Liars and Damn Liars

The worst is over! We don’t need to raise any more money! Fannie and Freddie don’t need any more money, but give us a Blank Check anyway! Inflation is only 2.5%. It is pointless for me to go on. Let me just emphasize at this time, for you to go back and check the records both theirs and mine when I tell you that:

THE WORST IS NOT OVER, IN FACT IT IS JUST BEGINNING.

The Good News is that it’s not too late to protect yourself. To be forewarned is to be forearmed. Be careful who you decide to listen to and who you choose to follow. More importantly do your homework and make up your own mind

Could Global Markets Collapse Again in a 1930s-Style Debt Crisis?

INTERNATIONAL BANKING

It seems that with each passing month the estimates for losses in the international banking system keep rising. This time last summer the largest loss estimates were around $400 billion and by the end of the year it was twice that. Then last quarter we saw estimates rise to $1 trillion. Last week, the number was raised to $1.6 trillion - four times official, original estimates and enough to pose a grave risk to the world’s financial system. If the financial institutions are unable to raise enough new capital to cover their losses, the credit crisis will worsen. Lenders will be forced to curtail loans by roughly a 10:1 ratio to losses in order to preserve their capital ratios. This would imply a further contraction of credit by up to $10,000 billion [$10 trillion] worldwide. These losses are not all sub-prime. In fact more than half, about $800 billion, is from corporate liabilities that have yet to be written off. I could go on, but I’ve made my point; the bottom line is that there are estimates out there of at least another $1.1 trillion in losses still to be written off. How likely is it for any of the sovereign wealth funds to be still willing to put up more money, except on very highly dilutive terms to current shareholders? No sane investor should be even contemplating investing in C or WU or their elk. Be prepared - Bear Stearns and IndyBanc were not just one-of-a-kind situations. Banks are going to need to be able to take their illiquid paper and convert it into liquid Treasuries so that they can then make loans so that they and the economy can continue to function.

Banks have already started to reduce their lending for the first time in 20 years. Initially there was the illusion that the tightening of standards was not affecting actual loans as banks were taking back loans they had spun off earlier to SIVs, giving the appearance of a continued lending expansion. However, declines in total lending now strongly suggests that the risk of a Depression has intensified CONSIDERABLY by what looks likely to become the largest credit contraction in history. Although perhaps as much as 60% of the losses due to sub-prime mortgages have already been written off, I warned you all as far back as last December that there were far larger losses lurking in the prime and Alt-A loan portfolios as the Recession starts to spread throughout the economy. Those loan books are more than six times the size of the sub-primes.

In 1980, every major financial bank in the US was technically bankrupt as they were all stuck with Latin American bonds far larger than their capitalization. If the Fed had made the banks mark their portfolios to market, the US economy would have gone into a deep Depression. Instead, the FED let them keep the defaulted bonds on their books at face value so that they could later write off the bad loans after most were refinanced using Brady Bonds and had accumulated enough profit from raping the American public with criminally wide spreads. It took six years for the Banks to recover as the FED then allowed them to maintain their usurious spreads.

But this time it (Really) is Different

The last time it was Government Bonds and although Governments can be technically bankrupt, they are not really as long as there is an IMF and they can continue to tax. They don’t disappear and they can eventually pay some back and refinance the remainder. This time around, it is individuals and companies and NOT countries that owe the money. There is no IMF for them and they can and do go bankrupt and disappear as they do not have the power to tax. Yesteryear solutions will not work this time: Throwing money at the problem, when they don’t even realize what the real problem is amounts to doing more of what created the problem in the first place and yet they expect a different outcome (is that not the definition of Insanity)? Since all we seem to have out there are Keynesian Economists, they keep confusing cause and effect in their wrong-headed attempts at finding quick and easy solutions.

HOPE VS. REALITY

FREDDIE AND FANNIE

Was anyone listening to the Congressional testimony of Federal Reserve Chairman Bernanke and Treasury Secretary Paulson? Neither had the courage to give any straight answers to any questions and both insisted that “all that was needed was more regulation” while asking Congress for a Blank Check. Of course, neither would venture to guess just how much money that Check might turn out to be. Barely 20 years ago, the U.S.'s total outstanding mortgage debt made up roughly 30% of our GDP and Homeowners held close to 70% equity stakes in their homes. Today, mortgage debt equals nearly 80% of GDP and the average homeowner owns less than 50% (and falling) of the equity in their homes. This dramatic change in the nature of home ownership and debt financing occurred nearly overnight (five years) and Fannie, Freddie and Wall Street made it all possible. Released from capital-ratio requirements and backed by the inferred “To Big To Fail” Government Guaranty, they were able to buy a nearly unlimited amount of mortgages so that to date, Freddie and Fannie finance and/or guaranty more than 80% of all mortgages in the United States.

Former St. Louis Federal Reserve President William Poole asserted that these institutions are essentially insolvent. But in the same story, Senators Schumer and McCain both said Freddie and Fannie could not be allowed to fail and will potentially cost US taxpayers trillions. Make no mistake, the problems with Fannie and Freddie have to be resolved. The world has assumed their implicit backing by the Government: How easy would it be to refinance ($2 Billion/day) US debt if this paper was allowed to default? The authorities have lost control and all they can do is attempt to crisis manage. Thus far, no one has suggested any good solutions, only stop gap expedient ones. The Fed and Treasury and whatever administration comes in will do the same as the current group, which is to try to buy time so that (they pray) the wounds can heal and hopefully put in place rules to prevent another such occurrence.

But since when do new government rules solve a problem? They had rules in place, they were called the Securities Act of 1933-34 and they worked for more than 50 years but then Paulson, Cox, their Frat Buddies on Wall Street and their bought and paid for politicians, completely gutted its provisions in their ever increasing search for higher and higher profits. And now we want to repeat the same mistakes of the past by putting Frat Buddies in charge of regulating Frat Buddies. Getting a Wolf to guard the Hens while electing good looking, glib public speakers who haven’t got a clue as to how the economy or economics works so that they can easily be influenced by their Frat Buddy Lobbyists. Wall Street has already donated over $35 million to Obama, the most liberal Senator ever and completely devoid of any real experience in anything except politics. Unfortunately for us, McCain is no better as he too is a Socialist. The solution to solving the problem is always the same: You must first discover what the Real Problem is and not be confused or side tracked by the effects and/or consequences of the Real Problem.

Mortgage Reworks: Postponing the Inevitable?

New research from Moody's shows a full 42% of sub-prime borrowers whose mortgages were reworked in the first half of 2007 are defaulting anyway. All the proposed bailouts and stimulation packages working their way through Congress, plus the rest of the proposed spending plans, will not fix the problems and could easily destroy the dollar. When the 2009 Budget Deficit hits $1 trillion, that could mark the end of the dollar standard that has governed world trade since World War II.

BUDGET DEFICITS

This year will set a record for the largest Budget Deficit ever. In my opinion when the bills for salvaging FNM and FRE and all the stimulus packages come due the Budget Deficit should surpass $ 1 TRILLION. What affect do you think that will have on the US $, INFLATION and the US and World Economies?

THE REAL PROBLEM AND POSSIBLE SOLUTION

The Real Problem is NOT sub-prime mortgages, they are just an effect, a symptom of the real problem. Six years of 15% to 35% Real Estate profits compounded annually led everyone (like every bubble always does) into believing that we were in a new paradigm and that these price increases would continue on indefinitely. Under these conditions, sup-prime, zero down 100% liar loans did not seem all that unreasonable. The Real Problem became a massive amount of over building of homes, which high and rising prices (profits) will always bring forth. The result is a huge over supply of unsold, vacant, overpriced homes and no way of clearing the over supply. The result is exactly the same as what happened during the Savings and Loans Crisis; both of which were really caused by Government meddling in the economy! All the Congressional investigations in the world will never come up with that conclusion. They will, like the last time and every other time there is a problem, look to find SCAPEGOATS There will be big show trials like Koslowski, Keating or Martha Stewart who were not guilty and even if convicted were never convicted for the reasons the public thinks or that anything to do with the problems. They put them on trial to serve as Red Herrings to keep the public’s eye off the ones who were really responsible, Government!

SOLUTION

The solution today should be the same as the solution that worked back in the 80’s. There is no way around it, we must clear the massive over-hang of vacant unsold homes by creating a new Resolution Trust Company, close the institutions that cannot be saved, merge the weak ones that can be saved with stronger ones and take the massive amount of foreclosed and unsold properties and defaulted loans off the books of the institutions, salvage what can be salvaged and AUCTION off the rest quickly. The result will be to bring down prices down to affordable levels in 2 years instead of 10. Average homes, even at today’s already lowered prices, are still not affordable to the average worker. The People who have lost their homes will then be able to buy, maybe even the same home that they lost, at half the price or lower, which they then will be able to pay for even at higher, normal 7% mortgage rates. The cost to the taxpayer will be estimated at about $3 trillion, but will probably end up costing no more that $1 trillion. The majority of Banks and Brokers will not only be saved, but become healthy again so that they and the economy can then get back on track doing their thing. The cost to the taxpayer can then be recouped in a similar fashion to Chrysler by taking back equity or options in the institutions that were Bailed Out. Anything else, such as the Double Speak from Paulson and Berenanke and/or the plethora of New Deal type policies that are even now floating around Congress, WILL result in a 1930’s type DEPRESSION lasting a minimum of 16 years. SOCIALISM DOES NOT WORK THE WHOLE WORLD KNOWS THAT and is moving toward Capitalism Except the USA, Chavez and Castro. But don’t get your hopes up - NO ONE SEEMS TO BE LISTENING. Not to me anyway.

P/E’s AND OTHER FINANCIAL RATIOS

The P/E ratio for the S&P 500 is currently at a super lofty 23 times earnings. Historically, in times of rising inflation, the stock market goes through "multiple compression." That means P/E ratios fall more than earnings. If multiples were to fall 35%, back to 15%, that P/E would still be at an historic sell signal level and the market would still see another drop from there. I do not relish being an alarmist, yet sometimes the reality of a situation must be faced before it’s too late. Such may be the case now with the US and global economies (go back and re-read my “GOLD and a KNODRIETIEFF WINTER Dec. 2007”). To be more specific, many market analysts sometimes do in fact sound like alarmists at times. To scream "1930s-style Depression" every time the global economy moves from an expansion phase of the business cycle into a declining phase (typically leading to a recession but not depression) would not be desirable. However, once every 60 years or so, a 1930s style Depression typically does occur, and this time the global economy is experiencing the kind of Financial Strains and possible collapse that only occurs once every 54 to 64 years.

What then distinguishes a 1930s-style downturn from a more normal downturn? The difference always lies in the status and size of the debt relative to the GDP of a particular country and the state of the global monetary system as it relates to the foreign exchange market. In a nutshell, human complacency builds to an extreme state leading to poor decision-making with respect to RISK especially credit expansion and speculation on both the part of governments and private sectors. The resulting financial debacle due to the collapsing debt pyramid that goes along with that complacency typically leads to a global Depression, not just a Recession. All of which is compounded by unworkable Socialist Government policy. Bailing out their Frat Buddies in the name of helping the “Middle Class”

This is exactly what the Kondratieff Long Wave Cycle is all about. Many mistake this cycle to be one that is used to predict where a market or an economy is going. On the contrary, it is a cycle which very few are even aware of. It was discovered when Stalin commissioned Nick Kondratieff to predict the downfall of Capitalism. Instead he discovered that Capitalism was self-correcting and self-regenerating and occurs regularly every 50 to 60 years. The Kondratieff Cycle was discovered to actually be a cycle of excessive debt creation followed by debt repudiation. Is that not exactly what is beginning to occur in many parts of the globe and especially here in the USA? Human nature becomes too overconfident during the decades of expansion that characterizes the "up-waves" of the Kondratieff cycle. At the top of each cycle, most feel that "it is different this time". This kind of behavior still occurs everywhere and will continue until humanity learns to be more prudent and less impetuous with their finances but more importantly, learns to study the past. In conclusion, this generation of investors is on assignment to learn what no prior generation has yet learned and to go where no generation has gone before. The assignment is to learn from their Grandfathers, to be prudent and not be "irrationally exuberant." They need to learn to re-balance portfolios as the marketplace changes and understand that being a conservative investor does not mean holding onto stock for the long term and taking no action, but instead to reallocate their portfolios and keep them balanced (i.e., between stocks, bonds, cash, and Gold, etc.)

GOLD VS STOCKS

If you had invested in the Dow Jones Industrial Average at the start of New Millennium (2000), your return as of July 2008 would be 0%. If you factored in inflation and the devaluing of the dollar over that same time period, your true rate of return would be a negative 40%. During that same period, investing in Gold stocks would have produced a return of over 400% Give me some of that old fashioned Barbarous Relic aye!

What happens to Gold and Gold stocks during a Major Bear Market and/or during a Depression?

THE GREAT DEPRESSION AND MARKET CRASH OF 1932 to 1935

Between 1929-1935, the comparative investment results of Gold VS. Stocks (DJIA) (since FDR confiscated all gold in 1933) will have to be made using Homestake Mining as a proxy for gold bullion.

From Oct. 1929 to Dec. 1935, the DJIA lost 64% of its value. During that same period of time, the DJUA lost 79% of its value. Now let’s compare that to a $10,000 investment in Homestake Mining which increased in value to $62,000 during that same period of time for a gain of 620%.

THE MARKET CRASH (1973/1974)?

From the market high in 1973 to its low in 1974, the DJIA and the S&P 500 lost almost half their value - while the previously high-flying Fifty–Fifty stocks plummeted more than 60%. Even the relatively "safe" utilities were decimated as they dropped more than 50% from their 1973 high to their nadir in 1974 as interest rates soared. However, students of financial history took profitable refuge in Gold metal stocks. The Gold Mining Index, composed of ASA, Campbell Red Lake and Dome Mining, appreciated more than 260% from its 1973 low (40) to its 1974 high (147). This merits being redundant. During the severe 1973/74 Bear Market, stocks lost half their value while Gold mining companies more than tripled.

THE MARKET CRASH OF 2001 to 2003

While the markets on average went down over 60%, GOLD increased from $255 to $375 for a gain of 45% in 2 years, which as we all know was only the beginning of a new 16 year Bull Market for Gold which now stands at over $930.

GOLD $1500 HERE WE COME

Gold was and still is the best form of money. We are currently in a 60-year global experiment in paper money. All paper money experiments have ended in hyperinflation with the currencies becoming worthless; but all previous hyperinflations were contained within a single country. This time, because of the worldwide reserve status of the US dollar, it will be global in nature. In today’s inflationary environment, investing in fixed income AAA securities instead of being a“SAFE” investment, are in fact guaranteed losses when you take inflation, taxation and purchasing power into account. GOLD, on the other hand, is a store of wealth with a 5,000 year history. The US dollar is down 85% in purchasing power since 1971. In 1971 you could buy a car with 100 ounces of Gold; a car was about $3,500 and Gold was $35 an ounce. With 1,000 ounces or about $35,000, you could buy a nice house. Today, you can still buy a luxury car with 100 ounces and a luxury home with 1,000 ounces. It also takes less Gold to buy the DJII today than it did in 1971. People with long term savings should own Gold as the core of their entire wealth. I know I am being redundant when I emphasize that this current cycle is not just a conventional Bull Market in precious metals. I think we’re not too far away from a paradigm change into some form of GOLD BACKED new global monetary system. But it will not take place until most countries have at least 15% to 20% of their reserves in Gold, which in my estimation requires a minimum of $5,000 Gold in the next 3 to 8 years.

WHAT’S THE RELATIONSHIP BETWEEN GOLD AND OIL?

There’s not a great deal of correlation in the short term but at times it can sur look like there is. However, on a longer term basis the correlation has been on the order of 16 to 1. Using this measure, the price of Gold should be closer to $1,500 which is close to my last year’s projection for the end of 2008.

BUY GOLD

Can I be any clearer than that! Gold is now in a consolidation phase with a projected downside target in the area of $850 to $900. Do not attempt to trade as the market will do whatever it has to do to make the majority of investors wrong. I would use any additional weakness to add to my positions.

HOW NOW DOW

The Industrials bounced hard TODAY and is likely the start of the final part of the up side correction. This should be the final rally into early to mid-August to complete wave 2 up, a last chance to raise cash and get short before a "Hold on to your socks" Crash takes place into Oct., Nov. The Industrials could approach the 11,800 to 12,000 area

Although we are due for a sharp 1 to 3 week rally, It may be fast and furious because of a great deal of short covering BUT it will only be a bounce. The reality of the situation is that Secular Bear Markets involve very deep declines and will not end until the typical investor “ throws in the towel” Just as its time to buy. So far, the statistics show that we are not even close to the “throwing in the towel” stage. We are still in the ‘buy and hold for the long term” Stage Since we are in a major Secular Bear Market it requires using Bear Market Numbers to determine Over-Sold, buy signals and Over-Bought sell signals. Continue to ignore Paulson, Berenanke, Government, Wall Street and especially the Media’s Pollyannaish pronouncements. The street is only just beginning to catch up to what I have been WARNING you about all along.

If you have been heeding my musings, then you are in 50% to 60% Gold, Silver and Cash and own puts on the USO (OIL) Use this Rally to pick up some shorts using the Double Down ETF’S such as SDS, SRS, DXD, SKF, QID If, on the other hand, you have been following Kudlow, Cramer and the rest of the talking Heads that are on TV, keep the faith it’s not too late to protect yourself. I am expecting a rally lasting 2 to 3 weeks. Use it to get out of your long positions. As we should experience Group Rotation but not much follow through. BUILD up your cash, Buy GOLD and start nibbling on the above mentioned ETF’s as a way of establishing your short positions. The market, like Gold, is still only in the process of completing its first major Wave.

YOU AIN’T SEEN NOTHING YET

GOOD LUCK AND GOD BLESS

August 2008

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Aubie Baltin CFA, CTA, CFP, PhD.

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Palm Beach Gardens FL. 33418

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