The Houdini Economy

I believe there are many, many parallels in the world economy today, to that of previous economic depressions. We need only to look at past history. However, historian's all have different accounts and points of view. Is historical information based on objective analysis, primary evidence or a biased second hand account?

Is the economic events of today so different to that of the past? We are constantly told we are living through the worst economic downturn since the Great Depression; then we are told Australia has a resilient economy and that we are weathering the storm. Surely it can't happen to us?

"But we live in a modern, innovative, high-tech society today!"

In the 1920s America - the "Roaring Twenties", the sharemarket was booming, the humble car was built for the masses (T-Model Fords), and the population was extremely opportunistic. The population had never felt so wealthy, the horse and buggy were essentially gone from urban areas and the economy had never been more innovative. It seemed the good times would always last.

And today? We live in the so-called "new economy". A modern, innovative, high tech economy. We have never felt wealthier. We expect the good times to always get better. The next 20 years will be better then the last 20 years.

These are two different points in history - but the same human traits of economic complacency are well and truly alive today. There is usually a large economic depression every 75 years - the average life span of a human. Is it a coincidence economic lessons repeat? Is it a coincidence that each generation since the 'silent' generation (of the 1920s and 30s) has progressively had worse money habits than their parents generation? Everything used to be bought within our means, today its on credit, and we have little incentive to save for a raining day.

Houdini economy

** The big difference between 1929 and today, I believe, is the acceptance of mis-information by the general public and an acceptance to think the monetary system will always work. We live in the so called "Information Age", yet our diluted statistics mean we live in a Houdini economy. It's all smoke and mirrors. Government's have an interest to keeping the public unaware about what is really happening in the economy - to maintain political and social stability (in the short run).

However, comparing today to the past has become distorted because economists, Governments, and the media think they are comparing apples to apples. Today, statistics are treated as gospel. We believe that the stats on the nightly news are accurate, objective and unbiased. Why are we not learning from recent events? Many of the economists and bankers who got it wrong, are still in positions of power and influence. Central banks are being given expanded powers (particularly the Fed Reserve), rather than face increased accountability.

More often than not, an economic number today will be grossly diluted to that of 75 years ago. For example, the unemployment rate, or level of inflation are grossly misunderstated today.

For instance why is unemployment so low at the moment? In the 1930s it got to 32 per cent in Australia! Yet it is still around 5 per cent today, despite a recession and economic turmoil worldwide.

Answer: The ABS counts people as been employed if they are working just 1 hour per week.

But as the following chart shows, the number of hours worked has been falling gradually in the last 15 years. For starters there are a lot more part time jobs. It's good for people who want to work less, but its bad for recording what the real unemployment rate should be.

Chart 1:
Source: Kohler, ABC News

Getting back on topic - lets compare further to the last Great Depression:

1929 to 1932- the greatest sharemarket crash in history put the world into a Great Depression. In 3 years the market fell 89 per cent.

Current sharemarket crash? Depends on your measuring stick, namely, the monetary system has changed. 1929 money was backed by gold. Today it is backed by an exponential curve of debt.

If we use the Dow/Gold Ratio (which is what the 1929 sharemarket crash was recorded against), then the current bear market we have today really started in 1999 (not 2007). So far from top to bottom of the bear market the Dow Jones has fallen 84 percent measured against gold (the old monetary unit).

Perhaps we are already in economic depression but we just aren't awake to it?

As the following chart shows, the inflated US Dollars of today have diluted the impact of what is really happening. From 1999 to 2007 the Dow Jones rose in nominal terms, while the old monetary system was showing the economy was sick (and crashing), now both these measuring sticks are showing the US and world economy is continuing to tank.

Chart 2: Dow Jones over last 100 years
Wow - look at the 1929 crash! It's huge. What this chart fails to show is that important change of the monetary rule book in 1971 (when the gold link was removed).

The following chart puts the 1929 crash, and today's sharemarket crash into a better perspective (apples vs apples).

Chart 3: 100 yeas Dow/Gold Ratio.
Source: Steve Hickel, gold-eagle.com

The last dip in Dow/Gold Ratio:

Notice has taken at least 32 years to reach a new peak in the Dow/Gold Ratio in the last two downturns. In the last downturn there was stagflation in the 1970s, a change of the monetary rulebook in 1971, a commodity price peak in 1982, and an increase in social security outlays of Governments among other things. There was no great depression, but inflation was accepted and new bubbles came along to occupy everyone's money. The key last time is that there remained confidence in the new fiat monetary system. I believe this time round will be different.

Clearly there is a huge difference between Chart 2 and Chart 3. Chart 2 is an inflation drive chart. Chart 2 characters a true free market which goes from undervalued to overvalued and back over time. (Change the monetary system (methodology), and you will change the shapes of the charts!)

Steel industry today vs 1920s

Lets compare 1920s and today even further...

In the 1920s, there was a huge boom in the United States steel industry. 15 per cent of steel was used in automotive manufacturing. By 1928 there was over 21 million cars, enough for 1 in every 6 Americans. When the Great Depression hit however, by the mid 1930s over 50 per cent of the United States steel capacity stood idle.

Today there is vast amounts of steel capacity standing idle also. Lets compare.

Kingdom of Rust

According to latest research from Macquarie Bank, there is some 362 million tonnes per annum of unutilised steel capacity in the world.

Chart 3: Today, around 25 per cent of the world's steel capacity is sitting idle.
Source: Macarthur Coal Presentation - 17 June 2009

To put this into perspective, this is equivalent to:
- every single steel mill in Europe, Japan and Korea shutting down OR/
- ¾ of China’s steel production closing down.

With all this recent iron ore hype in the Australian sharemarket (in the last couple of months), just stop for one moment and envisage 3 out of every 4 steel mills in China closing down. Only the lowest cost (lowest debt) iron ore, coking coal, steel producers could survive a sustained turn down. Clearly there is too much capacity worldwide. This is not unique to just the steel/iron ore industries. The capacity for most goods today is built on the premise that the current monetary system will continue to work, that the world economy will continue to expand at a rapid rate, and that our tolerance of debt will continue to expand.

All this extra capacity will have to be removed from the system. Many companies will continue to go under. This is only natural. In the boom times too much competition led to cheaper cars and airfares, and even steel was pre-fabricated in China and exported back to Australia! There needs to be a giant shake-out across industry worldwide. Give it a few years..

Baltic Dry Index

Much of the gains on the Australian Securities Exchange (ASX) in recent months have been on the back of a bounce in commodity prices (ie. A fall in the US Dollar), and increased shipping movements out of China for Australian iron ore and coal. This has also lifted the Baltic Dry Index (BDI), which had a major crash in 2008. The BDI is a daily number published by the Baltic Exchange – it tracks world wide international shipping prices for dry bulk cargoes such as iron ore. It shot up in the boom years, and crashed big time last year as the following chart demonstrates.

Chart 4: Baltic Dry Index crashed 94 percent when the resources boom bust, its now rebounded on growing Chinese iron stockpiles.
Source: Bloomberg

The following chart from Alan Kohler pictures an interesting relationship between the BDI and movements in the Australian and US Dollar. Positive movements in commodity prices (particular in US terms) and the BDI - is a positive force for the Australian sharemarket.

Chart 5: Baltic vs AUD
Source: Kohler, ABC News

I believe its now time for the BDI to fall sharply once again. The third quarter of the calendar year is traditionally the worse for commodity prices (from my experience, particularly in base metals). Apparently about 10 per cent of the world Capesize ships (the largest) are sitting of Chinese ports, unable to unload their iron ore. The two largest iron ore terminals in China are said to be close to full capacity. Now that the 2009/10 iron ore benchmark prices have been finalised (with Japan and Korea), my bet is the Chinese have done most of their shopping for this year, and will try to manipulate the market in the short-run to really hammer down prices come next year.

World Trade

Ok, so i've talked about the BDI - what about world trade as a whole?

The following chart from Alan Kohler paints a bleak picture for world trade. It uses a base of 100 for the peak in world trade (some 12 months ago). Already we have gone from a massive boom, and the big bust continues at a greater magnitude than the 1929 trade bust. Just like the 1920s America – there is significant overcapacity in the world. Trade flows are stalling.

Chart 6: World trade has fallen off a cliff much higher then the Great Depression slump.Source: Kohler, ABC News

Covering up debt - back to the suitcase method

We all know what hiding bad debts can do... Subprime mortgage-backed securities, bundled together, given a AAA rating and sold overseas to unknowing investors worldwide. This grand scheme worked for a while... now it appears the humble suitcase is back in vogue to move Government debt around.

Here is a rather amusing article. If this were true... the US/Japanese Governments are running out of places to hide their debt!!

Suitcase With $134 Billion Puts Dollar on Edge

Two Japanese men are detained in Italy after allegedly attempting to take $134 billion worth of U.S. bonds over the border into Switzerland. ..

The trillions of dollars of debt the U.S. will issue in the next couple of years needs buyers. Attracting them will require making sure that existing ones aren’t losing faith in the U.S.’s ability to control the dollar. ..

Think about it: These two guys were carrying the gross domestic product of New Zealand or enough for three Beijing Olympics. If economies were for sale, the men could buy Slovakia and Croatia and have plenty left over for Mongolia or Cambodia. ..

Let’s assume for a moment that these U.S. bonds are real. That would make a mockery of Japanese Finance Minister Kaoru Yosano’s “absolutely unshakable” confidence in the credibility of the U.S. dollar. ..

Bad news can only be covered up for so long. Question everything!

Scott

There isn’t enough silver to go around

To date I haven’t posted much on gold and silver, a subject I intend to spend more time on in the near future (particularly on gold companies in Australia).

The following is extracts from one of the best silver articles I have read to date, from well-known silver commentator, Ted Butler. I encourage all to read the full article titled, A Presidential Bombshell.

Here is a quick summary of some of the points made in Ted’s article.

In the United States:
- In 1959, the US Treasury Department held approximately 2.1 billion ounces in silver bullion inventories plus 1.3 billion ounces in circulating coinage, for a total of 3.4 billion ounces of silver.
- By 1971, the Treasury held only 170 million ounces of silver bullion and most silver coins were removed by investors from circulating coinage and eventually melted into bullion.
- In only 12 years, the US Government transferred 94 percent of its holdings to the private sector (over 3.2 billion ounces).
- The US Government became a net buyer of silver again in 2001 to mint American Silver Eagles.

Silver per-capita

In the United States:
- In 1959, there was almost 19 ounces of silver for every person in the United States.
- Today the U.S. has no government reserves of silver.

Worldwide:
- in 1959 there were about 9 billion ounces of silver bullion in the world, with a population of 3 billion, there was a per-capita amount of 3 ounces for each of the world’s citizens.
- Today, there is a per-capita amount of silver of 0.15 of an ounce per person (1 billion ounces divided by 6.8 billion population).
- By way of comparison, the per-capita amount of gold bullion equivalent in the world has remained remarkably stable at around three-quarters of an ounce per person, for more than 100 years.

So if you hold just one 1-ounce silver bullion coin today, consider yourself wealthy. Likewise if you hold just 1 ounce of gold.

Further in Ted’s commentary on May 11, he quoted a speech from President Lyndon Johnson which was made on July 23, 1965. This is what President Johnson said:

"Now, all of you know these changes are necessary for a very simple reason--silver is a scarce material. Our uses of silver are growing as our population and our economy grows. The hard fact is that silver consumption is now more than double new silver production each year. So, in the face of this worldwide shortage of silver, and our rapidly growing need for coins, the only really prudent course was to reduce our dependence upon silver for making our coins.
If we had not done so, we would have risked chronic coin shortages in the very near future.
Some have asked whether our silver coins will disappear. The answer is very definitely-no.
Our present silver coins won't disappear and they won't even become rarities. We estimate that there are now 12 billion--I repeat, more than 12 billion silver dimes and quarters and half dollars that are now outstanding. We will make another billion before we halt production. And they will be used side-by-side with our new coins.
Since the life of a silver coin is about 25 years, we expect our traditional silver coins to be with us in large numbers for a long, long time.
If anybody has any idea of hoarding our silver coins, let me say this. Treasury has a lot of silver on hand, and it can be, and it will be used to keep the price of silver in line with its value in our present silver coin. There will be no profit in holding them out of circulation for the value of their silver content."

Silver is rare. It's so rare, 99 out of 100 people wouldn't know about it. It’s a finite store of value with no debt or liability attached to it. Unlike gold it is also an industrial metal as well as a monetary metal. In 1959 President Johnson used the word’s “world shortage” and “silver is a scare material”. Less than 15 years after those worlds the price of silver rose from US$1.29 to more than US$50 in 1982. In 1959 there was 9 times more silver and 3.8 billion extra people than today! – so why don’t we hear stories of silver’s extreme rarity today? We only get a handful of gold reports on the news, and it will always be referred to in USD terms. Apparently the world is flat, not round.

Silver has become so rare for the first time in human monetary history there is more than four to five times more silver above ground than gold. Even more amazing is that silver has been manipulated so much by Governments, and commercial banks that it remains dramatically undervalued compared to gold. The silver market in dollar terms is one of the smallest and easiest commodity markets to manipulate. Total above ground silver is currently worth US$12 billion at current prices compared to almost US$4 trillion for gold. Keep in mind there is about 1 billion ounces of silver, and 4 to 5 billion ounces of gold. Something is not right here.

Gold-Silver Ratio

The historical gold/silver ratio (over many centuries) was around 15 to 1. The primary reason is that silver was around 15 times more abundant in the earth's crust than gold. Today the gold silver ratio is 80 to 1, almost double the average for the last 200 years of 33, and the average of 20th century average of 47.

Chart 1: Gold Silver Ratio over last 200 years
With available silver more rare than gold, silver has considerable gains to record. Gold will do very well, but silver should provide exceptional returns within the next decade. Another way to put it, the purchasing power of silver should rise greater than the purchasing power of gold. Some analysts believe silver will get to a gold/silver ratio of 1:1 within our lifetime. I think this is highly plausible and not out of the question.

Something has been keeping the silver price down for many years... It's Government, Central Bank and Commercial Bank manipulation... I will go into more depth another time, in the meantime Ted Butler's weekly commentary website is worth a bookmark.

- Scott

Measuring the market meltdown so far…

Measuring the market meltdown so far…

It's been a little over year since the All Ordinaries hit its highest point of 6873 on 1 November 2007. On Friday 21 November 2008 it hit a low of 3201 – a fall of 53 percent.

Chart 1 shows the All Ordinaries (the main index for the Australian Sharemarket XAO.ax) in the last 18 months. The earliest and strongest signal that we were entering a bear market was back in January 2008. Since January, the market has tried to find a bottom. After falling, only 2 possible outcomes are possible - i) pause and go sideways ii) Go UP. On each occasion, the XAO paused, then broke support (the green cross), in the search for a new bottom. A bottom has still not been made!

Chart 1: All Ords in last 18 months
As the following chart 2 shows the current financial bear market is rivaling the 1929 crash in speed and depth, so far. With the 1929 crash, heavy losses came straight away, whereas the current bear market had a small correction before it started in August 2007, then a decent crash in Dec-January 2008, then in July-August-September. If we are to follow 1929 from here, there is still some pain to come before the bottom. The current bear market is already worse then the early 1970s (first oil shock) and the Dot Com crash.

Chart 2: Alan Kohler, ABC News 24 Nov 2008
* Note however, that after the initial crash in 1929, from November to January of 1930 the US sharemarket rebounded some 50%, before resuming its major bear market. December-January periods tend to be good months for the sharemarket historically, but not always so (like last Dec-Jan).

Chart 3: in The Financial Review 24 Nov 2008
Chart 3 compares all the bear markets in the 1900s showing the mean percent decline and magnitude (over days). This chart shows that it is comparitable with 1901, 1906, 1919, 1937, and 1973 - but the duration of the current bear market is much much shorter to reach this decline. Only 1929 stands out. Could the ultimate bottom be somewhere near 1929...? and in what time frame?

Comparing the meltdown in terms of Gold and Silver

In the last year the All Ords has gone down some 53 percent measured in terms of Australian Dollars (the stock are measured in $AUD p/share). When you measure the All Ords in terms of gold or silver though(or any other commodity such as wheat, oil or other tangable no-liability (no debt) asset), you will see that the sharemarket has been crashing for several years, going back to the Dot com days. In 1999, 1 point of the Dow Jones could buy you 45 ounces of gold. Today 1 point of the Dow Jones can buy you around 9.5 ounces of gold. In these terms, the Dow has crashed by over 72 percent so far. A similar picture is happening to the housing market in the US (and in Australia), which I will touch on in a future post.

To measure the All Ords, I merely used historical year end gold/silver data (in tons) with year end All Ords data. The charts speak for themselves.

The unique qualities of gold and silver is that it accounts for all the debt and money created throughout time. When sharemarkets, real estate and credit markets bubble, people flock to undervalued gold and silver.

Chart 4: Gold vs All Ords
Notice in the 1970s and early 1980s, gold quickly fell to its overvalued region. Then the sharemarket became undervalued. The All Ords peaked in 1999 (same as Dow Jones) in terms of gold.

Chart 5: Silver vs All Ords
Like gold, silver did the monetary accounting in the 1970s and early 1980s, however today is a very different picture. Silver is extremely out whack and very undervalued compared to gold in Chart 4. The All Ords looks very expensive in terms of silver.

Eventually gold and silver will go back to the expensive levels at the bottom of the charts - but there is some way to go yet!

More good stories to come on gold (and particularly) silver...

Commonwealth Bank now has larger market capitalisation than Citibank

Last Friday, as one market commentator pointed out, with the falling shareprice of Citibank below US$5 per share, the market capitalisation of the Commonwealth Bank (CBA.ax) is now larger then Citibank, once one of the world's largest banks, and still huge in terms of Tier 1 capital and revenue.

Shareholders are now betting the bank will be bailed out by the US Government and that equity holders would be wiped out. As I write this, there are news clips coming out saying the US Government will guarantee close to $US300 billion ($475.3 billion) of Citigroup's assets with an additional an additional $US20 billion in capital to help it stay alive (for now). **insert more fuel to the world economic fire**

Still to come: Housing bubble in Australia, and my thoughts on Obama's Presidential win (in an world economic/monetary viewpoint).

Cheers,
Scott