Beware the Wealth Effect

by Addison Wiggin – March 28, 2011

  • Fed's "wealth effect" gives precious metals a smackdown… Dan Amoss on what the Fed really is likely to do next… and what you should expect
  • Six reasons natural gas is still a good bet… and 11 ways to play it
  • Jim Nelson on an emerging market juggernaut about to take a breather…
  • Artificial clouds fixing soccer matches… a "jobs program" by another name… a reader who gets it… another book recommendation… and more!

0:00
— Gold slumped about $25 over the weekend. At last check, the spot price was $1,412. Silver, too, got whacked.
At $36.55, it remains $2 above where it was only a month ago.

As today is options expiration on the Chicago Mercantile Exchange, we're sure traders are covering bets and taking profits.

But we detected another sell signal for the yellow metal… and it's a specious one, at best.

0:23
— "Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action," Fed Chair Ben Bernanke wrote in a Washington Post Op-Ed following the announcement of QE2 last November.

"Higher stock prices will boost consumer wealth and help increase confidence," he continued, "which can also spur spending."

If Joe Wage Earner sees a bigger 401(k) balance, the theory goes he'll go out to Home Depot and redo the kitchen.

0:45
— Indeed, with the S&P above 1,320 this morning, the "wealth effect" does seem to be at play once ag
.

Consumer spending rose 0.7% last month, the largest increase since October 2010. Add to that the fact that most Americans got their Social Security withholding slashed by one-third starting the first of the year, thanks to the stimulus rushed through Congress at the end of last year… and the Fed governors want you to know it.

Friday afternoon, Philadelphia Fed chief Charles Plosser hinted at monetary tightening in the "not-too-distant future."

"The economy has gained significant strength and momentum since last summer and seems to be on a much firmer foundation going forward," he said.

1:07
— On Saturday, St. Louis Fed chief James Bullard, reading from the same playbook, went a step further.

He let it drop that QE2 might be wound down before its scheduled June 30 end date because "the economy is looking pretty good."

1:20
— The dollar index has even popped, firming to 76.4, a full point higher than it stood at this time a week ago, when it touched a 15-month low.

1:30
— Unfortunately, disposable income, with "inflation" factored in, fell 0.1% last month, according to the Commerce Department. It's the first drop since September.

Consumer prices for gas and food rose in February at their fastest clip since July 2008.

1:45
— "The Fed must soon choose," sums up Strategic Short Report editor Dan Amoss, "from one of three possible paths for its balance sheet: expand it, keep it the same size or shrink it.

"With the recent public backlash against QE2 and its impact on food and energy prices, I expect the Fed will try to please everyone, and merely decide to keep its balance sheet flat after June 30." That means taking the proceeds from maturing bonds and rolling them into new bonds.

"Since several hundred billion in assets on the Fed's balance sheet will mature in 2011 and 2012, reinvestment of these maturities will, in the Fed's mind, keep Wall Street cronies happy with risk-free primary dealer trades. It would also keep the administration and Congress happy by maintaining a healthy pace of debt monetization.

"Such a 'QE Lite' policy may somewhat cushion stock prices, but would will also send the message to foreign creditors and dollar holders that the U.S. isn't serious about repaying its obligations in honest money.

"Therefore, we should expect to see even more commodity hoarding and stagflation."

1:57
— Trying to decipher Fed policy hints on a Monday morning reminds us of an interview Jon Stewart did with Alan Greenspan on The Daily Show that we reprised in I.O.U.S.A.:

Stewart: When you lower the interest rate and drive money into… stocks, that lowers the return people get on savings.

Greenspan: Ah, yes, indeed, yes, indeed.

Stewart: So they've made a choice: "We would like to favor those who invest in the stock market and not those who invest in a bank. That helps us."

Greenspan: That, no, that's the way it comes out, but that's not the way it is.

Stewart: [Laughs his ass off.]

2:05
— Not to mention, the recession "was much worse than they were reporting," says ShadowStats.com's John Williams of the Federal Reserve's figures on industrial production.

On Friday, the Fed issued revisions to this key indicator dating back to the official start of the recession in late 2007, based on newer, supposedly more accurate data.

"Total industrial production," says a Fed notice, "is now reported to have declined 1.4 percentage points and 1.7 percentage points more sharply in 2008 and 2009, respectively."

Put on a graph, the recovery thought to represented by the blue line on this chart is actually represented by the red line.

"The revisions here," says Mr. Williams, "should be repeated somewhat in upc oming revisions to retail sales, new orders for durable goods and the GDP.

"Within the next four months, these pending benchmarks should continue to confirm that the downturn in the U.S. economy has been longer and deeper than previously indicated in official reporting."

Which means the recovery isn't as robust, either. And in theory, the Fed will need to keep its foot on the monetary accelerator. How does that square with the latest jawboning we got this weekend?

2:18
— We'll have to wait for the answer to our always skeptical questions. For the moment, Wall Street has its rally cap on again, the S&P powering toward 1,320 this morning.

"With conflict accelerating in the Middle East," says Jonas Elmerraji of our small-cap desk, "continued fallout from the disaster in Japan and renewed concern over debt problems in Europe, there are plenty of fundamental reasons why it may not make sense to be a bull."

But if you have a short time horizon, "it's dangerous to be concerned with whether or not the market 'makes sense,'" Jonas cautions. "Valid though bears' concerns may be, there's a difference between being right and making money."

2:33
— Oil is pulling back a bit this morning, the moment-by-moment developments from Libya having less impact on supply now than they did even a few days ago.
A barrel of West Texas Intermediate fetches $104.22.

2:43
— Natural gas futures are also pulling back after hitting a seven-week high last week, at $4.39 per million British thermal units.
Supplies are plentiful and the forecast in much of the U.S. is for warmer weather the next few days. That's the short-term view.

"Compared to nuclear, natural gas looks real good," says Capital & Crisis editor Chris Mayer, taking the long-term view, and one we've taken ever since the Japan earthquake damaged the Fukushima reactor complex.

"Natural gas utilities are much cheaper in upfront costs. The payback on your investment is much quicker. They are perceived as safer. Natural gas is also a clean-burning fuel. We also have lots and lots of cheap gas in the North America."

And there's more: "The global LNG trade is set to expand greatly over the next several years. LNG is liquefied natural gas. It's what will take natural gas from being a local commodity to a global one.

"The long-term opportunity is tremendous for North American gas producers. They can sell natgas in Europe or Asia for prices more than double what they get at home."

[Ed. Note: You still have a few more hours to claim your copy of Byron King's special report 11 Ways You Can Profit From the End of Nuclear and the Return of Natural Gas. You can claim your copy just by making a donation for earthquake relief in Japan.

But today's your final chance: We'll spend the next day or two bundling your donations and sending a check to the Red Cross. Here's where to go.]

2:58
— "The boom in Brazil may be coming to a close," says Jim Nelson.
Not that it won't keep growing. "The problem isn't the direction it is moving. We're concerned over the speed it'll move over the next several months and years.

"The central bank of Brazil has some difficult decisions coming up. So does the new president. Even an economy as stable as Brazil has to watch one metric more than anything else: inflation. Since late 2009, the country has been struggling to keep up with rising costs."

Since the first of the year, Brazil has raised interest rates twice, from 10.75% to 11.25% and now to 11.75%. "It's the cost of rapid growth," Jim says. "Even in the depths of the global recession, while the U.S. rates were slashed to zero, Brazil kept 8.75%."

But at some point, Brazilian stocks will start to cry uncle. "Since Jan.1, the Bovespa — Brazil's main stock index — is down 3.5%. Unfortunately, there's a serious possibility that it could get even worse going forward."

Jim has downgraded a couple of top-performing Brazilian income plays to "hold." For one of his favorite opportunities right now, check this out.

And if you want the best stock picks from all our editors, we're just over 72 hours away from releasing our latest video, 6 Stocks for Right Now — a premium available to members of Agora Financial's Equity Reserve.

For a one-time fee, lower than if you subscribed to all these services separately, you get access to all our stock-picking services. Membership is still available through next Thursday at 5 p.m. It's the last time it will ever be offered at the current fee.

3:30
— We can't decide whether this is ingenious, or another example of credit-fueled folly.

With Qatar winning rights to host soccer's World Cup in 2022 — in the summer, when temperatures can run to 122 degrees Fahrenheit — there's talk of an artificial cloud to cover the stadium.

Although in the artist's rendering, it looks like a giant mobile phone.

Imagine the sponsorship opportunities!

Imagine the sponsorship opportunities!

It's the brainchild of Saud Abdul Ghani, a professor at Qatar University. "He said the artificial cloud will move by remote control," reports a local English-language newspaper, "made of 100% light carbonic materials, fuelled by four solar-powered engines and it will fly high to protect direct and indirect sun rays to control temperatures at the open playgrounds."

Ghani says the upfront cost for a working model would be a mere $500,000.

Who are we to say this won't work?

We were skeptical of the indoor ski arena at the Emirates Mall until we saw it with our own eyes. The entire ski area is encased in glass through which you can watch the skiers enjoying their apres ski beverages at a faux chalet, all the while dining on Lebanese food at one of the restaurants in the mall.

4:05
— "Large and ongoing U.S. military expenditures are actually an indirect form of societal welfare," writes a reader, who caught our tallies last week of the war in Libya.

"For example: when a U.S. warship launches a $750,000 cruise missile, a large number of U.S. workers must be employed to replace it. Only a few dollars worth of plastic, aluminum, steel and chemicals actually leaves the U.S. and are destroyed when the missile finds a target.

"When the U.S. 'gives' Egypt a billion dollars in foreign aid … and Egypt then spends the money in order to buy U.S. military hardware, the net effect is that U.S. company shareholders and workers received a billion dollars from Uncle Sam.

"If we bring our troops home from various war fronts, what jobs will they find? How many may turn to illegal activities just to earn a living, as happened after the end of the U.S. Civil War.

"It might be argued that the large U.S. military-industrial complex is actually a kind of 'holding tank' for a large number of people who would otherwise be, in one form or another, destitute.

"If too many Americans saw little opportunity for themselves and their children, civil unrest would surely result … just as is happening in the Middle East."

The 5: Give us time.

5:00
— "Did you ever notice how some people seem to absolutely lack a sense of
humor?" another reader inquires.
"I refer, of course to the 'former colleague' whose cynical rip you published on Friday.

"I'm something of a newbie here, but even I realized right away that you were exaggerating for effect in your original remarks. Why couldn't he? No sense of humor.

"At the risk of overgeneralizing, that lack is something I find to be more prevalent in participants in the 'protest industries' than elsewhere. The term comes from a book I recently found, called The Genius of the Beast, by Howard Bloom, which I recommend to you. You might even want to add it to the stock of the Laissez Faire bookstore.

"The subtitle mentions a radical 're-vision' of capitalism. How new or radical it is, I cannot say, but it is fascinating, and it describes how and why the structure of capitalism has room for both Agora Financial and your erstwhile colleague.

"While he has a place at the table, so to speak, I didn't see any positive advice in the segment you published, beyond the implication that we should all load up, ASAP, on garlic, crosses and silver bullets and stay away from you guys! Again, typical of a 'protest industry,' alas.

"Keep up the good work!"

The 5: Thanks for the recommendation. Upon review this morning, we discovered we already have The Genius of the Beast in stock, right here.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S. "I think in the long run, you will be wrong on natural gas," writes another reader, "because many, including Indonesia and the Philippines, are pursuing deep drill geothermal for electric power production."

The 5: Perhaps, but we don't see it as an either-or proposition. Geothermal has considerable potential, too, and Byron King has discussed it many times in this space since late 2007.

Still, even if geothermal quadrupled its percentage of worldwide power generation, it would barely put a dent in natural gas.

Bottom line: We expect there's plenty of room for both to grow. Tonight is your final chance to snag Byron King's special report 11 Ways You Can Profit From the End of Nuclear and the Return of Natural Gas plus a one-month trial of Outstanding Investments… all with our compliments, in exchange for your donation to earthquake relief in Japan. Thank you, if you've already given. Details if you haven't, here.

rspertzel

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