California On the Brink, A Rare Bull Market, China’s Potential Mistake and More!

by Addison Wiggin & Ian Mathias

  • State of emergency: How California (and other states) could be the next bailout target
  • Despite the recession, a raging bull market… that you’ll wish didn’t exist
  • Forget 2010… major mortgage player predicts falling home prices till 2011
  • Frank Holmes on a commodity trade revolution
  • Plus, China boom or China bust? Our macro man weighs in


  We’ll start today with a quick look at the world’s tenth largest economy (for now, anyway): California.

As we forecast   “State governments will have a negative impact on GDP in coming quarters,” writes Dan Amoss, our resident CFA and editor of Strategic Short Report. “In the next few payroll reports, we’ll start to see these budget crises lead to larger job losses in the government sector.

“These budget crises were seeded when state governments started spending on the naive assumption that the real estate bubble and windfalls from capital gains taxes would never end. They hired new employees in droves over the past decade on the assumption that tax ‘revenue’ was sustainable. According to Michael Mandel of BusinessWeek, the public sector of the U.S. economy created 2.4 million jobs over the past decade — twice as many as the private sector


“Now California is preparing to pay its bills with IOUs. Eventually, some government jobs will have to go.

“U.S. taxpayers will likely extend a lifeline to California’s bankrupt state government before the end of summer. At a May 21 hearing in Congress, Rep. John Culberson of Texas asked Treasury Secretary Geithner if he would ‘rule out bailing out California or any other states with our tax dollars.’ Geithner replied, ‘We will have to do exceptional things, as we have done already, to fix this mess. That’s not putting on the table or taking off the table any specific thing like that.’

“Translation: a bailout will likely arrive if California’s budget is in danger of a chaotic collapse, but it will have to come on tough terms. The Treasury will probably provide a bridge loan on the condition that California’s government quickly pay back the money with fiscal austerity measures. Why the tough terms? Because after the recent moonshot in 10-Year Treasury yields, even Secretary Geithner is learning that the market will impose limits on the federal government’s deficit spending.”

(BTW, We’re currently offering a screamin’ deal on Dan’s Strategic Short Report…   Geesh, California can’t even afford a proper send-off for the King of Pop. Thousands upon thousands will rush into the Staples Center in Los Angeles today for a memorial to Michael Jackson. Between keeping extra cops and medics on hand, to traffic control, to post-event cleanup, the city of Los Angeles will spend around $2 million on the memorial… money, of course, it doesn’t have.

“I did reach out,” acting LA Mayor Jan Perry said. “I said, ‘Is there any way to direct me to people who can assist, in Michael’s memory, in deferring the cost of this event? I’m still waiting for a callback.”

  Since the U.S. as a whole is just barely better off than the Golden State, we’re hearing more and more calls for… deep breaths… another stimulus package. Exhibit A:

“We should be planning on a contingency basis for a second round of stimulus,” said Laura D’Andrea Tyson, one of President Obama’s economic advisers. Tyson claimed the $787 billion stimulus passed back in February was “a bit too small,” and that “the economy is worse than we forecast on which the stimulus program was based.”

Exhibit B: When pressed on CNBC of a second stimulus, leader of the president’s Council of Economic Advisers Christina Romer said quite confidently, “We’ll do whatever it takes.”

  If you’ll allow us one more government-directed gripe today… We’ve found a raging bull market despite the current recession: Congressional travel expenses. Lawmaker spending on overseas vaca… sorry, diplomatic excursions has nearly tripled since 2001. See for yourself:

According to a study from The Wall Street Journal, hundreds of lawmakers (and their spouses and entourages) traveled overseas last year at a record taxpayer cost of $13 million. And that doesn’t include off-budget costs like spending in war zones or borrowing government planes to jet set abroad.

Some of last year’s most diplomatically vital trips include: Five representatives checked out the Galapagos Islands to “learn about global warming.” Six senators attended the Paris Air Show. Eight lawmakers enjoyed a delightfull eight-day Italian excursion. And perhaps taking the cake, the House Homeland Security Committee’s jaunt to Brazil, Agentina, Peru and Panama… pertaining to the defense of U.S. borders, we must assume.

While the official numbers arent out yet, the WSJ claims expenses this year appear just as outrageaous. There are over 20 government employees whose sole job function is to plan congressoinal outings.

  Meanwhile, U.S. home prices will likely continue falling all through 2010, says a report from mortgage insurer PMI Group. According to bean counters there, home prices in 30 of the 50 biggest metropolitan areas of the U.S. have at least a 75% chance of falling through 2010 and into 2011. (Heh, only an economist can make a prediction that awkward.) While we won’t dive too deep into the forecast, the fundamentals make sense… home prices could get another shot “by a demand shock of high unemployment and a supply shock of distressed foreclosure sales,” said LaVaughn Henry, senior economist at PMI.

  In spite of yesterday morning’s sell-off, stocks ended yesterday with small gains. The S&P 500 inched up a quarter of a percent. The same index opened down about 1% today.

Aside form the usual economic malaise and the threat of the coming earnings season, the oil sector in particular is dragging down the big indexes this week. With crude down to $64 a barrel — a $9 fall since this time last week — dreams of $100 barrel profits and new drilling projects are being dashed left and right.

  Gold remains under pressure, too. At $925 an ounce, the spot price is just a hair above yesterday’s lows.

  “If you need more proof that the commodities world is changing,” writes Frank Holmes of U.S. Global Investors, “just take a look at how historical patterns have shifted. The graph below shows the five-, 15- and 30-year patterns for copper prices.”

“The 30-year pattern shows what used to be a rule of thumb when I first got into this business — buy in November and sell in March. This was because of seasonal stockpiling during winter months leading into major building and construction projects in the spring and summer months.

“In contrast, the 15-year pattern is dramatically different. This pattern shows copper prices rising from January-May and then trading pretty much sideways for the rest of the year, with modest peaks and valleys along the way. A similar pattern is drawn to represent the past five years.

“The reason for the trend shift is China.

“According to research from Dundee Wealth Economics, China’s copper consumption grew from about 1.8 million metric tons in 2000 to nearly 5 million metric tons in 2008. This pushed China’s share of global consumption from 13% in 2000 to 28.5% last year. In the first quarter of 2009, Dundee estimates, China accounted for 38% of the world’s copper usage.


“Copper isn’t the only metal where China is king. China also lead global consumption growth for aluminum, zinc, lead and nickel from 2000-2008.”

  We recognize China as the world’s new commodity king, but we also wonder… is the country’s rabid hoarding of materials really doing it much good?

“We don’t see how China can maintain production,” writes Rob Parenteau, “by stuffing warehouses with inventories and allowing banks to finance commodity speculation, although we understand the political imperative to do so.

“Maybe we lack sufficient imagination, but this approach does not strike us as a plausible exit strategy from the broken global growth model. It is a stopgap measure at best, designed to buy time, with fingers crossed that global demand gathers enough speed by year-end. We thought Asia faced some serious macro challenges at the beginning of this year, and we see no reason to change our mind yet.

“China, undoubtedly, has extraordinary potential, and we would not for a moment disregard the desire of Chinese leaders to achieve the status of the next global hegemon. The fact of the matter is that until China is prepared to accept currency appreciation, and thus prepared to reorient its growth strategy away from export-led development without simply putting up redundant capacity or building up speculative inventory stocks, its goal is likely to remain elusive…

“Asia’s production structure needs to recalibrate for a slower Western consumer growth profile, and that inevitably must involve steps that scrap excess capacity and allow new domestic demand sources to flourish. When we see it, we will be happy to flag it. In the meantime, using bank credit to keep production going and stuffing inventories in warehouses looks like a precarious gambit, at least from the vantage point that Dr. Richebacher cultivated over his career.”

Of all the macroeconomic forecasts out there, we admit we’re most intrigued by the China boom or China bust debate… there are very smart people on both sides armed with equally compelling arguments. We’re looking forward to watching this one develop. If you seek Rob’s take on the matter,   “The reader who said that paying a million dollars to have lunch with Warren Buffett was ‘beyond stupid’ must have missed what happened next,” a reader writes. “Zhao Danyang [2008’s winning bidder, who dined with Buffett last week], who runs Hong Kong-based Pureheart China Growth Investment Fund, offered some advice of his own to Mr. Buffett regarding a stock. It is not known if Mr. Buffett acted on this information, but it doesn’t matter. On the news that he had even accepted a few copies of the annual report from his guest, the stock shot up double digits.

“As it would happen, Mr. Buffett’s guest owned said shares himself, garnering him some $14 million in instant profits, as reported on June 6 in the South China Morning Post. By the way, the Post said he paid $2.1 million, for a profit of 666%. There’s more than one way to skin a cat in China. No pun intended.”

Thanks for reading,

Ian Mathias

The 5 Min. Forecast

P.S. Attention numismatists and silver bulls, we’ve got quite an opportunity for you: Back on June 17, we gave you first crack at a collection of 2009 First Strike Silver Eagles. Our small file snatched up nearly 2,000 of ’em. We’ve learned today that our friend Nick Bruyer at First Federal Coin Corp. has located another batch… if you’re at all interested,


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