The Catalyst! / The Daily Reckoning

verfasst von - ELLI -, 27.12.2002, 21:17

-->The Catalyst!

The Daily Reckoning

Ouzilly, France

Friday, 27 December 2002

------------------

*** Where's the surprise? So far, things are happening
pretty much as we expected. So, watch out, dear reader...

*** Stocks have worst December in history. Gold soars...

*** The dollar in big trouble. Mortgage applications
down...retailers cut prices...the End of History?

------------------

Where's the surprise, we keep asking ourselves?

So far, stocks, gold, Greenspan, and the dollar have done
pretty much exactly the opposite of what most people
expected of them, just as we thought they would.

"Stocks almost never go down three years in a row," said
the experts at the beginning of the year. But stocks went
down again in 2002. With only 3 trading days left, the Dow
is having its worst December in history.

Gold buyers, meanwhile, are having a good time. Gold was
supposed to go nowhere - because that's where it always
goes, we were told. Nowhere was fine with us, here at the
Daily Reckoning, since other investments were
falling...but, as Addison pointed out in yesterday's essay,
yellow metal did even better than we expected. Gold funds
have been the best performers of the year - and gold itself
has done even better.

Mr. Greenspan was supposed to be hiking interest rates in
2002 in order to trim off the buds of a blossoming boom.
Instead, he cut rates by 50 basis points...and then the Fed
launched a massive PR campaign to convince the public that
deflation posed no threat whatsoever to the economy.

"Buy...buy...buy...today," Fed governors seemed to say,
"we'll make sure prices are higher tomorrow..."

On the other hand, at the beginning of this year most
sensible economists saw the threat to the dollar. The U.S.
has to import 80% of the world's available savings annually
in order to keep the dollar steady. Many people noticed
that this was not likely to continue.

And so the dollar fell - as expected.

What worries us is that everything seems to be going just
as we thought it might. Like a man who has just had a good
night at cards, we worry about what will happen to us on
the way home.

Where's the icy patch in the road? Where's the drunken
teenager? Where's the speed trap?

"There's a crack in everything God made," said
Emerson...even in our own predictions. More tomorrow...

Eric...

-------------

Eric Fry on Wall Street...

- Investors returned from the Christmas holidays in a
festive, stock-buying mood, and their buying pushed the Dow
more than 100 points higher shortly after the opening bell.
But by late afternoon, investors' bubbly disposition had
turned as flat as a day-old glass of champagne. The Dow
finished the day 15 points lower at 8,432, while the Nasdaq
fell 4 to 1368.

- Gold stocks bucked the trend as the XAU Index of gold-
mining stocks soared more than 4%. The yellow metal itself
added $2.10 to $349.40. Gold is one hot commodity these
days. The increasingly precious metal has gained ground on
10 of the last 11 trading days, and has jumped $34 in less
than a month.

- The yellow metal has soared 24% this year, which means
that it is only three trading days away from registering
its biggest annual gain in 23 years. Maybe gold is still
"real money" after all. The world's best-known imitation,
the U.S. dollar, continues its dreary slide. Yesterday the
dollar fell about half a percent against the euro to 103.6
cents per euro - a new three-year low for the struggling
greenback.

-"We are still very early in a major dollar sell-off,"
Bridgewater Associates asserts."The U.S. needs to attract
80% of the world's available capital just to keep the
dollar stable." The job of attracting wheelbarrows full of
foreign capital seems to be getting harder every day,
especially because foreigners aren't as eager to buy U.S.
assets as they used to be.

-"The U.S. has been the beneficiary of a virtuous cycle of
foreign investment," Bridgewater explains,"in which a
strong dollar and strong financial markets led to further
foreign investment in the U.S., which led to a stronger
dollar and stronger financial markets. This virtuous cycle
is in the process of flipping to a vicious cycle, as poor
performance of U.S. assets leads to a drying up of foreign
demand for them, which in turn creates a drag on U.S.
assets, and this vicious cycle is only in its early
phases."

- In 1990, foreign-owned assets amounted to 33% of U.S.
GDP, but today they are valued at over 70% of U.S. GDP. For
example, foreigners own more than 30% of the total U.S.
Treasury market, along with large slugs of the corporate
bond market.

-"These holdings are so big and so much larger than U.S.
assets abroad," says Bridgewater,"that they are a long-
term risk to U.S. financial markets...The recent slide in
the dollar...indicates that the global demand to hold
dollar assets is waning and falling short of the financing
hurdle presented by the U.S. current account deficit...The
combination of a weak dollar with rising gold and commodity
prices smells like monetary inflation."

- That distinctive odor seems to be wafting through the
U.S. financial markets, which is one reason why bonds are
unlikely to be star performers in 2003. This year, while
stock market investors suffered a third consecutive year of
misery, buyers of bonds had themselves a splendid time.

- Both the 10- and 30-year bonds produced a total return
greater than 12%. Not too shabby for boring old fixed-
income. But the best days for the bond market are probably
in the past, at least that's the message from commodity
markets. Oil has been a particularly vocal"messenger."
Yesterday, oil prices surged to new two-year highs above
$32 a barrel.

- Gold over $350? Oil over $30?...Hmmm...Smells like
inflation.

-------------

Back in Ouzilly...

*** Consumers are expected to keep
borrowing...spending...and blowing themselves up. But
what's this? The latest week shows a sharp drop in mortgage
applications. One week doesn't make a trend...but the trend
has to start sooner or later, we think.

"The best for housing is probably behind us," said Sung Won
Sohn of Wells Fargo.

***"Retailers Set to Cut Post-Holiday Prices," says the LA
TIMES.

"Car dealerships ratchet up end-of-the-year discounts,"
adds the Kansas City Star.

Inflation? What strange sort of inflation is this...where
commodities' prices rise...and manufactured items fall?
Marc Faber takes a stab at an answer below...

*** A few years ago, Francis Fukayama published a much-
discussed essay inspired by the collapse of communism. The
triumph of democracy, peace and prosperity meant the 'end
of history,' he argued.

Fukayama has such a talent for getting things wrong; he
should have been a Wall Street strategist!

We pass this along today, dear reader - a gratuitous
reflection that has little to do with your investments -
merely because we happen to be thinking about it.

Fukayama misunderstands both what the collapse of communism
really meant...and how history actually works.

History is an account of the madness of crowds, not the
march towards democracy. In the 20th century, the world
became more and more democratized...and the cost of
communications decreased. Both trends headed in the same
direction - towards bigger crowds, madder than ever. That
is why the world's worst wars were fought in the 20th
century and not before.

Nor did the collapse of communism bring an end to these
trends. The cost of telecommunications continues to
drop...while life in America and elsewhere is more
collectivized than ever before - and thus more subject to
the madness of crowds. The means of production are no
longer owned by a few rich capitalists, but by millions of
small, collectivized lumpenshareholders - through mutual
funds and pension funds. Health care decisions are
determined not by individual patients and doctors, but by
functionaries working for the U.S. government. The economy
itself dances to tunes called, not by buyers and sellers
with their own money at stake, but by bureaucrats at the
Federal Reserve!

And foreign policy? Never before has American military
policy been so entangled with so many people, places and
ideas so completely foreign to so many voters. And yet,
rarely has a president had so much popular support.

On every front...domestic, economic, monetary,
military...never before have so many people had such a
great opportunity to get together and make a monumental
mess of things.

Do not weep for the death of history, dear reader; it has
only just begun.

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---------------------

The Daily Reckoning PRESENTS: Skyrocketing commodity prices
and a bubble in real estate portend one of two things,
suggest Dr. Marc Faber: a serious bout of deflation - or
(gulp) rising interest rates! The latter would"kill" the
consumer-led recovery predicted by American main-stream
analysts.


THE CATALYST!
By Marc Faber

Although we are, in fact, in a deflationary environment for
manufactured goods, principally because of the rising
supply of"cheap" consumer goods from China - a shift has
taken place in the last two years from a bull market for
equities to inflation of hard assets: residential real
estate and commodities.

But whereas it would appear that housing inflation in the
U.K. and the U.S. is nearing an end, commodity prices
appear to have completed a multi-year base and are poised
for further gains.

According to the Office of Federal Housing Enterprise
Oversight, a federal agency that regulates Fannie Mae and
Freddie Mac, its index of prices for single-family homes
rose just 0.84% in the third quarter, compared to a rise of
2.39% in the second quarter. Moreover, with the exception
of a brief period following the September 2001 terrorist
attacks, this index has been rising at a rate of about 2%
per quarter during the past two years as declining interest
rates boosted house prices.

The report by the Office of Federal Housing actually found
that home prices fell in seven states in the third quarter,
which compares to price falls in only three states in the
second quarter. Similarly, prices fell in 33 of the 185
metropolitan statistical areas studied, compared to 22 in
the second quarter. Still, compared to a year ago, house
prices rose by 6.2%, which is far higher than the annual
average increase of 4.6% since 1980, but is down
significantly from the recent 12-month appreciation peak of
9% recorded in the first quarter of 2001.

According to the National Association of Realtors,
assembling their reports from a different set of data, home
prices rose 9.8% in the 12 months ended in October 2002 -
the fastest such pace since 1987.

The point remains...at present, housing prices are rising
far more rapidly than incomes, a phenomenon that is
obviously not sustainable in the long run, as affordability
will become a problem sometime in the future - at least in
areas where prices are rising by close to 20% per annum.
So, whereas the flight into real estate may be nearing an
end, the outlook for commodities is far more appealing. It
is worth noting that despite weak global economic
conditions and weak stock markets around the world, the CRB
Commodity Futures Index has risen by more than 20% this
year.

Commodity prices have also been in a bear market for more
than 20 years and, in the age of capitalism, have never
been as low as just recently.

Therefore, once fundamentals improve, prices could run away
on the upside. For example, if synchronized growth around
the world should materialize - a scenario about which we
have serious reservations, but which is nevertheless a
possibility for the short to medium term given central
bankers' propensity to print money - then obviously the
demand for all commodities should improve and drive prices
higher.

But more importantly, with people like Mr. Bernanke at the
Fed, and actually even being a serious candidate for future
chairman of the Federal Reserve Board, depreciation of the
dollar and a rise in commodity prices is almost guaranteed
- particularly if the economy weakens.

In fact, Bernanke's declaration to the National Economists'
Club in Washington that"The U.S. government has a
technology called a printing press," didn't go unnoticed by
the believers in sound money (gold), who subsequently
pushed gold prices through an important resistance level.
[Editor's note: Gold traded to $351 at the opening in Hong
Kong this morning...and has gained $36 in the last month,
or roughly since Bernanke made his speech. Next stop? Who
knows, but $414 is the ten-year high set on February 5,
1996...no doubt, an important level to watch. Addison.]

It is unlikely the U.S. dollar will depreciate
significantly against the euro and the Japanese yen,
although I am of the view that the bearish sentiment
towards Europe is overdone. For one, I am a believer that
the inclusion of the ten countries from Central Europe and
the Mediterranean (Hungary, Poland, the Czech Republic,
Slovakia, Slovenia, Lithuania, Estonia, Cyprus, and Malta)
into Euroland will be highly beneficial in the long run. It
will add to Euroland about 70 million people who will be
only too eager to work for far lower salaries than Western
Europe's union-controlled workers. There is finally hope
that the workers' union power in Western Europe will be
badly shattered and that growth prospects for this economic
zone of more than 450 million people will be very exciting.

Nevertheless, it is not likely that the Euro will
appreciate by more than another 10% or so against the U.S.
dollar in 2003, since the beneficial impact from this
European enlargement will only be felt very gradually.
Equally, it is unlikely that the Japanese yen can
appreciate much against the U.S. dollar, given Japan's own
economic problems.

Therefore, it is more likely that the dollar will
depreciate against hard asset prices, including
commodities.

Furthermore, Barry Bannister, in a very comprehensive study
on commodities for Legg Mason Wood Walker Inc., shows how
per capita oil consumption soared in Japan in the 1950s and
1960s, and later in South Korea from the mid-1970s up to
recently.

In other words, when countries industrialize, the demand
for commodities inevitably increases very rapidly.
Economies that are based on manufacturing and the
production of goods tend to be heavier users of industrial
commodities than service-based economies. Therefore, if the
rapid pace of industrialization in China continues, and
picks up in India and Vietnam, then per capita demand for
oil and other commodities is likely to increase very
dramatically and drive all commodity prices much higher.

Lastly, commodity prices have always had a tendency to
spike up during wars. With the prospects of a war in the
Middle East increasing, we would not be surprised by a
strong rise in commodity prices in 2003.

Thus, the following potent combination makes for a fairly
convincing case that we're on the eve of an explosive rise
in commodities prices: the 20-year commodities bear market
coming to an end; characters like Mr. Bernanke at the Fed;
rising budget deficits not only in the U.S., but also in
other industrialized countries; rising demand for
commodities in Asia; and the possibility of a nasty and
long-lasting conflict in the Middle East, which may in the
end involve the entire region, including Saudi Arabia and
Iran.

Indeed, if commodity prices do continue to rise, then
interest rates will rise and bond prices will decline.
Interest rates and the CRB Index are closely correlated -
that is, when commodity prices rise, interest rates tend to
follow, and vice versa. The recent rise in commodity
prices, which so far has not been accompanied by rising
interest rates, is therefore unprecedented and would
suggest that, sooner or later, commodity prices will
collapse once again in a serious bout of deflation...or
interest rates will suddenly increase meaningfully.

I am leaning towards the latter scenario, thanks to Mr.
Bernanke, who reflects very much the thinking of mainstream
American policy-makers and self-promotional economists -
such as CNBC's Larry Kudlow - who continue to believe that
easy money and aggressive interest rate cuts can solve all
the world's economic ills and that a new, powerful equity
bull market is just around the corner!

If commodity prices are indeed at the very beginning of a
secular bull market, as I believe, then such a rise will
inevitably be accompanied by rising interest rates.

In fact, the very big surprise for American economic
policy-makers, investors, and consumers who have just been
on a borrowing spree could be that, in 2003 and 2004,
interest rates will rise quite considerably and"kill" the
refinancing boom that has taken place in the last couple of
years as a result of rapidly declining interest rates. If
interest rates were to rise, refinancing activity would
inevitably slow down...and with it"consumption" growth.

Peace on Earth,

Marc Faber,
for The Daily Reckoning

P.S. I might also point out that refinancing activity could
decline even if interest rates didn't rise but just stayed
at their present level, as it is likely that most
homeowners have already refinanced their homes.

Editor's note: Dr. Marc Faber, editor of The Gloom, Boom
and Doom Report, has been headquartered in Hong Kong for
nearly 20 years, during which time he has specialized in
Asian markets. Dr. Faber is a member of Barron's Roundtable
and a major contributor to:

Strategic Investment
http://www.agora-inc.com/reports/DRI/ProfitGrow/

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• The Catalyst! / The Daily Reckoning - - ELLI -, 27.12.2002, 21:17