Hawkish Fed Comments From Warsh, Bullard, Plosser Why? Terrible Economic Numbers, Chicago PMI, MBA Mortgage Applications

U.S.$ weakness of late has spurred a cacophony of comments around the world for a new reserve currency. Now the Fed is attempting to fight back. Over the last few days a number of Fed governors have made hawkish statements to bolster the U.S.$ (the fact that these comments were offered before, during and after the G20 summit is not a coincidence).....

Fed's Warsh says Fed may need to roll back policies sooner - DJ

Fed's Warsh says last few months show continued improvement in economic performance - Reuters

Fed's Bullard says Fed should consider rules governing quantitative easing policies with rates near zero - Reuters

Fed's Plosser says policy shift may need to be aggressive - Reuters.com
Reuters.com reports the Federal Reserve will have to act quickly, and "perhaps aggressively" when the time comes to pull back its extraordinary support for markets in order to avoid stoking inflation, the president of the Federal Reserve Bank of Philadelphia said.

"The Fed will need courage," Charles Plosser said in remarks prepared for delivery at Lafayette College in Easton, Pennsylvania. "I believe we will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels."

The Federal Reserve cut interest rates to near zero percent last December and put in place an unprecedented array of emergency support programs as it battled the deepest recession since the Great Depression. That has worried some market participants that inflation will result. "Just as the Fed has taken aggressive steps in flooding the financial markets with liquidity during this crisis to reduce the possibility of a second Great Depression, it will also have to take the necessary steps to prevent a second Great Inflation," Plosser said. "We recognize the costs that significantly higher inflation and the ensuing loss of credibility will impose on the economy if we fail to act promptly, and perhaps aggressively, when the time comes to do so," he said.

...However, economic reality still suggests the need for aggressive stimulus.....

September Chicago PMI 46.1 vs 52.0 consensus, August 50.0

ECONX Chicago PMI Halts Expansion - Briefing.com
The expansion in the manufacturing sector hit a major speed bump as the Chicago PMI declined 3.9 points to 46.1 in September, well below the consensus expectation of 52.0. The drop below 50 signals a contraction in manufacturing. A negative feedback loop seems to have reentered the manufacturing sector...

The drop in PMI was mostly due to a severe cutback in both new orders and order backlogs as new orders declined 6.2 points to 46.3 and order backlogs declined 9.1 points to 36.7. It seems that manufacturers had bought into the economic recovery scenario and decided to ramp up production in August. At the same time as production revved up, the contraction in new orders had ended and most firms expected growth to continue into the future. The increased production was used to work off the backlog along with the new orders that arrived. Unfortunately, at the same time as production ramped up, consumer demand in September seems to have stalled and along with it the recovery effort. Wholesalers and retailers did not need any new goods and orders dropped precipitously. Production in September tumbled.

As long as consumer demand continues to stumble, the recovery effort cannot be sustained. Instead of multiple months of expansion, we may see these PMI indices becoming highly volatile as production meets a fluctuating order schedule.

There was one positive sign from the data. While inventories are still contracting, the rate of contraction slowed. Eventually inventory levels will shrink enough to force manufacturers into production just to restock the shelves. Unfortunately, the consumer will dictate when this will happen. Other components of the index showed problems in manufacturing including: The prices firms paid expanded for the second consecutive month as the index rose to 51.3 from 50.0. The contraction in employment held steady as the index increased only 0.1 to 38.8. Supplier deliveries reentered a contraction phase as the index declined to 49.3 from 54.6.

MBA Mortgage Applications -2.8% vs +12.8% Prior

...And the struggle between reality & the desire to support the U.S.$ has the Fed speaking out of both sides of it's mouth....

Fed's Lockhart says worst is likely ahead for commercial real estate - DJ
Says return to robust bank lending unlikely in near term

...The take away? We must not let the short-term strength in the U.S.$ alter our investment strategy. This strength was purely cosmetic and created for the G20 summit. The stagflation trade is alive and well (Please see the Sept. 7th post for details). This trade will gain strength as poor economic numbers continue to evolve during a time when prices manufacturers pay for goods continues to increase (see the red text above).

The asset of choice for this environment is Gold. We don't know all the answers but we are eminently comfortable owning gold. Gold is the only international monetary asset with globally declining supply and rising demand. How smart do you have to be to join us?

Companies of Interest

(Please click on the link above to review previous EPS/Company posts)

Periodically I will post the EPS news or other relevant coverage of companies we find interesting. This is not a recommendation to purchase or sell the shares. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Of course, if you are an investor in any of the Fortune's Favor Family of Funds or a client of RCM our door is always open. Feel free to call or email questions at any time for further information.

C Citigroup: China wants Citigroup to expand - WSJ (4.70 )
WSJ reports a top banking regulator in China said Citigroup's local operations "absolutely" should expand in the country, suggesting the U.S. government's big stake in the bank isn't troubling Chinese regulators. Citigroup's China unit was "very prudent and careful" amid the global financial crisis and now should be "expanding, absolutely,"

Yan Qingmin, director of the Shanghai branch of the China Banking Regulatory Commission and one of the top regulators for foreign banks in the country, told The Wall Street Journal in an interview. Showing an unusual willingness by a regulator to comment on an individual company, Mr. Yan offered a glimpse into how China views the recent overhaul of the U.S. financial system and said Citigroup should take advantage of growth in the Chinese economy and expand in the world's most populous nation. He signaled a view that despite the shock of seeing an "aircraft carrier" of the U.S. financial industry fall into the government's arms, Washington's support for Citigroup was the correct decision and that the result has done little to alter how Chinese policy makers regard the financial-services giant.

August Existing Home Sales Disappoint, Fed Accounts For 50% of Q2 Treasury Purchases, Review of Fed Indefinitely Delayed

The equity market weakness yesterday and today have very little to do with the Fed statement contrary to what you may hear on the financial news networks. No game changing comments were issued by the Fed and this morning's home sales number (August Existing Home Sales 5.10 mln vs 5.35 mln consensus; M/M change -2.7%) further highlights the continued need for easy credit. Don't forget economic numbers that reflect a continued need for quantitative easing are equity market friendly. (please review the Sept. 17 post for a complete explanation)

I am, however, reprinting the following Zero Hedge story as it explores an impending issue that could be equity market bearish and must be monitored closely.

Federal Reserve Accounts For 50% Of Q2 Treasury Purchases
By Tyler Durden of Zero Hedge
Created 09/20/2009 - 15:13

The degree of intermediation by the Federal Reserve in the issuance of US Treasuries hit a record in Q2, accounting for just under 50% of all net UST issuance absorption. This is a startling number, as the Fed's $164 billion in Q2 Treasury purchases dwarfs the combined foreign/household UST purchases of $101 billion and $29 billion, respectively, over the same time period. In fact, the Fed was a greater factor in UST demand than all three traditional players combined: Foreigners, Households and Primary Dealers, which amounted to a $158 billion in net Q2 purchases.

This dramatic imbalance puts a lot of question marks over how the upcoming hundreds of billions in incremental Treasury purchases will be soaked up, now that QE only has $15 billion of capacity for USTs: with Households lapping up risky assets it is unlikely they will look at Treasuries absent some dramatic downward move in equities, while Foreign purchasers, which many speculate are in a game of Mutual Assured Destruction regarding UST purchases, have in fact been aggressively lowering their purchases of Treasuries (from $159 billion in Q1 to $101 billion in Q2, an almost 40% decline in appetite!).

Will the US make these purchases much more attractive come October when QE for USTs ends? And if so, what kind of rates are we talking about? One thing is certain: in terms of priorities of the Federal Reserve, keeping the equity market buoyant, is a distant second to ensuring successful auction after auction well into 2010. After all there is near $9 trillion in budget deficits that need financing over the next 10 years.
READ MORE...

So, is it any surprise that the Fed doesn't want a review of it's structure and governance?

Fed to miss review deadline - WSJ WSJ reports the Federal Reserve won't meet the U.S. Treasury's Oct. 1 deadline to prepare a broad review of the central bank's structure and governance, a Federal Reserve official said. The Treasury requested the study in June as part of its sweeping blueprint for revamping financial-system regulations, saying a review of the central bank was needed "to better align its structure and governance with its authorities and responsibilities."...

In the face of these pressures, Fed officials have been reviewing the central bank's practices on a range of fronts. Fed governor Betsy Duke is leading a study of the governance of the 12 regional reserve banks, vice chairman Donald Kohn has been leading efforts to improve the Fed's transparency and Fed governor Daniel Tarullo has been leading a review of its bank supervision practices. It isn't clear if the Fed will complete the study and, if so, when. A Fed official said it had become a low priority while other efforts are under way.

CDO Improvement Aids Banks, Holiday Jobs Scarce, U.S. Mortgage Delinquencies Set Record, Delayed Foreclosures Becoming a Problem

Positive developments in the credit markets continue to lead the equity markets higher...
Liquidation of CDOs aids banks - FT
FT reports billions of dollars' worth of the complex securities at the heart of the financial crisis are being liquidated, enabling banks, insurance companies and other investors to clear toxic assets from their books.

Market participants say the unwinding is occurring in the market for collateralized debt obligations (CDOs). Hundreds of billions of dollars of CDOs have defaulted, but the structures can only be liquidated if the underlying collateral can be sold. In recent weeks, more investors have been buying the underlying assets at deep discounts, leading to increased trade and boosting prices for some existing CDOs.

"There has been a significant increase in the amount of CDO liquidations," said Vishwanath Tirupattur, analyst at Morgan Stanley. "The rally across asset classes has given investors an incentive to liquidate." The recent rally has been particularly marked for CDOs backed by corporate bonds and loans. Of the more than $500 bln of CDOs backed by asset-backed securities sold in the boom years, $350 bln have already experienced an "event of default".

The Fed meets today and will make a statement about monetary policy. Many pundits on TV are suggesting that the Fed may begin to outline the exit strategy for monetary easing. However, I would humbly suggest that if the Fed is aware of the following three stories (these being the tip of the proverbial iceberg) then there will be no meaningful change to the Fed's monetary stance.

Of course, if there is no change in the epic fiat money proliferation by the Fed then we would expect a continuation of the current inflation rally in assets. Please remember, inflation is currency event not an economic event. For more thoughts on this matter please see the Sept. 17th post.

Holiday jobs look scarce as pessimism grips retail - WSJ WSJ reports nearly half the nation's 25 biggest retail chains expect to hire fewer holiday workers this season than they did last year, another sign that retailers aren't counting on recession-strained shoppers to relax the tight grip on their pocketbooks this year. About 40% of stores surveyed across a broad swath of retailing told the Hay Group, a human resources consulting co, that they expect to hire between 5% and 25% fewer temporary workers this year than last, when the recession forced many retailers to trim staff in response to falling sales. That's a grimmer outlook than the Hay survey found a year ago, when 29% of retailers said they would be slashing their holiday workforce. "Our staffing levels will likely be down slightly," said an American Eagle (AEO) spokeswoman. "We've been focused on creating high levels of efficiency."

U.S. mortgage delinquencies set record - Reuters.com

Reuters.com reports high U.S. unemployment keeps pushing up the rate of mortgage delinquencies, which could in turn drive personal bankruptcies and home foreclosures, monthly data from the Equifax credit bureau showed.

Among U.S. homeowners with mortgages, a record 7.58% were at least 30 days late on payments in August, up from 7.32% in July, according to the data obtained exclusively by Reuters. August marked the fourth consecutive monthly increase in delinquencies, and the report showed an accelerating pace.

By comparison, 4.89% of mortgages were 30 days past due in August 2008, while in August 2007, the rate was 3.44%, Equifax data showed. The rate of subprime mortgage delinquencies now tops 41%, up from about 39% in each of the prior five months. The results, which correlate with consumer bankruptcy filings, suggest U.S. homeowners remain under financial stress despite signs of improving sentiment and fundamentals in the U.S. housing market. August bankruptcy filings were up 32% from a year earlier, compared with a 35% year-over-year increase in July.

Delayed foreclosures stalk market - WSJ

WSJ reports legal snarls, bureaucracy and well-meaning efforts to keep families in their homes are slowing the flow of properties headed toward foreclosure sales, even when borrowers are in deep distress. While that buys time for families to work out their problems, some analysts believe the delays are prolonging the mortgage crisis and creating a growing "shadow" inventory of pent-up supply that will eventually hit the market.

The size of this shadow inventory is a source of concern and debate among real-estate agents and analysts who worry that when the supply is unleashed, it could interrupt the budding housing recovery and ignite a new wave of stress in the housing market. "There's going to be a flood [of bank-owned homes] listed for sale at some point," says John Burns, a real-estate consultant based in Irvine, Calif. When that happens, Mr. Burns believes, home prices will fall further, particularly in markets with large numbers of foreclosures. Overall, he expects home prices to decline 6% next year.

Gold and The COT Short Position, U.S. Treasury Winds Down Money Market Funds Guarantee

I have been asked by a few readers about our thoughts on the COT short position in the Gold market. For those not aware, COT represents the commercial traders in Gold. Conventional wisdom states that if COT has a significant short position look out below. In our opinion this "wisdom" is incorrect. I would like to direct your attention to the chart above as well as the comments by Jim Sinclair below for a better understanding of the situation. Moreover, I would suggest using conventional wisdom during unconventional times is in essence a flawed approach.

As the C-wave began to accelerate from $439 on 8/23/05 to $692 on 5/16/06, commercial traders were heavily short. Their net short position as a percentage of open interest was -50.6% on 8/23/05. The lowest reading since 2001. Like August 2005, the time is right for the C-wave advance. When the time is right, price will follow. As of 9/15/09, commercial trader net short position as % of OI -49.2%. The most negative readings since 8/23/05.

Those advocating caution towards gold on the basis of commercial trader concentration on the short side, referred to as overloaded trade, ignore that gold’s strong advance from August 2005 to May 2006 developed from a similar "concentrated" position.

Thanks to a blog reader, I have received this information in response to my question last week about the expiration of the money funds insurance program set up by the U.S. Treasury.

From the Press Room of the U.S. Treasury:
Treasury Announces Expiration of Guarantee Program for Money Market Funds
Program Winds Down as anticipated, Generates $1.2 billion in participation fees for U.S. Taxpayers

The U.S. Department of the Treasury today announced that the Guarantee Program for Money Market Funds (the "Program") will expire today. The Program was initially established for a three-month period that could be extended up through September 18, 2009. Since inception, Treasury has had no losses under the Program and earned approximately $1.2 billion in participation fees.

"As the risk of catastrophic failure of the financial system has receded, the need for some of the emergency programs put in place during the most acute phase of the crisis has receded as well," said Treasury Secretary Tim Geithner. "The Guarantee Program for Money Market Funds served its purpose of adding stability to the money market mutual fund industry during market disruptions last fall and ultimately delivered a healthy return to taxpayers."

Treasury designed the Program to stabilize markets after a large money market fund's announcement that its net asset value had fallen below $1 per share ("broke the buck") in the wake of the failure of Lehman Brothers in September of 2008. Maintaining confidence in the money market mutual fund industry was critical to protecting the integrity and stability of the global financial system.

Important US$/Gold Events, Basel Compliance, "Option" Mortgages to Explode, U.S. Treasury Stealing Premiums? Volcker Calls for Trading Restrictions

Possible important US$/Gold events in the near future:

The G20 meeting in the U.S. city of Pittsburgh on Sept. 24-25:

Will the discussion about a new reserve currency continue to pick up steam? If so, the recent slide in the US$ could become a little steeper and in turn the Gold rally above $1,000 a little more secure.

September 30th:

"Sept. 30th is the fiscal year end for the U.S. Treasury. It is also the date when ALL banks across the globe must become Basel II and Basel III compliant." Bill H. GATA The rules state banks that are not compliant will be restricted from trading with compliant banks. Due to the massive "off balance sheet" derivative exposure that U.S. banks have Basel III compliance will be problematic. Will this development create renewed weakness in the US banking system? We will need to monitor credit spreads closely in the coming weeks for clues of any Basel impact.

Meanwhile, the next shoe to drop in the real estate train wreak appears to be gaining momentum with the "option" mortgages coming under fire. As equity investors, an increase in foreclosures should be viewed as positive. Yes, you read the last sentence correctly, allow me to explain.

The equity market rally has gained steam over the last few weeks not because of the much discussed possible economic recovery but because of the falling US$. As the US$ sinks to new lows cash in short term instruments is forced to seek refuge. Gold and silver are obvious choices for shelter, but these markets are tiny compared to the amount of US$ looking for cover and so the entire equity market structure is enjoying the massive flow of funds.

In fact, the market capitalization of the entire precious metals mining group is only about $225 billion compared to over $3 trillion in U.S. money markets. Can you see why we have made precious metals and the mining companies a major focus of the Fortune's Favor Family of Funds?

But I digress, an increase in foreclosures will force the Fed to continue the easy credit solution. Monetization of U.S. treasuries will continue, world demand for a new reserve currency will get even louder and as a result the US$ will continue to decline in value forcing cash into assets that will outstrip the ever increasing inflation. "Here endeth the lesson." (Another movie quote! "Somebody stop me!" I did it again!?!? The Jaime Lee Curtis quote from Wednesday's post was courtesy of the movie A Fish Called Wanda.)

"Option" mortgages to explode, officials warn - Reuters.com
Reuters.com reports the federal government and states are girding themselves for the next foreclosure crisis in the country's housing downturn: payment option adjustable rate mortgages that are beginning to reset. "Payment option ARMs are about to explode," Iowa Attorney General Tom Miller said after a Thursday meeting with members of President Barack Obama's administration to discuss ways to combat mortgage scams. "That's the next round of potential foreclosures in our country," he said... Because the new monthly payments can be five or 10 times what borrowers are accustomed to paying, they "threaten a much greater hit to the consumer than the subprimes," Goddard said, referring to the mortgages often extended to less credit-worthy borrowers that fed the first wave of the financial crisis... The mortgages tend to be "jumbo," or for significantly large amounts, Goddard said, making it even harder for borrowers to sidestep foreclosure. He said he expected to see an increase in scams as distressed homeowners become more desperate to refinance big debts.

Does the following story mean the U.S. Treasury is in effect stealing the premiums asset managers have paid for money market insurance? I would welcome any thoughts on this matter.

U.S. Treasury to keep $1.2 billion money fund premiums - Reuters.com
Reuters.com reports the U.S. federal government will keep about $1.2 billion in payments collected to backstop money market funds even after its insurance program ends on Friday, a U.S. Treasury official said. The money "will stay with the Treasury," the official told Reuters on Thursday, speaking on condition of anonymity because the decision has not been officially announced. The payments, from asset managers, were essentially insurance premiums used to fund guarantees the Treasury put in place a year ago to prop up the $3.5 trillion money market fund industry.

Is the development in the story below the coup de gras for Goldman Sachs? Last year the broker was forced to become a bank to gain access to Fed handouts. Now it seems there is an attack building on the very core of Goldman's earning power.

Volcker calls for restricting banks' risk, trading activity - WSJ
WSJ reports former Federal Reserve Chairman Paul Volcker on Wednesday said banks should operate in a much less risky fashion, including not making trading bets with their own capital, comments that could provoke intensified debates over the future of financial regulation.

Mr. Volcker, who currently is chairman of the White House's Economic Recovery Advisory Board, suggested banks should be restricted to trading on their client's behalf instead of making bets with their own money through internal units that often act like hedge funds. "Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking," he said in a speech to the Association for Corporate Growth in Los Angeles.

U.S. Debt-Ceiling Fight Looms, UN Demands New Global Currency, China Trade War

I'm not hearing much about this story in the news yet but I suspect the debt-ceiling will become center stage in the weeks ahead. At risk is the fate of the US$ trend. In the unlikely event that congress somehow puts its proverbial foot down and refuses to increase the debt ceiling then no doubt this would stem the slide of the greenback. However, I suspect the third paragraph holds the tastiest morsel of information. In order to avoid looking weak on fiscal responsibility right before an election Congress will pass all that is required now to increase the debt ceiling and in turn add to the US$ weakness. Stay tuned, this could get interesting....

Treasury gets ready for debt-ceiling fight - WSJ
WSJ reports the Obama administration, concerned about the possibility of a big political fight over the national debt, is looking at how it can continue funding the government in the event that Congress hinders its ability to borrow money.

Treasury Department officials are examining tools employed by previous administrations, including disinvesting government retirement funds and suspending interest payments to federal accounts, according to people familiar with the matter. They are also looking at what to do in the unlikely event of a govt shutdown.

At issue is the debt ceiling, a dollar limit controlled by Congress that dictates how much the U.S. can borrow. Treasury Secretary Timothy Geithner told the Senate in a letter last month that the $12.1 trillion ceiling could be hit as early as mid-October, and said it needs to be increased so the U.S. can continue funding operations and making debt payments. Mr. Geithner didn't indicate the increase he was seeking. With the U.S. borrowing about $30 billion a week, some economists say the Treasury will need an increase of as much as $1.5 trillion if it wants to avoid another request before the 2010 midterm elections. The U.S. could default on its debt if Congress doesn't raise the debt ceiling, but it is a remote scenario.

...Meanwhile, as the players in the US rearrange the chairs, the rest of the world wants to rewrite the playbook...

UN wants new global currency to replace dollar - Daily Telegraph Daily Telegraph reports the dollar should be replaced with a global currency, the United Nations has said, proposing the biggest overhaul of the world's monetary system since the Second World War.

In a radical report, the UN Conference on Trade and Development (UNCTAD) has said the system of currencies and capital rules which binds the world economy is not working properly, and was largely responsible for the financial and economic crises. It added that the present system, under which the dollar acts as the world's reserve currency , should be subject to a wholesale reconsideration. Although a number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency, the UNCTAD report is the first time a major multinational institution has posited such a suggestion.

In essence, the report calls for a new Bretton Woods-style system of managed international exchange rates, meaning central banks would be forced to intervene and either support or push down their currencies depending on how the rest of the world economy is behaving. The proposals would also imply that surplus nations such as China and Germany should stimulate their economies further in order to cut their own imbalances, rather than, as in the present system, deficit nations such as the UK and US having to take the main burden of readjustment

I'd like to take a moment and pose a question before you read the next story.

Here is the set up: Let's say your name is Otto and you are the president of a country with a huge deficit and a currency going the way of the wampum. And, let us further assume that the trading partner holding the biggest amount of said debt and wampum is, oh I don't know... China.

Now the question: Should you start a trade war with China at a time when your country is most vulnerable? Would that be smart? Would it be diplomatic? Or, in the immortal words of Jaime Lee Curtis, would it be STUPID? (Extra credit to those who can name the movie)

China strikes back on trade - WSJ
The Wall Street Journal reports China indicated Sunday it would restrict U.S. imports of chicken and auto products after Washington's move to slap punitive sanctions on Chinese tire imports, raising tensions in a trade dispute ahead of two planned meetings between the countries' leaders.

Citing a jump in Chinese imports, the Obama administration said Friday it would impose stiff tariffs on Chinese-made tires for the next three years, invoking a section of trade law that China agreed to as a condition for its joining the WTO in 2001. The move essentially would cut off the source of nearly 17% of all tires sold in the U.S. last year and hit cost-conscious consumers particularly hard, as retailers will have to find alternative sources for the lower-end tires that make up much of what China sends to the U.S.

Beijing responded quickly. Sunday, its Ministry of Commerce said it was starting antidumping procedures against U.S. exporters into China of chicken and auto products. It said it had received complaints from local producers that the U.S. products were being dumped in China at below-market prices. The ministry denied that the move, which could lead to sanctions, was protectionist. "China has consistently opposed trade protectionism, and the country's actions since the financial crisis have reflected this stance," the ministry said on its Web site. "China is willing to continue to act in accordance with countries around the world to push forward the world's economic recovery."

The announcement didn't specify the timing or the exact kinds of goods involved. An official with the U.S. Trade Representative's office Sunday defended the trade decision and warned that Washington would be "inquiring closely" over the next several days as to the basis for China's response.

Gold Takes Out $1000/oz, China Alarmed by US$ Printing, CIC Looks To US Real Estate, FHA: Another Taxpayer Assault?

Gold changes hands above $1000/ounce this week as China continues to sound the alarm regarding US$ weakness...

China alarmed by US money printing - Daily Telegraph Daily Telegraph reports

The US Federal Reserve's policy of printing money to buy Treasury debt threatens to set off a serious decline of the dollar and compel China to redesign its foreign reserve policy, according to a top member of the Communist hierarchy.

Cheng Siwei, former vice-chairman of the Standing Committee and now head of China's green energy drive, said Beijing was dismayed by the Fed's recourse to "credit easing". "We hope there will be a change in monetary policy as soon as they have positive growth again," he said at the Ambrosetti Workshop, a policy gathering on Lake Como. "If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies," he said.

China's reserves are more than -- $2 trillion, the world's largest. "Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets," he added. The comments suggest that China has become the driving force in the gold market and can be counted on to buy whenever there is a price dip, putting a floor under any correction.

I devoted Monday's post to the rise of the inflation trade. Well, I thought I'd throw another log on the proverbial fire with the story below. The Chinese realize they are in possession of a bunch of rapidly depreciating paper and they are in the process of plowing said paper into any hard asset they can find. This process is, of course, the very definition of inflation.

CIC looks to pile cash into U.S. real estate - WSJ
The Wall Street Journal reports China's $300 bln sovereign-wealth fund is eyeing big investments in distressed U.S. real estate, according to people familiar with the matter. To finance some of the deals, China may rely on the U.S. government.

In recent weeks, officials from China Investment Corp. have held talks with U.S. private-equity fund managers, including BlackRock (BLK), Invesco Ltd. (IVZ) and Lone Star Funds, about potential investments in beaten-down property assets, namely mortgage securities backed by office buildings, hotels, strip malls and other commercial property. CIC also is considering buying ownership interests in buildings, according to the people with knowledge of the matter.


In addition, CIC is weighing investing through one of the U.S. government's bailout programs, the Treasury's Public-Private Investment Program, known as PPIP. The program is designed to rid banks of toxic mortgage securities by enticing investors to buy these assets with financing from the U.S. government. Representatives for CIC, BlackRock, Invesco and Lone Star declined to comment.

Here we go again...

Concerns are mounting FHA may need taxpayer assistance - WSJ
WSJ reports as it tried to help shore up the ailing housing market during the past year, the Federal Housing Administration increased its exposure, particularly to mortgages in high-cost states that have also seen some of the sharpest price declines.

Now concerns are mounting that the agency -- and the U.S. taxpayer -- may have to pay the price. The FHA insures loans secured with down payments as low as 3.5%. But values in many markets in which it has been increasing its activity have fallen far more than that in the past year. The result: A growing number of homeowners with FHA-backed loans owe more than their homes are worth and are more likely to default Officials worry that the resulting losses will help push the FHA's reserves below the level required by Congress. The value of those reserves will be revealed in the agency's annual review due Sept. 30. If they have fallen below the minimum, that could prompt a new round of questions about the role government should play in stabilizing the housing market.

David Stevens, the FHA's new commissioner, said on Friday that the agency will continue to support the housing market and isn't in danger of needing a taxpayer bailout. But some housing analysts warn that, if home prices decline much further, the agency would require taxpayer assistance for the first time in its 75-year history.

US$ Decline, T-Bond Prices Decline / Rates Up, CRB Index Down, Precious Metals Higher

By viewing the five charts above, (UUP = US$, TLT = Treasury bonds, CRB = Commodities, GLD = Gold) you have just witnessed a graphical demonstration of the beginning of the stagflation trade. Those of you who read this blog regularly know we have been warning of the inevitable rise of hyper-inflation at a time when a jobless recovery will lead to the obvious quagmire of a stagnant economy. Well, last week's price movement across a broad front foreshadows the deleterious economic environment ahead.

Allow me to fit the puzzle pieces together and create a little illumination:

• UUP = US$ -> The US$ broke down against a basket of currencies last week and in doing so took out major long-term support. The weakening US$ trend has been going on for a while as the Fed continues to print currency out of thin air in an attempt to stimulate the economy. The latest magic trick and perhaps the last straw has been the monetization of treasury debt. The Fed's buying of government debt at a time when the Obama administration continues to inflate the deficit has led to a loss of confidence in the US$ as the reserve currency of the world. This corrosion of confidence and abuse of Fed powers is the leading cause of the hyper-inflation trend. Remember, inflation is a currency event not an economic event.


• TLT = Treasury bonds -> T-bond prices were down last week which of course results in higher yields. This rate creep up is in its infancy. However, if rates continue to rise, eventhough the Fed is supporting the market, this will be a clear indication that inflation fears are beginning to dominate.
  
• CRB = Commodities -> The commodity complex as a whole sold off last week. Basic materials such as energy suffered declines indicating that an economic recovery is not in the offing. I would not typically read too much into any one week but with the US$ off so much last week one would have expected to see the whole commodity complex higher. Instead, we witnessed a bifurcated commodity complex that screams of stagflation; economically sensitive commodities suffered as inflation sensitive commodities rallied.
  
• GLD = Gold -> The key inflation sensitive commodity rallied strong last week as did the price of silver. Tuesday the 1st was perhaps the most telltale day when the inflation sensitive precious metals complex closed higher in the face of a stronger US$.

The developments of last week could be viewed as troubling if you are not prepared. However, if you are a member of the Rosenthal Capital Management family, then you are all smiles this week. You know we are prepared for this development and in fact welcome the trend.

I feel at this time we are compelled to clear up a little misunderstanding. We should give credit where credit is due. Yes, Ben Bernanke has been able to create "shoots" in the economy. We stand corrected and beg for Ben's forgiveness for our ever doubting his ability to create "shoots". We would however, respectfully request he visit his ophthalmologist or perhaps a neurologist to discuss his confusion recognizing colors. The "shoots" that he sees are real but they are GOLDEN not green.

Cerberus Update, Weak Retail Sales, FDIC's Blair Worried About Commercial Loans, Prime Borrowers Becomming a Problem, VMware Company of Interest

Cerberus denies talk of fund defaults - Reuters
Reuters reports Cerberus Capital Management yesterday dismissed market speculation that some of its hedge funds, which have suffered losses and heavy redemptions, are in danger of default. Traders in London and Frankfurt were buzzing with talk that a major hedge fund was headed for default. Much of the talk was directed at Cerberus, a private-equity and hedge-fund firm hit hard by losses at Chrysler and GMAC. "There is absolutely no truth to the speculation," said Tim Price, a Cerberus spokesman.

Where have we heard this type of denial before? Oh yes, I remember, last year with Bear Stearns and Lehman denials to name just a few. We better keep an eye on this story. We learned last year that big hedge fund failures can lead to big problems for the equity markets.

Weak back-to-school sales spell trouble for holidays - WSJ
WSJ reports shoppers are focusing on deals and limiting buying mainly to necessities, based on August sales estimates that herald another tough holiday season for beleaguered retailers. Despite sales tax holidays in several states designed to spur sales, back-to-school spending remains lackluster, according to industry experts.

Retailers' recent efforts to shake customers from deep discounts and spur buying by tightly controlling inventories are fizzling. Now, retailers that traditionally rely on back-to-school sales as an barometer of demand for the remainder of the year face tough choices on stocking and hiring. Customers should find ever slimmer pickings and fewer clerks (this doesn't bode well for those thinking unemployment is close to the peak) as stores hold off on early holiday orders and further trim costs...

We have seen an equity market recovery in the first half of this year based on a return to normalcy in the credit markets. Going forward, a new catalyst will need to develop to push the equity markets higher. One such catalyst could be an economic recovery and in turn better earnings in Q3 and Q4. However, stories like the one above cast a pall over a possible economic recovery and raise the question: Can the equity markets continue to move higher if positive earnings momentum does not materialize?

The following two stories add to the shroud being drawn over any possible recovery in Q3 and Q4...
FDIC's Bair says commercial loans "looming problem" - Reuters.com
Reuters.com reports the chairman of the FDIC said commercial real estate issues will increasingly drive U.S. bank failures. FDIC head Sheila Bair told CNBC Tuesday evening that commercial real estate loans remain a "looming problem" for banks' balance sheets and she expects the area to increasingly be a driver for bank failures during the remainder of this year and 2010.

Bair said she would try to avoid tapping its line of credit with the Treasury Department. "We'd like to try to avoid that," Bair told CNBC in an interview... Bair said the FDIC has not yet decided whether to charge the bank industry more special assessments to replenish the fund. She defended the loss-share agreements that the FDIC has extended to acquirers of failed banks, saying the arrangements have saved the agency billions of dollars over the past two years.

Pace of delinquencies for prime borrowers is accelerating - WSJ.com
WSJ.com reports the long recession and rising joblessness are taking an increasing toll on the nation's most credit-worthy borrowers, who are now falling behind on their mortgage and credit-card payments at a faster pace than people with poor financial histories.

The mortgage-delinquency rate among so-called subprime borrowers reached 25% in the first quarter but appears to be leveling off, rising only slightly in the second quarter. The pace of delinquencies for prime borrowers is accelerating. Since prime loans account for 80% of U.S. bank exposure to mortgages and credit cards, these losses could ultimately exceed those from weaker borrowers. Such delinquencies on mortgages made to prime customers rose 5.8% in the second quarter, compared with a rise of 1.8% among subprime customers. Still, the delinquency rate for prime loans was 6.4%, far below the 25.4% rate for subprime loans, according to the Washington-based trade group.

Companies of Interest
(Please click on the link above to review previous EPS/Company posts)

Periodically I will post the EPS news or other relevant coverage of companies we find interesting. This is not a recommendation to purchase or sell the shares. I will not engage in the hackneyed approach of other bloggers and give advice about when to buy or sell. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Of course, if you are an investor in any of the Fortune's Favor Family of Funds or a client of RCM our door is always open. Feel free to call or email questions at any time.

VMW VMware: AmTech reviews Vmworld 2009; sees virtualization approaching acceleration phase (33.75 ) With approximately 12,500 attendees, AmTech was taken aback by the activity level at Vmworld 2009. Throughout the day, firm spoke with numerous contacts and clearly the IT industry remains committed to virtualization. In fact, firm has increased conviction that virtualization is approaching an acceleration phase in its adoption curve. They believe virtualized desktop infrastructure (VDI) will be HUGE. In fact, a VMW executive believes it offers a ~50% reduction in total cost of ownership and that the industry will be 50% virtualized within 5 yrs. Customers want to save money and lessen complexity. Virtualization is the #1 vehicle for CIOs to both save capex/operating expense dollars while easing complexities of the data center. Virtualization penetration of new server shipments is ~15% in CY09...

Swedish Riksbank Takes Unprecedented Step, FOMC Minutes, Gold Bullish

This story is a must read and read carefully. The unprecedented actions of the Swedish Riksbank may be the precursor to a whole new phase of the quantitative easing shell game. And make no mistake about it, a true shell game is going on with the worlds fiat money supply.

The central bankers are moving ever greater amounts of consistently devaluing currencies from one hat to another in an attempt to get the public or should I say, the sucker, to spend money it doesn't have. Of course, hustlers don't work alone. A partner usually jumps in first and throws money around to get everyone excited, or perhaps stimulated is the more appropriate word. Can you guess who the partner is in this scenario? Leave your guess by posting a comment at the end of this post.

I'm reading through the minutes of the latest FOMC meeting as I write this missive. The FOMC again is reiterating the need to keep interest rates low for the foreseeable future. If we fit this FOMC fact together with the recent comments out of China's central bank confirming their decision not to touch interest rates or lending standards for at least the next six months a puzzle begins to take shape. The puzzle is a picture depicting the fear of an economic slowdown dramatically out weighing any concerns about inflation. And if we now add the story below to the puzzle a crystallization of the image appears.

The picture I have just described is overwhelmingly Gold bullish. I trust you will not dismiss the $25 gold advance today as coincidence.

Bankers watch as Sweden goes negative
By Andrew Ward in Stockholm and David Oakley in London

For a world first, the announcement came with remarkably little fanfare.
But last month, the Swedish Riksbank entered uncharted territory when it became the world’s first central bank to introduce negative interest rates on bank deposits.

Even at the deepest point of Japan’s financial crisis, the country’s central bank shied away from such a measure, which is designed to encourage commercial banks to boost lending. But, as they contemplate their exit strategies after the extraordinary measures of the past two years, central bankers will be monitoring the Swedish experiment closely.

Mervyn King, the Bank of England governor, has hinted he may follow the Swedish example as the danger of a so-called liquidity trap, where cash remains stuck in the banking system and does not filter out to the wider economy, is an increasing concern for the UK.

Hoarding is exactly what happened in Japan earlier this decade when the Bank of Japan implemented quantitative easing between 2001 and 2006. Japanese banks refused to lend, in spite of central bank stimulus, because of fears over the dire state of the economy.

If this continues to happen in other economies, central bankers may be left with little choice but to follow the Swedish example. John Wraith, head of sterling rates product development at RBC Capital Markets, says: “The success of the UK’s quantitative easing experiment hinges a lot on whether the banks will use the extra money they are getting for lending to individuals and businesses. “If there is no sign of this over the next few months, then the Bank of England might consider a negative interest rate. In essence, it is a fine on banks that refuse to lend.”

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