Awaiting the Final Bubble
London, England
Tuesday, May 27, 2008
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*** Why an 8th rate cut won't matter...remembering on the Great Moderation...
*** A recession by the numbers...two things you don't dare criticize...
*** Guilty by association and dropped under the campaign bus...a modern way to feel like a 16th-century heretic...and more!
Yesterday, markets were closed in both the United States and Britain. Still, here at The Daily Reckoning 's mobile command post, we continued our lonely vigil. What are we waiting for? What are we watching for?
Ah, dear reader...just a little dignity, a little grace, a little courage and beauty. That's all we ask. Can we find it on Wall Street? In Washington? In politics or economics? We hope so, because that's all we have to work with here at The Daily Reckoning .
Oil went up yesterday. Asian markets fell – with Japan taking its biggest hit in six weeks. And the dollar fell. Speculators are beginning to bet that the Fed will cut rates for an 8th time; that's the world on the street. As we predicted, the first 7 cuts have done wonders for the prices of oil, gold and commodities...but little for the real economy. Oil has gone up 60% in six months...putting big pressure on U.S. household budgets. Now, instead of taking the hint – that it's time to go in the other direction, by raising rates to head off rising prices – speculators think Ben Bernanke will continue battling deflation with further rate cuts. Maybe, maybe not...but our guess is that it doesn't matter. Even if the Fed raises rates, it is unlikely to raise them enough to block the consumer price inflation already in the pipeline.
In economic theory, the supply of money is the key to prices. Prices should remain more or less stable when the supply of money increases at the same rate as the supply of goods and services. But in the last 15 years, the U.S. money supply increased about twice as fast as GDP. The surprising thing was that prices didn't rise. That was the period known as the Great Moderation. As reported here yesterday, food prices only increased at a 2.5% annual rate...even though money supply, MZM, was going up at nearly 9%.
We have given our opinion as to why consumer prices did not go up. We guessed, too, that those trends that labored so hard to hold them down have now walked off the job. Prices now seem to be adjusting to a higher money supply, with food up 4% last year, officially. Unofficially and anecdotally, consumer prices are rising at about 10% per year.
But while consumer prices were stable during that 15-year period...asset prices frequently went into bubble territory. And now, we await the Final Bubble, dear reader...about which we will have more to say later in the week.
In the meantime, the winner of the Enron Prize, and former headman at the Fed, Alan Greenspan, is in the news this morning. The Financial Times reports that he believes "there still greater than 50% probability of recession."
Warren Buffett, on the other hand, says recession is already a fact of life. And he says it will be "deeper and longer that people expect."
The old timer's definition of a recession was 'when your neighbor loses his job.' When you lose your own job, it's a depression. How many people have lost their jobs in this downturn? Well, for the answer to that question we look to the same people who give us the official inflation numbers – the apparatchiks at the U.S. Labor Department. Therein, of course, hangs a tale...and we will let Dana Samuelson of Danagold tell it:
"The average person judges a recession mainly on employment. If jobs are available, then the economy is holding up. If jobs are scarce, the economy is poor. By that standard, the economy is really struggling, with payrolls down in each of the first four months of the year. But the headline figures, again, don't reflect the lived reality of Americans. At 5.0% in April, down from 5.1% in March, the current BLS unemployment rate is relatively low by historical standards. Yet the number of jobless Americans of prime working age, that is, men aged 24 to 54, is historically high at 13.1%. Most of these people don't qualify as unemployed but they are nonetheless out of work.
"Why don't these would-be workers show up in the headline statistics? Mainly because the government's definition of the unemployed includes only people who do not have a job, have actively looked for work in the four weeks preceding the survey, and are currently available for work. But it excludes the self-employed, 1099 workers who can't get enough contracts, those working part-time or on commission only, and the under-employed (like real estate agents waiting tables or mortgage brokers bagging groceries). It also doesn't count those who've given up looking for work altogether – a category known as 'discouraged workers,' defined as persons not currently looking for work specifically because they believe there aren't any jobs available for them. Some analysts say this particular group of jobless Americans – who believe their prospects for finding a job are getting ever dimmer, yet who don't figure in the computation of the unemployment rate – represent the nation's dire job situation. According to John Williams' Shadow Government Statistics, the primary source for unbiased economic data, if adjusted for 'discouraged workers,' the actual unemployment figure for April rose to 13.1%, up from 13.0% in March. Now that's recessionary!"
Real inflation at 10%? Real unemployment at 13%? Maybe. But we have not quite seen the fall off in consumer spending that these numbers suggest...
...stay tuned.
*** Since we have so little market news to report to you, we will take our quest for truth and beauty to other areas: global warming and the children of Israel for example. Both are touchy issues. In Europe, if you say you are skeptical of global warming, they look at you like a lion at a Christian. In America, you can say almost any nasty thing you want against Arabs...but if you are planning to run for public office, don't dare to criticize Israel.
We begin by telling a story that a Jewish colleague told us yesterday.
"You really have to be careful to maintain good relations with your neighbors. That's something my family discovered in WWII. My father was just a little boy in Paris when the war broke out...and then the French surrendered. You know, France was divided in two...there was the zone occupied by the Nazis and there was the unoccupied zone to the South. Since they were Jewish, they figured they'd sneak across the line and once they got to the unoccupied zone, they would just keep a low profile, not mention to anyone that they were Jews, and they would be safe. But my father was only a kid. And when they put him in the local school, in the little town they were staying in, the first thing he did was tell everyone that he was a Jew. So everyone knew why they were there. And then, when the Germans took over all of France anyone in the village could have denounced them and get them sent to a concentration camp. But no one did."
This recalled another story. A disagreeable French woman, then in her '70s, once told us that during the war she had been the directress of a boarding school for little children. It was a Catholic boarding school. But it was wartime and a few of the children were Jewish, sent there by their parents in the hopes that they would be safe.
"When the Germans came to Lyon, they came around to the school. They demanded that we send out the Jewish children. The truth is, I don't like Jews. But I disliked the Nazis even more. I had already changed the school's records so the Jewish names didn't show up anywhere. So, I told the lieutenant that we only had Catholic children. And I showed him the list. If he had wanted to pursue the matter, he probably would have found the Jewish kids and then sent them and me to the camps. But maybe he didn't really want to find them...you never knew; it was a strange time."
Well, times are always strange, we guess. And we find our little bits of courage and grace here and there...in odd places...and generally in the shadows. In the harsh light of the public eye, these civilized little acts of kindness and courage wilt like wildflowers...or get run over by a campaign bus.
When a presidential candidate discovers that a former friend or supporter has become a liability, for example, he is "thrown under the bus." Jeremiah Wright has the tire tracks to prove it – since he was thrown under the bus of the Obama campaign. The Obama group also sacrificed Robert Malley, an advisor on the Middle East, after it was revealed that he had met with Hamas officials. As every American knows, the Hamas fellows are bad hombres, and anyone who meets with them is no friend of Israel. Since being a friend of Israel, like wearing a flag on the lapel, is a requirement for America's top office, Obama had to push Malley off the team and then run him over with the bus.
Zbigniew Brzezinski, former national security advisor, said he thought the Jewish lobby has become too powerful and is showing a "McCarthyite tendency...by slandering, vilifying, demonizing. They very promptly wheel out anti-Semitism..."
So far, Mr. Brzezinski hasn't been dropped under the bus, but he should probably check his ticket.
Over on the McCain bus, another man of faith has been tossed beneath the treads. The Rev. John Hagee has views worthy of a man with great faith. According to Gideon Rachman's Blog in the FT , he believes the European Union is headed by the Antichrist. In his mind, the EU is a prelude to Apocalypse. And who are we to say he is wrong? There's no mention of it in the EU charter, but who knows what they're up to?
If Mr. Hagee had stopped there, he probably would have been all right, since most Americans agree that there is something ungodly about Europe. But then he goes further...and says that the Jews were murdered in WWII for a good reason – to drive them to Israel. It's all part of God's plan, he says; God made Hitler so the Jews would move to Israel, so the Apocalypse would come, followed by the second coming. How he knows God's plans in such detail, we can't imagine, but that's the beauty of faith; you can believe anything you want...until you put it to the test.
Rev. Hagee is a McCain supporter. But McCain is no longer a Hagee supporter; the reverend had to go "under the bus."
Under the bus, too, is where skepticism regarding global warming is going. George W. Bush fairly recently got on board, agreeing that the earth's climate is changing and the humans are to blame for it. And now all three candidates not only favor doing something about it – all endorse the idea of "cap and trade" as a palliative measure.
Here too, faith conquers wit. No one really knows what direction the earth's mean temperature is going...or why. There are only hypotheses.
"But if you really want to know what it's like to be a 16th-century heretic, try saying you're a bit skeptical about man-made global warming," writes Harry Mount in the Daily Telegraph .
In the middle ages, the Catholic Church made money by offering sinners a way to buy their way out of Hell – with an indulgence. In today's secular world, you will have to buy your way out of the sin of using too much fossil fuel, by buying "carbon rights."
Until tomorrow,
Bill Bonner
The Daily Reckoning
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The Daily Reckoning PRESENTS: The following story, first published in the Rude Awakening , tells a cyclical tale. I liked the story so much that I'm including it here in case you missed it. I'm not recommending the idea – not because I don't like it, but because I'm finding bigger upsides elsewhere for us right now. But it's one to keep an eye on...
ACID ROCKS
by Chris Mayer
Interesting how certain threads come together... I read recently that copper producers are complaining about the skyrocketing costs of sulfuric acid. A few days later, I read about Mosaic, a fertilizer company – about how the rising cost of sulfuric acid could impact its profit margins. Then last week, I came across a piece about how the cost of treating water is "going through the roof." The main culprit is, once again, the rising price of sulfuric acid.
As one water utility rep said: "As sulfuric acid prices increase, so do the products that contain this ingredient. The U.S. has also seen a shortage in supply of sulfuric acid. The U.S. has imported the majority of sulfuric acid from China in the past, but recently, China has slowed the trade of sulfuric acid to the U.S. because its own demand is greater than what China can produce for both the U.S. and itself." In short, demand is swamping supply. Sulfuric acid prices in March hit a record high of $329 per ton, according to Purchasingdata.com, after trading at $90 per ton as recently as October. Sulfuric acid shortages?
Hmmm... Well, time to take a look at this, think I.
"Sulfuric acid is one of those unheralded lubricants that keep the gears of the industrial economy spinning," says Chemical and Engineering News. "Although less in the limelight than petrochemicals such as ethylene or polyethylene, it is, in fact, the largest-volume chemical in the world."
We use sulfuric acid in mining to extract copper, nickel and uranium. We use it in steel production and in making fertilizers. We use it to refine oil and to treat wastewater. It goes into the plastics we make, and a bunch of other things. The biofuel boom has kicked off a big increase in the demand for sulfuric acid. In fact, some 60% of the sulfuric acid ends up in agriculture. The surge in ethanol production is a doublewhammy on sulfuric acid. First, all that corn needs fertilizers. And second, the ethanol facilities themselves also use sulfuric acid in their own processing. A typical ethanol facility requires 2,000 4,000 tons of sulfuric acid per year.
Then there is that great demand pull from China and India. Traditionally, these two countries produced what they needed. But now their own rapid industrialization has turned the tables. They've switched from being exporters to importers of sulfuric acid.
The boom in metals such as copper and nickel also drives the demand for sulfuric acid. Smelting operations typically throw off sulfuric acid as a byproduct. But even here, metals companies need more than they can produce.
Supply is also tight. As with many commodities, there was a long period when sulfuric acid prices went nowhere. This led to a decrease in production facilities. I found one example of a closure as late as November 2006, when GenTek shut down a sulfuric acid facility due to "adverse market conditions."
There also seems to be little new capacity on tap. Industrial Info Resources, in Sugar Land, Texas, tracks this sort of thing. According to IIR, of the $89 million invested in sulfuric projects in the U.S. in 2007, most of the funds went toward planned maintenance, rather than expanded capacity. It also turns out that not only is supply tight, but there are all kinds of transportation bottlenecks in delivery – such as a shortage of rail cars. Key Compton, president of a sulfuric acid producer in Texas, said toward the end of last year that customers soon "may be paying prices for sulfuric acid that they've never seen before."
So how can you play it? Well, there are a number of producers of sulfuric acid. Most are big chemical companies that you wouldn't own because you want exposure to sulfuric acid. Owning them is like buying Home Depot because you think it sells a great lawn mower. The only "pure play" on the idea I could find is a little company called Chemtrade Logistics in Canada, one of the world's largest suppliers of sulfuric acid. It trades in Toronto under the ticker symbol CHE. You can find a quote on Yahoo using
CHE-UN.TO.
It's a Canadian income trust and pays a monthly distribution of about 10 cents. Based on a price of $11.44, that's a yield of 10.5%. The company appears to be in good financial condition and throws off a lot of cash flow, much of which investors pocket in the distribution. It's not a sexy business, but it looks like an interesting play on what seems to be at least a temporary scarcity of a key chemical. Chemtrade is not a one-trick pony. It also produces liquid sulfur dioxide and sodium hydrosulfite. The company also sells into a wide range of end markets, so you're not tied to the fortunes of any single sector. The company has an excellent presentation of its business, complete with slides, on its Web site.
Since I have not completed my research on either Chemtrade or the overall sulfuric acid industry, I do not recommend Chemtrade. But since this sector is red-hot at the moment and appealing on many levels, I decided to share the insights I've gleaned so far. I plan to do more research on the idea. I would advise all investors do the same.
Regards,
Chris Mayer
for The Daily Reckoning
P.S. The skyrocketing price of sulfuric acid shows how interrelated the world's commodity markets and economies have become. And these interrelationships can produce investment opportunities at light speed. Agriculture, energy, metals... they're all part of one big story – one big, rapidly evolving story. And even though this pick isn't quite ready to recommend, there are some investments I've been tracking that you might want to take a look at. Read more here...
Editor's Note: Chris is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning . He is the editor of Mayer's Special Situations and Capital & Crisis – formerly the Fleet Street Letter .
Chris also recently wrote a book: Invest Like a Dealmaker: Secrets from a Former Banking Insider . Get your copy now...
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