So if you want to see the gloomiest picture of Downtown used in an upbeat story see today’s headine.
Reuters: Only three major U.S. cities see economic recovery: study
What 3 you have to ask? Lots of ink on this one from all over, but nary a mention locally? Even reverb over the pond of the story. Curious. Maybe the reference to ‘Brookings’ got confused with the bigger news today here about ‘Brooks Brothers.‘
Many precious metals mining stocks are now trading at bargain prices but the old “buy and hold” strategy no longer applies in this fluid market environment, says Florian Siegfried, CEO of Precious Capital AG. In this exclusive interview with The Gold Report, Siegfried says investors need to do their homework and pick their entry and exit points carefully as he names some undervalued opportunities he expects to provide above-average returns in the next market run-up.
The Gold Report: This is the first time you are speaking with The Gold Report, Florian, so maybe you could give us a brief overview of Precious Capital AG and its investment focus.
Florian Siegfried: Precious Capital is an independent, privately held fund-management company in Zurich, Switzerland, with a team of financial and mining professionals. Our investment strategy is to identify undervalued future winners in the precious metals mining space. Often these are companies that are not yet the focus of the bigger institutional brokers, have good future expansion potential, have reasonable market capitalization and are driven by good management teams. We took over the company in December 2008, and since then the business has grown quite consistently and this year is performing very well for us.
TGR: Can you give us your European perspective on the current global economic and financial situation and where things might be headed?
FS: We are long-term bulls on gold because we think that the debt crisis in Europe has been downplayed for too long and there is no solution to the problem. Eventually, we expect to see a credit deflation where most of these bankrupt governments in Europe are no longer able to repay their debt, which will translate into more stress in the banking sector. In our view, this will lead to a deflationary downward spiral, which cannot be manipulated any longer by printing money because eventually the insolvent banks will fail to lend, and then there is no possibility to lift asset prices anymore. When that happens, the investor community will have a huge preference for liquidity and unleveraged assets.
“Gold is the most favorable asset class in a time of credit deleveraging.”
We think gold is the most favorable asset class in a time of credit deleveraging. An investor in gold will make money in real terms as the credit bubble deflates. Investors who are long in euros or commodity-based currencies will actually lose in purchasing power as credit deflation hits. This is our long-term view and we think that there is no further room to manipulate asset markets, as they have been in the past. I think that we are at the triggering event here.
TGR: How much air do you think can come out of this whole system? And how much can prices deflate overall?
FS: That’s a difficult question. One has to look at various asset classes. We would be rather bearish on base metals, such as iron ore, which has already declined quite dramatically since the beginning of the year. China has to rebalance its economy, which largely depends on capital investments and exports and this could become a real problem now. I wouldn’t be surprised if in two or three years we would see prices off by 30% or so. Oil prices are still getting some support because of the geopolitical situation, but as China slows down, consumption is probably going to decline and we could see oil off 20% over the next few quarters.
In the equity markets, I think earnings disappointment is going to be a major topic next year. Sooner or later, the market has to realize that if Europe is in a recession, China is slowing down and the U.S. is not getting ahead of the curve, where would earnings growth come from? So, I would expect equity prices, overall, in a year’s time could be lower, probably by 10–20%.
TGR: In reading through your Precious Capital fund materials, it was interesting to note the major credit crises over the last 300 years, starting with the South Sea Bubble in 1725 and then the British Credit Crisis of 1772 and then the panics of 1825 and 1873, followed by the market crash in 1929 that started the Depression. Then we had the bad recession in 1973. Now we have this global financial crisis that started in 2008. If the previous 300-year pattern holds, it would indicate another severe event around 2025–2030. Do you think the Federal Reserve and foreign central banks can keep things together and prevent a major collapse in 2025–2030?
FS: These kinds of cycles have a common characteristic. In each, you have good times, with real or so-called “prosperity,” mostly driven by excessive use of leverage and debt. 2008 was the same, with too much credit and debt. Bear Stearns and Lehman Brothers failed to serve the debt because they were too highly leveraged. Then the whole system broke down because if one bank failed, many others would fail.
“The precious metals industry does well in a deflationary environment because the gold price goes up against the whole commodity complex while input costs such as crude oil or steel are probably stabilizing or will become less expensive than they were in years of higher inflation.”
I think we are still relatively early in this kind of cycle. The Federal Reserve and the European Central Bank have really acted ambitiously to solve the crisis and prevent the system from collapsing by just printing money to loan at 0% to the banking system. But, eventually, what is it going to change? In the long run nothing, because it’s not just a liquidity crisis. It’s also a solvency crisis. The only solution to too much leverage is less leverage. Only the market can bring that leverage to a level where it is actually sustainable. I believe the stimulus, TARPs and LTRO programs from all the central banks have only pushed the inevitable credit deflation cycle down the road.
TGR: So how does all this influence your investment strategy?
FS: We try to identify industries that actually make money in a deflationary environment. Lower commodity prices create margin pressure for most industries and they don’t do as well as during times of inflation. The precious metals industry does well in a deflationary environment because the gold price goes up against the whole commodity complex while input costs such as crude oil or steel are probably stabilizing or will become less expensive than they were in years of higher inflation. Eventually, I think it is the market’s desire for liquidity, which will cause gold prices to continue rising.
So, the long-term view is very bullish, but it’s a very volatile market, and last year gold stocks really underperformed. This is mainly explained by a lack of liquidity and investor confidence. The whole precious metal sector has overpromised and under delivered and many M&A transactions did actually destroy shareholder value. I guess investors have reset their expectations dramatically after all this frustration. However, this can provide opportunities and we try to use some of our technical indicators to trade these stocks while they are getting into an overbought or oversold condition. This past April and May, when the market was really capitulating, we were buyers in most of the stocks we like.
Right now we think the market is a bit overpriced and we’ve had a very good run in most of these gold mining shares. Now they could go into a little correction mode and probably lose another 10% or 15%. So, we sold some of our positions at the end of September and are waiting for more favorable buying opportunities in the next few weeks. It’s not a buy-and-hold strategy that we want to apply here. One can really trade swings if you can get the timing right. We are always invested in the sector, but sometimes we have 30% or 40% cash.
TGR: How has your strategy paid off over the last couple of years?
FS: Since we took over the fund in December 2008, we are up about 140% in U.S. dollars and this year as of end of September we are up about 26%. We have some winners in the fund that performed well based on the discoveries and the operational improvements they made. We were regularly buying when the markets dried up, which forced stock prices to go lower. There were actually no signals that would suggest a long-term fundamental downturn. We see these corrections as tradable opportunities. I was calling brokers in May and it was unusual to see how defensive they were, saying to stay away from gold stocks until gold hits $2,000/ounce (oz). We got the feeling that was probably the bottom of the market. Timing is of the essence. Pick your stocks carefully, especially in the junior space, because most of these companies will never make money for their shareholders.
“When things move up and get overbought, always take profits and have cash on the sideline to buy into the dips.”
That brings me to our selection strategy. The first thing we look at is management. The mining business is very challenging, with a lot of risks. The people with the right experience who have done it before will attract the money from the Street to bring a story to reality and attract institutional money in the future. The next thing we look for is geology. Can a good deposit become bigger and can this ever become a mine and what and how long will it take? In addition, a solid balance sheet with little leverage and good networking capital in the bank is key, so they don’t have to tap the equity markets in these volatile times.
We are largely positioned in the midtier mining space because the industry as a whole has started to change. Many of the large gold mining companies have grown too big and aren’t flexible anymore. Their strategy was for growth in size, rather than profitability. As a result, many have failed to make money for shareholders. Now, the whole industry has started to focus on smaller projects with lower capital requirements. As a result, we think the market has shown a preference for companies that run easy mines, which can be expanded operationally and can be financed by the market without the risk of significant equity dilution.
Many companies have good assets but don’t have the critical mass to attract institutional money. We expect to see more mergers taking place between junior companies or midtier producers. It doesn’t make sense to have two companies producing, let’s say, 150,000 oz (150 Koz) per year trading at a market cap of $500 million (M). It would be an enormous task for them to get into a league where they could attract institutional money. Growing to a $1 billion (B) market cap internally is probably going to be a tough task. With smart merger and acquisitions (M&A), becoming a 200–300 Koz producer by combining two businesses can get it into the $1B market-cap range more easily. We think that M&A among junior producers is going to be a major topic in the next few quarters.
TGR: So, let’s talk about some specifics on companies you’re currently invested in that you think look interesting.
FS: One company we own that we think was undervalued at the beginning of the year is OceanaGold Corp. (OGC:TSX; OGC:ASX), which is a 250 Koz producer in New Zealand. It has transitioned from a company that only operated there, to a more internationally based one. Its Didipio project in the Philippines is well advanced and should get into commercial production next year. We think OceanaGold is going to make a lot of money as cash costs drop and production increases. It had some cost issues over the last 12 months or so mainly due to the strong New Zealand dollar versus the U.S. dollar. The Philippines operation has a lot of credit from copper, which will lead to ongoing cost improvements.
The company has good management and its growth is pretty well financed right now with no need to tap the equity markets in the near future. The stock has had a good run, up about 68% this year. I would rather wait for a correction before buying it here. If management continues to execute its strategy it has the potential to grow to 400–500 Koz/year of production over the next three to four years.
TGR: How about some other ones that you like?
FS: We have also been acquiring Endeavour Mining Corp. (EDV:TSX; EVR:ASX), which is proposing a smart acquisition of Avion Gold Corp. Unlike many M&A deals that have hardly created long-term shareholder value because of management issues and lack of synergies among operations, both Endeavour and Avion are West African gold producers. Avion was running out of money in the second quarter and Endeavour took the challenge to pick up the whole company in a share deal. The combined entity would be a gold-focused producer with four mines and combined annual production of about 300 Koz. Its reserve base would be close to 3 million ounces (Moz), with a resource base of about 10 Moz and a market cap of close to $1B. Compared to companies with similar production profiles and resource bases, we think Endeavour looks rather cheap. The political situation in Mali in West Africa is certainly holding the stock down to a certain degree. I think the management team will make this deal happen and create shareholder value in the long term.
TGR: How about some other ones?
FS: Another company we were just adding to our portfolio is Keegan Resources Inc. (KGN:TSX; KGN:NYSE.MKT), which is in a relatively safe jurisdiction in Ghana, West Africa. It had a sharp price decline from trading at a little over $9/share, down to around $2.38/share by the middle of May. Its Esaase project had the classic capital expenditure (capex) overruns. They underestimated the cost of the project. When financing requirements changed, the markets became very skeptical and the shares dropped. We feel the project economics are still favorable and that it can operate on a smaller scale than the planned 300 Koz/year with a $500M capex budget. Management is in the process of recalculating a smaller plant with a much lower capex, about $150–200M, rather than $500M.
After the recent rally, Keegan’s market cap is now about $270M, with about $170M in the bank and 6 Moz resource in the ground. The company is almost trading at cash, which provides good market support. When the new project economics are published, it will probably show a 100–160 Moz/year operation with a lower strip ratio and lower operating costs. The recoveries will be the same, say 92–93%. Many of the long-term shareholders and institutions went in at $7–9/share. With the stock trading around $3.97/share, we think it has some real catch-up potential from here. PMI Gold’s Obotan mine is about 10 kilometers southwest of Keegan’s Esaase project and PMI just raised $100M to start construction of the mine. We originally invested in PMI Gold at $0.10/share back in October 2009.
TGR: How about companies that are a little closer to home? Certainly the Yukon has had quite a bit of activity lately. What do you like there?
FS: We think the Yukon is a great jurisdiction for mining. With devolution of resource management responsibilities in April 2003, the Yukon has its own policy for mining, which we regard as a major benefit for mining companies. The top part of the Yukon has great and underestimated potential from a geological standpoint. The main challenge is the remote locations where you have to bring in all your equipment by helicopter and the short drilling season, which goes from about April/May until the snow comes in October.
In the silver space there we like Alexco Resource Corp. (AXR:TSX; AXU:NYSE.MKT), which is producing silver from its Bellekeno mine in the historical Keno District. It is fully financed by Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) with a very tight share structure of about 65M shares outstanding. We think it has the potential to grow resources and production through internal cash flow and no debt. Nevertheless, the company suffered a 27% increase in cash costs in the first half of the year versus 2011 due to lower base metal credits and mining of lower-grade material. These factors brought the price down quite significantly this year by -45%, to about $3.80/share.
What we like about Alexco is that the company is producing now and has many exploration and development projects in the same district. Most of the exploration and development money it’s spending will add to future production. It will probably produce around 2 Moz silver this year. As new projects are added, it will become a two- or three-mine operator in the next two to three years, all funded by internal cash flow. The Keno District has very rich silver grades, historically averaging 50 ounces/ton or so. It’s all underground, which is a big plus because the mine can operate year-round with the concentrate being shipped out by road throughout the year. The management team has a good reputation and when we visited the mine in May of last year our impression was that the exploration and development team are all solid and experienced mining people.
TGR: Any others you’d like to mention up there?
FS: Some of these Yukon stocks really fell out of favor over the last few months. One company we like, especially because the shares are also still trading at very depressed levels despite good news, is ATAC Resources Ltd. (ATC:TSX.V). This is a pure exploration company with a large land package. All the gold discoveries it released this year point to a potentially huge system that could be described as a Carlin-type gold discovery.
We visited the project last year. The company has identified multiple targets on its so-called Rackla Gold Belt, which is about 185 kilometers long. Every time the company releases results, we see that this system is potentially growing into something much bigger. The grades are phenomenal, like 10.24 grams/ton (g/t) over 46 meters, and not very deep. The stock is down to around $2.36/share, from $10/share in July 2011. The company is well financed and has a good management team. If one looks for value in exploration, I think ATAC is a good name to have at these low levels.
TGR: What about companies in other parts of Canada?
FS: We have St Andrew Goldfields Ltd. (SAS:TSX), which has had a choppy ride in the last few quarters and is now attractive from a valuation standpoint. Based on the progress the company has made since the beginning of the year, we see a turnaround with bottom line net profits and operating cash flows. Production is growing steadily toward 100 Koz this year and costs are coming down. However, a few weeks ago it announced an overstatement of its Inferred resources on its operating Holloway and Holt mines, which brought the share price down to about $0.46/share.
We like the experienced team headed by Jacques Perron and the location in Ontario, which is one of the best places to be for mining. The projects are rather high-grade underground operations, which is a positive factor because it makes for more stable operating margins when you have volatile gold prices. The company seems to be on track to achieve its production goal in 2012, but given the operational problems in 2011, the stock is still on a depressed level. The company is fully financed and both production and resources should grow in the next three to four years. Operationally and financially the story looks now much better than last year. The company also has a large land package for exploration and a tax pool of $190M on its balance sheet, which is more or less the market cap right now. The share price doesn’t reflect underlying resources and the reserves in the ground.
One shareholder who probably has a high degree of control in the company may contribute to the market underperformance. But, in a good gold market, a stock like St Andrew should probably trade at $0.80–1.00/share, to reflect the operational business.
TGR: Let’s turn to some projects and companies that have operations in the U.S. What do you like there?
FS: We have a development stage company in the fund called Romarco Minerals Inc. (R:TSX), which has the Haile project in South Carolina. This project has been delayed due to the completion of a full Environmental Impact Statement (EIS). The stock is therefore in a penalty box, but the project economics are very favorable. It will have low costs and gold grades of about 1.8 g/t open pit, which is rather high. The stock is trading at about $1/share. I would say that Romarco could be a takeover target for a midtier producer or even a senior, based on the quality of the asset and the location. Once the EIS issue has been resolved, probably next year, then we think it will be a very attractive stock to own. The main risk is permitting and finance, should the company require to raise more equity, which would be dilutive with the current low share price.
TGR: Maybe you can summarize what our readers ought to be doing in the coming months to take advantage of what you think lies ahead.
FS: The key is to see the fundamentally positive development of the industry. Gold mining shares are trading at historically low valuations, e.g., on a price-to-earnings ratio basis or compared to the price of bullion. I would stress, however, that these shares can be very volatile and people can get frustrated if they don’t perform. They sell in a down market and then miss the opportunity to buy when the market rebounds. One has to be really disciplined. Never get married to a company, no matter how good it looks. When things move up and get overbought, always take profits and have cash on the sideline to buy into the dips.
But, as long as we have these fundamental problems in the world with money printing and low economic growth, recessions and depressions, it will be very bullish for gold mining companies. In order to outperform the gold price, you can’t just be long all the time and not trade these stocks. One really has to be more active and when the market is capitulating, you have to pick up your most attractive shares. Always do your own due diligence on these companies. Check out the management and how it does operationally, and look at past track records. Once you have identified the right companies that fit your portfolio, then just try to play the sector in a little bit more of a contrarian way. That’s my advice.
TGR: Thanks for talking with us today, Florian.
FS: Thanks for having me.
Florian Siegfried is the chief executive officer of Precious Capital AG, a Zurich-based fund specializing in global mining investments. Siegfried was previously the CEO of ShaPE Capital Ltd., a SIX Swiss Exchange-listed private equity company, where he was instrumental in raising more than CHF 50 million in equity capital. Siegfried is also a board member of GoldQuest Mining Corp. He holds a master’s degree in finance and economics from the University of Zurich.
Shadowstats.com Author John Williams wonders if politics are at play behind the latest jobs report, which shows 114,000 new U.S. jobs since September and a 0.3% drop in unemployment since August. Investors need to know how seasonal factors and month-to-month volatility affect the Bureau of Labor Statistics’ reports. In this exclusive interview with The Gold Report, Williams explains why he doubts that we are in a recovery. The take-away? Look at the unadjusted figures before you sell your gold.
The Gold Report: John, as Mark Twain famously quipped, “There are three kinds of lies: lies, damned lies and statistics.” The Bureau of Labor Statistics (BLS) just came out with new jobs numbers that show the country added 114,000 jobs since September and the unemployment rate dropped to 7.8%, down from 8.1% in August. On Shadowstats.com, you argue that the numbers are wrong and pointed to politics as a possible reason for the incorrect figures. Are unemployment statistics being manipulated and if so how?
John Williams: I normally put out a commentary on the numbers, and, in this one, I raised the possibility of politics as a factor. The problem is very serious misreporting of the numbers and the result is what appears to be a bogus unemployment rate. The BLS reported a drop in the unemployment rate from 8.1% to 7.8%, three-tenths of a percentage point, which runs counter to what is being experienced in the marketplace.
What few people realize is that the headline unemployment rate is calculated each month using a unique set of seasonal adjustments. The August unemployment rate, which was 8.1%, was calculated using what BLS calls a “concurrent seasonal factor adjustment.” Each month the agency recalculates the series to adjust for regular seasonal patterns tied to the school year or holiday shopping season or whatever is considered relevant. The next month, it does the same thing using another set of seasonal factors. Rather than publish a number that’s consistent with the prior month’s estimate, it recalculates everything, including the previous month, but it doesn’t publish the revised number from the previous month.
The assumption is that the monthly recalculations don’t make much difference over time, but they do. The depth and the protraction of the current severe economic downturn have thrown off the annual seasonal-factor adjustments. The result is very volatile seasonal factors month-to-month. That means the new calculations for the September number may have resulted in a very significant revision to the August number. Again, though, the BLS doesn’t publish that, so the headline August-to-September 2012 change in the unemployment rate is not consistent and not comparable. Last December, when the BLS put the seasonal adjustments on a consistent basis for the year, as it does once per year, the November 2011 unemployment rate had just been reported as showing four-tenths of a percentage point drop—an unusually large monthly decline that never took place. When revised to a consistent basis, the drop in headline November unemployment revised to two-tenths of a percent. That is a big change. I think something like that happened here.
The BLS knows what the actual number is. It has an actual estimate for August, which is consistent with September, but it doesn’t publish it because it says it “doesn’t want to confuse data users.” But it is putting out numbers that have no meaning month-to-month. One month before the election and a month after Federal Reserve Chairman Ben Bernanke announced Quantitative Easing (QE) 3, is not a time to have inaccurate numbers. The BLS should publish the consistent numbers now.
TGR: You have said that BLS has been using this recalculation method for years. Do you feel that this month the numbers were more skewed than usual because of the political timing?
JW: Because there is no transparency in the calculation and reporting process, it leaves open the possibility of manipulation. What has happened here, though, is that in the wake of the economic collapse, the seasonal factors have been heavily distorted and are not stable on a month-to-month basis. Where the concept originally might not have made that much of a difference, it does make a big difference now. I suspect that is why we woke up to such a screwy unemployment rate this time around.
The 114,000 jobs growth in the payroll survey (which reflects the number of payroll jobs, counting multiple jobholders more than once) also is suspect and subject to concurrent-seasonal-factor adjustments. There, however, the BLS publishes revised estimates for the two prior months that are on a consistent basis with the headline number. Nonetheless, jobs in even earlier months are not re-reported, although they too are recalculated each month, with the effect that jobs reported in earlier periods can be moved into present reporting, boosting the current numbers, without the related earlier changes being revised in the published historical numbers. Nonetheless, the purported 114,000 jobs gain was not statistically significant.
From the household survey, which gives us the unemployment rate and counts the number of people who are employed (multiple-job holders are counted but once), the headline gain in employment was 873,000, the largest seasonally-adjusted monthly increase since Ronald Reagan’s first-term. That number clearly is nonsense and again suggests there is a severe problem with the seasonal factors.
TGR: Do you think the unemployment rate was manipulated on purpose or did the bad economy just make the reporting more confusing?
JW: It could have been manipulated. I do not know and do not have direct evidence of current political massaging of the data. I know for certain that there have been direct political manipulations by different administrations, since the days of President Lyndon Johnson, involving various data sets that have included the gross domestic product (GDP), the trade numbers and the employment and unemployment numbers.
From what I’ve seen of the Obama administration, the reporting has been reasonably clean. Nonetheless, at best, the administration is using seriously flawed data, and the reporting and calculation process has the potential for manipulation. The timing of the announcement of such a big downside swing in unemployment certainly is a fortuitous circumstance for the administration’s political needs.
Main Street U.S.A., however, has a much better sense on the economic reality than do the government’s economic statisticians. If the headline unemployment rate is not as advertised, a goodly portion of the public will not buy it. Past experience has shown gimmicked reporting often backfiring on the manipulators.
TGR: What is the correct unemployment rate? What would be a reliable data set?
JW: I don’t know of one. The unemployment rate comes out of government surveying and data manipulation, and the base number is wrong. What are good in theory are the un-adjusted numbers, although unemployment definitions still suffer. Those don’t get revised for the seasonal factors. But there you have regular annual patterns of economic activity, so you’ll see the unemployment rate go up and down as it follows the normal flow of annual business activity through the various seasons. Even so, it makes some sense to look at that unadjusted series over time. The average person doesn’t think of himself or herself as employed on a seasonally adjusted basis, but a lot of people, according to the government, are so employed.
If you surveyed everyone in the country as to whether he or she were unemployed, you’d get an unemployment rate above 22%, instead of the headline 7.8%. The difference is in how the government defines whether someone is unemployed, versus the view from common experience.
TGR: What are the ultimate consequences of inaccurate statistics on the stock market, commodity prices and everyday people?
JW: Right now, the impact of the unemployment numbers is mostly political, although the Federal Reserve has made it part of its targeting in terms of QE3. But the primary political concerns are on the impact to the upcoming election, which is what makes the timing of this release so suspect.
There is a serious problem with the reporting. If it has been used to manipulate the public, that eventually will come out. If it hasn’t, the simplest thing is for the BLS just to publish the actual numbers. They have them. They don’t have to do any recalculations. They’ve already done that. They just need to publish them in a timely manner.
TGR: There seemed to be an impact on the stock market. The Dow ended Friday up. Was that simply a coincidence?
JW: Yes, the market jumped all over the place. But I see no rationale whatsoever behind the movements in the stock market. Any numbers will be used to spin a story that will explain what’s happening with stocks at a given point in time.
TGR: What about commodity prices? What will this do to gold?
JW: You had some sell-off in gold Friday. Again, that could all be spin. Was it due to people thinking Bernanke was not going to have to ease monetary policy as much? I’m not into day-to-day calling of the markets. The stock market is absolutely irrational. You can make up all sorts of stories based on that. Markets respond to lots of really worthless information—the 114,000 gain in payrolls for example is not statistically meaningful. It could have been a contraction as well as a gain, when the 129,000-job margin of error is considered. Yet, the markets gyrate wildly over very small changes that have no relationship to what’s actually happening in the economy. I think traders just love to trade. It’s like going to the racetrack and betting on a horse because of how it wiggles its ears. It has little to do with the underlying fundamentals.
TGR: Is there an ultimate consequence of having faulty data? Do incorrect numbers build on themselves and become more inaccurate over time? Will we see a jump in the unemployment rate in December when they are recalculated after the election? Are there other consequences?
JW: When governments use bad numbers, and believe them, they don’t respond appropriately to problems like unemployment and inflation. People don’t properly target their investment returns or adjust their income projections. There are good reasons for having accurate information, but accurate numbers just are not coming out of the U.S. government at the moment.
TGR: You mentioned the correlation with the announcement of QE3. When we talked in May, you called QE “dangerous” and said it would eventually lead to a massive decline in the U.S. dollar, triggering new dollar selling and lead to dollar inflation, spikes in oil prices and eventually hyperinflation. Your special commentary on inflation and systemic conditions comes out next week on ShadowStats. Can we expect any good news?
JW: The outlook hasn’t changed. I’ve been looking at this for a long time. Let me put it this way: The economy is not suddenly improving. Underlying fundamentals have not changed. You just are getting bad-quality numbers.
The average guy has a pretty good sense of what is going on. When Main Street suddenly starts getting jobs and businesses pick up, then we will know the economy is picking up. Shy of that, I’d be wary of anything I hear out of the government on business activity.
TGR: So the reports that we are in a recovery aren’t accurate? What indicators should we be watching?
JW: Over time, you will find the better-quality statistics are confirming that we never had an economic recovery, and that we’re not about to get one. When you have faulty numbers, you need to look at the underlying fundamentals to see what’s happening. The problem is the consumer doesn’t have the liquidity, either from the standpoint of income growth or credit availability, to sustain positive growth in the GDP.
TGR: Thank you for your time, John. We will check in with you periodically to see if you see any changes in those numbers.
Walter J. “John” Williams has been a private consulting economist and a specialist in government economic reporting for 30 years. His economic consultancy is called Shadow Government Statistics (ShadowStats.com). His early work in economic reporting led to front-page stories in The New York Times and Investor’s Business Daily. He received a bachelor’s degree in economics, cum laude, from Dartmouth College in 1971, and was awarded a Master of Business Administration from Dartmouth’s Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar.
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Virtually all Americans will pay taxes during their lifetime. The uncertainty that came packaged with the Great Recession has allowed for the proliferation of many other economic misconceptions, especially in regard to taxes. Today’s economic context for tax reform is very complex. Most immediately, the economy is still in the midst of a slow recovery with an unemployment rate that remains too high. Even with robust rates of job growth, it will take years to close the jobs gap. An important role of fiscal policy in the near term is to support recovery in the labor market.
Nothing’s sure but death and taxes, which is why it doesn’t make sense to argue about who pays taxes. The more correct argument is over who pays which specific taxes, to what extent, and at which point in time. This latter discussion is more complex, and the resolution less satisfying, which is why you never see it. The truth of the matter is that all people pay taxes in some way, and virtually every worker pays income (oops, I mean “payroll”) taxes. Everyone pays taxes someway, somehow; directly and indirectly. The only variables are rate and timing.
Thus, it’s not wise to talk about how 47% don’t pay any income taxes—the government will still tax them somehow.
Some hack calls out FoxNews for lying about unemployment:
During a segment criticizing the Obama administration for its messaging on the economy, a Fox & Friends graphic claimed that the “real unemployment rate” had increased from 7.8% in 2009 to 14.7% now.
But in order to make the claim that unemployment had increased from 7.8% to 14.7% during Obama’s time in office, Fox had to conflate two different statistics and completely distort Obama’s jobs record.
The 7.8 percent figure is the official unemployment rate from January 2009. This statistic reports on people who are unemployed and actively looking for a job. But as of the latest report, the official unemployment rate is 8.1 percent (0.3 percent higher than it was in January 2009), not 14.7 percent.
The 14.7 percent figure is a completely different measurement of the unemployed, which in addition to those who are actively looking for work, also counts people who are unemployed and discouraged from looking for a new job, part-time workers who prefer full-time employment, and more. This alternative measure of unemployment, which conservatives often call the “real” unemployment rate, was 14.2 percent in January 2009 — 0.5 percentage points lower than it is today.
So, it sounds like unemployment hasn’t gotten that much worse during the course of Obama’s administration,* doesn’t it? Oh, wait…
* As if the president is primarily responsible for every last aspect of the economy anyway, but that’s a post for another day.
In terms of forward guidance I think the Fed Chairman’s speech provided little direction, but Friday’s precious metal price action into the close and the various sell side notes that I have seen suggest that this, at least initially, is too bearish a conclusion. The following excerpt from the speech, in particular, was taken as clear evidence of more and aggressive easing in the pipeline.
As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.
Great emphasis has been attached to the chairman’s use of the word “grave” as a clear tell-tell sign of more easing to come. I find this quite interesting since it is one of the first instances of such “new speak” interpretation of the Fed’s statements akin to the good old days of Trichet and the utterance of (strong) vigilance. Needless to say, next week’s jobs market report has suddenly been propelled to a key market event and every single US data point will now be watched with caution. On that note, the next ISM reading as well as consumption figures will be equally important to watch.
I think Tim Duy’s interpretation is the right one then (hat tip Calculated Risk) with my emphasis.
On net, Bernanke’s speech leads me to believe the odds of additional easing at the next FOMC meeting are somewhat higher (and above 50%) than I had previously believed. His defense of nontraditional action to date and focus on unemployment points in that direction. This is the bandwagon the financial press will jump on. Still, the backward looking nature of the speech and the obvious concern that the Fed has limited ability to offset the factors currently holding back more rapid improvement in labor markets, however, leave me wary that Bernanke remains hesitant to take additional action at this juncture. This suggests to me that additional easing is not a no-brainer, but perhaps that is just my internal bias talking.
On balance the main point for me is that the recent change in economic data clearly merits policy change on the basis of the Fed’s reaction function.
The unemployment rate in the US is sticky and the Fed has been persistently concerned about this which is indeed a strong signal to the policy bias especially as inflation expectations are well behaved. Inflation has come down significantly in the US running at 1.4% YoY and the Taylor Rule rate is now declining (though still in level terms way above 0 but that has more to do with the inputs than anything else). We have had two consecutive months of sub-50 ISM readings and consumption growth appears to be rolling over. My interpretation of the forward looking indicators is that they look better than the consensus suggests, but the Fed lives in the here and now and will act accordingly.
Another interesting point here is that despite the visible and strong recovery in the growth rates of US housing market indicators, Bernanke mentions the level of the housing market and not the change which suggest that the despite a good run of data with respect to the change in housing market indicators the level is still seen as depressed.
The bottom line is that some form of easing is coming but what I find highly uncertain is the timing and aggressiveness of such easing. The August minutes had already stipulated potential moves for the Fed in the form of an extension of the low interest rate commitment, lowering interest rates on excess reserves as well as an extension of Operation Twist or outright asset purchases (probably through MBS securities). But which of these measures will be employed and in what order?
One thing for example which I find very interesting is the glaring gap between Bernanke’s discussion of the effectiveness of unconventional monetary policy and its effect on the real economy (i.e. labour market). In that sense, it seems quite clear to me that quantitative easing can have a strong effect in the context of imminent deflation risks and strong downward pressures in asset prices. In such an environment the portfolio effect and, indeed, outright price effect from aggressive central bank action can be very effective.
However, whether quantitative easing can be effective in countering a structural and sticky unemployment rate (and indeed a structurally declining labour force participation rate) seems much more uncertain to me. Obviously, this goes back to the point that the Fed is the wrong tool for the job at hand, but it also raises the issue of what kind of easing the Fed is planning here.
Of the measures mentioned above one of the only things which would have an effect on the labour market (from a theoretical point of view) is an extension of the low interest rate commitment. This would be a signal to companies that their cost of capital would remain low and incentivise investment and thus, in theory, additional labour input. But such a process is slow and arguably a weak remedy in the context of structural labour market issues.
More generally, we must ask ourselves whether an extension of the low interest rate commitment be enough for the market Clearly not and in any case, an extension much beyond Bernanke’s term would be meaningless as the looming presidential election has created uncertainty as to how strong this commitment is, if for example Bernanke is faced with a Republican president.
What about an extension of Operation Twist then? If this is combined with an expansion of the balance sheet through purchases of MBS I think this could be an effective medicine (although in general I find it hard to see how it could meaningfully affect the labour market). However, the theoretical argument here is fair. By influencing long rates the Fed is likely to stand the greatest chance of supporting the ongoing recovery in the housing market and thus, by derivative, the US economy.
Ultimately, I see two sources of uncertainty here. Firstly, it is not clear to me that the US economy is heading into a hole in the second half of 2012 to an extent that would allow very strong Fed action. Secondly, while the Fed clearly seems committed and perhaps even pre-committed to more easing the nature of such easing and its scope is still very uncertain to me. The upside risk attached to much stronger easing is clearly there (not least because we also have the ECB coming in with policy measures soon), but the spectre of grave disappointment has not been completely extinguished in my view.
After a week with the family in a cottage in Sweden Alpha Sources is ready to get back into the grind. Returning from holiday as a macro analyst is always daunting given the barrage of news and data that you will have inevitably “missed”. From reading the news and last week’s sell and buy side research this morning Alpha.Sources sees a bit more positive note. Apparently, the significance of recent months’ very aggressive monetary policy easing around the world seem to be having their slow, but predictable effect. A few more sell side notes than Alpha Sources had expected are now looking towards the second half with a bit more optimism.
There is still the strange feeling among many investors however that 2012 will be a repeat of 2011 and that sideways movement into the summer will eventually be released in another sharp draw down in global risk asset prices. As always, the extent to which this remains the consensus among investors even as monetary policy continues to ease in both conventional and unconventional fashion, Alpha Sources is getting more confident that bears may just get caught out.
It is important though to be extremely sensitive to the data at this juncture with key economies such as China and the US at obvious inflection points.
In the US and despite the visible deterioration of the data in the past month, the call for a recession is still at risk. An ISM at 49 is normally not associated with a recession and further deterioration into the mid 40s in July would be needed to give a recession signal. Still, global bond markets continue to predict a very dire future with more and more investment grade yields going into negative territory and anything generally assumed safer than handing over your money to a teenager in a department store, seeing bid. Still, I am skeptical that such signals from an essentially manipulated and stretched market are all they are made out to be and prefer to stay close to the real economic data for now. This week sees a big chunk of data releases as well as the Fed chairman is scheduled to speak, so watch out for direction.
China Rising or Falling?
In the case of China, Prime Minister Wen recently warned that positive momentum is not yet visible in the economy. This suggests more stimulus is on its way beyond the two rate cuts already implemented.
But, is this bullish because monetary stimulus in China will lead the economy up and indeed lead a general continuation of the global EM easing cycle? Or is it bearish because it suggests that conditions in China are worse than expected?
Alpha Sources would lean towards the former, but unless the data starts to turn this remains a hope and perhaps even a fool’s one as it depends on the authorities’ ability to micro manage the economy. As ever, the discourse on China is stretched by unrealistic expectations. On the one hand there are those who believe that China is able to reach pre-crisis growth rates of 10-12%. It isn’t and there is no doubt that many global commodity producers have too much capacity relative to the growth level that China is able to attain. On the other hand, the chorus of those calling for a hard landing and essentially a collapse of the Chinese economy has, at times, been deafening. Alpha Sources finds it difficult to see exactly why this is supposed to happen now. China may be headed for a big crash, but such things rarely occur on the back of and in the midst of extreme euphoria and not excessive pessimism.
Alpha Sources’ base case scenario is that more stimulus from China will be able to drive positive sentiment forward, but also that between those calling for status quo and a crash, China is likely to achieve neither and in stead simply achieve a new trend growth level much lower than before.
Upside surprises in Europe?
Despite the perceived victory of the periphery in the recent EU summit Merkel remains resilient in her demand that if Spain and Italy eventually will need bailout, the price has to be considerable handover of sovereignty to EU and Germany on the fiscal side. This is a reasonable claim even if the message to the outside is that Spain will avoid direct involvement in sovereign affairs due to the technical nature of the bailout money being distributed to its banks.
Still however, the recent sharp reversal in the rhetoric by the Spanish Prime Minister Rajoy and the promise of yet another round of cuts come in nicely on the back of the market finally starting to see signs that perhaps even senior creditors of Spanish banks be forced to take losses. Alpha Sources welcome such realism by part of the periphery, but is still left with the bitter taste in the mouth from watching drastically different measures being applied to the little ones (Greece and Ireland).
In this sense, the ever eloquent Chris Wood is spot on in his recent juxtaposition between the situation in Spain and Ireland.
GREED & fear has been calling for losses to be imposed on subordinated bank bondholders for some time as the best way of imposing a loss, and allowing the capitalist system to start working again. It is, therefore, encouraging that this approach may actually be adopted as already discussed in the case of Spain as one of the Eurozone’s preconditions for recapitalisation, which by the way means a significant diminution in Spanish sovereignty. Still, given that so much of this subordinated debt has been sold to retail investors as savings products, such a policy is going to create a firestorm in Spain politically. It must, therefore, be wondered if the loss ends up being imposed anyway on the sovereign balance sheet of Spain as buyers of these products demand to be made good. The Spanish owners of junior bank debt may also wonder why he or she is being treated so differently from Ireland where the ECB seemingly forced the Irish Government not to impose losses on subordinated bondholders thereby putting the Irish taxpayer on the hook. GREED & fear would not like to be viewed as a cynic. But the difference could be that the Irish subordinated debt was owned by big institutional investors whereas in the case of Spain it appears to be the little guy.
Another case in point that I feel the need to elaborate on is Greece. Only two months ago did the consensus hold that Greece would leave the Eurozone or perhaps even that the country would be forced out. Alpha Sources always thought that this was mad and we know now that it was. The difference between the first PSI and the warmongerings from Merkel and the EU were clear.
In the case of the former, the risk was chiefly that Greece would not accept the terms under the restructuring (laid out by the IMF and the EU) and simply apply a unilateral haircut. In the case of the latter however, Greece was seen being in the corner pleading that the country would not want to leave but simultaneously also getting starved of essential liquidity to keep the country running.
Investors should remember that differential treatment between large and small economies in what has become a near perpetual bailout effort by part of the EU, the IMF and the ECB is a mistake that may eventually become the problem itself.
Finally, it is important to dwell a bit on the recent ECB meeting where not only the main refi rate was reduced but also, and much more significantly, where the deposit rate was cut to 0%. This marks the first major central bank trying to take a stab at the problem of a slump in velocity and essentially a broken monetary policy transmission mechanism. As such, bulging reserves without a corresponding pick up in lending to the real economy remains one of the main problems in the developed world (from the point of view of monetary policy makers that is). Sweden enforced negative interest rates on reserve balances in 2008, and now the ECB is essentially following in the Riksbank’s food steps.
In this way and just as Alpha Sources has spent the last couple of days catching up with the news, so it seems that European policy makers with Spain now apparently open to imposing losses throughout banks’ capital structure and the ECB delivering the boldest monetary policy step since the Fed opened up the QE bag in 2008, Europe may finally be catching up.
We are just coming up on the 30-year anniversary of what might have been Pittsburgh’s Etch a sketch moment. Three decades ago Pittsburgh was just about halfway through the 18 months that changed it forever. In August 1981 the region’s unemployment rate was 7.2%; a high, but not scary level. Total unemployed in the region measured 86,600. 18 months later in January 1983 over 212 thousand would be unemployed and the unemployment rate was at least officially reported as 18.2%.
At the very worst of the Great Recession (AP style guide requires the use capitals for that), regional economic conditions would barely hit half those numbers. If anything those numbers understate the differences between the two periods. The recent peaks in unemployment rate and total unemployed only reached those levels because there has been a turnaround in migration. There has been several years of net population migration into the Pittsburgh region, and that clearly has an impact on labor force data. Without the new residents coming into the region, neither the regional unemployment rate nor count of unemployed would have been as high. 30 years ago we all know the opposite was going on here with a steady stream of unemployed workers departing the Pittsburgh regon. The result was making those January 1983 peaks peak lower than they might otherwise have been.
Don’t get me wrong, 30 years ago there was still a lot of denial going on. Lots of folks believing manufacturing was going to rebound and there was no reason to shift course. Some of that denial persists to this day, but at some point 30 years ago a plurality of the collective consciousness accepted the inevitable and decided to move on if only because there was no other choice.
More grim ruminations on our economic prospects: What if recessions do permanent damage, diminishing a nation’s productive capacity?
As I wrote on Thursday, recessions are commonly understood as disruptive rather than destructive to the economy as a whole. But a paper presented Friday at the Brookings Institution warns that recessions may do lasting harm, like an untended house that not only needs a good dusting, but has also started to rot.
The term for this possibility sounds perfectly harsh: hysteresis. (The definition is more benign; it simply means that the past affects the present.)
The proper antidote to hysteresis, the authors write, is an increase in government spending. They write that under current conditions there is a good chance such spending would be self-financing, as tax revenues from resulting economic activity would outweigh the cost. But there is little prospect that Congressional Republicans will revisit their opposition to stimulus this year. Which means that our current experiment will run to completion: If hysteresis is real, we will know it by its consequences.
Of course past actions and behaviors affect the present, often negatively. But there are, just as often, positive consequences, as well as neutral consequences. This is how economic tradeoffs work, in the long run, at a macro level. The call for government intervention, though, does not follow from the premise.
In the first place, harm cannot be determined until after the fact, and harm is a subjective value (though it should be noted that it can be an objective term). Production capacity is not, in and of itself, a worthy end goal, particularly if higher production is inefficient relative to its alternatives. Furthermore, no economic occurrence is inherently harmful; it is only ever harmful to some party. What one party finds harmful another may find beneficial, and so Bastiat’s lesson of the broken window ignored once again.
In the second place, government intervention is not guaranteed to solve the problem. It would seem that the history of government intervention would show, on the whole, that most forms of intervention are net-negative, often benefiting a politically-connected, generally at the expense of the masses. While the technocratic solution to various economic problems can hypothetically be both correct and possible, in practice government intervention is generally more skewed to incentive distortion and political corruption, to use a phrase, the theory doesn’t jive with the real world.
Researchers with the Federal Reserve Bank of New York found that investors who used low-down-payment, subprime credit to purchase multiple residential properties helped inflate home prices and are largely to blame for the recession. The researchers said their findings focused on an “undocumented” dimension of the housing market crisis that had been previously overlooked as officials focused on how to contain the financial crisis, not what caused it.
More than a third of all U.S. home mortgages granted in 2006 went to people who already owned at least one house, according to the report. In Arizona, California, Florida and Nevada, where average home prices more than doubled from 2000 to 2006, investors made up nearly half of all mortgage-backed purchases during the housing bubble. Buyers owning three or more properties represented the fastest-growing segment of homeowners during that time.
“This may have allowed the bubble to inflate further, which caused millions of owner-occupants to pay more if they wanted to buy a home for their family,” the researchers noted.
Investors defaulted in large numbers after home values began to drop in 2006. They accounted for more than 25 percent of seriously delinquent mortgage balances nationwide, and more than a third in Arizona, California, Florida, and Nevada from 2007 to 2009.
Sweet Keynes but the banksters just do not have a clue. Somehow, the FRB of New York has come to the hilarious conclusion that somehow, mysteriously, those who “flip” houses are the root cause of the recession. Talk about clueless.
The question that the NY FRB is apparently too stupid to ask is: Why would some people suddenly decide to “flip” houses? Answer: because it’s generally profitable due to the increased demand for houses as a result of a)artificially low interest rates from The Fed, b) massive fraud among the banks in regards to loan application, c) the Federal Government’s willingness to subsidize market risk, and thus eliminate moral hazard, through the agencies Freddie Mac and Fannie Mae, and d) the general tendency of the government to encourage and subsidize home ownership through, among other things, federal income tax breaks. Basically, the government as at the root of most of the problem here, and the Federal Reserve played a major role.
Of course, the FRB is not going to admit to wrongdoing, particularly since greedy businessmen make for a more compelling villain in this narrative. But blaming people for responding to incentives at the margin, as clearly happened in this case, is indicative of just how worthless mainstream macroeconomic analysis clearly is. Quite simply, it takes an astonishing amount of either dishonesty or short-sightedness to come to the conclusion that greedy businessmen are to blame for the current recession instead of the incentive system in which they operated.
The shallowness of this analysis, if honest, is simply evidence that those who are currently in charge are simply too stupid to merit the power with which they’ve been entrusted. If, on the other hand, they are liars, the case for their removal from power is not in any way diminished. In sum, there is no excuse for those presumed to be intelligent, and thus deserving of power, to be offering analysis this putridly vapid; they must be summarily dismissed and the system must be dispatched with.
* Cf. Dr. Sowell’s book Applied Economics.