What A Real Recovery Looks Like Part II

Back in March I posted "What A Real Recovery looks Like". Back then there had been plenty of positive talk in the media about President Obama's policies finally having had the desired effect in getting the economy going again. The fourth quarter GDP for 2011 (which then was the prior quarter) was 4.1% (annualized). Certainly this was a strong number which, if sustained, would signal a strong recovery indeed. That, however was not to be the case. Annualized GDP growth posted at 2% for 1st QTR, 2012 GDP followed by 1.5% in the 2nd QTR, 2012. Clearly President Obama will not see the recovery hoped for in time for the election in November.

In the previous post I had compared the Reagan recovery to the Obama recovery for two reasons. First, both Presidents inherited an economic mess with very sharp downturns. Secondly, each President took a very different approach to the recovery making for an interesting comparison. I make this comparison not to make a political point. This is, after all, an economic blog, not a political blog. But contrasting the two, I believe, yields some interesting insights.

You may recall that in March I compared the labor participation rates of the two recoveries. In a strong recovery we would expect to see the participation rate increase while unemployment decreases.

From my previous post:

Below I present two graphs. One is from the 1980's when we clearly had strong GDP and job growth. The other is our current environment. Keep in mind that we currently have a declining unemployment rate. The question is what does it mean in light of the labor participation rate.

As you can see, during the 1980's people entered the labor force as jobs became widely available.

In this recent graph we can see that even as unemployment has declined, so too has the labor participation rate.

The graph below shows the inverse relationship between unemployment and the labor participation rate:

The Wall Street Journal examined this same comparison July 28th, 2012 and noted:

The reality is that the Great Recession ended three long years ago. In this Less Than Great Recovery, the economy shows promise for one good quarter then slows back down. As the nearby chart shows, this is the third straight year of sputtering recovery. Growth of 4.1% in the fourth quarter declined to 2% in the first and now 1.5% in the second. The stock market rose as investors bet that the lousy growth will inspire more Federal Reserve easing.

They also note:

It's important to understand how unusual this kind of weak recovery is. Deep recessions like the one from December 2007 to June 2009 are typically followed by stronger recoveries, as there is more lost ground to make up.

The most recent comparable recession occurred in 1981-1982. Yet as the nearby chart shows, the Reagan expansion exploded with a 9.3% quarter and kept up a robust pace for years. By the 12th quarter of expansion, growth popped up to 6.4.%. At this stage of the Reagan expansion, overall GDP was 18.5% higher versus 6.7% for the Obama recovery, according to Congress's Joint Economic Committee.

Another comparison is the actual job numbers themselves. Reagan had a double dip recession in his first term with negative job numbers soon after his election. It took nearly two years before he went from negative job numbers back to positive job creation, but when it did, it posted a massive 1,114,000 new jobs in September 1983 alone! Certainly an amazing achievement. From that point on job creation numbers in the 100's, 200's and 300's thousands.

That same period in Obama's term in September of his third year produced 202k jobs but has been declining since and has been an anemic 75k average over the past three months.

When one considers that 30 years ago when Reagan was President, both the population and the size of the economy were smaller, the contrast looks even worse.

And lastly, consider this, the New York Times estimates we need to be creating 150k jobs a month just to keep up with normal population growth.

Of course, there are other differences as well between the two eras. The Federal Reserve policies were remarkably different. In a future post I hope to show how the Federal Reserve's current policies are making Obama's job much more difficult than they were under Reagan in a way that may seem contrary to traditional economic thought. But that is a post for another day.
 

Hong Kong to Open 1,000 Metric Ton Gold Vault

In the previous post I described how western gold vaults were being emptied by the LBMA and its members who are alleged to have raided both allocated and unallocated client gold holdings in order for the LBMA to fix the price of gold (down). I've referenced the "London trader" here and here. In addition I have documented several stories of China acquiring gold here.

Of course, one might be dismissive of an anonymous "London trader". After all, where are the facts? Well today we can add some tangible evidence that China is adding to its gold storage capacity:

Hong Kong’s largest gold-storage facility, which can hold about 22 percent of the bullion now in Fort Knox, will open in September to meet rising demand from banks and the wealthy, according to owner Malca-Amit Global Ltd. (3271)

The facility, located on the ground floor of a building within the international airport compound, has capacity for 1,000 metric tons, said Joshua Rotbart, general manager for the Hong Kong-based company’s Malca-Amit Precious Metals unit. Two of the vaults may hold assets, including gold, for banks and financial institutions, and others will be used for diamonds, jewelry, fine art and precious metals, said Rotbart.

The move in Hong Kong reflects increased demand for gold in Asia even as the commodity struggles to sustain its rally into a 12th year. Gold-demand growth in China, the world’s second- largest user after India last year, is slowing, according to the World Gold Council. Vault charges will depend on each customer’s operations, according to Rotbart, who declined to give a figure for the venture’s cost beyond millions of dollars.

“Hong Kong is a very important center for gold, especially because it acts as a doorway to China,” said Sunil Kashyap, head of Asia-Pacific foreign exchange and precious metals at Scotiabank. “Current international hubs are in New York, Zurich and London. There’s still a need to set up an Asian hub for physical gold. The trend is for more people to look at storage and trading in Asia, when it comes to physical metal.”

So here is tangible evidence that support the London trader's assertion. And from the same story:

“The general trend is for moving the assets from the West to the East,” said Rotbart, who also oversees business development and marketing of the company’s vault in the Singapore FreePort. “Proximity to China is very important.”

 So as western vaults are being emptied, China and other Asian countries are filling them up and building new vaults.

What do you think they know that western investors don't seem to know? Perhaps its that western economies and financial institutions are so rotten to the core, they can no longer be trusted.

Are the Gold Vaults Empty?

No, this isn't a post about conspiracy theories that Fort Knox has no gold. Its about a very real possibility that banks don't have the gold in their vaults they claim. Gold that they are charging customers to store but may have lent out or sold. This is not a conspiracy. In fact, its already happened before at Morgan Stanley in 2005.

Of course, what would seem like a tin foil hat conspiracy before 2008 sadly just seems par for the course following the shenanigans of the last several years. Just to remind you of the surrealism of the past several years we've experienced:

• Berni Madoff's billion dollar Ponzi scheme exposed.
• Mortgage fraud by most all major banks including document forgery.
• MF Global bankruptcy where over $1 Billion of client "segregated" accounts were stolen without a single arrest.
• PFG Best goes bankrupt after $200 million of client "segregated funds" go missing while regulators were clueless.
• Libor scandal that required the tacit collusion and fraud of several of the world's biggest banks.

In light of all of this, as well as the mismanagement and irresponsible leverage that bankrupted Lehman and forced the Fed to have Merrill Lynch and Bear Sterns acquired by marginally better managed banks, would it be surprising at all if the banks didn't have the gold they say they have?

Before we go any farther, let's just review some terms and concepts so that you fully understand what you are about to read so that you can understand the magnitude of what is taking place.

First, you may recall how I described traditional banking versus shadow banking in a previous post. Just as traditional banking utilizes a fractional reserve system where $1 is leveraged ten times in loans, gold banking operates on the same principle. Banks can leverage and lend many times their gold deposits. In addition, they write derivative contracts on gold which is estimated to be 100 times the actual physical gold holdings!

Secondly, remember how I described how segregated accounts are supposed to be just that...segregated and not mixed with the bank's assets. Clearly in the case of MF Global and PF Best this was not done according to law, a fraud that resulted in massive losses on client funds. In a very similar way, when a bank takes on gold deposits from clients, the gold is either allocated or unallocated. Allocated means you deposit your numbered bars with the bank. The bank charges you storage fees and when you want your gold back you notify them and get your same gold returned. If its the same gold it can easily be verified by matching the serial numbers on the bar. Unallocated gold may be lent by the bank and when you get it back it may be any gold that is considered "good delivery". In this case, the serial numbers will not match but you get bank a similar amount just like when you deposit dollars at a bank and withdraw different dollars from the ATM. You don't care about the serial numbers as long as its the same value you deposited.

Lastly, LBMA stands for London Bullion Market Association. This market in the UK along with the COMEX in the US, largely determine the paper price of gold each trading day.

With that in mind, click the link below to discover just how deep the rot is in the global banking system.

Three Graphs Explaining When to Dump Gold and Buy Stocks

To break up the doom and gloom of today's markets and economy I want to focus on the future. At some point in the future, the gold trade will come to an end, the great Keynesian experiment will end and the markets will be forced to reset once central bank manipulations fail to kick the can down the road a little further.

Just as this will likely mean the peak in gold and a new currency regime, it will also open up new opportunities in the investment world. And in order to be ready for that time you must know what to look for in order to recognize it. This point will likely be a once in a life time chance to buy stocks very cheaply and set you up for the next twenty years to follow.

There are three graphs that show the cyclical patterns that lead to long term equity bull markets.

The first graph below shows the Dow/ Gold ratio. As Gold goes up or the Dow goes down, the ratio decreases. Though this graph only shows up to 2009, today the ration is about 8, virtually unchanged. This is primarily due to the temporary affects of QE1, QE2 and Operation Twist- all Fed operations to stimulate the economy by increasing the money supply. This has artificially increased the Dow even as Gold has leveled off the last year due to Europe's problems that have made dollar assets relatively more attractive that Euro assets. The trend, however will almost certainly continue as the USD as safe haven is merely transitory and the value of gold will increase due to buying by non western central banks and possibly by the BIS (Bank of International Settlements) making gold a Tier 1 asset.

When the Dow/Gold ration approaches 1, it will be time to transition from physical gold holdings to stocks, that is selling gold at a high and buying stocks at a low. Of course this will hopefully be in the context of a financial system that is more stable and strong oversight from a renewed SEC that prevents more MF Globals and rehypothecating theft.

The second graph below shows the S&P 500;s variation around the mean (average). As you can see below, the index dropped to its long term mean during the financial crisis, but just briefly, before bouncing back up on QE enacted by the Fed. You can see below there were several times the S&P 500 dropped well below its mean in 1920, 1932 & 1982. We should expect to see another significant drop below the mean before another long term bull market in stocks can resume.

You'll notice above that the market hit the mean return in the "teen years" before dropping through and hitting its bottom in 1920. These were tests of the long term support levels. The market hit this support level twice before falling through the mean. I believe the 2009 decline is a similar test of the support level and we may see another test of support off the mean before a major drop through.

The the first graph used the Dow as its relative index and the second used the S&P 500, they essentially both measure the US stock market. Both represent a need for the US market to drop in order for the market to revert to the mean and have the Dow/Gold ratio to decline.

 In the third and final graph below we can see the S&P 500 Price to Earnings ration relative to the S&P 500's dividend yield. From Grant Williams we get the data that:

The 1982 bull market began with the S&P 500 trading at 7X earnings and yielding 6.3% (Green dotted line left). It ended in the tech blow off at 30X earnings at 1% yield (red dotted line, left. As we stand today, the S&P 500 is yielding 2.5% and is trading at roughly 11X earnings (blue line left)

As you can see, the PE ration and Dividend yields of the S&P 500 move in the opposite direction. This makes sense since higher stock prices result in a lower yield at any given dividend.

The important point though is that you can see that the yield (brown line) is once again crossing the PE line (purple line) on the far right side of the graph just as it did in the early 1970's on the left side of the graph. Following the historical oscillation of the two we should expect lower PE ratios going forward and higher yields on stocks. The two lines should continue to diverge as they did in the 1970's setting up the buying opportunity of a generation. Will it take another eight years from this point as it did back then? Possibly.

But I expect that its more likely that we have been setting up events since 2008 where all three of these graphs will meet their targets together in what may be a perfect storm that happens abruptly. When its does, whether it takes one year or ten, it will mean that a transition is underway.

Until then, keep stacking gold and silver.

Eric Sprott on Stocks, Gold, Oil and the Macro Economy

This is a great interview by King World News with Eric Sprott.

You can listen to it here.

The most important takeaway I got from this interview: China may be buying 1/2 of all gold produced in the world each year, excluding what they mine and keep for themselves even as they have quit buying US Treasuries. Simply amazing.

Turkey Joins India in Buying Oil with Gold from Iran

Earlier this year in January I noted in a post that India was planning to avoid both the pesky US petrodollar as well as upcoming Iranian sanctions by reverting to the purchase oil with the world's oldest currency (and soon to be the most prominent reserve currency) gold.

Today we learn that Turkey has joined them:

Turkey has exchanged nearly 60 tons of gold for several million tons of Iranian crude oil, despite its promises to uphold Western sanctions on Iran’s energy sector, according to recent Turkish reports.

By using gold instead of money, Turkey is able to skirt Western sanctions on Iran’s oil trade, particularly those pertaining to SWIFT, the global money transfer service that until recently assisted the Central Bank of Iran and other Iranian financial institutions.

Over the past several months, Turkey has given Iran 60 tons of gold, or more than $3 billion, according to a July 8 report on the Turkish news site Vatan Online. The report was translated by the Open Source Center, a translation service used by the CIA.

If central banks are storing gold as a reserve currency and using it to make purchases essentials, why shouldn't we?

And one final thought on oil priced in gold. Take a look at this graph. Though the two fluctuate quite a bit in terms of US Dollars, the relationship is much more stable when priced against each other. Notice how the yellow line (oil priced in gold) is relatively stable while the blue line (oil in dollars) is declining. Note that this graph is logarithmic so the difference is actually much bigger than it appears. The blue line goes from an index at 100 to near zero showing that the USD has lost nearly 98% of its oil purchasing power while gold has remained constant. You can read more on the dollar decline here.

Makes you wonder why airlines don't do the same as India & Turkey.

Merrill: Gold to hit $2,000 by Years End

Merrill Lynch is not one of the typical "gold bugs" so I found this interesting.

Many have expected more QE from the Fed in one form or another since the last non-farm jobs numbers that were a huge disappointment. The Fed, however, did not give any clues into a bias in easing in the recent Fed minutes released. Never the less, Merrill predicts more QE is coming, which would be bullish for gold as its bearish for the US dollar.

From CNBC:

Merrill Lynch has added its voice to the chorus of gold bulls who have been predicting that bullion will hit $2000 an ounce.

 Francisco Blanch, Head of Global Commodity & Multi-Asset Strategy Research at the investment bank, says he expects the Federal Reserve to initiate an asset-purchasing program of as much as $500 billion in the second half of the year, which will drive spot gold much higher by the end of the year.

"We think that $2,000 an ounce is sort of the right number,” Blanch said on CNBC Asia’s “Squawk Box” on Thursday. “We believe that ultimately the Fed will be forced to do quantitative easing . If it happens in September, as our economists expect, we will get a rally sooner in gold. If it happens after the election (in November), we will get the rally a little bit later; probably we will touch $2000 an ounce sometime next year.”

Spot gold was trading almost unchanged at $1,569.71 an ounce by 6.14pm GMT on Wednesday and inched up to about $1,572.80 in early Asian trade on Thursday. The metal has fallen nearly 20 percent since touching an all-time high of $1,918 in September last year, as a combination of Europe’s debt crisis and concerns over global economic growth triggered a selloff in risk assets like commodities.

Despite this decline, market watchers from prominent investor Jim Rogers to hedge fund manager Eric Sprott have continued to stay bullish on gold, believing that central banks around the world will continue their policy of monetary easing and investors will seek out the metal as an inflation hedge.

Traders are expecting the Fed to embark on a third-round of bond purchases to stimulate the U.S. economy on concerns that the recession in Europe and the slowdown in China could worsen. Yield on benchmark 10-year Treasury notes ticked down to 1.517 percent, and the 30-year note was also marginally lower at 2.614 percent as investors sought refuge in the safe-haven asset.

Axel Merk, President and Chief Investment Officer of Merk Investments, says it is almost certain that the U.S. policymakers will ease monetary policy, maybe as early as next week when Fed chief Ben Bernanke delivers the central bank's updated economic assessment to Congress.

 Merk said Bernanke is a believer in using a weaker currency to boost a nation’s competitiveness and get out of a recession, and will therefore use monetary policy as a tool to spur a U.S. economic recovery.

“He did say that going off the gold standard during the Great Depression helped the U.S. recover from the Great Depression faster than other countries, meaning that debasing your currency is helpful,” Merk told CNBC Asia’s “Squawk Box”. “That’s what he is trying to do.”

Some traders are not as bullish on gold. Andrew Su, CEO of Sydney-based commodities trading and advisory firm Compass Global Markets, said he expects gold to decline over the next few months and that it could fall to as low as $1,300. This is because investors will be liquidating gold, which has made them money in the past year, and trying to prop up losses in equities.

“I also believe that the chances of quantitative easing this year from the Fed are much lower than market expectations and we will see a sustained rally in the US dollar,” he said. “I believe we will see an accelerated fall below technical support at $1,530 in the short term to see prices fall to settle around $1,300.”