Good day… A quiet trading day to start the week off yesterday. As I turn on the computers this morning the dollar index is trading right at the level it was yesterday morning. The currencies were up a bit through most of Monday’s trading day, but the dollar came back in Asian trading leaving us right about back where we started.

The only data released yesterday was the index of US leading indicators which rose slightly in June for a third consecutive month. The numbers gave a bit of hope for all of the bulls, with many exclaiming that the US economy has turned a corner and the recession has ended. I am not so sure, as rising unemployment and continued weakness in the housing market will likely hold any recovery back.

Aaron Stevenson sent me a story he read on CNNMoney.com yesterday which highlighted the labor problems here in the US. The article states that more than 650,000 Americans will have used up all of their unemployment benefits by September, and the Labor Department is expecting the problem to accelerate. “In the next few weeks, the victims of the mass layoffs that happened six months ago – when the pace of layoffs was at its zenith – will start running out of their basic benefits. A total of 4.4 million people are expected to face this fate – or 65% of the entire filing population. And while they may have up to another year of unemployment insurance benefits – thanks to the confusing patchwork of extensions that were enacted last summer – they will soon be unaccounted for in government unemployment reports.”

As Chuck has continually pointed out, the Labor Department doesn’t track anyone who has been unemployed more than 26 weeks, and has no plans to adjust the way the report claims (even though they know they are under-reporting the actual unemployment rate!). As a result, the weekly jobs data will probably start showing declines in continuing filers later this year. But these declines won’t be because of an improved job market, but instead will be because many of these filers will be falling off the Labor Department’s radar.

Even the director of the White House’s National Economic Council, Mr. Lawrence Summers, isn’t feeling so rosy about the prospects for recovery. “I don’t feel there’s a basis for predicting that income growth is going to resume in the near term,” Summers said in an interview yesterday. So while the US economy may not be sinking any more, Summers doesn’t believe the economy will be able to quickly pull itself back up from the deepest recession in a half a century. “The pace of growth next year I think is very much in doubt, and difficult to predict, and will depend crucially on our effectiveness in implementing the programs that have been legislated and the kind of confidence that’s provided by what Congress is able to do in crucial areas like health care and financial regulation and energy,” Summers said.

The focus today will shift to Federal Reserve Chairman Ben S. Bernanke who will be giving his semiannual monetary policy testimony to Congress today. The markets are looking for Bernanke to map out an ‘exit strategy’ for the loose money policies which have been enacted over the past few years. Bernanke gave a sneak preview of his testimony in an opinion piece which he wrote for the Wall Street Journal yesterday. “When the economic outlook requires us to do so,” the central bank will employ a series of tools to tighten policy, Bernanke said in the piece. He outlined five different ways the central bank will be able to prevent the record reserves that banks have accumulated from causing money supply and inflation to surge.

I don’t doubt that Bernanke and the Fed have the means to pull liquidity out of the system. What I question is if they will have the cojones to use these methods when the time is right. In order to stem inflation, the Fed will be required to start tightening policy just as the economy is starting to recover. If they tighten too early, they could squash the recovery, and if they wait too long, inflation could spiral out of control. History has shown that the FOMC is typically late in their move to tighten.

And the likelihood of an anemic recovery heightens the risk that the Fed will be late in reacting. The recovery will be weak compared with historic recoveries from recession. I just can’t imagine Bernanke stepping up and pushing rates higher in the face of a weak economic recovery. But we will see what he has to say to congress today. His testimony could be good for the dollar, if he is able to convince the markets that he and his compatriots will step up to the plate and keep inflation at bay. Again, I just don’t believe he has the fortitude to time his move correctly.

Chuck sent me a note after reading a great piece by the Mogambo Monday.. The Mogambo doesn’t think Bernanke will be able to rein in inflation, and believes investors should protect themselves by purchasing gold:

“And if you don’t think that gold will shoot up when inflation starts roaring like that, then you are obviously new at this investing business and you haven’t had time to look at what happened to the price of gold when it was $35 an ounce in 1970 and over $800 an ounce by 1980 when the inflation (from the vast expansions of the money supply needed to simultaneously finance the War on Poverty and the War in Vietnam) was rising along this same parabolic ride.”

I love how you always know exactly where the Mogambo stands on things! I can’t argue with his logic and agree that gold is a good hedge against rising inflation which I’m sure we will see on the other side of this recession/depression. Every investor should have a portion of their overall investment portfolio dedicated to precious metals, and our unallocated metal select accounts are one of the most efficient ways I know of to hold gold.

Speaking of the precious metal, gold held above $950 an ounce overnight, and seems to be on a fairly sharp upward path. Gold has gained just over $45 in the past two weeks and looks set to test resistance levels around $960. If it can push through these levels, the next resistance would be around $985. And just think what the price will do once we start seeing signs of inflation creeping back into the global economy.

So the dollar will likely move up today as long as Bernanke can ‘deliver the goods’ in his testimony to congress. But if the dollar does rally, I would take advantage and look at the move as an opportunity to purchase currencies at better levels. Some of the largest, and smartest investors are looking to do the same, and share our believe that Bernanke will be unable to turn the liquidity pump off in a timely fashion. PIMCO, the manager of the world’s biggest bond fund, said it is looking to buy the Brazilian real as the dollar slumps and growth in emerging economies outpaces that of developed nations. According to a report published by PIMCO, investors should buy emerging market currencies to protect themselves against the risk that US policy makers will allow the dollar to slide should they lack the skill to “drain the system of emergency liquidity at the appropriate time.” The report goes on to say “In light of an expected long-run erosion in the value of the US dollar, Pimco will look to take positions in select emerging market currencies that we believe have the most compelling appreciation potential.”

Want to take a position in the emerging markets without the risk? Why not look at our new BRIC MarketSafe CD. It combines Brazil, India, Russia, and China into a 3 year CD which is protected against any downside risk. I think we came up with a real winner on our newest MarketSafe!

Currencies today 7/21/09: A$ .8132, kiwi .6548, C$ .9040, euro 1.4217, sterling 1.641, Swiss .9362, rand 7.8703, krone 6.2998, SEK 7.685, forint 191.68, zloty 2.9982, koruna 18.1561, yen 94.20, sing 1.4419, HKD 7.750, INR 48.4337, China 6.8305, pesos 13.2694, BRL 1.8987, dollar index 78.923, Oil $64.16, 10-year 3.61%, Silver $13.555, and Gold… $947.85

That’s it for today… It is food day here today, as we celebrate everyone with July birthdays. The crew is coming in with food galore; Krispy Kremes, Cake, and every imaginable form of dip n chips. It is going to be a real challenge for me to stick to my diet today (but I guess I can have a free day every once in a while right!?!?) Hope everyone has a Terrific Tuesday, mine is sure shaping up to be one!

Source: US Leading Indicators Push Higher

We have been raking in huge profits in all our cyclical and aggressive plays since we called the turnaround in Brazil last October 27:  Petroleo Brasileiro (NYSE: PBR) — known as Petrobras – Vale (NYSE: VALE), Apple Inc. (Nasdaq: AAPL), BHP Billiton Ltd. (NYSE: BHP), Research in Motion Ltd. (Nasdaq: RIMM), IBM (NYSE: IBM), Amazon.com Inc. (Nasdaq: AMZN),  Diamond Offshore Drilling Inc. (NYSE: DO), and Ciena Corp. (Nasdaq: CIEN) have all done splendid.

And over the longer term, all of these companies are going to continue delivering, with some obvious profit-taking bouts along the way.

One of such profit-taking episode could be starting right now.  And it could be driven by Standard & Poor’s recent downgrade of United Kingdom’s sovereign debt rating.  This was in turn followed by the comments coming out from PIMCO that suggest the United States’ debt rating could be in jeopardy.  Even though S&P minimized that possibility, when Bill Gross speaks, the bond markets listen.

General Mills met earnings expectations in March and raised its earnings outlook.  It has been benefiting from the drop in commodities prices, especially agricultural. In addition, the firm, like many in the consumer business, has suffered from a strong U.S. Dollar, which reduced the value of the profits abroad.  The nice thing about consumer staples is that, since people have to eat in good and bad times, these companies are not cyclicals, but rather suffer very little in downturns.

That has been the case for General Mills, which in the last report showed a 4% sales increase from the same quarter in the prior year.  And this sales increase was achieved despite a 6% drop in the sales of food service and bakery products, where the firm nonetheless managed to increase pricing.  But this sector is being de-emphasized with some divestment.

Just think about the solid brands that allow General Mills to dependably keep chugging along every quarter, increasing sales as the population grows. General Mills also boasts well established and new brands that keep increasing its market penetration around the world.   Since then, the dollar has corrected in value and the commodities prices have dropped. That will show up in next month’s earnings report and the stock should perform nicely.

The company is dominant with its Pillsbury brand, which has more than two-thirds of the market.  Cheerios, which has come under some scrutiny for health claims by the FDA, is the top cereal franchise in the ready-to-eat segment.  In addition, we are going to see hundreds of new products being launched soon.

The global story is only beginning for this company, even though they are already in China, and many other fast-growing emerging markets.  This international presence, which right now accounts for only 20% of the company’s total sales, is likely to grow much faster in the near future.  This will be achieved with joint ventures and by leveraging the brands that have the highest international penetration, like Nature valley and Haagen Dazs.

The stock is trading with a price-earnings ratio of only 16 times and an attractive dividend yield of 3.3%. But looking at the company’s growth, it is trading at only 13 times future earnings.  This is a low-risk proposition, as both the company earnings and the dividend appear to be very safe. In addition, the stock has a small short ratio that should diminish if we see profit-taking in the cyclical.

Last but not least, in addition to the short-term technical turning bullish at the end of April, as the stock crossed its 13-day and 50-day exponential averages to the upside, the long-term technicals have also turned bullish and the stock is still way oversold.

Recommendation: Buy General Mills Inc. (GIS) at the market and accumulate more if you see weakness (**).

(**) – Special Note of Disclosure: Horacio Marquez holds no interest General Mills Inc.

Source: Buy, Sell or Hold: General Mills Inc. (NYSE: GIS) is a Wholesome Company with Profit Coming Down the Pipeline

In a report posted on the Web site of Pacific Investment Management Co. (PIMCO) – which runs the world’s biggest bond fund – Chris Caltagirone and Bob Greer said inflation will return as soon as 2010 and will remain a factor for some time to come after that- a scenario that makes commodities and TIPS (Treasury Inflation-Protected Securities) “two [investment choices] that can provide investors diversification as well as exposure to sectors that may benefit from future economic developments.”

In the near term, however, Caltagirone and Greer expect excess capacity and high unemployment – among the key catalysts of supply and demand – to extend deflation for several more months or quarters.

However, they believe that “the policies of the Federal Reserve and the Obama administration, which are designed to avoid deflation, are likely to reflate the economy over the next three to five years,” Caltagirone and Greer wrote.  “Although we expect growth to contract in 2009, [the] government stimulus [outlays] may reflate the economy as soon as 2010 and beyond that.”

Caltagirone and Greer join a growing chorus of prominent inflation hawks that includes Warren Buffett, Marc Faber and Jim Rogers.

On Monday, Buffett said in a CNBC interview that inflation levels could reach as high as those in the 1970s as a result of the government’s attempts to resuscitate the economy.

That same day, Faber – publisher of the Gloom, Boom and Doom Report – agreed.

“The massive money printing we have and the massive deficits we have now will make it difficult when there are some price pressures for the Federal Reserve to actually increase interest rates,” Faber said in a Bloomberg Television interview.

Likewise this week, Rogers – a longtime commodities bull – said that conventional U.S. Treasuries that aren’t inflation-protected are going to take a beating from U.S. policies.

Inflation’s Catalyst: Uncle Sam’s Wallet

President Obama’s 2010 budget plan is already forecasting a $1.8 trillion deficit for the current budget year

In addition to the $789 billion stimulus bill passed in mid-February, U.S. Treasury Secretary Timothy F. Geithner has said he is ready to commit up to $1 trillion to strengthen the nation’s banks and jumpstart lending.

The basic logic – which Money Morning’s Martin Hutchinson outlined as far back as November – is that with the government pumping so much money into the economy, it’s bound to have an inflationary impact.

The high inflation Buffett referred to peaked in March 1980, when the consumer price index (CPI) gained 14.8% from the year before.

And though it seemed excruciating, the highest the CPI moved last year was 5.6% in July, followed closely by a 5.3% increase in August, according to the Bureau of Labor statistics.

Recently, consumer prices fell 0.8% in December and increased 0.3% in January. February inflation statistics are due for release next Wednesday (March 18).

How Protect and Profit from Rampant Inflation

In their PIMCO report, Caltagirone and Greer recommend investors consider TIPS.

“The decline in TIPS prices makes them attractive now on both an absolute basis and relative to nominal Treasuries,” they wrote. “In addition, although we expect inflation to remain low in the near term, we believe that inflation will rise in the medium term, which means TIPS may be a more strategic, as well as tactical, investment opportunity.”

Starting as soon as next year, they expect government stimulus measures to kick in and reflate the economy.

And with commodities projected to rise in step with inflation, Caltagirone and Greer recommend investing in PIMCO’s (naturally) CommodityRealReturn strategy, which “gains exposure to commodities through derivatives that track the Dow Jones AIG Commodity Total Return Index, and the derivatives are collateralized with an actively managed TIPS portfolio.”

Money Morning’s Investment Director Keith Fitz-Gerald wrote a how-to guide for TIPS investing, in which he suggested a pair of TIPS funds, one by PIMCO, to help investors hedge.

Another way to hedge is with gold.

Investors panicked when the yellow metal dived along with the economy. But Money Morning’s Hutchinson – an investment banker with more than 25 years’ experience on Wall Street and a leading expert on the international financial markets – understood perfectly what other investors did not.

“Gold is not a safe haven against recession,” Hutchinson said. “It’s a safe haven against inflation.”

But with commodities and inflation on the rise, gold could reach as high as $1,500 an ounce by the end of the year, Hutchinson said.

“Everybody thinks that because we’re having a horrible recession, we’re not to going have inflation. I think that’s probably wrong,” Hutchinson said. “I think gold has quite good hidden-store value.”

Money Morning recently outlined five ways investors can play gold – from safe to speculative.

Source:  Two Ways to Protect Yourself When the Inflation Alarms Return

It’s a growing theme here at Contrarian Profits. As the US economy falters, many of the contrarian investment experts we publish daily are advising readers to go global.

Last week, William Patalon in Money Morning argued that every successful investor needs a China investment strategy,  and Taipan Daily editor Justice Litle wrote about how the most bearish man in America, Nouriel Roubini, is bullish on emerging markets. This from Andy…

In his new book, “When Markets Collide: Investment Strategies for the Age of Global Economic Change,” the co-CEO of bond-investing giant Pimco, Mohamed El-Erian, argues that global expansion has fundamentally changed the way to invest.

Last week, in a Q&A with Money, he said…

• “In the old days, if the US economy contracted, the rest of the world would do even worse. But today, if the US contracts, the rest of the world might contract by only half. That’s a fundamental change. The wealth of the emerging middle class in countries like Brazil, India and China is becoming a force in itself.”

• “The typical US investor tends to have about 80 percent of equities in the US. The world of tomorrow suggests a much greater exposure overseas. In general, you should consider holding a third of your equities in the US, a third in industrial countries outside the US and a third in emerging markets.”

Of course, each week brings another reason why the global investing trend is undeniable.

Last Tuesday, the Dow Jones Indexes said it was ready to launch The Global Dow, an index whose components will be selected by the editors of The Wall Street Journal.

To accentuate how global the financial world has gone, Rupert Murdoch, who owns Dow Jones, unveiled the The Global Dow plan while he was in Mumbai, India.

Murdoch, the mega-wealthy media tycoon, pretentiously said:

“The world is changing and how we measure that change economically and financially is clearly a challenge and an opportunity. We have seen a re-weighting of risk around the world, but the world itself is being economically re-rated and so we need an index that allows investors to take advantage of these changes. Indian companies will obviously have a place in The Global Dow as will companies from other emerging countries where we have seen an unprecedented economic emancipation over the past two decades.”

And, according to a horribly written press release from Dow Jones:

“The Global Dow will track the share prices of existing and future global leaders in every industry. Vigorous companies from emerging economies will be included along with companies from emerging sectors such as alternative energy.”

Lousy quotes and bad press release talk aside, you can get the point.

The global reality is crashing into us at breakneck speed. So fast, perhaps, that The Wall Street Journal’s managing editor, Robert Thompson, didn’t think he sounded like a boob when he issued the following statement:

“While we must reflect the global stock market as it is, we must also recognize the rapid rise of companies in countries such as India. We have already seen great Indian companies acquiring famous brands such as Jaguar and Land Rover, but these developments are just the beginning of a long-term trend that will fundamentally change the international corporate landscape. As with the Dow Jones Industrial Average, the component choices for the new index will be based on the editorial judgment of the world’s leading business journalists, that is Dow Jones journalists.”

What a self-serving mouthful.

Murdoch and minions should take a lesson from John Tsang, Hong Kong’s Financial Secretary.

Source: Global Investing Juggernaut Gains Momentum

But don’t despair. Because a trend that has long been talked about – economic decoupling – is finally starting to manifest itself as other world economies, particularly the so-called “BRIC” markets of Brazil, Russia, China and India, have continued to grow even as the U.S. economy has slowed. That means profit opportunities abound for U.S. investors, despite myriad messes on the home front that include a collapsed housing market, a mortgage crisis that turned into a five-alarm credit conflagration, and a plunging greenback that seems to have left its parachute on the airplane that it jumped from.

Some of the profit pathways to play:

• Investors can eschew the U.S. market completely, and pursue profits abroad.
• They can latch onto the U.S.-based members of the “Global Titans” club, companies with their headquarters in America that derive a hefty chunk of their profits from overseas markets.
• Or investors can ferret out U.S. investments that are either immune to some of this country’s current economic afflictions, or that are problem-plagued now, but a good bet for a turnaround later.

A Year to Forget?

Like a Dickens’ novel, 2007 was a definite “Best of Times/Worst of Times” combination for the U.S. economy. Volatility and crisis were the watchwords for much of the year. After key stock indices reached record highs in the middle of the year, the explosive emergence of the subprime mortgage debacle and related credit crunch pushed share prices into a nosedive that steepened as the year progressed.

With a 0.6% increase in gross domestic product (GDP) for the fourth quarter of 2007 and a first quarter that’s supposed to be flat at best, it’s clear that we’re not out of the woods, yet. Many fear that 2008 will find the United States in a recession. Other investors believe we have already experienced the first elements of a recessionary contraction.

“If I had to be bold, I’d say we began a recession in December,” Bill Gross, manager of the PIMCO Total Return Fund (PTTAX), told the Financial Times in a recent interview.

The Homeowner Blues

As 2007 progressed, many Americans experienced a growing despair as they watched their largest asset – the family home – experience a significant value decline. The United States is experiencing its worst housing recession in more than 15 years. And that domicile downturn is far from over. Consumers are being forced to watch as the housing slump siphons off the equity they’ve built up, even as it shaves the market value of their homes. Consumers with marginal credit who’d signed up for adjustable-rate loans have seen their mortgage rates “reset,” and then had to watch as their monthly mortgage payment ballooned to the point that they could no longer afford those payments.

For many, unfortunately, refinancing hasn’t been an option. The vanishing homeowners’ equity made such deals unfavorable to lenders. And with the burgeoning credit crisis that quickly became global in nature, banks and mortgage firms have slashed the available amount of refinancing loans that homeowners needed to escape their soaring mortgage payments.

Soon, the banks that had made the questionable calls on subprime loans were in trouble, too. With the housing market cooling, the homeowners who couldn’t refinance also discovered that they couldn’t sell. Homeowner defaults – loans that are 30 days or more past due – soared and started a firestorm that has swept through the global financial-services sector, singing such stalwarts as Citigroup Inc. (C), Fannie Mae (FNM), UBS AG (UBS), and others.

“It will take most of the year to work out of the housing slowdown. Currently, the inventory of unsold homes is at an eight to nine-month level. We have to get this down to a more normal level of four to five months. In order to get to this level, housing starts will remain low,” Dr. Robert Sweet, an economist at MTB Investment Advisors, the investment-advisory subsidiary of M&T Bank Corp. (MTB), said in an interview with Money Morning.

And we might be getting closer to the bottom. In fact, existing home sales rose in February, the first such increase in the past seven months. But it’s probably too soon to get excited about a full housing recovery.

“It looks like this may be a temporary pause,” Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Mass., told Bloomberg News after the existing homes sales report was released. “The price declines have helped, and people are still getting financing, though not on the good terms they could before.”

“We’re still a long way from a recovery in housing,” Gault said.

The Fed to the Rescue?

U.S. Federal Reserve policymakers cut the benchmark interest rate by less-than-expected three-quarters of a percentage point at their last meeting, a move that was designed to energize a badly flagging economy without causing inflation to spike or exacerbating the greenback’s decline.

When central bank policymakers reduced the key Federal Funds rate from 3% to 2.25% on March 18, it was the sixth time in seven months the closely watched benchmark had been reduced. Many analysts had been expecting a reduction of a percentage point – or even more – as such recent events as the near-collapse and subsequent Fed-led bailout of U.S. investment bank The Bear Stearns Cos. Inc. (BSC) stoked fears that the U.S. financial system was ready to seize up.

The policymaking Federal Open Market Committee (FOMC) has now cut the Fed Funds rate six times and slashed the Discount Rate for direct loans to banks eight times since August, when the subprime mortgage market collapsed and created a global credit crisis.

While the FOMC made it clear that inflation has grown as a concern, it still says that economic worries remain the biggest problem and emphasized that it was ready to act again if need be.

“Today’s policy action, combined with those taken earlier, including measures to bolster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity,” the FOMC said in its March 18th statement. “However, downside risks to growth remain. The committee will act in a timely manner as need to promote sustainable economic growth and price stability.”

It seems the Federal Reserve and other global central banks have successfully tempered the credit crisis since mid-March. The Fed’s effective bailout of the now defunct Bear Stearns created a floor under the sub-prime wreckage.

The good news is that a host of high-risk credit indices have posted big rallies over the last eight weeks. That includes a blizzard of new fixed-income issues as companies return en masse to fund their operations.

But don’t get too excited…The debt crisis is far from over.

LIBOR Rates Barely Budge Lower

While several indicators have improved recently, other important sources of funding remain under pressure. This tells me the sub-prime crisis is now spreading from the mortgage-backed securitization market to consumer installment debt.

Also, inter-bank lending rates have yet to fully recover from their pre-July 2007 levels while bank credit is contracting, not expanding – an ominous sign as the United States struggles to escape a slowdown.

Three-month London Inter-Bank Borrowing Rates (LIBOR) has barely budged since the Fed rescued Bear Stearns. The majority of financial institutions continues to hoard cash and refuses to trust overnight lending facilities.

The Main Sub-Prime Fear Factor:
Overnight Lending Rates Barely Move

While it’s safe to assume that some areas of the credit markets have not stabilized, other areas of the credit markets have indeed started to breathe easier. Among those normalizing this spring is the sub-prime market.

Sub-prime is Finally Tamed

According to Fitch, the international credit-rating agency, banks have probably written off approximately 80% of their bad loans through mid-May.

It’s not over for every bank. Some banks, including Switzerland’s Union Bank of Switzerland (UBS) continue to surprise the markets on a weekly basis with a host of spectacular losses tied to real estate, sub-prime, leveraged loans, and auction rate securities.

But for the most part, however, the sub-prime crisis is past its inflection point. What matters now is how and when other credit indicators normalize.

As of yesterday, the sub-prime crisis has resulted in approximately US$200 billion worth of write-downs for global banks. The lion’s share of those losses came from UBS and others in the United States and the United Kingdom.

For the most part, Asia and Latin America have escaped the crisis. Their banks remain highly liquid compared to their peers in North America and parts of Western Europe.

The securitization model (aka rolling sub-prime mortgages into securities and selling them) is still alive and kicking overseas, but it was NOT a primary investment source for Asian and Latin banks. Therefore these savvy banks avoided most toxic sub-prime products like collateralized debt obligations or CDOs.

Credit Spreads Narrow

As I continue to track the normalization of credit markets, I’m encouraged by the narrowing credit spreads across several markets – a bullish development.

One key indicator I follow – the spread between three-month Treasury bills and the three-month LIBOR – has narrowed considerably since March to 0.85% from 1.83% back in early April.

That tells me that the “safe haven” trade on short-term Treasury bills since the sub-prime crisis first erupted last summer is reversing. It also means that risk is gradually returning to the credit markets. Prior to mid-April, three-month T-bills plunged way below the Federal Funds rate to a low of 0.81% – severely overbought as investors scrambled for safety.

Another bullish indicator now flashing green is the yield spread between 30-year municipal bonds and 30-year Treasury bonds.

Prior to mid-March, the yield differential between 30-year municipal bonds and long-term T-bonds ballooned to their highest in history as investors fled municipal debt. The average yield on high quality municipal bonds has plummeted 70 basis points (0.70%) after reaching a peak on February 29.

Earlier last winter, as yields soared, savvy investors like Bill Gross of PIMCO and venture capital investor, Wilbur Ross, scooped-up those fat yields. In hindsight, that was a great speculation as yields have plunged versus T-bonds.

Also, some mortgage and financial companies, including non-financial issuers, are successfully raising capital again since April. Though financing remains much more expensive compared to 12 months ago, it’s nevertheless a positive development for global capital markets.

Beware of High-Risk Debt Markets

High-yield bond indexes and preferred securities have also rallied since late March.

Preferred securities, which provide stock and income-like features, have also rallied. But financial service companies that most issue these preferred securities and write-downs are far from done. I would avoid preferred securities and those juicy, but dangerous yields.

The same is true for high-yield bonds and other busted credits, including sub-prime securities as the economy continues to slow.

High-yield or junk bond defaults remain historically low at just below 2% of all outstanding issues. Previous recessions have seen defaults surge almost three times this level.

In my view, the recent rally is nothing more than a dead-cat bounce. More junk bonds will default over the next 6-12 months.

The Next Credit Crisis: Consumer Installment Debt

I’m still highly dubious that credit markets have bottomed. Sub-prime is now largely history. But other segments of the credit spectrum that have a far more profound impact on the American consumer are just beginning to unravel.

The consumer is now threatened by a liquidity crisis. Housing values continue to heavily contract and revolving credit installment debt is becoming harder to secure.

The culprit is less the write-downs themselves and more the virtual “shutdown” in the securitization market. At its height, the securitization market provided 66% of household borrowings in the first quarter of 2007. Without this market, consumer credit losses may be far worse than currently estimated.

Auto loans, personal loans, mortgage loans, and other segments of installment debt are still contracting. Auto loans are especially vulnerable with defaults recently hitting a 10-year high of 3.4% in March. And more Americans are dropping their house keys to their local lenders as housing values continue to plunge below the cost of their mortgages.

Consumer deflation has arrived at the absolute worst time as savings rates are barely positive. Soaring energy and food prices, declining home values, surging auto delinquency loans and gradually rising unemployment depict a growing liquidity crisis now underway for the consumer. Also, most, if not all, installment debt is structured to finance domestic consumption. It’s not a pretty picture.

Stay defensive and avoid most debt markets, except high quality short-term Treasuries and investment-grade bonds. The consumer credit bear-market is underway.

ERIC ROSEMAN, Investment Director

EDITOR’S NOTE: As of today, our Sovereign Society research team is working on a special report to give you the information you need to protect yourself from this second coming of sub-prime – when it hits the real economy – including your personal credit report. Please look for this special report coming to your email inbox this weekendSource: Is Sub-Prime Finally Over? Yes and No

Source: Is Sub-Prime Finally Over? Yes and No

The big news today is happening on the highways…

But first, let’s look at the basic figures.

Yesterday produced a weak rally in the stock market – with the Dow up 68 points. Oil lost $3, to close at $128. The dollar rose slightly. And gold got whacked for a $17 loss, but still closed above $900.

You’ll remember how we left you yesterday…we hope you remember, because we can’t. But we think we said that the US consumer should be cutting back. His energy is much more expensive. His food is more expensive. His house is going down in price. He can’t borrow as he used to. He has to cut back, we keep saying; he has no choice. And when he cuts back, the US has to go into a slump. And here we agree with Warren Buffett; it will be longer and deeper than more people think.

We agree with George Soros too; the slump will result in a “noticeable decline in living standards” for most Americans.

But as we signed off, we noted that we were waiting for the evidence…the proof that the consumer is cutting back.

Now we have it. And it comes from the highways.

“Steepest drop in driving since ‘40s,” says a CNN headline item.

According to the report, Americans drove 11 billion miles less this past 12 months than they did the year before.

In the 1940s, the reason for the cutback in driving was obvious to everyone – the country was at war. The auto companies practically stopped making cars so they could turn their production to tanks, jeeps, and trucks. Oil too was diverted from leisure use in the 48 states and used to power ships and airplanes.

But after the GIs came home, they got married, bought cars, filled up their tanks, and headed for the open road. Every year since, until very recently, the national odometer showed more miles driven than the year before.

Now, something big has happened…for the first time since WWII, Americans are driving less.

America’s truckers too are pulling off the road. A report in the New York Times says that many cannot afford to fill their tanks. Diesel fuel is selling for as much as $5 a gallon. This puts the cost of filling a 250 gallon tank well above $1,000. And many truckers fill their tanks three times a week.

Naturally, the auto industry has to downshift. Not only because gasoline is so expensive, but also because the average household is struggling to pay its other bills too. After it pays the interest on its debt, it has less left over than ever before. And then, it has to pay for food, gasoline…and other things, many of them imported. Of course, food and energy are rising sharply, but until recently, Americans could count on low-cost Asian producers to cut prices on our imports. Now, import prices are rising at 14.8% — the highest rates since the early ‘80s.

We’ve already accused the official numbers of lying; now we call Bill Gross, who runs the biggest bond fund in the world, PIMCO, to the stand, to help make our case.

“If we calculated inflation the same way other countries do it, our CPI would be 1% higher,” says Gross. (Bond yields would be 1% higher too, he notes.)

Prices are going up more than the official numbers tell us, in other words. About the only thing that is going down, for the typical American, is the price of his house. And here the news that house prices are going down more than we thought too. The latest survey results from Case/Shiller show the average house in America’s largest 20 cities down 14.4% in March compared to a year earlier – the largest drop on record.

Can you blame the lumpenconsumer for getting down in the dumps? Everything that we warned him about is happening to him. His bills are coming due…his assets are going down…and his income is falling.

Yes, dear reader, that too. The job numbers show a modest decline in employment. What they don’t show is the many people who are “self-employed” who are having a hard time finding work. One of the great benefits of the internet was that it allowed workers much more flexibility. Many found they could leave the 9-to-5 office routine, move to the beach or the mountains and still continue to work on-line. Here in London, for example, there are probably thousands of Americans who are enjoying life in the city, while continuing to work via the worldwide web. We see them in Starbucks, for example, with their heads down and their laptops up. Freelance work was a big advantage for the former employee, because it allowed him to go where he wanted when he wanted. It was a relief to the employer too because it permitted him to reduce internal office costs and fixed expenses. But in a downturn, the easiest thing for an employer to cut is the out-of-office staff. He can just send them an email!

Often these freelance consultants are mature workers who then find it very difficult to get back into the regular market.

“Out of a job and out of luck at 54,” begins an article on the subject in today’s press. Apparently, there are many thousands of people who are “too young to retire, too old to get a new job,” says the report.

Curiously, these facts and circumstances are not showing up in the stock market. Instead, they are showing up in consumer confidence numbers – which continue to sink. Traditionally, stock indices and consumer confidence numbers coincide. When stocks go up, people are confident. When they go down, they lose heart. But not necessarily in that order. In 2005, however, the numbers began to diverge. Stocks rose. Confidence fell. Investors saw clear sailing. Consumers saw rough seas.

Who’s the better weather forecaster? We’ve put our money on the consumers.

And more opinions…

*** Another item from the automobile sector. An auto dealer south of Kansas City has tried to motivate buyers by offering a free gun with every new auto. Predictably, the European press regards this as more proof that Americans are all gun-crazed yahoos.

We don’t know why they needed more proof. We thought the matter had been settled; of course Americans are gun crazed yahoos. At least, the best of them are.

Why has the price of oil risen so much in the past few months? Is it a supply and demand issue as some believe; or is it because of an out-of-control futures market driven by the proliferation of commodity index funds and rampant speculation, as everyone tries to get in on the rise in commodity prices? This is a very complex issue, with a lot of emotion attached to it.

This week I try to give you an understanding of why oil prices have risen and whether they are likely to stay at such lofty heights or maybe even fall! And we look at a very odd statistic: where are all the tankers? There are some very unusual things happening in the oil patch. If you are currently exposed to the energy or commodity markets, or are thinking about it, I believe you will find this letter of interest. At the end of the letter, I also tell you how you can personally see that help gets to the victims of Cyclone Nargis in Myanmar. It is a desperately needy situation. There is a lot to cover, so we will get to the essay right after this quick note.

I have talked for the past few months about why I feel we may be in for a tough investment environment and a Muddle Through Economy. I think in this type of market cycle it is important to increase your portfolio allocation weighting to noncorrelating investment strategies. I work with Steve Blumenthal and his team at CMG to help investors find managers who can take smaller minimums and who have such alternative strategies. We are creating a platform of managers that you can access for your personal portfolio. I recently completed a special write-up on Eric Leake of Anchor Capital, an investment advisor I am particularly impressed with. For the last 12-1/2 months, he is up 16.77%, in comparison to the S&P 500 index that is down -2.08% (net of fees from April 30, 2007 through May 15, 2008). Equally impressive is that he has generated this return while being uncorrelated to the S&P, and with lower volatility than the market.

You can get this report and others I have written by going to https://cmgfunds.net/public/mauldin_questionnaire.asp and filling out the form. If you are a manager and would like to be considered for the platform, drop a note to PJ Grzywacz at pjg@cmgfunds.net. And if you are an investment advisor and would like to see the managers that are on our platform and determine whether they might fit into your client portfolios, we do have a program to work directly with you.

And as always, if you have a net worth of over $2 million, I strongly suggest you go to www.accreditedinvestor.ws and register there. My partners in the US (Altegris Investments), London (Absolute Return Partners) and South Africa (Plexus) are experts in alternative investment strategies, including hedge funds and commodity funds. We have a very strong selection of funds in a wide variety of styles to help you diversify your portfolio. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.) And now, let’s jump into the oil patch.

Those Nasty Index Speculators

Are institutional investors in the form of large commodity index funds the reason behind the current rise not just in oil prices but in the prices of seemingly all commodities? Michael Masters, a long-short hedge fund manager, in testimony before the Congressional Committee on Homeland Security and Governmental Affairs, said:

“You have asked the question ‘Are Institutional Investors contributing to food and energy price inflation?’ And my unequivocal answer is ‘YES.’ In this testimony I will explain that Institutional Investors are one of, if not the primary, factors affecting commodities prices today. Clearly, there are many factors that contribute to price determination in the commodities markets; I am here to expose a fast-growing yet virtually unnoticed factor, and one that presents a problem that can be expediently corrected through legislative policy action.”

You can read the entire testimony at http://www.mcadforums.com/forums/files/michael_masters_written_testimony.pdf, but let’s hear the basics of his argument:

“What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.

“These parties, who I call Index Speculators, allocate a portion of their portfolios to “investments” in the commodities futures market, and behave very differently from the traditional speculators that have always existed in this marketplace. I refer to them as “Index” Speculators because of their investing strategy: they distribute their allocation of dollars across the 25 key commodities futures according to the popular indices – the Standard & Poors – Goldman Sachs Commodity Index and the Dow Jones – AIG Commodity Index.”

These index funds are composed of a number of commodities. While oil is the biggest component of the various funds, they also have exposure to grains, base metals, precious metals, and livestock. When you buy one of these funds you are buying a basket of commodities.

Why would an investor want exposure to a long-only index of commodities? Perhaps for portfolio diversification, as commodities are uncorrelated with the rest of the portfolio, or as a way to play the growing demand for commodities of all sorts from emerging markets, as a hedge against inflation, and so on. Mainline investment consultants began to suggest a few years ago to their clients that they get into the commodity market on a buy and hold basis, just like they do with stocks and bonds.

And they have done so in a very large way. As the chart below shows, at the end of 2003 there was $13 billion in commodity index funds. By March of this year, that amount had grown 20 times, to $260 billion. Masters also shows that this corresponds with the stratospheric rise in commodity prices. In many commodity futures markets, index speculators are now the single largest participant.

“Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat,” says Bill Gross of PIMCO. “This recession, though currently mild, and, as of yet, not even officially validated, may not be your garden-variety, father’s-Oldsmobile type of downturn.”

Has the Dow seen its lows for the year, as Richard Russell says? Is the housing crisis over, as the Wall Street Journal says? Is the credit crunch over, as Warren Buffett says?

As the song says, “it ain’t necessarily so.”

House prices are going down. They’ll take the American consumer down with them. The “crises” may be over…but the long, slow, slump is still ahead.

We left Paris this morning on the 6:43 train. The train glides out of the Gare du Nord…then eases its way out of the city. Once clear of the suburbs, the Eurostar’s Casey Jones opens up the throttle…pretty soon, the train is travelling at more than 200 mph…so fast that if you try to look at something out of the window, it is gone before you have a chance to study it.

Arnold Schwarzenegger came over to France recently. He took a little train ride with France’s president, Nicholas Sarkozy, and had the same experience.

“Wow…” or words to that effect, he is reported to have said…”I didn’t know trains went so fast.”

Americans ought to get out more. We’ve been living and travelling outside the US for the last 14 years. It’s a big world…there’s a lot to see. And what we see is a world that is changing fast…growing…evolving…experimenting…

…and leaving America behind.

We don’t know whether high speed trains are a good idea or not, from an investment standpoint that is, but American infrastructure seems to be on “a pot-holed highway to hell,” as an English writer put it in the Financial Times last week. In the Eisenhower years, the interstate highway system was the envy of the world. Now, foreigners laugh at US infrastructure.

The lack of high speed trains is just emblematic of a deeper problem in the US – a lack of savings and investment for the future.

The Daily Reckoning doesn’t pussyfoot around with the implications of it. Sell America, sell its money, sell its property, sell its shares, sell its foreign policy, sell its bonds. Yahoos and members of Congress will say we are ‘unpatriotic.’ Investment pundits will say we are stupid. Selling America is not a smart thing to do, as the greatest investor of all time, Warren Buffett, reminds us.

But as to these charges, we deny the first and await the market’s judgment on the second. America needs a correction; it would be unpatriotic to deny it to her. Besides she will be a better, strong, more decent and civilised place when people stop spending more than they afford…start saving again…and return to minding their own business. And Buffett, himself, is now coming to Europe looking for places to put his money.

In the short run, we could see a revival of the dollar. European interest rates held steady – with the key lending rate of the European Central Bank at 4% — while Bernanke cut the Fed’s rate seven times. Under those conditions, it’s amazing that the dollar didn’t fall more.

Now, inflation has dipped down in Europe…allowing the ECB to cut, if it chooses…while the Fed’s rate cuts seem to have come to an end. With no more obvious reasons for the dollar to fall…it has stabilised. Next, it will fall for reasons that are less obvious and more important. But our view on America is long-term…and it comes tethered to our views on inflation and oil…and practically everything else. So let us begin by looking at Philadelphia. The City of Brotherly Love used to make things and sell them at a profit. From this healthy exchange, Philadelphians, like so many other Americans, were able to raise their own wages and living standards to not only the highest levels in the world…but the highest levels the world had ever seen. Never before in human history were ordinary people so rich.

Naturally, this led to a certain amount of self-satisfaction…which led to complacency…which led people to think they’d be all right no matter what they did. Then came a series of events and trends that seemed to prove they were right. China began making things at much lower cost. Wal-Mart distributed these things to Americans at low prices. Instead of keeping merchandise in inventory, retailers switched to “just-in-time” systems, which further allowed them to cut costs. In real terms, prices of raw materials plummeted too.

Then, the Fed lent money below the rate of inflation. Normally, the Fed’s easy money policies – in addition to lending at 1%, it has been increasing the money supply twice as fast as GDP for 20 years – would cause consumer prices to soar. But after Paul Volcker wrung inflation out of the system in the ‘80s, China helped keep the squeeze on – holding prices down despite a huge increase in the supply of dollars.

Wall Street played an important role too. It came up with innovative ways to pass the Fed’s money along to American households – allowing them to spend money they never earned.

The whole thing was almost too wonderful. No matter how much Americans spent…it seemed as though there was always more where that came from.

From 1980 to the present, the savings rate fell from over 10% to under 1%. Debt grew twice as fast as incomes – except for financial debt, which grew three times as fast.

Now, the factory jobs have packed up and moved to Asia…there are few left in the Philly area. In their place, are jobs in health, education and finance…that is to say, in the service industry. And today we get word from Philadelphia that inflation-adjusted wages are down from $17.25 per hour in 2001 to only $16.59 today. More people are forced to take part-time work – because they can’t find full time jobs. And the number of hours worked by Americans is falling nationwide.

In Europe, wages are substantially higher – in part because the euro is high…and in part because unemployment is high (fewer low-wage jobs exist). Not only that, Europeans work fewer hours. As reported in this space, the average salary in America is now about $38,000….compared to $42,000 in France. But the typical American also only gets two weeks off, whereas the typical Frenchman gets five weeks holiday. Doing the math crudely, which is the only way we do math, we find an hourly average wage in France of $25.50!

Today’s Financial Times mentions a 36-year-old man in Philadelphia who has had to take a job at a deli counter, earning only $7 an hour. Our two daughters, meanwhile, both hold unskilled, part-time jobs in London – working at a pub and a health food store – where they both earn $12 an hour. And both are eligible for free public health care.

*** China reported consumer price inflation over 8%. Ah yes, dear reader, those happy circumstances that permitted the typical Philadelphian to enjoy Everyday Low Prices at Wal-Mart are gone. Now, inflation has been globalised…along with the labour market, the food market, and the oil market. The Chinese want higher wages. And their inputs – raw materials and oil – are rising in price too.