A Melman Minute — September 6, 2011
| By | Leonard Melman |
|---|---|
| Date | September 6, 2011 |
Thanks to the long weekend just past, we were able to update some of our economic research at “The Melman Report” and one particular study is radiating bright “red warning flags”. We are referring to the Federal Reserve Board’s publication of “Foreign Holdings of U.S. Debt.”
According to the latest available figures, the two national governments holding the greatest amount of U.S. debt are China and Japan, with China slightly over $1 trillion and Japan slightly under that figure. What we find to be of particular interest is that the Chinese figure peaked last October. When the biggest holder of U.S. government debt stops adding to their holdings and in fact is beginning to sell from that accumulation, we get very worried. Here is why.
For the best part of a decade, the U.S. as a nation has been living far beyond their means, purchasing goods from foreign nations far in excess of what they export and paying for the difference with newly-issued debt. As long as other nations and individuals were happy to purchase that new debt as it was issued, the ‘ball game’ could hold together, but if they ever stopped, then the United states would be in deep trouble and one of the results of such trouble would be the necessity of raising interest rates offered on government paper in order to attract buyers. However, raising interest rates could be catastrophic for the real estate markets in particular.
There is yet another indication that a dramatic change in momentum regarding foreign purchases of U.S. debt has been taking place. Throughout 2008, 2009 and early 2010, the year-over-year figures of U.S. debt in foreign hands showed a consistent growth rate of near or above $400 billion per year. Following an abrupt drop to the $330 billion figure in mid-2010, that rate returned to >$400 billion per year by late 2010 and early 2011 – but since then a dramatic shift has taken place.
Beginning in March 2011, a steady decline in the year-over-year comparison figure has taken place and in the first figure issued for September, the year-over-year gain had shrunk to just +$276 billion, the lowest such figure since 2007! In our opinion, something is beginning to frighten foreigners away from U.S. government debt. It could be the weakening state of the U.S. economy, it could be the tremendous levels of debt already in existence, it could be the horrendous deficits now occurring on a regular basis or any other combination of reasons.
In our opinion, whatever the reasons, the stark figures themselves are sufficient to suggest that something particularly ominous may be taking place. This change in sentiment regarding U.S. government debt could be yet another reason why our 2011 forecast for a peak in gold of $1,850 has already been surpassed and it appears to us to be only a matter of a relatively short time span before gold exceeds the $2,000 per ounce level.
If anyone is looking for a reason to believe that something of an extraordinarily negative nature is taking place, he or she might take the time to examine the chart of the DAX Index, Germany’s major market index. We are told that Germany is Europe’s strongest economy. We are told that the Germans will be willing participants in bailing out weaker European nations. We are told that Germany is the bastion upon which other nations are betting.
With all that in mind, how then can the utterly dismal performance of the German stock market be explained – and it is utterly dismal. In just a matter of a few weeks, the DAX has collapsed from almost exactly 7,600 this spring to a Monday close at 5,246 – a loss of over 30%! It is also noteworthy that at its Monday close, the DAX was actually only about 1,400 points above the dramatic lows of early 2009, while it was now (as of Monday AM) 2,354 points below the highs of 2011.
In other words, the back of the long rally from March 2009 has been broken and the rate of declines in its securities markets is accelerating. This seems to us to be strange behaviour if the German economy is everything the pundits claim it is cracked up to be – and at TMR, we tend to be much more impressed with market action than politicians’ words. And that action is not good of late, not at all.
Even worse, weakness in the German market is not only confirmed, but even exceeded by weakness in Europe’s second largest economy, that of France. The French CAC Index, which is now barely 500 points above the 2009 lows, has given back fully two-thirds of the 2009-2011 bull market run.
(Just for the record, we have maintained that, while impressive, the stock market rallies in major markets since 2009 have not constituted powerful and sustainable new bull markets, but corrective rallies inside an ongoing and potentially devastating bear market which has a long way to go to the downside. The ferocity of the declines in Germany, France and other markets suggest to us that our overall interpretation is not far from the mark.)
For many months, analysts have been attempting to explain why mining companies, particularly those directly associated with gold, have seen their average price action significantly under-perform record-setting action in the metal itself. Several important reasons are now being openly discussed.
A recent study authored by financial writer Andrew Peaple suggests two possible reasons. One area of thought is that major miners frequently under-perform in relation to their own predictions. He noted that copper and metallurgical coal production for the past year has been 15% below the level of production forecast in 2008. This data suggests that the investing public does not have full confidence in the mining industry’s own projections.
Another influence on lagging share performance has been the steady increase in expenditures combined with the lengthy delays in getting projects approved. In terms of expenses, he noted significant rises of late in energy costs, wage costs and equipment pricing due to shortages. He also quotes Anglo American as stating that, “...getting the right permits to set up a new mine in Australia takes three years now, compared to one year back in 2006.” What was not mentioned is that those extended years – typical of recent delays in other nations as well - are frequently filled with huge expenditures which produce no present or future revenue, but are spent hiring experts, preparing environmental studies, adding staff to fill out seemingly endless permit applications, etc.
Our own observation is simply this: over-regulation reduces the ultimate performance of all industries, a fact which can be readily observed in the American fiascos relating to the U.S. Justice Department inflicting harm on Boeing for simply choosing the most economic place in which to locate a new plant; in their attack on numerous lenders for ‘not supplying sufficient information relating to the risks of residential loans’; and for the recent objections to the merger of AT&T and T-Mobile USA. Ironically, these types of actions diminish the ability of industry and commerce to provide new jobs – which is supposedly the highest priority of governments.
Financial markets in North America opened sharply lower this morning with the Dow Industrials plunging by almost 300 points and the TSX Index down by over 200. However, by 8:30 AM PDT, some rallying is taking place and presently the Dow is off by about 220 while the TSX is only slightly improved at about -185. Gold opened stronger, reached a new historic high above $1,920 and then encountered heavy selling, driving the price down to near $1,880 at present. Silver, platinum and palladium are all trading moderately lower while base metals are also lower on balance and mining share indexes have given back early gains and are now close to unchanged.
In other markets, crude oil is down by about $2.00 per barrel, the U.S. Dollar Index is sharply higher to just under 76 and long term interest rates, both 10 year and 30 year, have been driven down to record low levels.