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Original Analysis

POSTED ON April 4, 2011  - POSTED IN Original Analysis

The following article was written by Mary Anne and Pamela Aden for the April 2011 edition of Peter Schiff’s Gold Letter.

7 Gold nearing $1500, silver nearing $40, oil well above $100! What a week… what a month… what a year!

Escalating violence in Libya is adding fuel to the already strong bull markets, especially with concern growing that turmoil could spread into even more countries.

The threat of possible supply disruptions is providing the real fire under oil, while demand continues to grow. Gold and silver, in turn, are the safe havens as inflation concerns and uncertainty prevail.

POSTED ON March 29, 2011  - POSTED IN Original Analysis

By Michael Pento

By its very definition, fiat money is something created out of thin air: the word “fiat” is Latin for “let it be done” (as in, by decree). But the convenience that such a currency system offers central bankers is paid at the expense of savers. With nothing of real or lasting value on which to anchor, the value of fiat currencies can always blow away like ashes on a windy day.

For the past 40 years or so, every country on the planet has relied on fiat money. To a very large extent, this means that the national economies are far more exposed to the whims of their central bankers than they have been in the past. So, if central bankers go off their meds, the danger to the currency becomes profound. Unfortunately, at America’s Federal Reserve, it seems the inmates are now running the asylum.

We are being led to believe that falling prices are evil, and that only an increase in inflation can save our economy. From the moment the financial crisis took hold in 2008, Fed Chairman Ben Bernanke has looked to lower the dollar’s value and cause asset prices to rise – especially in real estate. But his pitch is wildly off the mark. The Fed can’t control the exact rate of inflation, nor can it direct where inflation will be distributed across the economy. In other words, inflation is like a knuckleball: once you let it loose, you’re never really sure where it’s going to go. And Bernanke’s pitches are so wild it would make Tim Wakefield jealous.

Thus, we are seeing rising prices everywhere except where Bernanke really wants them – real estate. Data released last week shows that the median price of existing homes declined 5.2% in February compared to the previous year, to $156,100. New home prices fared even worse; the median sales price dropped to $202,100 in February, from $221,900 a year earlier – a tumble of some 9%!

However, commodity prices provide the arena in which the the Fed’s lack of inflation control becomes most apparent. So far this year, gold is up over 4% and the CRB Index is up 8%.

Meanwhile, over the same period, the dollar has dropped over 4% against other fiat currencies, according to the Dollar Index. This has occurred despite global economic developments that would normally benefit a currency that has “reserve” status: Japan, the world’s third largest economy, has been taken off-line due to a catastrophic earthquake; the EU is facing another massive bailout bill as Portugal failed to pass austerity measures; and, a sandstorm of destabilizing revolutions is sweeping through the Middle East. Yet, instead of providing a safe haven for skittish capital, the dollar has recoiled.

It’s really no wonder that faith is waning. As the dangers of inflation become increasingly apparent, there is still no prospect for a change in policy any time soon. By all reasonable accounts, commodity prices will continue to surge as real interest rates continue to fall. Right now, the yield on the one year T-bill is .23%, while the YoY increase in inflation is 2.1%. And this is using the government’s twisted figures! I estimate real interest rates are somewhere close to -8.75%. Therefore, investors are being thrust into the arms of precious metals and away from dollar-based assets. There really isn’t much choice.

However, since the real estate market was in a prolonged and lofty bubble, it will be the last asset class to respond to the Fed’s dollar debasement strategy. Although Bernanke is noted for his Great Depression scholarship, it should be obvious by now that he never spent much time studying asset bubbles. If he did, he would have learned that gold took decades to recover from its crash in 1981. The NASDAQ is still 45% below its all-time nominal high set over a decade ago. And, unlike housing prices, these markets were allowed to clear themselves after their respective crashes. Prices dipped more than 70% before turning north in earnest. In contrast, home prices are being kept in a rump bubble by Fed stimulus. Amazingly, since 40% of the core CPI is owner’s equivalent rent, Bernanke will continue to miss the mark about the true level of the inflation he has created.

The aftershock of the real estate bubble has sent millions of homes into foreclosure, left 11% of homes vacant, and caused 23% of mortgage holders to be without any equity in the home. Unless the Fed starts to create credit to buy houses directly off the market, it will be very difficult to get real estate values to move higher.

It is clear that by trying to channel his inflation into just one asset class, Bernanke has placed the entire US economy in severe danger. He now faces a serious conundrum. Does he raise interest rates significantly to fight inflation at the cost of a second housing market collapse, or does he sit idly by and watch the broader economy become as unaffordable as a resetting Option-ARM mortgage? Neither choice is pleasant, but one thing’s for sure: if the bond vigilantes start to raise interest rates for him, we’ll know his knuckleball missed the strike zone.

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POSTED ON March 23, 2011  - POSTED IN Original Analysis

By Peter Schiff

Very few people have either the time or patience to sift through the data released by the Treasury Department in the wake of its bond auctions. But the numbers do provide direct evidence of the country’s current financial condition that in many ways mirror a financial shell game that typifies our entire economy.

Despite continued deterioration of America’s fiscal health, the Treasury is still attracting adequate numbers of buyers of its debt, even with the ultra low coupon rates. Market watchers take these successful auctions as proof that our current monetary and fiscal stimulus efforts are prudent. But who’s doing the buying, and what do they do with the bonds after they have been purchased?

Most people are aware that foreign central banks figure very prominently into the mix. They buy for political reasons and to suppress the value of their currencies relative to the dollar. And while we think their rationale is silly, we do not dispute that they will continue to buy as long as they believe the policy serves their own national interests. When that will change is harder to determine. But another very large chunk of Treasuries go to “primary dealers,” the very large financial institutions that are designated middle men for Treasury bonds. In a late February auction, these dealers took down 46% of the entire $29 billion issue of seven year bonds. While this is hardly remarkable, it is shocking what happened next.

According to analysis that appeared in Zero Hedge, nearly 53% of those bonds were then sold to the Federal Reserve on March 8, under the rubric of the Fed’s quantitative easing plan. While it’s certainly hard to determine the profits that were made on this two week trade, it’s virtually impossible to imagine that the private banks lost money. What’s more, knowing that the Fed was sure to make a bid, the profits were made essentially risk free. It’s good to be on the government’s short list.

Given that the Treasury is essentially selling its debt to the Fed, in a process that we would call debt monetization, some may wonder why it doesn’t just cut out the middle man and sell directly. But the Treasury is prevented by law from doing this, so the private banks provide a vital fig leaf that disguises the underlying activity and makes it appear as if there is legitimate private demand for Treasury debt. But this is just an illusion, and a clumsy one to boot.

One wonders how the market could be soothed by these results when they are so clearly manipulated. But the more important question is when the foreign governments reverse their currency policies, and when the investment banks are no longer guaranteed a quick short term profit, will there be anyone left willing to show up at Treasury auctions?

According to the Office of Management and Budget, the U.S. government is expected to run a $1.6 trillion deficit in fiscal year 2011 (which expires in September). The Federal Reserve’s current quantitative easing program is taking down a large share of that red ink. But “QE2” expires in July, and in fiscal year 2012, the Federal government is projected to run a $1.1 trillion deficit (that of course could grow if the economy weakens). An additional $1.1 trillion in Treasury notes and bonds will mature over that 12 month period. So in total, the Treasury will need to issue a total of at least $2.2 trillion in notes and bonds in FY 2012. This translates into quarterly borrowing needs of approximately $550 billion, more than double the average of the last two quarters. To put this into perspective, the entire U.S. personal savings rate is about $650 billion annually. Even if every dime of this amount were ploughed into Treasuries, we would still need to borrow or print another $1.6 trillion.

At the height of the financial crisis in Q4 2008, the Treasury issued a record $560 billion of notes and bonds. Fortunately for them, that spike corresponded neatly with huge inflows of funds into Treasuries as investors sought safety from collapsing equity and corporate debt markets. Will the Treasury catch that break once again? There may be another financial panic, but will investor reaction be the same this time around? Bill Gross, the founder and chief investment officer of PIMCO, the world’s largest private purchaser of bonds, recently announced that he is reducing his Treasury holdings to zero. It is not clear what would convince Gross to get back into the market with both feet, but one might expect at minimum it would take much higher interest rates.

If private investors stay on the sideline, how does anyone expect the Treasury to sell its inventory without the support of a quantitative easing program from the Fed? Do they expect the Chinese to reverse course on their current policy and start heavily buying U.S. debt once again, irrespective of the damage to their own economy? That seems extremely unlikely given the drift in Chinese currency policy. More likely the Fed will remain the only buyer, meaning QE3, 4, and 5, are all but certainties. There should be no remaining doubts…the U.S. Government intends to monetize its own debt. Of course, as bad as things will be if QE ends, it will be that much worse the longer it continues.

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POSTED ON March 18, 2011  - POSTED IN Original Analysis

By Peter Schiff

One of the immediate financial consequences of the catastrophic Japanese earthquake is that Japan needs to call on its huge cache of foreign exchange reserves to rebuild its shattered infrastructure. To pay for domestic projects, Japan will require yen – not dollars, euros or Swiss francs. As a result of these conversions, the yen rallied considerably after the quake struck.

POSTED ON March 14, 2011  - POSTED IN Original Analysis

Michael Pento’s Market Commentary

A few months ago, the chorus sung by the recovery cheerleaders reached a crescendo when expanding consumer credit statistics and surging US trade deficits provided them with “evidence” of an economic rebound. In declaring victory, they overlooked the very nucleus of this past crisis: namely, the enormous debt levels and bubbling inflation that created fragile asset bubbles. If they had recognized the original problem, they would have remained silent. In reality, only a reduction in US debt levels or increase in the value of the dollar would have signaled a budding recovery; but, thanks to the Federal Reserve and Obama Administration, there is virtually no way those results will ever be seen.

Last week’s Flow of Funds report issued by the Federal Reserve clearly underlines the fact that we, as a country, haven’t just avoided deleveraging, but rather continue to accumulate debt. At the end of the last fiscal year, total non-financial debt (household, business, state, local, and federal) reached an all-time record high of $36.2 trillion. Not only is the nominal level of debt at a record, but also debt-to-GDP – a far more worrying statistic. In Q4:07, total non-financial debt registered 222% of GDP. In 2008 and 2009, it was 238% and 243% respectively. As of Q4:10, that figure had risen to 244% of GDP, For some perspective, look back to the turn of the millennium, when total debt-to-GDP was ‘just’ 182%. Even that level points to a sick economy, but today’s make you wonder how the patient is still breathing.

It is clear to me that the overleveraged condition which brought the economy down in 2008 still exists today – only worse. For all the suffering and displacement that has gone on, all we have accomplished is an unprecedented transfer private debt onto the Treasury’s balance sheet. Now that the Fed is (hopefully) just months away from taking the printing presses off overtime, the paramount question is how fast interest rates will climb. The Fed has been able to keep yields this low through relentless devaluation and a propaganda campaign that convinced the majority of investors that deflation was a credible threat (kinda like those phantom Iraqi WMDs).

But Washington’s ability to continue that ruse is coming to an end. The unrelenting growth of the Fed’s balance sheet, increasing monetary aggregates, surging gold and commodity prices, $100/barrel oil, soaring food prices, and trillions of dollars of new debt projected for the near future have served to vanquish the deflationists. Any echoes of those once prominent voices can barely be heard amid the thunderous roar of oncoming inflation.

So therein lies the problem for the Fed. Any further debt monetization by the central bank now becomes counterproductive. That’s because as inflation rates climb, bond investors demand higher interest rates. The lower real interest rates become, the less participation there will be in the bond market from private sources. If you don’t believe me, ask Bill Gross.

The Fed is now damned if it does and damned if it doesn’t. Interest rates have been artificially suppressed for such a long time that no matter what Bernanke does come June, interest rates will rise. If it enacts another iteration of Quantitative Easing, the Fed may find itself the only player in the bond market. Of course, the Fed could potentially buy all of the auctioned Treasury debt in order to keep rates low—as uncomfortable a position as that may be—but still all other interest rates, from bank loans to municipal debt, would skyrocket. Unless… the Fed decided to buy all that debt too. Hello Zimbabwe!

That scenario is still farfetched, but Bernanke’s logic eventually leads there. The truth is that only a central banker could afford to own bonds that are yielding rates well below inflation, and growing even more so. Even if Bernanke ceases firing dollars into the bond market, yields will still have to rise to the level at which they provide a real return. How much higher would rates go, you ask? Well, Mr. Gross has some thoughts on that:

“Treasury yields are perhaps 150 basis points or 1½% too low when viewed on a historical context and when compared with expected nominal GDP growth of 5%. This conclusion can be validated with numerous examples: (1) 10-year Treasury yields, while volatile, typically mimic nominal GDP growth and, by that standard, are 150 basis points too low; (2) real 5-year Treasury interest rates over a century’s time have averaged 1½%, and now rest at a negative 0.15%!; (3) Fed funds policy rates for the past 40 years have averaged 75 basis points less than nominal GDP, and now rest at 475 basis points under that historical waterline.”

To the above I say: not a bad start, Mr. Gross, but these aren’t exactly average times. We have never had a Fed balance sheet anywhere near the $2.6 trillion that it is today. The nation has never faced the prospect of $1 trillion deficits as far as the eye can see. Nor have we ever had our total debt as a percentage of GDP reach 244%.

The bottom line is that a massive increase in the supply of debt coupled with a rising rate of inflation will always place upward pressure on interest rates. Once the Fed steps aside from buying 70% of the Treasury’s current auctioned output, it will leave a gaping hole. And for those Pollyannas who claim we are in an economic recovery, I would ask them the following questions: Who will supplant the Fed’s purchases of Treasuries at current yields? Since the level of debt in the economy has grown since the recession began, why won’t rising rates place us back into an economic funk? Can the Fed unwind its balance sheet before inflation ravages the country? And, if the Fed isn’t able to raise rates significantly, what will stop the dollar from collapsing?

Then again, I guess it all comes down to one simple question: do you believe the laws of supply and demand apply to US Treasuries? If you do, then watch out for soaring yields.

POSTED ON March 7, 2011  - POSTED IN Original Analysis

By Peter Schiff

As the world confronts one of the most critical periods of economic upheaval that it has ever seen, it is clear that our most influential economic stewards have absolutely no idea what they are doing. But, like kids with a new chemistry set, they are nevertheless unwilling to let that stand in the way of their experimental fun. As they pour an ever-growing number of volatile ingredients into their test tubes, we can either hope that they magically stumble on the secret formula to cure the world’s ills, or more pragmatically, we can try to prepare for the explosion that is likely to result.

POSTED ON March 2, 2011  - POSTED IN Original Analysis

By Peter Schiff

In the world of precious metals, silver spends a lot of time in the shadow of its big brother gold.

Gold, with its high price-to-weight and distinctive yellow tint, has always occupied a special place in the human psyche. To many people across many ages, gold is simply the ultimate form of money – and, as a long-term, stable store of value for one’s personal wealth, I agree it’s hard to beat.

However, rare circumstances are aligning today that I believe will make silver the true champion of this bull run.

POSTED ON March 2, 2011  - POSTED IN Original Analysis

The following article was written by Mary Anne and Pamela Aden for the March 2011 edition of Peter Schiff’s Gold Letter.

7 The commodity market is on fire! Be it copper, cotton, cattle, corn, sugar, energy, or resources… most tangibles are at record highs or new highs. This is why the CRB index also recently hit a record high.

Growing global demand has been the main driving force, with a boost from other factors like natural disruptions and political scares.

Gold and silver tend to move in the same general wave as the rest of the commodity world, but the reasons why are different in many ways.

POSTED ON March 2, 2011  - POSTED IN Original Analysis

Michael Pento’s Market Commentary

It now appears that the United States has finally succeeded in its efforts to destroy confidence in the U.S. dollar. Given the currency’s reserve status, its ubiquity in financial markets, and the economic power and political position of the United States, this was no easy task. However, to get the job done Washington chose the right man: Fed Chairman Ben Bernanke. Thanks to Bernanke’s herculean efforts, investors across the globe have now been fully weaned from their infantile belief that the U.S. dollar will remain the ultimate safe haven currency.

The proof of Ben’s success can be seen in comparing how the foreign exchange markets reacted to the recent crisis in the Middle East with how they reacted to the financial crisis of 2008. Back then, investors looking for safety abandoned their foreign currency positions and piled into the U.S. dollar (the market for U.S. Treasury Bonds in particular). As a result of these fund flows, the U.S. dollar surged 20% from August to November 2008.

However, during this latest round of global destabilization the dollar experienced no such rally. In fact, the greenback shed about 5% of its value since the Tunisia revolution began in December of 2010. The reason should be clear; the Fed has placed international investors on notice that it will unleash even greater doses of dollar debasement at the first whiff of additional economic weakness, deflation threat, or dollar appreciation. Just this week, Bernanke once again made clear that despite what he considers to be a better growth outlook at home and abroad, and spreading global inflation, the United States will not pull back from monetary accommodation, even as other nations conspicuously do so. The architect of U.S. monetary policy has stated explicitly that dollar debasement will continue for the indefinite future.

Knowing this, why would any international investor seeking a “safe haven” choose to park assets in U.S. sovereign debt? If Bernanke is to be believed, continued economic weakness in the U.S. will cause low-yielding Treasuries to lose value due to inflation while the weakening dollar erodes the underlying value of the bond in real terms. This is a one-two punch that sane investors will seek to avoid. It is no coincidence that a record percentage of U.S. Treasury auctions are now being bought by central banks, for whom sanity is a lowly consideration.

But in reality, the Fed has much less influence over the dollar’s value than do central bankers in Beijing. There is little disagreement among economists that without Chinese support, the dollar would be a dead duck. But for the last twenty years or so the monetary arrangement that pegged the yuan against the dollar served the interests of both countries. The U.S. enjoyed a flood of cheap imports, the benefits of ultra-low interest rates, and a strong currency. The Chinese received a booming export economy, which accounted for about a third of the country’s GDP, and the ownership of a significant portion of the future of the United States. To maintain this peg, the People’s Bank of China had to print trillions of yuan and perpetually hold more than $1 trillion U.S. dollars in reserve.

But recently, having led to rampant money supply growth and inflation in China, the peg has become more trouble than it’s worth, particularly from the Chinese perspective. The latest reading on YOY money supply growth has China’s M2 increasing by 17.2%; which has helped send their reported CPI up 4.9% YOY.

Inflation in China is pushing up the prices of its exports. According to the latest survey released February 14th from Global Sources (a primary facilitator of trade with Greater China), export prices of various China products are likely to increase in the months ahead, especially if the cost of major materials and components continues to soar. The survey of 232 Chinese exporters revealed that 74% of respondents said they boosted export prices in 2010. The U.S. Bureau of Labor Statistics reported in early January that its China import price index rose 0.9% in the fourth quarter after holding steady for the previous 18 months. And Guangdong, the biggest exporting province, said recently that it would increase minimum wages by around 19% this March.

But here is the rub; China maintains its peg in order to keep export prices from rising in dollar terms. But the peg is now causing export prices to rise anyway. As a result, the policy is a dead letter. The simple fact is that the threat to China’s exports will exist whether they let their currency appreciate or not. But a strong currency offers the benefit of greater domestic consumption, while a weaker currency offers them nothing.

The Chinese government will take the path that preserves and balances their economy while enriching their entire population, rather than go down the road to never ending inflation. For China the realistic hope is that the greater purchasing power of a strong currency will enable their growing middle class to supplant U.S. consumers as the end market for China’s own manufacturing efforts. However, for the U.S. the challenge will be to develop a diversified manufacturing base in an expeditious manner before surging interest rates, a plummeting dollar and soaring inflation overwhelm the economy.

The dollar’s recent reaction to the turmoil in the Middle East and China’s inflation problem illustrate that we have come to a watershed moment in American history. The decade beginning in 2010 should prove to be the decade in which the U.S. dollar loses its status as the world’s reserve currency. As bad as that blow may be, the loss may provide the shock needed to get our economy back on a sustainable path. The real danger lies in refusing to adapt to the changing environment. Our current economic stewards are acting as if the dollar’s status is written in stone, when in fact it’s hanging by a thread.

POSTED ON February 24, 2011  - POSTED IN Original Analysis

Michael Pento’s Market Commentary

Civil revolt is currently spreading across the Arab world. What began in Tunisia has now metastasized into Bahrain, Egypt and Libya. Though two dictators have been ousted, the chances that these regimes will fundamentally transform from autocracy to a system of free markets and property rights are also up in the air. An important question is whether or not Saudi Arabia will eventually get into the mix; and, if so, whether the current struggle in Libya would morph into a proxy war between Saudi Arabia (Sunni Muslims) and Iran (Shiite Muslims). It remains to be seen whether the new regime in Egypt—whatever form it ends up taking – will allow Iran to use the Suez Canal to parade warships across the Mediterranean Sea and into Syria. If so, what would Israel’s reaction to such a perceived provocation be?

There are many unknowns, but what is known is that the turmoil has had an immediate and significant impact on the price of oil. WTI is now trading just below $100 a barrel and Brent Crude is already well above the century mark. If the unrest does indeed spread to Saudi Arabia – which produces 12 million barrels of oil per day and is the second largest producer in the world – mainstream analysts have made some wild predictions about how high the oil price could reach. Rising energy prices will further cripple the third world, which has already been placed under extreme pressure from skyrocketing food costs.

The United Nations announced in early February that global food prices were at an all-time high. The USDA indicated this week that 2011 corn inventories will be the lowest since 1974. Despite the fact that farmers have boosted the output of wheat, rice, and feed grain by 16% since 2000, demand has outstripped supply by 4 percentage points. Corn is up 95% and wheat has increased 70% since their year-ago levels. Overall, global food costs have jumped by 25% YoY since January 2009.

It is evident that global consumers continue to get pummeled by rising food and energy prices. Meanwhile, in addition to coping with rising inflation rates, the US consumer is also being hurt by the continued contraction in the price of houses – which are typically their primary assets. S&P/Case-Shiller indicated on Tuesday that their National Index dropped 4.1% from Q4 2009 thru Q4 2010. Home values have now dropped for 6 consecutive quarters and clearly indicate the real estate sector is suffering a double dip. The ramifications of all the above data are foreboding for US GDP growth. Most importantly, anemic economic growth will worsen our debt-to-GDP ratio and thereby place further pressure on our already damaged balance sheet.

The Fed’s reaction will be as predictable as ever.

We already know that Chairman Bernanke exculpates the Fed for any blame in creating inflation either domestically or abroad. In fact, he refuses to even consider rising food and energy prices in his definition of inflation. Americans could be paying $50/pound for ground beef, but as long as their houses are still losing value, Bernanke doesn’t see an inflation problem. Meanwhile, they’re eating squirrel for protein while making payments on a mortgage twice as expensive as the house.

The truth is that Bernanke doesn’t know what causes inflation, so he can’t be expected to spot it, much less do something about it. Using the Fed’s own history as a guide, Bernanke will view rising commodity prices as a threat to GDP growth and a sign of pending deflation. That’s because the Fed is caught up in a ‘Phillips curve’ philosophy that only equates economic growth and prosperity with inflation. In short, Bernanke believes that slow growth and rising unemployment rates equate to deflation, despite plentiful contrary examples in history.

Since he believes rising commodity prices are deflationary and have nothing to do with his own loose monetary policy, the Fed is likely to expand its balance sheet to a greater degree. The fact that the Fed’s massive money printing effort is the progenitor of global food riots completely escapes him. As more damage is done, the Fed will use the resulting contraction in GDP to justify a third round of quantitative easing – further harming the GDP.

Unfortunately, the vicious cycle of stagflation will grow more acute with each iteration of the Fed’s love affair with counterfeiting. Countries that make the mistake of continuing to peg their currencies to the US dollar will suffer more inflation and more destabilization. Since it will be hardest for the US to ditch the dollar, our hopes are dimmer.

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