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Taylor on us Economy, Markets & Gold

April 1, 2002

As a whole, stocks remain enormously overvalued. Thanks to Decision Point ( we know the latest GAAP S&P 500 earnings yield is a measly 2.24%. Of that yield, 1.38% is paid out in dividends which means that these companies are retaining only $0.86 for every $100 invested in these stocks. So if you buy the S&P 500 Index, you will put $1.38 in your pre-tax pocket for every $100 you invest. How much of the $0.86 that is retained is hypothetical since even GAAP accounting is in large part based on theoretical concepts.

By contrast you can buy a 10-year Treasury and get paid $5.41 for every $100 you invest. Moreover, this income is exempt from local taxes. So why do stocks remain so popular? Because people remain convinced - thanks to the ongoing hype and spin on CNBC that there will always be a bigger fool who will pay a higher price for stocks purchased today. And since over the past 20 years that has been true a great deal of the time, it is hard for investors to relate to the historical fact that so much of the time over the past 100 years, that has not been true. If investors want to know the truth rather than engage in pure fantasy, the truth is there to be had. People frequently interviewed in our newsletter like David Tice, Ian Gordon, Dr. Ravi Batra, over the past three years. And in April, we will be featuring our interview with Jim Rogers who has been saying get out of stocks and into raw materials.

The outrageously low earnings yield of 2.25% suggests investors remain highly confident that the U.S. economy and hence that stock prices will regain their upward momentum. Otherwise they would be buying Treasuries that yield more than 5% in cash with favorable tax treatment. But when you look at the fundamentals of our economy and the global markets there is real reason for concern. Consider some of the following points.

  • The U.S. Trade deficit grew unexpectedly in January to $28.5 billion, up from $24.7 billion in January. The trade deficit on physical goods grew to $34.1 billion, from $31 billion in December. How long can this red ink flow without it negatively impacting the dollar? The reason for the January expansion was an apparent "economic recovery" in the U.S., or at least a willingness on a part of Americans to spend more borrowed money. This is troublesome not only because you cannot live beyond your means forever, but also because the U.S. is no longer able to produce the basic essentials for the survival of a strong nation.
  • Trade deficits are financed by recycling them into U.S. investments. But with U.S. investments so overpriced and with demand pricing power continuing to decline, how much longer can this go on? Greenspan himself is worried about these deficits and the hemorrhaging of interest payments back to the owners of capital that is being sent to the U.S. In his March 13th address to the Independent Community Bankers of America conference in Honolulu on March 13th, here is what Alan Greenspan had to say. "During the past six years, about 40% of the total increase in our capital stock in effect has been financed, on net, by saving from abroad. This situation is reflected in our ongoing current account deficit, which, by definition, is a measure of our net investment in domestic plant and equipment financed with foreign funds, both debt and equity. But this deficit is also a measure of the increase in the level of net claims, primarily debt claims, that foreigners have on our assets. As the stock of such claims grow, an ever-larger flow of interest payments must be provided to the foreign suppliers of this capital. Countries that have gone down this path invariably have run into trouble, and so would we."
  • The Securities & Exchange Commission is still protecting the U.S. Housing Bubble by allowing Fannie Mae and Freddie Mac to avoid file insider transactions, file audited financial statements and register their securities with the SEC. This is allowing these organizations to expand the leverage on their balance sheet and God knows what else that allows the housing mania to continue. Sooner or later this will result in another destabilizing implosion.
  • The IMF warns that setback against the fight against terrorists could set back the U.S. economy. It should be obvious by now that the war against terrorism is not going as well as first depicted in our press. Moreover, tensions are mounting in the middle-east to the point where more and more talk of nuclear war is being discussed. As it becomes obvious to the markets that the U.S. deficit is beginning plunge back into a sea of red ink in order to pay for an ever expanding war, what will that do to an already overvalued stock market? I think it is interesting to note that the U.S. Federal deficit grew to $204 billion since last September. If George W. keeps it up, he might oversee a larger deficit than his father who ran some of the largest deficits in our history!
  • State budgets are collapsing due to plunging tax receipts. If the economy is rebounding, why are tax receipts still in decline? If local and federal tax receipts continue in decline, that is a sure way to know all this talk of a rising economy is pure baloney. Remember the government always gets its money!
  • The U.S. production of real things continues to decline as evidenced in the trade numbers. But what you don't see talked about much in the press is GM's plans to cut $3.4 billion in spending this year. GM told securities analysts that it will cut $2 billion from its North American material cots; $1.3 billing from its manufacturing, engineering, and health-cares budgets; and $1 billion from capital spending. Obviously cuts in a basic industry like this will put downward pressure in other related industries such as machine tools, steel, etc.

In general the living standards of Americans are getting squeezed. And as Dr. Ravi Batra told us when we interviewed him, as that happens, people tend to borrow more and more until eventually a threshold of lethality is reached at which time the economy collapses and debt repudiation and an economic depression get underway. The consumer has never really let up in his spending patterns except for a brief period immediately following 9/11. With 2/3 to ¾ of the American economy depending on the consumer and with the consumer already running full speed, that leaves recovery up to capital spending because it is hard to perceive additional demand coming from consumers. And yet, what CEO in his right mind is going to undertake huge capital projects when profit margins are being squeezed thanks to global oversupplies, an overvalued U.S. dollar and cheap manufactured goods form China and elsewhere.

Could We be on the Verge of a Raw Materials Bull Market?

While we are holding on to the idea that Ian Gordon's Kondratieff Winter model is on track, we also think Jim Rogers may be right in his bullish posture toward raw materials. We interviewed Jim on Wednesday March 27th. He is convinced the Rogers International Raw Materials Fund, which you can get into for as little at $10,000 is going to benefit from a major bull market in commodities. Three major reasons: 1) For twenty to twenty five years, there has been very little expansion in capacity for almost all raw materials. At the same time the stock piles have been drawn down. 2) The U.S. and governments everywhere are printing money like mad. This he argues will have to result in increased demand for raw materials. (This is one area we and Ian Gordon might dispute). 3) War. Jim points out that wars are always bullish for raw materials.

Could Ian Gordon and Jim Rogers both be right? We think so. But in any event, be sure to read our interview with Jim. As always he has some honest and unique views on the world. He is right more often than not. It is very much worth at least considering his ideas seriously.

What I believe is likely though is that repeated attempts to inflate our way out of another Depression will continue to prolong the time required to fix the problem. It is my sincere belief that we are about to discover what Japan has been discovering, namely that there is no way out of a deflationary spiral than to let the markets do their work. Any attempt to override the natural forces of markets by printing money, rigging stock or gold prices will only prolong the agony and delay the recovery. This should be no great new discovery for Americans who were brought up with free market indoctrination. Yet even Milton Friedman now seems to be selling out to this line of thinking. Apparently he is not willing to face the reality of what is about to hit us. Apparently Dr. Friedman cannot stomach the thought that the Austrians were right when they maintained that it is impossible to limit money supply growth to 2% or 3% without the discipline of gold. Going "Cold Turkey" is the only way to recover. Yet our economy.

Accordingly we continue to stay put with our current Model Portfolio, though we are entertaining the idea of finding some room to make an allocation to the Rogers International Raw Materials Fund, which we will tell you more about in our April issue.


Jim Rogers on Gold & Raw Materials.

Jim Rogers has some very outspoken ideas about gold. He is bullish on gold, but at this stage at least he is not as bullish on gold as he is commodities in general. His fund has a 3% weighting in gold bullion. We think his relative lack of enthusiasm for gold is in part because he doesn't understand the extent to which the bullion banks have already dishorded the yellow metal to keep the price down. We think he isn't yet aware of the enormous short position the gold bullion banks are about to face, thank to the endless gold carry trade they were encouraged to engage in. Getting money at ½% with a guarantee from Mr. Greenspan that "Central Banks will continue to lease out increasing amounts of gold should the price begin to rise," was too good to pass up. It was a heck of a party as long as it lasted. By my oh my. What a hangover these fellows are about to experience!

Never subjected to the emasculation of his God given talent by an increasingly intrusive corporate fascism that threatens to destroy us all, as a regular on CNBC, I recall Jim providing high quality information to investors unequaled by few others on the tube. Thank God people like Jim Rogers still exist in America. He is not only a financial genius, but he is willing to share his insights with others. In my view, that makes him a national treasure. As editor of this newsletter, I am grateful and humbled that this Wall Street giant was willing to share his views with the readers of J Taylor's Gold & Technology Stocks by way of the following interview, conducted on March 24, 2002.

Another Good Week - Gold Continues to Look Bullish

Gold had another good week last week. It closed in New York at $303.20. The yellow metal is continuing to look very bullish. At the end of this past week, its 50-day moving average was $292.39 and its 200 day-moving average was $280.54.

Two facts come to mind that I found very encouraging at the end of this past week. First, the percentage of days in which gold finishes lower in New York at the close of business is far less than in the past when gold finished lower more than 90% of the time. Secondly, attempts now by the Germans to scare people away from the gold markets does not seem to be nearly as effective as prior attempts by Britain, Switzerland and a host of other countries.

What is clear is that that demand for gold is rising around the world. In Japan, investors have been buying gold like mad. They see gold as a safe store value - a place where they can transfer their wealth out of paper currencies that may evaporate into thin air as their accounts are no longer insured. But with events heating up to very high temperatures in the Middle East, apparently a great deal of gold is now being purchased from those countries and also reports are that China is continuing its buying spree. Add to that factor a stock market that at best is heading sideways for a long time to come and at worst will plunge to much lower levels, and a dollar that is extremely overvalued and you have the ingredients for a massive new bull market in gold as people transfer money out of dollars into gold.

Interestingly, Dow Jones reported last week that the Malaysian Prime Minister Mahathir Mohamad proposed making the Gold Dinar a common currency for trading among Islamic countries to reduce dependence on the U.S. dollar. The prime minister would use gold for international trade only and would not propose to use it as a national currency.

The Dinar, an Islamic currency used in the Middle East since the beginning of Islam, is tied to the value of gold in the open market. By using the gold Dinar for trade settlement, the cost of doing business will be reduced as the need to hedge is minimized according to the Malaysian Prime Minister.

Interestingly, the report stated that the Malaysian Finance minister drew up plans for an electronic payment system that uses a common currency for trade among Islamic countries. The would presumably use the Gold Dinar as their unit of currency in this plan. Presumably, this system would be at least somewhat similar to GoldMoney which was invented and patented by James Turk.

But the important thing to note is that these Muslim countries in the Organization of the Islamic Conference, which number fifty-seven, are thinking along these lines so that they do not need to rely on U.S. dollars. One would think as tensions heighten between the U.S. and Muslim countries and as the U.S. continues to police money movements, this kind of system may be seen as a way of getting around U.S. restrictions and to hide their plans for commerce and perhaps mischief as well.

The first use of gold as money occurred around 700 B.C., when Lydian merchants (western Turkey) produced the first coins
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