RCM Editorial: An Explosion of Debt Relative to GDP

RCM Comment - Gary Rosenthal:

Examine the Total Credit Market Debt vs. GDP chart below and you will quickly realize why all of the government's bailout programs are paper tigers and are destined to miss their intended mark by a wide margin. The credit collapse of 1929-30 did not hit bottom until the early 1950s. The strong U.S. economic expansion from the early 1980s until recently was driven by an extraordinary rapid climb in the amount of debt per dollar of GDP. At its peak in 2008 total debt per dollar of GDP was dramatically higher than the peak of 1929-30. In a single snapshot you can see that the U.S. consumer has completely lost his credit worthiness at a time when the banking system has regained its sanity and adopted lending standards not seen since the 1950s and '60s. In short, until U.S. consumers substantially repair their balance sheets (through savings or bankruptcy) consumer expenditures (and in turn the U.S economy) are likely to be on a downward spiral for an extended period of time no matter what the government tries to do. No amount of government spending will offset the vicious cycle of a collapse in consumer spending and rising unemployment.

The government's misguided Keynesian answer to declining tax revenues is sharply accelerated spending, unprecedented budget deficits and borrowing and higher taxes. Common sense would tell you that something is completely out of whack with this formula. Who would lend money indefinitely to a government who has completely lost control of fiscal responsibility? The answer is that eventually no one. Thus this program of uncommon sense will eventually be largely funded by the printing press until the U.S Dollar loses its role as a reserve currency with our trading partners. How long will it take the Dollar to lose its place in international finance is anybody's guess, but the next time gold goes through $1000/ounce it is very unlikely to come back.

MISH'S Global EconomicTrend Analysis:

The chart below from Ned Davis illustrates the real problem: An explosion of debt relative to GDP. In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

Total Credit Market Debt vs. GDP


















The above chart is similar to those detailed in Fiat World Mathematical Model. Here is the ending snip on psychology that is at the heart of the matter.

Political Will vs. Consumer Psychology

What happens next depends somewhat on the political will of the central banks and politicians. However, it depends more on the psychology of the borrowers. If consumers and businesses refuse to spend and instead pay back debts (or default on them along with rising unemployment), the picture simply is not inflationary, at least to any significant decree.

The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model.

At some point the market value of credit will start expanding again, but that is likely further down the road, and weaker in scope than most think.
Henry Blodget's Five Misconceptions are another way of looking at the psychology of the situation. The sad reality is that both Geithner and Bernanke are trapped in academic wonderland with failed models about what happened in the Great Depression and why.

Geithner said "Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience." I agree. Unfortunately, Geithner's solution is to Zombify the taxpayer instead. What needs to happen is for banks to write off the bad debts. The Fed pleaded with Japan to do just that. Now Bernanke and Geithner refuse to follow that advice.

Bear in mind this insanity is just round 1. When it does not spur lending for reasons stated above, Geithner will be back at it begging for more taxpayer funds to bailout the banks. By the way, is this even legal? Offering no collateral loans is a handout. Many on the Fed, including Bernanke have stated the Fed can provide liquidity not capital. What is a no-recourse loan but capital? Of course the Fed is offering these guarantees via the FDIC.

News that Moves: The U.S. Housing Numbers Revealed, 5-Yr Treasury Auction Disappointment

RCM Comment: The following story is a pristine example of the misinformation and misdirection coming out of the traditional financial news media. It is the stupidity of articles like this that compels us at Rosenthal Capital Management to publish this blog and set the record straight. This article mirrors a plethora of news coverage Monday that extolled the virtues of the housing numbers released by the government. To compound the error, investors were told the equity markets were rallying due to this number. Completely incorrect; equity markets rallied, right or wrong, because of the Geitner plan. This action is not surprising because government engineered rallies typically occur around government announcements of this ilk.

But I digress. Let's set the record straight: 1) The majority of "bargain hunters" are the repossessing banks of foreclosures not new buyers. 2) When banks foreclose, the value of the mortgage is recorded as a sale, hence there is nothing unexpected about "sales" climbing during a period of rising foreclosures. 3) And this one is my favorite, the median value rose, which was tauted as a good thing. However, the median value rose because foreclosures are happening on bigger houses. In other words, the housing crisis is getting worse as foreclosures are occurring not only with subprime borrowers but now prime borrowers as well.

March 23 (Bloomberg) -- U.S sales of previously owned homes unexpectedly climbed in February as record foreclosures brought bargain hunters into the market to take advantage of lower prices. Read more...

RCM Comment: The Fed is buying $300 billion of short term U.S. debt, but today's auction is disappointing? Hmmm...

TALKX Floor Talk: Market pulls sharply off the highs following disappointing 5-Yr Treasury Auction -Update-
The bid/cover was only 2.02 and the high yield slid to 1.849% with only 19% allotted; Indirect Bidders slid to aprox 33%. Note that the disappointing U.S. auction results come on the heels of the UK failing to attract enough bidders in its bond auction today. According to the NY Times, the last time a conventional bond, or one not linked to inflation, failed to cover was in 1995.

News that Moves: The US$ Reserve Status in Question, China Comments on US$ and Debt

RCM Comments: With all the noise about bailouts and payouts and market rallies, I'm afraid you may be distracted from perhaps the most important story brewing. We have highlighted in these pages more than once over the last few months the importance of the movement coming from China to impose its will on the world financial community. Please read these two stories closely. A move away from the US$ as the reserve currency will be destructive for the value of the US$ and US treasury bond prices as well as bullish for gold prices.


China takes aim at dollar - WSJ
The Wall Street Journal reports China called for the creation of a new currency to eventually replace the dollar as the world's standard, proposing a sweeping overhaul of global finance that reflects developing nations' growing unhappiness with the U.S. role in the world economy. The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China's increasingly assertive approach to shaping the global response to the financial crisis. Mr. Zhou's proposal comes amid preparations for a summit of the world's industrial and developing nations, the Group of 20, in London next week. At past such meetings, developed nations have criticized China's economic and currency policies. This time, China is on the offensive, backed by other emerging economies such as Russia in making clear they want a global economic order less dominated by the U.S. and other wealthy nations. However, the technical and political hurdles to implementing China's recommendation are enormous, so even if backed by other nations, the proposal is unlikely to change the dollar's role in the short term. Central banks around the world hold more U.S. dollars and dollar securities than they do assets denominated in any other individual foreign currency. Such reserves can be used to stabilize the value of the central banks' domestic currencies. John Lipsky, the IMF's deputy managing director, said the Chinese proposal should be treated seriously. "It reflects officials' concerns about improving the stability of the financial system," he said. "It's interesting because of China's unique position, and because the governor put it in a measured and considered way."


Official says China to continue buying U.S. debt : AP reports China will continue buying U.S. government debt while paying close attention to possible fluctuations in the value of those assets, a vice governor of Beijing's central bank said Monday. Investing in U.S. Treasury bills is ''an important component part of China's foreign currency reserve investments,'' People's Bank of China Vice Governor Hu Xiaolian said at a news conference on Monday. ''So as an important component we are naturally relatively concerned with the safety and profitability of U.S. government bonds,'' Hu said -- a statement apparently aimed at concerns that rising debt to fund Washington's stimulus package could spur inflation and weaken the dollar.

RCM Editorial: Fed Action Leads to Market Reversals: The Cat May Have 9 Lives

A quick update to the post on Friday the 13th:

I wrote last Friday that this week's action would hold some of the keys to unlock the true direction of the markets going forward. Dead cat bounce or a real change in direction? That is the question that needs answering.

Allow me to begin by writing that real changes don't happen in a week and time is needed to prove out any new trend. This is why we at Rosenthal Capital Management have a discipline of leaning in the direction we believe the markets are taking as opposed to plunging. Then we watch closely for signposts along our path that validate our thinking and act accordingly. If we don't receive the correct feedback we reassess and live to fight another day. Make no mistake, it is this discipline, among others, that allowed us to not only survive the bear market mauling of 2008 but even prosper.

Today, we are officially leaning towards a more bullish stance. Last week I mentioned the G20 meeting and options expiration as reasons for volatility this week. Both have had their impact, but perhaps the biggest game changer was revealed by the Fed. The announcement by Helicopter Ben and the Fed to buy US debt had the effect of pushing the US equity indices (DOW, S&P500, NASD Comp.) above key areas of resistance. These markets have now broken downtrends on volume and notice must be taken. Furthermore, the group with the highest ranking out of 197 William O'Neil groups exploded higher. If the markets are going to trend higher leadership must develop and this is a good first step. Shame on you if you need to inquire as to what group I am referring. I invite all avid readers of this blog, owners of any of the Fortune's Favor Family of Funds and all others working with Rosenthal Capital Management to join me and say, THE NUMBER ONE GROUP IS PRECIOUS METALS.

On the 13th I wrote: "a solid long position in gold...a short of the US$ and US Treasury Bonds..."

Due to the events of this week we bore witness to a dramatic move higher in gold prices and a serious plunge down in the value of the greenback. However, when the Fed announced its intent to "buy $300 billion of long-term US treasuries" the knee-jerk reaction was to put a serious bid in Treasury prices. I want to be very clear: this does not change our opinion on the direction Treasuries will inevitably take. We believe that this move up in price/down in yield, for US debt will give way when the realization that a devaluing of the US$ makes this debt less attractive. Higher yields must be demanded when the underlying currency is losing value. Furthermore, I'd like to call to your attention once again to the issues China has been raising about US debt obligations. We would not be surprised at all to see stories written in the coming months that the Fed has been the bidder on US debt the Chinese have been selling.

I will end by writing that if a bottom of sorts has been reached there is no need to be the first to take the plunge. Be careful, market bottoms take time to develop and often require retests of lows, which can be painful. Continue to focus on leadership and accumulate opportunistically.

RCM Editorial: Barney Frank vs. Barney the Dinosaur. Who Would Cause More Damage As a Congressman?

Barney the Dinosaur has a child's intellect, so he would not understand the damage he is causing. While Barney Frank's intellect is certainly debatable, he's an adult, so he should understand the damage, which makes him that much more dangerous.

The answer to the question: Barney Frank!

Barney is my favorite fool on Capitol Hill; the hippopotamus of hypocrisy, the deacon of delusion (I could go on, but the target is so easy it is not really fair) has done it again. He is truly a hippopotamus in a china shop as he makes comments and pushes agendas that create unintended collateral damage. And, like the consummate politician, he never has the courage to take responsibility for his actions. Let's not forget his constant use of threats and coercion to force banks to "meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods". He wielded the Community Reinvestment Act (CRA) of 1977 like a cudgel. The CRA was well-intended and effective but like many sound pieces of legislation it was bastardized by fools.

Barney Frank and his ilk are at the very root of this credit crisis. However, instead of taking responsibility for his actions Barney uses the tools of a true grifter and with a little misdirection tries to avoid the blame. For the last couple of days he has gotten up on the bully pulpit and blathered on about AIG trader compensation. Today, he made the comment, "Now is the time to begin acting like owners". While this may sound good to the untrained ear, don't be misled. The consequences of the government "acting like owners" would be severe. This action would be seen as a type of (if not all out) nationalization, which would be absolutely disruptive to our banking system and cause further instability in our equity markets.

A respected colleague of ours, Michael Johnson of M.S. Howell explains: "...government attempts to increase the consistency of their approach have increased speculation that all new bank holding companies - especially Goldman Sachs (GS) and Morgan Stanley (MS) - could be forced to announce large reductions in their dividends or raise dilutive capital to repay their original TARP loan and reduce government interference." Naturally, either of these actions would be destructive to share prices. Don't forget to thank your friendly congressman, Barney, if this should occur.


RCM Comment: Meredith has been on point throughout this crisis, so her thoughts bear close examination.
Meredith Whitney on CNBC says same thing will happen in the financial sector this year as last year, but with different assets being purged. Whitney says banks will purge assets, driving valuations lower, sending the equivalent marks on each others portfolios down. Says so much credit is going out of the system, so even if you're ok, your credit situation is weakened, leading to a higher probability of default...Thinks April will be a very busy month as the stress test results are released and banks decide what to sell.

News that Moves: Swiss Franc Intervention, TALF Issues, China Concerns and the Privateer

RCM Comment: So, the debate continues to rage: Is this a dead cat bounce or the beginning of the next bull market? Next week's action will be very telling due to a confluence of events sure to impact traders. The G20 meeting this weekend (bound to focus on currency manipulation), supposed start of the TALF program, and options expiration on Friday all have the potential to create volatility. The following stories shed some light on the issues.

LONDON, March 12 (Reuters) -

Gold jumped more than 2 percent on Thursday, boosted after the Swiss National Bank sold francs against the euro and raised the spectre of a race to devalue major currencies. Analysts said the SNB intervention means one of the world's safest currencies is being deliberately undermined to help boost growth and that other countries could follow. "If all currencies are being devalued against each other then gold is a currency which is going to profit from it," Commerzbank analyst Eugen Weinberg said. "So we have bad currencies, worse currencies and the worst currencies, and gold could be an alternative stable currency in this case." Spot gold rallied to a high of $930.45 and was quoted at $923.45/924.95 an ounce at 1444 GMT from $906.65 late in New York on Wednesday. U.S. gold futures for April delivery on the COMEX division of the New York Mercantile Exchange rose $14.20 to $924.90 an ounce. The Swiss franc had its biggest ever one-day drop against the euro after the SNB said it had sold francs as part of a drive to boost the economy, which also includes an interest rate cut and planned bond buy. "The SNB have now fired the first formal shot in the forthcoming currency war," ING Bank said in a note.

TALF bogs down as investors balk - WSJ reports the govt's $1 trillion program to spark consumer lending hit another roadblock when investors balked at signing an agreement required to participate in the program, arguing that it gave Wall Street dealers and the Federal Reserve too much power to look at their books and reject them from the program. The Fed-and-Treasury-backed program is set to begin next week, but it faces the tough task of getting potentially hundreds of financial cos to agree on the wording of the contracts. Some of the issues bogging down the lawyers involved include how the dealers will protect themselves if an investor accidentally or purposefully misrepresents something about themselves as a solid borrower. Investors, particularly hedge funds, are bristling over language about how the Fed or dealers may decline their application, and that the Fed or any agency it deems appropriate may decide to comb through an investors' books or query any documents if and when it chooses.

ECONX NY Fed extends first TALF Subscription -Update-
The Federal Reserve Bank of New York today announced that it will extend the window for the first subscriptions for funding from the Term Asset-Backed Securities Loan Facility (TALF) by two days. The extension was requested by market participants in order to allow more time for borrowers to complete the documentation associated with the initiation of the program. The New York Fed will begin accepting loan requests starting at 10 a.m. ET on March 17, 2009, as originally published. The window for receipt of TALF loans has been extended through 5 p.m. ET on March 19, 2009. Lending rates on TALF loans will be set on March 19, 2009 at 8 a.m. ET. The settlement date will remain March 25, 2009 and the dates for the April subscription and settlement remain unchanged.

RCM Comment: If the next story gains traction - as it may at the G20 meeting - then hold on tight, this ride is about to get bumpy. We have published a couple of stories over the last few months that suggest China is starting to get restless. The best way to defend a portfolio as the mandarin giant begins to sway would be a solid long position in gold as any diversification by China out of US assets will be Gold bullish. For that matter, a short of the US$ and US Treasury Bonds should be a no brainer. In fact, this type of a position could be a win/win. If global markets continue to rally, then the fear premium comes out of the US$ and Treasuries. But if markets head lower again and China is rocking the boat we could see lower values of US asset prices during a time when the government is conducting huge new debt offerings to fund the deficit and Obama's new budget.

Wen voices concern over China's U.S. treasuries - The Wall Street Journal reports Chinese Premier Wen Jiabao expressed concern over the outlook for the U.S. government debt China holds, urging Washington to take effective policies to restore the American economy to health. He also said China can do more to boost its economy if that becomes necessary. Speaking at his annual press conference, Mr. Wen voiced confidence in the Chinese government's ability to keep its own economy growing, and said it has the resources to roll out additional stimulus measures if needed. "We have reserved adequate ammunition. We can at any time introduce new stimulus policies," he said. Mr. Wen reaffirmed that China can meet its traditional target of economic growth of around 8%. He said market expectations last week of another stimulus package were based on "rumors and misunderstandings," and that China's existing four trillion yuan investment program addresses "both short term and long term needs." "We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. I do in fact have some worries," Mr. Wen said in response to a question. He called on the U.S. to "maintain its credibility, honor its commitments and guarantee the safety of Chinese assets."

China hit by massive drop in exports - Financial Times Financial Times reports Chinese exports fell 25.7% in February compared with a year ago, much higher than analysts had expected, as the global economic crisis began to take its full toll on the country's export sector. However, the government also announced a strong increase in fixed asset investment in the first two months of the year, which economists said was a sign that fiscal stimulus measures were starting to have an impact. China's exports have decreased for four months in a row, but until February the rate of decline had been much slower than seen in other Asian countries with large export sectors. The headline figure for last month probably masks an even steeper decline given that there were a shorter number of working days in February 2008 because the Chinese new year holiday fell during that month. Given the timing of the holiday, analysts had forecast only a modest drop in exports last month and were surprised by the size of the drop. Imports continued to decline sharply, falling by 24.1% in February. The trade surplus, which has been at record levels for the last four months, also shrank sharply from $39.1 bln to $4.84 bln.


RCM Comment: Food for thought as the markets gyrate...

The Privateer-

The fiction that increased expenditures leading to increased consumption will make new factories and plants spring out of the ground as if by magic is fatally wrong. What must increase is SAVINGS, which leave unconsumed goods out in the economy. These are the economic means necessary to build factories and tools on factory floors. While Americans try to save, Obama cancels it with taxes and consumption.

The US government has, on behalf of American taxpayers, pledged more than $US 11.6 TRILLION over the past 19 months to bail out banks and stimulate economic growth according to data compiled by Bloomberg. The blindingly obvious question is: Where is the money going to come from? The clue is in the fact that all this is being done by the government on behalf of the American taxpayer. That being so, the American taxpayer will have to pay for it all. The only problem is that nobody has asked a taxpayer.

RCM Reprint: Karl Denninger on CDS and the Vicious Cycle

RCM Comment: The following explanation, while a little esoteric, offers unparalleled insight into a major component of the credit crisis:

Karl Denninger-

I buy a CDS on GE (a few weeks ago) for a couple hundred basis points ($200,000 per $10 million)The SELLER of that CDS protects against possibly having to pay by shorting whatever he can against that short credit position. This means he buys PUTs, he shorts the common, he does whatever he needs to in order to lay off that risk. He does this because if GE goes bankrupt their stock would presumably go to zero; therefore, if he has a potential $10 million exposure on the CDS he will short $10 million face value of the common stock, or buy enough PUTs to pay him $10 million if the stock goes to zero.

The PUT writer (assuming he buys PUTs), being a market-maker, will in turn short the common to lay off the risk as well. This hammers the stock price which then reflects into the pricing models for the CDS, driving them higher.This cycle repeats; unfortunately credit rating models include market cap as one of their inputs, which causes a credit downgrade (eventually.) That in turn adds more pressure. This cycle is repeated until the company is destroyed.

Why is this not a problem with options and straight short sales? Because with both straight short sales and PUT purchases the short side is required to post margin every night, and if the price goes the wrong way they get an immediate margin call and are required to buy that position back at a loss. That in turn puts pressure UPWARDS on share price and arrests the slide. As such the people selling short (whether stock or listed options) do not dare short in unlimited amounts, because if they get caught on the wrong side of a squeeze they are dead.

The enforcement of risk against the people betting on a bankruptcy through regulated instruments puts a natural limit on their activity and prevents an unwarranted "death spiral".

But in the CDS world there is no mark-to-market margin supervision, because there is no central counterparty supervising exposure and demanding it. As a consequence it is only the counterparty and the written document that can demand collateral posting and usually that is either on an infrequent schedule (monthly, quarterly, annually or on an "event") or in some cases not at all provided the writer maintains some specific credit rating criteria themselves!

Without nightly margin supervision on CDS short positions these vehicles have turned into the means to launch monstrous focused attacks on specific companies; the buyer has limited risk and virtually unlimited reward.

This is exactly like me buying fire insurance on your house, and in addition I can name the amount of insurance I want to buy, even exceeding the house's value!How nervous will you get if I buy $10 million in "fire insurance" against your $100,000 bungalow and then start stacking up gasoline cans in my driveway?As a direct and proximate cause of this ability to distort the market it becomes possible to create self-fulfilling prophecies almost on demand, with the people doing it profiting handsomely - at the expense of American workers and otherwise-sound companies.This form of exploitation of the market must stop.

News that Moves: Market Rally Sustainable?, Tedbits/Jim Rogers, Hedge Funds Turn to Gold & The ETF GLD Fraud

RCM Comments: As I write this, the equity markets are up over 5% and all the bobble heads on TV are trying to call a bottom. For days now, as the "Obama" bear market gained steam there was a rising tide of bottom callers, most of whom point to major oversold reading to justify a rally. While a rally can materialize at any time, the real question is sustainability. I won't begin to speculate on the answer, but I will say that while I agree we had major oversold readings on many indicators we also had surprisingly mixed sentiment readings that are not common at market bottoms. We will certainly need to monitor the situation closely, but I will say that this rally resembles other short covering rallies we have experienced over the last 7 months or so that have only led to new lows. Most often, markets bottom with capitulation or boredom. We have not seen capitulation, and by boredom I mean a reduction in volatility and sideways movement in a tight trading range that lasts for a while. The behavior of the market over the next few days will give us better insight as to the true direction; until then, here are a few thoughts from sources we respect that may help keep everything in perspective.

TedBits: The only reason they (Obama administration) are reducing the deduction for charity for those earning over $250,000 dollars, at a time when we need charity more than in the last 70 years, is so the people relying on charity will have to rely on government.

And...

Two hundred and fifty-two US commercial banks and savings institutions with total assets of $US 159 Billion were termed problem banks at the end of last year by the Federal Deposit Insurance Corp. The FDIC insurance fund has fallen to $US 19 Billion from $US 52 Billion at the end of 2007. It too is broke.

Obama’s Making It Worse - Maria Bartiromo interviewed Jim Rogers, and when she asked, “What do you think of the government’s response to the economic crisis?” he said . . . “Terrible. They’re making it worse. It’s pretty embarrassing for President Obama, who doesn’t seem to have a clue what’s going on - which would make sense from his background.”

Jim classically continued . . . “And he had hired people who are part of the problem. Geithner was head of the New York Fed, which was supposedly in charge of Wall Street and the banks more than anybody else. And as you remember, Summers helped bail out Long Term Capital Management years ago. These are people who think the solution is to save their friends on Wall street rather than to save 300 million Americans...We’re going to have social unrest in much of the world. America won’t be immune."

RCM Comment: I would like to take this opportunity to welcome the crowd to the investment theme of precious metals. Our core belief in this theme over the last three years has helped lead Rosenthal Capital Management's direction of the Fortune's Favor Family of Funds. That direction has resulted in a rather dramatic outperformance vs. the markets and our peers. For those of you who have enjoyed this theme with us I will offer a note of caution: With the crowd comes big upside opportunity but also even bigger volatility. So, as I have written before, "please hold on to the Bar."

Hedge funds turn to gold - FT FT reports Hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks. The gold bulls include David Einhorn, founder of hedge fund Greenlight Capital... Other funds looking at gold include Eton Park and TPG-Axon, investors said. Investors such as Mr Einhorn are turning to gold because they are worried about the response of the US Federal Reserve and other central banks to the global economic crisis. A bet on gold is essentially a bet against all paper currencies. "The size of the Fed's balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed," Mr Einhorn wrote in a recent letter to his investors. "Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself." Mr Einhorn's comments -- and the revelation he is buying gold itself -- are in line with the views held by other large institutional investors in Europe, according to bankers in London. The head of commodity sales at one major bullion bank told the FT that he had never been so busy dealing in gold for large investors in his life. (See 8:51 comment)

Bearish big investors catch gold bug - WSJ
WSJ reports large investors, including some who anticipated troubles for the housing and financial sectors, have been buying gold, concerned that moves by governments to shovel money at problem areas could cripple leading currencies. Cos such as Eton Park Capital Management, Greenlight Capital, Hayman Advisors and Paulson & Co. have been ramping up gold exposure in recent months, according to investors in the funds. Blue Ridge Capital and Highfields Capital Management also have been recent buyers, according to public filings about their year-end holdings. Some of these funds have become among the largest holders of gold exchange-traded funds, such as the SPDR Gold Shares ETF (GLD), while also buying gold futures contracts, swaps and even physical bars of the yellow metal. The recent purchases of gold by the hedge-fund investors, some of whom have top records, suggests they are coming to share deep worries about the health of global economies and how ongoing problems are being addressed.

RCM Comment: This story illustrates the crowds' disturbing negligent behavior with regard to gold investments. The crowd is evidencing an utter lack of due diligence when accumulating shares of GLD. In an effort to help my fellow man I will highlight some key issues in the hopes that the information may redirect the lemmings before they run off the cliff:

1) More shares of GLD have been created over the last few months than there has been gold traded on Comex. If GLD is supposed to be backed by physical gold how would this be possible? Answer: It is not possible, so GLD is not truly backed by gold bullion.

2) The GLD prospectus states that there will be no auditor of the fund. This should be a major red flag to all investors. If you have something to hide you don't use an auditor. Now repeat after me...Madoff.

3) Page 12 of the prospectus states that the assets of GLD are commingled and not set aside in a designated account. Hence, if the bank administering GLD should have a problem, for instance be nationalized, then GLD holders become creditors of the bank, not owners of bullion. Repeat after me...counter party risk. Last time I checked, counter party risk was at the very center of the credit crisis.

RCM Editorial: Obama's Budget Proposal: Sensible or Senseless?

I'm at 36,000 feet and on my way home after an epic snowboarding trip to Vail, Colorado. I have spent the last 4 days knee deep in fresh powder shredding the back bowls, but a thought has been tugging on my mind. Much to my chagrin, I have been unable to mollify this sinking feeling that our country is being run by a gaggle of neophytes. And so I feel I must put pen to paper, or fingertip to key as it were, and shed some light onto the deadly mold growing in the hallowed halls of our government. The growth of which I speak (whose obnoxious smell is fatal to our society) has a name: tax increases.

Those of you who read this blog know that we try to avoid a political discussion. We generally keep our thoughts focused on developments we feel are moving the markets. A political discussion seems really pointless due to both parties' phenomenal inability to do anything right. But, I suppose this is nothing new. Historically speaking our country has gone through periods of utter ineptitude in leadership and we always seem to pull through.

Today's missive will focus on the question of tax increases during a recession. Is it sound? Is it healthy? Is it smart to raise taxes during a recession? I know it is popular. If you are pandering for votes you will most certainly get a resounding applause in the town hall if you blame the rich and the big bad corporations. Forget about the fact that 'rich' is defined by this administration as an income of over $250,000 (a broad net that catches many struggling small businesses) and never mind the fact that corporations in fact offer jobs to the very same people applauding. Nope, use the biblical rally cry of 'tax the rich', 'tax the corporation' and listen to the adulation that pours out of your constituents. So we know it is popular, but is it effective? Is the Messiah going to lead us out of this recession with tax hikes, or simply into an economic desert for the next 40 years? We are hitting turbulence...No, I mean quite literally as we start our descent into Palm Beach International. I will pick this up tomorrow from the trading desk...

...O.K. I'm back at RCM headquarters, looking at the sun come up over the horizon, smelling the ocean and listening to the palm trees. It is good to be home, but we still have this little problem of Obama's budget package that is rife with tax increases. I would like at this moment to ask those of you who are reading to think if you can remember any time in history when tax increases helped any country get out of a recession. Please comment at the end of this blog with a concrete example of tax hike success. I would truly love to know as the knowledge may very well make it easier for me to sleep at night.

On the other hand, I can certainly come up with examples of tax cuts helping an economy recover. Take, for example, Ireland's dramatic cutting of corporate taxes to 0%. This decision led to an economic boom and a significant increase in employment for a country that had been a perpetual looser in both categories.

Would you rather stay Stateside? O.K., let's talk about the 1980s. Jimmy Carter's obstreperous tax and spend administration left us with a 90% top tax bracket, double-digit unemployment, an economy in a shambles and inflation soaring. Reagan, love him or hate him, dropped taxes across the board while closing loopholes that the rich employed to escape the egregious rates. This led to a serious increase in tax receipts, job creation and economic recovery. I'm going to go out on a limb and sight the Bush administration for a moment. Before you caterwaul at the screen take a deep breath and continue reading. We all agree the Bush administration was a disgrace. I will gladly concede the Bush stupidity seemed to be boundless, but as my Dad likes to say, "even a blind hog finds an acorn sometimes". The acorn: In 2004 companies were allowed to bring profits into the U.S. that they had earned and left abroad, paying a tax of only 5.25%. Prior to this one-time tax break, repatriated profits were taxed at the full federal rate of 35%. As a result, $312 billion was brought home leading to an $18 billion boost to government coffers. This cash infusion helped shore up companies' domestic operations.

So I ask again, why on earth is the Obama administration raising taxes? Must we repeat the mistakes of past administrations? The very definition of insanity is doing the same thing over and over but expecting different results. There is over $500 billion foreign-earned profits in overseas accounts today. Even a simpleton like Bush knew that dropping the tax rate on this cash horde would result in a boost to tax receipts. Am I wrong, aren't we trying to reduce the deficit? Wouldn't a quick $26.25 billion help?

When I questioned Obama's preparedness to lead, believers chided me for being obtuse and offered up the mantra that 'Barack is really smart and will surround himself with smart people'. Well, I ask the believers: How smart does he look now? How about the people he is putting around him, four of whom want us to believe they can't figure out the taxes they owe? Is this the type of change and leadership you were looking for? Please don't offer up the new mantra of 'he inherited a mess and it will take time'. While both of these statements may be true, neither answers my question. Leadership doesn't take time to evidence itself and choosing people to surround you who don't lie or cheat would be the first step.

I have taken time out of my trading day to address these issues because the budget proposal is clearly affecting the markets. The equity markets are leading indicators of the economic picture and they are speaking with every tick lower. As I finish this piece the S&P 500 is at new lows: down 5% with 15 minutes to the close. Instead of using the new budget proposal to show leadership by focusing on the credit crisis, Obama has acted like a child with a new toy and pushed his agenda without any regard for its effect on the real world. Example, his agenda blew out one of the remaining legs of the market; the medical sector. Without a doubt his proposals are hostile to capital on many fronts and instead of extinguishing the inherited fire he is adding fuel to it. As long as this path into the economic desert is followed we at Rosenthal Capital Management will continue to maintain our posture of defending capital that led to profits in 2008 and continues to generate profits in 2009 with our fund Fortune's Favor Precious Metals leading the charge.