February 17, 2004


As I wrap up from Paris tonight, gold is up $5, the dollar is trading near all-time lows against the euro, bond yields are flat, and stocks are up. The Fed told us that foreigners snapped up $75.7 billion in U.S. stocks and bonds in December, less than November, but still net buying, not selling. I told Strategic Options Alert subscribers today that it won't make sense, it won't be based on values, and it will be deadly for a lot of investors...but we could see a lot of liquidity move into stocks in the next few months. How much? I think enough to push the market to a new high. I note that financials, as measured by the banking index (BKX), broker/dealers (XBD), and S&P financials (XLF) are all at new all-time highs. That's right. They've recouped their bear market losses and made new highs. Small caps could be next. A few weeks ago I thought this was improbable, based on the action in the S&P 100. But at the margins, in the most speculative shares, we're seeing signs that it COULD happen. If it does, it's a pure speculators's play. Institutions can't afford to be on the sidelines. And individual investors will find it very hard to resist. I suggest you do, though, unless it's play money. Keep accumulating gold shares. As I'll explain tomorrow, I think they'll do well even in a non-inflationary scenario. The posting was pretty heavy today. But it's issue week for me (meaning I'm putting together the March paper issue of SI.) So I've got a lot of material on my desk that I wanted to pass along. Now, I'm passing along to dinner. G'night from the right bank, Dan

Who's the Fourth Largest Owner of U.S. Bonds?

Here's a fact: between 2002 and 2003, Caribbean banking center's added to their ownership of U.S. bonds by almost 40%, from $49.5 billion in 2002 to $69.5 billion in 2003. They are now the fourth largest owner of U.S. bonds, behind Japan, China, and the U.K. You can see how, with just a little imagination, you could come up with some intriguing explanations for this. Narco traffickers, terrorists..Hungarian born international financiers building a huge position up...to gain some leverage. Some political leverage. Or it could just be hedge funds. I'm checking with my friend John Mauldin, the hedge fund guru, about this. And aside from the cloak and dagger, it seems like a new kind of issue in international capital flows...non-state actors establishing huge positions in U.S. bonds. If it's just an aggregate number--a few hundred or thousand wealthy individual investors holding U.S. bonds through off-shore banks--it's much less...ominous. Curiously, the Fed doesn't seem to know much about. Hat tip to the fire-breathing Doug Noland at Prudentbear.com for unearthing this exchange last week between a man who knows a thing or two about capital flows--former Goldman Sachs co-chairman and current senator Jon Corzine--and Alan Greenspan. Here's the exchange with commentary from Doug. Emphasis added is mine. "It is fascinating to have the former Goldman Sachs co-chairman posing questions to our Fed chairman. I found the following discussion, and Dr. Greenspan's apparent impatient demeanor, especially intriguing. Senator Jon Corzine: "With regard to top 10 countries holding our national debt. I have a particular curiosity about the Caribbean banking centers and what their implications are with respect to our concern about funding of all kinds of miscellaneous problems that could potentially exist. And I would love to hear an analysis of what is driving the fourth-highest concentration of our debt being held by Caribbean banking centers." Alan Greenspan: "I'm sorry, was that a question to me?" Senator Corzine: "Yes, that is a question that we can ask if there could be an analysis that..." Alan Greenspan: "One has to look at it." Senator Corzine: "Yes, please." Alan Greenspan: "And in the context of, as you are far more aware than I, that the amount of information that those individual institutions in those various areas produce is less than we would like to see. But we'll take a look at it and see what we can find." Senator Corzine: "I think the issue in the funding of global terror, one wonders why so much of the external debt the United States is getting housed in among institutions that we have very little idea about. I think it's a fair..." Alan Greenspan: "We'll see what we can find." Noland comment: It is Simply Not Credible that the Fed has not by now spent significant resources delving into the issue of ballooning holdings of U.S. securities at off-shore banking centers.

Bait and Switch

Everyone seems to think the outsourcing phenomenon mainly benefits U.S. corporations first, in the form of lower labor costs, and foreign wage earners in the second, in the form of higher relative wages. But it may turn out to benefit shareholders of domestic-listed shares in countries where the outsourcing is done. At least that's what the quote below from this article suggests. Here are the key graphs: "At present it is spoken of in hushed tones, but it's a reality. US companies, especially if the founders are of an Indian origin, are definitely thinking of a flip, where the subsidiary in India becomes the parent company and the erstwhile US parent company becomes its subsidiary. This is done through a swap of shares. The newly-formed Indian parent company then proceeds to get listed in India. "Service companies command better valuation in India compared to the US. Also cost for listing in the US is comparatively high and regulations more stringent. Thus, many US-based service companies having development centres in India are looking at an Indian listing that is achieved through a flip," said Shefali Goradia, head (international tax practice), Nishith Desai Associates. "A couple of IT-enabled services (ITES) companies, where the parent was set up in Silicon Valley with subsidiaries in southern India, are in the final stages of discussions with their consultants on adopting this model." I counted 31 Indian shares trading on major international exchanges. I've listed them below but haven't begun to dig into them for specific recos. That's next. For now, anything with a three our four letter symbol trades on the American market either NYSE and AMEX (3 letters) or Nasdaq National Market (four letters). There are ten U.S. listings. Anything more than that is an issue that trades over the counter, either on the Nasdaq bulletin board or overseas. They are: Arvind Mills Ltd. (AVRNF) Dr. Reddys Labs (RDY) Gail India Ltd. (GAILY) Grasim Industries Ltd. (GRSJY) Gujarat Ambuja Cements Ltd (GUJRY) HDFC Bank (HDB) Icici Bank Ltd (IBN) Indian Petrochemicals Ltd. (IDNCY) Indian Rayon and Industries (INRXY) Indo Rama Synthetics (IDRMY) ITC Limited (ITCTY) Infosys (INFY) JCT Ltd. (JCCTY) JK Corp. Ltd. (JKCXY) Larsen and Tourbo (LTORY) Mahanagar Telephone Nigam (MTE) Ranbaxy Laboratories Ltd (RBXLY) Rediff.com (REDF) Reliance Inds Ltd (RLNIY) Satyam Computer Services (SAY) Sify Ltd (SIFY) Silverline Technologies (SLTTY) Southern Petrochemical Inds (SXPCY) Ssi Ltd (SSXGY) State Bank of India (SBKIY) Sterling Biotech Ltd. (STLGFM) Tata Motors Ltd. (TENKY) Tata Tea Ltd (TTAEY) Videocon Intl Ltd (VDOIY) Videsh Sanchar Nigam Ltd (VSL) Wipro Lts. (WIT)

Gold and Price Stability

If you want to know how exceptional the current monetary regime of the dollar standard is, check out the excerpt below from a study by the Office of National Statistics in the U.K. Money stat: for 188 years, prices rose a little over three times. Since 1938 (with the help of FDR and Nixon) they've risen more than forty times. "If there had been decimal currency 250 years ago, a penny then would have bought more than a pound does today, according to a new long-run price index which tracks the path of consumer price inflation since 1750. It shows that between 1750 and 2003, consumer prices rose about 140- fold. "Most of the increase over the period has occurred since the start of the Second World War: between 1750 and 1938 prices rose by a little over three times, but since 1938 more than fortyfold. However, in the earlier period inflation was not constant: prices roughly doubled between 1750 and the end of the 18th century, but were at about the same level over 100 years later, prior to the start of the First World War. The fluctuations during this period partly reflect harvest quality and wars, with a 50 per cent increase in prices over the first ten years of the Napoleonic Wars. "The First World War also had a significant effect on prices, with prices more than doubling during the war and the two succeeding years. But in the period 1921-1934, prices fell in most years, or at most showed very small increases, reflecting the falls in profits and wage costs associated with the Depression. Prices have risen in every year since, with particularly rapid price increases between 1973 and 1981, when prices more than tripled and the inflation rate exceeded 10 per cent in each year except 1978. "This was a time when all the industrialised world was struck by a series of supply shocks, including a quadrupling in the world price of crude oil in 1973." You'll note that 1973 was also time, not coincidentally, that Nixon took the U.S. off the gold standard and launched this modern experiement in floating exchange rates with currencies backed by nothing but current perception of future growth prospects.

High Yield AND Capital Gains: Chart of the Day

The Reserve Bank of Australia calls its benchmark interest rate of 5.25% "accomodative." Oh my goodness. But they also suggest room to raise rates if the Australian economy overheats. The range suggested by a bank official is between 5.25 and 6.25. Quick, get some Aussie bonds! While the U.S. Fed is slouching towards monetary purgatory, central banks in Australia and England are offering global investors yields that make it easy to get out of the dollar. And if your cost basis is dollars, the Everbank World Currency CDs I mentioned in the Housing Report are a great way to get yield and benefit from any continued gains in the currency of your choice. I recommended the Aussie currency CD because of the hawkishness of Australia's central bank. (If you want to know more about this, send me an e-mail at strategicinvestment@agora-inc.com with "Everbank" in the subject line.) The chart below shows the gain in the Australian dollar over the last year, via the Philly listed Australian Dollar Index (XAD). It also shows the performance of the Australian iShare (EWA). Speaking of which, the composition of the iShare is significantly financial (30% banks). But it's also 20% basic materials...which by the way is a PERFECT way to play commodity prices and the Asian stories...capital intensive basic materials industry on a continent within shipping distance of Asia's resource ravenous economies. A LOT MORE on this in the March issue and later this week. Australian Stocks and Currency Powering Up

Here Comes the Wage Gap Issue

Election issue watch: outsourcing. Greenspan and the Chairman of the White House Council of Economic Advisers don't believe outsourcing is an economic problem. It may be a political one, though. First, economically, it's not clear yet what the long-term impact of outsourcing will be. Short term, according to a Bloomberg article, "Over the next 15 years, 3.3 million U.S. service-industry jobs and $136 billion in annual wages will move to India, the Philippines, China and Malaysia, among other countries, according to a study by Forrester Research Inc., a Cambridge, Massachusetts, consulting company." That's 3.3 million in addition to whatever manufacturing jobs are displaced. Of course an economy is always gaining and losing jobs. Ideally, jobs are created in those industries an economy has a comparative advantage in. For example, as computing and technology become more pervasive, you'd expect more jobs in new technology related-fields or in other parts of the economy that use technology in new ways. This is sort of a second-generation, more sober "new economy idea that recognizes today's technology is just a tool, not and end. However, despite the promises of bio-tech, nano tech, silicon chips, etc...we simply haven't seen this yet. Yet. Will we? I don't' know. In the short-term, to those who've lost their jobs (and have a vote) the loss of jobs looks more like a major decline in living standards of living than the sign of a "dynamic economy." Not so, said the Chairman of the Federal Reserve in his testimony to the Senate last week, "What will ultimately determine standard of living of this country is the skill of the people.'' Workers, after all, aren't machines. A human being can't be made obsolete because he loses his job. He may have to train for a new job and adjust. But that happens all the time in an economy. And in truly competitive economies, workers adjust and gravitate toward the higher wage jobs. That's the theory, anyway. In reality, the missing component to the theory is the lack of new job creation in the United States. Maybe it's coming. Maybe we really are on the cusp of robust, tech-driven, work-force transforming boom. We simply don't know. This a new development in global trade, where jobs become a commodity and move across borders as easily as lumber, pomegranates, or scrap metal. If labor is commodified (employers get the most skill at the cheapest cost because of a competitive labor market), it should lead to generally lower prices, which you'd think would be good for consumers. But even if the world were approaching a golden age of a price stability, you'd have the problem of income instability. As the job market gets shuffled, a lot of workers get "displaced." And until the new job-producing industries make themselves known, you're going to find an awful lot of disaffected, displaced workers/voters. They won't have time for the subtleties of macro-economic labor market theory, and unproven theory at that. But they WILL understand the emotional logic of a growing "wage gap." And they'll want it closed. With tariffs. My guess, Kerry introduces the idea of tariffs into his campaign, or simply names Dick Gephardt as his running mate. At a debate sponsored by Pace University in September of last year, Gephardt said, "We need to have a policy to build new jobs in this country. Part of it is fair trade, not just free trade. Most everybody here voted for NAFTA, voted for the China agreement. I did not. I led the fight against it. That's the kind of trade policy we need that globalizes with fairness and standards around the world so work, wherever it's performed, is given a fair wage for their hard work." First, it looks like a throw away line, but a "policy to build new jobs." Hmm, how about the free market? Second, what is "fair trade?" I'm guessing the kind that doesn't cost American jobs but provides cheap goods. But I'm sure we'll find out soon.

February 16, 2004

Wastepaper, Quote of the Day

Tom Donlan gets it right in is commentary in Barron's this week. You might think that with the big fat greenback making the cover of the Economist and everyone and his dog going bearish on the dollar, the truly contrarian play is to be a dollar bull. Sentiment is so universally negative that this must be an extreme, right? Well, sentiment is negative, but the money managers and traders I had dinner with in London last week said now one is actually making the bearish trades. Everyone is convinced the dollar is going down. But very few traders are actually "selling it." This tells me there's a rational understanding that the twin deficits make the dollar a weak proposition. But emotionally, no one is ready to contemplate life with dollar/euro at $1.50 and dollar British pound at 2/1. It reminds me of an old golden retriever I had. His hips were going. He couldn't run. He'd routinely fall down stairs. It was obvious his best days were behind him and that he'd have to be put down eventually. But all I could see when I looked at him was the dog that used to spend all day chasing tennis balls and digging for rocks. What the currency markets need is some emotional closure. "You don't have to wish for gold coins clinking in your pocket to realize that gold is still a relevant measure of wealth, no matter how many economists denounce it as a barbarous relic. Without some attachment to harder values, the half-life of paper money is Hobbesian -- "nasty, brutish and short." "Fortunately, the U.S. is not merely on the Greenspan standard. Confidence in the chairman of the Federal Reserve is trending lower with the dollar, and deservedly so. Interest rates would be substantially higher than they are if Greenspan had not been part of the two-year soft-dollar policy. "In reality, however, the U.S. is on the gold standard, the crude-oil standard, the copper standard, the commodity-index standard, the stock-market standard, the bond standard and the interlocking standard of all currency markets. Every day, millions of traders, speculators and investors pass judgment on the dollar and its stewards as much as on the supply and demand for whatever they happen to be buying or selling that's priced in dollars, euros, yen, yuan, rupees or wastepaper. When the dollar goes down, that's a sign we're going wrong. "As any Argentine must know by now, the markets, like the mills of the gods of old, grind slow, but they grind exceedingly fine. At the moment, the markets threaten to grind the dollar to powder.

February 14, 2004

Greenspan's Sucker Punch

One of the reasons you can expect to see a liquidity-induced rush into the stock market are the figures below. Greenspan, somewhat disingenuously, claimed in his Senate testimony that low interest rates have not cause huge growth in the money supply, and therefore not led to a liquidity induced bubble. Partially true. But, by lowering the real return on cash to nearly zero, Greenspan has given money market mutual funds a swift kick in the rear, propelling them directly into the market. He's not doing savers any favors, although he appears to be doing all he can to get everyone into the market for one gigantic top before the election. Give the man a Nobel. Here are some stats from AMG data services and the Investment Company Institute. Notice the relationship. As money market mutual funds witness an exodus, domestic equity mutual funds get manna: * At the retail level, assets of retail money market funds decreased by $4.37 billion to $893.03 billion for the week ended Wednesday, February 11. *Equity funds report net cash inflows totaling $4.1 billion for the week ended February 11. Net investor inflows are now coming into equity funds at a rate of $8.6 billion per week (as measured over four weeks), the heaviest rate since March, 2000; *Domestic Equity funds report inflows totaling $2.79 Billion or 69% of the total net inflows Despite the trash return, there are still over $2 trillion in money market mutual fund assets under management. These funds own T-Bills, CDs, and short-term commercial paper--all of which currently "yield" very little, less than 2% on average. The advantage for savers is liquidity. You can get to your money easily if you need it. The disadvantage is that if you throw in a management fee, add in inflation, and compare it to the yield available in equities (even if it's not historically robust right now), holding cash is pretty painful at low interest rates. One way of looking at that $2 trillion in money market mutual fund assets then, is additional market cap in equities. Dump that on top of the Wilshire 5,000s current market cap of $11.1 trillion and you have a stock market back at levels it hasn't seen since 2000. It would still be off the Wilshire's high at $14.7 trillion. But this is just retail money market money we're talking about. A little kick from some growth from the monetary base and you can see how it's conceivable the market could actually make a new high this year. It's still insane, but conceivable nonetheless.

February 13, 2004

Trade Deficit Within Kissing Distance of Half a Trillion

Chart below courtesy of briefing.com showing the trade deficit in nominal terms on a monthly basis. The December trade deficit came in at just under half a trillion dollars, $489.4 to be exact. It was up 17% in 2003. The supposedly good news from the numbers is that import prices were up 1.3%. This is a sign that the falling dollar is beginning to make foreign goods more expensive in the U.S. That's fine as theory. But in reality the biggest increases in import prices are in energy, namely a 6.2% increase in oil prices. We've yet to see inflation, or at least noticeably rising prices in finished consumer goods. In other words, I don't think this is the kind of inflation that will force the Fed to raise interest rates before November. Exports, for their part, actually declined--which is not exactly what you want to happen with a depreciating currency. You want it to make your exporters more competitive. Such is the problem with deficits, however. Rather than taking surplus dollars to buy American goods and services, foreigners are using them to buy U.S. government bonds. This has the short-term effect of keeping the dollar from falling even further. But it has the long-term effect of hurting exporters. It's not exactly an ideal situation...a rising deficit, falling exports, and a falling dollar. And quixotically but as I've explained elsewhere, also this macro economic nervousness is bond bullish. Welcome to bizzaro land.

Quote of the Day

"While demands for dollar-denominated assets by foreign private investors are off their record pace of mid-2003, such investors evidently continue to perceive the United States as an excellent place to invest, no doubt owing, in large part, to our vibrant market system and our economy's very strong productivity performance. Moreover, some governments have accumulated large amounts of dollar-denominated debt as a byproduct of resisting upward exchange rate adjustment. Nonetheless, given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents." Alan Greenspan, testifying in front of the House Committee on Financial Services, February 11, 2004

February 11, 2004

Deficits and National Power

Off to make some final changes to an essay on deficits that my friend David Galland is publishing. I'll do a full review of the Greensphinxes statement tomorrow. For now, an quote on deficits and national power from Andrew Sullivan. "The one thing you learn from history is that inattention to national finances is the surest sign of decay in global power."

Short Term Logic

"The world's exchange system should be regarded as completely out of control." So says Lord Rees Mogg in the weekly missive below. I think he's spot on, as the English say. I'll have more to say about it in a different post, looking specifically at Chinese and Japanese currency reserves. And by the way, thank you for all the suggestions on what to call Lord Rees Mogg's weekly contributions. I especially liked Rees-Blogs. Short Term Logic by William Rees Mogg 12 February, 2004 The G7 meeting at Boca Raton has been a failure. This is bad news for everyone. It is bad news for the United States and has been followed by a further fall in the dollar. It is bad news for Japan, which has been buying vast numbers of dollars in order to stabilise the yen. It is bad news for China, under ever greater pressure to revalue or float the renminbi. It is bad news for Europe, with an overvalued euro and a depressed domestic market. It is bad news for Britain, with the pound at its highest rate against the dollar for eleven years. As the G7 communiqué piously observed that “excess volatility and disorderly movements in exchange rates are undesirable for economic growth”, the markets have already given the G7 a massive snub. Some dealers had hoped that the G7 would at least take the pressure off the dollar for a few days. What has actually happened has made the world’s central banks look completely impotent. As their authority is essential to their effectiveness, they have lost their most powerful weapon. The world’s exchange system should be regarded as completely out of control. One view is that the dollar is a problem for everyone else except the United States. So long as the Asian countries lend billions of dollars to the United States, it is possible for the U.S. Government to run the double Budget and trade deficits. And finance them by their borrowing. It is possible for American consumers to continue to buy on borrowed money. This is short term logic. At some point the American economy will have to be brought back into balance. That point is probably closer than most of us think. Whoever wins the Presidential election will have to try to restore the balance of the Budget in the difficult post-election year. The continued decline of the dollar does, in any case, threaten the re-election of President Bush. The Democrats seem to have found their most “Presidential” Presidential candidate in years. Senator Kerry is a war hero with the best senior statesman’s profile in the political casting lot. He seems already to have a united party behind him. He will carry New York and California in November. He could win, and he will win if the American voters believe that the Bush administration have lost control of the economy. As the G7 plainly has lost control of the world’s currency system, American voters could well decide that the U.S. economy was in trouble, even if employment remains high and growth is maintained. Both economics and politics are ruled by expectation, as the Austrian school of economists pointed out. Prosperity is how the economy is doing today; expectation is how the economy is expected to do next year. When the dollar is at $1.27 to the euro, $1.87 to the pound, and only buys 105 yen, one does not need to ask what the expectation is. The markets are telling us that there is trouble on the way, and the trouble is not good news for the re-election campaign. ###

He Huffs... And He Puffs...

Looks like Easy Al is everyone's pal today. Look at gold and the Dow in the hours imediately following his Humphrey-Hawkins testimony on Capitol Hill. He finished up around 11 am: Gold!... ...and the Dow "The economy is set for vigorous growth," said the history's most notorious bubble blower. Investors appear to be skeptical, though (as they should be). The Dow rally may already be breaking down.

Charts of the Day: Put Your Bull Markets in Perspective

Tomorrow night I'm headed up to London to have dinner with some fund managers and investment advisors. It's part of my participation in the investor's roundtable sponsored by the London financial magazine "Moneyweek" and its lovely and charming editor, Merryn Somerset Webb. I don't think gold bulls are too welcome right now. But we do make for good entertainment. Today, I got this shot across the bow, "The writings of ultrabears with their persistent prognostications of Armageddon remind me of nothing as much as the old prophets of Marxism who were continually prophesizing that capitalism would would implode under the weight of its own contradictions....Such apocalpytic commentators see bubbles everywhwere and are extremely bearish on everything...The only acceptable investments seem to be (usually) commodities and (invariably) gold." The followed a chart, similar to the one directly below, with the headline, "Spot the Bubble." My version compares Newmont, a proxy for unhedged gold majors, to the Nasdaq. Nasdaq vs. Newmont, weekly close, Jan. 03 to the present Not so fast, my friend. Let's put our bull (and bear markets) in perspective. Gold is coming off a 20-year bear. It's performance in the last year is the initial stage of what I think is a multi-year bull. Like all stocks, gold stocks can get ahead of earnings. But gold companies are in the business of mining a commodity (and monetary asset) that's increasingly demand. Business is good. On the other hand, the Nasdaq is the George Foreman of indexes. It's taken some big blows. And though it looks sturdier now than a year ago, it's really just one year older, one year fatter, and one year more bloated. As you can see from the chart below...this is a tale of two bull markets. One that's dead and bouncing...and one that's alive and growing. Nasdaq vs. Newmont, 1987 to present

Gold ETF on the Way...Finally

This is good news. "SAN FRANCISCO--(BUSINESS WIRE)--Feb. 9, 2004--Barclays Global Investors, N.A. (BGI) has filed a Form S-1 Registration Statement for the iShares COMEX Gold Trust with the U.S. Securities and Exchange Commission. The Trust is intended to provide investors with a simple and cost-effective means of making an investment similar to an investment in gold. The objective of the Trust is for its shares to reflect, at any given time, the price of the gold owned by the Trust at that time less the Trust's expenses and liabilities. Once available to investors, shares of the Trust can be purchased and sold throughout the U.S. market trading day. The Net Asset Value (NAV) of the Trust's shares will be determined daily by the Trustee on the basis of the settlement price for spot-month gold futures contracts announced by COMEX. "

The Difference Between Winning and Losing

Looks like the OODA loop (or Boyd cycle) is hitting a critical mass...sort of like Malcolm Gladwell's Tipping Point a few years ago. Or maybe the Boyd cycle has reached a tipping point as a useful metaphor for a good decision making process. I noticed a link to page on OODA loops at from Instapundit today. You can find the link, with a good graphic of the loop itself, here. If Glen Reynolds (Instapundit) links to it, you can be sure it's going to start showing up in a lot of places. In the alternative media/libertarian freelance newsgatherer/subjective opinion maker space....the Instapundit is the King (Drudge is the jester). The quote is taken from Grant Hammond's "The Mind of War," which I have on my recommended reading list at the Insider home page, and which I'm reading now. Despite the title, the book isn't about war so much as it is about John Boyd's contribution to the science of knowing, or epistemology. Boyd simply added the element of time and said that in a competitive environment, from the battlespace to the marketplace, the ability to process new information faster, find what's important, and make a good decision is a key competitive advantage. It is the difference between winning and losing. As Hammond says, "Knowledge of the strategic environment is the first priority. "