Market Watch - February 28, 2011
The market remains overpriced. There is no reason to be invested in either the stock market or the bond market. Bonds pay very little. And the 12 month demand for cash for bond refinancing, and for financing new bonds issued to cover current government deficits, is so great that interest rates must rise. When interest rates rise, bond prices go down. There is no reason to believe that bonds won't crash exactly as they did in the 1980s from the run up of interest rates during that decade. Pressure on bonds is greater than it was in the 1980s.
The safest investments today are cash, and gold and silver. Cash will give the investor flexibility when opportunities finally arise. Gold and silver are in long-term bull markets. Gold and silver are particularly good investments in an environment like today's. As leading currencies like the euro and the dollar continue to decrease in value, gold and silver are going up in price. Gold and silver have a monetary history of 5000 years. No paper currency (called fiat money) like ours has survived more than an average of 40 years. 39 years ago, when Nixon closed the gold window and refused to redeem dollars for gold, the U. S. became a fiat currency nation. There was nothing backing the dollar of a commodity nature (gold, silver, etc.) as required by The Constitution. Without an anchor like gold and silver on a currency, history points out that politicians will do with it as our politicians are doing today. They will ruin the nation's currency with war, debts and welfare growth.
Question: The market is up 700 points this year, about 6%. With only two months of our current calendar year gone, the market is increasing at the rate of about 30% annually. What could be better than this?
Answer: There is no fundamental reason for the market to be at these levels. The latest round of Quantitative Easing has put cash in broker's hands. This has caused speculation. Speculative trading has caused the market to go up in value.
Additionally, there is a market for high grade stocks because of the fear of pending inflation. Companies like Abbott Labs, Coca Cola, Johnson & Johnson, and Sysco Corp. that are A+ rated stocks that pay good dividends, are seen as "hedges" against currency inflation because they operate all over the world in every currency.
The general market, however, is not priced for gains—it's priced for losses. A good barometer is the dividend yield on the Dow Jones Industrial Average. The annual dividends paid on the Dow the last 12 months were $288, representing a 2.35% yield, on a Dow price of 12, 268 points. The average Dow dividend yield over the years is 4.3%. If the market was selling at only the average Dow yield of 4.3%, instead of 12, 268 points, the Dow would be priced at 6,699 points. That is 45% less than it is selling for currently. There is a continuous reversion to the mean in economics. As the math shows, the market is in a posture to potentially hurt investors badly.
Question: Why does Market Watch mention that cash could be a better investment than bonds when cash pays less in yield than bonds pay?
Answer: Bonds pay so little because the Federal Reserve System has the power to set short term rates. Consequently, short term rates for banks borrowing from the FED are very low—about ½ of 1%. Since cash is scarce (ask anybody!), it's logical that interest rates would be much higher. Long-term rates cannot be manipulated by the Fed because long term investors will only accept market rates for long-term risk. Short term rates, however, are set low by the Fed so they can continue to finance ballooning government deficits. Staying in cash may not "pay well", but the cash is not at risk, either.
Question: How does the Fed actually "finance" government debt?
Answer: Deficits are financed thusly:
| 1. | The Fed prints $1.6 billion of new money (this year's expected deficit); |
| 2. | Cash is given by the Fed to the U. S. federal government who uses the cash to pay bills; |
| 3. | The Fed sells the bonds issued to them by the U. S. government to banks. The notes, most likely, are 10 year notes that pay 3.5% annually to the investor. |
| 4. | The bank lacks the cash to buy, let's say, $10 billion of these new notes, so the Fed "loans" the banks short term money at a cost of ½ of 1% annually |
| 5. | The bank pays the Fed annually at the rate of ½ of 1% ($50 million annually for a $10 billion loan). The bank "makes" $350 million on the $10 billion investment in treasury bonds. With some fancy computer entries, and no investment risk, the bank books a $300 million profit; |
| 6. | While the public does not generally realize this, the Fed, and the U. S. government, are doing this to rebuild bank's liquidity. While these are only "paper profits", the interest costs get paid annually by the U. S. Government. The U. S. Government can't afford the interest payments so they borrow the interest payments from the Fed (see #1 above and start cycle again). |
This is an example of wealth being printed, and not produced. It is occurring while federal debt is increasing at an unbelievable $55,000 per second. This government of ours, at the end of the current fiscal year, will have federal debt in excess of $14 trillion, equal to our GNP, real banana republic numbers. A few weeks ago, the two top ratings agencies, Moody's and S & P, lowered Japan's credit rating and issued a warning on the U. S. dollar. Imagine the cost to U. S. taxpayers if we lose our AAA credit rating. That would cause interest rates to rise, too, because investors would want to be paid more for the greater risk of buying U. S. Treasury Bonds.
Question: With gold and silver up so much over the last ten years, many Wall Street and business journal articles are saying gold and silver are in a true bubble. These articles suggest gold and silver are set up for a significant decrease in price.
Answer: The last time we went into almost any business district in any city in this country and saw people holding up signs all over the place saying that "we buy gold" was in the early 1980s. The question is why? The answer is that there are so many U. S. dollars out there around the world that are no longer considered a "store of value". Countries, and individuals, holding dollars want to trade them in on something that has lasting value. Dollars are used all over the world as currency. The dollar's rapid decrease in value has increased demand for gold and silver. There is no evidence that this trend will stop.
Market Watch previously published that if gold was traded for all of the U. S. coins and paper currency we have issued (M-1 money supply), gold would be re-priced to $3500 an ounce. If our entire M-3 money supply were to be redeemed in gold, gold would be valued in excess of $55,000 an ounce. These numbers are staggering. Even more staggering: from 1939 to 1949, the M-3 money supply (total money supply) of the United States could be redeemed in full for $38.50 an ounce. We had that much gold in U. S. vaults. Gold moves towards the strong. We were economically strong then, and we are now getting weak. The largest purchasers of gold in the world are China and India, respectfully. They are purchasing gold and silver because they hold so many dollars in their reserves. They do not trust the dollar to maintain its value.
Conclusion
If you had two grandchildren given $10,000, which grandchild would be better off in ten years: the one to whom was given $10,000 in gold and silver, or the child to whom was given a $10,000 check? (If any grandchildren out there are reading this, lobby for the 10 grand in gold and silver.)
In ten years gold has gone from under $300 an ounce to $1400, an increase of more than 450%. Silver is up much more than that. The U. S. dollar however has lost 21% of its purchasing power in the last ten years. Stocks are over priced, bonds are heading south, and gold and silver continue to go up. Cash pays very little, but it "feels good".
The cautious investor will stay with "feel good" cash. Adding to gold and silver investments is wise if one feels there will be continuous future increases in federal debt levels. Increases in the price of gold and silver occur as the country's debts increase. As U. S. Debts increase, the purchasing power of the dollar decreases. Simple math indicates the bull market in gold and silver has a long ways to go.
Caveat Emptor
George Rauch
February, 2011
