17 January 2009

World demand collapse, bonds next

Bonds are a bubble, shares suspect, currencies wobbly... buy the precious metals before the inflation really starts...


"Anyone following the economic news in recent months has to be stunned at the declining economic activity. Japan had a 16% drop in machine orders for November. US car sales down 30 to 40%. Even world car leader Toyota has sales down 20 to 30%. Worldwide car sales are way down too, anywhere from 10 to 20% depending on which area.

US retail sales are down 2 plus percent, but depending on what stats you look at, autos -30% plus, that 2% number is far worse than it looks.

The EU region is seeing marked declines in orders and exports. Japan had a stunning 15 to 17 % drop in exports from the previous year. China had over 100,000 factories close by end of 08. The list is endless.

Of course all this collapsing demand is hitting commodities and energy. Gold has fared better overall, but is torn between central bank inflation efforts and deflation in general in every major economy. Even China is said to see possible flat growth in 09, something that they consider akin to Armageddon, as they need 15 million new jobs each year just to stay even with population growth.

World credit is mostly unavailable. Banks won’t lend and despite the bailouts of $2 plus trillion (really $8 trillion for the US alone depending on how you add up the numbers) of capital infusions, it’s said they need another $2 trillion just to get solvent. Mostly what the Central banks have done is to shore up the banking system but it’s far from functional. Since credit is so hard to get (for everyone, people, businesses, even municipalities) there is little reason to expect the US to recover soon. In fact, the continual calls on the popular financial media that we are bottoming is beginning to sound very hollow.

And, if the US is not likely to recover soon, no one else will either, and it’s really more like a world economic death spiral. Deflation is lurking out there.

The US Fed and Treasury have committed over $8 trillion and counting to various shoring up efforts, and the ECB another $4 plus trillion in various ways to prevent their own total banking implosion.

Germany just had what’s called a failed auction of German Bunds (their Treasury bonds) last week, selling only about 79% of the issue. While not a disaster, that means that the world is tiring of all the new lending at such low bond rates. The biggest shoe to drop would be the US Treasury market if it ever loses enough buying interest and US interest rates start to rise on their own.

The US Fed can buy US treasury bonds directly if it wants, but that is effectively monetizing the debt. Even so, the US dollar has held up better than many people thought. But that cannot last indefinitely.

Massive new government debt issuance

The only hope for the world’s governments to escape massive new indebtedness is for the Western economy to recover soon. Otherwise the US and other Western central banks will start buying everything in sight, and in fact already are. The US Fed stated already it’s beginning quantitative easing, which essentially buying any and everything to shore up markets and keep interest rates down. Japan’s BOJ just stated they intend to buy corporate bonds and if necessary even stocks directly – another example of quantitative easing.

Will new US and European and Japanese and (Chinese too!) efforts to stimulate and reverse collapsing demand do the trick? CNBC and all the optimists aside?

No. How can the US government replace the economy? If the US economy is $14 trillion a year in size, and we see a 10% drop in GDP, something that looks likely already, and Japan with the same situation, and the EU and also China, all facing GDP declines on the order of the teens percent, there is NO way governments can stimulate enough to replace that. The only outcome would be massive new public debt. Then the US and every other major economy ends up with public debt to GDP ratios of 300% like Japan has now. It (reflation) can’t work.

We have to look ahead. In 6 months, I will bet that the US treasury market finally starts to see buying resistance. A situation similar to what just happened to the German Bund auction where a good part of the issue failed to sell. Right now, the US treasury market is bubble like, but most of the reason is people fleeing into cash like assets, and even .1 percent yield seems to do. In fact, since we are in deflation in many respects, those low yields on Treasuries are actually higher than they look.

Next in line is bond and currency trouble

But, unless the US and other central banks give up massive stimulus, all that will happen is the bond markets will rebel. And then the jig will be up. The only thing that has prevented a full scale world economic collapse has been massive central bank infusions globally for the last year and a half. Even with all that, world GDP is declining, and as we said, we see stunning statistics like Japanese exports dropping at a rate of 17%, US car sales down 30 to 50%, and EU exports declining too, and so on. World shipping at a standstill. So, things are not turning around at all. Rather all that central bank money did was slow the rate of decline slightly.

The only alternative the world’s governments seem to consider is more and more stimulus. So, ultimately they are all basically leveraging their currencies to try to replace collapsing world demand. And that is not working. But, it seems the governments cannot/won’t consider alternatives to borrowing all they can till the bond markets rebel. And, I would bet that we are going to get there.

If the bond markets rebel, and stop buying up all these new government bonds then there are no alternatives to a real depression. As we said, the only thing that can pull the world out of this downward spiral is for real organic economic activity and growth. But, what are the odds of that in the next year? Zero.

So, the next stop in this devolving world economy will be the bond markets and a bond rebellion. I would suppose that the various central banks will then basically buy all their own new Treasury bonds. So, they basically will threaten their currencies too. How long till the currencies themselves see the heat? A year or two?

These are all reasons why gold spot prices have held up better than most other assets. Even with gold hovering around $800, it still is up compared to around $660 back in Oct 07. I know the gold stocks are down, but they are always more volatile. Gold as an asset class is holding better than practically anything, except perhaps US Treasuries. But, ultimately we know the fate of the US treasury market will be to reverse and start declining, probably with some failed auctions. But of course the US Fed can buy them then, but how long can that last before the US dollar gets hammered?

Currency watch

In any case, we are on a currency watch for the Yen, Euro, USD and others. We are looking for signs the bond markets are going to rebel, (not quite there yet but close). When that happens, the major currencies are going to go through hell.

We expect that some of the better big cap gold stocks will be a place to be then, and of course gold. Silver too, but I prefer gold personally because it’s a central bank reserve asset.

As far as other havens like some currencies, they are certainly possibilities, but the problem is, which ones? Which currencies will win if the bond markets start to rebel on new sovereign debt issues, and auctions of new bonds not only for new debt, but to rollover the existing bonds? That is a BIG question. Because of that uncertainty, the currency markets will be in for a great deal of turmoil in the next year or two ahead. Even so, currencies are a big problem, but people still need cash. So we work the problem.

Nevertheless, despite the pain that people feel with the precious metals markets, it’s still one of the only safe havens with any future. So, we all have to try and remember the larger picture out there, namely that the next phase of this world economic crisis will be bond turmoil accompanied by currency turmoil. And this will be rearing its head in the next year or two, max. It already is starting to appear here and there anyway now."

Copyright © 2009 Christopher Laird
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