Best & Worst

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

By most measures, 2008 will go down as one of the toughest years in market history. Major US indexes down 30% or more. Many overseas bourses down much more. Defaults, bankruptcies, forced liquidations. There were few places to hide.

As such, I feel fortunate to have made it thru this difficult year pretty much in one piece. What worked and what didn't?

Gold. For years we wondered how gold would fare in a deflationary scenario. We found out. Gold weathered this year's deflationary storm well, and actually closed about 5% higher on the year. I also managed to 'trade around' my gold position, as I let a significant chunk fly during the spike to $1000 in the spring. Better lucky than smart...

Cash. Hard to beat this asset class during a deflationary period. My cash positions have ranged from 40-70% over the past couple of years. Cash helped cushion the fall when the markets broke late summer.

Pharma. I began to perceive value in select pharma stocks such as Merck (MRK) and Pfizer (PFE) in late 2007/early 2008. Because of their undervalued condition and high dividend yields, I felt that these names had a good chance of swimming against a deflationary tide. I was wrong. While pharma did go down less than the general market, you can't spend relative performance.

Energy. Historically, my timing has been lousy in this sector and this year was no exception. I began buying oil, nat gas, and select energy stocks after they pulled back 15-20% from their highs in mid/late summer. Little did I sense that the sell off was only beginning. So, here I am once again lugging an underwater energy position into year end.

In summary, I anticipated the deflationary scenario pretty well by carrying high cash positions and paring back some gold near its highs for the year. But I wasn't totally in synch with my own forecast, as I took on risky positions in pharma and energy that went down with the rest during the Fall forced liquidation period.

My hope is that I'll be able to effectively apply lessons learned this year towards what is shaping up to be an equally, or perhaps even more, challenging market environment in 2009.

positions in gold, oil, nat gas, MRK, PFE

End of the Innocence

Who knows how long this will last
Now we've come so far, so fast
But, somewhere back there in the dust
That same small town in each of us
--Don Henley

Pep's must read missive today on social mood included mention of a Bloomberg profile of NewPage's shutdown of the Kimberly, Wisconsin mill. Judging by Xmas card notes from my Wisconsin friends at other NewPage facilities, there's plenty of concern that other mills closer to the original central Wisconsin operations of the old Consolidated Papers, Inc. are next in line.

Editor's note: The Kimberly facility was aquired by CPI not long before CPI was gobbled by Stora Enso (STEAV) in 2001, which later sold all CPI assets to NewPage in 2007. Follow?

When I left in 1995, never in my wildest dreams did I suspect that this bedrock employer would someday become a microcosm of our building socioeconomic strife and unrest.

It's easy to chalk up what's happening now to global competition, and to cushy union contracts that reduced adaptive capacity of local workers. There's some of that to be sure.

But I can't help but wonder about the role of easy money and credit in dismantling a first string industrial competitor. Let's follow the bouncing check:

Late 1980s/early 1990s. CPI borrows to fund internal expansion for the first time in company history.

1990s. More CPI borrowing continues to fund several external acquisitions. Globally, capacity grows as competitors enter the industry on the back of cheap borrowed capital.

2000. Awash in supply, the paper industry turns down while CPI saddles record debt.

2001. Finland based Stora Enso borrows huge to buy CPI. Deal is worth about $5 billion in equity and assumed debt.

2002-2007. More borrowing by Stora to upgrade some paper machine lines. Older machines shut down. Multiple RIFs (reduction in force) shreds local workforce.

End 2007. Drowning in debt and soft global markets, Stora sells coated paper assets (i.e., 'CPI' assets) to NewPage for about $2.5 billion (Stora eats a 50% loss on their trade). NewPage funds the buyout with, yep, more debt.

2008. NewPage and parent Cerberus struggling under soft market conditions and debt load. Kimberly mill shuttered.

Where would this situation be today if central banks around the world were not creating $trillions in cheap credit over the past two decades?

Much different, me thinks.

no positions

Energy Bar

Here come the world
With the look in its eye
Future uncertain but certainly slight
--INXS

The energy complex has taken it on the chin during this period of forced liquidation. Filled up my car this weekend for ~$20, less than half of July's cost.

This won't last. Sure, energy demand has decreased with the slowing global economy. But supply is contracting also as present and planned capacity is being wiped off the boards. As such, the long term fundamentals for oil and natty gas are improving.

Paraphrasing Jim Rogers, I'm having a hard time seeing how the price of oil isn't appreciably higher 5-10 yrs from now.

A number of oil companies are leasing tankers and taking delivery of physical crude at these prices. Wish I could do the same.

Alas, I'll have to settle for 'paper' rather than 'wet' barrels. Have been adding to my energy ETFs at current price levels.

positions in oil, natural gas

Hard Nocks

Meet the new boss
Same as the old boss
--The Who

Albert Nock was a social commentator of the early 20th century who abhorred collectivism and distrusted government. I recently completed his 1935 essay Our Enemy, The State. The book is available online and can be read in a few hours. Be sure to absorb the end notes as you go--they add considerable context.

Nock makes a number of salient points that I want to note here for purposes of future reference.
-->There is a difference between government and the State. Government focuses solely on securing an individual's natural rights (life, capacity, property) and goes no further. The State presumes that individuals have no rights except those granted by the State, and holds itself above justice whenever it is advantageous to do so. The State's scope far exceeds the scope of government.

-->When the State takes over social welfare programs, it creates an aura of monopoly. As such, individuals become less disposed to help the poor on their own. After all, the State has it covered, right? (this is the first reference to this idea that I have found--one that's been on my mind for a while)

-->Individuals give up their liberty when they identify with the State. i.e., If the State is doing wrong, then I'm doing wrong. Because I don't want to do wrong, then the State can't be wrong.

-->There are two methods for satisfying needs and desires: 1) production and exchange of wealth (economic means) 2) uncompensated appropriation of wealth produced by others (political means). The political means tends to be preferred because it requires less exertion.

-->Every essential element long afterward found in the American State can be traced to the chartered corporations and mother countries that bankrolled early American settlements. In other words, our political system is more consistent with, than different from, the systems we purportedly 'ran away from' when founding this country.

-->Historical review suggests that the US is grounded in the 'merchant state' rather than in government grounded in natural rights and popular sovereignty.

-->Building on the work of Beard (1913), through an economic lens the Constitution can be viewed as a triumph of the minority speculators/merchants/creditors over the majority farmers/artisans/debtors.

-->Free markets cannot co-exist with the State. (nice claim which when you think about it seem painfully obvious)

References

Beard, C.A. 1913. An economic interpretation of the Constitution of the United States. New York: The Free Press.

Nock, A.J. 1935. Our enemy, the State. New York: William Morrow & Company.

Pennant Race

Sometimes you picture me
I'm walking too far ahead
You're calling to me, I can't hear
What you've said
--Cyndi Lauper

After the volatile action we've witnessed over the past couple months, many traders have likely viewed the market's mellow meander over the last couple sessions as a welcome holiday gift.


The technical picture indicates that we've been consolidating for a few weeks. The flag, or pennant, pattern evident in many indexes such as the S&P 500 (SPX) will be resolved soon.

How prices break (up or down) should offer an idea for where the tape's headed in the near term.

no positions

Shout It Out

In violent times
You shouldn't have to sell your soul
In black and white
They really really ought to know
--Tears for Fears

In a Buzz post this morning, Mr P leveraged a fine essay by another smart cookie, Walter Williams of George Mason University.

I'm going to quote his entire 9:35 am post here. Re-read until you master the thought behind it. If you do, you'll grasp a root cause of our current problems.

Socialism

The following is from an editorial written by Walter Williams of George Mason University:

"Knowing the dangers posed by central banks, we might ask whether our country needs the Federal Reserve Bank. Whenever I am told that we need this or we need that government program, I always ask what we did before. It turns out that we did without a central bank from 1836, when President Andrew Jackson closed the Second Bank of the United States, to 1913, when the Federal Reserve Act was written. During that interval, we prospered and became one of the world's major economic powers.

The justifications for the Federal Reserve Act of 1913 were to prevent bank failure and maintain price stability. Simple before-and-after analysis demonstrates that the Federal Reserve Bank has been a failure. In the century before the Federal Reserve Act, wholesale prices fell by 6 percent (prices normally fall as production increases); in the century after they rose by 1,300 percent. Maximum bank failures in one year before 1913 were 496 and afterward 4,400. During the 1930s, inept money supply management by the Federal Reserve Bank was partially responsible for both the depth and duration of the Great Depression.

It is not wise for us to permit a few people on the Federal Reserve Board to have life and death power over our economy. My recommendation for reducing some of that power is to repeal legal tender laws and eliminate all taxes on gold, silver, and platinum transactions. That way there would be money substitutes and the government money monopoly would be reduced and hence the ability to tax--some people would say steal--from us through inflation.

I could not have said anything better myself, and of course agree. Mr Williams' last statement I have referred to before. By devaluing a currency over long periods of time (which every central bank does), a nation effectively makes the rich more wealthy and the middle class and poor less. This occurs because the rich own assets that rise in price and therefore hold their value relative to money while income is devalued. A middle class wage earner makes less each year without even knowing it.

Of course, government is coming to our rescue with bailout after bailout; it makes their power grow. The Federal Reserve, by driving real interest rates to negative levels for years knowingly provided the fuel to create a massive real estate bubble, is itself the greatest socialist institution ever created. Companies that are too big to fail by definition illustrate socialism.

The U.S. is rapidly becoming socialist where government will become a larger and larger part of the economy and our lives and make more and more poorly thought out decisions. This will over time decrease productivity and profits.

Risk is high, but only the government knows how high.

positions in gold and silver

Greenback Mountain

Nothing is planned
By the sea and the sand
--The Who

A primary focus in 2008 was to increase liquidity by building cash reserves. I was pretty fortunate along these lines, with current accounts now sporting better than one year's worth of expenses.

I was planning to continue accumulating cash over the next couple of years. However, the massive amount of government-sponsored stimulus that has been, and will be, injected in world economies has me rethinking just how aggressive my cash build should be. The huge pending increase in dollar supply conjures visions of 1920s Weimar Germany citizens chucking piles of worthless marks into the furnace for heating purposes.

Jim Rogers commonly refers to the dollar a 'flawed currency'--which may be a rare understatement for him. (Of course, he's also referred to the situation as an 'inflationary nightmare' and 'inflationary holocaust.' He's in the process of unloading his remaining dollars in favor of commodities. He knows that to preserve wealth and purchasing power in an inflationary environment, you want to trade worthless paper for tangible assets.

So, I'm thinking of scaling back my cash build in 2009. If I go this direction, incremental funds will be applied towards my mortgage paydown project (real estate is a hard asset) or towards acquiring more gold--particularly at sub $1000 bullion.

position in gold

Calling Goose Island

A strange game. The only winning move is not to play. How about a nice game of chess?
--Joshua (WarGames)

In my view, Tuesday's FOMC statement was a watershed event. The Fed essentially said it will print money into oblivion in order to pull the economy out of the ravine.

Of course, we knew this all along. But the pointedness of the Tuesday language signals that the Fed is ready and willing to engage in global thermonuclear war against deflation.

Mr P captures the gist better than I:

"Yesterday was a sad day indeed. The Federal Reserve said it will 'print as much money as necessary to revitalize growth.' As I've pointed out, this won't revitalize growth, as it creates nothing but more dollars. What they're really saying is 'We will borrow as much as necessary from your children's standard of living to keep things going today.'"

One more time, the Fed is saying that we will borrow as much as necessary from your children's standard of living to keep things going today.

Visualize looking your kids in the eye and saying, "Someday you'll thank us for this."

Sadly, chances seem better that our kids will someday be looking us in the eye and asking, "How could you have done this to us?"

Gold sure seems an appropriate insurance policy against the WOPR.

position in gold

Cuts Like a Knife

This wouldn't be the first time
Things have gone astray
Now you've thrown it all away
--Bryan Adams

We achieved resolution in last week's head and shoulders pattern in the US Dollar, as the Dollar Index knifed thru 84.5 earlier this week.

Today, the Fed cut the fed funds rate from 1% to an unprecedented .25%. To calm fears that the Fed is running out of ammo as it approaches the famed 'zero bound,' the third from bottom paragraph in today's FOMC statement essentially stated that the Fed is willing to print money to buy all kinds of financial assets.

The USD was eviscerated on the news. In an email to Fleck, Jim Grant suggested that the above mentioned paragraph should have been labeled "Gold 36,000."

Indeed.

I've been a buyer of gold and oil at these levels.

positions in gold, oil

The Loopholes of Section 8

I got something now to think about
I'll work all day but not to pay it out
Keep on working
Keep on working
--Pete Townshend

If one reads the Constitution of the United States, it's difficult to conclude that this document is the perfect government framework promoted in social studies classrooms and by some policy wonks. Instead, it reads like a document of compromise, and one geared towards consolidating power towards a central authority. Moreover, the document seems structured in a fashion that virtually guaranteed expansion of the State over time.

Parenthetically, a similar view appears to have been held by many, if not the majority, of American citizens at the time of the Constitution's creation and ratification in the 1787-1789 period (see for example, Cornell 1999; Storing 1981).

No portion of the Constitution reflects the expansionist tone better than Article 1, Section 8. This section, which specifies the powers of Congress, includes a number of open ended clauses which over the years have served as 'loopholes' for the US government to justify more power and authority over the people. Three clauses stick out in particular:

General Welfare clause. "The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare [emphasis mine] of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States." New Deal and other social programs have been justified by evoking the General Welfare clause.

Commerce clause. "To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes." From this clause sprang myriad government regulatory bodies and commissions that rendered US markets 'unfree' soon after the Constitution's ratification.

Necessary And Proper clause. "To make all laws which shall be necessary and proper [emphasis mine] for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof." This is the final clause of Section 8, and reads like a catch-all for anything that Congress might do that is not specified elsewhere in the document. The open-ended nature of this clause has made it a favorite citation of bureaucrats when justifying increases in government scope.

Early Federalists, such as Alexander Hamilton, understood the utility of these loopholes in promoting Statist agendas.

There are those who claim that government size has grown because we have strayed away from the Constitution as written. I submit that the opposite may be true--that largely by following the Constitution and exploiting its specified loopholes, we were bound to assemble the governmental Leviathan that we currently face.

References

Cornell, S. 1999. The other founders. Chapel Hill, NC: University of North Carolina Press.

Storing, H.J. (1981). What the Anti-Federalists were for. Chicago: University of Chicago Press.

Handout Hill

"You hear that, Mr Anderson? That is the sound of inevitability."
--Agent Smith (The Matrix)

The policy maker endgame involving the saga that is the auto bailout seems little in doubt. For bureaucrats linked to the union lobby, bankruptcy of Ford (F), General Motors (GM), or Chrysler is politically unacceptable. Bankruptcy laws provides more authority for revising previous labor agreements--something the UAW desperately wants to avoid.

It's easy to connect the dots.

Why is President Bush picking up the bailout baton? While he may not be connected to the union lobby, he is thinking about his legacy. He's willing to place these companies on life support so that they don't die during his watch. Let their ultimate demise be the next guy's problem.

The old Potomac Two Step.

no positions

The Real Deal

Take that look of worry
I'm an ordinary man
They don't tell me nothing
So I find out all I can
--Phil Collins

Anyone seeking to wrap their heads around current economic and market problems is well advised to study the Great Depression. The parallels are interesting. To obtain a solid grasp of the context, one should bracket study around the early 1910s (founding of the Fed and WWI) to mid 1940s (WWII) period of US and world history.

If you're seeking fresh insight unshackled from revisionist history, I recommend accounts of Anderson (1949) and Rothbard (1963). Both provide outstanding perspective as viewed thru the eyes of expert economists with excellent command of the period.

More recently, I've been sampling the writings of a group of 'social commentators' of the times. Folks like Albert Nock, Isabel Paterson, and Henry Hazlett offered perspective thru the lens of journalists rather than trained economists. I've found their views to add considerable color to Depressionary history.

You'll most certainly learn things never taught in typical social studies or history classes.

Currently, I'm chewing thru work of Garet Garrett. Garrett was a writer for the Saturday Evening Post from the 1920s to 1940s. Unlike much of the mainstream media at the time, he opposed America's involvement in both world wars. He also wrote lucidly about the causes of the Crash of 1929 and about New Deal policies (to which he was largely opposed).

I just completed Garrett's 1932 book, The Bubble That Broke the World. Garrett particularly focuses on the role of post WWI debt financing in blowing the 1920s bubble and its subsequent poppage. The 2nd essay, which is truly must reading, entitled "Anatomy of the Bubble" deftly describes public works spending (the 'pyramid' metaphor is brilliant), ins and outs of banking operations and leverage, and the herd mentalities that precipitate finanical booms and busts.

Like many works from this period, it could have been written yesterday.

References

Anderson, B.M. 1949. Economics and the public welfare. New York: D Van Nostrand Co.

Garrett, G. 1932. The bubble that broke the world. Boston: Little, Brown, & Company.

Rothbard, M.N. 1963. America's Great Depression. Princeton, NJ: D Van Nostrand Co.

Peak Performance

Spent the last year
Rocky Mountain way
Couldn't get much higher
--Joe Walsh

Possible dandruff pattern setting up in the USD.

Watch USD 84.5ish for confirmation.

position in USD

Rhyme and Reason

I been laid off from work my rent is due
My kids all need brand new shoes
So I went to the bank to see what they could do
They said son looks like bad luck got a hold on you
--Simply Red

It's hard not to draw parallels between 1932 and today. A massive credit bust that followed a 'crackup boom.' Prices of nearly all risky asset classes cut in half (or more) from their highs. Unemployment ripping higher. Lack of cash. Bankruptcies and defaults. An unpopular outgoing Republican president who initiated huge bailout programs to try to stem the tide. An incoming Democratic president hailed as 'the one' to lead us out of the muck with the promise of stepping up his predecessor's stimulus to new heights.

With a New New Deal pending, folks would be well advised to brush up on economics and politics during the Great Depression.

Those that do will hear history's rhyme. And perhaps heed history's warning to position away from the pain that almost certainly awaits.

no positions

Warfare & Welfare

You fell and cried as our people were starving
Now you know that we blame you.
You tried to walk on the trail we were carving
Now you know that we framed you
--The Who

Opponents of the current war with Iraq often argue that the conflict is unjust on the grounds that it violates individual liberties. Such an arguement is correct and applies to all wars. Wars violate the freedom due all individuals.

Somewhat paradoxically, many of those who oppose military conflicts tend to condone government programs aimed at improving ‘social welfare.’ Those in favor of such ‘progressive’ social programs fail to acknowledge that the same liberties they passionately seek to preserve by abolishing military conflict are compromised when pursuing government sponsored welfare initiatives.

Compare, for example, the infringement of liberty during wartime versus the loss of freedom imposed by one of the more entrenched social programs here in the United States, the Social Security program. Parenthetically, it is instructive, and somewhat ironic, that the word ‘security’ appears in the title of this social program. Are not most military programs promoted under the ruse of ‘national security?’

Many object to the Iraqi war because it has decreased individual rights to privacy. Programs such as the Patriot Act have increased state capacity for monitoring individual activity. Profiling techniques to rapidly detect potential threats have compromised freedoms of individuals of particular race or religion. People deemed as potential threats have been quarantined in prison and detainment zones. None of these approaches are peculiar to the present Iraq war, of course. During WWII, the US government imposed curfews, monitored the activities of people of particular ethnic descent, and operated concentration camps such as Manzanar.

The Social Security program has violated privacy in similar fashion. Individual social security numbers were spawned by this program, permitting pervasive government monitoring of individual activities. Profiling is commonplace—both in terms of those deemed to qualify for state assistance, and those who must pay into the system to support others. Detainment comes in the form of slums or prison.

Privacy is a subset of the general category of property rights. The tab for the Iraqi war is currently about $1 trillion. US citizens foot this bill, either through higher taxes, increased debt, or a depreciated dollar. Particular industries, such as those in transportation sectors, have lost some freedom of operation. Once again, none of this is new. Resources necessary to fight wars must be funded; fiscal burdens on citizenry must be imposed. The state often assumes control of industries during conflict, as the US government did with the domestic railroad industry during WWI.

The Social Security program has similarly driven confiscation of property. The Social Security tax is, of course, direct evidence of this. However, similar to the fiscal drag imposed by supporting a standing army during peacetime, the persistence and escalation of the Social Security program has driven government to spend more on this program than incoming receipts. Higher tax rates, more debt, and further dollar devaluation have been, and will continue to be, the consequences.

Liberty is also lost through increased dependence on government. If people come to depend on a standing national army for security, then they typically become less capable of defending themselves. Moreover, they must surrender a perpetual stream of property in order to fund the protection agency. Similarly, a significant citizenry has become dependent on Social Security benefits, to the point where they may have trouble existing without this resource stream. To fund this dependence, an ever increasing quantity of resources must be channeled away from private ownership towards government agency. Dependence on either the warfare or welfare state reduces freedom.

When it comes to loss of liberty, warfare and welfare are two sides of the same coin. If individuals oppose freedom lost from one but not the other, then this hypocrisy suggests either ignorance or political bias.

no positions

Mother Goose

"Son, your ego's writing checks your body can't cash."
--Commander Tom 'Stinger' Jordan (Top Gun)

Over the past few months we've heard a litany of complaints about economic decisions made by government officials and regulators. Here are a few I ran across just yesterday.

"OFHEO regulators were lax in their oversight of Fannie Mae (FNM) and Freddie Mac (FRE)."

"Paulson mistakenly let Lehman fail."

"Central banks around the world are not moving quickly enough to unfreeze global credit markets."

"Greenspan kept interest rates too low for too long and precipitated the housing market bubble."
"Bernanke hasn't lowered rates enough and is exacerbating the housing market decline."

Such complaints are as old as our choice to let bureaucrats govern economic decisions rather than letting market participants police themselves. Lacking the incentive and information of the market context, bureaucrats will consistently make erroneous economic decisions. Moreover, central planners will be slow to recognize their errors and to revise their decisions.

In the wake of bureaucratic errors strewn over decades, one would think we'd realize the folly of this approach and hand control back to market mechanisms. Instead, we seek more state control--or control from a different set of bureaucrats (e.g., "Our central planners are better than theirs.")

This is the mother of all wild goose chases.

no positions

Safety Dance

We can go where we want to
To a place they will never find
And we can act like we come from out of this world
Leave the real one far behind
--Men Without Hats

For me, an important measure of risk aversion continues to be yield on short term T-bills. T-bill yields remain next to nothing. Although extremely reduced appetite for risk was certainly predictable years back, actually seeing it in motion is quite amazing.

That said, as government intervention continues to pour $ trillions of stimulus into economies and markets worldwide, I'm keeping a closer eye on T bill yields for a potential reversal.

If short rates begin to scream higher, this should be bullish for stocks in the near term and, I would think, VERY bullish for gold.

position in gold