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Friday, September 23, 2011

Twist and Pout

The following text, in italics, was written yesterday after the markets had closed.  I got busy, and didn't hit the 'post' button.  Today's comments are at the bottom of the post...

You may have noticed today that just about everything in the financial markets went all to hell.  The stock market got slammed.  Precious metals got slammed.  Oil got slammed.  About the only thing that showed a gain was, shockingly, the US dollar.

What happened?  Yesterday, good, old Uncle Ben Bernanke announced, "Operation Twist".

The short explanation of this centrally planned economy move was the Fed's intent to "flatten" the yield curve.  Basically, they want to make short-term interest rates much closer to long-term interest rates.  The thinking is, by making long-term loans more affordable, more people and businesses will borrow, and the economy will miraculously shake off this depression.

Yeah.  How's that working out?

Well, bank stocks, in particular, took a beating.  Banks earn money on the difference between short-term rates (which is usually the rate by which they borrow from the Fed) and the long-term rates.  Tighten margins, and you lower profits.  Lower profits, kill stock price.  A pretty simple concept.

Simple to those of us that are able to think outside of the "impact models" the Fed surely used when they crafted this ill-conceived plan.  Don't ya just love central planning?

Uncle Ben also noted that, contrary to previous reports, the ENTIRE economy is sucking wind.  Shocking news, I know.  After he let it be known that the whole economy is in trouble, the rest of the stock in the market started to crater.

This little event apparently triggered margin calls.  Big Dog investors can buy stocks by only having to put up a percentage of the actual price of the stock they've purchased.  If the price of the stock goes down, the brokerage houses get panicy, and require the buyers to increase the amount in their margin accounts.  That means they have to come up with more cash.

If you don't have it sitting in a bank account, you must sell assets.  Many of these folks sold precious metals.  If you looked at the make-up of the drop in PM prices, approximately 1/3 of the drop was due to a rising dollar, and the rest was due to sell-offs.

Look at this chart -

It is showing the relationship between the Dow Jones Industrial Average, and the price of gold for the last 10 years.  Quite the trend, no?

So, back in 2000 and 2001, it would cost you around 40 ounces of gold to buy one share of each of the Dow companies.  You'll notice that the chart only goes to August 2009, and that ratio was down to 9.98 ounces to one share.  That means that over the 10 year period, gold gotten 4 times more valuable than the Dow (or the Dow was only 1/4 as valuable as gold).

What's it look like with today's close?  6.18:1.  Holy crap.

What's next?

Who friggin' knows?!  Personally, I'm sticking to my plan:  Until the federal government stops printing money, and they start running a balanced budget, I'm holding my precious metals.  I'll continue to buy more each month (or buy other tangible products).


As mentioned, the idea behind Operation Twist was to push down rates so consumers and businesses would rush out, get loans and SPEND, SPEND, SPEND!

Two problems with that:  First, consumers aren't buying lots of homes or cars right now.  Uncertainty with jobs and the economy have people jittery.  Home values also continue to drop.  Why would you rush out to buy a home with the high expectation that its value would drop in the near future?

The second problem is with businesses.  If you don't absolutely, positively need something, you don't buy it.  There's no fluff.  Right now, you're looking for ways to trim costs, not increase expenditures.  The only type of credit businesses are interested in are for cash flow - Accounts Receivable factoring, lines of credit, etc.  Few are looking to buy long term assets like heavy equipment or real property.

Banks aren't making a lot of these cash flow loans because they don't think businesses will have the ability to repay them.  Many businesses understand this, and THIS is one of the reasons they're hoarding cash.  They realize that they have to pay their bills strictly from their internal cash, and if they want to expand, or to take advantage of business opportunities, they're going to have to fund the purchases 'organically' - with their own money.  The old fashioned way.

Bottom line:  Buckle up, it's gonna be a bumpy ride for a while...
Back to today:

My oh my.  Right now, the Dow is up a smidge, but precious metals are continuing their decline.  Big time.  Gold is down about another $60 an ounce.  Silver is now approaching its prices near the beginning of the year, and is down over 10% TODAY.

The talking-heads on TV are finally discussing how this is because the margin buyers are literally having to cover their asses because of their paper losses.

Disturbingly, the talking heads (at least those on Fox Business Channel) are posing the question:  What will it take to spur more lending?

Everyone wants the 'quick fix'.  Our national mindset has got to change.  The 'go-go-go' economy moves very quickly, and when things start to go badly, they go badly in a big way.  Steady, measured, non-hyped growth is manageable and allows companies to adjust course when needed.

Throw in a government that is bent on central planning - looking to do what it can to control the economy to get more tax revenues - and you end up with the mess we've got.

Everyone wants to be the hare, but the tortoise is the one that usually finishes the race...

Copyright 2011 Bison Risk Management Associates. All rights reserved. Please note that in addition to owning Bison Risk Management, Chief Instructor is also a partner in a precious metals business. You are encouraged to repost this information so long as it is credited to Bison Risk Management Associates.


GunRights4US said...
This comment has been removed by the author.
GunRights4US said...

It's hard to stomach such steep declines in one's PM portfolio, but the underlying reasons for holding PMs haven't changed one iota. This central planning crap is going to blow up in their faces eventually, and and when it does the price of gold per oz is going thru the roof. I'm holding long - and strong. (I might up my holdings in lead though.)

Chief Instructor said...

I'm in two worlds. Personally, I look at this as a great "buy" situation and will increase my holdings. I do it once a month, and I still have cash to spend.

From my business perspective, the last few days have been rough. When we buy scrap gold to be melted down, the state requires us to hold it for 30 days to ensure none of it was stolen property. We melt once a week - the stuff we bought approximately 5 weeks ago. When the market's going up, it's great, we make our regular margin, plus some. When it's like today, we took a bit of a bite in the arse. A month ago, spot was 5% higher than it was today. We've got healthy margins on our scrap business, so we're still in the black.... just not as deeply!