls and their flunkies and so called advisers will only make the matter worse, because they are attacking the effects, not the cause. No one regardless of the Government interest rate subsidies will loan $500,000 on a $300,000 and falling home and live to stay solvent. As a matter of fact, any homeowner who can afford to pay and remains in this type of situation is being reckless and ill advised. That too will soon end as falling home prices spread to the prime multimillion dollar homeowners as well.

The problem is an oversupply of overpriced, non-affordable priced homes flooding the market as more and more homes go into foreclosure. THE ONLY SOLUTION is to drop prices to the point where the average American can afford to buy the average home. The Laws of Supply can be manipulated in the short run, but are irrefutable in the long run and the long run is here now. The one thing that makes capitalism work as compared to all other systems that cannot and do not work is the working of supply and demand in a free market. The more we manipulate and interfere with its workings, the deeper the hole becomes. It only makes common sense to stop digging. But alas, Governments using common sense is an oxymoron in itself.

DURATION: When it comes to how long this real estate crash will last, since I broke my Ouija Board, I can only go back in time and examine what happened in the past. The average bubble takes 8 to 10 years to correct and that is with 20% down and 30 year mortgages. Anyone who thinks that the biggest bubble since the Tulip and South Seas Bubbles will be over in 2 to 3 years, is either delusional or smoking some very powerful stuff. To make matters worse, the USA has never been in as weak a financial position as they are today. We have never had as large a combination of debt both external and internal, both Government and Private with as large a trade deficit and $60+ trillion worth of liabilities (Medicare & Social Security) due to explode in the next 5 to 25 years. Although the current Credit Crisis has been long and excruciating, all my experience and everything that I follow suggests that “You ain’t seen nothing yet.”

Am I pessimistic? You might say that. But I like to think of myself as being realistic. Since I don’t have a crystal ball and since I also know that history repeats and that when it comes to man there is nothing new under the Sun, I go back and study the past in order to get an insight into the future. Unfortunately no one in power can remember what happened last week let alone 10, 30 or 75 years ago and none are interested. What about the future? No one is interested in what will happen past the next election.

BAD THINGS HAPPEN, that is Law of Nature, the way of life and our world. But it is how you handle it that makes all the difference. My philosophy is simple “Hope for the best, prepare for the worst and you will never be disappointed.” If the worst happens, it won’t break me and might possibly even benefit me. As history unfolds, you may find that I try my best to provide "tomorrow's news today." Fortunately for you dear reader and non-subscriber, it's not too late for you to subscribe so as to keep abreast of this still-unfolding saga of our lifetime. TO BE FOREWARNED IS TO BE FOREARMED.

By addressing what may ultimately prove to be one of the most compelling and tragic financial disasters of all time, my forecast was considered to be near-blasphemy by most financial analysts, as they and the mainstream media continue to project strong future returns for real estate investments as late as the third quarter of 2007 and have now shifted to touting that the worst is now over. You’d think that Wall Street would be feeling embarrassed and humiliated enough about its own performance that its top executives and strategists would have the good sense not to be out there peddling fresh nonsense about how the credit-market crisis has pretty much played itself out. Don’t be fooled by the latest sucker rally, especially when it comes to the Homebuilders and Financials (that I had called to the exact day three letters ago). That the “worst may be behind us” is a pipe dream. The first thing you need to remember is that these guys still don’t have a handle on what they’re dealing with as their own write-down increases with each reporting period. And even if they did, we know that when it comes to their own balance sheets, they simply cannot be trusted. They are locked into a perennial Bullish mode. Except for perhaps Goldman Sachs, they would not know how to handle a Bear Market even if they had foreseen it coming.

Before we can figure out where things are in this crisis and where they are headed, it’s important to understand how we got into this mess in the first place. One explanation is that we got here because mortgage bankers and brokers were sleazy, investment bankers were greedy and incompetent, rating agencies were compromised, and regulators either were blinded by deregulatory ideology or chose to look the other way. But what if that isn’t the real story? What if, that for the better part of a 70 years (except the 5 Clinton years of Peace Dividends and a Republican House and senate), the United States had been living way beyond its means, consuming more than it produced and investing more than it saved in many highly speculative poor investments because of wrong signals that caused distorted decisions due to the FED induced below normal interest rates and cheap credit. What if China, India, Taiwan, Korea, Japan and others along with all those Petro-Dollars were willing to finance that ever increasing trade deficit on easy terms, also distorted by ultra low interest rates. They thought it allowed them to peg their currencies to the dollar so as to gain a competitive advantage and generate higher job creation and economic growth in their home markets. However, if everybody is doing the same thing, there is no advantage to be gained. And what if this mutually advantageous imbalance in trade and investment flows wound up creating massive overcapacity and a huge supply of cheap dollar-denominated credit that virtually invited all players all over the world to throw caution to the wind and make ill-advised lending and investing decisions? Not only is this a more plausible explanation, but I think it is the real underlying story. And if that is the case – if the story of the credit bubble and it’s bursting is more fundamentally about macroeconomic imbalances than just greed and regulatory failures – then that has very different implications for where we go from here.

One thing is for sure, continuing on doing more of the same (lowering rates, printing more money and easing credit) is definitely not the answer. These implications mean that things won’t be “fixed” simply by having the financial sector write off its losses and bad loans and promise to do a better job next time with their risk management and a brand new set of government regulations. If only the taxpayers will bail them out just one more time. Rather, it will require a Major Recession at best or a Depression at worst to correct the tremendous imbalances that have been created in almost every sector of the world’s economies. Real Estate and the Financial sector are just the first of many to have begun their painful readjustment.

In the past, every time a major bubble burst it caused readjustments which culminated in a reduction in the overall standard of living, until the country as a whole began to live within its means. In practical terms, it means that households will have to reduce consumption, increase savings and stop piling up credit card debt and using whatever home equity is left as an ATM.

It means that the Federal Government must stop running huge operating deficits by cutting real spending and not just cutting the increases in spending. That will never happen until they are forced to.

It means that the price of homes must return to levels that reflect the incomes of the people who live in them and/or reflect the cash flow from tenants.

It means that the price of stocks, bonds, commodity futures and derivatives must return to levels that reflect real cash flows and risk-adjusted economic values, not speculative inflation values that rely primarily on momentum. Buying on breakouts to new highs was invented in the 50’s by a man called John Darvas, a world traveling dancer, who relied on day old Wall Street Journals to make his picks. IBD’s Can-slim is really just a modern sophisticated updated version. It too, like every other popular system eventually stops working, once it becomes too popular.

Such a broad reduction in wealth and living standards will come with higher unemployment, stagnant if not falling wages and falling incomes, during a sustained period of negative economic growth preceded initially by inflation, a falling dollar and rising Gold prices

WHERE WILL ALL THE MONEY COME FROM TO FUEL A NEW BULL MARKET? At the beginning of this 30 year Bull Market, less than 25% of all pension fund monies were invested in the Stock Market and 75% were in Bonds. Today over 75% is invested in the Stock Markets and a significant percentage is invested in Hedge Funds, Commodities and other highly speculative investments. Need I spell out what this will mean to the values of pension funds that are even now, at these still lofty stock market levels under funded, and what about all the 401K’s, university endowments and personal savings of seniors? You don’t have to have a Doctorate in Economics to see that this adjustment is already under way and it would be very naive and dangerous to assume that a bubble correction that took 30 years to build is anywhere near completion in less than two years. Sustained Bull Markets require ever increasing amounts of money. Have you noticed that the latest 1000 point rally has occurred on 30% less volume? Looks to me like it was mostly short covering as pessimism reached oversold levels. REMEMBER, eventually everything reverts back to its mean.

Simple logic in conjunction with our study of history of others bubbles of this magnitude including the most recent bubbles like the Stock Market and Real Estate in Japan in the 1980’s, the USA in the 1990s and the Tech Bubble of 2000, suggest that the turmoil in financial markets won’t be over until the end of 2009-10, at the earliest with a lot riding on what comes out of the new government beginning early 2009. And since there is always a lag of at least a year between what happens with new government regulation and what happens in the economy, it’s unlikely that the economy will bottom out before the end of 2010. Depending on what Congress and the New President does it could last a lot longer than expected.

What is important to keep in mind is that this should be mostly a process of markets correcting their own excesses and imbalances. However, if history is any guide and we end up with a new, “NEW DEAL” with Government playing “The Blame game,” they can and will make matters a lot worse than if we allowed the Free Market to correct itself. The New Deal of the 30’s, thought by many to have saved Capitalism from itself, has now been accepted in academic circles to have been just a myth. It turned what should have been not more than a 2 or 3 year recession into a 17 year depression. Now here we are some 75 years later: What will they do this time?

The following is an excerpt of a letter that was published on in Dec. 2005. that might be worth rereading at this time:

What is IT? Why hasn’t IT happened and When will it happen?

To listen to the Bears over the past ten years, you would have thought we would all be in breadlines and soup kitchens by now. So far, all of the ranting about doom and gloom sounds more like the boy who cried wolf than accurate forecasting. But I do believe that when “IT” happens, things are going to get much worse than anyone can imagine. Even though the markets at their lows in March of 2003 had lost over $6 trillion of value, that was not “IT.”

“IT” is a major financial meltdown followed by an economic contraction. IT is a sharp downward spiral that takes everything down with it. IT will be started by a catalyst, a spark that will get everybody’s attention. But IT is already built into the system, like a pile of oily rags, all just sitting and waiting for spontaneous combustion or a match or a spark to ignite IT.

Some of the candidates for the catalyst include: 1) Crash of the Dollar 2) Stock Market Crash

3) Derivative meltdown at a major bank 4) Nuclear terrorist attack 5) Major terrorist attack on the US (Bio or Chemical) 6 ) Major Corporate Debt Default 7) Major Municipal or State Default

8) Foreign Dumping or perhaps simply a refusal to continue buying US Treasuries.

These are the matches. By themselves, most can be easily weathered. But when combined with the poor underlying fundamentals of the economy and stock market, such as $800 Billion trade deficits and $600 Billion budget deficits, sitting on top a mountain of Public and Government Debt and unfunded pension and medical liabilities; then IT can turn into an inferno.

Below are some of the oily rags just waiting to ignite.

a) Massive amounts of derivatives ($90+ Trillion)

b) Overvaluation of the Dollar

c) Overvalued stock market (19 times last 12 months earnings is overvaluation)

d) Massive build up of Government debt

e) Record Low % cash levels in mutual funds

f) Massive build up of personal debt g) Under-funded pensions (Government & Private)

h) Housing Bubble I) Deflation or Inflation

j) Municipal and State deficits

But one thing for sure, IT will not happen as everybody expects. Some are waiting to see the writing on the wall; most want to see the fire before they will believe there is danger. Things haven’t really changed that much over the past 5 years. Investor attitudes are much too complacent. They see nothing to worry about. Yet liabilities have been outpacing income for six years: Since Year 2000, income growth has slowed while expenses have continued to accelerate.

So why hasn’t IT happened yet? Thus far the Fed has succeeded in playing Fire Chief and kept pouring liquidity into the system. But the Fed CANNOT keep the money and credit spigots wide open indefinitely: Afterall, is that not the definition of inflation? All they are doing is delaying the inevitable, not curing it. Adding liquidity is only making our future economic problems worse. It’s the same as adding tons of kindling in a time of drought. Excessive liquidity was the main cause of the 90’s Bubble in the first place and for that matter, every other bubble throughout history. The Crash in 1987 came as a shocker but Fire Chief Greenspan and his liquidity hose were on the phone to the banks and brokers offering unlimited credit to any institution that needed it. He saved a meltdown with five minuets to spare. The downturn in 1997 was again saved by Allan and his liquidity hose. In 1998, the Long Term Capital Management debacle caught everyone flat-footed; once again along came the Fed to the rescue... Then came Y2K and the Fed just automatically turned on the printing presses to prevent any problems. All of these problems had similar characteristics - they were sudden and solved by the Fed with increased liquidity.

Along comes 9/11 and Greenspan once again took out his liquidity hose and drove interest rates down to 1%. But this time, liquidity was not enough, it required two G.W. Income Tax cuts to halt the recession and get the economy rolling again. Only this time the 1% interest rates fueled the biggest real estate boom in American history.

The fabled liquidity that Wall Street crows about doesn't really exist. In fact, the Fed’s solutions have once again driven stock prices to levels of irrational exuberance. Too much liquidity has destroyed the allocation function of interest rates. Corporations and individuals have taken on unmanageable debt loads. Excessive liquidity drove the housing bubble. Too much liquidity must eventually weaken the dollar and force the FED to raise interest rates to much higher levels. Adding more liquidity won’t solve any of these problems; it just exacerbates them by delaying the inevitable and quite possibly will make matters worse. It is taking ever increasing amounts of money and credit just to hold on to where we are.

There are three kinds of lies: Lies, Damned Lies, and Statistics. In other words, clever people can turn accurate statistics into tools to cover up even the most outrageous lie. Take our Government’s latest boast on inflation for example. They will happily tell you that inflation is falling — according to “Core” inflation it is officially running at 3.3% right now — down from 3.6% a year ago. By the way, when was the last time that they mentioned that their target rate for inflation is between 1% and 2% and even at that rate, the value of the dollar is cut in half in 36 years. But that refers to only core inflation, which excludes food and energy prices. That’s a clever trick. But it hardly gives us an accurate measure of the REAL inflation that consumers feel every day in their wallets. There’s a reason why consumer confidence numbers have fallen off a cliff. In the REAL world, people are spending more for every bite they take and mile they drive. Much more of Middle America is tapped out! Yet the apologists for the economy and in turn the Stock Market, are still handing out rose-colored glasses and telling us everything is just rosy.

Here’s one more statistic that Government and the Pollyannas of the investing world are leaning on: GDP “grew” at 0.6% in the 1st quarter, so that means we can’t be in a recession, right? WRONG! Something called “Final Sales to Domestic Purchasers” — the measure of how much money people are REALLY spending fell in the 1st quarter for the first time in over 15 years. In other words, that 0.6% “growth” was caused by a buildup in inventories. What happens to the measure of real growth if the true inflation rate is say 6.9% instead of the reported 3.3%? Would you believe (-) 3%. Hmm, excess inventory and declining prices— that doesn’t bode so well for corporate profits going forward, does it?


So far we are right on track, as per my last few letters. Not only did the oversold market rally exactly on queue, but it rallied up to my maximum projected 61.8% pullback target. Is it time to go SHORT? Is it time to sell in May and go away?


As you can see, although the bullish sentiment figures have come back up to sell signal territory, they are still not high enough to give us a MAJOR BEAR MARKET SELL SIGNAL. As I have explained in discussing Gold in my last letter, how quickly everybody turns Bearish at the first signs of a correction, is actuality evidence that we are no where near a final top in Gold: When it comes to the general market it is exactly the opposite, as everybody holds on desperately to their perennial Bullishness and is strong evidence that a major top is being formed: So What do we do now? If you shorted the market as it touched its 200 DMV at 13,000, you are in good shape, BUT use close stops as the market seems to me that it just does not want to go down just yet. We may see as much as a 300 to 500 point sell off, but I would still be looking for at least one more RALLY back up or at least some further sideways consolidation, until Bullish sentiment numbers are in the 75 range. Meanwhile tighten your stops. Don’t let a profit turn into a loss.

The VIX is also sinking fast and approaching Major Sell Signal Territory

The safest bet for today is to keep your powder Dry and wait for a clear major sell signal. If I get one in between letters I will send out a Special Sell Signal Bulletin.


Just as the Stock Market is working on building its overall FINAL major top, the Gold Market and its respective stocks are still in the process of building their major base pending an explosion into their next up phase. Watch the individual stocks, they most probably have already made their lows and if not, they are very, very close to doing so. Start accumulating the Juniors. I think that the next up phase in Gold will be led by the stocks both Juniors and Seniors, instead of by bullion. You can pick your own favorites or stick with the ones already mentioned.

Gold, on the other hand, might need a little bit more base building and may I repeat, could come down to my maximum projected pull back low of $825 to meet its 200 day moving average. BUT yet again, it Might Not. Moving sideways for a while longer may be sufficient to complete its base. But whatever you do, DO NOT SELL YOUR GOLD! Continue to add to your positions should any further weakness develop.

I started to buy DGP, the ETF that represents Double Gold. At $19 and intend to continue buying more at every $1 up or $1 down.

I also sold July at the money puts on AEM, ABX, GG, and KGC, all stocks that I want to own and intend to buy more of.





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Aubie Baltin CFA, CTA, CFP, PhD.
2078 Bonisle Circl e
Palm Beach Gardens FL. 33418
[email protected]

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