Sunday, March 21, 2010

What Folks Like You Are Thinking Right Now, and the Decreasing Benefit of Additional Debt

I must have had a few too many beers this afternoon, because I swear my alma mater, Cornell, just advanced to the Sweet 16 - in convincing fashion no less.

Must have had a beer or sixteen today!

Some Ink in Casey's Daily Dispatch - Inflation/Deflation, Wiring Money to Central America, and More!

On Monday, I penned a piece for Casey's Daily Dispatch that highlighted the investment and geopolitical conclusions that our local "phyle" reached during our most recent meeting.

Last night our Sacramento Phyle got together at a local restaurant to banter about the usual talk you'd expect to overhear at such a place – like government confiscation of retirement plans, expatriation, wiring money to Central America, and our favorite shorting techniques; you know, the usual.

Our attendees are all medium to longtime Casey subscribers, ranging from Davis to the Sierra foothills, and we all enjoy getting together to break bread, have a drink, and talk about things that we quite frankly can't talk to anyone else in our lives about.

We kicked off the night chatting about the potential confiscation or lockup of retirement funds – namely 401(k)s and IRAs – by the U.S. government. Our fear is that with U.S. federal debt truly spiraling out of control (as detailed by Bud Conrad in the last Casey Report), there will come a point where the government will likely appoint itself "custodian" of all retirement accounts. Stocks are too risky, let us invest your money "safely" in government-sponsored annuities (i.e., government paper that no one else will buy!).

We've chatted before about using IRAs to purchase assets that can't easily be confiscated – such as overseas real estate – but the tenor at this meeting was more cautious than ever. Several members are seriously considering emptying their retirement accounts over the next few tax years and taking whatever penalties and taxes will be assessed.

But then where do you put the money? "Not in your local Citibank account!" someone joked. The consensus was that you'd probably be wise to get the money overseas, and possibly into physical bullion in the process.

In terms of the timing, the scary thing is that it could potentially happen real fast -- striking with lightning speed as the last downturn did. We put the odds on it happening after 2012, as we didn't believe it'd be politically feasible at the moment, especially with an election slaughter upcoming this year. But if the next leg of the financial crisis strikes, all bets could certainly be off.

The group as a whole is still favorably inclined towards gold, but our outlook has decidedly changed since the peak of gold stocks a couple years ago. At that time, we'd talk about junior miners, looking for the next really big play. Nobody has the stomach for that now – I know I don't – not after losing our shirts when gold tanked last time! Now gold is looked at as more of a safety play – something that could decline but is likely to decline less than other assets.

One contrarian-minded member joked that this probably meant that gold stocks are still a good buy, since the Wall of Worry is still making our stomachs churn!

Our feeling on the markets, for the last 4-6 months, has been: "What's taking so long?" We're universally bearish on the stock markets. Some of us have stayed in equity positions, raising trailing stops along the way. Others bailed early in the last rally. But on the whole, our picks for an S&P finish were around 800 or lower – decidedly more bearish than your average CNBC analyst!

Finally we still believe the big – and maybe only – question to ask right now is the inflation/deflation question. None of us are yet convinced that we've seen the last of deflation... we're still holding a wary eye to the situation, allowing the possibility that a wave of asset deflation potentially even more powerful than the last one could be on the way. And if that happens, you'd want to follow the playbook of the last bout – get long the dollar, and get out of everything else.

We generally agreed that serious inflation, and likely hyperinflation, is the most probable endgame. With the big question being, will that be prefaced by a serious, extended period of deflation first? If that happened, the dollar could rally quite a bit. And all assets would in turn get hit, probably severely, though we expect that gold would hold up better than most others. And eventually the dollar will have to be sacrificed, thanks to our fabulous deficits. So that's not a long-term play by any means.

So overall we're still in a wait-and-see mode as a group – battening down the hatches, preparing for the next wave of the storm to hit! We'll be meeting up again in early May, potentially with some new fireworks to chat about!

The Marginal Productivity of Debt

More and more economic studies seem to be indicating that the more debt we take on, the less good it's doing us - in fact, the marginal benefit may now be less than zero!

First, a piece passed along by good friend and astute reader Carson regarding the debt saturation dilemma.

This reminded me of a guest piece we published in 2009 by San Francisco School of Economics Professor Antal Fekete entitled The Marginal Productivity of Debt. Which began:

The paper mill on the Potomac is furiously spewing up new money. According to the manager of the mill, as indeed according to the Quantity Theory of Money, this should stop prices from falling and the economy from contracting.

In this article I present an argument why this conclusion is not valid. On the contrary, I shall show that new money created on the strength of a flood of new debt, is tantamount to pouring gasoline on the fire, making prices fall and the economy contract even more. The Obama administration has missed its historic opportunity to stop the deflation and depression inherited from the Bush administration because it entrusted the same people with the task of damage-control who had caused the disaster in the first place: the Keynesian and Friedmanite money doctors in the Fed and the Treasury.

Moral of the story is that Ben Bernanke "can create all the money he wants and more, but he cannot make it flow uphill."

Since this piece was published about a year ago, whether or not Bernanke has even created quite a bit of money is up for debate. Depends who you ask/read. Either way, it's tough to make the case that the money is flowing, at least just yet.

It's starting to trickle, but that was to be expected with this bear market bounce. Where we head from here should be the real key - either the next shoe drops, or the trickle steadily increases - we shall see.

My Trading Activity - Still Short the S&P (Twice)

Nothing changed - this position is still a train wreck - markets are still rising on low volume - due to fall any day - blah blah blah.

As good friend and astute reader Carson recently pointed out, the markets can stay irrational longer than you can stay solvent. Oh, so true. Love hurts!

Still double short the S&P...though these positions used to look much sexier!

A classic bear market bounce...probably.
(Source: Yahoo finance)

Have a great rest of the week in the markets! Comments are always welcome and very much appreciated.

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