March 21, 2013

March 21, 2013

Today’s Biggest Investment Theme: Investors’ Worldwide Search for Yield

For years now, the Fed and other central banks have had short-term rates pegged very close to zero.  At the same time, the Fed, Japan, the U.K., Switzerland, Europe, and many other countries are printing money via quantitative easing.

Cyprus and Gold

Early this week, Europe panicked because of Cyprus.  We see gold as the biggest beneficiary of the crisis in Cyprus, but we do not see the Cypriot banking system upending and crashing the world banking system…

Bullish on U.S. Stocks, Japan Stocks, and Gold

It appears that in the last two months, the investing public is finally feeling comfortable enough to buy stocks.  This is why we are encouraged to see that finally the investors, after buying long bonds, corporate bonds, and junk bonds in search for yield, are shifting some of their money from money market funds into stocks.  That is correct: they are not selling their bonds.  Rather, they are now abandoning their money market funds in search of stocks that can yield (say) 2+ percent, which is more than 10 times the amount they annually earn in the money market funds. 

Why are Investors Finally Awakening Now?…

Where is it coming from?…

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Japan Eyes Potential Energy Windfall from Commercial Methane Ice Extraction

A Japanese research team under the auspices of a state-run company has made a significant breakthrough in the exploitation of a new source of natural gas — one with game-changing potential for the Japanese energy sector.

Energy security weighs heavily on the minds of Japan’s leaders.  The EIA (Energy Information Administration) estimates that Japan is only 16 percent energy self-sufficient.  Although Japan has coal, it has little in the way of other conventional hydrocarbon reserves, and is now the world’s largest importer of liquefied natural gas (LNG).

Until 2011, nuclear power had been a significant part of Japan’s energy strategy.  30 percent of its electricity was generated by 54 operational reactors until the disaster at the Fukushima Daiichi plant led to a virtual shutdown of Japan’s entire nuclear industry.  Only two reactors are operational again, and public sentiment has turned decisively against nuclear energy.  Despite this catastrophic drop in electric production capacity, Japan has only experienced shortages, and not the full-scale blackouts that some grim pundits had predicted…

The Promise of Methane Hydrates…

Methane Hydrate Deposits — A Potential Game-Changer for Energy-Hungry Nations
Japan Methane.jpg
Source: Deutsche Bank

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Chinese Officials Fight Corruption: The “Rot That Has Reached the Roots”

When Xi Jinping became the heir apparent to China’s top post in December, we commented on the apparent seriousness of his intention to make anti-corruption efforts an early and critical part of his rule.  We also pointed out that his father, Xi Zhongxun, had been a liberal and reformer persecuted by hardliners during the Cultural Revolution and rehabilitated after Mao’s death — in short, that the younger Xi has a family history that lends credibility to his anti-corruption stance.  We also commented in January that the state seems to be making selective use of new media to let the Chinese people take the exposure of corrupt officials into their own hands — at least when the officials in question aren’t too high up in the echelons of Party power.

Underlying all talk of corruption in China is the memory of Tiananmen Square.  Although western media portrayed the 1989 protests as being “pro-democracy,” the Chinese overwhelmingly perceive them as having been motivated by disgust and frustration with official corruption.  In his first speech as Politburo head, Xi acknowledged that if corruption were left unchecked, it would threaten the stability of the Chinese state.  This is the existential dilemma that lies unspoken behind the urgency of current anti-corruption drives, and the selective “pressure release” the state is cautiously permitting through citizen muckraking on Sina Weibo (China’s Twitter analogue).

“The Chinese Way”…

Little Red Envelopes: Endemic Bribery in China Goes Beyond Officialdom

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New Cases Showcase Instances of U.S. State and Municipal Corruption

Illinois got a slap on the wrist last Monday as the Securities and Exchange Commission announced a settlement to deal with the state’s fraudulent pension finances, and their impact on bondholders.

It wasn’t the only time last week that corruption in state and local government was in the news: a jury in Detroit delivered guilty verdicts on 24 of 30 counts in the corruption trial of former mayor Kwame Kilpatrick — the two most serious of which carry maximum sentences of 20 years apiece.  (The Detroit proceeding, unlike the SEC’s, involves actual charges and actual enforcement against actually responsible individuals.)

Rod Blagojevich’s Corrupt Administration Helped Build Illinois’ Pension Insolvency

Rod Blagojevich.jpg

Source: Wikimedia

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The Inflation Targeting Balancing Act

According to the U.S. Federal Reserve Bank’s web site, the objectives of its monetary policies are to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

The Chairman of the Fed has suggested in recent months that the Bank intends to maintain its stimulative quantitative easing (QE) asset purchasing programs in place until the economy demonstrates sufficient strength to generate enough job growth to get unemployment down to 6.5 percent, and can generate inflation of about 2.5 percent.

As we discussed last week, the U.S. economy has made some progress on the employment front as the official unemployment rate has been declining; it now stands at 7.7 percent — even if the official numbers leave a lot to be desired.  Recent progress aside, “maximum” employment does not look likely any time soon.

With respect to stable prices — another area where the official numbers leave a lot to be desired — the numbers are also showing a pickup.  The February 2013 data released last week said that consumer prices rose 2.0 percent over the previous 12 months, which is up from January’s 1.7 percent figure.

Inflation of 2 percent is still well below the Fed’s desired 2.5 percent target, and is also well below the 100-year average of about 3.2 percent.  We believe this gives the Fed a lot more room to keep their foot on the QE gas pedal.

The St. Louis branch of the Fed chart below shows the long-term swings in the U.S inflation (as measured by the Consumer Price Index, or CPI).  The average rate for the past 100 years is estimated at about 3.2 percent.


If the Fed is Successful in Driving the Official, Manipulated Data Higher, What Will it Do to the Prices of Basic Needs?

Keep in mind that the calculation of consumer prices in the CPI includes many periodic adjustments to weights, seasonal smoothing calculations, and many changes to what is in the basket of goods used to calculate CPI.  In most cases, the effect of these manipulations tends to lower the official rate of inflation.  Many of these manipulations of how the statistics are calculated have taken place since the 1980s… and you can see in the St. Louis Fed’s chart above that the official inflation number has gotten less volatile in the past few decades.

While the government’s latest inflation data said prices were up 2.0 percent in the past 12 months, the prices of a fixed basket of certain basic, essential needs (representing food, clothing, shelter, and energy) as measured by our Guild Basic Needs IndexTM were up 6.9 percent over the same 12 month period.

One Year isn’t a Trend, So Let’s Take a Look at a Longer Period

If the economy reverts back to the 100-year average inflation rate of about 3.2 percent, what does that mean?  At 3.2 percent inflation, prices double about every 20 years.  We have not gathered 100 years of data for the cost of basic, essential needs, but since the start of 2000, the prices of certain basic, essential needs show an average annual increase in price of about 4.8 percent.  At that pace, the cost of things people need and consume every day are on pace to double every 15 years.

Guild Basic Needs IndexTM

Feb 2013.jpg

The Fed had Better Be Careful What it Wishes For

Another thing a higher inflation rate means is more stress on the U.S. Treasury.  While the Fed wants to engineer higher prices in the economy, there is definitely a point that is too high.  Can they engineer that too?  The Treasury doesn’t want them to be too high, as the government has a lot of debt outstanding and a lot of future bills that are calculated based on CPI as the cost-of-living adjustment mechanism.  It is a delicate balance, but nonetheless, we expect two things to continue:  1) We expect QE to continue, and 2) we expect the official inflation rate to continue to understate the reality of what Americans experience at the store.

Stay tuned to these letters, and visit periodically to track the cost of basic, essential needs in America.

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