Jan 23, 2004

->THE SUPERCYCLE OF DEBT -John Mauldin, FrontlineThoughts

MARKET NEWS DIGEST

U.S. stocks trade lower -CBSMW
Nasdaq joins blue chip retreat; Microsoft holds gains
By Mark Cotton, CBS.MarketWatch.com
Jan. 23, 2004

NEW YORK (CBS.MW) -- U.S. stocks were flat-to-lower Friday in afternoon trade as earnings-inspired gains for Microsoft failed to a halt a modest blue-chip retreat, while the Nasdaq Composite drifted into negative territory.

"We're just in the process of digesting the recent gains in the market," said Todd Clark, head of listed equity trading at Wells Fargo Securities. "It's fairly quiet and we're not seeing a whole a lot of new money coming in."

The Dow Jones Industrial Average was down 46 points, or 0.4 percent, at 10,576, off an early high of 10,643, and was in danger of ending its weekly winning streak.

The Nasdaq Composite was down 1.40 points, or 0.1 percent, at 2,117, but had been up as much as 19 points earlier in the session.

The S&P 500 eased 1 point, or 0.1 percent, at 1,142.

"Investors are punishing companies that only meet earnings expectations or give just moderate guidance for the next quarter or the full year. The selling pressure comes from people taking 10 to 20 percent of their positions off the table on solid earnings."

http://www.cbs.marketwatch.com

Gold edges up on weaker dollar -FT
By Ivar Simensen
January 23 2004

The prices of spot gold rose in morning trade on Friday as the falling dollar made the precious metal more attractive to international investors. Oil prices were steady following recent strong gains.

Gold fixed at $411.40 per troy ounce in London, up from $409.20 in New York on Thursday as the dollar fell to its lowest level against the euro in eight sessions.

However, trading was choppy with many Asian markets closed for the Chinese new year.

Gold prices have been trading close to the $410-mark this week after hitting a 15-year high of $430.50 in early January. On Wednesday the German Bundesbank said that it wanted to sell 600 tonnes of bullion reserves under any new agreement between central banks. Under the current deal, which expires in September this year, the banks have agreed to sell no more than 400 tonnes each.

Oil prices were little changed following strong gains earlier this week. Brent crude was 5 cents higher at $31.16 per barrel, up $1 from Friday a week ago. Rising demand for heating oil due to a cold winter in the US has driven crude prices to their firmest since the war in Iraq in recent weeks.

http://www.ft.com

Dollar falls anew vs. euro -CNNfn
U.S. currency drops 4 cents since Monday as ECB signals it will not intervene or lower rates.
January 22, 2004

LONDON (Reuters) - The euro hit a one-week high against the dollar Thursday as investors treated a lack of recent aggressive opposition by euro zone policymakers to renewed euro strength as a green light to buy the single currency.

The euro had risen to $1.2724, up two thirds of a percent from late New York levels and adding nearly four cents just since Monday. The euro hit an all-time high near $1.29 last week.

The dollar also fell against the yen, down half a percent on the day to a one-week low of ¥106.30.

In its monthly bulletin, the European Central Bank reiterated its concern about excessive currency volatility.

ECB chief economist Otmar Issing is due to speak at the World Economic Forum in Davos later. But he again hinted on Wednesday euro strength was not a one-way bet and interest rates were unlikely to fall, echoing council member Nout Wellink.

"The softening in the tone of verbal intervention by euro zone policymakers is re-intensifying the pressure on the dollar," said Steven Pearson, chief currency strategist at Halifax Bank of Scotland Treasury Services.

http://www.cnnfn.com

Oil at 10-month high after blast -CNNfn
Explosion at Algerian natural gas plant closes country's largest refinery, boosting crude prices.
January 20, 2004

LONDON (Reuters) - Oil prices hit a fresh 10-month high Tuesday as a huge explosion at a liquefied natural gas plant in Algeria closed the country's largest refinery and main oil export terminal.

The shutdown fueled concern over global supplies as freezing temperatures test wafer-thin fuel stocks in the United States.

U.S. light crude futures for February delivery rose 83 cents to $35.90 a barrel, the highest level since the U.S. invasion of Iraq in March. London's Brent crude futures rose 55 cents to $31.12 a barrel.

Prices marched higher after the explosion ripped through the vast petrochemical plant in the Algerian port city of Skikda on Monday, killing at least 23 people and shutting down all activity at the oil and gas refinery complex.

http://www.cnnfn.com

Sell oil for gold, Mahathir tells Saudi Arabia -Forbes

JEDDAH, Saudi Arabia, Jan 18 (Reuters) - Former Malaysian Prime Minister Mahathir Mohamad said on Sunday that Saudi Arabia should sell oil for gold, not dollars, to avoid being "short-changed" by a decline in the U.S. currency.

"The price of oil is $33, but the U.S. dollar has declined by 40 percent against the euro so you're effectively getting $20," Mahathir told an economic conference in Saudi Arabia's Red Sea city of Jeddah. "So you're being short-changed."

Saudi Arabia, the world's biggest oil exporter, has justified higher world oil prices by saying they are necessary to compensate for the slide in the U.S. currency.

Mahathir, who retired last October, spent much of his time in office upsetting Western governments and defying their economic orthodoxies. But he became a respected spokesman in Islamic and developing states and received an ovation in Jeddah.

He suggested countries tally their total annual imports and exports and settle the difference at the end of the year in "gold dinars". Sounding a discordant note, Mahathir also warned Saudi Arabia against rushing to join the World Trade Organisation (WTO), saying it was not necessarily a positive move.

FULL STORY

Morgan's Debt Swapping Passes Lending -Bloomberg

Jan. 20 (Bloomberg) -- J.P. Morgan Chase & Co., for more than 200 years, has made most of its money by arranging loans to governments, companies and individuals. So far in the 21st century, the bank is getting more revenue by rearranging borrowers' debt payments in the so-called swap market.

The second-biggest U.S. bank gets as much as $10 billion a year helping customers from Fannie Mae, with the highest credit rating, to Humana Inc., whose debt is at the lowest investment grade, get cheaper financing by exchanging one borrower's fixed debt payments for another's floating rate obligation. These interest-rate and currency swaps are now New York-based J.P. Morgan's biggest money-maker.

``This is a leviathan business for us,'' said Michael Davie, 41, London-based managing director and co-head of European interest rates at J.P. Morgan, which last week agreed to buy Bank One Corp. of Chicago to boost its assets to more than $1 trillion.

The market for interest-rate and currency swaps, invented in 1981 by Salomon Brothers banker Jon Rotenstreich for International Business Machines Corp., grew 20 percent in the first half of last year to $100 trillion, according to the Basel, Switzerland-based Bank for International Settlements.

``Derivatives and interest-rate swaps help spread risk in our economy and are one of the leading reasons that our capital markets are the best in the world,'' said Gary Gensler, a former U.S. undersecretary of the Treasury under President Bill Clinton. Gensler was called in to assess the damage to world financial markets posed by the possible collapse of hedge fund Long-Term Capital Management's derivatives positions in 1998.

U.S. Federal Reserve Chairman Alan Greenspan has said swaps and other derivatives -- financial obligations whose value is derived from debt or equity securities, commodities or currencies -- make markets and economies more flexible and resistant to shocks by spreading risk.

http://www.bloomberg.com

COMMENTARY

THE NEW BULL MARKET IN GOLD -Craig R. Smith
The 10-Year Cycle ... From Ch. 4, Rediscovernig Gold in the 21st Century, 7/01

As a kid in the early 1960s, I used to go to the bank to buy rolls of pennies, dimes, quarters and half-dollars. Little did I know that collecting coins would later become my vocation.

Yes, times were simpler back when Mercury dimes and Indian head pennies could be found in loose change and slipped into my Blue Book coin collection.

Life also seemed more stable because the pace of change was slower and more predictable. Even our money was more stable because you could still go into any bank and exchange a paper promise (a dollar) for the real thing - a silver dollar or two silver half-dollars.

But that all changed in 1965 when even the promise of payment in silver was removed by the Fed. Starting in 1965 our coinage began a gradual decent from 90 percent pure silver to zero today.

I do not think it’s a coincidence that ever since the late 1960s the rare coin market has continued to steadily grow in a cyclical fashion.

Throughout my 35-year experience in the coin market I've observed two important facts:

1. They don't make historic coins anymore.
2. U.S. rare coins follow a ten-year cycle.

About 20 years ago (1979 -1980) during the Carter administration we had double-digit inflation, double-digit interest rates and gold bullion increases of 721 percent, while numismatic coins escalated 1,222 percent.

Then suddenly bullion prices dropped with virtually no opportunity to sell out for most investors. Rare coins also dropped, but at a slower rate that allowed enough opportunity for profit taking.

Ten years later (1988-1989) Wall Street first discovered U.S. rare coins and again we experienced a bull market cycle, this time pushing prices up as much as 600 percent. Only those who understood the 10- year cycle were prepared for it.

By the end of 1990 the market began a stair-step decline until 1995. This drop appeared to be an over-correction, as some coins dropped as much as 80 percent, until they hit 14-year lows.

In 1996 the rare coin market stabilized and in 1997 and 1998 brought more than 20 percent average growth. In 1999 many segments of the rare coin market increased by 30 to 40 percent, such as $20 dated Liberty gold coins.

Then came the year 2000 with all of its fanfare. As mentioned, the apocalyptic predictions prompted many gold buyers to opt for bullion gold. Yet it was the rare coin buyers who were the real beneficiaries - despite the falling gold bullion price.

Some U.S. Gold Commemorative coin prices escalated 60 to 75 percent before the end of 2001. Why? Because we are right on target for another 10-year cyclical boom in both gold and U.S. rare coins. Only this time, it not only represents a decade, but also a century and millennium economic super-cycle.

Next RMP: More from Chapter 4: RARE COINS: Cyclical Volatility

P.S. Americans need to increase their personal gold coin holdings before prices rise another 50% in the next two years (from $420 to $600 per ounce) just like they have in the last two years (from $280 to $420 per ounce.

My conclusion is simple: GOLD: OWN MORE IN '04!
Request my 2004 Gold Rush Kit ... FREE to serious investors who want to understand today's exciting gold and U.S. rare coin markets.

Despite Drop, Signs Look Good for Gold -NY Times
By JONATHAN FUERBRINGER
January 18, 2004

INVESTORS who poured more than $1.5 billion into gold and precious metals mutual funds in the last year got a shock last week.

The price of gold plunged 3.2 percent on Thursday and was down 4.6 percent for the week, to $407. For the year, gold has fallen 2.2 percent.

What happened to gold stocks was even more painful. Even before the price of gold plunged on Thursday, two leading precious-metals indexes fell sharply. By the end of the week, the gold index of the Chicago Board Options Exchange and the gold and silver index of the Philadelphia Stock Exchange were each down more than 10 percent. That led to an average loss of 10.4 percent through Thursday for the precious-metals funds followed by Lipper Inc.

Despite this sell-off, investors kept moving money into precious metal funds, adding $53 million in the week ending Wednesday, according to AMG Data Services. Investors, in this case, seem to know what they are doing. Though gold has stumbled, the gold rally won't fade for good until the dollar stops declining.

The dollar rallied briefly last week, setting off the decline in gold prices, but mixed signals from the Bush administration, the Federal Reserve and European central banks and finance ministers suggest that nothing fundamental has changed.

Still, the sudden fall in the price of gold is a warning that the road ahead for gold and gold company stocks is likely to be much less smooth than the rally that brought gold back over $400 an ounce last month. The current sell-off is a reminder that chasing gold at these prices is much riskier.

John Hathaway, a gold fund portfolio manager at Tocqueville Asset Management, said the plunge in gold stocks was easy to explain: the stocks were ahead of the metal. "By our own reckoning," he said, "the stocks were discounting gold at $500 an ounce or a little more. At some point you have to see a pullback, and maybe that is what we are getting."

Jean-Marie Eveillard, co-president of First Eagle funds, said the gold stocks might lead gold lower for the next couple of weeks or months. But he is holding his ground. "I am not a trader so it does not bother me," he said of gold's fall.

FULL STORY

A PROLONGED, PHONY AFTER-BUBBLE -Bill Bonner, DR
Jan. 19, 2004

"There are three kinds of economists," said Sir Eddie George in the Times of London. "Those who count and those who can't."

Mr. Greenspan's British counterpart showed us which group he belonged to. Today, we now wonder about America's economists.

"The Fed has arguably offset the bursting of one bubble by inflating another... "

The Economist magazine referred to the way housing has been puffed up by lower interest rates. As rates went down, Americans found that they were able to buy bigger and better houses - for the same monthly payment. Housing prices rose... leaving people freer to refinance their existing houses and 'take out equity.' The money was then used to buy stocks or consumer items. Either way, the results are misleading enough to make Americans regard Alan Greenspan as though he might be a hero and George W. Bush as though he might be a two-term president.

"The longer a bubble is left to inflate," continues the Economist, "the more it encourages the build-up of other imbalances, such as excessive debt. When these imbalances unwind, there is a risk of a long period of sluggish growth. Mr. Greenspan's fans claim that America has escaped a prolonged downturn. That may prove to be so, but it is too early to be sure, simply because the imbalances created by the bubble, such as low saving and record borrowing, have yet to be unwound. Instead, the economy has been kept going by a further bout of consumer borrowing and by massive government borrowing, pushing the total budget deficit to 5% of GDP. Such indebtedness is unsustainable. At some stage households must save more and spend less, as must the government. At the very least, America's debt overhang leaves its economy more vulnerable to its next downturn."

You recall a recent IMF report that suggests the next downturn could pose "significant risks," not only to the U.S. but to the rest of the world as well. Net financial obligations to the rest of the world could soon be equal to 40% of the total U.S. economy, the IMF concluded, "an unprecedented level of external debt for a large industrial country."

Other developed nations - Japan, Germany, France - have large government deficits. Japan's deficit is even larger than ours. Some nations have current account and/or trade deficits, too. But only we have the proud twin towers of debt, deficit and duplicity - Alan Greenspan and George W. Bush. Working together, they have given us a government deficit reaching up to almost 5% of GDP and a trade deficit of about the same size.

"Without those tax cuts I do not believe the downturn would have been one of the shortest and shallowest in U.S. history," says John B. Taylor, undersecretary of the Treasury.

Good thinking, John. And let's not forget the interest rate cuts, either. Without such quick and decisive action by the feds, the U.S. might have had a real correction, instead of a phony one. People might have stopped spending, paid down their debts... and begun saving again. They might have lost their jobs and regretted having gone so deeply into debt. Stocks might have fallen to levels where they were a good buy again. By this time in the cycle, people might actually have some money to spend, and we might be looking ahead to a real recovery, instead of a prolonged, phony after- bubble.

And without such prompt and reckless action by the feds, Greenspan and Bush might be sweating a disgrace they did not merit... rather than a respect they do not deserve.

http://www.dailyreckoning.com

Why Is That Dollar Bill Worth Anything? -NY Times
By HAL R. VARIAN
January 15, 2004

WHY is that dollar bill in your pocket worth anything? One answer is that it's valuable because it says it is. To the left of the portrait of George Washington, the dollar proclaims: "This note is legal tender for all debts, public and private."

Dollar bills are "fiat" money - they are valuable because the government in power says so. People can, however, write contracts that specify payment in other currencies. If a contract specifies payment in euros, dollars will not fulfill the contract, despite what is printed on them.

A more profound, and perhaps slightly unsettling, reason that a dollar has value is simply that lots of people are willing to accept it as payment. In this view, the value of a dollar comes not so much from government mandate as from social convention.

FULL STORY

SKIN-DEEP PROSPERITY -Martin Weiss, SafeMoneyReport
Jan. 19, 2004

FIRST, the glittering economic prosperity of recent years was skin deep. Below the surface, something very ugly has been going on — something hard to define and quantify — but ugly nonetheless.

SECOND, for many Americans, the family as a social norm is collapsing, and the collapse is accelerating. That decline, in turn, is linked, directly or indirectly, to child abuse, child molestation, child abduction, and child murder.

THIRD, the decline of the family also has vast economic consequences — such as a bigger financial burden on governments for education, health care, elder care, and more.

FOURTH, trying to buy quick prosperity with big government injections of money and debt right now doesn’t seem like it will do much good. It could even make things worse.

FIFTH, even in the best case scenario, we’re still piling up unpayable debts that SOMEONE is going to have to pay for. Maybe it will be retired folks whose Social Security and Medicare gets cut. Maybe it will be the broad middle class that gets stuck with huge tax hikes. Probably both.

Martin on Monday email.

Investors have irrational expectations on returns -Bloomberg
January 19, 2004
BY JOHN DORFMAN

Irrational expectations

As recently as the 1970s, most finance professors scorned the idea of mixing psychology and investing, said academic and author Robert Shiller.

Shiller is professor of economics at Yale University, a fellow at Yale School of Management and author of "Irrational Exuberance" (Broadway Books, $15.95).

Until recently, he said, most academics believed the stock market was governed by "rational expectations."

Stocks allegedly sold for the "optimally estimated present value of future cash flows," Shiller noted. He was among the first to question that theory, pointing out that it fails to account for the market's heaving volatility.

"The market does not move consistently with interest rates, consumption," dividends or productivity, he said. He believes investment bubbles such as the Internet stock craze of the 1990s in the United States and the tulip bulb mania of the 1630s in Holland drive a stake through the heart of rational-expectations theory. To Shiller, the existence of bubbles is proof that investors have irrational expectations, not rational ones.

Investment bubbles

Delving further into the subject of investment manias, money manager Jeremy Grantham said he has identified 27 investment bubbles in financial history.

In all 27 cases, he said, prices came back to the trend line that prevailed before the bubble started.

Grantham also talked about the effect of the U.S. presidential election cycle on the stock market. Years one and two in a president's term show stock performance 4 percent and 4.6 percent below the long-term trend, he said.

Year three shows performance 8.7 percent above trend, and "this is a classic year three" with strong gains by small stocks, growth stocks and low-quality stocks.

http://www.bloomberg.com

THE SUPERCYCLE OF DEBT -John Mauldin, FrontlineThoughts
Jan. 16, 2004

Debt and the dollar, employment and interest rates, the US economy and world trade, money supply and inflation/deflation, taxes, deficits, commodity prices, politics, war, regulation plus a host of other variables.

They are all related in a very complex and dynamic fashion. Changing one of them may change each of the others in often unpredictable ways, which in turn affect all the others. Today, we start a series trying to understand how they fit together and what the implications are for our investments.

We are in a stimulus driven recovery. As noted last week in my 2004 predictions, I think it will last for most of this year, if not the entire year. Yet, easy money and stimulus are not without a price. Messing with a free market is a perilous task. On the other hand, to have not acted would have insured a double-dip recession of what I think would have been of serious proportions. Will the stimulus be enough to start a self- reinforcing growth cycle? The task immediately before us is not to determine the correctness of any one policy. That is for the debating society and later letters. But for now, we need to see what the effects of the current trends and policies are likely to be.

The Thighbone of Jobs

The old spiritual goes "the thighbone is connected to the hipbone" and so on. The key factor as to whether the stimulus of low rates and tax cuts will be viewed in the future as real or as artificial is whether or not the economy can produce jobs. Everything is connected to jobs. Consumer spending is connected to jobs. Without income growth which comes from jobs, consumers cannot continue to borrow and spend. Consumer sentiment is tied to jobs. The housing market is tied to employment as increased employment will increase the demand for housing.

Tax receipts and thus reduced deficits are obviously tied to employment. The more people who work, the greater the amount of total US savings. Increased employment is a key factor for business spending.

But the recent employment report is not an optimistic one. And if you delve deeper, it is even more problematic. My friend John Vogel sends me a detailed analysis of the employment numbers each week, often within an hour or so of the release. For the last 26 weeks, we have a comparison of 383,195 for the most recent period versus 407,788 for the prior year. 24,000 per week lower is not anything to be jubilant over. Note that both numbers are close to the 400k that economists use to determine job creation thresholds.

The economy, coming off the most powerful quarter in decades, produced a paltry 270,000 jobs. As Stephen Roach notes, "There seems to be a real disconnect between the actual numbers on the hiring front and the impressions that have been formed in financial markets. Total nonfarm payrolls have expanded by only 328,000 workers over the August to November 2003 period -- an average of 82,000 per month. That's far short of the pace of job creation that normally occurs at this stage in a business cycle recovery -- somewhere in the range of 250,000 to 300,000 per month. Yet many have been quick to interpret the recent modest pickup in hiring as a sign that Corporate America is finally breaking the shackles of risk aversion and emerging from the funk of recent years. The mix of recent hiring trends tells a very different picture.

"It turns out that fully 84% of the total increase in nonfarm payrolls over the August to November period is traceable to hiring in four segments of the labor market -- the temporary staffing industry, health, education, and government -- where combined jobs have increased by 68,000 per month. In other words, the bulk of the so-called hiring turnaround since August has been concentrated in either the contingent workforce (temps) or in those industry groupings that are least exposed to global competition. This hardly speaks of a US business sector that has consciously made an important transition from downsizing to expansion. It merely reflects the fact that scale is increasing in the most sheltered and least productive segments of the economy." (www.morganstanley.com)

Read that last paragraph again. The let's tie it to a small item buried in last week's Dallas Fed report. In the latest period, the average wage for temporary labor was $13.50 per hour versus $15.00 per hour a year ago. Further, maybe due to internet purchases, there were actually 72,000 less workers in the retail sector (think Christmas). This is distorting the seasonally adjusted numbers, which is why looking at averages of the real numbers as we did above is important.

GregWeldon offers us these tidbits about employment: Real earnings deflated in December by 0.6% and rose at less than an annualized 1% for the last four months. The slicing and dicing the Philly Fed report, which somehow was spun as positive, "...the reading posted by the Number of Employees category, FELL, as did the reading for Average Workweek. Perhaps even WORSE, is the decline in the expected Number of Employees, as the 6-month outlook fell to 15.1 from November's 17.5 ... marking a sizable drop from November's reading of 21.3. Also, the 6-month outlook for the Average Workweek fell to 16.7 from 24.6.

"Bottom line: Firms have become LESS optimistic about HIRING."

The employment numbers for the rest of this quarter are especially critical. There is a massive new supply of government bonds being sold in February. Will the employment number turn bullish and thus push up rates? Maybe just more of the same old sideways? Or will numbers surprise on the downside? What will that do to the stock market? Won't that make a difference on the dollar? But that affects rates again and the trade deficit, which drives the global economy and exports and so on and so on. It's all connected, gentle reader.

I believe the economy will be ok this year because of the stimulus from 2003 and the continuance of the tax cuts, at least through the elections. But I worry about the longer term sustainability of the recovery unless we start to produce jobs at a faster pace. When almost as many people drop out of the job market as are hired at new jobs, that is most worrisome. When incomes are not rising and hours worked are falling, as is the case for the most recent periods, that is troubling.

I agree with Martin Barnes of the Bank Credit Analyst when he writes: "As far as monetary policy is concerned, the Fed has already made it clear that it is prepared to go to extreme lengths in order to prevent the economy from slipping into deflation. If the Fed wants to create inflation, then it can do so by drowning the financial system in excess dollars. Of course, the dollar would collapse, but that would be part of the reflationary process. An end to the Supercycle would be deflationary, so one way to delay the end would be to create inflation in order to devalue the burden of outstanding debt. The bottom line is that the demise of the Supercycle is not imminent. The economy will suffer another downturn in the next few years, but the authorities should still be able to find ways to prevent a terminal shakeout."

When to Buy Gold

I have been bullish on gold for two years. I get asked all the time about when to buy gold. The answer is pretty much always "now is a good time," or on the next pullback add some more. The above process of the Supercycle is terribly bullish for gold in terms of dollars. It could be dramatically bullish, although I sincerely hope not. I still look for a more Muddle Through ending, but there will be inflation at the end of the process, and that is bullish for gold. If you are in Europe, you have not yet seen a bull market in gold. But I believe it will eventually translate itself into a bull market in other currencies as well.

Gold may go nowhere this year. Or it may continue its rise. I don't know short-term, but longer term, over the coming decade, I think there is plenty of room in the gold market. I would add to any positions on a systematic basis.

Frontlinethoughts

ABOUT THE EDITOR

David M. Bradshaw is Editor of Real Money Perspectives, publisher of Rediscovering Gold in the 21st Century: The Complete Guide to the Next Gold Rush (7/01) and has been an economic commentator since 1987, when he produced the World Economic Perspectives radio show. In 1997, he produced a one-hour TV documentary, "Preparing Wisely for the Next Millennium," which was distributed free of charge at Blockbuster Video nationally. In 1999, he produced a one-hour radio special, "The Big Picture: The Shape of Things to Come" discussing geopolitical, economic and spiritual trends in the 21st Century. MORE...