Catalyst for Crisis

Addison Wiggin – June 1, 2011

  • Two more triggers for the pending financial crisis: Insolvent U.S. banks and the return of the CDO monster
  • Chris Mayer on site in a frontier market rich in natural resources… and that's not even the best thing going for it
  • Three numbers going in the wrong direction, and the Dow's bad reaction
  • The Schiff-Stansberry standoff likened to pro wrestling… and other unique thoughts in the mailbag

   "Since none of the root causes of the problem have been dealt with," our friend Rick Rule warned on King World News yesterday, "the situation is ripe for a repetition." Rule is just the latest in a litany of voices that've contributed to our unease.

In today's 5 Min. Forecast, we continue to look for a catalyst to the new financial crisis on the verge of which we believe we're standing.

To the list of possibilities we submitted yesterday — Mobius' concern over $600 trillion in unregulated derivatives, the ongoing Greek crisis and a Federal Reserve balance sheet leveraged 51:1 — we submit a couple more today.

Like the potential insolvency of the Big Four commercial banks left standing (sic) after 2008.

   "If we do not see a meaningful recovery in home prices by the end of the year," says Christopher Whalen of Institutional Risk Analytics, "we may need to contemplate impairment charges on first liens owned by banks and wholesale write-downs of second-lien exposures.

"This implies solvency issues for Bank of America, Wells Fargo, J.P. Morgan Chase and Citigroup, and big losses for the U.S. government and private investors."

The problem for the Big Four is that their books are still laden with mortgages valued at 2007 home prices. If they were valued accurately, many would be worth 25% less. If they were in a housing hot spot like Nevada or Arizona, they'd be worth 50% less.

And if they were second mortgages — which in the event of a write-down are second in line behind the first — they'd be worth zero.

There will be no "meaningful recovery" in home prices before year-end. Yesterday, the Case-Shiller numbers confirmed the double dip in housing. In fact, housing prices have fallen by a larger percentage now than they did during the Great Depression.

   Meanwhile, even as the finance industry chokes on the debt and derivatives already in existence, new ones are being created.

In fact, this month heralds the arrival of the first collateralized debt obligations (CDOs) on commercial real estate in three years.

The rating agency Fitch says it's been getting inquiries about new CDOs for office buildings and factories.

"The collateral contemplated," according to a report from CoStar Group, "is ranging from seasoned commercial mortgage-backed securities (CMBS), newly originated commercial real estate (CRE) loans to a hodgepodge of CRE debt."

A "hodgepodge"?


Wasn't it mystery-meat debt "products" that got us into so much trouble in 2007-08?

And such good timing too: "A lot of investors may be leery with the extra supply in the market," says a portfolio manager who deals in commercial mortgage-backed securities. Lest he be accused of being a party pooper, he spoke to Reuters on condition of anonymity.

Has Wall Street learned nothing?

That's a rhetorical question. The more-meaningful question is what are you going to do about it? We have an action plan outlined here.

   The payroll firm ADP says private employers created an underwhelming 38,000 jobs last month. "A whole 760 new jobs per state!" quips Byron King in an email today. A bevy of analysts and traders surveyed by were expecting 175,000. Oops.

The goods-producing sector actually lost 10,000 jobs. Meager growth in the service sector took place among small and medium-size businesses.

This is the first in a trifecta of job reports we get at the start of the month. Tomorrow we get the government's latest read on first-time unemployment claims, which have been lousy of late.

Then comes "Jobs Jamboree Friday," as our friend Chuck Butler calls it — upon which we take the solemn duty of deconstructing the Labor Department's monthly unemployment figures.

   The "margin squeeze" we've been watching since last November is finally taking its toll on U.S. manufacturing. The monthly ISM manufacturing index fell below 60 in May for the first time in 2011.

In fact, it tumbled to 53.5… the lowest reading since September 2009. Recall 50 is the dividing line between expansion and contraction.

Within the index, we see manufacturers' costs are still rising… but new orders are slowing so much they're in danger of shrinking by the time next month's report comes out.

The reading is lower than the lowest guess of all the Wall Streeters polled by Bloomberg.

   The number of Americans on food stamps rose nearly 1% between February and March, according to new figures from the Agriculture Department.

The exact number is 44,587,328 — or 14.4% of the population. Both of those figures are records.

   The cascade of rotten numbers appears to have wiped out all the gains the Dow and the S&P made yesterday. Hot money is rushing into Treasuries; the yield on a 10-year note has slipped below 3% for the first time in six months.

   However, other asset classes are holding their own. Oil is hugging the $102 per barrel level. Gold is at $1,537. Silver is a few pennies below $38.

The dollar index is down, but not by much. At last check, it was 74.4.

   Sales of U.S. Silver Eagles notched their third-highest month ever in May, just as we anticipated the last time we checked the figures. May sales totaled 3,653,500 — a figure exceeded only by January 2011 and November 2010.

If the pace so far this year continues through the rest of 2011, the Mint will sell more than 45 million Silver Eagles — smashing last year's record of 35 million.

Demand is so intense that the Mint's San Francisco office is cranking up its dies again. For the last decade, Silver Eagle production was limited to the Mint's West Point location.

Bottom line: A lot of bargain hunters showed up last month as the price of silver collapsed 25%. The ideal entry point for new purchases was a couple of weeks ago, but now still isn't a bad time. Guidance on how to maximize your silver gains is right here.

   "South Africa has been a winner as the global appetite for commodities soared in recent years," says Chris Mayer, who's been on his own travels recently in search of frontier market opportunities.

"It reported a trade surplus in 2010, its first since 2003, with its chief exports being gold and precious stones, metals and minerals. Natural resources are a big part of the economic pie in South Africa, as you'd expect.

"There are several large mining companies with roots back to the gold and diamond booms of the 19th and 20th centuries. There are also many smaller projects that are interesting, and I'll be visiting a few of them."

What's more, South Africa has "arrived" — in the sense that leaders of the BRIC countries — Brazil, Russia, India, and China — invited South Africa to its most recent summit. It's BRICS now.

"Beyond the resource story," Chris adds, "there is also a growing consumer base in Africa. More people with cell phones using banking products, eating a richer diet and buying cars. This is a huge area of opportunity that seems to get overlooked in the hunt for natural resources, but that I think may be the better story."

Want to see the fruits of Chris' research once he's done? Here's where to start.

   Government debt in Colombia — another frontier market that's captured our attention — has won investment-grade status from Moody's.

S&P made the same move during our visit there in March. The move clears the way for still more pension funds and other institutional investors to buy Colombian bonds.

Meanwhile, Colombian stocks are getting a potential boost from this week's opening of the Integrated Latin American Market, or MILA — the long-awaited merger of the Colombian, Peruvian and Chilean exchanges.

As we noted in March, when the Nordic exchanges were merged in similar fashion, the market in Norway jumped 10-fold. Many of the positive catalysts we described in the Apogee Advisory episode covering our trip to Colombia are starting to ignite. It's still not too late to act.

   "I am somewhat concerned about the apparent mudslinging you have involved yourself in between Porter Stansberry and Peter Schiff," writes a Reserve member. "It sounds like you have come down on the side of Porter. Is there a business relationship between Agora and Porter? In the interest of fair reporting, you should disclose any such business involvement. Does Agora have a stake in this fight?

"If not, they are both big boys, let them settle their differences themselves."

The 5: We have no stake in the fight… other than puerile enjoyment.

   "The pugilistic tone of the exchange," writes another reader, "comes across about as serious and believable as professional wresting. Doesn't matter who says what about whom as long as you spell the names correctly.

"If you want to make it more entertaining for your readership, you can go at each other wearing leotards, masks and capes."

   "Libertarian crap," writes a reader in response to Patrick Cox's remark yesterday, "Decisions about treatments should be left to doctors and patients.

"Your doctor doesn't know about unproven drugs and nutraceuticals, and one look at the Swanson catalog shows hundreds. A few are good (I use a few myself), but others can cause health problems or just waste money.

"Patients choosing treatments? How many insist on whatever advertised drug, regardless of the cost, because insurance covers it? You really want to stop obesity, tell fat people to stop having kids — that is the quickest fix.

"The FDA saves lives because it requires proof of effectiveness, while drug companies are constantly trying to circumvent it. Overseas drug trials, nonreporting of adverse effects, exaggeration of effectiveness, advertising expensive drugs that are no better than generics. I own some small biotech, so I know how slow approval is, but to remove strict regulation is nuts.

"Other 'freedom' purveyors are busily passing anti-abortion laws in all the red states and trying to defund the EPA and Planned Parenthood right now. They, apparently, have no trouble getting in the middle of people's health care. Libertarian crap."

   "Statist crap," responds a reader on our blogsite."The FDA does no such thing. It just wastes taxpayer money and keeps Big Pharma in business by approving proven ineffective drugs and keeping effective ones off the market.

"Obviously, owning some biotech hasn't translated into learning anything about it. Statist crap."

   "From everything I have read," writes a third, "the FDA is rotten to the core. They are bureaucratic on drug approval, yet still often approve dangerous drugs, and are slow to take dangerous drugs off the market.

"Their head honchos usually go to work for a Big Pharma company after a few years with the FDA. The board sometimes approves drugs that their own scientists have recommended against. Something that readers of this newsletter might find interesting, after all the hoopla of banks to big to fail, is the CNN report 'Feds Found Pfizer Too Big to Nail.'

"When the FDA found PfÍzer criminally negligent in it's marketing of the drug Trasylol, which probably shouldn't have been approved to begin with, it decided it couldn't really do anything. Turns out firms that have been criminally negligent can't be a Medicare provider. And of course, Medicare needs all those PfÍzer drugs. So they allowed Pfizer to set up a subsidiary to accept the criminal charges."

   "Love you guys," writes our last reader for the day. "Here is my question for your experts and your hard-nosed readership: If laughter really is the best medicine… shouldn't the FDA be regulating it?"

The 5: For God's sake, don't give them any ideas.


Addison Wiggin
The 5 Min. Forecast

P.S. The aforementioned Rick Rule will join us this year, as he does every year, for the Agora Financial Investment Symposium in Vancouver.

The event is now sold out… but as usual, we'll offer high-quality audio recordings of all the main sessions… plus, a concise written summary of every breakout session, complete with recommended names and tickers. Watch this space to learn how to get yours.


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