By B.P.T., on October 20th, 2011
At 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 400,000 new jobless claims last week, which would would be 4,000 less than the previous week.
At 9:45 AM EDT, the weekly Bloomberg Consumer Comfort Index will be released, providing an update on Americans’ views of the U.S. economy, their personal finances and the buying climate.
At 10:00 AM EDT, the Philadelphia Fed Survey report for October will be released. The consensus is that the index will be at -9.8, which would be an increase of 7.7 points from the previous month.
Also at 10:00 AM EDT, the Existing Home Sales report for September will be released. The consensus is that existing homes were sold at an annual rate of 4.93 million last month, which would be an decrease of 100,000 from the previous month.
Also at 10:00 AM EDT, the Leading Indicators report for September will be released. The consensus is that this index was increased 0.3% last month, following an increase of 0.3% in the previous month.
At 10:30 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
By Christopher Briem, on October 19th, 2011
The news is that Harrisburg has filed for bankruptcy. While technically true that they have filed for bankruptcy, this may be shot down before it all begins. The funniest part of this at the moment is that all the judges for this are in Tampa for a conference. So hold your breath.
Remember, bankruptcy has not been far below the horizon here in the past. The closest the city of Pittsburgh should have come to bankruptcy was in the early 1990’s just as Tom Murphy became mayor. Yet the history is that the City of Bridgeport, CT had just before that time tried to file bankruptcy but was denied by a federal court to even enter bankruptcy. Municipal (Chapter 9) bankruptcy is not like bankruptcy for you and me in lots of ways. US constitutional issues prevent a judge from exerting many of the powers over a state entity the same way might happen in recievership for an individual or company.
In Bridgeport’s case the court ruled that the city was not really broke enough to file for bankruptcy, i.e that it had the fiscal capacity to tax or borrow its way to meet its obligations. Unlike other bankruptcies which really look at assets and liabilities, Chapter 9 is more about cash and the fiscal capacity to raise cash. Most public assets are not going to be considered for sale or liquidation no matter, so there is no risk of the mayor’s chair being carted off to a flea market.
The thing is that while I believe the City of Pittsburgh was in a far worse shape than Bridgeport was at the time, that precedent was clearly the biggest thing on the mind of city lawyers who likely advised a bankruptcy filing would not go forward. I personally bet they were wrong on that and that Pittsburgh was not in as good shape as Bridgeport was and well over the line of insolvency in a public sense. There is even a school of thought that says if Bridgeport just waited another year before filing its fiscal condition would have been so bad that the court would have had no choice but to let the filing go forward.
Still I bet Bridgeport’s aborted bankruptcy is the only thing that kept the Murphy administration from filing for bankruptcy right as they took office when they were told the city was about to go cash zero. Prevented from bankruptcy all sorts of even worse things happened. The result was that over the subsequent decade city in succession ’sold’ or liquidated the water department into the water authority (long story there), the city’s debt ballooned, tax liens sold off to a third party without much concern for city of Pittsburgh development and no significant increase (Pension bonds were a wash I would say.. at best) in pension funding would leave us where we are today. So today we have more debt, more pension liability, no direct control of the water system (think of all the problems that has caused) and had much of a decade of neighborhood economic development arrested because it was held hostage by a wall street company that couldnt spell in Latin.
Then there is this logic people say the Commonwealth of Pennsylvania must ‘approve’ any bankruptcy filing. Also technically true in the legal sense. In the real world sense it is not so important. The lawyers might argue, but consider a few things. In Pennsylvania the state approval for letting a federal bankruptcy filing go forward is mostly embedded in the Act 47 law and process. There has been municipal bankruptcy in Pennsylvania, even one recently in the case of Westfall Township. Did Westfall get permmission to file for banktruptcy? I would argue it didn’t in that an Act 47 process only began after they filed and had a bankruptcy proceeding move forward. The state went along, but it was kind of after the fact. And in one of the stranger acts of jurisprudence.. some folks may remember the monster AHERF bankruptcy that still lives on in shaping the region’s state’s health care system. AHERF, even though it was not a municipality, was a Chapter 9 bankruptcy. Does not quite make sense to me, but I think it was just too big and too complex to really fit into a Chater 11.
In the bigger sense it does not matter if the state really approves a major bankruptcy or not. If bills go unpaid, or say bond payments don’t go out. Bad things happen and at some point someone would be forced to do something. The state would have little choice to ‘approve’ a bankruptcy, or a judge would find some way to rule that a filing could go forward.
Also unmentioned in the article is the story of Vallejo, California and its bankruptcy that is just about to come out of. That also is a case where I have argued the fundamental finances there are far better than they were (or are) here. Go figure and again think about all the victory signs last month when the state accepted the while pension accounting scheme. Is Vallejo a model for what may happen in Harrisburg? Probably not just yet.
So what happens now? My guess is that when the judges get back from Tampa and have a hearing on any of this they are likely to push back and say no… no filing for you. Sort of like the soup guy on Seinfeld. Federal judges are not going to want to get into what is, on top of everything else, a political circus in the city of Harrisburg. They will tell them they are not there to settle the city’s political problems, whether or not that is the verbiage of any actual ruling who knows. So a bankruptcy may happen… but I bet it is not right now.
Still, I am surprised the Commonwealth let this all get this far already. There are consequences across the state for such financial miasma in any one municipality, let alone in the state capital.
By Simon Grey, on October 19th, 2011
As can be easily seen from this chart (source), the money stock as measured by the Federal Reserve has grown by approximately 6.67% in the last five months! Since real GDP is projected to grow by only 1% (and will likely be revised downwards ex post), this means prices are going to rise fairly dramatically in a short period of time. And just in time for the holidays!
Anyway, there are a couple of ways this will play out, at least in the short-term. Either consumers will face higher prices or manufacturers, suppliers, and/or retailers will face lower profit margins (or some combo of these possibilities). I doubt that retail prices will rise much in the short term because most people can’t afford price hikes in lieu of relatively stagnant income over the past year. Instead, I think businesses will eat the increased costs in the short term, most likely through the holidays and the post-holidays stock liquidations.
After the new year begins, though, I think prices will begin to rise. And when that happens, it won’t be pretty. Thanks, Bernanke!
By The Gold Report, on October 19th, 2011
 According to Edward Karr, CEO of RAMPartners, the band is tuning up and the guests are just starting to arrive. Instead of selling before the party really gets going, he advises keeping a “decent percentage” of cash to take advantage of opportunities to buy both physical gold and junior mining stocks. His real bottom-line advice in this exclusive Gold Report interview? Tap into what makes you happy in life.
The Gold Report: RAMPartners is based in Geneva, Switzerland, a country that made economic news a month ago when the Swiss National Bank capped the Swiss franc at 1.20 francs per euro, slashed interest rates and flooded the market with Swiss francs. Did you agree with those moves and what impact do you think they had on the gold price?
Edward Karr: I emphatically disagree with the move by the Swiss National Bank. To me it makes no sense to peg the Swiss franc at 1.20 to the euro. Switzerland is, in effect, backstopping Greece and all of the other indebted countries in Europe. This is lunacy. Greece or anyone can just hit the Swiss National Bank’s bid at 1.20 and convert into Swiss francs, which it would probably rather have than its euro position.
Since this policy, we’ve seen a psychological shift in markets. People have been rethinking the Swiss franc as a safe-haven currency. The Norwegian kroner looks more like a safe-haven currency now than the Swiss franc. I’m just happy Switzerland is not part of the European Union and not part of the euro. I hope it will understand the foolishness of the 1.20 peg and get rid of it soon.
As to the current effect on the gold price, right around when this happened gold topped and started to sell off. I don’t think they are directly related, but I think it is psychological. If the Swiss franc holds at 1.20 to the euro, if a hedge fund or a corporation hits the Swiss National Bank with a billion euros, it is no big deal. But what about 10 billion, 100 billion, even a trillion? Then it starts becoming a big deal. At some point does Switzerland have to start selling its gold reserves to continue this lunacy? Switzerland now has 1,146 tons of gold. Maybe people are worried that if that gold starts to come out it could put downward pressure on the bullion price; hence, we have seen a little sell off in the overall market.
TGR: Just a few years ago, the Swiss Central Bank had more than 2,000 tons of gold in its reserves. What is your view on the sale of so much of its reserves?
EK: I think it was extremely shortsighted. Switzerland has a long history of fiscal stability and gold has been a very important part of that stability.
Right now, Switzerland has the world’s eighth largest gold reserve, which is quite impressive for such a small country. But, the 1,146 tons of gold it has at current market values is really only about $60 billion. That might seem like a big number, but it is minuscule in comparison to the trillions that global governments are going to have to print to combat this increasing financial crisis.
TRG: Gold has fallen steadily since reaching about $1,900/ounce (oz.) in August. It now sits at about $1,670/oz. Why has it fallen recently?
EK: I think the logical explanation for falling prices is that gold is a relatively liquid asset. Governments, hedge fund managers, bankers and individuals are all facing a severe cash crisis. In that environment you have forced liquidations. Governments are doing all they can to put a positive spin on a terrible environment. But, if you’re a global macro hedge fund manager who has heavy redemptions, you have to sell your liquid assets to raise cash.
Man Investments is one of the biggest hedge fund groups. Last month it announced record redemptions of $7 billion. The firm has to raise cash, so what is it going to do? There are no bids out there for Greek debt, no bids for mortgage-backed securities, no bids for countless other OTC financial derivatives. Gold is liquid; it is easily tradable and has been part of the massive global scramble to cash that we’ve seen in the last two to three months.
TRG: How low could gold go?
EK: That’s a great question. The only credible answer is that gold can go a lot lower than anyone expects. A lot of Johnny-come-latelies have bought into gold in the last few years. A big downdraft will shake out a lot of loose hands.
Europe is on the edge of a cliff. Dexia Bank might fall any day. UniCredit in Italy is right behind. I think we will see a severe domino effect that will make 2008 seem like a walk in the park. If Dexia or UniCredit or the European Central Bank itself had a big major gold position and it had forced liquidation, it will have to sell and the price could go down pretty dramatically.
TRG: Are you willing to be more specific on the price?
EK: It would not surprise me at all if I came in tomorrow and gold was at $1,000/oz., a 60% decline from the current levels. If gold were to fall that dramatically, to $900/oz. or $1,000/oz., it would represent an incredible buying opportunity. That’s when you would want to go all in and buy all you could, because it will snap back like a bungee jump.
When you buy gold, you want to buy it and take physical possession. Owning gold isn’t about the price paid. You shouldn’t look at the price every single day. By the time this crisis is over, it’s going to be about how many ounces you actually have in your possession—under your mattress, in your safe, not in your bank, I hope.
TRG: Your fund holds bullion and junior precious metal equities. How have you changed the way you manage the fund in the midst of this volatility?
EK: We have adjusted our portfolios and we are managing money a little differently. Volatility has certainly increased. In the last month, junior mining stocks are down 40%, 50%. When you get into these high volatility ranges, liquidity drives up as well, delivering a one-two punch. Selling 10,000 or 20,000 shares on a junior mining stock can take it down 25%.
You have to be nimble and you have to be able to stay the course. You don’t want to over-leverage. You want to keep a decent percentage of cash and have some dry gunpowder to take advantage of big sell-off opportunities.
TRG: When I look at my investment portfolio, which consists largely of junior gold explorers, I see nothing but red. I want to sell everything and wait for opportunities. Do you believe that is prudent or do you have better advice?
EK: The investment game is 99% psychological, and it is you against yourself. In my experience, when you feel it is the right time to sell it is exactly the wrong time to sell. I sincerely believe that investors who sell out now are going to miss out on one of the greatest rides of their lives.
Central banks around the world are going to have to put together trillions of dollars. Quantitative Easing (QE) 3 is going to make QE1 and QE2 seem like a little prelude. The Fed is going to have to team up with the European Central Bank and print an incredible amount of money to recapitalize the whole financial system. When they do that, it will set up a moon shot for precious metals and junior mining companies.
This party is just getting started. You can see the house, you can hear the music and see people, but you have not even walked in the front door. Wait for the party; don’t leave before it even begins!
TRG: What are some rules of thumb for investing in junior resource companies during uncertain times?
EK: I like to own good companies with solid management teams and great assets. And then, it all comes down to the timing. The current markets are fantastic for finding attractive entry points. As a general rule, when it feels the worst is usually the best time to buy.
When people get scared, markets and stock prices get way out of line. That is when you need to have the courage to really step in and accumulate. Worst case, if the banks collapse and the ATMs actually do stop working, those who own physical gold will be better off than 99% of the other people out there. But it is more likely that the markets will rebound quickly as QE3 comes in and the ECB and the Fed turbo charge the printing presses. Then, the junior mining stocks and bullion will be off to the races.
TRG: What are some names you have positions in?
EK: I’m quite bullish on Sagebrush Gold Ltd. (SAGE:OTCBB), which trades on over the counter in the U.S. I like the company because it recently acquired a former producing gold mine and mill in Nevada. Nevada is a great jurisdiction; it has rule of law, most of the mines are easily accessible and it has the geology. It is the second most prolific gold zone in the world after the Witwatersrand of South Africa. Sagebrush bought the Relief Canyon mine and its brand-new $30 million (M), state-of-the art facility. It should start production by mid-2012. Relief Canyon currently has a 155 thousand ounce (Koz.) resource and it has an aggressive exploration program on the property right now.
TRG: There are dozens of companies in Nevada. What makes this one different?
EK: A couple of things. Sagebrush has an asset ready to go into production tomorrow. With junior exploration companies that becomes really important. If you have a producing cash-flow asset, you are not as subject to overall market conditions, especially financing, that many junior companies get themselves into. Plus, Sagebrush has strong financial backers including Dr. Philip Frost as a significant shareholder. That gives me a lot of comfort the company will get into production quickly.
Let’s look at the economics of Sagebrush and assume gold holds at $1,500/oz. Sagebrush’s cash costs at Relief Canyon should be about $700/oz. With their 155 Koz. resource, that project could throw off $125M in cash flow over the next two to three years.
And the really exciting part of the Sagebrush story is its very high potential exploration package. The senior exploration geologist is Art Leger, an old hand who has been very successful. I believe he has found upward of 20 million ounces of gold on different crews and discoveries. He came to Sagebrush with a property called Red Rock; a friend who is a legendary natural resource investor told me he felt the Red Rock property was possibly the best exploration address he has ever seen.
Sagebrush’s Red Rock property is surrounded by some of the majors: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:NYSE; ABX:TSX), Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.A) and Paramount Gold and Silver Corp. (PZG:NYSE.A; PZG:TSX). This is prime exploration real estate and Leger thinks there are several world-class deposits on Red Rock. Sagebrush has a RC rig on property right now. It has done extensive geophysical work, defined drill targets and the drill program is underway.
TRG: Is Sagebrush looking to get listed on the TSX Venture or the TSX main board?
EK: I believe so. It is exploring both the TSX and the AMEX in the U.S. I would like to see the company listed on a more major exchange, where it will get increased visibility and liquidity, probably more research and publishing.
There is a further arbitrage opportunity here. Recently, Sagebrush acquired all of the assets of Continental Resources Group Inc. (CRGC:OTCBB). The deal was 0.8 shares of Sagebrush for every share of Continental. I believe the acquisition is still being worked out and the share swap will happen in the next few weeks. So the big opportunity is to buy the shares of Continental. Effectively, you are getting Sagebrush shares at around $0.31 with the current Continental price of $0.25. Sagebrush is in the $0.50 range, so this is like grabbing dollars for $0.60. Warren Buffet recently said he would buy Berkshire all day long for $0.90 on the dollar. By buying Continental, you get Sagebrush for $0.60 on the dollar. Plus Sagebrush acquired Continental’s portfolio of uranium exploration assets. Uranium is currently really beaten up post-Fukushima, but it is not going away longer term. I believe uranium prices will rally back when the cycle turns and patient investors will be well rewarded on this unique play.
TGR: One interesting note with Sagebrush is that it has Debra Struhsacker, an environmental consultant, as part of the management team. That’s unusual. Would you care to comment on that?
EK: Debra is a fantastic addition to the Sagebrush team. Having the foresight to have an environmental consultant in at this early stage of the company’s evolution really shows the management team is very serious and it is looking to move this project into production as fast as possible.
TGR: You talked about having some powder dry for when you’re ready to strike. What striking opportunities do you see in the market at this point?
EK: I like Nevada, as I mentioned. Another location that I really like is Colombia, which I think is setting itself up to be one of the hottest mining destinations of the future. Colombia is doing all of the right things from a political and economic standpoint. It has incredible undiscovered resources.
We’re a shareholder in a new gold exploration company there called Dicon Gold Inc. It is a Canadian company that is currently private. But I understand that it plans an IPO on the TSX in the next couple of months. Dicon has an incredible management team in place. I think this is really going to be one to watch.
TGR: Did you get in at the capital pool level or as a private placement?
EK: It was a private placement. I don’t think it is a capital pool; it is a straight IPO. We just recently participated in a private placement that was a very, very small round. We want to get involved in a much bigger way on the IPO.
TGR: Do you have one more name?
EK: Going back to Nevada, Yukon-Nevada Gold Corp. (TSX:YNG) is a real interesting opportunity. You’re looking at a stock that is $0.37 a share. I just had the management team in my office and I was very impressed with their presentation. The company has $80M in cash and a $300M market cap. It will re-enter production with one of the few roasting facilities in Nevada capable of producing 300 Koz. a year consistently. It has an autoclave in the recovery circuit.
Yukon-Nevada is an incredible buy. From what I understand, a couple of New York City hedge funds that had a substantial position had heavy redemptions. This stock has sold off from $0.80 down to $0.37 in the open market. We are not a shareholder yet, but we are looking to acquire at these levels.
TGR: Edward, can you leave our readers with some sage Karr wisdom that they can lean on in these unprecedented economic times?
EK: I truly believe that we are heading into a very, very challenging time for humanity in general. The ultimate goal in the financial markets is like the ultimate goal in life—to survive. But you also want to be happy and to prosper. You need to keep it all in perspective.
Your readers are in the top 1% of the global population. And if they own physical gold, they may be in the top one-tenth of the top 1%. A lot of people in the world live hand-to-mouth every day and they remain relatively happy.
I think it is really important to tap into that happiness. Take some time out to be grateful for all you have in life. Enjoy time with your friends and with your family. Spend time on what is important to you. Help people who are less fortunate than you are.
At the end of the day, we’re here for a good time, not for a long time. It is important to enjoy the journey each and every day. Don’t get so worried about the downdraft of your gold position or your junior mining stock. Keep it all in perspective.
TGR: Very wise words. Thank you for talking with us today, Edward.
Edward Karr is the founder of RAMPartners SA–an investment management and investment banking firm based in Geneva. Since 2005, RAMPartners has helped raise more than $100 million for small capitalization companies in fields such as natural resources, high technology, health care and clean energy. Prior to founding RAMPartners, Karr worked for a private Swiss asset management, investment banking and trading firm based in Geneva for six years. At the firm, he was responsible for all of the capital market transactions, investment and marketing activities. Prior to moving to Europe, Karr worked for Prudential Securities in the United States and has been in the financial services industry for 20 years. Before his entry into the financial services arena, Karr was affiliated with the United States Antarctic Program and spent 13 consecutive months working in the Antarctic, receiving the Antarctic Service Medal for his contributions of courage, sacrifice and devotion. Karr studied at Embry-Riddle Aeronautical University and Lansdowne College in London, England, and received a B.S. in economics/finance with Honors from Southern New Hampshire University. He is a licensed pilot and certified master scuba diver as well as a current board member and vice president of the American International Club of Geneva and co-chairman of Republican’s Abroad Switzerland.
By B.P.T., on October 19th, 2011
The Mortgage Bankers’ Association purchase index will be released at 7:00 AM EDT, providing an update on the quantity of new mortgages and refinancings closed in the last week.
At 8:30 AM EDT, the Consumer Price Index report for September will be released. The consensus is that CPI increased by 0.3% last month, and there was a 0.2% increase in CPI when food and energy are removed.
Also at 8:30 AM EDT, the Housing Starts report for September will be released. The consensus is that construction on 590,000 new homes were started last month, which would be a increase of 19,000 from the previous month.
At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.
At 2:00 PM EDT, the Beige Book report will be released, giving us more information about economic conditions in each Federal Reserve district in advance of the next Fed meeting.
By Ajay Shah, on October 18th, 2011
A lot is being written about inflation in India today. I thought it’s worth writing about the fascinating insights into inflation that come from focusing on the distinction between tradeables and non-tradeables.
What is a tradeable
A tradeable is a product which can be transported across the world at relatively low cost. As an example, steel is tradeable while cement or paint are mostly non-tradeable barring special short-hop opportunities like Gujarat-Karachi or Amritsar-Lahore or Calcutta-Chittagong or Trivandrum-Colombo.
Steel is a nice tradeable that one can think clearly about. There are no barriers to the movement of steel worldwide. Hence, there is only a world price of steel. The quoting convention used worldwide is to express the price of steel in USD. The price of steel in India is thus the world price of steel multiplied by the INR/USD exchange rate, plus a markup for freight (The cif/fob ratio).
If there is a customs duty of (say) 10%, then the price of steel in India is 1.1 times the world price of steel expressed in rupees. For the rest, nothing changes when a customs duty is introduced. Gram for gram, every fluctuation in the INR/USD or the world price of steel shows up in the domestic price of steel.
Non-tradeables are things like cement (which are hard to transport) or haircuts (which are impossible to transport).
Measurement
Before we can analyse and control inflation, we must measure it well. Inflation is defined as the rise in the price of the average household consumption basket. The CPI is the best measure of inflation in India.
Everything in the CPI basket can be classified into the two categories: tradeable vs. non-tradeable. As a thumb rule, WPI non-food non-fuel is a rough measure of tradeables inflation. Fluctuations in food and services prices, which make the CPI diverge away from WPI non-food non-fuel, are a measure of non-tradeables.
Year-on-year inflation reflects an averaging over 12 months. If you want to get a faster sense of what is going on, you need to look at point-on-point seasonally adjusted changes. These yield early warnings of inflation, which are 5.5 months ahead on average. Such data is updated every Monday by us. The shift from y-o-y inflation, to p-o-p SA inflation, is a free lunch in measurement and monitoring.
The WPI is a useful database of many price time-series in India. But the overall WPI is useless in thinking about inflation in India: there is no household in India which consumes the WPI basket.
The use of WPI inflation, and the exclusive use of y-o-y inflation, are litmus tests of professional competence in the Indian landscape.
The function of the central bank
The job of RBI is to deliver low and stable inflation: to deliver y-o-y CPI inflation of between 4 to 5 per cent.
They have failed in this task. From February 2006 onwards, in every single month, y-o-y CPI inflation has exceeded 5 per cent. This is an important time for introspection at RBI and outside it. What have we done wrong, in the structuring of RBI, which has got us into this mess?
It is useful to think of this as a principal-agent problem. The people of India are the principal. RBI is the agent. The principal hires the agent and gives him resources. In return, the agent has to be held accountable. Delivering low and stable inflation is the accountability mechanism. It is a quantitative monitorable measure of the performance of the central bank. That we have sustained failure on this function, from February 2006 onwards, suggests that we should be modifying the nature of the contract between the principal (the people of India) and the agent (RBI).
How RBI can influence the price of tradeables
RBI has absolutely no say on the world price of steel. In that sense, the prices of tradeables are beyond the control of RBI.
When RBI raises the interest rate, more capital comes into India, which tends to give an INR appreciation, thus making tradeables cheaper. Thus, an RBI rate hike does impact upon the domestic price of tradeables.
It is also worth pointing out that the central banks of most major countries are high quality inflation targeters. They deliver on their mandate of delivering low and stable inflation. As a consequence, inflation in the global tradeables basket tends to be low and stable. Tradeables prices are a helpful source of price stability, most of the time.
(That a large part of the CPI basket is tradeable, and seemingly beyond the control of the central bank, is no excuse. There are dozens of high quality central banks visible in the world, with very large shares of the CPI basket in tradeables, who are delivering on inflation targets. We in India should not accept excuses).
How RBI can influence the price of non-tradeables
Non-tradeables reflect aggregate demand and aggregate supply in India. RBI can influence these by raising or lowering the short-term interest rate. When interest rates are made slightly higher, household consumption and investment demand are slightly lowered.
A critical feature of non-tradeables inflation is expectations. If people expect 10% inflation, they tend to wire high price rises into their negotiation of wage and other contracts. This generates inflationary momentum. Particularly in a place like India, where the institutional structure of monetary policy is primitive, economic agents have little confidence in the ability of policy makers to rein in inflation. As a consequence, inflation is highly persistent. Once high inflation sets in, economic agents expect high inflation to continue. There is a great deal of momentum in inflation.
For years now, some economists have argued that inflation will subside by itself. It will not. Inflation does not mean-revert to the target zone of 4 to 5 per cent by itself. We are now in a trap of high inflationary expectations. This structure of expectations will need to be broken. This can happen in two ways. RBI needs to turn a new coat, and convince people that it now cares about inflation without any other conflicts of interest. And, rate hikes have to take place.
There are two paths to inflation control: changing the structure of expectations and reducing aggregate demand. The former is almost a free lunch. It only requires institutional change. The latter is hard work; it inflicts pain.
What about supply factors?
Some argue that supply bottlenecks in India – such as hideous rules about mandis – are the cause of inflation.
The trouble with this explanation is that the supply bottlenecks have always existed. They have existed in high inflation times and in low inflation times. It is, thus, not possible to claim that supply bottlenecks have caused the inflation crisis which began in February 2006.
Can rate hikes deliver inflation control?
When C. Rangarajan was RBI governor, there was an inflation crisis, and rate hikes did deliver on inflation control. The phase of price stability ushered in then lasted all the way till February 2006. This shows us that even in India, it can be done.
We have to remember that in his time, the monetary policy transmission was much weaker than what we see today. With a bigger wall of capital controls, domestic rate hikes did not deliver inflation control by impacting on the INR (through higher capital inflows). With a smaller and weaker Bond-Currency-Derivatives Nexus, the monetary policy transmission from the short rate into aggregate demand was inferior, then. Yet, he got it done.
Conversely, with a very primitive financial system and monetary policy transmission, the central bank of Zimbabwe delivered a nice hyperinflation. We can quibble about the potency of the monetary policy transmission, but we should not doubt the ultimate domination of monetary policy in shaping inflation. In the long run, little else matters in shaping inflation.
Part of the story of the 1990s lies in clarity of purpose at RBI and policy credibility. Rangarajan’s period had good quality speeches, which did not dilute the message on inflation control as the dharma of the central bank. In contrast, in recent times, RBI has repeatedly written low quality speeches. To an expert reader, they have conveyed the lack of knowledge on monetary economics at RBI. To the non-expert reader, they have waffled on the subject of taking responsibility, and have encouraged the average economic agent to think that high inflation is here to stay.  
By The Gold Report, on October 18th, 2011
 Steve Palmer, founder and chief executive of the Toronto-based investment manager AlphaNorth Asset Management, prefers metals that have uses beyond sitting in a basement safe or gift-giving. In this exclusive interview with The Gold Report, Palmer explains why he is looking closely at hardworking base metals that could take off with increasing global demand and a market rally he is forecasting through the end of the year.
The Gold Report: In August, you wrote that you did not believe the U.S economy was heading into another recession despite continued investor concerns about global growth. Do you still believe that?
Steve Palmer: Yes, there is nothing that has transpired that would cause me to change that view. The economic data has been quite good. The market was retesting the low that it hit on Aug. 9 and it briefly dipped below that level. But it had one of the largest rallies in the last 25 years to rise above that low. From a technical point of view, the retest was successful and we have continued to trade higher since Oct. 4. I believe the bottom is in and the stock market will rally significantly into the end of the year. The recent market action only further supports that view.
TGR: As we emerge from that bottom, how are you choosing between undervalued companies right now?
SP: I am trying to focus on the less speculative names. Even the companies that are well financed have been experiencing greatly depressed share prices, so there are strong gains to be made in those. You don’t have to go searching too far down the food chain into the really speculative stuff to generate strong returns.
TGR: You’ve written that equities remain extremely attractive relative to historical valuations and are particularly attractive relative to other asset classes, such as bonds. Do you believe equities are the best place for investors to be if the bottom falls out of the market, as it did in 2008?
SP: I don’t believe that the bottom is going to fall out. But if you were to believe that that’s the case, bonds are the place to be temporarily. If you remember back to 2008, the meltdown only lasted a few months and then the market started to move higher. Historically, it is clear that equities do outperform bonds over longer timeframes. Many investors do not realize that they can lose money in bonds. Investors can take a significant capital loss on bonds unless they hold them to maturity if yields go up. A 10-year bond that is yielding 2% is locking in a 2% return for 10 years and equities are likely to far exceed that.
TGR: Also, if inflation is higher than 2%, investors are losing money.
SP: Investors should also be mindful of the tax differences. In Canada, capital gains are taxed at half the rate as interest. If you’re earning 2%, by the time the taxman gets through with it, it turns into 1%. Then if you have inflation, you are losing money every year, or at least losing purchasing power.
Investors are hoarding cash and piling into fixed-income products. They will probably continue to do that until they start losing money or see others making a lot more than they are in the equity market. Then we will see a shift.
TGR: You forecast that the equity markets are going to rebound through the end of the year. So that shift could be about to occur.
SP: For many investors it is going to take longer. Most of them will probably miss at least the first half of the rally and then they will pile in right at the end.
TGR: Recently, the asset mix in the AlphaNorth Partners Fund was 37% technology, 25% energy, 27% metals and 11% precious metals. Why does the fund have more exposure to metals than precious metals?
SP: I am not a big fan of precious metals at the moment. The precious metal stocks are far more expensive than the metal names. Both in terms of a net asset value and, on a multiple basis, precious metals are typically double the price. Base metals are, as the commodities themselves are, something that gets consumed, something people actually need. Many of the products that we use today require them. Whereas precious metals have minimal uses other than sitting in your basement vault or wearing them around your neck, which is not very practical.
TGR: That’s certainly not the case with silver. Silver has a huge industrial demand component.
SP: The major uses for silver historically have been for industrial uses, jewelry and photography. The photography component has been declining rapidly with the increased use of digital cameras. If it were not for investment demand increasing in recent years, the total demand for silver would have declined. The silver price would not be anywhere close to where it is currently if it wasn’t for the investor demand through exchange-traded funds and people hoarding it.
TGR: What’s your thesis for investing in base metals?
SP: Base metals are tied to global economic growth. Global growth should reaccelerate shortly and continue to be driven by China. The results will be favorable for supply/demand fundamentals for the commodities.
TGR: What particular base metals are you most bullish on?
SP: I have no particular favorite. The companies that are represented in the fund are a mix of different base metals. Most base metals companies have a combination of metals. For example, I met with Canadian Zinc Corporation (CZN:TSX; CZICF:OTCQB) this morning, which has zinc, lead and silver.
TGR: Those are quite common in one deposit. Are there some other base metal companies that you believe have some upside?
SP: Orbite Aluminae Inc. (ORT:TSX) is a base metal name with a twist. It is not just a base metal name. The company actually works with alumina—aluminous clay, Orbite Aluminae calls it. It has a process for extracting alumina from the clay in Québec.
Québec is home to about 12 aluminum refineries because of cheap hydroelectric power. When you combine electricity with alumina you get aluminum. Basically, two tons of alumina plus some power creates one ton of aluminum. Companies have been shipping alumina in from South America and all over the world, whereas in the future, it is anticipated that Exploration Orbite will be able to supply aluminum locally for much lower cost.
TGR: That is an interesting name that might not come across the radar screen of most investors. What are some common themes in the precious metal companies that are part of the fund?
SP: They are relatively early-stage companies with favorable odds of a major discovery, or they have a very cheap valuation relative to the peer group. The holdings are skewed toward gold.
TGR: You figure out which are the best in class and then compare valuations?
SP: It is somewhat subjective. You have to assess what the odds are that the company will find something, how big the discovery could be, and weigh it against the current valuation. We try to get in situations that have cheap valuations relative to the potential of what they can find and that have high odds of actually finding something.
TGR: Do most of these companies have prefeasibility studies?
SP: These companies are across the spectrum. Some of them have a resource already. It is a question of how big the resource can get. Some of them are earlier stage where they don’t have any drilling yet, but they have some very attractive targets.
TGR: When The Gold Report spoke with you in May, you said, “If I only make 50% on a position I’m disappointed. I’m trying to get into something that has lots of potential and make multiple times my invested capital. So, that’s why we focus on the long side.” What are some positions that you have taken in the precious metals space that you believe have long-term potential for gains that are significant?
SP: One example would be Ryan Gold Corp. (RYG:TSX.V). The Yukon has had many significant discoveries in the last couple of years. It is a very hot area right now and many companies have been getting good drill results. Ryan Gold has a huge land area there. It has an abundance of soil samples and some other geotechnical work done, which indicate some very promising drill targets. The company has a market cap of about $80 million (M) versus $60M in cash as of June 30. I view it as very high odds that Ryan Gold will find a significant gold deposit on its property. It’s just a question of time. The initial drill results will be out in the next few weeks. The company is also well financed.
I do own a few other companies in the Yukon, but I have the most confidence in Ryan Gold being able to find something very significant and offering the best returns from current levels.
TGR: Are there any other stories that you really like?
SP: Majescor Resources Inc. (MJX:TSX.V) and Seafield Resources Ltd. (SFF:TSX.V:) are examples of a couple I have mentioned before.
For example, Seafield has a strong potential to add to its resource. Its valuation is less than most other Colombian junior gold explorers. I like that there has been insider buying recently in the stock.
Majescor has some similar attributes. It is in Haiti, so it’s a totally different area, but the company just recently raised money and has cash to proceed over the next year. Insiders participated in that raise as well. It’s a very low market cap.
TGR: Majescor also has a project in Madagascar, a volcanic massive sulfide project, which seems like something that you would be interested in because it has not only gold and silver, but also copper-zinc-gold-silver mineralization. What is your view on that project?
SP: The major reason that I own Majescor is for its Haiti project. But it is also good to invest in a company that has multiple projects. If one doesn’t work out then the hope is that the other one will.
TGR: What’s your outlook for gold and silver?
SP: My view of gold and silver is that they trade with the U.S. dollar. The U.S. dollar has rallied in recent weeks and gold has dropped $300. If the commodities all improve and appreciate over the next couple of quarters, gold will probably get dragged along. But they aren’t the preferred commodities that I like to invest in at the current time. I think there are other commodities that make more sense and that will perform better.
TGR: Namely?
SP: Copper, potash, oil, gas, zinc and coal.
TGR: Thank you very much for talking with us.
Steve Palmer is a founding partner and chief investment officer of AlphaNorth Asset Management. Prior to founding AlphaNorth in 2007, he was employed at Canadian Equities, one of the world’s largest financial institutions, as vice president where he managed the Canadian equity assets of approximately $350 million. Palmer managed a pooled fund, which focused on Canadian small-capitalization companies from its inception to August 2007 achieving returns that were ranked #1 in performance by a major fund ranking service in their small-cap, pooled-fund category. He also managed a large-cap fund, which ranked in the first quartile of performance among other Canadian equity pooled funds. From 1997–1998, Palmer was employed as a portfolio manager at a high-net-worth investment boutique. Palmer earned a B.A. in economics from the University of Western Ontario and is a Chartered Financial Analyst.
By Doug Gentry, on October 18th, 2011
Just a quick update on my previous post – about the Greece debt crisis.
Pundits and observers, who are no smarter than you or me, are assuming that Greece will default on its sovereign debt. This is as if the United States decided not to pay off our U.S. bonds one day.
To avoid a total market meltdown, the “grownups” in the European community would probably insist that the private banks holding Greek bonds accept cents on the euro. If Greece owes me $100 on a bond I purchased last year, I would only receive $45.
 Haircut for Greece Creditors? The term of art for this reduction in the payoff is a haircut. Lots of figures rattling around the news sphere. I’ve seen suggestions/estimates of a write down of 30 to 60%. That qualifies as a buzz cut.
By B.P.T., on October 18th, 2011
At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:30 AM EDT, the Producer Price Index for September will be released. The consensus is that the index increased 0.3% last month, and was unchanged when food and energy are excluded.
At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.
At 9:00 AM EDT, the Treasury International Capital report for August will be released, showing the flow of capital in and out of the United States economy.
At 10:00 AM EDT, the Housing Market Index for September will be announced. This index is created from a survey of home builders, so it shows the confidence that the sector has in the overall economy and their business.
At 1:15 PM EDT, Federal Reserve Chairman Ben Bernanke will speak before the Boston Fed Bank conference on the topic of long term effects of the great recession.
By Simon Grey, on October 17th, 2011
The social uprising — called “Bank Transfer Day” — encourages bank customers to take their cash out of big banks and put it in smaller banks and credit unions instead. The movement is ostensibly in response to aggressive fees institutions are rolling out to recover profits lost from new financial regulations, notably Bank of America’s (BAC – News) decision to stick debit card users with a $5 monthly fee and Wells Fargo’s (WFC – News) $3 test of the same.
Of course, one need not be a pot-smoking leftist to think that putting one’s money in a bank that doesn’t charge you usage fees is a good idea. And one need not view opening up a checking account with a cheaper bank as a way to show solidarity or prove one’s radicalism. Going to a cheaper bank is simply good business.
At any rate, if you’re going to bank, you may as well bank with an institution that hasn’t perpetrated massive fraud against its customers or the American people. To that end, I also recommend putting your money in a credit union; I’m very happy with mine. I haven’t gotten ripped off, and no one who works at my credit union has been arrested on fraud charges, nor is anyone calling for such a thing.
Better yet, transferring your money from one of the big banks to a local bank or credit union strikes me as a way to a) end the “too big to fail” nonsense once and for all and b) strike back at the criminals running the major banks. In the case of the former, taking your money elsewhere means that any future bailouts will ostensibly be used for fat cat traders who didn’t have enough foresight to cover their risks, since the “little people” with bank accounts will be elsewhere. In regards to the latter, it will considerably harder for the major banks to turn a non-fraudulent profit if they have no customers.
I’m with the OWSers on this.
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