The Daily Reckoning - Lahars (Dan Ferris)

verfasst von Firmian, 19.12.2003, 23:00

-->Lahars

The Daily Reckoning

Paris, France

Thursday, 18 December 2003


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

*** Another GUDD day... ho hum...

*** But whoa! Deflation ahead... bonds strong... we can
smell the sushi...

*** Profits getting squeezed... commodities
pressured... boomers pinched... another dopey editorial
column... and more!

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

Gold up, dollar down. Yesterday, gold rose $4.30. The
dollar fell.

It was a GUDD day, as we used to say.

That is what seems to happen almost everyday, so we
paid it no mind. What we found interesting was the
bond market. In the face of record deficits... a
falling dollar... and GDP growth that is supposed to
be the fastest in 19 years... U.S. dollar bonds should
be collapsing. Instead, they are remarkably strong.

Our colleague, Karim Rahemtulla, offers an
explanation:

"It looks like deflation ahead - full steam! Consider
this: We have had a loose money policy in the US for
almost three years. Full-open on the spigot. Borrow
for 0%, 12 months free financing. 60 months free on
your car. 4% adjustable rate mortgage on your house.
5.5% fixed rate for 30 years. Buy now, pay in 2006.
And people are buying...

"In any normal economic cycle, inflation would have
already reared its head. But, if you look at the
numbers so far this year, inflation is dead. The PPI
just reported negative as did the CPI. So far this
year neither has moved much at all...

"What does this mean? If the Fed is priming the pump
like we have never seen before, and consumers are
buying goods like they are going out of style, where
is inflation? To the contrary, if the Fed ever stops
priming the pump or the consumer cuts back, we will
have deflation across the board. Prices today are
falling in the face of huge demand...

"8.2% GDP and no inflation?? What if GDP was half
that or"only" 3%? Prices would plunge and so would
the market. This house of cards is going to fall
hard. Interest rates will not rise until we see three
or four months of sustained CPI and PPI increases.
Barring that, the pump will be left open - just like
it was in Japan. The country will be awash in cheap
money, but the borrowers will not have capacity left
to borrow...

"I guess the biggest difference between Americans and
the rest of the world is our gluttonous appetite for
everything, including debt. Shorting the market is
becoming more and more appealing daily."

So, we are still headed to Japan, after all?

Eric, your thoughts please...

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

Eric Fry, our man on the scene in Manhattan:

- America is a land of economic marvels: No one saves
money, but everyone spends it. Consumers buy things
with money they don't have... but never seem to run
out. Home prices skyrocket... even though the majority
of Americans can't afford one. Bull markets flourish
on Wall Street, even though the average stock sells
for 35 times earnings. Commodity prices soar, yet the
inflation rate barely budges. And most incredibly of
all, the dollar's value collapses, but foreigners
still buy billions of dollars worth of Treasury bonds
every month.

- Will America's delicious economic fantasy ever end?
Will our legendary privileges ever expire? A Day of
Reckoning may yet arrive. But in the meantime, we
Americans will busy ourselves buying overpriced
stocks, denominated in an overvalued currency.

- Yesterday, the Dow gained a little and the dollar
fell a lot. This regrettably familiar pattern is
inflicting a great deal of pain on those foreign
investors who - so reliably - keep plowing their
hard-earned euros and yen into our financial markets.
The dollar's double-digit drop against the euro since
the end of July has completely erased the Dow's 10%
gain since then.

- The staggering greenback stumbled again yesterday,
to its 10th new record low against the euro since
Thanksgiving! At the end of the New York trading
session, one euro fetched $1.24... and European
tourists, armed with fistfuls of muscle-bound euros,
are flocking to Midtown Manhattan's pricey emporiums.
While strolling through Barney's earlier this week,
your New York editor overheard more French and German
than English.

- Manhattan's retailers and restaurateurs may be
delighted by the boost their bottom lines receive
from the dollar's weakness. But we suspect their
mirth will be short-lived. Receiving more of
something that is continuously becoming worth less is
hardly the sort of"prosperity" that produces wealth.

- The dollar's continuing travails boosted the gold
price by $4.30 yesterday, to a new seven-year high of
$412.70 an ounce. Gold is not the only commodity to
make a succession of multi-year highs. The slumping
dollar, coupled with resurgent demand from China and
elsewhere, is lighting a fire under almost all
commodities.

- Within the last two days, copper prices touched a
6-year high, nickel reached a 14-year high, and
platinum surged to a 23-year high. Hmmm... looks like
a bull market. Incredibly, despite the surging price
of many commodities and the plummeting value of the
dollar, the U.S. inflation rate (as reported by the
U.S. government, at least) remains miraculously
contained.

- The U.S. consumer price index fell 0.2% in
November. Excluding food and energy, prices fell 0.1%
- the biggest drop in 21 years. As the Labor
Department counts inflation, consumer prices for all
goods and services rose 1.8% for the 12 months that
ended last month. Core prices rose 1.1% from a year
earlier, the smallest gain since 1966.

- Either the government doesn't know how to measure
inflation in the real world, or U.S. consumers no
longer consume items that contain natural resources.
You decide... but here's a hint: Even in our highly
productive, Internet-powered economy, the average
single-family home in America contains about 400
pounds of copper.

-"Now we're faced with the odd world," observes
CNN/Money's Justin Lahart,"where the prices of raw
materials have risen sharply for two years, pushing
the Commodity Research Bureau's index of commodity
prices a smidgen short of its all time highs, and yet
inflation, as measured by the consumer price index,
is remarkably muted."

-"You can come up with all sorts of reasons for this
odd divergence," says Lahart;"however, the final
effect is the same: Between rising commodity costs
and consumer prices that are barely budging, many
U.S. companies risk seeing their profit margins
ground to a fine powder."

-"Take the auto industry as an example," offers
Lahart."New car prices fell 2.1 percent over the
past year, according to the most recent CPI report.
But the base cost of many of the things that go into
a car has risen, as has the cost of the energy it
takes to build it."

- But who cares if GM earns a few pennies less per
share because the steel price is rising? This sort of
inflation is invisible to most Americans. The only
inflation most of us care about is the"good" kind -
stock price inflation and home price inflation.

- Wall Street knows all about the good kind of
inflation. New York City's securities firms will pay
out about $11 billion in bonuses in 2003, compared to
$8.6 billion in 2002. The average bonus for the
industry's 161,000 workers in New York City will be
about $69,000 in 2003, up from last year's average
$52,400 - that's a 31% inflation rate.

- But here's a thought: Wall Street's average bonus
may be 31% higher in dollar terms... but it's only 10%
higher in euro terms. Now that's inflation!

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

Bill Bonner, back in Paris...

*** Amazon offers us another great opportunity. The
stock is up 160% this year. Thank you. Thank you.
Thank you. We get a second opportunity to sell the
great"River of No Returns" stock...

*** $146,000 is the average baby boomer's net worth,
according to the Wall Street Journal. About half of
that is in real estate equity. How will the boomer
ever retire? Sell his house? Rent? And hope to drop
dead before reaching 70...?

*** Humility, dear reader. Humility. Whatever
happens, remain humble.

Why? Because it is the only way to keep from making a
fool of yourself.

The thought crossed our minds the other day when our
book made it to the Number One spot on the NY Times
bestseller list. For a nanosecond, we felt the warm
flush of fame... fortune... success...

And then we came to our senses, and realized that we
were still the same pathetic scribbler we had always
been... with no more of a clue about stock prices, the
war in Iraq, church attendance, or the subjunctive
mood than we had yesterday.

The advantage we have over our fellow scribblers - if
we have any at all - is that we glory in our
ignorance. We're proud of it to the point of
arrogance.

We know we know nothing. The other poor schlep thinks
he knows not only what will happen - but what is best
for everybody. It makes no sense, generally, to buy
an expensive stock. But this fellow is sure they're
going up - so why not? He thinks there is some
federal agency in charge of making stocks go up. And
if there isn't, he's ready to vote to establish one.
He's ready to send troops to Iraq because he's sure
he can do a better job of running the place than the
local incompetents... and he knows good and well what
will happen if he doesn't.

And now he's sure that the economy is looking up. It
is improving because his fellow meddlers at the Fed
have twisted the right knobs. And if the economy
fails to response, they'll jerk on some other lever.
One way or another, they'll get it right, he thinks.

*** The know-it-alls got a boost in the New York
Times recently - the leading rag of know-it-all-ism -
in a column by David Brooks, whom we have mentioned
in these pages before. Mr. Brooks cites"two long
economic booms" as evidence that government works.
"They are a 'howling refutation'" says he, of"those
anti-political cynics." He did not mention your
editor by name.

We are a"well-governed nation," concludes the Times
man.

A little humility would have helped Mr. Brooks. The
poor schmuck seems to have fallen into a special kind
of absurdity... both ridiculous and menacing at the
same time. He seems to want to prove that government
is not incompetent. His example serves him poorly; it
shows government not as a fool, but as a knave.

A boom in a heavily indebted, consumer-led economy is
no virtue. It is nothing more than a reckless
shopping spree. He sees the boxes and bags - full of
gadgets and geegaws. He notices the retail clerks
ringing up the charges. He spots the trucks pulling
up to the loading docks... and the ships unloading
their vulgar cargo in Long Beach or Newark. But he is
as blind to what is really going on as a squirrel to
a park mugging. He watches the transaction from his
tree limb, but has no idea what is really going on.

But how will we pay for this stuff? How does this
spending make us better off? The questions never seem
to occur to him.

He is right, of course, that the booms had government
to thank. The Feds set interest rates too low... and
piled up paper money too high. People took the bait;
they borrowed too much, spent too much, and saved too
little. Now, it takes $45 billion per month in
overseas capital - most of the world's savings, in
fact - just to make ends meet. All the assets in
America put together are only worth about $50
trillion. Each year, the nation effectively sells off
another 1% of its net worth - just to continue living
beyond its means.

Instead of fostering a"positive trend," government
not only allowed Americans to ruin themselves in an
orgy of debt, it rented the hall and served drinks!

There is the trouble with thinking you know
something: the range of error is much broader than
the pinprick point of truth. You might even get as
confused and misguided as Mr. Brooks.

Be humble, dear reader; you'll make fewer mistakes.
Besides, it will make you feel soooo superior.

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

The Daily Reckoning PRESENTS: As in life, the
greatest lessons of investing are often forged on the
hot coals of great loss...


LAHARS
By Dan Ferris

Imagine driving up to your house, walking around to
your backyard, and looking into a hole that is so
wide you can't see the other side of it, five times
as deep as the Empire State Building is tall.

That's how visiting the Grand Canyon felt to me, when
I first saw it 15 years ago. I got out of my car,
walked over to the edge, and suddenly I was looking
500 stories down. It dwarfs us all right. It makes us
realize how far down into the earth's crust you can
go before it starts getting hot.

Erosion did all this... amazing... or at least, I'd
always heard that the Grand Canyon was the product of
millions of years of erosion.

Turns out, it probably isn't, though. The other day,
I heard that geologists say the Grand Canyon wasn't
cut out of the desert floor by rivers eroding it for
millions of years. Instead, they believe it happened
very quickly. Hearing this immediately made sense to
me, although I'm not exactly sure why. Maybe it was
simply that I like it when the popular view is wrong.

The event that many geologists believe created the
Grand Canyon is known as a"lahar." A"lahar" occurs
when massive flash flooding sends tons of boulders
rushing downward. One lahar can wreak more
destruction than millions of years of erosion.

I'd forgotten about that odd sensation of staring
down into a hole in the world's floor that was one
mile deep and miles and miles wide. Until I heard
about lahars. I think we should use that word more.
It applies to all kinds of things besides canyons.

What about market lahars? That's what happened in
2000. The Nasdaq Canyon of 2000 - 2002 took that
index from 5048 in March 2000, down to 1108 in
September 2002.

People who held on to their Nasdaq stocks when it
fell apart for three years still aren't anywhere near
where they were in March 2000. They'll never get
their money back. They're living in the Grand Canyon.
And they're unlikely to return to the top again. The
Nasdaq lahar cut through their brokerage accounts and
its effects still overshadow anything that has
happened since.

Terminal illnesses and injuries can be personal
health lahars. My own personal health lahar happened
in 2002, when I had my second back surgery. The pain
in my right leg was absolutely intolerable. Morhphine
barely took the edge off. So I felt I had no choice,
as much as I loathed the idea of them cutting into me
again.

Today, I live free of all that horrible pain. But
I'll never be the same. My right foot and areas on my
right leg are still numb to this day. My leg muscles
are as tight as piano wire, too. Lying flat on the
floor, I can barely raise either leg 45 degrees off
the ground. I can't really run or do anything
vertically jarring because I never know when another
disc will give out on me. I used to run 10 miles
every day when I was in my 20s. Now I walk the dog
around the block and I'm done. I'm only 42.

The first time I injured my back several years ago,
I'd just made a bunch of money on gold stocks. I quit
my job, cashed out my gold stocks, and decided that I
was going to compete in the Guitar Foundation of
America's International Guitar Competition. I started
practicing several hours a day, seven days a week. My
friends heard me play, and said,"Wow. You've really
been practicing. You sound incredible." I felt light.
I ran up and down the hills of Fell's Point in
Baltimore, traveling to and from various guitar gigs
and parties.

The lightness lasted three weeks. Then, I herniated
the L5/S1 disc in my lower back, and that was the end
of my career as a classical guitarist. That's how I
came to write to the readers of Extreme Value, my
investment advisory, every month. A lahar changed
everything, and I had to change what I did and who I
was. I couldn't play guitar anymore, and I'd run out
of money from my gold stock investing days.

I wasn't sure what to do about my back. But I decided
that no lahar was ever going to cut deeply into my
wallet ever again. I believe that the only way to
keep such grand events from destroying your wealth is
to insist upon a margin of safety in every investment
you make.

Money... health... only if you're really lucky do you
lose these things gradually and in small increments,
over long periods of time. Being really smart helps,
but is not required. What's more usual, in my
experience, is that you lose them in single, painful
life-changing swoops. Lahars.

I remember the first thing I ever did as an investor.
I had graduated from college with a music degree, so
naturally I was waiting tables for a living. I worked
constantly, always taking double shifts whenever they
were available. I saved up $4,700 in cash. That was
more money than I'd ever had in one place at one
time.

I bought a brand new, handmade classical guitar from
a guitar maker in Seattle, Washington named Mark
Stanley. I still have it. He did quite a job on it.
He even dyed the wood and made the rosette around the
sound hole himself. No one ever does that. That cost
me $2,700. With the remaining $2,000, I opened a
commodity futures trading account.

Six months later, I closed the account. My broker
sent me what was left: a check for $286 and change.

As with all lahars, I was never the same after that.
For about a year afterward, anytime anyone talked to
me about investing, I either clammed up or shouted
him down. I wasn't much fun, but I eventually got
over it - and learned from it.

Lahars pull everything right out from under you. And
it always feels like they take much more than you
deserve to lose. Of course, as Clint Eastwood said in
the film, Unforgiven,"Deserve's got nuthin' to do
with it."

That's how people felt in September 2002, when the
stock market was in its third straight down year.
That's how I felt after my last back surgery. That's
how I felt when I lost 86% of my money trading
futures.

My greatest fear for my neighbors, and for you and
for anyone is that many, many people are going to
have that feeling of sudden, severe loss, some time
in the next couple of years. The stock market rally
of the past year has them forgetting that they're
still more than 50% in the hole. I can understand
that. I often forget that I have no sensation in my
right foot.

Then I bang it on the end of a chair, and instead of
feeling horrible pain, it just throbs lightly. Then I
remember that I can't really use it the way I used
to. And that I probably never will be able to again.

Investors today are like losers at a craps table.
They started with $10 grand. They were up $100 grand
in early 2000. They lost $99 grand. Now they've got
$2,000 and they're feeling pretty good again. Hey,
they've doubled their money. That's good, isn't it?

I don't know what it is that's going to cause most
investors to lose and lose big, but I am confident
that it will come. That's what I've learned. That's
how life works. You either plan for such cataclysms,
or you get run over by them, usually just when you're
feeling most confident.

That, at last, is what's different about money and
health, as opposed to geology. You can prepare for
what lies ahead. You can ask yourself what you'll do
if the money in your pocket loses all its value, or
if your house loses half its value - and you can take
measures to protect yourself.

Those things might not happen, but something like
them will.

Yours,
Dan Ferris

P.S. Today I do yoga and stretching for my back and
practice Extreme Value Investing for my money. Those
are the answers I've found. It took me years of pain
and suffering to find them. I've often thought lately
that I probably wouldn't trust them as the answers to
my two biggest life challenges if they hadn't
required years of pain to find them. But they did.

And it's because they were the result of"life
lahars," geologic events that changed the shape of my
life's landscape, that I have confidence in them.
They were born of trials. They're the result of the
my greatest losses.

All you can do in this world is prepare for the worst
and do your best. That's what I try to do. That's
what I think you should do, too.

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