Friday, October 31, 2008


The "bust to boom" indicator made a sharp bottom at a very low ratio 4 days ago. This indicator has historically made sharp turns. It often makes a few pump fakes but once it turns it typically turns hard. At the last top, the indicator outdid itself. It did a few pump fakes in early 2006 and then dropped like a rock, only to do a 180 back to a final top in May of 2007. The fall from 57% in May 2007 to 26% last week was the largest move I can find. On October 10, 2002, the jumping off point for stocks after the last recession, the indicator had reached 30%. At that bottom, the indicator soared from 30 to 34 and then back to 29 in April of 2003 when the market successfully stayed will above the October 10 low. The jump of the last 4 days may be a pump fake but smart investors will not try to catch the exact bottom. Those who have bought when this indicator is below 34% have had very strong 3 and 4 year returns.


Yesterday, reported real consumer spending made the same move made November 1974, March 1980 and November 1990. Real spending is more the function of inflation reports than a function of actual spending. Inflation jumps at the tail end of the business cycle. While we all know that house prices, oil prices, wheat prices, corn prices, cattle prices, electronics prices, etc., etc. are falling, we see a report about real consumer spending, based on high inflation, making big news.

In case you are not familiar, stocks did very well in the months that followed the above dates.

The McCain Long Shot

A regular reader sent the following link to a political quiz.

I score as a strong libertarian. In many ways, I am a classic liberal; I believe in freedom! I desire the least amount of government interference in my life as is reasonable.

I count the Rasmussen poll as reliable as polls can be, but a margin of error of 4% can be an 8 point swing. The race for President has tightened but McCain is still a 4 point underdog; he could squeak out a win or he could lose by more than 8. His hope lies with the electoral collage. Our founding fathers wisely set up a system whereby California (which did not exist) could not rule the land. The law of the land is that the electoral college vote is the one that counts, several million votes against McCain in New York and California will be of no consequence. McCain's best shot is to win all the "slightly leaning" states and to pull off upsets in Ohio, Colorado and Virgina; a tall order indeed. Virginia has traditionally voted republican but it leans heavily toward Obama. A number of other combinations would work but all are long shots.

Stranger things have happened and the turnout should break several long term records. A significant percentage of democratic voters are opposed to one party government, when push comes to shove, many a centrist democrat will "pull the lever" for McCain. Our country continues to struggle with the unintended consequences of one party rule under FDR and Lyndon Johnson. The one party rule from 1992 to 1994 resulted in no harm when republicans blocked the big government takeover of health care proposed by Hillary, but the potential harm of a Pelosi, Reid, Obama combination is great. My opinion is that the actual harm will be much smaller than the potential but we should avoid the risk if we can.

Employment Growth in the Travel Industry?

A few days ago, I mentioned that the travel industry has been one of the few areas (outside of government) where employment growth has been strong. I mentioned that the baby boom generation is traveling. There is more to the story.

The key other point is that package deals are being purchased. Instead of shopping for a vacation rental within a half day drive, the public is leaving the car at the airport. The reduction in total air miles flown has not been on the level of reduction in miles driven. Many travelers are buying package deals. Many destination resorts are doing much better than most individual rental properties. The employment growth is real, but, as always, the media emphasis comes after the trend has run along way. Yesterday, the New York Times published a front page article telling about how driving is making a come back.

The naive have used the article as the reason to "jump back into energy investments". Exxon just announced the biggest profits in history and the high profits make its PE multiple low. Exxon was the number one performing large cap investment over the past 35 years. It is a well run company. The left uses it and Wal-Mart as punching bags but this is mostly jealousy from those who wish they had invested. Still, the big energy boom that lasted from 1999 to 2007 has run its course.

I disagree with the many who believe we are in a commodities "super cycle". These folk see China as the largest economy in the world in just a few years and they see huge on-going demand growth for commodities. The reality is that Japan, a country that must import almost 100% of its raw materials, is on the other end of the China see-saw and the Yen, like the US dollar has turned. Shares in Japan were on fire for many years until about 20 years ago. Shares in Japan are now all the way back to the prices of 20 years ago, just as the cycle is turning. The upturn of growth in Japan will not suppress growth in China but one of the reasons that Japan will do well is its efficiency in using resources. China has the most progress to make in increasing the efficiency of its use. China, embarrassed by the smog at the Olympics, has built an assembly line to produce nuclear power plants. China is going to contribute to a dramatic reduction in the growth in digging and transporting coal.

Japan and a number of "old" EU countries and Russia combined are experiencing reductions in population. Population growth rates have fallen dramatically in many countries, including China. The worlds population growth would probably end by 2050, except for the longevity factor.

All the while, technological innovations are soaring ahead at break neck speed. Some of these innovations will dramatically prolong life, contributing to population growth, but many others will dramatically cut the per person use of the most valuable commodities. (The number one cause of death is heart disease and hearts are being "renewed" with outpatient injections. Just one example of innovations that will dramatically prolong life.)

The examples of reduced need for commodities is endless. For thousands of years, the real, inflation adjusted, price of commodities has been negative. The history of more efficient use is a several thousand years old. The stories about Joseph in Egypt are about learning how to use grow and preserve commodities. I have fussed about the foolishness of using corn oil in car engines but genetically improved elephant grass will produce 5 times the energy oils for a fraction of the costs. The next time the price of oil rises, elephant grass or some other cheap raw material will be ready to compete. We do not need an Obama boondoggle to talk the market into improving elephant grass or some other best alternative.

It is time for a backlash against big government. So far, the credit crisis has resulted in a backlash against big business. By the next, election (only 2 years away: :-)), there should be a backlash against the padded salaries of government workers.

The tide seems to be flowing in the big government direction right now but the government is broke and broken. The Bush tax cuts do not expire until 2010. To enact Obama's big spending programs, the government would have to take on even more debt. Democrats will hold significant majorities in the house and senate but they will not gut the military budget quickly and many are not in the mood to borrow and spend. The $500 tax rebate checks and the other $500 credits to be issued by the Obama plan will not do much. The decline in the household expenditures for inflated energy and food will be the much larger tax cut. The family household budget will be repaired faster than government budgets. Many state budgets are in horrible condition.

The baby boom generation will continue to travel. A significant portion of their energy savings will flow into their travel budget. The strengthening US dollar has made and will make international travel more affordable.

Don't Try to Trade Copper; Use it as an Economic Indicator

A regular reader wants to know how to make money off my projected continued decline in the price of copper. The following was my response.

The best way to trade commodities is with a futures account, however, this is a specialized business filled with professional snakes. The commodities trading pit is not the kind of place where a modest investor would want to hang out.

The main point about copper is that the price decline shows that the market turn is happening and that inflation rates will soon fall, as the significantly lower price of raw materials work their way through the production cycle.

As noted, 1) stocks have historically appreciated an average of 350% more during times of declining inflation; 2) during a time of declining inflation, bonds normally appreciate first and then there is an overlap, where financial stocks gradually take over before consumer spending explodes.

Manufacturing recessions play out a little different than real estate recessions but since I presented the numbers for the last real estate recession earlier, I will go over the numbers from the last recession. In 1999 the S&P 500 Bank Stock Index fell from .32 times the S&P 500 Index to .18 times the S&P 500 Index. The total return for the year was 22.7% but the bank index underperformed the S&P by 44%. At the bank stock bottom in March of 2000, the Bank Index got down to 15.5% of the S&P.

The S&P 500 in 2000, 2001 and 2002 returned -9.2, -11.9 and -22% respectively. In 2003, the first good year after 3 down years, the S&P was up 30.7%. From the March 2000 bottom at 15.5%, the bank index soared. The nominal bottom of the S&P was on October 10, 2002. In other words, the -22% return in 2002 included a plunge to the bottom in October and a strong rally to year end. The bank index was going almost straight up before the S&P joined the move. By April of 2003, the bank index had reached 37% of the S&P. Over the next two years, the bank index performed in line with the S&P, but by June of 2006 the bank index was trading at 32% of the S&P.

From the bottom in March 2000 to the peak in April of 2003, the bank index outperformed the S&P 500 238%. Unfortunately I don't have the bank index total returns handy. The weak substitute I can offer is that while the S&P was down 9.2% in 2000, the broad Financial Sector was up 26.9%.

One problem with the 2000 recession numbers is that the events of 9/11 distorted the outcome. I should also note that the top performing sector in 2001 and 2002 and the second performers in 2003 and 2004 was the real estate sector. These broad based returns, from 2000 through 2004 were 27.6%, 11.7%, 3.6%, 36.9%, and 31.2%. As you can see, the person who invested in the right place, early during the 2000 recession, did very well. Indeed, if one put up 20% of total value to buy real estate in early 2000, one made about 130% return in 2000, a tough year when the average big stock fell 9.2%.

As noted, real estate recessions play out differently than manufacturing recessions. The industrial metals index was about 62% of the Gold index in early 2000. The bottom of 39% was not reached until March of 2003, right at the take off of the big Dow Stocks. The ratio was at 76% in July of 2007 and it is already lower than the March 2003 bottom. It was trading around .35 a few days ago. The above illustrates that this recession, being a real estate recession will see even bigger swings than the average recession. By the way, real estate gets hammered in almost all recessions; the difference in a real estate recession is that real estate drags the rest of the market down, whereas in a manufacturing recession, high interest rates and the loss of jobs drags down real estate.

In nominal terms, the massive decline, in the price of copper from July 2007 to today, was from $4.11 to $1.66. After such a massive decline, a one to 6 month bounce would not be a surprise. The market sometimes takes time to digest a move before following through with the "second leg". I believe the price will go below 50 cents but that does not mean one will automatically make high returns by shorting copper futures, by nature, futures tend to be short term speculations. The main problem with futures is getting the timing right. When one looks into the future, one always looks through a cloudy crystal ball. It is easy to be off a few months, which can turn a wonderful trade into a major loss.

The clear immediate future is stuff that is already "in the works". The lower price of raw materials, the move that has already happened, will translate into lower prices of goods as those prices flow through the production cycle. Gasoline being sold at $1.48 wholesale in Texas and Louisiana will not reach North Carolina for a few weeks. My local Shell station was selling regular at $3.04 last week and is down to $2.69 this morning but it is a solid bet that it will be selling regular at $2.08 within three weeks (perhaps 4.5 weeks to get past the Thanksgiving Holiday).

The reason economist call copper, Dr. Copper, is because its price gives us an indication of our economic future. However, one should not try to use a decline in the price of copper to predict a further decline in copper. While it is obvious that the demand for copper will remain low until there is a rebound in the economy, we must remember that the stock market also leads the economy. As I have noted before, the prices of commodities are a lagging indicator, similar to unemployment. We do not see the worst of unemployment or declining copper prices until after the economy is well into a downward path. By the time these measures are indicating that we are in a recession, it is time for stocks and real estate to start their recovery.

In September, we had the largest reported monthly jump in existing home sales in 5 years. It was the first time in 30 months that existing home sales were up year over year. A bottom is being made in housing. The first bounce may prove to be only a test but it is a great sign. We are in the third phase of real estate, when sales are rising even though average price is still falling. In North Carolina the foreclosure ratio fell 27% last month. Nationwide about 35% of all homes sold last month were deeply discounted foreclosures. The other 65% of the homes probably were sold at higher prices (perhaps well below listing prices but still at higher year over year prices). Foreclosure sales tend to be concentrated, more neighborhoods are stable than are collapsing.

The key measure, as always, is supply and demand. The supply of homes for sale has fallen 5 months in a row from 11.3% months to 10 months of sales. The reason real estate did so well in 2000 to 2004 was the supply hit 2 months in early 2000 and was still only 4 months when the real estate fireworks really started in 2005. The time to sell real estate was in 2005 or early 2006, when supplies were just ready to exceed 6 months of sales. With only a modest pickup in home sales, the current 10 months supply could fall quite rapidly. A significant number of rental homes for sale will come off the market when their owners realize the market has turned. Many potential buyers have hesitated to buy while prices are falling. The sales rate will jump when these buyers realize that prices are rising. Because it takes time to locate the best properties, it is important to start looking and to make offers well before prices start moving up. The attitude of sellers will be very different once they hear that prices are rising.

Building permits are very low. There is pent up demand that is frozen while potential buyers wait until they know their job is secure or when their bank is more willing to offer great terms. Just in a few weeks, the 30 year mortgage rate dropped from 6.5% to 5.9%, rallied to 6.4% and is now back at 6%. In normal times, banks would only charge about 1.5% more than the 30 year bond. The 30 year traded at 4.04% yesterday. Home loans at 5.5% would make many more homes affordable to many more people.

Please note that with the exception of a few economist, Art Laffer being among the concerned, a turn in labor costs is not being forecast. In the late 60's and early 70's, the labor movement had a strangle hold on business. Obama will move policies toward the failed strong union policies of the past, but not nearly as far as his liberal friends in congress will attempt to pass. In the 60's and 70's, government policy ultimately resorted to hyper inflation of goods and services prices in order to counter the extraordinary salaries being collected by workers. Real interest rates were kept negative, at least up until deregulation hit and Ronald Reagan fired the air traffic controllers. The run up in commodities prices that occurred in the late 70's was accompanied by a run up in labor costs. Businesses had a difficult time making real profits and by 1982 PE ratios were down to 7 times. As usual, when the pendulum swung the other way, it went too far. In 2007, the average executive got a 38% raise. In 2008, the average executive will see a 15% cut in pay. The market correction in executive pay has started. Art Laffer's concern is that the pendulum will now swing to big increases in minimum wages and in union membership growth. Unions bankrupted the airlines, the rail roads and Chrysler, GM and Ford are on the brink. The best solution for GM would be to file Chapter 11 bankruptcy in order to get out from under outdated union contracts and dealership franchise laws. The more likely scenario is another government bailout.

This time is different! Dangerous words but labor in India, China and elsewhere is plentiful and technological innovations are reducing the cost of labor per unit of product even more. Obama's protectionist rhetoric was political rhetoric. He is not likely to push hard enough to end previous free trade deals.

Back at the start of the 80's, inflation rates fell dramatically as both the price of commodities and the price of labor came down. This time, inflation rates never got to extreme levels, even with the price if copper going more than 800% in a few years. This time, inflation rates will come to even lower lows. The unions who have spent billions of workers dues on support for Obama still face the new economy where robots do our manufacturing and where the low cost region is where the work gets done. By the way, Toyota will export trucks made in Tennessee to Latin America.

I say again, the average monthly return on stocks during times of declining inflation rates is 1.17% compared to .33% during times of rising inflation. Bonds will move first, financial stocks next and consumers will buy like crazy after they start seeing the price of things like Coke (corn syrup) fall dramatically. Just as the talk of GM bankruptcy gets the most play, there will be a massive shift of consumer spending from gasoline, energy and inflated food prices to consumer durable goods.

Thursday, October 30, 2008


From October 1973 to December 1974, real estate, as measured by an REIT index, declined 32%. Buyers in December 74 could not know the recession was over, indeed the declaration that there had been a recession occurred many months later. Buyers in December did know that the yield on real estate investment trusts had reached 12.9% at a time when 30 year treasury bonds yielded 9%. Buyers who bought in December 1974 and sold in August of 1979 made 245% cash on cash return on their investment in addition to very fat dividends.

The fall in real estate from August 1979 until July 1982 was even more dramatic. The total decline was 56%. Even so, at the market bottom, the yield had reached just 9.5% while 30 year treasury bonds were paying 15.5%. Buyers in July 1982, before the recession was official, made 113% in less than 5 years plus more fat dividends. Those who bought levered bonds did even better than real estate buyers.

The decline from 87 to 90 was 38% and once again, the adventurous who bought real estate during the recession did very well. From October 1990 to December 1997 they made 232% cash on cash plus fat dividends that started at 11.12% in October 1990.

The decline before the 2001 recession was 33% and the subsequent gain was 177% plus dividends that started at 8.8% in November of 1999. In this case, the time to buy was even before the recession started!

The average peak to trough over the past 35 years has been 39.5%. The biggest decline was 56% from 1979 to 1982.


VNQ, the Vanguard REIT, went down 56% from March 2007 to yesterday. During the same period the S&P 500 went down 35%. Real estate is cheap relative to Stocks. The yield on the VNQ has shot up to 8.34% while the yield on stocks is about 3%. You earn 278% more in dividends on the REIT. The 30 year treasury bond yields 4.1%, less than half the REIT yield.

In the early 1980's the FOMC was eager to kill out of control inflation. Short term interest rates were raised to 19% in 1981. The great majority of people thought rates were going even higher. The US Government had to offer 15.5% to sell its thirty year guaranteed rate of return. It was very difficult to see that it was time to buy real estate during the summer of 1982 when 30 year mortgages required the payment of 17% interest and while short rates were still around 15%. Those who bought had no way of knowing that short rates would be down to 9% within a couple of months.

Yesterday, the FOMC cut short rates to 1%. The 30 year mortgage has been bouncing between 5.9% and 6.4% but this rate needs to fall to 5.5% to be in line with treasury rates. Those who buy real estate now should get a low cost variable rate loan, like the ones being offered at credit unions at 4.5%. One can earn 8% on 4.5% borrowed money, in addition to making capital gains on the entire asset value.

Please note, all of the above returns except the previous sentence were cash on cash returns. The person who bought real estate with leverage most likely made many times the cash on cash returns.


Our common sense tells us to buy when prices are low. The decline of 56% over the past 19 months is as large as the biggest decline in the past 35 years. Our government has boosted the monetary base by 48% in just a few weeks. While I and others have complained about the negative precedent set for the future, we do not deny that the investment of 700 Billion Dollars by the Federal Government will provide a tremendous boost to our economy.

Those who keep trying to declare this crunch to be a repeat of the great depression do not know their history. The response of the government after the market crash of 1929 was to shrink the monetary base by half, this fed has increased it by almost half. Obama , Pelosi, Frank and Reid are anxious to move forward with the same New Deal style programs that caused the Great Depression to take years to end but the dramatic pump priming already done by the treasury and FOMC is going to work by the time the congress can make too many mistakes. Ben Bernanke wrote his thesis on the great depression. He is well aware of the mistakes made by the Fed. He is not inclined to repeat them.


Wednesday, October 29, 2008


A regular reader emailed a chart showing how our soldiers in Iraq will vote heavily for McCain. As we all know, Obama would have pulled out of Iraq in defeat 19 months ago, terrorism would be on the loose again. Now that the Iraq phase has been all but won, Obama refuses to admit that this phase of the war on terror has been won. He learned from Bill Clinton that the best political strategy is to repeat certain words until the storm passes, words similar to "I did not have sex with that woman". The war on terror is one of those areas where Obama found a politically popular point and stuck to it no matter the facts. He continues to win brownie points with many Americas by saying that he will end the war in Iraq. McCain gets little credit for helping win the war in Iraq.

As regular readers know, I hate the fact that the US Government spends 33 billion dollars per year to subsidize ethanol. I hate even more the fact that the government forces its "free citizens" to "spread our wealth" to the "poor" farmers. I hate that we are forced to spend trillions of dollars on a fuel that causes children in poor countries to go hungry. I hate that the production of that fuel harms the environment greatly. And, I hate the hypocrisy. The situation is like that of Ananias and Sapphira, the lies are one thing but the hypocrisy gives off the putrid smell of death. Obama does not care, provided he is the elected one. In the face of growing evidence that ethanol and wind mills are not up to snuff, Obama continues to extol their value.

Obama continues to support annual subsides to wealthy farmers to the tune of 33 billion dollars. At the same time, he attacks McCain for the oil company subsidies that Obama helped pass. Obama voted for oil subsides in a trade off to win ethanol subsidies. McCain voted against both oil and ethanol subsidies. McCain and Obama disagree with the economic policies of Bush, McCain objects to the reckless spending and Obama objects to the lower taxes on capital gains, inheritance and income.

It is understandable how the public was easily duped when the price of oil was rising. Bush joined the democrats in making it look like the government could solve an economic problem; when will politicians learn? Democrats went much further than Bush when they repeated, at least a few thousand times, that "we cannot drill our way out of this crisis". The reason the price of gasoline is about to drop to $2 is because a huge amount of drilling was done over the past 6 years. Marginal new supplies have finally topped marginal new demand. Yes, I know, demand is down because of world wide recession but supplies of 60 million barrels per day in the late 90's were boosted to 87 million barrels per day now. If supplies were still at 60 million barrels per day, we would not see prices falling. In addition to the producing supplies, the discovery of 70 billion barrels of oil off the coast of Brazil, not more than a drop of which has been produced, puts OPEC in the position of continuing to sell all they can at $67 because the price will be lower in a few years. US offshore drilling will help us by the time demand growth resumes.

Obama likes to claim that he will create 5 million new jobs in the alternative energy business. I have a couple of news flashes for him, 1) the millions of subsidized jobs created in Europe to build wind mills and solar panels are at risk, 2) the private sector will create the jobs in the most productive area, if wind mills is one of the winners, that will be just as good if nuclear power is one of the winners. However, the rational for investing huge sums into wind mills was marginal at $147 per barrel but really stupid at $67 per barrel. Sixty percent of the investors in T. Boone Pickens energy fund have asked for their money back. The Pickens plan relied on government subsidy to work. The likelihood of massive government subsidy for wind mills has fallen now that the price of oil is down 60%. Obama's campaign slogan is Change, yet he has handcuffed himself to a winning political story even though he knows the economical story is false. Or is he so naive to think that we can or should beat the Europeans at government subsidy and ownership of businesses?

Areva, the nuclear plant builder in France, just made a deal with Northrup Grumman to build a nuclear parts plant in Virginia and the Department of Energy just signed off on the wisdom of reprocessing nuclear waste into new fuel. For a very long time, our nuclear power plants have burned 4% of the fuel and left 96% as waste. Even at such low utilization rates, nuclear plants have been economically competitive with other means of energy production, including dirty coal. It takes 10 nuclear regular nuclear plants to produce the fuel for one fast burner plant. The fast burners will turn tonnes of nuclear waste into trillions of dollars worth of fuel.

A couple of days ago, I had a conversation about nuclear power with a friend from Canada and a friend from Switzerland. The thought that nuclear power might be the answer was almost repulsive to each of them. However, when the Canadian learned that China has built a nuclear power assembly line, which will make possible the production of electricity for 1.3 to 2 cents per kilowatt, he acknowledged that nuclear power makes economic sense. The friend from Switzerland was unwilling to dwell on the economic question but repeatedly went back to the dangers of nuclear power. The events at Chernobyl are ingrained in his thoughts. However, he was willing to accept my point that at least 10s of millions of people have died producing coal power or by breathing dirty coal air. When asked what the world would be like if we did not consume coal or nuclear energy, he had no answer. If memory serves, there were 14 people who died immediately at Chernobyl and the expert estimates of those who died because of radiation range from 40 people to 2 million people. I believe the low number is in the ball park and my friend believes the high number is. We ultimately had to agree to disagree. Thus far, my friend has delayed the installation of roof top solar panels: he is waiting for the relative total price per kilowatt to come down. He will have a long wait. Jimmy Carter put roof top solar panels on the White House, Ronald Reagan took them down.

Obama and my Swiss friend continue to support wasteful spending, but: 1) Thunder Horse, in the US Gulf of Mexico, just brought another 100,000 barrels per day online, 2) Mexico just voted to allow drilling in the Gulf of Mexico by companies that know how to find and economically produce oil, 3) natural gas production growth in the US has grown dramatically over the past couple of years and it should grow for 50 more years, 4) China has broken ground on two new refineries, one in Nigeria, 5) Russia is adding a Chinese spur line to its pipeline from Siberia to Japan, 6) Kazakhstan is moving forward with the development of the huge Kashagan oil and gas field, 7) the net growth of the worlds population was down in the 90's down more each year of the 2000's and it should reach zero in about 50 years, 8) every day trillions of energy saving substitutions are being made.

The stock market in resource rich Russia is down 70%. Bulk supply shipping rates are down 87%. The mortgage interest rate bottomed in 1977 three years after the end of the real estate recession. The mortgage interest rate bottomed in 1993 almost three years after the end of the real estate recession. Smart investors will buy real estate today, using variable rate financing, and they will lock in fixed rate financing in a couple of years. As evidenced by the shipping rates, the demand for iron oil and other goods required to build big factories or big office buildings or big bridges will be slow for a number of years.

On the other hand, the US economy continues to be amazing. With the exception of autos, retail sales continue to be extremely strong. Total loan growth in America continues at double digit rates, down from the peaks, but still strong. Americans are apparently taking the money they would normally put into a new car and spending and spending part of it elsewhere. The strongest area of employment growth is in the hotel and leisure goods business. Apparently, retired baby boomers are traveling. Based on research done by the Cleveland Federal Reserve Bank, inflation expectations are from 1 to 1.6% and GDP growth for 2009 will be in the 3% range! The guys and gals on TV are talking about a bust but the market bust shows a major decline in capital goods, energy and materials and a surge in other areas.

How can it be that housing, banking and autos are in a major recession but the US economy is still so relatively strong?

I always circle back to the innovations taking place. Yesterday, I wrote about the progress being made toward "print manufacturing". In a few years, if a company needs a certain part, it will download the specs and hit the "print" button. Supper strong, super tiny materials will be arranged according to the specs. The savings will be huge.

Yesterday, Google settled the law suit between them and book publishers. Google, perhaps through Amazon, Sony and others, will soon make millions of out of print books available on line. Google will keep 36% of the sales revenue and 100% of the advertising revenue. Google will win but so will the rest of the world. Shared knowledge is extremely powerful. The invention of the printing press was one of the greatest inventions ever. Even so, it took a major shift in attitudes to make the printing press feasible and another major shift in attitude to make its products useful. Think about how life would be today if only priest were allowed to read. China was once the greatest nation on earth but it lost its way when those in power decided knowledge should be sequestered.

The savings that will be realized by the movement of paper books to electronic readers will be enormous. The number of trees saved will be in the trillions. The easy access to great stores of knowledge will trump the benefit of saved trees many times over. Sales of the "Kindle Two" will be huge relative to the Kindle. Amazon might win big but the people will win more.

Mountains of new royalty income will flow to those who have written "good stuff" in the past. Those who write "good stuff" in the future will find an audience. Under the "laws of the long tails", we know that the distribution curve will be flattened. The most popular stuff will not necessarily lose readership, but billions of people will find millions of books on the subjects they enjoy. The costs of any one book may vary greatly but the net cost of reading good books will fall dramatically.

Thousands of book stores and thousands of video rental stores will close or convert to coffee shop book and movie preview locations, kind of like sports bars for books, videos and magazines. Floor space at many other stores, including Wal-Mart, will be reallocated. Paper newspapers will go the way of answering machines, fax machines, analog TV, hand written letters, dial up Internet, cameras that use film and yellow pages (for a longer list go to

The "gales of creative destruction" are nothing more than the biblical teaching that there is no joy without suffering. When Obama, McCain and others, push to eliminate pain, they also push to eliminate the resulting benefits. The push to eliminate pain is the equivalent of taking heroin or drinking excessively. While Obama has done a masterful job of running as a liberal democrat during the primaries and as a centrist democrat during the general election, he has not changed his fundamental positions. He is still a big spending, "spread the wealth", liberal. He is still willing to shrink the economic pie, provided he and his "friends" get a much larger piece of the smaller pie.

The good news is that multiple new economic pies are in the oven. The market will spread the benefits around the world. For example, the decline in the cost of books is going to be of greatest benefit to the poorest of people. Can you imagine how the availability of cheap books and videos will change the lives of billions of poor children in Africa, China and India?

The bad news is that we are a long way from one of the attitude shifts we need in America. Unfortunately, the old rhymes that compare school houses to jail houses have come true. Most of our children are locked into holding cells for a few hours each day. I taught a few classes at local middle and high schools last month. I learned more than I wanted to know. Our teachers need the authority to expel children from class. Children who are not motivated to learn should not be allowed to disrupt the educations of those who are. Indeed, classrooms are "old school". Each child should have his own "study office" with the freedom to come and go to the gym or playground or education conference, provided he works hard enough to "keep his job". Political brainwashing should cease. The Google book project grants free library access to millions of volumes. Motivated children should be given free access to these millions of volumes. Children and adults should have access to the facts. Obama is not the one at fault for his willingness to ignore the facts, he is simply a reflection of a society that has been brainwashed.

Tuesday, October 28, 2008


Stocks do 350% better during times of declining inflation; such an important concept for investors to appreciate. Many investors think bonds are the investment to own during times of low inflation but the irony is that bonds should be bought when inflation is high but about to go down. Stocks and bonds are first cousins. Unlike gold, stocks and bonds earn a stream of cash; most bonds give off a fixed, limited and guaranteed stream and stocks give off a variable stream. The stock variable stream grows best during times of low to moderate inflation. Real estate is an even more distant bond cousin. Utilized real estate also usually throws off a growing stream of cash. Real estate is more closely related to stocks than to bonds. The rough times are when the net returns produced by stocks or real estate are negative.

The US dollar has recently skyrocketing against many currencies. One of the sharpest runs has been against the Aussie Dollar. By the same token, the Japanese Yen has risen even faster than the dollar. Marvin Appel writes about foreign investing in "Investing with Exchange Traded Funds". He notes how volatile emerging growth stocks can be and how one one can lose money for very long periods of time in foreign stocks. If you are not enjoying this market, say a word of thanks that you are not heavily invested in Russia.

Back in 1967, democrats were in control of our three "houses" of government (the make up of the supreme court is always important but never truly "in control of a party"). Under one party rule, a lot of mistakes in the same direction were made. The presidents of the 70's were all forced to fight hyper inflation. Nixon, Ford and Jimmy Carter still get blamed for tough times that were the result of the inflationary policies of the Johnson years. By the Carter years, wage inflation was so bad that the only way to keep the economy together was to allow the hyper inflation of other stuff. The FOMC went along with the hyper inflation "cure". Interest rates adjusted for inflation were negative from 1973 to 1981. Indeed, by late in the Carter years, real interest rates reached minus 6%! while the price of gold soared and the US dollar collapsed.

We just got a small taste of what it was like during the 70's; real interest rates were negative by a percent or two from late 2002 until early 2005. Negative real interest rates hyped the value of houses just as the congress pushed banks to lend 100% to non qualified buyers. We are all paying the price for "forced charity". We are paying a great price yet due to our lack of understanding we are about to continue in the direction of forced charity.

The good news, so far, is that there is no wage-price spiral, like the one of the 70's. Real interest rates were positive during 2006 and 2007 and only went negative, again, at the end of the oil-commodity price spike. Real rates went negative by about 2% last summer and the stock market has been pounded almost as bad as it was in the late 70's. The difference this time is that inflation expectations have already collapsed, as noted in the price of every thing from copper to oil. Some talking heads continue to worry that large increases in money supply will cause hyper inflation but the truth is that the tendency of most businesses and consumers will be to pay down debts over the next several years.

Back in the 70's and early 80's, wages went up rapidly regardless of the price of raw materials. Starting by 1966, union members got big wages, the minimum wage was raised rapidly and even the very tough recession of 1973-74 did not take away the inflation caused by mandated wage increases. Without the intervention in the markets by government and unions, the invisible hand of Adam Smith would have solved the problem quickly. As it was, the invisible hand eventually won but it had to battle the fact that the starting wage of a bag boy at the local grocery went from $1.00 per hour in late 1965 to $1.80 per hour by 1968; an 80% increase in about 2 years! Bag boys earned $2.50 by 1970, an increase of 250% in slightly over 4 years. And, they all made about the same, the hard working ones and the goof offs. The real price was much higher as everyone paid extra to cover the waste perpetrated by the goof offs.

This time around, amazingly, we continue to experience deflation in durable goods prices. We were on the edge of seeing significant price increases in manufactured goods about the time oil hit $147 per barrel but the turn has been made. The number of people working in manufacturing jobs continues to fall. Around the world, manufacturing jobs are being reduced as are the prices of everything from computer phones to car batteries.

There are two things going on here: 1) "Ricardo style" processes where one manufacturing set up after another is reviewed to find more efficient ways to produce goods while using fewer materials, and 2) The more important process going on is the Schumterian "gales of creative destruction". In other words, inventions are totally changing the way things are done. For example, scientist have invented carbon fibers that weigh less than steel but are many times stronger than steel. More importantly, they are learning how to "print" these fibers into any shape they want. The day is near when a manufacturer or maintenance company will need no parts inventory; it will "print" the part it needs just as the part is needed. Can you imagine the savings of capital and transportation? Can you imagine a world where steel is no more valuable than flint arrowheads?


The sad thing is that politicians who do not appreciate what drives Schumterian creativity are about to win control of government. As part of the backlash against the ridiculous executive bonuses that have been paid and as a result of a news media that has been willing to fight the war on terror with a war of words, these politicians propose that we throw the baby out with the bath water. They want to increase already high taxes on innovation. The economic rule is simple, tax innovation more and the less of it you get.

The additional taxes to be applied to capital gains is a terrible economic idea and sending "refund" checks to those who do not pay taxes could be the start of yet another gigantic and harmful government program.

Thomas Jefferson would be appalled. In the 1780's Jefferson was very concerned because there were too many parasites living off the industry of others. Can you imagine Jefferson's heartache if he saw his and our constitution being shredded?

Obama says it is a matter of fairness, to confiscate from some and give to others. Of course, tax policy will never be exactly fair and there will always be those who pay too much and those who pay too little, but forced "charity" is a disservice to the provider and the recipient. It takes away the incentive to work from both parties. It is the stuff of the Lyndon Johnson years. At the time of Johnson, one could argue about the need for government largess as the way to solve the major civil rights problems of the day. As usual the government did things the hard way and made matters worse before they could get better. Millions of children have been raised by single Moms as a result of the mistakes made by Johnson (perhaps even Obama himself).

Obama's missing ingredient is that the hardest working people are the ones who make life better for the rest of us. The fellow who just invented the process for "weaving" cloth at 10,000 times the old speed will become rich but he will save the people of the world trillions of dollars. Obama says this man should be taxed heavily; I say that this man is likely to spend millions to save us more trillions, if we give him a fair shake. How about the thousands of inventors who only occasionally hit a single or a double, compared with this mans home run. Inventors normally strike out many times more often than they even make it to first base. The inventor who makes $200,000 in one year and is taxed heavily may not want to risk his balance on another high risk, high potential project.

Again, the economic truth is simple, when the government taxes rich people and subsidizes poor people, the result will be fewer rich people and more poor people. The law of supply and demand is more powerful than all laws made by man. The laws of man can be changed but only God can repeal the law of supply and demand.

In the mean time, real interest rates are set to rise in the USA and in Japan. The market is waiting with baited breath for the FOMC and the Japanese central bank to decide about lowering the nominal short rate. The prices of many things are falling, including the price of money. The strength of the US dollar and the Japanese Yen shows the relative projected strength of our economies. Countries like Canada, Australia and Russia are seeing a collapse in their currencies (and thus higher inflation rates) as a result of the lower demand for the raw materials produced in these resource rich countries.

Ironically, the best news would be for the FOMC to not need to lower short rates. The yield curve is very steep. Both monetary policy and fiscal policies are pushing the US economic locomotive forward. To further bring down the price of gold and other commodities, real interest rates need to go up. The strongest move would be for short rates to hold or rebound while the price of abundant supplies of coal, copper, oil, Tupperware and other durable goods falls. As low cost nuclear energy comes on line in China, the cost of durable goods will fall another notch.

(By the way, Intel expects to make 7 trillion digital radios over the next several years; more than 1,000 radios for each man woman and child on the planet. Your computer telephone is going to know the amount of milk that is left in the jug inside your refrigerator.)

Monday, October 27, 2008


The Calvary bugles can be heard in the distance, relief is on the way. In recent days, consumers have been pleased to spend $20 less on a tank of gas, but the gas that will sell for $2 per gallon is just entering the far end of the pipeline. A few weeks from now, consumers will be pleased to save $40 per tank (20 gallon tank). The sound of other bugles, telling the story of relief can be heard. It is not just the price of gasoline that is coming down.

Saturday a friend in the plastics business mentioned that his company posted a huge price increase in July. At the time, oil was trading around $145 per barrel. My friend admits that his company will hold up prices for as long as they can. The company needs to rebuild its balance sheet before adjusting to the current price. The decline from $145 to $62 is a 57% decrease in his companies prime raw material. Inflation is on the way down!

The 5 year EU Bund has dropped from 4.75% to 3.25% since June! The cost of 5 year EU money is down 32% in 4 months. South Korea just lowered its short rate by the largest move ever. Rates just went from 5% to 4.25%, a 15% decline in one day. The news media is talking about how this recession might last three years but the big drag on the economy, housing, just saw its first year over year sales increase in 30 months. Home sales were up 5.5% in September and up 1.4% year over year. The percentage of homes in foreclosure is falling fast because the foreclosed homes are being dumped on the market rapidly. The banks want these properties off their books. The short term effect is the final drop in average home prices even while prices rise in most communities.

It is worth repeating that based on price moves that have already happened, the average household is going to reduce its spending on fuel, including transportation fuel, by $4,800 per year. Include the savings to the consumer from price decreases of other raw materials and the average household will spend $12,000 less in the next 12 months. This $12,000 increase in the family budget will not be taxable income, it is more like found money.

This cycle was unusual in that the economy stayed very strong even as consumers were pounded mercilessly by higher prices. Now that the higher prices are dissolving, the consumer is going to see times like the 90's, after the last real estate recession. I remind you that after the bottom was made, Best Buy went up 1,400% in less than 3 years.

For some time I have recounting the events that occur during an economic slowdown. Three of the key things expected: 1) a drop in commodity prices, 2) a decline in bond rates 3) a sharp turn around in bank stocks. So far, we have seen 1) a steep drop in commodity prices followed by a minor bounce which lasted for a couple of weeks and then a resumption of the decline, 2) a significant decline in bond rates in the US followed by a minor bounce during which stubbornly high EU Bund rates finally rolled with passion, and 3) we saw a significant V bottom in bank stocks followed by a "correction". Pretty soon, the pace of bank consolidation will pick up and prices will rise.

This morning in London, the financial sector is off 5.8% while the Energy sector is off 6.1% and the Basic Materials sector is off 8.5%. Keep in mind that the EU will not benefit as much from lower fuel prices as will Americans. In the EU, there is much more use of mass transit, but in both countries the sharp decline in fuel prices is just beginning to make its way to consumers. RELIEF is on the way.


While McCain has been accused of using the race card, Obama is set to enjoy the most lopsided and largest turn out of black voters in our history. Obama will likely receive 98% of the black vote. Only in recent days has McCain found the way to get the message out that Obama's policies would push the country back toward the welfare state. More than 200 years ago, Thomas Jefferson lamented that there were too many parasites feeding off the efforts of the industrious. TJ would not be fond of many of McCain's ideas but he would deplore the policies proposed by Obama. Government has gotten control of too much. The recent mistakes made in the housing-banking arena demonstrate again that individuals and small businesses make mistakes but when big business and big government make mistakes the costs are enormous.

The good news is that Obama continues to moderate his positions. When he ran against Hillary, he was a flaming socialist. His most recent proposals reduce the level of pain he would cause the economy because he has reduced the size of the income re-distributions that he would force upon the "rich". The interesting thing is that Obama appears to be headed for a box that is upside down from the box where Bill and Hillary found themselves. Obama might actually be forced to fight proposals pushed by the most liberal of democrats.

In the know republicans are unlikely to admit that an Obama administration will not be as "socialist" as it is being painted during the heat of the election. The danger is the direction because the number of parasites has grown to well beyond majority proportions. Eisenhower warned of the feeding at the trough by the industrial-military complex, however, the over kill of defense spending did not do the kind of harm that will be done if we move back to the policies of the 70's. In his campaign against Hillary, Obama railed against free trade, he supported the union check off system that would take the secret ballot out of the system and he supported the fairness doctrine. I suspect that Obama will not destroy the benefits brought to consumers through free trade; his rhetoric of the past was for the purpose of staying to the left of Hillary during a critical time in the primary. Unfortunately, he will go along with too much support for oppressive labor policies but I doubt that the check off system will be instituted, it is just too anti-democratic to pass or to stand a supreme court review. The fairness doctrine was very harmful and, again, so anti-democratic that I doubt it will be re-instituted. Thoughtful liberals and conservatives hold tight to our rights of free speech.

While Americans have learned that the media is biased, we constantly get taken in by the media. In the old days, there was a stark difference between op-ed pieces and the news. Today, most news is op-ed in disguise. Opposing stories are ignored. The "old media", newspapers, magazines and network TV is dominated by liberals. As always, the market finds its way around impediments. The market place and free speech are like water flowing down a mountain, it will ultimately find its way to the atmosphere, most likely making it into the ocean along the way. Today we have talk radio, cable TV and the Internet serving to counter balance the "old media". And, once again, restrictions on contributing to political campaigns has become a joke. McCain has been hoisted on his own petard while it was Obama who committed to accepting limits before he rejected limits.

Right at this moment, polls suggest that democrats will sweep all three houses and may gain a filibuster proof majority in the Senate, a dangerous combination. I would not bet that McCain pulls out a victory but I would bet that the race tightens greatly. For perhaps the first time ever, polls show that the majority of Americans believe rule by one party is best. I disagree strongly, but the more important point is that a significant number of those who believe one party rule is best are far right republicans. Many independents and moderate democrats are likely to flinch before voting for a democratic house, senate and white house. In North Carolina, Obama has a slight lead in the polls but NC has traditionally (for 25 plus years) voted for a democratic state government and a republican national government. Liddy Dole is running behind as is McCain but I would bet that they pull out narrow victories in NC.

The investment reason to discuss the elections is that the fear of one party, extreme left rule, is over done. In the final days of the campaign, the irrational anxiety will calm down. Just having the election over will be a relief.

At the bottom of the market, there is fear of everything. I chuckle at the fears expressed of hyper inflation that might come come as a result of the surge in money supply. We are seeing record declines in prices for all sorts of goods and yet during a time of panic some folks raise the fear of hyper inflation. Right now, the fear of socialism is more reasonable than the fear of hyper inflation. A good measure of how much money is being printed is the total loans being made. So far, the pattern is very consistent with past cycles, the growth in lending prior to the recession was quite high, growing at better than 14%, but the growth in lending has slowed substantially in recent weeks. The rate fell and then bounced but loan growth should remain slow for a year, two or three after the recession is over.

When I report that the average household will spend $12,000 less on inflated prices, over the next year, I do not mean to suggest that the entire $12,000 will be spent in other ways. The pain suffered by those who paid too much for houses, stocks and SUV's will not go away immediately. Most consumers will use a significant portion of their savings to repair their balance sheets. Many loans will be paid off or at least paid down. The growth in the money supply will be stronger than the past few years but not so strong as to cause great inflation.

The fear of hyper inflation is from those who have noted that the FOMC is suddenly growing the monetary base at a 14% annualized rate. We must remember that the banks are more responsible for printing money than is the FOMC. When banks have tighter lending standards, less money is printed. This is where we are now, the FOMC is actually having to increase the monetary base rapidly because the banks are reluctant to lend, except to top score credits. Indeed, it is clear that the FOMC did not lean hard enough against the banks during the boom times of a few years ago. Now, it is appropriate for the FOMC to lean against the banks by making more money available.

Other doom and gloom projections about the coming great depression are the result of fears that the banks have stopped lending. I say again, existing home sales jumped by 5.5% in September, to 5.18 million units. The average price of those homes was around $200,000. The total value of US housing loans made in September approached the 1 trillion dollar mark. During times of fear, there are boogie men around every corner but the US is the most solid country ever. We make mistakes but we recover from them. The quality of the loans made in September was a far cry from the quality of the loans made in September of 2005 when the congress said bankers would go to jail if they did not loan to the unqualified.

The current problem developed over a long period of time. It will not be solved overnight but our country began taking its medicine three or more years ago. We sent a rider out to Fort Laramie a long time ago. Now we can hear the sound of bugles. Relief is on the way.

Friday, October 24, 2008

Oh No! A Democrat at Halloween


This morning the US Dollar has appreciated 7% versus the Australian Dollar and the Japanese Yen has appreciated 4% against the US Dollar. What a turn? The price of raw materials being mined in Australia, assuming no change in local prices, just dropped by 11% to Japanese buyers. Stocks do well during times of declining inflation rates. As lower priced raw materials work their way into products, the initial event will be an increase in manufacturing profit margins but the lower costs will later show up in lower priced products. Inflation rates are going to fall in the USA and even more in Japan, which imports a very high percentage of its raw materials.

Many an international mutual fund is charted to exclude Japanese investments. The rational is that Asian emerging growth nations are at the other end of the Japan see-saw. If you hold international funds, in 401-K accounts or elsewhere, you should focus on Japanese stocks. Over the long term, China, India and other nations will grow faster than Japan but Japan will be a strong performer for the next many years. Japan under performed from 1989 until 2003. It's relative performance has been strong since 2003 but the recent sharp declines have brought shares close to the 2003 bottom. EWJ is an exchange traded Japanese Fund.


The cheapness of the US stock market has reached 1982 levels by a growing list of measures. Stocks were very cheap in 1982. Overnight, stocks in Japan, Korea and London were down again. How low can they go?

Bond investors have always included the smartest of investors. While bond investors must ultimately guess, just like the rest of us, their business has much more straight forward math involved. In recent weeks, bond buyers, by nature a conservative bunch, have been willing to buy long fixed rate bonds instead of buying TIPS (variable rate inflation protected securities). Many of these buyers are 100% bond buyers; the charters they hold forbid them from buying anything other than fixed income securities. These buyers are currently willing to lock funds into 3.6% for ten years rather than earn a variable rate starting at 2.5% for 10-years. The implication is that inflation rates will stay low for 10 years. The difference between 3.6% and 2.5%, with relatively minor adjustments (as can be seen on the Cleveland Fed Web Site) is the markets inflation forecast. Inflation expectations are at 1.1%!

Sock investors should be elated. Stocks do very well when inflation rates decline. Investors often times miss an important distinction here. Investors frequently assume that stocks do well when inflation rates are low. Stocks do best during the move from high inflation to low inflation. Victor Canto has frequently made this point. In "Understanding Asset Allocation" he included a table that shows: average monthly returns during times of decreasing inflation rates. From 1948 to 2004, the average monthly return on stocks was 1.17% during times of decreasing inflation and .33% during times of increasing inflation. Bonds and stocks are distant cousins. Bonds and real estate are more like the Hatfields and the McCoys. From 1948 to 2004, the average monthly return on treasury bonds was .3% during times of decreasing inflation and negative .44% during times of increasing inflation. I don't have the numbers from real estate handy but real estate returns are almost inversely related to bond returns. Please note that the risk of loss is much higher in bonds than it is in stocks.

OPEC just met and lowered production quotas by 1.5 million barrels per day. The people of the world are drowning in oil that is 10 feet deep and OPEC just lowered the level to 8.5 feet. The wholesale price of gasoline is down another 11 cents this morning. Retail gasoline should sell for $2.04 within 2 to 4 weeks. By the way, it is true that a wholesale price increase would have been reflected in the retail price quicker, but so what? If you were in the gasoline business, you too would be slower to lower prices than to raise them. Do your part by shopping for the lowest price. You can check prices on line and avoid going out of the way to save a few dollars per fill up. The station that is slow to lower prices will get the message quickly.

While we obsess over the price of gasoline, we miss the big movers. From 2005 to 2007 the shipping rate index for bulk commodities went from 1,000 to 11,500. It has taken less than a year for the rates to fall all the way back to 1,000. The number of supertanker sized ship loads going from Chile to China has fallen rapidly.

In 2000, the supply of palladium, a metal used in automobile catalytic converters, were tight. Prices soared. By 2001, Ford Motor felt forced to buy stockpiles to prevent having to shut production lines. That decision ultimately cost Ford a Billion Dollars. The invisible hand of Adam Smith is always at work. The world finds always finds substitutes when necessary.

It is the folly of man to believe that he can force substitutes on the market. In recent weeks, the prices of numerous metals have fallen 50% or more. Palladium is an interesting metal. Because it can absorb 900 times its volume of hydrogen, it is seen as a "metal of the future". The problem is that the push to build hydrogen fuel cells (and wind mills and ethanol plants) loses its economic reason to be when supplies of oil are abundant. The reason the price of oil has fallen from $147 to $63, 57%, is because supplies are abundant. Cuba just raised its estimate to 20 Billion Barrels for a field that is common to the USA. When Nancy Pelosi was blocking off shore drilling, she and her friends used very old USGA estimates. The old survey estimated total recoverable off shore USA oil of 18 Billion Barrels. If the one field next to Cuba has 20 Billion Barrels, how much oil do you think there might be in more than 10,000 miles of coastline? Back when the survey was done, the 70 Billion Barrels off the coast of Brazil had not been discovered. Do you think that the estimates might have been higher had it been known that Brazil found 70 Billion Barrels under two of 13 known formations off their coasts? Do you think similar formations off the coast of the US will be explored in the future?

It is unfair but fun to compare the current situation to that of WWII. Back in those days, inflation rates were negative. Around the world, much time and effort were spent recycling everything. Can you imagine a soccer mom driving a dually truck to haul a couple of school kids during those days? Consumers would have used more of many things had they been available but supplies were rationed. It is the height of hypocrisy for politicians to ride in massive SUV's while recommending tax increases on the pension funds of Exxon owners. The experience of WWII shows that the price changes of goods can be negative for a very long time and interest rates can go very low. The stock, bond and commodity markets are all suggesting that inflation is going to virtually disappear.


The "book" says that consumer staples reach their relative price peak right at the end of the expansion phase. This is part of the natural flight to safety. The book also says that commodity prices start coming down hard during the early contraction phase. Many commodity prices have now been falling for a year but even the stragglers have been falling for at least 4 months. The book says that bond values go up during the late contraction phase. Bonds peaked by some measures in June of 2006 and by many other measures by July of 2007. According to the bond market, we have been in the late stages of contraction for 15 months. Finally, still in the late contraction phase, the book says we will see a V bottom in financial stocks. Since the July 11 "bottom", the S&P 500 Index has fallen 27.5%, the KBE S&P Banking Index has fallen 3.9%, the TLT 20 year treasury index has gained 4.6% and the KRE Regional Bank Index has gained 12.9%!

The "book" goes on to say that the market bottom will be made before the economic recovery starts. The market bottom will happen soon after the turn in financial stocks and consumer cyclical stocks will be the first stocks to jump after the bottom has been made. The official declaration of a recession will not be made until well after stocks have risen sharply.

The ROW (rest of the world) gets hit harder during real estate recessions than does the USA. This morning, the US Dollar has once again soared. The US economy is relatively strong. It is other countries which need to cut their interest rates and they are obliging. The brakes are gradually being let up in one country after another. As the dollar soars, the price of gold and oil falls, but there is more to the price of gold and oil than the strength of the dollar. In the last few months, the dollars needed to buy one Euro has fallen from $1.58 to $1.26. After this big move, the price changes of oil in terms of Euro Dollars are getting close to the levels seen in terms of the US Dollar. The point is that the price of oil, money and other commodities went up around the world and now these prices are coming down around the world.

Japan has been in an economic funk for 18 years. Japan, as a major importer of raw materials, will benefit greatly from the decline in commodity prices. Even so, it appears that Japan will be forced to lower interest rates. Sony, a major consumer cyclical products company, just took a big hit on lower earnings and a weak forecast. Once again, the market keeps telling us that we are in the late contraction phase, where bonds are increasing in value and where financial stocks are showing relative strength and in many cases real gains, but where we have not quite reached the market bottom. We have not quite reached the point where consumers find 100's of billions of unspent gasoline and heating oil dollars in their pockets.

It does not take a rocket scientist to see that wholesale gasoline priced at $1.44 is going to flow through pipelines and reach consumers at around $2.04 in 2 to four weeks (retail prices have already hit $2 in Texas and Oklahoma). One can use simple arithmetic to estimate the savings Americans will see over the next year. A year of oil at $147 would have cost Americans more than 1 Trillion Dollars. A year of oil at $63 per barrel would cost Americans 460 Billion. The difference in a year of each price works out to 613 Billion Dollars. The savings from lower prices of everything from money to corn chips will be substantially more than the savings from energy. Politicians are anxious to do a 150 Billion Dollar stimulus package so that they can take credit for the turn; a turn that will result from annual savings to US consumers of more than 1.4 Trillion Dollars. A savings of about $12,000 per household! As we saw last time, a stimulus package where the government borrows 100 Billion to give out $600 checks does not stimulate the economy. Forcing consumers to borrow $600 does not make them want to spend money. A fall in the price of gasoline from $4.11 per gallon to $2.04 per gallon has nothing to do with borrowed money. The owners of oil reserves are hurt and the consumers of oil benefit, but those hurt did not have their property confiscated by the government. The person who finds an extra $40 in his pocket after filling up his tank does not have extra debt hanging over his head.

A few months ago, consumers, businesses and countries around the world were playing the same game Ford played in 2000. There was a rush to buy up all the supplies of raw materials possible; before the prices went higher. Now that the world wide recession has hit, it will take many years for stockpiles to be worked off. Capital intensive mines run during good times and bad. At the height of the craze, investments were made in new production facilities. Many of these projects will be completed. For example, the Willow Creek Mine in Nevada will spend the next several years finishing the development of a 6 million acre project while knowing that supplies will be more than adequate when the project finally goes into production. Mines will continue to produce as long as all marginal costs are covered. The huge capital cost will have to be recovered during the strong times of the next cycle.

The price of raw materials is substantially higher today than they were in 2002. The price of copper went from below 50 cents in 2002 to above $4 in 2007. It is now around $1.80. I don't want to guess when but it will probably make it back to 50 cents. As raw materials prices fall, the inflation rate as measured by the CPI will fall. Interest rates will fall but real interest rates will rise. As US real interest rates rise, the value of the US Dollar will continue to rise and the price of Gold will continue to fall. If gold prices fall, the owners of DZZ will make as much as 200% of the decline in prices. This is one way to "win" while the market makes it's way to the bottom.

Wednesday, October 22, 2008


The US dollar is soaring because the growth prospects in the USA are better than in the rest of the world. This week, EU central bankers will cut rates to improve the prospects for future growth. Canada cut rates last week, Australia cut rates last month and there are more cuts on the way. Long term mortgage rates in the USA have once again fallen to 6%. Credit spreads are narrowing. The surge in the US dollar is consistent with strong relative US stock market performance. After real estate recessions, US stocks tend to do better than international stocks. Good times are around the corner.


Right in the middle of a recession is the time to have a consumer spending surge. This is not the time for gloom and doom. AT&T just reported lower than expected earnings because it sold a surprising number of subsidized Apple I-Phones.

The consumer spending surge, where thousands of dollars of food, fuel, money and other commodity savings are transferred into consumer goods, has started. Keep in mind that those paying $2.87 today for gasoline will pay $2.20 in a few weeks. The stimulus of lower prices will be in the range of 500 Billion to 1 Trillion Dollars, far more than the $100 Billion of government refund checks sent a few months ago.

How Low Will Interest Rates Go?

During the real estate recession of 1990, the 30-year treasury bond traded at 9% in mid 1990 and at 5% in late 1993, a decline of 44%! Will housing construction snap back faster this time than last? There are too many houses in countries from Iceland to Bulgaria. If the thirty year rate were to follow the prior pattern, it would be down to 3.4% in a couple of years and banks would be making huge profits.

There is demand for long term construction money, for nuclear power plants, around the world. For example, Italy has decided to build 8-10 nuclear power plants, having declared the closing down of nuclear plants a 50 Billion Euro mistake. Should a new US congress decide to rebuild bridges across the USA, the demands for long term funding would be significant.

However, for the past several years, China has built interstate highways on a scale never seen before. The point is that demand for long term financing is not the key to interest rates. There are three factors that have been keeping the lid on interest rates; they all have to do with keeping inflation low. 1) In our new global economy, there are ample supplies of labor. 2) There is better understanding and use of fiscal and monetary policies. 3) Innovations continue to boost productivity.

In our global economy, supplies do not get wasted by inefficient users, nearly as much. The age of chopping down trees to burn in out door fire pits is largely over. While it is true that Americans and others drive extra large and wasteful cars, businesses do a good job of finding the low cost producer. Furthermore, the run up in commodity prices has made the citizens of the world aware of the tremendous waste committed. For the next many years, consumers will look for ways to conserve.

We all know that Greenspan let interest rates stay too low for too long during the real estate bubble, but even the current down turn is mild compared to those of the past. Thousands of savings and loans and banks went busted during the last real estate recession. The many countries that built up sovereign funds during the boom times are cushioning the down turn. Petro dollars are being recycled. Substitutions, that result in lower consumption of resources, are being made by the second.

Innovations are spewing out of laboratories across the country and around the world. The most exciting innovations are nano sized. Last week, a fellow at NC State announced a way to "weave" nano super strong fabrics at about 10,000 times the normal rate. Before long, we will need very few people working in manufacturing plants. We can all spend our time inventing something neat or at least offering some service or another to our fellow citizens.

Productivity is better than found money. For one to find a wad of money, someone else must have lost a wad of money. Productivity produces new money out of thin air. At first, the bulk of this money goes to the people who use the new idea to lower cost and increase profits. Before long, productivity shows up in lower prices. Lower prices show up in lower interest rates.

I don't know where interest rates are headed, but I know that interest rates and commodity rates trade together. I also know that, for the first time in many years, China's steel mills are not running flat out. The world wide demand for highly elastic goods has fallen. The price declines are as large as those seen at the end of the inflationary 70's; back when treasury bonds offered 14% returns. Long term treasury bonds paid 2.5% during the 1940's. Stranger things have happened!


When the real estate recession began to bite in 1989, international stocks began to suffer in relative terms. 1989 was a good year for investments with the average investment up 18.24%, but the average REIT was up only 8.6% and the average international stock was up 10.5%. The next three years, international stocks were at the bottom of the list of performers. In 1990 the average investment was down 4.8% while the average international stock was down 23.4%. From 1989 through 1997, international stocks were the worst or second worst performers 7 out of 9 years. The 1990's were great years to be an investor, an American investor. A similar story can be told about the years following the 1973-74 real estate recession. US stocks do very well in the years that follow real estate recessions.

This morning the EU has fallen relative to both the US Dollar and the Japanese Yen, again. The big turn is still happening. The price of a barrel of oil is trading below $70, the China market is down again, the 10-year treasury bond rate is down, the wholesale price of gasoline is down to $1.63 (implies the retail price will soon fall to $2.23), gold is down another $11and the list continues. Silver, platinum, Korean stocks, Thai stocks, European stocks, Hong Kong stocks are all trading down. Over the next 12 months, assuming energy prices stay at current levels, the average household will save $4,800 on energy costs. The savings in other areas are more difficult to determine but they will be even greater. With the price of copper, steel, zinc, palladium, down 50% or more, the price of your next new car will be considerably lower than it would have been. Loan rates will soon be at lows not seen in 70 years.

This morning, the big movers, in England, are once again basic materials, capital goods and energy. Commodities of all stripes have gone from tight supply to excess supply. In the mean time, Paulson has asked banks to apply for bail out money by November 14. Paulson's push to get congress to act was once like a man whose house was on fire. After he got control, the government bail out is moving as fast as molasses. At the same time, the FOMC is supplying all sorts of funds to the banking system. Bankers are being given plenty of liquidity with which to remain in business while they wait to find out their fate. Will they be forced to sell shares to the government or not? Many banks will be forced to merge with others. Those who do not need the government money are making plans to buy banks that do not "qualify". The treasury department has been given extraordinary power to pick winners and losers. It is clear that the Bush administration cared more about making big money for the super fat fat cats than about winning republican votes. The action of throwing McCain and the rest of republicans under the bus, has caused billions if not trillions of dollars to run from the market just when money should be running to the market. The super fat cats have purchased billions of shares, including shares from former fat cats. A number of billionaires who were not close buddies of the super cats are now millionaires.

Yesterday, a sophisticated reader, one who is in the investment business, worried that the huge amounts of money being printed by the FOMC are going to cause hyper inflation. I reminded this fellow of the fact that private banks actually control the printing of money. Yes, the FOMC has injected high powered reserves but the money pipeline flows through the banks. The FOMC cannot fill the swimming pool as fast as the banks can collectively drain it. To put it another way, the job of the FOMC is to lean against the banks. The FOMC did not do its job a few years ago when the banks were "printing tonnes of money", but it is currently trying to fill the pool that is being drained rapidly by banks. The monetary base has recently grown by more than 15%! The FOMC is supplying money; stocks and money growth trade together; the new supply of money is increasing the demand for stocks.

Banks print money by loose lending. There are always willing borrowers. The way congress set up the mortgage rules, banks were being paid fees to lend money and there was no end to the lines at the door. The banks that sold the loans seemed to have avoided all risks; most got burnt by buying the AAA rated securities packaged by investment bankers such as Paulson. The current situation is that many banks are on the hook for bad loans made in the past. The average bank has raised the qualifications for getting loans. The FOMC is printing money but banks are soaking up old loans.

To put the above in mathematical terms M*V = P*Q = GNP. The FOMC is printing money but the velocity of money has fallen dramatically and thus the product of P*Q probably fell from second quarter levels. In the energy, basic materials and capital goods areas, we know that it is P that is falling rapidly. Quantity sold in a some areas has been falling but there is a see-saw effect going on. The further the declines in P, the greater the Q that will be sold. In the past quarter, GNP was probably lower than the previous quarter but the quantity sold is going to soar over the next couple of quarters.

The other thing to remember is that money is nothing but another commodity; the rapid fall in the price of commodities, including the falling price of money, is anti inflationary. Copper went up from 50 cents to $4.25 while the retail price of gasoline went from $1.25 to $4.11. The price of copper is now close to $2 and, based on the wholesale price that is working its way to market, the retail price of gasoline is down to $2.23. The price of copper went up 850% while the price of gasoline went up 320%. Gasoline gets noticed, with big signs posted on every corner, while the price of copper is hidden in the price of other goods. The price the FOMC charges for money has fallen from 5.25% last year to 1.5% this year. The decline in the price of money has been bigger than the decline in the price of copper which was bigger than the decline in the price of gasoline. The average fellow spends far more on money and other commodities than he does on gasoline.

One of the ways to play the current situation is to own commodity short funds. For example, there is a double short gold fund and a double short oil fund. These funds have been soaring for the past few months. If the price of gold and oil continue to go down, these funds will continue to do well. I am most confident about the continued decline in the price of gold. The current price includes a "flight to quality" premium. People have purchased gold because they believe the wheels are coming off the economic wagon.

One fundamental reason to buy gold is to protect against negative real interest rates (inflation). The thing is that declining commodity prices are going to raise real interest rates. As soon as the economy starts to move, the FOMC is going to reduce the stimulus of new money, short rates will rise and gold will face high real rates. The past several years were remarkable in that inflation remained relatively tame even as the price of corn, copper and oil exploded. China gets all the blame for the high price of corn, copper and oil, but it also should get the credit for supplying labor at cheap rates. The average American has been blessed by the lower cost of goods and by the creation of high paying jobs in America, jobs that in one way or another are connected to the strong economic growth in China.

In regard to the international situation, Iran's economy is being crushed by the decline in oil prices. The risk of war with Iran keeps going down. Iran is now talking to western nations about nuclear power plants. Russia is about to finish Iran's first nuclear power plant. Volume refiners can supply Iran with nuclear fuel for these plants at a small fraction of Iran's cost of refined ore. The Israelis now believe it will take 5 more years for Iran to make a nuclear bomb. It is in Iran's best interest to sue for peace, especially if they do not have the expertise to build a bomb. The country is hurting and Amadenijhad is at risk of losing power next June. The point for investors is that gold is partly over priced due to exaggerated fears of war. Said another way, it is the price of industrial metals that pull the price of gold up or down; deflation in industrial metals means the rational for holding gold has been reduced.

THE BAD NEWS -- the world wide slow down in economic growth combined with increases in production of commodities over the past 7 years has resulted in a steady decline in the price of goods -- THE GOOD NEWS

Add the savings from oil, corn, copper, money and all other commodities and the average house hold will save $12,000 to $15,000 per year for the next many years. Can you see why companies such as Best Buy will sell a lot of goods over the next several years? Can you see why auto sales are finally going to turn up? Can you see why mortgages are going to get paid?

A sophisticated friend, one who makes his living in the investment arena, made a great point yesterday when he noted that he knows of no one who has lost their job as a result of the current economic recession. One can argue that lay offs are coming and that there are people out of work and there are people hurting, but, the other side of the coin is that the cure is already on the way. Last night, I paid $2.87 for gasoline. The highest I paid this summer was $4.11. Within two months, I expect to pay less than $2.11. On the way up, the extra $2 per gallon hurt, but it will help on the way down. My tank is a 22+ gallon tank. I normally buy about 21 gallons. $42 savings per fill-up will be welcomed relief. Two to five years from now, there will be much talk about just how low prices will go. With anti oil democrats about to take control of government, the US will spend too much money subsidizing wind mills and solar panels. Taxpayers will foot the bill for extra energy supplied. This will mean lower fuel prices and it will mean that we continue to buy a lot of foreign oil. We will pay a lower price by the time the fields in Cuba and Brazil are fully developed.

Buying at a low price from foreign suppliers is not a bad thing. We get fair value for our money when we trade. I frequently buy Washington state apples and grapes from Chili. Still, we should allow drilling while reducing subsidies. We can bring the price of gasoline down to $1 per gallon. Yes, we should convert our tax system from an income tax to a consumption tax, we should be taxing the use of energy rather than subsidizing the production of it, but that is another story. For now, investors should deal with the good news. Make enough money in stocks over the next several years and the relative importance of the price of gasoline will collapse.

Tuesday, October 21, 2008


Stock prices turn up just as the great majority of people come to know that there is a recession. For more than a year, some have argued that the US is in a recession. The housing business was in a recession way back when the total economy was growing by better than 3%. The auto business was in recession way back when US exports were soaring. The last quarter of 2007 contracted by a tiny amount but the next quarter saw rapid growth. By the classical definition, the US is in recession only if it experiences two negative quarters in a row. After the swoon in September, it is highly likely that the current quarter will be a negative quarter, however, recessions tend to be over by the time most people believe we are in one. The public believes.

Looking back, we see that the real estate recessions of 1973-74 and 1990-91 ended just when housing starts hit rock bottom, just when real retail sales fell rapidly and just as industrial production hit the skids. Over lay the numbers and this recession is just where the 73-74 and the 90-91 recessions were when the markets began to soar.

Stocks were up big in November and December of 1974, but they were down for the full year. In 1975 the average small stock appreciated 52.8% in value, the average large cap value stock appreciated 43.4% in value, the average conglomerate appreciated 37.2% in value, the average growth stock appreciated 31.7% in value and the average non US stock appreciated 26.9% in value. In November of 1974, at the jump off point, new housing starts hit a low not seen in many prior years. The words being used by the news media were about how bad the recession would be and was another great depression upon us?

Google the headlines in early 1975 and you would come to the conclusion that the consumer was unemployed and broke. Many Americans were very confused. Why were stocks going up during the worst of times? Most people decided to wait before "jumping back in". Many waited for a "pull back" buying opportunity. In 1976, the respective gains for the classes of stocks mentioned above were 57.4%, 34.9%, 23.8%, 13.8% and -.6%. (Notice that international stocks do not do nearly as well as US stocks in the years just after a real estate recession). Those who bought a non levered $1,000 worth of small stock shares on January 2, 1975 saw the value climb to $1,520 in a year and to $2,392 in two years. Those who used maximum leverage turned $1,000 into more than $10,000 ($10,000 into $100,000) in two years.

The story of the next and only other real estate recession since 1973-74 is the same. The market "released" around February of 1991, right when everyone was well aware that a recession had hit. The returns on small US stocks (large companies but small relative to S&P 500 companies) over the next several years were: 1991, 44.6%; 1992, 23.4%; 1993, 21%; 1994, 3.1%; 1995, 34.5%; 1996, 17.6%; 1997, 22.8%; 1998, -7.3%; 1999, 29.8%. It was easy to miss the 44.6% return in 1991 because "the wheels were falling off the economic wagon". Even the 23.4% returns of 1992 were not easy to grab because the world looked to be in such great trouble, after all Hillary was about to force the takeover of the private health care system. The average person found the way to start adding money to the markets by the mid to late 1990's. Today, they still wonder what hit them when stocks went down from 2000 to October 2002. The returns of -3.6%, 2.5% and -15.3% of 2000 through 2002 hurt badly if one did not catch the 44.6% return of 1991.

Yesterday, the story went around that OPEC will slash production this week. How silly the concern! At $70 per barrel, windmills and other expensive alternative energy projects make economic sense. OPEC can encourage the building of windmills if it likes. Once the huge capital per kilowatt is spent to build a windmill, it will not be shut down even if oil drops to $5 per barrel. The windmill that does not make economic sense to build makes economic sense to operate. Each member of OPEC certainly wants to keep their oil revenues high. Total revenues are a function of both price and quantity. The current price is well above the cost of exploration and development of new supplies.

Cuba just discovered 20 Billion Barrels; it will make huge profits at $30 per barrel, any oil not sold by OPEC today for $70 will be competing against Cuban oil in a few years. Within 10 years, the USA will be extracting oil from fields adjacent to the Cuban fields.

A few months ago, resources were the King of the Hill. Resources were in tight supply. China, for one, was seeking supply deals from all around the world. Today, resource after resource is being stock piled. Aluminum, steel, copper, zinc, silver and other industrial metals are being stock piled; the amount being consumed is lower than the amount being produced. Gold is being horded because people fear that the wheels are falling off the economic wagon, but, the fact that home sales in England are down 53% from a year ago shows just how much the demand for zinc plumbing facets has collapsed. Palladium has never (as far back as I can find) been so cheap relative to gold! The CRB Index divided by spot Gold prices has not been so low since the fall of 1982, the jumping off point for one of the greatest bull markets of all time. Most of 1982 was a recession year but stocks took off by September. Small stocks gained 28% on the year and were up another 39.7% in 1983.

A few months ago, resources were the King of the Hill, but the King has taken a fall. Many want to help this King back up the hill. Yesterday, energy and materials stocks lead the charge. All the while, the new King is gaining strength. Last night, during a meeting on other matters, I learned that our church pumpkin sale is $4,000 ahead of last year. I noted that people have money to spend and I mentioned that the average family will spend about $4,800 less on fuel over the next 12 months versus the last 12 months. The chorus of gloom and doom from the other committee members was amazing. One believed the drop in the price of gasoline was temporary, another said that those who still have jobs have money and the third said 401-K accounts had been devastated. All points made were true but they all were looking backward. Markets do well during times of falling inflation rates. Inflation rates cannot fall unless they are high in the first place. Getting to the high inflation rate was fun for the owners of resources; the fall will be fun for the consumers of resources.

In a couple of weeks, when retail gasoline hits $2.30 per gallon, these attitudes of gloom and doom will begin to fade. The new king of the hill is not resources but consumers. While Ben Bernanke talks about another economic stimulus package, Americans are starting to receive their first "energy rebate checks". The total value of the energy rebate checks is at least three times the size of the prior government rebate program and the energy rebate checks will just keep on giving. Just like Alan Greenspan, Ben is talking gloom just when boom is approaching.

Perhaps one more set of numbers is worth posting. From November 23, 1990 (during the middle of the real estate recession) to October 1993, Rex Stores (RSC) went up 643% in value. Over the same time frame, Best Buy (BBY) went up 1,472%!

Yesterday, the word on the street was that Circuit City will close hundreds of stores to avoid bankruptcy. CC cannot afford to stock and man these stores during the Thanksgiving through New Years selling season! The consumer appears to be totally tapped out. On the other hand, we know that millions of people will sign up for cable and buy new TV's between now and the analog signal cut off in February. Can you believe that the second generation of the Android mobile computer is close to production? before the first generation has gone on sale! The mad rush is on! Consumers are about to be flush with cash. Retailers will have a surprisingly good season. King Oil is dead, long live King Consumer!

Monday, October 20, 2008


The markets are involved in an "economic recovery bounce". In other words, it does not matter if the economic recession is over or not, the things that were hit hard in recent months are enjoying a bounce. Sectors such as basic materials and energy are participating in the bounce, it is going to take a long time for traders to come to realize just how abundant the worlds supply of materials.

Prior to the 1990-91 real estate recession, copper stockpiles were virtually non existent. Stockpiles were listed at 500,000 tonnes but those were spread out at various sites, making it almost impossible to load up a full train without further production. The recession hit but the mines did not close down. Supplies were re-built. By 1994, copper stockpiles reached 6,000,000 tonnes; just in time, because a necessary ingredient of the 1990's economic boom was abundant industrial metals. By 1997, stockpiles were back down to 1,000,000 tonnes, but toward the end of the boom new mines opened and, wouldn't you know, during the economic slowdown of 2000, stockpiles reached 8,000,000 tonnes. When the events of 9-11-2001 caused further economic heartburn, stockpiles reached 10,000,000 tonnes. The swing in copper inventories from bottom to top was 20 fold.

Last year, there were almost no stockpiles of aluminum, zinc etc., but, during the economic cycle of the 1990's, zinc stockpiles rose from 500,000 tonnes to 12,500,000 tonnes and aluminum went from 100,000 tonnes to 2,600,000 tonnes. The swing in aluminum stockpiles was 26 times. so far. It will take years for auto makers to totally retool.

With the disappearance in the demand for copper, zinc, aluminum and other metals upon us, is the economic trade going to last? Not likely. The tea leaves that tell the future are always vague, but it is easy to understand that the demand for copper and other metals is highly cyclical. Copper traded for 50 cents per pound just a few years ago, during a time when more was being put into stockpiles than was being sold. Copper traded for $4 per pound last year. Copper traded last week for a little over $2 per pound. One set of copper users, car manufacturers, are selling cars at the lowest pace seen in 30 years. Car manufacturers are no longer outbidding one another for scarce copper. The price of copper is on its way to 50 cents or less.

Believers in peak oil, tend to believe that all resources are in short supply. They "buy" the theory that China and India will consume all the worlds resources. They believe in the impossible.

The stock market in China has fallen from 6,000 to 2,000 in less than a year! The Chinese market traded below 200 in 1991. I am not suggesting that the Chinese market is about to fall all the way back to 200. What I am saying is that the drop from 6,000 to 2,000 is a forecast of economic slowdown in China. So far, the rate of growth in China has fallen from 11.5% last year to 9.3% in the most recent quarter. If the EU is in recession, which it appears to be, then exports from China to the EU will slow.

I can't remember the ratios but one tonne of uranium replaces many tonnes of coal and one tonne of carbon nano-fibers replaces many tonnes of steel, the same way that one tonne of two by fours replace many tonnes of logs in a home. No one knows how many people our world can support but, so far, the number is many times larger than the forecasts of Mr. Gloom and Mr. Doom of ages past. China's policy of one child per family has been a tough pill for the Chinese people to swallow, but domestic population growth is negative in Japan and most of Europe. The age when children provided an economic benefit to the family are no more. In any event, our world history is of using resources more and more efficiently. The cost to produce and spend a copper penny is at least 1,000 times the costs to electronically produce and spend a penny.

The ""economic rebound trade" is part of our ongoing "see-saw trade". The weight of the energy, basic materials and capital goods can be held off for a short time but it will prove to be more than enough to push up the value of the consumer side of the see-saw. Please note that while consumer staples have been one of the beneficiaries of the confusion, consumer staples are not on the receiving end of this see saw. Consumer staples have held up very well as a part of the flight to quality (people have gotten off the see-saw to avoid the gyrations). The flight quality has included the flight to gold and t-bills. T-bills are being purchased to yield half a percent safe interest and gold is being purchased at $800 per ounce. The irony is that people are willing to accept almost "guaranteed" losses to avoid what they see as greater risk. They are avoiding risk at a time when the probabilities of upside risk are very high.

Back in the days of hard money, dollars were gold or silver or they were backed by gold or silver. The US Government was forced to constantly suffer runs on the bank. During strong economic times, there would be runs on silver. During strong economic times, as the value of industrial metals, such as silver, copper, zinc and aluminum sky rocketed, smart investors would bring gold to the bank and trade it for silver. No matter what the ratio set, the government soon found itself having to accept too much gold in exchange for all its silver or during hard times, the government ran out of gold when tonnes of silver were exchanged. In the late 1500's, Sir Thomas Gresham wrote down the rules about bad money driving out the good. This rule has become known as Gresham's law. In the past year, the value of industrial metals has collapsed. In particular, the price of industrial metals has collapsed relative to the price of gold.

Gold and industrial metals are now in a long downtrend. The decline in the value of industrial metals is part and parcel to a decline in inflation rates. Lower inflation rates produce higher real interest rates. The rational to hoard gold disappears during times when interest rates are higher than inflation rates. Thus, contrary to common beliefs, it is often the price of industrial metals that drags the price of gold up and down, not the other way around.

The above statements are not meant to be an affront to Gibson's Paradox. The price of gold actually moves inversely to the real interest rate on the long term bond. This is perhaps the most important fundamental understanding that one needs to do well as an investor. The key point that is so frequently ignored is that rising short term rates are tools used by central bankers to ultimately lower long term rates. Commodities trade with short interest rates and inflation but a rise in short interest rates, inflation and commodities tends to ultimately push long rates down. It is counter intuitive but true that rising inflation proves to be a powerful force that ultimately drives bond rates down.

All of the above explains why the ratio chart of silver to gold provides better forecasts than the average economist. At the start of one of the worst bear markets of all time, from 1970 to 1982, silver was valued at 5.7% of the value of gold. By the time the market was ready to soar, in the fall of 1982, the price of silver was valued at only 1.75% of the value of gold. The ratio still had a long way to fall. By 1991, the ratio hit 1%. It was time to buy real assets, every thing from semiconductors to real estate. Prior to the big 2000 peak in tech stocks, the ratio had bounced all the way to 2.4% in 1998. It got back to the 1.2% range when it was time to buy stocks and real estate in 2002 and 2003. In 2006 and 2007, the ratio rose to 2.2% and 2.3%. It was time to avoid real estate in particular. Today, this ratio is back to 1.2%. Those who suggest that we are at the start of another great bear market are not paying attention to relative values.

Looking at the numbers from a different angle, we find that by 2002 it took 810 ounces of gold to buy the average house. Since then, the price of houses increased but the price of gold soared. Today, it only takes 300 ounces of gold to buy the average house. Which is cheap, houses or gold? The numbers for silver tell a similar story; it took 53,000 ounces of silver to buy the average house in 2004 but it takes only 15,000 ounces today. The relative cost of a house has fallen 72%! Today, the smart investor sells his gold and silver to buy real estate or stocks on the other end of the see-saw from capital goods, basic materials, energy and consumer staples.

Hank Paulson is taking plenty of time to let the Sword of Damocles hang over the heads of bankers. Bankers do not know their capital positions until after the government buys mortgage backed securities. This period of uncertainty is giving weak kneed investors ample opportunity to sell at low prices, and, how! The public has sold and sold stock mutual funds and bought gold and t-bills. Last year, there was 7 trillion dollars in US money market accounts, this year, with the Dow Jones down 40%, the public continues to sock away money in these funds. The buying opportunity of an age is upon us but the people are afraid.

The public continues to hold energy, capital goods and basic materials in their 401-K accounts. Thus, in the place where they continue to invest, on a regular monthly basis, they continue to buy the "wrong stuff". Again, the economic recovery trade in these sectors is only a bounce. These sectors had great runs, the prices are down enough to find support but not enough to make these sectors the place to invest for major profits. Industrial metal mines will continue to pump out ore at steady rates. For a few years, much of it will be added to stockpiles. Sales of existing homes picked up a bit last month, this does not mean that builders will rush out to build millions of new homes in 2009 or 2010; not in the USA, England, Australia or China. The car story is similar, customers are not going to rush out to buy the big SUV's sitting on lots all around the world. Lower gasoline prices will cause a rebound in the number of miles driven but for many years to come there will be a relative increase in miles driven in more fuel efficient cars and a relative decrease in miles driven to miles not driven. For example, those who own two cars will drive the more efficient one the most and more trips will be made by scooter.

Lower interest rates, lower fuel prices and lower commodity prices will put more money in the hands of consumers. The real price of manufactured goods is going to continue to fall. Retailers are going to enjoy a surge in consumer spending. There is an economic recovery in the works, but the current bounce in "old" sectors is only a bounce. The real value of homes is rising. Banks will soon begin to recognize a bounce in the value of mortgage backed paper. Bank stocks down 50% over two years are set to recover. The rotation to bank stocks is underway. Soon, there will be a nice surge in retailers and technology stocks will follow. For now, the best values are in the banking sector.

Oil supplies work differently than metal stockpiles in that much oil is left in storage under-ground. During the 1990's when oil was in abundant supply, drillers continued to operate their equipment, they continued to drill for oil. They spent most of their efforts finding new oil rather than developing fields where oil was known to exist. This is the reason that when demand soared by 20 million barrels per day, there were no shortages. The oil companies did a great job of developing existing wells. The price went from $1 per gallon to $4 but the free market pricing system maintained order. Eventually, the congress was forced to release restrictions on drilling. Over the next several years, drillers will once again drill when new oil is not immediately needed.

Cuba has reported the recent discovery of 20 Billion Barrels of Oil, in the Gulf of Mexico, adjacent to US waters! During the debate about allowing US off shore drilling, old US Geological numbers were often quoted. Tell me the truth, do you really believe there are only 18 Billion Barrels of Oil off the entire coast of the USA when Brazil has found 70 Billion Barrels, so far, and when Cuba has found 20 Billion Barrels, so far? We know that millions of barrels annually leak into the waters off the coast of California. Eventually, stupidity gets trumped by economics. We will eventually extract the oil from California waters rather than let it pollute our planet.

No matter if Obama or McCain is our next President, either will have to contend with a liberal congress. One that, so far, has been too stupid to collect oil that is ours. A congress that would rather pay friends to pollute than to allow resources to be used. The price that will be paid again will be pork money given to the friendliest of campaign donors. We are not about to run out of resources, we are about to run out of ways for government officials to pay off their friends.