-- Posted Sunday, 8 April 2007 | Digg This Article

The Year of the Pig: The March to the Slaughterhouse Continues

I noted in my February 21, 2007 edition (http://www.grandich.com/docs/alert_02-21-07.pdf), I was becoming so bearish that I was contemplating shorting the U.S. stock market. I was hoping for one last big rally on the perception the Fed would be cutting (or already had cut) interest rates. Ideally, this would occur as the DJIA went through 13,000 while TOUT-TV (CNBC) took out their party hats, balloons and noisemakers.

We witnessed how the “Don’t Worry, Be Happy” crowd on Wall Street is prepared to be the pied piper to the lost sheep when the Fed statement was perceived to have changed towards a more accommodating stance. While this rally can still occur, the number of bearish fundamentals continues to increase, which makes it even harder not to pull the trigger now.

Among the numerous bearish factors that greatly concern me:

·     Subprime fiasco – I was certainly far from being alone in writing extensively about this long before it “burst” onto the scene. I can’t help but chuckle (even though millions of Americans are being hit hard) when I hear and see politicians calling for someone’s hide for failing in oversight. Why the laughter?

On February 26, 2004, the then chairman of the Federal Reserve, Allen Greenspan said, “American consumers might benefit if lenders provide greater mortgage product alternatives to the traditional fixed rate mortgage. To the degree that households are driven by fears of payment shocks but willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.”

Helloooooooo!  If the Number One Man of Finance is feeding the flame, not dousing it, who can fully blame all the other parties now caught up in the fire? Let’s also not forget that while he encouraged more risk, he was also the author of the dramatically lower interest rates that made credit that much easier.

One potential big negative not readily being discussed is the fact that mortgages found their way into ever-more-complicated structured instruments on Wall Street and into portfolios around the globe. Much of Wall Street’s huge mortgage-related business has been built on being the middle man in a chain, originating or buying mortgages and then pooling the loans as backing for bonds sold to investors. At times, these mortgage-backed securities are themselves packaged with other kinds of loans into more complex debt products known as collateralized debt obligations or CDOs. The subprime fiasco has impacted this area of the market hard. Issuance has fallen by more than half this year compared to last year. Many investment bankers are left holding subprime loans and related securities that they can’t sell and are continuing to lose value.

To the Pied Pipers and TOUT-TV, who have tried hard to make a case that the worst is already behind us, I remind them that Federal Reserve Governor Susan Beis recently said subprime mortgage market problems could escalate. She pointed out that lenders were likely to see an increase in defaults involving borrowers who took out mortgages with low teaser interest rates, which jump to higher levels during the life of the loan. “What’s happening is the front end of this wave of teaser rate loans is coming onto full pricing,” she said. “So what we’re seeing in this narrow segment is the beginning, not the end, of the wave.”

·     Housing Bubble has burst. Don’t be fooled by an odd month’s worth of statistics. The bubble has burst. The shell game is over and there’s no quick solution. The number of borrowers in the U.S. falling behind on the riskier types of home mortgages continues to grow. Even mid-level loans (known in the industry as “Alt-A” mortgages) are seeing a marked increase in defaults. Previous cheap money allowed almost all on the housing ladder. Now, with most unable or unwilling to get on the lower rungs, the upper part of the housing ladder has no bottom support. To appreciate how all price levels are being impacted, note that homes in Bergen County, New Jersey that sell for four times the country’s median price, have now gone into foreclosure.

·     Debt - America’s total debt load has climbed to $44.5 trillion, or 331% of GDP. That’s twice the level of 30 years ago. The last time it was this high? The Great Depression, when it was above 250%.

·     Corporate America - Corporate profits have not only peaked, but appear to be heading for a prolonged downturn. Global corporate debt meanwhile, hit its highest volume on record in the first three months of this year according to Dealogic.

·     Borrowed Money - The amount of money borrowed from brokerages that do business on the New York Stock Exchange to buy shares rose to a record in February. The last time it was at a record? June 2000.

·     Economic Indicators - Numerous economic indictors, including factory orders and capital spending, are pointing to a sharp slowdown that can lead to a recession in the next 12-18 months.  Don’t let the payroll numbers from yesterday fool you. Historically, there’s always a lag between economic indicators turning down and payroll numbers shrinking.

·     Politics - While the politicians tried in vain to put on a good face after last November’s elections, yours truly said one of the biggest problems facing the U.S. was the Democrats and Republicans becoming the “Hatfields vs. McCoy’s” of the 21st century. I think it’s evident that the feud is deep and only going to get uglier. I believe the world sees it as well, and that’s one of the reasons for the U.S. Dollar continuing to slide.

·     China - The U.S. has once again cut off its nose to spite its face by slapping sanctions on Chinese paper imports. It’s no coincidence that when we imposed tariffs of up to 20% on Chinese coated papers in 2002 in retaliation for tariffs by the Chinese on steel imports, the U.S. Dollar began a slide of 35% despite the World Trade Organization reversing those levies. The latest move by the U.S. threatens an already slowing U.S. economy and once again gives cause for the Chinese to lessen or stop capital inflows into our bond market.

Bottomline –

The last hurrah in the U.S. Stock Market is nearing its end. I’m going to still hope for one last rally to new all-time highs in conjunction with the Pied Pipers on CNBC-TV declaring all is well in the world (I know they do it every day – I’m just waiting for them to do it with party hats and nosiemakers.)

U.S. Dollar –

Once the U.S. stock market puts in “the” top, I fully expect the “Don’t Worry, Be Happy” crowd on Wall Street to use the continuing slide in the U.S. Dollar as a positive for the stock market. How so? They will claim a cheaper dollar will make U.S. goods cheaper overseas and that’s great for multinationals. Don’t sweat China, India, Brazil and all the other “growing” economies, the U.S. “was” a great economic power. The only party that doesn’t know the U.S. Dollar is dead is the U.S. Dollar. It’s been my firm belief that 80 on the U.S. Dollar Index will be tested and eventually broken. If and when it does, the world will get a sell signal on the dollar and the fat lady will have sung.

Important note – Brazil is the latest central bank to publicly announce its plan to diversify its foreign-currency reserves. The central bank’s monetary-policy director said, “The idea is gradually, at a slow pace, to raise part of our reserves in assets not linked to the U.S. Dollar.”

Oil –

When we hit $50, I felt the worse was over and thought a broad trading range of $50 to $65 would take hold. I still do but realize we can overshoot $65 for a while on geopolitical and weather concerns. How fast the world slows down economically versus weather and geopolitical factors is the $64,000 question (and I don’t have the answer at this time).

Gold –

Other than stepping aside for a couple of significant corrections, I’ve been an ardent bull. In early March, many in the gold camp turned bearish or were looking for a sizeable correction. (Even the strategist of one of bullion’s biggest websites was hedging himself daily). In fact, the Hulbert Digest noted in a March 7th article in Marketwatch, that it hit 0% bulls (which means that the average gold timing newsletter had no exposure to the gold market whatsoever). Yours truly stood firm because none of the factors that kept me bullish to that point had changed. Sure enough, gold has rallied and is heading for a challenge of last year’s highs around $735.

Readers know the drill by now:

·           U.S. Dollar - The number one bullish factor is the declining U.S. Dollar, which about 8 out of 10 times leads to a rising gold price.

·           Geopolitical Concerns - Geopolitical concerns here and abroad are likely to only get worse, bolstering gold as an alternative to the world’s reserve currency.

·           Strong physical and investment demand -  Gold’s rally the last few weeks came in the face of a marked increased in central bank selling, proving that this once detrimental factor is no longer a major concern. The IMF recently reported that central bank gold holdings fell to the lowest level since 1948.

·           Manipulation/gold cartel – I see another so-called gold expert has dragged GATA (http://www.gata.org) through the sarcasm mud non-believers of manipulation seemingly like to do versus openly debate GATA with facts. While I openly declare I don’t agree with my friend Bill Murphy to the extent of the manipulation on a daily or hourly basis, Bill and GATA have gone so much further in substantiating their side of the argument than the non-believers. And quite frankly, the non-believer-argument of no possible manipulation is a non-starter to begin with.

As I noted in recent newsletters, even Fed Chairman Bernanke has openly declared before Congress that he’s a member of the government’s Plunge Protection team. And if that’s not enough, the self-declared five-star general of the “Don’t Worry, Be happy” crowd on Wall Street, Jim Cramer, openly attested to his own manipulation of the stock market and said it’s done all the time. Yet gold can’t be manipulated? Come on!

I think the so-called gold cartel continues to lose ground and any victories are short-lived and come with a heavy price. All in all, gold hasn’t looked better in quite some time.

Silver –

I think we’re getting close to one of those periods when it outperforms gold. It continues to get a pass from being part of the base metal camp because of its “kissing cousin” relationship with gold.

Copper –

When it broke below $2.50, I said I was looking for a rally back to $3 for an opportunity to turn bearish enough again to suggest shorting it. I’ve waited to pull the trigger because large specs have had a very significant short position and they needed to be squeezed. They still may need to be rung out some more but copper is strictly a scale-up sell from here to $4.

Other base metals –

I’ve been a constructive bull on China but I’m now seeing signs of serious overheating and steps by China that going forward should lead to a slowing of growth. It’s not going to be evident for several months, but the time has come for me to take a “live chicken versus dead duck” approach to China. In addition, the U.S. is dramatically slowing. Therefore, I suggest serious under-weighting in base metals and respective stocks. This doesn’t mean no exposure, just have far more towards precious metals.

Uranium –

I became bullish at $17. My target of $100 is upon us. It’s still hard to see why it can’t go higher but I feel we’re more than halfway through this bull market. It’s not yet time to abandon ship, but one should be very selective going forward and not to be afraid of lightning up too early. I am sure you would rather end up being a year too early versus a day to late. We can still see $125+ but I would sooner see it stay around $100 for the balance of the year.

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-- Posted Sunday, 8 April 2007 | Digg This Article

Peter Grandich is the Managing Member of Grandich Publications, LLC (www.grandich.com).
The company publishes The Grandich Letter (first published in 1984) which covers the metals and mining industry, follows world markets and economies, and covers the Canadian markets from an American prospective.

Grandich also provides a variety of corporate finance and development services to publicly-held companies.

Peter Grandich is also the Managing Member of Trinity Financial, Sports & Entertainment Management Company, LLC (www.trinityfsem.com), a Registered Investment Advisor in the State of New Jersey. Trinity provides investment advisory services to individuals, small to mid-size businesses, professional athletes and entertainers.

Peter is a long-standing member of The New York Society of Security Analysts and The Society of Quantitative Analysts.

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