Morning in Arizona

Morning in Arizona
Rainbows over Canyonlands - Dave Stoker

The Headline Animator

Monday, May 03, 2010

Macro Trends: America’s New Chapter

Macro Trends: America’s New Chapter

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Sir Winston Churchill - Speech in November 1942

There are moments in history when one or more events can change the fundamental direction of a nation. The most obvious contemporary example is the radical alteration in national defense following the World Trade Center attack by terrorists on 9/11. A political case in point would be the resignation of the 37th President of the United States, Richard M. Nixon. A third such occasion would be the regulatory fallout from the Three-Mile Island nuclear accident.

This past week, the first chapter of America’s 21st century was written. The Senator Carl Levin’s Permanent Subcommittee on Investigations’ 10 hour interrogation of Goldman Sachs executives; the fury unleash by the southwestern state of Arizona enacting its new anti-immigration law, and the BP’s environmentally catastrophic Gulf of Mexico drilling disaster.

Alone, these events would leave their respective acute scars upon the landscape after temporarily shaking public confidence and inflaming anger. Long-term effects on industrial and investment policy, and society, certainly, would be limited. This confluence of events, at this period in time of near total political polarization, by everyone on every subject, due to fundamental demographic changes and the recent domestic and global economic collapse, will trigger the periodic inevitable rewriting of the American narrative for the next generation. Investors and investment professionals alike must fully recognize this metamorphic moment we are in to successfully navigate tomorrow.

Goldman Sachs

It was a bad week for capitalism. The mightiest of the investment banks was mortally wounded on live television. The personification of Thatcherism and supply-side economics, which guided America’s industrial policy for the last thirty years, was exposed as being indifferent to the average citizen’s pain and suffering, rightly or wrongly, during and following the worst economic downturn since the Great depression. Two days after this public display, the SEC referred to the Department of Justice a criminal complaint of fraud against Goldman Sachs which compounded their image problem of indifference with moral infidelity.

As I wrote last week, no investment firm has ever survived a criminal conviction. On Friday, Standard & Poor’s downgraded shares of Goldman Sachs from a buy to a sell while Bank of America Merrill Lynch cut its rating on the stock to natural from buy. The price of its stock closed down for the week at 145 from a high of 161. For the month, GS traded as high as 186.

Goldman’s employees interested in a long career on Wall Street are planning, or will do so shortly, their exit strategy before the worst might occur. In the coming months there will be a brain drain on the firm. Weaker CVs and paycheck traders will remain on the sinking ship for as long as possible. Top management will be replaced as punishment for the significant drop in shareholders’ value as well as allowing trading profits to interfere with client relationships – and getting caught. The most conservative’s clients will leave first; firing the firm and choosing a competitor. Lawsuits will flood the company from bitter clients with a loss from previous deals. The government will allow them to bleed to death from a thousand cuts from investigations, innuendo, and prosecution.

Buy the GS Jan 2012 100 strike puts and/or sell the Jan 2012 100 strike calls and wait. Time is on your side.

The Economy

The FDIC has closed 64 banks to date with another 700 + on the problem bank list. Federal dollars from the stimulus bill is propping up economic data. Artificially low interest rates are lifting share prices. Real estate assets are dead money. The economy is much weaker than popular news stories would have you believe.

Global business will change the nature of our country this decade as well. Respective debt levels for the European PIIGS (Portugal, Ireland, Italy, Greece, and Spain) nations, is unsustainable. Europe as a whole is facing over the coming three years more than $2 trillion dollars in maturing debt. That much refinancing will be unavailable in the marketplace for high credit risk debt.

A three-year $146b rescue package has tentatively been approved by the EU and the IMF just for Greece, in exchange for a self-induced economic depression, cannot be repaid. It is delaying the inevitable default or restructuring on their debt. Meanwhile, this will cause protest and violence in the streets of Athens leading to an unstable political environment. Without austerity measures Greece’s debt will collapse causing the European Union to quickly unravel. There is only a 50/50 chance that the EU will still exist in 24 months. Either scenario can throw the world financial system into turmoil for the second time in four years.

The US over this same period has enormous and unsustainable funding requirements too.

Australia, Brazil, Canada, China, and India have raised interest rates as industrial and food commodity prices experience inflation. Australia announced a new 40% windfall profits tax on miners. China again raised its banking reserves requirement by 50 basis points. Another interest rate hike is expected later this year. Prices are rising here in the US as well; however, the reality of modern macroeconomics and the granularity of deflationary and inflationary forces coexisting across different asset classes in the same economy is an unfamiliar and difficult concept to grasp. Real estate prices will continue to slump, due to an absent of consumer credit and borrowing demand. Energy prices will move higher than previous thought, in part, because of the BP oil well fiasco (more on this later) and higher demand in Asia and South America. Food prices are higher.

As confidence falls and tensions rise later in the year, a substantial stock market correction will occur and gold will make new highs. Gold’s correction earlier this year did not break its long-term trend line.

Contrary to conventional thinking, a lower or very slowly rising Chinese Yuan against the dollar is in the US best interest. Consider this example: if you are PADI certified to scuba dive and understand buoyancy, think of role your weight belt plays. Your body mass (the dollar) is greater and heavier than your belt (the Yuan).

But the density of the lead weights in your belt assists you to descend. If the Yuan rapidly decouples from the dollar today, the dollar’s intrinsic properties, massive debt and deficit spending, low GPD growth, net imports, energy consumption, war, will cause the dollar to fall rapidly, accelerating a move away from the dollar as the world’s reserve currency.

Whenever this reign ends, America will be the last one to know.

The stock market has rallied since March 2009 on cheap money and undervaluation; the former is unsustainable and the latter no longer the case. In my predictions for 2010, I predicted market highs for this year would be made in the first or second quarter. I stand by that prediction.

Move to cash and gold bullion or bullion-backed ETF’s: SGOL, PHYS, and GTU.

Arizona Immigration Law SB-1070

Seldom will a single state law radicalize national politics. We witnessed that last week. Two months ago, conventional wisdom in Washington DC was predicting a horrible November for Democrats at the polls. President Obama actually would benefit from a weaker Democrat-controlled congress, was the thinking. Legislation passed into law would be more moderate and his base more docile and manageable.

Anger exploded in Hispanic communities across the nation like a well struck piñata when Arizona governor Jan Brewer signed into law a measure for local police, after contact, to question, identify, and detain people who might be illegally in this country, on reasonable suspicion. I live here in Arizona and that criteria could apply to one-half of the state’s population; two-thirds of the state’s population during the summer months. As a practical matter, a subset of American citizens would be guilty, until proven innocent. For some, Arizona has become France.

Yes, the Arizona/Mexico border is porous. Yes, the federal government has failed for decades to secure the border. And, yes it is a conduit for criminal activity. Lifting the prohibition on the consumption of marijuana, as a solution, would blunt border crime. But this porous, unsecured border is also a businessman’s pipeline for cheap labor. Once upon a time, unions were the gatekeepers of blue-collar jobs. After deregulation included breaking the back of unions, an incentive for undocumented workers to enter this country, and underbid for jobs, arose. Now, policing workers is left to the employers and the federal government – an unintended consequence of union busting.

On the other hand, this underground economy contributed to the US economy’s strength, including housing, without official statistical attribution, until anti-immigrant sentiments began driving workers away. This undocumented workforce bought starter homes allowing these homeowners to buy move-up homes. They spent money on fast food, goods at Wal-Mart, purchased movie tickets and bought big screen televisions. They rented apartment units to live in, tuxedos for weddings and graduations, and hotel rooms. That is one reason why reported economic data seems stronger than actual activity. The underground economy, or lack thereof, is always embedded inside official reports.

Furthermore, according to this December 2007 Congressional Budget Office (CBO) paper, unauthorized immigrants do pay state sales and property taxes; file state and federal income taxes, and pay into social security. Because they often use a fake social security number, the funds paid into SS is never withdrawn. States are also reimbursed by the federal government if an unauthorized immigrant is arrested and held for a minimum of four days by local authorities. Only a cynic would ask, in these tough times, could there also be a tiny profit motive embedded inside this new law?

Ten additional states, Colorado, Georgia, Maryland, Missouri, Nebraska, Ohio, Texas, Oklahoma, North Carolina, and Utah, have elected officials, promising to introduce bills in their respective legislatures, similar to the new Arizona law.

Animosity, on both sides of this issue, is growing. Many cities and organizations are calling for boycotts on all things Arizona. Several Arizona-bound meetings have been canceled. Colombian born, international singing star Shakira, flew into Phoenix on Tuesday to denounce the new law. Major League Baseball’s Players Union is calling to move the 2011 all-Star game from Phoenix. The GOP is rethinking letting Phoenix host the 2012 convention. A California tea-party group has retaliated by boycotting the city of San Francisco. In an unprecedented step, the Arizona Republic, the State’s largest newspaper, ran on the Sunday edition’s front page, an editorial in opposition to senate Bill 1070.

May Day protests, in 70 cities around the country, showed thousands of supporters of immigration reform out in the streets. Entertainer Gloria Estefan loaned her star power to the Los Angeles protest. U.S. Representative Luis V. Gutierrez (D-Ill.) allowed himself to be arrested at the protest in Washington DC, escalating demonstrating over this law to civil disobedience. Neither side is backing down.

The old political middle ground has been condemned, as no longer inhabitable by identity politics, and is, hereby, being demolished this election year, at the state level, by the will of the people; we will either lurch to the right or to the left.

BP Underwater Gulf Gusher

The most devastating event this week, both in terms of financial and social damage, is BP’s Gulf of Mexico deep sea drilling rig disaster; gushing from 200,000 gallons or 5,000 barrels of crude oil per day, to 1,000,000 gallons or 25,000 barrels per day, or more - no one knows for sure, into the ecologically sensitive Louisiana estuaries. Alabama, Louisiana, and Mississippi account for 19% of the US refining capacity.

A pipe from the Deepwater Horizon drilling rig, located 50 miles offshore and 5,000 feet below the surface, ruptured April 20th, ironically, the 40th anniversary of Earth Day. The explosion, which killed 11 workers, was first reported to be leaking about 40,000 gallons per day. That figure was revised three times.

A remote-controlled shut-off switch, called an acoustic switch and costing about $500,000, was not employed on this drilling rig. This devise is design to and could have stopped the flow of oil after the rupture. It is not required on rigs by the US. It is mandatory for offshore drilling by Norway and Brazil. Norway has used them since 1993. Some oil companies use this devise even when they are not required.

Double-hull tankers will see a pickup in business. Makers of cleanup materials will do well. Chemical companies will also play a part in the aftermath of the catastrophe. With the fishing industry destroyed at least for the next five years, it’s possible that Genetically Modified (GM) and farm raised crawfish, scrimp, and oysters may become an alternative supply of gulf seafood.

Expect to see a $1 to $2 impact to the price of gasoline this summer and spot oil above $100.00 a barrel, as the interruption of production, inspection of other offshore rigs, regulatory review modification, and the beginning gulf coast cleanup operations transpire. At this time, it is unknown how to cap the leak. Drilling a new well to stop the flow of this one could take two to three months to complete, experts say. There could be more than 10 million barrels of oil at that well location. America’s gulf coast has become the poster child for clean, renewable energy. That sector is no longer out of favor as this weekend.

The most famous comparisons for this oil spill are the January 28, 1969, Santa Barbara Well Blowout off the coast of Santa Barbara, California, losing 100,000 barrels and the March 24, 1989, Exxon Valdez oil tanker spill in Prince William Sound, Alaska, losing 240,000 barrels of crude.

The truest comparison, however, is the Ixtox1 oil spill in the Gulf of Mexico, 600 miles south of Texas. On June 3, 1979, the Mexican government-owned oil company Pemex was drilling an 11,000 feet deep well when the explosion occurred. In total, 352,400 barrels of oil escaped. It took 2 months for oil to land on the Texas coast versus 10 days for the BP spill. Experts did not finally cap off the leak until March 23, 1980.



We are in a new century. The pages of history are forever turned by the winds of unexpected events and timing. We either curse or applaud that moment in time but what is impossible to do is to reverse its existence.

Move to cash and gold, avoid corporate bonds, short Goldman Sachs and the financial sector, and buy clean tech ETFs.

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