first majestic silver

Maybe Ignore the Signals

March 1, 2005

Never in my twenty years of observing the markets have so many clear strong signals been presented for view. They cover the entire spectrum. They span the globe. They are worth a quick review. It will be difficult to maintain order in their flow. Some are dire. Others offer up huge opportunity. Some qualify as omens. Most seem ignored. It is hard to know where to start. In deference, why not with our own Mr Magoo, who gave the most important signal of all? He used to drive into guard rails. Mr Greenspan is prone to hit the high guard rail and low guard rail.

FED CONUNDRUM: Our unjustifiably revered wise fool Fed Chairman admits he is confused. After six rate hikes on the short end, the long end has ignored his directives. Mark this event down on the bond ledger next to the Irrational Exuberance speech on the stock ledger. Greenspan is a very poor student of either economics or credit markets. His expertise is in providing liquidity in a monumental inflation era. He is the king of inflation, thus the lightning rod for its criticism. Low interest rates triggered a commodity bull market boom, which has caused a powerful cost inflation problem. That inhibits economic growth. The grandest carry trade the world has ever known has the Bank of Japan directly buying long-term US Treasury Bonds. Tokyo bankers also serve as an outsourced agent for monetizing USTBonds on order by our Federal Reserve. The US Fed has staggering inflation machinery at work in its Far East outpost. Is Greenspan so dense that he has not noticed the price inflation raging in the entire cost structure driven by the falling USDollar and nascent Chinese demand? Is Greenspan so stupid as not to notice BoJ clandestine actions in the last ten years? These factors each contribute to economic distress, lost wages, and liquidation prices. When inflation is redefined through revisionist textbooks, the bond market will occasionally contradict the Fed directives. Then again, maybe we should ignore the signal.

FLAT YIELD CURVE: One of the most reliable signals known to link economic forecasts to the bond market, a flat yield curve means a recession is highly likely over the horizon. This makes sense to anyone separated from the vested interests of the USGovt and Wall Street. Even as the key 10-yr TNote yield has risen from under 4.0% in the last few weeks almost to 4.4% here, the 2-yr TBill yield has kept pace. The Treasury yield spread has maintained itself at 75 to 85 basis points. The entire yield curve is rising, dealing out losses to bond investors. This is a great signal for gold, as losses mount across the entire bond maturity curve. If the yield curve should go inverted, where long-term rates go below short-term, the effect of lost profitability, lost jobs, and lost control of debt balances will make for a confusing climate for gold investors. Maybe we should ignore the signal.

CENTRAL BANK DIVERSIFICATION: In the past few months, we have heard several central banks attempting to walk as fast as they can away from USTBonds. Late last year, we heard that central banks from Russia, China, India, and Indonesia were to diversify away from US$-denominated reserve holdings. Now South Korea intends to diversify away from USTBonds. This is tactful constructive language for "getting the hell out of dollars." The USGovt vast protection racket apparatus springs into action. The central bankers attempt to retract their words, but the damage is done. It reminds me of Guilda Radner of "Saturday Night Live" going off the handle about soviet jewelry, then ending with "never mind" as though no damage had been wrought (confused with soviet jewry). Better yet was her diatribe about endangered feces, an errant reference to endangered species. A worldwide abandonment of the USDollar and our garbage debt paper is underway. This is a dire signal for the US$ and a great signal for gold. Maybe we should ignore the signal.

LOW VIX (FEAR FACTOR): Whenever complacency sets in, when investors become assured, over-confident, certain that the "Greenspan put" will continue to preserve their hind bacon, the VIX goes low and stays low. It measures built-in option premiums for the S&P stock index. With low option premium comes low perceived risk. The VIX has served well as a fine contrary indicator for decades. We are at multi-year lows at the same time that a mini-revolt has occurred in the bond market. A little volatility has entered lately into this volatility index. This portends upcoming stock losses and major selloffs. Maybe we should ignore the signal.

FANNY MAE BREAKDOWN: This behemoth new age bankrupt "LTCM-like" centrifuge beast has broken down below its critical support level of 61-62. To be sure, it is 20 times the size of Long-Term Capital Mgmt. A rescue is in progress, wholly consistent with the Plunge Protection Team modus operandi to interfere with any and all signals. The FNM share price is approaching 60 after bottoming below 58. Repeated rescues have formed a huge rounded top for the stock chart. Its core capital position is probably empty. Its accounting practices are fraudulent and scrutinized. Its accounting is totally inadequate. Its officers are likely criminals. Why is so difficult for the market to perceive that the Federal National Mortgage Agency is in bankruptcy receivership? This is the primary foundation to the entire residential housing bull market, a foundation of soft shifting sand, if not a mudslide akin to those in southern California. The housing market is at risk from interrupted free flow of funds for mortgages. Maybe we should ignore the signal.

DOW TRANSPORT INDEX BREAKDOWN: Don't look now, but Dow Transports registered a failure. For months and months, Dow Theorists awaited the Dow Industrials to confirm the new highs from Transports. Instead, the leading indicator Transport index broke down. This story is almost totally unreported, yet so important. We have our confirmation of a bear market in stocks for 2000, which is in harmony with the poor January month for stocks. The Dow Industrials index is putting in a double top. China was the major force behind the worldwide brisk transport activity, what with shipments of raw materials to the Middle Kingdom and return shipments of loaded finished product cargo to the USA. Nevermind that 23% of container vessels returned empty to China from Los Angeles. We might have some evidence of early slowdown in the grand Chinese expansion. Maybe we should ignore the signal.

COST INFLATION RAGES, WHILE WAGES ARE TAME: The investment community is only beginning, after over two years of live education, to comprehend that price inflation is not a simple homogeneous systemic phenomenon. Easy money triggered a commodity and resource bull market. So material costs (including energy) have risen across the board. The Producer Price Index has risen twice as fast as wages or consumer retail prices. Costs rise while end product pricing power is absent. A powerful fantastic squeeze is underway. Corporate profit margins in the real economy are being squeezed, where physical things are made and serviced. Household discretionary budgets are also being hindered, where food and energy costs have overwhelmed the unimpressive income sources. This is the result of intentional pre-meditated attempts by the Fed to promote inflation. We have asset bubbles inside the USA, and an excessive factory buildup in China, thus a failure. Maybe we should ignore the signal.

END OF PRODUCTIVITY GAINS: On the day it was announced, the market held the data within its field of vision. Since then it has been lost. The Q4 productivity came in at +0.8% which marks the end of high gains in efficiency. The markets have gotten it very wrong for over two years. Amidst widespread and deep job layoffs, and deployment of equipment in the place of workers, output per worker rose. There is more. With service outsourcing to China and India, with manufacturing offshored to Asia generally, the US Economy has imported productivity. This helps to explain why job growth is lousy within the USA. Asian has won the benefit. Market pundits proclaim that brisk job growth is next domestically here, yet demand comes from Asia, growth occurs in Asia, and investment goes to Asia. They have forecasted most everything wrong so far, so beware. Let me make the claim with productivity is actually negative right now, after removal of nonsensical hedonic adjustments from the information technology sector. They double count output and greater equipment speed. This goes parallel with negative savings rate, due to the same goofy calculations. This curve ball has been a central topic in past Hat Trick Letter issues. Maybe we should ignore the signal.

NEGATIVE REAL INTEREST RATES: Despite the rise in short-term rates to 2.5% on the Fed Funds target, price inflation across the economy is certainly greater than that level. The Fed admits they have yet to achieve the elusive neutrality. We have more rate hikes to endure. In my analysis, price inflation must include housing, energy, food, services, taxes, education, town services, insurance, and more. A more accurate measure of price inflation might be 6% to 8%, perhaps higher. Disregard the fraudulent USGovt statistics (says the statistician), as they are intended to be false. Our govt runs a protection racket with bonds. The actual real short-term interest rate, defined as the 3-month TBill yield minus price inflation, is more like minus 4%. Monetary inflation still actively pushes up prices. The challenge is to determine where, and how to measure it, certainly how to profit from it. Inflation in its basic form, money supply explosion, continues to rage. This presents a giant opportunity to profit from asset inflation or commodity inflation. Inflation remains a concept badly understood among the public. Great attempts are made to clarify how monetary expansion can work to depress finished product prices, when factories are over-built in Asian industrial expansion. Maybe we should ignore the signal.

CRB HITS 300, COPPER HIGH, CRUDE OVER 50: Nothing points to higher material costs better than the Commodity Research Bureau's CRB index. It does contain heavy weights for meats, cotton, coffee, and cocoa. For the first time in several years, the CRB broke above 300 last week. The copper price hit new historic highs at 150 also. Crude oil was forecasted by those incredibly consistent sell-side Wall Street analysts to go back under $40 per barrel. This led to laughter among my crew of trusted informed buddies. Crude bolted back above $50 in the last two weeks. China must disappear and the USA must enter a painful recession for crude oil to return to prices noted in days of yore. And yes, conservation inside the US Economy is non-existent. The US energy policy can be summarized simply as "SUV's, MacMansions & Iraq" sadly. Food prices have relaxed somewhat, an oasis in the materials desert (not dessert). Maybe we should ignore the signal.

INELASTIC OIL SUPPLY: This is not so complex as it sounds. As the crude oil price has risen, new supply has not come to market in response, a confirmation of being post-peak. Equipment at drill sites is old, and its costs are rising. Few second tier properties remain. This is unreported. Notable is the cutback by Exxon-Mobil and Chevron-Texaco in exploration budgets. Instead, they grant dividends to share holders and declare stock buybacks. They identify few large deposits as opportunities to discover. Saudi Arabia is almost assuredly in decline of oil production. Disregard their ministry words, look at their output which has not risen with higher prices. Australian output is in sharp decline. Labor strife seems unending in West Africa, the site of heavy potential production. The rising oil price has only encouraged bandits and laborers alike to demand a bigger cut. Supply will not increase with higher prices. Rather, battles will crop up over supplies, like in Iraq. The Russian Govt surely gave us a glimpse of the battle for oil properties. Look for Russian oil production to go into decline. Should the USGovt decree that Venezuela should benefit from greater freedom and democracy, then liberate? That would halt production. Maybe we should ignore the signal.

IRAN & BATTLE OVER CASPIAN SEA: This story is huge among true experts, among the energy professionals, among the cutting edge energy journals. Curiously, the US press & media fails to even report it. The confrontation between the USA and Russia is over Iran. The US news networks seem pre-occupied by stories of nuclear armament and equipment sales. The Caspian Sea contains estimated oil deposits which compare favorably to Saudi Arabia and Alberta. Disputes are argued. Pipelines are under construction. Leverage is applied. Most Americans are not even aware of the nation of Turkmenistan. They will be. They are not aware of its location. They will be. They probably think it is Turkey. It is not. Eyes are trained on Iraq, which diverts troublesome activity north of the Caspian Sea. Implications to energy prices, the role of OPEC's new competitive rival energy & commodity cartel, and the impact to the Petro-Dollar system are fully discussed in my March Hat Trick Letter issue. Americans remain clueless to what the Iran squabble is all about. Some think it is about democracy. They are asleep even after the tendered offer from China to acquire Unocal. It is generally safe never to assume Americans are interested in much more than a sixpack of beer, a dumb TV comedy, and maybe a toss before turning in. Our news networks have an embarrassingly easy job of keeping our population either in the dark or on a misdirected path. Maybe we should ignore the signal.

DURBAN DEEP MINE SHUTDOWNS: This one is a beautt!!! Way back in summer 2002, my father's college roommate from Dartmouth talked to me about his huge investment in South African gold miner stocks. It represented a hefty portion of his life savings. He was convinced of the gold bull market, and the distress on the USDollar horizon. He was shocked that my urgent message to him was to avoid all South African gold miners. He touted them as the world's largest gold producers. We both knew how one third of the entire above-ground gold supply in existence has been mined from the Union of South Africa. So he was puzzled. My view was that Western banks from 1999 to 2001 had preyed upon the SA rand currency. Deutschebank, Barclays, and JPMorgan were principle culprits. Their perceived strategy was to crush the rand in order to accelerate SA gold production, a sure response to lower SA domestic costs. It worked, as SA output soared. My expectation was for that to unwind, and SA mining costs to rise sharply. Adam Hamilton of Zeal LLC reported this in adept style. In addition, my view was that the Marxist movement would greatly interfere with costs or operations. Well, the SAGovt went much further and nationalized the gold industry. They forced a low-ball takeover price and high-ball license fees. Worse still, they forced through legislation community development, construction of housing, schools, road, and social centers. Costs rose and the profit picture for SA miners deteriorated. It was my worst case scenario, twice over. Last week Durban Deep announced mine shutdowns, insufficient cash for operations. They are not alone among SA miners under distress. Gold production is at risk. Higher prices are over the horizon. Maybe we should ignore the signal.

CHINA INFLATION BACKFIRE: The pipeline for systemic price inflation goes through China, who interferes with the easy process of generating price inflation, as we saw in the 1970 decade. The US Economy exports inflation with our trade deficits in an uneven exchange. When the inflation returns from Asia, it arrives as imported deflation. The US Economy is NOT a closed system. This concept is horribly misunderstood, and is discussed also in the March Hat Trick Letter issue. The USA continues blindly, with poor counsel, on a path of suspended financial animation, even as Asia slowly takes ownership of our land. We sell them assets which are debt securities, which renders them our credit masters. Maybe we should ignore the signal.

MERGERS & ACQUISITIONS: When big Wall Street firms pursue and acquire large companies, this means at least three things. Liquidity is brisk, to enable such large transactions, whether a stock swap or some debt secured. The currency of the acquiring stock is over-valued, which enables spending it to overpay in the first place. Few real growth opportunities present themselves of substance, inducing bad investments in takeovers. This is a paper phenomenon, not a business issue. Talk is replete with nonsense about synergy (unlikely), joint market share (so what?), and more. Without exception, the activity leads to enormous job layoffs, as administration costs are worked down. M&A usually means a market top in stocks, just like in 1999. M&A often give insiders a perfect open door to cash in stock options, as the public eagerly gobbled up overpriced shares in large volume. MCI with Qwest and Verizon, Federated with May, who cares? It gives CNBC something to discuss when we switch the channel in midday. How quickly we forget. Maybe we should ignore the signal.

HYPE OVER INTERNET STORY: The clear new darling is Google, which has a fine business model, strong ad revenue, and a great proprietary set of search engine tools. That much is sure. As for its valuation, a 120 PE ratio leads to a quizzical glaze. Claims that ex-lockup share sales (insider executive options) will broaden ownership and lead to share price stability smacks of public relations spin. Even if its revenues and earnings grow at 50-70%, this stock is selling for twice its value in my book. EBay is down 30% from its highs. Amazon is down 35% from its highs. Yahoo is down 15% from its highs. My gut says we are looking at expensive ice tea stands with short barriers to entry for competitors, just like in 1999. Maybe we should ignore the signal.

HIGH BULL RATIO AMONG INVESTMENT ADVISORS: The exact figure eludes me, but it was over 70% recently for some extended time period. The consensus is clearly bullish after a two-year bull market in stocks since the fall of Baghdad. The next shock & awe might be the lousy investment returns when the majority is so bullish. The weather vane measure among professional has been a highly reliable contrary indicator for many years. Sentiment was very high in 1999 also, but this time is different. Maybe we should ignore the signal.

VIOLENCE CONTINUES INSIDE IRAQ: In Greek Mythology, Tantalus was offered some luscious fruit from a tree. Every time he moved toward it for a bite, it was withdrawn from his grasp. The violence in Iraq is reminiscent of Tantalus. The cost of the Iraqi War has become a massive drain on the federal budget, placed conveniently off-budget so as to minimize the deficit itself. See the next paragraph. Violence was supposed to be lessened after the cities were secured. Violence was supposed to be lessened after electricity, fuel, and food supplies were restored. Violence was supposed to be lessened after jobs for reconstruction were created. Violence was supposed to be lessened after the elections ensured power to be in Iraqi hands. Violence was supposed to be lessened after their energy industry restored production and returned wealth to Iraqis. Call me crazy, but heavy crippling costs in my view are sure to continue, and troop withdrawals (if they occur) will be temporary. In Hillah, a massive bomb was detonated, leaving 125 dead. The French journalist Aubenas was abducted, and remains held captive. The Kurdish pipeline explosion interrupted northern supply lines. US federal costs are a certain drain, even as crude oil supply is anything but certain. The question people should ask is whether civil war brews quietly. Maybe we should ignore the signal.

FALSE SIGNALS ON USGOVT BILLBOARDS: My considered sustained analysis has that almost every single USGovt statistic is a lie, an intentional deception. Orwellian Stat Lab methods include hedonic adjustments for quality improvements, deletions in Q3 under political motives and for reasons pertaining to cost of living adjustments, distortive seasonal adjustments, omissions in inflation indexes, and chain weighting. Advanced deceptive techniques have contributed to ruin each and every statistic disseminated like sheer propaganda from the USGovt. Let me repeat. Most major economic statistics are lies, and thus serve as false signals. They appear on grand billboards as pernicious advertisements. Maybe we should accept these signals, since foreign bond buyers and domestic investors are supposed do. My opinion is that official statistics should be slapped with fines for human indecency, and insult to intelligence.

 

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website http://www.goldenjackass.com that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

Jim's career continues to make waves in the financial editorial world, free from the limitations of economic credentials.

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Pure gold is so soft that a strong man can squeeze it and shape it.
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