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CyclePro U.S. Stock Market Outlook

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Welcome to CyclePro - Your web resource for Technical, Esoteric Analysis, and Market Forecast Commentary.

Introduction

The current U.S. stock market appears to be following a similar path as was previously witnessed by U.S. investors in 1929 and 1987, and more recently by investors in the Japan Nikkei in 1990, Hong Kong in 1997, and many others. These were the most famous world stock market "crashes" of the century. We have already witnessed crashes in internet and high-tech industries during 2000, will this year also be added to this prestigious list for a "Crash" in the United States? Will the global economy crash too?

Current Commentary -- Where Are We Now?

Friday, October 3, 2008 PM

Another List of Possible Bank Failures; The following is a table of the top 130 US banks that are, in my opinion, most vulnerable to failure out of the 8600 banks for which I have performance data. The statistics used are current as of June 30, 2008.

The column headings have the following definitions:

E/A	Equity / Assets
IM	Interest Margin
NPA/A	Non-Performing Assets / Assets
NPA/ELR	Non-Performing Assets / Equity Loss Reserves
ROE	Return on Equity
RBCR	Risk-Based Capital Ratio
TC/TA	Tangible Capital / Tangible Assets
Assets	Total bank assets
Rank	Overall Rank

The table includes banks of all sizes whose performance data is the worst of each of the seven categories. To develop this list I found the top 75 worst banks of each category, ranked them, and then grouped them by a calculation that grouped these rankings across all seven categories from most worst to least worst. The ranking gives a higher value to banks that hit multiple categories and a lower value for those that only hit one or two categories. For example, the #1 worst bank in my list is Ameribank and #4 is Integrity Bank, both of which have already been seized by FDIC.

I have no idea which of these banks will actually be seized. And it is quite possible there will be FDIC seizures for banks not on this list. For example, on a scale of 1 to 5 (1 being best to 5 being worst) IndyMac was ranked a 3 just before they were seized. FDIC maintains a watchlist of the 117 most vulnerable banks for which I'd like to think I have most of them in my list here. But in the environment were now find ourselves, I believe this list of bank are more likely than not to be seized. Before all the dust settles over the next 6-12 months, many of these banks are likely to go under.

US Banks - Highest Likelihood of Failure

Institution Name	E/A	IM	NPA/A	NPA/ELR	ROE	RBCR	TC/TA	Assets	Rank
Ameribank, Northfork, WV * Seized by FDIC 9/19/08	4		2	3	5	4	3	104M	1
First Priority Bank, Bradenton, FL * Seized by FDIC 8/1/08	1		23	2	6	1	1	258.6M	2
Main Street Bank, Northville, MI	3			12	3	5	5	112.4M	3
Integrity Bank, Alpharetta, GA * Seized by FDIC 8/29/08	6	3	4	1	16	13	9	1.1B	4
Fulton Financial Advisors, NA, Lancaster, PA		2			1			46.5M	5
Nebraska Rural Comm, Morrill, NE				1				1.4M	6
Wellington Trust Co NA, Boston, MA		1						87.2M	7
Security Bank Of Gwinnett County, Suwanee, GA		8	6	5	7			369.2M	8
BBM, Birmingham, AL			1	5				1.3M	9
Ebank, Atlanta, GA	7			4	26	11	18	137.8M	10
Eastern Savings Bank, FSB, Hunt Valley, MD			1	6				1.1B	11
American Sterling Bank, Sugar Creek, MO	5			29		2	8	258.1M	12
Port Trust, Charleston, SC				2				<1M	13
Imperial Savings & Loan Assn, Martinsville, VA	2		72	24	15	3	2	9.3M	14
Fremont Investment & Loan, Anaheim, CA	11	6	56	26	14	22	23	5.7B	15
Strategic Capital Bank, Champaign, IL	13					15	7	675.8M	16
Citizens Comm Bank, Ridgewood, NJ	9			19		10	19	46.4M	17
Alpha Bank & Trust, Alpharetta, GA			13	14		12		383.2M	18
Magnet Bank, Salt Lake City, UT			5	7	24	30		344.8M	19
Mayes County, Pryor, OK				3				21M	20
First Natl Bank Of Nevada, Reno, NV * Seized by FDIC 7/25/08			31	31	2	9		3.4B	21
First Georgia Comm Bank, Jackson, GA			11	17		18		263.6M	22
Morton Savings Bank, Morton, PA	10	42			27	27	21	18.3M	23
Bankfirst, Sioux Falls, SD			3		10			346.3M	24
Platinum Comm Bank, Rolling Meadows, IL	18			8		26	32	80.2M	25
Security Pacific Bank, Los Angeles, CA			21	28	4			587.7M	26
Freedom Bank, Bradenton, FL	23				12	6	45	284.1M	27
PFF Bank & Trust, Pomona, CA	46		25	9	35	31		4.1B	28
Rivergreen Bank, Kennebunk, ME	17					7	31	97.9M	29
Ocala Natl Bank, Ocala, FL			24	11	31	28		258.3M	30
Bethany Baptist, Farmingdale, NJ			3	13				<1M	31
Bright Hope, Philadelphia, PA			7	9				<1M	32
First Century Bank, NA, Gainesville, GA	14				19		27	45.9M	33
Mellon Bank, NA, Pittsburgh, PA							4	39.5B	34
Sterlent, Pleasanton, CA				4				88.9M	35
Wells Fargo Bank, Ltd., Los Angeles, CA		4						305.2M	36
Alliance Banking Co, Winchester, KY	24				20	14	46	55.4M	37
First St Bank, Danville, VA	16					19	30	27.3M	38
Comm Bank, The, Loganville, GA			8	10				628.1M	39
Ameriprise Bank, FSB, New York, NY	8						11	1.5B	40
Bishop De Mazenod, Houston, TX			2	17				<1M	41
Lewiston Catholic, Lewiston, ID			4	15				<1M	42
Allst Bank, Vernon Hills, IL	15				30		28	923.3M	43
Fifth Street Baptist Church, Richmond, VA			5					<1M	44
High Desert, Apple Valley, CA			13	7				157.6M	45
Putnam Fiduciary Trust Co, Boston, MA		5						378.1M	46
Silver St Bank, Henderson, NV * Seized by FDIC 9/5/08			34	33	18	35		2B	47
St Bank Of Lebo, The, Lebo, KS			28	15	32			25.5M	48
Depository Trust Co, The, New York, NY	30	10				37	50	3.6B	49
C M A, Bham, AL			12	10				4.5M	50
Newton County Loan & Savings, FSB, Goodland, IN			10	34	41			7.3M	51
Ing Bank, FSB, Wilmington, DE	12	58					17	79.5B	52
Home Town Bank Of Villa Rica, Villa Rica, GA		7	17					224.5M	53
Wells Fargo Bank, NA, Sioux Falls, SD							6	503.3B	54
First Security Natl Bank, Norcross, GA			9	16				147M	55
Omni Natl Bank, Atlanta, GA	52		35	32		36		1B	56
Circolo Campobello Di Licata, Amherst, NY			14	12				<1M	57
Vineyard Bank, NA, Rancho Cucamonga, CA			39	40	38	41		2.3B	58
First Frontier, Lynbrook, NY			6	21				<1M	59
Downey S & La, F.A., Newport Beach, CA			33	35	34			12.6B	60
American St Bank, Tulsa, OK	68		70	59	43	64	70	11.1M	61
Franklin Bank, S.S.B., Houston, TX		46	43	37	42			5.6B	62
Westsound Bank, Bremerton, WA			7					428.5M	63
Alliance Bank, Culver City, CA			50	36	51	32		1.1B	64
Firstcity Bank, Stockbridge, GA			16	13				255.4M	65
West Hartford, Farmington, CT			8	22				3.8M	66
Citizens Natl Bank, Macomb, IL						21	10	461M	67
Mutual Bank, Harvey, IL			44	39		34		1.7B	68
Farmers Bank, Lincoln, NE	63		68	58		61	63	19.5M	69
Pacific Western Bank, San Diego, CA					8			4.3B	70
St. Helena Parish, Chicago, IL			10	23				<1M	71
Metlife Bank, NA, Bridgewater, NJ	39	52					36	7.7B	72
Home Fed Savings Bank, Detroit, MI	48			66	36		54	16.5M	73
St. Gertrude'S, Mora, NM			26	8				1.7M	74
St. Margaret, St. Louis, MO			15	20				<1M	75
Bestwall Brunswick, Brunswick, GA			9					<1M	76
Redwood Bank, Watertown, NY		9						18.3M	77
Security Bank Of North Fulton, Alpharetta, GA					9			182.5M	78
Universal Savings Bank Fa, Milwaukee, WI		75	20		40			4.3M	79
Westernbank Puerto Rico, Mayaguez, PR	50	35		54				17.1B	80
Los Padres Bank, Solvang, CA	41					49	51	1.2B	81
First United, San Jose, CA			32	6				17.8M	82
Texico St Bank, Texico, IL	70		48	38			72	9.4M	83
Centennial Bank, Ogden, UT			12	27				212.3M	84
Jennings St Bank, Spring Grove, MN			19	20				47.9M	85
Security Savings Bank, Henderson, NV			18	21				254.5M	86
Corus Bank, NA, Chicago, IL		62	40	45				9B	87
Almena St Bank, Almena, KS	58					33	58	16.2M	88
Alliant Bank, Sedgwick, KS			45	50	55			16.7M	89
Comm Trust Bank, Hiram, GA		13	27					279.4M	90
County Bank, Merced, CA			58	49		43		2.1B	91
Southern Comm Bank, Fayetteville, GA			22	18				378.1M	92
Bank Of Parsons, Parsons, KS	44					55	53	11.8M	93
Guaranty Bank, Austin, TX	27						15	15.9B	94
Real Financial, Edina, MN			31	11				28.3M	95
Farmers St Bank, Fairmont, NE			38	48	74			7.3M	96
Mesilla Valley Bank, Las Cruces, NM			36	60	64			17.3M	97
Bankunited, FSB, Coral Gables, FL			57	46	58			14.2B	98
Alliance Of Poles, Cleveland, OH			18	25				<1M	99
Bear Stearns Bank & Trust, Princeton, NJ		11						879.9M	100
First Bank, Roxton, Texas, The, Roxton, TX	59				72	74	59	19.9M	101
First Private Bank & Trust, Encino, CA					11			638.8M	102
Mt Zion Woodlawn, Cincinnati, OH			11					<1M	103
Nova Savings Bank, Berwyn, PA	29						16	520.1M	104
Mcclave St Bank, Mcclave, CO			75	73	57	67		19M	105
Meridian Bank, Eldred, IL						8	38	44.2M	106
Riverside Bank of Gulf Coast, Cape Coral, FL	25				21			620.5M	107
Filley Bank, Filley, NE	56					62	56	15.1M	108
Freeport St Bank, Harper, KS	57					60	57	16.2M	109
First St Bank Of Altus, Altus, OK	31					16		124.5M	110
Delaware Sterling Bank & Trust, Christiana, DE		12						32.3M	111
Neighborhood Comm Bank, Newnan, GA			26	22				240.1M	112
Old West, John Day, OR			29	19				90.6M	113
Heritage Comm Bank, Glenwood, IL					25	24		263M	114
First-Knox Natl Bank, Mount Vernon, OH	21						29	818.8M	115
Bank Of Wyandotte, The, Wyandotte, OK	67					58	69	12.7M	116
Colorado FSB, Greenwood Village, CO					13			99M	117
Pnc Bank, NA, Pittsburgh, PA							13	128.3B	118
Citizens St Bank, Carleton, NE	62					73	62	12.1M	119
Anchor St Bank, Anchor, IL	71					54	73	13.7M	120
Oglesby St Bank, Oglesby, TX	69					59	71	12.1M	121
Bank Of New York, The, New York, NY		34					20	130.1B	122
Milford B & La, Milford, IL	66	72					68	18.8M	123
Central Progressive Bank, Lacombe, LA			14					480.9M	124
Rocky Mountain Bank & Trust, Florence, CO	19						37	212.2M	125
Sc Firefighters, Columbia, SC				14				3.7M	126
University Bank, Ann Arbor, MI							14	113M	127
Kaiser-Lakeside, Oakland, CA			33	24				28.5M	128
Valley Wide, Vernal, UT			28	29				<1M	129
Oakdale St Bank, Oakdale, IL	72					75	74	16.7M	130

Possibility of Martial Law At least one Congressman admitted that he was told that not passing the bailout bill could result in the declaration of martial law. I concur that this was a very real possiblity. If the bill had not passed, the stock market would likely have dumped hard, similar to what happened last Monday. While there are many that suggest the PPT would step in and support stocks to keep them from falling, I disagree. It depends upon what the Presidents Working Group on Financial Markets wants to accomplish. Last Monday was an example where it was clear there was nothing supporting the market. In fact, I believe the selloff was stronger to the downside because short selling was not allowed on the 800+ financial stocks. When a short-seller needs to exit their position, they must buy it back and that creates support. Without shorts being there to buy back their own positions, there was a shortage of buyers and that causes stocks to drop much faster than normal. You have witnessed first hand what happens when the stock market becomes less liquid because of poorly conceived government regulations -- an aftereffect of the law of unintended consequences. Public opinion of the bailout quickly shifted from opposition to acceptance following Mondays min-crash -- it is amazing how quickly Americans can be herded like sheep when their pocketbook is immediately threatened. A stock panic today of similar magnitude would certainly have helped set the stage for a martial situation.

If it was going to happen, this weekend was the very best opportunity. Because the bailout bill passed the House, I do not think the likelihood has disappeared, rather I think it has simply stepped aside awaiting the next opportunity. Here are the points that I have identified as necessary before martial law is likely (and this of course is my worst nightmare):

1. Bush signed an executive order in Spring, 2007 authorizing the sitting President to suspend Constitutional government indefinitely in the event of a catestrophic emergency (the definition of emergency is up to the President to decide).
2. I interpret the executive order that in such an emergency Bush will have the power to temporarily "nationalize" corporations deemd to have strategic national importance, such as banks, oil, airlines, food distribution, etc.
3. US Elections could be suspended indefinitely (again, timing is everything so a move sooner is more likely than waiting as few weeks)
4. A few months ago Bush reassigned the US Army 1st Batallion from Iraq to US to train for "domestic operations" and to be on-call beginning 10/1/08 to quell riots and public unrest.
5. US Treasury has the authority to do just about everything in Paulsons original bailout proposal... in the event of an emergency. Anything not specifically authorized may be granted to the Treasury by the President. This includes confiscation of gold, silver, and any other commodity deemed necessary in support of the US financial and banking system.
6. The strategy of FDIC announcing bank seizures on Friday nights, sets up a perfect backdrop and maximum drama for Bush to declare such an emergency this weekend. I would expect the next FDIC announcement to be many banks at one time.
7. Quite possible he might declare a "bank holiday" and keep banks closed for several days.
8. Failure for Congress (damned if they did and damned if they didn't) to pass the bailout bill allows Bush to hold Congress up as the scapegoat to blame for the crisis and therefore justifying his need to declare an immediate emergency.
9. If Bush wants to leave office with maximum impact, this is a golden opportunity for him to make his move.

This is a nightmare scenario that I truely hope does not come to pass. I think the pressure is off for the time being because the House did pass the bailout bill. President Bush has already signed it. The new bill has gone from Henry Paulson's initial 3 page document to 450 pages, full of add-on's and pork. A declaration of martial law by Bush may not happen this weekend, but the possibility still exists and if it happens is most likely before November's election. Stay tuned.

Sunday, September 21, 2008 PM

Short-Selling: The new SEC ruling has halted all short-selling on 799 financial companies effective immediately and continuing through 2 October 2008, but the halt may be extended to no more than 30 days beyond that. I find it quite peculiar that 2 October + 30 days = 2 November, which is just 1 trading day before the US election. No new shorts may be initiated, but for those that are already short have no choice but to buy to close out their position. This creates an artificial rally, but only if there are buyers.

The problem was from naked short-sellers. In other words, primarily hedge funds, would sell a stock short without borrowig it first. It was purely financial machination of a derivative nature that only limited their leverage by the margin required by their trading counterparties. With this extreme leverage, funds could drive down the stock price of any company or commodity. For the financial stocks, it was particularly devious because much of quality rating is based upon stock performance. An investment bank, like Lehman for example, would be able to trade with counterparties at certain credit rating levels while posting appropriate margin. Once their rating is lowered, their credit quailty immediately comes into question and it is no longer a speculative decision to request more margin from Lehman, but a contractual one. When a companies credit rating is lowered, the stock price tends to fall more. And that fall could trigger another credit rating downgrade. It very quickly becomes a death spiral. Naked short-selling is not illegal, but predatory and intentional manipulation to artificially move stock & commodity prices is illegal. Hedge funds have gotten so large and powerful with huge sources of cash that their influence in markets has been very unsettling. As momentum players, once a stock or commodity starts to move (in ether direction) other funds pile in and that greatly exagerates the move.

James Angel (finance professor at Georgetown University in Washington) said on short-selling: "When you see flies around a carcass, it doesn't indicate that they killed the animal. They're just trying to make dinner out of it."

Traditional shorting is a necessary component of a properly functioning and efficient marketplace. Investors must be allowed to buy a stock just as easily as selling it. Without shorting, markets will skew with a very unnatual upside bias. At some point, there will simply cease to be any more buyers so those that hold stock will not be able to sell -- there will be a void in liquidity that eventually will drop the stocks price dramatically downward to a more realistic level. What this means is that a stock who used to trade a $1 daily price is likely now to trade in $2 or $3 swings -- the longer this short-selling suppression remains expect ever-widening daily swings. Potentially a great opportunity for nimble traders that don't mind surfing in shark infested waters.

Instead of banning all shorting, the SEC should have banned only naked short-selling and sought the parties responsible and prosecuted them. The SEC is starting to monitor daily shorting positions like they used to do for long positions. Geez, this is just common sense, SEC is supposed to be regulators and they didn't even consider short selling an issue worthy of monitoring? At least now both long and short positions are supposed to be publically reported to investors.

Goldman-Sachs - Last derivative standing?: Selling CDOs from one trading group while shorting them in another... sounds to me like Goldman knew what they were doing by getting their competitors loaded up with more poisonous paper (like the elderberry wine in Arsenic and Old Lace). As the last investment bank in what appears to be in surviveable shape, Goldman is in the perfect position to monopolize whatever business it can scrape up. David Viniar (Goldman-Sachs CFO) said that "Goldman has compassion for the employees of the failed firms (Lehman & Merrill), their bad fortune is a benefit (to Goldman) ... clearly when there is less competition it is better for us ... more pricing power and a competitive advantage." That is, of course, if there is any business to scrape up. Dick Bove said "If the markets do not recover, Goldman cannot come back, it has no ability to do better than the businesses it serves."

Goldman's core business model is almost identical to that of Enron. Enron primarily traded energy products while Goldman trades anything and everything. There was no derivative too exotic for them to play, in fact these guys created markets for many of the more bazaar and convoluted products. Their role in the market was to be the middle man that takes on deals from almost anyone, retains a transaction a fee, and then offsets that position to another counterparty. By offsetting each deal, Goldman/Enron remained financially neutral. This made them kind of like a pseudo-exchange for OTC (over the counter) derivative products -- they created liquidity that otherwise was almost non-existent. They were, in effect, market-makers, the go-to guys of last resort. Bear Stearns, Lehman, Merrill and Morgan-Stanley played similar roles. But maintaining financial neutrality is only a figment of academia. Once one or more counterparties default, everything changes. In Enron's case, it was PG&E's bankruptcy that started their unravelling. For Goldman, it is the basket of companies that have recently gone bankrupt. Their Cinderella world has shattered.

Morgan-Stanley is walking death -- they will not survive. Perhaps the recent bailout will put them on life support for awhile, but once the financial umbilical is pulled, their final collapse should follow soon thereafter.

The reason I said Goldman may be surviveable is due to their relationship with the Federal Reserve. Goldman is a stockholder in the Federal Reserve and that gives them extrodinary clout. Further, as the strongest of the two remaining investment banks, Goldman will probably be deemed too important to fail because they would be the sole independent market-maker for derivative trading. Of course their business model will have to change because I really think the entire OTC derivative concept will be disassembled and repackaged with some kind of exchange-like transparancy and SEC-expanded oversight.

One caveat to this, as pointed out by a recent discussion I had with JesseL at Jesse's Café Américain is that Lehman was also a stockholder in the Federal Reserve. And look where that got them. Actually they were just too far gone to be bailed out and were sacrificed to save the rest of the wolf pack.

Citigroup, Bank of America, and JP Morgan: In my opinon, Bank of America (BAC) is in a very similar position as Morgan-Stanley, but of their own doing. While they hold massive amount of derivatives on their own, they have taken on a tremendous amount of additional baggage from the likes of Countrywide and Merrill. Citigroup is also in a bind with their derivative exposure. JP Morgan - the pillar of banking excellence (?) - IS the Federal Reserve so there is no chance of a collapse from them.

I think there is a backroom plan abrew. The US financial system needs financial structure from a variety of firms. I think these three are the chosen ones to get whatever taxpayer bailout is necessary to ensure their survival. They will be allowed to gobble up all of the other failing banks. After the dust settles I hardly expect much from them in the form of competition.

AIG: If I am now a stockholder in AIG, I want a discount on my auto insurance!

$700 Billion Mortgage Bailout: For a hastily thrown-together plan such as this, $700 Billion provides a lot of room for fraud and corruption to siphon a portion of that off into personal pockets. We saw how Bush/Cheney assigned Iraq repairations exclusively to Halliburton without competing bids, so I thoroughly expect the same consideration here. Republican-backed corporations will be given exclusive access to participate in the management, dispersement, and siphoning of funds. There are no government agencies equiped to handle it all, it must be contracted out. Time is critical since the US election is only 6 weeks away and political pawns could soon be gone from office -- all of this good-old-boy infrastructure needs to be in place and operational before that happens, if there is any payback due, now is the time to do it.

What it really boils down to is that Hank Paulson has been granted sole power to administer the machinations necessary to try to arrest the current crises. He has been granted sole, and unquestionable, power to demand which institutions buy what and which institutions must sell. Bush is in a daze and cannot fathom what is happening and Congress is apparently just as clueless. As a result, the real power of the country has been turned over to 2 unelected persons: Hank Paulson and Ben Bernake. Bush no longer calls teh shot, Hank does. Right now, you'd better hope they think you are friendly, because if you are a foe they have the power to bury you and you will not have any recourse.

Please be aware that the $700B is only just a starting budget. This is merely a limit to how much the Federal Reserve can hold on its books at any one time. Once various transactions are completed and this balance goes down, it is likely to be replenished over, and over, and over again.

How much do you think this will eventually cost? Well all you really need to do is go back to how much the initial cost estimate was to go to war with Iraq, $50 billion. We have already past the $800B mark (Iraq & Afghanistan combined) and heading much higher -- clearly more than 16x the original estimates. Now I must confess that the $50B estimate was artificially low because Bush simply would not accept any higher estimate -- although I recall Lawrance Lindsey's original estimate was for $100- $200B. From that figure to current Iraq estimates of closer to the Stiglitz estimate of $3T it may end up being at perhaps 15x.

At least this time it does not appear as though Bush is playing low-ball. He really can't, after all how much does he understand about high finance? He understands about getting high but does he know anything about finance like what we are dealing with... not even Bernanke understands it and had to ask for a primer from industry traders.

Karl Denninger acknowledged that the original 1980's S&L bailout estimate was $20B but ended up costing $160B. That's an 8x.

Given our recent history, I think a 3x may be way too conservative and a 5x downright scarey. But judging by our past in handling cost estimates during crises 5x should prove to be way too low. But just so we have something to work with, let's just say it will end up being 5x, or about $3.5 - $4T.

If that doesn't scare the pants off of you, then consider that this estimate is only just this particular bailout... there's still a lot more fit to hit the shan.

How much is $700B? Consider this from a gold perspctive... The US currently has 8136.2 tonnes of what the US Treasury classifies as "Deep Storage" gold. This translates to 287M ounces. At friday's closing spot price of $871.80 all of this gold is worth $250B.. only 1/3 of what Paulson is asking for this bailout. That's right, if the US were to sell off its entire cache of gold it would just barely make a dent in this initial bailout.

In fact if you considered all of the gold held by World central banks: 31,000 tonnes (as of 2005), it would only amount to $953B. If my estimates from above prove to be accurate, this amount would barely make a dent in the final cost -- we would have to come up with 3-4x more gold just to pay off this bailout.

Taking this one step further, world-wide annual gold production is 50M ounces. It would take 16 years of consistent gold production to total $700B.

The bottom line is that we need to recognize that this initial estimate of $700B is nothing compared to what the final cost will be. And that cost will reach far beyond everything financial. Even if it reaches $4 trillion or more, the ripple through the global economy will be be felt by just about everyone. The US middle class will be completely destroyed - they are the only ones paying taxes. But even those not paying taxes will be significantly affected as the tsumani of bailout-injected inflation wipes out everyone on low and fixed incomes.

Dillution of the Dollar is Inflation to Everyone Else: Last wednesday when the FED announced they were going to print and issue new Dollars as part of the inital bailout. Consider that the FED is not much different than a bank selling shares to raise capital the only real difference is the FED's shares are called US Dollars. In every case of selling additional shares is dilution of shareholder equity. Once Dollar holders realize this, the USD will head down again - likely to new lows soon. This action by the FED to sell more Treasuries should send a signal to large Dollar holders around the World, if they have not already started, to lighten up on their USD exposure. The former standard reserve currency is no more.

Of all of the US banks that issued new shares to raise capital, how many were able to continue operating normally without further bailout infusions from the FED? Nope, I cannot think of any either. The FED has been there to backstop all of these banks. Who is going to backstop the FED? Not the US Taxpayer, the numbers are growing too huge for that, taxes cannot possibly cover the costs that the FED is going to burn through.

I know the situation is quite dire to say the least. But, is this IT? Is this move by the FED the pivotal stroke that will send the USA into inescapable insolvency? Is this the event that historians will always refer to as the moment when the last gasping possibility of recovery was snuffed out, and Depression II began in earnest?

Not sure how the rest of you feel, but I see this latest FED move as THAT key pivotal event.

Yes, folks, you are witnessing the dawning of Depression II.

Look around at all of the products and businesses that have been hit by flying shrapnel from the mortgage-backed derivative bomb:

• banks - like real banks
• investment banks
• home builders
• ratings agencies
• insurance companies
• securities brokers
• real estate brokers
• commercial real estate
• construction
• commodities (for building supplies)
• municipal property taxes
• individual home mortgages
• autos
• student loans
• every US citizen (bailout induced inflation as a form of efficient taxation)

and then there are the fringes that may not have felt the full impact yet, but the shock wave will hit them soon enough:

• tax supported municipal programs and even services such as police and fire protection
• credit cards
• homeowners associations
• medium and high-end retail outlets
• basically any product or service deemed a luxury or elective are likely to experience a reduction in sales. For some the losses will be too much and will simply go out of business.
• Cities and counties that rely upon property taxes will have to resort to other schemes to raise revenue - they will cut non-essential programs very late into the cycle - so for example, look for increases in traffic citations as an alternate form of taxation.

2nd Quarter Bank Losses: From information I gleaned from BankRate.com the following suffered extreme losses in their total bank asset value (this is the gross change in total assets from 31 March 2008 to 30 June 2008):

• Citibank -68.3B (SD & NV branches)
• B of A -32.7B (including Countrywide losses)
• JPMorgan -29.1B
• HSBC -10.8B
• WaMu -10.8B (** Siezed by FDIC 9/25/2008)
• St Street -8.6B
• Merrill (Bank) -5.0B (** Merged with Bank of America 9/7/08)
• SunTrust -3.2B

Combining the 6 quarters between 31 December 2006 and 30 June 2008:

• Wachovia Mortgage -69.5B (** Merged with Citigroup 9/28/2008)
• WaMu Bank -38.3B (** Siezed by FDIC 9/25/2008)
• LaSalle Bank -12.1B (MI)
• SunTrust -11.1B
• Sovereign -10.3B (PA)
• Chase Bank -9.5B (DE)
• Merrill Bank -9.2B (** Merged with Bank of America 9/7/08)
• Lehman Bros Bank -8.3B (** Declared bankruptcy 9/7/2008)

Since the end of 2006, 20 banks have lost $1B or more (combined loss -127B).

Since the end of 2007, 21 banks have lost $1B or more (combined loss -202B).

Please keep in mind that these asset values are provided by the banks to the FDIC and other reporting agencies. If their books hold difficult to value Level III derivatives then their assets reflect their own model estimates, not necessarily a real-world market value.

FDIC Bank Closures: Another FDIC bank siezure took place Friday 19 September 2008 with Ameribank, based in Northfork, WV. It was listed as one of my medium-sized banks in last weeks list of banks most likely to fail. I updated the chart to mark that banks date of siezure.

Update on Trump Towers and Solis Resort Spa: These are the two high-rise condo properties in south Florida that I had reported on earlier. The Solis construction has been largely shut down since I last reported on them. There was one week with a full crew, but that was short-lived. Recently there have been 6-8 crew looking busy but with no visible improvement. Basically I noticed 2 supervisors, 1 or 2 crane operators, and 4-5 workers. On a project of this size, these few workers are not going to accomplish very much. What it looks like they may be doing is simply securing the unused construction inventory by moving it from ground to upper floors to twart thieves.

Trump Towers is in a bind. This is a 3 tower project, each of which contain 271 units. Before construction began, all 3 towers were completely sold out. The first tower has been available for occupancy since January, 2008. The 2nd building should already be completed but there are no tax records yet. The 3rd building is still under construction but final paint and polish is occurring right now -- I am guessing occupancy as early as January, 2009. The first tower now has sales records for 103 units ranging from $525,000 to $2,100,000 each. But the sicky widget is there are at least 60 buyers suing the developers for misrepresentation. Apparently Donald Trump only lent his name for the project to initially help get the units sold, but the project may not always carry the "Trump" name. The buyers contend they were duped into paying a 36% premium over comparable units elsewhere because they were told, and the prospectus showed, that it would be a Trump property. It was only after they received sales contracts that they discovered the Trump name missing. Mr. Trump was not specifically listed in the suit.

Apparently Donald Trump is amused and said he was flattered that the buyers thought his name deserved such a premium. But there is more to this suit than just the possibility of a name change. Alledgedly, the developers manipulated secondary sales prices from Tower I with over-inflated prices so that buyers in Towers II and III were compelled into paying higher prices for their units.

Although it appears that the Trump Towers project is likely to be completed, I am sure that it was troublesome that one of their commercial loan providers, Lehman, is now bankrupt.

I know from various records that Lehman played a big part in providing partnered loans for nearly all of the high-rise condominums in this area, but I have not yet been able to determine if Lehman's bankruptcy was a factor in the Solis project getting all but shut down.

VultureCondos reports that bulk purchase real estate vulture funds are circling S. Florida, Las Vegas, and S. California markets believing that after last weeks Wall Street near-meltdown and subsequent Fed bailout, that now is the bottom and it is time to swoop in and start buying depressed condos. Apparently their current target is buying properties that are 40% to 50% of 2006 market highs. I have been searching around various real estate websites related to the S. Florida market, and I do not get a sense that there has been any panic yet, no broad based liquidation effort, and individual owners are still lowering their asking prices only a teaspoon at a time. If the vulture funds think now is the time to swoop in, I bid them good luck. Maybe there are a few developers that got caught with high-priced inventory during a broad downturn coupled with losing financing from former providers such as Lehman, but overall I think the real estate markets have a long way to fall yet. The best time to buy is when there is real panic, but it is not here yet, not even close.

Sunday, September 14, 2008 AM Whoopie, CyclePro celebrates its 10 year anniversary this month!

Lehman Troubles: As you are probably already aware, Lehman Brothers is in deep doo-doo and this weekend is the equivalent of the weekend when Bear Stearns was sold off to JPMorgan for pennies along with a Federal Reserve backstop on the debt. The Fed appears to be playing tough trying to force Barclay's and Bank of America to duke it out over the spoils. Is there are possible 3rd party? I am not so sure -- although JPMorgan and Goldman Sachs are in position to eventually take over the entire financial and banking system, Lehman's risk is too great. Besides, Lehman is more of a competitor than a comrade. At least for Barclay's and Bank of America the better parts of Lehman could enhance their existing business model. After already taking on Countrywide Financial, B of A is in no position to burdon their own suvival by taking on Lehman's balance sheet without an exerciseable put option.

The moral hazard is alive and well.

Even for these vultures, none of the parties seem interested in taking on the massive risk exposures without some kind of Bear Stearns-like backstop by the Fed. Does a vulture really know the difference between a dead carcass from natural causes vs one caused by toxic poisoning? I dunno, maybe it's the putrid odor wafting out of Lehman's decaying balance sheet.

Push comes to shove, the Fed is not likely to simply allow Lehman to crater in an implosive bankruptcy. I believe the Fed will further indebten US taxpayers and engineer a hefty bailout once again. While Barclay's and Bank of America have been getting the media exposure over this drama, I would not be surprised if JPMorgan ends up getting a hefty chunk of prime Lehman flesh, and using their built-in clout with the Federal Reserve to backstop for a near- riskless opportunity for JPMorgan. Once again, US Taxpayers will be stuck with all the ugly parts.

Bank Ratings: The following tables show the banks and credit unions that I think are the most likely to fail over the course of the next several quarters. As economic conditions worsen, particularly with falling real estate values, these institutions appear to be the most vulnerable. The raw data was obtained from the BankRate.com website which provides safety ranking (CAEL: capital adequacy, asset quality, profitability and liquidity) and financial health performance ratios on over 8200 US banks and 4600 credit unions. The banks listed are all FDIC insured (the credit unions are not insured with FDIC).

I downloaded the entire database. The data is current as of 2nd Quarter, 2008.

You will note that the top of the large banks is Integrity Bank, which was siezed by FDIC two weeks ago. I had done some preliminary analysis and had Integrity pegged before the FDIC announcement, but unfortunately I did not have enough time to polish it up for posting here on CyclePro. I had posted an earlier report to Bear Forum using 1st Quarter, 2008 data, so the list below uses more current data.

The rank is a score by how many different performance ratios each bank scored as a top 20 worst performer out of the 19 different ratios (listed below). For example, Integrity Bank was a top 20 worst performer for 12 of the 19 performance ratios. The list is further refined to weigh in if the bank was also on a similar lists for 1st quarter, 2008 and for year 2007. My logic is that a bank that has been having severe financial problems for a long period of time is more likely to be siezed by FDIC than a bank that just recently started to show up on my worst performer list. That said, there were several banks (IndyMac as a good example) that were siezed by FDIC (or Implode-O-Meter) which were not ranked 5 or even 4... IndyMac was rated a 3 (ie: 1=best... 5=worst).

Performance ratios used in this analysis:
     Return on Assets
     Operating Return on Assets
     Return on Equity
     Interest Margin
     Fee Income / Assets
     Overhead / Asset
     Non-Performing Assets / Assets
     Non-Performing Assets / Equity Loss Reserves
     Loss Reserves / Loans
     Family Mortgage MBS / Assets
     Commercial Real Estate Loans / Assets
     Construction Loans / Assets
     Commercial & Industrial Loans / Assets
     Consumer Loans / Assets
     Equity / Assets
     Tangible Capital / Tangible Assets
     Risk-Based Capital Ratio
     Loans / Deposits
     Non-Interest Bearing / Deposits

There were quite a few rating changes from 1st quarter to 2nd quarter. For example: H & R Block Bank, Kansas City, MO had the biggest change, from a 1 (best rating) to a 5 (worst rating). The following 6 banks changed from 2 to 5:
     The Union Bank, Marksville, LA
     Providence Bank, Alpharetta, GA
     First Frontier, Lynbrook, NY
     First Natl Bank Of Lacon, Lacon, IL
     First Natl Bank Of Wayne, Wayne, NE
     First Natl Bank Of Platteville, Platteville, WI

There were 91 banks with rating changes from 3 to 5. Overall there were 1556 banks with lower ratings for Q2 vs Q1.

But things were not all bad, in fact 1 bank went from a rating of 5 to a 1, 4 banks moved up from 5 to 2. Overall there were 2096 rating upgrades -- some good news for a change.

(Monday August 18, 2008 AM): There has been some discussion lately about the apparent shortage of available retail physical silver bullion products. It seems as though investors are having a difficult time obtaining bullion coins or bars. Personally, I have not noticed a problem since my most recent purchase was last Spring and recent phone conversations with my usual suppliers did not suggest a tighening of inventory. However, it is what it is.

In the event that newly fabricated bullion products are in such short supply that investors may be willing to take some risks to get them, I wanted to post the following photo I took in 2003 of a bogus silver bar from the 1980 silver bull market. This photo shows that someone took an authentic 100oz bar and bored out 3 columns filling them with lead. On the outside the bar looked completely normal and testing by weight did not reveal the hidden deception. The precious metals dealer that provided this sample told me that the only way to know was to either have a very keen ear to listen to the "thunk" sound when held up and rapped like a bell, and the other way was to physically cut or drill into it.

I am not aware of any problems in any of the available bullion products. I was told that all known bogus bars fabricated during the 1980's, like this one, were removed from circulation. However, that does not mean that theives with not try it again, particularly as the price of silver rises enough to make it worth their while. I believe that all recently fabricated silver bullion products coming directly from reputable sources should be clean and reliable.

Please be cautious when dealing with unknown dealers or blackmarket opportunists.

(Sunday August 17, 2008 PM): Last weekend I was browsing through the information at BankRate.com and came across data they maintain that assesses the Safety Rating of each of the 8260 banks and 4600 Credit Unions in the U.S. The ratings are 1-5 with 1 being the highest or strongest banks and 5 being the worst or most vulnerable to faulure, at least that is my description of them. So I decided to download the entire database of data. The following tables summarize the banks by state, for the 4 categories showing the highest percentage rated 4 or 5 (bad states), lowest percentage rated 4 or 5 (good states), highest percentage rated 1 or 2 (good states), and lowest percentage rated 1 or 2 (bad states).

Puerto Rico has been included in the data and is significant in that it is consistently one of the worst "states". This one surprised me since I had not heard anything about banking safety quality in Puerto Rico. Georgia was another that surprised me.

The following summaries contain data only for US Banks (I did not include Credit Unions at this time).

(Sunday August 17, 2008):

The following is an updated chart of the U.S. Residential Mortgage Debt Outstanding. Along with it, I overlayed the Average Mortgage Debt per Financed Household. The average debt and the total debt follow an almost perfect correlation. Along with existing homes, included in the average debt is all of the new homes constructed for which the buyers used mortgage financing. The data is updated as of Q1'08 which is the most recent I could find available. The household counts are from US Census data.

Click chart to enlarge.

If home market prices have fallen to the 2003 level, then it means the total mortgage debt outstanding is underwater to the tune of $4.3 Trillion. The average mortgage debt is at least $100,000 underwater, per hoursehold!

In 2003 there were 105.3 million households and now about 110.7 million. Therefore, a net of 5.4 million new homes have been added to the inventory. The number of households with mortgage financing in 2003 was 33.9 million and now it is 35.5 million -- this is weird, quite contrary to what I would have guessed. Since so many people who otherwise had homes completely paid for then took out HELOC loans, I really would have expected the number of financed homes to increase much more then the number of new homes.

The Case-Shiller Housing Index is showing a very clear selloff in home prices. The chart below shows the 20-City, 10-City, and Miami indexes which reveal -17.8%, -19.1%, and -28.6% average price declines, respectively.

Click chart to enlarge.

Miami is an interesting housing market. Throughout recent history (at least since 1987 for which Case-Shiller data is available) the variation in average home prices has stayed very close to the US average... well, until August-September, 2004. The following charts shows the Miami-US spread, ie: the average home price for Miami minus the average home price in US. From 1987 through 2004 Miami prices varied from US averages by about $10,000. Then in August-September is when the correlation broke down and Miami prices soared -- the variance went from $0 to $59,000 in 2.5 years. Of course there were interest rate incentives, but that also affected the entire US, not only Miami. What set Miami apart from the rest of the US was one thing, fraud. Fraud in the form of unrestrained speculative property flipping, no-doc and liar loans, realtors front running buyers to inflate prices, panic buying to own the last of ocean-front views. Heck, even if you had to stand on your toes and stretch your neck out around the corner of the building to see a tiny glimps of water was considered "ocean view" property. The frenzy was so frothy that a buyer had to be prepared to plunk down a deposit on the spot or risk losing the deal an hour later to another "professional property flipper". Every 3rd person on the street was a "realtor".

The California market was not much different. Home prices were already out of reach for most buyers. For many hopeful buyers, no-interest loans were the only means to home ownership. I wrote on CyclePro back then how no-interest was only slightly different than renting, the buyer gets to profit if prices rise, but they can walk away without losing equity if prices fall. The only reason banks went along with the scheme was because they collected fat fees and then bundled the mortgages up and sold them to unsuspecting investors. You have already been reading about the whole MBS (mortgage-backed securities) crisis and the CDO (collateralized debt obligation) crisis that tagged along, so I will not go into any more detail here.

While the entire US experienced rampant mortgage abuse, it was California and S. Florida that allowed systemic fraud to escalate the housing market into an ponzi orgy of unimaginable magnitude. These were industrial-strength bubbles.

It is precisely the reason that California and S. Florida experienced such wreckless froth that their consequent reversion must be similarly severe on the downside. Overall, housing prices tend to rise along with income levels. When home prices get too far out of line with incomes, something has to give to get back into equilibrium. If incomes cannot rise, then home prices must decline. Certainly there are geographic pockets that attract a more affluent population, but even their incomes still drive the affordability of home prices in that area. The rule of thumb has always been and will continue to always be: families can afford a home costing no more than 3x of their household income.

Is it no wonder why so many families have to maintain multiple jobs in order to keep up with their mortgages?

Click chart to enlarge.

If it was only home buyers that were affected it would be a bad situation. But unfortunately things tend to get intertwined with other aspects. For homeowners in areas that experienced these massive housing price increases, they were either pushed out by rising property taxes and insurance rates, or they used their Cinderella equity to cash out and spend as though they were living in that perpetual fantasyland. The bubble has burst. Housing prices are coming down. The Cinderella home equity ATM machine is out of order. And the carriages are turning back into pumpkins. Homeowners that withdrew home equity cash are now faced with property with values less than their new outstanding debt balance. It is not just new home buyers, it is also those that had previously owned their homes yet withdrew so much equity that they are now at underwater-par with the new buyers. Habits are difficult to break, and after many years of home equity ATM spending, homeowners have turned to their credit cards to continue their fantasy lifestyles. Foreclosures are rising, setting records not seen since the 1930's. Defaults on everything related to debt are rising: homes, cars, credit cards, student loans, you name it, if there is debt involved defaults are increasing. No debt is immune at this point.

This is what has already happened. Now we get to talk about was is likely to happen in the coming months and years.

Because so many people have been caught up in this tangled debt web, it will have a huge impact on the overall economy. Spending will have to be curtailed in order to address this debt, the defaults, and the cleanup. To make matters much worse, US Congress passed the housing bill that now allows the US government to baskstop Fannie Mae and Freddie Mac losses -- all of which will have to be paid by tax dollars. Now it is no longer a problem of only those that participated in the speculative housing, freewheeling home equity spending, and all of the fraudsters that helped make it all happen. Now, the 75% or so of prudent Americans -- that did not get involved, that resisted raping their home equity, that saved earnings, that kept their debt balance at manageable levels -- are now being forced to donate to the housing bailout. Taxes will rise. I certainly expect traditinal taxes to rise, but it is the stealth taxes that will be the most pervasive. By stealth tax, I mean inflation -- in his Congressional testimony last month, Ben Bernanke admitted to Ron Paul's questioning that inflation is, in fact, a tax. No one can escape the tax of inflation because all commerce conducted in US Dollars will be automatically adjusted to withhold the tax. What I mean by this is as tangibles and commodity prices rise, everyone will either be forced to pay the higher price or switch to an alternate commodity. As more begin using the alternate it puts pressure on its price so it rises too, then another alternate is sought. Pretty soon, no alternatives are left and unless demand reduces, prices will continue rising. It is this incremental price increase that has the exact same effect as if a tax were imposed on the original base price of that commodity.

Because it is all built in to the price, it is therefore a "stealth" tax. This is the most efficient form of taxation to which no one can escape if you wish to exchange in commerce using US Dollars. This is precisely why George W. Bush has never raised formal taxes, because spending Dollars the US government did not have and the Federal Reserve accomodating by create whatever necessary. There was no need to raise formal taxes and have the populace protest. Instead, Bush was able to spend, spend, spend, and tell Americans to likewise spend, spend, spend. Meanwhile and unbeknownst to most Americans, they were being treated like the frog in the pot, gently being warmed ever so slowly. Unfortunately, the fire has gotten hot and prices are rising so fast that everyone is now noticing, and screaming for relief. The tax that is infation is being paid, whether you like it or not. If you don't like it, move somewhere that does not have an inflatable fiat currency -- look around, nope, I cannot find one either.

But the stock market is holding up well despite the myriad of financing crisis. Or is it? While the DJIA is down far enough to be considered in a bear market, it is still much higher than it should be (in my opinion of course). The following chart uses the inflation data from Shadow Stats to recalculate the DJIA when adjusted for inflation (using year 2000 as the base). Please notice that January, 2000 was the all-time inflation-adjusted peak and the "value" of the index has been falling ever since.

Click chart to enlarge.

This chart clearly notes the 35 year inflation-adjusted stock market cycle (17.6 years down + 17.6 years up). It is not as visible on a standard stock chart, but when inflation is taken into account the cycle emerges. Adding 17.6 years to the DJIA peak in 2000 provides an estimate for the next low, Summer 2017.

Another illustrative thing about this chart is the effect inflation actually has on stock prices. I am sure that the vast majority of stock investors believe that as long as stock prices rise they are profiting. Just because the price level quote in the paper, or on the ticker across the bottom of your TV screen, shows a higher price does not mean that the "value" of the dollars used to buy those shares are necessarily worth what the higher price suggests. It's a mirage. Inflation is a tax which systematically and very efficiantly eats away at those profits. The chart makes it clear, that the current DJIA is no better off now than when Alan Greenspan gave his famous "Irrational Exuberance" speech in 1996. And, at the time Greenspan though stock prices were overvalued!

By the way, just to clarify the curved lines on this chart. This chart is displayed as linear while the curved lines are logarithmic. I cannot display it both ways at once. Logarithmic lines are useful to denote changes in percentage rather than absolute linear value. This makes it possible to compare previous portions on the DJIA history with the current data. For example, the blue line represents extreme bull market peak levels tounched in 1929, 1966, and 2000 while the green lower line represents bear market bottoms, such as those in 1932, 1982, and what I expect to be in 2017. The 1948 low was not low enough to touch the green line, but it was a signficant low nonetheless. The future DJIA may very well show a printed price level above or near where it is today, it does not matter really, because after adjusting for inflation, the 2017 level should be much closer to 4000 (which coincidently, is roughly where the 1966 peak ended).

My previous forecast for Gold has been rather sobbering after being slapped hard by the market. The following first chart should help explain what has happened. I labeled "I" where I had originally forecast to and up to that point everything was working as planned. We got a weak rally off of that low for 3 days. Unfortunately, prices turned down again and a point "II" we had what appeared to be 5 waves down -- this is bad news for bulls because it means it is likely to be wave 1 of a 5 wave structure down before it completes.

I cautiously reduced 50% my call options with a bit of a loss. We are currently at point "III". The next chart shows the intra-day detail of GLD. On Friday (8/15/08) I put half of what I sold (from point II) into more call options and plan to use the remain portion to buy more calls very early Monday morning (8/17/08). The reason is the following chart:

Here I have labelled what I believe is the terminal few waves of the whole sell-off. How far down the red 5 goes I have no idea, but I think it will be sharp and very brief. The reason behind this expected move is based almost entirely upon the likelihood of spillover of broker selling to meet margin calls. Those market sell orders have probably already been placed so they should be filled during the opening sequence. I have already placed my orders to buy my remaining call options with the hopeful expectation of getting filled during this sharp down-draft. GLD closed at 77.63 -- at times like this you have to pre-calculate what you believe the option prices will be well in advance of the price move -- will Monday's sell-off drop to 76, 75, 74, or lower? Or will it rally instead? The final 5th wave of a 5th wave are notoriously difficult to guage accuarately. This is why I started buying Friday, just in case Monday unexpectedly rallies right out of the chute, or in case my pre-market buy orders do not get completely filled.

Notice on Friday's chart that the volume was unusually high while the price drop was rather contained. The range for the day was only slightly more than 1 point. This tells me that there was an unusual number of buyers offering price support and that for the rest of the day the bull/bear fight was rather subdued (as demonstrated by progressively lower volume coupled with progressively lower volatility).

One more reason for my bullishiness following the recent gold selloff is the following chart: a long term ratio of gold price divided by HUI index. I noted where each of the ratio peaks occured corresponded with very nice lows in the price of gold. HUI is the index of unhedged gold stocks. The ratio shows the ebb and flow of investor preference for stocks vs physical metal. When the ratio is high it means you can buy more HUI with each ounce of gold -- meaning investors prefer physical gold and shun gold stocks. When the ratio is low it means investors prefer gold stocks as one ounce of gold buys fewer shares of HUI.

Clicking on the chart shows the recent daily detail. Statistically speaking, last weeks selloff of gold stocks was an very rare outlayer. I think it is significant. I am aware that just because the ratio hit an extreme level does not necessarily mean the market must turn, but I guage my investments by these anomolies along with Elliott Wave, such that if the wave structure breaks down unexpectedly, I have my signal to get out early and stay out until forecastable indicators improve.

Click chart to enlarge.

The next topic I want to discuss is deflation vs inflation. As I have stated previously we are in the midst of a Kondrateiff Winter (see more discussion below). Traditionally, winter is characterized as a severe deflationary season of the full Kondrateiff long wave. I said in a previous posting that the stagflationary feel of the economy was not Winter-like, that something has to give. If you guage commodity inflation by the CRB index, then it appears that the inflationary side of the argument may be waning since the CRB is down almost 20% from the July, 2008 peak. I think over the next 2-3 months we could see a left shoulder formation in the large head-n-shoulder pattern. If Kondrateiff Winter is to take hold, then the CRB should not make new highs any time soon.

Now Ben Bernanke has made it quite clear that he has no intention of allowing the US economy to fall into a deflationary recession and certainly not a depression (apparently he carries a printing press in his back pocket to create Dollars as necessary and a helicopter on stand-by to distribute them). Please make sure you understand that Ben Bernake is a banker, he works for the banking organization called the Federal Reserve, which is a corporation of which all shareholders are banks. His primary responsibility is to his banker buddies. Any other benefit derived from Federal Reserve machinations is totally superficial and merely coincident with the intended effect of supporting the banking system. To think that the Federal Reserve changes policy to help average Americans financial goals demonstrates a severe misunderstanding. The Federal Reserve will only come to the rescue of us little guys once they are satisfied the banking system is functionally stable. Right now we are in a massive crisis situation and all Federal Reserve focus is squarely on its member banks. Even independent banks are being left out.

The Fannie/Freddie bailout is illustrative. Morgan Stanley (MS) is functionally insolvent. The Federal Reserve and US Treasury recognize that an MS failure is too similar in magnitude to Bear Stearns. All they need right now is another big-name Wall Street firm going bankrupt. The inter-connective dealing between MS and other Wall Street firms is so intertwined that failure is not an option at this time. So what does the Federal Reserve do? They take MS under their wing and give them a little job to do. MS is supposed to help oversee the finances of the Fannie/Freddie bailout... all without looking at their books. It is kind of like the mobster movies, if MS knew the details they'd have to be killed. So MS is being allowed to limp along as a gopher (go-for this, go-for that) for Bernanke and Paulson... just a little something to keep MS busy and out of trouble.

This all begs the question about what to make of the government and Federal Reserve bailouts. All I can say, is what we are witnessing is hugely inflationary, particularly if the economy tanks further and additional bailouts continue. That said... the inflationary impact of these machinations are not necessarily going to be felt today or tomorrow. The effects are more likely to be felt several years from now. It simply takes a very long time for everything to work its way through the system. Ultimately, we should see dramatic inflation -- I expect double digits. Whether it turns into hyperinflation depends upon Ben Bernanke and Hank Paulson and the extent of future bailouts.

So for right now, I think were are seeing the early stages of a blizzard brewing.

(Friday July 25, 2008 AM):

S. Florida Real Estate Update: As a CyclePro news scoop: Just south of the Trump Towers project is the construction site for the luxury Solis highrise condos. The developers have run out of money and construction has ceased. The only activity at the site this week is the presence of a lone security officer. The cranes are idle, no wet cement flowing to the upper floors, the entire building carcass is fully exposed to the elements of nature. This is not a good time for a large project like this to cease construction midway -- we are early in the hurricane season. The Solis condos were supposed to sell for $900,000 and up. The Solis was the south-most property that would have unobstructed eastern and southeastern ocean views. The parking garage floors are higher than the Tropicana condo just to its south, so that all Solis units are well above the Tropicana roof. Construction was stopped at the topmost parking floor, the first residence floor was just about to be started.

Right between the Solis and Trump Towers is the Ocean Palm Motel. It was sold last year to developers of Chi Miami who also had made plans to build an ultra-luxury highrise condo. Chi was to include Bentley shuttle service. Fortunately for them, they chose to suspend the project before demolishing Ocean Palm an starting their own construction. The Chi condos are only one unit per floor, which means 6000 square feet (4700 inside plus 1300 oceanside terrace) and each unit terrace includes its own private pool. Prices were to start at $5.2M per unit.

If the Solis developers do not find new funding soon to continue construction, the current building will be an unsightly blemish for the Sunny Isles Beach skyline. The developers will have to hope that the building does not get overgrown with mold, because if sufficiently severe, the entire project may have to be dismantled before any renewed construction can begin.

Of the 9 highrise condos currently under construction in the Sunny Isles Beach area, the Solis is the first to run out of money and halt construction. At CyclePro, I had previously predicted that at least 1/3 to 1/2 of these projects would go belly up before they finished and Solis is helping to see that prediction though.

(Saturday July 12, 2008 PM): Gold Update:

The following chart shows a technique which I use that has a fairly high success rate. The trendline off of the resistance tops of the previous 2 peaks is the same trendline that became support holding this weeks lows. The 5 waves up (so far) from June'08 lows suggests the move is impulsive while all of the downward activity since Mar'08 highs appears to be mostly corrective. Take a step back and look at a 1-2 year chart and the picture becomes more clear.

Click chart to enlarge.

I think the next significant bull wave in gold has just started and this chart breakout is a high probability confirmation.

As I see it right now, there are 3 separate Elliot Wave scenarios beginning from the Jun'08 lows.

If the recent 5 waves is really a count of 1-2-3-4 and now 5 (Scenario I) it suggests topping near 96 and a near term pullback to 900 area over the next week or two. Following that a very strong rally should commence that decisively takes out previous Mar'08 highs. Of the 3 scenarios, this is the most bullish. This also happens to be my preferred EW count.

However, if the waves up are 1-2, 1-2 and now 3 then it suggests we could rally up to near Mar'08 highs before a pullback lasting perhaps 2-4 weeks before resuming higher later. This is my secondary EW count.

The 3rd scenario is a valid EW count structure, however, I believe it is a low probability. This is a more bullish pattern than Scenario II but less than I. The thing to watch here is whether the existing rally can continue with significant strength. For example, a strong move well above 96 before a pullback of more than 1 day might raise the likelihood of scenario III while weakening Scenario I. The main difference between Scenario I & III is the timing and the price targets.

Just for the isolated impulsive move up from Jun'08 lows, Scenario I targets 110-116, Scenario III targets 105-110, Scenario II unlikely to reach 105.

             

(Saturday June 21, 2008 PM): Before reading any further, please read this article by Karl Denninger, Did Bank Of America / CFC Write The Housing Bill? (dated Saturday 6/21/2008 10:08am)

Also please read the supporting article from National Review, NRO Doc Drop: BofA-Scripted Bank Bailout Looks Awfully Similar to Dodd-Drafted Housing Bill (dated Friday 6/20/2008 11:34pm).

This sort of thing happens quite often but the ramifications are not always as big as this. I know as fact that Enron routinely provided the write-up for Congressional bills related to US energy policy, energy trading, and derivative trading. Look where that got us (and Enron)!

I know this a quite a rant, but in my opinion this one is big, real big.

Make no mistake this is a bomb, a financial bomb, and every bit as potent as any nuclear device that could physically decimate an entire city or state. This bill is a cleverly veiled attack on the financial sovereignty of the United States. As such, it should be considered a treasonable act.

Apparently Bank of America/Countrywide Financial may not only have provided the write-up for the homeowner mortgage bailout bill, but some of the Congresspersons & Senators responsible for the bills introduction may have received illegal payoffs in the form of extra-special personal mortgage terms via Countrywide. Not necessarily in that order... the story of Dodd, et al getting V.I.P. mortgage terms has been out for quite some time already.

However, now we find out within the text of this bill that BAC may have written what amounts to a PUT option with a strike price of $300 billion. If this PUT goes in-the-money, we as taxpayers get stuck paying for it.

And, if Denninger & National Review Online are correct about the bills intentionally crafted loopholes that allow other banks to write their own equivalent of PUT options means the in-the-money exposure to US taxpayers may be virtually unlimited... not $Millions, not $Billions, but $Trillions!

After reading Denninger's article and the other article links, think it over for a few hours to really let it sink in how expansive this bill could get, then pick up the phone, fax, and/or email your Congressional representatives and voice your opinion of this incredibly potent financial timebomb.

You can bet that if BAC is successful with this, the top execs will receive substantial bonuses for instrumentally helping to save BAC from ($300 Billion) insolvency. I'll be damned if I am going to sit back and let my hard-earned tax dollars go straight into their pockets.

The truth is starting to come out. Bank Of America was less interested in buying Countrywide's business than they were to buy the political influence behind Countrywide's VIP loans to key Congresspersons & Senators. BAC's $4 Billion stock buyout of Countrywide was a drop in the bucket compared to BAC's potential for $300 Billion portfolio loss.

Kill this bill!

And while you are at it phone, fax, and/or email each of the members of the Congressional & Senate Ethics Committees and tell them what you think about Dodd, et al receiving personal bribes (via special Countrywide mortgage terms) to promote this bill that may have actually been written by the persons making the bribe!

While all of this campaign to alert our Congresspersons is necessary to keep us taxpayers from being exposed to incredible losses, this is really just the first step... the ultimate goal needs to be that all persons participating in this slight of hand maneuver be charged with felonies for bribing our public officials. As for the key Congresspersons & Senators, censure & impeachment are inadequate, with the very magnitude of the financial disaster this may cause, treason is the only acceptable charge.

(Sunday June 1, 2008 AM):

The body of evidence is clearly tagging the current economic climate as "Stagflation", at least for the time being. We are in the midst of a deflationary Kondratieff Winter (see more discussion below) at the same time as significant monetary inflation pressures, predominantly from crude oil and commodity prices. Normally, stagflation is a Kondratieff Summer phenonmenon. If this is to play out as a true Winter, then I would expect the inflationary portion of the economy to taper off so the deflation/depression aspect to take full control. To be honest I have no idea which way things will go, but either way I believe gold & silver will be the least risky investment. The Gold/Silver and DJIA/Gold ratio charts continue to track my long-term outlook and are unlikely to be affected by the struggle between inflation/deflation.

I have been harping for many years about how Crude Oil is essentially a world currency in much the same way as gold is -- both are accepted without reservation anywhere in the world at spot market value. However, Crude Oil is quickly consumed where almost all of the gold ever mined in the history of man still exists. In some form, every item on the grocery store shelf requires energy to manufacture and energy to transport it. Crude Oil is the raw source for all of this energy. As the price of Crude Oil rises, all alternate sources of energy competatively rises in price: coal, nuclear, natural gas, etc.

In my part of the country diesel pump prices are now just under $5/gal and regular gasoline is hovering just above $4. To help find lower priced gasoline at stations in your area, try this link and specify your zip code. Please note that this is not a comprehensive list of gas stations, only those that report their prices to OPIS. But it does provide a good general assessment of the range of pump prices available in your area.

The following chart shows the market value of Crude Oil imports into the US from 1999 - 2008 (OPEC plus non-OPEC imports). The 2008 estimate may appear to be wacked out as an outlier, but the numbers don't lie. We are on target to pay as much in 2008 as 2005 & 2006 combined... or another angle, as much as as the 5 years 1999-2003 combined. The 2nd chart shows the details for 2008 actual and estimated values.

      

The prices for Jan-May are monthly averages while Jun-Dec are current CL futures prices. Import data source: US Census - Foreign Trade Statistics.

Just the move from 2007 to 2008, the incremental price rise of Crude Oil along with unchanging US demand and a falling US Dollar, means we are all collectively paying $166B more for oil this year than what we paid last year. That is $166B of discretionary income redirected to only energy demand. That's about $550 per US resident. At least those elegible for the Bush Economic Stimulus will be able to offset some of their increased energy costs this year. Whatever stimulus Bush was hoping to achieve was sideswiped and ended up being an energy cost rebate rather than economic stimulus. Too bad US taxpayers were the ones paying for the rebate. The stimulus checks have therefore become more of a welfare check, and alas, no benefitial stimulus effect to the economy. Chock up another failure for the Bush adminstration.

The US Department of Energy estimates that each American uses 500 gallons of gasoline per year. At todays prices, that's about $2000/yr per person. Overall the US consumes 146B gallons of gasoline per year which is currently valued at $584B.

If the median lifetime of an American car is 17 years and the average car uses 750 gallons of gasoline per year then at $4/gal a total of $51,000 is spent for fuel on each car. Regardless of how efficient a car is, it takes the energy equivalent of about 2340 gallons of gasoline to produce each new car.

Refined Crude Oil yields: 51.4% gasoline, 12.3% jet fuel, 3.3% heating oil, 28% other fuels, 2% road asphalt, 1% lubricants. One barrel contains 42 gallons (159 liters).

Locally filtered bottled water is usually vended at $1/liter which is roughly what gasoline costs at the pump. One barrel of filtered water would cost about $159, Evian would be over $300/bbl.

The US Strategic Petroleum Reserve (SPR) is currently 99% full and holds up to 570M bbl of oil. If imports were cut off, this amounts to no more than a 60 day supply. The SPR is currently valued at $72.4B.

In the Corn-Ethanol debate, year 2006 statistics show that 1.8B bushels of corn were grown to produce 4.9B gallons of ethanol. Since it takes 1/2 gallon of gasoline to produce 1 bushel of corn, then that means the US consumes 900M gallons of gasoline/year to grow the corn used to make ethanol. Approximatly 21.5 gallons of gas can be refined from 1 barrel of crude oil. 900M gallons represents approximately 42M bbl oil, and that only represents about 1% of all US oil imports.

Greenspans Evil Alchemy

In the past I periodically ripped Alan Greenspan for using the US economy as his laboratory for his financial alchemy experiments. Up until 1996 his record was not too bad, almost commendable. In December, 1996 he gave his famous "Irrational Exuberance" speech in which he recognized the stock market was overheating. However, almost immediately he changed his view and began a series of meddling that blew the stock market way beyond all sense and reasoning. In his acedemia days he routinely theorized that economic cycles could be minimized through specific interventions. He got hi