Thursday, October 27, 2011

Signs of worldwide economic collapse and the rise of the US dollar

October has been a pretty spectacular month with regimes falling all over the Middle East, swept by the so called Arab Spring revolution.
In Europe, the France and Germany duo represented by Merkozy has grown apart in what seems to be a very poisoned and fragmented relationship. Illustrative of the tensions between them would be a weird occurrence when Sarkozy told an audience that Merkel helped herself with another serving of cheese while claiming she`s on diet. There is a very clear resentment and distrust between European leaders. Sarkozy also blasted David Cameron, the UK prime minister for interfering in Euro zone affairs while not being part of the Euro zone. The brits on the other hand are seriously considering exiting the EU. Berlusconi just presented yesterday a joke of a plan that infuriated Merkel, plan of increasing retirement age to 67 years by 2026(seriously?2026?). It`s no wonder Merkel took this proposal as a bad joke.

Europe has achieved so far, after long and hard fought battles, to have an EFSF fund worth around 400 billion euros. However, this sum is not nearly enough to prevent possible bank failures that may arise as result of 50% or higher "haircut"( aka forcing banks to take losses on Greek bonds) on Greek, Italian, Spanish or Portuguese debt. Most experts would conclude that the sum required would be close to 3 trillion euros, which is considerably higher. Only problem is that no one in Euro zone is willing to come up with the money, so what they`re trying to do now is borrow that money from outside sources and call that "leveraging the EFSF". Problem therefore amplifies as no one wants to lend them the money. So far US treasury secretary, Timothy Geithner refused to commit US money(as we all know US is in a deep hole herself), Brazil politely refused saying EU should be able to come up with ways of funding, China basically said no,no while criticizing reckless social entitlement programs, which they`ve called unsustainable. Few months earlier China contemplated helping EU in exchange for trade advantages that EU clearly dismissed as it would dig EU way deeper into a hole and trade deficit. However, situation now by the end of October is much more dire for China than two months ago when China supposedly offered help in exchange for trade benefits. China had to recently buyback shares on a number of Chinese banks to sure up investor confidence, plus there are ample reports of places in China where real estate market crashed 50% and would seem this is only the beginning of what should be a spectacular crash. There was also a reported case of 25% crash in real estate price happening overnight, due to some real estate developer slashing prices spectacularly on their offerings. As China is clearly in a hole at the moment, it`s very much unlikely they`ll give Europe more rope to hang themselves with. To add offense to injury, Sarkozy has just announced yesterday that he`ll try to negotiate with China some kind of lending deal for leveraging the EFSF. Good luck with that mission impossible! And this is where we are today.

All these developments, however, where extremely sugar coated by the media, giving false hope to investors while saying Europe is working on a plan to work out a plan to eventually think about working out a possible plan in drafting a plan. Market went up each time these non-event news popped out. Goes to show whole market is controlled by high frequency traders that have less common sense than a 10 year old that can only express himself through knee jerk reactions. Nothing new under the sun though.
While the non-event news were extremely sugar coated to be regarded as good developments, the bad ones were strategically given out at the end of market sessions(like the initial NO vote for EFSF in Slovakia).
As things stand at the moment, market has prized in a full recovery in EU and worldwide consequently. Nothing can be more false. There has never been such a perfect storm for a total market collapse, as US is in shambles with revolution brewing in the streets, revolutions sparkling out in Europe(Italy, Spain, Greece, UK), China poised for a violent hard landing.

While things are heading for collapse in Europe, in the US market has never been this bad, with consumer confidence dropping to 2008-2009 levels. This month`s earnings had pulled major negative surprises such as Apple missing its target for first time in many years. Banks reported dismal results, which they`ve tried to sugar coat and point to profits that only exist in some of their cooked books.
As even the darlings of US recovery, such as Ford and Apple are beginning to stumble, prospects in US look very dim. Presidential candidate Ron Paul made a statement recently saying real unemployment number is north of 20% and growing.
Companies are laying off people left and right. Banks are making huge cutbacks in personnel, Bank of America planning to lay off 30.000 employees with At&t, Bristol-Myers, Verizon and many others to follow suit. All these layoffs are perfectly mirroring situation in Europe, where Philips, Novartis and Nokia laid of dozens of thousand of people and planning more layoffs.
Yes, some would make the case market is growing in some areas, as some are doing good. However in most of these cases, companies are just stealing market share from other competitors(such as Google taking market share from Yahoo, Microsoft, Apple, RIM), market as a whole is seriously crashing. You can`t have overall market growth when 1 or 2 companies are growing 20% while 5 other similar companies are shrinking 30%. Talking heads on TV that want to make this case are just doing their usual sugar coating routine.

Now let`s take a stroll back down the memory lane of 1930 and the great depression. See how similar news headlines and sugar coating were to what we have today. For every warning piece of news there were few others to counter balance it for good measure and give confidence to investors:

In March of 1929 newspaper headlines began to hint that things were not quite as rosy as people had been led to believe. However, for every piece of bad news, there was an upbeat message to counter the bad news. Here’s a good example of a 1929 newspaper headline story, excerpted from the New York Herald Tribune, and which ran on March 28, 1929.
Headline: ‘Stocks Soar As Bank Aid Ends Fear of Money Panic’. The story read, in part, “The stock market strode out from under the shadow of a panic in call money … revived in all its old strength yesterday.
Assured that the New York banks were ready … to prevent a money crisis, the public and the professional trader set out to repair the damage done to prices on Monday and the major part of Tuesday.
Stocks in the aggregate, though bucking a 15 per cent rate for loans, enjoyed the greatest advance … in a single day in the last two years. Not even the surging bull markets of … 1928 saw such a day of heavy buying.”
This sort of reportage was typical of the 1929 newspaper headlines, right up to and following the market crash in October. Investors were told that this was just a ‘correction’ and the market would remain prosperous through at least 1930.
 How should investors position themselves given this dire context?

Some would argue governments will start to print more money in order to resume growth and therefore safe havens such as gold and silver are the place to be. In support of this view, we have seen recently some money printing coming out of Bank of England. However, it`s the same Bank of England who doesn`t think other central banks will follow suit (Fast forward to min 4:50 ).
In the US, there is big opposition from Republican presidential candidates against further money printing which resulted from popular Tea Party rhetoric. FED members are fearing of being replaced as an act of political retribution for more money printing. Several candidates have made strong statements, saying they`ll be looking to replace Ben Bernanke and other high ranking FED members.
Others have also argued the case that while US is heading to an election year, likelihood of more money printing is very low during 2011-2012. Revolution fermenting on the streets(in all major US cities) and violent protests are not helping the money printing case either, as money printing would further ignite people on the streets due to higher living costs that would result as consequence.
In case of a world economic collapse(where we pretty much are as we speak), US dollar would seriously appreciate, giving US consumer an edge and calm the spirits on the streets. A perspective that would entice politicians heading into elections.
Printing money at this juncture might be a risk that many won`t be willing to take. Opponents of more money printing can now also make the strong case of previous failures of QE1 and QE2 to really re-ignite the economy. Similar policies undertaken by Bank of England have also failed to deliver.

If we look back at 2008, both gold and silver crashed badly until stimulus started to kick in. We`ve seen silver lose half of its value going from 18 to 9 dollars. I`d say it`s very likely that we`d see a repeat of this scenario unfold again with few minor adjustments such as steeper and longer decline due to factors mentioned above. Also, what many analysts failed to notice so far is that the Euro zone countries that suffer the most, such as Spain or Italy are actually very rich countries. Mr. Richard Sulik, the leader of the SaS party in Slovakia, one that opposed the EFSF, made the case that Italy could easily raise the money by selling some of its huge gold reserve. This might be a last resort option that many are failing to take into account. After Europe would have exhausted all the alternative financing options with the money of other countries, they`ll see no other choice but to finance themselves by selling their ample gold reserves in the open market.( Sulik said Italy should sell its gold reserves instead of also participating in any bailout program. )
If the EU states follow such action and start selling gold, France, Italy, Spain, Portugal will begin to start taking offers on their gold on the open market. It`s pretty obvious what the effect of such move might be. Oh and I forgot to mention ECB can`t print money as EU law forbids it and they`ve even acted on raising interest rates since 2008. While some EU members like France, would love to see money printing by ECB, Merkel and Germany clearly opposes.

So far we`ve seen an interesting price action in gold and silver. They`ve performed on par with the market in general. When market was doing well, based on fake sugar coated news, gold and silver was doing well also, when some bad news surfaced, both gold and silver went down. This trend was broken recently due to false expectations of money printing from Europe( on wishful thinking of France) and false QE3 news coming from US in an attempt to throw a bone to the starving market.
Some say that in times of dire economy, gold and silver are the safe havens. However gold and silver have performed well only in lukewarm times of relative uncertainty. Whenever seriously bad news came flooding in, silver and gold sold off quite heavily. In absence of good news and in the company of dread coming out of media, such as we`re about to soon see as reality has a tendency to hit you in the head, gold and silver should crash on par with the market. Unfortunately, whether you like it or not, best place to be at the moment in whole world is the US dollar and the US bonds.

I`d advise going long UUPT or for the ones with little more risk appetite, start looking for a window to short precious metals. Plays to look at: GLL for gold and ZSL for silver. In the event of full market crash which should be much bigger than one we`ve faced back in 2008, gold and silver might drop much more than they did in 2008. Gold might hit 1000$/oz and silver 10$/oz.

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