Archive for July, 2010

Prepare to pull the trigger on speculating!

Thursday, July 29th, 2010

Back in When to start speculating again?, we mentioned that

When governments do ?something? about the deflationary pain, it will be a signal to shuffle your money back into speculation.

So, what will be the signs to watch out for?

Just a month ago, RBS warned their clients to get read for this:

Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on “monster” quantitative easing (QE)”.

Marc Faber reckoned that it will happen soon and has given a rough time-frame…

When the money spigot turns on again, that’s the sign to start speculating again (note: speculate at your own risk). For those who are new, please read Bernankeism and hyper-inflation to understand the context of this article.

If the Australian economy ?booms? further, how is it setting the stage for a bigger bust later?

Wednesday, July 28th, 2010

Not long ago, the former Prime Minister of Australia, Kevin Rudd warned that Australia is facing a demographic crunch, which if not solved, will have grave implications on the Australian economy in the long-term. To put it simply, everything else being equal, Australians are getting older and older, which means that the Australian economy will not be able to continue increasing its production of goods and services. That means that the economic growth will slow, stagnate and eventually turn negative. On top of that, the Australian economy seems to have a problem with ?skills shortage,? which is threatening future economic growth (see Skills shortages shaping up as risk to economy).

Given that the Australian economy (as in most other modern economy) is a debt-based one, any slowing of growth will result in deflation, which is a complete show-stopping outcome (see Why is the modern economy so dependent on ever-lasting growth?).This demographic situation that Japan is already facing right now, and as we wrote in Currency crisis: UK, Japan and US, will be the first developed nation to face the consequences of the demographic time-bomb.

The easy solution is to increase the immigration intake, in order to fill the ranks of tax-payers, skilled workers and consumers so that the ?bicycle? economy can continue to stand (a bicycle has to move continuously in order to stop toppling).

Unfortunately, the idea of further population growth is an extremely unpopular among the electorate. Complaints, gripes and dissatisfactions related to the population issue (e.g. too much time in traffic jams, commuters crammed like sardines into trains and buses, poor-quality housing, rising power prices and climate-induced water shortages) are making the electorate fed-up. With the Federal election looming, no politician will want to be seen to support the idea of further population growth.

So, who is to blame for this? Since Australia is one of the least densely populated nations in the world, Australia should not be overcrowded in theory. But what happened?

The easiest target to place the blame on is the government, both on the Federal and State level. There is a chronic lack of investments in infrastructure, health, education, basic services and urban planning. Their symptoms include overcrowding, congestion, price inflation of basic services like utilities, rising youth unemployment.

But before we place all the blame on the government, what about the private sector? Businesses are warning politicians against the idea of cutting immigration levels, which will exacerbate the ?skills shortage? crisis.

But instead of blaming the government, let us thrust this provocative idea?could the ?skills shortage? crisis be at least partly due to businesses not investing in the training and development of its workers? There are some statistical and anecdotal indications (and you may even personally experience them):

  1. Youth unemployment rate in Australia is three times nation average
  2. Long-term unemployment continue to rise (see Growing structural unemployment in Australia)
  3. Discrimination against the unemployed job-seekers
  4. Discrimination against those who do not meet the stringent ?experience? requirements

If you look carefully at the above list, you will notice a commonality among them: the presence of a positive feedback loop (see Thinking tool: going beyond causes & effects with systems thinking) ? the disadvantaged job-seeker becomes less desirable as an employment candidate, which further disadvantages that job-seeker. Anyone in this situation will eventually give up in seeking employment, which results in him/her becoming long-term unemployed.

From some anecdotal observations, businesses (especially the small businesses which account for the majority of employment in Australia), on the other hand, have ?no time? to invest in training and development of its workers. Since they are flat out producing and making ends meet, such investments are considered dead monies that do not contribute to the bottom line. Furthermore, given the ?skills shortage,? they would not want to invest on their workers, only have them poached by other business. Again, there is a positive feedback loop here: lack of investments result in lack of growth in productivity, which in turn reduces the margins required for investments (see Another Achilles Heel of modern society- narrow margin), which discourages further investments, which result in further lack of growth in productivity.

As you can see by now, the easiest way out for the business sector is for the government to increase the intake of skilled migrants. That way, they can have the skills they require at the expense of others (those who trained the skilled migrants back in their home countries). That is why you will see them business industry leaders lobbying against the politicians? popular intention of cutting migration.

If for whatever reason, Australia does not fall into a deflationary recession, and pressure for the economy to increase its production of goods and services intensifies, we will see the ?skills shortage? crisis intensify. There will be further upward pressure on wages, which will increase the costs for businesses. Rising cost will place further pressure on the viability of some businesses, which will in turn increase the risk of business failures.

At the same time, if nothing is done about the long-term unemployment issue, then there will be a further division between the haves and have-nots in Australian society as those who are currently and appropriately skilled and employed will enjoy higher income while those who are unemployed and/or underemployed will be become more so. As more and more unemployed join the ranks of long-term unemployed, it will result in more social problems and further increase in the budgets of the government through increased welfare payment.

On the other hand, if the immigration spigot is loosened to alleviate the ?skills shortage? crisis, it will lessen the upward pressure on wages but put upward pressure on the price inflation of essential services, which in turn will induce the RBA to increase interest rates further. For a country where households are highly indebted, rising interest rates and/or price inflation will further strain family budgets, which will further increase the risks of debt defaults. This situation is a classic illustration of the Austrian Business Cycle Theory. As we quoted Ludwig von Mises in The first step in an economic slowdown?mal-investment in capital,

It is customary to describe the boom as overinvestment. However, additional investment is only possible to the extent that there is an additional supply of capital goods available. As, apart from forced saving, the boom itself does not result in a restriction but rather in an increase in consumption, it does not procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. The entrepreneurs employ the available supply of r + p1 + p2 as if they were in a position to employ a supply of r + p1 + p2 + p3 + p4. They embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later. The unavoidable end of the credit expansion makes the faults committed visible.

In the same way, if the Australian economy continues to ?boom,? entrepreneurs may not account sufficiently for rising price inflation (due to lack of infrastructure) or wage levels (lack of appropriately skilled labour). This will make many investment projects unrealizable (especially the mining projects). In fact, some businesses may even not be viable. For example, a recent survey found out congestion is affecting worker productivity and causing business owners to think of closing their businesses or move it elsewhere. These are symptoms that the economy does not have sufficient resources to maintain the current trajectory of growth. Eventually, more and more liquidation of mal-investments (e.g. projects, businesses, etc) will happen. Unfortunately, with the private sector of the economy highly indebted, this can trigger debt deflation. The end result will be a massive waste of unrealizable capital investments and projects. In 2007, we caught a glimpse of the effects of mal-investments?Owen Hegarty, former MD of Oxiana (today is called ?OZ Minerals?) said in a newspaper interview (see Rising metals price=rising mining profits? Think again!),

The cost increase at Prominent Hill makes Oxiana the latest resource developer to feel the impact of tight construction market conditions and cost increases in materials and equipment ? the so-called downside to the commodities boom.

“I think we’ve nailed it now,” Mr Hegarty said. “We’ve got that little bit of extra padding with the contingency (up from $75 million to $88 million) and we’re only 12 months away from commissioning. Being within the zone of a 30 per cent increase inside of 12 months is actually not too bad when compared with what other people are experiencing.

“Just about every second you turn around, the price of something else has gone up.”

From what we see, the Australian economy has hit a ceiling for which it is very hard to break through. For this reason, as Australian-based investors, we are looking into increasing our allocations to investments that have greater exposure overseas (note: this is NOT financial advice).

Why central bankers are obsessed with inflation not breaching a certain band?

Sunday, July 25th, 2010

If you follow central bankers all over the world, you will notice that for many of them, their monetary policy (under normal economic circumstances) targets a particular rate of price inflation. In Australia, the RBA targets price inflation to be around the 2-3% band, according to their preferred measure of price inflation. In the US, the band was 1-2% (we doubt they are in the position of targeting price inflation now, given that they are now in the zone of unconventional monetary policy). It is not the same for every central bank though. For example, Singapore?s central bank, Monetary Authority of Singapore (MAS), based their monetary policy on the exchange rate.

By now, you may wonder why the RBA specifically target the band of 2-3%? Why not 4-5%? Why not 9-10%? Why not even higher so that price inflation will ?inflate? away the debt of the masses, as in the 1970s?

Around 4 months ago, Saul Eslake wrote a very insightful article (unusual for a mainstream economist),


These inflation targets were chosen because, when inflation is about ”2-point something”, people tend not to notice it. And when they don’t notice it, they tend not to do things to protect themselves against it that are likely to lead eventually to prices rising at a faster rate.

By contrast, when inflation is, say, 4 per cent or higher, experience amply demonstrates that people do notice it – and they start to do things to protect themselves against its adverse consequences, such as seeking higher wages, or (in the case of businesses) putting up prices in anticipation of faster increases in costs.

The inevitable result is that, sooner or later, inflation starts rising at a faster rate than 4 per cent, and the central bank is eventually obliged to raise interest rates to slow the economy sufficiently to bring inflation back down to 4 per cent again. But when it has done so (at some cost in terms of unemployment), people start doing the same things again to protect themselves against the effects of 4 per cent inflation.

In other words, a 4 per cent, or higher, inflation rate is unlikely to be sustainable in the way that a 2 or 3 per cent inflation rate has been. It is likely to result not only in inflation being more volatile, but also in economic activity being more volatile and, probably, slower on average.

You may notice that this is what we implied in an article that we wrote back in December 2008: Demand for money, inflation/deflation & its implication. Once you understand the logic, you will be able to see the application of systems thinking. In other words, once price inflation goes over a tipping point, it becomes a dynamic process whereby money supply will balloon in an ever increasing positive feedback loop, resulting in higher and higher price inflation rate, which if not arrested, becomes hyperinflation.

Concerns about China’s slowdown

Thursday, July 22nd, 2010

Back in April, when economic ?experts? were expecting further growth in the Chinese economy, we wrote in this article that

Contrarian investors like Marc Faber believes that the Chinese economy will ?slow down regardless? any time from now on. Whether this slowdown will be a nice soft-landing or a gut-wrenching crash is another matter.

Marc Faber was on record for saying that there?s a possibility that China may ?even crash.? How could the pundits missed the signs that something is really wrong with the Chinese growth in 2009? As we wrote back then, there were plenty of signs:

? there are massive excess productive capacities in the Chinese economy. As we wrote in Is China going to dump their excess metal stockpiles?, there are eye-witnesses? reports of ghost cities, vacant office blocks and apartments in China. It had been reported that China?s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined. All these points to a massive mis-allocation of resources in China, which according to the Austrian School of economic thought, a pre-cursor to a bust (see our free report, What causes economic booms and busts?).

That?s why, as we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap, the Chinese government will have to rein in their runaway economy sooner or later (e.g. through administrative means, revaluation of the yuan). The longer they delay, the bigger the inevitable bust will be.

Today, the financial markets are finally noticing that China is slowing down more than expected. For example,

  1. Rate of decline for Chinese industrial production is more than expected.
  2. And if Chinese government statistics can be believed, even the inflation numbers were below expectation.
  3. Spot iron ore prices have been in free-fall since May.
  4. Steel production has now fallen to its lowest rate of growth since 2001.
  5. The Baltic Dry Index has lost more than 50% in one month.

Back in January, when we wrote Chinese government cornered by inflation, bubbles & rich-poor gap, we were wondering when the Chinese government will bite the bullet and rein in the runaway economy. We didn?t have to wait long to see it happening.

The question that the pundits and the financial markets will be wondering is this: will this unexpected rate of slowdown continue for rest of the year? Will it continue on to 2011? If they get it wrong (again), it goes to show that they have underestimated the resolve of the Chinese government to cool down the economy.

The risk is that the Chinese government may accidentally let the slowdown turn into a crash. We shall see.

Silver question on “How to buy and invest in physical gold and silver bullion”

Tuesday, July 20th, 2010

Yesterday, we were very delighted to receive this email from one of our readers regarding our book, How to buy and invest in physical gold and silver bullion:

I have been reading through your archives for the past few weeks, and also have just finished reading the gold and silver ebook. It is a wonderful resource, and I feel for the first time that I now have some educational starting points that will make any investing I do more of a strategy and less of a gamble.

I wanted to ask you about a point that came up in the gold and silver book – when talking about storage there was plenty of practical information about the security aspects, and a glancing mention of the fact that silver will corrode/tarnish and so will need to be kept in a “sealed” environment.

Could you possibly add some detail to that point? How sealed should it be? Absolutely airtight? Is there any way to clean it or reduce this problem without detracting from the value of the bullion/B Coin? Over what length of time will this be an issue?

Thanks again for a great e-book and for a very accessible and educational journal. I’m enjoying learning how to think again.

If you want to know the answer, you can look up this article on our other web site: More details about storing silver.

Should you leverage to the max in a long-run bull market?

Sunday, July 18th, 2010

Between 1970 and 1980, gold was in a bull market. In 1971, the average price of gold was around US$40. By January 1980, it hit US$850. So, the question is: Surely, it was a good idea to leverage as much as you can in the 1970s (assuming you knew that gold would be in a bull market)? Since gold prices multiplied by 21 times from 1971 to 1980, and if you leverage to the maximum at any time in the 1970s, you will become filthy rich by 1980 right?


If you leveraged say, 10:1 in December 1974, you will be likely to be financially wiped out by August 1976. Between that time, gold prices fell from US$195 to US$103- a correction of 47%. Then from August 1976, gold resumed its up-trend to the high of US$850.

The lesson here is clear. Even in the midst of a long-term bull-market, you can become bankrupt if you are highly leveraged and unlucky.

Next question to ask: What if a lot of people are highly leveraged at the same time, in the same asset class, believing that it is in a long-term bull market? We will turn the answer to this question to our readers.

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Thursday, July 15th, 2010

This announcement is for those who are into trading?

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Another biased media report: home loans on the rise?

Tuesday, July 13th, 2010

In our report, How To Foolproof Yourself Against Salesmen & Media Bias, we wrote about how the media uses headlines to slip in their bias.

Well, here is a great example from this article in the Sydney Morning Herald (SMH)- Home loans on the rise:

The number of home loans issued to borrowers have marked their first rise in eight months are buyers looked beyond higher interest rates to wade back into the market. In a sign of caution, though, the size of a typical loan shrank.

In an another article from the SMH- Home loans up for first time in eight months:

A WEAK spot in the property market is showing tentative signs of recovery, after a surprise bounce in new lending to home buyers.

The headlines from the Daily Telegraph isn?t much better.

Despite the positive spin in these headlines, there?s a little detail that caught our eye. What is it?

These paragraphs were tucked in Home loans on the rise:

The monthly rise also masked some mixed trends including a surge of refinancing sparked by lower 3-year fixed rate loans, said Westpac senior economist Andrew Hanlan.

Excluding refinancing, the May figure is up only 0.8 per cent, following a 0.1 per cent fall in April, according analysis by Westpac.

Borrowing for owner occupied housing also edged down 0.3 per cent to $13.7 billion, seasonally adjusted.

In other words, most of the ‘rise’ in home loans are due to refinancing. Refinancing basically means ‘closing out’ the existing loan and taking out a new loan. The headline number included the refinanced new loan but does not subtract the old loan that was ‘closed out.’

Arguably, when refinancing increases, it is a sign of financial stress as borrowers tend to refinance themselves out of problems first before trying other options. Although this may or may not be the case for the majority of refinancing, at the very least, the reality is not as positive as what the headline implies.

We shall see.

If you want deflation, you would love Germany

Sunday, July 11th, 2010

From our previous article, one of our readers was very indignant at the current state of affairs. As he wrote,

During inflationary times, those who speculated made more money than those who held cash. so you could argue that those who held cash felt the "inflationary pain" but why wasn’t the government pressured politically to do something as they were when they get spooked by deflation?

Then when deflationary times come its the turn of those who held cash to benefit while those who already made their money out of speculation and over leveraging to feel the "deflationary pain", after all they did take too much risk.

I don’t think its fair or right for governments to manipulate the economy to prop up the prices of the investments of the speculators (who helped create all these bubbles in the fist place). Basically that means that they got to make a lot of money out of speculating but they didn’t take any real risk as government will step in to do "something" about the pain.

If the don’t feel the pain they will continue recklessly speculating.

Meanwhile that very same "something" the governments will do to help the speculators avoid pain will probably mean devaluation of the currency one way or another so that once again those who did not speculate and over leverage will feel the pain.

The governments actions will tend to encourage more people to speculate! I would like to see deflation happen, does anybody else feel the same way???

On the first point, why are governments more spooked by deflation than by inflation? The simple reason is that in a democracy, the mob rules. Unfortunately, the mob is heavily indebted as a whole. All we have to do is to look around and see that the culture of debt is deeply ingrained in society. For young people, not only is it fashionable to get into debt, it is very difficult not to get into debt. For example, buying your first home is enough to put you in debt for decades.

The last time governments became spooked by inflation was in 2008 when oil and food prices shot through the roof (see Who is to blame for surging food and oil prices?). If governments continue its policy of doing ?something? about deflation for a sustained period of time, we believe it will be a matter of time before prices of necessities will resume its surge again. As usual, the blame will be put on ?shortages? and ?speculators.?

But not all governments in the world are biased towards inflation. Germany is the exception here. The trauma of the hyperinflation during the Weimar times is seared into the German consciousness. As a result, they will avoid anything that hints of inflation. Unlike the English-speaking countries, politicians in Germany who stick to discipline, austerity, balanced budgets and stand against moral hazards see their popularity go up.

Coincidentally, Germany is also the most important member of the Euro zone. As a result, their attitude towards inflation is being imposed on Europe. In the recent G-20 meeting, the G-20 endorsed a halving of budget deficits by 2013 as the target.

But as George Soros wrote in a recent article,

The situation is eerily reminiscent of the 1930s. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banking system and the economy may not be strong enough to do without fiscal and monetary stimulus.

The Great Depression of the 1930s is one of deflation. In Soros? opinion, the G-20?s endorsement of government de-leveraging has increased the risk of deflation today.

So, in the coming months, we can see why the deflation argument will be gaining the upper hand.

When to start speculating again?

Thursday, July 8th, 2010

As we wrote before in Notice the change of narratives in the financial markets?, the theme for the coming months is likely to be deflation (contraction in the supply of money and credit). The symptoms of deflation will include falling asset and commodity prices and appreciation of the US dollar.

The reason why deflation is gaining the upper hand is that governments are not renewing their appetite for maintaining the crutch (economic ?stimulus?) to keep the economy from sinking. In Europe, the government themselves are deleveraging (see Keep up spending- Who?s right? Europe or America?).

But as contrarian investors, we have to keep one step ahead. As deflationary forces gather steam, eventually the government will be spooked. Eventually, they will be pressured politically to do ?something? about the situation. That ?something? will ultimately boils down to turning on the monetary printing press.

For example, as this news article reported, there is an expectation that the Chinese government will do ?something? if stock prices continue its downward trajectory. In the US, RBS recently warned its clients to be prepared for a ?monster? money-printing operation from the Federal Reserve (long before RBS released this, readers of this blog already know beforehand that this will happen- see Bernankeism and hyper-inflation).

When governments do ?something? about the deflationary pain, it will be a signal to shuffle your money back into speculation.