»The Daily Reckoning by Bill Borner

What are stocks and gold telling us?
19 AUGUST 2011

Poitou, France

Wow...another whack.

Wall Street got whacked hard yesterday. It had begun to look as though things were getting back to normal. Then...whammo!

Yesterday, the Dow took a 419 point hit. Gold rose $28 to close decisively above $1,800.

We keep an eye on stocks and gold. Stocks measure the value of America's businesses. Gold measures the value of America's - and the world's -- money. What are these measures telling us?

That we're on the road to Hell!

Of the two measures, gold is harder to figure out.

Stocks are obvious. America's businesses aren't worth 20 times earnings. They're not worth that much because we're in a Great Correction. And after the action of last week...and yesterday...it is becoming clear that this correction will probably last a long time.

Layoffs are increasing. Home sales are falling. And consumer prices are rising at a 6% annual rate. The New York Times:

The Philadelphia Federal Reserve Bank's business activity index fell to minus 30.7 in August, the lowest level since March 2009 when the economy was in recession, from 3.2 in July.

That was much worse than economists' expectations for a reading of plus 3.7. Any reading below zero indicates a contraction in the region's manufacturing.

A second report showed sales of previously owned homes fell 3.5 percent in July, to an annual rate of 4.67 million units, the lowest in eight months. Economists had expected home resales to rise to a 4.9 million-unit pace.

Separate data from the Labor Department showed initial claims for state unemployment benefits increased 9,000, to 408,000. Another report from the department showed the Consumer Price Index increased 0.5 percent in July, the largest gain since March, after falling 0.2 percent in June.
So don't expect most businesses to increase sales. And don't expect profits to go up. Businesses have already done a very good job of squeezing costs in order to survive the downturn. That helps keep up profit margins. But it's murder on the economy. One business's costs are another business's revenues. While profits rise, revenues fall. Not good for the long term.

The biggest single expense for most businesses is the payroll. People are expensive. So, if you're a good businessman, you try to get rid of as many people as possible - and not hire more of them. Even when you think business is improving, you try to service the new sales with the same staff. A little more over-time...streamlining administration...making the enterprise more efficient.

In that regard, computers and modern communications technology have been helpful. They make it easy to fire people! But they don't seem to lead to the kind of GDP boosts that you need to create jobs and increase standards of living.

That's why the 10 million or so jobs that disappeared in this downturn won't come back. And it's why the real unemployment rate in the US hasn't been this high since the Great Depression.

If that weren't enough, there are other reasons to expect stock prices to go down. The main reason is because that's what stock prices do. They go up. Then, they go down. Sure, they have a lot of reasons. But people usually only find the 'reasons' after the fact. Like commentators and analysts this morning...struggling to find the 'reasons' for yesterday's 419-point drop.

The only thing we really know is that markets go up and down. And yesterday, Mr. Market wanted to go down.

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*** Here at the Daily Reckoning we've been expecting lower stock prices for a long time. Wall Street has never completed its 'rendezvous with disaster' that began in January 2000. As we see it, stocks began a bear market almost 12 years ago, after an 18-year bull market. But the bear market was never allowed to fully express itself. Instead, the feds came in - like rap stars into a late-night party. They turned up the music. They poured drinks for everyone. They brought drugs and hookers. And pretty soon, the party was going louder and wilder than ever.

But now the party's over. The feds are still opening bottles. But nobody's drinking.

The bear market is back. By our reckoning, the Dow should fall below 5,000 before it is over. Most likely, it will not be a short, quick collapse. Instead, it will be a long battle...stretched over many years...with the feds fighting over every inch.

Anyhow, that's our story. That's been our story for many years. Seeing no reason to change it, we'll stick with it.

*** But what about gold? There...well, we admit to a certain feeling of 'I told you so.' But it was one thing to tell Dear Readers to buy gold when it was selling for $300. It's another thing to suggest it at $1,800. Gold was a steal at $300. At $1,800, it's probably close to fair value.

That doesn't mean it won't go higher. In fact, we think it will go much higher. But it's a rare bull market that makes it so easy for investors. But gold is harder to figure out.

If the economy is really in a Great Correction...

...and if it will be in a funk for years...a Japan-like slump...

...and if investors are fleeing stocks and buying dollars and dollar-based bonds...

...then, why is gold going up?

Are investors really looking ahead to the feds' reaction to a double-dip recession? Are they thinking that Bernanke et al will panic...and print more money? Are they worried about higher rates of inflation?

Or maybe investors figure - with interest rates so low - they might as well hold their money in gold. Who know what could happen? Who knows what the feds will do? Who knows anything?

At least gold is something you know won't go away.

Possibly. But we don't think investors are that smart. Or that forward-looking.

*** Zombie, zombie in the night...

Ah, modern technology comes to the aid of looters. Right in our home state, too. Here's the report:

(CNN) -- A "flash mob" believed to have been organized on the Internet robbed a Maryland convenience store in less than a minute, police said Tuesday, and now authorities are using the same tool to identify participants in the crime.

Surveillance video shows a couple of teens walking into the Germantown 7-Eleven store Saturday at 1:47 a.m. Then, in a matter of seconds, dozens more young people entered and grabbed items from store shelves and coolers. Police said the teens left the store together, without paying for anything.

"At least 28 different individuals" have been confirmed on the video, Capt. Paul Starks told CNN Tuesday.

Although investigators have said they '"can't confirm how this (robbery) was organized," Starks does believe the Internet was involved.
Armageddon Can Wait

Until August 15, 1971, wealth was tallied in units of a real and natural thing --gold. It measured out the world's other real things -- its resources and its output. Its main advantage was that it couldn't be diddled. That turned the authorities against it; they couldn't make more of it.

Nuestra Senora de Atocha, a Spanish galleon, sank in a storm off the Florida coast in 1622. When it was found in the 1970s, its treasure of gold doubloons, was just as valuable as it was when the ship left Havana 350 years before.

But, post 1971, we have a new, avant-garde money system. Wealth is counted up in pieces of paper...or as electronic 'information' Each unit has no real value of its own. It only represents a claim against real goods and services. And each year, it purchases fewer of them.

What is most remarkable about this freakish new money system is that it is always on the road to Hell but never seems to get there. Since 1971, paper currencies have lost value at a breakneck speed. You'd think their necks would be broken by now. In 1972, we bought a gallon of gasoline for 25 cents. Now, it is 16 times that much. Gold has gone up 50 times...for a 98% loss to the dollar holder. If this pattern continues for another 40 years, a gold doubloon will buy about what it does today. A dollar will buy nothing.

And then, along came S&P with more bad news: not only is the dollar disappearing, but if you lend money to the US government you might not get it back. The stock market took the news badly. But bond investors bought with even more lusty recklessness than before. It was as if they really didn't want the money back anyway. Yields on US 10-year notes fell from around 3% to scarcely more than 2%, giving investors a negative real yield.

But the fall in yields should not come as a surprise. Japan's government debt lost its Triple A status in 2002. Yields did not rise. Instead, they stayed between 1% and 2%. Then, last week, Japanese 10-year notes - IOUs of the most deeply indebted nation on earth -- reached an all time high. Yields fell below 1%, briefly.

You may think that investors have lost their minds. But no more than usual. It's not the nominal rate that investors care about; it's the real rate. For 20 years, stocks and property in Japan have gotten hammered. Bond buyers are the only ones who've made any money. Deflation takes prices down. Even a zero interest rate gives them a positive return. And it isn't even taxable.

And now the US Fed follows in Japan's footsteps. The Fed announced last week that it would continue to lend money for two more years, asking little more than a 'thank you' in return. Zero is the going rate at the Fed's lending window - just as it is in Japan.

When Richard Nixon implemented his new monetary system, 4 decades ago, he set in motion a huge expansion in the world's supply of cash and credit. Gold was limited. Paper money was left to run wild. Ben Bernanke famously announced how it worked in a 2002 speech, entitled "Deflation: Making Sure it Doesn't Happen Here," he explained:
...the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Bernanke made it sound like a piece of cake. He should have appended a footnote. Inflating is easy when the credit cycle is expanding. When an economy transforms itself from grasshopper to ant, it gets harder. People switch from borrowing, spending and investing to exterminating debt and hoarding cash. That's why none of the stimulus measures - fiscal or monetary - has done any significant good. And it is why no policy adjustment, short of debt cancellation or hyperinflation, will make any damned difference.

The whole situation is one for the history books. Four decades of paper money - with no effectively no limit on credit expansion - have created mountains of debt in all the developed countries. Now, private sector debts are being sloughed off and asset prices wobble - making investors fearful and skittish. The more they sweat, the more they seek the safety of US Treasurys, and the lower interest rates go. Low rates delay Armageddon... if Japan is any indication...almost indefinitely. The economy continues on the road to Hell...and picks up speed. When it finally arrives, we don't know. But we bet the price of gold will be higher when we find out.

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