The Daily Reckoning - Gunships and Opium (Dan Denning)

verfasst von Firmian, 07.07.2004, 19:50

-->Gunships and Opium

The Daily Reckoning

Milford, Nova Scotia

Wednesday, July 07, 2004

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*** Obnoxiously accurate forecasts...and golf!

*** Three Transsexuals, two gay men and a madam...

*** Nova Scotia real estate, Euro-snobs, espressos, sock-
juice and more!

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Again, we leave the news to Baltimore while we enjoy our
vacation. More from the woods of Nova Scotia...below.

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Tom Dyson, from the mean streets of Baltimore...

- Caution. We have now entered into 'Red Light' Mode.

- At one point last weekend, while we were doing our best
to observe your Independence Day, we found ourselves
sitting on a curb in"the block" (downtown Baltimore's less
glamorous side) drinking cheap red wine with three
transsexuals, two gay men and a madam...but, we digress...

- The 'red light' we refer to today has nothing to do with
the shadowy clubs and street corners of Baltimore's seedy
underbelly, but a stock market 'sell' signal. You see, dear
reader, we here at the Daily Reckoning will venture far and
wide to deliver you the goods...including territory
forbidden to brokers, market makers and stock market
shills. 'Sell', we say, and here's why:

- World-renowned analyst Dr. Steve Sjuggerud, editor of the
industry's fastest growing newsletter, True Wealth, has
created an indicator he calls the 1-2-3 stock market model.
The indicator moves into 'red light mode' when 1) stocks
are expensive and 2) the Fed is raising rates.

- On Wednesday, the second piece of this rather simple
puzzle fell into place; Greenspan hiked the short-term cost
of money by a quarter-point. As for stock valuations, well,
we needn't tell you how expensive they are - loyal readers
will already be aware of the rich valuations - but we will
tell you anyway.

- This week Barron's lists the market's P/E at 21.6. Dr.
Sjuggerud considers fair value at a P/E of 17, making
stocks 21% overvalued at today's prices. In order for the
indicator to move back into yellow light mode, the Fed
either needs to lower base rates or leave them unchanged
for at least six months. Or stocks must return to fair-
value."We are likely more than a year away from either of
these," says the obnoxiously accurate forecaster,"it's red
light mode, get used to it."

- Astute readers will be wondering how this indicator has
fared in the past. Well, the results are, of course,
excellent. Going back 80 years, there were 25 instances
where stocks were in red light mode for at least 3 months
on the trot...stocks fell on 20 occasions at an average
rate of 14% a year.

- When Dr. Steve Sjuggerud speaks, the markets
listen...apparently. Like clockwork, yesterday, all three
major indices had the stuffing carved out of them with more
ferocity than a cosmetic surgeon with a grudge. The Nasdaq
received the brunt of the knifing - traders chopped off
over 2.1% for a loss of 43 points on the day and moving the
index below 2,000 for the first time since June 22.

- It was the most painful drop in tech stocks since
September 10th 2003. The blue chips fared better, but only
slightly; the Dow sustained at 63-point fall closing the
session at 10,219, while the S&P sagged to a 9-point
deficit, a loss of 0.8%.

- Gold dropped nearly $6 in yesterday's trade, falling down
to $392. But as your editor added the finishing touches to
his notes this morning, he noticed that gold had already
regained the loss and is now up over the two-day period.
The barbarous relic currently hovers at $398.9 and the
pound, the euro and the Japanese yen are all making sharp
moves to the upside as we write...

- Another obnoxiously accurate forecaster with whom we've
also had the opportunity to hit the links, James Boric, is
on a roll. He has now hit 8 consecutive winning trades
using his 'momentum, strength and trend' system. James
didn't want us to advertise the fact - and jinx the streak
just as he selects his ninth trade today - but we know
better.

- We don't understand his system, and we couldn't tell you,
even if we did, but it works...6 of the 8 trades have been
put options, betting on over-valued companies set for a
fall. Since the streak started on February 24, our Penny
Stock Fortunes editor has averaged 36.7% gains. Your editor
keeps pestering James,"What's the next one going to be?"

-"Well... I'm not sure yet," he keeps saying, clutching a
ream of data print-outs within his arms,"I've spent all
morning creating my short list from over 70 initial
candidates and now I have to run the final three stocks
through my final six tests and screens..."

- We also note that friend...accurate, and not so obnoxious
forecaster...John Mauldin, who has not invited me to play
golf yet, has hit #9 on the N.Y. Times Business Best Seller
list with his book 'Bull's Eye Investing'...

- And the purposefully obnoxious...and, er, wholly
accurate...Mogambo Guru, who we are sure is lethal on the
golf course, is quoted at length in this week's issue of
Barron's. See the Market Watch section...

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Bill Bonner, back on the road...

*** Homeland Bound...

If there is a real estate bubble in North America, it has
not expanded out to Canada's maritime provinces. Unlike
the hot markets of California and New York, here in Nova
Scotia, the property market is as cool as an abandoned
corpse. Many houses appear to have not merely been taken
off the market, but simply forgotten by it. Grass grows
high on the lawns. Trees begin to poke through garage
roofs. And prices?

Pity the poor man who tried to get rich leveraging property
in the Annapolis Valley. On George Street, in Annapolis
Royal, a realtor's office offers what appears to be a nice
3-bedroom, two bath Victorian-era house near the center of
town for only $129,000 - Canadian dollars. That's less
than $100,000 US dollars. Outside town, a farm of 130
acres, including a 4-bedroom, 2-bath house and several
outbuildings, is offered for only $199,000 Canadian. The
farm is situated on the neck of land between St. Mary's bay
to the east and the Bay of Fundy to the west - with
frontage on both.

Nova Scotia must be the West Virginia of Canada. There is
no sign of luxury or waste. People drive old cars, often
old pick-up trucks with plenty of rust. If they are
spending themselves deep into debt, there is no sign of it.
Nor is there any need for it - they are already poor, or so
it appears.

Then again, a man would have a hard time spending himself
into the poorhouse around here; there is nothing to spend
on. There are no luxury shops. The only entertainment is
movies - shown only in the summer time and only on Thursday
and Friday nights. The cafés in Annapolis Royal are
modest. You'd have to eat a dozen meals a day to run up a
decent tab. You can't even get a cup of designer coffee.

"Do you have café latte," we asked.

"Nope."

"Do you have espresso?"

"No."

"How about cappuccino?"

"No."

"Well, what do you have?"

"Just regular coffee."

"Well, is it strong?"

"No."

"We'll have tea."

One of the telltale marks of a returning American euro-snob
is that he can't bear American coffee. It tastes, say the
French, like 'sock juice.' They regard it as not merely a
sign of different tastes, but a sign of laxity…of a lack of
discipline and rigor…a cultural failure. A character
weakness. Serious people do not drink weak coffee, they
believe.

We came up to Nova Scotia out of habit. When we lived in
Maryland, we used to drive up for a week or two in the
middle of July to escape the heat. This is also the
homeland of Elizabeth's grandparents...whom we came to
visit every summer.

Though the grandparents have gone to their eternal rest,
this area of Nova Scotia lives on unchanged. Instead, it
is we who have changed. The place seems smaller, simpler,
and more rustic than we remembered. Besides, Paris was
chilly when we left. Here, it is even chillier; we get no
sense of relief.

The weather here is often cold, even in July; yesterday, we
sat around an open fire reading...hoping the sun would come
out. Still, our family holds on to a sentimental
attachment, like an old chair that came from a favorite
aunt.

"In the United States," wrote de Tocqueville,"the more
opulent citizens take great care not to stand aloof from
the people; on the contrary, they constantly keep on easy
terms with the lower classes: they listen to them, they
speak to them every day. They know that the rich in
democracies always stand in need of the poor; and that, in
democratic times, you attach a poor man to you more by your
manner than by benefits conferred."

Of course, the 'democratic times' de Tocqueville saw were
those of the republic's humble beginnings. Today, America
is an uneasy empire, with millions of opulent citizens in
its debt-drenched homeland.

We note in passing that the rich have gotten a lot richer
in recent years; their financial assets have gone up. The
poor, meanwhile, have made no financial progress in more
than 30 years. And as reported in this space just
yesterday, last year merely extended the trend - real wages
rose less fast than inflation.

For the present, the rich and the poor are on speaking
terms. But grievances are building up. Manufacturing jobs
are disappearing. Instead of investing their money in new
factories and new industries, the rich are putting their
money overseas. Even Warren Buffett is moving cash
offshore. Foreign holdings by High Net Worth Individuals
doubled in 2003.

Meanwhile the poor indulge themselves in the illusions of
consumer debt. As long as someone is willing to lend them
money so they can buy a new SUV, they seem happy.

But interest rates are probably beginning an epic trend to
the upside. And soon the sunny days of debt expansion will
turn into the dark night of debt repayment - at higher
rates. We don't know exactly what will happen, but we
doubt the poor will like it.

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The Daily Reckoning PRESENTS: A war over Taiwan is not just
some kooky conspiracy theory, but a credible scenario.
First, we published a guest essay by Marc Faber, called
Painful Resolutions, published on April 29 2004. Now our
own Dan Denning takes up the story...


GUNSHIPS AND OPIUM
by Dan Denning

On a strange geopolitical note, the Pentagon announced this
week that the Navy will be deploying seven aircraft carrier
groups around the world in an operation designed to give
the"ability to provide significant combat power to the
President in response to a national emergency or crisis."

The Navy calls it part of its"surge tactics," the ability
to project a lot of force in a lot of places at one time.
Initial reports were that all seven carrier groups would be
deployed near the South China Sea. If that were true, it
would be a not so subtle attempt to tell China that the
U.S. means business about Taiwan.

It would also be a big strategic gamble, putting that many
inviting targets in such close proximity to lethal anti-
ship missiles.

But it turns out not to be true. That is, not all seven
groups are going to be in the same region as an
unprecedented"show of force." The Navy's purpose is to
conduct joint operations with other countries and project
U.S. force in five separate theaters at the same time.
There may be more than one carrier group near China. But
there assuredly won't be seven in the same theater.

If anyone steals the election in 2004, it's going to be the
Chinese. China may be very close to picking a time to go
after Taiwan while the U.S is preoccupied in Iraq. That
might seem rash. But think about it in terms of winning
without fighting.

Question: When could the Chinese attack Taiwan without
provoking a U.S. response?

Answer: At a time when political pressure constrains the
U.S. from responding. Bush sending carrier groups into the
straits of Taiwan weeks before a general election? Is the
American media mature enough to see that as a legitimate
response to honor our agreements with Taiwan?

Or would critics be right in calling it election year
brinkmanship? Either way, it would be a bold challenge and
the last thing the President needed at such a time.

It could also happen early in the next term of either
President. The same logic applies. Challenge early and get
your opponent on his strategic heels.

If this sounds nuts I understand. Do governments really
think this way about one another? Yes, apparently, they do,
thus operation Summer Pulse. You'd be hard pressed to find
two more paranoid defense establishments in the world than
the American and the Chinese.

It's hard to imagine, with $124 billion in trade between
them and their economic futures now intimately intertwined,
that America and China would go to war over Taiwan. But
both appear determined to do just that if they feel they
have to. Let's hope they don't have to.

Even if the Americans succeed in staring down the Chinese
this summer, they won't have won any points with Chinese
policymakers. China has seen this kind of thing before. And
it's still bitter about it.

When I was in the Forbidden City, none of the relics or
artifacts were there. Why? They're all in Britain and
France.

In the 1830's Britain's East India Company was exporting
tons of opium to China. According to Wikipedia.com, it
traded the opium for tea and manufactured goods. As you
might expect, all that opium created a lot of addicts. The
imperial government (Qing Empire) made opium illegal in
1836 and began closing down the dens.

And here's an interesting note if you like looking for
historic parallels. According to an essay posted on the
Washington State University website, one of the big
grievances that caused the war was that the British refused
to hand over British citizens charged with crimes in China
to the Chinese legal system. The British considered China's
legal system barbaric. The Chinese, naturally, resented
having foreign soldiers exempt from domestic laws.

The British spent two years running their gunships up and
down the coast, bombarding the Chinese into submission. And
in 1942 the Treaty of Nanking reopened the opium trade and
exempted British citizens from Chinese law (it's all
sounding so familiar.) Two years later France and the U.S.
also signed similar treaties with China. The war planted
historic seeds of resentment that still flower today.

It's probably hard for English and American students of
history to understand this kind of resentment, England and
America never having suffered occupation and military
defeat in the modern world. My point in bringing this whole
interlude up is that China is just now nursing a national
sense of growing power. Trying to subdue it by reenacting
the kind of diplomacy that's recalled as a national shame
at the hands of the West is likely to fire up even more
Chinese nationalism. It's likely to provoke the Chinese
into"doing something" about Taiwan.

Perhaps the strategy is to put military pressure on China
and hope that it leads to cracks in the political façade.
The first opium war forcibly opened up China for free trade
(especially for opium). A new war broke out in the period
from 1856 to 1860. This time, the British and French united
under one command and pressed for even more advantage. They
were joined by Russia and the United States (which was
about to have problems of its own.)

In the second opium war the Western powers succeeded in
driving the emperor from his palace in Peking and occupying
the city. The eventual settlement of the war opened up ten
more Chinese ports to trade, made it permissible for
foreign ships (including warships) to navigate the Yangtze
river, allowed Chinese workers the right to work overseas,
gave foreigners the right to travel inside China, and
granted Christians the right to own property and
proselytize.

The West is still trying to get China to open up, but on
Western terms. And we're still using guns to do it. The
Chinese, for their part, are rolling back political
freedoms in Hong Kong and rattling sabers at Taiwan.

Who's going to win this time? And will it take more than an
economic war to find out?


Regards,

Dan Denning
for The Daily Reckoning

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• The Daily Reckoning - Gunships and Opium (Dan Denning) - Firmian, 07.07.2004, 19:50