June 18, 2010

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Is there a difference between a Greek tragedy and a Spanish one?

Europe: The shift in emphasis from Greece to Spain was predictable (previously discussed in our weekly audio commentaries). The problems plaguing the Greek state are shared in countries across Southern and Eastern Europe, as well as Ireland. What brings Spain into focus this week? Rumored bailout funds needed to the tune of 250 billion euros, dwarfing the 110-billion-euro Greek bailout by a decent margin. We are, after all, talking about the fifth largest economy in Europe. Despite the efforts of the ECB to stave off contagion, we have that venerable organization facing, according to Fitch, hundreds of billions of euros in asset (translated: debt obligation) purchases to prevent sovereign debt crises from escalating. This is on top of the 10 billion euros per week already being spent to buy unwanted bonds in the primary and secondary markets throughout Europe.

The ECB is up against the wall. A growing number of European economists see the end of the euro (in its current form). Our opinion: Should the euro survive, it will be after a number of outright defaults and a change in the membership roll. In the immediate term, bank restructuring in Spain has been penciled out at 30 billion. Of course, each bank bailout is nothing more than a shifting of consequences from individual financial institutions to a collective tax base. Which of these tax bases would you expect to be happy with this transference of liabilities once they discover what has been done to them?

So long as structural changes are ignored and band-aid solutions (“just throw more money at it”) are implemented, the decay brought on by decades of bad debt accumulation will continue to destabilize financial markets, economies, and currencies. Is it any wonder that we find gold at all-time highs at the end of this week? It seems that central bankers will be the last ones to figure out the real state of affairs in the world economy – or at least the last to admit it.

2. Gold: New highs, again.

Gold: Between periods of deflation and inflation lurks an unknown period of time that seems like an eternity – until it is measured in nanoseconds. Aggressive inflation is a monetary event that needs no economic preamble. Significant movements in the price of gold now relate to a change in awareness across the globe: Big government and big money solutions in the context of crisis are just more fuel for the fire in a pre-existing state of instability. We had a “breakout” in the gold price today, above $1250.00. This opens the door for an imminent move to $1350-1400. This price move, while beguiling (12 month ROR of 34.46%), is less significant than gold’s standing in relation to paper assets: the Dow/Gold Ratio is now at 8 to 1. We will have a lot to talk about and many deep considerations for allocation shifts as that number sinks to 3 or 2 or 1 to 1. The price of gold in that context and the values of the Dow and S&P will surprise us all.

Conceptually, you’ve joined us in prioritizing the ownership of a non-productive asset (gold pays you nothing in dividends while you own it). This “golden priority” is critical when productive assets are being revalued and discounted (in the context of a bear market). Even more critical is the redeployment of capital towards productive assets. That time is not now, but in reference to past bulls markets, we may have several years yet to go.

3. Market Contradictions.

Amid evidence of more economic weakness, stocks posted their strongest rally in 11 months on speculation that Europe’s debt crisis will be contained – or so the headlines suggest. Reports showed housing starts and permits at levels well below expectations (593 vs. 648 and 574 vs. 625, respectively) while the Philadelphia Fed Business Outlook dropped from a reading of 21.4 to 8 (in June). National retailer Best Buy also came up with disappointing numbers, posting a year-over decline in earnings of 14% on higher revenues (suggesting the need to discount prices).

Still, the markets trended higher – for technical reasons, but also due to blatant collective intervention. The Fed monetized nearly $13.922B worth of mortgage backed securities in the week and brokerage firms were gaming stocks higher with obscene purchases of S&P futures on low volumes at the close of Thursday’s session. This may constitute the beginning of a second bailout effort within the context of a worsening economy, a trend that can last through the summer before fading in the next earnings season. Fortunately for MWM clients, metals-related assets have been a benefactor from these near panicked monetizations.

Thank you all … and have a great weekend!

David Burgess
VP Investment Management

David McAlvany
President and CEO