We said we were doing some serious thinking this week. Maybe it is the season. But more and more, our thoughts become grayer. Less black. Less white. Less hard. Less soft.

A few years ago, it looked to us as though the world financial system had gone to war. We cheerfully awaited the victory parade. We figured Mr. Market would whup the feds good and hard. It hasn’t happened so far.

On one side, are the forces of a natural market correction… following a long, long period of expansion. The easier money gets, the more people tend to mis-spend and mis-invest it. Then, inevitably, their mistakes must be corrected. That’s what bear markets and recessions are for.

But the feds don’t like bear markets or recessions. And at least since Keynes outlined his general theory back in the early 20 th century, they’ve believed that they don’t have to put up with them. Keynes took a page from the Old Testament. Government should act like an enlightened Egyptian Pharaoh, he didn’t say, but should have. It should run surpluses in the fat years and deficits in the lean years… thus flattening out the pattern of boom and bust.

Pharaoh was no dope. He stored up grain for 7 years, when the harvests were bountiful. Then, when the 7 lean years came, he released the grain to the people. Problem solved.

Keynes believed that modern government could do the same thing. But Pharaoh was not running a democracy. He had no voters to answer to. So, if he wanted to store grain in the fat years, he could do so.

In theory, the US government could do the same. But in fact it never runs significant surpluses. There are too many people who want too much bread and too many circuses. And you don’t win votes by denying the voters what they want. So, in practice, the feds run deficits even in the fat years! Last year, before the downturn really started to bite, the US federal government ran the biggest deficit in history – nearly half a trillion dollars.

Now, let’s imagine how that would work for a bad Pharaoh. He would give out grain in the fat years. This would encourage farmers to produce less grain. Then, when the lean years came, Pharaoh would have no grain to give out… and the farmers would have less grain stored up themselves, since they grew less during the boom years. The famine would be worse than ever.

Then, if we can imagine that Egypt was trading with China at the time, perhaps Pharaoh could borrow grain from the Zhou dynasty to help ease the peoples’ pain. Perhaps he could mortgage the pyramids. Whatever, he – and the Egyptian people – would have been in much better position if he had done as Joseph told him in the first place… lay up stores in good times, draw then down in bad times. How difficult is that?

But Bernanke didn’t see the famine coming. Neither did Geithner. Or Greenspan. Or any of the other savants Pharaoh interpret his dreams . None of them expected hard times. None of them warned the public. None of them encouraged the government to save money for the recession. Nassim Taleb asks why Bernanke was reappointed after he clearly failed the most critical test. But heck… the federal government is an equal opportunity employer. Employees aren’t let go just become they’re incompetent.

Anyway, getting back to our thoughts…

… it looked like a battle to us – between the forces of inflation (the feds)… and the forces of deflation (the market). But battles usually have clear winners. One side is master of the field; the other retreats. One side is victorious; the other is defeated.

Alas, some wars produce no hozannahs of success… and no wailing widows of failure. Some end in draws… or in confusion… or in disgrace and bankruptcy for both sides.

Like the bad Pharaoh, the feds saved nothing. Now, they have to try to work their Keynesian magic on credit. This puts them in a weak position; like a government that wages war on borrowed money. They can continue their campaign only as long as lenders allow them. They can’t wage the war as effectively as they’d like. Then again, maybe they can’t lose it as spectacularly as they might.

For the moment, their credit is still good. The bond market foresees an inflation rate of less than 2%. Bankers, taking money from the government, are happy to lend it back to them.

But the forces of the correction are giving up little ground. While stocks rally, the real economy remains in a funk.

“Sharp drop in start-ups,” is a news headline from yesterday. New business start-ups are a major source of new jobs. Bad omen.

Even glamour publisher Conde Nast is forced to make cut-backs. It has told employees that they may not spend more than $1,000 a night when they are travelling.

A Pimco economist says savings rates are still going up… and may exceed 8%. This represents hundreds of billions of dollars taken out of the consumer economy. Oddly, while it makes the slump worse, it also helps finance the government’s battle against it. Savers buy US debt (albeit indirectly).

So, the battle is still going on… and the outcome is still in doubt.

*** Racehorse prices are in freefall, says a report out yesterday. But collectible cars are still doing well.

Yesterday, we saw someone drive by in a huge, gaudy pink Cadillac from the 1960s. It had magnificent fins and enough chrome to stagger a blind man. In it were a middle-aged man and woman, looking very comfortable and proud. They were travelling in style… in a rolling sculpture.

Old cars are not only holding their values, they’re still going up. But not all old cars. Detroit’s muscle cars have been falling in price for the last three years. Not very green?

*** And here’s a report we received over the internet, from Aaron Trask:

“Everyone is right to fret about inflation but the “deflation scare” isn’t over yet, says Charles Nenner, founder of the Charles Nenner Research Center.

“Renowned for his cycle work, Nenner sees deflation remaining dominant until year-end and inflation not picking up for another 18 months. But that will be the start of a 30-year (yes, year) upcycle for inflation says Nenner, who spent 12 years as a market-timing consultant for Goldman Sachs.

“The investing implications of this scenario are clear: Nenner is bullish on gold for the long-term and even more bullish on gold mining stocks, which he says are currently cheap relative to bullion. After a secular decline, Treasury yields are set to rise, with Nenner predicting the 10-year yield will reach 5.50% by Spring 2013, a 45% rise from Friday’s close of 3.78%.

“What’s less clear is the timing of this trade. Nenner believes the “deflation trade” is about to reassert itself in the short-term, meaning strength in the dollar and Treasuries, and weakness in commodities and equities, as we’ll discuss in more detail in a forthcoming segment.

“For those who believe the dollar is doomed, Nenner notes “all currencies are bad.” In other words, currency trading will be a game of relative bets vs. a one-way trade against the greenback, as so many expect.”

Until tomorrow,

Bill Bonner

Source: The Battle Continues

The downgrade has both financial and political ramifications.  It is sure to increase the country’s cost of borrowing and may even boost the out-of-favor Conservative Party to victory in the next election, which may come as early as next year.

Even though the agency reaffirmed its ‘AAA’ long-term and ‘A-1+’ short-term credit ratings for the United Kingdom, the downgrade may be cause for alarm among its debt holders and citizens.

“We have revised the outlook on the U.K. to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100% of GDP and remain near that level in the medium term,” Standard & Poor’s credit analyst David Beers said in a statement, according to Reuters.

S&P questions the government’s stance regarding “how quickly the erosion in the government’s revenue base may be repaired, the extent to which the growth in government spending can be curtailed, and consequently the pace at which historically high fiscal deficits are likely to narrow,” Beers said in the statement.

Just minutes before S&P announced the ratings cut, the government released figures that revealed the budget deficit hit $13.4 billion (8.5 billion pounds) in April, the most for that month since records began.

Government bond futures, British share prices and the pound fell sharply after the S&P announcement.

Britain’s finance minister Alistair Darling said the economic future is still not clear and S&P could reverse itself if the United Kingdom is able to make significant progress towards reducing its budget deficit to its stated goal of $276 billion (175 billion pounds) this year.

The government has launched a program of quantitative easing to buy a record $340 billion (220 billion pounds) in government bonds, which has ballooned the deficit.  Some analysts have criticized the program and characterized government projections that deficits would shrink in the future and spark economic growth as unrealistic.

But the government is holding to its view.

“There are significant uncertainties in the global economy at the present time and S&P point out that the outlook could be revised back to stable ‘if fiscal outturns are more benign than (they) currently anticipate’,” a Treasury spokesman said, according to Reuters.

“The Budget set out a clear plan to halve the deficit in five years. That judgment was based on a deliberately cautious view of the public finances,” the Treasury added.

S&P said Britain’s high debt ratings were supported by its wealthy, diversified economy, fiscal and monetary policy flexibility, and relatively flexible product and labor markets, Reuters reported.

But in an ominous warning, S&P said that it would consider lowering the U.K.’s top-tier AAA debt rating if the next Government does not take radical measures to reduce the scale of public debt, according to the Daily Telegraph.

“The rating could be lowered if we conclude that, following the election, the next Government’s fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory,” Beers said.

The specter of a divisive election – now likely in 2010 – is raising political uncertainty about how government policy may affect fiscal matters in the future.
Analysts were unsure if fallout from the economic crisis could convince voters to change parties in order to deal with the deteriorating debt situation.  But S&P’s downgrade is sure to bear on the minds of the victorious party.

“Whoever wins the next election, tax hikes and sharp spending cuts will be the order of the day – but today’s announcement by S&P puts that much more pressure on the next government to act quickly,” Colin Ellis of Daiwa Securities Group Inc. told Reuters.

Source: S&P Lowers U.K. Credit Outlook Putting Election in Flux

Teachers are supposed to make complex things simple. But these two guys are about as clear as mud, as they dance around monetary policy jargon like drunken nightclubbers.

I’ll get to Merv in a minute, since he had more dire things to say about the state of Britain’s economy this morning. First up, though, let’s wrestle with Mr. Bernanke’s latest explanation of current monetary policy…

What’s In A Name? A Lot If You Listen To These Guys

Let’s get one thing straight, folks… don’t call it “quantitative easing,” okay?

It’s “credit easing.”

Get it wrong and you’ll find yourself in detention with the guv’nors.

“Credit easing” is the term Bernanke uses to describe the Fed’s monetary policy, now that interest rates are practically at zero.

In “normal” times, banks use conventional methods like adjusting interest rates to control the flow of money into an economy. Low rates encourage consumers to buy more and financial institutions to lend more money. High rates are supposed to slow consumer buying and lending.

But these aren’t “normal” times. Simply put, there’s only so far you can go to make money cheap. And with rates cut just about as far as they can go, both the Fed and Bank of England have pretty much exhausted their traditional monetary policy tool. That’s when more drastic measures need to be considered.

Entering stage right… “quantitative easing.”

Or not.

If you listen to Messrs. Bernanke and King, they’re foxtrotting their way around the issue to avoid describing it this way.

Desperate Times Call For Quantitative Measures

Quantitative easing can include targeting the cash that commercial banks have with the central bank. But instead of using an interest rate, it sets a target on the balance that the banks have with the central bank. The central bank can then meet that target by purchasing the banks’ assets – which means cranking up the printing press and using new money to pay.

In theory, this boosts the amount of money that commercial banks have, who are then supposed to release it into the broader economy through increased lending, etc.

Trouble is… when that doesn’t happen, the policy is essentially a waste of time – as Japan discovered earlier this decade when the banks just kept the cash.

In a recent speech, Bernanke noted that the Fed’s current policy is “conceptually distinct” from quantitative easing. It’s called “credit easing” and involves not just buying assets like bonds from commercial banks, but from several markets.

This adds to the Fed’s own holdings and also boosts the overall liquidity flow, but despite Bernanke’s unnecessary semantics, the end goal is the same: To put more money into the financial system through quantitative measures.

Britain Braced To Go Deep In 2009

Over in Britain, Mervyn King is almost at the end of the monetary policy line, too.

After a series of heavy cuts, interest rates are now at 1% (down from 5% in October), and given the governor’s latest assessment of the economy this morning, it won’t be long before the Bank of England takes further action.

Warning that “the economy is in a deep recession,” with a 4% annual GDP contraction projected for the second quarter, King said the BoE will continue to use the “full range of instruments at its disposal” to tackle the situation. But he also said that the length and depth of the recession would hinge “to a significant extent” on the rest of the world (there’s that “globalization” thing gone awry again) and whether the coordinated measures to increase credit and spending are successful.

Despite having the power to boost the monetary base (and one option is through the quantitative easing mentioned above), there are uncertainties about whether it will work. Nevertheless, with King and his fellow bankers believing that the recent interest rate cuts are having less impact, they’re giving these extra measures a shot.

On the agenda: Buying assets to boost corporate spending, plus increasing the money supply. Loosely translated… “Crank up the printing presses, mate.”

But it also means, in King’s words, “unconventional policies,” too. Specifically, that means making purchases through the BoE’s Asset Purchase Facility, which means the money spent on assets will be matched by an equivalent amount of Treasury bills sold. Not so much quantitative easing, but matching. Nevertheless, these quantitative easing measures still exist. The BBC says the Bank of England’s additional stimulus efforts over the second half of 2008 increased its balance sheet by 160% and swelled the monetary base by 35%.

No matter what the governors call it, additional efforts like this to stimulate the U.S. and U.K. economies are still designed to “ease” more money into the financial system by printing it – just in a different, less well-known way.

But with interest rates at zero, we’re getting down to last resort-type measures here. If it doesn’t work, they’re going to have to work on some really flashy dance moves.

Source: Bernanke And King In The Last Chance Monetary Policy Saloon

Usually it’s solved by the price of things coming down. But in the case of the housing market, things are a wee bit trickier…

Prices have started to fall, but many still can’t get the mortgage they need to get on the ladder.

I talked about affordability yesterday. I said that from our perspective it doesn’t matter precisely how much house prices fall. We’re confident they will, and our investment strategy reflects that.

Happily, though, a report today puts some numbers into the mix. Apparently, 28% of employed young people can’t afford even their cheapest local properties. In parts of London and the south west, more than 40% are priced out of home ownership.

Hometrack, who published the report, reckons that if prices come down 10%, then the average will drop from 28% to 22.5%. In other words, a fifth of those currently priced out will be able to get their hands on a front door key.

That’s what some (especially those in that magic fifth) would like to see happen. Will it?

Ah, if only economics were that simple! If only we weren’t plagued by all these pesky ‘ifs’ and ‘buts’. But we are. So let’s glove up and pick our way through the brambles…

Affordability is the key. The big thing dampening affordability right now is the tight-as-a-drum credit market. Mortgages you used to be able to get, you now can’t. Those you still can, meanwhile, are more expensive.

Professor Steve Wilcox, the academic who crunched the numbers for the Hometrack report, calculates that the cost of repaying a mortgage rose by 12% last year. But this situation could reverse.

I don’t think it will, however. At least, not enough to reverse the general house price trend, which will carry on downwards.

Today’s report gives us an idea of where prices might end up. But housing market forecasts are ten-a-penny, especially at the moment. I’ve read everything from a predicted 5% drop to an almighty 40% crash.

The trouble is, to put a hard, meaningful number on it, you have to make all sorts of assumptions which themselves are meaningless.

Will the lending market ease up, and if so by how much? How much will would-be buyers rely solely on their own incomes, as opposed to borrowing from other sources, such as relatives?

All these factors make it tricky to obtain a useful forecast for affordability. And then there’s sentiment…

What about those who’ve decided to rent rather than buy? Renting is comparatively cheap right now. But many renters are renting because they don’t want to buy an asset they believe will soon fall in value.

Even if homeownership becomes comparatively less expensive (prices fall, borrowing gets cheaper, or a combination of both), will that fear recede by a proportionate amount? Unlikely. By how much, then, and over what period of time?

Ah, now we’re into the realm of guesswork…

The good news, though, is that it doesn’t actually matter by precisely how much the housing market will fall. Watch the trends; don’t worry about trying to package the world into a neat, numerical model.

The outlook for the UK economy is bleak. It’s not just housing — today we read that the purchasing managers index (PMI) for the service sector fell to 49.8 in May, down from 50.4 in April. A PMI of 50 represents stagnation — neither contraction nor expansion.

So basically, our service industries expanded ever so slightly in April (not good), but contracted a little in May (worse).

You don’t want the fate of your investments to be tightly bound up with the British economy. Because the British economy’s going down. Instead, look for companies making money in expanding foreign markets.

As our research director Theo would surely say: “The UK stock market is your window on the world. Use it!”

The fight for Congo’s mines…

Gold. Copper. Diamonds. Uranium.

Congo has them all, in abundance. And the Chinese are desperate to get their hands on this mineral wealth. They’re investing a whopping $9 billion in the Congo economy.

Below, Garry White explains why. But first, a word from Manraaj Singh, our emerging markets wizard:

“Pow!”

Thanks, Manraaj.

Of course, Manraaj has a LOT more than that to say about Congo. Right now he’s putting the finishing touches on a recommendation that will give you exposure to the very richest mines in this resource-rich country.

“If I’m right about this investment,” he says, “it’s going to offer the sort of profits that makes China’s deal with the Congo look small!”

For more details, read today’s free edition of Profit Hunter HERE.

China to build “10 New York Cities” — and this is the commodity they’ll need!

Garry White was full of beans at this morning’s meeting. Our commodities man was at a mining conference yesterday, and he’s come back brimming with verve and new ideas.

“One guy there was saying China’s building the equivalent of 10 New York Cities. Well, they’re gonna need a lot of steel, a lot of concrete, and a lot of electricity once they’re up and running.”

Which means one thing. Coal!

“If you don’t have coal in your portfolio, you’re missing out on potentially the biggest commodities bull run of the 21st century so far,” says Garry.

Discover how you can play this trend with an investment that not only puts coal in your portfolio, but also gives you a claim on cash from mining monsters BHP Billiton and Rio Tinto!

Until tomorrow

Ben Traynor

Source: House Prices Need To Drop 10% For First-Time Buyers To Get On The Ladder

And with inflation soaring, we can’t expect the Bank of England to cut interest rates this week to try to alleviate any of the pain.

To add insult to injury, the pound, our national virility symbol, has plunged against the euro, so we can’t even afford to go away from it all on holiday on the Continent. And we came last in Eurovision… again. We seem to be becoming the sick men of Europe.

If you can’t beat them, they say, join them. So has the time finally come to dump the poor old pound and plump for the euro?

Why Europe could be in as much trouble as the UK

With the euro now among the world’s strongest currencies, you might assume that the eurozone was in a much better state than Britain. But take a closer look and you soon see that plenty of problems have been cropping up on the other side of the Channel, as well as across the Irish sea.

Take housing. Last week’s Nationwide house prices survey showed that prices were down 4.4% year-on-year in May, the biggest fall since the early 1990s. That’s pretty grim.

But in Spain house prices have already fallen 15% across the board since September, according to the developers’ association (APCE). And in Ireland, house prices were down nearly 10% year-on-year up to the end of March.

Of course, the UK property market is set to get a lot worse. But the same could be said for Spain and Ireland.

Then there’s consumer confidence. In Britain this has crumpled, according to the latest GfK indicator, to its lowest point since Margaret Thatcher was ousted from office. Again, pretty grim. But the eurozone isn’t immune either – French consumer confidence has now fallen to its lowest level in 20 years.

And as for inflation, despite the European Central Bank’s (ECB) reputation as a hard-nosed inflation fighter, Europe’s having trouble with rising prices too. Last Friday’s figure turned out worse than expected, coming in with an annual rate of 3.6%, adding to what ECB president Jean-Claude Trichet has called policy makers’ “biggest challenge”. Despite the strong currency, that’s 0.6% higher than in the UK. Indeed, the pressure’s now building on the ECB for the next move in interest rates to be up.

And the broader picture for the euro isn’t looking a lot brighter than for the pound, either. Because long-term private investors are pulling their cash out of the eurozone at the fastest rate since the creation of the single currency, says a report by BNP Paribas.

Foreign direct investment in plant and factories has swung down over the past year to a negative €149bn (£117bn), including a drop to minus €19bn in March alone as the surging euro drove up relative labour costs in southern Europe. Add in a $280bn withdrawal of private funds from eurozone equities and bonds, and total outflows have exceeded €400bn over the last twelve months.

The euro is now suffering from the “reserve currency curse”, says Ambrose Evans-Pritchard in The Telegraph, as central banks in Asia, Russia, and the Middle East use it as an alternative to the dollar. “While Asian funding has helped ease the credit crisis in Europe, it has also pushed the exchange rate to damaging levels. The eurozone has gained financial flows, but has lost industrial and investment flows.”

BNP’s currency strategist Hans Redeke sees mounting signs of stress. “There are lots of ugly surprises in store as deleveraging finally hits Europe. Investors are going to stop treating the eurozone as if it were just Germany. We will discover in this downturn whether the eurozone is really an ‘optimal currency area’. This is the test”.

So, on reflection, maybe this isn’t the time for the Treasury’s great and good to contemplate dumping the pound. And if you’re still unconvinced, here’s what the FT’s Martin Wolf has to say. He’s such a staunch opponent of such a move, he’s even just criticised his europhile peers in print: “the Lex column argued last week that the UK was close to meeting the economic tests for joining. Lex is wrong.

Three reasons why our currency should be left alone

We’ve not been hurt historically by being out of the euro, says Mr Wolf. Between the first quarter of 1999 and the first quarter of 2008, Britain’s economy expanded by 28% compared with 21% in the eurozone as a whole and 16% in Germany. Nor has London’s position as a financial centre been hurt.

In fact, had the UK been a recent eurozone member, our present situation could be even worse. Our credit bubble would have inflated more, because euro interest rates have been lower. On top of that, now that the domestic spending boom is over, there’d have been no offsetting benefit from the recently plummeting pound.

Inflation may well now rise faster in the UK than in the eurozone, but at least we have some hope of controlling this. The Bank of England can set interest rates to suit Britain alone, rather than relying on the ECB, which is arguably far more concerned with how suitable interest rates are for Germany. If the BoE sticks firmly to its 2% inflation target, Britain will almost certainly veer into recession, but then so will the eurozone countries.

So forget the euro – our currency should just be left alone, to find its own level. Which of course, looks like it could well be considerably lower than it is now.

Source: Should Britain Dump the Pound for the Euro?

Chancellor Eyebrows is going to have a private meeting with some supermarket men to talk about rising food costs. But the Treasury won’t give any specifics — it’s all a bit hush-hush…

Airlines cower in fear as oil hits a new high of $135 a barrel. I argued last Tuesday that high oil prices are set to wreak havoc on the UK economy.

It’s all very depressing. So, to cheer us up, let’s talk about something shiny!

Gold!

“The recent correction in gold appears to be over for now,” says my colleague Garry White. “Now is most definitely a time to buy gold.”

The reason is that inflation is on the rise. Last month’s monthly US inflation figures came out at 0.2%. But few people believe the true figure is anywhere near that low.

The same is true this side of the Atlantic. Between April 2007 and April 2008, consumer prices rose 3.0%, according to official figures. We all know that’s unrealistically low.

So, more and more investors are buying gold as a hedge against inflation.

Last Friday, Garry tackled the question of which made a better inflationary hedge — oil or gold. As he sensibly pointed out, you don’t actually have to choose, so why not have both? The signs are bullish for both commodities.

But with oil passing $135 a barrel yesterday, you may be starting to worry that a bubble is forming. There’s certainly a strong case to be made for taking a second look at gold, even if you are already invested.

As Garry explains today, some experts reckon gold is the trade to be in right now.

But you need a strategy. No market goes up in a straight line, so what’s the best way to play this?

Garry suggests setting a sensible level and ‘buying on dips’ below that price — a tried and tested way of maximising your gains.

Find out what Garry believes is the best way to play gold, as well as the best strategy to employ right now.

Banking shares — a perspective

As we’ve mentioned before, Theo Casey, my number-crunching right hand man, is wary of the banking sector. He smells a value trap…

But here at Fleet Street Daily we like to present more than just the one view. Our penny share guru Tom Bulford disagrees that it’s a trap. The value in shares like Royal Bank of Scotland looks genuine to him.

“One thing I was told when I was a young fund manager,” he says, “was to buy shares when the yield exceeds the price earnings ratio.”

That is the case for the Royal Bank of Scotland (RBS) even if it halves the dividend.

Recommended

—FLEET STREET LETTER ALERT—

3 “Gloom-Loving Stocks” for the Coming Recession

Dark clouds are gathering over the UK economy.

But for contrarian-minded investors, this spells opportunity.

The Fleet Street Letter has just been given permission to share three such money moves with you today.

You can read the full briefing here.

Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. Customer Services: 0207 633 3600.

Thirdly, banking shares are beaten down because banks are carrying out rights issues. RBS is raising £12 billion, HBOS £4 billion, and there is speculation that others will follow.

But Tom points out that this is just a technical problem. It will pass, and the financial positions of the banks will be strengthened by the extra funds raised.

We’re not saying you should go out and fill your boots with finance stocks. But it’s an interesting point of view — the value that’s been uncovered could well represent a genuine buying opportunity.

But Tom himself isn’t especially interested in the big name financial shares. They’re far too mainstream for him!

He’s a penny shares man — going after small, undiscovered shares trading for pennies, the ones that tend to make the fastest and largest gains.

Tom’s hunting ground is a tiny arm of the London Stock Exchange called the Alternative Investment Market.

Find out more about Tom’s investment philosophy, including why the smallest names can often make you the biggest money.

At least, since it started monitoring customer mood with its own survey four short years ago. Says their chief economist Fionnuala Earley:

“Food and fuel prices remain high and with house prices no longer rising it is unlikely that consumer confidence will pick up very quickly.”

The Daily Mail agrees under a headline “Broke Britain”. Families have less to spend as household income is eaten up by “unavoidable outgoings”. Discretionary spending – what’s left over after the “unavoidables” – is at its lowest level since 1991.

Economic forecasters Capital Economics expect food prices to continue to rise for some time yet at an annualised 6% and electricity prices will rise up to 10% in the second half. The average Council Tax bill is up 4% and the average water bill up 5.8%.
—————————————————————-

—FLEET STREET LETTER ALERT—

3 “Gloom-Loving Stocks” for the Coming Recession

Dark clouds are gathering over the UK economy.

But for contrarian-minded investors, this spells opportunity.

The Fleet Street Letter has just been given permission to share three such money moves with you today.

You can read the full briefing here

Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to
lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. Customer Services: 0207 633 3600.

—————————————————————-

And then there’s the inexorable rise of the oil price. It notched up another record hitting $122 yesterday. For the car driver presently, that translates into 110p for an average litre of unleaded petrol. A level that means it has now crossed the £5/gallon threshold and filling the tank sets you back a wallet-denting £75. An average litre of diesel costs even more at 120p, or £82 a tankful.

But hey, don’t worry CPI inflation is only 2.5% when you factor in all those DVDs, flat screen TVs etc. etc. it all pans out…doesn’t it? Add in too the darkening cloud hanging over the housing market… But the frontline casualties to date look like house builders and, as we suspected, estate agents.

Estate agents are going to the wall in numbers. As we know the credit crunch begat the mortgage famine which in turn begat a recession in housing transactions. That last part is a potential stake to the heart of those whose business is to broker the deals for a fee. No deals, no fees. No fees, no business. A slump in home sales has seen 1,000 estate agents close to date and 4,000 lose their jobs.

It’s a strange situation Peter Bolton King, chief executive of the National Association of Estate Agents, tells the Mail:

‘The irony is that there is no shortage of people who want to move house, but without mortgages they just can’t do so. Estate agents are having to close because there just isn’t enough movement in the housing market.’

I know, our hearts bleed for the poor unfortunates. Given their infestation in many high streets, some trimming may be no bad thing but the death of the market helps no one in the end. In Argentina they have a saying: La plata que no se meuva, se meura. Money that doesn’t move, dies. Putting aside the phrase probably arose during their ruinous experience of hyperinflation the central thought is one of the nature of markets – a market that doesn’t move, dies. And in the case of the UK housing market presently, it’s showing a weak pulse.

(Hispanic speakers are welcome to correct my rusty linguistics!)

*** There’s still plenty of money around judging by an art market that continues to make the headlines. Monet’s ‘A Railway Bridge at Argenteuil’, “considered a prime example of high Impressionism” says the International Herald Tribune fetched a record $37m yesterday.

The previous owners paid $12.6m in 1988. A prize possession no doubt but aesthetic pleasure aside in investment terms that’s a modest return – a little over 5.5%pa. For that you can keep your Monet your editor will stick with his more humble investment trust savings scheme.

Or perhaps a permanent interest bearing share (PIBs) is worth a look these days. One of these unfashionable and little known fixed interest investments – the Britannia 5.555% – is yielding over 8% Collins Stewart advises in a note this morning. No doubt a good deal more than you’d get in even Britannia’s most generous savings account.

More adventurous investors might like to consider what is perhaps the last of the emerging markets: Africa. The pros have been turning their sights on it. The FT reports today ICAP plc, the interdealer broker, is setting up a hedge fund investing in Africa and the Middle East. The region has not escaped the attention of our own emerging markets expert Manraaj Dheensay. He’s found a great opportunity to invest in the region and interested readers should look out to hear more about it from Manraaj, coming through this Saturday.

Regards,

Rob Mackrill
The Daily Reckoning

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But then stock markets don’t deal in the present. They are “the great expectation machine” as one author had it. They look as far ahead as they can and try to picture how it will look. Evidently, they see an improving picture later in the year. Sounds encouraging, though as with all forecasts it could prove dead wrong. Much as the Met Office produces long-range weather forecasts using the latest technology which also can go hopelessly awry. Even their short term forecasting can be a disaster for those of us who remember Michael Fish dismissing the wild notion of a hurricane one fateful evening in October ’87.

What financial markets spy in the distance and what the rest of us experience day to day are two different things, of course. Warren Buffett thinks the US recession will be longer and deeper than most expect as consumers struggle with a wealth squeeze from falling house prices coupled with higher expenses from fuel and food prices. The Fed lopped another 25 basis points off the Fed funds rate as new data reveals the US grew in the fourth quarter of last year, but not by much. US interest rates now sit at 2%, about half the rate of inflation.

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Recession is not the central forecast for most analysts of the UK economy but the signs of deterioration continue apace. Most visibly in the housing market, a powerful symbol in our home owning culture, which continues to weaken. British bank HBOS is the latest to report house prices are falling – by 3.7% over the year to April.

Easing commodity prices if sustained will be welcomed by the world’s central bankers. It takes some of the “push” out of “cost-push” inflation – where higher input costs force higher prices – and opens up more wiggle room for further easing in interest rates. The impact of relentless price increases showed up once again in the latest UK factory gate prices this week.

Manufacturers have been paying more for raw materials and charging higher prices on finished goods.Given a slowing global economy, commodity prices should ease up as aggregate demand turns down. But then there’s the elephant in the room in the shape of China. As such a sustained easing of commodity is probably a big ask, at the very least until after the closing ceremony at the Beijing Olympics this summer.

The dollar has rallied from its recent low against the euro. A euro now buys $1.54 against a recent low of $1.60. As for the pound, it buys you a satisfactory $1.98 if you’re flying west and a miserly €1.28 if you’re flying east.

Our currency of choice, gold, has had a tough week down around $90 since its mid-April high. Is it over for gold? Not in our book. The inflation-adjusted high is more than twice its current level and when central banks are done reflating the global economy, we suspect it could go a lot higher yet.

Enjoy your week-end.

Regards,

Rob Mackrill
The Daily Reckoning

London ’s leading index headed straight up at the open adding 69 points at the open to 6,156 following a good day on Wall St. yesterday.

The Dow put on 189 points to close above 13,000 for the first time since the start of the year – no doubt a significant closing level for technical analysts. The gain came as financial stocks made the running and in spite of ExxonMobil shedding 3.6%. Exxon is struggling to up production reports the FT as it falls victim to resource nationalism. African production fell 20% after it was forced to hand over more to host governments and its Venezuelan interests were nationalised.

Continues below …

FLEET STREET LETTER ALERT

3 “Gloom-Loving Stocks” for the Coming Recession

Dark clouds are gathering over the UK economy.

But for contrarian-minded investors, this spells opportunity.

The Fleet Street Letter has just been given permission to share three such money moves with you today.

You can read the full briefing here

Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. Customer Services: 0207 633 3600.

The bounce in US stocks reverberated around the time zones. The Nikkei was up over 2% to close above 14,000 and China’s leading index, the Shanghai Composite added almost 5% as it breaks out from a six month downtrend. European bourses are up across the board this morning.

So is it over? Or is this premature as the IHT suggests? Stock markets are forward looking by six months or so, so are presumable focused somewhere on the end of this year and the bulls see something better out there. But lest we get too carried away the world can look very different at street level. It was only on Monday that Warren Buffett was warning “ my general feeling is that the recession will be longer and deeper than most people think. This will not be short and shallow. I think consumers are feeling gas and food prices and not feeling they’ve got a lot of money for other things.”

Except perhaps for the one off “tax rebate” cheque sent to US taxpayers in the post this week. But some relief is coming too from a sector that of late has been a chronic thorn in the side of central bank inflation targets – the commodities market. Commodity prices have been falling of late across the board – energy, industrial and precious metals and agricultural commodities. The price of crude is down for a fourth day running with Brent Crude at $110 and West Texas light sweet crude a shade under $112. Lehman Bros said recently there was $20-30 of “hot money” in the crude price.

Why the pull back? It’s all about the dollar says commodity strategist, David Moore of Commonwealth Bank in Australia:

“The demand for investing in commodities as a hedge for U.S. dollar weakness has faded.”

Which gives us a clue as to the nature of the demand. There’s actual physical demand for commodities according to their use and then there’s more speculative investment demand. With the revival of interest in the sector, how much of the price is attributed to each? We don’t know but given the rapid rise in popularity of the commodity exchange-traded fund, we suspect the balance has tilted significantly in recent years towards the speculator.

That fading interest in hedging has helped the dollar claw itself back from a low point at 1.60 to the euro, to 1.54 now. When even central bankers are telling the market it’s not so bad, investors worries are starting to subside. Says Japanese fund manager Tetsu Emori:

“Worries about the financial market turmoil and even an economic slowdown seem to be softening, so that’s why people are selling gold.”

As such gold continues its slide south, at one point unwinding all the way to its $850 price at the start of the year. Just as the dollar stages something of a rally, the Gulf States may finally be coming to the conclusion that pegging to it is not after all such a good idea as dollar weakness adds to their domestic inflation problems. Something even Alan Greenspan actually advised them to do on a visit to the region. Kuwait has been the only one to drop its peg to date and has seen its currency appreciate almost 8% against the dollar since. Its Finance Minister Mustafa al-Shimali seems confident other Gulf Cooperation Council states will follow its lead – “some countries will do what we are doing.”

Here at home, the winds of political change look to have blown pretty hard yesterday. UK government worries about taking a pasting from the electorate in the local elections proved well founded. They did – their worst result for 40 years. With the Mayoral vote still pending, it could prove a very black day for New Labour. Still after 11 years in government you take some wear and tear, mistakes are made, support disintegrates, people get disillusioned or just fed up with the same old faces.

And it doesn’t help when the much touted UK economic miracle that has notched up 60 consecutive quarters of growth is looking a good deal less miraculous. The progressive puncturing of inflated house prices, aided and abetted by a mortgage famine is exposing gradually testing the debt-laden underbelly of once enthusiastic consumers. British bank HBOS announced house prices fell by 3.7% annualised over the year to April. It is the worst housing market performance since 1993 and comes on top of a controversial scrapping of the 10% starter tax rate. Who’s to blame? The government, of course. Much to the delight of the Tories for whom the ERM debacle is now but a fading memory.

Regards,

Rob Mackrill
The Daily Reckoning

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