 | | The Daily Reckoning | Wednesday, September 21, 2011 |
- The ESRB "calls all authorities"; gold stocks react accordingly...
- 3 reasons gold stocks are performing differently in 2011...
- Plus, Bill Bonner on the law of marginal utility, real "change" and drowning the rich...
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|  | | | | No Laughing Matter | | European Banks Stress Tests and Other Bad Jokes | | |  | | Eric Fry | Reporting from Laguna Beach, California...
We like a good joke. Here’s a cute one:
What’s invisible and smells like carrots?
Answer: Bunny farts. Here’s another one...
Two fish swim into a wall. The one turns to the other and says, “Dam!” But we don’t like bad jokes very much. Here’s one:
What did the fisherman say to the card magician?
Answer: Pick a cod, any cod! Here’s another one...
Many large European banks are solvent. The recent stress tests of European banks were “a joke,” according to Jim Chanos, the famous short seller who laughed all the way to the bank when betting against fatally flawed companies like Enron, Conseco and Boston Chicken.
“The [stress] tests are a joke,” Chanos declared during an interview yesterday on Bloomberg TV. “The accounting is a joke and the markets are beginning to say, ‘No More!’” Chanos said he would be short these banks right now if European regulators had not outlawed the practice last month.
The stress test “joke” is only one small sliver of the European game of make-believe. Central bankers and politicians throughout Europe are continuing to pretend that various insolvent banks and insolvent governments are in fine shape...as long as they get a little bit of help form the ECB.
But the financial markets are providing ample evidence to the contrary. The share prices of many European banks are plummeting, while the yields of many European government bonds are skyrocketing. The now-infamous Greek two-year government bond yields a whopping 134%!
In other words, even if European banks can pass a contrived stress test with flying colors, they are flunking the “normalcy test.” Many European banks, like many European governments, have erected such a fragile and precarious financial structure that bankruptcy seems inevitable, even without any additional stress.
A deepening crisis of some kind is certain, especially because the US economy is still reeling from the credit crisis of 2008. Fearing a repeat of ’08, the US Federal Reserve is springing into action, which pretty much guarantees a repeat. Earlier today, the Fed christened the launch of “Operation Twist” — a scheme to buy up a bunch of the long-term Treasury bonds.
Confused?
Don’t be. Operation Twist is simply a new form of Quantitative Easing, which was simply a new form of printing money out of thin air. (The Fed says it will pay for its new purchases with proceeds from the sale of the short-dated Treasuries it already owns. We don’t believe it. By hook or by crook, the Fed’s balance sheet will probably grow over the next few months. We will be watching). Op Twist, therefore, is merely the next illogical step in a regrettable progression toward dollar debasement. After Op Twist, look for Operation Contort, Operation Zig-Zag, Operation Bait-and-Switch, Operation Capital Control and ultimately, Operation Devalue.
The longer the Federal Reserve continues its misguided operations, the bleaker the prospects for the US dollar. But the greenback is not the only paper currency at risk these days. The formerly stodgy, conservative Europeans are beginning to call plays from the American Central Banking Playbook.
The European Central Bank (ECB), in response to the sovereign debt crisis unfolding around the periphery of the euro zone, has embarked on a quantitative easing program of its own — buying billions of euros worth of Greek, Spanish and Italian government bonds in the open market. At the same time, the ECB is also part of a central banking cabal that is providing undisclosed quantities of short-term credit to European banks. And to judge from recent headlines, the ECB is just getting warmed up.
The European Systemic Risk Board (ESRB) announced earlier today that systemic risks within the Europe Union’s financial system “have increased considerably” over the last three months. According to the ESRB’s grim diagnosis, “Key risks stem from potential further adverse feedback effects between sovereign risks, funding vulnerabilities within the EU banking sector, and a weakening of growth outlooks both at global and EU levels...Signs of stress are evident in many European government bond markets, while the high volatility in equity markets indicates that tensions have spread across capital markets around the world. The situation has been aggravated by the progressive drying-up of bank term funding markets, and availability of US dollar funding to EU banks had also decreased significantly...
“The high interconnectedness in the EU financial system has led to a rapidly rising risk of significant contagion,” the ESRB concludes. “This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond.”
The ESRB’s prescribed cure: More of everything that hasn’t worked. The ESRB — sounding a bit like Broderick Crawford in the old Highway Patrol TV series, yelling into his police radio, “Calling all cars! Calling all cars!” — called on “all authorities” to band together and do something.
“Decisive and swift action is required from all authorities,” the ESRB warned. “Authorities must act in unison with a total commitment to safeguard financial stability. Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities...[And if necessary] lend to governments in order to recapitalise banks, including in non-programme countries.”
In other words, print euros, dollars, Swiss francs or anything else you can print and throw it in the direction of failing financial institutions and/or bankrupt sovereigns.
Your California editor will not judge the merits or shortcomings of the ESRB’s directive; but he will hail it as yet one more undeniable “buy” signal for gold and silver.
The surging bull market in central bank hyperactivity is all-but- certain to deliver a robust and long-lasting bull market in precious metals. Thus, for the fourth time in the last six editions of The Daily Reckoning, we turn our attention to the gold stock sector.
As if following The Daily Reckoning’s script, gold mining stocks aroused from their slumber last Thursday — immediately after we highlighted their months-long underperformance, relative to gold itself, and remarked, “Gold stocks are very lowly priced, relative to gold. This looks like a buying opportunity, not simply because gold stocks are cheap relative to gold, but also because gold stocks are cheap from almost every fundamental perspective.”
Since those words appeared, the prices of gold and silver are both down about one percent. But curiously, most gold stocks have gained ground. Some have gained a lot of ground.
The HUI “Gold Bugs” Index is up more than 4% since last Wednesday. A short list of standouts would include:
- Newmont Mining (NEM) — Up 8.5%
- Silver Wheaton (SLW) — Up 9.0%
- Anglogold (AU) — Up 7.2%
- Goldfields (GFI) — Up 9.1%
- IAM Gold (IAG) — Up 8.1%
This recent past might not be prologue, but why wouldn’t it be? In a world of increasingly suspect paper currencies, what’s to stop gold from continuing to rally? And in a world of hyperactive central banking — when money-printing is the go-to cure for whatever ails a sickly economy — what’s to stop gold stocks from soaring?
Gold is not a “Sell,” and neither are gold stocks.
To read again — and more — about the appeal of gold stocks relative to the metal itself, please check out the column below by the ever- insightful, Chris Mayer, editor of Mayer’s Special Situations...
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| | The Daily Reckoning Presents | | Why Gold Stocks Have Not Performed...Yet | | |  | | Chris Mayer | It’s one of the great mysteries of the market this year. For the first half of the year, the HUI Gold Bugs Index — made up of gold mining stocks — was down 9%, despite the fact that the price of gold was up 30%. What gives?
Normally, gold stocks give its investors some leverage to the gold price. Historically, gold stocks move 2-3% for every 1% move in gold. Not so in 2011.
There are some reasons for this. In order of importance, I rate them as follows:
1. The cost of production is up a lot.
Energy costs represent 20-35% of costs. Then there are steel costs, chemicals and labor — not to mention declining grades, which mean chewing through more rock per ounce of gold mined. As a result of these rising costs (and the next bullet), cash profit margins for the industry are not much higher than they were three years ago, even though gold is much higher.
There is little relief coming here, though the retreat in the price of oil helps. This can also be turned around, however, as a positive for some low-cost, high-margin gold miners. It makes their properties all the more valuable and gives you a good cushion investing in them.
2. Taxes have gone up huge.
CIBC notes, in a recent report, that cash taxes per ounce mined have gone up 1,200% in the last six years! Put another way, taxes are up to about $200 an ounce from under $20 an ounce six years ago. This is a statistic that went from practically meaningless to heavy anchor in just six years.
Again, there is little relief coming on No. 2. Political risks will probably play a bigger role in gold mining as gold prices rise, giving politicians incentive to take more. Nationalization? Confiscatory taxes? These are concerns. Again, this can be turned around as a positive for gold stocks in safer jurisdictions.
3. There is much skepticism about the price of gold holding its big gains this year.
As a result, there is reluctance on the part of investors to give gold mining shares the full benefit of the price increase when they think about what they are worth. You can see this in Wall Street research in which analysts assume lower gold prices going forward.
Only time will take care of this skepticism. The longer gold sticks around at $1,700-1,800 an ounce, the more the market will believe it is here to stay. This is the way markets work. Every bull market must overcome disbelief and skepticism as it unfolds. Bull markets die when there are no more disbelievers. They die when there are no more skeptics. We are a long way from that with gold.
Notwithstanding all of the above, gold stocks are fundamentally cheap based on cash flow. One of the most remarkable charts I’ve come across is the nearby one showing the collapse in the cash flow multiples of gold stocks. They’ve gone from over 20 times in 2008 to about 10 times this August!
The last time gold stocks got this cheap, on this basis, was back in 1979, when the group touched 8.5 times cash flow. This preceded a parabolic move in gold stocks in which they ultimately ran up four- fold. The 1970s is an interesting period to look at because gold stocks also lagged the price of the metal all the way up.
The chart above is a beauty from CIBC, which clearly shows how the 1970s unfolded. I can certainly see some scenario like that — in which cash flow multiples hit a floor and then spike — playing out in the 2011-12 timeframe. Which means you don’t want to sell gold stocks right here. At worst, you hang on to them, even the dogs. (The old saying is, “In a hurricane, even turkeys will fly.”) When that rush comes for gold stocks, they will all go up.
Moreover, looked at in terms of price to net asset value, gold stocks are trading about where base metal stocks are. This has never happened before. Gold stocks have always traded at significant premiums to base metal stocks. So this is another value metric that favors gold stocks and their investors.
If you don’t own gold stocks yet, now is a great time to buy them. And if you already own them, you should certainly hang on, or add to your favorites.
Regards,
Chris Mayer,
for The Daily Reckoning
P.S. I’ve been saying for weeks now that there will be some great buying opportunities in the coming months...provided we keep a cool head and know what we’re looking for. I’ve got plenty of companies on my watch list right now, some of which I’ll be featuring in upcoming alerts and Mayer’s Special Situations issues.
If you’re already a member of my Mayer’s Special Situations research service, you’ll be receiving your next alert this Friday. As you know, this is the space where we get into portfolio specifics and update our positions. I’ll be writing to you in a couple of days. If you’re not a member, but would like to become one, I encourage you to check out this presentation. It details a little of our investment philosophy and drills into one specific idea I’ve recently been researching. Check it out here.
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| | | | | | Bill Bonner | | Fake Fixes for the Real US Debt Problem | | |  | | Bill Bonner | Reckoning from Buenos Aires, Argentina...
Not much market movement yesterday. Dow basically flat. Gold rose $30. Gold investors don’t seem to be able to decide. Is the economy good for gold...or bad?
Here’s our opinion: This is a good time to own gold. But it won’t seem like a good time. Not now. Because the Great Correction just gets worse and worse. And as the correction bites the economy, the dollar goes up against almost everything.
“Gold is not going down,” says David Rosenberg. But we’re not so sure. Gold investors bought gold to protect themselves against the dollar. But in the short and medium term, they won’t need protection against the dollar. They’ll need protection against everything else! They’re likely to be disappointed with gold and drop it as this period of de-leveraging drags on.
Yesterday, we promised to explain what was really behind what Tyler Cowen calls “The Great Stagnation.” We haven’t forgotten. We’ll come back to it. Just hold on.
First, let’s look at how this world economy is slipping into a worldwide depression.
Just check out the container shipping volumes at California ports. They’re down nearly 10% from a year ago. That’s a big drop in world trade. What happened? Did Americans finally get enough gadgets and gizmos from Asia? And what does it mean for the Asian exporters? Their economies depend on buying from overseas. They’re export economies. Of course, it is true that local demand is increasing. Eventually they’ll adjust to fewer exports and more domestic consumption. But adjustments take time...and are usually linked to major financial crises. What will happen?
Here’s an answer from Britain’s Telegraph newspaper:
China ‘faces subprime credit bubble crisis’
Monetary tightening in China threatens to pop the $1.7 trillion (£1.07 trillion) credit bubble in local government finance and expose the country’s simmering “subprime” crisis, according to the Communist Party’s economic guru.
Mr. Cheng said China is entering a “very tough period” as growth runs into the inflation buffers, threatening the sort of incipient stagflation seen in the West in the 1970s and leaving the central bank with an unpleasant choice.
“The tightening policy is creating a lot of difficulties for local governments trying to repay debt, and is causing defaults,” he told a meeting at the World Economic Forum in Dalian. “Our version of subprime in the US is lending to local authorities and the government is taking this very seriously.”
“Everybody assumes that they will be bailed out by the central government if they default, but I disagree with this. It means that the people will ultimately pay the bill for it all, at a cost to the broader welfare.”
Meanwhile, in Europe, Italy got downgraded by S&P. Angela Merkel lost a critical vote. And Greek bankruptcy is right around the corner. And back in the US the typical American is suffering. He had equity of 61% in his house back in 2001. Now, he’s got a paltry 38%. And he’s lucky to have that. There are 11 million homeowners who have less than zero equity. They’re ‘under water’ and still sinking.
One in four young people is jobless...with sentiment among the youth at a record low. The old people may be optimistic, but not the young.
And 15% of the population — a record number — is now below the poverty line. That’s 46.2 million people living in poverty in the richest nation on earth.
But don’t worry, dear reader, president Obama is on the case. He says he has a solution to the US debt problem. He says he’ll cut expenses and raise revenue. Why didn’t we think of that!
A quarter of the cuts are supposed to come from the military budget. But they’re totally fraudulent. The feds don’t really know how much their wars will cost. So when they talk about ‘cuts’ and ‘savings’ they are talking about reductions in projected costs, not real costs. They’re made-up numbers, in other words. Even they admit that the savings are “illustrative” — rather than real. And there’s no way these illustrative savings will turn real — not as long as America stays on the imperial path.
Obama also wants the rich to pay more in taxes. Heck, Warren Buffett is on board. And so are most of the voters.
Of course, most of the voters don’t pay taxes at all! Not net. About half of the people eligible to vote get more from the feds than they pay in taxes. That leaves the “rich” shouldering an outsize burden. Already, the top 1% pays 30% of the taxes.
But if you’re rich, don’t expect any sympathy from us or anyone else. The rich have rigged the system in their favor. Everyone else has gotten poorer while they’ve gotten richer. Voters will be happy to soak the rich. Heck, they’d drown them if they could get away with it.
And more thoughts...
But let’s go back to the big picture. Tyler Cowen thinks the US enjoyed the low-hanging fruit. Fertile farmland, cheap energy, abundant water, easy credit...getting rich was a piece of cake.
He mentions too that investments in health care and education seem to have reached points of diminishing returns. The US spends far more on both than other countries...and gets no extra benefit. Our schools are not better. And Americans don’t live as long as people who spend only half as much on health care.
Can we fix this problem, asks Mr. Cowen? Wasting no time answering his own question, he responds that we just need to boost the prestige of scientists...and count on human ingenuity and innovation to come up with a solution. Heck, even Thomas Friedman could have come up with that! In other words, he thinks the system can heal itself.
But the real problem is not a ‘low hanging fruit’ problem. It’s a declining marginal utility problem. And a zombie problem.
As a society ages its institutions become brittle and inefficient. They are no longer dynamic and productive. And, they become nests for dead-head zombies. The two things go hand in hand. On the one hand, declining marginal utility undermines the productivity of future inputs. And the zombies take over...making it impossible to direct inputs elsewhere. The zombies protect their turf; they make sure they get more resources, not less.
Take education, for example. A little of it goes a long way. When a person learns to read and write, the whole world of ideas and information opens up to him. Whether more inputs of formal education actually pay off or not is open to question. Clearly, beyond some point, they don’t. Americans spend twice as much per student as they did 40 years ago. The educational attainment results are about the same. Which suggests that the marginal utility of investment in the education industry declined to zero 4 decades ago.
Most the world’s great ideas...great books...and great inventions were produced by people who spent relatively little time in formal school settings. But now, every goofball and half-wit is expected to have a college degree. What do you expect? A college degree isn’t really worth very much.
But the zombies want their children to go to college. And the zombies want cushy jobs as ‘educators’ and educational administrators. (They don’t want to teach...that’s too hard!) And children are no dopes either; they know it’s a lot more fun to spend 4 years at Party U., at someone else’s expense, than 4 years out in the real world. Especially now, when it’s hard to get a job. That’s part of the reason student loans have quadrupled since ’07.
Obama promised to bring ‘change’ to the nation. But change is the last thing the zombies want. And it’s the last thing that Obama would want to give. The voters wouldn’t stand for it.
Instead, we have a Great Stagnation...an economic deadend...where further inputs into traditional, zombie-controlled institutions no longer pay. More credit? More military spending? More Medicaid? More Social Security? More education? More consumer spending? More hiring? More capital investment? More energy consumption? More programs? More unemployment compensation? More taxes? More laws? More regulations? More lawyers? More educators? More security guards?
Will they pay off?
Not a chance.
Tune into tomorrow to find out how to really fix the problem.
Regards,
Bill Bonner,
for The Daily Reckoning
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