Too Much, Too Soon, Too Fast The Daily Reckoning Australia Monday, 5 October 2009 ---

------------------------------- From Dan Denning in St. Kilda: --Before we get started, if you missed our conversation about gold stocks and gold speculations last week, have a read of Doug Casey's thoughts on the subject last week, to which we referred in our article.

Doug is a rich source of resource wisdom and was the source for some of our observations last week. A few readers wrote in suggesting we ripped Doug off without giving him credit. As Doug is a friend, we wouldn't rip him off but should have linked back to his site last week. --

And on to today...Shouldn't this be an interesting week? "Markets have gone up too much, too soon, too fast," says Nouriel Roubini. The ASX 200 fell nearly 100 points on Friday, or 2.11%. This echoed the previous day's trading in New York. --Friday wasn't so bad on the Dow. But the jobs report released by the U.S. Department of Labor showed 263,000 lost jobs in America and an official unemployment rate of 9.8%. --That rate is undoubtedly much higher, once you figure in people who've given up looking for work but are no longer included in the survey.

In fact, the "U-6" figure kept by the Department measures labour "underutilisation" in the economy. And according to that figure, U.S. unemployment is at 17%, nearly twice the figure quoted on Friday. --There have been jobless recoveries from recession before. But you still have to wonder how there can be such a big difference between the stark news in the job market and the behaviour of the stock market. True, economists will tell you that jobs are the last thing to recover from a recession. Businesses don't hire until they are sure everything is in the clear. --And we are often told that stocks lead the economy. The market has priced in a recovery which the labor market will confirm...eventually.

At least that's the conventional wisdom. It's reassuring. --But the unconventional wisdom is probably more correct. The unconventional wisdom is that low interest rates (near zero in the U.S.) have driven people out of cash and forced them into higher-yielding and often speculative assets. The biggest obvious beneficiaries of low rates and credit facilities has been financial sector stocks themselves (and presumably their options-laden directors). --The question this week is whether there is any momentum left in that trade. Can easy central bank policies keep stocks going higher? Or has the trade exhausted itself? And if it has, what happens next? --Well, one answer is that you may again see a mini-rally in the U.S. dollar and a fall in common stocks and commodities (oil and gold especially).

We'd expect this to a cyclical dollar rally. In the bigger picture (a secular trend) the dollar is toast. But markets do not move in linear fashion. They give and they take. And the dollar may be due. --If we do get a greenback rally, this may pave the way for a higher Aussie gold price. The strength of the Aussie dollar has capped the gold price here in Australia. But we reckon you may get a nice move in the Aussie gold price if the greenback rallies. The question is whether U.S. dollar strength takes gold down too, neutralising the benefit of the weaker Aussie. --How do you sort out the relationship between two currencies, one commodity, and many stocks? It all sounds complicated. That's why we've added another mind to the trading desk here at Daily Reckoning Australia headquarters on Fitzroy Street. Murray Dawes is at the helm of the trading desk today.

We'll keep you posted on what he has to say. --One question we'll have for him: what the heck should investors do with Woodside Petroleum (ASX:WPL)? Dow Jones newswires is reporting that over the weekend, Federal Resources and Energy Minister Martin Ferguson awarded permits to explore ten new off-shore oil and gas blocks in the Carnarvon Basin off the Northwest coast of Australia. --Woodside is one of the firms that won a permit. Ferguson said that, "The additional investment in Australia's offshore petroleum exploration sector not only offers exciting potential for petroleum discovery but will ultimately help to further develop our petroleum resource and underpin our security of energy supply,"

--The security of Australia's energy supply is exactly the issue our special situations analyst Mike Graham took up in his research about Australia's oil industry. You can find that complete report here. The findings may surprise you. --With respect to Woodside, there are not too many better blue-chip energy stocks in Australia. Unlike the smaller explorers though, the blue chips are valued differently. Adding to their reserves is crucial, so that the company is not inexorably depleting its assets. But the energy blue chips like Woodside are well known by analysts and they are well-traded by institutions. --This, in our mind, makes Woodside a perfect candidate for a Slipstream trade. That is, if we were a full time trader, we'd be looking for a pattern in the stock chart to see where key levels of support and resistance were. But since we don't run the trading desk, we'll ask Murray and see what he says. --Today's thought of the day from John Robb at Global Guerrillas, "The American 'kleptocracy' has run out of steam due to too much debt and is already in the midst of a perpetual depression.

Why? The US middle class -- faithful to the cult religion of free markets even while being taken for all they are worth via a 35 year process of substituting debt accumulation for income gains -- is financially broken. If this is even remotely true: is the US headed for Privatopia and the viral spread of Global Guerrillas?" --Substitute "Australia" for "America" and it makes just as much sense, doesn't it? ---------------------------------- And now over to Bill Bonner in London, England: Uh oh...maybe it will be a Red October after all...

Two important things happened yesterday, both of which cast a crimson light on things. First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October. Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up. What's a 'greed investment?'

It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly. What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds. The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April. And what about gold? Well, that's the other important thing that happened yesterday. Gold held above $1,000. So what? So what?? Well, dear reader, you are in a prickly mood this morning, aren't you? This is important because gold could go either way.

Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else.

Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much. There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks.

That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level. If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over. The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong. On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too. But on the pessimistic, bearish side...

"September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop. What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too. But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are. As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind.

But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government. But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath. ********************

Meanwhile, from Phoenix comes news that a new wave of defaults is about to slam into the mortgage industry. Commercial properties, retail space, office complexes, apartment buildings are hard to rent. You can see why. In 2007, America was already outfitted with far more retail space than it actually needed. Americans had gone on a shopping spree for the previous ten years...prompting builders to add more and more space.

By 2006, the United States had 10 times as much retail space per person as France. This was the bubble phase of a boom in consumer credit that began in 1945. When you get to the bubble phase, few people stop to ask questions. Instead, everyone assumes that the trends in place will remain...and even intensify. So even into 2008, in Phoenix as well as other growing areas - principally in the sand states - the building continued. And now it is 2009. Where are the shoppers?

Where are the renters? Alas, they are thinner on the ground than anticipated...and the developers are having trouble paying their mortgages. Commercial mortgage backed securities are carrying 5 times the unpaid balances they had in June '08, says Bloomberg. Imagine how disappointed lenders will be when these loans default. And then, imagine how American investors will feel when a new wave of mortgage defaults and foreclosures is hits the commercial property market.

A new wave of foreclosures and falling house prices may be approaching the housing market too. Alan Abelson, in this week's Barron's, reports on the outlook as described by Amherst Securities. The research group estimates an overhang of 'hidden inventory' of some 7 million units. These are properties owners would like to sell - if and when the market strengthens. Trouble is, the market may not strengthen soon enough. Then, many of these hidden properties could come right out in the open, as mortgages are reset, marriages break up, and people move on.

Amherst says these people are in the "delinquency pipeline" which eventually flushes out the market. And it calculates that another 300,000 properties enter the pipe every month. Falling prices have reduced 'owners' equity' - the part of the house the homeowner owns free and clear of a mortgage - to only about 43%. This number includes people who have no mortgage at all - more than 50 million of them. Abelson speculates that the actual equity in the hands of the 'owners' of mortgaged houses must be substantially less. Pushed by joblessness...not to many life's other, normal hazards...many of these people are surely going to default.

Of those in the "delinquent pipeline," nearly 10% haven't made a payment in more than two years. Sooner or later, the banks and mortgage holders will be forced to take action...and more houses will come onto the distressed property market. Eager to put this recession behind us?

Hey, don't be in such a hurry. Recessions do good work. Depressions are even better (see essay below....) More and more people get something from government. Fewer and fewer are net taxpayers.

This is the basic formula that bankrupts democracies. The political system becomes skewed towards spending; then, there's no stopping it. Once the majority of voters and special interests has an interest in increasing spending - even by borrowing - rather than in limiting taxes and debt, the game is practically over. USA Today reports on the number of children whose lunches are furnished partly at taxpayer expense. The figure rose from 24 million in 1990 to 31 million today.

That is, the welfare program increased by a third during the biggest boom in history. Think what will happen during the bust. Keep reading for today's essay... ................................................. (According to a pair of researchers from the University of Michigan, a depression does more for longevity than diet or exercise. Life expectancy during the worst years of the Great Depression increased from 57.1 years in 1929 to 63.3 years in 1933, says the report by Jose A. Tapia Granados and Ana Diez Roux. It didn't matter whether you were a man or a woman, black or white. And it didn't matter if you were in the US during the Great Depression or in Spain, Japan or Sweden during their economic downturns. The results were the same.

By contrast, life expectancy declined during the boom years. For most age groups, "mortality tended to peak during years of strong economic expansion (such as 1923, 1926, 1929 and 1936-1937)," they wrote in the "Proceedings of the National Academy of Sciences." Conventional wisdom holds that recessions are times of stress. People do not eat as well. They skip medical check-ups. They should drop dead earlier. Instead, they live longer. Perhaps it is because the economy slows down, allowing people to live at a more comfortable pace.

Maybe the unemployed get more sleep. We don't know. But if you want to live an extra six years, nothing works like a slump. When it comes to economic health too, nothing beats a depression. Last week, World Bank president, Robert B. Zoelick, explained to Washington how the dollar made Americans wealthy: "The United States is incredibly fortunate that the dollar enjoys this special status [as the world's reserve currency.]" It made it possible for Americans could buy things abroad with dollars and then, rather than come back to the United States as a claim against US assets, the dollars stayed in foreign central bank vaults. It was as if the Untied States, and the United States alone, could issue IOUs and never have to pay up.

An "exorbitant privilege," Valery Giscard d'Estaing called it. Since the end of WWII, the world had no real alternative. It had to use the dollar in its international transactions, just as it once used gold. This had a marvelous effect on world trade and roughly the same effect on America as a winning lottery ticket. And like a lottery winner, she was ruined by it. With no effective limit on the number of IOUs they could issue, Americans issued far too many. From a low of around 2% of disposable income in 1945, US debt service rose to nearly 15% in 2007. In terms of total debt/GDP, the ratio was only about 150% in 1945, but that was with public debt from the war years at 120% of GDP. By 1950, the war debt had been cut down to about 70% of GDP, with private debt still at about 35%. At the height of the bubble years - 2005 to 2007 - total debt in America hit 360% of GDP, only 60% of it owed by the federal government. Of course, most economists saw nothing to worry about.

Instead, they set to work proving that such a 'dynamic' and 'flexible' economy would never fail. They even won Nobel Prizes for elegant formulae that showed investors how to beat the market, year in and year out. Then, the bottom fell out of asset prices in '07-'09. In March of this year, Americans found that their stocks had fallen back to real values not seen since 1968. Their houses were sinking fast too. By May 2009, one out of every four US homeowners was 'underwater' - with a mortgage greater than the value of his house. Incomes and profits were falling, along with the net worth of the typical American household. Everything was falling - except debt. How the gods must have roared when they saw the looks on their faces! In the biggest, longest boom of all time - even with a monopoly on the world's reserve currency - Americans had lost ground. But while Americans were once damned by good fortune, they are now blessed by bad luck.

"Looking forward, there will increasingly be other options to the dollar," says Mr. Zoelick. Thank the rascal gods. Americans are saving again...rebuilding their balance sheets...and, eventually, their economies. They can even look forward to living longer. And with a little more bad luck, maybe their moron economists will wise up too.)

Until next time, Bill Bonner