Keeping One's Head in the Sand

THE INTEREST RATE CONUNDRUN

An inverted yield curve was always thought to be a harbinger of recession, but low and behold we are in a Goldilocks Economy instead; or are we? In the past, inverted yield curves were usually caused by a drying up of liquidity, signified by sharply rising short term interest rates due to curtailed credit expansion and a shrinking money supply, engineered by the FED in the face of sharply rising inflation.

This time around the situation is much different. The world is awash in liquidity and inflation is being masked by the world's excessive capacity expansion and the government's manipulation of the CPI figures. But what the Economists, Wall Street and the Media have failed to realize, is that although it takes awhile longer to develop, creating massive amounts of money, out of thin air, is the harbinger of DEPRESSION.

Today, the Banks and other financial institutions, representing almost 40% of the economy, are in deep trouble, as they try to cover up their bad loans and avoiding defaults and foreclosures by turning them into negative amortization loans: Then in order to maintain their earnings they are making massive loans to feed a takeover and buyout frenzy; that it the past, has always been the surest sign of a Stock Market top. For the time being it seems to be working but it's only serving to delay the inevitable while at the same time exacerbating the problem, as the Banks end up being the BAG HOLDERS, as they have always have been, at every major top. Will the Government (Read Public) bale them out once again? It looks to me like we are attempting to douse the fires of inflation by pouring massive amounts of liquidity on to the very same fire and for the time being it seams to be working but we cannot get away from the fact the massive amounts of fuel and kindling (easy credit and Money) are being added, which in the end will only exacerbate the inevitable.

SO WHAT IS DRIVING DOWN INTEREST RATES?

Is it possible the everyone is convinced that inflation has been conquered for ever in the face of sharp increases for all good and services that we buy every day: from soft drinks to wine, from steak to bread, not to mention health care and home insurance. In the constant effort to earn a decent return in the face of low and falling interest rates Wall Street and the fund managers are reaching for ever increasing risk in their attempt to maintain their performance. But Risk is Risk no matter how you slice it and Risk eventually always comes home to roost. But when it comes to the super rich ($200 million and up) their objectives are different than ours; they are not interested in earning a greater return on their principle, they are more interested in preserving it. And so in this ever riskier investment environment they are buying treasuries that even at to days lofty prices are still yielding a higher return than inflation, driving down interest rates: Its fear, not wildly optimistic outlooks that is the cause of the low rates, since a huge demand for any thing including bonds raises prices, which whgen it comes to bonds, lowers interest rates.

INFLATION

Inflation still is and has always been a monetary phenomenon. Falling prices on computers and TV and IPods etc. does not constitute DEFLATION. Unlike the 30's when the money supply was cut in half; Bernsnke in his own words has assured us that the FED has learned its lesson and if he has to he will shovel money out of helicopters to stop deflation. However they cannot keep on expanding the world's money supply at a rate of 7 to 10% above real growth rates and not end up with rampant inflation as well as massive over capacity building. The USA has seemingly avoided inflation thus far by creative accounting, attracting as much as 80% of the worlds savings and eating into our capital stock while the worlds real estate, stock and commodity market inflate, sopping up the excess money floating around and masking for a time the real inflation which is beginning to gallop in such areas as medical costs; now 15% of our economy and growing rapidly; Property Taxes and Insurance rates. Remember 3% inflation cuts the value of our currency and our savings in half in less than 25 years. Both government and corporate pension plan obligations are seriously under funded, causing Fund Managers to take on ever increasing amounts of risk by investing in illiquid Hedge Funds and Takeover pools. Not if but when the Bond and Stock markets top out can you imagine the carnage the will be done to the already under funded remaining pension funds?

STATISTICS DON"T LIE BUT LIERS USE STATISTICS

Massive Bubbles, when they burst, never end in soft landings. The bursting of the Real Estate bubble, the largest in history, has only just begun and in my opinion its duration will last any where between five and fifteen years; depending on the sharpness of the correction, before we can expect any kind of reversal of trend. The largest home building company's are already reporting 50% drops in sales and that is not counting the cancelled contracts of sales already made. Prices in reality have dropped by 25% or more but their declines are being masked by massive giveaways of upgrades and in some cases cars as well as interest rate buy downs. But all this trickery will only work in the short run. Eventually all the short term chicanery will show up in their bottom lines. Is that not what their extremely low P/E's are warning us about?

PROBABLE ACTIONS AND THEIR CONSEQUANCES

It is possible, maybe even probable, that the FED will not be able to resist the clamor by the no nothing Politicians and their Socialist Media flunkies to resume flooding the market with money and easy credit by cutting interest rates in an attempt to stop the natural and necessary unwinding of an overblown real estate market and over-heated economy. But throwing Fiat money at the problem will not only not solve the problems but will exacerbate them and perhaps turn a necessary and normal recession into a full blown depression. How could this possibly happen? Easy especially since most people, politicians and Economists and are convinced that FDR stopped the Depression and saved capitalism from itself. But in reality turned what should have been a normal two year recession into a depression that lasted seventeen years. It is impossible to learn from History if we keep on rewriting it to suit our politics; that is the main reason why history repeats; we can never learn anything from a politicized past.

"YOU CAN FOOL ALL OF THE PEOPLE SOME OF THE TIME…………."

GOLD: The Government and its Federal Reserve Banks cannot continually create money out of thin air indefinably with any consequences. The printing of money does not create resources it just means that more money is chasing the same amount of resources and is that not the classic definition of inflation? We are already seeing the signs as it is taking more and more money to get each 1% growth until eventually all the money in the world will be unable to sustain any growth in the economy at all and all we will be left with will be a run-away inflation. Based on the so called low inflation over the last twenty five years Gold will have to reach something north of $2,200 to just get back to its previous 1980 high.

However the world's stock markets are all in full blown BLOW-OFF stages and technically they all look very strong, so watch out let the Bull run only fools try to stop runaway trains. But be careful not to get sucked into the euphoria that will be fomenting at the top. As I have mentioned in my previous letters, this Bull can run into January and should the FED cut interest rates before then it could even extend into March 2007.

Only drunks, fools and liars can pick exact top and or bottoms and I'd prefer to believe that I am none of those.

There are a time and a place for all things and now is the time to be building your cash and keep your powder dry for the next BIG opportunity. As far as Gold is concerned we have only had the first of three stages of its bull market and we are now in either the finishing stages of a WAVE II consolidation or that consolidation is now finished and the market is just biding its time in at age 1 of WAVE III, waiting for the next inevitable break in the US$ to explode upward.

HAND HOLDING

Incase you have not noticed the markets have been behaving almost exactly as I have been expecting them to act over the last four months and therefore I really have nothing much that's new to report on. So this letter is nothing more that a hand holding letter, meant to offer some comfort to those of my loyal readers that seem to need it and to assure you that nothing has happened to change my opinions. Last but not least; be careful not to get sucked in by the tremendous amount of euphoria that will accompany these markets at their tops. You may recall the level of bullish sentiment should reach all time high reading the will preceed the biggest bear market since the 30's.

GOOD LUCK AND GOD BLESS

Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]
561-840-9767

November 20, 2006

DISCLAIMER
The above is my personal opinion, and in no way be deemed investment advice to buy or sell anything. It is submitted purely for informational purposes, based upon my understanding of the markets.