Flashing Red

Addison Wiggin – August 23, 2011

  • Traders don rally caps, ignoring one of the most reliable recession indicators, now flashing red
  • One market where there’s no sign of inflation… Chris Mayer on what it means
  • Abe Cofnas on why the yen and Swiss franc are due to fall from their lofty levels
  • Alan Knuckman on the prospect of a record year for the farm economy, despite massive losses to drought
  • Strange tale of underwater treasure… Lessons in lemonade from a reader to her 5-year-old… and a reader who’s got it all figured out

   “Rally time!” read an exasperated IM this morning. “Finally… sheesh.”

The Dow is up 175 points, above 11,000 again. The S&P 500 is also up more than 1%, and the Nasdaq could soon post a 2% gain on the day.

If we didn’t know any better, we’d say all was well with the world.

   Traders appear to be taking cheer from Chinese and European manufacturing numbers, for perverse reasons. Both numbers are below 50, indicating that manufacturing is contracting. But the contraction isn’t as bad as the “consensus” figured… so it’s party time!

Either that, or traders are like a gaggle of trophy wives with rich, cheating husbands. Today they just needed to go out and buy something to make themselves feel better.

   If they knew a little more about the “Philadelphia Fed State Coincident Index,” we’d likely be having another 500-point day… in the other direction.

The Philly Fed index crunches for employment figures from all 50 states. As with other indexes, the key level to watch is +50. A sustained drop below 50 is a “flashing red” recession indicator.

With the release of today’s number, the index has been below +50 for three straight months.

Since 1980, a recession has followed every time the index has moved below the +50 level… with one exception.

That was last year. QE2 didn’t create any new jobs, and its vaunted stock market gains proved ephemeral… but it did short-circuit a return to an “official” recession.

The Street pays little heed to this report, but we wouldn’t be surprised if it was sitting at the top of Ben Bernanke’s inbox first thing this morning. If he’s looking for a whiff of deflation as an excuse to hint at a new easy-money policy during his speech at Jackson Hole, Wyo., on Friday, he just got it.

Just guessing here: He might not crank up the printing presses just yet… but as he did last year, he may order the maintenance crew to oil up key parts and tighten the joints.

   “The turbulence of the last couple of weeks has produced some odd figures,” muses Chris Mayer, his keen nose sensing a whiff of deflation from elsewhere. “The oddest might be the yield on the Treasury Inflation-Protected Securities (TIPS), which slipped into the negative last week for the first time ever.

“That means that investors are paying the U.S. Treasury to hold their money and give it back at the end of 10 years — with no interest at all.

“To me, it means investors are really afraid. They heard someone yell the house is on fire and have begun throwing the good china out the window. It also means investors are betting that the U.S. economy is contracting, or will contract. Hence, inflation, as they see it, will not be a problem. The dollars they get back will at least be worth the dollars they put in.

“I think they will be disappointed about the purchasing power of the dollar,” he adds. “But rates are low across a spectrum. Based on Bankrate.com surveys, a money market pays 0.57%. A five-year CD pays 1.78%. A 30-year mortgage is 4.39%. Amazing.”

   The dollar index pulled back this morning. It’s below 74 today for the first time in nearly a week. The euro, which makes up 57% of the dollar index, has firmed to $1.44 on the nose.

   “Last week,” observes Strategic Currency Trader’s Abe
Cofnas, “global market sell-offs caused a flight of capital into the ‘safe-havens’ of the Japanese yen and Swiss franc.

“Of course, the continuing strength of these currencies is anathema to their countries’ economic health. Too strong a currency increases the cost of exported items, which, naturally, reduces their demand. In both Switzerland and Japan, export growth is practically the only path to economic growth.

“That’s why their central banks have been quick to voice their concern over their currency strength, even going as far as to intervene on occasion.”

But short term, the chart action tells Abe the trend can’t last. “There is a very strong prospect that these currencies will weaken, either by markets selling them against the dollar or through intervention.”

Abe laid on two trades accordingly. We’ll know how they play out by Friday, because that’s the way it works in the market that Abe tracks, alone among North American currency advisories. For access to this one-of-a-kind service, look here.

   Gold is taking a well-deserved breather today. After breaking above $1,900 overnight, it’s pulled back to $1,867 as we write. Still, that’s a higher spot price than any time before this week.

   Gold has reached another milestone: GLD, the SPDR gold ETF, is now the biggest ETF by market value.

At $76.7 billion as of Friday, Bloomberg data indicates GLD has eclipsed SPY, the S&P 500 index ETF. It’s valued at $74.4 billion.

   Silver is also pulling back today, but looking none too shabby at $42.74.

   “It used to be,” says our veteran of the commodity pits Alan Knuckman, “that grain traders would peer out the windows from the Chicago Board of Trade to see rain drive down summer prices.”

Not this year. For one thing, Chicago had record rainfall in July, while “our neighbors to the south and southwest have experienced drought conditions.”

What’s more, “Iowa and Illinois — along with Minnesota, Nebraska and Indiana — are the major soybean producing states. And drought conditions are creeping into these key areas.”

Check out the slideshow of how the nation’s drought zone has marched steadily northward the last six weeks:

[Click for slideshow]

“These pictures are more worthy than modest words by any analyst,” says Alan.

What the pictures don’t show is that despite crop losses, the government forecasts a record $94.7 billion profit for the farm economy this year, thanks to high prices for the crops that can be salvaged.

Alan’s agriculture gains this year include 95% on soybean meal, 102% on sugar, and an impressive 217% on wheat. That’s in addition to gains like 233% on gold and 295% on heating oil. You can be on board for Alan’s next round of plays right here.

[Ed. Note: Whether it’s commodities, currencies, stocks, bonds or options, our team has you covered. And for the first time, we’re making it possible for a select group of readers to sit in on a summit with all our editors.

The dates are Oct. 13-14. The place is here in Baltimore. We’ll even pick up your lodging and a portion of your airfare. What’s more, if you sign up now, you get instant access to the urgent teleconference we recorded with our editors last week… and instant access to a report detailing our team’s favorite gold plays.

It’s an unbeatable combination during this delicate time in the markets. If you missed the invitation last night, we urge you to check it out at this link.]

   Given our interest in sunken treasure of late we can’t overlook this strange tug of war over some gems that, for all we know, may or may not exist.

Early last year, a retired doctor named Jay Miscovich claimed he’d located a stash of emeralds underwater worth $500 million — where exactly no one will say. To pay for the recovery work, Miscovich sought out financing — recruiting a cast of characters including…

  • His brother Scott, a doctor in Hawaii
  • Dean Barr, a former hedge fund executive with Citigroup
  • Neil Ash, a Manhattan accountant.

It wasn’t long before the Miscovich brothers were suspected by the other players of absconding with the best of the emeralds. Those suspicions grew when Ash, the accountant, claims he took a group of prospective investors to a vault to inspect the gems and they were gone.

The Miscovich brothers say the whole empty-vault story was made up so the investors could make off with the best of the stash. He said, she said.

Whatever the truth, the court case was settled last Friday, terms undisclosed. The ownership and whereabouts of the gems remain a mystery to the public.

These aren’t the gems, but you get the picture

More litigation may follow. “The brothers have not filed a salvage claim in federal court,” according to a Reuters story, “but when they do, that could invite others to challenge it.

“The U.S. government, Florida or foreign nations might try to claim the emeralds,” Reuters explains, “depending where it was found and if it was located near a shipwreck.”

We have no interest in who was right or wrong in the civil litigation — the brothers or the investors. But we suspect this much: The government will want “their” share…

That, if anything, is one take-away from our new documentary, Risk! More to come…

   “My two young sons and I participated in selling lemonade on Saturday,” writes a reader who caught our account of Lemonade Freedom Day. “We had a great time and started some invaluable business lessons.

“When I got to the part about taxes, I explained that when they got older, Uncle Sam would take just about half of their profits. My 5-year-old son, who was sitting there with his $10 in hand, got quiet, and then quipped, ‘Then I’ll move to another country!’

“Amazing. He’s 5.

“Our politicians need to be keenly aware — these kids are smarter than they think.

“Thank you for all you do.”

   “I was an electrical contractor for 20 years,” writes a reader amused by the removal of streetlights in Rockford, Ill., supposedly to save the city money. “I have installed thousands of streetlights all over California.

“My solution: One man with a screwdriver or socket. Take off the cover at the base of the pole. Twist the inline fuse holder and remove the fuse. Four minutes. It took longer to write this than to do the work. If they find the money, put the fuse back in.

“All we can do is keep laughing at all this insanity.”

The 5: Amen. Good attitude. You must own a fair amount of gold.

   “When will the Federal Reserve of Stupidity get the message that price drops may actually be a good thing?” a reader asks rhetorically.

“I don’t know too many people that wake up every day and go to their normal place of business just to hear customers say, ‘Wow, those rising prices are a good thing! I like paying $8/lb. for this steak that I was able to get for $7/lb. last week. Mr. Grocer, can you raise the price again for me next week?

“But apparently, some numbskull with too much time on his hands thinks that those consumer price increases are a good thing, since he’s locked in a basement with a printing press in front of him all day and nothing better to do.

“Benny, get out in the real world! Rick Perry may have been incorrect to call you out as ‘almost treasonous,’ but the Coinage Act of 1792 still specified death to anyone convicted of counterfeiting. It doesn’t make a difference to me which we call you, but the penalty is the same. All I can say is you deserve each other.”

   “With all the complaints about the various programs of the Federal Reserve that helped create a massive debt, I wonder what would have happened if the Federal Reserve had not gone ahead with QE1 and QE2.

“Would America have gone down in flames — what would have happened? I have no idea what other solutions were considered and rejected and wonder what the various critics would have offered as solutions.

“Perhaps you can enlighten me with other possible roads we could have taken.”

The 5: We don’t know, of course. But here’s one possibility: The market could have been allowed to do its work. The big banks that took big risks could have been allowed to fail. Healthy banks that didn’t take such risks could have taken over the business of the failed banks’ customers.

Would it have been painful? Absolutely, for a lot of people. But not nearly as painful as papering over the bad debts, postponing the inevitable day of reckoning and punishing savers all along the way.

History provides a working model, by the way, for how not to give in: The depression of 1920-21 was vicious, but it was over in 18 months because both the Fed and President Warren Harding stood aside. They let “too big to fail” institutions do just that and allowed matters to take their course.

   “I find it interesting after reading newsletters like yours that over time that you don’t recognize your own involvement in creating the very economic conditions your members seek to escape.

“Economics, obviously, isn’t all about supply and demand, but whims and endless appetites, often enough, corrupted, that your members are forever chasing. For example, there was no need for America to deindustrialize in favor of China. That decision was made for us.

“Likewise, an economy is a nation’s resource, and it’s a shame those who help develop it regard it as their personal piggy bank that they can just up and move, taking their marbles with them, blithe to the labor of others who helped put them where they are. Worse, that nation-states let them get away with it.

“In future, I can see that the only solution to prevent such global economic decimations from happening again (apart from restraining banks) are private-community partnerships, where workers and communities own a stake in commercial enterprises, that can only be sold with the consent of all interests.

“Also, a focus should be made on bread-and-butter industries that serve real needs, not flighty, idiotic products and services, unless a community wants to front the burden when others recognize the frivolous and refuse to pay for it.”

The 5: Glad you’ve got it all figured out. Please, by all means, check back once you’ve established your communitarian utopia… assuming you don’t have to off a few million dissidents or kulaks or who knows who won’t go along with your master plan willingly.

If you’re not sure what we’re talking about, please read this article. We walked the Killing Fields on our trip to Phnom Penh in May. Bones, teeth and shreds of clothing from those murdered there are still visible, routinely belched from the earth after the annual floods recede from the plain in which the bodies are buried.

That dark and gruesome affair happened within our lifetimes and was diabolically motivated by the same world-improving impulse you exhibit. Thanks, but we’ll seek our fortune elsewhere.

   “Your 5 Min. Forecast alone is worth the price of subscription. When I see it in my inbox, I stop whatever I am doing to read. Your market analysis, with just a touch of tongue-in-cheek is unbeatable. KEEP it up!!”

The 5: Another unvarnished letter of praise? We must be on a roll…

Cheers,

Addison Wiggin
The 5 Min. Forecast

P.S. “I expect oil prices to drift back upward,” writes Byron King in the new issue of Outstanding Investments, restoring the otherwise missing cash flows to producers.

“I believe that oil prices, and share prices within the energy sector, will recover sooner than most other parts of the economy and stock market.”

A few excerpts from the issue turn up in Peter Brimelow’s latest MarketWatch column, where we’re reminded that Outstanding Investments is the top-ranked performer among all newsletters tracked over a 10n-year span by the independent Hulbert Financial Digest… No. 1 “by a significant margin,” Brimelow adds helpfully.

Supply-and-demand issues aren’t all that Byron sees driving the oil market right now. For a hair-raising wild card that could double or even triple today’s price of $85 a barrel, look here.

In 2004, we posted a report called The Total Destruction of the U.S. Housing Market. It was based, in part, on an internal report by Fannie Mae revealing the firm’s exposure to the derivatives market.

The report was publicly available information, posted on Fannie’s website… until we drew attention to it. Fannie pulled the report from its website and fired its author.

There are risks involved in trying to connect the dots on a daily basis. Those risks came to light yet again yesterday… as The 5’s managing editor Dave Gonigam explores…

If you’ve never heard of Antiwar.com, you can be forgiven for thinking it’s a website run by a bunch of aging, unreconstructed hippies still mourning the demise of the Soviet Union.

In fact, its guiding lights are two men with an extensive history in the libertarian movement: Eric Garris and Justin Raimondo shared a long and fruitful association with the late economist and historian Murray Rothbard.

Antiwar.com, launched as Bill Clinton prepared his 78-day air war over Serbia in 1999, is unabashedly libertarian in outlook, devoted to the notion that, in Randolph Bourne’s famous words, “War is the health of the state.”

Still, the site publishes commentary by, and has earned praise from, a diverse spectrum of writers — from Pat Buchanan to Daniel Ellsberg. In addition, it’s an invaluable aggregator of geopolitical news drawn from media sources around the globe.

It is also, it turns out, the subject of an FBI investigation.

Or so a blogger with no connection to the site discovered, after securing some FBI documents under the Freedom of Information Act.

The documents, posted here, are heavily redacted, and the FBI has not vouched for their authenticity. But assuming they’re genuine, they reveal the site came on the FBI’s radar in 2004.

During an unrelated investigation, the FBI discovered Antiwar.com had reposted a couple of terrorist watch lists the U.S. government had supplied to assorted agencies and companies. In other words, publicly available information.

On this flimsiest of pretexts — plus the fact that people under investigation went to the website now and then — the FBI concludes the site, Garris and Raimondo deserve more scrutiny.

“There are several unanswered questions regarding www.antiwar.com. It describes itself as a nonprofit group that survives on generous donations from its readers. Who are these contributors and what are the funds used for?

“It is recommended that a preliminary investigation be opened to determine if [redacted] are engaging in, or have engaged in, activities which constitute a threat to national security on behalf of a foreign power.”

“What in the name of the Constitution is the FBI doing,” wrote Raimondo in his column breaking the story yesterday, “investigating the contributors to a legal organization that is engaged in exercising its right to free speech, absent any evidence of criminal activity?”

Another unanswered question: What happened after this document was filed in 2004? “We need to ask for more FOIA documents,” says Garris, “and see what else they have been investigating, because most of this information is pretty old and it’s very possible there’s a lot more that’s been done since this report was originally compiled.”

“Our contributions come from our readers,” he adds in an interview on Antiwar.com’s podcast feed. “Our average contribution is $50. We do get contributions from time to time for $1,000 or more. When they come in, we don’t investigate everyone who gives us money. I’m worried that the FBI is going to send us some money from another country and use that as an excuse investigate further.”

If that hasn’t happened already.

rspertzel

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