EMRATIO – More Back to the Future

There I was, blissing on the latest chart and info posted on Calculated Risk, and the point was made by the commentariat (ht Evil Henry Paulson IIRC) that EMRATIO was the real tell regarding the state of the economy in the US...so I had to update my CIVPART-EMRATIO spread chart, which shows continued widening.

But then I got to thinking about the change in EMRATIO, so I smoothed things a bit by making a 3 Month Moving Average, and then took the Year Over Year change in that to generate the second plot. For rate of change, this recession is in there with the best of them and out does the double dip of the 80's - what it does not have (so far) is duration...

A Beatiful Science Dream Came True On The 20th Anniversary!

Two news items make the bullish case for precious metal palladium stronger.

First, a 20 years old beautiful science dream is finally confirmed this week. The breaking news quickly spreads through the global Medias. Read it here, here, here and here. On the 20th anniversary of the initial Fleischmann-Pons announcement of the original Cold Fusion, and on the same University of Utah campus, scientists from the US Navy SPAWAR lab presented their experimental work that convincingly proved that Cold Fusion is real, at the annual American Chemical Society meetings.

This news brings renewed hope that we may finally have a virtually inexhaustible new energy source to replace the world's depleting fossil fuels, cut carbon emission (Secretary Steve Chu are you listening?), and overcome the world's looming Peak Oil energy crisis.

I have previously discussed the connection between Cold Fusion and palladium. Cold fusion relies on palladium as the metal has a unique property: its extreme affinity to hydrogen and deuterium helps the deuterium nucleus to get closer and fuse into helium, releasing lots of energy. I have followed cold fusion developments, and tracked the research of Pamela Mosier-Boss and colleagues at SPAWAR. I also mentioned the Arata public demo, the first successful public demo, in a previous Seeking Alpha article. Read the heated debates in the comments.

For the first time, the SPAWAR discovery is accepted as real, as no one, not even the skeptics would question the credibility of the experiments any more. The remaining controversy is in the interpretation of the observations. To any one who knows physics, it's conclusive that nuclear reaction must have happened, as neutrons and gamma rays are detected.

No wonder the news quickly spread through the global Medias in less than 24 hours! I can not emphasize enough how important this break through means to humanity's energy future! I immediately called my Congress representatives but found out that they have already noticed the story, and have printed copies sitting right on their desks!

How many investors immediately realize the connection between palladium and cold fusion, and are quick to seize one of the best investment opportunities in a generation?

How many politicians realize the EXTREME DANGER if the cold fusion technology falls into the wrong hands? It can be developed into a new energy source, or a new thermal nuclear bomb! The research can be done with a couple million dollars, the materials are readily available: palladium and heavy water. Such a horrible weapon can be easily smuggled in undetected. There is no radiation. No suspicion could be raised as the heavy water is perfectly drinkable and the palladium is merely a precious metal! A terrorist could also pull a "Cold Fusion Bomb" hoax and the threat must be treated as credible, as we have no way of discrediting such a hoax if we do not grasp the Cold Fusion technology ourselves!

I urge people to contact elected politicians and urge for support of the Cold Fusion research, not only to secure our energy future, but also to prevent this potentially dangerous technology from falling into the wrong hands!

Now back to palladium. One Russian news story makes the metal extremely bullish, in the immediate future. The news suggests that Norilsk Nickel (NILSY.PK), the world's largest nickel and palladium mine, may run out of cash and could be on the brink of shut down. A Norilsk Nickel shut down will have a huge impact on the global supply of nickel, palladium and platinum, as they supply 20% of the world's nickel, 45% of palladium and 12% of platinum. Their shut down could immediately send prices of all three metals flying in the ensuring panic of shortage, particularly palladium.

The latest news that Russian Deputy Prime Minister Igor Sechin was inquiring about Norilsk's finances knocked the stock (NILSY.PK) down as much as 14%. Mr. Sechin demanded an explanation of the 86 billion rubles (US$2.6 billion) share buyback and other matters.

At the end of August, 08, Norilsk Nickel launched a controversial stock buyback program to buy back 7,947,000 shares at 6167 Roubles per share, or 49 billion Roubles (US$2B). The buyback proceeded even as some share holders fought against it in court, denouncing the program for depleting the company's cash reserve and push it to the brink of bankruptcy.

Then on March 11, 09, Norilsk announced that they are re-selling the buyback shares for a mere $355M, getting only 18 cents back on the dollar. It's absolutely hilarious! As commodities collapsed, companies are suspending dividends, issue new shares and do all they can to raise and preserve cash liquidity. But Norilsk Nickel threw cash away in a meaningless stock buyback, and then had to re-sell the shares for a fraction of the cash. WHY?

This story and the Russian Government investigation of Norilsk Nickel finances imply that they could be in a deep financial mess concealed to the public, and that they are desperate for cash, as their mining operation is losing money heavily at current low nickel and copper prices (my estimate is a loss of $0.5B to $1B per quarter). If they run out of cash, they must shut down the mining operations. It will send the palladium price to the moon when that happens.

To seize the opportunity, you can buy any physical palladium metal you can find. Better yet, buy shares of Stillwater Mining (SWC) and North American Palladium (PAL). These two are the only primary palladium producers in the world. You can also buy South African PGM mining companies, like Anglo Platinum (AAUK) and Impala Platinum (IMPUY.PK). Palladium metal can be bought from APMEX and PAMP or other precious metal dealers. I am trying to talk with SWC and PAL to see how they can help average folks to acquire physical palladium more easily for investment.

The FED has unleashed the nuclear option: US debts monetization. It means mass printing of money and inevitable collapse of the US dollar. It makes a compelling case for owning precious metals to safeguard your financial security: Gold, Silver, Platinum and Palladium. I will talk about outlook of US dollar and how to survive the hyper-inflation in the next articles.

Looking at the fundamentals of supply and demand, palladium beats other precious metals hands down. Again I want to caution people against buying Gold ETF (GLD) and Silver ETF (SLV), as I do not see convincing evidences that physical metals actually exist to back these two ETFs, and the silver bars serial number list contains lots of red flags to be trusted. If you like silver, you'd better owning physical silver or silver mining stocks like SSRI, PAAS, HL and CDE.

Some thought on what looming hyper-inflation would do to banks. I believe that NO BANK can survive the hyper-inflation, regardless of how sound their balance sheets look. The reason is simple: Why would any one leave money in a bank if the currency is losing value rapidly? All banks will fail if people are withdrawing cash en mass. But please do NOT rush to your bank to withdraw your cash tomorrow. I do NOT want to cause bank runs. You still have enough time to gradually and orderly withdraw money from your bank and put the money into precious metals and other valuable physical assets.

I am looking for short opportunities in all bank stocks. Jim Rogers said he was shorting JP Morgan (JPM), which looks to be a good choice. Some other bank names come to consider: Bank of America (BAC), Citibank (C), Wells Fargo (WFC), Bank of New York (BK). All banks ultimately will fail or be nationalized. There is absolutely no investment value in any bank. Bottom line: There can be NO healthy banking industry without a sound monetary system, just like no fish can live without water. But too many people have already shorted banking stocks. In light of the on-going short squeeze in financial stocks, it is better to wait patiently a little longer, before entering short positions in banking stocks at higher price levels.

Full Disclosure: The author is heavily invested in SWC and PAL, and shipping stocks like EXM, DRYS, EGLE, TBSI, GNK, NM. I own silver mining stocks SSRI, PAAS and HL. I do not currently have short positions in banks but am waiting for opportunity to short.

Absolute Confidence?

Not just the Chinese government, but every investor can have absolute confidence in the soundness of investments in the U.S.
– President Barack Obama, March 14, 2009, as reported in Bloomberg.

Statements like this one are causing me to lose confidence in the Obama administration’s economic policies. The particular investments about which the Chinese have been concerned are US Treasury securities. Absolute confidence in US Treasury securities is exactly what we don’t need. Absolute confidence in these securities is precisely the problem. The problem – for the US, anyhow – is that everyone wants to hold US Treasury securities instead of investing their money in productive activities (or spending it on the output of productive activities).

This is not just true of Americans; it is true of the world, including the Chinese. China has four choices:
  1. It can buy US Treasury securities.

  2. It can buy other US securities that represent productive uses of money.

  3. It can buy non-US securities, in which case the value of the dollar will fall and make US products more attractive, thereby encouraging Americans to invest in productive activities.

  4. Or it can buy no securities at all, in which case the value of the Yuan will rise, making non-Chinese products more attractive, thereby encouraging non-Chinese (including Americans) to invest in productive activities to replace the Chinese products that have become more expensive.
China has been choosing the first of these four options, and if it has “absolute confidence in the soundness of investments in the US,” then it will continue to choose that option, and Americans will continue not to invest in productive activities.

There is a common but misguided belief – to which President Obama, as one may surmise from his statement above, apparently subscribes – that a loss of confidence in US assets would have disastrous consequences for the US economy. In a boom time, or an inflationary time, that would be the case, but in a deflationary environment like the present, the consequences are more likely to be good. The Wall Street Journal, as an example, gives a typical statement: of the “loss of confidence would be a disaster” point of view:
In the worst-case scenario, a significant new aversion to U.S. investments could drive down the dollar and drive up interest rates, worsening the U.S. recession.
First of all, driving down the dollar would not worsen the recession; the direct effect would be to mitigate the recession by making US products more attractive. As for rising interest rates during a recession, that would indeed be a worst-case scenario, but it would not be the result of the aversion to US assets. It would be a result of a bad US policy response to that aversion.

My logic should be fairly clear:
  1. The Treasury has a choice whether to finance long-term or short-term

  2. The Fed has a policy – until further notice – of holding the federal funds rate below 0.25%, which policy requires it to purchase enough T-bills to keep short-term US Treasury rates near zero.

  3. Therefore, there is no limit on the Treasury’s choice of financing. It can issue as many or as few long-term securities as it chooses. What it does not finance long term, it will be able to finance short term at a near-zero interest rate, since the Fed will purchase enough T-bills to assure this.

  4. Therefore, the Treasury controls the supply of long-term Treasury securities.

  5. Therefore (assuming that the demand curve for such securities has the usual downward slope in the relevant range), the Treasury controls the price of long-term Treasury securities.

  6. Therefore (since bond yields – i.e., interest rates – depend inversely on prices), the Treasury controls the interest rates on its long-term securities.

  7. During a time of potentially deflationary recession, it will not be in the nation’s interest for the Treasury to allow interest rates on its long-term securities to rise, nor will it be in the nation’s interest for the Fed to allow short-term rates to rise.

  8. If they do so – whether or not they do so in response to a drop in demand for those securities – it is simply bad policy. Bad policy is not the result of declining confidence in US securities; it is the result of bad choices by policymakers.
So which interest rates are we talking about? Short-term Treasury interest rates? Those are controlled by the Fed and will not rise unless the Fed allows them to rise. Long-term Treasury interest rates? Those are controlled by the Treasury and will not rise unless the Treasury allows them to rise.

Or are we talking about private sector interest rates? Corporate bonds, as an example, are priced according to risk spreads over Treasury bonds. Those risk spreads depend on the amount of additional risk involved in owning corporate bonds and the amount of compensation that investors require for accepting that additional risk. The key word here is “additional.” A loss of confidence in US assets would most likely make US assets in general more risky. But how would it increase the additional risk of corporate bonds relative to government bonds? If anything it would do the opposite: the loss of confidence would weaken the dollar, making it easier for US corporations to sell their products, thereby increasing their profitability and their creditworthiness and reducing the additional risk from owning their bonds.

So – subject to exogenous changes in risk and in the price of risk – private sector interest rates will not rise either, unless policymakers allow them to rise. The only good reason to allow rates to rise would be if excess demand begins to lift the US out of its deflationary recession and to threaten it with excessive inflation – a scenario inconsistent with “worsening the US recession.” Loss of confidence in US assets is not the worst-case scenario; bad policy is. Under current circumstances, encouraging excessive confidence in US Treasury securities is itself an example of bad policy. It’s not the worst case, but it’s far from the best.

DISCLOSURE: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management.

Port of Los Angeles TEU Volumes Year Over Year

Over at Calculated Risk yesterday there was a post on the TEU traffic at the Port of Los Angeles, with lots o' discussion on what was going on. I prefer the Year Over Year view of this sort of data, which accounts for seasonal variability in the month to month changes. This plot is the rate of change for the YoY (3 month MA), so the absolute level of TEU volumes is still climbing if the plot is above 0%. Below 0%, there is an absolute decline in YoY TEU volumes, though the MoM number could still be up (just lower than the same month in the previous year)

  1. Total (In + Out) TEU volumes began declining in absolute terms prior to the start of the recession, have been doing so continuously since that start, and recently began moving sharply downward

  2. There was a period of flat to mild decline in YoY TEU volumes in 4Q2004 to 3Q2005

  3. In the last recession (2001), while the rate of growth significantly declined, it did not go negative (3 month MA of TEU volumes)

The Calculated Risk post:


Targets vs. Projections

There is a widespread view that the Fed’s “longer run projections” for the inflation rate can be interpreted as targets that the Fed will attempt to hit. The logic goes something like this. Suppose (as we shall presume) that the Fed has some target for the inflation rate but that it does not announce that target explicitly. The Fed will do its best to hit that target. It may not hit the target exactly: it may undershoot the target, or it may overshoot the target. Since the Fed is aiming directly for the target, the Fed is equally likely to undershoot the target by any given amount as to overshoot the target by the same amount. Therefore the target itself is also the Fed’s best “average” guess as to what the actual inflation rate will be. Thus, if the Fed makes a forecast (or a “projection”), we can conclude that the forecast is equal to the target.

Unfortunately, there is a flaw in this logic. The fact that the Fed is aiming directly for the target does not imply that the Fed is equally likely to undershoot as to overshoot the target by any given amount. If you’re driving directly down the middle of a lane but the right side of the lane is more slippery than the left, you’re more likely to skid to the right than to the left. From the Fed’s point of view, the possibility of undershooting its target should be considered more “slippery” than the possibility of overshooting the target.

If the Fed overshoots its target, it can tighten policy and push the inflation rate back toward its target, just as, if you start to veer to the left, you can turn the steering wheel to the right and get back in your lane. If the Fed undershoots its target, it may find itself in the same sort of liquidity trap that it is in today. In that case, policy may become ineffective, and the Fed may not be able to correct the undershoot. If you skid to the right, where the road is icy, then turning the steering wheel to the left immediately will not help you get back in your lane. So while your “target” is the middle of the lane, an “average forecast” would have to account for the fact that you’re more likely to miss that target on the right than on the left. Similarly, the Fed is more likely to undershoot its target than to overshoot.

So a target and a forecast are not the same thing. If the Fed were to release both a set of targets and a set of forecasts for future inflation rates, the targets should be higher than the forecasts. And if (as it has in fact done) the Fed releases only forecasts (or projections) and not targets, then, if we are to take the Fed at its word, and if the Fed agrees with the logic of my last paragraph, then we should conclude that its implicit inflation targets are higher than the inflation rates that appear in its projections.

Unfortunately, even if the Fed does agree with my logic, I don’t think we can take the Fed at its word. My impression is that the Fed is playing a language game in which all parties have implicitly agreed that the word “projection” will be used to mean “target.”

If this is true, then it’s bad news, because it means that the average expected inflation rate over the “longer run” will be less than the Fed’s projected “central tendency” of 1.7% to 2%. And more specifically, it means that the risk of deflation will never be entirely gone. If you’re on a four-lane highway and the right shoulder is icy, you’re better off driving in the left lane, where there is minimal risk of veering onto the icy part. But the Fed has declared its intention to keep driving in the right lane – at less than 2% inflation, right next to that icy place where a severe recession (much like the one we are currently experiencing) could render policy ineffective.

DISCLOSURE: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management.

U-6’s Disturbing Seasonal Trend

U-6 non-seasonally adjusted has become my weathervane for employment distress, and there are two disturbing trends (in addition to the value being too damn high at 16%!):

  1. The rate of change reaccelerated (the second derivative increased) - we need to see that start to come down or at least stabilize for that light in the tunnel be daylight and not train.

  2. The seasonal trend should be for the absolute value to decline going into the first quarter, but it is not - it is increasing - not good.

This is what I am talking about - unfortunately, the time series is somewhat limited for U-6 - but as you can see, even through the last recession the seasonal pattern of a Month Over Month decline held. Things are different this time.