The "R" Word

Greenspan came out again today and said that a recession is a possibility. He actually said that there is a 1/3 chance of a recession in 2007.

This whole situation is slightly humorous to me, and let me tell you why. Stepping away from the economic side of things. As Fed Chairman, you pretty much are unable to tell the truth about the economy when things aren't going so well. Americans are emotional investors and words of that nature would rock the market and send it into a spiral.

So I think that Greenspan, now 81 years of age, finally isn't responsible and can tell the truth about the economy. He doesn't have to clean up the economic mess when it comes, so he doesn't have to try and spin the situation. After 18 years of deception, the guy finally wants to speak his mind...truthfully.

More Than...Less Than...

I'm am going to start a more than/less than series. This is going to be a series of post regarding how often "economists" have been overly optimistic in their prediction, or the economy is just that much worse than expected. Each post will begin with a direct quote from Bloomberg as these statistics come out. Here we go...

"U.S. workers were less productive last quarter than initially estimated and labor costs jumped, raising the risk of faster inflation."

Productivity measures how much work an employee does in one hour of work. The productivity is down from a 3% annual rate to a 1.6% annual rate. That statistic is from the labor department. They also said labor costs rose 6.6%.

You know who really hates this news? The Fed. They really want to cut interest rates, probably this summer some time. Inflationary news makes a rate cut by the feds harder and harder to justify. Also, it looks like we might be heading towards a stagflation. Every statistic that has come out in the last month has shown increasing inflation and decreasing productivity.

In conclusion, rising labor costs and decreasing productivity is not good news.

Sub-Prime Update: New Century

All in all, the death toll of sub prime lenders is 31. That's 31 sub-prime lenders that have declared bankruptcy. I'm going to give you a short list of some of the big ones:

Freemont Gerneral, 5th largest lender
First Franklin, 11th largest lender
Ownit, 17th largest lender
MLN, 19th largest lender
ResMAC, 21st largest lender
ECC/Encore, 24th largest lender
Fieldstone, 25th largest lender

Now it looks like New Century is on the chopping block. They are the 3rd largest lender of sub prime mortgages, and it's looking like we will be singing Queen's, "Another One Bites the Dust." This is a HUGE company that is in the process of tanking.

Bloomberg has compiled a list of their debts among other statistics that I would like to share with you. Also, I have a contradiction. Bloomberg has them listed as the number one sub prime lender. Either way its a big deal. Bloomberg reports (not exact quotes, but a summary):

New Century reported on March 2nd that it faces criminal probe and will need waivers from its own lenders to stay in business. The company will probably be forced to declare bankruptcy. Bankruptcy is "more likely than not." They are running on fumes and the only way they can stay above water is if they can find a large company to provide capital in exchange for a majority ownership. In other words, a buy out.

At the end of this past September, New Century owed $1.5 billion dollars to Morgan Stanley and UBS AG. In all, New Century is said to have 16 credit lines totaling $17.4 billion. The terms of those credit lines stated that New Century had to have timely and accurate financial results. New Century failed to meet this term as it didn't produce an annual report by March 1.

They did receive some credit line extensions, because of there obvious inability to repay the money. Goldman Sachs Group Inc. and Credit Suisse Group gave New Century extensions. Some of the other creditors that gave extensions include, but are not limited to: Bank of America Corp., Barklays Plc., Bear Stearns Cos., Citigroup Inc., and Deutsche Bank AG. This is a text book example of how Chairman Bernanke was dead wrong when he said that he didn't expect sub prime problems to have a spill over into the prime sector. All of these companies denied comment or didn't return phone calls.

The company is facing criminal probe regarding its accounting and trading in securities. S&P down graded New Century's credit rating from B to BB-. Today, the stock is currenty down over $9.50, which is a 65%+ decline.

KPMG LLP, the companies auditor, stated that, "substantial doubt exists as to the companies ability to continue."

You have to look beyond the numbers and two steps ahead to really realize the implications of sub prime spill over into the prime sector. New Century is going to be delinquent on $17.4 billion dollars of debt. All of it credited by prime lenders. Those losses directly effect the lending standards of the prime market. As these companies tighten the noose on lending standards, the economy will begin to feel the strangle hold. The housing sector will be hit harder and harder as lenders make it more difficult for folks to buy a new home. The feed back loop will just be more dramatic as time passes. See the post entitled "Feedback Loop," if you need a better explanation.

Moderate Growth?

Ben Bernanke has predicted that he expects the Goldilocks economy to continue. He said that he expects economic growth to even start to increase mid year. Well, today the Institute of Supply Management's Index of non-manufacturing business, which makes up 90% of the economy, came out. And just like every other statistic that has come out in the last month, it is lower than what most "economists" expected. It fell from 59 to 54.3, which is the slowest growth in over 4 years. This statistic suggests that the slowdown in housing and manufacturing IS spreading to other sectors, which again is contrary to Bernanke's words. Half of the 18 industries surveyed, including retail, financing, and construction, reported slower earnings.

Bernanke is either lying to us, ignorant to the world (which I doubt), or the most optimistic person I know. He says no sub-prime spill over. Woops. He said the recession of the housing market wouldn't spread. Woops. He said he expects mid year increased growth. Woops. He doesn't see a recession...we will see. With me, his credibility is shrinking, not that there was much there to begin with.

I would like to make one more brief point in this post. Every freckin statistic that comes out: inflation, GDP growth, manufacturing, new home sales, etc...economists have been over optimistic on every one. Not one economist has errored on the pessimistic side. This is what I see EVERY day. Inflation...higher than predicted. New home sales...lower than predicted. GDP growth...slower than predicted. Manufacturing/orders for durable goods...less than predicted. I would like to come out with a not so bold prediction. When the unemployment statistic comes out this Friday, it will be higher than predicted. Give me a break.

Market Volatility

The market continues to be very volatile is things progress here. The DOW started the day down, but is currently up. The markets seem to be watching the current economic situation closely. I use the word closely with caution, because I definitely don't think that they are reading in between the lines here. If they were, they wouldn't have any money in the market period.

What I'm talking about, is the strong market reactions to Bernanke's speech, economic statistics such as inflation, unemployment, and home sale. They seem to be reacting to the lending/credit sector as they continue to put out very pessimistic numbers. They also seem to react to the price of light crude oil which is down today and what I believe to be the reason that the market is trading up this A.M. New unemployment statistics come out this Friday and I believe that they are going to impact the markets. I expect the 4.6% unemployment to rise to somewhere in the range of 4.8-5%. I believe this because manufacturing and construction jobs are declining sharply. These are jobs lost in the housing market, as it continues to spiral downwards.

Foreign markets seem to be taking it the worst still. European markets are falling as we speak, and the Nikkei fell another 3% over night. If this is the big one, the global end of the liquidity bubble. We will begin to see the $340 trillion derivatives market get dragged into the mess. Yes, that's a trillion with a "t". That's a story for another day.

I would once again like to focus on the carry trade. The Japanese Yen is now at a 3 month high against the dollar, and still rising as carry traders unwind their investments. Today, the Yen has risen against all 16 major currencies of the world. It has reached its highest value against the British Pound since October, and the same story against the Euro since November. I would like to reiterate a very important point. Global markets are COMPLETELY dependant on a strong Yen carry trade and weak value of the Yen. As these go, so goes the markets.

Remember, that these ridiculous market gains seen across the world are not "real" bull markets. Real is in quotations, because they are not based on fundamental economic growth. They are based on liquidity growth in the form of a larger monetary base and easy lending standards. The global growth in money supply that we are seeing today is unique to our history, and a lot of that money is finding its way into the markets. Folks, just because you print money and throw it into the market, doesn't mean that the stocks are worth more in real terms. It means that the government is robbing you in the form of inflation instead of imposing a direct tax. Think about it...

Short Term Outlook for Gold

Gold has had a major breakdown in price. We had a double peak formation with this past July's high and we were unable to break through. It happened that the global sell off came when we were poking at this resistance and caused a sell off. This sell off has pulled us down and through the $650 /oz.

I expect a sharp decline back to $580-590 /oz. Then the major up leg will begin. I strongly believe this because we have similar double peak formations in silver, the XAU, and HUI. We will pull back to the 200 day moving average where we have found infallible support. We will move positive from there.

A sign that this up leg wasn't THE up leg, was that the HUI was leading bullion prices. In other words, the HUI index was pulling bullion prices up instead of the bullion pulling the HUI.

Also, the breakouts that we saw in gold/USD wasn't seen in all other currencies. For example the C$ didn't experience the breakouts, or fake outs as I like to call them. All of this news is trivial to me. The move down should be swift, and the turn up should be swift. In the long run I am still very bullish on gold. A lot of people will exit their positions and buy back in once we hit the the 200 day MA. Not me. I would hate to miss the market after some geopolitical event that might cause a $50-$100 jump in the price /oz of gold. Also, although I'm pretty confident in my support lines and break down points, I haven't been in the game long enough to completely trust myself.

I still hold to my prediction of gold/silver hitting record highs in 2007.

WHY!?!?

That's the million dollar question. Why have the markets all of the sudden decided to correct so sharply. I contribute this to several factors. Realize that none of these factors have anything to do with the real problems in the U.S. economy: housing market, lending sector, inflation, and government debt. The media has refused to acknowledge these things, so I assume the average investor doesn't look at them as seriously as they should. The markets relay this information. We wouldn't see the DIJA, NASDAQ, and S&P as high as they are today if the general consensus thought there was something to worry about. Albeit, there has been lots of negative statistics coming out over the last month or so, Bernanke continues to say that everything is A ok.

I have mainly contributed a couple of items. The Chinese government cracking down illegal trading which retracted a market that needed retracting. The U.S. stock market was well over due for a correction after 18 months of unprecedented growth. Greenspan's talks of recession were conveniently timed with the market correction. Those are all fine and dandy, and probably have contributed in some way shape or form to the correction that came and is still coming.

But I think the real reason is drying up liquidity due mainly to Japan and its carry trade. As each day passes, I feel stronger and stronger that this is the driving reason of the correction. I have beat to death the notion of the huge amount of liquidity on a global level and talked of how the Yen carry trade is a large driver of this force.

The day before the correction, the Bank of Japan raised interest rates to .50%, with talks of further rate hikes in the future. This will result in the further strengthening of the Yen, making the carry trade more risky and less profitable. What have the actual results been? The Yen hit an 11-week high and is continuing to strengthen against all of the major currencies of the world. The carry traders have been cashing in on the investments abroad. Which is ripping liquidity from the markets. As these markets artificially push higher and higher, it takes larger amounts of liquidity to keep them afloat.

I believe that this is the driving force of the market correction. I look to see how high the Yen goes to see how low the markets will go. This makes me believe that the BoJ will be under large pressure to NOT raise there interest rates any higher. This is a very interesting situation to me. We will see of the central banks of the world try and off set this retraction in liquidity by creating some of there own in the form of printing money or lowering interest rates. The saga continues...